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[House Hearing, 105 Congress]
[From the U.S. Government Publishing Office]

 
THE IMPACT ON INDIVIDUALS AND FAMILIES OF REPLACING THE FEDERAL INCOME 
                                  TAX

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

                                HEARING

                               before the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED FIFTH CONGRESS

                             FIRST SESSION

                               __________

                             APRIL 15, 1997

                               __________

                             Serial 105-15

                               __________

         Printed for the use of the Committee on Ways and Means

                     U.S. GOVERNMENT PRINTING OFFICE
47-448 CC                    WASHINGTON : 1998

                      COMMITTEE ON WAYS AND MEANS

                      BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
BILL THOMAS, California              FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida           ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut        BARBARA B. KENNELLY, Connecticut
JIM BUNNING, Kentucky                WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York               SANDER M. LEVIN, Michigan
WALLY HERGER, California             BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana               JIM McDERMOTT, Washington
DAVE CAMP, Michigan                  GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota               JOHN LEWIS, Georgia
JIM NUSSLE, Iowa                     RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas                   MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington            WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia                 JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio                    XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania      KAREN L. THURMAN, Florida
JOHN ENSIGN, Nevada
JON CHRISTENSEN, Nebraska
WES WATKINS, Oklahoma
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri

                     A.L. Singleton, Chief of Staff

                  Janice Mays, Minority Chief Counsel

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.

                            C O N T E N T S

                               __________

                                                                   Page

Advisory of April 8, 1997, announcing the hearing................     2

                               WITNESSES

                                 ______

Armey, Hon. Richard, K., a Representative in Congress from the 
  State of Texas.................................................     6
Family Research Council, Martin J. Dannenfelser, Jr..............    46
Hubbard, R. Glenn, Columbia University...........................    31
Mitchell, Daniel J., Heritage Foundation.........................    43
National Center for Policy Analysis, Barry Asmus.................    37
Steuerle, C. Eugene, Urban Institute.............................    21
Tax Analysts, Martin A. Sullivan.................................    41

                       SUBMISSIONS FOR THE RECORD

Center for the Study of Economics, Columbia, MD, Steven Cord, 
  statement......................................................    65
Ramstad, Hon. Jim, a Representative in Congress from the State of 
  Minnesota, statement...........................................     5
Schaefer, Hon. Dan, a Representative in Congress from the State 
  of Colorado, statement.........................................    66
Tauzin, Hon. W.J. ``Billy,'' a Representative in Congress from 
  the State of Louisiana, statement..............................    67

THE IMPACT ON INDIVIDUALS AND FAMILIES OF REPLACING THE FEDERAL INCOME 
                                  TAX

                              ----------                              

                        TUESDAY, APRIL 15, 1997

                          House of Representatives,
                               Committee on Ways and Means,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:08 a.m., in 
room 1100, Longworth House Office Building, Hon. Bill Archer 
(Chairman of the Committee) presiding.
    [The advisory announcing the hearing follows:]

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

FOR IMMEDIATE RELEASE                                 CONTACT: (202) 225-1721

April 8, 1997

No. FC-6

                 Archer Announces Hearing on the Impact

                      on Individuals and Families

                  of Replacing the Federal Income Tax

      
    Congressman Bill Archer (R-TX), Chairman of the Committee on Ways 
and Means, today announced that the Committee will hold a hearing on 
the impact on individuals and families on replacing the Federal Income 
Tax. The hearing will take place on Tuesday, April 15, 1997, in the 
main Committee hearing room, 1100 Longworth House Office Building, 
beginning at 10:00 a.m.
      
    Oral testimony at this hearing will be from invited witnesses only. 
However, any individual or organization not scheduled for an oral 
appearance may submit a written statement for consideration by the 
Committee and for inclusion in the printed record of the hearing.
      

BACKGROUND:

      
    In the 104th Congress, the Committee held five days of hearings on 
problems caused by the current Federal income tax system and proposals 
to replace the Federal income tax. The Committee then began to examine 
how the proposed replacement systems would affect specific segments of 
society and the economy, holding hearings on the impact of replacing 
the income tax on small businesses, State and local governments, tax-
exempt entities, international competitiveness, domestic manufacturing, 
energy and natural resources.
      
    In announcing the next hearing, Chairman Archer stated: Two years 
ago, this Committee began a careful examination of how we could 
replace--in its entirety--our current income tax system. Now the 
Committee picks up on where it left off last year. Following this 
hearing, the Committee will continue to examine the impact of proposed 
alternatives, including the effects on employee benefits and retirement 
and personal savings incentives; home ownership and real estate 
generally; agriculture; retail sales; financial services; service 
industries; and health care.'' Dates for hearings on these topics will 
be announced in future advisories.
      

FOCUS OF THE HEARING:

      
    The focus of this hearing will be on the impact on individuals and 
families of replacing the Federal income tax with one or more of the 
proposed alternative tax systems. The basic alternatives are an income 
tax (with one or more rates); a flat tax (such as the one introduced by 
House Majority Leader Dick Armey); a national sales tax (such as the 
one introduced by Reps. Schaefer and Tauzin); a value added tax (both 
invoice-credit and subtraction methods); and an income tax system with 
an unlimited savings deduction (such as the USA tax system introduced 
by Senator Domenici and former Senator Nunn). The witnesses should 
assume that any new tax system would replace, on a deficit-neutral 
basis, the individual income tax, the corporate income tax, and estate 
and gift taxes.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Any person or organization wishing to submit a written statement 
for the printed record of the hearing should submit at least six (6) 
copies of their statement and a 3.5-inch diskette in WordPerfect or 
ASCII format, with their address and date of hearing noted, by the 
close of business, Tuesday, April 29, 1997, to A.L. Singleton, Chief of 
Staff, Committee on Ways and Means, U.S. House of Representatives, 1102 
Longworth House Office Building, Washington, D.C. 20515. If those 
filing written statements wish to have their statements distributed to 
the press and interested public at the hearing, they may deliver 200 
additional copies for this purpose to the Committee office, room 1102 
Longworth House Office Building, at least one hour before the hearing 
begins.
      

FORMATTING REQUIREMENTS:

      
    Each statement presented for printing to the Committee by a 
witness, any written statement or exhibit submitted for the printed 
record or any written comments in response to a request for written 
comments must conform to the guidelines listed below. Any statement or 
exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
Committee.
      
    1. All statements and any accompanying exhibits for printing must 
be typed in single space on legal-size paper and may not exceed a total 
of 10 pages including attachments. At the same time written statements 
are submitted to the Committee, witnesses are now requested to submit 
their statements on a 3.5-inch diskette in WordPerfect or ASCII format.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
comments in response to a published request for comments by the 
Committee, must include on his statement or submission a list of all 
clients, persons, or organizations on whose behalf the witness appears.
      
    4. A supplemental sheet must accompany each statement listing the 
name, full address, a telephone number where the witness or the 
designated representative may be reached and a topical outline or 
summary of the comments and recommendations in the full statement. This 
supplemental sheet will not be included in the printed record.
      
    The above restrictions and limitations apply only to material being 
submitted for printing. Statements and exhibits or supplementary 
material submitted solely for distribution to the Members, the press 
and the public during the course of a public hearing may be submitted 
in other forms.
      

    Note: All Committee advisories and news releases are available on 
the World Wide Web at `HTTP://WWW.HOUSE.GOV/WAYS__MEANS/'.
      

    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-225-1904 TTD/TTY in advance of the event (four 
business days notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.
      

                                

    Chairman Archer. The Committee will come to order. Today 
I'm pleased to continue our series of hearings on alternative 
tax systems for structural reform of our current income tax. 
Over the past 2 years, the Committee has heard expert testimony 
on the shortcomings of the current income tax and the impact of 
proposed alternative tax systems on various sectors of our 
economy.
    We covered a lot of ground in the 104th Congress, but we 
still have much work ahead of us. Today, April 15, is a fitting 
day to examine the impact of fundamental tax reform on 
individuals and families.
    As most people by now in this country know, I continue to 
do my own income tax, so I understand first hand the 
frustrations of millions of taxpayers as they struggle to 
figure out their income tax forms.
    That's why it's so important that Congress respond when 
public sentiment about our tax system turns critically 
negative. If our income tax is perceived as unfair, inefficient 
and complex, it's time to reevaluate how we fund government. 
Without public confidence in our tax system and the 
administration of pertinent laws, our system of voluntary 
compliance cannot survive.
    I've come to the conclusion that the Tax Code is so broken 
that it can't be fixed. I don't think better management at the 
IRS will do the trick, and I don't think minor reforms of the 
Tax Code will work. Instead, I believe we need to fundamentally 
overhaul and simplify the Federal Tax Code.
    The current code is unfair, riddled with loopholes, 
excessively complicated, overly intrusive and antigrowth. We 
can and we must do better. I think we should pull the income 
tax out by its roots and throw it away so that it never grows 
back, and remove the Federal tax collector, the IRS, from any 
direct contact with every individual American citizen, that is, 
to get the IRS completely and totally out of the lives of every 
individual American.
    I favor replacing the income tax with a tax on consumption 
that is fairer and simpler and more conducive to economic 
growth.
    Our witnesses today will address the many key questions 
about how families and individuals fare under current law, and 
whether alternative tax proposals may improve or worsen their 
lives.
    I'm also extremely pleased that our Majority Leader, and my 
very close friend, Dick Armey, has joined us today to discuss 
the merits of his bill, H.R. 1040.
    I am now pleased to yield to Barbara Kennelly, the Acting 
Ranking Democrat on the Committee for any comments she might 
like to make.
    Ms. Kennelly. Thank you, Mr. Chairman. Good morning. This 
morning, the Committee is scheduled to hear testimony on the 
possibility of reforming the income tax and the impact on 
families. We would do well to recall that for all the 
complexity of the Code, the majority of all individual filers 
are in the 15 percent tax bracket, or pay no income tax at all.
    First and foremost, any serious tax reform proposal should 
do no harm, and not leave these American families any worse off 
than they are today. It would be a cruel hoax to tell citizens 
a flat tax is possible, and not highlight the loss of a 
progressive tax system or the transition costs involved.
    The second tax reform test ought to be deficit neutrality, 
or at least not increasing the deficit. There are those who 
would advocate a flat tax, which the Treasury Department 
projects would lose on average $138 billion annually. When the 
Federal budget deficit has come down in each of the last 4 
years, such an approach borders on the irresponsible if this 
loss of progress is not factored in.
    This Committee has a longstanding interest in tax fairness 
and simplicity. After careful thought and thousands of hours of 
work, we enacted the Tax Reform Act of 1986 which reduced taxes 
on individuals by $280 billion over 5 years, and took 6 million 
low- income families off the income tax rolls. The country is 
certainly very different economically than it was then, we have 
to admit today that we are dealing in a truly global economy.
    And so I would say, yes, it is time to conduct another 
thorough review. However, we would do well to recall that the 
largest deductions are home mortgage, state and local taxes, 
and charitable contributions, and that the largest exclusions, 
employer provided health and pension benefits, dwarf the 
largest deductions.
    Taken together, these items account for the bulk of tax 
preferences in dollar terms. The Members, Democrat and 
Republican, House and Senate, were well unwilling to tackle 
these items in 1985 and 1986.
    I do not see any reason to believe that any legislation 
that would reach the President's desk in 1997 or 1998 would be 
any different.
    In the absence of such action, fundamental reform is 
unlikely in this session. I, however, feel that we should 
continue to look for possible doable tax reform, and obviously 
listening to the Chairman's remarks, I agree with him on 
simplicity.
    It is also agreed that the 1986 Tax Reform Act, while 
dropping people from the rolls, also made business taxation 
even more complicated with the Alternate Minimum Tax, AMT, and 
passive loss changes. We should learn from these actions.
    Having said that, I would welcome proposals to simplify the 
Internal Revenue Code, correct errors or rid the Code of 
outdated, unworkable provisions. In that vein, I am hopeful 
that the witnesses before us today will offer us constructive 
suggestions to do just that.
    Thank you, Mr. Chairman, and, I, too, welcome the Majority 
Leader who is appearing before us, and who is so active in this 
question. Thank you.
    Chairman Archer. Thank, you, Ms. Kennelly.
    [The opening statement of Mr. Ramstad follows:]

Opening Statement of Hon. Jim Ramstad

    Mr. Chairman, thank you for your continued leadership in 
exploring fundamental reform of our deeply flawed tax system.
    Last year this committee had the opportunity to examine the 
impact of replacing our current system on several segments of 
society--from local governments, to large and small businesses, 
to tax-exempt organizations. But no group is more fundamental 
to our nation's well being than the one we are highlighting 
today--individual Americans and their families.
    Providing relief to American families is what major tax 
reform should be all about.
    Our current system hurts families by being overly complex, 
costing billions of dollars and billions of hours to comply. 
Our current system also hurts families by creating 
disincentives to work, save and invest for their futures.
    Replacing our present tax system could mean a much lower 
tax burden for American families, allowing them to keep more of 
what they earn. Tax reform could also help us reach our 
economic potential, which would mean more jobs and a better 
standard of living for American families.
    Again, Mr. Chairman, thank you for this opportunity to 
examine how American taxpayers and their families could be 
affected by fundamental tax reform.
      

                                

    Chairman Archer. I would like to invite our honored 
Majority Leader to take the witness chair, and to tell him that 
the reception will be warm here, in spite of our minor 
differences on this issue, and welcome to the Committee.
    Without objection your entire printed statement will be put 
into the record, and you may summarize in any way that you see 
fit verbally, and you may proceed.

    STATEMENT OF HON. RICHARD K. ARMEY, A REPRESENTATIVE IN 
CONGRESS FROM THE STATE OF TEXAS, AND MAJORITY  LEADER,  HOUSE  
                      OF  REPRESENTATIVES

    Mr. Armey. Thank you, Mr. Chairman. First of all let me 
thank you for holding these hearings. You alluded to our minor 
differences, and I would say, Mr. Chairman, they are minor. I 
think on the big things you and I are in perfect agreement.
    We do find ourselves in agreement with the proposition that 
the current Tax Code is no longer acceptable to the American 
people. That proposition gets increasingly more verified each 
time we take a poll on the matter.
    I first engaged this subject in January 1994 when I became 
convinced that the American people were fed up with the Tax 
Code, and would not tolerate a continued Tax Code of this type 
very much longer.
    I should tell you, looking at some of the reasons why I 
found that they are fed up with it, the first is its 
complexity. And I was laughing at myself this morning. Mr. 
Chairman, my mother, who had only a high school education, 
spent most of her time, most of the years when I was a 
youngster at home, doing taxes for people throughout the 
community--individual taxes, taxes often for farmers and small 
businesses.
    And in those days she was able, even with a high school 
education, to help people do their taxes, and they would then 
feel that they had some opportunity for things to come out 
right.
    Today we find that the Tax Code is so complex that in a 
recent poll of IRS agents, the agents themselves answered only 
78 percent of the questions correctly. The people that are 
mandated to enforce the Code can't get it right. This is a new 
story.
    But here's my latest iteration of that story, Mr. 
Chairman.As you know, I have a Ph.D. in economics. I've been 
studying these sorts of things all my life, and I, too, do my 
own taxes. My own taxes are somewhat simple. I am not a wealthy 
person. And one would think that I could do my taxes.
    I have here today my tax refund check--$400 less than what 
I thought it would be when I sent my forms in to the IRS. I 
meticulously worked my way through the 1040 form, and the 
instructions. I thought I had covered all my bases. I filed my 
taxes a month and a half ago, and just 2 days ago I received a 
notification from the IRS that I had failed to decrease the 
value of my itemized deductions relative to my adjusted gross 
income, and they were making the adjustment on my behalf, and 
that I would get my refund check at some amount.
    I can't imagine having to go to heaven some day and face my 
mother and explain how I could make a mistake like that, 
especially when she's sure to remind me that that requirement 
in the Tax Code was put into effect during a period of time in 
which I was a Member of Congress. My only plea can be, Well, 
Mom, I didn't vote for it.
    But at any rate, this shows me, I think, on a daily basis, 
the complexity is too much. We have all kinds of statistics on 
that which you'll find in my statement.
    Seventy percent of people recently polled said they want a 
new Tax Code. Only one out of ten people said that they felt 
the current Tax Code could be repaired.
    Taxes as we have them today are too high. There's no doubt 
about it. And, quite frankly, we believe that you can lower 
people's taxes and still retain the aggregate earnings.
    Taxes are not neutral, and they do hinder economic 
opportunity. Taxes undermine good government. Now, I started 
studying this in January 1994. At that time, the unrest among 
the public had been consolidated primarily and almost 
singularly into an organization called Citizens for an 
Alternative Tax System. Mr. Chairman, you know them as 
principal advocates of a national sales tax.
    I, naturally, in 1994 began to study the sales tax as an 
alternative to the existing Tax Code. And I felt frustrated in 
my efforts to respond in that way. At that point I rediscovered 
the work of Professors Hall and Rabushka, and began to restudy 
the flat tax, and as you know, I settled on the flat tax as a 
solution.
    The problem is simple: the current Tax Code will not work. 
It is no longer acceptable to the American people. The solution 
is to replace it, and replace it altogether.
    Why the flat tax? You get the simplicity that we're looking 
for, you get fairness, in that everybody's treated the same as 
everybody else. You will get an encouraged growth rate, because 
we end the double taxation of savings and investment that you 
have under the current Tax Code, and virtually everybody who 
has studied the flat tax is in agreement on that.
    There will be lower taxes. There is a de facto 
progressivity that's due to the generous family allowance that 
for a family of four is $33,800. This means that if you earn 
$25,000 you owe no tax. A family of four earning $50,000 will 
pay only 6 percent of its income in taxes, and a family earning 
$200,000 would pay 14 percent.
    The flat tax is profamily in many ways, not the least of 
which, it relieves the family of the burden of just dealing 
with this complexity which if you do your own taxes you know 
can be a difficult thing.
    It is an honest way to tax. I have to tell you, Mr. 
Chairman, I believe that in the end all taxes are paid by 
people, and all taxes are paid out of current income. And the 
flat tax, as a direct, honest income tax, accepts that 
proposition.
    We are told by even the Federal Reserve Bank of Kansas City 
that the flat tax will lower interest rates by as much as 25 
percent, and nobody that has examined the flat tax disputes 
that it will lower interest rates. The only dispute is in the 
estimators view of how much.
    And let me just say very quickly that I believe very 
profoundly that in a flat tax world, charitable giving will go 
up because I think charitable giving is first a function of 
what charity is in your heart, and second, a function of what 
you have to give.
    And in a flat tax world, where more people have better 
jobs, with more promotions and more take-home pay, they will 
give more. That is what happened in the eighties, where the tax 
value of charitable deductions went down, charitable deductions 
more than doubled, and charitable deductions to faith-based 
institutions more than tripled.
    Those are my comments, Mr. Chairman, and I'll be happy to 
answer any questions.
    [The prepared statement follows:]

Statement of Representative Dick Armey

    Mr. Chairman, I appreciate you affording me the opportunity 
to testify before the committee today on the subject of tax 
reform. I would also like to commend you for holding these 
hearings and focusing attention on the need to end the tax code 
and the IRS as we know it.

                         The Tax Code is Broken

    As you have stated so many times yourself, Mr. Chairman, 
our current tax system is broken and needs to be scrapped and 
replaced with a system that is fair, simple and honest. The 
current tax code is complex; unfair; inhibits saving, 
investment and job creation; imposes a heavy burden on 
families; and undermines the integrity of the democratic 
process. It must go.
    I'd like to focus my remarks today on the effect government 
taxation has had on America's families. Unfortunately, during 
the past few decades the tax system has become more complex, 
less fair, more destructive to the economy, and, in the 
process, more of a burden on American families.

Complex

    The complexity of the tax system is incomparably worse than 
when I was growing up. When I was a child, during tax season my 
mother prepared tax returns for farmers and other small 
businessmen in Cando, North Dakota. Though she only had an 
eighth grade education, she was able to prepare tax returns and 
feel comfortable that they were correct.
    Today, even the best-trained tax attorney must question his 
ability to accurately complete a tax return. During the past 
forty years, the tax code has grown mind-numbingly complex. The 
number of words in the income tax code has increased more than 
four-fold to 800,000. There are more than 6,000 pages of 
accompanying tax regulations for the income tax.
    Each year Americans devote 5.4 billion hours complying with 
the tax code, which is more time than it takes to build every 
car, truck and van built in the United States. The IRS sends 
out more than 8 billion pages of forms and instructions which, 
if laid end to end, would circle the earth 28 times.
    In my own family we have experienced the costs of 
complexity. Like so many other American families, time we spend 
searching for receipts and studying tax law could be spent with 
our children.

Unfair

    The main reason the tax code is complex, of course, is the 
proliferation of deductions, credits and other special 
preferences in the law. Because of these loopholes, taxpayers 
with similar incomes can pay vastly different amounts in taxes. 
This uneven treatment of taxpayers is fundamentally unfair and 
is at odds with the American value of equality before the law.
    According to a recent poll by Luntz Research, three-
quarters of Americans believe it is common for taxpayers with 
similar incomes to pay vastly different amounts in taxes. 
Perhaps this is why more than two-thirds support a fundamental 
overhaul of the tax system.

Heavy Taxes

    The American people are beleaguered by the highest tax 
burden in American history. Taxes represent a larger share of 
the economy than ever before. As a result, American families 
now pay more in taxes than they spend on food, clothing and 
shelter combined.
    According to the Tax Foundation, in 1955 the typical family 
paid about 27 percent of its income in total taxes. Today, the 
typical family pays about 38 percent of its income in taxes--a 
40 percent increase in the tax burden.
    The Tax Foundation data reveal the key truth to why so many 
families feel as though two incomes are needed to do what one 
income accomplished a generation ago. While per capita income 
has doubled in the past generation, a majority of the higher 
income families have earned has gone to pay taxes.
    Since 1955, 52 percent of the growth in wages for the 
typical single-earner family has gone to the government. For a 
two-earner family, 59 percent of the growth in wages has gone 
to pay higher taxes. The fact is, the second earner today works 
not to support the family, but to support the government.
    But the tax code's anti-family bias doesn't stop there. The 
code often places a stiff cost on marriage through the so-
called marriage penalty, under which people getting married 
face a tax increase. In addition, for years the value of the 
personal exemption, which includes the exemption for children, 
fell as inflation slowly but, over time, dramatically 
diminished the value of the personal exemption.
    As you know, Mr. Chairman, most of the growth in the tax 
burden has come from higher payroll taxes and higher taxes at 
the state and local level. The only good news for families came 
in 1981. Were it not for President Reagan's 25 percent 
reduction in income tax rates and indexing of personal 
exemptions and the tax brackets to inflation, Americans would 
be paying significantly more in taxes than they do today.

Hinders Economic Opportunity

    While the economy has been generally healthy, it is not 
growing at its potential because of a tax policy that is biased 
against work, saving, investment and entrepreneurial activity. 
In fact, recent growth has sparked fears of inflation. When 
Alan Greenspan raised interest rates last month, he was 
indicting our current tax code, which prevents our economy from 
sustaining robust growth levels. By placing multiple layers on 
saving, the tax code reduces the amount of investments in new 
machines and technology that make American workers more 
efficient and competitive. By favoring certain economic 
activities over others, the tax code distorts financial 
decisions and reduces economic efficiency.
    According to a study by Jane Gravelle, an economist with 
the Congressional Research Service, and Larry Kotlikoff, an 
economist at Boston University, the corporate income tax costs 
the economy more in lost production than it raises in revenue 
for the Treasury. Dale Jorgenson, the chairman of the Economics 
Department at Harvard University, found that each extra dollar 
the government raises in revenue through the current system 
costs the economy $1.39.

Undermines Good Government

    In 1956, then Senator John F. Kennedy said, ``The lobbyists 
who speak for the various economic, commercial and other 
functional interests of this country serve a very useful 
purpose and have assumed an important role in the legislative 
process.'' Today, the lobbying industry is more than three 
times as large as it was when John Kennedy was President.
    But as the government has grown and tax burdens and tax 
favoritism has proliferated, the lobbying industry has 
flourished. Today, the lobbying industry is the largest private 
sector employer in Washington. One out of every six private 
sector workers--62,072 people--work in the lobbying industry.
    The lobbying industry generates $8.4 billion in revenue 
each year, making it larger than the entire economies of 57 
countries. Data from the Clerk of the House show that more 
lobbyists work on taxes than any other issue. The lobbying 
industry is no longer as innocuous as in John Kennedy's day. As 
tax favoritism has increased, so has the number and influence 
of lobbyists. As I have said many times before, it is not 
healthy for our economy or our democracy that so much talent, 
energy and resources are diverted toward securing special 
consideration under the tax system.

                         The Flat Tax Solution

    Last month I introduced with Senator Shelby H.R. 1040, 
which would scrap the entire income tax code and replace it 
with a flat-rate income tax that treats all Americans the same. 
This plan would simplify the tax code, promote economic 
opportunity, and restore fairness and integrity to the tax 
system. The flat rate would be phased-in over a three-year 
period, with a 20 percent rate for the first two years and a 17 
percent rate for subsequent years.
    Individuals and businesses would pay the same rate. The 
plan eliminates all deductions and credits. The only income not 
subject to tax would be a generous personal exemption that 
every American would receive. For a family of four, the first 
$33,800 in income would be exempt from tax. There are no breaks 
for special interests. No loopholes for powerful lobbies. Just 
a simple tax system that treats every American the same.

                   What a Flat Tax Means for America

Simplicity

    The flat tax replaces the current income tax code, with its 
maze of exemptions, loopholes, and targeted breaks, with a 
system so simple Americans could file their taxes on a 
postcard-size form. The Tax Foundation estimates that a flat 
tax would reduce compliance costs by 94 percent, saving 
taxpayers more than $100 billion in compliance costs each year.

Fairness

    The flat tax will restore fairness to tax law by treating 
everyone the same. No matter how much money you make, what kind 
of business you're in, whether or not you have a lobbyist in 
Washington, you will be taxed at the same rate as every other 
taxpayer.

