[House Hearing, 105 Congress]
[From the U.S. Government Publishing Office]
REDUCING THE TAX BURDEN
=======================================================================
HEARINGS
before the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTH CONGRESS
SECOND SESSION
__________
JANUARY 28, FEBRUARY 4 AND 12, 1998
__________
Serial 105-97
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
60-897CC WASHINGTON : 2000
COMMITTEE ON WAYS AND MEANS
BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut BARBARA B. KENNELLY, Connecticut
JIM BUNNING, Kentucky WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
JOHN ENSIGN, Nevada
JON CHRISTENSEN, Nebraska
WES WATKINS, Oklahoma
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisories announcing the hearing................................ 2
WITNESSES
Congressional Budget Office, June E. O'Neill, Director........... 202
______
American Council for Capital Formation, Mark Bloomfield.......... 264
American Family Business Institute, Harold I. Apolinsky.......... 112
American Farm Bureau Federation:
Carl B. Loop, Jr............................................. 109
Dean Kleckner................................................ 305
American Forest & Paper Association, Douglas P. Stinson.......... 125
American Institute of Certified Public Accountants:
David Lifson................................................. 69
Michael Mares................................................ 170
American Tree Farm System, Douglas P. Stinson.................... 125
Apolinsky, Harold I., American Family Business Institute, and
Small Business Council of America.............................. 112
Associated General Contractors of America, Richard Forrestel, Jr. 104
Bartlett, Bruce R., National Center for Policy Analysis.......... 75
Beach, William W., Heritage Foundation........................... 137
Blair, Robert A., S Corporation Association...................... 237
Bloomfield, Mark, American Council for Capital Formation......... 264
CATO Institute, Stephen Moore.................................... 230
Clements, Christopher and Kimberly, National Beer Wholesalers
Association, and Golden Eagle Distributors, Inc................ 98
Cold Spring Construction Company, Richard Forrestel, Jr.......... 104
Communicating for Agriculture, Wayne Nelson...................... 243
Cowlitz Ridge Tree Farm, Douglas P. Stinson...................... 125
Cox, Hon. Christopher, a Representative in Congress from the
State of California............................................ 93
Entin, Stephen J., Institute for Research on the Economics of
Taxation....................................................... 276
Feenberg, Daniel, National Bureau of Economic Research........... 65
Florida Farm Bureau Federation, Carl B. Loop, Jr................. 109
Forest Industries Council on Taxation, Douglas P. Stinson........ 125
Forrestel, Richard, Jr., Associated General Contractors of
America, and Cold Spring Construction Company.................. 104
Foster, J.D., Tax Foundation..................................... 157
Golden Eagle Distributors, Inc., Christopher and Kimberly
Clements....................................................... 98
Graetz, Michael J., Yale Law School.............................. 48
Hannay, Roger, National Association of Manufacturers, and Hannay
Reels, Inc..................................................... 134
Hartman, David A., Institute for Budget & Tax Limitation, and
Hartland Banks, N.A............................................ 309
Herger, Hon. Wally, a Representative in Congress from the State
of California.................................................. 15
Hulshof, Hon. Kenny C., a Representative in Congress from the
State of Missouri.............................................. 253
Institute for Budget & Tax Limitation, David A. Hartman.......... 309
Institute for Research on the Economics of Taxation, Stephen J.
Entin.......................................................... 276
Kelly, W. Thomas, Savers & Investors League...................... 326
Kies, Kenneth J., Price Waterhouse LLP........................... 187
Kleckner, Dean, American Farm Bureau Federation.................. 305
Kucinich, Hon. Dennis J., a Representative in Congress from the
State of Ohio.................................................. 256
Lifson, David, American Institute of Certified Public Accountants 69
Loop, Carl B., Jr., American Farm Bureau Federation, Florida Farm
Bureau Federation, and Loop's Nursery and Greenhouses, Inc..... 109
Mallory, Sharon, and Darryl Pierce, Straughn, IN................. 19
Mares, Michael, American Institute of Certified Public
Accountants.................................................... 170
McCrery, Hon. Jim, a Representative in Congress from the State of
Louisiana...................................................... 91
McIntosh, Hon. David M., a Representative in Congress from the
State of Indiana............................................... 18
Mizell, Jeannine, U.S. Chamber of Commerce, and Mizell Lumber and
Hardware Company, Inc.......................................... 128
Moore, Stephen, CATO Institute................................... 230
National Association of Manufacturers, Roger Hannay.............. 134
National Beer Wholesalers Association, Christopher and Kimberly
Clements....................................................... 98
National Bureau of Economic Research, Daniel Feenberg............ 65
National Center for Policy Analysis, Bruce R. Bartlett........... 75
National Society of Accountants, and National Tax Consultants,
Inc., William Stevenson........................................ 281
Nelson, Wayne, Communicating for Agriculture..................... 243
Regalia, Martin A., U.S. Chamber of Commerce..................... 164
Riley, Hon. Bob, a Representative in Congress from the State of
Alabama........................................................ 37
Salmon, Hon. Matt, a Representative in Congress from the State of
Arizona........................................................ 35
Savers & Investors League, W. Thomas Kelly....................... 326
S Corporation Association, Robert A. Blair....................... 237
Serotta, Abram, Serotta, Maddocks, Evans & Co.................... 215
Small Business Council of America, Harold I. Apolinsky........... 112
Stevenson, William, National Society of Accountants, and National
Tax Consultants, Inc........................................... 281
Stinson, Douglas P., American Forest & Paper Association,
American Tree Farm System, Forest Industries Council on
Taxation, Washington Farm Forestry Association, and Cowlitz
Ridge Tree Farm................................................ 125
Tax Foundation, J.D. Foster...................................... 157
Thune, Hon. John R., a Representative in Congress from the State
of South Dakota................................................ 154
U.S. Chamber of Commerce:
Jeannine Mizell.............................................. 128
Martin A. Regalia............................................ 164
Washington Farm Forestry Association, Douglas P. Stinson......... 125
Weller, Hon. Jerry, a Representative in Congress from the State
of Illinois.................................................... 12
SUBMISSIONS FOR THE RECORD
American Bar Association, Section of Taxation, statement......... 338
American Trucking Associations, Inc., Robert C. Pitcher,
Alexandria, VA, statement...................................... 344
Bond Market Association, statement............................... 346
Distribution & LTL Carriers Association, Alexandria, VA, Kevin M.
Williams, statement............................................ 348
Institute for Research on the Economics of Taxation, Michael
Schuyler, statement and attachments............................ 350
Johnson, Calvin H., University of Texas at Austin, School of Law,
letter and attachments......................................... 365
Kennelly, Hon. Barbara B., a Representative in Congress from the
State of Connecticut........................................... 9
Kleczka, Hon. Gerald D., a Representative in Congress from the
State of Wisconsin............................................. 11
National Air Transportation Association, Alexandria, VA,
statement...................................................... 375
National Cattlemen's Beef Association, Clark S. Willingham,
statement...................................................... 376
North Dakota Public Service Commission, Bruce Hagen, statement... 377
White House Conference on Small Business, statement.............. 378
REDUCING THE TAX BURDEN
----------
WEDNESDAY, JANUARY 28, 1998
House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to notice, at 11:35 a.m., in
room 1100, Longworth House Office Building, Hon. Bill Archer
(Chairman of the Committee) presiding.
[The advisories announcing the hearings follow:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
January 21, 1998
No. FC-10
Archer Announces Hearing Series on
Reducing the Tax Burden
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing
series on proposals to reduce the Federal tax burden on the American
public. The hearing will begin on Wednesday, January 28, and be
continued on Wednesday, February 4, and Thursday, February 12, 1998, in
the main Committee hearing room, 1100 Longworth House Office Building,
beginning at 10:00 a.m. each day. The first hearing day will address
proposals intended to correct perceived unfairness in the tax code,
focusing on the ``marriage tax penalty,'' and the estate and gift tax
(or ``death tax'').
Oral testimony for January 28th will be from invited witnesses
only. Both invited and public witnesses will have the opportunity to
testify on Feb 4th and 12th. Any individual or organization not
scheduled for an oral appearance may submit a written statement for
consideration by the Committee or for inclusion in the printed record
of the hearing.
BACKGROUND:
The Federal tax burden, as a percentage of Gross Domestic Product,
has been rising in recent years. It is currently 19.9 percent, a height
not reached since World War II. The annual Federal budget deficit has
declined greatly over the past several years, and current projections
show years of budget surpluses. The rising tax burden and improved
fiscal outlook have elicited various tax reduction proposals. This
hearing series is designed to explore some of these proposals.
In announcing the hearing, Chairman Archer stated: ``If the
politicians in Washington exercise restraint, we soon may find
ourselves in a post-deficit era, where our greatest challenges will be
social and moral, not economic. I believe the era we're entering will
test how big a government the people want, or whether they want a
smaller, less taxing government that enhances individual power,
freedom, and opportunity, strengthening our moral fabric, freeing
families to provide more for themselves, their neighbors and their
communities. We must care for each other more, and tax each other
less.''
FOCUS OF THE HEARING:
The first hearing day will address proposals intended to rectify
perceived unfair provisions in the tax code. It will focus on the
``marriage tax penalty'' and the estate and gift tax (or ``death
tax''). The second day (February 4th) will consider tax rates: What are
they and what should they be? That session also will address
alternative minimum tax relief for individuals, proposals to reduce
Federal income or payroll taxes, and provisions in the tax code that
operate as ``hidden rates'' and which cause effective tax rates to
exceed statutory rates. The third day (February 12th) will review new
savings incentives and likely will address modifications to the new
capital gains law, such as eliminating the 18-month holding period for
the new 10 and 20 percent capital gain rates, and proposals to provide
an exclusion for interest and dividend income. The hearing may be
continued on additional days on other tax reduction topics.
DETAILS FOR SUBMISSIONS OF REQUESTS TO BE HEARD:
Requests to be heard on February 4th and February 12th must be made
by telephone to Traci Altman or Bradley Schreiber at (202) 225-1721 no
later than the close of business, Thursday, January 29, 1998. The
telephone request should be followed by a formal written request to
A.L. Singleton, Chief of Staff, Committee on Ways and Means, U.S. House
of Representatives, 1102 Longworth House Office Building, Washington,
D.C. 20515. The staff of the Committee will notify by telephone those
scheduled to appear as soon as possible after the filing deadline. Any
questions concerning a scheduled appearance should be directed to the
Committee staff at (202) 225-1721.
In view of the limited time available to hear witnesses, the
Committee may not be able to accommodate all requests to be heard.
Those persons and organizations not scheduled for an oral appearance
are encouraged to submit written statements for the record of the
hearing. All persons requesting to be heard, whether or not they are
scheduled for oral testimony, will be notified as soon as possible
after the filing deadline.
Witnesses scheduled to present oral testimony are required to
summarize briefly their written statements in no more than five
minutes. THE FIVE-MINUTE RULE WILL BE STRICTLY ENFORCED. The full
written statement of each witness will be included in the printed
record, in accordance with House Rules.
In order to assure the most productive use of the limited amount of
time available to question witnesses, all witnesses scheduled to appear
before the Committee are required to submit 300 copies of their
prepared statement and an IBM compatible 3.5-inch diskette in ASCII DOS
Text or WordPerfect 5.1 format, for review by Members prior to the
hearing. Testimony should arrive at the Committee office, room 1102
Longworth House Office Building, 48 hours prior to each hearing day (no
later than 10:00 a.m.).
WRITTEN STATEMENTS IN LIEU OF PERSONAL APPEARANCE:
Any person or organization wishing to submit a written statement
for the printed record of the hearing should submit at least six (6)
single-space legal-size copies of their statement, along with an IBM
compatible 3.5-inch diskette in ASCII DOS Text or WordPerfect 5.1
format only, with their name, address, and hearing date noted on a
label, by the close of business, Wednesday, March 11, 1998, to A.L.
Singleton, Chief of Staff, Committee on Ways and Means, U.S. House of
Representatives, 1102 Longworth House Office Building, Washington, D.C.
20515. If those filing written statements wish to have their statements
distributed to the press and interested public at the hearing, they may
deliver 200 additional copies for this purpose to the Committee office,
room 1102 Longworth House Office Building, at least one hour before the
hearing begins.
FORMATTING REQUIREMENTS:
Each statement presented for printing to the Committee by a
witness, any written statement or exhibit submitted for the printed
record or any written comments in response to a request for written
comments must conform to the guidelines listed below. Any statement or
exhibit not in compliance with these guidelines will not be printed,
but will be maintained in the Committee files for review and use by the
Committee.
1. All statements and any accompanying exhibits for printing must
be typed in single space on legal-size paper and may not exceed a total
of 10 pages including attachments. At the same time written statements
are submitted to the Committee, witnesses are now requested to submit
their statements on an IBM compatible 3.5-inch diskette in ASCII DOS
Text or WordPerfect 5.1 format. Witnesses are advised that the
Committee will rely on electronic submissions for printing the official
hearing record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. A witness appearing at a public hearing, or submitting a
statement for the record of a public hearing, or submitting written
comments in response to a published request for comments by the
Committee, must include on his statement or submission a list of all
clients, persons, or organizations on whose behalf the witness appears.
4. A supplemental sheet must accompany each statement listing the
name, full address, a telephone number where the witness or the
designated representative may be reached and a topical outline or
summary of the comments and recommendations in the full statement. This
supplemental sheet will not be included in the printed record.
The above restrictions and limitations apply only to material being
submitted for printing. Statements and exhibits or supplementary
material submitted solely for distribution to the Members, the press
and the public during the course of a public hearing may be submitted
in other forms.
Note: All Committee advisories and news releases are available on
the World Wide Web at `HTTP://WWW.HOUSE.GOV/WAYS__MEANS/'.
The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
business days notice is requested). Questions with regard to special
accommodation needs in general (including availability of Committee
materials in alternative formats) may be directed to the Committee as
noted above.
***NOTICE--CHANGE IN TIME***
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
January 23, 1998
No. FC-10-Revised
Time Change for Full Committee Hearing on
Wednesday, January 28, 1998,
on Reducing the Tax Burden
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the full Committee hearing on reducing
the tax burden, previously scheduled for Wednesday, January 28, 1998,
at 10:00 a.m., in the main Committee hearing room, 1100 Longworth House
Office Building, will begin instead at 11:30 a.m.
All other details for the hearing remain the same. (See full
Committee press release No. FC-10, dated January 21, 1998.)
Chairman Archer. The Committee will come to order. I would
like our guests and staff to take seats as quickly as possible
so that we can commence.
Today is the first in a series of hearings to examine
proposals to reduce the tax burden on individuals while
correcting perceived unfairness in the Tax Code. This will
probably be a neverending task as long as we have the income
tax, but we must proceed to do the best that we can.
The tax burden on the American people is the highest in our
Nation's peacetime history. The social and moral consequences
of high taxation on America's families are devastating.
Families are struggling today because the government is taking
their money before they have a chance to invest it in
themselves, their children, and their communities. It's money
that is denied to workers, diminishing their ability to pay for
their own childcare needs, healthcare needs, or to prepare for
their retirement years in comfort and security. American
workers are caught in a tax trap. The harder they work, the
longer they work, the more they pay.
Can the people in the back of the room hear me? This is
very important. I want everyone to be able to hear.
Mr. McDermott. There's nothing wrong with the speakers down
here.
Chairman Archer. I can hear you very well.
Be sure that the PA system works the same for Charlie
Rangel when it's his turn. [Laughter.]
American workers are truly caught in a tax trap today in
the United States because the longer they work, the harder they
work, the more they pay. That is wrong. It shouldn't be that
way. I personally believe that we must care for each other more
and tax each other less. That is why, to strengthen families
and children while protecting against big government, we must
reduce the debt and the record high tax burden on the American
people. We must remember that when we pay down the debt, that
helps preserve Social Security without forcing Americans to pay
record high taxes.
There is room both to save Social Security and to protect
Americans from high taxes. Yes, Congress must shore up Social
Security, and we will do so. But we must also look at the ways
our existing Tax Code unfairly prevents individuals from saving
more of their income to reach their retirement goals. If we
agree to the President's request to maintain the high tax
status quo, we will perpetuate a marriage penalty on 21 million
couples. We will force more than 25 million Americans, many of
whom make as little as $26,000 a year, into higher tax
brackets.
The first focus of this morning's hearing will be the
marriage tax penalty. Based on a recent CBO study, matrimony
translates into an average of $1,400 in additional taxes for
some 42 percent of American couples. The marriage tax penalty
is a well-known topic on Capitol Hill. As many will recall, the
Contract With America and the Balanced Budget Act of 1995
contained provisions to lessen the tax bite on working married
couples. This relief suffered under the veto pen of the
President, so it is important that we turn our attention once
again to what 21 million married couples perceive as unfair. I
am pleased that we are joined this morning by Sharon Mallory
and Darryl Pierce of Indiana, who will share with the Committee
their personal experience with the marriage penalty.
Today's hearing will also focus on the death tax, which
with its estate, gift, and generation-skipping components, can
cause the tax collector to compound the tragedy of a family
death by taking over half of the deceased person's lifetime
savings. I must add, that's only the beginning. As you get into
the later years of your life, if you continue to produce and to
earn more, you will have up to 44 percent in income tax taken
out of your earnings. The remaining amount will be taxed at 55
percent, so that your heirs, your children, will receive only
25 percent of what you have worked very hard in your later
years to be able to accomplish. The death tax forces the sale
or reorganization of family-owned businesses and it costs jobs.
It creates development pressure on farm and ranch land, and
contributes to the loss of open space.
Last year we were able to take a first step to providing
relief from the death tax. We convinced the Clinton
administration to support death tax relief after they initially
accused those who sought such reductions as being ``selfish.''
As I said earlier, taxes are at a record high level. I hope
no one will defend the high tax status quo. The purpose of
these hearings is to listen to various tax relief proposals so
the Committee can determine which taxes should be reduced. I
intend to be conservative in my approach. I will resist the
temptation to over promise. We are still within the constraints
of reducing the deficit and keeping a balanced budget. Yes,
there is room to pay down the debt and to cut taxes. But no, we
must never let the budget be tipped out of balance again.
Before we begin, I would like to recognize Mr. Rangel for
any comments that he might like to make.
Mr. Rangel. That's very kind of you, Mr. Chairman. Welcome
back. As the Committee starts to work, I think the better we
can understand the agenda, the more closely we can work
together as Democrats and Republicans. I gather from what I
have heard over the airwaves and read in the paper that your
top priority is going to be rooting up or pulling out the IRS
and bringing a flat tax, consumption tax or some kind of tax
that would be even-handed across the board. If that is your
priority, since I have been waiting for it for 3 years, do you
have any idea whether we might get a chance to vote for that in
this Committee? I hate to be against something when I haven't
the slightest idea what it's going to be. Will we have a chance
to vote on any of these simplified taxes this year?
Chairman Archer. We would be happy to have the outward
expressed support, Mr. Rangel, of you and the Minority on the
Committee. I am sure we could move the bill rather rapidly when
that occurs. The President has not seen fit to make any
proposal for structural tax reform. So perhaps it will be left
up totally to the Congress. It needs to be bipartisan. It can
not be driven just by one party. It's too important to the
lives of all the people in this country.
Mr. Rangel. But it's hard to know which idea we're
supporting. There are so many different ideas. You have some
and Mr. Armey has some. They were all in the closet. So if
someone could get organized and bring something to us, then we
can see whether or not the bill with its simplification and its
cost would warrant us joining together to pass it. So would
that be done this year or are we just going to just air it out
and let people be educated about the possibility of changing
the system?
Chairman Archer. I think it's very hard to predict what we
will do in that regard this year. I do know that we will
continue to have hearings on this issue, where all Members will
be able to become better versed on the various reform plans and
be able to crystallize their own opinion as to what vehicle
they believe is the best. But at this point, I cannot
anticipate whether we will have a markup of a bill. But I can
anticipate this: we will have a tax relief bill within the
current income tax of some kind this year.
Mr. Rangel. I think then my Democratic colleagues on the
Committee won't have to worry about the flat tax this year. We
can concentrate on some of the ideas that the President has.
You might have noticed, Mr. Chairman, that the President had
any number of ideas that fell within the jurisdiction of this
Committee. Certainly Social Security, low-income housing
credits, expansion of Medicare, educational zones, childcare,
school construction, and the African trade bill. My God, it
looked like a program just designed for us.
Now I share your concern about the marriage tax penalty and
the death taxes and the other reduction in taxes that you have,
but so that we might be able to plan and work more closely
together, could you give me any idea of when you intend to see
whether or not the President's agenda would be able to get on
the Ways and Means calendar?
Chairman Archer. As we move through the various items that
are before the Committee, particularly with each individual
Subcommittee, there will be plenty of opportunity to flush out
all proposals and consider all options this year.
Mr. Rangel. Welcome back, Mr. Chairman. I'm glad I won't
have much time to deal with the flat tax, but there's so many
other things that we could work on, I look forward to working
with you.
Chairman Archer. You are most welcome, Mr. Rangel. Should
you wish to submit any proposal on your own as to what is the
appropriate way to restructure the income tax, we would be
pleased to have that in the hopper too.
Mr. McDermott. Mr. Chairman.
Chairman Archer. Yes.
Mr. McDermott.
Mr. McDermott. Mr. Chairman, I would like to ask unanimous
consent to enter my statement in the record. I offered to
eliminate the marriage tax penalty last year. I want the record
to show that all the Republicans voted against my repeal
proposal last year which was the same as your 1995 tax
proposal. So it will be interesting to hear the rhetoric today
about this whole issue as we come back to it.
Chairman Archer. Without objection, all Members will be
able to insert any written statement into the record at this
point.
[The opening statements follow:]
Opening Statement of Hon. Jim McDermott, a Representative in Congress
from the State of Washington
I applaud the Chairman for choosing to hold a hearing on
the problem of the marriage penalty. This is an issue which I
tried to address during last year's Balanced Budget debate.
The proposal I offered last year, which I would like to
mention today, would have eliminated the marriage penalty for
many taxpayers by adjusting the standard deduction. It was not
a new idea. The proposal I advocate was included in the 1995
Budget Conference report passed by Congress. To be fair, you
could characterize this as a bipartisan fix to the marriage
penalty.
The marriage penalty fix I support simply would increase
the standard deduction for joint filers so that it equals twice
that of single filers. The standard deduction in tax year 1997
is $6,900 for joint returns and $4,150 for single returns. Two
singles get a combined standard deduction of $8,300 compared to
$6,900 for a couple--thus penalizing the couple for getting
married. In my view, increasing the standard deduction for
joint filers is the simplest, fairest, easiest, and most
fiscally responsible way in which to address the structural
marriage tax penalties within the code.
As you can see from the attached charts to be inserted into
the record, the fix I proposed last Congress would have
eliminated virtually all marriage penalties, and, it even
provides a modest bonus for one-earner families.
The McDermott plan is progressive: Since most high-income
taxpayers do not use the standard deduction, the Congressional
Budget Office (CBO) has found that only 36% of the benefits
from this type of change goes to taxpayers earning $50,000 or
more--meaning--64% of the benefits go to couples earning less
than $50,000/year. CBO found that other leading repeal
proposals direct at least 65% of the benefits to those
taxpayers earning more than $50,000/year.
The McDermott plan is comparatively affordable: CBO
estimates that increasing the standard deduction for joint
filers costs roughly $4 billion/year. Estimates prepared by the
Joint Committee on Taxation verify this finding. Meanwhile, CBO
found other leading repeal proposals cost as much as $29
billion/year.
The McDermott plan is family friendly: In addition to
eliminating the marriage penalty, the standard deduction fix
slightly increases the marriage bonus (see charts)--making it
more affordable for the spouses of single earners who prefer to
have a parent stay at home to care for their child or children.
This bonus provides a small incentive without creating a new
program and is not excessive so that it overly penalizes
individuals for being unmarried.
The McDermott plan is simple compared to the problems
raised by other repeal proposals which will force taxpayers to
do their taxes twice in order to figure out which is the best
choice for their family.
In 1997, repeal of the marriage penalty was pushed aside by
the Republican Majority. Inexplicably, in the W&M Committee,
where roughly 20 members signed the Contract with America, my
amendment failed. Most likely, the Majority preferred cutting
taxes for corporations (not mentioned in their contract). In my
view, a tactical decision was made that it was more important
to provide tax cuts preferred by the business community (such
as reducing the corporate AMT and corporate capital gains tax
cuts) than it was to address the marriage penalty.
In fact, no legislation was introduced during the 105th
Congress to repeal the marriage penalty until after the budget
agreement passed Congress last August.
Now that repeal of the marriage penalty is finally being
addressed and if it sincerely is a priority of this Congress, I
would urge my colleagues to take a second look at my proposal
before they rush to advocate an alternative.
Structural Marriage Tax Penalties and Bonuses in 1997 Dollar and Percentage Amounts by which Joint Income Tax
Liabilities Exceed those of Two Singles (Marriage Tax Bonus Shown in Parenthesis)
----------------------------------------------------------------------------------------------------------------
Income Levels Joint Income
($000s) Tax Liability 50/50 60/40 70/30 100/0
----------------------------------------------------------------------------------------------------------------
$20 $1,170 $210 22% $345 42% $378 48% ($810) (41%)
$25 $1,920 $210 12% $210 12% $384 25% ($810) (30%)
$30 $2,670 $210 9% $210 9% $269 11% ($810) (23%)
$35 $3,420 $210 7% $210 7% $210 7% ($1,272) (27%)
$40 $4,170 $210 5% $210 5% $210 5% ($1,922) (32%)
$50 $5,670 $210 4% $210 4% (252) (4%) ($3,222) (36%)
$60 $8,028 $1,068 15% $1,476 6% (304) (4%) ($3,664) (31%)
$75 $12,228 $1,444 13% $1,256 11% $281 2% ($3,918) (24%)
$100 $19,228 $1,444 8% $1,444 8% $1,152 6% ($4,668) (19%)
----------------------------------------------------------------------------------------------------------------
Source: CRS
McDermott Amendment Changes the Structural Marriage Tax Penalties and Bonuses: Dollar and Percentage Amounts by
which Joint Income Tax Liabilities Exceed those of Two Singles (Marriage Tax Bonus Shown in Parenthesis)
----------------------------------------------------------------------------------------------------------------
Income Levels Joint Income
($000s) Tax Liability 50/50 60/40 70/30 100/0
----------------------------------------------------------------------------------------------------------------
$20 $960 $0 -- $135 16% $108 13% ($1,020) (52%)
$25 $1,710 $0 -- $0 -- $174 11% ($1,020) (37%)
$30 $2,460 $0 -- $0 -- $59 2% ($1,020) (29%)
$35 $3,210 $0 -- $0 -- $0 -- ($1,482) (32%)
$40 $3,960 $0 -- $0 -- $0 -- ($2,132) (35%)
$50 $5,460 $0 -- $0 -- ($462) (8%) ($3,432) (39%)
$60 $7,636 $676 10% $84 1% ($696) (8%) ($4,058) (35%)
$75 $11,836 $1,052 10% $864 8% ($111) (1%) ($4,310) (27%)
$100 $18,836 $1,052 6% $1,052 6% $760 4% ($5,060) (21%)
----------------------------------------------------------------------------------------------------------------
Source: CRS
Statement of Hon. Barbara B. Kennelly, a Representative in Congress
from the State of Connecticut
Thank you, Mr. Chairman, for the opportunity to testify
here today. As you well know, I have worked on the marriage
penalty for many years. In fact, CBO recently completed an
excellent report on the topic for me. For those of you who may
not have seen it, it is entitled ``For Better or for Worse:
Marriage and the Federal Income Tax.'' I commend it to your
attention. Copies are available by calling CBO or my office.
First, let me briefly summarize the problem. According to
CBO, based on sheer numbers of returns, an estimated 42% of
couples incurred marriage penalties in 1996, 51% received
bonuses, and 6% paid taxes unaffected by their marital status.
That distribution varies markedly across the income
distribution. Only 12% of couples with incomes below $20,000
sustained penalties and 63% received bonuses. Couples with
incomes between $20,000 and $50,000 were somewhat more likely
to receive bonuses than to incur penalties, whereas couples
with incomes above $50,000 were somewhat more likely to incur
penalties than to receive bonuses. Couples with just one earner
never incur a marriage penalty and receive a bonus at all but
the lowest income levels.
Three factors have the greatest influence on whether a
couple bears a marriage penalty or receives a marriage bonus:
the couple's total income, the division of the income between
husband and wife, and the presence and number of children that
determine the filing status of unmarried individuals and
qualify taxpayers for the EITC and personal exemption.
The largest bonuses, measured as a percentage of income,
occur in two cases. First, two-earner couples with one child
and very low incomes split equally between spouses receive a
larger EITC as the credit phases in and thus receive a bonus of
up to 13% of their income. Second, low-income single-earner
couples in which each spouse has one child, and for whom
combining children into one tax unit increases the size of the
EITC, receive bonuses of up to 11% of income. The largest
bonuses in dollar terms--more than $5,600--go to childless one-
earner couples with incomes between $180,000 and $190,000.
The largest penalties, measured as a percentage of income,
are greatest for low-income couples who have several children
and an equal division of income between spouses; the loss of
EITC on joint returns can cost such families up to 18% of
income. In dollar terms, the penalty resulting from difference
in tax brackets, limitations on itemized deductions, and the
phaseout of personal exemptions combine to impose the maximum
penalty--more than $21, 599--on couples whose income is equally
divided between spouses and whose taxable income exceeds
$527,500.
Although the prevalence of marriage penalties and bonuses
indicates that the tax code fails to provide marriage
neutrality, it more successful in achieving equal treatment of
married couples with similar incomes. If couples were required
to file individual tax returns, those with one earner would
face substantially higher tax rates than those with two earners
who have roughly equal incomes. Because the tax code generally
requires couples to file jointly, those with different
divisions of earnings between spouses incur more nearly equal
tax rates. Marriage penalties and bonuses arise from this
equalization of tax rates for couples with different divisions
of earnings.
Marriage penalties and bonuses are not deliberately
intended to reward or punish marriage. Rather, they are the
result of a delicate balance of disparate goals of the federal
income tax system. The principal goals are equal treatment of
married couples, marriage neutrality and progressive taxation
and they are in fundamental conflict.
Nonetheless, as two-earner couples become more prevalent,
more and more Americans will incur marriage penalties. For this
reason, I think it is important that we move to provide more
equitable treatment for these working couples, consistent of
course, with our other goals.
Therefore, I am pleased to be here today with my friend and
colleague, Representative Herger and support H.R. 2593. This
bill would simply restore the pre-1986 law--the two-earner
deduction. It would allow couples a 10% deduction for up to
$30,000 of the lower-earning spouse's income. I offered a
version of this as an amendment in Committee during the markup
of the Republican Contract with America. I think it is a
reasonable solution to a very difficult problem and would urge
my colleagues to support H.R. 2593.
Thank you.
[GRAPHIC] [TIFF OMITTED] T0897.001
Chairman Archer. We are fortunate to have with us today
Members of our own body, Mr. Weller, Mr. McIntosh, and Mr.
Herger. We are happy to have you here. We would be pleased to
hear your testimony. I have already spoken about Sharon Mallory
and Darryl Pierce, who are coming with Congressman McIntosh.
You might wish to further introduce them. We'll be pleased
to receive their testimony.
But first, Mr. Weller, we would be happy to have your
testimony.
STATEMENT OF HON. JERRY WELLER, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF ILLINOIS
Mr. Weller. Thank you, Mr. Chairman. First, I want to
commend you and this Committee for conducting these hearings on
inequities in the Tax Code, and thank you for inviting our
colleagues to testify on clearly what is arguably our Tax
Code's most unfair provision, the marriage tax penalty. I know
from my conversations with you, Mr. Chairman, this has been an
area of great concern to you over the years. I really
appreciate your leadership in working on this issue.
Last night, President Clinton gave his State of the Union
address outlining many of the things he wants to do with the
budget surplus. The surplus provided by the bipartisan budget
agreement which cut waste, put America's fiscal house in order,
and held Washington's feet to the fire to balance the budget
for the first time in 28 years. While President Clinton paraded
a long list of new spending items totalling at least $46 to $48
billion in 30 new programs and proposals, we believe that a top
priority should be returning the budget surplus to America's
families as additional middle-class tax relief. This Congress
has given more tax relief to the middle class and the working
poor than any Congress in the last half century.
I think the issue of the marriage tax penalty can best be
framed by asking these questions. Do Americans feel it's fair
that our Tax Code imposes a higher tax penalty on marriage? Do
Americans feel it's fair that the average married working
couple pays almost $1,400 more in taxes than a couple with
almost identical income living together outside of marriage? Is
it right that our Tax Code provides an incentive to get
divorced? In fact, today the only form one can file to avoid
the marriage tax penalty is paperwork for divorce. That's just
wrong.
Since 1969, our tax laws have punished married couples when
both spouses work. For no other reason than the decision to be
joined in holy matrimony, more than 21 million couples a year
are penalized. They pay more in taxes than they would if they
were single. Not only is the marriage tax penalty unfair, it's
wrong that our Tax Code punishes society's most basic
institution. The marriage tax penalty exacts a disproportionate
toll on working women and low-income couples with children. In
many cases, it's a working woman's issue.
Let me give you an example, and there's a chart to my
right, an example of how the marriage tax penalty unfairly
affects middle-class, married, working couples. For example, in
my district, I'll use an example of a machinist at the local
Caterpillar manufacturing plant in Joliet, who makes $30,500 a
year in salary. His wife is a tenured elementary schoolteacher,
also bringing home an identical income of $30,500 a year in
salary. If they both filed their taxes as singles, after
standard deductions and exemptions, as individuals they would
pay in the 15 percent tax bracket. But if they choose to live
their lives in holy matrimony and now file jointly, their
combined income is $61,000, and pushes them into a higher tax
bracket of 28 percent, producing a marriage tax penalty of
$1,400 in higher taxes.
On average, America's married working couples pay $1,400
more a year in taxes than individuals with the same incomes.
That's serious money. Every day we get closer to April 15, more
married, working couples will be realizing that they are
suffering the marriage tax penalty, and will be looking to us
to do something about it. Why? Because if you think of it in
terms that mean something to the folks back home, $1,400 is a
downpayment on a house, several months worth of car payments, 1
year's tuition at a local community college, or several months
worth of quality childcare at a local daycare center.
To that end, Congressman David McIntosh and I have authored
the Marriage Tax Elimination Act. It would allow married
couples a choice in filing their income taxes, either jointly
or as individuals, whichever way lets them keep more of their
money. Our bill already has the bipartisan cosponsorship of 232
Members of the House, and a similar bill in the Senate also
enjoys widespread support.
It isn't enough for President Clinton to suggest tax breaks
for childcare. The President's childcare proposal would help a
working couple afford on average 3 weeks of daycare.
Elimination of the marriage tax penalty would give the same
couple the choice of paying for 3 months of childcare or
addressing other family priorities. After all, parents know
best, in fact better than Washington what their family needs.
We fondly remember the 1996 State of the Union address when
the President declared emphatically that ``the era of big
government is over.'' We must stick to our guns and stay the
course. There never was an American appetite for big
government, but there certainly is for reforming the way the
existing way government does business. What better way to show
the American people that our government will continue along the
path to reform prosperity than by eliminating the marriage tax
penalty.
Ladies and gentlemen, we are on the verge of running a
surplus. It's basic math. It means Americans are already paying
more than is needed for government to do the job we expect of
it. What better way to give back than to give mom and dad and
the American family, the backbone of our society, what they
have earned. We ask President Clinton to join with Congress and
make elimination of the marriage tax penalty a bipartisan
priority.
Of all the challenges facing married couples today in
providing home and hearth for America's children, the U.S. Tax
Code should not be one of them. Let's eliminate the marriage
tax penalty, and do it now.
Again, thank you, Mr. Chairman.
[The prepared statement follows:]
Statement of Hon. Jerry Weller, a Representative in Congress from the
State of Illinois
Mr. Chairman:
I want to commend you for holding these hearings on
inequities in the tax code and thank you for inviting my
colleagues and I to testify on what is arguably the most
immoral provision in our tax code...the marriage tax penalty
Last night, President Clinton gave his State of the Union
Address outlining many of the things he wants to do with the
budget surplus.
A surplus provided by the bipartisan budget agreement
which:
cut waste,
put America's fiscal house in order, and
held Washington's feet to the fire to balance the
budget.
While President Clinton paraded a long list of new spending
proposals--without mentioning the accompanying increase in
bureaucracy and red tape--we believe that a top priority should
be returning the budget surplus to America's families as
additional middle-class tax relief.
This Congress has given more tax relief to the middle class
and working poor than any Congress of the last half century.
I think the issue of the marriage tax penalty can best be
framed by asking these questions: Do Americans feel its fair
that our tax code imposes a higher tax penalty on marriage? Do
Americans feel its fair that the average married working couple
pays almost $1,400 more in taxes than a couple with almost
identical income living together outside of marriage--is it
right that our tax code provides an incentive to get divorced?
In fact, today the only form one can file to avoid the
marriage tax penalty is paperwork for divorce.
Since 1969, our tax laws have punished married couples when
both spouses work. For no other reason than the decision to be
joined in holy matrimony, more than 21 million couples a year
are penalized. They pay more in taxes than they would if they
were single. Not only is the marriage penalty unfair, it's
immoral that our tax code punishes society's most basic
institution. The marriage tax penalty exacts a disproportionate
toll on working women and lower income couples with children.
Let me give you an example of how the marriage tax penalty
unfairly affects middle class married working couples.
For example, a machinist, at a Caterpillar manufacturing
plant in my home district of Joliet, makes $30,500 a year in
salary. His wife is a tenured elementary school teacher, also
bringing home $30,500 a year in salary. If they would both file
their taxes as singles, as individuals, they would pay 15%.
But if they chose to live their lives in holy matrimony,
and now file jointly, their combined income of $61,000 pushes
them into a higher tax bracket of 28 percent, producing a tax
penalty of $1400 in higher taxes.
On average, America's married working couples pay $1,400
more a year in taxes than individuals with the same incomes.
That's serious money.
Particularly if you think of it in terms of:
a down payment on a house or a car,
one years tuition at a local community college, or
several months worth of quality child care at a
local day care center.
To that end, Congressman David McIntosh and I have authored
the Marriage Tax Elimination Act.
It would allow married couples a choice in filing their
income taxes, either jointly or as individuals--which ever way
lets them keep more of their own money.
Our bill already has the support of 232 Members of the
House and a similar bill in the Senate also enjoys widespread
support.
It isn't enough for President Clinton to suggest tax breaks
for child care. The President's child care proposal would help
a working couple afford, on average, three to four weeks of day
care. Elimination of the marriage tax penalty would give the
same couple the choice of paying for three to four months of
child care--or addressing other family priorities. After all,
parents know better than Washington what their family needs.
We fondly remember the 1996 State of the Union address when
the President declared emphatically that, quote ``the era of
big government is over.''
We must stick to our guns, and stay the course.
There never was an American appetite for big government.
But there certainly is for reforming the existing way
government does business.
And what better way to show the American people that our
government will continue along the path to reform and
prosperity than by eliminating the marriage tax penalty.
Ladies and Gentleman, we are on the verge of running a
surplus. It's basic math.
It means Americans are already paying more than is needed
for government to do the job we expect of it.
What better way to give back than to begin with mom and dad
and the American family--the backbone of our society.
We ask that President Clinton join with Congress and make
elimination of the marriage tax penalty... a bipartisan
priority.
Of all the challenges married couples face in providing
home and hearth to America's children, the U.S. tax code should
not be one of them.
Lets eliminate The Marriage Tax Penalty and do it now!
Thank you, Mr. Chairman.
Chairman Archer. Thank you, Congressman Weller. Now,
Congressman Wally Herger.
STATEMENT OF HON. WALLY HERGER, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF CALIFORNIA
Mr. Herger. Thank you, Mr. Chairman and Members of the
Committee for the opportunity to testify today about a serious
inequity in the Tax Code. When a couple stands at the altar and
says ``I do,'' they are not agreeing to higher taxes. Yet under
our current tax law, that is precisely what is happening to
millions of married couples each year. According to a recent
report by the Congressional Budget Office, an estimated 42
percent of all married couples, some 21 million couples
nationwide, incurred marriage penalties in 1996. The average
marriage penalty that year approached an astonishing $1,400. I
believe that addressing this inequity in our tax law should be
a top priority for this Committee as we work to provide the
American people further tax relief in 1998.
Mr. Chairman, as financial pressures push more and more
nonworking spouses into the labor force, an increasing number
of families will fall prey to this marriage tax. A major reason
why so many of these joint filers face this added tax burden is
that the very first dollar earned by the low-earning spouse is
taxed at the marginal rate of the high-earning spouse, not
necessarily at the lower 15-percent rate faced by single
filers. This problem was exacerbated in 1993 when the number of
tax brackets was increased from three to five. That change
created even more opportunities for dual-income, married
couples to be bumped into higher brackets, and to face even
larger marriage penalties.
To address this problem, I have introduced legislation
along with Mrs. Kennelly to restore the two-earner deduction.
As many of you may remember, between 1982 and 1986, dual-income
couples were entitled to a significant tax benefit to help
offset the marriage penalties built into the Internal Revenue
Code. The two-earner deduction, once fully phased in, entitled
married couples to a 10-percent deduction on up to $30,000 of
the low-earning spouse's income. However, for a variety of
reasons, Congress eliminated this tax benefit in 1986. My bill,
H.R. 2593, the Marriage Penalty Relief Act, would simply
restore the two-earner deduction. I am pleased to report that
this legislation has attracted a broad bipartisan group of 155
cosponsors in the House so far, including 35 Democrats. I am
particularly gratified that 27 Members of this Committee, 21
Republicans and 6 Democrats, have thus far signed onto this
legislation.
I should make it clear for the record, Mr. Chairman, that I
strongly support a complete elimination of the marriage
penalty. I am an original cosponsor to the bill introduced by
Mr. Weller and Mr. McIntosh. I am encouraged to learn that the
Congressional Budget Office is now projecting a $660 billion
surplus over the next 10 years. I sincerely hope that this
fiscal dividend can be used in part to ensure that our Tax Code
no longer punishes married couples. However, I also recognize
that Members of this body and of this Committee have a variety
of ideas about where to dedicate this projected surplus. If
budgetary and political conditions prevent us from completely
eliminating the marriage penalty in this year's tax bill, I
would certainly hope that we can at least take a significant
step toward achieving that objective.
Mr. Chairman, restoring the two-earner deduction would
enable us to make meaningful progress toward that goal in a way
that provides targeted relief to those couples who are
particularly hard hit by this inequity. When a couple stands at
the altar and says ``I do,'' they are not agreeing to higher
taxes. Congress should act this year to address the fact that
in too many cases, they will be paying higher taxes.
I want to again thank Chairman Archer for the opportunity
to testify. I look forward to working with all interested
Members on this issue as the Committee works to provide the
American people further tax relief this year. I would also like
to ask that Mrs. Kennelly's statement in support of my
legislation, which she had hoped to deliver today in person, be
included in the record following my testimony. Thank you.
[The prepared statements follow:]
Statement of Hon. Wally Herger, a Representative in Congress from the
State of California
Thank you Mr. Chairman and Members of the Committee for the
opportunity to testify today about a serious inequity in the
tax code. When a couple stands at the altar and says ``I do,''
they are not agreeing to higher taxes. Yet under our current
tax law, that is precisely what is happening to millions of
married couples each year.
According to a recent report by the Congressional Budget
Office, an estimated 42 percent of all married couples--some 21
million couples nationwide--incurred marriage penalties in
1996. The average marriage penalty that year approached an
astonishing $1,400. I believe that addressing this inequity in
our tax law should be a top priority for this Committee as we
work to provide the American people further tax relief in 1998.
Mr. Chairman, as financial pressures push more and more
non-working spouses into the labor force, an increasing number
of families fall prey to this marriage tax. A major reason why
so many of these joint filers face this added tax burden is
that the very first dollar earned by the lower-earning spouse
is taxed at the marginal rate of the higher-earning spouse, not
necessarily at the lower 15-percent rate faced by single
filers. This problem was exacerbated in 1993 when the number of
tax brackets was increased from three to five. That change
created even more opportunities for dual-income married couples
to be bumped into higher brackets and to face even larger
marriage penalties.
To address this problem, I have introduced legislation--
along with Mrs. Kennelly--to restore the two-earner deduction.
As many of you may remember, between 1982 and 1986, dual-income
couples were entitled to a significant tax benefit to help
offset the marriage penalties built into the Internal Revenue
Code. The two-earner deduction, once fully phased in, entitled
married couples to a 10-percent deduction on up to $30,000 of
the lower-earning spouse's income. However, for a variety of
reasons, Congress eliminated this tax benefit in 1986.
My bill, H.R. 2593--``The Marriage Penalty Relief Act''--
would simply restore the two-earner deduction. I am pleased to
report that this legislation has attracted a broad, bipartisan
group of 155 cosponsors in the House so far, including 35
Democrats. I am particularly gratified that 27 members of this
Committee--21 Republicans and 6 Democrats--have thus far signed
on to this legislation.
I should make it clear for the record, Mr. Chairman, that I
strongly support a complete elimination of the marriage penalty
and am an original cosponsor of the bill introduced by Mr.
Weller and Mr. McIntosh. I am encouraged to learn that the
Congressional Budget Office is now projecting a $660 billion
surplus over the next 10 years, and I sincerely hope that this
fiscal dividend can be used, in part, to insure that our tax
code no longer punishes married couples.
However, I also recognize that members of this body--and of
this Committee--have a variety of ideas about where to dedicate
this projected surplus. If budgetary and political conditions
prevent us from completely eliminating the marriage penalty in
this year's tax bill, I would certainly hope that we can at
least take a significant step toward achieving that objective.
Mr. Chairman, restoring the two-earner deduction would
enable us to make meaningful progress toward that goal in a way
that provides targeted relief to those couples who are
particularly hard-hit by this inequity. When a couple stands at
the altar and says ``I do,'' they are not agreeing to higher
taxes. Congress should act this year to address the fact that
in too many cases, they will be paying higher taxes. I want to
again thank Chairman Archer for the opportunity to testify
today, and I look forward to working with all interested
members on this issue as the Committee works to provide the
American people further tax relief this year.
[GRAPHIC] [TIFF OMITTED] T0897.002
Chairman Archer. Thank you, Congressman Herger.
Congressman McIntosh, you may proceed in any way you see
fit. If you wish to give a statement and then introduce Ms.
Mallory and Mr. Pierce, that's fine. If you want them to speak
first, that's fine. The floor is yours. You may proceed.
STATEMENT OF HON. DAVID M. MCINTOSH, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF INDIANA
Mr. McIntosh. Thank you, Chairman Archer, Mr. Chairman,
excuse me. I want to say I appreciate the Committee hearing
this issue today, and more importantly, the spotlight that you
are able to shed on this important issue.
Let me first introduce Sharon and Darryl. The Committee can
hear from them directly. Then I would like to add a statement
about the importance of this issue. Sharon and Darryl are two
constituents of mine. Sharon wrote me a letter last February
that really moved me to find out what is at stake in this
marriage penalty issue. She explained that she and Darryl both
work at the Ford Motor plant in Connersville. They live in a
small rural community in my district, make about $10 an hour.
Darryl does a little farming on the side. They wanted to get
married. They went to H&R Block to find out what would be the
consequences, if they got married, on their tax form. Well, as
Sharon put it in her letter, not only would she have to give up
her $900 refund, she found out that together they would pay
$2,800 in taxes. Quite frankly, they couldn't afford it, Mr.
Chairman, and wrote to me that they can't afford to get
married, and wanted Congress to do something about this unfair
marriage penalty in the Tax Code. It broke their hearts.
Well, it broke my heart when I heard their story. They have
been kind enough to tell their story to others and to come here
today. So why don't I now turn it over to Sharon Mallory.
Sharon and Darryl, if you want to share your thoughts about
this penalty and how it affects you, and then I'll have a
statement at the end of that, Mr. Chairman.
STATEMENT OF SHARON MALLORY AND DARRYL PIERCE, STRAUGHN,
INDIANA
Ms. Mallory. My name is Sharon Mallory, of Straughn,
Indiana.
Mr. Thomas. Sharon, excuse me. These microphones are
horrible today, worse than usual. If you speak directly into
it, you might have a better chance. We do want to hear your
message. Thank you.
Ms. Mallory. My boyfriend Darryl Pierce and I are
constituents of Congressman David McIntosh. Darryl and I love
each other very much and want to be married, but the IRS won't
let us. We are victims of the marriage penalty. We traveled
here from Indiana today to tell the Committee how the marriage
penalty affects us, and to urge the Committee to adopt
legislation introduced by Congressman David McIntosh and
Congressman Jerry Weller to eliminate the marriage penalty.
Darryl and I both work at the former Ford Electronics Plant
in Connersville, southeast of Indianapolis near the Indiana/
Ohio border. We make less than $10 and work overtime whenever
it is available. Darryl does some farming on the side to
supplement our income. Last year Darryl and I decided we wanted
to get married. However, when we went to our accountant in an
H&R Block office in New Castle, Indiana, she said that not only
would I forfeit my $900 refund, but that we would also have to
write a check to the IRS for $2,800. To us, this is real money.
It's food on our table and clothes on our backs. For Darryl and
me, the marriage penalty was large enough that we were forced
to put off our marriage.
Last February, I wrote to Congressman McIntosh about our
situation. In my letter, I wrote, ``Darryl and I would very
much like to be married. I must say it broke our hearts when we
found out we can't afford it. We hope some day the government
will allow us to get married by not penalizing us.''
I know that Congress and the President wouldn't purposely
single out married couples for higher taxes, but that is the
effect of this tax. I understand the Committee and the Congress
may have different ideas about how to cut people's taxes this
year. Let me urge you to include eliminating the marriage
penalty on the top of your list. It is too important an issue
for too many families to ignore. According to the Congressional
Budget Office, 21 million families pay an average of $1,400
more in Federal taxes just because they are married. This
cannot be allowed to continue. Strong families are the
backbones of strong communities and the heart of a strong
country. I don't know how many other couples postpone or cancel
their marriages because of the marriage penalty, but one family
is one too many. By approving legislation to eliminate the
marriage penalty, this Congress can do something that will help
millions of families in a real and tangible way. I urge you to
approve this legislation as soon as possible. Thank you.
[The prepared statement follows:]
Statement of Sharon Mallory and Darryl Pierce, Straughn, Indiana
My name is Sharon Mallory of Straughn, Indiana. My
boyfriend, Darryl Pierce, and I are constituents of Congressman
David McIntosh.
Darryl and I love each other and very much want to be
married. But the IRS won't let us. We're are victims of the
marriage penalty.
We traveled here from Indiana today to tell the committee
how the marriage penalty affects us--and to urge the committee
to adopt legislation introduced by Congressmen David McIntosh
and Congressman Jerry Weller to eliminate the marriage penalty.
Darryl and I both work at the former Ford Electronics plant
in Connersville, southwest of Indianapolis near the Indiana-
Ohio border. We make less than $10 and work overtime whenever
it is available. Darryl does some farming on the side to
supplement our income.
Last year, Darryl and I decided we wanted to get married.
However, when we went to our accountant in an H & R Block
office in New Castle, Indiana, she said that not only would I
forfeit my $900 refund but that we also would have to write a
check to the IRS for $2800.
To us, this is real money. It's food on our table and
clothes on our children's backs. For Darryl and me, the
marriage penalty was large enough that we were forced to put
off our marriage.
Last February I wrote to Congressman McIntosh about our
situation. In my letter, I wrote: ``Darryl and I would very
much like to be married and I must say it broke our hearts when
we found out we can't afford it. We hope someday the government
will allow us to get married by not penalizing us.''
I know that Congress and the President wouldn't
purposefully single out married couples for higher taxes. But
that's the effect of this tax.
I understand that the committee and the Congress may have
different ideas about how to cut people's taxes this year. Let
me urge you to include eliminating the marriage penalty at the
top of your list. It's too important an issue for too many
families to ignore.
According to the Congressional Budget Office, 21 million
families pay on average $1,400 more in federal taxes just
because they're married.
This cannot be allowed to continue. Strong families are the
backbones of strong communities--and the heart of a strong
country. I don't know how many other couples postpone or cancel
their marriages because of the marriage penalty. But one family
is too many.
By approving legislation to eliminate the marriage penalty,
this Congress can do something that will help millions of
families in a real and tangible way. I urge you to approve this
legislation as soon as possible.
Chairman Archer. Thank you, Ms. Mallory.
Mr. McIntosh. Mr. Chairman, is there still time available
for my statement or do you need to move on?
Chairman Archer. If you can make it as brief as possible,
yes. Your entire written statement, without objection, will be
inserted in the record.
Mr. McIntosh. Thank you, Mr. Chairman. I would also ask,
Jerry and I have received numerous correspondence and e-mails
from people like Sharon and Darryl about the marriage penalty,
if we could also ask permission to submit those as part of the
record as well.
Chairman Archer. Without objection.
Mr. McIntosh. I would just make two points to the
Committee. One, this marriage penalty disproportionately
discriminates against women. When the Tax Code was written in
the sixties with the married filing jointly, most families in
this country had one wage earner, traditionally the husband.
Today, that has changed. Seventy-five percent of the families
have both spouses working. When the wife decides to go to work,
perhaps she has been out of the job force raising children and
goes back to finish her career, she gets hit with all of that
penalty, as much as a 50 percent marginal tax on her income. So
some have said that Jerry Weller and David McIntosh's bill
would be the Working Women's Tax Relief Act of 1998, because
they are hit disproportionately and unfairly by this marriage
penalty.
The second point that has come out in research recently by
a professor at the University of Cincinnati Law School, is that
minority families are also disproportionately discriminated
against by this penalty. That is because oftentimes the woman's
income in those families is of a greater percentage than
traditional families in the whole of the population in the
United States. Therefore, they suffer a larger penalty when you
look at minority families as compared to typical families in
the United States. That's because oftentimes they have to have
two people working in order to earn enough money to get ahead
and have a chance to survive in our economy.
So this bill to eliminate the marriage penalty not only
would strengthen families, but it would eliminate a policy that
discriminates against women and discriminates against
minorities as well. I wanted to make sure that that point was
in the record, and will submit my testimony, the complete
testimony for the Committee.
Thank you, Mr. Chairman, very much. I know you care a great
deal about this issue. I appreciate this hearing.
[The prepared statement and attachments follow:]
Statement of Hon. David M. McIntosh, a Representative in Congress from
the State of Indiana
Mr. Chairman, fellow members of the Committee, I want to
thank you for inviting here before this prestigious body to
speak about the Marriage Penalty, but much more importantly,
you have my profound gratitude for shining the public spotlight
on this insidious tax.
As Sharon and Darryl's testimony makes so heart-breakingly
clear, the marriage tax is immoral. There's no more adequate
way to describe a designed government policy which undermines
the traditional institution of the family and, most tellingly,
discriminates against women and minorities.
The marriage penalty entered our tax code thirty years ago
and has systematically undermined the family ever since. The
trend in our nation has seen a decrease in marriage and
increase in divorce. Many people, like Sharon and Darryl, want
to marry but cannot afford it. Divorce is reaching epidemic
levels. There are twice as many single parent households in
America today since the marriage penalty came into effect.\1\
The terrible financial strain caused by the marriage penalty
contributes to this. Simply put, the marriage penalty is doing
great harm to our society by frustrating family cohesion.
---------------------------------------------------------------------------
\1\ The Statistical Abstract of the United States, Department of
Commerce, Table No. 146, ``Marriages and Divorces,'' p. 104: 1996.
---------------------------------------------------------------------------
The devastating consequences of divorce on parents and
children are well documented. When parents divorce, they are
likely to die earlier, their general health is worse, and
sadly, many divorced adults, particularly young mothers, are
thrown into poverty.\2\ The effects on children are no less
devastating. The National Fatherhood Initiative has shown that
where there is a divorce, the children are more prone to
violence, illegal drugs, suicide, and drop out of school. Over
Ninety percent, Ninety percent!, of children on welfare are
from homes with only one parent.\3\
---------------------------------------------------------------------------
\2\ Dr. Wade Horn, The National Fatherhood Initiative, ``Father
Facts 2,'' p.10: 1997.
\3\ Ibid.
---------------------------------------------------------------------------
And by the way, don't interpret these facts as an attack on
single mothers. I was raised by a single mom. I know the
sacrifices she made for us. Single moms are heroes born out of
necessity.
Let us simply get rid of the government penalties that push
these moms toward divorce and illegitimacy. Big government in
Washington and its marriage penalty tax have become the number
one enemy of the American family and its affects on working
women and minorities are particularly devastating.
The marriage penalty could equally be known as ``The Tax on
Working Women.'' When the marriage penalty was proposed America
was a far different place and large numbers of women were not
yet in the workforce. Today, 75 percent of married couples have
two incomes.\4\ The marriage penalty almost always hits the
second-earner the hardest. Therefore, this tax clearly
discriminates against women who may chose to enter the
workforce to provide a better life for their family. These
women can be taxed at an astounding 50% marginal rate.\5\ The
Weller-McIntosh Tax on Working Women Elimination Act is the
ultimate piece of legislation in the women's liberation
movement. If our bill passes, women--and men--will have much
greater freedom to choose to work without having to worry about
the taxman.
---------------------------------------------------------------------------
\4\ The Congressional Budget Office, ``For Better of for Worse:
Marriage and the Federal Income Tax,'' (June 1997), Table 10, p.39.
\5\ The Greater Washington Societies of Certified Public
Accountants, Sept. 1997
---------------------------------------------------------------------------
African-Americans are particularly devastated by the
marriage tax. The marriage penalty occurs when both spouses
work and make roughly the same income and black women
historically have entered the workforce in larger numbers and
make comparatively more money than whites. 73% of married back
women are breadwinners and black women contribute approximately
40% of their household's income.\6\ Our legislation brings
fairness back into the tax code so that African-American women
and families can keep more of their hard earned money to
provide for their children.
---------------------------------------------------------------------------
\6\ Dorothy Brown, ``The Marriage Bonus/Penalty in Black and
White,'' University of Cincinnati Law Review (Spring 1997), p.5.
---------------------------------------------------------------------------
I know you agree with me that we must completely rid our
tax code of this bill that hurts families, working women, and
minorities. Therefore, I categorically reject those who have
said that the federal government can't afford it. No one in
Congress asked married people if they could afford it when they
passed it. It's time for the federal government to tighten its
belt to help families. I say we cannot afford to allow it to
continue because of its pernicious effects on families. I will
work with this committee to ensure adequate funding to
eliminate the marriage penalty is included in the budget
resolution. To guarantee support from those who favor
eliminating the marriage penalty, the budget resolution must
include enough resources to abolish the marriage penalty.
Mr. Chairman, we in Congress must be held accountable for
failing to respond to the American people when we defy the
traditional values of the American people. We have a choice. We
can continue down the path of destroying the family, penalizing
marriage in our tax code, the path of high crime, drug use,
divorce, and children being brought up without knowing the
difference between right and wrong.
Or we can choose a different path: a path based on the firm
conviction that the family must be the foundation of our
society. We can choose a path where families are lifted up--not
punished by government. It is the way by which young people
like Sharon and Darryl can find happiness and finally be
married. I believe most strongly that for our nations' future,
we must choose to lift up the family. I joined Jerry Weller in
introducing legislation to eliminate the marriage penalty and
remove one more obstacle in the recovery of the family. Even if
some in Washington scoff at this idea, the American people have
a special wisdom in these matters. They will support our
efforts to succeed in this effort to eliminate the marriage
penalty. It is crucial that we succeed because the success of
the family and the success of America are inseparable.
Thank you, Mr. Chairman.
I would ask that I could submit a speech I gave on the
marriage penalty as well as a marriage penalty paper prepared
by my office for the record.
TO RENEW THE AMERICAN FAMILY by David McIntosh, R-IN
Speech to Christian Coalition, September 13, 1997
Some say that it takes a village to raise a child. No! It
takes a family and it will take a family to rebuild our nation
and once again make it the guiding moral light for this world.
These are two competing visions for America's future. One is
right. One is wrong. Putting the family first, builds a great
nation. But putting the village--that is the government--first,
tears down the family and the nation crumbles.
We, as a nation, must learn from history that societies
which rely on government, instead of families,to solve their
problems never prosper. 500 years before Christ, the prophet
Nehemiah returned to Jerusalem, the city of his forefathers and
found it in ruins. The City wall had broken down and thieves
and marauders preyed upon the people. Even worse, the Bible
says that the Israelites were forced to pay excessively high
taxes, to a remote government in a far off capital. Families
had to sell their property and give up on their inheritance
just to pay what the King of Persia's tax collectors extorted
from them. We know Nehemiah set about rebuilding the walls of
Jerusalem using the strength of the family. He assigned each
family a piece of the wall to rebuild. When his enemies
threaten to kill the Israelites, Nehemiah mounted a family
defense. ``Don't be afraid. Remember the Lord, who is great and
awesome, and fight for your brothers, your sons and your
daughters, your wives and your homes.'' With each family
defending a portion of the wall, Nehemiah defeated his enemies.
500 years before Christ the people of Israel followed God's
plan, employed a family defense, rebuilt the walls of a new
Jerusalem, and were blessed with a society that was moral and
just.
History repeats itself. Let us fast forward to today,
nearly 2000 years after the death of Christ, and ask ourselves:
What is happening in America? America that for 200 years was
founded on the principle that God has blessed every man and
woman in this nation with certain inalienable rights, among
them, life, liberty, and the pursuit of happiness. America that
has become for most of the world a shinning city on the hill in
which truth, justice, and freedom are hallmarks of everything
we do.
For the last thirty-years, America has turned away from the
commandment to entrust the family with the well-being of our
society. Indeed, America's government has begun to
systematically punish the family. Starting in 1969, America has
taxed married couples more than if they are divorced or single.
That is the year the marriage penalty entered into our tax
code. Today, 21 million couples in America suffer and strain
under a marriage penalty tax. The average cost to the family is
$1,400 a year.
Here is how the marriage penalty works. First, when a young
couple decide to get married they pay higher rates and lose
some of their deductions. Second, when the couple has children
they are penalized once again. Under the budget we passed, many
families only receive a portion of the $500 tax child credit
because they are married and earn too much money. Third, when
their children go to college the family is punished by paying
higher taxes on savings they use to pay tuition. Fourth, when
they retire, they are penalized in Social Security and Veterans
benefits, if they remarry. The worst part of the marriage
penalty is that it discriminates against women who, when their
children are old enough, want to go back into the workforce to
provide an even better life for their family. These women can
be taxed at an astounding 50% marginal rate.
This is wrong. Washington should not punish families that
need two incomes to make ends meet. A constituent of mine,
Sharon Mallory, wrote me an anguished letter about how this
marriage tax hurt her. Let me read to you from her letter.
``Dear Congressman McIntosh, My boyfriend, Darryl Pierce, and I
would very much like to get married....We both work at Ford
Electronics and make less than $10.00 an hour; however, we do
work overtime whenever it is available....I can't tell you how
disgusted we both are over this tax issue....If we get married
not only would I forfeit my $900 refund check, we would be
writing a check to the IRS for $2,800....Darryl and I would
very much like to be married and I must say it broke our hearts
when we found out we can't afford it.''
Sadly, Darryl and Sharon's story is not unique. One of my
staff in Muncie, Indiana told me of a young couple, who asked
not to be named, that has a terrible problem in their family.
They were driving home one evening and were struck by an on-
coming car. The couple's 6 year-old daughter suffered severe
brain damage. She is now having to learn to walk and talk all
over again. Our government, out of compassion for people like
this, has programs to assist families and allow them to pay for
their medical bills. This family went to a government case-
worker to seek help for their little girl's therapy. The
devastated parents were told that the husband makes 10 dollars
more a year than the government will allow in order to qualify
for any assistance. What did the case worker say to the family?
That they have two choices. One, the father can quit his job
and go on welfare. And if that's not bad enough, The second
choice was that they can get a divorce! The mother can take the
child and qualify for government assistance.
Once again, I say this tax is wrong and immoral. Our
government should not force 21 million families to choose
between divorce and economic prosperity, on the one hand, or
staying married and financial hardship, on the other. In the
Gospel of St. Matthew, Christ said about the family ``What
therefore God hath joined together, let not man put asunder.''
Our government has ignored this warning. What are the
consequences of such folly? Look at what has happened to
America during these last thirty years? Each of us, as we look
around in our neighborhoods and our streets and our cities,
know that the family is under assault. In Hollywood, on the
Internet, and in Washington, the family is a favorite and
familiar target. This barrage has weakened the family as the
foundation of our society.
In our inner cities, in our small towns across America, and
in our neighborhoods, the walls of our communities, built up by
the American family, are crumbling. We face a crisis in our
country. In the last thirty years, since the marriage penalty
began, 9 million couples decided not to get married in the
United States. Many of these young people are like Sharon and
Darryl who want to marry but cannot afford it. 2 million more
marriages ended in divorce, And there are twice as many single
parent households.
What does this breakdown of the family mean for mothers and
fathers, and most importantly, for the children of broken
families? Studies show that when parents divorce, they are four
times as likely to die early,e more respiratory and digestive
illnesses. And sadly, many divorced adults, particularly young
mothers, are thrown into poverty. The effects on children are
no less devastating.
The National Fatherhood Initiative has shown that where
there is a divorce, the children are prone to violence. 72
percent of juvenile murderers and 60 percent of America's
rapists grew up in homes without fathers. They are 4 times more
likely to use illegal drugs; 3 times more likely to commit
suicide, and twice as likely to drop out of school. When they
join the workforce, their pay is lower, with less of a chance
to be promoted. These poor children, who are not responsible
for their fate, are even more likely to be trapped in a cycle
of poverty. Over Ninety percent, Ninety percent!, of children
on welfare are from homes with only one parent.
And by the way, don't interpret these facts as an attack on
single mothers. I was raised by a single mom. I know the
sacrifices she made for us. Single moms are heroes born out of
necessity. Let us simply get rid of the government penalties
that push these moms toward divorce and illegitimacy.
Big government in Washington and its marriage penalty tax
have become the number one enemy of the American family.
My friends, we cannot let this stand. We must pass a bill
that Jerry Weller and I have introduced into Congress that
eliminates the marriage penalty from the tax code. Our bill is
simple--It says families may choose. If they pay less taxes
filing jointly as a normal couple, they may do so. If they pay
lower taxes by filing as individuals, they may choose to do
that instead of having to file for a divorce to get this tax
break.
The prophet Jeremiah says: ``Stand at the crossroads and
look. Ask for the ancient paths. Ask where the good way is. And
walk in it.'' My friends, as the 20th century draws to an
end,America indeed stands at a crossroad.
We have a choice. We can continue down the path of
destroying the family, penalizing marriage in our tax code, the
path of high crime, drug use, divorce, and children being
brought up without knowing the difference between right and
wrong.
Or we can choose a different path: a path that is based on
the ancient ways of Nehemiah where we recognize that the family
must be the foundation of our society. We can choose a path
where families are lifted up--not punished by government. It is
the way by which young people like Sharon and Darryl can find
happiness and finally be married. It is the path that allows
Americans to provide for their children without the government
pressuring them to divorce.
Again, the choice is ours. For the sake of America, and
freedom, and the young boys and girls who are our nations'
future, we must choose to lift up the family. I feel it is my
personal calling to begin by fighting with every ounce of my
being to end the marriage penalty tax once and for all. I ask
you in the Christian Coalition to join me in this calling. Let
us act boldly, with the courage of our convictions, to link arm
and arm and march to Washington with the goal of unconditional
surrender.
Let us never stop praying that our nation's leaders will
understand that the laws of this land must not try to ``put
asunder what God has brought together.'' let us call on our
nation's leaders, our leaders in Congress, and the President
to: Demand that families are put at the head of our national
agenda. Demand that America once again has a government that
respects the sanctity of marriage. We will be silent no longer.
Tonight, we say to Sharon and Darryl and to all those facing
marriage penalties: No more broken promises. No more broken
hearts.
In our crusade, I urge you to: Support your leaders here in
the Christian Coalition--Pat Robertson, Don Hodell, Randy
Tate--as they fight across this great land on behalf of the
American family. As they fight in Washington to rid our tax
code of the penalties against marriage and the family. If the
Christian Coalition makes repeal of the marriage penalty tax
your number one priority, we cannot fail. This is crucial
because the success of the family and the success of America
are inseparable. I am confident, that with the help of God, we
will succeed.
And when we do, America will once again be on the path of
righteousness. And when we have restored the family, we can re-
fortify the walls of this great country with the building
blocks of freedom, faith, and virtue. Then, and only then, as
we enter the 21st century, will America be that shining city on
the hill.
Thank you, God bless you and God bless America.
Congressman David M. McIntosh, Second District, Indiana
Do you pay more in taxes just because you're married?
What is the marriage penalty?
The IRS punishes millions of married couples who file their
income taxes jointly by pushing them into higher tax brackets.
The marriage penalty taxes the income of a family's second wage
earner--often the wife's salary--at a much higher rate than if
that salary were taxed only as an individual.
For example, consider a couple whose husband and wife each
earn $30,500 for a total household income of $61,000.
Subtracting their personal exemptions and standard deductions
of $11,800, this couple's taxable income is $49,200. At this
income level, the couple is taxed at the 28 percent marginal
rate for a total tax bill of $8,563.
However, if this couple were divorced or living together
but not married, they would get a better tax break from Uncle
Sam. For example, with each earning $30,500 and subtracting
their individual exemptions and deductions of $6,550 each,
their taxable income would be $23,950 each. That means their
incomes would each be taxed at the lower 15 percent marginal
rate for a tax bill of $3,592 each.
So the married couple pays more in taxes just because
they're married. That's a marriage penalty of $1,378. Overall,
according to a recent report by the Congressional Budget
Office, more than 21 million couples suffer a marriage penalty
averaging $1,400.
----------------------------------------------------------------------------------------------------------------
Marriage Penalty Example Individual Individual Couple
----------------------------------------------------------------------------------------------------------------
Adjusted gross income:.......................................... 430,500 430,500 461,000
Minus personal exemption and standard deduction:................ 46,550 46,550 411,800
Taxable income:................................................. 423,950 423,950 449,200
Tax liability:.................................................. 43,592 43,592 48,563
Marriage Penalty:............................................... .............. .............. 41,378
----------------------------------------------------------------------------------------------------------------
Incidentally, there's also a marriage penalty for the
personal exemption and standard deduction. In the above
example, the exemptions and deductions for an individual total
$6,550. Common sense says that for a married couple the
exemptions and deductions should be double that of an
individual, or $13,100. Unfortunately, common sense doesn't
apply to the IRS. The family's personal exemptions and standard
deductions total $11,800--that's $1,300 less that what two
individuals living together receive.
Consequences of marriage penalty?
Families today are under assault. Broken homes. Fatherless
children. Single moms struggling to raise their children while
also ensuring there's food on the table.
When Washington taxes couples more just because they're
married that hurts working families who are playing by the
rules. Rather than helping families stay together, the marriage
penalty contributes to the breakdown of the family.
What does this breakdown mean for mothers and fathers?
Studies show that when parents divorce, they are four times as
likely to die at an earlier age,\1\ their health is worse \2\
and sadly many divorced adults, particularly young mothers, are
thrown into poverty.\3\
---------------------------------------------------------------------------
\1\ Joseph E. Schwartz. ``Sociodemographic and Physchosocial
Factors in Childhood as Predictors of Adult Mortality.'' American
Journal of Public Health 85 (1995):1237-1245.
\2\ L. Remez. ``Children who Don't Live with Both Parents Face
Behavioral Problems.'' Family Planning Perspectives. (January/February
1992).
\3\ Jeanne Woodward. ``Housing America's Children in 1991.'' U.S.
Bureau of the Census, Current Housing Reports H121/93-6. U.S.
Government Printing Office, Washington, D.C., 1993.
---------------------------------------------------------------------------
The effects on children are also devastating: 72 percent of
juvenile murders \4\ and 60 percent of rapists \5\ grew up in
broken homes. They are more likely to use drugs, more likely to
commit suicide and more likely to drop out of school.\6\ And
today 75 percent of children living in single-parent families
will experience poverty before they turn 11 years old.\7\
---------------------------------------------------------------------------
\4\ Dewey Cornell. ``Characteristics of Adolescents Charged with
Homicide.'' Behavioral Sciences and the Law 5 (1987):11-23.
\5\ Nicholas Davidson. ``Life Without Father.'' Policy Review
(1990); see also Karl Zinsmeister. ``Crime is Terrorizing Our Nation's
Kids.'' Citizen (August 20, 199): 12.
\6\ Wade F. Horn. ``The National Fatherhood Initiative.'' Father
Facts II.
\7\ National Commission on Children. ``Just the Facts: A Summary of
Recent Information on America's Children and Their Families.''
Washington, D.C., 1993.
---------------------------------------------------------------------------
What's the solution to the marriage penalty?
In September Reps. David McIntosh, R-Ind., and Jerry
Weller, R-Ill. introduced H.R. 2456, the ``Marriage Tax
Elimination Act of 1997.'' The bill would benefit married
couples regardless of whether they have children. Its idea is
simple: It allows families to decide how they file their income
taxes--either individually or jointly, whichever gives them the
greatest tax benefit. Ending the marriage penalty will allow 21
million families to keep more of the money they earn, rather
than paying more in taxes to Uncle Sam.
In Congress who supports the Marriage Tax Elimination Act?
Over 226 House co-sponsors--including Speaker Newt
Gingrich, Majority Leader Dick Armey, Majority Whip Tom DeLay,
Conference Chairman John Boehner, Conference Vice Chairman
Jennifer Dunn and Conference Secretary Deborah Pryce.
Who else supports McIntosh's bill?
``Government, by taxing married couples at higher rates
than singles, has for too long been a part of the problem. At a
time when family breakups are so common, Congress should pass
legislation to encourage marriage and ease the burden of
families trying to form and stay together. This legislation
places government on the side of families.''
The Christian Coalition, Don Hodel, president
``David McIntosh has touched a nerve--his bill to eliminate
the marriage penalty will help put an end to Washington's
punishment of families. Washington should be supporting
families, not undermining them. McIntosh's bill is a bold step
in the right direction to make the tax code more family-
friendly.''
Americans for Hope, Growth and Opportunity, Steve Forbes,
chairman
``American's for Tax Reform supports the efforts of the
Sophomore Republican Class in leading the march toward tax
relief for working American couples. We support efforts to
enact the `Marriage Tax Elimination Act' for America's working
couples. We would like to thank David McIntosh in particular
for his efforts.''
Americans For Tax Reform, Grover Norquist, president
``Current law forces many married Americans to pay a higher
tax bill than if they remained single and had the same combined
income. Such a double standard is wholly at odds with the
American ideal that taxes should not be a primary consideration
in any individual's economic or social choices.''
National Taxpayers Union, Al Cors, director
``We welcome the `Marriage Tax Elimination Act' introduced
today by representatives Dave McIntosh and Jerry Weller. This
bill can be a first step in recognizing in law that the family
is the first church, the first school, the first government,
the first hospital, the first economy, and the first and most
vital mediating institution in our culture. In order to
encourage stable two-parent, marriage-bound households we can
no longer support a tax code that penalizes them.''
The Catholic Alliance, Keith Fournier, president
``By eliminating the marriage penalty, Congress will send a
strong message to couples across America that the institution
of marriage is important and that the government should work to
strengthen, not weaken it. With the passage of the `Marriage
Tax Elimination Act,' couples and families will no longer be
robbed of their hard-earned money, and it will enable them to
work towards their own financial independence at retirement.''
Traditional Values Coalition, Rev. Louis P. Sheldon,
chairman
``We urge Congress to put the tax code where its rhetoric
is and eliminate marriage penalties. Serious steps to reform
tax laws would mean real liberation for women, those who work
and those who may have to in the future.''
National Independent Women's Forum, Barbara Ledeen,
executive director
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Chairman Archer. Mr. Pierce, do you have anything to add to
what Ms. Mallory said?
Mr. Pierce. No. She said it all.
Chairman Archer. We are happy to have you before us. You
have graphically pointed out to the Committee the unfairness of
this marriage penalty in the Code. I will say for myself that
when I came on this Committee in January 1973, coming from the
State of Texas, our property laws automatically provide that a
spouse that is not working has title to 50 percent of
everything the spouse that is working earns. I was offended
enormously by the marriage penalty because it totally
disregards the property rights that are established by each
State. This is a little bit different an issue than the one
that Ms. Mallory and Mr. Pierce brought up, but it is another
part of the inequity in the marriage penalty. I have fought
against it my entire career on this Committee. So I welcome
your testimony today.
I yield to Mr. Rangel for any inquiry that he might like to
make.
Mr. Rangel. Mr. Chairman, I pass my time.
Chairman Archer. Mr. Thomas.
Mr. Thomas. Thank you, Mr. Chairman. I thank all of my
colleagues, and especially those who came from Indiana. The old
saying, love conquers all, apparently doesn't cover the IRS.
Although Mr. Pierce, your willingness to defer to Ms. Mallory
indicates that you are ready for marriage. [Laughter.]
Even though the IRS won't let you. I just found the opening
exchange between the Chairman and the Ranking Member
interesting since in the 103d Congress the Chairman of the Ways
and Means Committee, Mr. Gibbons, and then in the 104th, the
Ranking Member of the Committee, Mr. Gibbons, has long been an
advocate for a system different than the current system, and
went so far before he retired to actually write a bill to
produce just such a different system. I am just a little
surprised perhaps that there appears to be a newness to the
subject of fundamentally reforming the tax system.
Mr. Rangel. Will the gentleman yield? I assume you are
referring to me.
Mr. Thomas. Very briefly.
Mr. Rangel. I am very anxious to see what document is
coming out. I have just as much interest as Sam Gibbons or
anyone else on this Committee. But we can't just keep educating
people. We need a bill before us. Thank you.
Mr. Thomas. I thought the road to a bill was education. I
guess we're supposed to put the old cart before the horse.
Let me say that I'm a cosponsor of legislation dealing with
this. I commend all of you for trying to get at the problem,
although I believe the Chairman's comment, that as long as we
have the current system, it's going to be a continual chase
through the system. I don't think this is partisan. I do not
think it's a vestigial remain from a previous era. Just let me
make one point to illustrate that.
We just passed a tax package in the Balanced Budget Act.
Because the administration insisted that we limit people's
access to the new so-called Roth IRA, we in fact have
perpetuated, reinforced and ingrained the marriage penalty in
the Tax Code as recently as last year. If you are single, you
can deal with an income up to $100,000 and a rollover into the
new IRA. But if you are married, that married couple is limited
to the $100,000, regardless of their income. It is something
that is very difficult to root out, given the way in which the
tax structure is created.
I commend you for your efforts. We will support your
efforts. But I think what we need to do is look fundamentally
at repealing those sections that create limits, that produce
choices such as we see here before us. There should be no
penalty in the Code for marriage. I, for one, think I'm going
to introduce legislation to repeal the cap, for example, on the
Roth IRA, as my indication that at some point we have to say
you can't play games with the numbers. You simply have to
eliminate any reason for treating two people who happen to be
married differently than two people who do not.
So I compliment you. I support your effort. Frankly, what
we need to do, and Mr. McIntosh you indicated this creates a
little bit of publicity on this issue. There are an awful lot
of people who know about it. What we need to do is sensitize
our Members to move on it. Thank you very much.
Chairman Archer. Ms. Dunn.
Ms. Dunn. Thank you very much, Mr. Chairman. I have a
couple of questions. One I'll ask you, members of the panel.
Have you had the scoring done on your two plans? Could I get
the numbers if you have?
Mr. Herger. The latest Congressional Budget Office number
that I am aware of, Congresswoman Dunn, is about $9 billion a
year on my approach, and about $29 billion for complete
elimination.
Ms. Dunn. Is that over 5 years or is that over 1 year?
Mr. Herger. That is per year, based on figures from 1996.
Mr. Weller. If I might respond, Ms. Dunn. While the
Marriage Tax Elimination Act, which allows a married working
couple to choose to file jointly or as two singles has not been
officially scored by Joint Tax yet this year, a similar bill in
a previous Congress 2 years ago was scored roughly at about $18
billion in revenue loss to the Federal Government. But there is
also a different way to say that. That is, that's an $18
billion tax on marriage that should not be being collected
today.
Ms. Dunn. Thank you very much. I think we need to start
with some background. I think this is a superb idea. I think I
am on both your pieces of legislation. If I'm not, I certainly
ought to be on your legislation because I think the points that
were made, particularly by Mr. Weller and Mr. McIntosh about
how working women are very concerned about this penalty that
they are paying when they are married. It's not fair to them
that this money is going to the IRS. We all know that it's not
spent as well by the Federal Government as it would be by
people who are able to keep this money in their pockets and
decide where they want to put this money.
Mr. Chairman, my second question is one that I would like
to ask you or somebody. I am wondering what the reason was for
doing away with this obviously important part of the Tax Code
in 1986. Is there justification that we ought to know as we are
moving back into this area?
Chairman Archer. We'll be happy to have a presentation or a
briefing on that for the Members of the Committee. I am
reluctant to try to take the time now to explain what I know
historically happened. But the marriage penalty has been in the
Code beginning back in 1969. It was exacerbated to a degree in
1986, but it's been with us a very long time. It occurred
initially because of the political pressure of the singles who
came before this Committee and said ``it's cheaper for two
people to live together than it is to live separately.
Therefore, it is unfair to us to have everybody treated the
same.'' That political pressure welled up and caused the
Committee and the Congress to insert what we now term the
marriage penalty. But that was the genesis of it originally.
Ms. Dunn. Thank you, Mr. Chairman. I suspect that the
number of dollars included must have been very tempting for
those people who believed the Federal Government's role should
be expanded. These dollars certainly have been going the last
few years until just recently to pay for lots of big government
programs. I think it's time to turn that around.
Mr. Weller. Will the gentlelady yield? You asked the
question on the impact on the Federal Government if they lose
the revenue that's currently collected with the marriage tax
penalty. But if you think about what $1,400 means to a married
working couple in Washington State or in Illinois or Indiana or
California, $1,400 is 1 year's tuition at Joliet Junior College
in my district. It's 3 months of childcare. In fact, I have a
chart over here.
You know, the President has a politically attractive idea
regarding expanding the childcare tax credit. Well, according
to the President's own figures, that $360 that an average
couple that would qualify for the President's childcare tax
credit would be able to purchase 3 weeks of childcare. But with
elimination of the marriage tax penalty, that extra $1,400 that
the average married working couple would be able to keep as a
result of the Marriage Tax Elimination Act would purchase 3
months. So you have 3 weeks versus 3 months of childcare in
comparing the two proposals.
Ms. Dunn. And also the right of the parents to choose what
they want to do in the area of childcare. Thank you very much.
Chairman Archer. Let's see who is here at this time. I
guess on the list on the Minority side, Mrs. Thurman is.
Mrs. Thurman.
Mrs. Thurman. Mr. Chairman, I actually don't have any
questions at this time. I am looking forward to the debate as
we get into this, and certainly any of the offsets. I know that
Mr. McIntosh and I have talked about this on the floor. There
are several proposals, I understand, that are being looked at
in this area. Hopefully as this day goes on, we will have the
opportunity to see how this all unfolds. But my heart does go
out to folks that are here testifying before us today. It is
unfortunate that we have a penalty in taking what many of us
think is a wonderful part of our lives, of being married and
having that opportunity. So I certainly think there are things
that we need to look at. But let's see what happens as we go
on.
Chairman Archer. Mr. English. Does any other Member of the
Committee wish to inquire? If not, thank you very much.
Our next panel is scheduled to be three more of our
colleagues. I don't know if they are here. Congressman Kasich,
Congressman Salmon, and Congressman Riley. If one or more of
those colleagues are here, they are invited to come and take a
seat at the witness stand. I see Congressman Riley.
Congressman Riley, welcome. Congressman Salmon, welcome. If
Congressman Kasich shows up, we'll be happy to receive his
testimony also.
Congressman Salmon, just briefly, the rules of the
Committee are that we would like for you to keep your oral
testimony within 5 minutes. Without objection, your entire
written statement will be inserted in the record. If you are
ready, we are happy to have you here. You may proceed.
STATEMENT OF HON. MATT SALMON, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF ARIZONA
Mr. Salmon. Thank you very much, Mr. Chairman. I appreciate
the opportunity to testify before the Ways and Means Committee
in support of the Riley-Salmon Marriage Protection and Fairness
Act. The Taxpayer Relief Act, now law, provided Americans with
the first significant tax cut in almost a generation, but our
work is not done. Mr. Chairman, as you so aptly pointed out,
Americans were taxed at the post-World War II record of 19.9
percent of the Gross Domestic Product last year.
Lawmakers from both sides of the aisle have called for the
next round of tax cuts, to revise the Tax Code as it pertains
to married couples. One of the most indefensible aspects of our
current Tax Code is that over 40 percent of married couples pay
more in taxes filing jointly than they would if the husband and
wife each filed individually. That's a crime.
This marriage penalty has been criticized by President Bill
Clinton, Speaker Newt Gingrich, and Majority Leader Trent Lott.
To ensure that the tax law would not punish married Americans,
Representative Jerry Weller and Dave McIntosh introduced a
bill, which I have cosponsored, and would eliminate the
marriage penalty for some 40 percent for the 40-some odd
percent of couples who pay tax filings jointly, pay more taxes
filing jointly than they would as unmarried individuals.
However, it would upset the principle embedded in our current
law, that different families with the same total income should
be treated equally for tax purposes. Consequently, it would
place most couples in which both spouses work full time in a
more favorable tax position than families in which one spouse
remains at home or works part time.
Jerry Weller and Dave McIntosh have put this issue on the
map. For that, we are deeply indebted. Taxpayers owe them a big
debt of gratitude. I applaud their leadership on this issue.
But income-splitting offers a better fix to this important
problem.
The Riley-Salmon bill would permit married couples to use
income-splitting on their tax returns and would increase the
standard deduction for married couples. These changes would
offer almost all married couples a tax cut, would eliminate the
tax penalty on marriage that exists under current law, and
would continue the current policy that different families with
the same total income should be treated equally for tax
purposes. Senator Lauch Faircloth has introduced virtually the
same bill in the Senate, that's S. 1285.
Most importantly, the income-splitting legislation we have
introduced treats equitably those families in which one parent
stays at home. As the New York Post has editorialized, this
approach would end the marriage penalty and benefit hard-
pressed, one-income married families. Another attractive
feature Maggie Gallagher noted in a Washington Times column on
the marriage penalty, that income splitting would keep
government from taking sides on the mommy wars. Indeed, as the
Congress and President contemplate proposals to improve daycare
for young children, including the President's proposal to pour
billions of dollars into daycare centers, while ignoring
parents that raise their kids or have relatives who participate
in child rearing, pursuing a marriage penalty fix that does not
assist spouses who choose to stay at home or work part time
should cause us to pause.
Profamily organizations such as the Family Research
Council, Eagle Forum, and tax reform groups such as National
Taxpayers Union, are aligning behind our approach because it
benefits all married couples. Some will undoubtedly criticize
our proposal as too difficult to achieve, given budgetary
limitations. Indeed, the bill would likely require Washington
to run on $30 billion less of tax money from America's
families. But the preservation of security of the cornerstone
of America, the smallest most important unit of government, the
family, is too important to short-change with more economical
but less effective proposals.
Additionally, Chairman Archer, you recently unveiled a
proposal that would cap Federal taxation at 19 percent of Gross
Domestic Product, which if enacted, could amount to an annual
tax cut of up to $75 billion. A comprehensive marriage penalty
fix would represent less than half of this amount.
I know that when we talk about the budget and numbers and
the fact that this is probably double what the proposal from
McIntosh and Weller is offering, I know it makes us a little
bit queazy. But who would have ever thought 3 years ago that we
would be where we are today in terms of balancing the budget.
We are within a stone's throw of doing it.
I have a belief that if the American people can get
energized about something, and if we representing them get
energized about something, all things are possible to he that
believes it. Let's go get it done. Thank you.
[The prepared statement follows:]
Statement of Hon. Matt Salmon, a Representative in Congress from the
State of Arizona
I appreciate the opportunity to testify before the Ways and
Means Committee in support of the ``Riley-Salmon Marriage
Protection and Fairness Act.'' The Taxpayer Relief Act (now
law) provided Americans with the first significant tax cut in
almost a generation. But our work is not done. As Chairman Bill
Archer has pointed out, Americans were taxed at a post World
War II record (19.9) percentage of Gross Domestic Product last
year.
Lawmakers from both sides of the aisle have called for the
next round of tax cuts to revise the tax code as it pertains to
married couples. One of the most indefensible aspects of our
current tax code is that over 40 percent of married couples pay
more in taxes filing jointly than they would if husband and
wife each filed individually. This ``marriage penalty'' has
been criticized by President Bill Clinton, Speaker Newt
Gingrich, and Majority Leader Trent Lott.
To ensure that tax law would not punish married Americans,
Representatives Jerry Weller and Dave McIntosh introduced a
bill, which I have cosponsored, that would eliminate the
``marriage penalty'' for the 40 some-odd percent of couples who
pay more taxes filing jointly than they would if each spouse
filed as an unmarried individual. However, it would upset the
principle embedded in current law that different families with
the same total income should be treated equally for tax
purposes. Consequently, it would place most couples in which
both spouses work full time in a more favorable tax position
than families in which one spouse remains at home or works part
time. Jerry Weller and Dave McIntosh have put this issue on the
map. Taxpayers owe them a debt of gratitude, and I applaud
their leadership on this issue. But ``income splitting'' offers
a better fix to this important problem.
The Riley-Salmon bill would permit married couples to use
``income splitting'' on their tax returns, and would increase
the standard deduction for married couples. These changes would
offer almost all married couples a tax cut, would eliminate the
tax penalty on marriage that exists under current law, and
would continue the current policy that different families with
the same total income should be treated equally for tax
purposes. Senator Lauch Faircloth has introduced virtually the
same bill in the Senate (S. 1285).
Most importantly, the income-splitting legislation we have
introduced treats equitably those families in which one parent
stays at home. As the New York Post has editorialized, this
approach would end the marriage penalty and benefit ``hard-
pressed one-income married families.'' Another attractive
feature: Maggie Gallagher noted in a Washington Times column on
the marriage penalty that income-splitting would keep ``the
government from taking sides in the mommy wars.'' Indeed, as
the Congress and President contemplate proposals to improve day
care for young children--including the President's proposal to
pour billions of dollars into day care centers, while ignoring
parents that raise their kids or have relatives who participate
in child-rearing--pursuing a marriage penalty fix that does not
assist spouses who choose to remain at home or work part-time
should cause us to pause.
Pro-family organizations such as the Family Research
Council and Eagle Forum, and tax reform groups such as National
Taxpayers Union are aligning behind our approach because it
benefits all married couples. Some will undoubtedly criticize
our proposal as too difficult to achieve given budgetary
limitations. Indeed, the bill would likely require Washington
to run on $30 billion less of tax money from America's
families. But the preservation and security of the cornerstone
of America, the smallest, yet most important unit of
government--the family--is too important to shortchange with
more economical, but less effective proposals. Additionally,
Chairman Archer recently unveiled a proposal that would cap
federal taxation at 19 percent of Gross Domestic Product, which
if enacted, could amount to an annual tax cut of up to $75
billion. A comprehensive marriage penalty fix would represent
less than half of this amount.
I look forward to working with the Committee on passing a
marriage tax relief bill that benefits all families.
Chairman Archer. Thank you for your testimony.
Congressman Riley, we would be happy to receive your
testimony. Again, your entire written statement, without
objection, will be inserted in the record. You are recognized
to proceed on your oral testimony.
STATEMENT OF HON. BOB RILEY, A REPRESENTATIVE IN CONGRESS FROM
THE STATE OF ALABAMA
Mr. Riley. Thank you, Mr. Chairman. Mr. Chairman, I want to
thank you for holding this important hearing today. I
appreciate the opportunity to come and speak before the
Committee about the marriage tax penalty. I think that we can
all agree that the marriage tax penalty is unfair and is
misguided. According to the Joint Tax Committee in 1996, more
than 21 million married couples paid a marriage penalty costing
more than $28 billion a year. But as simply the average
American couple will pay $1,400 more in income taxes simply
because they are married. In my opinion, it is difficult to
comprehend the devastating effect that the marriage penalty has
had on our society. Instead of encouraging and helping families
to stay together, our current Tax Code is forcing them apart.
Unfortunately, President Clinton's 1993 tax increase made
the marriage penalty even more painful for married couples. For
example, according to the National Center for Policy Analysis,
the marriage penalty for couples earning $50,000 is $1,326 if
they have no children. However, if they have two children, the
marriage penalty would be $4,348, a penalty of $1,500 per
child.
Yesterday, I introduced the Marriage Protection and
Fairness Act, that will once and for all eliminate this
penalty. My proposal is unique because it allows couples to
effectively split their combined incomes for tax purposes. That
means that taxes for married couples would be figured by adding
up the income of both spouses and dividing by two. Each would
be taxed on half of their own total income. Furthermore, the
bill also increases the basic standard deduction for married
couples to twice the standard deduction. This would lower the
tax burden for all families and would lower it regardless of
how many children they have. Moreover, it would neutralize the
tax incentive for two versus one income.
Mr. Chairman, there are many good marriage penalty relief
proposals before Congress today. Like many of our colleagues, I
am a cosponsor of the Weller-McIntosh Marriage Tax Elimination
Act. But suppose one spouse earns $30,000 a year, and the
family needs more income. If the other spouse takes a paid job,
then the couple will benefit from the Weller-McIntosh proposal.
But if the first spouse works harder to increase his own
earnings by working overtime, by taking a second job, or by
getting a promotion, the couple gets no benefit at all.
Essentially, this means that two couples with the same family
income, would pay a different Federal income tax. The couple
where one spouse is a full-time homemaker would pay a higher
tax than a couple in which both spouses work.
That is why I introduced the Marriage Protection and
Fairness Act. I believe that my proposal is the fairest way to
eliminate the marriage tax penalty. It is the one that makes
the most sense. It will help millions of working couples who
are simply trying to make ends meet, and will allow them to
keep more of what they earn. Under this proposal, the tax
burden would be the same if one spouse earned all the family
income, or if both contributed to the family's earnings. It
would allow millions of Americans to make a choice on how many
breadwinners there should be, without incurring any penalties
for that choice. It will also create incentives for families,
that will allow one parent to stay at home to take care of and
raise their children.
