[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
FUNDAMENTAL TAX REFORM
=======================================================================
HEARING
before the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
__________
APRIL 11, 12, and 13, 2000
__________
Serial 106-115
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
71-879 WASHINGTON : 2001
_______________________________________________________________________
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC
20402
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 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
WES WATKINS, Oklahoma LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
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
American Business Conference, Barry K. Rogstad................... 256
American Farm Bureau Federation, and Oklahoma Farm Bureau, Steve
Kouplen........................................................ 66
Americans for Fair Taxation:
Hon. John E. Chapoton........................................ 135
Leo E. Linbeck, Jr........................................... 42
Angell, Wayne, Bear Stearns & Company, Inc....................... 115
Armey, Hon. Richard K., a Representative in Congress from the
State of Texas, and House Majority Leader...................... 217
Association for Manufacturing Technology, James H. Mack.......... 263
Barcroft Consulting Group, and National Retail Federation, John
G. Wilkins..................................................... 98
Bear Stearns & Company, Inc., Wayne Angell....................... 115
Bill Helming Consulting Services, Inc., Bill Helming............. 309
Brookings Institution, Hon. Bill Frenzel......................... 159
Center for the Study of Taxation, Patricia M. Soldano............ 332
Chapoton, John E., Vinson & Elkins, LLP, and Americans for Fair
Taxation....................................................... 135
Christian, Ernest S., Washington, DC............................. 163
Davis, Frank L., Jr., Alexandria, VA............................. 201
English, Hon. Phil, a Representative in Congress from the State
of Pennsylvania................................................ 147
Entin, Stephen J., Institute for Research on the Economics of
Taxation....................................................... 335
Foster, J.D., Tax Foundation..................................... 168
Frenzel, Hon. Bill, Brookings Institution........................ 159
Global Strategy Group, Inc., Jefrey Pollock...................... 286
Hamilton, Billy, Texas Comptroller Office of Public Accounts..... 127
Helming, Bill, Bill Helming Consulting Services, Inc............. 309
Howard, Jerry, USX Corporation................................... 260
Institute for International Economics, Gary Hufbauer............. 177
Institute for Policy Innovation, Aldona Robbins.................. 315
J.C. Penney Company, and National Retail Federation, Del
Threadgill..................................................... 140
Kotlikoff, Laurence J., National Bureau of Economic Research, and
Boston University.............................................. 91
Kouplen, Steve, American Farm Bureau Federation, and Oklahoma
Farm Bureau.................................................... 66
Linbeck Corporation, and Americans for Fair Taxation, Leo E.
Linbeck, Jr.................................................... 42
Linder, Hon. John, a Representative in Congress from the State of
Georgia........................................................ 7
Luntz Research Companies, Frank Luntz............................ 282
Mack, James H., Association for Manufacturing Technology......... 263
Martin, James, Horseshoe Bay, TX................................. 69
McCracken, Todd, National Small Business United.................. 51
Metcalf, Gibert E., National Retail Federation, and Tufts
University..................................................... 106
Moore, James O., Smithtown, NY................................... 195
National Association of Manufacturers, and Tupperware
Corporation, James E. Rose, Jr................................. 267
National Association of Realtors, Scott Rooth.................... 57
National Bureau of Economic Research, and Boston University,
Laurence J. Kotlikoff.......................................... 91
National Retail Federation:
Gilbert E. Metcalf........................................... 106
Del Threadgill............................................... 140
John G. Wilkins.............................................. 98
National Small Business United, Todd McCracken................... 51
Oklahoma Farm Bureau, and American Farm Bureau Federation, Steve
Kouplen........................................................ 66
Peterson, Hon. Collin C., a Representative in Congress from the
State of Minnesota............................................. 10
Pollock, Jefrey, Global Strategy Group, Inc...................... 286
Portman, Hon. Rob, a Representative in Congress from the State of
Ohio........................................................... 274
Powell, James L., Fort McKavett, TX.............................. 312
Regalia, Martin A., U.S. Chamber of Commerce..................... 327
Robbins, Aldona, Institute for Policy Innovation................. 315
Rogstad, Barry K., American Business Conference.................. 256
Rooth, Scott, National Association of Realtors................... 57
Rose, James E., Jr., National Association of Manufacturers, and
Tupperware Corporation......................................... 267
Skarbek, Janet L., Cinnaminson, NJ............................... 129
Soldano, Patricia M., Center for the Study of Taxation........... 332
Tauzin, Hon. W.J. ``Billy,'' a Representative in Congress from
the State of Louisiana......................................... 221
Tax Foundation, J.D. Foster...................................... 168
Texas Comptroller Office of Public Accounts, Billy Hamilton...... 127
Threadgill, Del, National Retail Federation, and J.C. Penney
Company........................................................ 140
Traficant, Hon. James A., Jr., a Representative in Congress from
the State of Ohio.............................................. 226
Tupperware Corporation, and National Association of
Manufacturers, James E. Rose, Jr............................... 267
U.S. Chamber of Commerce, Martin A. Regalia...................... 327
USX Corporation, Jerry Howard.................................... 260
Wilkins, John G., National Retail Federation, and Barcroft
Consulting Group............................................... 98
Worley, Steven, Colbert, GA...................................... 191
SUBMISSIONS FOR THE RECORD
Adams, Charles, Williamsville, NY, statement..................... 349
American Forest & Paper Association, W. Henson Moore, statement.. 354
American Petroleum Institute, Michael Platner, statement......... 356
Apolinsky, Harold, Sirote & Permutt, P.C., joint statement....... 420
Argus Group, Dan R. Mastromarco, and Sirote & Permutt, P.C,
Harold Apolinsky, joint statement.............................. 420
Associated General Contractors of America, Alexandria, VA,
statement...................................................... 361
Barcia, Hon. Jim, a Representative in Congress from the State of
Michigan, statement............................................ 365
Bell, Thurston, National Institute for Taxation Education,
Hanover, PA, statements........................................ 389
Berthoud, John, National Taxpayers Union, Alexandria, VA,
statement...................................................... 395
Burton, David R., Prosperity Institute, Alexandria, VA, statement 404
Cain, Herman, Godfather's Pizza, Inc., Omaha, NE, statement...... 366
Cargill, Barry, Small Business Association of Michigan, Lansing,
MI, statement.................................................. 409
Council of Smaller Enterprises, Cleveland, OH, statement and
attachment..................................................... 365
Godfather's Pizza, Inc., Omaha, NE, Herman Cain, statement....... 366
Hall, Hon. Ralph M., a Representative in Congress from the State
of Texas, statement............................................ 369
Herbert, Glendale O., Pembrok Equity, New York, NY, statement.... 399
Hodous, Robert P., Payne & Hodous, Charlottesville, VA, statement 398
Kahn, Joseph M., Stanford University, Decisions and Ethics
Center, Palo Alto, CA, statement............................... 370
Keating, Raymond J., Small Business Survival Committee, statement 411
Klein, Lori, Taxpayer Protection Alliance, Phoeniz, AZ, statement 413
Loftman, Bert, Atlanta, GA, statement and attachment............. 378
Mastromarco, Dan R., Argus Group, joint statement................ 420
Mitchell, Daniel J., Heritage Foundation, statement and
attachments.................................................... 379
Moore, W. Henson, American Forest & Paper Association, statement. 354
National Federation of Independent Business, statement........... 385
National Grain Trade Council, statement.......................... 388
National Institute for Taxation Education, Hanover, PA, Thurston
Bell, statements............................................... 389
National Taxpayers Union, Alexandria, VA, John Berthoud,
statement...................................................... 395
O'Donnell, John B., Chula Vista, VA statement.................... 396
Payne & Hodous, Charlottesville, VA, Robert P. Hodous, statement. 398
Pembrok Equity, New York, NY, Glendale O. Herbert, statement..... 399
Platner, Michael, American Petroleum Institute, statement........ 356
Prosperity Institute, Alexandria, VA, David R. Burton, statement. 404
Redefining Progress, San Francisco, CA, statement................ 405
Schulz, Robert L., We the People Foundation for Constitutional
Education, Inc., Queensbury, NY, letter........................ 417
Sirote & Permutt, P.C., Harold Apolinsky, and Argus Group, Dan R.
Mastromarco, joint statement................................... 420
Small Business Association of Michigan, Lansing, MI, Barry
Cargill, statement............................................. 409
Small Business Survival Committee, Raymond J. Keating, statement. 411
Taxpayer Protection Alliance, Phoenix, AZ, Lori Klein, statement. 413
UWC-Strategic Services on Unemployment & Workers' Compensation,
statement...................................................... 415
We the People Foundation for Constitutional Education, Inc.,
Queensbury, NY, Robert L. Schulz, letter....................... 417
FUNDAMENTAL TAX REFORM
----------
TUESDAY, APRIL 11, 2000
Committee on Ways and Means,
House of Representatives,
Washington, DC.
The Committee met, pursuant to notice, at 10:02 a.m., in
room 1100, Longworth House Office Building, Hon. Bill Archer
(Chairman of the Committee) presiding.
[The advisories announcing the hearing follow:]
ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
April 3, 2000
FC-20
Archer Announces Hearing on
Fundamental Tax Reform
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing to
consider fundamental tax reform proposals. The hearing will begin on
Tuesday, April 11, and be continued on Wednesday, April 12, and
Thursday, April 13, 2000, in the main Committee hearing room, 1100
Longworth House Office Building, beginning at 10:00 a.m. each day.
Oral testimony at this hearing will be from invited witnesses only.
Witnesses will include Members of Congress, prominent tax reform
experts, well-known economists, and other interested parties. However,
any individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Committee and for
inclusion in the printed record of the hearing.
BACKGROUND:
In the past several years a host of legislative proposals have been
offered which would significantly change the kind of tax regime
contained in the Internal Revenue Code. These include the flat tax, the
national retail sales tax, and the USA and Simplified USA tax. Other
ideas not yet in legislative form abound. In 1995, 1996, and 1997, the
Committee on Ways and Means held extensive hearings on many of these
specific proposals and more generally on the subject of fundamental tax
reform. Leading advocates of specific legislation introduced as well as
economists, business leaders, and Members of Congress testified. In
particular, the Committee devoted considerable attention to both H.R.
1040, the flat tax proposal introduced by the Majority Leader Richard
Armey (R-TX) and H.R. 1467 a retail sales tax proposal introduced by
Rep. W.J. (Billy) Tauzin (R- LA).
Since those hearings, a number of new legislative proposals have
been introduced. These include H.R. 134 by Rep. Phil English (R-PA) and
H.R. 2525 by Rep. John Linder (R-GA) and Rep. Collin Peterson (D-MN)
among others. This hearing will provide the opportunity for the
Committee to consider these newer proposals as it has with prior
proposals.
In announcing the hearing, Chairman Archer stated: ``Over the past
5 years, I've made cutting taxes and simplifying the tax code a top
priority. Still, the tax code is too complicated and confusing, and we
need to get the IRS out of the lives of American taxpayers. That's why
I'm proud to announce this three day hearing as part of the first ever
Congressional summit on fundamental tax reform. We'll look at a host of
new ideas which will eliminate our current tax code and replace it with
something that is simpler and fairer. We need to rip the current tax
code out by the roots so that it can never grow back.''
FOCUS OF THE HEARING:
The focus of the hearing will be on which tax system is best for
America in the new millennium, with a particular emphasis on tax reform
proposals that have been introduced since the last set of hearings in
1997. In particular, the Committee will want to hear from witnesses as
to the relevance of these proposals to the international marketplace in
which our companies and individuals must live and compete and whether
these proposals meet the established criteria of being fair, simple,
enforceable, and compatible with the other parts of the tax regimes
which exist in America, namely State taxes.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Any person or organization wishing to submit a written statement
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch
diskette in WordPerfect or MS Word format, with their name, address,
and hearing date noted on a label, by the close of business, Tuesday,
April 25, 2000, 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, by close of business the day before the hearing.
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 submitted on an IBM compatible 3.5-inch diskette in WordPerfect or
MS Word format, typed in single space and may not exceed a total of 10
pages including attachments. 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, company, address, telephone and fax numbers where the witness or
the designated representative may be reached. 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 advisors and news releases are available on the
World Wide Web at ``http://waysandmeans.house.gov''.
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
April 10, 2000
FC-20-Revised
Time Change for Full Committee Hearing
on Thursday, April 13, 2000, on
Fundamental Tax Reform
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the full Committee hearing on
Fundamental Tax Reform, previously scheduled for Thursday, April 13,
2000, at 10:00 a.m., in the main Committee hearing room, 1100 Longworth
House Office Building, will begin at 10:30 a.m.
All other details for the hearing remain the same. (See full
Committee press release No. FC-20, dated April 3, 2000.)
Chairman Archer. The committee will come to order.
Today, we begin our Congressional Summit on Fundamental Tax
Reform, which will be a 3-day open discussion that will
hopefully lead to an overhaul of the archaic and meddling
income tax code that has outlived its useful life. Americans
spend 6.1 billion hours each year filling out the IRS forms and
$200 billion in compliance costs. And I am told that is a
conservative estimate, and some national magazines say that it
could go as high as $500 to $600 billion a year. All of that
means that the tax code is too complicated and confusing,
unnecessarily so.
In addition, Americans treasure their privacy and their
individual freedom, and the income tax is the most intrusive
part of the Federal Government in the lives of each American.
We had a witness not too long ago who sat right at the
chair in front of me, and as I asked other witnesses what would
you give not to have to deal with the IRS every year, she--a
middle-income lady from Connecticut--responded, ``I would give
my first-born child.'' Obviously, she had an untoward
experience with the IRS.
But the IRS is not really at fault most of the time. The
fault is their responsibility to enforce a law that has grown
from 16 pages in 1913 to 2,840 pages today. And when you
include all of the regulations, I believe it is in excess of
14,000 pages.
It is true the IRS has had its problems, but I am glad that
Congress took action in 1998 to help at least fix some of those
problems. Yet unless we face the fact that the income tax
cannot be fixed--and I believe that to be a fact, having
participated in numerous efforts at reform in the 29-plus years
that I have been here in the Congress--there will always be a
need for the IRS as long as we have an income tax and a host of
interpretation about what is income on which no two economists
completely agree.
Because of our income tax, American workers are caught in a
tax trap: The harder they work, the longer they work, the more
they pay, and that is wrong.
What are we taxing when we tax income? We tax work. We tax
savings. We tax upward mobility. We tax productivity. In sum,
we tax success. And that is just not right.
Most economists believe that the more you tax of something,
the less you are going to get of it. Do we really want less
work, less savings, less upward mobility, less productivity,
and less success? I don't think so, not in America. And yet
that is what is driving our taxation program when we tax income
as the base.
Last week, President Clinton celebrated our new economy,
but our new economy is shackled by an ancient tax code, a code
that gives us headaches, invades our privacy, and hurts our
ability to compete and win the international marketplace
competition. Our tax code simply can't keep up with the economy
and the rest of the world in the 21st century.
We see that in the Internet tax debate. We see it in the
WTO decision on FSC, Foreign Sales Corporations. We see it in
the flight of U.S. corporations overseas to escape our tax
code: Chrysler has become a German corporation, Amoco has
become a British corporation, and Bankers Trust has become
Deutschebank, a German corporation, because of our tax code.
We have heard a lot about corporate tax shelters recently,
but the ultimate tax shelter for U.S. firms is just to pick up
and leave. Do we really want that? I don't think so.
So this summit is to show Americans that our horse-and-
buggy tax code won't work in our Internet economy. It is time
to work together to replace it with a fairer, simpler, and
better system.
I now recognize Mr. Rangel for any statement he would like
to make.
Mr. Rangel. I appreciate this opportunity, Mr. Chairman.
For a long time, you have been very concerned about the
complexity of the tax code and its unfairness to taxpayers. I
would have thought, however, that since the Republicans have
shown an equal concern about this very sensitive subject matter
during all these years that you have enjoyed the Majority, that
we wouldn't have had to wait 6 years just to have another
hearing.
I would have hoped that, during this period of time that
you have enjoyed the Majority, a piece of legislation would
have been drafted, we would be holding hearings on specifics,
and it would not be a Republican idea but it would be
Republicans and Democrats working together in trying to improve
the tax system.
But, consistently, there hasn't been just a lack of
cooperation between our parties. There has been a lack of
conversation between our parties.
Take this hearing, for example. Why, if you had discussed
this with me or the Speaker had discussed this sensitive
subject matter with our Democratic Minority Leader, we would
have said that these hearings are far too important for the
tax-writing committee to be holding at the same time that we
are debating and voting on tax legislation on the House Floor.
I don't see how you expect Members of this Committee to be in
attendance at hearings, to listen to our Members and other
witnesses, and at the same time expect us to be on the Floor
supporting our legislation or at least protecting our
jurisdiction on the House Floor.
But I really don't think that this hearing has anything to
do with legislation. I think this has to do with lack of a
political legislative agenda on which we can work together. And
so, once again, we have got to talk about pulling up the income
tax code by the roots--pulling it up by the roots and
substituting it with what? Substituting with ideas that we will
hear about today? Is there a bill? No. Have we had hearings?
No.
We have a document here that is in front of the Members. It
has a concept called Americans for a Fair Taxation. Very well
prepared. What we don't have is something that we will go into
later. We don't have a statement from the Joint Committee on
Taxation.
Now, I know how much you depend on the private sector to
provide for progressive legislation, but the Joint Committee is
nonpartisan. They are supposed to give revenue estimates on
these bills. One way or the other, we have got to get a
document before this Committee so we can see how much these
concepts really cost us.
Now, from time to time, Mr. Chairman, you will find some
Members here, Republicans and Democrats. I hope our witnesses
will understand that our absence from these hearings is no
disrespect to the Chair, to our colleagues, or to the
witnesses. It is because the very same 3 days that we have
scheduled hearings on tax reform are the very same 3 days that
we have scheduled tax legislation on the House Floor.
Why it was done this way I really don't know. But it is
clear that these hearings are for public consumption and not
legislation. We have no bill. We don't expect to have a bill.
We don't expect to legislate in this area this year, or for the
last 6 or 7 years. We never expected to.
So there are so many other questions I have, but out of
respect to our two colleagues who have come here to testify. I
would tell you that the Chair has no plans for any legislation
on this subject matter, not this, not Social Security, not
Medicare reform. But it is interesting because it really closes
out the years of the Republican Majority. This is how they
started it off--with hearings about pulling the tax code up by
the roots. And, this is how we are going to end it with
hearings about pulling it up by the roots.
Thank you, Mr. Chairman.
Chairman Archer. We have two of our colleagues who will
lead off the testimony this morning. Are you gentlemen prepared
to speak about phantom legislation for which there is no bill
before the committee?
Mr. Linder. No, sir, but we would be pleased to talk about
H.R. 2525 that was introduced by a Republican and a Democrat on
July 14th of last year.
Chairman Archer. So there is legislation before the
committee on which we are holding these hearings today.
Mr. Linder. That is correct.
Chairman Archer. Would the gentleman also venture a guess
as to whether this is appropriate procedure to hold hearings on
legislation before there might be any action on the
legislation?
Mr. Linder. It strikes me as the right thing to do.
Chairman Archer. Well, the Chair welcomes our two
colleagues, Mr. Peterson and Mr. Linder, to present their bill,
H.R. 2525, and, Congressman Linder, if you would lead off.
First, welcome to the Committee.
Mr. Linder. Thank you.
Chairman Archer. I compliment both of you on the work on
this bill, and the committee is prepared to hear your
testimony, and you may proceed, Mr. Linder.
STATEMENT OF HON. JOHN LINDER, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF GEORGIA
Mr. Linder. Thank you, Mr. Chairman. Mr. Chairman, I have a
prepared statement that I have submitted for the committee, and
I will summarize, if you don't mind, the aspects of H.R. 2525.
It strikes me that if Congress had sat down in 1912 and
said how can we build a tax system that is destructive of
capital formation, that is inefficient, is unproductive, and is
punitive, they couldn't over 88 years have come up with a
better solution than we have got today.
This is inefficient. We have seen studies from a variety of
sources that for a small businessperson to collect, comply, and
remit $1 in business income taxes, it costs them anywhere from
$4 to $7 to do it.
It is unfair to young people. It is the single largest
stumbling block and impediment to getting from the first rung
of the economic ladder to the second because, as you said in
your statement, the harder you work, the more you save, the
more you invest, the more we take.
It is undecipherable. As you know, the IRS tells us if you
call them asking for help in your tax return, 25 percent of the
answers you get are going to be in error. They don't even
understand it.
Our proposal is to abolish all taxes on income, to change
the paradigm. Do not tax what we put into society but tax what
we take out in terms of personal consumption. Abolish all taxes
on income, the gift tax, the estate tax, capital gains tax, and
the payroll tax, which supports Social Security and Medicare
and which is the largest tax that three-fourths of America
pays, larger than their income tax, and replace it with a one-
time frank, transparent, at-the-checkout national sales tax.
You spend $100, the first $23 goes to the tax man, the rest
goes to the merchant.
Under today's system, if you earn $100 and you are in the
average income withholding bracket of 28 percent, the
Government is going to take the first 36 bucks whether you
spend it or not. So everyone is going to have improved
purchasing power.
We have learned from studies that there is no way for a
corporation or a business to pay a tax. They don't have a
mechanism. I have been built seven businesses, and there is
simply not a secret drawer where money piles up behind you that
you find your money for the corporate share of the payroll tax.
There is not a secret drawer for the income tax. It comes out
of price. It is passed down the line in price until somebody
finally consumes the product, and that person not only consumes
the product but all the taxes that have been embedded in it
along the way.
What would happen to the system? Just imagine being the
only nation in the world selling goods and services into a
global economy with no tax component in our prices. Exports go
up. You, Mr. Chairman, have said--you have quoted on this floor
on several occasions that a research group interviewed 500
international corporations domiciled overseas, asked them what
they would do if we abolished all taxes on income and went to a
sales tax. Eighty percent said they would build their next
plant in America; 20 percent said they would relocate to
America. You referred to that actually in your statement about
all the companies leaving this country. Exports increase.
What would happen----
Chairman Archer. Congressman Linder, I am informed by
members of the committee they are having difficulty
understanding your presentation--or hearing it, not
understanding it.
Mr. Linder. Okay.
Chairman Archer. Perhaps you are too close to the mike, or
maybe it is that the sound system just isn't working well this
morning.
Mr. Linder. Well, I will try it again. Is this better? Can
you hear it better? Collin says I talk too fast.
Mr. Chairman, for those who say that the sales tax is
regressive on the poor, let me say the most regressive tax they
have is the payroll tax that taxes, between what they and their
corporation pay on their behalf, 15.3 percent of everything
they earn up to $76,000. We not only get rid of that, we also
get rid of the embedded cost of the IRS, and we believe at
retail 22 percent of everything you pay is embedded business
cost of the IRS. But we also give to every family a rebate at
the beginning of every month that totally rebates the tax
consequences of spending up to the poverty line. So everyone
will have increased purchasing power, and everyone will have
increased freedom.
Can you imagine the privilege in a free society where no
one knows how much you make, how you make it, how you invest
it, if your investment makes money or loses, or how you spend
your money? You will have the privilege of anonymity again,
which we think is important in a free society.
There are 100,000 people today at the IRS who know more
about me than I am willing to tell my children, and I want them
out of my life, and yours, too. And I agree that they are just
doing their job, but nobody should know that detailed
information about us.
In 1912, a Senator in the discussion of the 16th Amendment
was ridiculed and laughed off the floor of the Senate for
making this statement: ``Mark my words, that before this is
over, they will be taking 10 percent of what everybody earns.''
Oh, how I wish it were so, giving fresh meaning, I think, to
that wonderful country western song, ``If 10 Percent's Enough
for Jesus, It Ought to Be Enough for Uncle Sam.''
We want to get rid of the tax on incomes entirely and tax
what people choose to spend.
[The prepared statement follows:]
STATEMENT OF THE HON. JOHN LINDER, A REPRESENTATIVE IN CONGRESS FROM
THE STATE OF GEORGIA
Thank you Mr. Chairman and members of the committee. I
appreciate the opportunity to testify today about H.R. 2525,
the FairTax Act of 1999, which I introduced along with Collin
Peterson earlier in this Congress. Mr. Chairman, I ask that my
written statement and a series of articles discussing the
FairTax be made a part of the record.
The FairTax Act would repeal all individual income taxes,
corporate income taxes, payroll taxes, self-employment taxes,
capital gains taxes, and death and gift taxes. It would replace
these with a 23 percent national retail sales tax on all new
goods and services sold to consumers. All sales of new goods
and services to consumers would be taxed once and only once,
without any exceptions. Business inputs would not be taxed
since those items will ultimately be taxed when they are sold
to consumers, thus adhering to the principle that goods be
taxed once and only once.
Because there are no exceptions to the FairTax, and because
we realize that those Americans at the low end of the income
scale spend a higher proportion of their income, the FairTax
provides every household in America with a rebate of the sales
tax paid on necessities. Thus the FairTax is progressive, and
every family is protected from tax on essential goods and
services. The rebate would be paid monthly in advance in an
amount equal to the sales tax rate multiplied by the federal
poverty level--that level of spending literally defined by the
U.S. government as required to purchase necessities. For a
family of four, the rebate level is $22,500--meaning that every
family of four will receive a check at the first of each month
for $431.25, the amount that family would pay in taxes on
monthly poverty level spending. If you spend more than the
poverty level, you pay the sales tax. If you spend less than
the poverty level, you get to keep the rebate check anyway.
It would be a mistake to emulate the states' attempt to
achieve sales tax progressivity by exempting various categories
of goods or services from tax because that methodology doesn't
achieve progressivity at all. For example, affluent people buy
more expensive food, housing and clothing than do poor people,
so when these categories of goods are exempted, affluent people
benefit disproportionately. In addition, these exemptions add
complexity and compliance costs to the system, and lead to
outrageous results. In any New York bagel shop, for example, a
plain bagel is tax-free but a bagel with cream cheese is
taxable. Moreover, any one exception to the sales tax will
inevitably lead to efforts to exempt other products. Not only
would those efforts lead to a perversion of the sales tax just
as lobbying today has perverted the income tax, but also when
some goods or services are exempted, a higher tax rate must be
charged on those things that remain taxable to maintain the
same level of revenue. Such a preferential scheme is bad as a
matter of economics and unfair to those companies and workers
who make the goods that remain taxable.
The FairTax will end the complexity of compliance with our
current system. Today, according to the Tax Foundation, we
spend about $250 billion each year filling out forms, hiring
tax lawyers and accountants and collecting information needed
only for tax purposes. These unnecessary costs amount to about
$850 for every man, woman and child in America. To the extent
these costs are incurred by businesses, those businesses hide
them in the cost of everything that we buy. The Tax Foundation
has estimated that compliance costs would drop by about 90
percent under a national sales tax. Why? Because the present
system requires that Americans must provide over one billion
information returns to the IRS annually. Americans file a
quarter billion tax returns annually. Under the FairTax, this
would be an unpleasant memory.
The FairTax would be collected by states and retailers just
as current state sales taxes are. The FairTax gives retailers a
25 basis point commission for collecting the tax and offers
state sales tax authorities another 25 basis point commission
to administer the tax. We believe that it makes the most sense
for state civil servants that have years of experience
administering a sales tax to take that job. The FairTax would
then dismantle the IRS and create a sales tax bureau in the
Treasury to administer the collection of sales tax from the
states. The only tax collector that the consumer would ever see
is the smiling face behind the register at the local grocery
store.
Beyond simplicity, the FairTax holds the promise of
ecomomic growth and a higher American standard of living. The
FairTax would stop the punitive taxation of work inherent in
the income and payroll tax and end the multiple taxation of
savings and investment. The FairTax would end the bias against
investment in education. Economists anticipate the FairTax,
because it is neutral toward savings and investment, will lead
to much higher levels of savings and investment which in turn
will lead to greater productivity and output. Dr. Dale
Jorgenson of Harvard and Dr. Laurence Kotlikoff of Boston
University estimate, in two separate studies, that the FairTax
would increase GDP between 7 to 14 percent over the current
system. While clearly not endorsing the FairTax specifically,
even our current Treasury Secretary, Dr. Larry Summers,
concluded in some of his academic writings that a complete
shift to consumption taxation might raise steady-state output
by double digits.
Why is such growth predicted? Because by giving Americans
their entire paycheck, American consumption is increased. And,
by untaxing our business and corporations, American businesses
will become more competitive with foreign businesses. Consider
the recent WTO ruling that found the Foreign Sales Corporation
(FSC) export incentives to be a violation of WTO rules.
Congress created FSCs with the knowledge that our current tax
system was undermining our ability to compete abroad. The
FairTax would solve this problem by removing the current tax
burden on American production and allowing American goods to be
sold overseas with no tax consequences embedded in the price.
Further, the FairTax would apply to all imported goods sold in
America. In contrast, today foreign goods enter the U.S. market
free of any significant tax burden. This places U.S. produced
goods at a big competitive disadvantage. This disadvantage is
made worse because most of our major trading partners eliminate
a big part of their tax burden on exports since their value
added taxes are border adjusted. They impose a large VAT on
U.S. goods imported into their country. This disadvantage is
built into our tax system, and it exports high paying U.S. jobs
to our foreign competitors.
Unlike our perversions of the income tax, the FairTax is in
compliance with the WTO rules because it is an indirect tax,
it. For the first time, American businesses and American
workers will be competing on a level playing field with our
foreign competitors.
The FairTax is simple, understandable and transparent.
People understand the FairTax. They don't understand the
present tax system. Even tax professionals and tax
administrators don't understand the present system. Moreover,
today a huge proportion of the overall tax burden is hidden
from the ordinary taxpayer's view and passed on to those who
can least afford it. Under the FairTax, people will for the
first time actually understand their tax burden and have
confidence that their fellow citizens are bearing their fair
share.
Mr. Chairman and members of the Committee, the present
system is broken beyond repair. It is costing the American
people dearly in terms of opportunities lost and a lower
standard of living. It is time to start over. I believe that
the FairTax--as the only proposal today that ends the
regressive payroll tax and allows American workers to compete
fairly with our foreign competition--represents the best
alternative to the present system. I think that after you study
the plan you will agree.
Thank you.
[Attachments are being retained in the Committee files.]
Chairman Archer. I thank the gentleman for his testimony,
and because I assume this bill is a bipartisan bill, inasmuch
as Congressman Peterson is with you there at the witness table
as a cosponsor of this legislation, we will be happy to now
hear your testimony, Congressman Peterson.
STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF MINNESOTA
Mr. Peterson. Well, thank you, Mr. Chairman, and members of
the committee, and it is bipartisan. We have four Republicans
and four Democrats on the bill, and we are hoping to add some
more. But we appreciate your calling this hearing and
appreciate your leadership on this issue.
Mr. Chairman, I have some materials that I would like
entered in the hearing record immediately following the
testimony, if that is appropriate.
Chairman Archer. Without objection, so ordered.
Mr. Peterson. Thank you.
Mr. Chairman, not too long ago, it was inconceivable that
this committee would focus on a replacement as comprehensive as
the national sales tax, which is embodied in H.R. 2525. We had
a few lonesome voices like Democratic Member Sam Gibbons, who
used to rage against the tax system and say that there was a
better way to collect taxes. But it didn't seem like there was
enough time to ever consider them, and each year we get into
the tax policy game of musical chairs that began to see which
of the tax extenders would remain standing. We saw a constant
flow of new ideas for credits and deductions that vied for the
ultimate award to be enshrined in the Internal Revenue Code.
So I think we have come far as Republicans and Democrats to
be here today, and no group is more pleased, I think, that we
are having this hearing than the American people.
Now, why as a CPA, and especially a Democratic CPA, do I
believe in the Fair Tax and why do I think this is the best
replacement for the current system? I have watched the making
of tax laws as a practitioner on the outside. I have been here
as a legislator now for 10 years under Democrats and
Republicans. And every tax simplification Congress has passed
has added more pages to the U.S. Tax Code and has made the
system more complicated. And that was under both Democrats and
Republicans.
I have been highly critical of my own party on this point.
I think that the 1986 Tax Act was without a doubt the worst
piece of legislation that has ever been passed in this
Congress. It did lasting damage to many Americans for no good
reason. And it complicated the code to the point where we can't
understand it a lot of times, and it complicated our lives.
But, in all due respect, since the Republicans have taken
over in 1994, you have added 547 pages of statute and 2,327
pages of regulations, just through 1999. So we have kind of got
the same thing going on here, and I think that is why it is so
positive that we are looking at legislation to replace the
whole system here today.
When 49 practitioners last year were given the same
information and asked to complete a Federal income tax return,
they came back with 49 different answers. No matter what your
intentions, you know, we haven't simplified the tax code, and
it is time that I think we admit that this system cannot be
fixed in spite of all of our best efforts.
I don't think this system can be salvaged even if we all
wanted to do so. And I also don't think that taxing income is
the best way for us to raise revenue in this country given the
way the economy is changing.
Mr. Chairman, I think Americans want true tax reform. Poll
after poll shows we are collectively disgusted with our system.
Members are hearing from their constituents about this. We are
now on the third edition of the Taxpayer Bill of Rights. Each
taxpayer gripe hearing is like watching Halloween I, II, and
III. Only the names and witnesses change, but the plot does
not. The unofficial annual holiday honoring the height of our
enmity for our income tax system is just around the corner,
April 15th.
Congress has voted to scrap the tax code once and is likely
going to do it again. But while something called tax reform
just might happen, the real question is this: By what criteria
will its success be judged? And what do we want to see in an
ideal tax system?
I have come to the conclusion that the Fair Tax fits the
bill for a number of reasons.
First of all, there are no exemptions, so we might actually
be able to keep this simple and not give preference to one
group or another and not give rise to a whole horde of
lobbyists descending on your committee asking for special
treatment.
It would help solve one of our biggest problems today, and
that is this trade deficit, the balance of trade deficit that
we have. As John said, the current tax system has an embedded
cost that the economists tell us is around 20 or 22 percent.
That means that we are exporting all of these taxes, American
taxes, in the price of our exports. One of the biggest pluses
of this system is it will take that out of the export stream,
it will reduce the cost of what we are charging for goods and
services sold around the world by an average of 20 or 22
percent, and it will be GATT legal.
In addition to that, when imports come into this country,
they are going to be taxed the same as domestic goods and
services if they are used for personal consumption, just like
goods and services that are made here in the United States.
It also eliminates the most regressive tax, the payroll and
self-employment taxes. These are, as I say, I think, the most
regressive, and they are the toughest thing for many of our
farmers and small businesses because in a lot of cases they pay
more in those kinds of taxes than they do in income taxes.
It makes equity capital more available and affordable
because we will no longer be taxing savings and investment.
It will be much easier to administer. We would only need to
keep track of the approximately 1.6 million retail and service
businesses in the U.S., as opposed to the more than 169 million
individuals who file tax returns and pay taxes now under the
current system.
The Fair Tax plan makes sense, and it will work for the
21st century. I would be willing to predict that most States,
if we pass this, will get rid of their income tax because they
won't have an income base to place it on, and piggyback on to
our system for collecting sales taxes in their State. If they
do that, we would have a mechanism to tax Internet businesses
the same as we tax businesses on Main Street, which is
something that we are going to have to do, and there is no
reason why we ought to prefer an Internet business over one
that has a store on Main Street.
So I think, understandably, the people so far don't have a
lot of faith or confidence that Congress is going to come up
with tax reform, and that is too bad. And when I explained this
to my father, he said, ``Well, you know, that is never going to
happen. That makes too much sense.''
I hear that from a lot of my constituents as well when I
tell them about it, but the Fair Tax is well thought out, it is
well researched, it is simple, and it is fair.
So let's show the American people that we can take bold
steps and do what is right. Let's move this Fair Tax through
the Congress. Doing so would make the American people keep
every penny of their paychecks and have some say over how much
tax they pay, and really, I think, be a tremendous boom for the
economy because we would not tax--if you didn't spend your
money and you saved it, you could keep it. And if you want to
go out and buy a new Mercedes or a new airplane, you would pay
tax and, you know, that just drives the whole decisionmaking
process in the right way.
So this, I think, the right solution to tax reform. I hope
that we can move this ahead in a bipartisan manner.
Thank you, Mr. Chairman.
[The prepared statement follows:]
STATEMENT OF THE HON. COLLIN C. PETERSON, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF MINNESOTA
Thank you Mr. Chairman and Members of the Committee. Mr.
Chairman, I have some materials I would like to have entered
into the hearing record immediately following my testimony this
morning.
Mr. Chairman, not too long ago, it was inconceivable this
committee would focus on a replacement as comprehensive as a
national sales tax. A few lonesome voices, like Democratic
Member Sam Gibbons, raged that there could be a better way to
collect taxes--but there was never enough time to consider
them. Each year the tax policy game of musical chairs began to
see which of the tax extenders would remain standing. The
constant flow of new ideas for credits and deductions vied for
the ultimate award, to be enshrined in the Internal Revenue
Code. We have come far, both Republicans and Democrats to be
here today. But no group is more pleased than the American
people.
Why, as a C.P.A., and especially a Democrat C.P.A., do I
believe the Fair Tax is the best replacement for our current
system? I've watched the making of tax laws as a practitioner
and as a legislator--under Democrats and Republicans--and every
tax ``simplification'' Congress has passed has added more pages
to the US Tax Code and made the system more complicated.
I have been highly critical of my own party on this point.
I think the 1986 Act was the worst piece of legislation ever
passed. It did lasting damage to many Americans for no good
reason and it complicated the Code and our lives.
But since the Republicans took over, you've added some 547
pages of statute and 2,327 pages of regulation--through 1999.
When 49 practitioners were given the same information and asked
to complete a federal tax return they came back with 49
different answers. No matter what your intentions, you have not
simplified the federal tax code.
I don't think we'll ever fix this system. I don't think
this system can be salvaged even if we wanted to do so. I also
don't think that taxing income is the best way to raise the
revenue this country needs.
Mr. Chairman, Americans want true tax reform. Poll upon
poll shows we are collectively disgusted with our system.
Members are hearing from their constituents. We are now on the
third edition of the taxpayer bill of rights. Each taxpayer
gripe hearing is like watching Halloween I, II and III. Only
the names and witnesses change. The plot does not. The
unofficial annual Holiday honoring the height of our enmity for
our income tax system is just around the corner. Congress has
voted to scrap the Code once and likely will again. But while
something called tax reform just might happen, the real
question is this: By what criteria will its success be judged?
What do we want to see in an ideal tax system?
I've come to the conclusion that the Fair Tax fits the bill
because:
1) There are no exemptions, so we might actually be able to
keep this simple and not give preference to one group or
individual over another.
2) It would help solve one of our biggest problems, our
balance of trade deficit. With our current federal tax system
we are exporting the cost of the tax system in most goods and
services. The economists who worked on developing the Fair Tax
estimate that this cost averages about 20%. The Fair Tax would
eliminate that cost, and it would be ``GATT legal.'' In
addition, imports coming into the U.S. would be taxed the same
as domestic goods and services if they are used for personal
consumption.
3) It eliminates payroll taxes and self-employment taxes.
These are some of most regressive taxes we currently have and
they are one of the biggest burdens for many of our farmers and
small business persons.
4) It makes equity capital more available and affordable,
because we will no longer be taxing savings and investment.
5) It will be much easier to administer--we would only need
to keep track of the approximately one point six (1.6) million
retail businesses in the U.S., as opposed to the more than one
hundred sixty-nine (169) million individuals who file tax
returns and pay taxes.
6) The Fair Tax plan makes sense and it will work for the
21st century. I would be willing to predict that most states
would piggyback on our system. We would also have a mechanism
to tax Internet businesses the same as business on main street.
Understandably, the people don't have a lot of faith in
Congress when it comes to tax reform. As my Dad said when he
heard about it, ``That will never happen--it makes too much
sense.''
The Fair Tax is well thought out, well researched, simple
and fair. Let's show the American people that we can take bold
steps and do what's right. Let's move the Fair Tax through the
Congress--doing so would let the American people keep every
penny of their paychecks and have some say over how much tax
they pay.
Thank you, Mr. Chairman.
[Attachments are being retained in the Committee files.]
Chairman Archer. Thank you, Congressman Peterson.
Mr. Camp?
Mr. Camp. No questions.
Chairman Archer. Ms. Dunn?
Ms. Dunn. Thank you very much, Mr. Chairman.
Gentlemen, thank you for coming to testify today. This is a
fascinating hearing we have going on today, and I know that
Ways and Means members will be moving in and out of this
meeting. But it is great to be able to be at the head of the
line to ask you questions. That usually doesn't happen when you
are in the bottom row.
But I do have a couple of questions I would like to ask
you. Could you explain to the committee how the national retail
sales tax compares to the more broad-based taxes that we see on
sales in Europe?
Mr. Linder. Well, first of all, they typically have a
value-added tax, which adds a tax every time you add value to a
product, from the time you get the order to turn it into a
bumper to put it on a car, and it is a hidden tax. It is buried
in the cost of goods and services.
One of the first principles of this tax is that everything
be transparent so that everyone would know when they buy
something what the tax was to the Federal Government.
This tax is only retail consumption. No taxes between
businesses, no taxes for farmers. If a farmer buys a tractor to
work his land, there is no tax. If he buys a hat to put on his
head to do so, there is a tax.
It taxes everything only one time, so a used house would
not have a tax in it, but a new house would. But it is only
personal retail consumption that is taxed.
Mr. Peterson. John has explained it well. I think the thing
that also should be pointed out is that in Europe, they not
only have the value-added tax that is added at every level and
added into the price of the product so you don't know what it
is, it is also at different levels, depending on what type of
goods and services it is.
But the other thing that they did is they kept the income
tax, so they have two taxes. They have the income tax and the
value-added tax. And I will tell you today that if we don't get
rid of the income tax, I will not support this bill. The only
way I support this is to completely eliminate all of the
current system and replace it with this. The worst thing that
we could have is to do what Europe did, and that is, have an
income tax and a sales tax.
Canada did the same thing, and my district is right up
alongside of Canada. That didn't work very well because they
weren't able to take the cost of goods and services out of
their products because they kept their income tax, they kept
their Social Security tax, and they added the GST tax on top of
it.
So what we are doing here has not been done any other
place, and I think if we pass this, we will become the Hong
Kong of the world and this economy will boom, and it will be a
great thing for America.
Mr. Linder. Let me add a point to that, if I might.
Americans are paying this tax today. They are paying the
embedded cost of the IRS at retail, about 22 percent, we have a
study that says. They are paying all the cost of businesses,
the cost of businesses, attorneys, and accountants to avoid the
tax. There are payroll tax costs. There are income tax costs.
There are compliance costs, all embedded at price.
Ours is the only bill that gets rid of all those taxes and
gives competition the opportunity to drive out of the price of
goods and services that 22 percent.
Ms. Dunn. I think it is really important to continue to
make that point, that this national retail sales tax would be a
replacement for the current income tax system. It would not be
in addition to the current income tax system. I think we have
got to say that over and over again. Mr. Peterson, you did say
that, and people need to realize that there has got to be a
mechanism to get rid of the old tax code before we move in a
new tax code.
Is there anything like that being thought of right now?
Mr. Peterson. Well, in our bill, we do call for the repeal
or the process to repeal the 16th Amendment so that it will
never rise again. So we have tried to address is, but, you
know, I am a cosponsor of the bill to scrap the code, and I
have been criticized or it has been criticized that, you know,
it is irresponsible to terminate the code without having a
replacement. Well, we have a replacement. It is here today, and
I am cosponsoring it.
You may disagree with some of the aspects of it, or you
might have your own way to replace it, but some of us that feel
strongly about this have come up with an alternative, and, you
know, it is time to get rid of this income tax code. It is so
screwed up it cannot be fixed.
Ms. Dunn. Let me ask you, gentlemen, how would your
proposal affect the national and the individual rate of savings
in our country?
Mr. Linder. Well, if you don't tax--first of all, the
average income earner who has a 28 percent withholding rate and
a 7.65 percent share of the payroll tax will have an increase
in take-home pay the next day of 56 percent. We are all going
to be savers. We are all going to be investors. Because when
you drive the embedded cost of the IRS out of the price of
goods and services and replace it with this tax, the cost of
living will be about a percent higher, but we will all have an
increase in take-home pay and we will all be investors.
We believe the increase in savings is going to be huge. We
think the interest rates are going to go down 25 percent
because of that.
Mr. Peterson. You know, the American people, they are
smart. And when it becomes apparent, which it will almost
immediately, that if they spend money they are going to pay
tax, if they save money they are not going to pay tax, it is
going to change the psychology of this country.
Now, we have tried to increase the savings rates with IRAs
and all this other stuff. It hasn't worked. It has gone down.
And I guarantee you that if this thing changes, as somebody who
sat across the desk and did taxes for people, they are going to
figure this out and they are going to save more. I don't know
how much more but----
Ms. Dunn. So that means that every dollar that is invested
or saved by an income earner is not going to be taxed under
your program.
Mr. Peterson. That is correct.
Ms. Dunn. Thank you.
Thank you, Mr. Chairman.
Chairman Archer. Mr. Kleczka?
Mr. Kleczka. Thank you, Mr. Chairman.
Let me thank both of you for appearing before the committee
today. In your presentation, you criticized the current tax
code extensively and said little about the proposal, which I
think, before we move on it, the American public has to
understand much better.
It seems that you are touting this plan as a 23 percent
sales tax, and I just question that calculation. Let me ask
either one of you, if this were to be the law of the land and I
would go and purchase a suit for $100, what would the sales tax
be on that suit? The cost of the good is $100. What would be
added on for this national sales tax?
Mr. Linder. It is our design to have the sales tax included
in the cost of the good. Currently, your income tax----
Mr. Kleczka. Okay, that is fine. Let's say it is included
in the good. The cost of the good is $100.
Mr. Peterson. It is $123. It is $23.
Mr. Kleczka. That is not what we are told. We are told it
is 30----
Mr. Linder. If it was----
Mr. Peterson.--dollars on $100----
Mr. Linder. Let me explain to you, Mr. Kleczka, what the
current system is. You are currently taxed on a tax-inclusive
basis, which is to say, the Government takes the first $36 of
what you earn, within what you earn. If you treat this on a
tax-inclusive basis----
Mr. Kleczka. I am trying to compare it to the current sales
tax. If I buy something in Wisconsin now, then----
Mr. Linder. It will be 29.9----
Mr. Kleczka. Wait, could I finish? If I buy something in
Wisconsin now, there is a 5.6 percent sales tax. It is the
State sales tax. It is a half percent county tax and 1 percent
stadium tax, since now the taxpayers are building stadiums.
Okay?
If I buy something for $100, that 5.6 is added on. Now,
tell me what my total cost of a suit would be if the suit
itself costs $100.
Mr. Linder. The added-on Federal national sales tax would
be 29.9 percent, and if you want to compare apples----
Mr. Kleczka. Now, that is not the 23 percent we are told
about.
Mr. Linder. The tax-exclusive rate is 29.9 and the tax-
inclusive is 23 percent. If you want to treat the income tax on
an exclusive basis, which is to say, divide the amount of money
you have to spend into what the Government took out of it, you
would be paying an effective sales tax rate of 56 percent
today, so we are still cutting it in half. You have to treat it
either as an exclusive or an inclusive tax.
Mr. Kleczka. You know, what I am trying to do is go back to
my constituents and explain what this proposal is all about.
And my concern is, am I to tell them that the sales tax is 23
percent or 30 percent? I suspect that in an attempt to sell
this you are trying to minimize what the actual impact is, so
you are saying 23; however, the effective rate to be charged on
goods and services is actually 30.
So what I am going to do when I respond to any letters I
get on this issue, I am going to say what they have proposed is
a 30 percent sales tax rate, and we are told by the tax experts
around here that to be revenue neutral, that tax rate would
have to be 59 percent.
Mr. Peterson, would you like to respond to that?
Mr. Peterson. Well, I don't know where you get the 59
percent.
Mr. Kleczka. To be revenue neutral. As it stands, your 30
percent would cost--would deny big revenues that are, you know,
coming in today.
Mr. Linder. We have three different studies that disagree
with you.
Mr. Peterson. Yes, the people that did the studies from MIT
and Harvard and Stanford estimate that, as we said, the
effective tax rate is 23 percent when you figure out what the
percentage is of the total price of the goods and services.
That is what it comes out to be.
But we can argue----
Mr. Kleczka. Okay. Well, the joint committee----
Mr. Peterson. Figures lie and liars figure, but----
Mr. Kleczka. The joint committee, which works for the
committee or is assigned to the committee, did come up with
that amount.
Could you explain to the committee how local units of
government and State governments are going to pay this sales
tax? As I read the proposal, all goods and services are taxed
for governmental units. Could you explain how that works?
Mr. Linder. Well, first of all, most governments are
heavily labor-intensive and they are going to have a huge
savings on their payroll tax just to begin with.
Mr. Kleczka. Okay. How are they taxed? You forgot to finish
the point.
Mr. Linder. If they buy something that they are going to
use in the business of running the city, they are going to pay
a tax on it.
Mr. Kleczka. So they are going to pay a 30 percent tax.
Now, how are they to treat their payroll? Let's say the city of
Milwaukee has a $50 million payroll in a month, are they taxed
at 30 percent on that also?
Mr. Linder. No, no, 7.65 percent of that payroll is going
to be coming out of their side and 7.65 coming out of their
employees' side.
Mr. Kleczka. Okay. That is the FICA tax, is it not, and HI?
Mr. Peterson. Well, yes, but we eliminate----
Mr. Linder. We eliminate the Social Security and Medicare.
Mr. Peterson. Eliminate the Social Security tax. Part of
what this bill does, it doesn't just get rid of the income tax,
it gets rid of the payroll tax.
Mr. Kleczka. Okay. And so how is the payroll tax to be
funded--I mean, the Social Security trust fund to be funded?
Mr. Peterson. It is going to be funded out of the proceeds
of the sales tax, and that----
Mr. Kleczka. Okay. But so----
Mr. Peterson. The economists figured that in.
Mr. Kleczka. So is income going to be sales taxed also?
Mr. Linder. No.
Mr. Peterson. No.
Mr. Linder. Only what they spend.
Mr. Kleczka. That is unclear.
Chairman Archer. The gentleman's time has expired. There
will be additional opportunities.
Mr. Collins?
Mr. Collins. Thank you, Mr. Chairman.
If I understood you right, for this to be revenue neutral,
based on the estimated revenue of this year, about $2
trillion----
Mr. Linder. 1995 is the last number we have.
Mr. Collins. 1995, okay. A couple of questions, then. How
do you treat accumulated savings prior to the implementation of
this tax?
Mr. Peterson. They are not taxed. Savings aren't taxed
under any circumstances.
Mr. Collins. If you take the funds out of savings and spend
them.
Mr. Peterson. Okay. If you spend them on personal
consumption, new goods and services that are used in personal
consumption, then you would pay tax.
Mr. Collins. Even though they were accumulated after tax?
Mr. Linder. Correct.
Mr. Peterson. Right.
Mr. Collins. Okay.
Mr. Linder. Let me make a point on that, Mr. Collins. If
senior citizens who have saved all their life and accumulated
something and paid tax on the accumulation and paid tax on the
interest earned and the capital gains earned, they are
currently paying this tax every time they spend something. They
are currently paying the embedded cost of the IRS. All we are
saying is you get to take your money out of your IRA with no
tax consequences. There will be no tax on your Social Security
revenues or any income you have. But you will pay a 23 percent
inclusive sales tax when you buy things, which is about what
you are paying today.
Mr. Collins. Okay. Another question. How do you treat
depreciation that businesses already have in place prior to the
implementation? Because there would be no depreciation after
the implementation.
Mr. Peterson. Well, depreciation is not necessary or
relevant because we don't tax income. And so one of the
problems that we have had in talking to people about this is
that they are so ingrained in thinking about the current system
that they can't conceive of us moving away and not having to
worry about all this stuff, depreciation and deductions and all
of that. But because we are not taxing income, it is
irrelevant. The only thing that makes any difference is what
you are spending for your own personal consumption. So
depreciation is important in doing your financial statements
for reporting, you know, but other than that, it won't make any
difference.
Mr. Collins. But depreciation is your way of expensing----
Mr. Peterson. But we aren't taxing income anymore.
Mr. Collins. Before we run out of time, what about existing
excise taxes? Do you eliminate those or replace those?
Mr. Linder. No. We tried to draft a bill that merely
replaces the current system of taxing income to another system
of taxing expenses without making policy decisions. It is my
view that this bill would fail on the floor of the House if we
eliminated the excise tax on tobacco. We would fail on that
issue alone. So we decided we will take on excise taxes at
another time.
Mr. Collins. That would include the 12 percent excise tax
on a lot of major purchases?
Mr. Linder. Correct.
Mr. Collins. It is already in place. It would stay there.
Okay.
That is all. Thank you, Mr. Chairman.
Chairman Archer. Mr. Watkins?
Mr. Watkins. Mr. Chairman, I have no questions of my two
colleagues. I have for the next panel when we get to it.
Chairman Archer. Thank you.
Mr. Rangel?
Mr. Rangel. Let me thank you for your efforts. I would say
that this Committee has not been responsive to your legislation
``over the years.'' But we have a few months left, and who
knows what can happen.
The Social Security system, since there is no payroll tax
contribution to it, would benefits be paid out of the general
funds with monies that would be collected from the taxes?
Mr. Linder. The monies would apply to the Social Security
trust and the Medicare trust in the same manner they currently
are because your employer would submit your income, what they
paid you in salary, and your earnings would still be credited
to your account, and the 40 quarters for which you get your
benefits out of Social Security will still be the same as the
current system. All we are doing is gathering the money a
different way.
Mr. Rangel. So would the money be paid out by the
Appropriations Committee rather than by the so-called Social
Security trust fund?
Mr. Linder. The revenues that would come from the general
sales tax collections would be applied to the Social Security
trust and the Medicare trust in the same way they are now based
on earnings.
Mr. Rangel. Now, since your sales tax is on top of the
excise tax, how would it apply to a gasoline tax?
Mr. Peterson. Well, if you are buying gasoline for your own
personal consumption, there would be this tax on gasoline like
anything else.
Mr. Rangel. On top of the excise tax?
Mr. Peterson. On top of the excise tax, yes.
Mr. Rangel. Now, Mr. Kleczka reviewed that. We have the
Joint Committee on Taxation, which is a bipartisan effort,
Republican and Democrat, and they have given an analysis of
your bill. They say that the tax-neutral rate is 59.5 percent
over 5 years, and neutrality over 10 years would be 57 percent.
You don't argue with the Joint Taxation Committee's estimate.
Mr. Linder. Sir, we have not seen that study yet. Is that
fairly recent?
Mr. Rangel. Yes, it is April the 7th.
Mr. Linder. We have some economists that will argue with
that, yes.
Mr. Peterson. You know, it is hard for me to believe
because the retail consumption base in this country is 20
percent higher, according to our economists, than the income
base. So it is hard for me to believe that it is going to take
59 percent of a base of 20 percent higher than the current
income base to raise the same amount of revenue.
Now, I don't know--I haven't seen the study, but it would
be hard for me--I mean, I think we would raise so much money we
wouldn't know what to do with it all.
Mr. Rangel. Well, if this is to be considered a bipartisan
effort, don't you think in 6 years that you guys would be
entitled to a Joint Committee Tax estimate of the cost so that
you would have plenty of time to bring in witnesses to defend
it? I mean, if this is serious, these questions should not be
presented to you this late in our legislative agenda.
Mr. Chairman, I ask unanimous consent that the Joint
Committee's evaluation of this legislation be placed into the
record.
Chairman Archer. Without objection, so ordered.
[The information was not available at the time of
printing.]
Mr. Rangel. This concept is complicated, and you can bet
your life that most of the American people haven't the
slightest idea what you are talking about. Are you saying that
cities and States have to pay taxes on hiring policemen,
firemen, doctors, nurses; that the health care that is provided
has to be taxed; and, this is going to be fair and equitable
and across the board? The whole idea of cities being able to
piggyback on Federal income tax programs or States being able
to attach to our system would not work because the vehicle
would be no longer there. And so, therefore, they would have to
now think of new ways for them to get the revenues that would
be necessary for them to run their local and State governments.
It is a revolutionary concept and one that merits not only
hearings but an opportunity for the American people to be
educated. They then can weigh whether it makes any sense the
proposal works for them, and whether for local government or
State governments.
But the most important thing, in my opinion, whether or not
it is a Democratic Congress or a Republican Congress, is how in
God's name do you think you could possibly revolutionize the
tax system unless it is bipartisan in terms of the cooperative
spirit that you bring to this Committee. That bipartisanship
has to come to the Ways and Means Committee and has to come
from the House. Other than that, you are not realistically
talking about revolutionizing the tax system. You may have an
opportunity to express views, but the only way that we can
bring about any dramatic change in pulling up the tax code by
the roots and not increasing its complexity, as the way we have
done in the last 7 years, is to make certain that at least we
are reading from the same page in how we are going to present
it to the American people and, therefore, to the Congress and
this Committee.
So I want to congratulate you for your special effort. I
wish I could give you some hope that we would be able to
consider it in this Committee. But as you know, soon we will
have the Easter recess in order to celebrate the resurrection
of our Lord and Savior, Jesus Christ, as well as Passover, and
then after that we will be moving into Memorial Day for those
who lost their lives. We will go through June, probably be busy
at Committee two or three days a week, and then July 4th we
have to close shop to celebrate our independence.
Come August, of course, our conventions will be the main
consideration, Republicans and Democrats. September we will
come in for a couple of weeks, and then in October, of course,
we get down to the campaign.
So how we squeeze this into our so-called legislative
agenda, I don't know, but maybe, just maybe. If we can keep
this idea alive, we will find the bipartisanship that you two
have enjoyed and worked with over the years being conveyed to
this Committee and to the House and Senate. And, we can take a
hard look at the income tax system as we know it and take a
look at the changes that we can make in a bipartisan way.
These hearings really complicate things because we have a
lot of legislation on the House floor right now. But, again,
the absence of Members should not be interpreted as an absence
of concern of the serious nature in which you present this
legislation.
Thank you, Mr. Chairman.
Mr. Linder. I thank the gentleman.
Chairman Archer. Mr. Crane?
Mr. Crane. Mr. Chairman, I don't have questions for our
witnesses, but I would like to take advantage for an
opportunity to express my appreciation to all of you for the
support. I am sorry for you absence, and I can't tell you how
exciting it is to be back again and contemplate an opportunity
to serve my country, my district, my family and friends and
colleagues. And I want to express appreciation to all of you,
from my distinguished chairman here to my ranking minority
member, Charlie Rangel, for all of the input I got from you
folks. It was really reassuring and very helpful and
beneficial, and I look forward to a very positive and dynamic
future.
It is one of those things I am humbled by, but, on the
other hand, we dig in our heels, fight the good fight, keep the
faith, and we shall continue. Thank you again, all of you.
Thank you.
[Applause.]
Chairman Archer. The gentleman from Illinois is to be
congratulated for taking his life in his hands and moving
forward in a positive way, and I know all the members of the
committee share that view.
Mr. Rangel. Would the gentleman yield?
Chairman Archer. Mr. Rangel?
Mr. Rangel. I think you know the love and affection that we
have had for you over the years. You gave us a chance to
display it by indicating a unique type of courage for all of
us. No matter what shortcomings we have, we can never wrestle
the demons to the ground unless we have the courage first to
admit it and then to do something about it. So it was a bad
setback, but you have set a standard for all of us to follow.
We welcome you back.
Mr. Crane. Thank you.
Chairman Archer. Mr. English?
Mr. English. Thank you, Mr. Chairman. I would like to also
congratulate these two gentlemen for having the courage to
offer a truly revolutionary tax plan. And it has a number of
features that make it similar to the one that I have proposed
in terms of the incentives. But the one that I think is
particularly important and I would like you to comment on is
the whole question of border adjustability.
We obviously, when we discuss tax reform, tend to focus on
how tax simplification benefits the individual taxpayer. The
individual taxpayer all too seldom recognizes that they have a
big stake in tax reform because of the impact of the tax system
on their job, and this is particularly true in export
industries.
I wonder if you gentlemen would comment on how you think
the question of border adjustability, taking the taxes off of
exports and putting the tax on imports, would benefit the
American economy long term.
Mr. Peterson. Well, as I said during my statement, I think
that one of the reasons we are running this huge trade deficit
is because we are exporting our tax system, which is expensive,
and it adds greatly to all of our products, even the farm
products, the raw commodities that come out of my district.
So there is no question in my mind that if we can change
this system where we can wring the cost of the Internal Revenue
Code out of the system, which is 22 percent, that means that
the price of goods and services are going to be 78 percent of
what they are now. Obviously, we are going to sell a lot more,
and it is going to create more jobs.
You know, we are also going to tax the imports coming into
this country if it is used for personal consumption. So for the
first time in a lot of areas, we are going to put ourselves on
the same footing as these foreign countries, and we are not
going to have our companies having to go overseas to
manufacture products just to send it back into this country
because of tax considerations, which is happening now.
You know, I can't quantify it, but I can guarantee there is
going to be a significant increase in jobs and commerce if we
pass this bill in the world market.
Mr. Linder. Let me add something to that. I mentioned in my
opening statement that the chairman often refers to the poll
done by Princeton Group of foreign companies wanting to
relocate here. In addition to that, imagine how many United
States corporations dealing in overseas sales have dollars
stranded all over the globe, billions upon billions of dollars,
because it is cheaper to borrow here at 8 percent than it is to
repatriate your dollars at 35 percent.
All that money would come home. Building on these shores
would be much more attractive both for foreign companies and
our domestic companies. So we would see a huge change in the
global balance of trade.
Mr. English. Certain sectors of the economy tend to be more
tax sensitive in the sense that they tend to operate on thinner
margins. One of those, I sense, is manufacturing. And in the
recent example of the steel crisis that faced U.S. steel
producers, do you feel that a border-adjustable tax in that
case would have allowed America's steel industry to thrive in
the face of foreign competition?
Mr. Peterson. Well, my district doesn't include steel
manufacturers, but I----
Mr. English. That is why I am calling on you as an
objective observer.
Mr. Peterson. Well, I have got to believe that if you can
take 22 percent of the cost of your production out of the price
of your product and if that steel coming into this country is
going to go into cars that are going to be used for personal
use, it is going to be taxed, I mean, it has got to go a long
way to solving this problem.
One of the reasons that we are having trouble in the world
market is we are trying to export our tax system, and it is an
expensive tax system, and it is a big penalty on everybody that
is in the world market.
Mr. English. Thank you, Mr. Chairman. I have no further
questions. And, again, I want to compliment the gentlemen for
their excellent testimony.
Mr. Linder. Thank you.
Chairman Archer. Mr. Stark?
Mr. Stark. Thank you, Mr. Chairman.
Gentlemen, thank you for providing a creative approach to
changing basically the whole way we handle commercial
transactions in the country.
I would note that, Collin, you have introduced legislation
to have a refundable dependent care tax credit to help
families, but that obviously wouldn't work anymore, and you
would be willing to give up helping people with their dependent
care for this program.
Also, the 60 percent rate, I might add, probably comes
because somebody forgot to calculate what your rebates cost.
You would be giving rebates to every American in here, which
amounts to about $400 or $500 billion a year, and that is about
50 percent more than we collect in taxes now.
But I am going to stick with the 60 percent rate here and
discuss the impact on Medicare. This would apply to doctors'
fees and pharmaceutical drugs. Now, the Republicans on this
committee just voted a month or so ago to deny senior citizens
a discount on their prescription drugs. We Democrats all voted
for it. And now we saw in the paper the other day that senior
citizens are paying 15 percent more if they are uninsured for
their prescription drugs.
You guys would add 60 percent on top, so that prescription
drugs for my seniors, Zocor, for instance, would go from an
average retail price of $107 a month to $172 a month, or $780 a
year more. Prilosec for ulcers would go up $840 a year.
Procardia for people with heart problems would go up over
$1,000 a year in cost. At the same time, you would raise the
Part B premium on Medicare automatically from $45 a month to
about $73 a month. And this is most interesting. We just
celebrated the fact that the Part A trust fund became solvent
to the year 2023. Under your plan, increasing the hospital cost
60 percent would make the Medicare trust fund insolvent in the
year 2003. You guys just chop 20 years off the solvency of the
Medicare trust fund.
If you really want to scare the seniors, then just think
about those who had bought long-term care insurance. Nursing
homes cost over $100 a day. You guys would kick that up to $160
a day, and the long-term insurance would no longer cover it.
While we talk about insurance, every American would have
their insurance bill automatically increased by 60 percent. Not
only that, they would have to increase the face amount because
the repair prospects for collision damage or storm damage under
a homeowner's policy would go up by 60 percent.
It seems to me that you are asking the average American to
spend an awful lot of money that they are not now spending, and
particularly those in the lower incomes, which I know you both
understand. Congressman Peterson being an accountant knows that
lower-income people spend a far higher percentage of their
income in consumption than do people who are paid well like you
and me. We don't spend so much. So we get a gift out of this.
But people making $70,000 a year and less really get hammered
because they have to spend so much more of their income.
Now, I know that we kind of forget about middle-income
people and low-income people in Congress because we get these
big salaries. But to think that we are going to rack them up
with a 60 percent tax rate on what they spend hardly seems
quite fair.
So aside from the fact that we are about to destroy
Medicare with this and that is interesting--you talked about
lobbyists and their costs. It seems to me, when I listened to
you on National Public Radio, you did a good job. That is my
commute program. I heard you guys on the radio this morning
while you were on television.
The lobbyists and the doctors and the accountants are going
to have to pay 60 percent of what they bill when they bill it
to the Government in cash while they wait for the collectibles
to come in. Now, I have a hunch that every lobbyist in
Washington is going to be in here fighting this bill.
So I think that while it is interesting to talk to people
about lowering their income tax and their payroll tax, I think
we've got to tell them a little bit more about the other side
of this coin. And I would like to know how you plan to save
Medicare, which would now go broke in 2 or 3 years, when you
have added 60 percent to the cost. Have you got any ideas for
that?
Mr. Peterson. Well, this was not designed to save Medicare
or change Medicare. We are trying to just replace one tax
system with another.
Mr. Stark. If you would yield, I understand that. But
unintended consequences----
Mr. Peterson. And I disagree--you know, I do not agree with
the Joint Tax Committee, with all due respect, in this 60
percent number. Now, we asked them a long time ago for this
information, and now I am getting it from the other side of the
table before they gave it to us. And I think that is a little
bit unfair, and, you know, we didn't need to wait 6 months to
get this information.
But I can understand that because----
Mr. Stark. Excuse me, Collin. It was given to the
Republicans a long time ago.
Mr. Peterson. Well, I am not trying to get into Republicans
or Democrats. This is not why I am involved in this. You know,
for whatever reason, we didn't get the information. So the
first I heard this is today. I cannot believe that the 60
percent figure is right. I don't know where it is coming from.
You know, maybe people want to put this in as bad a light
because they are concerned about protecting the current system
or whatever else, you know.
But it depends on what you believe and how you believe in
the marketplace. I know that some of you think that the drug
companies are making a lot of money.
Mr. Stark. I know that.
Mr. Peterson. Okay. Well, then they are paying the maximum
corporate tax rate----
Mr. Stark. No. They are paying the lowest corporate tax
rate of any major industry in the country through all their
deductions and credit.
Mr. Peterson. Well, but who gave them the deductions and
credits?
Mr. Stark. We did.
Mr. Peterson. Okay. So if they are making a lot of money,
they are paying a lot of taxes, generally.
Mr. Stark. They should.
Mr. Peterson. They should. But, you know, it--I think it is
hard to argue that the current tax system is fair or
progressive as it relates to these different companies, and I
think that we do penalize people's incentive to work and all
these other things. I think it is a much better policy in this
country to tax when people spend money and to not tax when they
save money. I think that is in the best interest of the
country, and we do exempt on the bottom end the people--if you
are a family of seven, you are going to get $31,200 of your
spending exempted from this tax completely.
So we have fairly well insulated the bottom end----
Mr. Stark. But you and I would get the same amount.
Mr. Peterson. Right. Well, why not?
Mr. Stark. Well, what have we done to deserve it? I mean,
the taxpayers are already paying the----
Mr. Peterson. You have the same necessities of life as
anybody else. I mean, everybody needs to have a place to live--
--
Mr. Stark. But I have got a lot more income than everybody
else.
Mr. Peterson. Well, and if you save it, you won't pay any
tax, which is, I think, a good thing because then that money is
going to be available----
Mr. Stark. Collin, I can't sell that in my district. They
don't even want to pay me, much less have me go home and
defend----
Mr. Peterson. Well, I can't speak for your district, but I
just think it makes sense. You know, that is where I am coming
from. We can have a disagreement on that. But I really think
that in the best interest of the country this is a better
system, a better way to raise the money.
Mr. Linder. Let me just say, the only thing I agree with
what you said is that the lobbyists will indeed oppose this.
Mr. Stark. Because of the----
Mr. Linder. Because 60 percent of them make their living
because of their intellectual capital in the tax code that we
have drafted over 88 years.
Mr. Stark. Well, whatever they are lobbying for, I mean,
the interesting thing is having to pay the tax the day you send
a bill to the client, and if the clients are as slow-paying as
some people I know, you are going to really affect the cash
flow. This would go to every lawyer and physician. Think of the
doctors coming to complain how long it takes Blue Cross to pay
them or HCFA to pay them. But when the doc does the operation
and sends the bill, they would have to pay 60--even Collin's
figure of 30, let's split the difference and say 45 percent of
that fee has to be paid in cash to the Federal Government.
Think about what this would do. And Collin as a CPA knows that
cash flow probably is more important to these people in
operating their practices. You would take a big cut out of that
because for people who are carrying receivables, 30, 60, 90
days, there would be a major problem. We would all be paying--
--
Chairman Archer. The Chair notes this is a very interesting
conversation, but the gentleman's time has long since expired.
Mr. Stark. I thank the Chair for his indulgence, and I
thank the witnesses for----
Chairman Archer. The gentleman will have other time today,
frequently.
Mr. Lewis?
Mr. Lewis. Thank you, Mr. Chairman.
With a national retail sales tax, what role would the IRS
play? I would assume that it would be diminished.
Mr. Linder. We anticipate a small agency within the
Treasury Department that will contract with the various States
and pay them to collect the tax, just like 45 States are
already doing with their sales tax now.
Mr. Peterson. So we sunset the IRS in this in, I believe,
2005. We have 110,000 employees. We probably need, you know,
10,000 to do compliance, because one of the--the one issue
where you are going to have a problem is we don't tax
businesses, so you are going to have a lot of people that are
going to want to say they are in business so they can buy a car
or buy a plane for their business. Now, that is already
happening under the current system, but, clearly, you are going
to have that kind of pressure with this kind of system, so we
will need people out there to police this and to try to make
sure that these businesses are legitimate businesses and they
are not some kind of sham just to get around the sales tax. So
much diminished.
Mr. Lewis. So the intrusion into individual lives would be
greatly diminished.
Mr. Peterson. Right.
Mr. Linder. Everybody in America would be a voluntary
taxpayer, and they would pay taxes exactly when they choose and
as much as they choose by how they control their spending.
Let me speak just a little bit to the compliance question,
which I think was at the edge of your question. Currently the
IRS says they collect--they have a compliance rate of 75
percent. It is very easy just to cheat on your tax return, lie
on your income, and you have a 99 percent chance of not being
audited. Under our proposed system, you have to have someone
conspire with you to cheat. And since 80 percent of the tax is
going to be collected by 20 percent of the businesses, such as
Wal-Mart and Home Depot, they are not going to be interested in
helping you cheat because they have too much to lose.
The States that currently collect the sales tax tell us on
average the compliance rate is 92 percent. So we not only
capture the underground economy, but we think the compliance
rate will be much higher than currently.
Mr. Lewis. Wonderful. Thank you.
Chairman Archer. Mr. Tanner?
Mr. Tanner. Thank you, Mr. Chairman.
I, too, thank you all for your innovation. I have long
thought that we could do some things here in Congress that
would simplify the tax code and would also give us a chance to
realize some of the principles of taxation that you all have
expressed, and so I thank you.
I have a couple of questions about the mechanics, I
suppose. There would be a 23 to, I think in your words, Mr
Linder, 29.9 percent levy on the local payrolls of State and
local governments under this provision.
Mr. Linder. Not on payroll.
Mr. Peterson. Not on payroll.
Mr. Tanner. Well, on wages. There would be a sales tax paid
on wages of State and local government employees?
Mr. Linder. On waivers? I can't hear what----
Mr. Tanner. Wages.
Mr. Linder. Wages? No, that is not my understanding.
Mr. Tanner. It is in this bill, as far as I can read.
Mr. Linder. Correct.
Mr. Tanner. Am I incorrect?
Mr. Linder. You are correct.
Mr. Tanner. I am correct?
Mr. Linder. Yes.
Mr. Tanner. You said the difference earlier that would be--
that they would save money because payroll taxes would be
eliminated under your proposal.
Mr. Linder. That is correct.
Mr. Tanner. There is a difference between the 20-something
percent that would be levied on the wages of the local
employees, State and local government employees, and the amount
of contribution they are presently making to the payroll taxes,
anywhere from as much as 20 percent, depending on what number
you used, to maybe 15 percent.
Now, we have passed a law called unfunded mandates. I don't
know how they pay for that if we impose that on the taxpayers
of the State and local governments. I am from Tennessee where
we have a sales tax-based system, so I guess I am more
sensitive to that than you are. Could you help me with that?
Could you explain how that would work?
Mr. Peterson. Well, I think one of the reasons that this
provision is in there--and this, I guess, depends on how you
come at this. But I think--I am convinced that if we take the
income tax, the corporate income tax, payroll tax off of
businesses, then you are going to have a reduction overall in
the price of goods and services of 20 to 22 percent. So what
these people buy in local governments are going to go down. The
costs of goods and services are going to go down 20 or 22
percent.
So if you believe that, then you are going to have a
tradeoff here basically that is going to be even if you believe
that the rate is 29.6 percent.
Mr. Tanner. Do you have any data? I mean, that is the first
question----
Mr. Peterson. Well, yes. Economists----
Mr. Tanner.--that is going to be asked by State legislators
and all of the government employees in the urban areas as well
as the little towns like I come from. How are they going to pay
it?
Mr. Peterson. Well, the economists from Harvard, MIT, and
Stanford that did the work on this say that the costs of goods
and services on average are going to go down 20 percent because
we are going to take the cost of the income tax and payroll tax
system out of the price of goods and services.
So we are trying to leave people----
Mr. Tanner. Well, you understand my question.
Mr. Peterson. Yes, I understand----
Mr. Tanner. When I go home and the little town I live in is
going to buy a police car and they are going to pay this tax on
that police car, they want to know how they are going to come
up with it other than raising the local property taxes. They
are going to pay a sales tax on the salary of the five or six
policemen we have.
Now, if the price of the paper that they buy comes down, I
guess it might make up for the tax they pay on wages of the
policemen and firemen. I don't know. But I think we need to
look at the unfunded mandates law if we think it is worthwhile
and see how we can relate it to this law.
The other question I had is what about the case of retail
sales over the Internet. Are they taxed under your proposal?
Mr. Linder. Yes. Under this principle, we would not----
Mr. Tanner. You understand we just passed a moratorium on
all Internet----
Mr. Linder. Well, we passed a moratorium on special access
charges, but the Internet is still susceptible to the same
sales tax that the catalogue sales are and Sears has been
paying this for 60 years.
On this principle, we think that Government ought to be
neutral between competing parties, and if the fellow down the
street puts up a store and sells books out of it, participates
in your community, votes in your elections, and serves on your
library board, he ought not to be put at a 7 percent
disadvantage to Amazon. So under the principle that Government
ought to be neutral, everything ought to be taxed exactly the
same. And Internet sales and catalogue sales would be captured
at the national level.
Mr. Peterson. Well, and people are mixing----
Mr. Tanner. We have a moratorium until October of next year
on retail sales taxation over the Internet.
Mr. Linder. The moratorium is only on special access
charges.
Mr. Peterson. Well, the Federal Government doesn't charge
sales tax----
Mr. Tanner. That is not my information, but----
Mr. Peterson. The Federal Government doesn't charge sales
taxes on anything right now.
Mr. Tanner. Under your proposal, I understand it would.
Mr. Peterson. Well, we would. But I am just saying right
now--so when people talk about this, they get this mixed up
between the State issue and the Federal issue. We aren't taxing
anybody retail sales at the Federal level. The only people that
are taxing and where it is an issue is at the State level.
Mr. Tanner. Right.
Mr. Peterson. And they get this mixed up, and so I think a
lot of people don't even really know what this is about. You
know, they are just reacting that they are against taxing the
Internet, and I am, too, in terms of taxing the Internet
service and making this available to people. I am against
taxing that. But one of the positive things about this piece of
legislation is that we will tax all sales, wherever it is, and
I think that the States will piggyback on this system, because
they will no longer have the income tax to base their income
tax system on. I think the States are going to go away from the
income tax, will piggyback on this, and then that will help
solve----
Mr. Tanner. Well, let me ask you one other question, so I
can explain it to people when they ask me because I am
interested in it. Under your bill, do you propose to tax the
Internet access?
Mr. Peterson. No.
Mr. Tanner. Well, now, I thought you said there were no
exemptions earlier.
Mr. Peterson. Yes, there will be a sales tax on all
services if it is used for personal use. So if you are using
the Internet in your house for your own personal use, you will
pay a sales tax, like everything else. If you use the Internet
in your business, you will not pay a tax because businesses are
not taxed under this at all. Businesses----
Mr. Tanner. Internet access charges to individuals, non-
business, would be taxed under this provision.
Mr. Peterson. Right, because----
Mr. Tanner. So we would have to change the moratorium on--
--
Mr. Peterson. And so is your phone bill, so is any other
utility.
Mr. Tanner. I am just trying to find out what we are and
are not doing.
Thank you, Mr. Chairman.
Chairman Archer. Mr. Hayworth?
Mr. Hayworth. Thank you, Mr. Chairman. My colleagues from
Minnesota and Georgia, I appreciate you coming down today to
talk more about this, and I also take time to salute you
because I hear from several people in my district who are very
captivated by the notion of changing, reforming our system of
collecting taxes.
My friend from Minnesota may have touched on this a little
bit in his answer to a previous question, but I think there is
a legitimate concern that we need to address--and if it has
been touched on already, I apologize for raising the issue
again--about the so-called sticker shock. When we make a
transition from the current taxation policy to this form of
sales tax, there are those who say, wow, take a look at perhaps
a one-time escalation in price. Would you agree that is a
legitimate challenge in making this transition? And what about
that whole notion of sticker shock and a jump in prices?
Mr. Linder. We have a study out of Harvard that says that
the reduction in sales in the first year would decline by 8 to
9 percent, and in the fourth year we will be spending more than
we are currently spending under the current system because
people would have so much more discretionary income to spend
with.
Mr. Hayworth. So the flip side is--and this was brought up
at a town hall. When there was a lament about the sticker
shock, somebody said, well, yes, but look at what you are
taking home, because I think the epiphany for many of us comes
when we enter the world of work, get a paycheck and say, ``The
Government has taken how much already? Gee, if I just took home
what I earned.''
And yet there is another question that arises, and I know
our friends, the retailers, will be along to talk about this. A
lot of folks tend to take the position, well, wait a minute, we
have already become the tax collector for the State, for the
county, for the city, all these sales taxes. Please don't make
us the tax collector for Uncle Sam. That is one heck of a
responsibility.
But I wonder, too, about the percentage--will there be a
temptation for different businesses to say, well, let's pop the
prices up to an even percentage. It not only will be easier to
figure, but there will be a little bit in there for us in terms
of care and handling. Is that a legitimate concern?
Mr. Linder. Yes, but we think the marketplace works. We
really trust that the competition will drive that embedded cost
of the IRS out of the price of goods and services. If we didn't
trust the marketplace, we wouldn't be interested in this. For
every retailer that wants to put a few pennies extra in there,
the guy down the street is going to take a few pennies out
because his interest is market share. He is going to make more
because he is going to sell more.
So we think we have a very efficient system. We think that
we are in a period of time right now when everything is penny-
sensitive. The competition has never been keener. And we think
that will drive the price of goods and services down.
Mr. Hayworth. Gentlemen, how do we get from here to there?
I mean, is it just take over on an arbitrary date, or is there
a transition period?
Mr. Peterson. The only transition rule in this is going to
be--you know, it is on the 1st of January. The only transition
rule is the inventory that you have on hand at that date you
will get a credit against the sales tax for that inventory
because the price--the current price of the tax system is in
those goods and services. So we would, in fact, be collecting
the tax twice on that. So that would be the only transition
rule.
We would go cold turkey on January 1st of--I think in the
original bill it was 2001. Now it is probably going to have to
be delayed beyond that if we move this year. But it would be
cold turkey.
Mr. Hayworth. One final point. I appreciate your advocacy
of this plan, but I also know that you take your oaths of
office very seriously and you are willing to come here as
honest brokers and advocates. As you look at the plan you have
introduced, in all candor, what do you consider to be the
limitations or the drawbacks? Are there any things that concern
you both in terms of what has been drafted?
Mr. Linder. I have two concerns. The first one is for the
States to administer and oversee the collection of taxes on
services will be much more difficult than on products. And the
second concern, which is very real with me, is that 15 years
after this passes, we are going to have a hard time finding
employees because this economy is going to grow so rapidly.
Every foreign company, is going to want to build in our country
because there are no tax consequences. Every investor in the
world will be in our equity markets because there are no tax
consequences. And we will have so much growth that I am worried
about finding employees.
Mr. Peterson. You know, any piece of legislation has got
things that can be questioned or places that can be improved.
And I think there has already been some issues raised here
today that ought to be looked at. And I come at this with the
idea that you folks can help us make this a better situation. I
think we ought to look at the issue with the local units of
government and see if there is a better way to address that.
But I think that the biggest concern that we are going to
have in the implementation of this, as I said earlier--and we
have got big problems in the current system with compliance.
But we are going to have a significant problem because we don't
tax businesses. You are going to have people trying to create
businesses so they can avoid the tax. And that is going to be
one of the biggest challenges in implementing this, is setting
up a system whereby we can ferret out what is a legitimate
business and give them a number and a way to control this. We
are going to have to have some kind of a system whereby we can
make sure that when the Federal Government gives you a number
to be in business, that you are legitimate business, and then
use that as an underpinning to make sure that people don't get
around this law. That would be my biggest--I think that is the
one place where you are going to have people trying to
undermine this. And it can be handled, but it is going to have
to be thought out very carefully.
Mr. Hayworth. Well, again, gentlemen, I thank you. You are
to be commended, and there are many of my constituents in the
6th District of Arizona who have more than a passing interest
in this, have a deep and abiding conviction that this could be
the answer in terms of tax reform. And I pledge to you as a
committee member we will take a close look at this, and, again,
Mr. Chairman, I commend you for calling these hearings today.
Chairman Archer. Mr. Jefferson?
Mr. Jefferson. Thank you, Mr. Chairman.
I also would like to comment you members for taking a stab
at this issue of tax reform. But I have some questions about a
part of it that I think a lot of folks in the country are going
to be concerned about.
We have done a lot in this committee and throughout the
Congress to incentivize home ownership as a way of creating a
wealth of people and a way of providing for them a chance for
what we call the American dream.
We have also done a lot in our committee to try and build
communities through incentives for rental property development,
both rehabilitation projects and new ones, and we have done
low-income housing credits for that, and we have done
accelerated depreciation.
On the other hand, for home ownership, as you know, we have
allowed the deduction of mortgage interest payments, and these
have incentivized home ownership and have been probably the
principal incentive for the ordinary person in the whole tax
code.
Now, if I understand the bill correctly, it will place a 30
percent retail sales tax on purchases of newly constructed
homes. It seems to leave out old homes, although I am not quite
sure, but it seems to leave that out. But it also imposes a 30
percent sales tax on rentals whether the apartment is new or
old. And then it seems to include sort of a new tax here under
this definition of financial intermediation services, the
difference between the home mortgage and the--I am sorry, the
mortgage interest rate and the Federal rate, there is a 30
percent tax on whatever that difference is.
So let me ask you this: Am I correct that your bill imposes
a 30 percent retail sales tax on purchases of newly constructed
homes?
Mr. Peterson. That is correct.
Mr. Jefferson. And let me ask you this: Do you know if any
State imposes such a tax? I don't think any State imposes such
a tax now, right?
Mr. Peterson. No. But you have to, again, go back to the
underlying principle that the economists tell us that 28
percent of a home, a new home, is the embedded cost of the
current tax system, payroll taxes, corporate income taxes. So
28 percent of the cost of that home is going to go away if we
pass this bill. Then you add 30 percent back onto it, you are
about where you started off.
Mr. Jefferson. Again, you have the discrepancy that exists
between Joint Tax and those who are putting together this
legislation about what the rate will actually be.
Mr. Peterson. Right.
Mr. Jefferson. But let's assume it is a 30 percent rate. If
someone buys a home for $200,000, is the tax on that $60,000?
Is that the way you would calculate it?
Mr. Peterson. This is the one place--in all other
instances, the tax is paid up front, but in the case of homes,
we think that is a large enough purchase that it is not fair to
ask the lenders to pay that tax and have to collect it back
over the length of the mortgage. And so the way that it works
on a new home is you pay tax on the equity portion, whatever
your down payment is, you would pay the tax on that, and then
you would pay the tax on the principal part of your mortgage
payment every month. So that would be spread out over the
length of the mortgage.
On a $200,000 house, if you had $40,000 down, you would pay
the tax on that, and then you would pay the tax on the
principal as you paid off the principal of the rest of the
mortgage.
Mr. Jefferson. So where does the taxpayer get this money
from? He has to borrow the money as part of the overall loan?
Mr. Peterson. Well, he gets it--I mean, he has to borrow
the 28 percent of the embedded cost of the tax system that is
in the house right now. He borrows that.
Mr. Jefferson. Well, you are talking about----
Mr. Peterson. So it is the same----
Mr. Jefferson. Yes, but on top of that, in real terms, on
top of the cost of the house, if the fellow is buying a house
at $200,000, the so-called embedded cost is already there. I
mean, that is what he is getting. Then he pays a mortgage on it
now, and he pays his mortgage interest rate over time. This
sales tax thing is a new feature here. It is something you
would have to borrow, it seems to me, to add to his liability
on this thing.
Now, let me ask you this: This intermediation charge, you
agree that is a new charge, the difference between----
Mr. Linder. It is simply a way to get to how to charge for
banking services, and we are trying to borrow--we are only
charging sales tax on the service provided. If you borrow
$100,000, there is a service cost. We don't pay the sales tax
on $100,000 that you are going to borrow and pay back, only on
the service aspect that the bank incurs in making that loan for
you.
Mr. Jefferson. You calculate that as the difference between
the mortgage rate and the Federal rate. That is what it seems
to be--and I don't know that necessarily--those two necessarily
jibe in every case, but, anyway, that is the way it is
calculated here. That is another issue.
Does the bill impose--on apartment rentals, are you
troubled at all by the proposal that we would increase the cost
of housing by 30 percent for somebody who is renting? Does that
trouble you at all? Or you think it isn't a problem, especially
for moderate- and low-income people?
Mr. Peterson. The price of building that apartment building
is going to be 30 percent less than it is currently because you
are not going to have all of those payroll taxes and corporate
income taxes to pay. So, theoretically, if the cost of that
rental property is less, then the amount that you have to
charge for rent would be less as well. Plus we exempt--like for
a family of five, you don't pay any tax on $25,400, and part of
that $25,400 is the rent that you would pay on your apartment.
So you are insulated from the tax on that portion of it.
Mr. Jefferson. In the case of the new home purchase, you
made an explanation about getting rid of embedded costs. In the
case of rental, of course, it applies to old and new. So if a
person is in a rental unit now and it is an old unit, won't
that person just experience an increase in rent because of this
proposal?
Mr. Peterson. Yes.
Mr. Jefferson. I would think so. And in the case of a new
one, you could say the rent rate is just being established, so
it is taken off for the first time, perhaps. But in every case
of--now, we have made--we try to make it easy for people to
find decent and affordable home ownership, rental properties
through what we have done in the tax code, through the low-
income housing tax credit. We made a big deal out of that over
the years, and it has been--most people say it has been
effective in building communities.
I just wonder if you are going to put some housing out of
the reach of low-income families and without any sort of a
provision before it, because we take the low-income housing tax
credit away.
Mr. Peterson. It is a legitimate concern, and I would just
say that I think that the things that are embedded in the code
that we can all agree are good public policy and are needed to
get people what we think they need and deserve, then they can
withstand the scrutiny of this Congress, and we can set up a
program to accomplish the same thing with a direct
appropriation. We don't have to do this through the tax code.
So the low-income housing tax credit incentives--I mean, we are
wasting 50 percent of that money to have these brokers sell
these credits in the first place. We could eliminate that.
I have worked with low-income housing tax credits. I see
how much of it goes to the people that sell the credits and
don't go to the folks that actually invest in the properties.
So, again, if that is what we want to do to encourage home
ownership for people in rental property, we can have an
appropriation, we can have a program that spends that money
directly, and we can all vote on it, and it will be out in
front. And I think that is a better way to do it.
Mr. Jefferson. Won't you have to set up----
Chairman Archer. The gentleman's time has expired.
Mr. Jefferson.--some bureaucracy to deal with all that
stuff?
Chairman Archer. Mr. Becerra?
Mr. Becerra. Thank you, Mr. Chairman. And I appreciate that
our two colleagues have stayed for such a long time answering
so many questions, and I appreciate also their proposal and
their efforts to try to reform our tax code.
Mr. Jefferson raised some of the questions I was going to
ask, so let me just continue along those lines.
Inherent in your discussion is the fact that we have
embedded in the cost of items that we currently sell income tax
rates--or the income tax that we pay as individuals, other
taxes such as the payroll tax, and that by eliminating those
taxes and placing it all under a sales tax, we can have at
least a simpler, cleaner understanding of what our tax really
is. So we take that $200,000 home. Under your legislation there
would be a tax of $60,000 on that home that could be spread
over the life of a mortgage in terms of the paying of that tax.
My understanding from what you are saying as well is that
because we are now eliminating income taxes, payroll taxes, all
other forms of taxes, those embedded taxes now being
eliminated, we can now actually reduce the cost of items that
we purchase, so, therefore----
Mr. Linder. And we think the market will do that. We think
that $200,000 home will cost about $140,000 to build.
Mr. Becerra. So you are saying it will cost about $140,000
to build, so, therefore, you are actually saving a little bit.
So even though you are paying a tax, your cost really won't be
much different from what it was before.
Mr. Linder. But you are going to be paying for it with your
whole paycheck. If you are the lowest-income earner right now
in a rental unit with a 15 percent withholding level and 7.65
percent your share of the payroll tax, you are going to get
tomorrow a 30 percent increase in take-home pay. Most people
who buy homes, the first consideration they have in going to
the mortgage lender is how much of your income--how much take-
home pay do you have? Can you afford to make the payment? And
you are going to have an increase in take-home pay.
Mr. Becerra. Your proposal would try to put more money in
people's pockets at the beginning.
Mr. Linder. That is correct.
Mr. Becerra. A concern I have, though, is that if you are
saying that the cost of that new home will be $140,000 instead
of the $200,000 now, then for someone to sell that home, a home
builder to sell that home, you would have to sell that at
$140,000, when before this tax may have been in place, someone
would have purchased the neighboring home at $200,000. But now
the home is selling for $140,000. How do you tell the neighbor
that purchased the home for $200,000 under the old system that
now his home is really valued at $140,000 because the neighbor
next door bought it at $140,000?
It seems to me that what you have told all the neighbors is
the value of your homes has just dropped quite a bit.
Mr. Peterson. Well, no, because under our plan, one of the
principles is that things are only taxed once. So we only tax
new property. So that home next door is not taxed when it is
sold.
Mr. Becerra. So do you mean to tell me that someone else
will now purchase the next year the neighbor's home that cost
the neighbor $200,000 at $140,000?
Mr. Peterson. Well, no, because if it was a new home, the
tax would be added on to it. It would be back up to $200,000.
So you would be in the same position as you were with a used
home.
Mr. Becerra. So let's take this scenario. The year 2000 a
home was built, and under our current system, the homeowner
purchased it for $200,000. The year 2001 we go into your new
tax system, and you are saying that same home will really cost
about $140,000. The neighbor would buy that new home next
door--a purchaser would buy that home next door for $140,000.
Mr. Linder. Plus taxes----
Mr. Becerra. Plus the tax. Plus the tax.
Mr. Peterson. $60,000.
Mr. Becerra. $60,000. The neighbor that bought the home for
$200,000 in the year 2000 now wishes to try to sell. I am a
purchaser seeking a home in that neighborhood. I look at the
home that cost $140,000 plus the tax, but the purchase price is
listed as $140,000, and I now look at the homeowner who
purchased the home for $200,000 in the year 2000, that
homeowner is not going to sell it for $140,000. I am probably
not going to be willing to pay----
Mr. Linder. First of all, both of these houses have tax
costs in them. One is visible and the other is invisible. But
they are both going to wind up costing about the same.
Mr. Becerra. Yes, but--and you may be right that it may be
invisible, but the prices are not invisible to people shopping
for homes, and I have a difficult time understanding how anyone
as a neighbor is going to want to see a $60,000 reduction in
the value of their home and someone else is going to, as a
purchaser, be willing to shop for a home that is priced at
$60,000 more than what someone else bought the home.
Mr. Peterson. As someone who has spent 20 years advising
people and spending most of my life figuring out how to get
around the tax code, I can tell you what is going to happen
with this. Used houses will become very popular for a while
because they are not taxed. That is the psychology of the
American people. If they can find something that they can buy
and not pay the tax, they are going to just gravitate toward
that. So I think you are going to actually see the used houses
become more valuable for a while. Eventually it is going to
sort out as the system goes into effect.
Mr. Becerra. And, you know, we would have to roll the dice
on that, but I think the same problems you see with real estate
you would see with funeral services. You are going to tax
people to go bury their deceased relatives; doctors' services,
which were discussed; prescription drugs, a 30 percent tax on
prescription drugs for elderly who are right now on fixed
incomes; nursing homes; the Internet, which we here have agreed
should not be taxed for at least a few years until we figure
out what, if anything, we should do. Somehow we are going to
have a total change in mind-set, and then we are still rolling
the dice.
I thank you for all your efforts and your time, and, Mr.
Chairman, I thank you also for the indulgence on the time.
Chairman Archer. Ms. Thurman will inquire.
Mrs. Thurman. Thank you, Mr. Chairman.
Just to reiterate the comments by my colleagues, we do
appreciate the work that you have put into this. I am probably
one of the few members other than--well, I may be one of the
only members here that has had to deal with a service tax ever
before through the State of Florida when Governor Martinez was
Governor and tried to impose a service tax on the State of
Florida and the residents. And I have to tell you it was pretty
nasty, very nasty, and it was only at 6 percent. But what it
was basically doing was putting a sales tax on services, on
everything that was defined through the Federal SIC codes. So
it became a rather--it actually ended up being fairly
embarrassing because it ended up being repealed within about a
6-month period of time.
But in saying that, there are a couple of things I would
like to ask about. Florida is also one of those States that
does not have a State income tax, although State income taxes
would be piggybacked somewhat on our income tax. So even though
yours may be 30 percent or 60 percent--whoever's numbers you
agree with--what happens to a State if their income tax is no
longer available to them? I mean, replacing it with a sales
tax, property taxes?
Mr. Peterson. Well, I think that, you know, first of all, I
was in the State legislature in Minnesota when we tried to tax
services, so I have been through that. But the thing that you
need to understand is that those same people that are going to
be collecting this tax are paying a huge income tax, corporate
income tax, payroll tax burden, and I think a lot of them would
be willing to have their services taxed with the sales tax if
they can get rid of that other part of the system. So that is a
new part of the equation that was not there, you know, when we
were just going to put the sales tax on top of what is already
there.
But in the case of the States that have income tax, I think
it is unlikely that any State will be able to maintain an
income tax if we don't have a Federal income tax, and I think
that is a good thing. And I think what will happen is you will
see States piggybacking onto our sales tax system.
For example, in Minnesota, we exempt food, clothing,
medicine, you know, all of those kind of things. And because of
that, we have to have a 6.5 percent sales tax. If we taxed
everything, like we are doing in our bill, we could drop that
to 2 percent and raise the same amount of money.
So I think you are going to see States piggyback onto this
Federal system, be able to drop their rates, and still collect
more money than they are collecting now.
Mrs. Thurman. How do they piggyback onto this system? I am
not sure that I understand that.
Mr. Peterson. Well, because your merchant is going to
charge you on your Federal sales tax, you know, 30 percent,
whatever it is. So the State will just add on another 6
percent, and then they will get their revenue based on the same
taxable sales as the Federal, and they just piggyback right on
and it makes it simple.
Mr. Linder. Let me make a comment on that, Mrs. Thurman. We
have had Governors tell us that they would love to see this
because they would eliminate all their exemptions and
exclusions, tax everything equally just like ours does, and it
is much easier for them to administer and oversee. We are
making the retailers be cops today. They are picking out who
gets taxed and who doesn't, and we shouldn't ask that of our
retailers. They should tax everything the same.
I practiced dentistry. Why should my profession be
privileged to operate in Georgia and not have pay to have a tax
when the neighbor who is a jeweler has to collect the tax? So
we are operating under a principle that no industry should be
favored over another industry, no business section should be
favored over another. Everybody should pay equally the same
because they are all serving consumers.
Mrs. Thurman. Well, but the business is not paying the tax.
Mr. Linder. That is correct.
Mrs. Thurman. The customer is paying the tax. You can't say
that it is a privilege by the business.
Mr. Linder. It is a privilege not to have to collect it and
turn it in.
Mrs. Thurman. However, in saying that, I mean, if I look at
the constituency that I represent of about--you know, the
second poorest district, maybe just above that poverty line but
still one of the poorest districts, and a very old district. I
mean, the three or four things that they have to depend on,
which has already been mentioned: housing, food, medicine,
going to the doctor. And, you know, what you are saying to
them--and they are not necessarily paying or receiving or
paying a payroll tax or doing any of those kinds of things. For
them, what benefit is this to them?
Mr. Linder. Well, there are two benefits. The first one is
we are going to drive the embedded cost of the IRS out of those
things that they are currently paying now.
Mrs. Thurman. But is there an enforcement mechanism in this
bill to make sure that those things drop?
Mr. Linder. No, we actually trust the market. We actually
trust the free market system to do that.
But, secondly, they are going to have a rebate at the
beginning of every month that is going to totally rebate the
tax consequences of purchasing the necessities, which the HHS
determines every year----
Mrs. Thurman. For everybody?
Mr. Linder. For everybody. We don't need an agency
determining who deserves it and who doesn't, because then we
are back in the income business. Every household will get a
rebate check at the beginning of every month that will totally
rebate the tax consequences of spending up to the poverty line.
For a household of five, that is about $25,000. Their check of
about $500 a month would totally rebate the tax consequences of
spending up to that. So we not only drive the current 22
percent embedded cost of the IRS out of the purchase of milk
and bread, but we also add a check to that so they don't pay
the 23 percent sales tax on it.
Mrs. Thurman. So who is going to pay that difference? I
mean, somewhere along the line throughout this----
Mr. Linder. Who is going to pay the check?
Mrs. Thurman. Well, no. I mean, if somebody is not paying
and it is above this--I mean, who gets squeezed in this?
Mr. Linder. Actually, the consumption base is a very
consistent base over the last 40 or 50 years. Even in downturns
of the economy, we have seldom had a turndown of more than 3
percent. So the consumption base is a far more steady predictor
of revenues than is the income base.
Now, let me tell you who is going to get hurt the most: the
guy who is worth $300 or $400 million and he has got all his
money in tax-free municipals. He is going to have to pay taxes
for a change.
Mr. Peterson. Plus the spending base is 20 percent higher
than the income base. People spend 20 percent more than they
report in income. So it is a higher base to start with.
Mrs. Thurman. But I would imagine it also depends on what
you are spending on and what grouping you are in as to your
needs.
Mr. Peterson. Yes. But, again, you know, most seniors, a
lot of them have their homes paid for.
Mrs. Thurman. Sure.
Mr. Peterson. So that is not going to be an issue. And I
think with most seniors the amount that we have in here for the
poverty level spending is going to cover their drugs and food
and clothing, because most seniors are not spending a lot of
money on clothing either, probably.
So, you know, it is going to vary between people, but, I
mean, generally, I have had seniors--I have had town meetings
and talked this through with seniors. And once they understand
it, you know, I think most of them think it is a good thing,
not so much for them but for their kids, because what most
seniors are concerned about is that their kids or grandkids get
a chance to make it in this world, and this takes the burden
off of them. You know, they have no taxes on their payroll.
They get to keep their whole check, and they decide whether
they are going to spend it and pay the tax or whether they are
going to save it and start a business or whatever, which I
think is a better way.
Chairman Archer. The gentle lady's time has expired.
Mrs. Thurman. Thank you.
Chairman Archer. Mr. Doggett?
Mr. Doggett. Thank you, Mr. Chairman.
Mr. Linder, do I understand that the idea of this
legislation is to apply it to all forms of commerce with one
simple rate?
Mr. Linder. All forms of personal consumption.
Mr. Doggett. All forms of personal consumption. So that
would include any and all purchases that are made through
electronic commerce over the Internet?
Mr. Linder. Yes.
Mr. Doggett. And I had thought prior to today that there
were not any individuals in the Congress that were advocating
using electronic commerce as a source of Federal revenues. But
do I understand that it is the objective of you and all the
supporters of this measure to rely on electronic commerce, as
well as other forms of commerce, as a Federal revenue source?
Mr. Linder. Yes. You were not here when I made the point. I
would like to make it again. We think Government should be
neutral in respect of competition between businesses, and it
ought not give a 6 or 7 percent disadvantage to the fellow down
the street because he is selling it door to door instead of
over the Internet.
I have said for some time that in respect of being neutral,
Internet commerce should be taxed, anyway. I bought a Gateway
computer just recently over the Internet, and I was taxed on
it. And the reason I was taxed on it is because Gateway has a
store in my district.
Mr. Doggett. And there may well be good arguments for that
point of view. But even those who have held that point of view
in the past, I have not heard anyone else advocating that, in
addition to State and local taxes, we should use the Internet
and electronic commerce as a major Federal revenue source.
Indeed, as I understand, under your proposal, almost the
exclusive Federal revenue source would be to rely on taxation
of all forms of consumption, including all consumption through
the Internet.
Mr. Linder. You understand the bill perfectly.
Mr. Doggett. Okay. And as far as the level of tax that you
will impose for the Federal Government on electronic commerce
and other kinds of commerce, what is the level that you think
will be necessary in order to fulfill the objectives of revenue
neutrality?
Mr. Linder. Since we are replacing income tax, which is
tax-inclusive of what you earn, the inclusive basis is 23
percent of what you spend. If you treat it as a sales tax, as a
tax-exclusive rate, it would be 29.9 percent.
Mr. Doggett. So under your--it would be what, now?
Mr. Linder. 29.9 percent.
Mr. Doggett. Under your best-case scenario as a sponsor of
this legislation, then it would be 29, almost 30 percent that
would be imposed now for the first time as a Federal revenue
source on electronic commerce along with these other sources.
To an Internet start-up company that is not earning any
revenues at present, in fact, is having losses, this is a real
change in their tax situation, isn't it? They are not paying--
--
Mr. Linder. No, actually not. Actually not.
Mr. Doggett.--taxes now. Now they will be involved.
Mr. Linder. No. They only collect the tax. The consumer
pays the tax.
Mr. Doggett. I see. But if there is no income tax being
imposed on many of these Internet start-ups, they don't have
any tax to pass on to their consumers at present, do they?
Mr. Linder. They are paying the payroll tax. They are
paying it right now.
Mr. Doggett. All right. And I want to have some discussion
about the payroll tax with you as well. But you do see the more
we rely on electronic commerce, you feel, perhaps contrary to
the attitude of those who supported the Internet Tax Freedom
Act, that we should look at electronic commerce as a major
source of Federal revenue.
Mr. Linder. I think we should treat it the same as the
fellow down the street. But let me repeat that the bill that we
passed to delay taxation on the Internet has nothing to do with
sales taxes. You can collect sales taxes on the Internet today
if the local community chooses to do that. It is only the
access charges we have the moratorium on.
Mr. Doggett. Well, there is some dispute about the Internet
Tax Freedom Act and what it does and does not do. But it is
pretty clear that Governor Gilmore is seeking a tax-free zone
on the Internet----
Mr. Linder. Yes, he is.
Mr. Doggett.--to the exclusion of any sales taxes, and you
obviously disagree with him in his approach and feel that we
should apply a sales tax not only for the States but for the
Federal Government on all this kind of commerce, just as you
would to non-Internet commerce.
Mr. Linder. That is exactly correct. I think the Government
ought to be neutral.
Mr. Doggett. Now, with reference to the payroll tax, if I
might ask you, Mr. Peterson, about that. There are many
constituents that I have had--and I am sure each of you as
well--who have always viewed Social Security as a little
different from other types of Government programs. In fact, I
have had even a few who have said let's get the Government out
of Social Security. And that is based in large measure on the
feeling out there that people pay into Social Security as a
form of public or social insurance and that they have a stake
in Social Security and preserving Social Security as a result
of their own payments--much like premiums into a private
insurance program.
Isn't there a danger that if we eliminate entirely those
kind of payments and rely exclusively on general revenue to
finance Social Security that we will undermine that
relationship between people and Social Security and perhaps
permit those who have never supported Social Security to
undermine and destroy Social Security?
Mr. Peterson. Well, I guess you could make that argument,
but I think a bigger concern is that down the road they are
projecting we are going to have 100 percent more people on
Social Security and only 17 percent more people working.
Now, I would argue that if we don't change this system, we
have an unsustainable situation because, as you know, we have a
pay-as-you-go system. And so, you know, if you look at that,
you are talking about a payroll tax of 30 percent. And I think
that is a lot bigger danger to the system than what we are
talking about here.
So I would argue that one of the best things we can do for
Social Security and Medicare is to change the way we raise this
money. Instead of basing it on employment, which is diminishing
in relation to the people that are retired, base it on what
people spend. I think that is a much better way to do it.
And this whole idea that somehow or another 7.65 percent or
15.3 percent equates into exactly what the Medicare and Social
Security should be is not true. We have only set those rates to
cover what we projected in the future was going to be the needs
of the system, which is not necessarily related to what we are
actually paying people.
My grandfather retired in the 1950s. He paid in like $2,000
and lived to be 90 years old and drew out hundreds of thousands
of dollars. And we have all kinds of examples of that.
So, you know, I understand where you are coming from, and
there has been a lot of rhetoric that has backed everybody into
this corner. But the truth of the matter is this is a pay-as-
you-go system, and it is going to fall apart.
Mr. Doggett. I thank you for your response.
Chairman Archer. The gentleman's time has expired--has long
since expired.
The Chair believes that it probably would be wise for the
committee to stand in recess for about 45 minutes, and,
gentlemen, all of the members have inquired of you, so you are
excused. And when we return, we will have our first panel up as
witnesses.
Mr. Linder. Thank you, Mr. Chairman.
Mr. Peterson. Thank you.
[Recess.]
Chairman Archer. The committee is not going to come to
order, but just for notifying those who are here, those two
buzzers mean we have a vote on the floor, and we will go vote,
and when we come back, whatever members are here, we will
proceed with the hearing. But we will continue to be in recess
until we return from this vote.
[Recess.]
Chairman Archer. The committee will come to order.
The Chair invites the next witness panel to come have seats
at the witness table: Mr. Linbeck, Mr. McCracken, Mr. Rooth,
Mr. Kouplen, and Mr. Martin.
Mr. Linbeck, if you would be our lead-off witness, and I
would ask each of you gentlemen if you will identify yourselves
for the record before you commence your testimony. We will have
that available. And, Mr. Linbeck, welcome to the committee. In
fact, welcome to all of you. And, Mr. Linbeck, if you are
ready, you may commence.
STATEMENT OF LEO E. LINBECK, JR., CHAIRMAN, LINBECK
CORPORATION, HOUSTON, TEXAS, AND VOLUNTARY CHAIRMAN, AMERICANS
FOR FAIR TAXATION, HOUSTON, TEXAS
Mr. Linbeck. Thank you very much, Mr. Chairman.
My name is Leo Linbeck. I am from Houston, Texas. I am
chairman of Linbeck Corporation, a family-owned business
engaged in the construction industry. I am also serving as
voluntary chairman of Americans for Fair Taxation.
Americans for Fair Taxation was founded about 4 years ago
for the purpose of doing research, both market and academic,
into what could be an appropriate replacement system for the
current income tax system. We devoted considerable time and
resources in going to the consumer, the taxpayer, and asking
them what it is they value about the current system and what it
is they dislike about the current system and what they would
believe to be an appropriate body of contents to be embedded in
a new tax system, in a replacement tax system.
This took about 3 and a half years and it engaged an
iterative process out of which we learned from the consumer
what it is they valued, and then we asked the academic
community to give us their analysis as to whether or not what
we learned in the market research was economically efficacious.
After having done that for the period of time I described,
about 3 to 3 and a half years, we then took what we considered
to be the product that had been gleaned from that research and
did market testing. And we went to three cities in the first
instance--Bakersfield, California, Traverse City, Michigan, and
Charleston, South Carolina--and did testing to determine if
people know about the system, what would their attitude be in
respect thereto, and we found that their attitude changed 21
points, which we were told by experts, of which I am not one,
that is a significant movement in attitude.
We then tested the system in 31 different markets to
discern if people would, in fact, when they learned about it,
want to become involved in furthering the interest of that
particular system. And from that exercise we learned that they
were very interested in doing that to the extent that in a 3-
week period we generated approximately 200,000 phone calls and
hits on the website seeking additional information.
We then did the third level of testing to determine if when
people knew about it and they were informed enough to become
members of Americans for Fair Taxation, would they, in fact,
contact their elected Representative to make known to their
Representative their wish to bring into law the Fair Tax. We
were very pleased with the results we generated from that
effort, the results of which were very, very significant. A
Senator from New York received over 12,000 phone calls in 2
weeks, which he reported to me was an extraordinary response.
That is basically the background. It is an effort
undertaken in the private sector exclusively. There were three
of us at the outset who embarked on that research journey, and
we are, as I said, private citizens. We are involved in
business, civic, and charitable activities. But none of us are
experts in the field of taxation.
What we learned at the end of the day is that there are
four essential elements to the Fair Tax. Number one is that
when people understand that you eliminate the sales tax, that
is by far the most important factor in garnering their support.
We learned, and did not know at the outset, that a very small
percentage of people itemize, less than 30 percent of the
taxpayers on average itemize. And for the person who works for
wages, we learned that approximately 60 percent of that non-
itemizing group, the payroll tax is the largest tax. And we
found that when people understood that the payroll tax would
one of the elements of the existing system that would be
eliminated, it greatly enhanced their enthusiasm for the total
replacement of the income tax system.
The second most important feature is the rebate. The rebate
is framed in a manner that permits a family to receive in
advance a rebate equal to the amount of tax that will be due in
that month in the purchase of essential goods and services. We
examined in our research a variety of ways in which to deal
with the problem of the regressivity that is perceived to be
embedded in a sales tax, and found that a universal rebate on
essential goods and services was the most efficient.
The third element that is most important in the hierarchy
of interest is that there be no exceptions and no exclusions.
People are very, very concerned about the complexity of the
system they wish to replace.
And, finally, the need for a constitutional amendment to be
certain that there is not both an income tax and a sales tax.
Mr. Chairman, we appreciate the chance to be here with you
today. We look forward to any questions, and we urge the
Committee on Ways and Means to favorably consider the Fair Tax
and move it on the track after hearings to a vote on the floor.
Thank you very much, sir.
[The prepared statement follows:]
STATEMENT OF LEO E. LINBECK, JR., CHAIRMAN, LINBECK CORPORATION,
HOUSTON, TEXAS AND VOLUNTARY CHAIRMAN, AMERICANS FOR FAIR TAXATION,
HOUSTON, TEXAS
I would like to thank you, Mr. Chairman and members of the
committee for the opportunity to testify before your committee
on replacing the current tax system. I am the Chairman of
Linbeck Corporation and voluntary Chairman of Americans for
Fair Taxation (AFT). AFT is a grass roots citizens
organization, based in Houston Texas, dedicated to replacing
the current tax system with the FairTax. I am testifying today
on behalf of AFT.
The FairTax
The FairTax was introduced on a bi-partisan basis by
Representatives John Linder and Collin Peterson during the
first session of this Congress. The FairTax will repeal
individual income taxes, corporate income taxes, all payroll
taxes (including Social Security, Medicare and self-employment
taxes) and the estate and gift tax. It would replace these
taxes with a 23 percent national retail sales tax on all goods
and services sold to consumers.
Individuals will no longer file tax returns. Businesses
will collect and remit the sales tax in a manner similar to
that in 45 states and the District of Columbia.
The FairTax is a tax on final consumption. Business to
business transactions will not be taxed since those goods and
services will be taxed when the goods and services into which
they are incorporated are finally sold to consumers. Education
and training expenses will be treated as an investment in human
capital and not taxed. Exports will not be taxed. Imported
goods will be taxed when they are sold at retail in the U.S.
The FairTax is Progressive
Unlike the present tax system which taxes many poor people,
the FairTax will literally untax every poor person in America.
This is because the FairTax will provide every household in
America with a rebate of sales tax paid on necessities. Thus,
the FairTax is progressive and every family is protected from
tax on essential goods and services. Because of the rebate,
those below the poverty line will have negative effective tax
rates and lower middle income families will enjoy low effective
tax rates. The table below shows the annual allowances and
rebate amounts.
Fair Tax Rebate Amounts for Calendar Year 2000
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Single Person Single Person Single Person Married Couple Married Couple Married Couple
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Family Size HHS Poverty Level (1)Fair Tax Annual Annual Rebate Monthly Rebate Fair Tax Annual Annual Rebate Monthly Rebate
Consumption Allowance Consumption Allowance
(Married Couple)
1 $8,350 $8,350 $1,921 $160 $8,350 $1,921 $160
2 $11,250 $11,250 $2,588 $216 $16,700 $3,841 $320
3 $14,150 $14,150 $3,255 $271 $19,600 $4,508 $376
4 $17,050 $17,050 $3,922 $327 $22,500 $5,175 $431
5 $19,950 $19,950 $4,589 $382 $25,400 $5,842 $487
6 $22,850 $22,850 $5,256 $438 $28,300 $6,509 $542
7 $25,750 $25,750 $5,923 $494 $31,200 $7,176 $598
8 $28,650 $28,650 $6,590 $549 $34,100 $7,843 $654
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
A(1) Federal Register: February 15, 2000 (Volume 65, Number 31, Pages 7555-7557).
The rebate will be paid monthly in advance. The total
annual rebate amount will be equal to the sales tax rate times
the federal poverty level. In addition, because the federal
poverty level for a two person household is not twice as high
as that for one person, an additional amount will be provided
in the case of married couples to prevent any marriage penalty.
The FairTax effective tax rates for families of four at
various consumption levels are shown in the figure below.
[GRAPHIC] [TIFF OMITTED] T1879.001
A family of four, for example, could spend $22,500 per year
free of tax because they will have received over the course of
the year rebates totaling $5,175. $5,175 is the amount of sales
tax paid on $22,500 in expenditures. A family spending $45,000
per year will effectively pay tax on only half of their
spending and, therefore, have an effective tax rate of 11% or
half the FairTax rate.
It would be a mistake to emulate the states when they
attempt to achieve progressivity by exempting various
categories of goods or services from tax. First, this does not
achieve the advertised goal. When food is exempted, for
example, not only hamburger is exempted but also filet mignon;
not only macaroni and cheese is exempted but also caviar and
lobster. In fact, research indicates that 60 percent of the
gain from such exemptions goes to the top 40 percent of
taxpayers. In addition, these exemptions add complexity to the
law as lines are necessarily drawn. Moreover, one set of
exemptions will inevitably lead to lobbying to exempt other
products. Finally, exempting particular goods or services leads
to higher tax rates on those that remain taxable which is
economically distorting and inefficient as well as unfair to
those companies and workers in the sector that remains taxable.
Administration
The FairTax affords state governments the opportunity to
administer the FairTax within their states in return for a fee.
The fee will be equal to < of one percent of the revenue
collected. Alternatively, the state could contract with another
state or simply elect for the federal government to collect the
tax directly. In our view, smoother administration and fewer
start-up difficulties will result if the sales tax is
administered by civil servants that have years of experience
administering a sales tax.
Americans for Fair Taxation (AFT)
AFT worked hard to develop the FairTax. We engaged economic
researchers at leading universities throughout the country. We
engaged professors of law. We conducted focus group research
with demographically diverse groups of citizens in many
different geographic locations to determine what attributes the
American people wanted in a tax system. The result of these
efforts was the FairTax.
We have now begun the process of bringing the FairTax to
the attention of the public. AFT now has over 250,000 members.
AFT's grass roots support is growing every day. We aim to soon
have an AFT chapter in every State and Congressional district
in the country.
Economic Impact of the FairTax
The FairTax will have a dramatic positive impact on the
standard of living of the American people and lead to higher
rates of economic growth. The current tax system punishes
people who are trying to improve the financial position of
their families by working, saving or investing. It is a huge
barrier to upward mobility. The FairTax will stop the punitive
taxation of work inherent in the income and payroll tax and end
the multiple taxation of savings and investment. The FairTax
will end the taxation of investment in education.
Instead it will tax consumption. It has the broadest
possible consumption base. Therefore, the FairTax has the
lowest possible marginal tax rate in a consumption tax that
protects the public from sales tax on expenditures to purchase
essential goods and service.
Economists anticipate the FairTax will lead to much higher
levels of savings and investment which in turn will lead to
greater productivity and output. Work by Harvard economist Dale
Jorgenson shows a quick 9 to 13 percent increase in the GDP.\1\
Similarly, Boston University economist Laurence Kotlikoff
predicts a 7 to 14 percent increase.\2\ The FairTax will
eliminate the present tax system's bias against savings and
investment. Thus, savings and investment will increase. A
larger capital stock means that people will have more capital
to work with embodying the latest technology and their
productivity will increase. Higher productivity, in turn, will
increase real wages.
---------------------------------------------------------------------------
\1\ Dale W. Jorgenson, Economic Impact of the National Retail Sales
Tax, National Tax Research Committee. See also, ``The Economic Impact
of Fundamental Taxing Consumption,'' Dale W. Jorgenson, Testimony
before the House Ways and Means Committee, March 27, 1996 and ``The
Economic Impact of Fundamental Tax Reform,'' Dale W. Jorgenson,
Testimony before the House Ways and Means Committee, June 6, 1995.
\2\ Laurence J. Kotlikoff, Replacing the U.S. Federal Tax System
with a Retail Sales Tax: Macroeconomic and Distributional Impacts,
National Tax Research Committee. See also, ``The Economic Impact of
Replacing Federal Income Taxes with a Sales Tax,'' Laurence J.
Kotlikoff, April 15, 1993, Cato Institute Policy Analysis.
---------------------------------------------------------------------------
Businesses, in the final analysis cannot pay wages higher
than the productivity of their workers warrants. If they do,
they will quickly go bankrupt. Thus, the key to increasing real
wages is higher productivity. The key to higher productivity is
two fold. Education and capital investment. The FairTax makes
both education and capital investment more attractive.
Education
The FairTax is the most education friendly of any tax
reform proposal and is much more supportive of education than
current law. The FairTax embodies the principle that
investments in people (human capital) and investments in things
(physical capital) should be treated comparably. The current
tax system, in stark contrast, treats education expenditures
very unfavorably.
Today, to pay $10,000 in college or private school tuition,
a typical middle class American must earn $15,540 looking only
at federal income taxes and the employee payroll tax.\3\ The
amount one must earn to pay the $10,000 is really more like
$20,120 once employer and state income taxes are taken into
account.\4\
---------------------------------------------------------------------------
\3\ $15,540 less 7.65 percent in employee Social Security ($1,189)
and Medicare payroll taxes less 28 percent in federal income taxes
($4,351) leaves $10,000.
\4\ Economists generally agree that the employer share of payroll
taxes is borne by the employee in the form of lower wages. This figure
assumes that employees bear the burden of the employer payroll tax and
that they are in a seven percent state and local income tax bracket.
$20,120 less $5,634 in income tax (28 percent), $3079 in payroll taxes
(15.3 percent) and $1,408 in state and local income taxes (7 percent)
leaves $10,000.
---------------------------------------------------------------------------
The FairTax does not tax education expenditures.\5\
Education can be paid for with pre-tax dollars. This is the
equivalent of making educational expense deductible against
both the income tax and payroll taxes today. Thus, under the
FairTax, a family will need to earn $10,000 to pay $10,000 in
tuition, making education much more affordable.\6\ The FairTax
makes education about half as expensive to American families
compared to today.
---------------------------------------------------------------------------
\5\ H.R. 2525 defines education and training to mean ``tuition for
primary, secondary, or postsecondary level education, and job related
training courses.'' It excludes ``room, board, sports activities,
recreational activities, hobbies, games, arts or crafts or cultural
activities.''
\6\ If the states kept their income taxes rather than replacing
them with a sales tax, then the family would need to earn $10,753,
about half of what they would need to earn today.
---------------------------------------------------------------------------
Education is the best means for the vast majority of people
to improve their economic position. It is the most reliable
means that people have to invest in themselves and improve
their earning potential. Yet the tax system today punishes
people who invest in education, virtually doubling its cost.
Only the FairTax would remove this impediment to upward
mobility. No other tax reform plan will do so.
The FairTax is More Fair than the Current Tax System
The FairTax is more fair than the present tax system.
Rather than holding people down by taxing them for working,
saving, investing or getting an education, the FairTax taxes
people when they consume for their own benefit above the
necessities of life. The FairTax eliminates special
preferences, credits and deductions for politically favored
interests. It treats everyone the same. It has no loopholes.
International Competitiveness
Under the FairTax, imported goods and domestically produced
goods will pay the same U.S. tax. This stands in stark contrast
to the present system, where U.S. companies and workers must
pay income tax and payroll taxes but foreign goods enter the
U.S. entirely free of any tax other than whatever modest
customs duties are levied.
The FairTax will, by its very nature, be border-
adjusted.\7\ Exports will not be taxed since they are not sold
at retail in the U.S, but imports will be taxed when sold at
retail in the U.S. or when brought into the U.S. by a
consumer.\8\
---------------------------------------------------------------------------
\7\ Border adjusted is a value added tax (VAT) term. Since VATs,
unlike the sales tax, impose a tax on all stages of production, a VAT
must rebate the tax on earlier stages of production when goods are
exported to achieve a zero tax rate on exports. This is called border
adjustment. Because a sales tax does not impose any tax on goods unless
sold at retail, there is no need for a border tax adjustment rebate.
\8\ As with domestically produced goods, imported capital goods and
other business purchases would not be taxed immediately. But the output
of goods produced by capital goods would ultimately be taxed when
consumption goods were produced and sold.
---------------------------------------------------------------------------
A national sales tax will comply with World Trade
Organization (WTO) rules. WTO is the successor to the General
Agreement for Tariffs and Trade (GATT). Under WTO rules, an
indirect tax may be border adjusted while a direct tax may
not.\9\ Since a sales tax is indisputably an indirect tax, this
border adjustment feature will pose no difficulty. Foreign
value added taxes, also indirect taxes, are typically border
adjusted. Income taxes are direct taxes and may not be border
adjusted.\10\ Many on this committee may find this aspect of a
national sales tax of particular interest since the WTO just
found the Foreign Sales Corporation (FSC) export incentives to
be a violation of WTO rules.
---------------------------------------------------------------------------
\9\ See Agreement on Subsidies and Countervailing Measures, Annex
1.
\10\ The status of the flat tax, which is a subtraction method
value added tax but administered like an income tax, is unclear under
WTO rules but it seems highly likely that it would be deemed a direct
tax given its similarity in appearance and administration to an income
tax.
---------------------------------------------------------------------------
U.S. businesses will be much less likely to locate their
plants overseas and foreign companies will come to the United
States. Americans will be employed building these new plants
and Americans will be employed in the new plants. America will
become the most attractive place in the developed world in
which to do business. We will attract more and higher paying
jobs.
The FairTax is less Intrusive
The FairTax will be less intrusive. Rather than having to
report almost every aspect of their lives to the federal
government, Americans will be relieved of such intrusions.
April 15th will be just another Spring day. The privacy of the
American people will be enhanced considerably when the FairTax
is enacted.
The income tax is collected with a heavy hand. In 1995, the
IRS assessed over 34 million civil penalties on American
taxpayers in an effort to force compliance with the tax system.
Of these, about 4.1 million were forgiven. The present system
requires that we inform on each other. Americans must provide
over one billion information returns to the IRS (primarily
1099s and W-2s). Under the FairTax, all of this would no longer
be necessary.
The FairTax respects the privacy rights of the American
people to a vastly greater degree than the income tax. No
longer will Americans have to report the details of their lives
to the federal government. No longer will they have to confess
to whom they gave money, where they earned money, what medical
problems they had and so forth.
The FairTax will reduce Evasion
Under the income tax, evasion is a major, continuing and
growing problem. Notwithstanding a much larger Internal Revenue
Service (IRS), more burdensome information reporting
requirements, increasing stiff and numerous penalties and a
host of legislative initiatives, the problem is getting worse.
Based on IRS figures, tax evasion has increased by 67 percent
during the past 11 years. As a percentage of Gross Domestic
Product (GDP), tax evasion has reached 2.0 percent compared to
1.6 percent in 1981. Taxes evaded continue to be in the range
of 22 to 23 percent of income taxes collected. These IRS
figures do not include taxes lost on illegal sources of income.
The tax gap now is about $200 billion.
Tax evasion will decline under the FairTax because the
chance of evaders being caught will increase and the incentive
to cheat will decline. The FairTax will reduce the number of
tax filers by roughly 90 percent. Thus, if enforcement
resources remain comparable, audit rates will rise. Moreover,
since the audits will be much simpler than current audits,
audit rates will rise still further. Therefore the chance of
evasion being detected will increase.
Since marginal tax rates are much lower under the FairTax
than under present law, especially for small businesses and
sole proprietorships where disproportionate evasion occurs
today, the benefit to cheating will be lower. Today, if a self-
employed taxpayer fails to report $1,000 they will benefit by
$433 ($280 because of the income tax and $153 due to the self-
employment tax). Under the FairTax, they would benefit by $230.
In short, the gains from evasion would decrease and the
potential costs of evasion from detection and enforcement would
increase. Thus, the amount of tax evasion can be expected to
decline markedly.
Compliance Costs will Fall
The FairTax is a simple tax. The administrative burdens
placed on businesses are much less. In fact, they are
comparable to tracking revenue for income tax purposes. There
will be no more alternative minimum tax, no more depreciation
schedules, no more complex employee benefit rules, no more
complex qualified account and pension rules, no more complex
income sourcing and expense allocation rules, no more foreign
tax credit, no more complex rules governing corporate
acquisitions, divisions and other reorganizations, no more
uniform capitalization requirements, no more withholding and
the list goes on. Businesses will simply need to keep track of
how much they sold to consumers.
Compliance costs will, therefore, fall under the FairTax.
Today, according to the Tax Foundation, we spend about $250
billion each year filling out forms, hiring tax lawyers,
accountants, benefits consultants, collecting information
needed only for tax purposes and the like. These unnecessary
costs amount to about $850 for every man, woman and child in
America. To the extent these costs are incurred by businesses,
they must be recovered and are embedded in the cost of
everything that we buy. The money we spend on unnecessary
compliance costs is money we might as well burn for all of the
good it does us. The Tax Foundation has estimated that
compliance costs would drop by about 90 percent under a
national sales tax.
The FairTax is Simple, Understandable and Transparent
The FairTax is simple, understandable and transparent.
People understand the FairTax. They don't understand the
present tax system. Even tax professionals don't understand the
present system. Money magazine, for instance, each year asks 50
CPAs to fill out a relatively straight forward middle class
family's tax return. Each year they get 50 or nearly 50 wrong
answers. Of course, the answers are only wrong if you believe
the magazine's tax advisors are better than the survey
participants. Today a huge proportion of the overall tax burden
is hidden from the ordinary taxpayers view. Under the FairTax,
people will for the first time actually understand their tax
burden and have confidence that their fellow citizens are
bearing their fair share.
The FairTax will help Charities
Charities will thrive as never before--for two reasons.
First, the FairTax provides the equivalent of a deduction, for
itemizers and non-itemizers alike, against both the income and
payroll tax. Remember, all the charitable deduction does is
allow someone to make their contribution from pre income tax
dollars (but after payroll tax dollars). The FairTax will
enable all Americans to give to their favorite charity free of
income tax, free of payroll tax and free of sales tax. Second,
total philanthropy as a percentage of GDP has held steady at
around 2 % for at least two decades. As people become more
prosperous, they give more to philanthropic causes. The FairTax
will enlarge the economy dramatically and will lead to a
corresponding increase in charitable giving.
Pre-Tax Prices will Decline
Costs are one of the primary determining factors for
prices. One of the costs that businesses must recover if they
are to stay in business is taxes. Dale Jorgenson of Harvard
University estimates that the income tax and payroll tax are
embedded in the price of goods and services to such an extent
that they raise prices by 20 to 30 percent. His results are
shown in the figure below. When these taxes are repealed by the
FairTax, costs will go down and competition will quickly drive
prices down 20 to 30 percent depending on the product. In
addition, although Dr. Jorgenson research did not consider
these effects, higher levels of investment will make the
economy more productive and the elimination of loopholes that
distort the economy will make it more efficient, These effects
will be seen both in the form of higher real wages and lower
prices. Moreover, lower compliance costs will reduce costs and
prices still further.
[GRAPHIC] [TIFF OMITTED] T1879.002
The FairTax helps Homeowners
Homeowners will do very well under the FairTax. Homeowners
will have the equivalent of a supercharged mortgage interest
deduction because under the FairTax mortgage interest can be
paid free of sales tax and free of income and payroll taxes. In
terms of the current system, it would be as if the mortgage
interest deduction was allowable against payroll taxes. In
addition, existing homeowners will be able to make their
principal payments with tax free dollars. Buyers of newly
constructed homes will have to pay sales tax, just as they must
pay for their house from after tax dollars today, but the
marginal tax rate is lower under the FairTax. In addition,
interest rates will fall by about 25 percent because lenders
will no longer have to charge a tax premium to make up for the
tax on interest income. Once interest is no longer taxable nor
deductible, interest rates will quickly fall toward the current
tax-exempt rate. Homeownership will be more affordable and
prospective homeowners will be able to save their downpayment
more quickly under the FairTax.
Financial Markets
The FairTax will increase the market value of long-term
financial assets such as stocks, real estate and non-callable
bonds. The price of those assets reflects the fact that the
future income stream of those assets will be taxed. When that
tax is removed, the future income stream will increase and
therefore the present discounted value of those future income
streams will increase as well. Thus, the market value of the
assets will increase considerably.
Conclusion
Support for the FairTax is growing rapidly. Once people
understand the FairTax and grasp all of the positive things it
would mean for them and for the country, they generally support
it. AFT will continue to bring the FairTax to the attention of
the public.
AFT looks forward to working with this committee to pass
the FairTax. It is in your power to move beyond the current
indefensible tax system and replace it with a tax system more
in keeping with what the public wants. We appreciate the
opportunity to present our views to you today. Thank you.
Chairman Archer. Thank you, Mr. Linbeck.
Mr. McCracken?
STATEMENT OF TODD McCRACKEN, PRESIDENT, NATIONAL SMALL BUSINESS
UNITED
Mr. McCracken. Mr. Chairman and members of the committee,
my name is Todd McCracken, and I am president of National Small
Business United, the Nation's oldest small business advocacy
organization.
NSBU was founded when the income was just 23 years old,
with only two pages in forms and several pages of instructions.
NSBU has not grown at the exponential rate of the income tax
laws, but we do now represent 65,000 businesses nationwide.
In 1997, our diverse bipartisan 32-member small business
board of trustees decided it was time for NSBU to take a hard
look at a new tax system rather than just continue to take easy
potshots at the system we have now. After a year-long process
in which the current system and various alternatives were held
up and examined from all sides, our initially skeptical board
finally selected the Fair Tax as the best possible system for
small businesses, without a single dissenting vote.
Why? At every stage of a business' life, it faces
significant tax obstacles. At the start-up level, savings are
taxed and start-up costs are not deductible, and capital
investments are made from after-tax dollars and then taxed
multiple times, when the income is earned and when the
underlying asset that generates that income stream is sold.
They are taxed when growing because the Government takes an
increasing share of income as more money is made. They are
taxed when exporting because U.S. taxes raise the price of our
goods relative to foreign goods. They are taxed when they add
jobs because our extraordinarily high payroll taxes increase
costs of hiring. Family businesses are discouraged because they
are taxed when they are sold or passed on.
I would like to call special attention to the current
payroll tax burden that small businesses and their employees
must endure. It is an enormous tax that receives relatively
little attention given the share of revenues it accounts for.
In fact, a survey by NSBU and Arthur Andersen found that small
businesses cite payroll taxes as their most significant tax
burden.
Payroll taxes, after all, must be paid whether a business
is making money or not, and it is a tax on workers, the
lifeblood of any small business.
Finally, we have the extraordinary complexity of the
current code. I would submit to you that the entrepreneurial
community is more vexed by the labyrinth that our system
creates than it is by the amount of taxes paid. We are the only
part of the taxpaying public that sees every aspect of the tax
system: tax withholding and filing, estate taxes and capital
gains taxes, among others.
Since the Fair Tax abolishes all Federal income, FICA,
estate, and capital gains taxes, it would allow small
businesses to prosper as never before in this country. The Fair
Tax would allow businesses to begin with savings put aside with
pre-tax dollars. It would allow them to grow unfettered by the
income tax and without an eye on the capital gains tax. It
would allow them to hire without discouragement from the
payroll tax. It would allow them to export, unfettered by
punitive American taxes on our exports.
It would allow them to make capital investments unfettered
by hidden costs in the capital assets. It would discontinue the
charade of taxing income multiple times. Most importantly, it
would repeal the self-employment and payroll taxes which are
the most despised by entrepreneurs.
Small business owners would have greater access to capital,
the lifeblood of a free economy. Small business owners would be
free to pass their businesses on to their children.
Compliance costs would diminish. Individuals not in
business would never have to file a tax return again, and
business returns would be vastly simpler. More than 7,000
incomprehensible sections of the Internal Revenue Code would be
exchanged for one simple question: How much is sold to
consumers? This question is asked of retailers in 45 States in
our Nation today. Ninety percent of our $250 billion annual
compliance bill would just disappear.
We are often asked why retailers should support this plan.
No single industry is more burdened by the multitude of State
and Federal tax laws than retailers. Retailers today are both
tax collectors and taxpayers. Under the Fair Tax, there will be
no more uniform inventory capitalization requirements, no more
complex Government rules on employee benefits and retirement
plans, no more tax deprecation schedules, no more tax rules
governing mergers and acquisitions, and no more international
tax provisions. Retailers will have ``found'' money in lower
compliance costs. Retailers will also receive an administration
fee for complying with the greatly simplified law.
It is for all these reasons that there is increasing
support for the Fair Tax among small businesses. In our most
recent survey, we found that a national sales tax had surpassed
a flat tax as the preferred form of tax reform among small
business owners. Even more interestingly, support for a sales
tax among retailers in the survey was almost a high as support
among manufacturers, though small retailers still gave the flat
tax their narrow support.
In conclusion, the Fair Tax would reinstate the novel
concept that Americans have a right to understand the law to
which they are subject. This would be a boon for small business
that quite often lack the legal and accounting staffs to be in
compliance with the tax code. It would enhance compliance costs
so honest taxpayers pay less.
After the process that we went through, we are confident
that as this committee understands the essential differences in
the proposal, you will favor the Fair Tax plan. We are
confident that the more you know about the Fair Tax, the more
you will support it.
We want to thank you for the ability to appear here today,
and especially want to thank you for holding these very
significant hearings. You can do nothing more profoundly
significant for the small business community and the entire
Nation than to continue to push forward with fundamental tax
reform.
[The prepared statement follows:]
Statement of Todd McCracken, President, National Small Business United
Mr. Chairman and Members of the Ways and Means Committee:
My name is Todd McCracken, and I am President of National
Small Business United (NSBU), the nation's oldest national
small business advocacy organization.
Mr. Chairman, NSBU was founded when the income tax was just
23 years old--with only two pages in forms and several pages of
instructions. NSBU has not grown at the exponential rate of the
income tax laws, but we now represent 65,000 businesses
nationwide. We represent the varied tapestry of the America's
entrepreneurs, from immigrants seeking a more fertile
environments in which to grow their dreams to family businesses
that have remained for generations. The average size of our
membership is 12 employees. We are nonpartisan. We do not ask
whether the policies we endorse are republican or democrat: we
ask whether the policies enable entrepreneurs to thrive.
NSBU applauds this Committee for having the courage to
explore the FairTax. In February, a national survey conducted
by American Express confirmed what NSBU already knew. The
survey showed that 74 percent of entrepreneurs consider tax
reform a top priority. But since the vast majority of Americans
share commons dislike for our present system, it is easier to
demagogue the current system than to reach consensus on what a
new and more ideal system should look like.
NSBU leads entrepreneurial organizations not only by
defining the principles on which tax reform should be based,
but lending our full support for a specific proposal: the
FairTax national sales tax plan. In 1997, our 32-member small
business Board of Trustees decided that it was time for NSBU to
take a hard look at a new tax system, rather than just
continuing to take easy pot-shots at the system we have now.
After a year-long process in which the current system and
various alternatives--various flat tax plans and other forms of
a sales tax among them--were held up and examined from all
sides, our initially skeptical Board finally selected the
FairTax as the best possible system for small businesses,
without a single dissenting vote. If you knew this diverse
group of independent-minded entrepreneurs like we do, you would
realize just how remarkable this vote was. After we all had a
chance to ask our questions and have them thoughtfully
answered, this decision, that many of us thought we could never
reach, suddenly seemed obvious.
We would like to explain to the committee why NSBU,
consisting of firms in all sectors, including service firms and
retailers, endorsed a national sales tax plan. We want to
contrast the FairTax with such plans as the flat tax and other
sales tax plans. And last, we want to suggest the next steps
this committee should take if it is serious about considering
reform.
The Current System: Fundamentally Broken
Discouraging Entrepreneurs at Every Level. Most
entrepreneurs--that is unless they make a career of selling tax
shelters--correctly see our system as punishing each step
towards the American dream. At every stage of a business' life,
it faces significant tax obstacles. At the start-up level
savings are taxed, and start-up costs are not deductible.
Capital investments are made from after-tax dollars and then
taxed multiple times, when the income is earned and when the
underlying asset that generates that income stream is sold.
They are taxed when growing because the government takes an
increasing share of income as more money is made. They are
taxed when exporting, because U.S. taxes raise the price of our
goods relative to foreign goods. They are taxed when they add
jobs, because our extraordinarily high payroll taxes increase
costs of hiring. Family businesses are discouraged because they
are taxed when they are sold. And finally, the owner gets to
meet the undertaker and the IRS on the same day as the
government effects a leveraged buy-out of the businesses.
The Burden of Payroll Taxes. But I think this committee is
certainly familiar with the current income tax code and the
many compliance obstacles it creates. So, I would like to call
special attention to the current payroll tax (primarily FICA)
burden that small businesses and their employees must endure.
It is an enormous tax that receives relatively little attention
given the share of revenues it accounts for. In fact, a survey
by NSBU and Arthur Andersen found that small businesses cite
payroll taxes as their most significant tax burden.
The U.S. has made a fundamental shift toward payroll taxes
in the last 30 years. In 1995, 38 percent of all federal
revenues came from payroll taxes, compared to just 14 percent
(of a lower tax bill) 40 years ago. From 1970 to 1990, business
received nine social security (FICA) tax increases totaling
60%, three unemployment (FUTA) increases totaling 94%, three
FUTA base increases totaling 133%, and 19 FICA base increases
totaling 677%.
At first glance, payroll taxes might seem to be an
equitable form of taxation. The unemployed are not taxed, and
larger businesses with more employees are taxed more than
smaller businesses with fewer employees. However, most small
businesses are much more labor intensive than their larger
counterparts. Payroll taxes cause these small businesses to be
taxed at a higher effective rate than larger, more capital-
intensive firms. Moreover, holders of corporations organized
under Subchapter ``S'' (which are almost always small) have
been forced to pay both sides of this tax, making for a
substantial tax increase.
Businesses must pay their payroll taxes whether or not they
make a profit. The fact that this huge tax must be paid
regardless of the financial condition of the company creates
substantial problems. First, it discourages new businesses.
Most new businesses lose money in their early days, and payroll
taxes amount to one more debt that must be somehow financed.
Second, it discourages employment. The only way that a business
in a financial bind can reduce payroll taxes is to reduce
payroll; this means fewer jobs or lower wages.
A payroll tax amounts to a tax on employment. Today,
businesses and their employees pay about 15% out of every wage
dollar (below the cap) in FICA taxes. Through this substantial
hike in the cost of hiring and working, the payroll tax
reverses the needed incentives in the American economy. Taxing
businesses for hiring an employee clearly discourages increased
employment, which is damaging to the unemployed, the business,
and the economy. And, of course, payroll taxes are the most
regressive taxes we have, where only earned income (as opposed
to investment income) is taxed, and only earned income up to a
certain, annually adjusted level is taxed.
Unnecessary Complexity. Small firms are accountable to a
protean system that is so complex simply because we choose to
tax savings and investment. We waste an estimated $3.70 in
compliance costs for every dollar we pay in taxes. We endure
the lion's share of the $250 billion in annual compliance
costs, when we cannot pass these essentially fixed costs on to
consumers as larger firms can. We endure the lion's share of
the more than 34 million civil penalties issued.
Our current tax system is certainly a testament to the
indomitable spirit of American entrepreneurs, but it is not
enlightened tax policy.
The FairTax: The Best System for Small Business
The FairTax is enlightened policy. Since the FairTax
abolishes all federal income, FICA, estate, and capital gains
taxes, it would allow small businesses to prosper as never
before in this country. By instituting a 23 percent tax on all
end-use goods and services, the FairTax would sweep away the
burdens of the current tax system and create a new dawn for
American entrepreneurship and economic growth.
The Fair Tax would allow businesses to begin with savings
put aside with pre-tax dollars. It would allow them to grow
unfettered by the income tax, and without an eye on the capital
gains tax. It would allow them to hire without discouragement
from the payroll tax. It would allow them to export, unfettered
by punitive American taxes on our exports. It would allow them
to make capital investments unfettered by hidden costs in the
capital assets. It would not penalize good years and bad by
implementing the best of income averaging, a zero rate of tax.
It would discontinue the charade of taxing income multiple
times. Most importantly, it would repeal the self-employment
taxes which are the most despised by entrepreneurs. The Fair
Tax would tax Americans on income, but only at the point that
they consume that income, not when they invest and save. Small
business owners would have greater access to capital, the life-
blood of a free economy. Small firm owners would be able to
pass their business on to their children.
Simplicity and Lower Compliance Costs. Compliance costs
would diminish. Individuals not in business would never have to
file a tax return again, and business returns would be vastly
simpler. More than 7,000 incomprehensible sections of the
Internal Revenue Code, would be exchanged for one simple
question: how much is sold to consumers? This question is asked
of retailers in 45 states of our Nation today, so the
additional burden on these businesses would be negligible.
Ninety percent of our $250 billion annual compliance bill would
disappear.
Greater Visibility and Understanding. As complexity
disappears, we would reinstate the novel concept that Americans
have a right to understand the law to which they are subject.
Moreover, they will immediately see and understand the tax
rates and any changes that occur. The mentality of ``Don't tax
you; don't tax me; tax that fellow behind the tree'' would be
gone. The current complexity of the code leaves most Americans,
rightly or wrongly, feeling that they bear an unfair share of
the tax burden. The poor believe that advantages must lie with
those who are more well-off. The wealthy see their high
marginal rates and eliminated deductions and feel singled out
by the tax system. And the middle class assume that credits for
the poor and loopholes for the wealthy mean that they alone
should the country's tax burden. While there are both fallacies
and accuracies in each group's assumptions, the unfortunate
side effect is a polarization of the country and a universal
feeling of victimization. And it should be clear to any
rational observer that this feeling leads to tax avoidance and
cheating on an unprecedented scale. If we can remove these hard
feelings about the tax code, we can markedly improve compliance
and give a boost to national comity at the same time.
The FairTax would do just that, by making visible the taxes
now buried in goods and services. We would have a uniform tax
for all the world to see and understand. How would the rich guy
avoid some taxes? Only by saving and investing, which helps us
all. But some day, he or his descendants will spend his
profits, and taxes will be collected. At the same time, those
less fortunate will receive a rebate lowering their total tax
bill and effective tax rate, even if they don't save a nickel.
This is a system all Americans can understand and be united
behind--and voluntarily pay. The tax system would achieve
greater enforceability with less intrusiveness. Today, more
than $200 billion in income taxes, over 20 percent of the total
collected, are not voluntarily paid.
Economic Growth. Almost every researcher who has examined the
FairTax have concluded that the U.S. will experience
significantly higher economic growth rates if this plan is
enacted. Specifically, Harvard's Dale Jorgenson predicted a
quick nine to thirteen percent increased in the GDP, while
Boston University's Laurence Kotlikoff predicts a seven to
fourteen percent increase. Essentially, this growth will happen
because the tax code will no longer discourage work,
investment, savings, and education. Even studies that start
with more pessimistic assumptions, like that by Nathan
Associates for the National Retail Institute, predict greater
long-term economic growth, though to a smaller degree than
others predict.
There are those, of course, who fear that the FairTax will
discourage consumption and thereby cause a drop in economic
growth. The FairTax is, after all, a tax on consumption, and we
always get less of whatever we tax (like work, savings,
investment, etc.). But there are several salient facts that
mitigate, even eliminate, this fear. First, institution of the
FairTax would mean that consumers have their entire paycheck to
spend, free of any tax withholdings or FICA payments. Consumers
would be able to spend this greater income on goods that cost
no less than they do currently, because economists tell us that
the elimination of taxes currently embedded in the price of
goods and services will cause that price to go down
dramatically. At the same time, the elimination of the tax on
interest income will cause interest rates to drop dramatically,
probably by about 25 percent. Taken together these two
consequences of the FairTax should actually have the effect of
increasing consumption.