Prosperity

    Because the flat tax treats all economic activity equally, 
it will promote greater economic efficiency and increased 
prosperity. When saving is no longer taxed twice, people will 
save and invest more, leading to higher productivity and 
greater take-home pay. When marginal tax rates are lower, 
people will work more, start more businesses and devote fewer 
resources to tax avoidance and evasion. And because tax rules 
will be uniform, people will base their financial decisions on 
common-sense economics, not arcane tax law.
    As you know, Mr. Chairman, the Joint Committee on Taxation 
hosted a conference in January at which a broad group of 
economists forecasted the results of tax reform proposals. 
Every economist who attended reported that a flat tax would 
result in a larger economy. Economists affiliated with the 
Brookings Institution, Federal Reserve, CBO, Coopers & Lybrand, 
DRI/McGraw-Hill, Harvard University and others all found that a 
flat tax would lead to higher living standards. The unanimous 
finding of such a diverse group of economists shows that there 
is virtually no debate as to whether the flat tax would 
increase economic growth, but only by how much.
    According to one study by a former chief economist for 
Congress' Joint Committee on Taxation, under the flat tax the 
economy would be 5.7 percent larger after five years than under 
the current system. That translates into $522 billion in higher 
output, or $3,000 in higher income for the typical family of 
four. Michael Boskin, a former chairman of the Council of 
Economic Advisors, estimates that the flat tax would increase 
the size of the economy by ten percent.

Lower Taxes

    According to data by the U.S. Treasury Department, the bill 
would cut taxes by about $30 billion in the first year of 
enactment. When the rate is reduced to 17 percent in the third 
year of the proposal, there would be significant further tax 
reduction. The bill is carefully designed, however, to 
safeguard taxpayers against higher deficits. Rigid spending 
caps are included in the plan. Coupled with the additional 
economic growth the flat tax will spur, the tight spending 
controls will ensure that the budget reaches balance by 2002.

Progressivity

    Under the flat tax, the more you earn, the more you pay. In 
fact, because of the high family exemption, the more a taxpayer 
earns, the greater the share of his income he pays in tax. A 
family of four earning $25,000 would owe no tax under the 
proposal. A family of four earning $50,000 would pay only six 
percent of its income in income taxes, while a family earning 
$200,000 would pay 14 percent.

Pro-Family

    The flat tax eliminates the marriage penalty and nearly 
doubles the deduction for dependent children. By ending the 
multiple taxation of saving, the flat tax provides all 
Americans with the tax equivalent of an unlimited IRA. This 
will make it easier for families to save for a home, a family 
vacation, a college education for their children, or for their 
retirement years.

Pro-Taxpayer

    The flat tax trusts average Americans by giving them the 
freedom to make their own economic decisions. In addition, the 
flat tax includes a special safeguard against higher taxes. It 
requires a three-fifths supermajority vote of Congress to raise 
the tax rate, lower the family allowance or add loopholes.

Honesty

    By eliminating itemized deductions and special breaks, the 
flat tax would have a chilling effect on special-interest 
lobbying and transform the political culture in Washington. 
Under a simple, transparent system that taxes all income one 
time at one rate--and requires a supermajority vote to add a 
loophole--there will be far fewer lobbyists than under today's 
system. Instead of being divided into numerous special-interest 
groups, the flat tax will make every American equal under the 
tax code with a shared interest in lower rates and continued 
fairness.

Lower Interest Rates

    According to a study by an economist at the Federal Reserve 
Bank of Kansas City, published in the Kansas City Federal 
Reserve's Economic Review, the flat tax would reduce interest 
rates by 25 percent, or about two percentage points. Lower 
interest rates under the flat tax will not only reduce the 
costs of student, car and credit card loans, they will also 
offset the loss of the home mortgage interest deduction. 
According to reports by the Congressional Research Service and 
the Tax Foundation, the flat tax will have no meaningful effect 
on home values.
    Consider how a sharp reduction in interest rates would 
affect the average family that earns $50,000 and deducts $5,000 
in mortgage interest. The home mortgage deduction saves this 
family $750 in taxes, where a 25 percent drop in interest rates 
saves it $1,250 in lower interest payments. That family is $500 
better off under the flat tax with lower interest rates--even 
without the home mortgage interest deduction (and not counting 
the higher personal exemptions).

More to Give

    As incomes rise under the flat tax, so too will donations 
to America's charities. Over the past several decades, 
increases in giving have closely tracked increases in personal 
income. This trend continued during the 1980s when, even as the 
tax value of the deduction declined and fewer taxpayers were 
able to take the charitable deduction, charitable giving 
increased. Because incomes will increase significantly under 
the flat tax, giving will rise in the long run as well, even 
without the charitable deduction.
    I believe the flat tax would represent a tremendous step 
forward for American families. It would simplify the tax 
system, saving taxpayers countless hours and resources, freeing 
up time and money to meet more important family needs. A flat 
tax would also lead to increased prosperity and higher wages. 
Coupled with a tax cut, the higher incomes under the flat tax 
would significantly increase the take-home pay, allowing 
parents to meet the important needs of their family.
    Perhaps most importantly, a flat tax would be true to our 
values. A tax system under which every American is treated the 
same and special-interest provisions are removed would do a lot 
to increase the American public's faith in their government.
      

                                

    Chairman Archer. Thank you, Mr. Majority Leader. Have you 
done your income tax for this year?
    Mr. Armey. Yes, I have.
    Chairman Archer. Because I was going to volunteer to help 
you work through the work table on how you lose your itemized 
deductions, in the event you needed any consultation or help.
    Mr. Armey. Well, I'm going to go back and review that part, 
because I certainly don't want to suffer this embarrassment 
next year.
    Chairman Archer. It's so typical of what we have in the Tax 
Code today, you're given something with one hand and it's taken 
away with the other hand. And we see that over and over in the 
Code.
    You and I both agree that we need to do that. We need to do 
something about that and change it.
    Could you tell the Committee what the maximum tax rate 
would be under your flat tax proposal?
    Mr. Armey. If we were to implement the flat tax today, Mr. 
Chairman, we would start with a 20-percent rate. We would hold 
that rate for 2 years, and on the third year it would be 
lowered to 17 percent.
    We believe that gives the growth effect of the flat tax 
time to work its way into the economy and allows us to move to 
the 17 percent and stay there indefinitely.
    Chairman Archer. Do you have revenue estimates on your 
proposal? Will a 20-percent rate in the first 2 years duplicate 
the revenue from the current code?
    Mr. Armey. I believe the 20-percent rate, given the family 
allowance at the level we have it, gets us within $30 billion 
of current revenue.
    Chairman Archer. $30 billion?
    Mr. Armey. $30 billion.
    Chairman Archer. Per year. Because the comments that were 
made by Ms. Kennelly early on were that you would lose $138 
billion in the first year.
    Mr. Armey. My bill, as I've written it, does not score that 
way. I know a lot of people have raised their eyebrows about 
the $30 billion, but I have to tell you, Mr. Chairman, if I 
were to endorse revenue neutrality I would be endorsing 
spending at its current levels, and I believe spending must 
come down anyway, so the flat tax as I've written it would 
provide further incentive for that.
    And we have written in there spending caps to see to it 
that we would not worsen the deficit.
    Chairman Archer. I have just one last question. In the 
event that your proposal were considered by this Committee, and 
in the event that a majority on the Committee believed that it 
would be appropriate to add some limited number of deductions, 
like charitable contributions, or home mortgage interest, would 
you be able to support such a bill, as a final package?
    Mr. Armey. One would never want to turn their back on it 
altogether. I would resist that. I believe that the way you get 
simplicity and you make it stick is that you eliminate the 
whole playing field for special exemptions and itemized 
deductions.
    Once you've done that, then you've broken the Code. If you 
put in the homeowners' deduction, you've got now in place the 
first best reason to add charitable deductions. Once you have 
that in place, you've got two good first best reasons to do 
something, you're back in the same game.
    If the Committee were to report a bill to the floor that 
reinstated in the new flat Tax Code these deductions--they 
would obviously have to adjust the rates to compensate for the 
revenue loss that would attend that--and I would petition the 
Rules Committee for the opportunity to offer an amendment in 
the form of a substitute that would give me a chance to have a 
vote on the flat tax written as I wrote it.
    Chairman Archer. Well, you have just confirmed what you and 
I have privately talked about and confirmed my respect for you, 
in that you believe that this should be a pure flat tax, and 
not be dolled up with any kind of additional deductions, no 
matter how appealing, nor be extended to tax dividends, 
interests, or what we might call unearned income. And I greatly 
respect you for that.
    Mr. Armey. Let me just say, Mr. Chairman, that I developed 
this model while making a trip to New Hampshire, not as a 
candidate last year, where having read their license plates, I 
decided to say the motto is Stay Flat or Die. But if you want 
tax reform to stick, you better stick with it.
    Chairman Archer. Ms. Kennelly.
    Ms. Kennelly. Thank you, Mr. Chairman. And I salute your 
mother for doing those tax returns. I think, though, probably 
the fact that she got a good high school education had as much 
to do with it as the simplicity of the Tax Code, and that's 
something we'd like to get back to.
    Mr. Armey, I'm still interested in the $138 billion figure, 
because I know that last year we had a lot of trouble getting 
the cuts we were looking for to balance the budget. I think we 
have to be realistic.
    I respect both of your opinions--the Chairman and the 
Majority Leader. But I have to say to you, though, that the 
American people have to understand very, very much up front 
that they could lose their home mortgage deduction and they 
have structured their finances based on that. They could lose 
other deductions, and that's why we have to make sure that the 
public understands.
    But I am very interested in the charitable deduction. I 
come from a town, Hartford, that used to be well off. It's now 
on the list of the poorest cities in the United States of 
America, and I have met with people in the charitable world.
    And they deal with the goodness of people's hearts 
constantly. As you mentioned, that's how people give to 
charity. But I have to tell you something, Mr. Majority Leader, 
a lot of it has had to do with the Tax Code.
    And I would like you to explain once more what you just 
said, that when the tax rates go down the giving doubled, is 
that what you said?
    Mr. Armey. Let me just relate, I believe the $138 billion 
figure you have comes from someone who scored me at 17 percent 
in the first year. I'm at 20 percent in the first year.
    Ms. Kennelly. Somebody at Treasury.
    Mr. Armey. The home mortgage deduction is a worry to 
people, and what I have done, and people have done it by as 
many as 180,000 hits on the flat tax home page in a single 
month, when people try the current Tax Code with their home 
mortgage deduction and try the new Tax Code without it, more 
often than not they'll say I'd rather change.
    In fact, I think in a recent poll, 54 percent of new 
mortgage holders said that for the other advantages they would 
get in a flat tax, they would happily give up their home 
mortgage deduction. That, I think, is quite manageable by 
education.
    Now, the charitable thing, I think you have to rely on the 
empirical observation and some common sense. First of all, no 
intelligent, rational person is going to be willing to give 
$100 in order to gain a $33 reduction in their taxes.
    So clearly they're not making charitable contributions for 
the tax advantage. They make the contribution out of their 
belief in the purpose at hand, and how much money they have 
available.
    What we saw in the eighties, when the tax value of a 
charitable contribution was cut to one third of its prior 
level, we saw that in fact charitable contributions doubled 
nationwide in the eighties, and tripled for faith-based 
organizations.
    Faith-based charities, I think, are perhaps more often more 
reliant on the smaller denomination gifts of low-income people 
and clearly as they had more they gave more.
    Ms. Kennelly. Mr. Majority Leader, I still think the jury 
is out on that mortgage interest question, and we're going to 
have to be discussing this more, but you and I both know that 
we don't have a simplified tax system yet. And no, someone 
doesn't give $100 to get $33. But when someone earns $50 
million and they would rather give to a charitable institution 
than give to the government, other things come into play.
    And so that's another area I think we have to continue to 
look at. I'm not arguing with you that the system is not too 
complicated. It's much too complicated. It's antiquated. So I'm 
not here saying we don't need tax simplification, we don't need 
more tax fairness. I just want to make sure that the American 
people know what they're getting into when they give up a 
progressive tax system.
    Mr. Armey. I agree. They should. That's why I wrote the 
book. That's why I put it on the home page.
    Ms. Kennelly. I bought it.
    Mr. Armey. And that's why I invite people, try it for 
yourself.
    Ms. Kennelly. Thank you, Mr. Chairman.
    Chairman Archer. Thank you. Mr. Collins.
    Mr. Collins. Thank you, Mr. Chairman. Thank you, Mr. Armey 
for your comments and the proposals you've put forward, because 
it does give us some interesting data to talk about.
    My area of concern is that of small business, and how small 
businesses may be affected by either the consumption tax or by 
the flat tax. What have you determined or what have your 
studies shown a small business with profits between $75,000 and 
$150,000, how would they be affected? That seems to be a major 
concern of small businesses.
    Mr. Armey. Mr. Collins, the first reaction I have is that 
under the flat tax we would expense inventory and capital 
expenditures. So obviously the simplicity of the Code shows up 
right away for a small business.
    I have not worked out anything in particular, but the long 
and the short of it is that they would take any legitimate, 
necessary business expense, deduct that from gross earnings, 
and then pay the flat rate on the net earnings of the business, 
while they expense capital and inventory.
    At this point, that's the best answer I can give you. I 
can't resist saying, by contrast, the small business 
organization in a flat tax world is not asked to be the tax 
collector for the State as a retailer, and they would hold no 
responsibility for any taxes other than their own, as opposed 
to a national sales tax, where they would be asked to collect 
taxes on behalf of the government.
    Mr. Collins. But in contrast, a lot of small businesses do 
collect consumption tax on behalf of State government or local 
government. So that would be just adding one more entity line 
to the collection there.
    But on the small business, and the difference seems to be, 
the concern is between the graduated tax rates on the smaller 
profits, versus the competitive edge that larger business may 
have with the flat tax. Now they will have the same flat tax 
rate as the larger business.
    Mr. Armey. They would have the same rate. And obviously 
their business expenses are enumerated, but whether you're a 
small business or a large business, you must get to net 
earnings, and then you pay the same rate as anybody else.
    The object of the flat tax is to tax each dollar earned in 
the country in a tax year irrespective of its source at exactly 
the same rate as every other dollar that's earned.
    Mr. Collins. In the area of small business--and I've been 
in small business--I'm still a small business man. I've had 
some type of small business for 35 years. I know I don't look 
that old. But I have.
    But, you know, with the incentives that are there for the 
small investor to take a risk, and with the graduated tax rates 
and then of course the competitive edge that a lot of people 
with the resources and wherewithal that are in bigger 
businesses trying to compete with, I have some concern, too, 
that the flat rate may impose a higher or larger tax liability 
on small business.
    Now, one thing I do like is your loss carry forward, 
because I've suffered some of those years when I had some loss 
carry forward that would not have been beneficial to me.
    Now, under the individual taxpayer under the flat tax, what 
are your deductions there?
    Mr. Armey. Well, let me just again remind you that any time 
you have high marginal rates you punish success and you 
discourage people from growing. The rates being the same, 
people would have all the incentive in the world to grow.
    If you file the flat tax as an individual, it's a very 
simple calculation. You take your personal or your family 
exemption. For a family of four it's $33,800. You deduct that 
from your gross earnings, you get then your adjusted gross 
earnings, you apply the flat rate of 17 percent times that. In 
two simple calculations you're out of there and you go on, and 
you don't need to have all of the IRS records to find out what 
your brother-in-law is paying. All you have to know is the size 
of his income, and the size of his family, and you can 
calculate his taxes, and know that he's paying the same as you, 
and therefore you feel like there's justice in the world.
    Mr. Collins. Well, I can appreciate the simplicity. I am 
concerned that there may be a higher tax liability on small 
business, and that's one of the areas that I really want to 
focus in on.
    I'm filing today. This is the first time. I told my 
brother, who is my CPA, that we're making history this year. I 
am actually filing on time. I will be sick at midnight tonight, 
but I'm still filing.
    Mr. Armey. Well, I appreciate that, and you know, in the 
old days when you first started your business, it was easier to 
file on time.
    Chairman Archer. Mr. Christensen.
    Mr. Christensen. Thank you, Mr. Chairman. And thank you, 
Mr. Armey, for your testimony and also for the fact that you've 
been leading the charge with our Chairman on this whole issue 
of restructuring the Tax Code.
    I'm interested in hearing your opinion on whether or not 
tax policy should have any affect on social policy. You know, 
our code obviously plays a large role in the development of 
social policy, everywhere from tax credits for low-income 
housing to myriad deductions, for home mortgage, charitable and 
life insurance and everything else.
    Let me ask you specifically, though, there's a lot of 
momentum right now on the Senate side in terms of some of the 
sin taxes, and also trying to affect the way some of the 
cigarette companies are targeting our children, and especially 
women.
    I mean, it's deplorable what I see Philip Morris doing 
right now in a campaign to go after the younger females in an 
ad campaign. I really struggle with it, and I really am 
frustrated.
    I am not of the opinion right now though that the way to 
effect change is through tax policy, but a lot of people are 
jumping on that band wagon. How do you feel about the social 
policy aspect?
    Mr. Armey. Well, as often I do, I take my instruction from 
Milton Friedman who once made the observation that once you set 
the rate everything else is social policy. I believe that the 
object of a Tax Code should be to raise that necessary revenue 
for the government in that manner which is the least meddlesome 
against the freedom of individuals.
    I do not believe you ought to use the Tax Code in order to 
try to direct human action and human behavior in one way or 
another. Now, when you get down to the so called sin tax 
doctrine, that is, of course, a very heavy decision that 
carries with it a tone of morality, and often plays against 
some of our very heartfelt concerns, such as children and 
cigarette consumption, and so forth.
    But in the end, we have discovered that the States and 
other areas tend to levy higher excise taxes in these areas of 
consumption precisely because they are price inelastic, that 
the principal motivation for the consumption is so compelling 
that they are hardly mitigated against by pecuniary influences.
    So insofar as you say, for example, we're going to raise 
revenue and decrease smoking, you can't do both. It's going to 
be one or the other. And we have found that in many of these 
areas, there's just a lack of responsiveness.
    Now there may be, and certainly must be things to address 
there, but I don't think that you--should I say, compromise the 
integrity of your Tax Code with respect to the question of 
neutrality in order to fulfill social objectives that might 
otherwise in fact be better fulfilled with other measures.
    Mr. Christensen. Thank you. Thank you, Mr. Chairman.
    Chairman Archer. Mr. Jefferson.
    Mr. Jefferson. Thank you, Mr. Chairman. Good morning, Mr. 
Armey. I want to ask you a question that I've run across in 
some of the studies that I have been provided which suggests 
that a totally flat rate, although it simplifies the Code, 
would involve a substantial shift of the tax burden from those 
in the highest income tax brackets to lower and middle income 
tax payers.
    The flat rate would raise the share of taxes paid by low- 
and middle-income tax families, and sharply reduce the share of 
taxes paid by the wealthy. And the reason for it is that for 
those people who are characterized as the working poor, this 
eliminates the Earned Income Tax Credit or EITC.
    Now, I recognize that you have a higher floor where your 
taxation would start, but still above the limit that you're 
dealing with, that presents something of a problem. Is your 
limit now $33,000?
    Mr. Armey. $33,800 for a family of four.
    Mr. Jefferson. OK. The other is with respect to the effect 
on Federal Insurance Contributions Act, FICA, on employer paid 
health policies, and on other employee benefits that an 
employer may now exempt. Am I correct in thinking there may be 
a problem with this shifting, or do you have another answer for 
it?
    Mr. Armey. Any time you're examining any change in the Tax 
Code, the redistribution charts are always the most difficult 
thing to measure out. You can say that anybody today who files 
a standard deduction, irrespective of the size of their family 
and the number of dependents, is going to be better off in a 
flat tax world than they are in today's world by virtue of the 
lower rate and the higher relative family exemption.
    Many people at the low-income bracket would find their loss 
of earned income tax credit compensated for by that gain. 
Insofar as they're not compensated, then if you're engaging in 
a program of income maintenance for the low income, we think 
that should be transferred to the spending side of the ledger, 
not to the taxing side of the ledger. It's just a value 
judgment we make.
    We know that as many as 10 million low-income families, or 
low-income individuals will be taken off the tax rolls in the 
flat tax world by the analysis that's been made of it. And, 
finally, what we've seen is, for example, Ross Perot last year 
who only paid 9 percent of his income in taxes, under the flat 
tax he would pay 17 percent of his income.
    If, in fact, as it is generally alleged, loopholes and 
exemptions are things that are most advantageous to the 
wealthy, then, of course, a Tax Code that eliminates them 
should have its greater impact on the wealthy. I believe the 
flat tax as I've written it is at least as fair as the current 
Tax Code relative to the question of progressivity, and I 
believe it is clearly more fair relative to a more widely held 
view of fairness, that fairness is when everyone is treated the 
same as everyone else.
    And so I am perfectly willing to advance the flat tax as 
I've written it, on the fairness question, with great 
confidence that it holds up under scrutiny by individuals.
    Mr. Jefferson. It appears that there is some question about 
it, because most of the loopholes, things we characterize as 
loopholes are really enjoyed by taxpayers who are not in the 
upper brackets, as it turns out.
    Let me ask you one other thing, if I might. On the issue of 
shifting the way we characterize income, there's been a problem 
under previous codes that when you have a class of income that 
has a lower tax rate, or no tax rate, and it can be 
characterized from the type of income that has a higher rate to 
that which has a lower. That's when the escaping of the tax 
liability takes place.
    If you have a system where you have no income tax on 
capital gains, no capital gains tax, and no tax in a few other 
areas, but that taxes everything that comes in wages and 
salaries, won't that be a powerful incentive to mischaracterize 
or to recharacterize the title you put on the income source to 
avoid paying tax altogether? Won't we have more tax avoidance 
problems under something like that?
    Mr. Armey. Frankly just quite the contrary. Since the rate 
applies the same to every dollar irrespective of the source, 
there would be no reason to say I got it from this source 
versus that source. What we do with capital gains taxation is 
very important. We do not double tax that income.
    That income right now is doubled taxed at a very 
prejudicial rate. We would collect the taxes on capital 
earnings at the source in the same way as they are collected at 
their source now.
    And I can give you a quick illustration. I have been filing 
my taxes with the IRS every year of my life since I was 16. I 
have never in all those years written a check to the IRS. The 
reason being my taxes were collected at the source, they were 
held on my account by the IRS, and at the end of the year I 
filed in such a way as to clean up my account with them, and 
they gave me, sometimes grudgingly, a refund of that extra 
money with no credit for interest earned during the time they 
were holding what is my savings.
    Now, we're doing the same thing with investment earnings. 
We'll collect the tax at its source. We'll make the remittance 
at its source, but we won't ask you to suffer taxation on that 
same earnings a second time.
    Mr. Jefferson. Thank you, Mr. Chairman.
    Chairman Archer. Thank you. Dick, I understand that you've 
got an 11 o'clock appointment. Is that correct?
    Mr. Armey. I imagine. I don't know.
    Chairman Archer. Could you take two more questions before 
you have to leave?
    Mr. Armey. Yes, I could.
    Chairman Archer. Ms. Dunn.
    Mr. Armey. As long as they're not too tough.
    Ms. Dunn. I'll give you a couple of easy ones, Mr. Leader. 
Thank you, Mr. Chairman. I'm interested on behalf of the 
taxpayers in my district, and as a small business owner and the 
owner of a small family business in several areas.
    And I am wondering if you could briefly tell us the effect 
of the flat tax, your flat tax with regards to what happens to 
the IRS, and estate taxes and savings.
    Mr. Armey. The IRS, I think--there's been an analysis. I 
forget where it was done--that as much as 94 percent of the 
current compliance costs with the IRS would be eliminated under 
the flat tax. I would guess--and I know I've heard the Speaker 
talk about a goal of reducing the size of the IRS by 60 
percent. I would guess the flat tax would more than fulfill 
that goal.
    Now, obviously, you will always have an enforcement agency 
any time you have a Tax Code. The question is, if you have a 
minimal code and a civilized code, can you have a minimal and a 
civilized IRS? I think you can accomplish that with a flat tax.
    Ms. Dunn. And estate tax, and savings.
    Mr. Armey. Under the flat tax, there is no estate tax. 
Again, we're trying to end double taxation. You should collect 
every dollar, gather every dollar into the tax base, tax it 
once in the year it's earned, and it should never be taxed the 
second time.
    Savings, again, you paid taxes on your earnings in this 
year, you save them in any multiple number of ways, and you 
would not be taxed on that a second time.
    Ms. Dunn. Thank you, Mr. Chairman.
    Chairman Archer. Mr. Portman.
    Mr. Portman. Just a quick question, Mr. Leader. First, 
thank you for being here today, and thank you for testifying 
before the Commission to Restructure the IRS. That was very 
helpful to us.
    We spent, as you know, about the last year looking into the 
problems at the Internal Revenue Service, and there is a 
consensus now, I think it's fair to say, among our 17 
Commissioners, including Senator Kerry and myself, who are the 
cochairs, that until you simplify the Tax Code, you're really 
not going to be able to ultimately improve the IRS in the way 
all of us would like to see.
    As long as you have the current Tax Code, it will be very 
difficult to administer it. That being said, there are things 
we should do with the IRS to make it work better, and we 
appreciate your testimony on that, and your giving us some 
pointers on simplification.
    One of the concerns that we have focused on with this 
commission is the EITC, and the degree to which that causes 
problems of administration at the IRS. Of course, there's a 
good deal of fraud with the program as well. And in our 
interviews with over 300 online IRS employees, the EITC came up 
time and time again as a problematic part of what they have to 
do.
    In response to the question of Mr. Jefferson, you talked 
about the fact that with a more generous exemption, up to, I 
think, $33,800, you wouldn't be having an EITC. There wouldn't 
be the process of taxpayers filing and receiving a refund.
    But that doesn't pick up everybody among the working poor. 
And you mentioned on the spending side addressing it. Is your 
thought that the tax system might not be the best place to 
address some of those problems, but rather you'd do it in terms 
of new spending from Congress? How do you respond to that?
    Mr. Armey. That is my thought. I mean, we're basically 
making a decision that we have certain levels of income, given 
certain family sizes and so forth, that are insufficient to 
achieve an acceptable level of living for that family, and that 
we want to supplement that family's income.
    Now, there are two ways you can do that. You can either do 
it directly through the expenditure way, which I think is the 
more clear, direct and honest way to do it, or you can do it 
through the Tax Code. We tried that with the EITC, and I think 
one of the heartbreaking things about our effort to work that 
way is the fact that it's resulted in an enormous amount of 
fraud, and has driven up the compliance frustrations of the 
agency enormously.
    But it's also fed a certain cynicism among the taxpayers. 
When, you know, people frankly don't need to read your tax 
forms, like the IRS has been doing quite frankly 
illegitimately, but they know, the word goes through a 
community that somebody is getting away with something, and 
there's a resentment from that.
    Either somebody resents it or they mimic it. And when those 
things happen I think that creates a cynicism throughout the 
country. We pride ourselves with the concept of a voluntary tax 
system. I think if you're going to have a system of voluntary 
compliance, people are going to have to believe it's simple, 
it's fair, it's honest, and nobody has an opportunity to game 
it.
    And if I don't believe somebody else is doing it, then I 
will restrain myself from doing it. But once you allow that 
cynicism to creep in, I think you have a self-defeating 
process.
    Mr. Portman. Thank you. Thank you, Mr. Chairman.
    Chairman Archer. Dick, one last question, and then we will 
release you. Mr. Hayworth.
    Mr. Hayworth. I thank the Chairman, and the Leader. Thanks 
for coming by to see us today, and I appreciate this preview of 
the great debate that will take place in terms of tax reform.
    You touched earlier on a subject of great concern to me, 
especially on April 15, in your response to the question from 
our colleague from Washington State, in terms of the flat tax 
and its impact on the IRS.
    One of the stated goals of the new majority in Congress is 
to end the IRS as we know it. Indeed, Chairman Kasich of the 
Budget Committee this weekend on national television talked 
about abolishing the Internal Revenue Service as it exists 
today.
    And while you offered a projection that seemed to align 
with the estimation of the Speaker, in terms of reducing the 
size of the Internal Revenue Service by some 60 percent, or 
perhaps in excess of that, one of the criticisms of the flat 
tax I am hearing is that perhaps it would not alter the role of 
the IRS enough in terms of its intrusive nature.
    Indeed, some of the work done by Raymond Keating of the 
Center for Small Business Survival as reported in the Journal 
of the Foundation for Economic Education, talked about the 
institution of the income tax and how it has grown to this 
leviathan stature in our society.
    What safeguards should we take if we end up with a flat tax 
to in fact make sure that the system does not grow back again 
at some future date for future generations?
    Mr. Armey. I think it goes back, frankly, to the question 
asked earlier by Chairman Archer. It seems to me you have to 
write the flat tax with enormous discipline. I mean, make it as 
simple as you can make it. And I think we've done that. And 
then stick by your guns. Resist all the temptations.
    Ninety-nine percent of all the enemies of the flat tax make 
their living in Washington, DC. A great many of them are tax 
lobbyists, and they make their living making it more complex.
    And so somebody is going to have to be stubborn about this. 
I am stubborn about it, because I think you have to be.
    Then you have to write in safeguards. For example, we said 
it takes a three fifths vote in either house to either raise 
the rate, reduce the family exemption, restore any itemized 
deductions, or create multiple rates.
    Now, no Congress can completely protect America from a 
future Congress. But you can write in those safeguards that 
will make it as difficult as can be. And I think anybody, 
whether it be my plan or any other plan, that got enacted into 
law, you would have to have those safeguards in place.
    Trust me on this: you can write a national sales tax, and 
if you don't have that discipline, vigilance, it, too, can grow 
into the same kind of horrible monstrosity that we have today.
    Any Tax Code can grow that way unless you put in the 
discipline at its outset, and then the safeguards against easy 
change.
    Mr. Hayworth. I thank the Leader. And that certainly points 
up the importance of today's vote later, when we talk about a 
two-thirds majority needed to increase taxes.
    Again, thank you, Mr. Leader. And I thank the Chairman.
    Mr. Armey. Thank you.
    Chairman Archer. Thank you, Mr. Armey.
    Mr. Armey. Thank you, Mr. Chairman.
    Chairman Archer. I told you that you would have a warm 
reception, and I think that you have left unscathed.
    Mr. Armey. I thought you were referring to the hot seat. I 
do appreciate it. Thank you all.
    Chairman Archer. Our next witnesses are in a panel. Messrs. 
Steuerle, Hubbard, Dr. Asmus, Dr. Sullivan, Mr. Mitchell and 
Mr. Dannenfelser. If you could come to the witness table 
please.
    Welcome, gentlemen. Most of you, I'm sure, are aware of the 
rules of the Committee, that we're going ask you to limit your 
oral testimony to 5 minutes, and the little lights there will 
tell you how you're proceeding.
    The yellow light comes on, that means you have 1 minute 
left, and the red light means, as is always the case in our 
society, stop.
    Your entire printed statements, without objection, will be 
inserted in the record. And we're most pleased to have you with 
us this morning, and, Mr. Steuerle, if you would lead off, we'd 
be pleased to receive your testimony. If you would each 
identify yourselves for the record, then you may get into your 
oral testimony.
    Mr. Steuerle.