Mr. Chairman, we in Congress have a moral obligation to
promote the family. If we are serious about giving working
American families tax relief, if we are serious about reducing
juvenile crime rates and keeping our children off drugs, if we
are serious about solving our Nation's many other social
problems, then we must promote legislation that promotes the
family. I can think of no other more important profamily
initiative that we in Congress can initiate than the repeal of
the marriage tax.
Mr. Chairman, my bill is the same legislation that has been
introduced by Senator Faircloth, Senator Hutchinson, and
Senator Mack in the other body. Our proposal is not a
revolutionary concept. In fact, it was the law until 1969. I
urge this Committee to strongly consider the merits of the
Marriage Protection and Fairness Act in its efforts to repeal
the marriage penalty tax.
Thank you, Mr. Chairman.
[The prepared statement and attachments follow:]
[GRAPHIC] [TIFF OMITTED] T0897.007
Statement of Hon. Bob Riley, a Representative in Congress from the
State of Alabama
Mr. Chairman, I want to thank you for holding this
important hearing today. I appreciate this opportunity to speak
before the Committee about the marriage tax penalty.
I think we can all agree that the marriage tax penalty is
unfair and misguided. According to the Joint Tax Committee, in
1996, more than 21 million married couples paid a marriage
penalty, costing them an extra $28 billion a year in taxes. To
put it simply, the average American couple will pay $1,400 more
in income taxes simply because they are married. In my opinion,
it is difficult to comprehend the devastating effect the
marriage penalty has had on our society. Instead of encouraging
and helping families to stay together, our current tax code is
forcing them apart.
Unfortunately, President Clinton's 1993 tax increase made
the marriage penalty even more painful for married couples with
children. For example, according to the National Center for
Policy Analysis, the marriage penalty for couples earning
$50,000 is $1,326 if they have no children. However, if they
have two children, the marriage penalty would be $4,348--a
penalty of $1,511 per child.
Yesterday, I introduced the Riley-Faircloth Marriage
Protection and Fairness Act that will once and for all
eliminate the marriage tax penalty. My proposal is unique
because it allows couples to effectively split their combined
incomes for tax purposes. That means that taxes for married
couples would be figured by adding up the income of both
spouses and dividing by two. Each would be taxed on half of the
total income. Furthermore, the bill also increases the basic
standard deduction for married couples to twice the standard
deduction of single filers (totaling $8,300 for 1997). This
would lower the tax burden for all families, regardless of how
many children they have. Moreover, it would neutralize the tax
incentives for two versus one income.
Mr. Chairman, there are many good marriage penalty relief
proposals before Congress today. And like many of my
colleagues, I am a cosponsor of the Weller-McIntosh Marriage
Tax Elimination Act. But, suppose one spouse earns $30,000 and
the family needs more income. If the other spouse takes a paid
job, then the couple will benefit from the Weller-McIntosh
proposal. But if the first spouse works harder to increase his
own earnings by working overtime, by taking a second job, or by
getting a promotion, the couple gets no benefit at all.
Essentially, this means that two couples with the same
family income would pay a different federal income tax--the
couple where one spouse is a full-time homemaker would pay a
higher tax than a couple in which both spouses work.
That is why I introduced the Marriage Protection and
Fairness Act. I believe that my proposal is the fairest way to
eliminate the marriage tax penalty, and it is the one that
makes the most sense. It will help millions of working
couples--who are simply trying to make ends meet--and will
allow them to keep more of what they earn. Under this proposal,
the tax burden would be the same if one spouse earned all of
the family income, or if both contributed to the family's
earnings. It will allow millions of American families to make a
choice on how many breadwinners there should be, without
incurring any penalties for that choice. It will also create
incentives for families that will allow one parent to stay at
home to take care of and raise their children.
Mr. Chairman, we in Congress have a moral obligation to
promote the family. If we are serious about giving working
American families tax relief, if we are serious about reducing
juvenile crime rates and keeping our children off drugs, if we
are serious about solving our nation's many other social
problems and living up to our obligations, then we must promote
legislation that promotes the family. I can think of no more
important pro-family initiative that we in Congress can
initiate than the repeal of the marriage tax penalty.
This debate over the marriage tax penalty is about the
survival of the American family. It's about correcting
unintended consequences. And if, under my proposal, 1,000,
10,000, or 100,000 American families are able to keep one
parent at home to care of the children, then I believe our
nation will be better off. I cannot think of a more noble goal.
Mr. Chairman, this committee has the opportunity to once
again reduce the tax burden on the American people. And like
many of our colleagues, your work and the work of this
committee is to be commended. As you begin preparing a tax
relief package, I urge you to include the Marriage Protection
and Fairness Act.
The time to pass this legislation is now. Working American
families simply cannot wait any longer.
Thank you, Mr. Chairman.
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Chairman Archer. Thank you, Mr. Riley. You and Congressman
Salmon are appearing together. Is there any difference in the
proposals that each of you would make or are you basically
behind the same proposal?
Mr. Salmon. It's the same bill, Mr. Chairman.
Mr. Riley. Exactly.
Chairman Archer. That's very, very helpful. I must say that
your approach is very appealing to me because again, coming
from a community property State, the property laws require
exactly what you are proposing. Half of each spouse's earnings
belong legally to the other spouse.
Mr. Riley. Yes, sir. That's exactly. What we can't do, Mr.
Chairman, is codify into law something that differentiates
between two working couples with the same income. That
essentially is what the former proposal does. I want to
compliment Congressman Weller for all the work and the
attention that he has brought to it, but I think we do need to
take it one step further. I think we need to go back and never
penalize any spouse for making the decision to stay home and
raise their family. Essentially, that's what we do. That is one
thing that I don't believe this Congress believes in. I know
it's certainly not something that I believe in.
Mr. Salmon. You know, Mr. Chairman, every politician just
about that's here, when they get up, they talk about family
values. I think it would be a real mixed message out of
Congress that we would send if we are saying basically you
mothers that decide to stay home or work part time so you can
spend more time with your children, we are going to penalize
you or continue the penalty for doing such. I think it sends
the wrong message out of Congress. Some say ``Can we afford to
do it?'' I say, ``Can we afford not to do it?'' I think that at
a time when the message is and has been for parents to be more
involved in their children's education, for parents to be more
involved in raising their children, for parents to be more
involved to make sure that their kids are off the streets, not
causing mischief. When a couple decides the best way for them
to address that issue is to have either mom or dad at home, I
think it really sends a poor message from Congress that we
disagree with you, that doesn't really add value.
Chairman Archer. Having said what I did, I also have to be
a realist about the amount of revenue that we are going to be
able to put into a tax package this year. We certainly will
make an effort to move in the direction of ameliorating the
negative impact of the marriage penalty. But how far we can go
will depend upon how much revenue we will be able to put into
the tax bill.
Does any other Member wish to inquire?
Mr. Shaw.
Mr. Shaw. Mr. Chairman, just very briefly I would like to
compliment all the witnesses, and this panel particularly, who
testified on the marriage penalty tax. It's certainly something
that we should take down. We partially took down the barrier to
marriage in the welfare reform bill, in which we paid people
not to work, not to get married and to have kids. We have to
take this last one down in the tax bill. It's absolutely
ridiculous that it's this way.
To share with you an anecdote that we had in our own
office. A young lady who works for me on my staff had a New
Years Eve wedding. They waited for their license to be dated on
the first of the year in order to avoid a marriage penalty.
This is absolutely ridiculous, that we penalize people for
being married. I compliment you for your work in this area, and
am very hopeful that this will be the top priority of the Ways
and Means Committee, to get rid of this unfair tax. Thank you.
Thank you, Mr. Chairman.
Chairman Archer. Does anyone else wish to inquire?
Mr. Weller.
Mr. Weller. Thank you, Mr. Chairman. I want to commend my
friends, Mr. Riley and Mr. Salmon, for their interest in this
issue. I have enjoyed talking with them and working with them.
Of course whatever idea is the best idea, the bottom line is we
want to eliminate the marriage tax penalty.
A couple questions I have. The Congressional Budget Office
study highlighted not only the marriage tax penalty, but they
also mentioned the so-called marriage bonus. In studying the
CBO study, they pointed out that the single earner family,
where one individual, the husband or wife works and the other
one might stay at home or is not a wage earner, I was
wondering, how does your legislation impact the so-called
marriage bonus? Does that marriage bonus still exist or does it
eliminate the marriage bonus for a married couple with one
source of income?
Mr. Riley. Congressman, it essentially does the same thing
that your legislation does. It allows them an option to figure
their tax liability in any one of three different forms, choose
the lowest of the three and that's what they would do. If there
is a bonus, I'm not too sure that that is a bad idea. If
anything, I wish that we could encourage more spouses to stay
home and raise their children. If that is an unintended asset
to this bill, then I think it's one that I would encourage.
Mr. Weller. Of course I am one who believes the bonus is a
good thing. We certainly don't want to jeopardize that. But let
me ask this. I was asked this question regarding our
legislation. Have you had the legislation scored yet? Do you
know the revenue impact?
Mr. Riley. No. We haven't. We filed it yesterday. It is
being scored. I think as Congressman Salmon said a moment ago,
it's going to be more expensive. We know that going in.
Probably by $8 to $10 billion. That is no menial figure. But
again, when you talk about codifying into law something that
discriminates against a homemaker, I do not believe that we can
allow that to happen in this country. Even though it may be
another $8 or $10 billion, I think it is going to be well worth
the price that we pay.
Mr. Salmon. If I might address that too. It will be
significantly higher on an annual basis than the other one,
even though as Congressman Riley mentioned, it hasn't been
scored yet. But I would like to go back to what we have seen,
Congressman Weller, since we have been in the Congress. The
projections on revenues have vastly exceeded what we ever
anticipated. There is a possibility in this next budget, we
will already see a surplus.
I believe that it simply gets down to priorities. If this
is our number one priority for the Congress, we can make it
happen. We can figure out a way to make it happen and really
not have any other aspect of government suffer for it.
Mr. Weller. Thank you. I look forward to working with you.
I share your goal, the number one must do as we look at this
year's budget negotiations when it comes to the tax provision
is eliminating the marriage tax penalty. So again, thank you.
Mr. Riley. Let both of us compliment you on your leadership
on this. We really appreciate it.
Mr. Salmon. If it wasn't for you, Congressman Weller, I
don't think any of us would be here today. So we must both
compliment you. I am a cosponsor of your bill as well.
Mr. Riley. So am I.
Chairman Archer. Mr. Hayworth.
Mr. Hayworth. Thank you, Mr. Chairman. I have no real
question other than just a commendation to my colleagues. Along
with my seatmate here, the gentleman from Illinois, I am very
pleased to see my colleague from Arizona, from the first
district. I think this is intriguing. And one of the newcomers
to the House of Representatives, the gentleman from Alabama.
Thank you for bringing sound, logical thinking and a good dose
of common sense here to the District of Columbia. I think you
are both to be commended. This is a very intriguing proposal.
We'll continue to study this as we also study the proposal by
our colleagues from Illinois and Indiana. I just want to thank
you again for your input into this debate and your solution.
Chairman Archer. Has the gentleman completed his inquiry.
Mr. Hayworth. Yes, sir. I know it's hard to believe.
Chairman Archer. Are there any other Members who wish to
inquire? If not, thank you very much. I appreciate your input.
Our next panel is Michael Graetz, Daniel Feenberg, David
Lifson, and Bruce Bartlett. Will you please come to the witness
table?
If you gentlemen, when recognized, will state where you are
employed and what you do for the record, and then proceed into
your testimony. And, as I mentioned earlier, we would
appreciate it if each of you would keep your oral presentation
within 5 minutes, and your entire written statement, without
objection, will be inserted in the record.
Mr. Graetz, we are delighted to have you back before the
Committee. You're no stranger to the Committee over the years,
and you go back to when the first marriage penalty was really
inserted into the law. So we are really pleased to have you
back before the Committee. And, again, if you'll tell the other
Members what you are doing now, and whom, if anybody, you
represent, we'd be pleased to hear your testimony.
STATEMENT OF MICHAEL J. GRAETZ, PROFESSOR OF LAW, YALE LAW
SCHOOL, NEW HAVEN, CONNECTICUT
Mr. Graetz. Thank you, Mr. Chairman. I am currently a
professor of law at the Yale Law School, and represent only
myself, I fear.
I thank you for inviting me to testify. The last time I
testified before this Committee on this subject was in May 1972
when we were considering the impact of legislation that had
been enacted in 1969. Here we are 25 years later on the same
topic.
I attached to my statement a chapter from my recently
published book, ``The Decline (and Fall?) of the Income Tax,''
which I've made available to the Members and to the staff. I
can, therefore, just summarize a few of the key points I would
like to make.
As you know, Mr. Chairman, in 1969 and shortly thereafter,
the marriage penalty affected very few people. In 1972, when
Treasury testified, it said that only 15 percent of married
couples suffered a marriage penalty, while 85 percent received
a bonus. In the last 25 years, the scale and scope of the
marriage penalty have expanded dramatically. I think today
somewhere between one-half and two-thirds of all married
couples face a penalty because of some provisions that were
omitted from the numbers that you have discussed earlier.
There are two causes of this vast expansion: one is the
transformation of the Nation's work force and, in particular,
the entry of married women into the labor market, as has been
discussed earlier. The median income of those families is 40
percent greater than that of families with only 1 earner.
Second, while the composition of the Nation's work force was
changing so dramatically, Congress after 1969, was adding to
the Tax Code a number of new marriage penalties. The earned
income tax credit provisions have a very large marriage penalty
in them, in some cases the tax can be as high as one-fourth of
a combined couple's income. The 1993 changes requested by
President Clinton and accepted by Congress added whopping
marriage penalties at the top of the income scale and for
Social Security recipients.
These new tax penalties on marriage, in my opinion, Mr.
Chairman, have resulted from efforts by Congress to fit tax
measures into straightjackets imposed by budgetary revenue
constraints coupled with the desire to make distributional
tables come out right. The fact that Congress now routinely
enacts sizeable penalties on marriage for the sole purpose of
conforming to distribution tables demonstrates the dangers of
subordinating important tax and public policy goals to such
constraints.
Second, because marriage penalties have been introduced to
the Code through specific provisions as well as in the tax
rates schedules, finding a solution to this problem is going to
be extremely difficult. There are two general approaches before
the Committee today, as you have heard, neither one of which,
in my view, is entirely satisfactory. The first is to try and
focus on specific tax penalties and to root them out wherever
they appear; allowing deductions or credits for a portion of
wages of the low-earning spouses, for example, would be such an
approach. It would not affect, for example, Social Security
recipients. And it's not clear to me why tax penalties for
marriage are more important for citizens at one part of the
income scale rather than at the other, or for workers rather
than retirees.
The second approach, exemplified by Congressman Weller's
bill and some others is to allow a married couple to file tax
returns as if they were unmarried. As you pointed out, Mr.
Chairman, this reintroduces distinctions between community
property and common-law States and creates incentives to shift
the ownership of assets. I think ultimately you have to base
such an approach on the aggregate income of the couple in order
to make it work.
In my book, I suggest that the marriage penalty is one of
the major reasons the American public is now so dissatisfied
with the income tax. It is one reason to take seriously
restructuring of the tax system. To be sure, we've seen today
people who have not married, and we know there are couples who
have divorced because of this tax penalty on marriage. It is
routine for couples to hold marriages in January rather than in
December and put their families and friends to a bizarre
inconvenience.
No one would design a tax system that penalized marriage.
No broad reform of the tax system before the Congress should
retain any tax penalty on marriage. The marriage penalty should
be removed from our system, but I am, frankly, Mr. Chairman,
skeptical about whether that can be done while retaining the
current income tax in place.
When a tax system departs fundamentally from the values of
the people it taxes, it cannot sustain public support. When
people lose respect for a tax law, they will not obey it.
Arbitrary and unfair tax distinctions of this sort instill
disdain for the law and disrespect for those who write and
enforce it.
Let me just end with this quote from an exchange between
Senator Robert Dole--I report this in my book--and between a
couple, Angela and David Boyter, in a Senate Finance Committee
hearing in 1980 on this subject. Senator Dole says, ``You are
divorced now?'' Mr. Boyter: ``We are divorced now and have been
for several years.'' Senator Dole: ``You live together
though.'' Mr. Boyter: ``That is right. The IRS told us that
that was preferable to getting remarried every year and then
divorced.'' Mrs. Boyter: ``My mother did not think so, but the
IRS did.''
Now is the time to conform the tax system to the values of
America's mothers.
Thank you, Mr. Chairman.
[The prepared statement and attachment follow:]
Statement of Michael J. Graetz, Professor of Law, Yale Law School, New
Haven, Connecticut
Mr. Chairman, and members of the Committee--
Thank you for inviting me to testify on this important
issue. I first sat at this table at a hearing on this subject
more than twenty five years ago in May, 1972, when I was
serving at the Treasury Department.
My views on this issue are set forth in Chapter Two of my
recently published book, The Decline (and Fall?) of the Income
Tax, which I have attached to this statement. That chapter also
reviews the history of the taxation of married and single
persons under the income tax. Its history makes clear that this
issue is no simple or straightforward matter. In this brief
statement, I shall merely emphasize a few major points:
1. From the inception of the income tax in 1913 until 1969,
there was no tax penalty for marriage. The marriage penalty
originated in 1969 as a by-product of a well-intentioned
Congressional effort to improve income tax equity for single
people. In 1972, the Treasury Department testified that fewer
than 15% of married couples faced any marriage penalty, while
more than 85% of married couples enjoyed a tax reduction by
filing joint returns. At that time, the marriage penalty
affected only this relatively small number of upper-middle-
income couples. It had virtually no impact at the bottom or top
of the income scale. In the past twenty five years, both the
scale and scope of income tax penalties on marriage have grown
dramatically so that today, somewhere between one half and two
thirds of all married couples pay greater income taxes solely
because they are married.
2. There are two causes of this great expansion of income
tax marriage penalties. The first is the transformation of the
nation's workforce, in particular, the entry of married women
into the labor market. Today, nearly three quarters of married
women under age 55 are in the labor force. The median income of
these families is 40% greater than families with only one wage
earner.
Second, while the composition of America's labor force was
changing so dramatically, Congress was adding to the tax code a
variety of new marriage penalties. By so doing, incentives for
divorce or for remaining unmarried were created for wide
segments of the population that previously had been unaffected.
The earned income tax credit provisions, which first came into
the Internal Revenue Code in the mid-1970s and have been
greatly expanded since, frequently impose a very large marriage
penalty on low income workers. In some cases, the additional
tax can be as much as one fourth of two low income workers'
combined incomes. The 1993 changes in the tax rate schedule
requested by President Clinton and accepted by Congress, added
whopping marriage penalties for high-income taxpayers, in some
cases as much as $15,000 of additional taxes a year. Income tax
penalties on marriage now appear throughout the tax code, in
the provisions taxing Social Security, for example, and in
provisions such as last year's tax legislation's phase-outs of
certian new benefits for families with children, and for
education or retirement savings.
These recent new tax penalties on marriage have resulted
from efforts by Congress to fit tax measures into a
straightjacket imposed by budgetary revenue constraints coupled
with a desire to make the distributional tables ``look right.''
The fact that Congress now routinely enacts sizable penalties
on marriage for the sole purpose of conforming to a specific
combination of revenue and distributional targets demonstrates
the dangers of subordinating important tax and public policy
goals to such constraints.
3. Because marriage tax penalties have entered the code in
recent years both through the tax rate schedule and through new
penalties being added here and there within specific
provisions, finding a clean and complete solution to this
problem is not easy. There are two general approaches--both of
which are represented in bills before this committee today--
neither one of which is entirely satisfactory.
The first line of attack is to focus on specific marriage
tax penalties and try to root them out whenever they seem
important. This, of course, requires establishing priorities,
which are inevitably controversial. For example, allowing a
deduction for a portion of the wages of the lower-earning
spouse, as was in the law prior to 1986 and has been re-
proposed here today, reduces marriage penalties for taxpayers
who can use the deduction, but does nothing to alleviate
marriage penalties, for example, due to the workings of the
earned income tax credit or the way Social Security benefits
are taxed. It is not clear to me, why tax barriers to marriage
are more important for higher-income citizens than for lower-
income citizens or even for workers rather than retirees.
The second approach--exemplified by Congressman Weller's
bill--is to allow a married couple to file tax returns as if
they were unmarried. This is an expensive and potentially
complex solution. It also reintroduces distinctions between
married couples who live in community property states and
common law states--a distinction which has long plagued the
income tax--and creates opportunities for tax savings by
shifting the ownership of investment assets within a family.
I am inclined to think that if a general solution to this
problem is to be attempted in the current income tax, it should
be based on the aggregate income of the married couple, not on
their individual incomes. For example, a married couple might
be allowed to fill out their joint return, but to treat half of
the income as earned by each spouse and file as single persons.
This would avoid some of the potential problems of Congressman
Weller's approach, but would also represent a comprehensive
attack on the income tax penalties on marriage. I doubt if this
alternative would be significantly less costly in terms of
revenues than Congressman Weller's bill. The approach I have
just described also would not solve the problem, which has been
emphasized by some analysts, of taxing a married woman who
enters the labor force at a marginal income tax rate that
depends on her spouse's income. In other words, while this kind
of approach could eliminate tax penalties solely due to
marriage, it would not eliminate certain tax disincentives for
married women to work. This does not trouble me, because I
regard the marriage tax problem as a problem of an income tax
system endorsing and incorporating the wrong values; I am far
less concerned with its behavioral effects.
4. In my book, I suggest that the marriage tax penalty is
one of the major reasons the American people have become so
dissatisfied with the income tax, one of several reasons to
take seriously the task of restructuring the nation's tax
system. This penalty, to be sure, has induced some people to
remain single who otherwise might have married, or to divorce,
and no doubt has induced many more couples who do marry to
postpone their weddings from December to January to save at
least one year's marriage penalty. They and their families and
friends all rightly hold Congress responsible for such an
absurdity.
No one would design a tax system in a way that penalized
marriage. No broad reform of the tax system recently introduced
in the Congress--whether a restructuring of the income tax as
Congressman Gephardt has proposed, or elimination of the income
tax in favor of some form of consumption tax as others have
proposed--should retain any tax penalty on marriage. The
marriage penalty must be removed from our tax system. I am,
however, somewhat skeptical about whether that can be done
while retaining in place the current income tax with its many
complexities and barnacles.
When a tax system departs dramatically from the fundamental
values of the people it taxes, it cannot sustain public
support. When people lose respect for a law, they will not obey
it. Arbitrary and unfair tax distinctions--such as those based
on marital status--instill disdain for the law and disrespect
for those who write and enforce it. The voluntary compliance of
private citizens which is essential to enforce any tax statute
will diminish.
Consider this quote from an exchange reported in my book
between Angela and David Boyter and Senator Robert Dole at an
August, 1980 hearing of the Senate Finance Committee on this
subject:
Senator Dole: ``You are divorced now?''
Mr. Boyter: ``We are divorced now and have been for several
years.''
Senator Dole: ``You live together, though?''
Mr. Boyter: ``That is right. The IRS told us that that was
preferable to getting remarried every year and divorced.''
Mrs. Boyter: ``My mother did not think so, but the IRS did.''
I applaud the Chairman for calling these hearings to
demonstrate that Congress has now become serious about
responding to the changes in society, in the economy, and in
the tax law, that have occurred since the marriage penalty was
first introduced in 1969. The absence of a perfect, or even
fully satisfactory resolution to this difficult problem should
not become an excuse for not acting. The public is properly not
indifferent about whether the nation's income tax law
encourages marriage or divorce. I hope that this Committee will
soon begin to bring the tax system into greater conformity with
the values of America's mothers.
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Chairman Archer. Mr. Feenberg.
STATEMENT OF DANIEL FEENBERG, RESEARCH ASSOCIATE, NATIONAL
BUREAU OF ECONOMIC RESEARCH, CAMBRIDGE, MASSACHUSETTS
Mr. Feenberg. I work at the National Bureau of Economic
Research in Cambridge, Massachusetts. I represent only myself.
Marriage penalties can be quite significant. For working
couples with modest income, penalties of $1,000 or $2,000 are
typical. For successful professionals, the increase can be
$10,000 or $20,000. More significantly, for two working-poor
parents near the EIC maximum, the penalty could be several
thousand dollars.
While the available statistical evidence does not support a
large effective marriage tax on marriage and divorce rates, the
situation is morally troubling, to say the least. Economic
analysis of the marriage penalty usually centers on other
aspects. First the system may be thought to be unfair because
it imposes the same tax burden on married couples with two
earners as it does on a one-earner couple with the same income,
even though the latter is better off by the value of the
additional untaxed home-produced services. This is an important
argument because it justifies different tax liabilities for
families according to the within-family distribution of income.
If this argument is accepted, it is again possible to reduce or
eliminate the marriage tax without giving up graduated rates.
The second concern that economists generally have is that
married women are typically thought to be quite responsive to
changes in the aftertax wage rate. This makes it particularly
inefficient to tax married women at their husband's marginal
rate. In 1995, Martin Feldstein and I analyzed a number of tax
reform proposals, including a revival of the second-earner's
deduction which allowed the secondary earner to deduct 10
percent of her earnings up to $30,000 from total income. For
married women with earnings below $30,000, this represents a
10-percent reduction in the marginal tax rate. With no change
in labor supply, we found a cost of $7.2 billion at 1994
levels, but we estimated a net $5.7 billion increase in wage
earnings. This would reduce the cost in the individual income
tax side of the budget by $1.1 billion. In addition, the
increased earnings also increase the payroll taxes by about
$0.9 billion, bringing the net loss to $5.2 billion. In this
case, the static revenue estimate overstates the actual loss by
38 percent. So the revenue argument against the deduction is
substantially moderated by the consideration of behavioral
effects.
We also simulated the law with a cap set at $50,000 rather
than $30,000. This is a better match to the 1981 law after an
allowance for inflation. The surprising feature of this
analysis is that the more generous plan dominates the original.
More specifically, the higher deduction limit raises the static
revenue loss by about $700 million, but induces an additional
$1.7 billion in earnings. While the personal income tax still
falls by $200 million, this is offset by greater payroll tax
revenues.
At the price, the secondary earner's deduction is an
especially attractive plan because it reduces marriage
penalties by about a third or more without much increasing
marriage bonuses and with very little complication to the tax
form. I note that the secondary earner's deduction has no
phaseout range, and I applaud that. A phaseout of the benefit
would just aggravate the marriage tax at some higher income
level.
H.R. 2456 creates a new filing status called a combined
return similar to optional separate filing but with deductions
apportioned by formula and using the schedule for single
taxpayers. My personal view is that combined return of the form
contemplated is highly problematic from the tax administration
complexity perspective. The plan adds at least 40 boxes to the
form 1040 and doubles the number of supporting schedules that
couples with separate property would have to attach. Even
taxpayers not benefiting from the new provisions might spend
substantial time confirming that disappointing fact, and few
will understand the justice for their disappointment.
We did simulate a number of plans which allowed the
secondary earner to file a separate return for wage income only
and with all deductions and exemptions on the couple's primary
return. While quite costly, these plans did well on a
deadweight loss per dollar of revenue basis and would be worth
considering. With only one form of income separately taxed, the
additional lines on the form are few and the additional
complexity is minimized.
There are a number of provisions in the law, including the
earned income tax credit, the phaseout of personal exemptions,
limitations on itemized deductions, and the thresholds for
taxation of Social Security that aggravate the marriage tax.
The apparent rationale for these phaseouts is that not only
should the Tax Code be progressive overall, but that each
provision of the Tax Code should be progressive on its own.
This is not attractive logically. Progressivity should be a
feature of the entire Tax Code, and not of the individual
paragraphs of the Tax Code. Perhaps we could have fewer of
these carbuncles on the Code if, like the British, we called
them clawbacks instead of phaseouts.
Finally, separate filing provides a dramatic example of the
role that graduated rates play in generating tax complexity. It
is often alleged that taxes need not be flat to be simple since
the effort of looking up the tax liability in the table is
independent of the number of brackets that were used to create
the table. But those 40 additional boxes on the 1040 that would
be required by the combined return are due to the fact that
with graduated rates the amount of tax depends upon exactly who
has earned the income. It is the individual's specific marginal
tax rate that means the tax cannot be simple unless it is also
flat.
My last remark would be to point out that neither of the
proposed bills do anything to ameliorate the marriage tax
generated by the EIC phaseouts. This is very unfortunate
because it is at these lowest income levels that the tax is the
greatest in proportion to income and where the effects on
marital status might be expected.
Thank you for your attention.
[The prepared statement follows:]
Statement of Daniel Feenberg, Research Associate, National Bureau of
Economic Research, Cambridge, Massachusetts
With graduated rates, higher income taxpayers pay a greater
percentage of their income in taxes. But there is no obviously
correct way to compare individuals and couples. The individual
with 50K of annual income pays a higher average tax rate than
the individual with 25K of income. But what rate should the
couple with 50K of income pay? Are they like the individual
with the same income, and should they pay the higher rate? Or
like two single taxpayers each with half that of income, and be
subject to a lower average rate set for the less well off? Does
it matter if both are working at a low wage, or just one at a
high wage? And should couples with the same income pay the same
tax, anyway? It isn't a question that can be answered
scientifically by investigation into whether two can live as
cheaply as one.
As you know, single and married people face different tax
schedules under current law, with the tax liability of married
individuals based on the couple's joint income. Consequently,
tax burdens change with marital status, although whether up or
down depends upon the closeness of the incomes of the spouses.
The more equal the incomes, the greater the tendency for tax
liabilities to increase upon marriage.
The marriage penalty is no mere technical problem, and
marriage non-neutrality is inevitable in a tax system with
income splitting and graduate rates. From 1982 to 1986 the law
departed from pure income splitting by the introduction of the
secondary earner's deduction. That substantially ameliorated
the marriage penalty but was dropped when TRA87 provided an
even greater relief from the marriage penalties through lower
marginal rates. Recent increases in statutory marginal rates
have aggravated the marriage penalty again, as has the
introduction of taxable social security benefits. The 1997
Taxpayer Relief Act includes a child credit which adds a
potential marriage tax of $500 per child to those couples where
both husband and wife earn between $65,000 and $75,000. Their
income together puts them above the phaseout range for a
couple, but apart they would receive the full benefit.
Under current law the magnitude of the marriage penalty can
be quite significant. For working couples with modest incomes,
penalties of one or two thousand dollars are typical. For two
very successful professionals, the increase could be ten or
twenty thousand dollars. More significantly, for two working
poor parents near the EIC maximum, the penalty could be several
thousand dollars, perhaps 15% of income. Of course a similar
number of couples receive a marriage bonus. It may hard to
reduce the tax without increasing the bonus, or we may consider
the bonus to be desirable.
While the available statistical evidence does not support a
large effect of marriage taxes on marriage and divorce rates,
the situation is morally troubling, to say the least.
Economic analysis of the marriage penalty usually centers
on other aspects. First, the system may be thought to be unfair
because it imposes the same tax burden on a married couple with
two earners as it does on a one earner couple with the same
income, even though the later is better off by the value of the
additional untaxed home produced services.
This is an important argument, because it justifies
different tax liabilities for families according to the within
family distribution of earnings. If this argument is accepted,
it is again possible to reduce or eliminate the marriage tax
without giving up graduated rates.
The second concern is that while the labor supply response
of married men to the after-tax wage is still controversial,
most economists in both parties believe that women are quite
responsive to changes in the after-tax wage rate. This makes it
particularly inefficient to tax married women at their
husband's marginal rate. In fact, currently the typical married
woman's marginal rate is even higher than her husband's rate,
once social security tax and benefit rules are accounted for.
Reducing the marginal rate faced by the more elastic earner
will improve efficiency.
In 1995 Martin Feldstein \1\ and I analyzed a number of tax
reform proposals including a revival of the secondary earner's
deduction. This was a feature of the tax law from 1982 to 1986,
and as with HR 2593, it allowed the secondary earner to deduct
10% of her earnings from total income. For married women with
earning below $30,000 this represents a 10% reduction in the
marginal tax rate.
---------------------------------------------------------------------------
\1\ Feldstein, Martin, and Daniel Feenberg, ``The Taxation of Two-
Earner Families'' in Martin Feldstein and James Poterba, editors,
Empirical Foundations of Household Taxation, University of Chicago
Press, 1996.
---------------------------------------------------------------------------
In our analysis we forecast the revenue effect after
accounting for the change in labor supply induced by the higher
after tax wage rate and lower tax liability. We take the
elasticity of hours with respect to the net of tax share to be
.45.
With no change in labor supply, we found a cost of 7.2
billion dollars at 1994 levels. But we estimated a net 5.7
billion dollar increase in wage earnings. This would reduce the
cost on the individual income tax side of the budget by 1.1
billion to 6.1. In addition, the increased earnings also
increase the payroll taxes that these women and their employers
pay by about .9 billion, bringing the net loss to 5.2 billion.
In this case the static revenue estimate overstates the loss by
38 percent. So the revenue argument against the deduction is
substantially moderated by the consideration of behavioral
effects.
We also simulated the law with a cap set at $50,000 rather
than $30,000. That is a better match to the 1981 law after an
inflation correction. The surprising feature of this analysis
is that the more generous plan dominates the original. This
occurs because the $30,000 cap provides no favorable effect on
the incentives of secondary earners with initial earnings above
$30,000, while nevertheless reducing the tax that they pay.
More specifically, the higher deduction limit raises the static
revenue loss by approximately $700 million, but induces an
additional $1.7 billion in earnings. Although the personal
income tax still falls by $200 million, this is offset by
greater payroll tax revenues.
At the price, the secondary earner's deduction is an
especially attractive plan because it reduces the marry about a
third or more, without much increasing marriage bonuses, and
with very little complication to the tax form. I note that the
secondary earner's deduction has no phaseout range, and I
applaud that. A phaseout of the benefit would just aggravate
the marriage tax at some higher income level.
HR 2456 creates a new filing status called a ``combined
return'', similar to optional separate filing but with
deductions apportioned by formula and using the schedule for
single taxpayers. We did not do an analysis for any form of
optional separate filing, perhaps because the revenue cost
seemed too great at the time, but I would expect that the
importance of accounting for behavioral effects would be as or
more important than for a secondary earner's deduction.
Anyone doing such an estimate for separate filing must face
the problem that even if one knew the current distribution of
property within the family, that distribution might be affected
by tax-avoidance measures induced by the availability of the
new filing status. With no simulations, I have no quantitative
evaluation of HR 2456.
My personal view is that a combined return of the form
contemplated by HR 2456 is highly problematic from the tax
administration and complexity perspective. The plan adds at
least 40 boxes to the Form 1040, and doubles the number of
supporting schedules that couples with separate property would
have to attach. Even taxpayers not benefiting from the new
provisions might spend substantial time confirming that
disappointing fact, and few will understand the justice of that
disappointment.
We did simulate a number of plans which allowed for the
secondary earner to file a separate return for wage income
only, with all deductions and exemptions on the couples primary
return. While quite costly, these plans did well on
a``deadweight loss per dollar of foregone revenue'' basis and
would be worth considering. With only one form of income
separately taxed, the additional lines are few, and the
additional complexity minimized.
Finally, separate filing provides a dramatic example of the
role that graduated rates play in generating tax complexity. It
is often alleged that taxes need not be flat to be simple,
since the effort of looking up the tax liability in the tax
table is independent of the number of brackets. But those 40
additional boxes on the 1040 would be required under separate
taxation with graduated rates because the amount of tax would
depend upon exactly whose income is whose.
Neither HR 2456 nor HR 2593 do anything to ameliorate the
marriage tax generated by the EIC phaseouts. This is
unfortunate because it is at the lowest income levels that the
tax is the greatest proportion of income and where effects on
marital status might be expected.
Thank you for your attention.
Daniel Feenberg is Research Associate of the National Bureau of
Economic Research, Cambridge MA. The views expressed here are
those of the author, and not of any institution.
Chairman Archer. Thank you, Mr. Feenberg.
Our next witness is David Lifson. Mr. Lifson, you may
proceed.
STATEMENT OF DAVID LIFSON, VICE CHAIR, TAX EXECUTIVE COMMITTEE,
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
Mr. Lifson. Mr. Chairman, and Members of this distinguished
Committee: I am David Lifson, vice chair of the Tax Executive
Committee at the American Institute of CPAs--the national
professional organization of CPAs with more than 330,000
members. Many of our members are tax practitioners who,
collectively, prepare income tax returns for millions of
Americans. We appreciate this opportunity to testify today on
the marriage penalty.
The AICPA urges that the tax system be modified to
eliminate or reduce the marriage penalty. The tax system should
be marriage neutral. Both simplification and equity must also
be considered. This issue involves tax, social, and economic
policy decisions that must be coordinated to maximize the
benefit of any change. We want to help and we can be very
helpful.
Your background studies confirm that under the current tax
system, a marriage penalty, or a marriage bonus, exists. The
bonus is intentional often, and is the result of prior tax
policy. The penalty is often unintentional.
There are currently at least 63 provisions in the Internal
Revenue Code where tax liability depends on whether a taxpayer
is married or single. In 1996, when the GAO released their
report on this topic, there were only 59 reasons. Then, there
were 59 reasons to leave your spouse. Now, with the 1997 tax
act, there are 63 reasons, representing nearly a 7-percent
increase in only 1 year. [Laughter.]
The marriage penalty results from two root causes: stacking
of joint income against progressive tax rates, and phaseouts of
credits, deductions, and exemptions often designed to prevent
abuses or to produce targeted benefits. We recommend that at a
minimum Congress should consider adopting standard phaseouts
for three income levels--low-income, middle-income, and high-
income taxpayers--rather than the 20 current levels; and adopt
one standard phaseout method for all. Note that the phaseout
ranges would eliminate many of the 63 penalties since the joint
amounts would be twice the single ranges, and the phaseout
ranges applicable to married-filing-separate taxpayers would be
the same as those for single taxpayers.
We have provided you a table to study our proposal further.
In one careful step, you could go a long way to attack two of
the most talked about issues today in taxes: complexity, and
the marriage penalty.
In addition, there are related tax problems that arise
because of marriage and joint liability. We urge this Committee
to give these matters their due consideration. For example, the
innocent spouse rules need modifications, as do the treatment
of carryover tax attributes, and NOL computations in the 50
percent of our marriages that end in divorce. Further, we
suggest that Congress provide for allocated liability instead
of joint and several liability on joint tax returns. And
perhaps most importantly, further consideration of separate
returns or separate liability calculations must be considered
as an option.
Again, we have provided you with background material in
this area. It's with our materials.
The AICPA has been studying this area, including H.R. 2593
providing a limited two-earner deduction, and H.R. 2456
allowing limited combined returns. These and other bills
included in the discussions today need to go further and need
to be coordinated into a single rational improvement.
You should consider all possible approaches--provide for
the separate calculations; provide for something like a two-
earner deduction; provide a tax credit; adjust or broaden the
current rate bracket schedules so that there is less marriage
penalty; or, as I said earlier, you can adopt a standard
phaseout for the three income levels, eliminating many of the
63 marriage penalties.
In conclusion, the AICPA urges that the tax system be
modified to eliminate or reduce the marriage penalty or bonus.
We have discussed a number of possible approaches to address
this problem. However, each of these provisions needs to be
thoroughly analyzed in order to provide the intended economic,
tax, and social benefits. Standard phaseouts could go a long
way. All alternatives should be considered.
American families, American workers, and all American
taxpayers deserve everyone's careful analysis and
consideration.
The AICPA thanks you for listening.
[The prepared statement and attachments follow. Appendices
are being retained in the Committee files.]
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Chairman Archer. Thank you for your testimony and your
input.
Mr. Bartlett. We'd be happy to have your testimony.
STATEMENT OF BRUCE R. BARTLETT, SENIOR FELLOW, NATIONAL CENTER
FOR POLICY ANALYSIS
Mr. Bartlett. Thank you, Mr. Chairman. I'm a senior fellow
with the National Center for Policy Analysis, which is a think
tank based in Dallas, Texas.
First, I would like to say that I associate myself
completely with all the statements previously made. I agree
with everything that the other three witnesses have said, and
in particular, I think that Mr. Graetz is right to point to the
pernicious effect of the domination of income distribution
tables in the tax policy process, because that's what has given
us all these crazy phaseouts that are so well detailed in the
previous testimony.
What I would like to concentrate on is the notion that
anything short of fundamental tax reform is very unlikely to
completely get rid of the marriage penalty. I support all of
the legislation that has been offered, and I think that in the
end it will probably be revenue constraints that determine how
much or how little is ultimately able to be done in terms of
the marriage penalty. I would just hope that whatever approach
to alleviating the marriage penalty that Congress adopts be
done with some vision of tax reform in mind. Personally, I
think the flat tax is the best way that we should go, but going
to a consumption tax, such as a national retail sales tax,
would also get rid of the marriage penalty. I think that either
of these approaches ought to be in the mind of the Congress as
they adopt incremental changes to the Tax Code, whether it be
in terms of the marriage penalty or in other legislation.
I would like to call attention to the discussion in the
Joint Committee's pamphlet, which points out, quite correctly,
that the Congress cannot simultaneously do three things. You
cannot have progressive tax rates, you cannot have equal
treatment of couples with equal incomes and be marriage
neutral. Historically, the Congress has accepted the first
premise--the first principle--and the second principle, and
abandoned the third. And we are now here to try to redress this
problem. But, anything we do to redress the marriage penalty in
terms of the legislation that is under discussion is going to
violate the second principle. You are going to have a situation
in which married couples with the same gross income are going
to be paying quite different taxes depending solely on how that
income is earned; whether it's earned by a single earner or two
earners, and what is the split of income between those two,
because the marriage penalty is exacerbated, or it's worst,
when a married couple each have approximately equal income.
So, I think that you need to be aware that you may be
leaving one minefield for another, and that we'll be back here
in a couple of years to try to fix another problem. And, as you
know very well, Mr. Chairman, this whole problem came about
because in 1969 the single earners were all complaining that
they were overtaxed relative to married couples, and you
changed the tax brackets to alleviate that problem and created
another one.
So, I would emphasize the need to go to fundamental tax
reform. And, as the Joint Committee's pamphlet correctly points
out, a pure flat rate tax system does eliminate the marriage
penalty; and also having a consumption tax would do the same
thing. But that would require abandoning the first principle,
which is the principle of progressivity in our tax system. I
agree with Professor Feenberg that you don't necessarily have
to have progressive rate structure to have a progressive tax
system. You can do a lot of things with the personal exemption,
with things like the earned-income tax credit to achieve pretty
much any degree of progressivity you wish to have in the
overall tax system without the necessity of having progressive
tax rates. And, I believe that there is now a growing
consensus, at least among economists, and among some tax
theorists as well, that maybe progressivity of the rate
structure is not necessarily something that we ought to accept
without question.
Of course, the other approach you can take is to simply
abandon the family as the fundamental tax unit and go to a pure
individual filing system such as we had before 1948. There is a
growing agreement, I think, among many tax theorists who are
cited in my testimony to this regard as well. Certainly going
to something like the choice system in the Weller-McIntosh bill
moves us a long way in that direction, but it might be worth at
least considering the possibility of going to a mandatory
individual filing system.
I'll just stop there and take your questions. Thank you.
[The prepared statement follows:]
Statement of Bruce R. Bartlett, Senior Fellow, National Center for
Policy Analysis
A marriage penalty results when a married couple pay more
taxes by filing jointly than they would pay if each spouse
could file as a single. Marriage penalties only result when
both spouses have earned income. Single earner couples never
pay a penalty and in fact always get a bonus from the Tax Code.
A marriage bonus results when a couple pay less taxes than they
would pay as singles.
The marriage penalty fundamentally results from
progressivity of the Tax Code.\1\ Marginal income tax rates
rise from 15 percent to 39.6 percent. This causes a marriage
penalty because the earnings of the secondary worker (the lower
paid spouse) in effect come on top of the primary earner's.
Thus, a secondary worker may find his or her income taxed at a
marginal rate higher than they would pay if taxed as a single.
To see how this works, consider a husband with taxable
income of $25,000 per year. Under both the single and joint tax
schedules he would pay 15 percent tax on that income. If his
wife also makes $25,000, however, only the first $17,350 of her
income would be taxed at 15 percent. The remaining $7,650 of
her income will be taxed at 28 percent, because it puts the
couple's total income above the $42,350 ceiling for the 15
percent bracket. Thus she will pay 13 percent more tax on that
income (the difference between 15 percent and 28 percent) than
she would pay if she were taxed as a single. In this case, that
would make the marriage penalty $994 per year.
On the same total income, a couple may either get a tax
bonus or pay a tax penalty depending on what the income split
is between husband and wife. The couple in the earlier example
paid the maximum marriage penalty on their $50,000 joint income
because each spouse earned half the income. However, if one
spouse earned substantially less than the other, the marriage
penalty would have become a marriage bonus. If the husband
earned $40,000 per year while the wife earned $10,000, instead
of paying a penalty of $994 per year, they would have received
a bonus of $910. That is, they would pay $910 less in taxes as
a couple filing jointly than they would pay if each were taxed
as a single.
The marriage penalty is most likely to strike couples whose
incomes are roughly equal. No couple with equal incomes or
those within 10 percent of each other receive a marriage bonus
and most receive penalties. As noted earlier, no single earner
couples pay a marriage penalty and virtually all, regardless of
income, receive a bonus.
To get an idea of how marriage penalties and bonuses affect
real people, the Congressional Budget Office (CBO) looked at
Internal Revenue Service and Census data. The CBO found that
the highest proportion of marriage penalties occurred when the
higher earning spouse made between $20,000 and $75,000 per
year. Couples with incomes above and below these levels were
more likely to receive a tax bonus for being married.
Thus we see that marriage penalties are most likely to
impact on couples with middle incomes whose incomes are roughly
equal. In an interesting article, Professor Dorothy Brown of
the University of Cincinnati College of Law has argued that
these two factors mean that blacks are more likely to suffer a
marriage penalty, while whites are more likely to receive a
marriage bonus from the Tax Code.\2\ The reason is because
among married couples, black women are more likely to work than
white women. Furthermore, working black women on average
provide a higher percentage of the couple's total income than
working white women. According to a 1990 study by the U.S.
Commission on Civil Rights, 75 percent of black women work
full-time, whereas only 62 percent of white women do. And
working black women contribute 40 percent family earnings,
while working white women contribute just 29 percent.\3\
Although the marriage penalty is inherent in the nature of
progressive tax rates, its magnitude has gone up and down with
changes in the tax law. When the income tax was established in
1913, there was no distinction between married and unmarried
taxpayers. There was a single rate schedule that applied to
both.
The tax problems related to working women were much less in
those days because only a small number of married women worked
outside the home. In the census of 1900, there were only
769,000 married women in the labor force, out of a total of
27,640,000 workers. Even single women were unlikely to hold a
paying job at that time. The female labor force participation
rate was just 20 percent in 1900, compared to 86 percent for
men.\4\
In the 1920s, however, a number of couples in community
property states began filing separate tax returns, with each
spouse claiming half the couple's total income.\5\ This was
justified on the grounds that under community property each
spouse is deemed to own half the couple's joint earnings,
regardless of who earned them. By contrast, in common law
states, the earnings of a spouse generally belonged to that
spouse. Among the states with community property laws at that
time were Texas, Arizona, Idaho, Louisiana, Nevada, New Mexico,
Washington and California.
Initially, the Attorney General of the United States ruled
that couples in community property states could split their
income for tax purposes. This had the effect of reducing taxes
for most couples. For example, if a husband had $20,000 of
earnings and his wife had none, they would be taxed as if each
earned $10,000. This generally put them in a lower tax bracket
and lowered their joint tax liability. Had this state of
affairs been allowed to continue, it would have led states to
adopt community property laws just to give their citizens a cut
in their federal income taxes.
Congress and the Treasury Department attempted to thwart
the use of income splitting through legislation and
regulations. Eventually, a case reached the Supreme Court on
the question of income splitting. In Poe v. Seaborn (1930), the
Court ruled that state community property laws did allow
couples to split their incomes for federal income tax purposes.
And as expected, it did indeed lead several states to change
from common law to community property in order to give their
citizens a tax cut at no expense to the state. This trend
accelerated when tax rates shot up during World War II. By
1948, Oregon, Nebraska, Michigan and Oklahoma had changed their
laws to become community property states.\6\
Obviously, this situation led to a great deal of
unfairness, with citizens of some states paying significantly
lower federal income taxes than citizens of other states with
the same income. The magnitude of the marriage penalty for
couples in common law states in 1947 was quite high. Some
couples in common law states were paying 40 percent more in
federal income taxes than they would have paid in a community
property state. A couple with a joint income of $25,000, for
example, would have paid $9,082 in federal income taxes in a
common law state, but only $6,460 in a community property
state.\7\ As Professor Michael Graetz of Yale recently noted,
``this absurd situation did not engender great respect for the
integrity of the income tax.'' \8\
Congress finally resolved this problem in the Revenue Act
of 1948, which extended the principle of income splitting to
all married couples.\9\ This constituted a significant tax cut
for most married couples. The bulk of the benefits accrued to
couples with middle incomes.\10\
More significantly, almost every married couple saw a sharp
reduction in their marginal tax rate--the tax that applies to
the last dollar earned. A couple earning $51,000, for example,
saw their marginal rate drop from 75 percent to 59 percent
between 1947 and 1948. Again, those in the middle brackets, not
the rich, were the principal beneficiaries.
In practice, the impact of lower tax rates was mainly on
women. Since a married woman's earnings came on top of her
husband's, she was in effect taxed at her husband's marginal
tax rate on the first dollar of her earnings. With marginal tax
rates going as high as 90 percent after World War II, this very
strongly discouraged married women from working.
Although the institution of income splitting was highly
beneficial to most married couples, it created a problem for
single taxpayers. As a result of income splitting, a married
couple mow paid significantly less tax than a single earner
with the same income. Congress tried to address this inequity
in 1951 by creating a new tax rate schedule for single heads of
households, which roughly split the difference between the
married and single tax schedules.
Singles, however, continued to agitate for tax relief. By
1969, some single taxpayers were paying 42 percent more federal
taxes than a married couple with the same income. That year
Congress created a new tax schedule for singles that was
designed to keep the tax burden on singles and married couples
with the same income within 20 percent of each other. This
legislation created a significant marriage penalty for the
first time.\11\ As a result, some married couples now paid more
taxes by filing jointly than they would have paid if both filed
as individuals.\12\
Further contributing to the rise of the marriage penalty
was the steep rise in the number of women in the labor force.
The number of women in the labor force increased by about 50
percent between the late 1940s and the early 1970s. The labor
force participation rate for women has continued to rise since
and in 1997 was almost double the rate of 1947. This is
important because a marriage penalty only occurs when a husband
and wife both have earned income. With women working in greater
and greater numbers, this means that the likelihood of a couple
suffering a marriage penalty rose concomitantly.
As knowledge of the marriage penalty grew, increasing
numbers of couples began to take matters into their own hands
by getting divorced for tax reasons. One couple, David and
Angela Boyter, received national publicity for getting divorced
each December, allowing each to file as single for the year,
and then getting remarried in January.\13\ Eventually the IRS
cracked down on this charade, but not before moving Congress to
action.\14\ By 1981, there was strong political pressure to
redress the marriage penalty problem. A variety of proposals
were put forward to accomplish this goal.\15\
In the Economic Recovery Tax Act of 1981, Congress
attempted to redress the marriage penalty by giving the lower
paid spouse a 10 percent tax deduction on income up to $30,000,
for a maximum deduction of $3,000. While this provision did not
eliminate the marriage penalty, it did redress the problem
substantially for most married taxpayers.\16\
The secondary earner deduction did not live long, however,
and was eliminated by the Tax Reform Act of 1986. But because
the Tax Reform Act sharply reduced tax rates for most
taxpayers, the net effect was to reduce the number of couples
suffering a marriage penalty and the magnitude of the
penalty.\17\ Nevertheless, some couples were worse off.\18\
The most recent tax legislation with a major impact on the
marriage penalty is the 1993 tax bill.\19\ Interestingly, the
provision of the legislation that exacerbated the marriage
penalty was not the increase in tax rates, but the expansion of
the Earned Income Tax Credit (EITC). The EITC is a refundable
income tax credit for workers with low earnings. It creates
marriage penalties because it is phased-out as incomes rise and
because it is maximized for workers with two children.\20\ No
additional credit is available for three or more children in a
single qualifying family. Depending on their income, therefore,
a two-earner couple might significantly increase their joint
EITC benefit by divorcing. And if they have more than two
children, the benefits of divorce can be enormous. In 1996, for
example, a two-earner couple with four children and each
earning $11,000 would have increased their EITC payment from
$1,375 to $7,120 by getting divorced, with each spouse claiming
two children.\21\
As noted earlier, the principal effect of the marriage
penalty has been on wives, because they generally earn less
than their husbands and thus are in effect taxed at their
husbands' marginal tax rate. This means that wives generally
receive less aftertax income on each dollar they earn than
their husbands do. This alone is sufficient to significantly
discourage work effort among married women. There is a
considerable amount of economic research clearly demonstrating
that high marginal tax rates reduce labor supply, especially
for married women.\22\
The disincentive effects of high marginal tax rates on
married women are aggravated by their looser attachment to the
labor force than men and their child-rearing
responsibilities.\23\ Although most married women who work do
so because of financial necessity, many do not. Their income is
not essential for maintaining a couple's standard of living.
Such women may work for a variety of reasons, including the
simple joy of doing so. But the consequence is that they are
more easily driven from the labor force by tax disincentives
than married men are. For this reason, economic theory suggests
that married women should be taxed less than married men.\24\
Thus it should come as no surprise that tax policies
affecting the marriage penalty have had a significant impact on
female labor supply. The institution of income splitting in
1948 and the effective reduction in marginal tax rates had a
significant effect on women's work decisions. Between 1947 and
1950 the labor force participation rate for married women shot
up, raising their share of the female labor force from 46.2
percent to 52.1 percent. Those with a husband present, those
most likely to be affected by income splitting, increased their
labor force participation most, increasing their share of the
female labor force from 40.9 percent to 48 percent. By
contrast, single, widowed or divorced women, who gained nothing
from income splitting, saw their labor force participation stay
flat or decline. The labor force participation rate for men was
also unchanged over this period.
A study of the 1981 tax act, which reduced the marriage
penalty by instituting a secondary earner deduction, shows that
married women's work expanded by almost enough to pay for the
deduction's revenue loss.\25\ Analysis of the Tax Reform Act of
1986, which lowered the top marginal tax rate from 50 percent
to 28 percent, shows that married women responded more strongly
to the increased work incentive than men did.\26\ Another study
estimated that if the marriage penalties remaining after the
Tax Reform Act were eliminated, the average married woman would
increase her hours worked by 46 hours per year. High-income and
low-income women would respond even more strongly, increasing
their work hours by 100 hours per year.\27\
The latest estimates by Martin Feldstein and Daniel
Feenberg suggest that the labor supply response of married
women to reduction of the marriage penalty could be quite
large. Sharply cutting the tax rate on secondary workers could
lead to an increase in earnings by such workers of as much as
$66 billion per year.\28\
In addition to effects on labor supply, the marriage
penalty also impacts the marriage/divorce decision. There is
certainly no question that over time the number of couples
living together without marriage has sharply increased. The
Census Bureau reports that 523,000 adults of the opposite sex
were living together in 1970. By 1996, this figure had risen to
3,958,000. In 1970, unmarried couples represented just 0.5
percent of the married couples in the United States. By 1996,
this percentage had risen to 7.2 percent. At least some of this
is undoubtedly due to tax considerations.
Several studies have looked at this question. They find
that the marriage penalty has a small but significant impact on
couples' decision to marry. When the marriage penalty rises
aggregate marriage rates fall. There is a much greater impact
on the timing of marriage, with couples often delaying marriage
late in the year to minimize their marriage penalty.\29\
Finally, there is some evidence that taxes encourage divorce,
especially on the part of women who are affected most by the
marriage penalty.\30\
As noted earlier, from 1913 to 1948 Congress adopted an
approach to taxation that did not differentiate between married
and unmarried persons. There was only one tax schedule and
everyone paid the same rates. A single person and a married
couple with the same income paid the same tax. Congress did not
willingly adopt income splitting in 1948. It was forced to do
so out of necessity resulting from the consequences of a
Supreme Court case. Nevertheless, the effect was to replace the
individual with the family as the fundamental unit for
taxation.
It has long been known that a tax system cannot
simultaneously do three things: (1) have progressive tax rates,
(2) have equal tax treatment of couples with the same income,
and (3) be marriage-neutral.\31\ The last point means that
marital status would have no effect on an individual's tax
liability. If the first point is accepted, one must choose
between the second and third. In 1948, Congress chose the first
and second and abandoned the third.
In recent years, a number of tax theorists have questioned
Congress's decision. Progressivity is no longer assumed to be a
primary criterion of our tax system. Increasingly, tax
theorists question whether it is fair to penalize those with
higher incomes, while economists produce more and more data on
the economic cost of progressivity. At the same time, others
question the assumption of family-based taxation. They argue
that a system of individual filing would be fairer, simpler and
more efficient.
The notion of progressivity has been under attack for many
years. Tax experts have long known that exemptions, deductions
and exclusions in the Tax Code can easily erode the nominal
progressivity of the rate structure. They have also known that
progressivity breeds complexity, evasion and imposes a large
deadweight cost on the economy. But the idea that ``fairness''
demanded higher tax rates on those with upper incomes was too
widespread to challenge.\32\
By the 1980s, however, opinion had shifted sufficiently
that there was now serious support for the idea of a flat tax,
one with a single tax rate for all taxpayers regardless of
income. So popular was the idea that in 1986 Congress went a
long way toward a flat tax by creating a two-rate tax system,
with a top rate of just 28 percent. Eventually, even academic
tax theorists began to come around to the idea. Now it is
common to read criticism of progressivity in leading law
journals, where earlier it would have been unthinkable.\33\
At the same time, economists have increasingly come to see
the cost of progressivity as extremely high. One study put it
this way:
Even a mild degree of progressivity in the income tax system
(as measured by the steepness of the marginal rate schedule)
imposes a very large efficiency cost. For example, in
comparison with an equal revenue proportional income tax, a
progressive income tax with average tax rates varying over the
life cycle between .23 and .32 and marginal rates ranging from
.23 to .43 imposes an efficiency cost greater than 6 percent of
full lifetime resources.\34\
Since that study appeared, many others have come to similar
conclusions about the overall welfare cost of progressivity in
the U.S. tax system.\35\ As a result, a recent president of the
American Economic Association has said, ``Today, it is fair to
say that many, if not most, economists favor the expenditure
tax or flat rate income tax. This group has joined the
opponents of progressive taxation in the attack on the income
tax.'' \36\
Just as progressivity increasingly has become questioned as
a norm of taxation, so too many tax theorists now question
whether the family should be the fundamental unit of taxation.
They suggest that the individual, rather than the family, is
the most appropriate unit of taxation. Such a move would
eliminate the marriage penalty completely, but would also
eliminate marriage bonuses. Such bonuses, however, may be
inappropriate because there is no particular reason why couples
should receive special treatment from the Tax Code merely
because they are married. To the extent that we wish to aid
children, we could target tax deductions or credits directly to
the children, rather than families in general.\37\
Individual taxation may also be better suited to changing
societal mores. In 1948, relatively few women worked, few
headed households, and most couples had a single earner. Now
women work in almost the same percentages as men, female-headed
households are common, and families represent a decreasing
share of households. Indeed, growth of the marriage penalty is
as much due to demographic changes as changes in the tax
law.\38\ According to the Census Bureau, nonfamily households
have risen from 18.8 percent of all households in 1970 to 30.1
percent in 1996.\39\ It is also worth noting that most major
industrialized countries use the individual as the basic unit
of taxation.\40\
It is not necessary to completely abandon the family as the
basic unit of taxation in order to eliminate the marriage
penalty. It would only be necessary to allow couples the choice
of filing as singles or jointly. This would preserve marriage
bonuses for single-earner couples, but eliminate the marriage
penalty for two-earner couples. However, Congress would also
have to pass rules about dividing joint income, such as
interest and dividends, and allocating itemized deductions,
such as for mortgage interest and dependents.\41\
The major objections to the choice approach are complexity,
cost and abandonment of the principle that couples with the
same income should pay similar taxes. It would be complex
because many couples would, in effect, have to do their taxes
twice: first jointly and then as singles to see which way they
would come out ahead. Also, whatever rules are adopted for
allocating joint income and deductions are bound to be
complicated.
Allowing couples to choose their filing status would also
be costly. According to the CBO, it would have reduced federal
revenues by $29 billion in 1996.\42\ It will also lead to
situations in which certain couples will pay less total taxes
than others with the same income. This could create pressure in
future years for further tax measures to redress this perceived
imbalance.
Congress certainly needs to be wary about adding additional
complexity to an already overly complicated Tax Code. However,
in recent years Congress has enacted a number of very
complicated provisions to the tax law involving phase-outs for
various tax benefits that also have the effect of worsening the
marriage penalty for some couples. For example, the child
credit is phased-out for couples with incomes over $110,000 and
over $75,000 for singles. This means that a couple making
$75,000 each would qualify for the full $500 per child credit
if they divorce, but receive nothing if married.\43\
Almost any solution to the marriage penalty is likely to
increase complexity and raise questions about cost and
fairness.\44\ Short of going all the way to an individual
filing system, other options for redressing the marriage
penalty include restoration of the second-earner deduction,
such as that included in the 1981 tax bill, widening tax
brackets and modifying provisions such as the EITC that create
marriage penalties.\45\ Given the cost of full elimination of
the marriage penalty and budgetary realities, in the end
Congress will probably be forced to choose among these more
limited options if it decides to address the issue at all.
A better solution to further tinkering with the Tax Code
would be to move toward a flat rate income or consumption tax.
By eliminating progressivity, it gets at the root cause of the
marriage penalty.\46\ Although there are many other arguments
for a flat tax, this one may prove most persuasive to two-
earner couples.
Endnotes
1. Other factors contributing to the marriage penalty are the
standard deduction, personal exemptions, the Earned Income Tax Credit,
phase-outs for personal exemptions, and the limitation on itemized
deductions. See Congressional Budget Office (CBO), For Better or for
Worse: Marriage and the Federal Income Tax (Washington: USGPO, 1997),
pp. 15-25.
2. Dorothy A. Brown, ``The Marriage Bonus/Penalty in Black and
White,'' University of Cincinnati Law Review, vol. 65, no. 3 (Spring
1997), pp. 787-798.
3. U.S. Commission on Civil Rights, The Economic Status of Black
Women: An Exploratory Investigation (Washington: USGPO, 1990), pp. 100,
105.
4. Bureau of the Census, Historical Statistics of the United
States: Colonial Times to 1970, 2 parts (Washington: USGPO, 1975), pt
1, pp. 132-33.
5. The following discussion draws heavily on Joint Committee on
Taxation (JCT), The Income Tax Treatment of Married Couples and Single
Persons, Joint Committee Print JCS-17-80 (Washington: USGPO, 1980), pp.
19-25.
6. For a discussion of the spread of community property laws and
other means by which people attempted to exploit the opportunity to
split incomes, see Carolyn C. Jones, ``Split Income and Separate
Spheres: Tax Law and Gender Roles in the 1940s,'' Law and History
Review, vol. 6, no. 2 (Fall 1988), pp. 259-310.
7. House Report 1274, 80th Congress, 2nd session (1948), p. 22.
8. Michael J. Graetz, The Decline (and Fall?) of the Income Tax
(New York: W.W. Norton, 1997), p. 31.
9. For details, see Stanley Surrey, ``Federal Taxation of the
Family--The Revenue Act of 1948,'' Harvard Law Review, vol. 61, no. 7
(July 1948), pp. 1097-1164.
10. House Ways and Means Committee, Reduction of Individual Income
Taxes, 80th Congress, 2nd session (Washington: USGPO, 1948), p. 28.
11. For evidence that small marriage penalties existed for some
taxpayers before 1969, see John Brozovsky and A.J. Cataldo, II, ``A
Historical Analysis of the `Marriage Tax Penalty,''' Accounting
Historians Journal, vol. 21, no. 1 (June 1994), pp. 163-187.
12. Grace Blumberg, ``Sexism in the Code: A Comparative Study of
Income Taxation of Working Wives and Mothers,'' Buffalo Law Review,
vol. 21, no. 1 (Fall 1971), pp. 49-98; Joyce Nussbaum, ``The Tax
Structure and Discrimination Against Working Wives,'' National Tax
Journal, vol. 25, no. 2 (June 1972), pp. 183-191.
13. The reason this worked is because for tax purposes a couple are
regarded as married for the full year if married on December 31, and
they are considered separated for the full year if divorced on that
day. For these and other complications regarding whether a couple is or
is not married for tax purposes, see Toni Robinson and Mary Moers
Wenig, ``Marry in Haste, Repent at Tax Time: Marital Status as a Tax
Determinant,'' Virginia Tax Review, vol. 8, no. 4 (Spring 1989), pp.
788-819.
14. Graetz, Decline of the Income Tax, pp. 35-38.
15. Lynda S. Moerschbaecher, ``The Marriage Penalty and the Divorce
Bonus: A Comparative Examination of the Current Legislative
Proposals,'' Review of Taxation of Individuals, vol. 5, no. 2 (Spring
1981), pp. 133-146.
16. Joint Committee on Taxation, General Explanation of the
Economic Recovery Tax Act of 1981 (Washington: USGPO, 1981), p. 35.
17. Harvey S. Rosen, ``The Marriage Penalty Is Down But Not Out,''
National Tax Journal, vol. 40, no. 4 (December 1987), pp. 567-575;
Douglas W. Mitchell, ``The Marriage Tax Penalty and Subsidy Under Tax
Reform,'' Eastern Economic Journal, vol. 12, no. 2 (April-June 1989),
pp. 113-116.
18. Joint Committee on Taxation, General Explanation of the Tax
Reform Act of 1986 (Washington: USGPO, 1987), p. 19.
19. Daniel Feenberg and Harvey S. Rosen, ``Recent Developments in
the Marriage Tax,'' National Tax Journal, vol. 48, no. 1 (March 1995),
pp. 91-101; Gregg A. Eisenwein, ``Marriage Tax Penalties After the
Omnibus Budget Reconciliation Act of 1993,'' CRS Report for Congress,
93-1000E (November 19, 1993).
20. Anne L. Alstott, ``The Earned Income Tax Credit and the
Limitations of Tax-Based Welfare Reform,'' Harvard Law Review, vol.
108, no. 3 (January 1995), pp. 559-564; Edward McCaffery, ``Taxation
and the Family: A Fresh Look at Behavioral Biases in the Code,'' UCLA
Law Review, vol. 40, no. 4 (April 1993), pp. 1014-1020.
21. Janet Novack, ``The Worm in the Apple,'' Forbes (November 7,
1994), p. 98.
22. The most recent research is summarized in Congressional Budget
Office, ``Labor Supply and Taxes,'' CBO Memorandum (January 1996); and
Robert K. Triest, ``The Effect of Income Taxation on Labor Supply in
the United States,'' Journal of Human Resources, vol. 25, no. 3 (Summer
1990), pp. 491-516.
23. Jerry Hausman, ``Taxes and Labor Supply,'' in Alan J. Auerbach
and Martin Feldstein, eds., Handbook of Public Economics (New York:
North-Holland, 1985), pp. 247-249.
24. Michael J. Boskin and Eytan Sheshinski, ``Optimal Tax Treatment
of the Family: Married Couples,'' Journal of Public Economics, vol. 20,
no. 3 (April 1983), pp. 281-297.
25. Daniel Feenberg, ``The Tax Treatment of Married Couples and the
1981 Tax Law,'' NBER Working Paper No. 872 (April 1982).
26. Nada Eissa, ``Taxation and Labor Supply of Married Women: The
Tax Reform Act of 1986 as a Natural Experiment,'' National Bureau of
Economic Research Working Paper No. 5023 (February 1995); idem, ``Tax
Reforms and Labor Supply,'' in James M. Poterba, ed., Tax Policy and
the Economy, vol. 10 (Cambridge, MA: MIT Press, 1996), pp. 119-151.
27. Deenie K. Neff, ``Married Women's Labor Supply and the Marriage
Penalty,'' Public Finance Quarterly, vol. 18, no. 4 (October 1990), pp.
420-432.
28. Martin Feldstein and Daniel Feenberg, ``The Taxation of Two
Earner Families,'' NBER Working Paper No. 5155 (June 1995).
29. James Alm and Leslie A. Whittington, ``Income Taxes and the
Marriage Decision,'' Applied Economics, vol. 27, no. 1 (January 1995),
pp. 25-31; idem, ``Does the Income Tax Affect Marital Decisions?''
National Tax Journal, vol. 48, no. 4 (December 1995), pp. 565-572;
idem, ``Income Taxes and the Timing of Marital Decisions,'' Journal of
Public Economics, vol. 64, no. 2 (May 1997), pp. 219-240; David L.
Sjoquist and Mary Beth Walker, ``The Marriage Tax and the Rate and
Timing of Marriage,'' National Tax Journal, vol. 48, no. 4 (December
1995), pp. 547-548; Alexander Gelardi, ``The Influence of Tax Law
Changes on the Timing of Marriages: A Two-Country Analysis,'' National
Tax Journal, vol. 49, no. 1 (March 1996), pp. 17-30.
30. Leslie A. Whittington and James Alm, ``'Til Death or Taxes Do
Us Part: The Effect of Income Taxation on Divorce,'' Journal of Human
Resources, vol. 32, no. 2 (Spring 1997), pp. 388-412.
31. Boris I. Bittker, ``Federal Income Taxation and the Family,''
Stanford Law Review, vol. 27, no. 6 (July 1975), pp. 1395-96; Jane M.
Fraser, ``The Marriage Tax,'' Management Science, vol. 32, no. 7 (July
1986), pp. 831-840; Marvin Chirelstein, Federal Income Taxation, 7th
ed. (Westbury, NY: Foundation Press, 1994), p. 219.
32. See Walter J. Blum and Harry Kalven Jr., The Uneasy Case for
Progressive Taxation (Chicago: University of Chicago Press, 1953).
33. See, for example, Richard L. Doernberg, ``A Workable Flat Rate
Consumption Tax,'' Iowa Law Review, vol. 70, no. 2 (January 1985), pp.
425-485; Charles R. O'Kelley, Jr., ``Tax Policy for Post-Liberal
Society: A Flat-Tax-Inspired Redefinition of the Purpose and Ideal
Structure of a Progressive Income Tax,'' Southern California Law
Review, vol. 58, no. 3 (March 1985), pp. 727-776; Curtis J. Berger,
``In Behalf of a Single-Rate Flat Tax,'' St. Louis University Law
Journal, vol. 29, no. 4 (June 1985), pp. 993-1027; Richard A. Epstein,
``Taxation in a Lockean World,'' Social Philosophy and Policy, vol. 4,
no. 1 (Autumn 1986), pp. 49-74; Joseph Bankman and Thomas Griffith,
``Social Welfare and the Rate Structure: A New Look at Progressive
Taxation,'' California Law Review, vol. 75, no. 6 (December 1987), pp.
1905-1967; Jay M. Howard, ``When Two Tax Theories Collide: A Look at
the History and Future of Progressive and Proportionate Personal Income
Taxation,'' Washburn Law Journal, vol. 32, no. 1 (Fall 1992), pp. 43-
76; Jeffrey A. Schoenblum, ``Tax Fairness or Unfairness? A
Consideration of the Philosophical Bases for Unequal Taxation of
Individuals,'' American Journal of Tax Policy, vol. 12, no. 2 (Fall
1995), pp. 221-271
34. Alan J. Auerbach, Laurence J. Kotlikoff, and Jonathan Skinner,
``The Efficiency Gains from Dynamic Tax Reform,'' International
Economic Review, vol. 24, no. 1 (February 1983), pp. 81-100.
35. Charles Stuart, ``Welfare Costs per Dollar of Additional Tax
Revenue in the United States,'' American Economic Review, vol. 74, no.
3 (June 1984), pp. 352-362; Charles L. Ballard, John B. Shoven, and
John Whalley, ``General Equilibrium Computations of the Marginal
Welfare Costs of Taxes in the United States,'' American Economic
Review, vol. 75, no. 1 (March 1985), pp. 128-138; idem, ``The Total
Welfare Cost of the United States Tax System: A General Equilibrium
Approach,'' National Tax Journal, vol. 38, no. 2 (June 1985), pp. 125-
140; Dale W. Jorgenson and Kun-Young Yun, ``Tax Reform and U.S.
Economic Growth,'' Journal of Political Economy, vol. 98, no. 5, pt. 2
(October 1990), pp. S151-S193; idem, ``The Excess Burden of Taxation in
the United States,'' Journal of Accounting, Auditing and Finance, vol.
6, no. 4 (Fall 1991), pp. 487-508.
36. Joseph A. Pechman, ``The Future of the Income Tax,'' American
Economic Review, vol. 80, no. 1 (March 1990), p. 1.
37. Harvey Rosen, ``Is It Time to Abandon Joint Filing?'' National
Tax Journal, vol. 30, no. 4 (December 1977), pp. 423-428; Alicia
Munnell, ``The Couple versus the Individual under the Federal Personal
Income Tax,'' in Henry J. Aaron and Michael J. Boskin, eds., The
Economics of Taxation (Washington: Brookings Institution, 1980), pp.
247-278; Pamela B. Gann, ``Abandoning Marital Status as a Factor in
Allocating Income Tax Burdens,'' Texas Law Review, vol. 59, no. 1
(December 1980), pp. 1-69; Laura Ann Davis, ``A Feminist Justification
for the Adoption of an Individual Filing System,'' Southern California
Law Review, vol. 62, no. 1 (November 1988), pp. 197-252; Marjorie E.
Kornhauser, ``Love, Money, and the IRS: Family, Income-Sharing, and the
Joint Income Tax Return,'' Hastings Law Journal, vol. 45, no. 1
(November 1993); Edward J. McCaffery, Taxing Women (Chicago: University
of Chicago Press, 1997).
38. James Alm and Leslie Whittington, ``The Rise and Fall and
Rise...of the Marriage Tax,'' National Tax Journal, vol. 49, no. 4
(December 1996), pp. 571-589.
39. Bureau of the Census, Statistical Abstract of the United
States, 1997 (Washington: USGPO, 1998), p. 59.
40. CBO, For Better or Worse, p. 60.
41. JCT, Income Tax Treatment, pp. 38-46.
42. CBO, For Better or Worse, p. 55.
43. For a discussion of other provisions of recent tax laws that
exacerbate the marriage penalty for some couples, see David J. Roberts
and Mark J. Sullivan, ``The Federal Income Tax: Where Are the Family
Values?'' Tax Notes (October 26, 1992), pp. 547-550; Albert B.
Crenshaw, ``For Two-Income Couples, More Reasons Not to Get Tied,''
Washington Post (August 24, 1997); Janet Novak and Laura Saunders,
``Torture By Taxation,'' Forbes (August 25, 1997), pp. 42-44; Diana
Furchtgott-Roth and Kevin Hassett, ``The Skyline Tax,'' The Weekly
Standard (September 29, 1997), pp. 13-14; Janet Novak, ``The Old Shell
Game,'' Forbes (December 29, 1997), pp. 76-81.
44. Opponents of eliminating the marriage penalty have already made
this point. See Jonathan Chait, ``Penalty Box: The Folly of Fighting
the Marriage Tax,'' The New Republic (October 20, 1997), pp. 14, 16.
45. CBO, For Better or Worse, pp. 47-56; Jonathan Barry Forman,
``What Can Be Done About Marriage Penalties?'' Family Law Quarterly,
vol. 30, no. 1 (Spring 1996), pp. 1-22.
46. CBO, For Better or Worse, p. 56; Joint Committee on Taxation,
Impact on Individuals and Families of Replacing the Federal Income Tax,
JCS-8-97 (Washington: USGPO, 1997), p. 103.
Chairman Archer. Thank you, Mr. Bartlett.
And my compliments to all of you because you have given us
some excellent testimony, and I can assure you that the
Committee is going to consider what you've said very seriously
before we act.
Do all four of you basically agree on a particular approach
which is appropriate to solve this problem? We have a problem;
we know that. But the solution to the problem is what we have
to focus on. Now, do you think all four of you could come
together on the appropriate solution?
Mr. Graetz. Mr. Chairman, I think that there are two
difficulties here in our coming together. One is the revenue
that you are prepared to devote to this issue. If you give us
unlimited revenue, I suppose we could reach a solution as
quickly as the Committee could, but we all know that that's not
the current reality. And so the question would be setting
priorities about where you would first relieve the marriage
penalty, and we might have different priorities.
I think that we probably would come fairly close to a
solution once you told us how much revenue we had to spend on
it. We could probably come to some agreement; although, I want
to be clear that my differences with Mr. Feenberg are
important. He is focused on the behavioral effects of this
marriage penalty on people entering the labor market, and I'm
focused on what taxing marriage does in terms of the signal it
sends to the American people about how the Congress and the
American people's values line up. I think this is a very
serious issue. This was, as Congressman Thomas said earlier, it
was a huge issue during the welfare debate, and it seems to me
it's an extremely important issue now concerning values and how
the tax system reflects values. So there is a difference
between us. I wouldn't put as much weight on incentives as Mr.
Feenberg.
I also want to compliment Mr. Lifson on the phaseout point.
That is clearly something that I think we could all endorse in
some fashion: to move to his phaseout solution. And this is the
first time I've heard that idea. As we said, Mr. Chairman, I've
heard most of them over the past 25 years.
Chairman Archer. Mr. Feenberg, since your name was
mentioned would you like to comment?
Mr. Feenberg. There's no disagreement in values between me
and Professor Graetz. I'm testifying to the things that I know
most about. That doesn't mean that I disagree with what he
testified about--other, no doubt, more important things.
Chairman Archer. Well, let me comment on that. Before, it
seemed like we always talked about what is the economic impact
of everything that we do here. Now I've begun to focus on what
is the moral and social impact of how we tax. I believe we're
going to have to talk more about that, and think more about
that, because it has a dramatic effect on our society, both
morally and socially. But, of course that's my own view which I
expressed right in this room a week ago in the press conference
that I held.
There was one reason for my asking you that question,
beyond what we've discussed, and it is because I have reached
the point of believing you will never fix the income tax; that
the income tax is, in effect, an attractive nuisance, which is
a very specific legal term meaning that it draws all kinds of
bad things into it over time. I will say that I used to be for
the flat tax, Mr. Bartlett, back in 1985, until I went through
the 1985-1986 reform effort, and after that I became convinced
you'll never fix the income tax. Though we shrank the amount of
deductions, we did reduce the number of tax rates to two--
statutorily at least. By 1990, we were already back to 3 rates,
and by 1993 we were back to the 5 rates we have now. The
empirical data prove that what we seem to learn from history is
that we never seem to learn from history.
Now you tell me how we're going to keep an income tax,
which inherently is an attractive nuisance, simple. I don't
believe it's possible. I don't believe this body will pass a
flat income tax without a deduction for charitable
contributions and home mortgage interest. Nor do I believe that
it will be able, politically, to pass a flat income tax without
taxing dividends, rent, royalties, and what we call--I think
inappropriately, but nevertheless--unearned income. It will not
happen.
And so you are off to the races again. You planted the seed
again, replanted the income tax--the roots are there and the
tree is spouting even before you get out of this Committee.
Inevitably you are back into all of the ramifications about how
we solve this problem. That's why I asked you the question,
because there is not unanimity among you as to how we solve it,
and we will always have to redefine income. It is an uncertain
term, and we will forever be creating inequities as we solve an
inequity, and then we will have to patch that.
So, I personally believe that the right way to do this is
to let people pay their taxes when they spend their money and
then you have no problem with a marriage penalty. But, that's
my own personal view which has been developed over the years.
Now, let me ask you all this--there are several things that
are specific to this marriage penalty, and I want to ask you:
under any proposal that you might be comfortable with, would
there be a marriage bonus? And if so, what would it be? And
would that, over time, be perceived as being equitable?
Mr. Bartlett. Well, speaking for myself, I think a case can
be made for getting rid of the bonuses. I don't really see any
reason as a matter of public policy why a man and a women
without children who simply happen to be married should pay
substantially less taxes than they would pay as singles. You'd
get rid of that by going to an individual filing system.
I think when we talk about families, what we really mean
are families with children, and I think you should target the
tax relief to the children directly and not to the institution
of marriage per se. Obviously, that's a somewhat controversial
point, but I think that that's the way we ought to think about
going. And I think that certainly the Weller-McIntosh bill
moves a long way in that direction. But, I think it is worth
noting that if you got rid of the bonuses, it's about the same
in the aggregate as the penalties, so that if you went to a
pure individual filing system it wouldn't really cost the
treasury anything.
Chairman Archer. Before I move on to you, Mr. Graetz, I ask
Mr. Bartlett: will the flat tax proposal that you endorse
completely eliminate the marriage penalty insofar as doubling
the exclusion for two people who are married compared to a
single?
Mr. Bartlett. It could easily be designed to do that.
Chairman Archer. No. But, let's take the Armey-Forbes
approach, is it double the exclusion for a married couple
compared to a single?
Mr. Bartlett. No, I think it's more.
Chairman Archer. So it still has a marriage penalty. You
cited that a flat tax gets rid of the marriage penalty, but
their proposal does not get rid of it.
Mr. Bartlett. Well, I would point out also that the sales
tax proposal--the Schaefer-Tauzin bill, for example--also has a
marriage penalty, because it has the rebate mechanism that is
based on family size, based on the Census Bureau----
Chairman Archer. Well, of course, that is one proposal that
is out there----
Mr. Bartlett. I'm just saying that there are many marriage
penalties, and you can design----
Chairman Archer. But certainly where all income is treated
equally and you pay your taxes when you spend your money, you
have no marriage penalty. All income is treated equally. You
don't have to get into the definition of income.
Mr. Bartlett. I'm just saying the rebate mechanism does, or
can, create a marriage penalty, that's all.
Chairman Archer. But, the point I wanted to make is that
there will not be an automatic elimination of the marriage
penalty if you go to a flat income tax.
Mr. Graetz.
Mr. Graetz. Mr. Chairman, I just wanted to say a word about
individual filing on a mandatory basis. That was the law before
1948. And, as you know well, what happened during the period of
1941 until 1948--which is the period when the income tax was
extended to the masses because of the Second World War--is that
a number of common-law States started moving to community
property. A number of States started to reverse their marital
property laws which had been in place historically depending
primarily on whether they had adopted the British property
system or a continental system--as Texas did. You cannot have
an individual filing that would not reintroduce the problem of
community property and common-law States that caused such havoc
in the forties. You also would introduce the prospect of tax
planning by shifting the ownership of property to the low-
income spouse. That is to say, if you just move some stock to
the low-income spouse, then the dividends on that stock would
be taxed at a lower rate than if the stock is owned by the
high-income spouse.
The reason that we have a marriage bonus is that Congress
decided in 1948 that the way to solve this problem under a
progressive rate schedule was to give married couples the best
possible split of income, which in a progressive system is to
treat them as if the income came equally from each partner. I
have to say, I think that marriage bonuses are much more benign
than marriage penalties.
But I think that moving back toward an individual filing
system is going to add complexity, in the filing of tax
returns, and also in terms of family arrangements. You're going
to hear from different couples than you heard from today, but I
suspect you'll hear from some.
Chairman Archer. Well, don't you have to continue to define
income and who earns the income? Now, I happen to believe that
in a marriage, half of a married couple's income is earned by
each spouse legally. Why should our tax laws not accept that?
But then you have different laws within the States on property
and you get all fouled up with the beginning point, which is
who earns this income legally. That is a very difficult
question to answer, and you never get away from it with an
income tax.
Well, do either one of the other two of you want to comment
on my initial question?
Mr. Lifson. Well, I would say that we could agree to a
method, and I would say that we could agree to a baseline. What
we would have a hard time agreeing on is not elimination of the
penalty, but who gets the bonus, if anybody.
But I would say as an accountant, I have listened to many
enraged other accountants, quite enraged about who should get
these bonuses. But I think that my fellow panelist said, it's a
much more benign argument about who should receive a bonus than
who should pay a penalty. The true issue is creating an
equitable base line, and arguably looking at the concept about
whether once you are married two of you are taxed jointly,
because of your marriage, or whether you are allowed to remain
an independent economic unit as so many marriages would like to
remain. You can still respect and report your income jointly.
And you can still tax it as if each person earns half. All of
these are modest mechanical considerations that I think can be
worked out. How to spend the bonus is beyond what I think we
could work out.
Chairman Archer. Well, that's why I asked the question
about the bonus. Because that is an inherent part of whatever
we ultimately do.
Mr. Bartlett. Could I just say one thing? I think that
while it is very important that we have some idea of ultimately
where we would like to go in terms of dealing with this
problem, you can't overlook the budgetary constraints. And I
just think that in the end you are going to be faced with a
dilemma. You're going to have a certain pot of money, and you
are going to have many competing interests, and at the end of
the day you are going to have whatever: $5 billion, $10
billion, however many billion, to devote to this one problem,
and you'll simply have to shoehorn some proposal that fits the
numbers into it. But I would like to suggest that when the time
comes that you look very carefully at the incentive effects
because, as you know, the Joint Committee now has the authority
to do some modified behavioral responses in terms of dynamic
scoring, and it may very well make the difference between going
with one approach or another that may have the same static cost
but they may have quite different dynamic costs.
Chairman Archer. Well, I think you are absolutely correct
in everything that you said. I want to highlight the end of it
because when we took over as a Congressional majority 3 years
ago, I pushed very hard for the Joint Committee on Taxation to
begin to take into account behavioral response; they do that
now, contrary to what an awful lot of people write out there.
They do take into account behavioral response. What they do
not, and cannot, take into account is microeconomic feedback
because that is determined by CBO. The Joint Committee has
really updated and modernized their estimating process, I
think, to become more accurate.
Let me ask one last question. The Committee has indulged me
and I apologize to the Members. The term targeting is now used
more in the arena politically. You heard the President use it
in his speech last night, that all tax relief should be
targeted. Now, doesn't targeting, in effect, impact in a bad
way on the marriage penalty?
Mr. Graetz. Mr. Chairman, this is a particularly
complicated question because many of the new marriage penalties
in the Code--and I mean the ones that are there because they
have been added subsequent to the 1969 change in the rate
schedule--are due to targeted provisions. For example, the
reason that a married couple who are retired will pay more
taxes in many instances than an unmarried couple who are
retired is because of the way in which the income taxation of
Social Security works. The reason that low-income workers--and
I have to say, listening to the couple that was here today and
the magnitude of the marriage penalties they were describing, I
suspect--I don't know this because I haven't seen their
returns, but I suspect--that part of the marriage tax they are
talking about is because of the way the earned income tax
credit works in its phaseouts. They said they made less than
$10 an hour and it sounded to me like they might be in that
targeted group. And here the problem, Mr. Chairman, is that
many of these penalties--many of the largest of these
penalties--now exist in specific provisions of the Code.
The AICPA again is to be complimented in looking for a
general approach to some of these phaseouts. I have to say, I
dread the thought of teaching the 1997 phaseout rules to my
basic income tax class, and I have the luxury of having Yale
Law students to try and master them.
Chairman Archer. Well, in effect, I would synthesize what
you said by saying that targeting can become a code word for
greater marriage penalties and much higher complications in a
Code that we say we want to simplify.
All of you are nodding your heads, and the record should
show that.
I thank you very much for your testimony.
Any inquiry by other Members?
Mr. Weller.
Mr. Weller. Again, thank you, Mr. Chairman, for your
leadership by conducting this hearing. I think as we raise the
profile of this issue every day we get closer to April 15, more
of these 21 million married working couples are going to
realize that they are paying this marriage penalty and they are
going to be looking to the President and Congress to work
together in a bipartisan way to solve it.
And I have a question that I would like to address to Mr.
Lifson. And of course, I like your suggestion of working to
make the Tax Code marriage neutral. And I appreciate your
identifying 63 areas in the Tax Code where the marriage penalty
exists beyond just the joint combined income situation.
As we worked on the Marriage Tax Elimination Act, and in
consulting with many of your members who happen to reside in
Illinois in my district and throughout the country--and of
course many of them had their ideas and suggestions which
produced the legislation that we have in the Marriage Tax
Elimination Act--I remember one of them said--and that was just
recently, in fact, I was just talking to one just this past
week--he said, you know, I have a couple before me right now--
we were on the telephone--and he says, this couple, I just
informed them that had they stayed single, they each would have
received a tax refund. But because they chose to get married,
they are going to owe taxes. Clearly illustrating the problem
in the marriage tax penalty.
Just from your perspective as representing a lot of the tax
preparers across the country, which do you think is a higher
priority: addressing the problem that comes from filing jointly
with a combined income pushing you into a higher tax bracket,
or eliminating those 63 targeted tax provisions, which creates
63 additional marriage tax penalties?
Mr. Lifson. I think that in most of our discussions the
easiest target, if you'll excuse the term, the easiest target
for simplification is going to a single table, that is, one
table for all. It has the greatest appearance of both
simplification and equity to it. And neutrality, everybody pays
according to one table.
I think to simply look at 1 of the 63 items is a naive
approach and that you have to dig in deeper if you really want
to solve the problem rather than the initial appearance of the
problem. It won't take the American taxpayers long to come into
my office and find out that just because it is advertised that
there is now only 1 table that there aren't 60 more problems
for them to think about. I think that you have to do both.
Mr. Weller. Well, thank you.
Again, thank you, Mr. Chairman, for conducting this hearing
because it does raise a very important issue that affects 21
million married, working couples across the country. And when
you think about it, $1,400 on average for each of these couples
is a drop in the bucket here in Washington, but for a couple
back in Illinois, or any of our communities we represent,
that's a year's tuition to a local community college, 3 month's
worth of child care at a local daycare center, several month's
worth of car payments. It means a lot. And the bottom line is
we need to be working to eliminate this penalty.
Again, thank you, Mr. Chairman, for your leadership in
conducting this hearing.
Mr. Herger [presiding]. Thank you.
Mr. Feenberg, you mentioned in your testimony that you had
done research on the labor market effects of restoring the two-
earner deduction. I wonder if you could elaborate, that on how
you feel that proposal would affect tax revenues.
Mr. Feenberg. Our conclusion was just that the proposal
would be cheaper than it looks because it lowers the marginal
tax rate on a group that has relatively elastic response--
elastic attachment to the labor force. There would be
additional earnings from secondary earners and that would come
back into the income tax and into the Social Security taxes
which is just as important. And so that in the end the thing
turns out to be cheaper than might look at first glance. And in
particular, if you put a higher cap--$50,000 instead of
$30,000--there are more people who are still at the margin,
rather than receiving the capped amount, and so there is still
more labor supply and that makes it even cheaper so that it
dominates. That is it has a lower foregone revenue but it is
better from a utility perspective from each taxpayer's point of
view.
So, it's not really a statement about whether it's a good
thing or a bad thing, it's just a statement that if you follow
through all the effects on labor supply, it's likely to be
cheaper than it looks at first glance.
Mr. Herger. Thank you very much. I think that certainly is
an important point to bring out. I appreciate your doing so in
your testimony.
Mr. Hulshof will inquire.
Mr. Hulshof. Thank you, Mr. Chairman. Just briefly, and I
think each of you has mentioned in your own words that any time
we talk about targeted tax relief, we are subject to budgetary
constraints. Mr. Bartlett, I think you said it most forcefully
at the end. And I think each of these particular provisions,
whether it's Mr. Weller, Mr. McIntosh's bill; Mr. Riley, Mr.
Salmon's bill, indeed even the freshmen class has a tax bill.
And in our efforts to at least address the marriage tax
penalty, we simply raised the deduction to twice that of what
it would be for individuals. And one of the complaints of that,
we understand, is for those that itemize, they would not then
get that targeted tax break; even though 75 percent of the
Americans in this country don't itemize.
But again, budgetary constraints being such that they are,
we're looking at about $4 to $5 billion a year for that
simple--and I emphasize simple--solution.
Mr. Lifson, I've had several CPAs in my district who have
thanked me on behalf of their industry for what we have done
with the Taxpayer Relief Act as far as job security and some of
the complicating factors.
And Mr. Feenberg, this question goes to you because in your
testimony you actually began to address, for example, how many
additional lines it would be on certain forms because, quite
frankly, even beyond the experts in the field, Mr. Lifson, from
the CPAs, one of the concerns, slash complaints, I heard from
constituents over the holiday was: thanks for the tax relief,
but where was the simplification. So taking into account all of
the measures here, Mr. Feenberg, are there certain proposals
that you have considered that actually do promote
simplification? I think in addition to more across the board
relief for the American people, we need to look constantly at
ways to simplify our present Tax Code. Which of these
proposals, Mr. Feenberg, have you looked at that may be better
than others as far as simplification.
Mr. Feenberg. First of all let me say, the source for the
information on how many boxes might be added to the form came
from looking at State tax forms that do allow for this. And
Iowa was the one I remember that had about 50 additional boxes
for that; others were fewer. There is really no way around that
kind of complexity, I think, if you allow for some sort of
separate filing.
With respect to simplification as a way of reducing the
marriage tax: Well the 63 phaseouts all go with 63 special
provisions and the only way to get simplicity is to look at
those provisions and see if you can do without them. We got
very good results in terms of deadweight loss per dollar of
foregone revenue from a relatively simple thing like the
secondary earner's deduction. It doesn't devastate the law, but
it's not going in the right direction, obviously, it's a small
step in the wrong direction for simplification.
Mr. Graetz. Mr. Hulshof. If I could just add----
Mr. Hulshof. Mr. Graetz, yes.
Mr. Graetz. Any time you increase the standard deduction,
which as I understand it is the way you are approaching this
problem, you will move people who otherwise would itemize, on
to the standard deduction. And historically, this has been a
very sound way of simplifying the tax law. That is, to the
extent that more people don't have to keep records, and don't
have to itemize their deductions, this does increase
simplicity. So, I think on simplicity grounds your suggestion
should get high marks.
Mr. Hulshof. Any one else? Mr. Bartlett.
Mr. Bartlett. I would just say that responding to Chairman
Archer's point as he was leaving about targeting, is that I
think targeting is a dirty word, contrary to what the President
says. I think it has given us all these pernicious problems
that we're dealing with here to a very large extent.