But there are additional reasons why prices should fall and
thereby encourage additional consumption. Since the FairTax
will encourage savings and investment, greater investment
dollars will be available to improve the productivity of
American business, causing prices to drop still more. Greater
productivity is likely to lead to greater corporate profits,
which is likely to lead to improved stock market gains. The
last few years have proven what stock market gains can mean for
consumption and continuing economic growth. So, we have been
persuaded that these very appropriate concerns are nevertheless
unfounded.
Improved Work-Force. Any current survey of the small
business community will show finding and keeping qualified
workers is their greatest challenge. Businesses cannot find
enough workers with specific educational backgrounds, nor can
they find sufficient workers with broad-based educational
backgrounds. To further compound matters, most small businesses
cannot create and maintain their own education and training
initiatives the way some larger businesses can. The FairTax
comes to the rescue by essentially ``un-taxing'' education.
Currently, a middle class taxpayer must earn $15,540 (ignoring
state taxes) to pay $10,000 in tuition. Under the FairTax, only
$10,000 must be earned, because education is not taxed.
Improved International Trade Position. The current tax
system buries taxes in all sorts of goods and services. But
this becomes an especially big problem in the international
arena. These embedded taxes mean that American goods and
services are more expensive than they otherwise would be,
thereby hurting American exports. But it is even worse than
that. Many of our competitors impose a Value Added Tax (VAT),
which is rebated at the border. That means that we have foreign
goods coming into the U.S. which have no embedded taxes,
competing with domestic goods with very high embedded taxes.
The FairTax reverse this position, creating much greater
incentives for goods and services to be produced in the U.S.
and making those products much more competitive abroad.
Retailers Aided by FairTax. Why should retailers support
it? No single industry is more burdened by the multitude of
state and Federal tax laws than retailers. Retailers are today
both tax collectors and taxpayers. Under the FairTax, there
will be no more uniform inventory capitalization requirements,
no more complex government rules on employee benefits and
retirement plans, no more tax depreciation schedules, no more
tax rules governing mergers and acquisitions, and no more
international tax provisions. Retailers will have ``found''
money in lower compliance costs.
Under the FairTax retailers will also receive an
administration fee for complying with a greatly simplified law.
The FairTax actually compensates the industry for compliance
burdens. Moreover, the FairTax will encourage uniformity among
increasingly disparate state taxing schemes that have pitted
small retailers against large direct mailers. As we have seen
with state income taxes, states will face great pressure to
bring their system into line with the federal standard. The
FairTax could lead to a way out of the current stalemate on the
internet and sales taxes.
It is for all these reasons that there is increasing
support for the FairTax among small businesses. In the most
recent survey NSBU conducts with Arthur Andersen, we found that
a national sales tax had surpassed a flat tax as the preferred
form a tax reform among small business owners. Even more
interestingly, support for a sales tax among retailers in this
survey was almost as high as support among manufacturers,
though small retailers still gave the flat tax their narrow
support.
While respected economists haggle over the dimensions of
the economic benefits, they are unanimous in their view the
FairTax would greatly enhance economic performance by improving
the incentives for work and eliminating the current bias
against saving and investment. Even the National Retail
Institute's study by Nathan Associates shows that the economy
would be one to five percent larger under a sales tax than in
the absence of reform.
The FairTax Versus the Alternatives
The major alternative to a national sales tax is, of course
a flat tax. And, while a sales tax and a flat tax are both
improvements over the current system, and both are essentially
consumption-based taxes, the sales tax is clearly preferable to
small business for two key reasons.
The Flat Tax. First, a sales tax is vastly simpler to
administer than a flat tax. While a flat tax creates uniform
rates, it still leaves the question of determining income, and
still leaves business owners with the need to hire tax advisers
and accountants to sort through those remaining rules. And, of
course a flat tax leaves in place the requirement for
businesses to withhold and file taxes (of both payroll and wage
taxes) on behalf of their employees. This system is the source
of more civil penalties on small businesses than any other.
Second, a flat tax would have to leave in place the pillars
of the income tax system we have today: tax withholding, a
central enforcement agency, and the need to define and
determine taxable income. Given this scenario, it is not a
stretch to imagine that we could readily creep back to the same
system we have now. Congress decides to allow an additional
deduction or allowance for this or that. How to pay for it?
Let's increase the rate, but only for people above a certain
income level. Once the dam breaks, there is no turning back.
With a sales tax, the entire income infrastructure is
dismantled. It is very hard to conceive of it being easily
reconstructed; it has an inherent integrity that is much more
difficult to breach.
But not all sales taxes are created equal. The FairTax
holds special appeal for the small business community for two
reasons. First, it eliminates the payroll and self-employment
taxes that are the most burdensome on small businesses, and
which are easily the most regressive taxes this country has
ever imposed. This elimination both greatly helps small
business (we discussed the payroll tax burden at length above)
and makes the FairTax system much more progressive than
competing sales tax plans.
Second, a key pillar of the FairTax is its uniformity.
Rather than picking and choosing among end-use products to tax,
it taxes everything. Going down a different path, and exempting
certain goods or services from taxation would be very dangerous
and greatly diminish the support the FairTax has from the small
business community.
Conclusions
Defenders of the income tax system fondly quote Oliver
Wendell Holmes who said, ``taxes are what we pay for a
civilized society.'' But this phrase does not stoically
celebrate the 'income tax' per se and was made before the
income tax even existed. What Holmes should have added is that
a civilized society must also collect taxes in the most
civilized manner.
The income tax is the antithesis of a civilized system for
entrepreneurs. Unlike many unwise state sales taxes, the
FairTax would fully exempt any business inputs from taxation,
i.e. all business-to-business transaction would be free of tax.
In this way it would remove the mythology that businesses pay
taxes as opposed to their owners, employees or consumers. It
would make all taxes visible. It would convey the true cost of
government to every American on each purchase they make,
precluding government from raising taxes other than by changing
the rate for all. Quite simply, it would allow businesses to
keep the entire profit from their operation and transfer the
emphasis of taxation away from income-producing activities to
consumption.
The FairTax would reinstate the novel concept that
Americans have a right to understand the law to which they are
subject. This would be a boon for small businesses that quite
often lack the legal and accounting staffs necessary to be in
compliance with the tax code. It would enhance compliance so
honest taxpayers pay less.
Mr. Chairman, if we can get entrepreneurs who, by genetics
I suppose, are independent minded, to agree upon this plan,
than your committee can do so also. But in order to do so, you
must put aside politics and predilection. We are confident
that, as this Committee understands the essential differences
in the proposals, you will favor the FairTax plan. Now here is
what I ask of you.
First, this Committee must not consider its job done in one
hearing. These plans deserve further introspection. Hearings
should be conducted on all relevant topics affecting tax
reform. We are confident that more you know about the FairTax,
the more you will support it.
Second, the Joint Tax Committee and other institutions that
analyze distribution should change their means of portraying
the burden of consumption taxes. Why do we persist in scoring
taxation of savings and investment as a gain? Income is not
income until it is consumed. Why not present distributional
tables as an alternative on taxes paid over consumption?
Third, we urge all members of this committee to understand
the issues presented here. One of the reasons taxes have risen
in this nation is because so much is hidden from the consumers
on which all taxes ultimately fall. Do not fault the FairTax
because it makes these taxes visible.
We want to thank you for the ability to appear here today,
and we especially want to thank you for holding these very
significant hearings. You can do nothing more profoundly
significant for the small business community and the entire
nation, than to continue to push forward with fundamental tax
reform.
Chairman Archer. Thank you, Mr. McCracken.
Mr. Rooth?
STATEMENT OF SCOTT ROOTH, REALTOR, CASHIERS, NORTH CAROLINA,
CHAIRMAN, PUBLIC POLICY COORDINATING COMMITTEE, AND MEMBER, TAX
REFORM WORKING GROUP, NATIONAL ASSOCIATION OF REALTORS
Mr. Rooth. Mr. Chairman, members of the committee, my name
is Scott Rooth, and I am realtor from Cashiers, North Carolina.
I am here today on behalf of 760,000 members of the National
Association of Realtors, NAR. Currently, I serve as chairman of
the Public Policy Coordinating Committee and as a member of the
Tax Reform Working Group.
In the tax reform debate, NAR supports the goals of tax
reform and substantial simplification because, as self-employed
individuals, our members face significant compliance
challenges. We emphasize, however, that the tax rules that
apply to home ownership, especially since 1997, are among the
simplest to administer in the entire tax system. NAR continues
to aggressively oppose the flat tax, and as for today's
hearings, the National Association of Realtors has taken no
official position on H.R. 2525, the Fair Tax proposal advanced
by Americans for Fair Taxation. We neither oppose nor support
it at this time. We understand that we have been invited here
today to share some concerns that we might have and we have
identified to Mr. Linbeck.
Some may say that we are here today to protect a special
interest. Even if that is true, consider the magnitude of your
decisions about how to tax real estate in a new tax system.
Today, more than two-thirds of all Americans own their own
home. This is an all-time high. The fastest growing category of
homeowners is our minority population. Last year, 43 percent of
first-time home sales were to minorities and immigrants.
Individuals in every income class own homes. Notably,
lower-income families have a greater proportion of their net
worth tied up in the home. Federal Reserve data shows that even
at the $10,000 to $25,000 income range, 51 percent own their
own homes. Real estate is the most widely held asset in our
economy. Thus, real estate affects the largest number of
households and voters in this country.
NAR believes that changes to the tax system will inevitably
have a substantial impact on the value of those homes. We urge
you to be very careful in how you make decisions about the
taxation of homes and other real estate.
Depending upon how you do the computation, the Fair Tax
would impose a sales tax of either 23 or 30 percent on the
purchase of a new but not an existing home. NAR has grave
reservations about any sales tax plan that would tax the
purchase and sale of a home. We embrace and salute Chairman
Archer's publicly stated view about the consumption tax
systems, and he has clearly stated that the purchase of a home
should be treated as an investment and not be taxed.
NAR rejects any proposition that the purchase of a home
should trigger a tax. We believe taxing the sale makes housing
more expensive and makes it harder to afford. A tax of 23 to 30
percent, paid at the time of the sale, adds substantial costs
to an already expensive transaction. In today's market and
under today's tax laws, newly constructed housing is more
expensive than existing housing by a factor of approximately 20
percent. Under the Fair Tax model, the sales tax cost will fall
squarely on this higher cost of new housing.
To test our perceptions about sales tax on homes, we held
focus groups in three cities in this country. In one such focus
group in San Diego, our random sample pulled up one strong
supporter of a sales tax plan. But at the end of debate at the
end of the day, even that proponent was absolutely opposed to
any tax on homes. And I quote his final summation, ``A home is
what we are, it is what we work for.''
The Fair Tax imposes a sales tax on all consumer retail
services, as we have already heard today, everything from real
estate commissions to contract and document preparation,
termite inspections, appraisals, painting and fix-up
maintenance, legal advice, on and on, would be added on to the
cost of this transaction.
Rental income housing we have already heard referred to. We
are absolutely opposed to any tax on rental income housing as
it makes moving up to home ownership even more difficult.
One very attractive feature of the Fair Tax plan is that it
imposes Federal tax only once. This is a worthwhile objective.
The Fair Tax model relieves all businesses from paying any
payroll, income, or sales tax. Thus, investors in either
residential or commercial rental property would pay no sales
tax on their purchase of these income-producing properties.
Similarly, if a business occupied the building, these
businesses would not be required to pay tax, and this is a good
thing for our investment group of properties.
How do we get there from here? Ladies and gentlemen,
transition is the key in our business. The 1986 Tax Act was a
debacle in our industry. It was also a debacle that almost led
to the end of the savings and loan industry in this country. We
urge you to look very closely at the transition issue of this
bill.
Only in the last 2 to 3 years has investment real estate
regained its footing, and from 1988 to about 1992, even real
estate residential values fell. And because of this depression
in commercial real estate, the resulting tax credit crunch was
almost the end of our industry.
We thank you very much for allowing us to speak here today.
We look forward to addressing your questions, and thank you,
Mr. Chairman.
[The prepared statement follows:]
STATEMENT OF SCOTT ROOTH, REALTOR, CASHIERS, NORTH CAROLINA, CHAIRMAN,
PUBLIC POLICY COORDINATING COMMITTEE, AND MEMBER, TAX REFORM WORKING
GROUP, NATIONAL ASSOCIATION OF REALTORS
Mr. Chairman and members of the Committee. My name is Scott
Rooth. I am a Realtor from Cashiers, North Carolina. I appear
here today on behalf of the NATIONAL ASSOCIATION OF REALTORS...
(NAR) where I presently serve as Chairman of the Public Policy
Coordinating Committee and as a member of the Tax Reform
Working Group. NAR represents 760,000 real estate professionals
engaged in all aspects of the real estate business. About 80%
of our members are residential sales agents and brokers, and
about 20% are principally engaged in commercial brokerage,
leasing and management.
NAR and Tax Reform
Since 1995, NAR has been actively involved in the tax
reform debate. Our focus then was on the flat tax. NAR
continues to aggressively oppose the flat tax, because it would
repeal the mortgage interest deduction (MID) and the deduction
for state and local property taxes. We believe, and economic
studies confirm, that eliminating the MID causes the value of
homes to drop, thereby destroying equity and wealth. The loss
of value nationally is about 15% and as much as 25% in high
cost states such as California. The study that the respected
econometric analysis firm of Standard & Poors/DRI performed
indicated that the loss in home value under the flat tax was
permanent. NAR viewed this as simply unacceptable and so
opposed the flat tax.
In conjunction with our work on the flat tax, NAR adopted a
series of tax reform principles and guidelines designed to
clarify our own thinking and to enumerate the features of a tax
system that would treat real estate fairly. Those principles
and guidelines are attached as Appendix A of these comments.
The principles and guidelines delineate the elements of real
estate transactions and investment in real estate in order to
assess the impact of proposed replacement-type tax systems on
our industry. The flat income tax falls short under the
criteria enumerated in those principles and guidelines. By
contrast, Chairman Archer's publicly stated view that the
purchase of a home should be treated as an investment and not
subject to a consumption tax is completely consistent with
those guidelines.
The principles and guidelines include elements applicable
to both income and consumption tax models. NAR has no
preference for one type of tax system over another. We believe
that both income and consumption tax models could be crafted
that would be practical for our industry.
Simplification
NAR shares Chairman Archer's perspective that the current
income tax system is overly complicated and burdensome. Its
complexity is particularly crushing for small businesses. We
support tax reform's goals of substantial simplification,
because, as self-employed individuals, our members face
significant compliance challenges.
The tax rules that apply to homeownership, however, are
among the simplest rules for individuals to comply with in the
entire tax system. All that an individual must do in order to
comply with the MID rules is to take the Form 1098 that the
lender provides and transfer the MID and property tax numbers
on Form 1098 to Schedule A of the Form 1040. This is no more
difficult than entering an individual's wage and salary from
Form W-2 or providing the amount of interest and dividends from
Form 1099. Even if seller financing is involved, a settlement
services provider such as a title company or attorney can
usually provide an amortization schedule to the buyer and
seller so that both parties can determine the amount of
mortgage interest paid each year. Accordingly, we can think of
no rationale based on simplification for eliminating the MID
and property tax deduction in any income tax model.
The FairTax, H.R. 2525
In the context of today's hearings, the NATIONAL
ASSOCIATION OF REALTORS has taken no official position on the
FairTax proposal advanced by Americans for Fair Taxation (AFT)
(H.R. 2525). We neither oppose nor support it. We understand
that we have been invited here today to share with you the
issues we have identified as NAR's Tax Reform Working Group has
studied the plan and met with Mr. Linbeck and his AFT
associates.
Why Does Real Estate Matter in the Tax Reform Debate?
Some may say that all we are doing here today is protecting
a special interest. If so, it is a ``special interest'' that
affects the two-thirds of all Americans who own their home.
This homeownership rate is an all-time high. By contrast,
during the decade of the 1980's, homeownership rates actually
declined, dipping to about 62 percent. Given the progress over
the past five years in not only reversing the decline, but
actually reaching the highest homeownership rate in our
history, it is difficult for us to understand why we would want
to do anything to disrupt housing markets by changing the tax
system.
Individuals in every income class own homes. Notably, the
lower the family's income, the greater the proportion of their
wealth is tied up in their homes. According to the Federal
Reserve, even at the $10,000 household income level, almost 35%
of households own a home, but only 8% of these households own
stock. By contrast, the wealthiest 1% of households own 43% of
all direct stock holdings, and their homeownership rate is 94%.
The chart in Appendix B shows the rates of ownership and median
values of some family assets by income and age categories.
Simply stated, real estate is the most widely held asset of any
category of household wealth in our economy.
It is worthwhile to compare ownership of a home with
ownership of securities. In today's high-flying stock market,
high Dow Jones averages mask some real turmoil. Of the 1,000
stocks tracked by the Wall Street Journal's Shareholder
Scoreboard, 442 display a negative return for all of 1999. By
contrast, of the 138 Metropolitan Statistical Areas (MSA) NAR
monitors, only 12 showed a decline in median prices from 1998
to 1999. The worst performing housing market lost only 7% of
its value. Again, it is difficult for us to understand why we
would want to do anything to disrupt housing markets by
changing the tax system. (Appendix C presents a series of
statistics on various aspects of homeownership and some
comparisons with assets such as securities.)
Even if you believe that real estate is a special interest,
it is the special interest that affects the largest number of
households and voters in the country. If you believe as NAR
does that changes to the tax system can have a substantial
impact on the value of those homes, then we believe you should
tread very carefully when considering tax legislation that
could negatively affect that most valuable of all possessions.
Achievements in Housing Among Minorities
The fastest growing category of homeowners is our minority
population. Last year, 35% of first-time homebuyers were
minorities and immigrants. Minorities and immigrants are highly
motivated towards homeownership. 67% of African-Americans and
65% of Hispanics rank homeownership as a top priority. There is
great understanding that homeownership is the way that
Americans build wealth and savings. In 1999, NAR was a leading
sponsor of the Congressional Black Caucus Foundation's Summit
on Housing and Wealth Accumulation. By the end of 1999, we had
achieved the highest number of minority homeowners in American
history. At that time, a record 5.9 million African-American
and 4.2 million Hispanic families had achieved the goal of
homeownership.
Today, one in ten Americans were not born in the United
States. We have made great progress in helping these families
to achieve homeownership. Again, therefore, we are compelled
ask why we would want to do anything to disrupt housing
markets, particularly for minorities and immigrants by changing
the tax system.
How Do You Get There From Here?
For NAR, the overriding question about any tax reform is
``How do you get there from here?'' Real estate professionals
are particularly sensitive about transition because of the
violent fallout from the 1986 Tax Reform Act. That bill pulled
the rug out from under real estate investments, because it
changed the tax rules for existing real estate investments in
midstream without adequate transition. The result was a
depression in real estate, a near-collapse of the financial
system and a loss in value to existing assets. Only in the last
two or three years has investment real estate regained its
footing. From 1988 to about 1992, even residential real estate
values fell or were flat because of the depression in
commercial real estate and tight credit.
The FairTax provides no mortgage interest deduction (MID)
because the MID is part of an income tax system, but not a
consumption tax system. The loss of the MID will inevitably
create additional transition problems. Contrast a home bought
the day before the new tax system went in place, and a home
purchased the day after. The home bought the day before the new
tax system was implemented would no doubt change in value the
day after the new system was implemented, because the two
homes, even if they were identical, would not be on the same
playing field. The MID matters a very great deal, and
transition would be essential for all homes that were purchased
under the current system.
What is the Tax Rate?
The FairTax is intended to replace the existing income,
estate and payroll systems with a retail sales tax. Depending
on how you do the computation, the FairTax would impose a tax
of 23 or 30 percent on all goods and services. The tax rate
under the FairTax, stated in H.R. 2525 at 23%, is what is
called an ``inclusive'' rate. This in contrast to the way we
usually think about sales taxes which today are stated in what
is called an ``exclusive'' rate. What does this mean?
The way we are accustomed to think about sales taxes is in
a tax ``exclusive'' manner. If a good costs $100 and the sales
tax is 6%, then we pay $106.00, with $100 to the seller, and $6
to the taxing authority. The tax ``inclusive'' method works
differently. The example that follows illustrates the inclusive
and exclusive methods by using the stated FairTax rate of 23%.
Two examples based on $100 can assist in understanding the
tax ``inclusive'' and tax ``exclusive'' methods. First, think
of a seller who wishes to charge no more than a total of $100
for a product, including both the sales price and the tax. If
the seller is to remit 23% of that total $100 retail cost to
the government, then the seller will receive $77 as follows:
Price charged to purchaser $100
Sales Tax at 23% $23
Proceeds to seller $77
This is the tax ``inclusive'' method. The 23% tax is
included in the retail purchase price the buyer pays.
Now think of a seller who wishes to realize or net $100. If
we were to apply the tax ``exclusive'' model used today, the
seller would have to charge a total of $129.87, as follows:
Total gross purchase price: $129.87
LESS: 23% sales tax $28.87
Net proceeds to seller $100.00
Effective rate for purchaser: 30%
The FairTax uses the tax ``inclusive'' method, so that the
seller receives less than the stated $100 purchase price.
Today's sales tax uses an ``exclusive'' method, so the seller
receives the full $100.
Buying and Selling a Home
The FairTax would impose a sales tax of either 23% or 30%
on the purchase of a new (but not an existing) home. AFT's
theory does not include existing homes in the tax base, because
today they have already borne the incidence of the income tax.
In the future, if the FairTax were adopted, when a home that
had been subject to the sales tax was sold, it also would
already have been taxed.
We have expressed grave reservations to AFT and other sales
tax advocates about any tax system that would tax the purchase
of a home. We believe the imposition of a tax is a substantial
barrier to affordability. A tax at 23% or 30% paid at the time
of the sale, adds substantial costs to an already expensive
transaction.
NAR's informal economic analysis of the sales tax model
showed that the imposition of a sales tax causes the value of a
home to drop. The drop is not as dramatic as under the flat
tax, and, unlike the flat tax, the value of homes does
eventually restore itself to where it would have been in the
absence of the sales tax. (Under the flat tax, the decline in
the value of homes is permanent and never recovered.) Under a
sales tax, the value of homes does not decline as much when
existing homes are excluded from taxation, as under the
FairTax, but there is still a decline. Because homes represent
so much of our national wealth, we have a fundamental question
as to whether it is wise to substantially erode that wealth in
the pursuit of tax reform.
We have another specific concern about taxing new homes. In
today's market and under today's tax laws, newly-constructed
housing is more expensive than existing housing by a factor of
about 20%. Since both new and existing housing are subject to
the same tax laws today, there appears to be a premium on the
cost of new housing, even net of today's tax. Under the FairTax
model, then, the 23% or 30% sales tax cost will fall heavily,
indeed, on this higher-cost housing. The Committee will need to
assess the impact this will have on housing starts and the
economy.
NAR chose not to rely on future predictions of economic
models (beyond our informal preliminary analysis). To test our
concerns about the present, rather than make guesses about the
future, we went directly to Americans, both homeowners and
prospective homeowners. We conducted focus groups in
Cincinnati, San Diego and Philadelphia. The focus group
participants were chosen at random. In San Diego, our random
sample happened to draw a man who was active in the national
sales tax grass roots movement. He came to the meeting
remarkably well informed about the current tax system and about
the philosophy of a national sales tax. He was persuasive to
the group about the merits of changing to a national sales tax.
After some general discussion, the facilitator asked how the
group would feel about taxing the purchase of a home. This
fellow was shocked, as were other members of the group. At the
end of the meeting, the group took a straw vote about
supporting a sales tax that imposed tax on the purchase of a
home. The vote against such a model was unanimous. Even the
persuasive sales tax advocate said that he could never support
a tax on the purchase of a home. Another participant summed up
the feelings well: ``A home is what we are, it's what we work
for.''
Predicting the Future
AFT responds to our concerns about a 30% increase in the
cost of a home by saying that interest rates will be lower.
They also say the purchaser will have more cahse, because that
person will no longer be paying income and payroll taxes.
Our Working Group members have differing views about how
the economy will perform and whether interest rates will really
decline. This is because market performance is subject to
numerous forces beyond the scope of the tax system. When
Congress makes tax law changes, it is of course essential that
it get the best possible economic information and forecasting
on the likely outcome of the changes. Despite their
sophistication, however, these prediction models have not
necessarily come to fruition.
The economic models that drove the tax cuts in 1981 and
1986 assured declining deficits and more revenue collections
for the government. The impact of the 1981 tax cuts was an
increase in the deficit. After 1986, there was a depression in
real estate and a slowdown in the economy because of problems
in the financial system caused by the real estate depression.
The result was even bigger deficits as the government supported
the collapsing financial system. The tax rate increases in 1993
were accompanied by cries of alarm that there would be a
significant recession and more deficits. Since 1996, the
economy has exploded, and the government is in a surplus for
the first time in more than a generation. Markets rely on more
than the tax system.
Similarly, we have differences among ourselves about
employer behavior in the future. To devise a crude example, say
that an employer today pays an individual $50,000, for a net of
$35,000 or $40,000 after all payroll, state and federal
withholding. If the FairTax were adopted how much will that
employer continue to pay the employee? Will the employer
continue to give the employee the same net pay of $35,000 to
$40,000? Or will the employer still pay the gross $50,000
salary? Will the elimination of income and payroll taxes
benefit the employer, the employee or both? We disagreed among
ourselves. You may, too.
Taxes on Services
We have a further concern about the impact of the FairTax
30% sales tax on real estate sales transaction. The FairTax
imposes the sales tax on all retail (but not business to
business) services. Real estate sales commissions would be
taxed, as would services provided for title searches, contract
and document preparation, termite inspections, appraisals,
painting and fix-up maintenance, legal advice, tax advice and
settlement or escrow fees. Each of these services would be
subject to the 23% or 30% tax. Again, the cost of completing
the housing transaction just went up.
In states that have attempted to impose sales taxes on
services, Realtors... have joined with other service providers
from dry cleaners to newspaper delivery providers to doctors
and lawyers to oppose sales taxes on services. We believe that
the imposition of sales taxes on the services associated with
the purchase and sale of property will put a significant cost
burden on prospective purchasers that would yet another barrier
to homeownership.
What about Renters?
Under the FairTax, rents paid by consumers for their
residences are taxed as consumption. Under the current system,
we acknowledge that renters do not receive any of the tax
benefits enjoyed by homeowners or landlords. Many, many renters
would like to own a home, but find numerous barriers to
affordability. Paying rent is certainly a form of consumption,
but we are troubled about imposing such a heavy tax on one of
life's fundamental necessities.
What about Investors in Real Estate and Other Business
Activities?
One very attractive feature of the FairTax plan is that it
seeks to impose tax once and only once on any activity or
purchase. This is a worthwhile objective to pursue. The FairTax
model achieves this result by relieving all businesses from
either income or sales taxation. Thus, investors in real
estate, whether the investment is in residential rental
property or in commercial space, would pay no sales tax on
their purchase of these income-producing properties. Similarly,
if a business occupied the building, that business would not be
required to pay sales tax on its rent, because business-to-
business activities are not taxed under the FairTax model.
Outside the context of real estate, the local bookstore would
not pay income or sales tax on its revenues or on any of the
inventory or supplies used in the business, nor would Barnes
and Noble.
This single-level tax, applied only to retail consumption
by end-users of goods and services (i.e., individuals) appeals
to those interested in capital formation for business. A
single-level tax is certainly a valid economic model. Even
under current law, a significant amount of investment real
estate income is taxed only once at the federal level, because
real estate is often held by individuals or in partnerships.
Inevitably, the Committee will have to make a political
decision about whether exempting all business-to-business
transactions from a sales tax is the best method of achieving
the highly desirable goal of single-level taxation.
Conclusion
In the words of a former member of this Committee, America
was built on real estate. We like it that way and look forward
to working with the Committee to improve the tax system.
Appendix A
REAL ESTATE-BASED TAX REFORM PRINCIPLES AND GUIDELINES
Tax reform has been a major political theme since 1995. Tax
reform supporters advocate complete elimination of both the
current income tax code and the Internal Revenue Service. They
would replace the current system with either a revised, broad-
based, low-rate income tax model or a consumption tax.
Advocates stress that any system adopted would be designed to
be more fair and more simple than current law. Despite
criticisms of the IRS, little consideration has been given to
date to the mechanics of administering a new tax regime.
Anticipating that a variety of proposals will continue to
emerge and that any reform process will be evolutionary, the
National Association of Realtors... has developed guidelines
and principles to use in evaluating proposals as they emerge.
The guidelines are intended to provide a systematic means of
evaluating both income and consumption taxation models. No
principle would apply to every feature of any proposal. These
guidelines are intended to cover a range of possibilities based
on the elements of real estate transactions that potentially
give rise to taxable events under current law and that could
give rise to taxable events under income and consumption tax
models. Not surprisingly, the guidelines list many principles
that respond to features of the current income tax system, and
only a limited number of applications to a consumption tax
model.
A real estate investment has three distinct phases:
acquisition, holding period and disposition. In addition,
numerous services are associated with these phases of
investment. Accordingly, these guidelines are organized to
reflect those phases. Furthermore, a real estate investment is
capital intensive, so the guidelines are based on the premise
that the risks inherent in capital investment will be
recognized in any tax system. In an income tax system, those
risks would be recognized with a meaningful differential
between the treatment of ordinary income and capital gains. A
consumption tax system would properly recognize the risks of
capital investment by treating real estate investment as a form
of savings, and not consumption.
The National Association of Realtors... believes that the
present income tax system, despite its flaws, has helped create
a home ownership system that is unequaled in the world.
Similarly, investment real estate is the most widely-held
capital asset in the nation. In all income groups, the
ownership of both residential and investment real estate is
widely distributed.
Finally, the critical question in any tax reform effort, no
matter what model is adopted, is ``How do we get there from
here?'' Any changes to the tax system, whether incremental or
sweeping, must include careful planning for adequate
transition.
REAL ESTATE-BASED TAX REFORM PRINCIPLES AND GUIDELINES
Tax reform proposals generally fall into two categories:
income tax models and consumption tax models. The features of
those models vary, so not every principle below would apply to
every proposal. The National Association of Realtors...
believes that a workable tax system should:
Acquisition
Treat home ownership as investment, and not as
consumption.
Encourage savings and tax-based incentives for
home purchases.
Eliminate penalties for using savings for home
purchases.
Treat services associated with the purchase of
real estate as part of the investment costs of the transaction,
and not tax those services.
Holding Period
Preserve mortgage interest deduction benefits.
Treat debt financing for owners of investment
property as a business expense.
Provide cost recovery rules that reflect a viable
economic life for real estate investment for both owners and
tenants.
Allow netting of income from real estate
activities against other income streams.
Disposition
Maintain a meaningful tax differential between
ordinary income and gain from sales of capital assets.
Apply capital gains provisions equally among all
investments, including real estate.
Tax only true economic gain.
Defer recognition of gain on disposition of all
real estate until reinvestment ceases.
Preserve loss carry forward principles.
Treat services associated with the sale of real
estate as part of the investment costs of the transaction, and
not tax those services.
Real Estate Operations
Preserve independent contractor status for real
estate professionals.
Preserve (or establish) the principle that
ordinary and necessary business expenses, including interest,
should be deductible under an income tax model, and nontaxable
under a consumption tax model.
Transition
Provide transition rules to preserve owner equity and
eliminate adverse effects on real estate assets in service at
the time of enactment.
APPENDIX B
OWNERSHIP OF ASSETS BY INCOME AND AGE
--------------------------------------------------------------------------------------------------------------------------------------------------------
Stock Retire Acct Home Stock Retire Acct Home
--------------------------------------------------------------------------------------------------------------------------------------------------------
All Families Income 48.8% 48.8% 60.2% $25,000 $24,000 $100,000
Less than $10,000 7.7% 6.4% 34.5% $4,000 $7,500 $51,000
10,000-24,999 24.7% 25.4% 51.7% $9,000 $8,000 $71,000
25,000-49,999 52.7% 54.2% 68.2% $11,500 $13,000 $85,000
50,000-99,000 74.3% 73.5% 85.0% $35,700 $31,000 $130,000
100,00 or more 91.0% 88.6% 93.3% $150,000 $93,000 $240,000
Age of head Less 40.7% 39.8% 38.9% $7,000 $7,000 $84,000
than 35
35-44 56.5% 59.5% 67.1% $20,000 $21,000 $101,000
45-54 58.6% 59.2% 74.4% $38,000 $34,000 $120,000
55-74 58.9% 58.3% 80.3% $47,000 $46,800 $110,000
65-74 42.6% 46.1% 81.5% $56,000 $38,000 $95,000
75 or more 29.4% 16.7% 70.0% $60,000 $30,000 $85,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
ASource: Federal Reserve Board, Survey of Our Summer Finance.
Tax Notes on Homeownership
Home largest asset for most families.
In 1998, 66% of households own a home, while only
49% own any stock, either directly or indirectly.
Median value of home for owners is $100,000; while
median value of stock holdings in only $25,000 (1998).
Housing wealth is more evenly distributed across
the income distribution than any other asset, except for
vehicles. The Federal Reserve Board reports that the wealthiest
1% of households own 43% of all direct stock holdings, but only
own 9% of all value of personal residences.
Although minority households have lower
homeownership rate, for those that do own, their home is an
even larger share of their wealth than for majority households.
Homeownership rate of minority households in 46.8%
compared to 71.8% for white households in 1998.
Although homeownership declines with income, for
those that do own, their home is an even larger share of their
wealth the lower is household income.
For households earning less than $10,000 annually,
less than 8% own any stock, direct or indirect, while 34.5% own
their own homes.
For households earning less than $10,000 annually
who do own stock the median value of stock holdings is only
$4,000, while those homeowners earning less than $10,000 have a
median home value of $51,000.
For much of the current elderly their largest
source of retirement wealth is their home.
In 1998, 77% of households aged 75 plus own a
home, while less than 30% own any stock, either directly or
indirectly.
Median value of home for owners aged 75 plus is
$85,000; while median value of stock holdings in only $60,000
for those who own stock (1998).
High Stock Market masks many losing stocks while
most housing markets share in national gains.
Of the 138 MSA monitored by NAR, only 12 displayed
a decline in median prices from 1998 to 1999. The worst
performing housing market lost only 7%.
Of the 374 IPO's issued between June 1999 and
April 2000, 99 are trading below their issue price as of April
4, 2000 (that is they lost money), with an average decline of
36%.
Of the 1,000 stocks tracked by the Wall Street
Journal's Shareholder Scoreboard, 442 display a negative return
for all of 1999.
Mortgage facts (from 1997 American Housing Survey):
Of the 65.5 million homeowners in the US, 39% own
their home free and clear (no mortgage). So that's 40 million
with a mortgage, of which about 30 million claim take the MID.
Over 7 million have more than one mortgage (may
include home equity loans and lines of credit).
About 3 million only have a home equity line or loan
without a regular mortgage
Chairman Archer. Thank you, Mr. Rooth.
Mr. Kouplen?
STATEMENT OF STEVE KOUPLEN, PRESIDENT, OKLAHOMA FARM BUREAU, ON
BEHALF OF THE AMERICAN FARM BUREAU FEDERATION
Mr. Kouplen. Chairman Archer and members of the committee,
my name is Steve Kouplen. I am a farmer from Okmulgee County,
Oklahoma, where I operate a cow-calf operation on some 2,000
acres. I am president of the Oklahoma Farm Bureau and am here
today on behalf of the American Farm Bureau Federation.
Farm Bureau members are ready for fundamental tax reform.
They have become increasingly frustrated with the current tax
system and disheartened that every attempt to change the system
makes the system even more complex.
The current tax system forces farmers and ranchers to
consider the tax consequences of each input purchase, commodity
sale, capital asset purchase, or capital asset sale. Farmers
and ranchers should be making decisions based on the economics
of the situation, not the consequences of the tax situation.
After a lifetime of hard work and paying taxes, farmers and
ranchers are faced with double taxation through capital gains
and estate taxes. If they sell equipment, livestock, and other
assets at retirement, they find the Federal Government ready to
take a share as capital gains taxes. These taxes often
discourage retirees from reallocating assets to a more
appropriate mix for their retirement years. Young producers
lose the opportunity to purchase assets that they can use more
economically than current owners.
Planning for the transfer of assets at death has become a
time-consuming and costly activity. Many family farms are
multi-generation family farms. Transferring farms and ranches
from one generation to the next without a huge tax load is
critical to the financial success of these farms. Many farms
are lost when death taxes force farmers and ranchers to sell
part or all of their business to secure enough cash to pay
death taxes.
Farm Bureau supports replacing the current Federal income
tax system with a new tax that encourages, not penalizes,
success and encourages savings, investment, and
entrepreneurship. It should be transparent, simple, and require
a minimum of personal information.
It must be fair to farmers and ranchers in payroll taxes,
the alternative minimum tax, the capital gains tax, and
personal and corporate income taxes. A consumption tax must not
tax business-to-business transactions or services unless sold
for final consumption.
The American Farm Bureau Federation supports H.R. 2525, the
Fair Tax Act of 1999 and any other tax reform proposals
consistent with Farm Bureau policy.
The national sales tax plan sponsored by Representatives
Linder and Peterson is a bold attempt at fundamental reform. By
ending the Federal individual and corporate income taxes,
capital gains tax, estate tax, and payroll taxes for Social
Security and Medicare, many of the concerns that Farm Bureau
members have with the current tax system would be eliminated.
These changes would have far-ranging impacts on day-to-day farm
and ranch management and the transfer of farms and ranches from
one generation to the next.
If H.R. 2525 is enacted, attention should be given to two
potential problems that are of concern to farmers and ranchers.
First, a national sales tax will need to be meshed with
existing State and county sales taxes. Second, only the 5
percent of the farmers and ranchers who sell directly to
consumers should be required to keep records and remit sales
tax money to the proper collection agency in order to avoid a
heavy compliance burden.
We look forward to working with you to promote fundamental
tax reform that will be good for farmers and ranchers and good
for the citizens of our country.
Thank you, Mr. Chairman.
[The prepared statement follows:]
STATEMENT OF STEVE KOUPLEN, PRESIDENT, OKLAHOMA FARM BUREAU, ON BEHALF
OF THE AMERICAN FARM BUREAU FEDERATION
Mr. Chairman and members of the committee, good morning. My
name is Steve Kouplen, and I am president of the Oklahoma Farm
Bureau. I have a Hereford cow-calf operation on 2,000 acres in
Okmulgee County, Oklahoma. I am appearing here today on behalf
of the American Farm Bureau Federation (AFBF) and the Oklahoma
Farm Bureau. AFBF represents more than 4.9 million member
families in all 50 states and Puerto Rico and produce nearly
every type of farm commodity grown in America.
Farm Bureau members are ready for fundamental tax reform.
They have become increasingly frustrated with the current tax
system and disheartened that every attempt to change the system
to benefit farmers and ranchers makes the system even more
complex. Simple ideas, such as income averaging for farm and
ranch incomes that vary greatly year to year, become almost
incomprehensibly complex when changes are passed by Congress
and regulations issued by the Internal Revenue Service (IRS).
The national sales tax plan sponsored by Reps. John Linder
(R-GA) and Collin Peterson (D-MN), H.R. 2525, is a bold attempt
at fundamental reform. By eliminating the federal individual
and corporate income taxes, capital gains tax, estate tax and
payroll taxes for Social Security and Medicare, they would
address the hundreds of concerns that Farm Bureau members have
with the current tax system. These changes would have far-
ranging impacts on day-to-day farm and ranch management and the
transfer of farms and ranches from one generation to the next.
The current tax system forces farmers and ranchers to
consider the tax consequences of each input purchase, commodity
sale, capital asset purchase or capital asset sale. Tax
planning has become a normal part of everyday decision making.
Farmers and ranchers should be making decisions based on the
economics of the situation, not the tax consequences of the
situation.
After a lifetime of hard work and paying taxes, farmers and
ranchers are faced with double taxation, with the capital gains
tax at retirement and the estate tax at death. If they sell
equipment, livestock and other assets at retirement, they find
the federal government as a silent partner ready to take a
share as capital gains taxes. These taxes often discourage
retirees from reallocating assets to a more appropriate mix for
their retirement years. Younger producers lose the opportunity
to purchase assets that they can use more economically than the
current owners.
Planning for the transfer of assets at death has become a
time consuming and costly activity. Many family farms are
multi-generation family farms. Transferring farms and ranches
from one generation to the next without a huge tax load is
critical to the financial success of these farms. Asset
transfer decisions that were delayed because of the capital
gains tax are further complicated by the estate tax. Many farms
are lost when death taxes force farmers and ranchers to sell
part or all of their business to secure enough cash to pay
death taxes.
These problems would all be swept away by the tax reforms
as proposed by H.R.2525.
If H.R. 2525 is enacted, attention should be given to two
potential problems that are of concern to farmers and ranchers.
First, a national sales tax will need to be meshed with
existing state and county sales taxes. State Farm Bureaus have
worked for decades in their respective states to develop a
state sales tax system that treats farmers and ranchers fairly.
They want to avoid having to start over again on basic sales
tax issues with state governments.
Second, only about 5 percent of the farmers and ranchers
sell directly to consumers. These should be the only ones that
have to keep records and remit sales tax money to the proper
collection agency. Farmers and ranchers buy billions of dollars
of inputs for production purposes that are also purchased by
consumers for final use. This includes a wide range of items
from pickup trucks to lumber for building repairs to hand
tools. They do not want to get caught in the compliance burden
that may be necessary to ensure that all retail sales taxes are
properly collected.
Farm Bureau Policy
Farm Bureau supports replacing the current federal income
tax system. The new tax code should encourage, not penalize,
success and encourage savings, investment and entrepreneurship.
It should be transparent, simple and require a minimum of
personal information.
We support a replacement tax system if it meets these
guidelines:
(1) Fair to agricultural producers;
(2) Implemented simultaneously with the elimination of all
payroll taxes, self-employment taxes, the alternative minimum
tax, the capital gains tax, death taxes and personal and
corporate income taxes;
(3) Revenue neutral;
(4) Repeals the 16th amendment; and
(5) Any flat tax proposal or other reform proposal not
based on gross revenue received.
We support requiring a two-thirds majority for imposition
of new or additional taxes, or for the increase of tax rates. A
consumption tax must not tax business-to-business transactions
or services unless sold for final consumption.
At an American Farm Bureau Federation Board of Directors
meeting in March of this year the board took specific action to
support the Fair Tax Act of 1999 and any other tax reform
proposals consistent with Farm Bureau policy.
We look forward to working with you to promote fundamental
tax reform that will be good for farmers and ranchers and for
all citizens.
Chairman Archer. Thank you, Mr. Kouplen.
Mr. Martin, you are clean-up hitter in this group, and if
you are prepared, you may proceed.
STATEMENT OF JAMES MARTIN, HORSESHOE BAY, TEXAS
Mr. Martin. Yes, sir. Mr. Chairman and members of the
committee, my name is James Martin, and I am grateful for the
opportunity to testify today. I am the former general vice
president of the Ironworkers International Union. I also served
as deputy chairman of the Dallas Federal Reserve Board. I would
like to ask that my written statement and a recent op-ed
article that I co-authored with Gale Van Hoy, the executive
secretary of the Texas Building and Construction Trades
Council, be made part of this hearing.
Chairman Archer. Without objection, any printed material or
statement by any one of the witnesses will be inserted in the
record in full.
Mr. Martin. Thank you, sir.
The tax system is one of the primary reasons that so many
people are having such a hard time getting ahead financially.
The existing tax system is holding the working men and women of
this country back. I believe that the Fair Tax, introduced on a
bipartisan basis as H.R. 2525, is the best plan to make our tax
system better.
American workers are disgusted with the present tax system.
They want to see fundamental change. They see loopholes and
special provisions in the tax law that benefit politically
powerful interests but these are not available to ordinary
people. They see accountants and lawyers putting together
intricate deals that take advantage of these loopholes. They
have seen tax reform after tax reform passed by Congress, and
yet the situation only gets worse. In the meantime, the taxes
taken out of their paycheck seem to remain about the same or
even go up every year. The Fair Tax would eliminate all
loopholes and all of these games. It is a straightforward tax
system that would eliminate the ability to gain advantage
through tax shelter deals.
Most Americans don't understand the current system. For
that matter, I am not convinced anyone really understands the
current tax system, including the people that try to administer
it at the IRS. It is just too complex. I believe that the
American people have the right to understand the tax system. A
system that is so complex that virtually no one understands it
is going to lead to unfairness. The Fair Tax would give us a
simple tax system that anyone can understand.
The current tax system holds people down. The only way for
most people to get ahead is to get an education or training, go
to work, and to save. Yet this is precisely what the current
tax system punishes. Work is taxed more heavily than any other
form of income due to the combination of high payroll taxes and
the income tax. Under the current tax system, we generally have
to pay for education or training for ourselves or our children
with after-tax dollars. You have to save with after-tax dollars
unless you are willing to tie up your money until retirement.
The Fair Tax taxes only consumption. Education and training are
treated as an investment in people and are not taxed. Wages and
salaries are not taxed. And savings is not taxed.
The Fair Tax would eliminate not only the income tax but
also payroll taxes. For many people, the payroll tax is a
bigger burden than the income tax. It is a regressive tax that
taxes only wages and taxes people earning less than $76,200
more heavily than those earning more. The Fair Tax is the only
tax reform plan to address this problem. No other plan would
repeal payroll taxes. Workers would be able to keep their
entire paycheck. There would be no withholding of income or
payroll taxes. What we earn is what we would receive in our
paychecks.
Americans also want more control over their own financial
future. They want to be able to make choices for themselves and
their families rather than have the decisions made for them in
Washington. They want to be able to save or go to school or get
training without having to deal with complex tax provisions or
pay a large tax.
The current tax system imposes a heavy burden on American
workers and businesses exporting to foreign markets and on U.S.
workers and businesses competing with imported goods in the
U.S. markets. In contrast, foreign goods enter the U.S. market
free of any significant tax burden. This places U.S.-produced
goods at a big competitive disadvantage.
Our tax system is one of the major reasons that we have
such a large trade deficit. This disadvantage is made worse
because most of our major trading partners eliminate a big part
of their tax burden on exports since their value-added taxes
are border adjusted. This disadvantage is built into our tax
system, and it exports high-paying jobs to our competitors. We
should be exporting goods, not good jobs.
There is nothing that can be done about this problem if we
keep the income tax, but the Fair Tax fixes the problem. The
U.S. will stop shooting itself in the foot. For the first time,
foreign-produced goods will bear their fair share of the tax
burden. U.S.-produced goods and foreign-produced goods will be
subject to the same tax when they are sold retail in the U.S.
Exported U.S. goods will bear no tax burden. This will make
American firms and American workers more competitive both in
domestic markets and abroad. It will enable us to create and
preserve more high-quality and high-paying jobs, and it will
improve the standard of living of American workers.
We need to rethink the tax system. It really is broken
beyond repair. It is time to do something about it. The Fair
Tax is legislation that deserves support, and I would urge you
to pass this legislation.
I thank you, and I would be glad to answer any questions,
Mr. Chairman.
[The prepared statement follows:]
STATEMENT OF JAMES MARTIN, HORSESHOE BAY, TEXAS
Mr. Chairman and members of the committee, I am grateful
for the opportunity to testify today. I am the former General
Vice President of the Ironworkers International Union. I also
served as Deputy Chairman of the Dallas Federal Reserve Board.
I would ask that my written statement and a recent Op-Ed
article that I coauthored with Gale Van Hoy, the Executive
Secretary of the Texas Building and Construction Trades
Council, be made a part of the hearing record.
The tax system is one of the primary reasons that so many
people are having such a hard time getting ahead financially.
The existing tax system is holding the working men and women of
this country back. I believe that the FairTax, introduced on a
bipartisan basis as H.R. 2525, is the best plan to make our tax
system better.
American workers are disgusted with the present tax system.
They want to see fundamental change. They see loopholes and
special provision in the tax law that benefit politically
powerful interests but are not available to ordinary people.
They see fancy accountants and lawyers putting together
intricate deals to take advantage of those loopholes. They have
seen tax reform after tax reform be passed by Congress and yet
the situation only gets worse. In the meantime, the taxes taken
out of their paycheck seem to remain about the same or go up
every year. The FairTax would eliminate all loopholes and all
of these games. It is a straightforward tax system that would
eliminate the ability to gain advantage through tax shelter
deals.
Most Americans don't understand the current system. For
that matter, I am not convinced anyone really understands the
current tax system, including the people that have to try to
administer it at the IRS. It is just too complex. I believe
that the American people have the right to understand the tax
system. A system that is so complex that virtually no one
understands it is going to lead to unfairness. The FairTax
would give us a simple tax system that anyone can understand.
The current tax system holds people down. The only way for
most people to get ahead is to get an education or training, to
work, and to save. Yet this is precisely what the current tax
system punishes. Work is taxed more heavily than any other form
of income due to the combination of high payroll taxes and the
income tax. Under the current tax system, we generally have to
pay for education or training for ourselves or our children
with after-tax dollars. You have to save with after-tax dollars
unless you are willing to tie up the money until retirement.
The FairTax taxes only consumption. Education and training are
treated as an investment in people and are not taxed. Wages and
salaries are not taxed. Savings is not taxed.
The FairTax would eliminate not only the income tax but
also payroll taxes. For many people, the payroll tax is a
bigger burden than the income tax. It is a regressive tax that
taxes only wages and taxes those earning less than $76,200 more
heavily than those earning more. The FairTax is the only tax
reform plan to address this problem. No other plan would repeal
payroll taxes. Workers would be able to keep their entire
paycheck. There would be no more withholding of income or
payroll taxes. What we earn would be what we receive in our
paychecks.
Americans want more control over their own financial
future. They want to be able to make choices for themselves and
their families rather than have the decisions made for them in
Washington. They want to be able to save or go to school or get
training without having to deal with complex tax provisions or
pay a large tax.
The current tax system imposes a heavy tax burden on
American workers and businesses exporting to foreign markets
and on U.S. workers and businesses competing with imported
goods in the U.S. markets. In contrast, foreign goods enter the
U.S. market free of any significant tax burden. This places
U.S. produced goods at a big competitive disadvantage. Our tax
system is one of the major reasons we have such a large trade
deficit. This disadvantage is made worse because most of our
major trading partners eliminate a big part of their tax burden
on exports since their value added taxes are border adjusted.
This disadvantage is built into our tax system and it exports
high paying jobs to our competitors. We should be exporting
goods not good jobs.
There is nothing that can be done about this problem if we
keep the income tax but the FairTax fixes this problem. The
U.S. will stop shooting itself in the foot. For the first time,
foreign produced goods will bear their fair share of the tax
burden. U.S. produced goods and foreign produced goods will be
subject to the same tax when they are sold at retail in the
U.S. Exported U.S. goods will bear no tax burden. This will
make American firms and American workers more competitive both
in domestic markets and abroad. It will enable us to create and
preserve more high quality, high paying jobs. It will improve
the standard of living of American workers.
We need to rethink our tax system. It really is broken
beyond repair. It is time to do something about at. The FairTax
is legislation that deserves support and I would urge you to
pass this legislation.
Thank you. I would be glad to answer any questions you may
have.
Chairman Archer. Thank you, Mr. Martin.
Mr. Rooth, you have said you are neutral on H.R. 2525. Is
there any structural tax reform proposal that you positively
support?
Mr. Rooth. Not at this time, Mr. Chairman.
Chairman Archer. And do you have any specific
recommendations that you might make to the committee as to what
sort of avenues we might look into in order to get to ultimate
structural tax reform?
Mr. Rooth. As I had mentioned, our chief concerns are in
any form of taxation on the first-time home buyer, on the
taxing of rental rents, on the transition rules. 1986 was a
devastating event in our industry because most people assume
that this is a long-time investment purchase. And to change the
rules in midstream can be an earth-shattering event for them.
Chairman Archer. Well, I certainly agree with that, as the
leader of the opposition to the 1986 Tax Reform Act and citing
in the debate the very things that we learn from hindsight in
advance as to what would happen to real estate and the S&Ls.
Mr. Linbeck, how would you respond to Mr. Rooth's specific
objections to the Fair Tax?
Mr. Linbeck. Well, Mr. Chairman, I understand the concern
that he has expressed, but I suggest that the elements of the
Fair Tax relating to the sale of new homes and the manner in
which the producer price is predicted to go down on average by
about 20 percent would suggest that the cost of that new home
including the tax would not go up. But of equal importance, if
I may, is that one needs to look at the purchasing power side
of the equation as well. As I am sure he knows, the essential
components of a person's ability to purchase a home are
typically the interest rate that one has to pay, the amount of
spendable income that they have to apply to the debt service on
the home that they purchase, and the amount of time that one
has to save in order to pay the down payment on a new home.
Under the Fair Tax, there is virtually unanimous
expectation that interest rates will go down, and if interest
rates go down, then that means the debt service for a
comparable home would go down. If a person receives in their
paycheck 100 percent of what they earn, then they are better
able and equipped to pay the debt service that is applicable to
the home they choose to buy.
And, finally, under the existing law, research suggests to
us that it takes a person on average between 7 and 8 years to
save for the down payment on a new home. Under the Fair Tax,
since there is no tax on either the payroll level or the income
level, a person can save for that down payment in between 4 and
5 years.
So in considering all of those factors together, it seems
to us that the environment for purchasing new homes will be
improved, that it will not deteriorate, as suggested by the
analysis put forward earlier.
Chairman Archer. Are there any probative economic studies
that show what we might see in the decline of long-term
interest rates if the Fair Tax were adopted?
Mr. Linbeck. Yes, sir, there is a position paper that is
the product of the research effort that spells out the more
technical details of that. But the shorthand response is that
the tax wage is eliminated between tax-exempt and taxable
bonds. So it is assumed--and it seems to be appropriately so--
that the interest rates will come down at least by the
difference between taxable and tax-free bonds.
Chairman Archer. Well, would you estimate that to be 100
basis points, 150, 200? Or what range?
Mr. Linbeck. Well, in the current environment, that is
probably 175 to 200 basis points, and that is leaving aside the
risk issue, assuming the risk on the security is comparable as
between those that are compared. But, in addition, it is
commonly believed that there will be more money in the system
in order to provide additional capital, thereby driving
interest rates down still further.
One of the reasons driving that, of course, will be that
corporations that have earned income overseas who are now
deterred from repatriating it because of the tax that would
apply would be able to bring it back, thereby relieving the
burden that they currently place on the domestic capital
markets for the need for their cap ex expenditures.
Chairman Archer. Thank you.
Mr. Kleczka?
Mr. Kleczka. Thank you, Mr. Chairman.
I think the more we learn about this national sales tax
bill, the more questions are raised. Mr. Rooth, you have been
in the home-selling, home business, so you probably know more
about it than any member of the committee. Under this proposal,
it is guessed, hoped, prayed, that the price of the home is
going to go down about 20 percent, a newly constructed home is
going to go down by 20 percent, and so a 30 percent add-on
sales tax under this proposal won't be that burdensome.
In my experience around here--and I can cite right off the
top of my head--every time we put more dollars into student
loans and grants, we find that the more we give the kids to
help offset their educational costs, the more the tuition goes
up. Okay?
In your experience or in your knowledge of this bill, is
there anything that is going to guarantee that those homes are
going to go down by 20, 25 percent for new construction? I just
fail to believe that.
Mr. Rooth. Well, for someone to step forward and try to
crystal ball what the economic impact will be I think is next
to impossible. How an employer treats their wages I think is
difficult for us to predict. In certain conditions of labor, I
am sure that they will be maintained because of prior
contractual arrangements.
But I would say to you that in 1981, in 1986, and again in
1993, we tried to predict the outcome of changes in the tax
provisions and estimate what it would do to the rental income
or the residential real estate market and the commercial real
estate markets, and we were wrong on all three attempts, 1986
being almost a doom-and-gloom situation.
So I think it is difficult for anyone in our business to
predict the impact that this might have.
Mr. Kleczka. Well, we know one thing. If this would become
law, there would be a 30 percent add-on at closing.
Mr. Rooth. Right, and one of the things that concerns us a
great deal I alluded to in my oral comments, and that is the
impact of the services fee on every aspect of the closing of
the transaction, whether it be attorney's fees, title fees,
impact doc fees, appraisal fees, home inspector fees. There is
a plethora of different fees at closing in that transaction.
And for the first-time home buyer, that is a very important
component because we are looking at a down payment and what
they have to put to the transaction.
Mr. Kleczka. Are those fees taxed today?
Mr. Rooth. No, they are not.
Mr. Kleczka. Mr. Linbeck, what would be the business tax
under this proposal?
Mr. Linbeck. The business tax? There is no tax on business-
to-business transactions.
Mr. Kleczka. So it would totally repeal the corporate
income tax?
Mr. Linbeck. Yes, and also the----
Mr. Kleczka. So businesses would pay no tax at all.
Mr. Linbeck. That is correct.
Mr. Kleczka. How would a person be advantaged, let's say,
in the 15 percent income category or even 28 percent income
category? That person would not pay income taxes anymore, but
he or she would be paying 30 percent at minimum, and Joint Tax
tells the committee, to be revenue neutral, that tax would
almost have to approach 59, 60 percent. So how does a person
who currently pays 28 percent be advantaged by paying in excess
of 30 percent on every good and service that person needs to
survive?
Mr. Linbeck. That is a very good question, and it is one
that concerned us a great deal. And we spent an enormous amount
of time researching this, and we found that the person in that
income category today is paying the biggest tax in the payroll
tax, and the rebate tacked on top of the payroll tax in effect
brings that person to the point when they have to buy products
that no longer have the embedded income tax in them is
completely tax free at the poverty level and below. Those that
are above the poverty level continue to get the benefits on a
gradated basis.
Mr. Kleczka. That poorer person would get a rebate every
month?
Mr. Linbeck. Yes.
Mr. Kleczka. And so they would--right now I file a once a
year my taxes. In fact, today I mailed them in with a check,
okay? And, you know, I am not ready to commit hara-kiri. It is
something you have to do as an American citizen. But under this
new system, that poorer person would have to file something
every month to get their monthly rebate, would they not?
Mr. Linbeck. No, sir. Under the provisions as embedded in
the bill, they would make a request once a year to the Social
Security Administration, which request is a postcard with their
Social Security number on it. The Social Security
Administration runs that through the system to make certain it
is a valid Social Security number and that it has not already
been used. And then based on family size as promulgated by
Health and Human Services, the rebate is automatically
dispatched to them at the beginning of each month.
Mr. Kleczka. So every month they get a check, and there is
no--and it doesn't bear any relationship to their actual
purchases.
Mr. Linbeck. That is correct.
Mr. Kleczka. So for that month that they received a check,
for whatever reason they didn't buy much, but they,
nevertheless, get that same check every month.
Mr. Linbeck. That is correct.
Mr. Kleczka. Well, that is a heck of a deal. Could you
explain to the committee how this tax on local and State
government works? The authors of the bill didn't even realize
that the payroll of the municipalities would be taxed as
national sales tax. Now, maybe you know more about the bill
than the authors, but are you aware that payroll is taxed under
this proposal?
Mr. Linbeck. I am not aware of the specific mechanism by
which it is taxed. I am aware of the principle that the tax on
products that are consumed are taxed regardless of their origin
or who produces them. And in the area of Government services,
they are taxed just like if they were produced by the private
sector. But I am not personally familiar with the mechanics by
which that would----
Mr. Kleczka. So you are not aware that the payroll of any
municipality would have applied to it a 30 percent national
sales tax?
Mr. Linbeck. There is a paper that is prepared as part of
the information on the Fair Tax that deals with the
technicalities of that.
Mr. Kleczka. Well, that is more than a technicality. That
is a big, big liability for our municipalities. Right now if
you would exclude workmen's comp and unemployment comp, the
major contribution on that payroll by local municipal
government is the FICA tax. Well, that is going to be taken
off, and in lieu of, we are going to be asking Milwaukee and
Cleveland and all cities to pay 30 percent of their gross
wages. That is one big one for the property taxpayers in this
country. So they are shedding a 7 percent plus liability, and
we are replacing it with a 30 percent.
Mr. Linbeck. And that is a proper concern, and that is why
there was specific research done on that in order to make
certain that there was a level playing field as between
services provided by Government and services provided by the
private sector, the intent being that there would be no
differentiation between the tax outcome as between public and
private services.
I apologize for not knowing the specific technicalities of
it, but there is a position paper that has been prepared by
researchers----
Mr. Kleczka. Well, see, our dilemma is we are asked to
support this critter, and we have to know those things because
that is of big, big importance back home.
Mr. Linbeck. And I would encourage you, if there is any
prospect of your support, that you become familiar with the
technical side of it.
Mr. Kleczka. Well, that is more than technical. That is one
of the mainstays of this bill.
Mr. Linbeck. The principle is that there is a level playing
field of taxation as between public and private service
providers.
Chairman Archer. The gentleman's time has expired.
Mr. Kleczka. I thank the chairman.
Chairman Archer. Ms. Dunn?
Ms. Dunn. Thank you very much, Mr. Chairman.
I want to welcome you, gentlemen. Thank you for coming and
expressing your point of view. I think it is a fascinating
discussion, and we all have lots and lots of questions. And we
also have questions on behalf of the folks we represent at
home, so I think it is a wonderful opportunity for us to get
you all together.
Mr. Rooth, I wanted to ask you a question. In your
testimony, you said that you oppose the flat-rate flat tax that
has been discussed by folks as we reform the tax system, and I
was going to ask you, because in some discussions of that tax,
there are bills that would exempt interest deductibility, and
so that would still be provided. And despite that, you still
oppose the flat tax.
Mr. Rooth. It is difficult to oppose the ``flat tax''
because without a bill on the floor for me to speak directly
to, it----
Ms. Dunn. Well, just assume it is a flat tax with
deductibility continuing for mortgage interest and charitable
donations and maybe medical expenses.
Mr. Rooth. I would say that it is an issue that we would
take very serious looks at. There are economic impacts on
rental income housing, and home purchase would be the most
important thing that we would consider. I am also concerned
about transition issues in the depreciable items.
Ms. Dunn. And then when we were talking about the national
retail sales tax, did you say that you would expect a full
exemption for the purchase of homes because they would be
considered investments?
Mr. Rooth. In my comments to the chairman, we feel that the
purchase of a home, because of its significant nature, is an
investment.
Ms. Dunn. Do you prefer the current tax system for the
taxation of purchasing homes?
Mr. Rooth. Yes.
Ms. Dunn. Okay. Thank you.
I wanted to ask Mr. Linbeck, what are you finding out there
among folks you are talking with about the Fair Tax? Are you
finding a building consensus behind this as people begin to
understand how it works? And if you are finding that, what do
you see as the movement through the Congress? Are we now in an
education period? What do you see the process being for the
success of your program?
Mr. Linbeck. As I mentioned, we have conducted market
research for the last several years in order to discern what,
in fact, was the embedded attitude of the electorate in respect
to this issue.
Since we have learned what we believe that to be, we are
now involved in an educational effort. We expect over the next
30 to 90 days to ratchet that up to the extent that the 50
major markets in this country will be exposed to the
availability of the Fair Tax, and the whole thrust of the AFT
effort is to inform the electorate and then leave it up to them
to decide whether or not they wish to support it and manifest
that support through their contacting of the people that they
vote for.
I only vote for one Congressman and two Senators, and it
would be presumptuous of me to expect a response from people
for whom I don't vote.
But if they hear from enough of the people that send them
to Congress and they have a persuasive enough basis on which
they form their position, we think it is going to be a very
strong groundswell of support for the Fair Tax. Our research
suggests that. And most recently, when the four essential
elements that I shared in my oral testimony are known to the
electorate, over 70 percent of the people support it.
So we are very encouraged by that, but, again, we think the
success or failure of the Fair Tax undertaking will be the
degree to which the constituents in the grassroots in the
country become energized by the prospect of its passage.
Ms. Dunn. I think that is very realistic, and I guess I
would urge all of you who are involved in this discussion not
to give up hope that there may not be all the members of the
Ways and Means Committee here or that people aren't talking to
us out in the districts. The discussion is important, and as
part of the educating process, it has to be taking place now.
Frankly, I think that because we don't have a lot of time
left in this year, there is not a lot of legislative time,
because I am waiting for the freshness of the new
administration, I think there will be great attention paid to
this as we move through this year and move into next year.
But I think there are benefits of the Fair Tax, as there
are benefits of other forms of tax as replacements for this
totally outdated income tax system that we penalize people with
today.
Let me ask one more question, and whoever on this panel can
answer it, I would appreciate it. We have talked a lot about
the effects of the Fair Tax on border adjustment, and I am
wondering if somebody could address this once again in this
panel. How would products made in the United States benefit
from a national retail sales tax?
Mr. Linbeck. Well, I am not an expert in this or anything
else, but I will take a crack at it based on what I have
learned from our research. And it is a timely question in that
there has recently been a WTO finding that the existing
international trade vehicles that have been used by exporters
does not conform to GATT or the World Trade Organization rules,
thereby disadvantaging exporters under those rules.
It is our understanding and belief that in the regimen of
the Fair Tax, all of the embedded taxes occasioned by the
current system would be purged from their cost structure, and,
therefore, they would be able to export their products into an
international market on a much more competitive basis. And it
has been suggested in some of the companies with whom we have
visited who are heavily involved in export that the 20 to 25
percent lowering of their producer price would have a dramatic
impact on both their ability to increase their market share and
maintain their margins, but also penetrate new markets that
heretofore have not been available to them because of the tax
disadvantage that they are burdened with.
Mr. McCracken. If I could add just briefly, it will also
encourage businesses to continue to be in the United States and
to come to the United States to produce the products. It
creates enormous incentives to do things here as opposed to
abroad.
Ms. Dunn. That is a really good point. We have been stuck
with the FSC ruling right now, and some of the other problems
we have, the H-1-B visa cap and so forth that causes people to
start looking toward going overseas to be competitive.
Thank you very much. Thank you, Mr. Chairman.
Chairman Archer. Would it not also prompt the return of all
of the companies that have gone offshore for tax reasons that
are currently operating in tax havens like Bermuda and the
Cayman Islands and Aruba and other places?
Mr. Linbeck. Well, it is our belief that it would remove
the incentive for them to take that kind of a step. Whether it
would immediately cause them to return, only they could answer
that. But all of the incentive for them to be located in an
external domicile would be removed. And as a matter of fact,
all of the advantages of being domiciled in the U.S. would
return to them, which is a good skilled labor force,
availability of capital, good mature markets, and a secure
economic system. So my instinct is that the vast majority of
those who were driven offshore by virtue of the tax system
would return quickly.
Chairman Archer. Thank you.
Mr. Tanner?
[No response.]
Chairman Archer. Ms. Thurman?
Mrs. Thurman. Thank you, Mr. Chairman.
We have been given kind of a grouping of editorials that
have been written across the country in support of your tax or
replacement. One of the things that I found interesting,
especially because we are now sitting in a situation where we
have the Joint Tax coming in and saying it could be anywhere
between 30 to 57 percent, are we going to go back out and
resell this? I mean, when you talk about going nationally, are
you going to tell them about potentially this costing 30 to 57
percent?
Mr. Linbeck. Is that addressed to me?
Mrs. Thurman. That would be addressed to you, and it would
be addressed to the business--anybody that wants to respond to
this.
Mr. Linbeck. I will try to respond. Our objective is that
whatever the tax is, that it be revenue neutral. Our
undertaking of this effort was totally bipartisan. We have
undertaken the research on a bipartisan basis. All of our
polling was doing by a joint venture of a Republican and
Democratic pollster. Our commitment to the effort is that it be
consistent with two principles: that it be bipartisan and,
number two, that it be revenue neutral.
The research that we have received suggests the rate that
we have been promulgating. If at the end of the day and if the
base is consistent with what we understood to be the broadest
possible base the rate is higher, that is the rate that we will
use. We are not really trying to sell the rate but, rather, the
principle.
Mrs. Thurman. But it does sound much better to be able to
say a 23 percent sales tax versus a 30 or a 57 percent.
Mr. Linbeck. Absolutely, it does. And, also, one ought to
bear in mind that it is a replacement tax.
Mrs. Thurman. Correct. Let me just give you some examples
of some things, and any of you can talk about this. But we did
some calculations quickly just to figure out, say, a couple
making $50,000, using dependent care credit, with two children,
and they are using standard deductions. Their income tax would
be about $2,810; the employee's share on the payroll tax,
$3,825; employer share, $3,825--with a total of $10,460. That
sounds a little outrageous, I agree.
Then you go down, though, and you say the proposal is
consuming, say, 30 percent of the $50,000, or at a rate of 30
percent, which is the lowest rate that has been given tough, is
at about $15,000, and then the rebate, which would be the 0.23
times the 1,750, which would be the poverty, comes to a total
of about $11,078. So what you really would be is you would have
a net tax increase of about $618. So, actually, you would be
ending up paying more in a tax under a sales tax than you would
under the current system.
And then if you went to somebody--and then if you went to a
57 percent rate, which Joint Tax has said----
Chairman Archer. Would the gentle lady suspend for one
moment? My presence is now being mandated on the floor of the
House of Representatives, so I am going to leave for a while,
and Congressman Hulshof will preside.
Mr. Hulshof. [Presiding.] Thank you.
Chairman Archer. The gentle lady may commence. Sorry.
Mrs. Thurman. So then at 57 percent at $50,000, it is
$28,500. The rebate would be $3,922, with a tax of $24,578,
with the net tax increase then being $9,579.
I don't know how to particularly--then if you talk about
issues of taxing food and medical and drugs and all of those
kinds of things, how do I sell this to either the $50,000
person a year making $50,000 and/or the senior who is now going
to be picking up a cost that is not being shared by them? And
then you can go on with a $30,000 single mother.
I mean, simplification is good. I understand the reason.
But when you look at it from a dollar, a pure dollar, of who is
going to pick up the cost of this, I have some concerns in who
this is being shifted to. Maybe somebody can talk to me about
that because I need to be able to explain that at home.
Mr. Linbeck. If you are asking me----
Mrs. Thurman. Oh, whoever would like to take----
Mr. Linbeck. I will be glad to give you my thoughts on it,
and they consist of the--if the numbers are correct and someone
ought to be able to sit down with the person who understands
the Fair Tax and all of its complexity and simplicity and the
income tax and its complexity and simplicity and come to an
understanding of what the comparison is, then we ought to have
a common basis for moving forward.
In all candor, I couldn't follow all of the numbers in my
head to know what the variation may or may not be as between
the findings that were expressed----
Mrs. Thurman. It is based on two very simple things. One
would be the consumption of $50,000 at a 30 percent or 57
percent, depending on where we are under Joint Tax, and what
payroll--and what the difference would be what they paid a day
and what they pay under the--what your system would be
including the rebate. And it seems to be quite different.
Mr. Linbeck. I would encourage you to invite someone in who
understands the system and see if you can work through those
numbers with those persons, and it does not ring true to me,
based on what I have previously discerned from the research,
but it is very possible that we have made an error in it. And
if we have, that can be corrected. But if not, then that will
inform us all.
Mrs. Thurman. Then I would just say to you that I will be
glad to open my office if you would like to send somebody and
show me where we are wrong.
Mr. Linbeck. Well, I am not sure we can show you where you
are wrong, but we can show you where the calculations come out.
Mrs. Thurman. Thank you.
Mr. Hulshof. Mr. Portman?
Mr. Portman. Thank you, Mr. Chairman. And I want to commend
the panel for taking the leap off the cliff, with the exception
of our friend from the realtors who is not there yet, with at
least coming up with what I view to be a very creative and
innovative approach. I think it has problems, and I am going to
ask you about some of those problems. But our current system is
too complex, too complicated, and the compliance costs are a
big hit on our economy and individual Americans who are filling
out their taxes even as we speak. And then, finally, it does
penalize savings and investment in a way that is
counterproductive to economic growth. So we need a new approach
to taxes.
My concerns with the Fair Tax are some of those you have
already heard. I think the percentage that would be paid is the
key issue. It affects really so many other issues related to
it, including, of course, the compliance, the possibility that
there could be enormous compliance issues with the many
transactions which would occur every day. Also, of course, it
affects what the States might do. The States do tend to
piggyback on us. They do that with our Federal taxes. I think
they would tend to do it with this tax. And so the rate that we
are talking about, whether it is 24 percent or 65 percent--as
Pricewaterhouse has said, there is a range, depending on
compliance, depending on other assumptions about economic
growth. I think you have to add what the States are going to do
currently with regard to their income taxes and corporate
income taxes on top of that, and you end up having a fairly
onerous percentage. So that is one of the issues that I have,
and I won't get into that because I think you probably heard a
lot about that earlier this morning. And we can go back and
forth on what that percentage might be, but I think it is
important as to, again, so many other issues.
My understanding is that today about 60 percent of the
taxes are paid by the top 10 percent, somewhere between 55 and
60 percent. Is that your understanding? I am talking about
Federal income taxes, forgetting the payroll tax. You know,
people say we don't have a very progressive system. The top 1
percent pay about 25 percent of the taxes; the top 10 percent
pay about 30 percent of the taxes.
Have you all looked at the Fair Tax in terms of this
analysis? And it is really building on the question from the
gentle lady from Florida that you just heard. But what would
the top 10 percent of wage earners in this country pay as a
percentage of the Fair Tax?
Mr. McCracken. Well, I understand that--actually, that is a
very difficult question to answer because it is based not on
what you earn or what you are worth; it is based on what you
consume, on basically what you take out of the economy. So it
is going to vary widely. Bill Gates could pay billions of
dollars this year in taxes if he consumed that much, or he
could pay nothing in taxes this year if he chose to reinvest
everything he makes back into the economy into creating jobs.
So it is very different from the income tax, and it is hard
to look at in quite the same----
Mr. Portman. It is very different, but although the
analysis will depend on certain assumptions, it shouldn't be as
difficult as you indicate because Bill Gates will still get a
salary, so will Rob Portman, so will everybody else. And the
question is: Of the top 10 percent of wage earners, what
percentage will they pay in terms of the Federal sales tax?
Now, again, our current system is very progressive, and
this is one of the issues that all of us who are interested in
tax reform have to deal with. And those who think it is not,
again, I believe are wrong. When you get into tax reform, you
will find out it is very difficult to end up with the same
distribution you have now if you really believe in fundamental
reform unless you are going to go to a tiered system.
But I just wondered if you had a number on that, what the
top 10 percent of wage earners would pay as a percentage of the
Fair Tax?
Mr. McCracken. I don't. Do you want----
Mr. Linbeck. No, I have seen no data, to my knowledge,
there is no data available because it does, as Mr. McCracken
pointed out, depend on the behavior of the individual in
respect to their spending habits. And over a lifetime, one can
make those calculations with a reasonably high degree of
certainty, and it is my understanding that given the rebate and
the elimination of the payroll tax and the stripping away of
the tax embedded in products and services that we buy, the Fair
Tax will be as progressive if not more progressive than the
current system.
So, in general, that is the principle we think underlies
the plan, but we cannot tell you what the idiosyncratic outcome
would be for an individual taxpayer.
Mr. Portman. Well, I am not looking for the idiosyncratic
or individual. I am going on average. And you do have to make
certain assumptions, which I know you have made, with regard to
purchases, and GAO has done that and other groups have done
that over the years. It is very difficult to do. I know the
Treasury Department, I think under Ronald Reagan, tried to do
that. And where you have to start, is purchases and income. I
just think it would be helpful to know that, frankly, to be
able to respond to some, I am sure, of the critique that you
got this morning, and the most recent question indicates that
we will be concerned about that. There is with every
fundamental tax reform proposal, whether it is a flat tax, the
Fair Tax, or some hybrids that are out there.
A couple other questions, if I could. One, there is
obviously a compliance issue when you have got, let's say for
argument's sake, a 30 percent sales tax. There is going to be
an incentive for folks to figure out a way to barter or figure
out a way to deal with it outside the tax system that is not
there currently. In my own county, we have 5.5, 6 percent sales
tax, the counties that I represent, and taking it up to 30
percent is going to change people's behavior. So there is a
compliance issue there.
The bigger compliance issue that I worry about, though, is
the rebate. I look at the earned income tax system, where we
are told by the Treasury Department there is probably a 20 to
22 percent mispayment. Some would say that is fraud. Others
would say it is error. It is probably a combination of a lot of
things. But it is an enormously difficult rebate system for the
IRS to enforce. They aren't structured to do it.
Who would enforce your rebate system? You know, when you
get something in the mail, at the IRS now, that says I am
eligible for the EITC, for the most part a check then goes from
the taxpayers to that person because, frankly, it is very
difficult to audit and have appropriate compliance. When there
is auditing and compliance, it can get very difficult for the
agency that does that because you have millions of taxpayers
and, frankly, you are going into issues that are very intrusive
and personal to people in terms of their income. How would you
determine whether people who applied for the rebate deserve the
rebate?
Mr. Linbeck. Well, first of all, there is no means test. It
is a universal rebate. But the mechanism to implement the
rebate is driven by the Social Security Administration and the
use of the Social Security number. So if the subject person
seeks a rebate, they send a card to the Social Security
Administration on which they have placed their Social Security
number. If there are multiple beneficiaries of the rebate they
wish to claim, they list each of those Social Security numbers.
The Social Security Administration runs that through the
system to see if each of those are a valid Social Security
number, or if there are duplicates of that same number, that
triggers an inquiry as to who is the legitimate holder of that
number. That then triggers the rebate on a periodic basis every
month in an amount equal to the number of the tax times the
Health and Human Services determination as to the poverty level
for that size family.
Mr. Portman. Well, having----
Mr. Hulshof. I must say to my friend that your time is----
Mr. Portman. I am sorry. With the indulgence of the Chair,
let me just finish up that point and just say that it is much
simpler having just one flat rate based on whatever the poverty
rate is for that number of individuals. I will say, though,
there are still going to be major compliance issues, and we
ought not to overlook those and we should be concerned about
those.
I have lots of other questions, but, again, I want to
commend you all for taking the leap and for making this
innovative proposal.
Mr. Hulshof. The gentleman's time has expired. As I yield
to my friend from Texas, I know that one of the issues that he
has been pursuing quite vigorously in this committee is the end
of abusive corporate tax shelters, and I would suggest that
were the Fair Tax to be implemented and business income no
longer being taxed, it would eliminate these corporate tax
shelters that you have been so----
Mr. Doggett. I will have to take up another agenda, and I
am glad Mr. Linbeck is here to add support to that.
Mr. Hulshof. I yield to the gentleman.
Mr. Doggett. Let me begin, though, with my neighbor, Mr.
Martin. I appreciate the service that you provided our
community in central Texas, and I know that you are approaching
an age when Social Security is important to you and many of the
people that you work with. And one of the concerns that I have
about this, James, I was down at the Archives last week, and
just down from where the Declaration of Independence is there
for everybody to look at, they now have up a quote in
connection with an exhibit from Franklin Delano Roosevelt. And
the essence of it is that he set up a payroll contribution
system for Social Security so that every American would feel
that they have a stake in Social Security and that no
politician would ever be able to take that Social Security
system away from them.
Isn't there a danger, as you heard me ask the sponsor of
this measure this morning, that if we totally eliminate what
has become a burdensome payroll system, no doubt, but if we
totally eliminate that system, we may set up a way that those
who don't support Social Security will be able to undermine it
because no longer will each American feel that they are paying
in something specifically for that system?
Mr. Martin. Mr. Doggett, my own opinion on that is that if
the transfer system is done in a proper manner and it is clear
and it is able to be understood by the rank-and-file working
American, that they will feel secure with it. They will be
looking at overall totals, and they will be listening to
Congress and various administrations tell them how much is in
there and how long the fund is solvent for. And I think if
those numbers are consistent, I think that they will have the
same degree of either concern or satisfaction that they do now.
Mr. Doggett. I appreciate it.
Mr. Linbeck, I wish that we had more citizens that were as
interested in affecting public policy as you obviously are,
because I have heard from a number of constituents there in
Austin that you have either talked with personally or others of
this effort have talked to personally.
There are several concerns, and mine are similar to the
ones that I raised this morning also. I gather that you
envision that after this act is put into place, electronic
commerce will provide a significant source of Federal revenues.
Mr. Linbeck. It is our expectation that it would. The
expectation under the Fair Tax is that all terminal
transactions, by whatever distributional means, will be subject
to the tax. So that would be brick and mortar, Internet
transactions, and mail transactions.
Mr. Doggett. And your goal is to try to get this tax into
place just as soon as you can as a replacement for the income
tax.
Mr. Linbeck. Yes, sir.
Mr. Doggett. And so I gather, therefore, that you would not
support extending the Internet tax moratorium until 2006.
Mr. Linbeck. I would personally support not having any tax
on the Internet medium.
Mr. Doggett. Sure, the access.
Mr. Linbeck. The access.
Mr. Doggett. But I am talking about taxes on transactions.
Mr. Linbeck. But to tax the transaction, I would support
taxing immediately, as long as it was an evenhanded
application. I think the dislocation occurs and the unfairness
occurs when you have different means of distribution taxed on a
different basis, or at least not enforced in a uniform fashion.
We contemplate that under the Fair Tax there would be
uniform application of the tax so that everyone has a level
playing field from which to embark on their economic activity.
Mr. Doggett. I am accustomed, from my perspective, at
least, to getting advice from the majority leader, Mr. Armey,
that I consider to range from bad to worse. But I was listening
to his comments on Sunday about your proposal on Fox News,
which I am sure you saw----
Mr. Linbeck. No, sir, I didn't.
Mr. Doggett. Well, he was asked if he supported your bill,
and he said ``no, it doesn't work and, furthermore, it is
regressive and it adds inevitably to the tax code, making it
equally as complex as today's income tax.'' And he also said
that no country has ever made a successful change from an
income tax to a sales tax, and that when Canada went to a
higher sales tax, the use of cash in the Canadian economy
tripled in just 6 months. I am quickly summarizing the latter
part of his testimony. The first part was a direct quote.
I am just going to ask you if Mr. Armey has finally gotten
something right.
Mr. Linbeck. Well, I must admit, if the Fair Tax had the
attributes he ascribes to it, I wouldn't be for it. I don't
know what he is looking at, but the provisions that are
embedded in House bill 2525 do not appear, through my own
observation nor the research that has been undertaken, to have
those kinds of outcomes. I would certainly not be in favor of
any system that didn't have a preferential option for the poor.
And in my judgment, the Fair Tax is the only bill currently
being considered that represents that kind of an option.
Mr. Doggett. What about the specific issue--my last
comment, Mr. Chairman--that he raised? I know I covered a lot
of it, but greater reliance on a national sales tax in Canada
greatly increased the underground economy, and he specifically
said the use of cash in the Canadian economy tripled in just 6
months, as an indication of too much sales tax resulting in an
underground economy.
Mr. Linbeck. Well, I have no frame of reference for his
data. But it is my understanding that in Canada the problem
arose because they promised to eliminate the income tax and
replace it with a sales tax. When they passed the sales tax,
they kept the income tax as well. And if that is a correct
understanding of the facts, then it is not surprising to me
that people would take extreme measures to find whatever relief
from the burden that was imposed on them with both tax systems
that was available to them. But our research suggests to us
that there is no reason to believe that there would be a higher
incidence of evasion or leakage or cheating under a transparent
uniform sales tax at the Federal level than there is under the
present income tax system. And we have made no assumptions in
the body of the research that suggests that it would be less.
We have just assumed it would be the same.
Mr. Doggett. Thank you very much. And thank all of you.
Mr. Hulshof. Mr. Lewis?
Mr. Lewis. Thank you very much, Mr. Chairman.
Mr. Rooth, what would be the impact of this legislation on
minority home ownership?
Mr. Rooth. Excuse me, on which home ownership?
Mr. Lewis. On minority.
Mr. Rooth. Minority?
Mr. Lewis. Right.
Mr. Rooth. As we have stated earlier, and I have a handout
that I will be happy to include to any of the members that we
have done, that basically we find that minority spending is a
huge part of our economy here in housing, that the priorities
of home ownership are highest among minorities and far higher
than all Americans combined. Anything that restricts that
purchase, we are going to have great difficulty with.
The actual impact of this legislation on the first-time
home buyer or on minority home buyers is next to impossible to
predict. As I have mentioned earlier, we have been wrong in
every other prediction we have ever made. But I am very
concerned about the impact to such a large amount of our
population.
Mr. Lewis. Are you troubled by the possibility of a 30-
percent increase on renter apartments, on new home
construction?
Mr. Rooth. I am absolutely concerned with it on new home
construction because we have already demonstrated that there is
an excess cost of new home construction of 20 percent today. So
if we were to add another 30 percent to that, that could
conceivably be a 50-percent impact. But the rental housing
sector is probably what concerns me the most because if I can
rent you an apartment today for $500 a month, there is nothing
to say that I can tomorrow afford $650 or $700 a month because
I can't predict what the employer is going to pass on to me in
my paycheck. Unless I have a contract about my employment, I
cannot guarantee that I am going to get my full paycheck.
Mr. Lewis. Thank you, Mr. Rooth.
Mr. Linbeck, are you concerned that 2525 will impose an
increase, a dramatic increase on purchase of prescription
drugs, hospital bills, doctor bills, and nursing home care when
home care is already going higher and higher and you come and
you are suggesting that you are going to add more of a cost?
Mr. Linbeck. Yes, sir. I would be very concerned about it
if I believed that would be the outcome. I am persuaded by the
rigor and the intensity of the----
Mr. Lewis. But I want you to persuade me. I want you tell
me how we are going to, with 2525, how can we keep the cost of
prescription drugs, doctor bills, nursing home care from going
up, up, up?
Mr. Linbeck. In my judgment, the prescription drug issue,
as well as other health care issues, will be subject to the
same type of market forces, in terms of stripping away the
costs that are currently embedded therein by the current
system, thereby lowering the cost at the producer level, the
net outcome of which, we believe, based on the research we have
been given, is that the price that the consumer pays will not
be higher, including the tax, than it is today. But on top of
that, the purchaser of the products will have more money in
their pay environment. Their gross pay will be their net pay.
In addition, they will get the rebate in an amount equal to the
tax on essentials, and in most of the Health and Human Services
information, with which I am familiar, health care is a
component of the cost that they use in determining what the
cost of living would be for the poverty level.
So it is our understanding and belief that there will not
be a disadvantage, particularly to the poor, but rather an
advantage to the poor under the Fair Tax in purchasing the
essentials.
Mr. Lewis. But the costs of health care is not just
something that should be the concern of the poor, but is middle
income, working people, so much of their limited income is
going to try to pay doctor bills, and buy prescription drugs,
to provide nursing home care.
Mr. Linbeck. And it is our belief, Congressman, that those
costs at the producer level will come down. Let's look at that
particular doctor who is dispensing that care. They will no
longer have to administer the current tax system in the
management of their office. They will no longer have to keep
track of any of that information, so the compliance costs will
go down very substantially. It is expected that those costs
will be passed along to the consumer, to the patient that they
are treating.
Mr. Lewis. But if I am doctor running an office and I have
nurses and others assisting, I have to collect those taxes,
right?
Mr. Linbeck. Yes.
Mr. Lewis. But you do believe that health care should be
accessible, affordable and it should not be out of the reach of
any of our citizens. When you come along and put up another
tax, additional costs, you are moving health care further and
further away from working Americans.
Mr. Linbeck. If we believed that was the outcome, we would
be gravely concerned about it. We believe the outcome will be
contrary to that assumption, and that it will, in fact, not go
up in cost over where it is today.
Mr. Lewis. Thank you.
Mr. Linbeck. Yes.
Mr. Lewis. Thank you, Mr. Chairman.
Mr. Hulshof. Mr. Watkins?
Mr. Watkins. Thank you, Mr. Chairman. To a couple of you,
Mr. Rooth and Mr. Kouplen, I have a background in both of those
areas; first, in agriculture, as Mr. Kouplen knows, and then
later on in building and real estate. So I have got a couple of
questions I would like to take up with both of you.
I know in the agriculture area, a lot of us have worked
very hard because of blatant double taxation on estate tax,
trying to get more relief and more relief in that area, and we
have made some headway, but we have not got it repealed yet,
and we realize that is something a lot of farm families are
very interested in doing.
I also recognize, if we stop and look through I think in
detail, that if we have a tremendous just total change of
direction, agriculture would probably end up being in the tax
structure overall we could be hurt in agriculture a great deal.
So I think we have to be very careful on how we go into it.
A bill I am working on, and Ken Hulshof, my good friend
from Missouri, I know probably would be interested in this
bill, and I am working on it with staff and others. But one of
the things in agriculture right now, we have an age problem, a
population that is out there getting closer to 60 years of age,
and not only with that, it is very difficult for maybe their
offspring to enter, but along with that situation, many of them
cannot get out. Now, let me share with you it is a capital
gains situation. It is a fact that I know from experience.
I will use the example that maybe 30 years ago a farmer may
have bought land at $200 an acre. Today it may be $700 an acre.
He has been farming with the inflation of that land. And I
understand that. I have been there. I understand. And as a
result, now he is 70 years old. He cannot sell and pay capital
gains tax and pay his debts. He doesn't have the money, and so
he is locked. And these are some of the most patriotic,
hardworking, 15-, 16-hour-a-day families, husbands and wives,
out on that farm.
I am working on a bill that will allow us, hopefully, at
least what we are allowing for, $500,000 on a piece of real
estate--if you happen to have capital gains, you can go up
there--for that to be for a farm, home, and the surrounding
land. That would allow a lot of relief for a lot of farmers out
there if they were allowed to do just as our city cousins were
able to do with a $500,000 home. Now, I think we should get
hopefully a little bit better situation worked out than that,
but I am going to be going full bore trying to get something
like that.
Do you feel like that would be a great help to a lot of our
farmers? Now, I know you have got 2,000 acres, but you take
$500,000, for a lot of farmers, they have got several hundred
acres, and it would be a big help I think.
Mr. Kouplen. I think the Congressman is right on target
with that. As you know, the most appealing aspects of this
proposal is the elimination of the capital gains tax and the
death tax or estate taxes. And you know, as well as those of us
in agriculture, the situation that we have been in over the
last couple of years, is a very tough situation. We are a very
capital-rich industry and a cash-poor industry. And like you
say, the age of our farmers and ranchers in this country is
getting to be 60/65 years on average. When they do decide they
want to sell, they find out they have a silent partner in the
Government. A lot of them decide they cannot afford to sell.
Instead they hold on, and sooner or later when the death tax
situation arises, their heirs find out that they must sell a
great portion of it. This makes that farm economically
unfeasible because they have had to sell that much of it. just
to keep what is left.
So that aspect of it and compliance costs are the main
aspects that we like in this plan, and that is what we would
look for in the Farm Bureau in any plan that comes from your
committee.
Mr. Watkins. On that, let me say that I just don't foresee
an overhaul of the tax deal for some for several years. Maybe
when a new President comes in, there may be some opportunity
with the Congress and all to get something overhauled, but I
don't see it coming down otherwise.
Let me ask you about real estate, having been a builder. I
was sitting on the other side of the aisle when the Tax of 1986
came in. I told them it was probably the most un-American tax
bill that ever came down through here because, really, it was
nearly wiping out that opportunity of getting the home, the
American dream.
What kind of happened to the real estate industry right
after that? Are there any lessons that we should learn here? Do
we need something on the record?
Mr. Rooth. I think the most important thing that we learned
and the thing that we have got to focus on with any new tax
plan, and let me say that our membership is much in support of
the simplification, whatever it might be. Transition is a word
that I want each and every member of this committee to
remember. Because what we did not have in 1986 was a good
transition plan. Anything that happens overnight in a major
investment sector like real estate has the tendency and the
possibility of a severe impact and ripple on the economic
climate of this country. So I would encourage you, in any bill
that you do, that we have got to have adequate thought about
transition.
1986 was as severe as it was primarily because of the loss
of passive loss and some of the credit issues that came out.
But had we had a sound transitional period of 2 to 5 years, I
feel we could have survived it in a much better light.
Mr. Watkins. I think that is a very good point, as we look
at it.
Thank you, Mr. Chairman.
Mr. Hulshof. I thank the gentleman.
Mr. Watkins. He has been wanting to do that all along.
Mr. Hulshof. I appreciate the gentleman, and before I let
the panel go, just a couple of quick comments. I was flipping
through an old Farmer's Almanac recently, and I came across
this passage that said, ``If Patrick Henry thought taxation
without representation was bad, he should see it with
representation.''
[Laughter.]
Mr. Hulshof. And I think were this a town meeting back in
the 9th Congressional District of Missouri, if I were to take a
quick survey, as some of you talk about focus groups, probably
a third of those in attendance would invariably say, ``We like
the ideal, Mr. Linbeck, of such as H.R. 2525''; another third
might say, ``We like a flat income tax''; and the other third
is not yet sure of what sort of system they would like to go
to. But what that says is that two-thirds of those in
attendance think that we should do something radically
different than the present tax code.
Mr. Kouplen, let me just echo the comments of Mr. Watkins.
As the only son of a Missouri farm family, we continue to try
to work within the existing tax structure to make it easier to
pass that family farm on to the next generation. We put the
elimination of the death tax on the President's desk last fall,
as well as the capital gains rate and relief from the
alternative minimum tax, and unfortunately we didn't get that
tax relief to you. But we continue to work on those efforts.
Just two quick questions, Mr. Linbeck, because I need some
health in that proverbial town meeting that I have talked
about.
I think it makes economic sense, the argument that you have
made, that were we to move to this retail-type of tax, that
there would be pressure on interest rates to go down. And you
and the chairman, the real chairman, were discussing how many
basis points that would be, and yet I felt the same thing would
happen if and when Congress began to balance its books; that
is, to balance the Federal budget, that the pressure would be
on interest rates to come down.
And yet as we have seen the economy continue to expand, the
chairman of the Federal Reserve, and I am not being critical,
but in an effort to gain, get arms around the monetary policy,
the pressure has been just the opposite, that interest rates,
of course, have gone up. So what can you tell me, Mr. Linbeck,
that I can talk to my constituents about to assure them that
were we to make this fundamental reform, that we would, in
fact, see interest rates dropping rather than going in the
other direction.
Mr. Linbeck. The only comfort I could suggest in respect to
that, and bear in mind I am not Alan Greenspan, and I cannot
talk in terms that he talks in and perhaps that is a blessing
or not. You will have to make your own judgment on that. But in
my judgment, the fact that there will be a lot more money in
the capital markets by virtue of the issues that I raised;
number one, the repatriation of the earnings of corporations
who work overseas, they will be able to bring that money back
and no longer have to borrow from the capital markets to meet
their Cap X expenditures, the elimination of the tax wedge from
interest rates that exist today. There is no reason to believe
that people will not loan money at the tax-free rate that they
are loaning it today if there was no consequence to them having
done so.
And finally, when everybody gets their entire paycheck, let
us assume for the sake of discussion that the average person
has about a 23- to 27-percent withholding from their current
paycheck in the combination of payroll check and income tax
withholding, hereafter, they would get 100 percent of that in
their paycheck. If they only save 10 percent of that increment,
that is a 2-percent to 2.5-percent increase in savings on the
total payroll that we currently have in the country. That is a
very substantial incremental increase in funds to go into the
capital markets.
For those three reasons, I think it is reasonable to assert
that there will be a lowering of the interest rates coming out
of the Fair Tax passage.
Mr. Hulshof. Last question for you, and I know we have got
other panelists waiting and some on time constraints, so I will
cut my questioning short, but with this final question, and I
recognize in your written testimony, Mr. Linbeck, you talk
about charitable contributions.
Mr. Linbeck. Yes.
Mr. Hulshof. And I agree with you to the extent that I
think we are Americans, we are a charitable people. And when we
see that there are those that need, we open up our pocketbooks
or volunteer our time or our talents. And yet I also recognize,
as someone who itemizes our family, and I muddle through our
tax forms because I want the same experience that you have each
April 15th, but I also believe that there are some who are
motivated, perhaps to give to certain charities or certain
philanthropic organizations because of their ability to take
some sort of a deduction.
And so my concern is that there may be some significant
charities that all of us will continue to give to, but that we
might, the incentive is that perhaps there are some other
charities that we do make a donation to simply because we are
going to at least get at least a small tax benefit. Do you
believe that is not the case?
Mr. Linbeck. Well, obviously, we are concerned about that
prospect, and that is why we commissioned specific research on
that issue. It was instructive to me to learn that there was a
similar concern surrounding the infamous 1986 Tax Act that has
been referred to lovingly earlier.
It seems to me that the evidence that was put forth then
suggested from the charitable community that if they lowered
the rate to the degree which they were going to lower the rate,
that would have an adverse impact on charitable giving. As a
matter of fact, the exact opposite occurred. There was an
increase in charitable giving. There seems to be only one
direct correlation: the more money people have in their pocket,
the more money they give to charity.
I think it is also noteworthy that for the people who don't
itemize, the people who tithe to their church, and that is the
principal beneficiary of the eleemosynary activities at that
level, they are giving after-tax and after-payroll-tax dollars.
Just imagine how liberating it will be to them for the first
time to have their whole paycheck from which they can extract
those funds they wish to give to their church or the charity of
their choice. Our belief is, and the evidence suggests very
strongly, that if anything, there will be an uptick in
charitable giving, not a depressing impact from the Fair Tax.
Mr. Hulshof. Thank you, Mr. Linbeck.
Mrs. Thurman. Mr. Chairman, I have to comment on a comment
you made.
Mr. Hulshof. Surely.
Mrs. Thurman. Because, Mr. Kouplen, I just want you to
know, though, in 1997--even though the last tax package did not
get up to the President--the one in 1997 did, and it was a very
bipartisan act, and we did lower the capital gains, and we did
take care of some of the inheritance tax, and there are
floating proposals out there. So I just could not let that go
by.
Mr. McCracken. Can I add one more quick point on the issue
of the charitable deduction?
Mr. Hulshof. Mr. McCracken?
Mr. McCracken. It is important to realize that, in fact,
charitable giving would be tax preferred under the Fair Tax;
that is to say, you would not pay additional sales tax if you
gave money, as opposed to spending it. So you would pay a tax
if you spent the money. You wouldn't pay the tax if you gave to
a charity. And that is the case for a whole range of different
kinds of attributes we discussed here today, whether it is rent
or other things.
It is important to realize that anything for which there is
not a deduction in the Code now, it is essentially taxed
because we were paying for it with after-tax dollars. And so
just because it is taxed under the Fair Tax, doesn't mean it is
a brand-new tax that we are not paying right now.
Mr. Hulshof. I thank the panelists for your patience. You
are excused with the thanks of this committee.
I will call the next panel to step up, and I will yield to
the chairman, Mr. Archer.
Chairman Archer. The chair invites the next panel to be
seated at the witness table.
Gentlemen, welcome to the committee. Dr. Kotlikoff, I
understand you have pressing engagements elsewhere, so to
accommodate that, the chair will recognize you first, and you
may proceed.
STATEMENT OF LAURENCE J. KOTLIKOFF, PROFESSOR OF ECONOMICS,
BOSTON UNIVERSITY, AND RESEARCH ASSOCIATE, NATIONAL BUREAU OF
ECONOMIC RESEARCH
Mr. Kotlikoff. Thank you, Mr. Chairman.
Chairman Archer and other distinguished members of the
Committee on the Ways and Means, I am honored by this
opportunity to discuss with you the Nation's need for tax
reform and the role that consumption taxation, particularly a
Federal retail sales tax, could play in enhancing the economy's
economic performance and improving its distribution of
resources.
Chairman Archer. Dr. Kotlikoff, can I remind all of the
witnesses, again, if you will identify who you are and whom you
represent, in that event, before you start your testimony, for
the record, please.
Mr. Kotlikoff. I am Larry Kotlikoff. I am a professor of
economics at Boston University and a research associate of the
National Bureau of Economic Research.
Our Nation's economy has been performing remarkably well in
recent years, but our economic success is no reason to be
complacent about a tax system that is extraordinarily complex
and highly distortionary and that plays a critical role in an
overall fiscal system that is like to visit enormous burdens on
our children and grandchildren.
I think the Congress and the administration are under the
impression that our fiscal house overall, generally speaking,
is in good order; that we are running large surpluses and that
those surpluses are going to be enormous for as far as the eye
can see and that they are going to take care of the fact that
close to 80 million baby boomers are going to be retiring
starting in 8 years, and then in about 11 years, starting to
collect Medicare benefits on top of the Social Security
benefits they will be collecting in 8 years.
Well, that is not the case. Suppose you take more realistic
projections than the CBO baseline; namely, suppose you don't
assume that Federal purchases, as a share of GDP, will decline
by 20 percent over the next 10 years and by 30 percent over the
next 30 years. If you, instead, assume that Federal purchases
are going to, grow with the economy, then according to a
Federal Reserve and CBO generational accounting study that will
be published in the American Economic Review next month, we
cannot afford to cut taxes, as some of the members of this
committee advocate, and we cannot afford to raise spending, as
some other members advocate. Instead you need to have an
immediate and permanent 25-percent hike in the Federal income
tax in order to keep our children from paying even higher tax
rates.
Now, why am I saying all of this in the context of tax
reform? Well, the key distributional question that confronts
our country is how are we going to be treating the next
generation compared to ourselves. And consumption taxation has
the advantage that it will place a larger burden of paying for
the Government's bills onto rich and middle-class elderly, as
well as middle-aged people, and place less of the burden on
today's younger people as well as future generations.
Now, let me indicate why it is that a consumption tax would
be generationally more equitable. The reason is that the
current elderly and those who are about to retire, the baby
boomers, have one primary economic activity in front of them,
which is consuming. This is a fine activity, but it is not one
that is subject to federal taxation, apart from some excise
taxes.
So moving to a consumption tax would place a larger burden
on the elderly, in general. But the poor elderly, those who are
living off of Social Security, would be fully insulated from a
consumption tax because the Social Security benefits are
indexed to the Consumer Price Index. So what we are talking
about is asking the rich and middle-class elderly, who have
received enormous transfers over the years from Medicare and
Social Security to help bail out their children and
grandchildren.
A retail sales tax is a transparent consumption. Its
adoption would greatly reduce compliance costs because you
won't have an army of lawyers, and accountants, and tax
planners spending their entire working lives trying to lower
people's taxes. And you won't have people like me spending 3
days trying to get our tax returns together. That is a terrific
plus. An retail sales tax would also reduce enforcement costs
because the effective marginal tax rates will be lower.
We have had some discussion back and forth this morning
about how high the tax retail sales rates would be. And I think
that the number 59 percent has been cited, and the number 30
percent, and 23 percent. I think there is some comparison here
of apples and oranges. The 59 percent is a tax-exclusive
number, while the 30-percent number is a tax-inclusive number.
I think the right number to use here is the tax-inclusive
number because you want to compare it with the Federal income
tax, plus the payroll tax, both of which are calculated on a
tax-inclusive basis.
If you consider the Federal income tax and the payroll tax
for somebody who has low income, there is a 15-percent federal
income tax, plus a 15-percent payroll taxes (employer plus
employee). Also, a lot of low-income people get the earned
income tax credit, and when they earn a dollar, they lose
roughly 20 cents on the margin. So, effectively, they are in a
50-percent marginal tax bracket.
So, the comparison is 50 percent versus 30 percent for
those low-income people because the 30 percent is really what I
think a comprehensive retail sales tax at the Federal level
would generate in terms of a tax-inclusive rate that could be
compared with the alternative that we now have. And If you also
consider middle-income and high-income people, you find that
they are paying close to 40- to 50-percent tax brackets at the
margin.
So with a retail sales tax we would end up with a lower
effective tax rate because we are going to be broadening the
base. Consumption is a much bigger base than the payroll tax
base, and it is also probably as big as the income tax base
when you take into account all of the exemptions and deductions
from the income tax base. So in some fundamental sense, it must
be the case that effective tax rates if you are shifting to
taxing all of consumptions.
And in the process of broadening this base, we are going to
be eliminating all kinds of distortions. We talked about saving
distortions and labor supply distortions, but we are also going
to get rid of the lock-in effect on the sale of appreciated
assets, the subsidy to health insurance, which is helping to
speed up the rise in health care costs, differential tax
treatment of investment in different kinds of capital, the tax
advantage to debt versus equity, the marriage penalty, the
subsidy to home ownership. And I could go on, but you get a
sense that there are some major efficiency gains here to be
had.
Chairman Archer. Dr. Kotlikoff, sadly enough, your time has
expired sometime back. But if you want to add something for a
very short period of time, the chair will be glad to receive
it.
Mr. Kotlikoff. I appreciate that.
The knee-jerk reaction to the consumption tax by the public
is that it is regressive because the public compares
consumption to current income. But economists think lifetime
income is the correct resource measure, and consumption is
roughly proportional to lifetime income. So one should think
about a consumption tax as being a proportional tax. In
contrast, the payroll tax, which would be replaced under the
Fair Tax proposal, is regressive relative to lifetime income.
Take Bill Gates; his payroll taxes are a pittance relative to
his lifetime income.
The Fair Tax gets rid of a very regressive tax. It also
gets rid of the income tax, which is progressive on a lifetime
basis, but has lots of exemptions for certain activities that
the rich engage in more than the poor. All in all, I agree with
Leo Linbeck that the Fair Tax proposal, though I have some
suggestions to improve it relative to what is being proposed,
would improve intragenerational equity, and as I said, it would
certainly improve intergenerational equity. Hence the Fair Tax
would be a lot fairer than what we have now.
Thank you.
[The prepared statement follows:]
STATEMENT OF LAURENCE J. KOTLIKOFF, PROFESSOR OF ECONOMICS, BOSTON
UNIVERSITY, AND RESEARCH ASSOCIATE, NATIONAL BUREAU OF ECONOMIC
RESEARCH
Chairman Archer and other distinguished members of the
Committee on Ways and Means:
I'm honored by this opportunity to discuss with you the
nation's need for tax reform and the role that consumption
taxation, particularly a federal retail sales tax, could play
in enhancing the economy's economic performance and improving
its distribution of resources.
Our nation's economy has been performing remarkably well in
recent years, but our economic success is no reason to be
complacent about a tax system that is extraordinarily complex
and highly distortionary and that plays a critical role in an
overall fiscal system that is likely to visit enormous burdens
on our children and grandchildren.
The complexity of the tax code doesn't just drive taxpayers
crazy. It also costs them a significant amount of time--time
that could be spent working or time that could be spent
enjoying life. Having just spent three days doing my taxes, I
have a refreshed sense of the substantial costs to the man in
the street and the nation as a whole of complying with the
federal income tax code.
The distortions of our tax system also diminish the
nation's well being, but in ways that are less transparent.
Today, almost all American households are in combined federal,
state, and local marginal income tax brackets of roughly 50
percent. Because governments are collectively confiscating half
of every dollar most workers earn, most workers work many fewer
hours than they would were their tax payments independent of
their labor earnings. And since the government is confiscating
half of every dollar of income most savers earn on their non
tax-favored retirement accounts, many Americans choose to spend
today rather than save for tomorrow.
Tax Reform's Importance for Fiscal Sustainability and
Generational Equity
Eliminating complexity and distortions would be cause
enough for reforming the federal income tax, but there is a
much more pressing reason: notwithstanding recent wishful
projections about future government surpluses, our fiscal house
is not in order. Indeed, getting it in order would require not
cutting federal income taxes, as some in this chamber advocate,
but immediately and permanently raising them by over 25
percent. That assessment comes not from academia, but from the
Congressional Budget Office and the Federal Reserve Bank of
Cleveland. A joint CBO-Cleveland Fed generational accounting
study, to be published next month in the American Economic
Review, shows that such a tax hike is needed to achieve
generational balance--a situation in which our children and
grandchildren will face tax rates that are no higher than those
we face.
The 25 percent or greater requisite tax hike is derived
under the assumption that growth in federal purchases of goods
and services keeps pace with growth in the overall economy.
This responsible assumption can be contrasted with the
irresponsible one underlying the projection of very large
surpluses over the next few decades. The irresponsible
projection, whose surpluses are routinely cited by advocates of
tax cuts and spending hikes, assumes that, as a share of GDP,
federal spending will decline by 20 percent by the end of this
decade and by 30 percent by roughly 2040.
Who am I to say that the federal government won't shrink to
this extent relative to the economy? Just a parent of a two and
a nine year old who knows that such shrinkage is highly
unlikely and that basing policy on that assumption amounts to
gambling with our children's future--an enterprise worthy of
neither this Congress nor this administration.
Our long-term fiscal position is bleak for one
straightforward reason. Right now there are about 35 million
older Americans. But waiting in the wings are 78 million baby
boomers who will start collecting Social Security checks in
just eight years and Medicare benefits in just eleven years.
Over the next 30 years, the number of elderly will increase by
100 percent, while the number of workers will rise by only 15
percent. This enormous disparity in the growth of the number of
elderly and in the number of those who will support them would
be much greater still if the recently convened Technical Panel
of the Social Security Advisor Board is correct in its
assessment that the baby boomers will live substantially longer
then the government's actuaries now predict.
What does tax reform have to do with addressing the
generational imbalance in U.S. fiscal policy? Essentially
everything. To see this, let's start with what a tax reform
would tax. Since the federal government is currently taxing
wages and capital income, the only meaningful reform would
involve taxing consumption on a comprehensive basis (as opposed
to levying, as it currently does, a few excise taxes). And each
of the major tax reform proposals advanced in recent years does
precisely that.
The retail sales tax clearly taxes consumption. But so does
the Flat Tax. Just ask Robert Hall, one of the originators of
the proposal, who describes his Flat Tax as, effectively, a
Value Added Tax. A value added tax taxes output less investment
(because firms get to deduct their investment.) Now investment
equals saving, so taxing output minus investment is taxing
output minus saving, which is taxing consumption, since output
minus saving equals consumption.
The Flat Tax differs from a VAT in only two respects.
First, it asks workers, rather than firm managers, to mail in
the check for the tax payment on that portion of output paid to
them as wages. Second, it provides a subsidy to workers with
low wages. The first difference is one of form, not substance.
The second is more important, but doesn't negate the basic fact
that the Flat Tax taxes consumption.
So what does taxing consumption have to do with achieving a
generationally equitable fiscal policy? Again, essentially
everything. The reason is that the current elderly as well as
the baby boomers, who will shortly retire, have one primary
economic activity left to accomplish--consumption. And under a
consumption tax, they will pay a lot more in future taxes than
they would under the current tax system. Although the elderly
as a group would share in the burden of a consumption tax, the
poor elderly--those living exclusively on Social Security
benefits--would not because their benefits are indexed to the
consumer price level and are thus guaranteed in real terms.
To recapitulate, given the likely path of government
spending and the inevitable aging of our society, our children
and our children's children are in for extremely rough
sledding. Indeed, the CBO-FED study suggests they will face
lifetime net tax rates \1\ that are 80 percent higher than
those we face if nothing is done. This generational imbalance,
rather than the treatment of the rich versus the poor within a
generation, is the fundamental issue of economic justice facing
us today. Consumption taxation can address that issue by asking
the current and near-term elderly to do their fair share in
helping to achieve generational balance.
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\1\ The lifetime net tax rate is defined as the present value (to
birth) of taxes paid over the lifetime net of the present value (to
birth) of transfer payments received over the lifetime divided by the
present value (to birth) of lifetime labor income.
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Consumption Taxation and Economic Efficiency
Consumption taxation is needed not just to help our
children. It is also needed to simplify the tax code and reduce
effective marginal tax rates. The Fair Tax proposal is a case
in point. This proposed reform would eliminate both the
personal and corporate federal income taxes as well as the
payroll tax, and replace them with a federal retail sales tax
plus a rebate based on each household's demographic
characteristics. Compliance costs would be vastly lower under a
retail sales tax. So would, it seems, enforcement costs. The
reason is that a broad based sales tax, with no exemptions for
housing or any other forms of consumption, would feature much
lower effective marginal tax rates than those we now face and,
therefore, much smaller incentives to evade taxation.
The lower effective marginal tax rates under the Fair Tax
would also mean much smaller economic distortions than
currently exists. This reflects the proposition, which is well
known to economists, that the welfare costs of distorting
economic incentives rises with the square of effective marginal
tax rates.
In addition to substantially reducing saving and labor
supply distortions, a comprehensive retail sales tax would
eliminate a myriad of other distortions such as the lock-in
effect on the sale of appreciated assets, the subsidy to health
insurance associated with the deductibility of premium
payments, the differential tax treatment of investment in
different kinds of capital, the tax advantage to debt over
equity finance, the marriage penalty, and the subsidy to home
ownership.
Is Consumption Taxation Regressive?
Consumption taxation has a bad rap among the general
public. It's viewed as regressive when, indeed, it's nothing of
the sort. To economists, consumption represents the primary
measure of economic well-being. So it makes sense to compare
households' taxes with their levels of consumption to determine
whether those who are better off pay more than those who are
worse off. But consumption is financed not just by current
income, but by lifetime resources, which consists of lifetime
earnings, lifetime inheritances and gifts received, and initial
net worth. So comparing a household's taxes with its command of
economic resources requires comparing its taxes with lifetime
resources, not current income.
Since lifetime resources are either consumed or bequeathed
and since bequests will, themselves, ultimately finance
consumption, taxing consumption is like taxing lifetime
resources. If consumption is taxed at a fixed rate, as in the
case of the Fair Tax and the Flat Tax proposals, the
consumption tax will be proportional to lifetime resources;
i.e., the tax would be neither progressive nor regressive, but
rather proportional.
So if there were no system of taxation to begin with and we
introduced a consumption tax, someone with twice the level of
lifetime resources as someone else would pay twice the amount
of tax. But we aren't starting from scratch. Instead, we are
starting from a tax system with some very progressive and some
very regressive elements. When measured relative to lifetime
resources, the personal income tax is highly progressive, while
the payroll tax is highly regressive. And the corporate income
tax is essentially proportional to lifetime income since it
reduces the net returns to all households no matter the size of
their lifetime resources. The fact that the current tax system
is not strongly progressive and may even be regressive is the
reason that moving from the current system to the Fair Tax,
with its progressive rebate, could end up raising the overall
degree of tax progressivity.
The lifetime resource perspective leads naturally to
comparisons of tax burdens within a cohort, since the lifetime
resources of the young and old will be quite different simply
because of their ages. Among the elderly, the Fair Tax would be
particularly progressive because a federal sales tax would
lower the purchasing power of the rich elderly who live off
their assets, but not the poor elderly, whose primary means of
support--Social Security benefits-would be automatically raised
in response to a sales-tax induced increase in the price level.
Hence, the Fair Tax features not just a demographic rebate, but
also, implicitly, a rise in Social Security benefits. If
government transfers to the poor young were also effectively
indexed to the price level, the adoption of the Fair Tax would
also trigger a rise in those transfer payments as well.\2\
---------------------------------------------------------------------------
\2\ This sentence and the one preceding it assume the price level
will rise with the adoption of the Fair Tax. If the Federal Reserve
used its monetary policy to maintain the consumer price level, the
adoption of the Fair Tax would entail a decline in the level of
producer prices and, thus, the nominal wages and capital income
received by productive factors. Under this scenario, government
transfers, if they weren't reduced in nominal terms, would end up
maintaining their purchasing power, while factor payments would not.
I.e., the same real redistribution toward the poor would arise.
---------------------------------------------------------------------------
Were the very staid and well established businessmen and
women who advocate the Fair Tax to proclaim that their tax
reform 1) levies a tax on the holdings of wealth, 2) provides a
highly progressive tax rebate, and 3) implies an increase in
Social Security benefits and, most likely, transfers to the
poor, they would probably be viewed as members of a vast left-
wing conspiracy. But this is precisely what they are
recommending.
The fact that a consumption tax is, in part, a tax on
wealth is well know to public finance economists, but not to
the general public. The reason is that when a consumption tax
is levied, it lowers the amount of actual consumption that can
be purchased with a given amount of wealth since some of the
wealth must be spent on the consumption taxes. Stated
differently, the imposition of a consumption tax visits an
immediate real capital loss on wealth holders because their
assets no longer have as large a claim on current or future
consumption.
My sense is that the Fair Tax would be more progressive
than the current system when assessed on a cohort-by-cohort
basis and measured relative to lifetime income. However,
knowing the actual degree to which the Fair Tax would enhance
intragenerational progressivity requires additional empirical
research based on lifetime models of consumption and saving.
Such research is now underway, and I would expect that a year
from now we'll have a pretty clear picture of the policy's
potential impact on the distribution of resources within each
generation.
The Long-Term Impact of Consumption Taxation on the Economy
In contrast to the limited empirical analysis of
consumption taxation that has been conducted to date,
consumption taxation has been studied extensively with large-
scale life-cycle simulation models. My own research and that
with Alan Auerbach, Cleveland Fed David Altig, Kent Smetters,
and Jan Walliser indicates that the Fair Tax would raise the
economy's living standard over the long term by roughly 15
percent.\3\ This long-run increase in output is generated by a
major long-run increase in capital formation and a modest
increase in labor supply.
---------------------------------------------------------------------------
\3\ See Kotlikoff, Laurence J., ``Replacing the U.S. Federal Tax
System with a Retail Sales Tax--Macroeconomic and Distributional
Effects,'' mimeo, December 1996 and Altig, David, Alan J. Auerbach,
Laurence J. Kotlikoff, Kent Smetters, and Jan Walliser, ``Simulating
Fundament Tax Reform,'' forthcoming, The American Economic Review,
2001.
---------------------------------------------------------------------------
Part of the reason that consumption taxation stimulates
saving and labor supply is its improved incentives to work and
save. But the primary reason involves the shifting of fiscal
burdens away from young savers and onto old spenders. It is a
little know, but extremely important fact that the elderly in
our country have much higher propensities to consume out of
their remaining lifetime resources than do the young and
certainly than do the unborn, whose propensities to consume in
the present is, of course, zero. The fact that the elderly
consume their remaining resources at a higher rate than other
generations is precisely what the standard economic theory of
saving--the life cycle model of Nobel Laureate Franco
Modigliani--predicts. This explanation for this prediction is
intuitive; the elderly are closer to the end of their lives
than are the young and are, therefore, running short on time to
spend their resources. To compensate, they have to spend at a
faster rate.
As described in Gokhale, Kotlikoff, and Sablehaus (1996),
essentially all of the decline in the rate of U.S. saving in
the postwar period can be traced to the government's five-
decade long policy of taking ever larger sums from the young
and giving them to the old.\4\ This intergenerational
redistribution, carried out primarily through Social Security,
Medicare, and Medicaid, has led to a dramatic rise in the
absolute and relative consumption of the elderly. Since 1960,
for example, the elderly's share of economy-wide consumption
has increased more than four times fast than has their share of
the population. Typical 70-year olds are now consuming roughly
twice the amounts consumed by typical 30-year olds. In 1960, by
contrast, 70-year olds consumed less than three quarters of the
amounts consumed by 30 year olds.
---------------------------------------------------------------------------
\4\ Gokhale, Jagadeesh, Laurence J. Kotlikoff, and John Sablehaus,
``Understanding the Postwar Decline in U.S. Saving: A Cohort
Analysis,'' The Brookings Papers on Economic Activity, no. 1, 1996,
315-90.
---------------------------------------------------------------------------
In shifting to a consumption tax, the U.S. would shift more
of the tax burden onto the current middle class and rich
elderly and partly reverse the postwar process of taking from
the young and giving to the old. In addition to depressing
national consumption and raising national saving, the switch to
consumption taxation would, as indicated above, ameliorate our
grievous imbalance in generational policy.
The simulation studies also show substantial long-run
welfare gains for all lifetime income classes from switching to
consumption taxation. Indeed, under the Fair Tax, the initial
upper income elderly are the only ones to suffer welfare losses
during the transition.
Tax Rates
Simulation analysis and a variety of empirical calculations
suggest that the retail sales tax rate needed for revenue
neutrality under the Fair Tax, assuming no decline in the real
value of government purchases, would be roughly 30 percent when
measured on a tax-inclusive basis. This tax rate could be
expected to decline by 3 or so percentage points over time as
the economy expands. Moreover, if the Fair Tax were structured
to include the consumption of existing housing services in its
tax base, the initial Fair Tax rate would probably be about 3
percentage points lower. This could be accomplished by
assessing the tax on the imputed rent on housing, where the
calculation of imputed rent is based on a fair market valuation
of housing real estate. This valuation could be done by local
municipalities in the course of appraising houses for local
property taxes.
A tax-inclusive consumption tax rate of 30 percent
translates into a tax-exclusive consumption tax rate of 43
percent. While the 43 percent rate sounds very high, proper
comparison of the Fair Tax tax rate with the current payroll
and income tax rates requires evaluating the consumption tax
rate on a tax-inclusive basis. Even a 30 percent tax rate may
sound like a high rate. But one needs to bear in mind that
middle and upper income households in America are typically in
combined income tax and payroll tax marginal tax brackets of 40
percent or more and that low income Americans are typically in
even higher tax brackets once one considers the phase out of
the earned income tax credit. Hence, given the state of U.S.
marginal taxation, 30 percent is a low number.
Transition Issues
Shifting to a consumption tax requires thinking carefully
about transition issues. In the case of the Fair Tax, one would
want to make sure that the vast sums that have been accumulated
tax free in retirement accounts not avoid taxation. How this
could be accomplished fairly and quickly is not altogether
clear. But what is clear is that the large amount of revenue to
be raised here could help limit the size of the Fair Tax Rate.
Note that this problem doesn't arise under the Flat Tax because
the Flat Tax maintains an explicit tax on labor income and
retirement account withdraws are included in the labor income
tax base.
While the Flat Tax deals with this transition issue much
more easily than does the Fair Tax, the Fair Tax avoids the
potential for special transition rules that would favor
existing business capital under a Flat Tax and, thereby,
dissipate the tax's implicit taxation of existing wealth.
Transparency and Perceived Fairness
The Fair Tax would be easily understood by the general
public, and it would be clear to all that everyone--rich and
poor alike--pays the tax. In contrast, under the Flat Tax,
wealthy individuals who have no labor income will appear to be
paying no tax when, in fact, they will implicitly do so through
the revaluation downward of the market value of their assets,
assuming no special transition rules in behalf of those assets.
Conclusion
The Fair Tax has a lot to recommend it. It would most
likely help the poor more than the rich. It would substantially
improve the economy's economic performance. It would save
Americans enormous amounts of time complying with the
bewildering provisions our current tax code. And it would
redress the grave intergenerational imbalance America still
faces with respect to its fiscal policy.
Chairman Archer. Thank you, Dr. Kotlikoff.
Mr. Wilkins?
STATEMENT OF JOHN G. WILKINS, MANAGING DIRECTOR, BARCROFT
CONSULTING GROUP, ON BEHALF OF THE NATIONAL RETAIL FEDERATION
Mr. Wilkins. Thank you, Mr. Chairman. My name is John
Wilkins. I am managing director of the Barcroft Consulting
Group, and I am here on behalf of the National Retail
Federation. My statement reports on the findings of a
PricewaterhouseCoopers study, of which I was principal author.
Nine years ago, Mr. Chairman, I testified before this
committee on international competitiveness, and I observed that
a greater reliance on taxing consumption and a lesser reliance
on taxing income would be healthy for the economy. I continue
to hold that view, but I do not subscribe to abandoning the
income tax altogether and replacing it with a sales tax. Our
study shows that there could be very harmful results in the
short run as a consequence of that action.
In the early 1990s, Coopers & Lybrand undertook to develop
an economic model that combined the personal income tax and the
corporate income tax models that are used by the Joint
Committee of Taxation's staff and the Treasury's staff for
revenue-estimating purpose, combining those with a large-scale
macroeconomic forecasting model, retaining the best features of
all three models.
Unlike many other models, the model includes foreign trade
and other international transactions. The model permits the
economy to be in disequilibrium, which is important during
transition periods. The model's database includes 100,000
households and 15,000 corporations; whereas, other models
sometimes have only a handful or sometimes only one. The model
tracks 85 different industries, producing 85 different
products.
However, the most distinguishing feature and important
characteristic of the model is that it focuses on the near
term. It forecasts detailed information on the performance of
the economy on a year-by-year basis as the economy makes the
transition to a national sales tax regime. And the model shows
that this transition may not be nearly as smooth or as simple
as we may like.
Much of the discussion today surrounding the sales tax is
centered on the tax rate. On the usual tax-exclusive basis of
State sales tax rates, the rate for H.R. 1467 would be 18.8
percent if there were 100-percent compliance, there were no
exemptions or transition rules and only revenue and not the
budget were required to be kept in balance. The Fair Tax rate
would be somewhat higher because it also repeals the payroll
tax.
Since tax changes will affect the spending side of the
budget, as well as the revenue side, a more meaningful measure
of budget neutrality would raise that 18-percent rate I
mentioned to 24 percent. However, that rate would still rely on
what I would consider an unrealistic assumption that compliance
will be 100 percent. If compliance turns out to be no better
than it is under the Federal income tax, then that rate would
have to go up further to 29 percent. And if financial services,
rental housing and employer-provided fringe benefits are taken
out of the base, as many believe would eventually be the case,
then the budget-neutral tax rate goes up to 37.5 percent. Last,
if States add on their income tax and their sales tax in a
piggyback fashion, which would undoubtedly be the case, then
the rate facing consumers would be 53.6 percent and could rise
to 64 percent, if compliance slips down to the level applicable
to proprietors' income.
In the long run, the economy will perform better under a
sales tax. By 2010, we predict that real GDP would be up some
$178 billion, real personal consumption will be up $16.5
billion, national savings will be up thanks to higher personal
savings and higher corporate savings. These salutary
accomplishments are similar in direction, if not magnitude, to
the long-term findings of other studies you will hear about.
It is the short-term results, however, that concern me. In
the short run, there will be a speed-up of consumer purchases
in anticipation. This will cause a temporary economic downturn
when the tax actually becomes effective. The economy will
shrink by 1.1 percent in the first year of the tax and GDP will
remain below the baseline until the fourth year. Personal
consumption will be lower, in real terms, until the ninth year;
corporate profits will be about 2 percent lower, on average--
although some will be higher and some will be lower than that
throughout the tenth year. After that period, we see profits
rising. Employment will be lower than expected through the
fourth year of the tax with 1.5 billion jobs lost; prices are
predicted to rise by roughly the tax rate, although eventually
the price rise will subside as the economy picks up steam; and
investment will increase some 7 percent, with roughly a third
of that financed by foreign capital. Corporations will finance
about half of their new investment through retained earnings.
In conclusion, keeping within my 5 minutes, Mr. Chairman,
while it is important, very important, to seek a fairer and
simpler tax structure--as you have explained--to replace the
incredibly complex code we have today, swapping the income tax
for a sales tax is an experiment that could bring our
flourishing economy down. It is not one we ought to be trying
now.
Thank you, Mr. Chairman.
[The prepared statement follows:]
STATEMENT OF JOHN G. WILKINS, MANAGING DIRECTOR, BARCROFT CONSULTING
GROUP, ON BEHALF OF NATIONAL RETAIL FEDERATION
Mr. Chairman and Members of the Committee:
I am managing director of the Barcroft Consulting Group and
I am here on behalf of the National Retail Federation. My
statement reports on the findings of a study undertaken by
PricewaterhouseCoopers (``PWC'') for the National Retail
Federation Foundation. I was principal author of that study,
which examines the economic impact of substituting a national
retail sales tax (``NRST'') for the federal income tax.
Introduction
Nearly nine years ago, I testified before this committee on
the issue of international competitiveness and the role of
income taxation. In that statement, I noted that the United
States relied less on consumption and more on income taxes to
finance government than virtually all of the other
industrialized nations--even when state retail sales taxes are
included in the equation. Although our income tax structure is
by no means a pure income tax--having some elements of a
consumption tax mixed in with an income tax--I nonetheless
observed that a greater reliance on taxing consumption and less
reliance on taxing income, would be healthy for the economy by
spurring savings and helping keep income tax rates low. That
was 1991 and this is 2000. And I continue to hold that view.
While I applaud the desire of the chairman to replace the
current tax code with something that is simpler and fairer, I
do not, however, subscribe to abandoning an income tax
altogether and replacing it with a national sales tax. As our
study shows, this could have very harmful short-term and mid-
term economic results. In light of the remarkable economic
achievements of the past decade, it would be foolish to simply
get rid of a tax structure under which the economy is
flourishing and replace it with an untried system with
uncertain economic consequences.
The PWC study, largely completed last year when I was
director of PricewaterhouseCoopers' national economic
consulting group, focuses on the economic impact of replacing
the income tax with a national sales tax similar to the Fair
Tax proposal. The proposal examined was H.R. 1467 rather than
H.R. 2525, which had not been introduced at the time of the
study. One significant difference is that H.R. 1467 does not
repeal federal payroll taxes while the Fair Tax, H.R. 2525,
does and consequently requires a higher tax rate.
What follows is a discussion of (1) why the PWC dynamic
model is particularly capable of recognizing the effects of a
national sales tax on the economy in general and on retailers
in particular; (2) why the proposed national sales tax rate
could eventually be much higher than proponents advertise due
to likely exclusions, the need for budget neutrality, and
transition rules; and (3) what impact this kind of tax would
have on short-term and long-term economic growth, consumption,
corporate profits, employment, and trade.
The Dynamic Estimating Model
In the early 1990s, Coopers & Lybrand undertook to develop
an economic model that was missing from the arsenal of tax
analysis tools available to government economists and others
concerned with the potential economic impact of fundamental tax
reforms. The traditional microsimulation models used by the
staff of the Joint Committee on Taxation (``JCT'') and the
Treasury Department's Office of Tax Analysis for revenue
estimating purposes are based on large samples of individual
and corporate taxpayers and consequently are ideal for
analyzing the impacts of tax law changes on the taxpayer
population. These models are not, however, capable of analyzing
the impact of fundamental tax reforms on the economy. For such
analysis economists turn to macroeconomic models.
Unfortunately, macroeconomic models are rarely designed for tax
analysis: they frequently have only two or three producing
sectors; some have only a single household or a handful of
households to represent the entire population of taxpayers and
consumers; and most examine the economy only when it is in
equilibrium, with labor and other resources artificially
restricted to be at full employment.
The PWC model was designed specifically for analysis of tax
reforms, such as the replacement of the income tax with a NRST.
In order to retain the benefits of the microsimulation models
used by the JCT and the Treasury, the PWC model has three
prongs, incorporating two microsimulation models with a
macroeconomic forecasting model. The two microsimulation models
are an individual income tax model with 100,000 separate tax
return records and a corporation income tax model with 15,000
synthetic tax return records. The third prong of the overall
model is a macroeconomic forecasting model that provides year-
by-year short-term forecasts of the economy as well as mid-term
and longer-term forecasts. Importantly, the PWC model has the
following traits that distinguish it from most other models:
The PWC model contains an open economy, allowing
changes in foreign trade, cross-border investment flows and
exchange rate adjustments. Many models are restricted to closed
economies that ignore the existence of foreign trade and other
international transactions.
The PWC model permits the economy to be in
disequilibrium during transition periods. Most other models
artificially force the economy to always be in equilibrium,
with no unemployment of labor and other resources--even during
periods of transition from an income tax to a sales tax.
The PWC model's database includes records for
100,000 households and 15,000 corporations. Most models include
only a handful of households and corporations. Sometimes only
one household represents the entire household sector.
The PWC model tracks 85 different industries,
producing 85 different products for intermediate and final
sales.
Most models represent the entire producing economy with
only two or three industries frequently producing only two or
three different classes of goods.
The most important distinguishing characteristic of the PWC
model is that it focuses on the near and intermediate term. The
key feature is the model's ability to forecast detailed
information on the performance of the economy on a year-by-year
basis as the economy makes the transition from an income tax
structure to a sales tax structure. The PWC model shows that
this transition is not nearly as smooth and simple as some
sales tax proponents would like. It is this ability of the
model to provide short-term transition results on an annual
basis that provided the main impetus for its construction.
The PWC model has been used successfully to evaluate a wide
range of tax proposals, from the recommendations of the Kemp
Commission to the national sales tax. The model was also used
to produce dynamic revenue estimates for the January 1997
symposium on dynamic revenue estimating sponsored by the staff
of the Joint Committee on Taxation.
Required Tax Rates
Much of the discussion surrounding national sales taxes
centers on the required tax rate. This rate depends obviously
upon the tax base--all consumption or some portion of
consumption after certain exclusions. It further depends upon
the amount of taxes to be replaced on a neutral basis. It also
depends upon the degree of compliance--100 percent or some
lesser fraction as is the case with the income tax. Lastly, it
depends upon mitigating provisions such as increased social
security benefits for the elderly designed to prevent too much
double taxation of their lifetime earnings, family allowances
designed to prevent some of the associated redistribution of
tax burden and other transition rules designed to lessen short-
term economic disruptions.
Tax Exclusive and Tax Inclusive Tax Rates. The discussion
of tax rates is confused by the practice of proponents of the
NRST to couch the rate in so-called tax inclusive terms. Sales
tax rates are usually considered on a tax exclusive basis.
Under this normal tax exclusive concept, for example, a $30 tax
on a $100 item is considered to represent a 30 percent tax
rate. The consumer would pay the retailer $130, $30 of which
would be forwarded to the tax authorities.
Proponents of national sales taxes like to measure the tax
rate in this example by dividing the $30 tax by the tax
inclusive price, which is $130. The tax rate calculated this
way would be only 23 percent (30/130). Under the tax inclusive
rate concept, confusion is likely to arise when a customer is
quoted a 23 percent tax inclusive rate on a $100 purchase and
finds the sales clerk asking for $130.00 ($100 plus $30 tax)
rather than the expected $123.00 ($100 plus $23 tax). The
confusion will be reinforced by the fact that all state sales
taxes are always quoted on the normal tax exclusive basis.
Revenue Neutral vs. Budget Neutral Tax Rates. A second
concern in determining the appropriate rate for a national
sales tax that would replace other existing federal taxes
involves the concept of neutrality. Most believe that any
replacement tax ought to be neutral: the government should be
left as well off under the replacement tax as it is under the
current tax structure. Independent of its political appeal,
neutrality focuses the spotlight on the economic pluses and
minuses that could result from restructuring the tax system as
opposed to the consequences of making the government bigger or
smaller, which can be done without restructuring the tax
system.
There are two ways to identify neutrality (revenue and
budget) and two ways of measuring neutrality (static and
dynamic). Revenue neutrality means that the replacement tax
raises the same revenue as the current tax. Budget neutrality
means that the replacement tax leaves the overall budget
surplus (or deficit) unchanged. Budget neutrality is the better
measure because it recognizes that, by influencing the price of
government purchases, interest rates, or transfer payments, for
example, tax changes can affect the spending side of the budget
as well as the revenue side.
Static measurement of budget neutrality fails to take
account of how a replacement tax influences the budget by
accelerating or retarding economic growth. Dynamic measurement
of budget neutrality corrects this shortcoming by taking into
account macroeconomic effects, such as a short-term change in
the level of employment, that can affect government spending
and revenue. The dynamic measure of budget neutrality is the
most meaningful concept for a replacement tax.
These concepts can be illustrated as follows. According to
the PWC model, a very broad-base national sales tax, such as
the Tauzin-Traficant proposal to replace the current federal
personal and corporate income taxes, the federal estate and
gift tax, and most federal excise taxes would require a tax
exclusive rate of 18.8 percent under the somewhat unrealistic
assumption of 100 percent compliance and revenue neutrality.
This rate would be a 15.8 percent rate on a tax inclusive
basis, reasonably close to the 15 percent claimed by the
sponsors. In order to maintain budget neutrality--even on a
static basis--the rate would have to be raised from 18.8
percent to 24.5 percent. This is because the federal government
would want to fully maintain the purchasing power of all
transfers payments (social security, welfare, unemployment,
etc.) in order to protect the elderly, the poor, and other
transferees. In order to do so, these transfer payments must be
increased by the amount of the tax on the goods and services
they would purchase. Holding recipients of federal government
transfer payments harmless in this manner while maintaining
real federal spending on goods and services requires a budget-
neutral NRST rate of 24.5 percent (or 19.7 percent on a so-
called tax-inclusive basis)--still figured at an unrealistic
100 rate of compliance.
On a dynamic basis, this 24.5 percent budget neutral tax
rate could be lowered slightly to 24.1 percent by the tenth
year of the tax, thanks to a somewhat improved economy;
however, there are still other concerns involving base erosion
and compliance that need to be factored in before an ultimate
budget neutral tax rate can be determined.
Compliance. Most experts concede that it is difficult to
estimate the rate of compliance under a NRST. What is not in
dispute, however, is that the compliance will be lower the
higher the NRST rate. Moreover, while state sales tax rates
appear to have relatively high rates of compliance, these
compliance rates are not comparable to the NRST. State sales
tax compliance is high because the sales tax rates are
relatively low--typically 4 to 6 percent--and their tax bases
are relatively narrow. Unlike the value added tax, there is an
incentive on the part of both consumers and sellers to avoid
the tax. Individuals could easily avoid the NRST in a number of
ways, such as disguising personal consumption expenditures as
business costs that would not be subject to tax.
If tax compliance is no better than the 83 percent overall
compliance rate under the federal income tax, the budget
neutral tax rate would have to be raised from 24.1 percent to
29.0 percent. If compliance matches compliance rate for
proprietors under the federal income tax, then the budget
neutral rate would be raised another 5.9 points to 34.9
percent. Keep in mind that the compliance rates under the
income tax are strengthened by forced compliance of withheld
tax on wages and by numerous checks and balances payer-provided
information returns and audits.
Exemptions and Allowances. Many have observed that
enactment of a NRST would encourage many special exemptions
from the base. Three of the most frequently mentioned are:
removing consumption of financial sector services
entirely from the base, since the taxation of such services is,
at best, extremely complicated and would be difficult to
administer;
removing rental housing services and the resale of
existing homes from the tax base so as to continue a current-
law tax preference and to mitigate problems arising from
unequal treatments of owner-occupied and rental housing; and
removing employer-provided fringe benefits from
the tax base so as to vastly simplify the tasks of businesses,
which would otherwise be untaxed.
The effect of removing these items from the NRST base would
cause the budget neutral tax rate to rise to 37.5 percent with
compliance equal to overall income tax compliance and to 45.1
percent with compliance equal to income tax compliance of
proprietors.
Effect of State and Local Tax Piggybacking. Once states
lose their ability to piggyback their income taxes off the
federal income tax, it is anticipated that many would elect to
instead piggyback their revenue needs by adding a state sales
tax rate to the federal rate. For consumers, this would further
boost the overall rate on consumption to 53.6 percent assuming
overall income tax compliance and to 64 percent assuming
proprietor's income tax compliance. These figures assume the
above exemptions and allowances would be established.
The PWC model is not alone in estimating tax rates for the
NRST that are considerably higher than proponents frequently
cite. A National Bureau of Economic Research study place the
tax rate at 27.3 percent if payroll taxes are not included in
those taxes to be replaced and 45.4 percent if payroll taxes
are also replaced. A Joint Economic Committee (``;JEC'') study
concluded that the NRST rate would have to be at least 32
percent unless imputed items of consumption, like ``rent'' that
the national income accounts assume homeowners pay themselves
were also included in the base. Furthermore, if food, medicine,
and physician's services were excluded (as is commonplace among
many state sales taxes) the rate would have to rise from 32
percent to 49.3 percent. Alternatively, they found that if all
services were excluded from the base but food and medicine
continued to be taxable, the rate would have to rise to 64.6
percent.
Impact of the NRST on the Economy
In the long run, the economy will perform somewhat better
under a NRST. The results of the PWC model show:
By 2010 real GDP will be higher by $178 billion
(1.8 percent) and will remain above baseline throughout the
forecast period.
By 2010 real personal consumption expenditures
will be higher by $16.5 billion (0.3 percent) and will remain
above baseline throughout the forecast period.
Throughout the forecast period national private
savings is higher than under the baseline thanks to higher
personal savings as consumers delay consumption and higher
corporate savings as businesses reinvest a large portion of
undistributed corporate profits.
These salutary accomplishments are similar in direction to
findings of other studies. Only the magnitudes may differ. It
is in the short run that the PWC study finds harmful results.
Economic Growth. Gross domestic product (``;GDP''), the
value of all goods and services produced in the country, would
increase in real terms in anticipation of the enactment of the
NRST, as consumers speed up purchases they would otherwise make
at a later date.
The aftermath of the speedup is a sharp economic downturn
in the year the tax becomes effective. Instead of achieving an
expected 2.0 percent rate of real growth in 2001, the assumed
first year of the tax, the economy would shrink by 1.1 percent.
Although the economy would begin to grow again in subsequent
years, it would take until the fourth year of the tax for GDP
to reach its pre-NRST level. Before the economy fully
recovered, the cumulative loss in real GDP (measured in 1992
dollars) would reach $180 billion and annual employment would
dip by 1.5 million jobs. By 2010, real GDP under the NRST would
be 1.8 percent above the level that the current income tax
would have achieved. Given a growth forecast of about 2.3
percent per year, the 1.8 percent of additional GDP represents
only a 9-month speedup in economic growth over a ten-year
period.
Consumption. Personal consumption expenditures in real
terms would be below the current-law baseline until the ninth
year after the NRST was introduced. During the 2001-2008
period, the cumulative decline in consumer spending (measured
in 1992 dollars) would exceed $500 billion. Over the first five
years of the tax, consumption would be 1.5 percent lower on
average than it would be under current-law tax; and over the
second five years, consumption would be down 0.2 percent from
expected levels.
The overall drop in consumption and the subsequent pickup
as the economy recovers masks many important details.
Consumption changes will vary greatly according to income
levels and according to items of consumption. Changes in
consumer purchases reflect the fact that the NRST generally
shifts the tax burden away from higher income families and
toward lower income families. Although the poorest of the poor
may be roughly compensated for their loss of the refundable
earned income credit by repeal of the payroll taxes, the
moderately poor and many in the vast middle class must have
higher overall tax burdens in order to balance those with the
highest incomes whose consumption taxes would be far smaller
than their income taxes. Households with incomes in the bottom
fifth of the income scale would have to reduce their purchases
of durable goods by 13 percent on average for the second five
years after introduction of the NRST and purchases of
nondurable goods by 6 percent. In contrast, households with
incomes in the top fifth of the income scale would increase
their purchase of durables by an average of 2.4 percent and
their purchases of nondurables by 0.3 percent for that same
period.
Saving and Investment. In nominal terms, the net private
saving of U.S. residents and businesses under the NRST would be
about 18 percent higher than under current law for the ten-year
period, 2001-2010. Government saving is assumed to be virtually
unaffected (that is, the NRST is assumed to be a budget-neutral
replacement for current-law taxes that would be repealed). For
that same period, personal saving would be higher by about 15
percent. The nominal dollar increase in private saving would
come about equally from personal saving and corporate saving.
Corporations would be expected to finance about half of all
induced new investment through their own saving, by retaining
approximately 15 percent of the repealed corporate income tax.
The remaining 85 percent of the corporate income tax would be
distributed to shareholders in the form of increased dividends.
Over the ten-year period, 2001-2010, induced gross private
domestic investment would add another 7 percent to the amount
of nominal investment under current law. This increase in
investment is nearly twice as large as the increase in gross
national saving. Consequently, roughly half of all induced
investment is foreign-owned investment flowing into the United
States in response to lower financing costs and the elimination
of the Federal corporate tax on equity income. Although most of
the growth in real investment occurs in the business sector,
most of the increase in nominal investment can be attributed to
the rise in the price of residential investment due to the tax
on new construction under the NRST.
Corporate Profits. On average, corporate profits are about
2 percent lower over the ten-year period, 2001-2010; however,
there are notable exceptions for certain industries and certain
years. In the aggregate, profits return to the level expected
under current law by the year 2010, and are expected to improve
thereafter.
Employment. Due to the near term decline in consumer
spending, private sector jobs and civilian employment are
expected to be lower than they would be under current law
through the fourth year of the NRST. The near term estimate
would indicate a drop of 1.5 million jobs. Thereafter, jobs and
employment will pick up. The labor force is expected to expand
by about 1 percent as potential second earners and others are
lured into the workplace by vastly lower taxes on wages and
salaries and entrepreneurial income.
Anticipatory Consumption Speedup. Introduction of a NRST is
expected to create a speedup in purchases of goods and services
between the time the tax is announced and the time it becomes
effective. If the NRST were imposed as of January 1, 2001, a
surge in personal consumption of both domestically produced and
imported goods and services would occur in 2000. In addition,
equipment investment would accelerate to take advantage of
depreciation deductions in the year 2000 before the income tax
is repealed. Together, these factors produce a temporary drop
in personal saving and a temporary rise in the real rate of
economic growth in 2000. Real GDP in 2000 is estimated to be
2.8 percent above the level that would have been obtained in
the absence of a proposed NRST. Thereafter, real GDP is
depressed by $180 billion from 2001 through 2003. By 2004, real
GDP has recovered to pre-tax change levels, and remains above
the pre-tax change baseline throughout the remainder of the
forecast period.
After the speedup in spending in 2000, personal consumption
expenditures remain $500 billion lower than they would
otherwise be until the year 2009. In other words, during the
first eight years of the NRST, consumption would be depressed
as families and individuals respond to the tax by saving more
and spending less. It is only after disposable income increases
sufficiently that consumption picks up enough to pass the pre-
tax change baseline level.
Real investment in equipment is down in 2002 from the pre-
tax change baseline due to the tax-motivated speedup of
investment into 2000. Thereafter, equipment investment is
higher as businesses respond to a lowered cost of capital. Real
investment in non-residential structures is down in 2003 and
2004, but picks up significantly after 2004. However, real
investment in residential structures remains below pre-tax
change baseline levels over the entire 2002-2010 period.
Prices. Prices for consumer goods and services quickly rise
by the amount of the tax, and then some. The portion of the
price increase in excess of the tax is due in part to the
higher cost of imports (from the weaker dollar) coupled with
the ability of some domestic producers of competing goods to
hike their price to that of imports. Consumer prices similarly
rise 25 percent--roughly the nominal rate of sales tax,
unadjusted for any exemptions or transition rules--by 2002 and
gradually drop from that peak to a level that remains about 18
percent above the pre-change baseline.
Examined on a year-over-year basis, these price increases
generally amount to a large, one-time hike in prices as the
NRST is imposed, with some moderation of this increase in the
longer run. Due to a weaker dollar, merchandise import prices
increase by nearly 4 percent shortly after the NRST is imposed
and are 6.5 percent over baseline levels in 2010. Merchandise
export prices are also above baseline levels. In 2001 and 2002
they are nearly 3 percent above the baseline. However, due to
lower interest rates, which reduce business costs, export
prices are only slightly greater than baseline levels for most
of the remainder of the forecast period. The overall impact on
prices is measured by the change in the GDP deflator, which
initially rises 20 percent above the baseline price level
before settling back to a 13 percent price rise relative to the
baseline.