STATEMENT OF C. EUGENE STEUERLE, SENIOR FELLOW, URBAN INSTITUTE

    Mr. Steuerle. Good morning. Thank you, Mr. Chairman. My 
name is Gene Steuerle, and I'm a senior fellow at the Urban 
Institute here in Washington, DC.
    When it comes to tax reform, family issues are often among 
the last to be considered. In practice, however, these issues 
often dominate the revenue adjustments that might be required 
in moving to any different type of system.
    I should indicate, by the way, that my testimony deals 
primarily with family issues defined as those adjustments that 
are required according to such things as family size and the 
distribution of income and resources within the family.
    Having served as economic coordinator of the Treasury's 
1984 to 1986 tax reform effort, I can warn anyone trying to 
redesign tax reform that these types of family issues at times 
will drive the process, if for no other reason than that so 
much money is involved.
    Now, many provisions of the current Federal income tax are 
specifically designed to take into account the economic 
circumstances of the family. My testimony deals with the 
dependency exemption, a child credit such as proposed by both 
political parties, but not enacted; the earned income credit; 
the child dependent care credit; the so-called kiddie tax; the 
standard deduction; the special rate schedule for heads of 
household; marital income splitting, and the treatment of 
alimony and child support.
    All of these are the family type issues which I am going to 
try to deal with briefly. However, I will speak only to the 
first three of these issues, given the time constraint, and the 
rest of the issues are discussed in my testimony.
    Over the 48-year period from 1948 to 1996, the dependency 
exemption has grown four fold. During that same period, 
however, per capita personal income has grown sixteen fold. As 
a consequence, the dependency exemption fell from about 42 
percent of per capita personal income in 1948 to less than 11 
percent by 1996.
    The dependency exemption for 1996 would need to be set at 
about $10,000 for it to represent the same percentage of per 
capita income as it represented in 1948. If converted to a 
credit that offset taxes, the exemption would need to be about 
$1,500 per child.
    This decline in the dependency exemption, along with 
increases in Social Security taxes, has increased the tax 
burden of families with children relative to almost all other 
taxpayers. It is one of the major reasons for consideration 
today of a child credit.
    Now, a child credit is a possible alternative mechanism for 
delivering tax relief to families with dependent children. And 
although both political parties have proposed such child 
credits, none has been enacted to date.
    Significant simplification gains are possible if tax relief 
for dependent children is provided through one mechanism rather 
than several. A credit mechanism that combined the benefits of 
an earned income credit and the dependency exemption could be 
coordinated better also with rules for phasing out welfare 
benefits.
    Congress may also have a very unique opportunity today to 
link some unified child credit with a requirement that a credit 
is available only to families who purchase health insurance for 
their children. That is, in one combined effort, Congress could 
partially reverse the historic trend toward increasing the 
relative tax burden on families with children, could reduce 
dramatically the lack of health insurance among children and 
among some adults as well, and reduce some of the very high 
implicit tax rates on those who decide not to go on welfare in 
the first place.
    Proponents of any type of tax reform have a major difficult 
issue to deal with when dealing with the earned income credit, 
some of which came up in the previous questions and answers. 
For example, it is impossible to remove many low-income 
families from filing returns as long as the earned income 
credit is designed in its current form.
    For those who favor many types of consumption taxes, the 
earned income credit also affects dramatically the 
simplification gains they hope to achieve because the earned 
income credit is necessarily income based, that is, it's phased 
out for high income individuals on the basis of their income, 
not on the basis of their wages or consumption.
    The problem is not solved by making the issue of relief for 
low-income workers a problem for the welfare system, because 
those systems also contain implicit income taxes that require 
income reporting.
    My testimony today had dealt with the many family sensitive 
issues that must be dealt with in major tax reform. Several of 
these issues affect large numbers of taxpayers and affects 
significant amounts of revenues. While certain types of reform 
efforts technically may be beyond an income tax, you really 
cannot bypass these family issues.
    Thus, earned income credits and welfare programs have 
income phase outs that operate like income taxes, even in the 
presence of a consumption tax. And a consumption tax, or a 
value-added tax or retail sales tax that did not allow for a 
child care deduction, a decision would still have to be made as 
to whether child care expenses will be taxable as consumption 
services.
    Some divorce settlements would have to be renegotiated 
under any major tax reform, even though they might be based on 
an allocation of tax benefits under former law.
    Of all the issues I've raised, perhaps the largest and the 
most important are those that relate to the way the tax system 
adjusts for the presence of children through tax credits, 
dependent exemptions and the earned income credit.
    Recent bipartisan support for child credits, and the push 
for tax reform create a unique opportunity to lessen the 
increasing reliance of our tax system on families with 
children, to expand significantly health insurance for 
children, and at the same time to reduce the extraordinarily 
high tax rates and marriage penalties on many low-income 
individuals. Thank you.
    [The prepared statement follows:]

Statement of C. Eugene Steuerle, Senior Fellow, The Urban Institute

    Any opinions expressed herein are solely the author's and 
should not be attributed to The Urban Institute, its officers 
or funders.
    The family is the primary social structure in the United 
States for nurturing, raising and paying for the needs of 
children. Support for families, however, has long been an 
expressed policy goal of both major U.S. political parties. 
Whether U.S. tax policy--as opposed to expenditure policy--
should be designed specifically to benefit families is an issue 
of legitimate debate. In a recent article with Professor 
Michael McIntyre of Wright State University, we subscribed to 
the traditional view that a personal tax system should be 
designed primarily to distribute tax burdens in a way that is 
fair to all individuals, irrespective of their family 
circumstances. At the same time we concluded that a tax system 
cannot be fair to individuals unless it takes into account the 
differences in ability to pay that result from the way that 
resources are shared within families of different sizes and 
types.
    When it comes to tax reform, ``family'' issues are often 
among the last to be considered. In practice, however, these 
issues often dominate the revenue adjustments that might be 
required in moving to any different type of system. Having 
served as the Economic Coordinator for the Treasury 
Department's 1984 to 1986 tax reform effort, I can warn anyone 
trying to redesign the tax system that ``family'' issues at 
times will drive the process if for no other reason than that 
so much money is at stake. Congress' recent debate over a child 
credit demonstrates just how expensive changes here can be. One 
reason is that decisions over how to treat children or spouses 
in the tax Code typically involve millions, tens of millions, 
or even hundreds of millions of people. A change of $500 for 50 
million taxpayers, for instance, might require that $25 billion 
in tax liabilities be shifted annually. By way of contrast, 
most other reform issues involve far smaller numbers of 
taxpayers.
    Many provisions of the current federal income tax are 
specifically designed to take into account the economic 
circumstances of the family. Examples of some family-sensitive 
tax issues follow:
     the dependency exemption;
     a child credit (proposed by both major political 
parties, but not enacted);
     the earned income tax credit;
      the child and dependent care credit; the 
``kiddie'' tax;
      the standard deduction and tax-free levels of 
income that vary in amount for different types of households;
      the special rate schedule for heads of 
households;
      marital income splitting and the rate schedule 
for single taxpayers; and
      the deduction for alimony payments and the 
nondeductibility of child support payments.
    Obviously, all tax issues affect the family in some manner 
or another. For instance, the home mortgage interest deduction 
and the charitable contributions deduction affect families in 
different ways. However, I will confine my discussion today 
mainly to those issues where adjustments in tax burden are made 
according to the size of the family--in particular, the 
presence of children.
    One major source of complication must be admitted up front. 
Current tax law includes several measures designed to benefit 
low-income families. Some of these measures are defended on tax 
policy grounds, whereas others are defended on spending policy 
grounds. A major objective of family taxation reform--indeed, 
one that has become unavoidable--should be to coordinate the 
tax measures that are designed to benefit low-income families 
with children with the various direct expenditure programs 
targeted at such families. Indeed, as I will demonstrate, tax 
administration often requires this coordination whether we 
desire it or not.

                        A. Dependency Exemption

    The dependency exemption is a major mechanism for adjusting 
tax burdens for the costs of supporting children and is the 
only mechanism that provides tax benefits to all middle-income 
families with dependent children. The dependency exemption for 
1996 was $2,550 per dependent child. Since 1987, it has been 
phased out for high-income taxpayers. For tax year 1994, 
taxpayers claimed a total of approximately 70 million 
dependency exemptions.
    Few changes in federal income tax laws over the past four 
decades have had as far-reaching effects on the distribution of 
federal tax burdens as the shift in the relative tax burdens 
from taxpayers without dependent children to taxpayers with 
dependent children. The increase in relative tax burdens has 
been particularly marked for middle-income taxpayers with 
children.
    The increase in relative burdens on families with dependent 
children did not occur because policymakers, after careful 
study, concluded that parents with dependent children were 
being taxed too lightly. Instead, it happened primarily because 
the chief mechanism for granting tax relief to families with 
dependent children--the dependency exemption--was not adjusted 
sufficiently to keep up with economic growth.
    Over the 48-year period from 1948 to 1996, the dependency 
exemption has grown from $600 to $2,550--slightly more than a 
four-fold increase. During that same period, per capita 
personal income has grown from $1,425 to $23,882, which is more 
than a sixteen-fold increase. As a consequence of economic 
growth, the dependency exemption fell from about 42 percent of 
per capita personal income in 1948 to less than 11 percent by 
1996.
    The dependency exemption for 1996 would need to be set at 
approximately $10,000 for it to represent the same percentage 
of per capita income as it represented in 1948 (Figure 1). 
Simply to adjust the dependency exemption for post-1948 
inflation would require that it be increased to nearly $4,000. 
If converted to a credit that offset taxes, the exemption would 
need to equal $1,500 or more per child to reduce taxes for the 
same proportion of income as in 1948.
    This decline in the dependency exemption, along with 
increases in Social Security taxes, has increased the tax 
burden of families with children relative to almost all other 
taxpayers and is one of the major reasons today for the 
consideration of a child credit.

          B. Tax Credit for Dependent Children (Child Credit)

    A child dependency credit, generally referred to as a child 
credit, is a possible alternative mechanism for delivering tax 
relief to parents with dependent children. The credit might be 
a fixed amount per dependent child, or the amount of the credit 
might vary with family size. It could be fixed in amount at all 
income levels; some would phase out at middle-or high-income 
levels, although phase outs by their very nature involve 
implicit rather than explicit tax rates. Although both 
political parties have proposed child credits, most major 
reform proposals do not deal with this issue.
    Significant simplification gains are possible if tax relief 
to families with dependent children is provided through one 
mechanism that integrates the benefits of current law and any 
new benefits that policymakers are prepared to give to families 
with dependent children. Under current law, relief is now 
targeted at families with children through the dependency 
exemption and, for low-income families, through the earned 
income tax credit (EITC). Adding a third relief mechanism with 
a different set of eligibility rules appears needlessly 
complex. Nonetheless, rolling two and perhaps all three 
mechanisms into a single mechanism would require some changes 
in policy--for example, a uniform definition of ``dependent'' 
would probably be required. Such changes may create some 
additional winners and losers in order to achieve gains in 
administrative economy.
    In tax theory, there is no strong case in favor of a credit 
over a deduction or vice-versa. Indeed, as a technical matter, 
for families of one size but different incomes, it is possible 
to develop a credit-based system that would replicate exactly 
an exemption-based system. Assuming the continuation of the 
EITC and the commitment of the nation to provide minimal levels 
of support to many low-income individuals, the use of a unified 
credit would seem to be the preferred approach. In addition, a 
credit mechanism that combined the benefits of the EITC and the 
dependency exemption could be coordinated better with various 
rules for phasing out welfare benefits than is possible under 
current law.
    Finally, I have also suggested that Congress may have a 
unique opportunity today to link some unified child credit with 
a requirement that the credit is only available to families 
that purchase health insurance for their children. In one 
combined effort, Congress could partiality reverse the 
historical trend toward increasing the relative tax burden 
placed on families with children, reduce dramatically the lack 
of health insurance among children (and among some adults as 
well), and reduce some of the high implicit tax rates imposed 
on those who decide not to take welfare or who move off of 
welfare.

                      C. Earned Income Tax Credit

    Current law provides low-income workers with a refundable 
tax credit--that is, besides reducing the tax liability for 
low-income families, the government sends a check to the 
taxpayer for any amount by which the allowable credit exceeds 
that taxpayer's liability for taxes payable on his or her 
income tax return. This earned income tax credit (EITC) 
provides significant benefits to low-income families with 
dependent children and more limited relief to other low-income 
individuals. Taxpayers with income over specified income 
thresholds are not eligible for the EITC.
    The EITC began as a limited program in 1975 during the Ford 
administration and has been expanded several times since then, 
with large increases enacted in 1986, 1990, and 1993 and some 
modest adjustments in 1996. The 1993 additions were only 
scheduled to become fully effective in 1996. Most of the 
credits represent amounts refunded to households.
    Historically, the EITC has been promoted as a useful 
mechanism for lowering income taxes and offsetting FICA (Social 
Security) taxes for low-income individuals with dependent 
children; for some it also offset the work disincentives 
associated with welfare. Both of these goals continue to be 
invoked to justify the EITC. Today, the EITC probably should be 
considered primarily as an extension of a combined welfare/tax 
system. That is, it has important tax and welfare features that 
to some extent are inseparable.
    Proponents of many types of tax reform have many difficult 
issues to face with the EITC. For example, it is impossible to 
remove most low-income families from filing returns as long as 
the EITC is designed in its current fashion. For those who 
favor many types of consumption taxes, the EITC also affects 
the simplification gains that they hope to achieve by 
eliminating requirements to measure capital income for tax 
purposes. The EITC is necessarily income-based, unless high-
income individuals with low wages or low levels of consumption 
are to be made eligible for the EITC. To administer the EITC, 
therefore, the tax authorities must obtain substantial 
information about the capital income of prospective recipients 
of the EITC. A similar constraint applies to welfare 
authorities administering Food Stamps, Supplemental Security 
Income, and other programs. The problem is not solved by making 
the issue of relief for low-income workers a problem for the 
welfare system. Those systems contain implicit income taxes 
that affect millions. Meanwhile, businesses, banks, and other 
institutions would still need to perform income reporting even 
if the main body of the income tax were converted to a 
consumption tax.
    Revision of the EITC is likely to be a topic on the public 
agenda for some time, whatever the political fate of the major 
reform plans. The EITC has received political support from many 
sources, including, at various times, from the leadership of 
the two major political parties. In my view, it represents an 
intermediate step as the nation searches for a way to convert 
welfare into work support. It has been favored both because of 
the work incentives that it provides compared to welfare, as 
well as the relief that it delivers to low-income families. 
Some supporters have seen it as a politically viable 
alternative to an increase in the minimum wage. The EITC, 
however, has also received criticisms from a range of sources, 
partly because of problems with its implementation and partly 
because it is not well integrated with income-tested welfare 
programs. Congress and the IRS have attempted to deal with the 
problem of ineligible participants receiving the credit by 
reforming eligibility criteria and by checking more closely 
with taxpayers over the existence of dependents. Error rates, 
however, remain very high.
    An additional problem in the EITC remains to be addressed: 
the ability of taxpayers to overdeclare income to receive 
higher credit amounts. This problem, which I have labeled the 
``superterranean economy'' (as opposed to the underreporting of 
income in the subterrranean economy), does not require 
cheating. Two neighbors could baby-sit for each other and 
generate significant EITCs as a consequence.

Coordination of Tax Provisions with Implicit Taxes Embedded in 
Welfare Programs.

    I recognize that your focus today is on tax reform, while a 
focus on family issues keeps pulling us toward discussion of 
transfer programs as well. For low and moderate income 
individuals, however, tax and transfer issues simply can no 
longer be separated. An important objective of public policy, 
whether characterized as tax policy or welfare policy, should 
be to substantially reduce the high marginal ``tax'' rates that 
low income individuals typically face when they attempt to 
enter the workforce or the effective tax rates that low income 
workers face simply by choosing never to go on welfare. A 
reduction in those rates presumably would discourage long-term 
dependence on welfare. It would also reduce the extent to which 
low-income workers perceive that they are being treated 
unfairly.
    Figure 2 shows the combined tax rates derived from tax and 
welfare programs just before the enactment of welfare reform--
although it is doubtful that these rates have changed much 
since then. In effect, welfare recipients who worked faced 
combined tax rates of 70 percent not just when they went to 
work at minimum wage but all the way up toward three times the 
minimum wage (the effective marginal rate on additional work is 
often even higher than this ``average'' rate on all earnings). 
At one to three times minimum wage for a full-time worker, few 
individuals receive much in what is commonly thought of as 
welfare: AFDC or its replacement, TANF (Temporary Assistance to 
Needy Families). The high tax rates at those income levels 
derive from federal income tax, phase out of the EITC, state 
income tax, phase out of housing benefits for those who receive 
them, phase out of Food Stamps, and phase out of eligibility 
for Medicaid. All phase outs, remember, basically take away 
benefits as income increases. Avoidance of such poverty traps 
should be an important, long-term, objective of any major tax 
reform.
    In addition to the large tax rates on work, marriage 
penalties are enormous for low-income individuals. For a 
typical welfare recipient who married someone with a modest 
paying job, their combined income would fall by an additional 
30 percent or so just from marriage alone. Many marriage 
penalties are caused by welfare, but some are in the tax code 
itself due to the earned income tax credit and the standard 
deduction. Thus, another potential advantage of a unified 
approach to tax and welfare issues is the opportunity provided 
for reducing marriage penalties. Although, as discussed later, 
there are also marriage penalties for higher income individuals 
due to the rate structure, but these are smaller relative to 
income than those faced by low income individuals.
    Let me return briefly to how a child credit provides a 
means of linking together these concerns between the welfare 
system and the tax system. Just as a welfare payment operates 
as a refundable tax credit that is phased out as income 
increases, so also a child credit could be designed to be there 
when the welfare payment was no longer available. Once the 
credit is fully phased in, it can be allowed to remain constant 
throughout the low-and middle-income ranges, thereby avoiding 
the implicit taxes that result under current law from the 
phase-out of the EITC or welfare credits.
    In effect, a child credit can be explicitly designed to 
reduce, although not eliminate, some of the poverty traps and 
marriage penalties faced by low income individuals. As far as I 
can tell, none of the major tax reform proposals on the 
national agenda attempt to address the poverty traps created by 
the interplay of tax and welfare policies. Several of them 
attempt to replicate the distribution of taxes at low-income 
levels and simply to leave these issues to another time and 
place.

                          D. Child-Care Credit

    Parents with one or more children under age 13 may claim a 
tax credit under current law for a portion of the expenses for 
child care and household services that they incur in pursuing 
gainful employment outside the home. The allowable credit is a 
percentage (30 percent at low-income levels, phased down to 20 
percent) of qualifying expenses. Qualifying expenses are capped 
at $2,400 (one qualifying dependent) or at $4,800 (two or more 
qualifying dependents). In the case of a two-job married 
couple, the expenses eligible for the credit generally cannot 
exceed the income of the lower-earner spouse. Taxpayers 
claiming the credit must provide the Internal Revenue Service 
with the name, address, and taxpayer identification number of 
their provider.
    A deduction for child-care expenses was introduced in 1954, 
during the Eisenhower administration, primarily as a mechanism 
for encouraging mothers on welfare to work outside the home. 
The deduction was capped at $600 and was phased out at rather 
low income levels. The allowance has been expanded several 
times and was converted into a credit in 1976. The child-care 
credit was claimed in 1995 by just over 6 million taxpayers for 
total credits of under $3 billion. For a taxpayer with adjusted 
gross income of $10,000 or less and two qualifying dependents, 
the maximum credit is $1,440. The maximum credit is $960 for 
parents with income of $30,000 or more.
    The case for repeal on efficiency grounds is at best mixed. 
An initial and continuing purpose of a child-care allowance has 
been to mitigate the tax and welfare disincentives that some 
parents face in taking a job in the labor market. The 
efficiency problem arises if the tax system tries to be neutral 
between child care provided in the home and child care provided 
outside of the home. The current credit generally favors child 
care outside of the home for those with low and middle incomes, 
but favors child care in the home for taxpayers with above 
average incomes. Eliminating any adjustment for child care 
clearly would favor child care in the home, as can be seen most 
readily by examining the circumstances of a single parent who 
must obtain child care in order to work. Maintaining an 
adjustment, on the other hand, would cause some modest increase 
in the tax rate, which could have some efficiency costs.
    The case for a child-care allowance on fairness grounds 
also is mixed. One argument for a child-care allowance is that 
it constitutes a legitimate cost of earning income and ought to 
be deductible in a tax system seeking to measure net income (or 
net consumption). Those arguing that child-care expenses 
constitute a business cost can show that the costs of child 
care are closely analogous to certain expenses, such as the 
costs of travel away from home, that are deductible as a cost 
of earning income. On the other hand, those costs are also 
analogous to certain other expenses, such as the cost of most 
types of personal clothing, that are not deductible, 
notwithstanding a close relationship to business. Because 
child-care costs arise from the quintessentially personal 
decision to have and raise children, a case for the deduction 
on business-expense grounds can never be conclusively made.
    As a practical matter, I believe that some adjustment is 
appropriate but needs to be limited and kept simple. 
Nonetheless, any reform proposal that attempts to eliminate 
filing requirements cannot maintain a child care credit or 
deduction unless these could be channeled directly through 
employers.