And I would emphasize what I said earlier that you should
look at this whole problem with the obsession with distribution
of taxation to the exclusion of every other provision. And that
is basically what happened last year, as you know better than I
do, is you can't give a tax cut to the rich, so we've got to
put in a phaseout, and that creates additional problems and it
just multiplies to the point where it becomes utterly absurd.
And I would endorse Professor Graetz's proposal that you not
produce income distribution tables during the deliberation
process. I realize that's probably politically impossible, but
I would suggest it anyway.
Mr. Hulshof. Well, Mr. Bartlett, let me say as my
concluding thought that as a freshman Member in this body and
certainly on this Committee, I probably personally have learned
more in this past year than any year in my lifetime, other than
the year after I got married. And it has been astounding to me
in our debate on tax relief that somehow families, married
couples who are successful, are demonized to some extent in the
political argument and they should not be entitled to the same
good policy decisions that those making less, or who aren't
quite as successful. And that has been an interesting lesson to
learn as a new Member.
Thank you, Mr. Chairman. I yield back whatever time I have
remaining.
Mr. Herger. Thank you very much, Mr. Hulshof.
And I want to thank our distinguished panel for their
testimony.
And with that we'll move to our next panel on death taxes.
And Congressman Jim McCrery, a Member of our own Committee,
will be first to testify.
Mr. McCrery.
STATEMENT OF HON. JIM MCCRERY, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF LOUISIANA
Mr. McCrery. Thank you, Mr. Chairman. If Chairman Archer
were here, I would also thank him for the leadership that he
exhibited last year in taking significant steps to lessen the
burden of the estate tax, sometimes called the death tax.
And while we did some good work last year, I think there is
more needed to reduce this unfair tax, especially burdensome, I
think, on small businesses and family farms owned by hard
working families. And eventually, Mr. Chairman, in my opinion,
the estate tax should be abolished. We should not have an
estate tax, and I think there are some sound reasons for that
conclusion. Number one, as I said earlier, it's unfair. Number
two, it discourages savings and investment. It destroys small
businesses and family farms. It double taxes income. And, it
doesn't provide much revenue to the Federal Government; less
than 1 percent of our revenues are derived from this tax.
So, it ought to be done away with. But if we decide, for
budget scoring reasons, as we did last year, that we cannot
abolish the estate tax, then we ought to look at some more
tinkering this year that would reduce the burden. And I think
there are some ways that we can do that.
I want to suggest three ways, and I'll do these in order of
priority. Number one, the family business exemption that we
created last year should be increased. Simply by increasing
that family business, family farm exemption, we do the most in
the most efficient way to save family farms and businesses from
extinction. Number two, we should consider making the unified
credit a true exemption so that the lowest rate of 18 percent
applies to the first dollar of value in a person's estate upon
which they actually pay the tax. As you know, Mr. Chairman, now
because of the unified credit the first tax rate that is
applied in a taxable estate is 37 percent, when we have an 18-
percent rate on the books. So, that's the second thing that we
ought to look at, making that a true exemption. Third, we
should consider raising the unified credit. Mr. Chairman, those
options are less attractive to me than abolition of the estate
tax but, short of a proposal that allows us to abolish the
estate tax, I think we ought to look at making adjustments in
those three areas. Mr. Chairman, my full testimony is in
writing, it has been presented to the Committee, and I would
appreciate it submitted for the record.
[The prepared statement follows:]
Statement of Hon. Jim McCrery, a Representative in Congress from the
State of Louisiana
Thank you Mr. Chairman for giving me the opportunity again
to testify before the Committee on the estate and gift tax.
Please also let me congratulate you on the leadership you
showed last year in taking significant steps to reduce the
burden of this unfair tax. As the author of the H.R. 1299, the
Family Business Protection Act, which provided a $1.5 million
exemption for family owned business, I am very pleased with the
estate tax reduction in the Taxpayer Relief Act of 1997.
Nevertheless, I know that you invited me here today because you
understand more is needed to reduce this unfair tax, a tax
especially burdensome on small businesses owned by hard working
families, and that eventually, it should be eliminated.
Mr. Chairman, the death tax should be abolished because it
discourages savings and investment, double taxes income, and
collects minimal revenue. High estate tax rates serve to
discourage savings. While we have several statutory rates for
the taxation of estates, the first rate that is actually
applied is 37%, then the rates go up to 55%. I doubt that many
support rates of such magnitude even on the very wealthy, let
alone a small businessperson who has never been guilty of
conspicuous consumption, but through sound business practices
has managed to build up an estate subject to the federal death
tax.
The estate tax also has inordinately high compliance costs.
Specifically, the National Federation of Independent Business
estimated that the government and individuals collectively
spend some 65 cents for each dollar of estate and gift tax
collected-that's $5 to $6 billion annually-for enforcement and
compliance activities. The end result of this process is for
the businessperson to spend down their assets in an attempt to
avoid the burden of this tax, thus depressing job creation and
economic growth.
Mr. Chairman, the death tax is unfair because it taxes
earnings that have already been subject to federal taxes. After
all, business owners already pay income and capital gains
taxes, yet when they die, they must pay taxes again.
And Mr. Chairman, despite the fact the estate tax only
accounts for approximately one percent of federal revenues,
eliminating the estate tax would have created salutary effects
on the economy. For example, a 1996 study by the Heritage
Foundation found that a repeal of the death tax would have
positive effects on the American economy over a nine year
period. It found that the nation's economy would average as
much as $11 billion per year in extra output, an average of
145,000 additional jobs would be created, household income
would rise by an average of $12 billion per year above current
projections, and revenues would be recovered due to the growth
generated by its abolishment. I would hope all of this evidence
would lead us to conclude the death tax belongs only one
place--six feet under.
Due to our scoring system, we decided abolition of the
estate tax was too costly in 1997. Should we again make that
determination, I believe we should make further modifications
to the estate and gift tax. Many people believe only the
wealthy pay estate taxes. While the affluent can afford the
costs of attorneys and accountants to avoid or minimize the
estate tax, the small businessperson cannot. In fact, the
Internal Revenue Service reported that of the 69,772 death tax
returns filed in 1995, almost 85% were for estates of $2.5
million or less. Since the unified credit has not been indexed
beyond 2006, small businesses will continue to find their
assets can easily exceed the threshold for taxation. Therefore,
please consider the following proposals.
First, the family business exemption should be increased.
As the value of the unified credit goes up, the value of the
family business credit goes down so that the combined credit
does not exceed $1.3 million. By 2006, the family exemption
will only be $300,000. Considering the devaluation this credit
will experience over the course of ten years, many businesses
may decide not to incur the costs of applying for the credit
and instead continue to spend down their assets in an attempt
to avoid the death tax. Increasing this exemption is the best
way to save family farms and businesses from extinction.
Second, the outdated tax rate structure must be reformed.
Mr. Chairman, while I am flexible in seeking these reforms, let
me suggest the model set up in my legislation. According to
H.R. 1299, the unified credit will be made a true exemption so
that the lowest rate of 18% applies to the first dollar of
value in a person's estate upon which they actually pay the
tax. The rates would then be graduated, as under current law.
Lastly, we should consider raising the unified credit. If
the unified credit had been indexed since 1986, it would be
worth approximately $840,000 today. The unified credit will not
reach that level, however, until 2003 and will continue to be
undervalued when it reaches $1 million in 2006. In fact, I
estimate the credit should be worth somewhere between $1.2-$1.5
million by that time. Thus, while our committee has made great
strides to lower the burden of the estate and gift tax, we
could do more to make the unified credit consistent with
today's dollars.
While these options are not as good as abolition, and some
could increase complexity, they are preferable to the status
quo. Again, thank you for this opportunity to testify. I will
be happy to take any questions at the appropriate time.
Mr. Herger. Without objection----
Mr. McCrery. Thank you, Mr. Chairman.
Mr. Herger [continuing]. We'll do that. Thank you, Mr.
McCrery. Mr. Cox, your testimony.
STATEMENT OF HON. CHRISTOPHER COX, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF CALIFORNIA
Mr. Cox. I thank the Chairman and I thank the Members for
focusing needed attention on this important issue. I want to
commend you for your leadership in holding these hearings and I
welcome the opportunity to talk about the urgent need to repeal
the death tax.
We did important reform. We ameliorated, to a certain
extent, the awful incidence of the death tax in the last
Congress, but this tax, perhaps better than any part of the
Internal Revenue Code, begs for elimination because tax
simplification is all about making the system both fair,
understandable on the one hand, and predictable on the other
hand. The death tax is none of these things. In one fell swoop,
we could get rid of over 80 pages of the Internal Revenue Code,
nearly 300 pages of regulations, were we to eliminate it. But
every time we change it, what happens in the real world is that
small businesses have to call their lawyers, redo their estate
plan, and take a look at the whole thing from key man life
insurance to the way the business might be carried on in the
event of partial liquidation.
It actually raises the costs of tax compliance and one of
the very, very serious and pernicious aspects of this tax is
not highlighted when economists tell us how much money it
raises or what the cost of compliance is and that is what it
costs people who are not dead or dying to prepare for that
eventuality.
I just went to Sonny Bono's memorial service, as a lot of
you did. He, tragically, met his death earlier than he'd
expected, but we're all going to die. All of us, at some time.
And so we all have to prepare for this. That's why we know that
even the nominal compliance costs, the ones that economists can
keep track off, by some estimates amount to 65 cents on every
dollar that we collect. So, not only does this tax get us
barely 1 percent to start with but then 65 cents out of every
dollar is sucked out of the economy or sucked directly out of
Federal revenues because that's what it costs to comply with
the tax.
As you perhaps know, I've introduced legislation in each of
the last three Congresses to kill the death tax and I'm proud
to say that support has been growing ever since our colleague,
Mr. Gephardt, drew attention to this tax by trying actually to
increase it. Support has been growing for getting rid of it
altogether. The White House Council on Small Business, which
the White House itself gathers together, this is not a partisan
thing, I hope, but the President of the United States and the
White House, which he controls, are the ones that put the thing
together. And they've made a list of over 50 important policy
steps that they hope the Congress and the President will take
together to protect and expand small business in America.
Number four on that list is repealing this tax. Ending it, not
mending it. Repealing this tax, number four on a list of over
50 that the White House Council on Small Business says is
necessary for their survival.
Now, some people are going to tell you that the death tax
isn't really a death tax, it's an estate tax. In fact, that's
what the legal jargon is, the estate and gift tax. That,
basically, this is a tax on the rich and its purpose is
redistribution of wealth. It is utterly failed in that it does
not redistribute wealth from rich to poor. To the contrary,
it's one of the main causes of a conglomeration of wealth in
America as multinational corporations, in many cases, acquire
what used to be small businesses. It's one of the number one
killers of small business in America.
And, furthermore, the people who pay the tax are not the
rich because they can use an estate plan to either put that tax
off forever or avoid it altogether. Rather, the people who pay
the tax are not even the people who own small businesses or
small ranches, although we hear about them a lot. They're the
people who work in those operations. The incidence of this tax
is greatest, heaviest, and most serious on low-wage workers in
small businesses and on family farms and on ranches.
And no economic study that I've seen even attempts to
quantify what it means to have a 100 percent tax when you lose
your job, when you lose your livelihood. But that's what
destroying a small business is all about, that's what a
property tax masquerading as an income tax is all about,
because that's what this is. Liquidity of the business,
liquidity of the ranch, liquidity of the farm has nothing to do
with whether the tax is owed. And so, given the steep rates and
the fact that it's assessed on aftertax savings, aftertax
values, almost always there's got to be litigation about the
value of those assets which consumes more wealth and requires
liquidation on the part of that business and then further
liquidation in the end to satisfy the tax.
Because the American people understand how pernicious this
tax is, because they understand it's not about redistribution
of wealth, except to the extent that it's causing small
business to go away and big business to get bigger, they've
been voting to get rid of it routinely. In our State, Chairman
Herger, you know that we repealed this death tax, we repealed
our inheritance taxes by an initiative vote of the people.
Now, the Los Angeles Times editorialized that this would be
an extremely unpopular thing, that this would be protection for
the rich, and so on, and you know what the vote was? You know
what the vote of the people was? To eliminate the death tax in
California? Sixty-five percent. And they didn't just eliminate
the death tax. They said you can never bring this ugly thing
back without another initiative of the people. Even the
legislature can't do it.
I'd just like to close with a personal story about a
constituent of mine who is an estate tax lawyer. One would
think that perhaps the small lobby in favor of this tax would
comprise chiefly people who make money from it, estate tax
lawyers. Well, one person at least who is an estate tax lawyer
doesn't feel that way. And he told me he could find another way
to earn a living as a tax lawyer if we were to do the right
thing and get rid of this tax. And he recounted to me an
example, one of the reasons that he feels this way. Recently,
he said, he was finishing the estate planning for one of his
clients and, as he said, occasionally sadly happens in his
business, that client became fatally ill. So serious was his
problem that he had to go to his house and rush to his bedside.
His family were all gathered there because it was clear he was
slipping and on that man's last day on Earth, he spent two and
a half hours with his estate lawyer who had him sign documents.
And the lawyer told me that the effect of signing these
documents was that the family could avoid that tax. There was
no economic effect in real life, just a tax effect. And if he
failed to sign the documents, then there would be a big
liability and so he spent the time going over these documents
with the man while his family sat outside and they missed those
last hours with him because of us, because we imposed this
horrible death tax. No one of our constituents, no American,
should spend his or her last hours on Earth that way. This is
an evil, pernicious, counterproductive assault on small
business, thrift, savings, hard work and it deserves to die. I
thank you.
[The prepared statement follows:]
Statement of Hon. Christopher Cox, a Representative in Congress from
the State of California
Chairman Archer, I want to commend you for your leadership
in holding these hearings today, and I welcome the opportunity
to talk about the urgent need for repeal of the death tax.
Mr. Chairman, this tax raises less than 1% of federal
receipts. It is not paid by the rich and those who can afford
the fancy lawyers and accounts needed to legally avoid the tax.
It is paid by the small businessman and the farmer and by those
who work for these individuals who pay a 100% tax when they
lose their jobs as businesses are liquidated.
Having introduced legislation in each of the last three
Congresses to kill the death tax, I am proud to report that
support has grown as the American people recognize the danger
this most unfair tax poses to them and their families. They
realize that the death tax is unfair, confiscatory, and
contrary to the values of hard work and saving on which this
country built its success. In 1993, when I first introduced the
Family Heritage Preservation Act, my bill had only 29 co-
sponsors in the House and had not been introduced in the
Senate. Today, the same legislation is endorsed by 168 members
of the House and 30 members of the Senate.
As far back as 1982, the voters of California sent this
message to their state legislature when they overwhelming
supported Proposition 6, which repealed the California state
inheritance tax. Nearly 65% of the voters in the most populous
state in the nation repealed their state inheritance tax by
popular initiative. Proposition 6 not only repealed these
onerous taxes, but it stipulated that the state legislature
could not reimpose this state death tax unless another popular
initiative of the people instructed it to do so. Mr. Chairman,
the people in my state could have tried changing the details of
the law, they could have raised exemptions or lowered rates,
but instead they wisely chose to do away with state death taxes
completely.
Numerous states like Iowa have followed California's lead,
and many other states like Pennsylvania are beginning to follow
suit. Foreign nations like Israel, Australia, and Canada, which
are not considered to be low-tax nations, have repealed their
death taxes due to the social and economic harm they cause. I
have received thousands of petitions that represent just a
fraction of the millions of Americans who, like Californians in
1982, are fed up with the death tax.
Support for repealing the death tax transcends the usual
boundaries that often seem to divide us. Democrat and
Republican, rich and poor, white and black, people around the
county want to kill the death tax. The death tax is not an
issue of class warfare or left-leaning versus right-leaning
economists--everyone agrees that the death tax seeks to repeal
the most basic of human natures, the desire to provide for
one's family and loved ones.
We are familiar with the concept of a sin tax, a government
levy on goods like cigarettes and alcohol. ``If we have to tax
something,'' states the logic behind such taxes, ``why not tax
behavior that is damaging to society and individuals?'' The
death tax is the opposite of a sin tax--it is a virtue tax.
Self-professed liberal scholar Edward McCaffrey labelled the
death tax as a tax on virtue because it taxes exactly the kinds
of behavior we consider to be virtuous and want to encourage:
savings, investment, and most importantly, work.
After you have worked to put food on the table, clothes on
your back and a roof over your head, the most powerful reason
to continue to work is to provide for your family and those you
care about. You want to work hard to make life easier for your
children. Yet the death tax thwarts this basic human instinct.
While you may have worked hard, taken risks, built a business,
and paid your taxes, you discover that at the end of the line,
Uncle Sam stands between you and your loved ones and demands up
to 55% of everything you have left.
I will leave it to other witnesses here today to testify
about the many economic benefits resulting from repeal of the
death tax, but I want to take a moment to highlight a few of
these, paying particular attention to the erroneous notion that
repeal of the death tax will leave the federal government
starved of revenue. When we consider the role death taxes play
in tax revenues it is important to keep several points in mind:
Death taxes collect approximately 1% of federal
receipts, and one study suggests that 65 cents on every dollar
is lost through enforcement, compliance and other costs.
Instead of being confiscated or used to build elaborate legal
devices to avoid the tax, this money would be used in an
economically beneficial way by private citizens, expanding
opportunity for all Americans, and therefore, the tax base for
the federal government.
The current discussion of the expected ``budget
surplus'' indicates that we have achieved a balanced budget.
Assuming this trend continues, it would more than offset any
initial loss in revenue from death tax repeal.
Repeal of the estate tax will lead to increased
federal tax collections from income and payroll taxes.
According to a Heritage Foundation study, repealing the death
tax in 1997 would have resulted in increased annual economic
growth by $11 billion, an additional 145,000 new jobs, and
increased annual personal income by $8 billion each year. A
retrospective study of the economy over the 20-year period from
1971 to 1991 showed that net annual federal revenues would have
been $21 billion higher if the death tax had been repealed 20
years ago.
Some have suggested that we should again merely modify the
death tax instead of repealing it outright. But this won't
change the underlying incentives against hard work; it will
simply add yet another layer of bureaucracy and regulation to
what is already one of the most litigated and contentious areas
in the entire tax code. Last year, in testimony before this
Committee, one witness testified that this ``mend it, don't end
it'' approach to the death tax would actually add $3 billion in
new litigation and accounting costs to the current system as
families and businesses try to structure their assets to meet
the new standards.
We have the opportunity to simplify the tax code, to cut an
entire section of the law that punishes savings and investment,
punishes hard work, breaks up family businesses, and makes the
next generation keep trying to climb the same rung of the
economic ladder. The death tax is contrary to our principles,
it is contrary to sound economic policy, and it should die.
I'd like to close with a story that illustrates that the
death tax is not merely destructive but immoral. I was talking
with a city council representative in one of the cities in my
district. The city council is a part-time job, and this man is
an estate tax planner and a tax lawyer in his real life outside
politics. He came up to me and he thanked me for my efforts to
repeal the death tax and shared with me his experience as a tax
lawyer. The day before, he said, he spent several hours with
one of his clients on his client's deathbed. The man's family
was waiting in the next room, but this dying man was forced to
give up some of his last hours on earth to sign forms necessary
to avoid the death tax. These papers created no new wealth,
they were economically useless, except that they allowed this
man's family to keep the wealth he had worked for them to have.
So this man signed the papers, but he was deprived of some
of his last moments with his family. The government got no
money. The tax lawyer got paid, and he came to his Congressman
and complained that this is not what the government of the
United States of America should do to its citizens during their
final moments on Earth. I think that in this we must all agree.
The death tax deserves to die, and I thank the Committee
for providing me this opportunity to testify.
Mr. Herger. Thank you very much, Mr. McCrery, and thank you
for your work, Mr. Cox. I thank you both for your past
legislation in this area of which I've been a cosponsor in the
last several Congresses. Mr. Cox, your story reminds me of an
example as well.
I'm from an agricultural community just north of Sacramento
in Northern California and from an agricultural family. And I
remember, in my office, not that many years ago, a family came
in to talk to me and to discuss their individual situation in
which this lady's father, who had farmed in our area and who I
knew, grew up with, and knew all my life, explained to me the
frugality of their family, which I already knew, and the fact
that he had even saved money up and his ranch was debt-free. He
had money, a seemingly substantial amount, in the bank to take
care of the death tax. Yet, it was not nearly enough, and they
were forced to sell this ranch that had been in the family
since about the turn of the century. They were forced to sell
it just to pay the death taxes. And, as I know you know and I
certainly know, this is just one of many examples, not only on
farms but on small businesses. No, you're absolutely right,
this is a tax that, in my opinion should be done away with. I
thank you very much.
Yes, Mr. Collins.
Mr. Collins. Thank you, Mr. Herger. Mr. Cox, you made a
statement there that you know that a lot of family-owned
businesses, small businesses are selling their businesses to
conglomerates in order to avoid the death tax. Would you go
into a little more depth of why?
Mr. Cox. As I alluded to, the death tax which can exceed 50
percent, is imposed irrespective of whether there's any money
in the business that is closely held or the farm that is
closely held or the ranch that is closely held by the person
who died. And so, you have to pay the tax somehow and that
means you have to sell off whatever you've got. You might need
to sell off the assets of the business but you might also need
to sell off your house. I mean, the tax does not care whether
it's a personal heirloom. Sell it. There is no quarter given by
the death tax.
Mr. Collins. Yes, maybe I should just give you an opinion
that I have as to why this may be occurring. Simply the tax
rates themselves. If you wait and die, your estate is going to
pay 55 percent, but if you sell, then you pay on the gain of
that sale at a much less or a much lower rate. And, too,
oftentimes when a business is passed on due to the death of the
principal owner, there is a tendency for that small business to
fail because of the tax liability. It will exist because of the
value of that estate, which often leads, as you say again, to a
sale. But also, when the principal owner dies and money has to
be borrowed to either pay the tax or to continue the operation
of that business once the tax liability is met, it prevents the
heirs from having the same financial status that the principal
had; interfering with their ability to borrow funds to continue
the operation of that business. So, I think that it is often
the cause of the sale of a business. I do know that it is
occurring and I do know that there are a lot of small
businessmen who carry a tremendous amount of life insurance in
hopes that they will be able to meet that liability and
continue the operation of that business after it is passed to
the next generation. I'm one of them. Thank you.
Chairman Archer [presiding]. The Chair would advise the
remaining Members in the room that we have a vote on and that
we have about 3 minutes left to vote so the Committee will
stand in recess until after this vote. Hopefully 15 minutes
from now or maybe less we will continue with our next panel.
Thank you.
[Recess.]
Mr. Herger [presiding]. We'll now reconvene our next panel
on death taxes. First on the panel will be a brother and
sister, Christopher Clements and Kimberly Clements, whom we
will allow Mr. Hayworth to introduce in just a minute. Also,
Richard Forrestel, Jr., Carl B. Loop, Jr., and Harold I.
Apolinsky.
Mr. Hayworth, would you like to introduce your
constituents?
Mr. Hayworth. Thank you, Mr. Chairman. Ladies and
Gentlemen, I'm very pleased to introduce to my colleagues here
on the Ways and Means Committee, Christopher and Kimberly
Clements of Tucson, Arizona. Chris and Kim are the children of
the last William M. ``Bill'' Clements, the owner of Golden
Eagle Distributors, a beer wholesaler based in Tucson. Golden
Eagle also has several facilities throughout Arizona's sixth
district, including Casa Grande, Globe, Holbrook and Flagstaff.
Bill Clements died unexpectedly, following a 2-month battle
with cancer, and Chris and Kim will share with the Committee
their experience with the death tax upon inheriting and keeping
Golden Eagle Distributors. Thank you, Mr. Chairman.
Mr. Herger. Thank you, Mr. Hayworth.
Kimberly, would you like to begin?
STATEMENT OF CHRISTOPHER AND KIMBERLY CLEMENTS, GOLDEN EAGLE
DISTRIBUTORS, INC., TUCSON, ARIZONA; ON BEHALF OF THE NATIONAL
BEER WHOLESALERS ASSOCIATION
Ms. Kimberly Clements. Thank you, Congressman Hayworth and
Mr. Chairman. Ladies and Gentlemen of the Committee, it is an
honor for my brother, Christopher, and I to be testifying here
today on the Federal estate tax. My name is Kimberly Clements
and my brother and I are the third generation owners of Golden
Eagle Distributors, Inc., headquartered in Tucson, Arizona.
Golden Eagle is an Anheuser-Busch beer wholesalership which
just celebrated 50 years of doing business in the State.
Unfortunately, this anniversary was not shared with the one who
was responsible for the company's success. Three years ago, our
father, William M. Clements, passed away after a brief but
courageous bout with cancer. This left my mother, Virginia, my
brother and I the task and responsibility of continuing our
father's work in the community as well as in our industry.
If there was one thing that Chris and I learned from our
father, it was commitment. In 1976, our tiny company with just
a handful of employees was faced with a national brewery
strike. Dad made a lot of sacrifices, but he never laid off one
employee. Now, 22 years later, Chris and I are directly
responsible for over 260 employees and their families. Our
company has grown substantially because we have continuously
reinvested dollars back into the business by building new
warehouses, adding to our fleet, developing new departments,
and, most of all, hiring more employees.
The most significant contributors in Tucson do not come
from multinational corporations. They come from independent
family businesses; the restaurants, the corner markets. And
Golden Eagle is no exception. These businesses know the value
of giving back to the community. These businesses know that
value of family and its importance in today's society.
In a Congress that is deemed profamily, it has not fully
recognized the unique nature of the family business. Golden
Eagle Distributors is the core of the Clements family. It is
what we have rallied around following the death of our father,
knowing that the business is the family legacy.
When Dad died, there were so many questions that were asked
not only to one another, but by our employees and by members of
our community. What will happen to Golden Eagle Distributors?
Thankfully, our estate plan was barely completed 6 months prior
to his death. If we hadn't been prepared, the financial as well
as emotional effects on the family and on our community would
have been devastating.
Mr. Clements. Mr. Chairman, Ladies and Gentlemen of the
Committee, this is the real impact of the Federal estate tax.
It devastates families, businesses, and communities. The death
tax barely comprises 1 percent of all Federal tax revenue yet
its overall effect is much more far reaching.
My sister and I, quite frankly, are some of the lucky ones.
We had a father who saw fit to plan accordingly to protect his
family, his employees, and his community from the greed of the
government. I say greed because much of our business has been
taxed and over taxed already. The motions and moneys families
must endure to protect themselves and their businesses from the
government are well-documented. Lawyers, accountants, and open-
handed insurance representatives are paid thousands of dollars
to set up the trusts, the wills, the funds to pay the death
tax. Our father was no exception, but at what cost? Certainly,
these moneys could have been used more productively and
invested back into our business and its employees.
Although this Congress saw fit to raise the death tax
exemption levels in this year's budget agreement, it did little
to calm the fears and concerns of family businesses. In fact,
the current legislation that attempts to give added relief to
family businesses does not assist the majority of medium to
large family businesses. These new laws are a pittance and fail
to address the large amounts of capital the majority of family
businesses have invested directly in their buildings, their
inventories, their employees, capital that almost certainly
would not meet the current or future exemption levels.
For example, in the coming year, Golden Eagle plans to
invest in its Tucson operations well over $1 million in capital
and human resource improvements. These expenditures are
necessary in order to remain competitive in an already
cutthroat business environment. The death tax exemption levels
passed by this Congress would not even account for the
inventory in our warehouse. However, the more insulting aspect
of the death tax is the fact that the Federal Government offers
families the privilege to pay the tax in installments over 14
years and charges them interest to do so, essentially taxing an
already unfair tax.
Our own Arizona Senator, John Kyl, and his esteemed
colleague, Congressman Chris Cox, who you heard from today,
have the correct approach to the death tax. Do away with it.
Indeed, according to a recent article in Insight magazine, if
the death tax were eliminated, the U.S. economy would be
producing $79.2 billion more in annual output and creating
228,000 more jobs a year.
Obviously, eliminating the death tax is not a completely
realistic expectation for this Congress. Therefore, Mr.
Chairman, we hope that you and your colleague will consider
recognizing the unique nature of the family business, and
exempt from the death tax those closely held by 50 percent or
more of family members. It is time to lift this incredible
burden from the families of America. It is time to recognize
America's greatest resources: the entrepreneur, the
philanthropist, the risk-taker. A family businessowner is all
these things and more. We know. We learned from the best.
We thank the Chairman and the Committee for the opportunity
to share our views on this vital, comprehensive issue and look
forward to progressive steps to alleviate this unfair tax on
American family businesses. Thank you very much.
[The prepared statement and attachments follow. Attachments
are being retained in the Committee files.]
Statement of Christopher and Kimberly Clements, Golden Eagle
Distributors, Inc., Tucson, Arizona; on behalf of the National Beer
Wholesalers Association
Mr. Chairman, ladies and gentlemen of the Committee, we are
very privileged and honored to address you today for not only
ourselves, but also for beer wholesalers across the country who
belong to the National Beer Wholesalers Association. We hope we
will answer some pressing questions regarding the inequity of
the death tax.
Why should a person build a business in America? Why should
a person sacrifice everything to run the risk of having his or
her livelihood taken away from his or her family?
It seems a silly question, but it is asked more frequently
than many people think. This is the dilemma the American
entrepreneur faces today--to invest capital in his or her
company and community, and risk its future if anything were to
befall him or her.
The vision of our Founding Fathers was simple enough--that
all Americans should reap the fruits of their labor--that the
right to life, liberty, and property is sacred and divined by
God.
Hundreds of thousands of immigrants come to the United
States every year fleeing from the tyranny of non-democratic
regimes, from poverty, from terrorism. Whatever the reasons,
people come with the thought that the United States will give
them the inalienable freedoms of life, liberty, and property.
Many start families, begin businesses, work hard, and see
their lives grow.
However, the thought that the government, over time, could
take away all that they have built is unconscionable to many
immigrants and, indeed, to many Americans who have been here
for generations.
Today in America, without ``proper planning''--which
usually entails the investment of numerous resources in the
guise of accountants, lawyers, and wayward insurance
salespeople--a family can see their business and livelihood
stripped away by the most destructive tax created--the estate
tax (or now commonly known as the death tax.
The family entrepreneur, who puts his good name and
reputation on the line to create jobs and wealth for his loved
ones and his community, is one of America's greatest resources.
Yet, if this vital resource fails to protect his family from
the government to which he provided countless tax revenues and
the creation of innumerable jobs, he may find that upon his
passing that his family is forced to sell their life's work to
pay the government again.
The greatest misperception about death taxes is that they
only affect the very rich. However, death and taxes do not
discriminate. Death taxes are hardest on the small farmer, the
independent shopkeeper, the restauranteur, and the beer
wholesaler--small business people with families and strong ties
to the communities they serve.
In fact, a recent study reported that ``nine out of 10
family businesses that failed within three years of the
principal owner's death said that trouble paying estate taxes
contributed to their companies' demise.''
Mr. Chairman, our family is one of the lucky ones.
We had a father who planned properly and who allocated the
appropriate resources to make sure his family, his employees,
and his community would be well protected.
Yet who would have known?
Who would have known that during the Christmas of 1994, our
father, William M. ``Bill'' Clements, an entrepreneur and
philanthropist, would be driving down the street and suddenly
be unable to see? Who would have known that subsequent tests
and diagnoses would discover cancer throughout his body? Who
would have known that two arduous months later he would leave a
wife, two children, a business, and a community wondering...?
What is next?
To understand the answer to this question, we would like to
share with the committee how far our family business has come
and where it has yet to go.
In 1941, our grandfather, Dudley M. Clements, founded All
American Distributing Co., which was a wholesale liquor
operation in Phoenix, Arizona. Dudley, a banker by trade, was
raised in Casa Grande, Arizona. His father, William Preston
``W.P.'' Clements, was a banker and rancher. W.P. also served
as mayor of Casa Grande back in the early 1900s.
They raised Dudley with a strict work ethic and he survived
much of the depression by working in Idaho as head of the new
state liquor board, which was formed following the repeal of
prohibition. His son, Bill, was born April 29, 1936, in Boise,
Idaho. After a brief move to New York City following Bill's
birth, Dudley along with wife, Patricia, and son moved to
Arizona.
Several partners joined to form All American Distributing.
One of the more notable partners was the cinema singing cowboy,
Gene Autrey. During that time, Arizona was a growing state and
business was good. Over the years, All American grew from a
small wholesaler with a limited portfolio of products into a
large supplier of beers, wines, whiskeys, and scotches. Over
time, the business even expanded to several different markets
including Casa Grande, Globe, Flagstaff, Holbrook, and Tucson.
In 1956, August A. Busch, Jr., Chairman of Anheuser-Busch
(A.B.) and affectionately known as ``Gussy,'' called our
grandfather to ask a seemingly simple question, but one with
extensive implications.
Would Dudley handle Budweiser?
Our grandfather was skeptical. Back then, Budweiser was a
regional brand known primarily in the Midwest and in the East.
Schlitz, A-1, and Coors were the big brands in Arizona, with
Budweiser merely an afterthought. Nevertheless, several of
grandfather's key managers prodded him, and All American began
to distribute Budweiser in Tucson, Casa Grande, Globe, and
parts of Phoenix.
At that time, our father, Bill, was in college at the
University of Washington, playing football and majoring in
engineering. With all those activities, he had practically no
interest in entering the family business.
After graduation, a degree in engineering brought many
opportunities. In fact, Dad furthered his education and
received a Ph.D. in Environmental Engineering from the
University of California at Berkeley. He stayed in the San
Francisco Bay area and eventually started his own firm. Much of
his work involved the military and the National Aeronautical
Space Administration (NASA). At one point, he was designing air
flow specifications for spacecraft and consulting with the
Defense Intelligence Agency (D.I.A.).
Government projects began to dry up in 1967, when President
Lyndon B. Johnson successfully moved many contracts out of
California and into his native state of Texas. Dad was left
contemplating his future. As it turned out, back at All
American, Anheuser-Busch began to inquire about the status of
Dudley's son.
A.B. wanted a succession plan for the family.
Sensing the long-term stability and profitability in the
wholesale business, Dad returned to Phoenix with his new wife,
Virginia, and worked alongside his father. He worked hard to
learn the wholesale business, which was no easy task since he
had no formal experience or training. Moreover, his father was
very strict with him, holding him to higher expectations than
his other employees. Despite his doctorate, his father expected
him to perform even the most menial tasks, like scrubbing
floors. But Dad persevered and came to know the business from
the ground up.
After several years, market pressures finally forced our
grandfather to separate the liquor and the Budweiser side of
business. Budweiser, along with Anheuser-Busch's other brands,
had grown and deserved more attention. Consequently, Dad, Mom,
and the two of us moved to Tucson to open the corporate
headquarters for our new company.
So, in the spring of 1974, Golden Eagle Distributors, an
exclusive distributor of Anheuser-Busch products was born.
The first few years in Tucson were difficult. Budweiser
held a market share of less than 10 percent and, for a while,
Golden Eagle destroyed more beer than it sold.
In 1976, a national brewery strike nearly crippled the
company. Dad dug deep into his own pockets and borrowed to keep
the company afloat. He lost nearly 18 months of profits but
never laid off one employee. It was this type of commitment to
his company that would endear his employees to him for years to
come.
The strike soon ended and Golden Eagle finally had the
freedom to grow. Between 1977 and 1984, Golden Eagle saw
incredible change, including the proliferation of new brands
like Natural Light and Michelob Light. In 1981, Tucson was the
number one test market for a risky excursion in the light beer
category, Budweiser Light.
With the new growth, our company created new departments
and new job opportunities. Golden Eagle added an in-house
Marketing Department (one of the first of its kind in the
nation). Chain stores began to demand more attention, so Golden
Eagle established a National Account Representative position to
better serve local buyers. Growth in computer technology
mandated the development of an in-house Data Processing
Department that continues to change and evolve with the needs
of the business. With more employees, human resource management
became a priority and our company established a Vice President
of Human Resources.
Through it all, Dad felt that it was imperative to give
back to the community of Tucson and the cities of the
surrounding branches for all he had received. He embraced
countless community projects and donated his time and money to
worthy causes. From Chairman of the United Way, to the Boy
Scouts of America, to the Copper Bowl Foundation, to creating
the Greater Tucson Economic Council--Bill Clements was a man
who could never say ``no'' to anyone who asked for help. In
addition, he was politically active and a close friend and
confidant to many past and current members of this Congress.
Not surprisingly, this legacy of duty to others continues to
grow, both in ourselves and in our company.
On February 23, 1995, our father died unexpectedly after a
brief yet valiant bout with cancer. He was 58.
At that time, we were both forced to forgo many training
steps we would normally take and assume executive positions in
the company. Currently, we are working to be recognized by
Anheuser-Busch as Equity and Successor Managers of the company.
Luck, and extensive and expensive estate planning, has
allowed Golden Eagle Distributors to survive. Indeed, with the
unprecedented growth in the business over the past twenty
years, we are extremely fortunate that Dad foresaw the need to
protect what he had built.
Yet at what cost?
Thousands of dollars were spent to hire lawyers,
accountants, and insurance people to draw up trusts, wills, and
accounts to protect the fruits of Dad's labor. Congress making
changes to the already complicated tax laws forced Dad to
frequently reevaluate our company's plan. Ironically, he
finished the final arrangements in our family's estate plan
barely six months before his death.
Golden Eagle could have better used these ``necessary''
resources in the business for new salespeople, more trucks,
better benefits, etc. In other words, we could have reinvested
them in people.
It was hard work, sacrifice, perseverance, and faith in
people that allowed our father to be successful. Dad, however,
knew that success in America carried with it a terrible price.
We are lucky that all these measures were in place and that our
company did not have to be sold to satisfy the I.R.S. Hundreds
of jobs would have been lost and countless lives devastated.
Thankfully, estate tax planning usually provides for no
taxes due when the first spouse dies. However, at the death of
the surviving spouse, it becomes very difficult and complicated
to keep control of a family business for the next generation
due to the heavy burden imposed by death taxes.
Today, nearly three years following the death of our
father, Golden Eagle is still a growing company forged by a
vision of teamwork, fairness, and duty.
Golden Eagle is a company of 242 employees across Arizona
with annual wages and benefits of $10.3 million. It paid $3.1
million in state luxury taxes and purchased $5.3 million goods
and services. Golden Eagle employees participate i funds from
the corporation. Our health plan is one of the finest in the
industry with employees able to choose almost any doctor they
want.
All of this viable economic activity takes place in six
separate counties statewide--communities that would be severely
affected if the company ever had to be sold to satisfy the
greed of the federal government.
There is a misconception in Washington, D.C., about how
family businesses operate. Many government bureaucrats, who
have never invested a lifetime in building a future for a
family and a community, see family businesses as cash rich and
easily able to pay the whopping 55 percent death tax levy.
However, the vast majority of families who own a business
have capital tied up directly in the operation. Not only in the
plant(s) and equipment, but in the lives of its employees.
Golden Eagle, for example, has capital tied up in the education
of salesman Orlando Iosue's children and in driver Rudy
Duarte's new marriage. While tangible items may be easily sold,
it is the human capital that is the most precious and the most
fragile.
We are thankful that this Congress saw fit to pass new laws
friendly to family businesses. Many in Congress, to their
credit, attempted to alleviate the death tax burden by
increasing the exemption levels from $600,000 to $1 million by
the year 2006 in the last budget agreement.
Unfortunately, these new increases in the unified credit do
little for the majority of family businesses. In fact, none of
the provisions, including those specifically targeted to
family-owned and operated businesses, provide significant help
for medium to large family businesses. Moreover, they are very
complex to implement for small family-owned businesses.
Further, although the current law provides for installments
of 14 years to pay off a levied death tax, the government
charges interest for this ``privilege.'' Although Congress
reduced the rate from four percent to two percent, expecting a
family that has paid countless taxes over the life of a
business to pay interest to the government when a loved one
dies is ridiculous. This interest payment is not even
deductible for estate or income tax purposes.
Again, an entrepreneur may have a net worth near or upwards
of this amount, but most often his capital is tied up in
nurturing his business. We think Senator Jon Kyl from Arizona
and Congressman Christopher Cox from California have the
correct approach to the death tax dilemma--do away with it! Mr.
Chairman, we also know that if you had your way, this would be
your solution as well.
According to a recent Insight magazine article on the
nation's growing tax burden, if the death tax were eliminated,
``the U.S. economy would be producing $79.2 billion more in
annual output and creating 228,000 more new jobs a year.'' This
is growing evidence that the tax revenue gained from the
increase in Gross Domestic Product (GDP) and jobs would be
enough to offset the elimination of the death tax.
Understandably, the thought of completely eliminating the
death tax may not be completely realistic for this Congress.
Therefore, it is important that Members of Congress continue to
recognize the unique nature of the family-owned business and
consider exempting from the death tax a family business that is
closely held by 50 percent or more by family members. As you
know, the current laws provide some help for these types of
businesses, but fall well short of eliminating the tax.
Mr. Chairman, ladies and gentlemen of the Committee, the
death tax is an injustice to American working families who have
risked everything to make a business grow and create
opportunities for their employees and communities. It is
especially unfair to the smallest of businesses for they do not
have the resources to set up the trusts, the accounts, and the
wills to protect themselves from the death tax.
It is time to lift this burden from the hundreds of
thousands of family businesses in this country. Let us begin to
protect one of America's greatest resources--the entrepreneur,
the risk taker, the provider, the community leader, the
philanthropist. A family business owner is all these things,
and more. We know--we learned from one of the best.
Why should a person build a business in America? To
perpetuate it. To make it grow. To keep it through the
generations. To provide opportunity for its employees and the
community.
We are committed to sending the message for those who might
not have a voice. We hope that other wholesalers and all
closely held family businesses would see fit to rally behind
this important cause and give it the support it deserves.
We thank the Chairman and the Committee members for the
opportunity to address this vitally important issue and look
forward to progressive steps to alleviate this unfair burden on
American family businesses.
Mr. Herger Thank you, Mr. Clements. We'll now hear from
Richard Forrestel, Jr., treasurer, Cold Spring Construction
Co., Akron, New York, on behalf of the Associated General
Contractors of America.
Mr. Forrestel.
STATEMENT OF RICHARD FORRESTEL, JR., TREASURER, COLD SPRING
CONSTRUCTION COMPANY, AKRON, NEW YORK, ON BEHALF OF ASSOCIATED
GENERAL CONTRACTORS OF AMERICA
Mr. Forrestel. Thank you and good afternoon. I am Richard
Forrestel, Jr., a CPA and treasurer of Cold Spring Construction
Company based in Akron, New York. I would like to thank
Chairman Archer and the other Members of this distinguished
Committee for the opportunity to discuss the devastating impact
of the Federal estate tax, or death tax, on family-owned
businesses. I am testifying on behalf of the Associated General
Contractors of America, AGC, a national trade association
representing more than 33,000 firms, including 7,500 of
America's general contracting firms. AGC is the voice of the
construction industry.
While AGC's membership is diverse, the majority of AGC
firms are closely held businesses, like our own. AGC member
firms are 94 percent closely held, 81 percent are owned by
fewer than four persons, and over 80 percent are small
businesses with an average construction project under $5
million.
Cold Spring was founded by Grandpa in 1911. We are a
closely held, family-owned construction firm that specializes
in highway and bridge construction. Our projects range in size
from $1 million to $30 million. Dad and his brother, Uncle Tom,
both entered the business after serving our country in World
War II and worked together until Uncle Tom died in 1977. Dad,
our chief executive officer, still remains very active today.
In addition, my brother Steve, our president, and my brother
Andrew, our vice president, are actively involved in managing
the business. We have eight siblings who are not involved in
Cold Spring, although each worked for Cold Spring every summer
to pay for college, as did 12 of my first cousins.
Congress needs to be reminded that Americans are smart
people. When faced with an onerous tax like the death tax,
family held businesses have been forced to jump through
numerous, peculiar, and sometimes ridiculous tax hoops to
ensure the livelihood and continuation of their family
businesses.
I began working for Cold Spring in 1975 and would like to
describe some of the estate planning techniques we have
employed in our battle to save our family business. Uncle Tom
died at the young age of 49 in 1977. At the time, both he and
Dad owned half the business. Subsequent to Uncle Tom's death,
Dad negotiated with Aunt Jo and bought Uncle Tom's stock in the
company. This transaction was completed in 1979.
In 1980, Dad found himself with a potentially nasty estate
tax problem brewing. Cold Spring did an estate freeze and
created a preferred class of stock. In addition, a nonvoting
common stock was created. Dad and Mom then began to gift the
voting stock to the three of us involved in the business and
the nonvoting stock to our eight siblings not involved in the
business. Dad and Mom both used their unified credits to
expedite the gifting. They brought their 11 children together
in 1987 and told them of the gifting program. One of our
sisters suggested that we have the option to call their
nonvoting stock at some future date. This stock was called in
the early nineties. As Dad approached 70, he felt it was
necessary to create some immediate liquidity in his estate and
the corporation redeemed his preferred stock.
In 1980, Cold Spring bought a large life insurance policy
on Dad's life. The reason for this purchase was to create
liquidity in Dad's estate in the event of his demise. Cold
Spring still maintains the policy on Dad along with policies on
Steve, Andy, and me. More than $2 million has been paid in life
insurance premiums since 1980 on these policies. The primary
purpose of these, of course, is to ensure liquidity in our
various estates to pay for estate taxes. In addition, Cold
Spring has spent more than $2 million since 1980 redeeming
stock from various shareholders. Again, these transactions were
driven by estate taxes.
Cold Spring missed a glorious planning opportunity in 1986
to become an S corporation when it found itself with three
classes of stock. Those three classes of stock existed because
of estate taxes.
Chairman Archer, I have hit the highlights as to the hoops
Cold Spring has jumped through to provide for a fourth
generation in our family business. We have diverted enormous
amounts of capital and management time to this process. We
ought to be buying bulldozers and backhoes built in Peoria,
Illinois, rather than intangible life insurance policies. We
should also be providing long-term security for our employees.
I believe the country and our company would be better served
had these capital and intellectual diversions not been
necessary.
I appreciate the efforts made by this Committee in
attempting to provide some estate tax relief to family-owned
businesses as part of the 1997 Act. However, Congress needs to
do much, much more to help the family-owned businesses
threatened by the estate tax. AGC ultimately supports repeal.
Short of full repeal, AGC supports every effort to reduce the
impact of estate taxes on family-owned businesses so that they
may survive to the next generation. I urge you to include
estate tax repeal or large-scale estate tax relief in any
upcoming bill. Thank you.
[The prepared statement follows:]
Statement of Richard Forrestel, Jr., Treasurer, Cold Spring
Construction Company, Akron, New York, on behalf of Associated General
Contractors of America
I am Richard Forrestel, Jr., a CPA and Treasurer of Cold
Spring Construction, based in Akron, New York.
I would like to thank Chairman Archer and other members of
this distinguished Committee for the opportunity to discuss the
devastating impact of the federal estate tax, or the death tax
as we often refer to it, on family-owned businesses.
I am testifying on behalf of the Associated General
Contractors of America, a national trade association
representing more than 33,000 firms, including 7,500 of
America's leading general contracting firms. They are engaged
in the construction of the nation's commercial buildings,
shopping centers, factories, warehouses, highways, bridges,
tunnels, airports, waterworks facilities, waste treatment
facilities, dams, water conservation projects, defense
facilities, multi-family housing projects, and site
preparation/utilities installation for housing developments.
While AGC's membership is diverse, the majority of AGC
firms are closely-held businesses like my own. AGC member firms
are 94% closely-held, 81% are owned by fewer than four persons,
and over 80% are small businesses with an average construction
project size under $5 million.
Please note that the survey data mentioned in my testimony
is drawn from the 1997 AGC/Deloitte and Touche Insights in
Construction Survey and the 1995 Center for the Study of
Taxation Federal Estate Tax Impact Survey.
I. What the Death Tax Has Meant to My Family
Cold Spring Construction Company was founded by Grandpa in
1911. We are a closely-held, family-owned construction firm
that specializes in highway and bridge construction. Our
projects range in size from $1 million to $30 million. Dad and
his brother, Uncle Tom, both entered the business after serving
our country in World War II and worked together until Uncle Tom
died in 1977. Dad (C.E.O.) still remains very active in the
business today. In addition, my brothers Steve (President) and
Andy (Vice President) are actively involved in managing the
business today. We have eight siblings who are not involved in
Cold Spring, although each worked for Cold Spring every summer
to pay for college, as did 12 of my first cousins.
Congress needs to be reminded that Americans are smart
people. When faced with an onerous tax like the death tax,
family-held businesses have been forced to jump through
numerous, peculiar, and sometimes ridiculous, tax hoops to
ensure the livelihood and continuation of their family
businesses.
I began working for Cold Spring in 1975 and would like to
describe some of the estate tax planning techniques we have
employed in our battle to save our family business. Uncle Tom
died at the young age of 49, in 1977. At the time, both he and
Dad owned 50% of the business. Subsequent to Uncle Tom's death,
Dad negotiated with Aunt Jo and bought Uncle Tom's stock in the
company. This transaction was completed in 1979.
In 1980 Dad found himself with a potentially nasty estate
tax problem brewing. Cold Spring did an estate freeze and
created a preferred class of stock. In addition, a non-voting
common stock was created. Dad and Mom then began to gift the
voting stock to the three of us involved in the business and
the non-voting stock to our eight siblings not involved in the
business. Dad and Mom both used their unified credits to
expedite the gifting. They brought their eleven children
together in 1987 and told them of the gifting program. One of
our sisters suggested that we have the option to ``call'' their
non-voting stock at some future date. This stock was called in
the early 1990's. As Dad approached 70, he felt it was
necessary to create some immediate liquidity in his estate and
the corporation redeemed his preferred stock.
In 1980 Cold Spring bought a large insurance policy on
Dad's life. The reason for this purchase was to create
liquidity in Dad's estate in the event of his demise. Cold
Spring still maintains that policy on Dad today along with life
insurance policies on Steve, Andy, and me. More than $2 million
has been paid in insurance premiums since 1980 on these
policies--the primary purpose of these is, of course, to ensure
liquidity in our various estates to pay for estate taxes. In
addition, Cold Spring has also spent more than $2 million since
1980 in redeeming stock from various shareholders. Again, these
transactions were driven by estate taxes.
Cold Spring missed a glorious planning opportunity in 1986
to become an S Corporation when it found itself with three
classes of stock. Those three classes of stock existed because
of estate taxes.
Chairman Archer, I have hit the highlights as to the hoops
Cold Spring has jumped through to provide for a fourth
generation in our family business. We have diverted enormous
amounts of capital and management time to this process. We
ought to be buying bulldozers and backhoes built in Peoria,
Illinois rather than wasting capital on intangible life
insurance policies. We should also be providing long-term job
security for our employees. I believe the country and our
company would be better served had these capital and
intellectual diversions not been necessary.
II. What the Death Tax Means to All Family-Owned Construction Firms
The federal estate tax is one of the most onerous obstacles
to business continuity and growth. When the owner of a family
business dies, his or her estate is subject to federal and
state estate taxes. The total value of the estate includes the
value of the family business along with other assets such as
homes, cash, stocks and bonds. Currently, an estate over
$625,000 is subject to the federal estate tax, and an estate
over $3 million will be taxed at an astronomical 55% rate. This
unfair tax is on top of the income, business, property, sales
and capital gains taxes that have been paid on these same
assets over a lifetime. This is double taxation of the worst
kind.
Even the smallest contractor has lifetime capital assets,
property, real estate and insurance over $625,000. Most family-
owned construction firms invest a significant portion of their
after-tax profits in equipment, facilities, and working
capital. This is necessary for these firms to increase their
net worth, create jobs, and continue to be bonded for larger
projects.
Accordingly, the burden of the federal estate tax falls
squarely on family-owned businesses, such as my own. The result
is that many of these family-owned business must be sold,
downsized, or liquidated just to pay the estate tax.
Please allow me to tell you about several ways that the
estate tax impacts small family-owned construction firms--
focusing on business continuity, cost of estate planning, job
destruction, and the human toll.
Business Continuity
It is part of the American Dream to create a prosperous
business and to pass that success on to future generations.
Business continuity--the passing of years of hard work to the
next generation--is a great concern to most family-owned
businesses. Unfortunately, more than 70% of family businesses
do not succeed to the second generation and 87% do not survive
to the third generation. Furthermore, it is estimated that 90%
of family businesses that fail shortly after the death of the
founder fail because of the estate tax burden placed on family
members.
This is especially true in the case of capital-intensive
industries such as construction. In a recent survey, 62% of
AGC's membership said that the federal estate tax would make it
significantly more difficult for the business to survive the
death of the principle owner. For a business like Cold Spring,
the federal estate tax and other tax considerations of passing
a business to the next generation are an overwhelming obstacle.
Cost of Estate Planning
Let me state for the record, I am fortunate as a CPA to
have a grasp of the impact of the death tax on our business.
However, most of my colleagues in family-owned construction
firms do not have an accounting background. More importantly,
many construction firms do not have a CFO or in-house
accountant. Remember, our goal is to construct buildings,
bridges and highways. You can only imagine the frustration I
share with my colleagues in the construction industry when we
are confronted with the intricacies of the Internal Revenue
Code. The current tax code, and particularly the estate tax, is
so difficult to understand that most construction firms,
notably smaller firms, are forced to hire costly outside
accounting and legal advisors for estate planning.
Those family-owned businesses that do survive to the next
generation have spent thousands, sometimes millions of dollars,
on estate planning so they are capable of paying the estate
tax. Please note that I said to pay the tax, not to avoid the
tax. Of AGC firms involved in estate planning, 63% purchase
life insurance, 44% have buy/sell agreements and 29% provide
lifetime gifts of stock. Again, allow me to use Cold Spring as
a family-owned business example. We spend in excess of $100,000
a year in insurance costs and accounting fees to ensure that we
have the capital to pay the estate tax and transfer our
business from one generation to the next.
These finances are being diverted from useful means that
could support firms like mine in becoming more efficient and
creating jobs. In fact, it is not unusual for contractors to
forgo new equipment, manpower, and technology to plan for
estate taxes. This monetary cost is in addition to the valuable
time spent by family-owned business owners on estate planning,
which would be better spent managing their companies so they
are able to better compete in the marketplace.
Job Destruction
The estate tax not only affects the business owner, but
also his or her employees. The Center for the Study of Taxation
found that family-owned businesses created 78% of all new jobs
in the United States from 1977 to 1990. In fact, AGC's family-
owned firms employ on average 40 persons and have created on
average 12 new jobs each in the last five years. At Cold Spring
we help support 150 families through employment. The estate
tax, however, can destroy these jobs because firms are often
forced to sell, downsize or liquidate to pay this onerous tax.
On average, 46 workers lose their jobs every time a family-
owned business closes. Finally, let us not forget the impact
that these family-owned businesses have on their immediate
community. These family-owned businesses not only offer jobs,
but they are also a vital part of every community providing
specialized services, supporting local charities, and returning
earnings back to the local economy.
The Human Toll
It has been said that, ``At birth you get a
certificate...at marriage you get a license...at death you get
a bill.'' That is the human side of the estate tax. Little
needs to be said of the immense grief of the passing of a loved
one. However, I do not believe that the fear of losing one's
business should be any part of mourning the passing of a parent
or sibling. Making a decision on the future of a family-owned
business includes generations of hopes and dreams of your
family, as well as your employees. The estate tax has a toll--
it hits when families are most in turmoil, especially owners of
small family-owned businesses.
III. Provide Death Tax Relief Now
I appreciate the efforts made by this committee in lowering
the estate tax as part of the Taxpayer Relief Act of 1997. I
also understand that numerous pieces of legislation have been
introduced in the 105th Congress that would repeal or reform
estate taxes. However, Congress needs to do much more to help
the growing number of family-owned businesses facing the estate
tax. AGC ultimately supports repeal of the federal estate tax.
Short of full repeal, AGC supports every effort to reduce the
impact of estate taxes on family-owned businesses so they may
survive to the next generation. I urge you to include estate
tax repeal or large-scale estate tax rate relief in any
upcoming tax bill. This issue continues to loom over employers
and their employees on a daily basis.
Thank you for the opportunity to speak to you about this
important issue. I will be happy to answer any questions.
Chairman Archer [presiding]. Thank you, Mr. Forrestel. Let
me just quickly interject, before I recognize Mr. Loop, that
no, we have not done enough, but we should never forget the
dramatic change for improvement rather than disimprovement that
occurred after the election in 1994, because prior to that time
the issue was, is the exclusion going to be reduced. You may
remember that.
Mr. Forrestel. Yes, sir.
Chairman Archer. Mr. Loop.
STATEMENT OF CARL B. LOOP, JR., PRESIDENT, LOOP'S NURSERY AND
GREENHOUSES, INC., JACKSONVILLE, FLORIDA; VICE PRESIDENT,
AMERICAN FARM BUREAU FEDERATION; AND PRESIDENT, FLORIDA FARM
BUREAU FEDERATION
Mr. Loop. Thank you, Mr. Chairman, Members of the
Committee. My name is Carl Loop. I'm president of Loop's
Nursery and Greenhouses, Incorporated in Jacksonville, Florida.
I serve as president of the Florida Farm Bureau. I'm also vice
president of the American Farm Bureau. I'm pleased to be here
today to talk about the unfairness of estate taxes and the
threat they pose to family farmers and ranchers.
Farm bureau's position on estate taxes is straightforward;
we recommend their elimination. This issue is so emotionally
charged that last year farm bureau members sent more than
70,000 letters to Washington calling for an end to the death
taxes. I wrote several of those letters myself because death
tax threatens the continuation of my family's livelihood.
In 1949, I started a nursery business with a $1,500 loan
and a borrowed truck. In the early years, we got by living on
my wife's salary from teaching school and everything I earned
went back into the business. For 49 years, I worked with my
wife and children. We worked hard to build our business into
one of the largest wholesale growers of flowering pot plants
and tropical foliage in the southeastern United States.
My family feels that our operation not only grows a needed
product, but makes a positive contribution to our community. We
employ over 85 people year round, support community activities,
and provide a stable tax base. It's hard for us to understand
why the government wants to penalize us for being successful,
especially when we've already paid taxes on everything that
we've earned. Inflation has increased the value of both our
land and equipment to the point that my family would have to
sell part of the nursery to pay death taxes. This could prove
fatal to our business. Because greenhouses are a single-purpose
structure, they don't have a whole lot of market value and the
only thing a forced partial sale would accomplish would be to
destroy our business viability.
My son and daughter would like to continue the family
business and I would like to pass it on to them. For the past 5
years, I've been working with attorneys to plan for my death. I
purchased life insurance. I recapitalized the business, issued
two classes of stock, set up revocable and irrevocable trust
agreements, gifted assets, given stock options, and shifted
some control of the business. After hours of worry and large
attorney fees, I still don't know if my estate plan will serve
to save our family business. I guess that won't be known until
after my death.
It seems to me and my family that Loop's Nursery and
Greenhouses is worth much more to our community and the
government as an ongoing business compared to the amount of a
one-time estate tax payment. If my family is forced out of
business by the death tax, the business will close, my family
will lose their livelihood, people will lose their jobs, and a
community-minded business that pays taxes will be gone.
My situation is not unique. As a farm bureau official, I
talk with farmers and ranchers across this country and I can
tell you that people everywhere are concerned that death taxes
will destroy their family businesses. Many don't know how
severely they will be impacted because they don't realize how
much the value of their property has increased because of
inflation. Others understand the consequences but fail to
adequately prepare because, first, the law is complicated,
second, estate planning is expensive, and third, death is a
subject that is difficult for a lot of people to talk about.
The Tax Relief Act of 1997 made improvements in the estate
tax system by increasing the exemption to $1 million by the
year 2006 and creating the $1.3 million family business
exemption. We commend Congress for enacting these changes.
While they are helpful, most of the benefits are far in the
future and the family business exemption has made the estate
tax law even more complicated.
Farm bureau renews its call for the elimination of estate
taxes. Action by Congress is needed to preserve our Nation's
family farms and ranches, the jobs they provide, and the
contribution they make to their communities. I want to thank
the Committee for this opportunity to be here today to explain
why farmers and ranchers feel so strongly that death taxes
should be eliminated. Thank you.
[The prepared statement follows:]
Statement of Carl B. Loop, Jr., President, Loop's Nursery and
Greenhouses, Inc., Jacksonville, Florida; Vice President, American Farm
Bureau Federation; and President, Florida Farm Bureau Federation
My name is Carl B. Loop, Jr., I am president of Loop's
Nursery and Greenhouses, Inc., a wholesale plant nursery
operation in Jacksonville, Florida. I serve as President of the
Florida Farm Bureau Federation and as Vice President of the
American Farm Bureau Federation. Farm Bureau is a general farm
organization of 4.7 million member families who produce all
commercially marketed commodities produced in this country.
Last year's Taxpayer Relief Act made cuts in estate taxes
that are helpful to agricultural producers but stopped short of
ending death taxes that can destroy a family business. I am
pleased to be here today to talk about the unfairness of estate
taxes and the threat they pose to family farmers and ranchers.
Farm Bureau's position on estate taxes is straightforward.
We recommend their elimination. The issue is so emotionally
charged that last year Farm Bureau members sent more than
70,000 letters to their representatives and senators calling
for an end to death taxes. I wrote several of those letters
because death taxes threaten the continuation of my family's
livelihood.
In 1949, after graduating from the University of Florida, I
started my nursery business with a $1500 loan and a borrowed
truck. In the early years we got by living on the teacher's
salary of my wife, Ruth. Everything that I earned was
reinvested in the business. For 49 years I, along with my wife
and children, have worked hard to build our business into one
of the largest wholesale nursery operations in the southeastern
United States.
I am proud that my nursery has allowed me to support my
family and send my three children, Carol, 42, David, 39, and
Jane, 32, to college. David, earned his degree in ornamental
horticultural and agriculture economics and now runs the
business on a daily basis. Without his involvement I wouldn't
have been able to come here today. My youngest daughter, Jane,
would also like to come into the business.
Loop Nursery and Greenhouses, Inc., grows flowering pot
plants and tropical foliage in 350,000 square feet (nine acres)
of greenhouses. Also part of the business are warehouses, cold
storage and the equipment needed to grow, harvest and market
our products. Between 85 and 100 people are employed year-
round.
My family feels that our operation not only grows a needed
product, but makes a positive contribution to our community. In
addition to employing 85-plus people, we are a community minded
business which provides a stable tax base for city, county,
state and federal government. We do not understand why the
government wants to penalize us for being successful,
especially since we already paid taxes on what we have earned.
Inflation has increased the value of both our land and
equipment to the point that my family would have to sell part
of the nursery to pay death taxes. This could prove fatal to
our business because our assets can't be easily liquidated.
Because greenhouses are single purpose structures, they don't
have much market value and the only thing a forced partial sale
would accomplish would be to destroy the viability of our
business.
My son and daughter want to continue our family business
and I would like to pass it on to them. For the last five
years, I have been working with attorneys to plan for my death.
I have purchased life insurance, recapitalized the business,
issued two classes of stock, set up revocable and irrevocable
trust agreements, gifted assets, given stock options, and
shifted control of the business. After hours of worry and large
attorney fees I still don't know if my estate tax plan will
save our family business.
It seems to me and my family that Loop's Nursery and
Greenhouses, Inc., is worth much more to our community and the
government as an ongoing business when compared to the amount
of a one-time estate tax payment. If my family is forced out of
business by death taxes everything that I have worked for will
be lost, my family will lose its livelihood, 85-plus families
will lose their incomes and the community will lose a valuable
part of its business base.
My situation is not unique. As vice president of the
American Farm Bureau, I talk with farmers and ranchers from
across the country and I can tell you that people everywhere
are concerned that death taxes will destroy their family
businesses. Many don't know how severely they will be impacted
because they don't realize how much their property has
increased in value due to inflation. Others understand the
consequences but fail to adequately prepare because the law is
complicated, because lawyers, accountants and life insurance
are expensive and because death is a difficult subject.
It bothers me and my family that while death taxes can cost
farm and ranch families their businesses and cost them hundreds
of hours and thousands of dollars for estate planning,
relatively little revenue is generated for the federal
government. The estate tax raised a total of about $17.2
billion in fiscal year 1996, as reported by the Office of
Management and Budget.
The potential impact of estate taxes on the future of
American agriculture is enormous. Ninety-nine percent of U.S.
farms are owned by individuals, family partnerships or family
corporations. About half of farm and ranch operators are 55
years or older and are approaching the time when they will
transfer their farms and ranches to their children.
The situation in my state of Florida is acute. The value of
farmland there has been inflated far beyond its worth for
agriculture because developers are willing to pay high prices
to convert farmland to other uses. It is not uncommon for land
to be valued at as much as $10,000 an acre. On paper this makes
a Florida farmer look like a wealthy person, but my farm
neighbors aren't rich. They simply don't have the money to pay
a huge estate tax bill without selling part or all of their
business. While estate tax planning can protect some of the
farms, it is costly and takes resources that could be better
used to upgrade and expand their businesses.
The Tax Relief Act of 1997 made improvements in the estate
tax system by increasing the per person exemption to $1 million
by 2006 and creating the $1.3 million family business
exemption. We commend Congress for enacting these changes.
While they are helpful, most of the benefits are far in the
future and the family business exemption has made the estate
tax law even more complex.
Farm Bureau renews its call for the elimination of estate
taxes. Action by Congress is needed to preserve our nation's
family farms and ranches, the jobs they provide and the
contribution they make to their communities. Until repeal of
estate taxes can be accomplished, Farm Bureau urges increasing
the estate tax exemption to $5 million per person, indexing the
exemption for inflation and cutting the tax rate for assets
above the threshold by half. Special-use valuation should be
expanded, an estate tax exemption for protected farmland should
be put in place and the annual gift tax exemption should be
increased to $50,000.
Thank you for the opportunity to be here today to explain
why farmers and ranchers feel so strongly that death taxes
should be eliminated.
Chairman Archer. Thank you, Mr. Loop, and finally, a
gentleman who is no stranger to our Committee and a gentleman
who I greatly respect, who is one of the Nation's outstanding
experts on the death tax and all of its details and
complexities, Mr. Harold Apolinsky.
STATEMENT OF HAROLD I. APOLINSKY, GENERAL COUNSEL, AMERICAN
FAMILY BUSINESS INSTITUTE, AND VICE PRESIDENT, LEGISLATION, AND
PAST CHAIR, SMALL BUSINESS COUNCIL OF AMERICA
Mr. Apolinsky. Thank you, Mr. Chairman. It is a privilege
to be with these members on these panels. These stories to me
of family businesses are just absolutely chilling. Mr. Loop is
correct when he says that the majority of people, I think maybe
80 percent of the people in this country who will be impacted
by this 55 percent death tax, do not really know it. Unless you
hire me or somebody else as an estate tax lawyer or sell life
insurance, it just does not occur to you. We all get a dose of
income tax every April but we do not get a dose of death tax
until someone dies.
As you say, I am an estate tax lawyer. I have been doing
this for 36 years. I have been teaching estate planning at both
the University of Alabama School and Law and Cumberland School
of Law for 26 years. I flew up this morning and go back this
evening. I feel privileged, on behalf of the American Family
Business Institute and the Small Business Council of America,
to share ideas with this Committee for your important work.
In my firm, we have 110 lawyers in Alabama. We believe that
is enough lawyers to solve any problem or cause any problem,
depending on what the client really would like to hire us to
do. We have nine full-time trust and estate lawyers and yet we
all agree that this death tax needs to be repealed. Even though
it would impact our practices, we will find something
productive to do. We have seen how harmful it is to family
businesses, family farms, family capital to want to get rid of
it.
It is relatively easy to calculate the death tax. Most
people, as Mr. Loop says, have not. You simply add up the fair
market value, of everything a person owns; qualified retirement
plans, life insurance, even tax exempt bonds are not exempt
from the 55 percent death tax. You subtract liabilities, you
subtract $1 million, and then multiply by 50 percent. That's a
little conservative because the top rate, as you know, is 55
percent. If you have a large qualified retirement plan, you
basically pay 75 percent in tax, both income and estate, and so
the children get 25 cents on the dollar.
Thank you for repealing the 15 percent extra excise tax on
retirement accounts because when that hit, only 10 percent went
to the children. But I still think a 75 percent tax on
qualified retirement plans is unreasonable.
And then, if parents decide they want to leave assets to
grandchildren, there may be an extra 55 percent generation-
skipping tax. I am blessed with two grandchildren. One is seven
and one is four. I understand why they are called grandchildren
because they really are grand. But if you want to leave the
grandchildren a significant amount, I'm widowed, let's say more
than $1 million, there's an extra 55 percent generation-
skipping tax on top of the 55 percent estate tax on what goes
to grandchildren. So, it is really confiscatory.
I am grateful that your Committee encouraged Congress to
increase the tax-free amount from $600,000 to, this year,
$625,000. It moves up in rather odd increments, I must admit.
It is good that you do not build stairs in houses or people
would fall down because it is so unusual and uneven. It would
be easier if it went up equally but I understand the budget
problems.
I tell my clients that, the tax-free amount will be $1
million in 2006 so please live as long as you can, which seems
to please them. Unfortunately, if you have a qualified family-
owned business interest, you really need to die early. You have
described the Code, and I agree, Mr. Chairman, as a lawyer in
your past life, as an attractive nuisance. In my judgment, 2033
A, the Qualified Family Owned Business Exclusion, is an
unattractive nuisance. Both the American College of Trust and
Estate Counsel, ACTEC, senior estate planning lawyers, I am a
member, and the Real Property and Probate section of the
American Bar Association have asked that this provision be
repealed. In the most recent issue of Trusts and Estates, the
writer described 2033 A as one of the most ambiguous and
complicated tax provisions to be passed in decades. So help me,
this is true. There is even a web page now on the Internet on
2033 A. I have given the Committee my exhibit C to my testimony
as a tool to try and understand 2033A. As Professor Graetz
said, I, too, am apprehensive as I kick off my estate planning
class this spring as to whether the law seniors can understand
this Code section. I warned them that they may go through the
entire semester and then I will be so happy if I get the estate
tax repealed. I promised all 56 of them an A but they will get
no tuition rebate.
I determined if a business fits under 2033A, you have to
master a fraction with 14 variables. It is simply so complex.
With dynamic scoring the cost of repeal will drop dramatically.
Please put this as number one because this is the one thing, as
the Clements family mentioned, that you cannot program. You
just do not know when death is going to strike. You can program
a lot of other things, but this one, I would say, we ought to
try to put first. If we repeal the death tax, obviously the
inherited step-up in bases would logically go away. Income tax
will be collected when assets are sold. It should not bother
anybody because if you are going to sell something, you know
the price, so we can stop litigating values. You also expect to
pay a tax when you sell something. We do not have to worry
about the profit on a home anymore.
If you still find you do not have enough money, repeal
2033A. It will not harm the lawyers because we really have not
picked up all the legal fees yet that are out there that we
will when we explain and investigate 2033A. Remove the death
tax from qualified retirement plans. And, number three, reduce
the top rate. I do not think of this as a prowealth situation.
As the panel described it, I think it is profamily and projobs.
I believe the American people will endorse that. Sixty Plus, a
great organization started us down this road of repeal. We are
grateful to Roger Zion and his team and Jim Martin. They did a
poll recently of the American people and 77 percent of them
said that they would rather vote for a Member of Congress who
repealed the death tax, as for someone who would not. That 77
percent wanted that death tax repealed. I have attached as
exhibit D, a list of 15 states that have repealed their State
death taxes since 1980, 15 of them. They took an exit poll in
California and people said it was not fair to tax during life
and at death. It was a fairness issue in California and
elsewhere. Indiana is going to repeal, I believe, this year,
and Kansas will repeal as well.
H.R. 902 in the House, Representative Cox's bill, now has
166 cosponsors to repeal. Senator Kyl now has 30. Please strike
a blow for fairness and simplicities and families. Put me and
my colleagues out of work. Repeal the death tax. It would be
one of the most wonderful things we could do. We should, in my
personal view, repeal the Internal Revenue Code but I think
that may come a little bit later. I would like to get rid of
the death tax first. Thank you, Mr. Chairman.
[The prepared statement and attachments follow:]
Statement of Harold I. Apolinsky, General Counsel, American Family
Business Institute; and Vice President, Legislation, and Past Chair,
Small Business Council of America
Mr. Chairman and Members of the Committee, I am Harold I.
Apolinsky, General Counsel of the American Family Business
Institute and Past Chair of the Small Business Council of
America (SBCA) and currently Vice President--Legislation. I am
also a practicing tax attorney (over 30 years) who specializes
in estate planning and probate. For over 25 years, I have
taught estate planning and estate, gift and generation-skipping
taxation as my avocation to law school seniors at both the
University of Alabama School of Law in Tuscaloosa, Alabama and
the Cumberland School of Law in Birmingham, Alabama. I am here
to present our views on the unfairness of the estate, gift and
generation-skipping taxes.
The American Family Business Institute is a year old non-
profit organization. Our members are family businesses
employing over 5,000 employees throughout the United States
facing forced sale or liquidation because of this 55% death
tax. Our mission is to educate and alert family business owners
regarding the death tax and to seek its repeal by Congress. We
hope you will put us out of business this year.
SBCA is a national nonprofit organization which represents
the interests of privately-held and family-owned businesses on
federal tax, health care and employee benefit matters. The
SBCA, through its members, represents well over 20,000
enterprises in retail, manufacturing and service industries,
which enterprises represent or sponsor over two hundred
thousand qualified retirement and welfare plans, and employ
over 1,500,000 employees.
We are delighted and heartened by the overwhelming response
that this issue has evoked from Members of Congress and their
staffs. It is indeed refreshing to observe the level of
understanding and commitment that individual Members have
demonstrated. The existence and harm of the 55% death tax is
not generally known other than to estate tax lawyers and
families who have suffered the loss of a loved one owning more
than the applicable exclusion amount, now $625,000.
Thank you for the increase in this tax-free amount. I
advise my clients to try and live to 2006, but die early if
they own a qualified family business. Unfortunately, neither
this nor the unworkable 2033A Family-Owned Business Exclusion
will save 90% of family businesses.
We submit that the time has come for Congress to repeal the
estate, gift and generation-skipping taxes. It is unfair to tax
people all their working lives and then again at death.
An estate tax due nine months after death is imposed on the
transfer to children or other heirs of the taxable estate of
every decedent who is a citizen or resident of the United
States ($625,000 of assets are now exempt). The graduated
estate tax rates begin effectively at 37% and increase to a
maximum rate of 55% (see Exhibit ``A'' for how the tax is
calculated). Taxes on bequests to spouses may be deferred until
the last-to-die of husband and wife.
A gift tax is levied on taxable gifts (excluding $10,000
per donee per year) as a back-stop to the estate taxes. The
graduated rates are the same. (The current $625,000 exempt
amount may be used during life for gifts or at death.)
An extra, flat 55% generation-skipping tax is imposed on
gifts or bequests to grandchildren ($1,000,000 is now exempt).
Combined income and estate taxes frequently consume 75% or
better of retirement plan accounts at death (see chart attached
as Exhibit ``B''). Thank you also for repealing the 15% excise
tax. With that, only10% would go to children.
The 1995 White House Conference on Small Business
recommended repeal of estate and gift taxes. In fact, ranked by
votes, this was the number four (out of sixty) recommendation
to come out of the Conference.
It is well known that only 30% of family business and farms
make it through the second generation. Seventy percent (70%) do
not. Only 13% make it through the third generation. Eighty-
seven (87%) do not. The primary cause of the demise of family
businesses and farms, after the death of the founder and the
founder's spouse, is the 55% estate tax. It is hard for the
successful business to afford enough life insurance. (Premiums
are not deductible and deplete working capital.)
The new Qualified Family-Owned Business Interest Exclusion
(QFOBI) is now the most complex provision in the Tax Code. At
best, it will help less than 5% of family businesses facing
sale or liquidation from the death tax. Just look at Exhibit
``C'' which I use to try and teach 2033A. It may make you
laugh. Both the American College of Trust and Estate Counsel
(to which I belong) and the Real Property and Probate Division
of the American Bar Association have urged repeal. In an
article in the January 1998 issue of Trusts & Estates the
author referred to 2033A as ``one of the most ambiguous and
complicated tax provisions to be passed in decades.''
The estate tax took its present form primarily in the early
30's. The express purpose was to ``break-up wealth.'' Is this
consistent with a free enterprise economic system and a very
competitive world economy? The 55% estate and gift tax cannot
be justified as playing an important role in financing the
federal government; it now brings in less than 1.2 percent of
total federal revenues. The expense of administering this
system probably offset 75% or more of the revenue. Since the
step-up in basis will also be repealed, resulting in tax when
assets are sold by heirs, the net loss of revenue will be
modest.
Since 1980, 15 states have repealed their state death tax
(see Exhibit ``D''). California voters approved Proposition 6
in 1982 to repeal the California death tax. Exit polls
determined that voters, even in this state with such a wide
disparity between rich and poor, did not feel it fair to pay
taxes during life and at death. The fair approach is to repeal
the death tax in 1998.
As I have testified before, if the estate tax were
repealed, we believe based upon studies conducted by Professor
Richard Wagner of George Mason University, by the Heritage
Foundation and by Kennesaw State College that the beneficial
effect on the economy would be significant. According to the
study conducted by Professor Richard Wagner of George Mason
University, the effect of the estate tax on the cost of capital
is so great that within eight years, a U.S. economy without an
estate tax would be producing $80 billion more in annual output
and would have created 250,000 additional jobs and a $640
billion larger capital stock.
The Heritage Foundation study utilizing two leading
econometric models also found that repealing the estate tax
would have a beneficial effect on the economy. The Heritage
analysis found that if the tax were repealed in 1996, over the
next nine years:
The nation's economy would average as much as $11
billion per year in extra output;
An average of 145,000 additional new jobs could be
created;
Personal income could rise by an average of $8
billion per year above current projections; and
The deficit actually would decline, since revenues
generated by extra growth would more than compensate for the
meager revenues currently raised by the inefficient estate tax.
We submit if repealing estate taxes accomplished only half
of these things, the country would be significantly better off
than staying under the current draconian estate tax system. The
estate tax system raises very little revenue at a heavy cost to
the economy. It generates complex tax avoidance schemes, it
promotes spending instead of saving and it promotes people
``giving up'' on the family business or farm. It helps my
estate tax lawyers (now 9 in my 110 lawyer firm), but is not
fair to families or good for my country.
The Kennesaw State College Study on the Impact of the
Federal Estate Tax, prepared by Astrachan and Aronoff, studied
in detail the impact of the estate tax on members of the
Associated Equipment Distributors (AED), an association
composed of capital-intensive family-owned distribution
businesses and on newly-emerging, minority-owned family
enterprises selected from lists published by Black Enterprise
Magazine. The study showed that for the AED group:
Nearly $5 million is spent annually in life
insurance premiums in order to have proceeds available to meet
their estate tax liability. The survey shows an average of
$27,000 per year expended by distributors on such insurance.
$6.6 million has been spent on lawyers,
accountants and other advisors for estate tax planning
purposes. On average companies spent nearly:
$20,000 in legal fees
$11,900 in accounting fees
$11,200 for other advisors
In addition to the protection provided by life
insurance premiums, roughly 12% of the AED respondents reserved
over $51 million in liquid assets for the purpose of having
cash available for the payment of the estate tax.
The study showed that 57% of the businesses felt that the
imposition of the estate tax would make long term survival of
the business after the death of the current owner significantly
more difficult. They are not wrong--the statistics show it is
extraordinarily difficult to have the family business survive
the death of the first generation. Working capital to a
business is like fuel to an airplane. When you run out of fuel,
the plane comes down whether at an airport or not. Removing 55%
of the value of a family business often removes more than 55%
of the working capital.
Australia repealed their estate and gift tax laws in the
mid-1970's. It was felt that these transfer taxes were an
inhibitor on the growth of family businesses. The legislative
body of Australia sought more jobs which they believed would
come if family businesses grew larger and were not caused to
sell, downsize, or liquidate at the death of the founder to pay
estate taxes. More recently, Canada has also repealed estate
taxes for the same reasons.
The SBCA has a legal and advisory board comprised of the
top legal, accounting, insurance, pension and actuarial
advisors to small business in the country. It is contrary to
the financial interests of these board members in their tax
practice and advisory businesses to urge repeal of these
transfer taxes. We stand firmly behind repeal or significant
reform, however, because it is the right thing to do to help
grow family businesses, provide jobs and encourage the
entrepreneurial spirit needed for small businesses to become
large businesses.
We applaud the bills introduced by Congressman Cox (HR 902
now with 166 co-sponsors) AND Senators Kyl (S-75 now with 30
co-sponsors) and Lugar (S-30) to repeal these taxes. The
country will be far better off if any of them become law. As a
country, we cannot stand by and see one more farm or one more
small business get torn apart because of an obsolete tax
supposedly in place to redistribute massive wealth. Part of the
problem with estate taxes is that many of the families who are
ultimately destroyed by the estate tax are not even aware that
it exists. Many times no one in the family has ever been
subjected to it.
The 55% death tax (the highest in the world) does the most
harm to capital of any tax we have. Once it leaves the family
at death and goes to Washington, it never seems to come back to
provide jobs back home. It is simply not fair!
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Chairman Archer. Thank you, Mr. Apolinsky. Let me piggy-
back momentarily on what Mr. Loop said. I believe it's accurate
to say that we did not increase the complexities in the Code
relative to the small business exemption but we did not
simplify them. We left in place the complexities that were
already in the Code. Is that a fair statement, Mr. Apolinsky?
Mr. Apolinsky. Mr. Chairman, I am afraid we did add to the
complexity. I am afraid that 2033 A is an additional complexity
because it incorporates 14 provisions from 2032 A. I realize it
is elective, which is useful. But, from an estate planner's
perspective, we feel the necessity to contact all of our family
business clients, explain the law to them, have them engage us
to check it out, make any required changes and, document
material participation. So, this is an additional burden, and
expense to family businesses. I worry that only about 2 to 5
percent of family businesses will really qualify. But I think
every family business needs to take a look at it to see if they
can, ultimately, qualify because it may save $400,000 or
$500,000 in tax.
Chairman Archer. My understanding, though, and you
certainly have been one of my educators on this over the last
several years, is that the existing definition of small
business or farm in the Code before the 1997 act was already so
very complex that it, in itself, limited the practical
application to a very small percentage of people who thought
they probably qualified. Is that a fair statement?
Mr. Apolinsky. Mr. Chairman, that is a fair statement. As
you remember better than I, in 1976, Congress wanted to save
the family farm, a great idea. Congress passed 2032A. It is 11
pages of statute. It has now been challenged constantly in
court. There have been 138 court decisions to date. About two-
thirds were won by the Internal Revenue Service. This is
probably at least an equal number in the pipeline. You are
exactly right. And then, you know, I realize, it was not the
House, in my judgment authorized 2033A. It came out of the
Senate. I tried to start teaching this in 1995 when it was the
Dole-Roth.
Chairman Archer. That is a correct thing to say in this
room, Mr. Apolinsky. Thank you very much. [Laughter.]
Mr. Apolinsky. I hope no Senators are here. [Laughter.]
Chairman Archer. Let me comment just briefly on a couple of
things. I read an article recently where a financial counselor
was telling his clients, you should not have an IRA, you should
not have a tax-deductible retirement plan because in the end
the taxes are so brutal at the time of your death that it is
far better to do something else. Now, what a terrible thing to
have to say to the American public. It is terrible to tell
people if they get married, they're going to pay more taxes. It
is also terrible to tell them if they put aside for their own
retirement, it's a mistake because of the Tax Code.
I don't think the Members of Congress understand that the
savings that the law permits, and our salaries, which go into a
thrift savings account for our retirement, will be taxed at
unbelievably high rates at the time of death. As you've pointed
out, that applies to all tax-deductible savings accounts, so
much so that you end up, if you leave funds in that account and
you die prematurely, before you actuarially have been able to
pull out the amount there in your lifetime, what you leave to
your children gives them roughly 25 percent. That is highway
robbery and I appreciate your suggestion that if we don't do
anything else, we should change that, well, you've said many
other things, but as a part of it, that we should change that
provision in the Code.
Now, let me ask you if you have any data for us as to the
net revenues that the death tax provides to the Federal
Government, because I've read articles that say that the cost
of collecting it and the loss of other revenues, through other
tax programs, actually is virtually an offset to where it
produces no net income to the Federal Government. Do you have
any data on that at all?
Mr. Apolinsky. One of the members of the next panel, Bill
Beach, has worked with a group that I have assisted from a
technical standpoint to try and do a study of what would be the
revenue from a combination where you repeal the death tax,
factor in the expenses, and, although I have not seen their
final study, factor in some income from sales by heirs
selling--using a carryover basis.
Chairman Archer. Good.
Mr. Apolinsky. But, my impression, everything I have seen,
supports the concept that roughly 65 percent of the dollar goes
into the cost of collecting. Then, if you factor in the revenue
that will come from the sale by heirs from that, I think it
would be a question whether it is 2 or 3 or 4 years before it
becomes positive revenue. More revenue will flow if family
businessowners spend time with their marketing people, their
manufacturing people, and less time with their tax lawyers. As
much fun as I enjoy being with them and I love being paid by
them.
I have one client in Birmingham, Alabama, a little town,
that is paying $2 million a year in life insurance premium to
try to keep a family bottling company in the family through the
third generation. His expansion has just stopped. I told him, I
said, Jimmy, let me tell you what I'm working on, to repeal.
Would it mean anything to your company if I got the tax
repealed? His eyes got wide. He said, Harold, I'll promise you
I will build a bronze statue to you at Legion Field, which is
our football stadium. People will walk by and say, who's that
old man in the houndstooth hat, because we have Bear Bryant's
statue there. They'll say, I don't know him but I know that's
Harold Apolinsky. He got the estate tax repealed. [Laughter.]
Chairman Archer. That's a great story. Now, in a socialist
or communist country, I could understand it, but it defies me
that in a free-enterprise country that has built the finest
life, economically, for any people in the history of the world,
not without its faults, but nevertheless in a relative sense,
the finest life for the people who are its citizens of any
country in the history of the world, that we would say to
people in the later years of their life, if you continue to
work and to produce and to expand the wealth of this country,
you will be losing because all that you can ever leave to kids
out of that will be 25 percent. That the government will get 75
percent because at 44 percent income tax that comes off the top
and then another 55 percent of the 56 percent that is left
leaves you with 25 percent. What incentive is there for people
to continue to produce and to build more for everybody in this
country, jobs, and so forth? And, clearly, it is wrong and we
should do something about it.
Let me stop there and recognize my colleagues for any
inquiry they might like to make. First, Mr. Hulshof.
Mr. Hulshof. Thanks, Mr. Chairman. Ms. Clements, Mr.
Clements, I hope that America hears your story and I'm
confident that your father is probably looking down and smiling
because he knows that the lessons he taught you you have
learned well. As the only son of a Missouri farm family, I know
firsthand your plight.
First of all, we welcome you here to Washington, DC. We
have to continue to tell this story back home and I hope you go
back to Arizona and continue to talk about your story because
of the incredible battle we have ahead of us. Just a few short
months ago, a high-ranking official in this White House made
the public pronouncement that those of us who seek to change
the death tax laws are committing the ultimate act of
selfishness. A high-ranking Congressman from my State of
Missouri, who once sat on this Committee when his party was in
the majority, has tried in the past to lower the exemption so
that more family businesses and more family farms, Mr. Loop,
are subject to paying the tax in an effort to satisfy the
government's insatiable appetite for more taxes. And so, when
we have those on the other side that are fighting the efforts
to repeal and do away with the death tax, we have formidable
foes but I think if your story and stories that each of you
have told, if we can talk back home in our congressional
districts and tell those stories, then I believe the best
policy will come out. And, quite frankly, Ms. Clements, I
thought your testimony hit the nail squarely on the head in
that the vision of our Founding Fathers was very simple. And
that is, all Americans should be able to reap from the fruits
of their labors. And that's the right of life and the liberty
and property and that is a sacred right and we should be able
to pass on the fruits of our labors to those who follow us and
that, in essence, is the American dream. So, please continue to
tell your story because my personal opinion is a simple one and
that is that the death of a family member should not be a
taxable event, period. So, we welcome you here but please help
us continue to fight this fight. And I appreciate the time, Mr.
Chairman, and yield back.
Ms. Clements. Thank you.
Mr. Clements. Thank you, very much.
Chairman Archer. Mr. Hayworth.
Mr. Hayworth. Thank you, Mr. Chairman. I'd like to thank
all members of the panel and, of course, I'm especially pleased
to have Chris and Kim Clements here from Tucson. I would echo
the comments of my colleague from Missouri and point out the
irony. We saw it again last night in the State of the Union
Address, to have one side of the chamber rise in enthusiastic
applause for the largest tax increase in American history,
which I thought was extremely telling, and, from the Chief
Executive, this rather unique modern revisionism less than 5
years after the fact.
Be that as it may, Chris and Kim, in a town not very far
from one of your facilities, you have one in Holbrook, over in
Winslow, Arizona we had a townhall meeting a couple of months
ago. I think it ties into what Mr. Apolinsky said. Many
concerned citizens came by there. We had the townhall there in
the council chambers. Two young men, in particular, who hope to
go to military academies had received permission to leave their
class and come to the townhall. And we were talking with small
business owners, with seniors, about the scourge of the death
tax and one of the young men, so earnest as a high school
junior or senior, stood up, Congressman, sir, do you mean to
tell me the government taxes you upon your death? And the
knowing laughter, almost a variation of Art Linkletter's ``Kids
Say the Darndest Things,'' was incredible, but all too often
that laughter is to keep from crying because we are talking
about our tax policy in the realm of the absurd.
Chris, I have no compulsion to try to dredge up emotional
times for you and Kim, but so often people are accused of
putting on the green eyeshade and looking at the bottom line,
all of that. Can you take us back to that trying time
immediately following your father's death? Both emotionally and
financially. Is there any way to encapsulate the challenges you
faced immediately, even following the plan that your father had
instituted? If you had to sum it up, what was the greatest
challenge in the wake of all that and dealing with this notion
of the death tax, Chris?
Mr. Clements. The greatest challenge. Well, I think the
greatest challenge in this regard is really comforting our
employees, comforting our mother who had no experience in the
business other than being the wife of our father, and assuring
everyone that, indeed, the business would go on, that we would
attempt to perpetuate it the best we could.
Kimberly touched on the vast outpouring of affection in
terms of questions and what we received not only from our
employees but also our community. We have a company that is
very active in our community and in many of the communities
around the State. And the questions came from them much more,
in terms of will the business be sold, do you have to pay a
large levy. And people were rather educated about it and,
because we give so much back, they were wondering exactly what
would happen to us.
Congressman Cox hit right on the head with his tale today
about the gentleman who was on his deathbed and preparing his
estate. Kimberly motioned to me and said, well, that sounds
really familiar because our mother was doing the same sort of
things because our father was virtually incapacitated. She was
making sure everything was OK, that the business would not have
to be sold, and it's interesting because now we're engaged in
evaluating the life of our mother. How long will she live? When
she dies, what would the business be worth then? At that time,
how much insurance will we need to provide for ourselves in
order to pay the government? That's a very interesting task
because we're not tax lawyers and we certainly don't understand
all of it. All we understand is that our father is gone, and
that we have a responsibility to our employees and our
community to continue what he had started. That's the only
thing we've ever understood.
Mr. Hayworth. Chris, thank you very much. Mr. Forrestel, as
the treasurer of your family business, you left us with a very
intriguing statement. We won't ask you to inventory it right
now but you talked about the amazing possibilities that existed
for your business if that money weren't taken out to deal with
this type of planning.
Mr. Loop, I thought one particular observation you had was
especially germane: why should you be punished for succeeding
and living the American dream.
And, just in conclusion, Mr. Apolinsky, ``J.D.'' in my name
does not stand for juris doctor. I'm not an attorney, I've
never played one on television. But, I do find it encouraging
that you and your brethren in the legal profession are
perfectly willing to take on other work and, in conclusion, Mr.
Chairman, I'd just simply like to echo the words of our dear
colleague from Colorado, Bob Schaffer, who makes the point that
he believes there should be no taxation without respiration. I
thank you and yield back.
Chairman Archer. Gentlemen and ladies, thank you very much
for all of your testimony. We appreciate your coming and giving
us the benefit of it. You're excused and we will go to the next
panel, the next and final panel.
Douglas Stinson, Jeannine Mizell, Roger Hannay, and William
Beach, if you'll please come to the witness table.
Welcome to each of you to the Committee. Thank you for
coming today. Mr. Stinson, would you lead off, and give us the
benefit of your testimony, and I think since you've been in the
audience you know the general procedures here that we'd like
for you to limit oral testimony to 5 minutes or less, and your
entire written statement, without objection, will be printed in
the record. You may proceed. Mr. Stinson? Yes, sir, and if
you'll identify yourself for the record.
STATEMENT OF DOUGLAS P. STINSON, OWNER, COWLITZ RIDGE TREE
FARM, TOLEDO, WASHINGTON, ON BEHALF OF FOREST INDUSTRIES
COUNCIL ON TAXATION, AMERICAN FOREST & PAPER ASSOCIATION,
AMERICAN TREE FARM SYSTEM, AND WASHINGTON FARM FORESTRY
ASSOCIATION
Mr. Stinson. Thank you, Mr. Chairman. My name is Doug
Stinson, and I'm a tree farmer from the State of Washington. My
wife and our three children own the Cowlitz Ridge Tree Farm
which consists of four parcels of forest land totaling 1,000
acres near Toledo, Washington. I'm here today to represent the
American Tree Farm System, a national network of 70,000 private
forest landowners committed to protecting water, wildlife, soil
and recreation and at the same time to grow trees for forest
products. We are committed to sustainable forestry.
Tree farmers are private citizens from all walks of life
who take great pride in practicing forest stewardship on their
land, and I'm proud to be speaking on their behalf. In
addition, I'm proud to be speaking for the Forest Industries
Council on Taxation, the American Forest and Paper Association,
and the Washington Farm and Forest Association.
Two years ago, I sat before this Committee and told you
about the disincentives built into the Federal Tax Code that
discourage people from being good forest stewards,
specifically, the capital gains tax and the estate tax
provisions. The Taxpayer Relief Act of 1997 went a long way
toward remedying these problems, and I commend you for your
actions and your support for American forests, but to ensure
the long term health of American private forests which make up
58 percent of our total forest land, we must go further.
