UNITED STATES OF AMERICA

PRESIDENT\'S ADVISORY PANEL ON

FEDERAL TAX REFORM

NINTH MEETING

TUESDAY

MAY 17, 2005

The Panel met in the Auditorium at

McDonough Hall, Georgetown University Law School, 600

New Jersey Avenue, N.W., Washington, D.C., at 9:30

a.m., Connie Mack, Chairman, presiding.

PRESENT

THE HONORABLE CONNIE MACK, Chairman

THE HONORABLE JOHN BREAUX, Vice Chairman

THE HONORABLE WILLIAM ELDRIDGE FRENZEL, Panel Member

ELIZABETH GARRETT Panel Member

TIMOTHY J. MURIS Panel Member

JAMES MICHAEL POTERBA Panel Member

CHARLES O. ROSSOTTI Panel Member

WITNESSES

JOSEPH BANKMAN Ralph M. Parsons Professor of

Law and Business, Stanford

University

MARTIN FELDSTEIN George F. Baker Professor of

Economics, Harvard University

and President and CEO of the

National Bureau of Economic

Research

GROVER G. NORQUIST President, Americans for Tax

Reform

PAMELA F. OLSON Partner, Skadden Arps Slate

Meagher & Flom, LLP

LESLIE B. SAMUELS Partner, Cleary Gottlieb Steen

& Hamilton, LLP

JON TALISMAN Partner, Capitol Tax Partners

ERIC J. TODER Senior Fellow Urban Institute

MARK A. WEINBERGER Americas Vice Chairman ‑ Tax

Services, Ernst & Young, LLP

I‑N‑D‑E‑X

Page

Welcome by Senator Connie Mack 3

Panel I: Economic Perspectives on Tax Reform

Testimony by Martin Feldstein 3

Panel II: Policy Perspectives on Tax Reform

Testimony of Mark Weinberger 29

Testimony of Jon Talisman 38

Testimony of Leslie B. Samuels 47

Testimony of Pamela F. Olson 54

Panel III: Issues Associated with \"Return‑Free\"

Filing

Testimony of Eric J. Toder 103

Testimony of Joseph Bankman 111

Testimony of Grover Norquist 119

P‑R‑O‑C‑E‑E‑D‑I‑N‑G‑S

(9:30 a.m.)

CHAIRMAN MACK: Welcome everyone. In order to save some time, I\'m going
to forego any kind of opening statement other than to thank Georgetown
University Law Center for making this conference room available to us.
Our first panelist this morning will share with us some economic
perspectives on tax reform, a Professor of Economics, Martin Feldstein,
Harvard University and President and CEO of National Bureau of Economic
Research and, Marty, we\'re delighted that you\'re with us. John, do you
want to make a comment?

VICE CHAIRMAN BREAUX: Yes, I would just say that I think today\'s panel
is particularly outstanding, obviously starting with Martin Feldstein
but all the other former Secretaries, Assistant Secretaries and the
people who really ran the show. I think that this is a tremendous
opportunity for our panel to learn from some very distinguished people
who have actually worked in the vineyards on these matters and I\'m
looking forward to it with a great deal of interest.

CHAIRMAN MACK: Marty.

DR. FELDSTEIN: Thank you very much. I\'m delighted to be here. I agree
with the witnesses who\'ve told you that the current tax system not only
is too complex but also has serious adverse incentive effects on saving,
on individual work effort, on the way in which people are compensated
and therefore, is in need of change.

But I think it\'s worth bearing in mind that the tax system has become
much better over the years. When you look back at the fact that marginal
tax rates are down substantially, forty years ago, 91 percent top
marginal tax rate, even in 1980 70 percent. So I think that represents
significant progress. Similarly, the corporate tax rate is down from 52
percent to 35 percent. We have fewer deductions and exclusions thanks to
the Tax Reform Act of \`86 and the taxation of dividends and capital
gains has now been brought down.

So all of that, I think, represents significant progress and progress
that has important favorable effects for the economy. With lower tax
rates on individuals, we have stronger work incentives. People aren\'t
distorted in the way they take their compensation. They\'re not as
likely to take their compensation in fringe benefits rather than in cash
that\'s more valuable to them and saving incentives are improved.

I think lowering the tax on corporate income by bringing down the
corporate tax rate and by lowering the tax rate substantially on
dividends and capital gains has also been very helpful not only for
increasing the saving incentive, but also for removing some of the
distortions in the form of investment that occurs in the economy, the
mix between corporate and other and changing the financing incentives by
lowering the bias against dividends and in favor of debt finance that
exists in our law.

So the question is, where do you want to go next? And, the two things
that I think should be primary goals are to reduce marginal tax rates
that distort, continue to distort, individual incentives of all sorts;
and secondly, to reduce corporate income tax distortions that now reduce
saving by lowering the net return, that reduce dividend payout because
of double-taxation and that increase the use of corporate debt, which
raises the riskiness of the economy.

Now the fundamental reforms that have been a focus of much of the
testimony would achieve these goals. You would have lower rates and
you\'d have a reduction or elimination of the corporate tax bias if you
replaced our current system with a value-added tax or a national retail
sales tax or a flat tax or a consumed-income tax. But I think that any
of these fundamental reforms would raise very serious problems of
implementation, of distribution and of transition.

I think the distributional problems really eliminate a pure VAT
(value‑added tax) or a pure flat tax. I think an X‑tax or a consumed
income tax that would avoid those distributional problems would involve
major transition problems and we can come back to that if you want
during the questions.

So my own sense is that the best route to progress is in piecemeal
reforms. Piecemeal reforms could lower individual marginal tax rates and
they could reduce the distorting effects of the corporate income tax.
The two that I thought I would focus on for the couple of minutes in
this prepared part of my remarks are a change in the way we tax
two‑earner families from the current method of combining their incomes
to one that taxes husbands and wives separately and secondly, to
integrate corporate and personal income taxes.

Let me start by saying something about taxing husbands and wives
separately. As you know, now if a man is in the 25 percent bracket and
his wife goes to work, her first dollar of earnings are taxed at 25
percent. Obviously, that\'s symmetric. If the woman were working and the
husband joined, that would be the same thing. If we move to a system of
separate taxation, that would dramatically lower the marginal tax rate
on second earners.

This is not some strange new idea. We, the United States, are really the
outlier in comparison to other countries around the world. Most
countries around the world treat each member of a married couple
separately for tax purposes.

I think this kind of a shift to a separate taxation of husband\'s and
wife\'s earnings can be done in a revenue‑neutral way. Obviously it
involves changing the rate structure from what we have today and so
there are many different ways that it could be done. Moreover, there\'s
a choice as you do it between whether you do it just for wage and salary
income or you do it for all income. Again, I think that\'s a technical
issue that would have to be faced if you go down that road.

Let me finally say something about the idea of integrating corporate and
personal income taxes. A common method that has been used in other
countries is the so‑called \"gross‑up and credit\" method. The idea
there is simply to impute to individual shareholders their pro rata
share of corporate earnings and then to regard the corporate tax that is
paid by the company as a kind of withholding at the source.

So the corporate income tax then is also imputed to individual
shareholders. So you would get the equivalent of a 1099 from your
company saying that regardless of what your dividends were, the earnings
that correspond to your share ownership this year was \$112 and the
corporate tax is paid by the company on those earnings with so many
dollars. The individual would then receive a tax refund if their
personal rate was less than the corporate tax rate and would, since our
maximum personal rate is now the same as the corporate rate, in that
situation owe no additional taxes.

Now you could combine that with other kinds of corporate tax reforms
that I know that you\'ve heard about, investment expanding, changes in
interest rules and the like. But the basic advantage of moving to an
integrated system is that, first of all, it would lower the tax rate on
equity investment and on savings and thereby would provide a better
incentive for saving for a more appropriate distribution of consumption
between the short term and the long term. It would reduce the
anti‑dividend bias in the current law because with an integrated system
like this, there would be no change in taxes as dividends were altered
by the company. And it would reduce the current bias in favor of debt
finance. So I think it has a lot to recommend it. I\'ll stop there and
open for any questions that you have.

CHAIRMAN MACK: Marty, thank you very much for those thoughts and we\'ll
start with Bill Frenzel.

MR. FRENZEL: Dr. Feldstein, thank you very much for your testimony. You
state that the goals are to reduce marginal rates and reduce corporate
rates and obviously, we don\'t have any money to buy down rates and so
we\'re obliged to reshuffle the cards and rearrange what\'s out there.
Do you have any particular advice on the rearrangement?

DR. FELDSTEIN: I think the split of the taxation of husbands and wives
into two separate taxes needn\'t cost any money. It\'s a question of the
rate structure that you pick for individuals under the new rules so that
you would have something that favored two‑earner couples relative to
single‑earner couples, that help to reduce marginal tax rates on second
earners, but in terms of the overall cost of it, that needn\'t have a
cost.

The corporate income tax, unless you made other changes would have a
cost, but that, too, could be changed either within the corporate tax; a
variety of technical aspects of the corporate tax, in terms of the
definition of taxable income at the corporate level or through any of
the tax expenditure items, corporate and personal, that I know you all
have been thinking about.

MR. FRENZEL: Is it preferable, in your opinion, to reduce those
preference items to achieve the goals that you\'ve suggested?

DR. FELDSTEIN: It is.

MR. FRENZEL: Thank you. We think so, too.

CHAIRMAN MACK: Beth.

MS. GARRETT: Yes. Thank you. I appreciate both your suggestions. I want
to focus on the integration. We also heard testimony last week from Al
Warren and have talked about integration. As you know, there are several
different ways you can get there. The proposal you discuss is one that
would allow the rate to be collected at the individual\'s tax rate. So
if it\'s less than the 35 percent, there would be a credit.

Another way to integrate is to have an exclusion of dividend income at
the individual level, which just taxes it then at the corporate rate.
Can you explain why you presented this mechanism? I take it you prefer
that over the exclusion method. And what are the considerations we ought
to take into account as we determine how is the best way to integrate?

DR. FELDSTEIN: I\'d have to think harder about that rather than give you
a snap answer to that question. I think one of the issues in thinking
about integration is how it would affect those who do not currently pay
taxes at all. But the particular issue that you raise is not directly on
point with that. Of course, nontaxable entities that own shares,
foreigners that own shares, would not benefit from this because they\'re
not currently subject to double-taxation in the United States and that
is certainly one of the advantages of doing this.

VICE CHAIRMAN BREAUX: Thank you, Marty, for your recommendations and
your thoughts. I was particularly interested in the suggestion that what
we ought to be doing, I think I heard, is relatively piecemeal reform as
opposed to a major wholesale change in the current code. I think that
the charge from the President was to do a number of things and we all
know the outlines that he gave us.

One of the proposals would be called a piecemeal approach. Take the
current code and try and simplify it within the current code structure
paying attention to mortgage deductions and charitable contributions and
revenue neutral and assume the current tax cuts are going to be made
permanent which is a challenge in and of itself. I don\'t know why we\'d
look for anything else to do. If we can do that, we\'ve done an
incredible job. Some say an impossible task.

But there are other alternatives we can offer and the concept and the
thinking of some is to say, \"All right. Have the current code, make the
changes, piecemeal approach, but then look at some other alternatives
which would be big picture major changes.\" Some have considered a
consumption tax. Some have considered and talked and recommended to us a
consumption tax tailored with an income tax so you can have
progressivity preserved.

If we do look at a big picture alternative as one of our options to
throw back to the President, do you have any suggestions on how we do
that, particularly with the idea of a dual type of system? Is that
feasible or not?

DR. FELDSTEIN: The idea of a dual system seems like complicating an
already complicated tax system. You can get progressivity without having
a dual system in which you have two separate tax bases which is the way
you described it to me. So you could do it with a consumed income tax
where the tax base is consumption or you could do it with a so‑called
X‑tax, a value‑added tax, where at the business level you deduct, if
you\'re a business, the payroll payments that you make and you subject
those to taxation at the individual level subject to a progressive
schedule. You might call that a combination of a value‑added tax and an
income tax, but it\'s just an income tax on wage and salary income, the
part that\'s been excluded at the business level.

Of all of the different options for doing it, I think that X‑tax is the
one that has the fewest transition problems. I think a consumed income
tax immediately raises questions about what you do about existing assets
that people have. Can they get a deduction by \"saving the things
they\'ve already saved\" into some special account? Or do they pay tax
on money that they consume even though they\'ve already paid tax on it
previously under the income tax? That I think raises very difficult
transition problems.

The most serious problem under an X‑tax comes because of the general
idea that it would exclude interest deductions at the company level. If
you exclude interest deductions at the company level, interest rates
ought to fall and probably would fall because of the reduced desire to
use debt finance by companies. But the companies that are starting with
a large long‑term debt that have issued a lot of bonds in the past are
going to find that their profits fall substantially.

Individuals or other investors who are holding those bonds would get
windfall gains because the market interest rate on new bonds would fall.
So even in that case which I think is the best case in terms of
minimizing transition problems and distribution problems, you still have
a significant transition problem.

If you go to a more VAT‑like thing where you don\'t get a deduction for
wages, then the inflationary pressures of the transition would be
enormous. But I don\'t think anybody would think about going down that
direction as a pure VAT. But even an add‑on VAT of some kind would
create inflationary pressures in the transition.

VICE CHAIRMAN BREAUX: Thank you very much.

MR. ROSSOTTI: Professor Feldstein, we found already that there aren\'t
any completely clean, perfect solutions for these. I particularly agree
with both of your points conceptually. But in terms of the corporate
integration to the extent that we in some way broadened within the
individual income tax some forms of tax-free saving vehicles that
individuals would have and there\'s already a significant percentage of
stocks that are held by individuals in tax accounts but to the extent
that we broadened those and made it more and more possible for people to
basically hold most of their corporate stocks in those accounts, then
they would have a zero rate essentially on dividends as well as capital
gains for the stocks that were in those. Would you see that as a viable
path, recognizing it wouldn\'t achieve instant integration? But if you
went more and more in that direction, would that be something that would
solve the problem as you see it?

DR. FELDSTEIN: No, it wouldn\'t do as much as integration. It would
eliminate the distinction between corporate and noncorporate. It
wouldn\'t change the bias in favor of using debt. And of course, it
would only exclude dividends and capital gains up to the limit of
whatever size savings account you allow. So I think it would fall quite
far short which is not to say that I don\'t think those are good things.
So if the outcome of this entire process was to say that we learned a
lot and we\'re going to go back to increasing the Roth‑type IRAs, make
them more flexible or the two‑part proposal that the Administration had
a few years ago, I would say that was progress relative to where we are
today.

MR. ROSSOTTI: Thank you.

MR. MURIS: Marty, it\'s good to see you again.

DR. FELDSTEIN: It\'s good to see you, Tim.

MR. MURIS: On the transition points particularly moving to more of a
consumed income tax, are you saying that they\'re not going in that
direction? The transition costs just make it not worth the effort or do
you have some specific ideas?

DR. FELDSTEIN: I don\'t have a way to get around that. I think there is
a serious problem either way that you go. What do you do about
preexisting financial wealth or wealth in general? When individuals go
to spend it under a consumption tax, do you say, \"That\'s consumption.
We\'re going to tax it\" in which case they\'re paying a new tax on
something that they\'ve already paid tax on before?

Or do you say, \"If they take that money that they have in their current
stock account or bank account and they put it in some new special
account, they get a deduction for it\"? Then a lot more people would pay
no more taxes going forward. So you end up then with schemes of the sort
that were proposed years ago when people talked about these kinds of
things where you say, \"We\'re going to do it over ten years and we\'ll
have two systems running in parallel.\" It seems like a very complicated
world.

That\'s why I think if you want to go to a consumed income tax type
approach a much cleaner way of doing it is the so‑called X‑tax where you
basically have a value‑added tax but you exclude the wages as a cost of
business at the business level, tax it at the individual level subject
to whatever degree of graduated tax rates you want.

MR. MURIS: Thank you.

CHAIRMAN MACK: Jim.

MR. POTERBA: Marty, you\'ve spent a great deal of time studying the
incentive effects of the tax code and one particular area is the effect
on health insurance purchases and the health sector that inclusion of
health insurance premiums in taxable income is a current major
expenditure. If one were to try to trim that in some way, would you have
any advice on how to try to do that and what kind of economic effects
would you see following from those kind of reforms?