                             E. Kiddie Tax

    Under current law, as amended in 1986, children under the 
age of 14 are taxable on their unearned income at the marginal 
tax rate of their parents. This rule is popularly, if 
inexactly, referred to as the ``kiddie tax.'' Its point is to 
prevent parents from avoiding the bite of the graduated rate 
structure by shifting investment income to their children. Its 
initial purpose was to simplify tax planning costs. Its 
adoption, indeed, did reduce the tax planning benefits 
obtaining from establishing certain family trusts, thereby 
reducing the complexity for the taxpayer and the tax 
authorities that is associated with such tax planning. Earned 
income--e.g., income that children earn from babysitting or 
delivering newspapers--is not subject to the kiddie tax rule. 
Nonetheless, in 1986 Congress went much further than the 
initial ``kiddie tax'' goals when it dramatically reduced or 
eliminated the personal exemption for children with earnings 
who were also claimed by their parents. This created much 
additional filing complexity and a significant increase in 
children required to file. Simplification requires a 
restoration of something like an additional personal exemption 
for children, even though on strict equity grounds some 
children would thereby generate more personal exemption than 
others.

        F. The Standard Deduction and Tax Free Levels of Income

    The tax-free level under current law is determined by two 
mechanisms: the taxpayer exemption and the standard deduction. 
For 1996, the taxpayer exemption was set at $2,550. This is the 
same amount as the dependency deduction. These personal 
exemptions were set at $2,000 after the phase-in of the 1986 
tax act (1989) and have been adjusted upwards for inflation 
since then.
    Each type of filing unit has its own standard deduction 
level. For married couples in 1996 it was $6,700 for a per 
capita standard deduction of $3,350. Heads of household 
received a standard deduction of $5,900, while single 
individuals could claim a standard deduction of $4,000. 
Relative to being single, the standard deduction creates a 
modest marriage penalty for many moderate income couples 
typically amounting to $195 in extra tax liability.
    Personal exemptions, on the other hand, are of equal size 
for all persons. Together with the standard deduction they 
provide for a tax-free level of income of $6,550 for a single 
individual, $8,450 for a head of household, and $5,900 for each 
member of a couple (Table 1). Excluding the earned income tax 
credit (EITC), most reform proposals would increase this tax 
exempt amount. Only flat and retail sales tax proposals usually 
remove marriage penalties from this source, although there is 
no reason that other reforms could not also achieve that goal.

                                                     Table 1                                                    
 Family-Sensitive Provisions Relating to Marital Status of Parent: Current Law, Flat Tax, USA Tax and 10-Percent
                                                       Tax                                                      
----------------------------------------------------------------------------------------------------------------
                                                                                            USA Tax             
                                                                    Current    Flat Tax    (personal  10-Percent
                    Features of  Tax Regimes                      Law (1996)   (wage tax      tax         Tax   
                                                                              component)  component)            
----------------------------------------------------------------------------------------------------------------
Tax-exempt amounts for adult individuals:                                                                       
    married (per capita)........................................      $5,900    $10,700*      $6,250      $6,925
    single......................................................       6,550      10,700       6,550       7,750
    head of household...........................................       8,450     14,000*       7,950      10,100
Total Exempt amount, 2-parent family of four (husband, wife, 2                                                  
 children)......................................................      16,900     31,400*      17,600      19,350
Total exampt amount, 1-parent family of three (parent, 2                                                        
 children)......................................................      13,550     24,000*      13,050      15,600
Marriage penalty from rate structure............................         yes          no         yes         yes
Marriage penalty from exemptions................................         yes          no         yes         yes
Alimony deduction...............................................         yes          no         yes         yes
Child-support deduction.........................................          no          no         yes          no
----------------------------------------------------------------------------------------------------------------
* Exemption does not appy to in-kind fringe benefits or employer share of FICA payroll tax, although both are   
  fully taxable under business tax.                                                                             
 NOTE: The tax-exempt amounts do not include the amounts that would be exempt to low-income familes on account  
  of the earned income tax credit.                                                                              
 Source: Michael J. McIntyre and C. Eugene Steuerle, Federal Tax Reform: A Family Perspective (1996, p. 44).    

                   G. The Head of Household Schedule

    The head-of-household schedule was introduced into the tax 
code in 1951. Its purpose was to extend to one-parent families 
some portion of the tax benefits that two-parent families 
received under the marital income splitting regime adopted 
nationally in 1948. Under that regime, marital partners were 
allowed to report one-half of the total income of their marital 
partnership on the same rate schedule used by single 
individuals. In contrast to the head of household schedule, the 
benefits of marital income splitting were available to all 
marital couples, whether or not they had dependent children.
    The purpose of the head-of-household schedule is to take 
account of the differences in ability to pay of heads of 
households relative to equal-income single individuals due to 
the difference in their support obligations. In effect, the 
head of a one-parent family is allowed to split income with a 
dependent child, with the child's portion of the parent's 
income being taxed at a low or zero rate. The head-of-household 
schedule operates like a dependency exemption that increases in 
value with increases n the total income level of the one-parent 
family.
    The special rate schedule for one-parent families creates 
the potential for marriage penalty because a husband and wife 
with children could reduce their taxes under current law by 
getting a divorce, using the deduction for alimony to equalize 
their individual incomes, and then having one former spouse 
file as a head of household and the other spouse file as a 
single person. The former spouses cannot both file as a head of 
household under current law and still live together, because a 
head of household is defined as a person providing more than 
half of the cost of maintaining the household. It does not 
appear that significant numbers of married couples have availed 
themselves of this tax-avoidance opportunity.
    Heads of household bore significantly higher tax burdens 
because of the decline in dependent exemptions noted above. If 
child allowances were raised significantly, this would reduce 
the need for a separate head of household rate schedule.

                      H. Marital Income Splitting

    The modern history of the current federal system of marital 
taxation begins in 1948, when Congress adopted marital income 
splitting as a conscious federal policy. Before the 1948 
reform, federal family taxation policy was in disarray.
    In a tax system that provides for full marital income 
splitting, each spouse is taxable as an individual on one-half 
of the total income of their marital partnership. Such a system 
is not designed primarily to benefit dependent children. It is 
available, after all, to childless couples and to couples with 
adult children no longer dependent on their parents. Its 
purpose is to tax each spouse on that share of the total income 
of their marital partnership that is used to enhance their 
material well-being. It can be viewed as implementing the 
traditional income tax policy goal of relating the burdens of 
taxation to the consumption and net savings of individual 
taxpayers.
    In 1969, Congress adopted a special tax rate for single 
individuals that guaranteed that they would pay no more than 
120 percent of the tax imposed on marital partners having the 
same aggregate income. This 120-percent rule reflected a 
political compromise between those who contended that equal-
income marital couples should bear equal taxes and those who 
contended that individuals with equal income or equal earnings 
should pay equal taxes notwithstanding differences in their 
marital status. The revenue cost of introducing the ``singles'' 
rate schedule was modest--on the order of $200 million per year 
in forgone revenue. Despite the low cost, the implications of 
this change for federal tax policy were very large, for reasons 
explained below.
    Under the system adopted in 1969, marital partners became 
taxable on their aggregate incomes as a unit, under a rate 
schedule with brackets exactly twice as wide as the brackets 
under the rate schedule of prior law. The tax brackets on the 
marital unit schedule, however, were less than twice as wide as 
the brackets on the newly created schedule for single persons. 
The effect was that two marital partners having approximately 
equal separate incomes would pay less in tax if they were 
allowed to file separate tax returns and to compute their 
separate tax liabilities on the new singles schedule. The only 
way to do so, however, was to terminate their marriage. The tax 
savings that marital partners could obtain from getting a 
divorce and filing separately came to be called a ``tax on 
marriage'' or a ``marriage penalty.''
    Congress has adopted legislation from time to time to 
reduce the marriage penalties created by the 1969 act. Other 
legislation, unfortunately, has increased those penalties. 
Marriage penalties were reduced sharply under the 1986 tax act, 
due to the flattening of the rate structure and the 
introduction of fuller income splitting at middle-income 
levels. Marriage penalties were increased significantly by the 
way that the 1993 tax act increased tax rates for high-income 
individuals. No changes have been made in the basic system of 
multiple graduated rate schedules introduced in 1969, which 
necessarily produces marriage penalties. Plans that attempt to 
replicate the existing distribution of tax burdens, such as the 
USA plan and Gephardt 10-percent tax, tend to continue that 
basic structure.
    A perfectly flat tax would eliminate all marriage penalties 
created by the graduated structure. This approach, combined 
with the equal per capita standard deductions provided to 
single and married persons, would eliminate almost all marriage 
penalties created by the rate structure, although not--as 
mentioned above--the very large penalties due to welfare and 
EITC type of provisions. To eliminate marriage penalties, one 
also needs to eliminate phase-outs such as the phase out of 
itemized deductions and the personal exemption phase out.

                 I. Alimony and Child Support Payments

    Under current law, alimony is deductible to the payor and 
taxable to the recipient. The effect of this arrangement is to 
extend some degree of income splitting to formerly married 
individuals. Thus, the treatment of current law is consistent 
with the income splitting approach to family taxation.
    In the typical case, alimony flows from the higher-earner 
taxpayer to the lower-earner taxpayer. In a tax system having 
graduated rates, therefore, taxing the recipient of alimony 
rather than the payor results in a net reduction in the 
aggregate tax burdens of the two former spouses. If the tax 
savings to the payor and the tax detriment to the recipient are 
properly taken into account in setting the level of the alimony 
payments, the alimony recipient should obtain a net benefit 
from having been made taxable on the alimony payments. That is, 
the recipient would receive an additional alimony payment 
sufficient to pay the tax and to give that individual some fair 
share of the resulting tax savings. Divorce settlements that 
provide for the payment of alimony are typically structured so 
that they deflect some or all of the tax savings from the 
alimony deduction to the alimony recipient.
    The proper tax policy treatment of child-support payments 
is unclear. Those who hold that the earner is the proper 
taxpayer on earned income presumably would oppose the deduction 
of support payments. The earner rule, however, is inconsistent 
with marital income splitting--an approach endorsed under 
current law and under several reform proposals. If an income 
splitting approach is carried over to children, then child-
support payments would be deductible to the payor and taxable 
to the child, not to the custodial parent. It certainly would 
be an odd result, however, to allow income splitting between 
separated parents and their children and to not allow it within 
fully intact families.
    As discussed above, the dependency exemption can be 
understood as a mechanism for allowing limited income splitting 
with children. If the dependency exemption, or a child credit, 
is generous, then the issue of who to tax on support payments 
has reduced importance, because the parent taxable on the 
support payments presumably would be the one who would be 
allowed to claim the dependency exemption or credit.
    Despite all of these arguments, perhaps the simplest system 
administratively, and the one with the fewest enforcement 
problems, is to tax income to the earner and to grant 
exemptions and credits primarily upon the basis of with whom 
the child lives most of the year. In a tax system with 
graduated tax rates, a rule that taxed child-support payments 
to the recipient parent and made them deductible by the payor 
parent typically would result in lower aggregate taxes on those 
parents, assuming that the payments flow from the higher-
bracket taxpayer to the lower-bracket taxpayer. The point is 
similar to one that can be made with respect to alimony 
payments. Both parents would be better off under a deduction 
rule as long as some mechanism was in place that would require 
them to share fairly the net tax savings. Even in a single-rate 
system, such as a flat tax, divorced or separated parents would 
obtain a net benefit from the deduction rule whenever the 
recipient parent's income otherwise would have been below the 
tax-exempt level. For simplification purposes, however, most 
flat and consumption-based taxes would assume that the flat 
rate structure eliminated most concerns over who paid tax and 
would rely upon withholding of the tax at the source of 
payment, such as the employer or business.

                               Conclusion

    My testimony today has dealt with the many family-sensitive 
provisions that must be dealt with in any major tax reform 
effort. Several of these family related issues affect very 
large numbers of taxpayers and involve significant amounts of 
revenues. While certain types of reform efforts technically may 
move beyond an income tax, they often cannot bypass these 
family issues. Thus, earned income tax credits and welfare 
programs have income phase outs that operate like income taxes 
even in the presence of a consumption tax. In a consumption tax 
or value-added tax or retail sales tax that did not allow for a 
child care deduction, a decision would still have to be made as 
to whether child care expenses were to be taxable as 
consumption services. Some divorce settlements would have to be 
renegotiated under major tax reform, especially when they were 
based on the allocation of tax benefits under current law.
    Of all the issues I have raised, perhaps the largest and 
most important are those that relate to the ways that any tax 
system adjusts for the presence of children through child 
credits, dependent exemptions, and the earned income tax 
credit. Recent bipartisan support for child credits and the 
push for tax reform create a unique opportunity to lessen the 
increasing reliance of our tax system on families with 
children, to expand significantly health insurance for 
children, and, at the same time, to reduce the extraordinarily 
high tax rates and marriage penalties on those low-income 
individuals who decide to work rather than rely on welfare.
      

                                

    Chairman Archer. Thank you, Mr. Steuerle. Our next witness 
is Mr. Glenn Hubbard.

 STATEMENT OF R. GLENN HUBBARD, RUSSELL L. CARSON PROFESSOR OF 
ECONOMICS AND FINANCE, COLUMBIA UNIVERSITY, NEW YORK, NEW YORK; 
 RESEARCH ASSOCIATE, NATIONAL BUREAU OF ECONOMIC RESEARCH; AND 
  DIRECTOR, TAX POLICY STUDIES, AMERICAN ENTERPRISE  INSTITUTE

    Mr. Hubbard. Thank you, Mr. Chairman. My name is Glenn 
Hubbard. I am an economics professor at Columbia University in 
New York.
    I have on the wall in my office at Columbia a framed copy 
of the four pages of the original income tax form, including 
both the instructions and schedule. Compared with the stack of 
papers that was on my desk as I prepared my 1040 this year, I 
observe that the tax system has obviously gone through a stark 
and twisted change.
    The most vocal discussion about which you have been hearing 
on fundamental tax reform has to do with changing the tax base 
from an income tax to a consumption tax. Many economists 
support such a move, based on economic efficiency, fairness, 
and simplicity.
    Perhaps less vocal but, I would argue, also quite important 
are voices for fundamental income tax reform--that is, taxing 
broad measures of income, but tax them only once, as Mr. Armey 
was suggesting.
    An example of this debate is the discussion of corporate 
tax integration. The U.S. Treasury has put forth a proposal 
forward that end in 1992.
    An interesting point--to which I will return in a moment--
is that many of the improvements that economists identify for 
consumption taxation could be achieved with fundamental income 
tax reform. I would encourage you to step back from labels 
except one--``radical.''
    The current tax system is widely and properly regarded as a 
patchwork quilt of incentives and disincentives. It is tempting 
to call the current tax an ``income tax,'' and, by extension 
characterize a ``consumption tax'' as its savior. The current 
tax system is, however, in fact, a hybrid of income and 
consumption tax characteristics.
    Forgetting about labels for a moment, I would like to 
define a fundamental tax reform as one satisfying the following 
characteristics: First, a combination of a business level tax, 
which would either be on cash flow or business income, 
depending on the system, and a household wage tax. Second, for 
an income tax version of tax reform, let depreciation 
allowances approximate economic depreciation, and for 
consumption taxation, let businesses deduct capital 
expenditures. Third, the business level tax would not 
distinguish between debt and equity financing. Fourth, in order 
to minimize marginal tax rate differences across businesses and 
investments, firms could carry forward net operating losses 
with interest. Finally, the system would have lower marginal 
rates, preferably with a single marginal rate across businesses 
and households, but with personal or family exemptions.
    To fix ideas, an example of an income tax version of this 
kind of reform, is the comprehensive business income tax that 
the Treasury suggested in 1992, in which there would be no 
interest deduction but no taxation of interest and dividends at 
the individual level.
    On the consumption tax side, one logical prototype would be 
the flat tax that Mr. Armey described. Such a tax would include 
both a business cash flow tax and a household wage tax. Is one 
of these more radical than the other? They are both quite 
radical, and both worthy of consideration.
    The only difference in the stylized descriptions I gave you 
for the two systems is that the income tax depreciates capital 
expenditures, while the consumption tax expenses them.
    That is an important point, because one argument that is 
often raised against consumption taxation and in favor of 
income taxation is that consumption taxes do not tax capital 
income, and are hence unfair. But not so fast.
    Remember that the only difference between those two 
fundamental reforms, income tax and consumption tax, as I 
described them, is depreciation versus expensing. That really 
amounts to the consumption tax forgiving the tax on the time 
value of money on depreciation allowances. That's a very small 
component of what is commonly called capital income, most of 
which represents returns to risk or entrepreneurial skill.
    What are the implications of this observation? Again, I 
think it serves to underscore that we think more about 
``radical'' than ``income tax'' versus ``consumption tax.'' 
Thinking about the underlying characteristics, of the reforms, 
it is possible to get there from here. One way, of course, 
would be an overhaul; simpler still would be to begin with 
corporate tax integration and possibly saving incentives.
    There are some pitfalls to avoid: I urge you to avoid the 
Trojan horse of small simplification proposals, and to avoid 
very expensive departures from fundamental tax reform such as 
education tax credits.
    In closing, Mr. Chairman, on a day when the national 
attention is drawn to the problems of the tax system, thank you 
for allowing me the opportunity to appear.
    [The prepared statement follows:]

Statement R. Glenn Hubbbard, Russell L. Carson, Professor of Economics 
and Finance, Columbia University Research Associate, National Bureau of 
Economic Research, Director of Tax Policy Studies, American Enterprise 
Institute

    Mr. Chairman, Ranking Member Rangel, and members of this 
distinguished Committee, I appreciate the opportunity to appear 
before you today. It is fitting, Mr. Chairman, that you have 
chosen ``Tax Day'' as an occasion for investigating the impact 
of fundamental tax reform on individuals and families. 
Policymakers and economists rightly focus on three criteria for 
judging changes in the tax system: economic efficiency, 
fairness, and simplicity. On all three grounds, fundamental tax 
reform is likely to improve the economic well-being of American 
individuals and families.

                  The Need for Fundamental Tax Reform

    Many recent proposals for fundamental tax reform have 
advocated replacing the current tax system with a broad-based 
consumption tax.\1\ Economists' support for such proposals 
centers on gains in economic well-being made possible by tax 
reform. Three sources of efficiency gains, it is argued, would 
accompany a switch to consumption taxation. First, the removal 
of the current tax on returns to new saving and investment 
would increase capital accumulation and, ultimately, family 
incomes. Second, the consumption tax would remove distortions 
in the allocation of capital across sectors and types of 
capital. Third, a broad-based consumption tax would avoid 
potentially costly distortions of firms' financial structures. 
Recent estimates suggest that efficiency gains from consumption 
tax reform could be substantial. Professor Dale Jorgenson of 
Harvard University estimates the present value of growth 
opportunities created by the move from the 1985 tax law to the 
Tax Reform Act of 1986 to be about $1 trillion in 1987 dollars 
(Jorgenson, 1996). Jorgenson estimates that, had the United 
States moved from the 1985 income tax law to a broad-based 
consumption tax, gains in growth opportunities would have 
doubled to about $2 trillion. The additional gains are due to 
leveling the playing field and expensing business investment. 
Professor Alan Auerbach of the University of California, 
Berkeley estimates that the move from the current tax system to 
a broad-based consumption tax would raise output per capita by 
about eight percent (Auerbach, 1996).
---------------------------------------------------------------------------
    \1\ See, for example, Robert E. Hall and Alvin Rabushka (1983, 
1995), Nicholas Brady (1992), and Alliance USA (1995).
---------------------------------------------------------------------------
    With respect to fairness, many economists believe that 
consumption represents a better measure of ``ability to pay'' 
than does current income, because households' consumption 
decisions depend on wealth and expected future income as well a 
current income. Finally, a properly designed broad-based 
consumption tax promotes simplicity. Several consumption tax 
systems avoid much of the costly complexity associated with the 
present income tax.
    Another group of proposals has suggested reforming the 
income tax, in particular toward taxing broad measures of 
income--once.\2\ While the debate between ``income tax reform'' 
and ``consumption taxation reform'' often characterizes the 
differences between the two plans for reform as significant, I 
argue below that, with respect to efficiency gains, the 
distinction between reform toward a broad-based income tax and 
reform toward a broad-based consumption tax is relatively 
minor. This is not to say that there are not important 
efficiency consequences of moving from the current tax system 
to a broad-based consumption tax. Instead, I mean simply that 
most such consequences can be traced to reform of the income 
tax. In addition, the distributional consequences of broad-
based income tax reform and consumption tax reform are broadly 
similar. Much, though not all, of the simplification made 
possible by consumption tax reform can be achieved through 
income tax reform.
---------------------------------------------------------------------------
    \2\ See, for example, American Law Institute (1992) and U.S. 
Department of the Treasury (1992).
---------------------------------------------------------------------------

                         Fundamental Tax Reform

    The current tax system is widely regarded by economists, 
policymakers, and taxpayers generally as a patchwork quilt of 
incentives and disincentives. In addition, while it is tempting 
to call the current tax system an ``income tax,'' that system 
is in fact a hybrid of income and consumption tax 
characteristics. Hence, to fix ideas, I use the term 
``fundamental tax reform'' to represent tax proposals with the 
following characteristics:
    (1) A combination of a business-level tax (with either cash 
flow or business income the base) and a household wage tax.
    (2) For an income tax version of reform, I assume that 
depreciation allowances approximate economic depreciation; for 
the consumption tax version of reform, businesses will deduct 
capital expenditures.
    (3) The business-level tax does not distinguish between 
debt and equity financing.
    (4) In order to minimize the differences in marginal tax 
rates across business entities and investments, firms will be 
allowed to carry net operating losses forward with interest.
    (5) Lower marginal tax rates, with single marginal tax rate 
across business entities and households; the household tax can 
have a personal or family exemption.
    While not all tax reform proposals share these 
characteristics, I focus on the characteristics to make a 
simple comparison between fundamental income and consumption 
tax reforms. I would also hesitate to add that fundamental 
income tax reform put this way is very much in the spirit of 
radical tax reform.

                  Bases of Income and Consumption Taxes

    To illustrate the difference between broad-based income and 
consumption taxes (of the form I just described), compare two 
hypothetical taxes--a pure uniform rate income tax and a 
subtraction-method value-added tax (as a representative 
consumption tax). The base of a pure uniform-rate income tax 
includes all forms of labor and capital income; the tax applies 
a flat rate against this income. Such an income tax could be 
implemented by means of a business-level (both corporate and 
noncorporate business) tax on receipts less wages, materials 
costs, and capital depreciation, plus a household-level tax on 
wages. For simplicity, suppose that the same (flat) rate is 
imposed in both the business and household tax. Abstracting 
from risk considerations (which I discuss below), then, the 
revised income tax has three components: (1) a wage tax, (2) a 
tax on returns from marginal investment projects, and (3) a 
cash flow tax on returns from existing capital and investment 
projects yielding economic profits. Within the context of 
broad-based income tax reform, the Treasury Department's (1992) 
Comprehensive Business Income Tax (CBIT) proposal generally 
followed this model. That proposal would deny deductibility at 
the business level of payments to debtholders and 
equityholders, but it would not tax such distributions at the 
investor level. Hence, in principle, the tax base is receipts 
less payments for employee compensation and other variable 
inputs and capital depreciation charges.
    Under a subtraction-method value-added tax (VAT), each 
business has a tax base equal to the difference between 
receipts from sales of goods and services and purchases of good 
and services from other businesses. This measure of value added 
is then taxed at a fixed tax rate. Because the aggregate 
business tax base equals aggregate sales by businesses to non-
businesses, the tax base is equivalent to aggregate 
consumption. As long as the tax rates are the same, such a tax 
is equivalent to a European-style credit-invoice value-added 
tax.
    Following the Hall-Rabushka Flat Tax (Hall and Rabushka, 
1983,1995), one could equivalently permit a deduction for wages 
at the business level with wage taxation at the same rate for 
individuals. Hence the subtraction-method VAT can be thought of 
as a combination of a wage tax and a tax on business cash flow. 
Viewed in this way, (this form of) a consumption tax is quite 
similar to the broad-based income tax.\3\ The difference 
between the two taxes is that the income tax base depreciates 
capital expenditures, while the consumption tax base deducts 
capital expenditures.
---------------------------------------------------------------------------
    \3\ This similarity is true in the context of business taxation. 
The Flat Tax addresses the distortion between housing capital and 
nonhousing capital more completely than CBIT.
---------------------------------------------------------------------------

              Differences in the Taxation of Capital Income

    The conventional description of a consumption tax or a cash 
flow tax assumes that all income from capital is exempt from 
taxation. To explain this view, one can decompose the base of 
the Flat Tax into two parts: The first is a business cash flow 
tax, the base of which is receipts from sales of goods and 
services less purchases for labor and materials and expenditure 
on capital goods. The second is a wage tax.\4\
---------------------------------------------------------------------------
    \4\ The subtraction-method VAT combines the two pieces, with a base 
equal to receipts less the sum of wages and purchases from other firms.
---------------------------------------------------------------------------
    Under the cash flow tax, the present value of depreciation 
allowances for one dollar of current investment is one dollar, 
while under the income tax, the present value is less than one 
dollar. For a risk-free investment project, the tax savings 
from depreciation allowances represent risk-free cash flows, 
which the firm would discount at the risk-free rate of 
interest. For a marginal investment--one in which the expected 
rate of return just equals the discount rate--the upfront 
subsidy to investment provided by expensing equals the expected 
future tax payments. It is in this sense that the return to 
capital is not taxed under a cash flow tax or a consumption 
tax.
    Life-cycle simulation models used to evaluate tax reforms 
follow this intuition and generally assume one risk-free return 
on accumulated savings.\5\ In such models, the shift from an 
income tax to a consumption tax is equivalent to forgiving the 
taxation of capital income from new saving and imposing a one-
time tax on existing saving used to finance consumption.
---------------------------------------------------------------------------
    \5\ See, for example, Alan Auerbach and Laurence Kotlikoff (1987); 
R. Glenn Hubbard and Kenneth Judd (1987); and R. Glenn Hubbard, 
Jonathon Skinner, and Stephen P. Zeldes (1995)
---------------------------------------------------------------------------
    What about investments which yield economic profits? That 
is, in addition to risk-free projects, suppose that certain 
entrepreneurs have access to investments with returns 
associated with rents to ideas, managerial skill, or market 
power. In this case, rates of cash flow in excess of the firm's 
discount rate for depreciation allowances are taxed. Cash flows 
representing economic profits are taxed equivalently under the 
broad-based income tax and the cash flow tax (or consumption 
tax). As long as the scale of projects with economic profits is 
limited, the tax saving from expensing should be invested in 
another risk-free asset. Hence, for projects yielding economic 
returns, only the return representing the risk-free rate is 
untaxed under the cash flow tax or consumption tax.
    What about risky investments? First, risky investments 
generate high or low returns after the investment is made. The 
component of capital income that represents luck after a risky 
investment has been made can be treated like the economic 
profit in the foregoing example of the income tax and the cash 
flow tax.
    Second, risky investments have a higher required rate of 
return before the investment is made than risk-free 
investments, reflecting a risk premium to compensate savers for 
bearing risk. Whether either tax system levies a tax on the 
risk premium depends on how one defines a ``tax.'' If a tax is 
defined as an increase in expected government revenue, then 
both the income tax and the cash flow tax include the risk 
premium. If, in contrast, a tax is an increase in the 
discounted present value of government revenue, then neither 
tax system includes the risk premium. In either case, the 
central point is that the stylized income tax and the 
consumption tax treat the return to risk-taking similarly.
    To summarize, what is often called the return to capital 
can be thought of as the sum of the risk-free return, economic 
profits, and returns to risk taking (payment for bearing risk 
and luck). In contrast to the base of the consumption tax, the 
income tax includes the opportunity cost of capital, which 
equals the rate of return on a marginal riskless project.