Cowlitz Ridge Tree Farm has four goals: first, to earn a
living; second, to live in balance with nature; third, to leave
the land in better condition than when we acquired it, and
fourth, to educate the public and other landowners on the value
of good forest stewardship.
Cowlitz Ridge is managed as an economically viable forest.
We are operating on a sustained yield basis and have harvested
approximately 65 percent of our forest growth in the past 26
years. In other words, we're growing more wood than we're
harvesting. To make sure that our forests remain sustainable we
invest $325 per acre to establish and nurture a new stand of
trees. We will not see any cash flow for 25 years and will have
to wait 60 to 80 years for the full return of that investment.
You can see investing in timberland is not for the faint-
hearted. Many risks, including wildfire, wind storms, and
insect blights and regulatory uncertainty are involved as we
work to build a legacy for our children and grandchildren, and
this legacy is not just for our family. We give educational
tours to several hundred people each year. Our forest lands are
open to the public for hunting, berry picking, hiking, and
horseback riding.
Today, family-owned tree farms are still being destroyed by
the Federal estate tax, because many of them are highly
illiquid. For tree farmers, much of their cash is in standing
trees. If you've heard the saying, ``land rich and cash poor,''
well, that's an apt description of many forest landowners. The
annual household income of the average tree farmer is less than
$50,000, yet, on paper, the typical tree farmer can be valued
at well above $2 million. Even with the increase in the
exemption under the unified credit and newly created business
exclusion, which provides a total exclusion of $1.3 million,
the death tax hit on these forest lands can be several hundred
thousand dollars. This forces many families to liquidate the
timber or, even worse, to fragment the woodland by selling off
pieces of their forest land. We need incentives for landowners
to stop conversions.
In Washington State, the Department of Natural Resources
current figures show there's 100 acres a day of prime forest
land being converted. The death tax is the leading cause of
forest fragmentation today, and in my opinion, the greatest
threat to the long-term health of American forests. Thousands
of American families like mine cycle earnings back into their
businesses. At Cowlitz Ridge, we spend approximately $25,000
each year on forest regeneration and timber stand improvement.
We protect and enhance habitat and watersheds. We have excluded
200 acres of forested wetlands and streamside buffers from
harvest. We minimize soil disturbance when we harvest and keep
our regenerative cuts to between 5 and 20 acres. Because we
replant immediately after we harvest and use large, high
quality seedlings, we minimize herbicide use and avoid aerial
spraying.
The death tax provisions you included in the Taxpayer
Relief Act of 1997 will ease the estate tax burden of many
small landowners, but it leaves many issues unresolved. For
instance, the $10,000 gift exclusion and the $750,000 special
use valuation were areas indexed for inflation. The increase in
unified credit was not indexed. When you consider that many
harvests don't occur for 40 to 60 years or more, you can see
that inflation alone can put many families over the total
exclusion limit.
My family has worked hard on our tree farm to earn a living
and create a forest where wildlife, water, air quality, and
aesthetic beauty are sustained. We have formed a limited family
partnership to help pass this legacy on to our children. We are
in the process of forming a habitat conservation plan, but I'm
still concerned with all that we have done, our children will
still be forced to break up Cowlitz Ridge Tree Farm. It's
disturbing to know that the death tax generates only 1 percent
of all Federal revenues, and for that jobs are lost,
communities damaged, and forests destroyed. It seems to me
that's a high price to exact on our national heritage for such
little return. Thank you.
[The prepared statement follows:]
Statement of Douglas P. Stinson, Owner, Cowlitz Ridge Tree Farm,
Toledo, Washington, on behalf of Forest Industries Council on Taxation,
American Forest & Paper Association, American Tree Farm System, and
Washington Farm Forestry Association
My name is Doug Stinson, and I am a Tree Farmer from
Washington State. My wife, our three children, and I own the
Cowlitz Ridge Tree Farm--four parcels of forestland totaling
1000 acres near Toledo, WA.
I am here today representing the American Tree Farm System,
a national network of nearly 70,000 private forest landowners
committed to protecting water, wildlife, soil and recreation
opportunities and at the same time grow trees for forest
products. We are committed to sustainable forestry. Tree
Farmers are private citizens from all walks of life who take
great pride in practicing forest stewardship on our land, and
I'm proud to be speaking on their behalf. In addition, I am
proud to be speaking for the Forest Industries Council on
Taxation, American Forest & Paper Association and the
Washington Farm Forestry Association.
Two years ago, Tree Farmer Chester Thigpen of Mississippi,
and I sat before this committee and told you about the
disincentives built into the federal tax code that discourage
people from being good forest stewards--specifically the
capital gains and the estate tax provisions. The Taxpayer
Relief Act of 1997 went a long way toward remedying those
problems. Along with millions of other Americans, I commend you
for your actions and support for America's forests. But to
insure the long-term health of Americas private forests, which
make up 58 percent of our total forestland--we must go even
further.
As I told this committee in 1995, we have four goals at
Cowlitz Ridge Tree Farm:
1. To earn a living.
2. To live in balance with nature.
3. To leave the land in better condition than when we
purchased it.
4. To educate the public and other landowners on the value
of good forest stewardship.
Cowlitz Ridge is managed as an economically viable forest.
We are operating on a sustained yield basis, and have harvested
approximately 65% of our forest growth in the past 20 years. In
other words, we are growing more wood than we are harvesting.
To make sure that our forests remain sustainable, we invest
$325 per acre to establish and nurture a new stand of trees at
Cowlitz Ridge. We won't see any cash flow for 25 years and will
have to wait between 60 and 80 years for the full return on
that investment.
So as you can see, investing in timberland is not for the
fainthearted. Many risks, including wildfire, wind damage, and
insect blights are involved as we work to build a legacy for
our children and our grandchildren. Just two weeks ago, in
fact, New Hampshire Tree Farmer Tom Thomson lost 90 percent of
his 1,060-acre woodland to an ice storm. For the past 20 years,
Tom had been building a legacy for his son. Today, most of that
legacy lies in splinters on the ground.
But many Tree Farmers face another risk, one that is much
more certain to strike than an ice storm: The Death Tax.
Today, family-owned Tree Farms and small businesses are
still being destroyed by the federal estate tax because many of
them are highly illiquid. For Tree Farmers, much of our cash is
literally in our standing trees. You've heard the saying ``land
rich and cash poor.'' Well, that's an apt description of many
forest landowners. The annual household income of the average
Tree Farmer is less than $50,000. Yet on paper, the typical
Tree Farm can be valued at well above $2 million. Even with the
increase in the exemption under the unified credit and newly
created business exclusion which provides a total exclusion of
$1.3 million, the Death Tax ``hit'' on these forestlands can be
several hundred thousand dollars. This forces many families to
liquidate the timber, or even worse, to fragment the woodland
by selling off pieces of their property.
In Washington State, 25,000 acres of prime forest land a
year is converted to other uses. The Death Tax is the leading
cause of forest fragmentation today, and in my opinion is the
greatest threat to the long-term health of America's forests.
Thousands of American families like mine cycle earnings
back into their businesses. At Cowlitz Ridge Tree Farm, we
spend approximately $25,000 each year on forest regeneration
and timber stand improvement. We protect and enhance habitat
and watersheds. We have excluded our 150 acres of wetlands from
harvest. We minimize soil disturbance when we harvest and keep
our harvest areas small. Because we replant immediately after
we harvest, and use large high quality seedlings, we minimize
herbicide use and avoid aerial spraying. This is a large
investment of time and money. But it's worth it to me as long
as I know I can pass our legacy along to our children and their
children's children.
The Death Tax provisions you included in The Taxpayer
Relief Act of 1997 will ease the estate tax burden of many
small landowners, but it leaves many issues unresolved. For
instance, the $10,000 gift exclusion and the $750,000 special
use valuation were the only areas indexed for inflation. When
you consider that many harvests don't occur for 60 years or
more, you can see that inflation alone can put many families
over the total exclusion limit.
My family has worked hard on our Tree Farm to earn a living
and create a place where wildlife, water and air quality and
aesthetic beauty are sustained. We have formed a limited family
partnership to help pass on this legacy to our children. We are
in the process of forming a habitat conservation plan. But I am
concerned that even after all I've done they will be forced to
break up Cowlitz Ridge Tree Farm. It's disturbing to know that
the Death tax generates only one percent of all federal
revenues. And for that, jobs are lost, communities damaged and
forests destroyed. I'm not an economist, but it seems to me
that's a high price to exact on our national heritage for such
little return.
I applaud you for convening these hearings. Further reforms
in the estate tax for Tree Farmers and small business owners
will save jobs, strengthen communities and help guarantee the
long-term health and productivity of our nation's private
forestlands.
Thank you.
Chairman Archer. Thank you, Mr. Stinson. Our next witness
is Jeannine Mizell. If you'll identify yourself, we'll be
pleased to hear your testimony, and you may proceed.
STATEMENT OF JEANNINE MIZELL, OWNER AND MANAGER, MIZELL LUMBER
AND HARDWARE COMPANY, INC., KENSINGTON, MARYLAND, AND MEMBER,
U.S. CHAMBER OF COMMERCE
Ms. Mizell. Good afternoon, Mr. Chairman and Members of the
Committee. I am Jeannine Mizell, a third-generation owner and
manager of Mizell Lumber and Hardware Company which is located
in Kensington, Maryland. I am also a member of the U.S. Chamber
of Commerce, the world's largest business federation,
representing more than 3 million businesses and organizations
of every size, sector, and region. I appreciate this
opportunity to tell my story and to express the views of the
U.S. Chamber on the Federal estate and gift tax and the need
for its repeal or significant reform.
My grandfather founded Mizell Lumber in 1922. In 1931, he
purchased the property on which Mizell Lumber is still
operated. He paid approximately $55,000 for the property. My
father, Fred Mizell, joined his dad in the family business in
1947. My father worked 6 days a week for 37 years. He rarely
took a vacation or even a day off. Then, one Friday night in
1984, he drove home from work, suffered a heart attack, and
died at the age of 63. At that time, his assets, the most
valuable of which was Mizell Lumber, passed to my mother. My
mother died on September 7, 1990. In administering my mother's
estate, my two brothers and I were told by our attorney that we
would need to hire appraisers to determine the fair market
value of the business including the land on which Mizell Lumber
is operated. I can recall feeling shocked when I learned that
we would have to pay Federal estate taxes on the value of the
lumber company as of the date of my mother's death. The land,
which my grandfather originally had purchased for $55,000 and
which had been in the family for almost 60 years, was now
appraised at $1, 247,000. To our surprise and chagrin we owed a
whopping $297,000 in Federal estate taxes. In addition, we had
to pay more than $5,000 for the appraisals and $40,000 for
attorneys' fees because the estate had many issues so complex
that it took two and a half years for it to be settled, and all
of this was occurring as we were grieving the loss of our
mother.
These days I hear so much talk that Americans are not
saving enough for retirement and are buying too many things on
credit. Well, my father could have taught a class on fiscal
responsibility. He never used a credit card in his life. He
didn't purchase a new car until he had the money saved up to
pay cash for it. My dad worked hard, 6 days a week, 52 weeks a
year. He always lived within his means and saved for the
future. His number one priority was his children's education.
He sent all 3 of us through 12 years of catholic school and
then to the college of our choice and most importantly he
wanted to leave a legacy to his children and grandchildren.
How was my father rewarded for his lifetime of hard work
and frugality? We had to liquidate his certificates of deposit,
bank accounts, stocks and bonds, and send nearly all of the
cash we could come up with to the Internal Revenue Service,
yet, that still wasn't enough to pay the Federal estate taxes.
We were allowed to defer paying approximately $150,000 of the
total tax liability over 15 years. We have sent an estate tax
payment of about $19,000 to the Internal Revenue Service every
June and will continue to do so until the year 2006.
I feel very fortunate that we didn't have to liquidate or
sell the business in order to pay off these estate taxes.
Nonetheless, I ask, where is the incentive to work hard,
invest, be responsible, and pay as you go if a businessowner's
estate is taxed the fair market value on property that has been
in the family for decades.
I have three small children. My oldest son is 9 years old,
and he sits behind me today. He is a fourth-grader at Holy
Cross Elementary School in Garrett Park, Maryland. He is a
straight-A student and recently won the National Geographic
Geography Bee for his entire school, beating out all of the
older students in grades five through eight. He deserves to
attend one of the finest universities in the United States. If
I could invest my share of the estate taxes that we are paying,
his college education and that of my two younger children would
be assured.
In conclusion, it is clear to me that the estate and gift
tax depletes the estates of taxpayers who have saved their
entire lives forcing many successful family businesses to
either lay off workers, borrow funds, reduce capital
investments, or, in a worst case scenario, liquidate or sell to
an outsider. Taxpayers should be motivated to make financial
decisions for business and investment reasons and not be
punished for individual initiative, hard work, and capital
accumulation. The U.S. Chamber believes that the estate and
gift tax should be completely repealed, however, if outright
repeal is not feasible at this time, it should be significantly
reformed in order to reduce or eliminate its negative effect on
individuals and the owners of family businesses.
Thank you for allowing me the opportunity to testify here
today, and I ask that my entire written statement be placed in
the record.
[The prepared statement follows:]
Statement of Jeannine Mizell, Owner and Manager, Mizell Lumber and
Hardware Company, Inc., Kensington, Maryland, and Member, U.S. Chamber
of Commerce
Mr. Chairman and members of the Committee, my name is
Jeannine Mizell and I am a third generation owner and manager
of Mizell Lumber and Hardware Company, Inc., which is located
in Kensington, Maryland. I am also a member of the U.S. Chamber
of Commerce--the world's largest business federation,
representing more than three million businesses and
organizations of every size, sector, and region. I appreciate
this opportunity to relate my story, and to express the views
of the U.S. Chamber on the federal estate and gift tax and the
need for its repeal or significant reform.
I hereby ask that my entire statement be incorporated into
the record. While this afternoon's topic of discussion is the
federal estate and gift tax and its negative affect on
businesses, such as mine, the U.S. Chamber would also like to
point out that additional tax relief measures need to be
enacted to further increase economic growth, productivity and
international competitiveness.
These tax measures include: repealing, or in the
alternative, further reducing the alternative minimum tax and
capital gains tax; permanently extending the research and
experimentation tax credit; simplifying the foreign tax rules;
reforming and restructuring the Internal Revenue Service,
simplifying the worker classification rules, further expanding
individual retirement accounts; lowering the maximum tax rate
on the reinvested earnings of all flow-through entities, and
further reforming the S corporation rules.
BACKGROUND OF THE ESTATE AND GIFT TAX
Originally, federal estate taxes were imposed primarily to
finance wars or threats of war. The first federal estate tax
was a stamp tax imposed in 1797. The first progressive estate
tax was adopted in 1916, with the maximum tax rate varying from
10 percent in 1916 to 77 percent in 1941. The gift tax was
first imposed in 1924, repealed two years later, and then
reinstated in 1932.
Before 1976, estate taxes were imposed on transfers
occurring at death, while gift taxes were imposed on transfers
made during a taxpayer's life. In 1976, the estate and gift tax
structures were combined and a single unified graduated estate
and gift tax system was created. This unified tax system has
since applied to the cumulative taxable transfers made by a
taxpayer during his or her lifetime and at death.
In 1948, Congress provided the first marital deduction,
allowing 50 percent of the value of any property transferred to
a spouse to be excluded from a decedent's taxable estate. This
deduction was later increased to 100 percent. In addition, an
individual can give to an unlimited number of recipients up to
$10,000 in gifts annually without triggering the gift tax.
Under the current estate and gift tax rate structure, rates
begin at 18 percent on the first $10,000 of cumulative
transfers and reach 55 percent on transfers that exceed $3
million. In addition, a 5-percent surtax is imposed upon
cumulative taxable transfers between $10 million and
$21,040,000.
A unified tax credit is available to offset a specific
amount of a decedent's federal estate and gift tax liability.
From 1987 through 1997, the unified credit effectively exempted
the first $600,000 of cumulative taxable transfers of a
decedent from the estate and gift tax. Under the Taxpayer
Relief Act of 1997, the effective exemption amount was
increased to $625,000 for 1998, $650,000 for 1999, $675,000 for
2000 and 2001, $700,000 for 2002 and 2003, $850,000 for 2004,
$950,000 for 2005, and $1 million for 2006 and years
thereafter. The exemption amount, however, will not be indexed
for inflation after 2006.
In addition, the Taxpayer Relief Act of 1997 created a new
exemption for ``qualified family-owned business interests''
beginning in 1998. However, this exemption, plus the amount
effectively exempted by the applicable unified credit, can not
exceed $1,300,000. Whether a decedent's estate can qualify for
the maximum $1,300,000 exemption amount will depend on the
blend of personal and qualified business assets in the estate
at death.
THE ESTATE AND GIFT TAX IS COMPLEX, UNFAIR AND INEFFICIENT
When the government in a free society uses its power to
tax, it has an obligation to do so in the least intrusive
manner. Taxes imposed should meet the basic criteria of
simplicity, efficiency, neutrality and fairness. The federal
estate and gift tax fails to meet any of these requisites.
The estate tax is anything but simple to understand or
comply with. It is a multi-layered taxing mechanism so complex
and convoluted that it has given rise to a cottage industry of
estate tax planners, accountants and lawyers. While this may be
acceptable to those professionals who make their living from
the federal estate and gift tax system, it is not acceptable to
the thousands of individuals who are forced to pay billions of
dollars each year in estate taxes, planning fees, and
compliance costs.
Even the simplest of estates require a certain amount of
estate tax planning in order to avoid the pitfalls of this
complicated tax system. Estate tax planning often includes the
creation of one or more trusts, such as a living trust or ``Q-
TIP'' (qualified terminable interest property) trust, adding
even more expense for taxpayers. The estate tax system also
contains generation-skipping provisions designed to tax
transfers from grandparents to their grandchildren. While the
newly-created ``qualified family-owned business interest''
exclusion will reduce estate taxes for some businesses, the
provisions have added complexity to an already overly
complicated tax system.
The estate and gift tax is also inefficient. Taxes are
efficient when they waste few resources in the collection
process, impose no unnecessary compliance costs on taxpayers
and make a high percentage of the proceeds available for public
goods. The estate tax has very high collection and compliance
costs, even though its revenues only account for slightly more
than one percent of total federal tax collections. Individuals
and businesses that do not owe estate tax still spend millions
of dollars on estate planning and tax return preparation. For
example, in 1995, approximately 31,000 estates were subject to
estate tax, however, about 70,000 estates had to go through the
expense of filing estate tax returns.
The other characteristics of an acceptable tax are its
neutrality and fairness. While measuring these aspects require
a certain amount of subjectivity, the estate tax can not be
considered either neutral or fair to individuals or businesses.
The highly-progressive nature of this tax severely penalizes
those who have saved more, risked more, and worked harder than
others.
Furthermore, those with large estates often hire expensive
estate tax planners and attorneys to establish elaborate estate
plans in order to eliminate, substantially reduce, or defer
their estate tax liabilities. Unfortunately, many small and
family-owned business owners are either unaware of the need for
estate tax planning or unable to afford it, which later results
in enormous estate tax liabilities for such businesses. In
order to pay such liabilities, these businesses are forced to
either lay off workers, borrow funds, reduce capital
investments, liquidate, or sell to an outside buyer. These
actions hurt everyone connected with these businesses,
including its owners, employees, customers, vendors, and
families.
THE ESTATE AND GIFT TAX THWARTS ECONOMIC GROWTH AND PRODUCTIVITY
Public policies should not only improve our nation's
current economic environment, but also ensure our future
prosperity. The key to a stronger economic future is simple to
define (i.e., a high rate of economic growth), but difficult to
achieve. It is strong economic growth that will allow us to
maintain our position of world leadership, increase our
standard of living, and meet the daunting demographic
challenges that will begin to present themselves early in the
next century.
But economic growth does not occur by accident. Just as our
farmers do not rely on good luck for bountiful harvests,
neither can we rely on chance or the momentum of the past to
propel us in the future. The seeds of tomorrow's economic
success must be planted today, and so, when evaluating economic
policies, we must ask how they would cultivate long-term
economic growth.
By definition, economic growth is simply the product of
growth in the labor force (i.e., the number of hours worked)
and growth in productivity (i.e., output per hour). With growth
in hours worked largely determined by demographics, sensible
economic policy must emphasize strong productivity growth.
This is a crucial issue because productivity growth has
been languishing for the past quarter-century or so. After
expanding at a healthy 2.7 percent rate during the 1960's, for
example, productivity growth has slowed to an anemic one
percent rate so far in the 1990's. With growth in hours worked
hovering a little below 1.5 percent, long-term economic growth
is thus limited to 2.5 percent--well below the average of the
post-World War II era.
While measurement problems related to productivity have
expanded with the growing share of the economy devoted to
service-producers rather than goods-producers, the decline in
economic growth over the same period confirms that we are
suffering a decline in the underlying growth rate in
productivity. The question then becomes: What can we do to
raise productivity growth?
Like the farmer who sows the seed corn and cultivates the
soil, households and businesses must also prepare for the
future. Virtually all economists agree that this is done by
saving and investing in capital--both human capital (education)
and physical capital (plant and equipment). Thus the issue of
long-term productivity growth and, in turn, economic growth
becomes one of fostering additions to, and improvements in,
capital. Consequently, today's economic policies must be
targeted toward improving economic growth by fostering saving,
investment, and capital formation. Only through such pro-growth
policies can we lay the foundation of prosperity and security
for our children into and beyond the 21st century.
To boost productivity, the federal government must end its
misdirection of resources and curb its appetite for borrowing
so that national savings and investment can be increased. This
will yield stronger productivity growth, which in turn will
propel the economy on a higher growth track. Besides balancing
the budget, other policy elements that would aid long-term
economic growth include overhauling our regulatory and tort
systems, enhancing education and job training programs,
reducing the tax burden, and reforming the tax code.
THE ESTATE AND GIFT TAX NEEDS TO BE REPEALED OR REFORMED
While the Taxpayer Relief Act of 1997 will provide some
businesses with relief from the estate and gift tax, and is
certainly a step in the right direction, the best solution
would be to repeal the tax outright. The U.S. Chamber supports
legislation introduced by Senator Jon L. Kyl (R-AZ) and
Representative Christopher Cox (R-CA)--the Family Heritage
Preservation Act (S. 75, H.R. 902)--which would immediately
repeal the federal estate and gift tax. However, if repeal is
not politically feasible in the near term, additional reforms
should be implemented to make the tax less harmful to small
business owners and their workers.
First, the unified credit (and its corresponding exemption
amount) should be increased even further. In today's
marketplace, the value of many ``small'' businesses easily
exceed the prescribed exemption amounts, making them
potentially subject to estate tax. In addition, the recently-
enacted $1-million exemption amount should be phased-in over a
much quicker time period. For example, while the effective
exemption amount is scheduled to increase to $1 million by
2006, such amount will not exceed $700,000 until 2004. The
credit also needs to be indexed for inflation so its value is
not eroded over time. Under current law, once the effective
exemption amount reaches $1 million, it is scheduled to remain
at that level indefinitely.
Second, overall estate and gift tax rates--which can reach
as high as 60 percent--need to be significantly reduced. The
value of a decedent's taxable estate only has to exceed $2
million before it becomes subject to a 49-percent rate, and $3
million before it becomes subject to a 55-percent rate. These
rates are excessive and need to be significantly lowered in
order to promote business and job growth. The U.S. Chamber
supports legislation introduced by Senator Don Nickles (R-OK)--
the Estate Tax Reduction Act of 1997 (S. 650)--which would drop
the maximum marginal estate tax rate to 30 percent.
Third, in order to promote the continuation of family-owned
businesses, the amount of the newly-enacted ``qualified family-
owned business interest'' exclusion needs to be further
increased, as well as expanded to encapsulate more businesses.
When a substantial portion of a decedent's wealth is invested
in his or her business, payment of the estate and gift tax can
be extremely difficult without having to liquidate or sell the
business, sell key assets, lay off hard-working employees, or
borrow against its assets. The U.S. Chamber supports
legislation introduced by Representatives Jim McCrery (R-LA),
Jennifer Dunn (R-WA), and others--the Family Business
Protection Act (H.R. 1299)--which would, among other things,
exempt from estate tax the first $1.5 million in value, and 50
percent of any excess value, of a ``qualified family-owned
business interest.''
Fourth, existing installment payment rules need to be
further broadened. Under current law, the estate tax
attributable to a ``closely-held'' business can be paid in
annual installments over a 14-year period. In addition, tax on
the first $1 million in value of a such a business is eligible
for a special two percent interest rate. In addition to
increasing the 14-year installment period, more businesses
should be able to qualify for installment plans, and a greater
amount of estate tax should be eligible for a low, or zero
percent, interest rate. The U.S. Chamber supports legislation
introduced by Senators Charles E. Grassley (R-IA), Trent Lott
(R-MS), and others--the Estate Tax Relief for the American
Family Act of 1997 (S. 479)--which would, among other things,
increase the installment payment period to 20 years.
MY ESTATE TAX HORROR STORY
My grandfather founded Mizell Lumber in 1922. In 1931, he
purchased the property on which Mizell Lumber is still operated
for approximately $55,000. My father, Fred Mizell, joined his
Dad in the family business in 1947. My father worked six days a
week for 37 years, rarely taking a vacation or even a day off.
Then one Friday night in 1984, he drove home from work,
suffered a heart attack, and died at the age of 63. At that
time, his assets, the most valuable of which was Mizell Lumber,
passed to my mother. However, my mother died on September 7,
1990.
My two brothers and I were told by our estate tax attorney
that we would need to hire appraisers to determine the fair
market value of the business, including the land on which
Mizell Lumber is operated. I can recall feeling shocked when I
learned that we would have to pay federal estate taxes on the
fair market value of the lumber company as of the date of my
mother's death. The land, which my grandfather originally had
purchased for $55,000, and which had been in the family for
almost 60 years, was now appraised at $1,247,000. To our
surprise and chagrin, we owed a whopping $297,000 in federal
estate taxes! In addition, we had to pay more than $5,000 for
the appraisal itself, as well as $40,000 for attorney fees
because the estate had many issues so complex that it took two
and one-half years to settle the estate. All this was occurring
as we were grieving the loss of our mother!
I hear so much talk in the news regarding the fact that
Americans are not saving enough for retirement and are buying
too many things on credit. Well, my father could have taught a
class on fiscal responsibility. He never used a credit card in
his life. He didn't purchase a new car until he had the money
saved up to pay cash for it. My Dad worked hard six days a
week, 52 weeks a year. He always lived within his means and
saved his money for the future. His number one priority was his
children's education. He sent all three of us through twelve
years of Catholic schools and then to the college of our
choice. Most importantly, he wanted to leave a legacy to his
children and grandchildren.
How was my father rewarded for his lifetime of hard work
and frugality? We had to liquidate his certificates of deposit,
bank accounts, stocks and bonds, and send nearly all of the
cash we could come up with to the Internal Revenue Service. And
yet that still wasn't enough to pay the federal estate taxes!
We deferred paying approximately $150,000 of the total taxes
due over fifteen years. Mizell Lumber has sent an estate tax
payment of about $19,000 every June, and will do so until the
hear 2006. I feel very fortunate that we didn't have to
liquidate or sell the business in order to pay off these estate
taxes. Where is the incentive to work hard, invest, be
responsible and pay-as-you-go if a business owner's estate is
taxed at fair market value on property that has been in the
family for decades?
I have three small children. My oldest son is nine years
old. He is a 4th grader at Holy Cross Elementary School in
Garrett Park, Maryland. He is a straight-A student and recently
won the National Geographic Geography Bee for his entire
school, beating out all the older students in grades 5 through
8. He deserves to attend one of the finest universities in the
United States. If I could invest my share of the estate taxes
that the business is paying, his college education, and that of
my two younger children, would be assured.
CONCLUSION
The estate and gift tax depletes the estates of taxpayers
who have saved their entire lives, often forcing successful
family businesses to liquidate or take on burdensome debt to
pay the tax. Taxpayers should be motivated to make financial
decisions for business and investment reasons, and not be
punished for individual initiative, hard work, and capital
accumulation. The U.S. Chamber believes that the estate and
gift tax should be completely repealed. However, if outright
repeal is not politically feasible, it should be significantly
reformed in order to reduce or eliminate its negative effect on
individuals and the owners of family businesses.
Thank you for the allowing me the opportunity to testify
here today.
Chairman Archer. Thank you, Ms. Mizell, and, without
objection, your written statement will be put in the record in
full as will be true of all witnesses. The next witness is Mr.
Hannay. Welcome.
STATEMENT OF ROGER HANNAY, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, HANNAY REELS, INC., WESTERLO, NEW YORK, ON BEHALF OF
NATIONAL ASSOCIATION OF MANUFACTURERS
Mr. Hannay. Thank you, sir. Good afternoon, Mr. Chairman
and other Members of the Committee. My name is Roger Hannay,
and I am president and chief executive officer of Hannay Reels,
Inc., a small manufacturer in the foothills of the Catskill
Mountains in upstate New York, 25 miles from Albany. What we
make is heavy duty reels that wind up hoses such as on a fire
truck or on a fuel delivery aircraft refueler, and so forth.
I'd like to address you today about the death tax. It's
been aptly named that several times today. For years, it's been
euphemistically known as the estate tax, which reminds me more
of a nice place in Virginia that you raise horses than a tax,
so I will continue to refer to it as the death tax--it is,
after all, indeed, a tax on dying.
On November 10, 1997, my dad, George, was lost to us, to
myself and my siblings, and he was a second-generation owner
and former chief executive officer and current chairman when he
passed away. He missed just about as few days of work as my
counterpart's dad did over the years he was there; he was still
at work 1 week before his death at age 77. I'd like to thank,
in absentia, but in spirit, Mike McNulty--my own Congressman
who's on this panel--for his kindness to us at that time. He
and his dad were both there for the memorial service.
Our fourth generation which consists of my son, Eric, and
my daughter, Elaine--who's with us a little bit further back in
the room today--they represent the hopes and plans of our
company for continuation of the business. They are both
committed to succeeding in both senses of that word. To do so,
we'll have to successfully navigate the mine field of the
normal family planning issues: getting along with each other;
making the business work; deciding who has gifts for what areas
of the business, and, also, surviving the repeated blows from
the death tax. It's a challenge that revisits us with every
generation. The tax challenge is definitely in our case the
more difficult of those two challenges in our family which is
reasonably nondysfunctional--to use a double negative.
Death taxes are an issue, not just because of the recent
loss of our dad but also because of the need to prepare for my
passing. I just realized, looking in the mirror, I'm now the
older generation. So, for the sake of our 150 employees and
what they represent to our little community which has about 300
residents, we'd like very much to see that happen without the
necessity for selling the business simply to pay the taxes.
My dad's estate will, not may, be subject to a full IRS
audit; it's a sure thing; it's a slam dunk because of its
dollar value. Almost any successful small manufacturing
business or small farm or tree stand will be for an automatic
audit. As chief executive officer and also other roles such as
oldest son, older brother, executor, and father to my kids, I
will literally be dealing with the grief over our dad's loss
for probably the next 4 years. I heard one optimistic number
earlier today of two and a half years, but it makes it very
difficult to have closure over the loss of our dad. I also lost
my mom April 20 of last year, so it was kind of a double whammy
kind of year for us.
I will not attempt, today, to deal with the more technical
issues of the tax. There are many people in this town and
beyond that are much better trained and qualified to do that
than I, and you heard some of them today, however, even with my
limited tax knowledge I am aware of a couple of basic points.
First of all, I understand that the net revenue produced by
this tax after factoring out the costs of collecting it and
auditing it are roughly 1 percent of Federal revenues. If we're
wrong, we're all wrong together today, because we've all been
using roughly that number. The modest source of revenue that
that brings imposes unbelievably complex and costly burdens on
my business. It causes a dark cloud over our business and
thousands of others like it. Did we, indeed, dot all the i's
and cross all the t's? Can you ever really know in advance with
certainty that the estate plan is correct and complete? I don't
think so. What's the value of 20/20 hindsight when we, as
executors, talk about could have done, should have done, might
have done, if the business has to end up being sold. At least
with most other taxes, you can debate and adjust while you're
still alive; not so with the death tax.
It's also very obvious to me and others here today that it
represents at least double taxation without representation
which Patrick Henry would have had difficulty with. Everything
in one's estate has already been taxed once before, in some
cases twice.
From time to time I lament with my accountants also that
I'd like to spend some more of my time and money with them
talking about creative and positive things, not defensive
things like planning for the death event. There really are
other things that accountants and lawyers can do besides this
activity as we've already heard.
I'd like to make it real clear that I'm not advocating
further tinkering, tweaking with the present tax, although we
do appreciate the modest Band-Aid that's been applied for the
next few months. We basically want to kill the death tax as New
York State, for one, has already done for the year 2000.
Why is dying a taxable event? It's almost like this is the
punishment for having the audacity to die. I sense quite a bit
of support for repeal out in the hinterlands. It has been said
at least partially in jest, ``If it moves, tax it.'' I'd like
to suggest--maybe we could propose a new saying, ``If it quits
moving, don't tax it anymore.''
Since some friends have become aware that I would be active
on this subject, I began receiving some unsolicited war stories
one of which very much resembles my colleague to the left here
in terms of a forest land where the loss of a multigenerational
family farm, or family business, has indeed occurred; there was
no alternative.
In closing, I've heard that something close to 95 percent
of family-owned businesses don't make it successfully to the
fourth generation as ours is attempting to do, and a very high
number not to the second or third. If so, I think we have to
candidly ask ourselves, ``How many of these failures are
because the families just didn't get along or competitive
pressures--which are certainly formidable challenges--and how
many are successful in those arenas only to lose it to the tax
man?'' I thank you very much for your kind invitation to be
here today.
[The prepared statement follows:]
Statement of Roger Hannay, President and Chief Executive Officer,
Hannay Reels, Inc., Westerlo, New York, on behalf of National
Association of Manufacturers
Good afternoon gentlewomen and gentlemen, my name is Roger
Hannay and I am President and CEO of Hannay Reels, Inc., a
small manufacturer with 150 employees in the foothills of the
Catskill Mountains, 25 miles from Albany, New York.
I'd like to address you today about the ``death'' tax,
which for years has been euphemistically known as the
``estate'' tax. Frankly, the word ``estate'' reminds me more of
a nice place in the countryside of Virginia where you raise
horses, rather than a tax, so I will continue to refer to it as
the ``death tax.'' After all, it is indeed a tax on dying. On
November 10, 1997, my siblings and I lost our Dad, George, a
second generation owner and former CEO and then Chairman of our
company. On April 20 of the same year, we had lost our Mom. Our
fourth generation, my son, Eric, and my daughter, Elaine, who
is with me here today, represent the hopes and plans we have
for continuation of the business. They are both committed to
``succeeding'' in the business (in both senses of that word).
To do so, we will have to successfully navigate the minefield
of ``passing the torch'' of leadership in the company and
surviving repeated blows from the death tax. The tax challenge
is definitely the more difficult one of the two in our
reasonably non-dysfunctional family (to use a double negative).
Death taxes are an issue not just because of the recent loss of
my father, but also because of the need to prepare for my
passing. For the sake of our 150 employees and what they
represent to the community, we would like very much to see that
happen without being forced to sell the business simply to pay
taxes.
My father's estate will be subjected to a full audit by the
IRS, because of its dollar value. Almost any successful small
manufacturing business will exceed the threshold for an
automatic audit. As CEO, and also oldest son, older brother,
executor, and father, I will literally be dealing with the
grief over the loss of my parents last year for about the next
four years until the final death tax audit is complete. This
makes it very difficult to have closure regarding the loss of
my parents.
I will not attempt today to deal with the more technical
issues of the tax. There are many people, in this town and
beyond, who are much better trained and qualified to do that
than I. However, even with my limited tax knowledge, I am aware
of a couple of basic points. First of all, I understand that
the net revenue produced by this tax, after factoring out the
costs of collecting and auditing it, are roughly one percent of
federal revenues. This modest source of revenue imposes
unbelievably complex and costly burdens on my business. It
casts a dark cloud over our business and thousands of other
family owned businesses: Did we indeed dot all the i's and
cross all the t's? Can you ever know (in advance) with
certainty that the estate plan is correct and complete? What is
the value of 20/20 hindsight when we talk as executors about
``could have done'' or ``should have done'' if the business has
been sold? At least with most other taxes, you can debate and
adjust, while you are alive. Not so with the death tax.
It is also very obvious to me that it is a tax that
represents at least double taxation without representation, a
principle that would have been unthinkable to Patrick Henry.
After all, virtually everything in one's estate has already
been taxed at least once before.
From time to time, I lament with my accountants that I
would like to spend some of my time and money with them talking
about creative and positive things, rather than defensive
things like planning for the death event. There really are
other things accountants can do in addition to tax planning.
I'd like to make it very clear that I am not advocating
further ``tinkering'' or ``tweaking'' with the present tax,
although we do appreciate the modest tinkering with the
lifetime exclusion that has been proffered as a short-term
Band-Aid. We basically want to ``Kill the death tax.'' Why is
dying a taxable event? It's almost as if this tax is the
punishment for having the audacity to die.
I sense quite a bit of support for repeal out in the
hinterlands. It has been said, at least partially in jest, ``if
it moves, tax it.'' Perhaps we could begin to agree on a
philosophy of ``if it quits moving, don't tax it anymore.''
Since some friends have become aware that I would be active
on this subject, I've begun to receive unsolicited ``war
stories'' from these folks about the situations of their own
parents, and what it meant in terms of the loss of a multi-
generational family farm or family business. As I become aware
of more of these in detail, I will be happy to share them with
all who are interested.
In closing, I've heard that something close to 95 percent
or more of family-owned businesses do not make it successfully
to the fourth generation, as ours is striving to do. If so, I
think we have to candidly ask ourselves how many of those
failures are because of competitive pressures or families just
not getting along (which are certainly formidable enough
challenges), and how many are successful in those arenas only
to lose these endeavors to the death tax?
I thank you very much for your kind invitation to be with
you today.
Chairman Archer. Thank you, Mr. Hannay. Our last witness on
this panel is Mr. William Beach. Mr. Beach, welcome.
STATEMENT OF WILLIAM W. BEACH, JOHN M. OLIN SENIOR FELLOW IN
ECONOMICS; AND DIRECTOR, CENTER FOR DATA ANALYSIS, HERITAGE
FOUNDATION
Mr. Beach. Thank you very much, Mr. Chairman. Members of
the Committee on Ways and Means of the House of
Representatives, it's a great pleasure for me to be here today.
My name is William W. Beach. I am the John Olin Senior Fellow
in Economics at the Heritage Foundation and being the last
witness on the last panel, I am literally at the end of the
day.
I'm going to abandon my formal remarks; what you've heard
from everybody on the panels preceding what I'm about to say.
It's much more important than what I'm about to say, because
they are speaking to the heart of the matter, and the heart of
the matter is that we have in the estate tax an utter
contradiction, not only the rest of the Tax Code and everything
it stands for but of the basis of this country; that if we work
hard; if we live by the law; if we try to succeed; educate
ourselves; save, we will succeed, and as Carol Moseley-Braun, a
Senator from Illinois, said in a hearing before the Finance
Committee not too long ago, ``in fact, it's the nightmare of
the American dream.'' It's the thing that you wake up when
you're 55 years of age, and you say, ``Oh my gosh, my
accountant has just told me that there's something out there
called the estate tax.'' So let me being--since I'm the last
witness, sort of be the sum-up person--and also, Mr. Chairman,
I'm the one that wears the green eyeshade, and I have some
answers to revenue questions that you asked in the previous
panel.
There are a number of arguments for why we should repeal
the estate tax; you've heard them all, and it's very important
to listen to what is being said about how it hurts businesses.
The other side of that and not represented at these panels is
it hurts people who have jobs in these businesses. So, an
indirect effect of the estate tax is that it reduces the number
of jobs. It also reduces the number of potential jobs, thus,
hurting people who are young; who are struggling; who are
entering the labor force. We could say an indirect effect of
the estate tax is to hurt the working man and the working women
in the place in which they live most and that is in their
checkbook.
Represented at these panels today and at other panels at
other Committee hearings on this subject have been women in
business. It's very important to note that with the fastest
growing segment of the self-employed people being women
entrepreneurs, that the estate tax has become a quintessential
women's issue. So among the victims of the estate tax, not only
do we count people who are laboring, workers, we can now count
women.
Did you know, Mr. Chairman, that the most feared tax among
black businessmen today is not the income tax; not the
corporation income tax; not the foreign services tax, it's the
estate tax. A recent survey by Kennesaw State University
professors of accounting and economics--a very nice survey,
which I'm happy to send you if you don't have a copy of it--of
black businesspeople in this country, African-Americans, who
have struggled to provide for their children the kind of life
that they didn't have when they started out says the estate tax
is the surprise, the thing that would be the most unexpected
development. And why this is such a feared tax is all of their
life savings have gone into their businesses. These are people
who are successful in their businesses but not in their
pocketbook.
Asian-Americans, we could go on and on and on again. In
fact, I think, Mr. Chairman, the strongest argument today for
the estate tax comes from the liberal wing of the American tax
community. You know because you have had testimony from
Professor Edward McCaffery. His amazing admission being a
person who in every other respect will approach taxes from a
liberal standpoint, but he must now conclude that he is not in
favor, cannot be in favor, must be opposed to the estate tax,
and I'll read one short paragraph from his testimony before the
Senate Committee on Finance June 7, 1995, ``I am an unrequited
liberal in both the classical and contemporary political senses
of that word whose views on social and distributive justice
might best be described as progressive,'' and indeed he will
haunt this Committee because of a recent book that he just
published called Taxing Women--you'll see it come up many, many
times during this tax season.
I used to believe in the gifts and estate tax as a vehicle
for obtaining justice. I am now prepared to confess that I was
blind, but now I can see.
It seems to me that there are three ways to repeal the
estate tax, Mr. Chairman, and that's in my written remarks.
First, outright repeal, it has an amazing support in both the
House and Senate, and, indeed, the economic and revenue effects
of outright repeal, similar to that in House Resolution 902 or
in Senate bill number 75, are very, very good. In a study we
prepared in 1996, in August, on this subject we found that if
we were to repeal the estate and gift tax, we would have $11
billion more annually in gross domestic product, 145,000 more
additional jobs; personal income would rise by $8 billion a
year, and the deficit would in fact be unaffected after the
fifth year. I would strongly support outright repeal as the way
in which we should proceed, particularly as a result of last
night's speech by the President. Oddly enough, he put us on a 1
year short order for Social Security reform. If we, indeed, go
the direction of personalization or even partial
personalization as a majority of the advisory council on Social
Security have recommended, then we're going to have projections
of many middle-income Americans with substantial estates upon
their retirement in the year 2025 to 2040. The estate tax, if
it's not addresses, will be a problem that everybody will face.
The second way is phaseouts. Phaseouts are very attractive.
We don't get the economic benefits of repeal immediately, but
if you're interested in revenue and protecting the revenue then
there are ways to phase out the estate tax over a 10-year
period. I would recommend rate reduction coupled with a steady
increase in the unified credit, and we are working on
simulations that show what that does.
The most interesting and exciting approach--and I'll
conclude with this--is what we are calling the unified capital
gains. This is a relatively new idea that came out of a hearing
in front of the Senate Finance Committee last year. The unified
capital gains repeals the estate tax and takes all of the
estate tax base and places it under the capital gains tax. It
follows directly what Mr. Apolinsky was talking about where we
in fact no longer have step-up in basis. Putting in place a $1
million exemption for taxable dispositions out of estates and
taxing the rest of those dispositions if they are taxable under
capital gains law essentially results in about a 50-percent
reduction statically in what you would otherwise get from the
estate tax. The dynamic effects are substantial. We're
measuring now the economic effects of eliminating compliance,
putting all of that together, Mr. Chairman--to answer the
question you asked Mr. Apolinsky--out of a total static loss
from outright repeal of $180 billion in estate tax revenues
over 7 years, the Treasury of the United States would be at a
loss of no more than $24 billion if you take in the static and
dynamic effects from unified capital gains.
On any of these proposals, we'd be very happy to supply the
Committee with additional details. We've measured each of
these; measured them using, I think, the best macroeconomic
models available, The Warten Econometric Forecasting
Associates, DRI, McGraw-Hill. Most economists, now, are on the
side of phasing out at least the estate tax or of the unified
capital gains tax move.
Thank you very much for allowing me to have these remarks,
and I urge the Committee to move forward on estate tax reform.
[The prepared statement follows:]
Statement of William W. Beach, John M. Olin Senior Fellow in Economics;
and Director, Center for Data Analysis, Heritage Foundation
My name is William W. Beach, and I am delighted to present
the following arguments in support of estate tax repeal to the
Committee on Ways and Means of the United States House of
Representatives. I am the John M. Olin Senior Fellow in
Economics at the Heritage Foundation, a Washington based public
policy research organization. The following remarks constitute
my own opinions, and nothing in this testimony should be
construed as representing the views of The Heritage Foundation
or support by the Foundation for any legislation pending before
the Congress.
Testimony
The 105th Congress took important steps in the Taxpayers
Relief Act of 1997 toward lightening the burden of death taxes
on certain well-defined taxpaying segments. By expanding the
exemption of taxable wealth for estates containing small
businesses or farms, the Congress officially recognized the
harmful effects that death taxes now have on entrepreneurship
and family-owned enterprises. By increasing the unified credit
from six-hundred thousand to one million dollars over 10 years,
the tax writing committees signaled their understanding that
estates of this size will be increasingly common in the near
future and that small estates should not be taxed.
The tax act of 1997, however, did little more than address
the immediate shortcomings of this peculiar tax. The increase
in the unified credit keeps taxpayers roughly even with
inflation, even though a little less than half of the higher
credit comes in the last two years of the ten-year phase-in
period. The additional exemptions for small businesses will
offer some taxpayers relief, but the complex steps that
taxpayers must take to discover whether they are eligible for
the higher exemptions will require significant legal advice and
the counsel of high-priced accountants. It is doubtful that
more than a few hundred estates containing small business
assets will ever qualify for these ``tax savings'' Congress
enacted last year.
The actions taken by Congress in last year's legislation
had one additional effect: they left largely in place all of
the arguments for repealing federal death taxes. It remains a
tax that unintentionally falls most heavily on small
businesses, farmers, ethnic minorities, women entrepreneurs
and, indirectly but importantly, on poor people. While
virtually every Congress since the middle 1930s has spent
considerable effort designing tax policy that would help these
types of taxpayers, intergenerational wealth transfer taxation
has produced an effect almost completely opposite that of
nearly every other part of the Code. It appears that the estate
tax actually bears down most heavily on the intended
beneficiaries of wealth taxation, not the tax policy's apparent
targets:
owners of small and medium-sized businesses, who
often are ethnic or female, discover too late for remedy that
their legacy of hard work and frugality will not pass to their
children but instead will fall victim to confiscatory taxation
and liquidation;
farmers, many of whom are descendants of the
Populists who rallied at the end of the nineteenth century in
support of wealth taxation, lose their farms not because of
wealthy agribusinesses or capitalist ``robber barons'' but
because the federal government demands a tax payment upon death
from people who have invested their earnings back into their
family legacy and have maintained meager liquid savings;
workers suffer, too, when small and medium-sized
businesses are liquidated to pay estate taxes and when high
capital costs depress the number of new business creations that
could offer new jobs;
and poor people are harmed by the estate tax, not
only because the general economy is weakened by the estate
tax's rapacious appetite for family-owned businesses but also
because the estate tax discourages savings and encourages
consumption (particularly among wealthy individuals), thus
undermining the federal income tax from which the funds are
raised to support programs for disadvantaged Americans.
What should Congress do to address these problems stemming
from federal death taxes? In my view, nothing short of repeal
will eliminate the significant indirect effects of the tax,
such as job losses that result from forced liquidations of
businesses contained in taxable estates. Indeed, repeal may be
the only appropriate step if Congress wishes to address the
moral quandaries raised by multiple taxation.
There appears to be three repeal options open to Congress:
immediate repeal of those Code sections that permit estate,
gift, and generation-skipping taxation; a phase-out plan that
reduces the top tax rate and raises the unified credit over a
specified number of years; and the unified capital gains tax
(which repeals federal death taxes and unifies the old estate
tax base with the capital gains tax base). Let me describe each
option separately.
Immediate Repeal
Ending death as a taxable event is the objective of H.R.
902, sponsored by Congressman Chris Cox, and S. 75 offered by
Senator Jon Kyl. These two identical bills repeal estate, gift
and generation-skipping taxes and currently enjoy substantial
support in their respective chambers: there are 31 sponsors of
the Senate bill and 161 sponsors of this legislation in the
House.
Many of the co-sponsors of these two bills doubtless
support repeal because of the compelling moral argument behind
this reform, which I describe below. However, others are more
comfortable with repeal following several demonstrations that
federal revenues are enhanced by elimination of federal death
taxes rather than harmed.
An analysis by The Heritage Foundation using two leading
econometric models found that repealing the estate tax would
have a large and beneficial effect on the economy.\1\
Specifically, the Heritage analysis found that if the tax were
repealed this year, over the next nine years:
---------------------------------------------------------------------------
\1\ William W. Beach, ``The Case for Repealing the Estate Tax,''
The Heritage Foundation Backgrounder, no. 1091, August, 1996.
---------------------------------------------------------------------------
the nation's economy would average as much as $11
billion per year in extra output;
an average of 145,000 additional new jobs could be
created;
personal income could rise by an average of $8
billion per year above current projections; and
the deficit actually would decline, since revenues
generated by extra growth would more than compensate for the
meager revenues currently raised by the inefficient estate tax.
The Heritage analysis of repeal's positive effects has been
recently supported by work on the unified capital gains tax by
Richard Fullenbaum and Mariana McNeill.\2\ Their work includes
estimates of how much economic output would change from
eliminating the costs of complying with death tax law. These
costs were not included in the Heritage study of 1996. Had they
been, the positive effects described above would be enhanced.
---------------------------------------------------------------------------
\2\ Richard F. Fullenbaum and Mariana A. McNeill, ``The Effects of
the Federal Estate and Gift Tax on the Aggregate Economy,'' forthcoming
from The Research Institute for Small & Emerging Business (1998).
---------------------------------------------------------------------------
Phasing Down Tax Rates and Increasing the Unified Credit
A number of Members have expressed interest in slowly but
steadily reducing the top statutory tax rate on estates.
Congressman Pappas in particular has championed this approach
to repeal. Others have indicated an interest in coupling
reductions in rates with increases in the unified credit, which
accelerates the phase-out period by shrinking the number and
size of taxable estates. Over time, federal death taxes simply
disappear.
There are a number of unpublished revenue and economic
estimates of various phase-out plans, all of which indicate
that significant improvements to economic efficiency follow
reductions in death tax burden. However, the positive economic
and revenue effects that come from immediate repeal overwhelm
those that stem from a slow phase-out program. Not only do
compliance costs continue to burden taxpayers, but tax
avoidance behavior persists, which results in capital and labor
costs remaining higher than they otherwise would be following
outright repeal.
Despite the likelihood that phasing out the estate tax
would result in fewer economic bonuses than would immediate
repeal, the advocates of the phaseout option argue that the
Treasury would ``lose'' fewer tax dollars than under the
immediate repeal option. While my research indicates that
immediate repeal produces more total income tax revenue after
the four years than the phase-out option, the advocates of this
more cautious approach are doubtless correct on the direction
of revenue change in the very short run.
The Unified Capital Gains Tax
The unification of the estate tax base and the capital
gains tax base through the unified capital gains tax appeals to
those repeal advocates concerned with the moral dimensions of
federal death taxes as well as those focused on repeal's
revenue effects. The proposal repeals all federal death taxes
(thus ending death as a taxable event) and imposes the long-
term capital gains tax rate on only those asset transfers from
estates that 1) would be taxable under existing capital gains
law and 2) exceed a special one-million dollar exemption on
otherwise taxable dispositions from estates to persons as
defined and recognized in present tax law. Some advocates of
this approach would end step-up in tax basis.
By making the ``tax moment'' the disposition of an asset
rather than the death of a taxpayer, the unified capital gain
tax addresses many of the moral concerns advanced by supporters
of outright repeal. Death is not the taxable event, and
unprepared taxpayers will no longer be forced to liquidate
ongoing businesses or family assets just to pay a tax. Of
course, the unified capital gains tax only eliminates one layer
of multiple taxation: many assets created from after-tax income
will be taxed again under capital gain tax law. However, the
repeal of the estate tax clearly moves tax policy in the
direction a flatter tax system, and the proposal should
interest those tax policy reformers interested in fundamental
tax changes.
Economic analysis of the unified capital gains tax by
Fullenbaum and McNeill indicates that this tax policy change
would likely result in improved economic performance and
surprisingly little revenue ``loss'' in the short run.
Fullenbaum and McNeill predict significant employment and
income gains from repeal, largely stemming from the drop in
capital and compliance costs that follow unification. The small
drop in revenues reverses sign after four years, and income
taxes from individuals and corporations grow above CBO baseline
projections.
The Moral Argument for Repeal
All three of these proposals for repealing federal death
taxes draw on a growing body of empirical evidence and
philosophical argument that is ineluctably undermining the
historical justification for intergenerational wealth transfer
taxation.
Between 1913 and 1916 the Congress deployed a system of
income taxation that had two objectives: to raise revenue for
the federal government and to contain the economic power of
wealthy individuals through taxation. This latter objective
dominated Congress's discussion of income taxation and inspired
support among political activists during the ratification
process for the Sixteenth Amendment to the United States
Constitution. In its common translation, the ``containment''
objective of early tax policy meant simply this: the increasing
concentration of wealth in the hands of a few individuals
prevents many Americans from enjoying the economic
opportunities that this country was founded to provide and that
our fundamental law protects.
While revenue requirements were always high on Congress's
agenda, especially during the ensuing world war, it is fair to
say that wealth containment was the fundamental public policy
goal that Congress intended wealth taxation to achieve. It also
is fair to say that, after eighty years of estate taxation,
this objective has not been met.
If it was Congress's intention to craft a public policy
that threatens and destroys small and medium-sized businesses,
devastates rural communities, weakens the economy and depresses
job growth for new and displaced workers, and makes it more,
not less, difficult for poor people to rise up the income
ladder and participate more fully in the economic opportunities
of American civilization; they could have done little better
than the estate tax. But this outcome, of course, was precisely
the opposite of Congress's purpose.
U.S. wealth taxation policy surely is a classic instance of
unintended consequences. Reversing these perverse results
should be the current Congress's principal tax policy program.
It is politically unconscionable as well as morally dubious to
assert, on the one hand, that a principal objective of U.S. tax
policy is to expand economic opportunity for disadvantaged
Americans--blacks, Hispanics, women, workers, and poor people--
while, on the other hand, vigorously enforcing a part of U.S.
tax policy that contracts their economic opportunity.
This dilemma is resolved only by repealing the estate, gift
and generation-skipping tax. Reforms that ``protect'' certain
taxpayers from the estate tax (an intriguing admission in
itself of the contradictions inherent in the law) through
increases in the unified credit do nothing for those Americans
above the new taxable threshold but who are no different from
their brothers and sisters just below the threshold except that
they are modestly more successful. Reforms do nothing for
workers in firms that are not ``protected,'' for farmers whose
land values have risen above the new threshold because they
abut a new suburb or cross a cellular transmission grid, or for
poor people living in an economy still insufficiently robust to
lift them out of poverty. Reforms do nothing to reverse the
incentive to consume rather than save or to purchase expensive
life insurance, legal and accounting advice that moves
resources to sectors of the economy that do little to raise
worker productivity and worker wages. And reforms do nothing to
resolve the public's increasing demand that Congress enact
substantive tax reforms that result in a simpler, flatter, and
fairer tax system.
It is ironic but perhaps fitting that most of the energy
for estate tax repeal has come from political conservatives.
One would think that the rich tradition among American liberals
of supporting middle class incomes, jobs for new workers,
economic opportunities for disadvantaged groups, and protection
of the family farm would have made estate tax repeal a top
objective. Surely the liberal objection that repeal would only
benefit rich people could be addressed by modest changes to
capital gain tax law where, indeed, many wealthy people
currently choose to be taxed. And surely the objection that too
much revenue would be lost with repeal could be addressed by
simple demonstrations that the estate tax currently undermines
the income tax directly through legal avoidance schemes that
shelter income from estate taxes and indirectly through
consumption rather than savings.
Take, for example, the growing evidence of the estate tax's
harm to the general economy and to jobs in particular.
Economists across a wide political spectrum have produced a
rich body of empirical and inferential evidence that the estate
tax reduces economic activity and fails to achieve its stated
purpose. For example, Alan Blinder, who served in President
Clinton's first Council of Economic Advisers and later as Vice-
Chairman of the Board of Governors of the Federal Reserve
System, argued that ``[t]he reformer eyeing the estate tax as a
means to reduce [income] inequality had best look elsewhere.''
\3\
---------------------------------------------------------------------------
\3\ As quoted in Edward J. McCaffery, ``The Uneasy Case for Wealth
Transfer Taxation,'' The Yale Law Journal, Vol. 104 (November 1994), p.
322, note 143. Also see Joseph E. Stiglitz, ``Notes on Estate Taxes,
Redistribution, and the Concept of Balanced Growth Path Incidence,''
Journal of Political Economy, Vol. 86 (1978), Supplement, pp. 137-150;
Alan S. Blinder, ``A Model of Inherited Wealth,'' Quarterly Journal of
Economics, Vol. 87 (1973), pp. 608-626; Blinder, ``Inequality and
Mobility in the Distribution of Wealth,'' Kyklos, Vol. 29 (1976), pp
607, 619; Michael Boskin, ``An Economist's Perspective on Estate
Taxation,'' in Death, Taxes and Family Property: Essays and American
Assembly Report, ed. Edward Halback, Jr. (St. Paul, Minn.: West
Publishing Co., 1977); Lawrence H. Summers, ``Capital Taxation and
Accumulation in a Life Cycle Growth Model,'' American Economic Review,
Vol. 71 (1981); Martin Feldstein, ``The Welfare Cost of Capital Income
Taxation,'' Journal of Political Economy, Vol. 86 (1978); and Laurence
J. Kotlikoff, ``Intergenerational Transfers and Savings,'' Journal of
Economic Perspectives, Vol. 2 (1988).
---------------------------------------------------------------------------
The complex estate and gift tax edifice rests on the
foundation that taxing intergenerational wealth transfers
results in less concentrated wealth holdings and that this
leads in turn to greater economic opportunity and a more
democratic society. If the tax's supporters cannot sustain the
argument that the estate tax improves equality of economic
opportunity, then there exists little else (except perhaps
inertia) to recommend continuation of this part of U.S. tax
policy. Other, simpler taxes could meet revenue objectives far
more efficiently and fairly.
Academic support for intergenerational wealth taxation
remains warm, in large part because of the role it plays in the
most important theoretical treatise on liberal egalitarianism,
John Rawls's A Theory of Justice.\4\ Since its publication in
1971, this careful, magisterial presentation of the case for
liberal democracy infused with just institutions has permeated
thinking on most issues in social and political theory. It is
fair to say that no stronger theoretical case for
intergenerational wealth taxation exists.
---------------------------------------------------------------------------
\4\ John Rawls, A Theory of Justice (Cambridge, Mass.: Harvard
University Press, 1971).
---------------------------------------------------------------------------
At the center of Rawls's case for wealth taxation is the
principle that ``[a]ll social primary goods--liberty and
opportunity, income and wealth, and the bases of self-respect--
are to be distributed equally unless an unequal distribution of
any or all of these goods is to the advantage of the least
favored.'' \5\ While at first blush this principle would appear
to suggest radical egalitarianism in economic and political
life, Rawls recognizes the superiority of ``free'' over
socialized markets to produce benefits for the least advantaged
citizens, which leads him and many like-minded political
theorists to support significant differences in the economic
conditions of individuals within a generation. After a century
of economic experimentation, there can belittle doubt that
everyone achieves greater economic benefit when individuals are
allowed to discover their own comparative advantage and focus
their labor in the area where they can make the greatest
economic difference.
---------------------------------------------------------------------------
\5\ Ibid., p. 303.
---------------------------------------------------------------------------
This tolerance for intragenerational differences leads
Rawls to oppose all income taxes, since economic income stems
from natural differences in talent and from differing
propensities of individuals to apply themselves to hard
work.\6\ However, two principles considerations compel Rawls to
take substantial exception to intergenerational differences in
economic condition.
---------------------------------------------------------------------------
\6\ Rawls advances a consumption tax to replace income taxes. ``For
one thing, it is preferable to an income tax (of any kind) at the level
of common sense precepts of justice, since it imposes a levy according
to how much a person takes out of the common store of goods and not
according to how much he contributes (assuming here that income is
fairly earned).'' Ibid., p. 278.
---------------------------------------------------------------------------
First, Rawls opposes the transfer of accumulated property
to succeeding generations because it undermines the first
principle of a just society: that everyone has ``an equal right
to the most extensive total system of equal basic liberties
compatible with a similar system of liberty for all.'' \7\
Those who begin with a significant unearned endowment of
property resources place others not so advantaged in a less
equal condition, and this undermines the principle that
everyone should have access to the same system of equal basic
liberties.
---------------------------------------------------------------------------
\7\ Ibid., p. 302.
---------------------------------------------------------------------------
Second, this difference might be tolerated if it produced
greater benefits for the least advantaged than for the
advantaged. However, intergenerational wealth transfers create
benefits that flow in the opposite direction: Over time, they
enhance the advantages of inheriting generations and generally
degrade the liberties of the unbenefitted. The ``[t]he taxation
of inheritance and income at progressive rates (when
necessary), and the legal definition of property rights, are to
secure the institutions of equal liberty in a property-owning
democracy and the fair value of the rights they establish.''
\8\
---------------------------------------------------------------------------
\8\ Ibid., p. 279.
---------------------------------------------------------------------------
While Rawls does not advance confiscatory taxation of
intergenerational wealth transfers, his argument does imply
substantial taxing discretion by the state. In his universe,
the state guides the institutions of distribution; should
government determine that wealth transfers constitute
significant barriers to the equal enjoyment of liberties (as
defined by Rawls), it clearly has the power to tax away as much
of the wealth that moves between generations as it deems
necessary to restore justice.
A number of objections could be raised against the Rawlsian
case for wealth transfer taxation, not the least of them being
the questionable assertion of government authority over the
intergenerational disposition of private property. If wealth is
acquired legally and transferred peacefully (that is, in some
non-tortious fashion that breaches no contract pertaining to
property), government has no ethical standing to interfere with
its disposition.
Of course, liberal egalitarians claim a more expansive role
for government, a principal element of which is the progressive
enhancement of equality of condition among citizens. Thus, it
is important first to consider the estate tax within the
context of the argument that justifies the tax's existence. If
it can be shown that the estate tax does not advance the
ethical program of the liberal egalitarians, then other
objections to this tax that can be raised without assuming this
ethical and moral framework become more compelling.
This approach to analyzing the estate tax was taken in a
seminal monograph by Edward J. McCaffery published in The Yale
Law Journal in 1994.\9\ Professor McCaffery comes to the debate
over the estate tax with impeccable political credentials.
Unlike many critics of intergenerational taxation who frame
their objections within a larger, politically conservative
analysis of contemporary government, McCaffery formulated his
critique of the estate tax within a liberal framework. As he
stated last year before this committee:
---------------------------------------------------------------------------
\9\ Edward J. McCaffery, ``The Uneasy Case for Wealth Transfer
Taxation,'' The Yale Law Journal, Vol. 104 (November 1994), pp 283-365.
I am an unrequited liberal, in both the classical and
contemporary political senses of that word, whose views on
social and distributive justice might best be described as
progressive. I used to believe in the gift and estate tax as a
vehicle for obtaining justice. As to the latter belief, only, I
am now prepared to confess that I ``was blind, but now can
see.'' \10\
---------------------------------------------------------------------------
\10\ Edward J. McCaffery, ``Testimony before the Senate Committee
on Finance, June 7, 1995.''
McCaffery raises five general objections to the liberal
egalitarian argument supporting intergenerational wealth
taxation. Each of them assumes the ethical and moral objectives
of the liberal program.
1) The currently combined income and estate tax system
encourages large inter vivos gift transfers, which have the
effect of creating a greater inequality of starting points or a
less level economic playing field. This predictable effect of
the estate tax law is aggravated further by the fact that high
estate tax rates encourage the consumption rather than the
transfer of wealth. Purchasing goods and services instead of
saving the funds that support that consumption produces larger
differences between rich and poor people. Thus, the estate tax
is illiberal because it undermines rather than advances the
liberal egalitarian objective of equality of economic
opportunity.
2) While higher wealth transfer taxes might reduce the
level of inter vivos gifts, and other tax law changes could be
made to penalize the spending behavior of rich families, it
currently is both practically and politically impossible to do
so. On the one hand, analysts are becoming increasingly aware
of the intergenerational focus of much current saving behavior
at all income levels. Liberals should promote the creation of
transferable wealth among the less advantaged. On the other
hand, politicians are becoming increasingly aware of how much
voters want taxes to fall, not rise. The estate or inheritance
tax has been repealed in Australia, Canada, Israel, and
California; and the movement for tax reform is a spreading,
worldwide movement.
3) There will always be differences between the starting
conditions of people in a non-ideal world.
If liberal egalitarians attempted to eliminate all the
differences that stem from intergenerational wealth transfers,
they would risk leaving the least advantaged even worse off
than they were before. Not only would confiscatory taxation
reduce the consumption behavior of wealthy people, thereby also
reducing employment and incomes among poorer citizens, but it
would depress the amount of economic capital as well, thereby
reducing economic expansion and income growth, both of which
are central to improving the conditions of the least
advantaged.
4) ``[It] is the use and not the mere concentration of
wealth that threatens reasonable liberal values.'' \11\
Generally speaking, the accumulation of savings and the
promotion of earnings that underlie the growth of savings are
``goods'' that liberals like. Earnings and savings create a
``common pool'' of resources that can be used to promote
improvements in the general welfare through public and private
means. Liberals generally regard the consumption behavior of
the wealthy as objectionable; thus, wealth transfer taxation,
which attacks savings and promotes wanton consumption, is
wholly ill-suited to the attainment of an ideal liberal
society.
---------------------------------------------------------------------------
\11\ McCaffery, ``The Uneasy Case for Wealth Transfer Taxation,''
p. 296.
---------------------------------------------------------------------------
5) The best tax policy that liberal egalitarians could
pursue, if attaining liberal social and political objectives
truly motivates the liberal program, is one that taxes
consumption, not savings. McCaffery writes that ``[b]y getting
our reasonable political judgments wrong--by taxing work and
savings while condoning, even encouraging large-scale use
[consumption]--the status quo impedes the liberal project....
The real threats to liberty and equality from private
possession alone turn out, on closer scrutiny, to relate to
possession qua potential or actual use, each of which can be
addressed--indeed, can best be addressed--in a tax system
without an estate tax.'' \12\
---------------------------------------------------------------------------
\12\ Ibid.; emphasis in original.
---------------------------------------------------------------------------
Not only, then, is the estate tax inconsistent with a
liberal program of promoting quality of economic condition, but
it encourages behavior that works against liberal objectives.
It supports consumption and depletion by penalizing savings and
earnings. it encourages the kind of strange world where it
costs less for a millionaire like Steve Forbes to spend $30
million of his own money on a presidential campaign than to
save $30 million for his children's future--an investment upon
which he will pay 55 percent transfer tax as opposed to a
campaign expenditure upon which no additional taxes are ever
levied. How many new jobs and new businesses did Mr. Forbes's
campaign create as opposed to the same amount saved in a bank
that lends the funds to entrepreneurs and business managers?
Liberals and conservatives are beginning to answer this
question in precisely the same way.
Chairman Archer. Thank you, Mr. Beach, and you certainly
are the appropriate person to wind up this hearing today with
your expertise in this field. I believe, personally, that if it
were not for revenue implications--and that's what you
addressed to a great degree in your testimony--we would be
pursuing repeal of the death tax.
Mr. Beach. I agree.
Chairman Archer. And that the majority in this Congress, a
majority that has had a new approach to things beginning in
January 1995, would be supportive of that.
Mr. Beach. Yes.
Chairman Archer. But we do have to deal with the revenue
constraints, and we do have to deal with the official estimates
and not the estimates that come from Heritage even though in
the end the estimates coming from Heritage, may prove to be
more accurate. We have that limitation.
Mr. Beach. That's right.
Chairman Archer. And we are limited by the constraints of
the Budget Act, such that--as I've been saying over the last
few days--we cannot risk tipping the balance into a deficit
again in this country. We're on the threshold of a balanced
budget, which to me is a millennium in itself. It's a dream
that I had when I came to Congress in 1971, but only a dream,
and it is going to become a reality. We must adhere to that for
the benefit of our children, and the death tax is relative to
what's going to happen to our children too, which is awfully
important. I hope that your data will be factored by CBO and
the Joint Committee when they undertake their estimates on
whatever proposal comes before the Congress, but we are forced
to live with those official estimates of the Joint Committee
and CBO. And as a result, even though it is a relatively small
percentage of the revenue that comes into the Federal
Government, it still is a significant amount of money unless we
can get those estimates changed, so I personally will welcome
your input, and I hope that it will be considered very
carefully by the estimating agencies of the government.
I thank all of you for your testimony, because I've said
over and over again now for 2 or 3 years that the income tax is
bad for this country because it puts all Americans in a tax
trap: the harder you work, the longer you work, the more you
pay, and that's wrong. But when you add the death tax on top of
it, it becomes the harder you work, the longer you work, the
more you save, the more you pay, and that is doubly wrong. That
creates an environment that works against the best interests of
all Americans, not just the producer but those who benefit from
that production by having gainful jobs and the ability to
support their own families. To me, that's the essence of what
our country stands for: to encourage a work ethic, to encourage
savings, and, thereby, to create more wealth that can be shared
by all the people in this country.
So, I am completely with you philosophically on what we
need to do, but we have to work through this estimating process
and these revenue estimates if you----
Mr. Beach. If I could just have one comment on that, Mr.
Chairman. First of all, we've been blessed to work very closely
with the Joint Committee and to learn how they work with their
staff, and this Committee is well served by the Joint Committee
staff. The revenue estimates I could disagree with, but the
level of disagreement would be under $1 billion per year. But
it is true--and I think your economists will privately tell you
this as well--that here we're dealing with a tax issue that
more even than the income tax has an economic story that needs
to be understood. So, let me recommend this--knowing your
rules, and knowing that you need to work with the static--what
I call the static estimates--to ask the Joint Committee to do
what it did last year and that is to bring several groups
together each posed with the problem, measure the effects of
the elimination of the estate tax, and have that report
produced by whoever will now be the Chief of Staff and given to
this Committee to inform them of the range of estimates--ours
is one of those--that come from repeal. I think that
information would be very informative to the Committee. It
would do two things: It would move the estate tax forward, and
it would also move this Committee forward, I hope, more closely
to consensus, dynamic revenue estimating.
Chairman Archer. Well, we began, 3 years ago, to get more
behavioral response into the estimating process, as I mentioned
during the discussion on the marriage penalty, and I'm pleased
about that because I've been Chairman of the Joint Committee on
Taxation as well as Chairman of the Ways and Means Committee,
and I believe we should always strive for accuracy. I don't
want something to come out because it weighs in favor of what I
believe in that isn't accurate. That means that we do have to
take into account behavioral response, and in the end we have
to bridge the disconnect between the CBO and Joint Committee,
and that disconnect is as follows: that the CBO, today, has a
responsibility for the macroeconomic impact; that is, how many
more jobs are going to be created, and how much extra income
tax will flow into the Treasury as a result of whatever we do?
The Joint Committee does not have the ability to do that, nor
do they have, under the law, the responsibility to do that.
They must accept whatever the baseline is that the
Congressional Budget Office puts out, and then they must
overlay their estimate as to the specific tax change, and the
baseline that the CBO puts out is not changed to accommodate
what impact the tax change will have on the economy. Now,
that's our responsibility; to find a way to overcome that, and
we're in the process right now of trying to work through that,
but our goal should always be accuracy, and I just want to
assure that I'm going to do everything I can to see that
happen.
Mr. Hulshof.
Mr. Hulshof. Thank you, Mr. Chairman. Thank each of you for
being here, and Ms. Mizell, it's great to have your supporters
here. It sounds like that straight-A 9-year-old fourth grader
might have a future in politics someday.
Mr. Beach, I want to be a devil's advocate for the brief
moments I have, and I want to be, just for purposes of this
question, as a hard as it is for me, an unrequited tax liberal.
Mr. Beach. All right.
Mr. Hulshof. And here is their argument: If the principle
objective of our U.S. tax policy is to expand economic
opportunities for disadvantaged Americans, and the way we do
that is to redistribute income from one segment to another,
then doesn't your proposal to repeal--and, again, this is a
hypothetical--the fact that you're trying to repeal the death
tax--shouldn't the Bill Gates of the world be required to pay
to help provide economic opportunity for those on the lower
rungs of society? What is the response to that liberal tax
argument?
Mr. Beach. Well, thank you for that question, and I know,
Mr. Hulshof, that that was difficult question for you to ask.
[Laughter.]
It's an interesting response. The tax rate of the estate
tax is so high that it does several things if you're wealthy.
First of all, it tells you, ``Don't save your money, spend it
today.'' So instead of saving money that creates jobs for
ordinary Americans; that expands the economic pie--and by the
way, that expands the income taxes that come into the Federal
Government--what we have is a signal sent by the estate tax,
``Buy that cigarette boat; go to that vacation home in Vale,
and buy expensive art in London.'' In other words, it supports
consumption expenditures rather than savings. So, it doesn't
have the effect that you would expect it to have on wealthy
people. Now, wealthy people also have this advantage: They can
hire Harold Apolinsky; they can hire the high-priced
accountants and lawyers which allow them to find out early in
life that they're going to have this problem and then to set in
place a lifetime plan which is oftentimes very expensive of
avoiding the 55, the 50, even the 35 percent tax rate. So, they
have that ability, and the people that you've heard today
generally do not; they're surprised by that tax. And then they
can distribute their money through gifts and trusts and other
kinds of things, again, expensive to their children and to
other people. What happens when that happens? It maldistributes
wealth. It perpetuates wealth just like the consumption of
wealth maldistributes consumption.
So, I think--and there are many other responses I could
make here, but if you go down all of these responses and you
talk to someone who's on the liberal side in a quiet moment in
a bar perhaps, they have to conclude, ``This is the tax I have
to oppose,'' because it is keeping people from entering the
work force. It is telling people to consume and to--you know,
conspicuous consumption, and we lots of pictures from Aspen and
Vale are troublesome sometimes. It is undermining the income
tax; it is hurting blacks and women, minority entrepreneurs,
all of them.
Mr. Hulshof. How so? How does repeal of the death tax--how
would help the disadvantaged or minorities?
Mr. Beach. Well, if I'm--let's suppose that I'm a Hispanic
person and I have worked and saved and now I've opened a
business and 20 years later this business is a big business for
me; I've hired 5 or 6 people. Why have I done that? To provide
a better life for my children. That's really the overriding
thing. The intergenerational consideration of parents overrides
money any day; trumps it.
Let me give you the story of Wen Trac. She escaped from
Indochina when she was 13 years old; illegally entered the
United States--this is a documented case--and began to work the
streets in Seattle--it was the only thing she knew how to do.
She saved some money and she opened a bucket and washerboard
business, and by the time she was 30 she had enough money to
open a storefront drycleaning business; married, two daughters.
Now, she's 72 years of age. She has two drycleaning businesses.
She has learned that she's going to have to liquidate the
entirety of her holdings in order to pay the estate tax. All of
her savings was in that business, not in the form of cash, but
in the form of a job for her two daughters, and those two
daughters are now going to have to go back--maybe on the
street, but certainly not where Wen Trac wanted them to go.
And we all know the famous story of Mr. Thigpen. He was in
the tree business, and he and his wife of 40 years working up a
business--treegrowers of the year twice in a row. This is a
wonderful business. Liquidating that business, and it's a very
strong prospect. Mr. Thigpen, by the way, is a grandson of
slaves that his son is going to have to go to work for one of
the local Mississippi farmers. Now, they may be a white farmer.
Is that the outcome that people on the liberal side want?
Is that what they want for Wen Trac or the Hispanics or for the
African-Americans? It's that contradiction which led Mr.
McCaffery to depart and say, ``This is not consistent with the
liberal vision of what taxes should do.'' We have spend 70
years now building a Tax Code that would help disadvantaged
people and redistribute wealth. This is wrong; it is
contradictory; it is inconsistent; it has to be excised from
the body of Tax Code in order for the rest to be consistent.
Mr. Hulshof. Well, I appreciate that, and your description
of this conspicuous consumption suddenly brings the
realization--my parents, I think, just put a new bumper sticker
on their car that says, ``I'm spending my children's
inheritance.''
I want to thank Mr. Chairman for the time and thank each of
you for being here.
Chairman Archer. Well, thank you, Mr. Hulsolf, and I'm
grateful to all four you for the input that you've given the
Committee today.
I want to make one last comment, and that is relative to--
was it McCaffery that you said, Mr. Beach?
Mr. Beach. Yes, Mr. Chairman.
Chairman Archer. Who identified himself as a contemporary
liberal and a historic liberal, or what was the other?
Mr. Beach. Classical as well as contemporary.
Chairman Archer. Classical as well as contemporary. And I
would say that that is an oxymoron----
Mr. Beach. Well, that may be.
Chairman Archer [continuing].--because I would refer
everyone in this country to read the recent book on Thomas
Jefferson called American Sphinx. He was the classical liberal,
and I am identified as an 18th century liberal, and in today's
contemporary times I'm identified as a conservative. There is
no connection between the classical liberal and the
contemporary liberal because Thomas Jefferson said, when the
Constitution was being framed, No. 1, the Federal Government
should never have any taxing authority. He was the classical
liberal. The Federal Government should have no taxing
authority. And then he, furthermore, said, during the creation
of the Constitution, to his friend James Madison, ``Godsend
that our Nation never have a government it can feel.''
Now I say to all of you, do you feel the estate tax, the
death tax? Do you feel the income tax? Do you feel the
government regulations? Do you feel the government programs
from Washington? And I think the answer is very clear.
Thank you very much. I wish you well.
The Committee will be adjourned.
[Whereupon, at 3:50 p.m., the hearing was adjourned subject
to the call of the Chair.]
REDUCING THE TAX BURDEN
----------
WEDNESDAY, FEBRUARY 4, 1998
House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to call, at 10 a.m., in room
1100, Longworth House Office Building, Hon. Bill Archer
(Chairman of the Committee) presiding.
Chairman Archer. The Committee will come to order. We're
still awaiting our first witness, but in the interim, I would
like to make a few comments and then recognize Mr. Coyne for
what comments he might like to make.
Today we hold the second in a series of hearings on
proposals to reduce the tax burden on the American people.
Taxes as a percentage of gross domestic product this year are
at the highest level in our Nation's history in peacetime.
Disappointingly, the President's budget increases taxes to
an even higher level in 1999. High taxes represent a moral and
a social challenge to families that are struggling to make ends
meet. The more the government takes, the less the families have
to invest in themselves, their children, their retirement,
their health care, their education, and their communities.
This year I intend to do two things: reduce the national
debt and provide tax relief. If we fail to do both, millions of
middle-income taxpayers, especially those who are planning for
their retirements, will suffer.
When the government takes away the resources people were
counting on to help themselves, the people will turn to big
government to solve their problems. High taxation creates an
endless cycle of public dependency and too big government.
Isn't it better to pay down the debt and reduce taxes so
people have more money to spend on their own child care needs,
health care needs, and everyday needs? They should be free to
invest this money themselves.
Today our hearing will look at tax rates--what they are,
and what they should be. The Tax Code has five statutory tax
rates, but according to a report released today by the Joint
Committee on Taxation, 21 hidden tax provisions force more than
33 million Americans to pay higher taxes than they thought.
These sneak attack tax hikes are akin to false advertising by
the government.
One in four taxpayers aren't in the brackets that they
thought they were. For example, a senior citizen earning
$30,000 a year who thinks that he or she is in a 28 percent tax
bracket really pays a marginal rate of 42 percent, thanks to a
phaseout of the exclusion for Social Security benefits. Five
million seniors suffer that fate.
A single parent making $40,000 a year with 2 children in
college who thought that he or she was in the 15 percent
bracket will pay a marginal rate of 53.5 percent, 53 and a half
percent, due to the phaseout of the Hope scholarship that they
are involved in. 1.2 million Hope scholarships taxpayers are
hit by this sneak attack tax hike.
The list goes on and on, but that's just under the regular
rate. There's also the two-rate alternative minimum tax, which
can kick in at unpredictable times.
What throws you into the AMT? Three major things: paying
State and local taxes, having children, and getting sick. Do
those sound like tax shelters? I don't think so.
According to Joint Committee estimates, the individual AMT,
which applied to only 414,000 taxpayers in 1995, will hit 8.8
million in the year 2008. And that's just the taxpayers who
will pay the AMT.
There are also millions more who will lose some or all of
their child credit, Hope credit, lifetime learning credit,
dependent care credit, and other tax credits each year because
credits cannot reduce regular tax liabilities below the AMT
liability. The AMT is a tax hike time bomb. And it's
disappointing that the President's budget leaves it ticking.
Finally this morning we'll hear about a proposal to protect
taxpayers who make as little as $26,000 a year by lowering the
28 percent tax bracket to 15 percent for millions of Americans.
For every $5,000 the 15 percent tax bracket is expanded, each
taxpayer affected would save $650.
This across-the-board, middle-class tax cut would let 25
million Americans have more money to invest in themselves,
their children, and their communities. It's another reason why
reducing taxes solves more social problems than increased
spending.
Let me just close with a reminder as the Committee weighs
the merits of various tax proposals. I intend to be
conservative. I am not going to over-promise the American
people and create unrealistic expectations. I will never, I
repeat, never, tip the budget out of balance. And I will favor
proposals that simplify the Tax Code.
I will say to my colleagues that all of us are in for a
rude awakening when we learn that the budget law, the PAY-GO
provisions, which is the law of the land today, prohibit us
from using any surplus moneys for tax reduction. And that in
itself, unless it is changed, will severely limit the ability
of this Committee to create a tax relief bill. I will add also
that that same budget PAY-GO provision prohibits us from using
any savings in discretionary spending for tax relief.
I am going to do all that I can to see that this law is
changed. But in the interim, it is going to be very, very
difficult to be able to pass a tax reduction bill unless we
simply increase taxes on somebody else, which results in no net
tax relief. And that is not a desirable position for this
Committee to take.
So, having said that, I now recognize Mr. Coyne for any
statement that he might like to make on behalf of the Minority.
Mr. Coyne.
Mr. Coyne. Thank you, Mr. Chairman, for the opportunity to
make this statement on behalf of the Ranking Member, Mr.
Rangel.
As we begin this hearing on Federal tax burden and as we
begin putting together the tax component of the fiscal 1999
budget, I want to urge the Committee to take a serious look at
the recommendations contained in President Clinton's budget
regarding taxes.
I believe that there is fairly broad bipartisan support for
many of his provisions; for example, the low-income housing tax
credit. Our colleagues Mr. Ensign and Mr. Rangel have
introduced legislation to increase the State volume limitation
on the low-income housing tax credit. I am a cosponsor of the
bill, and there is a great deal of bipartisan support for the
low-income housing tax credit.
I would ask the Chairman to hold a hearing on this issue
and to include this provision in the Chairman's mark that he
will eventually present to the Committee.
The President's budget request also recommended an
expansion of the education zone program that was included in
last year's Taxpayer Relief Act. This expansion would provide
needed assistance to State and local governments in meeting the
need to repair and construct public schools. Addressing this
issue through the expansion of last year's act would help our
community schools while minimizing bureaucracy and
administrative costs.
Many of us hope that there will be bipartisan interest in
addressing the issue of tax credits for school construction
bonds. I would also ask the Chairman to consider including this
provision in his mark as well.
The President's budget request included tax provisions to
assist working families in meeting child care expenses. This,
too, is an issue of bipartisan concern and interest. I hope
that we can develop a bipartisan child care initiative similar
to the one suggested by the President.
The President's budget also proposes an extension of
expiring Tax Code provisions like the research credit, the work
opportunity credit, the welfare-to-work credit, and the
brownfields tax incentives. I would hope that we could work
together in a bipartisan fashion to address these issues as
well.
The hearings that we are currently engaged in seem to be
designed to highlight some of the problems that exist in the
current tax system. Such hearings can be very helpful to the
Committee in suggesting important focal points for our tax
reform efforts.
Some of the issues that are being raised, however, like the
marriage penalty, have been discussed in this Committee as long
as I have served on it. We all agree on the nature of the
problem and the need to fix it. The sticking point has always
been how to fix such problems in a fiscally responsible way.
I look forward to the Chairman's proposal for solving this
difficult question, and I hope that we can work together to
address it.
Thank you, Mr. Chairman.
Chairman Archer. The Chair thanks the gentleman for his
statement. And now, without objection, any other Member will be
permitted to insert a written statement into the record.
[The opening statement of Mr. Ramstad follows:]
Statement of Hon. Jim Ramstad, a Representative in Congress from the
State of Minnesota
Mr. Chairman, thank you for your leadership in examining
the tax burdens confronting American families.
I especially appreciate this focus on tax rates, which is
fundamental to discussions of tax fairness.
We know that more and more families are going to be pushed
into alternative minimum tax situations, which is probably the
only thing on earth worse than paying the ordinary income tax.
And I am pleased we will be looking into the ``hidden
rates'' in our tax code that effectively raise the tax burden
beyond statutory rates.
As you point out, Mr. Chairman, Americans are now paying
more in taxes as a percentage of GDP than at any peacetime in
history. I look forward to our discussion today and in the
coming weeks, as we explore critical tax issues facing American
families.
Thank you, Mr. Chairman.
We now turn to our first witness, one of our own
colleagues, Congressman John Thune. John, we're happy to have
you before the Committee today, and we're pleased to receive
your testimony.
I will say to you and for the benefit of any subsequent
witnesses that the rules of the Committee are not too different
from other Committees. We're going to ask you to keep your oral
testimony to 5 minutes. And the yellow light will come on in
front of you when there's 1 minute to go, and the red light
will come on when 5 minutes have expired. Your entire printed
statement will, without objection, be inserted in the record.
And that will apply to all witnesses.
So we're happy to have you, John. You may proceed.
Mr. Thune. Thank you, Mr. Chairman and Members of the
Committee.
STATEMENT OF HON. JOHN R. THUNE, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF SOUTH DAKOTA
Mr. Thune. I do appreciate as most of you I think should
have a copy of my written statement. And I will try as best I
can to explain briefly these proposals and summarize my
comments.
Let me just start by saying that the reason I think we're
having this discussion today is that we are for the first time
in about 30 years in a position where we're talking about
operating in the black, potentially having a surplus. And any
time you do that, it's a situation where I think for some
politicians, that's a dream, but for the taxpayers, it's a
nightmare.
My concern has been all along with respect to this issue
that we look at putting aside money to retire the debt, to
repay the trust funds. And, in fact, I am cosponsoring
legislation which would do that here in the House.
But I sort of got interested in this whole subject where
these bills are concerned as I was listening some weeks and
months ago to many of the President's proposals for new
spending. The thing that struck me about that was that I think
it's a very dangerous precedent to start embarking on a course
of new spending because we are doing well today and building in
a lot of new government programs into the base assuming that at
some point in the future, we'll have the revenue to support
those programs. And I'm not sure at this point in time we're
prepared to make that assumption.
So, as an alternative to that, people would ask me, ``Well,
if you don't like what the President's proposal is with respect
to child care, what do you have as an alternative?'' And so we
started to think about that.
Really, what we came up with were a couple of proposals
that I think address the need but do it in a very different
way. And that is to allow individuals and families to make the
decisions about how they want to address those needs in their
lives, rather than having a government solution to it. And so
we drafted a couple of bills.
Of course, let me just say also that I agree with you, Mr.
Chairman, that anything that we do ought to be in the context
of a balanced budget. We should not in any way finance any tax
relief with our children's future. And so to the extent that we
are able to do anything, I think it's going to mean it's
because we have the room to accommodate and absorb within the
budget any tax relief that we might put out there.
Having said that, the two bills that I would bring before
you today really are an attempt I think to do something which
is sort of novel around here. One of the things that troubles
me the most about many of the President's proposals is this
obsession with targeting, you know, that we're going to try to
pick winners and losers and we're going to please this group if
you act this way.
These bills really are designed to distribute tax relief in
a broad, even way. And, frankly, as I look at the first bill,
which raises the caps, the income caps, at which the 28-percent
rate would apply, it does, in fact, take a number of people,
about 10 million filers we're told in this country, out of the
28 percent bracket back to the 15 percent bracket and allows I
think people who are trying to improve their lives, trying to
do better to be rewarded and rather than as a disincentive push
into a higher, much higher tax rate. And so it's a way which I
think is very simple and clean, and that's the other aspect I
like about that bill.
With the whole issue of where we go in terms of tax policy
in this country, I think it's the right approach. And when you
made the comment in your opening statement about you're going
to favor attempts to simplify the Tax Code, that, too, is a
priority of mine and one reason why I think this particular
proposal makes so much sense. It starts moving us to where we
are getting more people paying at the 15-percent rate. And I
think that's something that's a very positive development.
The other bill just let me say briefly as well is a fairly
straightforward, simple thing. And that is to raise the
personal exemption for each individual taxpayer.
When you sit down and figure out again who benefits from
raising the exemption or from the raise in the thresholds, it
does deliver tax relief to those in the middle- and low-income
categories.
Now, if you assume, of course, that the payroll tax comes
off somewhere in the $60,000 range, you've got people who are
caught in the middle there who are paying the payroll tax, the
28-percent rate. And I think what this does is you are really
penalizing people in the middle-income categories. This
attempts to correct that, and it also, with the personal
exemption bill, helps those who are currently in the 15 percent
tax bracket.
So in trying to summarize all of that, what we were looking
at doing with these is an approach which is simple, which is
fair, which is a broad-based approach, rather than a targeted
picking winners and losers, which treats people the same,
whether they are married or whether they are single.
I've had people ask me ``What does a single person get out
of all of this tax relief?'' Most of the bills that we pass we
say we're doing this for married people or married with
children.
And, again, this is not discriminatory in the approach.
It's very straightforward. It's across the board. And I think
it's the right approach for the future as we move toward what I
hope will be a debate about tax reform, about how we can
further simplify the Code and make it more friendly to the
taxpayer.
Let me just close by saying that I don't know what we might
have in terms of budgetary constraints, what we might be able
to accommodate in terms of a tax relief proposal this year, but
to the extent that we can, my own view is having looked at a
lot of the tax relief proposals that are out there, that this
makes the most sense in my view and moving toward the long-term
goal again of simplifying the Tax Code and of doing tax relief
in a way that benefits everybody in this country and not a
select few.
So, with that, I will close. Thank you for the opportunity
to present testimony this morning.
[The prepared statement follows:]
Statement of Hon. John R. Thune, a Representative in Congress from the
State of South Dakota
Chairman Archer, members of the Committee, thank you for
the opportunity today to talk about tax reform proposals. This
is indeed an important and timely topic. The American taxpayers
are on the verge of realizing the most significant tax cut in
over 17 years.
The Taxpayer Relief Act of 1997 provided important relief
for taxpayers at every stage of life from the cradle to the
grave. At the same time, we did nothing to make the already
complicated tax code any simpler. The passage of the Middle
Class Tax Relief Act of 1998 and the Taxpayer Choice Act of
1998 would help us make strides toward tax relief that is both
broad and simple. I also hope these bills can be considered as
an alternative to future targeted tax cuts and as an
alternative to new government spending.
In his State of the Union address, the President outlined
his policy goals. Now that his budget is out, we know his ideas
translate into some $150 billion in new Washington spending.
Most of us can agree with his goals. From important priorities
like caring for and educating our children, to providing health
care for an aging population. These are important issues. On
that we all agree.
However, the differences are clear in trying to determine
how best to achieve those goals--particularly with the prospect
of a revenue surplus. The President's programs mark an
incredibly expansive reach by the federal government into the
lives of Americans. At the same time, he is highlighting the
need to reserve any surplus for Social Security. While I agree
Congress must begin to restore the Social Security Trust Fund,
the juxtaposition of saving and spending sends mixed signals to
me and to the American public.
There is a responsible approach to dealing with any
potential surplus. Accordingly, I support an approach that
would apportion any potential surplus to paying off debt and
restoring the integrity of the various federal trust funds,
while reducing taxes on hard working Americans. Such an
approach would allow us to give something back to the taxpayers
of this country. After all, it is their money.
If the President is able to build $150 billion in new
Washington spending into his budget, it would necessarily
follow that the President and Congress could give back the same
amount to the taxpayers. The best solution to helping working
families deal with tough issues like child care is to give them
some money back and allow them to make the best decision about
how to address this important need.
In order to provide for some tax relief that is both fair
and effective, my friend and colleague from the State of
Washington, Congresswoman Jennifer Dunn, and I introduced two
pieces of tax relief legislation that I believe will serve as
alternatives to the new Washington spending in the President's
budget. At the same time, these bills are consistent with the
dual goals of distributing tax relief broadly and evenly and of
simplifying an inordinately complicated tax code.
The first bill, the Middle Class Tax Relief Act, addresses
the concept of ``bracket creep'' by allowing working Americans
to enjoy success rather than suffer the penalty imposed by a
significantly higher tax bracket. The Middle Class Tax Relief
Act would lower taxes by raising the income threshold at which
the 28 percent tax bracket would apply. Simply put, more income
of working Americans would be subject to the 15 percent tax
bracket rather than the much higher 28 percent bracket.
This legislation would help middle income-earners who are
doing better and making more, but as a consequence, have
graduated from the 15 percent tax bracket. Due to bracket
creep, 28 cents of each additional dollar they earn now goes to
the federal government. Under our legislation, many of these
hardworking people would have an incentive to continue to be
hard working people, by removing the threat of a higher tax
rate on each additional dollar they earn.