The notion espoused by some that pre-tax prices would drop
some 20-30 percent under a NRST (so that after-tax prices would
not rise and may even decline) is a peculiar one. This could
only happen if all of the personal income tax, the corporation
income tax and payroll taxes are currently embodied in retail
prices. Tax incidence--that is, who actually bears the ultimate
tax burden--is an elusive question that has been the focus of
many economic papers, because the answer is not clear. However,
the general consensus among economists is that perhaps a
portion of the corporate income tax may be passed on to
consumers in the form of higher prices, but that the majority
is ultimately paid by corporate owners in the form of lower
after-tax profits and by employees in the form of lower
compensation. Most economists concede that personal income
taxes and payroll taxes are ultimately borne by labor and are
not passed on to consumers in the form of higher prices.
Nominal Output. In nominal terms, personal consumption
expenditures are expected to be above their baseline level by
$1,582.9 billion per year on average for the 2006-2010 period.
This represents an increase of 18.3 percent over the average
that would have occurred in absence of the NRST. Note, because
prices would be 18.5 percent higher, on average, for this
period, this nominal increase is consistent with a slight real
decline in real consumption expenditures during this same
period.
Trade. Merchandise exports and imports are both impacted by
the NRST. Exports are made relatively cheaper to foreigners
because the dollar is somewhat weaker under the NRST. Imports
are subject to the NRST and are also more costly for U.S.
consumers to buy due to the weaker dollar. As expected, in real
terms, exports grow about 4.3 percent over the baseline during
the last five years of the forecast period, 2006-2010; and
imports drop an average of about 1.6 percent during that same
period. In nominal dollar terms, both exports and imports are
larger than under current law due to the sharp price increases
for imports discussed above. Real net merchandise exports
increase by $448 billion (in 1992 dollars) over a ten-year
forecast period. However, over the same ten-year period, net
merchandise exports in nominal dollars decline by $68 billion
relative to the baseline. This nominal merchandise trade
deficit helps to finance domestic investment.
Conclusion
If a NRST is enacted, the U.S. economy would lag behind for
at least three years and employment would dip by more than one
million jobs. Beneficial effects would not be felt for at least
five years after adoption. While it is admirable to seek a
fairer and simpler tax structure to replace the incredibly
complex income tax code, trading an income tax in for a
national sales tax is an experiment that could bring serious
harm to a flourishing national economy. Uncertain long-run
benefits are far insufficient to risk the short-run setbacks in
virtually all sectors of the economy.
Chairman Archer. Thank you, Mr. Wilkins.
Our next witness is Dr. Metcalf. You may proceed, Doctor.
STATEMENT OF GILBERT E. METCALF, PROFESSOR OF ECONOMICS, TUFTS
UNIVERSITY, MEDFORD, MASSACHUSETTS, AND RESEARCH ASSOCIATE,
NATIONAL BUREAU OF ECONOMIC RESEARCH
Mr. Metcalf. Thank you. I am Gilbert Metcalf, a professor
of economics at Tufts University and a research associate at
the National Bureau of Economic Research.
I appreciate the opportunity to speak before this committee
on the topic of tax reform, and I would like to focus, first,
on the issue of fairness or progressivity, and second on the
issue of the relative merits of a national retail sales tax
versus alternative consumption tax proposals.
First, the issue of progressivity. As has been noted
before, consumption taxes look very regressive when households
are distributed by annual income. People tend to earn the
highest incomes in their life around middle age and the lowest
incomes in their youth and old age. And consequently, in an
annual income analysis, lower income groups are likely to
include some young and elderly people who are not poor in a
lifetime sense. Similarly, higher income groups are likely to
contain some people at the peak of their age earnings profile,
for whom peak earnings are a poor measure of annual ability to
consume.
In previous research, I have considered the distributional
impact of a replacement of the personal and corporate income
tax with the national sales tax, and while the analysis does
not capture the precise nature of the Fair Tax proposal, it is
close enough to demonstrate a number of key points. That
research, summarized in my written testimony, shows the
following:
First, using an annual income analysis, a national sales
tax, with family allowances similar to the Fair Tax, would look
highly regressive. But when a lifetime income analysis is
undertaken, when we think of people's resources over their
entire lifetime, then the tax reform looks much more
distributionally neutral.
And this lifetime distributional neutrality of the sales
tax depends importantly upon the family allowances that the
Fair Tax proposes or allowances similar to the ones that the
Fair Tax proposes. And without these, the sales tax reform
looks moderately regressive, even on a lifetime basis.
A second aspect of a consumption tax reform bears
mentioning, and there has been some allusion to this. In the
shift from an income to a consumption tax, existing wealth is
subjected to a one-time wealth tax. This by itself provides a
great deal of progressivity.
So let us see how this works. Existing wealth is subjected
to the national sales tax at the time that it is spent. So
imagine that I have a million dollars in existing savings and a
national sales tax at a 30-percent rate is imposed, if I spend
that million dollars immediately, I will pay $300,000 in sales
tax and consume $700,000 in goods and services. The same result
arises if instead of a sales tax I am subjected to a 30-percent
initial wealth tax. The retail sales tax effectively taxes away
30 percent of that initial wealth, and this example
generalizes. No matter when I spend that wealth on consumption
or even if I die and leave that money to my children, I end up,
under the retail sales tax, in exactly the same boat as under a
one-time tax on initial wealth.
In addition to adding progressivity to the reform, this
one-time tax adds efficiency, since this is a lump-sum tax,
which is the most efficient of all taxes.
Next, let me turn to the second point, the relative merit
of a sales tax versus other forms of consumption taxes. It
seems to me that one of the greatest difficulties that the
proponents of the flat taxed faced was the perception that rich
people would avoid taxation, since they were not subject to
taxation at the personal level, and that problem is eliminated
under a sales tax.
And we have talked about the transparency of the sales tax
as one of its virtues. This transparency extends to the problem
of transition giveaways. Unlike other forms of consumption
taxes, any efforts to provide advantages to certain sectors or
to grandfather existing capital from the wealth tax I just
mentioned, would be highly visible.
And so to the extent that Congress wishes to enact a clean
tax reform, and I hope that is the intent of this committee,
this visibility provides support for that effort. Avoiding the
transition compensation to old capital will allow a lower tax
rate, greater progressivity and larger efficiency gains from
the reform.
There has been a lot of discussion of the appropriate tax
rate. Let me focus on tax-inclusive tax rates to be comparable
to income tax rates. The 23-percent tax rate is achieved in the
Fair Tax proposal that I have seen by subjecting Government
purchases to the sales tax and assuming that Federal spending
will be held constant. This, in effect, subjects Government to
a substantial spending cut, and I think needlessly mixes issues
of tax reform with the issue of the appropriate size of
Government.
I calculate a tax rate of roughly 33 percent would be
required to achieve a revenue-neutral reform; yet, as Dr.
Kotlikoff has noted, even a 30-percent rate or 33-percent rate
leaves a middle-income worker facing a 15-percent Federal tax
rate and 15.3-percent payroll tax rate unaffected at the
margin.
Second, the experience at the State and local level with
sales tax is that there is enormous pressure to exempt certain
goods and services from taxation, and Congress must resist this
temptation at the Federal level. The rebate on spending on
amounts up to the poverty level appropriately addresses
distributional concerns and further exemptions would only
reduce the efficiency gains from the reform, while adding
complexity to the administration of the tax.
So, in conclusion, consumption tax reform is one of a
number of attractive options for improving the current tax
system, and of course other possible options would be to
simplify the current income tax. The Fair Tax proposal, here
before you today, has many attractive features. But I think its
success depends, importantly, on its being a clean reform with
few transition rules and tax-base exemptions.
Thank you.
[The prepared statement of Mr. Metcalf follows:]
STATEMENT OF GILBERT E. METCALF, PROFESSOR OF ECONOMICS, TUFTS
UNIVERSITY, MEDFORD, MASSACHUSETTS, AND RESEARCH ASSOCIATE, NATIONAL
BUREAU OF ECONOMIC RESEARCH
Introduction
I appreciate the opportunity to submit written testimony to
the Committee on Ways and Means on the very important topic of
fundamental tax reform. Just over four years ago, I had the
privilege of participating in an Issues Seminar on tax reform
hosted by this committee at Airlee House in Virginia. While the
bills before this committee may be different than those under
consideration four years ago, the issues have not changed.
Much of my research on the topic of tax reform has focused
on distributional considerations. The main result from that
research is that the focus on annual income as a measure of
individual welfare significantly biases distributional analyses
of consumption taxes towards making them look more regressive
than they are when an individual's lifetime earnings
possibilities are taken into account. In this testimony, I'd
like to review why annual and lifetime income perspectives lead
to such different results and then to present some findings
from research that I have conducted using the Consumer
Expenditure Survey.\1\
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\1\ This research is presented in Metcalf (1997).
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II. Background
An incidence analysis attempts to answer the question of
who bears the burden of a particular tax. Any attempt to
evaluate the ``fairness'' of a tax (or a change in the tax
system) requires knowing whose disposable income is changed and
by how much in response to the tax. Economists often refer to
taxes as ``regressive'' or ``progressive.'' There is often some
confusion as to the meaning of these terms and so it is worth
defining them carefully. The definition that most economists
use relies on the average tax rate--the ratio of tax
liabilities to income.\2\ A tax is said to be regressive if the
average tax rate falls with income. It is proportional if the
average tax rate is constant and it is progressive if the
average tax rate rises with income. Low income people pay a
higher (lower) fraction of their income in taxes if the tax is
regressive (progressive).
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\2\ More precisely, the numerator is the change in real disposable
inicome resulting from the change in the tax law. If a new tax is
imposed, the change in disposable income might occur because prices
have gone up so that a given income purchases fewer goods and services
or it might occur because have fallen.
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Early tax incidence studies used the results of partial or
general equilibrium models to inform judgments about relevant
incidence results. In effect, these studies used existing
research results to generate plausible assumptions about the
incidence of specific taxes. Pechman (1985) represents the
classic example of this type of research. The time frame for
analysis is one year, and Pechman assumes that consumption
taxes are passed forward and borne by consumers in proportion
to their expenditures. Taking this approach, Pechman finds that
consumption taxes are quite regressive. A recent study by Gale,
Houser, and Scholz (1996) confirms this view. In an analysis of
a shift from the current income tax to a flat tax they find
that the lowest income group would see their average tax rate
increase by 2.2 percentage points (81% increase) while the
highest income group would see their average tax rate decrease
by 7.1 percentage points (17% decrease).\3\ Similarly,
Feenberg, Mitrusi, and Poterba (1997) find that there would be
a substantial shift in tax burden to the poor in shifting from
the income tax to a retail sales tax using annual income to
rank households.
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\3\ Table 8-2, page 290 of Gale, Houser, and Scholz (1996).
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An alternative approach utilizes estimates of lifetime
income as a measure of the taxpaying unit's economic well-
being. Invoking Friedman (1957) and the permanent income
hypothesis as well as life-cycle considerations, economists
have long recognized that annual income may not be a very good
measure of an individual's potential to consume. With perfect
capital markets, individuals should be grouped according to the
present discounted value of earnings plus gifts received. This
theory makes the difficulties with the annual incidence
approach readily apparent. People tend to earn the highest
incomes in their life around middle age and the lowest incomes
in their youth and old age. Consequently in a cross section
(annual) analysis, lower income groups are likely to include
some young and elderly people (as well as some people with
volatile incomes who have obtained a low realization) who are
not poor in a lifetime sense. Similarly, higher annual income
groups are likely to contain some people at the peak of their
age earnings profile for whom peak earnings are a poor measure
of annual ability to consume.
To see why a lifetime approach makes a difference, imagine
a world with identical people with identical skills and an
identical pattern of earnings over their lifetime. Figure 1
illustrates the lifetime income and consumption paths of a
typical person in this imaginary society. Income is initially
low and rises to a peak in the middle years. It than falls as
this worker gradually cuts back on work and enjoys more
retirement leisure. Consumption is constant over the lifetime.
In early years individuals borrow against future income to
finance consumption that exceeds income. Savings occurs in the
middle years, first to repay borrowing from the early years and
then to finance consumption in the retirement years. In this
stylized example, I'll assume that all savings are consumed so
that at death there are no assets remaining.
[GRAPHIC] [TIFF OMITTED] T1879.003
Next assume that there is one person of each age in this
society. Otherwise people are identical. Figure 1 now has an
additional interpretation. In addition to it indicating
consumption and income patterns over an individual's lifetime,
it also shows income and consumption patterns for our society
of individuals at any one point in time. Now consider an annual
incidence analysis of a national sales tax. Since consumption
is constant across all individuals, tax payments will also be
constant. But since income varies (based on where people are on
their lifetime income schedule), the average tax rate (taxes as
a fraction of annual income) will fall as income rises. The tax
will look very regressive. But this is clearly wrong.
Individuals are exactly the same in this hypothetical society
and over their lifetimes will earn exactly the same amount of
income and pay exactly the same amount of taxes. A lifetime
incidence analysis will correctly conclude that this tax is
proportional.
III. A Distributional Analysis of a Sales Tax Based on the
Consumer Expenditure Survey
H.R. 2525 (introduced by Rep. John Linder (R-GA) and Rep.
Collin Peterson (D-MN)) would replace the personal and
corporate income tax, all payroll taxes, the self-employment
tax, and the estate and gift tax with a national retail sales
tax. The tax is levied on a destination basis, meaning that
imports are subject to the tax while exports are exempt. H.R.
2525 (otherwise known as the ``Fair Tax'') would provide
families with a rebate of sales tax on spending up to the
federal poverty level.\4\
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\4\ The rebate is adjusted so that a married couple with no
children would receive the same rebate as two unmarried individuals
sharing a household (a marriage penalty elimination adjustment).
---------------------------------------------------------------------------
In previous research (Metcalf (1997)), I used data from the
1994 Consumption Expenditure Survey (CES) to measure the
distributional impact of a replacement of the personal and
corporate income tax with a national retail sales tax rate.
While the analysis does not capture the precise nature of the
Fair Tax proposal, it is close enough to demonstrate a number
of key points. Ignoring payroll taxes in my analysis will
likely bias the analysis towards making the reform appear less
progressive. Thus the results I present can be viewed as lower
bounds on the progressivity of the reform.
First let me note that after making adjustments for
consumption expenditures that are difficult to tax, I
calculated that a tax exclusive tax rate of roughly 18 percent
would be required for a broadbased retail sales tax replacing
the income tax to be revenue neutral. Adding payroll taxes and
the estate tax to the proposal would increase the required tax
exclusive tax rate to 30 percent.\5\ This tax rate assumes that
Congress will hold the real level of government spending fixed.
This could be done by exempting government spending from the
tax. If government spending is taxed (as is proposed in H.R.
2525), then nominal government spending would have to increase
to keep real spending constant. (See Table 1 below for
details.)
---------------------------------------------------------------------------
\5\ Using 1991 data, Feenberg, Mitrusi, and Poterba (1997) estimate
that a tax rate of nearly 29 percent would be required to replace the
income and payroll taxes. Both my estimated tax rate and those of
Feenberg et al. are measured as a percentage of the producer price. To
compare the average income tax rate, we can re-express the tax rates as
percentages of consumer prices. Expressed that way, the required tax is
23 percent.
Table 1. Aggregate Consumption and Taxation
------------------------------------------------------------------------
(1) (2) (3)
------------------------------------------------------------------------
Taxes Replaced
By Retail Sales
Tax
Personal Income 544.5 544.5 544.5
Tax
Corporate Incom144.0 144.0 144.0
Tax
Payroll Taxes 428.8 428.8
Estate and Gift 15.2 15.2
Tax
Total Income Tax 688.5 1,132.5 1,132.5
Retail Sales Tax
Base
Personal 4,698.7 4,698.7 4,698.7
Consumption
Expenditures
Adjustments to
Personal
Consumption
Expenditures:
Indirect Taxes (266.9) (266.9) (266.9)
Owner Occupied (280.2) (280.2) (280.2)
Housing
Imputed Financial (146.0) (146.0) (146.0)
Services
Non-Profit (236.6) (236.6) (236.6)
Activities
Farm Food (0.5) (0.5) (0.5)
Net Foreign 19.8 19.8 19.8
Spending
Consumption Ta3788.3 3788.3 3788.3
Base
Family Allowance (1500.0)
Net Consumption 3788.3 3788.3 2288.3
Tax Base
Retail Sales Tax 18.2% 29.9% 49.5%
Rate (Tax-
Exclusive)
Retail Sales Tax 15.4% 23.0% 33.1%
Rate (Tax
Inclusive)
------------------------------------------------------------------------
ASource: Metcalf (1997)
Those adjustments do not allow for the family rebate based
on poverty level. The Fair Tax Proposal exempts from taxation
spending up to the poverty level. Based on 1994 poverty levels,
this rebate would (in effect) exempt $1.5 trillion from the
Retail Sales Tax base. This raises the required tax rate from
30 to nearly 50 percent \6\ . On a tax inclusive basis
(comparable to an income tax rate), this is a rate of 33
percent.
---------------------------------------------------------------------------
\6\ Feenberg, Mitrusi, and Poterba (1997) estimate that a rate
exclusive tax rate of 45.4 percent would be required.
---------------------------------------------------------------------------
My first analysis considers a shift from the current income
tax to a broad based retail sales tax. The tax base is quite
comprehensive. Housing services are not taxed per se but are
taxed at the time of purchase of the house. The same approach
is used for other durable goods. Medical services are included
in the tax base as are other services. Table 2 (and Figure 2)
shows the distribution of a shift from the income tax to a
broad based income tax using both an annual and a lifetime
income incidence approach. The second column shows the change
in average tax rate (change in tax as a percentage of annual
income) for households ranked by annual income. Based on the
annual income approach, the tax reform is very regressive. Tax
liabilities increase for the bottom 70% of the income
distribution and decrease for the top 30%. The changes are
quite substantial with the lowest income decile seeing their
average tax rate increase by 64 percentage points.\7\ Meanwhile
the top decile's average tax rate falls by 7%. Another way to
measure the regressivity of the tax reform based on annual
income is to note that the Suits Index falls from 0.202 (income
tax) to -0.217 (retail sales tax) as a result of the reform.\8\
---------------------------------------------------------------------------
\7\ The size of the tax shift for this lowest income decile
indicates one of the problems of the annual income approach. It tends
so magnify average tax rates as income is likely to be poorly measured
and also low relative to consumption. It is for this reason ftha
tPechman (1985) dropped th ebottom half of the lowest income decile
from his analysis. The median change in tax rate for this decile is
32.9%. Except for the lowest decile, median and mean tax rates are
fairly similar.
\8\ The Suits Index is a tax-based analogue to the Gini
Coefficient. It ranges from -1 to 1 with negative values indicating a
regressive tax and positive values a progressive tax. The Suits Indexc
for the income tax that I report is not comprable to estimates of the
Suits Index reported elsewhere for the personal income tax since I
attribute the corporate income tax to households in this study.
---------------------------------------------------------------------------
Column 3 redoes the analysis using a lifetime income
analysis. The variation in changes in average tax rates across
lifetime income deciles falls markedly relative to the annual
income analysis. The reform is still regressive--the lowest 70%
of the income distribution face tax increases while the top 30%
enjoy tax decreases. However the differences are not nearly as
large as when measured using annual income to rank households.
Moreover, the change in average tax rates is much smaller with
the lowest lifetime income decile facing an average increase in
their average tax rate of 5.7 percentage points while the top
decile's average tax rate falls by 2 percentage points. Ranking
households by lifetime income, the Suits Index now falls from
0.068 to -0.010 with this tax reform.
[GRAPHIC] [TIFF OMITTED] T1879.004
Table 2. Distribution of a Broadbased Retail Sales Tax: No Family
Allowance
------------------------------------------------------------------------
Decile Annual Lifetime
------------------------------------------------------------------------
1 64.3 5.7
2 24.4 4.0
3 17.4 1.0
4 11.5 1.0
5 7.3 1.2
6 2.3 0.4
7 3.9 0.4
8 -0.6 -2.0
9 -0.9 -1.3
10 -7.0 -2.0
------------------------------------------------------------------------
ATable reports change in average tax rate from reform
ASource: Metcalf (1997) This analysis repeals personal and corporate
income tax and replaces it with a national retail sales tax.
[GRAPHIC] [TIFF OMITTED] T1879.005
Next, I add the family allowances based on poverty
levels.\9\ Table 3 and Figure 3 presents the results.
---------------------------------------------------------------------------
\9\ This analysis differs from the Fair Tax proposal in not making
a marriage penalty adjustment.
Table 3. Distribution of a Broadbased Retail Sales Tax: Family Allowance
------------------------------------------------------------------------
Decile Annual Lifetime
------------------------------------------------------------------------
1 40.9 2.2
2 19.1 1.5
3 14.2 -0.9
4 9.6 0.2
5 6.6 0.8
6 1.5 0.0
7 4.4 0.1
8 -0.3 -2.0
9 -0.1 -0.3
10 -5.8 0.1
------------------------------------------------------------------------
ATable reports change in average tax rate from reform
ASource: Metcalf (1997) This analysis repeals personal and corporate
income tax and replaces it with a national retail sales tax.
[GRAPHIC] [TIFF OMITTED] T1879.006
Compared to Table 2, the tax is modestly less regressive on
an annual basis. However it continues to look very regressive.
The Suits Index for the sales tax with rebate is -0.155
indicating considerable regressivity (relative to the income
tax system it replaces for which the Suits Index equals 0.202).
The story changes dramatically when I rank people by lifetime
income (last column). Now there is no clear pattern to the
change in average tax rates. The change ranges from a decrease
of 2 percent (decile 8) to an increase of 2.2 percent (decile
1). Ranking households by lifetime income the Suits Index for
the sales tax with rebate (0.054) is nearly the same as for the
current income tax (0.068). If you compare Table 2 to Table 3,
it is easy to see that rebates based on the poverty threshold
can offset any remaining regressive aspects of a national sales
tax when ranking households by a measure of lifetime income.
These results indicate that it is not impossible to structure a
consumption tax that is broadly progressive.
IV. Other Issues
The distributional analysis above is a ``steady-state''
analysis and ignores transitional considerations. In any switch
from an income to a consumption tax, there is the potential for
a lump sum tax on old capital. One difficulty with previous
consumption tax proposals has been that these losses have been
compensated through transition rules that cost significant
amounts of revenue and require higher tax rates. Much of the
efficiency gains from a consumption tax reform are lost if such
transition rules are enacted. The benefit of the retail sales
tax is that it makes it more difficult to incorporate these
kinds of transition rules and so increases the probability that
the reform will indeed be efficiency enhancing.
One other consideration worth mentioning is the current
debate over taxation of internet sales. While this is not a
distributional issue, it is an important issue of fairness and
it will be important to treat internet transactions just like
any other retail sales transaction. If the federal government
can do this correctly, it increases the odds that state and
local governments will also treat these sales correctly under
state and local sales taxes.
V. Conclusion
It is quite possible to design a distributionally neutral
consumption tax reform. Doing so, however, requires an
understanding of the difference between annual and lifetime
income. Measuring lifetime income is conceptually easy but in
practice impossible. This raises hurdles to the use of lifetime
income for distributional analysis in policy circles but it
does not negate its importance as you take up the important
topic of fundamental tax reform. Thank you for the opportunity
to comment on this issue.
References
Feenberg, Daniel R., et al. ``Distributional Effects of
Adopting a National Retail Sales Tax,'' Tax Policy and the
Economy, 1997, 11: pp. 49-90.
Friedman, Milton. A Theory of the Consumption Function..
Princeton, NJ: Princeton University Press, 1957.
Gale, William, et al. ``Distributional Effects of
Fundamental Tax Reform.'' In Economic Effects of Fundamental
Tax Reform, ed. Henry Aaron and William Gale, 281-315.
Washington, DC: Brookings Institution, 1996.
Metcalf, Gilbert E. ``The National Sales Tax: Who Bears the
Burden?,'' Washington, DC: Cato Institute. Cato Policy Analysis
No. 289, Dec. 8, 1997.
Pechman, J. Who Paid the Taxes: 1966-85?. Washington DC:
Brookings, 1985.
Chairman Archer. Thank you, Dr. Metcalf.
Dr. Angell?
STATEMENT OF WAYNE ANGELL, CHIEF ECONOMIST, BEAR STEARNS &
COMPANY, INC., NEW YORK, NEW YORK
Mr. Angell. I am Wayne Angell, chief economist at Bear
Stearns, and formerly, Mr. Chairman, 8 years as a member of the
Board of Governors of the Federal Reserve system.
I believe the case for fundamental tax reform rests on
whether the current tax system poses a serious risk to the
continuation of our current prosperity through the first decade
of the 21st Century. Piecemeal amendment of our tax code cannot
alter the one fundamental problem facing our economic
expansion, our national shortfall of saving. Only the national
undersaving or overconsumption stands in the way of our
continuing prosperity.
As the chart on page 2 of my testimony indicates, just
maintaining our national saving rate is far less than optimum
in a new-era economy that relies on investment spending to
continue to rise as a percent of GDP. Our savings shortfall has
accelerated over the last 3 years to 4 percent of GDP, and of
course that then would be our current account trade deficit.
Without fundamental tax reform, the gap between national
saving and investment is likely to continue to widen. The new
era of business focus on cutting costs by relying on increased
nonresidential capital goods investment that have risen from 9
to 14 percent of GDP over the last decade is likely to continue
to increase equity market wealth and to depress the household
saving rate. Depressed domestic saving is currently balanced by
the expectation of higher equity prices that is part of the
ingredient and the inflow of saving from abroad.
Now, I do not join the scare-mongers who suggest that our
rising trade deficit cannot go on forever. Our rising trade
deficit can go on as long as global investors, including, in
particular, U.S. investors are willing to hold an ever-
increasing ratio of their wealth in the United States.
Nevertheless, it is correct that our rising trade deficit makes
our economic expansion more vulnerable to any adverse news,
period; that is, if the Federal Reserve were to make an
inflation mistake during the 5- or 10-year period ahead, the
interest rate consequences would be much worse.
I hope you will choose fundamental tax reform. Take away
the current tax system disincentive to save. All Americans will
benefit by participating in the wealth-creating process that
begins by the decision to abstain from spending income and
thereby to save. Far too long, we have lived with the incorrect
assumption that imposing higher tax rates on individual incomes
can reduce income and equality.
If we desire equality of incomes, we need a new
consumption-based tax system that will provide more
encouragement to save for those who are poor and who would like
to become wealthy. The acceleration of capital goods investment
is a first step toward improving income equality, for it is
rising capital investment that is driving the increase in labor
productivity and rising real wages that directly contribute to
the capacity of working families to save.
If a nation undersaves, then real interest rates will move
higher. As long as our national saving does not match our
spending on capital goods, real interest rates must move enough
higher to offset the increased exchange rate risk faced by
global investors. If global savers approach satiation by an
overconcentration of loans and investments in the United
States, then the full tax burden on saving must be shifted to
borrowers.
Alan Greenspan is right on target in recognizing the
inflation risk that would be associated with a low Fed funds
rate, while real corporate bond rates are rising. Nothing would
endanger this expansion more than for the FOMC to peg the
Fund's rate below the level consistent with Triple B corporate
bond rates. Corporate bond market yields reflect our shortfall
of saving while the demand for capital goods is rising.
Unfortunately, to the extent that rising real interest rates
dampen investment spending, labor productivity cannot
accelerate to the optimum economic equality level.
The Americans for Fair Tax Proposal--the Fair Tax--is the
superior starting point for fundamental tax reform. First, the
Fair Tax proposal directly deals with our, one imbalance,
under-saving. The 23-percent national retail sales tax would
dramatically increase household savings rates. And I would be
happy to respond to questions as to why I differ from the other
panelists in regard to that rate.
Second, only the Fair Tax proposal has a perfect offset for
the growth slowdown that would occur if a national saving rate
were to quickly rise to the national investment rate around 20
percent GDP. By eliminating the cost of Government in the
prices of goods we export, the growth of exports accelerates.
By subjecting imported final goods to the sales tax, domestic
production of goods would crowd out imported goods. That would
mean that imported goods would compete fairly and squarely
under the same burden of Government cost as domestic-produced
goods. Both would be subject to the 23-percent uniform sales
tax rate.
During the adjustment period, consumer spending would
likely fall, exports would leap upward and imports would fall.
After the adjustment period, growth rates of consumer spending,
exports and imports, would tend to normalize at a rate somewhat
higher as is consistent with the higher capital spending
induced by lower interest rates and lower interest volatility.
Without fundamental tax reform, our expansion is apt to
encounter an increasing risk of being aborted by a policy
mistake. Let us not wait too long to act now as the current
balance between rising inflow of saving and an increasing trade
deficit could change from global balance to global imbalance.
The longer we delay in dealing with this tax impediment to
saving the more risky our future.
[The prepared statement follows:]
Statement of Wayne Angell, Chief Economist, Bear Stearns & Company,
Inc., New York, New York
Mr. Chairman, members of the committee, thank you for the
opportunity to testify on the subject of fundamental tax
reform. I believe the imperative case for fundamental tax
reform rests on whether the current tax system poses a serious
risk to the continuation of our current prosperity through the
first decade of the Twenty-first Century.
The focus of my advice is (1) do not underestimate our
potential for achieving a very long period of growth at a rate
approaching five percent and (2) do not ignore the potential
for an economic policy breakdown to precipitate an abrupt end
to this expansion. Just as we have benefited enormously from
new high technology capital investment, so also would an end of
this expansion with a likely collapse of labor productivity
growth be unusually difficult for workers and investors alike.
Although our current expansion, at nine years, is the
longest expansion in our history, it is far short of achieving
the 4.3 percent average annual growth rate over 36 quarters
from 1963 to 1972. The estimated average growth rate over the
last nine years ending in the first quarter of 2000, at 3.6
percent, is a good beginning for an expansion that has a
potential to go on another nine years. If we succeed in growing
another nine years by continuing the 4.4 percent average rate
of the last four, then we would achieve an 18-year average
growth rate of 4 percent.
Undersaving as a risk to this expansion
Piecemeal amendment of our tax code cannot alter the one
fundamental problem facing our economic expansion--our national
shortfall of saving. The continuation of our accelerating
prosperity is dependent on the means to finance non-residential
capital investment that is growing at twice the rate of growth
of gross domestic product. Without fundamental tax reform our
current under-saving requires an inflow of capital from abroad
that has its counterpart in a rising trade deficit.
Only the national undersaving (or overconsumption) stands
in the way of our continuing prosperity. As long as economic
growth remains on this current track of four straight years of
growth rates approaching 4-\1/2\% percent, the current system
of tax rates will provide more revenue than projected growth of
government expenditures. Some, including Alan Greenspan, seem
to be suggesting that the correct approach is to rely on rising
public saving to offset the adverse impact of rising equity
market wealth on household saving. This is an austerity
approach, which I believe actually increases the risk of
difficulty in funding our under-saving.
But, as the chart below indicates, just maintaining our
national saving rate is far less than optimum in our new era
economy that relies on investment spending to continue to rise
as a percent of GDP. Adding 1999-government investment of
approximately 2-\1/2\% of GDP to the private investment shown
in the chart brings national investment spending to 20 percent
of GDP. Subtracting government investment from government
spending increases national saving to 16 percent and implies an
inflow of saving from abroad of 4 percent of GDP. One constant
in our equation is that the balance of payment is balanced;
saving (capital) inflows equals the current account deficit.
Without fundamental tax reform the gap between national
saving and investment will get worse. The new era business
focus on cutting costs by relying on increased non-residential
capital goods investments, that have risen from 9 to 14 percent
of GDP over the last decade, is likely to continue to increase
equity market wealth and depress the household saving rate.
Depressed domestic saving is currently balanced by the
expectation of higher equity prices that is part of the
ingredient in the inflow of saving from abroad.
Now I do not join the scaremongers who suggest that our
rising trade deficit cannot go on forever. Our rising trade
deficit can go on as long as people who live abroad are willing
to finance it. However, it is correct that a rising trade
deficit makes our economic expansion more vulnerable to any
adverse news period that would cause global investors to lose
confidence in the exchange value of the dollar. That is, if the
Federal Reserve were to make an inflation mistake during the
five or ten year period ahead, then the interest rate
consequences would be much worse.
I hope you will choose fundamental tax reform. Take away
the current tax system disincentive to save. All Americans will
benefit by participating in the wealth-creating process that
begins by the decision to abstain from spending income and
thereby, to save. Currently, our saving rate is too dependent
on the higher income and higher wealth segment of our citizens.
Why not shift to a consumption-based tax system that will
enhance the incentive of all income groups to participate in
the rewards of wealth creation.
For far too long we have lived with the incorrect
assumption that imposing higher tax rates on high-income
individuals can reduce income inequality. First, marginal
income tax rates including the double taxation of corporate
profits directly subtract from saving by reducing the capacity
of taxpayers to save. Second, marginal tax rates, which include
some very high marginal rates on low income households as the
earned income tax credit is phased out, tilt the preference of
households to spend a higher proportion of their disposable
income. If we desire equality of incomes, we need a new
consumption-based tax system that will provide more
encouragement to save for those who are poor and would like to
become wealthy.
It is essential to understand that in a market system
economy, prices will adjust so as to correct imbalances.
Scarcities lead to higher prices that ration out scarce goods
and provide incentives to produce more of that good. And that
includes saving as a scarce good.
The tax burden on saving is fully shifted to borrowers
If a nation under-saves then real interest rates will move
higher. It is important to note that the current move toward a
larger government surplus, an increase in government saving,
has led to a somewhat lower interest rate on Treasury
securities, while corporate bond interest rates have increased.
As long as our national saving does not match our spending on
capital goods, real interest rates must move enough higher to
offset the increased exchange rate risk faced by global savers.
As global savers approach satiation by an over-concentration of
loans and investments in the United States, then the full tax
burden on saving must be shifted to borrowers.
For two decades we have filled the shortfall of national
saving by an inflow of investment and lending from abroad. But
a continuation of the domestic saving shortfall will continue
to require higher real interest rates to both attract saving
inflows and to offset the adverse wealth effect on domestic
saving. Eventually, an inflow of saving from abroad becomes
ever more risky as foreign savers contemplate the equity and
exchange rate risk of being so heavily weighted in the United
States.
For a country mired in under-saving, high marginal tax
rates on the return to saving must necessarily lead to higher
returns on saving until either the higher return is sufficient
to restore the saving balance or until the entire tax rate is
fully passed forward to borrowers. In either case, higher
marginal tax rates on saving are completely frustrated by none
of the tax falling on savers and all of the tax falling on
borrowers.
Increasing income inequality vs. increasing income equality
As long as the return on capital goods accelerates with the
new technology induced productivity of capital we need more
saving. That means that, one way or another, the return on
capital will rise. A higher return on capital will continue to
increase income inequality. Under the current tax system our
income distribution pattern will continue to flow toward
augmenting the income of the wealthy that have higher savings
rates. This process toward inequality of incomes is likely to
continue until that domestic saving imbalance is reduced.
The continuation of the acceleration of non-residential
capital goods investment is a first step toward improving
income equality. For it is rising non-residential capital
investment as a percent of GDP that is driving the increase in
labor productivity and rising real wages that directly
contribute to the capacity of working families to save. This is
the growth solution.
The sub-optimum growth solution
It seems to me that too many policy makers have become
overly pessimistic concerning the likelihood of increasing
saving by fundamental tax reform. Consequently, they are
looking toward sub-optimal growth and a sub-optimal federal
debt ratio. Central banks and monetary authorities around the
world are going to need more Treasury securities than are
likely to be available to facilitate the dollar's reserve
currency role. This committee has a wonderful opportunity to
restore a more optimistic vision by recommending fundamental
tax reform.
Given our current tax system there is no alternative to
increasing real rates of interest. Rising real rates of
interest tends to work more quickly toward limiting investment
spending than in increasing saving rates. Unfortunately, to the
extent that rising real interest rates dampen investment
spending; labor productivity cannot accelerate to the optimum
economic equality level.
Alan Greenspan is right on target in recognizing the
inflation risk that would be associated with a low Fed funds
rate while real corporate bond rates are rising. Nothing would
endanger this expansion more than for the FOMC to peg the funds
rate below the level consistent with rising Baa corporate bond
rates. Corporate bond market yields reflect our shortfall of
saving while the demand for capital goods is rising.
And, if this committee helps to restore policy maker's
confidence that household savings could be counted on to rise
sufficiently to close the imbalance, then they would be free to
consider some optimum federal debt level as a contrast to the
political proposal to pay down the national debt.
More importantly, Alan Greenspan should no longer be so
concerned that rising household wealth from equity market gains
would lower national saving. As he now sees it, rising equity
prices increase wealth faster than the increase in income.
Thereby consumer spending rises faster than income and the
savings rate falls.
Fortunately, the revised Federal Reserve de-emphasis on the
level of equity market prices has lessened the risk that global
investors might, at some point, reduce the inflows of saving
into the U.S. equity market and that could pull the down the
dollar. Ultimately it is the dollar exchange rate risk that
could jeopardize the FOMC's freedom to lower interest rates as
they did in the fall of 1998 during a period of deflation risk.
It is imperative that, as our inflation rate approaches zero,
the FOMC maintain its domestic policy focus so as to avoid
deflationary episodes such as occurred in 1986, 1990 and 1998.
Fundamental tax reform
From my perspective as a Wall Street economist, the
Americans for Fair Tax proposal--the FairTax--is the superior
starting point for fundamental tax reform.
First, the FairTax proposal directly deals with our one
imbalance--undersaving. Household behavior responds to a change
in relative prices. The 23 percent national retail sales tax
would dramatically increase household savings rates.
Second, only the FairTax proposal has a perfect offset for
the growth slowdown that would occur if the national saving
rate were to quickly rise to the national investment rate
around 20 percent of GDP. By eliminating the cost of government
from the goods we export, the growth rate of exports
accelerates. And, by including imported final goods in goods
subject to the sales tax, domestic production of goods would
crowd out imported goods. That would mean that imported goods
would compete fairly and squarely under the same burden of
government cost as domestic produced goods--both would be
subject to the 23 percent uniform sales tax rate.
During the adjustment period, consumer spending would
likely fall, exports would leap upward at about the same rate
that resources can flow into export industries, and imports
would fall. After the adjustment period during which saving and
investment converge to the same percent of GDP, growth rates of
consumer spending, exports and imports would tend to normalize.
These new normal rates of growth of GDP, exports and imports
would be somewhat higher as is consistent with the higher
residential and higher non-residential spending induced by both
lower interest rates and by lower interest rate volatility.
Conclusion
Without fundamental tax reform our expansion is apt to
encounter an increasing risk of being aborted by a policy
mistake. The 4.3 percent expansion over the 36 quarter period
ending in 1972 came to an end as the Federal Reserve made the
policy mistake of shifting its focus of monetary policy toward
increasing economic growth. Undoubtedly, the Congressional
stand-pat policy on leaving top marginal tax rates at 70
percent after lowering rates in the 1963-64 Kennedy round of
tax rate cuts from 90 to 70 percent, contributed to the FOMC
focus on using money creation to maintain economic growth.
Let us not wait too long to act now as the current balance
between rising inflow of saving and an increasing trade deficit
could change from global balance to global imbalance. And, if
fundamental tax reform is not done, then you may end up
tempting other policy makers to do what they cannot do. Surely,
the FOMC cannot successfully control economic growth. Nor can
the FOMC successfully control equity market asset values. The
longer we delay in dealing with this tax imbalance the more
risky our future.
Chairman Archer. Thank you, Dr. Angell. I am struggling
with how to best use my time to take advantage of all of the
talent that is represented at the witness table today. It is
not often that we have access to this sort of economic talent.
Do you gentlemen agree with the general concept that the
more you tax of something the less you are going to get of it?
Mr. Angell. Yes.
Chairman Archer. Does anyone disagree with that?
Mr. Wilkins. I am sorry. Could you repeat it.
Chairman Archer. Do you agree with the general thesis that
the more you tax something the less you are going to get of it?
Let the record show all witnesses are nodding assent.
And do you disagree that the income tax, as a base of
taxation, taxes work, savings, productivity and incentive? Does
any one of you disagree with that?
No. The answer is apparently they all agree with that. Then
why are we using a system that reduces work, reduces
productivity, reduces savings and reduces incentive? I don't
understand it? And yet is not factored in, and I will be glad
to get your responses. I am going on a little here with a
soliloquy, but I am curious, Mr. Wilkins, as to whether the
survey, the study that you mentioned that was done by
Pricewaterhouse, included any of these basic factors.
Mr. Wilkins. Yes. Income tax is certainly put in there
carefully, Mr. Chairman. The argument, of course, you are
making are an argument against any income tax, but it is also a
good argument for keeping tax rates as low as possible. An
income tax that has relatively low rates is going to have
relatively lesser impact on the disincentives that you just
talked about.
Chairman Archer. Yes, it is true that the higher marginal
rates create a greater disincentive. But any taxation of income
will operate the same way even if it could be done at the flat
tax level. By the way, flat tax is dead. It has basically been
assigned to oblivion by its own creator, Professor Hall, but
even if you could do a flat tax, it would still be true that
the more hours you work, the more you are going to pay in
taxation. It just does not increase incrementally by the
graduated tax structure. And you are still taxing work. You are
still taxing at a lower rate, and I agree it would be better,
you are still taxing work effort.
Mr. Wilkins. Let me just make one more comment in response
to your question, Mr. Chairman, and that is our study does not
differ a great deal with many of the other studies that show
there are going to be positive benefits in the long run from
switching from an income tax to consumption tax. What our study
shows is that there are some very dangerous effects in the
short run in getting there. You are giving an enormous
incentive to saving and a disincentive to consumption, and by
golly they both work. GDP drops and consumption drops just the
way you might expect them to.
Chairman Archer. No, no. I did listen very carefully to
your presentation, and I noted that you distinguished between
the short-term and the long-term. But I am wondering, even if
in the long term, these studies have any way of factoring in
work effort and productivity, and how it is burdened by the
income tax and how it is freed up by abolishing the income tax?
And I doubt very much that those factors have been adequately
put into the models. Additionally, and I want to develop a few
more points and then I want to get responses from all of you.
The cost of compliance with the income tax is to be $250
billion estimated and some say it could go as high as $500- to
$600 billion a year. But being a conservative, I will take the
lower number and work off of $250 billion. It means that some
of the brightest and best minds in this country are spending
full time coping with this tax code, which produces no wealth.
And if those minds were freed to go into the marketplace, and
their ingenuity, and use their mental capabilities were
designed to produce wealth, would we not also have a bigger
GDP? Is that factored into all of these studies? I rather doubt
it. And so I think the studies are flawed because they are
unable to cope with a lot of these intangibles as to the truth
benefits that will come.
And then, finally, I want to ask each one of you, which I
have done to a number of other witnesses, not today, but in
previous hearings, what would you pay, Dr. Kotlikoff, not to
have to deal with the IRS every year?
Mr. Kotlikoff. That is a good question.
Chairman Archer. What value, in dollars, would you assign
to that, personally?
Mr. Kotlikoff. Probably somewhere between $3,000 to $5,000.
Chairman Archer. I take it you do your own income tax from
your testimony, and if you do, I am there with you, and I am in
the process of trying to handle that right now.
Mr. Kotlikoff. Right.
Chairman Archer. What would you pay, Mr. Wilkins, not to
have to deal with the IRS every year?
Mr. Wilkins. I apparently haven't had as bad an experience
as Larry Kotlikoff has had with the IRS. It certainly would be
nice not to have to deal with them on a personal level, and I
have had to deal both with my own taxes, my elderly mother's
taxes, and other taxes, but it would not be worth that much to
me. I think I have probably wasted hundreds of dollars, but not
thousands of dollars of my time.
Chairman Archer. You must have a very cheap tax prepayer.
Dr. Metcalf, what would you assign as a value that you
would pay not to have to deal with the IRS every year?
Mr. Metcalf. Well, I am the wrong person to ask, I am
afraid, for two reasons. One is that my income is fairly
simple, as a professor. But, second, as a public finance
economist, I am rather embarrassed to say I get some
consumption value out of filling out tax forms. So it helps me
in thinking about it to talk to my students. So I am an
outlier, I am afraid.
Chairman Archer. So it is a learning experience, and you
benefit from it.
Mr. Metcalf. Yes, sir.
[Laughter.]
Chairman Archer. Dr. Angell?
Mr. Angell. Chairman Archer, I am one of those fastidious
taxpayers that really wants to do it exactly right, and there
is a lot of personal pride and integrity in that. I would
happily pay $25,000 compensatory costs to not have to go
through that process. But I would like, in addition, $80,000 of
punitive costs in regard to the entire intrusion into my life.
And even though I want to do it most accurately, I do not like
that kind of big Government in my personal financial life.
Chairman Archer. Well, you alluded to what was going to be
my next question. How much value do you attach to your personal
freedom and privacy? Thomas Jefferson said in his second
inaugural address that one of his most notable achievements
while in public office was the removal of the Federal tax
collector from any direct contact with the American citizen
because he understood, probably more than any other American,
the value of individual freedom.
Now, put that into your hopper. Dr. Kotlikoff, how much is
your individual freedom and privacy worth?
Mr. Kotlikoff. I had one minor audit that was pretty much
an even split with the Feds, so to me it is not so much an
issue of private freedom. I think the Government is going to
have to collect taxes no matter how we do it. I do not get
exercised over the existence of the IRS, to tell you the truth.
I am just concerned about the next generation, and the fact
that we are not looking ahead to the retirement of all of these
baby boomers and distributors. I am also concerned that tax
inefficiencies have been getting worse over time.
I think that if more Democrats really looked at this tax
proposal, they would see that it is really very much a
Democratic proposal. It is getting rid of the regressive
payroll tax. It has got a very progressive rebate. And it is
going to presumably maintain the real spending power of Social
Security beneficiaries, food stamp beneficiaries and people on
Welfare.
I also has an implicit wealth tax, as Gil Metcalf was just
describing. today, if you are Bill Gates and spend your $80
billion or so on consumption, you don't pay any taxes on it.
But under the retail sales tax you would. And if you don't
spend you wealth yourself, you give it to your kids, and they
spend it, plus some interest, they'll pay taxes on it. And in
present value, it is equivalent to a one-time wealth tax on $80
billion. That, to me, is very progressive.
Mr. Linbeck does not seem like part of a vast left-wing
conspiracy, but he actually is. And it is really time, I think,
for the Democrats to recognize that what is being proposed here
is something they should be advancing.
Chairman Archer. Okay. I think there is merit to what you
are saying. I also think that when you talk about the Baby
Boomers and the problems that we are going to have in the next
century which has not started yet we have got to be concerned
about two things--savings had productivity. We have got to
start presaving, and we have got to increase productivity. And
those are the only two answers to the problems that are looming
ahead.
Mr. Kotlikoff. Let me just say, if I could, respond on the
issue of saving.
I have studied in simulation models with other economists
the whole way consumption taxation increases saving. And part
of it has to do with these economic incentives, that you are
not facing a double tax on saving. But a large part of it has
to do with the fact that you are putting a bigger burden on the
older people who are the big spenders in this economy. Their
propensity to spend, to consume, out of their remaining
lifetime resources is two to three times higher than that of
younger people. The reason our national saving rate is so low,
to be quite honest, is because we have been spending five
decades taking ever larger sums from young savers and giving it
to old spenders. The consumption of old people, relative to
young people, in the post-war period has roughly doubled.
This is exactly what economic theory predicts, which is
older people, because they have fewer years left to go, are
spending at a more rapid clip. So when you put more of the
burden onto the old people and away from the young people, you
are really taking from spenders and giving to savers. That is
the real reason, in these simulation models, based on the
standard life cycle and neoclassical model of economic growth,
that you actually get a crowding in of capital, you get more
saving, and you get the national output to go up by about 15
percent in the long run.
Chairman Archer. That is also, I think, very helpful and
very interesting.
Let me just pursue with Mr. Wilkins how much value you put
on privacy and individual freedom in your own life. Is it also
down there around $100?
Thank you, Dr. Kotlikoff. I understand you have to leave.
Mr. Wilkins. You are speaking to someone who just got
through filling out the census long form, so I have a little
different view. Back to thousands of dollars on this, several
thousand dollars. I really do share your view that it would be
very nice not to have somebody looking over our shoulder all of
the time and have some more privacy.
I will have to say that I am a little concerned about my
neighbor down the street. I would just as soon they continue to
look at him for a while.
Chairman Archer. Dr. Metcalf, is this also a learning
experience for you so it really is something that you are
benefitting from?
Mr. Metcalf. Well, I did the short census form, so I am not
so exercised.
No, I think as an individual I share your concerns
certainly about privacy. As an economist, in addition, I think
I share your frustration that income is enormously difficult to
measure. And if we could tax consumption, a lot of that
intrusion, the need for intrusion goes away. And if we were in
a world without taxes, initially then, I think we would
certainly want to choose a consumption tax. And the real
frustration, I suspect, is that we are in a world with one tax,
we want to switch to a world with a better tax. So there are
clear benefits of making that shift, but there are real costs
in how we get from A to B that are what you have to struggle
with and how to deal with.
Chairman Archer. And, Dr. Angell, you said if I asked, you
would explain why you disagree with the other panelists and why
you believe a 23-percent rate is the appropriate rate.
Mr. Angell. Yes. But it is not just that disagreement. I
disagree with Mr. Wilkins' notion that the short run would
provide slower growth. I think just the opposite. I think we
would come out of the gates very, very fast with the transition
to the America for Fair Tax proposal. That would occur because
consumer spending slowdown would be very significant and abrupt
in the tax year that you made the transition. But that would
free up resources to enable our companies to crowd out imports,
and it would also free up resources to move into the export
industry. And we have got American companies or global
companies and they know how to do it, and they simply do it
wherever it is best to do it. So I would expect to come out of
the gate at 6-percent real growth rate.
Chairman Archer. I see.
Mr. Angell. Now, expecting, thereby, that we have a very
strong economy, that then is going to lead to higher consumer
spending. That is we are going to have an incremental increase
in consumer spending because people's perception of their
lifetime income will be so much higher. Alan Greenspan talks a
lot about the wealth effect that comes from equity price
increases that causes consumer spending income ratio to rise.
But I think there is another wealth effect that has been
overlooked, and that is this new technology economy develops
such increases in labor productivity and such improvement in
job opportunities, that the human capital that is estimated by
the young worker is a whole lot different than it would be if
we were in an economy that was really lost in the doldrums. So
we need to be freed up to save the money, to fuel the capital
spending that we are doing, and I expect that will then produce
high tax receipts.
Now, I would also want to question whether the income tax
is passed backward onto the wage earner or forward to
consumers. I think the corporate income tax is largely passed
forward to consumers. But if my firm received a thousand-dollar
asset management fee and we had to put a 23-percent sales tax
on it, and it would be $1,230, I don't think there's any chance
that my bonus arrangement with the company would be the same as
it is now, and the firm would not need to pay me the same
amount they paid me now because I always take into
consideration my after-tax income in deciding whether or not I
wish to remain employed.
Thank you.
Chairman Archer. I am grateful to the responses from all of
you, and I have imposed on my colleague, Mrs. Thurman. Thank
goodness she is the only one that I have imposed on. Mrs.
Thurman, it is your turn.
Mrs. Thurman. Mr. Chairman, I just want you to know that
the one question that I might have had, the guy left already.
[Laughter.]
Mrs. Thurman. So you did a very good job on that.
I have a couple of questions, and, you know, Dr, Angell, I
was listening, and I was sitting here thinking if I were a
business person, and I am a business person in the office that
I run, and I think about the cost of running my office and what
this would incur if I had to have an electrician come in, and
it is going to be an extra 30 percent or if I am going to have
somebody check the plumbing or you are going to have an
electrical bill or whatever other kinds of services that are
being provided to me, that is going to raise the cost of every
service that is provided.
So if you take that into effect, then this assumption that
it is going to, just because the payroll taxes are going to
come down and the employer might save some money there, that it
is going to be passed onto the worker or not passed onto the
worker, I mean, I don't know where we get into a better
situation here at all, not to mention the fact that they say
the accountants and all of these people are going to be taken
out.
Well, you know what, I remember in the State legislature
when the businesses came to us and said, ``Look, you have got
to raise the amount of money that we are going to--that we are
collecting these taxes for you because we needed another
proportion of this so that we can continue to do the paperwork
and the constant thing.'' The same thing with the doctor's
office, the hospitals. I mean, you know, they are overburdened
with insurance things. Now we are going to add this idea that
they are going to have to, you know, bear the cost of 30
percent on every billing that they do, and somebody is going to
have to take care of that paperwork.
Mr. Angell. But a lot of it is passed backward already;
that is, we are a Nation, using international comparison, we
are a Nation of very high tax compliance. But, we are
increasingly low tax compliance in regard to nannies, and
craftsmen who are working and who are insisting on cash
payment.
Mrs. Thurman. Are you suggesting that would get rid of that
problem?
Mr. Angell. No, I'm saying it is already there. What I am
saying is if the Federal Reserve continues to do its job well,
then people say I do not have the ability to pay more, and so
consequently when the worker has a reduction of the payroll
tax, the worker has a reduction of the income tax, the worker
is willing to do the work at a lower rate than otherwise would
be the case. And that include Government workers.
Mrs. Thurman. I am not so sure when they have to pass along
to themselves a 30-percent on every payment that they are
making.
But let me go to Dr. Metcalf--or maybe, Mr. Wilkins, can
you respond to that, though, as far as the paperwork and the
kinds of things. I mean, you seem to be this lone voice out
there suggesting that this may not be the best thing to do at
this time.
Mr. Wilkins. I suggest it is not best to do this on a big-
bang basis because it will hurt the economy quite a bit. I
disagree with Dr. Angell, I think in degree more so than in
direction. We find the incentives in a national sales tax work
extremely well, so well that consumption drops, savings
increases and the economy temporarily goes in the tank. That is
what has us worried. That is what has retailers worried. They
may like the long-run situation, but they may not be here in
the long run. That is the concern.
On the paperwork, I think you are right. There is going to
continue to be paperwork to do this. Unfortunately, most of
that burden is going to be on retailers under this new law.
Mrs. Thurman. And States, particularly if that is where the
collection point is.
Mr. Wilkins. If States are the ones that are going to have
to collect the tax, since the Feds will not be collecting any
more, that is right. I would concede that it is probably not
nearly as difficult or as big an overall job as we would
probably have with the income tax. But the burden of collecting
it is clearly shifting to States and to retailers.
If I could just mention, Mr. Chairman, one point about
cutting the tax rate and pushing it on to individuals, I do not
understand why we would think that cutting the income tax is
all going to go ahead into prices. We don't see that happening.
And the only anecdotal evidence I recall is the 1986 act, when
we cut the rate from 50 percent to 28 percent, almost in half,
I do not recall my accountant or my lawyer or my physician
cutting his prices that I had to pay. So I guess, I only base
it on anecdotal evidence, but I guess I do not see it the same
way Dr. Angell would see that.
Mrs. Thurman. Mr. Chairman, do I have time for another?
Okay.
Dr. Metcalf, in your testimony that was given to us earlier
on page 15, you go through it. Actually, the title of it starts
with rebating the payroll tax and then goes on. And the last
paragraph, you just need to explain it to me a little bit.
``There are important distributional considerations that I have
not considered in this analysis. Transitional gains and losses
will be substantial in any tax reform, and in particular reform
that shifts from income to consumption taxation. A shift
without any transitional rules from income taxation to a
national sales tax will [among other things] induce a transfer
from the current elderly to the current young. It is also worth
noting that this study does not take into consideration the
broad economic gains that might be expected from converting to
a consumption-based tax system. Low-income Americans may very
well realize gains in after-tax income from the tax shift if
the economy improves and wages rise,'' which is contrary to
somewhat what we are hearing here, that wages actually could go
down.
Can you explain that to me a little bit.
Mr. Metcalf. There are a lot of ideas embedded in that, and
I do not have what you have in front of you. I am not sure what
it is that you have. But let me speak first to the transition
issue.
Two examples, in my comments I noted that there is this
windfall tax on existing--a one-time wealth tax, so to speak.
And many of the problems of previous consumption tax reforms
has been an effort to try to create transition rules to somehow
avoid this one-time wealth tax. And to my way of thinking, that
simply decreases the efficiency gains of the reform. It
requires a higher tax rate because you are giving money back.
This issue of transfers from the current elderly to the current
young is the point also that Larry Kotlikoff was making, that
if we go to a sales tax, the current elderly have a much higher
propensity to consume, therefore will be paying more in taxes
than under the current system.
Whereas, younger people that have more saving ahead of them
and therefore will be paying less in taxes relative to the
current tax system, which taxes both consumption and savings,
which is what an income tax is.
Mrs. Thurman. But it also could mean that the younger,
being myself, with a mother, ending up paying for that extra
consumption by that elderly, costing me and shifting that
burden even further.
Mr. Metcalf. Well, it is true that we go through phases of
high consumption and low consumption. And my kids are
teenagers, so I feel like I am in a high-consumption phase
right now.
Mrs. Thurman. I have two in college.
Mr. Metcalf. Yes. But, clearly, you have years of saving
ahead of you; whereas, if you were 70, you probably would not.
Chairman Archer. Mrs. Thurman, have you completed your
questioning?
I came on this committee when Wilbur Mills was chairman of
the committee, and it was operated very differently in those
days. But I remember, in the middle of the afternoon, he would
be here by himself and all of the other members would be
absent. And I was told so often that is how he became so
knowledgeable about the Code because he was always here and
very few other members were present at hearings. And on
afternoons like this, where I have the opportunity, without
imposing on too many other members to explore in greater detail
with wonderful witnesses all types of concepts, I understand
the benefit that comes from it.
I thank all of you for your presentation today, and I know
that I have learned, and I do wish that there had been more
other members here to learn from you.
You are excused.
Our next panel is invited to come to the witness table, the
final panel for the afternoon. Mr. Hamilton, Ms. Skarbek, Mr.
Chapoton, and Mr. Threadgill.
As usual, all of your written statements, without
objection, will be inserted in the record. And to the degree
that you can, if you will synopsize those in your oral
presentation, it would be appreciated. And if you will identify
yourselves before you begin to testify, for the record, that
would be very helpful.
Mr. Hamilton, would you commence.
STATEMENT OF BILLY HAMILTON, DEPUTY COMPTROLLER, OFFICE OF THE
TEXAS COMPTROLLER OF PUBLIC ACCOUNTS, AUSTIN, TEXAS
Mr. Hamilton. Mr. Chairman and members, I am Billy
Hamilton, and I am deputy comptroller of public accounts for
the State of Texas. Carole Keeton Rylander, the Texas
Comptroller of Public Accounts, was delighted to receive an
invitation to testify before this committee regarding the
fundamental tax reform measures under consideration today.
Unfortunately, her schedule didn't permit her to be in
attendance, and so she asked me to testify on her behalf.
My comments today are directed only to the feasibility of
State administration of the Fair Tax proposed by H.R. 2525. I
do not intend to comment on the economics or any other aspects
of the proposal.
The Texas Comptroller's Office has administered a sales and
use tax since 1961, and I have been involved with
administration of the tax since 1982. Last year, the Texas
Comptroller collected about $13 billion in sales tax revenue
for more than 600,000 businesses. I offer my experience with
sales tax administration, as well as the size of the Texas
sales tax program, as the basis of qualification to speak on
the administerability of H.R. 2525.
As you know, H.R. 2525 would permit States to collect and
administer the Fair Tax on behalf of the Federal Government. In
my opinion, Texas would be well-equipped to administer the Fair
Tax based on our experience in administering our own sales tax.
Even though the base rate and other characteristics of the Fair
Tax are significantly different from the Texas sales tax, it
would be feasible for our office to collect the Fair Tax by
expanding and enhancing the systems we currently have in place.
For example, we would expand our current system for
registering Texas retailers to include registration of sellers
under the Fair Tax, 615,000 businesses are currently registered
as sellers in Texas. Under the Fair Tax, we estimate that about
1.5 million Texas businesses would have to be registered;
expand our taxpayer assistance efforts to respond to a larger
volume of telephone, letter and e-mail inquiries from sellers
who collect the Fair Tax and individuals who pay it; expand our
Revenue Processing Division to process more returns and tax
payments on a more frequent basis and to remit tax collections
to the Federal Government on an almost daily basis; expand our
current audit team and train all auditors to examine businesses
for both the Fair Tax, as well as the Texas sales tax; and, of
course, expand our information technology systems to collect
and maintain computerized records critical to the effective
administration of a consumption tax like the Fair Tax.
The expansion of our systems to administer the Fair Tax in
this manner I have just described would be sizable. Under the
Fair Tax, we would serve approximately 900,000 more filers than
we do currently. We estimate that serving that many additional
taxpayers would require between 1,100 and 1,600 more full-time
employees. The Texas Comptroller currently employs about 2,700
people on a full-time basis.
In spite of this expansion, the compensation for electing
the Fair Tax that would be provided to the States under the
terms of H.R. 2525 would likely cover our projected costs. As a
first approximation, we estimate the cost to the Comptroller's
Office for collecting the Fair Tax at full implementation,
would be between $100- and $150 million a year. I emphasize,
however, there would be significant costs to begin collection,
including the cost of facilities to house the additional
processing facilities, the capital costs of information
technology and revenue processing equipment and the costs of
notifying, registering and educating taxpayers on the new tax.
However, these seem to be manageable within the amount that is
allowed under provisions of the bill.
In closing, I believe that if the Fair Tax is to become a
reality, the United States Government would be well-served to
make use of the existing expertise of the States. Many States
have administered consumption taxes since the 1930s and have
developed particular capabilities in this area. We also have
extensive experience in dealing with the affected businesses.
As long as the administrative fee paid to the States is
adequate in relation to the costs of collection, I see no
reason that the State of Texas could not effectively administer
this tax.
Thank you, Mr. Chairman.
[The prepared statement follows:]
STATEMENT OF BILLY HAMILTON, DEPUTY COMPTROLLER, OFFICE OF THE TEXAS
COMPTROLLER OF PUBLIC ACCOUNTS, AUSTIN, TEXAS
My name is Billy Hamilton, and I am the Deputy Comptroller
for the State of Texas. Carole Keeton Rylander, the Texas
Comptroller of Public Accounts, was delighted to receive an
invitation to testify before this committee regarding the
Fundamental Tax Reform measures under consideration today.
Unfortunately, Comptroller Rylander's schedule did not permit
her attendance, and she has asked me to testify here on her
behalf.
My comments today are directed only to the feasibility of
state administration of the Fair Tax proposed by H.R. 2525. I
do not intend to comment on the economics or any other aspects
of the proposal.
The Texas Comptroller's office has administered a sales and
use tax since the 1960's, and I have been involved with
administration of the tax since 1982. Last year, the Texas
Comptroller collected $13 billion in sales tax revenue from
more than 600,000 businesses. I offer my own experience with
sales tax administration, as well as the size of Texas' sales
tax program, as the basis of my qualification to speak to you
about the administerability of H.R. 2525.
As you know, H.R. 2525 would permit states to collect and
administer the Fair Tax on behalf of the federal government. In
my opinion, Texas would be well-equipped to administer the Fair
Tax based on our experience in administering our own sales tax.
Even though the base, rate and other characteristics of the
Fair Tax are significantly different from the Texas sales tax,
it would be feasible for our office to collect the Fair Tax by
expanding and enhancing the systems we currently have in place.
For example, we would:
Expand our current system for registering Texas
retailers to include registration of sellers under the Fair Tax
(615,000 businesses are currently registered as sellers in
Texas; under the Fair Tax, 1.5 million Texas businesses would
have to be registered);
Expand our taxpayer assistance efforts to respond
to a larger volume of telephone, letter and e-mail inquiries
from sellers who collect the Fair Tax and individuals who pay
it;
Expand our Revenue Processing Division to process
more returns and tax payments on a more frequent basis and to
remit tax collections to the federal government on an almost-
daily basis;
Expand our current audit team and train all
auditors to examine businesses for both the Fair Tax and the
Texas sales tax; and
Expand our information technology systems to
collect and maintain the computerized records critical to
effective administration of a consumption tax like the Fair
Tax.
The expansion of our systems to administer the Fair Tax, in
the manner I've just described, would be sizable. Under the
Fair Tax, we would serve approximately 900,000 more filers than
we do currently. We estimate that serving that many additional
taxpayers would require 1,100 to 1,600 more full-time
employees. The Texas Comptroller currently employs about 2,700
people on a full-time basis.
In spite of this large expansion, the compensation for
collecting the Fair Tax that would be provided to states under
H.R. 2525 would likely cover our projected costs. As a first
approximation, we estimate that the cost to the Texas
Comptroller's office for collecting the Fair Tax at full
implementation would be $100 to $150 million per year. I
emphasize, however, that there would be significant costs to
begin collection, including the cost of facilities to house the
additional processing facilities, the capital costs of
information technology and revenue processing equipment, and
the costs of notifying, registering and educating taxpayers on
the new tax.
In closing, I believe that if the Fair Tax is to become a
reality, the U.S. government would be well-served to make use
of the existing expertise of the states. Many states have
administered consumption taxes since the 1930s and have
developed particular capabilities in this area. We also have
extensive experience in dealing with the affected businesses.
As long as the administrative fee paid to the state is adequate
in relation to the costs of collection, I see no reason that
the State of Texas could not effectively administer the Fair
Tax.
Chairman Archer. Thank you, Mr. Hamilton.
Ms. Skarbek?
STATEMENT OF JANET L. SKARBEK, CINNAMINSON, NEW JERSEY
Ms. Skarbek. Thank you, Mr. Chairman. My name is Janet
Skarbek. I was asked here today to specifically address the
viability of administering a national sales tax from the
perspective of a professional that deals with State sales tax
administration every day.
I started my career as a CPA working at the IRS Regional
Inspector's Office. After receiving a Master's of Taxation from
Villanova University's Graduate Tax Program, I went to work for
a Big 6 accounting firm where I was responsible for the
management of sales and use taxes for clients in the Mid-
Atlantic region. I am currently employed by a Fortune 500
company, where I am responsible for sales tax compliance and
administration.
I have not been asked to speak about the economic impact of
the proposed national sales tax, nor have I been asked to
provide an opinion as to the overall feasibility of such a
plan. My testimony will specifically address business
administration and the related concerns raised by such a tax.
The views I express in this testimony are my own and should not
be construed as representing any official position of my
employer.
In my opinion, the administration of the national sales tax
would ``probably'' be simpler and easier than administering the
current income taxes and payroll taxes it proposes to replace.
I emphasize ``probably'' because the detailed procedures that
businesses would be required to follow, with regards to
documentation, have yet to be established. These details will
be essential in determining the potential administrative costs
to businesses.
The national sales tax, as proposed, would not duplicate
most of the larger problems that businesses currently encounter
when dealing with the States' sales taxes. However, there are a
few issues that will need to be addressed.
Under current State sales tax administration, businesses
are required to either collect the sales tax or the appropriate
exemption documentation from their customers. The documentation
that most States require vendors to collect from their exempt
customers includes: the purchaser's name, address and
registration number, the seller's name, a description of the
property being purchased, a statement that the property being
purchased meets the requirements for the exemption, and a
signature from the purchaser.
Whereas, the currently proposed national sales tax merely
requires businesses to accept copies of their customers'
registration permits in good faith. The States are very aware
that their tougher documentation requirements can be defeated
by individuals using copied or forged certificates. Making cash
purchases with such illegal documentation generally results in
the lack of any audit trail.
Due to the fact that the proposed national sales tax rate
is higher than any current State sales tax rate, I strongly
believe that further rules and regulations would be developed
to remove the current control weaknesses. The burden that those
potential rules and regulations would place upon business is
unknown. The simpler solutions tend to allow more tax evaders
to slip through, while the more tedious solutions tend to put a
larger responsibility on businesses.
Under most current State sales tax systems, if an
individual purchases a product in a State and is not charged
sales tax in that State, that individual is legally required to
self-assess that State's tax. For example, if you live in
Virginia and you purchase a table from L.L. Bean, L.L. Bean
does not currently have nexus with Virginia and is therefore
not required to collect Virginia's sales tax. Upon receiving
your table from L.L. Bean, you are supposed to check your
receipt and make sure you paid sales tax. If sales tax was not
paid, you are legally required to self-assess that tax. And I
am sure everyone in this room reviews all of their receipts and
makes sure to self-assess tax when legally required.
Now let's face it, the State sales tax system is not
working when it comes to individual's self-assessing the tax.
The proposed national sales tax would also require individuals
to self-assess when sales tax was not originally paid to the
seller. One such example occurs when orders are placed over the
Internet and shipped from locations outside the United States
into the United States.
Due to the fact that individual self-assessment does not
work for the States, it is doubtful that compliance would
increase at the national level. I am confident that this hole
would also be plugged by future rules and regulations. The
question then arises as to the burden these controls would
place upon businesses.
In closing, the administration of the national sales tax
would probably be simpler and easier than administering the
current income taxes and payroll taxes, depending upon the
procedural requirements. Every issue I have addressed in my
testimony today is further addressed in my written statement.
I appreciate the opportunity to speak at this first-ever
Congressional Summit on Fundamental Tax Reform. The testimony
heard over the next 3 days from the members of Congress, the
economists and the business leaders on improving the IRS, as
well as on the various tax reform proposals, can only serve to
improve our future tax system. But I am afraid you have your
work cut out for you.
[The prepared statement follows:]
STATEMENT OF JANET L. SKARBEK, CINNAMINSON, NEW JERSEY
I was asked here today to specifically address the
viability of administering a national sales tax from the
perspective of a professional that deals with state sales tax
administration every day.
I started my career as a CPA working at the IRS Regional
Inspector's office. After receiving a Master's of Taxation from
Villanova University's Graduate Tax Program, I went to work for
a Big 6 Accounting Firm where I was responsible for the
management of sales and use taxes for clients in the Mid-
Atlantic region. I am currently employed by a Fortune 500
company, where I am responsible for sales tax compliance and
administration.
I have not been asked to speak about the economic impact of
the proposed national sales tax, nor have I been asked to
provide an opinion as to the overall feasibility of such a
plan. Therefore, I will limit my testimony to specifically
addressing business administration questions and the related
concerns raised by such a tax.
In my opinion, the administration of the national sales tax
will ``probably'' be simpler and easier than administering the
current income taxes and payroll taxes it proposes to replace.
I emphasize ``probably'' because the specific details and
mechanisms of how the tax will actually be administered leaves
too many unanswered questions. The simplicity of the tax itself
is without question. However, the procedures and compliance
requirements that still need to be drafted will significantly
impact the ease and simplicity of administering this tax from a
business standpoint.
Potential Costs
The costs to administer a national sales tax are unknown
because the business requirements and documentation procedures
have yet to be determined. However, if the procedures are
similar to those imposed by states with sales taxes, the costs
of administering the proposed tax should be significantly less
than the costs of administering the current income taxes and
payroll taxes. Between employees and accountants used to track
the information and prepare the returns, and the attorneys
needed to interpret and argue the gray issues contained in the
massive tax codes, American businesses spend billions of
dollars every year complying with their federal tax burdens
States collect more in sales tax than they do from the
combination of the individual income tax, corporate income tax,
and property taxes. This fact usually surprises people because
so little time and money is spent administering the sales tax.
Sales taxes are generally quite simple to administer. However,
some of the states have goofed up the simplicity, by adding new
exceptions every year.
Also note that not all current costs associated with
administering the payroll taxes would be completely eliminated
under the new proposal. The proposed tax would merely change
the source of funding for social security payments, but would
not change how the social security payments are calculated.
Therefore, companies would remain responsible for tracking
wages. W-2's and yearly filing for the self-employed would
still be essential.
For the businesses that are already collecting at least one
state's sales tax or the necessary exemption documentation from
customers, most companies are already familiar with the basics
of sales tax administration. The education of these businesses
on the national sales tax would be fairly straightforward
(again depending upon the procedural requirements). For those
businesses new to sales tax (such as direct mail and internet
retailers, banks, and insurance companies), they would have a
larger learning curve.
Problems encountered by businesses currently administering
the states' sales taxes
The national sales tax as proposed would not duplicate most
of the larger problems that businesses currently encounter when
dealing with the states' sales taxes. The first and foremost
complaint that businesses have with the current states' sales
tax systems is that:
--all of the 45 states that impose a sales tax
have different rules regarding what is taxable, when it is
taxable and the amount of tax. Even when a state's tax appears
to be similar to another state's, their respective courts often
interpret those laws differently.
It's fairly simple to become proficient administering one
state's sales tax, but administering to several of them is a
very difficult feat. The national sales tax would be just
that--``national.'' As proposed, there are no regional or local
zones that would be established with different guidelines (tax
rates or exemptions) to complicate the national sales tax.
Another area that concerns many small and large businesses
is nexus. Nexus, for sales tax purposes, is the minimum
connection that must exist between a vendor and a state before
that state can require the vendor to collect sales tax. A
salesman or an independent contractor can create nexus for a
business. Making deliveries to a customer in a state using a
company truck can create nexus for a business. Nexus would not
be a major concern for businesses if the states applied the
same interpretation of what constituted ``minimum connection''
in the creation of nexus. However, the states are not
consistent in their criteria. Some states take the position
that if a company's salesman visits one customer in their
state, that is sufficient to create nexus. Other states take
the position that it takes 10 visits to create nexus. There is
no across the states standard to easily assess whether a
business has nexus with a state. As proposed, the requirement
that a business collect the national sales tax is not dependent
upon a business' nexus with any specific state.
The topic that raises the blood pressure of more sales tax
administrators on a daily basis is the topic of drop-shipping
for customers. This occurs when a business sells to one
customer and that customer requests that the products be
shipped directly to their customer. The problem is that many of
the states take the position that if a business is not
registered in a state, they cannot provide the documentation
(generally a resale certificate) that would otherwise allow the
sale not to be subject to the state's sales tax. The basic
underlying premise for the sales tax is ``the sales tax should
only be paid by the ultimate consumer purchasing the product.''
However, this goes out the window in the states that take the
position that only registered businesses can provide the
necessary exemption documentation to support their stance that
they are not subject to tax. When this occurs double taxation
can take place on property that is drop-shipped into those
states. First, it would be paid by the company that is not
registered in the state. Next, it would be paid by the ultimate
consumer purchasing the product.
This places businesses that have nexus with such states at
competitive disadvantages with those that do not have nexus
with such states. For example, assume Company A has nexus with
State Q and Company B does not have nexus with State Q. Company
A would have to collect sales tax on shipments for a customer
that has no nexus with State Q and is not registered with State
Q when shipping to their customer's customer located in State
Q. However, if Company B made the same sale and shipments, they
would not be required to collect the tax. As proposed, a
company's nexus with a state would not put it at a competitive
disadvantage with companies that did not have a minimum
presence in the state.
Many states tax the property and services that are
purchased by businesses. Determining what purchases are taxable
in a state, which ones qualify for an exemption, and how to
obtain such exemptions is an ongoing concern for many
businesses. The national sales tax would not result in nearly
as many problems because according to Chapter 1, Section 102
``(n)o tax shall be imposed under Section 101 on any taxable
property or service purchased for a business purpose in a trade
or business.'' However, the definition of the statement
``purchased for a business purpose in a trade or business''
needs to be more fully developed. The proposed definition is
``purchased by a person engaged in a trade or business and used
in that trade or business--(1) for resale, (2) to produce,
provide, render, or sell taxable personal property or services,
or (3) in furtherance of other bona fide business purposes.''
The definition needs to be further defined because opposing
opinions on the taxability of various business purchases still
remain. For example, would a business lunch be taxable? My
interpretation is that they would not be taxable. However,
there are those that disagree with that interpretation. All
such questions and gray areas need to be eliminated.
Compliance
Under the current state sales tax systems, non-compliance
will generally fall into one of three categories:
1) underpaying the tax because of a mistake,
2) underpaying the tax due to a difference in opinion from
the states on the many gray areas of the laws, or
3) underpaying the tax intentionally.
The regulations that are developed in order to reduce these
compliance problems could make the tax difficult or easy to
administer from a business standpoint. The current proposed
national sales tax is more lenient on what a seller can accept
as exempt documentation in lieu of the tax, than what the
states currently require. Most states require that the
purchaser provide the seller an exemption certificate that
includes the:
a) purchaser's name, address, and registration number,
b) the seller's name,
c) a description of the property being purchased,
d) a statement that the property being purchased meets the
requirements for the exemption (i.e. resale, exempt business
purpose, etc...), and
e) a signature.
The proposed national tax merely requires the vendor to
receive in good faith a copy of a registration permit from the
purchaser and for the seller not to have at the time of the
sale reasonable cause to believe that the buyer was not
registered. Due to the fact that the proposed national sales
tax rate is higher than any current state sales tax rate, the
controls should be at least as tough as those imposed at the
state level.
The first non-compliance category listed above is
underpaying the tax because of a mistake. Most mistakes made by
businesses and individuals are the result of a lack of
knowledge that something is taxable. The simpler a tax is the
less likely that mistakes will be made.
The states have made parts of their sales/use tax laws so
complex and difficult to follow, that there is close to 100%
non-compliance with some sections. This is the case with the
sections relating to individuals self-assessing use tax.
According to most current state sales tax systems, if an
individual purchases a product in a state and is not charged
sales tax, the individual is legally required to self-assess
that states use tax. For example if you live in Virginia and
you purchase a table from LL Bean--LL Bean does not currently
have nexus with Virginia and is therefore not legally required
to collect Virginia's sales tax on their shipments to Virginia
customers. Therefore, you would be required to self-assess the
tax.
The states' sales tax systems are not working when it comes
to individuals self-assessing. Most Americans don't even know
that they are legally required by most states to do this. The
proposed national sales tax is much simpler and this problem
would be much smaller because a business' lack of nexus with a
state would not effect the fact that it would generally need to
collect the tax from these customers. Whether a business had
nexus with a state would be irrelevant to the fact that the
national sales tax would be required to be collected by the
vendor in most situations. Therefore, essentially more
businesses would be collecting the tax when shipping products
directly to individuals' homes and fewer individuals would have
the need to self-assess the tax. In addition, the marketing
advantage that many direct marketers and internet retailers
without nexus in a state have over other businesses physically
present in a state would not exist under the national sales tax
(when the direct marketers or internet retailers have a
physical presence in the United States).
The second area of non-compliance falls under the category
of underpaying the taxes due to a difference of opinion from
the states on the many gray areas of the laws. The fact that
the national sales tax as proposed is based on the presumption
that many businesses would not be subject to the national sales
tax and that all purchases by individuals (with very few
exceptions) would be taxable eliminates most of the gray areas
that would come under contention.
The third area of non-compliance is due to those
individuals that intentionally underpay the tax. There will
always be individuals attempting to illegally outmaneuver
paying their fair share of taxes, just like there will always
be individuals trying to create new and more potent computer
viruses. With any tax system, it's a matter of trying to stay
one step ahead of the law breakers.
There are several areas where the details of the internal
controls that will be used to stop those intentionally trying
to make purchases without paying tax are not currently defined
under the proposed ``Fair Tax Act.'' These internal controls
will be essential to determining the ease with which businesses
can meet their tax responsibility. Here are five areas that
need to be further developed.
1) What controls would be established to stop importers
from shipping their goods over our borders and selling them tax
free on a black market?
2) What controls would be established to ensure that
Americans traveling over the borders and purchasing their goods
without the tax and bringing them back into the United States
will self-assess the tax? Chapter 1, Section 103(b) provides
that ``(i)n the case of taxable property or services purchased
outside the United States and imported into the United States
for use or consumption in the United States, the purchaser
shall remit the tax imposed by Section 101.'' Section 101(c)
provides that if a consumer imports taxable property directly,
they would pay both the sales tax and any import duty together
at the same time at customs. Section 101(d) states that ``(t)he
person using or consuming taxable property or services in the
Unites States is liable for the tax'' except when the person
pays the tax to the person selling the taxable property or
service and receives a qualifying receipt. The compliance for
individuals self-assessing the states taxes is almost non-
existent. What controls would be instituted to increase
compliance?
3) What controls would be established to tax goods
purchased over the internet and shipped directly to customers
from locations outside the United States?
4) What controls would be in place to locate individuals
that register non-existent companies (where no actual business
is taking place) in order to obtain the documentation to
provide vendors in order to make personal purchases tax free?
5) What controls will be in place to stop individuals from
utilizing their companies' certificates of registration in
order to make tax free personal purchases? This is another area
where states know the problem exists. However, if the person
makes the purchase with cash, the audit trail is generally non-
existent.
The regulations and controls that would be established in
answer to the above questions could be very simple or very
complex for businesses to follow. The simpler solutions tend to
allow more tax evaders to slip through. The more tedious
solutions tend to put a larger burden on businesses.
For example, in response to question number 5, a simple
procedure could be established that:
1) a company must designate a specific employee(s) to be
responsible for the tax documentation,
2) the employee would be required to register and sign a
document that they will not illegally use the tax documentation
to make personal purchases tax free, and
3) the employee provides a copy of the documentation to
each vendor that the company makes non-taxable purchases from.
However, this simple procedure leaves open several loop
holes. First, if the designated employee actually uses the tax
documentation for personal purposes there would be very little
in the way of an audit trail to weed out such occurrences. The
records at her employers would show no indication of the
misdeed. Second, what would stop a dishonest clerk at the
vendors from making another copy of the tax documentation and
then making tax free purchases with the documentation and cash.
This would essentially be untraceable.
An example of a slightly tougher solution that would rely
more heavily on businesses would establish that:
1) every company that registers receives a booklet of
exemption certificates containing sequential numbers, the
company's name, and identification number,
2) every company would be responsible to keep a log of the
exemption certificate number and what vendor they gave the
exemption certificates to.
This procedure, although not fool proof, would result in
fewer employees utilizing such certificates for their own
purposes. An audit of the log and purchases made by the company
from specific vendors would show any certificates that were
missing. Copying of certificates by vendors for their own use
would also be less likely since the certificates would be
printed by the government.
This then raises the question of ``when is a seller
relieved of liability when collecting documentation?'' Section
103(d) provides that when the vendor accepts a copy of the
registration certificate in good faith and has no reasonable
cause that the purchaser was not registered that this is
sufficient to relieve the vendor of liability. The issue of
``what constitutes the acceptance of documentation in good
faith'' is an area where the states and businesses currently
hold varying opinions. For example, what happens if the
government establishes a set of guidelines to indicate that a
certificate is valid and a clerk at a store accepts one that is
missing a little identifying insignia in the bottom corner?
Would the store that mistakenly accepted the counterfeit
documentation be subject to the tax that they should have
collected from the customer? The mere fact that vendors would
now be required to look for this insignia would place a large
responsibility on vendors.
You can see from the above, that the details of what would
be required of a business in the day to day activities of
compliance would be essential in determining the full impact a
national sales tax would have on businesses.
What agency (agencies) would administer the tax?
Section 401 provides that states which maintain a sales tax
and which enter into a cooperative agreement with the federal
government can choose to administer the federal tax for \1/4\
of one percent of the revenue they collect and remit to the
federal government. They also have the ability to contract out
the work to another state. Title III, Section 302 would
establish within the ``Department of Treasury a Sales Tax
Bureau to administer the national sales tax in those States
where it is required.'' Specifically, those states that cannot
or choose not to collect the national sales tax.
The current national sales tax proposal suggests that the
states should administer the tax because of their previous
experience administering a sales tax. Just because a state has
experience, does not mean that it is good at what it does.
There are states that are great administrators and states that
are very poor.
It would be simpler to have all administrative
responsibilities fall under the Sales Tax Bureau than under the
45 states that currently impose a sales tax. Imagine the IRS
administration problems under 45 different roofs. It would be
best to have one organization responsible for administering the
tax and to make sure the individuals in that organization are
well educated and trained. If there were several agencies
administering the tax, the administrative controls would be
significantly diluted. In addition, for businesses operating in
more than one state, there is confusion as to which agency
would have control over the returns.
Conclusion
In closing, I appreciate the opportunity to speak at this
first ever Congressional Summit on Fundamental Tax Reform. The
testimony heard over the next three days from the members of
Congress, the economists, and the business leaders on improving
the IRS, as well as on the various tax reform proposals, can
only serve to improve our future tax system. I'm afraid you
have your work cut out for you.
Chairman Archer. Thanks, Ms. Skarbek.
Mr. Chapoton?
STATEMENT OF HON. JOHN E. CHAPOTON, PARTNER, VINSON & ELKINS,
LLP, ON BEHALF OF THE AMERICANS FOR FAIR TAXATION [FORMER
ASSISTANT SECRETARY FOR TAX POLICY, U.S. DEPARTMENT OF THE
TREASURY]
Mr. Chapoton. Thank you, Mr. Chairman. My name is John
Chapoton. I am a partner with the law firm of Vinson & Elkins,
and I am here on behalf of the Americans for Fair Taxation.
Mr. Hank Gutman and I have a statement that we have
submitted for the record, and I would like to just give a brief
summary of the points that we have made, again, focusing on the
administrative points.
I think a starting point, when you assess or evaluate any
tax system, is how understandable the rules are and how
predictable the outcome of calculating the tax is. I think when
you look at our present income tax, you have to say that it
does not meet that test very well. We have all sorts of special
rules, we have phase-ins, we have phase-outs, we have disputes
on what has to be capitalized, what doesn't have to be
capitalized, we have rules for determining ordinary income and
capital gains. So it is complex and, unfortunately, efforts at
simplification have failed. It absolutely becomes more complex
every year.
I think it is reasonable to conclude, I think it is really
cannot be doubted that the Fair Tax that is before you today
would eliminate most of these complexities and would, thus,
eliminate the administrative costs that those complexities
bring with them. There are objections voiced to the national
sales tax, the distribution issues, the transition issues.
Would the rate be so high that Americans would object? There
are other objections. I think the Fair Tax deals with those in
a very straightforward and open manner. I want to just talk
about the administrative points, however.
One thing we ought to keep in mind is that consumption
taxes are used, in one form or another, very widely in the
world. All of our trading partners, I guess for all of our
trading partners, most of them certainly have consumption
taxes, most in the form of value-added taxes. Some 17.8 percent
of the OECD countries--tax rate of the OECD countries are in
consumption tax form.
And of course the States, as we have heard today so many
times, depend a great deal on sales taxes to raise their
revenues. Six States, including the State of Texas, my State,
depends on the sales tax for most of its revenues. So sales
taxes are easily understood. They generally or the perception
is that they work well. Most businesses selling to retail
customers collect and report the tax today and it is a familiar
tax. So there is strong evidence that if the Federal Government
decided to do so, it could administer a national sales tax.
The Fair Tax or any other national sales tax, though,
would, of course, have to be a higher rate than we have
experienced in any State sales tax to this date. And as the
rate goes up, we know the incentive to avoid or evade the tax
goes up by imaginative interpretation or simply by cheating.
The rate of tax measures the potential reward for evading or
simply avoiding the tax. So the rate of the tax is an important
question in administration and enforcement of the tax. We
discuss several specific areas in our paper. But what jumps out
at you, as you review these issues, is that for the most part,
these difficult issues that will be presented in a national
sales tax are areas that present huge complexities in the
income tax today, and the compliance problems that go with
that.
Take a single example, but a very important example. That
is mixed-use property or mixed-use service; that is, where a
person buys a service or a good and uses it partially in
business and partially personally. That will be a difficult
administrative problem in the sales tax. But it is a very
difficult problem in the income tax today, determining when an
expense is personal or business. It is the subject of much
litigation and it is a constant thorn in the side of the income
tax. So that is just one example. There are many others that
the Fair Tax or any national sales tax will have problems to
deal with, but they are not increased problems, they are
problems that we already have to deal with. And, indeed, in
many instances, I think it is possible to argue that the Fair
Tax would lessen those problems.
I think the key point is that when you look at the
administration and enforcement of a sales tax, it is just how
many taxpayers would be taken out of the system all together.
Today, everybody is in the system. We have 120 million
individual income tax returns, some 22 million business returns
and over 200 million total returns. Only retail businesses,
only a portion of today's business returns, would be in the
system, if you will, in a sales tax, and that would only be a
fraction of the total returns filed by individuals, trusts, and
partnerships and businesses today.
So in enforcement terms, this means there would be far
fewer opportunities to evade or avoid the tax. Fewer taxpayers
would have the opportunity to bend the rules or simply cheat,
even if they were inclined to do so, and even if they were
doing so now under the income tax. Under the income tax,
everyone has the chance. You have the chance in the privacy of
your own home to claim excessive deductions or ignore small
amounts of income. And the more individual taxpayers hear about
others bending the income tax rules, that the wealthy are not
paying their share or because of tricky schemes by so-called
investment schemes and investment bankers, people are less
inclined to pay their own fair share. That is a problem with
any uneven tax, and I am afraid an uneven tax is what we have
today.
Of course, small cash-based business, the street vendor,
the contractor who comes to your house for a single job will be
a problem under a sales tax. They will collect the tax on what
they sell and not have the incentive to pay it over or they may
give you a wink and a nod and say they won't collect the tax if
you will hire them to do the job. But the clarity of the rules
will, under a sales tax, would make that more difficult, and
probably it would make them easier to catch and penalize. Lack
of understanding of the rules would not likely be a very
compelling defense.
And more important for today's discussion, this is not a
new problem. This is the group of taxpayers, the small cash-
based businesses, that is the single largest component of the
so-called tax cap under the income tax today. There is no
reason to think this would be more of a problem under the sales
tax, and it might even be easier to address, given the
transparency of the tax.
So, Mr. Chairman, let me just conclude by saying that this
committee and the Congress may decide not to go the sales tax
route for any number of reasons, for economic reasons, for
transition considerations, but I think enforcement and
administration questions should not prevent the very serious
consideration and study of the Fair Tax.
[The prepared statement follows:]
Statement of Hon. John E. Chapoton, Partner, Vinson & Elkins LLP, on
behalf of the Americans for Fair Taxation (Former Assistant Secretary
for Tax Policy, U.S. Department of the Treasury)
Dear Mr. Chairman and Members of the Committee:
We are pleased to have the opportunity to submit this
statement on behalf of Americans for Fair Taxation. We commend
Chairman Archer and the Committee for undertaking a serious
study of a national retail sales tax as embodied in the
FairTax. We have been asked to comment on the administration of
the FairTax.
One key element in the evaluation of any tax system is
whether the rules are understandable and the outcome of the
calculations predictable. Our current income tax system clearly
fails to meet these criteria for most individual taxpayers and
for many large corporate taxpayers as well. Features of the
individual income tax that increase its complexity include
elections, distinctions between capital and ordinary gain or
loss, valuation questions, capitalization of certain business
costs, recordkeeping requirements, rules restricting favorable
tax treatment, itemized deductions, the alternative minimum
tax, the earned income tax credit, and a large number of phase-
in and phase-out provisions. Attempts to simplify the income
tax have failed, and indeed, the Code annually grows more
complex. The FairTax would eliminate these complexities, and
the administrative costs associated with them.
In considering a national sales tax, the Committee should
be aware of the important role that consumption taxes already
play both within the U.S. and globally. Consumption taxes are
an important source of revenue for governments generally; this
is an area where the U.S. has lagged behind other nations. The
success of so many other governments in administering
consumption taxes should indicate to the Committee that the
U.S. can successfully administer a comparable tax.
Internationally, countries ranging from Albania to Zambia,
including almost all our major trading partners rely heavily on
consumption taxes. These are typically in the form of value-
added taxes, which have essentially the same economic effect as
retail sales taxes. The administration and enforcement of these
levies are not problem-free, but there is reason to conclude
those problems may not be as great as we are encountering with
our individual and corporate income taxes.
Of the 29 OECD countries, only the U.S. does not have a
value-added tax. Among OECD members, the United States has the
lowest general consumption tax collections as percentage of
total taxes (7.9% in 1996) other than Japan (5.3%). The average
share of taxes raised from general consumption across all OECD
countries is 17.8 percent. At the federal level, the U.S.
collected $70 billion in consumption taxes, in the form of
excise taxes, during FY 1999.
[GRAPHIC] [TIFF OMITTED] T1879.007
In the U.S. today, consumption taxes, including both
general and specific sales or excise taxes, are used by every
state and many local governments. In 1999, approximately 32
percent of all state and local taxes, or more than $262
billion, were collected this way. Forty-five states have
general sales taxes. In 1998, general sales tax revenues
accounted for more that half of total tax collections in
Florida, Nevada, South Dakota, Tennessee, Texas, and
Washington. When selective sales or excise taxes are included,
these same states all collect more than 70 percent of their
revenues through consumption taxes.
[GRAPHIC] [TIFF OMITTED] T1879.008
Apart from some current issues with e-commerce, existing
sales tax administrative systems seem to work reasonably well.
Indeed, a number of significant current income tax system
problems do not exist under a sales tax. The income tax and
trade complexities we are currently facing with Foreign Sales
Corporations (FSCs) are merely one example of the difficult
issues that we must regularly address. These income tax
structural problems would go away under a consumption tax
system. The marriage penalty issues and corporate tax shelter
concerns--two tax policy issues attracting much attention
today--would largely disappear under a sales tax regime.
For tax year 1997, IRS reports that 63.5 million individual
tax returns were signed by paid tax return preparers. This is
more than half of the 120.8 million individual income tax
returns filed. This is, of course, in addition to the
substantial burdens imposed on individual taxpayers who prepare
their own returns. Under the FairTax, this burden on individual
taxpayers would be eliminated. The only new administrative
burden would be the annual need to register families to qualify
for the family consumption allowance.
Most businesses selling to retail consumers collect and
report sales taxes today. While their sales tax administrative
burdens would become somewhat more complex (at least until
state and local tax systems are brought into conformity), this
would be more than offset by the fact their income tax burdens
would disappear. A variety of other new burdens would be
imposed on businesses making retail sales, but many of these
would substitute for burdens already required under existing
state and local sales taxes. Indeed, the FairTax contemplates
that the myriad of existing sales and local tax bases would
over time be brought into conformity with the newly defined
federal sales tax base. This by itself would be a major
simplification for retailers--especially those operating in
multiple jurisdictions.
Certainly there are issues of tax administration that must
be addressed. A variety of services, including financial
intermediation services, and other products not generally
subject to sales taxes today would become taxable. Devising the
appropriate tax structure will be a complex undertaking; many
of our trading partners are wrestling with these issues today.
Additional work will be required in this area. Another area of
potential administrative difficulty is presented when property
with both taxable and nontaxable uses (``mixed use property or
services'') is purchased. Apportionment is required under the
FairTax. However, this requirement is unlikely to be any more
burdensome than distinguishing between business and personal
expenses under current law.
The Federal Government and state and local governments
would be required to pay sales taxes on their purchases, which
would be a new administrative burden. Governmental entities
will be required collect tax on their sales as well.
It is reasonable to assume that total state government tax
administration costs would rise under the FairTax because they
would largely be responsible for collecting the new federal
sales tax in addition to their own sales taxes. In recognition
of this, the FairTax provides for a 0.25-percent payment to
states for administering the tax. While we have not studied
whether this amount would be sufficient to cover the increased
costs of administration, a cost reimbursement feature is an
important tool for assuring that states provide adequate
support to collect all taxes that are due under the new system.
There are, however, potentially significant administrative cost
savings if a uniform tax base were to be adopted across all
taxing jurisdictions.
It is very important to keep in mind that administrative
costs in general, and compliance costs in particular, are
likely to rise as the rate of tax increases. Pressure to avoid
taxes--through imaginative interpretations of the rules or by
simply cheating--increase as the tax rate goes up. The rate of
tax measures the potential reward to a person contemplating
avoidance or evasion. If the rate becomes excessive,
enforceability could undoubtedly become a problem. However,
these enforceability concerns may not be as significant as
those that currently exist under the federal income tax.
Enforceability is more of a problem if opportunities for
avoidance are presented by the mechanics of the tax, such as
through exceptions and special rates. The states, for example,
generally exempt a variety of goods and services. The FairTax,
by contrast, has virtually no exclusion and no special rates.
It contemplates a very comprehensive tax system. We want to
emphasize as strongly as possible, the critical importance,
from an administrative standpoint (as well as an economic
standpoint), of keeping the tax base as broad as possible, and
thus the rates as low as possible.
In sum, the FairTax provides the opportunity to reduce
administrative burdens on taxpayers. As with the consideration
of any new tax regime, and as we continually face under current
law, there will be questions and problems to be solved. We
believe that these administrative questions can and should be
seriously addressed. Administrative issues should not stand in
the way of further serious consideration of the FairTax.
Chairman Archer. Thank you, Mr. Chapoton.
Mr. Threadgill?
STATEMENT OF DEL THREADGILL, VICE PRESIDENT OF TAXES, J.C.
PENNEY COMPANY, DALLAS, TEXAS, AND CHAIRMAN, NATIONAL RETAIL
FEDERATION TAXATION COMMITTEE
Mr. Threadgill. Thank you, Mr. Chairman and members of the
committee. My name is Del Threadgill, and I am vice president
and director of Taxes for the J.C. Penney Company and the
current chairman of the National Retail Federation's Taxation
Committee.
The National Retail Federation is the world's largest
retail trade association, representing an industry of 1.4
million establishments, employing more than 22 million
Americans or about one in every five workers, with sales in
1999 of more than $3 trillion.
I am here today to express the retail industry's strong
opposition to a national retail sales tax, as proposed. Our
principal concern is that no one really knows what the full
impact of replacing the entire Federal income tax structure
with a consumption-based sales tax will have on our economy. It
has never been done before in any major industrialized Nation,
let alone the world's largest economy. As evidenced by the
comments from the previous panel, even the experts disagree
over the impact from such a radical change. At a time when our
economy is experiencing its longest period of sustained growth
in history, do we really want to bet the ranch on some untried
tax policy experiment?
Americans are truly dissatisfied with the current tax
system, and rightfully so. The retail industry cannot and will
not defend the income tax as it currently stands. It is
entirely too complicated and cumbersome. As for fairness, it is
hard to understand why a tax system that determines a person's
contribution to the cost of Government based on his ability to
pay is less fair than a system that is based on what he spends.
Yesterday, the National Retail Federation released a study
of congressional tax reform proposals. That study was prepared
by the nationally recognized economic consulting group within
PricewaterhouseCoopers. PWC utilized an economic model capable
of estimating both the short-term and long-term consequences of
tax reform; in other words, what will happen in the short run,
as opposed to 10 years from now.
Retailers thought it imperative to know what might happen
to the economy and consumers in the short run as well. PWC was
instructed to use their expertise to determine what they
believed to be the correct answer. There was no predisposition
given to PWC as to what the retail industry expected to see
from the study. We simply wanted to know what the facts were.
The PWC findings should be of concern to both taxpayers and
lawmakers alike. While it did show the economic gains at the
end of a 10-year period under a national retail sales tax, it
is the interim period that causes the heartburn. The study
clearly shows that there will be short-term chaos in the
economy and in the retail industry.
In the best-case scenario, the study found, one, that the
required budget-neutral tax rate would range from 24 to 65
percent, depending upon the number of exemptions and the rate
of taxpayer compliance.
Second, serious economic disruptions would occur under a
national retail sales tax, at least in the short run. The
economy would be depressed for a period of at least 3 years,
consumer spending would be depressed for at least 8 years with
consumer purchases down over $500 billion and up to a million-
and-a-half American jobs would be eliminated. The question we
have as an industry is how many smaller retailers and other
small businesses would still be around to enjoy the long-term
benefits of a national sales tax after this transition period.
And, third, a national retail sales tax would redistribute
the Federal income tax burden from higher income to middle-
income families, with the purchasing power of low-income
households being down 8 to 14 percent under a national retail
sales tax.
Retailers believe that a national retail sales tax would
exacerbate the underground economy, become a Pandora's box of
carveouts and exemptions for Washington's special interests,
burden small business and require additional IRS or a like-
minded agency's oversight. The retail industry would encourage
lawmakers to take a measured approach to tax reform to ensure
that a new system is both fair and equitable for everyone.
Thank you, Mr. Chairman.
[The prepared statement follows:]
Statement of Del Threadgill, Vice President of Taxes, J.C. Penney
Company, Dallas, Texas, and Chairman, Taxation Committee, National
Retail Federation
Mr. Chairman and Members of the Committee:
Good afternoon, and thank you for the opportunity to
testify before this Committee today.
My name is Del Threadgill, and I am Vice President and
Director of Taxes for the JCPenney Company and the current
Chairman of the National Retail Federation's Taxation
Committee.
The National Retail Federation is the world's largest
retail trade association, representing an industry of 1.4
million retail establishments, employing more than 22 million
people--about 1 in every 5 American workers--with sales in 1999
of more than $3.0 trillion.
I am here today to express the retail industry's strong
opposition to a proposed National Retail Sales Tax (NRST). Our
principal concern is that no one really knows what the full
impact of replacing the entire Federal income tax structure
with a consumption-based sales tax will have on our economy. It
has never been done before in any major industrialized nation,
let alone the world's largest economy.
As evidenced by the comments from the previous panel, even
the experts disagree over the impact from such a radical
change. At a time when our economy is experiencing its longest
period of sustained growth in history, do we really want to
``bet the ranch'' on some untried tax policy experiment.
Americans are dissatisfied with the current tax system, and
rightfully so. The retail industry cannot and will not defend
the income tax as it currently stands. It is entirely too
complicated and cumbersome.
As for Fairness, it is hard to understand why a tax system
that determines a person's contribution to the cost of
government based on his ability to pay is less fair than a
system that is based on what he spends.
Yesterday, the National Retail Federation released a study
of Congressional tax reform proposals. The study was prepared
by the nationally recognized economic consulting group within
PriceWaterhouseCoopers (PWC). PWC utilized an economic model
capable of estimating both the short-term and long-term
consequences of tax reform. Models utilized by some national
sales tax proponents are only capable of estimating the long-
term effects of tax reform (i.e. what happens at the end of a
10-year period.)
Retailers thought it imperative to know what might happen
to the economy and consumers in the short-term as well. PWC was
instructed to use their expertise to determine what they
believed to be the correct answer. There was no predisposition
given to PWC as to what the retailers expected to see from the
study. We simply wanted the facts.
The PWC findings should be of concern to taxpayers and
lawmakers alike. While it did show some modest economic gains
at the end of a 10-year period under a NRST, it is the interim
period that causes the heartburn. The study clearly shows that
there will be short-term chaos in the economy and the retail
industry.
In a ``best-case'' scenario, the PriceWaterhouseCoopers
(PWC) study found:
1) The required budget-neutral NRST tax rate would range
from 24-65%, depending on the number of exemptions and the
taxpayer compliance rate.
a seperate Congressional Joint Economic Committee
report confirms PWC's findings by estimating that a NRST rate
of 19-65% would be necessary.
2) Serious economic disruptions would occur under
a National Retail Sales Tax.
the economy would be depressed for three years--
with GDP down $180 billion.
consumer spending would be depressed for eight
years, with consumer purchases down $503 billion.
up to 1.5 million American jobs would be
eliminated.
the question arises as to how many retailers and
small businesses would still be around to enjoy the modest
long-term benefits of a NRST?
3) A National Retail Sales Tax would redistribute the
federal income tax burden from higher income to middle and low-
income families.
the purchasing power of low-income households
would be down 8-14% under a NRST while high-income households
would not be affected.
Retailers believe that a NRST would exacerbate the
underground economy, become a Pandora's box of carve-outs and
exemptions for Washington special interests, burden small
businesses, and require additional IRS or like-minded agency
oversight.
The retail industry would encourage lawmakers to take a
measured approach to tax reform to ensure that a new system is
fair and equitable for everyone. Americans may not like the
current Federal income tax or the IRS, but they may like a
National Retail Sales Tax even less.
Thank you.
Chairman Archer. Thank you, Mr. Threadgill.
The chair has no questions for this panel.
Ms. Thurman?
Mrs. Thurman. Mr. Hamilton, were you around when the
service tax was contemplated and passed in Florida?
Mr. Hamilton. Yes, ma'am, I was.
Mrs. Thurman. Did you have any experience in talking with
the comptroller there as to the issues, or the Department of
Revenue, the issues that they had and concerns of the
collection of these taxes?
Mr. Hamilton. Yes, ma'am. And one of my good friends was
the commissioner of revenue until very recently there, and we
actually imposed service taxes in the same period in Texas.
Mrs. Thurman. Are yours still in place?
Mr. Hamilton. We had the good sense not to tax advertising,
and that seems to have been a very important thing not to do.
[Laughter.]
Mrs. Thurman. So you now have services.
Mr. Hamilton. Yes, ma'am.
Mrs. Thurman. Everything but advertising?
Mr. Hamilton. Well, as with most things on the Texas sales
tax, it is a hit or miss. Generally, things like information
services, data processing services, miscellaneous retail
services, which would be like repairs of shoes and whatnot,
telecommunication services, just a fairly wide range, but not
all services.
Mrs. Thurman. But those were all taxed.
Mr. Hamilton. Yes, ma'am.
Mrs. Thurman. Because one of the things we heard through
our Department of Revenue was the burden that it was going to
put on them, as well as to Mr. Threadgill on the issue of
retailers of the collection.
But I want to go to Mr. Chapoton.
Mr. Chapoton. In the bill, actually, and I am asking these
questions because actually Mr. Linbeck was in my office the
other day, and he told me to ask these hard questions, so
hopefully this isn't hard. In one of the parts, you talk about
tax to be separately stated and charged. Now, I don't have a
real big problem with some of it because even today, you know,
I go into the store, I purchase something, I know it has a
sales tax. If they tell me I am spending $100, I get charged my
6 percent or 7 percent. At the end of the day, I know I am
going to pay $107. But there is an interesting one in here that
I don't understand. And it says you pay the property or
services' price exclusive of tax, the amount tax paid, the
property or service price inclusive of tax, and then the fourth
one, and I don't know what this means, the tax rate, which is
the amount of tax paid, per paragraph 2, divided by the
property or service price inclusive of tax, per paragraph 3.
Just to kind of get to the simplicity issue that everybody
is going to pay this, I need to understand what does that mean?
Mr. Chapoton. Well, I think that is part of the danger of
reading statutory language. I think what it is trying to say is
it is a tax-inclusive rate. And so that, and this point was
made earlier today, that when you look at the tax, it is not,
if you have a dollar, it is not 23 percent of a dollar, it is
23 percent of $1.23. Do you understand that?
It is like the income tax today. It is a tax-inclusive
rate.
Mrs. Thurman. Right.
Mr. Chapoton. You do not pay the income tax out of other
income, you pay it out of the income you are taxed on, and this
is the same thing. So I am not sure I have even seen the exact,
specific language you are talking about, but it is clear to me
that is what it is trying to do.
Mrs. Thurman. Is there a reason for that? I mean, why
wouldn't you just put down this is the tax you are paying, end
of story--I mean, just like we do today. I mean, I am just
curious.
Mr. Chapoton. You could do it either way, really. You could
do it either way. It changes the rate, but you could do it
either way.
Mrs. Thurman. Mr. Hamilton, let me go back to another
question. When you said you did the services, how many
additional people did you have to put on to collect the
services tax that----
Mr. Hamilton. I think we added about 20 people.
Mrs. Thurman. That is it?
Mr. Hamilton. Yes, ma'am. I mean, it was fairly straight--I
should have mentioned earlier that the one group of services
that we didn't tax were professionals, like lawyers, doctors.
That might have been a problem, too, or maybe not. But at any
rate, they weren't taxed. But it didn't require a lot of
additional people because a lot of where the services were
being delivered, people were already registered for either the
Texas sales tax or the Texas corporate franchise tax or one of
our other taxes. So we were able to find them.
Mrs. Thurman. But you think there would be a lot of other
people that might have to be registered under this?
Mr. Hamilton. Yes, ma'am, about 900,000 extra. But a lot of
it is because it is picking up a wider band of services than
our sales tax. It picks up the professions, for one thing, the
lawyers, doctors----
Mrs. Thurman. Do you see that as an increased cost to the
State?
Mr. Hamilton. Increased in--well, the administrative costs
there would definitely be a significant administrative cost to
the State, if, for no other reason, than the rapid processing
of the returns and the money that would be required, and I
think a more extensive audit and enforcement effort to deal
with what Buck was referring to.
Mrs. Thurman. Right. And I would go to that as an
enforcement issue because even today, with your flea markets
and any other things that are out there, how do you deal with
those issues?
Mr. Hamilton. Well, as with most sales taxes, the majority
of the tax is collected from very large retailers, the J.C.
Penney's and the Wal-Marts and whatnot. The way that we deal
with flea markets, and gun shows and a lot of itinerant
peddlers is we have enforcement officers--that is our term--
compliance officers in other States, that do routine canvasses
of the shows when they are in progress. And they will go
through and register every one of the taxpayers or anyone that
is there that is making sales, ensure that the tax is being
collected. There are marginal problems with that. It is
certainly true, but that is part of the requirement on all of
our enforcement offices that they do so many canvasses of those
types of shows every year.
Mrs. Thurman. But, Mr. Threadgill, that is a part of the
problem that you have in those two is this underground economy
that is going to start not just only in the flea markets and
other areas like that, but the sale. I mean, is that the--
because you raised that issue.
Mr. Threadgill. Certainly, the concern is, in coming up
with what the rate would need to be to be revenue-neutral or
budget-neutral, making sure what is included or not included in
the base. And I think Mr. Chapoton mentioned the fact that a
lot of cash-based businesses and what happens to those, and as
the rate gets higher, the chances of those going underground
becomes more and more.
I know in the Canadian experience, when they instituted
their GST tax, there was a study a couple of years later that a
number of businesses went underground, and that was a 7- or 9-
percent GST-type sales tax, on top of their income tax. But
there was a study that a lot of businesses, cash-based
businesses, went underground.
Mrs. Thurman. Mr. Chairman, I appreciate the fact that you
have given us the opportunity to learn a lot today. And I want
to say my thanks to all of the witnesses, those who are still
here, for your sincerity in trying to answer our questions and
to let you all know that no matter what we are asking in
questions, we all should take seriously what is before us on
any of these proposals. Because I think the one thing we all do
agree, that we have got to simplify for the American people,
however we do that, the tax code. So I appreciate, Mr.
Chairman, your time and the time of our witnesses.
Chairman Archer. The chair adds his gratitude to all four
of you, as well as to all of the other witnesses that have been
before the committee today. Thank you very much.
There is no further questioning that I know of and no
further witnesses today, so the committee will stand adjourned.
[Whereupon, at 4:18 p.m., the hearing was adjourned, to
reconvene on Wednesday, April 12, 2000, at 10:00 a.m.]
FUNDAMENTAL TAX REFORM
----------
WEDNESDAY, APRIL 12, 2000
House of Representatives,
Committee on Ways and Means,
Washington, D.C.
The Committee met, pursuant to call, at 10:00 a.m., in Room
1100 Longworth House Office Building, Hon. Bill Archer
(Chairman of the Committee), presiding.
Chairman Archer. Today we continue with our tax summit on
structural tax reform and what alternatives we might look at to
replace the current archaic code which we commenced yesterday.
And leading off this morning is one of our own colleagues,
a member of the Ways and Means Committee and gentleman from
Pennsylvania, Mr. English.
And Mr. English, we are happy to have you with us this
morning on the other side of the witness table, and we will be
pleased to hear your presentation as to what you think is an
appropriate alternative.
STATEMENT OF HON. PHIL ENGLISH, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF PENNSYLVANIA
Mr. English. Thank you, Mr. Chairman.
I appreciate the opportunity to appear here today. I
believe that the current tax system is broken. I believe it is
one of the reasons why our economy is having trouble competing
internationally and I believe it is one of the reasons why so
many taxpayers question the legitimacy of their government.
I believe that we need to find a better way of applying
taxes and generating the revenue to do what we need to do. And
I want to especially congratulate you, Mr. Chairman, for
raising that issue at this time. By getting involved now, I
think we have an opportunity to shape the debate for the
future.
A couple of years ago, when I came to Congress, I became
aware of some of the problems with the current tax system
simply by talking to constituents.
I was dissatisfied by many of the alternatives that were
being offered including the flat tax and the idea of a national
sales tax.
And I have spent a lot of time working to develop an
alternative based on the old Nunn-Domenici proposal which was
described at the time as a consumed income tax.
I have introduced the Simplified USA Tax Act because I want
to reform the American tax system in a way sensible to the
average citizen and that will pass the test of time.
Not only do we need a tax system that is fair and sensible,
we need one that is stable. As bad as the current system is--
and I am one of its severest critics--the last thing we need to
do is enact reform that is so radical and experimental that
Congress will be faced with revamping it all over again in a
few years.
The Simplified USA Tax is revolutionary in that it
addresses the strongest points of concern with the current
system while, at the same time, addressing concerns about the
equity of other tax reform proposals being considered.
SUSAT is based on principles that I feel are vital to any
meaningful reform, imposing a simple tax to encourage
efficiency, ensuring that income is taxed only once wherever
possible, establishing trade equity for American products,
taking the double tax burden off of savings so as not to
discourage individuals from saving, providing incentives for
investment in good-paying jobs in physical capital and in human
capital. And including an accommodation with respect to the
Social Security Payroll Tax, the most regressive tax of all.
In my tax reform proposal USA stands for ``unlimited
savings allowance.'' Everyone is allowed an unlimited Roth IRA
in which they can put the portion of each year's income they
save, after paying taxes and living expenses.
After five years, all funds in the account may be withdrawn
for any purpose, and all withdrawals, including accumulated
interest and other earnings and principal are tax-free.
Nothing could be simpler and nothing could give people a
better opportunity to save, especially young people. Because
only new income earned after enactment of SUSAT can be put into
the USA Roth IRA, young people starting to move into their
higher earning years are the ones who will benefit the most for
the longest time.
The Tax Code should give everyone the opportunity to keep
what they save and, if they wish, to pass it along to
succeeding generations. Therefore, the death tax would be
repealed under my proposal.
Under a new tax code, tax rates, in my view, should be
lower, especially for wage earners who must now pay both an
income tax and a 7.65 percent FICA payroll tax on the same
amount of wages.
It is my intention that the final tax rates under SUSAT,
after all adjustments are made, will be as low as possible,
consistent with budget limitations.
At present, the USA Tax starts out with quite low rates, 15
percent at the bottom, 25 percent in the middle, and 30 percent
at the top.
These rates are reduced even further by allowing wage
earners a full tax credit for the payroll tax that is withheld
from their paychecks under current law.
I do not propose to repeal the payroll tax because to do so
would imperil Social Security.
However, I do allow a credit for it, and when the credit is
taken into account, the rates of tax on workers' wages are very
low, and the seven percent to 17 percent range for nearly all
Americans.
Under the simplified USA Tax, the tax rate on the first
$40,000 of taxable income from wages cannot exceed 7.35 percent
which is the basic USA rate of 15 percent less 7.65 percent.
Under the current Code, the combined payroll tax/income tax
rate is 22.65 percent.
On the next $32,000, the rate cannot exceed 17.35 percent
which is the middle USA rate of 25 percent less the payroll tax
credit.
Under the current code, the combined payroll tax/income tax
rate is 35.65 percent. The Simplified USA Tax provides tax
relief for all Americans, especially when they own their own
home, give to their church, educate their children, and set
aside some savings for a better tomorrow.
Under this proposal, everyone gets a deduction for the
mortgage interest on their home and for charitable
contributions they make. Child support is also deductible.
Generous personal and family exemptions are also allowed
under this proposal.
The Simplified USA Tax is simplicity itself. The tax return
will be short, only a page or two for most of us. But more to
the point, the tax return will be understandable. For the first
time in a long time, America's tax system will make sense to
citizens who will file their tax returns and pay their taxes.
SUSAT also contains a new and better way of taxing
corporations and other businesses, that will allow them to
compete and win in global markets in a way that exports
American-made products, not American jobs.
If enacted in the United States, we have some reason to
believe this innovative approach to business taxation will soon
become the worldwide standard by which other countries model
their systems.
All businesses, corporate and non-corporate, are taxed
alike at an eight percent rate on the first $150,000 of profit
and 12 percent on all amounts above that small business level.
This system would be border adjustable. It would also
address the territoriality problem which is at the core of our
fight with Europe over FSC. If we were to pass this business
portion alone of my tax system, it would address the FSC
problem and, at the same time, it would allow us to import a
foreign tax base.
The new revenue from the import tax will be, we estimate,
about $160 billion, a large portion of which will never become
a cost to the U.S. economy. We do not know exactly how much
will be shifted back to the foreign companies that sell in the
U.S. market, but both basic economics and common sense tell us
that a large portion will be absorbed by foreign sellers and
therefore will never enter the U.S. economy.
I think the point here is that the amount is large and that
the Simplified USA Tax provides a correspondingly large tax cut
for Americans. At the same time, it gets rid of the AMT, the
death tax, and depreciation.
Mr. Chairman, wrapping up, for too long, the Tax Code has
been an albatross around the neck of the economy. This is not
very smart and it is certainly not fair to those citizens whose
standard of living are substantially lower as a result.
It is time to restore people's faith in the integrity and
competence of their tax system, and in the process take a major
step toward helping U.S. companies compete in the global
marketplace.
SUSAT is the product of a great deal of work by many people
and I want to compliment them here. I am proud to be the
sponsor of H.R. 134.
I invite the Committee to look in a bipartisan fashion at
this issue and consider providing the American people the fair
and sensible tax system that they deserve.
Mr. Chairman, I appreciate the opportunity to testify.
[The prepared statement follows:]
Statement of the Hon. Phil English, a Representative in Congress from
the State of Pennsylvania
Good morning, Chairman Archer and my distinguished
colleagues on the Ways and Means Committee. I appreciate the
opportunity to testify before you today on the issue of
fundamental tax reform. I commend the Chairman for scheduling
these hearings as we agree that this is an issue whose time has
come.
I have introduced the Simplified USA Tax Act, H.R. 134,
because I want to reform the American tax system in a way
sensible to the average citizen and that will pass the test of
time. Not only do we need a tax system that is fair and
sensible, we need one that is stable. As bad as the current
system is--and I am one of its severest critics--the last thing
we need is to enact reform that is so radical and experimental
that Congress will be faced with revamping it all over again in
a few years.
The Simplified USA Tax is revolutionary in that it
addresses the strongest points of concerns with the current
system while at the same time addressing concerns about the
equity of other tax reform proposals being considered. The
Simplified USA Tax is based on principles that I feel are vital
to any meaningful reform:
Imposing a simple tax to encourage efficiency
Ensuring that income is taxed only once
Establishing trade equity for American products
Taking the double tax burden off of savings--so as
not to discourage individuals from saving
Providing incentives for investment in physical
capital and human capital
Including an accommodation with respect to the
Social Security payroll tax--the most regressive tax of all.
In my tax reform proposal, USA stands for ``Unlimited
Savings Allowance.'' Everyone is allowed an unlimited Roth IRA
in which they can put the portion of each year's income they
save after paying taxes and living expenses. After five years,
all funds in the account may be withdrawn for any purpose and
all withdrawls--including accumulated interest and other
earnings and principle--are tax free. Nothing could be simpler
and nothing could give people a better opportunity to save;
especially young people. Because only new income earned after
enactment of the Simplified USA Tax can be put into the USA
Roth IRA, young people starting to move into their higher-
earning years are the ones who will benefit the most for the
longest time.
The tax code should give everyone the opportunity to keep
what they save, and if they wish, to pass it along to
succeeding generations. Therefore, the federal estate and gift
taxes would be repealed under my proposal.
Under a new tax code, tax rates should be lower, especially
for wage earners who must now pay both an income tax and a
7.65% FICA payroll tax on the same amount of wages. It is my
intention that the final tax rates under the Simplified USA Tax
Act, after all adjustments are made, will be as low as possible
consistent with budget limitations. At present, the USA Tax
starts out with quite low rates--15% at the bottom, 25% in the
middle, and 30% at the top. Then, these rates are reduced even
further by allowing wage earners a full tax credit for the
7.65% Social Security and Medicare payroll tax that is withheld
form their paychecks under current law. I do not propose to
repeal the payroll tax because to do so would imperil Social
Security, however, I do allow a credit for it and when that
credit is taken into account, the rates of tax on workers'
wages are very low--in the 7% to 17% range for nearly all
Americans.
Under the Simplified USA Tax Act, the tax rate on the first
$40,000 of taxable income from wages cannot exceed 7.35% which
is the basic USA rate of 15% less the 7.65% payroll tax credit.
Under the current code, the combined payroll tax/income tax
rate is 22.65%. On the next $32,000 (up to the maximum payroll
tax base of $72,000), the rate cannot exceed 17.35% which is
the middle USA rate of 25% less the 7.65% payroll tax credit.
Under the current code, the combined payroll tax/income tax
rate is 35.65%.
The Simplified USA Tax Act provides tax relief for all
Americans, especially when they own their own home, give to
their church, educate their children and set aside some savings
for a better tomorrow.
Under this proposal, everyone gets a deduction for the
mortgage interest on their home and for the charitable
contributions that they make. In addition, the Simplified USA
Tax Act allows for a deduction for tuition paid for college and
post-secondary vocational education. The annual limit would be
$4,000 per person and $12,000 for a family.
Generous personal and family exemptions are also allowed
under this proposal. On a joint return, the family exemption is
$8,140 and there is an additional $2,700 exemption for each
member of the family. Therefore, a married couple with two
children pays no tax on their first $18,940 of income.
The Simplified USA Tax is simplicity itself. The tax return
will be short, only a page or two for most of us, but more to
the point, the tax return will be understandable. For the first
time in a long time, America's tax system will make sense to
the citizens who file the tax returns and pay the taxes.
The Simplified USA Tax Act also contains a new and better
way of taxing corporations and other businesses that will allow
them to compete and win in global markets in a way that exports
American-made products, not American jobs. Experts who have
studied it believe that, if enacted by the United States, this
innovative approach to business taxation will soon become the
worldwide standard by which other countries will model their
systems.
All businesses, corporate and non-corporate, are taxed
alike at an 8% rate on the first $150,000 of profit and at 12%
on all amounts above that small business level. All businesses
will be allowed a credit for the 7.65% payroll tax they pay
under current law. All costs for plant, equipment and inventory
in the Unites States would be expensed in the year of purchase.
All export sales income is exempt, as is all foreign-source
income, and all profits earned abroad can be brought back home
for reinvestment in the United States without penalty. Because
of a 12% import adjustment, all companies that produce abroad
and sell back into U.S. markets will be required to bear the
same tax as companies that both produce and sell in the U.S.
The new revenue from the import tax will be about $160
billion, a large portion of which will never become a cost in
the U.S. economy. We do not know exactly how much will be
shifted back to the foreign companies that sell into the U.S.
market. But both basic economics and common sense tell us that
a large portion will be absorbed by foreign sellers, and,
therefore, will never enter the U.S. economy. A middle ground
estimate would be $80 to $120 billion. The point is not the
exact amount. Rather, it is that the amount is large and that
the Simplified USA Tax Act provides a correspondingly large tax
cut for Americans.
For too long the tax code has been a needless drag on the
economy. This is not very smart and certainly is not fair to
those citizens whose standard of living are lower as a result.
It is time to restore people's faith in the integrity and
competence of their tax system and, in the process, take a
major step helping U.S. companies compete in the global
marketplace.
The Simplified USA Tax Act is the product of much work by
many people over a period of years. I am proud to be the
sponsor of H.R. 134 , a simplified version of the USA Tax first
introduced by Senators Nunn and Domenici in 1995. I hope that
this committee will be able to work in a bipartisan fashion to
provide the American people the fair and sensible tax system
that they deserve.
Thank you Mr. Chairman for the opportunity to testify
before you today. I would be happy to answer any questions you
may have at this time.
Simplified USA Tax
The Simplified USA Tax (SUSAT) would completely replace the
current income tax system, both corporate and personal. SUSAT
consists of two parts:
An 8 to 12 percent business tax paid when income
is produced.
A 15, 25, and 30 percent progressive rate tax paid
by individuals when they receive wages, interest, dividends and
other income.
Wage income and capital income are taxed exactly the same.
Income from equity capital is no longer taxed more heavily than
income from debt. Incorporated businesses are no longer taxed
more heavily than unincorporated ones. Most importantly, income
that is saved is no longer taxed more heavily than income that
is consumed. Both are taxed exactly the same.
To further assure equal treatment of wage income--whether
consumed or saved--a full income tax credit is allowed for the
current OASDHI (Social Security and Medicare) payroll tax.
Because of the payroll tax credit, wage earners will
immediately begin paying less taxes.
The business tax is internationally competitive. Imports
are taxed, but export sales of American-made goods and services
are not. Further, U.S. companies are no longer penalized when
they make money abroad and bring it home to reinvest in
America.
Both the individual tax and the business tax are extremely
simple. Only a few steps exist in order to calculate the taxes.
All are clearly stated and readily understandable, thereby
relieving taxpayer confusion and leaving little opportunity for
the IRS to interfere.
Moreover, because SUSAT repeals federal estate and gift
taxes, the IRS will no longer take away a part of anyone's
lifetime savings.
[GRAPHIC] [TIFF OMITTED] T2159.001
The USA Tax for individuals is simplicity itself; a truly
minimalist approach that achieves a great deal without a lot of
complex rules. Basically, all anyone needs to do is (1) add up
their income, (2) subtract a few simple deductions, (3) apply
USA's low tax rates to the balance, (4) take credit for
employee-paid OASDHI payroll tax and income taxes withheld by
employers, and (5) pay the additional amount, if any, that is
due.
[GRAPHIC] [TIFF OMITTED] T2159.002
[GRAPHIC] [TIFF OMITTED] T2159.003
USA Roth IRA: The Centerpiece of the Individual Tax
The USA Tax would eliminate the double tax on income that
is saved, and, therefore, make taxes a neutral factor in the
choice between consuming income immediately or saving it in
order to consume later.
USA accomplishes this feat in the simplest and fairest way
possible by allowing everyone to contribute after-tax income to
a USA Roth IRA patterned after the one in Section 480A of the
current code with certain modifications. Although called an
``IRA,'' the USA version is in reality a universal savings
vehicle that can be used for any purpose, not just retirement.
Everyone is eligible to contribute all or any
portion of their current year's taxable income to a specially
denominated account (like present IRA accounts at all banks and
financial institutions).
Because no deduction is allowed, the person must
first pay the tax on all income and then contribute to the USA
Roth IRA. Further, all contributions must be made in cash.
Because all money that goes into the USA Roth IRA
represents post-effective date after-tax income, no additional
tax is imposed either on the accumulated principal amount or on
the earnings on principal inside the account.
Accumulated principal and earnings on principal
can be withdrawn at any time and for any purpose.
Overview of USA Business Tax
The USA business tax is a cash flow tax on all forms of
business organization, corporate or noncorporate.\1\ The
calculation of a business's tax liability for the year is a
simple five-step process:
---------------------------------------------------------------------------
\1\ Like the present corporate income tax, however, the USA Tax
exempts all religious, charitable and other nonprofit organizations
described in section 501(c) of the current code.
---------------------------------------------------------------------------
1. Add up total sales during the year from operations in
the United States;
2. Exclude sales of goods and services for export;
3. Deduct all purchases from other businesses, including
expensing of capital equipment, inventory items, supplies,
etc.;
4. Apply the rate schedule to the remaining gross profit to
determine tentative tax;
5. Subtract from tentative tax a credit for the 7.65
percent employer-paid OASDHI payroll tax.
The ``gross profit'' tax base in No. 4 is the amount the
business earns on a cash basis after expensing its capital
equipment and paying its suppliers, but before paying its
employees, stockholders and its creditors. Because the USA
business tax allows no deduction for wages, dividends or
interest, it collects a uniform tax on all forms of income--
labor and capital. Such ``neutrality'' is essential to basic
fairness and economic efficiency. Under international treaties,
it is also an essential ingredient of the important export and
import features of the USA Tax.
The most important operational components of the USA business tax, in comparison to the current code, are set
forth below.
----------------------------------------------------------------------------------------------------------------
Item Business Taxation USA Tax IRC of 1986
----------------------------------------------------------------------------------------------------------------
1 Corporations Taxed Separately from Individuals Yes Yes
2 All Business Entities Taxed as Corporations Yes No
3 Deduction for Dividends Paid No No
4 Deduction for Interest Paid No Yes
5 Deduction for Compensation Paid to Employees No Yes
6 Credit for Employer-Paid FICA Payroll Tax Yes No
7 Requires Depreciation of Capital Investment No Yes
8 Allows Expensing of Capital Investment Yes No
9 Deduction for Contributions to Qualified Employee No Yes
Plans
10 Taxes Foreign-Source Income on A Worldwide Basis No Yes
11 Applies Territorial Rule to Exclude Foreign-Source Yes No
Income Derived from Operations Abroad
12 Taxes Export Sales of American-Made Products & No Yes
Services
13 Taxes Imports of Foreign-Made Products & Services Yes No
----------------------------------------------------------------------------------------------------------------
The USA business tax rate schedule is as follows:
------------------------------------------------------------------------
Gross Profit Rate
------------------------------------------------------------------------
$0 to $150,000 8%
Excess over $150,000 12%
------------------------------------------------------------------------
Repeal of Estate and Gift Taxes
Not only does The Simplified USA Tax allow all Americans a fair
opportunity to save and invest, it repeals the federal estate and gift
taxes and, therefore, allows them a fair opportunity to pass their
accumulated savings on to their children and succeeding generations.
This repeal applies across the board to everyone and to all assets
presently owned and acquired in the future, whether held in USA Roth
IRAs or held outside such accounts.
Chairman Archer. Congressman English, thank you so much for
bringing this alternative before the Committee. I doubt that we
will have adequate time this morning to fully explore all of
the details, but I look forward to examining them in great
detail.
And so, at this time, I have no questions.
Mr. Rangel?
Mr. Rangel. Mr. Chairman, I did not have the opportunity to
make an opening statement.
Chairman Archer. Nor did I.
Mr. Rangel. But I want to apologize to my friend and
colleague, Congressman English. He has put a lot of work in
trying to get a better way for us to raise the revenue that is
necessary to run our government.
We can see that the timing of this type of hearing makes it
very difficult for the Members to listen to his ideas. At the
same time, we are trying try to protect our jurisdiction on the
House Floor.
So I do not know whether this was thought out by our
leadership. Yesterday, while we were here listening to the
merits of a federal sales tax, there were people on the House
Floor--get this, Mr. English--a Republican by the name of Mr.
Terry who brought a bill up on the Floor to approve the
President's increase in taxes. But, he recommended that they
vote no against it.
The Republicans brought up the bill to show what the tax
raises would be. When I asked why they did it, they said
because the President's taxes were as a tiger in a cage, and
that they wanted to kill the tiger before it got out.
So you can see, from a tax point of view, that did not make
much sense.
Now, while we are here are trying to figure out the
complexities of your bill, they have got another revenue-
Constitutional issue, on the House Floor saying that we cannot
close tax loopholes unless we have two-thirds vote in support.
Well, people may support that but we cannot do it sitting
here listening to you.
Tomorrow, at long last, we get a chance to pull up the tax
code by the roots. That is, to abolish it. To sunset it and say
there is no more tax code for anybody. It is all over.
But then I read the fine print. It will not be the Ways and
Means Committee that would be replacing the old tax code.
Guess what?
It will be a private commission, not even Congressional.
They will come out and they will have the hearings. They will
listen to you. They will listen to me. And, they will listen to
the private sector. Maybe they will listen to our Chairman, but
only four Members of Congress will be there. Then, they will
report back some legislation. Guess what it is supposed to be
for? For new taxes.
So they are changing the rules just when I have reached
almost the top of my game. They have turned everything over to
the private sector. The Ways and Means Committee's jurisdiction
is being taken away on the Floor and given to outsiders.
So please do not be disappointed because the Members are
not here. They are trying to protect their jurisdiction. They
are on the Floor. They are listening, and it is very difficult.
But you have done a tremendous job over the years.
Mr. English. Thank you.
Mr. Rangel. And I just hope that we in the Congress will
have a chance to listen to your ideas and that they will not
get some cockamamie private sector group to study your
legislation. The Constitution says it is the Ways and Means
Committee, and as long as I am around, we will do the tax law.
So you keep sticking with us and not those private groups.
I want to thank you, Mr. Chairman.
Mr. English. And I would like to thank the gentleman for
being here despite all of the distractions and let me reassure
him there are no caged tigers in my proposal. Thank you.
Mr. Rangel. Thank you.
Chairman Archer. Well I have listened to the gentlemen's
comments, and I am beginning to wonder that whatever activity
we have in this room, there will always be some reason to
complain about it.
I hear complaints about procedures. I hear complaints about
substance. I hear complaints about me personally. It just seems
to be ``there you go again.''
Mr. Crane?
Mr. Crane. Thank you, Mr. Chairman.
I simply want to commend my colleague, my distinguished
colleague, Phil English, for his tax proposal and we have had
several and we will continue to get hearings on several, as you
know, and any one of them is superior to the existing obscene
code.
So any chance we have to move forward, you can count on me.
And thank you for appearing and testifying.
Mr. English. I thank the gentleman.
Chairman Archer. Mr. Weller?
Mr. Weller. Well thank you, Mr. Chairman. I want to commend
you for your leadership in bringing these hearings to this
Committee room.
I also want to commend my colleague, Mr. English, for
having the courage and the commitment of time and effort to put
forward his own reform proposal. Because one thing I have
learned is that in every provision in the Tax Code there is
always a reason it was put there and there is somebody who
wants to keep it there.
I have learned that over the last several years serving on
this Committee. So I salute you for your proposal.
You know, one of the top priorities of this Congress, the
Republican majority, is bringing fairness to the Tax Code. And
of course I know that is your goal of your proposal is making
the Tax Code more fair.
And I am just really proud that, you know, last week the
President signed our effort to bring fairness to the Tax Code
by wiping out the Social Security earnings penalty on seniors
between the age of 65 and 70 who want to continue working or
who are forced to continue working.
And I am also very proud that the House overwhelmingly
passed--and in fact 48 Democrats voted with, rejected their
leadership's pressures and voted with every House Republican to
wipe out the marriage tax penalty with the passage of H.R. 6.
And our legislation--which eliminates the marriage tax
penalty essentially wipes it out for 25 million married working
couples who on average pay $1400 more in higher taxes just
because they are married--is a big victory if you want to bring
about tax fairness.
And I am so pleased that the Senate has moved quickly. The
Senate at this moment is of course considering their proposal
which is pretty similar to H.R. 6, the Marriage Tax Elimination
Act, which wipes out the marriage tax penalty.
My hope is that the House and Senate can reconcile their
differences relatively soon, and we can put on the President's
desk another major initiative which will benefit 50 million
married working individuals who suffer the marriage penalty
just because they are married.
Mr. English, I was just wondering from the perspective of
your tax proposal, how do you address the marriage tax penalty
in your proposal?
Mr. English. We would effectively dramatically reduce it
because of the structure that we have put in place. I will
leave it to others to describe where a marriage tax penalty
might creep in.
I have retained multiple tax rates and the implication of
that is there is always a danger of a marriage tax penalty
being reintroduced.
I would welcome the gentleman to take a look at my proposal
and come back to us with any suggestions he might have of
addressing that problem in our code.
As the gentleman knows, because he has immersed himself in
this issue more than anyone, it is very difficult to completely
eliminate the marriage tax penalty and there is always a
potential when you have progressive taxation that when people
get married, as a couple they will end up paying more taxes
than they did as two individuals.
I am not sure we have addressed that as fully as we should
in this tax proposal and I would welcome the gentleman's input.
Mr. Weller. Well, you know, Mr. English, one of the things
I have observed also is, particularly in the last seven-and-a-
half years, there has been a desire by some to target tax cuts,
target tax relief, which means you pick and choose politically
who benefits.
It usually means very few get very little in tax relief and
unfortunately that targeting has caused more so- called
marriage tax penalties in the last few years than any other
consequence of the code.
Of course the biggest consequence of the Tax Code is for
joint filers. You know, a married couple. They are both in the
work force. Their combined income usually pushes them into a
higher tax bracket, creating the marriage tax penalty.
But if you talk with those who are tax preparers, they will
tell you that there are over 60 marriage tax penalties in the
code, primarily resulting from means' testing and targeting of
tax cuts because the income eligibility is never twice that for
married couples filing jointly compared to that of a single
filer.
And clearly as we look at bringing fairness to the tax
code, not only do we want to eliminate the marriage tax penalty
for joint filers, but we need to look at those so-called
targeted provisions because they create a lot of consequences
for those who work hard and happen to be married.
Mr. English. I thank the gentleman. I would point out to
him that what we tried to do was eliminate many of these
targeted provisions which after all are adjustments for other
problems in the Tax Code.
What we tried to come up with was a clean and very simple
tax system that in the process does eliminate many of those
marriage penalties that you discussed, and makes the Tax Code
far simpler.
We found that the complexity in the Tax Code did not arise
from multiple rates as much as from many of these very
complicated and overlapping policies that were loaded into the
Tax Code.
So as a result we think we have gone a considerable
distance toward finding an equitable and global approach to
these problems.
And I thank the gentleman.
Mr. Weller. Well your point is a good one.
You know particularly in education one of our goals is to
make college more affordable. That is why we have worked to
expand opportunities with the student loan interest deduction.
And of course for married couples, not only is there a marriage
tax penalty on the income eligibility for joint filers, but if
you have got a couple kids getting married right out of
college, they are paying off their student loans, you know they
are eligible for the full student loan interest deduction. But
once they choose to get married, they discover that interest
deduction is cut in half because they have to share it as if
they were just one person.
And that is just not fair and that is just one more reason
that as we look at tax reform, I think we really have to take a
good look at the so-called targeting and preferences and means'
testing and how it is created marriage tax penalties as well as
other consequences that just are not fair.
Mr. English. The gentleman makes an excellent point. Let me
say that instead of providing many of the targeted tax breaks
for tuition that had existed and that we have recently put into
law, what we have tried to do is consolidate these into a
substantial deduction that would be available per student,
$4,000 per student up to $12,000 total for a family.
And we think that when you run the TRAPs on that, the tax
relief is very substantial to families and makes up for some of
the other adjustments that we have tried to make in the last
few years to help use the Tax Code to support higher education.
Mr. Weller. My last question----
Chairman Archer: The gentleman's time has expired.
Mr. Weller. Thank you, Mr. Chairman.
Chairman Archer. Mr. English, thank you for the work you
have done on this and giving us another alternative to look at.
And unless you have something important to say, you are
excused.
Mr. Weller. Thank you, Mr. Chairman.
Chairman Archer. Our next panel will please come to the
witness table. Congressman Frenzel, Mr. Christian, Dr. Foster,
and Mr. Hufbauer.
While you are being seated, I officially welcome each of
you to the Committee. Certainly some of you are no strangers to
this room and to this Committee, and we are particularly happy
to have you back in our presence and to hear your sage
comments.
The Honorable Bill Frenzel is no stranger to any of us up
here at the dias having been seated up here for many years
yourself, and we are particularly happy to have you back and to
listen to your wisdom which has always been present whenever
you speak in this room.
And so we welcome you again, and if you will lead off, we
will be pleased to hear your testimony.
STATEMENT OF THE HON. BILL FRENZEL, GUEST SCHOLAR, BROOKINGS
INSTITUTION [FORMER MEMBER OF CONGRESS]
Mr. Frenzel. Thank you, Mr. Chairman.
Chairman Archer. And I think Mr. Rangel also wants to
welcome you.
Mr. Rangel. I want to welcome all of you, particularly, my
friend Congressman Frenzel. Please give my best to your lovely
wife, Ruth, and I want tell you how much you have been missed
around here.
The one thing that makes serving in Congress exciting is
the memories of the good old days. Thank you for coming back.
Mr. Frenzel. Thank you----
Mr. Ramstad. Mr. Chairman? Mr. Chairman?
Chairman Archer. Mr. Ramstad, I apologize.
Mr. Ramstad. Not at all, Mr. Chairman.
Chairman Archer. Mr. Ramstad has a very----
Mr. Ramstad. I just want to join in the chorus of singing
the praises of my predecessor, somebody I am proud to call my
mentor and my friend, and without whose tutelage, I would not
be sitting here today. Somebody who distinguished himself on
this panel for 16 years serving the Third Congressional
District of Minnesota.
He also served as ranking member of the Budget Committee
and the House Administration Committee.
Bill Frenzel is, as one person who introduced him put it
best, if you look up in the dictionary, the word ``statesman,''
you will see Frenzel's picture.
It is a pleasure, Bill, to welcome you back to the
Committee.
[The opening statement of Mr. Ramstad follows:]
Opening Statement of Hon. Jim Ramstad, a Representative in Congress
from the State of Minnesota
Mr. Chairman, thank you for commitment to reforming our
deeply flawed tax system and for giving the American people a
public forum through this week of hearings to examine the
options available to us.
We already know that the current system flunks the critical
tests of efficiency, simplicity, flexibility, political
responsibility and fairness.
Americans spend billions of dollars complying with an
incomprehensible system that discourages saving and investment.
Our tax code robs Americans of time, privacy, economic
opportunities and incentives to be innovators.
Our complex tax code puts American businesses at a
disadvantage with their foreign competitors, robbing them of
the opportunity to create jobs and find new markets for
American products.
We want Americans to work and save for their family's
future. But as you point out, Mr. Chairman, our tax system
tells Americans that the more you work and save and succeed,
the more you pay.
I appreciate the opportunity to examine alternatives which
meet the important goals of rewarding work, encouraging savings
and improving our competitiveness abroad.
Again, Mr. Chairman, thank you for convening these critical
hearings. I look forward to hearing the testimony today.
Mr. McCrery. Mr. Chairman, I would say me too.
Chairman Archer. Let me just add one other thing since we
are getting into this friendly colloquy here.
The last major battle I think that you and I and Phil Crane
fought on the Floor of the House was the opposition to I think
the ill-considered Tax Reform Act of 1986, and unfortunately we
barely lost that battle but I think history will show that we
were right.
And maybe the next major battle that we participate in,
whether from the inside or the outside, we will win. So we are
happy to have you before the Committee.
Mr. Frenzel. Thank you Mr. Chairman and Committee members.
You have brightened the life of an old man by putting wings on
the dog, and I am really pleased to be back here in this
marvelous room with you distinguished Committee members.
Mr. Chairman, on this Committee all of us who have ever
served here have been very frustrated with the Tax Code. We
have seen the complications, the difficulties, and looked for
ways to improve it. We have always been frustrated in what we
have tried to do.
Size and complexity are major problems for our
constituents, but they are less serious than the perverse
incentives that have worked their way in the Code. They have
gotten into the Code for good reasons, but there are a couple
that have always bothered me, and led me in the chase for some
kind of responsible tax reform.
The most prominent of these has been the inadequate
incentives for savings. Secondly, I have followed international
taxation for some time and been disappointed that we have had
more incentives to import than to export.
I have also been concerned about regressivity and job
creation disincentives in our Social Security taxes. And of
course, the general layering of the Code as we try to repair it
has been a problem as well.
H.R. 134, Mr. English's bill, answers these problems.
I have tried to follow this bill and its predecessors over
a period of at least ten years since I left the Congress, and
was interested in the original Nunn-Dominici proposal which was
one of the predecessors of this bill.
It is not a simple bill but it does some things right. One
of the reasons that we have had trouble in the past with any
kind of tax reform bill is it presents such a big, ugly bundle
that it is easy to form a majority against it.
If you are going to truly reform the Code, you have to
change alot of things, and those changes hurt an awful lot of
people.
I want to talk about four aspects of H.R. 134. The first
one is international. H.R. 134 has the international parts
right. We should not tax foreign income. We need to relieve
taxes on exported goods and services and we need to assess
taxes on imports to equalize the burdens that the domestic
producers bear.
The FSC has been a pretty lonely incentive for us, and it
is weak compared to the combination of incentives offered by
many of our foreign competitors. Now, even its existence is in
peril.
H.R. 134 provides powerful savings incentives. Once the
taxes are paid on income going into the investment account,
there is no additional tax on inside buildup or on withdrawals.
Congressman English has used the simple mechanism of the
Roth IRA to solve one of he major complexity problems of the
original USA Tax.
Third, H.R. 134 relieves problems of regressivity and
disincentives of job formation caused by our high Social
Security taxes.
We have made the Tax Code, the Income Tax Code, more
progressive over the last 30 years, but because the Social
Security taxes are levied on the first dollar of earnings, the
overall tax burden has probably become more regressive.
And, of course, other than in times of full employment,
which we are enjoying now, those taxes can be a real job
creation disincentive.
So I believe that Congressman English in H.R. 134 has done
a pretty good job of giving us some simple principles which can
be put into a total tax reform bill.
I would like to note here that tax rates under this tax
bill can be flattened or made even more progressive.
Congressman English has structured it to make it roughly equal
to the current burden tables. I think that is the right place
to start even though you may not want to finish there.
Mr. Chairman, I commend this tax bill because it gives some
promise for achieving the things that I have always thought
were most important in tax reform.
It is probably an exaggeration to call it simple because
life is not simple, and it does not tear the system out by the
roots as you, Mr. Chairman, have always wanted to do, but it
does rough up the system pretty well.
I think it can do the tax reform job, and I believe it is
workable and understandable, at least for a starting place for
this Committee.
And I thank you and the Committee for your kind words and
for allowing me to testify today.
[The prepared statement follows:]
Statement of the Hon. Bill Frenzel, Guest Scholar, Brookings
Institution, (Former Member of Congress)
Mr. Chairman and Members of the Committee:
It is, as always, a pleasure to return to the scene of
one's former crimes. I appear here today on my own behalf and
my testimony does not represent the opinions or conclusions of
The Brookings Institution. I congratulate the Chairman and the
Committee for holding these Tax Reform hearings. The time is
ripe.
You are all, as was I, very fortunate to be able to serve
on this distinguished and historic committee. I hope you are
less frustrated than I was about our ability to produce a Tax
Code in which our country can have more confidence.
The need for major surgery on the U.S. Tax Code has been
obvious for years. Over the years, complications and
``simplifications'' alike have created a system of bewildering,
and indefensible, size and complexity. Nobody intended that it
be so cumbersome, but it got that way for a variety of reasons
well known to the committee (we live in a complex society and
economy; politicians run on platforms of change; its easier to
amend than to delete; simplicity and fairness are sometimes in
conflict). Whatever the reasons, today many taxpayers cannot
comply (without help) with the Code, and tax collectors have
great difficulty enforcing it.
But, size and complexity are problems that are less serious
than the perverse incentives that have worked their ways into
the Code. Four that I have found particularly troublesome are:
(1) inadequate incentives for saving; (2) more incentives to
import than to export; (3) regressivity and job creation
disincentives in our Social Security taxes; and (4) the endless
layering of good, and, at the time, necessary, adjustments
which have led to unacceptable complexity. Each of you could
list many more.
The origins of most of these policies go long way back in
history. They undoubtedly made good sense when enacted. Now,
the world has changed, and it will continue to change even more
swiftly. Regulators are already having difficulty keeping up.