   Efficiency and Distributional Consequences of Consumption Taxation

    Acknowledging that, relative to a broad-based income tax, a 
consumption tax exempts only the risk-free component of capital 
income may warrant a reconsideration of the efficiency and 
distributional consequences of a shift toward consumption 
taxation. In the interest of brevity, I discuss below only five 
areas that need to be reconsidered: (1) saving and investment, 
(2) intersectoral and interasset distortions, (3) distortions 
of business financing decisions, (4) asset price effects, and 
(5) long-run distributional consequences.

Saving and Investment

    Much of the interest by economists and policymakers in 
consumption taxation reflects a belief that such tax reform 
will increase domestic saving and investment. While the 
responsiveness of saving to changes in the net return can be 
large in life-cycle simulation models, available empirical 
evidence based on household data suggests that the sensitivity 
of household saving to changes in the net return is modest, at 
least for most households.\6\ In addition, if only the risk-
free interest rate is exempt under a consumption tax (relative 
to an income tax), the stimulus to domestic household saving 
may not be large. For business investment, however, the 
combination of the shift to expensing and recent large 
estimates of the responsiveness of investment to changes in the 
user cost of capital suggests that consumption tax reform can 
still be a potent stimulus for domestic investment.\7\
---------------------------------------------------------------------------
    \6\ See, for example, the review in Eric Engen and William Gale 
(1996).
    \7\ See Kevin Hassett and R. Glenn Hubbard (1997).

---------------------------------------------------------------------------
Intersectoral and Interasset Distortions

    Moving to a broad-based consumption tax eliminates current 
distortions in the tax treatment of alternative sectors (for 
example, corporate versus noncorporate) and of alternative 
assets (for example, owner-occupied housing versus business 
capital). Efficiency gains from removing these distortions are 
likely to be large.\8\ It is important to note, however, that 
these gains--essentially arising from eliminating differential 
taxation of alternative forms of capital income--arise from 
income tax reform. That is, while substantial intersectoral and 
interasset gains may be achieved from a shift from the current 
tax systems to a broad-based consumption tax, most such gains 
are achievable in a move from the current tax system to an 
integrated income tax system, as in the Treasury Department's 
CBIT proposal.
---------------------------------------------------------------------------
    \8\ See, for example, the estimates reported in Alan Auerbach 
(1996).

---------------------------------------------------------------------------
Financial Distortions

    While life-cycle simulation models of tax reform do not 
consider distortions of business financing, some evaluations of 
tax reform have concluded that tax-induced distortions of 
corporate capital structure and dividend decisions can generate 
significant efficiency costs (see, in particular, U.S. 
Department of the Treasury, 1992). A move to a broad-based 
consumption tax of the ``flat tax'' form would clearly remove 
these distortions; neither interest payments nor dividends is a 
deductible business expense, and neither is taxed to investors. 
The same outcome would obtain under income tax reform of the 
CBIT form, however.

Asset Price Effects of Tax Reform

    Conventional analyses of tax reform using life-cycle 
simulation models focus distributional analysis on the short 
run--in particular asset price effects in the transition from 
the current tax system to a broad-based consumption tax. In 
such models in which there is a representative household within 
a cohort, asset price effects represent a redistribution across 
generations. Relative to fundamental income tax reform, the 
shift to a broad-based consumption tax entails two potentially 
significant asset price effects. For equities, the shift from 
depreciation to expensing reduces the value of old capital and 
equity. In life-cycle models with a representative household 
within a cohort, the decline in the value of old capital is 
largely borne by older generations, who own a 
disproportionately large share of the capital. For debt, to the 
extent that the price level rises in response to a shift to a 
consumption tax, the value of existing nominal bonds falls. 
Other significant asset price effects of tax reform stem from 
the shift from the current tax system to a broad-based income 
tax with uniform capital income taxation. For example, the 
adverse consequences of tax reform for the prices of existing 
homes reflects this shift in the income tax. In addition, many 
effects of tax reform on equity values (through the removal of 
dividend and capital gains taxes) arise from corporate tax 
integration an income tax reform and not from the shift to 
consumption taxation per se. These effects on equity values 
would, for example, have accompanied the Treasury Department's 
1992 proposals via dividend exclusion or CBIT.\9\
---------------------------------------------------------------------------
    \9\ The Treasury Department's ``dividend exclusion'' proposal 
follows the CBIT proposal for equityholders would neither be deductible 
at the business level nor taxable at the investor level.

---------------------------------------------------------------------------
Long-Run Distributional Consequences of Tax Reform

    Critics of consumption tax reform sometimes claim that, as 
a tax base, ``consumption'' is less equitable than ``income'' 
because the benefits of not taxing capital income accrue to 
households with high levels of economic well-being.\10\ Recall, 
however, that, relative to a uniform income tax, a consumption 
tax exempts only the opportunity cost return to capital from 
taxation. Using U.S. household data, William Gentry and I 
(1997) found that heterogeneity of household portfolios within 
a cohort is significant, highlighting the significance of 
examining consequences of eliminating differential taxation of 
capital income in tax reform. We also found that holdings of 
assets most easily identified with economic profits (for 
example, active business interests of the households) and risky 
returns (for example, equities) are highly concentrated among 
high-income and high-net-worth households. This finding 
suggests a more progressive distribution of the tax change than 
that generated under the assumption that all capital income 
represents opportunity cost. Furthermore, our distributional 
analysis indicates that this qualification is economically 
important. Designing ``distribution tables'' similar to those 
used in Washington practice, we find that more than one-third 
of the reduction in the shore of taxes paid by very high-income 
households in switching from an income tax to a consumption tax 
is offset by assuming that only the risk-free return to saving 
is exempt from taxation in the reform.
---------------------------------------------------------------------------
    \10\ This would be true, for example, if the ratio of household 
wealth to permanent income, all other things being equal, increase with 
permanent income, as suggested by R. Glenn Hubbard, Jonathon Skinner, 
and Stephen P. Zeldes (1995).
---------------------------------------------------------------------------

         Conclusions and Implications for the Tax Reform Debate

    A shift from the current tax system to a broad-based 
consumption tax is best thought of as a two-step process. 
First, most elements of consumption tax reform are consistent 
with moving to a pure income tax with uniform capital taxation. 
Second, for a switch from this pure income tax to a consumption 
tax, the key element of reform is replacing depreciation 
allowances for physical investment with expensing of capital 
assets. These points suggest the need for reevaluating 
conventional conclusions about efficiency and distributional 
consequences of tax reform. They also indicate that fundamental 
income tax reform and consumption tax reform are not in many 
responses significantly different directions in tax reform.
    The observation that fundamental income tax reform and 
fundamental consumption tax reform have similar consequences 
also has several implications for policy analysis of tax 
reform. First, policy analysis should study effects of tax 
reform on economic well-being within cohorts as well as across 
cohorts. Second, because many of the gains made possible by 
consumption tax reform can be achieved through income tax 
reform--and in particular, through integrating corporate and 
individual income taxation--income tax reform should occupy a 
prominent place in the tax reform debate. Third, incremental 
reforms toward integration and toward making capital taxation 
more uniform may offer a significant starting point for more 
fundamental tax reform. Finally, Mr. Chairman, while the 
Committee is rightly concerned with the need for radical reform 
of the current tax system, both radical income tax reform and 
radical consumption tax reform are likely to improve the 
economic well-being of American individuals and families.
    Thank you again, Mr. Chairman, for the opportunity to be 
with you today.

                               References

    Alliance USA. ``Description and Explanation of the Unlimited 
Savings Allowance Income Tax System.'' Tax Notes, March 10, 1995, 66, 
pp. 1483-1575.
    American Law Institute, Federal Income Tax Project. Reporter's 
Study Draft, Integration of the Individual and Corporate Income Taxes. 
Philadelphia, 1992.
    Auerbach, Alan J. ``Tax Reform, Capital Allocation, Efficiency, and 
Growth,'' in Henry J. Aaron and William G. Gale, eds., Economic Effects 
of Fundamental Tax Reform. Washington, D.C.: Brookings Institution, 
1996.
    Auerbach, Alan J., and Kotlikoff, Laurence J. Dynamic Fiscal 
Policy. Cambridge: Cambridge University Press, 1987.
    Brady, Nicholas F. ``Remarks Presented at the Graduate School of 
Business, Columbia University.'' December 10, 1992.
    Engen, Eric M., and Gale, William G. ``The Effect of Fundamental 
Tax Reform on Saving,'' in Henry J. Aaron and William G. Gale, eds., 
Economic Effects of Fundamental Tax Reform. Washington, DC: Brookings 
Institution, 1996.
    Gentry, William M., and Hubbard, R. Glenn. ``Distributional 
Implications of Introducing a Broad-Based Consumption Tax,'' in James 
M. Poterba, ed., Tax Policy and the Economy, Volume 11. Cambridge: MIT 
Press, 1997.
    Hall, Robert E., and Rabushka, Alvin. Low Tax, Simple Tax, Flat 
Tax. New York: McGraw-Hill, 1983.
    Hall, Robert E., and Rabushka, Alvin. The Flat Tax (2nd ed.). 
Stanford: Hoover Institution Press, 1995.
    Hassett, Kevin A., and Hubbard, R. Glenn. ``Tax Policy and 
Investment,'' in Alan J. Auerbach, ed., Fiscal Policy: Lessons from 
Economic Research. Cambridge: MIT Press, 1997.
    Hubbard, R. Glenn, and Judd, Kenneth L. `` Social Security and 
Individual Welfare: Precautionary Saving, Borrowing Constraints, and 
the Payroll Tax,'' American Economic Review, September 1987, 77, pp. 
630-646.
    Hubbard, R. Glenn, Skinner, Jonathan, and Zeldes, Stephen P. 
``Precautionary Saving and Social Insurance,'' Journal of Political 
Economy, April 1995, 103, pp. 360-399.
    Jorgenson, Dale W., ``The Economic Impact of Fundamental Tax 
Reform,'' in Michael J. Boskin, ed. Frontiers of Tax Reform. Stanford: 
Hoover Institution Press, 1996.
    U.S. Department of the Treasury. Integration of the Individual and 
Corporate Tax Systems: Taxing Business Income Once. Washington, DC: 
U.S. Government Printing Office, 1992.
      

                                

    Chairman Archer. Thank you, Mr. Hubbard.
    Dr. Asmus.

  STATEMENT OF BARRY ASMUS, Ph.D., SENIOR ECONOMIST, NATIONAL 
                   CENTER FOR POLICY ANALYSIS

    Mr. Asmus. Thank you, Mr. Chairman. My name is Barry Asmus. 
I'm a senior economist at the National Center for Policy 
Analysis. And thank you, Chairman Archer, for coming out and 
saying hi to us a few months ago.
    Good morning to you, and to the distinguished Members of 
the Committee on Ways and Means. I cannot think of a more 
important task than the need for tax reform on this April 15 
day of ``send me the money.''
    I'm hopeful that this Committee and this Congress can help 
make tax reform a reality. The global information economy is 
indeed much different than the industrial one. Labor and 
capital are highly mobile.
    All you need to start a business today is to have a fax 
machine, a modem, and a brain, and you can have a business 
anywhere in the world. Labor is highly mobile, but indeed, 
capital also is highly mobile. Capital flows are 100 times 
greater than world trade flows.
    So the world can no longer be understood as a collection of 
national economies. Indeed, we're in a situation where 
boundaries are porous, and we have to think of the global 
economy as an electric highway where capital gets up and goes 
to where it's wanted and stays where it's well treated.
    This globalized information economy is driving distribution 
costs down and transaction costs to zero. Everything is 
becoming more efficient, everything except the way we do taxes.
    We can no longer afford $200 to $300 billion of compliance 
costs. We can no longer afford to treat capital with double and 
triple taxation. We can no longer afford a capital gains tax 
that locks capital to less productive uses.
    Taxing income was always wrong, because it's a tax on 
production, supply, output and employment. But now it makes 
even less sense in a global, information economy.
    The income tax was designed for the industrial age, people 
working in factories, on farms and for large companies. Taxes 
were withheld. Compliance was relatively easy. That day is 
over.
    The electronic infrastructure is creating a worldwide 
economy where products have value added all over the world. The 
dress or shirt you buy at a store in St. Louis may have 
originated with cloth woven in Korea, finished in Taiwan, and 
cut and sewn in India. Then there is a brief stop in Milan to 
pick up its ``made in Italy'' label, before its final journey 
to a store in St. Louis.
    In short, economic transactions will happen anywhere, and 
individual income will come from everywhere.
    In my recent book, ``When Riding a Dead Horse, For Heaven's 
Sake Dismount,'' I argue that we're moving toward the contract 
society. A growing number of American workers will become 
entrepreneurs as we enter the 21st century. Many of them will 
be working on a contractual basis as a means to earn their 
income. There will be more than one employer, and many sources 
of income.
    Those of us that work for a large company would be assigned 
to certain tasks, and will proceed to contract them out to the 
high quality, low price bidder. The contractual economy will 
make individual income more difficult to track, and the IRS 
will have to become even more intrusive in the individual 
taxpayer's life.
    A consumption tax is the answer for the global economy, it 
is efficient and doable in a contractual economy, and it makes 
much more sense if we want a growth economy. I strongly agree 
with Professor Dale Jorgenson, chairman of the department of 
economics of Harvard University, that a revenue neutral 
substitution of a consumption tax for the existing income tax 
would have an immediate and powerful impact on the level of 
economic activity.
    There would be a drastic jump in savings, a substantial 
rise in labor supply. There would be a huge shift toward 
investments, and exports would increase. The fundamental tax 
reform we are talking about today would enhance prospects for 
U.S. growth and would benefit families.
    As America becomes more entrepreneurial and the world 
economy more global, taxpayers do not need the high compliance 
costs that go with defining and tracing income from a growing 
number of sources. Taxpayers do not need an intrusive IRS that 
invades their privacy. They do not need a tax that jettisons 
incentives to work, produce, create and be employed. They do 
not need a tax that reduces wages and is widely perceived as 
unfair.
    But American families do need a tax that is simple to 
comply with, that removes the disincentives to work, that 
encourages savings and investment, that will equip them with 
more capital, that will empower them by giving them choices as 
to how much tax they pay, and will expand their job 
opportunities.
    Members of the Ways and Means Committee, I ask you: how 
many families do you know that would appreciate a tax where 
compliance is simple, a tax that is proportional and fair, a 
tax that eliminates the underground economy, a tax that 
provides the right incentives to save, work and produce, a tax 
that abolishes the IRS, a tax that increases their disposable 
incomes, a tax that in essence transfers income from a 
government that does not earn the money to those people who do.
    Imagine with me an American future where the only memorable 
thing about April 15 was that it was just another beautiful 
spring day. Thank you, Mr. Chairman.
    [The prepared statement follows:]

Statement of Barry Asmus, Ph.D., Senior Economist, National Center for 
Policy Analysis

               Tax Reform: The Need for a Consumption Tax

    Perhaps the most urgent reason for tax reform is that we 
risk a breakdown in the implied contract Americans have with 
their government, as our system of generally voluntary tax 
compliance erodes under abuses by, and mistrust of, the 
Internal Revenue Service. However, my remarks today do not 
address that point directly, but rather deal with the changing 
nature of the workplace which will in the not too distant 
future dramatically increase the difficulty of identifying 
income, tracking income and collecting a tax on income.
    The current income tax system relies heavily on employers 
to collect taxes from employees. Employers receive tax 
preferences for benefits furnished their employees. But that 
employer-employee structure is changing in the Information Age:
    (1) The workplace is decentralizing as more and more people 
are becoming independent contractors and consultants, receiving 
income from a range of diverse sources.
    (2) The family and how it functions is evolving, as wives 
enter the workforce and both partners assume nontraditional 
roles.
    These trends will intensify and, as they do, the current 
tax system will become even more cumbersome, intrusive and 
inefficient than it is today. A consumption tax makes sense 
today and it will make even more sense as the decentralization 
of work becomes more defined. Technological advances portend a 
time in the not too distant future when governments will be 
forced to turn to new ways of gathering revenue in a global 
economy.

                   Technology and the Ability to Tax

    In the Information Age, the new source of wealth is not 
mainly material. It is information. Knowledge extraction, 
integration and application are replacing the shipment of raw 
materials from remote locations to manufacturing centers as the 
dominant world business. Knowledge has become the main source 
of economic value. Matter matters less and less. Knowledge and 
ideas matter more and more.
    Labor in the global economy is highly mobile. What do you 
need to be in business around the world? Four things: a 
telephone, a modem, a fax machine, and a brain. It is one thing 
to rely on an income tax when people work in factories and 
taxes are deducted monthly. But the income tax was an 
Industrial Age solution meant for Industrial Age employers and 
family structure.
    It will be much more difficult to rely on an income tax 
when entrepreneurs are multiplying by the millions. Compliance 
costs are already too high. They will get worse as the society 
evolves. Not only will it be necessary to enlarge the Internal 
Revenue Service as people find more and more ways to create 
wealth, but the IRS will become more intrusive and its 
procedures more subject to abuse than at present as it 
struggles to trace income. In a one-family-one-paycheck 
economy, compliance verification is minimal. But that scenario 
is disappearing.
    On the other hand, with a national sales tax there would be 
no need for the government to know the amount of a person's 
income. For purposes of taxation, it would be irrelevant.
    And what of tax deductions and credits granted employers 
under the present system for their employees' fringe benefits? 
Congress spends a lot of time proposing legislation such as the 
$500 per child tax credit in an effort to make the current 
system fair. The decentralizing workplace will exacerbate the 
problems arising from the tax system's current bias toward 
working for an employer. By contrast, either a flat tax or a 
national sales tax would remove these problems, although the 
sales tax would be preferable.
    Capital, too, is less likely to be fixed. On the electronic 
highway, it can instantly go where it is wanted, and stay where 
it is well treated. As information and knowledge are forged 
into capital, the world is connected by blips on the computer 
screen that race across countries and continents in 
microseconds. The dollar amounts we are talking about are huge; 
sometimes a hundred times larger than current world trade flows 
on an annual basis. How does government track transactions that 
get more complicated and cross many national lines?

                     Adjusting to a Global Economy

    The world can no longer be understood as a collection of 
national economies. Electronic infrastructure is creating a 
world-wide economy. Products have value added all over the 
world. The dress you buy in St. Louis may have originated with 
cloth woven in Korea, finished in Taiwan and cut and sewn in 
India. Then, there was the brief stop in Milan to pick up its 
Made in Italy label before the final journey to a store in St. 
Louis.
    The principles of freedom, private property and the free 
market coupled with an intellectual system driven by knowledge 
and technology will render obsolete the old paradigm of 
extraction and central control by governments and business. The 
growing global economy enhances the importance of economic 
trade while reducing the influence of politics and control. How 
easy it is to walk through a customs checkpoint declaring 
``nothing'' when a billion dollar software package resides in 
your head.
    In the new paradigm, the means of production in capitalism 
are not chiefly land, labor, and machines which traditionally 
have been regulated, controlled, and taxed by government, but 
rather emancipated human intelligence. Under capitalism, the 
mind-generated production system, the driving force of growth 
is innovation and discovery. Governments must let go of their 
paternalistic control over people. So must corporations. The 
antiquated income tax must give way to the consumption tax just 
as corporate hierarchies yield to flat, horizontal management 
controls.
    A consumption tax can maximize market efficiencies, broaden 
the tax base, encourage growth, savings and investment and thus 
promote the economic growth needed to meet the needs of our 
social and economic system. It is the only type of tax that can 
meet the needs of workers, whether self-employed or working for 
an employer, and families in an Information Age.
    But American workers and families cannot go forward with an 
Industrial Age behemoth like the Internal Revenue Service 
grasping at them to hold them back. We need a tax system as 
innovative and creative as the American worker. A national 
sales tax can meet that need.
      

                                

    Chairman Archer. Thank you, Dr. Asmus.
    Our next witness is Dr. Sullivan.

    STATEMENT OF MARTIN A. SULLIVAN, Ph.D., ECONOMIST, TAX 
                 ANALYSTS, ARLINGTON, VIRGINIA

    Mr. Sullivan. Good morning, Mr. Chairman, and Members of 
the Committee. My name is Martin Sullivan. I'm a tax economist. 
In the past, I've worked at the Treasury Department, at the 
Joint Committee on Taxation, and as a consultant in the private 
sector.
    Now I work as an economist for Tax Analysts, a nonprofit 
organization in Arlington, Virginia.
    It's truly an honor for me to be here today before the Ways 
and Means Committee, and I'll try my best to make useful 
comments.
    Let me say at the outset that I firmly believe that the 
U.S. tax system needs reform. Americans should not have an 
anxiety attack every time they do their taxes. And the Tax Code 
should not be a repository of dozens and dozens and dozens of 
tax breaks, for everything from historical structures to sewage 
treatment facilities.
    Mr. Armey's proposed flat tax is a very intriguing piece of 
legislation. It certainly does simplify the tax system. All my 
friends downtown who practice corporate tax law and 
international tax law and pension tax law would be out of 
business if the flat tax were enacted.
    But on the other hand, the proponents of the flat tax 
overplay their hand when they say the tax system would not just 
be simpler, but simple, under a flat tax. Under the flat tax 
you would still have hundreds of millions of tax forms. You'd 
still have complex Tax Court cases. You'd still have an 
intrusive IRS, and you'd still have tax lobbyists.
    Mr. Armey's flat tax eliminates every--let me say it 
again--every single tax loophole in the Code. No more 
deductions, except for business expenses, and no more tax 
credits. For this, I think, the Majority Leader needs to be 
commended.
    I mean, who would have ever thought 10 years ago that the 
Majority Leader of the House of Representatives would be taking 
the lead on repealing the mortgage interest deduction. I think 
it's extraordinary, and he deserves a lot of credit.
    Finally, the flat tax, with its $22,000 standard deduction 
for married couples, and its $5,000 of additional deductions 
for each child, does, indeed, provide a lot of tax relief for 
middle-income families.
    So let's review what we've got here. We've got tax 
simplification. We've got loophole closing, and we've got big 
tax relief for middle class families. So why don't we go ahead 
right away and enact this middle class flat tax cut?
    Well, there's one little problem. The plan doesn't hold 
together. From both an economic and a political point of view, 
it's not credible. Like my grandmother once told me, if it's 
too good to be true, then it probably is.
    The flat tax simply isn't as good as its proponents make it 
out to be, and let me explain why.
    The first big problem with the flat tax is the 17-percent 
rate. This rate is way too low for revenue neutrality. The 
Treasury says the rate has to be closer to 21 percent. I know 
some people don't trust the political motives of the Treasury 
Department, but I think this number is a very solid number, and 
I think Mr. Armey said it himself a few minutes ago when he 
said at 20 percent his proposal falls $30 billion short. So 
that means 21 percent is a revenue neutral flat tax.
    But I think 21 percent is too low realistically, and let me 
explain why. The Armey bill doesn't have any transition relief. 
If you don't have transition relief, many businesses will be 
unfairly saddled with retroactive tax increases.
    I think in the end there will be transition relief for any 
bill that gets through this Committee. Unfortunately, 
transition relief is extremely expensive, and that would add at 
least 2 percentage points to the flat tax.
    Finally, the third problem with Mr. Armey's flat tax is its 
repeal of the earned income tax credit. Does anybody for a 
moment really think that this Committee is going to pass a 
major tax reform bill with massive cuts in benefits for the 
poor?
    If I were advising my clients, I'd say that's absolutely 
unrealistic. I think you have to add another percentage point 
to the flat tax rate when you take into account that the EITC 
or something exactly like it is going to be enacted into law.
    Now, when you put this all together, you get a revenue 
neutral flat tax rate of 24 percent, and I haven't even talked 
about mortgage interest deduction, or charitable deduction, or 
deduction for payroll taxes.
    Now, I know a lot of the proponents of the flat tax are 
going to say well economic growth is going to take care of all 
these problems. I do think the flat tax will help economic 
growth, but it's all orders of magnitude we're talking about 
here.
    I think if you do a survey, the best you're going to get is 
2 or 3 or 4 or 5 percent economic growth after 10 years from 
this flat tax. What does that mean in terms of the revenue 
neutral tax rate? It means 1 percentage point higher.
    So that means you take that 24 percent, you could bring it 
down to 23 percent maybe. And when you put all that together, 
and then you start doing the calculations, you're going to find 
that not everybody gets a tax cut under the flat tax. Namely, 
businesses are going to pay more--a lot more-- under the flat 
tax. And single individuals are going to pay a lot more under 
the flat tax.
    For example, under a 23-percent flat tax, the not so 
uncommon case of a single worker earning $30,000 would pay 25 
percent more in taxes. This would be a little hard to swallow, 
considering the fact that many wealthy people would receive 
enormous tax cuts under the flat tax.
    Under the flat tax it would not be uncommon for wealthy 
individuals to have their taxes cut in half. Under the flat tax 
in many cases, millionaires would pay no tax at all.
    If Congress wishes to provide tax relief for middle income 
families, it does not have to radically restructure the tax 
system. It could simply raise the standard deduction, or as now 
being actively negotiated, a $500 child credit could be added 
to the Code.
    Finally, I would be remiss if at this hearing I did not 
mention that the flat tax would repeal many family friendly 
features of the current Tax Code. The flat tax would repeal the 
child care credit. It would repeal the adoption credit. It 
would repeal medical savings accounts. It would repeal the 
deduction for extraordinary medical expenses. It would repeal 
the deduction for losses from thefts, fires, floods and other 
disasters.
    Most importantly, the flat tax would eliminate the tax 
benefits for employer-provided health care. This would likely 
result in reduction of health insurance coverage for working 
families.
    This concludes my testimony, and I'm very grateful to the 
Committee for this opportunity to share my views.
    Chairman Archer. Thank you, Mr. Sullivan. Our next witness 
is Mr. Mitchell. Mr. Mitchell, if you would identify yourself 
and proceed.