And this relief pays no attention to family status or other
behavioral factors. Presently, the higher 28 percent tax rate
applies to a single person making more than $25,350. Our
legislation would raise that threshold to $35,000. For heads of
household, the 28 percent rate starts at $33,950. We would
raise that to $52,600. For married couples, the 28 percent rate
starts at $42,350. We would raise it to $70,000.
According to the Tax Foundation, over 29,000,000 filers
would see their taxes lowered under this proposal, with the
average savings of nearly $1,200 per filer. Over 10 million
filers would move out of the 28 percent bracket to the 15
percent bracket.
A $1,200 tax cut could pay for sixteen weeks of child care,
four car payments, and up to three months of housing bills, or
fourteen weeks of grocery bills. That's real help for working
families.
The other bill I propose is the Taxpayer Choice Act. The
Taxpayer Choice Act would raise the personal exemption from
$2,700 to $3,400. The bill would reduce the taxable income of
hard working Americans and allow them the freedom to choose how
best to use the benefit of their tax reduction. By reducing
taxable income by $700, this legislation would deliver broad
based tax relief to taxpayers in the lower and middle income
ranges.
This change is straightforward and easy to calculate. For
someone in the 15 percent tax bracket, I have estimated a
savings of $100, or for a family of four, $400, or the
approximate equivalent of five weeks of child care, a car
payment, housing payment or five weeks of grocery bills. That's
real relief and those are real life choices. For earnings in
the 28 percent tax bracket, I estimated the legislation would
provide $200 per individual, or $800 per family of four. That
is approximately equal to ten weeks of child care, almost ten
weeks of grocery bills, three car payments, or a couple of
housing payments. As is true today, the deduction would phase
out for wage earners whose incomes exceed $124,500.
These bills both say to the people of this country: You
have the freedom of choice. We trust your judgement. We believe
you are capable of caring for your children and making good
decisions about their future. We believe that as a matter of
principle, America is infinitely better off when families and
individuals are making decisions rather than Washington
bureaucrats.
As we reform the tax code, we should resist from targeting
tax cuts. Too often, Washington has chosen to pick winners and
losers as it moves to cut taxes. For too long Washington has
tried to dissect our society as it attempts to do something as
simple as lowering taxes. I supported last year's Taxpayer
Relief Act, which had plenty of targeting in it. That law has
made important changes in the tax code to lower the burden of
many individuals and businesses.
However, I believe we should strive toward a more perfect
union and look for ways that allow all Americans--irrespective
of marriage status, age, or heritage--to participate in the
benefits of the greater freedom that comes with lower taxes. We
should strive to make all taxpayers equal under the law.
Furthermore, we should take a consistent approach to making
the tax code simpler. Most of the tax relief proposals I have
seen to date further complicate the tax code. Such efforts do
not take us down the road toward a less intrusive and more user
friendly government.
I would like to come back to a point I made earlier. We
agree with the President that working families in America need
relief. However, the President has mistakenly interpreted that
need as a request for more Washington spending and targeted tax
cuts. What working families are really asking for is not more
federal government, but relief from more federal government.
At the same time, the two bills, the Middle Class Tax
Relief Act and the Taxpayer Choice Act, both work toward a tax
code that is more simple and more fair. Americans waste way too
much time and money filling out tax returns. It's a dream for
lobbyists, lawyers and tax preparers. It's a nightmare for the
American taxpayer.
The two bills I introduced yesterday are consistent with a
simpler, fairer approach to the tax code. Now is the time to
reform the code with a focus on inviting all Americans to
participate in the benefits of a growing economy. These are our
goals and I look forward to working with the Chairman and the
rest of this committee to make these initiatives become a
reality.
Again, I thank the chair and would be happy to answer any
questions you may have.
Chairman Archer. Thank you, Congressman Thune.
Does any Member of the Committee wish to inquire?
[No response.]
Chairman Archer. If not, I compliment you on your
testimony. We're glad to have your entire statement. And we
wish you well.
Mr. Thune. Thank you. We need your help. Thanks.
Chairman Archer. The next panel is: Dr. J.D. Foster; Mr.
Michael Mares; Dr. Martin Regalia; and Mr. Kenneth Kies. I
think all of you were in the room when I cited the rules the
Committee likes to operate under in these hearings. So I won't
repeat them but just to welcome all of you en banc, as it was,
to the Committee.
And according to the schedule before me, Dr. Foster will
lead off. So if you are prepared, Dr. Foster, we will be
pleased to receive your testimony.
I would like to add one other thing in that I'd like for
each of you to identify yourselves and if you're representing
anybody, to identify who that is before you commence your
testimony.
Dr. Foster.
Mr. Foster. Thank you very much, Mr. Chairman.
STATEMENT OF J.D. FOSTER, PH.D., EXECUTIVE DIRECTOR AND CHIEF
ECONOMIST, TAX FOUNDATION
Mr. Foster. I'm J.D. Foster, the executive director and
chief economist of the Tax Foundation. I appreciate the
opportunity to appear before the Committee today.
I personally think we have a very good reason to be talking
about tax reductions today. The economy is producing tax
revenues far in excess of what was projected just a few months
ago. As the President's budget makes clear, the surpluses that
we're looking forward to in the near future are largely the
product of these revenues. So I find a certain simple logic for
using some of these tax revenues for tax relief.
In considering tax cuts, I think we should take a couple of
lessons from tax reform. One of these lessons is the imperative
of focusing on economic growth. Yes, it's true the economy is
doing well right now, but that's no reason why we shouldn't
allow it to do better. I believe tax cuts should always be
gauged by their ability to encourage economic growth.
A second lesson from tax reform is tax simplification.
Complexity in the Tax Code is wasteful, and it is wrong. The
one sure consensus on tax reform is that the Tax Code is too
complex. Tax reform is not the issue today, but the lessons are
the same.
No tax cut should complicate the Tax Code. Every tax cut
should be oriented toward encouraging economic growth. Reducing
marginal tax rates hits on both counts. Reducing marginal tax
rates has many other benefits, however.
If your concern is the tax burden on families generally,
then tax rate reduction is your answer. If your concern is the
marriage tax penalty, tax rate reduction will help without the
complexity inherent in many of the solutions we have been
talking about. If your goal is to encourage private savings,
then again tax rate reduction is your answer.
This Committee has heard for years that Americans save too
little. Assuming this is true, high marginal tax rates must
bear much of the blame. People respond strongly to incentives
and disincentives. Why do you suppose brokerage houses
advertise track records of yielding value to investors if
investors are not swayed by yields?
Why do supermarkets advertise their prices in the local
paper? Because even reductions in the price of a can of soup or
a bunch of bananas is going to alter consumer behavior.
Even the Tax Code relies heavily on disincentives to
function. It has a highly developed system of tax penalties to
discourage tax cheating. If monetary penalties discourage tax
cheating, why would we think that high marginal tax rates
wouldn't discourage saving? Reducing marginal tax rates and
thereby reducing the tax burden on saving will increase
national saving.
If your goal in tax reductions is to increase investment in
plant and equipment, then again tax rate reduction is your
answer. Reducing marginal tax rates reduces the cost of
capital, particularly if those rate reductions are extended to
the corporate tax system.
The 1997 tax bill was criticized because many provisions
affecting individual taxpayers introduced new complexities in
the Tax Code. I've attached to my testimony the new rules on
capital gains and losses. These new instructions are mind-
numbing. And it is wrong to inflict them on taxpayers.
Despite these complexities, I believe last year's tax bill
was a great victory for taxpayers. It slowed but did not halt
the rising tide of taxes. And it may have ushered in a new era
of tax cutting. However, it also opened up the Congress to real
criticism for reasons beyond complexity.
The bill created millions of winners, but it created a
legion of the ignored. In appearance, this was rent seeking at
its worst. This is not a game I believe the Committee or the
Congress should be playing.
The surest way to avoid this unseemly game while providing
significant tax relief is to reduce tax rates. Tax rate
reduction can be devised so that all taxpayers benefit and not
just a select few.
Tax rate reduction is simple. Many tax cut proposals are
complex. Its simplicity encourages a sense of public fairness.
Tax rate reduction is easy to explain and, therefore, easily
garners public support. And tax rate reduction is very
flexible. By lowering rates and raising bracket points, you can
fine-tune the amount of tax relief that you want to give the
American people.
The opponents of marginal tax rate reduction are primarily
special interests who want to get a bigger slice of the pie for
their own constituencies, appropriate for a democracy but not
the best way to reduce taxes in my opinion.
Some might argue that we've reduced our statutory tax rates
significantly over the last 17 years and we probably shouldn't
go any further. This argument might be valid if we are only
talking about whether to cut taxes. But once we're talking
about cutting taxes, the argument has no merit.
High marginal tax rates of the past were counterproductive
and have been roundly repudiated. Today's rates have no basis
in theory. They're a product of revenue requirements and
politics. If the politics and the revenue requirements have
changed and would permit tax reductions, then marginal tax rate
reductions should be this Committee's primary goal.
I believe it's time to create a virtuous cycle. Cut taxes
to spur economic growth. Use the additional revenues from
faster economic growth to cut taxes further and keep the
process rolling. Cutting marginal tax rates I believe is your
first best choice for tax reduction. They're your first best
choice for creating this virtuous fiscal cycle.
Thank you, Mr. Chairman.
[The prepared statement follows:]
Statement of J.D. Foster, Ph.D., Executive Director and Chief
Economist, Tax Foundation
Mr. Chairman, Mr. Rangel, Members of the Committee, it is
with great pleasure that I appear before this Committee to
testify to the importance of focusing on tax rates as the
centerpiece of any tax reduction program in 1998.
I am the Executive Director and Chief Economist of the Tax
Foundation. The Tax Foundation is a 60-year old non-profit,
non-partisan research institution. Our mission is a simple one:
To provide accurate and timely information on matters of
federal, state, and local fiscal policy so that policymakers
may make better policy.
Mr. Chairman, we have good reason today to discuss tax
reduction. We have an economy that is yielding tax revenues far
in excess of official expectations of only a few months ago.
This enormous revenue stream has created the possibility of
budget surpluses in the near or very near future. While the
caution previously urged by White House officials and others
against a change in policy predicated on surpluses is well-
taken, it is perfectly appropriate for this Committee to
consider what actions it might want to take should a surplus
arrive earlier than expected. Further, as this happy prospect
of surpluses is the product of extraordinary growth in tax
receipts, there is a certain simple logic to using the
surpluses for tax relief.
Another reason to consider tax relief is simply that taxes
are now at their highest levels in our nation's history. Last
year, Tax Freedom Day arrived on May 9, the latest day ever.
Tax Freedom Day is a simple representation of the total
federal, state, and local tax burden. If all of the average
taxpayer's income goes to pay his taxes beginning on January
1st, then Tax Freedom Day is the day his annual fiscal debt to
society is marked ``Paid In Full.'' Tax Freedom Day 1998 is
almost certain to fall even later in the calendar.
It's also important to rite last year's historic tax cut.
Why is that? Because last year's tax cuts were slight indeed
compared to the revenues produced by a strong economy.
Which Taxes to Cut
There are, therefore, very good reasons to consider tax
reductions at this time. In establishing a tax cut program, I
believe the Committee should take a couple pages from the tax
reform debates. The number one tax policy lesson from these
debates is the great imperative to get the tax base right.
Economic distortions due to taxation are minimized when the
definition of the tax base is correct. On the other hand,
whatever the tax rate, economic distortions grow with each
error in the tax base.
A second lesson from the tax reform debates is the
importance of tax simplification both economically and
politically. Complexity in the tax code is wasteful and it is
wrong. If there is anything about tax reform about which there
is a general consensus, it is this--the current tax system is
too complex. Perhaps if the Members of the Committee were
required to do their own taxes as a condition for sitting on
this Committee, then the proliferation of complex tax changes
would cease halt.
Of course, tax reform is not the issue here, today. But the
lessons remain the same. In an ideal world the Committee's
focus ought to be to effect tax policy changes that simplify
the system and that move the federal income tax in the
direction of a proper definition of taxable income. That would
mean, for example, increasing as far as possible the ability of
taxpayers to exclude capital income from taxation, eliminating
that abomination of federal tax policy known as the Alternative
Minimum Tax, and integrating the personal and corporate income
taxes.
To the extent reality impinges on this ideal world, as it
must in a democracy, I would urge the Committee to eschew
narrow, targeted tax changes in favor of reducing marginal tax
rates. Whatever distortions exist in the federal income tax,
and they are legion, they are given greater r are the marginal
tax rates to which taxpayers are subjected. Conversely,
reducing tax rates reduces virtually all the distortions
created by the tax code that rob the economy of vitality and
rob the American people of greater opportunity and prosperity.
This Committee is fully versed in the distortions to the
economy created by the federal income tax and in the multitude
of opportunities for greater prosperity lost as a result.
Therefore, I will not discuss them in great detail. Instead, I
will briefly enumerate the most important of these.
Income taxes imposed on wages and salaries reduce the
incentive to work and, conversely, increase the incentive to
take one's leisure. At very low tax rates, one's incentive to
work is about equal to one's economic contribution to society.
At low tax rates the price of leisure is high. At high marginal
tax rates, one's return to work a few more hour's drops rapidly
and the price of leisure drops along with it. Reducing marginal
tax rates directly reduces the disincentive to work.
This Committee has heard for years that the people of the
United States save too little. Assuming this is true, the
federal income tax must bear much of the blame. Despite the
many slivers of tax relief available to some saving, current
law continues to heap layer upon layer of tax on additional
saving. In most cases, income is taxed as earned irrespective
of what one does with it. If it is saved, it is likely to face
multiple layers of additional tax in the form of taxes on
interest, dividends, corporate income, capital gains, and
estate taxes.
People respond to incentives and disincentives. Why do
brokerage houses advertise their strong track records yielding
value to investors if investors are not influenced by yields?
Why would car companies advertise price reductions, year-end
discounts, and low financing rates if they fail to elicit more
sales? Why do supermarkets advertise their sales in the local
papers? Because even reductions in relatively low-priced items
can alter consumer choices.
The tax code has a highly developed system of tax penalties
to discourage taxpayers from cheating on their taxes. Why would
we believe that monetary penalties would be effective in
discouraging tax cheating, and yet not believe that monetary
penalties would be effective in discouraging saving? Reducing
marginal tax rates and thereby reducing the tax on saving
directly reduces the disincentive to save.
To demonstrate how widespread would be the benefits of
marginal tax rate reductions, consider:
If a major concern is the tax burden on families
generally, then rate reduction will help.
If your concern is the marriage penalty, or even
the single tax filer penalty, then rate reduction will help--
without the complexity inherent in most solutions to this
problem.
If your goal is to encourage additional investment
in plant and equipment, then rate reduction is your answer
because it would reduce the cost of capital, particularly if
the rate reduction is extended to the corporate income tax
rates. Rate reduction reduces the tax on dividend and interest
income and, if extended to capital gains, it can further reduce
the tax burden on capital gains.
The 1997 tax bill was criticized, not entirely unfairly in
my opinion, for being a hodgepodge of tax provisions, some
large and some small. Many of the provisions, particularly as
they relate to individual taxpayers, introduced enormous new
complexities into the tax code. I have attached to my testimony
the new rules appearing in this year's tax instructions for.
These instructions are mind numbing. Indeed, perhaps the
Committee could use these instructions as a simple test of the
qualifications of any person seeking employment at the Joint
Tax Committee: They must be able to explain this procedure, in
English, after reading it through no more than ten times. I
suggest few would pass the test.
I believe last year's tax bill was a tremendous victory for
taxpayers. The tax cuts slowed, but did not halt the tide of
rising taxes and may have ushered in a new era of tax cutting.
However, last year's tax bill also opened the Congress to real
criticism for reasons beyond complexity. The bill created
millions of winners, but it also created legions of the
ignored. In appearance, at least, this was rent seeking at its
worst. This is not a game I believe the Committee or the
Congress should be playing.
The surest way to avoid a similar trap and yet to provide
significant tax relief is by reducing tax rates. Tax rate
reduction can be devised so that all taxpayers benefit, and not
just a select and well-represented few. There are other
important reasons to favor tax rate reduction:
It is simple. A great many tax cut proposals would
increase the tax complexity hurdle for those lucky taxpayers
who would qualify.
It's simplicity further enhances a public sense of
its fairness. The Congress would not be perceived as bestowing
relief on a select few.
It is very flexible. Through the lowering of rates
and raising of bracket points, the Committee has a great
ability to fine-tune the amount of relief, again without
complex special rules and effective dates.
And it is easy to explain and therefore easily
garners credibility and public support.
The case for making tax rate reduction a major component of
any tax relief bill is so compelling it is worth considering
why it might not be favored in some quarters.
One valid reason for emphasizing alternate tax cut
proposals would be if the Committee was to choose to correct
the tax base instead. As noted above, taxable income is badly
defined under current law. Working towards an economically
sound definition of taxable income should always be a policy
goal of the first order.
A second source of opposition to across-the-board marginal
tax rate cuts might arise from special interests who will fight
to get a bigger piece of any tax cut pie for their own
constituencies. Even when their objectives are sound, as is
often the case, they put this Committee in the terrible
position of playing Santa Claus to a select few. A good example
of such a special interest is the ``pro-family'' groups whose
efforts resulted last year in the child tax credit--an item of
zero consequence for economic growth and one that specifically
targeted certain beneficiaries to the exclusion of all others.
This year these same groups are back fighting to eliminate the
marriage tax penalty. The marriage tax penalty relates to the
tax burden of some married couples relative to the tax they
would owe if they were ``single'' filers. It is problematic.
Yet for every four couples suffering from the penalty, there
are five couples who pay less tax because of their joint filing
status than they would had they filed single.
If the pro-family groups were fightiress the marriage bonus
families and the marriage tax penalized. To my knowledge, they
are silent on the bonus, and so they stand self-indicted as
purely special interests. Across-the-board rate cuts, in
comparison, would benefit proportionately those subject to the
marriage penalty, those subject to the marriage bonus, and all
single tax filers.
Finally, some might argue that statutory tax rates have
declined significantly over the past 17 years, and that further
reductions are therefore not needed. If one opposes tax
reductions generally, then this argument is at least
defensible. However, if the question is not whether to cut
taxes, but how, then this argument is without foundation. The
high marginal tax rates of the past were found to be counter-
productive and have been roundly repudiated. Today's rates have
no basis in theory. They are the product of revenue
requirements and politics. If the politics and revenue
requirements permit tax reductions, then marginal tax rate cuts
should be the Committee's primary goal.
[GRAPHIC] [TIFF OMITTED] T0897.082
Chairman Archer. Thank you, Dr. Foster.
Our next witness is Dr. Regalia. And if you'll identify
yourself, we'll be pleased to receive your testimony.
Mr. Regalia. Thank you, Mr. Chairman.
STATEMENT OF MARTIN A. REGALIA, PH.D., VICE PRESIDENT AND CHIEF
ECONOMIST, U.S. CHAMBER OF COMMERCE
Mr. Regalia. My name is Martin Regalia. I'm vice president
and chief economist for the U.S. Chamber of Commerce. And we
thank you for inviting us here today to testify.
Well, few people actually like paying taxes. Most of us
understand the need to pay tax to provide basic services,
provide roads, infrastructure, national defense. However, we
believe the government also has the responsibility to tax in a
simple, efficient, and fair manner and to keep the overall
burden on individuals and businesses as low as possible.
Our Federal tax burden is too high. Total Federal receipts
as a percentage of GDP were 19.8 percent in 1997, up from 17.8
percent just 4 years ago. We agree with you, Mr. Chairman, that
Federal taxes as a percentage of GDP need to be reduced. And we
appreciate your leadership in this area.
The maximum marginal tax rate for individuals is now a
stifling 39.6 percent and applies to income derived from sole
proprietorships, partnerships, limited liability companies, and
S corporations.
In addition, the corporate income tax rates vary from 15
percent to a troubling 39 percent. Tax rates should be lower
and less steeply graduated for all individuals and businesses.
Furthermore, the Tax Code contains various hidden taxes
created by phaseouts of tax benefits and tax floors for certain
expenses.
Some benefits phase out at a low level of income, yet are
justifiable because they are intended specifically to benefit
low-income taxpayers.
Other benefits, however, such as itemized deductions and
personal exemptions, phase out at middle and upper incomes and
are really done so only to raise more revenue. While doing so,
they create disincentives for work, savings, and investment.
And the Tax Code should be adjusted to remove these
disincentives.
Social Security and Medicare taxes have climbed
dramatically since their inception. The combined employer-
employee tax rate for self-employed individuals, which self-
employed individuals bear entirely themselves, is an astounding
15.3 percent, up from 9.6 percent in 1970 and 3 percent in
1950. These taxes should be reduced, or at a minimum, made
deductible for income tax purposes.
The Federal estate and gift tax is onerous tax which should
be repealed or significantly reformed by further increasing the
unified credit, reducing overall tax rates, and expanding the
family-owned business exclusion.
Another counterproductive tax is the alternative minimum
tax. Originally envisioned as a method to ensure that all
taxpayers pay a minimum amount of tax, the AMT penalizes
individuals and businesses that save and invest, both
requirements for economic growth.
While the 1997 tax act made certain reforms to the
corporate AMT, it did not fully repeal the depreciation
adjustment or reform the individual AMT. The AMT should be
eliminated. If that's not possible, additional reforms should
be enacted, such as creating an exemption for unincorporated
businesses, eliminating the depreciation adjustment, increasing
the individual exemption amounts, and allowing taxpayers to
offset their current year AMT with accumulated tax credits.
The 1997 act provided approximately $151 billion of gross
tax relief over the next 5 years. However, business and
business-related tax and investment incentives accounted for a
very small portion of those.
We urge Congress to continue to reduce the Federal tax
burden. And we think that there are a number of ways that they
could do this. We think that permanently extending the research
and experimentation and the work opportunity tax credits,
further reforming Subchapter S rules, reforming the foreign tax
rules, simplifying the worker classification rules, providing
corporate capital gains relief, and increasing the equipment
expense allowance are all areas for concern.
Finally, we think that restructuring the IRS to make it a
more efficient, accountable, and taxpayer-friendly organization
is something that needs to be done now.
Thank you very much.
[The prepared statement follows:]
Statement of Martin A. Regalia, Ph.D., Vice President and Chief
Economist, U.S. Chamber of Commerce
Mr. Chairman and members of the Committee, my name is
Martin Regalia. I am Vice President and Chief Economist of the
U.S. Chamber of Commerce--the world's largest business
federation, representing more than three million businesses and
organizations of every size, sector and region.
The U.S. Chamber appreciates this opportunity to express
our views on how to reduce the federal tax burden of
individuals and businesses. I will be addressing various
aspects of this increasingly growing problem, including high
statutory tax rates, ``hidden'' taxes buried throughout the
federal tax code, the alternative minimum tax for individuals
and corporations, and additional tax relief measures which
would reduce the overall federal tax burden.
Our Overall Tax Burden is Too High
Justice Holmes once commented that taxation is the price we
pay for civilization. Let's face it, nobody likes paying taxes.
However, most of us understand that our federal, state and
local governments need to tax its citizens in order to provide
basic services which we all want and expect (e.g., roads,
national defense, schools). I suspect most individuals and
businesses would not complain so much about taxes if they were
fair, simple, properly administered, and promoted economic
growth, saving, and investment. Unfortunately, our existing
federal tax system fails to meet these basic criteria.
Simply stated, taxes should be levied for the purpose of
obtaining those revenues necessary to fund limited government
expenditures in a way that minimizes their negative impact on
taxpayers, overall economic growth and the international
competitiveness of American business. History demonstrates that
taxation carried to unreasonably high levels defeats its basic
purpose by doing irreparable harm to the civilization and
freedom that government is designed to protect. Aggravating the
problem of overtaxation in America is the notion that the
federal government wastes a good portion of its revenues on
unproductive projects, services, and bureaucracies.
The overall tax burden on American families and businesses
is too high. According to the Tax Foundation, total taxes
imposed on individuals as a percent of total income was almost
35 percent in 1996. Federal taxes accounted for 23 percent,
while state and local taxes accounted for 12 percent. Based on
this study, Americans work almost three months every year to
support the federal government.
According to the Office of Management and Budget (OMB),
total federal receipts, as a percentage of Gross Domestic
Product (GDP), was 19.8 percent in 1997, up from 17.8 percent
just four years earlier. Federal individual income tax
receipts, as a percentage of GDP, has risen from 7.7 percent in
1992 to 9.3 percent in 1997, while the percentage for corporate
income tax receipts has risen from 1.6 percent in 1992 to 2.3
percent in 1997. In addition, social insurance and retirement
receipts, as a percentage of GDP, has increased from 1.6
percent in 1950, to 4.4 percent in 1970, to 6.8 percent today.
Federal Tax Rates Need to be Lowered
Federal individual income taxes are too high and need to be
lowered. Generally, an individual's federal income tax
liability is determined by multiplying his or her taxable
income, or tax base, by the applicable tax rates, and then
subtracting various tax credits.
Overall income tax rates for individuals dropped
significantly in the 1980's. The Economic Recovery Tax Act of
1981 reduced the maximum statutory tax rate from 70 percent to
50 percent, and the Tax Reform Act of 1986 further reduced it
to 28 percent. However, the Tax Reform Act of 1986 also
eliminated or limited certain deductions or exemptions, such as
those relating to personal interest and passive losses, which
expanded the tax base for many individuals.
Since 1986, however, the maximum statutory tax rate has
been increased, first to 31 percent in 1990, and then to 39.6
percent (36 percent plus a 3.6 percent surcharge) in 1993.
Deductions and exclusions for individuals, on the other hand,
have not been increased in equal measure. This is a primary
reason why the federal income tax burden on individuals has
increased over the last few years.
For 1997, a 15 percent tax rate applies to the first
$24,650 of taxable income for single filers ($41,200 for
married couples filing joint returns). The marginal tax rate
then almost doubles to 28 percent for single filers with
taxable incomes between $24,650 and $59,750 (between $41,200
and $99,600 for married couples). The rate increases to 31
percent for single filers with taxable incomes between $59,750
and $124,650 (between $99,600 and $151,750 for married
couples), and to 36 percent for single filers with taxable
incomes between $124,650 and $271,050 (between $151,750 and
$271,050 for married couples). For taxable incomes above
$271,050, a maximum statutory 39.6 percent rate applies for
both single filers and married couples. A taxpayer's effective
maximum tax rate can be even higher when various phase-outs
(e.g., certain itemized deductions, personal exemptions) are
taken into effect.
These tax rates are not only too high, but apply to most
types of income, including those derived from a sole
proprietorship, partnership, limited liability company or S
corporation. This creates a disincentive for business owners to
work longer hours and generate additional income since they
realize that an ever increasing share of their income will be
going to the federal government. At a minimum, legislation
should be enacted to lower the maximum income tax rate on the
reinvested or retained earnings of these business owners.
Furthermore, the progressive nature of the federal income
tax system causes many married dual-earner couples to be
subjected to a ``marriage penalty''--that is, they pay more in
combined income taxes than they would if they were not married
and were filing single returns. This is simply unacceptable and
needs to be remedied.
The high rates of income tax imposed on corporations are
just as troubling. The maximum federal corporate income tax
rate is 39 percent, and applies to taxable income between
$100,000 and $335,000. Taxable income in excess of $335,000 is
subject to varying rates of 34 percent, 35 percent and 38
percent. The taxable income of certain personal service
corporations, including those that perform health, law,
consulting, and engineering services, is taxed at a flat rate
of 35 percent.
To make matters worse, certain amounts of corporate income
are subject to double taxation--first at the corporate level,
and then at the individual level when non-deductible dividends
are distributed to shareholders. Small or family-owned
businesses may be able to characterize most or all payments to
their owners as deductible wages, rather than non-deductible
dividends. However, such payments would have to be deemed
``reasonable'' compensation, and could be subject to a maximum
individual income tax rate of 39.6 percent, as well as Social
Security and Medicare taxes.
Social Security and Medicare taxes, perhaps two of the most
criticized taxes, have climbed dramatically since their
inception. The combined employer-employee tax rate--which self-
employed individuals must bear entirely on their own--is
currently 15.3 percent, up from 9.6 percent in 1970 and 3
percent in 1950. The maximum taxable wage (and self-employment)
base has also increased steadily, from $7,800 in 1971 for both
Social Security and Medicare, to $68,400 today for Social
Security, and an unlimited amount for Medicare.
These two taxes have become a growing thorn in the side of
American workers and businesses. Individuals must work harder
and longer hours to fund these programs, which may or may not
be fiscally sound when they retire. Regardless of whether
Social Security becomes fully or partially privatized, we need
to reduce the growing tax burden of this, as well as the
Medicare, systems. At a minimum, such taxes should be
deductible for income tax purposes in order to eliminate double
taxation on the wage bases.
The federal estate and gift tax is another tax which needs
dramatic reform. This tax is extremely onerous, not only
because it is triggered by death and is based on the value of a
decedent's accumulated assets, but because its tax rates are so
high and take affect at such a low threshold. For example, in
1997, a tax rate of 37 percent applies once a taxable estate
exceeds $600,000. The rate quickly climbs to 55 percent once
the taxable estate exceeds $3 million. In fact, a 60 percent
rate applies to taxable estates between $10 million and $21
million.
The estate tax should be repealed. If repeal is not
feasible, significant reforms should be implemented. Such
reforms include further increasing the unified credit, reducing
overall tax rates, increasing and expanding the newly created
``family-owned business interest'' exclusion to encapsulate
more businesses, and broadening the installment payment rules.
There are other federal taxes which have high rates of tax.
These include the federal unemployment tax (FUTA), alternative
minimum tax on individuals and corporations, capital gains tax,
accumulated earnings tax, personal holding company tax and
various excise taxes (e.g., airline ticket tax, fuels tax).
All of these federal taxes create an enormous financial
drain on American individuals and businesses and dampen capital
formation, job growth and work initiative. While it would be
difficult for us to state with exact specificity the ideal tax
rate for each type of federal tax, we do support lower and less
steeply graduated tax rates for all individuals and businesses.
``Hidden'' Taxes Should be Eliminated
In addition to the high maximum income tax rates, there are
numerous provisions in the federal tax code which have the
effect of increasing the effective marginal rates of tax on
individuals and businesses. One of the more common forms of a
``hidden'' tax is the phase-out of various tax benefits (e.g.,
credits, deductions, and exemption amounts).
Tax credits that phase-out include the earned income tax
credit, dependent care credit, adoption credit, and the newly-
enacted child and education tax credits. Tax deductions with
phase-out ranges include those relating to individual
retirement accounts (both deductible and non-deductible Roth
IRAs), total itemized deductions, the $25,000 allowance for
certain ``passive'' losses, and student loan interest expenses.
Tax exemptions that phase-out include the personal exemption
for both regular and alternative minimum tax purposes.
The phase-out ranges for the above-mentioned tax benefits
vary widely across the income spectrum. Some benefits, such as
the earned income tax credit, phase-out at relatively low
levels of adjusted gross income (AGI) (e.g., $30,095 for
families with two children). Such phase-out levels are
justifiable because the credits were intended specifically to
benefit low-income taxpayers.
Other tax benefits phase-out at middle- and upper-income
levels. For example, in 1998, married couples who participate
in employer-provided retirement plans are not eligible to
deduct IRA contributions once their AGI reaches $60,000.
Personal exemptions for single individuals begin to phase-out
once their AGI reaches $121,200 in 1997 ($181,800 for joint
filers). Certain itemized deductions begin to phase-out (up to
80 percent) once a single individual's or married couple's AGI
reaches $121,200 in 1997. There appears to be no direct
correlation between these benefits and the levels of income at
which they phase-out. The phase-out ranges make no economic
sense, and appear designed solely to reduce the benefits' costs
to the federal government or to act as revenue-raisers for
other provisions in the tax code.
In addition, the tax code contains several percentage
``floors'' which must be exceeded before certain deductions can
be claimed. For instance, qualified medical expenses are only
deductible to the extent they exceed 7.5 percent of a
taxpayer's AGI. Certain miscellaneous deductions, such as
unreimbursed employee expenses and investment fees, must exceed
2 percent of a taxpayer's AGI before they can be deducted.
These floors affect all taxpayers and should be reduced or
eliminated to allow taxpayers to claim legitimate deductions.
The Alternative Minimum Tax Must be Further Reformed
One of the most counter-productive taxes ever created is
the alternative minimum tax (AMT). Originally envisioned as a
method to ensure that all taxpayers pay a minimum amount of
taxes, the individual and corporate AMT penalizes businesses
that invest heavily in plant, machinery, equipment and other
assets. The AMT significantly increases the cost of capital and
discourages investment in productivity-enhancing assets by
negating many of the capital formation incentives provided
under the tax system, most notably accelerated depreciation.
The AMT cost-recovery system is among the worst of
industrialized nations, placing our businesses at a competitive
disadvantage internationally.
To make matters worse, many capital-intensive businesses
are perpetually trapped in AMT as they are unable to utilize
their suspended AMT credits. The AMT is essentially a
prepayment of tax which is substantially unrecoverable for most
businesses. In addition, those not subject to AMT must still
expend valuable time and resources in order to maintain several
depreciation schedules and calculate the AMT.
Significant reforms of the corporate AMT were enacted in
the Taxpayer Relief Act of 1997. ``Small'' corporations (those
with average gross receipts of less than $5 million in 1994,
1995 and 1996, $7.5 million in years thereafter) are no longer
subject to the AMT. In addition, for all other corporations,
depreciation recovery periods (e.g., 5-year property, 10-year
property) used for AMT purposes are conformed to those used for
regular tax purposes for property placed in service after 1998.
The legislation, however, did not eliminate the AMT
depreciation adjustment for recovery methods (e.g., accelerated
versus straight-line depreciation). Therefore, depreciation
will continue to be slower for AMT purposes than for regular
tax purposes. Furthermore, the repeal of the depreciation
adjustment for recovery periods only applies to assets placed
in service after 1998. Therefore, all existing assets of
corporate businesses will continue to be subject to this
depreciation adjustment.
Moreover, the recently-enacted tax law did not reform the
AMT for individuals. A ``small business'' exemption was not
created, the depreciation adjustment was not repealed or
modified, and the AMT tax rates of 26 percent and 28 percent
were not reduced. Furthermore, the AMT exemption amounts
($33,750 for single filers, $45,000 for married couples filing
joint returns) were not increased to keep up with inflation or
to take into account the new child and education tax credits.
As a result, many individuals will soon find themselves
subject to a tax they never even knew existed. Sole
proprietors, partners and S corporation owners will continue to
be exposed since their business income flows through to their
individual income tax returns. According to the Joint Committee
on Taxation, the number of individual taxpayers subject to AMT
is expected to increase from approximately 600,000 in 1997 to
8.4 million in 2007, while the AMT tax burden is expected to
grow from about $3.6 billion in 1997 to $18.4 billion in 2007.
The best way to provide individuals and corporations with
relief from the AMT would be to repeal it outright. If repeal
is not possible, the AMT should be substantially reformed in
order to reduce its harmful effects on businesses and
individuals. Such reforms include: providing a ``small
business'' exemption for individuals; eliminating the
depreciation adjustment for both individuals and corporations;
increasing the individual AMT exemption amounts; allowing
taxpayers to offset their current year AMT liabilities with
their accumulated minimum tax credits; and making the AMT
system less complicated and easier to comply with. We urge you
to enact these reforms as soon as possible.
Additional Business Tax Relief is Needed
The Taxpayer Relief Act of 1997 provided approximately $95
billion of net tax relief ($151 billion of gross tax relief) to
families and businesses over the next five years. Gross
business-related tax cuts, however, only accounted for about
$19 billion of the total. While we commend Congress for
enacting the legislation, we urge it to continue reducing the
overall federal tax burden on the business community. We agree
with you, Mr. Chairman, that federal taxes, as a percentage of
GDP, need to be reduced, and appreciate your leadership in this
area.
There are many other tax issues of great importance to our
members, and we look forward to working with you to further
them in Congress. These issues include:
Capital Gains Tax
While the new tax law reduces the maximum capital gains tax
rate for individuals from 28 percent to 20 percent (10 percent
for those in the 15 percent income tax bracket), it also
lengthened the holding period for long-term capital gains from
12 months to 18 months. This holding period should revert back
to 12 months, and rates should be further reduced, if possible.
In addition, capital gains tax relief is still needed for
corporations, whose capital gains continue to be taxed at
regular income tax rates.
Equipment Expensing
In 1998, businesses can generally expense up to $18,500 of
equipment purchased. This amount will gradually increase to
$25,000 by 2003. This expensing limit needs to be further
increased, and at a faster pace, in order to promote capital
investment, economic prosperity, and job growth.
Foreign Tax Rules
While the new tax law contains some foreign tax relief and
simplification measures, our foreign tax rules need to be
further simplified and reformed so American businesses can
better compete in today's global marketplace.
Individual Retirement Accounts (IRAs)
While the new tax law expands deductible IRAs and creates
nondeductible Roth IRAs, both types of IRAs need to be further
expanded (e.g., increase contribution limits, eliminate phase-
out ranges) in order to promote saving and personal
responsibility.
Independent Contractor / Employee Classification
The current worker classification rules are too subjective
and restrictive, and need to be simplified and clarified. We
support the creation of a more objective safe harbor for
independent contractors, while leaving the current 20-factor
test and Section 530 safe harbors in tact.
Internal Revenue Service Reforming and Restructuring
The overall management, oversight and culture at IRS needs
to be changed in order to make it a more efficient, accountable
and taxpayer-friendly organization. We support legislation
which the House overwhelmingly passed in November and look
forward to working with you towards its enactment.
Research and Experimentation (R&E) Tax Credit
While the new tax law extends this credit through June 30,
1998, it needs to be extended permanently, and further
expanded, so businesses can better rely on and utilize the
credit.
S Corporation Reform
While the Small Business Jobs Protection Act of 1996
contained many needed reforms for S corporations, such as
increasing the maximum number of shareholders from 35 to 75,
there are many other important reforms which still need to be
enacted, such as allowing preferred stock to be issued and
creating family attribution rules.
Self-Employed Health Insurance Deduction
This deduction is scheduled to increase from 40 percent in
1997 to 100 percent in 2007. We believe this timetable should
be accelerated to give self-employed individuals a full
deduction as soon as possible.
Work Opportunity Tax Credit
This credit, which encourages employers to hire individuals
from several targeted groups, needs to be permanently extended
beyond its June 30, 1998 sunset date.
Conclusion
Our long-term economic health depends upon sound economic
and tax policies. Our federal tax burden is too high and needs
to be significantly reduced. In addition, our tax system
encourages waste, retards savings, and punishes capital
formation--all to the detriment of long-term economic growth.
As we prepare for the economic challenges of the next century,
we must orient our current tax policies in a way that
encourages more savings, investment, productivity growth, and,
ultimately, economic growth.
Thank you for allowing me the opportunity to testify here
today.
Chairman Archer. Thank you, Dr. Regalia.
Our next witness is Mr. Michael Mares. We're happy to have
you here, and you may proceed.
Mr. Mares. Thank you, Mr. Chairman.
STATEMENT OF MICHAEL MARES, CHAIR, TAX EXECUTIVE COMMITTEE,
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
Mr. Mares. Good morning. Good morning, Members of the
Committee. I am Michael Mares, chair of the AICPA's Tax
Executive Committee. We appreciate the opportunity to testify
today on hidden tax rates and the individual alternative
minimum tax, or AMT.
Let me begin with the AMT, one of the most complex parts of
our tax law. The AMT is designed to ensure that taxpayers pay a
minimum amount of tax on their economic income.
In many cases absent the AMT, taxpayers taking advantage of
special deductions and exclusions would pay little or no tax.
However, since the AMT exemptions and brackets aren't indexed
for inflation, more and more taxpayers have been snared in the
AMT's web over the past few years.
In many cases, it is difficult or impossible to calculate
the AMT without a great deal of added effort and time.
Furthermore, the inclusion of adjustments and preferences from
passthrough entities compounds the problem.
Aggravating the situation is the AMT impact that the
Taxpayer Relief Act of 1997 will have on middle-income
taxpayers. For example, the child credit, the Hope credit, and
the lifetime learning credit will not be able to reduce AMT.
The result is that, as our examples in Appendix C show, a
married couple with less than $70,000 of income can pay an
alternative minimum tax or, worse, a single parent with only
$45,000 in income pays an $800 AMT. Can these problems be
reduced or eliminated?
We believe so and would offer the following separate
recommendations: first, index the AMT brackets and exemptions;
second, eliminate itemized deductions and personal exemptions
as adjustments for AMT; third, reduce the regular tax benefits
of AMT preferences for all taxpayers--for example, by
lengthening the depreciable lives for regular tax purposes, the
AMT adjustment could be eliminated--fourth, allow certain tax
credits against AMT, such as the child credit and the tuition
tax credits; fifth, provide an exemption for low- and middle-
income taxpayers from AMT if their adjusted gross income is
less than $100,000; and, finally, consider the impact of AMT in
all future tax legislation.
Of course, repealing AMT would solve the entire problem for
all individuals. We are also deeply concerned, as the Treasury
pointed out, that AMT will apply to more and more taxpayers
over the next few years, most of whom I could argue were never
intended to be covered or affected by AMT.
Since these taxpayers have little or no familiarity with
the rules, it is likely that the IRS will need to allocate more
resources to educate them and to answer their questions.
The AMT also poses a compliance challenge to the IRS since
many of the underlying adjustments or preferences appear
nowhere else on a taxpayer's return. This makes verification of
the calculation difficult.
Another area of complexity is the hidden tax rate, also
known as phaseouts of various benefits or credits over a wide
range of incomes based on a variety of definitions of income.
There is currently no consistency among phaseouts in either the
measure of the income, the range of income over which the
phaseouts occur, or the method of applying the phaseouts.
Even filing status doesn't consistently affect tax
phaseouts. For example, the individual retirement account
deduction phaseouts vary for single individuals versus married
couples filing a joint return. However, the phaseout range for
the $25,000 passive loss allowance for certain rental
activities is the same for both types of taxpayers.
Further compounding the complexity is the fact that many of
the phaseout ranges from married, filing separate taxpayers
versus joint filers are not consistent.
Simplicity can be achieved by eliminating the phaseouts
altogether and, if necessary, making the politically difficult
decision to raise tax rates to generate the needed revenue.
However, significant simplification can be achieved by
providing consistency in the measures of income, the range of
income over which the phaseouts apply, or the method of
applying the phaseouts.
We suggest that there be three phaseout ranges: low-,
middle-, and high-income taxpayers. Our written testimony in
Appendices A and B contains our proposed ranges.
We also suggest that the phaseout ranges for married,
filing separate taxpayers, single taxpayers, and head of
households be 50 percent of the phaseout range for joint
filers. This would eliminate the marriage penalty as well.
Finally, we recommend the deduction or benefit phaseouts
evenly over the phaseout range. Phaseouts which are merely
disguised tax rate increases create computational problems and
frustrations at all levels of income. If they are to be
retained, they should be standardized and applied consistently.
This Committee has the opportunity as a result of these
hearings to help the American taxpayer by eliminating or
substantially reducing two areas of extreme frustration and
complexity. The AICPA is willing to assist you in any way that
we can to help resolve these issues.
I will be happy to answer any of your questions. Thank you.
[The prepared statement and attachments follow:]
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Chairman Archer. Thank you, Mr. Mares.
Our final witness is no stranger to the Committee. His
leaving the Joint Committee was a great loss for the country,
but we're happy to have him back in a different role.
Ken Kies, you are now recognized. You need to identify
yourself in your new role for the record, and you may proceed.
Mr. Kies. Thank you, Mr. Chairman.
STATEMENT OF KENNETH J. KIES, MANAGING PARTNER, PRICE
WATERHOUSE LLP
Mr. Kies. Actually, I think I am here in my role of
cleaning up work that I did not finish when I left. So I'm here
in my individual capacity having recently departed my position
as Chief of Staff of the Joint Committee on Taxation.
My testimony centers on a study undertaken by the staff of
the Joint Committee on Taxation on individual taxpayers
concerning effective marginal tax-rate issues. The study was
released yesterday.
The study was requested by you, Mr. Chairman. You
specifically asked that the Joint Committee staff identify
situations where a taxpayer's effective marginal tax rate might
differ from his or her statutory rate and the magnitude and
impact of these differences.
At the outset, let me explain what we mean by an
individual's effective marginal rate. This concept differs from
the Tax Code's five statutory marginal rates of 15 percent, 28
percent, 31 percent, 36 percent, and 39.6 percent, which apply
to a taxpayer's taxable income within a specified range.
The effective marginal rate seeks to measure the increase
or decrease in an individual's tax liability that results from
an additional dollar of income. An effective marginal rate of
40 percent would mean that a dollar of additional income would
produce 40 cents of tax.
In many cases, an individual's effective marginal rate will
be higher than the so-called advertised statutory rate. This is
because of various phaseouts, phase-ins, floors, and other
provisions that limit the availability of deductions, credits,
or exclusions based on an individual's taxable income. An
example will help to illustrate.
Take the case of the tax provisions requiring Social
Security benefits to be included in taxable income as income
rises above certain levels. For married taxpayers whose
modified adjusted gross income exceeds $44,000, up to 85
percent of Social Security benefits are taxable. When this
couple reaches the $44,000 threshold, each additional dollar of
income will cause an additional 85 cents of Social Security
benefits to be included in taxable income.
This effectively raises the Federal marginal tax rate to
185 percent of the statutory rate because each dollar of
additional income causes income to rise by a dollar while
taxable income rises by $1.85.
The Joint Committee study examines numerous provisions in
the Tax Code that produce similar results. These include:
phaseouts, phase-ins, and floors applicable to itemized
deductions, personal exemptions, IRA contributions, and the
child credits and educational tax credits added by the 1997 act
among other provisions.
All told, the Joint Committee study found that 33.2 million
taxpayers, or one-quarter of all individual taxpayer returns,
face effective marginal rates that are different from the
statutory tax rates. Actually, taking into account the number
of joint returns involved, approximately 50 million adult
taxpayers are affected.
The Joint Committee study also found that these differences
are felt by taxpayers at all income levels. These differences
have a real impact on individuals, as the Joint Committee study
suggests.
A chief concern is that high marginal effective rates can
provide significant disincentives to work and save. For
example, a retiree considering whether to take a part-time job
may conclude that the payoff as subject to an effective tax
rate that greatly exceeds the statutory rate is insufficient to
offset the loss of leisure time and effort expended.
Particularly harsh results can arise when a taxpayer is
subject to more than one of the phaseouts at the same time. It
is possible for the interactions of the phaseouts to create
marginal tax rates that could be considered excessive.
In one hypothetical example discussed in the Joint
Committee study, a retiree with two children in college could
face an effective marginal rate as high as 90 percent.
Actually, as the footnote to the study indicates, when State
taxes are taken into account, that taxpayer's effective
marginal rate exceeds 100 percent. That particular taxpayer, by
the way, was a taxpayer in the 15 percent marginal rate
bracket.
The Code's floors and phaseouts also raise equity issues.
On the one hand, these provisions in many cases operate to
increase the progressivity of the Tax Code by increasing
average tax rates as income rises.
On the other hand, almost all the provisions reviewed in
the pamphlet of the Joint Committee create what economists
refer to as horizontal inequities. Two different taxpayers may
have the same income. One can be subject to a phaseout while
the other is not, resulting in significantly different
effective marginal rates for these otherwise similarly situated
taxpayers.
Another cause for concern is complexity. Many of the
phaseouts and floors require additional computations,
increasing compliance burdens, and enhancing the likelihood of
error. These provisions also may make the Code less
transparent, leading to taxpayer confusion regarding the nature
of the income tax. The end result may be greater taxpayer
disillusionment, a sense of unfairness, and reduced compliance.
I commend the Joint Committee study for your review as you
continue efforts to refine the tax system and provide tax
relief. The report lends support to the view that hidden tax
rates and their impact should be among the primary factors
weighed by policymakers in evaluating future changes to the
Code.
I thank you for the time, and I would be happy to take any
questions, Mr. Chairman.
[The prepared statement follows:]
Statement of Kenneth J. Kies, Managing Partner, Price Waterhouse LLP
Good morning, and thank you for inviting me to testify at
this important hearing. I am appearing today in my individual
capacity, having recently departed my position as chief of
staff of the Joint Committee on Taxation.
My testimony centers on a study undertaken by the staff of
the Joint Committee on Taxation on individual effective
marginal rate issues, which was released yesterday. The study
was requested last November by Chairman Archer. He specifically
asked that the Joint Committee staff identify situations where
the taxpayer's effective marginal tax rate might differ from
his or her statutory tax rate, and the magnitude and impact of
those differences.
At the outset, let me explain what we mean by an
individual's ``effective marginal tax rate.'' This concept
differs from the Tax Code's five statutory marginal rates of 15
percent, 28 percent, 31 percent, 36 percent, and 39.6 percent,
which apply to a taxpayer's taxable income within a specified
range. The effective marginal rate seeks to measure the
increase (or decrease) in an individual's tax liability that
results from an additional dollar of income. In many cases, an
individual's effective marginal rate will be higher than the
advertised statutory rates. This is because of various phase-
outs, phase-ins, ``floors,'' and other provisions that limit
availability of deductions, credits, or exclusions based on an
individual's taxable income.
An example will help to illustrate. Take the case of the
tax-law provisions requiring Social Security benefits to be
included in taxable income as income rises above certain
levels. For married taxpayers whose modified AGI exceeds
$44,000, up to 85 percent of Social Security benefits are
taxable. When this couple reaches the $44,000 threshold, each
additional dollar of income will cause an additional 85 cents
of Social Security benefits to be included in taxable income.
This effectively raises the federal marginal tax rate to 185
percent of the statutory rate, as each dollar of additional
income causes taxable income to rise $1.85.
The JCT study examines numerous provisions in the Tax Code
that produce similar results. These include phase-outs, phase-
ins, and floors applicable to itemized deductions, personal
exemptions, IRA contributions, and the child tax credits and
education tax credits added by the 1997 Act, among other
provisions. All told, the JCT study found that 33.2 million
taxpayers--or one quarter of all individual taxpayer returns--
face effective marginal rates that are different from their
statutory tax rates. (Actually, taking into account the number
of joint taxpayer returns involved, approximately 50 million
adult taxpayers are affected.) The JCT study also found that
these differences are felt by taxpayers at all income levels.
These differences have a real impact on individuals, as the
JCT study discusses. A chief concern is that high marginal
effective tax rates can provide significant disincentives to
work and save. For example, a retiree considering whether to
take a part-time job may conclude that the payoff--if subject
to an effective tax rate that greatly exceeds the statutory
rate--is insufficient to offset the loss of leisure time and
the effort expended.
Particularly harsh results can arise when a taxpayer is
subject to more than one of the phase-outs at the same time. It
is possible for the interactions of the phase-outs to create
marginal tax rates that could be considered excessive. In one
hypothetical example discussed in the JCT study, a retiree with
two children in college could face an effective marginal tax
rate as high as 90 percent.
The Code's floors and phase-outs also raise equity issues.
On one hand, these provisions in many cases operate to increase
the progressivity of the Tax Code by increasing average tax
rates as income rises. On the other hand, almost all of the
provisions reviewed in the JCT pamphlet create what economists
refer to as ``horizontal'' inequities. Two different taxpayers
may have the same income and one can be subject to a phase-out
while the other is not, resulting in significantly different
effective marginal rates for these otherwise similarly situated
taxpayers.
Another cause for concern is tax complexity. Many of the
phase-outs and floors require additional computations,
increasing taxpayer burden and enhancing the likelihood of
error. These provisions also may make the Code less
``transparent,'' leading to taxpayer confusion regarding the
nature of the income tax. The end result may be greater
taxpayer disillusionment, a sense of unfairness, and reduced
compliance.
The issue of effective marginal tax rates becomes even more
complex--and can produce even greater distortions and
inequities--when one also takes into account the alternative
minimum tax, payroll taxes, and State income taxes.
I commend the JCT study for your review as you continue
efforts to refine the tax system and provide tax relief. The
report lends support to the view that ``hidden'' tax rates, and
their impact, should be among the primary factors weighed by
policymakers in evaluating future changes to the Tax Code.
Thank you for your time. I would be glad to answer any
questions you might have.
Chairman Archer. My compliments to all four of you. I think
you have all given us superb testimony to focus on a part of
the Tax Code that we have not looked at enough in the past.
Allow me to comment on a few points. Dr. Foster, you said
that over the last 17 years, we have reduced the rates. I guess
you excuse 1990 and 1993.
Mr. Foster. Well, we've reduced the rates compared to where
they were 17 years ago, sir.
Chairman Archer. Right. We did for a while, but then we
went back up the ramp again. I wanted to make that very clear.
Mr. Mares, do you have any estimates of the revenue impact
of the phaseout recommendation?
Mr. Mares. No, sir, we do not.
Chairman Archer. That's going to be very, very important
within the constraints that we're going to have as to what we
can do in the way of tax reduction.
Mr. Mares. Mr. Chairman, I think, though, it's important to
note that we believe by establishing standard phaseout
ranges for low-, middle-, and high-income taxpayers and
adjusting those ranges to meet the revenue needs, that
simplicity can be achieved to a large degree without a
significant revenue detriment.
Chairman Archer. Well, that's good to hear because the
Committee should look at that type of simplification provided
that we do not embrace an awful lot of revenue losses.
Then you get into the politics of it. If you are trimming
down the revenue losses, you very possibly are taking away
something from a particular group.
Mr. Mares. Yes, sir.
Chairman Archer. It sounds a lot easier as you present it
than it may be for the Committee to enact.
I think you had a very complex recommendation as to what we
ought to do on AMT. In the end, you said: Well, maybe it's
better to abolish it. I am not sure that we gain, over the long
term, an awful lot by simply chipping around the edges in
implementing the kind, although meritorious, of suggestions
that you made.
I am wondering what all of you would think about
eliminating the AMT and, in the process, carefully looking at
those items that get thrown back into the formula for the AMT
to determine whether they are legitimate in a bipartisan way as
tax policy and then if they are legitimate, to let them
continue to be used by all taxpayers and not come back in and
thrown in this alternative minimum tax. It might very well mean
that we'd have to shave back some of those deductions or apply
them a little differently but, in doing so, be able to
eliminate the alternative minimum tax.
Do you want to comment on that?
Mr. Mares. I will start, Mr. Chairman. I think when you
look at the adjustments and preferences that create the
alternative minimum tax, you can break them into two broad
categories: what I will call the business deductions; that is,
the difference in depreciation, the difference between
percentage of completion versus completed contract and
construction contracts; and what I will call the individual
preferences, the elimination of the personal exemption, the
State income taxes, which were mentioned here frequently, and
so forth.
One of the things I think it's important to point out is
that for individuals, many, many of those individuals driven
into the AMT find themselves being in AMT because of those
individual preferences. And if you were to eliminate those
individual preferences and allow the same deductions for AMT,
such as interest, taxes, medical expenses, miscellaneous
itemized deductions, and so forth, I believe you would solve a
tremendous amount of the individual AMT problems.
Now, as to modifying the various preferences or adjustments
that make up the business aspects of AMT, that certainly----
Chairman Archer. I was speaking more of the individual
side.
Mr. Mares. Well, these are. These business preferences
directly impact individuals. I have a number of individuals who
operate through partnerships, S corporations that are directly
affected by these.
By reducing the regular tax benefits of these various
preferences--again, depreciation is a good example--you could
eliminate the need in those specific areas for an AMT to
address the preferences that Congress believes should be
addressed.
Chairman Archer. Well, the Committee should look at that.
We have a responsibility to continuously look at the Code from
a policy standpoint and determine what is an appropriate
deduction and what is not. I really have always felt that our
responsibility should be devoted to that, rather than this
arbitrary alternative minimum tax, where we tell people: Well,
it's all right for you to tax this.
I sit next to my friend Charlie Rangel from New York. In
1986, there was a proposal to eliminate the deductibility of
State income taxes. That was the proposal put before this
Committee on tax reform.
The New Yorkers came in and strongly said: ``Well, wait a
minute. We can't support tax reform if you don't give us
deductibility of State income taxes.'' That's a major item of
expense for their people. They succeeded in placing the
deductibility of State income taxes into the tax reform bill.
Now you're telling me State taxes are one of the major
things that cause you to pay more Federal taxes. So, on the one
hand, the New Yorkers thought they were doing something to give
an appropriate--and they articulated it very well--deduction
for income tax purposes. Now we find that it's a major factor
in snapping back with a tax on those very same people through
the alternative minimum tax. So they did not succeed.
Now, that seems rather inconsistent to me. I hope the
Committee will take a long look at how we can work to have a
better Tax Code and get completely rid of this extra
formulation, which is so arbitrary under the minimum tax. So I
thank you for your input on that.
Now, Dr. Regalia said that we have a 39.6 top marginal tax
rate. After you listen to Mr. Kies, that is not so. I think on
behalf of full disclosure and truth in legislating, we should
put into every new proposal a requirement that it state the
true effective tax rate. We do it on many other things. Of
course, the purpose of these hearings is to dig into what
really are the effective tax rates.
One thing none of you mentioned which also gets into play
on this is that if you have one spouse that is earning
significant income and the other spouse is not gainfully
employed and the other spouse decides, ``Well, gee, I want to
go out and dabble and start my own little business,'' or
whatever else, ``I want to have my place in the sun,'' the
first dollar of their income comes in at the highest marginal
rate of the other spouse. For no extra benefits, they also
begin to pay the 15.3 percent payroll tax.
Now, paying that tax when you earn a benefit is one thing,
but the other spouse will not receive an added benefit. He or
she will receive the benefits through the other spouse's
activities.
So the marginal rate is in an approximate 60 percent range
for the activities of the second spouse. Now, is that a
deterrent against somebody trying to gainfully produce
something?
Of course, in most instances, the extra spouse would be a
woman, not always, but in most instances. Is this not denying
women, married women, a real equal opportunity to earn
something in their own right? Am I missing something or do
you----
Mr. Kies. One of the things that the study of the Joint
Committee on Taxation did in terms of looking at the marginal
tax rates, at least indirectly, was to focus on the impact on
incremental work effort, whether by the primary income earner
or a secondary income earner.
Certainly in the case of the second spouse, the
disincentive to be economically productive, to go out into the
work force is quite substantial because of the high marginal
tax rate that may immediately impact the second earner.
Chairman Archer. Particularly if they're self-employed when
they go into the workplace.
I again want to just add to this idea that the top marginal
rate is 39.6 percent. I wonder if Michael Jordan believes that
because his Medicare premium is $1 million a year. No matter
how much he earns, he is going to continue to have to pay an
additional 2.9 percent. And that's certainly in income tax.
He's not getting an additional benefit for doing that.
I thank you very much. I now yield to Mr. Rangel for any
inquiry he might like to make.
Mr. Rangel. I have no questions, Mr. Chairman.
Chairman Archer. Any other Member of the Committee wish to
be recognized?
Mr. McCrery.
Mr. McCrery. Thank, Mr. Chairman.
I don't have any questions, but in looking over the Joint
Committee's report, I just want to highlight for the
Committee's attention some of the numbers that were brought out
by the report. They were alluded to but not mentioned
specifically.
For the AMT, Mr. Chairman, in 1998, it's expected that
856,000 citizens will file returns that will be affected by the
AMT. Ten years from now, though, only 10 years from now, that
number will be 8.8 million Americans, from 856,000 to 8.8
million in only 10 years. That's an appalling figure to me.
We're talking about in other forums right now changing the
Tax Code. The reason that I'm interested in changing the Tax
Code is because of the huge compliance costs of the current tax
system and the drag on our economic production that it creates.
Imagine--and you mentioned, Mr. Chairman, the reformulation
that we have to go through on our tax returns to figure the
AMT. Imagine that if we expand it by--I don't know. I can't
even figure the math it's so high, 10 times perhaps over the
next 10 years. I mean, that's just a mind-boggling calculation.
The compliance costs are going to get so much worse in this
country. It's something that we really need to pay attention
to. And I'm glad that the Chairman asked these witnesses to
highlight the AMT in their testimony. I think it's a part of
the Tax Code that just begs for attention. And we ought to do
away with it, but, short of that, we certainly ought to raise
the exemptions or tie the exemptions to inflation so we don't
catch all of these millions of Americans that aren't affected
now.
Chairman Archer. Mr. Kies, would you like to comment?
Mr. Kies. Mr. McCrery, can I just add one other thing to
that? To underscore the concern you have raised, it should be
noted that the growth that's going to occur in the number of
taxpayers subject to the AMT will occur in what I think has
traditionally been thought of as relatively middle-income
classes of taxpayers.
In 1998, the $50,000 to $75,000 expanded income class--so
that's not taxable income. That's beyond gross income in many
cases. The number of taxpayers will go from 68,000 returns or
0.3 percent of all returns subject to the individual AMT, in
1998 to 1.3 million returns, or 5.8 percent of all returns in
2007 subject to the individual AMT. In the $75,000 to $100,000
income class, it will grow from 1 percent of all returns
subject to the individual AMT in 1998 to 19.7 percent of all
returns in 2007. So it's a 20-fold increase in the number of
taxpayers in those income classes, which has not traditionally
been thought of as taxpayers that would be the targets of the
AMT.
Mr. McCrery. Absolutely. That clearly demonstrates that
this thing is out of control. It's affecting people that were
never intended to be affected by the AMT, Mr. Chairman. And I'm
hopeful that you'll continue in your effort to----
Mr. Levin. Would the gentleman yield?
Mr. McCrery. I'd be glad to yield.
Mr. Levin. Just, Mr. Kies, maybe you know the answer
because I think that the figures are striking. What's the cost
of remedying?
Mr. Kies. Well, Mr. Levin, one approach to solving this
problem that we've talked about a lot is just indexing the
exemption amount because that would substantially restrain this
migration of taxpayers from the regular tax to the AMT. The
cost we estimated a year ago, or the Joint Committee estimated
a year ago, over 10 years was $33 billion.
The key to this, Mr. Levin, is the longer you wait to try
and correct the problem, the more expensive it will be because
it's in the out years that there's this very dramatic up turn
of the number of taxpayers.
Mr. Levin. So it goes up every year, but it's $33 billion
over time?
Mr. Kies. Yes, it goes up every year, but in the out years,
it's going up much faster.
Mr. Levin. Right, right, right.
Mr. Kies. So each year you wait, those out years get more
expensive.
Mr. Levin. Thanks for yielding, Mr. McCrery.
Mr. McCrery. You bet.
Thank you, Mr. Chairman.
Chairman Archer. None of you mentioned specifically, but
last year on a bipartisan basis, the Congress and the President
gave a significant child credit in the Tax Code to help
families meet the expenses of rearing their children, $500 per
child, which they are free to spend and invest in their
children's education or anything else that they wish.
It was agreed after considerable deliberation that for a
joint return, it would be given in full up to $110,000 of
adjusted gross income a year. It would then begin to phase out,
depending on the number of children, for AGI up to roughly
$150,000. The credit would be given in full to families who had
taxable income of under $110,000 of adjusted gross income on a
joint return.
Now, what is the reality of the impact of the alternative
minimum tax on the ability of those families to be able to get
what the Congress promised them?
Mr. Kies. Mr. Chairman, because the child credit cannot be
used against the AMT, there are millions of taxpayers who will
either not get the credit or will get less than the full credit
who are below that phaseout range at the top. This will occur
because of the fact that either they will be pushed into the
AMT or they won't be pushed into the AMT but because their
regular tax liability can't drop below what they would pay
under the AMT, the credit is useless to them because it cannot
be used against their regular tax either. So each year it will
become a larger number, but it's in the millions of taxpayers
that will be affected.
The Joint Committee pamphlet does lay out some of the
statistics on that, but I think as many as 15 million taxpayers
will receive either a zero child credit or less than the full
child credit, much of which is because of the AMT effect. By
the time we get to 2008, There will be 21.7 million taxpayers
affected by this. So that's going to grow over time as well.
Chairman Archer. Thank you.
Mr. Portman.
Mr. Portman. Thank you, Mr. Chairman.
I want to start by congratulating the Ways and Means
Committee for having these hearings and for taking seriously
the prospect of moving forward with what I consider to be real
simplification of our current Tax Code that makes sense but
makes it more honest.
Mr. Chairman, given your propensity to want to pull the Tax
Code out by the roots, I want to commend you particularly for,
despite your strong views on that, looking seriously at this
and kind of peeling back the layers of the onion to try to
figure out what the real problems are in our current Tax Code.
Mr. Mares, as you know, we looked into these hidden taxes a
lot in the context of the IRS Commission, really from the
perspective of the IRS, and also, of course, from the
perspective of the taxpayer. But it's a nightmare for the IRS
to administer the phaseouts.
The AMT is the same way. And, as Ken has pointed out
consistently over the last year or so, as the AMT, as Mr.
McCrery says, begins to affect more and more middle-income
taxpayers, that complexity will only be increased, not just for
the taxpayer but for the IRS. And it's a tremendous challenge.
We've got a good report here from Joint Tax that I think
gives us a lot of the intellectual framework to be able to move
forward with this. And, again, I want to really thank the
Chairman for bringing this up to the surface.
The President has given us about 100 to 150 billion
dollars' worth of new spending. So we're in an interesting
position, really, for the first time since I've been here, in 5
years, maybe the first time in a couple of decades, where we
actually have the ability to talk about some of these tax law
changes because so many of them are so costly.
Ken pointed out that it will cost $30 billion over 10 years
just to index the exemption for personal AMT, not even getting
to repeal it or adjust the corporate side. So I hope we'll take
advantage of that, the little bit of a buffer we have now, and
maybe talk a little less about spending and a little more about
how to get people real relief.
My question is: How do we get at this? Does it make sense
assuming that we can't use that $100-$150 billion in total or
that it's not enough, which is I think a pretty good
assumption? Does it make sense, instead of having phaseout, Mr.
Mares, from your point of view to do something else in terms of
gaining back some of that revenue such as adjusting rates or is
that too controversial to get into?
Mr. Mares. I think clearly that's the Congress' decision as
to how to spend the budget surplus, whether it's through tax
deductions, debt reduction, or additional spending----
Mr. Portman. Let's assume for argument's sake--I mean, I
agree with that, I hope we can use some of that so-called
surplus we don't have yet but at least use some of that new
spending the President has in his budget and put it into tax
relief through simplification along the lines of what you're
talking about.
Let's assume, though, that we don't have all of that to
use, that we need to come up with new revenue in order, let's
say, to take care of either the personal AMT or to do something
with these phaseouts; in other words, to make the Tax Code more
honest so people are actually paying the rate they're supposed
to pay. Would you recommend, if necessary, raising marginal
rates in order to take out the hidden taxes?
Mr. Mares. That is the most direct and honest way to tell
the taxpayers what they will be paying. And if that were the
price of eliminating the complexity within the phaseouts, where
the taxpayers are already paying the rates----
Mr. Portman. Some taxpayers are.
Mr. Mares. Pardon me?
Mr. Portman. Some are, and some aren't.
Mr. Mares. A great number of taxpayers are. With the
alternative minimum tax affecting, even as Mr. Kies pointed
out, middle-income taxpayers, there are already hidden rates
built in there.
By eliminating those phaseouts and putting the rates where
they need to be to generate the revenue, I think you're telling
the American public: Here's what we need to operate the
government. Here's the rate that we feel is appropriate in a
straightforward manner and at the same time simplifying the tax
preparation jobs of millions of taxpayers.
Mr. Portman. Mr. Kies, you're no longer in public service.
You can now speak honestly. Do you have a comment on that?
Mr. Kies. I thought I always did speak honestly.
Mr. Portman. On that specific idea.
Mr. Kies. Yes, on this one. Raising the marginal rates to
eliminate the phaseouts.
Mr. Portman. And AMT.
Mr. Kies. I think you should----
Mr. Portman. Be honest about it.
Mr. Kies. [continuing]. I recommend you proceed very
cautiously with that solution.
Mr. Portman. Politically I know that's difficult.
Mr. Kies. No. But the problem is if you do what is
proposed, it could invite bringing back the phaseouts later on.
And all you would do is just get higher effective marginal
rates in the long run. I think you really need to just
basically consider whether these phaseout provisions really
make sense and whether they're necessary and appropriate given
what they do in terms of creating high hidden marginal tax
rates.
And the AMT question is to some extent--it's part of the
problem, but it's to some extent a separate problem because
it's really a question of: Who do you want the AMT targeted at?
Clearly when you have a nonindexed exemption amount, you
are going to over time sweep in a whole bunch of people that
really have no business being in the AMT at all, no matter what
their marginal tax rate is. I see them as, while related,
somewhat separate issues.
Mr. Portman. So if your choice was to slightly raise the
marginal rate and eliminate the AMT or keep the AMT and index
for inflation, you would take the index?
Mr. Kies. I think I would take the index.
Mr. Portman. Thank you, Mr. Chairman.
Chairman Archer. Mr. English.
Mr. English. Thank you, Mr. Chairman.
Mr. Regalia, in your testimony, you talked about the need
to make further changes in the AMT. You also referenced the
work opportunity tax credit. I wonder how you or your
association would feel about placing the work opportunity tax
credit and/or the welfare-to-work tax credit in a position
where it would be available for use by AMT companies if we come
up short of actually abolishing the AMT.
Mr. Regalia. Well, at the risk of more complexity, I think
that certainly the more exemptions you bring into the AMT to
lower the effective rate of that tax by making the type of
credits that you talk about available to those companies would
be of benefit.
I think that as an economist, I would have to look at that
solution kind of as the second order of smalls. I mean, it
really is a very modest approach to addressing a problem that I
think requires a more substantial fix.
Mr. English. Well, and, as I point out to my wife,
sometimes modest is affordable, too. I mean, that's another
angle on it.
And on the point of harmonizing the phaseouts, Mr. Mares,
can you summarize for us what effect the phaseouts have on the
marriage penalty currently in the Code?
Mr. Mares. We think it has a relatively significant impact
because not all of the phaseouts for married filing separate
are 50 percent of the married filing joint. Likewise, the
phaseouts in many cases--and, again, because there's no
consistency, it's difficult to sit here and say this phaseout
is consistent, this one isn't.
The phaseouts for single and heads of household are often
but not always about 75 percent of the phaseout for married
filing joint returns. So by standardizing the phaseouts, by
making single phaseouts, head of household phaseouts, and
married, filing separate phaseouts, 50 percent of married
filing joint phaseouts, you would help reduce the marriage
penalty and provide consistency.
Mr. English. Dr. Foster, in your testimony, you said
something that I think in Washington is considered radical,
although I think it makes a lot of sense to me, and that is
that savings rates are to some extent sensitive to tax rates.
What is the body of scholarly economic opinion on that? And
are there economic studies that you can offer to this Committee
to support the notion that when you change the incentives in
the Tax Code, you can dramatically increase the savings rate?
Mr. Foster. Yes, sir. The body of scholarly knowledge is
all over the map. You find a pretty uniform distribution from
those who think there's almost no effect to those who think
it's absolute and complete.
There are a lot of studies that will show that savings do
respond to changes in effective tax rates on saving. There are
a lot of studies to show that labor will respond dramatically
to changes in effective tax rates. And then there are a lot of
studies that show just the opposite.
It's amazing to me that much of economics is based on the
assessment and analysis of the price mechanism and how people
will react and then so many economists go out of their way to
find studies to show just the opposite.
Mr. English. Dr. Foster, let me just say that since I
support your view on this, I'd welcome any studies that you
could throw our way that would support the position that I
intuitively support. And I appreciate your testimony.
Mr. Kies, I was wondering: Do you have any recent revenue
estimates on the exemption in the current law for State and
local taxes since the Chairman brought that up?
Mr. Kies. I believe, Mr. English, in the tax expenditure
pamphlet published by the Joint Committee on taxation there is
some information about the impact of the State and local tax
deduction, which was published, I believe, this past December.
So there is some current information on that. And certainly the
Joint Committee could you provide you with any updated
information as well.
Mr. English. Thank you.
And I want to compliment you in your testimony on your
explanation of marginal tax rates. Do you feel that marginal
tax rates have a significant impact on work effort?
Mr. Kies. Mr. English, my own personal view is that they
clearly do. As Mr. Foster pointed out, there are people that
fight over this issue. Some believe that the higher the
marginal tax rate goes, that some people will work harder to be
able to hold themselves economically where they were before the
rate was raised.
However, clearly at some point, people will prefer leisure
time over further work if the return from work is so small. The
one example that's illustrated in the Joint Committee study,
where an ostensibly 15 percent marginal rate taxpayer could
actually be subject to an effective marginal tax rate in the
excess of 100 percent is a pretty graphic example of where it's
extremely unlikely that such a person is going to try to work
harder because you can't catch up if you're subject to a tax
rate of over 100 percent.
Mr. English. Thank you, Mr. Kies. That's a powerful
insight. And I appreciate this panel and the perspective you
have brought.
Thank you, Mr. Chairman.
Chairman Archer. Mr. Weller.
Mr. Weller. Thank you, Mr. Chairman. Again I want to
commend you for this series of hearings, which is looking at
ways of not only simplifying the Code but also to find ways to
allow working, middle-class families to keep more of what they
earn. I think these hearings continue to work in that
direction.
I'd like to direct my questions to Dr. Foster. I was
looking with interest at your testimony. And you were somewhat
critical of some who have been involved in the effort to
eliminate the marriage tax penalty. I noticed in your testimony
that you are essentially arguing that we should be looking to
eliminate the bonus or so-called bonuses, which would be a tax
increase for those couples.
I find when I talk in the district that I represent and I'm
out listening to the folks in the portion of Chicago that I
represent or the south suburbs of Chicago, that sometimes their
ability to grasp the concept makes it difficult for us to
explain it.
The marriage penalty is an issue they relate to. And they
understand a large number of married couples pay, 21 million
couples, on average about $1,400.
When it comes to a discussion of rates and changing the
rates, they have a harder time understanding how it will affect
their pocketbooks because their first concern is: If we adjust
the rates, how will that affect my family? What will we see as
a net or a negative impact?
I've used as kind of an example in the district that I
represent a machinist at Caterpillar and a schoolteacher with a
combined income of about $61,000 who on average pay a $1,400
marriage tax penalty when they file jointly.
I was wondering if you could tell me what type of rate
reduction would be necessary to eliminate that $1,400 marriage
tax penalty for that machinist and schoolteacher in my district
who make about $61,000.
Mr. Foster. I'm quite sure it's a significant rate
reduction. The marriage tax penalty is without a doubt a
terrible thing to have in the Tax Code. And it's a product of a
number of factors.
My point with the marriage tax penalty is only that by
focusing on it to such an extent, we're ignoring vast legions
of taxpayers. Tax relief I believe ought to be general and not
specific to specific groups. The marriage tax penalty when you
focus on it and fix it, you're focusing an awful lot of tax
relief on a fairly narrow group of people.
So that's the reason I brought the marriage tax penalty up
in that discussion, not that we shouldn't address it. We
should. But you can address it in a lot of ways.
You may not fix it entirely. In fact, I'll be surprised at
the end of the day when legislation finally passes if we've
fixed the marriage tax penalty to the point where that entire
$1,400 penalty is gone. There will probably be a modest fix to
it. I'd rather get the modest fix through a rate reduction than
through something that will further complicate the Tax Code.
Further, I would be surprised if in general taxpayers have
any more difficulty understanding a rate reduction than any
other tax reduction you can imagine. The marriage tax penalty
is somewhat difficult to calculate for the taxpayers involved.
If I tell them ``I'm going to reduce your tax rate, statutory
tax rate, from 15 to 14 percent'' or ``28 to 27'' or perhaps
even ``eliminate these phaseouts,'' it's hard to imagine
anything that would be easier to understand.
Mr. Weller. The question that I get is: What does a change
in 1 percent mean for me? I mean, that's the type of question
I'll get in a response, whether I'm at a union hall or the VFW,
a chamber of commerce, a business and professional women's
club, the type of response.
I was just wondering: To eliminate that average marriage
tax penalty of $1,400, can you give me a projected rate
reduction that would be necessary to achieve that?
Mr. Foster. No, I can't. I think Ken probably can.
Mr. Weller. Mr. Kies, could you?
Mr. Kies. If the family's gross income is approximately
$60,000, and assume their taxable income, just to take a rough
number, might be around $40,000. That family is probably in the
28 percent marginal rate bracket. Thus, a 1-percent reduction
from 28 to 27 would save them approximately $400 of income tax.
So you'd have to take them down about 4 percentage points to
eliminate at $1,600 marriage penalty, roughly speaking.
Mr. Weller. Thank you very much. That's the answer I was
looking for. Thank you
Chairman Archer. Mr. Nussle.
Mr. Nussle. Thank you, Mr. Chairman.
My questions go more toward what I have been learning in
the town meetings I have been holding over the last 3 months in
my district. I was pretty proud of the work that we had done as
a Committee last year on some tax relief.
When I went home and actually discovered what the
negotiations and compromises and deals and agreements with the
White House ended up in meaning as far as complications in the
Tax Code, I discovered that maybe we could have or should have
left well enough alone with all of the complaints that I
received. I don't agree with that. I am very proud of the work
that we did.
But my point is this: There's a big difference between
targeted tax breaks and tinkering. I guess that's what I'm
concerned about. Targeted and tinkering is what I think we run
the risk of doing.
I know that part of the reason why we're having these
hearings is because we're in the context of a possible budget
surplus and we're looking for ways to deal with that surplus.
I'm just wondering from all of you if it's worth the effort
to go through this again in a very small, targeted, tinkering
sort of way, as opposed to putting all of our efforts into what
Mr. Foster described as certainly the ideal world of tax reform
and total simplification.
I would much rather see in this endeavor--in a year when
we're not sure what the surplus is going to be, when unintended
consequences and complications continue to be the hallmark of
any reforms that we seem to go through, is it better to just
leave well enough alone, store away the surplus as a squirrel
would store away the nuts during winter, and wait for a better
playingfield to play on, and work more toward tax reform and
simplification, as opposed to tinkering? That's kind of my
overall question.
And I guess, Mr. Kies, since we don't get to pick on you
anymore behind closed doors, we'll pick on you first in front.
I just want to congratulate you on your service and wish you
the best of luck in your new endeavors. And I'll give you the
hot potato first.
Mr. Kies. Thank you, Mr. Nussle.
I think the answer to your question is that there isn't
only one squirrel. And one squirrel may put the nuts away, but
there's a bunch of other squirrels that are going to come after
him. So you'd better be prepared to figure out what you want to
do with the nuts.
I guess my recommendation to the extent you're going to
focus on tax relief is you try to focus on things that either
address problems like this alarming individual AMT problem,
which will be a simplification move because to the extent you
can reduce the number of taxpayers that are going to be pushed
onto the AMT, that's an improvement.
And the other recommendation is that you then try and to
the extent that you're designing tax relief to keep
simplification in mind. For example, on the marriage penalty,
one element of the marriage penalty is the fact that the
standard deduction for a married person is less than twice that
of a single person. You could increase the standard deduction
for a married person to equal twice the single person standard
deduction and add no complexity whatsoever to the Code because
it would simply increase their standard deduction, no new
complexity.
Another obvious example of where you could deliver broad-
based tax relief without adding complexity is to widen the 15
percent marginal rate bracket, which would be an across-the-
board benefit to all taxpayers generally speaking, but it
wouldn't add any new complexity.
I would recommend you consider those types of approaches,
as compared to the kind of more targeted things that have
phaseouts associated with them, that have complex new sets of
rules that the IRS will be required to administer, that
taxpayers will have to deal with and that tax return preparers
need to learn and apply. I think it really is time to step back
and not direct tax relief in that manner because I think people
need to be able to digest what happened in the 1997 Act.
Mr. Nussle. My only point--you know, I agree with you.
There are certainly more squirrels that have different ideas of
what to do with the surplus.
My only concern is that we've got the House. We've got the
Senate. We have the White House. We've got all sorts of
interest groups and people that have special concerns about the
Code. And by the time we get done with a very simple idea,
which could take a page for you to write this, we're off into
some--and it's amazing to me how many people came up to me in
my town meetings and just said: Look, folks, thank you for the
very nice little tax relief you gave us. Certainly it will add
a lot more paperwork and complication. Please this time, please
don't simplify it any more than you already have. Keep it.
Store it. Put it toward the debt. Don't spend it. And let's not
worry about tax relief. Focus on tax reform.
I was amazed how many people that would automatically, you
would think, in a very knee-jerk sort of way move toward tax
relief. I was very surprised at their comments.
So I appreciate your testimony today. And I think you're
right. If we can't keep it simple, we ought to just forget
about it and store those nuts for the rainy day that we know is
coming.
Chairman Archer. We do have to vote. I think we have
probably pretty well worn you out now. So unless there's
objection, you're excused. And we will go vote. Then we will
come back rapidly after we vote on the last 5-minute vote and
attempt to get the next panel before the Committee.
The Committee will stand in recess.
[Recess.]
Mr. McCrery [presiding]. If we could have everybody's
attention? We have completed testimony and questions of the
first panel. If the second panel could come forward and take
their seats, I believe Chairman Archer will be here
momentarily. And as soon as he arrives, we can begin. If we can
get everybody to come forward and have a seat from the last
panel?
Thank you all for coming forward and having a seat. We're
trying to find Chairman Archer or some other Members. I feel
lonely up here. I don't want to be your only audience.
We expect more Members to be here momentarily. We just had
a vote on the floor. We were supposed to have a second vote on
the floor, but it did not occur because we voice-voted that
issue. And I'm afraid some Members may be confused on the
floor. So we're waiting to give them a chance to get back.
OK. At this time, we'll hear from the last panel on the
hearing concerning reducing the tax burden. We're pleased to
have with us today: June O'Neill, the Director of the CBO;
Stephen Moore, director of fiscal policy for the CATO
Institute; Abram J. Serotta, partner, Serotta, Maddocks, Evans
and Co. from Augusta, Georgia--and I believe Congressman
Norwood is going to further introduce Mr. Serotta in just a
moment--Robert A. Blair, chairman and president of S
Corporation Association; Wayne Nelson, president, Communicating
for Agriculture.
I'm told that Ms. O'Neill has another engagement this
afternoon where she has to give testimony. So she may have to
excuse herself before this panel has completed its testimony.
And, Ms. O'Neill, certainly feel free to leave to satisfy your
other obligations.
At this time, we'll begin with Ms. O'Neill.
STATEMENT OF JUNE E. O'NEILL, DIRECTOR, CONGRESSIONAL BUDGET
OFFICE
Ms. O'Neill. Mr. Chairman and Members of the Committee, I
thank you very much for inviting me to testify on the issue of
marriage penalties and bonuses today.
As you know, the Congressional Budget Office published a
study of marriage and the Federal income tax last summer. This
morning I will summarize the highlights of the study. I will
also very briefly summarize the highlights of my prepared
testimony, which I would like to submit for the record.
Mr. McCrery. Without objection, all written testimony will
be submitted for the record.
Ms. O'Neill. The current U.S. tax system is not marriage-
neutral. More than 20 million married couples pay higher taxes
than they would if they were single. They incur a marriage
penalty averaging $1,380 per couple. However, another 25
million couples get a marriage bonus. As a consequence of
marriage, they save about $1,300 per couple in taxes.
In recent years, a growing number of married couples have
paid marriage penalties, raising questions of fairness. But it
is also important to consider other issues, such as effects on
work and marriage, that arise from the tax treatment of
families and individuals.
Marriage penalties and bonuses are byproducts of attempts
by the Congress to balance the tax treatment of families and
individuals while preserving other desired features of the tax
system.
On the one hand, the Tax Code seeks to levy the same tax on
couples with the same money income. On the other hand, it tries
to minimize the effect of marriage on a couple's tax liability.
However, a tax structure with progressive rates cannot attain
both goals. The incompatibility of progressive rates, equal
treatment of married couples, and marriage neutrality results
in a continuing tension within the Tax Code.
Before 1948, the income tax was levied on individuals, so
marriage had no effect on tax liabilities. But in 1948, the
Congress enacted joint filing for married couples, who were now
taxed on their combined income. Progressive tax rates and
income splitting served to lower the tax liability of most
couples at that time. Thus, the marriage bonus was created.
Two decades later, in 1969--in response to complaints from
unmarried taxpayers about singles' penalties, the other side of
the coin--the Congress made the tax schedule more favorable to
single filers. That action established marriage penalties.
Changes in tax law since that time have shifted the balance
between penalties and bonuses.
In the late seventies, the size and incidence of the
marriage penalty increased as inflation pushed marginal tax
rates higher. In 1981, Congress made an explicit effort to
reduce marriage penalties by enacting the two-earner deduction,
which allowed two-earner couples to deduct 10 percent of the
earnings of the low-earning spouse, up to $3,000.
The Tax Reform Act of 1986 eliminated the two-earner
deduction, but at the same time it sharply reduced the
importance of marriage penalties and bonuses by flattening the
tax rate structure.
The pendulum swung in the opposite direction with the
addition of three rate brackets in 1990 and 1993. Those and
subsequent changes in 1997 had the effect of increasing the
size of both penalties and bonuses.
Along with changes in the Tax Code, the dramatic rise in
married women's work participation and earnings over the past
two decades has increased both the fraction of couples paying
penalties and the average size of those penalties.
Between 1969 and 1995, the fraction of working-age couples
in which both spouses had paid employment increased by half,
from 48 percent to 72 percent. Over the same period, the
incomes of husbands and wives in two-earner couples became more
nearly equal.
Greater equality of earnings between spouses makes marriage
penalties more likely and larger. Three-quarters of all two-
earner couples now incur a marriage penalty. By contrast,
ninety percent of one-earner couples get a bonus.
Penalties affect two different sets of taxpayers, but for
different reasons. At the middle and top of the income
distribution, the progressivity of the tax rate structure, tax
rate brackets, and limits on credits and deductions cause most
penalties. For low-income couples, however, the earned income
tax credit generates most penalties.
The EITC, begun in 1975, provides tax relief for low-income
working families with children, but it is also a source of
marriage penalties for those families. Subsequent increases in
the credit have only worsened its impact.
Much of the current concern about marriage penalties
revolves around the question of whether it is fair for two
people to pay higher taxes just because they are married.
However, marriage penalties affect how much couples choose to
work and even whether they marry or divorce.
CBO estimates, for example, that because of the work
disincentives associated with joint taxation, the total
earnings of married couples are roughly 1 percent less than
they otherwise would be.
Increases in the incidence and size of marriage penalties
have brought renewed interest in reducing them. The problem is
difficult to fix, however, and satisfying every goal is not
possible.
Furthermore, changes that reduce marriage penalties can
have unintended impacts. Options to reduce marriage penalties
range from relatively minor alterations in the current Tax
Code, such as restoring the two-earner deduction, to more
significant changes, such as allowing couples to file single
returns, all the way to comprehensive tax reform.
Any change that reduces or eliminates marriage penalties
faces an inevitable tradeoff. Lower taxes for some couples
entail either reduced Federal tax revenues or higher taxes for
other taxpayers.
Revenue-neutral options necessarily redistribute taxes from
people now incurring penalties to other taxpayers, either
couples who now receive bonuses or single filers. Avoiding such
redistribution could result in large revenue losses, but at the
same time, some options would lower marginal tax rates, thereby
inducing some couples to work more and pay additional taxes
that would offset the revenue losses.
Despite the thorny issues raised, public discussion of the
subject, such as this Committee's hearings provide, is helpful
in identifying tradeoffs within the tax system and the
importance of such considerations in possible designs for
fundamental tax reform.
Thank you very much.
[The prepared statement and attachments follow:]
Statement of June E. O'Neill, Director, Congressional Budget Office
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Mr. McCrery. Thank you, Ms. O'Neill.
I know you have some time constraints. So at this time, if
any member has questions for Ms. O'Neill, ask now or let her
go.
[No response.]
Mr. McCrery. Thank you very much, Ms. O'Neill. We
understand you have----
Ms. O'Neill. Thank you.
Mr. McCrery [continuing]. Some more testimony to give at
another meeting. So you're excused.
Next we have Mr. Serotta. I'm going to jump Mr. Serotta
ahead so that Congressman Norwood can introduce his constituent
and then----
Mr. Norwood. Thank you very much, Mr. McCrery. I do
appreciate you and all the Members of the Committee and
Chairman Archer holding this very important hearing that is
near and dear to all of the working people of America. And we
are grateful for you focusing on this today.
Mr. Chairman, it's a real honor for me to introduce to the
Committee today one of Augusta, Georgia's finest: Abram
Serotta. Besides being a very dear friend of mine, Mr. Serotta
currently serves as the president of Serotta, Maddocks, Evans
and Co. in Augusta, Georgia. He works in all areas of taxation
and is in charge of SME's health care services.
He is a frequent lecturer on college campuses and he has
published several articles, and is currently a contributing
writer and editorial adviser to the Practicing CPA, which is
published by the AICPA.
Accounting Today elected Mr. Serotta as one of the hundred
most influential CPAs in the United States. And I'm pleased to
tell you that they did that before he made that large
contribution to their magazine.
Seriously, Mr. Chairman, it is an honor for me to introduce
my good friend to your Committee this morning. And I am
confident that his testimony and responses to the panel's
questions will make everyone in this room today a little wiser.
And though, Mr. Chairman, I know I need not say this, you
do know, all of you know, April 15 is coming very soon. And I
ask you to be very kind and gentle to my CPA. That's the last
thing I need is a CPA mad at me.
Thank you, Mr. Chairman.
Mr. McCrery. Thank you, Mr. Norwood.
And with that buildup, Mr. Serotta, it had better be good.
You may proceed.
STATEMENT OF ABRAM SEROTTA, SEROTTA, MADDOCKS, EVANS & CO.,
AUGUSTA, GEORGIA
Mr. Serotta. I appreciate, Mr. Chairman, the opportunity to
testify before the Committee today on alternative minimum tax
and hidden rates. I'm a member of the American Institute of
CPAs, but I'm here in conjunction with conversations that I've
had with Congressman Norwood about ideas of tax reform and tax
simplicity.
As he stated, I'm a CPA in Augusta, Georgia. We file about
3,000 tax returns. I consult and teach other CPAs. So my views
are shared by many other CPAs as well as thousands of taxpayers
that we represent.
I'm here today to represent the CPA in the field, not in
the academic world, the one that's administering, implementing
the tax laws that you in Congress are passing.
We all want tax simplification. We all want a less Tax
Code. We ask that you, the Congress, prioritize simplicity,
unlike the complex tax laws of 1997. We're happy with the tax
reduction in these laws. We're not as happy with the
simplicity.
The alternative minimum tax was a tax on preferences and
adjustments to make sure certain taxpayers who had their taxes
reduced due to tax shelters, heavy depreciation, special
preferences, like stock options, would pay some tax. It was not
conceived to penalize taxpayers who had more than two children,
credits under the 1997 Tax Relief Act, employee business
expenses, or State income taxes.
Are taxpayers going to get what Congress promised was a
statement made earlier? And that's what I'm here to ask. My
suggestion is to simplify the alternative minimum tax. I'm not
opposed to doing away with it, by the way, but to simplify it.
And there are many solutions out there. You could take in
my attached testimony the alternative minimum tax form, 6251,
and you could just use lines 8 through 14 and eliminate the
other lines. And you will eliminate many of the taxpayers that
Mr. Kies mentioned earlier.
Tax credits are not computed in alternative minimum tax.
And they should not be used as a penalty on taxpayers. Those
single mothers that send a child to college are going to be hit
with that.
Mr. Chairman, I do have practical solutions. I've submitted
those to your staff. I've submitted those to Congressman
Norwood. In fact, he has sent some forward to the Joint
Committee to get them scored so that you will have the answers
to the questions about how much this is going to cost me.
There are simple solutions, and then there are political
solutions. I'm here on the practical side and will not address
the political side. Last year I only had about 50 clients hit
with AMT. This year I estimate about 250. And next year I
estimate about 500 clients. However, every one of my clients
has to compute whether they're subject to the AMT.
Let's look at those taxpayers that are doing their returns
by hand, doing them themselves. They're going to get hit with
the AMT, not know it, send their return in. They're going to
get a letter back from the IRS with penalty and interest. And
then they're going to call their Congressman. And I don't want
to be a party to those calls.
I've given you an example of a jewelry traveling salesman
who travels on the road who is on a W-2 of $107,000. He's hit
with AMT, 50-percent reduction for meals, 2-percent reduction
for miscellaneous itemized deductions, and so forth. He is
being hit, and his effective tax rate has just been hit bad.
The 3 percent of adjusted gross income on the itemized
deductions was a hidden tax. I've given you testimony as to why
that happened. It was a way to raise taxes 1 percent with
hidden rates. Now that's 1.19. But the thing of that, line 28,
where that number goes, the IRS has refused to put the
computation on the form. Not only is it hidden, but they've
refused to disclose it.
We think that's an affront. We ask that hidden rates be
disclosed. And I think earlier somebody said we should disclose
the hidden rates in every tax law. I'm here to say at least do
that so that I don't get the calls that ``I cannot add up
itemized deductions'' and I have to tell them that Congress
passed this 3 percent and didn't want you to know that it was
an additional rate.
I have many other examples enclosed from $30,000 to
$330,000 of hidden rates, of hidden loss of deductions, IRAs,
tax credits. They're all in my testimony. I ask you and the
staff to look over it.
And finally I urge Congress to pass laws that are easy to
administer that will increase compliance if they're easy to
administer and decrease frustration.
[The prepared statement and attachments follow:]
Statement of Abram Serotta, Serotta, Maddocks, Evans & Co., Augusta,
Georgia
I want to thank you for the opportunity to testify before
you today on alternative minimum taxes and hidden tax rates.
I am a CPA in a firm in Augusta Georgia. I represent
approximately 3,000 tax return filers. I consult with other CPA
firms and also teach taxation. My views are shared by many
other CPAs representing many thousands of taxpayers. I
represent the CPAs ``in the field'' who must comply with the
complex tax laws you are passing.
We all want tax simplification. We want a less complex Tax
Code. We ask that you, the Congress, prioritize simplicity,
unlike the complex laws you passed in 1997.
Since you have heard testimony from others on alternative
minimum tax, let me expand on it from a hidden rate standpoint.
The alternative minimum tax with preferences and
adjustments was created to make sure taxpayers who had their
taxes reduced due to tax shelters, heavy depreciation, and
special preferences, such as stock options, etc., would pay
some tax. It was not conceived to penalize taxpayers who had
more than two children, credits under the Taxpayer Relief Act
of 1997, employee business expenses, or state income taxes.