DR. FELDSTEIN: I think the current system does drive the kind of
insurance that we\'ve come to have because employer payments for health
insurance are excluded from taxable income and are a business expense to
the company. A lot of compensation flows in that way and the current
estimate of the tax expenditure associated with it is more than \$100
billion a year. So it wins first prize for the largest tax expenditure.

But it also has this tremendous distorting effect in leading individuals
and companies to want to take compensation in the form of health
insurance and that in turn drives up the cost of health care. So I would
put it high on the list of things to deal with except for two things.
One is the health savings accounts that were enacted as part of the 2003
Medicare legislation. I think the health savings accounts do change that
incentive and we\'re yet to see at least in Massachusetts the rules
won\'t be in place to allow those policies to be sold until later this
year.

So I want to wait and see what happens. Whether in fact this notion that
individuals can get a substantial tax break if they accept the large
deductible in their health insurance policy changes the nature of health
insurance in this country. I think that would be a direct way of doing
it.

I think there are imperfections in the way the health savings accounts
were designed, the fact that they depend on a deduction rather than a
co‑insurance rate. That means that the most that a family can spend
before they hit complete insurance is \$5,000 as opposed to a 50 percent
co‑insurance on \$10,000 which would keep more people sensitive to the
cost of medical care and not increase their maximum out‑of‑ pocket
expenditure.

The other thing I would say is that, when I was chairman of the Council
of Economic Advisors under President Reagan, we tried to do this and
proposed putting a ceiling on the maximum amount of health insurance
that an employer could pay in tax‑free way. There are ceilings on every
other kind of benefit, on the pension contributions, on life insurance.
Those seemed to make sense.

Not one member of the Congress was prepared to introduce the
President\'s legislation. Now I think we made a mistake of setting too
low a limit. So if you\'re going to go down this route, you have to set
a limit that people will today say, \"That doesn\'t affect me.\"

CHAIRMAN MACK: Let me switch to the international arena for a second and
see what thoughts you might have with respect to that. We\'ve heard a
lot about international competitiveness and we\'ve discussed things from
worldwide taxation to territorial, the issue of deferral. I think that a
lot of the comments we heard last week fundamentally said, \"If you can
get the corporation tax rate down low enough those issues just go
away.\" How low do you think you\'d have to go in order for those issues
to go away?

DR. FELDSTEIN: I don\'t know the answer to that. The international
taxation is certainly a very complex part of our corporate tax
environment. I\'m not an expert on those issues and so I could mislead
you more than help you if I tried to comment on that.

CHAIRMAN MACK: All right. Very good. We do have time. You have a few
more minutes before you have to go. Beth, did you have another question?

MS. GARRETT: If I could follow up. I wanted to follow up on Charles\'s
question about savings incentives. Certainly, one of the things that
we\'re looking very seriously at in the context of the current income
tax system is how to use it to increase net savings in the country and
there are lots of different proposals. You mentioned LSA proposal which
also has a third component that is simplification reform of employer
provided retirement accounts. There are proposals about refundable
savers credits. There are proposals about changing the default rules in
the 401k and other employer‑provided programs.

As we think through those things, what do you recommend that actually
have the most promise of actually increasing savings rather than just
encouraging people to shift savings into the new accounts? And also how
do we take account of the longer term fiscal effects of some of these
back‑ loaded plans? They\'re outside of our window of ten years but it
can still be a substantial revenue loss particularly if the entitlement
programs become more problematic.

DR. FELDSTEIN: There has been, as I\'m sure you know, a lot of empirical
research on the impact of these plans and I think the preponderance of
the evidence is that they have, the ones that we now have, the 401ks,
the IRAs, although it\'s easier to say it about the 401ks, have
increased savings, not only increased individual savings but increased
national savings. That is the increase in saving of the individuals
exceeded the loss of revenue to the government. So they have been
positive.

Now, of course, for a lot of people, the \$2,000 ceiling becomes just a
ceiling and therefore, they get a reward for doing saving that they
would have done otherwise. And to that extent, you\'re not raising
saving. You\'re just as you said moving it from one place to another.
Now, that\'s obviously true for some people. But as I said, the evidence
is that on balance there\'s enough induced additional saving for people
who would not have hit that cap otherwise that it does raise national
saving.

But if you move to a significantly higher set of numbers, I think
\$5,000 per person was the number in the Administration\'s proposal a
few years ago, then obviously very few people are going to find a level
that they were already doing. So there\'s much more scope for it to have
a positive incentive effect. I think that\'s the key thing about it.

If it didn\'t complicate these rules more, I think one could think about
a rule that said you have to save a certain amount in a nonqualified
plan if I can call it that. Let\'s say five percent of your income or
three percent of your income and you only get a deduction for or you
only get to put into a Roth‑type IRA amounts in excess of that.

Or I guess another way of saying that is if you put seven percent of
your income, whatever number it is, the first three percent going into
the Roth IRA doesn\'t count. So there are different ways you could
imagine doing it but they would add complexity.

MS. GARRETT: Thank you.

VICE CHAIRMAN BREAUX: If I might, Marty. Do you have any thoughts about
the concept of automatic enrollment in savings accounts where the
individual would have the right to opt out but the employer would put
into it? Any thoughts about this massive new Federal mandate which I
happen to support?

DR. FELDSTEIN: I think there\'s a lot of evidence that says it is
voluntary as you described it. I believe that is a fair use of the word
to say that it would be voluntary if I can opt out. There\'s a lot of
evidence from corporate experience. The default rule: if your employer
says you\'re in but you can come out, people are much more likely to
take up a 401k, then if they\'re told \"If you want to get in, you can
just go down the hall and sign up.\" So I think that if what we\'re
trying to do is to encourage people to participate in this, something
where people are in unless they choose to come out, is a good idea.

VICE CHAIRMAN BREAUX: Thank you.

MR. ROSSOTTI: Professor Feldstein, on the corporate integration, you
talked about dividends but what about the capital gain side? What is
your suggestion there?

DR. FELDSTEIN: Fortunately, we\'ve brought the capital gains rate tax
down to 15 percent. Should it be 10 percent? Ten would be better than 15
but at 15, I remember when the additional minimum tax and the
alternative minimum and all those things piled on to keep it over 40
percent.

So I look at the 15 percent and say we\'ve made a tremendous amount of
progress on that especially also in a low inflation environment. The low
inflation rate means that now we\'re taxing real capital gains. Not too
many years ago, inflation was driving that number and people were paying
taxes on book gains that didn\'t represent real increases in value. So I
wouldn\'t worry so much about that if, in fact, we eliminated the double
taxation of that income, of taxing it first at the corporate level and
then taxing the retained earnings as capital gains.

MR. MURIS: I wanted to ask a question about the relative magnitudes of
two kinds of benefits from tax reform, one that you\'ve written about in
terms of impact of the high marginal rates not to focus on the work
incentives, but on all the effort people make to move the money around
and the other is you were talking about the X‑Tax and the benefits that
are derived there particularly in terms of moving more towards
consumption. Obviously, you can accomplish both to some extent. But I\'m
wondering about the relative magnitudes roughly in your mind of the
benefits of those two different kinds of benefits.

DR. FELDSTEIN: The X‑Tax would in effect move you to a consumption base
if you had a pure X‑Tax. It would be a value‑added tax plus a wage tax
and so there would be no taxation of dividends. There would be no
taxation of capital gains. I have a feeling that the United States
Congress is not going to enact such a tax. But if you ask me
analytically, \"Is that a clean way of doing it,\" I would say, \"Yes.\"
But I think as a practical matter, doing things in terms of piecemeal
reforms and lowering marginal tax rates so there\'s less incentive to do
these things is a better route to go.

MR. MURIS: But analytically, you think the X‑Tax would have
significantly greater benefits.

DR. FELDSTEIN: I think the X‑Tax would have substantial benefits. But
it\'s so easy for it to creep back into being our current personal
income tax. You say, \"We\'re going to keep a few deductions and we\'re
going to include a few things because we\'re certainly not going to let
all capital gains go untaxed\" and lo and behold, you\'re back to the
income tax again. So it\'s a fine line. So a very impure X‑ Tax doesn\'t
represent progress at all.

MR. POTERBA: Marty, help us think about the high marginal tax rates that
emerge from phase‑ outs and other things at the moment. We\'ve seen some
empirical attempts to find, say, that the phase‑outs of the EITC or of
some of the itemized deductions affect taxpayer behavior. The studies
seem to find relatively little evidence of much going on there in spite
of a lot of research which suggest that high marginal rates in general
discourage individual effort and other things.

Do you have any wisdom on how to think about those results where the
marginal tax rates are high just over small windows? Would those kind of
high marginal rates still worry you in the same way that high rates
associated with a broad structure would?

DR. FELDSTEIN: They worry me less. It depends on who is paying those
high marginal tax rates over short ranges, how sophisticated they are
about thinking about marginal tax rates versus average tax rates. So if
you ask me would I rather have an EITC phase‑out over a narrow range of
incomes where the marginal tax rate over that narrow range is very high
or to have the EITC phase‑out over the current very long range, I think
we would be better served with a narrow range even though that would
mean higher rates over that narrow range.

CHAIRMAN MACK: Liz Ann Sonders who couldn\'t be here with us today,
she\'s listening in on a conference call and asked me to raise a
question with respect to treatment of financial institutions under
either of a VAT or an X‑Tax and your thoughts on that.

DR. FELDSTEIN: Very complicated. I participated in discussions about
that when all this was talked about in some detail 20 years ago. I
don\'t think we really resolved how one should, for example, tax the
imputed value of financial institution services. So I\'m not going to
try to answer that one.

CHAIRMAN MACK: And in order to get you out here on time, I have one more
question and I think we\'ll let you go. And it has to do with the
expensing of capital investment, in essence, versus lower corporate
income tax rates. Which is more pro growth, getting that marginal
corporate tax rate down or expensing?

DR. FELDSTEIN: There are a variety of problems that you don\'t solve by
expensing. You don\'t solve the double-taxation of dividends. You don\'t
solve the bias in favor of debt, but you certainly do provide a
substantial incentive for additional investment. So I think there\'s a
lot to be said for doing that.

But you don\'t want to have both the expensing ‑‑ I think there are
problems of having the expensing of equipment at the same time that you
are allowing a deduction for the interest payments, and indeed -‑ let me
just leave it at that. So you have to think about those two as part of
package. Again, it\'s all much cleaner if you move to an integrated
system and do the expensing within that integrated system while at the
same time disallowing the interest deduction. But that raises transition
problems.

CHAIRMAN MACK: Okay. Marty, thank you again for your time and for your
thoughts here this morning and we got you out on time.

DR. FELDSTEIN: You did. Thank you very much.

CHAIRMAN MACK: You\'re quite welcome.

DR. FELDSTEIN: Good luck.

CHAIRMAN MACK: Let me make a few introductory comments with respect to
our next panel. We have four former Assistant Secretaries of Treasury
for Tax Policy and I must tell you that we have anxiously been waiting
for this opportunity. We really do look forward to your insight, Mark
Weinberger, Jon Talisman, Leslie Samuels and Pam Olson.

We have asked each of them to focus their opening comments on a specific
aspect of tax reform. Mark Weinberger who is currently the Americas Vice
Chairman of Tax Services at Ernst & Young, LLP and previously served as
the Chief of Staff to the President\'s 1994 Bipartisan Commission on
Entitlement and Tax Reform will discuss the role of presidential
commissions in forming policy and some practical concerns about getting
reform enacted into law. John Talisman who is currently with Capitol Tax
Partners will share his thoughts on issues including fairness,
complexity and the practical realities of any tax reform option. Leslie
Samuels who is currently wit the law firm Cleary Gottlieb will discuss
issues related to financial institutions and transition. Finally, Pam
Olson who is currently with the law firm Skadden Arps will provide us
with insight on the international dimensions of tax reform. Again, we
look forward to your testimony and, Mark, we\'ll start with you.

MR. WEINBERGER: Great. Thanks, Mr. Chairman. I did such a good job on my
commission that you have to be here today. I appreciate you seeking my
advice in any regard. Chairman Mack, Vice Chairman Breaux, members of
the Panel, thank you for the opportunity to talk with you. I\'m really
supposed to share some practical insights, political insights, into the
commission process and what you should be thinking about at a high level
and then we\'ll get to the details on questions.

Advisory panels such as this one obviously play a crucial role in policy
making. Unlike the Congress, the Panel has the luxury of stepping back
and taking a more comprehensive look at the tax objectives that a system
should serve and how best to design the system. Basically, Congress has
to navigate through what I call the five Ps: policy, politics, process
(getting through all the committees), personalities (the various
chairmen, ranking members and all the members of Congress) and
priorities (many competing priorities). This panel has the luxury of
focusing on only one, policy.

You\'ve heard over the course of your public meetings that the current
tax system is in dire need of reform. This panel has the unique
opportunity to take the first step towards meaningful change by
providing guidance to the Administration and Congress on how to
formulate a better tax system that reflects the needs of the 21st
Century.

I\'ve had the privilege of participating in a tax policy process from
many different vantage points, from the Senate Finance Committee, from
the Bipartisan Commission on Entitlement Tax Reform, from the Treasury
Department and now from the private sector and as I thought about the
work that you\'re now having to go through there were some broad key
lessons that may prove helpful when you begin to formulate your
recommendations, six to be exact. While they might be self‑evident at
one level as you work through the process, I think it\'s very easy to
forget these very basic tenets.

First, seize the opportunity to be bold. Remember if no one criticizes
what you produce, you were not bold enough. This is not to say that you
won\'t be criticized even if what you produce is not bold. I remember
when I was at the Entitlement Commission and we started our process and
I received personally 350,000 postcards telling us we were destroying
the social security net before we even put an option on the table. So
people will take notice.

Do not be afraid to question the value going forward of policy decisions
made in the past. I\'d recommend that you tackle issues that
historically have been steeped in politics like the role of tax
expenditures and the issues surrounding tax exempt status. Report your
focus on the contributions you can uniquely make. A set of clear
principles and a few options for reform that can provide a roadmap for
policymakers. You need not get mired in the statutory drafting process
that is the dominant role of the Congressional committees.

Second, rule things out as well as ruling them in. There have been a
number of very thoughtful submissions to this panel. To the extent that
the Panel feels that these or any of these submissions do not meet the
criteria set forth by the President, simplicity, fairness and growth,
the Panel should affirmatively take these options off the table. Do not
underestimate the value of narrowing the debate to productive, practical
proposals.

Third, don\'t let the best, the perfect, be the enemy of the good.
Acknowledge that a perfect system is one that exists only theoretically.
It may be the best in the real world to work toward a simply system that
accomplishes rough justice and fairness.

For example, an EITC that could be used by the taxpayer that it\'s
intended to benefit is better than a complex one designed to combat
every possible tax avoidance scheme. Moreover, a coherent, integrated
and simple savings proposal may prove more productive than a plethora of
targeted incentives aimed at select taxpayers saving for specific
purposes.

And they come up to five. No tax reform plan can do it all.
Prioritization is very important. Prioritize your objectives for tax
reform. Where you start not only affects where you end up but also
affects every decision you make along the way.

For example, if you like a pro-growth system that is also fair and
simple, first design a system to maximize economic growth and then alter
it to make it fair and simpler. Your April statement, a principle,
suggests that simplicity may be your paramount goal. If that\'s the
case, start from a set of simple administrable rules and then build in
elements to promote growth and fairness.

A broad base and certainty are cornerstones of all three of the
President\'s objectives, fairness, simplicity and pro-growth. A broader
base creates less distortion in business decision‑making. \>From a
fairness standpoint, it would not choose winners and losers. \>From a
simplicity perspective, it would limit gamesmanship and it provides
transparency and certainly allows all taxpayers to make law decisions.

Next, setting priorities means making tough choices. As you establish
your priorities, understand there are no easy choices. Tradeoffs are
inevitable. For example, if you want to encourage savings or capital
formation, are you willing to acknowledge that those who are most able
to save will benefit disproportionately. That\'s a tradeoff between pro
growth and fairness. Or if we wish to encourage broader health insurance
coverage through the tax code, are we willing to let the IRS evaluate
what medical expenses should qualify? That\'s a social policy
consideration versus simplification. In some cases, the dualing policies
are both good. They just can\'t function together in a tax system that
is going to be simple. I think that ought to be a consideration of the
panel.

A tax code that has only one objective can be designed as a simple
system. The more you want from the system the more complex the rules
will need to be. Let me use the AMT as an example to punctuate the
point.