   STATEMENT OF DANIEL J. MITCHELL, McKENNA SENIOR FELLOW IN 
             POLITICAL ECONOMY, HERITAGE FOUNDATION

    Mr. Mitchell. Mr. Chairman, and Members of the Committee, 
my name is Daniel Mitchell. I serve as McKenna Senior Fellow at 
the Heritage Foundation, and the views I express in this 
testimony are my own and should not be construed as 
representing any official position of the foundation.
    Thank you for holding this hearing and giving me the 
opportunity to discuss why fundamental tax reform will benefit 
individuals and families. In my comments I will be discussing 
the flat tax, but it should be noted that other proposed 
alternatives that tax economic activity only one time at one 
low rate, such as a national sales tax, would have similar 
economic benefits.
    America's tax system is a disgrace. Productive economic 
behavior is severely penalized. Savings and investment are 
subjected to as many as four layers of taxation. Billions of 
hours are required each year to comply with an increasingly 
incomprehensible maze of tax forms, regulations and documents.
    The economic damage imposed by our antigrowth Tax Code is 
staggering, with economic output reduced by hundreds of 
billions of dollars every year. The real cost, however, should 
be measured in terms of lost jobs, foregone income, lower 
living standards, and reduced economic security.
    The problems of the current code are almost too numerous to 
quantify, but they can be lumped into three main categories. 
Number one is excessive marginal tax rates. The Federal income 
tax has a top rate of 39.6 percent, meaning that successful 
entrepreneurs receive barely 60 cents of benefit for every 
dollar they contribute to the Nation's well-being.
    This burden clearly reduces incentives to engage in 
productive behavior leading to lower levels of work, saving, 
investment, risk taking and entrepreneurship. And, of course, 
added on to the Federal income tax are numerous other Federal, 
State and local taxes.
    The second problem is the bias against savings and 
investment. And this is perhaps the most pernicious feature of 
the current Tax Code, in the way that capital income is 
subjected to discriminatory treatment.
    Between the capital gains tax, the corporate income tax, 
the personal income tax and the death tax, the government 
penalizes any returns with as many as four layers of tax. 
Needless to say, this means some income faces effective tax 
rates of 80 percent, 90 percent or more.
    Not only is this policy unfair. It has profoundly adverse 
economic consequences on the economy, since every school of 
thought, even Marxism, agrees that the only way to generate 
higher wages and rising living standards is through savings and 
investment.
    And finally we have complexity. We have 5.4 billion hours 
spent every year on tax returns. This is more than all the man 
hours used in the entire automotive industry in America. The 
Tax Foundation estimates that just the income tax system alone 
imposes $157 billion of compliance costs on the economy. This 
is not the money sent to Washington, DC. It's not the foregone 
economic growth. It is simply the lawyers, the accountants, the 
lobbyists, the tax preparers and the manhours needed to comply 
with the current system.
    Well, the Tax Code today is so fundamentally flawed the 
only realistic solution is to completely scrap it and start all 
over. Fortunately, there is widespread recognition that it does 
need radical reform. Indeed, the two major alternatives, the 
flat tax and the sales tax would solve all three of the 
aforementioned problems.
    Both proposals satisfy the following criteria of a simple, 
fair, progrowth Tax Code, namely that all income should be 
taxed at one low rate, and only one time and the tax should be 
collected in the least intrusive way possible.
    Let me explain that further. Taxing income at one rate. The 
flat tax does tax economic activity at one low rate. Not only 
does this ensure equal treatment under the law; it also 
minimizes tax penalties against productive economic behavior.
    Taxing all income one time: the flat tax eliminates the 
myriad forms of double taxation in the Tax Code. By taxing 
income only one time, tax reform would substantially increase 
savings and investment, which is a prerequisite for economic 
growth.
    And then simplification: by discarding all the special 
provisions in the Tax Code, a flat tax makes the calculation of 
tax liability considerably simpler than it is today. Moreover, 
the level playingfield created by the flat tax means that 
taxpayers no longer have any incentive to time their income and 
deductions in ways that minimize tax liability.
    As a result, business and personal decisions will be guided 
by consumer preference and economic efficiency, rather than tax 
consideration. But while the key principle of the flat tax is 
equality, it turns out that a simple system based on taxing all 
income one time at one low rate will lead to substantially 
faster economic growth.
    This is confirmed by numerous academic studies, and was 
also revealed at a conference of economic forecasters sponsored 
by the Joint Committee on Taxation. And while the estimates 
obviously vary of the additional economic growth, it is worth 
noting that even an increase of just one-half of 1 percent in 
the growth rate would by the tenth year mean $5,000 of 
additional output for an average family of four.
    Faster economic growth is not the only reason why tax 
reform will help families. The substantial reduction in 
compliance costs will mean additional savings for the average 
family. Moreover, if lawmakers decide to combine tax reform 
with tax relief, as almost certainly would have to occur to 
overcome political inspired objections, taxpayers could benefit 
from immediate tax relief.
    A 17-percent flat tax, for instance, would reduce tax 
liabilities by an average of $1,100.
    Thank you very much. I'll be happy to answer any questions.
    [The prepared statement follows:]

Statement of Daniel J. Mitchell, McKenna Senior Fellow in Political 
Economy, The Heritage Foundation

    Mr. Chairman and members of the Committee, my name is 
Daniel Mitchell, and I serve as Mckenna Senior Fellow with the 
Heritage Foundation. The views I express in this testimony are 
my own, and should not be construed as representing any 
official position of The Heritage Foundation. Thank you for 
holding this hearing and giving me the opportunity to discuss 
why fundamental tax reform will benefit individuals and 
families. In my comments, I will be discussing the flat tax, 
but it should be noted that other proposed alternatives that 
tax economic activity only one time at one low rate, such as a 
national sales tax, would have similar economic benefits.
    America's tax system is a disgrace. Productive economic 
behavior is severely penalized. Savings and investment are 
subjected to as many as four layers of taxation. Billions of 
hours are required each year to comply with an increasingly 
incomprehensible maze of tax forms, regulations, and documents. 
The economic damage imposed by our anti-growth tax code is 
staggering, with economic output being reduced by hundreds of 
billions of dollars every year. The real cost, however, should 
be measured in terms of lost jobs, foregone income, lower 
living standards, and reduced economic security.
    The problems of the tax code are almost too numerous to 
quantify, but they can be lumped into three main categories. 
These are:

Excessive marginal tax rates

    The federal income tax has a top rate of 39.6 percent, 
meaning that successful entrepreneurs receive barely 60 cents 
of benefit for every dollar they contribute to the nation's 
economy. This burden clearly reduces incentives to engage in 
productive behavior, leading to lower levels of work, saving, 
investment, risk-taking, and entrepreneurship. Added on top of 
the federal income tax, of course, are numerous other federal, 
state, and local taxes.

Bias against savings and investment

    Perhaps the most pernicious feature of the tax code is the 
way in which capital income is subjected to discriminatory 
treatment. Between the capital gains tax, the corporate income 
tax, the personal income tax, and the estate or death tax, the 
government paralizes any returns with as many as four layers of 
tax. Needless to say, this means some income faces effective 
tax rates of 80 percent, 90 percent, or more. Not only is this 
policy unfair, it has profoundly adverse consequences on the 
economy since all economic theories--even Marxism--agree that 
the only way to generate higher wages and rising living 
standards is through savings and investment.

Complexity

    An IRS-commissioned study several years ago estimated that 
taxpayers spend 5.4 billion hours on their tax returns. That is 
more than all the man-hours used in the entire automative 
industry in America. According to the Tax Foundation, our 
income tax system alone imposes $157 billion of compliance 
costs on the economy. This is not the money sent to Washington. 
Nor is it the amount of foregone economic growth. It is the 
cost of the lawyers, accountants, lobbyists, tax preparers, and 
man-hours needed to comply with the current tax code.
    The tax system today is so fundamentally flawed that the 
only realistic solution is to completely scrap it and start all 
over. Fortunately, there is widespread recognition that the 
current tax system needs radical reform. Indeed, the two major 
alternatives, the flat tax and the sales tax, would solve the 
three aforementioned problems. Both proposals satisfy the 
following criteria of a fair, simple, pro-growth tax code:
    ``All income should be taxed at one low rate and only one 
time, and the tax should be collected in the least intrusive 
way possible.''
     Taxing all income at one rate. The flat tax taxes 
economic activity at one low rate. Not only does this ensure 
equal treatment under the law, it also minimizes tax penalties 
against productive economic behavior.
     Taxing all income one time. The flat tax 
eliminates the myriad forms of double taxation in the tax code. 
By taxing income only one time, tax reform would substantially 
increase savings and investment, which is a prerequisite of 
increased economic growth.
     Simplification. By discarding all the special 
provisions in the tax code, a flat tax makes the calculation of 
tax liability considerably simpler than it is today. Moreover, 
the level playing field created by the flat tax means that 
taxpayers no longer have any incentive to time their income and 
deductions in ways that minimize tax liability. As a result, 
business and personal decisions will be guided by consumer 
preference and economic efficiency rather than tax 
considerations.
    While the key principle of the flat tax is equality, it 
turns out that a simple system based on taxing all income just 
one time at one low rate will lead to substantially faster 
economic growth. Numerous academic studies conclude that tax 
reform would boost economic growth, and a conference of 
economic forecasters sponsored by the Joint Committee on 
Taxation also found strong agreement that shifting to a tax 
system that follows the aforementioned principles will increase 
the economy's output. Estimates of the additional growth, 
needless to say, were varied. It is worth noting, however, than 
even an increase of just one-half of one percent in the growth 
rate would, by the tenth year, mean $5,000 of additional output 
for an average family of four.
    Faster economic growth is not the only reason why tax 
reform will help families and individuals. Any analysis of the 
impact on real people should include the substantial savings in 
compliance costs. The Tax Foundation estimates that sweeping 
tax reform could reduce compliance costs by more than 90 
percent. The bulk of those savings will occur on the business 
side, but that will translate into higher wages, lower prices, 
and greater returns to workers, consumers, and shareholders. 
Moreover, if lawmakers decide to combine tax reform with tax 
relief, as almost certainly would have to occur to overcome 
politically-inspired objections, taxpayers could benefit from 
immediate tax relief. The 17 percent flat tax, for instance, 
would reduce income tax liabilities for individuals by an 
average of more than $1,100. Even at a 20 percent rate, the 
flat tax would provide relief for individuals averaging more 
than $500.
    Finally, although it would be impossible to put a price tag 
on this benefit, fundamental tax reform could have a 
significant effect on the level of distrust and hostility which 
the public feels toward our tax system. The current system is 
riddled with discrimination. Taxpayers are either penalized or 
subsidized on the basis of how they earn their income, how they 
spend their income, or the level of their income. By adopting a 
flat tax, which makes all taxpayers play by the same rules, 
lawmakers could help restore confidence is a system that has 
lost moral legitimacy.
    Thank you and I will be happy to answer any questions.
      

                                

    Chairman Archer. Thank you, Mr. Mitchell.
    Our next and last witness is Mr. Dannenfelser. Please 
identify yourself for the record, sir, and you may proceed.

  STATEMENT OF MARTIN J. DANNENFELSER, JR., ASSISTANT TO THE 
  PRESIDENT FOR GOVERNMENT RELATIONS, FAMILY RESEARCH COUNCIL

    Mr. Dannenfelser. Thank you, Mr. Chairman. My name is 
Martin Dannenfelser. I'm assistant to the president for 
government relations at the Family Research Council. Mr. 
Chairman, and Members of the Committee, I deeply appreciate 
this opportunity to discuss the issue of tax reform with 
particular emphasis on the need to provide relief to working 
American families.
    A brief glance at the Federal tax situation for families in 
the early fifties will illustrate the urgency felt by me and my 
associates at the Family Research Council. At that time, only 
about half of working families were subject to the personal 
income tax. That is, the $600 personal exemption, plus the 
standard deduction were enough to leave the bottom half of 
family incomes at the zero tax level.
    The payroll tax was paid by virtually everyone, as it is 
now, but at much lower levels--under 4 percent, counting the 
employee and employer share combined, for the first part of the 
fifties.
    Today, the median income family is paying around 30 percent 
of their income in taxes, about half of that in income taxes, 
and about half in payroll taxes.
    Should there be any surprise in the light of these figures 
that despite the enormous economic progress of recent decades 
there is so much talk of a middle class squeeze? Even leaving 
aside the relative stagnation in pay growth that began in the 
early seventies, this trend in Federal tax burdens on working 
families would be enough to make families feel squeezed.
    Mr. Chairman, no one is saying that the tax incidence of 
the early fifties is something we can return to now. In 
particular, the families of that era benefited from the nature 
of Social Security's start up as a pay as you go system of 
retirement insurance. The first generation of workers had a 
lighter burden of retirees to support, and therefore lighter 
payroll taxes than would be possible for any subsequent 
generation to enjoy.
    But consider this simple fact: Year after year in most 
countries at most times, workers earn about two thirds of 
national income on a pretax basis. The remainder is earned by 
holders of capital. This latter kind of income comes not in 
wages, but in such forms as corporate profits, rents, interest 
income and capital gains, yet workers who account for roughly 
67 percent of pretax income are currently paying more than 75 
percent of Federal taxes, a share that has been steadily rising 
in recent decades.
    Holders of capital earn one-third of national income, yet 
are paying only one-fourth of Federal taxes. Mr. Chairman, my 
guess is that most Americans are unaware of this trend toward 
higher taxes on workers, and lighter taxes on capital, even 
though they feel the impact of the trend in their take home 
pay.
    There may even be a surprising number of economists who are 
unaware of it. But to the degree that economists are aware of 
it, I believe they tend to think this trend is not such a bad 
thing. They assume that capital as defined in the lead economic 
studies, machines and buildings, is what drives economic 
growth, and that the trend of the tax burden away from physical 
capital and on to working families will help the overall 
economy in the long run more than if the trend were in the 
opposite direction.
    The problem, Mr. Chairman, is that such economists are 
working under an obsolete definition of capital. When capital 
theory was formulated in the 19th century, most workers, the 
bulk of whom were farm laborers, and a minority of whom were in 
factories, had little education. Many if not most were, in 
fact, illiterate.
    In the 19th century, quantum leaps in economic efficiency 
often did not coincide with the invention and use of new types 
of machines. The 20th century, which has featured the rise of 
management and information technologies is very different.
    Today the quantum leaps in economic growth are more often 
associated with the education level of a country's work force. 
A country can lose virtually all of its buildings and machines, 
as Germany and Japan did as a result of Allied bombing in World 
War II, and still regain high rates of economic growth within a 
few short years.
    Why? Germany and Japan lost a much smaller percentage of 
their trained workers in the war than they did of their 
buildings and machines. And in a modern economy, human capital 
is much more important than physical capital.
    One of the greatest economists of the 20th century, the 
late Theodore Schultz, Nobel prize winner, of the University of 
Chicago, recognized the centrality of human capital in modern 
economies in part by studying the postwar German and Japanese 
experiences.
    What is the nature of human capital? Mr. Chairman, we are 
back to the tax treatment of the family. Human capital is 
created by the family. No other institution is so essential to 
the raising of children, and hopefully their development into 
the well-fed, healthy, educated workers of the future.
    Given what modern economics has learned about the roots of 
economic growth, there is no way that the income of working 
families should be taxed more heavily than the owners of 
machines and buildings. Should tax reform proposals considered 
by this Congress put even more of the burden on working 
families than is the case today?
    Given these realities, I would propose several guidelines 
for the Congress to keep in mind as it goes forward with 
changing the Tax Code. One, investment in human capital should 
be treated no better, but also no worse than investment in 
physical capital. Two, just as proper maintenance of machines 
and buildings is a necessary business experience, and thus is 
fully recognized as such by the Tax Code, proper maintenance of 
human capital should also be part of the Tax Code.
    Once basic maintenance has been exempted from taxable 
income, the most economically efficiency tax system is likely 
to involve the widest possible definition of income, and at the 
same time as a result, the lowest possible rate of taxation, 
consistent with current and projected revenues.
    I appreciate the opportunity to share these views, and look 
forward to answering your questions.
    [The prepared statement follows:]

Statement of Martin J. Dannenfelser, Jr., Assistant to the President 
for Government Relations, Family Research Council

    Mr. Chairman, I deeply appreciate this opportunity to 
discuss the issue of tax reform with particular emphasis on the 
need to provide relief to working American families.
    A brief glance at the Federal tax situation for families in 
the early l950s will illustrate the urgency felt by me and by 
my associates at the Family Research Council. At that time, 
only about half of working families were subject to the 
personal income tax; that is, the $600 personal exemption plus 
the standard deduction were enough to leave the bottom half of 
family incomes at the zero tax level. The payroll tax was paid 
by virtually everyone, as it is now, but at much lower levels--
under 4 percent, counting the employee and employer share 
combined, for the first part of the l950s.
    Today, the median family is paying around 30 percent of 
their income in taxes--about half of that in income taxes and 
half in payroll taxes. Should there be any surprise, in the 
light of these figures, that despite the enormous economic 
progress of recent decades, there is so much talk of a middle-
class squeeze? Even leaving aside the relative stagnation in 
pay growth that began in the early l970s, this trend in Federal 
tax burdens on working families would be enough to make 
families feel squeezed.
    Mr. Chairman, no one is saying that the tax incidence of 
the early l950s is something we can return to now. In 
particular, the families of that era benefited from the nature 
of Social Security's startup as a ``pay-as-you-go'' system of 
retirement insurance. The first generation of workers had a 
lighter burden of retirees to support (and therefore lighter 
payroll taxes) than would be possible for any subsequent 
generation to enjoy.
    But consider this simple fact: year after year, in most 
countries at most times, workers earn about two-thirds of 
national income on a pre-tax basis. The remainder is earned by 
holders of capital. This latter kind of income comes not in 
wages, but in such forms as corporate profits, rents, interest 
income, and capital gains.
    Yet workers, who account for roughly 67 percent of pre-tax 
income, are currently paying more than 75 percent of Federal 
taxes, a share that has been steadily rising in recent decades. 
Holders of capital earn one-third of national income, yet are 
paying only one-fourth of Federal taxes.
    Mr. Chairman, my guess is that most Americans are unaware 
of this trend toward higher taxes on workers and lighter taxes 
on capital, even though they feel the impact of the trend in 
their take-home pay. There may even be a surprising number of 
economists who are unaware of it. But to the degree economists 
are aware of it, I believe they tend to think this trend is not 
such a bad thing. They assume that capital as defined in elite 
economics--that is, machines and buildings--is what drives 
economic growth, and that the sub rosa trend of the tax burden 
away from physical capital and onto working families will help 
the overall economy in the long run more than if the trend were 
in the opposite direction.
    The problem, Mr. Chairman, is that such economists are 
working under an obsolete definition of capital. When capital 
theory was formulated in the l9th century, most workers, the 
bulk of whom were farm laborers and a minority of whom were in 
factories, had little education. Many if not most were in fact 
illiterate. In the l9th century, quantum leaps in economic 
efficiency often did coincide with the invention and use of new 
types of machines.
    The 20th century, which has featured the rise of management 
and information technologies, is very different. Today the 
quantum leaps in economic growth are more often associated with 
the education level of a country's work force. A country can 
lose virtually all its buildings and machines--as Germany and 
Japan did as a result of Allied bombing in World War II--and 
still regain high rates of economic growth within a few short 
years. Why? Germany and Japan lost a much smaller percentage of 
their trained workers in the war than they did of their 
buildings and machines. And in a modern economy, human capital 
is much more important than physical capital. One of the 
greatest economists of the 20th century, the late Nobel Prize 
winner Theodore Schultz, of the University of Chicago, 
recognized the centrality of human capital in modern economies, 
in part by studying the post-war German and Japanese 
experiences.
    What is the nature of human capital? Mr. Chairman, we are 
back to the tax treatment of the family. Human capital is 
created by the family. No other institution is so essential to 
the raising of children and, hopefully, their development into 
the well-fed, healthy, educated workers of the future.
    Given what modern economics has learned about the roots of 
economic growth, there is no way that the income of working 
families should be taxed more heavily than the owners of 
machines and buildings. Still less should tax reform proposals 
considered by this Congress put even more of the burden on 
working families than is the case today.
    Given these realities, I would propose several guidelines 
for the Congress to keep in mind as it goes forward with 
changing the tax code:
    l. Investment in human capital should be treated no better, 
but also no worse, than investment in physical capital.
    2. Just as proper maintenance of machines and buildings is 
a necessary business expense, and thus is fully recognized as 
such by the tax code, proper maintenance of human capital 
should also be part of the tax code. This implies a much more 
generous tax exemption or credit for family members than we 
have today.
    3. Once basic maintenance has been exempted from taxable 
income, the most economically efficient tax system is likely to 
involve the widest possible definition of income and, at the 
same time and as a result, the lowest possible rate of taxation 
consistent with current and projected revenue needs.
    Mr. Chairman, a flat rate tax system that is family 
friendly is a tax system that is achievable as a practical 
legislative goal. It also makes the most sense for the future 
not just of American families, but for the productivity of our 
information economy. I sincerely hope the Ways and Means 
Committee and Congress will move in this direction in the 
months ahead.
      