My suggestion is to simplify the alternative minimum tax
(or do away with it) by limiting it to just special preference
items, especially those items from line 8 to 14 (post 1986
depreciation, adjusted gain or loss, incentive stock options,
passive activities, beneficiaries of estates and trusts, tax-
exempt interest from private activity bonds, and other) of the
Form 6251. Tax credits should be allowed for alternative
minimum tax purposes and should not be a penalty to taxpayers.
I had approximately 50 individual clients in 1996 who were
affected by this tax, but I had to compute it for all of my
clients. I predict that in 1998, over 250 of my clients will
pay alternative minimum tax--several who make under $60,000.
Enclosed is a 1997 tax return summary for a traveling
salesman, who earns just over $107,000. His business expenses
totaled $32,215. Because of: (1) his alternative minimum tax of
$4,778, (2) his 50% loss of meals of $2,838, and (3) the 2%
adjustment to miscellaneous itemized deductions of $2,218, he
loses a total of $9,834 of deductions (more than 30% of his
expenses), which at a 28% rate is $2,754 of lost tax savings.
The 3% of adjusted gross income in excess of a base amount
for itemized deductions was a planned hidden rate. Congress
debated between a 31% and 33% tax rate. The compromise was a
31% rate with a 3% adjustment for itemized deductions (31%
times 3%) and a hidden rate of .93%. Today with a 39.6 rate,
the hidden rate is (39.6% times 3%) 1.19%. The 3% adjustment
for adjusted gross income does not appear on the itemized
deduction form, Schedule A. Line 28 of Schedule A has no place
for the mathematical computations. I receive many calls a year
from clients saying that I cannot add correctly because their
total deductions on the form do not match the total allowed
deductions at the botom of the page. The IRS's answer; there is
not a big demand to have this shown on the return.
I have enclosed other examples of hidden rates, showing the
loss of exemptions, and phase-outs based on adjusted gross
income. In my opinion, any phase-out serves as a hidden rate.
CONCLUSION:
I urge Congress to pass laws that are easy to administer;
and will therefore, increase compliance and decrease
frustration.
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Mr. McCrery. Thank you, Mr. Serotta. I assure you we share
your goals. And we appreciate very much your bringing to the
Committee practical common sense solutions to some of these,
and we will take a look at them.
Now Stephen Moore, the director of fiscal policy for the
CATO Institute.
Mr. Moore.
Mr. Moore. Thank you, Mr. Chairman.
STATEMENT OF STEPHEN MOORE, DIRECTOR, FISCAL POLICY, CATO
INSTITUTE
Mr. Moore. I'm grateful for the opportunity to testify this
morning. Let me say that the CATO Institute gets no government
grants or contracts, and neither do I personally.
I was very much pleased with Chairman Archer's proposal
that was released last week for a roughly $200 billion tax cut
over the next 5 years. I'm very much in favor of a very large
tax cut being enacted this year precisely because we're looking
at very large budget surpluses. And those surpluses should be
returned to the taxpayers.
I would simply have two caveats. First, if we're going to
do a tax cut this year, which we should, it should be
consistent with the idea of simplicity and fairness. It should
move us in the right direction, either toward a consumption tax
or a flat tax. Unfortunately, I have to say, Mr. Chairman, that
last year's tax bill did not pass that test. We made the tax
system more complicated.
What I want to talk to you this morning about is an idea
that we have been promoting, which is the idea of expanding the
15-percent tax bracket so that it applies to more middle-income
workers.
As way of background, let me say that one of the tax acts
that's passed in this Committee over the last 15 years that was
probably one of the single best pieces of legislation in my
opinion was the Tax Reform Act of 1986. We cleaned out a lot of
the pollution in the Tax Code. We got those rates down. We got
them to 15 and 28 percent. And I'm with Jack Kemp on this. If
we could move back to that system we had back in 1986, I think
the economy would grow much faster and we'd be moving
significantly in the right direction.
We actually have a plan at the CATO Institute called the
alternative maximum tax idea that would say that no taxpayer
should have to pay more than 25 percent of their gross income
in Federal combined payroll and income tax and if they want to
short-circuit this complicated 9,000-page Code, they could
simply fill out a postcard, return, pay 25 percent of their
gross income in taxes, and be done with it. This would in a
sense because of the 15 percent payroll tax creates a two-rate
system of 10 and 25 percent.
If we can't do that this year, then let's move toward this
system of at least providing broad middle-class tax relief in a
way that actually reduces tax rates. And what I'm talking about
here is expanding the 15 percent tax bracket.
Now, if you look back at the 1986 Act, what you find is
that the intent of Congress was that we would create two rates.
The 15-percent rate would be applicable to all low-income
workers and to all earners that were in the middle class. And
the 28-percent rate would apply to wealthier taxpayers.
Unfortunately, because of real income growth over the last
12 years or so, we have seen a system where more and more
middle-income taxpayers are now being forced into the 28-
percent and in some cases the 31-percent tax bracket.
This is a simple matter of tax fairness. There are now 21
million Americans in America today that make between roughly
$25,000 and $50,000 income. And, believe it or not, Mr.
Chairman, these are the Americans who pay the highest combined
payroll and income tax bracket of any Americans in the entire
economy. That is to say, a $40,000 single worker pays a higher
marginal tax rate than Bill Gates does.
To demonstrate this point, I want to, if I could, show you
a couple of charts to demonstrate this point. What this chart
is essentially showing you, this is essentially showing the
combined payroll tax and income tax rates that are applicable
to Americans at various income levels.
What it shows is that if you look at the people who--this
is for single filers, incidentally--make over $25,350--that's
where the 28-percent bracket kicks in for single workers--those
folks are paying the highest rates.
And so what I am suggesting is that we take this line here
and we bring this over like this so that those middle-income
workers are paying 30 percent, 15 percent on their income and
15 percent on their payroll, not a combined 43 percent, which
is what they are paying now.
Again, this would apply to roughly 21 million working
Americans. If we want to provide broad-based tax relief to the
middle class and we'd want to do it in a way that is in a
supply side progrowth direction, let's bring rates down for
those folks. Eventually I'd like to have that 30-percent rate
go across the board, but at least start with those middle-
income workers.
Quickly, this, Mr. Chairman, is the same rate chart but for
married couples. Now, you can see the situation is a little
better for married couples, but again you see that big hump,
camel hump, there. Again, let's flatten that out. Let's get rid
of that 28-percent bracket for folks in that income range
between roughly $42,350 and $64,000.
That is the proposal, Mr. Chairman. I think it's consistent
with sound progrowth tax policy, but it also would provide very
significant tax relief for voters in that income range.
Thank you.
[The prepared statement and attachments follow:]
Statement of Stephen Moore, Director, Fiscal Policy, CATO Institute
In 1986 Congress passed and President Reagan signed a
landmark and heroic piece of legislation: the 1986 Tax Reform
Act. The 1986 TRA closed economically inefficient tax loopholes
and dramatically reduced income tax rates for all Americans.
The result of the 1986 Tax Reform Act was to create a
simple two-rate income tax system: 15 percent and 28 percent.
It should be emphasized that the 1986 TRA was a bipartisan
measure and was sponsored by Democrats Rep. Richard Gephardt
and Senator Bill Bradley and Republicans Rep. Jack Kemp, and
Senator Bob Packwood, with important contributions from the now
Chairman of this Committee, Bill Archer.
A major objective of the 1986 Act was for the 15 percent
income tax bracket to apply to all low income and the vast
majority of middle income workers. The 28 percent bracket was
primarily to apply to wealthier workers.
In the post-1986 TRA era, we have passed several bad tax
bills, most notably the 1990 budget deal and the 1993 budget
deal, both of which unraveled tax simplification and created a
new multitude of tax rates climbing to a high of 39.6 percent.
I agree wholeheartedly with Jack Kemp and others that a very
good start to tax reform would be to get us back to the two
bracket system of 15 and 28. We have a plan that we are
promoting at the Cato Institute called the MAXTAX that would be
even more pro-growth. It would create two income tax rates at
10 and 25 percent wrapped around the payroll tax. I have
attached to my testimony an explanation of that plan, which
involves giving taxpayers the freedom to choose between this
low rate gross income tax or the complex current system.
Another pernicious trend since 1986 should be rectified by
this Committee to restore tax fairness for the middle class.
More and more middle income workers have now been pushed into
the 28 percent tax bracket--and some are now paying the 31
percent bracket. This phenomenon is occurring because the tax
brackets are not indexed for real income growth, just nominal
income growth.
Today, there are roughly 21 million workers with earnings
between $30,000 and $50,000 a year most of whom pay marginal
income tax rates of 28 percent.
Believe it or not, these workers pay the highest marginal
tax rates under our federal tax system. Why? Because they pay a
28 percent federal income tax rate on top of a 15 percent
payroll tax. The combined rate of 43 percent is higher than the
top income tax bracket for even the wealthiest Americans at
39.6 percent. The two charts that I have attached to my
testimony show the problem graphically. The middle class
workers--particularly single workers--face punitive tax rate
burdens. And as Reagan taught us: taxes matter most at the
margin.
Nixon once called these neglected citizens the ``silent
majority.'' Both parties lay claim to speaking for these
working class Americans, but neither party seems to be
listening to them.
Ever since the sweeping Reagan tax cuts of 1981, neither
political party has done much to directly benefit the middle
class in the pocketbook. The latest figures from the
nonpartisan Tax Foundation highlight that since 1980, despite a
Republican in the White House for 12 of those 17 years and a
Republican-controlled Congress for 3 of the 5 others--the tax
bite on median-income families has continued to ratchet upward
to 38.5 percent. Federal taxation is now at its highest
peacetime level, as a share of Americans' incomes, since the
height of World War II.
Much of the escalating tax burden has, of course, been
attributable to hikes in the regressive payroll tax. For most
Americans, payroll tax increases have canceled out, nearly
dollar for dollar, the benefits of the Reagan income tax cuts.
Meanwhile, the federal gas tax has been tripled since 1980,
state and local property taxes continue to climb and so does a
multitude of obnoxious fees and assessments.
Last year Rep. Dick Armey (R-Tex.) called this plight of
American workers, ``the middle class squeeze.'' Exactly the
right diagnosis. But what is either party doing about it? Last
year Republicans passed a niggling tax cut about one-third as
large as what they had promised in 1994.
Yes, for families with young kids this is blessed relief--a
$1,000 tax cut for a family of four. There are still millions
of middle-class households without kids at home and without
capital gains income that will angrily learn come April 15th
that they get essentially nothing out of this tax bill.
Jack Kemp and Ronald Reagan taught us that tax rates
matter, too. Combining payroll tax, federal income tax, and
state income taxes, many middle income families are approaching
a 50 percent marginal tax burden. If a stay-at-home mother
wants to get back in the workforce, full- or part-time, she's
paying nearly 50 percent tax on her first dollar of income
earned. Counting the costs of child care, she may only bring
home 20 cents on the dollar. Often she can't afford to work.
Republican Senator Paul Coverdell of Georgia has proposed
relieving the middle-class squeeze. He would raise the income
threshold on the 15 percent income tax bracket. I understand
that Mr. Archer will propose to do so as well.
Under current law the 28 percent tax bracket creeps up on
single workers at an income level of $25,350 and on married
couples at $42,350. The 15 percent bracket should be stretched
to $35,000 income for singles and $50,000 for married couples.
This would reduce federal revenues on a static basis by $25
billion a year--or roughly the amount of the budget surplus now
being projected. The principle here is simple: all middle-class
families in America should be in the 15 percent tax bracket--
not the 28 percent bracket. In fact, eventually, Congress
should expand the 15 percent tax bracket to apply to all
Americans with earnings below $65,000 a year--the income level
where people stop paying payroll taxes.
This is not a plan that is vulnerable to attacks as a ``tax
cut for the rich.'' It is designed to benefit the workers who
earn between $30,000 to $50,000 a year.
This plan would provide middle-class workers, not symbolic,
but meaningful tax relief. A single filer with an income of
$32,000 a year would receive an $864 tax cut. A married couple
with taxable income of $48,000 a year would receive a tax cut
of $734. Preliminary estimates indicate that the plan would
result in a static revenue loss of $20 to $25 billion annually.
This is less than the projected budget surplus. Dynamic
analysis would suggest that as much as one-third of the static
revenue loss would be recouped through more work and savings.
Newt Gingrich and Trent Lott have announced that
Republicans will cut taxes again in 1998. The bigger the tax
cut, the better. But I urge this committee that whatever is
done: cut taxes and aim to simplify. No more ``targeted''
education tax credits, no more loopholes and complexities. The
President's tax plans are deeply flawed in this area. H&R Block
is the primary beneficiary of the White House proposal. Tax
cuts in 1998 should make the tax code simpler and the tax
burden lighter.
Consistent with these principles, I am very much in favor
of two other ideas that have been presented before this
Committee: indexing capital gains for inflation and relieving
Americans from the burden of the Alternative Minimum Tax.
Inflation is a thief. It is not fair to tax Americans purely on
phantom gains. In this low inflation environment, indexing
capital gains would not impose much of a cost on the Treasury,
but would provide investors an insurance policy against a
return to a high inflation regime.
Bill Archer and Paul Coverdell's ideas are sound. Marginal
rate cuts are necessary to improve American competitiveness in
the global economy. It is noteworthy that almost all nations in
the world have been cutting tax rates since 1981--see tables.
We should broaden the 15 percent tax bracket this year. In 1999
or 2000 we should vastly simplify the tax system by flattening
the income tax, or better yet, by adopting a national
consumption tax.
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Mr. McCrery. Thank you, Mr. Moore, for that very
interesting proposal.
Now we'll hear from Robert Blair, chairman and president of
the S Corporation Association.
Mr. Blair.
Mr. Blair. Thank you, Mr. Chairman. Thank you, Members of
the Committee.
STATEMENT OF ROBERT A. BLAIR, FOUNDER AND CHAIRMAN, S
CORPORATION ASSOCIATION
Mr. Blair. My name is Robert Blair. I am the founder and
chairman of the S Corporation Association, an association that
I established because I found that many entrepreneurs
throughout the United States found themselves unrepresented
here in Washington. We are about 45,000 companies strong among
the 2 million S corporations that exist in the United States.
It's a small beginning, but 45,000 strong is a strong voice.
I want to talk today about the inequity that applies to the
S corporations owners of the United States, and I applaud this
Committee for looking at inequities that apply across the
spectrum, whether to married couples or to others.
The essential issue that I am here to talk about is
entrepreneurship. In our youth, all of us studied in our books
the great entrepreneurs of yesteryear. Whether it was Eli
Whitney or Robert Fulton, we looked back, and we saw great
vision, people taking great risks, and succeeding against the
odds.
The modern media bombard us with the great successes of
today's entrepreneurs. Bill Gates or Mary Kay or Ted Turner.
These people not only took risks and achieved greatness, but in
many instances, they created whole new industries.
Of course, behind all of those big stories that hit the
front pages of the newspaper, regrettably, are the many more
unreported stories of entrepreneurs who took the risks but did
not achieve great success. For every great success, there are
many failures.
I know of which I speak. I come from a family of
entrepreneurs. At the time of the Great Depression, my father,
Tom Blair, had to leave the employment of his father's road
construction company because jobs were stripped away.
With an eighth-grade education and a passel of kids--I'm
number 11 of 13--he moved from the North Carolina region to
where there might be work. He found that work in Virginia.
He went there seeking work, and what he also took with him
was an entrepreneurial spirit that has flowed through our
family at least since the 1850s. He created with his eighth-
grade education a road construction company, intending to do
what all of us want to do: have great success.
I wish I could tell you my father's version of the Bill
Gates success story now. I can't. Success did not come easy. He
went up, and he went down. He suffered through two
bankruptcies. He suffered when I was 15 years old a complete
disability that took him completely out of commission for 5
years when he simply could not work.
By that time, in his early sixties, what did he face? He
had 13 children. He had to put food on the table. He was
receiving a mere $30 a week in disability insurance. Times were
not exactly pretty.
But he eventually got up from his bed and he worked. And
from that work, many of his sons, myself not included, and his
grandsons have gone off to create other road construction
businesses which are prospering today.
Why do I tell you a family story? Because, while it makes
me feel terrific, the burdens and the obstacles that life puts
in your path--whether it's the Great Depression or whether it's
simply a tough technical hurdle--an entrepreneur, even one with
seemingly endless spirit and zeal, doesn't need the U.S.
Government placing additional burdens and obstacles in his way.
In 1954, the Congress saw the wisdom of creating something
called the S corporation, or Subchapter S of the Internal
Revenue Code. By doing this, Congress permitted American
entrepreneurs who created their small and family businesses to
operate at least under the shield of limited liability from
plaintiffs' attorneys, who obviously were scouring the
landscape for opportunities on behalf of their clients.
Congress permitted these S corporation owners to be taxed at a
partnership tax rate. That was the good news of what the
Congress saw and did in the fifties.
As a result of that vision, Congress spawned
entrepreneurship throughout the country, in every sector of the
economy, be it rent-a-car companies or florists or heavy
manufacturers. You name the industry, and I will bring you an S
corporation. That's success, job-creating success, people
taking risks, but fair and reasonable risks of the market,
rather than risks that are imposed artificially by the
government.
To understand what I mean by that, let's revisit 1993,
about which the 1993 distinguished Chairman of this Committee
spoke earlier. In the 1993 Omnibus Budget Reconciliation Act,
tax increases went up to 39.6 percent.
Why do I speak of that in the context of S corporations?
Because those individual rates apply to the S corporation
owners who had seized on and in him, build on the platform
established by Congress in the fifties.
With that as a backdrop, the tax hike of 1993 was
disastrous. Allow me to flesh this out with another real-life
example. A dear friend of mine started a company in 1975 with a
handful of employees. By the early nineties, he had grown to
6,000 employees, succeeding against great odds, in a tough
business with narrow margins of profit of perhaps 3 percent.
What happens in a company where you've self-capitalized, where
you have to put most of your money back in your business? You'd
better watch that margin, or there will be nothing left to
reinvest.
So along comes the huge tax increase of 1993. Now my friend
has to take more money out of the company to pay his higher tax
bill to the U.S. Treasury. He needs money to continue to
capitalize, but he doesn't have it anymore. So he goes into the
debt markets, and he borrows.
Now he has higher taxes debt, which comes with the added
costs of debt service. By 1995, his back is against the wall
because, as an entrepreneur who operates in the form of an S
corporation, he faces the fact that he must personally apply to
every financial institution which lends him money, and
personally guarantee what is becoming unmanageable debt.
For my friend whose story is all too common among S
corporations today, it became too much. Back against the wall,
facing the prospect of personal bankruptcy because the debt
would overwhelm him, he did the opportune thing. He sold out to
a public company.
And what did that public company proceed to do? Not
surprisingly, it downsized the business, reversing the job-
creating machine my friend had established, sweated to grow,
and worked to sustain.
That's the personal side of what has happened to S
corporations. Let's look at the more empirical evidence now.
National Association of Manufacturers' polls discovered that,
in the aftermath of the 1993 tax hike, 43 percent of their S
corporation members, a significant portion of the trade
association, would not increase capital investment as a direct
result of the higher tax rates and other obstacles placed on
them by the government. Forty-seven percent of those surveyed
said they would not hire more employees as a result. And 23
percent said they would actually have to engage in layoffs.
These are real numbers and they are numbers that only tell us
how common my dear friend's dilemna now.
What is the solution? The beginning of the answer has been
submitted by Mr. Crane, who has introduced a bill, the Small
Business Investment and Growth Act (H.R. 2884), to try to
rectify part of the problem. I thank Mr. English for being one
who has recently come on as a cosponsor of this important
legislation.
What does Mr. Crane's bill recognize? It recognizes that
yes, the S corporation companies of America deserve not a major
break, but certainly not the illogic of the tax ``penalty''
placed on them in 1993. Mr. Crane's bill recognizes the
entrepreneurial spirit which is in their veins, and helps
ensures that it will continue to be the job-creating force that
this country historically has been able to depend upon.
The Crane bill says: If you are going to reinvest in your
company, Mr. or Ms. S corporation owner, or if you have to take
money out of your business in order to pay these increased
taxes, we'll stop penalizing you for doing what we need you to
do. We'll roll back the 39.6-percent rate you pay to the
highest C corporation rate, provided you leave that money in
the company. When and if you take any of that reinvestment out
at a future point, you then would have to pay the highest
applicable individual rate.
While this is unquestionably a reasoned approach, we
limited it so that the lower rate would only apply to $5
million of the company's Federal taxable income. And that cap,
together with strong antiabuse provisions, ensure that we keep
this proposal not only fair and logical, but also at a
reasonable cost to the Treasury. Needless to say, we are
confident that whatever small investment is made ``up front''
by the Treasury will be repaid many times over, because
Congress would simply be facilitizing reinvestment--not
penalizing it--spurring even more growth, productivity and job
creation from the entrepreneurs who have proven themselves
capable of delivering throughout the economical history of our
Nation.
Mr. Chairman, I will wrap up by saying that the S
Corporation Association has made this its top priority on
behalf of its own members and affiliates, as well as two
million S corporations around the United States.
I am pleased to report that the National Association of
Manufacturers' Small Manufacturers' Group has also made this
one of their top priorities. And the numerous trade
associations with whom we work have made or are making this one
of their major goals as well.
We hope that you will work with us to pass that
legislation. We thank you for holding this hearing today.
[The prepared statement and attachment follow:]
Statement of Robert A. Blair, Founder and Chairman, S Corporation
Association
Good morning, Mr. Chairman and Members of the Committee. My
name is Robert Blair, and I am the founder and Chairman of the
S Corporation Association, or S-CORP as we are known, a group
which speaks for more than 45,000 S corporations in virtually
every industry nationwide. On behalf of our members and our
affiliates, I wish to thank the Chairman for taking time today
to address some of the tax rate inequities facing key segments
of the U.S. population, and to explore some of the ways in
which we can begin to rectify them. I applaud the Chairman's
leadership in pursuing this important topic, and am grateful
that you have allowed me to come before this body today to
share my views with the Committee. I am certain that today's
proceedings will help lay the critical groundwork for focusing
on strategic and reasonable means by which we can redirect the
tax system, through the legislative process, to encourage the
type of economic activities that we as Americans have long
valued.
Recognizing the Entrepreneur
The essential issue that I will talk about today is a value
that is more a part of American economic history and tradition
than perhaps any other: that value is entrepreneurship. We
have, as a society, long heralded and embraced the
entrepreneur, and our culture reflects this value in every way
imaginable. Our children are taught from grade school about the
vision of entrepreneurs like Eli Whitney, Robert Fulton,
Alexander Graham Bell, and Henry Ford, and how these men took
risks that changed the way America competes in and leads the
world. Our magazines, films and television news shows regularly
trumpet the genius of entrepreneurs like Bill Gates, Warren
Buffet, Mary Kay and Ted Turner, and remind us of the personal
and professional risks that they took to literally create
industries like computer software, investment banking,
cosmetics and broadcast media. Quite simply, America is in love
with the entrepreneur, and for good reason. Ours is the one
country in the world where the Horatio Alger story can come
true, where one person can have a vision, take a risk, and make
that vision into a monumental reality, all within a single
lifetime.
But all entrepreneurs do not achieve the great success of a
Bill Gates or a Ted Turner. Most fail. Many who fail pick
themselves up and try again. I know of which I speak. I am the
eleventh of thirteen children. My father was forced to leave
his father's road construction company when the great
Depression stripped away many of the jobs that my father and
others had. With an eighth grade education, he traveled to
southeast Virginia to find employment and then to start his own
road construction company. But success did not come easy. Over
a period of three decades he rose...and he fell. He went
bankrupt twice--he was disabled from a construction accident
for more than five years. But he never quit. The
entrepreneurial blood that flowed in his veins flows today in
the veins of his sons, several of whom started their own road
construction businesses. While some may say that I got lost
along the way and became a Washington lawyer, I can assure you
that that entrepreneurial blood flows in my veins as well. My
creation of the S Corporation Association is a testament to the
entrepreneurial spirit of Tom Blair, to my grandfather, Thomas
Blair, who went from building railroads to building roads for
cars, to my great grandfather, William Robert Blair, who left
Ireland and found work building the railroads of the Midwest.
But why, do you ask, do I raise a family story? Because the
spirit of the entrepreneur is challenged enough without the
government placing burdens and obstacles in the path. I watched
the Congress do just that when it passed the Omnibus Budget
Reconciliation Act in 1993.
Congress had a decidedly different view in 1954.
S Corporations: Congress Seeks To Foster Entrepreneurship
In 1954 the Congress knew a good thing when it saw it. The
Congress recognized the value of entrepreneurship and sought to
create a way to encourage and promote the economic spirit on
which our country was built by creating the concept of the S
corporation. The S corporation was launched as a means of
ensuring that when a person has a business vision, takes
personal risk to launch that vision and helps to fuel the
economy by making that vision into economic reality, he or she
does not get penalized by the tax system while they are doing
something fundamentally good and important for the American
economy. Because for an S corporation, where the shareholders
are the business, these companies were permitted by Congress to
limit the personal liability of the owners, but be taxed like
partnerships.
What did Congress do when it created special companies in
1954? The answer is simple: It spawned entrepreneurship. In
1978, S corporations made up only about 20 percent of U.S.
corporations. By 1995, there were 2 million S corporations
operating in virtually every industry and in every state across
America, and these businesses accounted for half of all
corporations in America. While a small handful of these
companies have realized truly great success, the IRS tells us
that the vast majority of these companies are small businesses,
with average assets of less than $10 million. But while
principally small, these companies account for about 40 percent
of the U.S. tax base. These are not the IBM's and Microsofts of
the world; they are mostly family businesses, or companies
started by small groups of families or by friends from the same
school or town. They are corner stores and the kinds of
businesses that employ significant segments of entire
communities. They are the businesses that create local wealth
as well as national wealth.
In order to launch these businesses, we should remember,
their owners have risked large amounts of their own personal
assets, often putting up all of their savings to see whether
they can make their vision work. Most of them, no matter how
successful their company has become, still must guarantee
personally every penny of debt that their businesses take on.
These businesses are not concentrated in any geographic
region, nor are they aggregated in a particular industry.
Rather, they are evenly spread across the U.S. industrial base,
with about a third operating in the service sector, a third in
the retail trade and financial sectors, and a third in
manufacturing, mining, agriculture and other traditionally
``heavy'' industries. Some of these businesses have been lucky
enough to grow and employ a few hundred workers, while others
have stayed small but productive, and just as critical a part
of the national economic landscape.
In short, in 1954 Congress had its own vision--it wanted to
create a way to enable businesses to organize, reasonably limit
the liability of the individuals who started the company,
acknowledge the extraordinary risks and challenges these
individuals faced, and impose taxes fairly and appropriately.
Congress sought to promote entrepreneurship, and it succeeded.
The S corporations of today stand for entrepreneurship, the
most basic American economic ideal, and they have fulfilled
their mission by becoming the engines of economic growth and
job-creation that Congress hoped that they would be.
The Disaster of 1993
Then, of course, came the disaster of 1993. That was the
year that Congress may have forgotten about its S corporations,
and its desire to foster and support entrepreneurship.
Congress most certainly did not intend the consequences
that struck many S corporations, but intent is not relevant
when you are the entrepreneur fighting in a viciously
competitive market, who must also overcome government improved
burdens and obstacles. What am I talking about?
When Congress raised tax rates to 39.6% in individuals, it
forced S corporation owners, most of whom self-capitalize, to
take substantial additional monies out of their businesses
simply to pay taxes. A dear friend took his S corporation from
a handful of employees to over 6,000 employees in just twenty
years. His margin of profit was at best 3 to 4 percent. That
big 1993 tax increase took dollars that he would have re-
invested in his corporation and deposited them with the IRS.
Short on capital, he was forced to go to the capital markets to
borrow large sums of money. Now he had debt service and higher
taxes to pay. By the end of 1995, he was on the verge of losing
everything--after all, as the owner of an S corporation, he had
to guarantee his corporation's debt. He saved himself by
selling to a public company which immediately downsized his
twenty-year-old creation.
A simple example will further illustrate my point: Let us
say that an owner's share of her S corporation is $250,000 this
year. Of that amount, the owner pays herself $125,000 in salary
and non-wage distributions, and invests the remaining $125,000
to buy one new machine and hire one new employee. With the tax
hike of 1993, she will pay federal income taxes at an
astonishing rate of 64 percent of her actual take-home pay.
More importantly, she will pay the same tax bill as another
business owner of a standard or ``C corporation'' who took home
$250,000 in salary and distributions and chose to reinvest
nothing in his business. I cannot conceive of a greater
disincentive for reinvestment and economic growth for this
critical class of businesses.
In polls of S corporations since their shareholders' tax
rates increased, these companies regularly report that the
added tax burden is the primary reason they cannot reinvest as
much money into their companies as they did before their taxes
went up, and that they would put more money back into their
businesses and into the economy if they were freed up by tax
laws to do so. In recent surveys by the National Association of
Manufacturers of their small manufacturers, about 40 percent of
which are S corporations, the increase in tax rates on S
corporations was a key reason that 43 percent of these
businesses said they would not increase capital investment, or
that they would reduce investment in their businesses. During
this time of great economic expansion, in fact, 47 percent of
these companies said that the higher tax burden on S
corporations, together with other government mandates, would
keep them from hiring more employees. Twenty-three percent said
they planned to lay off workers as a direct result. If we
believe that the economic good times of the past few years have
been universal, imagine what gains we could have realized if S
corporation tax policies were not so misdirected as they now
are.
The Crane Bill: A Critical Beginning
In November 1997, Congressman Phil Crane introduced the
Small Business Investment and Growth Act, a bill to encourage
the entrepreneur and to help our economy derive the benefits
from that entrepreneur's work and risk. On behalf of all S
corporations, I hope that the Committee will advance
Congressman Crane's important measure as a means of trying to
bring fairness for the entrepreneur back into the tax code on a
permanent basis.
The Crane bill has a simple objective: to reduce the
inequities imposed on S corporations as a result of the tax
rate increase of 1993, and to begin to help America's S
corporations to put money back into their companies so they can
continue to expand and create more U.S. jobs. Congressman
Crane's bill acts on what history--not to mention our own
business owners--tells us to be true: If we empower our
entrepreneurs with sound policy, rather than punish them for
investing and for growth, if we recognize the risk these
entrepreneurs take every day rather than make it even riskier
for them to stay in business, we will reap the benefits of
these policies through more corporate spending, more jobs, and
more productivity. Congressman Crane's bill is an investment in
a proven entity--the entrepreneur--for our own economic future
and that of our children.
To accomplish these important objectives, Congressman
Crane's bill would lower the federal tax rate paid by S
corporation shareholders to no more than the highest applicable
C corporation rate when the shareholders reinvest their
earnings in their businesses, and/or when the company
distributes earnings for the sole purpose of making tax
payments. To ensure that virtually every S corporation in every
sector benefits from this measure, companies of every size
would be able to participate, but the reduced rate would be
applicable only to the first $5 million in federal taxable
income of the S corporation. This ensures that the Congress
supports and promotes entrepreneurship, but does not do so at a
level that adversely affects the federal treasury.
The Crane bill extends to S corporations in every industry
group imaginable, but it also has limitations to protect
against abuses. For example, the measure only allows so-called
``personal service corporations'' to benefit from the reduced
tax rate to the extent that they are not only reinvesting in
their businesses, but making demonstrable investments in true
capital expenditures such as plant, property and equipment. And
as I mentioned, because we want to see this critical change be
made available to all S corporations rather than a select
handful, we support the notion that the rate reduction can only
be made widely available if it is limited in its amount, in
this case to $5 million of the S corporation's taxable income.
I am proud to say that the S Corporation Association,
together with the National Association of Manufacturers, has
worked closely with Congressman Crane and his office on this
important measure, and our Association will make this our top
priority for 1998. I know that this is also a priority for NAM,
whose Small Manufacturers reported last year that eliminating
the S corporation ``shareholder penalty'' is their second-most-
pressing legislative priority. I need hardly tell the Committee
that many other trade associations--and particularly those
whose members are typically small and/or family businesses--are
eager to see this proposal advance.
Thank you, Mr. Chairman, and Members of this Committee, for
permitting me to come here today.
The Small Business Investment and Growth Act, (H.R. 2884)
Need for the Legislation
As a result of the tax increases of 1990 and 1993,
S corporation shareholders are unfairly burdened by a higher
tax rate than is applied to any other corporate entity in
America. S corporations--which represent more than 2 million
businesses in virtually every sector and in every state
nationwide--are especially penalized when they reinvest in the
growth and preservation of their businesses, and when they
distribute earnings for the sole purpose of paying taxes. S
corporations, which are predominantly small and traditionally
family-owned businesses, have originally been the engines of
America's economic growth. But because of the disincentives of
current tax laws, these entrepreneurial establishments are
hindered from reinvesting in their businesses and continuing
their strong tradition of economic expansion and job creation.
Goals of the Legislation
The Small Business Investment and Growth Act
promotes investment among America's S corporations in jobs and
business growth; provides for targeted rate reduction for all S
corporation owners, regardless of industry or size, when they
invest in their businesses; allows certain personal service
corporations which make substantial investments in capital
improvements to benefit from the targeted rate reduction; and
ensures against potential abuses by certain companies.
Key Provisions
The bill would lower the federal tax rates paid by
S corporation shareholders to no more than the highest
applicable C corporation rate when the S corporations reinvest
earnings in their businesses (rather than distribute the
profits) and/or when they distribute earnings for the sole
purpose of making tax payments.
The lower tax rate would be applicable only to the
first $5 million in federal taxable income of the S
corporation. Any combination of reinvested earnings and
earnings distributed solely for making federal tax payments
would qualify.
To avoid potential abuses of the reduction, an
exclusion applies to some personal service corporations (PSCs).
In general, PSCs (defined by IRC 448) would be eligible for the
rate reduction only to the extent that their reinvested
earnings are offset by capital expenditures. The $5 million
taxable income cap would still apply, though a PSC would be
allowed to use a three-year carry forward account for
reinvestment to offset its capital expenditures.
Mr. McCrery. Thank you, Mr. Blair, for excellent testimony.
Mr. Nelson, I'm told that our clock and the lights are
broken. So if you'd try to summarize your written testimony in
about 5 minutes, we'd appreciate it. Thank you.
Mr. Nelson. I sure will. Thank you, Mr. Chairman, and
Members of the Committee, for our invitation to testify on
important tax issues.
STATEMENT OF WAYNE NELSON, PRESIDENT, COMMUNICATING FOR
AGRICULTURE
Mr. Nelson. My name is Wayne Nelson. I'm president of
Communicating for Agriculture, an association of farmers,
ranchers, and rural small business people with members in all
50 states. our national headquarters are in Minnesota.
CA's worked on tax fairness issues affecting farmers,
ranchers, and small business for many years. And we want to
commend Congress for taking several positive steps last year on
tax reform. We also believe that with the U.S. economy and the
Federal budget appearing to be in better shape than at any time
in recent memory, there is an opportunity to do more. We
believe that a balance can be achieved that would allow for
Federal debt reduction, maintaining a balanced budget, and
providing for tax reduction.
Mr. Chairman, I operate a farm in southern South Dakota. It
seems that every year, income taxes get more complicated with
most farmers and small businesses unable to do their own tax
returns. Simplification of the Tax Code would go a long way
toward helping farms and small businesses. Communicating for
Agriculture supports the IRS reform measures presently moving
through Congress.
Recently it seems that the IRS has been using the TAM,
technical advice memorandum, in a more frequent manner and in a
manner that seemingly skirts or goes beyond the intent of the
tax laws that Congress has previously enacted. It seems unfair
that when Congress works hard to deliberate and pass tax
legislation that a new interpretation growing out of one court
case can change the outcome for thousands of taxpayers.
An example has been the deferred payment contract problem
for farmers last year. The IRS issued a technical advice
memorandum that said farmers could no longer use deferred
payment contracts to sell grain and livestock in one tax year
and receive the proceeds in the next year. Thankfully, Congress
fixed this with the legislation last year.
We are concerned that one of the most recent TAMs again
seeks to reinterpret tax policy to go beyond the intent of
Congress. It involves self-employment taxes for farmers on
rental income. In 1996, the IRS issued a TAM that effectively
repealed the longstanding law that allowed farmers to choose
whether their rental income would be subject to self-employment
taxes now set at 15.3 percent.
Congress allowed farmland owners to make the election by
arranging their affairs to intentionally pass or fail a three-
part test. Farmland owners accomplished this election through
the use of their farm lease agreements. The election has been
offered since the fifties when Social Security benefits were
first offered to farmers, enabling retired farmers to choose to
pay self-employment taxes on cash rental income to become
eligible for Social Security.
The recent memorandum now reverses this option and states
that farmland owners that also materially participate in the
farming activity and rent to a farmer or a family farm business
entity, they must pay the 15.3 percent tax on their rental
income.
It doesn't seem fair that farmland owners are now being
singled out to pay self-employment taxes on certain cash rental
income. The self-employment taxes should apply to income from
labor. And the cash rent income is value and equity in the land
and does not represent labor.
It seems extremely unfair to allow an owner of an apartment
complex or other commercial people to be able to not pay self-
employment tax on their cash rental income but farmers still
have to do this.
On my farm in South Dakota, we also have problems, as with
many farms in America, with weather and with prices. So we have
ups and downs in farm income.
In the seventies and the early eighties, income-averaging
was available to help level out this income from year to year.
This last year in the budget bill, income-averaging for farmers
in a limited basis was included. It is sunsetted in the year
2000, and we would like to see that extended.
Additionally, another useful self-help tool has been
proposed. This is called the FARRM, or the farm and ranch risk
management, accounts. These accounts would let qualified
individual farmers and ranchers set aside up to 20 percent of
their farm income each year. These individuals would have to
materially participate in farming with the amount to be set
aside calculated from their Schedule F portion of their tax
return.
The contribution would be tax-deferred, but any interest
earned on the account would be included in the individual's
annual gross income. The distributions would be treated as
taxable income in the year that they were received. Any money
left in the account over the 5-year limit would be subject to a
10-percent penalty. Individual farmers that don't meet the
participation guidelines for 2 consecutive years would have to
immediately distribute the funds in the account.
We think this and other ideas are ones that are fair from a
tax standpoint. And they provide a useful financial management
tool.
Mr. Chairman and Members of the Committee, thank you for
letting us share our views with you, we appreciate it.
[The prepared statement follows:]
Statement of Wayne Nelson, President, Communicating for Agriculture
Chairman Archer and members of the Committee, thank you for
the invitation to testify on important tax issues. My name is
Wayne Nelson and I am President of Communicating for
Agriculture, an association of farmers, ranchers and rural
small business people with members in all 50 states with our
national headquarters in Minnesota. Communicating for
Agriculture celebrated its 25th anniversary last year, and CA
has worked on tax fairness issues affecting farmers, ranchers
and small businesses throughout nearly all of those years. We
want to commend Congress for taking several positive steps last
year, notably on estate tax reform.
We believe, with the U.S. economy and the federal budget
appearing to be in better shape than anytime in recent memory,
there is opportunity to do more. We share the view that
Americans are paying more overall in taxes than they'd like to,
and more than is necessary, for our government systems to run
as efficiently as it can. We understand that taxes are
necessary to maintain our country's infrastructure, our
educational systems, and provide services citizens depend on.
However, we believe a balance can be achieved that would allow
for federal debt reduction, maintaining a balanced budget,
providing for tax reduction, and still improving services.
Mr. Chairman, I operate a farm in southern South Dakota so
I deal with taxes on a frequent basis. It seems that every year
income taxes get more complicated with most farmers and small
businesses unable to do their own tax returns. I know on my
farm I spend a good deal of time and money with my accountant
who does a good job of charting a course through the maze of
complex rules to prepare a tax filing on my operation.
Simplification of the tax code would go a long way toward
helping farms and small businesses and Communicating for
Agriculture supports IRS reform measures presently moving
through Congress. Hopefully, this reform can be quickly enacted
to not only offer better understanding of the laws but also to
put tax payers in a stronger position when disputes arise with
the IRS.
Recently, it seems, the IRS has been using the Technical
Advice Memorandum (TAM) in a more frequent manner, and in a
manner that seemingly skirts or goes beyond the intent of the
tax laws that Congress has previously enacted. It seems unfair
when Congress works hard to deliberate and pass tax
legislation, which is interpreted and applied by the IRS for
many years, only to have it changed for thousands of taxpayers
by a new interpretation growing out of one court case. An
example is the deferred payment contract problem for farmers
last year. The IRS issued a Technical Advice Memorandum that
said farmers could no longer use deferred payment contracts to
sell grain and livestock in one tax year and receive the
proceeds in the next tax year. Thankfully, Congress fixed this
with legislation last year, but it should not have been
necessary to fix a long standing law that had been interpreted
by the IRS to allow deferred contracts in the years past only
to have the interpretation changed by the TAM.
We are concerned that one of the most recent Technical
Advice Memorandums again seeks to reinterpret tax policy to go
beyond the intent of Congress. It involves self employment
taxes for farmers on rental income. In 1996 the IRS issued a
TAM that effectively repealed the long standing law that
allowed farmers to choose whether their rental income would be
subject to self employment taxes now set at 15.3 percent.
Congress allowed farmland owners to make the election by
arranging their affairs to intentionally pass or fail a three
part test. The law provides that if a farmland owner receives
cash rental receipts from: (1) an ``arrangement'' whereby the
farmland is used to produce farm commodities, (2) when the
arrangement requires material participation by the farmland
owner in the production or management of the farm commodities,
and (3) when the farmland owner actually materially
participates in the production or management of the farm
commodities, then the farm land owner becomes liable for the
self employment tax and participates in the social security
system. Farm land owners accomplished this election through the
use of their farm lease agreements. The election has been
offered since the 1950s when social security benefits were
first offered to farmers enabling retired farmers to choose to
pay self employment taxes on cash rental income to become
eligible for social security.
The recent IRS memorandum now reverses this option and
states that farmland owners that also materially participate in
the farming activity and rent to a farmer or family farm
business entity must pay the 15.3 percent tax on the rental
income. The tax code does not require commercial or residential
property owners to pay self employment tax on cash rents. It is
not fair that farmland owners are now being singled out to pay
self employment taxes on certain cash rental income. Self
employment taxes should apply to income from labor. Cash rent
income shows the value of the equity in the land and does not
represent labor. It seems extremely unfair to allow the owner
of a large apartment complex to not pay self employment taxes
on the cash rental income but the farmland owner who might only
rent a few acres has to pay 15.3 percent self employment taxes
on their cash rental income.
Legislation has been introduced in both the Senate and
House to remedy this matter. H.R.1261 and S.529 would reinstate
Congressional intent by restoring the election by farmland
owners. Communicating for Agriculture is working toward the
enactment of this legislation, and we encourage you to include
it in a tax package this year.
On my farm in South Dakota, as well as farms and ranches
all over America, it is common for there to be wide swings in
income from year to year. Agriculture is inherently a volatile
business. The weather plays such a critical role in production,
and most farmers are at the mercy of mother nature. Weather
problems, coupled with uncertain prices for most farm
commodities, makes for widely varied income levels that can
push farmers to a high income tax bracket one year yet leave
them with no income or even a loss the next year when mother
nature and the markets don't cooperate. In the 1970s and early
80s income averaging was available to help level the income
taxes paid by farmers from year to year. Last year's Budget
Bill brought back income averaging on a limited basis for
farmers and ranchers and only until the year 2000. This useful
tool needs to be extended past the next three years.
Additionally, another useful self-help tool has been
proposed that would enable farmers and ranchers to even out tax
payments. The proposal is called FARRM or Farm and Ranch Risk
Management accounts. FAARM accounts would essentially allow
farmers and ranchers to set aside tax deferred income in good
years and draw money back out of the FARRM account in the lower
income years offering a reasonably balanced income from year to
year. These accounts would let qualified individual farmers and
ranchers set aside up to 20 percent of their farm income each
year. These individuals would have to materially participate in
farming with the amount to be set aside calculated from their
schedule F portion of their tax return. The contribution would
be tax deferred but any interest earned on the account would be
included in the individual's annual gross income. There would
be a 5-year limit on deposits to the account so a distribution
would have to be made. Distributions would be treated as
taxable income in the year they were received. Any money left
in the account over the 5-year limit would be subject to 10
percent penalty. Individual farmers that don't meet the
participation guidelines for two consecutive years would have
to immediately distribute the funds in the FARRM account. We
think the FAARM account proposal is a good idea--one is fair
from a tax standpoint, and one that provides a useful financial
management tool that would help producers contend with the
risky, volatile farm economy they face every day.
We thank you for inviting Communicating for Agriculture to
share our ideas and views with you.
Mr. McCrery. Thank you, Mr. Nelson.
And thank all of you for your testimony today. I'm sorry we
got a little behind schedule. We do have another meeting going
on at the Capitol. And, for that reason, we're going to suspend
questions. But if any Member has a question, I would invite
them to submit those questions to witnesses in writing.
Mr. Johnson has a comment, though, that he would like to
make before we move on.
Mr. Johnson of Texas. Thank you.
I just can't resist making a comment. You know, Mr. Blair
mentioned Amarillo. And the agricultural community is talking,
but don't forgot our Nation's cattle growers who are currently
dealing with Oprah Winfrey.
Mr. Serotta, I'm glad you're with us today. And I agree
that the individual alternative minimum tax ought to be
reformed, if not abolished. And I think our Chairman and the
one sitting in the chair now agree with that because the AMT
now is starting to affect hardworking families by penalizing
them for having children. That's the middle-income bracket that
Mr. Moore talked about.
Today after this hearing, I'm going to introduce a bill to
allow families to deduct their personal exemptions when
calculating the AMT, which they can't do under current law
today. It makes no sense to me that Congress granted families
an exemption for their children but then took it away to
calculate the AMT. It was imposed to make the rich pay some
taxes, as you know, and it wasn't meant to penalize middle-
income American parents and children.
With your permission, I will introduce the rest of my
remarks into the record. Thank you all for being here today.
[The prepared statement follows:]
Statement of Hon. Sam Johnson, a Representative in Congress from the
State of Texas
Mr. Serotta--I'm glad you're with us today and I agree the
individual alternative minimum tax (AMT) should be reformed, if
not abolished. The AMT is starting to affect our hard working
families by penalizing them for having children.
Today, after the hearing, I am going to introduce a bill to
allow families to deduct their personal exemptions when
calculating the AMT which they cannot do under current law.
It makes no sense to me that Congress gives families an
exemption for their children but then take it away when they
calculate the AMT. The AMT was imposed to make sure rich people
paid some taxes. It was not meant to penalize middle-income
America.
So I want to make sure our families are not penalized by
the AMT for having children. The message of my bill is simple--
children should not be taxed. Families with children must be
recognized as the future of America and should not be
penalized.
Families should continue to receive personal exemptions
when they calculate their taxes. While I think the best thing
to do would be to eliminate the entire AMT provision, I believe
that, until we can do that, we should protect our parents and
children from higher taxes.
Congress must take a close look at the tax code and make it
as simple as possible, removing provisions like this one that
only make it harder to save and plan for their families'future.
We granted certain personal exemptions to lower the tax burdens
on families. This was the right thing to do because hard
working Americans pay too much in taxes.
Mr. McCrery. Without objection. Thank you, Mr. Johnson. And
thank all of you very much.
The meeting is adjourned.
[Whereupon, at 12:30 p.m., the hearing was adjourned.]
REDUCING THE TAX BURDEN
----------
THURSDAY, FEBRUARY 12, 1998
House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to notice, at 10:13 a.m., in
room 1100, Longworth House Office Building, Hon. Bill Archer
(Chairman of the Committee) presiding.
Chairman Archer. The Committee will come to order.
Today we are holding the third in a series of hearings on
proposals to reduce the tax burden on the American people.
Taxes as a percentage of gross domestic product are currently
at their highest peacetime level in history, and I am committed
to bringing that rate down.
High taxes represent a moral and a social challenge to
families that are struggling to make ends meet. High taxes on
savings and investment represent a direct economic challenge, a
challenge that especially threatens people who are planning for
their retirements. When the government taxes away people's
savings, they'll have nowhere to turn but to the government,
creating even more pressure on the Social Security system. If
you want to save Social Security and help people realize their
retirement dreams, you have to stop the government from taxing
away people's savings. This is why tax relief is a vital part
of saving Social Security.
I believe that we can make changes to the current income
tax and create incentives to save and invest. While we should
not tax capital gains at all, the least we can do is simplify
the current capital gains rule by eliminating the 18-month
holding period. For 16 million Americans, capital gains is a
capital headache. Eliminating the 18-month holding period would
be a major simplification. When this Committee begins its
consideration of the Taxpayer Relief Act of 1998, I plan to
include an elimination of the 18-month holding period in my
mark, making assets held for more than 1 year eligible for the
10-percent and 20-percent rates.
I would refer, now that we head into the income tax
preparation time, the people of this country to the new
Schedule D form. As everyone knows, I continue to do my own
income tax, and I have not begun to try to come to grips with
the complexities in this new Schedule D form on capital gains.
But, believe me, it is going to pose a real headache for the
American people, and we need to change that and simplify it by
reducing the holding period from 18 months to 12 months.
We also need to look at reducing taxes on investment
income, especially for middle-class families. An exemption for
interest and dividend income, such as the one proposed by Mr.
Hulshof, is of particular interest. It would help turn people
who don't save into people who do and encourage those who save
only a little bit to save a little more. It would be a huge
simplification for those 30 million taxpayers who would no
longer have to keep track of 1099 and other investment records.
Finally--I've said this before, and I'm going to say it
again--as the Committee weighs the merits of various tax
proposals, I will be conservative, and I do not intend to over-
promise. I will never, I repeat, tip the budget out of balance.
And now, I am pleased to recognize Mr. Rangel for any
opening statement that he might like to make.
Mr. Rangel.
Mr. Rangel. Thank you so much, Mr. Chairman.
I share your concerns about complexities that we have to
deal with in whole or in part in the Tax Code. I'm very
concerned as to whether or not the Committee is just going to
focus on possible simplifications as relates to capital gains
or how much of the Committee's time is actually going to be
examining taxes or sales taxes or pulling up the Tax Code by
the roots and putting in a new Tax Code.
Because if we are not going to do it in the short time that
we have, I think that the Committee would be better able to
concentrate on the schedule that you drafted rather than the
rhetoric that we hear with those that are on the bus rides
around the country. Certainly, if there is going to be a
serious consideration of replacing the Code, I want to be a
part of that. But it is difficult to do when we have so many
different opinions in the Minority, as well as in the Majority,
as to the best way that we can do that.
Having said that, I will add to complexity by introducing
legislation with Mr. Ensign that would increase the State
volume limit on low-income housing tax credits. Also, I'll be
introducing legislation that the President has suggested,
hoping that we can get bipartisan support in a variety of other
areas that I hope that our staffs can work on together. So that
when we are in agreement with the President's recommendations,
we can do it in a bipartisan way, and so that in areas that
there are disagreements or that the issue will not reach our
calendar, that we would know that.
But most of all, I'm concerned with how much time, since I
understand that we have such a short legislative period, we
would be concentrating on a new system or whether we would just
move forward in trying to make it less complicated than it is
in view after the last tax bill, and wait until the next
session to deal with a broader attempt to substitute or reform
the Tax Code.
Thank you, Mr. Chairman.
[The opening statements follow:]
Opening Statement of Hon. Charles B. Rangel, a Representative in
Congress from the State of New York
Mr. Chairman, I would like to inquire about our Committee
agenda and whether we will see a proposal on tax restructuring
this year. I keep being asked about tax restructuring. Until I
see some details, it is very difficult to respond.
The President has proposed that we use any potential budget
``surplus'' to Save Social Security First. The Democratic
Members of this Committee will introduce legislation today to
act on the President's wise counsel and reserve any surplus for
Social Security. It is important that we maintain the fiscal
discipline that has led to our improved budget outlook. In
addition, the President's budget recommendations contain a
variety of tax provisions which are fully offset and for which
there is fairly broad bipartisan support. I believe that we
should also hold hearings on those issues and have an
opportunity to legislate on those issues this year. For
example:
Low-Income Housing Tax Credit
Mr. Ensign and I have introduced legislation to increase
the State volume limitation on the low income housing tax
credit. I was very pleased that the President's budget
contained a similar increase. There is much bipartisan support
for the low income housing credit.
Education
The President's budget includes an expansion of the
education zone program that we were able to include in last
year's Taxpayer Relief Act. This expansion would provide needed
assistance to State and local governments in meeting the need
to repair and construct public schools. I intend to introduce
legislation soon that includes the President's education tax
incentive and hope there will be bipartisan support for
addressing the issue of school construction. Addressing this
issue through an expansion of last year's Act will minimize
bureaucracy which should alleviate some of the Republican
concerns. Some have argued that the Federal government has no
role in this area. I would point out that the Federal
government has historically assisted school construction
through low-interest rates on tax-exempt bonds. The President's
proposal is another way of assisting local governments in
raising low-cost capital.
Child Care
The President's budget includes tax provisions to assist
working families in meeting child care expenses. Again I
believe there will be bipartisan interest in this issue and I
hope we will be able to have hearings to develop a bipartisan
response.
Extenders
The President's budget proposes an extension of expiring
provisions such as the research credit, work opportunity
credit, welfare-to-work credit, and brownfields tax incentives.
I am hopeful we can work together to address these issues.
Mr. Chairman, I would also like to inquire as to whether
this Committee will consider tobacco legislation this year.
Many of the proposals being discussed have fees that look a lot
like an excise tax. This Committee has a strong jurisdictional
claim on those aspects of the proposed legislation and we
should assert our jurisdiction. In addition, our authority to
establish trust funds enables us to have a voice in how the
proceeds of those taxes will be spent. We should have hearings.
Finally, Mr. Chairman, I would like to say a few words
about the issue of today's hearing. In our rush last year to
provide benefits for capital gains and savings, we lost track
of the need to have simple tax laws.
The capital gain tax reductions in last year's bill are
unnecessarily complex. Eliminating the 18-month holding period
requirement as suggested by the Chairman will not eliminate any
line of the very complex capital gains schedule. Eliminating
that requirement would reduce the amount of gains in the 28-
percent capital gains category but it would not eliminate that
rate category.
The really distressing aspect of the capital gains
provisions of last year's bill, is that they will get worse in
the future. In 2001, another rate category will be added. The
complexities of that new rate will make the calculations
taxpayers are struggling with now look simple.
[GRAPHIC] [TIFF OMITTED] T0897.198
Chairman Archer. The Chair would be most pleased if the
gentleman from New York would give his suggestions on how we
might simplify the Code or how we might, as he said, ``tear it
up by its roots,'' and any recommendations that you have will
be received and thoughtfully considered. The Chair knows of
none so far, but the Chair would certainly welcome them at any
time.
Our first witness today is Mr. Hulshof, a Member of the
Committee----
Mr. Rangel. May I respond to that, Mr. Chairman?
Chairman Archer. Mr. Rangel.
Mr. Rangel. Am I to believe from your remarks that, unless
I introduce a reform bill, we will not be considering one?
Because that's not the first time that you have responded that
way.
Chairman Archer. What I said to the gentleman, I think is
clear: that whether you introduce a bill or whether you make
informal suggestions as to how we might simplify the Code or
completely reform the Code, the Chair will give them full
consideration, whether they be done privately or publicly and
in whatever form. I would be more than happy to receive any
suggestions that you might have.
Mr. Rangel. The Chair is not responsive to my question as
to whether or not the leadership was coming forth with a bill,
but I appreciate your answer that you will entertain any
recommendations that I have, and I thank you for that.
Chairman Archer. The Chair will always be in a position to
prepare a mark for the Committee, and that mark will take into
consideration any suggestions that you might have. As the
gentleman knows, this need not be in formal legislative form.
The mark that the Chair presents to the Committee
traditionally, is not a statutory-language, pre-prepared bill,
but one that is put together after consultation with Members of
the Committee. The Chair would like to include the Minority in
those consultations, but so far has received no suggestions or
recommendations from the Minority.
Mr. Hulshof.
STATEMENT OF HON. KENNY C. HULSHOF, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF MISSOURI
Mr. Hulshof. Thank you, Mr. Chairman, Mr. Rangel, Members
of the Committee, thanks for the opportunity to testify before
you today about a piece of legislation that you, Mr. Chairman,
alluded to, and that is the SAVE Act, and that is the Savings
Advancement and Enhancement Act, legislation that my friend
from Ohio, Mr. Kucinich, and I plan to introduce today.
I also appreciate the chance to have these series of
hearings. You mentioned several times, Mr. Chairman, that the
percentage of taxes of GDP, now nearly 20 percent, is at the
highest rate since World War II, and I have appreciated the
chance to participate in the series of hearings that we've had
on reducing the Federal tax burden on the American people.
As you alluded in your opening comments, as a general
principle, individuals and families in this country need to be
encouraged to save and invest. In fact, the U.S. national
savings rate, as you know, ranks among the lowest of the
industrialized countries, especially among the G-7 countries.
Many economists believe that the reason for this low rate of
savings is because of tax laws that discourage saving in favor
of consumption.
Mr. Kucinich and I believe that this bill is something that
will remedy, at least for the small investor, that bias. As
families sit around the kitchen table this coming April to do
their tax returns, money that they have earned on their
interest-bearing savings account, interest-bearing checking
accounts, money-market accounts, or even wise investments are
included in income for tax purposes. And many of these
individuals who have been slugging away their nickels and their
dimes each year find themselves subject to this tax. Many of
them are middle- and low-income taxpayers. We should be
rewarding their thrift rather than punishing their thrift.
The bill is very simple, and I would invite other Members
of the Ways and Means Committee to cosponsor this legislation.
I think we have 5 Members on right now. But the SAVE Act is
very simple. It would allow an individual taxpayer to exclude
$200 of interest and/or dividend income for tax purposes, or
for joint filers, $400. This exclusion could be made up of a
combination of interest income and/or dividend income. You
know, many of the constructive comments that I heard back in
Missouri in the Ninth District after our tax-relief act of last
year, people were very happy that we enacted the first tax
relief in 16 years, but one of the constructive comments was
the targeted nature of the tax relief, and, as we've already
heard this morning, the discussion about the simplification
issue. The SAVE Act, I think, accomplishes both of those two
goals.
In the tax year of 1995 there were 66 million individual
tax returns that included interest income for tax purposes. In
that same taxable year, 26 million returns included a small
amount of dividend income, and most of those were small
investors. This is not a bill where those on the other side
would say that we're simply giving tax breaks for the wealthy.
Twenty-three percent of those who would get the benefit of this
SAVE Act have incomes between $1 and $15,000, and clearly two-
thirds have incomes between $1 and $50,000. So, we're really
trying to focus on the small investor in the low- to middle-
income families.
If this modest proposal were enacted--and I think that it
is very doable, Mr. Chairman--in total over 30 million tax
returns would no longer have a tax on savings and investment.
Thirty million taxpayers would not be taxed on their thrift
with this $200-$400 exclusion.
As is customary, Mr. Chairman, I would like to have my
entire statement in the record. I have an example that you can
look at particularly as it is compounded interest and certainly
the savings would be modest in the short term, but, again, I
think if you are looking over the long term--and Mr. Chairman,
you mentioned in your opening remarks, as we look at retirement
plans and Social Security and ways that we can help the
American people plan for their retirement, this is the way to
do that especially if we reduce the tax burden over the long
term.
The other point that I'd like to make as far as the across
the board relief is the simplification measure. For a majority
of working men and women, their taxable income consists of
their wages and a small amount of interest or dividend income.
Allowing this $400 exclusion for joint filers eliminates the
need for many individuals below the interest and dividend
thresholds to include this income when they fill out the
returns reducing the number of calculations and also the hassle
of gathering all the 1099 forms from multibanking and checking
accounts--all of that would be greatly reduced with the
introduction and passage of this bill.
And finally, I think that it is consistent with--as was
discussed--major, fundamental tax reform. I know the Chairman's
feelings as far as the consumption tax. This is consistent with
that philosophy as well as even the flat-income tax,
encouraging savings and investment. Again, taxpayers should be
encouraged, not punished for being thrifty. And I think that
this proposal falls right in line with the major tax reforms
that we have been considering.
To anticipate a question from my colleagues as far as the
cost, Joint Tax tells us that the 5 year cost of this
particular provision would be $15.2 billion. Again, so I think
it is very doable.
We would urge other Members to cosponsor this legislation.
Thank you, Mr. Chairman, for giving me and Mr. Kucinich the
opportunity to talk about this bill.
[The prepared statement follows:]
Statement of Hon. Kenny C. Hulshof, a Representative in Congress from
the State of Missouri
Mr. Chairman, I would like to thank you for the opportunity
to testify on behalf of the Savings Advancement and Enhancement
Act (SAVE Act), legislation that Representative Dennis Kucinich
(D-OH) and I plan to introduce today. Likewise, I would like to
thank you for holding the series of hearings on the need to
reduce the federal tax burden. With federal taxes making up
19.9% of Gross Domestic Product in 1998, taxes are now higher
than any point since World War II. These hearings have helped
highlight this fact, and I appreciate the ability to share with
the committee one of my ideas on how to let taxpayers to keep
more of their hard-earned money.
As a general principle, individuals should be encouraged to
save and invest. However, every April, when a family gathers
around the kitchen table to do their tax returns, the money
they have earned from an interest bearing savings or checking
account or from a wise investment is included in their income
for tax purposes. Many of the individuals who find themselves
subject to this tax are low and middle-income taxpayers. It is
wrong to punish these people for their thrift.
That is why Representative Kucinich and I are introducing
the SAVE Act. The bill is quite simple. It allows an individual
taxpayer to exclude the first $200 in interest and dividends,
$400 for joint filers, from their income for tax purposes. The
exclusion could be made up of any combination of interest and
dividends.
Consider the following. In the 1995 tax year, over 66
million tax returns reported interest income. 26 million
returns reported dividend income. All of these individuals
would receive relief under the SAVE Act. Likewise, the Joint
Committee on Taxation estimates that 19 million joint returns
have less than $400 in interest and dividend income. For these
families, their tax on savings and investment would be
eliminated. In total, over 30 million tax returns would no
longer include a tax on savings and investment.
Let me give you a real-life example of how the SAVE Act can
help a family save for the future. Lets assume that a family in
the 28% tax bracket receives a $4,000 gift upon the birth of a
child. They deposit this money in a savings account earning 5%
annually in interest. Under current law, after 18 years, the
family would earn $4,944.78 in interest on their $4,000 in
savings. Likewise, they would pay $1,384.54 in tax on the
interest they earn.
However, under the SAVE Act, the same family under the same
set of circumstances would earn $5,625.51 in interest, $680.73
more than under current law. More importantly, instead of
paying $1,384.54 in tax, the SAVE Act would limit the family's
tax on savings to $30.74 over the course of the 18 years, and
the family would not incur a tax on thrift until the 16th year
of the 18 year time span.
Overall, under the SAVE Act, this family would save
$2,034.53 when compared to the current law tax treatment of
interest and dividend income. For the average family in
Missouri's Ninth District, this $2,034.53 is a significant
amount of money.
The SAVE Act also simplifies the tax code. For the vast
majority of taxpayers, taxable income consists of wages and
minimal amounts of interest income. Allowing the $400 interest
and dividend exclusion for joint filers, $200 for single
filers, eliminates the need for individuals below these
interest and dividend thresholds to include this income when
filling out a tax return. Reducing the number of calculations
that a taxpayer must make when completing their tax return is
certainly a step in the right direction. Also, the hassle of a
taxpayer gathering various 1099 forms from multiple banking and
checking accounts when filling out a tax return will be greatly
reduced.
The SAVE Act is also consistent with the major fundamental
tax reform proposals currently under consideration. Under the
Flat Tax proposed by Majority Leader Dick Armey (R-TX), the 17%
Flat-Tax would apply only to wage, salary and pension income. A
national sales tax would tax consumption, not income. Whether
you support a Flat-Tax or a consumption tax, there is a
consensus. Taxpayers should not be punished for being thrifty.
Mr. Chairman, I thank you for the opportunity to testify
before the committee on behalf of the SAVE Act. As I mentioned
earlier, I stand ready to help you relieve the American people
of their crushing tax burden. I would be willing to answer any
questions members of the committee may have at this time.
Chairman Archer. Thank you, Mr. Hulshof.
Our next witness is Congressman Dennis Kucinich of Ohio.
We're happy to have you before the Committee. I think that this
may be the first time you have testified before----
Mr. Kucinich. Yes, it is.
Chairman Archer [continuing]. This Committee, and I hope
that you will feel welcome, and you may proceed.
STATEMENT OF HON. DENNIS J. KUCINICH, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF OHIO
Mr. Kucinich. I do, and thank you very much, Mr. Chairman,
for the opportunity to come before the Committee.
I am pleased to be here with Congressman Hulshof because I
believe that together we have laid the groundwork for a bill
that can be supported on both sides of the aisle. I am
certainly pleased to work with you on this because I think that
the opportunity is here to come up with a Tax Code that will
benefit millions and millions of Americans and at the same time
simplify the tax process. Those are two tests that I think that
the Chairman would certainly appreciate--I would hope so.
I represent a substantial part of the city of Cleveland and
its southern and western suburbs. In the past I have challenged
the wisdom of certain tax cuts. Last year I opposed tax cuts
because I believe they were designed primarily to--to benefit
primarily the wealthiest while shrinking vital government
services and guarantees.
But this SAVE Act is different and it has a lot going for
it. The SAVE Act is fair, it benefits a lot of people, and it
can be offset with other improvements to the Tax Code.
Now, consider the SAVE Act's fairness. The SAVE Act exempts
from taxation an individual's first $200 in dividend and
interest income, $400 for couples filing jointly. Obviously it
is most valuable to those people whose interest from earnings
and dividends are below the exemption threshold. These are
small savers, and they tend to be people with middle and lower
incomes. Sixty-seven percent of the returns claiming taxable-
interest income were filed by taxpayers with adjusted gross
incomes below $50,000. And 57 percent of returns reporting
dividend income were filed by taxpayers with adjusted gross
incomes below $50,000.
For many small savers, the SAVE Act will exempt all of the
earnings of their savings from taxation. For many others, the
SAVE Act will exempt a large portion of the earnings of their
savings from taxation.
Through the SAVE Act, they can keep what they save. The
SAVE Act will benefit many people. Now, according to the Joint
Committee on Taxation report I have here, half of all taxpayers
reporting taxable interest income in 1995 would not have had to
pay any tax on their interest if the SAVE Act had been in
place. That is a substantial number of people. Now, JCT
calculates, as Mr. Hulshof pointed out, that 30 million
taxpayers would have earned a tax-free rate of return on their
interest and dividend-yielding assets. Again, the majority of
these people are small or modest savers earning low or middle
incomes.
Finally, the SAVE Act can and should be an element in
improving the Tax Code, a project which should find offsets by
closing persistent, unfair tax loopholes. I would hope the
Committee would consider it--closing loopholes that create the
wrong incentives on trade, job creation, and job retention in
the United States. For example, there is a loophole that
exempts U.S. corporations from paying taxes when they move out
of the United States and then ship their goods back to the
United States for sale. That loophole could be closed.
The President has also recommended closing several
loopholes. For instance, the loophole for hybrid transactions
that created unfair advantage for U.S. companies to make
foreign investments rather than domestic investments in job,
plants, and equipment. The President also recommends that this
Committee prepare the country for justice and environmental
cleanup by reinstating superfund taxes so as to make polluters
pay for the cost of cleaning up rather than innocent taxpayers.
Closing these loopholes adds greater fairness to our Tax Code.
In conclusion, Mr. Chairman, the SAVE Act is viable, fair,
and will benefit middle- and low-income savers the most. The
SAVE Act is perfect for my constituents on the west side of
Cleveland and in the surrounding suburban communities who save
for a car, tuition, and vacation. They have saved now in order
to consume later. The SAVE Act gives them a little more of
their savings' earnings, so they can purchase that car a little
sooner or afford a little more tuition. The SAVE Act rewards
them for their thrift.
So, I appreciate the opportunity to work with Mr. Hulshof
and others in this, and am hopeful that you, Mr. Chairman, will
give this favorable consideration and that we can move this
bill forward in this session.
Thank you.
[The prepared statement follows:]
Statement of Hon. Dennis J. Kucinich, a Representative in Congress from
the State of Ohio
Mr. Chairman, Ranking Member Rangel, and members of the
Committee. Thank you for the opportunity to come before you to
speak in favor of the Savings Advancement and Enhancement Act
(SAVE act).
I represent a substantial part of the City of Cleveland and
its southern and western suburbs.
In the past, I have challenged the wisdom of certain tax
cuts. Last year, I opposed tax cuts that were obviously
designed to benefit primarily the wealthiest, while shrinking
vital government services and guarantees. But the SAVE act is
different, and it has a lot going for it. The SAVE act is fair,
it benefits a lot of people, and it can be offset with other
improvements to the tax code.
Consider the SAVE act's fairness. The SAVE act exempts from
taxation an individual's first $200 in dividend and interest
income; $400 for couples filing jointly. Obviously, it will be
most valuable to people whose earnings from interest and
dividends is below the exemption threshold. These are ``small
savers'' and they tend to be people with middle- and low-
incomes. Sixty-seven (67) percent of returns claiming taxable
interest income were filed by taxpayers with adjusted gross
incomes below $50,000. And 57 percent of returns reporting
dividend income were filed by taxpayers with adjusted gross
incomes below $50,000. For many small savers, the SAVE act will
exempt all of the earnings of their savings from taxation. For
many others, the SAVE act will exempt a large portion of the
earnings of their savings from taxation. Through the SAVE act,
they can keep what they save.
The SAVE act will also benefit many people. According to
the Joint Committee on Taxation, half of all taxpayers
reporting taxable interest income in 1995 would not have had to
pay any tax on their interest if the SAVE act had been in
place. That is a substantial number of people. JCT calculates
that 30 million taxpayers ``would have earned a tax-free rate
of return on their interest and dividend yielding assets.''
Again, the majority of those people are small or modest savers
earning low-or middle-incomes.
Finally, the SAVE act can and should be an element in
improving the tax code, a project which should find offsets by
closing persistent, unfair tax loopholes. The Committee should
consider closing loopholes that create the wrong incentives on
trade, job creation and job retention in the U.S. For instance,
there is a loophole that exempts U.S. corporations from paying
taxes when they move out of the U.S. but then ship their goods
back to the U.S. for sale. That loophole should be closed. The
President has also recommended closing several loopholes. This
Committee can prepare the country for justice in environmental
clean-up by reinstating Superfund taxes so as to make polluters
pay for the cost of cleaning up, rather than innocent
taxpayers. Closing those loopholes adds greater fairness to our
tax code.
In conclusion, the SAVE act is viable, fair and will
benefit middle- and low-income savers the most. The SAVE act is
perfect for my constituents on the West Side of Cleveland and
surrounding communities, who save for a car, tuition, and
vacation. They save now in order to consume later. The SAVE act
gives them a little bit more of their savings' earnings, so
they can purchase that car a little sooner, or afford a little
more tuition. The SAVE act rewards them for their thrift.
Chairman Archer. I compliment both you gentlemen for your
work on this SAVE Act.
Mr. Kucinich, are you aware of the fact that if we
reinstate the superfund tax that all that money will have to go
to cleanup waste sites?
Mr. Kucinich. Well----
Chairman Archer. How could that be used to offset your tax
suggestion?
Mr. Kucinich. I would say that if you did reinstate that to
clean up waste sites, that would create further offsets in
other areas that would benefit the taxpayers.
Chairman Archer. That is new spending, additional spending
that's not going on right now. The tax is earmarked and
designed specifically for the purpose of cleaning up. I'm
surprised that you would suggest that as an offset for a tax
reduction when it is already committed to and earmarked for
other spending.
Mr. Kucinich. The suggestion was made in the spirit
ofpointing out how we can force more accountability in the Tax
Code and at the same time achieving some benefits for the
constituents.
Chairman Archer. Well, I would simply say to the gentleman
that before this Committee we really have to be very precise as
we talk about offsets. If the gentleman would like to submit a
list of the specific offsets--not including the superfund tax
which clearly is committed to a specific spending program that
the people of this country believe is needed--we'll be happy to
receive them. If the gentleman is referring to the list that
the President has set up----
Mr. Kucinich. I am.
Chairman Archer. Then I would simply tell him that even the
Washington Post had an article last week that says it slams the
middle class, hits widows with annuities and taxes savings
which are inside buildup of life-insurance policies which hit
the holders of those policies--and those are the major areas of
revenue raising. If you call those loopholes, I think that you
are going to find an awful lot of people in this country,
including widows with annuities, will come out and say, ``Hey,
wait a minute, that's not a loophole.''
Mr. Kucinich. I don't think that I disagree with you on
that, but when I spoke to superfund, I was relating directly to
the President's comments on the--on revenue suggestions.
Chairman Archer. Well, those are most certainly revenues,
but they are committed and spoken for revenues that will have
to go into the payment for the cleanup which will not occur
without those revenues. Certainly the gentleman would not want
to see those moneys go for tax reduction and not cleaning up
the waste sites?
Mr. Kucinich. Well, I have been a strong supporter of that,
Mr. Chairman, and at the same time, I think that the
President's revenue suggestions would not deny the concerns
that you have, but at the same time there is a suggestion that
the revenue would be there with those offsets.
Chairman Archer. Well, let me be sure that I understand
you. If we get a superfund reform bill that structurally cleans
up waste sites instead of putting money into the hands of
lawyers, then we will consider reinstating the superfund taxes
so that money can then be spent to cleanup waste sites. Now, do
you think it can be spent twice? Do you think it can be also
spent to pay for tax reduction in the SAVE Act?
Mr. Kucinich. I'd be willing to consider the Chairman's
views on this.
Mr. Hulshof. I think, Mr. Chairman, you point out the very
difficult prospect that we face as a Committee. And I think
that the American people don't understand the fact that if, in
fact, we have true, honest surpluses, that those surpluses
can't be used for tax reduction. And I think that certainly,
under current budget laws being as they are with PAY-GO, and
coming up with revenue offsets, that's the difficulty. When we
try to craft and cobble together additional tax relief for the
American people under present budget laws it is very difficult,
and I think it is a misnomer because folks in my district
believe that if there is a surplus that those moneys can be
immediately used to reduce taxes. And we need to help make that
case to the American people--if that is the way that we want to
go--that the budget rules would have to be changed. But
certainly--I hope that whatever we decide as far as revenue
offsets and additional tax reductions and where that money
should come from, I don't think that it in any way prejudices
the idea of the SAVE Act.
And again, we think that as we focus on savings and
investment, particularly for the small investor, that the
concept of the SAVE Act is good. It is doable in the sense that
it is a $15 billion--over 5 years, which is, granted,
significant, but I think it is still an attainable goal. And I
certainly would hope that if we are able to put together a tax
bill in this session, that you would look favorably, Mr.
Chairman, and include this in the mark.
Chairman Archer. Well, I think that the gentleman's
response is a good one, and certainly, as I have said in my
preliminary comments, I compliment both of you for what I think
is a constructive proposal. But I'm not sure that it is
realistic to say that we're going to pay for this by closing
loopholes and reinstating the superfund tax. That just doesn't
mesh. Hopefully when we do have a tax bill we will be able to
offset it by using surplus, which is a result of people paying
in more taxes. But the only reason that we will have a surplus
is the dramatic increase in tax we take out of the American
people's pockets. And surely they should be entitled to get
some of that back since they are the ones providing the surplus
in the first place.
Let me ask you one specific technical question, and then
I'll move on to recognizing other Members of the Committee. Is
it your intention to give an exemption to everyone irrespective
of the amount of interest and dividends that they have, or will
it only apply to those with under $200 and $400?
Mr. Hulshof. No, sir. Our intent is for this to be
complete, across-the-board relief, no phaseouts. And so
certainly those that recognize great amounts of investment
income would be allowed to have this exclusion as well, but
clearly those on the low-income spectrum are the ones that
proportionally gain. And the $400 exclusion for an investor who
derives great amounts of investment income, it would not be
that significant. It would be less significant to that
investor.
Chairman Archer. Thank you.
Does any other Member wish to inquire?
Mrs. Johnson.
Mrs. Johnson of Connecticut. Just briefly.
Thank you for your testimony. Do you protect this from the
alternative minimum tax, or is it given preference under the
alternative minimum tax, so that the alternative minimum tax
can't deny people this protection of their savings?
Mr. Hulshof. Mrs. Johnson, that is a great question, and as
it is presently drafted, no, there is no particular protection
against the alternative minimum tax, but I would be happy to
look at that because I think----
Mrs. Johnson of Connecticut. I think we have to be much
more conscious of that in future legislation. I thank you for a
very thoughtful proposal.
I would, Mr. Kucinich, I would just share with you that
some of the proposals in the President's tax bill this time are
proposals that he made last time, and they have no support by
Members of either party because some of them, in fact, would
force jobs offshore. His proposal to tax annuities this time is
particularly destructive to middle-income women for whom it is
a key component of retirement security. So, unfortunately, we
cannot look at his tax proposals to fund proposals like this
that frankly are very thoughtful and in our interest. And I
appreciate your proposing them.
Thank you.
Chairman Archer. Mr. Ramstad.
Mr. Ramstad. Mr. Chairman, just very briefly.
First of all, I want to thank you, Mr. Chairman, for your
leadership in calling this hearing on these critical savings
and investment-tax issues, and I want to compliment my
colleagues at the witness table for what is really a straight
forward proposal with twin benefits as I see it. A broad-base
tax relief without complexity that encourages savings and
investments.
However, I must say to Mr. Kucinich--I do share my
colleague's concerns about what the administration calls
``unwarranted benefits.'' I know in your testimony you state
that the cost of the SAVE Act could be offset with improvements
in the Tax Code. You allude to the loopholes. But I think that
we all have to take heed of the study not too long ago by
Professor Feldstein at Harvard--former chairman of the Council
of Economic Advisors. He very carefully and very studiously,
after exhaustive research, documented the fact that were we to
convert all of our current savings to plant and equipment, our
savings rate is so abysmally low that we could not sustain any
long-term economic growth. That is a frightening indictment of
our savings rate in this country which rates, as we all know, a
distant last among our G-7 trading partners.
So, I certainly share the Chairman's concern and Mrs.
Johnson's concern about the administration's proposals which
really attack long-term savings vehicles that are so important
to the middle class and those who are trying to save in this
country.
So, I hope that you will review, Mr. Kucinich, all of these
so-called ``unwarranted benefits'' because I believe that they
are very counterproductive to our goal of encouraging savings
in this country.
Chairman Archer. Mr. Collins.
Mr. Collins. Thank you, Mr. Chairman, and thank you two
gentlemen for this proposal. I've always been opposed to taxing
interest earned on savings. I think it is a disincentive to
save.
Mr. Kucinich, Mr. Hulshof mentioned some real problems that
we face when it comes to the budget law and restraints there
based on the fact that that the PAY-GO versus the fact that we
can't use savings in discretionary areas for tax relief. Do you
have a position or any input on the suggestions that Mr.
Hulshof has indicated need to be addressed or looked at in the
budget law itself?
Mr. Kucinich. As part of this process of working on this
bill, I am getting more and more into some of these issues the
kind that Mr. Hulshof has addressed. And I think that these are
issues that are worthy of discussion. I keep an open mind on
it. The Chairman has made some comments which I am grateful
for. I have some of my own ideas about how we come to a
situation where--for example, on the superfund, if you will--
which is something that I am very concerned about--how the
taxpayers' money ends up--taxpayers end up paying a substantial
amount of money for the bailout, and I happen to come from the
persuasion that we should have done more to have the industries
pay more for that instead of taxpayers.
Now, I have a different--you know, I come to this
recommendation with a different point of view than some of you
may. But through my presence here, I demonstrate that though we
may be on different sides of the aisle there are issues that we
might be able to agree on even though we may have different
conclusions as to why--or different reasons why we would take
this particular position. And so, as I work in a bipartisan
manner, I am understanding a little bit more of your point of
view about some of these issues, and I hope that this will be
an opportunity to present my point of view as well. And through
that dialog, perhaps, maybe we can both--certainly on my part,
maybe I can learn a little bit more about your views.
Mr. Collins. Well, it's always good to have an open dialog
and debate, but I do recommend that you heed closely the
concerns that Mr. Hulshof mentioned in the area of restraints
that we have when it comes to budget law, and how we can--as we
save funds through different programs, we are not allowed to
use those funds for tax relief to the taxpayer.
Mr. Kucinich. I understand it----
Mr. Collins. I urge you to pay close attention to that.
Mr. Kucinich. I will do that, and I appreciate your word of
caution on that.
Chairman Archer. Mr. Weller.
Mr. Weller. Thank you, Mr. Chairman, and again, I want to
commend you for your leadership on this series of hearings on
reducing the tax burden on middle-class families.
I also want to commend Representatives Hulshof and Kucinich
for your initiative here. When I was in legislature, I had a
similar piece of legislation at the State level, so I think
that any incentive to increase savings, particularly for
retirement--I know that Representative Hulshof and I have had
conversations, and one of the concerns that I have is that so
many Americans have so little in savings for their retirement.
I saw a statistic this past fall where the average 55-year-old
had less than $10,000 in savings for retirement. And frankly,
that is scary when you think about it. And that is why ideas
such as this legislation are good ones that we should be
looking at.
I also want to commend the sponsors, too, for recognizing
the need to avoid the marriage-tax penalty. Because, in your
legislation, by doubling the exemption for a married couple by
$200 to $400, you avoid any marriage-tax penalties, and that
has been one of the problems with the President's ideas of
targeted tax cuts because every time he proposes a targeted tax
cut, he always seems to create another marriage-tax penalty.
So, I want to commend you for that.
And I have a question that I would like to address to Mr.
Kucinich, as part of, I guess, my friend from Georgia, Mr.
Collins had mentioned. You know, this--your proposal here, of
course, is an idea that we hope will encourage people to be
able to save for their retirement. And the President, in his
budget this past week, proposed a new tax on a retirement
vehicle used by many middle-class Americans, annuities, which
are, of course, an insurance product that many Americans
purchased for their retirement plan.
I was wondering, how do you feel? Do you support the
President's new tax on annuities?
Mr. Kucinich. I have--from what I have read about it and
understand about it, I haven't advocated that position. I'm--
I'd like the chairman to understand that in this last budget I
was one of the people from the other side of the aisle. I voted
against that last budget and the last tax proposal because I
didn't agree with it. And I'm not in favor of this particular
point that Mr. Weller is bringing out. I--while I consider
myself supportive of many of the President's proposals, I don't
agree with him on that one, and I'm willing to say so publicly.
Mr. Weller. So, you oppose his tax on annuities?
Mr. Kucinich. The one that you just talked about, I would
say that I'm not in favor of it at this time; I don't favor it.
Mr. Weller. Thank you.
Thank you, Mr. Chairman.
Chairman Archer. Does any other Member wish to inquire?
Mr. Collins. Mr. Chairman, if I could----
Chairman Archer. Mr. Watkins.
Mr. Collins [continuing]. Just make one quick statement.
I was in Japan 3 weeks ago with a group, and the parliament
members of the Japanese Government as well as some of the other
officials reiterated several times that the personal savings in
Japan is equivalent to between $10 and $11 trillion, far
exceeding what we save here in this country. So, I appreciate
what your doing.
Chairman Archer. Mr. Watkins.
Mr. Watkins. I'd like to thank the Members. We just got
back from a retreat some would say that they like to think of
it as being an advance--and I think that one of the advance
things that we've got to do is increase savings. We're the
lowest industrialized nation in the world with regard to
savings, I think about 3.5% or so. And one of my closing
remarks down at the retreat, or advance, was the fact that if
we didn't increase our savings, it was going to be hard for us
to maintain and sustain the economic growth that we have. And I
think the Chairman talked about a couple of ways that might be
considered along with other things that could be done. And what
concerns me is--the gentleman from Georgia just mentioned
Japan. The Asian countries, Japan specifically, has
underwritten a lot of our government securities over the last
few years, in the early eighties, and they have somewhere
between $150 billion and a $200 billion invested already in
some of the other Asian areas. If a serious problem develops
there, they will be pulling their investments and moneys out of
our country and trying to shore up, I think, a lot of their
other investments. I think they won't have much choice.
And we've seen what the depressed real estate values in
Thailand did to Hong Kong. It dropped that market by 10
percent, and it is dropping our GDP, all estimates would be,
about a half percent of the GDP. And so that doesn't encompass
the entire Asian problem.
And we have got to increase, I think as rapidly as we can,
the savings of this country so we can be in control of our own
destiny, so to speak, a lot more.
So, I commend everyone for trying to work on that area.
Thank you.
Chairman Archer. Thank you, gentlemen.
Mr. Hulshof. Thank you, Chairman.
Mr. Kucinich. Thank you.
Chairman Archer. We appreciate your presentation.
Our next panel, Mr. Bloomfield, Mr. Entin, and Mr.
Stevenson, would you come to the witness table?
Welcome, gentlemen. The rules of the Committee are as
follows. We would be pleased if you would limit your oral
presentation to 5 minutes or less. The lights in front of you
will tell you--when the yellow light comes on, it will be 1
minute to go, and when the red light comes on, it is 5 minutes.
Your entire written statements, without objection, will be
included in the record. And we are very pleased to have all
three of you before the Committee. If you will identify
yourselves at the beginning of your testimony for the record,
then you may proceed.
Mr. Bloomfield, would you lead off, please?
STATEMENT OF MARK BLOOMFIELD, PRESIDENT, AMERICAN COUNCIL FOR
CAPITAL FORMATION, ACCOMPANIED BY MARGO THORNING, SENIOR VICE
PRESIDENT AND CHIEF ECONOMIST
Mr. Bloomfield. Mr. Chairman, my name is Mark Bloomfield. I
am president of the American Council for Capital Formation, and
I'm accompanied by Dr. Margo Thorning, our senior vice
president and chief economist.
Let me make five brief points today.
First, an overview: The ACCF strongly supports the emphasis
Ways and Means Chairman, Bill Archer, has placed on the
significant impact of tax policy on savings and investment that
is so critical for our continued economic growth. Although the
current economic news is good, I share the concerns of the new
GAO report that even though Federal budget deficits have
declined recently, total national savings and investment remain
significantly below the average of the sixties and seventies
and continue to compare unfavorably with our that of
international competitors.
Tax policy should be supportive of capital formation if
real wages of U.S. workers are to increase, living standards
are to advance at a faster pace, and the United States is to
maintain the economic strength necessary to sustain its lead in
world affairs.
Second, the impact of tax policy on savings and investment
and economic growth. This Committee is to be commended for its
role in the capital formation provisions in the Taxpayers'
Relief Act of 1997. In particular, we need to build on the
recent progress in capital gains, IRAs, pension, and estate tax
relief and reform of the alternative minimum tax. We must now
move forward to further prosaving and proinvestment tax policy
initiatives in order to maintain strong economic growth. As we
move into the 21st century, we need to address new challenges
such as demographic changes, more stringent environmental
regulations, and the inadequate level of U.S. savings and
investment.
Third, Mr. Chairman, the impact of fundamental or
structural tax reform on economic growth. In my testimony
today, I have summarized several analyses that suggest that
substituting a broad-based consumption tax for the current
Federal income tax could have a positive impact on economic
growth and living standards.
I am particularly intrigued by a relatively new study,
Taxation and Economic Growth, by Professor Jonathan Skinner of
Dartmouth and Eric Engen of the Federal Reserve who examined
the correlation between the type of tax system--income versus
consumption tax--levels of economic growth over the period of
1965 to 1991 for a large sample of countries. The conclusion
was that income taxation is more harmful to growth than a
broad-based consumption tax.
The key question, of course, is whether it would be worth
the inevitable disruption, cost, and confusion that switching
to a totally new tax system would create. I believe that the
answer is yes. More reliance on consumption tax could have a
profound, positive effect on long-term economic growth. And
even small changes in economic growth rates can make a big
difference to living standards.
Fourth, the short-term agenda before this Committee. While
the long-term goal of U.S. Federal tax policy should be the
shift toward a broad-based consumption tax under which all
income that is saved is exempt from tax, in the short term
there are steps forward that the Committee should take and
steps backward that the Committee should avoid.
Steps forward: We applaud Chairman Archer for his
announcement today that the Chairman's mark will propose to
eliminate the 18-month holding period. We also urge the
Committee to further cut individual capital gains tax rates,
cut the corporate capital gains rate to restore the historic
parity between the individual and corporate capital gains,
expand further IRAs, and strengthen the pension system.
We also want to strongly commend Congressman Hulshof for
his proposal to restore the dividend-interest exclusion. And I
also want to take note of the Individual Investment Accounting
Act of H.R. 984, introduced by Mr. McCrery, which is an
unlimited IRA.
I also want to stress that all of these initiatives must be
made in a fiscally responsible manner.
Steps backward: We urge the Committee to weigh carefully
the proposals, including the revenue raisers, President Clinton
has made to ensure that any negative impact on savings and
investment is avoided.
Fifth, long-term goals. Voter discontent with the income
tax, recognition that today's balanced budget is likely to be
short-lived, growing awareness that the U.S. Tax Code is biased
against savings and investment, increasing concern with tax
impediments to the ability of U.S. firms to compete in the new
global marketplace and the growing expert opinion that tax
reform could raise total output, all argue that fundamental tax
reform should be a key long-term goal of U.S. policymaking.
In conclusion, Mr. Chairman, you have served on the Ways
and Means Committee for some 28 years. We, at the American
Council for Capital Formation, are celebrating our 25th
anniversary. We want to take this opportunity to thank you for
many years of trying to fix the income tax, whether it was the
Archer-Wagner capital cost recovery initiative in the early
years or the Archer capital gains tax initiative or the capital
formation measures in last year's tax bill. We now look forward
to working with you and this Committee on more basic,
structural changes in U.S. tax policy to enable this country to
face the economic challenges of the 21st century.
Thank you.
[The prepared statement follows:]
Statement of Mark Bloomfield, President, American Council for Capital
Formation
Introduction
My name is Mark Bloomfield. I am president of the American
Council for Capital Formation (ACCF). I am accompanied by Dr.
Margo Thorning, our senior vice president and chief economist.
The ACCF represents a broad cross-section of the American
business community, including the manufacturing and financial
sectors, Fortune 500 companies and smaller firms, investors,
and associations from all sectors of the economy. Our
distinguished board of directors includes cabinet members of
prior Republican and Democratic administrations, former members
of Congress, prominent business leaders, and public finance
experts.
The ACCF is now celebrating its twenty-fifth year of
leadership in advocating tax and regulatory policies to
increase U.S. saving, investment, and economic growth. Our
testimony today begins with a discussion of trends in U.S.
capital formation and the impact of tax policy on economic
growth. Next, we outline a short-term tax policy agenda,
including shortening the 18-month capital gains holding period,
reducing individual and corporate capital gains tax rates,
expanding saving incentives such as Individual Retirement
Accounts (IRAs), restoring the dividend and interest exclusion,
and strengthening the pension system. We conclude with options
for long-term, fundamental tax reform. These policies will
promote increased U.S. saving and capital formation and lead to
strong and sustainable economic growth as our nation enters the
twenty-first century.
We vigorously support the emphasis that Chairman Archer has
placed on the significance of saving and investment for
economic growth. Tax policy should be supportive of capital
formation if real wages for U.S. workers are to increase,
living standards are to advance at a faster pace, and the
United States is to maintain the economic strength necessary to
sustain its leading role in world affairs.
The Impact of Tax Policy on Saving, Investment, and Economic Growth
The Ways and Means Committee is to be commended for its
role in the pro-capital formation provisions in the Taxpayer
Relief Act of 1997, including the reduction in individual
capital gains tax rates, expansion of IRAs, estate and gift tax
relief, and reform of the corporate alternative minimum tax.
We must now move ahead to further pro-saving and pro-
investment tax policy initiatives. Although the short-term
outlook for the U.S. economy suggests continued growth, long-
term strength and economic stability require well-thought-out
changes in tax policy. In order to maintain strong economic
growth as we move into the twenty-first century, the United
States must address new challenges such as the demographic
changes that will leave the United States with a smaller ratio
of workers to retirees, more stringent environmental
regulations, and inadequate levels of U.S. saving and
investment over the long term. Without sufficient saving and
investment and cost-effective regulatory policies, the United
States cannot continue indefinitely to enjoy one of the highest
living standards in the world.
Investment spending in the United States in recent years
compares unfavorably with that of other nations as well as with
our own past experience. From 1973 to 1995, gross
nonresidential investment as a percent of gross domestic
product (GDP) was lower for the United States than for any of
our major competitors (see Table 1). The U.S. net saving rate
during the same period is also low relative to that of most
other industrialized countries, averaging 5.9 percent compared
to 18.8 percent in Japan, 10.4 percent in West Germany, and 8.0
percent in Canada. Though the U.S. economy is currently
performing better than the economies of most other developed
nations, in the long run our low saving and investment rates
will inevitably result in a growth rate far short of our true
potential.
International comparisons aside, even more disturbing is
the fact that net business investment in this country has in
recent years fallen to less than 60 percent of the level of the
1960s and 1970s. Net private domestic investment averaged 8.9
percent of GDP from 1960 to 1980; since 1991, it has averaged
only 5.6 percent (see Table 2). The U.S. net private domestic
saving rate, a key determinant of U.S. investment, has also
fallen sharply from an average of 8.1 percent in the 1960-1980
period to only 5.7 percent of GDP in the 1990s.
Numerous scholarly studies by top-flight experts such as
Harvard University's Dale Jorgenson, University of California's
J. Bradford De Long, Treasury Deputy Secretary Lawrence Summers
and others conclude that investment in plant and equipment is
the key factor in increasing productivity and economic growth.
Thus, tax policy to promote higher levels of saving and
investment is critical to the United States' future prosperity.
Recent Evidence on the Impact of Tax Policy and Economic Growth
To those who favor a truly level playing field over time to
encourage individual and business decisions to save and invest,
stimulate economic growth, and create new and better jobs,
savings (including capital gains) should not be taxed at all.
This view was held by top economists in the past and is held by
many mainstream economists today.
This is primarily because the income tax hits saving more
than oncefirst when income is earned and again when interest
and dividends on the investment financed by saving are
received, or when capital gains from the investment are
realized. The playing field is tilted away from saving and
investment because the individual or company that saves and
invests pays more taxes over time than if all income were
consumed and no saving took place. Taxes on income that is
saved raise the capital cost of new productive investment for
both individuals and corporations, thus dampening such
investment. As a result, future growth in output and living
standards is impaired.