The AMT is the real live result when priorities intersect. If, as a
matter of policy, policymakers decide that the tax code should encourage
behaviors through tax incentives, that\'s fine. Where the problem arises
is when the use of all the incentives lowers some taxpayers tax
liabilities so much that it now violates the notion of shared burden.
Which priorities should prevail? The AMT demonstrates a failed attempt
at trying to have both by structuring a system that offers incentives so
long that people do not take advantage of too many at one time.

The number one priority of a tax system in my view should be to raise
the required level of revenue in a simple and non‑disturbative way as
possible. Our current tax system certainly raises revenue but it also
functions as a mechanism to redistribute wealth and to encourage or
discourage certain behaviors. I think we can all agree that in many
cases the tradeoff for using the IRS as more than just a revenue‑raising
agency has been simplicity.

Finally, revenue neutrality means different things to different people.
The Advisory Panel has been directed that any proposal it recommends be
revenue neutral. Now that sounds harmless enough. However, remember
every poker game is revenue neutral. At the end of the day, the same
amount of money leaves the table but in vastly different pockets. Even a
revenue neutral package will have different effects to different
categories of taxpayers.

Some questions to consider are which set of taxpayers will have a higher
burden and which will have a lower burden. Is there a shift of burden
for individuals to businesses or visa versa? Is there a shift between
business sectors?

Knowing how the tax burden is distributed should not drive your policy
decisions but it should inform them. Also I would hope that tax reform
legislation could be crafted without stringently adhering to numbers on
a ten year revenue spreadsheet. Be mindful of the long‑ term fiscal
effects both positive and negative.

Just as revenue challenge is not as simple as it seems, it\'s important
to point out that distribution tables are not always as informative as
they may appear. For example, during the 1986 Tax Act, the distribution
tables showed income tax reductions for every income class because the
tables did not include the corporate income taxes. Since corporate taxes
are borne by individuals whether as employees as shareholders or
consumers, the distribution table did not show the comprehensive effect
of the 1986 Tax Act on individual taxpayers.

In conclusion, what you pose will not be enacted without change, a
reality that everyone acknowledges and is an inevitable part of the
process. That fact, however, does not diminish the importance of the
role that this panel will play in setting legislative process on the
right course.

I believe the opportunity exists to make real progress towards a newer,
vastly improved set of tax rules that will contribute not interfere with
economic decision making and that will be understood and respected by
taxpayers. As you move forward with your report, I offer whatever
assistance I can provide. I have attached to my written statement a
non‑exhaustive list of forty additional questions that raise more
specific areas to concentrate on as you move through your process. Thank
you and I welcome your questions.

CHAIRMAN MACK: Mark, thank you very much for that. I was thinking that
maybe we should have heard that on our first call. But then I reflected
on that that I think at this particular juncture, I thought it was very
important to hear those comments. So thank you for that. Jon, let\'s
move to you next.

MR. TALISMAN: Thank you, Chairman Mack. It is a pleasure to be here with
my former colleagues and peers to discuss the important issues of tax
reform. I feel somewhat like I\'m Bill Murray in Groundhog Day however.
Similar calls for reform have been made over the last four decades.
Milton Friedman actually called for a flat tax in the early 1960s. The
first Congressional hearing I ever attended in the early 1980s was on
the Flat Tax, the Hall‑Rabushka Plan and since that time obviously
we\'ve had numerous discussions of tax reform, one of them led by my
colleague to my left.

The complaints have been similar over the decades. The tax code is too
complex. It\'s not fair. It discourages hard work, saving and
risk‑taking needed for growth and it\'s difficult to comply with and
administer. These are all serious issues and they must be examined and
I\'m glad that this panel has been formed to do so. There are other
issues facing our current system that must be addressed as well, the
encroachment of the AMT, threats posed by the global economy and
financial instrument innovation, all of which I think are important
issues and threats to the current system.

However, I am mindful of the cautionary tale that my former boss,
Senator Moynihan, expressed at the Kemp Commission hearing before the
Finance Committee. He said, \"The thought of a new set of simple rules
is always appealing. However, any time a change of this magnitude is
under consideration with huge potential risks to the economy and shifts
of fortune in the balance, we must approach proponents\' claims with
caution and healthy skepticism.\"

So what are the issues that are central to reform that we must approach
with caution and skepticism. Complexity, equity and the effects on
savings and growth are the three that I\'ve been asked to talk about.

First of all, is our current system too complex? Well, yes in some ways
and no in others. Millions of low-income households do not file returns.
Seventeen percent of taxpayers file the 1040EZ, twenty‑two percent of
taxpayers file 1040As and about 70 percent do not itemize deductions.
However, for some reason over half of all taxpayers hire professional
assistance.

We do however have major sources of complexity which this panel should
focus upon in the current system, the taxation of business income,
treatment of pass-throughs, depreciation allowances and cross-border
income, capital gains, tracking basis, holding periods, different rates,
income phase‑outs which are somewhat designed by the effect of budget
rules as well as other policy implications, structural extenders that
uncertainty cause particularly with respect to the 2001‑2003 tax bills,
a myriad of savings vehicles which have been alluded to this morning,
itemized deductions, record keeping for charitable contributions in
particular, AMT, the earned income tax credit and again the taxation of
financial instruments.

The question of complexity, however, we have to ask really is the grass
really greener with respect to some of the other alternatives. I\'d like
to focus on a VAT because I think actually that\'s the one that seems to
have the more credence currently.

The following quote has been stated. \"We have been concerned for some
time about the seemingly inexorable and exponential increase in the
complexity of the tax system especially insofar it affects ordinary
people and small businesses.\" That\'s not a description of our income
tax. That\'s a description of the English VAT. It\'s the Chartered
Institute of Taxation of which is the leading charity focused on tax
issues in England.

Another quote from the Tax Advisor says \"The majority of people who do
not deal with VAT on a day‑to‑day basis seem to find the tax almost
unintelligible. The English VAT has been criticized as a stealth tax
because of lack of transparency and recently, the British Auditor
General discovered a 16 percent evasion rate in the VAT. So there are a
number of issues and again the question is is the grass really greener.

There are examples of VAT complexity that just briefly are anecdotal but
they\'re sort of fun, which is, is a roller coaster public
transportation, is a jaffa cake, which I don\'t know what a jaffa cake
is, but is a jaffa cake a biscuit or a cake because cakes are treated
more favorably under the English VAT and also bricks, depending on which
quantity you buy them in. Actually a single supply of 100 bricks is
cheaper under the VAT than two supplies of 50 bricks. My favorite
however is actually a sales tax example which is the six donut rule
which basically assumes that if you bought six donuts on premises you
were going to eat them on premises. But if you bought seven donuts, you
were going to eat them off premises and therefore, subject to sales tax.

Again, these are all examples of the potential complexities that need to
be guarded against if we\'re going to look at other alternatives. I\'m
not going to detail potential VAT complexities but I do have those in my
testimony.

The other issue is obviously one that Mark alluded to which is tax
expenditures. Much complexity has been caused by the over one hundred
special provisions added by Congress over the years, the
employer-provided health insurance which we\'ve talked about. The
mortgage interest deduction, savings incentives and the research credit
are examples of targeted incentives that Congress has provided.

The question is, will these really be eliminated in a movement to a VAT,
and if so, what are the consequences? For example, with respect to
pension benefits, what happens to rank-and-file employees with
employer-provided plans? There is no incentive for employers to continue
offering the plans and thus even if savings go up nationally, as
economists say may occur with the VAT, they may even be more skewed than
they are under current law.

Shifting to the question of equity, I think it\'s important to focus on
the makeup of our current tax system. We currently collect about just
short of \$3 trillion in total taxes as of 2002. About two‑thirds of
that is raised at the Federal-level and about one‑third is raised at the
state-level. The importance of that is recognizing that state taxes tend
to be regressive in nature and over the last decade the regressivity of
the state tax systems has increased. So again, one‑third of our total
taxes are state taxes and they tend to be regressive in nature.

It\'s also important to compare our system to the foreign systems in
determining equity and fairness. The U.S. has a lower tax burden than
virtually all of our trading partners in part because of the social
services that the other nations provide. Income taxes and social
insurance taxes are close to the OECD average but the big difference is
consumption tax. The U.S. has about four percent, a little over four
percent, in GDP in consumption taxes, generally state sales taxes and
excise taxes and the OECD average is 11.1 percent of GDP. There is no
major industrialized nation that uses only consumption taxes.

In recent studies, polling, and again I put only so much emphasis on
polling as a tax expert, but it is clear that the progressivity of the
current tax system is something that is treasured by the American
public. Sixty‑three percent of people according to USA Today believe
that upper-income people pay too little and two‑thirds chose the system
as progressive or more progressive than the current system according to
a Heite (PH) study. So it\'s important to realize that that vertical
equity is important as well-issues of horizontal equity; personal
exemptions, child credits are put in for horizontal equity reasons.
Casualty or extraordinary health costs are put in for horizontal equity
reasons and obviously, the issues of marriage penalties and bonuses
which we\'ve recently focused upon. Finally, I think issues of equity
that need to be focused upon by this panel are inter‑ generation equity,
the rate of consumption changes over a lifetime and transitional equity.

It\'s interesting that recent polling and economic studies indicate that
much support for a consumption tax comes from the misinformed belief
that it will be more progressive than the current system. However, Hall
and Rabushka in their famous book on flat taxes say, \"Now for some bad
news. It is obvious mathematical law that lower taxes on the successful
will have to be made up by higher taxes on average people.\"

Finally, shifting quickly to savings, we have to note with respect to
the effect of savings, the hybrid nature of our current system. We have
an imperfect income tax. It\'s sort of almost a piecemeal consumption
tax in some ways. Many forms of capital income are exempt. About
four‑fifths of all interest income is excluded through pensions, life
insurance policies and tax-exempt bonds. Almost half of all dividend
payments are exempt. Those that are included are taxed at reduced rates.
And obviously, the taxation of capital gains is a mishmash. It\'s not
indexed but it\'s taxed at realization, therefore, getting deferral and
then has special rates imposed. We also have a myriad of tax-favored
investment vehicles which we can discuss in questions.

So thus, what is the effect on savings and economic growth of shift to a
consumption tax? Obviously, the effect on savings is affected by many
factors other than taxes, technological advances. Oil prices in the
1970s caused a recession. So it\'s very difficult to isolate.

The efficiency gains of shifting to a consumption tax will ultimately
depend on both the rate and the details of the consumption tax. If the
rate exceeds 30 percent, the effect on savings obviously will diminish.
The international evidence on the effect of savings is ambiguous and
again, we have to determine what tax expenditures will remain.

Finally, I\'d like to say that there are substantial changes that I
think can be made to the current system. Again, 1986 style reform where
you broaden the base and reduce the rates, I think, is something that
should be focused upon. Certainly existing incentives to the extent that
they\'re retained can be simplified. The education incentives are a good
example of that. We have a number of incentives for spending in the
education area, an incentive to borrow in the education area and
incentives to save in the education area. All of those obviously need to
be examined and rationalized and we can talk about savings incentives,
family incentives, etc.

Also I think AMT reform would be a useful topic for repeal. Again, I
think we have to look at stability, the effect of sunsets, phase‑ins and
other budget gimmicks. I know Beth has done a lot of work on budgeting
effects on the tax code and I think that\'s something that should be
focused upon because I think it\'s created a lot of the complexity. In
conclusion, it is my conclusion that I believe it is easier to simplify
the existing system than it is to make most consumption taxes fairer and
ensure simplicity. Thank you.

CHAIRMAN MACK: Thank you, Jon. And, Les, why don\'t we go right to you.

MR. SAMUELS: Thank you, Mr. Chairman. I wanted to start by describing
some principles that I think the Commission ought to take into account
in judging the tax reform proposals that you\'ve heard. And that, I
think, is very important way to start.

First, the United States has the most complex and largest economy in the
world. Unfortunately, we also have the most complicated tax system. We
certainly can do better, but I think there\'s no silver bullet and at
the end of the day, my expectation is that even with a reform system,
it\'s going to have a certain amount of complexity. Obviously, we can
make it less complex, but we\'re not going to do away with it. I think
that when the Commission looks at the tax reform proposals that have
been presented that you should look at the proposals in a real‑world
way.

Fundamental tax reforms such as the retail sales tax, a VAT, a flat tax
will substantially change the existing system and I think the Commission
should evaluate these using criteria that can easily understood and
explained to the public. I think that that is a very important objective
of the commission and in particular, who are going to be the winners and
who are going to be the losers. Inevitably, there will be winners and
losers and in my experience, the winners don\'t think they\'ve won as
much as they do and the losers think that they lose more. So you have to
be able to manage that process.

The current system as Jon says is a hybrid system including some
consumption tax elements plus our payroll tax which by the way is quite
simple and it works pretty well. And our system, imperfect as it has
been, created by Congress over a long period, is the creature of the
political process. Tax planning and taxpayer behavior and a new system
will also be the product of the give and take of the legislative
political process. So judging the feasibility and impact of fundamental
tax reform proposals should be made in the context of the real world,
the reality of the legislative and political process.

Obviously, you\'re not going to know what that is but you shouldn\'t
make a judgment and recommendation based on a theoretical model that is
not going to be adopted in any form. I call it the Mars problem. The
academic research, and I respect it, assumes some perfect system and
unfortunately, we have to bring that back down to earth and we\'re not
going to have a perfect system. So when you look at tax reform proposals
that have been developed in the perfect model, you have to take away
some very healthy skepticism about how it will actually work in our
economy and our society.

CHAIRMAN MACK: Les, if you could hold just a minute. We\'re getting a
humming sound. If we could try to change that, that I think would be a
little more comfortable for all of us.

MR. SAMUELS: In thinking about major tax reform proposals of really
going to a consumption tax, no other industrialized country has made
that switch. So we don\'t have a system that\'s been road‑tested. I
think that we would really be asked to think about going on an airplane
on its first flight that was designed by a computer model and I don\'t
really have a lot of confidence in that. So we don\'t have real world
experience. We have significant risks of getting major tax reform wrong
and I think given the history the burden is on the proponents to show
that it\'s worthwhile to shift to another system as opposed to the type
of piecemeal reform that we talked about earlier today.

The other issue that has been discussed and alluded to which I think the
Commission should consider is first do not harm. The current hybrid
system for better or for worse has important incentives for social and
economic objectives, health care, retirement, charitable giving, child
care, education, owner‑occupied housing and those objectives are now
embedded in society. Obviously, we\'re not going to maintain them all in
the way they are now. If you\'re going to change the system, I think
you\'re going to have to make some changes, but you\'d better make sure
that you understand how you\'re going to affect the lives of millions of
families when you start changing provisions that can affect retirement
savings and health care and owner‑occupied housing. Those are very
important issues that affect almost everyone in the country. So I think
that when you consider a tax reform proposal, you should do it in that
context.

The transitional issues that are alluded to and some say, \"Well,
they\'re transitional issues,\" and make it sound relatively technical,
I think is a serious mistake. I view it as the elephant in the room
problem. The question is what are the expected consequences of the
transition to a consumption‑based system and in particular, what are the
consequences from what economist call the stealth tax on existing
wealth, savings and business investments.

So, for example, the elderly who have accumulated their savings in
after‑tax dollars if you switch to a consumption tax, they\'re going to
be paying a second tax when they consume their savings. Businesses that
invested in a new plant immediately before consumption tax aren\'t going
to get the benefits of that investment unless you have some transitional
rules. So there, it\'s not just the individual. It\'s also business and
highly leveraged companies. If you get rid of the interest, what is
going to be their fiscal and economic outlook?

So those are very important issues and I think that any system that
would be a switch to a consumption tax system is going to require
transition rules. Those transition rules, I believe, will reduce the
economic benefits of a consumption tax. My understanding is that a
substantial part of the projected economic benefits of the consumption
tax is the stealth tax because it allows you to lower the rate and
thereby encourage the future which I think if you describe that to the
public they might have a strong reaction to it.

With respect to sectors, the financial services sector is extremely
difficult. Professor Feldstein, I agree with him. No one has an answer
of how to deal with the financial services sector if you move to a full
consumption tax system or a very significant consumption tax. In
addition, I think, in terms of thinking about reform we should try to
reform on a piecemeal basis the taxation of financial instruments.