                                

    Chairman Archer. Thank you. I'm particularly grateful that 
each of you stayed within the suggested 5-minute period, which 
is not easy to do. And we'll have an opportunity to elaborate 
on your views during the inquiry period.
    Let me ask each of you, as a basic question, how many of 
you feel that our current tax system is desirable? Raise your 
hands. The clerk should record there are no hands raised.
    So it's simply a question of how do we reform it? And I 
wonder if what we seemed to learn from history is that we never 
seem to learn from history, because we have been trying to 
reform the income tax since its initiation in 1913.
    It seems to me that one of the core problems is that there 
probably are not two of you out there, or two economists in 
this country who can define income in the same way. It is a 
subjective term. Do any of you disagree with that?
    [No response.]
    Chairman Archer. So as long as we have income as the base 
of taxation, will we not forever be going through the exercise 
of defining income? Or do you think we can get around that.
    Mr. Hubbard.
    Mr. Hubbard. No. You have identified a critical point. The 
major source of complexity is that from measuring income, and 
from measuring certain kinds of expenses--depreciation, the 
issue of basis, and international tax provisions.
    You are correct in thinking that a consumption tax would 
considerably simplify matters.
    Chairman Archer. Dr. Sullivan.
    Mr. Sullivan. I would add, I entirely agree with Glenn, but 
there are still issues under a consumption tax that are still 
very thorny, like determining what are proper business 
expenses, home office deduction. Those issues would still be 
out there under a consumption tax.
    But I agree with Glenn.
    Chairman Archer. Well, they would not be there under a 
sales tax.
    Mr. Sullivan. Not under a sales tax.
    Chairman Archer. It depends on how you would implement--
what vehicle you would use to implement a consumption tax.
    Mr. Sullivan. That's correct. But under the flat tax, that 
would be.
    Chairman Archer. And just to further develop this basic 
concept, Dr. Sullivan, you said that the flat tax would be very 
simple for business because it's just a matter of businesses 
taking their business expenses.
    That, as I listen to you, presumes that we could know 
between us what business expenses are. We have seen a Cato 
Institute report where they say they're defining corporate 
welfare. And one of the items that they claim is corporate 
welfare is the business expense of advertising.
    So do we not further get into the problem of defining what 
business expenses are ultimately even under a flat tax?
    Mr. Sullivan. We still have----
    Chairman Archer. I mean, what is a legitimate business 
expense. Obviously it's like beauty. It's in the eye of the 
beholder.
    Mr. Sullivan. Yes.
    Chairman Archer. Clearly because we hear these debates 
going on over and over again today in this country. It 
fascinates me that we now have a recommendation, a proposal 
from the administration to simplify the Tax Code, and to pay 
for that, they want to complicate the foreign source income 
provisions.
    And in their proposals in their budget, where they want to 
do a number of things that are highly desirable politically, 
they add significant additional complications to the Code.
    And so I simply say that there are a lot of basic things 
here, other than just distribution of income, economic 
activity, and so forth, that we should look at that are 
difficult, I know, for economists to be able to quantify and to 
put into their formulations.
    How much is freedom and privacy worth to every individual 
in this country? If I file a flat tax it clearly is simpler 
than the current income tax, and I think it is desirable in 
comparison to the current income tax. But does it not still 
leave the IRS in my life?
    Can they not come back on me and ask me to provide the 
records to support the number on my post card tax return for 7 
years, and to prove the accuracy of that? Are they not still in 
my life, as an individual? And all of you are nodding your 
heads, I think.
    So I say that preliminarily to asking each of you this 
question: How much would each of you individually pay each year 
not to have to deal with the IRS?
    Mr. Dannenfelser, what would it be worth to you as an 
individual, not speaking for your organization, but you as an 
individual?
    Mr. Asmus. In an average year for me, I'd be willing to pay 
$3,000. But on the bad years of the IRS chasing me down, those 
years I'd be willing to pay $10,000 to $20,000.
    Chairman Archer. All right. Mr. Dannenfelser, how much 
would you pay not to have to deal with the IRS every year 
personally?
    Mr. Dannenfelser. My taxes have probably not been as 
complex as some others, and I have a CPA who does them for me, 
so I can factor in his costs. And with some of the other things 
we get from employers, I think there are probably other people 
who have much more complex situations.
    Probably I would be willing to pay somewhere between $500 
and $1,000--that's for my own direct costs. But there are many 
other indirect costs that I'm not seeing probably.
    Chairman Archer. Mr. Mitchell, what about you?
    Mr. Mitchell. Assuming that we're talking about replacing 
the current system with a low rate consumption tax, I'm sure 
I'd be willing to pay several thousand dollars just to reflect 
the tax savings that I would hopefully receive.
    Chairman Archer. Yes. Well, but if it were possible for us 
through structural tax reform to get the IRS completely and 
totally out of your individual life, how much would that be 
worth to you personally?
    Mr. Mitchell. That would probably be worth $1,000, $2,000.
    Chairman Archer. OK.
    Dr. Sullivan.
    Mr. Sullivan. I'd pay $500 a year to get the IRS out of my 
life.
    Chairman Archer. For your tax preparer.
    Mr. Sullivan. Yes.
    Chairman Archer. How many of you does his own tax return? 
And you still pay your tax preparer, Dr. Sullivan?
    Mr. Sullivan. I don't have a tax preparer. I do it all 
myself.
    Chairman Archer. All right. So you don't pay anything to a 
tax preparer. OK. And it's worth $500 to you not to have to do 
that every year?
    Mr. Sullivan. Roughly. Maybe more.
    Chairman Archer. Maybe more. OK.
    Mr. Steuerle.
    Mr. Steuerle. I'd say about the same. About $500, if I can 
avoid all interactions with tax authorities. Although I'm not 
sure that's possible.
    Chairman Archer. Mr. Hubbard.
    Mr. Hubbard. I would likely pay I think several thousand 
dollars because of the wasted time. But if I might, Mr. 
Chairman, I think there are two issues raised by your concern. 
One is the ``hassle factor,'' and the other is the ``anxiety 
factor.''
    I am not anxious about the IRS. Compliance is complicated, 
and filling my tax form out is a pain. But I view that as a 
hassle. I think many people whose tax returns are simpler than 
mine are far more anxious. It is the anxiety about the IRS that 
seems to be the public's great fear, not the number of hours 
that relatively high income taxpayers might spend filling out 
their forms.
    Chairman Archer. And it's really very hard to quantify 
that, isn't it. That is, what is the price of liberty, privacy 
in your individual life? And to each of us, it's a different 
thing.
    I had a middle-income lady from Connecticut who sat in that 
chair where you are, Mr. Hubbard, last year. And I asked this 
question of all the witnesses. And the answers were all similar 
to the ones you gave until it got to her, and she said I would 
give my first born child.
    Needless to say, she had had an untoward experience with 
the IRS. It wasn't just the monetary costs.
    But I do think it's important, as we look at these things, 
that we take into account some of the broader aspects of what 
the tax system does. Then when you get over into the issue of 
economic growth, it seems to me that it doesn't get adequately 
handicapped when you talk about distribution tables.
    But most of you have alluded to the fact that if we had a 
better tax system we could have some degree of economic growth 
in excess of what we have under the current system. Does any 
one of you disagree with that, that we could actually impact on 
our economic growth if we had a different system from the one 
that we have now?
    Mr. Mitchell. I think the evidence is very clear on that. 
The fastest growing economy in the world in the last 50 years 
has been Hong Kong, and they have a 15-percent flat tax rate 
now for the majority of filers. And the fastly growing economy 
coming out of the former Soviet empire is Estonia. They have a 
single rate tax system as well.
    And you look at our own history, when we reduced tax rates 
under Kennedy and under Reagan, the economy grew faster. I have 
a hard time believing that anybody could reject the proposition 
that a better Tax Code would lead to more economic growth.
    Mr. Sullivan. I think the evidence is very unclear on 
whether there's economic growth. I think there's a lot of 
uncertainty. I think the best guesses are that there are some, 
and I think it's worth going for. But I think there's been a 
lot of overblown claims about this is going to solve all of our 
problems.
    We'll get a little bit of growth from a consumption tax, 
and I think we should move in that direction. But I think the 
claims are way overblown, and there is no certainty about it.
    Mr. Asmus. Dale Jorgenson of Harvard University, Mr. 
Chairman, isn't known for his overstatements. In fact, I think 
his testimony before this Committee a year ago were full of 
understatements.
    But he argued that there would be a 10- to 13-percent 
growth in the gross domestic product or GDP. So he would argue 
there's significant growth, massive investment and saving and 
great increase in the labor supply and so on.
    So I think most economists would say that we would have 
significant growth under a national retail sales tax.
    Mr. Hubbard. Mr. Chairman, if I might offer an observation.
    Chairman Archer. Mr. Hubbard.
    Mr. Hubbard. All of the above might be close to correct. 
There is sometimes a confusion between a change in the rate of 
growth and the change in the level of output. In the long run, 
most economists believe output per worker will be higher as a 
consequence of tax reform. That is, there will be a higher 
level of output and a higher level of consumption.
    Over the short term, then, there will be a higher rate of 
growth. Very few economists would say that tax reform would 
permanently increase a growth rate. That's the sense in which I 
think there may be some confusion.
    Still, again, most of the evidence from the profession 
suggests that there would be significantly higher levels of 
output and consumption in response to the kind of tax reforms 
you are considering.
    Mr. Steuerle. One thing economists don't measure very well, 
Mr. Chairman, too, are the gains from simplification. And in my 
own book, I think, some of the gains from simplification are 
far in excess of some of the gains we're claiming we might get 
because of some more elaborate adjustments and incentives of 
the system.
    I think simplification is a major goal.
    Chairman Archer. I'm grateful that you said that, because 
the compliance costs today that are a result of complexity in 
this country are to me just wasted energy. And the great minds 
that are working in trying to cope with this Tax Code if they 
were producing wealth would, I think, create significant 
economic benefit for this country.
    So I'm really glad you threw that in there. I'm also 
disturbed, I must say--and there's not been much discussion 
about it today--about the underground economy, and our 
inability to collect the income tax.
    And I believe that one of you alluded to the electronic age 
and the way things are changing and shifting now. I've been 
told by some experts that the amount of uncollected taxes today 
will jump dramatically in the next century with the advent of 
the smart card and the ability to transfer money electronically 
without trace, which will basically defy the ability of the IRS 
to be able to enforce the income tax in bigger and bigger 
proportions.
    Does any one of you have any concern about that?
    Mr. Dannenfelser. We think that that is something that 
would be desirable. Looking at the consumption tax, of course, 
there would be--some things which would have to be looked at 
because whenever you get into higher excise tax and so on, you 
create the situation of black market economies, which you may 
have to deal with a consumption tax as well.
    But to the extent that this is becoming a more serious 
problem, that is a very reasonable point to look at.
    Our main concern, whether with an income tax or a 
consumption tax is to look at families. And with the issue of a 
consumption tax we feel that you would need to have some means, 
starting with the first dollar or compensating families for 
those expenses.
    With the income tax, of course, you have the personal 
exemption and that sort of thing. There would have to be some 
mechanism built in, some kind of rebate that we would hope 
would take into account the amount--per family member--would 
take into account the family income and the number of family 
members to somehow provide a rebate against what people are 
paying in consumption taxes, just as we would suggest in an 
income tax that you take into account income taxes and payroll 
taxes and provide some deduction in that area.
    Chairman Archer. Yes. Mr. Mitchell.
    Mr. Mitchell. I think we want to be cautious about how much 
money we assume that tax reform will get out of the underground 
economy. Whether you have a flat tax or a sales tax, a drug 
dealer is not going to report his income, nor is he going to 
levy a tax on his sales.
    Likewise, if somebody wants to evade taxes on the Internet, 
whether they earn income that way, or they sell things that 
way, if they want to simply remain anonymous, you're going to 
have great difficulty under either tax reform collecting money 
on people who are either illegal or simply have the ability to 
remain anonymous.
    But that's an argument for at least having a low rate so 
that their incentives to remain illegal or anonymous are lower.
    Chairman Archer. Well, I think it is a sine qua non that 
there will be leakage in any tax system--in any tax system. The 
question is the magnitude of the leakage, and the degree to 
which the American people perceive that that leakage is massive 
unfair or not.
    At least the drug dealer, when they buy a Mercedes is going 
to pay under the consumption tax. And the government, for tax 
collecting purposes, doesn't need to know their records.
    Let me go to other Members for inquiry. Thank you very 
much.
    Mr. Lewis.
    Mr. Lewis. Thank you, Mr. Chairman. Let me thank members of 
the panel for being here. As long as there is a government, 
there will be taxes. As long as there are taxes there will be a 
government agency to collect them. Citizens pay taxes. The IRS 
or some other government agency cannot collect taxes without 
interacting with citizens.
    It is impossible. To say otherwise is to mislead the 
American people. We must not attack the IRS for doing its job. 
Yes, there are problems with the Tax Code. Yes, some IRS 
employees could do a better job. But we must not attack the 
IRS.
    To attack the IRS is to attack ourselves. Fiery rhetoric 
leads to mistrust of the Federal Government, attacks on Federal 
employees, and worse.
    My question to you, members of this panel, is this: under 
any of these proposals, who will collect the taxes and how will 
they do so?
    Mr. Mitchell. I guess I'll start. I agree with you. As long 
as the government is going to take a $1.5 trillion out of the 
economy, they are going to need somebody with a gun as the 
ultimate enforcement vehicle saying give us the money.
    And whether it's one IRS in Washington or 50 different 
States collecting it under a sales tax, we're going to have a 
tax system that is based on the government being able to force 
people to give them the money.
    And I don't really blame the IRS. I blame the tax laws for 
being so complicated that it causes people to mistrust and 
dislike government.
    Mr. Steuerle. Mr. Lewis, I may be the only person in the 
United States that ever wrote a book which I dedicated to the 
IRS. I wrote a book about the IRS, and after interviewing a 
number of employees there, I was very impressed by their 
dedication.
    Having said that, when I examined the IRS, I also concluded 
that they had many more functions put upon them than they could 
possibly fulfill, and that that was perhaps the principal 
reason for their current problems.
    In a couple of columns that I have written, sort of open 
letters to the Restructuring Commission, I have made this same 
point, that if they really want to solve the IRS' problems, 
they've got to get at some of these fundamental issues of how 
much is demanded of the tax system. That is, you can't totally 
separate the issue of tax policy from tax administration.
    Policy has to be made somewhat simpler if we want an IRS 
that is able to administer the system, and provide the advice 
we really think the taxpayers deserve, but we're not willing to 
pay for as a people, because we're not willing to pay the 
agents the money to provide us the advice, and so on.
    Mr. Lewis. Thank you.
    Mr. Dannenfelser. Mr. Lewis, one of the other things I know 
was alluded to here earlier is one of the great frustrations is 
that taxpayers can't get an answer from the IRS that they can 
rely on and point to as being something where they know they're 
in compliance.
    And it's very difficult for a taxpayer to know when they're 
in compliance with the law. And there was a survey that said 
that 78 percent of the questions were answered incorrectly by 
the IRS agents.
    Now, that doesn't mean that the IRS agents should be 
totally to blame, because the system is unrealistic. But there 
needs to be a way to make it simpler so that people can 
understand it, but that also they can go to someone and get a 
clear answer and that they acted in good faith with that clear 
answer by somebody who is accountable, so that they are not 
held liable and penalized for following the advice that the 
government agent gave them.
    And that would do a great deal to restore the confidence of 
the people in the system.
    Mr. Asmus. Mr. Lewis, John Neisbet wrote a famous book 15 
years ago called ``Megatrends.'' And what gave him the idea for 
that book was that if someone would have subscribed to all the 
German newspapers during World War II--about 600 newspapers--
you literally could have predicted what the Nazis were going to 
do in World War II.
    So he said what about the idea then of subscribing to a lot 
of newspapers, bringing together all the ideas, the column 
inches, and see if any ``megatrends'' begin to exist. And so 
that was the genesis of writing that book.
    Before coming to this Committee, I thought it would be fun 
to go on CompuServe and America On Line and pull up all the 
stories I possibly could from all the major newspapers in the 
United States--the Chicago Tribune, the New York Times, and 
right across the country.
    And I've got a stack of articles about 3 feet deep. I think 
what--if the average American taxpayer knew what was happening 
with their fellow taxpayers concerning the IRS, there would be 
even more anger than there is now.
    What we all go through now is we read an occasional article 
in the Wall Street Journal or the New York Times and maybe in 
our local newspaper, and so over the course of a year we will 
read three or four things about the IRS, but when you kind of 
bring all these things together, as Neisbet tried to do as he 
put ``Megatrends'' together, it does shift the debate.
    Again, it's not that these are mean, ornery people. It's 
just that there's no competition. There's no accountability. 
There's no control, and they have enormous power over people's 
lives. And I think, Mr. Lewis, it would make you angry as well 
as it does myself.
    Mr. Lewis. OK. I notice my time has expired, Mr. Chairman. 
Thank you very much.
    Chairman Archer. Thank you, Mr. Lewis. The Chair totally 
empathizes and agrees with the comments you made, Mr. Steuerle. 
And I will say to my friend, Mr. Lewis, I don't believe there's 
been an utterance out of the Chair today bashing the IRS.
    There are abuses in the IRS.
    Mr. Lewis. Mr. Chairman, I didn't mean to imply that you 
had bashed. But I think one of my colleagues said earlier, and 
others have said from this position and on the floor and in 
other places around the country that we should abolish the IRS.
    People have been coming down pretty hard on hard working, 
dedicated Federal employees that work for the IRS.
    Chairman Archer. Well, I do want to abolish the IRS, 
because I want to get the privacy and the freedom of every 
individual back into their lives. And there are abuses in the 
IRS. But the major problem, I believe, is the complexity of the 
Code.
    I've been told that something as simple as head of a 
household, which is a basic part of our code, that determines 
how you are taxed, that if you call the IRS that an agent has 
to ask you 42 questions and get the answers to those before 
they can with certainty tell you that you qualify as head of a 
household.
    Now, that to me makes this code virtually obscene on such 
simple things as that. And so I really don't want to just bash 
the IRS. I want to talk about a code that we have given to them 
that is virtually impossible to administer and that has too 
many gray areas with too much subjectivity where there cannot 
be agreement, where too many taxpayers ending up having to 
negotiate their tax liability with the IRS, and reach a 
settlement.
    We should not have a tax system that puts taxpayers in that 
kind of position, or puts the IRS in that kind of a position.
    Mr. McCrery.
    Mr. McCrery. Thank you, Mr. Chairman. Dr. Sullivan, I want 
to start with you, if I may. You didn't raise your hand when 
the Chairman asked if the present tax system was as good as we 
can do. Basically that's what he asked.
    Mr. Sullivan. Oh, I think we could.
    Mr. McCrery. You think we can do better?
    Mr. Sullivan. We can do better, yes.
    Mr. McCrery. OK. In your testimony you didn't really say 
how we could do better. You just really ragged on the flat tax. 
But give us some positive suggestions. What should we do to 
make the current Tax Code better?
    Mr. Sullivan. I think I pointed out a lot of positive 
aspects of the flat tax.
    Mr. McCrery. You did. But your final analysis was we can't 
do it.
    Mr. Sullivan. Well, no. I'm saying that if we do it, I 
think we have to be realistic about the rate. That we could do 
it with a 23-percent tax rate. As I say, I think we should try 
to keep rates as low as possible. I think we should absolutely 
try to eliminate all types of deductions and credits in the 
Code, so that we can have a fairer and simpler tax system.
    Mr. McCrery. So is the 23-percent flat tax preferable to 
what we have now, in your view?
    Mr. Sullivan. I'm not trying to be cute, but I'll answer it 
in two ways: from an economic point of view, I think it is 
absolutely superior to what we currently have. From a personal 
point of view, or a philosophical point of view, there's a 
question about progressivity of the tax system. Everybody is 
entitled to their own opinion about progressivity.
    I would like to report that the flat tax would be much 
more--much less progressive than current law. If everybody felt 
comfortable with a tax system which was much less progressive 
than current law, and if I felt that way, then I think it would 
be a better system, yes.
    Mr. McCrery. So would your concerns be calmed if we had a 
simple tax system that had three simple rates, with no 
deductions?
    Mr. Sullivan. Right.
    Mr. McCrery. That would be better than a single rate 
system?
    Mr. Sullivan. If one desired to have more progressivity, or 
to retain the current level of progressivity that we now have, 
then yes, I think that would be better than the current system.
    It would be simpler. It would have a broader tax base, with 
a lot less loopholes. And that type of system would have--you 
would try to approximate the progressivity that we have now.
    Mr. McCrery. And how, if the base rate is, say, 15 percent, 
how high would you go?
    Mr. Sullivan. Well, again, that's a matter of personal 
preference on what one desires.
    Mr. McCrery. Have you looked at the numbers, though, given 
your personal bias that we ought to have a more progressive, 
simpler tax system? Have you looked at the numbers to show us 
where we would be in terms of rates to get a revenue neutral 
proposal?
    Mr. Sullivan. First of all, I don't have a personal bias, I 
don't think I've expressed a personal bias in favor of a 
progressive or whatever system, and I haven't looked at the 
numbers. I haven't done those calculations.
    I think it's perfectly legitimate to argue that the current 
tax system should be less regressive. It's a very valid point 
of view. All I am pointing out today is that consumption taxes 
would be less progressive than current law. That's all.
    Mr. McCrery. Thank you. I'm just a lawyer. I'm not an 
economist, and I'm not a tax expert, really. And I am convinced 
that the current Tax Code is a drag on economic activity in 
this country, and certainly is not what we ought to have in the 
next century. And frankly I lean toward the Chairman's idea of 
some sort of consumption tax, but I'm not there yet.
    So let me ask the panel a few questions about the 
consumption tax. And as I say, I'm not really an economist, so 
bear with me.
    I read that a huge percentage of our GDP occurs as a result 
of consumer activity. Consumption. So if we impose a 
consumption tax, wouldn't that dampen consumer activity, at 
least initially, and wouldn't that perhaps bring down our GDP, 
at least initially?
    Where am I wrong in that analysis? Explain that to me.
    Mr. Hubbard. Your question, Mr. McCrery, raises both a 
short-run and a long-run issue. Part of the goal of the 
consumption tax is to raise savings rates, which would 
ultimately lead to a higher capital stock, which would 
ultimately lead to higher wages and higher consumption.
    In your GDP accounting, another component of GDP is 
investment, which would respond very positively to a 
consumption tax. Most economists would argue that in the long 
run--whatever that means, of course--output per worker and 
consumption per worker would be higher as a result of the 
consumption tax.
    Mr. McCrery. Yes. That's what concerns me, is what is the 
long run? How many years does it take for us to get to the long 
run, and what do we do in the meantime?
    Mr. Mitchell. Well, if I could jump in. Even though I'm a 
flat tax fan, I think the sales tax wouldn't really have short 
term consequences in the sense that if you eliminate the income 
tax--and truly can do that, which is my concern with the sales 
tax--don't forget everyone gets a big boost in take home pay by 
the elimination of their withholding and for income taxes.
    And so even though retail prices might rise by whatever the 
tax rate is, you'd have that much higher take-home pay. The 
only short term consequence that I think might be significant 
is everybody might not rush out and buy all their big consumer 
purchases December 31, and then for the first 3, 6 months of a 
sales tax, or whatever that period would be, you might have 
some sort of big, artificial jump up and drop off. But I think 
that would be a relatively short-term phenomenon.
    Mr. Steuerle. There is, Mr. McCrery, a major issue among 
people who get into the technicalities of how you design 
consumption taxes, and that has to do with what one would do 
with existing pension savings, which are on the order of about 
$7 trillion in the economy.
    In fact, one of the fears is that if you immediately go to 
a consumption tax where you no longer favor pension savings, 
that in fact it would lead to a consumption binge by some 
current owners of pensions. And so that's one of the issues. 
It's actually in the opposite direction.
    Mr. McCrery [presiding]. I have a lot more questions, but I 
will allow my colleagues to follow their own line.
    Mr. Collins.
    Mr. Collins. Thank you, Mr. Chairman. Mr. Steuerle, you do 
bring up a very interesting and important point there about the 
transition problem with funds that are already in savings.
    We've talked a lot about the consumption tax versus the 
flat tax, but in reality both of them levied would be assessed 
at a flat rate.
    The flat rate on income would have your standard and your 
personal deductions, but then would also tax income on savings. 
Whereas the consumption tax, and a flat rate, would only tax 
those that are expended funds from an income, and the 
difference would be the income tax flat rate would be levied at 
the end of the year, and the consumption would be immediately.
    So that both are a flat tax as they affect the taxpayer. 
And in talking about flat tax and consumption tax, we fail to 
mention anything about payroll tax. Because the payroll tax has 
been one of the most concerned areas due to the fact of how 
much it's increased in recent years, and what it will increase 
or potentially increase for what's out there for potential long 
term liability based on those of us who happen to be born in or 
around or right after World War II and what that's going to do 
to those entitlement programs that address the payroll tax.
    That is a real concern. So that has not been mentioned, but 
I did want to bring that point up.
    Mr. Dannenfelser, you mentioned physical capital versus 
human capital. I'm a firm believer that physical capital also 
creates human capital by encouraging investments in machines 
and buildings that results in jobs of manufacturing or 
construction.
    But my question is this, because it's been mentioned, too, 
by several of you on the child tax credit--should we be looking 
at a child tax credit? Or should we be looking at possible 
increase, both phased in over the next 5 years, in the 
dependent and standard deductions, one versus the other?
    I think both would have substantial reduction in the tax 
liability of families. What are your comments in those areas? 
Child tax credit versus an increase in standard or dependent 
deductions?
    Mr. Dannenfelser. They would have similar effects. We 
believe that in the short run, at least looking at the $500-
per-child tax credit, that the costs associated with raising 
children are such a burden for families right now. And that 
with the increased tax burdens and so on that you've mentioned, 
such as payroll taxes and others, that it is becoming much more 
difficult.
    That is a part of people's wages that are just 
disappearing, and it's not accounted for in some of the other 
calculations. But certainly either one would be a benefit to 
families. But I think our preference in the short run would be 
for the $500-per-child tax credit.
    Mr. Steuerle. Mr. Collins, may I add to that?
    Mr. Collins. Yes.
    Mr. Steuerle. In theory, if all families were the same 
size, I could in theory design a tax system rate structure with 
a credit that was exactly identical to a rate structure that 
had an exemption. I won't go into the details of why, but I 
could literally make them replicate each other exactly.
    But what complicates matters significantly is that we also 
have a lot of welfare transfer systems, earned income credits 
out there. The existence of these systems, all of which in some 
sense you might think of as credit based, there's kind of a 
basis of support that phases out, as one's income goes up. This 
leads me to believe that one could get a better integrated 
system by thinking about a child credit as a mechanism.
    So that when one moved out of welfare, or never went on 
welfare in the first place, one had something like a child 
credit that went with one's family. If you do that, I think you 
can not only reduce some of these large work disincentives in 
welfare, you can also reduce where the really largest marriage 
penalties are, for low income people who marry. I mean, 
tremendous marriage penalties. They lose 30 percent of their 
income in some cases just because they marry.
    If you start going toward a child credit that is available 
that kind of goes with the child, independently of marital 
status, you can get at some of these problems. And it's for 
those reasons, primarily, that I tend to favor a child credit 
as opposed to a dependent exemption.
    But I say in theory, the pure tax system without welfare 
transfers or anything else, you could design systems that would 
be roughly approximately the same.
    Mr. Collins. Another difference, too, though would be the 
credit again is issued at the end of the year, where if you had 
an increase in the standard deduction or dependent deduction, 
that could be on a weekly or biweekly or monthly payroll.
    Mr. Steuerle. I think you could effect both of them with 
withholding, I think.
    Mr. Collins. I have one other question. We're down to short 
rows. May I ask it, Mr. Chairman?
    Mr. McCrery. Sure, Mr. Collins.
    Mr. Collins. The next question, if we should change--and 
I'd like to use a good Southern word, supposing--supposing we 
should change from the current system after making some interim 
changes, like the capital gains and dealing with the death tax 
and the alternative minimum tax and such, what would be your 
suggested date of implementation of that change? 1998, 1999, 
2000, 2001?
    Mr. Mitchell. I assume, just on the basis of avoiding a 
presidential veto, we're not talking about actually doing this 
legislation until 2001. But you all on the other side have 
probably better control of that than I do.
    Mr. Collins. Anyone else have a date they would like to 
throw out? A year? I agree with the 2000's, implementation in 
2001. To take the presidential politics out of it. Any other 
comments?
    Thank you, Mr. Chairman. Thank you all. It's been very 
interesting listening to you.
    Mr. McCrery. Thank you. Mr. Hayworth.
    Mr. Hayworth. Thank you, Mr. Chairman. For the purposes of 
full disclosure I should make mention of preexisting 
association with two of our panelists today. First, Dr. Barry 
Asmus, who I enjoy. He had the great good sense to live in 
Arizona, although I would like to see him move to the Sixth 
District instead of the Fourth District. But his daughter and 
my daughter went to high school together.
    And I also appreciated Dr. Asmus and his unique free market 
perspective, offering a humorous perspective, often when he 
would come to visit the Rotary Club of Phoenix, of which I was 
a member. And to Mr. Mitchell, my sometime broadcast partner, 
on National Empowerment Television.
    I thank you all for coming down today.
    Dr. Asmus, I want to return to a line of questioning that 
my colleague from Louisiana brought up, about a consumption 
tax, most often reflected in a national retail sales tax.
    I apologize, because I was meeting with other Arizonans out 
here, so perhaps this question has been asked before. And, Mr. 
Mitchell talked about it in passing a couple of moments ago.
    And that is the impact, again to use the term, the 
colloquialism of the gentleman from Georgia--suppose. Suppose 
we go to a national consumption tax, reflected in a national 
retail sales tax. You're looking at a one-time increase in 
prices of x amount.
    Now, we have seen comments from retailers saying, no, no, 
no. Let's not do this. It puts too much of a burden on 
retailers and point of sale, and it's very difficult for the 
retailers to do this, they maintain, or it adds another burden 
on them.
    I'm curious about the temptation factor, I'll call it. 
Let's say that prices have to increase, obviously to pay the 
tax, retail sales tax. Is there temptation for retailers then 
to add in an extra percentage for the amount of work they have 
to do?
    In other words, if we had to see a one time increase in 
prices of 17 percent, does the temptation exist for retailers 
to say, you know, that's worth about 3 percent to us with the 
extra work we have to kick in. Let's just jack up prices to 20 
percent.
    And would that not unintentionally--could that not within 
the realm of possibility unintentionally trigger an 
inflationary spiral? Or would that be--even with the increase, 
that would still be desirable over the system we have today?
    Mr. Asmus. Business and corporations do not pay taxes. 
Individuals do. They're reflected in the higher price of the 
products that people buy. The problem with our system today, 
that it's all hidden taxes, and everybody is not only confused, 
but truly does not know how much tax is represented in the 
price that they pay.
    So as we go to a national retail sales tax, it's clean, 
it's fair, it's above board. We can see it very clearly. Now, 
Dale Jorgenson says that producer prices probably would lower 
by about 20 percent.
    So if we are talking about a national retail sales tax of, 
say, 20 percent, I think this should net out at about the same 
consumer prices as we went in. But what's nice about this 
system that we're talking about today is now the consumer sees 
very clearly the tax portion of that.
    Furthermore, on your question, I do not think, if we're 
going to make retailers not only collect the State sales tax, 
but the Federal sales tax, I think there has got to be a 
remuneration for them providing that service.
    I don't think that it would be fair to have them have to 
bring in a lot more people or whatever it would take to do that 
for nothing.
    Mr. Mitchell. If I could just add to that, Congressmen 
Schaefer and Tauzin, I believe we need to have a one-half 
percent rebate to retailers to reflect the cost of collection.
    Mr. Hayworth. Dr. Asmus, you mentioned Dr. Jorgenson, and 
his estimation of the decrease in the production costs of some 
20 percent. Again, I guess it echoes what my colleague from 
Louisiana talked about, and that is the timeframe involved to 
do this. Those who proposed a flat tax, those who champion a 
consumption tax talk about this transition phase, how do we get 
there from here?
    Dr. Asmus, from your perspective, what should we keep in 
mind in that transition that would help to ease some of the 
problems that might be presented?
    Mr. Asmus. Well, I think the thing that would help ease 
some of the problem is if we're going to continue to stress 
progressivity on the taxing end of it, we've got some really, 
really serious problems here. But if we begin to say let's 
deliver our progressivity on the government expenditure end of 
it, we can begin to mitigate some of those problems.
    So as this discussion heats up and we continue to move into 
it, if progressivity is going to be the bending point, and it 
certainly bothers a lot of people, this is going to be a very 
difficult transition. But if we can say, look, is there a law 
on high, on Mount Sinai, that says that taxes, that we have to 
be as progressive as the current system that we have now?
    And we begin to then do it on the expenditure side, I think 
we can get from point A to point B.
    The point that I was trying to make in my testimony is 
this: that in a global economy and in a contractual economy, 
the question is not if we have to do this. The question is only 
when and how we are going to do this, because tracing income, 
as Chairman Archer has already pointed out, is one difficult 
problem. And it's going to get more complicated with each 
passing month, as we go into the global information economy.
    And so I think it is not going to be long when everybody is 
going to be sitting around this Committee saying, we know we 
have to do it. Now the question is how do we get there. And 
there are some transitional problems without question.
    Mr. Hayworth. Mr. Chairman, I have no further questions. I 
would just simply like to thank the panel for their attendance, 
and I look forward to continuing this discussion and moving 
past words to actions in the years ahead. Thank you very much.
    Mr. McCrery. Thank you, Mr. Hayworth.
    Gentlemen, if you would indulge me for just a couple of 
more minutes. First of all, Dr. Asmus, you said that we could 
infuse our system with progressivity through the spending side 
of government. Would you elaborate on that, please?
    Mr. Asmus. If we're concerned that we have a situation 
where people are too rich and other people are too poor, then 
we obviously have to do some things that would make it more 
pleasant for those that are on the poor side.
    For example, Dick Armey says we're going to make the first 
$33,800 of income exempt from a flat tax.
    Mr. McCrery. That's progressivity in the Tax Code. I'm 
talking about some examples of providing progressivity through 
spending--not tax expenditures, but spending.
    Mr. Asmus. Well, I think we would have to look at corporate 
welfare and say we must and should back away from that. And we 
leave welfare, poor welfare in place.
    Mr. McCrery. That's what I was afraid you were going to 
say. It frightens me to think that we're going to create 
progressivity through the spending side. We've tried that for a 
long, long time, and it hasn't worked very well.
    It infuses our society with all kinds of perverse 
incentives, none of which, I hope, we want to continue. So I 
would like for you to think about that long and hard, and when 
you come back here next time maybe have some more concrete 
examples of what you mean that maybe would allay my fears.
    Mr. Mitchell.
    Mr. Mitchell. Let me just comment that I think that the 
concerns about progressivity are greatly overblown, because 
they rest on--I'm talking the tax side--because they rest on 
the assumption that the economy is a fixed pie, and it's simply 
the job of you, the policy maker, to figure out who gets what 
slice.
    We saw in the twenties when we cut tax rates, the sixties 
when we cut tax rates, and the eighties when we cut tax rates, 
the rich reported more taxable income. Now, whether that was 
income they were hiding or whether that was new income they 
earned, the point is, at the end of these period of tax rate 
reductions, they wound up shouldering a greater share of the 
tax burden.
    And I think if we lose that fundamental understanding, that 
the whole reason we're doing tax reform is because we want the 
pie to get bigger, then it's going to be impossible to do tax 
reform, and that's an issue that has to be taken on directly.
    Mr. McCrery. Well, isn't there an inherent progressivity in 
a consumption tax?
    Mr. Mitchell. Well, that also depends on whether you're 
talking about just proportional progressivity, where Donald 
Trump makes a million times more than me under a flat tax will 
pay a million times more in taxes. Or are you talking about a 
system where you want him to pay at even higher and higher 
rates, and then you get into all the questions about will he 
simply start hiding or not earning as much income, and thereby 
avoid the payment of tax?
    Mr. McCrery. But in Chairman Archer's national sales tax, 
isn't there inherent progressivity in that system?
    Mr. Mitchell. Are you talking about the universal rebate? 
As far as I understand he doesn't have a bill.
    Mr. McCrery. No. I'm talking about those who consume more, 
pay more.
    Mr. Mitchell. Yes, but it's always measured on the basis of 
what is your total amount of resources you have available 
divided by how much tax you're paying. I think the 
progressivity in a flat tax and sales tax would be identical, 
and I think it would be the right definition of progressivity, 
which is everybody being treated equally under the law.
    Mr. McCrery. You touched on this earlier, gentlemen. What 
about the issue of, the transition from an income tax to a 
consumption tax system--say, the national sales tax for the 
elderly? For those who have saved under the current system, 
paid taxes on their income, saved after tax dollars, and now 
they're at the point where they have no income to speak of, but 
they are consuming.
    Doesn't that present a problem of fairness to the elderly? 
You're nodding yes. No one wants to speak to it.
    Mr. Hubbard. There is no easy answer to your question, Mr. 
McCrery. Transfer payments to the elderly could certainly be 
indexed. In that sense, the elderly would be indemnified.
    Regarding their wealth, the jury is actually out as to what 
the effect on asset prices is of fundamental tax reforms, 
because those reforms also involve forgiving the income tax.
    Imagine that I am a little old lady on Park Avenue, and I 
own stocks. While it is true that depreciation deductions are 
being disallowed in the companies in which I am holding stock, 
there is no more tax on dividends and capital gains.
    So it's not altogether clear that the elderly would be 
significantly worse off.
    Mr. McCrery. That's not what I'm hearing from the elderly.
    Mr. Asmus. And if you could also convince them that there's 
already probably a disproportionate share of transfer of income 
toward the elderly, vis-a-vis Social Security, Medicare, and so 
forth, that then certainly middle aged people and younger 
people could argue that our society is already transferring 
more income to the elderly than, quote unquote, their fair 
share.
    So you take that with his point and maybe this isn't as 
difficult as it might seem.
    Mr. McCrery. That's a good point. That's not easily made, 
but that's a good point.
    Mr. Steuerle. Mr. McCrery, a long time ago, I discovered 
that the only way to have legal change that doesn't create 
winners and losers is to maintain the status quo. And I'm not 
trying to be entirely facetious.
    There's a danger, and even people like myself play this 
game about identifying losers of, say, a proposal I might not 
like. But in fact all proposals, typically if there's a legal 
change, involves some transfer of functions, or some taking 
away of something government does, and it does create some set 
of losers and winners.
    And so despite the fact that we're not sure who all those 
are going to be, you certainly are going to face that issue no 
matter what reform you would undertake.
    Mr. McCrery. I agree, and certainly I want to make it clear 
that I am--I've already said this--I think the current system 
is terrible, and it ought to be junked, literally, thrown into 
the trash can. And we ought to start all over. And there are 
going to be winners and losers. No question about that.
    But in order to move this process forward, we're going to 
have to bluntly face these questions that are being asked by my 
constituents, by various interest groups. You can't just wave a 
wand and make it happen. You have to meet all these political 
objectives to get there.
    So I thought as long as I had such a distinguished panel, I 
would at least broach a few of these and get some ideas.
    Another question, and then I'll let you go. Another concern 
is people who have put much of their savings, their life time 
savings, frankly, into purchasing their own home. And now 
you're going to change the way that you tax not only purchasing 
that home, but the gain that's from the home.
    It presents us with some terribly difficult questions, I 
think, of fairness, generational fairness, and all those 
things.
    But I really want to commend you for excellent testimony. I 
think you have helped establish the case for a new Tax Code. 
And I hope you will be willing to help us figure out a way to 
construct a new Tax Code that is, indeed, fair. Can be defended 
as fair, and also more advantageous for our economy.
     Thank you all.
    [Whereupon, at 12:57 p.m., the hearing was adjourned.]
    [Submissions for the record follow:]