Relatively small, targeted Tax policy changes, like the ones
this committee has regularly made in the past, are not able to
keep pace with the speed of change. I believe that you must
make bold and massive changes to meet the new challenges.
But size and boldness usually mean a tax package so full of
fish hooks that no one will touch it. I, myself, was, for many
years in this Committee, a supporter of the theory of
``creeping incrementalism.'' Later, I have come to believe that
Band-Aids, even giant ones like TRA 1986, are more likely to
extend the problems than they are to solve them.
H.R. 134, the Simplified USA Tax, appears to me to be a
workable solution to the Tax Reform dilemma. In the interests
of full disclosure, I must admit I was exposed to the general
concept nearly 10 years ago when I attended, with about a dozen
accountants, tax lawyers and economists, a series of
brainstorming sessions which began with David Bradford's
``Consumed Income Tax'' and went through to the original Nunn-
Domenici USA Tax.
That original Nunn-Domenici proposal was an important
milestone in the development of H.R. 134, but, like many of its
ilk, it was too complicated. The cleverest of us could not have
explained it to our constituents very quickly or concisely.
That kind of bill is an easy victim for interests, which want
to retain the old code, or for partisan squabbling.
H.R. 134 cannnot be called simple, but it is
understandable. It is a suitable vehicle for the Committee's
Tax Reform efforts. I can't review the whole bill, but here are
some of the aspects, which appeal to me:
1. H. R. 134 has the international parts right. We should
not tax foreign income; we need to relieve taxes on exported
goods and services; and we need to assess taxes on imports to
equalize the burdens on domestic producers. We have had only
the lonely FISC as an export incentive. It's a weak one
compared to the combinations of incentives offered by many of
our foreign competitors, and now, its existence is imperiled.
2. H.R. 134 provides powerful savings incentives. Once the
taxes have been paid on income going into the investment
account, there is no additional tax on either inside build-up
or on withdrawals. Congressman English has used the relatively
simple mechanism found in the Roth IRA to solve the major
complexity problem of the original USA Tax. Withdrawals from
these after-tax savings accounts can be made for any purpose.
3. H.R. 134 relieves problems of regressivity and of
disincentives to job formation caused by Social Security taxes.
Since I first came to Washington, the income tax Code has
become more progressive as more people at lower levels of
income have been taken out of the code completely. But, because
the Social Security taxes are levied on the first dollar of
earnings, the overall tax burden has become more regressive.
And, in times of less than full employment, those taxes are a
real jobs disincentive for employers.
I personally support progressive income tax rates, with a
couple of caveats. The present highest rate is too high. The
EITC which I supported originally has been expanded to a point
where it could be better managed and enforced as an
appropriation entitlement rather than a tax entitlement.
It should be noted that tax rates under the Simplified USA
Tax could be flattened, or made even more progressive than
present rates. Congressman English has structured it to make it
roughly equal to the current burden tables. That may not be the
place you want to finish, but , to me, it's the right place to
start.
Finally, Mr. Chairman, I recommend H.R. 134, the Simplified
USA Tax, for the Committee's consideration because it gives
real promise of achieving most of the things I have always
sought in Tax Reform. It may be an exaggeration to call it
simple, because life is not simple. It isn't perfect, because
there is no such thing as a perfect tax bill.
And it doesn't tear the system out by the roots as you have
always wanted to do, but it does rough up the system pretty
well. Not only will it do the Tax Reform job, but its is
workable and understandable. Those two virtues may be able to
stand as proxies for the simplicity which has always been so
elusive.
Chairman Archer. Thank you, Mr. Frenzel.
Mr. Christian?
STATEMENT OF ERNEST S. CHRISTIAN, ESQUIRE, WASHINGTON, D.C.
Mr. Christian. Thank you, Mr. Chairman, Mr. Rangel, Members
of the Committee.
Congressman English's simplified USA Tax is, in my opinion,
a landmark achievement. I say that from the perspective of
having spent about 25 years in the Treasury Department and in
the private sector working on these concepts.
He is to be greatly commended.
His bill shows how the Tax Code can be simplified without
having to repeal the deductions for either home mortgage
interest or charitable contributions.
It shows how the double tax on savings and investment can
be removed without enacting a consumption tax.
How tax equity for working men and women can be achieved by
allowing them a credit for the payroll tax they already pay.
It shows how the archaic tax barriers to U.S.
competitiveness in world markets can be removed in a way that
protects and enhances American jobs.
Marginal tax rates can be lowered, a laudable goal.
Progressivity can be preserved.
Transitional dislocations can be avoided.
Congressman English's bill Simplified USA embodies some new
approaches. One is to include in the tax base of the United
States of America, for the first time in history, all amounts
derived by foreign-owned companies from selling goods and
services in our market.
The result of this shift may be to reduce, by something in
the area of $100 billion per year, the tax burden borne by U.S.
labor and U.S. capital, an enormous, implicit tax cut for the
American economy paid for by foreign-owned companies that
presently derive income from the U.S. market on nearly a tax-
free basis.
The largest beneficiaries of this implicit tax cut would
seem to me to be the wage earners of America. They receive a
full credit for the payroll tax they now pay.
Simplified USA is a plain-language, stripped-down version
of the current income tax, individual and corporate. It is
concentrated on the main goals of tax reform.
The basic amendments necessary to achieve these results are
neither unfamiliar nor shocking. First-year expensing of plant
and equipment is already allowed under the current Code for
small businesses.
It only remains for Simplified USA to make expensing
universal, which it should be.
There is nothing radical about removing the double tax from
personal saving and thereby taxing saved income no more heavily
than consumed income.
The Roth IRA already does this under the current Code for
retirement savings. Simplified USA uses exactly the same simple
mechanism for all savings.
There is also nothing new or radical about the idea of not
imposing U.S. tax on the income that American companies derive
from developing new markets abroad, or about the related idea
of not taxing exports of American made goods.
The Foreign Sales Corporation provision, commonly known as
FSC in the current Code is a flawed attempt to go halfway
toward these goals in the international competitiveness arena,
but FSC has run afoul of the WTO. Simplified USA, Congressman
English's bill, does the job correctly in a way that is
consistent with U.S. tax traditions and treaty obligations.
There is also nothing radical about bringing foreign-owned
companies into the U.S. tax base, and using he revenue to cut
taxes on American citizens. Europeans and others have been
doing this same thing in reverse to the United States for
decades.
The truly remarkable thing about Congressman English's
bill, Simplified USA, is that it has figured out how to level
the international playing field in a way that is consistent
with American tax tradition and history.
I submit, for your consideration, Mr. Chairman and members
of the Committee, that the usual reasons for not proceeding
with tax reform do not apply to the USA tax by Mr. English.
Genuine tax reform within the basic framework that he has
outlined, which can be improved, is an available option for the
Congress to choose if the Congress wishes to do so.
I strongly recommended Simplified USA to you as a great
place to start on the road to genuine tax reform.
Thank you very much for your attention.
[The prepared statement follows:]
STATEMENT OF ERNEST S. CHRISTIAN, ESQUIRE, WASHINGTON, D.C.
Introduction To Simplified USA Tax
The Simplified USA Tax by Congressman Philip English (H.R.
134) is a landmark achievement that shows how genuine tax
reform can become a reality without resorting to radical
experimentation. The tax code can be simplified without
repealing the deductions for home mortgage interest and
charitable contributions; the double tax on saving and
investment can be removed without enacting a ``consumption''
tax; tax equity for working men and women can be achieved by
allowing them a credit for the payroll tax they pay; the
archaic tax barriers to U.S. competitiveness in world markets
can be removed in a way that protects and enhances American
jobs; a simple deduction for the cost of post-secondary
education can, for the first time in history, help put
investments in human capital on a par with investments in
physical capital; marginal tax rates can be lowered;
progressivity can be preserved; and transitional dislocations
can be avoided.
Simplified USA embodies a new approach that has the effect
of including in the U.S. tax base for the first time in history
all amounts derived by foreign companies from selling goods and
services in the U.S. market. It seems to me that the result is
an enormous tax cut for the U.S. economy--perhaps $100 billion
per year or more--paid for by foreign companies that presently
derive income from U.S. markets on a nearly tax-free basis.
The biggest beneficiaries of this tax cut would seem to me
to be the wage earners of America who receive a full credit for
the payroll tax they pay now.
How Simplified USA Works--Structural Framework
Like current law, Simplified USA consists of a business tax
and a personal tax with multiple personal rates. The
illustrative tax rates below trace back to H.R. 4700 in the
105th Congress and were carried over without change into H.R.
134 when Simplified USA was reintroduced in the 106th Congress.
(1) A Business Cash Flow Tax is paid by corporations and
other businesses. The rate is 12% of gross profit. Profit is
computed using cash accounting; capital equipment is expensed
because the income it produces is fully taxed when received; no
deduction is allowed for interest or dividends paid for the use
of capital, or for wages paid for labor, but a full credit is
allowed for the 7.65% OASDHI payroll tax which is the
equivalent of a deduction for about 65% of wages up to $72,000
per year for each employee. Export income and all foreign-
source income is excluded from tax. A 12% import tax is
collected when foreign-based companies sell into the U.S.
market.
(2) A Progressive-Rate Personal Tax is paid by individuals
when they receive interest, dividends, wages, salaries, and
gains. The two bottom rates are 15% and 25% and the top rate is
30% on taxable income computed after deducting a Family
Allowance of $8,000, personal exemptions of $2,700 per family
member, home mortgage interest, charitable contributions and
post-secondary education expenses of up to $4,000 per family
member. Individuals are allowed a full tax credit for the
employee's share of the 7.65% OASDHI payroll tax withheld from
their wages and, if the amount of that credit exceeds their USA
income tax for the year, the excess is refunded. All
individuals are also allowed an unlimited USA Roth IRA for
personal saving--except that, unlike the current Roth IRA,
saving is not limited to retirement and can be withdrawn for
any purpose. Because tax is paid on the money going into this
special savings and investment account, there is no additional
tax on the inside build-up in the account or on withdrawals
from the account. For the first time in history, the double tax
on all personal savings will be removed and everyone will be
allowed to save for whatever purpose they desire.
Simplified USA is a plain-language, stripped-down version
of the current income tax (individual and corporate) that is
concentrated on the main goals of tax reform--which are (1) to
be evenhanded as between labor income and capital income; (2)
to be neutral in a person's choice to consume income or save;
(3) to remove the archaic barriers to international
competitiveness; and (4) to be neutral as between equity and
debt financing and evenhanded among all forms of business
organization.
The basic amendments necessary to achieve these results are
neither unfamiliar nor shocking. First-year expensing of plant
and equipment is already allowed for small businesses and
probably would have been made universal long ago except for
revenue limitations under the current code.
The idea of removing the double tax from personal saving--
and thereby taxing saved income no more heavily than consumed
income--has been around a long time. Since the enactment of the
Roth IRA in 1997, the simple yield-exemption approach to
removing the double tax is now familiar and standard fare. With
the Roth IRA already very much part of the tax landscape, it
only remains for Simplified USA to make it universal by
eliminating the dollar caps, the income limitations and the
restriction to retirement savings.
For decades, Treasury reports and bipartisan Congressional
studies on corporate/shareholder tax integration have
recommended uniform treatment of all forms of financing and all
forms of business.
There is nothing new about the idea of excluding foreign-
source income from taxation or about the related idea of not
taxing exports. The Foreign Sales Corporation (FSC) provision
in the current code is a flawed attempt to go halfway, but FSC
has run afoul of the WTO and it remains for Simplified USA to
do the job correctly in a way that is consistent with U.S. tax
traditions and WTO requirements.
The Road to Simplification
Once the basic amendments necessary to achieve neutrality
and international competitiveness are made, some of the most
complex portions of the code become moot. Substantial
simplification automatically occurs. Simplified USA also
undertakes to eliminate an array of miscellaneous deductions,
credits, exceptions and exceptions to exceptions that are
unnecessary when the basic rules are correct to start with. But
Simplified USA does not make a fetish out of repealing long-
standing and familiar deductions under the misguided belief
that they are the source of complexity in the code.
The existing and long-standing exclusions from income for
parsonage allowances, combat pay, municipal bond interest or
employer-paid health insurance are not the reason that Form
1040 is monstrously long and incomprehensible. Simplified USA
retains these and several other exclusions and deductions that
are easily understood and of nearly universal application
without any special eligibility requirements and that do not
require any side calculations. What, for example, is
complicated about the deduction for home mortgage interest? All
the homeowner does is take one number off the annual statement
from the mortgage lender and put that one number on one line of
the tax return.
Simplified USA will reduce the size and complexity of the
tax code by about 75 percent and the personal tax return (long
Form 1040) will be only a few pages--about like it was in 1960
before four decades of complexity ruined it.
Neutrality Between Saving and Spending
Simplified USA taxes income (whether saved or consumed)
only once. It does that by taxing income when received (first
tax) and then excluding the earnings on after-tax savings from
a second tax.
The current code's bias against income that is saved is
easily illustrated by a simple example: Mr. Jones earns $100,
pays a $40 income tax, and has $60 after-tax income left over.
If he uses the after-tax $60 to buy a car to drive to work (in
lieu of paying bus fare), he will not have to pay tax on the
value of the transportation services the car provides him; nor
should he. After all, he has already paid tax on the $60 once.
On the other hand, if instead of buying the car, Mr. Jones
saves the after-tax $60, he will have to pay bus fare (having
no car) and he will have to pay tax on the interest earned by
the $60 of savings. This is not a correct result. It biases Mr.
Jones's choice against saving.
Simplified USA produces the correct result: once Mr. Jones
has paid his tax, he is not taxed again, either on the interest
earned by his after-tax savings or on the value of the
transportation services provided by the car.
International Competitiveness
Simplified USA is carefully crafted to allow American
companies to compete and win in world markets without in any
way providing a tax incentive for American companies to move
their plants and jobs offshore. In fact, it makes the United
States of America a very attractive place to be for the purpose
of conducting a worldwide business.
Simplified USA does this by the combination of three
things. First, it replaces the current archaic and inconsistent
worldwide tax rule with a territorial rule consistent with
modern practice in other countries. Thus, when necessary, U.S.
companies will be able to invest and compete directly in
foreign markets without having to pay U.S. tax on the profits
they make in some other country's economy and bring home for
investment in America. Second, export income will be excluded
from U.S. tax. Thus, a U.S. company can stay home, manufacture
in the U.S. and sell into a foreign market without paying U.S.
tax. Third, an import tax will be imposed at the same rate as
the regular USA business tax rate--12%. Thus, while a company
may operate abroad when necessary to gain foreign-market sales
that cannot be reached by exports from the U.S., if it goes
abroad for the purpose of selling back into the U.S. market, it
will have to pay a U.S. tax at the border without the benefit
of any deductions.
International competitiveness will flourish under
Simplified USA, but there will be no runaway plants.
The Way Border Tax Adjustments Work--A Major Shift in the Tax
Burden
The border tax adjustments in USA have been borrowed from
the European VAT (which is a form of sales tax) and appended to
the business portion of the USA Tax in a WTO-permissible way--
but when appended to a business cash flow tax like the USA
business tax, the border tax adjustments operate quite
differently from they way customarily are thought of in the VAT
context.
Because the USA business tax is a tax on net cash flow
instead of a tax on goods, USA excludes from tax the revenues
derived by a business from exports. This full exclusion of
export revenues is similar to the partial exclusion provided by
the Foreign Sales Corporation (FSC) rule in the current
corporate income tax which the USA business tax resembles in
many ways.
Except for exports, USA includes in the tax base all GDP--
which, in turn, is equal to the sum of all returns to labor
(wages and salaries) and all unreinvested returns to capital
(interest and dividends).
By means of an import adjustment, USA also includes in the
tax base an additional amount which represents the amount of
goods and services that are produced by foreign-sited labor and
capital but sold into the United States market. The 12 percent
import tax might appear to make imported products more
expensive, and, in some cases, it will, but both neoclassical
economic theory and common sense say that in many more
instances involving a very large portion of the total dollar
value of imports, the foreign companies who sell these imports
into the U.S. market will have to absorb all or a major part of
the 12% import tax. They will do this by adjusting their pre-
tax price downward so that the after-tax price to the U.S.
purchaser is the same or nearly the same amount that purchasers
had previously been paying. When foreign companies do lower the
pre-tax prices, they are, in effect, paying the U.S. tax and
when a company pays a tax (whether it be U.S. tax or home
country tax), the burden of that tax will ultimately be borne
by its employees (in the form of lower wagers or fewer jobs)
and its shareholders and debtholders (in the form of lower
returns to capital).
As of the end of 1999, imports were $1.3 trillion involving
an almost uncountable number of U.S. buyers and foreign sellers
of an almost uncountable variety of imported goods and
services. Out of all this, no one knows how many of the foreign
companies will be ``price takers'' who will absorb all or part
of the import tax or how many will be ``price setters'' who
will not absorb any of the import tax. Therefore, no one knows
the precise dollar value of the import tax that will be passed
back to foreign labor and capital, but we do know that much of
it will be. The U.S. market is, after all, the largest market
in the world and the pressure on foreign companies to absorb at
least a part of the tax will be large. Only those who sell a
unique product for which there is no substitutable alternative
will be totally immune from that pressure, but there are not so
many of those situations and, even when they do exist, what may
be a unique product today may not be tomorrow.
The point is not to be precise about the exact amount of
import tax that will be borne by foreign labor and capital.
Rather, the point is to know that the dollar amount is large
and that even if 60 percent of the $160 billion import tax
revenue increase is borne by foreign labor and capital, that
mans that the U.S. economy has received roughly a $100 billion
per year tax cut.
Payroll Tax Credit--An Offset to Implicit and Explicit Taxes on
Wages
Not only is the payroll tax credit an historic breakthrough
in fairness, it is essential to the evenhanded treatment of
labor and capital that is the hallmark of Simplified USA and
the foundation on which genuine tax reform must be built.
A. Implicit Withholding Tax Offset by Payroll Tax Credit
Like the current corporate income tax, the USA business tax
is an implicit withholding tax on dividends. (Unlike the
current corporate income tax which favors debt over equity, the
USA business tax also serves as an implicit withholding tax on
interest as well.) This implicit withholding on interest and
dividends arises because the business pays tax on its as gross
profit without any deductions for interest paid or dividends
paid.
Like the current employer-paid OASDHI payroll tax, the USA
business tax also serves as an implicit withholding tax on
wages--because the business pays tax on its gross profit
without deducting wages.
But for the credit that Simplified USA allows for the 7.65%
employer-paid payroll tax (which reduces the implicit
withholding), the implicit withholding on wages up to $72,000
per employee per year would be 19.65% (12% + 7.65%); whereas
the implicit withholding on wages in excess of $72,000 and on
interest and dividends would be only 12% (the USA business tax
rate).
With the payroll tax credit, the implicit withholding tax is uniform as
follows:
------------------------------------------------------------------------
Interest
Wages up to $72,000 Wages above $72,000 and
Dividends
------------------------------------------------------------------------
12% 12% 12%
------------------------------------------------------------------------
B. Explicit Tax Offset by Payroll Tax Credit
When wages, interest and dividends are received by
individuals, the remainder of the tax on that income is
collected from the individual, and, in the case of wages, all
or part of that tax may be withheld at the source by the
employer as under current law.
In the case of wages up to $72,000, however, current law
imposes an additional 7.65% employee-paid OASDHI tax that is
explicitly withheld at the source by the employer.
Simplified USA allows the employee a credit for the 7.65%
OASDHI tax explicitly withheld from wages. With this credit,
wages, interest and dividends are all taxed equally, the only
variation being the rate bracket of the particular individual--
15%, 25% or 30%.
Resisting Analogies--Simplified USA Is Sui Generis
The Simplified USA Tax combines some elements that may also
be found, variously, to some extent, and in different forms, in
taxes said to be based on cash flow, net income, consumed
income or business value added, but because Simplified USA is a
hybrid, none of those analogies is altogether accurate or
especially illuminating.
Simplified USA is best understood as the current income tax
amended to allow (1) first-year expensing of capital equipment,
(2) an unlimited Roth IRA for everyone that applies to all
saving (not just retirement saving) and (3) a credit for OASDHI
payroll taxes. Internationally, it adopts a ``Super FSC'' for
outbound transfers (exports) and a ``Super Sec. 482''
adjustment on inbound transfers (imports).
If one insists on putting Simplified USA into some
preexisting generic category, the USA Tax on individuals is an
``income tax'' and the USA Tax on businesses is a ``business
cash flow tax'' (a concept which is well-known and long-
standing in the tax literature).
Chairman Archer. Thank you, Mr. Christian.
Our next witness is Dr. Foster. We will be pleased to
receive your testimony.
STATEMENT OF J.D. FOSTER, PH.D., EXECUTIVE DIRECTOR AND CHIEF
ECONOMIST, TAX FOUNDATION
Mr. Foster. Thank you, Mr. Chairman. It is a pleasure to
appear before the Committee again.
Tax reform obviously raises a great many issues. I am going
to focus on two in the international area.
The U.S. currently imposes tax on our citizen's foreign
earnings and allows a limited tax credit against foreign income
taxes paid.
Most tax reform proposals, such as Simplified USA, wisely
drop this policy, taxing instead only economic profits earned
at home, a system known as territoriality.
In the global economy, companies hire, produce, and sell
globally. The companies that best integrate these activities
over functions, product lines, and geographic areas, are the
most successful.
Current tax policy distorts our companies' pattern of
investment so they cannot maximize their global efficiency. The
price of this lost efficiency is jobs at home and abroad, and
the price gets higher every year.
If current policy is so wrongheaded, why do we keep it?
Because of misperceptions and misleading statements.
Our international tax policy is a tax based form of
protectionism and nothing more.
Protectionism seeks to bar foreign production that out-
competes domestic production. Recognizing that protectionism is
unsound, we have had a long history in this country in support
of free trade.
However, our tax policy erects tax barriers to
international investment by our citizens in the usually
mistaken belief that it would otherwise occur at home. This tax
barrier to international investment is solely intended to
protect jobs at home. The result, however, is that our current
policy prevents our companies from maximizing their
productivity, thereby costing us jobs.
Worse, the lost jobs are most likely to be higher-wage,
high-productivity jobs because therein lies our competitive
advantage. So we protect a few relatively low-wage jobs at the
expense of other higher-wage jobs--the typical result of
protectionism.
Most tax reform proposals, including the English proposal,
embrace free trade by allowing U.S. companies to achieve their
greatest efficiencies globally and so create more high wage
jobs at home.
Fundamental tax reform also opens the way for border tax
adjustments or BTAs in the form of an export rebate and a new
import levy.
An export rebate excludes from tax the profits made on the
export of domestic production. If the United States adopted
territoriality, then export rebates naturally address concerns
that territoriality would induce U.S. companies to shift
operations overseas. A company would pay no U.S. tax on goods
and services sold abroad, whether those goods are produced at
home or abroad.
Once markets adjust to the new tax regime, the value of the
tax rebate would shift back to U.S. labor in the form of higher
wages or back to U.S. capital in the form of higher returns,
permitting an expansion of the capital stock and therefore
increasing employment and output for foreign markets.
The counterpart to the export rebate is the import levy.
Initially, some of this levy would increase the price of
imports. The vast majority of these price increases would
quickly disappear, however, as U.S. consumers and businesses
substituted domestic for foreign production.
This in turn would force foreign suppliers to absorb much
of the tax. Thus, both the export rebate and the import levy
would encourage the creation of high wage jobs at home.
Business taxes, in almost all instances, fall on labor and
capital, but especially capital. If we imposed a BTA import
levy, it would also fall on capital and labor. However, if
would fall on the capital and labor of the countries producing
goods and services sold into the United States.
In other words, a BTA import levy effectively imports tax
base from abroad, shifting some amount of the domestic tax
burden to foreign workers and foreign capital owners.
For example, if the U.S. had a trillion dollars, of imports
a year, and we imposed a 12 percent import levy, that would
raise $120 billion in receipts. Even if the net shift of this
tax liability to foreign taxpayers were only half the suggested
amount, that would still mean a $60 billion annual cut in taxes
for U.S. citizens.
The important point here is that the BTA import levy shifts
U.S. tax burden onto foreign taxpayers, providing U.S. citizens
with a very significant effective tax cut, without reducing
revenues to the U.S. Treasury one cent.
One might expect that the Europeans and our trading
partners would not care for our shifting our tax burden onto
their citizens very much.
I would note, however, that many of our trading partners
have tax systems that allow them to do that very thing to us,
and they have been doing it to us for decades. One way to look
at this is we are recapturing tax base that they have been
stealing from us for decades.
Tax reform creates a welcome occasion to abandon a
counterproductive protectionist tax policy and allow our
workers and our companies to maximize their productivity. It
also means that we can implement border tax adjustments that
would further improve the competitiveness of U.S. labor and
U.S. companies.
In both cases, the clear result is higher employment and
higher wages.
Thank you.
[The prepared statement follows:]
STATEMENT OF J.D. FOSTER, EXECUTIVE DIRECTOR AND CHIEF ECONOMIST, TAX
FOUNDATION
My name is J.D. Foster and I am the Executive Director and
Chief Economist of the Tax Foundation. The Tax Foundation is a
non-partisan, non-profit research and education institution. It
was established 63 years ago to provide the American people and
policy makers with relevant, timely, and accurate information
and analysis on fiscal policy matters at the federal, state,
and local levels.
The sustained interest in tax reform should come as no
surprise. More than any other aspect of government the federal
income tax directly and repeatedly influences Americans' lives.
We may be most aware of this now during the tax season, but
every week our lives are touched and our decisions colored by
the income tax. How much should I save in my 401(k)? Should I
sell some stock and pay the capital gains tax to buy the stock
I would prefer? Should I go to college, to graduate school or
night school to get a better job and earn a higher salary if it
means a much higher tax rate? Should I take out a home equity
loan to buy a car? Should I buy a home or rent? If I rent and
lose the home mortgage interest deduction, can I afford to make
as big a charitable contribution to my church, synagogue, or
mosque?
The income tax is like an old machine tilling the fields of
the economy, reaping a harvest of revenue for the federal
government. Fourteen years ago the Congress performed a major
overhaul through the Tax Reform Act of 1986. In the intervening
years the Congress has passed hundreds of changes in the nature
of ongoing maintenance. But it has also passed scores of
changes asking the old machine to do even more: To supplement
welfare spending, to encourage saving for education, and so on.
Meanwhile the fields have changed steadily as has the pressure
to produce, putting ever greater demands on the tax machine.
Even under ordinary circumstances, another major overhaul would
be past due today.
Circumstances are far from ordinary, however. The growing
breadth of the economy combined with the rapid escalation of
computing power have spawned a degree of complexity in the tax
code affecting both individuals and businesses that was
unthinkable not long ago. This complexity has led to a growing
animus and distrust of the tax system, the Internal Revenue
Service, and the federal government in general.
It is unwise to impose upon citizens any system that is
torturously complex and affects so many areas of their lives.
This complexity of the code leads to a sense of imbalance and
unfairness. Some instances are obvious, like the marriage
penalty which the Congress is seeking to address this year.
Others are a matter of perception. We come to believe our
neighbor knows of some twist to the tax code that allows him to
pay less tax than we do.
Circumstances are also extraordinary because there is a
growing sense that an income tax is not the best type of tax
for any country. At issue is not whether the income tax
machinery can be made to work better, but whether it is the
right machine for the job. When the income tax was advanced and
adopted, it was well understood that it overtaxed saving and
investment. It was also understood that this bias would reduce
economic growth, but this was considered a reasonable price to
pay for the redistribution of income and wealth for which the
income tax is so adept. Today, the prosperity foregone is
unacceptable and the transfer of income and wealth can be
achieved by other means. Further, the income tax's deleterious
effects on international competitiveness that could essentially
be ignored fifty, forty, or even twenty years ago cannot be
ignored today.
To be sure, the federal income tax is not about to
collapse. There is no crisis. We could skip fundamental tax
reform, choosing instead to make repairs minor and major and
keep this old machine running a while longer. We could also
have set aside welfare reform, and foregone its many benefits.
We could postpone Social Security Reform and Medicare reform.
We could choose to do all these things, but that would not be
the wise or rational choice, not when the lives of millions of
Americans can be bettered by sound reforms.
What Is ``Fundamental'' Tax Reform?
The phrase ``fundamental tax reform'' is now code in tax
policy. To some it stands for a specific proposal, like the
Flat Tax or the National Sales Tax or the Simplified USA Tax.
To some it stands for a threat to stability and the status quo.
To others it stands for an alternative set of principles that
should guide tax policy and that undergird most tax reform
proposals: principles such as simplification, fairness, and
economic neutrality. As these principles are nearly universally
applauded, it is immediately clear how extensive the changes
must be for legislation to rise from being a run-of-the-mill
tax bill to the level of ``fundamental'' reform. The 1997
Taxpayer Relief Act, for example, included a great many
provisions, but no one would argue that this constituted
``fundamental'' reform.
Neutrality and Saving
One distinguishing feature of fundamental tax reform is the
meaning of the word ``neutrality.'' Does one mean neutral
within the framework of a classical income tax, or neutral in
some other sense? Our current system is a mutated income tax
that often taxes the returns to saving even more heavily than
would be appropriate under a normal income tax. The
unintegrated corporate income tax, the capital gains tax, and
the gift and estate tax are monuments to excessive taxation. On
the other hand, the federal income tax contains many features
consistent with a consumption tax, such as the pension and
savings provisions that effectively ensure that only one level
of tax is paid at the individual level on labor income that is
saved.
Given its current usage, at the individual level
``neutrality'' today clearly means taxing all labor income once
and only once, uniformly and consistently. In other words, for
individuals fundamental tax reform means shifting the tax base
from a combination of labor and capital income, to labor
income. For businesses, it means taxing only profits earned in
the United States. Neutrality for businesses also means only
taxing economic profits rather than financial profits, which is
achieved by allowing businesses to expense their purchases of
plant and equipment. Thus, it means changing a fundamental
principle on which the tax system is based.
Neutrality and Education
Neutrality also means imposing no higher a tax burden on
human capital income than on physical capital income. In the e-
world, a well-educated work force is vital. The ``e'' in e-
commerce could just as well represent ``education'' as
``electronic.'' The New Economy is built on technology,
communications, and information, all of which have value only
to the extent employees, investors, entrepreneurs, and managers
can use the technology to communicate and process the
information productively. In other words, it depends on people
with the education to use the tools effectively.
The tax code should not create a bias in favor of
education, neither should it have a bias against education as
it often does today. Neutrality means businesses should be able
to expense their physical capital acquisitions. It also means
individuals should be able to deduct in full the costs
associated with their education. We already do this to an
extent insofar as local school systems are funded with
federally tax-deductible property taxes. This same treatment
should extend to all reasonable expenses incurred by
individuals seeking to invest in their own human capital.
Pursuing Fundamental Tax Reform
Defining the goal of tax reform leaves a remarkable number
of options from which to choose. For example, one can ``scrap
the code'' as many advocate, suggesting that remedial action is
infeasible or impractical, and replacing the income tax with
some apparently new system. I say apparently new because, in
fact, none of the main proposals advanced to date are truly as
new and revolutionary as their advocates would have us believe.
The Congress could achieve the essential substance of the
Simplified USA Tax, for example, by allowing an unlimited
Individual Retirement Account and other pension savings, while
allowing businesses to expense all of their purchases of plant
and equipment. Similarly, while the Federal government has no
experience with broad sales taxes, it collects numerous
targeted excises while most states collect general sales taxes.
Thus even a National Retail Sales Tax, clearly the most radical
of the popular proposals, and the most problematic, is not
entirely alien. The ``revolution'' in fundamental tax reform is
not the novelty of the new tax system, per se, but the shift in
the tax base from a mutated definition of income to
consumption.
An alternative to ``scrapping the code'' would be to
``clean the code.'' It is entirely possible to achieve all the
goals of fundamental tax reform by radically amending the
existing system. For example, step one would be to allow people
to save as much as they want in tax-deferred accounts, without
regard to their current incomes or to when they choose to take
the money out of the accounts for consumption. Alternatively,
one could tax all labor income however employed, and forego
taxing all forms of future capital income.
Step two would be to eliminate the Alternative Minimum Tax
and all the other horrors of current law. The true source of
complexity in the tax code is not the home mortgage and the
charitable contribution deductions, and the others listed on
Schedule A. For individuals the true complexity lies in the
phase-in and phase-out of the Earned Income Tax Credit, the
phase-out of the other tax credits and other bells and whistles
enacted in recent years, the phase-out of itemized deductions,
the phase-out of personal exemptions, the Alternative Minimum
Tax, and the modern nightmare that is Schedule D for capital
gains and losses. For businesses the true complexity lies in
the system of depreciation allowances, the taxation of foreign
source income, and the special rules and rulings that go into
defining taxable income.
Step three would be to allow individuals a deduction for
personal expenses associated with education--to put human
capital formation on par with physical capital formation.
Step four would be to allow businesses to expense their
purchases of plant and equipment.
Step five would be to tax only income earned in the United
States, rather than seeking to cast an extraterritorial net in
a feat of veiled protectionism.
A great many other steps would be needed to ``clean the
code'' properly. The federal income tax is very much like a
vast mansion that has collected dust and all manner of rubbish
over decades of relative neglect, and in many areas may have
fallen into disrepair. It is possible to clean the mansion
again, to repair the walls, and to modernize the facilities.
Whether one should level the income tax edifice and start over
or just give it a thorough cleaning is a tactical and political
decision. The former may be more unsettling though more
thorough; the latter may appear easier, but it is less certain
to achieve the desired result.
A No-Cost Tax Cut
Some level of compliance and administrative costs are
inevitable with any tax system. Any amount in excess of the
minimum wastes the nation's resources. It is, in effect, a tax
with no offsetting benefit. Reducing those costs is therefore
equivalent to a tax cut in that it leaves more resources in the
private sector. But it is a tax cut that, at worst, leaves the
Federal government with no fewer resources than it had before.
Estimates of the compliance costs associated with the
Federal income tax often reach into the hundreds of billions of
dollars. Four years ago the Tax Foundation concluded that a
lower-bound for such an estimate was $157 billion. Today, that
figure might be closer to $175 billion. This is a lower bound,
so the actual figure is almost certainly much higher. For
argument's sake, suppose it is $200 billion.
Using the same methodology employed to find the lower bound
for compliance costs for the income tax, in 1996 the Tax
Foundation estimated the compliance costs associated with the
Flat Tax and the National Retail Sales Tax. In both cases the
analysis showed that compliance costs would fall by about 95
percent once the new plan was fully phased-in, assuming the new
tax system was enacted in its pure form. The reduction
associated with the Simplified USA Tax would be comparable.
Thus, even if transition issues and political considerations
caused the percentage reduction in compliance costs to drop to
50 percent, that still means an effective tax cut of $100
billion annually, or $1 trillion over 10 years. That is an
enormous amount of saving and should by itself be enough to
compel legislative action.
The International Dimension of Tax Reform
The foregoing discussion reveals many sound reasons for
pursuing fundamental tax reform, including simplification,
reducing compliance costs, improving the neutrality of the tax
code so that it is less of a hindrance to economic growth, and
reducing the intrusive aspects of the tax system into citizens'
lives. Each of these has been discussed extensively in numerous
forums, including this Committee. However, the international
dimensions of tax reform, particularly the change in the tax
treatment of foreign source income and the imposition of Border
Tax Adjustments have until recently received far less attention
than they deserve.
Protectionism and the U.S. Tax on Foreign Source Income
Subject to a vast array of special provisions, tests, and
rules, the essential features of U.S. international tax policy
are that the U.S. imposes federal income tax on U.S. citizens'
foreign earnings. The U.S. also allows a limited tax credit
against any resulting tax liability for foreign income taxes
paid. This policy goes under many names, the most common of
which is ``worldwide taxation,'' the most accurate of which,
however, is ``extraterritoriality.'' Most tax reform proposals
wisely move away from extraterritoriality to a system whereby
only economic profits earned in the United States are subject
to U.S. taxation, a system known as ``territoriality''.
Extraterritoriality violates tax neutrality as the term is
commonly used. A non-neutral tax system is hurtful to wage and
job growth because it directs our national resources of land,
capital, and labor away from their most productive and
beneficial uses. A driving motivation for tax reform must be
the recognition that a more neutral tax system is in our best
interests, and this is true whether the issue is economic risk-
taking, education outlays, the level of saving, the level of
investment, the forms of investment, or the locations of
investment.
The immediate effect of extraterritoriality is to distort
the pattern of international investment by U.S. companies and
therefore to reduce their competitiveness at home and abroad.
This loss of international competitiveness translates into
lower shareholder returns, but it also means a loss of jobs and
lower wages at home. One obvious consequence of the global
economy is that companies must hire, invest, produce, and sell
globally. The companies that are best able to integrate each of
these activities across product lines, across functions, and
across countries are the most successful. A U.S. tax policy
that distorts the pattern of activity of U.S. companies
inhibits them from maximizing their efficiency. Space
limitations prevent me from elaborating on these points.
However, I have written about these matters elsewhere in
greater detail, (See ``Promoting Trade, Shackling our
Traders,'' Tax Foundation Background Paper No. 21).
If extraterritoriality is so harmful to U.S. interests, it
is reasonable to ask why it remains the basis for U.S.
international tax policy. The answer is that its true nature
has largely been hidden behind fear mongering claims and
misleading statements. Extraterritoriality is a sophisticated,
tax-based form of protectionism. Tariffs, quotas, and other
devices seek to erect a wall against foreign goods that are in
some way less expensive or of better quality than domestically
produced goods. The only motivation for such policies is to
protect the businesses and the their employees who cannot
compete fairly with foreign goods. While some benefit from such
policies, consumers and other businesses that buy these goods
must accept either lower quality or higher prices and, on
balance, the nation suffers a loss.
The United States has long and consistently been the world
leader in the fight for free trade and open markets. This has
been a bi-partisan policy and a sound policy as history has
proven time and time again. Free trade countries prosper;
closed economies stagnate. Free trade encourages each nation to
do those things it does best while giving consumers the widest
array of choices at the lowest possible prices. There are, of
course, always bumps in the road and occasional backsliding.
But the broad support for free trade is remarkable, and well-
founded.
The essential goal of extraterritoriality is to ensure that
U.S. companies pay at least as much income tax on their foreign
activities as they would if those activities had taken place in
the United States. This sounds reasonable at first blush, but
if this principle is reasonable, why should we not require U.S.
companies to be subject to the same labor laws abroad as at
home? Certainly our stricter labor laws protect our workforce,
but they also raise labor costs and therefore put U.S. workers
at a competitive disadvantage. Why not subject these companies
to the same environmental laws they face at home? Again, our
more stringent rules generally protect the environment, but
they also raise producers' costs. Indeed, we have in recent
years heard calls for exactly such policies, and it is no
coincidence that these same voices have also consistently been
at the forefront of the fight against free trade.
Proponents of extraterritoriality will argue that if the
U.S. fails to tax the foreign income of U.S. companies, then
the tax code will create an incentive for those companies to
shift their operations to lower-taxed, foreign jurisdictions.
The proper way to express this, however, is that eliminating
the tax would eliminate a disincentive for companies to invest
globally and most efficiently, unfettered by U.S. tax policies.
Classic protectionism seeks to erect barriers to the
importation of goods and services to protect jobs at home.
Extraterritoriality seeks to erect barriers to international
investment by U.S. citizens in the usually mistaken belief that
this investment would otherwise occur at home. Thus this tax
barrier to international investment is also intended to protect
U.S. jobs.
Perhaps the most unfortunate aspect of the protectionism of
extraterritoriality is not that it unfairly protects U.S. jobs,
but that it may cost U.S. jobs, on balance, and reduce wages,
on balance. As noted above, U.S. companies organize their
operations on a global basis. Each element, subsidiary, and
division performs a specific set of roles and company
management strives to optimize the efficiency of each piece of
the corporate whole. The effects of a lost or foregone
opportunity in one area will negatively affect the efficiency
of many of the company's operations, including those based in
the United States. Sometimes these secondary effects are minor
and can be overcome; sometimes they are highly significant.
Thus a lost or foregone opportunity due to the U.S. imposition
of a protectionist, extraterritorial tax policy will often
reduce employment in a company's other operations throughout
the world, including in the United States.
The U.S. has one of the best educated, most productive work
forces in the world. If a U.S. company were considering an
increase in its foreign operations, it is very likely those
operations would represent lower-wage, less productive jobs. On
the other hand, the U.S. operations that would support these
low-wage jobs would tend to be higher wage, high productivity
jobs, such as those associated with research and development,
and support functions such as accounting, finance, marketing,
and management. Thus extraterritoriality protects a few low
wage jobs at the expense of other, higher-wage U.S. jobs.
The Many Roles of Border Tax Adjustments
Fundamental tax reform permits the adoption of Border Tax
Adjustments (BTAs), in the form of a rebate upon export of the
U.S. business tax and the imposition of the U.S. tax on the
value of imports. BTAs are a common feature of many national
tax systems and are an important feature of the Simplified USA
Tax.
The importance of BTAs to tax policy is better recognized
today in the United States thanks to the recent World Trade
Organization (WTO) ruling against the U.S. Foreign Sales
Corporation (FSC) provisions. The FSC is an important, though
relatively modest attempt to grant an income tax rebate on U.S.
exports. Fundamental tax reform and BTAs solve the FSC problem
by, in effect, making the export rebate total, universal, and
WTO compliant.
The role and consequences of BTAs, however, go well beyond
replacing the FSC. Their major effects are to enhance prospects
for U.S. companies and U.S. workers to compete globally; to
offset similar provisions adopted by our trading partners,
further enhancing our international competitiveness; and
effectively to ``import'' tax base from abroad, thereby
reducing the federal tax burden on U.S. citizens without
reducing revenues to the Federal government. I will address
each of these, briefly, in turn.
Export Rebates
An export rebate allows a U.S. producer to exclude from
taxable income the profits made on the export of domestically
produced goods and services. If the United States adopted
territoriality, then export rebates naturally address any
remaining concerns that territoriality would induce U.S.
companies to shift some operations overseas. If the United
States adopted both territoriality and export rebates, then a
company would pay no U.S. tax on goods sold abroad whether
those goods are produced at home or abroad.
Business taxes are generally and ultimately borne by the
factors of production, namely labor and capital. To be sure,
there are instances in which a new tax can be shifted, at least
temporarily, onto consumers. But in an increasingly global and
competitive world economy, consumers have a great ability to
opt for alternative, lower-priced goods and services, and this
is especially true in the United States because there is very
little we do not ourselves produce in quantity. Consequently,
consumers can effectively resist bearing business taxes, and
hence they are shifted back on to labor and especially on to
the owners of capital.
Upon initial introduction, an export rebate would allow
U.S. exporters either to enjoy higher profits on their exports
or to charge lower prices in an effort to capture a greater
market share. Once markets at home and abroad have adjusted to
the new tax regimes, the relative prices of U.S. exports would
largely return to their previous levels, and the value of the
tax rebate would be shifted back to U.S. labor and U.S.
capital. Any shift of the rebate to U.S. labor would be in the
form of higher wages. Most of the shift of the rebate, however,
would be in the form of higher returns to capital that the
market would translate into a larger capital stock permitting
more output for foreign markets. In other words, the export
rebate would be immediately beneficial, but it would be even
more so in the long run by raising wages, increasing jobs, and
increasing the competitiveness of U.S. exporters.
Import Levies
The counterpart to the export rebate is the import levy on
the full value of all imported goods and services. When first
introduced, some of this rebate would doubtlessly appear as an
increase in the price of imports. The vast majority of these
price increases would quickly disappear, however, as U.S.
consumers and U.S. businesses substituted domestically produced
goods and services for foreign goods and services. In large
measure, the ability to substitute domestic for foreign
production would force foreign suppliers to absorb much of the
tax.
As with the export rebate, once markets have fully
adjusted, most domestic prices would return to their pre-tax
reform levels at least insofar as the effects of BTAs are
concerned. Once the adjustment has been completed, importers of
foreign goods and services would have shifted some of their
demand to U.S. producers, with obvious beneficial effects for
domestic job and wage growth. Thus both the export rebate and
the import levy have the same effects in terms of raising U.S.
economic activity by increasing the international
competitiveness of U.S. labor and U.S. companies.
On Offsetting Exchange Rate Adjustments
One counterargument against the foregoing analysis is that
exchange rates would adjust to offset any price effects of
Border Tax Adjustments. I believe this argument is essentially
correct. What I do not know, and what nobody knows, is how long
this exchange rate adjustment would take to occur. It could be
instantaneous or, more likely, it could take many years.
Economists know a great deal about the fundamental forces
of exchange rate determination over the long run. They also
know a great deal about many of the forces that cause exchange
rates to evolve over time. For example, we know that exchange
rates move to clear the markets for foreign exchange and that
these markets are buffeted by changing international capital
and trade flows, by changing expectations about how these flows
will adjust in the future, by changes in tax policies, and by
changing expectations of relative inflationary pressures.
Given all these factors it should not surprise that
economists enjoy little success predicting exchange rate
movements over the next day or two, and they do no better
forecasting when exchange rate movements will take place and
how far they will move in the short and medium terms. This is
especially true within the context of fundamental tax reform.
Whatever influences BTAs might have on exchange rates would
almost certainly and for a long time be overwhelmed by the
shifting patterns of trade and capital flows into and out of
the United States in response to changes in the incentives to
save and invest.
What we can say is that if exchange rates move to offset
fully the competitive benefits of BTAs, then the worst that can
happen is that these benefits will not materialize. Such an
adjustment would likely take a long time to occur, however, and
unless and until it does the benefits will manifest themselves
and they could be very substantial.
``Importing'' Tax Base
The tax base is the amount that is subject to tax. In the
case of the income tax, for example, the tax base is the total
of labor and capital income generated in a year. The federal
gasoline excise tax base is the amount of gasoline purchased by
consumers in a year. The tax base is often manipulated to
exclude certain items and in the case of the income tax to
include others more than once. The net of these manipulations
yields an amount which, when subjected to the tax rates,
produces tax revenue. The growing Federal tax take in recent
years primarily result from the growth in the economy, which is
another way of saying it results from the growth of the tax
base.
Repeating a basic principle, business taxes in most
instances fall on capital and labor, the factors of production.
If the U.S. were to impose an import levy in the form of a
Border Tax Adjustment, this levy would also fall on capital and
labor. However, it would fall on the capital and labor of the
countries producing the goods and services for importation into
the United States. In other words, a Border Tax Adjustment
import levy effectively imports tax base from abroad, shifting
some amount of the domestic tax burden to foreign workers and
foreign capital owners.
To give some idea of the magnitude of these effects,
suppose once tax reform has been enacted with its Border Tax
Adjustments that the U.S. imported $1 trillion of goods and
services a year. Assuming a 12 percent levy, that would imply
$120 billion in import levy receipts. If, when all adjustments
were completed, U.S. consumers resisted all efforts by foreign
exporters to raise prices to compensate for the import levy,
then the U.S. would have effectively imported $1 trillion of
tax base and shifted $120 billion of tax liability onto foreign
taxpayers.
Of course, in some instances foreign producers would be
able to force U.S. consumers to bear some of the tax in the
form of higher prices, and in rare instances U.S. consumers
would bear all of the tax. Clearly, however, such situations
would create powerful incentives for affected consumers to
shift consumption toward lower-price domestic goods and
services. Thus much of the expected decline in imports from
imposing an import levy would occur in precisely those areas
where consumer resistance to the tax-induced price hikes was
incomplete.
Even if the net shift of tax liability to foreign taxpayers
were only half the amount of the hypothesized upper-bound, this
would still imply a reduction in taxes paid by U.S. citizens of
$60 billion annually. Whatever the figure in a given year, the
important point is that the Congress has within its means the
ability to shift tax burden onto foreign taxpayers, providing
U.S. citizens with a very significant effective tax cut,
without reducing revenues to the U.S. Treasury one cent.
Given the reaction of many of our trading partners to our
Foreign Sales Corporation provision, one might reasonably
expect them to object to the adoption of Border Tax
Adjustments. True, they would not likely be happy over this
development, but they would have no cause for complaint. Many
of our trading partners, especially the Europeans, have
employed such BTAs for decades as part of their consumption tax
systems. In other words, they have been importing tax base from
the United States for many years, effectively imposing their
tax burden on U.S. citizens. By adopting BTAs, the U.S. would
simply be recapturing U.S. tax base these trading partners have
claimed for all these years.
Conclusion
There is a great deal to commend comprehensive, fundamental
tax reform. Most of the problems associated with the federal
income tax are well established and virtually all of them can
be effectively addressed through sound reform. Fundamental tax
reform can dramatically reduce complexity and compliance costs.
It can free individuals from much of the intrusiveness that is
the hallmark of the income tax. It can put people and education
at least on par with machines by making the tax system neutral
with respect to human and physical capital formation. It can
free the economy to create more and better jobs, higher wages,
and more wealth.
Fundamental tax reform also creates a welcome occasion to
abandon a counter-productive protectionist policy of taxing
foreign source income in favor of a policy that will allow U.S.
companies to maximize their international competitiveness and
thereby contribute even more to the promise of greater
prosperity at home.
It goes even further by creating the opportunity to
consider implementing Border Tax Adjustments that would further
improve the competitiveness of U.S. labor and U.S. companies.
And, not to be overlooked, it creates a powerful
opportunity to provide American taxpayers with an effective tax
cut, both in the reduction of compliance costs and in the
importation of foreign tax base. This tax cut potentially could
total in the hundreds of billions of dollars annually, without
reducing receipts to the Federal Treasury. This is literally,
money left on the table that the Congress can sweep up and
bestow on the U.S. taxpayer.
Chairman Archer. Thank you, Dr. Foster.
Our last witness, Gary Hufbauer, welcome back to the
Committee. We will be pleased to hear your testimony.
STATEMENT OF GARY HUFBAUER, REGINALD JONES SENIOR FELLOW,
INSTITUTE FOR INTERNATIONAL ECONOMICS
Mr. Hufbauer. Thank you very much, Chairman Archer and
members of the Committee. Thank you for inviting me to testify
this morning.
Chairman Archer. Mr. Hufbauer, would you just briefly
identify yourself for the record?
Mr. Hufbauer. Sure. I am Gary Hufbauer at the Institute for
International Economics here in Washington, D.C.
The United States has a dysfunctional tax system for
business activity and in other areas as well, but I am going to
concentrate on business activity.
Our system poses burdens that are unknown to competitor
firms based in Europe, Asia, Latin America. It is true today
that the U.S. economy is the marvel of the world. Every place
you travel, you hear this.
But our magic ingredients are being adopted by our
competitors abroad. Those ingredients are an open economy, a
flexible labor force and the Internet.
Meanwhile, we continue to be handicapped by our tax system.
We follow an antiquated and impractical general rule. We tax
the worldwide income of our firms, but we do not tax the income
of firms abroad which are shipping goods and services into the
United States.
This rule dates from the earliest days of the Internal
Revenue Code when international commerce was in its infancy and
of course multinational corporations were unknown.
Successive Congresses, in their wisdom, have modified that
general rule, at least in terms of U.S. business operating
abroad, so we have the foreign tax credit and we have deferral
and we had the DISC and we have the FSC. But these tensions,
which date back to 1918, have created the extraordinarily
complicated tax system that we are coping with today.
The problems were highlighted by the recent ruling by the
WTO against the Foreign Sales Corporation.
As my colleagues on this panel have pointed out, European
countries routinely shift their tax burden abroad. They
routinely exempt their exporters from value added tax, which
amounts to about $100 billion a year. And of course European
firms use foreign sales subsidiaries, saving at least another
$10 billion a year.
By comparison, the Foreign Sales Corporation, as
Congressman Frenzel pointed out, was a tiny little measure,
saving about $3.5 billion a year for U.S. exporters.
Meanwhile, we face the problem of international tax
competition. At one time that was called ``the runaway plant
problem.'' Ross Perot, with his gift of sound bytes,
rechristened it ``the great sucking sound.'' That was
exaggeration, but it is true that we live in a world where
international tax competition is growing more important. We
also face the new issue of Internet sales, especially business-
to-business sales which our present tax code is incapable of
handling.
The Simplified USA business tax would eliminate the steep
tilt against U.S. exports because U.S. companies, like their
European competitors and their Asian competitors, would pay no
tax on exported goods and services.
And it would eliminate the tax motive for ``runaway
plants'' and that motive may get stronger in the years ahead.
Under the simplified USA business tax, any firm that produced
abroad, whether it is an American firm or a Latin American firm
or whatever, would be taxed when it sells goods and services
into the U.S. market.
Following these general principles, the simplified USA tax
would handle the very rapidly growing business-to-business E-
commerce.
At a stroke, the Simplified USA Tax would deal with some of
our most pressing international competitiveness problems.
Thank you very much.
[The prepared statement follows:]
STATEMENT OF GARY HUFBAUER, REGINALD JONES SENIOR FELLOW, INSTITUTE FOR
INTERNATIONAL ECONOMICS
Chairman Archer and members of the Committee, thank you for
inviting me to testify. The United States has a dysfunctional
system for taxing business activity. The corporate income tax
is enormously complex, it invites firms to establish production
abroad and sell goods and services back into the U.S. market,
it discourages U.S. exports, it is an open sesame for
international tax shenanigans, and it is not equipped for E-
commerce. Like learning Latin, learning the Internal Revenue
Code is great mental discipline for young lawyers. Otherwise,
it is a curse.
The U.S. system imposes burdens on business unknown to our
competitors in Europe, Asia, or Latin America. Today the U.S.
economy is the marvel of the world. But other countries are
learning the magic ingredients: a flexible labor force, an open
economy, and the internet. To stay competitive in the world, we
need a dramatically simplified system of taxing business
activity. Representative Phil English (R.-PA) has pointed the
way with his Simplified USA Tax, drawing on the concepts
pioneered by former Senator Sam Nunn (D-GA) and Senator
Domenici (R.-NM). My testimony concerns the international
aspects of business tax reform.
The United States follows an antiquated and impractical
general rule: it taxes worldwide business income. This rule
dates from the earliest years of the Internal Revenue Code, a
time when U.S. international commerce was in its infancy, and
the term multinational enterprise had not been coined. Under
the general rule, when a U.S. company makes and sells products
in France, the U.S. taxes the income. In the converse case,
France does not tax the income of French firms operating in the
United States.
The worldwide tax approach was born in a different era as a
method of administrative convenience, but it is defended today
by emotion not logic: ``Every U.S. corporation should pay U.S.
tax, whether it operates in Indiana or India, New Mexico or old
Mexico.'' Carried to its extreme, the general rule would render
U.S. firms totally non-competitive in a global economy, both as
exporters and producers.
Successive Congresses, in their wisdom, have modified the
general rule with practical exceptions, ranging from the
foreign tax credit, to deferral, to the Domestic International
Sales Corporation (DISC) and the Foreign Sales Corporation
(FSC). But the tensions stretching back to 1918 between the
impractical general rule of worldwide taxation and the
practical exceptions have generated an extraordinarily complex
system for taxing the international income of U.S. firms and
the U.S. income of foreign firms. The administrative burden is
a nightmare for the IRS and business alike.\1\
---------------------------------------------------------------------------
\1\ Gary Clyde Hufbauer assisted by Joanna M. van Rooij, U.S.
Taxation of International Income: Blueprint for Reform, Institute for
International Economics, 1992.
---------------------------------------------------------------------------
These problems were brought into focus by the recent WTO
Appeals Court decision against the Foreign Sales Corporation.
Elsewhere, I have severely criticized this decision.\2\ It
ignores legal history and it misreads the WTO text. But
Congress must now reckon with a WTO decision that tossed aside
the tax bargain painstakingly negotiated between the United
States and Europe twenty years ago.
---------------------------------------------------------------------------
\2\ Gary Hufbauer, ``A Critical Assessment: The World Trade
Organization Panel Report (dated 8 October 1999) and Report of the
Appellate Body (dated 24 February 2000), United States--Tax Treatment
for ``Foreign Sales Corporations' '' ', Institute for International
Economics web site www.iie.com, March 11, 2000.
---------------------------------------------------------------------------
European countries (and many others) routinely exempt their
exports from value added tax. This saves European exporters
about $100 billion a year of tax payments on export sales.
European firms routinely sell these same exports through tax-
haven sales subsidiaries located in exotic places like Bermuda
and Hong Kong. This saves European exporters another $10
billion a year of corporate income tax. By comparison, the
Foreign Sales Corporation saves U.S. exporters about $3.5
billion a year. Most of the 6,000 firms that use the FSC are
small and medium-sized exporters with little or no production
abroad.
As the FSC decision illustrates, the WTO honors an archaic
tax distinction that has no economic basis. WTO rules allow
corporate taxes measured by value added (Europe) to be excused
on exports and imposed on imports. But WTO rules forbid similar
adjustments for corporate taxes measured by income (United
States)--even though the distinction between the two tax bases
is more form than substance.\3\
---------------------------------------------------------------------------
\3\ Gary Clyde Hufbauer and Carol Gabyzon, Fundamental Tax Reform
and Border Tax Adjustments, Institute for International Economics,
January 1996.
---------------------------------------------------------------------------
Meanwhile, old and new problems fester in the world of
international taxation. One old problem is the ``runaway
plant,'' re-christened by Ross Perot as ``the great sucking
sound.'' Will U.S. firms pull up stakes and move abroad, and
then sell back into the United States--free of U.S. corporate
tax? Legislators in many countries understand that low business
taxes are a good way of attracting investment, and econometric
evidence bears out their sentiments. Perot exaggerated for
political effect, but the possibility of fierce tax competition
in a global economy cannot be lightly dismissed.
A new problem is E-commerce. Will U.S. firms be taxed on
their internet sales to customers abroad? Can foreign firms
sell into the U.S. market free of tax?
Congress could, in a single historical stroke, level the
field of export taxation, end anxiety about runaway plants,
resolve much of the looming debate over E-commerce, and discard
volumes of tax complexity. It could achieve all these goals by
replacing the corporate income tax with the Simplified USA tax.
Under the Simplified USA business tax, taxable income would
be determined by subtracting permitted deductions from taxable
receipts. Taxable receipts cover revenue from sales in the
United States, but not exports or production abroad. Permitted
deductions cover all costs of business purchases from taxpaying
U.S. firms. Payments for imports are either not permitted as a
deduction or are taxed directly. By excluding exports from
taxable receipts, and by either excluding imports from
deductible expenses or taxing them directly, the Simplified USA
business tax provides ``border tax adjustments''--just as in
Europe, but without adopting a sales tax.
When U.S. firms sell into foreign markets, their receipts
would not be counted in taxable income, and therefore would not
be taxed by the United States. The steep tilt in export tax
practices would be leveled because U.S. companies, like their
European, Asian and Latin American counterparts, would pay no
tax on exported goods and services.
The Simplified USA business tax would eliminate the tax
motive for runaway plants. Any firm that produces abroad and
sells in the U.S. market would effectively pay the same tax as
a competitor located in the United States. When U.S. or foreign
firms sell goods and services into the U.S. market, the U.S.
importer would be liable for the Simplified USA tax
(alternatively, no deduction would be permitted for the
purchase of imported goods and services). For example, shoes
made in Brazil and retailed by Walmart in Denver would pay
Simplified USA tax, and so would sophisticated software written
in Bangalore and sold to Citigroup in New York. The United
States would collect the Simplified USA business tax on about
$1.3 trillion annually of imported goods and services.
When U.S. firms both produce and sell abroad, they would
pay tax to the host country, not the United States. In fact,
under current law, the U.S. Treasury collects practically no
corporate tax revenue on active business conducted abroad by
U.S. firms. But this practical outcome results from the
interaction of outlandishly complex rules dealing with foreign
tax credits, foreign losses and deferral. The same outcome
would be a straightforward result of the Simplified USA tax.
U.S. firms would compete on a level tax playing field, whether
they produced in China, Germany, Mexico, or anyplace else.
How would the Simplified USA tax handle E-commerce? As
explained, business-to-business E-commerce (B2B) would not be
included in taxable receipts, and B2B imports would be taxed
directly (or deductions for imports disallowed). B2B is by far
the largest dollar volume of E-commerce transactions. At a
stroke, the most immediate E-commerce tax problem would be
resolved.
America's first income tax began 1861 to pay for the Civil
War. The Union imposed a 3 percent tax on incomes over $800.00
a year, which exempted most wage earners. The tax rate was
raised to 5% in 1862 on incomes over $10,000.00. Shortly after
the Civil War the income tax was repealed, the Bureau of
Internal Revenue remained in existence. Budget-balancing
statement have turned to income tax even in peacetime to
replace revenue lost by import and export duties. That was the
purpose of the income tax passed by congress in 1893 and ruled
unconstitutional by the Supreme Court in 1895. President Taft
pushed a constitutional amendment to revise that decision, and
an income tax was passed as soon as the 16th Amendment was
ratified in 1913 by only 31 states.
The new income tax was a luxury tax. Top rates remained
below 10 percent and most Americans didn't pay at all. Then
came World War I, which raised the federal budget from $1
billion in 1916 to $19 billion 1919; income tax rates rose to 3
percent on $2,000 and 70 percent on $1 million. After the war,
Treasury Secretary Andrew Million reduced the top rate to 25
percent and got most taxpayers off the rolls by raising the
minimum income subject to tax. But he also cooperated with the
Congress to create preferences, exemptions, deductions and
other tax breaks. The income tax had gotten the federal
government deeper into the business of allocating economic
resources, mostly out of public view.
During World War II, as federal spending rose from $9.6
billion in 1940 to $95 billion in 1945, income tax rates were
raised 19 percent on $2,000 and 88 percent on $220,000, and the
number of taxpayers rose from 14 million to 50 million.
The World War II tax is recognizable ancestor of today's
federal income tax. The $500 per dependent exemption of 1944,
raised to $600 in 1947, was a generous allowance no income tax.
Over time, inflation eroded the value of the exemption. The
Republican leaders of the 1950's feared voter's resentment of
the rich and did not reduce top rates. In the 1960's, JFK
stimulated the economy by reducing taxes significantly.
The experiment in maintaining the wartime's high tax rates
during peacetime in order to pay for the cold war and
redistribute money to the middle class and poor worked-both
economically and politically-for a generation and then stopped
working economically. In the 70's, runaway inflation, fueled in
part by Lyndon Johnson's refusal to raise taxes to pay for the
Vietnam War, propelled ordinary families into tax brackets
intended for the rich, while the myriad tax breaks available to
the wealthy made a mockery of fairness. As state, local, and
other tax rates also rose, a middle-class tax revolt helped
fuel the Reagan Republic victories of the 1980's and 1994.
Politicians have been struggling ever since to reduce income
tax rates to peacetime levels that the public and the economy
will tolerate.
Quoting the Federalist papers #35 penned in 1788 by
Alexander Hamilton, ``There is no part of the administration of
government that requires extensive information and a thorough
knowledge of the principles of political economy, so much as
the business of taxation. It might be demonstrated that the
most productive system of finance will always be the lest
burdensome.''
In a few days, I have been able to gather signatures from
disgruntled American's who support the Fair Tax plan. Be it
known that these signatures cross all lines of division in that
they represent ditch diggers to lawyers, truck drivers to
stockbrokers, Black, White, Hispanic, and Asians. To further
discern a more accurate consensus of the people, all you need
do is refer to the petition filed by the people of Arizona. On
Thursday, July 2, 1998, 170,000 Americans required of this
congress to abolish income tax and establish a National Sales
Tax. The Fair Tax Plan before you at this time is what the
people want and require of you now.
One thing that amazes me is that the national news media
has all but ignored this legislation. The rhetoric we as
Americans have been subjected to implied that the wealthy in
this country do not pay taxes, and that the tax burden has been
shouldered by the ``working poor and middle class.'' To this I
quote the designed Commander of Bastognne in his response to
the Nazis to surrender in World War II ``Nutz.'' Figures
recently released by the National Revue project quiet a
different notion. The quintile of taxpayers from lowest to
highest to outlined as such:
Lowest -2%
Low 1%
Middle 7%
High 16%
Highest 78%
When confronted with the truth in these matters of income
tax and this Administrations quest for an America steeped in
fairness, it is apparent that we are trying to shoot a game of
pool with a nylon rope.
I would like to thank the members of this committee for the
opportunity to address you regarding the Fair Tax plan, and
close with another quote from Alexander Hamilton's Federalist
Papers #36:
``It has been asserted that a power of internal taxation in
the national legislature could never be exercised with
advantage, as well from the want of a sufficient knowledge of
local circumstances, as from as interference between the
revenue laws of the union and of the particular States. The
supposition of a want of proper knowledge seems to be entirely
destitute of foundation. If any question is depending in a
State legislature respecting one of the countries, which
demands a knowledge of local details, how is it acquired? No
doubt from the information of the members of the county. Cannot
the like knowledge be obtained in the national legislature from
the representatives of each State? And is it not to be presumed
that the men who will generally be sent there will be possessed
of the necessary degree of intelligence to be able to
communicate that information?'' I hope so!
If William Jefferson Clinton so feels the pain of the
American people, let him with unanimous consent of US Congress
and Senate sign the Fair Tax Plan now. I implore you to
preserve our freedom, our liberty, and Save this Union by
Passing this legislation NOW!!
Thank you.
[Attachment is being retained in the Committee files.]
Chairman Archer. Thank you, Mr. Hufbauer.
Again, my thanks to each one of you.
I have several questions. I had not intended to get into
this today but you have prompted my inquiry.
The USA Tax was originally designed as a consumption tax,
as I recall, and introduced by Senator Domenici, is that not
correct.
And is it under the revisions that have been presented
today still a consumption tax?
Mr. Christian. It, Mr. Chairman, it does not double tax
saving, and by an economist's definition, that is what a
consumption tax is.
The difference between the original USA and the simplified
USA in this respect is straightforwardly as follows:
Under the proposal sponsored by Senator Domenici and
Senator Nunn, a deduction was allowed for personal saving. When
income was earned, if that income was saved, the tax was
deferred because a deduction was allowed, and then the tax was
imposed when the original amount saved----
Chairman Archer. Mr. Christian, because time is limited
today, I personally do not feel that I have the time to get
into all of those details.
I just simply wanted to know whether this is still a
consumption tax?
Mr. Christian. By an economist definition, yes.
Chairman Archer. But it does tax savings once?
Mr. Christian. That is correct.
Chairman Archer. Which, by my definition, would not be a
straight out consumption tax.
The mere fact you eliminate double taxation means that
there is still a single tax on savings, and a true consumption
tax does not tax savings at all.
And I am not trying to make an argument against it; I am
just trying to understand it.
The payroll tax credit that is a part of the system, as it
is presented today, I assume that is refundable?
Mr. Christian. That is refundable, that is correct.
Chairman Archer. All right. So in effect, what you are
really doing is you are replacing payroll taxes with general
income tax revenues coming out of the Treasury?
Mr. Christian. There is no change in the payroll tax
itself.
Chairman Archer. No. I understand that. But you are
offsetting the burden of the payroll tax with general Treasury
money?
Mr. Christian. That is correct.
Chairman Archer. Okay. Why not simply abolish that part of
the payroll tax and let the general Treasury make a
contribution each year in an amount equal to what the payroll
tax would have been directly into the Social Security fund?
Would not that be much simpler than having everybody have
to deal with a refundable tax credit? Because that is the end
result.
Mr. Christian. You could do it that way.
Chairman Archer. You are reducing the revenue in the
general Treasury fund by your tax credits, which is the
equivalent of the Treasury writing a check to the Social
Security Trust Fund.
And it just seems to me that would be far simpler, the end
result is the same.
Rather than going through all of this bit of the tax
credit, having the payroll tax withheld, so people foregoing
that amount of their paycheck until the end of the year when
they can get a refundable tax credit, why not just wipe out the
employees' side of the payroll tax, and at the end of the year,
have the payroll records which are being sent in determine the
amount of money and let the Treasury just write a check to the
Social Security Trust Fund?
Would that not be much simpler?
Mr. Christian. You could do that, Mr. Chairman.
The thought behind this approach was to not mess with
Social Security at all, not touch it, and not get into the
business of the Treasury writing checks out to people that are
not related to their incomes--other than as part of what
amounts to a tax refund----
Chairman Archer. Okay, but the Treasury will be writing
checks to people in this refundable tax credit. But the people
will have to wait for the entire year before they get their
check.
And it just seems to me that in the name of simplicity,
which we are always searching for in the Tax Code, that rather
than dealing with all of these multiplicity of tax credits that
have to be enforced and administered by the IRS, that we just
simply abolish that. Workers would love it, and simply make the
transfer in one transfer, rather than a multiplicity of
transfers coming out of the general Treasury.
That is just a thought that I had.
I must say to my friend and counselor and comrade-in-arms,
Bill Frenzel, that one comment that you made disturbs me a
little bit. And that is when you said there can be open upward
mobility for the marginal tax rates. That strikes terror into
my heart because we saw exactly that happen after the '86 Act
reduced the rates, and then there was upward mobility for the
rates in '90, and then there was further upward mobility for
the rates in 1993, and I just worry a little bit about deja vu
all over again, so you might want to comment on that.
Mr. Frenzel. I do want to comment on that, Mr. Chairman.
You are right. That was one of the reasons we opposed the Act,
because with the bubble in there, we knew that top rate was
going to go up again. And, as you suggested, it did go up a
couple years later.
I have indicated in my testimony that I believe the top
rate is too high now, but also I have indicated that I believe
in a system of progressive taxation.
And I only suggest that any tax rate can be raised or
lowered and of course is that kind of a system. You can
structure it anyway you want.
Mr. Chairman, if I could go back to your original question
to Mr. Christian?
Chairman Archer. Sure.
Mr. Frenzel. About whether it is an income tax or a
consumption tax. One of the early developers of this bill was a
David Bradford, a professor at Princeton who served in the CEA,
I believe. He always called it a ``consumed income tax'' and I
do not know if that is a euphemism, or whether it helps, but
that was his description of some of his early thinking.
Chairman Archer. I do remember that. I thank you for
reminding us of it.
Can you tell me what deductions under the current law are
eliminated in the USA Tax?
Mr. Christian. One very prominent deduction that is
eliminated is the deduction for state taxes.
Chairman Archer. State income taxes?
Mr. Christian. All state taxes, yes, sir.
Chairman Archer. Well, sales taxes are already non-
deductible.
Mr. Christian. They are non-deductible.
Chairman Archer. But would it also eliminate property
taxes?
Mr. Christian. Yes.
Chairman Archer. Okay. So no state income taxes or local
property taxes would be deductible?
Mr. Christian. That is true.
Chairman Archer. All right. What else?
Mr. Christian. There are a number of miscellaneous
deductions. I cannot recall any further right now, Mr.
Chairman. There are quite a few small ones. Everything other
than charitable and home mortgage interest, I believe, of the
miscellaneous itemized deductions is repealed.
Chairman Archer. What about the child credit the Hope
Scholarship credit, the EIC credits?
Mr. Christian. All of the credits, those that you
mentioned, the child credit, the earned income tax credit, and
the others are repealed. There are only two credits under the
bill. That is for the payroll tax paid and income tax paid
through withholding or estimated tax.
Chairman Archer. What about deduction for health expenses?
You did not mention that?
Mr. Christian. The personal itemized deduction or the
business deduction?
Chairman Archer. No, personal.
Mr. Christian. Personal. The medical deduction is not there
under this version of the bill.
Chairman Archer. So the deduction currently in the Code for
medical expenses to individuals is no longer available?
Mr. Christian. It is replaced by the Roth-IRA savings
mechanism. It is no longer available.
Chairman Archer. Okay.
Can you think of any other salient deductions under the
current code that are not available?
Mr. Christian. No, Mr. Chairman, not at the moment.
Chairman Archer. What portion of the stream of federal tax
revenues is border-adjustable under your plan?
In other words, today the entire cost to the federal
government is included in the price of the products that are
exported which has been estimated to raise the price of those
products by 20 to 25 percent on average.
What portion of that cost that is represented by the
federal tax burden has become border adjustable under the USA
proposal?
Mr. Christian. The business taxes are approximately,
including unincorporated business, about $320 billion. Personal
income taxes are about 8.5 or 9.
It is the business tax that is border adjusted. The
business tax does not apply to exports.
Chairman Archer. Can you just roughly say what percentage
of the total stream----
Mr. Christian. About 25 percent, I believe.
Chairman Archer. How much?
Mr. Christian. It would be, the numbers I gave, the
mathematical result is about 25 percent.
Chairman Archer. About 25 percent of the federal cost of
taxation will not be passed through in the price of the
product?
Mr. Christian. That is certainly correct.
Chairman Archer. Okay. Thanks.
And I assume you still have tax exempt foundations?
Mr. Christian. The organizations, such as universities,
schools, et cetera, that are exempt under present law, continue
to be exempt from the business tax under the USA.
Chairman Archer. And how do you go about taxing foreign
imports mechanically?
Mr. Christian. The mechanics under this version, the
English Bill, is there is an import tax imposed at the border
on the importation of goods from abroad.
Chairman Archer. So then the Customs Service then does that
when the product enters the country?
Mr. Christian. Well, it is primarily the importer. The
importer or the importer's agent is a U.S. taxpayer subject to
U.S. tax jurisdiction. They are the ones who owe to the
Internal Revenue Service the import tax.
Chairman Archer. So mechanically it becomes a burden of the
importer?
Mr. Christian. It becomes a payment responsibility of the
importer.
Chairman Archer. All right. And lastly, how do you avoid
the double taxation of corporate income, or am I mistaken? I
think that is what the presentation was that you eliminated the
double taxation?
Mr. Christian. The double tax on saved income is eliminated
by means of the Roth-IRA mechanism. I think you are asking
about the two-tier tax where----
Chairman Archer. What about dividends? You have got your
new uniform business tax type operation on corporations to
replace the current corporate income tax which, by the way, I
think is a very positive step forward.
What about the taxation of corporate dividends to the
owners of the corporation?
Mr. Christian. Those are taxed, as are interest payments
and as are wages----
Chairman Archer. Okay, okay. So you do not eliminate the
double taxation of corporate earnings?
Mr. Christian. In the sense you are asking it, that is
true, Mr. Chairman.
Chairman Archer. Okay, all right. I am not trying to pick
at you. I am just trying to understand this bill.
Mr. Christian. I am grateful for the attention, Mr.
Chairman.
Chairman Archer. I need to know what the proposal is.
Mr. Rangel?
Mr. Rangel. Mr. Chairman, I have to go on the House Floor
to protect our Committee's jurisdiction. But, before I leave, I
want to ask Bill Frenzel a question, since he enjoys the
expertise of former Members, as well as an advocate of tax
reform.
If we were going to dramatically change the tax system,
would you agree that the American people should first be
educated about the replacement proposal before they would
expect the Members of Congress to have the political courage to
eliminate the code?
Mr. Frenzel. Mr. Chairman, Congressman Rangel, I agree with
that. I do not think you can make major changes in the tax code
without some kind of a national debate and without the pretty
full cooperation between the Executive and the Legislative
branches of the government.
Mr. Rangel. Now, assume we accept, as a matter of fact,
that the composition of the Congress currently gives the
Republicans a very slight margin for the Majority. And, that if
there are any changes as a result of the election in November
and the Democrats win the Majority. Our advantage too would be
slight. Would you agree, if we are going to make any progress
at all towards reforming the existing system, that it has to be
done in a bipartisan way?
Mr. Frenzel. It has been my observation, Congressman
Rangel, that your statement is correct. It is very difficult to
pass a major piece of tax legislation without cooperation
between the parties and the Congress, and between the branches
of government as well.
Mr. Rangel. Well, I do not know really what is going to
happen, and no one else does in November. But there is one
thing I can tell you as a friend that Democrats have learned in
being in the Minority. That is: we can be in the Majority and
not cooperate and do absolutely nothing, or we can reach out to
the minority and work with the other side in trying to find out
how we can move the country and the Congress toward a better
system.
I think that, no matter who wins, the best thing for the
country and the coming campaign is to state upfront that we
cannot do it alone. There is not going to be any Democratic way
to reform the tax code and there certainly is not a Republican
way to do it.
But working together, we can find a way. And I think if we
had the confidence of the American people, then it is no
profile in courage to do the right thing in this Committee and
on the Floor and the Senate.
But we miss people like you because we could differ and we
could fight and then when it was all over. We could still talk
about the areas that we agreed on and how we can make progress,
and that has been missing.
And while we miss it from a friendship point of view. I
think, more importantly, the lack of talking together the lack
of cooperation means really that the Congress has not been
productive. We have taken advantage of that for political
purposes on both sides of the aisle. No one knows what impact
that will have in November, but it certainly has not done well
for us as a body.
The whole idea that we would turn over our tax writing
authority to a non-congressional committee bothers me a great
deal.
But in any event, please do not go too far away. We always
need you to remind us when we were working well together. And I
thank you for hanging in there always.
Mr. Frenzel. Thank you, Mr. Rangel. If I could comment just
briefly. The three largest tax reforms that I can remember were
'54, '69, and '86, and in each case we had a president and a
Congress of different parties, and they both managed to work
together. In '86, even when the Congress did not take my good
advice on that bill, there was very close cooperation between
the parties, as you will recall. I hope we can get back to that
kind of cooperation. Maybe this is an issue that will help draw
us back to that kind of working arrangement.
I thank you very much, but I assure you that other than an
occasional bit of testimony, I am not looking to threaten any
member's position on this Committee.
[Laughter.]
Mr. Crane: [Presiding]. Thank you.
Mr. Collins?
Mr. Collins. Mr. Chairman, the only comment I have is to
the previous member who questioned, and that is talk is cheap.
Mr. Crane. Any responses?
[Laughter.]
Mr. Crane. Mr. Portman?
Mr. Portman. Thank you, Mr. Chairman.
I have got so many questions and I appreciate the comments
from my friend from New York. I do not know why he is against
the Commission, but as I told him earlier, I think it is
exactly the way to do what he wants to do which is educate the
public, which is to make it bipartisan and which is to get
outside expertise, and then give it as a recommendation to
Congress and this Committee just like IRS reform and other
things would go through the normal process.
And I think it would be a tremendously positive and helpful
step in getting tax reform.
I want to commend all four of you. It is great that you
have come up with this plan. I have talked to Ernie a lot about
it and J.D. some. And I have been, as you know, struggling with
some of these issues too since IRS reform because you cannot
reform the IRS without a simpler tax code.
I do not come out quite with this proposal but I think
there are positive things in it.
I have a few questions, and I guess the two key issues of
course are first, what would the rate be. You have got some
rates here.
I guess my question to you would be, and you all have
impeccable integrity. So many of these folks who have come
before us have come up with rates that just are not accurate,
and without knowing what the rate is, whether you are for a
Fair Tax or a flat tax or a USA tax, or something that I have
talked to you about Ernie, more that I am thinking about that
has to do with a VAT tax and some other aspects, the rate is
absolutely critical.
The rate is absolutely critical, and I wonder about these
rates. So without questioning you about them today, I would
just say I hope that you can come up with current estimates of
the rates. Maybe these are them. They seem a little low to me
based on what we have done with some other analysis.
I hope you will use Joint Tax models so that we can compare
apples to apples.
The second question I would have is border adjustability.
Do you have good legal analysis which shows you that somehow we
would be able to tax imports at 12 percent, that we would be
able to cut out the export tax, and not have it be considered
by the WTO to be discriminatory.
There is no precedent for this. No other country does it.
And as you know, the VAT tax is something that is tested,
battle-tested, and we know that we can border adjust, and why
do you think this would be border adjustable.
Mr. Hufbauer. Congressman, I wrote a little monograph on
this and I will send a copy to you.
Mr. Portman. I would appreciate that.
Mr. Hufbauer. It is called Fundamental Tax Reform and
Border Tax Adjustments.
Of course, you do not know how the WTO will rule until the
case is actually before it. Nobody can say with 100 percent
confidence.
But the Simplified USA Tax, in its business aspects, as
proposed by Congressman English, is very similar to existing
systems which have been ruled to be border tax adjustable. Thus
I think the chances are very good that the U.S. would prevail
in any litigation that occurred on this issue.
Mr. Portman. Well those are two sort of fact issues. I
mean, it is difficult to know factually when there is not a
precedent. As you said, the chances are it would but it is a
big risk because it is an incredibly important part of the
proposal. And the second is it at an $80,000 level where you
have to kick in the 30 percent tax rate?
These are obviously going to be the deciding points on what
kind of tax reform makes sense.
If I could ask a couple of other questions quickly that go
to some of the things that Chairman Archer was I think trying
to get at.
The refundable tax credit experience with the EITC has been
miserable. And I would appreciate, Ernie, your response to
that, whether you could look at something where maybe you have
a more sort of honest direct transfer, as the President's
proposing now in Social Security. Everybody has a transition
cost in the Social Security proposal.
Because to have the IRS in the position of enforcing a
refundable payroll tax credit I think would be very difficult.
Also, what do you do with folks who are on the EITC now? I
assume you eliminate the EITC?
Mr. Christian. Mr. Portman, the earned income tax credit,
as it exists today, is eliminated. The earned income tax
credit, as it exists today, is a great problem of complexity,
it is a great problem of fraud. None of those considerations
seem to me to, in any way, apply to the credit that exists
under the English Bill. It is very straightforward. There are
no threshold requirements or anything of that nature, and the
big difference is as follows:
Under the English Bill, a credit is given for a tax that
has been paid. That tax is fundamental to the system. It has
been around a long time. It is well-tracked. The payroll tax is
a simple mechanism for tracking----
Mr. Portman. Ernie, if I could because my red light is
already on.
The challenge here, as I see it, is I think there will
still be some compliance issues but I agree with you, it would
be better because you will have a record of what the FICA tax
would have been.
But as you know, with the EITC, about 85 percent of it is
refundable as to payroll, about 50 percent as to income. You
still end up with some people who pay no payroll taxes in
effect, no income taxes in effect, and get the EITC.
How do you take care of those people, the working poor who
currently get EITC?
Mr. Christian. I do not know how anyone would be working
and not paying payroll tax, but perhaps that is possible.
Mr. Portman. No. I am saying the EITC is so generous that
it takes care of all of the payroll taxes, it also credits all
of the income taxes that some individuals pay and yet those
people get a transfer from the government. They are working
people but you are not covering those people. And I just wonder
how you would cover them?
Mr. Christian. The welfare element is definitely not
present in this credit.
Mr. Portman. I am sorry?
Mr. Christian. I said the welfare element that is present
in----
Mr. Portman. No, I am not talking about welfare, I am
talking about the EITC. You need to address that problem, or
you need to say you are not addressing it, I guess.
Mr. Foster. Mr. Chairman, I would like to take a quick shot
at this to put it in a framework.
The refundable part of the EITC is often considered to be a
tax-based system of welfare. And in fact, that is how CBO
scores it. It is not treated as a tax, it is treated as an
outlay.
This tax system, like many tax systems, provides a
framework within which we can make changes.
The Chairman was asking earlier about deductions that might
be in or out of the system. If a deduction was deemed
politically necessary or worthwhile, it can be put back in.
The system as current designed does not have the earned
income tax credit. There is absolutely no reason in the world
it could not be added on, much as one adds on an extra piece of
equipment on a car.
This is a frame work for taxing within which we can make
adjustments with rates, higher rates, lower rates, more
progressive, less progressive, adding in deductions, taking
them out, or adding in credits or taking them out.
Mr. Portman. I understand that, J.D., and we need to do
that. With the indulgence of the Chair, I looked at the '86
experience, what has happened since then, and that is the great
fear the Chairman has, and again, I really applaud you and
Congressman English for taking the leap and proposing this.
On the EITC, it is just a very simple question really and
not a simple answer, but you are covering most of the current
recipients of EITC because you are covering payroll.
You are not covering, though, folks who currently not only
have their payroll taxes offset by EITC, but also their income
taxes, and some folks who have both income and payroll tax, and
still get a transfer from the government under this Program for
the Working Poor, and I think you need to address that. There
are lots of ways to do it and I will not make suggestions, but
I think it needs to be addressed. Otherwise you have a hole
that I think the states and localities and others are not going
to be able to fill.
I have some questions on the pension side and on the health
care side that maybe we can talk about later. I think they are
very important because you do not have an employer match here,
so you do not have a 401K type proposal, although you say in
the materials, it preserves the 401K.
Mr. Christian. It is preserved.
Mr. Portman. I would like to talk to you about the fringes,
as well.
Thank you.
Thank you, Mr. Chairman.
Mr. Crane. Thank you.
Mr. English?
Mr. English. Thank you.
And on that point, Mr. Christian, do you want to comment on
the 401K situation?
Mr. Christian. Yes, sir.
Your bill, as you know, following up Mr. Portman's point,
the bill does retain the 401K provision. And it retains the
ability for the employer to match. The difference is that the
contribution to the 401K under the English approach is not
deductible, whereas it is presently. That is the difference
between--the employer match is not deductible under this
proposal.
But the 401K and that mechanism still exists and employer
matching is encouraged.
Mr. English. And I thank you.
Mr. Frenzel, you heard the exchange with regard to EITC and
the excellent points that my colleague from Ohio made with
regard to the hole that he identified that I frankly have been
very much aware of, because I have a lot of people on the EITC
in my district.
In your testimony, I believe that you commented that
perhaps rather than treating this as a tax program, we should--
and I hate the notion of tax program--rather than trying to
deal with this through the Tax Code, maybe this could be most
efficiently administered as a program through the federal
government, an expenditure.
Can you comment on that
Mr. Frenzel. Yes. I was a strong supporter of the EITC when
it was first effected here, and I thought the concept was
wonderful. But it was a very small program at that time.
Nowadays, because the program has gotten big and because
people have found out how to game the system, it has been my
judgment that we would do far better to make that into an
appropriations entitlement, rather than a tax entitlement,
where it could be enforced much better, and probably managed
better.
That is a personal comment on my part.
Mr. English. And one that I agree with.
Thank you, sir.
Mr. Foster, in your testimony, you touch on the notion that
by establishing this border adjustable system, which I believe,
having researched it, is GATT consistent, that we are, in
effect, importing a foreign tax base.
Would you care to comment on that further?
Mr. Foster. Yes, sir.
If you start from the proposition, as I do and most
economists do, that business taxes ultimately fall on labor and
capital, when you have a border tax adjustment import levy,
that levy, too, falls on labor and capital. The question is on
whose labor and whose capital.
Now some of this import levy obviously gets translated into
higher prices to consumers, and in some cases, that is
permanent. But in most cases, consumers will substitute
domestic for foreign production so that they are able to resist
the attempt by the importer to raise prices. When they are able
to effectively resist those price increases, the tax then gets
pushed back onto the foreign producer of those goods and
services sold into the United States.
Well, if they are being pushed back into the foreign lands,
that obviously means that the BTA import levy is paid by the
foreign labor and capital. Another way of expressing that is we
are importing their tax base.
Mr. English. And on that point, Mr. Portland made the
excellent point that none of our tax competitors have quite
this kind of a tax system as is being proposed here, but many
of them do have border adjustable systems.
How many of them, would you say that we compete with, what
proportion of our industrialized competitors have border
adjustable systems?
Mr. Foster. Well, probably 90 percent or more because we
are talking all of Europe, Japan, and Canada.
Mr. English. And we are at a competitive disadvantage with
them.
Finally, Mr. Hufbauer, you make an excellent point that
this tax system would eliminate the tax motive for runaway
plants. That is something that resonates in a district like
mine.
Would you care to elaborate?
Mr. Hufbauer. Sure.
The runaway plant phrase, as you well know, Congressman,
dates back to the Burke-Hastke bill of the early seventies.
The idea was that a U.S. firm would shut down its
operation, for example, in Ohio, and would move to, for
example, Mexico or Singapore, and would ship exactly the same
goods back to the U.S. And it would do this for a lot of
reasons. Wages were often cited. Other reasons as well. Taxes
were often mentioned as part of that business decision.
To the extent that taxes are part of that business
decision, under the simplified USA tax no firm escapes taxes in
the U.S. market by moving its production to a foreign country,
because when the goods are shipped back into the U.S. market,
they would be taxed just as if they had still be produced in
Ohio. That is, in my view, a huge improvement over the
situation that we have today.
Mr. Crane. I thank you gentlemen, and I am impressed with
the quality of the testimony today. We appreciate your
participation.
Mr. Hulshof?
No questions from Mr. Hulshof.
Well, then, this panel has concluded its work and I want to
thank you all and congratulate you for your presentations.
And any additional material you may have, submit in writing
and it will be part of the permanent record.
Now, with that, I think we are going to change the schedule
as it was originally presented, because we are going to break
for lunch.
So I would like to call our last panel up first, because
our next two panels--well our next one in line is not
available, and the one after is going to be longer in session
than we have left before the lunch break--so I would like to
invite Mr. Steven Worley from Lawrenceville, Georgia, and Mr.
James Moore from Smithtown, New York, and Frank L. Davis,
Alexandria, Virginia. I do not think he is yet here, but if he
appears after you two have made your presentations, we will
listen to his.
And gentlemen, we will proceed in the order I presented
you, and if you can limit your oral presentations to roughly
five minutes, any additional remarks will be made a part of the
permanent record, and we will start with you, Mr. Worley.
STATEMENT OF STEVEN WORLEY, COLBERT, GEORGIA
Mr. Worley. Thank you, Mr. Chairman.
My name is Steven Worley. I am actually from Colbert,
Georgia. I am a horse breeder and I am also in the construction
industry.
America's first income tax began in 1861 to pay for the
Civil War. The Union imposed a three percent tax on incomes
over $800 a year, which exempted most wage earners.
The tax rate was raised to five percent in 1862 on incomes
over $10,000. Shortly after the war, the tax was repealed but
the Bureau of Internal Revenue remained in existence.
Budget balancing statesmen have turned to income tax even
in peace time to replace revenues lost from imports and export
duties. That was the purpose of the income tax passed by the
Congress in 1893 and ruled unconstitutional by the Supreme
Court in 1895.
President Taft pushed a constitutional amendment to revise
that decision and an income tax was passed as soon as the 16th
Amendment was ratified by only 31 states.
The new income tax was a luxury tax. Top rates remained
below ten percent and most Americans did not pay at all, and
then came World War I, which raised the federal budget from $1
billion in 1916 to $19 billion in 1919.
Income tax rates rose three percent on $2,000 and 70
percent on one million dollars.
After the War, Treasury Secretary Andrew Million reduced
the top rate to 25 percent and got most taxpayers off the rolls
by raising the minimum income subject to tax. He also
cooperated with Congress to create preferences, exemptions,
deductions, and other tax breaks. The income tax had gotten the
government deeper into the business of allocating economic
resources, mostly out of public view.
During World War II, as federal spending rose from $9.6
billion in 1940 to $95 billion in 1945, income tax rates were
raised 19 percent on $2,000 and 88 percent on $200,000. The
numbers of taxpayers rose from 14 million to 50 million
Americans.
The World War II tax is the recognizable ancestor of
today's federal income tax.
The Republicans of the 1950s feared voter resentment of the
rich and did not reduce top rates.
In the 1960s, John Fitzgerald Kennedy stimulated the
economy by reducing taxes significantly. The experiment in
maintain the War-time high tax rates during peace time in order
to pay for the Cold War and redistribute money to the middle
class and the poor worked both economically and politically for
a generation, and then it stopped working economically.
In the 1970s, runaway inflation, fueled in part by Lyndon
Johnson's refusal to raise the taxes to pay for the Vietnam War
propelled ordinary families into tax brackets intended for the
rich, while the myriad tax breaks available to the wealthy made
a mockery out of fairness.
As state, local, and other taxes rose, the middle class tax
revolt helped fuel the Reagan Republican victories of the 1980s
and 1994.
Politicians have been struggling ever since to reduce the
income tax rates to peace time levels that the public and the
economy will tolerate.
Quoting the Federalist Papers Number 35, penned in 1788 by
Alexander Hamilton, ``there is no part of the administration of
government that requires extensive information and a thorough
knowledge of the principles of the political economy so much as
the business of taxation. It might be demonstrated that the
most productive system of finance will always be the least
burdensome.''
In just a few days, I have been able to gather signatures
from disgruntled Americans who support the Fair Tax plan. Be it
known that these signatures cross all lines of division in that
they represent ditch diggers to lawyers, truck drivers to
stockbrokers, Black, White, Hispanic and Asians.
To further discern a more accurate consensus of the people,
all you need to do is refer to the petition filed by the people
of Arizona on Thursday, July 2, 1998. One hundred and seventy
thousand Americans required of this Congress to abolish income
tax and establish a national sales tax.
The Fair Tax before you at this time is what the people
want and require of you now.
One thing that amazes me about the national news media has
all but ignored this legislation. The rhetoric we, as
Americans, have been subjected to implies that the wealthy in
this country do not pay taxes, and the tax burden has been
shouldered by the working poor and the middle class.
To this I quote the besieged Commandeer of Bastognne in his
response to the Nazis to surrender in World War II ``Nutz.''
Figures recently released by the National Revue project quiet a
different notion. The quintile of taxpayers from the lowest to
highest is outlined as such:
The lowest wage earners pay--2 percent.
The low 1 percent.
The middle 7 percent.
The high 16 percent.
The highest wage earners 78 percent.
When confronted with the truth of these matters of income
tax, and this Administration's quest for an America steeped in
fairness, it is apparent that we are trying to shoot a game of
pool with a nylon rope.
I would like to thank the members of this Committee for the
opportunity to address you regarding the Fair Tax plan, and
close with another quote from Mr. Alexander Hamilton's
Federalist Papers Number 36.
``It has been asserted that a power of internal taxation in
the national legislature could never be exercised with
advantage, as well as from the want of a sufficient knowledge
of local circumstances, as from as interferences between the
revenue laws of the union and of the particular States. The
supposition of a want of proper knowledge seems to be entirely
destitute of foundation. If any question is depending in a
State legislature respecting one of the counties, which demands
a knowledge of local details, how is it acquired? No doubt from
the information of the members of the county. Cannot the like
knowledge be obtained in the national legislature from the
representatives of each state? And is it not to be presumed
that the men who will generally be sent there will be possessed
of the necessary degree of intelligence to be able to
communicate that information?''
I certainly hope so.
If William Jefferson Clinton so feels the pain of the
American people, let him with unanimous consent of this
Congress and Senate sign the Fair Tax Plan now. I implore you
to preserve our freedom, our liberty, and save this Union by
passing this legislation.
[The prepared statement follows:]
STATEMENT OF STEVEN WORLEY, COLBERT, GEORGIA
America's first income tax began 1861 to pay for the Civil
War. The Union imposed a 3 percent tax on incomes over $800.00
a year, which exempted most wage earners. The tax rate was
raised to 5% in 1862 on incomes over $10,000.00. Shortly after
the Civil War the income tax was repealed, ominously, the
Bureau of Internal Revenue remained in existence. Budget-
balancing statesmen have turned to income tax even in peacetime
to replace revenue lost by import and export duties. That was
the purpose of the income tax passed by congress in 1893 and
ruled unconstitutional by the Supreme Court in 1895. President
Taft pushed a constitutional amendment to revise that decision,
and an income tax was passed as soon as the 16th Amendment was
ratified in 1913 by only 31 states.
The new income tax was a luxury tax. Top rates remained
below 10 percent and most Americans didn't pay at all. Then
came World War I, which raised the federal budget from $1
billion in 1916 to $19 billion in 1919; income tax rates rose
to 3 percent on $2,000 and 70 percent on $1 million. After the
war, Treasury Secretary Andrew Million reduced the top rate to
25 percent and got most taxpayers off the rolls by raising the
minimum income subject to tax. But he also cooperated with the
Congress to create preferences, exemptions, deductions and
other tax breaks. The income tax had gotten the federal
government deeper into the business of allocating economic
resources, mostly out of public view.
During World War II, as federal spending rose from $9.6
billion in 1940 to $95 billion in 1945, income tax rates were
raised 19 percent on $2,000 and 88 percent on $200,000, and the
number of taxpayers arose from 14 million to 50 million.
The World War II tax is the recognizable ancestor of
today's federal income tax. The $500 per dependent exemption of
1944, raised to $600 in 1947, was a generous allowance to the
parents of the baby boom generation. It meant the average
family paid almost no income tax. Over time, inflation eroded
the value of the exemption. The Republican leaders of the
1950's feared voter's resentment of the rich and did not reduce
top rates. In the 1960's, JFK stimulated the economy by
reducing taxes significantly.
The experiment in maintaining the wartime's high tax rates
during peacetime in order to pay for the cold war and
redistribute money to the middle class and poor worked-both
economically and politically-for a generation and then stopped
working economically. In the 70's, runaway inflation, fueled in
part by Lyndon Johnson's refusal to raise taxes to pay for the
Vietnam War, propelled ordinary families into tax brackets
intended for the rich, while the myriad tax breaks available to
the wealthy made a mockery of fairness. As state, local and
other tax rates also rose, a middle-class tax revolt helped
fuel the Reagan Republican victories of the 1980's and 1994.
Politicians have been struggling ever since to reduce income
tax rates to peacetime levels that the public and the economy
will tolerate.
Quoting the Federalist Papers #35 penned in 1788 by
Alexander Hamiliton, ``There is no part of the administration
of government that requires extensive information and a through
knowledge of the principles of political economy, so much as
the business of taxation. It might be demonstrated that the
most productive system of finance will always be the lest
burdensome.''
In a few days, I have been able to gather signatures from
disgruntled American's who support the Fair Tax plan. Be it
known that these signatures cross all lines of division in that
they represent ditch diggers to lawyers, truck divers to
stockbrokers, Black, White, Hispanic, and Asians. To further
discern a more accurate consensus of the people, all you need
do is refer to the petition filed by the people of Arizona. On
Thursday, July 2, 1998, 170,000 Americans required of this
congress to abolish income tax and establish a National Sales
Tax. The Fair Tax Plan before you at this time is what the
people want and require of you now.
One thing that amazes me is that the national news media
has all but ignored this legislation. The rhetoric we as
Americans have been subjected to implies that the wealthy in
this country do not pay taxes, and that the tax burden has been
shouldered by the ``working poor and middle class.'' To this I
quote the besieged Commander of Bastognne in his response to
the Nazis to surrender in World War II ``Nutz.''Figures
recently released by the National Revue project quiet a
different notion. The quintile of taxpayers from lowest to
highest is outlined as such:
Lowest -2%
Low 1%
Middle 7%
High 16%
Highest 78%
When confronted with the truth in these matters of income
tax and this Administrations quest for an America steeped in
fairness, it is apparent that we are trying to shoot a game of
pool with a nylon rope.
I would like to thank the members of this committee for the
opportunity to address you regarding the Fair Tax plan, and
close with another quote from Alexander Hamilton's Federalist
Papers #36:
``It has been asserted that a power of internal taxation in
the national legislature could never be exercised with
advantage, as well from the want of a sufficient knowledge of
local circumstances, as from as interference between the
revenue laws of the union and of the particular States. The
supposition of a want of proper knowledge seems to be entirely
destitute of foundation. If any question is depending in a
States legislature respecting one of the counties, which
demands a knowledge of local details, how is it acquired? No
doubt from the information of the members of the county. cannot
the like knowledge be obtained in the national legislature from
the representatives of each state? And is it not to be presumed
that the men who will generally be sent there will be possessed
of the necessary degree of intelligence to be able to
communicate the information?'' I hope so!
If William Jefferson Clinton so feels the pain of the
American people, let him with unanimous consent to the U.S.
Congress and Senate sign the Fair Tax Plan now. I implore you
to preserve our freedom, our liberty, and Save this Union by
Passing this legislation NOW!!
[The attachment is being retain in Committee files.]
Mr. Crane. Thank you, Mr. Worley. That was a very good
history lesson, too.
Mr. Worley. Thank you, sir.
Mr. Crane. Mr. Moore.
[Pause.]
Mr. Moore?
STATEMENT OF JAMES O. MOORE, SMITHTOWN, NEW YORK
Mr. Moore. Oh!
I am not here to castigate you guys for what you are doing
in Congress. I am here to offer some solutions for the problems
of us taxpayers which I am sure is within the realm of
possibilities of what you fellows do in writing the laws that
govern how we operate in the United States of America.
Good morning, Mr. Chairman. I want to thank you and your
Committee for having this much-needed hearing and for the
privilege of my having the opportunity to offer ways in which
to possibly achieve its stated purpose ``to make taxes fair and
as easy as possible,'' which is an almost universal desire of
every taxpayer in our country.
People with whom some items have been discussed have called
them radical in their diversity, but since there is a
connotation of negativity in it ``extensive changes'' should be
more appropriate.
Our Constitution is generally thought to be possibly the
best document human beings have ever written. One reason had to
do with its intent. freedom for people's self help with minimal
government interference. As President Eisenhower is credited
with having said, a government should do for its people only
those things they cannot do for themselves.
And was based on the fact that our Constitution does not
require government to feed, clothe, house, educate, nor provide
health care for its people. However, ours does so today in some
ways with funds collected from people equitably but too often
unfairly distributed.
Particularly, if not living to receive the benefits paid
for. Two examples: Social Security and Medicare, Monies are
collected equitably in that the same appropriate percentage is
applied to each person up to the same earning limit but only on
wages.
Unfairness is due to the fact that monies paid by a great
many people for promised benefits but who do not live to
receive them but is kept by the government.
In other cases, some of the monies goes to spouse and/or
children meeting some requirements but there is no provision
for any other beneficiary. That is taxation without recompense.
This is my second trip to Washington to testify to a
government entity. The first was an IRS hearing on December the
4th, 1987, at which I proposed changes in IRA withdrawals which
correctly requires withdrawals to commence at age 70-and-a-
half.
As explained in my written statement which has been sent to
you, it enable selective withdrawals if owning two or more IRAs
and eliminate the requirement that custodians make sure
withdrawals were made from each one.
Provisions of Notice 88-38 effected this change and was
signed 12 years ago today, and thus coincidentally I am
celebrating it in the City where it was signed.
Although that trip benefitted a great many people and
custodians, what this Committee intends to do is very much more
important; that it would benefit every citizen in this country
and possibly even non-citizens who pay income tax.
It would change April 15th from a dreaded day to just one
that happens to be the day the easily-done-tax-return is due in
the amount fair assessment has required to be paid.
What a relief. I am absolutely sure it is a doable
government operation provided fair is a must.
Again, thanks for this opportunity to testify and I feel
sure others who testify will have proven same thing I feel is
certain. Fair and easy taxes will come sooner than later.
Income tax is the only way to correctly collect from people
fairly because it is based on one basic fact. ability to pay.
No other tax reaches that commitment.
I have asked two gentlemen to come to see me in a telephone
call to Al Crenshaw yesterday afternoon, and to Howard Gleckman
this morning, because I know them both from my twelve-years-ago
visit to Washington, and they both promised to be here but they
had commitments elsewhere that's made them uncertain as to
whether or not they could.
But anyway, the complete story is told in the statement
that I sent you previously, and originally I was going to bring
with me two other supporting documents. The statement says
there are no enclosures, which was true. However, the staff
told me the two things that I wanted to bring with me to give
to you today they felt it better that I send them to you. So
therefore, those two addendums are also in the package that was
received by you folks from me recently.
Gentlemen, it's up to you. We want fair taxes, properly
assessed, and so simple that the one that I proposed I believe
could be prepared on two 8\1/2\ 11 sheets of paper
with all the instructions necessary and the forms required to
be incorporated in that. And a kid who is in the 4th grade and
knows how to add, multiply, subtract, and divide can do it
without a calculator.
Thank you, very much.
[The prepared statement follows:]
STATEMENT OF JAMES O. MOORE, SMITHTOWN, NEW YORK
Mr. Chairman and the committee members, I am Jim Moore from
Smithtown, New York but born in Birmingham, Alabama 84 years
ago last Wednesday. And as a Financial Planner, the
difficulties of my clients regarding tax returns have served to
make me aware of the need for reforms intended to be achieved
by this committee resulting in both simplification and fairness
in income tax laws. Therefore I am grateful for this
opportunity to offer some suggestions for your consideration
and action which might be analogous to the statement credited
to Mark Twain, ``Everybody talks about the weather but nobody
does anything about it.'' The analogy to you would be almost
everyone COMPLAINS about income taxes but this committee is
proposing to `DO' something about it.'' As a patriotic citizen
concerned about my fellow taxpayers, I want to congratulate
Congressman Archer and this committee for that ``DO SOMETHING''
attitude and attempt!
Although not considering myself to be a tax expert, the
following brief biographical sketch may serve to explain how
this patriotic citizen has developed some suggestions for tax
revision to do what Congressman Archer stated as basis for this
hearings to ``make taxes fair and easy as possible'' and also
to have said ``to examine proposals to replace the current tax
code.'' As I will explain in my summary, I am against
replacement.
My high school diploma was received in 1932 at age 16 from
Lyman Ward Military Academy in Camp Hill, Alabama. My
graduation at age 34 in 1950 from NYU as a night school student
after returning in 1945 from overseas service during WWII and
also have a continuing 60 year connection with the 7th regiment
in New York as first an active member and then in its Veterans
Association including seven years on its Governing Board and a
44 year working career, the last 37 with a large international
oil company before retirement in preparation for an active
retirement in that field of endeavor.
Activity as a Financial Planner made me greatly aware of
the need for revisions to provide the ``fair and easy'' income
tax laws called for by the Congressman Archer. One such needed
change had to do with IRS regulations for the requirement that
persons who are owners of IRA's must commence withdrawals upon
reaching age 70 \1/2\ in which I concur but did NOT agree that
those with multiple IRA's had to withdraw from each of them.
Therefore, at an IRS hearing on December 4, 1987, with support
from ICI, AARP, ACLI, Senator D'Amato, Congressman Carney and
mutual fund companies, etc. I proposed that investors could
aggregate their value and based on age, determine total
required to be withdrawn and then make withdrawal from one or
more to maintain the best investment resulting balance. The IRS
Notice 88-38 issued on April 12, 1988 effected that procedure.
And, the 100% vote of congress eliminating the $1 penalty
reduction of Social Security for wage earners would have been a
non-starter if my suggested tax revisions had been in effect as
set forth in the following summary:
SUMMARY:
The varied tax problems of my Financial Planning clients
gave me a much broader knowledge of intricacies of the tax laws
than I would have gotten in just preparing my own tax returns.
That resulted in proposed revisions set forth in the below
verbatim copy of the statement I made at the tax hearing of
Congressman Carney and Senator D'Amato on September 5, 1985.
The notes thereon show the continuing effort to get public and
then hoped for Congressional interest in effecting the much
needed revisions of personal tax laws. Although affecting
businesses, problems of its taxation are not addressed. Its
monetary items must be increased to reflect inflation over the
last 15 years to get to their equivalents of 1985 amounts.
Statement for tax hearing of Congressman Carney and Senator D'Amato at
Ward Melville High School, Setauket, NY on thursday, September 5,
1985--by James O. Moore, Smithtown, NY
My name is Jim Moore from Smithtown and I am on Social
Security. (Will be 70 on April 5 next year).
Almost everyone agrees (1) the current Tax System is ridled
with inequities that favor special interests (2) is so
voluminous and confusing that experts in the IRS sometimes give
different rulings on he same question and (3) now feel tax
simplification is essential.
Many tax simplification proposals are being considered.
Some include proposals that are anathema to Elected Officials
and Legislators of this State. Understably, they want to comply
with the wishes of their Constituents BUT, when Legislators are
Congressmen and Senators, they have a HIGHER duty to Legislate
for the whole country even to the extent of voting for programs
that are good for the country but not liked by local
Constituents!!
With this as basis for your decisions in House and Senate
on Tax simplification, herewith is a program for personal tax
returns on a basis that treats EVERYONE equally and fairly. The
proposed exemptions and tax rates may require adjustments to
assure they are revenue neutral and do not RAISE taxes in
totality.
First: all income received would be repotable including
social security, SSI, Welfare (including value of housing
allowance and clothing) but payments from social security would
not be reportable until all contributions by individual and
spouse have been recovered. Cola's would be included at full
rate and the special social security calculations would be
eliminated. Municipal bond interest, capital gains, tax
shelters, etc. would be reportable fully as income. however,
income credited but not withdrawn would not be reported until
withdrawn as is now done with IRA accounts return of principal,
of course, would not be reportable. This would apply to savings
accounts, mutual funds, cash and stock dividends held in
brokerage accounts etc etc.
Second: no deductions for anything!!!! including
contributions to religious & charitable groups, interest,
taxes, etc etc.
Third: states should eliminate sales tax on any item
costing less than $25, and neither they nor the Federal
government should consider value added tax as it is the most
harmful to the poor.
Fourth: eliminate all tax shelters, (not just those the
administration deem bad) so that economic viability rather than
tax advantages would be basis for investments.
Fifth: family income should be basis for personal
exemptions and currently suggest $5,000 for first. $4,000.
Second, $3,000. Third and $2,000. All others. A family of four
would pay no tax until income exceeded $14,000. approximating
current poverty income level. A suggested flat 20% rate or
better still, graduated scale of 10 to 40% might be used or
whatever is needed to give a revenue neutral income. Social
security taxes may also require adjustment. But, in order to
have everyone contribute to this great country for the
privelege of living here, assess \1/2\ of 1% on gross income so
that the family of four would pay $70, on its $14,000.
Exemption. This would be returned to the states from which
taxpayer files his return to offset no sales tax on $25.00.
This is an eminently fair and even handed program which
should eliminate the feeling that ``That guy makes X number of
dollars and pays no taxes. Why should I pay so much?'' Also, it
would end confusion on tax laws, reduce the volume upon volume
of tax laws; Myriads of pamphlets, files and paperwork, cut irs
staff considerably and save money for government, business and
individuals in the multi-millions of dollars. I believe such a
program would be welcomed by all taxpayers and businesses
except those whose livelihood depends on the present unfair
system!!!!
Note: Subsequent to this statement, a 6-5-86 letter to 8
people (Congressmen, Senators & Pres. Reagan) added provision
for a $5,000 allowance for fringe benefits. Thus any amount
paid by employers for pensions, INS, etc. would be reported on
W-2's BUT only any amount in excess of $5,000 allowance would
be taxable income. However, if amount paid by employer is less
than $5,000 or none at all, the taxpayer could purchase
protection desired or invest in IRA's etc. and deduct up to
$5,000 on tax return. Senator Bradley's 10-9-86 reply called
this an ``intriguing idea!!!'' Seniors could apply this against
medical expense as well as insurance premiums.
Added in 1994: If health care revisions provide for
deductibility of health care costs, they would be eliminated
from fringe benefits allowances for everyone not just seniors.
The first note refers to a 6-5-86 letter to 8 addresses on
adding fringe benefits deduction and the ``added in 1994'' item
on Health care relates to my 8-25-94 article on ``Declaration
of Independence from Socialized Medicine'' printed in local
Smithtown Messenger. It proposed 100% deductibility of medical
expenses, including health insurance premium less reimbursement
by the insurance company for claims. Then in 1999, I offered
some ideas to economic Security 2000 to be discussed at its
January Forum in D.C. but suggested tax revisions would solve
some of the problems of Social Security for which forum was
being held.
Referring only to items in the 9-5-85 statement, everyone
with whom I have discussed items therein have agreed they WOULD
provide the fairness intended but said IMPOSSIBLE!! Why?
Because they felt politicians would not agree to them and said
the effort was as useless as Don Quixote jousting at windmills.
I have never felt that way. Instead, I believe such revisions
ARE possible, and like the Lone Ranger, want to help people in
distress. Taxpayers?
My optimism is based on the fact that the IRS amended its
regulations on IRA withdrawals as covered above while I was
continuing this now 15 year effort at tax revision.
In connection with the vexing tax problem, I have recently
initiated an effort towards formalization of an organization to
be called COFEHATT, which is the acronym for ``Citizens
Organization For Equitable Health and Tax Treatment.'' However,
we intend to go one step further than ``equitable'' which can
apply by treating everyone the same at inception but be UNFAIR
in distribution. Thus, our additional requirement is ``FAIR.''
Implementing the suggested revisions, while keeping the laws
FAIR, the biggest benefit is the simplification which enables
everyone to prepare tax returns perhaps by IRS using the
equivalent of two 11 by 8 \1/2\ sheets of paper to explain and
provide form on which to prepare the return.
It is our view that the ability to pay is the only
criterion on which to base taxes and that ability is predicated
on income which should be generic and include in it every
source which would be wages, commissions, profit from self-
employment, profit from sale of material assets or securities,
dividends on investments and interest on savings and finally
ALL bonds whether commercial or municipal.
We feel absolutely sure that neither a FLAT nor National
Sales Tax is fair. If we are wrong, please let us know since we
do NOT want COFEHATT to provide erroneous information and lose
our credibility. The flat and sales tax could be instantaneous
but our proposal cannot be done in one ``fell swoop''
prohibited by contractual termination dates and some must be
put into effect incrementally or they would be calamitous
disaster to our economy.
If the committees's review of proposals received from all
participants in this hearing finds ours to be FAIR, we hope
some of our suggestions will be incorporated in laws that will
provide the intended benefits to ALL OF US.
However, should any proposal be either NOT ``doable'' for
reasons other than fairness or NOT considered fair we would
also appreciate being advised accordingly just as we hope for
your opinion regarding our position on FLAT and NATIONAL SALES
TAX.
It has been gratifying to make a second trip to Washington
on thus two matters so important to every citizen and also even
to every non-citizen taxpayer and much appreciated.
My thanks to your staff as well for ``squeezing me in''
after initially being told there was no vacancy.
Our is a wonderful country and I am proud to have served it
militarily and as a contributor to some degree in other ways.
[The attachments are being retained in the committee
files.]
Mr. Collins: [presiding] And thank you, Mr. Moore. You can
be assured that your full statement and any other accompanying
documents that you have presented will be entered into the
record.
Mr. Hulshof, do you have any questions, please?
Mr. Hulshof. Thank you, Mr. Chairman.
Let me first extend my appreciation, Mr. Worley and Mr.
Moore, for your efforts in being here today.
Mr. Worley I think you, if I am not mistaken, were here
through the entirety of yesterday's hearing as well.
Mr. Worley. Yes, sir.
Mr. Hulshof. I noticed you probably had better attendance
than many of us did, but I appreciate the fact. Just as a
general point, let me say that even as we are here discussing
fundamental tax reform, that elsewhere on the Capitol grounds
about 10,000 American citizens are gathered to express their
viewpoints about certain matters that Congress will be taking
up.
It just reminds me again of what an awesome thing that we
have, a representative form of government, that citizens are
allowed to come before a Committee such as this, or to stand on
the steps of the United States Capitol and to express their
opinion freely.
Whether it means petitions, Mr. Worley, as you have
submitted for us and gathered here, I think again it is just an
extraordinary testament to the type of government that we have.
Let me say--and, Mr. Worley, I am going to ask you a couple
of questions because there was something in your written
testimony, and as you mentioned it today, that really struck
me.
You pointed out that one thing that amazes you, as it does
me, is that some that report the news nationally have not
really given a full focus of attention as we are of these
series of hearings.
In fact, let me just quote you again because I think it
bears repeating.
``The rhetoric''--and this is you writing, I assume?
Mr. Worley. ``The rhetoric we as Americans have been
subjected to implies that the wealthy in this country do not
pay taxes and the tax burden has been shouldered by the working
poor and middle class'' to which you paraphrased the word
``nutz.''
Let me ask you about that. Because we have had a variety of
different opinions already over this day-and-a-half talking
about, for instance, whether we should have the fair tax as you
support, Mr. Worley.
We have had flat tax proponents. I suspect Congressman
Armey will be here to talk about that.
Mr. Moore, as I understand it from your testimony you do
not support a national sales tax or a flat tax, but a different
type of tax. I know my colleague, Mr. English, has got his
idea.
Again I think it is useful that we debate and discuss these
things. One thing that is frustrating for me especially, Mr.
Worley, being on this Committee, having the honor of serving on
this Committee, is the rhetoric that seems to percolate among
other Members, that if we try to provide tax relief, for
instance, we are ``giving tax breaks to the wealthy,'' when in
fact we may be trying to simplify the tax code.
Can you give us any guidance as a--and I do not mean this
in a derogatory term--but as a common, ordinary citizen who
watches what we do, how do we pierce that rhetoric so that we
can have an honest discussion about the best policy?
Mr. Worley. If I knew that, I would probably be the
President of this Nation.
I do not see, without a grassroots organization, or just by
citizens like myself stepping forward and talking to other
citizens, and saying this is what is going on and this is what
we can do if we will take it upon ourselves to do that. I do
not know that the national news media is going to give us any
kind of regard in this.
I do not know what we could do to cause them to do this
other than a revolt. Now that certainly, if a million Americans
came to the Halls of this Congress and said we demand tax
reform, it would certainly gather some sort of attention from
the national news media.
Mr. Hulshof. Let me ask you, how did you first get
involved, or have your interest peaked by this piqued by this
and the fact that you would try to collect signatures on a
petition, and then come from Georgia, or your home to come to
the Halls of Congress?
I mean what has motivated you to become an activist in this
area?
Mr. Worley. As an American Citizen, I have been abused by
the Internal Revenue Service. I purposely left out my personal
problems with them from this because I did not want to make it
just a personal matter.
My personal problems with the Internal Revenue Service are
neither here nor there. This is a total problem throughout the
country and it affects every American. And we have got to do
something.
If you have a car and it breaks down, you fix it. Well we
have been fixing our problem with the Internal Revenue Service
and our taxation of income for years now, and we are still
broken.
So maybe it is time that we junk the old car and go buy a
new one.
Mr. Hulshof. Well again I see my time is up. The red light
is on. Let me just again--and I see Mr. Davis has also joined
us here with the panel. But let me just again express my
appreciation that each of you would take the time, and probably
at your own expense, too, to come here to help enlist our
support on these various different ideas of the way we collect
revenue in this country.
Again, I think it is just testament to the type of Nation
that we have that you would have the opportunity to come here
and have your voices heard.
So thank you for that.
Mr. Worley. Thank you.
Mr. Moore. Thank you.
Mr. Collins. Thank you, Mr. Hulshof.
I know Chairman Archer will be back in just a few moments,
but I wanted to take the time and the opportunity to extend my
appreciation to Mr. Worley, being a fellow Georgian, for coming
and bringing a lot of common sense with him to address this
Committee, and also the list of names who signed your
petitions.
And I am sure if you had more time and had travelled a lot
more throughout Georgia you would have had a stack that would
have been much, much taller because I hear about this quite
often as I am travelling throughout the Third District of
Georgia, which goes from Clayton County down to Muskogee
County, which you are very familiar with.
I also understand from your opening that you are in the
concrete business?
Mr. Worley. Yes, sir.
Mr. Collins. And you have had 18 years of experience in the
ready-mix concrete business. And having pushed many a
wheelbarrow of concrete and finished some myself, too, I
appreciate the work and the hard work that you have endured.
We will take Mr. Davis' testimony at this time, and Mr.
Chairman will be back very shortly.
Mr. Davis?
STATEMENT OF FRANK L. DAVIS, JR., ALEXANDRIA, VIRGINIA
Mr. Davis. Thank you, Mr. Chairman.
Mr. Chairman, Members of the Committee, my fellow
Americans:
It is a privilege to be asked to testify this morning. My
name is Frank Davis. I am a retired Naval Reserve Aviator,
having spent 28-and-a-half years in Active and Reserve Service
to my country.
I consider myself still serving, albeit in a somewhat
different capacity, but with the same goal in mind. Protect my
country from all enemies foreign and domestic.
As you might expect, I consider that the duty of every
citizen.
I am co-founder and Executive Vice President and National
Director of Legislative Affairs for the National Retail Sales
Tax Alliance.
The National Retail Sales Tax Alliance is a nonpartisan,
nonprofit, grassroots organization working to replace the
federal tax system with a National Retail Sales Tax and abolish
the Internal Revenue Service.
I cannot think of a more fitting goal in life than to
bequeath my country, my children, and my grandchildren a free
society without an income tax and without an IRS.
I am a citizen activist. I speak as a very concerned
private citizen. My remarks reflect both my own thinking in
this matter and the advice and counsel of countless thousands
of American citizens who are likewise concerned about the ship
of state.
For example, the Internet has proven very helpful to the
National Retail Sales Tax Movement and tax reform in general.
FReeRepublic.com is an especially helpful site for keeping
a pulse on the American public with respect to fundamental tax
reform.
A number of prominent public servants have provided
outspoken leadership for the National Retail Sales Tax tax
reform movement and are noted in my extended remarks.
I want to personally thank you, Chairman Archer, for your
foresight and leadership these past five years. Notice, if you
will, ladies and gentlemen, that this is a bipartisan movement.
It is not about partisanship. It is about doing what is right
for America.
In addition, articles published in influential opinion
journals have contributed to the dialogue. I highly recommend
Dr. Allen Keyes' article ``The Case For Repealing The 16th
Amendment To The United States Constitution. Abolish The Income
Tax!'' published in Human Events Magazine on April the 17th,
1998.
I also commend to the Committee the testimony for the
record of Mr. Charles Adams, Historian.
A number of well-known organizations are invaluable in our
work and are noted in my extended remarks.
The National Retail Sales Tax Alliance supports both H.R.
2001 and H.R. 2525. We know that neither bill will pass in its
present form. We also know that there may well be additional
NRST bills added to the mix and that there will be provisions
added and subtracted until such time as the Committee has
reached consensus and a measure goes to the Floor of the House.
My promise to all Americans, to you Mr. Chairman, to the
Committee and the Congress and to all interested parties is
this:
The National Retail Sales Tax Alliance will work to ensure
that America gets a modern, national retail sales tax system
which will meet America's needs for the 21st Century and
beyond.
Mr. Chairman, there are at least three fundamental reasons
why the Income Tax System must be replaced with a national
retail sales tax:
Freedom.
Economic Growth.
And a quality of treatment under the law.
America is the only nation in world history whose founding
was based on the notion that certain unalienable rights are
handed down from God to the People and then are loaned to
government.
Since the dawn of man, governments have claimed that rights
are handed down from God to government, the Divine Rights of
Kings, and then loaned to the people. And this is a very
important distinction.
To the degree that America has become the great Nation is
it today and has the capacity to even become greater, the
concept of a citizen's unalienable rights is very important.
This concept differentiates the United States from every other
country in the world. Every U.S. Citizen's unalienable rights
are guaranteed by our Founding Fathers in the Declaration of
Independence and the Constitution.
Why then does the United States have a tax system which
severely restricts its citizens' Constitutional rights,
artificially limits their ability to work, save, and invest and
exacerbates class warfare by dividing them one from the other
on the basis of types and amounts of income?
These perverse disincentives to succeed and resultant
lower-than-it-should-be U.S. economic growth in recent years
are fueled by our oppressive Income Tax Code.
It defies comprehension.
The United States of America has a Tax Code based on the
19th Century Marxist class warfare notion of ``from each
according to their ability, to each according to their need.''
Do we really want to begin the 21st Century with a tax
system based on class envy and warfare? Which punishes those
who work, save, and invest and rewards those who do not?
Do we want to retain a tax system that annually invades our
privacy and usurps our Constitutional rights?
Or do we truly want to be free people?
Mr. Chairman, I would submit that we can never be a truly
free society so long as we allow the income tax and the
Internal Revenue Service to exist.
If we are to restore to American Citizens those freedoms
guaranteed by the Constitution, we must replace the federal tax
system with a national retail sales tax and, in the process,
abolish the Internal Revenue Service.
And while we are at it, we must also repeal the 16th
Amendment to the Constitution to complete the tax reform
process and to ensure that America will never have to suffer
another tax.
Dr. Keyes refers to the income tax as a slave tax
inherently incompatible with freedom. Abolishing it is
therefore not just economically feasible; it is a moral
imperative if we are to meet our obligations to bequeath
liberty to future generations.
Mr. Collins. Mr. Davis?
Mr. Davis. Yes.
Mr. Collins. I hate to interrupt you, but your entire
statement will be entered into the record. You have kind of
exceeded your time already, but we will give you about another
minute to wrap it up if you could, please.
Mr. Davis. Well let me go straight to a letter that I have,
an anonymous letter, which will take about a minute to read
that was sent to me:
Dear Friends and Buddies,
Most of you know that one of my most treasured beliefs is
that we are a free people. I am deeply saddened that every day
we lose more of those freedoms as the government usurps them in
the name of protecting us from ourselves.
Our current tax code is extremely damaging in that it
punishes success--the very thing this country was founded on
and so many lives were lost over--and it requires disclosure of
every aspect of our lives for public consumption.
My spirit is personally so broken by this that, after doing
our taxes, I realize I am chipping my--and she said it in
French--joy of life; I can't pronounce it--and very life away
and have become enslaved by the government.
I have decided to end it.
I am selling our business and will not continue to
contribute to this folly. It was a grim realization. Although
we have a lot to contribute to this country and its future with
our technology information and teaching, it is not worth the
payback anymore.
I give up.
The American dream has vanished. I am joining the ranks of
the crushed in spirit, the squashed, the oppressed. And yes, if
you are wondering, I am depressed about the whole thing. A good
cry sometimes helps, but that has been way too common of late.
And in a short note to Mr. Archer:
``Please record my support FOR the National Retail Sales
Tax to replace the tax code in this country. We must abolish
the oppressive tax code and REPLACE it. The FLAT TAX does not
accomplish replacement of the complexities of the code; it
merely masks them and simplifies computations. Therefore I urge
you to please support the FAIR TAX/National Retail Sales Tax.
``I also urge you to abolish the illegal agency known as
the IRS.''
I will close with that.
Thank you, Mr. Chairman. Thank you, Members of Congress,
for your time.
[The prepared statement follows:]
STATEMENT OF FRANK L. DAVIS, JR., ALEXANDRIA, VIRGINIA
Mr. Chairman, Mr. Rangel and Members of the Committee; my
fellow Americans. It is a privilege to be asked to testify this
afternoon. My name is Frank Davis. I am a retired Naval Reserve
Aviator, having spent 28 = years in active and reserve service
to my country. I consider myself still serving, albeit in a
somewhat different capacity, but with the same goal in mind:
protect my country from all enemies, foreign and domestic. As
you might expect, I consider that the duty of every citizen.
I am a co-founder and the Executive Vice President and
National Director of Legislative Affairs for the National
Retail Sales Tax Alliance. The National Retail Sales Tax
Alliance is a nonpartisan, non-profit grass roots organization
working with like-minded individuals, think tanks, other public
interest advocacy groups and businesses to replace the federal
tax system with a National Retail Sales Tax (NRSTA) and abolish
the Internal Revenue Service.
I cannot think of a more fitting goal in life than to
bequeath my country, my children and my grandchildren a free
society without an income tax and without an IRS.
I am a citizen activist. In my testimony today, I will
relate to the committee the viewpoint of a very concerned
private citizen. My testimony reflects both my own thinking in
this matter, and the advice and counsel of countless thousands
of American citizens, who are likewise concerned about the ship
of state.
For example, the Internet has proven very helpful to the
NRST movement; we are able to mine a rich field of pertinent
research, communicate with and share opinions with expert
economists and political scientists and more important, find
each other. In this regard, FReeRepublic.com is an especially
helpful site for keeping a pulse on the American public with
respect to fundamental tax reform.
A number of prominent public servants have provided
outspoken leadership for the NRST tax reform movement. I want
to personally thank you, Chairman Archer, for your foresight
and leadership these past five years. Also, now retired
Congressman Dan Schaefer, who was the primary sponsor of the
first NRST legislation introduced on March 7, 1996. Senator
Richard Lugar has long been an advocate of the NRST. In the
present Congress, leaders such as Congressmen. W.J. ``Billy''
Tauzin, Jim Traficant, John Linder and Colin Peterson, along
with the cosponsors of their respective Bills, are to be
congratulated. Congressmen Largent and Cox also deserve
recognition for their efforts in tax reform.
Notice, if you will, that this is a bipartisan movement. It
is not about partisanship, it is about doing what is right for
America.
In addition, articles published in influential opinion
journals have contributed to the dialogue. I highly recommend
Dr. Alan Keyes' article, The Case for Repealing the 16th
Amendment Abolish the Income Tax! published in Human Events
magazine on April 17, 1998.\1\
---------------------------------------------------------------------------
\1\ Dr. Alan Keyes. The Case for Repealing the 16th Amendment.
Abolish the Income Tax! Human Events, April 17, 1998.
---------------------------------------------------------------------------
Well known organizations such as The Americans For Fair
Taxation, the Tax Foundation, the Tax Education Association,
Heritage, the CATO Institute, The Argus Group, Citizens for an
Alternative Tax System, Citizens for a Sound Economy, and the
National Taxpayers Union have proven to be invaluable in our
work. And there are others.
Curiously enough, the article that constitutes my
``defining moment'' in respect of fundamental tax reform was
also published on April 17th--in 1991. Pat Buchanan's
nationally syndicated column that day was entitled ``A tax
whose time has gone?'' \2\ That is the day I became a tax
reform citizen activist. Mr. Buchanan has since published two
more articles favorable to the National Retail Sales Tax.\3\
---------------------------------------------------------------------------
\2\ Patrick Buchanan, ``A tax whose time has gone?,'' Tribune Media
Services, April 17, 1991.
\3\ Patrick Buchanan, ``Brave new world: no tax forms, no IRS,''
Tribune Media Services, April 15, 1994; Patrick Buchanan, ``Sales tax
alternative,'' The Washington Times, July 14, 1997, p. A12.
---------------------------------------------------------------------------
A quick word about the National Retail Sales Tax Alliance.
NRSTA does not support either H.R. 2001 or H.R. 2525; we
support both bills. We know that neither bill will pass in its
present form. We also know that there may well be additional
NRST bills added to the mix, and that there will be provisions
added and subtracted until such time as the Committee has
reached consensus and the measure goes to the floor of the
House.
Our promise to all Americans, to you, Mr. Chairman, to the
Committee and to all interested parties is this: The National
Retail Sales Tax Alliance will work to ensure that America gets
a modern National Retail Sales Tax system which will meet
America's needs for the 21st Century and beyond.
Mr. Chairman, there are at least three fundamental reasons
why the income tax system must be replaced with a National
Retail Sales Tax: freedom, economic growth and equality of
treatment under the law.
America is the most envied nation in the world. Not only
are we envied by the world's governments, we are envied by the
world's people. America is the only nation in the history of
the world whose founding was based on the notion that certain
unalienable rights are handed down from God to the people, and
then are loaned to government. Since the dawn of man,
governments have claimed that rights are handed down from God
to government [Divine Right of Kings] and then loaned to the
people, a very important distinction.
How important? To the degree that America has become the
great nation it is today, and has the capacity to become an
even greater nation, the concept of a citizen's unalienable
rights is very important to keep in mind as we consider
fundamental tax reform. This concept differentiates the United
States from every other country in the world. Every U.S.
citizen's unalienable rights are guaranteed by our founding
fathers in the Declaration of Independence and the
Constitution.
Why, then, does the United States have a tax system which
severely restricts its citizen's Constitutional rights,
artificially limits their ability to work, save and invest and
exacerbates class warfare by dividing them one from the other
on the basis of types and amounts of income?
These perverse disincentives to succeed, and the resultant
lower (than it should be) U.S. economic growth in recent years,
are fueled by our oppressive income tax code. It defies
comprehension--the United States of America has a tax code
based on the Nineteenth Century Marxist class warfare notion of
``from each according to their ability, to each according to
their need.'' Do we really want to begin the 21st Century with
a tax system based on class envy and warfare, which punishes
those who work, save and invest and rewards those who don't? Do
we want a tax system that annually invades our privacy and
usurps our Constitutional Rights? Or do we truly want to be a
free people?
We can never be a truly free society so long as we allow
the income tax and the IRS to exist.
If we are to restore to American citizens those freedoms
guaranteed by the Constitution, we must replace the federal tax
system with a National Retail Sales Tax (NRST), and in the
process abolish the Internal Revenue Service. While we are at
it, we must also repeal the 16th Amendment to the Constitution
to ensure complete tax reform and to ensure that America will
never have to suffer another income tax.
Dr. Keyes refers to the income tax as a. . . ``slave tax--
inherently incompatible with freedom. Abolishing it is
therefore not just economically feasible, it is a moral
imperative if we are to meet our obligation to bequeath liberty
to future generations.'' \4\
---------------------------------------------------------------------------
\4\ Keyes, op. cit.
---------------------------------------------------------------------------
Under the NRST, Americans would no longer have to annually
divulge to a faceless bureaucrat their most private and
personal financial information. How much money an American
earns becomes his or her own private business. Taxes will be
paid on the basis of how much a person ``takes out'' of the
economy rather than how much a person earns. Under the NRST,
those who consume the most, will pay the most in taxes. All
Americans will be encouraged to work, save and invest, and
government interference in their personal economic activities
will cease. That, my fellow Americans, is Freedom.
The next question before us is: Why does the United States
have a tax system that discourages and penalizes those
activities which grow the economy?
The progressive income tax system punishes those personal
and business activities that encourage economic growth. The
more a person works, saves and invests, the higher his or her
taxes become. Likewise, the more successful his or her
business, the higher his or her tax bill (which is passed along
to the consumer in the form of higher retail prices).
And there is the matter of hidden taxes and compliance
costs in the business income tax. The current tax system holds
both people and business back, rather than encouraging them to
move forward and become even more successful.
The change to a National Retail Sales Tax will cause (and
these are very conservative estimates) the Gross Domestic
Product rate of growth to double and the national personal
savings rate will triple.\5\ America will become the investment
``sponge'' of the world--attracting billions of dollars
invested elsewhere, further expanding the investment pool of
capital available for business expansion and job growth.
Interest rates will decline by 2 basis points, making it easier
and less expensive for business to borrow money for growth and
expansion and for individuals to qualify for home loans and
other big ticket items.\6\ The NRST will eliminate compliance
costs for individuals and reduce business compliance costs by a
factor of 90%. \7\ And, those who chose to participate in the
underground economy will pay taxes at the check out counter,
just like everyone else.
---------------------------------------------------------------------------
\5\ Laurence J. Kotlikoff, ``The Economic Impact of Replacing
Federal Income Taxes with a Sales Tax,'' CATO Policy Analysis No. 193,
April 15, 1993.
\6\ Americans for Fair Taxation Policy Paper, ``The Impact of a
National Retail Sales Tax on Interest Rates,'' April 21, 1997.
\7\ Tax Foundation Special Brief, ``Compliance Costs of Alternative
Tax Systems II, House Ways and Means Committee Testimony,'' March,
1997, pp 8, 9.
---------------------------------------------------------------------------
And the economic benefits of a switch to the National
Retail Sales Tax do not stop with these gains. Picture even
lower unemployment, more and better jobs for people willing to
work, higher wages, and more robust export markets.
In respect of exports, let me say that the recent WTO
ruling declaring the Foreign Sales Credit provision of the
current tax code illegal presents a challenge to America that
the National Retail Sales Tax handles very well. The National
Retail Sales Tax is a territorial border adjustable tax;
meaning it is not applied to exported goods and is applied to
goods imported for sale in America. The NRST is legal under the
terms of the WTO. The NRST levels the playing field between
domestic and foreign companies in respect of tax policy--it
treats them exactly the same.
The NRST, when implemented, will cause America, in your own
words, Mr. Chairman, to become ``the economic juggernaut of the
world.'' \8\ Foreign capital will flow into America and
expatriated capital will return to America. As you know, with a
NRST, jobs and companies that have ``gone offshore'' will
relocate to America. Foreign businesses will locate new
facilities here. In your words, Mr. Chairman, the NRST will
``allow our nation and its people to soar to unparalleled
prosperity in the next century.'' \9\
---------------------------------------------------------------------------
\8\ Rep. Bill Archer (R-TX), Chairman, House Ways and Means
Committee, ``Opening Statement of Chairman Archer Fundamental Tax
Reform Hearing,'' June 6, 1995.
\9\ Ibid.
---------------------------------------------------------------------------
The final point I'd like to make is that America's founding
fathers guaranteed that the Rule of Law (as opposed to the Rule
of Man--the ``Divine Right of Kings''--prevalent throughout the
world prior to America's founding) would apply in America. The
phrase ``Equal Justice Under the Law.'' is chiseled in granite
over the entrance to the Supreme Court Building, reminding us
of the absolute importance of this founding principle.
The progressive income tax makes a mockery of the Rule of
Law. The Rule of Law provides for equality of treatment before
the bar of justice. We are violating one of America's basic
founding principles by continuing to keep a progressive income
tax system in place.
The progressive income tax system, which divides us into
economic classes for the purpose of levying taxes, is
conceptually wrong and at its core, un-American. You will
recall that the founders were opposed to income taxes, and
insisted that the country finance itself through excise taxes
and tariffs.
In 1913 the 16th Amendment to the U.S. Constitution, the
single worst piece of legislation ever passed by any Congress,
was adopted. It fundamentally altered the relationship of the
American people and their government, as the founders in their
infinite wisdom knew would happen. The government became the
master, and the people became the slave. Dr. Keyes addresses
his remarks about the morality of the slave tax to this very
point.
But it got worse. The instigators of the first legal U.S.
income tax could have adopted a flat rate income tax, but they
chose a different course and thereby changed the American
political landscape. They accepted the second plank of the
Communist Manifesto as the core principle of the U.S. tax
system in 1913, and adopted a progressive rate income tax
system. Thus, the progressive income tax system, with its built
in appeal to those who practice the art of divide and conquer
by encouraging class warfare became institutionalized in
America. The progressive income tax intentionally pits
Americans of different economic classes one against the
another, and is used by demagogues for their own political
gain.
How can America enter the 21st Century with a 19th Century
Marxist tax system in place? And why would we want to?
Eighty seven years of tinkering has produced an unknowable
tax code full of social engineering experiments. This social
engineering has served only to make the code more complex and
further disunite the American citizens. Tax policy should be
focused on raising the funds necessary to operate government,
not as a laboratory to ``fix'' this or that perceived social
problem.
Americans are the most generous people on the face of the
earth; social programs that we agree upon (within
Constitutional bounds, of course) should be funded from the
spending side of the federal ledger, not the taxing side.
As we are guaranteed equality of treatment before the bar
of justice, all Americans must be guaranteed equality of
treatment before the bar of economic justice. The best way to
do that and to put an end to class warfare is to tax
consumption, not earnings. With, and only with a consumption
tax such as a single rate National Retail Sales tax, can we
Americans be guaranteed equality of treatment under economic
law.
I call upon the Congress to eliminate the social
engineering in the tax code by adopting the National Retail
Sales Tax. With the NRST, the economic class warfare that has
so divided this country over the past 87 years will eventually
go away--everyone will be working, saving and investing and we
won't have time to be envious of ``the Joneses.''
Americans believe that all men are created equal by their
Creator, and have an unalienable right to be treated equally by
their government. The progressive income tax violates that
fundamental principle.
Mr. Chairman, we are all stakeholders in America. As such,
we should be enjoying equality of treatment under the law. As I
have gone to great lengths to point out, we are not.
The NRST, because it is applied uniformly and taxes
everyone at the same rate, will be a constant reminder to each
of us that we are a stakeholder, and that taking an interest in
the affairs of this nation is an important duty of citizenship.
By demolishing the myth that there is a ``Free lunch,'' the
National Retail Sales Tax can become a unifying theme for all
Americans.
Accordingly, I call for all Americans to unite, to come
together and demand of our elected officials that the income
tax system be replaced with a simple, fair, flat National
Retail Sales Tax and that the IRS be abolished.
Mr. Chairman, I have in my possession (Appendix 1) an
eloquent message from a taxpayer, who prefers to remain
anonymous, that neatly sums up the frustrations millions of
Americans have about our tax and regulatory system. I would
like to read it for the record.
America will never be a truly free society so long as we
allow the income tax and the IRS to exist. America will never
realize its true economic potential so long as we allow the
income tax and the IRS to exist. Americans will never be
treated with equality so long as we allow the income tax and
the IRS to exist.
What better way to restore Americans' Constitutional
freedoms, invigorate America's economy through more robust
economic growth and ensure that every American is treated with
equality?
Isn't that what our Grand Vision of America is? One Nation,
under God, with liberty and justice for all?
Thank you, Mr. Chairman for allowing me to testify.
Dear Friends and Buddies,
Most of you know that one of my most treasured beliefs is
that we are a free people. I am deeply saddened that every day
we lose more of those freedoms as the government usurps them in
the name of protecting us from ourselves. Our current tax code
is extremely damaging in that it punishes success (the very
thing this country was founded on and so many lives were lost
over) and it requires disclosure of every aspect of our lives
for public consumption.
My spirit is personally so broken by this, that after doing
our taxes I realize I am chipping my [joy of life] and very
life away and have become enslaved by the government. I have
decided to end it.
I am selling our business and I will not continue to
contribute to this folly. It was a grim realization. Although
we have a lot to contribute to this country and its future with
our technologoy info and teaching, it is not worth the payback
anymore. The exhaustion of teaching, the aching legs and feet,
the sleepless nights waking up with leg pains after teaching
all day, the stress of it, the technology ``Keep-up'' issues
have all mounted too high unless there is big bucks in it.
Running our own business has meant learning too much about
regulations, forms, accounting etc. and handing over in excess
of 63% of our earnings. And that is before property and gas and
sales tax, let alone how to finance retirement and pay for
college and all that.
I give up. The American Dream has vanished. I am joining
the ranks of the crushed in spirit, the squashed, the
oppressed. And yes, if you were wondering, I am depressed about
the whole thing. A good cry sometimes helps, but that has been
way too common of late. Oh well.
[The following is a personal letter to the Committee, from
the same taxpayer]
To the House Committee on Ways and Means:
Please record my support FOR the National Retail Sales Tax
to replace the tax code in this country. We must abolish the
oppressive tax code and REPLACE it. The FLAT TAX does not
accomplish replacement of the complexities of the code; it
merely masks them and simplifies computations. Therefore I urge
you to please support the FAIR TAX/National Retail Sales Tax.
I also urge you to abolish the illegal agency known as the
IRS. It was not properly established according to our
constitution and has powers way beyond those ever envisioned by
our forefathers. The IRS simply MUST be eliminated, as everyone
in good conscience must admit.
May this committee please take this challenge to right the
wrongs perpetuated for many years by this agency called the
IRS. We need a constitutional, non-invasive, and non-
``targeted'' tax code, that treats us with equality. And enact
a tax code that preserves life, liberty and the pursuit of
happiness. . . not one that causes us to fear running afoul of
the IRS and requires keeping every scrap of evidence from every
sector of our lives, should it ever be demanded.
Thank you for your time
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Mr. Collins. Thank you, Mr. Davis. I expect by the close of
day next Monday when people, when most people finalize their
tax forms and write their checks, that we will be able to get
many, many more letters and also a lot more signatures on
petitions.
Mr. English?
Mr. English. Mr. Chairman, I have no questions. But I want
to thank these gentlemen for taking the time to exercise their
sacred right to petition Congress and to testify.
We appreciate your willingness to come forward and share
your views. And, frankly, I hope you are able to motivate many
more of our fellow citizens to get involved in this debate, to
provide their ideas, but to push this institution to reform a
tax code which has become an octopus which has reached into
virtually every part of our life.
I thank you for being here.
Mr. Davis. Thank you.
Mr. Collins. Thank you, Mr. English.
Mr. Hulshof, do you have any further questions for Mr.
Davis?
Mr. Hulshof. No. Thank you.
Mr. Collins. Thank you.
Mr. Archer, do you have any questions, sir?
Chairman Archer: [presiding] No, sir.
I simply want to thank all of the witnesses for coming and
presenting their views. We are very grateful for that. We know
some of you have come from a long way and together, some way or
another, we are going to work our way through and find an
answer.
Mr. Collins. [presiding] Thank you, gentlemen.
Mr. Worley, we do appreciate you sitting through the entire
service of yesterday and today.
Gentlemen, that concludes this panel and we will now recess
for lunch. Thank you. For those of interest, 1:00 o'clock will
be our time to reconvene.
[Whereupon, at 11:55 a.m., the Committee recessed, to
reconvene at 1:23 p.m., the same day.]
Chairman Archer. The Committee will come to order.
Continuing with our hearing, we have our next panel of our
colleagues: the Honorable Dick Armey, and the Honorable Billy
Tauzin, and the Honorable James Traficant, to talk about their
individual perspectives and potential alternatives for the
current income tax.
Welcome, gentlemen. We will start off with our friend Dick
Armey. We will be pleased to hear your testimony and your
recommendations.
STATEMENT OF HON. RICHARD K. ARMEY, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF TEXAS, AND HOUSE MAJORITY LEADER
Chairman Archer. Thank you, Mr. Chairman.
First let me appreciate you and your leadership in this
whole area of tax law. I have said many times, and I am happy
to say again, never could we have had a finer Chairman of the
Ways and Means Committee more devoted to a professional
commitment on the tax code.
I have had my own interest in the matter for some time, and
particularly in January of 1994 when I focused on the issue at
a level I had not done before.
I wrote the Flat Tax Bill. He later wrote his National
Sales Tax. We teamed up, as you know, and have spent the better
part of the last two years travelling across the country
speaking frankly to very large audiences where we have had a
clear commitment to end this nightmare called the current tax
code.
In our presentations before those audiences, we always
start off with a discussion of the burdens of the existing
code. I have on the billboards up here an example of how we
make the presentation.
For example, we divide the difficulties of the existing
code up between myself and Billy, and we point out that
families pay more in taxes, food, clothing, and shelter, and
now we also add transportation, combined.
Americans work an hour and fifty-seven minutes of every day
to pay federal taxes. Taxes are at peacetime record highs. And
I think one of the very big issues. $200 billion in annual
compliance costs for the current tax code.
Billy, when he opens his presentation, then will present
further facts. And by this time what we see in the audience is
a congealed understanding. Yes, this current tax code is a
horrible mess in our lives. It confounds us. It complicates our
lives. It costs us time, money, and energy, and it is generally
all-around depressing and we want to be rid of it.
I think, Mr. Chairman, you yourself have seen in your own
travels that there is a fairly clear agreement among the
American people. We want to be rid of this current tax code.
The next part of our presentation then focuses on:
All right, once we agree that we want to get rid of the
current tax code and replace it with something that is of
better service and less intrusion in our lives, where do we go?
It is at that point that I present what I still will argue
is the best alternative, the flat income tax, based on my
desire to have a tax code that does not intrude government
organization into the affairs of the family or the business.
No family or business decision about how to use your
income--whether it be consumption, savings, or investment--
should be made on the basis of tax considerations but should be
on family and business considerations.
So our tax code to be correct in my estimation should be
fair. It should be simple. It should be easily understood and
easily complied with.
It should eliminate double taxation and accept a standard
of fairness that I believe is the unique American definition of
``fairness.''
``Fair'' is when you treat everybody the same as everybody
else.
And it should forsake the sophistry that underlies so much
of what we have in our current tax code, overburdened as it is
with efforts of social control and income redistributions, a
sophistry that we hear pronounced so many times as the false
distinction between earned and unearned income that would give
rise to a justified sense of it is fair to treat some forms of
income differently than others.