There are many financial instruments that have roughly the economic
performance but are taxed differently and that doesn\'t make sense and
that\'s a significant problem in our existing system. Finally, in terms
of sectors, I would say looking at the state and local governments that
have built on, at least with respect to their income tax and their sales
taxes, they have built on essentially the Federal system or the lack of
a consumption tax in the Federal system.

So when you look at a new system, I think the way to start is to look at
the piecemeal system that we talked about earlier and see what kind of
system you would wind up with and then compare if you\'re going to go
for the home run, look at what that type of system would be and compare
it to the piecemeal system. In my view when you look at the real world
of the complex economy and our political process, any proposal to
completely eliminate the income tax for a consumption‑ based tax is not
a responsible approach and I think should be soundly rejected.

A proposal to combine a revised income tax with a VAT and an income tax
that has been piecemeal reform, I think, is a distant second for the
reasons that Professor Feldstein said. You\'re going to now have two
systems that business is going to have to deal with. So you lose a lot
of the benefits. At the end of the day, I think that you ought to be
looking very carefully at the piecemeal approach and focus your
attention on that. Thank you.

CHAIRMAN MACK: Les, thank you very much. Pam, we\'ll turn to you now.

MS. OLSON: Thank you, Mr. Chairman. I want to thank all of you on the
Advisory Panel for taking on the task of the pursuit of a better tax
system because the country certainly needs one. I think the job that
you\'ve taken on may appear to be a thankless one, but you probably have
no idea how thankless it\'s going to be until you issue your report and
start to see the reactions to it.

I want to echo one of Mark\'s thoughts with an expression from out west
which is, \"Aim for the stars. You may hit the trees. Aim for the trees.
You may shoot yourself in the foot.\" So I do encourage you to think
boldly.

I was asked to address international tax issues this morning but it
seemed to me from some of the opening questions of Mr. Feldstein that
the panel may have already heard an awful lot about this and may be
considerably along in its thinking about it. But at the risk of
repeating a bunch of stuff that you\'ve already heard, I\'m going to run
through some of my thoughts on the international area.

Perhaps more than any other area of the tax code, the U.S. international
tax regime appears, at least to the uninitiated, to have been designed
by a modern‑day Ptolemy. As the years have passed, we have augmented the
system with epicycles, but left its fundamental premises largely intact.
Those fundamental premises date to a time when the global economy and
the U.S. role in it were very different from what they are today.

Fifty years ago, the U.S. economy was economically dominant, accounting
for over half of all foreign investment in the world. The U.S. was a net
exporter and headquarters for the largest companies in the world were
located here. Today, the U.S. is far less dominant, but much more
dependent on foreign markets to sell our goods and services. In 2002,
trade and goods and services represented more than 25 percent of GDP,
nearly quadruple the trade and goods of four decades earlier.

Today the competition for capital is truly global and it is
multi‑leveled. Many foreign governments have gotten into the act in an
effort to increase domestic investments and create opportunity for their
citizenry. As a result, the U.S. and U.S. companies face a whole new
wave of competitive challenges and opportunities because global markets
make the rewards of invention and innovation greater.

If we hope to meet the challenges and seize the opportunities, it is
critical that we get our international tax rules right and quite
frankly, they have not been subject to a significant review for nearly
50 years. Our international tax rules are premised on the sovereign
right of the country in which income is earned to tax that income. The
general rule with exceptions is that the U.S. does not tax the foreign
income until the funds are repatriated and then allows a tax credit for
the taxes paid to the foreign country, but again, there are exceptions.
This is referred to as deferral because the tax is deferred until the
foreign income is brought home.

The effect of the U.S. tax on income at the time of repatriation is
effectively an additional hurdle to investment of foreign profits in the
U.S. relative to investments aboard what a former tax director of a
multi‑national company referred to as the 35 percent tax credit to keep
my money offshore. The system may not adversely affect companies whose
investment opportunities are growing foreign operations, but for those
with opportunities in the U.S. and abroad, the system can distort
investment decisions with its high hurdle to domestic reinvestment. It
is worth noting that this tax investment hurdle is not faced by foreign
competitors investing in the U.S. which may give them a competitive
advantage along with some other provisions of the code.

There are few fans of the current system. Nevertheless, there is
considerable disagreement over whether or how to change it. As you\'ve
heard, there are advocates of a territorial system used by many of our
trade partners which would not tax active foreign business operation at
all. A territorial system would end the current bias to domestic
reinvestment and could, depending on the design, simplify the tax
system.

There are advocates as well of repealing deferral which would also end
the domestic reinvestment disincentive unless a company by a significant
reduction in U.S. tax rates, and I\'m sure I\'m setting myself up for a
question here. However I believe such a change would significantly
disadvantage U.S. companies competing in the global marketplace whenever
foreign tax rates are considerably lower than those in the U.S.

No country has such a system today. As a consequence, none of U.S.
companies\' foreign competitors would be currently subject to higher
rates, which would leave U.S. companies alone with a higher tax cost on
current operations. There is evidence, in particular inversions and the
increase in foreign investor acquisitions of U.S. companies relative to
U.S. acquisitions of foreign companies, that our international tax rules
systematically encourage a move aboard. Moreover, it has become common
for the well‑advised startup to incorporate its operations offshore and
the well‑advised established foreign company to avoid entanglements that
might subject their foreign operations to the reach of the U.S. tax
laws.

I want to turn back to the exceptions to deferral for a minute because
one of the things you may end up with is the current system and then you
need to think about whether or not you need to improve the current
system. When enacted, the exceptions were essentially anti‑avoidance
rules intended to capture passive and so‑called mobile income. The
exceptions have grown while the make up of the economy has changed. The
result is that many U.S.-based companies are taxed currently on foreign
source income. The escape is inefficient business structures that may
defer the tax. This is particularly the case for the service sector
including financial services which is a temporary measure providing
relief of current U.S. taxation.

These provisions distort business and investment decisions. Attempting
to plan around them is a waste of valuable resources. We would do well
to move to a system that eliminates these distortions and leaves
businesses competing solely on the basis of the best product or service,
not the best tax planning.

I want to mention two other things. One is there\'s been a lot of talk
about piecemeal reform and certainly incremental reform is something
that I\'m sure you\'re looking at and should be looking at. I think
you\'ve been urged by some to do piece-by-piece as though you can just
make changes to the tax code without looking at the whole system. I just
want to caution you against that because you really do have to as I
think Dr. Feldstein said in the last panel consider the overall effect.
If you move in the direction of expensing but don\'t do something about
interest you\'re going to have eliminated our tax base. So that\'s
something you have to watch out for.

I also want to mention revenue neutrality, which Mark alluded to as
well. Our short‑term budget window is not the prettiest of pictures but
when we look out over the longer term it continues to worsen. And for
that reason, I hope that you will not dismiss the notion of including in
your report what might be considered a Chinese menu allowing people to
choose from different kinds of revenue‑raising options that they might
look to in the future as we need additional revenue to fund government
needs. Thank you.

CHAIRMAN MACK: Pam, thank you. I appreciate the comments of all four of
you and I think I\'ll start with Jim.

MR. POTERBA: Sure. Jon and Les, you both mentioned VAT and sales
tax-type options. I\'d like to ask the whole group if possible to
comment on the feasibility, or your view of the feasibility, of actually
using something like a retail sales tax at the kind of rates that would
be needed to collect revenue like what we collect with the current
federal income tax. Is that something which is within the imaginable set
of options that this group could consider?

MR. WEINBERGER: I\'m not going to set a precedent by going first on
every question but that one I will answer first. I think the rates \-- I
don\'t have the benefit of having a Treasury or Joint Committee anymore
to calculate rates for us in terms of what it would take to actually
replace the system. But based on my experience in the process when we
did look at things like this, the rate would be probably closer to the
30 percent range or so that I\'ve heard in various commission meetings
before.

I think it would be if you were going to have a national retail sales
tax, to your question on the end users at that high rate, I think you\'d
have great room for people evading the tax. I think there would be lots
of evasion which would require potentially a higher rate. I think that
the idea of replacing all of our income tax systems with just a sales
tax on the end user is, as Jon said, not been accomplished by any other
country in the world and would be a very heavy lift.

MR. POTERBA: Do we have specific evidence on the kinds of noncompliance
problems that come up? If any of you have examples, we would be very
interested in that.

MR. WEINBERGER: Let me just say one thing. It is interesting and maybe
some of my colleagues here do, but every single industrialized country
that had a national sales tax ended up adapting a credit invoice VAT as
a replacement to deal with cascading taxes plus the avoidance. So there
is lots of history out there with respect to administration.

MR. TALISMAN: I agree with that. I think that again as my testimony
indicated, the issue of switching to a sales tax, there was no country
that has really attempted this at the rate that we\'re talking about. So
it\'s very difficult for us to have any analytical evidence of
noncompliance. I think Mark is correct however. Anybody who has
attempted it has moved to a credit invoice system or another value‑added
tax system.

I think that the other issue is obviously the devil, ultimately with all
these tax systems, is in the details. You will find because of the
regressivity of a sales tax that you will have lots of carve outs, and
those carve outs we will have to define what is included in the carve
out, which again, people will try to fit themselves within those carve
outs, which will lead to some forms of noncompliance as well.

MR. SAMUELS: I would just say. There is a question of the rate. I heard
the rate on an exclusive basis might be like 40 percent. So I was
explaining this to someone and she said, \"You mean when I go to the
supermarket and buy a melon I\'m going to have to pay an extra 40
percent?\" And I think that if you had rates at that level people would
spend a great deal of intellectual capital in trying to beat the system
in New York and I\'m sure other states. People go to New Jersey to save
eight percent and bring back their stuff through the Holland Tunnel and
if you have a rate that that\'s high, you\'re going to have small
businesses, service businesses offering their products and services
without the tax and you\'ll have, I think, very significant evasion
problems which will then drive up the rate.

MS. OLSON: Forty percent is the number that I have heard as well. I
recall a couple of months ago seeing a study that said that you hit
serious compliance problems with the sales tax once you hit about a ten
percent rate. I can see if I can find that study again and if so, I can
pass it on to you.

But I think one of the things that has concerned me as well is the
sector of the economy that we would be looking for to collect this tax
because it is every mom and pop operation in the country in addition to
of course the large retail companies. But I think we have sufficient
compliance problems today with the income tax and payroll tax that
applies to those entities that we ought not look in the direction of
further increasing the burden of the tax that they\'re required to
collect for us.

MR. MURIS: Let me ask Jon a question following up on what he said about
polls and if anybody else knows anything. I\'m not surprised the people
say the rich pay too much. They also say the maximum rate should be 25
or 30 percent. It\'s like this current debate over judges where people
tell you we shouldn\'t change the rules but that everybody should get a
vote. I mean, given what economists call bounded rationality, it\'s
understandable why people, this same person in fact, could hold both
views. Do you know of any more detailed polling data which really tries
to dig in to see what people really think on the taxing system or
anybody else for that matter?

MR. TALISMAN: I don\'t specifically know of detailed polling data that
addresses these issues and I think in an effective way frankly. I think
the questions have to be asked in a relatively effective way with some
education because you\'ll get misguided answers.

MR. MURIS: Sure.

MR. TALISMAN: The economic report that cited by Slemrod, and there\'s
another one by Bartels, both of which provided evidence of the paradox
of this polling data which is people are in favor of progressivity and
yet they also favor the 2001 tax cuts. They favor the 2003 tax cuts.
They favor estate tax relief. They favor movement to a consumption tax
and the question is how can all those things be rationalized and the
fact is a lot of it is the fact that the American public is confused by
tax policy and I think they need \--

MR. MURIS: It\'s not accidental that it\'s confusing.

MR. TALISMAN: Right. That\'s true. We\'re confused up here. So if we\'re
confused up here, they should be confused.

MR. MURIS: Does anyone else have any comments or any knowledge of any
more detailed polling information?

MR. SAMUELS: I just recall in the \`90s Treasury was looking very hard
at tax reform and there was some polling and focus group on the Flat
Tax, which people said, \"Flat tax, it sounds simple\" and then you
said, \"Do you realize that capital income isn\'t taxed and so dividends
interest capital gain\" and they said, \"Oh, really. Then I don\'t want
it. I don\'t think that\'s an appropriate system.\"

MR. MURIS: Did it make a difference whether they had that income or not?

MR. SAMUELS: Well, I think since most of them don\'t.

MR. MURIS: Okay.

MR. SAMUELS: Of any significant amount.

MR. MURIS: Sure.

MR. ROSSOTTI: Pam, in terms of your concept on international, if we were
able to broaden the base by getting rid of most of the tax expenditures
and then potentially also eliminate the deferral but then bring the rate
down substantially, would that deal with the issues of both compliance
on the international side as well as competitiveness, do you think?

MS. OLSON: Yes, it would go a long ways towards addressing it. A number
of foreign governments as I think you\'re aware have adopted very low
rates in the last decade or so and there\'s continuing movement to bring
down those rates in a number of foreign countries. One of the things I
learned, to my surprise when I was at the Treasury Department and we put
forward a proposal that would have limited the interest deductions for
foreign companies investing in the U.S., was that you could strip into
Sweden and it had never occurred to me that tax rates even in countries
in Europe that are regarded as very high taxed had dropped on the
corporate sector to the point that there was an advantage in a country
like Sweden relative to the U.S.

I think a month or so ago Germany talked about reducing its corporate
rate as far as 19 percent. So there\'s a clearly a sharp trend down that
gives companies organized in those countries an advantage over companies
organized here in the U.S. if they\'re dealing with the current
application of the 35 percent rate.

VICE CHAIRMAN BREAUX: Thank you all very much. Delighted to see all of
you at a panel again and reminded of your very long and outstanding
government service. It\'s like deja vu all over again sitting here
asking questions. Every one of you has been before the Finance Committee
many times and thank you for your continued public service, even though
you\'re in the private sector now.

I heard some suggestions that we should be bold, but I would also label
this panel as the piecemeal panel in the sense that I think all of you
are recommending be bold but do a piecemeal recommendation to the
President. It seems to me that if you\'re going to have a panel it
should be bold and piecemeal doesn\'t equal bold. If you\'re going to be
bold, then you ought to be looking at new system and new ideas as
opposed to just a piecemeal approach. What\'s bold about a piecemeal
approach, Mr. Bold, over here?

MR. WEINBERGER: Yes, I did not recommend a piecemeal approach. I did not
recommend an approach. That\'s pretty bold, isn\'t it?

MS. OLSON: Are you running for office?

MR. WEINBERGER: Yes, right. I know better. As you well know, bold can
mean lots of different things. You take on the state and local tax
deduction. You take on the home mortgage interest deduction. You take on
charitable giving. You\'ll be perceived as bold. So bold can in a
political sense mean any different ways to attach the problem.

I do believe that this panel, as I\'ve suggested, outside of the
political process, has an opportunity to think the bigger thoughts and
to think about not only where we\'re funding today, but where we\'ll
need to fund for our government\'s needs in the future and what is the
best type of way to tax ourselves to meet those obligations. And we can
learn a lot by the international experiences.

I do think we need to look at additional ways and means to raise revenue
and that could be outside the income tax. It could be a change in the
income tax base, but I think if you\'re taking from my comments the
piecemeal approach, at least the clean break from an income tax to a
whole new system, is I think a difficult process. It doesn\'t mean you
don\'t think of additional means and ways to try and raise revenue.

VICE CHAIRMAN BREAUX: And that\'s maybe just some comment from other
members because it seems like the President has said, \"Look, take the
current system and simplify it with all the requirements\" but also give
us some other recommendations.\" So if we\'re going to look at other
recommendations as well, to me that says look outside the current income
tax structure with some type of a new system.

Now I think many of you, I think Jon, you\'ve talked about the
difficulties with a consumption tax and problems with it and I guess
both Pam and Les have said the same thing. So if we have a requirement
to perhaps look at another alternative other than saying within the
current system, does any of that stand out as more acceptable to all of
you than others? Can you give us a recommendation? Comments on that.

MS. OLSON: I will go first. I guess I would criticize the notion of a
retail sales tax and I would criticize the notion of moving entirely to
a consumption-based tax like a sales tax or a value‑ added tax to
completely replace all of our revenue sources. But I think you should
give very serious consideration to something like a credit invoice
method VAT back to augment the current system.

VICE CHAIRMAN BREAUX: Combined with an income tax?