While fundamental reform of the U.S. federal tax code
continues to interest policymakers, the public, and the
business community, the key question is whether it would be
worth the inevitable disruption, cost, and confusion that
switching to a totally new or substantially revised system
would create. Several new analyses by academic scholars and
government policy experts suggest that substituting a broad-
based consumption tax for the current federal income tax could
have a positive impact on economic growth and living standards.
The macroeconomic models used by the scholars in the studies
described below incorporate feedback and dynamic effects in
simulating the impact of adopting either a broad-based
consumption tax or a ``pure'' income tax.
For example, in Simulating U.S. Tax Reform, Professors Alan
Auerbach of the University of California and Laurence J.
Kotlikoff of Boston University, Drs. Kent A. Smetters and Jan
Walliser of the Congressional Budget Office (CBO), and David
Altig of the Federal Reserve Bank of Cleveland analyze the
impact of fundamental tax reform on equity, efficiency, and
economic growth.'' \1\
The authors use a general equilibrium model developed by
Professors Auerbach and Kotlikoff to examine five tax reforms
spanning the major proposals now under discussion. Each of the
reforms replaces the federal personal and corporate income
taxes, and each is simulated assuming the same growth-adjusted
levels of government spending and government debt. The reforms
are a ``clean'' income tax and four types of consumption taxes.
These consumption taxes are: a) ``clean'' consumption tax; b) a
Hall-Rabushka flat tax; c) a Hall-Rabushka flat tax with
transition relief; and d) Princeton University Professor David
Bradford's ``X tax.''
The clean income tax eliminates all personal exemptions and
deductions, and taxes labor and capital income at a single
rate. The clean consumption tax differs from the clean income
tax by permitting expensing of new investment (meaning that the
total cost of the investment is deducted in the first year).
This tax is implemented as a tax on wages with all saving
exempt from tax at the household level, and as a cash-flow tax
on businesses.
The Hall-Rabushka flat tax differs from the consumption tax
by including a standard deduction against wage income and by
not taxing the rental value of owner-occupied housing and the
value of services provided by consumer durables. The flat tax
with transition relief permits continued depreciation of
capital in existence as of the reform. Finally, the Bradford X
tax combines a progressive wage tax with a business cash-flow
tax where the business cash-flow tax rate equals the highest
tax rate applied to wage income.
Auerbach et al. conclude that switching to a consumption
tax can offer significant economic gains. The Bradford X tax,
to which the authors give the highest marks for its impact on
equity, efficiency, and economic growth, raises long-term
output by 7.5 percent and provides no transition relief from
its expensing provisions. It also hits the rich with higher
marginal tax rates than the poor. It is not surprising, then,
that in the long run the X tax helps those who are poor by more
than it helps those who are rich, the authors note. Still,
under the X tax there are no long-run losers; even the rich are
better off. Transition relief and adjustments that prevent
adverse distributional effects lessen the positive impact of
tax reform on the economy.
Another recent study, the Joint Committee on Taxation's Tax
Modeling Project and 1997 Tax Symposium Papers, summarizes the
results of a number of scholars who compared the macroeconomic
consequences of a broad-based unified income tax (a ``clean''
income tax in Auerbach's terminology) to those of a broad-based
consumption tax.'' \2\ Participants included Roger E. Brinner,
DRI/McGraw-Hill; Eric M. Engen, Federal Reserve Board of
Governors; Jane G. Gravelle, Congressional Research Service;
Dale W. Jorgenson, Harvard University; Laurence J. Kotlikoff,
Boston University; Joel L. Prakken, Macroeconomic Advisers;
Gary Robbins, Fiscal Associates; Diane Lim Rogers, CBO; Kent A.
Smetters, CBO; Peter J. Wilcoxen, University of Texas; Jan
Walliser, CBO; and John G. Wilkens, Coopers & Lybrand.
The economic impact of a ``pure'' income tax compared to a
``pure'' consumption tax is shown in Table 3. The effects of
the consumption tax proposals on GDP are generally positive
over the medium and long terms, although the magnitude of these
effects varies widely. For example, the Jorgenson-Wilcoxen
model predicts that under a consumption tax, real GDP would be
3.3 percent higher each year in the long run compared to 1.3
percent higher under a unified income tax. The Auerbach,
Kotlikoff, Smetters, and Walliser model predicts even greater
gains in the long run (7.5 percent) under a consumption tax and
losses (-3.0 percent of GDP) under a unified income tax.
Similarly, the Engen-Gale analysis shows that the capital stock
would be 9.8 percent higher in the long run under a consumption
tax but 1.6 percent smaller under a unified income tax compared
to current law. The consensus seems to be that the economy
would fare better under a ``pure'' consumption tax than under a
``pure'' income tax or under current law.
In still another new report, The Economic Effects of
Comprehensive Tax Reform, the CBO analyzes the effect of
switching from the federal income tax to a comprehensive
consumption-based tax using a general equilibrium model
developed by University of Texas's Don Fullerton and Diane Lim
Rogers of CBO.'' \3\
CBO's analysis shows that substituting a broad-based
consumption tax for an income tax would probably increase
national saving and ultimately raise the living standards of
future generations. It would increase the capital stock and
raise the level of national output by between 1 percent and 10
percent, although CBO concludes that increases at the upper end
of that range are unlikely.
The reform might be expected to increase economic
efficiency as well as output for a number of reasons, according
to the CBO study. First, the switch to a consumption base would
eliminate the influence of taxes on the timing of consumption.
Second, the new system might treat different sources' uses of
income more uniformly by including more of them in the tax base
and subjecting all of them to similar tax rates. Third, a
broader base would allow lower overall marginal tax rates,
reducing the amount by which taxes affect relative prices and
hence all kinds of economic decisions. CBO notes, however, that
efficiency is not the only criterion to use in judging the
desirability of tax reform. Administrative and compliance costs
are other important factors. If a consumption tax offered
substantial gains from reduced complexity, then even a minimal
gain in economic efficiency would be an added bonus.
Another relatively recent study, Taxation and Economic
Growth, by Professor Jonathan Skinner of Dartmouth College and
Eric M. Engen of the Federal Reserve Board of Governors,
examines evidence on taxation and growth for a large sample of
countries.'' \4\ The type of tax system a country chooses
significantly affects that nation's prospects for long-term
economic growth, according to Skinner and Engen. Figures 1 and
2 show the correlation in the OECD countries between income
taxes and economic growth and between consumption taxes and
economic growth over the period 1965-1991. These scatter plots,
largely confirmed in regression analysis, suggest that income
taxation is more harmful to growth than broad-based consumption
taxes, the authors note. Skinner and Engen's study also
suggests that tax policy does affect economic growth and that
lower tax rates do enhance economic growth. For example, a
major tax reform plan which reduces marginal tax rates by 5
percentage points will increase growth by 0.2 to 0.3 points.
Even modest growth effects can have an important long-term
impact on living standards, Skinner and Engen note. For
example, suppose that an inefficient structure of taxation has,
since 1960, retarded growth by 0.2 percent annually.
Accumulated over the past 36 years, the lower growth rate
translates to a 7.5 percent lower level of GDP in 1996, or a
net reduction in output of more than $500 billion annually.
Thus, the potential effects of tax policy, although difficult
to detect in the time-series data, can have potentially very
large effects over the long term.
The new studies described above reach the same conclusion
about the beneficial effect on economic growth of switching to
a broad-based consumption tax as earlier research by scholars
such as John Shoven and Lawrence Goulder of Stanford University
and Dale Jorgenson of Harvard University and Joel Prakken of
Macroeconomic Advisers in St. Louis, Missouri.'' \5\
Unfinished Business in Tax Policy Reform: Short-Term Agenda
The long-run goal of U.S. federal tax policy should be to
shift toward a broad-based consumption tax under which all
income that is saved is exempt from tax. In the short term,
there are steps forward the Ways and Means Committee could take
and steps backward the Committee should avoid. With regard to
the latter, President Clinton has made proposals, including
revenue raisers, that the Committee must weigh carefully to
ensure that they minimize any negative impact on saving and
investment. As to the former, we will comment on new saving and
investment incentives and modifications to the capital gains
law, as requested in the notice of this hearing.
Shorten the Eighteen-Month Holding Period for Capital Gains
The 1997 tax act contained a substantial reduction in
individual capital gains tax rates. For example, The Taxpayer
Relief Act of 1997 reduced the top capital gains rate from 28
to 20 percent on assets held for 18 months or longer. Under
prior law, the holding period for a long-term gain was only 12
months. While the capital gains tax rate reduction with a 12-
month holding period was estimated by Allen Sinai of Primark
Decision Economics and David Wyss of DRI/McGraw-Hill to reduce
capital costs by three to four percent, the requirement that
assets be held for 18 months rather than 12 months as under
prior law tends to diminish the effectiveness of the tax cut.
The longer the required holding period before an investor can
realize a capital gain, the greater the risk. A higher risk
premium means a higher cost of capital; thus less investment
will be planned than if the holding period were 12 months. The
18-month holding period also adds an unnecessary layer of
complexity to the code. For example, prior to the Taxpayer
Relief Act of 1997, Schedule D, the IRS form for reporting
capital gains and losses, had only 23 lines. The Schedule D for
1997 contains 54 linesmore than double the previous number.
In addition, most of our international competitors have a
holding period for long-term capital gains of one year or less
(in fact, many exempt long-term gains from tax). Restoring the
12-month holding period would be a positive step toward
lightening taxes on saving and investment.
Individual Capital Gains Tax Rates
Additional capital gains tax reductions would help move the
U.S. tax code toward a consumption tax base and enhance
economic growth. Previous studies by Allen Sinai and David Wyss
show that individual capital gains tax rates in the 14 percent
to 15 percent range have stronger positive effects on capital
costs, saving, and investment than does a top rate of 20
percent. Further reductions in the individual tax rate reduce
the cost of capital and increase investment, GDP, productivity
growth, and employment. In addition, such a tax cut would
essentially be revenue neutral, when unlocking and
macroeconomic consequences are included.
In addition, a 1997 CBO report documents the widespread
ownership of capital assets among middle-income taxpayers.
According to the CBO report, in 1989, 31 percent of families
with incomes under $20,000 held capital assets (not including
personal residences) and 54 percent with income between $20,000
and $50,000 held capital assets.
Reduce Corporate Capital Gains Tax Rates
The 1997 tax reforms failed to include a reduction in the
corporate capital gains tax from the 35 percent rate in effect
since the 1986 Tax Reform Act, although such a measure was
included in the bill reported out by this Committee and later
passed by the House. Reducing corporate capital gains tax rates
would also help move the U.S. tax code toward a consumption tax
base by lightening the burden on income from investment. It
could also help increase the Federal revenues needed to assure
projected budget surpluses, according to reputable econometric
analyses.
The failure to reduce corporate capital gains tax rates in
conjunction with the 1997 individual rate cuts heightens the
inequities already inherent in the double taxation of corporate
profits under current law, leading to excessive tax planning,
and may accentuate the trend away from the traditional
corporate form of organization.
Compared to other industrialized nations, the United States
taxes corporate capital gains very harshly. The United States
taxes corporate capital gains at the ordinary income rate of 35
percent, does not provide for indexation of such gains for
inflation, and does not allow capital losses to be used to
offset ordinary income. These last two factors increase the
risk, and therefore the cost of capital, for corporate
investments expected to yield capital gains. Fourteen out of
sixteen countries surveyed tax corporate capital gains more
favorably than does the United States, either through lower tax
rates, by allowing capital losses to offset ordinary income, or
by indexing gains for inflation. For example, Germany, the
Netherlands, Japan, and Korea permit corporate capital losses
to be deducted from ordinary income, and France taxes corporate
capital gains at 18 percent. In several of the Pacific Basin
countries such as Hong Kong, Singapore, and Malaysia, corporate
capital gains are exempt from taxes.
We therefore urge the committee to restore the historic
parity between individual and corporate capital gains tax
rates.
Expand Individual Retirement Accounts
Under the Taxpayer Relief Act of 1997, the traditional
``front-loaded'' (tax-deductible) IRAs were substantially
expanded and were made more flexible through the addition of
penalty-free withdrawal options. In addition, two new types of
``back-loaded'' IRAs were created--the Roth IRA PLUS and the
education IRA. Specifically, income limits on the traditional
deductible IRAs were phased-up over time. The income limits for
the $2,000 IRA deduction, which under prior law phased out
between $40,000 and $50,000 of adjusted gross income for joint
returns and $25,000 and $35,000 for individuals, are increased
gradually beginning in 1998 when the income phase-out range
will be between $50,000 and $60,000 of adjusted gross income
for joint returns and $30,000 and $40,000 for individuals,
until 2007, when the income phase-out range will be between
$80,000 and $100,000 for joint returns and $50,000 and $60,000
for individuals.
Further expansion of the income limits and contribution
ceilings for both front and backloaded IRAs--in particular the
education IRA, which is limited to only $500 per yearwould help
move the U.S. tax system toward a consumption tax base by
lightening the tax burden on saving. Prominent public finance
economists and scholars, including former Council of Economic
Advisers Chairman Martin Feldstein; Treasury Deputy Secretary
Lawrence Summers; and Professors David A. Wise of Harvard
University; James M. Poterba of Massachusetts Institute of
Technology; Steven E. Venti and Jonathan Skinner of Dartmouth
College; and Richard A. Thaler of Cornell University, have
concluded that IRAs--especially tax-deductible IRAs--do result
in new saving.
More than a dozen scholarly studies, using a variety of
data sources and employing several different statistical
approaches, have examined whether targeted saving vehicles such
as IRAs impact saving. For example, Professor Steven Venti's
testimony before a Senate Finance Subcommittee in 1994 examined
saving data from a Survey of Income and Program Participation
for three different age groups (families reaching age 60-64 in
1984, 1987, and 1991). Professor Venti found a striking
increase in saving the longer the family has been exposed to
the targeted retirement programs: IRAs, 401(k)s, and Keoghs.
The growth in IRA asset balances is astounding, Professor
Venti noted. The typical member of the youngest age group
family--with nine years of exposure to targeted retirement
saving programs--has nearly three times the targeted retirement
assets of the oldest group. There is a comparable increase in
total assets as well. In contrast, among families without IRAs,
the youngest families have only about 75 percent the financial
assets of the older families ($1,691 vs. $2,247 in constant
dollars). Professor Venti concluded that since total financial
assets, including balances in IRAs, are much larger for the
younger group in 1991 than for the older group that reached age
60-64 in 1984, targeted retirement saving programs did
stimulate new saving over the period.
Restore the Dividend and Interest Received Exclusion
The Tax Reform Act of 1986 repealed the deduction for the
first $100 of dividends received by individual shareholders
($200 by a married couple filing jointly) on the grounds that
the provision did little to reduce the double taxation of
corporate income because its monetary limit was so low. In
addition, the Joint Committee on Taxation concluded that the
deduction benefited high-bracket taxpayers more than those in
low brackets.
The 1984 Deficit Reduction Act repealed the 15 percent
interest-received exclusion that allowed a taxpayer to exclude
up to $3,000 of net interest ($6,000 on a joint return). The
reason for the change was that revenue losses under the IRA
provisions were higher than expected and also that the
provision might direct saving away from equity investment and
toward debt.
Restoration (and expansion) of the dividend and interest
received deductions would be a positive step toward shifting
the tax base from income to consumption. By reducing the double
tax on corporate income, even if only by a small amount, those
provisions would tend to reduce capital costs and encourage
saving and investment.
Strengthening the Pension System
With over $3 trillion in accumulated retirement assets, the
employment-based pension system provides a critical part of
national savings. But the effectiveness of that system as a
savings generator continues to be hampered by layer-upon-layer
of unnecessary regulation. Regulations limit who can save,
where and when they can save, how much they can save, and when
and how they must withdraw savings.
Over the last two years--with the creation of a new SIMPLE
plan for small business and the repeal of a variety of pension
rules--Congress has begun the process of peeling away some of
those unnecessary layers of regulation. There is still a long
way to go. A good place to start would be continued
simplification, including especially the limits on the amount
that can be saved and the rules that force withdrawal of
existing savings.
Unfinished Business in Tax Policy Reform: Long Run Goals
Fundamental reform of the U.S. federal tax code remains a
key goal for many policymakers. I want to take advantage of
this opportunity to express special thanks to Chairman Bill
Archer for his dedication and valuable leadership in this
regard.
Other prominent members of Congress, including House
Majority Leader Richard Armey (R-TX) and Senator Richard Shelby
(R-AL); Senator Pete Domenici (R-NM); and Representatives Dan
Schaefer (R-CO) and Billy Tauzin (R-LA), have all introduced
legislation to replace the federal income tax with a broad-
based consumption tax. House Minority Leader Richard Gephardt
(D-MO) has proposed broadening the current income tax base
while lowering rates. In addition, other reform plans are being
developed. For example, Senator John Ashcroft (R-MO) has
proposed reforming the income tax by reducing marginal rates
and providing a deduction for payroll taxes. Also, Americans
for Fair Taxation, a private group based in Texas, has proposed
replacing the federal income, social security, medicare, and
estate taxes with a 23 percent national sales tax.
In addition to political factors such as voter discontent
with the income tax, several factors contribute to the current
interest in tax reform:
The recognition that today's balanced federal
budget is likely to be a relatively short-lived phenomenon. A
new study by the General Accounting Office (GAO) predicts that,
absent improvement in GDP growth rates or policy changes such
as reduced social security benefits, budget deficits will
reemerge by 2012 as baby boomers begin to retire. Tax reform,
by encouraging more saving and investment, could be an
important tool as we seek to ensure a strong economy in the
twenty-first century.
A growing awareness that the U.S. federal tax code
is biased against the saving and investment that is crucial to
improving U.S. economic growth. The new GAO study observes that
even though federal budget deficits have declined recently,
total national saving and investment remain significantly below
the average of the 1960s and 1970s (see Table 2). In addition,
the United States has one of the highest tax rates on new
investment in the industrialized world. According to a 1994
study by the Progressive Foundation, the think tank affiliate
of the Progressive Policy Institute, the effective combined
corporate and individual federal tax rate on new investment in
the United States is 37.5 percent, compared to an average of
31.1 percent in other G-7 countries (see Figure 3).'' \6\
U.S. multinationals' goal of competing in the
global marketplace. Fundamental tax reform could enhance the
ability of U.S. firms to compete in global markets by reducing
the competitive disadvantage that they face. For example, as a
1997 study sponsored by the ACCF Center for Policy Research,
the public policy affiliate of the ACCF, showed, U.S. financial
service firms face much higher tax rates than do their
international competitors when operating in a third country
such as Taiwan (see Figure 4).'' \7\ A twelve-country analysis
shows that U.S. insurance firms are taxed at a rate of 35
percent on income earned abroad compared to 14.3 percent for
French-, Swiss-, or Belgian-owned firms. As a consequence of
their more favorable tax codes, foreign financial service firms
can offer products at lower prices than can U.S. firms, thereby
giving them a competitive advantage in world markets. Under the
broad-based consumption tax reform proposals discussed above,
all foreign-source income is exempt from tax.
The conclusions of new economic studies by
academic and public-sector tax policy experts that fundamental
tax reform could raise rates of saving, investment, and output.
As discussed earlier in this statement, a number of new
academic and government studies conclude that switching to a
consumption-based tax system would increase national saving,
reduce the cost of capital, and lead to higher levels of
capital formation and GDP.
Conclusions
Persistent low U.S. saving rates, despite recent good
economic growth and low unemployment, suggest the need for
short-term policy measures to reverse this pattern. In
particular, we need to build on the recent progress in capital
gains taxation, IRAs, pension and estate tax relief and the
AMT. The restoration of an exclusion for dividends and interest
received would also further the goal of lightening the taxation
of saving. In addition, a substantial body of research suggests
that fundamental tax reform and more reliance on consumption
taxes could have a profound positive effect on long-term
economic growth. Even small changes in economic growth rates
can make a big difference in living standards. As the United
States faces the economic challenges of the twenty-first
century, fundamental tax reform that moves the U.S. tax system
toward greater reliance on consumption taxes can be an
important policy lever for achieving stronger economic growth
and higher living standards.
Endnotes
1. Alan J. Auerbach, David Altig, Laurence J. Kotlikoff, Kent A.
Smetters, and Jan Walliser, ``Simulating U.S. Tax Reform,'' NBER
Working Paper No. 6248 (Cambridge, Mass.: National Bureau of Economic
Research, October 1997).
2. Joint Committee on Taxation, Tax Modeling Project and 1997 Tax
Symposium Papers, November 20, 1997.
3. Congressional Budget Office, The Economic Effects of
Comprehensive Tax Reform, July 1997.
4. Eric M. Engen and Jonathan Skinner, ``Taxation and Economic
Growth,'' NBER Working Paper No. 5826 (Cambridge, Mass.: National
Bureau of Economic Research, November 1996).
5. Dale W. Jorgenson, ``The Economic Impact of Taxing
Consumption,'' testimony before the Committee on Ways and Means of the
U.S. House of Representatives, March 27, 1996. Joel L. Prakken, ``The
Macroeconomics of Tax Reform,'' The Consumption Tax: A Better
Alternative? (Cambridge, Mass.: Ballinger Publishing Company, 1987).
Lawrence H. Goulder, ``Deficit Reduction through Energy, Income, and
Consumption Taxes: Impacts on Economic Growth and the Environment,''
Tax Policy for Economic Growth in the 1990s (Washington, D.C.: American
Council for Capital Formation Center for Policy Research, March 1994).
6. Enterprise Economics and Tax Reform, Progressive Foundation,
Progressive Policy Institute, Washington, D.C., October 1994.
7. The Impact of the U.S. Tax Code on the Competitiveness of
Financial Service Firms, (Washington, D.C.: American Council for
Capital Formation Center for Policy Research, July 1997).
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Chairman Archer. Thank you, Mr. Bloomfield.
Our next witness is Stephen Entin. After you identify
yourself, you may proceed.
STATEMENT OF STEPHEN J. ENTIN, EXECUTIVE DIRECTOR AND CHIEF
ECONOMIST, INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION
Mr. Entin. Thank you, Mr. Chairman.
My name is Stephen J. Entin. I am executive director and
chief economist of the Institute for Research on the Economics
of Taxation.
Thank you for the opportunity to discuss the tax treatment
of saving with you today. The issue has taken on an added
importance as baby boomers approach retirement with inadequate
savings and as the Social Security system totters toward
insolvency.
As the Committee is well aware, the income tax is heavily
biased against saving. Income is taxed when first earned. If it
is used for consumption, it is free of additional Federal
income taxes. If it is saved, however, the returns on the
saving are taxed again. This is the basic tax bias against
saving. In addition, the corporate income tax and the Federal
transfer tax compound the problem.
Removing the basic bias and eliminating the added layers of
tax should be a key goal of fundamental tax reform. I am glad
to see, Mr. Chairman, that you are still very determined to
proceed in that area.
The Taxpayer Relief Act of 1977 eased the basic income tax
bias against saving somewhat by liberalizing the restrictions
on deductible IRAs and adding the Roth and education IRAs. But
more needs to be done. Two proposals, in particular, would
improve the tax treatment of saving for low income or young
households that have relatively few current assets.
Senator Breaux and Representative McCrery have introduced
the Individual Investment Account Act. The bill would permit
taxpayers to defer taxes on saving without restrictions as to
the amount of saving, the time of withdrawal, or the income
level of the saver. All saving would be covered by the
proposal, so all savers would receive incentives, at the
margin, to save more.
My colleagues and I at IRET are preparing a paper on the
total overhaul of the tax system incorporating this approach. I
would like to share the paper with the Committee when it is
finished.
Representatives Hulshof and Kucinich are preparing a bill
that would exclude the first $200 to $400 in interest and
dividends from taxable income for single and joint filers,
respectively. The Joint Tax Committee estimates that, as of
1995, the exclusion would have covered all interest and
dividend income on returns filed by more than 32 million
households. Those returns involved more than 50 million
taxpayers.
At a 5-percent rate of interest or dividend, the exclusion
would protect all the income from up to $4,000 or $8,000 in
financial assets of individuals or married couples. Households
with larger amounts of assets would receive no incentive, at
the margin, to add to their savings. However, tens of millions
of low income or young households have less than these levels
of savings.
These proposals are better than other saving incentive
plans for low-income households because they have no strings
attached--no tax penalty for withdrawal regardless of how long
the saving has been held or the age of the taxpayer or the
purpose of the withdrawal. By contrast, most saving provisions
of the current law apply to retirement income and impose a
penalty as well as a tax for most withdrawals before age 59\1/
2\. People need some amount of savings they can tap into in an
emergency such as unemployment or a medical problem. The rich
can utilize provisions--the restrictive provisions such as IRAs
and pensions and still have money to set aside for instant
access. The working poor, however, are often unable to save for
retirement in one account and for emergencies in another.
Rather than risk a tax penalty, they put their savings in bank
accounts that are fully subject to the income-tax bias against
saving.
Efforts to lock people into retirement savings have had the
opposite effect of frightening low-income households away from
retirement-saving plans. Consequently, their assets are
overtaxed and build slowly. Therefore, many households never
achieve the levels of precautionary savings that they need
before they can set money aside for retirement. If low-income
households could receive the same tax-deferred or tax-exempt
treatment of saving available to our affluent citizens, without
restrictions, they could more quickly build their rainy-day
funds to acceptable levels and have more money to set aside for
long-term investment.
A complete rationalization of taxation of savings and
investment, including elimination of the transfer tax and the
double taxation of corporate and individual income, would
probably require total restructuring of the tax system. Until
then, small steps in the right direction would help individual
households and the economy.
Saving incentives must be part of the inevitable reform of
Social Security. To ensure that the added saving is used to
increase domestic business investment to boost U.S.
productivity, wages, and employment, Congress should also enact
faster writeoff of plant, equipment, and structures. Such steps
are affordable. Their dynamic effect on the economy and on
saving should ease budget concerns and should be counted.
Projected budget surpluses should also ease the adoption of
progrowth tax initiatives and, if necessary, the Budget Act
should be revised. Promotion of a more productive economy is
the best way to use projected budget surpluses to raise incomes
for retirees and the rest of the Nation.
Thank you.
[The prepared statement follows:]
Statement of Stephen J. Entin, Executive Director and Chief Economist,
Institute for Research on the Economics of Taxation
The public and this Committee have long been concerned
about the adequacy of saving in the United States, with regard
to both the financial well-being of individuals and households
and the health of the national economy. The subject takes on
added importance as the baby boomers approach retirement with
clearly inadequate financial resources.
The tax treatment of saving affects the ability and
willingness of people to save for emergencies, for education,
homebuying, and retirement. The ordinary income tax is heavily
biased against saving and in favor of consumption uses of
income. Income is taxed when first earned. If it is used for
consumption, it is free of additional federal income taxes. If
it is saved, however, the returns on the saving are taxed
again. This is the fundamental bias of the income tax against
saving. In addition to this basic bias, the tax system piles on
several additional layers of tax on income that is saved, in
the form of the corporate income tax and the federal transfer
(estate and gift) tax, compounding the problem.\1\
These multiple layers of tax on saving and capital increase
the cost of saving, leading to a smaller stock of capital than
would otherwise prevail. A smaller capital stock means lower
labor productivity, real wages, employment, and income than
could otherwise have been achieved.
A neutral tax code would not penalize saving relative to
consumption. There are two ways to make the taxation of saving
and consumption neutral. Either income that is saved should be
exempt from tax and the earnings of the saving and the
principal taxed upon withdrawal, or the amounts saved should be
taxed when earned but the earnings should be tax exempt. The
saving-deferred approach is embodied in deductible IRAs and in
401(k), 403(b), Keough, and employer-sponsored retirement
plans. The returns exempt approach is embodied in tax exempt
securities and the recently enacted ``back-ended'' Roth IRA.\2\
The tax bill enacted in 1997 liberalized existing
provisions that offset some of the tax bias against saving for
retirement, and added several vehicles to encourage saving for
education. Nonetheless, there is still much work to do to
provide saving with the neutral tax treatment that would be
most beneficial for taxpayers and the national economy.\3\
I should like to refer specifically today to two proposals
that would improve the tax treatment of saving particularly for
low income households and for young households who have
relatively few current assets.
Senator John Breaux (D-LA) and Representative Jim McCrery
(R-LA) have introduced the Individual Investment Account Act in
the 105th Congress as S. 330 and as H.R. 984. The bill would
permit taxpayers to defer taxes on saving without restrictions
as to amount of saving or time of withdrawal or income level of
the saver. It would allow unlimited tax deduction of amounts
saved, tax-free investment growth until withdrawal, no penalty
tax on withdrawal at any age, and no forced distribution at any
age. There would be no income tax at death; heirs could
maintain the deferral of the saving until they chose to
withdraw it.
Representatives Kenny Hulshof (R-MO) and Dennis Kucinich
(D-OH) are preparing to introduce a bill that would exclude the
first $200 or $400 in interest and dividends from taxable
income for single and joint filers, respectively. Figures
provided to the sponsors by the Joint Tax Committee from the
1995 tax year indicate that 30 million tax returns reported
interest and dividend income of less than $200. About 19
million joint returns reported interest and dividends income of
less than $400. Altogether, the $200/$400 exclusion would cover
all interest and dividend income on returns filed by more than
32 million households, covering more than 50 million taxpayers.
About 67 million households (about 57 percent of all taxpayers)
would receive partial or total relief from tax on their saving
under the proposal.
Assuming a 5% rate of interest or dividends, a $200
exclusion would protect all of the income from up to $4,000 in
financial assets held by an individual, and up to $8,000 in
financial assets held by a married couple. Many households have
assets in excess of these levels, and would receive no
incentive at the margin to add to their saving as a result of
the exclusion. However, tens of millions of households have
less than these levels of savings. They are concentrated among
the lowest income households in the country.
Both of these proposals for reducing the tax bias against
saving have an important advantage over other saving plans for
low income households. They are free of any tax penalty for
withdrawals, regardless of how long the saving had been held,
or the age of the taxpayer, or the purpose for the withdrawal.
By contrast, most of the provisions in current law that
protect a portion of saving from the biases in the income tax
apply to retirement income, and impose a penalty as well as a
tax for most early withdrawals. Unfortunately, people need
ready access to some amount of savings in the event of an
emergency, such as a spell of unemployment or a medical
problem; the tax code now provides only a few, narrow
exemptions to the early withdrawal penalty. The rich can save
for retirement in pensions and IRAs, and still have plenty of
income to set aside in ordinary saving for instant access. The
working poor, however, are often unable to save for retirement
in one account and for emergencies in another. They are afraid
to risk the tax penalty for early withdrawal from retirement
saving plans, and must put their saving in bank accounts and
money market funds that are fully subject to the income tax
bias against saving.
By allowing maximum flexibility for the taxpayer/saver, the
Breaux-McCrery and Hulshof provisions would be more useful and
attractive to low income households, and would encourage them
to do more saving, than existing tax provisions.
The restrictions that encumber most saving incentives in
current law are intended to increase long term saving, and, in
particular, to prevent people from drawing down their saving
before retirement age. It is unclear if the intent is to
protect irresponsible people from themselves, lest they waste
their retirement nest eggs, or to protect the federal
government, which does not want to support destitute senior
citizens on the dole. In either case, the idea seems to be that
it is necessary to lock savers into their retirement plans to
increase the amount of assets available to them in old age.
Not only is this dim view of the intelligence of the
population insulting and misguided, the tactic probably
backfires. The efforts to force people to save for retirement
have had the opposite effect of frightening low income
households away from the retirement saving plans. Consequently,
their assets build painfully slowly, and many never achieve the
levels of precautionary savings they need before they can
consider the luxury of setting money aside for retirement.
If the saving of low income households received the same
tax-deferred or tax exempt treatment available to retirement
accounts of more affluent citizens, their assets would build
faster, they would more quickly build their rainy day funds to
acceptable levels, and they would have more money available to
put into longer term saving vehicles, including retirement
plans. If all saving were to receive the same neutral tax
treatment, there would be more saving in total, less incentive
to withdraw and spend down saving at all ages, and,
consequently, more saving for retirement, than under current
law.
Most of the provisions in current law that protect a
portion of saving from tax bias have to do with retirement
saving. The bias in the income tax extends to all taxable
saving, not just that for retirement. Consequently, to create a
neutral tax system, all saving, whether for retirement, buying
a house, college tuition, a new car, a vacation, or protection
against a rainy day, should receive the same treatment as in a
tax-deferred income plan.
A complete rationalization of the taxes imposed on saving
and investment will probably have to wait for a total
restructuring of the tax system with one of three approaches:
A saving-deferred tax for individuals.
Allow savers to defer tax on all their net saving and tax
all net withdrawals of non-reinvested returns on capital on
individuals' tax forms, with no additional tax at the business
level. (Example: an integrated cash-flow tax, such as a
modification of the individual side of the (Nunn-Domenici) USA
Tax.)
A neutral business level tax.
Allow businesses an immediate write-off of all investment
outlays and tax all returns of capital on business tax returns,
with no additional tax at the individual level. (Example: the
Armey-Shelby Flat Tax.)
A retail sales tax.
Tax income when it is spent on final consumption goods and
services. (Example: Tauzin-Shaefer.)
Until such time as the country and the Congress are ready
for a totally new tax system, small steps in the right
direction would do a great deal to improve the performance of
the economy and the well-being of individuals and families.
Endnotes
1. After income has been earned and taxed, personal taxes on
returns on non-corporate investments, such as interest, rents, and
earnings of unincorporated businesses, constitute a second round of
taxation--double taxation--of income that is saved. Similarly, personal
saving invested in corporate ownership is subject to a second round of
taxation--the corporate income tax on the corporate earnings on that
saving. A third round of income tax--triple taxation--is imposed if the
corporation distributes its after-tax income as dividends to
individuals. If the corporation retains its after-tax earnings for
reinvestment, the resulting increase in the share price constitutes a
capital gain, also resulting in a third layer of tax on the retained
earnings if the shares are sold.
Capital gains may also occur when a business's earnings outlook
improves for reasons other than reinvestment. A new product or patent,
a rise in sales, anything that would lead to a jump in anticipated
income (income that the business has not even received yet) may boost
the current valuation of the shares or business. If the higher expected
business earnings come to pass, they will be taxed as corporate income
and/or personal business or dividend income. To tax the increase in the
current value of the business, either upon sale, gift, or bequest, is
to triple-tax the future income.
If the saving outlives the saver, the federal unified transfer
(estate and gift) tax may impose yet another layer of tax on the
saving. In addition to the federal income and transfer taxes, state and
local income, estate, and gift taxes impose multiple layers of tax on
saving and its returns. There are property taxes as well.
2. A neutral tax code would raise revenue without distorting
economic activity. The tax would do this by increasing the cost of all
private sector activities equally. The income tax, because it is
assessed on both income that is saved and the returns on that income,
taxes saving and investment more heavily than consumption.
Suppose that, in the absence of taxes, one could buy $100 of
consumption goods or a $100 bond paying 4% interest, or $4 a year. Now
impose a 20% income tax. One would now have to earn $125, and give up
$25 in tax, to have $100 of after-tax income to consume. The cost of
$100 of consumption in terms of pre-tax income has risen 25%. To get a
$4 interest stream, after taxes, one would have to earn $5 in interest,
pre-tax. To earn $5 in interest, one would have to buy a $125 bond. To
buy a $125 bond, one would have to earn $156.25 and pay $31.25 in tax.
The cost of the after-tax interest stream has gone up 56.25%, more than
twice the increase in the cost of consumption.
There are two general approaches to restoring neutrality. One is to
exempt returns on capital from tax. One would then have to earn $125 to
buy a $100 bond, earning $4 with no further tax. This is akin to the
tax treatment accorded state and local bonds. The other method is to
allow a deduction for income that is saved, while taxing the returns.
One would have to earn $125 to buy a $125 bond, earning $5 in interest
pre-tax; after paying $1 in tax on the interest, one would have $4
left. This is akin to the deductible IRA, or qualified 401(k) or
company pension plans.
3. There are many shortcomings in the existing tax provisions.
IRAs, 401(k) plans, and other deferred compensation plans that moderate
the tax bias against saving, as currently constituted, have several
shortcomings. In spite of the changes enacted in last year's tax bill,
there are still limits on the amounts that can be deducted. IRAs give
no added incentive to save to those who are already doing long-term
saving in amounts above the limits. (Senator Ashcroft has proposed
doubling the amounts that may be contributed to deductible IRAs, giving
more savers incentive ``at the margin''.)
Another drawback is that withdrawals from most plans before age
59\1/2\ are frequently subject to a penalty in addition to tax. This
often makes these saving plans unattractive to lower income savers who
cannot afford to save separately for emergencies and other near-term
goals, as well as a more distant retirement. Commendably, the tax bill
approved in 1997 waives the early-withdrawal penalty on IRA
distributions used to buy a first home or to pay qualified higher-
education expenses.
Two other liberalizations in the 1997 legislation are also steps in
the right direction, but they do not go far enough. The new Roth IRAs
permit savers to deposit after-tax money into custodial accounts in
which the earnings are tax free. But Roth IRAs also have income limits
on participants (higher than the income thresholds for non-Roth IRAs),
and limit the amounts that may be contributed. Further, assets must be
held five years or more in Roth IRAs and the individual must have
attained age 59 (or qualify for one of several exceptions) in order to
make withdrawals without a tax penalty. The non-deductible education
IRA in the same legislation also addresses the tax bias against saving
but is subject to contribution and income limits and is only penalty
free if used for eligible education outlays.
Another problem is that there is a mandatory age (70\1/2\) for
beginning to withdraw from non-Roth IRAs to force commencement of
recapture of the tax deferral, yet the saving done by the elderly is as
economically valuable as saving done by the young. Indeed, all saving
contributes to capital formation, productivity, and national income,
regardless of the motive behind it. There is no economic reason for the
government to discriminate against or discourage any type of saving.
Tax exempt bonds receive the same ``back-ended'' tax treatment as a
Roth IRA. The saver gets no deduction, but the returns are not taxed.
There is no holding period or tax penalty for early withdrawal to
frighten away low income savers. However, tax exempt bonds offer a
lower rate of return than ordinary bonds or stocks. The difference
reflects the marginal tax rates of the upper income taxpayers who
invest in the tax exempt securities. The issuing states, counties, and
cities capture the tax advantage through the lower interest rate paid
on such bonds, leaving the taxpayers only slightly better off than if
they had invested in taxable securities. Because of their relatively
low interest rates, these securities are not a good investment for
taxpayers in low tax brackets.
Chairman Archer. Thank you, Mr. Entin.
Mr. Stevenson, you may proceed.
STATEMENT OF WILLIAM STEVENSON, CHAIRMAN, FEDERAL TAXATION
COMMITTEE, NATIONAL SOCIETY OF ACCOUNTANTS; AND PRESIDENT,
NATIONAL TAX CONSULTANTS, INC.
Mr. Stevenson. Thank you. My name is William Stevenson. I
am representing the National Society of Accountants in which I
am the Federal tax committee chairman. I am also president of
National Tax Consultants Inc. in Merrick, New York.
Good morning, Mr. Chairman and Members of the Committee.
We're really pleased to testify today on this issue of Federal
tax burden, and when I'm finished everyone's going to think
that you planted me here.
The National Society of Accountants represents interests of
over 30,000 practicing accountants who provide accounting, tax
services, management advisory services to about 6 million small
businesses and individuals. In the past 10 years, I personally
prepared 5,000 tax returns, probably more.
Our comments today are going to focus on one area, namely
the complexity of the 18-month holding period for the new 10-
and 20-percent capital gains rate. We're also going to
demonstrate to you the problems this has caused many taxpayers
including tax preparers like myself.
The mind-boggling complexity in the new capital gains rate
and the reporting of it really needs to be eliminated. In
particular, the National Society endorses the elimination of
the 18-month holding period and in its place, we recommend what
Chairman Archer announced in his opening comments that a 20-
percent gains rate should be effective for capital assets held
for a year or more.
And here's why--and incidentally, this is not theory. This
is practicality as compared to some of the much broader issues
that we have been discussing. In 1996, the Schedule D had 19
lines on it, and it had 3 pages of instructions with a little
worksheet. This year, those 19 lines have grown to 54 lines and
4 pages of instructions. The complexity of the new capital
gains laws are particularly burdensome for owners of mutual
funds. Before 1997, taxpayers could report their mutual fund
distributions directly on the 1040 and then bypass the Schedule
D. In 1997, taxpayers must report the tiniest capital gains
distribution on Schedule D, and, according to one national
press report, the mutual fund trade industry estimates that the
1997 act's mandate regarding this change alone could affect 5
million of the 63 million investors in mutual funds. I really
think that it is a lot more than that based on my own personal
experience.
One of the publications referred to the 1997 tax law as
``the tax-preparation industry full employment act,'' and I
suppose I should thank you for it. But it is making me crazy,
too.
Each January, taxpayers owning mutual funds are inundated
by their annual reports and Form 1099-Div--Div means Dividend--
and they get these from all their different mutual funds. Even
tax-free funds often generate a statement containing capital
gains. Deciphering the Form 1099-Div has always been difficult,
but this year, for the average taxpayer and average investor,
it is particularly incomprehensible, it is indecipherable.
For the benefit of the Committee, we've submitted, as an
attachment to our written statement, a real-life example. This
is an actual client of mine. I have just taken one of his
mutual funds that he held for 2 years--and in this example,
I've pointed out to you the needless complexity of our new
capital-gains laws. When you get a chance to look at the
report, you will see that this taxpayer, Michael J.--I blanked
out his last name and Social Security number--he just invested
$39,000 in a mutual fund in March 1996. He added $20,000 over
the last 2 years and made a couple of withdrawals, and in
addition to that, we will assumed he sold it on December 15. In
that scenario, I had to go through 15 steps, first to determine
his holding period, his gain percentages, his gain and loss
profit--all of this prior to reporting it on the Schedule D,
and when you take a look at the D, you will think that he had
100 different transactions. This is just to report this.
And the same complexity applies to an investor whether they
had $1 million in the fund. Frankly, Congress has given us a
law that is almost impossible to follow.
We recognize that this also created a burden for the IRS.
So much so that they couldn't even process electronically filed
returns of Schedule D until today. What most people don't
realize is that farmers and fishermen, they have to file their
returns by March 2, so it is causing an enormous burden.
So, I see my time is up. Providing your questions aren't
too complex, I will be glad to respond to them at the end.
[The prepared statement and attachments follow:]
Statement of William Stevenson, Chairman, Federal Taxation Committee,
National Society of Accountants; and President, National Tax
Consultants, Inc.
The National Society of Accountants (NSA) is pleased to
testify on the issue of reducing the federal tax burden. NSA
commends Chairman Archer and the other members of the Committee
on Ways and Means for holding this most important hearing on
proposals designed to eliminate complexities or perceived
inequities in the Internal Revenue Code.
My name is William Stevenson, and I am testifying today in
my capacity as Chairman of the National Society's Federal
Taxation Committee. I have been an Enrolled Agent for many
years and have served on the Commissioner of Internal Revenue's
Advisory Group. I am president of National Tax Consultants,
Inc., a firm that concentrates on taxpayer representation
before the United States Tax Court, and also am president of
Financial Services of Long Island, a mutifaceted tax
preparation and accounting firm that services individuals and
small businesses on Long Island, in Merrick, New York.
NSA is an individual membership organization. Through our
national organization and affiliates in 54 jurisdictions, we
represent the interests of approximately 30,000 practicing
accountants. Our members are for the most part either sole
practitioners or partners in moderate-sized accounting firms
who provide accounting, tax return preparation, representation
before the Internal Revenue Service, tax planning, financial
planning, and managerial advisory services to over six million
individual and small business clients. The members of NSA are
pledged to a strict code of professional ethics and rules of
professional conduct.
The National Society's comments today will focus on the
complexity of the 18-month holding period for the new 10 and 20
percent capital gains rates, and proposals for an exclusion for
interest and dividend income.
Capital Gains
The National Society strongly supports the proposition that
a low capital gains rate is critical to spurring capital
formation and prosperity for the American work force. However,
the mind-boggling complexity in the new capital gains rates and
reporting should be eliminated. In particular, NSA endorses
elimination of the 18 month holding period involved with the
new maximum 20 percent capital gains rate. Instead, we
recommend that the top 20 percent capital gains rate become
effective for capital assets held for one year or more.
The technical impediments imbedded in the Internal Revenue
Code create the complexity which makes it difficult for
individual taxpayers to comply with the law and for the
Internal Revenue Service to administer it. We believe the
current 18 month holding period for capital gains, enacted as
part of the Taxpayer Relief Act of 1997, is an excellent
example of needless complexity.
According to IRS statistics, approximately 50 percent of
all federal tax returns are prepared by tax professionals. The
August 13, 1997 issue of Money Daily states the capital gains
measure of the 1997 law is likely to spur even more individuals
to take their tax reporting obligations to professionals for
assistance. Indeed, one tax professional quoted by Money Daily
called the 1997 law the ``Tax Preparation Industry Full
Employment Act.''
The National Society of Accountants supports the reduction
in the top capital gains rate to 20 percent. However, in order
to qualify for the 20 percent rate under the 1997 tax law, an
individual must now hold his or her capital asset for 18 months
or longer. Assets held for more than a year, but for less than
18 months, will be taxed under the new tax act at a maximum
capital gains rate of 28 percent. The Schedule D (Capital Gains
and Losses) for the 1996 Form 1040 contained 19 lines on the
schedule, accompanied by a 13 line worksheet in the instruction
book. The instructions for the form were three pages. Due to
the capital gains provisions of the 1997 tax act, the Schedule
D for the 1997 individual tax return contains 54 lines. The
instructions for the form have increased to four pages. Thy
considers to be needless.
The blame for such complexity can not be placed on the IRS.
The agency was given a mandate, based on enactment of the 1997
Tax Act, to design a tax form to provide accounting for at
least six capital gains tax brackets for 1997. The 54 line
Schedule D and the four pages of instructions were the
necessary result. And the complexity of the Schedule D will
only get worse by the year 2000 when the IRS will be faced with
designing a form which accounts for nine tax brackets.
The complexity of the new capital gains law will be
particularly burdensome for owners of mutual funds. Before
calendar year 1997, a taxpayer who had only taxable capital
gains distributions from mutual funds was permitted to report
those distributions directly on the Form 1040 and was not
required to file Schedule D. This now will be different. For
1997, taxpayers must report all capital gains, including mutual
fund distributions, on Schedule D. According to one national
press report, the mutual fund trade industry estimates that the
1997 tax act's mandate regarding this change alone could affect
5 million of the approximately 63 million Americans who own
mutual funds.
Each January, taxpayers owning mutual funds are inundated
by annual reports and Forms 1099-DIV from their mutual fund
companies. Taxpayers are bewildered by the statements and often
do not read the tax reporting instructions enclosed with them.
The Form 1099-DIV reports the amount of long-term capital gains
distributions and short-term capital gains distributions made
to taxpayers. However, the short-term capital gains are lumped
together with dividends on the Form 1099-DIV as one figure. No
wonder taxpayers are confused.
As indicated, deciphering a Form 1099-DIV has been a
difficult task for the average taxpayer. For 1997 tax returns
these forms are likely not only to be indecipherable, but
incomprehensible to mainstream Americans. For the benefit of
the House Ways and Means Committee, we have attached an example
of mutual fund capital gains reporting to illustrate the
needless complexity in the new capital gains law. In March,
1996, taxpayer ``Michael J.'' invested $39,000 in a mutual
fund. During the two years he held the fund, he invested an
additional $20,000, had two small liquidations of $1,500 and
$4,000, and reinvested quarterly dividends. For purposes of
illustration, we will assume he sold his entire investment
December 15, 1997. It sounds simple, but this scenario requires
15 different steps to determine holding periods, gain
percentage categories, and gain or loss in order to report the
transactions on Schedule D. Reporting capital gains this year
requires multiple steps; the average taxpayer who merely types
mutual fund purchase and sale dates into a tax software program
may not have an accurate result on the tax return.
Capital Gains and Farm Returns
The National Society of Accountants believes the complexity
of the calculations for 1997 capital gains has created a burden
for the IRS which impacts adversely on individual taxpayers. At
the same time the IRS is trying to encourage more taxpayers and
tax practitioners to use electronic filing, it has announced it
may have problems processing electronically filed returns
containing Schedule D. Taxpayers and tax practitioners who have
made a commitment to convert to electronic filing now are being
told by IRS that they may not be able to transmit their returns
electronically. The complexity in the tax law is causing
cascading problems at the IRS with respect to return processing
and electronic filing.
As we stated before, the blame for this cannot be placed on
the IRS. Some issues related to capital gains in the Taxpayer
Relief Act of 1997 were not resolved unchnical Corrections
Bill. With the resolution of the issues, the IRS was able to
finalize the Schedule D and to begin modifying its return
processing software. The time required to implement the
programming means that the IRS will not be able to process any
returns with Schedule D until mid-February 1998. A taxpayer who
files a paper return with a Schedule D before mid-February may
experience a delay in the processing of his or her return.
However, a taxpayer who files an electronic return containing
Schedule D may not even transmit it until February 12, because
IRS computers cannot accept it until then.
While the IRS estimates that only two percent of taxpayers
who report capital gains or losses will be affected by this
processing issue, farmers, fishermen and practitioners who
prepare their returns may experience particular difficulties.
Farmers and fishermen must file their returns and pay their
taxes by March 2 or be subject to estimated tax penalties. Yet
those taxpayers cannot even transmit their electronic returns
until February 12. Once the electronic pipeline is open,
practitioners will have a very short span of time to correct
errors in rejected returns. Electronic transmission is not
flawless, and often returns fail to transmit for various
reasons. Practitioners working the rejected returns must
correct errors, contact clients to verify information, and
retransmit the return. Practitioners who transmit large numbers
of electronic farm returns containing Schedule D could be
facing extremely heavy workloads related to reworking those
rejected returns at the height of their busiest season.
The National Society of Accountants applauds the IRS for
recognizing this problem and agreeing not to impose the
estimated tax penalty on any farmer or fisherman whose
electronic return is filed and accepted by March 9, 1998, which
reflects a one week extension. The IRS has every reason to
demonstrate its flexibility to practitioners enrolled in its e-
file program. To reach the goal of 80% of returns to be filed
electronically by 2007, as stated in the restructuring
legislation, the Service needs the enrollment of large number
of practitioners in its electronic filing program. ``Glitches''
such as the capital gains processing delay are disincentives
for tax professionals to embrace the electronic filing program.
Practitioners who make the commitment to invest time, money and
staff training to convert to the electronic filing program do
not want to switch gears in the middle of their busiest season
and revert to filing paper returns because IRS computers cannot
accept electronic transmissions. The National Society of
Accountants recommends that Congress reduce the complexity in
tax law, especially capital gains reporting, before serious
damage is done to beneficial IRS programs, such as the
electronic filing program.
Exclusion for Interest and Dividend Income.
Before the Tax Reform Act of 1986, the Internal Revenue
Code provided for a modest exclusion for interest and dividend
income. This exclusion was revoked by the 1986 Tax Act. The
National Society of Accountants recommends restoration of the
exclusion. While the stated objective by Congress for its
previous elimination of the provision in 1986 was to simplify
the tax law, our members never viewed the previous interest and
dividend exclusion as being a complex measure. NSA members
welcome a vigorous debate by Congress over the issue of whether
restoration of the exclusion has positive capital formation
benefits for the U.S. economy.
Conclusion
The National Society of Accountants is pleased to provide
these comments on reducing taxpayer burden. I hope that the
Society's insights have been helpful today and, on behalf of
all of the members, I thank you for your interest. I hope you
will feel free to contact NSA at any time for assistance with
any additional information you might need.
Attachment
On March 19, 1996, ``Michael J.'' invested $39,000 in the
Franklin Rising Dividend Fund. During each of the two years he
held the fund, he invested an additional $10,000. In 1996, he
had two small liquidations of $1,500 and $4,000. We will assume
that he sold his entire position on December 15, 1997.
In order for him to prepare an accurate Schedule D, he must
identify each investment including the reinvested dividends and
determine which of the three holding periods applies to each
one (12 months or less; more than 12 months but less than 18
months; over 18 months).
------------------------------------------------------------------------
ITEM
------------------------------------------------------------------------
1.............................. The initial investment was purchased on
March 19, 1996 and was held for over
18 months. The number of shares sold
during that year should be subtracted
from the original amount purchased.
The remaining shares fall into the 20%
category.
2.............................. The reinvested dividend was made on
June 3, 1996. It was held for over 18
months and falls into the 20%
category.
3.............................. A second investment of $10,000 was made
on June 20, 1996. Since it was sold on
December 15, 1997, it falls into the
28% category since it was held for
more than 12 months but less than 18
months.
4.............................. The reinvested dividend was made on
September 3, 1996. It was held for
less than 12 months and falls into the
28% category.
7 & 8.......................... The reinvested dividends and capital
gains were made on December 2, 1996.
These amounts are in the 28% category.
9, 11, 12 & 13................. The quarterly reinvested dividends were
all made in 1997 and sold in 1997.
Therefore, they are short term capital
gains and taxed at ordinary income tax
rates.
10............................. The new investment of $10,000, made on
March 10, 1997, will be taxed at
ordinary income tax rates.
14............................. The Fund's capital gain earnings has
been identified on Form 1099-DIV as
simply Capital Gain Distribution. On
the actual statement it shows up as a
Long Term Capital Gain (LT Cap Gain).
Therefore, we will presume it to fall
in the 20% category. However, in most
cases, this amount will be divided
into the middle and long-term groups
based on a percentage provided by the
mutual fund.
15............................. The Fund's other earnings or dividends
will be taxed at the ordinary income
tax rates.
14............................. The funds from the capital gain
distribution of $8,168.84 were applied
to ``Michael J.'s'' account on
December 1 and sold on December 15.
Therefore, the amount falls into the
short-term category.
15............................. The short-term capital gain
distribution which was applied to
``Michael J.'s'' account on December 1
will also fall into the short-term
gain category.
------------------------------------------------------------------------
Now that each transaction has been identified, the taxpayer
can begin to complete Schedule D. Once each transaction has
been placed into its proper category, the next step is to
determine the loss or gain for each item.
If we assume that the liquidation price of the fund on
December 15 was $25.25, then the calculation for the Schedule D
would show a gain on every transaction with the exception of
item 12. These transactions require 13 different entries on
Schedule D, and for each entry, calculations to determine the
proportion of sales price allocated to the entry.
A review of the attached documents shows this to be an
actual case. It is also a very simple and common example.
Imagine the difficulty of tax reporting for a taxpayer who has
several mutual fund holdings and transfers funds between them
at varying times during the year. Some funds attempt to be
helpful by providing the investor with figures that can be
directly entered onto a tax return, but an experienced tax
professional knows these entries are not always correct. Also,
many taxpayers have funds from different organizations, and
each mutual fund company has its own style of reporting
transactions. It is easy to see why capital gains reporting is
very complex and confusing to taxpayers.
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Chairman Archer. Mr. Stevenson, the questions are never
complex, but the results and the law create complexities often
that are unintended. I appreciate your input particularly
because, as I mentioned, I am now beginning to prepare my
return for this year, and it is not a very happy prospect.
Other than the reduction of the 18-month holding period to
12 months, what other areas of simplification might we consider
in the capital gains area alone?
Mr. Stevenson. Well, one of the things that is kind of a
corollary to it are the small amounts of foreign tax that is
withheld. You will have a taxpayer that will have a mutual
fund, and there will be a distribution--an index distribution
because there is some foreign-owned stock. That will throw up a
$5 or $15 foreign tax credit, and in that we have to prepare a
Form 1116 which is a very complicated calculation just to get
this guy back his $5 to a foreign country. You might want to
take a look at that. It is somewhat of a nuisance. It is not
too bad for us who prepare tax returns on a computer, but for
the people who do it manually it is----
Chairman Archer. Do you have a suggestion for the Committee
as to how we might change that?
Mr. Stevenson. Yes, just give--just say that if the
foreign-tax credit is under $50 just make it a credit--an
automatic credit without all kinds of complications. I just
used $50, make it $25 or whatever number it is. You don't
really need that----
Chairman Archer. Any other suggestions? In any event, if
you and your organization have got suggestions that you would
like to submit to us in writing, we would be most happy to
receive them.
Mr. Stevenson. Well, I feel like a mosquito in a nudist
colony because I don't know where to begin when you ask a
question like that. I mean there are so many things that we do,
and we'll be prepared to submit something----
Chairman Archer. Once you get into the entire Code it gets
to be massive, but just in the capital gains area alone, try to
find the best possible ways to simplify it. Will we be able to
handle the 18-percent rate with a 5-year holding period without
any great difficulty in the next century? Is that going to pose
the same sort of difficulties that we have today?
Mr. Stevenson. Congressman, I suspect that if there are no
changes in the law that there will be very few correctly
calculated Schedule D tax returns either done by preparers or
by taxpayers.
As far as the holding period, I think you are going to find
that also difficult to monitor because people just don't save
their records that long of a time. I mean the law says you only
have to keep them for 3 years unless you feel that you
fraudulently prepared your tax return, and now you are going to
require people to hold onto their records for a much longer
period of time.
Chairman Archer. So, if we correct the holding period from
18 months to 1 year for the 20-percent rate, we leave in the
law the 18-percent rate for the 5-year holding period beginning
in the year 2001. Clearly the 18-percent rate is a very
attractive thing because it reduces the tax by 10 percent if
you have held an asset for 5 years. On behalf of savings, that
is very attractive.
Mr. Stevenson. Yes, but what you don't realize is that that
20 percent, 18-percent rate, that can turn out to be a bogus
rate particularly if there is a significantly large capital
gain that throws off a State tax. That State tax, which could
be large, throws a taxpayer into the alternative minimum tax
situation and the capital--I mean I have a calculation where I
can show you that it is 21 percent. So, when Congress tells the
public that ``your rate is such--well, we're doing this for
you, and your rate is 20 percent and 18 percent,'' when you get
down to do the tax returns, it is really not that rate, quite
often.
Chairman Archer. But is that the result of reducing the
rate to 18 percent with a 5-year holding period? Or would that
problem exist relative to the 20-percent rate?
Mr. Stevenson. No, it's a failure to see the relationship
between the alternative minimum tax and how the tax return is
calculated on a much broader scale.
Chairman Archer. But that would apply also to the 20-
percent tax, would it not?
Mr. Stevenson. That is correct----
Chairman Archer. OK.
Mr. Stevenson [continuing]. Yes. I have somebody in my
office and we just did her return, and she wound up with at 21-
percent rate.
Chairman Archer. Well, in my opinion, the alternative
minimum tax has outlived its usefulness and should be repealed.
We should be very careful that the provisions in the Code make
sense. And once we decide they do make sense, if people can
take advantage of them, they should be able to take advantage
of them and not have a ``snapback'' in some broad, unintended
way hit them through the alternative minimum tax.
Mr. Stevenson. Well, you will have a huge--if you don't do
something about the alternative minimum tax next year, when the
middle class starts looking for all their credits, there is
going to be a human cry across this country that will make
Congress quite uncomfortable because a lot of people will not
get these credits because the AMT only allows you to take
credits up to the amount of the AMT tax. You can't go below
that. The same thing is true of low-income housing credits.
Chairman Archer. It's not been stated today, but it should
be stated, as a part of this hearing, that if we do reduce the
holding period for the 20-percent rate from 18 months to 1
year, it actually raises revenue over the 5-year period during
which we budget here in the House of Representatives. So, it is
not a revenue loser, and that makes it even more attractive for
the Committee.
Does any other Member wish to inquire?
Mrs. Johnson and then Mr. McCrery.
Mrs. Johnson of Connecticut. Thank you.
Your testimony has been very interesting and very helpful.
I would like any of you who have the time to look at the SAVE
bill that I put in about a year ago with Earl Pomeroy with the
intent of helping small businesses provide a defined benefit
option to their employees. This Committee passed what we called
SIMPLE--it didn't turn out to be quite so simple--but any
suggestions you would have to simplify this SIMPLE plan now
that we have some experience or your comments on the SAVE bill,
we will be looking at that in the Subcommittee later on as well
as some of these other options.
And then, last, let me just say, the Hulshof bill is very
interesting because it just rewards savings. The Tax Code on
the whole rewards savings for specific purposes, retirement,
home buying, what ever. And I'm just wondering where you stand
on that. Should we have pursued targeted approaches to
incentivizing savings on the theory that there was a far
greater urgency to help people save for retirement and that
home buying has an inherent, structural benefit for society
than we have across-the-board savings. Would you comment on
where you think we ought to go--particularly in light of the
fact that we just passed the Roth IRA and some of those things.
Should we hold, see how those are going to do? What is your
advice on this targeted versus general savings incentives where
we are now?
Mr. Entin. I mentioned in my statement that a provision
with no strings is better than a provision with strings.
Mrs. Johnson of Connecticut. I noticed that.
Mr. Entin. The retirement-saving restrictions tend to chase
people away from retirement-saving plans.
Any time you try to micromanage the public you are going to
have a lot of trouble, because you don't know what their
circumstances are, and they react to what you do. Across the
board is always better. All saving should receive some sort of
relief, either front-end or back-end, deductible or Roth-style,
and not just saving for retirement, because all saving is
subject to the tax bias.
The income tax is biased against saving. It is not neutral
as between saving and consumption.
So, when you provide pension-type treatment, you are
eliminating a bias. You are not giving a favor. And, of course,
if having a bias is bad for one form of saving, it is also bad
for any other, and it should be removed.
There are really two sides to the situation. You want to
encourage saving--or not discourage saving as under current
law. But there is also the treatment of investment in plant and
equipment. To get a double whammy from your saving incentives,
you really need to see an improvement in the creation of plant
and equipment in the country for labor to work with, so labor
may become more productive and get higher wages. If people add
to their saving as a result of incentives, they put it into the
global saving pool, and who knows where it will ultimately end
up triggering more investment in plant and equipment--it could
be here, it could be in China, it could be in France. Wherever
the saving goes, it is good for the saver. The saver will have
more retirement income, and will be earning money from the
return on the capital that he helped to create, and he will be
able to buy more goods and services in his old age.
But if you would also like to see U.S. workers getting the
benefit of the higher saving rate, and see more plant and
equipment in the United States, and boost U.S. wages so that
people are benefiting when they are young as well as when they
are old from their saving and that of their neighbors, then you
need to do something to improve the tax treatment of U.S.
domestic investment. We need expensing, not depreciation of
plant, equipment, and structures. All of the fundamental tax-
reform plans, in effect, move us from depreciation to
expensing. That is true for a saving-deferred tax that falls on
individuals and does not put an added layer of tax at the
business level, or for an Armey-style plan which allows for
expensing, or for a national retail sales tax which does not
fall on investment goods. They are all a distinct improvement,
and they give you the double whammy of higher wages as well as
higher assets for retirement.
Mrs. Johnson of Connecticut. Thank you.
Mr. Bloomfield. Mrs. Johnson, we took note of the SIMPLE
plan in our testimony, I would be pleased to go back to some of
our members----
Mrs. Johnson of Connecticut. Thank you.
Mr. Bloomfield [continuing]. And see how it operates in
person.
The second question about moving forward incrementally,
strings attached, no strings attached, retirement savings
versus education savings--my sense is that these incremental
changes, by and large, are good. Some may be better than
others, but I think that you are a heck of a lot better moving
toward a consumption tax where you don't differentiate.
Third, Chairman Archer, again I would like to commend you
for your initiative today to reduce the holding period and
comment more on its economic impact than its simplification
impact. CBO, in a 1997 report, indicated that now about one-
half of all U.S. families hold assets such as stocks, bonds,
real estate and businesses that might produce capital gains or
losses. And that proportion ranges to three-quarters of
families if homes are included. Since this is a problem for a
lot of Americans, I think your step will be helpful.
In an economic sense, if you look at a survey of
industrialized countries and Pacific rim countries and what
their holding periods are, you see that only one country,
Sweden, has a holding period longer than a year. And obviously,
with a longer holder period, there is more risk, it increases
the cost of capital, and you don't get the economic bang, that
the Committee, I think, thought it would get when you heard
expert witnesses like Alan Sinai who testified about the
economic benefits of capital gains tax cuts. The benefits are
reduced because of the holding period, and we would be a heck
of a lot more competitive according to this chart with a
shorter holding period.
Mr. Stevenson. May I respond for a second?
Chairman Archer. Yes, sir.
Mr. Stevenson. I'd like to suggest that Congress consider
eliminating the 10-percent penalty for early withdrawal. I
think that is one of the cruelest taxes. It does not prevent
anybody from taking money out of their retirement, because by
the time they do that they are desperate, and they have to give
away 10 percent of the money that they take out. I think that
that would also encourage some more younger people to make an
investment in their retirement plan. Whether or not they keep
it all the way to retirement, they will be saving it without
fear of having to be penalized 10 percent if they have to take
it out for emergencies.
Chairman Archer. Thank you.
By the way, Mr. Stevenson, I have just refreshed my memory,
and in the bill that we passed last year under the
simplification section we provided for a $300 exclusion for the
foreign-tax credit limitation. And it does not take effect
until this year. It had a prospective effective date. But I
guess we heard you in some way through ESP last year and put it
into the Code in our 1997 Tax Relief Act.
On the issue of savings--and on the issue of simplification
for the Code, would you or would you not agree with me that in
today's parlance that whenever we hear the targeted--the word
``targeting,'' or ``targeted'' tax relief used that it is a
code word for complications in the Code. Would you or would you
not agree with that?
Mr. Stevenson. Yes, it creates another category that you
have to deal with separately.
Chairman Archer. Because we're hearing that a great deal
out of the White House now. It is fascinating, too, that
Secretaries of the Treasury under both the Republican
administrations and Democratic administrations have been
enamored with staggered holding periods. I have always been
very concerned about it, and you have given us some very good
input today as to why my concerns were with some degree of
support.
Mr. McCrery.
Mr. McCrery. Thank you, Mr. Chairman.
First I want to thank Mr. Entin and Mr. Bloomfield for
their kind references to H.R. 984. And I want to talk about
that in just a minute.
First, though, Mr. Bloomfield, in your testimony, you urge
the Committee to weigh carefully the President's proposals to
make sure that we minimize their effect on investment. But you
have that little phrase labeled as a step backward. Could I
take that to mean that you don't favor most of the President's
proposals for revenue raisers?
Mr. Bloomfield. Well, as you know, there is a long list in
the old parlance ``to raise revenue you go after cats and
dogs.'' Now they are going after puppies and kids of puppies.
So, some of those things are so minuscule and beyond my
comprehension. But there are some issues that are raised today,
like annuities, like inside buildup.
The headline of the New York Times----
Mr. McCrery. Those are not puppies, are they?
Mr. Bloomfield. Those are not puppies.
After the President's budget came out, there was a
headline, I think in the New York Times, that said,
``Administration Sends Mixed Signals on Savings and
Investments.'' So, when I'm talking about steps backward, I'm
saying that there may be things in there because there are so
many of them, but I would look very carefully at all of them
and look at the fundamental question of what is their impact on
savings and investments. It is clear that some of the
``puppies'' could severely impact negatively on savings and
investments.
Mr. McCrery. I was also interested in, Mr. Bloomfield, your
admonition that we make sure that anything that we do with
respect to tax reform is done in a fiscally responsible way. I
suppose by that that you mean let's not create another large
deficit in fiscal terms.
And it is in that context that I want to examine, for a
moment, H.R. 984 because the primary criticism that we hear
about H.R. 984 is, ``Oh gosh, it will just cost billions and
billions of dollars.'' And I'm a little stumped by that
analysis because take H.R. 984 and strip all the fancy words
and basically what you have is an unlimited savings account,
and anything that you put in the savings account you don't get
taxed on, but when you pull it out you get taxed on it. Well,
obviously, if you pull money out of a savings account, you do
it because you are going to buy something, you are going to
consume. Then you get taxed. Explain to me how that is
different from a national sales tax. I don't think that it is
any different, but if I am right, and it is not any different,
then why can we rationalize a national sales tax, in terms of
its fiscal responsibility and not an unlimited savings account?
Mr. Bloomfield. Let me, if I could, respond in two ways.
First, I would make a difference--distinguish between
progrowth tax measures and general tax relief. I agree with the
Chairman that our tax levels may be too high. He's talked about
a long-term goal about reducing tax receipts as a percentage of
GNP, and I also understand the pressures that people are under.
But there is a difference, a fundamental difference in terms of
long-term economic growth between those two different tax
measures. And so let's put that, and let's put Mr. Hulshof's
and others in one category, and other measures in another.
The second question addresses fundamental tax reform.
Obviously your proposal is basically a consumption or consumed
income tax. There are three generic types of tax reform
proposals. There is the Hall-Rabushka plan and the Armey
proposal, which is a flat tax. There is the retail sales tax,
and the value-added tax. There's the unlimited IRA, which you
proposed. In many ways those proposals are more similar than
dissimilar because they only tax savings once. As Mr. Entin
pointed out, we're exempting investment from the tax.
And I would refer you to our testimony where we discuss the
views of some of the best economists in the country, the Joint
Committee work, Jane Gravelle, you know who testifies before
this Committee on many occasions, on the impact of tax policy
on economic growth. If you look at table 3, at the long-run
effect of a consumption tax--which is one of the three generic
ones--versus a unified income tax, you will see that the
economy is a heck of a lot better off under a consumption tax.
So, if you are concerned about Federal revenue, obviously,
if you have a stronger economy you are better off in the long
term. When you do revenue estimating, you don't look at the
macroeconomic impact, and that is a decision, obviously, that
the Congress has to make.
Mr. McCrery. Mr. Entin, would you like to comment on my
question?
Mr. Entin. We are preparing a total tax overhaul paper that
incorporates your approach, which I will share with you as soon
as it is available. It is one of the three approaches that does
get to the same tax base.
You must look at the growth consequences of it to get a
good feel for what it would do, what it would cost, and what
the rate structure would have to be. If you use static revenue
estimation, it all looks much harder to do than it really is.
As a result, all of the hundreds of billions of dollars of
additional income for the population is lost because of the
fear of proceeding. I hope you can cut through that Gordian
knot and proceed anyway.
While you are tearing out the income tax by the roots and
doing these major overhauls, you may find you will have to tear
out many of the provisions of the Budget Act by the roots in
order to get a fair hearing. I would certainly support you in
that activity.
Mr. McCrery. Mr. Chairman, I didn't get a satisfactory
answer, really. If I could pursue it for just a moment.
I appreciate everything that both of you said, and I agree
with you, but just from a common sense standpoint, if you
institute a national sales tax at 17 percent that is supposed
to equal the revenues in the current system, I don't understand
what is different about that and my proposal which, if you
impose a flat rate of 17 percent on anything consumed, anything
not saved, what is the difference in terms of revenue to the
government?
Mr. Entin. The sales tax is a substitute for the individual
income tax, the corporate income tax and, one would also hope,
the transfer tax (the estate and gift tax). If the universal
IRA proposal is passed as a substitute for all three, then a
rate structure similar to the sales tax should yield you the
same revenue. If you simply add it on to the current personal
income tax and leave the corporate tax the way it is and the
estate tax where it is, and then don't adjust the income tax
rates, you would get a different result. But if you make it do
the whole job, then both of those taxes are, in effect,
consumed-income taxes. They would have the same tax base and
you would get the same revenue for the same rate structure.
Mr. McCrery. Right. So, Mr. Chairman, my point is I think
we can look at this concept that's embodied in H.R. 984 as an
alternative to creating a new bureaucracy to collect a national
sales tax or a value-added tax. It's the same effect. It's a
consumption tax. It's just, to me, it seems like it would be
easier to convert--and easier to sell, frankly, to the American
public--than a national sales tax or something like that.
That's the only point that I'm making.
Mr. Bloomfield. Mr. McCrery, conceptually, in terms of the
economic impact, they're the same, so I would encourage you to
join the road show of Mr. Armey and Mr. Tauzin.
Mr. McCrery. I would be glad to.
Mr. Bloomfield. What is at issue here, though, is when
you're talking about fundamental reform, what is that reform?
As you know, there is one sales tax proposal--the 23 percent--
which not only replaces the individual and corporate taxes, it
also replaces Social Security, estate and gift taxes. Some of
these tax reform proposals deal with Social Security; the Nunn-
Domenici proposal does. Others do not. So, the rate structure--
that's one of the questions--depends on what you're replacing
with what.
Mr. McCrery. Absolutely. My only point is I think this
approach is worth looking at in terms equal to the sales or VAT
approach and the flat tax approach.
Chairman Archer. I would just jump in and say the Chair
welcomes all types of alternatives for consideration that will
get us to the same desired goal, and the Nunn-Domenici approach
gets us basically to most of the goals. But the attributes of
Nunn-Domenici, and I believe from your proposal as I understand
it, leave the IRS in everybody's life. Every individual still
has to file a return, and the IRS still survives, exists, and
is alive and well. And that is a big, big difference from the
standpoint of freedom and privacy and what value people might
attach to that.
In addition, the Nunn-Domenici and the Armey and your
proposal, as I understand them, will not get at the underground
economy because they're not going to file an income tax with
the IRS. As a result, the underground economy continues to
flourish without paying their fair share of the cost to
government. That is another difference, and I think an
important goal.
I don't think that your proposal, or Nunn-Domenici, would
qualify for border adjustability and all of the advantage that
would give us in reducing the price of our exports and seeing
more factories built in this country for export. So, the goals
of greater savings are there; the goals of simplification are
there, although Nunn-Domenici has significant complexities in
it also. Investment incentives, and so forth, are there, so I
congratulate you on that part of it.
Mr. McCrery. Thank you, Mr. Chairman. You and I certainly
don't want to do a road show right here, but I would say to the
Chairman that there are problems with an underground--a so-
called underground--economy with the national sales tax, as
well. In fact, most economists will tell you there's very
little difference in the impact to revenues between the two, so
I don't think that's a particular obstacle.
Chairman Archer. Sure, there are problems with leakage in
any tax system.
Mr. McCrery. Absolutely.
Chairman Archer. Any tax system is going to have leakage.
The question is, What kind of leakage and how is it perceived
by the public and how willing is the public to be to accept it?
The fact that drug dealers can escape is abhorrent to the
public, and the public understands that drug dealers will, when
they buy the expensive items in the marketplace--if you have a
spending sales tax, will pay.
Mr. McCrery. We're going to follow the Speaker's lead,
though, and get rid of those drug dealers over the next few
years, so we don't have to worry about them buying Cadillacs
anymore.
Chairman Archer. Well, let's hope so.
Mr. Watkins.
Mr. Watkins. Thank you, Mr. Chairman, Members of the
Committee, and the panel. We all know we're truly in a global
competitive economy, and I guess one of the great interests I
have sitting on this Committee is, I think we must analyze the
entire tax policy and how it affects our economy and allows us
to be able to compete in that competitive, global economy.
Mr. Bloomfield, you discussed the time periods regarding
selling, capital gains, for taxes and all. I know we must
increase our savings. We know we have the lowest percentage of
savings of any industrialized country in the world. I might add
I'm personally not worried about what's happening for my
future, but I'm worried about the future of my children and my
grandchildren, and the children and grandchildren of all the
people here. We've got to, in my opinion, shape and mold our
tax policy to let us have at least a fair and competitive--and
maybe even an advantage--tax policy, instead of being a
hindrance and detrimental.
I know some countries do not even have a corporate capital
gains tax. Now we, I think, moved in the right direction by
lowering the capital gains tax for individuals. But it seems to
me it would make good, sound policy for us to be able to
compete in that global economy to lower or drop, as much as we
can, the corporate capital gains tax, like we have with the
individual rates.
Now, I've got a couple of questions. Mr. Bloomfield, could
you provide, possibly, to me and maybe the panel, the countries
that do not have a corporate capital gains tax? And also, I
know it makes economic sense, but do you feel like this would
be good, something that is very much needed as far tax policy
to let us compete in this 21st century?
Mr. Bloomfield. Mr. Watkins, I will submit that for the
record, but I would like to, while I'm here, also respond to
your question.
[The following was subsequently received:]
[GRAPHIC] [TIFF OMITTED] T0897.141
Mr. Bloomfield. It makes no sense to differentiate between
individual and corporate capital gains rates for several
reasons. First, there is precedent. We've always had an
alternative capital gains tax rate in the Code from 1942 until
the Tax Reform Act of 1986. Number two, we tax corporate
capital gains much more harshly than do all our competitors. We
have a survey that I will submit that shows that 14 out 16
countries tax corporate capital gains more favorably than the
United States.
[The information follows:]
[GRAPHIC] [TIFF OMITTED] T0897.142
[GRAPHIC] [TIFF OMITTED] T0897.143
Mr. Bloomfield. Third, there's the efficiency of capital
markets. Capital is less mobile and you lose economic
efficiency because of the lock-in at the high rates that you
have with the corporate rate now at 35, as opposed to the lower
rate we have for individuals.
Fourth, the structure of U.S. business: The current
imbalance between individual and corporate capital gains rates
heightens inequities already inherent in what Mr. Entin talked
about--the double taxation of current profits--and you have
excessive tax planning that may accentuate a movement away from
the traditional corporate form of organizations.
Fifth, corporations provide a heck of a lot of venture
capital, as well as spinning off and funding their own venture.
So, if you're talking about the economic case for low capital
gains taxes--the impact on capital costs, capital mobility,
entrepreneurship--it makes absolutely no sense to differentiate
between individual and corporate capital gains if low capital
gains tax rates make economic sense.
Mr. Watkins. It sounds like you were loaded for my
question. [Laughter.]
Mr. Bloomfield. I try to be prepared.
Mr. Watkins. I just am concerned about making sure we do
not overburden, or that we have an overburden in some cases,
especially in a lot of our startup, entrepreneur-type
companies, with other corporations around the world. In fact,
96 percent of the consumers of the world live outside of the
United States. That's one heck of a big market, and as
businessmen tell me, ``I want to be able to be in that market,
and I want to be out there trying to penetrate that market, and
I don't want to be overburdened with regulations and with taxes
and with other things.'' And, I think this is something we've
got to do if we're going to be allowing our children and
grandchildren to be competitive in this world.
Mr. Entin, would you like to add to that?
Mr. Entin. I would add two points. Corporations are owned
by people. It's wrong to tax capital gains received by
shareholders directly from a corporation; it's also wrong to
tax capital gains that one corporation receives from another
corporation. That receiving corporation is owned by
shareholders. It's the shareholders' money, and if it's wrong
to tax it when they receive it, it's wrong to tax it in mid-
stream as well. Taxation of capital gains is double taxation
wherever you find it.
As for the competitiveness of U.S. companies abroad, it's
not just the taxation of capital gains at the corporate level
that does the damage. Our whole structure of international
taxation, of tax treatment of multinational corporations, puts
our firms at a competitive disadvantage in third countries--in
foreign countries--vis-a-vis other corporations from third
countries. What you really need to do is totally restructure
that whole treatment of U.S. corporations that earn income
abroad, and go from a global treatment of foreign source income
to a territorial system.
Mr. Watkins. Can you give me the facts on that?
Mr. Entin. Yes.
Mr. Watkins. I'd like to have the materials and information
in my office.
Mr. Entin. We really should not be trying to reach globally
to tax our people on incomes they earn in other countries, when
other countries are taxing that income. A territorial tax would
be a heck of a lot simpler and make our firms a lot more
competitive abroad.
Mr. Watkins. Thank you, Mr. Chairman.
Chairman Archer. Thank you. Any further questions of the
panelists?
All right, thank you very much, and we'll have our next
panel, please. Dean Kleckner, president of the American Farm
Bureau Federation; David A. Hartman, chairman of the Institute
for Budget & Tax Limitation; Thomas Kelly, president of the
Savers & Investors League.
Thank you.
Mr. Kleckner.
STATEMENT OF DEAN KLECKNER, PRESIDENT, AMERICAN FARM BUREAU
FEDERATION
Thank you, Mr. Chairman. I am Dean Kleckner. I am a farmer
from north Iowa, raising corn, soybeans, and hogs. I'm also the
elected president of the American Farm Bureau Federation, which
is not only the country's, but the world's, largest farmer
organization. Our members grow everything commercially that's
grown in the United States.
I commend this Committee for calling this hearing. I'm here
today to speak in just two areas--although you've covered a lot
already--the FARRM Accounts and capital gains tax relief. FARRM
is spelled F-A-R-R-M, Farm and Ranch Risk Management Accounts.
We support the creation of those to allow farmers and ranchers
to manage business risks better through savings.
FARRM Account legislation will soon be introduced, and I
just received a copy of the bill this morning by Representative
Hulshof, who is here, and Congresswoman Thurman. Under the
bill, farmers and ranchers would be allowed to put up to 20
percent of their net farm income--pretax--into a special
savings account. Money could remain in the account for no more
than 5 years, and then whenever it came out it would be taxed
at the going rate.
Last month Congressman Hulshof traveled to the American
Farm Bureau annual meeting to speak to farmers and ranchers
from around the country about this--and let me tell all of you,
he was enthusiastically received.
Let me explain why the idea of a pretax savings account for
farm income is so popular. Like other small business people,
farmers and ranchers have predictable expenses. I'm one; I
know. Each month we must pay for fuel, animal feed, repairs,
maintenance, insurance, utilities, and meet a payroll. And in
addition, we plan for seasonal expenses like taxes, seed, heat,
and fertilizer, and then budget for major purchases, often done
yearly or even less than that, like equipment, land, and
buildings.
While many expenses can be predicted and to some degree
controlled, farm income is neither predictable nor
controllable. The prices that farmers and ranchers receive for
their products are determined by forces we can't control:
markets and the weather. We don't know from 1 year to the next
if our business will earn a profit, break even, or be in the
red.
Few other industries face the challenge that farmers do
year after year after year. What all farmers and ranchers hope
for--I know I do--is that good years will outnumber the bad
ones. Believing that better times are coming, we get through
the tough times by spending our retirement savings, borrowing
money, refinancing debt, putting off capital improvements, and
too often, lowering our standard of living. None are good for
the business or the family that operate it.
FARRM Accounts--with the two ``R's''--will furnish a very
valuable risk management tool for farmers and ranchers and
provide a meaningful incentive to save for that rainy day. The
Farm Bureau commends Congressman Hulshof for his leadership on
this profarmer, prosaving legislation, and we ask each Member
of the Committee to cosponsor the Hulshof-Thurman FARRM Account
bill and urge its passage during this Congress.
Another subject: We also commend this Committee on Ways and
Means for capital gains tax relief that was passed last year as
part of the Taxpayer Relief Act of 1997. Lower capital gains
taxes that resulted from that bill are providing real benefit
to America's farmers and ranchers. The Farm Bureau believes it
is simply wrong to tax earnings twice. The capital gains tax
does that, first as earned income and then as investment
income. This double taxation results in inefficient allocation
of scarce agriculture resources and less net farm income.
Farmers and ranchers need capital gains tax relief to
ensure the cost and availability of investment capital. The tax
reduces the amount available for reinvestment. When borrowing
from banks or other institutions, the impact of the tax on farm
profitability can affect loan eligibility. Capital gains taxes
are a deterrent for new and expanding farms and ranches.
Some older farmers and ranchers want to sell their farms,
but they don't. I'm approaching that myself. We don't because
we don't want to pay the capital gains tax rate, even at the
lower 20 percent level. When we do sell, young farmers and
ranchers must pay a premium to cover the capital gains tax
assessed on the seller.
We, frankly, believe that capital gains taxes should not
exist, but until repeal is possible we support cutting the rate
to no more than 15 percent, regardless of the length of time
that assets are held, and believe that assets should be indexed
for inflation. We also recommend that the $500,000 exclusion
that you passed last year for the sale of a primary residence,
should be expanded to include farms and ranches. It's a matter
of equity, we believe, and of fairness.
Last year's reduction in capital gains taxes improved the
financial environment in which farmers and ranchers operate our
businesses.
We urge Congress to enact FARRM Accounts--with the two
``R's''--Congressman Hulshof's bill--and further reduce capital
gains taxes without delay. The result will benefit farmers,
consumers, and the economy. I thank you for this opportunity to
present this testimony.
[The prepared statement follows:]
Statement of Dean Kleckner, President, American Farm Bureau Federation
My name is Dean Kleckner. I am a hog and grain farmer from
Rudd, Iowa, and who serve as the elected president of the
American Farm Bureau Federation. AFBF is a general farm
organization of 4.7 million families whose members produce
every commodity commercially marketed in this country.
Farm Bureau commends the Committee on Ways and Means for
calling this hearing to focus attention on the importance of
saving and investment incentives. I am pleased to be here today
to speak on behalf of several initiatives that would be
beneficial to farmers and ranchers.
FARRM ACCOUNTS
Farm Bureau supports the creation of Farm and Ranch Risk
Management Accounts (FARRM), to help farmers and ranchers
manage risk though savings. Using Farm and Ranch Risk
Management Accounts, agricultural producers would be encouraged
to save money in good economic times for the ultimate lean
economic years.
Like other small businessmen, farmer and ranchers have
predictable expenses. Each month they must pay for fuel, animal
feed, equipment repairs, building maintenance, insurance,
utilities, and meet a payroll. They must plan for seasonal
expenses like taxes, seed, heat, and fertilizer they must also
budget for major purchases like equipment, land and buildings.
While many expenses can be predicted and to some degree
controlled, farm income is neither predictable nor
controllable. The prices that farmers and ranchers receive for
their commodities are determined by forces over which they have
no control, markets and the weather. Farmers and ranchers do
not know from one year to the next if their businesses will
earn a profit, break even, or operate in the red. Few other
industries must face such a challenge year after year after
year.
What all farmers hope for is that the good years will
outnumber the bad ones. Believing that better times are coming,
farmers and ranchers get through tough times by spending their
retirement savings, borrowing money, refinancing debt, putting
off capital improvements and loweriing. All of these activities
damage the financial health of a farm or ranch and the well-
being of the family operating the business.
The 1996 farm bill phased out government price and income
supports to farmers through the year 2002. Farmers and ranchers
supported this phase-out because of the promise of expanding
market opportunities and assurances by Congress that new ways
would be found to help farmers and ranchers manage their
financial risks.
FARRM accounts would encourage farmers and ranchers to save
by allowing them to put up to 20 percent of their net farm
income, pretax, into a Farm and Ranch Risk Management (FARRM)
Account. Money would be allowed to remain in the account for no
more than five years and would be subject to taxation at
withdrawal.
Farm Bureau asks each of you for your support for FARRM
accounts. Their creation will give farmers and ranchers a
meaningful incentive to save for a rainy day and provide a very
valuable tool for managing financial risk. We urge you to
cosponsor legislation to create FARRM accounts and to pass it
into law during the 105th Congress.
INCOME AVERAGING
Farm Bureau compliments Congress for including income
averaging for farmers and ranchers in the Tax Relief Act of
1997. This action added a much needed dose of fairness to the
tax code. Unfortunately, this important section of the bill
sunsets after 2000.
As explained earlier, farm and ranch income varies greatly
from year to year due to unpredictable markets and
uncontrollable prices. It is common for a typical farmer from
my state of Iowa to see his taxable income vary by 50 percent
over the course of a marketing cycle. During that same period,
his income tax rate can vary from 0 percent to over 30 percent.
This means that the farmer ends up paying more in taxes than
his nonfarm neighbor who earns the same aggregate income in
equal installments.
In addition to being unfair, a tragic result of a tax code
without income averaging is that it makes it more difficult for
farmers and ranchers to reinvest in their businesses and to
prepare for bad years. Farmers and ranchers can only save money
when the money they earn is available to invest. Without income
averaging, inflated tax rates produce high taxes that eat up
farm or ranch profits rather td for difficult financial times.
Beginning next year, income averaging will work by allowing
farmers and ranchers to reduce their farm income in a given
year by treating a portion of that income as if it was earned
in the three previous years. While the farmer's or rancher's
tax liability for the current year would be reduced, the amount
of taxes due for the previous two years could increase. This
creates fairness in the tax code and would allow farmers and
ranchers to save what they have earned instead of paying
overstated taxes.
Farm Bureau calls upon Congress to make income averaging a
permanent part of the tax code. The provision could by be
improved by allowing farmers and ranchers to allocate a greater
portion of current income to the lowest income year rather than
dictating that it be reallocated in equal installments.
CAPITAL GAINS TAXES
Farm Bureau commends the Committee on Ways and Means for
capital gain tax relief passed as part of the Taxpayer Relief
Act of 1997. Lower capital gains tax rates that took effect
last summer are providing real benefit to America's farmers and
ranchers.
Farm Bureau believes it is wrong to tax earnings twice. The
capital gains tax does that, first as earned income and then as
investment income. For farmers and ranchers the tax is
especially burdensome because it interferes with the sale of
farm assets and causes asset allocation decisions to be made
for tax reasons rather than business reasons. The result is the
inefficient allocation of scarce capital resources, less net
income for farmers and reduced competitiveness in international
markets.
Farmers also need capital gains tax relief in order to
ensure the cost and availability of investment capital. Most
farmers and ranchers have limited sources of outside capital.
It must come from internally-generated funds or from borrowing
from financial institutions. The capital gains tax reduces the
amount of money available for reinvestment by farmers and
ranchers. Financial institutions look closely at financial
performance, including the impact of the capital gains tax on
the profit-making ability of a business when deciding loan
eligibility.
Capital gains taxes affect the ability of new farmers and
ranchers to enter the industry and expand their operations.
While many think of the capital gains tax as a tax on the
seller, in reality it is a penalty on the buyer. Older farmers
and ranchers are often reluctant to sell assets because they do
not want to pay the capital gains taxes. Buyers must pay a
premium to acquire assets in order to cover the taxes assessed
on the seller. These higher costs for asset acquisition
negatively impact the ability of new and expanding farmers and
ranchers.
Farm Bureau believes that capital gains taxes should not
exist. Until repeal is possible, we support cutting the rate of
taxation to no more than 15 percent regardless of the length
the assets are held. We also recommend that the recently
increased exclusion on the sale of a primary residence, now set
at $500,000, should be expanded to include farms and ranches
and that rate relief should also be provided to incorporated
farmers and ranchers.
Farm Bureau also supports adjusting capital gains for
inflation so that only real gains in the value of assets would
be taxed. Under current law, many farmers and ranchers pay an
effective tax rate that is extreme and sometimes end up paying
more in capital gains taxes than the increase in the real value
of the assets. For assets held for long periods of time,
adjusting their value for inflation is a matter of fairness.
Farmland provides a good example. Farmers and ranchers on
average hold farmland for about 30 years. In 1967, farmland in
my state of Iowa was valued at an average of $257 per acre. In
1997, the average was $1,680. A farmer who bought 300 acres of
average land in 1967 for $77,100 and sold it in 1997 would have
a taxable gain of $426,400 and owe $85,380 at a 20 percent tax
rate. Average prices in the U.S. economy are now 4.26 times
what they were 30 years ago. This means that the real increase
of value on those 300 acres was $175,554, making the effective
tax rate on the real capital gain 48.6 percent.
FARMER IRA
Farm Bureau also supports allowing receipts from the sale
of farm and ranch assets to be placed directly into a pretax
individual retirement savings account (IRA). Withdrawals would
be taxed at the regular applicable income tax rate. Farm and
ranch assets accumulated over a lifetime are often the
``retirement plan'' for farmers and ranchers. Allowing these
funds to be placed into a pretax account would treat farmers
and ranchers in the same manner as other taxpayers who
contribute to IRAs throughout their working life.
EXEMPTION FOR THE FIRST $1,000 OF INTEREST INCOME
Farm Bureau believes that there should be no income tax on
the first $1,000 of interest income for individuals. While the
exemption would provide a great savings incentive for taxpayers
of all income levels, it would be especially beneficial to
middle and lower income taxpayers. It would be of special value
to young people trying to get into the farming business, to
students saving for college and to workers saving to buy their
first home. The savings incentive would also help young people
establish a pattern of saving leading to a lifetime of saving
and investing that would be good, not only for the individual,
but for the economy.
CONCLUSION
American farmers and ranchers are the most productive in
the world, allowing U.S. citizens to spend only less than 11
percent of their income on food, the lowest percentage in the
world.
Last year's reduction in capital gains taxes greatly
improved the financial environment in which farmers and
ranchers operate their businesses. In order for them to
continue their high level of productivity and improve on their
record, Farm Bureau urges Congress to make further improvements
in capital gains tax law, to enact FARRM accounts and to extend
income averaging without delay. The results will benefit
farmers, consumers and the economy.
Thank you again for the opportunity to testify today on
these matters of importance to our nation's farmers and
ranchers and their families.
Mr. Herger [presiding]. Thank you, Mr. Kleckner.
Mr. Hartman, please.
STATEMENT OF DAVID A. HARTMAN, CHAIRMAN, INSTITUTE FOR BUDGET &
TAX LIMITATION, AND CHAIRMAN AND CHIEF EXECUTIVE OFFICER,
HARTLAND BANKS, N.A., AUSTIN, TEXAS
Mr. Hartman. Thank you. Mr. Chairman, Members of Congress,
ladies and gentlemen, my name is David Hartman, chairman of the
Hartland Banks and chairman of the Institute for Budget & Tax
Limitation, both of Austin, Texas.
My testimony today presents the institute's proposals for
closing the U.S. capital formation gap. Before I commence, I
would like to applaud the efforts of you, Mr. Chairman, and
your Committee, to reduce, simplify, and make more efficient
our Tax Code.
Our Nation, which throughout most of this century was a net
exporter of financial capital to the rest of the world, has
recently been importing one-half of its net new capital
formation each year from abroad. This is no Marshall Plan. The
earnings which we pay to foreigners will drain our national
income in the future, and we cannot rely on endless importing.
The problems of insufficient capital formation have come from
four sources: the Federal deficit, taxing the corpus of our
existing capital, insufficient personal savings, and double
taxation of corporate income.
The Federal deficit has diminished, and the budget now
projects a current cash flow surplus. However, under our
present circumstances of a huge deficit in capital formation
and a pending Social Security crisis, a surplus of at least the
difference between the current inflows and outflows of Social
Security and Medicare should be the minimum for responsible
fiscal policy. Nearly that scale of surplus is projected for
fiscal year 2002--the sooner the better. Moving up rear-loaded
spending cuts could provide room to circumvent PAY-GO.