The flat tax is very simple. It says to the individual.
Take your total income earned in a given accounting period,
deduct from it a generous family allowance--for a family of
four that could be as high as $33,800--multiply the remainder
by 17 percent, and your taxes are filed.
If you are a business, you take your total business income,
deduct your business expense, multiply the remainder by 17
percent, and your taxes are filed.
We can cut that compliance cost down by 95 percent with
this.
Now let me just say, the flat tax is filed on a form like
this, the size of a postcard, 10 lines. In the original
iteration of the flat tax I had written it so that we would put
an end to withholding tax.
Your joint tax scorekeepers whacked me for $10 billion on
that. In those deficit days, that seemed like a terrible
burden. I took it out. But I would tell you, Mr. Speaker, when
you mark up the flat tax in your Committee to bring it to the
Floor, I would encourage you to follow my original advice and
drop the withholding tax.
You will have a chance in this Committee--and this is very
important for us to understand--by Constitutional authority we
will write the modern, up-to-date, civilized respectful tax
code for the American people in this Committee.
When this Committee does that work, you will find the flat
tax is a bill easily written, congenial to the taxpayer, and
one that you will get a fulfillment of what I think is one of
the great, heroic American ideals. voluntary tax compliance.
I look forward to your proceeding with this. I encourage
this Committee to move forward. Certainly you will be fair and
you will be judicious as you judge all of the alternative ways
in which you might write a new tax code for America. And I
stand fully confident that when you begin this prospect in
earnest you will find, as I have found, the only way to do this
job is to do it with the flat income tax.
Thank you.
[The prepared statement follows:]
STATEMENT OF THE HON. RICHARD K. ARMEY, A REPRESENTATIVE FROM THE STATE
OF TEXAS, AND HOUSE MAJORITY LEADER
Mr. Chairman, I appreciate your affording my colleague
Representative ``Billy'' Tauzin and me the opportunity testify
together. We have traveled to over 40 ``Scrap the Code''
debates to educate the American people on tax reform. Our
effort has been intended to elucidate the details of two major
alternatives to our current tax system to the public. I commend
you for your own commitment to this cause. I know from our
years of hard work together on this issue and our many
conversations that we share the same goal for tax reform. I
want to take this opportunity to thank you again for your
leadership, friendship and advice on this issue.
The Tax Code is Broken
Mr. Chairman, there is an emerging consensus among the
public policy community, members of Congress, and the public
that our current tax system is broken and needs to be scrapped
and replaced with a system that is fair, simple, low, and
honest. This growing consensus centers around the belief that
the current tax code is complex; inhibits saving, investment
and job creation; imposes a heavy burden on families; and
pollutes Washington's political culture. It cannot be fixed or
replaced. It must be scrapped.
At the beginning of the 20th century, federal taxes
accounted for less than 3 percent of U.S. gross domestic
product (GDP) and the entire tax code and regulations filled
just a few hundred pages. Today, federal taxes account for 20
percent of GDP, and a complete set of federal tax rules spans
over 46,000 pages. I'd like to focus my remarks today on the
problems with the current tax structure and how my bill, H.R.
1040, The Flat Tax, corrects these problems.
Current Code: Complex
This year, the tax code itself is 2,840 pages and about 2.8
million words. Taxpayers have to choose from 481 forms, a rise
of 20 percent from 403 forms in 1990. The system is steadily
growing more complex, causing over half of individual taxpayers
to use a tax preparer for their income tax return, up from less
than 20 percent in 1960.
Even the well trained are stumped by the complexity.
Unsurprisingly, the IRS receives over 110 million phone calls a
year from taxpayers asking for assistance. In 1999 the IRS was
only able to answer 73 percent of the phone calls correctly.
The inability of the IRS to answer over 25 percent of calls
signals an inherent failing of the current system.
In 1998, Americans spent 5.7 billion hours filling out IRS
forms--equal to 2.7 million workers doing nothing but IRS
paperwork. With spring in the air, my family wants our time
together to be better spent than digging deep in drawers
searching for receipts or trying to make sense of complicated
forms. I am confident there are many families like mine who are
forced to sacrifice time with their loved ones to spend time
making sense of the maze of forms and paperwork.
The Tax Code is Unfair
The unfairness of receiving a penalty for a wrong answer
given the tax codes' complexity strikes at the heart of the
American principles of fairness, justice, and equality before
the law.
In one typical case, according to the non-partisan General
Accounting Office, it took the IRS 18 months to correct an
erroneous $160,000 assessment to an individual who was actually
due a refund. The American people deserve fairness and they
deserve to be rewarded for their honesty, integrity, and
responsibility.
Yet the current tax code gives rise to legions of tax
lobbyists fighting for their own particular deduction, credit,
or other special preference in the law. Besides contributing
vastly to the complexity, taxpayers with similar incomes can
pay vastly different amounts. How much you pay in taxes is
correlated to how much time you have to study and learn the tax
code, and whether or not you have a lobbyist in Washington.
Record Peacetime Tax Burden
The total tax burden is at 20.7 percent of GDP--a post-
World War II high. In fact the tax burden is a major impediment
to our new digital economy. Some may argue that rising tax
burdens as real incomes increase is the appropriate outcome of
our current tax system. However, a progressive tax system is
designed to make the rich pay a higher amount than the poor--
not to increase the total tax burden on all citizens. The
disincentives imposed by implicit and explicit marginal tax
rates are growing and these disincentives reduce savings,
investment, and growth.
The only legitimate purpose of a tax code is to raise
revenue, and do that while doing the least harm to the economy
and to the people. Yet the high burden imposed on us by the tax
code also punishes us financially for activities and values
that we should encourage.
--If we marry, we pay higher taxes than when we were
single. We save for our children's education, only to pay taxes
on savings from those earnings. We work hard to do more for our
family, only to pay a higher tax rate on every new dollar that
we earn. We die and pass our farm or business to our family,
only to have them break up the business due to the punitive
``death tax.''
The Flat Tax Solution
The legislation I reintroduced this year with Senator
Shelby of Alabama, (H.R. 1040) scraps the entire income tax
code and replaces it with a flat-rate income tax that treats
all Americans the same. This plan would simplify the tax code,
promote economic opportunity, and restore fairness and
integrity to the tax system. The flat rate would be phased-in
over a three-year period, with a 19--percent rate for the first
two years and a 17-percent rate in subsequent years.
Individuals and businesses would pay the same rate. The
plan eliminates all deductions and credits. The only income not
subject to tax would be a generous personal exemption that
every American would receive. For a family of four, the first
$35,400 in income would be exempt from tax. There are no breaks
for special interests. No loopholes for powerful lobbies. Just
a simple tax system that treats every American the same.
Simplicity
The flat tax replaces the current income tax code, with its
maze of exemptions, loopholes, and targeted breaks, with a
system so simple Americans could file their taxes on a
postcard-size form. The Tax Foundation estimates that a flat
tax would reduce compliance costs by 94 percent, saving
taxpayers more than $100 billion in compliance costs each year.
Fairness
The flat tax will restore fairness to the tax law by
treating everyone the same. No matter how much money you make,
what kind of business you're in, whether or not you are
married, or even when you die, you will be taxed at the same
rate as every other taxpayer.
Prosperity
Because the flat tax treats all economic activity equally,
it will promote greater economic efficiency and increased
prosperity. When saving is no longer taxed twice, people will
save and invest more, leading to higher productivity and
greater take-home pay. When marginal tax rates are lower,
people will work more, start more businesses, and devote fewer
resources to tax avoidance and evasion. And because tax rules
will be uniform, people will base their financial decisions on
common-sense economics, not arcane tax law.
Lower Taxes
The flat tax was not designed to be revenue neutral. It
reduces unfairness. Because of the high tax overpayment, there
is room to provide tax relief. And the flat tax would provide
significant tax relief. When the rate is reduced to 17 percent
in the third year of the proposal, there would be significant
further tax reduction.
But the flat tax does have a progressive element. Under the
flat tax, the more you earn, the more you pay. In fact, because
of the high family exemption, the more a taxpayer earns the
greater the share of his income he pays in tax. A family of
four earning $35,000 would owe no tax under the proposal. A
family of four earning $50,000 would pay only six percent of
its income in income taxes while a family earning $200,000
would pay 14 percent.
The flat tax is pro-family. The flat tax eliminates the
marriage penalty and nearly doubles the deduction for dependent
children. By ending the multiple taxation of saving, the flat
tax provides all Americans with the tax equivalent of an
unlimited IRA. This will make it easier for families to save
for a home, a vacation, a college education, or retirement.
The flat tax also has a powerful political virtue in that
it excites the public. The crucial importance of this should
not be underestimated. Policy experts can and do sit in a room
and write their version of the ideal tax code but it will
remain a purely academic exercise if they cannot rally public
enthusiasm for change.
In fact, a Zogby poll shows that the following breakdown:
------------------------------------------------------------------------
Percent Favorable Percent Unfavorable
------------------------------------------------------------------------
Democrats 60 31
Republicans 75.1 19.1
------------------------------------------------------------------------
To the many Americans who have grown profoundly skeptical
of the federal government, politicians, and lobbyists, the flat
tax has spectacular appeal because it offers the American
people a straightforward deal. It also rids Washington of many
of the special interests' reason for existing: the current,
unfair tax system.
The flat tax scraps the current code and gives taxpayers a
new code that is simple, low, fair and honest. America deserves
no less.
Chairman Archer. Thank you, Congressman Armey.
Congressman Tauzin, you may proceed.
STATEMENT OF HON. W.J. ``BILLY'' TAUZIN, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF LOUISIANA
Mr. Tauzin. Thank you, Mr. Chairman.
Mr. Chairman, you asked us to focus today on three points.
The first was the fairness and simplicity of the
alternative plans.
The second was the impact on trade and commerce.
And the third was the compatibility with state tax
collection systems.
Let me first acknowledge that I am accompanied today by Jim
Traficant, my chief Co-Sponsor, who I am always pleased to
share a podium with. He will also be available to answer any
questions you might have.
Let me touch upon those three points. Without going into
all the great reasons why we need to scrap the code, I adopt
your great admonition that it is time to pull it out by its
roots and destroy it so it never returns again.
Moving to a consumption tax does that. It allows us to get
rid of the income tax code completely, to abolish the IRS, and
to move to a simple, fair tax code.
Why is consumption taxes on retail sales fair?
First of all, let me suggest to you that there is something
about an income tax code that is hidden from the American
public that is not very apparent until you examine it closely.
At your desk, in addition to the wonderful little book I
have written entitled the National Sales Tax. April 15th Just
Another Day, is also a copy of an article by Dale Yargenson,
the Chairman of the Department of Economics of Harvard
University, in which Dale Yargenson points out something that I
think Americans are not aware of. That is, that the income tax,
the fact that we currently tax income on individuals and
corporations and businesses, adds about 25 percent to the
finished product cost of everything made in America.
So the pervasive effect of income taxes, however you style
them--complex, simple, or flat--is that they add to the cost of
products made in America.
So the perverse effect of an income tax code is that it
punishes an American worker for buying his own products. It
punishes those products in export trade, and it rewards him
only when he buys a foreign product that comes in very often
exempt from foreign VAT, value added taxes.
So when you think about income taxes in comparison to
consumption taxes, you need to think about a single consumption
tax at the retail level compared to not one but two taxes on
the same money. the tax we pay from our paycheck that comes out
as withholding, and the tax we pay in higher American prices
for everything we make because income taxes have added 25
percent to the cost.
Take local bread for example. Studies indicate that 35
percent of a loaf of bread is income-tax related. If you get
rid of the income tax, according to Dale Yargenson, you reduce
the cost of a loaf of bread by that much in a competitive
marketplace.
A loaf of bread, instead of costing $2, should rightfully
cost $1.30. When you put a sales tax on the back of it at the
retail sale, you still have a much lower price for bread than
you have in America today. It is eminently.
In our plan that Jim Traficant and I have devised, you
remember that this is a plan that we introduced years ago and
have reintroduced every Congress. In this plan we go even
further to make it fair.
We also repeal all of the payroll taxes that are collected
from a worker's income up to the poverty line so that all
income under the poverty line is not only free of income taxes
under our plan, but also free of the payroll tax.
Now that is an extra 15 percent that goes into the workers'
income and fully makes up for the effect of the sales tax on
all the products you buy to take care of your family with
income earned under poverty.
Now think about that. You have got more money to spend. you
have got all of your paycheck, plus your payroll taxes that are
no longer going to the government. And you are buying products
made in America that can cost as much as 25 percent cheaper.
That is pretty fair. Pretty simple. It puts you in charge of
how much taxes you pay instead of a government that writes a
code and regulatory structure of 7 million words and nobody can
understand anymore.
On trade, Dale Yargenson points out that if we got rid of
the income tax and so reduced the cost of American products by
25 percent, the export trade from the United States would jump
29 percent annually and would be at least 15 percent higher
than it is every year thereafter.
In short, we would eliminate the trade deficit. American
products would go out tax free. No income tax effect on them.
And they would be taxed once in the place of destination
instead of being taxed in America and also taxed there. A 29
percent jump in exports.
Dale Yargenson also indicates if we were smart enough to do
what we recommend in a consumption tax at retail sale, we would
also increase investment in jobs and manufacturing in this
country by a factor of 80 percent. A huge increase in jobs, in
manufacturing, a huge increase in exports, a simple plan that
works for Americans that is fair, it is decent, it cuts the
cost of American prices, and also rewards workers for buying
their own products instead of punishing them.
That is a pretty good deal and one we ought to consider in
this room. What a great gift we could give to this country if
we ever pull that off.
Now you asked also about compatibility with state
collection systems. The good news is that 45 states currently
have sales tax collection systems. Under our plan, those states
do the collecting. We would encourage the last five to put up a
collection system, but if they do not we of course would set
one up in those five states.
But in 45 states, the states would do the collecting. Our
bill provides them with a one percent commission to cover the
cost of the collection. Our bill rewards the retailer with a
half of one percent to make sure the retailers' cost are
covered in the collection system, and the balance is then
remitted to the Federal Treasury.
Here is the good news on the collection system, how easy it
works. In most sales tax jurisdictions, 80 to 90 percent of the
sales taxes are paid by 8 percent of the retailers. The bulk of
it is done by the big national retailers.
Under our plan, they can remit directly to the Federal
Treasury if they want it on a national retail basis. In short,
the minimum amount of sales tax collection is then left to the
states for which they are paid a commission and for which the
retailers are paid a commission.
One final thought and then I know my time is up. We even in
our bill make provision to help the retailers with the software
they might need to make their collection systems for the
federal sales tax compatible with whatever plan may exist in
their states for state sales tax collection.
Mr. Chairman, I yield back.
[The prepared statement follows:]
STATEMENT OF THE HON. W.J. ``BILLY'' TAUZIN, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF LOUISIANA
Mr. Chairman, it is my honor to address the Committee on
the benefits of a national retail sales tax and my proposal,
H.R. 2001, the National Retail Sales Tax Act of 1999. I first
introduced this legislation, along with my friend, former
Congressman Dan Schaefer in the 104th Congress. Since then I
have been joined in this effort by Congressman James Traficant
and others, that understand the economic benefits of a national
retail sales tax. I look forward to working with you and the
members of the Committee to overhaul our current system and
lift the burden of the income tax from the shoulders of all
Americans.
The federal government's outdated, flawed and unfair
income-tax system has become a nightmare for all Americans. It
has grown from 14 pages in 1914 to more than 2,000 pages of
law, 6,000 pages of regulations and hundreds of thousands of
rulings and interpretations. Tax preparers and income-tax
experts who routinely testify before Congress admit that even
they do not fully understand all of the provisions and
ramifications of the Internal Revenue Code.
Since I last appeared before this committee in 1997,
Majority Leader Armey and I have taken our message of tax
reform to tens of thousands of people in over thirty cities on
the ``Scrap the Code'' tour. At every stop on our tour we have
been met by hundreds of Americans yearning to learn more about
the major alternatives to the current code.
While Congressman Armey and I may differ on which tax-
reform bill is best for America, we agree that Americans work
too hard for their money, have too little to show for it and
should not have to tolerate our inherently-unfair and overly-
complex federal income tax code. What's worse is that the
federal income tax code tells Americans how to live their
lives--encouraging some types of actions and discouraging
others.
Mr. Chairman, you have asked that these hearings focus on:
whether our respective fundamental tax reform proposals are
simple, fair and enforceable; the relevance of these proposals
to the increasingly global marketplace; and, their
compatibility of our proposal with State tax laws. First, let
me briefly explain my proposal, H.R. 2001, the Tauzin-Traficant
National Retail Sales Tax Act of 1999 (NRST).
My legislation would eliminate the personal and corporate
income tax code--including taxes on capital gains and savings,
inheritance and gift taxes, and all non-trust funded excise
taxes, abolish the Internal Revenue Service and replace them
with a 15 percent national sales tax on the retail purchase of
all goods and services.
Simple, Fair, Enforceable
Unlike the current income tax code or even the flat tax,
the national retail sales tax requires no federal individual
tax returns of any kind. Americans are forced to spend in
excess of 5 billion hours trying to calculate the amount of
income taxes owed to the federal government. This is absurd.
Individual Americans will pay their taxes when they make
purchases of retail goods and services. No receipts, no tax
returns, no audits, no hassle.
All goods and services for consumption would be taxed at
the same rate--no exceptions. If we exempted food, clothing,
and housing--which represents a substantial amount of the
American economy--the rate would have to be significantly
higher. The broader the NRST base the lower the rate. Exempting
entire categories of goods or services would inevitably lead to
an administrative nightmare of definitions.
The NRST will empower all Americans by giving them the
choice as to how much tax they pay. Our present income tax
system takes our money through withholding before we even
receive it. Most of us now consider that our wages are really
the ``take-home pay'' that we get net of all the deductions.
Under the present system, it doesn't matter if one of us is
more frugal than the other because we all pay the same amount
of tax. In fact, if we are more frugal than our neighbor we are
actually going to pay more and more tax because our earnings on
our savings will be taxed each year.
With the national retail sales tax we receive all of the
money we earn. Our checks are increased by the amount
previously deducted for federal income tax. With this money in
hand, we have the power to determine the amount of federal tax
we pay based on how much we choose to spend. The more you
consume the more you will pay in taxes. The less you consume
the less you will pay in taxes. The American people, not
Congress or the IRS, will have the power.
Also because of the way that the present income tax system
hides the amount of taxes we pay in the price of goods and
through withholding, I don't think any of us can really tell
how much tax we are paying to the federal government. By
eliminating the individual and corporate income tax, the estate
and gift tax and all non-trust fund excise taxes and replacing
them with a simple national retail sales tax, all of us will
see the amount of federal tax we pay each time we make a
purchase.
Critics of the NRST often claim that it is regressive--that
the poor have to devote a greater percentage of their income to
pay the NRST than do the rich. Under H.R. 2001, a tax credit
would be allowed for thousands of households with incomes below
the poverty line. This assures that all workers below the
poverty level will pay no taxes. The formula will be made
adjustable for non-working spouses and children by reducing
FICA deductions on every paycheck.
Enforcement is an serious issue for any tax plan. Will
there be people who try to evade the national retail sales tax?
Yes. There are always going to be people who refuse to pay any
tax. The current code has become so complex that it makes it
easier for people to cheat the system..
Under the NRST there will be dramatically fewer collection
points to watch. Instead of having to audit and collect
information on 250 million taxpayers and millions of
businesses, the government will have to watch a smaller number
of collection points. All but five states levy state sales
taxes. The other 45 states and the District of Columbia already
have the mechanisms and experience in place to enforce the
sales tax. Local administration and collection will translate
into better compliance rates. States will also have an
incentive to enforce the tax because the more they collect, the
more they receive to cover their administrative costs.
The NRST would ensure that the underground economy, those
individuals and businesses that don't file income taxes, would
pay their fair share. The underground economy encompasses not
only illegal sources of income, such as drug dealing, gambling,
and prostitution, but also the ordinary citizen who accepts a
lower price for cash payments and doesn't report the income or
the businessman who keeps two sets of books and pockets a
portion of the sales or takes improper deductions.
Relevance to the International Marketplace
Currently, Americans, in effect are taxed twice by the IRS.
Americans pay a federal tax on their income, and pay what
amounts to a ``hidden'' sales tax (believed to be as high as 15
to 20 percent) on the retail purchase of all goods and
services. The federal government calls this the ``corporate
income tax''--as if it were really paid by corporations. But,
in reality, consumers pay this tax in the price of goods they
buy. So under the present code, American income is literally
taxed coming and going. The net effect of the NRST, is to
eliminate two taxes and replace them with one clearly defined
tax on goods and services sold at the retail level.
This ``hidden'' sales tax makes it harder for American
goods to compete overseas. Due to the income tax and its
burdensome compliance costs, American products produced for
export leave the U.S. at a 15-20 percent competitive
disadvantage.
What's worse is that products imported into the United
States enjoy a 15-20 percent competitive advantage over our
American-made products. Most industrialized countries simply
exempt products for export from most of their taxation. This
exacerbates our trade deficit and translates into millions of
lost American jobs. Mr. Chairman, that's unfair to American
workers, products and companies.
Members of this committee are well aware that the World
Trade Organization (WTO) has determined that the Foreign Sales
Credit (FSC), a portion of the income tax code created to
mitigate the effects of the income tax code, constitutes an
illegal subsidy. In its October 8, 1999 Panel Report on FSC's,
the WTO found that ``...the United States is free to maintain a
world wide tax system, a territorial tax system or any other
type of system it sees fit. This is not the business of the
WTO. What it is not free to do is to establish a regime of
direct taxation, provide an exemption from direct taxes
specifically related to exports, and then claim that it is
entitled to provide such an export subsidy because it is
necessary to eliminate a disadvantage to exporters created by
the US tax system itself..''\1\
---------------------------------------------------------------------------
\1\ Adoption of a national retail sales tax would eliminate the
need for Foreign Sales Corporations. Under the NRST, no tax will be
placed on a product exported from the United States. In addition, since
the NRST is designed to only tax consumption, all purchases made for
business purposes would NOT be subject to the 15 percent tax. As our
country becomes more and more dependent on foreign markets for our
goods and services it is becoming increasingly clear that we must
fundamentally modernize our tax code to increase U.S. competitiveness
around the world.
---------------------------------------------------------------------------
There will also be what some economists call the ``sponge
effect.'' The U.S. is the world's largest market and has the
best infrastructure of any country on earth. When the income
tax is replaced with the national retail sales tax, it will
become the world's largest tax haven and a ``sponge'' for
capital from around the world.
Compatibility with State Tax Laws
Currently, 45 States and the District of Columbia levy
sales taxes (Alaska, Deleware, Montana, New Hampshire and
Oregon do not). These states have the experience and mechanisms
in place to administer the NRST. Under the Tauzin-Traficant
plan, States would collect the 15 percent national sales tax
from the retailers within the state and remit the tax to the
United States Treasury. Participating States may keep 1.0
percent of their collections to offset their collection
expenses. Similarly, any business required to collect and remit
the sales tax would be permitted to keep 0.5 percent of tax
receipts to offset compliance costs.
In closing, I believe that we should re-examine the basic
ideas on which this government was founded. Our Founding
Fathers insisted on the use of indirect taxes on individuals
and specifically forbade direct taxes like the income tax. We
have an opportunity to eliminate the income tax, the IRS, tax
returns, audits, and the penalties on our work, savings and
investments and replace them with a national retail sales tax.
We must free Americans from the trappings of the income tax
code.
The beauty of the national retail sales tax is its
simplicity and fairness. Those who spend the most will pay the
most. Those who spend the least will pay the least. No more
income tax forms. No more compliance costs. No more hidden
taxes. No more loopholes for the corporations and the rich.
What's important now is to begin a national dialogue and a
dialogue within this committee on tax reform. This debate isn't
simply about a flat tax vs. a national sales tax. This is about
fundamental tax reform vs. preserving the status quo.
Revolutionary change, such as scrapping the federal income tax
and abolishing the IRS, will never happen unless Americans
demand it.
Mr. Chairman, thank you again for holding these hearings
and for your leadership on this critical issue.
Chairman Archer. Thank you, Congressman Tauzin.
Congressman Traficant.
STATEMENT OF HON. JAMES A. TRAFICANT, JR., A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF OHIO
Mr. Traficant. I would just like to amplify upon Mr.
Tauzin's statement and commend you, Chairman, for your
leadership.
I believe if there is a possibility of changing a tax code
that is un-American, it has the greatest shot with Bill Archer
as Chairman.
I want you to know that your reform bill made a dramatic
impact in America. I want to thank you for working with me on
two of those issues, in changing the burden of proof and
judicial consent.
I wanted to give you one statistic before I give you my
statement:
Seizures of farms, homes, and businesses in 1997 were
10,037. In 1999, they were 161. Thanks to you, Chairman Archer.
And I want to thank the Republican Party for working with me.
One point I would like to amplify upon Billy's statement is
that the Consumer Price Index plays a big part in the analysis
of this particular bill. If there is any upward trend in cost,
then there would be a reciprocal upward allotment in the cost
of living allowance for seniors which are going to be very much
panicked over this legislation.
Where I can help I believe Mr. Tauzin and the Congress is
in trying to get hardcore democrat opposition to look at the
salient points of this legislation, because it will have to
have some Democrat support or they will continue to be at the
back of the bus in the minority for many, many years, because
the time has come.
I want to talk about attitude. General tax attitude.
If you fix up your home, you pay more taxes. If you let it
run down in America, you pay less. I am not talking about a
federal system, am I? But if you work real hard and you are
very industrious, you get hit over the head and pay more taxes.
If you do not work, you get a check.
We must reward people for industry and work. But here is a
point I would like to amplify upon what Mr. Tauzin has stated I
think very eloquently. Let me say this. I have great respect
for the Majority Leader. I believe a flat tax is absolutely
necessary--not an income tax, but a flat tax on final retail
sales consumption--for the following reason.
In my District we make the Cavalier, and Phil English is
right across the border and his people work there as well. That
Cavalier carries a 25 percent disadvantage against the Toyota
that is imported from Japan.
For the first time in history you would have a border-
adjusted tax. My Cavalier is made with a 25 percent overload
from the tax code, gets shipped to some other country overseas
and they put a value-added tax on that baby.
Then they come in under an agreement of some trade of some
sort with basically free access to our market, and then we are
worried about keeping our Cavalier plant in Lordstown, Ohio,
Mr. Chairman.
So I think when you look at the final retail sales tax,
here is a big issue. And here is one concern I have. I support
that 15 percent national retail sales tax, but ask you to
ensure that is going to be enough.
Now I heard this 30 and 50 percent crap, and this
opposition crap I think is distorting it to the American
people, but I think you will come up with that particular
number that is necessary.
But I think what is most important that we all take a look
at is that FICA and senior citizens. I think if there can be an
improvement to our bill, and I would ask the Chairman to look
at these machinations as you look at changing the code, that
rather than have the opportunity to politically scare seniors,
which I believe will be an opposition tactic and I predict it,
to leave FICA alone as we do and put a study in there with that
transition that would allow for a study and a natural
transition to, if it in fact proves to be worthy in that
regard.
But I think we leave open the opportunity to quantify
income. And that is how we in fact evaluate those that are in
hard times and those that are in good times. So I know that you
are working on that, and you are working on many of those
issues. But I would like to just close by talking about the
attitude of our tax scheme.
When people work hard, they get penalized in America. That
is not the type of scheme we need. We should be rewarding
industry and industrial strength.
And finally, I think American companies will come back
home. I think they will relocate in districts like mine, and I
would ask for special legislation to help my District.
With that, I thank you for allowing me the opportunity to
appear with two of the most distinguished Members of Congress,
and I am glad Mr. Portman has shown.
Thank you, Mr. Chairman.
[The complete statement of Mr. Traficant follows:]
Chairman Archer. I am grateful to all three of my friends
who are at the witness table today because all three of you
want to put your shoulder to the wheel to drive this tax system
to where it is not an odium on the American people, and rather
that it can be transferred into a position to where it can be a
strength.
All taxation, no matter how we collect it, is not a happy
thing for the American people. There is no tax system that is
going to be perfect without complaint. But the system should be
fairer. It should be simpler. And what you, Congressman Tauzin,
and you Congressman Traficant said, it should be one that is
designed to improve our competitiveness in the world
marketplace which in the next Century is going to be essential
to meeting the needs of the American people.
It must furthermore level the playing field between foreign
products and services entering this country and those that are
manufactured and produced and ideated in this country.
And if we go through tax reform and we do not do the
latter, we will have missed the golden opportunity for future
Americans. And so I thank you for what you have presented
today, all of you.
I say to my friend, Dick Armey, you have designed a system
that is much, much better than the current income tax system
and I applaud you for that.
I do wonder if--and I would like your response to this--is
there upward mobility on the rate structure in your system?
Mr. Armey. Well, Mr. Chairman, let me just say, no. There
is a single rate. Now if I make $100,000 a year, I pay 17
percent of that. If my good friend Sam Donaldson makes $500,000
a year for talking about what I do, he pays 17 percent of that.
Now he will pay more in taxes than I will, but we will pay the
same rate.
There is an adjustment at the low end in that the standard
deduction is a larger share of the percentage of total income
for low income earners than it is for high income earners, so
there is some progressivity put in there. But it must be
understood. When I wrote the flat tax, I said somebody has got
to be stubborn about this.
The first point about which you must be stubborn is it can
only be one rate. Immediately upon trying to introduce two
rates, you will bring complexities to the tax code that will
make it an unbearable thing.
And if I might say one other thing, when I tried to write a
tax code I wanted to fulfill a variety of objectives.
simplicity, honesty, fairness, neutrality. I have not found any
effort to put border adjustability into any tax code that does
not first violate the principle of neutrality and does not also
simultaneously trespass against all the other principles, and
would not in fact in the long run be eliminated and made
ineffective by adjustments and exchange rates.
So I do not place a lot of store in efforts to achieve
border adjustability in the tax code. I think that is--I think
it is an objective that is, first of all, errant, and secondly
comprises the rest of your effort.
Chairman Archer. But relative to my specific question,
there is no provision in your bill to prevent future Congresses
from raising the rate and going to marginal rates in your
system, is there?
Mr. Armey. No. Let me just say that first of all as we saw
in 1986, it is impossible for any Congress to protect America
from a future Congress.
We do put a provision in that says it takes a two-thirds
vote of both the House and Senate to either increase the rate,
reduce the family exemption, or add any complexities back into
the system. But that is about the best protection you can get,
and in the end it stands upon the ability of the American
people to hold their Congress's feet to the fire.
As we saw in 1986, future Congress's can fowl up anything.
Mr. Tauzin. Mr. Chairman, might I----
Chairman Archer. Mr. Tauzin, I know you were a little
nervous there in wanting to get into this question of border
adjustability, so what is your response?
Mr. Tauzin. Well first let me agree with Dick on this two-
thirds provision. We have it in our bill as well.
Let me say, this is how it works today under GATT. Many of
our trading partners have value-added taxes in their tax
system. If you go buy something today in London you will be
charged a value-added tax. But if you bring it to America, you
get that value-added tax back. It is rebated.
The effect of that is to allow those countries under GATT
to sell their products in the American market value-added tax
free.
Chairman Archer. Will you suspend for a moment?
Mr. Tauzin. Yes.
Chairman Archer. When the gentleman mentions GATT, he is
talking about currently the WTO.
Mr. Tauzin. The General Agreement on Trades and Tariffs.
Chairman Archer. Yes, which has been replaced by the WTO.
Mr. Tauzin. Yes, the WTO.
Chairman Archer. Correct.
Mr. Tauzin. The bottom line is that under these trade
agreements, value-added taxes can be rebated back when the sale
is made to another country.
So in effect the foreign product comes in and is purchased
value-added-tax free. We can't do that with our income tax code
under those agreements.
Our income tax code adds this 25 percent to the cost of the
automobiles made in America to any product we make in America.
It is shipped overseas and, guess what, the value-added tax is
then assessed on those products overseas.
So they pay both the income tax in America and the value-
added tax overseas. Whereas the foreign product pays whatever
income tax they have in that country with the value-added taxes
rebated. That is a natural advantage to the foreign product.
And let me say it again, Mr. Chairman. When you get rid of
the income tax, you get rid of that 25 percent hidden tax on
American products both consumed in America and shipped
overseas.
So suddenly if you do this, if you go to a national sales
tax, the American exported product gets taxed only once with
the VAT tax overseas, instead of being taxed here in America
first for the 25 percent burden, as Mr. Traficant pointed out,
and then getting taxed twice.
You do achieve border adjustability.
Now let me concede to Mr. Armey. Nobody can say what is
going to happen in future trade agreements, future exchange
rates, but it is inconceivable to me that we can suffer this
huge trade deficit with 19,000 American jobs lost for every $1
billion of that trade deficit, and not adjust our own tax code
to deal with it. And we can and we should, if we adopt a
national sales tax.
Chairman Archer. Do you believe--and, Mr. Traficant, I will
recognize you in a minute--do you believe that it is fairer for
foreign products to be able to enter this country under an
income tax system and pay no share of our cost of government or
to have to hear some of the burdens of this society?
Mr. Traficant. Absolutely not, Mr. Chairman. This is a
Final Retail Sales Tax Act. That Cavalier made in Lordstown is
only taxes at 15 percent if it is bought in America.
If that baby is exported, it carries no 15 percent and
would only be subject, as Billy said, to the VAT or the taxes
of those particular countries.
I know you are working feverishly on leveling the playing
field, but that is an awful big part of that. But let us also
look at the double taxation.
Now we sell that Cavalier, or we sell that Toyota that is
made overseas. It comes in. It carries now that 15 percent tax
just like the Cavalier.
Now we pay $20,000 for the car. Now it is $23,000. We sell
it in four years for $12,000. Now $12,000 of that car we did
not use. So there is a deduct for the unused portion of the
consumption that we originally paid.
So we are not taxing everybody twice, which we are also
doing. We take that dollar on income. We pay an income tax on
it. We put it in the bank. We take it out to buy the car, pay a
tax on the interest, then pay a sales tax on the car with a 24
percent cost factor due to the tax code.
So I think the only reasonable tax scheme that has to be
thoroughly investigated is one which adjusts that border-tax
issue, or our trade deficit will continue to balloon because
our free enterprise system is designed to produce at the lowest
cost, thus forcing our manufacturers into Mexico, forcing them
over into China to produce an item which we could perhaps
produce in America competitively by reducing that heavy load.
Chairman Archer. I am trying to understand the disconnect
between what Mr. Armey is saying and what the two of you are
saying.
He says that he is leveling the playing field with his
proposal. You are saying I take it that he is not leveling it?
He is further saying that your proposal creates an unlevel
playing field which benefits the United States of America, and
that unlevel playing field runs contrary to what he is
attempting to achieve in his tax proposal.
I am just trying to understand the difference between you.
Mr. Tauzin. Let me try. Mr. Armey's proposal does level the
playing field of paying taxes in America. It is a flat rate.
Everybody pays the same once you take your family deduction.
I applaud that. I think it is a much better plan than our
current income tax code.
But there is another playing field outside of the one that
we play on here in America. That is the global economy. In that
playing field, simply flattening income tax rates will not do
anything about the inequity of American products being taxed
twice in global trade, and foreign products only being taxed
once when they are brought to America.
That is the second playing field, if you will, that ought
to be leveled.
Now you can argue about whether our bill levels it fairly
or not, but it aims at leveling it. It aims at not only
leveling the playing field inside our country with the simple
flat rate everybody pays above the poverty line because we take
care of income under poverty, but it also levels the playing
field at the border which is the second one that as you pointed
out, Mr. Chairman, may be the most important in the long run as
this country goes more and more into global economic trade.
Mr. Traficant. Mr. Chairman, I would like to amplify on
that. There is a third playing field. And let me say this. I
think Mr. Armey has done a great service, and it may be his
legislation enacted into law, because I do not know if America
is progressive enough yet to take a hard look. It takes years
to make changes.
But there is a third playing field no one is looking at,
and Mr. Armey's tax scheme does not even attempt to challenge
it let along our current system. That is. The underground
economy that avoids the payment of income tax, that many times
is selling drugs on the street and getting an SSI check, where
we are sponsoring literally with our tax dollars, subsidizing
individuals who are paying no taxes.
Remember this. If that drug dealer buys a car, he is going
to pay the same tax as Mr. Armey will, or Mr. Archer will.
Every final retail sale is taxed with provisions to protect
those on the bottom, and with the Consumer Price Index being
calculated each year and adjusted for a COLA increase for those
at the top.
So are we concerned about our seniors? We must be. We must
be very careful.
Second of all, we are concerned about those at the bottom
end of the ladder. I have many of them. But why should I
continue to have an underground economy that goes untaxed with
the continuing complication of submitting any forms when we can
do away with forms and truly simplify it and raise revenue from
all transactions.
That is the third playing field that I think is not being
addressed by Congress and should be a salient point in the
discussion.
Chairman Archer. Mr. Armey, you are outnumbered there. You
certainly deserve to have an opportunity to respond.
Mr. Armey. Let me comment on both things.
I know this Committee is going to seriously undertake the
task of writing a new tax code and I applaud you for that. I
think this Committee should try to write a national sales tax,
or even try to write a national value-added tax. I think you
ought to try.
But in this process of doing that, I think you ought to
take a hard scholarly look at border adjustability. It is a
very complex and difficult subject fraught with a lot of
misconception, almost mysterious at times, and you should have
if you are going to try to sacrifice one of the what I think
precious principles of tax law and engage in social engineering
and income redistribution scheme called border adjustability,
then I think you ought to have some very sober assessment as to
whether or not it would work.
Because border adjustability is about trying to
redistribute income between Americans and foreigners, and
trying to encourage Americans specifically to buy American-made
products as opposed to foreign. Those are social engineering
objectives.
I think you will find when you study it thoroughly that it
is ill advised and does not achieve the desired results.
Now the question of the underground economy must also be
understood. It is wrong to say that you will capture the
underground economy with a sales tax and you will not do so
with an income tax.
In a world of income tax, a person who otherwise earns his
income honestly pays income tax on his income and then buys
cocaine from someone who earns his income dishonestly who does
not in turn pay income tax on his ill-gotten gains through the
peddling of cocaine.
In a sales-tax world, a person who otherwise earns his
income honestly does not pay sales tax on his purchase of
cocaine and the person who receives the income dishonestly may
in fact pay sales tax on his purchase of an automobile.
But I can tell you, if the guy is smart enough to figure
out how to acquire and sell cocaine and avoid taxes in that, he
will figure out how to avoid paying his sales tax. Indeed,
empirically speaking, we know as a matter of fact that every
nation state in the world that has ever tried to implement a
national sales tax has found the size of their underground
economy has in fact grown.
The most recent case is Canada where they found that the
use of cash in the Canadian economy doubled within six months
of their implementing a national sales tax. Because the fact of
the matter is, a national sales tax does not capture the
underground economy; it encourages it to grow larger.
Now I too am concerned about the underground economy. There
are two aspects of the underground economy. I think my flat tax
addresses the one that breaks your heart the most.
The first part of the underground economy, the one we like
to talk about, is people dealing in illegal transactions--
contraband, dope dealers, bank robbers, people like that. Well
obviously that is a question of criminal law not tax law.
The second, and the one that breaks your heart, is the guy
who looks at the current tax code--he is otherwise normally
very honest in his dealings in life and would love to be a
person who would fulfill all of his contract with America by
saying, yes, I will voluntarily pay my taxes but the tax code
is so unfair in the way it gives breaks to people other than
myself that I have a right to give myself a break.
It is so complex in terms of all the data points it must
track, that they are never going to find me if I do give myself
that tax break.
And that person succumbs to the temptation to, while
otherwise is almost perfectly honest in his life, cheat on his
taxes because it is a corrupt system and administered in a
nonfair way by mean-spirited people. And besides that, they are
treating my brother-in-law different than they are treating me,
so I have got a right to give myself a break.
The flat tax ends that. The flat tax, you know I have a
simple, decent, honest, fair tax code that is perfectly well
understood not only by me but by my 8th grader, and it treats
my brother-in-law exactly the same as it treats me so I have no
excuse to cheat on such a fair system. And besides that, it has
to track so few data points they would catch me if I did.
And you will get rid of most of the underground economy,
but you will have to take care of the drug dealers with another
method.
Chairman Archer. I have got one last question to ask for
both of you, and then I have presumed too much on the time of
the other Members.
Mr. Armey, what percent rate on your flat tax is required
to give us revenue neutrality, to raise the same amount of
revenues we currently raise from the income tax?
Mr. Armey. Let me say first of all, I appreciate that. I
never strived for revenue neutrality when I wrote the flat tax.
I wrote the flat tax in 1994, and I was perfectly content to
get within $30 billion of total expenditures. That is based on
my personal belief that the Federal Government is already too
big and spends too much of our money and spends it too
wastefully.
So given the formula the formula that I worked out at the
time and the size of the personal exemption that I chose to
give to the family, I came up with 17 percent. That is
something that would be wholly in the discretion of the
Committee of course as you wrote the bill.
I believe that if I went back in these surplus times and
went through the scoring process to rewrite the flat tax, that
I might come up with a different rate and it might be lower
than 17 percent.
It troubles me a little bit. As you know, you can read
about the flat tax on my web site at flattax.house.com, or you
can buy and read my book in which case we would both profit, or
you can find out.
There is a tendency on the part of people to believe that a
flat tax must be 17 percent. I know the Canadians are talking
about that and one or two other countries are talking about it.
So we should never get ourselves fixed to a percentage as the
necessary percentage.
My own view is in these surplus times we could get the
level of revenue neutrality we have found acceptable, given our
other budgetary patterns and still be under 17 percent, but
that would have to be something the Committee would have to
work out.
Chairman Archer. Well, Mr. Armey, that is all very
interesting, but on that basis, Mr. Tauzin could say, well, we
are only have a ten percent sales tax. We are going to
arbitrarily pick that, and give a tax reduction to everybody.
And do not bother us with trying to duplicate current
revenues.
But as this Committee begins to pursue alternatives to the
current tax system, we must put them all, as you say, on a
level playing field.
Mr. Armey. Umm hmm.
Chairman Archer. So we must know what the rate is on your
proposal to duplicate current revenues, which is the level
playing field on which we compare every proposal.
Mr. Armey. I would be more than happy to have you apply
that test with the apparatus of your joint tax committee and
your scoring apparatus. When you mark up the flat income tax, I
know you will apply that test, and you will come up with a
rate. Whatever that rate is, it will be still welcomed by the
American people.
By the same token, should you decide to mark up a national
sales tax, or a national value-added tax, again, this committee
making that mark would have to determine what that rate would
have to be.
Chairman Archer. Well, it just so happens that the Joint
Committee has done an updated analysis of your proposal, and
the rate on that is somewhere around 26 percent to duplicate
current revenues.
If we went with a 17 percent rate, which I continue to
still hear promoted by the advocates of the flat tax, we are
going to run massive deficits and we will more than use up the
amount of tax relief that is provided for in the budget that we
are voting on tomorrow.
Mr. Armey. Well, the first thing I would ask you, Mr.
Chairman, is give me the joint tax committee's report, and I
will, within a day or two, find out what their mistakes are. I
do not believe they have evaluated my flat tax. We will take a
look at it but I have not seen any scorekeeping on the flat tax
that has ever come anywhere near that figure.
Treasury, a few years ago, came out with a figure like
that. Within a day-and-a-half, we showed them their mistakes
and they retracted their study because in fact, under their
study, they found out that they could get--when made the
adjustment for the errors, they came back to 17 percent.
Chairman Archer. Your proposal is in statutory language and
it has been specifically been submitted to the Joint Committee.
Mr. Armey. Well, I will have to go over their work.
Chairman Archer. And the Joint Committee's estimates in the
end, whether it is the AFT proposal, whether it is a Tauzin-
Traficant proposal, whether it is the USA proposal, will be
judged based on the Joint Committee's estimates.
Mr. Armey. No doubt about it.
Chairman Archer. And I have debated with them for many,
many years about their estimates on capital gains and a lot of
other things and I have always lost.
And whatever they say will be the criteria for what we do
in this Committee. And the proponents of the flat tax have got
to get honest with the American people, along with the
proponents of every other proposal, and admit to a rate that
will duplicate current revenues.
And to make comparisons on rates that do not do that is not
level playing field.
Mr. Armey. Well, Mr. Chairman, let me just say I have not
seen the joint tax committee's evaluation of it. I have not
seen any evaluation like this from them or anyone else except
the errant one that the Treasury Department retracted three or
four years ago.
I would be happy to look at it.
The last thing that I want in arguing for a decent, honest,
simple, neutral tax code is for me to make arguments that are
not themselves honest.
I reserve the right, when joint tax works, to look at that.
It is possible they have not in fact scored my bill as I wrote
it or think I wrote it, and if they point some error in the
interpretation of the bill that causes such an aberration in
the scoring, I would be happy to address that in a rewrite of
the bill, as I am sure the Committee would be.
But I do not think it is appropriate for you to suggest
that I have not been honest on the bill based on some scoring
made by the Joint Tax Committee that I have not seen.
Chairman Archer. Well, the Treasury scoring is not what we
abide by in the Congress, as you well know. So that needs not
be referred to.
What we do abide by is the Joint Tax Committee scoring, and
they have never scored your proposal as being revenue neutral
at 17 percent.
Mr. Armey. I have never asked them to.
Chairman Archer. From the beginning until today. And the
argument in the past has been, no, we know it is not revenue
neutral, we wanted to give tax relief to the American people.
That is fine. But if we are going to compare on a level
playing field, then we have got to have a percent that will
duplicate current revenues. Then if want to give tax relief, we
can make an adjustment.
Mr. Armey. Mr. Chairman, I have never at any time since I
first rewrote the flat tax in 1994 ever suggested it was my
objective to be revenue neutral. I have always allowed that it
would be the Committee's objective to do that, should they ever
decide to mark it up.
And I have always been more than willing to work with any
agency or persons that wanted to try to score this code.
If the Joint Tax has scored my proposal and come out with a
conclusion that it would take 26 percent to get revenue
neutral, I would like to look at that. I believe they have made
a mistake.
I think I have a right to challenge their scorekeeping. You
certainly exercise that right. But I do not appreciate having
it suggested in here that I have been out before America being
dishonest about this proposal, especially in light of the fact
that I have not even seen this scorekeeping and have not had a
chance to evaluate it.
Four years ago, when the Treasury Department made these
pronouncements, in a day-and-a-half, we had them retracting
their study because they were wrong. And I fully accept the
possibility that the Joint Tax Committee has as much chance to
be wrong as I do, but I certainly will not have my integrity
impugned on the basis of a study I have not seen.
Chairman Archer. Let me say to my friend, I am not
impugning your integrity because I think you have honestly said
that the 17 percent is short and that you want to give a tax
relief to the American people.
But if we are going to compare alternative plans before
this Committee, then we cannot have every proponent say, oh,
well I intended to give tax relief.
We have got to have a rate that compares on a level playing
field. And the ultimate determinator of that will be the Joint
Tax Committee, not the Treasury. And irrespective of what
arguments any of us might have with them, they will be the
supreme court, as they always are.
And we must follow that and go with it.
Mr. Armey. I think, Mr. Chairman, if you do not mind, we
find ourselves in perfect agreement. I am offering you a form,
a structure within which to write the tax code. It will be
scored by Joint Taxes, as will everybody else's.
And I am going back to where I began this conversation,
when this Committee sits down and goes about the business of
writing a new tax code, you will, even if you try to write a
national sales tax or a national value-added tax, quickly come
to the conclusion that your time is better spent forsaking that
impossible task and writing the flat tax.
Chairman Archer. Mr. Tauzin, what percent on your sales tax
will duplicate current revenues?
Mr. Tauzin. Here is how we calculate it, Mr. Chairman?
Chairman Archer. Do you have a Joint Committee estimate
yet?
Mr. Tauzin. I do not think we do. But it is a very simple
formula. I will describe it to you, and I would do what Mr.
Armey has suggested it, submit it to the Joint Tax Committee.
Chairman Archer. Yes, I think that would be very helpful.
Mr. Tauzin. Yes. I think they have done some work on the
Fair Tax you heard yesterday.
Ours does not repeal all the payroll taxes, nor does it
contain an extra rebate, so it will differ dramatically from
any scoring you already have on the Fair Tax.
Let me tell you how we came to it.
We took the total amount of taxes we repealed, the income
tax, the gift tax, inheritance taxes, certain amount of excise
taxes, we added to it the commissions that would be paid to the
state and the retailers for collecting our tax, we divided that
total into the total consumption as reported by the Department
of Commerce, and we came up with a percentage.
Pretty simple formula. The percentage you come up with, if
you do that work, will be 12.9 percent, 12.9 percent national
retail sales tax would duplicate the income lost from all the
taxes we repealed.
We did not stop there. Because our plan also repeals the
payroll savings tax on all income earned under poverty.
We took that amount of taxes, divided that into the amount
of total consumption, and you get a two percent rate. That is
the amount of sales tax it would take to compensate Social
Security, Medicare for the loss of payroll taxes collected on
all income under poverty.
That two percent was added to the 12.9 percent to arrive at
our 15 percent national rate. That is the rate that according
to this simple math, replicates the amount of income that would
be produced from the following totals.
The income tax repeal on individuals and corporations, from
the gift taxes we repealed, from the death taxes we repealed,
from the commissions we pay to the states, and for the payroll
taxes we repeal under the poverty line.
Add up all those totals, divide it into the total
consumption as reported by the Department of Commerce, and you
will get a little less than a 15 percent rate.
Chairman Archer. I would appreciate it if you would get a
copy of your proposal to me so that I can get it scored by the
Joint Tax Committee.
Mr. Tauzin. Count on it, Mr. Chairman. We will do that
immediately.
Chairman Archer. And then just finally, before I yield to
other members, Mr. Armey, does your proposal repeal the death
tax too?
Mr. Armey. Yes, it does. It ends all forms of double
taxation.
Chairman Archer. Okay, thank you.
Okay, Mr. Doggett.
Mr. Doggett. Thank you very much.
Mr. Armey, if I understand correctly, despite your obvious
affection for Mr. Archer and Mr. Tauzin and Mr. Linder, you are
unalterably opposed to their proposal for a national sales tax.
As you told Fox News on Sunday, ``it does not work and
furthermore it is regressive and it inevitably adds to a tax
code that is equally as complex as today's income tax.''
Does that remain your opinion?
Mr. Armey. My opinion is that, first of all, the current
tax code must be forsaken, we have got to get rid of it, get
behind it. The best way to do that, the most effective way to
do that is the flat tax. It is the only proposal I know of that
can be written, can be enacted, and can be complied with by the
taxpayers.
Mr. Doggett. But I have accurately quoted your interview
with Fox. And that remains your position.
You think that their idea is a very bad idea that this
Congress should reject?
Mr. Armey. I think their idea is a much better idea than
the current tax code as we know it. I believe that in the
effort to actually sitting down, writing it out, enacting it,
that you will find it is an impossible task.
Mr. Doggett. Thank you.
And there was some reference to a Joint Tax Committee
analysis of your proposal. The only one I have seen, Mr.
Chairman, is the one yesterday that said that this sales tax
would have to be at a 59 percent level.
Is there one now available analyzing this flat tax too?
Chairman Archer. I am told that three is and I am
requesting a copy of it in writing which I will be happy to.
Mr. Tauzin. Mr. Doggett?
Mr. Doggett. Thanks. I am going to get to you in just one
minute because I have got some questions I want to ask you too,
Billy.
And as far as you mentioned a markup, has a markup been set
on this flat tax yet. Mr. Armey was referencing a flat tax
markup.
Chairman Archer. I am not sure to what he refers.
Mr. Doggett. Okay. Well, let me move on to something else
then. Am I correct in understanding, Mr. Armey, that you remain
opposed to requiring the Section 527 political bank accounts,
like Mr. DeLay has set up to disclose their contributors and
expenditures on the same basis that all of us, as federal
candidates and political action committees already do?
Mr. Armey. No. I have never said I am opposed to that. I
think I would be happy to have that kind of disclosure and for
the 527, for the labor unions, for any number of other
organizations that are out there now mucking around in our
world with relative anonymity spending other people's money.
What I am opposed to is just taking part of the issue to
the floor without this Committee exercising its jurisdiction on
it.
Mr. Doggett. As far as 527 political organizations, whether
the money comes directly out of a labor union treasury from the
Chinese government, from a corporate treasury, or from anyone
else, do you think that this problem of them taking unlimited
amounts of money and not telling what the source was is a
problem that requires prompt action by this Congress and a
floor vote?
Mr. Armey. I have mixed emotions about that. For the most
part, if the 527 complies with the performance requirements of
such an establishment, that is, does what is legally done under
the law given their charter, I am not sure that I have a need
to know where they receive their resources.
If in fact though, we want to make that disclosure
requirement, I would be happy to live with it, as long as it
was evenly imposed on all such organizations.
Mr. Doggett. But basically you do not think the fact that
they hide their contributors is a problem that this Congress
needs to deal with soon?
Mr. Armey. From my point of view, I do not care who is
paying your bills if you are minding your manners.
Mr. Doggett. Okay. And with reference to another issue that
you have expressed an opinion on, do I understand it is your
view that instead of the House acting promptly to address the
problem of abusive corporate tax shelters, as recommended by
the American Bar Association Tax Section and the Treasury
Department, that it remains your view that this Congress should
instead encourage corporate tax, I believe in your words,
``avoidance is necessary and legal and legitimate.''
Mr. Armey. Tax avoidance is legal; tax evasion is illegal.
This government writes the laws. We ask the American people,
whether through individual or corporate behavior, to comply
with the laws. If they comply with the laws that we write, we
have no complaint about them.
If we want to rewrite the law, we should do so. That is why
we have a Ways and Means Committee, that is why we have a
Senate Finance Committee, and it is our prerogative and our
duty to write the law.
Mr. Doggett. But, again,----
Mr. Armey. But as we write the law, we should never
exercise any prerogative to complain about the legal compliance
with the law we write.
Mr. Doggett. In terms of your priorities, you do not see
abuse of corporate tax shelters as something this House needs
to move on promptly to address?
Mr. Armey. I believe that is addressed. Chairman Archer has
addressed that repeatedly and recurringly and consistently
throughout all his efforts----
Mr. Doggett. You see nothing further that needs to be done
in----
Mr. Armey. I did not say that. I am saying that I am not on
this Committee and I am not an expert of it. I have a Chairman
though that is distinguished in the respect that he commands
across the nation is unparalleled in his understanding of the
Tax Code, and I am more than happy to work with him and this
Committee as they move forward.
Mr. Doggett. As far as tax avoidance, does your proposal
that you are advancing here in front of the Committee, repeal
those sections of the Internal Revenue Code that currently
prohibit tax avoidance?
Mr. Armey. Tax avoidance is legal, is a legal activity.
Anybody has a right to minimize their tax burden within the
existence of the law. This accounting 101. Everybody knows
that.
Tax evasion is illegal activity. I do not believe that tax
evasion should be tolerated, and tax avoidance is a basic right
of every taxpayer.
Mr. Doggett. You indicate that your concern in your written
testimony with the many pages and the millions of words that
are in the Tax Code.
Can you advise us of how many hundreds or thousands of
pages have been added to the Tax Code during the time you have
been majority leader?
Mr. Armey. I have no idea, but I can tell you it is
impossible to do much of anything with this existing code
except to abolish the separate parts like we did with the
marriage penalty or like we did with the earnings limitation,
cut it out. It is like cancer. You cut out the lump completely
and throw it away.
But this is one of the problems with the existing Tax Code.
You cannot either lower it or raise it without making it more
complex.
Mr. Doggett. Is the number of pages or sections or pounds
or words that have been added to the Tax Code during the time
you have been majority leader something you could advise the
Committee on?
Mr. Armey. I do not know the answer to that. It is roughly
the same as the number of pages that have been increased since
you have been on this Committee.
Mr. Doggett. Well, I have only been on it for about a year-
and-a-half. But in the last six years, you have added much more
than that, have not you?
Mr. Armey. I have no idea.
Mr. Doggett. No idea?
Mr. Armey. I do not count such things.
Mr. Doggett. Mr. Tauzin, let me see if I can get one idea
from you, and I only have one question for him, Mr. Chairman.
Do I understand that under your proposal, that you would
view as a significant federal revenue source, particularly in
future years, electronic commerce?
Mr. Tauzin. No, we have not addressed the issue of
electronic commerce.
Mr. Doggett. Well, you are going to tax, as a federal
revenue source, all the sales over electronic commerce, are you
not?
Mr. Tauzin. No, we have not addressed that issue at all in
the plan. The plan was written before electronic commerce even
began.
If you will let me answer.
Mr. Doggett. You cited some testimony and then you can
elaborate on that. Your written testimony----
Mr. Tauzin. Well, I am trying to answer you, Mr. Doggett,
give me the courtesy of an answer.
Mr. Doggett. Sure, if you would, sir. Your written
testimony indicates you do not want to exempt anything, that it
is important that it be a broad-based tax. So if you would tell
us if you plan to or to not impose a sales tax on electronic
commerce?
Mr. Tauzin. Let me try it again. Let me try it again.
When the Joint Taxation Committee reviewed the Fair Tax
plan you heard yesterday, they stated very clearly that the
estimate did not assume that retail Internet sales would be
subject.
We have not made an assumption one way or the other because
Internet retail sales now amount to less than two percent and
80 percent of those are in services that are not subject to
sales taxes today.
So let me make the point to you. The plan we wrote was
written to the advent of the beginning of this electronic
commerce technology phenomenon.
If the decision of this Congress is, at any point, to
subject Internet sales, goods or services, to taxation by any
jurisdiction, that is a decision we will make separate and
apart from the decision we make on changing the income tax code
to a consumption tax code.
We did not assume Internet commerce sales in our numbers.
They were not in our 15 percent projection. If Internet
commerce becomes a major part, as it certainly will be, we will
have to address that as a separate issue as written----
Mr. Traficant. Will the gentleman yield.
Mr. Doggett. Mr. Tauzin, as written, and as presented to
the Committee today, your bill contains no exemption for
Internet commerce sales, does it?
Mr. Tauzin. Let me say it again. The bill was written prior
to the advent of Internet sales and sales taxes on the Internet
even becoming an issue.
Let me make a point to you. If the decision of our
Congress, at some point, was to reject a recommendation of the
Commission that we created, that is, recommended no taxes on
Internet, if we reverse that decision and decided that the
states and localities did have a right to collect the sales tax
on those, or if we wanted to impose the national sales tax on
those numbers, those numbers would then be calculated----
Mr. Doggett. I appreciate that. But you understand, of
course, since you referred to the Joint Tax Committee, that
when scoring the Fair Tax, they included Internet sales and
said it would be substantially higher than 59 percent sales tax
if you did not include Internet sales.
And if we passed your bill as you presented it today, it
would impose a sales tax on every bit of E-commerce in this
country today.
Mr. Tauzin. Let me say it again. The assumptions we made in
our bill were based upon the current economy. The current
economy without the advent of substantial----
Mr. Doggett. In what year?
Mr. Tauzin. I am sorry?
Mr. Doggett. In what year?
Mr. Tauzin. We started the bill in 1996, I think it was.
Mr. Doggett. We had pretty good E-commerce going down our
way in 1996.
Mr. Tauzin. Yes. No. You did not have any E-commerce?No,
sir. In fact, a browser was presented to the American public in
1995. If you had a lot of E-commerce going in 1996, Texas was
substantially ahead of the world.
Mr. Doggett. It usually is.
Mr. Tauzin. It usually is. And guess what Texas did, sir?
Texas does not have any income tax, it has a sales tax. And
when Mr. Armey talking about there being no great country in
the world that has ever gotten rid of the income taxes and
adopted a sales tax and done well with it, he neglected to say
that the great country of Texas has made that decision and has
done fairly well with it.
In fact, the states that have gotten rid of their income
taxes and have gone to sales taxes do substantially better
economically than the states who either have income taxes or a
combination of the two. Texas is a good example why we ought to
do this for the country.
Why does it make sense to locate in a state which has an
income tax that is going to add to the cost of doing business,
when you can locate in the great State of Texas and pay no
income taxes, and simply have others pay the taxes when they
buy your products?
Texas understands that.
Mr. Doggett, you ought to understand it too, sir.
Chairman Archer. That is a good place to terminate this.
Mr. Traficant. Mr. Chairman, I want to make one quick
response, if I could, to my fellow Democrat.
Our bill would repeal corporate income taxes, shelters
would not be a big problem.
Second of all, if this Committee would ever decide to tax
the Internet, it would raise more revenue with our bill.
And I think that the numbers you are throwing around are
very arbitrary, and I do not think they come from sound,
pragmatic information.
Now let me just close by saying this. You had about ten
minutes. One thing I think is important in this process,
whether you are Democrat or Republican. We are trying to help
the American people. And one thing we do not want to do is
scare the American people by pushing partisan concepts.
And I would just like to say that I believe that our plan,
at 15 percent, is tentative. And I have talked to the Chairman
myself. I believe that it is something we can work out and make
manageable at a figure much lower than a flat income tax.
Chairman Archer. Let me speak just briefly to what my
colleague, Mr. Doggett, alluded to which appeared to me to be
an effort to say that Republicans have complicated the Tax
Code.
Now maybe I am misreading the inquiry.
First, the number of pages that we have to comply with and
the number of words that we have to comply with is primarily
being churned out by regulations out of the Treasury and the
IRS. And they are spewing out by the hundreds of thousands.
The number of additional pages to the Tax Code that have
occurred in the last six years, I regret. But the gentleman
from Texas realizes that the only tax bill that has been passed
was the one in 1997 that was negotiated with the Administration
which insisted on provisions that I could not prevent that
thoroughly complicated the Code and required many, many extra
pages.
Now you cannot have it both ways. On the one hand, you
cannot say the Administration is responsible for the wonderful
economy, but the Congress is responsible for extra pages in the
Tax Code. That does not wash.
And so let the record be very clear about that.
Mr. English?
Mr. English. Thank you, Mr. Chairman.
And Mr. Chairman, I want to compliment your performance
chairing this hearing in that you have given a great deal of
time for a variety of views to be heard and you have not
strictly honored the time limits.
I am going to keep my remarks brief. I want to compliment
these two gentlemen for the exceptional job they have done and
the majority leader has done of framing the issues of tax
reform.
You were not present earlier today when we heard testimony
with regard to my tax proposal which has some similarities to
yours.
And on the business side, there are some clear similarities
that I would like you to comment on.
Mr. J.D. Foster from the Tax Foundation described the value
of border adjustability very clearly.
And Mr. Tauzin, you and Mr. Traficant have also made a
strong case for it here.
Mr. Foster talked about, in effect, importing the tax base
of our competitor countries when exports are taxed.
Mr. Hufbauer, on the second panel, talked about how a
border adjustable tax eliminates the tax motive for runaway
plants.
I know, Mr. Traficant, that has been the source of a lot of
your interest in some of these issues.
I wonder if either of you could comment on the effect that
your plan would have on the cost of capital for businesses
trying to compete in the international marketplace?
Mr. Tauzin. Well, let me turn your attention, Mr. English,
to the study done by Dale Yargenson at Harvard University.
Mr. English. I am familiar with it.
Mr. Tauzin. He indicates in there that, in the long term,
in the long run, producer prices in America would fall by
almost 25 percent relative to prices under an income tax code.
Now, when producer prices fall and you are shifting away
from a tax code that penalizes savings and investment to one
that rewards savings and investment, and only taxes
consumption, the combination of consumer prices falling, which
means lower cost to produce products, and the combination of an
incentive for savings and investments, because there are no
taxes on interest earned or investment portfolios or capital
gains any more, both combined to increase savings rates and to
lower the cost of capital to those people who want to invest
and dramatically increase manufacturing opportunities in the
country.
In fact, his conclusion is, production would increase in
all industries and the rise of production of investment goods
would be much more dramatic.
The combination would be, according to Dale Yargenson,
absolutely phenomenal.
Mr. Traficant. I would like to just quickly respond
thereto, Mr. English, and appreciate all your efforts that you
have done on this.
Mr. English. And we appreciate yours, sir.
Mr. Traficant. I think that our bill will send a clear
message to the world that if you are going to play in the
biggest marketplace, the flea market of the world, it might be
good to put some roots in there, rather than look at 15 or 16
or 17 percent when the Chairman is done, ultimately looking at
the numbers and the prices.
And that Toyota may not be shipped into America, it is
going to be built in America because they are going to want to
take that competitive advantage away that American firm is
going to have.
When we drop the prices, the capital and the use of capital
will raise. When you are not taxing savings and investment,
there is going to be more savings, thus there is going to be
more capital, thus we are going to have a downward spiral on
inflation with a built-in hedge against inflation which will
provide more capital the normal way, through commercial loans
that are caused by savings, not by borrowing and foreign debt.
Mr. English. That make excellent sense.
Let me also quickly, gentlemen, ask you one last time so we
can clarify.
Neither of you are here advocating Internet taxation, are
you?
Mr. Tauzin. Let me say that again. No, we have not.
Mr. English. That is all you need to say.
Mr. Tauzin. No, we have not.
I do want to correct the record that the Tax Committee
report that the gentleman referred to on the Fair Tax, that is
not our plan. That is a plan that was presented yesterday did
make an assumption that Internet sales taxes would apply to the
Internet.
We made no such assumption.
We leave it to the good sense of your Committee in drafting
a national sales tax plan along with the other members of
Congress who are going to have to make that difficult decision
to decide it.
But if we decide it as a Congress, that goods and services
sold on the Internet were going to unfairly compromise in
competitive terms, goods and services sold within our states
and that are currently taxed, if we wanted to rationalize a
system, you can do it within a national sales tax context a lot
easier than you can trying to let 1700 jurisdictions tax the
Internet.
So while we make no judgment on that, Phil, we do not
recommend it. We make the point that at least if you want to
make a decision on that, the national sales tax is a place
where you can reasonably and rationally make those decisions.
Mr. Traficant. One thing I would just like to add briefly
is if that ever did happen, and we were to tax that Internet
sale activity, it would be very hard to avoid the tax and to
have an underground economy, would not it?
So I think that is a decision your Chairman and your
Committee makes, and our bill would be, in my opinion, an
enhancer for revenue, but we do not have it as a part of our
construct.
Mr. English. Mr. Chairman, I have plenty of other
questions, but I think out of courtesy, I will leave them to
another time. Thank you.
Chairman Archer. I overlooked, in my preliminary comments,
a compliment to our colleague, Mr. Traficant, who was kind
enough to compliment me on the IRS Reform Act, and without his
persevering efforts, I do not believe we would have shifted the
burden of proof, because he drove that issue or the levying on
someone's homestead without a court order.
And those two vital provisions in that reform were driven
by Congressman Traficant, and I was pleased to be able to be a
vehicle to carry his ideas into law.
Mr. Traficant. Thank you, Mr. Chairman.
Those were some of those additional pages too, were not
they?
Chairman Archer. Yes.
Mr. Traficant. Those very good things.
Chairman Archer. Yes. Yes.
Mr. Collins?
Mr. Collins. Thank you, Mr. Chairman.
You know, Mr. Chairman, I think it is interesting and good
that we have the dialogue among members especially as we have
seen here this afternoon. I have enjoyed listening to three
Texans in the dialogue. I have always heard that things are big
in Texas. Some people produce big ideas, some people produce
big talk.
You know, I came here in the elections of '92. I remember
the first yea here, the approach to the budget and deficit
reduction was a large tax increase. I do not how many pages it
added to the Tax Code, but I do know it some somewhere around
$250 billion over five years, and it taxed additional benefits
on Social Security. It took the cap off the Medicare earnings
for tax. It added an additional marginal rate. It also added a
surtax in retroactive taxation for the first time in history
and a 4.3 percent fuel tax increase for deficit reduction. That
was the approach of that budget of 1993.
I also know that in the beginning of 1995, when a new
majority was formed in this town by the people across this
country, that the CBO, the Congressional Budget Office,
reported that based on the way the government was running,
based on the previous majority, the deficits over the next ten
years from that date would be somewhere around $3 trillion
negative cash flow.
Spending was wild. It was about as wild as the approach to
the '93 tax reform and budget.
I also know that the only tax relief that the American
people have seen was in 1997 and then our seniors last week
with the signing of the earnings limit repeal.
But I do know too that at the beginning of 1999, the
Congressional Budget Office came back to the Congress and said,
look, based on the way the government is now operating, the
approach that we have taken to the budget process and to
attempted taxation relief, a strong economy that has made by
the people of this country that the projections were over the
next ten years, we would have $3 trillion positive cash flow.
Now a lot of people use the word ``surplus,'' but it is a
positive cash flow.
And even came back the first of this year and said there
would be another trillion, a $4 trillion positive cash flow.
I think that is quite substantial in comparison to any type
of regulations the IRS may have added to the pages of the Tax
Codes.
You know, I hear a lot and receive a lot of E-mail about
the proposed Internet tax.
I think one of the reasons the people get up in arms so
about a proposed Internet tax is because they do not want an
additional tax. It is not that they are not looking for a fair
tax, they just do not want an additional tax. They are already
taxed too much as it is.
And I have always felt like that excessive taxation comes
from excessive spending. We still have some spending that we
need to address, even as the majority.
Mr. Chairman, I appreciate the gentlemen that have been
here to offer their proposals on a flat income tax and a flat
national sales tax.
And to quote a good friend of mine from my district that
used to serve in the Congress of the United States, at home I
have friends for the flat income tax and I have friends for the
flat sales tax. And, Mr. Chairman, I am for my friends.
We thank you for this dialogue, we thank you for this
hearing, and we appreciate our colleagues coming with their
comments and their proposals.
Thank you, Mr. Chairman.
Chairman Archer. Thank you, Mr. Collins.
Mr. Becerra?
Mr. Becerra. Thank you, Mr. Chairman. And let me thank my
friend, Mr. Tauzin, for being such a sturdy character and being
able to sit there and take all the questions. We thank you for
your patience.
Mr. Tauzin. Thank you, sir.
Mr. Becerra. Let me go back to the Internet tax because I
think it is an important point to make. And I think you were
trying to be thoughtful in your response to that. That at the
time you were proposing this, we did not know the impact that
the Internet would have and the growth of sales on the
Internet.
I think everyone agrees that it is going to continue to
grow. And right now, Congress has agreed on a moratorium on
taking any action with regard to taxing the Internet.
In your written statement, in your testimony, you do say
exempting entire categories of goods or services would
inevitably lead to an administrative nightmare of definitions.
If now, if what you are saying is that because we were
expecting the Internet to become such a major player in retail
sales, you did not take it into account, can you reconcile that
with your statement that if you start having exemptions of
categories of goods or services, that this will inevitably lead
to an administrative nightmare of definitions.
How do you reconcile that now?
Mr. Tauzin. Well let me explain to you what we meant by
that, what we mean by that.
The concern was that there are categories of purchases,
like food and drugs, that might or should be subject to an
exemption. Because those are items that are used by all of us
regardless of our income and because those items tend to be
necessities in life that the people at the bottom there has
been a disproportionate share of their income in order to
purchase.
Many states give exemptions for food and drugs and other
items. All of those states have experienced bureaucratic
nightmares with their exemption program. Is Cheetos a food or
an entertainment? Who knows what it is?
So they have come with some bizarre descriptions of what is
a food that is exempt and what is not. And we have tried to
avoid that by simply providing the 15 percent rebate into a
worker's salary for the amount of money that otherwise would
have gone into the Social Security Medicare Trust Fund from
payroll taxes.
We make that up with a two percent add-on to the retail
sales tax.
In effect, we found a simple way of compensating people at
the bottom for the taxes they would pay on necessities like
food and drugs.
Mr. Becerra. Now, let me keep you focused at this stage,
and I am not asking you this is what you would do in your
legislation. But at this stage, now knowing what you know about
the Internet----
Mr. Tauzin. Let's talk about it.
Mr. Becerra.--yeah, what is your sense right now. How would
you treat the Internet in your legislation?
Would it be taxed so that there are no exemptions, or at
this stage, are you saying that maybe there is a need for an
exemption for Internet retail sales.
Mr. Tauzin. Let's talk about it.
First of all, understand that one of the reasons for a
national sales tax that I think is superior to a flat income
tax is the border adjustability question. The problem is that
American workers are penalized when they buy their own products
and rewarded when they buy foreign products.
If you want to keep to that border adjustability you have
to at least make room in your plan for the notion that you
cannot let American consumers buy foreign goods over the
Internet and escape the border adjustable tax.
So you probably have to take that into the consideration in
the context of a formal plan that we would eventually adopt
taking into account Internet sales.
Mr. Becerra. But then how would you account for the
difference between prescription drugs that are produced here in
America versus abroad? Would you now make an exemption for
seniors on Medicare who are on fixed income who have to
purchase drugs to now have the exempted from the tax, or will
they have to pay a tax?
Mr. Tauzin. I do not think that is the issue because our
plan provides a rebate whether you buy a foreign drug or a
domestic drug. You still get the 15 percent rebate, and we are
still producing products in America, according to the Harvard
study, at 25 percent less cost than we are producing them
today.
In effect, we are producing products in America that cost
less and you have more money to buy them with, so you still
come out better.
The issue you raise, though, which is a real one, is if you
go to a national sales tax base, in order to achieve border
adjustability, you must apply the tax to foreign imported
product, then must you simultaneously apply it to a domestic
product that is purchased over the Internet as opposed to
purchased in a brick and mortar store?
And the answer is, you may well have to. You may end up
with that conclusion. Because to exempt it might create a
problem with WTO.
Mr. Becerra. So what I hear you saying is. Probably look at
an exemption so that you can compete with foreign sales, but
not an exemption if it is a retail sale over the Internet
domestically?
Mr. Tauzin. No, what I am saying is I think you have to
apply the same rule to both.
Mr. Becerra. But then you would exempt domestic sales as
well?
Mr. Tauzin. If you ended up deciding you wanted to exempt
all domestic sales on the Internet from the national sales tax,
I think you would have to exempt the foreign imported purchases
as well.
Therefore, I think you would probably have to do what the
Joint Tax Commission did. You would probably have to assume
that they are all either subject to taxation or not.
And that is, as I said, is a decision we are going to
collectively have to make.
Mr. Becerra. But then what you are going to end up with is
a higher tax rate on your sales tax because, as the Joint Tax
Committee has said, that with the AFT proposal, which is
similar to yours, as a consumption tax, they assume that the
Internet retail sales will be taxed, and if they are not, that
means the tax rate you would have to impose on sales would have
to be even higher.
So you are going to have to impose a higher rate which is a
higher rate for that drug purchase by that senior for those
prescription drugs or for funeral services or for medical
services.
If I go have a surgery, a lifesaving surgery, I will have
to pay taxes on that, that someone who has got the good fortune
to be able to purchase on the Internet will have those
particular purchases exempted from the tax.
Mr. Tauzin. That is my point. I think you either have to
come to the conclusion that you exempt them all, in which case
you have a reduction in income not just to the federal system,
but to all the state and local jurisdictions.
You have to come to a conclusion that you have to
rationalize the tax collection across the board. I think we end
up, at some point, deciding the latter, but that is a decision
we all have to make.
If you do exempt them across the board, of course you need
higher rates on that which is not exempted. That is why we
start with the proposition that you ought to at least start
with the notion that the fewer exemptions the better, because
that applies a uniform treatment to all parties in the
marketplace.
And secondly, that you ought to keep the rate as low as
possible so that you spread the burden across the spectrum of
consumers. Always keep in mind that we protect those at the
bottom.
And I appreciate your reminding me of that because my
friend from Texas asked Mr. Armey to reiterate his quote on the
news show this weekend.
I heard him this weekend, and I almost called him up
because he is never said that in any of our debates, because he
knows better than to say that the plan we have presented is a
regressive tax plan.
You can have a sales tax that is regressive if you do not
take care of people under poverty. But we do. It is not
regressive.
You know what is regressive? What is regressive is an
income tax code that adds 25 percent to the cost of every drug,
every piece of bread, every bottle of milk that a family buys
to take care of themselves. That is what goes on today.
Mr. Becerra. And that is a notion that ultimately, if we
were to move towards a different system, would be tested
because it still stands to be seen if rates, prices on goods or
services would actually go down.
Mr. Tauzin. Let's talk about that for a second.
Mr. Becerra. Well, I know I am running out of time.
Mr. Tauzin. I think we got time.
Mr. Becerra. All right, but before we go there, let me ask
you this.
When do you think you will have some sense about what you
will do when your legislation with regard to Internet retail
sales?
Mr. Tauzin. Well, first of all, I would not do anything in
the legislation to make that decision until we collectively
make it as a Congress.
You would have to decide whether, if you were going to
national sales tax, whether you wanted higher rates on the
goods you do not exempt in order to exempt goods on the
Internet.
I do not think you would make that decision. I think we
would end up deciding to cover them all equally at some point,
but that would be a decision we would make jointly.
Let me mention, let me answer the question you asked about
whether prices would fall. The answer is at your local Wal-Mart
today. Wal-Mart and K-Mart compete bitterly right now for your
and my dollars.
I understand they are operating on extremely small margins.
And if it was not a competitive marketplace, they could
probably raise their prices 25 percent, and you and I would
have to pay it if the only place we could go is to one or the
other.
But because we have a competitive marketplace, they have to
operate on small margins. They cannot gouge us. Competition
does that.
If Wal-Mart all of a sudden tomorrow, because we repealed
the Income Tax Code, is now able to buy goods for substantially
less than they did last week, and they try to sell them to us
at the same price as they did last week, they will find out
that K-mart is taking their business away.
Mr. Becerra. But how are they purchasing them for less if
they are going to have to pay to purchase the goods that they
are going to sell are taxed?
Mr. Tauzin. Ah, but they do not. Read the bill. The bill is
only a retail sales tax. There is no tax on the wholesale,
there is no tax on the purchase of raw materials.
Mr. Becerra. Where is the savings on the goods that was
produced?
Mr. Tauzin. I am sorry?
Mr. Becerra. Where is the saving on the good that is
produced?
Mr. Tauzin. Here is where it comes from. In an income tax
world, even a flat income tax world, the two professors who
devised Mr. Armey's plan, Dr. Holland Rebushka have admitted
this I think in testimony to this Committee.
When you apply a tax on the earnings of individuals and the
earnings of corporations, you are effecting applying a VAT tax.
You are taxing the value added to the product as it goes
through the various stages of production.
At the very end, the consumer pays it all. It all ends up
in the price of the finished product. And you and I pay that
tax at the end.
Mr. Becerra. Right. But you are talking about a wholesale
product that has not gone through that whole----
Mr. Tauzin. But this is my point to you. If you repeal
income taxes, and you only apply the tax in our plan at the
very finished product retail end, there are no taxes collected
along the manufacturing process.
For example, the farmer does not pay a tax on the purchase
of seed and fertilizer because that is a tax for the purpose of
producing a product. There is no tax on those things under our
plan.
There is no tax on the purchase of the tractor designed for
business or the rental for office space. The tax does not apply
to the miller, it does not apply to the baker, it does not
apply to the wholesaler. The tax is only collected, under our
plan, at the very end of the retail point of purchase.
Mr. Becerra. Well, let's take food.
Mr. Tauzin. Okay.
Mr. Becerra. Anything grown in a field that is picked. Say
there is some----
Mr. Tauzin. Let's take wheat.
Mr. Becerra. Wheat, or any kind of crop. There are only so
many taxes that will be charged and that is only a certain
percentage. In the case of particular states, whatever it might
be, whatever the sales tax might be in that process.
How do you get to the point where you are reducing the
price by the 30 or so percent----
Mr. Tauzin. Twenty-five percent.
Mr. Becerra. Twenty-five percent. You are ultimately still
going to have a price for that product which you are expecting
to be able to lower as a result of the elimination of income
taxes along the stream are all these various taxes.
But ultimately you are talking a lot about being able to
reduce wages to make up a lot of the difference since employees
are no longer paying income taxes. You are assuming you will be
able to reduce wages of employees to reduce the cost of
employers in providing a particular good or service.
Mr. Tauzin. No, we are not. And that is what--you have got
to look at Dale Yargenson's study to see that. He does not
calculate a loss, a reduction in the wages. In fact, under our
plan, the wages go up by 7.5 percent.
Because you not only get your total wage, you also get the
7.5 percent your employer was formerly sending to the payroll
system.
Mr. Becerra. I thought you kept the payroll system? I
thought you kept the payroll tax?
Mr. Tauzin. Pardon me?
Mr. Becerra. I thought you kept the payroll tax?
Mr. Tauzin. You keep it above the poverty line. We only
repeal it below the poverty line. So if all income earned up to
the poverty line, the worker gets his full paycheck plus that
7.5 percent his employer was sending in.
See, you have got a lot more money now to go buy your bread
and your milk and your drugs.
In addition, because the businesses will no longer be
paying taxes on the income earned on the raw materials, the
wheat, eventually the flour, eventually the bread, eventually
the packaged bed products, eventually the donuts at Krispy
Kreme, wherever you are going, because none of the taxes are
collected on the value-added to those products and all the
compliance cost is done away with, all the lawyers and
accountants the businesses have to hire to comply with the
Code.
That saves you 25 percent----
Mr. Becerra. But where are the taxes on strawberries? How
many levels of taxation are there on, say, strawberries that
are picked and then shipped directly to a grocery store?
Mr. Tauzin. They are processed. Strawberries are first, you
know, there are farmers who grow them. They have to buy
fertilizer, they have to own land, they have expenses. Farmers
pay taxes.
If a farmer does not have to pay a tax on the income he
makes from the sale of his strawberries, that reduces the cost
of the strawberries to the consumer.
If the guy----
Mr. Becerra. Where I think the disconnect between what you
are proposing and what will ultimately happen is that you are
saying a quarter of the cost of all goods and services will be
eliminated by this particular change in the Tax Code?
Mr. Tauzin. Yes.
Mr. Becerra. And I think that is a big leap of faith. That
folks are out there saying, well, if I am going to pay this new
higher tax for a prescription drug, to bury my father, to have
that medical surgery that I need to stay alive, I want to know
how I am paying for it.
And you are asking a lot of folks to believe that all of a
sudden, we are going to see major drops in the cost of a lot of
these products and services.
I know I have taken up a lot of time, Mr. Chairman.
Mr. Tauzin. All I can tell you, Mr. Becerra, is that is the
nature of our free market competitive system.
Let me be honest with you. If there is a product out there
and if it is a cable service, and you have got no competitor to
it, you know, there is no direct broadcast satellite with local
programming into your town, and so you are bound to buy a cable
if you want your local program, I say that is a monopoly
provider of service, and our bill will not lower the cost
there. Because any monopolist can charge whatever he wants all
the time in our marketplace.
But whenever you reduce the cost to any competitive player
in a competitive marketplace, you will eventually reduce the
cost to the consumer. Otherwise, somebody will take his
business from him.
That is the nature of competitive bread businesses and
strawberry businesses.
Let me make a final----
Mr. Becerra. Before you make that final point, I agree with
what you just said.
If you can reduce the cost to the producer, certainly in a
competitive world the charge for that product will be lower for
the consumer.
Mr. Tauzin. I think that is correct.
Mr. Becerra. But the consumer's saying, you are telling me
to swallow, in some cases, a 30 to 60 percent tax on these
products and I am wondering if producers are going to be able
to reduce the cost that much so that I will not pay more.
That is where the leap of faith comes in.
Mr. Tauzin. That is a fair question. The only thing I can
tell you is, again, that it is going to be different depending
upon how many stages of production are in a product.
For bread, it is about 35 percent. That is not my number.
That is numbers derived by people who have studied this
carefully.
Dale Yargenson is not--the School of Economics at Harvard
is not the bastion of conservative thought. We are talking
Harvard University here.
They are telling us the average reduction in producer
prices is 25 percent of you get rid of the Income Tax Code.
Do you know what that says to you and I? That says that we
are being punished, as workers in our society, for buying the
products we make in America by 25 percent.
That is terrible.
Mr. Becerra. You know, and we can always cite studies that
show that it would be different than the 25 to 30 percent drop
in the price.
The difficulty I think a number of folks have is that when
you need an operation, you cannot ask, well did the price drop
on the cost of that operation, which will now, under your tax
scheme, be taxed?
I will have to pay a tax on the $7,000 charge for that
hospital bed, the $7,000 charge for that surgeon, the $5,000
charge for that anesthesiologist and all of that is going to be
taxed at a very high rate, and I have got to hope for my life
threatening surgery that I need, the lifesaving surgery that I
need, that in fact the prices will have dropped.
And that could apply to the senior on fixed income who
needs prescription drugs.
That could apply to my father who passes away and I have
got to pay for funeral expenses if I do not have money. That is
the difficulty I think folks have.
And you have been gracious and I thank you for the----
Mr. Tauzin. Let me, let me just say one final thought.
Mr. Becerra. Sure.
Mr. Tauzin. You see, the perniciousness of our current
Income Tax Code is that it hides the truth from all the folks
you have just described who go buy those services today.
The ugly truth is that they are buying those services with
after-tax dollars. They have already paid taxes on their
income, they have paid it on their savings, they have paid it,
in some cases, on their Social Security even. And then they go
buy those services.
And the ugly truth is they are paying the same taxes all
over again, because the services and the goods they are buying
made in America contain all this hidden income tax cost.
That is the ugly truth, and if you face that ugly truth
that we are paying twice on the same dollars every time we buy
necessities of life in this country, unless you buy a foreign
product, then you come to the realization that you would be
much better off paying it only once at the end instead of
paying it once on your income, and then once on the purchase.
Mr. Becerra. I do not think any American is deceived by the
notion that we are going to be able to just get rid of the Tax
Code and not have to pay taxes.
I think every American believes that it is an obligation to
keep this country a civilized society.
Mr. Tauzin. I agree with you. But if you had a choice of
paying once instead of twice, what would you choose?
Mr. Becerra. I choose to pay the lower, whichever is lower,
and I think most people will say, at the end, I do not care
which system it is, it is the one that reduces my taxes most.
Mr. Tauzin. That is right.
Mr. Becerra. And I do not know if the consumer will say
that it is fairer to pay it one time at a high rate versus many
times at a smaller rate.
I think we have to ultimately assure the American people
that they are not going to be further taxed by having gone to a
system, even if it is simpler.
Mr. Tauzin. That is a fair evaluation. I thank you for it.
Mr. Becerra. Thank you.
Thank you, Mr. Chairman, for the time.
Chairman Archer. Thank you, Mr. Tauzin.
Mr. Tauzin. Thank you, Mr. Chairman.
Chairman Archer. We appreciate your input.
The colloquy you just had with Mr. Becerra I think is
fundamental and is very constructive and important for us to
hear.
If I may just engage my colleague a moment further, the
points you are making are matters of concern that we have got
to address if we go in this direction.
I think it is important to note that fundamentally what we
all should try to achieve I think in how we tax is to create
the greatest opportunity for the greatest productivity and the
greatest competitiveness in the world marketplace so that we
can have an economy that not only grows, which it is currently
doing nicely today, but which creates better jobs, better
paying jobs.
We have full employment today. Hopefully, that will
continue for a long period of time.
But the important thing now is how do we elevate these
jobs, how do we have more in the family paychecks for all
Americans, and how much less does our tax system create
inefficiencies, non-productivity, waste, as it were.
We talk about waste in federal spending, but we have to
also talk about what waste there is in our tax system. We need
to come to grips with all of these and to make sure how it is
going to affect an individual product is important but perhaps
not subject to precise quantification.
I would add a couple of things, and I will be glad to have
a response from you because this will all go in the record and
I think that will be very helpful to consideration in the
future:
That when we pay taxes, both the cost of the tax and the
compliance costs are a cost of doing business. They must be
recovered one way or another. They are either going to be
recovered by the investor getting a lesser return on their
investment, or by labor being paid less, or by the consumer
being paid more.
There are really only three places for this to go.
Most people believe that in most products that it will be
passed on to the consumer in the price of the product rather
than going back against the investor and lowering wage rates.
To that degree, it must be recovered. But when we say there
is an average 20 to 25 percent, that does not mean that is the
same on every product. And the loaf of bread might be different
than medical care. And medical care might be different than
purchasing an insurance policy or whatever the rest of the
activity is.
And yet when we talk about a loaf of bread, which is a good
one because it is a staple in all of our lives, what the farmer
gets in the wheat is minuscule compared to what the expansion
of that price is through all of the middle men, the processor,
and everything else. And those people really are on the front
line in bearing the burden of the income tax, both compliance
costs as well as the tax itself.
I cannot, nor can Mr. Tauzin, for sure tell you what it is
going to be on a loaf of bread. But we can tell you some
averages. Because the one thing that is pretty basic is that
compliance costs for the current income tax which must be borne
by our society are a minimum of $200 billion a year.
Fortune Magazine says they could be as much as $500- to
$600 billion a year.
Now that is all wasted effort and somebody has got to pay
for it. It is not creating wealth. It is not creating bread, or
any other thing of real value in our lives. It is just a part
that has to be administered under this tax system.
If we can cut that down by 90 percent, then the burden of
anywhere from $180 billion to perhaps $2- or $3- or $4 billion
dollars is going to be removed as a cost in the total economy.
How it will relate to any individual product we cannot
absolutely be sure.
But I think as we seek, and this would be my overall
objective, and I think most of us would agree with it. We may
not agree how to get there. But that we should be very careful
as we spend the taxpayers money to assure that it is being
spent efficiently.
By the same token, we should have as efficient a tax system
as we possibly can. That is a long number of words that I have
put out there, but I would be glad to have your response.
Mr. Becerra. Mr. Chairman, I think most folks who may have
just heard your remarks would be nodding right now in full
agreement.
Certainly any time that we are using money in the stream of
the economy just to pay for administration, above and beyond
what is necessary to get that product to market, is certainly
an inefficiency and we should try to eliminate the total cost,
or at least reduce it to the degree possible.
In fact, I think Mr. Tauzin and everyone else who has come
before this Committee is completely genuine in their efforts to
try to come up with a system that just works better, whatever
it might be.
Obviously there are different beliefs about how we best do
that. My concern with any system, including the one we have now
which I agree is extremely cumbersome and every year we talk
about its cumbersomeness but we make it more cumbersome, my
belief is that whatever we do we have to be able to face every
American and say we have tried to do it by a change in the Code
so that it helped you.
I am not certain yet that I have heard a proposal yet that
lets me say it helped you--and by the ``you'' be able to
reference as many Americans as possible. I am not sure if I
have heard a proposal that includes as many ``you''s as
possible.
That is where I would be concerned. Because we get into
this notion of what is on paper. It looks good on paper, but
when you play it out the terms we use ultimately are very
different. As I always say, it looks really good in the war
room when the generals move the war ship here and the tank
there, it looks really good, but on the battlefield the folks
that have to fight the war look at it a little bit differently.
A quick example. I know that many folks, the Chairman
referenced this full employment. Full employment means that we
have some 7--8 million Americans right now who are not working
because about 4 percent of America is not employed, and that
includes only those who are actively searching.
I mention that because my father when he was still
employed--now he is retired--used to be among those folks who
would only be partially employed because his work in road
construction was temporal. During rainy seasons he could not
work because there was no road construction that would take
place.
So for three months out of the year, or sporadically
throughout the year whenever it would rain he could not work.
He would always work. He would find something else to do to
earn some money. But he could not work in the field that he
most practiced.
And while he was unemployed and had to either get
unemployment compensation or try to find a second job, he
really was not unemployed. He was seeking out work. So those
who are out there meaningfully trying to find a full-time,
well-paying job should not be lost in the shuffle when we talk
about full employment.
There are a lot of folks out there.
And in the same vein, as we try to reform the tax code to
make it better and fairer and more efficient, I think we have
to remember that the bottom line is the guy that does have to
go in for the surgery. Are we going to make it easier for him
to survive not just the surgery but the cost of the surgery
afterwards?
And as we buy the loaf of bread or buy the dental service
or bury our deceased loved ones, have we made the tax code work
better for them?
I do not think anyone approaches this without a real
thoughtfulness and desire to improve our taxation system. But
it is a lot bigger bear than most people would believe.
Chairman Archer. Well you have stated I think very well
what we should all strive for. My comment about full employment
was based on the economists saying we now have full employment.
Not to think that individuals are not sometimes covered up by
the average and are still out there looking for work.
But the important thing is that we give the greatest
economic opportunity to all Americans who want to get out and
work, to be able to work, and then not be content to simply
have a job but to improve----
Mr. Becerra. That is right.
Chairman Archer.--The quality of that job and the amount of
pay.
Mr. Becerra. That is right.
Chairman Archer. I feel so strongly that we must win the
battle of the global marketplace to be able to do that in the
next Century.
Mr. Becerra. I agree.
Chairman Archer. Thank you very much. You are excused.
[Laughter.]
Chairman Archer. The next panel, and the final panel for
the day, is Mr. Rogstad, Mr. Howard, Mr. Mack, and Mr. Rose who
will please come to the witness table.
A hearty welcome to each of you. Thank you for your
perseverance in waiting in the back of the room until you come
and give us the benefit of your input. We are most happy to
have you.
Mr. Rogstad, if you would, lead off. I think all of you
know the general rules under which we operate, which is please
identify yourself for the record before you testify and, if
possible, do not follow in the Chair's footsteps. Try to limit
your oral comments to five minutes, if at all possible and,
without objection, your entire printed statement will be
inserted in the record.
Mr. Rogstad.
STATEMENT OF BARRY K. ROGSTAD, ECONOMIST AND PRESIDENT,
AMERICAN BUSINESS CONFERENCE
Mr. Rogstad. Thank you, Mr. Chairman. I am Barry Rogstad,
an economist and President of the American Business Conference.
The ABC is a nonpartisan coalition of chief executives of fast-
growing American businesses.
I applaud this Committee for conducting these hearings and
highlighting recent progress toward fundamental tax reform, and
I thank you for the opportunity to comment here today in
particular in support of Congressman English's Simplified USA
Tax Bill.
My comments are made from two perspectives:
First, as an economist and as a member of the team who
worked with Senators Domenici and Nunn in the development of
the first USA Tax legislation introduced in 1995.
And, as a representative of mid-size growth companies who
have a keen interest in tax restructuring and the contribution
that it can make to the growth and competitiveness of the
American economy.
Today I am more convinced than ever that the USA Tax is the
best and most workable framework for achieving fundamental tax
reform.
I say that because:
One, it specifies the correct tax base, assuring that all
income is taxed and it is taxed once and only once.
Secondly, I think it drastically improves the neutrality in
the tax code with respect to the impact of taxes on the
behavior of individuals, households, and businesses.
And thirdly, and I know this is controversial, it allows
for a progressive rate structure and other provisions that,
quite frankly in my judgment, are necessary to achieve the
political consensus required for final passage of any tax
reform legislation.
I am here to support the bill introduced by Congressman
English, H.R. 134. Congressman English recognized the USA Tax
is a vastly superior method for treating international business
transactions and, most importantly, incorporates the correct
treatment of individual saving and business investment.
The English Bill improves upon the original proposal by
addressing provisions that were viewed by some as overly
complex. These concerns focused on the need to assure that
saving was taxed once and only once. Congressman English avoids
this perceived complexity while removing the double tax on
savings by relying on the now well established Roth IRA
framework.
We want to thank Congressman English and look forward to
his continued leadership of the USA Tax Reform.
From the perspective of American growth companies, I would
like to mention five important issues that basic tax reform
must address, and how the USA Tax succeeds in addressing each.
Of greatest importance is the level of saving and
investment as the foundation of continued economic growth and
improved standard of living of our citizens. The current income
tax, as you well know, is biased against saving and investment
and in favor of the consumption uses of income. We continually
ask ourselves as citizens and businesses, what is the rationale
for a national policy that reduces the level of our Nation's
seed corn that determines how our country, its businesses and
its citizens, prepare for the future?
Secondly, it is increasingly important in our ``new
economy,'' that we correctly tax human capital. We have come to
recognize that it is the skills and knowledge of our citizens
that underscore productivity growth and our competitive
advantage as a Nation.
Thirdly, the international implications of the USA Tax are
very significant to American businesses and their ability to
compete on a level playing field. Tax policy should seek to
ensure that these businesses make decisions based on market and
operating conditions and not features contained in national tax
regimes. Congressman English's bill achieves this result.
Fourthly, moving towards a simpler and understandable tax
system is an important objective of the business community. By
moving from accrual accounting toward cash flow accounting, the
USA Tax reduces the complexity and compliance costs which
businesses now face. Expensing of all investment outlays not
only assures the correct specification of net income from
capital in the tax base but would be the single most important
step in my judgment to the simplification of our tax code.
Finally, growth companies, many of them knowledge intensive
and with little collateral on which to borrow, are critically
dependent on equity financing. The current tax code, as you
know, by favoring borrowing over equity investment generates a
higher cost of capital for growth companies. Bringing
neutrality to debt and equity financing is a significant
forward step achieved by the English bill.
A couple of final comments just about the ramifications of
the first three of these points on the international
marketplace.
First of all, on the saving question it is very difficult
to argue today in this rather remarkable economy that the low
level of personal saving is a key problem. However, it
certainly is. It is now and will continue to be the core
determinant of long-term growth.
I would suggest to you that one way of looking at the
roughly $340 billion current account deficit we incurred in
1999 is that we are dependent to that amount on foreign saving.
If we want to remove that dependency, tax reform is in order.
Secondly, this question of correctly taxing labor income
can be a great opportunity for tax reform. Tax reform is about
getting the tax base correct. By proposing to expense capital
outlays, the USA tax correctly specifies the net return to
capital.
Neutrality in tax reform requires that we focus on taxing
net income to human capital as well so that we tax the returns
to capital and labor equally.
I would suggest to you that the net income to human capital
is gross income minus the cost of producing that which are
essentially outlays for training and investment.
Congressman English's bill allows up to $12,000 a year per
household for deductions for education outlays. I would suggest
to you that at some point in the deliberations about tax reform
you will see fit to deduct all expenses for investment in human
capital, the same way that we do for physical capital.
Finally, I just want to mention the international tax
provisions of this.
As you know, the English bill is territorial in nature. I
think territoriality provides a generic approach to dealing
with the FSC dilemma that we now face.
I think border-adjustability is an appropriate way for us
to unilaterally level the playing field with foreign
competitors.
I thank you, sir.
[The prepared statement follows:]
STATEMENT OF BARRY K. ROGSTAD, ECONOMIST AND PRESIDENT, AMERICAN
BUSINESS CONFERENCE
Mr. Chairman and Members of the Committee:
I am Barry Rogstad, an economist and president of the
American Business Conference (ABC). ABC is a nonpartisan
coalition of chief executives of fast growing midsize
companies. The American Business Conference has never been a
recipient of a Federal Government grant or contract.
I applaud the Committee's actions to hold this series of
hearings on fundamental tax reform, and its current focus on
the effects of our tax code on the functioning of American
businesses in the international market place. By holding this
series of hearings you recognize that the current tax code
remains a failed instrument. Nobody understands it. Everybody
thinks it is unfair. It is systemically biased against saving
and investment. It extracts revenues from the economy in a
hideously inefficient and expensive way. And through the
specific focus of this hearing, the Committee highlights the
blindness of the code to the competitive realities of our fast
moving global economy.
I was pleased to testify before this Committee in 1995
during an earlier series of hearings on fundamental tax reform.
At that time my remarks focused on the path breaking efforts of
Senators Domenici and Nunn with the introduction of the USA
Tax. The ABC is very proud of its role in the development of
that proposal.
Congressman Phil English has improved upon this original
formulation by introducing the Simplified USA Tax, H.R. 134. As
an alternative to our current tax system, Congressman English
recognized the USA Tax is a vastly superior method for treating
international business transactions, and most importantly,
incorporates the correct tax treatment of individual saving and
business investment.
The original USA Tax, in attempting to assure that saving
was taxed once and only once, was perceived by some as overly
complex. The English bill avoids this perceived complexity
while removing the double taxation on saving by relying on the
Roth IRA framework. This approach in H.R. 134 is technically
correct and fully understandable to the taxpayer. It provides a
workable blueprint from which to address the core challenges of
tax reform. We also recognize that there is additional detail
and refinement required before the Congress can achieve final
consensus. We applaud Congressman English for his efforts and
look forward to his continued leadership in tax reform.
My remaining comments reflect the perspective of midsize
growth companies toward basic tax reform.
First and foremost, American business leaders understand
the singular importance of saving and investment to continued
national economic growth and an improved standard of living for
our citizens. The current income tax is biased against saving
and investment and in favor of consumption. They ask, ``What is
the rationale for a national policy that reduces the level the
``seed corn'' that determines how our country, its businesses
and its citizens prepare for the future?".
H.R. 134 removes that bias by taxing the consumption and
saving uses of income in the same manner. It accomplishes this
by taxing all income once and only once. The English bill does
not, and this is a key point, offer a subsidy to saving, it
merely removes the double taxation on saving that now occurs.
Concern over a low level of national saving is a tough
argument to make during these remarkable economic times. Yet it
is, and will remain, a core determinant of the nation's future
economic performance.
Given the international focus of this hearing, a comment on
the contribution of foreign saving to the current U.S. economic
expansion is in order. In 1999 the current account deficit of
the United States was approximately $340 billion. This deficit
was ``financed'' through net foreign saving being invested in
this country of an equivalent amount. If our objective is to
lower or eliminate the trade deficit, we must address the
serious shortfall in our own saving behavior. The shortfall in
our national saving could become severe and obvious in the face
of any significant reduction in foreign saving and investment.
Said more directly, the correct tax treatment of saving and the
trade deficit are directly related.
Business leaders also support the integrated structure of
the Simplified USA Tax, and the correct specification of the
tax base contained in the proposal.
The structure of H.R. 134 provides for an integrated
alignment of the business and individual elements of tax
system. Tax revenues are the returns to capital and labor
services. Taxes can be collected where these factor incomes are
produced, at the business level; where they are earned, at the
individual level; or as is done under the Simplified USA Tax,
at both levels. This two-tier, split-rate approach, combined
with a credit for both the employer and employee shares of the
payroll tax, assures that all sources of taxable income are
treated equally. Income from wages is treated the same as
income from interest, dividends, and asset sales. And all forms
of income are treated the same in both the business and
individual components of the Simplified USA Tax. This treatment
assures both fairness and understandability by the American
people.
I believe the true revolution in tax reform is to achieve
the correct tax base. The properly defined tax base is the net
return to capital and labor services: or the gross returns less
the costs of producing these returns. Tax policy has been
replete with discussions on how to achieve the right definition
of net returns to capital. The approach taken in the English
bill correctly incorporates the best of these by expensing
investment outlays immediately.
However, economic efficiency and fairness require that we
achieve the same neutral treatment in the taxation of labor
services. Investments in human capital, primarily outlays for
education and training, are costs of producing higher gross
returns to labor and should be expensed. These and other
intangible investments are, as you know, becoming the core of
our ``new economy'' and our comparative advantage as a nation.
The English bill recognizes that tax reform must include the
expensing of these investments in human capital. It provides
for up to $12,000 in annual deductions for education per
household. I would suggest future deliberations by the Congress
on this issue may well remove limitations on qualified training
and education outlays entirely.
The international implications of the USA Tax are very
significant to American businesses and their ability to compete
on a level international playing field. Public policy should
seek to insure that businesses, both US and foreign-based make
decisions based on market and operating conditions only, and
not on the subsidies contained in national tax systems.
Congressman English's bill achieves this result.
The USA Business Tax is territorial. An American-based
business would not include in its gross tax base the proceeds
from sales made by subsidiaries outside the United States. It
would also not deduct the purchase of goods or services outside
the United States. For their part, foreign businesses with a
commercial presence in this country would include in their tax
base amounts received for goods sold or services provided in
the United States and would subtract amounts paid for goods
acquired and services provided in the United States.
To repeat, for an American company, territoriality would
free entrepreneurs to base their international strategies on
business opportunities rather than on tax considerations. From
a public policy standpoint, adopting a territorial system would
be the best approach to resolving the current dilemma regarding
the Foreign Sales Corporation (FSC) provisions in the code. It
would also vastly simplify the tax structure and the agenda of
this Committee.
The USA Business Tax is also border adjustable. Goods made
here and shipped abroad would receive a tax rebate. Goods made
abroad and imported and sold in the United States would be
subject to tax. This provision would align the tax system of
the United States with that of most of our major trading
partners while insuring that all products sold in this country
carried their appropriate share of the tax burden.
Simplification of the tax code is a longstanding objective
of tax reformers. By moving from accrual accounting towards
cash flow accounting, the USA Tax eliminates the maze of
complexities and the high compliance costs which businesses now
face. H.R. 134, by providing for expensing of all investment
outlays, leads to the correct and desired impact on the cost of
capital for American businesses. Its adoption would achieve a
greatly simplified tax structure.
The English bill would have other positive effects on the
cost of capital. The current tax code, by favoring borrowing
over equity investment, generates a higher cost of capital for
growth companies. These companies, frequently knowledge-
intensive and with little collateral on which to borrow, are
critically dependent on equity financing. Bringing neutrality
to debt and equity financing is a significant forward step
achieved by the USA Tax.
The Simplified USA Tax introduced by Congressman English
explains why tax reform is both necessary and possible. Perhaps
now the USA Tax will get the second look it so richly deserves.
Congressman English has championed a plan that does not
discriminate against saving and investment, is simple,
efficient, and understandable, is easy to administer, readily
accommodates a progressive rate structure, offers a full credit
for the FICA tax, and reflects international competitive
realities by excluding from taxation export sales and income
from foreign sources. It is fully worthy of further
consideration by his colleagues on this Committee and in the
Congress.
I would be happy to answer any questions you may have.
Chairman Archer. Thank you, Mr. Rogstad.
Mr. Howard.
STATEMENT OF JERRY HOWARD, VICE PRESIDENT, TAXES, USX
CORPORATION, PITTSBURGH, PENNSYLVANIA
Mr. Howard. Thank you, Mr. Chairman.
My name is Jerry Howard and I am Vice President of Taxes
for USX Corporation. Though I currently reside in Pittsburgh, I
worked for the USX Marathon Group in the 7th Congressional
District in Texas, and we found the 7th District to be one of
the best represented districts in the country.
I appreciate having the opportunity to have worked with you
and members of your staff for an extended period of time.
This is an opportune time to discuss fundamental tax
reform. I appreciate the opportunity to address the Committee
on this issue.
USX Corporation operates primarily in the integrated energy
and steel businesses. Our 1999 sales of over $29 billion ranks
us within the top 25 industrial companies in the United States.
Both our energy and steel businesses are capital intensive
and face strong foreign and domestic competition. U.S. tax laws
have an important bearing on our ability to compete in world
markets.
We have several serious concerns with the current Federal
Income Tax on businesses. We believe the current tax system is
anticompetitive, acts as a disincentive to investment, and is
unduly complex.
We support fundamental tax reform that addresses these
concerns. Any new tax system should be a replacement for the
current income tax system and should not result in additional
taxes on business.
The Simplified USA Tax proposed by Representative English
is a significant move in the right direction. We agree with the
fundamental concepts of his proposal since they address many of
our concerns.
For example, most industrialized countries rely mainly on
border-adjustable taxes in which export income is exempted and
imports are taxed.
In the U.S., however, export income is taxed and imports
are not. As a result, U.S. companies are at a disadvantage both
at home and abroad.
The Simplified USA Tax corrects this inequity by exempting
export income and taxing imports.
The present U.S. income tax system acts as a disincentive
to making capital investments because of the long cost recovery
periods. Since real capital costs are not fully recovered,
there is a tax on the capital investment itself. This makes
capital acquisition much more costly for U.S. businesses.
The Simplified USA Tax eliminates the increased cost on
capital by allowing an immediate writeoff of capital
investments.
The current U.S. income tax system is overly complex,
requiring companies to hire a large number of accountants and
attorneys in order to determine the amount of taxes owed and to
resolve disputes with the IRS.
While there will always be some complexity and uncertainty
in any tax regime, the Simplified USA Tax will be significantly
easier to understand and administer than the present income tax
law.
The aforementioned provisions of the Simplified USA Tax
represent significant improvements to the current U.S. tax
system. However, the following issues require further study:
As I mentioned, the Simplified USA Tax includes a tax on
imports which will help make U.S. companies more competitive in
the global marketplace. That being said, it must be recognized
that there are certain items that must be imported since
domestic supply cannot meet demand.
One notable example that directly affects USX is crude oil.
The imposition of a new nondeductible tax on imported crude oil
could cause the cost of refined products to increase and result
in higher costs to consumers.
Due care should be taken to ensure that consumers and U.S.
companies are not unduly harmed by this measure. A national
energy policy which promotes increased domestic oil and gas
production and enhances refining capacity in the United States
would lessen our demand on imports.
A major issue in developing any new tax system to replace
the present income tax law involves transition rules for costs
that have been incurred or credits generated during the period
that the present system has been in effect but that will not be
deducted or taken into account by the time the new system is
put in place.
Accordingly, transition rules should be fair and equitable.
In conclusion, a new tax system modeled around the
Simplified USA Tax would be a significant improvement over the
present system. It would eliminate the competitive disadvantage
inherent in the current system and allow U.S. companies to
compete more effectively with our foreign competitors.
We believe that a national energy policy that promotes
increased domestic oil and gas production and enhances refining
capacity, coupled with fair and equitable transition rules,
will cause the new system to achieve its intended results.
USX welcomes the opportunity to participate in the process.
Thank you.
[The prepared statement follows:]
STATEMENT OF JERRY HOWARD, VICE PRESIDENT, TAXES, USX CORPORATION,
PITTSBURGH, PENNSYLVANIA
Mr. Chairman, my name is Jerry Howard, and I am Vice
President-Taxes for USX Corporation. Though I currently reside
in Pittsburgh, I worked in the 7th district of Texas for a
number of years and found it to be one of the best represented
districts in the country. I have appreciated the opportunity to
work with you and members of your staff over an extended period
of time. We also applaud the members of this Committee who
announced their opposition to the Administration's budget
proposal to impose a tax on the recipients of tracking stock.
This ill-conceived measure would cause severe harm to companies
with tracking stock outstanding and reduce business expansion
while generating no benefits.
This is an opportune time to discuss fundamental tax reform
and I appreciate the opportunity to address the Committee on
this issue.
USX Corporation operates primarily in the integrated energy
and steel businesses. Our 1999 sales of over $29 billion rank
us within the top 25 industrial companies in the United States.
Both our energy and steel businesses are capital intensive
and face strong foreign and domestic competition. U.S. tax laws
have an important bearing on our ability to compete in world
markets.
We have several serious concerns with the current federal
income tax on businesses. We believe the current tax system is
anti-competitive, acts as a disincentive for investment, and is
unduly complex.
We support fundamental tax reform that addresses these
concerns. Any new tax system should be a replacement for the
current income tax system and should not result in additional
taxes on business. The Simplified USA Tax proposed by
Representative English is a significant move in the right
direction. We agree with the fundamental concepts of his
proposal since they address many of our concerns.
Competition Concerns
For example, most industrialized countries rely mainly on
border-adjustable taxes, in which export income is exempted and
imports are taxed. In the U.S., however, export income is taxed
while imports are not. As a result, U.S. companies are at a
disadvantage both at home and abroad.
The Simplified USA Tax corrects this inequity by exempting
export income and taxing imports.
Incentive for Investment
The present U.S. income tax system acts as a disincentive
to making capital investments because of the long cost recovery
periods. Since real capital costs are not fully recovered,
there is a tax on the capital investment itself. This makes
capital acquisition more costly.
The Simplified USA Tax eliminates the increased cost on
capital by allowing an immediate write-off of capital
investments.
Complexity of Current Tax Law
The current U.S. income tax system is overly complex,
requiring companies to hire a large number of accountants and
attorneys in order to determine the amount of taxes owed and to
resolve disputes with the IRS because the laws are so difficult
to interpret and administer. While there will always be some
complexity and uncertainty in any tax regime, the Simplified
USA Tax will be significantly easier to understand and
administer than the present income tax law.
The aforementioned provisions of the Simplified USA Tax
represent significant improvements to the current U.S. tax
system. However, the following issues require further study.
Oil and Gas Imports
As I've mentioned, the Simplified USA Tax includes a tax on
imports, which will help make U.S. companies more competitive
in the global marketplace. That being said, it must be
recognized that there are certain items that must be imported
since domestic supply cannot meet demand. One notable example
that directly affects USX is crude oil.
The imposition of a new non-deductible tax on imported
crude oil could cause the cost of refined products to increase
and result in higher costs to consumers. Due care should be
taken to ensure that consumers and U.S. companies are not
unduly harmed by this measure. A national energy policy which
promotes increased domestic oil and gas production and enhances
refining capacity in the U.S. would lessen our demand for
imports.
Transition Rules
A major issue in developing any new tax system to replace
the present income tax law involves transition rules for costs
that have been incurred or credits generated during the period
that the present system has been in effect, but that will not
be deducted or taken into account by the time the new system is
put into place. Accordingly, transition rules should be fair
and equitable.
Finally, a word about compatibility of the USA Tax with
other tax regimes.
Compatibility with Other Tax Regimes
Presently, the tax base for most state income taxes uses
federal taxable income as the starting point. Thus, any new
federal tax regime developed to replace the current federal
income tax will not be compatible. States should be able to
modify their tax systems to use the new federal tax base as the
starting point, making modifications and other adjustments
necessary to generate the same tax revenues from businesses as
are currently collected.
Conclusion
In conclusion, a new tax system, modeled around the
Simplified USA Tax, would be a significant improvement over the
present system. It would eliminate the competitive disadvantage
inherent in the current system and allow U.S. companies to
compete more effectively with our foreign competitors. We
believe that a national energy policy that promotes increased
domestic oil and gas production and enhances refining capacity,
coupled with fair and equitable transition rules, will cause
the new system to achieve its intended results. USX welcomes
the opportunity to participate in the process.
Mr. Kleczka [presiding]. I have no questions of this panel,
and the Chair is going to be right back.
Has Mr. Mack testified? Oh, I am sorry.
Mr. Mack, welcome. You do not win the prize for coming the
longest distance, you know, being from McLean, Virginia.
Welcome to the Committee and we look forward to your remarks.
STATEMENT OF JAMES H. MACK, VICE PRESIDENT, GOVERNMENT
RELATIONS, ASSOCIATION FOR MANUFACTURING TECHNOLOGY, MCLEAN,
VIRGINIA
Mr. Mack. Thank you, Mr. Chairman.
I am Jim Mack, and I am here representing U.S. producers of
machine tools and related manufacturing technology.
Our industry is the principal enabler of America's high
productivity levels which are the key to our current prosperity
and its continuation into the foreseeable future.
Our industry translates the dizzying advances in
information technology into the design of new manufactured
products and the factory floor automation that more efficiently
produces them.
However, our current tax code actually discourages American
manufacturing companies from acquiring new manufacturing
technology and from producing new products in the United
States.
It encourages international mergers and acquisitions that
transfer to foreign sources the ownership of technology, the
development of future technology, and decisions as to whether
American jobs will stay in America. The territoriality and
border-adjustability features of the USA Tax would reverse that
trend.
Some have criticized the USA business tax because, in order
to make it border adjustable in conformity with WTO rules,
labor costs would no longer be deductible.
The fact is, Mr. Chairman, that labor costs are not
entirely tax free today. The current payroll tax is a heavy
burden on businesses and on their employees--most particularly
on skilled craftsmen and skilled factory workers. It acts as an
incentive against hiring new workers. By providing a credit for
the 7.65% employer-paid FICA tax, the USA Tax actually reverses
the regressive impact of the payroll tax.
Congressman English's USA Tax is good sound tax policy and
AMT--The Association for Manufacturing Technology, strongly
supports it passage.
The USA Tax also meets all the requirements that the WTO
laid out in requiring you to repeal the Foreign Sales
Corporation (or FSC) and, therefore, would be a good starting
point when looking for solutions as FSC replacement.
FSC helps make U.S. exports more competitive in world
markets. Many AMT members, both large and small, have FSCs.
However, unless you act by October 1st, or unless a settlement
is reached with the European Union by that date, billions of
dollars in U.S. exports will be subject to retaliatory
compensation by the EU and possibly by others.
Simply repealing the FSC would deprive U.S. companies of a
powerful incentive to export and effectively amount to a $4
billion a year tax increase on U.S. exports.
On the other hand, simply replacing FSC with a slightly
different version could be inconsistent with the WTO decision
and could lead to European retaliation.
Mr. Chairman, we know that coming up with a replacement for
FSC that is consistent with the WTO ruling will be
extraordinarily difficult. Therefore, we believe that the best
possible solution is to move to a territorial, border-
adjustable system of taxation like the USA Tax which would not
tax export income at all but would impose a tax on imports.
This is the system used by all of our major trading
partners. The WTO Dispute Resolution Panel clearly pointed the
way in that direction when it stated that we could not couple
territorial treatment of exports with a system of taxing the
worldwide income of our companies.
Now we are not naive enough to believe that fundamental tax
reform like the USA Tax can be enacted by the first of October.
However, if you can achieve a bipartisan momentum for the USA
Tax approach, you and the Administration would have a powerful
incentive--a powerful club, if you will--to persuade the
European Union to reverse its current headlong dash toward an
October 1st trade war with the United States.
Absent such bipartisan momentum, the Administration
unfortunately has very little negotiating leverage, and the
prospects for averting disaster on October 1st are very bleak.
Passage of a border-adjustable cash flow territorial cash
flow tax that allows for expensing of capital purchases like
the USA Tax is one of AMT's top legislative priorities. We
strongly support Congressman English's USA Tax as the best
possible tax system for U.S. manufacturers and their workers in
an increasingly competitive (and even hostile) global trading
environment. It is also the best possible replacement for FSC.
The time for fundamental tax reform is long overdue. The
need to replace the FSC provides an excellent opportunity to
begin the process of real reform rather than simply searching
for a short-term fix. Thank you.
[The prepared statement follows:]
Statement of James H. Mack, Vice President, Government Relations,
Association for Manufacturing Technology, McLean, Virginia
I. INTRODUCTION
My name is James H. Mack, Vice President of Government
Relations at AMT--The Association For Manufacturing
Technology--a trade association whose membership represents
over 370 machine tool building firms with locations throughout
the United States. Pursuant to House Rule XI, clause 2(g)(4), I
am obligated to report to you that AMT has received $219,000 in
fiscal years 1997-2000 from the Commerce Department's Market
Co-operator Development Program to help pay for our export
offices in China and Mercosur.
I appreciate the opportunity to testify before the
Committee in support of Fundamental Tax Reform. My comments
will also address how Congress could use fundamental tax reform
to respond to the World Trade Organization's (WTO) dispute
resolution panel ruling that the Foreign Sales Corporation
(FSC) violates WTO rules and must be repealed by October 2000.
II. STATUS OF THE U.S. MANUFACTURING TECHNOLOGY INDUSTRY
The majority of AMT's members are small businesses.
According to the 1997 U.S. Census of Manufacturers, 69% of the
companies in our industry have less than 50 employees. They
build and provide to a wide range of industries the tools of
manufacturing technology including cutting, grinding, forming
and assembly machines, as well as inspection and measuring
machines, and automated manufacturing systems.
Everything in this hearing room, except for the people, was
either made by a machine tool or made by a machine made by a
machine tool. Several years ago, the Reagan and Bush
Administrations, responding to strong encouragement of over 250
Members of Congress, provided temporary import relief for our
industry, based on the threat posed to our national security
from Asian machine tool imports. They did so because of their
recognition that a strong machine tool industry is vital to
America's military and economic security.
Our industry is very cyclical. Price pressures are very
strong, and profitability is relatively low--even in good
years. Today, despite the extraordinary performance of our
overall economy, domestic consumption of machine tools is
nearly 30% lower than a year ago. Imports represent about half
of domestic consumption. And American-made machine tools
comprise only 13% of world supply. About 30% of our industry's
output is exported. If, as we believe, successful competition
in the global marketplace is the key to a strong and healthy
economy, then we need U.S. policies that reflect that goal. I
think most would agree that our current business tax policy is
inconsistent with that goal.
III. THE USA TAX
The anti-investment, anti-export biases of the current tax
code are well documented. Our tax code discourages saving and
productive capital investment in the United States; it
discourages exports; and it makes it hard for U.S. companies to
directly compete in foreign markets. America urgently needs a
tax system rebuilt from the ground up around a new set of
design principles to compete and win in world markets.
Your colleague, Cong. English (R-PA), has introduced
legislation which replaces our current tax system with a cash
flow tax that would be both border-adjustable and territorial
and would provide for the expensing of capital purchases. Its
enactment would, for the first time, truly level the
international playing field for U.S. companies in world
markets, including the United States.
The USA tax combines a low-rate business tax which allows
expensing of capital equipment with border-tax adjustments and
territoriality to produce an ideal result--a neutral,
evenhanded tax that treats all business alike (whether
corporate or noncorporate, capital intensive or labor
intensive, financed by equity or by debt, large or small) and
which, for the first time, is tilted in our favor when we
compete in our own and foreign markets.
The key to our current prosperity, and its continuation
into the foreseeable future, is improved productivity. Our
industry is the principle enabler of America's high
productivity levels. Our industry translates the dizzying
advances in information technology into the design of new
manufactured products and the factory floor automation that
more efficiently produces them. However, our current tax code
discourages American manufacturing companies from acquiring new
manufacturing technology and from producing new products in the
United States. It encourages international mergers and
acquisitions that transfer to foreign sources the ownership of
technology, the development of future technology, and decisions
as to whether American jobs will stay in America. The
territoriality and border-adjustable features of the USA tax
would reverse that trend.
Some have criticized the USA business tax because, in order
to make it border adjustable in conformity with WTO rules,
labor costs would no longer be deductible. The fact is that
labor costs are not entirely tax-free today. The current
payroll tax on wages up to $72,000 is a heavy burden on
businesses and their employees--most particularly on skilled
craftsmen and factory workers. It acts as an incentive hiring
new workers.
By providing a credit for the 7.65% employer-paid FICA tax,
the USA Tax reverses the regressive impact of the payroll tax.
Under current law, the first $72,000 of employee compensation
is taxed. Under the USA Tax, employee compensation under
$72,000 would be partially taxed (at a 4.35% rate) and employee
compensation over $72,000 would be fully taxed (at a 12% rate).
Cong. English's USA Tax is good sound tax policy, and AMT
strongly supports its passage. The USA Tax also meets all the
requirements that the WTO laid out in repealing the FSC, and
would, therefore, be a good starting point when looking for
solutions to FSC replacement.
IV. FSC REPLACEMENT
As I stated earlier, a WTO dispute resolution panel has
ruled that the FSC law, which allows U.S. exporters to exclude
part of their export income, violates WTO rules and must be
repealed by October 2000.
FSC helps make U.S. exports more competitive in world
markets. Many AMT members--both large and small--have FSCs.
However, unless Congress acts by October 1, or a settlement is
reached with the European Union (EU) by that date, billions of
dollars in U.S. exports will be subject to retaliatory
``compensation'' by the EU and possibly by others. Simply
repealing the FSC would deprive U.S. companies of a powerful
incentive to export and effectively amount to a $4 billion per
year tax increase on U.S. exports. On the other hand, simply
replacing FSC with a slightly different version could be
inconsistent with the WTO decision and could lead to European
retaliation.
Mr. Chairman, we know that coming up with a WTO-compatible
replacement for FSC that is consistent with the WTO ruling will
be extraordinarily difficult. But we do believe the best
possible solution is to move to a territorial, border-
adjustable system of taxation, like the USA tax, which would
not tax export income at all but would impose a tax on imports.
This is the system used by all of our major trading partners.
The WTO dispute resolution panel clearly pointed the way in
that direction when it stated that we couldn't couple
territorial treatment of exports with a system of taxing the
worldwide income of our companies.
Now, we are not naive enough to believe that fundamental
tax reform, like the USA Tax, can be enacted by October 1.
However, if you can achieve a bipartisan momentum for the USA
Tax approach, you and the Administration would have a powerful
incentive to persuade the European Union to reverse its current
headlong dash towards an October 1 trade war with the United
States. Absent such bipartisan momentum, the Administration has
very little negotiating leverage, and the prospects for
averting disaster on October 1 are very bleak.
V. CONCLUSION
Passage of a border adjustable, territorial cash flow tax,
like the USA Tax, is one of AMT's top legislative priorities.
We strongly support Cong. English's USA Tax as the best
possible tax system for U.S. manufacturers and their workers in
an increasingly competitive (and even hostile) global trading
environment. It is also the best possible replacement for FSC.
The time for fundamental tax reform is long overdue. The need
to replace the FSC provides an excellent opportunity to begin
the process of real reform rather than simply searching for a
short-term fix.
Thank you.
Chairman Archer. Thank you, Mr. Mack.
Mr. Rose, you are cleanup hitter today.
STATEMENT OF JAMES E. ROSE, JR., SENIOR VICE PRESIDENT, TAXES
AND GOVERNMENT AFFAIRS, TUPPERWARE CORPORATION, ORLANDO,
FLORIDA; AND BOARD MEMBER AND CHAIRMAN, TAX AND BUDGET POLICY
COMMITTEE, NATIONAL ASSOCIATION OF MANUFACTURERS
Mr. Rose. Thank you, Mr. Chairman, and Members of the
Committee:
I am very pleased to have the opportunity to testify on the
need for fundamental reform of our federal tax laws. My name is
Jim Rose. I am Senior Vice President for Taxes and Government
Affairs at Tupperware Corporation. I also serve as a Board
Member of the National Association of Manufacturers and chair
its Tax and Budget Policy Committee.
I am testifying today on behalf of NAM, 18 million people
who make things in America. The NAM is the Nation's largest and
oldest multi-industry trade association representing 14,000
members, 10,000 of which are small and mid-sized companies, and
350 member associations serving manufacturers and employees in
every industrial sector and in all 50 states. Headquartered in
Washington, D.C., the NAM has 10 additional offices across the
country.
The NAM has long supported fundamental tax reform. The NAM
has a long-standing belief that our current tax system is
fundamentally flawed and is a major obstacle to realizing the
full potential of our economy.
The solution calls for a new tax system that encourages
work, investment, and entrepreneurial activity. Importantly,
the new tax system should be competitive with our foreign
trading partners.
Specific changes should include:
Incentives for savings and capital formation;
Avoiding multiple tax system like the AMT;
No net tax increase on businesses;
Elimination of double taxation of corporate earnings;
And fair and equitable transition rules.
NAM members generally favor a system in which only income
sourced within the United States is taxed by the United States.
This is commonly referred to as a territorial tax system.
Any territorial tax system should embody simple sourcing rules
to determine where income is earned. Importantly, a territorial
system should encourage U.S. activities including R&D and
headquarter functions. This is accomplished, among other ways,
by not taxing foreign royalties.
These priorities reflect the significant challenges U.S.
manufacturers face in today's world economy.
While U.S. manufacturers enjoy a stable political
environment and a creative and energetic workforce, they are at
a significant disadvantage in the highly competitive world
economy.
For example, the cost of borrowing in the United States is
often higher than that of other countries, reflecting our
remarkably low U.S. savings rate.
The high cost of borrowing, when combined with our
relatively slow depreciation schedules, result in a less
attractive recovery of U.S. invested capital. Over time, this
will result in a less competitive U.S. asset base and,
ultimately, the loss of U.S. jobs.
Other signs of an uneven playing field have emerged.
A significant negative trade balance exists that continues
to increase. While NAM is a staunch advocate of open trade and
is certainly not looking for protective trade barriers, U.S.
manufacturers need and deserve a tax system that is competitive
with those of our major trading partners.
In a nutshell, their tax systems are all border adjusted
and many are territorial. Our tax system is neither. That is,
it is neither border adjusted nor territorial.
The need for a new tax system has been heightened in recent
months with the World Trade Organization's finding that Foreign
Sales Corporation constitute an illegal export subsidy.
An example might be helpful in understanding how U.S.
exporters are disadvantaged in the global marketplace. Let us
take a hypothetical Country A.
Country A's tax burden consists of an income tax and a VAT.
Companies that manufacture in Country A receive rebates of its
15% VAT when their goods are exported to the U.S.
Conversely, an exporting NAM member, and around 80% of its
14,000 members do export, does not receive a tax rebate when
its products are exported from the U.S. Instead, it finds that
its products are subject to the 15% VAT of Country A when they
are imported into Country A.
Incidentally, the 15% may actually exceed the normal profit
margin of the exported item.
Since the U.S. does not have a VAT system, and thus does
not impose a VAT on imported goods, imported goods from Country
A into our market come in tax free.
The Country A example incidentally has been adopted by
virtually all of our major trading partners. As you can well
appreciate, this tax environment significantly favors foreign
imports and discourages U.S. exports.
The story gets worse. Foreign companies competing with U.S.
manufacturers often operate with a territorial tax system that
does not tax foreign source income.
Territorial systems of our competitors can essentially
eliminate the home country income tax burden on export sales.
It is important to note that FSC-type benefits would be
allowable under WTO rules in the context of a territorial tax
system.
Furthermore, our U.S. tax system subjects foreign earnings
of U.S. companies to U.S. taxation when these earnings come
back to the U.S. and in certain other circumstances.
While the U.S. Tax Code does include a foreign tax credit
system to reduce this burden, the very complicated foreign tax
credit rules typically result in incremental U.S. taxation when
these funds come back to the U.S.
Accordingly, U.S. companies are inevitably discouraged from
investing in the U.S.
The U.S. world-wide taxation system is having another
negative effect on our economy. Increasingly, U.S. companies
often large and well known, are being acquired by foreign
companies.
While nontax business reasons often exist in these
transactions, the more favorable tax systems of the acquiring
foreign companies heavily influence the structure of these
mergers.
For example, an NAM member last year testified before this
Committee that the U.S. tax system was an important factor in
why their U.S. company was acquired by its German-based merger
partner.
Among other factors, the German-based acquirer benefitted
importantly from Germany's territorial tax system.
The scenario has been repeated at an alarming rate in
recent years. A recent study covering 1998 acquisitions
involving U.S. and foreign entities concluded that
approximately 85% of the combined value of the acquisitions
resulted from foreign entities acquiring U.S. entities.
This trend will result in a loss of American jobs as, after
an acquisition or merger, the headquarters of an the acquiring
entity typically survives and expands while the headquarters of
an acquired entity often is reduced in size and sometimes
eliminated, effectively moving jobs offshore.
Furthermore, R&D facilities and even plant locations can be
affected by these decisions.
In summary, American companies have well trained employees,
products, and technology to win in the global marketplace, but
the U.S. Tax Code has stacked the deck against us and in favor
of our foreign competitors, both here at home as well as
abroad.
The NAM is very pleased to participate in this dialogue
over restructuring the U.S. Tax Code and applauds this
Committee's efforts to fundamentally rewrite our tax code.
While NAM strongly supports fundamental tax reform, at this
time it has not endorsed any specific proposal. However, the
proposals under consideration have many attractive features.
Mr. Chairman, we certainly welcome the opportunity to work
with this Committee to develop a new tax system which is
simpler and encourages work, investment, and entrepreneurial
activity and, importantly, one that is competitive with the tax
systems of our foreign trading partners.
Thank you, Mr. Chairman.
[The prepared statement follows:]
STATEMENT OF JAMES E. ROSE, JR., SENIOR VICE PRESIDENT, TAXES AND
GOVERNMENT AFFAIRS, TUPPERWARE CORPORATION, ORLANDO, FLORIDA; AND BOARD
MEMBER AND CHAIRMAN, TAX AND BUDGET POLICY COMMITTEE, NATIONAL
ASSOCIATION OF MANUFACTURERS
Mr. Chairman and members of the Committee, I am very
pleased to have the opportunity to testify today on fundamental
reform of the federal tax laws. My name is James Rose and I am
senior vice president for Taxes and Government Affairs at
Tupperware Corporation. I also serve as a board member of the
National Association of Manufacturers (NAM) and chair its Tax &
Budget Policy Committee.
I am testifying today on behalf of the NAM--``18 million
people who make things in America.'' The NAM is the nation's
largest and oldest multi-industry trade association,
representing 14,000 members (including 10,000 small and mid-
sized companies) and 350 member associations serving
manufacturers and employees in every industrial sector and all
50 states. Headquartered in Washington, D.C., the NAM has 10
additional offices across the country.
The NAM has long supported fundamental tax reform,
reflecting our belief that the current tax system is a major
obstacle to realizing the full potential of our economy. The
solution calls for a new tax system that is simpler and
encourages, rather than penalizes, work, investment and
entrepreneurial activity, and importantly, a tax system that is
competitive with our foreign trading partners. Specific changes
endorsed by the NAM include incentives for savings and capital
formation; a single tax system for businesses, with no
additional components like the alternative minimum tax and no
net tax increase on businesses; elimination of the double
taxation of corporate earnings; and fair and equitable
transition rules.
Moreover, our members generally favor a system in which
only income earned within the United States is taxed within the
United States. This is commonly referred to as a territorial
tax system. However, as increasing globalization of the economy
often makes it difficult to determine the point where income is
``earned,'' any restructuring proposal should embody simple
sourcing rules. Importantly, such a proposal should also
encourage U.S. activities, including R&D and headquarters
functions.
These priorities reflect the significant challenges U.S.
manufacturers face in the world economy in which they must
compete to survive. U.S. manufacturers enjoy many advantages
including a stable social and political environment and a
creative and energetic workforce. Nonetheless, U.S.
manufacturers are at a significant disadvantage in the highly
competitive world economy. In particular, the cost of borrowing
in the United States often is higher than that of other
countries. This differential reflects the remarkably low U.S.
savings rate, as compared to that of other countries. A higher
cost of borrowing, when combined with relatively slow tax
depreciation schedules, results in a less attractive recovery
of U.S. invested capital. Over time, this will result in a less
competitive U.S. asset base and ultimately a loss of U.S. jobs.
Other signs of an uneven playing field have emerged,
including a negative trade balance that continues to increase.
The NAM is a staunch advocate of open trade and is not looking
for protective trade barriers. What is needed, however, is a
U.S. tax system that is competitive with those of our major
trading partners. The need for a new system has been heightened
even more in recent months with the World Trade Organization's
finding that foreign sales corporations constitute an illegal
export subsidy.
Let me give you an example of how U.S. exporters are at a
disadvantage in the global market. The tax burden on a foreign
product often consists mainly of a combination of income tax
and a Value Added Tax (VAT). A foreign exporting company that
manufactures products in Country A typically receives a rebate
of the 15 percent VAT when its goods are exported. The tax
burden of a U.S. product consists mainly of income tax. An
exporting NAM member (and around 80 percent do export) receives
no tax rebate when its products are exported from the United
States but finds that these products are subject to a 15
percent VAT when they are imported into Country A. In some
cases, the 15 percent tax on the value of the goods may
actually exceed the normal profit margin of the item. As the
United States does not use a VAT and therefore does not impose
such on imported goods, domestically produced goods that are
exported sustain the full effect of the U.S. tax burden plus
the VAT of Country A, while imported products sustain only a
portion of this heavy tax burden. This has the effect of
significantly favoring foreign products within the United
States and discouraging U.S. exports.
The story gets worse. Foreign companies competing with U.S.
manufacturers often operate within a territorial tax system
that does not tax foreign source income. Accordingly, the
territorial systems of our competitors can essentially
eliminate the home country income tax burden on export sales.
The U.S. tax system subjects foreign earnings of U.S. companies
to U.S. taxation when this money comes back to the United
States and in certain other circumstances. The federal tax code
does include a foreign tax credit system to reduce this burden.
However, too often the very complicated foreign tax credit
rules result in incremental U.S. taxation when these funds are
returned to the United States. In this environment, U.S.
companies are inevitably discouraged from investing in the
United States.
The U.S. worldwide tax system is having another impact on
our economy. Increasingly, U.S companies, often large and well
known, are being acquired by foreign corporations. Last year a
representative from a well-known NAM member company testified
before this Committee that the U.S. tax system was an important
factor in why their U.S. company was acquired by its German-
based merger partner. Among other factors, the German-based
acquirer benefited from Germany's territorial tax system.
This scenario has been repeated at an alarming rate in
recent years. For example, a recent study covering 1998
acquisitions involving U.S. and foreign entities concluded that
approximately 85 percent of the combined value of the
acquisitions resulted from foreign entities acquiring U.S.
entities. Why should we be concerned? One reason is the loss of
American jobs. After an acquisition or merger, the headquarters
of the acquiring party typically survives and expands, while
the headquarters of the acquired entity often is reduced in
size, and sometimes eliminated, effectively moving jobs off-
shore. As part of this restructuring, R&D facilities and even
plant locations can be affected by these decisions.
In summary, American companies have the well-trained
employees, the products, and the technology to win in the
global marketplace, but the U.S. tax code has stacked the deck
against us and in favor of our foreign competitors--here at
home as well as abroad.
The NAM is pleased to participate in the dialogue over
restructuring the U.S. tax code and applauds Congressional
efforts to fundamentally rewrite the tax code. At this point in
the debate, the NAM has not endorsed any specific proposal.
However, we welcome the opportunity to work with you to develop
a new tax system that is simpler and encourages not penalizes
work, investment and entrepreneurial activity and one that is
competitive with the tax systems of our foreign trading
partners.
Thank you.
Chairman Archer. Thank you, Mr. Rose.
The Chair is grateful to each of you for your outstanding
contribution to our deliberations on fundamental tax reform.
The points that you have made I think are pertinent, and I
am hopeful that the Committee will take them under advisement
and ultimately into implementation.
Mr. Kleczka?
Mr. Kleczka. No questions, Mr. Chairman.
Chairman Archer. Thank you very much, gentlemen. You are
excused.
The meeting will stand adjourned.
[Whereupon, at 3:40 p.m., the hearing was adjourned, to
reconvene on Thursday, April 13, 2000, at 10:30 a.m.]
FUNDAMENTAL TAX REFORM
----------
THURSDAY, APRIL 13, 2000
Committee on Ways and Means,
House of Representatives,
Washington, D.C.
The Committee met, pursuant to recess, at 10:35 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 is the final day of our hearings on structural
reform, and I believe it is going to be an interesting one.
We begin by receiving testimony from our own colleague, Mr.
Portman, who has a deep interest in tax reform. Then we will
hear from two pollsters, one republican and one democrat, on
what the American people are thinking about structural reform.
Thirdly, we will receive testimony from Mr. William Helming and
one of my long-time friends, Jimmy Powell, about a very
interesting tax reform proposal that Mr. Helming has developed.
Finally, we will hear the views of the U.S. Chamber of commerce
and testimony on the death tax and on the elements of
fundamental tax reform.
Mr. Rangel?
Mr. Rangel. Thank you, Mr. Chairman.
I don't know how we slipped up and let a Democrat get on
one of these panels, but I will have to stick around and see
that. This is going to be the most exciting hearing, because my
dear friend and fellow Committee member, Mr. Portman, will be
testifying. I say that not just out of a sense of affection but
because, realistically, he probably is the only one that will
be around here, as relates to witnesses, in order to do
something about the tax code. Most of the other people are just
giving some ideas of their frustrations before April the 15th.
I have known about Mr. Portman's concern about the
structure of our tax code and the constant contributions he
makes to make it a better instrument to guide the collection of
revenue. I really look forward to his testimony this morning
and look forward to working with him no matter what the
political composition will be of this committee next year.
Thank you.
Chairman Archer. Mr. Portman, welcome to a new position at
the witness table, but not to a new presence in this room. We
will be happy to receive your testimony.
STATEMENT OF HON. ROB PORTMAN, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF OHIO
Mr. Portman. Thank you, Mr. Chairman. It is a little
daunting, but I appreciate your words and Mr. Rangel's and my
colleagues who have the patience and fortitude to be here this
morning.
I am delighted to get a chance to testify briefly. I have
sat through, as you know, a number of the witnesses' testimony
with this series of hearings on tax reform, and I think it has
been very informative, I think it has been very thoughtful, and
I want to commend the chairman for having these hearings and
opening up a discussion. I have learned a lot about various
alternatives, and I guess what I hope is that we can at least
all agree that we must replace our current code with one that
is simpler, one that is fairer, and one that is less intrusive.
This morning, Mr. Chairman, I would like to switch gears
just a little bit even from the testimony I had planned to
present and talk a little bit more about why we need to change
our process, maybe how to get to structural tax reform, rather
than focusing so much on why a specific tax reform plan does or
doesn't make sense. I think over the next two to five years we
have a tremendous opportunity to move forward on tax reform.
Unlike some in this room and elsewhere, I believe it can
happen. In fact, I believe it must happen if America is to be
prosperous in the increasingly-competitive new century.
In 1996 and 1997, thanks to the chairman's support and
others, I had the opportunity to serve as co-chairman on the
National Committee on Restructuring the IRS. I served on that
with Bill Coyne, who is with us this morning. It was a blue
ribbon panel of experts, as you know, convened by Congress to
recommend reforms to improve taxpayer service at the IRS.
I want to touch on this commission only because I think it
relates the to the topic here today in two regards.
First of all, the Commission in its work found the
complexity of the tax code was one of the major--and I would
say the major--problem facing the Internal Revenue Service. It
is consistent with the hearings that we have had and the focus
of this committee on tax reform.
Second, because I think it says a lot about process--that
is, how to achieve reform--in the Commission we rolled up our
sleeves, spent literally a year auditing the IRS, kind of
turning the table and getting to the root of the key problems
at that agency.
It was a complex and very difficult task, but after
careful, thorough review we recommended the most comprehensive
overhaul of the IRS in 45 years. And, although some of those
recommendations were viewed as controversial at the time, and
although the Administration was initially opposed to our
findings, at the end of the day, I think, based on the
Commission's work and the credibility that the Commission's
research brought, we were able to enjoy broad, bipartisan
support and we got these important reforms enacted into law.
Throughout our work on the IRS Restructuring and Reform
Commission, there was one cross-cutting problem that kept
resurfacing. Of course, I am talking about complexity of the
tax code.
It was an evolutionary process. When we first started out,
folks weren't focused too much on the complexity. We were
focused more on the inner workings of the IRS. But on a
bipartisan basis, Mr. Chairman, commissioners came to conclude
that the code, itself, was the greatest problem facing a very,
very troubled agency.
This isn't news to members of this committee, but it
provided, I think, a clear basis for reform because we found
convincing evidence that there were enormous organizational
challenges that the tax code poses to the IRS.
Again, although tax simplification was not our mandate, I
think we pushed the envelope a bit in our recommendations,
because the problem was so pervasive.
As you know, our recommendations included the tax
complexity analysis because of that which subjects all
perspective tax bills to a Joint Tax Committee analysis to
determine complexity for the taxpayer and for the IRS. We also
recommended getting the IRS formally involved in the tax-
writing process, to comment on the administrative challenges,
which we are trying to get even today from the IRS as an
independent agency looking at this issue.
We also made recommendations--some members of this
committee remember those, because some were controversial--on
60-odd specific code sections that could be simplified,
including the alternative minimum tax, to reduce needless
complexity. Some of these reforms, incidentally, were included
in the 1997 Taxpayer Relief Act.
And, finally, we recommended and passed in law that there
be an annual meeting of the seven committees with IRS oversight
coming together with Ways and Means and Finance on both sides
of the Capitol to ensure this agency gets more consistent
guidance from the Hill.
So these reforms underscored the connection we saw between
the problems with the IRS and complexity of the tax code.
Now, my thinking today is, you know, how do we get from
point A to point B. How do we get to this fairer, simpler tax
code?
I think a Tax Reform Commission makes a lot of sense, and
the purpose of this commission would be to keep the ball
rolling, to help educate the public about the problem--and Mr.
Rangel talked about that yesterday--and the alternatives, and
also take some of the rough and tumble of partisan politics out
of the process to bring some non-partisan expertise to bear on
the problem in a focused way with a specific time table.
I do urge my colleagues to support the legislation on the
floor today because it does have this commission as part of the
so-called ``sunset the code'' idea. I think it is a much more
responsible piece of legislation this year as a result of that.
It is an 18-month commission.
I know, again, some commissions have had a checkered past
in this town, but others have worked very well, and the IRS
Commission is the model upon which the commission we will vote
on today is based--15 members appointed by both parties, both
Houses, and the President, short time table, and report to
Congress. It does not take away, in any sense, the
responsibility of the Ways and Means Committee or the Finance
Committee to work through a tax reform. Just like the IRS
Commission, it makes a recommendation. We then go through
normal procedures, subcommittee and committee, to come up with
a proposal that the Ways and Means Committee and the Finance
Committee think is appropriate to bring to the floor.
But I think we need to have this kind of outside expertise
brought to bear on this issue. Obviously, before we even have
the recommendation, the committee has a lot of work to do, and
it is doing it well this week, in laying out the framework for
tax reform we can all agree on.
I think part of this framework must be broad support, and
that means it must be bipartisan. And this is really for two
reasons. First, it is reality. It is going to be difficult for
either party to ramrod a tax reform plan through Congress on
its own. But second, and very importantly, is stability. We
need to ensure that future Congresses and administrations don't
throw out the tax code every time party control switches.
I think if there is anything in the code that is worse than
the complexity, it is the changes to code, and we have seen
thousands of them since 1986. People are looking for certainty
and consistency, so that kind of a broad-based, two-thirds
support I think is absolutely critical.
Revenue neutrality--I would just urge that any tax reform
plan we come up with must deal with the current revenue
estimates.
We have heard, as you know, Mr. Chairman, lots of testimony
here this week on various estimates of what rates could be, but
I think we have got to be able to compare apples to apples,
which is, let us deal with the issue of reducing the scope and
size of the Government separately, which I support, but, with
regard to tax reform, I think we have got to focus on keeping
it revenue neutral and how do we come up with the best way to
raise the revenue to meet our needs.
And finally, of course, fairness. I think we have to
recognize the progressivity of the current code. It is
extremely progressive, and the top 10 percent pay 60 percent of
the income taxes in this country. For political reasons, I
think a very regressive tax has no chance of passing, so I
don't think that we can throw the distribution tables too far
off. At the same time, we must deal with the reality that our
current code does penalize savings and investment, our current
code does add enormous complexity, which is a waste of time and
money and energy, and this is where, frankly, we have, I think,
the most potential to make a huge difference in terms of
economic growth in this country and, again, moving into the
next century with prosperity.
I think, Mr. Chairman, again, all of us have different
ideas. You know I have some specific ideas on tax reform. I
thought about talking about them today, but I think that is
less useful, frankly, than it is talking about process at this
point and moving the ball forward.
I appreciate your allowing me to testify here today and I
urge us to take that next step, move forward on a bipartisan
basis to put together a plan for reform, and I thank you for
your patience this morning.
Chairman Archer. Thank you for your input. The committee, I
think on a bipartisan basis, welcomes it.