MS. OLSON: Yes, and I know that there are some folks who think that
you\'re just buying additional complexity and additional paperwork by
doing so. But it depends on what you do with the money, whether you use
it to eliminate some of the other things about the tax system that do
create a lot of administrative burden like, for example, the individual
AMT.

There are so many candidates for simplification that would cost money
that the list could go on very long. And I actually think that using the
revenues from a VAT to significantly reduce rates, to increase
exemptions, to take a whack at the corporate tax rate, to have it
perhaps as well as a source that might be looked to to fund some of the
needs for entitlement programs down the road. I think putting all of
those things on the table would be a very valuable addition to the
discussion about tax reform as it goes forward.

VICE CHAIRMAN BREAUX: Let me ask Jon.

MR. SAMUELS: Sure. I guess in the context of thinking bold, I\'m all for
that. But I\'m also from Missouri, and that\'s the \"Show Me State.\" So
I\'d like to see some evidence of what some bold plans would be. I\'ve
always thought that if you had to change the system to reduce rates, and
basically now we have to deal with the AMT, that a credit invoice VAT is
something that could be considered.

I think that the biggest problem is, what rate it should be and how much
money you\'re going to raise? The Japanese instituted the VAT; they
started at five-percent, and by the way, even their government fell when
they did that. But that\'s a separate issue.

I think that if you started with a relatively low rate then you\'re
going to minimize the problems for the state and local governments
because they collect sales tax. The question is how do you integrate the
VAT system with the state sales tax, which as Jon said is one‑third of
the revenue that\'s raised. For the state and local governments, a
significant amount is from the sales tax. I think that if you want to
come up with a proposal you\'ll have to think about what does this
proposal going to mean for the states.

So I would have thought that if you wanted to consider something, a
relatively low VAT to start with is the way to think about it and
obviously it has the disadvantage of having two systems and actually we
tried a little mini‑consumption tax, Jon, the BTU tax. That was ill
conceived maybe but it was a consumption tax on energy.

VICE CHAIRMAN BREAUX: I thought it meant Breaux Tax U.

MR. SAMUELS: Just to give a little reality. That was a consumption tax
on energy and that\'s what it was and it didn\'t go anywhere and we had
a huge fight over a 4.3 cent increase in the gasoline tax which is kind
of interesting at this point. But it was an example of a
mini‑consumption tax at least for one sector and all the problems that
bubbled up in trying to implement that were very significant as a
practical matter, obviously political, but as a practical matter just
making it work.

VICE CHAIRMAN BREAUX: Jon.

MR. TALISMAN: Senator, I do think there are things to do that are bold
within the confines of a piecemeal approach. As Pam alluded to, I think
the AMT is a critical issue that needs to be focused upon. I actually
got off the phone with a friend of mine who called me up and started
cursing me out because he was doing TurboTax and putting in deductions
and his tax liability which is shown in the right‑hand corner wasn\'t
changing at all while he was inputting deductions and he couldn\'t
figure out why. So, I do think the AMT is absolutely critical.

With respect to an add‑on value added tax, I think one of the more
critical proposals that is out there, and certainly one of our most
significant thinkers in the tax area, is by Mike Graetz. The problem I
have with his proposal, though, as we talked about when you put on a
value‑added tax with an income tax, some of the savings benefits that he
comments that he believes may be out there with the consumption tax are
then muted by the income tax at the upper level. Not only that, he
leaves in place in my opinion the complexity of the income tax because
he has the income tax applying to people who make over \$100,000 where
much of the complexity occurs and he keeps in place the payroll tax
rebate at the bottom end, which I think is necessary, but again that\'s
where the other complexity occurs for low-income taxpayers.

For middle-income taxpayers, as I alluded to in my testimony, again a
lot of them file 1040EZs or 1040As. So the tax system is not
extraordinarily complex for them although they may believe it again
because of the paradoxes that we see and we need to address that. But I
don\'t think he accomplishes as much as I would hope. I think he
analyzes the issues correctly and then reaches a somewhat apparently
bold suggestion but actually I don\'t think it accomplishes that much.

VICE CHAIRMAN BREAUX: Thank you.

MR. WEINBERGER: Senator, before you move on, could I just add my views
of the VAT in terms of how it fits into the discussion since the other
panelists did? As I said at the outset, I think you have two
obligations. One is to look at the current system and you probably could
fix the current system in many ways without going to an alternative
revenue source.

But the other objective of the panel in what it is able to do is to look
out five or ten years and look at our needs over the long-term. If the
primary function of the tax system is to raise revenue and you look at
expected expenditures that say equal 28 to 30 percent of GDP because of
the entitlement growth and you don\'t think that the Congress or someone
has the ability to slow the growth in that to a level whereby it\'s
going to actually go down or stay flat, there\'s certainly been no
evidence in that case.

You could assume that we\'re going to need more revenue to meet our
obligations in the future. What is the most efficient way to increase
revenue? If you\'re going to fund the Social Security and Medicare
systems, can you raise payroll taxes high enough to get that kind of
revenue and what will that do to labor, the costs of labor, and hiring
and jobs? If you\'re going to tax the factors of income at that level,
what are you going to do relative to competitiveness, as Pam talked
about, to our foreign businesses versus U.S. businesses? So I think you
do need to look for other sources for that purpose and I think it would
be wise for the Panel to talk about those types of alternatives in that
context.

VICE CHAIRMAN BREAUX: Thank you all very much. It was excellent.

MS. GARRETT: Thank you all for coming. This has been terrific. And I
particularly appreciate your comments, all of you, about revenue
neutrality and the need to look to the future and the revenue needs of
the country. Our April statement set as our first principle that the
primary purpose of the tax code is to raise revenue and I think we have
to think about that in the context of exploding entitlement programs.

I want to ask you another difficult question and that is about the
distributional effects of tax reform and tax changes. And let me throw
out a few things and then I\'d just like to get your reactions to how we
ought to be thinking about distributional effects, fairness and the
kinds of tax burdens that we\'re putting on Americans.

One thing I think we have to keep in mind is that there\'s been growing
inequity of wealth in this country over the past few years. So it may be
the case that being distributionally neutral is not appropriate in a
world where actually the disparity between incomes is getting greater
rather than lesser. I think Jon mentioned we have to think about how
state taxes themselves have become increasingly regressive.

Another thing I throw out is it seems to me that although distributional
analyses typically just look at the income tax together with things like
the earned income tax credit, payroll taxes are the most significant
burden on most middle income Americans and we ought to think about how
all that interacts; and then finally as I think about distribution and
fairness, I tend to think beyond the regular distributional analysis and
think about things like inter‑generational fairness which I think Mark
mentioned.

You think about transparency as fairness and all of these sort of
invisible taxes, the AMT or phase‑outs and also fairness in terms of the
ability for everyone to benefit from tax incentives if we include
incentives for savings that do not also include refundable credits, but
it\'s only those with tax liability who are able to save or those who
have the income to save. So there are lots of different metrics along
which we can think about fairness in addition to the traditional
distributional analyses. I wondered if you could provide us some
guidance for how to think about those issues.

MR. TALISMAN: I will start, I guess. I think I spoke to this in my
testimony. But I do believe that we have to look at the progressivity
and fairness of the entire system. I do think that state taxes are a
component of our system. Unlike other countries, we do break it down to
the state and federal systems. As I alluded to, about one‑third of our
taxes are raised at the state level, and those tend to be more
regressive than at the Federal level.

I also believe that we have to look at the effects our decision making
on the various classes of people. As I said again with respect to a
value‑added tax for example or any consumption tax, as you alluded to
Beth, I think you have inter‑generational questions because people
consume at different points in their lives. So people when they\'re just
out of college tend to spend money and when they\'re retiring they tend
to dissave and tend therefore spend more money and therefore their tax
liabilities are going to go up relative to the middle aged population.
So we have to focus on those issues of inter‑generational equity.

I guess the final issue obviously is issues of fairness about what is
consumption. If you\'re saving and then spending on education, is
education consumption? Are we going to raise college tuitions because of
consumption taxes? Someone who has catastrophic health problems, are the
health costs treated as something that\'s subject to the consumption
tax? A lot of those issues of fairness need to be addressed and again I
think will raise the complexities that we\'re concerned about as well.
So I think all those issues have to be focused on.

MR. WEINBERGER: I would suggest, Beth, that fairness is the most
difficult issue that you have to define as a panel to deal with.
Fairness can mean so many different things to different people. So it\'s
really hard for us to give you a particular view. I think when you look
at fairness though as you identified it and as Jon said if you\'re going
to expand from income taxes to payroll taxes.

I think it\'s fair also frankly to consider the overall spending
programs that the government provides. Maybe that\'s a way to deal with
fairness outside the existing system. If you believe that the system is
supposed to collect enough revenue in a nondistortional way in order to
fund government, then you start to create redistribution and other acts
of fairness within the tax code. That leads to complexity and away from
simplification and certainly will cause higher rates and distort your
economic growth. So that\'s the tradeoff you face.

I don\'t know if I could define fairness as just horizontal and vertical
fairness. Are all taxpayers treated the same in similar circumstances is
one question. Then there\'s obviously the progressivity and
distributional fairness through our tables.

I would just go and highlight one thing that I think is not currently
done. When they analyze this distribution tables, I highlighted it in my
testimony, which is that the corporate income tax is not currently
distributed and that is a significant function of our revenue raising
apparatus and where it falls on whether it\'s shareholders or whether
it\'s consumers or laborers, someone needs to try and take a cut at. But
it is high. It\'s a lot of the burden of our tax system.

MR. SAMUELS: Beth, I think that in considering the progressivity issue,
first, just one comment. The distributional tables that I\'ve seen
include all the entire tax system including the excise taxes and the
payroll taxes. That kind of a traditional way of trying to explain
because you should look at the whole system, the federal system. And
with respect for example to the payroll taxes, yes it\'s a regressive
tax, but we do have the EITC to moderate that.

For a lot of people who spend most everything they earn, if they\'re not
saving, actually the payroll tax is just like the consumption tax for
them. If they\'re spending everything they earn, a lot of people do do
that, that\'s one way to think about it. So it\'s another way of saying
we have a consumption tax built into our system or at least a
consumption tax‑like system.

I think the basic issue, of course it\'s very difficult to decide
what\'s fair, but I think where we can have a consensus is that the
progressive tax system, a progressive tax system, where the taxpayers
who can better afford to help support the government and get the
advantages of a civil society is absolutely a fundamental kind of value
that we\'ve developed over the years and that obviously the question is
how much and that view can change from time-to-time.

I mean the progressivity, the numbers I\'ve seen, has gone down a little
bit with the tax cuts. That\'s the way it is and the question is in
looking forward should we go back to the progressivity that we had
before and if so, how would we do it. We\'re not talking about huge
differences, but small differences can make in terms of going forward
and thinking about the future can have an effect going forward.

So I think the basic question is to address the question of
progressivity and then say sometimes maybe we\'ll \-- depending on the
economy. When we had surpluses, it was a lot easier to think about tax
cuts than when you look at deficits way out into the future. And
obviously, Congress is going to have to deal with that and this is a
moving target. I think that as Congress faces the issues they ultimately
will have to deal with them one way or another.

I have faith in the system that they will deal with it. I think that
ultimately the people will tell our representatives that they have to
create a system that\'s going to work and create a healthy economic and
social country. So I think that those are \-- I wouldn\'t be so
concerned that we can\'t trust our Congress going forward when they face
really serious issues. It will come together.

MR. FRENZEL: Thank you very much. You got me confused. I see among you
two creeping gradualists and two leaping maximumists. If we\'re to take
both of your advice, we will only render ourselves entwined I think. All
of you mentioned fairness and fairness is what bugs us all. But there
are some extra problems that we face as we attempt to dissect the code
and to play with elements of it and see how they bear on other ones. We
go to your former colleagues in the Treasury and say, \"We need some
information on the distribution of burden on this particular item\" and
one of your former colleagues in a windowless cell in the bowels of the
building kills another ox and begins to look at its insides and tells us
that we don\'t really know how this works and we don\'t know how it
affects single mothers with six and a half children or red‑headed sea
captains carrying cans. It\'s really hard to dice this fairness thing
down to the gnat\'s eyebrow.

I believe that we\'re just going to have to have some kind of a
shorthand standard and is it the old quintile income analysis? What\'s a
fairer way to determine fairness for this panel?

MS. OLSON: Since I didn\'t speak the last time, I guess I\'ll go first.
First, Mr. Frenzel, you\'ll be happy to know that I never mentioned
fairness.

MR. FRENZEL: You get a gold star.

MS. OLSON: And I do think that as Mark said that fairness is, and I
think you\'ve said as well, the hardest thing to try to understand and
to try to figure out. I thought Steve Entin at your first panel made a
very interesting comment when he said that we can all agree that poor
people shouldn\'t pay taxes. That\'s kindness, not fairness.

The problem is that fairness is in the eye of the beholder and we all
have very different ideas about what constitutes fairness. And I get
very concerned about the extent to which we focus on the distribution of
tax burdens particularly since we tend to look at it on a very static
basis that doesn\'t take into account the fact that we\'re using an
annual accounting system that creates all sorts of distortions and that
people move through things over time. If we throw in the payroll taxes,
we\'re ignoring the effects of the Social Security\'s system payout
which when you put that together with the payroll tax yields a very
progressive system.

We have attempted in so many ways to enact provisions that create
fairness within the tax code, but what\'s one person\'s fairness is
another person\'s unfairness. I\'ll give you an example from my office,
a secretary there who happened to make a lot of money last year because
she worked some overtime. She found that she and her truck driver
husband lost the tuition benefits in the code because they phased out of
them on account of their income.

She doesn\'t think that\'s very fair. I\'m inclined to agree with her
but at any rate, we have done a whole lot of attempts to measure things.
We end up looking at statistical composites that have little connection
to individuals in the real world. So will you have to do a
distributional analysis? Yes, I suppose you will. And will you have to
use the quintiles that the Treasury Department produces? Yes, I suppose
you will. But I guess I would encourage you not to be driven too much by
what those tell you in your deliberations because I think that there\'s
a whole lot that is concealed in those tables.

MR. WEINBERGER: The only think I would add to that is as I mentioned in
my testimony that I think you have to prioritize your objectives in the
tax system and I believe if you have a decision that creates the most
economic growth and raises income, that\'s the best way to ensure higher
standards of living for everybody. That should be a basis. Then you can
modify the system to come up to make it fair or however you so define
and it leads you to a different place. If you start with you need total
tax rates that have distributional analysis of X, then you have to try
and carve out incentives of growth. So the process changes quite a bit
depending upon how you look at it.

MR. FRENZEL: Thank you.

MR. SAMUELS: I think that this issue of distribution and how you judge
it is obviously challenging, but we have to do our best and this is one
of those where the perfect can\'t be the enemy of the good. There has
been a history of distribution tables based on quintiles, which by the
way can include the corporate tax and the estate tax. That is possible.
Those tables have been done before.

So if you wanted to look at all the taxes including the excise taxes and
the Social Security taxes, you can see the whole system if you ask for
it. I think Treasury used to do it. I think they can still do it.

So I would say you start with that and then look at a rough guide. The
question of incentives, you also have to make a judgment about it.
There\'s this very good recent economist article on savings and they
point out, I was surprised, that they think that the cost of our savings
incentives like retirement benefits, life insurance, the whole gambit,
costs us about one percent of GDP in foregoing revenue. And they say,
\"By the way, we\'re saving less. Private savings is less than that now.
So we\'re actually potentially spending more on the incentive than the
savings that we\'re getting.\"

It\'s inexplicable, but that\'s what they \-- even if it was off a
little bit, you\'re not creating a lot with the incentives and I think
that the problem with the incentives that Mark refers to is you have a
lot of incentives that you give people and you\'re going to engage in
that behavior anyway. So you\'re not getting new behavior out of it.

The biggest problem is how to encourage people, and Marty Feldstein
talked about this, to do something that they wouldn\'t otherwise do, and
that is a traditional problem with creating incentives and that has to
be taken into account too in deciding what kind of incentives you want
in the system.

MR. TALISMAN: I actually would like to just go a little bit off topic
and talk about your entrails comment because I think one of the things
that is important also in this context is to keep in mind the fact that
our revenue estimators don\'t always get it right either.

MR. FRENZEL: We are painfully aware of that.