It is further proposed that the following changes be made
to the Internal Revenue Code in order to remedy the problems
that limit capital formation. First, allow rollover of capital
gains which are reinvested in any capital assets or accounts,
without taxation. Two, tax any capital gains not reinvested at
ordinary rates, after indexing, for inflation, which ironically
comes out pretty close to 20 percent.
Allow estates the same rollover as for capital gains with
continuity of ownership, including taxation at the prevailing
ordinary tax rates after indexing for inflation those assets
not reinvested. Allow all individuals the right to save and
invest up to a total of 15 percent of their income, with
exclusion from income taxation, without limitation of income or
nature of investment.
Fifth, end double taxation of dividends by exempting
dividends from income taxation, and by excluding increases in
retained earnings from capital gains on stocks. We note here
that we would consider that the interest should continue to be
taxed when received as income and when paid for productive
purposes, exempted as a factor cost.
The first four proposals, which should be considered the
most important for capital formation are estimated to cost $78
billion per year and are presented in order of priority. The
elimination of double taxation, while the most unjustifiable
and confiscatory, is of lesser priority due to its estimated
revenue cost of $99 billion and the fact that it will be in
part consumed rather than reinvested.
The right to exclude up to 15 percent of income should
promote a personal savings increase of $96 billion. The
reductions in capital gains and estate taxations due to
rollovers would fully translate into increased capital
formation.
Should Congress resolve to budget sooner a $98 billion
surplus equal to the net cash inflow of Social Security and
Medicare, the combined effect would be additional new domestic
capital formation equal to $240 billion. The net result, as
estimated, would return the United States once again to a
capital surplus in control of its economy's future.
The proposals presented for the first four items should
prove to be self-funded over the course of time. The additional
supply of capital that results would lead to a return to
interest rates comparable to those in the early sixties,
resulting in a reduction of $72 billion per year in Federal net
interest costs, prospectively and into the future. A
productivity increase dividend of perhaps a half a percent a
year could yield an additional $64 billion in taxes by 5 years
hence. The benefits would accrue to all Americans--a $100
billion-plus in mortgage interest and a $100 billion-plus
dividend in growth of personal income.
In summary, it is of critical importance that we adopt the
following measures to increase capital formation: rollover of
capital gains, indexing of capital gains for inflation,
rollover of estate assets, exclusion of 15 percent of personal
income saved, and run a responsible budget surplus. Hopefully,
the double taxation of corporate income could be included as
well in the future.
I conclude by reminding you that Federal Government
spending consumes an excessive portion of the Nation's
resources at the expense of the productive private sector and
capital formation. Nothing could brighten the future of this
country more than a commitment to less government and lower
taxation to enable closing the capital formation deficit.
Mr. Chairman, I have offered an additional exhibit, which I
would like to have included in the record. It shows the
comparison of a 20-percent capital gains tax compared to
indexed capital gains. And I would also like to request, if it
would be possible, that we offer the Institutes just released
assessment of the marriage tax penalty.
Mr. Herger. Without objection, that will be done.
[The prepared statement and attachments follow:]
Statement of David A. Hartman, Chairman, Institute for Budget & Tax
Limitation, and Chairman and Chief Executive Officer, Hartland Banks,
N.A., Austin, Texas
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Mr. Herger. Thank you, Mr. Hartman.
Mr. Kelly.
STATEMENT OF W. THOMAS KELLY, PRESIDENT, SAVERS & INVESTORS
LEAGUE, VILLANOVA, PENNSYLVANIA
Mr. Kelly. Thank you, Mr. Chairman. My name is W. Thomas
Kelly. I am the president of the Savers & Investors League in
Villanova, Pennsylvania.
I am here to discuss the Individual Investment Account Act,
H.R. 984, which has been favorably commented upon by some of
the other presenters here today. These accounts operate like
IRAs, and they can be described in just three sentences. Every
person can make unlimited tax deductible contributions to their
individual investment account. These assets are invested tax-
free until withdrawn by the owner or the beneficiary. There are
no penalty taxes, no forced distributions, and no estate tax at
death.
Now I'd like to describe just some of the attributes of
this legislation. First, it is fiscally sound. It produces tax
revenue gains, not losses. Also, it is bipartisan in
sponsorship, both in the House and the Senate. It has been
voter-taxpayer tested and enthusiastically endorsed. There are
few, if any, transition problems. It promotes new saving by
lowering the cost of savings. In effect, it converts an income
tax to a form of consumption tax so that savings are only taxed
once, as they should be.
Permit me to comment upon the cost. Static revenue
estimates show costs as being high and continue to grow
continuously over the years. However, when proper analysis of
this proposal is made through dynamic revenue estimates, they
show that costs are low, they stay low for a few years during
the transition period, then the static scoring shows that tax
revenues gain and grow and grow. Static scoring shows major tax
revenue losses, whereas dynamic scoring shows major tax revenue
gains. It is appropriate to state that static scoring has major
flaws in its inception and use. Static scoring must be changed.
Static scoring creates major tax policy mistakes.
What would be the effect of this legislation? First, I'd
like to comment on just two major effects--on jobs and on the
aftertax income of our taxpayers. Jobs, with this tax proposal,
will start to increase immediately. In less than 3 years,
400,000 new jobs will be created. That is about the same number
of jobs which are held in the city of Detroit currently, to
give a frame of reference. In less than 10 years the number of
jobs will increase by 1,300,000. That is approximately the
employment currently in the city of Chicago. In less than 15
years, the number of jobs will increase by 2,100,000, and that
number of new jobs is about two-thirds of the number of jobs in
New York City.
Talking about the aftertax income of our taxpayers, they
will increase in less that 10 years by about 10 percent. This
is through the income capital growth that this proposal
produces. The lowest quintile of those taxpayers have their
aftertax income increased by 15 percent. Obviously, they
increase more because they pay less in taxes, being in the
lowest quintile, and many of them pay no taxes; therefore, they
enjoy more of the gain that flows from the economic growth.
In conclusion, Mr. Chairman, H.R. 984 is most worthy of
Full Committee report, and further, this Committee, in my
judgment, must insist upon correcting the fundamental flaws of
static scoring.
Thank you. I'll be glad to respond to any questions.
[The prepared statement follows:]
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Mr. Herger. Thank you very much, Mr. Kelly. Mr. McCrery, I
know you have to leave. Would you like to inquire?
Mr. McCrery. Yes, thank you, Mr. Chairman. Unfortunately, I
do have to leave for an important meeting that started 3
minutes ago, but I did want to stay for all of your testimonies
and I thought all of them were excellent.
Mr. Kelly, I particularly want to thank you for your
contribution to H.R. 984. It was Mr. Kelly that originally
brought the idea to me, and I think it's--as you can see, Mr.
Kelly--gaining some favor in important circles around the
country, and we have more and more people looking at some sort
of savings-exempt type of income tax as an approach that makes
a lot of sense.
So, thank you very much for helping us with H.R. 984. As
you know, we're making some refinements to it now and hope to
have that completed in the near future. So I just wanted to
thank you, Mr. Kelly, and thank all of you for your testimony
today.
Mr. Herger. Thank you, Mr. McCrery. Mr. Kleckner, if I
could ask a question of you. In 1986, Congress did away with
income averaging for farmers. We brought it back again last
year, at least to extend through the year 2001. Could you tell
me, how would your recommendation of being able to put away 20
percent of any one year's income compare with income averaging?
Mr. Kleckner. In many ways they are comparable in the end
result, but we don't see them as being in opposition to each
other or interfering with each other. We support both. The
income averaging, if I recall correctly, was passed for 3
years; it would have to be authorized again. I think that's
necessary. Income averaging really affects us farmers mostly
when we have a spike in income. If you have a sudden spike in
income, income averaging allows you to go back over 3 years to
refigure your taxes. That's somewhat expensive. But, again,
it's good to have.
We see the FARRM Accounts, if they're enacted, as allowing
farmers to make up their own minds to set aside up to 20
percent. I think many farmers might only set aside 5 or 10
percent, but they have the option of 20 percent.
It's highly unlikely in my view that farm income would stay
high for 5 years, so few people would come to the place where
they were forced to take money out. Farm income goes up and
down. If I have 2 good years in a row, I'm happy; the third
year I'll probably pull some out. So the chances of money being
in there for 5 years are virtually nil in my view. We don't see
them as antagonistic toward each other; they're really
complementary.
Mr. Herger. Good. I thank you very much.
Mr. Hulshof to inquire.
Mr. Hulshof. Thank you, Mr. Chairman. First of all, Mr.
Kleckner, thank you for your testimony. Thanks for your kind
words, and I really want to thank the Farm Bureau for your
support and your interest, whether it's the national American
Farm Bureau Association or whether it's the 88,000 Missouri
Farm Bureau members, of which I am one. When all of you are
singing together in the same chorus, when you're voices are
singing the same refrain, it's a loud voice. And, certainly,
when you speak, we listen here in Washington.
I, too, as you know, Mr. Kleckner, am a farm boy and know
first hand of many of the things that you've talked about, and
I'm proud to have that background. As you alluded to, farm
incomes vary not only with market conditions and yield and
weather, but sometimes with the political decisions we make
here in Washington affect--especially on trade issues.
Certainly through the farm bill of 1996, it places more risk
management on farmers and ranchers, as far as future
responsibility.
You talked about--and Mr. Chairman, you mentioned--income
averaging; yes, it's due to sunset. Hopefully, we can allow
some more permanence in income averaging. But if I could
perhaps answer your question, Mr. Herger, as to how these two
work together. I guess they're somewhat--income averaging and
the FARRM Account would be sort of like distant cousins to one
another, although income averaging looks back, FARRM Accounts
look forward, and I do see them complementing one another.
One of the criticisms, if you want to call it that--that's
probably too strong of a word about income averaging--is that
it's useful only in a high year. As Mr. Kleckner says, when you
spike up you can take certain amounts of that income and
deflect it back in the preceding 3 years to help stabilize and
reduce the amount of taxation that would have occurred in that
high year.
Many of us in Missouri, in fact in the Midwest, recall all
too well 1993, with the great flood, and again in 1995. What do
you do in a down year? Income averaging only benefits farmers
and ranchers when they see a spike up and, hopefully, through
the FARRM Account, it would be a way for them to prepare for
the future in those third years, as you mentioned, Mr.
Kleckner, that invariably come when there are drought
conditions or too much rain or circumstances beyond farmers'
and ranchers' control to allow them to put aside. In fact, we
envision, perhaps, income averaging and FARRM Account
contributions. But, again, just some of the technical points,
and Mrs. Thurman and I are trying to work out the details and
expect this legislation to be introduced next week.
But an eligible farmer can take an above-the-line deduction
up to 20 percent of net farm income. The FARRM Account is
actually a trust. It's really not like an IRA, but it is income
that's tax-deferred, put into this trust account for up to 5
years--and I can't envision, Mr. Kleckner, 5 good years in a
row--but if, in fact, no distributions were taken from that
account, that in the fifth year you would have to take a
distribution. And it would then be taxed, of course, at the
time that it's removed and would be included as taxable income.
It would be similar to first-in, first-out rules, and that
is the money that you put in the first year would be the money
you would take out in the sixth year, and we have some other
technical aspects to the legislation to make sure that it's
mainly for individual farmers.
So, the long way around to answer your question, along with
what Mr. Kleckner said to you, Mr. Herger, is that we see these
as working together. Income averaging is good; it's a good,
useful tool. But the FARRM Account, I think, is another
management tool to help farmers spread the risk, and we
certainly appreciate the efforts of the Farm Bureau in helping
us promote the idea, and I yield back.
Mr. Kleckner. Mr. Chairman, I really think--and I'm trying
to remember back in my 30-plus years of farming--I really only
think I've used income averaging, when it was allowed, twice.
You don't very often have those spikes where it really is
effective to use. Something like FARRM, I can see a number of
farmers using it fairly often.
Mr. Herger. Thank you very much, and thank you for the sake
of the record, particularly, in clarifying that. I'm also from
agriculture country myself, and this is something that's very
important to all of us. Thank you.
Mrs. Johnson to inquire.
Mrs. Johnson of Connecticut. Thank you. Mr. Kelly, why
would you need this other FARRM trust approach if the approach
that you advocate was adopted?
Mr. Kelly. Could you repeat that?
Mrs. Johnson of Connecticut. Yes. Why would we need IRAs or
Roth IRAs or this new FARRM trust proposal if the approach that
you advocate is adopted?
Mr. Kelly. Well, certainly the approach which I am
suggesting does not remove those. Any corporation can and will
continue with their pension plans. As a matter of fact, if this
were introduced and passed, corporations could now return to
the proper approach that they've taken and install defined
benefit plans, as contrasted with defined contribution plans.
It's only what I'll describe as the insane way in which our
Nation taxes tax-qualified plans that has, in a sense, forced
corporations to gradually get away from defined benefit plans
and then lead others to install in lieu thereof defined
contribution plans or 401(k)s, or 401(k)s to supplement instead
of increasing defined benefit plans.
There's nothing that would keep corporations from doing
that which they wish. This merely offers another alternative, a
very fine alternative, where corporations can utilize this
approach also, and I might also add it helps solve the serious
problem of terminated employees and the portability of
pensions. You can go right down the list, and there are all
kinds of advantages as to why corporations would utilize and
encourage this kind of approach.
Mrs. Johnson of Connecticut. In your testimony you suggest
that if this approach were adopted there would be no need for
special IRAs, for education, for retirement.
Mr. Kelly. Yes, that's true, and I say that in this
context. Today we see IRAs popping up all over the place: the
education IRA, the medical savings accounts. But in the main--I
guess the Chairman commented earlier--when you see those kinds
of plans they become targeted plans, and they typically have
phaseouts, which means that you can join in at one stage of
life, then you're thrown out because you've moved up in
compensation. It's sort of a shell game; you're in or you're
out, and you can't figure out where you are.
Mrs. Johnson of Connecticut. Well, certainly the complexity
that we've created in the IRA laws, the complexities that we've
created both with targeting IRA privileges and phaseouts does
make it complex.
Mr. Kelly. Yes.
Mrs. Johnson of Connecticut. And it is becoming
extraordinarily complex, so the idea of simplifying this
dramatically, as you offer, is an interesting idea.
I do think, though, that you really need to give some
thought to the social consequences and the policy consequences
of letting people contribute as much as they want to and not
being taxed until they take it out and spend it, with no estate
tax at no time until they spend it, because compensation
schedules have an element of arbitrariness to them.
I know people who work extremely hard and get paid $30,000
a year, and I know people who get $250,000 a year and, frankly,
I don't think they do anything. So, compensation is not well-
related, necessarily, to contribution to our society. So this
kind of a tool, that's quite open-ended without any phaseout,
does allow, frankly, the rich to get richer, and it allows the
rich to get really a lot richer. I don't think you can really
justify that, so I think you have to deal with the issue of at
what point does society really need to encourage you to save?
And at what point should you be carrying your own weight in
providing support for government services?
So, I do worry about the lack of any phaseout, though I
understand perfectly well that the nondiscrimination rules in
the pension area have completely eliminated small pensions and
I'd like to get rid of a lot of that complexity.
But I think the option you offer is desirable because it
makes all of these other tools unnecessary, including the one
that Kenny was just talking about. But I don't see why we would
need any of these vehicles, really, if we did this right. But
at some point, I think, you do have to phase out that sort of
reward for savings at, in a sense, government expense.
Mr. Kelly. I certainly appreciate your views, and you're
not alone, but let me hasten to say that there is no reason,
absolutely no reason why a cap, such as you're suggesting,
should be imposed other than the fear or the feeling that
people might save too much. Saving is----
Mrs. Johnson of Connecticut. No, it doesn't go to that and
I think that's the important point here. My concern is not that
people might save too much. My concern is that by foregoing
taxes on income because it is saved, as desirable as that is,
we do reduce tax income for current expenses and invite that
income when you spend the money. Now you say this would
generate so much activity that it would offset that--I'd have
to see that. But the general concept is that if you save this,
we won't have you pay taxes on it until it comes back into the
stream. And at a certain point, you rob one generation for the
benefit of another generation, and there is a limit to how far
we can go in that regard.
Mr. Kelly. No; I'm sorry--and I will be glad to give you
the full report which better explains your questions--but let
me go on a second. When you have an upsurge in new savings, as
I think everyone here will agree will happen, you are certainly
going to have, through new saving, a reduction in the cost of
saving.
When you reduce the cost of computers, you get more
computers. Reduce the cost of savings, and savings go up. When
you have more savings, you have more capital. When you have
more capital, you have more production, you have more jobs, you
have a higher standard of living, and from that global
increase--and increased corporate taxes--from that whole global
increase, after a transition period from 8 to 10 years, our
Federal Government starts to collect more taxes then under the
existing system of taxation. You just have no comprehension--
and when I say you, I don't mean----
Mrs. Johnson of Connecticut. I understand.
Mr. Kelly [continuing]. I'm just talking about generally.
Mrs. Johnson of Connecticut. But it could also include me.
Mr. Kelly. Sitting here, people really don't appreciate the
power of compound rates of return. You don't want to thwart
that. Our income tax today kills it, and the higher your tax
bracket, the more it kills it, the more it cuts it down. That's
stupid, from just tax principles, and it really is stupid from
the government's viewpoint because the more you tax away a rate
of return, there's less capital to be invested thereafter.
You just have to study the report--I think you already
received the report in an earlier submission I made to every
Member of this Committee earlier this month. And I urge
everyone here, from both sides of the aisle, to study that
report. It was produced by a very fine economist group here in
Washington, DC. Fiscal Associates, Inc. Study that report;
understand what we're dealing with here. This is serious
business. The way we've taxed our capital as a nation has
really thwarted, really stunted our economic growth. We could
be far better off than we are today. So, anyway--[Laughter.]--
you hit a hot button.
Mr. Hartman. Mrs. Johnson, could I comment on that point a
moment?--because it bears directly on exactly what the
Institute for Budget & Tax Limitation is proposing as well.
There are some public misconceptions that exist as to how the
wealth process gets distributed and how it actually works. For
all that we put individuals, privately held corporations and
assets through in this country, and the huge amount of time
spent with accountants and attorneys and so forth, out of about
$1.7 trillion, we collect $20 billion of estate taxes. We stand
people on their heads; we force companies to be closed; we tend
to promote the breakdown of estates that give our country's
best interest, should distribute that wealth for reinvestment
and for consumption, passing down our capital. We sell farms
and turn them over to being subdivided, or whatever.
The point--but we don't look at what the real truth is. The
highly wealthy find a way to get around such circumstances. The
guy you snare in this situation is the poor soul that has been
building up a farm or a business, hasn't had time to play all
the wrinkles, didn't know he should be giving the business away
from the first year he got it to his kids, and he's the guy
that can least afford to pay those $20 billion in estate taxes.
The rest skate by and have done it forever. You won't stop it
and I won't stop it. If you look at lifecycles, you'll find
that this rich wealth described by income statistics is, in
fact, quite illusory. The fact of the matter is, people tend to
have, on average, little in savings when they're young. After
the kids are gone they save heavily, and they disgorge those
savings in retirement. And what you find is that the rich, as
shown by income statistics, are largely a figment of
statistical imagination.
We would all be better off, as the gentleman said, if we
would get rid of the spirit of envy and social manipulation and
let people work, profit, save, and invest, and let them keep
the money they work for to do those things.
Mr. Herger. Mr. Hartman, I want to thank you. We have about
5 minutes until the vote. I'm very excited by your energetic
close, Mr. Kelly. As a matter of fact, I want to run out and
save some money after listening to you.
Mr. Kelly. Sign up.
Mr. Herger. But we--I think it's very clear in this Nation
that we have a need to create an incentive to save; we know
that compared to other industrial nations we rank very low. And
I want to thank you very much for the very good testimony from
each of you and each of our panelists this morning on this very
important issue. And with that I adjourn the hearing. Thank
you.
[Whereupon, at 12:21 p.m., the hearing was adjourned
subject to the call of the Chair.]
[Submissions for the record follow:]
Statement of Section of Taxation, American Bar Asssociation
Mr. Chairman and Members of the Committee:
This statement is presented on behalf of the American Bar
Asssociation and supplements earlier testimony presented by the
Section of Taxation of the American Bar Association.
Under the U. S. income tax system, married couples with the
same income pay the same tax, no matter what the source of
their income. This result is the consequence of Congressional
action in 1948 that permitted married couples to aggregate
their incomes on one joint return and compute their tax
liability as if each spouse had received one-half of their
joint income.\1\
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\1\ Before 1948, each taxpayer reported his or her income and paid
tax as an individual. Married couples could file joint returns, but the
tax was computed using the same rate schedule as that applicable to
individuals. Joint returns were then an advantage only when one spouse
had deductible losses to offset the other spouse's income or when one
spouse had no taxable income.
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Before the 1948 Act, married taxpayers living in community
property states each reported one-half of community property
income for tax purposes under the decision in Poe v.
Seaborn.\2\ Under a progressive income tax, the effect of Poe
v. Seaborn was to shift earned income in community property
states \3\ from the higher marginal tax rate of the taxpayer
who earned it to the lower rate of the spouse who did not, even
when each files a separate return. The 1948 income-splitting
legislation made the result in Poe v. Seaborn immaterial in
determining tax liability, and eliminated the differences in
the tax liabilities of married couples based on where they
lived. After the 1948 change, however, income tax was still
calculated according to one basic rate schedule. Consequently,
the income levels at which marginal rates increased in a
progressive tax (``rate-breaks'') for an unmarried taxpayer
were exactly 50% of the rate-breaks for married taxpayers
filing joint returns. A taxpayer who married an individual with
less taxable income would, as a result, pay less tax. Thus, the
``marriage bonus'' was created.
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\2\ 282 U.S. 101 (1930).
\3\ Earned income is always classified as community property. The
very high marginal income tax rates in the 1940's caused some separate
property state legislatures to enact community property rules.
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In 1969, Congress responded to concerns of single taxpayers
that their tax burden was disproportionately large compared to
the tax liability of a married couple with the same income by
enacting an entirely new rate schedule for unmarried taxpayers.
This schedule reduced the tax a single individual would pay by
increasing the rate-breaks to levels which were 60% of those
for married taxpayers filing joint returns. The result of this
rate structure is that two taxpayers with approximately the
same taxable income who marry will pay more income tax than the
aggregate amount they paid as single individuals. Thus, the
``marriage penalty'' had been created.
Over the thirty years which followed enactment of the
individual tax schedule in 1969, a great deal has been written
about the marriage penalty. It has been studied by the GAO, the
CBO, the Treasury Department and the Joint Committee and this
Committee has received volumes of testimony relating to it.
Somewhat lost in the current deluge of criticism of the
``marriage penalty'' is one essential fact. IT IS IMPOSSIBLE TO
HAVE A MARRIAGE NEUTRAL TAX in a tax system that has a
progressive rate structure and in which couples with equal
family incomes pay the same tax. This proposition was
demonstrated with elegant mathematical simplicity by Assistant
Treasury Secretary Edwin S. Cohen in testimony before this
Committee in 1972.\4\ As he concluded then, and as remains the
case today, ``no algebraic equation . . . can solve this
dilemma . . . . All that we can hope for is a reasonable
compromise.''
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\4\ Case 1 is a single person who earns $20,000.
Case 2, two single persons each earn $10,000.
Case 3, a husband earns $20,000 and a wife earns zero.
Case 4, a husband and wife each earn $10,000.
If we want no penalty on remaining single--a large group insists
upon this--Case 1 must pay the same tax as Case 3. A single person
earning $20,000 pays the same tax as a married couple earning $20,000.
If we want no penalty on marrying, Case 2 must pay the same tax as
Case 4. Two single persons earning $10,000 each pay the same tax as a
married couple each earning $10,000.
If we want husband and wife to pay the same tax however they
contribute to the family earnings, Case 3 pays the same tax as Case 4.
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Until now, Congress has chosen to tinker with the effect of
marriage on tax liabilities, but has not changed the basic
relationship between the rate schedules that produces the
result. The revenue statistics reveal why the problem is
difficult. The CBO has reported that, under a ``basic measure''
of the penalty and bonus, 25.3 million joint returns received a
marriage bonus costing nearly $33 billion in revenue compared
to 20.9 million joint returns which paid a marriage penalty
increasing revenues by nearly $29 billion. Efforts to mitigate
the penalty without reducing the bonus (causing a tax increase
for some couples) are very expensive.
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To summarize the tax results:
Case 1 equals Case 3.
Case 2 equals Case 4.
Case 3 equals Case 4.
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It is, of course, true that one way to solve the problem is
to depart from the principle that all married couples with the
same income should be taxed alike. Some proposals already do
that by identifying characteristics which would justify a
different tax liability, principally a deduction or credit
based on the earnings of the lower earning spouse, but these
proposals continue to rely on the underlying principle that
married couples with similar incomes should bear the same tax
burden.
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Based on the fundamental mathematical principle that things equals
to the same thing must be equal to each other, the result should then
be that Case 1 equals Case 2, or, in other words, that the tax on a
single person earning $20,000 equals the tax on two single persons each
earning $10,000.
But that cannot be so if we are going to have a progressive income
tax structure, and progressive taxation is a basic tenet of our income
tax system. The tax on a single person earning $20,000--Case 1--must be
greater than the total tax on two single persons each earning $10,000
if we are to have a progressive rate structure . . . .
It becomes apparent from this analysis that you cannot have each of
these principles operating simultaneously, and that there is no one
principle of equity that covers all of these cases.
Hearings on Tax Treatment of Single Persons and Married Persons
where Both Spouses are Working, before the House Ways and Means
Committee, 92nd Cong., 2nd Sess (1972).
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Some have suggested a more radical solution--that each
individual taxpayer should be liable for tax on his or her own
income.\5\ Individual filing would eliminate differences in the
tax burden between married and unmarried couples having the
same income. A single individual and a married couple, only one
of whom had income, with the same income would, potentially at
least, pay the same tax.\6\ Because there are many who advocate
a return to filing as individuals, it is important to explore
some of the difficulties that would have to be faced were this
approach to be seriously considered.
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\5\ Most of the current tax scholarship to consider this question
concludes that a return to individual filing is the best way to achieve
tax neutrality with respect to marriage. See e.g., L. Zelenak, Marriage
and the Income Tax, 67 S.Cal. L. Rev. 339 (1994).
\6\ It would be possible, in theory, to adopt a different
definition of the appropriate tax paying unit. Any such definition
would have to have a simple characteristic so that all taxpayers would
know what the boundaries of the unit are and the IRS could enforce it
with the least possible intrusion into the personal lives of taxpayers.
However, there does not appear to be any alternative definition of
taxpaying unit, other than the individual or marriage, which has the
same simplicity and more relevance to tax paying characteristics.
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Issues Raised by Individual Filing
Supporting families. It is said that the marriage penalty
discourages two individuals with earned income from marrying.
The marriage bonus might also be said to encourage marriage
because of the tax advantage which a high earning individual
could obtain after marriage with a low earning spouse. While
there does not appear to be conclusive evidence for either
proposition, adoption of an individual filing system would
eliminate the marriage bonus. If Congress decided that there
should be a tax advantage for marriage despite adoption of an
individual filing system, it might consider whether to confer
tax benefits on spouses who stay home, for example, to care for
children. The child credit is one form of relief for families
with children that might be expanded as the married filing rate
schedule is eliminated. This would focus the effect of tax
advantages on a different characteristic, such as minor
children in the household, rather than the formal status of
marriage.
Assigning income between spouses. One problem that is
solved by a joint filing system is the assignment of income
from one spouse to the other without any shift of economic
benefit. The principal issue here is posed by Poe v. Seaborn,
under which community property income is divided equally
between spouses no matter which one earned or has control over
it. Requiring individuals to pay tax on their own incomes will
again raise the problem that the income-splitting joint return
was enacted to solve.
Individual filing is not practical unless this problem is
resolved. If Congress decides to return to individual filing as
the basic principle in the income tax, it would probably be
constrained to also provide that community property law will be
disregarded in determining federal income tax liability. Such a
decision would also require rules to allocate community
property income and deductions between spouses. These issues
are discussed below.
An alternative solution would permit voluntary assignments
of income. In Lucas v. Earl,\7\ the Supreme Court refused to
give effect for tax purposes to a binding contract under which
husband and wife agreed to share the husband's earnings. This
principle has been the bedrock of the income tax doctrine
forbidding the assignment of personal earnings to another
taxpayer for tax purposes, and any relaxation has been widely
viewed as seriously undermining the U. S. income tax. Voluntary
assignments of income between spouses should continue to be
treated as ineffective for tax purposes. A rule permitting
voluntary assignment, even when limited to interspousal
transactions, ignores ownership principles under which the
spouse who has the closest relationship to the income in
question could retain control over it. This would be
inconsistent with the principle underlying individual filing.
---------------------------------------------------------------------------
\7\ 281 U.S. 111 (1930).
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A return to individual filing will put pressure on
assignment of income principles in any event as taxpayers seek
to reduce tax burdens by shifting incomes within marriage.\8\
This will, in turn, cause potential compliance problems for the
Internal Revenue Service in the exercise of its responsibility
to assure that real transfers have occurred before income
shifting is permitted.\9\
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\8\ Married taxpayers who do pool their resources would be
encouraged to make interspousal transfers of property in order to
allocate income for tax purposes. Interspousal transfers would not be
taxable because married taxpayers are treated as a single taxpaying
unit for this purpose. IRC Sec. Sec. 1041; 2523. It might seem ironic
to some that present system of joint filing is attacked on the ground,
among others, that it is based on an inaccurate premise--to wit, that
married taxpayers universally pool their resources, when it is asserted
that they do not. In a system of individual filing, required for all
taxpayers, those who do pool may have an advantage in the allocation of
income to achieve the best possible outcome in determining tax
liability. Family law scholars might welcome such a result as
encouraging real transfers to spouses who would otherwise be in an
economically inferior position.
\9\ Audits of interspousal transfers to determine the appropriate
income tax consequences seem contrary to the purpose of section 1041,
which is to reduce the tax significance of these transfers. At some
level, this type of audit can become more intrusive than desirable or
even perhaps sustainable when viewed in light of the IRS' current
problems.
---------------------------------------------------------------------------
Determining how income should be allocated between spouses.
Allocation issues, as distinct from the filing burden discussed
below, are difficult. Many allocation issues may turn out to be
straightforward for most taxpayers and where the supporting
records for an allocation are lacking, arbitrary default rules
can be adopted. Nonetheless, there are some problems.
Business income. Spouses may participate in the same
business as owners, operators or employees. Business income may
not be clearly the income of either, or may be arbitrarily
allocated by them, potentially for tax effect. One possible
approach would be to allocate business income to the spouse
with control over the business.
Jointly owned property. The most administrable and
reasonable rule for jointly owned property would be for title
ownership to control how income from that property is allocated
for tax purposes.
Deductions. An itemized deduction expense might be paid by
one spouse, or from joint funds. In order to measure the
taxable income of each spouse most accurately in an individual
return system, the spouse who pays the expense should receive
the deduction (e.g., the spouse makes the payments on a joint
mortgage on the couple's jointly owned personal residence).
Payments from a joint account, or made under circumstances
where the identity of the payor cannot be shown from supporting
records, could be divided equally.
Personal exemptions or credits. These are rate reduction
devices for families with dependents. The spouse could allocate
these as they decide; any alternative approach seems unduly
burdensome and complex.
The filing burden. Both the Treasury Department (in its
report on joint and several liability) and the Internal Revenue
Service have asserted that separate filing for spouses would
cause an enormous processing burden for the IRS. Some states
now require married persons to pay tax individually and permit
spouses to file a single return on which the income and
deductions of the spouses are allocated between them. For most
taxpayers, this is not difficult. But it is also true that
state allocation requirements are probably simpler than those
that would apply to a federal allocation regime. States'
allocation systems begin with amounts reported on the federal
return, and rely on the federal system for substantiation.
Allocations for state purposes, moreover, carry less
significance because marginal rates are lower and effective
rates are lower still due to the deductibility of the state
income tax for federal purposes. It is a different matter if
allocation were permitted for federal purposes. Review of the
allocation decisions also adds administrative burdens.
Rates. Eliminating the joint return rate schedule will
change the allocation of the tax burden and the overall revenue
yield of the individual income tax. The tax burden would
increase on married couples in which one spouse earns most of
the income, absent broader changes in rate schedules. A shift
to an individual filing system would accordingly raise broader
issues of the appropriate rate schedule.
Intermediate Proposals
As the foregoing demonstrates, the costs of moving to a
system of individual filing are significant. The marriage
penalty can be alleviated but not eliminated, with less
comprehensive revisions.
Reducing the tax rate on earned income. The system of joint
filing in place since 1948 has had an impact on married persons
which is independent of marriage neutrality. When both spouses
have earned income, the income of one spouse (the ``secondary
earner'') is ``stacked'' on top of the income of the other (the
``primary earner'') for purposes of determining the marginal
rate of tax applicable to the secondary income. The secondary
income will then be perceived to have been taxed more heavily
than will the income of the primary earner. While there is no
obvious answer to which income is ``primary,'' the rational
choice is to treat the spouse with the larger income as the
primary earner.
One way to address the disproportionate tax burden imposed
on the second earner is to reduce the tax burden on the second
income through a mechanism like an earned income deduction.
From 1981 through 1986, a married couple filing a joint return
was allowed to deduct 10% of the earned income of the lower
earning spouse up to a maximum of $30,000. A similar provision,
adjusted to meet revenue requirements, would reduce the tax
burden on the income of the lesser earning spouse and could do
so at moderate cost. This proposal is more beneficial to higher
income married taxpayers because this is where the incentive
effect of the stacking problem is likely to be the greatest.
Another way to address the issue is through a tax credit.
The Tax Section adopted a Legislative Recommendation in 1978,
subsequently passed by the ABA House of Delegates, that would
permit a credit for married individuals equal to the taxes paid
on the earned income of the spouses in excess of the sum of the
taxes each spouse would pay on the separate income of each if
unmarried. The effect of the proposal is to assure that no
married individual will pay a greater tax on earned income due
to marital status.
Adjusting rate breaks for higher income taxpayers. The
marriage penalty was exacerbated by the 1993 tax changes,
particularly at upper income levels where the rate breaks for
the higher marginal rates for single individuals were placed at
a higher percentage of the similar rate breaks for joint
returns. This effect could be reduced by raising the rate
breaks for the joint return rate schedule. For example, the
rate breaks for the basic marginal rates (15, 28 and 31%) for
singles are approximately 60% of those for joint returns; thus,
the 28% marginal rate for 1997 for single returns begins at
$59,750, which is 60% of $99,600, the 28% rate break for joint
returns. On the other hand, the rate break for the 36% rate is
$124,650 for singles, which is 82% of the comparable rate break
for joint returns ($151,750); and the 10% surcharge begins at
the same income level for both singles and joint returns. The
effect is to produce a very large marriage penalty at the
highest incomes. That marriage penalty could be reduced by
reducing the income level at which singles begin to pay the
higher marginal rates, by raising the income level at which
joint filers begin to pay at the comparable marginal rate, or
by some combination of the two. This simple measure would
address the most striking examples of marriage penalties.
In 1969, the Congress decided to calibrate the brackets for
single taxpayers as 60% of the brackets for married taxpayers
filing jointly. A reduction in this relationship, which could
be accomplished by reducing the tax on married couples without
increasing the tax currently imposed on unmarried individuals,
would reduce the ``penalty'' on two earner couples who marry
but would, in the long run, cause a redistribution of a portion
of the income tax burden from married couples to single
individuals. Although related to the ``marriage penalty''
issue, the relative tax burden of single and married
individuals is a different issue, which ought to be considered
on its own merits.
The earned income tax credit. For taxpayers at the opposite
end of the income scale, there are also marriage penalty
effects. The most serious involves the earned income tax credit
and results from the application of the earned income tax
phase-out rule.
When the phase-out amount for an individual taxpayer is
more than half of the amount allowed for a married couple,
married taxpayers will have a smaller exemption (the phaseout
will begin earlier) than would be true for two individual
unmarried taxpayers. More generally, however, a married
taxpayer is required to aggregate his or her income with the
income of a spouse in order to apply the phase-out rule. This
is accomplished by requiring married couples to file a joint
return in order to obtain the benefit. The earned income tax
credit, for example, is phased out as the taxpayer's adjusted
gross income (or earned income if greater) rises above a
phaseout level ($11,930 for 1997).\10\ This level is the same
whether the taxpayer files as an individual or jointly with his
or her spouse, but she is required to file jointly if
married.\11\
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\10\ IRC Sec. Sec. 32(a)(2)(B); -(b)(2).
\11\ See IRC Sec. 32(d).
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In these cases, as with other means-tested welfare
benefits, the apparent purpose is to limit a benefit based upon
household resources, where marriage is used to define the
household. The difficulty with the definition is that many
households include individuals who are not married, and in some
instances, households do not include both spouses. Because of
the definition, however, and the relative importance of the
EITC to taxpayers in that income level, there is a strong
incentive not to marry. There may be sound programmatic reasons
for aggregating household incomes, but an adjustment in phase-
out levels for two income producing taxpayers in the same
household could significantly affect the impact of this
provision on marriage decisions.
Other phaseouts. Differential taxation of married couples
results also from other provisions in the Internal Revenue Code
which provide different levels of benefits depending on whether
the taxpayers are married or single. Some of these effects are
artifacts of the rate schedule, such as the amounts allowed as
standard deductions.\12\ In 1998, after indexation, an
unmarried taxpayer is allowed a standard deduction of $4,250,
which is more than half the $7,100 amount allowed to married
taxpayers filing a joint return. Taxpayers who marry are
limited to a standard deduction which is $1,400 less than the
amounts they could otherwise claim by not marrying and filing
separately.
---------------------------------------------------------------------------
\12\IRC Sec. 63(c).
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Phase out provisions for personal exemptions and itemized
deductions. Personal exemptions are subject to a phase out
beginning at specified adjusted gross income levels for which
the ratio between single and married filers is 67%.\13\
Itemized deductions are subject to a limitation imposed after
the specified adjusted gross income level for both joint
returns and returns of an unmarried individual.\14\ These
provisions are revenue raising devices at high income levels
and thus contribute to the marriage penalty at the top end of
the scale. Shifting the bracket levels to diminish the marriage
penalty could be effective to reduce the marriage penalty
effect of these phase-out provisions.
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\13\IRC Sec. 151(d)(3). The ``threshold amount'' is indexed. For
l998, the threshold amount is $186,800 for joint returns and $124,500
for single returns. Two individuals who marry will lose $62,200 of the
otherwise available threshold, depending on the relative amounts of
income earned by each.
\14\IRC Sec. 68(b). The ``applicable amount'' is $124,500. Two
taxpayers who marry will lose one full ``applicable amount.''
---------------------------------------------------------------------------
Conclusion
Individual filing is the only way to eliminate the marriage
penalty but it would require abandoning the fifty year old
objective of tax neutrality among married couples. A case can
be made in favor of that approach. However, it would entail
significant compliance, filing and administrative costs. On
balance, these costs appear to outweigh the potential benefits
of individual filing.
This statement has suggested other ways to reduce the
increased tax burden imposed on two income families in the
context of the present system. These alternative approaches
seek to minimize the impact of changes on the distribution of
the tax burden on all types of filers, a matter which will have
to be considered more fully as the Committee debates this
issue.
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Statement of Bond Market Association
The Bond Market Association is pleased to provide comments
on the subject of alternative minimum tax (AMT) relief for
individuals. The Association represents securities firms and
banks that underwrite, trade, and sell municipal, corporate,
government and federal agency bonds, mortgage- and asset-backed
securities and money-market instruments in the U.S. and
international markets. Our members account for over 95 percent
of the nation's municipal bond market activity. As such, we
take an active interest in tax provisions like the AMT that
affect savings, investment and the cost of capital. We commend
Chairman Archer for his leadership on AMT reform generally and
for focusing the committee's attention on individual AMT relief
in this hearing.
The municipal bond market is dominated by individual
investors, who hold bonds either directly or through mutual
funds. As of September 30, 1997, individual investors held
almost 64 percent of all outstanding municipal debt. They are
the single most important source of demand in the municipal
bond market. Most municipal bond interest earned by individual
investors is exempt from the ordinary income tax. As a result,
investors are willing to earn a lower rate of return on their
municipal bond holdings, and state and local governments are
able to benefit from a lower cost of borrowing. The lower pre-
tax return on municipal bond interest can be thought of as an
implicit tax paid by investors not to the federal government
but to state or local government bond issuers in the form of
reduced borrowing costs. Unfortunately, not all municipal bond
interest is entirely exempt from income taxation. Since 1986,
the interest on so-called ``private-activity'' bonds has been
subject to the individual AMT.
Private-activity bonds include any debt issued by states or
localities where more than 10 percent of the proceeds is used
by a private business and more than 10 percent of the debt
service is secured by a private business or where more than
five percent of the proceeds are lent to a private party. In
general, private-activity bonds may not be tax-exempt. This
restriction exists in order to prevent private parties from
unjustifiably benefiting from the federal tax exemption.
However, when imposing the limitation on private use of the
tax-exemption, Congress recognized that certain uses of
private-activity bonds are important in implementing public
policy goals. As a result, certain uses of private-activity
bonds are eligible for the tax-exemption subject to numerous
restrictions and limitations. Among these is a provision which
fully subjects private-activity bond interest to the individual
and corporate AMTs.\1\ The application of the individual AMT to
private-activity bond interest has resulted in some peculiar
market conditions which negatively affect the ability of states
and localities to borrow at the lowest possible cost.
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\1\ In addition, 75 percent of non-private-activity bond interest
is subject to the corporate AMT under the adjusted current earnings
provision.
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With careful planning, taxpayers are able to predict with
reasonable certainty whether in any given year they will be
subject to the ordinary income tax or the AMT. The interest on
most private-activity bonds is subject to the AMT but not to
the ordinary income tax, and interest on other municipal bonds
is exempt from both the ordinary income tax and the individual
AMT. As a result, ``AMT bonds'' tend to yield 20-30 basis
points (0.2-0.3 percentage point) higher than comparable bonds
which are not subject to the AMT. This increased yield
compensates AMT bond investors for the risk they face that
their bonds may be taxable if, as a result of poor planning or
an unforeseen change in circumstances, they unpredictably fall
under the AMT.
Municipal bond investors who anticipate that they will fall
under the AMT simply buy bonds which are not subject to the
AMT. Investors who believe they will pay the ordinary income
tax are able to buy AMT bonds at yields higher than they can
obtain by buying non-AMT bonds. Indeed, it is unlikely that the
federal government collects much, or even any, tax revenue as a
result of subjecting private-activity bond interest to the
individual AMT. Virtually all interest on AMT bonds is likely
paid to investors who fall under the ordinary income tax.
Unfortunately, the losers in this scenario are state and local
governments that issue AMT bonds, who face an unnecessarily
high cost of borrowing as a result of the tax treatment of
their interest. Clearly, the AMT was never designed with the
goal of increasing borrowing costs for state and local
governments.
As you know, the staff of the Joint Committee on Taxation
(JCT) concluded in a 1996 analysis that the number of
individual AMT taxpayers will rise dramatically in the coming
years because the ordinary income tax brackets are indexed for
inflation, but the income thresholds for the AMT are not
indexed. In 1996, the JCT staff predicted that the number of
AMT payers would increase from 600,000 returns in 1997 to 6.2
million returns in 2006.\2\ We agree with Chairman Archer, who
has wisely recognized that the AMT was never designed to apply
to a large number of taxpayers and that the AMT income
thresholds should be indexed for inflation. If they are not,
the negative effects on state and local borrowing that ensue
from the application of the individual AMT to private-activity
bond interest will be exacerbated. As more and more taxpayers
find themselves under the AMT, the market for AMT bonds will
shrink. The ``spread'' between AMT bonds and non-AMT bonds--the
differential in interest rates that state and local issuers of
AMT bonds must pay relative to other municipal bond issuers--
will widen. And, ironically, the federal government will
continue to collect little or no revenue from applying the AMT
to private-activity bond interest.
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\2\ Memorandum from Kenneth J. Kies, Joint Committee on Taxation,
to John L. Buckley, House Committee on Ways and Means, regarding the
``Dole Tax Proposal,'' September 13, 1996.
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In addition to indexing the AMT ``brackets,'' we also urge
the committee to reconsider the wisdom of applying the AMT to
private-activity bond interest. This provision of the tax code
serves no useful purpose. Its only perceptible effect is
unnecessarily inflated borrowing costs for state and local bond
issuers.
We appreciate the opportunity to present our views on the
individual AMT and the municipal bond market. We look forward
to continuing to work with committee members and staff on
issues of mutual interest.
Statement of Kevin M. Williams, Chief Executive Officer, Distribution &
LTL Carriers Association, Alexandria, Virginia
The Distribution & LTL Carriers Association submits this
statement on the need to reform one of the most unfair
provisions in the tax code, namely the estate and gift tax
laws. These code provisions impose an unconscionable tax rate
of up to 55 percent on an estate. They often cause severe
hardships to family businesses by forcing the sale of assets to
satisfy the taxes. The law penalizes lifelong savings and
investments based on antiquated social welfare goals.
The Federal government receives from these taxes about $15-
17 billion, less than 1 percent of its $1.7 trillion in annual
revenue. The main beneficiaries of these laws are accountants,
tax attorneys and charities who implement complex asset
transfer arrangements to legally reduce or avoid these onerous
taxes. These costly tax avoidance practices are employed
because the tax is perceived as unfair. Unfortunately, the
result is often that less sophisticated persons, who do not
employ these strategies, face the full brunt of these taxes.
While a strong case can be made for the repeal of the
estate and gift tax laws, our Association recognizes that may
not be politically feasible. We concur with Senate Majority
Leader Trent Lott, who stated:
``The estate tax is a monster that must be exterminated. If
it were up to me, we would simply repeal the estate tax in its
entirety. Unfortunately, our budget process does not allow us
to completely repeal this tax all at once. We must do it in
stages.'' Cong. Rec. S. 2566 (March 19, 1997).
Therefore, we recommend that, as this Committee addresses
the issue of reducing the tax burden, it seriously consider--as
a first step--making the estate and gift taxes simpler, more
equitable, and consistent with our other tax rates. As will be
discussed more fully, we recommend the following:
1. There should be no tax when the taxable estate is $10
million or less. Essentially, the unified credit, which now
allows a husband and wife to transfer $1.2 million, should be
raised to $10 million;
2. This nontaxable estate of $10 million should be adjusted
annually for inflation;
3. The graduated top rate on taxable estates should be
reduced from 55 percent to either 27.5 percent or preferably to
20 percent, which is the capital gains rate. Ideally a fixed,
but even lower, rate should apply to the taxable estate;
4. The annual gift tax exclusion of $10,000 per year, per
donee should be increased to $20,000; and
5. The double taxation which results when a capital gains
or income tax penalty is incurred because estate assets must be
sold to pay these death taxes should be eliminated by some
means.
The Distribution & LTL Carriers Association represents
trucking companies engaged in the warehousing, distribution and
transportation of freight in small shipments. This so-called
less-than-truckload segment of the industry generates
approximately $18 billion in annual revenue from interstate
transportation services. However, the overwhelming majority of
these firms are private, family-owned businesses. They are
entrepreneurs. Some involve several generations of families,
whose goal, like for all Americans, is to pass on to their
children the fruits of their labor. Estate tax reform is a top
priority for these companies, since these laws can effectively
bar or hinder their ability to transfer their business, which
is often the largest asset in an estate.
A 1995 Gallup survey found that one-third of the owners of
family businesses expect that some or all the company will have
to be sold to satisfy estate tax liabilities. The survey
further found that 37 percent of the business inheritors had to
shrink or reconstruct the enterprises solely to meet estate tax
obligations. This is because of the lack of liquidity or cash
to pay the estate tax. See, Cong. Rec. S. 2647 (March 20,
1997).
Last year, Congress merely tinkered with the estate tax
laws in the Tax and Budget Agreement. Essentially, the general
estate tax exemption of $600,000, which had remained static
since 1987, will be increased incrementally over ten years to
$1 million. As Senator Grassley stated in his remarks last
year, the $600,000 exemption needed to be increased by over
$200,000 just to remain current with inflation. Cong. Rec. S.
2565 (March 19, 1997). This change is too little, too slow.
Several bills have been introduced in Congress that would
raise to $10 million the amount of an estate which would be
exempt from taxes. (See, S.479 & S.482) There is no magic to
the $10 million level. It is generally based on the belief that
this level of lifelong savings is not inordinate wealth, which
the government should tax again and redistribute through its
spending programs. This Committee surely recognizes that the
beneficiaries of most estates are the spouse and children of
the decedent. It is a transfer of assets among family members.
Since the estate taxes do not apply when a spouse is the
beneficiary, the taxes are really punitive when the children
are the beneficiaries. As Senator Grassley aptly said, ``The
important thing to keep in mind about estate tax reform is that
estates do not pay taxes, surviving families pay taxes.''
It is ironic and sad when both the Administration and
Congress are attempting to promote education, child care,
medical coverage and savings and investments, they allow the
estate tax laws to undermine those goals. These assets are
often used by the family to provide for their children
(estimated cost to be $200,000 until age 21); to pay for
college (which can exceed $100,000 for four years at a private
university); to provide money for a down payment on a home or
pay off an existing mortgage; to cover catastrophic medical
expenses; or to provide a supplement for retirement beyond what
social security will pay. In sum, a lifetime of savings of $10
millionnchmark for Congress to consider as a dividing line
between taxable and nontaxable estates. This estate reform
should not be limited to qualified family businesses, but
should be available to all taxpayers.
Moreover, to avoid the annual creep upward of taxation,
there should be an indexation of the gross estate exemption for
inflation. The existing exemption level of $600,000 per
individual, established in 1987, lost over 25 percent of its
value to inflation in 1997 dollars. An erosion of the new
exemption level should be avoided through an annual inflation
adjustment.
In a similar manner, the annual exclusion, which permits
gifts of $10,000 per year, per donee that are not subject to
the unified credit, should be increased and preferably doubled.
The value of this gifting allowance has similarly been eroded
by inflation.
The tax rate for taxable estates should also be
substantially reduced. One has to go back to the old 70 percent
tax rate, imposed on so-called unearned interest income, to
think of a more confiscatory rate than the 55 percent estate
tax rate. Moreover, the total death tax burden can exceed 73
percent, according to Senator Susan Collins, when assets have
to be sold to pay estate taxes and capital gains are realized
from the sale. Cong. Rec. S. 2647 (March 20, 1997). This is
unconscionable!
The estate tax rate should be reduced and brought in line
with the much lower personal or capital gains tax rates. Senate
bill, S. 482, would reduce it by half, to 27.5 percent. This is
about the mid point range between the highest personal income
tax rate of 39.6 percent and the capital gains rate of 20
percent. We believe the property in an estate should be treated
like other real or personal property and taxed at the lower
capital gains rate of 20 percent.
Finally, Congress should devise a method to avoid the
double taxation that occurs when assets must be sold to satisfy
the estate tax requirements. One means would be to provide that
assets receive a stepped-up basis to fair market value when
they are devised or bequeathed by will, other legal
instruments, or by statutory law upon the death of the maker.
Conditions could be placed on this to limit the stepped-up
basis to family members or to that portion used to pay estate
taxes. There may be superior means to achieve this objective of
avoiding dual taxation.
We have not attempted to quantify the revenue loss to the
Federal government if our recommendations were adopted. The
loss would certainly be less than the full amount of $15-$17
billion now collected annually. Moreover, the net revenue loss
(revenue minus expenses savings) would be considerably less.
According to Senator Breaux, the Federal government incurs 65
cents in expenses for every dollars it receives under the
estate tax laws. Cong. Rec. S. 2566 (March 19, 1997).
Therefore, the net revenue loss under these reforms might be
$3-$5 billion annually. This is an extremely nominal cost to
the government, yet will provide significant benefits to many
taxpayers. It could be readily paid for with only a fraction of
the now projected $18 billion federal budget surplus.
The Distribution & LTL Carriers Association appreciates this
Committee's consideration of our views. Reform of the gift and estate
tax laws is an area where, with relatively modest impact on Federal
revenue, Congress can help many families and small businesses continue
to provide for their children and grandchildren through the
preservation of the business and personal assets that they created
through hard work, savings and investments.
Respectfully submitted,
Kevin M. Williams
Chief Executive Officer
Statement of Institute for Research on the Economics of Taxation (IRET)
PHASE-OUTS ARE BAD TAX POLICY, Economic Policy Bulletin No. 71, by
Michael Schuyler
The tax code is littered with rules that phase out various
deductions, exemptions, and credits as taxpayers' incomes rise.
Some of the items that taxpayers lose with higher incomes are
the deductibility of individual retirement account (IRA)
contributions, the earned income tax credit (EITC), the
exclusion of social security benefits from taxable income, a
portion of itemized deductions, even the personal exemption.
The Taxpayer Relief Act of 1997 (TRA-97) adds significant new
phase-outs. Its two largest provisions, the child credit and
tax subsidies for college students, are both conditioned by
phase-outs.
Phase-outs create troubling problems in the areas of
economic efficiency, simplicity, and fairness. Phase-outs raise
marginal tax rates throughout the phase-out zone and, thereby,
reduce incentives to work, save, and invest. Phase-outs make
the tax code more complicated, which raises tax enforcement and
compliance costs, both by making the tax code harder to
understand and by making tax liabilities harder to compute. The
instruction book that accompanies an individual's yearly tax
forms includes an obstacle course of special instructions and
worksheets testing whether various phase-outs affect the
taxpayer and, if so, how much each relevant phase-out restricts
the deductions, exemptions, or credits the taxpayer may claim.
Further, although phase-outs are often called fair because they
tend to increase tax progressivity, the arbitrariness and
surreptitiousness of most phase-outs violates any reasonable
standard of fairness.
A Flock of Phase-outs
Prior to this year's legislation, the individual income tax
eliminated or restricted the following deductions, exemptions,
and credits when taxpayers' incomes grew: the tax exemption for
social security benefits, the EITC, the deduction for IRA
contributions, the personal exemption, the medical deduction,
the miscellaneous business deduction, the total of itemized
deductions, the deduction for losses on rental real estate, the
dependent care credit, the adoption credit, the exclusion for
interest income from U.S. Savings Bonds used for higher
education expenses, and the alternative minimum tax exempt
amount.\1\ In addition, some tax provisions impose tougher than
normal requirements on taxpayers above various income
thresholds. An example is the increased amount of estimated tax
a person must pay to avoid underpayment penalties if the
person's adjusted gross income exceeds $100,000.\2\
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\1\ The limitations on the deductions for medical costs and
miscellaneous business expenses are properly classified as phase-outs
because, as a taxpayer's income rises, the taxpayer is required to
disregard for tax purposes increasing amounts of expenses in those
areas.
\2\ Compared to prior law, TRA-97 eases the differential in most
later years, and it suspends the differential for one year (tax year
1998). The differential in the stringency of the safe harbor amount of
estimated payments between taxpayers with AGIs above and below $100,000
is particularly inappropriate because higher-income taxpayers often
have difficult-to-predict incomes that make it very hard for them to
estimate their end-of-year tax liabilities accurately.
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To this already long list, TRA-97 has added a welter of
complicated new phase-outs. The benefits created in TRA-97 that
taxpayers lose as their incomes rise are: the $500 child
credit, the HOPE Scholarship tax credit, the lifetime learning
tax credit, the education IRA, the Roth IRA, the deduction for
certain interest on student loans, and the $5,000 tax credit
for first-time home buyers in the District of Columbia. TRA-97
did not remove any of the existing phase-outs. But in a few
cases (e.g., deductible IRA contributions), it raised the
income threshold at which a phase-out begins or otherwise eased
a phase-out.
Other federal taxes also have phase-out provisions. The
corporate income tax, for instance, imposes two surtaxes to
phase out the tax savings from the graduated corporate rate
schedule. The first surtax is 5% of every dollar of taxable
corporate income above $100,000 and below $335,000 and raises
the 34% statutory tax rate in that corporate income range to an
effective marginal tax rate of 39%; the second surtax is 3% of
each dollar of taxable income between $10,000,000 and
$18,333,333 and boosts the 35% statutory tax rate to an
effective marginal tax rate of 38%. Corporations with incomes
above $18,333,333 pay an effective flat tax rate of 35% on
total taxable income. The estate and gift tax phases out the
benefits of the unified credit and the graduated estate and
gift tax schedule with a 5% surtax. Although the top statutory
estate and gift tax rate is 55%, the surtax lifts the marginal
tax rate in the phase-out zone to 60%. The individual
alternative minimum tax (AMT) also has a phase-out. A certain
amount of income may normally be disregarded when computing the
AMT, but, as income increases, that exempt amount must be added
back to the tax base. (The individual AMT is, in effect, a
parallel individual income tax: people must pay either the
standard income tax or the individual AMT--whichever is
larger.)
Appendix I identifies the phase-out provisions in the
standard individual income tax. For each of these phase-outs,
it reports the income threshold at which the phase-out begins,
the income range over which the phase-out continues, and the
maximum number of percentage points by which the phase-out may
boost the marginal tax rate of people within its phase-out
zone. Appendix II covers the major phase-outs mentioned above
in the corporate income tax, the estate and gift tax, and the
individual AMT.
Chart 1 shows the income ranges over which most of the
individual income tax phase-outs occur. The tax code generally
designates phase-outs in terms of adjusted gross income
(AGI).\3\ For example, the new HOPE Scholarship tax credit is
phased out over the $10,000 AGI range from $40,000 to $50,000
for single filers and over the $20,000 AGI range from $80,000
to $100,000 for joint filers. The complexities of the Chart
drive home the large number and haphazard variety of income-
based phase-outs.
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\3\ In contrast, the schedule of progressive tax brackets is based
on taxable income. AGI differs from taxable income because AGI is
measured before subtracting personal exemptions and most deductions.
For example, if a couple with an AGI of $50,000 in 1997 has two
dependent children, claims the standard deduction, and files jointly,
the couple's taxable income would be $32,500--$17,500 less than the
couple's AGI. Because a given AGI corresponds to a taxable income that
is thousands of dollars lower (with the exact difference depending on
filing status, number of exemptions, and deductions claimed), phase-out
ranges would begin at much lower stated dollar amounts if they were
expressed in terms of taxable income instead of AGI.
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The relative heights of the lines are roughly based on the
potential of the various phase-outs to raise marginal tax
rates. For example, the partial phase-out of the dependent care
credit for 1 child increases the marginal tax rate by 1.33
percentage points, on average, for taxpayers with AGIs between
$10,000 and $28,000 who would otherwise qualify for the maximum
credit.\4\ The partial phase-out of the dependent care credit
for 2 or more children increases the marginal tax rate by 2.67
percentage points, on average, for taxpayers with AGIs between
$10,000 and $28,000 who would otherwise qualify for the maximum
credit. The phase-out of the tax credit for first-time District
of Columbia homebuyers would affect few taxpayers, but for
those taxpayers who would qualify except for being in the
phase-out range, the effective increase in their marginal tax
rates would be a whopping 25 percentage points.
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\4\ The partial phase-out of the dependent care credit actually
occurs in a series of steps, each covering $2,000 of AGI. Rather than
trying to report that complicated pattern, in which AGI changes within
a step do not affect the amount phased out but small AGI changes from
one step to the next have a very big impact, it is assumed throughout
this study that phase-outs proceed smoothly over the phase-out range.
Also, if the taxpayer could not claim the maximum credit for reasons
unrelated to the phase-out (e.g., dependent care expenses below that
permitted by the credit, lack of taxable income), either the phase-out
would not cause as much of a jump in the marginal tax rate or the
phase-out range would be shorter.
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Adding more complexity, many phase-outs use modified
definitions of AGI, and the modifications often differ from one
phase-out to another. For instance, the phase-out of the
social-security-benefit exemption adds to modified AGI half of
social security benefits and all tax exempt interest, and the
phase-out of deductible IRA contributions modifies AGI by
including IRA contributions and certain foreign earned income
and foreign housing allowances normally excluded from AGI.\5\
Because of these differences in the definition of modified AGI,
taxpayers need to follow very carefully the specific
instructions for the particular phase-out in question.
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\5\ Because the definition of modified AGI differs among the phase-
out provisions, the horizontal positions of the lines in the Chart are
not always strictly comparable.
[GRAPHIC] [TIFF OMITTED] T0897.172
Money for the Treasury and Progressivity
Phase-outs have two properties that lawmakers have found
very appealing: they increase the government's tax revenues and
they heighten tax progressivity. Acting Assistant Treasury
Secretary Donald Lubick referred to both these features when he
defended in Congressional testimony the Clinton
Administration's wish that the child credit be ``targeted,''
that is, phased out with rising income. ``A targeted child
credit is an efficient way to address the increase in relative
tax burdens faced by larger families...The relief is directed
to low- and middle-income taxpayers because of the limited
resources available for tax reduction and higher-income
taxpayers' relatively greater ability to pay current levels of
income taxes.'' \6\ Earlier in his testimony, Mr. Lubick had
associated phase-outs with fiscal responsibility. ``Given the
need for fiscal discipline, one of our principles throughout
President Clinton's tenure has been that tax relief should be
concentrated on middle-income taxpayers.''
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\6\ Statement of Donald C. Lubick, Acting Assistant Secretary (Tax
Policy), Department of Treasury, Testimony before the House Ways and
Means Committee, March 5, 1997.
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Although phase-outs limit the revenue cost to the
government of the deductions, exemptions, and credits being
phased out, whether that is desirable or undesirable depends on
circumstances. Taking more tax dollars from wage earners,
savers, and entrepreneurs is not necessarily a good thing. If
the tax revenues are used to finance wasteful or otherwise
inappropriate government spending programs, it would be better
to cut the spending and not collect the revenues. If the
spending represents the best use of the resources it consumes,
on the other hand, it is reasonable to seek revenues. Still,
that does not justify a particular phase-out rule unless the
phase-out has fewer undesirable side effects regarding economic
efficiency, simplicity, and equity than any alternative means
of increasing tax collections.
Standard estimation models, furthermore, usually exaggerate
the revenue savings. The problem is that the increased marginal
tax rates produced by phase-outs worsen anti-growth tax biases,
and those biases slow the economy. When the economy slows, tax
collections suffer. Standard revenue estimation models, though,
are static in the sense that they ignore those antigrowth
effects. Hence, a phase-out that weakens the economy tends to
save less revenue for the Treasury than advertised.
Similarly, unless one believes that the tax system is never
progressive enough and should always be more progressive
(logically culminating in complete, government-enforced
equality of incomes despite differences in people's
industriousness, skills, and saving behavior), greater
progressivity through the tax system is not necessarily a good
thing. Too often, proposals are made for increasing the tax
system's progressivity without inquiring whether it is
sufficiently progressive already or, perhaps, overly
progressive, given the problems created when the government
takes income from those who earned it and gives it to other
people. Moreover, if greater progressivity is sought, a
particular phase-out is the proper way to do it only if that
phase-out causes fewer problems than any other means of
redistributing the income.
How Phase-outs Increase Marginal Tax Rates
Over the income range in which a deduction, exemption, or
credit is being phased out, additional income adds to a
person's tax bill in two ways. First, the extra income is
subject to regular income tax. Second, the extra income reduces
the amount of the deduction, exemption, or credit that is being
phased out. A lower deduction or exemption raises taxable
income further, and further increases the tax. A lower credit
reduces the amount subtracted from tax, and again the person's
tax bill is higher than otherwise. In either case, the higher
tax is, in effect, a penalty on the extra income that triggered
the phase-out.
For instance, suppose that a person is in the 28% tax
bracket. Also suppose that the person had been claiming a
credit that is being phased out at a rate of 15 cents for each
$1 of added income. First, then, an extra $1 of income
increases the person's pre-credit tax liability by 28 cents. At
this point, the person's marginal tax rate is 28%. Second,
though, the extra $1 of income increases the person's tax
liability by another 15 cents because it reduces by that amount
the credit the person can subtract from his or her tax bill.
Thus, the additional tax triggered by an extra $1 of income is
43 cents (28 cents plus 15 cents). In this case, the person's
effective marginal tax rate is 43%, of which the phase-out is
responsible for 15 percentage points. The hike in the marginal
tax rate due to the phase-out extends over the income range in
which the deduction, exemption, or credit is being phased out.
At incomes above and below the phase-out range, the phase-out
does not affect the marginal tax rate.
As a concrete example, consider the phase-out of the HOPE
Scholarship tax credit. Suppose that a single parent has one
dependent child entering college, and suppose that tuition
costs are sufficient for the parent to claim the maximum $1,500
HOPE Scholarship tax credit in 1998 (ignoring for a moment the
income limitation attached to the new credit). The HOPE
Scholarship tax credit is phased out ratably over the $10,000
modified AGI range from $40,000 to $50,000. This taxpayer loses
15 cents of credit per dollar of income in the phase-out
range.\7\ Accordingly, if the parent's modified AGI is between
$40,000 to $50,000, each extra $1 of income will increase the
parent's tax bill in two ways. First, the regular tax on the
extra $1 of income will raise the parent's tax liability by
either 15 or 28 cents, depending on the parent's tax
bracket.\8\ Second, the extra $1 will reduce the HOPE
Scholarship tax credit by 15 cents, which raises the parent's
tax bill by 15 cents. Thus, in the phase-out zone for this
credit, the single parent's effective marginal tax rate on each
additional $1 of income will be either 30% (if the parent is in
the 15% tax bracket) or 43% (if the parent is in the 28% tax
bracket). Note further that modified AGI includes income from
saving as well as wages. Thus, parents who save for their
children's education are penalized with a reduction in the tax
credit designed to encourage education.\9\
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\7\ If the pre-phase-out credit were smaller, the loss per dollar
of income in the phase-out range would also be smaller. For example, if
tuition costs were sufficiently low that the taxpayer's maximum credit
was only $1,000, the taxpayer would only lose 10 cents of credit per
dollar of income in the phase-out range.
\8\ Tax brackets depend on taxable income, not AGI. At the start of
the phase-out, the taxpayer in the example will probably have a taxable
income within the 15% rate bracket. At about the mid-point of the
phase-out range, the taxpayer's taxable income will most likely cross
over into the 28% rate bracket.
\9\ Some parents may be able to avoid this penalty on saving for a
child's education by putting some of the saving in the child's name.
That way, returns on that portion of the saving would not restrict the
parents' eligibility to claim the credit. (This assumes it is the
parents who claim the credit and that they pay enough of the education
costs to do so.) Giving the saving to the child would mean that yearly
tax returns might have to be filed for the child on interest income.
Also, until the child reaches age 14, interest income might be taxed at
the parent's marginal rate because of the ``kiddie tax'' introduced as
part of the 1986 tax act.
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As another example, this one involving a deduction,
consider the 2% AGI threshold for the miscellaneous business
expense deduction. The tax code allows individuals to claim
miscellaneous business expenses only to the extent that they
exceed 2% of AGI. Suppose that a taxpayer itemizes, has
miscellaneous business expenses of $1,500, and an AGI of
$60,000. Because 2% of that AGI is $1,200, the person can only
claim miscellaneous business expenses of $300 ($1,500 of valid
deductions--$1,200 income-based disallowance). For this
taxpayer, an extra $1 of AGI would lower his or her
miscellaneous business expense deduction by 2 cents and raise
his or her taxable income by an additional 2 cents, for a total
of $1.02. If the taxpayer is in the 28% rate bracket, this
increases his or her tax liability by 28.56 cents (28% of
$1.02). The taxpayer's effective marginal tax rate on the added
$1 of income is 28.56%, of which the phase-out contributes 0.56
percentage points.\10\
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\10\ The size of the marginal tax rate increase depends on the
individual's tax bracket. For a person in the 15% tax bracket who
claims the miscellaneous business expense deduction, the boost in the
marginal tax rate due to the phase-out of this deduction would be 0.3
percentage points; for the person in the example in the 28% tax
bracket, it was 0.56 percentage points; for a person in the 31% tax
bracket, it would be 0.62 percentage points; for a person in the 36%
tax bracket, it would be 0.72 percentage points; and for a person in
the 39.6% tax bracket, it would be 0.792 percentage points.
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Phase-outs Worsen Tax Distortions
As explained above, when taxpayers lose deductions,
exemptions, or credits because their incomes are increasing,
the losses produce a spike in the taxpayers' marginal tax rates
throughout the range of income over which the phase-out occurs.
The tax rate spike hurts the economy because it aggravates tax
biases against work, saving, and a variety of specific products
and activities that the tax code treats more harshly than
others. By compounding tax biases, phase-outs urge people to
work less, save less, and be less productive.
Consider, for instance, a single individual of age 62 or
over who takes the standard deduction, has yearly social
security benefits of $12,000, and receives private pension,
interest, and dividend income of $30,000. This taxpayer would
normally be in the 28% tax bracket. Due to the income-based
phase-out of the exemption for social security benefits, each
additional dollar of income requires the individual to add 85
cents of social security benefits to taxable income, for a
combined increase in taxable income of $1.85. At the margin,
therefore, each extra dollar of income from private saving
raises the person's tax bill by 51.8 cents: 28 cents due to
regular tax and 23.8 cents due to the phase-out of the
exclusion for social security benefits. Note that the tax is
effectively imposed on the income from saving that triggered
the tax hike, not on the social security benefit itself. This
very high tax bite is a powerful inducement for the person to
save less and consume more. As a result, some people receiving
social security and some younger people planning ahead for
their retirement years will decide to save less than they
otherwise would because of the tax penalty. The tax-induced
drop in saving leaves those people less financially secure and,
because saving and investment are major contributors to
productivity, leaves society as a whole less productive.
Wage and salary income of people who continue working after
they begin receiving social security benefits can also trigger
taxation of benefits (as well as being subject to payroll
taxes). For those who fall in the phase-out zone for the
exclusion of benefits from income, the penalty against work
effort is at least as bad as against saving. If working
beneficiaries also run afoul of the social security earnings
test, the tax penalty will be even harsher, exceeding 100% of
added wage income in some cases.\11\
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\11\ Social security beneficiaries may earn limited amounts of
wages without losing social security benefits. However, for each dollar
of wages above the exempt amount, beneficiaries age 62-64 lose $1 of
benefits for every $2 in wages (a 50% tax rate); beneficiaries age 65-
69 lose $1 of benefits for every $3 in wages (a 33.33% tax rate). The
loss of benefits reduces the amount of benefits subject to tax,
resulting in a bit less of a tax spike than would be indicated by
simply adding up all the income, payroll, and penalty tax rates, but
effective marginal tax rates of 85% plus for people age 65-69 or 100%
plus for people age 62-64 are routinely possible.
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Complexity
Phase-outs worsen the complexity of the tax system. When a
deduction, credit, or exemption is phased out, taxpayers have
two additional administrative burdens. They must start by very
carefully reading the tax instructions to learn if the phase-
out might apply to them. Then, if the phase-out could affect
them, they must work through the actual phase-out computations.
The phase-out computations are generally not difficult, but
they are tedious and come, of course, on top of all other tax
calculations. In the Form 1040 Instructions for 1996, for
instance, the worksheet for calculating the phase-out of the
social security benefit exemption required 18 lines, the
worksheet for the personal exemption's phase-out had 9 lines,
and the worksheet for the phase-out of the IRA deduction took
10 lines (19 lines if there was a contribution to a nonworking
spouse's IRA). Many other phase-outs did not have separate
worksheets, leaving taxpayers to slog through the steps on
their own.
IRAs illustrate the complexity attributable to phase-outs.
From 1981 to 1986, IRAs did not have a phase-out, and each
worker could make yearly deductible contributions of up to
$2,000, subject to a few qualifications. Contributing was a
simple matter, and IRAs became hugely popular. The 1986 tax act
suddenly changed that. The IRA deduction was reduced or
eliminated if a taxpayer's modified AGI exceeded $25,000
($40,000 for a couple filing jointly) and if the worker or the
worker's spouse was an active participant in an employer-
sponsored pension plan.\12\ With this restriction, many workers
found themselves barred from making deductible IRA
contributions, and many others had to perform detailed
computations to ascertain if they could still contribute and,
if so, how much.\13\ No longer was making a deductible IRA
contribution a simple matter. Not surprisingly, IRA
contributions plummeted. Although this was mostly because so
many workers were now ineligible, the fact that people who
remained fully eligible also reduced their contributions
suggests that some workers found the new rules sufficiently
confusing and intimidating that they avoided IRAs for that
reason alone.
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\12\ This year's tax bill raises the threshold, introduces a new
type of nondeductible IRA (with its own phase-out), and makes other
changes.
\13\ Workers barred in some years from making deductible IRA
contributions may make nondeductible contributions, but that entails
still more paperwork, including an additional tax form to be filed and
a greatly complicated tax situation in the future as they make
withdrawals from the IRA. Withdrawals must be attributed proportionally
to deductible contributions and non-deductible contributions; the
former are taxable upon withdrawal, the latter are not.
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The phase-outs are probably somewhat more confusing than
otherwise because there are so many different phase-out
thresholds, as can be seen in Chart 1. One suggestion that has
been floated for easing the compliance burden is to establish
just a few phase-out thresholds, perhaps a low-income one, a
middle-income one, and a high-income one. Unfortunately, while
this suggestion is not without merit, coordinating phase-out
thresholds would reduce complexity only slightly; the bulk of
the problem would remain. A taxpayer would still have to
investigate the rules governing each phase-out that might apply
to him or her--the income level at which the phase-out begins
is one of the rules but there are many others--and then perform
all the calculations for that specific phase-out. Even worse,
the bunching of phase-outs would increase the odds that
taxpayers would be subject to more than one phase-out at the
same time. Multiple phase-outs occurring over the same income
range could create an extremely sharp spike in a taxpayer's
marginal tax rate and a quantum leap up in complexity of
calculations.
Fairness
Tax-policy debates about fairness often center on the
relationship between people's tax liabilities and their
incomes. What fairness really means in this context, however,
has proven extraordinarily subjective and controversial. Some
contend that people's tax bills should increase more rapidly
than their incomes. This relationship, which is known as tax
progressivity, demands, for instance, that if a person's income
doubles, the amount of taxes the person pays to the government
more than doubles. If one believes in progressivity, an
essential follow-up question--but one that advocates of
progressivity rarely address--is how much progressivity is
enough. Should taxes rise slightly more rapidly than income?
Should taxes rise much more rapidly?
A competing standard of fairness is that people's tax bills
should rise at the same rate as their incomes. With what is
known as a proportional tax, if a person's income doubles, the
person's tax bill also doubles. A good case can be made for a
proportional system. For the most part, a person's income
represents payments for labor and capital services offered to
the market, and the person's income is proportional to the
person's efforts and contributions to economic output. It is
only fair that a person making twice the effort and generating
twice the output should receive, after tax, twice the
compensation, which implies a proportional tax system.
The income tax system is already progressive because of its
exempt amounts and ascending schedule of marginal tax rates in
the various income brackets. If one believes that the current
rate structure does not provide enough progressivity, the most
direct and visible way to increase progressivity would be to
steepen the rate schedule or to increase the standard deduction
and/or personal exemption. Either method would be a clearer,
simpler way to increase progressivity than phase-outs.
On the other hand, suppose one believes in progressivity
but thinks that the income tax is already progressive enough.
In that event, the use of phase-outs to inject additional
progressivity would be unfair. And if one believes that
people's tax liabilities should be proportional, rising in step
with their incomes, phase-outs would certainly have to be
judged unfair.
Although discussions of fairness in the context of tax
policy often mention only the relationship between tax
liabilities and income, another very important criterion of
equity, surely, is according people equal treatment under the
law. Specifically, if a particular deduction, exemption, or
credit based on the nature of an expense is available to
taxpayers in general, it is unfair to take it away from a
particular group of taxpayers because of a characteristic
unrelated to the rationale for the deduction, exemption, or
credit. The child care credit and miscellaneous business
expense deduction provide good examples. These costs of earning
income are as real for high income earners as for low income
earners. The true measure of income--revenue less the cost of
earning the revenue--suggests that everyone should be allowed a
full deduction for such expenses.
Some policymakers defend the phase-out of the child credit
and other phase-outs by insisting that tax policy ought to
favor the poor and middle class. For example, early in 1997,
President Clinton said, ``Over the last four years, we have
provided tax relief to millions of working Americans and to
small businesses. But I want to go further by helping middle-
income Americans raise their children, send them to college,
and save for the future.'' \14\ At one level this message is
plausible: middle-income Americans may be overtaxed relative to
the services they receive from the government.\15\ But hidden
in the President's message is the very disturbing idea that tax
rules should be based on what groups a policymaker wants to
help or hurt, not on what rules would produce a less
distortionary and less complicated tax system. For example, the
phase-out of the child and education credits are a form of tax
discrimination against the upper middle class and wealthy.
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\14\ Budget Message Of The President in Office Of Management And
Budget, The Budget Of The U.S. Government, Fiscal Year 1998
(Washington, DC: Government Printing Office, 1997), p. 6. Although the
President claimed that his tax proposals were targeted towards the
middle class (he even labelled the main provisions a ``Middle Class
Bill of Rights''), the actual proposals defined the middle class as
ending at such low income levels that millions of households who regard
themselves as solidly middle class would be excluded. The
Administration, for example, recommended that the child credit begin
phasing out at a modified AGI of $60,000. By any objective measure,
that is hardly upper income. A two-earner couple would bump into that
phase-out if each has gross wages of just $30,000.
\15\ If some government services are not worth the money, the
appropriate response is both to cut taxes and to rein in government
spending.
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At the other end of the income scale are credits aimed at
discriminating in favor of the poor. One of the largest credits
subject to a phase-out is the EITC, a program of government aid
to the working poor. The EITC is, in essence, a welfare
program, but it differs from most welfare programs because it
has the commendable feature of pegging aid to work, at least up
to a certain level of income. Because one expects low-income
assistance to be reserved for the poor or near poor, means
testing of the EITC does not violate most people's personal
standard of fairness. The EITC phase-out is still troubling on
other fronts, though. It increases the EITC's complexity, and,
even more damaging, it creates a powerful disincentive against
additional work effort within the phase-out range.
Consider a single filer with 2 eligible children, wages in
1998 of $20,000, and no other income. This worker would qualify
for the EITC but be in the middle of its phase-out zone. The
phase-out rate for an individual with two or more children is
21.06%. Thus, an additional dollar of wages would increase the
worker's income tax by 15 cents (the person is probably in the
15% tax bracket) and reduce the credit the person can subtract
from tax by approximately 21 cents. As a result, the worker
would owe 36 cents more income tax on the extra dollar of
income. In other words, the EITC phase-out pushes this low-
income worker's marginal income tax rate from 15% to 36%. This
is a powerful work disincentive. If the same worker has only
one child, the EITC and its phase-out rate are both smaller.
The phase-out rate is approximately 16%. In combination with
the regular income tax, it produces an effective marginal
income tax rate of about 31%. (To find the total marginal tax
rate, one must add the payroll tax. The employee share of the
payroll tax increases the worker's marginal tax rate by another
7.65%. In addition, it is generally accepted that the employer
share of the payroll tax is passed on to workers, as well.) It
is true that the EITC provides a powerful work incentive while
it is being phased in (earnings from $0 to $12,260 in 1998),
but more workers are in the phase-out range than the phase-in
range.\16\ On balance, then, the EITC, which is often thought
of as a spur to work effort by the working poor, may actually
discourage more work than it stimulates.
---------------------------------------------------------------------------
\16\ Based on author's calculations using IRS data for tax year
1994 published in Therese M. Cruciano, ``Individual Income Tax Returns,
Preliminary Data, 1994,'' SOI Bulletin, Spring 1996, p. 25.
---------------------------------------------------------------------------
Another fairness-based criticism of phase-outs is that
although they can produce big tax increases, the rules and
arithmetic are so complicated that taxpayers are often unsure
of or confused about how much extra they are paying. People may
legitimately object to such hidden taxes in much the same
manner that they dislike having hidden charges tacked onto
other bills they receive. If a private merchant adds hidden
charges to bills, customers at least have the option of going
to other merchants who practice more open billing. Indeed, the
hidden charges may even be illegal! With tax bills from the
government, unfortunately, people do not have that choice. A
rising schedule of rate brackets is a much more visible method
of taxing away an increasing share of people's incomes as their
incomes grow than are phase-outs.
Conclusion
Phase-outs raise marginal tax rates and wreak havoc on
economic incentives over the affected ranges of income.
Although phase-outs can be extremely attractive politically
because they are partially hidden and can be (mis-)touted as
``fair,'' they are very bad tax policy--distortionary,
complicated, and unfair. Instead of adding more phase-outs to
the tax system, the President and the Congress should be
rescinding those already on the books. Ideally, all phase-outs
should be swept aside in a fundamental overhaul of the tax
system.
Phase-outs violate several key principles to which a tax
system should adhere. They needlessly damage economic
incentives: taxpayers who are in the process of losing
deductions, exemptions, or credits because of rising income
experience higher marginal tax rates than otherwise, thereby
sharpening harmful tax biases against work and saving. Phase-
outs are complicated, which confuses taxpayers and adds to
their paperwork costs. Further, although phase-outs are often
defended vigorously because they steepen tax progressivity, the
increased progressivity is actually unfair if the income tax is
already sufficiently progressive or too progressive. Regardless
of debates about progressivity, the arbitrariness and hidden
nature of phase-outs are contrary to tax fairness. Further,
phase-outs violate the concept of affording all citizens equal
treatment before the law.
In light of these problems, policymakers should reexamine the
phase-outs now in the tax code. Most should be eliminated. New phase-
outs should not be introduced. The inefficiencies and confusion
introduced into the tax system by phase-outs are further evidence that
fundamental overhaul and simplification of the tax system is sorely
needed. When politicians are seeking to save money for the U.S.
Treasury, phase-outs should be one of the last places they look, not
one of the first.
Michael Schuyler
Senior Economist
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Statement of National Air Transportation Association, Alexandria,
Virginia
The National Air Transportation Association (NATA)
represents the interests of aviation businesses nationwide. The
Association's nearly 2,000 member companies provide a wide
variety of aviation services, including on-demand air charter
under FAR Part 135. As this Committee moves forward examining
areas for tax simplification and relief, NATA on behalf of its
on-demand air charter members is setting forth an initiative
designed to provide a reformed and simplistic tax code for
America's aviation businesses.
Today, action is needed to ensure the economic
competitiveness of the aviation industry is not compromised,
aviation safety is enhanced, excise tax collections are
simplified, and the use of fuel efficient aircraft is
encouraged. Congress should implement one of the
recommendations of the Congressionally-created National Civil
Aviation Review Commission, that received unanimous support
from its wide range of members covering every aspect of
aviation, and change the method of taxation for on-demand air
charter operators from the airline transportation taxes to a
simple fuel tax.
Under the standards of the Part 135 code, operators employ
the most qualified and experienced pilots, and operate the
safest, most technologically-advanced aircraft. Currently, the
tax codes penalize on-demand air charter operators for the use
of this certificate, lumping these operators with the world's
largest airlines.
Enhancing the competitiveness of the on-demand air charter
industry is one of the many positive effects this change would
spur. The current tax law provides a significant financial
disincentive for operating under FAR Part 135, resulting in
aircraft accidents by operators that operate illegally to
circumvent the taxes. These illegal operations are an obvious
breech to this Nation's high standard of aviation safety, and
this simple tax change may be able to positively influence safe
practices for all using our Nation's aviation system.
The current tax code is gray, making it difficult to
understand the standards between commercial on-demand air
charter and non-commercial operations that often utilize the
same aircraft. Shifting to the fuel tax will allow all of
general aviation to operate in the same tax environment, and
eliminate confusion caused by these differences.
Today, the Internal Revenue Service (IRS) has agents
combing through the books of nearly 8000 charter operators and
corporate flight departments. Moving on-demand operators from
the obtrusive, labor-intensive transportation tax to a simple
fuel tax will save in government paperwork and oversight.
A fuel tax is also a good method of encouraging operators
to utilize more fuel efficient and quieter aircraft, helping to
reduce the amount of fuel burned, reducing air emissions and
protecting the overall health of the environment.
Moving on-demand air charter operators from the ticket tax
to a fuel tax will maintain the current revenue stream that
supports critical aviation programs. It also more accurately
reflects revenues flowing into the Aviation Trust Fund from
non-airline sources.
This year thousands of on-demand air charter flights will
carry passengers every day to destinations across the Nation.
On-demand air charter companies provide their customers
customized air transportation, staffed by highly trained pilots
using aircraft scrutinized by the same standards set forth by
the Federal Aviation Administration (FAA) as the major
airlines. These companies provide a vital link for their
customers, providing them with access to over 5,000 airports
across the country.
Promoting safety, simplifying the tax structure, and saving
taxpayer money are all important reasons to make this move, but
enhancing the competitiveness of aviation companies, often
small businesses, is truly a positive change. Together we can
continue to promote American small businesses, encourage growth
and supporting good business practices, while maintaining the
current high standard of safety.
Thank you for the opportunity to set forth this critical
initiative. NATA looks forward to working with Congress and
this great Committee to move forward these ideas. Together, we
can improve upon America's great air transportation system.
Statement of Clark S. Willingham, President-Elect, National Cattlemen's
Beef Association
Chairman Archer, Ranking Member Rangel, Members of the
Committee: On behalf of the National Cattlemen's Beef
Association (NCBA) and our 230,00 members from all segments of
beef production, thank you for your interest in reducing the
death tax burden on hard-working American families. I
appreciate the opportunity to share with you the devastating
effect death taxes have on the ability of cattlemen and women
to pass their family businesses on to the next generation.
Death is a lousy event to tax. For the past several
Congresses, relieving the death tax burden has been a top
priority for NCBA. We commend the Committee's hard work this
past year in making significant progress toward the ultimate
goal of eliminating death taxes from the federal tax code.
Through our own resources and as a member of the Family
Business Estate Tax Coalition, we are committed to working with
you and the Committee to achieve additional progress. As
evidenced by this hearing and the statements of Members of the
Committee, it is clear that reform of death taxes remains a top
priority in Congress.
From the cattle industry's perspective, the death tax is
the primary obstacle in keeping our family-owned businesses
intact and viable during the transition from one generation to
the next. Nearly one-half of our members have been in business
more than 50 years and 15% of our members have operated their
family business for more than 100 years. These are the folks
who for generations have contributed to the economy of the
local communities, who are the foundation of an industry that
represents 20 percent of the U.S. agricultural gross domestic
product and which annually generates over $150 billion in local
and national economic activity. Add to this high level of
economic activity the public monies generated, such as fuel
taxes, excise taxes, income taxes and related revenues, and one
must question the wisdom of a federal policy that effectively
erodes the base of the rural economy.
Death is a certainty for each of us. Unfortunately, it also
unleashes the IRS, which can take up to 55% of a business and
its assets before the next generation has the opportunity to
carry on the family tradition. Statistics indicate the average
age of a cattleman is 55 years, which suggests there currently
are a lot of ranch families who will soon face the burden of
federal estate taxation. Statistics also indicate that the
number of cattle operations has declined 20 percent since 1981,
a trend that many feel is accelerated by the burden death taxes
pose on surviving family members.
NCBA feels this burden has contributed to families selling
their family farming and ranching enterprises in anticipation
of the death tax. In addition, many of our members report that
their efforts to plan for the impact of estate taxes has led to
management decisions that are not always in the best interests
of operating a profitable enterprise.
We also believe, in addition to enhancing the well-being of
the beef industry, that estate tax reform will provide society
in general with environmental benefits. Any business that is
successful over a long period of time is one in which the
principals pay close attention to the maintenance, up-keep and
improvement of the production facility. For cattlemen, their
production facility is the land--land that they and their
ancestors have nurtured to ensure its ability to support their
beef herds, and land that they share with a natural ecosystem
that includes wildlife habitat, watersheds, riparian areas, and
so forth.
Unfortunately, a cattle operation is a capital intensive
enterprise typified by having most of its assets invested in
the land or cattle. In the event of the death of a principal
family member, the sale of the land and/or cattle becomes the
primary source of funds available to meet the costs of death
taxes. When this occurs, ranches or farms get split up,
particularly in areas of aggressive urban/suburban growth and
escalating land values. The net result is that land that once
provided nutritious beef or other staples for our diets and
habitat for Mother Nature's flora and fauna is instead used to
grow houses, shopping malls, and roads.
Taxing capital at death is frustrating when one considers
that the money used to buy, maintain and improve these assets
was taxed when earned. Adding to the insult are the estate tax
rates which can impose a top rate of 55 percent--which is
especially troubling when compared to the top capital gains tax
rate for individuals of 20 percent.
Obviously, NCBA's favored position is outright repeal of
death taxes. But if repeal is not likely, we strongly support
efforts to further reform the estate tax code, whether it be
through lower rates, increased exemptions or exclusions, or
some combination thereof.
During several hearings on death taxes this past year,
William W. Beach, Senior Fellow in Economics at the Heritage
Foundation, repeatedly stated that the costs of compliance and
lost economic activity due to the estate tax far exceed the
revenues gained by the federal government. Professor Richard
Wagner of George Mason University projects that over an eight-
year period, elimination of death taxes would add 250,000 jobs
and pump $80 billion in annual economic growth to the nation's
output. It is our hope that this kind of information can be
taken into account by budget analysts and provide you the
resources necessary to include additional death tax reforms in
any tax legislation you may consider this year.
I mentioned that NCBA is a member of the Family Business
Estate Tax Coalition, a large group made up of trade
associations and organizations who represent the vast majority
of this nation's family owned enterprises. This group worked in
a bipartisan fashion throughout 1997 to build the case on the
negative impact that the estate tax places on family
businesses. The message of the Coalition is simple, and perhaps
redundant, but it needs to be repeated.
Liquidity is the fundamental characteristic that
distinguishes the estates of family owned businesses from those
of individuals holding marketable securities and/or other
liquid assets. Publicly traded stock can be sold to pay the
death tax, doing little harm to capital investments that are
critical to the productivity of the business and the overall
financial well-being of a company. But a family owned business,
whether it's a ranching operation or a restaurant, must sell
critical assets--and often the business itself must be sold--to
pay death taxes, or suffer under the resultant debt load
necessary to continue in business.
Our campaign to reform/repeal the death tax is about jobs,
economic growth and the financial stability of this nation's
many small and medium sized communities. On behalf of the NCBA,
we thank you and your colleagues for holding this hearing. We
encourage you to move boldly in your efforts to provide
additional relief from the death tax burden.
We recognize the constraints placed on reforms by the
budget and want to work with you to maximize the benefits for
those who are most impacted. Thank you for your leadership on
this important issue, and for the opportunity to provide this
statement to the Committee.
Statement of Bruce Hagen, Commissioner, North Dakota Public Service
Commission
Thank you for the opportunity to comment for the record on
reducing the tax burden.
I believe Congress should make every effort to first reduce
the national debt before taxes are reduced. As I understand it,
it is now over $5 trillion. Any change in the tax laws should
give those people who have especially benefited from our system
in the last years the opportunity to help pay for our country's
debt.
The national debt climbed from about $900 billion in 1980
to over $4 trillion by the end of 1992. Since the beginning of
1993, the rate of increase in the national debt has
dramatically come down. Congress should try to continue this
downward trend.
When the Federal Government stops borrowing money to
operate our government, it means interest rates normally drop
and this benefits those folks who have to borrow money for home
mortgages, farm expenses, cars, business, manufacturing--the
entire economy.
I believe the American people expect that we should start
paying our debts and that we should do so on a consistent
basis. A sensible tax system that's fair to all and doesn't
favor the rich, who have certainly benefited in the last 20
years in our economic system, should always be a goal of this
democracy. A modern democratic civilization such as the United
States must have a fair tax system.
Our tax system could be improved. For example, Congress
uses the money that working people pay into Social Security to
help balance the annual budget of the United States. Congress
should not use Social Security funds to help balance the annual
government budget.
Thank you again for the opportunity to comment.
Statement of White House Conference on Small Business
The undersigned are the elected Regional Taxation Chairs
representing the 2000 delegates to the last White House
Conference on Small Business. We were delegated the
responsibility for advancing implementation of the conference's
recommendations with regard to the tax issues and reporting
progress back to the delegates. As you prepare to consider tax
policy issues again in the second session, the delegates to the
White House Conference on Small Business want to remind you of
the important tax issues for the growth and progress of small
businesses in America.
One of the strongest recommendations of the White House
Conference on Small Business was a call for the repeal of the
estate and gift tax. The Taxpayer Relief Act of 1997 included a
provision which effectively excludes the first $1.3 billion of
an estate where a qualifying small business constitutes over
half of the gross estate. While this is welcome relief, more
needs to be done to protect businesses from being dismantled at
the death of the principal. The passage of a small business
from one generation to the next has a positive impact on the
community, promoting stable employment, long-term community
support through community groups, and an active interest in
maintaining the quality of education and life in the
``neighborhood.''
If outright repeal is too costly under the budget
requirements, the tax issue chairs feel that proposals which
provide for continued reduction of the tax and the
administrative burden on small businesses would be helpful. By
focusing the legislation, Congress can provide relief directly
to farms and small family businesses while foregoing a
relatively small amount of revenue. The Congress should adopt a
tax policy moves the country toward the positive goal of
sustaining the economic vitality of a small business and away
from a policy which requires expensive and complex estate plans
and insurance. The reality today is that elaborate and costly
estate plans must be undertaken which drains assets from
productive business investment. Without such plans, there is no
guarantee that the business will last to serve the next
generation of owners or workers.
In general, the White House Conference urged Congress to
investigate a simpler, fairer tax system but purposely did not specify
what changes should be made. We would like to recommend that any
changes that are considered be analyzed for their impact on small
businesses and that representatives of the small business community be
included in any hearings on the subject.
We would be happy to work with you, your colleagues and your staff
to help you better understand the importance of these proposals to
small businesses and the U.S. economy. Thank you for your time and
attention to this matter.
Sincerely,
Region 1
Debbi Jo Horton, Providence,
Rhode Island
Region 2
Joy Turner, Piscataway, New
Jersey
Region 3
Jill Gansler, Baltimore,
Maryland
Region 4
Jack Oppenheimer, Orlando,
Florida
Region 5
Paul Hense, Grand Rapids,
Michigan
Region 6
Joanne Dougherty, Houston,
Texas
Region 7
Edith Quick, St. Louis,
Missouri
Region 8
Jim Turner, Salt Lake City,
Utah
Region 9
Sandra Abalos, Phoenix,
Arizona
Region 10
Eric Blackledge, Corvallis,
Oregon
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