[The prepared statement follows:]
Statement of Hon. Rob Portman, a Representative in Congress from the
State of Ohio
Thank you, Chairman Archer, for holding this series of
hearings on tax reform. It's been an informative and thoughtful
discussion, and I've appreciated the opportunity to learn about
the various alternatives to the current tax code, which I hope
we can all agree should be replaced by a simpler, fairer and
less intrusive system.
This morning, though, I would like to focus, not so much on
why a specific tax reform plan does or doesn't make sense, but
on the process of how we might bring structural tax reform
about within the next two to five years. Unlike some, I believe
it can happen-in fact, I believe it must happen if we are to
continue our current prosperity into an increasingly
competitive 21st Century.
In 1996 and 1997, thanks to the Chairman's support, I had
the opportunity to serve as co-chairman of the National
Commission on Restructuring the IRS--a blue ribbon panel of
experts convened by the Congress to recommend reforms to
improve taxpayer service at the IRS. We rolled up our sleeves
and spent a year literally auditing the IRS--to get to the root
of the key problems at the agency. It was a complex and
difficult task, but after careful, thorough review, we
recommended the most comprehensive overhaul of the IRS in 45
years. Although some of the recommendations were controversial
at the time, and although the Administration was initially
opposed to our findings, at the end of the day, based on the
Commission's work and the credibility it brought, we enjoyed
broad bipartisan support and got these important reforms
enacted into law.
Throughout our work on the IRS Restructuring Commission,
there was one cross-cutting problem that kept resurfacing. I'm
talking, of course, about the overwhelming complexity of the
tax code. On a bipartisan basis, Commissioners came to conclude
that the tax code ITSELF was the greatest problem facing a
very, very troubled agency. This isn't news to the Members of
this Committee. But it provided another clear basis for reform,
because the Commission found convincing evidence of the
enormous organizational challenges the tax code poses to the
IRS.
Although tax simplification was not our mandate, we pushed
the envelope a bit with our recommendations because the problem
was so pervasive. Among our recommendations:
1) Tax complexity analysis-subject all prospective tax legislation to a
Joint Tax Committee analysis to determine its complexity for the
taxpayer and the IRS.
2) Get the IRS formally involved in the tax writing process to comment
on the administrative challenges posed by the proposed tax law
changes.
3) Recommendations on 60-odd specific code sections that could be
simplified to reduce needless complexity-some of these reforms were
implemented in the 1997 Taxpayer Relief Act.; and
4) An annual meeting of the 7 committees with IRS oversight
responsibility to ensure that the agency gets more consistent
guidance from the Hill.
These reforms underscored the connection between the problems of
the IRS and the complexity of the code itself. But I believe they've
also had the effect of helping to convince Members of Congress and the
public that we'll never get at the real root of the problems at the IRS
unless we address the tax code itself.
Now, I know what you're thinking--despite the amount of rhetoric
devoted to tax code reform, little seems to get done (raise your hand
if you remember the Tax Reform Act of 1986). While the general notion
of tax reform has broad bipartisan support the devil, as always, is in
the details. So how do we get from Point A--the current code--to Point
B--a simpler, fairer tax code that actually makes sense for a 21st
Century economy? Let me offer a few suggestions.
First, let's establish a Tax Reform Commission. The purpose of the
Commission would be to keep the ball rolling, to help educate the
public about the problem and the alternatives, to take some of the
rough-and-tumble of partisan politics out of the process and to bring
some non-partisan expertise to bear, in a focused way and with a
specific timetable.
That's why I urge my colleagues to support the legislation that's
on the floor today--which not only contains the ``sunset the code''
idea that we've debated in the past--but in the meantime also
establishes a non-partisan NATIONAL COMMISSION ON TAX REFORM AND
SIMPLIFICATION. It is modeled on the successful National Commission on
Restructuring the IRS.
I know that Commissions have a checkered past in this town, but we
proved that they can work. The Commission will have 15 members--three
appointed by the President, four each appointed by the Senate Majority
Leader and the Speaker, and two each appointed by the House and Senate
Minority Leaders. It will have a short timetable -18 months--to
complete its work and make a report to Congress on ways to
fundamentally reform and simplify the tax code. The Commission's
recommendations will cut through some of the clutter and give the Ways
and Means Committee a specific starting-point for more general debate.
But even before we have a specific plan before us, this Committee
should take the lead by laying out a framework for tax reform that we
can all agree on. Any framework for tax reform should include these
three elements:
1. BROAD SUPPORT, meaning, of course, it must be BIPARTISAN:Taxes are
some of the most intensely partisan issues we consider in this
Congress--and there are real and legitimate differences between the
tax policy viewpoints of both parties. But, as we consider
structural tax reform, we need to have a plan that can draw
bipartisan support. Why? (1) Reality--neither party has the ability
to ramrod a tax reform plan through Congress on its own; and (2)
Stability: Ensure that future Congresses and Administrations don't
throw out the tax code when party control switches. There have been
thousands of changes to the Code even since 1986, and it's the
constant changes--as well as the complexity--that causes such
compliance headaches.
2. REVENUE NEUTRALITY: Any tax reform plan that stands a realistic
chance of becoming law cannot significantly increase or decrease
federal tax receipts. I'm not going to mention specific plans, but
there have been tax reform plans that have advertised a certain
rate that is predicated on significant reductions in the federal
budget. Our focus should be on developing a vehicle for reforming
the tax code--we can find plenty of other opportunities to have the
debate over reshaping the size and shape of the government.
3. Finally, FAIRNESS: I think we have to recognize the PROGRESSIVITY of
the current code and--for both fairness and for political reasons--
I just don't see a regressive tax passing. We can't have a plan
that throws the distribution tables too far off by shifting too
great a percentage of the overall tax burden onto one income level
or another. An important, but overlooked, part of ensuring tax
progressivity, in my view, is to reduce compliance costs and
burdens for taxpayers--particularly lower-and middle-income
taxpayers. If we can lower or eliminate altogether the costs of
complying with the code for a substantial number of taxpayers,
we'll have a much fairer and less intrusive system.
As some of you know, I've been working on my own ideas for how we
might accomplish those goals. And I know other Members of this
Committee have offered thoughtful plans for reforming the tax code. I
commend Chairman Archer for having these hearings to increase the
awareness and understanding of the challenge of tax reform.
Now, let's take the next step--on a bipartisan basis--to make tax
reform a clear policy goal for this Congress.
Thank you.
Chairman Archer. I have no questions.
Mr. Rangel?
Mr. Rangel. I am a little afraid of the idea of a
commission having such broad powers in determining
philosophically how we should collect the revenues that would
run our country.
With Social Security, I joined with the Chairman in
believing that a commission was the right way to go.
Philosophically I don't think there is that much diversity in
terms of how do you fund a system once you have already decided
the health care that you want to provide. But whether we are
talking a value-added tax, a Federal sales tax, or a
progressive income tax, I think we are elected to make those
type of decisions.
But I am attracted to the idea of bringing together groups
of professionals, excluding Members of Congress, have them
review and analyze the different systems that have been offered
to the Congress, and to report back to the Ways and Means
Committees the pros and cons of it.
But it just seems to me that I would not want presented to
the Ways and Means Committee, to the House, or however you work
this out, something that philosophically may be diametrically
opposed to what I think should be happening. Members are
elected to express their views of their constituents, are would
need to know what direction the commission would be going and
have an impact.
There is enough good ideas in what you are saying and I
think that your presentation is positive. We should have more
outside views, so that we don't waste a lot of times just with
hearings, where experts can come together, study a situation,
and then report back to the Congress.
I want to thank you for your thoughtfulness. We will
continue to rely for you for direction in assisting us. We
hopefully will move forward in bringing some resolution to this
problem.
Mr. Portman. Thank you. I will.
I would just make one quick comment, and that is that the
educational element to this that you mentioned--I believe it
was at yesterday's hearing--I think would be a tremendous
benefit that would come from a commission.
In the IRS Commission case, as Mr. Coyne knows, we held
hearings around the country, and I think that would be
appropriate.
A lot of it is going to be exactly what you say, which is
bringing experts in and also bringing people from everyday life
who are affected by these massive changes that are being
recommended to talk about the impact it would have on our
businesses, on individuals, families, and so there would be an
educational aspect to this and there would also be a lot of
analysis, and at the end of the day there may not be a
consensus recommendation. It may be just that--it may be just
information that Congress can use.
Ultimately, of course, I said earlier--which is obvious--
this committee and the elected representatives would have the
final say.
Mr. Rangel. Thank you.
Chairman Archer. Does any other Member wish to inquire? Mr.
Neal?
Mr. Neal. Thank you, Mr. Chairman.
Mr. Portman, you know of my regard for your opinions, and I
am delighted with much of your testimony, but let me ask you a
couple of specific questions that I think might focus part of
this discussion.
A certain amount of the tax reform debate relies upon the
old notion that the grass is always greener on the other side
of the fence. Certainly, retail sales tax supporters found that
out when joint tax Tuesday estimated that it would take a 60
percent sales tax to replace all Federal taxes.
I react favorably to Mr. English's philosophy when he said
yesterday that the last thing we need is to enact reform that
is so radical and experimental that Congress will be faced with
revamping it all over again in but a few years.
Let me ask you this. I know you have an interest in
simplification, especially in the pension area. I have
introduced a bill, which even Mr. Archer has commented on
favorably, that would eliminate 200 lines from individual
income tax forms. Mr. Houghton has another version of that and
has worked on international tax simplification, as well.
Do you think it is really possible that the committee, or
at least some of us, could hammer out a practical, reasonable,
wide-ranging tax simplification proposal? And do you think that
would satisfy many of the complaints about complexity in the
current system?
The 1986 Tax Act was intended to promote fairness,
simplicity, and economic efficiency. Regardless of how well the
committee achieved any of these goals, it has spent the last 15
years unraveling at least part of it.
Do you think that we would be any more successful this
time, or do we need a completely different tax system?
Mr. Portman. I guess I think both. I have always believed
that it is worth the committee's time and the Oversight
Subcommittee, on which I serve, to focus on simplification.
Every day we ought to be trying to simplify the tax code. At
the same time, and I think this gets to your question maybe
more directly--if we just do that, we will not have done
enough. Because of the forces in this town and elsewhere to
find special breaks and provisions in the tax code that help
individuals and help businesses, we will end up with the same
complexity problems, which is why we need, also, to have debate
on and movement toward a more fundamental tax reform measure
which would, indeed, replace the current code.
I also think we have to realize that, as long as we are
just taxing income, we are, in effect, taxing success and
taxing productivity, and all the economists with whom I have
talked and you have talked, right, left, or center, agree that
moving from something that penalizes savings and investment and
the next dollar earned to a system that taxes consumption more
would make sense from an economic perspective.
In our current code, with all the simplification you or I
might want to do, you can't get at that economic reality. What
we can get at is the compliance cost, which I salute you for. I
think your bill is a movement in that direction. But I think we
need to go on both tracks.
Mr. Neal. Thank you, Mr. Portman.
Thank you, Mr. Chairman.
Chairman Archer. Mr. Thomas?
Mr. Thomas. Thanks, Rob.
One of the concerns I have is that all of our focus is on
the hated IRS, for a lot of good reasons, and a lot of the
programs look at the domestic picture and the internal role of
the tax code, because we have structured ourselves so long in
that way.
You and I and others know that our tax code, vis-a-vis
other countries, has significant impact on trade.
It used to be that no one really wanted to look at Medicare
or other major Federal programs because it was, as they used to
say, the ``third rail.'' Although President Clinton probably
doesn't want to have credit for starting the debate by putting
out a plan that was examined in great detail and wound up being
found lacking, I think a significant education process went on
among Americans and those institutions--the media and others--
in examining an area that had not been at the forefront of
exploration, the Medicare system, and, beyond that, the health
care system and the delivery structures that go with it.
My concern about not wanting to put something forward--and
you always do the best you can--is not so much to worry about
failing, but that, absent something concrete about which debate
could turn, we aren't going to get the kind of educational
process among the American people that I think we need. A
sterile, academic discussion of options isn't the same as,
``This is what we have. This is what you are going to get. What
do you think of the difference?'' That focuses the debate.
The fact that we would fail, say, the first time around is
less important to me than how far have we advanced the American
people's understanding that we need something new,
notwithstanding what it was they just lost.
Having been on a commission recently dealing with
Medicare--yours was a bit more successful than ours--we,
nevertheless, I think, elevated to a degree the discussion,
because we put forth a specific plan.
Commission, us, somebody--esoteric, academic debates don't
create the intensity to choose. Something out front that could
be an alternative does.
Reaction?
Mr. Portman. I couldn't agree with you more. It is an
action-forcing event. And let me say I didn't use Thomas-
Breaux, which was the Medicare Reform Commission, as my
example, I used the IRS one because I am closer to it, but it
is a perfect example of what I am talking about. A major
difference, as you know, between the IRS Commission and Thomas
Breaux was the two-thirds requirement. Wasn't it a two-thirds
requirement for a recommendation to be made from the
Commission?
Mr. Thomas. Yes. It was 11 out of 17.
Mr. Portman. We had a different set of rules under which we
worked. Now, in the end we did get a two-thirds majority, but I
think it was too bad that at the end that effort was torpedoed
by representatives from the Administration.
But, by the same token, it certainly focused debate and it
certainly moved the ball forward, and I think it is a good
example.
People, again, say commissions don't work. Well, they have
a checkered past. Some have, some haven't. But I can tell you
these two examples of the IRS Commission and the Medicare
Commission I think would lead us to be favorably disposed
toward a commission approach to this.
IRS reform is difficult and Medicare reform is extremely
controversial and can become very political, but nothing is
bigger than tax reform because it is going to affect every
single person in America, every business, and how we transact
every business transaction.
As Mr. Rangel said, it is fundamentally government how we
collect our taxes.
I think Chairman Archer has, through the last few years,
done incredible work in moving the ball forward, because we
wouldn't be here at these hearings. We wouldn't have the
headlines that we are getting. But we need to now move it to
the next level, and I think it is helpful to take it out of
this politically-charged environment.
Frankly, the Administration hasn't been able to come to the
plate on it.
If you look to the history of tax reform, it has always
been led by Treasury. They have the expertise. They have the
ability to understand how it would be implemented. This
Administration has not taken the lead on that, unlike the
Reagan Administration in 1986. That may or may not happen in
the next Administration.
The wonderful thing about this commission is that, while it
includes the Treasury Department--and actually the Secretary of
the Treasury would make an appointment--and includes the
Administration, it does not rely on them. Instead, it relies on
Congress and the Administration, bipartisan, bicameral, moving
ahead on it.
So I agree with your observation, and I think the Medicare
Commission is another good example.
Chairman Archer. Mr. Portman, thank you very much.
Mr. Portman. Thank you, Mr. Chairman.
Chairman Archer. Our next panel is Frank Luntz and Jefrey
Pollock.
Welcome, gentlemen. If you will identify yourselves for the
record, you may proceed with your testimony. And, if possible,
we would appreciate your holding your verbal testimony to five
minutes. Your entire printed statement, without objection, will
be inserted in the record.
Dr. Luntz?
STATEMENT OF FRANK LUNTZ, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, LUNTZ RESEARCH COMPANIES, ARLINGTON, VIRGINIA
Mr. Luntz. Mr. Chairman, for the record, my name is Frank
Luntz. It is an honor to be here. Having had the opportunity to
present to a number of you in your offices and in various
places on the Hill and now being before this tremendous
chamber, I can tell you that distance only makes the heart grow
fonder.
I am sorry that the ranking member is not here. I would
have informed him that in our polling for New York, on more
than one occasion, he is the most popular and respected
political figure in the State. When we asked him why, the
number one reason was his voice. I was looking forward to
hearing his voice after we spoke today.
I begin with a single finding from my--
Chairman Archer. Dr. Luntz, would you identify your
official position in our world, for the record, before you
commence?
Mr. Luntz. My official position is the president of the
Luntz Research Companies. Thank you, sir.
I begin with a single finding from a survey my firm
completed just last week. When asked to choose the one
government agency or institution Americans hated the most, it
should come as no surprise that they chose the IRS. In fact,
the IRS was chosen more than every other Government agency
combined.
Mr. Chairman, that is just one reason why up to 80 percent
of Americans want fundamental tax reform and why so many
Americans want to rid themselves of this complicated,
confusing, and corrupt tax system.
I ask the members of this committee to answer one question
that we asked the American people--which would you rather have
happen to you, have your wallet or purse stolen or be audited
by the IRS? Of Americans, 45 percent chose the wallet or purse
stolen, 45 percent chose the IRS audit, and 10 percent actually
said they couldn't tell the difference between the two.
Now, if you ask the American people to set a fair tax rate,
most Americans would agree to something around 20 percent. But
what frustrates Americans the most is not the income tax rate
so much as it is the complexity of the system and the
perception that the rich have expensive tax attorneys and fancy
accountants to navigate the IRS code.
In public opinion research we have done in terms of tax
reform, Americans have four essential requirements
Number one, fairness. Americans want to know that the
family with the expensive mansion on top of the hill is paying
his or her fair share. Fairness does not mean soak the rich,
but it does mean the wealthy must pay their fair share.
Number two is simplicity. People do not want to pay
accountants to prepare their taxes, yet an increasing
percentage of working class families now need to because the
system is so complicated and so frustrating.
Number three, uniformity. Working families dislike having
tax advantages parceled out to those who hire expensive
lobbyists and tax lawyers. Americans want a Federal tax system
that treats billionaires like Bill Gates exactly the same as
bus drivers like Ralph Cramden.
Consistency--Americans hate how the tax code changes from
year to year. With all due respect, they want a tax code that
you all up there can't tinker with from year to year.
Tax reform is a middle class issue because it is the middle
class who work the longest and hardest and feel the most short-
changed by not finding all the tax deductions they are entitled
to. I ask you to think about just how often you all are
affected by the tax code.
When you wake up in the morning and drink your first cup of
coffee, you pay a sales tax. You start your car, you pay a gas
tax. You drive to work, you pay an automobile tax. At work you
pay an income tax. You turn on the lights, you pay an
electricity tax. You flush the toilet, you pay a water tax. You
get home at night, you pay a property tax. You turn on your TV,
you pay a cable tax. You make a phone call, you pay a telephone
tax. Even when you die, you pay a death tax.
Two-thirds of Americans believe that they are over-taxed
and they want a break, and that is why tax reform, Mr.
Chairman, is so universally popular and that is why, in
particular, they want an end to the marriage penalty and an end
to the death tax.
It doesn't matter whether you are a republican or democrat.
Americans believe that a recently-married couple should not pay
more in taxes just simply because they decided to get married.
It is one of the most sacred and important institutions in our
society, and you are going to have a difficult time finding
anyone who believes that they should have to pay more just
because a man and a woman tie the knot.
Similarly, it was Benjamin Franklin, my favorite founding
father, who said, ``There are only two certainties in life--
death and taxes.'' But I don't think even Ben Franklin would
have known that both those occurrences would have come at the
same time.
My colleague, Jef Pollock, has more numbers to share with
you, so I will close with the following observation: most
Americans believe you can fix the tax code, instill fairness
and consistency, and still maintain and strengthen programs
like Social Security and Medicare. They believe you have got
the power to do it all, and they want you to do it all.
And the people that I polled are not the Internet paper
billionaires, they are not the high-priced lawyers. They are
struggling to make ends meet. They sacrifice their own needs
and give everything they can to their children. All they want
to know is that you hear them and that you care, so prove it
with a new tax code that is consistent, flat, fair, and tinker-
proof.
Thank you, Mr. Chairman.
Chairman Archer. Thank you, Dr. Luntz.
[The prepared statement follows:]
STATEMENT OF FRANK LUNTZ, PRESIDENT AND CHIEF EXECUTIVE OFFICER, LUNTZ
RESEARCH COMPANIES, ARLINGTON, VIRGINIA
I begin with a single finding from a survey my firm completed just
last week. When asked to choose the one government agency or
institution they hated the most, it should come as no surprise they
chose the IRS. In fact, they chose the IRS more than every other
government agency--combined In fact, according to a colleague of mine,
Democratic pollster Peter Hart, few things frighten Americans more than
receiving an IRS notice in the mail.
Mr. Chairman, that's just one reason why up to 80% of Americans
want fundamental tax reform, and why so many Americans want to rid
themselves of this complicated, confusing and corrupt tax system. In
fact, for most Americans, the point of least favorable contact between
them and Washington occurs sometime late in the afternoon of April 15
when they deliver their tax return to the friendly local post office.
I ask this Committee to answer a question I put to the American
people: would you rather have your wallet or purse stolen or be audited
by the IRS? Among Americans, 45% would rather be audited, 45% would
rather have their wallet or purse stolen, and 10% said there was no
difference!
Now, if you asked Americans to set a fair tax rate, most would
readily agree to something around 20 percent. But what frustrates
Americans most is not the income tax rate so much as it is the
complexity of the system and the perception that the rich have
expensive tax attorneys and fancy accountants to navigate the Internal
Revenue Code.
In the public opinion research we have done in regard to tax
reform, Americans have four essential requirements for any new tax
code:
1) Fairness. Americans want to know that the family in the mansion at
the top of the hill is paying his fair share. Fairness does not
mean soak-the-rich, but it does mean the wealthy must pay their
fair share.
2) Simplicity People do not want to pay accountants to prepare their
taxes, yet an increasing percentage of working class families now
need to because the system is so complicated and frustrating.
3) Uniformity Working families dislike having tax advantages parceled
out to those who hire expensive lawyers and lobbyists. Americans
want a tax system that treats Bill Gates no better than Homer
Simpson.
4) Consistency Americans hate how the tax code changes from year to
year. With all due respect, they want a tax code that stops all of
you from tinkering with it.
Tax reform is a middle class issue, for it is the middle class who
work the longest and the hardest and feel the most shortchanged by not
finding all the tax deductions they are entitled to. I ask you to think
about just how often the working men and women of America are taxed in
their day-to-day livesa...
When you wake up in the morning and drink that first cup of coffee,
you pay a sales tax. When you start your car, you pay an automobile
tax. Drive to work, you pay a gas tax. At work, you pay an income tax--
and a payroll tax. You get home at night, you pay a property tax. Flip
on the light--you pay an electricity tax. Turn on the TV--you pay a
cable tax. Call a friend, you pay a communications tax. Brush your
teeth, you pay a water tax. Even when you die, you pay a death tax.
In short, two-thirds of hardworking American believe they are
overtaxed, and they want a break. That's why tax reform is so
universally popular, and why, in particular, Americans want an end to
the so-called marriage tax and the death tax.
It doesn't matter whether you are a Republican or a Democrat.
Americans believe that a recently married couple should not pay more in
taxes simply because they decided to get married. The institution of
marriage is one of the most sacred and important in our society, and
you would have a difficult time finding anyone who believes the
government should penalize a man and a woman simply because they choose
to tie the knot and start a family.
True, it was Benjamin Franklin, my favorite Founding Father, who
said there were two certainties in life: death and taxes. But I do not
believe even Dr. Franklin could have told us that both would occur at
the same time. Perhaps that is why only a fraction of Americans believe
they will ever be impacted by the death tax, and yet a clear majority
want that tax eliminated--now.
My Democratic colleague has more numbers to share with you, so I
will close with the following observation. Most Americans believe you
CAN fix the tax code, instill fairness and consistency into the system,
and still maintain and strengthen programs like Social Security and
Medicare. They believe you have the ability and the power to do it all.
And the people I poll are not the Internet paper billionaires. The
people I poll don't have the high priced lawyers and fancy CPA's at
their beckon call. The people I poll still struggle to make ends meet.
They still burn the candle at both ends to put food on the table and
keep a roof overhead. They still sacrifice their own needs and giving
everything they've got to make sure their children have every
opportunity for a brighter future. All they want to know is that you
hear them and that you care. So prove it, with a new tax code that is
consistent, flat, fair and ``tinker proof.''
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Chairman Archer. Mr. Pollock?
STATEMENT OF JEFREY POLLOCK, PRESIDENT, GLOBAL STRATEGY GROUP,
INC., NEW YORK, NEW YORK
Mr. Pollock. Thank you, Mr. Chairman.
My name is Jef Pollock. I am the president of Global
Strategy Group, a public opinion research firm for the
democrats.
Hemlines go up. Hemlines go down. Los Angeles has forsaken
the martini lunch for a sobering shot of oxygen. Public opinion
waxes and wanes. But what is the one thing everyone has
consistently agreed upon since Truman beat Dewey? Taxes, Mr.
Chairman, are too high, and the system we endure too complex.
Over 40 percent of Americans have considered Federal income
taxes to be too high since the 1940s, and for the last 30 years
that figure has risen to 60 percent, though admittedly it is
down from its high of 69 percent in 1969.
How much is too much? As my republican colleague, Dr.
Luntz, has stated, almost two-thirds of Americans say the
highest percentage we should have to pay for all taxes
combined--that is Federal, State, and local--should be less
than 20 percent of their income. And who is getting their free
ride? According to most Americans, it is the rich.
Fully two-thirds of the Nation believe that those in the
upper income bracket pay too little in taxes, and almost half
of all Americans say this is the aspect of our tax system that
bothers them the most.
Still, on a more personal level, less than half of the
population believes that the amount of taxes they will pay this
year is ``fair.''
Americans are focused on their persistence that our tax
code needs overhaul. Dr. Luntz is correct to demonstrate that
Americans are frustrated with their increasing reliance on
accountants. The middle class think they are being squeezed by
a complex system. An impressive 61 percent of Americans believe
the Federal income tax system needs major changes or a complete
overhaul.
The components of this overhaul encompass cutting taxes,
simplifying the process, and regulating the power of the IRS,
but, while these suggestions sound succinct, they come with
strings attached, further complicating the process of reform.
Simplicity--two-thirds of Americans find the Federal system
too complicated; yet, although the system of taxation is
considered too complex, Americans are unwilling to give up
deductions to simplify it, and they oppose, by a 57 to 34
percent margin, replacing the system with a simpler nationwide
sales tax.
Regulation--a vast majority of Americans, 68 percent,
believe the IRS has more power than it needs. There is no
``other side'' to this issue. Right or wrong, they feel the IRS
should be better regulated.
Tax cuts--Americans are equally in support of a tax cut for
all Americans, as well as a cut for moderate to low income
households. However, while 72 percent of Americans favor a cut
in Federal income taxes, it is not their highest priority. A
plurality, 39 percent, placed a high priority on Congress
passing a significant Federal income tax, but only 21 percent
say it is the top priority. And more than a third, 38 percent,
say it should be a low or not a priority at all.
In addition, when our firm, Global Strategy Group, frames
the question pitting tax cuts against generic spending,
Americans prefer tax cuts. But when you ask people about
cutting tax as opposed to spending on programs, Americans
choose, of course, to fund the programs they most enjoy.
So, although they are concerned about their own purse, the
point of contributing to the Government's coffers is clearly
understood and accepted.
The task that lies before you all is great. Americans are
not happy with the current tax system, and, although they do
offer solutions, the solutions are not without their own
complexities.
While Americans overwhelmingly want reform, they do not
want it at any cost. They will not trade tax reform for a cut
in specific spending programs, and they will not sacrifice
deductions for a simplification in the tax codes; however, they
will likely be receptive to a discourse on how to reform the
code, and we can be pretty certain they will embrace a plan to
equalize the tax contributions of all Americans and certainly
to reduce the power of the IRS.
As we approach April 15th, Americans are struggling to
complete their tax forms accurately and on time. There is no
better time to reassess the tax code and deliver a simpler,
fair system that addresses the perceived inequality of taxation
and the inappropriate power of the IRS.
Let us put last century's opinion on this issue to rest
forever.
Thank you, Mr. Chairman.
Chairman Archer. Thank you, Mr. Pollock.
[The prepared statement follows:]
STATEMENT OF JEFREY POLLOCK, PRESIDENT, GLOBAL STRATEGY GROUP, INC.,
NEW YORK, NEW YORK
Hemlines are up, hemlines are down. La Vida Loca replaces
Duck & Cover. L.A. has forsaken the martini lunch for a
sobering shot of oxygen. The Watergate has become just another
fashionable address. Public opinion waxes and wanes.
But what's the one thing everyone has consistently agreed
on since Truman beat Dewey? Taxes, Mr. Chairman, are too high.
And the system we endure, too complex.
Over 40% of Americans have considered federal income taxes
to be too high since the late 1940s. And for the last thirty
years, that figure has risen to 60% (though it is down from
it's high of 69% in 1969).
How much is too much? As my Republican colleague, Dr. Frank
Luntz has stated, almost two-thirds of Americans say the
highest percentage we should have to pay for all taxes
combined--that's federal, state and local--should be less than
20% of their income.
And who's getting the free ride? The rich. Fully two-thirds
of the nation believes that those in the upper income bracket
pay too little in taxes. And almost half of all Americans say
this is the aspect of our tax system that bothers them the
most. Still, on a more personal level, less than half of the
population believes that the amount of taxes they will pay this
year is ``fair.''
Now, although everyone likes to gripe vaguely about
situations they perceive to be out of their control, Americans
are focused in their persistence that our tax code needs an
overhaul. Dr. Luntz is correct to demonstrate that Americans
are frustrated with their increasing reliance on accountants:
the middle class think they're being squeezed by a complex
system.
An impressive sixty-one percent of Americans believe the
federal income tax system needs major changes or a complete
overhaul.
The components of this overhaul encompass cutting taxes,
simplifying the process and regulating the power of the IRS.
But while these suggestions sound succinct, they come with
strings attached--further complicating the process of reform.
Simplicity: Two-thirds of Americans find the federal tax
system too complicated.
Yet, although the system of taxation is considered
too complex, Americans are not willing to give up deductions to
simplify it. And they oppose (57% to 34%) replacing the system
with a nationwide sales tax.
Regulation: A vast majority of Americans (68%) believe the
IRS has more power than it needs.
There is no ``other side'' to this issue. Right or
wrong, they feel the IRS should be better regulated.
Tax Cuts: Americans are equally in support of a tax cut for
all Americans as well as a cut for moderate to low income
households.
However, while 72% of Americans favor a cut in
federal income taxes, it is not their highest priority. A
plurality of Americans (39%) place a high priority on Congress
passing a significant federal income tax cut; but only 21% say
it is the top prority. And more than one third (38%) say it
should be a low priority or not a priority at all.
In addition, when our firm, Global Strategy Group,
frames the question pitting tax cuts against generic spending,
Americans prefer tax cuts. But when you ask people about
cutting taxes as opposed to spending on programs, Americans
choose to fund the programs they enjoy. So although they are
concerned about their own purse, the point of contributing to
the government's coffers is clearly understood and accepted.
The task that lies before you all is great. Americans are
not happy with the current tax system and although they do
offer solutions, the solutions are not without their own
complexities.
While Americans overwhelmingly want reform, they do not
want it at any costs. They will not trade tax reform for a cut
in specific spending programs, and they will not sacrifice
deductions for a simplification of the tax codes. However, they
will likely be receptive to a discourse on how to reform the
code, and we can be pretty certain they will embrace a plan to
equalize the tax contributions of all Americans and reduce the
IRS's power.
As we approach April 15th, Americans are struggling to
complete their tax forms accurately and on time. There is no
better time to reassess the tax code and deliver a simple, fair
system that addresses the perceived inequality of taxation and
inappropriate power of the IRS. Let's put last Century's
opinion on this issue to rest forever.
All polls cited in this testimony were conducted
nationwide, and all polled only adults. Thus, the opinions
cited are representative of voters across the country.
Sources include:
ABC News/Washington Post Poll, 3/9 -3/11, 2000, M of E 3%.
AP Poll conducted by ICR, 3/26 -3/30, 1999, M of E 3.1%.
Gallup Poll, 4/17 -4/19, 1998.
__________, 3/5 -3/7, 1999, M of E 5%.
__________, 7/17 -7/18, 1999, M of E 5%.
__________, 1/13 -1/16, 2000.
Gallup/CNN/USA Today Poll, Margin of Error 3%.
__________, 4/6 -4/7, 1999, M of E 3%.
__________, 7/16 -7/18, 1999, M of E 3%.
FOX News/Opinion Dynamics Poll, 3/10 -3/11, 1999, M of E
3.3%.
NBC News/WSJ Poll, 7/24 -7/26, 1999, M of E 3.2%.
Pew Research Center Poll, 2/9 -2/14, 2000, M of E 3.5%.
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Chairman Archer. If I may inquire, where did you grow up?
Mr. Pollock. I grew up in Mr. Coyne's home State of
Pennsylvania, northeast Philadelphia.
Chairman Archer. Well, as a Texan, I greatly enjoyed your
statement that ``the task that lies before ya'll is great.''
And I thought perhaps you might have grown up in Texas.
Mr. Pollock. Too many clients in the south, Mr. Archer.
Chairman Archer. I would like to ask both of you what, if
any, difference exists between the polling data that each one
of you has been able to put together.
Mr. Luntz. I would say that, for the most part, it is
actually quite similar, though on some of the details it does
differ because the focus does differ, and I would acknowledge
to the Members that, depending on how you word the question,
you can get a different result.
I think we would both agree that the IRS is quite
unpopular. I think we would both agree that the public does
support the concept of tax reform. The question is always in
the details of that tax reform.
Today, more than at any other time, Americans believe that
there should be a consistent rate, rather than this progressive
rate, and that opinion did not exist five years ago, but it has
existed for about the past two or three years, and that opinion
continues to grow.
And I think we also would agree that the public does want
to ensure that any tax reform not subject programs like Social
Security and Medicare to any kind of disruption.
Mr. Pollock. I would agree with Dr. Luntz and say that the
devil is in the details. When you look at questions about
things like a flat tax, for example, that is when things get
very complex, because when you ask Americans straight out they
tend to like it, but once you ask them any single question that
starts to whittle way at deductions, they basically flip out.
They say, ``No. Forget it.'' And so it just takes one little
push to push them over the edge, so the simplicity sometimes is
deceptive in the questions.
Mr. Pollock. And the surprise is actually republicans and
democrats, alike, whenever we test the death tax, it is one of
the taxes that Americans hate the most, even though it is a tax
that very few Americans feel that they will ever face. That is
what makes it quite interesting. They are not responding from
their own personal benefit; they are responding from the
principal belief that Americans should not be taxed at death.
Chairman Archer. I am a little bit curious as to what
appears to be a dichotomy between the results that Americans
don't think higher-income people are paying enough, number one,
and the comment that today a majority of them don't like the
progressive rate structure. How do you explain that difference?
Mr. Luntz. It is very easy, actually. It is all the
deductions that you all have passed for various people that
frustrate Americans. It is not the rate; it is the idea that
the rich will have accountants and lawyers and people that can
find in the loopholes within the current tax code that enable
them to avoid having to pay taxes.
Mr. Pollock. And it is interesting, Mr. Chairman. Among
Americans, 45 percent say that the taxes they pay are fair, so
it is not as if it is 70 percent saying that it is unfair, or
something like that.
I would agree with Dr. Luntz that it is the deductions, and
that is the complexity that they feel.
Frank had a very good line about Bill Gates and Ralph
Cramden, that Bill Gates has all these attorneys and
accountants and etc. who can get him out of taxes. I am not
picking on him particularly, but that is the concept that
Americans feel.
Chairman Archer. Thank you.
Mr. Thomas and Mr. Neal.
Mr. Thomas. Actually, I believe it was Bart Simpson, wasn't
it? Ralph Cramden is someone I recognize. I figured you were
trying to go for the now generation with Bart Simpson.
Thanks to both of you, but I, too, like the chairman, am
kind of puzzled by the presentations, and then am curious about
why and how questions are asked.
Do you have any relevant poll data if you ask American
people whether rich people are happier than poor people?
Mr. Luntz. In fact, sir, we have looked at that, and the
most happy people in America are the middle class.
Mr. Thomas. And would you say that people are worth a
million dollars that find themselves in the middle class,
often?
Mr. Luntz. The people who are worth a million dollars would
probably define themselves as being upper middle class.
Mr. Thomas. Well, you can put all kinds of descriptive
terms in front of it, but I think even Bill Gates thinks he is
middle class, so I have difficulty, again, to deal with that
kind of description.
Do you think people believe that the rich people get
breaks--that is, it is easier to beat the system if you are
rich rather than poor?
Mr. Pollock. Absolutely.
Mr. Thomas. I think you get the point. You can go through a
series of stereotypical statements, and people will ascribe a
certain profile to the rich.
I think I could save you a lot of money and tell you
without polling that people think rich people don't pay their
fair share of the taxes.
Looking at this other chart--and I am using yours. Yours is
Powerpoint and it has a few more. That is the only reason.
Although Americans don't like the income tax system, they
oppose replacing part of it with a nationwide sales tax. Well,
I don't like one, and now you are going to give me two. Did you
try a question that said ``replacing it in its entirety,'' an
either/or question, rather than, ``If you don't like one, how
about two?''
Mr. Pollock. It is a good question, but, to be very clear,
none of these are--I am pulling from independent polling data,
so, as you will see, this is, you know, Gallup or--
Mr. Thomas. Yes, but it is the same fraternity.
Mr. Pollock. That is true. I agree.
Mr. Luntz. Mr. Chairman, you know that fraternities right
next to each other never get along.
Mr. Thomas. And then, of course, as you said, Mr. Luntz, in
terms of the way you asked the question, if I said, ``Would you
like to get rid of the income tax which would do away with the
IRS and replace it with a different tax,'' you have now loaded
the question, I think, sufficiently that people would go for
whatever the rest of the sentence was if you threw in getting
rid of the IRS.
So I am just kind of curious as to what you could provide
us with that would be slightly less entertaining, perhaps, but
a bit more enlightening, because when people don't like the
current tax system, don't like the complexity, don't like the
IRS, but want to hang on to their deductions, you kind of just
say, ``Don't wet your finger.'' We had better sit down and
build the best scientific economic revenue package we can, and
then go out and have people all agree that the unknown is not
as acceptable as the known, notwithstanding the fact that I
absolutely hate the known.
You folks are going to be in the boat with us, and we are
going to be using you, but I would really love to see somebody
try to cipher a series of questions with pull-out sections that
substitute back in, that, in essence, asks the same question
with variables, and then repeat it in different circumstances
to try to begin to build a base of at least relative
directional signals.
To your knowledge, has anybody begun doing this, or are we
going to have to pay for it?
Mr. Luntz. We have done this, to some degree, and what we
get, quite frankly, are mixed signals--that the public is
frustrated with what they have now, they are scared about what
you may give them. The problem, quite frankly, is their lack of
faith in people here to give them a system that truly is flat,
simple, and fair. They believe that, because of the outside
influences, they are afraid that the actual new product might
be more disruptive than what they have now, even though they
fundamentally don't like what they have now.
Mr. Thomas. Well, Mr. Luntz, you made the assumption the
flat tax is the one that we would look at. What about one that
got rid of all income taxes and allowed us to be competitive in
the arena of today, and especially tomorrow, in world trade.
Mr. Luntz. I used the word ``flat'' to indicate both a
sales tax and an income tax. I am not speaking just of the
income tax. Flat rate means that everybody pays the same rate,
regardless of whether it collects it based on what you spend or
what you earn.
Mr. Thomas. Even that, from a semantical point of view,
makes it difficult because of the identity of the various plans
and the terms that we use, so we are even more into a semantic
jungle.
Thank you very much, Mr. Chairman.
Chairman Archer. Just very quickly, to piggy-back on the
line of questioning of Congressman Thomas, I notice in one of
the charts that you have given us, Dr. Luntz, that you ask the
question, ``Should Congress completely overhaul the Federal tax
system that includes abolishing the IRS and replacing the five
different income tax rates with a single rate.'' It seems to me
that is an oxymoron, because if you have still got an income
tax, even with a single rate, you still have the IRS. I don't
know how you can do both.
Mr. Luntz. We were trying to get at not making a choice
between income tax and the sales tax. The way the you read the
question, you have assumed that it is an income tax rate.
One of the challenges in polling and to present to you all
is to be neutral in terms of the income tax or the sales tax
and try to judge the public's generic support for a fundamental
overhaul of the system. So perhaps we have not achieved that by
the question.
Chairman Archer. But if I were to answer the question--and,
as you know, I want to abolish the income tax, which I have
publicly stated for a long time, and I want to get the IRS
completely and totally out of every individual's life, but if I
were to answer this question and say that the IRS forever will
be out of my life and I only have to pay a single income tax
rate, I might be intrigued to embrace that. But I can't get
both. I can't have a single income tax rate and have the IRS
out of my life, because I have still got to keep the records
for seven years, and they are still going to audit me, and I
have still got all of the exposure, although in a more simple
form than the current code.
Mr. Neal?
Mr. Neal. Thank you, Mr. Chairman.
Dr. Luntz, I agreed with much of your testimony, but I want
to ask you a question.
You said that the American people view the IRS as
``corrupt.'' Did you use that term when you tested the
question?
Mr. Luntz. No.
Mr. Neal. No?
Mr. Luntz. We asked them, ``What institution do you dislike
the most? What Federal Government institution or agency do you
dislike the most?''
Mr. Neal. Let me just, if I can, address that question and
the use of that term ``corrupt.'' That word did more to poison
the way that we talk to each other in this institution than any
other word I have witnessed in the 12 years I have been in the
House. That word was used to poison the well of the institution
across the way and the way we talk and treat each other in the
House.
Now, if we use that word all of the time around here to
speak to each other or use that word when we wish to change an
institution and its behavior, we only bring the debate to a new
low, and that is the danger of using that term.
I would recommend to everybody here Joe Kline's piece in
the New Yorker about a year ago, ``The Town That Ate Itself,''
in which he went back and talked to Republican Members who used
that word and now say they regret using that word because of
what happened in the institution.
So if we didn't test that word, I don't know why we would
throw that word into the testimony today.
Mr. Luntz. Because, Mr. Congressman, I would invite you,
because this is not a partisan issue, to join me in focus
groups and face-to-face sessions with Members, and the words
that they use, not to describe the IRS but to describe the tax
code.
Mr. Neal. Right. I don't dispute that. I don't dispute
that, Doctor.
Mr. Luntz. It is the language--
Mr. Neal. It is the word.
Mr. Luntz. But it is the word that is used by the American
people to describe what they perceive as a system that is out
of control. And I invite you to join me in--
Mr. Neal. I would like to do that. But let me ask you a
quick question here. There is a Wall Street transaction called
``exchange funds'' that exactly accomplished that. Ralph
Cramden's wife, Alice, has to sell her stock and then pay
capital gains tax. What happens when Bill Gates goes into an
exchange fund and, in effect, trades stock and pays no tax? Is
this exactly the situation you referenced when you were
speaking earlier about the way the American people perceive the
tax code?
Mr. Luntz. No. I was merely using Ralph Cramden as a pop
culture figure, although I would correct you. Ralph Cramden and
Alice were so poor that they could never own stock, so they
could never sell it and have to pay the capital gains.
Mr. Neal. They were just blue collar democrats.
Mr. Luntz. Actually, they were the first blue collar
republicans. They were just before the Reagan democrats came
into being. [Laughter.]
Mr. Neal. I would suggest, Mr. Chairman, that the
transaction I made reference to--maybe Mr. Pollock could
comment upon it, if he would.
Mr. Pollock. There is no doubt, Congressman Neal, that
there is a feeling that the rich do get benefits. I don't think
that is exactly--I mean, in terms of questioning, that is not
something that hits them.
When you do focus groups--and I am sure you have seen this
up north--people, especially the middle class more and more,
are angered by the capital gains tax and that it is no longer a
tax on the rich, exclusively.
But, from a rhetorical battle, if we were taking it out of
the policy and into the rhetoric, it hasn't crossed the
threshold yet where they say, ``Oh, yeah, that is a tax where
we, the middle class, really need to change it,'' but it is
coming. It is coming. There is no doubt about it.
And with ever-increasing use of Ameritrade where the middle
class and everybody is getting involved in trading, you are
absolutely correct, that tax increases in prominence to them.
Mr. Neal. I will close on this note, Dr. Luntz, that the
Reagan democrats, which I represent, have come back home.
Thank you.
Mr. Luntz. I will allow you to have the last word. I hope
so.
Chairman Archer. I am hoping that we can wrap up this panel
before we go to vote, so that when we come back we can take the
next panel.
Ms. Thurman has requested time and Mr. Coyne has requested
time.
Well, I guess we can't do that. All right. Ms. Thurman?
Ms. Thurman. I will try to make this quick, and maybe you
all can just give us these answers in writing.
One, I would like to know, from both of you, what the
demographics were of your poll, who the people were that you
polled--you know, income, where they are.
Mr. Pollock. They are all nationwide. They are all general
population.
Ms. Thurman. But it would be good to have that information
available to us.
Mr. Pollock. Sure.
Ms. Thurman. Secondly, Mr. Pollock, when Dr. Luntz made the
statement that everybody agreed that we ought to get rid of the
death tax, your polling does not show that. Can you give me
just a brief explanation of what you found, because it also
would be counter to what Dr. Luntz has shown about the high-
paying person.
Mr. Pollock. They are not mutually exclusive,
unfortunately, and, unfortunately, one question doesn't cover
it. What Dr. Luntz is talking about is, in a series of
questions, when you ask people, ``Would you like to get rid of
X tax, Y tax, Z tax,'' when you put them all together at once
you will see that inheritance taxes and also the marriage
penalty, both of which Americans favor, in general, getting rid
of, don't rank higher, of course, than getting rid of an income
tax or getting rid of a local property tax, which bothers them
much more than do those. Of course, they hurt them a lot more
financially, so it makes sense.
So it is not dichotomous. You can have both in Americans'
minds. It is just, when you put them all together, if I have to
choose one or two, inheritance tax or, as they like to call it,
``death tax,'' and the marriage penalty, they are not going to
be number one and two. But when you ask them individually,
certainly people do think it is unfair.
The marriage penalty to me, when I have seen things, tests
even more egregiously, where people say, ``Just because I am
getting married doesn't mean I should have to pay more in
taxes.''
Ms. Thurman. Okay.
Mr. Pollock. Did that adequately address, Frank?
Mr. Luntz. And I would just say that we actually have
tilted the question, because I could not believe that Americans
would actually believe that someone like Bill Gates should not
have to pay a higher percentage of his savings and investment,
and we tilted questions so anti-death tax. But if you go out--
and, again, I invite you, as well, to come to these sessions
that I do--Americans just believe it is a matter of principle
that, even if you are rich, you should not lose up to half of
your savings and income just because you die.
Ms. Thurman. And then, I think, maybe taking off on Mr.
Archer's last question, when he talked about getting rid of the
IRS and then the different income tax rates, but also then to
the polling that Mr. Pollock saw that says, ``But don't take
away my deductions,'' so rate would be one issue. And then, if
you added in to that same question, do you think you would get
a different result if you said, 'but don't take away my
deductions,' as well?
Mr. Luntz. When you start to mention deductions, home
deduction being the most popular of all, you start to--
Ms. Thurman. Child credit.
Mr. Luntz. Yes. You start to see people begin to peel away.
But in the end they are prepared to pay more if you could
simplify the system. If you could say to Americans that we will
guarantee that this will take you either no time, in the case
of a sales tax, or 15 minutes, in the case of--
Ms. Thurman. As long as it only goes to 20 percent.
Mr. Luntz. Once you start getting above 20 percent in
taxation, you start to have Americans chafe at it. That is
correct.
Ms. Thurman. Okay.
Mr. Luntz. But simplification is so important.
Ms. Thurman. I think we all agree on simplification. I
think that is the one thing that we do agree on.
Chairman Archer. We are clearly not going to have time for
the Members who do wish to question to do that, so the Chair is
going to have the committee stand in recess so that we can go
vote, and then we will return.
[Recess.]
Mr. Crane [presiding]. We will resume.
We apologize for the interruption, but that is the way this
place is run.
I now would like to yield to our distinguished colleague
from Pennsylvania, Bill English.
Mr. English. Thank you, Mr. Chairman. I appreciate the
chance to pursue a line of questioning that occurs to me,
reading with interest the testimony of these two witnesses.
You have provided some very interesting insights on how the
public views tax reform and where it sees it as a potential
priority. I wanted to get a sense of whether either of you had
done any polling on international taxation.
I know, Mr. Luntz, you have done more polling on trade
issues than, I think, anyone in your profession of my
acquaintance, so I am wondering, have you polled on the idea of
a fair and equal tax on the imports and stop taxing exports--in
other words, border adjustability?
Mr. Luntz. Yes. Of course, no American will understand it
as border adjustability. It is much too complicated. But when
you begin to explain to them the defensive position that our
products are put in by the Federal tax code and the advantage
that foreign products have, again because of our tax code, not
only do they become frustrated with it, they demand immediate
change.
I would acknowledge that it is not one of the highest
priorities, but, in terms of your question, the public believes
that, at a minimum, our products should not be put at a
disadvantage, and preferably our products should have an
advantage over foreign products, and nothing in our Federal tax
code should undermine that advantage.
Mr. English. Mr. Pollock?
Mr. Pollock. I wish I had more to add, Congressman English,
but Dr. Luntz has done much more on the subject than I have.
Mr. English. Let me say one of the keys to broadening the
debate and broadening the support for fundamental tax reform,
in my estimation, is starting to include international tax
issues framed in terms that working people understand.
My colleague, Mr. Traficant, who testified yesterday, I
think has done a good job of taking that message back to
Youngstown, Ohio. I have tried to do the same thing in
Pennsylvania.
I think that international taxation, specifically border
adjustability, moves people, and I have gotten that sense from
discussing it at town meetings and actually just
unscientifically trying to get a reaction in terms of a show of
hands.
I would invite both of you to consider polling on this
point, and also polling on the question of, as one of our
witnesses yesterday testified, my proposal specifically would
end the tax incentive for run-away plans. I think that is
something that would resonate very much with the general
public.
On a separate point, Dr. Luntz, I see from the polling that
the Luntz Group did that the fairness quotient of the taxation
of alcohol and beer is perhaps in a different category from
other taxes. Only 20 percent feel the taxation of beer is
unfair.
I wonder, in polling, have you communicated to the people
you poll the fact that 43 cents on every dollar that they pay
for the draft of beer in a place like Eerie, Pennsylvania, is
taxed? This gets to the question of the visibility of taxation.
I wonder, if people are aware of what the level of excise tax
is, would those numbers change?
Mr. Luntz. They probably would change. In fact, in my
presentation, in my testimony I spoke of all the different
areas that we are taxed. Mr. Congressman, most Americans aren't
aware that, from the moment they wake up in the morning until
the moment they go to sleep at night, everything they do,
everything they consume, every part of their lives are taxed.
If they were made aware of just how much they were taxed, they
would say, ``To heck with everything.''
Mr. English. And do you think that insight would convert
into opposition, potentially, to a value-added tax if it were
applied? Most people don't know what a VAT is, but if it is
described to them, how would you expect them to react? Or do
you have any polling on this point, imposing a very broad and
visible tax on the public?
Mr. Luntz. In fact, if it were consistent, if it were
obvious, if it were clear, if it were applied evenly, and if it
got rid of the IRS, the American people would support it.
Anything that simplifies, makes more consistent, makes
flatter and fairer, any type of tax like that would be
supported over the current system.
Mr. English. So people don't view it as a priority to know
how much they are being taxed, as long as they have a sense
that the tax system is fair?
Mr. Luntz. One of the great reforms that I would wish this
committee would consider would be to remove withholding. If
Americans knew exactly how much they paid in taxes, this
committee would be cutting taxes every single year.
Mr. English. Thank you, Congressman.
Mr. Pollock. Congressman, I have done focus groups in
Westmoreland, close to your home, and in that county I have
talked to people about taxes. The fact is, we also have to
remember that there is mass confusion about what all of their
taxes are. I don't know what I am paying in property. Add the
property tax into this mix, which is, to many people,
extraordinarily egregious, property tax, income tax, sales tax,
whatever it is, they are confused as to what tax they are
paying at any given time, so certainly they don't know that 43
cents of their draft is going to a tax.
Mr. English. Very good.
Mr. Crane. The time of the gentleman has expired.
Dr. Luntz, I have given up on alcohol, but I have
increased, escalated my consumption of sugar, but that is still
a better deal, right, tax-wise? [Laughter.]
Mr. Luntz. I am not sure how much they put on sugar. I do
know that people have paid millions of dollars to keep that
sugar tax either lower or higher than it is today.
Mr. Crane. Okay.
Ms. Dunn?
Ms. Dunn. Thank you very much, Mr. Chairman.
I wanted to make one comment, based on Mr. English's
question, and that is that politics has become so personal
these days, and communicating is also required to be personal
for people to be able to connect government policy to what
really happens in their everyday lives. And it seems to me
that, if we ever began talking in terms of the number of
dollars that people pay in taxes, whether it is that huge gas
tax or the beer tax or property tax or death tax, and we have
got people thinking about what they could purchase for their
families' better quality of life for those dollars, that we
could end up with a mutiny. I hope that never happens.
It is shocking, Mr. Luntz, when you go through your list of
the taxes that people pay. I mean, if they are confused about
what taxes they pay, they pay every tax on everything every
hour of every day. It has really gotten to be way too much, I
think.
I want to ask you a couple of questions. One, I would like
to ask you gentlemen what you have learned, either from your
survey research or from focus groups, what single people are
thinking about our tax system.
For example, we have succeeded in reducing taxes in lots of
areas. We have provided for education credits when dollars are
set aside in education accounts for their children, we have
provided for capital gains taxes to be relieved on the purchase
of a house. For a single person, that house is still the same
amount of money and it still takes the same number of people
mowing the lawn and trimming the trees and to pay for all the
costs of owning a home. We provide for a child tax credit. We
have provided for a child care credit. We have provided for an
end to the marriage penalty. It goes on and on and on what we
have done for families who have children.
Are the singles starting to feel a little left out on this
tax system?
Mr. Luntz. Congresswoman, you have done a lot for hard-
working taxpayers, and I can assure you that they appreciate
it. The great frustration for single taxpayers now can be
summarized in two words, ``payroll tax.''
Americans, particularly those who are just starting off
their careers, are shocked when they find out just how much
money is taken out of their paycheck every two weeks and how
little confidence they have that they will actually get that
money back at the end of their careers when they are receiving
Social Security or other benefits.
It is not surprising that more young Americans believe in
the existence of UFOs than believe that Social Security will
exist by the time they retire, and that payroll tax every two
weeks is a frustration to them and they would like some relief.
Mr. Pollock. There is also the current--I wish Congressman
Johnson were here, because the current fad, of course, is to
talk about the gas taxes. And when I say ``fad,'' it is only to
say that they are talking about it right now. People really
want to talk about the gas tax. It is impacting them. They are
seeing it. They are seeing it on a daily basis. In Connecticut,
people are seeing prices over $2. So the gas tax right now,
which single people are looking at, also, because many of them
are commuters--young people using a lot of their car--the gas
tax is something that bothers them. It bothers them more on a
State level, though, certainly.
Ms. Dunn. Well, if I could have one change in our tax
system--and the chairman is not here right now to hear this--
but for all singles, the group of which I am one, I wish we
could just make one exemption in capital gains for the sale of
a home, because the huge difference between 250,000 and
500,000, which is what the couple gets, means that somebody
like me, if I choose to sell my house--and there are many of
``me's'' around this Nation--that we pay a capital gains,
especially if we have been living in an inflationary period for
any length of time.
Let me just ask you to augment what you both have said
about the death tax. I am very interested in public perception
of this, and I am very intrigued by the fact that folks you
have researched are fair about this tax. I am wondering, as we
consider whether this should be brought up as a stand-alone
bill--and somebody every now and then will question the Bill
Gates factor--I wonder if you could talk more in-depth on why
death tax needs to die.
Mr. Luntz. We have done this specifically. In fact, because
of the challenges that have been raised by people in both
parties, we attempted to weight the question as strenuously
against to death tax as we could, emphasizing that these people
probably have avoided taxes, that they have got high-priced
accountants and lawyers to help them avoid taxes, that they are
so rich that they can afford not to have to pay it. No matter
how hard we weight it, by two to one, at a minimum, Americans
want to get rid of this tax, because they just don't understand
why you should be prevented from handing down the things that
you have saved and invested to the next generation of
Americans, and how in this country you should have to lose up
to half of your savings and investments just because you have
been successful.
Congresswoman, I can't weight it any more against it. By at
least two-to-one, people want the total elimination of the
death tax.
Mr. Pollock. It is more of a common sense thing for
Americans. When they are thinking about the death tax, and
also, as I brought up before, the marriage tax, it just seems
to them to be silly. Why? Why, on X occasion, one of great
happiness and one of great sadness, does the Government get the
opportunity to then come in and tax them on that occasion?
In that respect, that is where Americans are looking and
saying, ``You know, this just isn't fair,'' whereas the other
things--as I point out, Americans will say, ``Okay, we
understand we have to fund Government programs. We understand
that our taxes do go to something,'' but those, in particular,
stand out as things that just don't seem right.
Ms. Dunn. Thank you very much.
Mr. Crane. Thank you.
Mr. Coyne?
Mr. Coyne. Thank you, Mr. Chairman.
Dr. Luntz, I was wondering, does it surprise you that your
findings of last week indicate that the least-liked Government
agency is the IRS, when politicians of every stripe, in order
to make political points, continue to malign the work and the
function of the Nation's revenue collection agency? Does that
surprise you?
Mr. Luntz. It has nothing to do, quite frankly, with what
is said here or with politicians; it has to do with the fact
that when Americans get that IRS tax form it scares them.
Mr. Coyne. Yes. So that is your explanation?
Mr. Luntz. Americans are afraid of the IRS. Absolutely.
They are scared of the IRS. Even today, even with the work that
you have done to change the system, Americans are still afraid
of the IRS.
Mr. Coyne. So if people were to say things about you going
around the country, that you were stealing money out of their
pocket and they were over-loading the U.S. Treasury by their
collections, how popular do you think you would be?
Mr. Luntz. Maybe a little more popular than I am without
people saying that.
Mr. Coyne. Well, I just think it is, in large part, a
result of the maligning of the function and the role of the
collection agency in this country that they are the least-
popular agency in the Government, if that is what your findings
show.
Mr. Luntz. I think I should make this as a formal offer to
this committee, that I would be happy--and we can't do it
within the beltway. We have to do it a little bit outside, but
maybe a place like Baltimore, which ``American Demographic''
has labeled as the most representative city in America. I and
my colleague will make this offer to you, at our own expense,
to bring you to the public and have you listen to how they
articulate their fear of the IRS. It is not the way, in this
case, that we word the questions, and it is not what you say
about them. It is how Americans fundamentally believe that
there is an agency that can penetrate their lives and do things
to them that they have no control over in an unjust and immoral
fashion.
I would invite this committee, for each of these issues--
the death tax, the marriage penalty, the IRS--to bring Members
out there so you can watch from behind the mirror as real, live
people respond to these questions. I think you might find it
useful.
Mr. Coyne. Well, it might surprise you to know that
everyone in this Congress goes back to their Districts every
weekend.
Mr. Luntz. I am sure.
Mr. Coyne. And that we mix with the people, and we know
what the people are saying, and we know that, as you pointed
out in your testimony, no one likes to pay taxes, but most
people, the majority of the people, recognize that it is a
necessity if we are to have any kind of civil society, and that
when you continually malign--whether it is the IRS or the
Defense Department or whoever it is, seem to me naturally they
are not going to have a very high rating in public opinion
tolls like you took.
Mr. Pollock, in your testimony you cite Dr. Luntz' survey
showing that two-thirds of Americans say that the highest
percentage we should have to pay for taxes, combined, all taxes
combined, should be less than 20 percent of income. Do you know
of any survey that tells us what services taxpayers are willing
to give up to achieve a 20 percent rate?
Mr. Pollock. Congressman Coyne, that is an excellent
question. And the point, of course, is nothing. And Americans
are hypocritical in public opinion. There is no doubt about it.
They don't make that rationalization. They want cuts, but not
at the expense of their government programs. So the question is
correct. And, unfortunately, that is the way the American
public responds.
Mr. Coyne. Well, do you have any specific programs that
Americans choose to fund rather than getting a tax cut, in your
surveys?
Mr. Pollock. Absolutely. The ones that have been bandied
about--and I believe that these have become prominent because,
as you are pointing out, politicians all over are talking about
them--but shoring up Medicare and Social Security certainly
come before a tax cut in the voters' minds, improving spending
on education, for example, as long as it is targeted spending,
as long as it makes sense and not wasteful spending on
education, and certainly some spending on health care. Those
are the four that have come up that I have seen in the last six
months in terms of both surveys and focus groups where people
are saying, ``Okay, we have got to spend on these things no
matter what.``
Mr. Coyne. Does either of your polling show what are some
of the reasons that Americans oppose a national sales tax?
Mr. Luntz. No.
Mr. Pollock. No. I haven't seen any.
Mr. Coyne. Thank you.
Mr. Crane. Mr. Portman?
Mr. Portman. Thank you, Mr. Chairman.
I want to thank Frank Luntz for the information that he is
giving us today and has given us over the years on this and
other issues, because it is very helpful, and these polls and
the focus groups do focus us a little bit more on what the key
issues are and what our constituents care about.
I want to ask a question about tax reform, since that is
the focus of the hearings.
I understand that when you ask people whether they agree or
disagree that overhaul of the Federal tax system, including the
abolishing of the IRS, and replacing five different income tax
rates with a single rate, that is popular, people agree with
it. But when you do your polling, Frank, about what people care
about, tax reform never shows up near the top. Why is that? I
mean, is it the good economy? Is it the sense of frustration,
that they know that nothing will happen with it? Or is it that
for most people it is just not a very important part of their
daily lives?
Mr. Luntz. Half of it is the good economy, but there is
another half. It bothers me. It troubles me to even say this,
but they have heard about tax reform and they have heard about
tax cuts for so long that they feel that they will never
receive it.
We talk about these things and make these promises, and
then, when we don't deliver, it undermines the credibility of
the institution and the promise, so that most Americans believe
that if the President or Congress were to offer them a tax cut
or tax reform, it would never actually happen.
It is one way that you could instill a sense of confidence
in this institution and in this body, to actually deliver on
making their lives easier, simpler, and providing them with
more money at the end of the day than they otherwise would have
had.
Mr. Portman. Over the last few years, you know, as we have
helped to provide some relief, including the child tax credit,
significantly, we have, in essence, begun to push the
progressivity of the code even further so that the top 10
percent of income earners are paying something like 60 percent
of the Federal income tax now. Again, it doesn't include
payroll tax, although that is also somewhat progressive because
of the cap. But it is an issue that, frankly, republicans, I
think, are probably of two minds about. One is we want to
provide tax relief to middle income Americans, but second is,
as you increasingly move middle Americans to a lower and lower
Federal income tax rate and you increasingly move folks who are
at the bottom of the economic ladder off the tax rolls
altogether--I think it is about six million Americans who don't
pay income taxes today who did a few years ago, because of the
changes that we have made--and as you enrich the EITC program
where more and more folks are getting a refund rather than
paying not just payroll taxes but income taxes--and some folks,
as you know, are paying income tax, payroll tax, then getting a
check from the Government in the form of the EITC that covers
both of those, plus. They are actually getting something back.
You begin to lose kind of a constituency for tax reform, or at
least for tax relief.
I don't know if my question to you is do you agree with me
or not on that. That would be the one question, I guess. Is
that one reason that there isn't as much interest in tax
reform, as well as maybe tax relief?
Second is: what does that mean for the prospects of tax
reform going forward?
Mr. Luntz. Americans tend to respond to big ideas in terms
of great change, and it seems very difficult to ask Americans
to accept the same tax structure today that they had 50 years
ago, when we have new technology and great inventions that are
changing the way things operate; that Americans would expect
that their laws and the things that govern them would be
updated as times change.
If you can attach yourself to that outlook towards the
future, I think you would be much more successful.
Support for tax reform will increase significantly in our
next economic downturn as Americans become frustrated and their
wallets and purses become tighter. It would be nice if you
could pass tax reform before they were demanding it of you.
Mr. Pollock. To be very clear about one thing that Frank
said, this concept that Americans are upset, or when they think
about the concept of a tax cut they don't actually believe it
will happen, there is a lot of talk of it, but it doesn't
happen, I conducted a bunch of focus groups in Connecticut
where Governor Rowland gave back to all Connecticut individuals
basically a per child, you got $50 a head, and even though it
seems like a trivial amount--and even the voters were saying
that it is silly to get a $50 check--they were all incredibly
satisfied just because somebody had actually delivered upon
giving them a check, getting them an actual refund, and they
gave him a lot of credit for it, even though they thought the
amount was trivial.
So I think Frank is absolutely right when he says it is
about 50 percent good economy and 50 percent they don't believe
it is going to happen.
Mr. Portman. Again, thank you all very much. We look
forward to continuing to get your input as we try to pursue
reform and simplification.
Mr. Crane. Well, Dr. Luntz and Mr. Pollock, we appreciate
your testimony. I think that is--unless Mr. Thurman has a
question yet?
Ms. Thurman. Did you all test the debt versus taxes at all?
It just has not been talked about much, and I am just kind of
curious how that plays in this.
Mr. Luntz. I have not done it but it has been done, and the
public right now is more concerned about the debt.
Mr. Pollock. Right now, when you look at it, the public
will take paying off the national debt over tax cuts on a
numerical level, and if you need the numbers I can get them to
you.
Mr. Crane. Very good. Well, we thank you for your
presentations. That will terminate this panel.
The committee, however, will now stand in recess until 1:00
p.m.
Mr. Luntz. Mr. Crane, welcome back.
Mr. Crane. Thank you.
The committee will come to order.
The Chair apologizes for being a couple of minutes late,
but we will commence at this time.
I welcome each one of you. We are delighted to see you, and
we will look forward to your presentation.
Mr. Helming, would you lead off?
Mr. Helming. I would be more than happy to, Mr. Chairman.
STATEMENT OF BILL HELMING, ECONOMIST AND BUSINESS CONSULTANT,
BILL HELMING CONSULTING SERVICES, INC., OLATHE, KANSAS
Mr. Helming. I assume that it is appropriate to suggest
that my written document will be submitted for the record, and
I will just--
Mr. Crane. Without objection, your entire written
statements will be included in the record, and you can
synopsize verbally, if you will.
Mr. Helming. Yes. I will do so.
It is, indeed, an honor and a pleasure to be here. I have
been self-employed for 27 years, a business consultant and
economist. I work out of my home, along with my wife, in
Olathe, Kansas. We have been working on this tax plan, the
Helming national consumption tax plan, for 16 years. We have
been advancing it with the help of a lot of people, including
the two other panelists here, and literally thousands of people
across the country.
We have been working on it as private citizens, paying our
own bills to get it done.
I think the most important introductory thing, Mr.
Chairman, would be that, as a practical matter, I have been
conducting focus groups for 16 years, literally a major cross-
section of the U.S. public, finding out what they liked and
what they didn't like about this plan and the other plans.
Bottom line: why fundamental tax reform?
Basically, the present tax code penalizes or greatly
restricts success, hard work in human capital, saving and
investment, economic growth, productivity, risk-taking, and the
transfer of family-owned small businesses from one generation
to the next. I have designed this plan to try to send the right
signal and to reward each of those things as opposed to
penalizing them.
As you know, Mr. Chairman, the marginal tax rate on labor,
under the current Federal tax code, is 35.6 percent. When you
put it all into one pot, it is 35.6 at the margin. The Helming
two-tiered consumption tax plan is 30.4, or 15.2 in tier one at
the business level, 15.2 on tier two at the retail level, times
two is 30.4. That is basically a 14 percent differential. I
tend to be real conservative. Let us say it is a 10 percent
differential.
That means that the economy would double in growth in 10
years, compared to the way we are operating now under the
present tax code, or the cost of goods and services would come
down by 10 percent. In the real world, it would be some
combination of the two.
Basically, the major benefits of such an approach would be
a stronger growth economy; more jobs; higher wages; more take-
home pay; lower cost of goods and services; lower interest
rates by a significant margin--15 to 25 percent--eliminates the
IRS from the wage-earner's perspective; major simplification;
and major advantages--in this case, competitive advantages in
the global market and trade arena; and a very visible tax.
Why is this possible? Well, it is very fundamentally
because, under such a plan, we are no longer double taxing
income, investment, or saving, while at the same time we are
taxing labor and capital pretty much equally, which Aldona
Robbins is going to speak to in a few minutes, which,
obviously, under the present tax system, we do not do.
It is also possible for you to get these many benefits for
the economy and the working Americans of this country because
it has a much broader tax base and a uniform tax rate.
The Helming NCT plan is specifically designed to achieve
all of these specific benefits. This will particularly benefit
lower-and middle-income wage earners.
I came to the conclusion some time ago, and certainly
believe it strongly today, that the status quo in terms of our
current tax code is unacceptable. If we can accrue such
tremendous benefits for the common working person in America
and the working families, as well as for the business
community, then it is clearly time to seriously embrace
fundamental tax reform.
Very honestly, all of these competing plans are going to
have essentially the same impact on the economy, in terms of
favorable benefits. Where the real differences come in is how
they are structured as it relates to how they specifically are
perceived to impact businesses, wage-earners and consumers, and
that comes in the structure of the tax reform proposals.
So, basically, the Helming NCT plan represents an excellent
and viable compromise, Mr. Chairman, and a common ground for
real fundamental tax reform because of its structure. It
reflects many of the best aspects and strengths of the other
competing proposals, while avoiding their weaknesses relative
to perceptions in fairness, political viability, simplicity,
and compliance issues.
Very simply stated, my plan is a two-tiered plan. Tier one
is a uniform and border adjustable activities tax at 15.2
percent, wherein the tax is levied on what businesses add to
output--i.e., internal labor costs and the return to capital
(profit). It applies to all businesses, the self-employed, and
nonprofit organizations and institutions and all Federal,
State, and local government agencies, and accounts for 57
percent of all Federal Government revenues raised.
Tier two is a 15.2 percent sales tax levied on consumer
purchases except for the necessities of life, which I will
define briefly in just a moment. The tier-two sales tax raises
43 percent of the total federal taxes.
I also want to emphasize that this plan envisions the
entire repeal and replacement of the complete federal tax code
as we know it today. All income taxes, the payroll taxes, the
self-employment taxes, and all excise, railroad retirement,
gasoline--in other words, nothing is left out.
It is essentially revenue neutral at two levels at 15.2
times two, to raise the same amount of revenues.
John Meagher just informed me today that the joint
committee on taxation did complete the scoring on my tax plan,
and their numbers came out very close to the numbers that we
have been using.
We deal with regressivity specifically by exempting the
necessities of life. I define those as food at the grocery
store, food mart, and vending machine, all prescribed medical
costs, and all home purchases and/or those who rent.
On the business side, all capital purchases and exports
would be tax exempt for the business. The competitive position
of U.S. businesses and the U.S. economy in the global
marketplace would be substantially improved over what it is
now. The reason for this is that we would be exempting exports
and taxing, as I know you very well understand, imports on a
border-adjustable basis. That, itself, would raise 10 percent
of the total revenues. Basically, it would encourage many
multi-national companies to come home, stay home, and hire more
U.S. workers.
Progressivity and freedom of choice are primarily an
outcome of how much and when consumers choose to spend, save,
invest, or reduce debt with their income over and above the
necessities of life.
Bottom line, Mr. Chairman, in terms of my verbal comments--
and I am looking forward to any possible questions that you
might want to ask--I come to this conclusion: if we can benefit
the U.S. economy in such a dramatic way and also benefit the
common wage-earner no positively in the United States and, the
working families of America, which clearly all the studies,
including Aldona Robbins and her husband, Dr. Robbins, and a
number of others who have helped me with this long and involved
process and helping me get to this point then, I simply ask
this rhetorical question. If so many people can be benefitted,
then why don't we embrace fundamental tax reform along these
lines?
Thank you very much.
[An attachment is being retained in the Committee files.]
Mr. Crane. Thank you, Mr. Helming, Mr. Powell, we will be
pleased to receive your testimony.
STATEMENT OF JAMES L. POWELL, LIVESTOCK PRODUCER, FORT
MCKAVETT, TEXAS
Mr. Powell. Mr. Chairman, I come here today as a livestock
producer. My interest in the Helming national consumption tax
is to seek its passage and produce change in the method that
Federal and State governments tax the hard-earned incomes and
lifetime savings of individuals and families.
Unless income, State, gift, and capital gains taxes are
eliminated, the small business owner, the family farmer will
continue to be liquidated at a precipitous rate.
The evidence provided by the U.S. Census Bureau, the USDA
National Statistical Service, each decade is compelling. These
numbers bear serious consideration.
In 1940, the rural population, those living in communities
of 2,500 or less citizens, was 43.5 percent of the total. In
1990, the rural population was 24.8 percent of the total.
The employment status of civilian workers employed in
agriculture in 1940 was 17.1 percent of the total workforce. By
1990, the number of agricultural employees had decreased to 1.6
percent of the total population. The number of farms producing
agricultural products had been reduced from 65 percent from
1940 to 1990. The size of those farms had increased 163
percent--corporate farms on the increase. In the last five
years, those farms have increased 6 percent, while the
individual, family, and partnership farm have decreased in
number.
This benign trend began in the 1930s and will continue
until some time in the future. Population increases in this
country and a disruption in foreign nations that import
agricultural products into the U.S. will create the beginning
of food shortages, much like the oil shortage that developed in
the 1970s.
The loss of population in agriculture and the large
increase in size of farms reflect a deterioration in U.S.
agriculture.
There are a number of indicators of deterioration. It is
clear that agriculture is not the preferred choice of many
youths. The minimum economic unit today in my area is about
6,000 acres, a value of about $1,800,000. In 1940, the minimum
economic unit was about 2,250 acres, a value of less than
$50,000. Today, to transfer this unit to heirs after exclusions
requires a heavy estate tax. An education can equip the young
heirs with an opportunity for employment in industry that now
offers a much higher income than agriculture. That is more
appealing to them than coming back to the farm for an
inheritance that will burden them with an enormous estate tax
after they have paid a hefty income and/or capital gains tax.
This country is losing its agricultural young, as is shown
by the increase in the average age of the person in agriculture
from 53.3 years to 54.3 years of age in only five years, from
1992 to 1997.
Another indicator of deterioration of agriculture is the
parity index of farm commodities. The index is based on farm
goods sold in 1914 equalling 100. That index has declined in
the last eight years from 51 in 1990 to 42 in 1998, a reduction
in the dollar return on goods produced of 5 percent.
That loss of income and persistent demand for payment of
death taxes has caused the operating debt of the farm community
to increase from $77 billion in 1980 to $80 billion in 1997, an
increase of 3 percent.
Yet another indicator is an increase in agricultural
imports for consumption. Food imports have increased 63 percent
during the current Administration from 1990 to 1995. Imports
will compete with domestic products and require those products
to sell at a price close to or below production cost. The
future of this country's food supply will gradually become
questionable.
With these negative trends confronting agriculture, it is
easy to understand the exodus of productive people from family
farming and the subsequent development of corporate farming and
increased importation of farm products to supply to U.S.
consumers.
The solution for agriculture and small business to the
problem that has just been described is the National
Consumption Act. It will release the unbearable income, estate,
capital gains tax from those few who now pay and place the tax
more fairly on a much broader-based population.
All imported products will bear a fair share of the tax
burden and release all U.S. exports, agricultural and
industrial, from taxes, thereby stimulating the economy.
All the citizens of the United States would be better
served by State and Federal governments if the Helming national
consumption tax were implemented.
If I might be permitted, might I quote one brief vignette?
Before coming here this week, an employee, after hearing the
explanation that my mission was to encourage the elimination of
the income, State, and capital gains taxes so that many of us
would not eventually join the ranks of the defunct, said to me,
``Tell them I never received a paycheck from a poor man.''
Thank you.
Mr. Crane. Thank you, Mr. Powell.
[The prepared statement follows:]
Statement of James L. Powell, Livestock Producer, Fort McKavett, Texas
Mr. Chairman, ladies and gentlemen of the Ways and Means
Committee I come here as a livestock producer. My interest in
the Helming National Consumption Tax is to seek its passage and
produce a change in the method that federal and state
governments tax the hard earned incomes and lifetime savings of
individuals and families. Unless income, estate, gift and
capital gains taxes are eliminated the small business owner and
family farmer will continue to be liquidated at a precipitous
rate.
The evidence provided by the U.S. Census Bureau and U.S.D.A
National Statistical Service each decade is compelling. These
numbers bare serious consideration. In 1940 the rural
population, those living in communities of 2500 or less
citizens, was 43.5% of the total. In 1990 the rural population
was 24.8% of the total.\1\ The employment status of civilian
workers employed in agriculture in 1940 was 17.1% of the
workforce. By 1990 the number of agricultural employees had
decreased to 1.6% of the population.\2\ The number of farms
producing agricultural products had been reduced by 65% from
1940 to 1990. The size of those farms had increased 163%.\3\
Corporate farms are on the increase. In the last 5 years those
farms have increased .6% while the individual, family and
partnership farms have decreased in number.\4\
---------------------------------------------------------------------------
\1\ U.S. Census Bureau. ``Statistical Abstract of the United
States.'' 27 July 1999. Online. http://www.census.gov/prod/www/
statistical-abstract-us.htm. Table #1412. 4 April 1999.
\2\ U.S. Census Bureau. ``Statistical Abstract of the United
States.'' 27 July 1999. Online. http://www.census.gov/prod/www/
statistical-abstract-us.html. Table #1430. 4 April 1999.
\3\ U.S. Census Bureau. ``Statistical Abstract of the United
States.'' 27 July 1999. Online. http://www.census.gov/prod/www/
statistical-abstract-us.html. Table #1100. 4 April 1999.
\4\ U.S. Census Bureau. ``Statistical Abstract of the United
States.'' 27 July 1999. Online. http://www.census.gov/prod/www/
statistical-abstract-us.html. Table #1441. 4 April 1999.
---------------------------------------------------------------------------
This benign trend began in the 1930's and will continue
until sometime in the future. Population increases in this
country and a disruption in foreign nations that import
agricultural products in the U.S. will create the beginning of
food shortages, much like the oil shortage that developed in
the 1970's.
The loss of population in agriculture and large increase in
size of farms reflect U.S. agriculture deterioration. There are
a number of indicators of deterioration. It is clear that
agriculture is not the preferred choice for many youths. The
minimum economic unit today in my area is about 6,000 acres, a
value of $1,800,000. In 1940 the minimum economic unit was
about 2,250 acres, a value of less than $50,000. To transfer
this unit to heirs after exclusions requires a heavy estate
tax. An education can equip the young heirs with an opportunity
for employment in industry that now offers a much higher income
than agriculture. That is more appealing to them than coming
back to the farm for an inheritance that will burden them with
an enormous estate tax after they have paid a hefty income and/
or capital gains tax. This country is losing its agricultural
young as is shown by the increase in the average age of the
person in agriculture from 53.3 years to 54.3 years of age in
only 5 years, from 1992 to 1997.\5\ Another indicator of the
deterioration of agriculture is the parity index * of farm
commodities. The index is based on farm goods sold in 1914
equaling 100. That index has declined in the last eight years
from 51 in 1990 to 42 in 1998, a reduction in the dollar return
on goods produced of 5%.\6\ That loss of income and persistent
demand for payment of death taxes has caused the operating debt
of the farm community to increase from $77 billion in 1980 to
$80 billion in 1997, an increase of 3%.\7\ Yet another
indicator is an increase in agricultural imports for
consumption. Food imports have increased 63% during the current
administration, from 1990 to 1995.\8\ Imports will compete with
domestic products and require those products to sell at a price
close to or below production costs. The future of this
countries food supply will gradually become questionable.
---------------------------------------------------------------------------
\5\ U.S. Census Bureau. ``Statistical Abstract of the United
States.'' 27 July 1999. Online. http://www.census.gov/prod/www/
statistical-abstract-us.html. Table #1102. 4 April 1999.
*Parity Price--``price for a commodity or service that is pegged to
another price or to a composite average of prices based on a selected
prior period. As the two sets of prices vary, they are reflected in an
index number on a scale of 100. For example, U.S. farm prices are
pegged to prices based on the purchasing power of farmers in the period
from 1910 to 1914. If the parity ratio is below 100, reflecting a
reduction in purchasing power to the extent indicated, the government
compensates the farmer by paying a certain percentage of parity, either
in the form of a direct cash payment, in the purchase of surplus crops,
or in a NONRECOURSE LOAN.
The concept of parity is also widely applied in industrial wage
contracts as a means of preserving the real value of wages. (Barron's
definition of parity price as written in the Barron's Financial Digest)
\6\ U.S. Census Bureau. ``Statistical Abstract of the United
States.'' 27 July 1999. Online. http://www.census.gov/prod/www/
statistical-abstract-us.html. Table #1116. 4 April 1999.
\7\ U.S. Census Bureau. ``Statistical Abstract of the United
States.'' 27 July 1999. Online. http://www.census.gov/prod/www/
statistical-abstract-us.html. Table #1113. 4 April 1999.
\8\ U.S. Census Bureau. ``Statistical Abstract of the United
States.'' 27 July 1999. Online. http://www.census.gov/prod/www/
statistical-abstract-us.html. Table #1441. 4 April 1999.
---------------------------------------------------------------------------
With these negative trends confronting agriculture it is
easy to understand the exodus of productive people from family
farming and the subsequent development of corporate farming and
increased importation of farm products to supply the U.S.
consumer.
The solution, for agriculture and small business, to the
problem that has just been described is the National
Consumption Tax. It will release the unbearable income, estate
and capital gains tax from those few who now pay and place the
tax more fairly on a much broader base of the population. All
imported products would bear a fair share of tax burden and
release all U.S. exports, agriculture and industrial from taxes
thereby stimulating the economy. All of the citizens of the
United States would be better served by state and federal
governments if Helming National Consumption Tax were
implemented.
If I might be permitted may I quote one brief vignette.
Before coming here this week an employee, after hearing the
explanation that my mission was to encourage the elimination of
the income, estate and capital gains taxes so that many of us
would not eventually join the ranks of the defunct, said ``Tell
them I never received a pay check from a poor person.''
Mr. Crane. Ms. Robbins?
STATEMENT OF ALDONA ROBBINS, VICE PRESIDENT, FISCAL ASSOCIATES,
AND SENIOR RESEARCH FELLOW, INSTITUTE FOR POLICY INNOVATION
Ms. Robbins. Thank you, Mr. Chairman.
I am Aldona Robbins, vice president of Fiscal Associates
and senior research fellow at the Institute for Policy
Innovation. I want to thank you for the invitation to appear at
these hearings.
As the committee has heard during the last two days, there
are lots of ways to implement fundamental tax reform. While the
proposals have important differences, I would like to focus on
some of what they have in common.
First, the tax bases of most reform proposals are basically
the same. Now, someone might say, ``Wait a minute. Doesn't a
sales tax tax consumption, a business tax business, an income
tax income?'' The short answer is yes, but those distinctions
really refer more to where the tax is collected than to what is
ultimately being taxed.
Government gets its revenue by taxing the income going
between households which provide labor and capital services and
businesses which provide goods and services. Because the two
flows--the value of the goods and services that businesses
produce and the value of the labor and capital services
provided by households--are made up of the same dollars, all
taxes can be viewed as being paid out of income earned by labor
and capital.
A second area of commonality is the tax rate. To raise a
given amount of revenue and holding exemptions constant, most
reform proposals should yield similar effective rates.
What is more, those that look to replace Federal revenues
should, likewise, end up with average rates close to the
current system.
I would like to highlight some findings from a project in
which we have rearranged the national income and product
accounts to analyze the current tax system, as well as
alternatives, on the basis of factor incomes.
Currently, the effective average Federal tax rate--and this
includes all Federal taxes--on the income of private business,
labor, and capital is 26.5 percent. The marginal rate on factor
income is 36.2 percent.
Suppose we were to replace the entire system of Federal
taxes with a comprehensive sales tax, which provides every
family with a refundable credit equal to the poverty line. In
that case, the effective average Federal tax rate on the income
of private business, labor, and capital would be about 24
percent and the marginal rate would be about 29 percent.
What about a generic business cash flow tax with or without
border adjustment in the same refundable credit? Again, the
average rate on factory income would be about 24 percent and
the marginal roughly 29 percent.
The effective rates of the alternatives are lower than
current law because the proposals have broader, more uniform
tax bases and a single rate. The rates of the alternatives are
the same because they both end up taxing the same dollars but
at different collection points.
Compliance is assumed to be the same as under current law.
The effective tax rate would be the same, regardless of what
the stated rate might be.
If the Joint Tax Committee says that the required rate is
really going to be 30 percent instead of 24, it simply means
that the current law rate must be higher than the 26.5 percent
that we had calculated.
Doing so, however, would not change either the conclusions
regarding the effective rates or the relative comparisons.
I would like to close with some comments about economic
effects. There are efficiency gains to be had in reform of the
current system. Both capital and labor pay higher rates on the
next dollar of income than on the average dollar, and--although
I didn't present verbally these results, they are in my written
remarks--capital is taxed more heavily than labor.
A single rate which would treat capital and labor the same,
as well as lower marginal rates, would encourage greater saving
and investment, lead to a more efficient use of resources, and
result in increased output.
There are, to be sure, important differences among
competing proposals for fundamental tax reform, but we should
not lose sight of the fact that the economic ramifications of
proposals that broaden the base, remove the bias against
capital, and lower marginal rates are essentially the same.
Thank you.
Mr. Crane. Thank you, Ms. Robbins.
[The prepared statement follows:]
Statement of Aldona Robbins, Vice President, Fiscal Associates, and
Senior Research Fellow, Institute for Policy Innovation
Mr. Chairman and members of the Committee, I am Aldona
Robbins, Vice President of Fiscal Associates and Senior
Research Fellow at the Institute for Policy Innovation (IPI).
Thank you for the invitation to appear at these important
hearings on tax reform.
Calls for tax reform stem from growing dissatisfaction with
record tax burdens, the complexity of the present code, and
worries that Americans aren't saving enough. As the Committee
has heard during two days of testimony, there are a myriad of
ways to implement fundamental tax reform. Some, like a national
sales tax, represent a radical departure from the current
system. Others, like a factor payment or generic business cash
flow tax, are less so.
While fundamental tax reform proposals have important
differences, they also have much in common. My remarks today
will focus on some key similarities.
First, the tax bases of most reform proposals are basically
the same. Someone will undoubtedly protest, wait a minute, a
sales tax taxes consumption, a business tax taxes business, and
an income tax taxes income. Those distinctions, however, really
refer more to the point of collection than to what is
ultimately being taxed.
Anyone who takes an introductory economics course usually
goes through an accounting exercise called the circular flow
describing the workings of a market economy. Businesses acquire
the services of labor and capital from households to produce
goods and services. Households exchange their labor and capital
services for the goods and services produced by businesses.
But, it is important to remember that the same people who make
up households also own and operate the businesses. Labels
merely serve to distinguish among economic activities.
Government gets its revenue by taxing the income going
between households and businesses. Here it is important to note
that the two flows--(1) the value of the goods and services
that businesses produce and (2) the value of the labor and
capital services provided by households--are made up of the
same dollars. A tax on the sale of goods and services reduces
the income that would otherwise be paid to labor and capital. A
tax on factor income reduces what workers and owners of capital
can buy. Because both flows measure the same thing, that is,
total economic activity, all taxes can be viewed as being paid
out of income earned by labor and capital.
A second area of commonality is the tax rate. To raise a
given amount of revenue, and holding exemptions constant, most
reform proposals should yield similar rates. What is more,
those that look to replace federal revenues should likewise end
up with average rates close to the current system.
Demonstrating these propositions requires some complex
accounting to attribute all taxes to factor income.\1\ Some
taxes easily translate into this framework while others require
more work. For example, people pay personal taxes on income
received for labor and capital services in the form of wages,
interest, dividends and so forth. The employer and employee
shares of payroll taxes come out of labor compensation. Less
obvious are taxes seemingly levied on business, but they, too,
affect the dollars flowing to factors. For example, the
corporate income tax reduces the pool of money available to pay
dividends or other forms of capital compensation to
shareholders. Even sales and excise taxes, which are seemingly
levied on the purchases of goods and services, come out of
factor income because they reduce the funds available to pay
the factors.
---------------------------------------------------------------------------
\1\ This requires rearranging the Commerce Department's National
Income and Product Accounts to better reflect taxes. Details will be
forthcoming in a study by Gary and Aldona Robbins entitled Road Map for
Tax Reform from the Institute for Policy Innovation this spring.
---------------------------------------------------------------------------
Table 1 summarizes the average and marginal tax rates on
labor and capital in private businesses. Accounting for three-
fourths of the economy, the private sector pays close to 90
percent of U.S. taxes.\2\ Table 2 contains average and marginal
rates for the rest of the economy.\3\
---------------------------------------------------------------------------
\2\ In 1999, private businesses produced 75.8 percent of the $9.3
trillion in GDP.
\3\ This includes federal, state and local government, government
enterprises, domiciles (which is people employed in domestic service
and the value of home ownership) and nonprofit institutions.
---------------------------------------------------------------------------
On average, taxes at all levels of government claim about a
third of labor income in the private sector. Federal taxes
amount to 25.9 percent and state and local taxes to 7.4
percent.\4\ Private business capital pays almost half its
income in taxes. The average tax rate at the federal level is
27.6 percent and 21.6 percent for states and localities.\5\
---------------------------------------------------------------------------
\4\ Table 3 contains the components of labor income for 1999.
\5\ Capital income is gross capital compensation less capital
consumption allowance. Table 3 contains the components of capital
income for 1999.
---------------------------------------------------------------------------
Private business capital and labor pay even higher marginal
tax rates. Out of the next dollar of income, labor pays 44.4
percent in taxes -35.6 percent to the federal government and
8.8 percent to states and localities. The marginal rate on
capital is 60.6 percent -37.6 percent to the federal government
and 23 percent to states and localities.
Combining capital and labor, taxes claim an average 38.5
percent of private business income. Federal taxes claim 26.5
percent while state and local taxes take 12.1 percent. That
implies that any proposal aiming to replace all federal taxes
would need a tax rate of somewhere between 25 and 30 percent on
all U.S. income, depending on the level of personal exemptions.
Summarized below are tax rates for current law and two
general approaches to tax reform--a comprehensive sales tax and
a generic business cash flow tax, with and without border
adjustment--which are assumed to replace all federal taxes.
Average and marginal rates are expressed as a percent of
private business income.
Tax Rates on Private Business Income
------------------------------------------------------------------------
Average Federal Marginal Federal Total Marginal
Tax Regime \1\ \2\ \3\
------------------------------------------------------------------------
Current Law 26.5% 36.2% 49.8%
Comprehensive 23.9% 29.2% 42.7%
Sales Tax
Generic business 23.9% 29.2% 42.7%
Cash Flow,
border
adjustment
Generic Business 23.9% 29.2% 42.7%
Cash Flow, no
border
adjustment
------------------------------------------------------------------------
AThe three proposals assume each family receives a refundable credit
equal to the poverty line times the tax rate. The revenue collected is
based on a single rate on private business income and labor
compensation in the rest of the economy. There are no special tax
breaks and all double taxes are eliminated.
\1\ Federal taxes as a percent of private business income (gross labor
income plus gross capital income less capital consumption allowance).
\2\ Federal taxes on the next dollar of private business income as a
percent of private business income.
\3\ Federal, state and local taxes on the next dollar of private
business income as a percent of private business income.
Because the tax bases for the three proposals are the
essentially the same, the effective tax rates needed to raise
the same amount of federal revenue as under current law also
would be the same. Replacing all federal taxes would require an
effective average rate on private business income of about 24
percent and a marginal rate of about 29 percent under either
the sales tax or the business cash flow tax, with or without
border adjustment. These effective rates are lower than the
26.5 percent under current law because the proposals have
broader, more uniform tax bases.
Even though the rate is flat, the system is progressive. In
this example, each family would receive a refundable credit
equal to the poverty line. While families below the poverty
line would face the same marginal rate as everyone else, they
still would better off than under current law. Because they
would get money back, their average tax rate would be negative,
and they would not have to pay FICA taxes.
A last point about the summary table. The calculations
assume that compliance would be the same as under current law.
The effective tax rate would be the same regardless of what the
stated rate may be. If the Joint Tax Committee says the
required rate is 30% instead of 24%, it simply means that the
current law rate must be higher than the 26.5% calculated in
the table. Doing so would not change either the conclusions
regarding effective rates or the relative comparisons.
I would like to close with some comments about economic
effects. There are efficiency gains to be had in reform of the
current system. First, both capital and labor pay higher rates
on the next dollar of income than on the average dollar.
Second, capital is presently taxed more heavily than labor. A
single rate, which would treat capital and labor the same as
well as lower marginal rates would encourage greater saving and
investment, lead to a more efficient use of resources and
result in increased output.
There are, to be sure, important differences among
competing proposals for fundamental tax reform. But, we should
not lose sight of the fact that the economic ramifications of
proposals that broaden the base, remove the bias against
capital and lower marginal rates are essentially the same.
Table 1.--Components of Average and Marginal Tax Rates on Private
Business Labor and Capital, 1999
------------------------------------------------------------------------
Labor Capital
All ----------------------------------------------------------
Government Average Marginal Average Marginal
------------------------------------------------------------------------
Total 33.3% 44.4% 49.1% 60.6%
Personal \1\ 14.2% 25.3% 19.5% 28.0%
Corporate 0.0% 0.0% 11.3% 14.3%
profits
Indirect 5.7% 5.7% 18.3% 18.3%
business \2\
Payroll \3\ 13.5% 13.5% 0.0% 0.0%
Federal
Total federal 25.9% 35.6% 27.6% 37.6%
Personal 11.4% 21.1% 15.6% 23.0%
Corporate 0.0% 0.0% 9.5% 12.2%
profits
Indirect 1.2% 1.2% 2.4% 2.4%
business
Payroll 13.3% 13.3% 0.0% 0.0%
State and
local
Total state 7.4% 8.8% 21.6% 23.0%
and local
Personal 2.8% 4.2% 3.9% 5.0%
Corporate 0.0% 0.0% 1.8% 2.1%
profits
Indirect 4.4% 4.4% 15.9% 15.9%
business
Payroll 0.2% 0.2% 0.0% 0.0%
------------------------------------------------------------------------
* Taken from Gary and Aldona Robbins, Road Map for Tax Reform, Institute
for Policy Innovation, forthcoming Spring 2000. Basic data from the
National Income and Product Accounts, April 2000 release.
\1\ Personal income taxes for labor are on wages and salaries. Personal
income for capital include taxes on interest, dividends, capital
gains, rent, royalties and so forth and estate taxes.
\2\ Indirect business taxes levied on output, like sales taxes or excise
taxes, are apportioned roughly two-thirds to labor and one-third to
capital based on their respective shares in the production process .
Indirect business taxes levied specifically on capital like property
taxes are attributed only to capital.
\3\ Employer and employee contributions for social insurance.
Table 2.--Average and Marginal Tax Rates by Major Producer, 1998 & 1999
Average Tax Rates
--------------------------------------------------------------------------------------------------------------------------------------------------------
Private Business \1\ Households \2\ Institutions \3\ Govt enterprieses \4\ General govt \5\
----------------------------------------------------------------------------------------------------------------------------------------
1998 1999 1998 1999 1998 1999 1998 1999 1998 1999
--------------------------------------------------------------------------------------------------------------------------------------------------------
Capital 47.5% 49.1% 8.1% 8.0% 26.2% 26.4% na na na na
Federal 26.3% 27.6% -10.1% -10.2% 3.6% 3.7% na na na na
State and local 21.2% 21.6% 18.2% 18.2% 22.6% 22.7% na na a na
Labor 33.2% 33.3% 22.4% 30.9% 28.1% 27.6% 14.8% 14.9% 15.2% 15.3%
Federal 25.8% 25.9% 19.3% 27.8% 25.2% 24.8% 12.2% 12.3% 12.5% 12.6%
State and local 7.3% 7.4% 3.1% 3.1% 2.9% 2.9% 2.6% 2.6% 2.7% 2.7%
Total Producer 38.0% 38.5% 8.5% 8.8% 28.0% 27.6% na na na na
Income
Federal 26.0% 26.5% -9.2% -8.9% 24.1% 23.7% na na na na
State and local 12.0% 12.1% 17.7% 17.7% 3.9% 3.9% na na na na
Marginal Tax Rates
Capital 58.5% 60.6% -1.4% -1.9% 28.7% 29.0% na na na na
Federal 35.8% 37.6% -18.4% -18.8% 5.8% 6.0% na na na na
State and local 22.6% 23.0% 17.0% 16.9% 23.0% 23.0% na na na na
Labor 43.9% 44.4% 35.5% 43.5% 39.6% 39.5% 24.7% 24.9% 25.5% 25.8%
Federal 35.2% 35.6% 30.7% 38.8% 35.2% 35.1% 20.8% 21.0% 21.5% 21.8%
State and local 8.7% 8.8% 4.8% 4.7% 4.4% 4.4% 3.9% 3.9% 4.0% 4.0%
Total Producer 48.8% 49.8% -0.3% -0.4% 39.0% 39.0% na na na na
Income
Federal 35.4% 36.2% -16.9% -17.0% 33.7% 33.6% na na na na
State and local 13.4% 13.5% 16.6% 16.5% 5.3% 5.3% na na na na
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Corporate and noncorporate businesses.
\2\ Labor services supplied by domestics and the imputed value of capital services received by those who own their own homes.
\3\ Mainly the nonprofit sector including hospitals, schools and churches.
\4\ Government-operated businesses which provide commercial services such as the Postal Service, Tennessee Valley Authority and state-controlled liquor
stores.
\5\ Functions normally associated with government including defense, police, education, and welfare.
Table 3.--Sources & Uses of Private Business Funds, 1999
------------------------------------------------------------------------
As % of Priv.
Sources $billions Bus GDP
------------------------------------------------------------------------
Total sources of private business 7,062.3 100.6%
funds
Private business GDP 7,018.5 100.0%
Taxable private business GDP 7,007.9 99.2%
Untaxable, in kind compensation 10.6 0.2%
Subsidies 43.8 0.6%
Uses
Total uses of private business funds 7,062.3 100.6%
Gross labor income 4,195.2 59.8%
Compensatio3,967.2ployees 56.5%
Untaxable employee payments in kind 10.4 0.1%
Compensatio3,956.8ivate busines56.4%
employees
Wages and salaries 3,386.5 48.3%
Employer contributions for social 279.9 4.0%
insurance
Other labor income 290.4 4.1%
Indirect business taxes on labor 228.0 3.2%
Gross capital income 2,867.1 40.9%
Corporate pro763.3with IVA and 10.9%
Profits tax liability 225.3 3.2%
Dividends 331.6 4.7%
Undistributed profits 162.1 2.3%
Inventory valuation adjustment (IVA) (13.0) -0.2%
Capital consum57.2n adjustment (0.8%
Net corporate interest paid 140.8 2.0%
Proprietors' income with IVA and CCA 646.7 9.2%
Untaxable in kind proprietors' 0.2 0.0%
income
Proprietors' net interest paid 93.8 1.3%
Other proprietors' income with IVA 3.7 0.1%
and CCA
Rental income of persons with CCA 62.4 0.9%
Other private business net interest 57.7 0.8%
paid
Consumption o796.4ed business 11.3%
capital
Business transfer payments 39.4 0.6%
Payments to persons
Payments to rest of world
Indirect business taxes and fees on 387.8 5.5%
capital
Statistical discrepancy -125.1 -1.8%
------------------------------------------------------------------------
AU.S. Department of Commerce, National Income and Product Accounts,
Tables 1.9, 1.15, 1.16 & 8.21, April 2000.
Mr. Crane. The Chair applauds and congratulates and is
grateful to each of you for the work that you have done, for
coming to the committee today and sharing with us your ideas,
but Gary and Aldona Robbins have been well-known to me for many
years and do excellent work in modeling what impact our
decisions are going to have on the economy and on jobs, and
James Powell is a tough Texan rancher, the kind of vibrant
individual this country was founded on, and Bill Helming, you
have spent many years in the vineyards developing your program,
and without any desire for personal gain, but to do something
for the good of this country. I respect all three of you, and I
am grateful that you are here before us today.
Tell me, let me ask you a couple of questions. I don't have
time to examine all the details, but we have it in writing and
we can, at another time, look through it. But can you synopsize
why you believe your plan is better than AFT?
Mr. Helming. Mr. Chairman, better than what?
Mr. Crane. Than the Americans for Fair Taxation that we
heard the first day of this week?
Mr. Helming. Yes. Well, I would simply say two major
reasons--and, again, from the perceptions of the common person
that I interface with, Mr. Chairman.
Number one, the rate differential is a dramatic difference
in terms of the perception on the part of the taxpayer. The AFT
Tax rate is simply too high.
And then, secondly, the consumer and at the J.C. Penney
level, the consumer is under the impression, and rightly so,
that businesses aren't paying their fair share. That is the
perception, and that is a major problem from a structural
standpoint, not from an economic standpoint, but from a
structural standard, in terms of political viability of what I
am proposing versus what is being proposed under the AFT plan.
Those are two major, critical issues.
Mr. Crane. All right. Thank you very much.
Mr. Helming. Could I just add one thing?
Mr. Crane. Sure.
Mr. Helming. In my findings over the last 15 or 16 years,
when it is all said and done, taking the typical taxpayer
across America, it is very clear to me after that period of
time that the removal of the entire tax code, including the
FICA payroll taxes and the self-employment taxes and getting
the IRS out of the lives of the wage earner--not the business
owner, but the wage earner--those two things are very popular
among the common people in this country.
Mr. Crane. Yes. All right. Thank you.
Now I am going to ask you a more difficult question. What
are the flaws in your program?
Mr. Helming. Well, I think perhaps a potential concern that
might be raised would be the exemptions that I build into the
plan to deal with regressivity. In other words, a potential
concern or question might be, well, okay, if we start out with
food and shelter and medical, then who is to say that your
committee and others in Congress might suggest something else?
Well, my response to that is as follows: first of all,
there is a very well-established precedent at the State level,
basically all 50 States, that for some time at the State level
they exempt the very things that I am talking about, so it is a
well-established precedent.
Secondly, I would envision that the tax--if you go to
manipulating, if you will, the social engineering issue and
Congress says, ``We are going to build in another exemption, or
another two or three,'' well then that is going to raise the
rate, and every American from Watts to Harlem is going to know
what change in the tax rates is and that is under consideration
and there will be a lot of negative response to that.
Lastly, to the potential concern that I raised, my response
and suggestion would be that any change in the new Federal tax
code be required by a super majority of the U.S. Congress.
Mr. Crane. Well, I think you have been very up front. I
know, when I talk about structural tax reform in my town
meetings, I have to say up front there is no tax system that is
perfect.
Mr. Helming. That is right.
Mr. Crane. No matter how we collect taxes, there are going
to be objections, there are going to be flaws, there are going
to be problems, and one day when I spoke very strongly, as I
do, about the need to get rid of the income tax in one of my
town meetings and suggested the concept of an alternative, a
man got up in the back of the room, raised his hand, and I
recognized him, and he said, ``I don't like your ideas.'' And
that is the first time anyone had ever said that to me. And I
said, ``Well, I am curious. Why?'' And he said, ``Because we
still have to pay taxes.'' And I said, ``You are right. We
would love for that day to come when we didn't have to pay
taxes, but the Government has bills to pay, and therefore we
have to collect taxes.''
So we should continue to seek the best way, and I thank you
for your input.
I am now going to recognize Mr. Coyne for any questions
that he might like to make.
Also, I have got to excuse myself for a very few minutes,
and if you will preside during my absence I will return
shortly.
Mr. Helming. Thank you.
Mr. Coyne [presiding]. Thank you, Mr. Chairman.
Ms. Robbins, your testimony notes that the fundamental
proposals for tax reform do not make poor families pay more
taxes. What about middle class and high-income families? What
happens with their total tax bills, the middle class and upper-
income families?
Ms. Robbins. When I refer to proposals, I am really talking
about the example that we structured here with the refundable
credit up to the poverty line.
I don't have distributional information with me at this
point. I think, as you know, Congressman, when we are talking
about broadening the base, there are going to be some
deductions that are going to be lost and some people are going
to be worse off. Others will be better off.
I think, overall, though, the objective of tax reform is to
try to get out as many of the distortions that exist in the
current system and broaden the base, bring down the tax rates,
and generate more--ultimately, the greater growth that would
result, I believe, from tax reform would, long run, make
everyone better off, but certainly starting out of the gate
there are going to be winners and losers.
Mr. Coyne. So you have no data that would show that middle
class--
Ms. Robbins. We have not constructed that information as
yet. This project is still under way, so we will eventually
have distributional tables.
Mr. Coyne. Okay. The economy is in its longest period of
expansion in the Nation's history, and the current tax system
doesn't seem to have hampered that amazing achievement for all
of us, or most of us. Do you think a sudden fundamental change
to the tax code could threaten that prosperity that we have
been experiencing?
Ms. Robbins. I have done some looking at the current
recovery and have compared it, for example, to the 1960s,
which, up until February, when we passed, I think, 106 months
in the 1990s, the 1960s had been the previous longest
expansion. It is interesting on the tax issue that the average
tax rates in the 1990s are higher than they were in the 1960s.
That is because we have programs like Social Security and
Medicare that are larger today, and also because State and
local governments have expanded over time.
So the average rates in the 1960s were actually lower, but
what was interesting is that during the 1990s the marginal tax
rates had been lower than they were in the 1960s, but they have
been trending up, so right now we are getting close to marginal
rates of where they were in the 1960s.
I guess what I am concerned about and keeping an eye on are
leading indicators, such as the stock market and investment, to
see if perhaps this recovery might not be starting to stall. If
it is, then I think the tax rate issue is certainly one area
that needs to be revisited.
I would argue that anything you can do to bring down
marginal rates will be added insurance to keep this recovery
going even further.
Mr. Coyne. Well, I guess I am not speaking so much of rates
as I am any structural change in the code that would come about
by saying that in the year 2003 or 2004 we are going to have an
altogether different method for revenue collection.
Ms. Robbins. Right.
Mr. Coyne. And aside from the progressive income tax that
has served us very, very well over the years.
Ms. Robbins. I guess, again, it would matter on what kind
of disruptions that are being discussed, although I think if
you look historically, when there have been changes to the tax
code, the economy is remarkably resilient and does make
adjustments pretty quickly.
Mr. Coyne. Thank you.
Ms. Robbins. You are welcome.
Mr. Coyne. John?
Mr. Tanner. I am sorry I got here late.
Mr. Helming, I was reading your proposal, and in it do
you--we had a hearing two days ago, I guess it was, and there
was a proposal for a national sales tax--
Mr. Helming. Yes.
Mr. Tanner.--that would apply to the cities and counties
and States in this country on not only their purchases, but
also on the wages paid, as a service.
I was reading yours. Is yours similar to that, that you tax
local--
Mr. Helming. No, sir. The plan that you have before you and
that I presented here today is for the Federal level, only, but
I can speak to the State level, if you would like me to.
Mr. Tanner. Yes.
Mr. Helming. The 15.2 tax rate at tier one and tier two is
required to achieve revenue neutrality for raising the same
amount of revenues as we do now.
I don't know if you were here when I spoke to that. The
marginal tax rate on labor under the current code is 35.6
percent, and under this plan it is 30.4, about a 14 percent
differential.
If you were to take the same formula and applied the tier
one and tier two to be revenue neutral--in other words, strip
out all income tax for those States that have income taxes and
sales taxes, property and real estate and property taxes--you
would basically have a 7.6 percent total, or divided by two,
3.8, so you would add 3.8 to 15.2, and you would basically have
a 19 percent rate to cover and replace all federal and state
government taxes.
You see what I am saying? That would replace all Federal
and State taxes.
Mr. Tanner. I think I heard you say that you favor the
super majority bill to raise taxes?
Mr. Helming. Well, to change anything in the tax code.
Mr. Tanner. To change anything.
Mr. Helming. I mean, what I am suggesting, assuming our
Nation and our American people are so fortunate to have a
fundamental tax reform embraced, my suggestion would be then
part of the law which you and your colleagues would be writing
would be a requirement that any structural change or change in
the rate in any manner would require a super majority of the
U.S. Congress.
Mr. Tanner. What about foreign money, raising the debt
ceiling? Would you also favor super majority to do that?
Mr. Helming. I am sorry. I am having a hard time hearing
you.
Mr. Tanner. To borrow money to raise the debt ceiling,
would you favor a super majority to borrow money?
Mr. Helming. I guess I probably would, but I haven't
thought about that one near as much.
Mr. Tanner. Well, would you agree that there is pressure in
the here and now to not raise taxes more so than the pressure
in the here and now from those yet unborn who are getting the
debt that we are leaving them to just simply borrow more money,
rather than paying for our consumption today? Would you have a
problem with that?
Mr. Helming. Yes, sir, I sure would.
Mr. Tanner. So if one believed that the pressure to not
raise taxes today is greater than the pressure from those that
are not here yet to not borrow from them, it seems to me the
super majority that we ought to be talking about as relates to
the tax code ought to be to borrow money rather than to pay for
what we do today.
I think we should think about the efficacy of what we are
doing with respect to our Nation's debt rather than what we are
doing with respect to the tax code as it relates to the here
and now, but that is just another--
Mr. Helming. I guess my emphasis, Congressman, is that,
when we look at a structural change and a fundamental change in
the revamping of the current tax code, as many others have
already said and as I have been saying for some time, if it is
done properly, you know, everybody in the economy essentially
wins. I mean, certainly the common wage-earner is going to
benefit from a faster-growing economy, lower interest rates,
lower cost of goods and services.
Mr. Tanner. I agree.
Mr. Helming. And so I don't think we can walk away from
that. I think, as long as we can do it and raise the required
amount of money to stay within the budget limitations, it seems
to me we ought to be doing it.
Mr. Tanner. I agree. It is curious this super majority
thing keeps coming up, but no one wants to talk the fact that--
Mr. Helming. The reason I bring that up is that, you know,
one of the very nice features about the structural aspect of
this two-tiered system is that it is levied across the entire
economy--the business sector and obviously the consumer
sector--and if Congress decides, for whatever reason or reasons
at some point, assuming we were to implement such a plan, that
it wanted to change it, it seems to me that ought to require a
major hill to climb before it was changed. That is all I am
trying to suggest.
Mr. Tanner. I understand the super majority thing. The
process, though, has always intrigued me because no one talks
about it in relation to borrowing money. They only talk about
it in relation to raising taxes.
Would you require a super majority to declare war?
Mr. Helming. Well, I think the Constitution says that is up
to the President in one sense--
Mr. Tanner. No, it is up to the Congress to declare war.
Mr. Helming. It is really up to the Congress. Yes.
Mr. Tanner. When you go down that road, what about a super
majority to elect people to come here to make these decisions?
I mean, when you start talking about super majorities--we had a
vote on it this week, and I don't want to argue about it, but
it has just always caught my attention when people talk about a
super majority as it relates to the tax code but not to borrow
money or do anything else around here. I wish--
Mr. Helming. I wouldn't quarrel with you that a super
majority conceptually is a good idea.
Mr. Tanner. You think it is?
Mr. Helming. Yes, I do for my tax proposal
Mr. Tanner. Well, that is an interesting conception.
I yield back the balance of my time.
Mr. Archer [resuming Chair]. Mr. Coyne, thank you for
presiding in my absence.
Again, we thank all three of you for coming and presenting
your proposal. It is clearly a well-thought-out proposal, and
it is going to be very helpful to us as we try to find our way
through to the final solution of what we can get past in
structural tax reform.
Mr. Helming. Mr. Chairman, my next step is to get it
introduced into Congress, but it is a pleasure to be here.
[The following was subsequently received:]
May 3, 2000
Congressman John Tanner
1127 Longworth Building
Washington, D.C. 20515
Dear Congressman Tanner:
Let me start by thanking you for being present during my
presentation at the Tax Reform hearings conducted by the House Ways and
Means Committee on April 13th. I am writing to clarify an answer I gave
to you regarding having a two-thirds majority rule as it pertains to
the tax code and specifically my proposal.
I need to tell you that I was having difficulty hearing questions
coming from the committee. I had to have Chairman Archer repeat himself
a couple of times earlier during the Q & A. Upon review of the written
transcript, I saw that I missed the concern you were trying to convey
in the context of your question. I'll briefly make a couple of points
that hopefully will better answer your question.
I am aware that some in congress have advocated a two-thirds rule
for raising taxes. I am sure there are many motivations that cause
these individuals to take their positions. For those who sincerely
think that such a move would help solve the inequities in the current
system, I think they would be disappointed by the results. I am in the
camp that believes the current code can't be fixed by tinkering with it
and that we should take advantage of the good times to phase in a new,
revenue-neutral code.
As a two-thirds rule could pertain to a new tax code, I think one
could argue for it. As it might pertain to my proposal, the two-thirds
rule would be used to primarily keep the overall structure in tact for
a longer period of time. Should an industry lobby for special treatment
or exempt status, for example, the overall tax rate levied at the
business and retail levels would go up. The two-thirds rule would make
it harder for that kind of change to occur and there would be a good
chance the voters would take a more active role in letting their
positions be known. The rule would apply to raising taxes, but under my
plan, the rule also applies to lowering the tax rate.
My motivation for having a two-thirds rule as part of my proposal,
is to ensure that the tax code will not change too much or too often.
The idea is to enact a code for the citizens, businesses and government
that will be predictable and consistent, that will remain in tact
through the rigors of political and economic change.
I hope this better explains my position. Again, thank you for your
time at the hearings and I hope well have an opportunity to talk more
about my proposal in the future.
Sincerely,
Bill Helming
cc: Bill Archer
John Meagher
Mr. Crane. Thank you so much. You are excused.
Our next panel is Dr. Regalia, Ms. Soldano, and Mr. Entin,
if you will come to the witness table.
We are glad to have all three of you with us today. I think
you probably, having sat in the room, know the general format
that we try to follow, which is that your entire written
statements will be put in the record without objection, and if
you will attempt to synopsize verbally within the five-minute
limit, we would appreciate it.
Dr. Regalia, if you would start off.
STATEMENT OF MARTIN A. REGALIA, VICE PRESIDENT AND CHIEF
ECONOMIST, U.S. CHAMBER OF COMMERCE
Mr. Regalia. Mr. Chairman, my name is Marty Regalia, and I
am vice president and chief economist of the U.S. Chamber of
Commerce.
The Chamber appreciates the opportunity to comment on
fundamental tax reform, and I will summarize my testimony
briefly.
Over the years, dissatisfaction with the Federal tax system
has resulted in the enactment of significant code changes in
about 11 of the last 25 years. Even these changes, however,
have not really fixed anything, and the discontent over the
code continues.
The current tax system is plagued by a number of
shortcomings. The system is cumbersome and excessively complex
and results in high compliance costs and produces a perception
of unfairness, as well as a lack of trust that not only
undermines compliance with the law, but respect for the
Government.
The system levies multiple layers of tax on income, capital
acquisitions, savings, and investment, and, as such, it is
biased against savings and investment that is crucial to our
continued economic growth.
It contains relatively high marginal rates, which are
economically distorting, foster tax avoidance, and reduce
compliance.
It suffers from a multitude of exclusions, exemptions,
deductions, and credits, which often cause decisions to be tax
driven, rather than made on the basis of sound economic
reasoning.
Clearly, the system is in need of substantial reform, or
even replacement.
The Chamber's members are currently evaluating a number of
the proposals, and, while they have not yet selected a single
approach or endorsed a specific proposal, they believe that,
whatever system is developed, it should address as many of the
following issues as possible:
The tax system needs to be simple and clear,
understandable, and relatively easy to apply.
It should eliminate or substantially reduce the incidence
of confiscatory multiple levels of taxation on capital savings
and investment and on productivity growth.
The system should have low marginal rates which imply a
relatively broad base with relatively few exemptions.
It should level the playing field in terms of our
international competitiveness. It should do this by avoiding
duplicative taxation and other jurisdictional problems and by
adopting a territorial approach that is border adjustable.
Fundamental changes to our tax system must also be
accompanied by appropriate, sensible transition rules. They
must be clear-cut, of sufficient duration to allow a chance for
the change to be properly interpreted, understood, and applied,
and provide an orderly movement into the new tax structure
without the application of undue costs.
The business world and our whole economic environment are
rapidly evolving, in part due to new technologies and
electronic commerce. Whether the system is reformed or
replaced, it must be consistent with this new economy and
afford sufficient flexibility to accommodate change with a
minimum of tinkering.
The task of designing and implementing a substantial reform
is daunting, but the rewards are continued economic growth and
a higher standard of living. We look forward to working with
you and the other members of the committee to achieve this end.
Thank you.
Mr. Crane. Thank you, Dr. Regalia.
[The prepared statement follows:]
STATEMENT OF MARTIN A. REGALIA, VICE PRESIDENT AND CHIEF ECONOMIST,
U.S. CHAMBER OF COMMERCE
The U.S. Chamber of Commerce is the world's largest business
federation, representing more than three million businesses and
organizations of every size, sector and region, and we appreciate this
opportunity to comment on reforming or replacing the federal tax
system.
Introduction
Over the years, dissatisfaction with the federal tax system has
resulted in the enactment of major tax code changes in 11 of the last
25 years: 1976, 1978, 1981, 1982, 1983, 1985, 1986, 1990, 1993, 1997
and 1998, with other changes in between. Yet, perhaps due in part to
the sheer frequency of changes, taxpayer discontent seems to have
mounted. Not only do critics cite the weight of the overall tax burden,
but they also point to the way the tax is collected--specifically, the
system's high marginal tax rates; its double, triple and sometimes
quadruple taxation of the same income; its high level of complexity;
its inherent anti-saving bias; its special provisions for certain
economic activities; its high cost of compliance; and its hindrance of
faster long-term economic growth.
As a result, from time-to-time, tax reform proposals have been put
forth that range from relatively straightforward alterations of the
current tax code to complete replacement of the income tax system with
an entirely new system of taxation.
General Observations
The primary purpose of a tax system is to raise revenue to provide
for essential public goods and services. While there may be some debate
over what constitutes an essential public good or service, and thus
over how much an economy should be taxed, most would agree there are
certain principles that a ``good'' tax system should embody:
Efficiency--A tax system is efficient when the cost of collection
and compliance is low relative to the amount of revenue raised. For
example, spending $10 to collect $100 in tax revenues is more efficient
than spending $50 to raise $125.
Neutrality--The distortion to economic decision-making should be
minimal. How is economic decision-making altered by the tax
consequences of a particular activity? Are sound economic fundamentals
driving economic decisions, or are individuals basing their decisions
largely on the tax ramifications?
Simplicity--Ease of understanding and fulfillment should be
widespread, allowing ordinary citizens to handle their own taxes with a
minimum of outside assistance. Firms, large and small, should be able
to easily understand and accurately apply the tax code to their
businesses.
Fairness--Are those in similar economic circumstances paying
similar taxes? This notion, termed ``horizontal equity,'' is relatively
straightforward. Another type of fairness that is more difficult to
measure, ``vertical equity,'' suggests that those who are in dissimilar
circumstances should pay appropriately different amounts of tax. These
are very
Certainty--Are changes to the tax code capricious, frequent or
unanticipated? Do households and businesses know much will be due and
when? Can they readily project their tax liability in coming years
under various sets of circumstances? Are they responding to the current
tax code or arranging their affairs in anticipation of the next change
to the tax laws?
At times, some of these principles may be at odds, but, in general,
the best tax systems would score reasonably well on these criteria.
In addition to the above characteristics, the designers of a new
tax system must also address a number of questions; for example, the
degree of ``progressivity'' or ``regressivity.'' A regressive tax
structure exists when lower-income individuals pay a higher proportion
of their income in taxes than do higher-income taxpayers. Conversely,
in a progressive tax structure, higher-income individuals pay a greater
proportion of their income in taxes than do individuals with lower
incomes.
A key issue to understanding and redesigning our tax system is to
recognize that it provides incentives for businesses and households to
behave in particular ways. As such, it can be used to promote specific
social goals or advance political agendas. Often, these social or
political goals run counter to the aforementioned principles and force
tradeoffs. The result can be a tax code that violates the principles of
sound taxation and imposes numerous unintended consequences. This can
cause significant economic damage. In designing a tax system for the
new millennium, we should be aware of any incentive structure we may
create and the likely response from the dynamic marketplace.
Another key point for those wishing to construct a new system, or
significantly alter the existing one, is the choice of the tax base.
Should we, for instance, tax income or consumption? If we choose
income, should it be income less a personal exemption (of how much?),
or income less a personal exemption less savings? Should we subtract
out charitable contributions? Mortgage interest? State taxes? If we
believe that consumption should be taxed, should we tax sales (some,
all, or retail?) or ``consumed income''?
Moreover, choices made about the tax base will have a significant
influence on the tax rate. As we narrow the tax base--i.e., as we
exclude more and more activity from taxation--tax rates will have to
rise to garner the same amount of tax revenue, at least in a
conservative, static sense (i.e., ignoring any impact on economic
growth). Other questions also arise: Should a single tax rate be used,
or are multiple tax rates preferable? Should different rates apply to
households and businesses?
Finally, another important consideration for any tax proposal is
how to get from ``here to there,'' and over what period. Regardless of
the long-term benefits that may accrue from a new tax system, making
the transition from the current income tax to a different tax regime
will undoubtedly create ``winners'' and ``losers.'' How these winners
and losers are treated could make the difference between moving to a
new system and keeping our current system. Transition rules in many
proposals have not been developed yet, but they will be of paramount
importance and should be examined closely, prior to adopting any new
system.
Current Tax Code
The current tax system, overall, is steeply progressive. Families
who find themselves in the highest quintile (top 20 percent) of pretax
annual income bear 77 percent of the income tax burden, and 53 of the
overall federal tax liability when income, social insurance and excise
taxes are included. At the same time, families who are in the lowest 20
percent have an effective income tax burden of negative two percent,
due to refundable tax credits, and those in the second lowest quintile
have an effective income tax burden of only one percent. Together,
those in the lowest two quintiles, while making up 40 percent of the
population, bear only 12 percent of the overall tax liability, i.e.,
income, social insurance and excise taxes. (Congressional Budget
Office, Budget Options, p. 43, March 2000.)
A degree of progressivity may achieve some measure of ``fairness''
in the eyes of some, via certain social goals, such as redistribution
of income or wealth, or be reflective, in part, of ability to pay.
However, just as taxes are necessary to operate our ``government of the
people, by the people, [and] for the people,'' from which everyone
derives benefits, good government is founded upon input and involvement
from the citizenry. When so many pay so little, if anything, towards
the operation of our government, they are not very concerned as to how
the revenues are spent--after all, it is not ``their'' money; it's
someone else's. They feel disinterested in, and disenfranchised from,
``the system,'' at the same time as those who pay a disproportionately
high rate of taxes fell cheated and oppressed by the system. A good
example of this apathy is reflected in low voter turnout for political
elections, and pervasive ignorance of political processes. A tax system
that requires some fair, material participation from all segments of
society in the funding of government invites their interest and
participation in how our government and our country operate. Government
is enhanced by an engaged citizenry. A system designed to replace the
current federal tax code and structure should reflect these ideals.
The current federal tax system is cumbersome and too complex. A tax
system cannot be perceived as fair if it is overly complicated. Unless
the average person can understand how the tax system works and prepare
necessary tax paperwork without an undue amount of education and
research, it will be held in disdain. A tax system that is so cryptic
that only the privileged few can understand it does not gain the trust
of the people--it seems to be written in a secret language by, and to
serve the purposes of, an elite minority. Most people are unable to
understand the tax laws and complete their own tax returns--well over
one-half of all tax returns are prepared by tax professionals. This
results in a lack of trust that not only undermines respect for
government and compliance with the law, but renders the law more
difficult to interpret and enforce. Difficulty in interpretation and
enforcement breeds uncertainty and problems in administering the law,
and results in a drain on the revenues, either through direct reduction
due to non-compliance, or exorbitant expenses incurred in educating
people in proper reporting and treatment of transactions; drafting and
issuance of lengthy regulations; auditing of tax returns; and
litigation of disputes. A new tax system needs to be simple and clear,
understandable and easy to apply, and with a minimum of computations to
undertake and tax forms to complete.
Currently, our federal tax system levies multiple layers of
taxation on capital acquisition, savings, and investment. As such, it
is biased against savings and investment that is crucial to sustaining
our economic growth. Take, for example, a business owner who operates
his or her own corporation, For that individual, such layers of
taxation can include: the income tax on corporate earnings; the
personal income tax and FICA taxes on wages paid by the corporation;
personal income tax on the sales of the investor's corporate stock;
capital gains tax on subsequent reinvestments made with those funds;
and gift, estate, and transfer taxes levied upon the remaining assets
transferred by this unfortunate taxpayer to others. When added
together, some income faces an effective tax confiscation in excess of
90 percent, a truly draconian figure. A new tax system should reduce
the incidence of such confiscatory cumulative taxes, and encourage
productivity, savings and investment. A fair tax system must encourage
and reward those who help grow our economy.
International Competitiveness
On the international competitiveness front, a tax system should be
``border-adjustable'' and mesh well with international tax treaties
entered into with our trading partners. For instance, U.S. corporations
doing business outside our borders should not be placed at a
competitive disadvantage by multiple taxation of the same transactions
or activities, or being subject to tax rates which are unfavorable when
compared to those levied upon our foreign competitors. If the United
States taxes its domestic businesses on their world-wide income, i.e.,
taxes the income of transactions or acitivites occurring in foreign
countries in which U.S. corporations conduct their business, and they
are also subject to tax by foreign jurisdictions, it places those
entities at a competitive disadvantage vis-a-vis their foreign
competitors. If the United States taxes those transactions or
activities at a competitively unfavorable rate, our companies are
disadvantaged. And, when our companies are disadvantages, their
employees, owners and our country, overall, are likewise disadvantaged.
A business, whether a corporation, partnership, sole proprietorship, or
in some other legal form, is nothing more than people, and when the
business is hurt, the people that ``make it up,'' are also injured.
Our current federal tax system protects certain of our businesses
from international competitive disadvantage through the Foreign Sales
Corporation (``FSC'') rules. Likewise, many international tax treaties
provide for elimination or reduction in the effect of duplicative
taxation. However, recently, the World Trade Organization (``WTO'') has
ruled that the Internal Revenue Code's treatment of FSCs violates the
WTO's conventions, constituting an illegal subsidy to U.S. firms. The
underlying bases of this dispute and preservation of border-
adjustability must be addressed and resolved in any replacement tax
system to make the playing field level in terms of international
competitiveness. Accordingly, our federal tax system must either be
crafted in such a manner to integrate with existing international
treaties or be coordinated with the drafting and adoption of new ones.
Conclusion
While proposals have been advanced for the reform or replacement of
our current federal tax code, neither our membership, nor the public,
has yet reached a consensus as to which approach makes the most sense
for America. Accordingly, we advocate additional study of these
proposals and their expected impact on the taxpayers, and our economy,
as a whole, before any one ``best'' system can be devised, embraced,
and advanced. Nonetheless, one thing we can says it that the current
system offers much room for improvement, whether that be through major
retooling or redesign, to achieve: simplicity; fairness; low marginal
rates with a broad tax base with few deductions; reasonable
progressivity; incentives for productivity, savings, and investment and
the fostering of international competition. At the same time, the
government must control its spending appetite so as to require the
smallest amount necessary to provide the goods and services demanded by
the public, and collect the taxes in a reasonable, cost-efficient and
effective way.
Fundamental changes to our tax system must be accompanied by
appropriate, sensible transition rules. They must be clear-cut; of
sufficient duration to allow a chance for the changes to be properly
interpreted, understood and applied; and provide an orderly movement
into the next tax structure without undue costs.
We must also keep in mind that the business world and the ways
which we structure and conduct transactions are evolving at a frenetic
pace. The advent and development of new technologies, including
electronic commerce, are altering the playing arena and the rules of
the ``game'' with dizzying speed. A new tax system must be carefully
crafted to encompass and accomplish its intended purposes. At the same
time, it must be sufficiently flexible to accommodate change with a
minimum of tinkering. Reasoned study and foresight must be applied to
designing the system, so that in the winds of change we do not have to
face the prospect of scrapping that system and returning to square one.
Let's not rush to judgment; let's do it right.
Vital to reaching a broad consensus on the outcome of this debate,
is the principle that everyone who is able to, should contribute to our
system of government, in return for its benefits and protections, and
have a stake and interest in the government. Only through the
expression of such interest can the consensus we seek be discovered.
Mr. Crane. Ms. Soldano will you now give us your testimony?
STATEMENT OF PATRICIA M. SOLDANO, PRESIDENT, CENTER FOR THE
STUDY OF TAXATION, COSTA MESA, CALIFORNIA
Ms. Soldano. Mr. Chairman, I am Patricia M. Soldano, Center
for the Study of Taxation. I am here today as president of the
Center for the Study of Taxation, but, more importantly, as
someone who has heard from numerous families about the effect
of the gift, estate, and generation skipping tax, also called
the ``death tax,'' has had on them and their businesses. Allow
me to share some death tax facts and some horror stories with
you today.
To pay a tax because someone dies at the highest rate in
our tax system on assets that have already been taxed before is
the reason that 69 percent of the general public believes that
the death tax is unfair--more unfair than payroll tax, income
tax, gasoline tax, sales tax, property tax, cigarette tax,
alcohol/beer tax, and even capital gains tax.
Why is the death tax so unpopular? Because it is a tax on
the American dream. Hard-working entrepreneurs who build their
family businesses and support our Nation's economy hope that
some day they will be in a position to will their life's work
to their children and not pay a 55 percent tax. Within the last
few years, new voices have called for the elimination of the
death tax, including the National Association of Women-Owned
Businesses, the National Black Chamber of Commerce, the
National Indian Business Association, U.S. Hispanic Chamber of
Commerce, U.S. Pan Asian American Chamber of Commerce, National
Association of Neighborhoods, and the Texas Conference of Black
Mayors.
These minority groups have just started to build their
businesses and they want to be able to pass on their assets to
their children, the benefit of years of hard work, without a 55
percent tax or an 80 percent generation-skipping tax if they
wish to give to their grandchildren, and these people are
represented by 47 percent of the female Members of Congress,
who have supported repeal of the death tax as cosponsors of the
bipartisan Dunn-Tanner bill, and I would like to thank
Congresswoman Dunn and Congressman Tanner for their work on
H.R. 8 and their tireless effort to repeal the death tax.
These women and minorities are real people who are
adversely impacted by the death tax. Money that they could use
to send their children to college or pay their family's
expenses is, instead, snatched by Washington. One unlucky
victim of this tax is Lynn Marie Hoopingarner of West
Hollywood, California, who writes to me, ``My family has
recently experienced a triple tax. My grandfather paid income
taxes on his income when he earned it. When he passed away two
years later, it was taxed again. My mother than suddenly passed
away this past spring, and it was taxed again--effectively, an
88 percent tax.''
In addition to the inherent unfairness and
inappropriateness of the death tax, it actually costs the
American economy a job. Yes, the death tax does eliminate jobs.
How many? In a survey recently done by the Center for the Study
of Taxation and the Policy Institute of New York, 365
businesses responded to a survey that they had already lost 14
jobs per business in the last five years due to the cost of
planning for this tax and actually paying the tax. That is
5,100 jobs in the last five years just within the 365 survey
base. In the next five years, they anticipate losing, on
average, 80 per business jobs. That is 80 jobs for 365
businesses--that is 15,000 jobs in the next five years.
In a recent survey of the National Association of Women
Business Owners, NAWBO, there were similar results. Within the
survey respondents of 272, on average 39 jobs have been lost in
the last five years per business, again for paying and planning
for this tax, and in the next five years, on average, 103 jobs
will be lost per business. That is 28,000 jobs just within that
survey respondent group.
Carri Bell, a NAWBO member who owns a business in Oklahoma
City, wrote in her response to us, ``I just settled my father's
estate and paid three-quarters of the total estate for taxes
and fees. Sold all of our stock and bonds and had to borrow.
When I die, there are no more disposable assets left, so the
business will have to be sold.''
The death tax also impacts our global competitiveness.
Since the United States has the second-highest death tax rate
of any country in the world, second to Japan at a 70 percent
rate--which you should know doesn't kick in until a $15 million
exemption--the death tax affects the competitiveness of U.S.
companies. Family businesses have to plan for the death tax by
buying expensive life insurance, selling assets, borrowing or
restructuring their business. It is expensive, time-consuming,
energy-wasting, and constant, year after year.
Many small-to mid-size family businesses sell out early to
corporations who are not faced with the death tax, ending the
opportunity of the family to carry on with the business and the
livelihood of the family.
In closing, I would like to tell you the story of Ida
Prichard of Seattle, Washington. In her own words, she writes:
``I am 77 years old. My history of work, thrifts, and efforts
to save money is unbelievable. Here is my reward. All of my
Social Security, plus more, goes for income taxes. I live off
my teacher's pension, as I do not want to cash my investments.
If I died today, I would pay about $200,000 in death tax. I am
helping a great niece go to college. I have two great nephews
coming up. All are bright children. I would like to help them,
not the IRS.
``I had a newspaper route in college. I worked for 50 cents
an hour doing office work under the program of President
Roosevelt. I have lost money in investments.
``I went to work when I had a death sentence with lung
cancer in 1967. I didn't miss a day when I was told that I was
only going to live three months.
``I am still working. I have a tenant and I tutor ESL
students. I do almost all my own work and cooking. I have never
had a bill I didn't pay. The way things are now, what the
nursing home doesn't get--if i am that unfortunate--the IRS
will. What did I make all this effort for? Our laws need to be
changed, but I have no clout.''
Gentlemen and gentlewomen of this committee, I urge you to
repeal the death tax. As the committee continues to actively
consider proposals to reform the tax system, I urge the
committee to recognize that outright repeal of the death tax
should be a principal component of any proposal. Let us show
the American people that their Government has a heart. Let us
show the hard-working American people like Ida Prichard that
they can pass away knowing that their life's hard work will
benefit their families. Finally, let us show them, the so-
called ``little guys,'' that they do have clout and their
Government is listening.
Thank you.
[The prepared statement follows:]
STATEMENT OF PATRICIA M. SOLDANO, CENTER FOR THE STUDY OF TAXATION,
COSTA MESA, CALIFORNIA
I am here today as the President of the Center for the Study of
Taxation, but more importantly as someone who has heard from numerous
families about the effect that the gift, estate and generation skipping
tax (``the death tax'') has had on them and their businesses. Allow me
to share some death tax facts and horror stories.
Most of you are already familiar with how the death tax effects mid
to small sized businesses because you have heard from those families
but you may not be aware of just how much it hurts. The facts show that
88% of the revenue generated by the death tax comes from estates $20
million or less! So yes, the very wealthy are generating some of this
revenue but most of it comes from families who own small and medium
sized businesses that cannot afford to pay the tax upon the death of a
family member without selling off most of the bequeathed assets.
To pay a tax because someone dies, at the highest rate in our tax
system, on assets that have already been taxed is the reason that 69%
of the general public believes the death tax is unfair. More unfair
than payroll tax, income tax, gasoline tax, sales tax, property tax,
cigarette tax, alcohol and beer tax, or even the capital gains tax. Why
is the death tax so unpopular? Because it is a tax on ``the American
dream.''
Hardworking entrepreneurs who build their family businesses and
support our nation's economy, hope that someday they will be in a
position to will their life's work to their children without paying a
55% tax.
Within the last few years many new voices have called for the
elimination of the death tax including:
National Association of Women Business Owners
National Black Chamber of Commerce
National Indian Business Association
U.S. Hispanic Chamber of Commerce
U.S. Pan Asian American Chamber of Commerce
National Association of Neighborhoods
Texas Conference of Black Mayors
These minority groups have just started to build their businesses
and they want to be able to give to their children the benefits of
their years of hard work without a 55% gift tax or an 80% generation
skipping tax if they wish to gift to their grandchildren. And they are
represented by (among others) 47% of the female Members of Congress who
support repeal of the death tax, as co-sponsors of the bipartisan Dunn-
Tanner bill, HR-8.
These women and minorities are real people who are adversely
impacted by the death tax. Money that they could use to send their
children to college or to pay other family expenses is instead snatched
by Washington. One unlucky victim of this tax, Lynn Marie Hooopingarner
of West Hollywood, CA writes to us, ``My family has recently
experienced a triple tax. My grandfather paid income taxes on his
income when he earned it. When he passed away two years ago it was
taxed again. My mother then suddenly passed away this past spring and
we were taxed again. Effectively an 88% tax rate.''
In addition to the inherent unfairness and inappropriateness of the
death tax, it actually costs the American economy and jobs. Yes, the
death tax eliminates jobs. How many?
In a survey done last year by the Center for the Study of
Taxation and Public Policy Institute of New York, 365 businesses that
responded to a survey have already lost 14 jobs per business in the
past five years due to the cost of planning and paying the death tax,
that is 5,100 jobs just within those 365 businesses and they anticipate
losing on average 80 jobs per business in the next 5 years, or in
excess of 15,000 jobs just within the survey group.
In a recent survey of members of the National Association
of Business Owners, (NAWBO) there were similar results. Within the
survey respondents of 272, on average 39 jobs have been lost in the
past five years per business or 1,000 jobs in total and 103 are
expected to be lost in the next five years for a total of 28,000 jobs.
Carri Bell, a NAWBO member, who owns a business in Oklahoma City,
wrote on her response, ``I just settled my father's estate and paid \3/
4\ of the total estate for taxes and fees. Sold all of our stock and
bonds and had to borrow. When I die there are no disposable assets
left--so the business will have to be sold.''
The death tax also impacts our global competitiveness. Since the
United States has the second highest death tax rate in the world,
second only to Japan at 70%, the death tax affects the competitive
advantage of U.S. companies. Family businesses have to plan for the
death tax by buying expensive life insurance, selling assets,
borrowing, or restructuring their businesses. It is expensive, time
consuming, energy wasting and constant, year after year. Many small to
mid sized family businesses sell out to larger corporations who are not
faced with the death tax ending the opportunity of the family to carry
on the business and livelihood of the family.
In closing I would like to tell you the story of Ida Pritchard of
Seattle, Washington in her own words. She writes: ``I am 77 years old.
My history of work, thrifts and efforts to save money is unbelievable.
Here is my reward! All of my social security (plus more) goes for
income tax. If I died today, I'd pay about $200,000 in death tax. I am
helping a great niece to go to college. I have two great nephews coming
up. All are bright children. I would like to help them--not the IRS. I
had a newspaper route in college. I worked for 50 cents an hour doing
office work under the program set up by President Roosevelt. I have
lost money in investments. I went to work when I had a death sentence
with lung cancer in 1967. I didn't miss a day when I was told I could
only live three months at the most. I am still working. I have a tenant
and I tutor ESL students. I do almost all my own work and cooking. I
have never had a bill I didn't pay on time. The way things are now what
the nursing home doesn't get (if I'm that unfortunate) the IRS will!
What did I make all this effort for? Our laws need to be changed but I
have no clout.''
Gentlemen and gentlewomen of this committee, I urge you to repeal
the death tax. Let's show the American people that their government has
a heart. Let's show the hardworking American people like Ida Pritchard
that they can pass away knowing that their life's hard work will
benefit their families. And finally, let's show them, the so called
``little guys'' that they do in fact have clout and that their
government is listening.
Thank you.
Mr. Crane. That lady sounds like my kind of American.
Mr. Entin?
STATEMENT OF STEPHEN J. ENTIN, PRESIDENT AND EXECUTIVE
DIRECTOR, INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION
Mr. Entin. Thank you, Mr. Chairman, members of the
committee. My name is Stephen Entin. I am the president of the
Institute for Research on the Economics of Taxation. Thank you
for this opportunity to discuss fundamental tax reform.
I am speaking on my own behalf, but I will present to you
today a tax system developed by the Institute's late founder,
Dr. Norman B. Ture. It is a simple saving-deferred cash flow
tax for individuals, which he called the inflow-outflow tax. It
has two chief attributes.
First, it gets the tax base right, using the correct
measure of income for tax purposes, one that maximizes economic
efficiency and yields the optimal growth of income.
Second, it shows the taxpayers the cost of government more
clearly than any other system.
Other advantages of the tax are that it uses concepts
familiar to most taxpayers, it easily incorporates tax relief
for the lowest-income citizens, and it greatly simplifies the
tax system.
A good tax reform would have two main objectives--namely,
economic neutrality and high visibility. The current income tax
is biased against saving and investment. The bias depresses
productivity and wages and keeps people's income some 10
percent or more below their potential.
Neutrality requires that the tax system treats saving on
par with consumption in one of two ways: saving should be tax
deferred until it is withdrawn for consumption, as with the
deductible IRAs and pensions; alternatively, income saved
should be taxed, but the earnings should be tax free, as with
Roth IRAs and tax-exempt bonds. All saving should get one or
the other treatment.
In addition, the extra layers of tax on saving imposed by
the corporate income tax and the estate and gift tax must be
eliminated.
Visibility requires that the tax system show the voting
public what they are paying for government so that they may
make an informed decision as to how much government spending to
support. Ideally, all citizens, except the very poor, should
pay something to help fund the outlays of the Federal
Government in order that they understand that the resources
used by the Government are not free or costless.
Taxes should be collected directly from individuals, not be
hidden at the business level. In fact, all taxes are paid by
individuals, not by businesses and not by goods.
There should be an annual filing that lets taxpayers see
their total tax payments for the year. People will not know
their total tax bill if it is collected in dribs and drabs at
the cash register.
Of the several tax plans you have looked at this week, an
individual cash flow tax is the best way to achieve the dual
objectives of neutrality and visibility. The inflow-outflow tax
is based on a few clear principles that determine what is and
is not taxed.
The tax would be imposed on individuals at a flat rate,
with a basic exempt amount to protect the poorest citizens.
There would be deductions to assure neutral treatment of saving
and to properly attribute income for tax purposes to the people
who ultimately receive and consume it.
All forms of labor compensation would be taxable.
Saving would be deductible--that is, tax deferred--and the
reinvested earnings would grow on a tax-deferred basis. All
distributions from saving would be taxed at the individual
level when the saver or the heir sold the assets to raise money
for consumption.
Transfer payments made to other people, either voluntarily,
as with gifts or charitable contributions, or involuntarily, as
with alimony payments or State and local taxes, would be
deducted from taxable income. Gifts and transfer payments
received would be added to the recipients' taxable income.
Cost of acquiring human capital, such as tuition, and other
costs of earning income would be deductible.
The inflow-outflow tax would be far simpler than the
current tax system. Expensing saving and taxing all returns
would eliminate capital gains calculations. There would be no
corporate income tax or estate tax. Investment by
unincorporated businesses would be expensed, not depreciated,
eliminating complicated capital cost recovery rules.
The tax would be territorial, both for simplicity and to
end the tax disadvantages that American firms encounter when
they compete abroad. Savings invested abroad would not be
deductible. There would be no tax on foreign-source income and
no complicated foreign tax credit.
Fundamental tax reform should replace the individual and
corporate income taxes, the estate tax, and the excise taxes.
The payroll tax should be addressed by Social Security
reform. The two reforms would reinforce one another. Social
Security reform would increase private saving. Tax reform would
encourage the investment of the added saving in the United
States rather than abroad, giving Americans the twin benefits
of greater income in retirement and higher productivity and
wages while they are working.
Thank you.
Mr. Crane. Thank you, Mr. Entin.
[The prepared statement follows:]
Statement of Stephen J. Entin, President and Executive Director,
Institute for Research on the Economics of Taxation
Mr. Chairman, members of the Committee, I appreciate the
opportunity to discuss fundamental tax reform with you today. The tax
system presented in this paper was the last work of Dr. Norman B. Ture
before his death in August, 1997. It is his concept of an ideal, highly
visible, and reasonably simple income tax that is neutral in its
treatment of saving and consumption uses of income. It is a simple cash
flow tax imposed on individual income. the tax is saving-deferred to
account for the cost of earning capital income. The multiple layers of
tax on estates, gifts, and corporations are eliminated. These correctly
measure net income, eliminate the current income tax bias against
saving and investment and provide substantial tax simplification. Dr.
Ture developed this proposal with the help of his staff at IRET.
Two purposes of a good tax system--raising revenue and ``pricing''
government
Any restructuring of the nation's tax system should be based on a
set of clear tax principles, which should be uniformly applied to the
exercise. Those who would redo the tax system should start by
recognizing the two key purposes of a tax system, 1) to obtain revenue
to pay for government goods, services, and activities, and 2) to let
the citizen-taxpayers know how much they are paying for government, so
that they may decide in an informed manner how much government activity
the wish to support with their votes.
Four principle attributes of a good tax system--neutrality, visibility,
fairness, and simplicity
A good tax system should fulfill its first objective, raising
revenue, in a manner that does the least damage to the economy. The
attribute required to achieve that objective is ``neutrality.'' A
neutral tax must be unbiased across economic activities, and
especially, not overly penalize work in favor of leisure, nor tax
income used for saving and investment more heavily than income used for
consumption.
The second objective, letting voters know the cost of government,
may be achieved by a tax system with the attribute of ``visibility'' or
transparency to the taxpayers. A very large segment of the population
must be made keenly aware that government costs money if government
spending is to be held to levels at which its benefits match its costs.
Toward that end, taxes should be paid directly by individuals. Taxes
should not be hidden by being levied on business and buried in the
prices of goods and services where voters may not see them. Nor should
taxes be collected piecemeal, a few cents or dollars at a time, as with
sales taxes, because doing so hides the annual total from the voters
and disguises the cost of government.
Additional principles or attributes of a good tax system include
fairness (properly defined), and reasonable simplicity, clarity and
understandability. These features lead to a low cost of compliance and
enhanced willingness to pay on the part of the taxpayers and to easy
administration and enforcement of the tax rules by the government.
Neutrality. Neutrality means measuring income correctly and levying
taxes evenly on all uses of income by all income producers, without
bias, to avoid distorting economic activity.
A neutral, unbiased tax system would begin with a sensible
definition of income subject to tax. Income is a new concept, revenues
less the cost of generating those revenues. It is well understood that
a business cannot reasonably be said to have a profit until its
revenues exceed its costs of production (properly measured). It should
be just as obvious that a worker cannot be said to have income until
his earnings exceed the amounts he spent on acquiring the education,
skills and tools that enable him to perform his job. Nor can a saver be
said to have income until his returns on the saving exceed the amounts
he spent to acquire the assets that generate the revenues. The full
value of all costs of earning revenues should be subtracted from
revenues before any tax is imposed.
Once income is accurately measured and allocated among taxpayers,
it should be taxed even-handedly. Neutral treatment requires that all
income be taxed at the same rate. It is improper to tax some income at
a higher rate than other income, either through graduated tax rates or
by imposing multiple layers of tax on some types of income but not on
others.