MR. TALISMAN: We had the example of the luxury tax which I\'m sure
Senators Breaux and Mack remember where they didn\'t dial that right
nearly at all and that obviously got repealed for those reasons. We run
the risk when we do a wholesale change in the code that our estimators
are not going to know what the effects of the wholesale change are and
that can have one of two effects. We can either run greater deficits or
they can cause an increased tax burden which could encourage
sluggishness in the economy. So I think we need to keep into account
your entrails comment, which I think is pertinent with respect to
revenue estimating as well as distributional tables.

MR. FRENZEL: Thank you.

CHAIRMAN MACK: I want to go back to the question that I asked of Marty
Feldstein earlier with respect to this issue about international
taxation because the panel really is \-- this is a very difficult area.
So I\'d like to have input, and I don\'t mean to say Pam only, any
thoughts anyone else has?

But the notion of broadening the corporate base suggests there are
things that you ought to change about the corporate base in order to
expand it. I\'d like to have some ideas about what you think those are
and can we get the rate down to a level that if we were to eliminate
deferral, because I do think this deferral distorts decision making
about investing? Now do we go about doing that and at what level? We\'re
presently at 35. I\'ve heard some people say you really need to get that
rate down into low 20s in order to make a difference. Others might say
28 to 30 might do it. But you can give me a sense about how you feel
about that and, Pam, if we can start with you and then any thoughts that
any of you want to throw in would be great.

MS. OLSON: Eliminating deferral in itself is a big base-broadener. So
you have one there if you go in that direction. There are less
mentioned, some of the complexities and difficulties in the taxation of
financial products. That is an area that has posed a problem for the
Treasury Department and the Internal Revenue Service and Congress for a
number of years and it is my view that it is almost impossible for
Congress to keep up if it\'s going to legislate changes in this area.

It is also difficult even if the authority is given to Treasury and the
Internal Revenue Service to make the rules work for Treasury and the
Internal Revenue Service to keep up. So for that reason, I think that
something on the lines of some greater conformity with the book
accounting might make some sense and might also broaden the base in a
more rationale way.

I\'m not sure how far the tax rate would need to come down in order to
be competitive and stay competitive internationally. That will depend in
part on how much of a company\'s operations are domestic and how much of
them are international and the extent to which they\'re able to
structure their affairs so that they\'re competing, operating, in
low-tax jurisdictions.

But certainly, if we\'re looking backwards, we might look at the OECD
average and the OECD average I think is in the mid 20s. When I say
\"looking backwards,\" I think it\'s hazardous to drive down the road
looking in the rearview mirror and that\'s what we would be doing
because our competition isn\'t necessarily for the future just going to
be OECD countries.

We\'re seeing obviously a lot of increased competition from China, from
India, from Singapore, countries like that that have been very
aggressive and so we need to be mindful where some of those countries
are going and obviously Singapore for example has lowered its corporate
rate considerably. Ireland is another jurisdiction that has lowered its
corporate rate significantly and attracted a whole lot of investment. So
we need to be mindful of what the rates are in the very lowest-tax
jurisdictions that might provide a lot of competition for us in the
future.

Again, I really don\'t know what the right number is, but I think low
20s is probably high end for what you may need to shoot for in order to
be competitive if you\'re going to go with the repeal of deferral in a
worldwide system of tax.

MR. SAMUELS: I would say that the taxation of international income is
really a very challenging issue. I spend actually a lot of my
professional time in that area and I would say a couple of things.

One, you have to look not at the nominal rates but at the effective
rates that U.S. multi‑nationals are paying and our foreign competitors
are paying. That is the right way to look at it. That\'s the way they
look at it. And you see a lot of U.S. multi‑nationals with an effective
rate that is lower, in some cases substantially lower, than the nominal
rate.

The second thing I would say is that, from my experience in the
government, there were times when the multi‑nationals came in and we
said, \"We really should simplify some of these international rules.
Here are some ideas.\" You had some reasonably good ideas and of course,
they\'re sophisticated taypayers and they went away and crunched their
numbers and they said, \"Actually, you know our computers are set up now
to handle this whole complex issue. So please don\'t change it because
you\'re just going to make us learn a new system. We\'re all set.\" That
is an aspect of this. This isn\'t from a tax policy point of view isn\'t
a very good answer. But people have been manipulating the system to
lower their rates.

Now in terms of getting rid of deferral, I guess one question, and
different ones can think about that, either tax everyone currently on
all of their income or adopt a territorial system. I think the problem
with the territorial system is from a competitiveness point of view,
although it sounds like they were very competitive, it raises money.

That\'s what the Joint Committee members said, I think, when they said
it raises a substantial amount of money. The question is why? And the
answer is if you get a territorial system, and you exempt dividends from
foreign subsidiaries from tax, then you have tax‑free income.

You shouldn\'t then give a deduction for interest that you used to
finance that tax‑free income. You can\'t deduct interest when you\'re
buying municipal bonds. You shouldn\'t be able to deduct interest when
you invest abroad and receive tax‑free income. Actually, some of our
competitors have that type of rule that they have territorial systems,
but there are limits on interest deductions.

The other thing that the territorial system could do is \-- you can\'t
deduct current losses that you incur outside the United States. But some
people set up their affairs so that when they\'re going to have losses,
they have them directly so they can use them currently. And you would
eliminate that as well. That\'s why it raises a lot of money. I think
it\'s a very complicated situation and I don\'t know the easy way out of
it. Again, there\'s no magic bullet here.

The other thing I would say in comparing our competitors, we talked
before about integration, which is interesting; I like some aspects of
it. But I think the panel should be aware that our competitors, like
England and France and Germany, are abandoning integration. It\'s like
the things they\'ve gotten rid of or they\'re getting rid of it and the
question is why?

If it\'s so great, why are they getting rid of it? And my understanding
is that there\'s an enormous amount of gaming that was going on because
they wouldn\'t give the benefits to nonresidents. So all of a sudden you
have, in Germany this happened, foreign pension funds owned German
stocks. The day before a dividend when the credits were available to
German nationals, a huge flood of stock came back to Germany for a very
short period of time and then came back out and Germany lost a lot of
revenue.

So they and the EU have some rules now that say that you have to give
the same benefit to all EU investors. So if you\'re going to give people
credits you have to give them to everyone in the EU. So people were
abandoning it. I think it\'s actually quite noteworthy, if you look
about what\'s going on in the world in terms of international pacts,
integration is actually going out of favor just when we\'re starting to
think it\'s a good idea.

CHAIRMAN MACK: Any other thoughts?

MR. WEINBERGER: Yes, I would add my thoughts to Les. I agree with Les.
Effective rates is what matters. So if you\'re going to go ahead and
broaden the base by taking away some benefits and repeal deferral, you
can\'t just look at the marginal statutory rate, obviously. You need to
look at how are we currently taxing our foreign operation of U.S.
companies versus what the new system would be and there\'s a lot of
self‑help currently that companies can do to get a low effective rate on
overseas investments right now.

So if you\'re going to just get rid of that and put our statutory rate
in, you can have a significant rate on our investment overseas and I
think that would be a mistake. If you believe that we need to be outside
the United States competing with other countries, the kind of exporter
neutrality, the export and import neutrality, we can get into a whole
bunch of mind‑numbing stuff. We won\'t, I hope. But the bottom line is,
I think you need to be conscious of the effect that would have on that
type of investor.

One thing that Les did mention that I think in the U.S. also \-- if you
broaden the base, how do you do it? What would you do? And I\'m not
necessarily a fan for repealing deferral. Again it could go either way.
I certainly may be for a territorial system, but not necessarily for a
system whereby you\'re going to currently tax our overseas investment.

One way to broaden the base, and very controversial, but it goes into
integration, it goes into fairness and equity, is the interest deduction
at the corporate level. Right now, a lot of the self‑help companies
could do to reduce their effective tax rate is through borrowing, excess
borrowing or crediting interest out of new instruments. If you can get a
lower rate and get rid of some of that specific type of gamesmanship,
maybe that\'s a benefit. But again, you have to look at it in the
broader context. That\'s one thing I hope you would at least think
about.

CHAIRMAN MACK: I am going to ask a question again for Liz Ann Sonders.
She says last week Steve Forbes suggested cold turkey; i.e., no
transition rules for his flat tax proposal. What are your collective
thoughts on that position? Is it feasible to go cold turkey, economic
impact, etc.? Anybody want to give a reaction to that?

MR. WEINBERGER: I\'ll just say you\'re clearly \-- the tradeoff that
you\'re making is fairness for growth. The quicker you get through the
transition the higher you have the growth element because you\'re not
paying for all the extra costs to transition. The fairness issue arises
because you\'re probably going to create lots of inequities from people
who are entered into existing contracts, long‑term leases, investment
deals, business decisions as well as double taxation of some assets. So
there\'s a tradeoff that you\'ll have to make. I\'ve never seen yet a
major, or even a minor tax change, where we haven\'t had transitions. So
it would be a pretty bold statement.

MR. SAMUELS: I would say it would be more than bold. I think it would
meet his criteria. It would be completely inadvisable. I mean you\'re
talking about taxing existing wealth the people have accumulated and
it\'s like waking up some morning and saying, \"The government\'s taken
X percent out of all your savings accounts. How do you feel about
that?\"

It\'s not something that would be, from a social point of view, accepted
and actually from an economic point of view, if you knew it was coming,
we would be really busy figuring out how to beat the system before it
changed and you would have economic dislocations. I don\'t know. No one
has done it and there\'s a good reason because I think we may start
really thinking about common sense prevails.

MR. TALISMAN: I think you found the one thing on the panel that we have
consensus.

CHAIRMAN MACK: We have a few more minutes if there are some other
questions that the panel would like. Jim, why don\'t you?

MR. POTERBA: You\'ve all touched on the fact that there is great pain
with playing with the tax expenditures. One of the ones that comes up
frequently in discussion we\'ve heard about is the state and local tax
deduction. Could I just draw each of you out to talk a little bit about
the cost and benefits of thinking about changing that and if you were
going to change it, how would you do it?

MR. WEINBERGER: I\'ll go last on this one.

MR. SAMUELS: I am in the high-tax state. A couple of comments. First, in
terms of the state and local income tax deduction, there is a long
history and actually it obviously has a political impact. It has had a
political impact. I think the question is, if you\'re going to reduce
because you don\'t have to go all or nothing, you can phase, you can do
a variety of things, what do you think that the consequences will be for
the people who are now taking it and are you giving them something else?
You have to look at the whole picture.

When we were looking at tax reform options in the \`90s, one of the
things that we looked at was raising the standard deduction and reducing
basically people who take itemized deductions and we had winners and
losers by state. It was very interesting not just with respect to state
and local taxes, mortgage interest because that varies by state,
charitable deductions.

There\'s a lot of economic and social behavior that we\'ve created. The
question is how do you want to change that for a better system and a
more economical system, a fairer system and I guess I would have thought
that a potential cutback on state and local income taxes might be in the
mix if you had something to give back to people because people had
relied on it.

The other thing I would say is that I actually find it kind of strange
that I have income from outside the United States so I get a foreign tax
credit. My firm does a lot of work outside the United States and so I
get a foreign tax credit against my federal taxes for the taxes that we
pay outside the United States. And if I had income from Canada, I\'d get
a credit actually for the Ontario Provincial income tax against my state
taxes. So I\'m getting the credit against my U.S. Federal income tax for
Canadian Provincial taxes, but I don\'t get a credit for New York State.
You have all these kind of little odd things.

And we do give foreign tax credits for foreign taxes we pay against our
U.S. tax. So if the idea is let\'s eliminate state and local income
taxes because we think state and local governments can be more efficient
in how they run and this is a subsidy for them, you\'re kind of saying
we don\'t care what foreign governments do. They can tax. In fact, some
of them actually try to tax right up to the 35 percent when they know
they have U.S. taxpayers, especially with respect to foreign natural
resources. Everybody knows that you should tax up to 35 percent and
that\'s what they do.

So I think that it is something that obviously should be on the table.
But I think if you\'re going to do it, you\'d better understand what the
consequences are and how you\'re going to balance that.

MS. OLSON: I guess I\'ll go next. There are economic arguments for
getting rid of the state and local tax deduction to the extent that the
state and local tax deduction represents, to at least some extent a
consumption of services, benefits, that you receive in the state.

There is no reason for you to take a deduction for that. That gets borne
by other taxpayers of other states who don\'t get the same benefits, but
whose federal taxes have to go up as a consequence. Some of the folks
who worked on the \`86 Act today will tell you that the design of the
AMT with the lack of indexing was exactly intentional for the purpose of
taking care of one of the things that they didn\'t take care of in the
reforms in \`86 and that was getting rid of the state and local tax
deduction.

As the AMT and its reach expands, the effect is that we\'re taking away
the state and local tax deduction for a whole lot of people. So right
now where we are if we do nothing, we\'re going to see a whole lot of
people losing their state and local tax deduction as the years run
forward, and it\'s really the next few years, and by the time we get to
2010, 2011, we have a huge number of taxpayers who will be paying the
AMT and therefore not getting a state and local tax deduction.

While I was at the Treasury Department, one of the things that we looked
at was ways to take care of the AMT and eliminate the AMT. And there are
ways in which it can be done in a progressive fashion like for example,
and one of the primary parts of this would be to use the state and local
tax deduction, putting both a floor on it to say that some part of the
state and local tax deduction would be reflected in your standard
deduction and then putting a ceiling on it. The effect of that is to
shift the tax-burden to higher income individuals, right now the AMT
hits a substantial number of taxpayers between roughly \$100,000 and
\$500,000. For most taxpayers by the time you\'re about \$500,000
you\'re into the regular tax and it doesn\'t really matter how high your
deductions go, the regular tax on your individual income is going to be
higher than what you would pay under the AMT.

So I think those are some of the things that you can take into account
as you go forward. I think it\'s entirely reasonable for you to consider
current law, things that people are going to be suffering under current
law if you do nothing; consider the economic arguments and also consider
a way perhaps of some reform that might make the system more
progressive.

CHAIRMAN MACK: I might just say at this point that we\'ve run a little
bit over. I think we\'re going to have call it at this point. Again,
thank you so much for your input. We appreciate it greatly.

Our next and last panel for today, we\'ve asked them to address their
comments associated with the \"Return‑Free\" Filing proposal. We have
three panelists, Eric J. Toder at the Urban Institute, Joseph Bankman, a
Professor of Law and Business Stanford University and Grover Norquist,
President of Americans for Tax Reform and we appreciate greatly the
three of you coming and sharing your wisdom with us. With that, Eric,
we\'ll start with you.

DR. TODER: Thank you very much, Senator Mack. It\'s pleasure to be here
as an economist talking about tax administration after we heard lawyers
talking about economic growth. I\'m going to talk about return‑free
systems. Questions I will address are what are return‑free systems, what
is the problem they seek to correct, what has been the private-sector
response to these problems, who can benefit from return‑free systems,
what tax system changes are needed to make them work and are they a
substitute for tax simplification.

Two types of return‑free systems, you may be familiar with these. Exact
withholding, under that kind of system many taxpayers don\'t have to
file returns at all. The tax liability is prepaid through withholding.
Examples of that are in the United Kingdom, Germany and Japan.

The second system is called a tax agency reconciliation. The tax agency
computes the final tax liability based on third party data that they
get. The examples in the U.S., Michigan had one for a while and
California is trying one. Joe will talk about that when I\'m finished.

The problem you all have heard about is high compliance costs. The IRS
estimates for 2002 that it took on average 26 hours and \$157 per
return, but these burdens fall disproportionately on some taxpayers
relative to others and here are a couple of charts. This is the
compliance costs for self‑employed taxpayers versus wage and investment
taxpayers. The W&I taxpayers are those who only have wages in passive
investment income and you can see that the dollars per return and the
hours per return are about four times higher for self‑employed taxpayers
as for W&I taxpayers.

This is another chart which shows by type of return filed and you can
see again much higher costs for those who file a 1040 than those who
file a simpler variance, the 1040A or the 1040EZ.

Part of the response to this is computerization. There\'s much more pay
preparer use. There\'s been a dramatic growth in the use of tax
software. In 1993, over 85 percent of returns were prepared on computers
either by paid preparers or individuals. There\'s also been a big growth
in electronic filing.

But it\'s important to stress that these increases in computerization
only reduce some costs. Taxpayers still have to keep records. They have
gather tax materials. They incur the cost of tax planning in order to
get the benefits they\'re due under the tax code and those three forms
of costs are 80 to 85 percent of the costs of compliance. So they will
remain with us on almost any system except tax reform.