Statement of Steven Cord, President, Center for the Study of Economics

    The Federal Government should tax land values, exactly as 
it has already done in 1798, 1811 and 1861, instead of taxing 
income, sales, estates, gifts or value-added. Why?
     Income, sales, estates, gifts and value-added are 
all desirable, so they should not be penalized by taxes. If 
they are taxed, the government is creating poverty and much 
irksome tax-preparation for American individuals and families.
     If land values are taxed instead, land-sites will 
have to be efficiently used, thereby creating jobs and economic 
growth. If those sites are under-used, then the improvements on 
them will not generate enough income to pay the higher land tax 
as well as a reasonable profit for the improvements, so they 
are likely to be fully used. Here is a tax which actually 
creates not only revenue for the federal government but also 
jobs and economic growth.
     Most Americans will pay less with this land value 
tax, aud so it could generate political support. It is more 
based on ability-to-pay than any current or suggested taxes.
    EVERY study that has been made of the 18 jurisdictions that 
have implemented a tax shift to land values has demonstrated 
that a spurt in new construction has followed the shift. No 
wonder that eight (8) recent American winners of the Nobel 
Prize in economics have endorsed laud value taxation.
    A land value tax should not be confused with taxes on 
workers aud businesses. It differs completely from those 
bummers. It can provide revenue while promoting the economy. 
The more of it, the better.
    But a federal land value tax must be properly implemented. 
This non-profit organization has studied LVT implementation for 
over 40 years and we have been intimately involved in the 18 
jurisdictions mentioned above so that we have hands-on 
experience. If the Committee is interested in learning more 
about this untapped revenue source, it should contact us for 
further information.
    It is not worthwhile to replace a bad tax with a maybe not-
so-bad tax. Be kind to American individuals and families.

Steven Cord testifies here on behalf of the Center for the 
Study of Economics, 2000 Century Plaza (#238), Columbia MD 
21044, (Ph.) 410-740-1177, (Fax) 410-740-3279, (E-mail) 
hgeorge(@ smart.net, (Web) http://www.smart.net/hgeorge.
      

                                

Statement of Hon. Dan Schaefer (R-CO)

    Thank you, Mr. Chairman, for inviting all of us here to 
testify before the Committee. I commend you for holding this 
series of hearings. Comprehensive tax reform is an issue that 
enjoys broad and clear support from citizens across the 
country, and will undoubtedly dominate this nation's agenda in 
the coming years. Your leadership in the tax reform debate is 
critical if we are to move forward on this issue.
    As you know, Congressman Billy Tauzin (R-LA) and I 
introduced legislation in the 104th Congress to close the 
Internal Revenue Service (IRS), eliminate the federal income 
tax and replace it with a National Retail Sales Tax. Today, 
Representative Billy Tauzin and I, joined by Representatives 
Joel Hefley, Charlie Norwood, Sonny Bono, John Linder, Bob 
Stump, Sue Myrick, Ralph Hall, and Roger Wicker, have 
introduced H.R. 2001, the National Retail Sales Tax Act of 
1997.
    The federal income tax system is impossibly complex, overly 
intrusive and economically destructive. Americans will spend 
over five billion hours and at least $200 billion complying 
with the income tax this year alone. That is the equivalent of 
three million Americans working full time just to fill out 
paperwork for the IRS.
    According to Stephen Moore of the CATO Institute, ``The 
average fee for preparation of a tax return is now almost $200. 
IRS data confirm that, in 1992, more than 50 million individual 
returns were done by tax preparers at an average fee of $200. 
Today, 80 percent of those using professional preparers have 
incomes below $50,000 of adjusted gross income. All told, 
Americans spend about $30 billion a year for the services of 
tax accountants and lawyers.'' Mr. Chairman, with all due 
respect to tax accountants and lawyers, those services add 
nothing to our national wealth.
    Tracking all this paperwork requires an IRS five times the 
size of the Federal Bureau of Investigation to watch our every 
financial move. The powerful IRS may search our property and 
records without a court order. When challenged by the IRS, 
Americans are considered guilty until they can prove themselves 
innocent.
    However, the most disturbing aspect of the income tax is 
its bias against hard work, savings and investment. Every 
dollar saved or invested by Americans is taxed at least twice--
lowering savings, driving up interest rates and weakening 
economic growth. As a result, the average family today earns 
15-20 percent less than they would without the biases of the 
income tax code.
    Contrast that to a National Retail Sales Tax, which would 
be easy to understand, visible and conducive to economic 
growth. A National Retail Sales Tax would be similar to the 
sales tax currently imposed by 45 states. Because H.R. 2001 
would eliminate the IRS, the states would collect the 15 
percent national sales tax just as they collect the state tax 
today. Both states and retailers would receive generous 
payments to cover their administrative costs.

So how would the Schaefer-Tauzin National Retail Sales Tax Act of 1997 
                    affect individuals and families?

    To begin, the Schaefer-Tauzin legislation repeals federal 
personal and corporate income taxes, capital gains taxes, 
estate and gift taxes and all non-trust fund dedicated excise 
taxes. For families and individuals, this means no more hidden 
income tax withholding or complicated tax forms to file every 
year. The National Retail Sales Tax Act of 1997 would end the 
multiple taxation of economically productive savings and 
investment by imposing a single 15 percent consumption tax on 
the final retail sale of all goods or services.
    Regardless of whether income is derived from wages, 
dividends, capital gains or any other source, it would not be 
taxed until it is consumed at the retail level. For example, 
the purchase of stock would not be taxed, but the brokerage fee 
would be, since it represents a service. Likewise, the proceeds 
from the sale of a stock would not be taxed as long as that 
money stays invested in the economy. On the other hand, if 
those proceeds were consumed for personal enjoyment, they would 
be taxed.
    Laurence Kotlikoff, a professor of economics at Boston 
University, conducted a study on the economic impact of 
replacing federal income taxes with a national retail sales 
tax. His computer-simulated model evaluated the impact on U.S. 
savings by replacing all federal personal and corporate income 
taxes with a national retail sales tax.
    Professor Kotlikoff's study concluded that a national sales 
tax ``would do away with the differential tax treatment of 
corporate and non-corporate businesses, which distorts business 
decisions; of capital gains and dividends, which affects 
decisions about retaining earnings; and of investment in 
equipment, structures, and inventories. A sales tax would also 
end encouragement of current relative to future consumption, 
the tax exemption for health insurance premiums.''
    Additionally, the study concluded that, in the long-run, a 
shift to a National Retail Sales Tax would raise the stock of 
U.S. capital between 29 and 49 percent and raise living 
standards in the U.S. between 7 and 14 percent. Further, 
Koflikoff found that a National Retail Sales Tax would end the 
work disincentive associated with the current tax structure.
    The Schaefer-Tauzin proposal would encourage savings and 
investment and discourage frivolous consumption. Savings are 
critical to a growing economy because they provide the pool of 
money that can then be used to invest in capital and equipment. 
Stimulated by new investment capital, the economy would respond 
with strong and steady growth. And since greater economic 
expansion and job creation would create a larger tax base, the 
National Retail Sales Tax could raise more revenue than the 
income tax does today.
    Mr. Chairman, I believe the greatest strength of the 
National Retail Sales Tax is that it exposes the hidden tax 
burden on every American. Under the federal income tax, 
personal and corporate income taxes are hidden in each and 
every consumer transaction. First, personal income tax is 
withheld from the consumer's paycheck, requiring every purchase 
to be made in after-tax dollars. The second hit comes at the 
cash register, when the consumer pays the hidden business taxes 
and compliance costs of every business that had a hand in 
producing that good or service.
    To help ensure that a national sales tax is not regressive, 
the Schaefer-Tauzin proposal provides a tax credit to guarantee 
that all workers receive a refund equal to the sales tax rate 
times the poverty level (adjusted for the number of dependents) 
in every paycheck. As a result, every wage earner will earn up 
to the poverty level tax free.
    Further, in an effort to help protect senior citizens 
against any increase in prices that may be caused by a shift to 
the National Retail Sales Tax, the Schaefer-Tauzin legislation 
requires the Social Security Administration to include the 
national sales tax in their benefit formula when determining 
cost-of-living adjustments for Social Security recipients.
    Finally, in the Schaefer-Tauzin legislation, the burden of 
proof lies with the government in any dispute with a taxpayer. 
And since H.R. 2001 closes the IRS, taxpayers will no longer 
have to worry about being intimidated by overzealous IRS 
agents.
    As consensus builds in America that the income tax should 
be reformed, it is clear that the National Retail Sales Tax 
would provide the greatest benefit to American taxpayers. 
Again, I want to thank the Chairman for holding these hearings 
and for his leadership in this most critical of debates.
      

                                

Statement of Hon. W.J. ``Billy'' Tauzin (R-LA)

    Mr. Chairman, it is my honor to address the Committee on 
the benefits of a national retail sales tax, and its impact on 
individuals and families. Today, Congressman Dan Schaefer (R-
CO) and I introduced the National Retail Sales Tax Act of 1997. 
In the 104th Congress we received overwhelming support from 
citizens across the country and are dedicated to pursuing this 
endeavor in the 105th. I look forward to working with you and 
the members of the Committee to overhaul our current system and 
lift the burden of the income tax from the shoulders of all 
Americans.
    Mr. Chairman, all taxes reduce our ability to consume and 
are really ``consumption taxes.'' Everyone I know intends to 
consume all the money they make, now or in the future. Some of 
us want to defer the consumption until we retire or until our 
kids are ready to go to college. Others want to consume a part 
of their earnings by donating it to a church or other 
organization. Others just use their earnings to consume today. 
However, anything we decide to do with the money we earn is 
consumption.
    Now, anytime government taxes away part of my money, it is 
reducing my ability to consume. Therefore, a 15% tax withheld 
from my income at 15% reduces the money I have with which to 
consume goods and services. For example, to purchase a $10 item 
of clothing with an income tax of 15%, I would actually have to 
make $11.80, pay 15% of this amount or $1.80 of income tax, and 
then use the remaining $10.00 to purchase the clothing.
    With a 15% national retail sales tax, I would have to earn 
$11.50 in order to pay the $1.50 in national retail sales tax 
and net the $10.00 needed to buy the article of clothing. In 
the case of an income tax or of a national retail sales tax, 
the taxes reduce my ability to consume because I have fewer 
dollars to use for consumption.
    My question to the committee is this, if all taxes are 
really consumption taxes, shouldn't we replace the present 
failed income tax system with a national retail sales tax that 
accomplishes the following:
    1. Frees individuals from filing any type of federal tax 
returns;
    2. Requires only simple returns from retail businesses;
    3. Abolishes the IRS and tears the income tax out by the 
roots;
    4. Increases our competitiveness in the world economy;
    5. Ensures that the members of the underground economy pay 
their share;
    6. Eliminates the taxes on production, investment and 
savings;
    7. Requires illegal immigrants and importers to pay taxes 
in the U.S;
    8. Empowers all Americans by giving them the choice as to 
how much tax they pay.

   How would the Schaefer-Tauzin Retail Sales Tax Act of 1997 affect 
                       individuals and families?

    First, the Schaefer-Tauzin bill frees individuals from 
filing any type of federal tax returns. In 1994, there were 
107,291,000 individual income tax returns filed. 107,291,000 
Americans were forced to spend in excess of 2 billion hours 
trying to calculate the amount of income taxes owed to the 
federal government. This is absurd.
    The national retail sales tax requires no federal 
individual tax returns of any kind. Individual Americans will 
pay their taxes when they make purchases of retail goods and 
services. No receipts, no tax returns, no audits, no hassle.
    Our legislation eliminates the taxes on work, investment 
and savings. Legislators understand that taxing something will 
produce less of it. By eliminating the income tax which 
penalizes work, investment and savings, we will get more work, 
investment and savings. Dr. Lawrence Kotlikoff and Dr. John 
Qualls both conducted detailed studies about the impact of 
replacing the present income tax with the national retail sales 
tax. They both found that the national retail sales tax causes 
the private savings rate (both personal and business savings) 
to rise substantially and produces faster economic growth and 
higher productivity. In both studies, the higher level of 
capital stock created under the national retail sales tax 
results in more job creation. More earnings by employees in the 
private sector fuels more consumer spending. Consumer spending 
thus rises from its current level, but actually declines as a 
percentage of GNP.
    There will also be what some economists call the ``sponge 
effect.'' The U.S. is the world's largest market and has the 
best infrastructure of any country on earth. When the income 
tax is replaced with the national retail sales tax, it will 
become the world's largest tax haven and a ``sponge'' for 
capital from around the world. According to Martin Armstrong of 
the Princeton Economic Institute, replacing the income tax with 
a national retail sales tax will create an inflow of foreign 
capitol into this country like we have never seen. Mr. 
Armstrong points out that the nearest comparable period in 
modern history was in 1940. Seeking to avoid the ravages of 
World War II, capital flooded into the United States and 
government bond rates were at one percent.
    A conservative estimate is that the adoption of the 
national retail sales tax will lower interest rates between 200 
and 300 basis points. Overnight we will see the debt service on 
our national debt reduced, perhaps enough to bring the budget 
in balance. Our businesses will be more able to purchase 
equipment and rapidly increase productivity. Our citizens will 
be able to refinance their homes and save hundreds of dollars 
per month in interest payments. In short, the United States 
will experience the greatest economic boom in our history which 
will be felt by all Americans.
    Finally, the Schaefer-Tauzin National Retail Sales Tax Act 
of 1997 will empower all Americans by giving them the choice as 
to how much tax they pay. Our present income tax system takes 
our money through withholding before we even receive it. Most 
of us now consider that our wages are really the ``take-home 
pay'' that we get net of all the deductions. Under the present 
system, it doesn't matter if one of us is more frugal than the 
other because we all pay the same amount of tax. In fact, if we 
are more frugal than our neighbor we are actually going to pay 
more and more tax because our earnings on our savings will be 
taxed each year.
    With the national retail sales tax we receive all of the 
money we earn. Our checks are increased by the amount 
previously deducted for federal income tax. With this money in 
hand, we have the power to determine the amount of federal tax 
we pay based on how much we choose to spend. The American 
people, not some bureaucrat lawmaker in Congress, will have the 
power.
    Also because of the way that the present income tax system 
hides the amount of taxes we pay in the price of goods and 
through withholding, I don't think any of us can really tell 
how much tax we are paying to the federal government. By 
eliminating the individual and corporate income tax, the estate 
and gift tax and all non-trust fund excise taxes and replacing 
them with a simple national retail sales tax, all of us will 
see the amount of federal tax we pay each time we make a 
purchase.
    For each of us who really wants to make the government more 
accountable this is a compelling difference between the present 
income tax, the other income tax proposals and the national 
retail sales tax. When our citizens see how much they are 
paying in federal taxes they will demand that we become more 
efficient and deliver better services to them.
    In closing, I believe that we should re-examine the basic 
ideas on which this government was founded. Our Founding 
Fathers insisted on the use of indirect taxes on individuals 
and specifically forbade direct taxes like the income tax. They 
did this because they were students of history and they know 
that every despotic country had one thing in common--direct 
taxation which helped enslave the people. We have an 
opportunity to eliminate the income tax, the IRS, tax returns, 
audits, and the penalties of our work, savings and investments 
and replace them with an indirect national retail sales tax. 
For all individuals and families, we must free America from the 
income tax.
    Mr. Chairman, thank you again for holding these hearings 
and for your leadership on this critical issue.

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