No tax system can easily avoid penalizing labor relative to
leisure. However, keeping tax rates as low as possible and avoiding
graduation avoids the worst of this distortion.
Making the tax system even-handed or neutral across various types
of saving and investment, and between saving and investment and
consumption, requires several steps. Multiple layers of tax on capital
must be avoided, and the basic income tax bias against saving and
investment must be eliminated by correctly treating saving and
investment as costs of earnings income. In particular:
The tax system must either allow savers to deduct saving
or to exclude the returns on saving from taxable income.
The income tax, by taxing both income that is saved and the returns
on that income, taxes saving and investment more heavily than
consumption. There are two ways to restore neutrality. One approach is
to exclude all saving from taxable income while taxing all returns on
the saving--a saving-deferred tax. This is the treatment currently
allowed to a limited degree with pensions and deductible IRAs and tax
exempt bonds. Other costs of earning income must also be expensed as
incurred. Investment outlays must be deducted in the year the outlay is
made (expensed), rather than depreciated over time or otherwise delayed
or ignored.
The dual taxation of Schedule C corporate income at the
corporate and individual level must be eliminated.
Corporate income should be recognized as belonging to the
shareholders, and should be taxed either on individual tax returns or
corporate tax returns, but not both. One way to eliminate the extra
layer of tax on corporations is to pass corporate earnings on to share-
holders for tax purposes as is done for income generated in
proprietorships, partnerships, and sub-Chapter S corporations.
Alternatively, shareholders could be given a credit against the
personal income tax for corporate taxes paid on the income of their
shares. These arrangements are called ``corporate-individual income tax
integration''. Another solution is to switch to a non-income type of
tax system, such as a VAT or sales tax.
The transfer tax on estates and gifts must be eliminated.
Most of an estate is saving that has already been taxed, often
repeatedly. If there is tax-deferred saving in an estate, such as
assets in a decedent's IRA or 401(k) plan, current law makes the heirs
pay income tax on those assets beginning shortly after the inheritance.
Therefore, the estate tax is always an extra layer of tax on saving.
The estate and gift tax should be eliminated, and any part of an estate
that was tax-deferred saving should remain tax-deferred as long as the
heirs continue to save it.
Several types of tax systems would serve to exclude saving and
investment or their returns from tax, end the bias against saving and
investment, and simplify the tax system. These ``neutral'' taxes
include the unbiased income taxes (saving-deferred and yield-exempt)
described above, retail sales taxes that exempt investment goods and
business supplies from tax, and value added taxes that allow expensing
of investment goods and other intermediate products and services
purchased from other businesses at each stage of production.
Since several types of taxes are equally ``neutral'', choosing
among them requires an assessment of their other characteristics and
how well they stack up against other important attributes of a good tax
system.
Visibility. Visibility requires that the tax system reveal clearly
to the citizen/taxpayer what he or she must pay for government goods,
services, and activities. Taxes are the ``price'' we pay for
government; taxes ``cost-out'' government for the taxpayer. Ideally,
all citizens should pay something to help fund the outlays of the
federal government in order that they understand that the resources
used by the government are not free or costless. However, compassion
dictates that the very poor should not be subject to tax. Therefore,
taxes should be levied on the largest number of people consistent with
compassionate treatment of those who cannot afford to pay.
At what stage in the flow of income should taxes be collected? At
the business level, after it has made its payments to other firms but
before its remaining revenues are paid out to its workers, savers, and
investors? When the revenues are received by the workers and owners of
the capital as earnings? Or when some portion of their income is spent
on consumption?
Goods and services do not pay taxes. Businesses do not pay taxes.
Only people pay taxes. All taxes, in fact, are taxes on income. Sales
and excise taxes either depress sales of the taxed products, reducing
the incomes of the people who provide the labor and capital used to
make them, or they reduce the purchasing power of that income when the
workers and savers attempt to spend it. Taxes collected by businesses
fall in reality on the income of the businesses' shareholders or other
owners, lenders, workers, or customers in the form of lower returns or
wages or higher prices.
Since taxes are really paid by people out of income, they should be
collected from people out of income. People see their tax liability
most clearly when they pay an individual tax on the (properly defined)
income that they have received, with a clear accounting, annually, at
tax time. Taxes should not be hidden from taxpayers by being imposed on
businesses as either corporate taxes, manufacturers excise taxes, or
value added taxes. Similarly, taxes should not be hidden by being
collected in bits and pieces over the course of a year as the taxpayer
goes shopping, as either sales taxes or value added taxes.
Fairness. Fairness is often stated as making the rich pay a higher
share of their income in taxes than the poor. Most people would agree
that there should be some amount of income exempt from tax to shelter
the very poorest citizens. Such an exempt amount imparts progressivity
to the tax system. Only people above the exempt amount pay tax, and the
more one's income exceeds the exempt amount, the greater is the tax as
a percent of total income (which is the definition of progressivity).
However, imposing further progressivity by means of graduated rates
above the exempt amount is not consistent with fairness if one
considers the effort it takes to earn additional income. Income is
correctly understood to be the earned reward for supplying labor and
capital services to the market. Except in rare cases, income closely
matches the contribution of the effort and services provided by
individuals to additional output. Therefore, graduated tax rates hit
people harder the more they contribute to the production of goods and
services. The added effort required to earn additional income, and the
notion of equal treatment under the law, strongly urge that a
proportional (single rate) tax on income (above the modest exempt
amount) is the fairest.
Simplicity. Ideally, a tax system should be easy for the government
to administer and enforce and should be easy and inexpensive for
taxpayers to comply with. Such a tax system would have to be simple
enough for people to understand and to follow.
A simple tax system must start with a simple, clear and logical
definition of income. A simple and logical definition of income would
make it possible to write clear regulations and instructions for
taxpayers to follow and tax collectors to enforce. Furthermore, if
people understood clearly what is and is not taxable, and agreed with
the logic of the system, they would feel comfortable that they and
their neighbors were paying the appropriate amount of tax. They would
have a greater sense that the tax system was fair,and a greater
willingness to comply.
Unfortunately, the current tax system is neither simple, nor
logical, nor understandable. Much of the complexity in the current tax
code stems from its ad hoc approach to defining taxable income. The
code is not based on any clear understanding of what constitutes income
or an accurate measurement of income, nor any set of coherent
principles regarding the imposition of tax. Additional complexity
arises from the multiple layers of tax to which some types of income
are subject and the multiple points of collection at which the taxes
are imposed. The lack of guiding principles and resulting chaotic
definition of income make for difficulties in administration and
compliance, because neither the IRS nor the taxpayer can figure out
clearly what is in or out of the tax base.
Most complexity is found at the business level or with respect to
specialized investments of individuals. Taxation of wages and ordinary
individual interest and dividends is fairly straightforward.
Simplification should not go so far as to eliminate tax filing by
individuals, as with a sales tax or VAT; that would sacrifice
visibility to an unacceptable degree, and is not necessary to achieve
significant simplification.
A tax proposal that conforms to the attributes and principles of a good
tax system.
As mentioned, there are several types of (largely) neutral tax
systems. Most achieve varying degrees of tax simplification.
Unfortunately, most fail to do a good job with respect to visibility,
which is one of the most critical attributes of a good tax system.
The following is a tax proposal that conforms to all the attributes
and principles of a good tax system. It is called the inflow-outflow
(I-O) tax.
Overview. The I-O tax system is an individual-based saving-deferred
tax with a number of additional deductions from revenue necessary to
properly measure and allocate the income for tax purposes. Inflows--an
individual's revenues from work, saving, and transfer payments
received--would be taxable. Outflows associated with earning the
revenues (such as net saving, investment, and some education outlays),
and income transferred to others (either voluntarily by gift or as
mandatory tax payments) would be deductible. Net taxable income would,
in effect, consist of revenues utilized for the individual's own
consumption.
For neutrality and visibility, net labor and capital income would
be taxed once and only once on individual tax returns. For fairness,
there would be personal allowances to shelter the poor from tax. For
neutrality and fairness, there would be a single tax rate imposed on
income above the exempt amount. The single rate would eliminate the
graduated tax rate bias against work, education, risk taking, and
success, and would treat all individuals alike under the law.
The I-O tax attributes income to the correct taxpayer. For
visibility, income should be taxable to the final recipient of the
income. People should be taxed only on the income over which they
retain control and of which they enjoy the benefit. If one taxpayer
gives revenue to another, either voluntarily (as by gift or charitable
donation), or due to legal obligation or government coercion (alimony,
fines, taxes), the donor should deduct that revenue from his or her
taxable income, and the recipient should add that revenue to his or her
taxable income.
The I-O tax defines income properly. Income is a net concept,
revenues less the cost of generating those revenues. Among the costs of
generating income are: training and education in the case of labor
income; the cost of acquiring income earning assets (saving and
investment) in the case of income from capital. Costs of generating
income must be deductible in full--expensed, not deferred (unless
compensated by payment of interest to maintain present value).
Details of the I-O system follow. An illustrative sample tax form is
appended.
Labor income. Individuals would pay tax on labor income (wages,
salaries, self-employment income, and the value of non-pension fringe
benefits) and pension receipts. The employer would report the total to
the taxpayer on a W-2 form, as it does for cash wages and pension
withdrawals under current law.
Transfers received. Individuals would pay tax on the taxable
portion of social security. (All payroll taxes would become deductible
in this tax system; therefore, over a phase-in period equal to a full
working lifetime, all social security benefits would eventually become
taxable.) Individuals would also pay tax on welfare and other transfer
payments received from state and local governments and charities,
insofar as they exceed the exempt amounts. (In practice, those who
receive charity would usually be too poor to owe tax, and would not
have to file a return.)
Income from saving and the net saving deduction. Individuals would
deduct their saving (a cost of earning future income) from taxable
revenues, and pay tax on all returns on saving (whether principal or
earnings on the principal or earnings of an unincorporated business)
when withdrawn. Reinvested returns would be tax-deferred.
In effect, all saving would be treated like current-law tax-
deferred pensions or IRAs. All income that individuals transfer to
financial intermediaries or other businesses through lending or the
purchase of shares would be deductible by the savers. Only those
earnings withdrawn or received by lenders, shareholders, or owners of
an unincorporated business (and not reinvested) would be taxable, and
would be reported on the individual tax returns. The ``inside build-
up'' of the saving in saving accounts, brokerage accounts, mutual
funds, corporate shares, or unincorporated businesses would not be
taxable. There would be no separate calculation of capital gains; they
would be covered in the proceeds from the sale of assets (whose full
cost was deducted at the time of purchase). The proceeds would remain
tax-deferred if reinvested. For example, trades within a brokerage
account would not be reportable unless money was withdrawn from the
account.
Pension contributions by employers and employees currently excluded
from employees' incomes would remain deductible saving. Since all
saving could be deducted in this system, all current-law restrictions
on the amounts allowed as contributions and withdrawals under employer-
sponsored pension plans would be eliminated.
The deduction for saving would be for net saving. Borrowing would
be considered ``dissaving'' and be considered taxable revenue to be
netted against amounts saved. However, borrowing would result in an
immediate tax liability only if used for consumption. Borrowing used to
buy assets such as stocks or a machine for one's business would not
result in more taxable income because the investment outlays would be
deductible saving. Also, repayment of debt and interest paid on debt
would be part of deductible saving. (But see alternative treatments of
home purchases, below.)
Each financial institution with which the taxpayer had dealings
would report the taxpayer's net saving or dissaving for the year as a
single number on a 1099 form, like those currently in use to report
interest or dividends on Schedule B. There would be no need for the
taxpayer to track all of his or her deposits and withdrawals over the
year to calculate the net amount. There would be no separate Schedule D
for capital gains.
Deductions of transfers paid. Charitable contributions would be
deductible by the donor. (As indicated above, the charitable gifts
would be taxable to the ultimate recipient, who would seldom have
sufficient income to owe tax. Current law simply allows the charitable
deduction and ignores the other side of the calculation.)
All payroll and state and local taxes would be deductible as income
over which the taxpayer has lost control and transferred to others.
State and local taxes are involuntary outflows. They largely fund
welfare and other aid to the poor (income transfers akin to charitable
contributions to persons below taxable levels of income) or education
(a transfer that pays for the cost of the recipient's acquisition of
human capital), all of which could be considered to be reasonable
deductions. Law enforcement and fire protection are services to the
taxpayer, but constitute remedies for or protection from casualty
losses, and ought not to be considered beneficial income. There are
some local government services that accrue to the individual taxpayer
or homeowner, such as water, sewer, and trash pick-up, but these are
often billed separately, in which case they would not be deductible.
Deductions of cost of acquiring human capital. Individuals would
deduct some portion of the cost of training and education. Tuition and
other training costs are already largely deductible in the form of
property taxes at the local level that pay for primary education, and
state income taxes that assist state universities. Tuition paid
directly by the student could be considered for similar treatment.
However, there is also a ``consumption'' or general living element of
education; it is not all a cost of earning future income. Some rough
adjustment must be made in what will always be a gray area.
Treatment of home ownership. We do not recommend ``pure'' inflow-
outflow treatment of the owner-occupied home, which would be to treat
it (as in the national GDP accounts) as an investment yielding income
in the form of shelter. Pure treatment would include the imputed rent
from the owner-occupied home in taxable income, plus the mortgage
borrowing that financed the home; it would allow a deduction for the
purchase price of the home, the repayment of mortgage principal and
interest, and outlays on maintenance.
This pure approach to the treatment of owner-occupied homes is
difficult to calculate. The alternative approach to neutral treatment
of saving--no deduction for the purchase of the asset, but no tax on
the returns, is an easier alternative, and the I-O tax would adopt it
in this instance. Neither the imputed rent nor the mortgage borrowing
would be taken into the homeowner's income. In exchange, there would be
no deduction of the purchase of the home, outlays for maintenance, nor
repayment of mortgage principal and mortgage interest.
Treatment of businesses. There would be no separate taxation of
businesses in a saving-deferred tax. Taxation of business income would
be completely ``integrated'' with the taxation of other income received
by the savers, be they corporate shareholders or partners or
proprietors of non-corporate businesses. Businesses would be treated
like pensions or IRAs owned by the savers: income that individuals
transfer to businesses through lending or the purchase of shares would
be deductible by the savers; only those business earnings distributed
to lenders and shareholders (and not reinvested) would be taxable and
would be reported on the individual tax returns. ``Inside build-up'' of
saving in the business would not be taxable.
The non-tax status of business in the inflow-outflow tax is not
arbitrary. The rules of the inflow-outflow tax naturally render a
business a non-taxable entity. Businesses would not be taxable because
their deductible outflows would always equal their inflows.
Business inflows include revenues from sales of goods and services
and income on financial investments, plus borrowing from lenders and
sales of new shares to stockholders. Business outflows include
operating costs--wages, purchases of materials, inventory, outlays on
research and development, rent and royalties paid, and all outlays for
investment in plant and equipment, structures, and (unlike current law)
land--plus state and local taxes and federal payroll taxes, interest
payments to lenders and dividend payments to shareholders. These
outflows are all costs of earning income or transfers of capital income
to lenders and shareholders for taxation on their returns. Any left-
over revenues saved by the business should be considered tax-deferred
saving by the shareholders. Nothing would remain to be taxed at the
business level. Consequently, there would be no need for businesses to
file income tax returns, eliminating most of the accounting, auditing,
and costs of enforcement and compliance in the current tax system.
In this system, the deduction for business investment would
effectively be passed along to the savers who lend money to, buy shares
in, or otherwise invest in the business. Savers would fully deduct
their purchases of stocks and bonds. These proceeds of stock and bond
issues, plus what we now call retained earnings, would just equal the
operating costs and (deductible) capital investment and net saving of
the business, eliminating taxable business income. This pass-through of
the deduction for investment would be an advantage for start-up
businesses that have little income as yet from previous investments
against which to take a deduction. It effectively eliminates the
problem of net operating loss carry forwards that delay and reduce the
value of deductions for investment and raise the cost of capital under
current law.
Territoriality. The I-O tax would be territorial, imposed on income
generated within the United States, not on income earned abroad. There
would be no deduction for saving invested abroad, and no tax on the
returns. There would be no credit for foreign taxes paid on foreign
income repatriated to the United States. Territorial taxation would
greatly reduce the confusing treatment of foreign source income that
cripples American firms attempting to compete abroad.
The I-O tax would not be ``border-adjustable'', that is, it would
not be forgiven on exports and imposed on imports, because it is
collected at the individual level on individual income. The producers
of U.S. exports worked and earned their income in the United States,
and should be taxed just as all other U.S. producers, while the
producers of U.S. imports worked and earned their income abroad, where
it is subject to foreign taxes.
Conclusion
The inflow-outflow tax is a neutral, highly visible tax system. It
correctly measures income, providing revenue to the government with
minimal disruption to the economy. It allocates income for tax
purposes, appropriately, to the final recipients of the income, thereby
informing the citizen-taxpayer of the tax cost of government. The I-O
tax also achieves a significant degree of tax simplification compared
to current law, and reduced costs of administration and compliance. The
I-O tax achieves these results in a superior fashion compared to most
other major tax reform proposals. It is deserving of serious
consideration by policy makers and students of political economy.
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Mr. Crane. Are there inquiries of this panel? Mr. Coyne?
Mr. English?
Mr. English [presiding]. Thank you, Mr. Chairman. I am
sorry I wasn't here for the entire testimony, but I did read
the written testimony previously, and I must say this is an
enormously distinguished panel.
Dr. Regalia, I was particularly intrigued by your comments
on border adjustability, and I am especially pleased to see the
Chamber's support of border adjustability, given the fact that
I sense that the business community is not monolithic on this
issue, but your testimony, I think, points the way that, on
balance, trade fairness is an important component on tax
reform.
Would you care to elaborate on that?
Mr. Regalia. Well, Congressman English, I think, having
worked for the Chamber for seven years, the one thing that I
could testify to unequivocally is that the business community
is not monolithic on anything, but on the area of border
adjustability I think that the recent problems that have
occurred with the FSC and with the WTO have heightened the
concern of this issue tremendously, and that there is perhaps a
greater understanding now of the issues that arise because of a
lack of border adjustability, the conflicts between a world-
wide tax system and a territorial tax system, and the
implications that can have, not just for the businesses that
trade directly abroad, but for everyone that deals with those
businesses and with businesses that deal with those businesses.
It is truly a broad-based economic issue at this point.
I think that the various--I mean, all in the business
community are waiting to hear, with bated breath what solutions
will be proposed to the current situation, and I think we are
heartened to see, in many of the specific tax proposals that
are out there, the willingness of all the authors of those
proposals to address this problem in a very clear-cut and
economically-sound manner.
Mr. English. Mr. Entin, I saw you took the contrary
position. Given your public policy pedigree, that should give
me second thoughts about my own support for border
adjustability. Why is it that you feel that taking the tax off
of exports, the embedded tax, and placing it on imports tilts
the playing field in any way? Doesn't it level it?
Mr. Entin. I have discussed territorial tax in my plan, but
I haven't specifically stated anything about border
adjustability. This has to do with the point of collection.
For example, in your plan you have a business level
collection and an individual level collection. Your business
level collection is border adjustable. It is natural, when you
have taxes on that level, that it be border adjustable. If,
however, you are taxing the individual before the individual
goes to the store, it is natural for it not to be explicitly
border adjustable because the very mechanics of where you have
collected it more or less arrive at the same point.
Let me explain that a little bit more clearly.
These taxes are generally taxes on income less saving,
which equals consumption, or, if it is at the business level,
it is on revenues minus investment, which equals consumption.
To measure consumption by taxing individuals, I want you to
take your income, subtract your saving, pay tax on your
consumption, then take your after-tax money to go shopping, and
when you arrive at the store you may buy a domestic product or
an imported product. There is no added tax on either one. I am
being neutral.
If, however, I make the individual wait until he goes
shopping to take out my tax, he is taking his pre-tax money to
the store, and at that point I levy a consumption tax on the
sum of his purchases of domestic goods and his purchases of
imports. The two together equal, again, the amount he has
consumed, and I am taking the exact same tax from the exact
same people. So I am being neutral in either case.
Whether something is border adjustable or not in an
explicit manner depends on where you have chosen to make the
collection point more than on anything else.
Mr. English. I guess my concern is, when you show up in a
store and there are two products on the shelf and one of them
has in the pricing the embedded tax of doing business in the
United States and the tax of whatever jurisdiction you are in,
and the other item does not have those taxes built in, isn't
there at least some price advantage to the foreign-produced
product as opposed to the domestically-produced product?
Mr. Entin. I don't think so, for three reasons. In the
length of time allowed for any response, I am not sure I can go
through all three.
Mr. English. I am chairing the meeting, so I will give you
a little extra time.
Mr. Entin. Okay.
Mr. English. I am very interested.
Mr. Entin. If you are thinking about Europe and its VAT,
remember, they have a corporate income tax, a personal income
tax, payroll taxes, and VAT. If you take out VAT, what is left
is still as big a tax burden as our total tax burden because
they tax a lot more than we do, so there are still taxes
embedded, if you want to think of it that way, in the imports.
If, however, you take a slightly different look at what is
going on in the production process, you have to realize that
workers work for an after-tax wage. Let me take two workers.
One works for Boeing on planes that are exported, and one works
in the corner grocery store and sells to the local population.
They both know they are paying tax when they go to the store.
When you impose a sales tax or a consumption-based tax, either
one, the workers know they are paying tax on what they consume.
Since they want to work for a satisfactory after-tax wage,
they have conveyed that attitude toward their employer and they
have asked for a wage that reflects the fact that when they go
shopping they have to pay tax. And that is as true for the
export worker as for the domestic worker. So there are taxes
imbedded in exports, even with a border-adjustable tax. All of
this stuff gets passed around.
I come back to the basic point I made earlier. If I am
taxing an individual's income minus his saving, either before
he goes to the store or after he goes to the store, I am
probably taking just the same tax liability from the worker
under the two systems.
The third point is that exchange rates adjust and washout
the effect of border adjustability sooner or later. If you
remove the tax on business, that added layer of tax on capital
formation that occurs when you tax the corporate level and the
individual level, and if you end the bias against saving and
investment, then I think we are going to be a lot more
competitive because we are going to have so much more
investment in plant and equipment in this country we are going
to be the more efficient producers of a lot of things.
But suppose we did become the most efficient producers of a
lot of things. Would we be running a big trade surplus? No,
because for people to be able to buy our goods they would have
to sell to us.
The objective of tax reform should be to make us very, very
efficient, very productive, and give us very high wages and
very high incomes, and that is true whether we were the only
country in the world or whether there were other countries with
which we were trading across the border.
Mr. English. And, Mr. Entin, I have to say on that
particular point I entirely agree with you. And this is a side
of trade policy that really doesn't get introduced into the
debate.
Dr. Regalia, would you like to respond to Mr. Entin's
points with regard to border adjustability?
Mr. Regalia. Well, not having reviewed all of them in
detail, I would have to say I think I probably agree with them.
I think that the issue of border adjustability comes up more
when you have two vastly different tax systems. If you were to
institute a truly territorial tax system in the U.S., tax
income once and only once, that there would be less of an issue
of border adjustability, given the various taxing points.
Mr. English. I agree.
Mr. Regalia. But when we go down the road of two very
different tax systems, two very different or multiple
collection points, many of which are layered on top of each
other, then these issues become much more important.
As you start to correct one issue, I think it helps to
correct the other, and I think that I would not disagree.
Mr. English. I have one concern on the exchange issue, and
I am not sure I can articulate this very well, but I am
concerned that the tax burdens fall disproportionately on
certain sectors of the economy.
For example, tax differentials have more of an impact on
manufacturing and certain kinds of manufacturing than they do
on certain kinds of services, and that, whereas much of the
economy might not be affected dramatically by the border
adjustability issue, I, who represent a largely manufacturing
District, still have got to be concerned that manufacturers,
where you produce a large volume of products with very thin
profit margins, would be particularly sensitive to tax
differentials, and the border adjustability argument might be
stronger in arguing that this is a policy we need in order to
maintain our manufacturing base.
I hope that is an articulate argument. Do you care to react
to it? Does that make any sense?
Mr. Entin. I think you are right to point out that we have
been seeing somewhat of a shift away from manufacturing towards
services and that some of the manufacturing industries have
appeared to be struggling. That is a valid point.
I think one of the reasons they are struggling, aside from
just the general drift of technological advance being stronger
in the intellectual property area than in the heavy
manufacturing, is that we have a tax bias particularly against
heavy manufacturing.
The depreciation allowances that we have in place today are
so seriously damaging to investment incentives for long-lived
assets, the very sorts of assets that steel and railroads and
the manufacturing sector employ, that we put a bias in the
economy against producing those goods in this country and in
favor of importing them.
If you move to any of the consumption-based taxes, where
business investment is expensed rather than depreciated and
where the corporate tax layer is stripped off, you would be
moving to a system where the change from current law is
greatest for those heavily-impacted sectors. I think they would
improve more than the other sectors under this type of tax
reform. That may solve your problem.
Mr. English. That is an interesting argument.
One of the common points I have seen between a number of
leading tax reform proposals--Mr. Armey's flat tax, for
example--I have a simplified USA tax. One of the common points
is moving to expensing as an alternative to depreciation.
Would both of you agree that this expensing issue may be
probably one of the most important things we do from a
competitive and growth standpoint in tax reform?
Mr. Regalia. I would think it would, and I also think it is
going to be one of the areas that require the most innovation
when it comes to transition rules because of the relationship
between old capital and new capital.
Mr. English. That is right.
Mr. Regalia. And when you are disadvantaging--when old
capital is so disadvantaged, if you were then to remove those
impediments to the new capital, you would create a situation
where you could significantly impair the ability of the older
firm to grow, and I think it is one of the areas that is most
important.
I look through much of the testimony the last couple of
days and almost everybody mentioned--the savings and investment
disincentives in our current code--one of the primary things
that you want to fix, and it is one of the most--as I said, it
will require the most innovation in constructing transition
rules to address that.
Mr. English. I have always adhered to the radical thesis
that the savings rates would be affected by changes in tax
policy. Do all three of you agree with that?
Mr. Regalia. I think, contrary to a long bit of what I have
read in economic theory, I think, in practice, I would have to
say yes, I think that it would affect the savings rates, and I
think that while we empirically have been unable to verify that
it is a result of the fact that we are drawing our sample from
a system that has had this corruption for years and years and
years, and so the data is unable to tell us the real answer.
I think it would make a difference. I think we saw that
with IRAs. Originally, when I worked at the Federal Reserve
Board, we contended that IRAs would change how you saved but
not how much you saved, and I think we have seen over the years
that even the very small IRAs that we have allowed have
probably boosted savings more than any of us thought early on,
and that after an initial phase we would have to say the
switching was minimal and the amount of net new savings was
more than we had anticipated, and I think that would be proven
for fundamental innovations to the tax code, as well, that we
would improve savings more than any of our economic models
would lead us to believe.
Mr. English. Ms. Soldano, any comment?
Ms. Soldano. Congressman English, our issue is death tax
only. It is the only thing that our organization focuses on.
Mr. English. Okay. And I agree with your position and I
recommend to you the writings of one of my constituents,
Professor Hans Senhold, who is retired from Grove City College,
whose book, ``Death and Taxes,'' is still the most succinct
argument and one of the best for repealing the tax.
Ms. Soldano. I agree.
Mr. English. Mr. Entin?
Mr. Entin. One reason that economists have failed to
understand the effect of the tax burden on saving is that they
got mixed up between levels of saving and the rate of saving.
If saving goes up, the level of saving goes up, incomes
rise, and, as incomes rise, so does consumption. Both saving
and consumption tend to rise. The saving rate as a percent of
the higher income may not be much higher, but the level of
saving is going to be a great deal higher under these tax
systems, and for some years the rate will be higher, as well.
I think economists got confused between levels and rates,
and a lot of the people who said that better tax treatment of
saving would not be a significant incentive are simply
mistaken. You would see a result.
Mr. English. Doctor?
Mr. Regalia. I was just going to say one of the most, I
think, interesting aspects of the simplified USA tax is the
deduction for investment in human capital, not just physical
capital. In today's economy, there is a whole theory of
economics on endogenous growth theory that speaks to this issue
of saving rate and growth rates in the economy versus levels of
savings and level of growth in the economy.
I think that one of the things we are beginning to see is
that the new economy, the information age, if you will, which
uses and relies so heavily on intelligence, training, human
capital attributes will find that the benefits to increasing
our human capital may exceed even the benefits from increasing
our fiscal capital, and I think that is a very innovative and
important aspect of some of these proposals that are
outstanding right now.
Mr. English. Thank you. I think not only is it good
economics, but it is also good as a selling point for the plan.
I want to thank all three of you for participating today. I
have just had an experience similar to what Mr. Archer had on a
November morning in 1994. I have awakened to discover myself
chairing the Ways and Means Committee, so I want to take this
opportunity to adjourn.
Thank you very much.
[Whereupon, at 2:14 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
Statement of Charles Adams, Historian, Williamsville, NY
Mr. Chairman and Members of the Committee:
The economics of our income tax is under assault by some of
our best economists and tax men, and for good reason. We have
learned much about how best to tax to collect public revenues.
The clear consensus of the unbiased economic studies
demonstrate our income and payroll taxes are a drag on the
economy, slow economic growth, produce chronic inflation,
discourage savings and enterprise, and put America at some
disadvantage in world trade with those nations, especially the
miracle economies, who have moderate, simpler tax systems-
systems that encourage and promote capitalism.
Our criticism should not stop there, however. While there
is just about nothing right with our current system
economically-speaking, not everything wrong with our current
system has to do with relatively recent science of economics.
Instead, it has to do with the spiritual values that were at
the core of the founding of America. The current system
denigrates these values in several respects. It has trampled on
our liberties, it is wasteful, and it is destructive of
economic and personal rights.
A national sales tax, if it replaced the income tax, would
rid the nation of the evils our income tax has produced. It
will also comply with the Constitutional command of uniformity.
If we were to pursue this course, our descendants in centuries
to come would look back upon us, as we look back upon our
Founders, with admiration for delivering future generations
from a tax that was oppressive, tyrannical, and corrupt.
Let us place the current tax system in historical context.
We do not need to go too far for our research. Adam Smith in
The Wealth of Nations, sets forth four signs of a bad tax
system:
a large bureaucracy for administration.
a system that puts taxpayers through ``odious
examinations...and exposes them to much unnecessary trouble,
vexation, and oppression.''
a system that encourages evasion.
a system that obstructs the industry of the
people, and discourages enterprise which might otherwise give
``employment to great multitudes,'' i.e. jobs.\34\
How well has our tax system adhered to the admonitions of
Adam Smith? Does it pass Adam Smith's test for a bad tax
system? The answer is clearly ``yes.'' His test defines our
system today. The FairTax national sales tax would return us to
these core values that have stood the test of time.
Looking at a Distant Mirror
Taxes were at the core of the world's great uprisings. And
taxes and the onerous methods of collecting them were at the
core of the founding of America.
The Statue of Liberty was a gift from the French to
commemorate the 100 year anniversary of American independence.
She stands at the entrance to New York's harbor as an
inspiration to the nation and the millions of immigrants who
arrived from Europe by ship before the jetage, ``yearning to
breath free.'' She was really a gift from the Romans. The same
Goddess of Liberty was depicted on Roman coins, just like she
was on our gold coins and early 50's piece; she was honored
with a number of temples, and Roman writers proclaimed,
``Liberty is a possession on which no evaluation can be
placed,'' and ``Freedom is beloved above all things.'' \1\ Yet
the coins and temples disappeared almost 200 years before
Rome's official demise when the Emperor Diocletian enslaved the
Roman people to ensure tax compliance, and he achieved this end
by chaining every taxpayer to his land, shop, or job. One
leading Roman historian acknowledged that Diocletian's tax
system did indeed save Rome, but he never asked ``whether it
was worth while to save the Roman Empire in order to make a
vast prison for scores of millions of men. `` \2\
The Romans did not submit to this tax enslavement without
resistance, so the Roman state resorted to brutal, savage
punishments. Zisimos, a Greek writer during this period, tells
us that the scourge and rack were used against taxpayers; and
to make the system work, fathers were compelled to prostitute
their daughters, and even children were sold into slavery.\3\
As one Roman declared, ``Let us flee to some place where we may
live as free men.'' \4\
This viciousness of the Roman state towards its citizen
taxpayers is what we need to focus upon, because it soon
infected the relation of the people with one another. Salvian,
the Bishop of Marseilles at Rome's fall, describes the evil,
the decadence and cruelty that the tax system had created. As
he said, any individual with any sense of human decency would
seek out another homeland.\5\ ``Rome was like a mother cancer
cell that passed its vicious propensities on to its children.''
\6\
A similar pattern appeared in Imperial Spain a thousand
years later. Spain, like Rome, taxed itself to death. To
enforce a similarly abusive, excessive tax system, Spain fell
back on ``applying the screw'' to reluctant taxpayers.\7\
``Applying the screw'' was not a figure of speech, like the
Roman scourge it was an instrument of torture. Unlike Rome
Spanish taxpayer resistance was disastrous for the state. Over
six major tax revolts erupted during the height of Spain's
glory and there is little doubt these revolts drained the
strength of the Crown and permitted Britain, France, and the
Netherlands to take over much of what was the greatest empire
of all time.
Spanish taxpayers responded with the same brutality meted
out by the tax bureau. In 1520, taxpayer deputies, summoned by
the Crown, promised their constituents there would be ``no new
taxes.'' However, the financial goodies promised by the king
were too tempting so they voted for new taxes. Riots erupted
throughout Spain. In Segovia, an angry mob seized the local
deputy and as they led him off for execution, his plea to
receive the last sacraments was denied-there was to be no
forgiveness in this life nor the life to come. I wonder, what
would these angry taxpayers have done to members of Congress
who approved Clinton's taxes? Or to George Bush who breached
his promise of ``no new taxes?''
The response of Spanish taxpayers included evasion and
emigration. The Spanish operated the most massive system of tax
fraud and evasion ever known, notwithstanding that the Crown
threatened evaders with the death penalty. All trade from the
New World was engaged in one gigantic smuggling operation. If
that wasn't enough, people fled from Spain in great numbers. As
one historian observed, ``In place of wondering at the
depopulation of villages and farms, the wonder is that any of
them remain.'' \8\
The use of cruel and savage punishments to enforce taxes
has repeated itself often throughout the course of Western
history. In France a hundred years of violence against
taxpayers and even tax collectors, culminated in the French
Revolution in which the tax man came out on the short end-
indeed, the whole lot of them were shortened about 10 to 12
inches apiece after the man who ran the guillotine had finished
his work-no tears were shed when their heads flopped into the
basket.
In the 18th Century, Sir Robert Walpole, Britain's first
prime minister, used ``vicious punishments'' to enforce his tax
system. He was, as one biography described him, ``In no way
squeamish about the liberties of the individual,'' and he used
``savage punishments, and the full authority of the Crown to
make the public conform to his system [of taxes].'' Eventually,
riots spread throughout Britain, as an ``expression of a
profound and cumulative hatred of a system oppressive,
tyrannical, and corrupt [with power].'' \9\ When Sir William
Blackstone wrote his great treatise (still in print),
Commentaries on the Laws of England (1765), there was no praise
for Walpole's tax enforcements, they were ``arbitrary'' and
``hardly compatible with the temper of a free nation.'' \10\
That same condemnation would easily apply to our income tax
laws today. It was less than 25 years after the riots in
Britain over Walpole's tax laws that the British colonists in
North America sensed the same sort of tax policy coming their
way, and they were willing to resort to violence and even
treason against the Crown's taxes.
The Founders of America were well aware of the history
summarized above. The great sage of the Enlightenment,
Montesquieu, in his The Spirit of Laws (1751), inspired the
Framers of the Constitution, and much of its form can be traced
to this great book. He was a tax-philosopher historian. If our
current tax makers and we as a people had been schooled in his
studies, as the Framers of our Constitution were schooled, we
may not be having the tax troubles that now infect our whole
social order. He taught emphatically that excessive taxation
produces slavery; noting that men living in a liberty oriented
society will foolishly submit to excessive taxation. He added a
further observation, that excessive taxes will require,
``extraordinary means of oppression.'' And from that, ``the
country is ruined.'' \11\ This conclusion of Montesquieu was
not a theory, it was plainly visible to him as a fact in the
governments of his day and of those in history. With
Montesquieu we are not dealing with logic, we are dealing with
what Oliver Wendell Holmes had in mind when he said, ``A page
of history is worth a volume of logic.'' \12\
The leading writer for the American Revolution was Thomas
Paine. ``Without the pen of Paine, `` said John Adams in poetic
rhyme, ``Washington would have wielded his sword in vain.''
Washington had Paine's pamphlets distributed to his troops to
read when they were in Winter Quarters during the dark days of
the war. America was a land of liberty, wrote Paine, because it
was a land of low taxes. Excessive taxes produced tyranny, he
wrote, caused by the foolish and naive attitude of the people
toward their government by believing that ``government is some
wonderful mysterious thing.'' And when the people believe that
illusion, ``excessive revenues are obtained.'' \13\
What drove men to revolution was simply overtaxing and
overblown governments. In short, when a government is just,
``taxes are few.'' And revolution was necessary and justified
to bring about a government ``less expensive and more
productive,'' which would bring about ``peace, civilization and
commerce. `` \14\
Direct Taxes: the Most Burdensome Type
The most pernicious of all taxes are the arbitrary,'' said
David Hume, the great Scottish philosopher, ``They are commonly
converted, by their management, into punishments on
industry...It is surprising, therefore, to see them have place
among any civilized people.'' \24\ Alexander Hamilton, a
leading proponent of the Constitution who favored broad taxing
powers, had no use for arbitrary taxes. ``Whatever liberty we
may boast of in theory, it cannot exist in fact while
[arbitrary] assessments continue.'' \25\
The Framers of the Constitution thought they had provided
against any arbitrariness in taxation by commanding that all
tax laws be UNIFORM, i.e. the same for all. But the uniformity
command disappeared in the 20th century when the justices who
upheld this condition, all died and were replaced with justices
willing to make that provision an ``empty shell'' as legal
scholars have described the present state of affairs.\26\ The
Congress can now adopt abusive, discriminatory, arbitrary
taxation to the extreme, thus fulfilling James Madison's fear
expressed in The Federalist, No. 10;
Yet there is, perhaps, no legislative act in which greater
opportunity and temptation are given to a predominant party to
trample on the rules of justice. Every shilling with which they
overburden the inferior number is a shilling saved to their own
pockets.
Madison concluded by arguing that ``The Majority...must be
rendered unable to concert and carry into effect schemes of
oppression.'' The Constitutional command of uniformity for all
taxation was one means to achieve that end, but once the Court
made that command an ``empty shell'' the U.S. Congress has with
impunity ``trampled on the rules of justice,'' with tax rates
deliberately made unequal, and with exemptions and other tax
favors for the best lobbyists, just as Madison had predicted.
Besides the disastrous consequences of both arbitrary
taxation and excessive taxation, Montesquieu focused on another
archenemy of liberty-direct taxation, which he described as
being ``natural to slavery, `` unlike indirect taxes, or a
``duty on merchandise is more natural to liberty, because it is
not so direct a relation to the person.'' \27\
This observation was over two thousand years old. The
Greeks discovered it by observing the many empires of the
world--all were despotic, tyrannies. And all had direct forms
of taxation, like wealth taxes, income or production taxes,
poll taxes, and the like. The Greeks concluded, tyranny was the
consequence of direct taxation. Except in times of war, direct
taxes must be avoided if liberty is to be preserved.
Cicero, the great Roman lawyer, also condemned direct taxes
as a danger to Roman liberty. He said:
Every effort must be made to prevent a repetition of this
[direct taxes]; and all possible precaution must be taken to
ensure that such a step will never be needed...But if any
government should find it necessary to levy a direct tax, the
utmost care has to be devoted to making it clear to the entire
population that this simply has to be done because no
alternative exists short of complete national collapse.\28\
Why, you may ask, is direct taxation so bad? Why did the
Greeks and Romans have so much contempt and hatred for what we
have lived under most of this century? They came to this
conclusion from history. They saw the tax system of the
Pharaohs of Egypt and the enormous oppressive bureaucracy the
Pharaohs maintained to collect taxes; they may also have
noticed that no word even exists in the Egyptian languages that
means freedom or liberty. Freedom and liberty just didn't exist
where direct taxes were in operation. In the past century, with
the income tax, the people of America have seen their liberties
slip away, one by one, year in and year out. Even in the
socalled protaxpayer Reagan years, the power of the IRS over
everyone's life increased dramatically. Over 150 penalties were
put in operation to increase the tax, almost double the tax,
for the slightest slipup by the taxpayer. Reagan and the
Congress of his era may have reduced rates, but they increased
IRS muscle in the process. Their process of ever increasing
powers, creating a musclebound bureaucracy, reminiscent of so
many ugly tax bureaucracies of the past, is what the Greeks and
the Founders were warning us about.
This concept did not go unnoticed by the Framers nor by
Montesquieu. At the Constitutional convention, Madison echoed
the Greeks on the matter of direct taxes. He said, almost as a
matter of fact, they would only be introduced during an
``extraordinary emergency.'' \29\ It was inconceivable they
would ever be a permanent, peacetime measure, for the reasons
both Montesquieu and the ancient Greeks propounded.
What was inconceivable then, has not been inconceivable in
the 20th century. We have made direct taxation the order of the
day and we have reconfirmed, for future generations, that the
Greeks were right. Direct taxes do produce tyranny. When the
Readers' Digest wrote a series on the abuses of power by the
IRS, they entitled the series, ``The Tyranny of the IRS.''
Unlike wise men, we have had to learn from history the hard
way-by reliving what others warned us about.
One of the high points in Thomas Paine's life was his
arrest and charge of seditious libel while in Britain. The
charge came about because of his book, The Age of Reason, in
which he condemned kingships, especially Britain. To his
defense came one of the world's greatest lawyers, Thomas
Erskine. He paid dearly for the defense of Paine, having been
dismissed by the King from his post as AttorneyGeneral. The
following is taken from his speech in 1792, which seems to
explain how our liberties have been lost to enforce our income
tax system.
...arbitrary power has seldom or never been introduced into
any country at once. It must be introduced by slow degrees, and
as it were step by step, lest the people see its approach. The
barriers and fences of the people's liberty must be plucked up
one by one, and some plausible pretenses must be found for
removing or hoodwinking, one after another, those sentries who
are posted by the constitution of a free country, for warning
the people of their danger.\30\
Our Current Tax System: Vexatious, Odious, Heavy and Direct
Let us leave the past and the Founders and see what shadows
of the past are cast upon us with our income tax.
Are our taxes arbitrary? There never was a tax law more
arbitrary than our current income taxes. In the 1950's,
Congress decided that the top bracket should be 91%; Kennedy
thought 70%; Reagan 28%; and Clinton wants to jack it back up
to around 40%. And as for exemptions, tax credits, and other
tax goodies, they vary from legislature to legislature-
arbitrariness to the utmost extreme making a field day for tax
lobbyists and a joy to the tax makers on the Ways and Means
Committee.
Are our taxes direct? Today we have nothing but direct
taxes, which make everyone both a tax collector and a taxpayer.
The IRS with more than 112,000 employees it he largest tax
bureaucracy in the world since ancient Rome. Its tentacles
reach out and have hold on more than 200 million people.
In the 1950s it was routine for an IRS agent to begin his
audit by telling the taxpayer, ``Ours is an honor system, which
is the only way it will work in a free society.'' Supreme Court
Justice Jackson, a former chief counsel for the IRS, said at
this time that instances of selfserving mistakes and outright
evasion were rare-and that was at a time when the infamous
``Information'' returns were nonexistent.\15\ Banks did not
report anything to the IRS about the affairs of their
customers. Nothing that went through a bank account was
photographed and held in storage for Big Brother to see.
Interest income was not reported; dividends were not reported;
real estate transactions and income was not reported; stock
transactions were not reported; income from independent workers
was not reported. Only wages were reported and that was done to
enable workers to file for a tax refund. U.S. Customs did not
demand to know how much money or travelers checks you were
carrying, nor did they punish and confiscate amounts in your
possession which were unreported. The tax system was an honor
system, and it worked.
The danger that income taxes may produce a massive
espionage system and destroy much of the liberty of the people
was a distinct possibility at the time America adopted its
first income tax. Even the experts were aware of the risk, but
they were quick to argue it would not be a possibility with the
long traditions of freedom of the American people. The danger
became apparent because of the income tax system in Prussia,
which, according to one German legislator who opposed the
system, covered the country with ``a perfect system of
espionage.\17\ In an income tax audit, a taxpayer who was
involved with securities, would be asked ``How many stocks did
you sell this year? On what day and at what exchange did you
sell them? What is the price of each? What is the name of each
company in which you have securities?'' This was considered
oppressive, the ``espionage'' that income tax advocates in
America in 1914, assured the people, would never happen here.
We have also have had to resort to savage punishments to
make the income tax system work. Backing up the espionage is
the fear of punishment--severe, long term prison terms which
hang over the heads of all taxpayers. Every March and April
prosecutions are published as front page items, to put terror
and to intimidate every taxpayer as the tax return season is in
full force.
Some punitive measures are, at times necessary for tax
enforcement, but have we gone too far? Are we outofstep with a
free society? With the rest of Western civilization? Outside of
the former Soviet Union no nation treats its tax offenders with
such harshness.
The destruction of these values by our income tax would
come as no surprise if, in our education, we had learned that
most great empires taxed themselves to death, spiritually as
well as economically. The Founders as well as the ancient
Greeks and Romans warned future generations about the tyranny
that would befall any nation that adopted a tax system like we
have endured. Their words speak from the past, like the ancient
prophets from Biblical times.
The evolution of our direct income tax system from an honor
to a spy system has taken almost 50 years, in slow degrees,
``as it were step by step,'' under plausible pretenses used to
hoodwink the sentries ``posted by the constitution,'' i.e., the
Supreme Court decisions, like Boyd v. United States, a tax case
which declared unconstitutional a statute that gave the revenue
bureaucracy the power to order a taxpayer to bring in his books
and records for examination. Said the Court:
And any compulsory discovery by extorting a party's oath,
or compelling the production of his private books and papers,
to convict him of a crime or to forfeit his property, is
contrary to the principles of a free government. It is
abhorrent to the instincts of an Englishman; it is abhorrent to
the instincts of an American. It may suit the purposes of
despotic power; but it cannot abide the pure atmosphere of
political liberty or personal freedom.\31\
That was in 1885. The case has been cited over 3000 times.
Finally, in 1983 it took a the Supreme Court acknowledge that
the Court had ``sounded the death knell for Boyd.'' \32\ Year
in and year out, with each new piece of tax legislation, the
IRS has been given increasing powers to spy, punish and
intimidate taxpayers on a level associated with a totalitarian
state. The Supreme Court, like Pontius Pilate, had the duty to
prevent this abuse of power-but like Pilate, the justices have
washed their hands before the multitude.\33\
Finally, not long ago on the MacNeilLehrer news hour on
PBS, an essayist was finishing what would otherwise have been a
fine talk, except he concluded his remarks with an assertion I
have heard frequently since early grammar school days-``America
is the freest country in the world.'' That may have been true
in times past, but it is not true today, not by a long shot.
There are many countries in the free world that grant their
citizens far greater freedoms than we enjoy in America. Not
only are we slipping to some degree in world commerce, we have
slipped a great deal more in matters of liberty and freedom.
And the reason? Our income tax and our government's zeal to
enforce it at all costs, including our liberty if it gets in
the way. As a free nation, we are a third string operation,
thanks to our tax system.
How Does the FairTax Address these Problems if the Direct Tax?
What needs to be done to restore our leadership and ranking
among free nations? The answer is easier than you may think. We
need to go back to our roots, to the ideals and passion for
liberty that was the driving force behind the formation of this
nation. The Founders had no use for direct taxation as a
permanent revenue device. They believed, as did the ancient
Greeks and Romans, that it was a great danger to liberty. They
were right and we are living proof of how right they were.
Without an income tax there would be no need to photograph
everything going through your bank account; no need for your
bank to notify the government about your cash account or other
financial dealings; no need for your interest, dividends, stock
sales, real estate transactions, and baby sitters to be
reported to Big Brother. No need for Customs to search
travelers to make sure they were not carrying too much money
with them; no need for judicial terrorism, savage punishments,
and psychopathic judges. The laundry list of government
intrusions would be minimal. In one fell swoop, the
totalitarian muscle behind our tax system would disappear.
1. Justinian Digest, L.xvii; Naphtali Lewis and Meyer
Reinhold, ed., Roman Civilization, Sourcebook II, The Empire
(New York, 1966) p. 539
2. M. Rostovtzeff, The Social and Economic History of the
Roman Empire I (Oxford, 1971) p. 53132.
3. Salvian, On the Government of God, ed. Eva M. Sanford
(New York, 1930) pp. 141-49
4. Rostovtzeff, Roman Empire, I. p. 398
5. Ferdinand Lot, The End of the Ancient World and the
Beginning of the Middle Ages (New York, 1961) p. 175
6. Charles Adams, For Good and Evil: The Impact of Taxes on
the Course of Civilization (Lanham, MD, 1993) ch. 11
7. ibid., p. 187
8. Martin Hume, Spain, Its Greatness and Decay (1479-1788)
(Cambridge, 1898) p. 221
9. J. H. Plumb, Sir Robert Walpole, vol. 2 (Clifton, NJ,
1973) p. 238-39
10. William Blackstone, Commentaries on the Laws of England
vol. I (London, 1765), ch. 8, p. 308
11. Baron de Montesquieu, The Spirit of Laws, vol. 1
(Dublin, 1751) Book XIII, ch. 8, p. 261
12. New York Trust Co. v. Eisner, 256 U.S. 345, 349 (1921)
13. Thomas Paine, The Rights of Man (Pelican, N.Y., 1969)
p. 206
14. The Writings of Thomas Paine, vol. III (New York, 1906)
pp. 81, 183, 189
15. Gerald Carson, The Golden Egg (Boston, 1977) p. 252
16. D. Saunders, ed., The Portable Gibbon, The Decline and
Fall of the Roman Empire, (New York, 1973) p. 375
17. Edwin Seligman, The Income Tax (New York, 1914) p. 264
18. ibid. pp. 27172
19. Diogenes, The April Game (Chicago, 1973) pp. 12021
20. Thomas Paine, ``Dissertation on the First Principles of
Government,'' Common Sense and Other Political Writings (New
York, 1953) p. 174
21. Blackstone, Commentaries, I, 307
22. Adam Smith, The Wealth of Nations (Harvard Classics,
1909) p. 563
23. See Adams, For Good and Evil, p. 386
24. David Hume, The Philosophical Works, vol. 3 (London,
1882) pp. 35660
25. Harold Syvelt, ed., The Papers of Alexander Hamilton
vol. III (New York, 1962) p. 104
26. ``The Uniformity Clause,'' 51 U. of Chicago Law Review
1193 (Chicago, 1984); 44 Tax Law Review 563 (New York, 1989)
27. Montesquieu, Spirit of Laws I, Bk. XIII, ch. 14, p. 266
28. Cicero, On Duties Il; see Cicero, On the Good Life,
trans. Michael Grant (New York, 1971) p. 162
29. James Madison, Records of the Debates in the Federal
Convention of 1787, Documents Illustrative of the Formation of
the Union of the Amerlcan States (Government Printing Office,
Washington, 1927) p.
30. James L. High, ed., Speeches of Lord Erskine, vol.
1(Chicago, 1876) p. 536; also found in 22 How St. Tr. 358, 443
(1792)
31. Boyd. United States, 116 U.S. 616, 63132 (1885)
32. United States v. Doe, 464 U.S. 606, 618 (1984)
33. Matt. 27:24
34. Smith, Wealth of Nations, p. 500
STATEMENT OF W. HENSON MOORE, AMERICAN FOREST & PAPER ASSOCIATION
Mr. Chairman and Members of the Ways and Means Committee, I
am very pleased to have the opportunity to address this
Committee concerning the issue of fundamental tax reform.
The American Forest and Paper Association (AF&PA) is the
national trade association representing producers of paper,
pulp, paperboard and wood products, as well as growers and
harvesters of this nations forest resources. As President and
CEO of AF&PA, I see evidence on a daily basis of how the U.S.
tax code negatively impacts the forest products industry as we
compete in the global economy.
The members of AF&PA encompass the full spectrum of US
businesses. They range from large integrated corporate
operations to small private tree farms long held within a
family. All our members are dedicated to business practices
that foster responsible environmental stewardship at home and
abroad. Many of our members, large and small, strive to
maintain a competitive presence in the global market.
As good as our economy is, the provisions of the current
tax code are a major obstacle to a level playing field between
the U.S. forest products industry and our competitors around
the world. Our taxes are higher than those of competing
nations. When added to trade barriers to exports of our
products, the US worldwide system of taxation functions as a
major obstacle to competition.
We are fortunate in this country to possess vast forest
resources that have actually been growing over time. Our
nation's 500 million acres of timberland contain over 36% more
wood fiber today than they did fifty years ago despite
continuously growing demand. Unfortunately, in recent years, a
greater proportion of our national wood and paper needs have
been supplied not from our own industry, but from imports.
The importance of our forest products industry is reflected
not only in our record of environmental stewardship but also in
the fact that we supply more than $230 billion to the nations
gross domestic product; we rank sixth among domestic
manufacturing sectors. We employ 1.5 million people and rank
among the top ten manufacturing employers in 46 states. The
forest products industry represents more than seven percent of
U.S. manufacturing output, and provides a basic renewable
resource that supports a unique and vital forest-based economy.
However, the U.S. forest products industry faces serious
international competitive threats, particularly from countries
where new capacity growth exports are not taxed and where
forestry, labor and environmental regulatory requirements are
not as strict as those in the United States.
Our industry has an enviable environmental record. Members
of AF&PA subscribe to the Sustainable Forestry Initiative, a
program that assures the practice of sustainable forestry
through the perpetual growing and harvesting of trees while
protecting wildlife, plants, soil and water quality. However,
unless we can improve the investment climate for forestry in
our own country, more trees will be grown and harvested in
other countries, many of which have less environmentally
sensible practices than we do in the US. Improvements in our
tax system will be beneficial not only to U.S. workers and U.S.
companies--they will support U.S. environmental goals as well.
Our industry is one of the most capital intensive
industries in the world. For the last 10 years, the pulp and
paper industry has been the most capital-intensive sector in
the United States. Extensive capital requirements for
environmental protection cost 13 percent of the capital
investment. This percentage is expected to more than double in
the coming five years.
Unfortunately, the US tax system discourages investment by
the domestic forest products industry. Moreover, competing
countries are using their tax codes to foster the growth of the
industry, benefiting non-US competitors. Our US tax system
raises greater disincentives to corporate investment in
manufacturing and corporate forestry activities than that of
any major competitor country. Our effective corporate tax rate
is the second highest among these competing countries.
Corporate capital gains are taxed at higher effective rates in
the US than in most competitor countries. And even within the
U.S., the identical asset--timber--is taxed as widely disparate
rates, creating disincentives for holding timber in corporate
form.
And it is not much better for our members who operate their
businesses in the non-corporate form. Some 9.9 million private
individuals and firms own over 390 million acres of forestland
in the United States. It typically takes anywhere between 30
and 80 years to grow and nurture trees before they can be
harvested and converted to useful products. To make and
maintain investments in forestry necessitates tax treatment
that recognizes the long-term nature of growing trees. Under
the current tax system that excludes capital gains treatment
for corporations and imposes onerous passive loss rules on
individuals, the effective tax rates for forestry investments
are a disincentive to domestic investment. I don't believe we
should be sending investment and jobs overseas, not when we
have immense unrealized opportunities at home.
Passive loss limitations intensify the capital drain during
the long period of growth of trees. These rules force many
landowners to carry these costs until they have a timber sale,
instead of deducting these costs annually. For some landowners,
these passive loss provisions require landowners to carry these
expenses for more than 25 years.
US estate tax laws, with rates as high as 55%, force many
who inherit family-owned tree farms either to sell these
properties for commercial development, or to prematurely cut
their trees in order to pay the tax bill.
Our association has not endorsed any specific tax reform
proposal. We applaud efforts to simplify our US tax structure.
The real question is how to get there from here. In the end,
any system of taxation is a formula. The preference for one tax
system or formula over others is dependent on what is included
in the tax base and where the rate of taxation is set. The
other important element of any new system will be whether the
transition rules necessary if we move to a new tax base enable
taxpayers to make the transition gradually and in a way that is
perceived to be economically fair.
Our industry supports the work of the committee in setting
out to reform the tax code and to institute a system that is
fairer and simpler for the American taxpayer. As this effort
moves forward, we will work with you to accomplish those goals
and to assure that any new tax system supports U.S. workers and
companies in our efforts to remain successful in increasingly
global markets.
STATEMENT OF AMERICAN PETROLEUM INSTITUTE, MICHAEL PLATNER, WASHINGTON,
DC
Introduction
Background
This testimony is submitted by the American Petroleum
Institute (API) for inclusion in the printed record of the
April 1 1, 12 and 13, 2000, Ways and Means hearings on
fundamental tax reform proposals introduced since the last set
of hearings on the subject in 1997. API represents more than
400 companies involved in all aspects of the oil and gas
industry, including exploration, production, transportation,
refining, and marketing .
Several new consumption tax proposals have been introduced
recently as complete substitutes for the current federal income
tax system. This statement will focus on the business tax
aspects of 1 ) the Simplified USA Tax Act (``USA Tax'') offered
by Rep. English; 2) the Fair Tax Act, or national sales tax
(``NST''), offered by Reps. Linder and Peterson; and 3) a
European-style credit-invoice value added tax (``CIVAT''). API
takes no position at this time as to whether the current income
tax system should be completely replaced, but there is no doubt
that as presently codified, it imposes wasteful and unnecessary
burdens on the economy. We commend the Committee and the
sponsors of these and previous proposals for their efforts to
improve our tax system and for moving toward the taxation of
consumption rather than the taxation of income.
Problems with Current Income Tax System
Over the years, changes to the Internal Revenue Code
(``Code'') and accompanying regulations have created the most
complex income tax system in the world. Because of this
complexity, unreasonable compliance and collection costs (both
to the government and to taxpayers) impair the efficiency of
the system; obscure or conflicting aspects of the Code and
regulations fail to operate as intended; and administrative
implementation of complex provisions often takes years,
creating long periods of uncertainty for taxpayers as to their
tax obligations.
The current income tax system is biased against savings and
investment, and in favor of consumption. Income generated by
corporations is taxed twice. For example, in the case of a
dividend, once when the income from which the dividend is
generated is earned and again when the dividend is received by
the shareholder. Moreover, because recovery of capital costs is
spread over time there is effectively a tax on the capital
investment itself.
Our income tax system is neither ``territorial'' nor
``border adjustable.'' Therefore, it does not allow domestic
and foreign produced goods' to compete on an equal basis in
domestic or foreign markets. Rather, the U.S. foreign tax
system acts to inhibit American competitiveness. U.S.
corporations are taxed on worldwide income, while many foreign
corporations are not. U.S. anti-tax deferral rules are the most
restrictive in the world; unnecessarily complicated mechanics
of the foreign tax credit limitation further reduce the
effectiveness of the credit as to a means to avoid double
taxation; and the volume and frequency of changes in the
foreign tax area continue to add compliance costs and
destabilize the ability of U.S. businesses to compete
worldwide.
Most of our trading partners have some form of value added
tax (``VAT'')--almost exclusively a CIVAT-that permits the tax,
under the rules of the World Trade Organization (``WTO''), to
be rebated on exports. Our income tax cannot be rebated on our
exported goods (domestically produced goods must bear the
imbedded costs of our income tax as well as local taxes imposed
in foreign markets), while goods imported into the United
States do not bear the VAT imposed in their country of origin.
Attempts to remedy this disparity in the tax treatment of U.S.
versus foreign exporters within the confines of the current
U.S. tax system have been mostly unsuccessful. The recent
decision of the WTO, which held that certain tax breaks offered
to U.S. foreign sales corporations (``FSCs'') constituted
illegal export subsidies, only served to highlight the
difficulty in preserving the global competitiveness of U.S.
businesses under our income tax system. Whatever comes out of
this tax reform process should have as one of its goals
enhancing the ability of U.S. companies to compete
internationally.
Guiding Principles in a Properly Designed Tax System
In general, API believes that properly designed consumption
taxes are preferable to income taxes. In studying consumption
taxes over a number of years, we have developed a set of
principles by which we evaluate alternative consumption tax
proposals. They include the following:
Minimize economic distortions;
Ensure that foreign and domestically produced
goods compete equally in the marketplace;
Permit the current deduction of capital
expenditures;
Impose only one rate or as few rates as possible;
Facilitate recovery of taxes in the marketplace;
Exclude from the base separately stated excise
taxes, including sales and use taxes, royalty payments to
federal and state governments, and non-cash exchanges;
Be relatively easy to comply with and administer;
and
Make the tax rate or amount of tax clear to the
ultimate consumer.
Concerns with Changing to a New Tax System
While we are supportive in principle of moving towards the
taxation of consumption, we urge the Committee to proceed with
caution. Because the income tax has been embedded in our
economy for more than eighty years, business decisions have
been, and continue to be, premised on economic assumptions
spawned by that system. Therefore, any radical change will have
profound implications on business structure, business
financing, and business operations themselves, and these
implications must be thoroughly understood before moving to any
new system. This is especially true in the capital intensive
oil and gas industry, where the results of decisions may take a
decade or more to manifest themselves.
For example, the tax treatment of imports of all basic
commodities for further manufacturing will have significant
ripple effects on the economy. Because more than half of the
crude oil used in the United States is imported, this issue is
of major concern to our industry. One of the proposals, the
Simplified USA Tax Act, imposes a nondeductible import tax that
would increase the price of energy to consumers. We believe
that any import tax should be imposed in a manner that is
designed to put the new tax system in parity with the VATs of
our trading partners.
In order to survive, our industry must operate where we
have access to economically recoverable oil and gas reserves.
Since the opportunity for domestic reserve replacement has been
substantially foreclosed by both federal and state government
policy, the tax treatment of international operations is
critical to our continued ability to supply the nation's
hydrocarbon energy needs. In addition, since our industry's
projects require large amounts of capital and are high risk,
long lead-time ventures, the tax treatment of the financing and
structuring of these ventures is an essential element of
decisions whether to proceed. We are concerned about the impact
of these proposals on our access to efficient sources of
capital, whether through traditional capital markets or through
partnerships, joint ventures, or other business structures.
Not only must the federal tax implications of any proposal
be considered, but state tax integration, U.S. financial
accounting treatment, and securities market effects must also
be thoroughly understood. Finally, consideration must be given
to the United States' role in the global economy. A unilateral
change in the basic taxation of inbound and outbound
transactions by the United States will require that new
treaties be negotiated in order to maintain the protections
afforded U.S. companies by the current income tax treaty
system. These protections include: elimination of double
taxation due to overlapping exercise of authority; facilitation
of business transactions between countries that might otherwise
be inhibited by overly intrusive national taxation; reduction
of high rate withholding taxes imposed by many countries on
payments to foreigners of items such as dividends, interest,
rents and royalties; and other provisions designed to lessen
the burden on international commerce of varying national
taxation systems.
The USA Tax, NST and CIVAT, all of which are different
forms of consumption based taxation, fully or partially satisfy
several of APl's eight evaluation criteria outlined above.
However, each also falls short in meeting some of the criteria
or leaves issues of concern unresolved. A discussion of each of
these specific proposals follows.
The Simplified USA Tax Act of 1999 (H.R. 134)
General Characteristics
The USA Tax satisfies several of the API criteria for
evaluating taxing systems. It would encourage the investment in
durable business assets by allowing the immediate deduction of
capital expenditures. API also favors this proposal for
recognizing that excise taxes should be excluded from the tax
base and for establishing one tax rate for business.
Several aspects of the USA Tax appear easier to comply with
and administer than the present income tax system. Allowing
immediate expensing of capital equipment is a great
simplification compared to the current complex depreciation
rules. Since the USA Tax is also a ``territorial'' system,
businesses would no longer have to incur many of the
administrative and compliance costs of the current system
relating to foreign operations. In certain respects, the USA
Tax would help to minimize economic distortions as compared to
the current system. Our present income tax system contains a
large number of complex deductions and credits, many of which
create competitive distortions in particular business sectors.
Different rules apply depending upon whether a business
operates in corporate or partnership form. The USA Tax is more
neutral because it would allow far fewer deductions and would
apply to all business sectors and forms of business
organizations, but there is considerable uncertainty as to how
the taxation of partnerships would affect the industry practice
of forming joint ventures for high cost, high risk projects.
Deductibility of the Import Tax
There are also several areas in which the English proposal
does not meet APl's criteria. The proposal would impose a 12
percent tax on the value of imports. Because the proposed tax
would not be deductible, when an importer sells an imported
good in the United States, the importer would be subject to the
8 to 12 percent consumption tax on the already paid import tax.
This double taxation would create an unwarranted economic
distortion by precluding foreign and domestic goods from
competing equally in the marketplace. Consideration should be
given to whether the imposition of an import tax is appropriate
at all on intermediate purchases of goods that will be
incorporated into a final product. This is especially the case
for raw materials, such as crude oil, that generally have
already been subject to high foreign taxes (which would no
longer be creditable against U.S. tax obligations under the USA
Tax proposal).
The USA Tax system is particularly detrimental to importers
by failing to allow the import tax to be either deducted in
arriving at the taxable base, or fully credited against net
liability as is the case with most credit-invoice VAT systems.
While most commentators focus on the payroll tax credit as the
key to border adjustability, the real focus should be on the
national tax treatment provisions of the WTO because, as
currently drafted, the USA Tax appears to penalize imports. If
a destination-based system such as the USA Tax is ultimately
adopted, this major error must be corrected.
Tax Visibility
API is concerned that the USA Tax is not structured in a
manner that would facilitate recovery in the marketplace. As is
the case with the current income tax, the USA Tax would be
imposed on the net income of a seller of goods, rather than on
the product sale. Such a system also makes the amount of tax
less clear to the ultimate consumer than would be the case with
a tax that could be separately stated as a specific percentage
of gross sales price.
Treatment of Non-Cash Exchanges, State Taxes, Payroll Tax
Credit
Further analysis and discussion is warranted regarding many
other aspects of the USA Tax proposal. For example, API
believes that non-cash exchanges should be excluded from the
tax base. Under current law, tax-free exchanges are a common
and important part of the oil and gas business. Inventory
exchanges of equivalently (or nearly equivalently) valued
barrels of oil or product are everyday occurrences involving
extremely high volumes that permit the efficient transportation
and supply of crude oil and product throughout the country.
Certainly, compensatory cash payments for value differences on
these exchanges should be taken into account for tax purposes,
but the full value of the exchanged products must not be
considered as a taxable transaction. In addition, careful
consideration must be given to the consequences of the proposed
elimination of deductions for state income taxes and the
replacement of the wages-paid deduction with a payroll tax
credit.
Credit-lnvoice Value Added Tax
In General
A CIVAT on sales of all goods and services appears to more
closely adhere to the principles API has identified for a
properly structured consumption tax. A CIVAT is imposed as a
multistage sales tax collected at each point in the production
and distribution process. A business subtracts the tax paid on
its purchases, including capital goods, from the tax due on its
sales. If the difference is a positive number, the business
remits that amount to the government. If it is negative, as may
occur in the case of exported goods, the business claims a
refund. Compared to the current income tax, the CIVAT has the
advantage of encouraging saving and investment. It does not
burden capital outlays, nor does it discriminate against U.S.
industry either in the U.S. or abroad.
Effective and Neutral Revenue Source
From an economic standpoint, a separately stated CIVAT on
the sale of goods and services appears to be the least damaging
way of raising revenue. It does not burden capital outlays, nor
does it discriminate against U.S. industry either in the United
States or abroad. It does not favor either capital or labor
intensive industries. Wages, rent, interest and profits, i.e.,
the return of entrepreneurship, each bear the same direct tax
burden. A CIVAT levied at the same rate on all consumption
should not cause a significant distortion in consumption
choices since the relative cost of goods and services would be
the same after imposition of the tax as before. A broad-based
CIVAT would not unduly burden the products of any one sector of
the economy. Any regional distortions would tend to be
minimized since no specific product or geographic region of the
country would be the focus of the tax. A uniform CIVAT applied
to goods and services would induce fewer distortions within
particular industries than other taxes.
Border Adjustability
A CIVAT is neutral with respect to goods produced
domestically and abroad. Not only are U.S. manufactured goods
not burdened with the tax when they are exported, but imports
must also bear the same tax as comparable domestically produced
goods. This border adjustment feature of the CIVAT-permitted
under WTO rules-means that the tax does not handicap U.S.
manufacturers, nor does it act to distort consumer's decisions
whether to buy domestic or imported goods. Some economists
argue that border adjustable taxes are not necessary because
monetary exchange rates will adjust to accommodate the change
in U.S. taxation. While this may be true in the long run (and
not everyone agrees), in the short run the adjustment period
could be very harmful to U.S. competitiveness.
Differences with Other Tax Systems
Under the CIVAT, the tax liability of a firm is equal to
the tax imposed on its sales net of a credit for the tax it has
previously paid on purchases for business use. Under a
subtraction-method consumption tax system like the USA Tax,
liability is determined by applying the tax rate directly to
the firm's value added, or the difference between its sales and
its purchases. CIVAT is a tax on a product while a subtraction-
method consumption tax system is based on a business's books of
account, similar to the current income tax system. From that
underlying distinction flows a number of practical differences
that API concludes favor the CIVAT.
Most commentators agree that while a single rate
consumption tax, without exemption, is preferable, the
overwhelming weight of political experience shows that the
United States would not adopt a single rate consumption tax
with no exceptions. Not one of the 45 countries that currently
collect consumption taxes has a single-rate, no-exemption tax.
Most have both exemptions and multiple rates. The CIVAT readily
accommodates these features. Because the tax a business pays on
purchases is credited against the tax it owes on sales,
businesses. are encouraged to register as taxpayers and to get
invoices from their supplier to document the tax paid. Also, a
CIVAT would reach previously untaxed income in the underground
economy, since all consumer consumption would be taxed when
goods and services are purchased.
National Sales Tax Proposal (H.R. 2525)
In General
Most NST proposals are relatively easy to understand since
they are similar to the various sales tax systems in place in
45 out of the 50 states. The NST is intended to replace the
current income tax, estate and gift tax, and most general
revenue federal excise taxes. Under the plan offered by Reps.
Linder and Peterson, the tax would be imposed at a 23 percent
rate on the sale of goods, including both tangible personal
property and real property, and services, including financial
intermediation services such as brokerage fees, banking fees,
and insurance fees. Although the NST is intended to be
compatible with current state sales tax systems, none of the 45
states currently utilizing such a system tax services as
extensively as is envisioned under H.R. 2525. A great deal of
work will have to be done with the various state taxing
authorities before they will become convinced to administer a
uniform NST on behalf of the federal government.
Businesses would collect tax on all their taxable sales of
goods and services and remit the tax to the government. Since
purchases of inventory for resale are not taxable, the complex
inventory rules of the current income tax system would be
eliminated. Purchases of equipment and real property used in
the production of taxable goods and services would also not be
taxable, so there would be full expensing of capital assets. As
noted above in the discussion of the USA Tax, the ability to
immediately expense capital assets is extremely important to a
capital-intensive business like the oil and gasindustry.
Border Adjustability and Territoriality
Like a CIVAT, the NST is neutral with respect to goods
produced domestically and abroad. Not only are U.S.
manufactured goods not burdened with the tax when they are
exported, but imports must also bear the same tax as comparable
domestically produced goods. This border adjustment feature of
the NST, which like the CIVAT should be permitted under WTO
rules, means that the tax does not handicap U.S. manufacturers,
nor does it act to distort consumers' decisions whether to buy
domestic or imported goods. The NST, like the USA Tax and
CIVAT, is a territorial system, which would help put U.S.
multinationals on a level playing field with their
international competitors.
Definitional Problems
Although it appears to be the intent of NST proponents that
businesses above the retail level will be outside the tax
system, this likely will not happen. While H.R. 2525 improves
on prior national sales tax legislative proposals in its
attempt to define what constitutes a tax exempt good or service
``purchased for a business purpose in a trade or business,''
uncertainties remain. For instance, while the proposal would
exempt purchases used in a trade or business ``(1) for resale,
(2) to produce, provide, render, or sell taxable property or
services, or (3) in furtherance of other bona fide business
purposes,'' it is unclear whether items such as financial
services, pollution control, environmental remediation, or many
other kinds of purchases would be covered by that definition.
Such questions would then have to be resolved during the often-
confrontational audit process between the taxpayer/tax
collector and the sales tax administering authority.
Excise Tax Concerns
H.R. 2525 would not repeal the retail and manufacturer
excise taxes, which include a federal excise tax of 18.4 cents
per gallon on gasoline, 19.4 cents per gallon on aviation
gasoline, 24.4 cents per gallon on diesel fuel and kerosene and
21.9 cents per gallon on aviation fuel. In addition, the
proposal would not repeal the environmental trust fund taxes,
many of which are imposed on products produced by the oil and
gas industry. The preservation of these excise taxes in
conjunction with the adoption of the NST is of particular
concern to our industry because these excise taxes constitute a
significant portion of the retail price of our products and
would be included in the base upon which the sales tax is
calculated. State excise taxes would also be included in the
base, as proposed, and this would again be a major problem for
our industry.
Transitional Issues
In General
While transitional issues will arise in the context of all
tax reform proposals, they become especially critical where,
for example, there is a significant shift in the basis of
taxation from income to consumption. Capital intensive
industries, such as the petroleum industry, have made long-term
investment decisions relying on the existing tax structure.
Changes in that structure would impact different companies,
often in direct competition, in an arbitrary and often
inequitable manner. The most obvious examples of transitional
issues occur in the areas of capital outlays and borrowings.s
For example, a capital asset (or inventory) purchased
immediately prior to the enactment of certain of the
consumption-based taxes would be denied recovery of all but a
miniscule fraction of its cost, whereas the same asset
purchased immediately following enactment would be permitted an
immediate 100 percent recovery against the tax base. In a
similar manner, borrowings based on the anticipation of an
interest deduction could become a significant burden on a
highly leveraged business after enactment of a consumption tax.
Depreciation
The proposed USA Tax partially addresses the transition
issue but stops far short of providing the equitable relief
necessary for business taxpayers. The issue of unrecovered
basis is addressed in the Simplified USA Tax Act through a
system of amortization that substantially lengthens the
recovery period under current law. This lengthened and
arbitrary classification of unrecovered costs into four groups
appears to be based on misconceptions regarding complexity and
revenue costs. Continuing the current method for unrecovered
basis of assets placed in service prior to tax reform would be
preferable to inserting another new capital cost recovery
regime. Permitting current law business deductions to be
carried out, thus honoring prior business plans and
commitments, is necessary to avoid inequitable distortions.
Interest on Pre-Reform Debt
Transitional rules that consider only lost depreciation
deductions fall far short of measures necessary to ensure the
success of tax reform. A continuation of current law interest
deductions for pre-reform debt can be as vital to a business as
cost recovery. If the interest deduction is offset by interest
income on the particular pre-reform debt (i.e., pre-reform
obligations continue to be both tax deductible to the debtor
and taxable to the lender), there would be no significant
revenue impact to the Treasury. Ignoring a continuation of the
interest deduction results in arbitrary windfall gains and
losses without any apparent justification.
Carryovers of Other Tax Attributes
Among other items of significant impact to business are net
operating loss and capital loss carryovers, business, foreign
tax and minimum tax credit carryovers, as well as other pre-
reform adjustments, such as those required under Section 481 of
the Code. The USA Tax attempts to solve this problem with a
further complex overlay to the depreciation recovery rule.
Operating and capital losses are simply a result of the annual
accounting convention for tax payment determinations. Their
carry forward is a valid claim on future tax payments that
would take into consideration the length of business cycles in
various industries and other issues of timing. There is no
valid distinction between unused business credits and future
deductions for depreciation and, in fact, credits are a
specific and distinct congressional incentive upon which
businesses have relied. The Alternative Minimum Tax was
intended as an advance payment of federal income tax.
Therefore, unrecovered credits require a reimbursement
mechanism. Transitional rules must include a provision clearly
permitting the Internal Revenue Service to make appropriate
adjustments to ensure that no taxpayer takes a double deduction
for any cost, nor suffers double inclusion of any income.
Summary
Reform of the current U.S. tax system is a worthy goal,
especially the movement from taxation of income to taxation of
consumption. Each of the alternative consumption tax proposals
makes important contributions to the reform effort. Any major
upheaval such as complete replacement of the current income tax
system will, however, require careful analysis of all possible
implications. We have lived with the present tax system for
over eighty years, and businesses have structured their affairs
within it. Any fundamental change, unless carefully
orchestrated, could cause massive turmoil, particularly in the
transition period from the old system to the new. At the same
time, it should be emphasized that while API has identified a
number of concerns regarding the prospect of comprehensive tax
reform, none of these problems are insurmountable.
STATEMENT OF ASSOCIATED GENERAL CONTRACTORS OF AMERICA, ALEXANDRIA, VA
Mr. Chairman and Members of the Committee on Ways and
Means:
The Associated General Contractors of America (AGC) has
endorsed the FairTax national sales tax (currently embodied in
H.R. 2525) that is promoted by the Americans for Fair Taxation.
This federal legislation would eliminate the death tax, self-
employment taxes, corporate and individual income taxes, the
alternative minimum tax, the capital gains tax and replace
these taxes with one simple, single rate, national sales tax on
the personal and final consumption of goods and services at the
retail level only. It would not affect social security
benefits, but simply change the funding mechanism. It would not
affect those Federal excise taxes used to fund construction
programs. In this endorsement, AGC joins other significant
national business groups including the National Small Business
United (the nation's oldest small business organization) and
the American Farm Bureau Federation among other notable groups.
AGC is the nation's largest and oldest construction trade
association, founded in 1918. AGC represents more than 33,000
firms, including 7,500 of America's leading general contracting
firms. AGC's general contractor members have more than 25,000
industry firms associated with them through a network of 101
AGC chapters. AGC member firms are engaged in the construction
of the nation's commercial buildings, factories, warehouses,
highways, bridges, airports, waterworks facilities, waste
treatment facilities, dams, water conservation projects,
defense facilities, multi-family housing projects, site
preparation, and utilities installation for housing
developments.
SUMMARY:
The FairTax national sales tax will, in one broad stroke,
accomplish the entire Federal tax agenda for the AGC. The
FairTax eliminates the methods of accounting and long-term
contract accounting problems faced by contractors. No earnings
would be taxed and, equally important, once the FairTax is in
place, no business-to-business transactions would be taxed.
The fundamental reform will provide the legislative vehicle
for total elimination of death taxes. The death tax is one of
the most onerous obstacles to family business continuity and
growth. At a minimum, an estate over $675,000 (gradually
increased to $1 million by 2006) will be subject to a federal
death tax rate of 37% and an estate over $3 million will be
taxed at 55%. In the capital intensive construction industry,
most firms easily have assets of the current death tax
exemption amount. More than 70% of family businesses do not
succeed to the second generation and 87% do not survive to the
third generation. Few have the liquid assets to pay death taxes
if their heirs were to inherit the business today.
Comprehensive tax reform of this magnitude is a strong vehicle
for full elimination of the death tax.
Additionally, several beneficial economic consequences
would follow from the FairTax. Replacing the income tax with a
national sales tax will dramatically improve the standard of
living of the American people. The FairTax would significantly
enhance economic performance by improving the incentives for
work and entrepreneurial activity and by raising the marginal
return to saving and investment. Entrepreneurs and small
business owners would be given greater access to capital, the
life-blood of a free economy. Investment would rise, the
capital stock would grow, productivity would increase and the
output of goods and services would expand. The economy would
create more and better paying jobs for American workers and
take-home pay would increase considerably.
The cost of construction supplies will fall. Today,
construction materials bear a heavy, hidden component of tax.
Approximately 25 percent of the cost of materials are taxes
that have been imposed upstream in the companies producing
those materials, according to Dale Jorgenson, who is the
President of the American Economics Association and Chairman of
Harvard University's Economics Department. When taxes are
removed, competition will drive material costs downward.
The cost of capital will fall, enabling construction firms
to make greater investments in productivity and inducing
further infrastructure investments. The construction industry
is capital intensive, requiring large investments in heavy
equipment. For instance, a 150-ton crane used in bridge
construction can cost more than $1 million. A scraper can cost
$700,000 and a large bulldozer can cost more than $800,000. By
eliminating the capital gains taxes and any tax on investment
and savings, the FairTax will enable contractors to make the
needed investments in equipment and supplies before tax, not
with what remains after the government has exacted a toll.
Workers would benefit. Because the FairTax repeals both the
income tax and payroll taxes, workers would enjoy the full
fruits of their labor. What an employee earns would be what the
employee would receive in his or her paycheck. Workers would
respond to a national retail sales tax by increasing the amount
of work effort they want to undertake. A reasonable projection
is that if the current federal income tax system were to be
replaced by a national retail sales tax, total hours worked
that people in the United States would choose to work would
increase by 8.25 percent.
There are more advantages. The FairTax would reduce fixed
compliance costs by as much as 90 percent. By imposing taxes at
the cash register, the FairTax would wholly exempt individuals
from ever having to file a return. Business-to-business
transactions would be fully exempt. The Tax Foundation
estimates that the FairTax would reduce compliance costs by 90
percent--more than any other tax plan. In addition to reducing
compliance costs, The FairTax would reinstate the principle
that Americans have a right to understand the law to which they
are subjected.
In sum, AGC believes that the FairTax is good for
construction and good for America. We strongly support this
proposal and urge Congress to seriously consider the FairTax as
a replacement to our current tax code maze.
ADDITIONAL DISCUSSION:
Construction is as vital to our economy as it is has been
to our historic growth as a nation. While statistics are always
moving targets, there were 487,783 construction firms in 1997.
Total civilian employment based on IRS records was 142,836,000;
construction directly accounted for more than 6.1 million
civilian employees who paid salary and wages of $28 billion.
There were $593 billion in total receipts. Construction firms
had assets of $315 billion in 1997, broken down roughly as
indicated below.
[GRAPHIC] [TIFF OMITTED] T1879.025
What is Wrong with Our Tax System?
Apart from paying high direct and indirect taxes, our
current tax regime places disproportionate burdens on
construction, stemming from the unique nature of the our
industry as a capital intensive, long-term, high-risk and often
family-owned and operated effort.
Through the income tax, behavior that is essential to
building--work, saving and investment--is punished. High
marginal tax rates weaken the link between effort and reward.
Multiple layers of taxation on work, saving and investment
reduce capital for new investment. A regressive levy of payroll
and self-employment taxes frustrates expansion. Finally,
although families own most construction firms, estate taxes (at
rates as high as 55%) due at death prevent owners from passing
their firms on to their children.
While construction is inherently capital-intensive, firms
are hampered by the capital gains tax, which doubly taxes
investment income while punishing losses which cannot be
predicted. Capital gains taxes discourage reinvestment to keep
businesses growing and operations competitive. Moreover,
because the industry is largely investment and reinvestment in
capital assets over many years, capital gains can result more
from inflation than appreciation, even when a firm is sold.
The tax system through inadequate capital cost recovery
allowances, the alternative minimum tax and the passive loss
limitations, makes investment in structures more expensive and
reduces demand for structures being built.
The cost of capital will fall, enabling construction firms
to make greater investments in productivity and inducing
further infrastructure investments and allowing their customers
to make greater investments in structures and other products of
the construction industry. The construction industry is capital
intensive, requiring large investments in heavy equipment. For
instance, a 150-ton crane used in bridge construction can cost
more than $1 million. A scraper can cost $700,000 and a large
bulldozer can cost more than $800,000. By eliminating the
capital gains taxes and any tax on investment and savings, the
FairTax will enable contractors to make the needed investments
in equipment and supplies before tax, not with what remains
after the government has exacted a toll.
The FairTax would exempt the poor from paying any federal
income, payroll or sales tax altogether. In fact, this means
that poor people that spend less than the poverty level amount
on taxable goods and services will enjoy a negative tax rate.
For three quarters of Americans, payroll taxes are a larger
burden than income taxes. Payroll taxes are imposed from the
first dollar of wage income earned, although the earned income
tax credit mitigates this burden to some degree. The AFT plan
would repeal the Social Security and Medicare payroll taxes
The sales tax imposes tax on the private use of economic
resources, not on social use. When an individual buys a good or
service for personal consumption purposes, he will pay tax.
When that money is used for a social purpose such as investing
in a job producing plant, conducting research to develop new
technologies or find new medicines or is given to a charity,
the individual will not pay tax. If an investor liquidates his
investments to fund consumption, a tax is imposed.
Virtually all economic models project a much healthier
economy if a national sales tax replaces the current tax
system. These models typically project that the economy will be
10 to 14 percent larger in 10 years.\2\ Real investment also
will spike upward. Harvard University economist Dale Jorgenson
forecasts that ``real investment would leap upward. As a direct
result of this dramatic increase in real investment, the
capital stock will rise as well. Kotlikoff forecasts that by
the fifth year after replacement, the capital stock will be
eight percent larger. By the 10th year, the capital stock will
be 15 percent greater. Over the long run, the capital stock
will be a full 29 percent larger than under the current income
tax regime.\3\
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\2\ See, ``The Economic Impact of Fundamental Tax Reform,'' Dale W.
Jorgenson, Testimony before the House Ways and Means Committee, June 6,
1995; ``Looking Back to Move Forward: What Tax Policy Cost Americans
and the Economy,'' Gary Robbins and Aldona Robbins, September, 1994,
Policy Report Number 127, Institute for Policy Innovation; ``The
Economic Impact of Taxing Consumption,'' Laurence J. Kotlikoff, April
15, 1993, Cato Institute Policy Analysis. Also see ``The National Sales
Tax: Moving Beyond the Idea, Tax Notes, March 21, 1996, David R. Burton
and Dan R. Mastromarco.
\3\ Kotlikoff also simulated an economy in which income taxes at
all levels of government were replaced by a comprehensive retail sales
tax and found that the stock of U.S. capital would increase by as much
as 49 percent.
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The federal tax will point the direction to sound state
sales tax policy Many state sales tax schemes improperly tax
business inputs and therefore cascade. When states repeatedly
tax purchases between and among firms, all firms are
disadvantaged, but especially disadvantaged are small firms.
The more small firms are utilized in the chain of production,
the more the enterprise--from raw materials to consumption--the
more they will pay in taxes. Under such an ill-advised scheme,
a company has every incentive to vertically integrate, rather
than contract out--even if contracting out were more efficient.
The normal tendency of small firms who have struggled under
such cascading tax schemes would be to associate this negative
characteristic with all plans that are called ``sales'' taxes--
even a national sales tax. However, the AFT believes it wholly
inappropriate to adopt a system that has cascading taxes. If a
business buys a good or service from another business, such a
purchase would not be taxed. Since no business to business
inputs are taxes, and no profits or income is taxed, businesses
pay an effective rate of zero.
While these are the highlights, there are more advantages.
Hidden taxes would become visible and more difficult to raise.
By placing the tax on the receipt for consumer purchases and by
repealing upstream taxes, it would convey the true cost of
government to every American on each purchase they make. This
not only adds integrity to the tax system, but it will also
keep taxes lower.
One of the best attributes of the FairTax is that it will
cause a drop in interest rates and reduce the carrying costs of
debt. Under the FairTax, conservative estimates predict that
mortgage interest rates will fall by 25 to 30 percent or about
two points on a 30-year conventional mortgage. To put this in
the context of housing, for a $150,000 thirty-year home
mortgage at an interest rate of 8 percent the monthly mortgage
payment would be $1,112.64. On that same mortgage at a 6
percent interest rate the monthly payment would be $907.64. The
two-point decrease in interest rates in this instance would
result in a $73,800 cost savings to the consumer.
Conclusion
The true tax reform debate will not take place in
Washington. Rather, it will take place at the grass roots
level. A consensus is growing that America can and must adopt a
better system of collecting the revenues necessary to fund the
federal government. Which alternative is best is the question
now on the national agenda. The FairTax would be simple,
inexpensive, understandable, administrable, visible, equitable,
pro-growth and respectful of privacy rights. The AGC has
endorsed the FairTax as the most sensible alternative to a
broken system. We encourage you to help make this tax plan a
reality by becoming actively involved.
Statement of Hon. Jim Barcia, a Representative in Congress from the
State of Michigan
Thank you for the opportunity to submit this statement on
the FairTax national sales tax plan. I am a cosponsor of H.R.
2525--a bill distinguished in its Congressional support by an
equal balance of Democrats and Republicans.
Mr. Chairman, our Congress is one of the most prodigious
legislative bodies in the world, but one would be hard pressed
to find any public law more despised than our Internal Revenue
Code. If we assembled ten different individuals in Bay City or
Saginaw, Michigan--the heart of the Midwest--and asked them
what they thought of the tax system today, we would get ten
different answers. None would be favorable and none would be
incorrect. The answers that I have heard are that our system is
too invasive of our privacy, heavy-handed, too costly, overly
complex, burdensome, punitive, invisible, anti-competitive,
unfair, destructive of our collective and individual
prosperity.
What would the FairTax do for the American people in my
view? It would reduce the wasteful administrative overhead of
our system: record keeping, the cost of advice, the cost of
filling our returns, and the cost of audit. Under any tax
system, we have to have tax collectors and payers. However, the
FairTax would eliminate entirely the collection, record keeping
and reporting responsibilities of individuals. This is much
better than filing a postcard sized return as the flat taxers
boast. In fact, most taxpayers now file a return very similar
to a postcard sized return in the Form of the 1040EZ. Under the
FairTax, 112 million taxpayers can simply let April 15th pass
as a beautiful Spring day. Congress will give them a permanent
extension. No returns, ever. No other tax plan can claim this.
The FairTax would repeal the payroll tax, which is the most
regressive tax of all. It takes a 15.3% bite out of every
single dollar earned, but only applies to the middle class wage
earner; at high incomes it falls to 2.9 percent. Moreover, it
only applies to wages, not dividends and interest.
The FairTax is the plan that will restore the fundamental
notion of fairness, notice of the law, and privacy rights on
which this country was based. Our nation deserves better than
the monstrosity of law we created in the last century. As we
look to the next millennium, we should have a clear vision of
what an ideal tax system should look like. The FairTax is that
system.
STATEMENT OF COUNCIL OF SMALLER ENTERPRISES, CLEVELAND, OH
Good morning Chairman Archer and members of the committee.
Thank you for hosting three days of hearings on Fundamental Tax
Reform proposals. Please allow this document to serve as
written testimony supporting Fundamental Tax Reform and the
Fair Tax, or the national retail sales tax proposal (HR 2525).
This testimony is submitted on behalf of the nation's
largest chamber of commerce. The Greater Cleveland Growth
Association and it's small business division, The Council of
Smaller Enterprises (COSE), represent over 16,000 businesses in
Ohio and over 250,000 lives in its health insurance plan. Based
in Cleveland, Ohio, our health insurance plan was adopted over
25 years ago to give our members, their employees and families
access to high quality, affordable health care benefits. We are
often cited and studied as a national model for health
insurance purchasing cooperatives. We support the Fair Tax
model because it promotes fairness and simplicity, improves the
competitiveness of American businesses, and will increase the
standard of living for the American people.
The Fair Tax plan as introduced in HR2525 (Linder, (R-GA)
and Peterson, D-MN) would repeal the federal personal income,
corporate income, estate, gift, capital gains, self-employment,
payroll, social security and Medicare taxes and replace them
with a 23% sales tax on all new goods and services. This tax
would be collected at the point of final purchase for
consumption. Every taxpayer will be subject tot he same tax
rate with no exceptions and no exclusions. Since the Internal
Revenue Service would be abolished under the Fair Tax plan, the
23% rate is intended to raise the same amount of federal funds
as raised by the current federal tax system. In addition, the
rate is calculated to pay for a universal rebate for essential
goods and services and pay for a fee to retailers and state
governments collecting the tax.
The universal rebate to all registered in the Social
Security system would replace, in effect, the exclusions on
clothing and food, for example, that states make for their
sales taxes. The universal rebate is proposed to be calculated
as the sales tax rate times the poverty level income adopted by
the government for different family sizes.
Proceeds from the Fair Tax would become the primary general
revenue source for the United States government. Social
Security and Medicare would be funded from this revenue stream.
The bill as proposed is estimated to be revenue-neutral for its
first full year in effect. The new tax system will then go into
effect one calendar year after the repeal amendment is
ratified, with a transition phase beginning with the
ratification of the amendment.
The COSE Board of Directors endorsed the Fair Tax on
October 12, 1999 (see attached Resolution). Our members,
primarily entrepreneurs and business owners, agreed that the
current system cannot be reformed. It must be replaced. COSE
believes HR 2525 is a positive non-partisan proposal that will
fix the current system by taxing citizen on what they spend,
not what they earn.
Thus, the time for change has come. Even former IRS
Commissioner Shirley Peterson acknowledged that the current tax
system should be changed. Head of the IRS in 1992, Commissioner
Peterson noted that ``we have reached the point where further
patchwork will only compound the problem. It is time to repeal
the Internal Revenue Code and start over.''
COSE believes there are valuable member benefits to the
adoption of the Fair Tax. Employees will be able to take home
their entire paycheck. Businesses will not have to pay capital
gains, payroll, income taxes or many other taxes which hurt
business growth. The elimination of the estate tax burden will
help family businesses grow. Finally, more capital will be
available to business owners since investment will not be
taxed.
On behalf of over 16,000 businesses in Ohio, we urge you to
support the Fair Tax proposal. COSE believes it is the most
sensible method to revise our current complex and ever-changing
tax code. Thank you for your time and consideration.
Attachment is being retained in the Committee files.
Statement of Herman Cain, Godfather's Pizza, Inc., Omaha, NE
Thank you Mr. Chairman and members of the committee. I
appreciate the opportunity to testify before your committee
about fundamental tax reform. I am Chairman of Godfather's
Pizza, Inc.
The current tax system is broken and no amount of tinkering
around the edges is going to fix it. It is too complicated. It
is too unfair. It holds people down economically. It destroys
hope and opportunity. It needs to be replaced.
A replacement system should satisfy six principles. First,
it should promote economic growth by reducing marginal tax
rates and eliminating the tax bias against savings and
investment. Second, it should promote fairness by having one
tax rate and eliminating all loopholes, preferences and special
deductions, credits and exclusions. Third, it should be simple
and understandable. Fourth, it should be neutral rather than
allowing the government to manipulate and micromanage our
economy by favoring some at the expense of others. Fifth, it
should be visible so people understand their actual tax burden
and so it clearly conveys the true cost of government. Sixth,
it should be stable rather than changing every year or two so
people can plan and so the system remains simple and
understandable.
In my view, there is more than one plan that would satisfy
these principles to varying degrees. There is more than one way
to vastly improve over the current tax system. One proposal
that would be highly constructive is the flat tax. It would
improve the tax system in all six areas. I, however, have
concluded that the FairTax, introduced on a bi-partisan basis
by Reps. Linder and Peterson as H.R. 2525, meets the six
principles that I outlined.
The FairTax would repeal individual income taxes, corporate
income taxes and the estate and gift tax. It is the only
proposal to repeal all payroll taxes (including Social
Security, Medicare and self-employment taxes). These taxes are
a regressive tax on jobs and upward mobility and it is time to
address them. The FairTax would replace these taxes with a 23
percent national retail sales tax on all goods and services
sold to consumers.
Individuals would no longer file tax returns. April 15th
would be just another day. Businesses would collect and remit
the sales tax. In addition, the FairTax would provide every
household in America with a rebate of sales tax paid on
necessities.
The FairTax would encourage Economic Growth
A national retail sales tax would significantly enhance
economic performance by improving the incentives for work and
entrepreneurial activity and by raising the marginal return to
saving and investment. Entrepreneurs and small business owners
would be given greater access to capital, the life blood of a
free economy. Investment would rise, the capital stock would
grow, productivity would increase and the output of goods and
services would expand. The economy would create more and better
paying jobs for American workers and take-home pay would
increase considerably.
Although the magnitude of the economic growth generated by
a flat rate, neutral tax system causes lively debate among
economists, virtually all agree that the large marginal tax
rate reductions in the FairTax combined with neutral taxation
of savings and investment, will have powerful positive effects
on the economy.
The FairTax would be Fair
The FairTax would provide every household in America with a
rebate of sales tax paid on necessities. Thus, the FairTax is
progressive and every family is protected from tax on essential
goods and services. Because of the rebate, those below the
poverty line would have negative effective tax rates and lower
middle income families would enjoy low effective tax rates.
The burden of paying the FairTax is fairly distributed. It
is, in fact, much more fairly distributed than the income tax.
Wealthy people spend more money than other individuals. The
FairTax will tax them on their purchases and as a result, they
pay more in taxes. If, however, they use their money to build
job creating factories or stores, or to finance research and
development to create new products, (all of which help improve
the standard of living of others), then those activities will
not be taxed. The FairTax is premised on the notion that it is
fairer to tax individuals when they consume for themselves
above the essentials of life, rather than when they invest in
others or contribute to society.
The FairTax in effect gives a supercharged charitable
contribution deduction because people can give to their
favorite charity free of any income tax, payroll tax or sales
tax. The charitable deduction today allows people to make their
contributions with pre income tax dollars (but after payroll
tax dollars). For the three-quarters of Americans that do not
itemize, most must today earn $155 to give $100 to their
favorite charity or to their church.\1\ Under the FairTax, they
must earn only $100 to give $100 since under the FairTax what
you earn is what you keep and charitable contributions are not
taxed.
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\1\ $155.40 less 7.65 percent in employee Social Security ($11.89)
and Medicare payroll taxes less 28 percent in federal income taxes
($43.51) leaves $10,000.
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Education is one of the keys (along with savings and hard
work) to an improved standard of living. That certainly was
true in my case. The FairTax is education friendly and is
dramatically more supportive of education than current law. The
FairTax embodies the principle that investments in people
(human capital) and investments in things (physical capital)
should be treated comparably. The current tax system, in stark
contrast, treats education expenditures very unfavorably.
Education is the best means for the vast majority of people
to improve their economic position. It is the most reliable
means that people have to invest in themselves and improve
their earning potential. Yet the tax system today punishes
people who invest in education, virtually doubling its cost.
Only the FairTax would remove this impediment to upward
mobility. No other tax reform plan would do so.\2\
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\2\ Neither the flat tax nor the USA Tax would remedy the current
bias against education.
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Today, to pay $10,000 in college or private school tuition,
a typical middle class American must earn $15,540 looking only
at federal income taxes and the employee payroll tax.\3\ The
amount one must earn to pay the $10,000 is really more like
$20,120 once employer and state income taxes are taken into
account.\4\
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\3\ $15,540 less 7.65 percent in employee Social Security ($1,189)
and Medicare payroll taxes less 28 percent in federal income taxes
($4,351) leaves $10,000.
\4\ Economists generally agree that the employer share of payroll
taxes is borne by the employee in the form of lower wages. This figure
assumes that employees bear the burden of the employer payroll tax and
that they are in a seven percent state and local income tax bracket.
$20,120 less $5,634 in income tax (28 percent), $3079 in payroll taxes
(15.3 percent) and $1,408 in state and local income taxes (7 percent)
leaves $10,000.
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The FairTax does not tax education expenditures. Education
can be paid for with pre-tax dollars. This is the equivalent of
making educational expense deductible against both the income
tax and payroll taxes today. Thus, under the FairTax, a family
will need to earn $10,000 to pay $10,000 in tuition, making
education much more affordable (not considering state income
taxes on education). The FairTax makes education about half as
expensive to American families compared to today.
The FairTax would improve upward mobility but no longer
punishing work, savings, investment or education. It would
better enable people to improve their lives. It would no longer
hold people back.
The FairTax would be Simple
The FairTax is a simple tax. Individuals who are not in
business would have absolutely no compliance burden, nor would
they be subject to the discretionary interpretation of the
current convoluted tax code. As for businesses, it puts much
fewer administrative burdens on businesses. In fact, filling
out a FairTax return is comparable to filling out line one
(gross revenue) of an income tax return. There would be no more
alternative minimum tax, no more depreciation schedules, no
more complex employee benefit rules, no more complex qualified
account and pension rules, no more complex income sourcing and
expense allocation rules, no more foreign tax credit, no more
complex rules governing corporate acquisitions, divisions and
other reorganizations, no more uniform capitalization
requirements, no more complex tax inventory accounting rules,
no more income and payroll tax withholding and the list goes
on. Businesses would simply need to keep track of how much they
sold to consumers.
Compliance costs will, therefore, fall under the FairTax.
Today, according to the Tax Foundation, we spend about $250
billion each year filling out forms, hiring tax lawyers,
accountants, benefits consultants, collecting information
needed only for tax purposes and the like. These unnecessary
costs amount to about $850 for every man, woman and child in
America. To the extent these costs are incurred by businesses,
they must be recovered and are embedded in the cost of
everything that we buy. The money we spend on unnecessary
compliance costs is money we might as well burn for all of the
good it does us. The Tax Foundation has estimated that
compliance costs would drop by about 90 percent under a
national sales tax.
The FairTax would be Neutral
Under the FairTax all consumption would be treated equally.
The tax code punishes those that save and rewards consumption.
Under the FairTax, no longer would the tax system be in the
businesses of picking winners and losers. The tax code would be
neutral in the choice between savings and consumption, neutral
between types of savings and investment and neutral between
types of consumption.
The FairTax would be Visible
The FairTax is highly visible, and because there is only
one tax rate Congress would be raising the rate on all
taxpayers at the same time. Moreover, all citizens would be
subject to the tax increase, not just a targeted few. It will
be much harder for Congress to adopt the typical divide-and-
conquer, hide-and-disguise tax increase strategy it uses today.
The FairTax would explicitly state the contribution to the
Federal government each and every time a good or service is
purchased.
The FairTax would be Stable
The FairTax would be more stable than the present system
for two reasons. First, because it is so simple and
transparent, it would not invite tinkering in the way that the
current system with its thousands of pages of code and
regulations does. People will resist attempts to make it more
complex and attempts to favor special interests because they
will understand what is going on. Second, taxing consumption is
a more stable source of revenue than taxing income. There are
fewer ups and downs in the consumption base.
A recent study showed that for the years 1959 to 1995, the
FairTax base was less variable than the income tax base. Why?
When times are unusually good, people will usually save a
little more. People tend to smooth out their consumption over
their lifetime. They borrow when young, save in middle age and
spend more than their income in retirement.
Impact on Restaurants and Retailers
I would like to discuss briefly the impact of the FairTax
on my industry, restaurants in particular and retailers in
general. The FairTax could have a positive impact on these
industries.
Like other firms, retailers will enjoy a zero corporate tax
rate and their shareholders will not be taxed on dividends
received from the retailer or capital gains on their investment
in the retailer. Compliance costs could be lower. Moreover,
over time, most states will conform their sales taxes to the
federal sales tax, reducing the costs of complying with
multiple rules in each state and their political subdivisions.
If people are willing and able to purchase more goods and
services in a healthy economy, then they will spend more money
at retailers and eat out more. There is nothing that hurts
restaurants more than a slow economy and nothing that helps
them more than a good economy. In this sense, the FairTax could
help restaurants and retailers.
Consumption is taxed once under both an income tax and a
national sales tax. Consumption purchases must be made from
after-income-tax and after-payroll-tax dollars today. The
primary difference between a sales tax and an income tax is
that the income tax double or triple or quadruple taxes on
savings. Consumers will see their paychecks increase by nearly
two trillion dollars. Since the FairTax is not a tax increase
but is revenue neutral, the repeal of the income and payroll
taxes will provide consumers with the money necessary to pay
for the sales tax.
Instead of having to comply with the complexities of the
income tax, payroll tax, and various other taxes, there will be
one sales tax on all goods and services. The firm will simply
need to calculate on a monthly basis its total retail sales.
Retailers will receive an administration fee for complying with
the sales tax. The fee is equal to < of one percent of the
revenues collected and remitted.
In summary, this is what the Fair Tax could mean for
retailers:
No more uniform inventory capitalization requirements;
No more complex rules governing employee benefits and
retirement plans;
No more tax depreciation schedules;
No more complex tax rules governing mergers, acquisitions
and spin-offs;
No more international tax provisions;
No more income tax or payroll tax withholding;
No more employer payroll tax; and
No more corporate tax.
I would also point out that restaurants in particular have
grave concerns that any national sales tax would treat
restaurant food differently from food purchased at a grocery
store. Food consumed away from home is no longer a luxury, it
is an essential part of the American lifestyle. The FairTax
would not discriminate between the two.
Conclusion
People want to be able to dream and to pursue their dreams.
As Dr. Benjamin E. Mays, late President Emeritus of Morehouse
College said, ``It isn't a calamity to die with dreams
unfulfilled but it is a calamity not to dream.'' The current
tax system not only destroys the ability of people to achieve
their dreams, it causes many people to give up dreaming
altogether.
We need a better tax system--a tax system more appropriate
for a free society. The current tax code can not be reformed to
achieve the stated objectives, it MUST be replaced. Please use
the power of the Congress to correct a tax code that has simply
gotten out of control and taken away people's freedom.
STATEMENT OF HON. RALPH M. HALL, A REPRESENTATIVE IN CONGRESS FROM THE
STATE OF TEXAS
Thank you for allowing me to submit my testimony to the
Committee on Ways and Means on the important subject of
reforming our nation's tax system. I am a cosponsor of H.R.
2525, the FairTax Act of 1999, legislation introduced by our
colleagues, John Linder and Collin Peterson.
H.R. 2525 would repeal the federal income tax in its
entirety, including all individual, corporate, payroll taxes,
self-employment taxes, capital gains, gift and estate taxes. It
would impose a revenue neutral national sales tax on all new
goods and services at the point of final consumption. Most
importantly, the FairTax would provide for a rebate in an
amount equal to the sales tax on essential goods and services.
No American would pay taxes on their purchase of these
necessities.
Mr. Chairman, I support H.R. 2525 because it is fair to all
Americans, it eliminates the complexity of our current system,
it encourages savings and investment, and it is a much more
efficient way to raise federal revenues than the current
system.
Under the FairTax, every taxpayer starts out on a level
playing field. There are no advantages to be gained by gaming
the system. Those who profit from the current complexities in
our tax code by sheltering income will no longer have an unfair
advantage. Essentially, all taxpayers will make their own
decisions about how much in taxes they will pay, in that they
are only taxed when they purchase a product.
The FairTax would help improve the economic security--and
thus the standard of living--for most Americans because it
rewards savings and investment. Today, our country has one of
the lowest rates of savings in the world. Under H.R. 2525, our
rate of savings should dramatically improve because the money
Americans choose to save or invest will no longer be subject to
any tax. This economic incentive to save should result in more
taxpayers saving and investing in our economy. Additionally,
lower income families also will benefit because they will be
able to keep all of their paycheck, without any costly tax
deductions.
Finally, Mr. Chairman, the FairTax is a tax that every
American can easily understand. It eliminates the enormous
complexity that is inherent in our current tax system while
providing a stable and efficient means to raise the necessary
revenues to fund federal programs. And most importantly,
because it is so understandable, H.R. 2525 will help restore
integrity to our country's tax system.
I urge this committee not only to review the FairTax and
other proposals that will be discussed during these hearings,
but also to act to change forever a system that is overly
burdensome, impossibly complex and inherently unfair. In short,
our current system does not work for the average taxpayer. Mr.
Chairman, the hearings this week are critical if we as policy
makers are serious about restoring confidence in the federal
tax system. I welcome this debate of the various proposals to
reform our present system, and I thank you for holding these
hearings.
STATEMENT OF JOSPEH M. KAHN, STANFORD UNIVERSITY, PALO ALTO, CA
Thank you for the opportunity to contribute to these
hearings on replacing the income tax. I am providing this
statement on behalf of the Stanford University Decisions and
Ethics Center. From 1996 to 1997, I had the privilege of
coordinating a team of economic researchers within the
Decisions and Ethics Center analyzing the impact on households
of a change from the current income tax regime to the National
Retail Sales Tax (NRST) proposed by the group Americans for
Fair Taxation. This proposal is now embodied in H.R. 2525.
Herein, I present the main findings of our study. The study
was based on the 1996 income tax code, and assumed that the tax
regime change would take place in 1998. Though the income tax
code continues to change each year and the proposed date of
changeover to the NRST remains in the future, I would not
expect any major changes in the study's general conclusions.
1. Summary of Main Findings
The Decisions and Ethics Center at Stanford University
investigated the impact on households of a change from the
current tax regime to the national retail sales tax (NRST)
proposed by Americans for Fair Taxation. Under this proposal,
all federal income and payroll taxes would be repealed, federal
revenues would be replaced by the NRST at a (tax-inclusive)
rate of 23%, and all families would be granted a rebate for the
amount of taxes paid at the federal poverty line. Our study
focused on individual families over their remaining lifetimes
rather than statistical aggregates in a single year. Our
analysis yielded several major conclusions regarding the impact
on families of a change to the NRST tax regime.
The current tax code is complex and there is probably no
change which can guarantee that everyone would be better off.
However, we find that most families would enjoy higher real
lifetime consumption under the NRST than under the current
regime. This is due to several factors, including lower tax
burdens on many households, lower compliance costs, lower
marginal tax rates, and increased economic growth and
efficiency.
Some wealthier seniors may experience a reduction in
purchasing power under the NRST. However, their own financial
well-being may not be the only issue they consider in their
decision to support a particular tax regime. Other factors,
such as the effect on their grandchildren or on the poor, may
take precedence in their decision.
This statement highlights the following points:
Incentives to work and to save tend to be higher
under the new regime--over 20% higher for many households. This
is primarily due to the replacement of high marginal income tax
rates with a flat rate on consumption.
Middle-class families tend to be financially
better off under the change. A combination of factors including
lower compliance costs, lower marginal tax rates, and increased
economic growth and efficiency contribute to improve their
prospects.
Existing homeowners tend to benefit under the
change, despite the removal of the mortgage interest deduction.
This is because existing owner-occupied homes would increase in
value, while existing mortgages would become more affordable.
Low-income families tend to be significantly
better off financially under the change. They would effectively
pay none of the national sales tax under the change because
they would receive rebates which cover the amount of taxes paid
at poverty level. In addition, any federal benefits they
receive would be indexed to match possible increases in after-
tax consumer prices.
Younger households tend to be financially better
off after the change, benefiting from improved economic
conditions over their entire careers.
Middle-and lower-income seniors tend to do better
financially under the change. Social security payments would be
indexed to a tax-inclusive price index, holding recipients
harmless against any changes in after-tax prices. Additionally,
the NRST rebate would more than make up for any losses in
after-tax purchasing power of pension benefits for these
seniors.
Some wealthier seniors would tend not to benefit
from the redistribution of the tax burden. This is because
wealthier seniors have a larger portion of financial assets
whose after-tax purchasing power may decline under the new
regime. However, for many seniors the removal of income taxes
from asset earnings and retirement account disbursements, the
exclusion of their existing homes from the NRST, and the repeal
of the estate tax would more than make up for any initial loss
in asset values.
Considered over a lifetime, the progressivity of
the NRST would be similar to that of the current income tax
regime. The progressivity of the NRST would be achieved through
use of a rebate and replacement of regressive payroll taxes.
2. Study Methodology
Our goal was to translate the economic effects of a change
in the tax regime into understandable impacts on individual
households. Traditional methodologies, which examine
statistical averages for a single year and aggregate very
different households, lack vital data and often do not reveal
important and key information.
In our analysis, we focus on specific households,
considering the impact of the actual tax code. Further, we
examined households over their entire remaining lifetime rather
than focusing on a single year. Examining a variety of family
profiles, we develop critical insights into the effects of a
change in the tax regime. We then varied individual household
characteristics and economic assumptions to ensure that our
conclusions are robust.
Taxes affect the household either directly, or indirectly
through the economy (see Figure 1 below). Direct taxation on
the household includes individual income taxes (including the
earned income tax credit), property taxes, and the employee
portion of payroll taxes.
Indirect taxes are collected from businesses (including
corporate income taxes, the employer portion of the payroll
tax, sales and service taxes, excise taxes, and corporate
property taxes). Businesses serve as intermediaries between
workers, investors, and consumers. So all indirect taxes and
other costs on business are ultimately paid by households:
through reduced wages and benefits, lower investment returns,
and higher prices. Economists cannot agree about how the
indirect tax burden is allocated among these three economic
activities. However, it is certain that all indirect taxes and
other costs are ultimately paid by households.
[GRAPHIC] [TIFF OMITTED] T1879.018
Figure 1. All Taxes Fall on Households
In addition to the visible tax revenues collected by
government, there are several effects of taxation which are
hidden, or less visible. These include seigniorage (the
inflation tax), compliance burden of the tax code, economic
distortions, and slower economic growth.
Our method accounted for the combination of direct,
indirect, and hidden taxation in an integrated framework.
Differences in direct taxes were computed by applying the tax
code to a household's financial situation, directly affecting
the funds available for investment and consumption. Changes in
indirect and hidden taxes were distributed to household
economic activities of work, investment, and consumption. The
taxes' magnitude and incidence result in changes to the after-
tax market prices, wages and investment returns available to
the household.
Resulting changes in the household's annual finances lead
to different levels of real consumption and investment, which
carry through to affect the household's finances over its
remaining lifetime. These changes are then integrated to
produce a summary measure of the effect on a household's
remaining real lifetime consumption.
3. Economic Assumptions
We compared the effects on real lifetime consumption of
replacing the 1996 Federal Income Tax code with the National
Retail Sales Tax proposed by Americans for Fair Taxation (AFT).
Throughout, we attempt to match AFT's proposed tax rate of 23%
(tax-inclusive) \1\ on all final goods and services, to exclude
from taxation any resale of existing consumer-owned housing,
and to include a rebate to all families based on federal
poverty levels for a given family size. We have also followed
AFT's proposal that Social Security is indexed to a consumer
price index which includes the NRST.\2\
---------------------------------------------------------------------------
\1\ A tax-inclusive rate is used for easier comparison with the
current income tax rates, which are for gross (tax-inclusive) income. A
23% tax rate on gross sales corresponds to a 30% tax rate on net sales.
The middle federal income tax bracket in 1996 was 31% of gross income,
corresponding to a 45% tax rate on net income.
\2\ In figure 2, the solid line represents Cleavers who have chosen
never to purchase a home. Only Cleavers with combined average career
income above about $40,000 per year are considered homeowners in this
graph.
---------------------------------------------------------------------------
We should note that we analyzed only law-abiding
households, those attempting to comply with the actual tax
code. Our conclusions would not remain valid for households
engaged in criminal enterprises, or otherwise able to evade
their current income taxes.
Our base case economic assumptions include a 3% inflation
rate under the status quo (with nominal tax brackets indexed
for inflation), incidence of direct taxes entirely on the
household, employer payroll taxes incident on workers,
corporate income taxes incident on investors, an NRST
distributed two-thirds to consumers and one-third to factors of
production (divided between workers and investors by their
value share in the economy), a 2% increase in economic
efficiency (real purchasing power) from lower compliance costs
(i.e., significantly less resources used to deal with filing
complex income tax forms), a 1% increase in economic efficiency
from other economic effects such as lower marginal tax rates,
and a minor 0.05% increase in real wage growth under the NRST
due to effects such as increased investment.
We tested variations in these base case assumptions to
ensure the robustness of our results. We found that perhaps the
most significant change in the level of improvement for many
families is if the replacement tax rate is changed. Replacing
the current income tax with a consumption tax, one might expect
at least the modest macro-economic improvements mentioned above
at any revenue-neutral tax rate. However, at the time of this
analysis there was some uncertainty as to the rate. A lower or
higher tax rate would obviously lead to either a better or a
more modest improvement (respectively) in most families' real
life-time consumption than is calculated at 23%. For low-income
families, any differences from the base case results tend to be
small, as a proportionately-changed rebate makes up for any
change in the NRST tax over the bulk of their expenditures.
Differences would be more marked for middle and higher-income
families, though the shape of graphs and general conclusions
that we present would remain valid over a range of possible
rates.
4. Effects on Typical Households
We began our study with an analysis of the finances of a
typical middle-class family--the ``Cleavers.'' The Cleavers are
a married couple, aged 40. They own their home and are
struggling to meet their mortgage payments while raising their
two children (ages 10 and 11). Both parents are employed
outside of the home. Some key financial information about the
Cleavers is shown in Table 1 (below).
Table 1
The Cleavers' 1998 Household Financial Snapshot (in 1996 dollars)
------------------------------------------------------------------------
Budget Item Amount
------------------------------------------------------------------------
Household Gross Wages $46,439
Taxable Investment Earnings $615
Visible Income, Employee Payroll, ($10,686)
and Property Tax Burden
Mortgage Payments ($8,385)
Charitable Contributions ($471)
Other Household Consumption ($24,453)
(excluding Value of Employer-
Provided Health Care Plan)
Remaining Income for Savings $3,060
Value of Employer-Provided Health $4,800
Care Plan
Employer Contribution to Tax- $929
Deferred Retirement Savings Plan
------------------------------------------------------------------------
In Figure 2 (below), we find that families with the
Cleavers' household profile would be financially better off
under the NRST regime. Even over a wide range of incomes from
poverty level, about $16,000 per year for the Cleavers' family
of four, to the higher income levels families with this profile
would be better off than under the current income tax regime.
A combination of factors including lower tax burdens, lower
compliance costs, lower marginal tax rates, and increased
economic growth and efficiency would allow middle-class
families like the Cleavers to enjoy higher real lifetime
consumption under the NRST than under the federal income tax.
Effect on Homeowners
One issue of concern to many middle-class households is the
effect of the change on the value of their homes. Because the
sales tax would apply only to new homes, the market value of
owner-occupied homes would increase under the new tax regime
(to the point where newly constructed homes would not be
disadvantaged from the viewpoint of prospective home buyers).
Also, homeowners with fixed-rate mortgages would find it easier
to make their mortgage payments under the NRST regime. This is
because if enough of the NRST falls on consumers, after-tax
consumer prices would rise to some extent. So mortgages could
be paid off with less valuable dollars.
[GRAPHIC] [TIFF OMITTED] T1879.019
Figure 2. Lifetime Improvement under NRST for the Cleavers*
It is also possible that mortgage interest rates would
decline, which would further benefit existing and prospective
homeowners (though this effect is not included in our base case
analysis). Since many middle-aged families already own their
homes and tend to have substantial outstanding fixed-rate
mortgages, they would be relatively better off under the NRST
regime. Figure 2 (above) illustrates the relative improvement
of current homeowners.
Variations with Income
Low-income Households
A critical factor in examining low-income households is the
status and amount of government subsidies (including transfer
payments) that they receive. These include Supplemental
Security Income and food stamps.
The working poor not receiving government subsidies tend to
be better off under the NRST regime. This enhancement of their
financial condition is due to the rebate system, which
effectively exempts the working poor from paying any of the
NRST. The repeal of the payroll tax allows this group to take
home their entire paycheck and avoid the substantial payroll
taxes (less earned income tax credit) that they face under the
current federal tax system. They are also relieved of the
indirect effects of replaced corporate income and payroll taxes
that currently decrease their wages and increase the prices
they pay as consumers. Figure 3 (below) illustrates the
improvement that would be experienced by low-income families
with other characteristics similar to those of the Cleavers.
[GRAPHIC] [TIFF OMITTED] T1879.020
Figure 3. Lifetime Improvement under NRST for Low-Income Cleavers
Currently, most government transfer payments (such as food
stamps, Supplementary Security Income, and Medicaid) are
indexed for inflation. It is possible that these transfer
payments would be indexed to an after-tax consumer price
indicator (CPI) that includes the NRST. If so, families would
receive both indexed transfer payments and the NRST rebate.
Figure 4 (below) illustrates the improvement under the NRST
for the ``Lowes,'' a low-income family with four children. The
Lowe household receives enough government subsidies each year
to bring them to 100% of poverty line consumption (about
$22,000 annually for the Lowe family of six). A combination of
rebate and full indexing of benefits would lead to substantial
financial improvement for low-income families like the Lowes.
In effect, indexing benefits to a CPI that includes the NRST
would over-compensate for the change, as the rebate alone
already reimburses the entire tax. Even if their subsidies were
indexed to a CPI that only partially or not at all included the
national retail sales tax, the rebate effectively exempts these
families from the NRST, ensuring that they would still be
roughly even or financially better off. Under welfare reform
that occurred after this study took place, we expect that those
families with household gross wages averaging in the lowest
range of figure 4 over their entire remaining careers would be
unusual cases.
[GRAPHIC] [TIFF OMITTED] T1879.021
Figure 4. Lifetime Improvement under NRST for a Low-Income Family
Receiving Government Subsidies
High-Income Households
Working households with higher incomes would no longer be
subject to progressively higher marginal income tax rates, and
tend to improve under the NRST regime. The top end of the
Cleavers' graph in Figure 2 illustrates their improvement.
6. Variations with Age
We found that age is an important factor in determining the
effect of the NRST on households.
Young Households
Younger households, as illustrated by the ``Juniors,'' tend
to be financially better off after the change. The Juniors are
a married couple, aged 25. They both work, and hope to buy a
home and start a family someday. They are just now beginning
their careers, and would experience most of their working lives
under the new regime.
A combination of factors including lower compliance costs,
lower marginal tax rates, and increased economic growth and
efficiency would allow younger families like the Juniors to
enjoy higher real lifetime consumption under the NRST than
under the federal income and payroll tax regime. Figure 5
(below) illustrates the improvement in lifetime consumption for
the Juniors over a wide range of income levels.
[GRAPHIC] [TIFF OMITTED] T1879.022
Figure 5. Lifetime Improvement under NRST for a Young
Family
Elderly Households
The ``Seniors'' represent a typical retired couple. We find
that the impact of the NRST depends critically on the amount
and composition of their savings. Because the sales tax applies
only to new homes, the value of the elderly's home equity tends
to increase under the new tax regime. Also, portfolios with a
higher proportion of their wealth in tax-deferred status (such
as in IRAs and ``401(k)'' plans) and in unrealized capital
gains would do relatively better under the NRST, since these
holdings would no longer be subject to federal income tax.
Some wealthier seniors would tend not to benefit from the
redistribution of the tax burden. This is because wealthier
seniors have a larger portion of financial assets whose after-
tax purchasing power may decline under the new regime.
However, for many seniors the removal of income taxes on
asset earnings and retirement account disbursements, and the
exclusion of their existing homes from the NRST, along with the
repeal of the estate tax more than make up for any initial loss
in asset values. Most elderly couples with moderate or limited
financial resources would be significantly better off under the
NRST (see figure 6). The rebate in place would already cover
all taxes on essentials (including some formerly hidden-taxes
built-in to today's prices). Provisions to fully index Social
Security for any increase in after-tax consumer prices would
then more than compensate for any loss on these families'
modest savings. And for those households with estates over
$1,200,000, the removal of estate taxes could more than make up
for any loss of the estate's purchasing power.
Figure 6 shows these effects on the Seniors for a wide
range of net worth (including home equity and private pension
funds). As a point of reference for this figure, the median
family net worth for a household whose head was between 65 and
74 years of age in 1992 was listed as $103,600 (Federal Reserve
Bulletin , October 1994). This suggests that the majority of
seniors are described in the lower range of wealth in figure 6,
and would experience considerable improvement under the NRST.
[GRAPHIC] [TIFF OMITTED] T1879.023
Figure 6. Lifetime Effect of NRST for the Seniors under a Range of
Financial Profiles at Retirement
While some wealthier Seniors may experience a reduction in
purchasing power, their own financial well-being might not be
the only issue they consider in their decision to support a
particular tax regime. Factors such as the effect on their
grandchildren or on the poor may take precedence in their
decision.
7. Effects on Marginal Tax Rates
Under the NRST regime, marginal tax rates on work and
savings would be substantially lower for many households,
increasing their incentives to work and save. This is primarily
due to the replacement of high marginal income tax rates with a
low flat rate on consumption.
We measured the incentives to work, computing the
additional (after-tax) real goods and services that a household
could consume by working additional hours. For example, suppose
that the Cleavers are contemplating working an extra hour a
year for each year over the course of their remaining careers.
And suppose that after all taxes under the existing tax regime,
they could purchase a total of 4 pairs of shoes with their
additional pay. If, under the NRST, they could instead purchase
5 pairs of shoes for that same extra work, then their marginal
incentives will have increased by 25%.
Figure 7 (below) shows that although the marginal
incentives may decrease for some low-income households, a broad
range of households experience significantly increased
incentives. Incentives to work rise by over 20% for many
families, depending on their earnings. On an economy-wide
level, these improved incentives would lead to higher economic
growth and efficiency.
[GRAPHIC] [TIFF OMITTED] T1879.024
Figure 7. Effect on Cleavers' Marginal Incentives to Work
8. Regressivity Analysis
There is a common perception that consumption taxes are
regressive, which would be supported in a myopic single-year
analysis of the tax system.
The argument is that:
In a given year wealthy people save a higher fraction of
their income than poor people, so the wealthy would pay a lower
fraction of their income in consumption taxes.
However, a lifetime analysis reveals that most or all of
the saved income of a household is eventually consumed in
retirement or by the heirs, at which time it is subject to the
consumption tax. So over a lifetime, a consumption tax--without
a rebate--is roughly flat across income categories.
Under the NRST, a consumption tax is combined with a rebate
which refunds all taxes up to poverty-level consumption. This
clearly makes the NRST a progressive tax.
9. Conclusions
Because the combination of the current tax code and
government subsidies is extremely complex, there is probably no
change that can guarantee everyone to be better off. But under
the National Retail Sales Tax proposed by Americans for Fair
Taxation, several factors would allow most families to enjoy
higher real lifetime consumption than under the current federal
income and payroll tax regime.
These factors include:
a rebate which would keep the amount of taxes paid
by most households similar to or lower than the current income
tax regime, and would effectively exempt low-income households
from the NRST,
indexing of Social Security, which would
effectively hold recipients harmless against possible after-tax
price increases,
lower compliance costs,
lower marginal tax rates, and
increased economic growth and efficiency
Some wealthier seniors would tend not to benefit from the
redistribution of the tax burden. However, their own financial
well-being might not be the only issue that wealthier seniors
consider in their decision to support a particular tax regime.
Other factors, such as the effect on their grandchildren or on
the poor, may take precedence in their decision.
I would like to again thank the committee for the
opportunity to contribute this testimony. Additionally, I
should like to recognize a number of individuals that were
helpful in this effort. This research has benefited from
discussions with William W. Beach, Dale W. Jorgenson, James M.
Poterba, and Gary Robbins. David R. Burton and Laura D. Dale
have contributed a number of questions and valuable
discussions. I am grateful for the dedicated assistance of
Roberto Szechtman and Ellynne T. Dec, along with Decisions and
Ethics Center research assistants J. Eric Bickel, William F.
Carone, Alexis G. Collomb, Jeffrey D. Cornwell, George K.
Ferguson, Kenneth B. Malpass, and Marcia F. Tsugawa. Our
lifetime model and methodology are an extension of work by
Stephen M. Malinak, Frederick V. Giarrusso, and Jeffrey K.
Belkora, along with suggested improvements from Paul B. Skov,
James M. Knappenberger, Derek D. Ayers, and Michael M. Reeds.
Special thanks to Elizabeth C. Brierly for editing large
portions of this report. Research guidance was provided by
Frederick V. Giarrusso and Center Director Ronald A. Howard.
The Decisions and Ethics Center gratefully acknowledges help
from those volunteers, and a gift from the National Tax
Research Committee that enabled this research effort.
Sincerely,
Joseph M. Kahn
Statement of Bert Loftman, M.D., Atlanta, GA
Mr. Chairman and Members of the Ways and Means Committee:
My name is Bert Loftman, and I am a physician based in
Atlanta, Georgia. I
greatly appreciate the opportunity to present testimony
regarding the impact of the FairTax on the US health care
delivery system. I am privileged to be the only witness
testifying on this subject. I can assure you that I speak for a
great many physicians with whom I have discussed the FairTax. I
am hopeful that, at some point, there will be formal resolution
by the physician groups. Attached to this written testimony is
a paper of mine from 1994 titled, ``Health Care Reform, An
Historic Perspective.'' This will supplement what I say here.
During the past few years, Congress has wrestled with the
many problems inherent with our current health care system, and
for good reason. The costs of health care delivery have
escalated exponentially. While it is often argued we have the
best heath care in the world, we have a selective system. Too
many Americans are without health care.
What are the root causes of this and how do you, as
policymakers, address these causes? I suggest that one of the
key causes is our tax system that separates the health care
recipient from the real costs of health care. In doing so, we
hold health care up as one of the few major U.S. industries
that is not responsible to consumers. To turn a phrase, our
health care system is in the intensive care unit.
What are the problems? To begin with, this system has
driven up the costs of health care. In 1965,health care was 5
percent of the U.S. economy. Now it has risen to over 15
percent. There are rising numbers of uninsured. These number
about 40 million or 15 percent of the population. For them,
individual health insurance is very expensive. They must
compete with the third party payer systems of employer-based
health insurance and Medicare. In the private and governmental
sectors, most people have employer-based-insurance. They face
the portability problem, where they must change insurance plans
when they change jobs. They also face the job lock problem
where they remain in unsatisfactory jobs because of the health
insurance coverage in their current jobs.
A few years ago, the third-party payers paid the providers
of health care with traditional fee for service or indemnity
insurance. Now they pay with a system known as managed care.
With this system, the insurance companies make what they
consider the appropriate health care choices. The problem is
that many patients would rather choose the quality of their own
health care and this dissatisfaction has led to political
unrest. Many health care reform discussions center about moving
away from employer-paid health care.
One way is a single payer system; but those countries with
socialized medicine are experiencing many difficulties. To
date, this has not been a popular solution in the US. Another
way is to use the income tax codes to offset the employer-based
health care exclusion that began during World War II. I refer
you to a paper that I wrote a few years back on the history of
how this occurred. These tax code changes include tax equity
where the income tax exclusion of employer-paid health care are
removed or individually paid health care receives the same
treatment. Another innovative way is medical savings accounts
that Congress legislated with the Kennedy-Kassebaum Bill. These
have not proved as popular as the proponents predicted. A major
reason was the many restrictions that were placed upon them.
Enter the FairTax into this debate. It is true that The
Fair Tax would greatly impact the U.S. health care system.
However, first we should consider what it would not do. The
Fair Tax is designed to be revenue neutral and would make no
changes in Medicare or Medicaid. It would leave intact the
federal safety net for the elderly and the indigent. Most
importantly, I believe, The Fair Tax would remove the income
tax exclusion that employer-based health care now enjoys. This
would not require employers to drop their benefit of health
care coverage. However, the incentive for health care coverage
would no longer be exclusively employer-based.
What would the FairTax do? More people would likely begin
to choose individually-based health care coverage. They would
probably choose non-cancelable policies. This would help bring
down the numbers of uninsured as people retained their
individually owned health insurance policies, even when they
were sick. As people chose individually owned health insurance,
the insurance industry would begin to respond with more
individually based insurance policies. People would likely
begin to look more favorably at low cost non-managed care
insurance policies. In other words, they would begin to favor
catastrophic insurance policies.
Of course, there is tax-free savings for health care and
other wants. When people have savings, they can begin to see
the advantages of low cost catastrophic coverage. This would
begin to connect people to the cost of their own health care
and this would begin to bring the cost of health care down.
Thus the Fair Tax would not only move us away from employer-
based healthcare with its portability and job-lock problems;
the Fair Tax would likely also lower the cost of health care
and bring down the number of uninsured. Regarding managed care,
individuals would own their own policies and have a choice of
whether they had prepaid managed care or catastrophic indemnity
insurance coverage.
Congress also wrestles with Medicare and its problem of
escalating costs.When Congress legislates to control these
costs, it fosters patient and physician unrest. This is because
when Medicare makes the choices, it is a form of rationing.
Consider that in 1965 when Congress enacted Medicare, many
people retired without health care coverage because most was
employer-based. They also retired without adequate savings
because the income tax is anti-savings. Under the FairTax,
people would begin to retire with individually owned
catastrophic health care coverage. Perhaps with the Fair Tax,
many people would choose not to change their health care
coverage when they retire.
The Fair Tax would not solve all the problems of the U.S.
healthcare delivery system, and I don't want to leave this
impression. Many people would still choose not to obtain health
care coverage. However, we must compare the FairTax to the
present system and not to an ideal. We must only ask if it
helps us get to the idea. In reality, there would likely be
less uninsured than the current 40 million people without
coverage. Many people would probably still prefer a corporate
health care system that manages their care. If so, the Fair Tax
does not discourage this.
The FairTax would likely effect the US health care delivery
system in a way that would lower costs, decrease the numbers of
uninsured, help alleviate the portability problems, give
patients choice and defuse the politics of our health care
system.
I would make a suggestion regarding professional or trade
organization as the American Hospital Association, the American
Medical Association, the American Nurses Association, the
American Pharmaceutical Organization, etc. These organizations
heavily lobby Congress but they have been silent on the impact
of taxation on the health care delivery system. Congress should
ask them to study this issue and poll their members so they can
take a stand on tax reform as health care reform.
A physician's first duty is to do no harm. I believe it is
the job of Congress to do the same. Our current US health care
system of employer-based health care does great harm. I hope
that when you ponder HR 2525 with its Fair Tax and repeal of
the 16th Amendment that you consider its favorable impact on
the health care delivery system.
Attachment is being retained in the Committee files.
STATEMENT OF DANIEL J. MITCHELL, HERITAGE FOUNDATION
I wish to thank the committee for the opportunity to
testify. The views I express are my own and do not necessarily
reflect those of The Heritage Foundation.
Mr. Chairman and members of the committee, the current tax
code of the United States is irreversibly broke and should be
repealed. The tax laws undermine the country's prosperity by
imposing needlessly harsh venalities on work, savings, and
investment. Many taxpayers face confiscatory tax rates and
often are forced to pay more than one layer of tax on their
income, while the politically well-connected can take advantage
of special deductions, credits, preferences, shelters, and
loopholes to minimize their own tax liability. The result of
this double standard is a tax system that not only penalizes
productive behavior, but also violates the fundamental
constitutional principle of equal treatment under the law.
For both moral and economic reasons, the current code
should be replaced by a single-rate, consumption-based tax. The
good news is that there are two major plans that meet these
criteria: the flat tax and the national retail sales tax.
Replacing the current system with either--but not both--of
these two taxes immediately would restore the principle of
fairness to the tax system because both would treat all
taxpayers equally. Both the flat tax and a national sales tax
would replace today's discriminatory tax structure with a
single low rate. In addition, either plan would eliminate the
current tax code's bias against savings and investment and
promote the kind of capital formation that America needs to
boost workers' incomes and ensure long-term economic growth. In
addition, because both tax reform proposals would be simple to
administer, the ultimate result would be a dramatic downsizing
of the Internal Revenue Service (IRS) bureaucracy and billions
of dollars in compliance costs saved each year.
How is it that these different types of taxes could produce
such similar results? The answer lies in the fact that the flat
taxed and sales tax are almost identical in purpose and
principle. Both rest on the fundamentally should principle that
all income should be taxes at one low rate and only one time
(what is known as a ``consumption base''), and that the tax
should be collected in the last intrusive way possible. The
only significant difference between the two is the collection
point. A flat tax is collected up front, imposing a single
layer of tax on income when it is earned, and a sales tax
imposes one layer of tax when the income is spent. In both
cases, income is taxes, but only once and presumably at a very
low rate.
WHAT DO THE FLAT TAX AND A NATIONAL SALES TAX HAVE IN
COMMON?
Most taxpayers assume that the flat tax and a national
sales tax are radically different ways to fund the federal
government. Because one tax is collected from the paycheck and
the other is collected at the cash register, this assumption is
understandable. Yet by almost every standard, the flat tax and
a national retail sales tax represent two sides of the same
coin. The common features of the flat tax and national sales
tax are:
A single flat rate. Under both plans, income is
taxed at one low rate. This would ensure that the government
treated taxpayers equally and would address the problem of high
marginal tax rates. The single low rate would promote faster
economic growth by minimizing tax penalities on work, risk-
taking, and entrepreneurship.
Adoption of the flat tax or a national sales tax
also would end the discriminatory treatment caused by a tax
code that grants preferences or imposes penalties on certain
behaviors and activities. Either reform would change the code
so that all taxpayers--and all income--are treated the same
under the law.
WHY THE FLAT TAX IS A CONSUMPTION TAX
To many Americans, consumption taxes are those
collected as the cash register--such as the state sales tax--or
value-added taxes like those they might encounter on a trip to
Europe. The national Retail Sales Tax, needless to say, is an
example of a consumption-based tax. Yet it also is possible to
collect a consumption tax through an income tax structure. This
s why economists and public finance experts consider the flat
tax a consumption tax. Why? Because, unlike the current tax
code, a flat tax does not impose greater penalities on income
that is saved and invested that on income that is consumed. A
tax code that does not discriminate against savings and
investment is considered a consumption-based tax system,
regardless of whether taxes are collected at the paycheck or at
the cash register. In this respect, the flat tax is a version
of a consumption tax.
WHY DOUBLE TAXATION IS DETRIMENTAL
To understand double taxation, consider a taxpayer who has
410 of disposable after-tax income. That taxpayer has a choice;
either to spend the income immediately or to defer consumption
by investing it. Consuming the money immediately yields $100 of
benefit immediately, but investing it would yield a return that
could allow the taxpayer to consumer, say, $115 a year from
now. The decision to invest obviously varies according to
individual preferences about the value of consumption today
compared with consumption in the future, but let us assume a
taxpayer would be willing to give up $100 of consumption today
in exchange for $100 of consumption one year later. In this
example, of course, the taxpayer will choose to invest. In
addition to making the taxpayer better off in the future, this
decision also has a desirable impact on the economy by
increasing capital.
Today's system of multiple taxation, however, undermines
capital formation. If the government decides to tax the return
earned on the $100 investment, the hypothetical taxpayer in the
above example may wind up sacrificing $100 of consumption today
to gain only $105 in after-tax consumption one year from now.
Fewer individuals under this scenario would choose to invest,
opting instead for immediate consumption and thereby depriving
the economy of their capital. In addition, under today's
system, taxpayers can look forward to paying two additional
layers of tax on this $100 investment; capital gains and death
taxes. Double taxation, therefore, significantly undermines
savings,investment, and future economic growth, and--because
every economic theory, even Marxism, acknowledges that capital
formation is the key to faster growth and higher wages--is
particularly self-destructive.
WHAT ARE THE BENEFITS OF A SINGLE-RATE TAX SYSTEM?
Fairness. The tax code is riddled with
discrimination. They are right. The government either imposes
tax penalities or grants tax preferences depending on the
source, use, or level of income. All of these special
provisions violate the principle that all citizens should be
treated equally by the law. The flat tax and a sales tax would
restore fairness in the system by ensuring that all taxpayers,
all income, and all products are treated the same.
Economic growth. Both the flat tax and a sales tax
would minimize the tax rate imposed on productive behavior and
eliminate the myriad forms of double taxation in the current
code. Consequently, either one would boost the economy's
potential growth rate and cause permanent increases in economic
output. How much the economy would benefit is not easy to
predict, but many economists project that, within 10 years, the
economy would be 5 percent to 10 percent larger than it would
be under the current tax structure.
Higher incomes. A low tax rate increases the
incentives to work and the desire to work longer hours. Tax
reform also makes workers more productive because companies
would be more willing to invest in upgrading their production
capabilities,giving their employees better machinery, tools,
equipment,and technology. As the attached chart illustrates,
this capital-drive increase in productivity is tied closely to
higher wages.
Job creation. Tax reform also will make employees
more valuable to business, thereby increasing wages for those
already working and stimulating the creation of new jobs. The
combination of lower taxes and faster growth will make it more
profitable to hire certain workers particularly those with low
skill levels who previously may have been considered
unemployable.
Increased wealth. The value of income-producing
assets (everything from stocks and bonds to office buildings
and pet stores) is determined by market expectations of future
income discounted by inflation, risk, and taxes. Once a lower
tax rate rate is put in place, whether through the flat tax or
a national sales tax, and double taxation is eliminated,
income-producing assets will become more valuable (that is,
there will be an increase in the present value of the future
after-tax income stream generated by those assets).
Savings and investment. Tax reform to eliminate
these penalties on capital formation would increase the
incentives to save and invest. Moreover, a flat tax or sales
tax would make the United States a magnet for capital from
around the world.
Lower interest rates. Tax reform will reduce
interest rates between 25 percent and 35 percent, according to
a study published by the Kansas City Federal Reserve Bank.
Lower compliance costs. Because both the flat tax
and a national sales tax would eliminate the bewildering
complexity of the current system, tax reform would slash the
$157 billion annual costs of complying with personal and
corporate income taxes.
Smaller IRS, more civil liberties. The current tax
code gives the IRS sweeping, virtually unlimited power to
monitor people's lives, track their assets, and review their
expenditures. Although neither the flat tax nor a national
sales tax can be expected to rid the United States of the IRS
or eliminate every possible conflict with the government, the
dramatic simplification that either reform would bring about
would significantly reduce the size, scope, and power of the
IRS bureaucracy.
Less political corruption. The tax code today is
the result of 97 years of special deals, loopholes, and
preferences. Each one of these loopholes benefits a special
inters. The flat tax or a national sales tax would remove from
the tax system the corrupting process of exchanging loopholes
for political support.
No social engineering. One of the most attractive
features of both the flat tax and a national sales tax is that
politicians no longer would be able to use the tax code for
purposes of social engineering. The flat tax would eliminate
all the biases and preferences in the income tax, and a sales
tax is designed so that all products and services would be
taxes at exactly the same rate.
RESPONDING TO THE CRITICS OF TAX REFORM
Criticism: Implementing a national sales tax would
create the risk that the United States might end up like
Europe, with both income and consumption taxes.
Response: Advocates of a national sales tax
properly vow that complete and irreversible elimination of the
income tax must occur before such a plan can be enacted. The
only certain way to prevent future politicians from pulling a
bait-and-switch on a trusting public, however, would be to
amend the Constitution by repealing the 16th Amendment, which
gives Congress the power to impose an income tax, and expressly
forbidding direct taxes or income. This presumably would mean
the abolition of Social Security and Medicare payroll taxes as
well.
Criticism: Neither the flat tax nor the sales tax
will capture the entire underground economy.
Response: This is true but meaningless. A drug
dealer is not going to report his income under the flat tax and
certainly will not collect taxes on the ``products'' he sells
under a national sales tax system. But the current system does
not capture this money either, so this argument hardly serves
as a reason to reject ax reform. At the very least, the flat
tax and a national sales tax would reduce the level of tax
evasion by people who are trying to protect their income from
unfair and excessive taxation today.
CONCLUSION
The current U.S. tax system is an unmitigated nature. On
both economic and moral grounds, the tax code should be
repealed and replaced with a system that treats all taxpayers--
and all income--fairly and equally. Both the flat tax and a
national sales tax satisfy this standard, and both would
improve the economy's performance substantially.
Because plans for the flat tax and a national retail sales
tax are so similar, lawmakers have no reason to champion one at
the expense of the other. Advocates of tax reform would seek
instead to highlight the benefits and similarities of the two
plans, and, when the opportunity arises, rally behind the one
that has garnered more political and popular support.
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STATEMENT OF NATIONAL FEDERATION OF INDEPENDENT BUSINESS
Introduction
The irony of tax reform is that even as it proponents have
grown more insistent, the tax code itself has simply grown.
It's larger and more complex today than when Hall and Rabushka
first offered their ideas to the world. So while others may
argue the relative merits of a flat income tax verses a
national sales tax, NFIB has focused its attention at the real
problem for America's small business owners--the current IRS
Code.
The fact is, the current income tax code is far too
complex. The tax code is a quagmire of confusion that forces
taxpayers to bear tremendous costs just to comply with it--
about $200 billion annually, or $700 for every man, woman, and
child in America. Consider this: There are 7 million words in
income tax laws and regulations. There are 703 tax forms. There
are 101,295 pages of IRS laws and regulations. The IRS sends
out about 8 billion pages of forms and instructions each year,
the equivalent of paper made from 293,760 trees, according to a
1995 study. The amount of paperwork the IRS receives each year
would circle the Earth 28 times. One billion 1099 forms are
mailed each year tracking interest and dividend income. The
private sector pays $250 billion just to comply with income tax
laws. The average cost of compliance for small-and medium-sized
corporations is $7,240 for every $1,000 in taxes they pay.
Nearly 60 percent of all taxpayers seek assistance to file
their tax returns each year, more time than it takes to build
every car, truck, and van produced in the United States. When
Money magazine asked 46 professional tax preparers to calculate
a hypothetical family's tax return in 1997, they responded with
46 different answers. As Albert Einstein once said, ``the
hardest thing in the world to understand is the income tax.''
The fact remains that real tax reform will not occur at the
same time the tax code is expanded and complicated even
further. We need to abolish the current code first and then
replace it with a code that offers lower taxes, encourages work
and savings, is fair to all taxpayers, foregoes social
engineering, contains no hidden taxes, and is difficult to
change.
Small Business and the Tax Code
So why are small businesses leading the charge to scrap the
IRS Code? The answer is simple. Small businesses--more than any
other segment of our economy--are the favorite target of the
IRS Code and the IRS. When tax reformers raise the issue of tax
code complexity, they are talking about the burden placed on
America's small businesses.
Most taxpayers don't even itemize. They receive their W-2
form, take the standard deduction, and send in their 1040EZ.
But all small business owners find themselves buried under the
most complex areas of the tax code. An while big corporations
have the luxury of accounting offices and high priced tax
professionals, many small business owners still file their our
returns. Any way you slice it, it's America's small businesses
that shoulder the brunt of tax code complexity.
Tax Code Complexity and Small Business
Small businesses historically pay about one-tenth the
income taxes collected by the federal government. That was
about $60 billion in 1994. But the burden of the tax code on
small businesses is much higher.
THe Center for the Study of American Business reported
small firms with fewer than 20 employees spent more than $5,000
per employee in 1992 to comply with federal regulations.
Paperwork costs alone--mainly comprised of tax-related
paperwork--cost these small firms more then $2,000 per
employee, or twice as much as the paperwork costs imposed on
firms with 500 or more employees.
Why are small businesses disproportionately affected? One
reason is that the most complex parts of the tax code are
targeted directly at small business owners. Take, for instance,
this example:
The individual Alternative Minimum Tax is a remarkably
complex and obtuse provision in a tax code not known for its
clarity. It literally requires taxpayers to calculate their
taxes twice, and then pay the larger amount. Compared to the
regular income tax, the MAT imposes lower marginal tax rates on
a broader income base. It's sort of a perverse ``Flat Tax.''