Chart 3 shows the change in shares of taxpayers by tax preparation
method between \`93 and 2003 and the notable fact here is the enormous
growth in software preparation and the dramatic drop in that bottom blue
line which is people who self-prepare their returns without software.

Electronic filing has also grown. It was to 48 percent by tax year 2003
and it will go over 50 percent this year for the first time.

So who are the potential users of return‑free tax systems? If you want
to have the exact withholding, which is the strongest variance of that
with our system with all the deductions, with joint filing, it\'s a very
small percentage. According to Treasury, the taxpayers in the lowest
bracket, with wage income only, no itemized deductions, no credits,
except for the child tax credit, was only 17 percent of taxpayers in
1999. With the extra 10-percent bracket added in 2001, there are even
fewer taxpayers now who are in the low bracket.

Administrative changes could, according to Treasury, raise those numbers
to 38 percent but this is what you would have to have. You would have to
have withholding on a bunch of other income sources, including interest
and dividends, pensions and IRAs, unemployment compensation and
unemployment benefits and capital gains distributions by mutual funds.
You\'d also have to have a separate determination of EITC outside of the
regular system.

In the U.K. where they do have exact withholding, they have the
following features of their law. They have individual filing. They have
only three rates. That is no joint filing, only three rates and 80
percent of taxpayers pay the basic rate. Withholding on interest and
dividends, no capital gains tax on housing and exemption of the first
7200 of capital gains and also fewer credits and deductions, no medical
deduction because they have national health and charitable deductions
and mortgage deductions are filed through institutions as opposed to by
individuals.

With tax agency reconciliation, you could have potentially more users
that would include all people whose income and deductions come from
sources reported by third parties. And that is everyone who can use
exact withholding plus two‑earner couples, people with matched sources
of income such as interest, dividends, mortgage interest deductions.

According to GAO and IRS, about 50 percent of taxpayers could be
eligible for this kind of system according to past studies. However, the
estimates of actual participation rates vary considerably. Examples of
ineligible taxpayers, taxpayers with self‑ employment income, taxpayers
with capital gains, taxpayers with most itemized deductions and credits.
I would point out that none of these systems being discussed do anything
for people who are self‑employed or for small businesses. They would
still have to file returns.

How tax agency reconciliation works. Generally, the way it would work is
the IRS would send a notice to taxpayers. Based on the notice, taxpayers
would determine whether they are eligible and whether they wanted to
participate. They would report their filing status and their number of
dependents to the IRS and then the IRS would compute tax based on the
W2s they got and the 1099s they got and so forth. Taxpayers could then
contest the IRS assessment, agree or disagree with that assessment and
then once that process is completed, either refunds would be forthcoming
or tax payments would be made.

Let me just mention a few pros and cons of this. Exact withholding would
require major tax simplification and administrative changes. So unless
there were a major tax overhaul, it couldn\'t even be considered
feasible. Tax agency reconciliation is more feasible, but would involve
some additional costs and I\'ll just mention two of them here.

One of them is the information returns would have to be processed a
whole lot faster than they are now. That would raise costs to the IRS
considerably. It would raise costs to employers and financial
institutions considerably. And even with that, there would be delays in
refunds to taxpayers, which might be unacceptable. So there are a lot of
problems that would have to be overcome before this kind of system was
put in place.

The benefits would be a reduction in compliance costs for some people,
mostly for those who now have relatively simple returns. But the one
thing that Joe mentions in his testimony and probably is the major
argument for this or something like this, is it does reduce the psychic
costs of return filing for those who find that troublesome even though
the actual burden isn\'t that big.

CHAIRMAN MACK: Does that word equate to fear?

DR. TODER: Yes. That might be a better way of putting it. Other
considerations that you ought to keep in mind: Would taxpayers trust IRS
calculations;

Alternatively, would they fear the IRS so much that if the IRS sends
them a wrong number they\'d be afraid to contest it;

Would taxpayers be aware that they still are responsible to supply
complete and accurate information? The IRS only gets some information
from employers. If for example you have outside consulting income and
you fail to report it you would still be liable for tax even if it\'s
not included in the IRS calculation;

Is this a cost effective use of IRS budget resources? We have
alternative methods of dealing with cost, which are growing, and more
spending on enforcement may be a higher priority at this time.

And, should people be responsible for their own tax returns? Is that a
responsibility of citizenship? Does it promote awareness of the cost of
government? Does it promote transparency of tax burdens? Those are
issues that you should think about.

Effects of tax simplification. It would facilitate having more taxpayers
subject to a return‑free system but exact withholding would remain
limited, possibilities for that, if we retain joint-filing.
Simplification would reduce the potential gains from a return‑free
system and I would point out it would not relieve self‑employed and
small businesses of the need to file returns. You\'d still have to worry
about how much of your use of your car is personal use or business use.

Conclusions: a return‑free system works only for relatively simple
returns with low compliance costs. If you went to one tax agency,
reconciliation would be more practical for the U.S. than exact
withholding. It is not clear to me at least that the benefits exceed the
cost given the growth and the widespread use in preparers and software
as alternatives and by the way, also the IRS has introduced a
free‑filing now over the web in a consortium with software preparers and
return‑free systems are not a substitute for tax simplification. Thank
you very much.

CHAIRMAN MACK: Thank you very much. Joe, we\'ll go to you next.

MR. BANKMAN: This panel has focused so far mostly on the problems of
taxation business income. I think that\'s entirely appropriate and I
support reform in that area. But the tax system also imposes a lot of
costs at the other end of the economic spectrum. We\'re talking about
the 40 percent of taxpayers who don\'t itemize and have wage and
interest income only.

The tax year starts off for these taxpayers with the receipt in the mail
of W-2s and 1099s. That\'s hardly self-explanatory documents. It then
goes to the forms and instructions and Americans are great at lots of
things, but reading forms turns out maybe not to be one of them. Studies
show that about 50 percent of adult Americans form the basic rudimentary
group in terms of reading comprehension. For these folks, the forms are
not simple. Of course, you could have a Ph.D. in Comp Lit from Yale and
still have anxiety when filing out a tax form.

The sad part about all this is all of this complexity at the bottom end
is to some extent unnecessary. When the form hits the State of
California, what does it do? It matches the taxpayers numbers against
the numbers in its computer. It looks at the taxpayers math against its
own math and if there\'s a discrepancy, California assumes that it is
correct and it sends out a notice of deficiency. If the state already
has that information, why not start the ball rolling by letting the
taxpayers know what\'s in their computer for those taxpayers?

And think of a tax return like a Visa bill. Visa doesn\'t send out a
blank sheet of paper to people each month. It sends out a statement of
the transactions that are in its computer and customers insist on this.
That\'s not just to save time and money. It\'s so that they can check
errors ahead of time instead of dealing with Visa later on.

The California ReadyReturn, which is what California has called its pro
forma return, or the agency reconciliation method that Eric spoke about,
was started this year for this first time. Fifty thousand taxpayers with
wage income only in the previous year and who appeared to have wage
income only for this year were sent a ReadyReturn which had that wage
data there and it also had the tentative tax liability they would owe.
And by the way, there\'s an example, it\'s not an example, it\'s a copy
of the notice those taxpayers got at the end of this PowerPoint
presentation. People can look at it. I\'m not going to try to scroll
through that right now.

Taxpayers then had the option, unlike the agency reconciliation method
that Eric mentioned; taxpayers could use the ReadyReturn but it was
really opted in. The only way they used it is if they said this is what
we want and they sent it back. All this was available online as well.
They could make corrections on that and send back online, file the
corrected ReadyReturn or they could simply use it as a basis with which
to determine their old return in the old‑fashion way. For that matter,
they could have thrown it out.

What happened? Despite a lack of advanced publicity about 15 to 20
percent of taxpayers will have used the ReadyReturn. I say \"about\"
because in California, taxes don\'t become overdue until after an
automatic extension which ends in October. So we\'re still getting some
ReadyReturns as we speak and there are still some paper returns to
collect. Ninety‑nine percent of the taxpayers surveyed who used the
ReadyReturn said they would do that next year. That\'s been a phenomenal
first-time project.

But what is more phenomenal I think are the comments and I put some of
them up on the board. \"Fantastic service.\" \"Best thing in the
world.\" \"Whoever thought of this deserves a big fat raise.\" \"Wow.
Government doing something to make my life easier for a change.\" At the
end of this PowerPoint, I have all the comments unedited received from
the first batch of surveys. I will get the staff the latest batch of
surveys.

I didn\'t put them on the PowerPoint because it would have become
undownloadable at that point. But they are the exact same pattern if you
just looked at the comments. \"Great pilot.\" \"This is great and
easy.\" \"Great program.\" \"Wonderful.\" \"Wonderful.\" \"Fast.\"
\"Easy.\" \"Free.\" So on and so forth. You really hear taxpayers speak
their own voice about what\'s important to them and what we find is that
these aren\'t taxpayers who think this is a minimal burden. People
don\'t write those comments unless they think they\'ve been relieved of
a true burden.

Minor criticisms. The beta version of this had frankly some mistakes. We
didn\'t explain what a PIN was for example and some people pointed that
out. Those are easy to correct. Bipartisan support, the leading Democrat
in California, Steve Wesley supported that, as have the finance
directors of Governor Schwarzenegger, leading officials, wide array of
policymakers.

But not everybody supports it and I want to go over some of the
arguments on the other side for a minute. One fear that Eric averted to
is that taxpayers will be intimidated into accepting the state\'s
numbers. We know how taxpayers behaved. Eighty percent weren\'t
intimidated. They said, \"No, we\'ll pass this time around.\" The people
who used it loved it.

Privacy concerns. In fact, this requires no new information to the state
government and it enhances privacy values because it lets taxpayers know
the information the government already has on them in their computer.

How about tax preparers? It\'s not going to affect most preparers but
there are some preparers \-- Intuit \-- that have opposed it. It\'s a
for‑profit company. They feel they have a franchise to protect. I don\'t
blame them for opposing it.

I do want to bring up one false argument, which Eric averted to, which
is that this competes with the private sector. We could farm this out.
The question is do taxpayers find it useful and is it cheap to get
taxpayers the information necessary to help them with their return. If
the answer is yes, you can have H&R Block maintain that website if it\'s
the lowest bidder. There\'s nothing in this that says government has to
do it.

Making taxes more visible is a value that Eric favors. I think it\'s a
value that Mr. Norquist favors. It\'s a value I favor. But the present
tax system is a lousy way of alerting taxpayers to what\'s happening.
It\'s mostly a reading comprehension tests with some record keeping
skills thrown in. And most taxpayers find it so onerous, they farm it
anyway.

We could enhance the visibility of the tax system by giving these folks
a ReadyReturn and including in big, bold‑faced type here\'s the tax
you\'ve paid. You took most of it out on your payroll as it went along.
Here\'s your average tax rate. Here\'s the rate on your next dollar. We
could even say we\'ve taken some payroll taxes. Maybe we could let Mr.
Norquist write that statement.

The ReadyReturn is really about choice. Taxpayers should get the right
to have access to the information if we can get it to them cheaply and
efficiently. Now California didn\'t have some of the problems Eric
averted to, that the government worried about, and I think this is
really because computerization is moving apace at the government level
as well as at the private industry level.

So, for example, taxpayers didn\'t get this delay. They didn\'t have
delayed refunds. In fact, as part of the ReadyReturn if you filed it
electronically as many taxpayers did, you could get your refund direct
deposited in two days. So actually, it sped up rather than delayed
refunds. So taxpayers get the choice of what to do with the ReadyReturn
and what they do with it is their business.

Now I can\'t imagine any taxpayer really not wanting to know what
information the government already has on them. But if we find those
taxpayers, we should allow them to opt out. We could have a \"Do not
disturb.\" \"Don\'t darken my door next year with this ReadyReturn\" and
we\'ll save the costs. The costs really turn out to be, for California,
mostly postage and just maintaining a website and as it would scale up,
the costs would go way down.

Now California differs from the Federal Government in two significant
respects. It doesn\'t have any EITC and it does have more timely wage
data than the Federal Government does. But you know if you\'re comparing
this reform to most of the reforms you\'re thinking of, you almost never
find a reform that is closer to being implementable than this reform.

And one of the key advantages this reform has is it\'s scalable. You
can\'t have a pilot program for example for the Flat Tax. But you could
do a Federal pilot for the ReadyReturn and if you did a pilot, you could
partner with the state and thereby solve your biggest implementation
problem, which is a timely wage data and which is one of the reasons, as
Eric averted to, that timeliness is a big concern on the Federal level.

You know I don\'t want to be one of those people that think this is the
only approach to go on. Unlike the previous panel, and maybe because
I\'m an academic, I actually favor a lot of those big-scale reforms like
the Flat Tax, X‑tax, like Michael Graetz\'s proposal, though not as much
as a flat tax, X‑tax. But what the ReadyReturn has going for it, it\'s
like a gift you could give 50 million American taxpayers. I would hope
that the Panel could recommend a pilot program as a way of starting to
give taxpayers that gift. I\'ll be happy to answer questions, I guess,
later.

CHAIRMAN MACK: Thanks, Joe. Grover.

MR. NORQUIST: I think this is a particularly bad idea, and first of all,
the present system which has lots of problems, is at least citizen‑based
and focuses taxpayers on what they\'re paying. Politicians tend to like
the sales tax which people have a very weak understanding of how much
they\'re paying as opposed to property tax where people have a rather
direct understanding of how much they\'re paying and I think that moving
to a so‑called return‑free system will reduce people\'s understanding of
what exactly they\'re paying and their focus on it will make it easier
to raise taxes.

A government, this is the flip side of that, it should become
government‑based and it would put the onus on taxpayers to then
challenge what it is. It\'s like playing in Las Vegas. The house sets
the rules and the house has its fingers on the scales. Do you really
want to go and argue with the IRS if they\'ve sent you a bill that\'s
higher than you think it ought to be?

It also gives the advantage just as the house in Las Vegas. The
interests of the government is to maximize its revenue. The idea that
the government doing your taxes for you will have your best interests at
heart is an interesting idea, but not one that I think makes a lot of
sense.

And again, the real interest here and we\'ve seen this in California, a
discussion by the folks who put this forward in California, they
projected a significant increase in revenue because they think the
government of California, in doing your taxes, will make your taxes much
higher than if you do it in California. There was a discussion about
Visa bills. On my Visa bill, I get a list of all the things that I got
with my money in addition to what I paid. We don\'t tend to get that
from the government at any level.

Then we get to the issue of visibility, which I think is the key thing
here. We want people to be aware of what they\'re paying and how much it
costs. The idea that one of the benefits is to reduce the psychic costs
of tax filing reminds me of the argument for the guillotine, which was
that it was more humane. It also meant that it would be used more
frequently and I think has the same problem with ReadyReturn.

Then the California example, I think there are several challenges as to
how much it was used, but the third one is the key. The California
officials keep saying that their real goal here is to raise revenue and
I think it would raise revenue. This seems to me the next step after
Milton Friedman\'s mistake of allowing us to go to withholding during
World War II; the next step in making it easier for the government to
get their hands on your income and making you detached from the actual
cost of government. For all those reasons, I think it\'s not a good
idea.

CHAIRMAN MACK: Grover, thank you. You were certainly to the point.
Charles, we\'ll start with you.

MR. ROSSOTTI: Eric, assuming the U.S. would have to go through the
agency reconciliation method, in other words, the IRS, did you ever make
any estimates of what the actual increased budgetary costs in the IRS
study would have to be because whatever number of cases you had each
taxpayer return would now be a case? I recall from my days that the
simplest kind of a case we exchanged information back and forth and
\$100 a case. I don\'t know whether you made any estimates.

DR. TODER: I have made no estimates of that. Each one would be a case
but it would not be insignificant. But I don\'t know.

MR. MURIS: Let me ask a couple questions if I could. Grover, I think
Milton Friedman now says that if we didn\'t have withholding the
government would fall on April 16th and I saw that principle in action
in the late \`80s in the catastrophic Health Insurance, which is
actually designed to have that effect.

MR. NORQUIST: You\'re making my case for me, right?

MR. MURIS: Yes, about withholding anyway, which we\'re not going to
change, but isn\'t this horse out of the barn in the sense that this is
a pretty minor change, isn\'t it? I mean do you really see it having
significant income effects and I wanted to ask Professor Bankman about
the income effects issue.

MR. NORQUIST: Yes, most disastrous things the Federal Government does
are minor changes. Very rarely does the Federal Government do a big bad
thing. They do a series of small ones and this just moves in the
direction of separating people from the true costs of government and
making it harder for them to figure that out. You\'re right. It\'s a
small step in the wrong direction.

But when you go from making this voluntary to mandatory, it will be a
really big one and just as with withholding, which is not voluntary but
mandatory, this will become mandatory as well and then the government
will have to have all your financial information and particularly for
those nice small businesses with the really complicated forms. If you
have a simple tax reform, this doesn\'t do anything for you. The really
interesting stuff is when you get everybody\'s financial data and you
make it mandatory and this is the step towards that.

MR. BANKMAN: Let me just say that the folks that gave comments on this
would probably disagree with Mr. Norquist\'s statement that this didn\'t
do anything for them. The projected increases in revenue were something
\-- I was at every hearing when this was adopted. It was adopted at a
hearing before the Franchise Tax Board and I testified in its favor and
I said this would not increase revenue at all.

The reason it doesn\'t increase revenue at all is while it will get a
few more people in the filing system, a lot of the people in this
category actually have refunds coming. So this will be the last thing
you\'d want to do if you were going to increase revenue. In fact, if it
has any effect, it\'s going to be a slight decrease in revenue.

The reason it\'s a slight decrease in revenue is right now the
government gets almost no income that isn\'t subject to third party
reporting but it gets a little bit. And now people are going to get a
return from the government which is going to be optional. It\'s not
mandatory, saying you can file this if you want. Suppose they have
moonlighting income and the moonlighting income isn\'t on the government
return. In fact, we\'re not getting the moonlighting income now anyway.
But to the extent we\'re getting a little bit, it stands to reason
we\'ll get a little bit less with it.

So when we look at the numbers, we\'d thought there would be a
negligible loss of revenue from it, certainly not an increase in
revenue. It\'s very hard given the fact that it\'s going to get more
people in the system that are going to get refunds and it\'s never going
to result in a higher tax base. It\'s very hard to imagine getting an
increase in revenue from this. This is something you do to lessen
taxpayer burden, not to get an increase in revenue.

MR. POTERBA: What do we do about the error rates that result under these
systems, either, Eric, if you know anything about the U.K., or Joe, do
we know the false matching rate or the failing to find the spouse and
match that income data? Has there been a controlled analysis of that?

DR. TODER: I\'m not familiar with that, Jim.

MR. BANKMAN: What California is going to do is they\'re going to do an
experiment taking a matching group and that will give us some sense of
what the real revenue estimates are. But apart from that, while the
error rates are small, I can\'t go beyond that. But I think the best
estimate will be to take 10,000 people in a control group in the same
group in which the pilot participants were randomly selected and try to
match in various ways and that will take awhile to get the estimates on
them.

MR. NORQUIST: One option is to the present system where individuals do
it and there\'s private competing software to do it. The other is a
government monopoly software. If you think a government monopoly
software is less error-prone over time than competing private ones, then
that would be the way to go. But that would probably be the first time
in modern history that\'s happened. The other one is the idea that
government workers are going to be more careful in doing your arithmetic
than you are. I think that\'s also unlikely.

MR. FRENZEL: Yes. I\'d like to ask Mr. Bankman. Assuming you\'re right
and the state doesn\'t get any more revenue and Grover is wrong with
that\'s their aim, what\'s in it for the State of California?

MR. BANKMAN: The only thing that was in it is to make life a little
easier for taxpayers and this originated by some state bureaucrats,
I\'ll be honest, who said, \"We could do this. We have a good computer
system. Why shouldn\'t we because we hear everybody saying how hard it
is. Let\'s give them a break.\" So that the motive for this, I think,
certainly on their behalf and on my behalf.

The people that are doing it in the Franchise Tax Board that came up
with it are middle-level bureaucrats. They\'re not getting a piece of
the cut. They don\'t have any big political aims. They\'re
middle‑of‑the‑road folks.

MR. NORQUIST: The Franchise Tax Board in its argument for this, this
came during a period of overspending where the government wanted more
money in California. This was part of the solution to that. This is not
independent of their desire to get more money.

MR. FRENZEL: There is some mailing costs on the part of the state. And
if, as you suggest, there\'s a willingness on the part of the people to
contest whatever the state suggests is their income, aren\'t you going
to have a lot more negotiation, a lot more, I guess what would have
been, compared to audit expense in the old system, give and take between
the taxpayers and the tax collectors?

MR. BANKMAN: This is an opt‑in system, so if you don\'t want to use it,
you throw away and most people did. So this shouldn\'t at all increase
the amount of disputes. I\'m not sure I\'d see the analytics on why it
would increase the amount of disputes. People that want to use it, use
it. People that don\'t want use it, do it the old fashioned way.

DR. TODER: I think I would agree generally on that. I mean, people, if
you don\'t use it, you just file separately just the old way and it\'s
not really in dispute.

MR. NORQUIST: Is withholding at present an option or is it mandatory?
Things are not done statically. If you start down this road, you will
continue down this road and if you give the government this option, this
will become mandatory not just for some people but for everybody. You
can bank on it. You\'ve seen this happen before. The government is not
going to give this as an option, decide they\'re making more money and
not extend it. They will.

MS. GARRETT: Joe, the question for you, and I\'d also be interested in
Eric\'s response to it as well. First, congratulations. I gave my talk
before this had been implemented. It sounds like it\'s going well. I\'m
glad California is leading on this. And I think it\'s particularly neat
when you combine it with John Talisman\'s testimony about how many
taxpayers file relatively easy forms, yet how many have been ‑‑ used tax
preparers and this sort of psychic disadvantages that Eric talked about.
But I\'d like your reaction to how you would combine that with a credit.

So since we do have the refundable EITC, it\'s possible we might
consider some other refundable credits. So how does this kind of a ready
return system work with a system where we need to have refundable
credits to help those at the lower end of the income spectrum take
advantage of tax benefits or to get some more progressive benefits that
our system needs to have?

MR. BANKMAN: I don\'t think it would be too difficult to integrate the
EITC or the refundable credits with this because remember most of the
people that are using it are going to get a refund anyway. So, in
effect, this is a subject population which is going to have money coming
back to them and whether the money is coming back as a refund of amounts
that were over‑withheld from them or a credit itself is not a problem.

You do have to have the ‑‑ enough data to run the EITC through that. I
think that can be done. That\'s the only ‑‑ what I see as the only
remaining implementation problem, but with recent changes in the EITC, I
don\'t think that, itself is a problem here.

DR. TODER: I think in the case of the United Kingdom where they have
some variant of the EITC for working families, they keep changing it,
that is done by a separate application to the Inland Revenue. It\'s not
done through their withholding system. And I imagine it would have to be
done that way here, too, if you were to do that. I guess the other
comment I\'d like ‑‑ as far as I know there\'s a very small percentage
of taxpayers in California that are eligible for this. Do you want to
comment on that, Joe?

MR. BANKMAN: No, actually, it turns out there about 16 million
Californians filing. Now, I may be off by a million on that, but that\'s
the rough number of total filers. Three million were eligible for this
pilot program, but there would be another 4 million eligible once
you\'ve bumped it up to include a little bit of interest income as well
as wage income, so you\'re getting a pretty healthy piece of the whole.
So I don\'t think this is just a few. Even the 3 million is 60 percent
of the state.

CHAIRMAN MACK: I have a question from Liz Ann Sonders for Mr. Bankman.
Is there any change in process that would eventually allow small
businesses and the self‑employed to be served by a ready return system?

MR. BANKMAN: Well, I don\'t think so, and of course, that\'s where the
tremendous problem is. So I agree with everything that\'s said, that the
tax burden on the small business is very large and the regulatory burden
is too, but the system simply isn\'t going to work for them because
they\'ve got lots of transactions that aren\'t subject to third-party
reporting and the state unfortunately isn\'t going to be able to help
them.

The most you can do, and this could be done for all Californians, I
think for all citizens, is the principle of knowing what information the
government has on you extends even in cases where you\'re not going to
get a bottom line number. So, for example, a lot of us might have
forgotten a little 1099 income because we have \$3.10 from some account.
If it\'s in the state\'s computer, it\'s cheap to put that on line and
make that accessible. So to that extent you could expand the kind of
information sharing element of this to all taxpayers but it doesn\'t
really deal with the complexity for the small business.

CHAIRMAN MACK: John?

VICE CHAIRMAN BREAUX: Thank you all very much for your observations in
the area of simplifying. I mean, it seems to me that particularly for
people in the wage only brackets, I guess, I mean, basically you\'re
sending this off to the Federal Government and you\'re saying who you
are and how many dependents you have and what your wages were and they
look at it and you tell them ‑‑ you, as an individual are telling them
what you think you owe and then they verify it and send it back.

I mean, I\'m not sure if they send them out in the first place if they
have the information. This is your wages and your deductions from the
dependent standpoint, having them just look at it and tell you what you
owe. I\'m not sure there\'s a lot of difference there. I mean, I think
no one disagrees with the fundamentals of this thing, that is the
individual telling the government what they owe so the government has to
verify it and if it\'s not correct, they come back and tell you what you
owe. They said, no, it\'s not correct, you actually owe \$100.00 not
\$50.00.

I don\'t know that it\'s ‑‑ from my perspective there\'s a lot of
difference. My question is, can it work? And Charlie and I were just
talking about the more complex taxpayers. Obviously, it\'s real
difficult, but you don\'t know which laws to apply. There\'s a lot of
changes and a lot of choices in that category. But for the simple
taxpayer, it seems like it could possibly work. I was wondering, Joseph
you mentioned Michigan tried it and apparently no longer is doing it.
Can you elaborate as to what happened there? It didn\'t work?

MR. BANKMAN: Actually, I think Eric mentioned that. I think Michigan\'s
proposal had this odd opt‑in feature, as I recall. And it never got ‑‑
it was kind of stillborn and I actually don\'t know the background on
the Michigan proposal. Eric, maybe you can ‑‑

DR. TODER: There is some discussion of that in the recently released
Treasury report and for some reason, taxpayers chose not to opt in. Very
few did and that was the problem with it. But exactly whether it was a
feature of the design or whether apparently it seems to be more popular
in California.

MR. BANKMAN: You know, I can\'t imagine there\'s a significant
difference between Californians and Michigan residents, though. So I
think that if you send out these same forms to people everywhere,
you\'re going to get people taking up on you ‑‑ taking you up on your
offer.

CHAIRMAN MACK: Joe, there was just a little snicker in the audience when
you said ‑‑

MR. BANKMAN: Well, we\'re much more normal than you think. But if it
were only true what you see on TV, we\'d have a lot more interesting
lives.

VICE CHAIRMAN BREAUX: Well, I appreciate it. You know, you look at it
now for a lower-income wage earner, and he gets all of his stuff
together. He sends it to H&R Block. H&R Block sends it back to him. He
then sends it to the Federal Government and if it\'s not correct, the
Federal Government sends it back to him and then you send it back to the
Federal Government. It would seems if you would just eliminate some of
those steps particularly for simple wage earners there may be
simplification in doing the right thing. Thank you all very much.

CHAIRMAN MACK: A couple of other questions and then we\'re going to
conclude. It\'s suggested that if you move to a return‑free system that
there might be more stability to the tax system and I think the point
there is that there would be fewer changes in the tax code going forward
if you had a tax‑free ‑‑ a return‑free system. Any reactions to that?

DR. TODER: Yeah, I think, you know, that\'s a political judgment.
Certainly if you made the kinds of changes in the law that would
facilitate a wider use of a return‑free tax system, and then after
you\'ve made those changes in the law, you then instituted a return‑free
tax system, it\'s possible that having it there would make it more
stable because then you wouldn\'t want to start introducing more
complexity from that point forward.

I doubt that it would do much good if you just did that right away
without other changes.

MR. NORQUIST: It would make tax increases easier and tax cuts less
recognized because what happens is the that government says everybody is
going to pay \$100.00 more and you just get this additional bill. It\'s
not as visible to you if they say, okay, line 7, add \$100.00 because
your government\'s thought of some new things to spend your money on,
okay. Or conversely, the other way around, a tax cut where the
government says we\'re now going to take \$100.00 less from you, fill it
out on your form, gets a lot more recognition. This is why this
Administration is always big on sending out those little rebates and so
on, \"Hey, did we cut your taxes, we wanted to make sure you saw that\".

Okay, and so going to this system would make tax increases easier and
tax cuts less likely, politically.

MR. BANKMAN: A return‑free system requires some structural changes. This
doesn\'t ‑‑ basically, you have to have a flat tax on interest and
dividends and withholding on the source. It puts more burden on the
employers because your W‑4 then becomes more of a tax return. Loses a
little progressivity, so there\'s some cost, but having said that,
there\'s a lot to be said for return‑free systems too. And if I thought
we were on the knife edge, you know, almost the return‑free system, I
would probably support that, though I think this is an easier way to get
most of the benefits. A return‑free system, though, it doesn\'t get the
one benefit you just mentioned.

CHAIRMAN MACK: Grover, I think, I guess, the last comment I would make
or question to throw to you is that when you started out, it sounded
like the issue of visibility of knowledge of how much you\'re paying was
really your major concern, but I\'m now going by what I saw, more
passion behind some of your other comments, which was basically, the
fear of in essence, turning over more information to government, privacy
kinds of issues.

MR. NORQUIST: Yeah, if you\'re paying 10 percent of \$20,000.00, the
government offering to do that calculation for you isn\'t a big favor,
okay? But if you\'ve got a more complicated code and a lot of ‑‑ a more
complicated tax system, the savings on your time comes when the
government demands all of that third party stuff that they don\'t have
yet for everybody. This leads inevitably to not being voluntary but
being mandatory, not being for some people but being for everyone and
those stick-in-the-muds that don\'t want to hand over more information
to the government are interfering with the IRS\' great new tool. And I
think it will drive demands for more violation of people\'s privacy,
more demands for people\'s information. We ought to be moving in the
opposite direction of getting the government out of taxing those things
that require more violation of people\'s privacy. The reason not to have
a death tax is that the government ought not to know how much gold is in
your teeth and everything in your basement on the day you die. Okay?
It\'s not just not breaking up the farm or the small business. It\'s
also not being in your life completely on that final day.

And the same thing with moving away from the double taxation of
dividends and interest. That sort of thing, you can get simplicity, you
can get greater efficiency with the government requiring less
information. This is a mechanism to make it easier for the government to
have more information, raise more money and maintain the complexity of
the Code instead of going to simplification.

CHAIRMAN MACK: If I make the assumption that I am paying what I should
pay under the present tax code and I complete my tax return by April
15th and regardless of whether I figure it out or have somebody do it
for me, I send this information in, I have now provided all ‑‑ you know,
provided government with, I guess, all the information that you say that
they shouldn\'t have. Where have I ‑‑ where have I missed the point
there?

MR. NORQUIST: The question is, does the government have it 24/7, all
through the year going forward so they have all that information, or is
it provided voluntarily by you and by you, in theory, so that there\'s
greater privacy? If the government is sitting on it at any given point,
their ability to share it is increased with other people, with whoever
they want, with other countries for tax purposes.

CHAIRMAN MACK: Gotcha. All right.

DR. TODER: Actually, I think there probably is a privacy issue but not a
government issue because I agree with the thrust of your question, the
government gets the information anyway that taxpayers are required to
report, but to make certain kinds of systems work well, it could be
necessary, depending on how you design the system to supply more
information to businesses earlier and that\'s certainly the case in the
UK for example, the way their charitable deduction works is you ‑‑
basically, it\'s the charity that submits the claim, not you through
withholding, so that your company knows how much you\'re giving to
various kinds of charities. It\'s not a ‑‑ and so I think it\'s ‑‑ if
you wanted to make this work in a widespread way, you\'d probably have
to have a lot more information supplied to your employer to make it
feasible.

MR. BANKMAN: Although I\'d say the ready‑return doesn\'t require any of
that.

DR. TODER: The ready‑return does not.

MR. NORQUIST: And the savings to your privacy come when the government
doesn\'t ask you how much you own on the day that you die because it
isn\'t taking any of it, not so much the back and forth sort of thing.

CHAIRMAN MACK: All right, I think that concludes this panel as well and
our hearing for today and I thank you for your participation and
appreciate all you coming.

(Whereupon, at 12:35 p.m. the above-entitled matter concluded.)