Who did Congress have in mind when it created the AMT?
American's small business. Of the AMT's 27 different
adjustments and so-called tax preference items--deductions
disallowed or reduced--16 are business related. Keep in mind,
we're talking about the individual Alternative Minimum Tax.
(Corporations have their own ATM.)
How complex is the AMT? Line 8 says, ``Enter the difference
between regular tax and AMT depreciation.'' That means small
business owners have to recalculate the value of their
depreciation allowances using either ``the straight line method
over 40 years with the same mid-month convention used for the
regular tax'' or the ``straight line method over the property's
class life with the same convention used for the regular tax''
or the ``150 percent declining balance method, switching to the
straight line method for the first year it gives a larger tax
deduction, over the property's class life.'' All depending on
the type of property involved, of course. And they have to do
this calculation for every depreciable asset they own!
Understand? Neither do small business owners. There are 26
other adjustments necessary to calculate AMT taxable income.
Worse yet, the AMT has the side effect of hitting taxpayers
when they can least afford the bill. A business suffering from
lower-than-expected revenues is more likely to fall into the
clutches of the AMT than a thriving business. The AMT literally
kicks a small business ``when it is down.'' As your cash flow
goes down, you AMT tax bite goes up!
The current tax code is full of ``AMTs.'' Depreciation
schedules, death taxes, accounting methods--all fall heaviest
on the individual with business-related income.
The only solution America's small business owners have to
these problems is to eliminate the 101,295 pages and seven
million words of IRS rules and regulations which make up the
current IRS code. Scrapping the IRS tax code is one of NFIB's
top tax priorities.
What Should the New Code Look Like?
Although NFIB is not promoting a specific replacement tax
plan, NFIB proposes the following Seven Points of Principle
that should be considered when developing a new tax code fair
to small business:
Lower Taxes--to create jobs and opportunities
Fosters growth--encourages work and savings
Fair--for all taxpayers
Simple enough--all taxpayers can understand
Neutral--no ``social engineering''
Visible--no hidden taxes
Stable--difficult to change
Some have asked to move beyond these seven principles and
outline what sort of tax code small businesses would like to
see. Here are some additional guidelines from surveys of our
members, and the results from the Small Business Summit NFIB
held in June of 1998:
Reduce the Overall Tax Burden
Any discussion of tax reform should only be held within the
context of an overall tax cut. Revenue neutrality destroyed
whatever benefits may have been derived from the 1986 Tax
Reform Act. We should learn our lesson and not be shackled into
thinking we have to raise Peter's taxes to cut Pauls. By
embracing a tax cut as part of reform, we can minimize the
concerns raised about winners and losers.
Moreover, this principle wraps up fairness and complexity
all in one. If all income and/or consumption were taxes at the
same rate, then much of the perceived unfairness of the current
system would be eradicated. Furthermore, distinctions between
types of income--earned, unearned--disappear, making the code
much less complex.
One important note is to observe that the single rate
principle should not exclude two-tiered plans--like Senator
Ashcroft's plan--that take payroll tax rates into
consideration. While the Ashcroft plan ostensibly includes two
rates--10% and 25%--taxpayers only see a single unified (income
plus payroll tax rates) of 25% on their income. Taken as a
whole, taxpayers still face just one marginal rate.
Tax Income Only Once
When tax reformers talk about ``fostering growth'' through
the tax code, they really mean reducing the current tax on
investment and savings. Right now, the tax code is biased
against savings and investment because it taxes investment
incomes twice or three times.
Here, we have growth and complexity together. Taxing income
once means eliminating death taxes. That reform alone would
make a dramatic improvement in reducing tax code complexity and
riaising economic growth. It also means eliminating the double
taxation of interest and dividends. There is overwhelming
evidence regarding the negative relationship between taxes on
cabins and investment and economic growth. As taxes on savings
go up, economic growth does down.
Visible to All Taxpayers
This is an ``anti-VAT'' principle, pure and simple. The VAT
is uniformly hated by small businesses because it is a hidden
tax. They've seen the damage the VAT has done in Canada and
Europe, and they fear the same results here in America. Back in
1985, we asked our members, ``Do you favor or oppose creation
of a value-added tax as a replacement for the current income-
tax system?'' Six out of ten said ``No.'' Our members voted
against the VAT because the fear it would be used to
supplement, rather than replace, the current income tax code. I
believe the case against the VAT has strengthened since then.
Conclusion
``Reckless'' and ``irresponsible'' are the works President
Clinton used to describe our plan to abolish the IRS tax code.
With all due respect to the President, what is truly
irresponsible is a tax code that is anti-work, anti-savings,
and anti-family. What's reckless is continuing to live with
seven million words that such the life right out of our
economy.
President Clinton has indicated that small-business owners
want to create ``fiscal anarchy'' by scrapping the code and
then figuring out what to do next. Bust small employers
understand that sometimes the old law must be put to rest
before a new law can take its place. The time for fundamental
tax reform is now!
NFIB thanks the Committee for focusing on this and
listening to the views of America's economic engin--small
business.
STATEMENT OF NATIONAL GRAIN TRADE COUNCIL
The National Grain Trade Council appreciates this
opportunity to provide its views on the recent adverse
international activities related to Foreign Sales Corporations
or FSCs.
The mission of the National Grain Trade Council is to
advocate and protect the principles and merits of open and
competitive markets for the production and distribution of
agricultural commodities. The National Grain Trade Council
represents commodity exchanges, boards of trade, national
marketing associations and more than 40 individual agribusiness
companies.
The Issue
As you know, the World Trade Organization has ruled against
the United States use of the Foreign Sales Corporation (after
15 years of use) labeling it an illegal subsidy. The WTO
Appellate Body upheld this Panel ruling. The WTO labeling of
the United States use of FSCs as a subsidy has resulted in
adverse rulings related to the United States Agreement on
Agricultural Exports. Under World Trade Organization
procedures, the United States is expected to withdraw the
illegal subsidy by October 1, 2000.
History
This problem has previously required Congress' attention
and time. The United States began using a Domestic
International Sales Corporation (DISC) in 1971. The purpose of
the DISC was to allow United States exports to be more
competitive by adjusting the level of taxes on exports to be
more like those of our competitors. As discussed below, the
U.S. has to compete with countries that do not tax any economic
process beyond their borders (a territorial process) while U.S.
corporations are subject to income tax on their worldwide
income. Additionally, the countries with a territorial process
employee a value added tax (VAT) and charge the VAT on imported
goods and services but exempt or rebate the VAT on exported
goods and services. This is the root of the unfairness.
In 1972 the European Communities requested dispute
settlement consultations regarding the DISC measure, alleging
that the DISC constituted an export subsidy. The United States
also requested consultations with France, Belgium and the
Netherlands contending that if the DISC measure were an export
subsidy then the tax exemptions provided by those countries for
foreign-source income were also export subsidies. The Panels
found that both the DISC measure and the European tax systems
had characteristics of an export subsidy prohibited under the
General Agreements on Tariffs and Trade (GATT) of 1947. This
dispute went on for many years.
In 1984 the United States replaced the DISC provisions with
the FSC provisions. The United States enacted the FSC in
response to a 1981 decision of the Council of the General
Agreement on Tariffs and Trade providing that countries need
not tax foreign-source income, including income from export
transactions, and the failure to do so does not constitute a
prohibited export subsidy. Acceptance of the GATT Council's
1981 decision by the European Community and the United States,
as well as other parties to the GATT was instrumental to
resolving the more than decade-long dispute between the EC and
the United States. However, in 1997 the European Union again
challenged, through the WTO, the United States use of FSCs
calling them export subsidies.
WTO Ruling
The WTO Appellate Body has ruled against the United States'
reliance on the 1981 GATT understanding and instead uses the
definition of a subsidy where ``government revenue that is
otherwise due is foregone or not collected.'' This in turn has
led the Appellate Body to use the ``but for'' test. That is,
would revenue otherwise be due the government ``but for'' the
enacted tax law.
In other words, if a government chooses to write its tax
laws such that it has no authority to tax economic processes
outside its borders, the foregone revenue is not a subsidy.
Whereas if the government writes its tax laws such that it has
the right to tax worldwide the economic process but chooses
only to tax the economic process that occurs within its
borders, the result is a subsidy. This is clearly form over
substance and results in an unfair playing field for American
exporters.
United States Impact
Without the FSC, American exporters are not able to compete
fairly with exporters of other countries. This inability to
compete will have a greater adverse impact on agricultural
exports than nonagricultural exports. This is due to the very
low profit margins related to agricultural commodities and the
international buyer's view of purchasing the commodity product,
which by its definition is no different than a competitor
product, at the lowest price. We expect this would lead to
lower US agricultural exports resulting in greater domestic
supplies and further depressing US farm prices and the overall
US farm economy.
Real Issue
The FSC is not the real issue. We are really talking about
a trade issue that is fixed through various tax provisions. We
can and perhaps will enact United States tax laws that equalize
the international tax playing field and remain WTO compliant.
That will require time and thoughtful analysis.
What the WTO Panel and Appellate Body are not recognizing
is that there are different economic playing fields in each
country and neither is superior to the other. Tax deductions
and incentives must be viewed in their entirety. All taxes,
both direct and indirect must be accounted for in determining
fairness. Substance and not form must be the basis of comparing
tax systems
Thank you for your attention to this matter.
STATEMENT OF THURSTON BELL, NATIONAL INSTITUTE FOR TAXATION EDUCATION,
HANOVER, PA
Mr.Thurston P. Bell submits the following witness
testimony. Mr. Bell is the Executive Researcher for the
National Institute for Taxation Education. His findings are
hereby respectfully submitted to the committee and contain the
most unique testimony from one of the most qualified advocates
for the people regarding IRS actions and behavior. His appears
to be the lone voice calling for reasoned comunication and
procedural compliance by the Tax Resistance movement and IRS
alike.
Mr. Bell's active investigation and research during the
last seven (7) years includes direct correspondence with the
IRS and intervention on the behalf of individuals whose cases
have previously been the most protracted and belligerent
exchanges between citizens and their government.
He is at the forefront in assisting the growing numbers of
people who have lost all faith in the IRS and the current means
of collecting revenue. This makes him the most moderate and
realistic voice in this arena of Law and Public Policy.
His research and reform efforts have aided the IRS in
identifing and correcting areas wherein complete breakdowns in
procedure had occurred in some IRS districts. He is creidited
with helping the service in some districts achieve renewed
compliance with statutory, regulatory, and published procedures
contained within the agency's Internal Revenue Manual.
Mr. Bell's past efforts and continuing work demonstrate his
good faith intent in providing testimony before the committee.
Furthermore, he is commited to resolving the growing resentment
of ``The People'' for their IRS. This ``Us vs. Them'' mindset
has been exaserbated by decades of IRS activity in complete
disregard of some 25 to 27 clearly delineated procedural
requirments and the agency's denial of the people's
administrative due process rights.
The following expose of the foundations of the problems and
questions that this committee seeks to resolve, must be
considered if the congress wants to truly address and fix the
tax problem, achieve the chairman's goals, and take decisive
action to restore public trust and the appearance of legitimacy
in the taxation activites of the U.S. Treasury Department.
Chairman Archer, and the Honorable Members of this
Committee:
Thank you for your time in consideration of my testimony.
My name is Thurston P. Bell. I am the Executive Researcher with
the National Institute for Taxation Education.
Upon my discovery of this Hearing and its notice to the
Public that all interested parties provided written testimony
for consideration and entry into the Committee's records, I
decided to afford myself of this unique opportunity to
communicate with a body which could affect change regarding a
subject which has absorbed the past 7 years of my life.
I sincerely hope that by sharing my unique experience with,
and exposure to, rarely seen or discussed historical documents,
I will capture the attention of this vigilant Committee and
spark thoughtful consideration of, as well as further inquiry
into, the foundations of taxation and the history behind the
reasoning of the prior Congresses as you debate future taxation
schemes like the National Sales Tax.
It is also my hope that this testimony will further
increase the progressive communication between the U.S.
Congress and a growing dissatisfied and distrusting sector of
the Public that has been denied due process of law by the
Executive Branch's and its revenue collection activities.
The IRS' abusive behavior alone caused the overwhelming
growth in the tax resistance community and a national mindset
of ``tax avoidance'' appears to be spurring the decision to
reconvene these hearings. Therefore, it is time for the two
governing parties (we, the People, and our representatives in
Congress) to come together and consider our separate positions
in order to mediate a reasonable and survivable remedy for
individuals as well as the Public.
Unfortunately, over 30 years of IRS abuse has made the
disenfranchised and disaffected citizenry notably belligerent.
Since animosity is so pervasive in the growing Tax Resistance
sub-culture of our society, a mindset fed by the convoluted and
seemingly endless conspiracy theories proffered by assumed
leaders within this ``movement,'' the voice of these
individuals and their ``leaders'' must be precluded from these
reasonable and civil hearings. Subsequently, the other side in
this issue, as embodied in this Committee, is doomed to
continue to grope for some way to reduce tensions and preserve
the Public Peace without coming to a full understanding of the
root cause of the tensions inflamed in the populace.
Therefore, in an effort to move this Committee forward to
some resolution of action that will be meaningful to all
Americans, I am providing this testimony to span this
communication chasm between the two sides.
As I understand, this Committee hopes to draft a law that
would create a new means of economic stabilization, without
adversely effecting the fiscal engines of the States,
permanently remove the IRS from the lives of the individuals
that make up the United States of America and, finally, the
income tax would be removed the at the root--so that it never
grows back.
This appears to be a reasonable set of goals for fixing
this problem, yet, to understand how to fix a system that has a
problem, or has become a problem, the system must be understood
and seen for what it is, how it functions, and the purpose for
which it was created.
Economic Stabilization
In 1947, Mr. Beardsly Ruml, who was at that time the
Governor of the New York Federal Reserve Bank, explained our
current system of income taxation before the American Bar
Association. He was also the man who created the system of wage
withholdings from the pay of those receiving wages as the means
of painlessly collecting the income tax.
In Mr. Ruml's speech, he explained that the main function
of the income tax was for the purposes of economic
stabilization, and that none of the money collected as income
tax goes to the operation of government. This full text of his
speech can be read at:
In 1973, as shown in an internal IRS Memorandum of the
Western Regional Offices, the IRS clearly admits, in its upper
echelons of operation, that it understands that the IRS is the
administrative arm of the economic stabilization program.
(see:www.nite.org/docs/croasmun--report.pdf)
There is little doubt that anything has changed the
substantive nature and purpose of the income tax over the past
27 years, as nothing had previously changed in the 26 years
between Mr. Ruml's public admissions and the IRS' 1973 internal
scheming of a plan to avert economic disaster. The looming
disaster began when tens of thousands of people began to claim
``exemption'' from the withholding of income taxes from their
``wages.'' This action on the part of the people threatened to
derail the stabilization program created by Mr. Ruml.
The first point that this Committee must understand, as it
considers any new taxation proposals, is that the income tax is
all about ``stabilization'' of a paper currency that is
inflated by both the spending practices of the U.S. Congress
(in support of a seemingly ever expanding and reaching Federal
Government) and the Banking practice known as Fractional
Reserve Banking.
In short, tampering with the primary means of economic
stabilization system risks the possible extended interruptions
of the currency removal stream. Such an event would adversely
effect the Power of the U.S. Congress, the ability of the
Federal Government to operate and provide for the benefits
granted to American Society, and, finally, the benefits enjoyed
by those controlling and operating the banking sector of our
society.
Considering the function and purposes of the income tax,
there is a very good reason for the Chairman's claim that the
Code is still ``...too complicated and confusinga...'' Such is
the natural result of a system devised: 1) to hide the
existence and exclusive attributes of Blind Trusts; 2) to
complicate the operation of Corporations--the primary income
tax shelter--so that the average individual can not incorporate
and thereby eliminate his exposure to tax liabilities, and 3)
to have a taxation regime that favors special interest groups
and corporations over individuals.
Still, the vital nature of this taxing scheme--economic
stabilization--appears to be the prime reason why the Honorable
Chairman might spend the remainder of his illustrious career in
the U.S. Congress searching for, and yet never discovering, a
solution to the problem of the income tax. He will not be
alone, as Mr. Ruml in his 1947 speech was looking for a way to
eliminate the corporate income tax. He never was able to do
this or claim that it was possible given the realities of paper
money and private benefits received by those in control of the
fractional reserve banking system.
If my recollection of the reports of the 1997 committee
hearings are accurate, then many Economists respected by you,
Mr. Chairman, publicly explained therein the potentially
disastrous effects of a National Sales Tax (NST). The consensus
was that a NST would have to be increased sharply within months
of its implementation in order to keep the economy from
disintegrating, or at least experiencing hyperinflation. It
appears certain that as long as this nation and the Congress
embrace paper money, or a non-intrinsic valued currency, there
will have to be an income tax.
State Fiscal Engines
It has been communicated that the proposals before this
Committee are to be considered in light of how they will effect
the fiscal engines of the State Income Taxes. This is very
important given that many States, like New York and California,
depend upon their Individual and Personal Income Tax systems as
great fiscal engines to operate their local system of
Government. Most of the states' income tax laws are dependent
on the construction and continued survival of the present
Federal Internal Revenue Code.
The income taxes imposed within the several states are
completely dependent upon the Federal Definition of ``Gross
Income'' as found in 26 USC Sec. 61 (the Internal Revenue
Code), and without that statutory definition all of the state
income taxation regimes would fail immediately.
This Committee must therefore take notice that any taxation
regime which might replace and/or do away with the Federal
Definition of ``Gross Income,'' and its active and enforceable
nature and subjugation to the Federal Judiciary, will destroy,
if not greatly hamper the operation of this great fiscal engine
as used by the States.
This leaves any taxation options outside of an income tax
to be untenable at this time.
Intrusion upon the Individual
This present situation is antithetical to the statement of
the Honorable Chairman, that his goal is to end the intrusion
of the Federal government (IRS) into the lives of individuals.
Again, in order to do this, those who deal with the IRS and
work with taxpayers on a daily basis cannot ignore the history
of the systems intrusion, and this committee cannot maintain
any hope of discovering and enacting a viable replacement
without knowing this history.
So far, history shows us that the earliest known instance
of any realization of this intrusion of the Federal Government
into the lives of the individual is found in the Page 37
interview of Mr. W.D. Williamson in the New York Times November
29, 1936 issue.
Mr. Williamson worked with the Social Security Board in the
creation of the Social Security Program. His comments are very
revealing:
``the biggest value of the tax, he added, would be to
introduce the majority of the 26, 000,000 workers to the
``privilege'' of contributing directly and consciously to the
cost of government.
``It will treat them as adult citizens. Able to bear the
thought of contributing to their government, instead of
treating them as children and collecting from them in hidden
taxation.'' He said.
He added that the plan extends Federal income taxes ``in a
democratic fashion'' to the lower-income brackets, the
government at the same time agreeing to undertake the new
function of paying old-age benefits to the taxpayers.''
(emphasis added)
This article and the transcript of its content are posted
at: www.nite.org/ref/ny--times.pdf and www.nite.org/ref/ny--
times.htm
This comment was made in regards to the first income tax to
be placed upon the people, the Social Security Tax, and you see
the government reaching into the lives of every individual,
including those in the lower income brackets.
It is clear from the above noted article that in order for
the Honorable Chairman to reach his worthy goal--getting the
IRS out of the lives of individuals--he is going to have to end
the direct federal taxation of the people--the root cause of
government's intrusion into the citizen's life.
For now, since the income tax is one of the two
foundational pillars supporting the present monetary system,
and thus our economy, the current tax system's reach into our
lives is necessary for the continued operation and health of
the economy that fuels our society and international markets.
Given the realities of the dependency of state taxation
regimes and the stabilization of the currency--both dependent
upon the current taxation of gross income--there appears to be
no end in sight to the intrusion of the IRS in the lives of
ordinary Americans. Therefore, the National Institute for
Taxation Education (NITE) seeks to encourage this Committee to
support, in the strongest terms, the reinstitution of proper
operation of the Treasury Department and the IRS, in the
enforcement of tax laws.
Enforcing the agency's compliance with the laws as written
by Congress will ensure citizens receive the rights and
remedies contained within the Statutes, regulations, Internal
Revenue Manual, and Publications governing the IRS
Administration. If Congress will do this, then the long process
of rehabilitating the agency's reputation with the enraged
citizenry can begin. Such action on the part of the Congress
will deter the agency from continuing its errant intrusions and
allow for the proper and lawful administration of the current
tax system until such time as a viable taxation alternative is
discovered.
This is the area in which the NITE is presently working.
The previous actions of the Congress and Senator Roth's Senate
Task Force indicate that there may be a possibility of
cooperation within government and the IRS. Yet the immense
efforts on the part of individuals have netted very small
reforms within the agency's stilted ``culture,'' as noted by
Former Treasury Secretary Rubin. Therefore, Congress must take
an active role in properly educating its Staff personnel who
handle IRS matters before the People can have any glimmer of
hope that the service will one day soon comply with the law in
every instance involving a taxpayer controversy.
Since replacement of the current system appears to be an
impossibility at this time (and given the parameters of this
Hearing as well as the fact that the IRS and the Congress are
both in need of a rebuilding of the people's confidence on the
matter of taxation) I would encourage this Committee to examine
pervasive culture or mindset noted by former Sect. Rubin, and
endorse the IRS adjusting its operations by making a concerted
effort to reform and comply with the laws and procedures. NITE,
and most of its members, believe that this is the most
reasonable and constructive activity in the interim.
Proper implementation and notification of the public as to
the procedures enacted into law, and as set forth by the
Secretary, will reduce building public tensions and re-
establish legitimacy of the official behavior of the IRS, and
the Congress, in the hearts and minds of the people.
If the People quietly accept that they cannot expect the
laws enacted to be enforced, then the legitimacy of government
will ultimately fail and the economy will soon thereafter
follow. The People are beginning to recognize that there is a
dual issue in the subject of taxation--the stability of Economy
and the Legitimacy of Government.
Even if an alternative ``workable'' tax scheme is
instituted, there is still going to be the matter of Justice
and proper implementation of the law by the IRS. There is a
serious question of whether or not the IRS will be able to
properly enforce and comply with the requirements of a new laws
in the future when it fails so miserably at complying with the
currently enacted laws today.
We must face the fact that the Office of Personnel
Management will most likely recruit its personnel for the new
Revenue Agency from the cadre that worked within the IRS before
its dismantling. Thus the old ``mind-set and culture,'' noted
by former Secretary Rubin a couple of years ago, will be re-
established within the new agency by the re-hiring of the old
IRS employees.
If this mindset and culture transfers to any new taxation
agency, the result may well be a rose being called by any other
name, or in this case a whip. Justice is not endemic to change,
and cannot be assumed to be so.
The Root of Income Taxation
The beginning of reduction in tensions between the people
and the government, without radical change, can only be found
in operating the income tax that we presently do have, within
the present day laws and procedures as written. This is
something that the IRS has failed for decades in doing.
However, the enactment of 1998 Internal Revenue Service Reform
and Restructuring Act opens the door to laws that appear to
force the IRS to follow proper administration. This would not
have come about but for the people and reformers being
supported by the Congress today.
The institution of Justice by present means is as immediate
justice as the law will allow, short of the tax laws complying
with the original precepts of income taxation. Any changes in
the income tax laws should from now on be examined under the
original precepts and criteria of income taxation:
A. The receipt of Benefits; and;
B. The Ability to Pay.
Anything short of these criteria has been deemed, from the
time of the first English Income Taxation Program over North
America, as instituted by George the III, as immoral and
unjust.
Removal and eradication of the Income Tax
It is well understood, and hard to argue against the
Chairman's desire to ``...rip the current tax code out by the
roots so that it can never grow back.'' Yet, the notion of this
gives rise to the realization that the Committee has a very
difficult task before it, as the Congress would have to
initiate the repealing of the 16th Amendment, as well as the
Income Tax, to assure that the Income Tax is never placed upon
the people again.
Only in this circumstance would the people be safe from
income taxation, as the subject to income taxation would return
to the rule of the U.S. Supreme Court in the Pollock case.
Such an action to secure an assurance that the tax would
not return would require a two-thirds vote of both houses and
the States to achieve. There is therefore great doubt that such
could be done. When this difficulty is examined under the fact
that the elimination of the 16th Amendment would also remove
the present day authority of the Social Security Tax in 26 USC
Sec. 3101, which is an income tax, any will of the Congress to
repeal the 16th Amendment should vaporize. The subsequent
political backlash would probably mean that nobody in the
Congress and Senate would be re-elected.
In some ways the difficulty of taking action on this matter
is a good thing. It provides an assurance to the American
People, as it keeps the Congress from doing something brash or
impulsive that would send the economy into shock.
The ``something brash'' I refer to would be best described
as the enactment of a National Sales Tax. Such a tax would have
to grow very quickly to control inflation and our economy would
end up suffering the effects of under-consumption. Or, in the
alternative, if the tax rate were too little, then
hyperinflation would ensue. Historically, National Sales Taxes
cause governments to go into greater debt to their centralized
banks to cover deficits. This is an important point in light of
the private ownership of the Federal Reserve Bank.
In regards to the National Sales Tax, throughout the
current debate I have yet to see any discussion of the fact
that in 1922 congress also considered a national sales tax. The
Honorable Committee might wish to read the reasons leading to
the rejection of this tax. Such a scheme was turned down
apparently due to the severe failure of the French National
Sales Tax that plunged the nation into 4 Billion Francs of debt
to the banks. There is also the fact that the Treasury
Secretary and his friends (the Banking Class Elite who had the
ability to pay) were not paying their income taxes as the
Secretary cried for some tax to be instituted to cover
shortfalls.
It is my understanding that the 67th Congress 3rd Session,
that Congressman James Frear of Wisconsin stated the following
in response to Treasury Secretary Andrew Mellon's urging for
the imposition of a National Sales Tax:
`...both houses presumably felt that the sales tax urged by
you [Andrew Mellon, Secretary of the Treasury and President of
Gulf Oil] was a vicious tax placed upon what both rich and poor
ate, wore, and used, not exempted, and that it was an unjust,
heavy burden to place on the backs of those who grub to make
ends meet, and who were thus asked to bear the rich man's
burden of excess profits you had successfully urged for repeal.
I refer to the vast army you sought to tax, and who have no
income tax to pay, but are glad to eke out a bare existence.
All of these would help disproportionately to pay your proposed
sales tax, whereas if you [Mellon] contribute the income tax
you are properly supposed to pay, as one of the richest men of
the world you would pay into the treasury according to Kline's
estimates on 300 Million dollars of wealth, an annual tax
running well into the seven or eight figures. If any evidence
of a sales tax failure, due to enforce under-consumption is
desired, then the present French National Deficit of 4 Billion
Francs is a warning.
`I do not believe in 'soaking the rich' because they are
rich, but in common with the overwhelming majority who make up
the country a belief exists that taxes should be laid according
to ability to pay, and this is the teaching of every recognized
authority in the history of every prosperous people. Your sales
tax proposal would pinch the poor by taxing their necessities,
and was believed to be unjust and vicious in principle and was
defeated in Committee by a vote of 19 to 5.' ''
What has changed in 88 years since to cause us to return to
considering the siren song of the National Sales Tax? Why does
this Committee, or at least the Honorable Chairman, continue to
posture politically by acting as though there is a solution to
the tax problem short of complete monetary reform?
These proceedings appear to smack of political
grandstanding by both parties for the appeasement of the
evermore-distrusting masses, which are continuing to grow. This
may be a noble and necessary effort in order to keep the Public
Peace, but nothing will replace good faith efforts of this
governmentally omnipotent Congress to assure JUSTICE in the
enforcement of the standing law, and provision of meaningful
administrative due process of law, as set forth by the U.S.
Supreme Court.
Remedial Congressional Actions
There appears to be no immediate solution to the problem of
the Income Tax at this time as there is no ``national will'' to
reform our monetary system or reduce the size of Centralized
Government. Yet these were the fundamental reasons for the
imposition of the income tax and the creation of the IRS--the
most powerful and foreboding agency of the U.S. Government.
In all fairness to the Establishment, I find myself
concurring with the words of Federal Reserve Chairman Alan
Greenspan on the subject of taxation and monetary stability. In
1999, he provided the Congress with two options on what to do
with the opportunities afforded it by the Budget Surplus.
Chairman Greenspan's advice that elimination of the
marginal tax rates, and thus taxation upon the poorest
Americans was one of the most reasonable statements on taxation
and justice that I have seen. I was shocked to see the Fed.
Chairman, an official who I used to see as an adversary,
encourage the U.S. Congress to embrace the opportunity to bring
this Nations Income Tax law into line with one of the two
original tenants of income taxation; The Ability to Pay. To
eliminate the Marginal Tax Rates does not eliminate the income
tax, but then again Mr. Chairman, for 5 years you have been
unable to eliminate the Income Tax. Also, remember, that as
long as there is paper currency, the Congress cannot and will
not eliminate the income tax that is so desperately needed to
keep this monetary system afloat.
What such an action does do, is move the taxation regime to
be directly in line with the original tenants of income
taxation by releasing the poorest of Americans from subjugation
to the complexity of the so far obfuscated IRS Administrative
process. Such an action is in the interest of Justice, which
originally governed income taxation. I say this is, just as the
poor are most often lacking in the educational stature to be
able to adequately defend themselves from IRS Administrative
claims, nor are they able to afford professional and competent
assistance to guide and aid them in prevailing against IRS
claims.
Just the dollar amounts alone, in the face of the cost of a
professional to aid the uneducated person in the defense of
their money creates an appearance that making a defense is a
waste of time and money. This makes for a situation which is
neither fair nor justifiable, and a situation for which nobody
has any will or idea as to how to fix. The elimination of
marginal tax rates is an action would be in line also with the
Chairman's goal of getting the ``...IRS out of the lives if the
American taxpayers.'' It might not free all Americans, but it
will be a start. And who knows, perhaps the savings to the
lower tax rates will trickle up to the middle class in the form
of lower child care costs. It is hoped that this Honorable
Committee finds agreement with the first option given by
Chairman Greenspan, and begins moving towards justice, so that
we will one day reach it. If we do not have justice in this
Society, debts and government programs will soon mean nothing.
A Just tax system is what is best for America. In light of
the 25 procedural and rights violations discovered in the great
majority of tax cases examined by the National Institute for
Taxation Education, the injustice is clear. Nevertheless, NITE
can only wonder as to what reasoning will be used to support
the issuance of new powers to the Treasury Department for a new
tax, when it is so clearly not complying with the laws that the
Congress has already enacted. The greatest fear and trepidation
surrounding this issue of a new tax is that fact that no tax,
once enacted, has ever been repealed.
History will show that those who realized the income tax
would be with us for the foreseeable future also predicted that
the most likely event is that the people will be saddled with
yet another tax on top of the income and sales taxes that
already burden them. At this time, Congress is unwilling to
provide any guarantee to the contrary and unable to muster the
political will to do abolish the income tax, as this would also
require the elimination of Social Security.
Chairman Archer and the Members of this Honorable
Committee, thank you for hearing me and placing my words into
the record.
Thurston Bell,
Executive Researcher
STATEMENT OF JOHN BERTHOUD, NATIONAL TAXPAYERS UNION, ALEXANDRIA, VA
The 300,000-member National Taxpayers Union commends the
Committee for holding additional hearings on fundamental tax
reform.
We have long favored replacement of the current income tax
system with a simple tax that would clear away many of the tax
obstacles to economic growth. Congress can and should consider
many approaches for replacing the current tax law in favor of a
better system.
We understand that the hearings scheduled for this week
will focus on ``tax reform proposals that have been introduced
since the last set of hearings in 1997,'' including ``H.R. 134
by Rep. Phil English (R-PA) and H.R. 2525 by Rep. John Linder
(R-GA) and Rep. Collin Peterson (D-MN).''
For many years our Board of Directors has been on record
that fundamental tax reform can be accomplished by several
different approaches. We have already endorsed the flat tax
introduced by Rep. Dick Armey and the national sales tax
proposal by Rep. Billy Tauzin. In this spirit, we are pleased
to announce our support for H.R. 2525, the FairTax.
We commend Rep. English for introducing H.R. 134. Clearly a
great deal of thought has been put into this proposal, and it
contains many attractive features. We are still studying this
proposal.
The FairTax proposes to replace the entire income tax
system with a simple federal sales tax on new goods and
services sold to consumers. The FairTax would repeal all
federal personal income, payroll, corporate income, self-
employment, capital gain, estate, death, and gift taxes.
The FairTax meets a number of basic requirements of NTU
policy for support of a sales tax, including that the tax
would:
be applied only once and would be visible at the
point of final purchase for consumption;
completely replace all income, death, and gift
taxes;
free individuals from filing tax returns or income
reports with the federal government; and,
ensure fair treatment of low-income taxpayers.
As you know, the imposition of federal personal income
taxes in 1913 has led to a number of economically, politically,
and socially destructive outcomes. Government's obsession with
trapping and extracting revenue from every earned dollar has
spawned high rates that penalize productivity, multiple layers
that punish saving and investing, and hideous complexity that
burdens the economy with over $200 billion in compliance costs
alone.
In the meantime, federal receipts have grown an astonishing
175,000 percent over the past 85 years, making the current tax
system the biggest boon to bloated government in our
nationÕs history. The Tax Code itself has become a
political trading vehicle for rent-seeking special interests,
while more American citizens fear the Internal Revenue Service
as a threat to their civil liberties than any other federal
agency.
If America is to remain prosperous and free in the next
century, the current system of taxation must be scrapped in
favor of an alternative that is simpler, fairer, more visible,
more economically efficient, and less burdensome. The FairTax
proposal would fulfill all of these requirements. Most
Americans would no longer face the anxiety of income tax filing
seasons, as federal taxes would simply be collected from
purchases.
The FairTax offers several unique advantages not offered by
other tax reform proposals.
Taxpayers would get to keep their entire paycheck, pension,
or Social Security benefits without any tax withholdings. Since
the income tax would be replaced by a consumption tax, this
feature would let citizens save money much faster for those
important family needs such as a new home, college education,
or retirement nest egg.
Since the income tax would be eliminated, we could abolish
the IRS along with all individual tax filings. Individuals
would never again have to fear an audit or seizure.
Today's tax system also has enormous hidden taxes, as
documented in a recent study by Bryan Riley for National
Taxpayers Union Foundation. These hidden taxes add as much as
20% to 25% of the price of everything we buy in the stores
today.
The FairTax makes the cost of government fully visible to
all taxpayers. No taxes are hidden in the form of payroll taxes
or corporate taxes. By being aware of the true burden of taxes,
Americans can once again rationally debate the size of
government without having to take politicians at their word.
Another advantage of the FairTax is that it would
completely untax the poor and those who rely on just Social
Security. The FairTax includes a monthly tax rebate to ensure
that all Americans can afford to buy their necessities tax-
free.
That's a stark contrast to the existing tax system that
collects hundreds of billions of dollars in taxes buried in the
cost of things we purchase. Under current tax laws, even
minimum-wage workers pay over 15% from their paychecks for
payroll taxes when you count both the employee and employer
share of the tax.
Another important advantage of the FairTax is that this
reform should be easier to keep intact should it become law. As
you know, in 1986 Congress and the President adopted a tax
reform plan that lowered the top income tax rate to 28%, but it
lasted less than five years, and the top rate today is over
40%.
Since the FairTax would scrap the entire income tax
apparatus, including the IRS, it would be much more difficult
to reimpose an income tax. We also believe that once people get
used to keeping their entire paycheck, pension and Social
Security benefits, they will never want to go back to the old
system.
Congress can and should consider many approaches toward
repealing the current tax law in favor of a better system.
Other proposals for a flat tax or consumption tax would address
many of the problems weÕve outlined, and NTU has
endorsed several such plans. We look forward to debate and
concerted action on the FairTax and other tax system
alternatives in the near future.
STATEMENT OF JOHN B. O'DONNELL, CHULA VISTA, CA
I am pleased the Congress is finally recognizing the
destructive nature of the present personal income tax. There is
the common misconception that the sixteenth amendment
authorized the income tax but as is evidenced by the Supreme
Court ruling in Stanton v. Baltic Mining Co., 240 US 103 (1916)
the sixteenth amendment--
``... conferred no new power of taxation but simply
prohibited the ... power of income taxation from being taken
out of the category of indirect taxation to which it inherently
belonged...``
Unfortunately, court rulings on the tax system have become
so befuddled that courts find in some districts the tax is a
direct tax authorized by the sixteenth amendment while in
others it is an indirect tax that applies only to the exercise
of licensed privileges. Such confusion within the courts should
of itself be sufficient to declare the statutes in violation of
due process for persons of only reasonable intelligence,
without the law expertise one can expect of jurists.
However, because others will undoubtedly present better
arguments on the problems of the present system, I will address
only the issue of economic performance that is affected by this
and other forms of transaction taxes.
The current assumption that some form of consumption tax is
the only alternative to an income tax is disheartening. I have
posted on the internet an analysis entitled Three Steps to
Economic Freedom at: http://www.geocities.com/CapitolHill/1067/
c00r4.html that demonstrates some of the more egregious
fallacies of generally accepted economic premises.
In this pamphlet I describe a ``Monopoly Tax'' that could
also be called a ``Limited Liability License Fee'' that would
provide all needed government finance while imposing no burden
on American citizens. Further, the method actually causes
optimum growth in capital. The details of why this is true are
a bit complex to present in this brief, but the essential
feature of this system is that it effectively changes taxes
collected by government that resolve to ``variable'' costs of
production into costs that resolve to ``fixed'' costs of
production.
Although economists usually recognize taxes that resolve to
fixed costs of production are superior to transaction taxes
that effectively create a ``wedge'' between prices paid by
purchasers and the price received by sellers, they seem somehow
forgetful when it comes to applying this obvious principle to
their tax proposals.
The rationale behind the impost and a demonstration of the
economic effect of its causing growth when properly constructed
is presented in the on line pamphlet. As a brief introduction
of the tax/fee, it is based on the capital value of limited
liability license holders [corporations] with the amounts of
the fee adjusted to maximize the growth rates of their value.
I have calculated an approximation of the tax receipts
using the FY 2000 budget as if it were funded by the Monopoly
Tax. Some obvious compromises must be used since there has not
been the accumulation of empirical evidence that would be
developed as described in the article. However, the scale of
things can be derived from existing data.
First comes an estimate of the asset value that would be
subject to the tax. Using the Wilshire 5000 equity value of
approximately $14.0 trillion and a guess that debt supported by
those equities is $6.0 trillion gives a total subject to the
tax of $20.0 trillion. Although it would be nice to apply the
progressive rates as described in my proposed system, that will
have to wait for the empirical data from actual application.
Lacking that data, consider a uniform [or average] tax rate
of 0.8% per month. While 0.8% per month may appear large to
some, consider that:
1. It is not unusual for the market value of these equities
to increase by more than 1% DAILY.
2. It is also not much different than the charge states
and/or localities charge people for the ``privilege'' of owning
a home.
3. And, if that is not enough to dissuade those who find
the amount excessive, consider that most, or even all, of the
amount to be collected by this tax [Or limited liability
license fee.] would have been paid as income and payroll taxes
``in the name of their employees'' but, because those taxes are
eliminated it becomes just a change in accounting these taxes
that had been called ``wages'' but were never seen by the so-
called wage earner. [There would, of course, need to be enough
time for contracts to adjust nominal wage rates to reflect the
new system.]
For the uninitiated, most personal income taxes and other
payroll taxes are collected by corporations that would instead
pay the monopoly tax while nominal wages [Not after tax wages
which likely will actually increase.] are reduced. In further
note of this consequence, it may be necessary to remind some
that wage rates are not set in a vacuum and the elimination of
those liabilities called taxes on wages would substantially
affect negotiated nominal wage rates.
Initially, other taxes paid by these corporations would
also be eliminated changing only the form [From ``variable'' to
``fixed'' costs.] and not the actual amount of taxes paid by or
through these corporations. Subsequent amounts would be
determined [as demonstrated in ``Three Steps, etc.''] by
maximizing the growth rates of corporate value and the overall
economy.
The yearly amount that would be collected by such a tax
would then be $0.16 trillions per month times 12 months, or
$1.76 trillions per annum. This is only $6 billion less than
the $1.766 trillion budget for FY 2000. Not a bad approximation
for such a crude estimate.
A significant consequence would be the replacement of a
very complex system of government revenue raising that imposes
a myriad of forms, rules and other burdens on many millions of
people and wastes untold hours of effort to comply with these
burdens that could better be applied to useful production with
a system that is simple for both the companies affected and the
bureaucrats tasked with enforcement. [There are about 7,-8,000
companies in the current Wilshire 5000 index. This could expand
to perhaps 10 times as many as some of the larger companies
choose to decompose themselves into several smaller units to
reduce their tax liability.]
Although a rigid proof of the above is a bit more
complicated than this simple example, it is also true that ALL
the present taxes collected hinder economic activity and differ
only in the way that hindrance occurs, while the above method
is recognized by economists as at least neutral or ``non-
distortionary'' in its effect on an economy and, by those
willing to examine the arguments presented in the more complete
pamphlet, actually can be optimized to cause the greatest rate
of capital formation given all other conditions existing.
I hope when it comes time to examine substitute methods for
the failing income tax system that this process will be
considered.
Thank you,
John B. O'Donnell
STATEMENT OF ROBERT P. HODOUS, PAYNE & HODOUS, CHARLOTTESVILLE, VA
The Hon. Bill Archer, Chairman, and Hon. Members of the
Committee:
I appreciate the opportunity to provide these comments for
your record regarding the need to replace the current Internal
Revenue Code with an uncomplicated rational new code. The
starting point for this effort should be the proposal for a
flat tax. The three basic concepts of the flat tax as applied
to individuals are one tax rate, no deductions and large
exemptions to eliminate taxes on those least capable of paying
them.
A variation of the income tax is preferable to a sales tax,
which is considered to be one of the most regressive forms of
tax. Implementation of a high-rate national sales tax could be
a substantial shock to the economic system. Aspects of the fair
tax proposal are intended to minimize this impact and the
regressive nature of the tax. However, in minimizing the
regressive impact and shock of implementation of a high-rate
national sales tax, we again begin to build complications into
a new system. In addition, sales taxes can end up with many
exemptions and variations which lead to significant
complications for merchants trying to apply such taxes.
Minimizing these difficulties by harmonizing the system with
the various state sales tax provisions would be a nightmare. In
short, while a national sales tax or fair tax may seem simple
at first blush, it has many pitfalls and complications which
will be hard to overcome.
Applying the three flat-tax principles mentioned above
should be just the beginning. To do nothing more than flatten
and simplify individual rates, exemptions and deductions leaves
most of the complicated provisions of the current Internal
Revenue Code still in place. For business entities we would
still have varying tax treatment for different types of
entities. Such varying treatment leaves in place the
increasingly complicated series of choices for formation of
business entities. The basic choices still remain sole
proprietorship, general partnership and corporation. Efforts
over time to obtain more favorable tax treatment have lead
first to the S corporation, then the limited partnership with
an S corporation general partner. Now we have added limited
liability companies, single member limited liability companies,
registered limited liability general partnerships and
registered limited liability limited partnerships. Development
of these entities is driven solely by taxes. The drive for new
types of entities can be eliminated by treating all entities
the same.
Only implementing the three flat tax principles would still
leave us with the estate and gift taxes with all of their
related complications. We would still have charitable lead
trusts, charitable remainder trusts, estate freezes,
generation-skipping transfers and differences in basis
depending upon whether property is received by gift or
inheritance. Adding to the problems are the nightmare of
dealing with various types of tax-favored deferred benefit
plans and the tax dodge presented by different income and
estate and gift tax treatment afforded life insurance in an
irrevocable trust.
There are many other complications created by the current
code which can easily be eliminated using the flat tax as a
starting point. The current code is a hodgepodge of social
programs, complicated administrative and bureaucratic
procedures and special tax breaks, all of which should be
eliminated or minimized in drafting a new code. There must be a
commitment to true simplification.
There are seven basic guidelines which should be used in
creating a new code. The tax law should be understandable. It
should be economically neutral and not encourage one economic
decision over another. Administrative requirements should be
minimized. The burden of taxation and supporting our government
should be reasonably allocated. The focus should be on raising
money for the functioning of government, and various provisions
encouraging different types of social efforts or actions should
be eliminated. Taxes should be paid directly by individuals
whenever possible. Finally, all income should be taxed in the
same manner.
I undertook to write a new tax code using these guidelines
to see how uncomplicated the tax law could be. I have been
successful. The code I have written starts with the flat tax
and then goes on to eliminate some provisions and simplify
others as the principles are applied to the whole tax law. In
addition to taxing all income in the same manner, this code:
Eliminates the distinctions between types of
business entities
Eliminates the marriage penalty
Provides one type of retirement account with
greater individual freedom
Eliminates special accounting provisions
Eliminates estate and gift taxes
Replaces excise taxes and special funds with a
low-rate comprehensive sales tax
Eliminates special litigation procedures
Eliminates the need for regulations and rulings
All of this is done while still eliminating or at least
lowering the tax bills of the persons who can least afford to
pay taxes. I have included this code in a book in which I also
address problems in the current tax code and deal with
objections to the suggested changes. The tax code is just 30
sections, and the whole book, including the code, is only 180
pages. The book is Let's REALLY Change Taxes. I would be happy
to provide a complimentary copy of the book to any member who
would like one. My business address is Payne & Hodous, 412 East
Jefferson Street, Charlottesville, Virginia 22902, and my
business phone number is 804-977-4507.
I would encourage you to stay with an income tax system as
the basic means of raising the money for the functioning of
government. I also encourage you to use the concept of the flat
tax as the beginning of a truly rational and uncomplicated tax
system.
Again, thank you for the opportunity to provide these
comments.
Robert P. Hodous
Statement of Glendale O. Herbert, Pembrok Equity, New York, NY
Mr. Chairman and members of the committee, I am grateful
for the opportunity to testify today. I am the owner of Pembrok
Equity, a New York real estate brokerage firm. Many myths
surround the current debate over tax reform alternatives,
perhaps more myths than truths.
Many opponents of a national sales tax have stated that it
would be bad for homeownership, since the rental of an
apartment or the purchase of a home would be taxed but the
mortgage interest deduction would be eliminated. This is a
myth. If such myths prevail, they will constitute a triumph of
rhetoric over reason. In fact the FairTax, introduced on a
bipartisan basis by Reps. John Linder and Collin Peterson as
H.R. 2525, would have a positive impact on the real estate
industry and help make the American dream of owning real estate
a reality for many Americans sooner. As a realtor, I am pleased
to submit this testimony outlining the positive effects of the
FairTax on real estate.
Point 1: Mortgage Interest Will be Paid for Out of Pre-Income
and Pre-Payroll Tax Dollars, Which is Much More Advantageous
than Today
Yes, the sales tax eliminates the mortgage interest
deduction, but when we hear this comment, we should ask
ourselves this question: what becomes of the deduction? These
deductions would not ``disappear'' in a negative sense. Rather,
they could not exist in the sales tax world since there would
be no income tax against which the deduction could be applied.
More importantly, however, they reappear in a different and
stronger form: the non-taxation of mortgage interest. Under an
income tax, the mortgage interest deduction serves the purpose
of ensuring interest payments are made against pre-income tax
dollars. Unless one does not have the income to offset or does
not itemize, the mortgage interest deduction accomplishes well
the purpose of offsetting income taxes paid on the mortgage
interest. In fact, in 1996, there were 29.4 million taxpayers
who took the mortgage interest deduction, for a total itemized
deduction amount of $220.2 billion.\1\ The tax expenditure
associated with this deduction in fiscal year 1999 is estimated
to be $53 billion.\2\
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\1\ SOI Bulletin, Winter 1998-1999.
\2\ U.S. Budget for Fiscal Year 2000, Analytical Perspectives.
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However, it is important to note that as large as it is,
the deduction is seriously limited today for lower wage earners
(read first time homebuyers trying to latch on to the American
dream) in the respect that it only serves to negate the income
tax. Today, mortgage interest payments must be made from after
payroll tax dollars, which comprises a significant segment of
the taxes Americans pay. As a national aggregate, in fiscal
year 1997 individual income taxes were $737.5 billion, and
payroll taxes were $539.4 billion, or 42 percent of the
combined total. Many taxpayers, especially lower income
individuals, who are purchasing their first home pay a greater
portion of their tax liability in payroll taxes than income
taxes.
Let us again see the world through the eyes of our fairly
average homebuyer. Recall the median family money income in
1997 was $44,568. Recall further that if that income were all
wage income, then that couple would have paid $6,819 in
combined payroll taxes on those wages (employer and employee
share). Even if that couple did not itemize (which they
certainly would because of the mortgage interest deduction),
the income taxes that they would pay if they filed married
filing jointly would be $4,856, or 29 percent less than the
payroll taxes. In other words, the couple would have paid more
payroll taxes than income taxes. When the couple takes a
mortgage interest deduction, the couple cannot take that
deduction against the most significant form of taxes that apply
to them--payroll taxes.
Now let us consider what happens under the Fair Tax. Under
the Fair Tax plan, mortgage interest is simply not taxed--not
at all. Therefore, like current law, homebuyers would pay
mortgage interest out of pre-income-tax dollars. But more to
the point, since the Fair Tax repeals both the payroll taxes
and the income taxes, the effect of not taxing their interest
payments is to ensure that the payments are made with both pre-
income and pre-payroll tax dollars. This will significantly
advantage home buyers relative to current law by reducing the
costs of their loan. Since the interest must be paid with after
payroll tax dollars, a taxpayer today must earn $108.28 to pay
$100 in mortgage interest today if only the ``employee'' share
of the payroll taxes are considered. If the employer payroll
taxes are considered \3\ (or if the taxpayer had a sole-
proprietorship), he or she must earn $118.06. Under the Fair
Tax, that taxpayer would only need to earn $100 to pay $100 in
mortgage interest.
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\3\ Most economists believe that the employer-employee split is
really a fiction; that employees really do bear the full 15.3 percent.
However, I make this adverse assumption in order to arrive at a
conservative estimate of the advantages of the Fair Tax.
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Let us examine the relative advantage of not taxing
interest payments vs. the mortgage deduction against income in
more detail. We again will use the median purchase price of a
previously occupied home, $146,000. But we add the fact that
mortgage interest rates are about 7-3/4 percent and that the
median term of all loans was about 27 years.
If we were to model our typical married couple above, with
a typical home purchase, with a typical interest rate, with a
typical term of years in a simple graph, we could compare how
much today's mortgage interest deduction benefits the home
buyer to relative to the full non-taxation of interest on
mortgages under the Fair Tax. Over the course of the 27 year
term, an interest rate of 7.75 percent would add $202,834 to
the required payoff of the loan. To completely pay off their
loan, our couple will have to earn $407,103 once employee
payroll taxes and income taxes (at the lowest 15 percent rate)
are taken into account. Considering the impact of employer
payroll taxes would make the figure higher. Under the Fair Tax,
in contrast, the couple would only need to earn $392,444 or
four percent less.
This is not the end of the advantages, however. Our
family's disposable income will probably go up by the 7.65
percent employer payroll tax and interest rates, and since
interest is no longer taxable, interest rates will come down by
about one quarter as they settle toward the municipal bond
rates. These two factors would save our couple over $142,764,
which consists of $92,055 in additional wages and $50,709 in
reduced interest costs. If we were just to consider the
interest rate reduction, the cost of homeownership would be
$341,735 or 16 percent less that under current law.
In short, homeownership under the Fair Tax is vastly more
affordable.
Point 2: Mortgage Interest Will Fall
Home mortgage interest rates will fall by 25 to 30 percent
(i.e., about two points on a 30 year conventional mortgage). A
legitimate question is ``why?''
The answer is that current mortgage interest rates include
a tax premium, which is the amount lenders pay in taxes on the
income received. The magnitude of the wedge can be seen by
comparing the interest rates on taxable bonds to tax-exempt
municipal bonds of comparable risk and term. The impact of
elimination of the tax wedge or tax premium on interest is
evidenced each day in the Wall Street Journal. Tax-exempt
municipal bonds tend to yield about 30 percent less than
taxable corporate bonds of similar term and risk. The decline
in interest rates will occur entirely because of the
elimination of the tax wedge or premium on interest and will
happen independently of the impact of the sales tax on savings
and investment.\4\ Investors will simply no longer need to
charge a tax premium to achieve a particular after-tax rate of
return.
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\4\ For an more detailed discussion of the impact on a national
sales tax on interest rates, see John E. Gobb, Economic Review, Federal
Reserve Bank of Kansas City, ``How Would Tax Reform Affect Financial
Markets?,'' Fourth Quarter, 1995. He estimates a 25-35 percent drop (p.
27).Jorgenson.
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Moreover, interest rates will probably fall further because
the supply of capital for borrowing will increase.\5\ That is
because a national sales tax is neutral toward savings. Because
the attractiveness of savings relative to consumption will
increase, investors will choose to save and invest more of
their money rather than use it to consume immediately. The
after-tax return on their investment makes deferring
consumption worthwhile. In contrast, the current income tax is
biased against savings and investment. The income tax double,
triple and often quadruple taxes savings.
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\5\ ``Probably'' because their will also be an increased demand for
that savings for investment purposes that will have a countervailing
effect.
---------------------------------------------------------------------------
Economic studies show that savings are responsive to
changes in tax treatment and that savings rates are closely
correlated to the return on savings.
Point 3: Lower Marginal Rates Will Reduce the Costs of
Principal Payments to Home Buyers
Sometimes the rhetoric surrounding tax reform loses site of
the fact that home principal payments are taxed today. As one
editorial put it ``if you bought a $150,000 house, you'd have
to pay $22,500 more in taxes.'' More in taxes? We forget that
taxpayers today must pay for the principal in homes with after
income tax and after payroll tax dollars. The interest is
deductible but the principal is not.
Under the FairTax, existing homes would never be subject to
the sales tax. Similarly, homes built after the FairTax was put
in place would only be taxed once when first sold and would
never be subject to sales tax again. In other words, used homes
are not subject to sales tax, only newly constructed homes are.
With respect to new homes, under the Fair Tax as with current
law, principal payments would be taxed but under the FairTax
the income earned to pay for that principal would not be taxed
by the income tax or the payroll tax. Moreover, since the Fair
Tax lowers marginal rates new home buyers would face lower
after tax costs of their principal payments.
Given the fact that a consumption tax taxes purchases, but
the income tax takes the money before we purchase, how can we
compare the two as they affect the homebuyer? The only proper
comparison is to ask ourselves this question: how much money
would a purchaser have to make to earn to pay for the principal
in the home? As noted, today, a purchaser of a home must make
principal payments with after tax dollars. A taxpayer who is in
a 28 percent bracket, and pays a 15.3 percent payroll tax,
would have to earn $176,000 to purchase a home of $100,000
devoid of the interest charge. They would have to make $265,000
to pay cash for a new home of $150,000. Under the FairTax, a
$100,000 existing home would cost $100,000 after-tax since no
sales tax would be imposed. A $150,000 existing home would cost
$150,000. At a marginal rate of 23 percent, a $100,000 new home
would cost $130,000 after tax and a $150,000 new home,
$195,000. So, the cost of making equity payments decreases as
well under the Fair Tax compared to current law.
[GRAPHIC] [TIFF OMITTED] T1879.013
Point 4: Individuals Will be Able to Save for the Purchase of a
Home Much Faster, Which Will Increase and Accelerate the Volume
of Home Sales
Since the Fair Tax does not tax savings and investment and
makes the payment of the tax largely elective, it will enable
new home buyers, second home buyers or buyers stepping up, to
save for their purchase faster. Buyers will be able to qualify
for a mortgage faster and existing owners will be able to sell
their homes faster.
Why can individuals save so much faster? First, the Fair
Tax removes the enormous disadvantage to savings and investment
under our income tax system. Today, savings and investment
income is greatly disadvantaged. Wage and salary income is
included in the income tax base when it is earned originally.
If that income is consumed, the benefits of consumption go
untaxed. However, if what is left of the wages and salaries is
saved (for example, for a new home), the earnings are taxed as
the income from that investment is generated. Then, if the
income-producing asset, such as a stock or bond, equipment or
real property interest is sold for more than it was purchased,
the benefit of the capital investment--the capital gain--is
taxed a third time. Corporate income (including capital gains)
is taxed at the corporate level and again when it is paid to
shareholders as dividends. Inter-corporate dividends are also
subject to tax, creating yet another level of taxation.
A principal advantage the Fair Tax has over an income tax,
therefore, is that the downpayment can be saved without
fighting against the cascading taxes on savings.
To illustrate the effects of the current taxes on savings
and investment, let's construct a typical fact pattern and then
analyze the effects. Let's take a married couple who wants to
purchase a new home of $146,000, which was the 1997 median new
home price (the FairTax would tax the sale only of newly
constructed homes).\6\ Let us further assume that that couple
will need to save $14,600 (10 percent) for the downpayment.
Since the median family money income 1997 was $44,568 \7\ ,
let's further assume that that is the amount our couple earns.
Today, the personal savings rate nationwide, as a percentage of
disposable personal income, is about 2.1 percent.\8\
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\6\ Statistical Abstract of the United States, 1998, Table 1203.
The median price of a previously owned home was $124,100. See Table
1204.
\7\ See Economic Report of the President, February 1999, Table B-
33.
\8\ U.S. Bureau of Economic Analysis, reported in Economic Report
of the President, February 1999, Table B-32.
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Our income tax system attacks their ability to save at the
very beginning, when our prospective buyer earns their income.
Our family will be taxed on their earnings at the 15 percent
rate under the income tax plus payroll taxes. To save $14,600
after-tax that family must earn, at the margin, an additional
$18,875 (looking only at the employee share of payroll taxes
and income taxes). They would have had to earn $22,688 if they
were in the 28 percent tax bracket, a more typical bracket for
homeowners.
If the $44,568 of our family's income was all wage income,
then that couple would have paid $3,409 in employee payroll
taxes on those wages. Note also that their wages were also
about $3,409 lower because of the employer payroll tax.
Economists generally believe that the employer share of the
payroll tax is borne by the employee in the form of lower
wages. After the standard deduction and two personal
exemptions, the couple would pay income taxes of $4,856. Hence,
using a standard deduction, the couple would have paid $8,265
in taxes on $44,568 leaving our family $36,303 after taxes. 2.1
percent of that disposable income is $762.
Today, assuming they earn 8 percent on their savings, they
are in the 15 percent bracket and save $762 each year at the
beginning of the year, they would be able to save their down
payment by early in the 13th year.
Under the AFT plan, their disposable income will increase
to $47,977 because of the repeal of all payroll and income
taxes. Assuming they continue to save 2.1 percent of this
amount, they would save $1,008 each year. Assuming they would
earn a lower 6 percent on this amount, then they would be able
to save a $14,600 downpayment in the 11th year. Note, however,
that the acceleration effect is much more pronounced if they
were in the 28 percent tax bracket. Even if we add 23 percent
to this amount, they would be able to save $18,961 in the 13th
year. This, however, is unrealistically pessimistic since the
repeal of all income and payroll taxes will reduce producer
prices. Harvard's Dale Jorgenson estimates that construction
prices will fall by 25 percent.\9\
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\9\ See, The Economic Impact of the National Retail Sales Tax, Dale
W.
---------------------------------------------------------------------------
What does this mean in national aggregates? It means that
we would accelerate the purchase of homes, increasing the
velocity of those sales. It also means that realtors would make
more money faster since there would be many more home sales
crunched into a smaller period of time. More sales mean more
commissions.
Point 5: The Fair Tax Makes Housing More Affordable by
Repealing Upstream Taxes
Housing today is taxed much more heavily than most people
realize. Like other firms, homebuilders pay corporate taxes and
payroll taxes, not only on their own accord, but in the form of
taxes embedded in the goods they purchase to build homes. These
upstream costs would disappear.
Research by Harvard economist Dale Jorgenson shows that
producer prices in the construction industry will fall 25
percent under the Fair Tax plan since the income tax and
payroll tax is embedded in the price of everything we buy. In
this case, new housing prices will be approximately the same
price including the sales tax as they are today and the
relative price of new and used housing will remain roughly
comparable to what they are today. If Jorgenson is wrong and
the sales tax causes prices to rise, then existing home prices
will rise immediately to reflect the fact that they are not
subject to tax. Although this would result in a one-time, quick
windfall gain to owners of existing houses, the relative price
of new and old homes will be comparable.
Conclusion:
The combination of these factors means that the Fair Tax
would be highly beneficial to real estate. The Fair Tax would:
reduce the tax burden on interest;
lower interest rates and make homes more
affordable;
lessen the pre-tax earnings a buyer must earn to
pay for a home;
quicken the pace of saving for a downpayment and
the pace of home sales;
make homes more affordable by eliminating the
taxes embedded in upstream producer prices.
As you review competing tax reform plans, let us keep in
mind one factor. The income tax is not the perfect system for
real estate and those that say that real estate might be hurt
simply because the mortgage interest deduction is removed are
performing a very shallow analysis. It takes a little more
effort to see the truth. I am pleased to support the FairTax as
a means of assisting more Americans in achieving the American
Dream of owning real estate.
STATEMENT OF DAVID R. BURTON, PROSPERITY INSTITUTE, ALEXANDRIA, VA
I am David R. Burton, President of the Prosperity
Institute. I am pleased to submit this testimony on behalf of
the Prosperity Institute. We would like to take this
opportunity to present our analysis of the impact of the
leading national sales tax plan on senior citizens. This plan
is called the FairTax.
Senior citizens are becoming a larger portion of the
overall population. In 1970, those over 65 years of age were
9.8 percent of the population. By 1999, seniors were 12.7
percent of the population. In 2015, seniors will account for
14.7 percent of the population and in 2020, they will account
for 16.6 percent.\1\
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\1\ Middle Series, U.S. Bureau of the Census, Statistical Abstract
of the United States, 1996, Tables 814 and 17, pp. 15 and 17.
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Under the FairTax, senior citizens, like others, will
receive a cash rebate effectively exempting consumption up to
the poverty level from tax. The sales tax rebate is equal to
the sales tax that would be paid on expenditures up to the
federal poverty level. Because the federal poverty level for
two persons is not twice the level for one persons, the FairTax
provides that married couples would receive an extra rebate
amount to prevent any marriage penalty. The rebate is paid
monthly in advance. Thus, poor seniors will pay no sales tax. A
household spending twice the federal poverty level (or more in
the case of a married couple) would pay an effective tax rate
of 11-\1/2\ percent.
Because income and payroll taxes are embedded in the price
of everything we purchase, it is not clear that prices, even
including the sales tax, will increase by very much.\2\ They
may not increase at all because pre-sales-tax prices may fall
once the income and payroll taxes are repealed. Nevertheless,
the FairTax makes sure that the Social Security benefits
indexing formula would be adjusted so that benefits will
increase to the extent, if any, that the sales tax results in
higher tax inclusive prices. The income tax imposed on Social
Security benefits will be repealed.
---------------------------------------------------------------------------
\2\ Dale W. Jorgenson, Economic Impact of the National Retail Sales
Tax, National Tax Research Committee, generally showing that producer
prices will fall 20 to 30 percent because of the repeal of income and
payroll taxes.
---------------------------------------------------------------------------
The income tax imposed on investment income and pension
benefits or IRA withdrawals will be repealed. Pensions funds,
IRAs and 401(k) plans have assets of well over $11 trillion.\3\
An income tax deduction was taken for contributions to most of
these plans and the earnings on these plans have accrued free
of any income tax. All beneficiaries and owners of these plans
expected to pay income tax on them upon withdraw and would not
be required to do so since the income tax would be repealed by
the FairTax.
---------------------------------------------------------------------------
\3\ Statistical Abstract of the United States, 1998, Tables 845-
847, pp. 533-534. In 1997, private pensions had assets of $4,846
billion and state and local pension funds had assets of $2,100. In
1996, Individual Retirement Accounts had assets of $1,347 billion. In
1997 section 401(k) and other defined contribution plans had assets of
$1,730 billion.
---------------------------------------------------------------------------
Repeal of the corporate and individual income tax and the
estate and gift tax will have a substantial positive impact on
the stock market.\4\ Those seniors that own stocks either
directly or through mutual funds, Individual Retirement
Accounts, 401(k) plans or otherwise will experience significant
gains. More seniors own stocks, mutual funds or have IRAs than
other age groups.\5\ In addition, unrealized capital gains that
would have been subject to the income tax when realized will no
longer be taxed.
---------------------------------------------------------------------------
\4\ In short, by repealing the corporate tax, the tax on dividends
and the tax on capital gains, the net of income tax future income
stream of corporations will increase and the capitalized value of the
that future income stream will increase as well.
\5\ U.S. Bureau Labor Statistics, Statistical Abstract of the
United States, 1998, Table 798, p. 514.
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The FairTax imposes a sales tax on newly constructed homes
but exempts existing homes and other used property from any
sales tax. Currently, equity payments on homes must be paid
from after-income tax earnings (i.e. principal payments are not
deductible). The purchase of existing housing is thus subject
to the income tax. Owners of existing homes may experience
large gains due to the repeal of the income tax and
implementation of the FairTax. Seniors and those nearing
retirement age have dramatically higher homeownership rates
than other age groups. (80 percent compared to 66 percent on
average).\6\ Homes are often a family's largest asset.
---------------------------------------------------------------------------
\6\ Statistical Abstract of the United States, 1999, Table 1215, p.
726.
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Under the FairTax, the estate and gift tax would be
repealed. The need for small businesses and farmers to engage
in expensive estate planning, involving attorneys, complex
estate freeze transactions and expensive life insurance plans
in anticipation of future estate and gift tax liability would
disappear. Heirs would no longer need to sell the business or
farm out of the family or borrow heavily, putting the business
at risk, to pay the estate tax.
Replacing the current tax system with a national sales tax
would make the economy much more dynamic and prosperous.\7\
Budget pressure on entitlement spending, already significant,
will become much more pronounced once the baby boom starts
retiring. The economic growth a sales tax would cause would
make it substantially less likely that federal budget pressures
will result in Medicare or Social Security benefits reductions.
---------------------------------------------------------------------------
\7\ ``The Economic Impact of Replacing Federal Income Taxes with a
Sales Tax,'' Laurence J. Kotlikoff, April 15, 1993, Cato Institute
Policy Analysis; Dale W. Jorgenson, Economic Impact of the National
Retail Sales Tax, National Tax Research Committee. See also, ``The
Economic Impact of Fundamental Taxing Consumption,'' Dale W. Jorgenson,
Testimony before the House Ways and Means Committee, March 27, 1996 and
``The Economic Impact of Fundamental Tax Reform,'' Dale W. Jorgenson,
Testimony before the House Ways and Means Committee, June 6, 1995;
``Looking Back to Move Forward: What Tax Policy Costs Americans and the
Economy,'' Gary Robbins and Aldona Robbins, Policy Report No. 127,
September 1994, published by the Institute for Policy Innovation;
``Replacing the Federal Income Tax with a Consumption-Based Tax
System,'' prepared by Nathan Associates for the National Retail
Institute (1996).
---------------------------------------------------------------------------
According to work by Stanford University economist Joseph
Kahn, those seniors with a net worth over $400 thousand (nearly
four times the median) may see a reduction in their purchasing
power. The largest decline in purchasing power, about 3.5
percent, is for those with net worth above about $700 thousand.
The primary reason for this effect is that wealth spent for
consumption purposes that is held in non-tax deferred accounts
like IRAs will be taxed when spent under a sales tax and would
not be taxed further under an income tax.\8\ Kahn assumes,
contrary to Jorgenson, that prices will rise.
---------------------------------------------------------------------------
\8\ ``Examining a Change to a National Retail Sales Tax Regime:
Impact on Households,'' November 1996.
---------------------------------------------------------------------------
Most seniors will be better off were the FairTax to replace
the current system.
STATEMENT OF REDEFINING PROGRESS, SAN FRANCISCO, CA
Environmental Tax Reform: An Idea Whose Time Has Come
[This testimony is largely excerpted from the monograph,
Tax Waste, Not Work: How Changing What We Tax Can Lead to a
Stronger Economy and a Cleaner Environment, by M. Jeff Hamond,
published by Redefining Progress (RP). For more information
about RP's work on tax shifting or to order a copy of the
monograph, call (800) 896-2100.]
Despite the sustained overall strong performance of the
American economy--such as a high rate of job creation,
declining deficits, and low inflation and unemployment--the
nation is still struggling with several important long-term
problems.
Among the most serious of these are the payroll tax and the
exploding growth of entitlement programs; the emergence of
global climate change as a significant environmental and
economic threat; the lack of economic opportunity in our inner
cities; and the dislocation and hardship that are being caused
by major economic transformations (such as the rapid growth of
information technologies) even as they provide exciting new
opportunities. Each of these problems has caused many scholars
and activists to look for solutions, but so far few good ideas
have moved from theory to actual policy.
A Fresh Approach to Some Old Questions
A new approach to fiscal and environmental policy--a
resource-based tax shift--holds the potential for improving
many of the country's problems simultaneously, while attracting
support across the political spectrum. This approach would
reduce current taxes on labor, innovation, and capital
formation and replace the revenue with new levies on pollution
and waste. Total federal revenue would be unchanged and the
current distribution of the tax burden across income groups
would be preserved.
A revenue-neutral tax shift of this type could be
accomplished through the use of new taxes or tradable emission
permits, but the basic idea--that the new revenue should be
used to reduce existing taxes--would be the same under either
mechanism. Many of the potential benefits of this policy idea
are dependent upon this ``revenue recycling.'' Because other
taxes are being reduced, this proposal is not a new revenue
source to buttress government expenditures. It would simply
replace a portion of federal revenues--perhaps 5 to 10
percent--with revenues from environmental taxes or permits.
The proposed new tax system is designed to be revenue-and
distributionally-neutral because the way in which a free
society decides to distribute the burden or spend public tax
dollars should be a separate issue from that of the method used
to raise the revenue. This distinction is not meant to be an
endorsement of the current tax distribution or size of
government. Rather, it is meant to emphasize the fact that the
tax shift is neither a tool to increase government (in fact, it
could do just the opposite), nor to shift the tax burden to the
rich or the middle class.
This new approach to public policy could create a powerful
alliance among those concerned with problems such as high taxes
on capital formation or on the average family; the need for
additional investments in human capital and research and
development (R&D); the threats to the global environment; the
costly regulatory burden on private industry; fiscal
irresponsibility; the complexity of international tax rules;
and job creation in inner cities. It would provide a rare
opportunity to enact tax cuts on both labor and investment
income. By so doing, it would attract support from both ends of
the political spectrum and potentially create incentives for
more investment in both human and physical capital--an economic
stimulus package with no revenue cost. Given the mounting
interest in fundamental tax reform, the weaknesses of the tax
reform plans that have been offered, and the growing
international momentum for addressing the threat of climate
change, such a proposal could not come at a better time.
The Tax Shift Concept
The current tax system sends the wrong signals to virtually
everyone. It discourages work, enterprise, and capital
formation while it encourages sprawl, pollution, waste, and the
inefficient use of resources. There is almost unanimous
agreement that the tax system needs reform.
There are really two sides to the tax reform debate--and
they aren't ``liberal'' versus ``conservative.'' Rather, they
are what should be taxed and what should be untaxed--and the
next attempt at major tax reform should focus on both. Look at
it this way: When the government wants to promote a social
goal, what does it do? It reduces income taxes--via credits,
preferences, and deductions--on particular activities that the
government thinks will help accomplish that objective. Retired
Sen. Bill Bradley (D-NJ) calls this practice ``government by
tax break,'' and it helps explain why the tax system is the
part of government that people hate the most. But what if the
government can accomplish social goals both through what it
taxes as well as what it untaxes?
Common sense dictates that you get less of what you tax and
more of what you don't. Since higher rates of saving and
investment can drive faster economic growth, many recent tax
proposals focus on reducing taxes on capital income in the
hopes of creating more saving and investment. Yet in an effort
to keep total revenue relatively stable, some of these
proposals would increase taxes on labor in order to untax
capital. This action would have the perverse result of raising
taxes on modest and average income people--and if common sense
applies, this in turn would result in less labor.
The argument works the other way as well: Higher taxes on
capital holders should not be used to finance tax cuts for
working people, because these tax increases penalize the
investment and entrepreneurism that creates new jobs and
opportunities. Such a policy untaxes labor in order to tax
capital. In an economy that needs more of both human and
physical capital, considering only these two options presents a
false choice.
Make no mistake: A tax code is primarily a means of raising
revenue. But it also sends powerful messages through what it
does, and does not, tax. In this light, why not develop a
socially useful tax system that would tax those things the
country needs less of, and untax those things of which society
wants more? This idea is being tried around the world, and even
the British news magazine The Economist has endorsed such an
approach. Tax Waste, Not Work suggests bringing this concept,
commonly called environmental or resource-based tax shifting,
to the United States.
This type of tax reform could lead to a cleaner environment
at the same time that incentives are provided for more work and
investment. Just as importantly, it could be designed without a
regressive shift of the tax burden if regressive taxes like the
payroll tax are reduced to offset the new levies. Revenues
could be gained from taxing carbon dioxide emissions, air and
water pollution, or consumption of virgin materials. Emission
permits could be auctioned to firms, which would also raise
substantial revenue; similarly, fees could be charged for the
use of certain assets held in common by the public. On the tax
reduction side, payroll, individual, and corporate tax rates
could all be reduced--without increasing the deficit or forcing
huge cuts in government services.
While such a shift from taxing ``goods''--the creation of
wealth through labor and investment--to ``bads''--the depletion
of wealth through pollution and environmental degradation--
cannot be a magic bullet for every economic and environmental
ill, it does offer a promising chance for promoting work and
investment while concurrently moving toward the types of
market-based policies that would be an improvement over the
current regulatory structure.
Deflecting Past Critiques
The idea of using market-based policies such as taxes or
emission permits to deal with environmental problems has been a
staple of the academic literature for decades. But these policy
tools have been widely criticized in the United States for a
number of reasons--all of which a tax shift would address:
Environmental taxes and permits have often been
pushed as tax increases, rather than as a lever for reducing
other taxes. A tax shift, however, would substitute higher
taxes on some things with lower taxes on others, with the
objective of leaving most individuals paying roughly the same
amount in total. Only recently has this idea for ``revenue
recycling'' been receiving attention from academics and public
policy groups. For example, the World Resources Institute's
Green Fees report and Ernst Ulrich von Weizsacker's book,
Ecological Tax Reform (both published in 1992), broke new
ground in this area; an interesting body of literature has
followed these front runners, discussing the potential benefits
of such ``recycling.''
The business community has lobbied against these
so-called ``green taxes'' in the past, fearing that they would
cost jobs, reduce economic growth, or detract from U.S.
competitiveness. But a tax shift, by reducing other taxes with
high distortionary costs, should greatly reduce or eliminate
these concerns.
Environmental taxes and permits have been
criticized for their regressive nature--that is, for affecting
the poor and middle classes relatively more than the well-off,
since lower income families spend a larger percentage of their
income on energy. Yet under a tax shift, other regressive taxes
could be reduced to maintain the current distribution of the
tax burden.
Past critics could point to the potential risk of
being the first industrialized country to advance these
proposals in a major way. But now there are models to look to,
as several countries have adopted ``green taxes''; and others,
including Denmark, Great Britain, and Costa Rica, have passed
mild tax shifts.
The Rationales for Change
Philosophic Rationales
A tax shift policy sends a powerful message from the
perspective of restoring legitimacy to public finance:
Individuals should be able to keep more of the fruit of their
toil, but should pay for the costs that they impose on others.
This change would restore both a coherent rationale and a sense
of values to the nation's tax system. Tax shifting also offers
the potential to draw public revenue from resources already
owned in common (e.g., public lands, the broadcast spectrum),
thereby enabling all citizens to receive dividends from the use
of common assets.
To the extent that it replaces the current tax structure, a
shift to resource taxes would also restore the notion that the
costs of today's actions should not be borne by future
generations. This would bring a sense of ``honest accounting''
back to government. In other words, rather than paying taxes
based upon their work or saving, people should increasingly pay
taxes based upon the resources they consume and the pollution
they cause. Thus, society ``pays'' for the problems it passes
on to its children, rather than passing on the burden.
Finally, by providing incentives for people and businesses
to invest in energy efficient vehicles, homes, and equipment, a
tax shift empowers people to reduce their own tax bills in a
way that the current system does not.
Economic and Fiscal Rationales
While tax shifting is a relatively new idea, the economic
rationales for pursuing it are numerous and rest on several
long-standing pillars of mainstream thought.
The current tax system imposes significant
efficiency costs and therefore retards economic growth.
Replacing a portion of these economically inefficient taxes
with ``corrective'' taxes (which have lower efficiency costs,
or ``deadweight losses'') could reduce the overall economic
cost of the tax system. It could also yield several important
economic benefits, ranging from more job creation and/or higher
wages to new investments in energy efficiency and higher
economic growth. Redefining Progress has sponsored research
that concludes that, depending on incidence assumptions and
revenue recycling choice, approximately three-fourths of
industry and workers stand to gain from environmental tax
reform, in terms of reduced tax burden and increased
competitiveness.
Current market prices for many goods do not take
the social and environmental costs of production or energy
consumption into account. Adding the costs of these
externalities into the price system, via the tax code or
emission permits, would make the economy more efficient.
Despite disagreement about how (and by how much) energy prices
ought to be raised, most economists would agree that energy
prices ought to be higher--and that higher prices would not be
as costly to the economy as some critics claim.
The academic literature has shown that the most
efficient use of any revenues from environmental levies would
be to reduce other taxes. While there is disagreement over
whether tax cuts on work or investment are more likely to yield
economic gains, it is this potential for lowering current taxes
that is likely to be the most appealing part of this proposal
for many individuals, private firms, and elected officials.
Environmental Rationales
Another motivating force for a tax shift is that it would
provide a least-cost approach to reducing pollution, waste, and
the long-term threat of climate change. In the summer of 1995,
the Intergovernmental Panel on Climate Change (IPCC)--a group
of more than 2,200 scientists and economists from nearly 60
nations--declared that ``the balance of evidence suggests that
there is a discernible human influence on global climate,''
signaling the growing scientific consensus on the issue. In
1998, over 2500 economists, including eight Nobel laureates,
signed a statement that global climate change carries with it
significant environmental, economic, social, and geopolitical
risks, and that market-based policies offer the most efficient
solution for slowing the effects of climate change.
The view that climate change is not an economic problem is
changing as the staggering costs of dealing with its effects
become more apparent. Despite greater energy efficiency in the
United States, global emissions of carbon dioxide are projected
to grow by 54 percent over the next 20 years. In response, the
U.S. government has begun to shift its view of the climate
change problem. In July 1996, the Clinton Administration
announced its support for the adoption of binding yet flexible
targets to reduce global carbon emissions. In 1997, the United
States negotiated the Kyoto Protocol, along with 160 other
countries, under which it agreed to reduce its greenhouse gas
emissions by 7 percent between 2008 and 2012. A tradable
emission permit system will be instrumental in achieving these
goals.
Industry leaders, policy makers, academic economists, and
many members of the environmental community have also shown
growing support for market-based approaches to environmental
policy. The Clinton administration, presidential candidate
George W. Bush, and many members of Congress have all stated
that climate change is a problem. Various business sectors--
most notably insurance and finance--are increasingly viewing
climate change as a threat to economic performance, public
health, and geopolitical stability. The focus of these
interests has not only been on the climate change issue, but
also on pollution, congestion, and solid waste. The possibility
of addressing these problems with less regulation creates the
potential for new alliances between business,
environmentalists, labor unions, tax reformers, and elected
officials at all points along the political spectrum.
Tax Shift Efforts at the State Level
Broader acceptance of environmental tax shifting as a
concept has gained momentum at the state level. Environmental
and tax reform groups in California, Florida, Maine,
Massachusetts, Minnesota, New Hampshire, Oregon, Pennsylvania,
Texas, Vermont, Washington, and Wisconsin are working on moving
specific reforms in their respective states. Proposed bases for
increased taxes include land use, vehicle miles traveled, large
livestock property, water pollution, and energy emissions, with
proposed decreases in payroll, income, sales, and corporate
taxes.
Although legislators remain wary of tax shifting, perhaps
because of reflexive suspicion of any tax measure, all U.S.
states have at least some environmental tax provisions, and
several have recently considered or are considering new
measures to shift taxes toward environmentally harmful
activities. In Minnesota, the legislature introduced the
Economic Efficiency and Pollution Reduction Act (EEPRA) in
1997, which would have combined a carbon tax with an offsetting
reduction in property and payroll taxes. The House Environment
Committee debated the bill, but it was withdrawn without a
vote. Environmental tax reform has been suggested as an
instrumental base for education finance reform in New
Hampshire. A court order mandating increased aid to education,
combined with enduring reluctance to introduce a sales or
income tax, has made pollution taxes a politically viable
alternative to increased property taxes. In neighboring
Vermont, a proposed legislative tax shift study lost by one
vote in the House in 1999.
It should also be noted that environmental taxes are much
more widely accepted in Europe than in the United States.
Consider these examples:
In Denmark, green taxes are being used to reduce
income taxes and employers' social security contributions.
In Finland, lower taxes on income and labor are
being offset, in part, by green taxes, such as a landfill tax,
and increased energy taxes.
In the Netherlands, part of the regulatory tax on
energy is being allocated to a reduction in employers' social
security contributions.
In Sweden, a 1991 tax reform resulted in higher
environment-related taxes and lower marginal income tax rates.
In the United Kingdom, revenue from a new landfill
tax is being used to reduce employers' social security
contributions by 0.2 percentage points.
The Potential Benefits of Change
The following are the most important potential benefits of
this fresh approach to fiscal policy, each of which is examined
in Tax Waste, Not Work.
1. Job creation could be spurred, take-home pay increased,
and/or incentives to enter the workforce enhanced as a result
of lower payroll taxes.
2. Reducing taxes that carry large efficiency losses could
enhance economic efficiency, thus improving the economy's
overall capacity to create jobs and wealth.
3. The collective threats of climate change (i.e.,
economic, health, environmental, and political) could be
addressed through a proactive solution.
4. Environmental benefits such as less pollution and waste
could be realized through market-based solutions, with less
reliance on heavy-handed government regulation such as vehicle
emission standards.
5. Businesses and individuals would have a greater
incentive to make new investments in technological innovations
or energy efficiency, thus exerting a new measure of control
over their own tax burdens.
6. The taxation of capital and business income could be
greatly simplified or reduced without shifting the tax burden
down the income scale.
7. New incentives would be created for investment in R&D
and the development of the businesses and technologies of the
future, helping U.S. companies gain competitive advantage in
new markets.
8. Inner cities could become more attractive business
locations because of their abundant labor and available scrap
materials.
9. Changes in energy prices could reduce congestion and
make mass transit investment more viable for private investors,
possibly reducing the need for public subsidies.
10. If there is a general consensus that taxing waste, and
not work, is reasonable, public trust in government--and
compliance with the tax system--will increase.
STATEMENT OF BARRY CARGILL, SMALL BUSINESS ASSOCIATION OF MICHIGAN
Mr. Chairman and Members of the Ways and Means Committee of
the United States House of Representatives:
My name is Barry Cargill; I am Vice President for
Government Relations of the Small Business Association of
Michigan. We are sometimes recognized by our acronym SBAM. We
are a state based small business trade association representing
8,000 small businesses in Michigan. We represent all types of
small business, from manufacturing businesses to retailers.
The FairTax is an issue that was heatedly debated by our
members and Board of Directors. In the end, our Board of
Directors unanimously approved the FairTax as the best
alternative to replace the current system. Education is key to
understanding benefits of the FairTax. In fact, the more that
our members learn about the FairTax, the more enthusiastically
they support it.
Todd McCracken of NSBU is scheduled to testify in support
of the National Sales Tax proposed by Citizens for Fair
Taxation (The Fair Tax Plan) and we would like to associate
SBAM with his comments.
SBAM shares the position of NSBU and supports the FairTax
as the best alternative for comprehensive national tax reform.
The debate over spending our projected federal budget surpluses
masks the fact that small businesses struggle under the burden
of a troubled federal tax system. The Fair Tax abolishes the
current system by replacing all federal income, payroll, death
and capital gains taxes. In place of the abolished taxes, the
Fair Tax proposes to institute a 23 percent tax-inclusive sales
tax on all end-use goods and services.
One of the key reasons we support the plan is that it will
reduce compliance costs unlike any other tax alternative. Small
businesses must use complex tax accounting rules to keep track
of income, inventories, types of expenses, depreciation,
various employee benefit regulations, payroll taxes (including
Social Security, Medicare, and unemployment taxes) and file the
necessary accounting and information returns. This takes
precious time away from trying to grow the business and become
more profitable.
Apart from the level of compliance costs, there is
something fundamentally different in the effect of these
compliance costs on small firms. First, small firms pay higher
compliance costs as a percentage of revenues. In many cases,
compliance costs such as those associated with pension plans,
payroll taxes, software, accounting system are fixed costs with
regressive effects on small companies. In most cases, small
firms must endure the same panoply of laws and regulations as
larger firms, the same recordkeeping and system requirements.
However, small firms have less revenue against which these
costs can be spread. Secondly, small firms do not have the same
capabilities to push these costs forward on consumers or
customers. When a large firm has associated revenue costs, they
often simply push these costs forward in the prices of goods
and services. When small firms incur such costs, they result in
lower wages, lower returns on investment and fewer
opportunities for entrepreneurs. Under the Fair Tax, only one
question is relevant to small businesspersons. How much did I
sell to customers? By reducing overhead to answering that
single question, the FairTax would reduce compliance costs by
about 90 percent, freeing capital and entrepreneurial energy.
Another reason we support the FairTax is that it shifts the
emphasis of taxation away from saving and investment and
productive activity.
Payroll taxes constitute more than one-third of all federal
revenue collections. Since 1970, business received nine social
security (FICA) tax increases totaling 133 percent, and 19 FICA
base increases totaling 677 percent. Additionally, payroll
taxes are a tax on employment and thus discourage hiring
employees. Employees are the winners when the tax system
encourages rather than discourages employment.
The death tax presents families with the problem of
liquidating the family business in order to pay for the taxes
on inheritance or to drain valuable resources from the business
to establish costly and confusing trusts. Only 40 percent of
all small businesses make it to the second generation and only
10 percent to the third.
Capital gains incentives have traditionally, and
inaccurately, been seen as a tool only of venture capitalists
and wealthy investors. However, we must remember the vast
networks of informal investors in the small business community.
Research conducted by the Small Business Administration (SBA)
shows that informal equity investors in small firms are a much
larger financing factor than venture capital. Eliminating
capital gains taxes would lead to a boon in small business
investment.
We would note that Members of this Committee will likely
read some testimony by large retailers that believe the FairTax
would hurt retail sales. Their statement appears to suggest
that there will be a sticker shock to a national sales tax. We
disagree with this assessment from several perspectives and
wanted an opportunity to advance these points.
First, like other firms, retailers will enjoy a zero
corporate tax rate and their shareholders will not be taxed on
dividends received from the retailer or capital gains on their
investment in the retailer. Like other firms, they will enjoy
much lower compliance costs. Instead of having to comply with
the complexities of the income tax, payroll tax, and various
excise tax, there will be one sales tax on all goods and
service. The firm will simply need to calculate on a monthly
basis its total retail sales. Retailers will receive an
administration fee for complying with the sales tax. There will
be no more uniform inventory capitalization requirements. There
will be no more complex rules government employee benefits and
retirement plans that serve as a barrier to providing employees
with retirement plans. There will be no more tax depreciation
schedules. Do large retailers really want to continue these
onerous laws?
Second, consumers will see their paychecks increase by over
$1.1 trillion. Finally consumers will have more money to spend.
Since the plan is revenue neutral, the repeal of the income tax
will provide consumers with the money necessary to pay for the
sales tax. Sales taxes were originally installed at the state
level in the 1930's because in times of economic fluctuation,
consumption is a more stable source of revenue collection.
Third, retailers will make more money in a prosperous,
growing economy. All respected economic projections predict a
much healthier economy. People are willing and able to purchase
more goods and services in a healthy economy. Typical estimates
are that they economy will be 10 to 14 percent larger within 10
years and consumption will grow very substantially. Some
studies show the potential gains to be much higher. Real wages
will increase.
We would note that in a study prepared by Nathan Associates
(March, 1996) for the National Retail Institute, which by its
own admission made every conceivable adverse assumption, the
economy will grow three percent more in ten years than it would
have under the income tax. The increase in consumption will be
1.15 percent less in the first year relative to what it would
have been under the income tax. Consumption will be higher in
the fourth year and every year thereafter than it would have
been under the income tax. The study assumed that every dollar
in new U.S. investment must come from the U.S. rather than
foreign investors and assumes a very low effects of higher
investment on productivity. It assumes no gain in productivity
from lower compliance costs.
As this Committee reviews the FairTax proposal, keep in
mind that consumption purchases must be made from after-income-
tax dollars today. The primary difference between a sales tax
and an income tax is that the income tax doubly or triply taxes
savings. How much tax on savings is too much? How much of a tax
on investment is too much? What is wrong with developing a tax
system that fully eliminates the tax on savings and investment
and gives consumers the choice to either spend or invest the
fruit of their labor?
There are other factors. For one, consumer interest rates
will fall dramatically, probably by about 25 percent, and
consumer's ability to finance consumption will be higher. In
the case of interest that is presently deductible, the fall in
interest rates and the lack of deductibility is just about a
wash for most people. Since consumer interest is not deductible
under present law, this effect will be strong with respect to
credit card or consumer loan financed purchases. Finally, the
committee should not dwell on the rate. The FairTax does not
raise more money than our current system ,it just makes the
taxes we pay visible. The relative purchasing power of the
dollar will remain the same; in fact, estimates are that real
wages would increase. We should not be opposed to truth in
advertising the cost of the Federal government.
The FairTax is a refreshing alternative to the current
quagmire of taxes and regulations. It would reduce complexity
and allow Americans to understand the tax system to which they
are subject. It will lower compliance costs. It will make the
taxes we pay visible. It will help our international
competitiveness. It will help America's entrepreneurs become
more prosperous, more vibrant and an even greater job
generator. This will help consumption as well as wages. And
when the economy does better, we will see even more surpluses
so the tax rate can be lowered.
Thank you for the opportunity to present the views of
Michigan small business. We encourage this committee to hold
additional hearings on the FairTax. We are confident that the
more that is learned about the proposal, the better it will
sound to you and the American public.
STATEMENT OF RAYMOND J. KEATING, SMALL BUSINESS SURVIVAL COMMITTEE
On behalf of the Small Business Survival Committee (SBSC)
and its more than 50,000 members across the nation, I
appreciate this opportunity to spell out SBSC's position on the
``Fair Tax Act.''
SBSC is a non-partisan, non-profit advocate for small
business owners across the nation. On a wide array of policy
issues impacting the small business community and the economy
in general--including taxes, regulations, trade, and government
spending--SBSC consistently argues from a principled, free-
market perspective.
As you know, the ``Fair Tax Act'' would eliminate all
income, payroll, estate and gift taxes, and replace them with a
national retail sales tax of 23 percent. The general revenue
rate would equal 14.91 percent, with the remaining 8.09 percent
going for Social Security and Medicare hospital insurance. No
tax would be paid on products or services purchased for
business, investment or export purposes. And except for some
isolated exceptions, the tax would be collected and remitted
(monthly) by the seller. In states that already levy a sales
tax, the state would administer the federal sales tax, keeping
.0025 percent of the amount collected for administrative costs.
In states that do not impose sales taxes, the federal
government would administer the tax.
A ``family consumption allowance'' would be rebated each
month to each family/individual in the amount equal to the
product of the sales tax rate and the monthly poverty level.
The Social Security Administration would mail the monthly
rebate, or provide rebates through smart cards.
SBSC supports throwing out the current messy, complicated,
unfair and anti-growth tax system that entrepreneurs,
businesses and individuals currently labor under in favor of a
national retail sales tax. On several occasions, we have
outlined the key principles that should buttress any serious
effort at tax reform:
Low Flat Tax Rate to Promote Economic Growth. The
lower and more proportional, or flatter, the tax rate system
the better. Obviously, a low tax rate boosts incentives for
working and risk taking.
No Taxation of Capital. Taxing returns on
investment and savings makes absolutely no economic sense.
First, taxing returns on capital is an example of double,
triple or more layers of taxation. Second, since investment and
entrepreneurship are the primary engines of economic growth,
taxing the returns on such activities is counterproductive.
Along these same lines, it must be remembered that labor is
powerless without capital, and therefore, taxing capital hurts
labor.
Inflation Factor. The detrimental effects of
inflation should be factored into any tax system's design. No
additional incentive for the monetary authority to inflate
should be provided by the tax system, and taxpayers should not
be penalized due to inflation. Therefore, tax brackets should
be indexed for inflation.
Clarity. The best tax system makes clear how much
is owed, who pays, and when the tax is being paid.
Simplicity. Tax payments should be made as easy
and as simple as possible for the taxpayer without any loss of
clarity.
Limited Bureaucracy and Intrusiveness. The fewer
tax collectors and the more limited their powers the better.
Minimize Incentives for Tax Avoidance. Taxes
should be low enough so as not to provide significant
incentives for avoidance.
No Additional Boost to Government Spending. A tax
system's design should not make it any easier for government to
increase expenditures.
How does a national retail sales tax--or the Fair Tax--
score according to these fundamental principles?
Low Flat Tax Rate to Promote Economic Growth.
Obviously, income would not be taxed under this plan and
consumption would be taxed at the final retail level at a flat
rate of 23 percent. By not taxing work, saving, investing, and
risk taking at all, pro-growth incentives and the economy would
receive major boosts.
For critics saying that such a tax would be regressive, in
fact a small amount of progressivity would be introduced into
the system through the family allowance rebate. SBSC's only
concern is to lower the proposed 23 percent tax rate.
No Taxation of Capital. The Fair Tax would do away
with cases of double, triple or more layers of taxation by not
taxing returns on investment and savings at all. Incentives for
saving, investment, and risk taking would skyrocket, with
entrepreneurship, economic growth, and job creation receiving a
significant boost.
Inflation Factor. The inflation question may seem
somewhat murky regarding the Fair Tax, but in the end, a retail
sales tax provides little incentive for the government to
inflate. One need only remember that inflation is a monetary
phenomenon, caused by money supply outpacing money demand.
Clarity. It remains difficult to imagine a clearer
tax system than the Fair Tax. Whenever one buys something, the
tax owed becomes immediately clear and is paid at that moment.
Simplicity. The Fair Tax would be far simpler than
an income tax system for individuals and many businesses.
However, some questions remain for retail businesses as to
whether a national retail sales tax eases or adds to their tax
compliance burdens. However, since most states already levy a
sales tax, additional compliance costs would be minimal, well
worth the elimination of federal income and death taxes.
Limited Bureaucracy and Intrusiveness. The Fair
Tax would allow the IRS to be disbanded and replaced with a
much smaller, less intrusive bureaucracy to collect sales taxes
in the very few states that do not impose sales levies.
Minimize Incentives for Tax Avoidance. One of the
most serious questions regarding the Fair Tax relates to tax
evasion. A national sales tax rate of 23 percent, especially
when combined with state and local sales taxes, and a seemingly
easy ability to avoid sales levies, creates a very real and
significant temptation for tax avoidance. Obviously, the best
way to deal with this issue is to cut the size of government
and lower the tax rate.
No Additional Boost to Government Spending.
Indeed, regarding its effect on government spending, the Fair
Tax actually should act as a restraint on the growth of
government. Every time a purchase is made at the retail level,
the cost of government becomes clear with the fair tax. Indeed,
little evidence exists that retail sales taxes are a major
impetus to the growth of government. In contrast, the current
income-and asset-based federal tax system fuels the growth of
government and hides the total cost of government from most
taxpayers.
As you can see, throwing out our current tax code in favor
of the Fair Tax would be a major pro-growth, pro-entrepreneur
reform. However, the biggest danger regarding the move from our
current income-and asset-based tax system to a retail sales tax
like the Fair Tax is the looming threat that in the end U.S.
taxpayers could be saddled with both a sales tax and an income
tax. Therefore, before a national retail sales tax is
implemented, the 16th Amendment to the U.S. Constitution, which
allows for the imposition of an income tax, must be repealed.
Without repealing the 16th Amendment, the chances that
politicians--who seemingly always seek to expand the power and
resources of government--would eventually impose both a sales
tax and an income tax are too great.
If the 16th Amendment were repealed, from an pro-economic
growth viewpoint, a retail sales tax is far preferable to any
kind of income tax.
Again, I appreciate this opportunity to address the ``Fair
Tax Act.'' Feel free to contact me at SBSC with any questions
or comments.
STATEMENT OF LORI KLEIN, TAXPAYER PROTECTION ALLIANCE, PHOENIX, AZ
Mr. Chairman, Honorable Members of Congress, Ladies and
Gentlemen:
Fundamental tax reform is an issue that is now sweeping the
nation. In a recent poll taken by the Tax Education Association
(TEA) 81.7 percent of the electorate now feel that tax reform
must be given high priority in the upcoming elections. The
study showed that although the IRS has attempted to create a
new image for itself, the public consensus is that the agency
is still as unpopular as ever. According to the poll, 75% feel
the IRS has too much power and 88.6% want to see the agency
further reformed or eliminated altogether. It also showed that
only 16.2% believe that our current income tax system is fair.
The Taxpayer Protection Alliance is a group of citizens
from Arizona who are dedicated to achieving fundamental tax
reform, which is non-other than the total elimination of both
our state personal and corporate income tax over the course of
four years. Currently, we have a petition initiative calling
for the abolition of our state income tax coupled with a voter
referendum, which does not allow politicians to raise our taxes
without voter approval. The ballot measure also calls for all
federally elected officials from Arizona to pledge in writing
to vote to abolish the federal income tax and replace it with a
national retail sales tax on consumption and have it duly noted
by their name on the ballot as ``Accepts IRS elimination
pledge.''
As many testifying here today have noted, removal of the
federal income tax system to be replaced with a national sales
tax has a myriad of benefits to our economy and personal
freedom. I would like to address today however, the benefit of
the states adopting similar measures throughout the nation to
coincide with the elimination of the current progressive income
tax on the federal level.
THE ARIZONA ECONOMY
While Arizona's employment rate is low and the economy is
strong, things could be much better. Many people who have jobs
have low-paying service sector jobs. Arizona ranks near the
bottom of the states in annual per capita income. About half of
all jobs held by Arizonans are in the bottom third of
industries ranked by average annual pay, according to economist
Debra Roubik of VisionEcon. 16% of all high-paying jobs in
Arizona are high-tech manufacturing jobs, and 14% are in high-
tech services (ATTACHMENT 1). These are the jobs being created
by the ``new economy.'' These are the jobs in the sector of the
economy with the greatest promise for the future.
THE IMPACT OF ELIMINATING INCOME TAXES ON THE STATE ECONOMY
A study for the Arizona Association of Industries by
Deborah Roubik of VisionEcon, published in January 2000, and
cited in the Arizona Business Gazette and other publications,
verified findings suggested by the classic work of Timothy
Bartik in 1991 regarding the effect of state taxes on local
economy. She found that for every 1 percent decrease in the
state corporate income tax rate there is a 0.3 percent increase
in new job creation, compounded annually. Furthermore, she
found an inverse correlation between the marginal personal
state income tax and high-tech service jobs as a percentage of
jobs in the state. That is, the lower the income tax rate, the
greater the percentage of high-tech service jobs, and vice
versa (ATTACHMENT 2).
The marginal state corporate income tax for a multi-state
corporation in Arizona is 3.5%.
Elimination of the state corporate income tax can be
expected to generate an increase in job creation of
approximately 1.2% per year, compounded annually, and increase
the number of high-paying, high-tech manufacturing jobs,
according to economist Debra Roubik.
Elimination of the personal income tax will assure that a
significantly greater proportion of those additional jobs that
are created will be in the high-paying high-tech service
fields.
Arizonans are losing out to residents of other states when
it comes to growth in earnings and higher paying jobs.
Arizona's residents are losing out to states like Nevada,
Texas, Washington, and Florida, where the absence of income
taxes create jobs with substantive earning potential--jobs with
a future. Although Arizona has a low unemployment rate, far too
many Arizonans are just barely ``getting by'' in low-end jobs
without much of a future.
ELIMINATING THE ARIZONA PERSONAL AND CORPORATE INCOME TAXES
IS THE MOST EFFECTIVE AND EFFICIENT SOCIAL WELFARE PROGRAM OUR
STATE CAN EVER PUT INTO PLACE.
SALES TAXES AS A REPLACEMENT FOR THE STATE INCOME TAX
A recent economic study by VisionEcon, using Arizona
Department of Revenue Annual Reports, demonstrates that, using
historical trends, the projected annual increase in sales tax
revenue generated by the typical growth patterns in the Arizona
tax base (Arizona employment is projected to continue growing
by almost 2% more than the national average), could be used to
painlessly reduce income tax collections every year. The result
would be a ``revenue neutral'' elimination of the income tax in
just seven years. This does not include any dynamic analysis.
That means it does not take into account the added revenues we
would get from the boom in economic activity and job-creation
coming about from reducing or eliminating the income tax. It
also does not take into account revenues from luxury tax and
estate and property tax revenues (ATTACHMENT 3).
Thus using dynamic scoring, it is plain to see how easily
the state's revenue stream can accommodate elimination of the
personal and corporate income tax.
Furthermore, in an Arizona Republic news article dated
April 2, 2000 it was reported that approximately $4.2 billion
in sales tax revenue goes uncollected each year as a result of
over 600 exemptions in the state sales tax, most of which were
enacted after intense lobbying from special interest groups.
This revelation came as news to most Arizona residents in
the private as well as the public sector. Few were aware that
these exemptions were ever passed into law. And these
exemptions are almost double the revenues currently collected
from the state income tax. Some of these special interests who
benefit from these exemptions, need them to offset the effects
of the income tax--that's the tradeoff. Special interests are
holding the average Arizona citizen and businesses hostage to
the income tax. IS THIS TAXATION WITH REPRESENTATION?
Governor Hull, in the same Republic article pointed out
that it is politically extremely difficult to overcome the will
of those special interests. But, if the Taxpayer Protection Act
was in effect, since many of those exemptions may have had to
get voter approval in order to go into effect, they may have
required an increase in some other tax to offset the exemption.
The special interests would have thus been cut out of the
loop--instead, today we see the voters cut out of the loop.
Furthermore, many special interest groups would not find it
necessary to seek exemptions if they didn't have to pay
personal and corporate income taxes.
WE WOULD BE BETTER OFF AS A NATION WITHOUT THE INCOME TAX
The income tax is based on a fundamentally flawed and
immoral idea that the state has a prior claim on the fruits of
another person's labor or property. A person's labor or idea's
are his/her property and the state has no right to seize those
assets, according to the precepts of our Founders. Thomas
Jefferson's view of government as the servant and the citizen
as the master has been turned upside down in large part due to
the income tax. The income tax inevitably places the citizen on
the defensive and takes away his very freedom and privacy. His
legal rights are further jeopardized, when, if found in error
on a tax form, he/her is now guilty until proven innocent.
Furthermore, the laws and constitution have been so
weakened in our country, that it is perfectly acceptable for
the government to extort billions and trillions in income tax
dollars and redistribute the wealth with no accountability to
those that they've robbed. If your neighbor came to your house
and took half of your property, he would go to jail. However,
if the government does the same and gives it to the neighbor
down the street who chooses not to live a productive life--it's
justified. What kind of lunacy have we become accustomed too.
This kind of unfair tax system corrupts the very soul of the
nation. Not only does it, by its very nature, corrupt the
political process, it corrupts the integrity of its citizenry,
by creating an environment whereby they feel unfairly assaulted
and violated by their government. They then try to avoid the
tax as we've seen with the highest non-compliance to date. The
income tax does not respect the boundaries of a free society
and has no place in a free society. It is frankly Un-American.
We can rename the House Ways and Means Committee, the House
Committee on Un-American Activities. (Just kidding)
The Taxpayer Protection Alliance calls for the complete
abolition of the income tax, the Sixteenth Amendment, and the
IRS. We would hope that this committee would adopt legislation
introduced by Rep. John Linder (R-GA) and Rep. Petersen (D-MN).
Then we can rest assured that we might usher in a new
Millennium of freedom and prosperity for all Americans. We
could do away with taxation without representation. We could
then claim we are the nation that believes in ``life, liberty
and the pursuit of happiness.'' Our Founders would accept
nothing less, why should we?
(Testimony written by Taxpayer Protection Alliance
Treasurer, Jeffrey A. Singer and Executive Director, Lori
Klein, 3431 W. Thunderbird Avenue, Suite 302-PMB, Phoenix, AZ,
85053, (602) 866-2394)
[Attachments are being retained in the Committee files.]
STATEMENT OF UWC-STRATEGIC SERVICES ON UNEMPLOYMENT AND WORKERS'
COMPENSATION
Comprehensive Tax Reform Must be Sensitive to Sound
Unemployment Insurance Policy
UWC-Strategic Services on Unemployment and Workers'
Compensation, the only business organization specializing
exclusively in public policy advocacy on national unemployment
insurance (UI) and workers' compensation issues, urges Congress
to Address UI payroll tax issues, including repeal of the 0.2%
Federal Unemployment Tax Act (FUTA) surtax and UI
administrative financing reform, when considering any
fundamental federal tax reform proposal. UWC supports a strong
UI program through which employers provide fair and affordable
insurance benefits for a temporary period of time to workers
with a strong attachment to work and who are temporarily and
involuntarily jobless when suitable work is not longer
available.
Several proposals have been introduced in the 106th
Congress to significantly change the current federal tax
system. Many of these proposals will repeal sunset the Internal
Revenue Code (IRC) including the FUTA. Rather than dissolving
the federal/sale, we urge Congress to repeal the unnecessary
0.2% FUTA surtax and enact UI reform as contained in H.R. 3174,
The Employment Security Financing Act of 1999, introduced by
Representative Jim McCrery (R-LA). H.R. 3147 is supported by 36
co-sponsors, as well as a broad based coalition of 32 states
and more than 100 business organizations. These measures would
ease the tax burden on employers by 25% while providing
critically important UI administrative financing reform.
The Dangers of Sunsetting FUTA
The FUTA was enacted in 1935 and made part of the IRC. The
FUTA is the basic controlling federal law for UI, The FUTA
provides the basic framework for the state UI system, as well
as the revenue for the state agencies which administer the UI
program and provide a public labor exchange. The FUTA also
permits states to receive loans if their UI trust funds are
depleted, and it provides and extension of UI benefit duration
during periods of high and rising unemployment.
We seriously doubt that a new, equally simple, equally
enforceable and similarly equitable system for UI/ES could be
re-created and enacted in place of the FUTA.
Completely repealing the FUTA will jeopardize the safety
net for workers and employers. Important financial and legal
protections for workers will be at risk, and employers will
face added payroll taxes. Both workers and employers will be
hurt by repealing the federal protection against ``raid'' on
state UI benefit trust fund reserves.
Not one of the proposals being considered at this hearing
address these issues. Thus, until a viable solution is debated,
proposals to ``scrap the Code'' should not include provisions
that would eliminate FUTA.
Repeal the 0.2% FUTA surtax
Under current law, employers pay the FUTA tax at the rate
of 0.8% of taxable payroll ($7,000). This tax rate is 25% too
high as a result of a 0.2% ``temporary'' surtax which is no
longer needed. The tax is being collected only because
inclusion of FUTA surpluses in the unified federal budget
allows the federal government to meet budget targets for
unrelated spending programs. The practice of counting FUTA
dollars for spending on other programs, leaving only an IOU
behind, is contrary to the very reason Congress placed these
funds in the Unemployment Trust Fund.
Congress originally imposed the surtax in 1976 to pay for a
temporary federal program of supplemental UI benefits. This
program expired long ago. The deficit created by this program
was retired in 1987, but the surtax has been extended until
2007. The FUTA accounts within the trust fund all exceed their
maximums, making this surtax unnecessary. The revenue form the
surtax is not needed for the UI/ES program. Only 50 cents out
of every FUTA dollar is being spent as intended for the
administration of the UI/ES, program and no additional funds
are necessary to fund the 50% FUTA share of extended benefits.
The FUTA surtax adversely affects nearly every employer.
The money collected from employers for this surtax inhibits
hiring low wage workers and siphons away dollars that would be
better spent on jobs in rural areas, and facility and equipment
enhancements to provide a better work environment and increase
productivity and competitiveness.
24 years of a ``temporary'' tax is too long! Congress should
act quickly to repeal the 0.2% FUTA surtax by (1) including it
as part of the business tax incentives in the minimum wage bill
currently in conference and (2) enacting H.R. 3174 (discussed
below).
Enact UI Administrative Financing Reform (H.R. 3174)
Although complete FUTA repeal is not desirable, FUTA reform
is overdue. The present UI/ES program is not working
effectively. Workers are under-served, employers are overtaxed
and state UI/ES agencies and under-funded. Under the current
system, the federal government collects 100% of the FUTA
receipts but returns only 50% to the states. Shortchanging the
funding to administer UI has led to workers collecting more
weeks of unemployment benefits during the tightest labor market
in recent history, and states are forced to reach into general
revenues and employer pockets (through add-on payroll taxes) to
make up for the shortfall.
H.R. 3174 is specifically designed to solve this problem.
It will restore integrity to the UI trust funds. Not only is
the0.2% FUTA surtax repealed, but he remaining trust fund
dollars will be returned to the states--in full! This will
allow states to provide the necessary resources to better serve
UI claimants, job seekers, veterans and employers. H.R. 3174
will combat UI fraud and abuse by providing states with
adequate funding.
H.R. 3174 is consistent with the concepts of tax
simplification being presented at this hearing. Unnecessary
paperwork will be eliminated as employers will only have to
complete and submit a single UI tax form rather than two
separate federal and state UI tax forms. Equally important,
state legislatures--rather than Washington bureaucrats--will be
responsible for determining how much is necessary to run their
own state UI programs. This will provide added flexibility and
accountability--without taking away any protections from
jobless workers.
UWC urges swift enactment of H.R. 3174. It is a win for
workers, employers and states and is the right direction for UI
reform. For more information, please contact Vince Sampson at
(202) 682-1515.
STATEMENT ROBERT L. SCHULZ, WE THE PEOPLE FOUNDATION FOR CONSTITUTIONAL
EDUCATION, INC., QUEENSBURY, NY
Mr. Chairman:
Mr. Chairman, I would like to thank you for the opportunity
to submit these remarks for the record of the hearing on
fundamental tax reform. I am Robert Schulz, and I am Chairman
of the We The People organization from northern New York State.
I have been very actively pursuing the cause of good government
for 20 years--at the local, state, and federal level. The
organizations I chair are devoted to educating citizens about
problems of governmental wrongdoing, especially when government
behaves in violation of the state or federal constitutions or
in violation of the law. I also chair a group called the All-
County Taxpayers Association in New York State.
For more than a year now, we have been focusing in
particular on issues of illegal operations of the federal
income tax system. We have been learning from many sources
about numerous aspects of those illegal operations. And for
over a year, we, in turn, have been informing millions of
people across the country about what we have learned--reaching
as many citizens as we can by using various media: radio,
newspapers, the internet, newsletters, and even television. I
am a talk-radio host on a national radio network and also on a
regional talk-radio show in Albany, NY. You may be aware that
last July, we held a symposium at the National Press Club here
in Washington to examine issues of illegal operations of the
federal income tax system. The symposium was broadcast live by
C-Span and rerun several times over the next few days. We held
another conference at the National Press Club last November to
further discuss the income tax issues and what to do about
them. Although we asked the leaders of our three branches of
government to send knowledgeable representatives to our
meetings at the NPC to refute allegations and arguments being
presented, they did not respond and did not even acknowledge
our requests. That has led us back here to Washington this week
for a third time, to deliver a Remonstrance to the leaders of
our three branches enumerating the people's grievances over the
illegal operations of the federal income tax system. We have
provided each of you a copy of the Remonstrance. Thousands of
copies of the video tapes of the July symposium and the
November conference have gone out and are now circulating all
across the country--many in public lending libraries for all to
borrow. A number of other individuals have been broadcasting
and publishing for years about the problems I am going to tell
about, and now millions of citizens are aware of them.
Well, what ARE those issues; what ARE those grievances; and
what are the remedies? I will summarize as succinctly as I can.
Congressional hearings for years have been the forum for
horror stories by citizens who have suffered all kinds of abuse
at the hands of the IRS. Our grievances include those
outrageous and arrogant behaviors by the IRS perpetrated by its
agents, policies, and procedures. We are particularly
distressed at the utter lack of respect for due process and the
denial of due process in IRS procedures, including the
unwillingness of the IRS to provide information about our due
process rights, the denial of our rights to see the evidence
against us, to confront and cross-examine those who have
testified against us, and denial of our rights against illegal
seizure of our property by the IRS because of an
unconstitutional anti-injunction law, 26 USC Section 7421.
But as bad as these behaviors are, they are only a small
part of it; the problems are much deeper and they started early
in the 20th century. Our grievances largely deal with issues of
hoax, fraud, and deliberate deception.
It has been well established since 1985, and unrefuted,
that the 16th amendment, the so-called income tax amendment,
did not even come close to being legally ratified in 1913. It
was, indeed, fraudulently declared to be ratified by a lame-
duck Secretary of State, Philander Knox, and just a few days
before he left office to make way for the Wilson
administration. Knox's motive is easy to see. He had for many
years been attorney for Carnegie, Rockefeller, Morgan, and the
Vanderbilts, and had put together the largest of their cartels.
He was paving the way for the Federal Reserve Act that was
passed later in 1913. The central bank would want a more
reliable flow of revenue to assure payment on the debt that the
government would be incurring. Knox had already had practice in
this method by his role in taking over the tax collection
systems in Honduras and Nicaragua to assure payment of loans to
those governments. Senator Nelson Aldrich, spokesman for
Rockefeller and Morgan, had pushed the income tax amendment
through the Senate in 1909, and, as a result of a meeting he
convened at his vacation ``cottage'' among several of the
nation's most powerful bankers representing Rockefeller,
Morgan, and the Rothschilds, he designed the Federal Reserve
legislation that passed in 1913, under the guise of banking
reform.
The research that conclusively revealed the fraudulent
ratification of the 16th amendment was done by Mr. Bill Benson,
a former investigator for the Illinois Department of Revenue
who spent a whole year among the archives of all 48 states and
the federal government. Here are some of his findings. [See
``Examples of States That Failed to Ratify the 16th Amendment''
on page 5.]
What has been the government's response to Benson's work?
Well, one senator, until recently a presidential candidate,
tried to pay Mr. Benson--offered to make him a millionaire if
he would only not publish the results of his work, turn over
all 17,000 certified documents he had obtained from the
archives, and agree never to talk about his research again.
However, to Mr. Benson, our republic is not for sale. He
published, and every member of Congress received a personal
copy of his two-volume report. I am sure he would be happy to
provide a copy to any member of this committee. It is not out-
of-date. It is history.
Other responses by Congress have been produced by the
Congressional Research Service in the form of a report written
in 1985 by Thomas Ripy about the 16th amendment issue and in a
1996 report by John Luckey titled ``Frequently Asked Questions
Concerning the Federal Income Tax.'' Neither report mentions or
addresses the key issue of fraudulent ratification of the 16th
amendment. They are, therefore, non-responses.
The courts have refused to address the fraud issue, calling
it a political question for Congress, even though fraud is
clearly a matter for the courts and is not subject to the
normal statute of limitations. Congress has said that it is a
matter for the courts. We say it is an issue for both Congress
and the courts, and it must be addressed. The government must
not stonewall on this issue any longer.
The IRS has addressed the 16th amendment question in it's
publication titled ``Why Do I Have to Pay Taxes?'' This is sort
of a mini-version of the Luckey Report, and can be found on the
Internet. Its answer to the argument that the 16th amendment
was not properly ratified is to state that the 16th amendment
was ratified on February 3, 1913, and then to quote the words
of the amendment. This, of course, is a non-response to the
question and means nothing. It is pathetic and insulting (and
the date is wrong; it was February 25).
Another major issue and grievance is that the IRS operates
in such a way as to collect income taxes from almost all
citizens even though no law or regulation requires most
citizens to file and pay income taxes nor to have those taxes
withheld from the money they earn. The IRC and its regulations
make liable for the income tax only ``foreigners here and
citizens abroad,'' but not most of us, unless we have income
earned abroad. This has been demonstrated of late by those,
especially employers, who have carefully studied and exercised
the rules as written and have succeeded in making the IRS abide
by them.
The standard response of the IRS to the liability argument
is to quote 26 USC Sections 1,6001,6011,or 6012, which the IRS
uses as the all-encompassing filing requirements. Section 1
imposes the tax on ``taxable income;'' Section 6001 says,
``Every person liable for any tax imposed under this
title...shall keep such records... make such returns...and
comply with such rules and regulations as the Secretary may
prescribe;'' Section 6011 says, ``When required by
regulations...any person made liable by any tax imposed by this
title shall make a return;'' Section 6012 says, ``Returns...
shall be made by...[e]very individual having...gross income
which exceeds the exemption amount...''
These, again, are non-responses that merely beg the
original question of just who is liable. The crucial question
becomes: What is ``gross income?'' And when we follow the
disjointed, disconnected, and deceptive trail through the code
and its regulations, we find in CFR 1.861-8(f)(1) that gross
income is income derived from foreign sources, i.e., foreigners
here and citizens abroad. When we follow the trail of
withholding law to find out what kind of income is subject to
withholding, it takes us to the same place and the same
conclusion: foreigners here and citizens abroad. The same is
true regarding liability for the Social Security tax, derived
from the International Labor Agreement of the 1930s. All three
trails lead to the same result.
Congressional response to the question of just who is
liable is exemplified in a 1989 letter from Senator Inouye to a
tax consultant constituent who asked about the precise
provisions of the IRC that render an individual liable for
income taxes. The letter says: ``Based on research performed by
the Congressional Research Service, there is no provision
which...requires an individual to pay income taxes.'' The
letter goes on to say that Article I Section 8 of the U.S.
Constitution gives Congress the power to lay and collect taxes,
and then makes the astonishing assertion that, ``Accordingly,
the IRC need not specifically state that individuals shall be
liable for income taxes because it is inferred from the
Congress' authority to so levy and collect.'' This letter would
have us believe that there is no need to bother with the
inconvenience of actually writing laws or regulations or
anything like that! Further, the letter then points out that
Section 7201 et al. sets forth penalties for failure to pay
taxes owed. The key word is ``owed,'' but the letter does not
explain how it is determined what taxes are actually owed or by
whom. Once again, we are given a non-response that simply begs
the question, along with a heavy-handed threat of prosecution.
The letter tries to give us the impression we can be prosecuted
for not doing something that no law or regulation requires us
to do.
It is significant that employers are learning of the scam,
as they are key to the whole system, along with the denial of
due process rights for individual citizens. The IRS uses the
false statements from employers (W-2s and 1099s) as prima facie
proof that employees have earned gross income that is taxable.
The IRS then makes it impossible in their procedures for an
employee to challenge the incorrect testimony of the employer
by refusing to issue summons so the employee can confront and
cross-examine the employer. Tax law 26 USC Section 3402 does
not protect employers from submitting false information. But
the IRS has bullied and coerced employers since the 1930s to do
so. Employees are then coerced into filing tax returns based on
false information submitted by employers and to ``voluntarily''
and unknowingly waive their 5th amendment rights when they sign
their 1040 forms, in order to get some small portion of their
money refunded.
What are the remedies? First, a national sales tax is not
the remedy, and we would not like to see the abuses by the
illegal operations of the IRS used as an excuse for imposing
such a tax. Excise taxes are most appropriate when used as
luxury, sin, or amusement taxes, not when used to tax the
necessities. Moreover, a national sales tax will be avoided by
those who can use vertical integration strategies, and the
people who can least afford it will end up paying a
disproportionate share.
The issue of the fraudulent ratification of the 16th
amendment must be addressed, not evaded, by Congress and by the
courts. Besides that, Congress must act to remove the
obstructions that prevent citizens from invoking the
protections of their constitutional rights when dealing with
the IRS in both administrative and judicial proceedings. The
due process issues and abuses must be resolved. The remedy is
to make the IRS and its agents obey the tax code and
regulations and respect citizens' constitutional rights to due
process, especially in administrative procedures. Denial of due
process is the main factor in the abuses by the IRS, because it
prevents people from defending themselves against those abuses.
Three changes to the code can go far towards accomplishing this
goal. All are in Chapter F (Administration): Sections
6326,6404(b), and 7421. Sections 6326 and 6404(b) effectively
enable errors or abuse by IRS employees to go uncorrected and
obstruct the IRS Commissioner from properly controlling
employees. Section 7421, as already mentioned, prevents
judicial intervention and review of illegal seizures of
property by the IRS in violation of our constitutional rights.
No statute can overrule the Constitution. Many of the horror
stories and abuses you hear about might be averted if it were
not for the obstructions to correcting erroneous or malicious
actions of subordinates by those above them or by the courts.
EXAMPLES OF STATES THAT FAILED TO RATIFY THE 16TH AMENDMENT
Philander Knox had received responses from 42 states when
he declared the 16th amendment ratified in February, 1913. It
was required that 36 of the 48 states at that time approve it.
Of the 42, Knox acknowledged that four had rejected the
amendment, bringing the number down to 38 that he said approved
it.
In Kentucky, the legislature acted on the amendment without
even having received it from the governor. (The amendment was
sent to the governor of each state in 1909 for transmittal to
their state legislatures.) The version of the amendment that
the Kentucky legislature made up and acted upon deleted the
words ``on income'' from the text of the amendment, so they
were not even voting on an income tax! When they straightened
that out, the Kentucky senate rejected the amendment. Yet
Philander, inexplicably, counted Kentucky as approving it.
In Oklahoma, the legislature changed the wording of the
amendment so that its meaning was the opposite of what was
intended by Congress, and this was the version they approved
and sent back to Knox. Yet Knox counted Oklahoma as approving
the amendment, despite a memo from his chief legal counsel,
Reuben Clark, that states were not allowed to change the
amendment in any way.
Attorneys who have studied the subject have published that
if any state could be shown to have violated its own state
constitution or laws in its process of approving the 16th
amendment, then that state's approval would have to be thrown
out. With that in mind, let's look at some other states.
The state constitution of Tennessee prohibited the
Tennessee legislature from acting upon any proposed amendment
to the U.S. Constitution received from Congress until after the
next election of state legislators. The intent, of course, is
to give the proposed amendment a chance to become an issue in
the state legislative elections so that the people can have a
chance to influence the outcome. It also provides a cooling off
period to reduce the tendency to approve ideas just because
they're trendy. You can probably guess that I am about to tell
you that the Tennessee legislature did not hold off on voting
for the 16th amendment until after the next election, and you
would be right--they didn't. That means they violated their own
state constitution; their approval is and was invalid, and it
brings the number of approving states down to 35, one less than
required for ratification.
Texas and Louisiana violated provisions in their state
constitutions prohibiting the legislatures from empowering the
federal government with any additional taxing authority. Now
our number is down to 33.
Thirteen states, including Tennessee again, violated
provisions in their constitutions requiring that a bill be read
three times over a period of at least three days before voting
on it. This is not a trivial requirement. So we must subtract a
dozen more states, bringing our number down to 21.
Several states returned unsigned, uncertified, or unsealed
documents back to Knox, and did not rectify their negligence
even after being notified and warned by him. The most egregious
offenders, were Minnesota, Ohio, California, Arkansas, and
Mississippi. Minnesota did not send any copy at all, only a
note from the governor's secretary, so Knox could not have
known at all what they voted on. Four of these five states were
already disqualified above, leaving California to be
subtracted, which brings our number down to 20, which is 16
fewer that the number required. These last five states, along
with Kentucky and Oklahoma, have particularly strong
implications with regard to the charge of fraud against Knox,
in that he absolutely knew they should not be counted.
We could go on, but with the number down to 20, this is a
suitable place to rest. Benson's findings show beyond doubt
that the 16th amendment was not legally ratified and that
Secretary of State Philander Knox did not just commit an error,
but committed fraud, when he declared it ratified in February
1913.
Very truly yours,
Robert L. Schulz
STATEMENT OF HAROLD APOLINSKY, ESQ., SIROTE AND PERMUTT, AND DAN R.
MASTROMARCO, THE ARGUS GROUP
Mr. Chairman and Members of the Ways and Means Committee:
We are pleased to submit this testimony which analyzes the
impact of the leading national sales tax plan, the FairTax on
nonprofit organizations. We believe that a shift to a
consumption approach would in fact be extremely beneficial in
several respects. It will improve economic growth--the primary
determinant of charitable giving. It would remove the bias
against non-itemizers. It would enhance the resources both
itemizers and non-itemizers have by ensuring that they can make
their contributions with pre-payroll tax dollars. This paper
presents these arguments.
Background Discussion:
Some 150 years ago, Alexis de Tocqueville marveled at
Americans' propensity to ``found seminaries, build churches,
distribute books... [He]... often admired the extreme skill
they show in proposing a common object for the exertions of
many and inducing them voluntarily to pursue it.'' If he would
visit America for a third time, he would find that charitable,
nonprofit organizations continue to play a vital role in
meeting needs unmet by the private sector or by governmental
agencies. From centers of learning, to health care facilities,
to poverty relief organizations, to public policy research
institutions, these institutions are an indispensable part of
the American economic and social landscape--and thankfully so.
Last year Americans donated more than $100 billion to
charities, churches, foundations and other humanitarian causes.
When it comes to evaluating various tax reform proposals,
it is right to consider its effect on charities. When
considering the effects of shifting to a consumption tax system
on the economy, on businesses and on individual taxpayers, we
must be careful to ensure the continuing ability of charities
to perform their essential role of facilitating charitable
acts. We must ensure that, under any tax system, the good works
of charities are not diminished.
However, some recent observers of American history
incorrectly assume a vast change. They believe that if
charitable donations are not deductible then charitable
organizations could not exist; indeed, charity itself might
cease to exist. The reason they always give is that the level
of charitable giving in this country has a one-to-one
elasticity tied to the tax code and tax deductions so the
steeper the rate of tax, the more pain one feels, the more
inclined they are inclined to be ``charitable.'' Their
conclusions are axiomatic as a syllogism:
1. steep marginal income tax rates and very high death
taxes improve the volume of gifts by reducing the relative cost
of giving versus consuming.
2. Reducing those rates will concomitantly reduce giving.
3. A consumption tax must reduce charitable giving since it
renders irrelevant a deduction against income, thereby
eliminating any advantage to giving.
While this is the crux of the main argument, other
arguments are advanced. The relative cost of capital for
nonprofits will increase, since a consumption tax may irradiate
the distinction between tax-exempts and for-profits on income
from passive or related sources.
These arguments have acquired a choristic-like following.
The Independent Sector, along with the Council on Foundations,
released a report on April 28, 1997 entitled ``The Impact of
Tax Restructuring on Tax Exempt Organizations,'' which was
intended to criticize consumption tax proposals. The report
concluded that under a sales tax contributions to tax exempt
groups would decline by at least $33 billion or 35%. They
estimated that proposals which eliminate the charitable
deduction would lower annual contributions on the order of 10
percent to 20 percent.
The First Misconception: A Deduction is Necessary
Large and small donors are not ignorant of the tax
ramifications of their actions, but neither are they primarily
influenced by them when doing charitable deeds. Individuals
give to charities not for tax deductions, but because they
believe in the charitable works they support. There is, of
course, much anecdotal data. In the early 1900's, before any
death tax and with very low income taxes, the Vanderbilts
endowed Vanderbilt University, the Stanfords endowed Stanford
University and the Dukes endowed Trinity College in Durham,
North Carolina.
The empirical data also suggest that there is, in fact,
little linkage between the tax deduction and nonprofit giving.
Giving actually increased after marginal rates were
significantly reduced in 1981 and again in 1986 and after the
elimination of the charitable deduction for non-itemizers in
1986. Total giving increased (in inflation adjusted dollars)
every year between 1983 and 1989.
The linkage assumed by researchers is not tempered by the
importance of economic growth in charitable giving. A tax of 90
percent on income, for example, will lead to enormous growth in
charitable giving as would an extraordinarily high death tax
rate. Apparently, the higher the rate, the higher the marginal
incentive to give and the lower the cost of giving. At a 90
percent tax rate, giving--as opposed to consuming--would only
cost 10 cents on the dollar. Hence to benefit charities, we
need to have a tax policy that makes holding onto the proceeds
of our labor is as painful as holding on to a hot pan.
If such a linkage were mandatory for charitable acts,
legitimate questions should be raised as to whether or not
one's donation truly constitutes a charitable act. Let's take a
taxpayer who is in a 40 percent income tax bracket. Assuming
the taxpayer is not subject to other restrictions governing
charitable donations, and assuming the taxpayer itemizes, if
the taxpayer gives ``x'' dollars to charities, his taxes will
be lowered by ``x'' times 40%. However, this simply means that
other taxpayers' taxes would have to be increased to make up
the difference of the taxes foregone. Thus, by saying the
taxpayer is inclined to be ``charitable'' because his taxes
would be reduced by ``x'' times 40%, we are saying that the
taxpayer is inclined to be charitable only since he can, in
part, be charitable with other taxpayers' money. If taxes
escalate by income bracket, then we are saying something more.
We are saying that the economic votes cast by higher wage-
earners are more important than those cast by non-itemizers or
lower wage-earners. The government might as well develop a
matching program, where the wealthier you are, the greater the
government values your opinion on where to spend your
eleemosynary resources and the greater your matching resources
from the pool of unwitting and unrecognized accomplices. Or
alternatively, the wealthier you are the more other taxpayers
need to subsidize your generosity in order to prompt it.
Thankfully, this is not the case. Acts of giving are often
spontaneous, compassionate impulses. Moreover, the data suggest
correlations of greater significance than a deduction. Active
civic participation is more important to a healthy nonprofit
sector than the presence of any tax credit or deduction.
Benefactors are far more influenced by the desire to contribute
to charitable causes. Most importantly, perhaps, income growth
has more to do with boosting charitable contributions than tax
incentives.
How much does economic growth influence charitable giving?
It has been said by researchers that as the fortunes of the
country go, so goes the contributions to philanthropic causes.
In fact, after years of analysis, we can be a whole lot more
specific: as the Gross Domestic Product changes, so goes
approximately 2% of the total value of the goods and services
to philanthropic causes. Total philanthropy as a percentage of
GDP has held steady at around 2% for at least two decades.\1\
Although the tax code has changed frequently and dramatically
over the past 23 years, giving as a share of personal income
has hovered around 1.83 percent. This measure reached as high
as 1.95 percent (in 1989) and as low as 1.71 percent (in 1985,
the year before non-itemizers ability to deduct charitable
contributions was permitted). The narrow range has persisted
even through the top marginal rate has fluctuated in that
period between 28 and 70 percent.
---------------------------------------------------------------------------
\1\ Giving USA, 1997. AAFRC Trust for Philanthropy, 1997. See,
http://www.cae.org/Trends/sk03.htm.
---------------------------------------------------------------------------
Because of the importance of the relationship between
giving and income, slight shifts in GDP represent considerable
dollars in charitable giving. For example, one quarter of 1
percent of GDP at $8.8 trillion (the estimated 1999 level)
equals $22 billion.\2\ As GDP goes, so eventually does
voluntary support.
---------------------------------------------------------------------------
\2\ Voluntary Support of Education 1996, Council for Aid to
Education. See, ``http://www/cae.org/Trends/sk14.htm. Other indicators
include the stock market. The trough in giving between 1971 and 1984
coincided with a poorly performing stock market during the 1974-1982
period and two recessions. The dips and rises of the stock market are
said to be mirrored by charitable support within a year
---------------------------------------------------------------------------
So at least the data--as opposed to theory--suggest that to
properly consider the effect of tax reform on charities, we
must consider the effect of tax reform on economic growth.
Giving is more dependent on how much donors have to give than
how much the government will match their contributions with the
taxes of middle income taxpayers.
Contrary to the assertions of the anti-consumption tax
choral group, one of the most constructive steps that can be
taken to improve the rate of economic growth would be to
replace the current tax system with a consumption tax. It is
the nearly universal opinion of economist that a consumption
tax, like the FairTax, for example, would reduce the tax bias
against work, savings and investment, improve the productivity
and competitiveness of U.S. firms and improve the real wages of
American workers. Replacing the income tax with the Fair Tax
will dramatically improve the standard of living of the
American people.\3\
---------------------------------------------------------------------------
\3\ A quote attributable to Maimonides [Moses ben Maimon[ (c. 1170)
seems particularly apt. ``Anticipate charity by preventing poverty;
assist the reduced fellowman, either by a considerable gift or sum of
money, or by teaching him a trade, or by putting him in the way of
business so that he may earn an honest livelihood, and not be forced to
the dreadful alternative of holding out his hand for charity. This is
the highest step and the summit of charity's golden ladder.''
---------------------------------------------------------------------------
Economic studies have been done on this as well. Work by
Harvard economist Dale Jorgenson shows a quick 9 to 13 percent
increase in the GDP after passage of the Fair Tax \4\ ;
similarly, Boston University economist Laurence Kotlikoff
predicts a 7 to 14 percent increase.\5\ These gains are in
addition to the increases that would have been achieved under
current income tax law. Most of these gains come in the first
decade. Work by economist Gary Robbins shows that replacing the
current tax system with a flat tax system that taxed capital
and labor income equally--such as the sales tax or the flat
tax--would increase the GDP 36.3 percent and increase private
output by 48.4 percent over the long run.\6\ Even a study by
Nathan Associates funded by the National Retail Institute,
shows that the economy would be one to five percent larger
under a sales tax than in the absence of reform.
---------------------------------------------------------------------------
\4\ Jorgenson, National Tax Research Committee. See also, ``The
Economic Impact of Fundamental Taxing Consumption,'' Dale W. Jorgenson,
Testimony before the House Ways and Means Committee, March 27, 1996 and
``The Economic Impact of Fundamental Tax Reform,'' Dale W. Jorgenson,
Testimony before the House Ways and Means Committee, June 6, 1995.
\5\ Kotlikoff, National Tax Research Committee. See also, ``The
Economic Impact of Replacing Federal Income Taxes with a Sales Tax,''
Laurence J. Kotlikoff, April 15, 1993, Cato Institute Policy Analysis.
\6\ Robbins, currently a principal in Fiscal Associates, is former
Chief of Applied Econometrics at the U.S. Treasury Department,
``Looking Back to Move Forward: What Tax Policy Costs Americans and the
Economy,'' Gary Robbins and Aldona Robbins, Policy Report No. 127,
September 1994, published by the Institute for Policy Innovation, p.
31, p. 47.
---------------------------------------------------------------------------
Those that state that charitable contributions would go
down after a consumption based tax approach may still choose to
make their arguments. However, to be valid they must succeed in
explaining why, after eligibility for itemized deductions was
constricted, charitable contributions historically rose.\7\
They must also address the issue of economic growth since
virtually every economist who opines that deductions are needed
for charitable contributions, also makes the case that a
consumption tax would improve economic prosperity.. Either
there is no linkage between economic growth and contributions
or a consumption based approach will not improve the economy--
both of which are against the prevailing economic wisdom.
---------------------------------------------------------------------------
\7\ Steve Moore, Director of Fiscal Policy Studies at the Cato
Institute, points out in a Washington Times article (June 18, 1997)
that ``the last time the [Independent Sector] tried to measure the
impact of tax code changes on charities, it predicted that the 1986 Tax
Reform Act would trigger an $8 billion decline in charitable
contributors in 1987. Instead charitable giving rose by $6.4 billion,
or 7.6 percent after the top rate fell from 50 percent to 28 percent.''
---------------------------------------------------------------------------
Moreover, it is not enough to point out only that the cost
of giving goes down because of the charitable deduction. If the
cost of giving is a determinant, they must also address why
their enthusiasm for the current income tax system's tax
benefits is not dampened by the fact the FairTax lowers the
costs of contributions. It does so in two respects.
To begin with, even if we assume that taxpayers are
encouraged to give only because of the charitable contribution,
the vast majority of contributors today do not receive any tax
advantage for their donations. The charitable contribution is
limited to those who happen to itemize (typically those who are
affluent enough to own real estate). According to the IRS,
Statistics of Income, there were only 30,587,000 itemizers in
1996 out of 111,694,000 taxpayers.
[GRAPHIC] [TIFF OMITTED] T1879.009
Since only itemizers may take the charitable contribution,
only about 27%, or one-quarter of all taxpayers, are even
eligible to take the charitable deduction. The relative ratio
of itemizers to non-itemizers has remained relatively stable
over the near term.
The most important question with respect to the charitable
constitution is not how the tax code treats a contribution, but
rather how much a taxpayer has at his or her disposal to
contribute. In other words, what must a taxpayer earn in order
to make that contribution? This is where the income tax system
severely restricts the ability of a non-itemizer to make a
charitable contribution. The graph below simply depicts the
effect of the income tax and the payroll tax on the earnings of
a taxpayer who does not itemize, but who is in the 28 percent
tax bracket. The combined effect of the 15.3 percent payroll
tax (assuming the employee bears it) and the 28 percent
marginal tax bracket means that the taxpayer must earn $176 to
make a $100 contribution to charity. In other words, the
government effectively imposes a $76 excise tax on the
taxpayer's gift to the charitable organization.
[GRAPHIC] [TIFF OMITTED] T1879.010
Of taxpayers who are eligible to itemize, an interaction of
complex additional restrictions apply to further erode the
benefit of the deduction. For example, if a donor contributes
appreciated property that is considered ``ordinary income-type
property,'' \8\ as opposed to long term capital gain, the donor
must reduce the gift by the amount of ordinary income that
would have been recognized if the property were sold. Hence,
gifts of inventory, art works, letters and other similar
property created by or for the taxpayer, are generally severely
limited to exclude appreciation. Corporations are limited when
making contributions of inventory or depreciable real property
to one-half of the ordinary gain that would have been realized
if sold.\9\ Moreover, the value of gifts of tangible personal
property and gifts to certain private foundations, must be
reduced by the ``total amount of the gain that would have been
long-term capital gains if the property were sold for its then
fair market value on the date it was contributed.'' \10\
Furthermore, individuals are subject to a deduction ceiling
based on the type of property contributed and the type of
charity to which the contribution is made--a ceiling that can
be as low as 20 percent of the individual's adjusted gross
income. These are just a few of the restrictions.
---------------------------------------------------------------------------
\8\ This provision is defined in Internal Revenue Code section
170(a) and the regulations thereunder.
\9\ This complex provision is contained in IRC section 170(e)(3).
\10\ IRC section 170(e)(1).
---------------------------------------------------------------------------
Even if a charitable contribution is allowed, it of course
only entitles the donor to make the gift after payroll taxes.
The U.S. Office of Management and Budget estimates the total
tax revenues lost from charitable contributions \11\ (known in
tax jargon as tax expenditures) to be $2.7 billion for
education, $2.4 billion for health, and $17.1 billion for other
purposes, for a total of about $22 billion. However, it is
important to note that as large as this tax expenditure is, the
charitable contribution is limited in one other significant
respect: it only serves to negate the income tax. Under the
current system, even if a taxpayer itemizes and even if he can
qualify to take the deduction, the charitable deduction only
off-sets one type of tax that he pays among the taxpayer's
total tax liability--the income tax.
---------------------------------------------------------------------------
\11\ See, Budget of the U.S. Government, Fiscal Year 1999.
---------------------------------------------------------------------------
These payroll taxes, be they employer-and employee-combined
payroll taxes or self-employment taxes paid by our nation's
more than 17 million entrepreneurs, comprise a significant
segment of the taxes Americans pay today. As a national
aggregate, in 1997 individual income taxes were $737.5 billion.
Payroll taxes were $539.4 billion, or 42 percent of the
combined total. Many taxpayers, especially lower income
individuals, pay a greater portion of their tax liability in
payroll taxes as opposed to income taxes.
To graphically illustrate what benefit is provided by the
charitable deduction today, let us see the world through the
eyes of a fairly average couple. In 1995, the median family
income of a married couple was $47,129. If that income were all
wage income, then that couple would have paid $7,210 in
combined payroll taxes on those wages (employer and employee
share). Even if that couple did not itemize (which they
certainly would because of the mortgage interest deduction),
the maximum income taxes that they would pay if they filed
married filing jointly would be $6,433, or 10 percent less than
the payroll taxes.\12\ In other words, the couple would have
paid more payroll taxes than income taxes. Even if that couple
itemizes, and the couple takes a charitable contribution
deduction, the couple cannot take that deduction against the
most significant form of taxes that apply to them--payroll
taxes.
---------------------------------------------------------------------------
\12\ $47,129--$7,100 (standard deduction for married filing
jointly) = $40,109. The income tax on taxable income of $40,109 =
$6,433.
---------------------------------------------------------------------------
The graph below depicts what an itemizing taxpayer must
earn today to donate $100 to charity.
[GRAPHIC] [TIFF OMITTED] T1879.011
Now let us consider what happens under the FairTax
consumption tax. Under the Fair Tax, charitable contributions
are not taxed--not at all. They are neither taxed to current
itemizers nor to non-itemizers. Therefore, like current law,
donors would donate earnings out of pre-income-tax dollars.
More to the point, since the Fair Tax repeals both the payroll
taxes and the income taxes, the effect of not taxing their
contributions is to ensure that the payments are made with both
pre-income and pre-payroll tax dollars.
Even for those who believe the deduction is important, this
should significantly advantage charities relative to current
law by reducing the costs of contributions. A taxpayer today
must earn at least $108.28 to contribute $100 if only the
``employee'' share of the payroll taxes is considered. If the
employer payroll taxes are considered \13\ (or if the taxpayer
had a sole-proprietorship), he or she must earn $118.06. Under
the Fair Tax, that taxpayer would only need to earn $100 to
contribute $100.
---------------------------------------------------------------------------
\13\ Most economists believe that the employer-employee split is
really fiction and that employees really do bear the full 15.3 percent.
However, we make this adverse assumption in order to arrive at a
conservative estimate of the advantages of the Fair Tax.
---------------------------------------------------------------------------
The relative advantage of allowing a deduction against
income vs. not taxing income or wages is depicted in the graph
below. In this graph, we see that the cost of charitable giving
will actually go down considerably under the Fair Tax. Hence,
even if taxpayers are wholly motivated to give due to tax
treatment, the Fair Tax lowers the cost of charitable giving
and increases the resources available for donations. In other
words, the cost of charitable giving relative to alternative
uses of the funds will go down.
[GRAPHIC] [TIFF OMITTED] T1879.012
However, this is not the end of the advantages. With the
adoption of the FairTax corporations may become major
contributors to charity. Under the current system, total
charitable contributions for corporations may not exceed 10
percent of taxable income. Repealing this limitation will free
up corporations to give more.
Second Misconception: The Relative Cost of Capital Will Rise
Charitable giving represents a significant and thankfully
growing outlay. Total charitable giving in 1997 was estimated
to be $143.5 billion in 1997, which represents the second
consecutive year of growth and the largest growth spurt since
1989. However, it is important to bear in mind that individual
charitable contributions, while certainly important, are only a
portion--and not a major portion--of the resources that fund
eleemosynary organizations today.\14\
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\14\ The Internal Revenue Service, SOI indicates that while the
total contributions, gifts and grants received by nonprofits was about
$110 billion in 1994, this was divided between contributions directly
from individuals and corporations ($49.2 billion), from affiliated
organizations ($8.7 billion) and from government grants ($52 billion).
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The major source of nonprofit income is not contributions
at all, but an item called ``program service revenue,'' which
includes commercial activities. Tax-exempt organizations
constitute a significant portion of the Gross Domestic Product
(GDP), more than 10 percent of GDP today, and their growth rate
has outstripped the GDP and the private sector. Moreover, all
tax-exempt nonprofits, particularly 501(c)(3) nonprofits,\15\
are increasingly reliant on commercially oriented as opposed to
donative oriented sources of income. This activity is
concentrated in the largest nonprofits. When nonprofits rely on
commercial sources of revenue, they derive that revenue
primarily from the service industries. On this income, little
tax is paid either because the nonprofits declare the income as
substantially related to their exempt function or because they
are able to successfully allocate deductions to the unrelated
income.
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\15\ There are a total of 28 different nonprofit exemptions.
501(c)(3)'s are religious, educational, charitable, scientific or
literary organizations, testing for public safety organizations, etc.
When we refer to ``nonprofits'' as opposed to other tax-exempt, we
generally refer to these 501(c)(3)'s.
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To place this in perspective, in 1994, the latest year for
which IRS statistics are available, the total revenue for
501(c)(3)'s was $589 billion. These nonprofits had $993 billion
in combined assets in 1994. As a percentage of total receipt
contributions, gifts and grants of all types (including from
governmental entities) comprised only 18% of the total
resources. Direct contributions were only about $50 billion, or
8.4 percent of the total. Program service revenue was $422
billion, or about 72 percent of the total resources of
nonprofits.
In fact, organizations with assets of $50 million and above
rely on contributions, gifts and grants for only 11 percent or
their income in 1991. This figure held steady in 1994,
according to the IRS.\16\ This can be contrasted with
organizations with under $100,000 in assets, which relied on
gifts, grants and other contributions for 52 percent of their
revenue. The $50 million asset group derived 76 percent of
their income from ``program service revenue'' as opposed to 33
percent of the $100,000 asset class organizations. There is a
steady increase in reliance on ``program service revenue'' as
the size of the nonprofit, measured by asset holding or gross
income, increases.
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\16\ Summary of 1998, SOI Bulleting, Report by Cecelia Hilgert.
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Additionally, commercial type activity is concentrated in
501(c)3's. Gross profits from sales and service is the largest
source of income for 501(c)3's. If income is ``substantially
related'' to the exempt purpose, it is not considered unrelated
business income activity and is wholly exempted from taxation.
While the tax paid by nonprofits have increased over the last
decade, the increase has not kept pace with the growth of
nonprofit's commercial sources of revenue.
The Fair Tax consumption tax does nothing to alter the non-
contribution resource base of nonprofit organizations. If the
nonprofit earns income that is program service revenue, it is
not taxable. It should also be pointed out that if the
nonprofit earns unrelated business income--income that is not
substantially related to its exempt purpose--that income would
also be tax free to the nonprofit under the Fair Tax.
Conclusion
We maintain that the Fair Tax would have extremely
beneficial effects on charities and philanthropic giving. The
Fair Tax will improve the primary determinants of charitable
giving--economic growth and real income. The Fair Tax would
remove the bias against taxpayers who want to contribute today
by enabling every taxpayer to make donations with tax free
dollars. The Fair Tax would enhance the resources both
itemizers and non-itemizers have to give by ensuring that they
can make their contributions with pre-payroll tax dollars.