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[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]

 
                    SIMPLIFICATION OF THE TAX SYSTEM

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

                                HEARING

                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                             JUNE 15, 2004

                               __________

                           Serial No. 108-68

                               __________

         Printed for the use of the Committee on Ways and Means

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_________________________________________________________________
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                      COMMITTEE ON WAYS AND MEANS

                   BILL THOMAS, California, Chairman

PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
E. CLAY SHAW, JR., Florida           FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut        ROBERT T. MATSUI, California
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
PHIL ENGLISH, Pennsylvania           LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona               EARL POMEROY, North Dakota
JERRY WELLER, Illinois               MAX SANDLIN, Texas
KENNY C. HULSHOF, Missouri           STEPHANIE TUBBS JONES, Ohio
SCOTT MCINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia

                    Allison H. Giles, Chief of Staff

                  Janice Mays, Minority Chief Counsel

                                 ______

                       SUBCOMMITTEE ON OVERSIGHT

                    AMO HOUGHTON, New York, Chairman

ROB PORTMAN, Ohio                    EARL POMEROY, North Dakota
JERRY WELLER, Illinois               GERALD D. KLECZKA, Wisconsin
SCOTT MCINNIS, Colorado              MICHAEL R. MCNULTY, New York
MARK FOLEY, Florida                  JOHN S. TANNER, Tennessee
SAM JOHNSON, Texas                   MAX SANDLIN, Texas
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia

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 June 8, 2004, announcing the hearing.................     2

                               WITNESSES

Internal Revenue Service, Hon. Don C. Alexander, Commissioner, 
  1973-1977......................................................    31
Internal Revenue Service, Hon. Mortimer M. Caplin, Commissioner, 
  1961-1964......................................................    25
Internal Revenue Service, Hon. Sheldon S. Cohen, Commissioner, 
  1965-1969......................................................    29
Internal Revenue Service, Hon. Fred T. Goldberg, Jr., 
  Commissioner, 1989-1992........................................    34

                                 ______

Fordham University School of Law, Tax Litigation Clinic, 
  Elizabeth Maresca..............................................    12
H&R Block, Premium Tax Services, Jeannette Parshall..............    15
New York City Fire Department, Robert Sweeney....................     8
Rivermine Software, Nina Doherty.................................     9

                       SUBMISSIONS FOR THE RECORD

Coalition for Tax Fairness, Timothy John Carlson, Arlington, VA, 
  statement......................................................    48
Father's Rights Association of New York, Efrain Rodriguez, Jr., 
  Mahopac, NY, statement.........................................    50
Klaassen, David R., Marquette, KS, statement.....................    51
Reform AMT, Alan Veeck, Pittsburgh, PA, statement................    52

                    SIMPLIFICATION OF THE TAX SYSTEM

                              ----------                              

                         TUESDAY, JUNE 15, 2004

             U.S. House of Representatives,
                       Committee on Ways and Means,
                                 Subcommittee on Oversight,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:02 p.m., in 
room 1100, Longworth House Office Building, Hon. Amo Houghton 
(Chairman of the Subcommittee) presiding.
    [The advisory announcing the hearing follows:]

ADVISORY

FROM THE 
COMMITTEE
 ON WAYS 
AND 
MEANS

                       SUBCOMMITTEE ON OVERSIGHT

                                                CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE
June 08, 2004

            Houghton Announces Hearing on Tax Simplification

    Congressman Amo Houghton (R-NY), Chairman, Subcommittee on 
Oversight of the Committee on Ways and Means, today announced that the 
Subcommittee will hold a hearing on the simplification of the tax 
system. The hearing will take place on Tuesday, June 15, in the main 
Committee hearing room, 1100 Longworth House Office Building, beginning 
at 2:00 p.m.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from invited witnesses only. 
Witnesses will include individual taxpayers and a panel of former 
commissioners of the Internal Revenue Service (IRS).
      

BACKGROUND:

      
    On April 2, 2004, Chairman Houghton introduced nine legislative 
proposals to simplify the U.S. Tax Code. The Houghton package of 
simplification bills highlights areas of the Internal Revenue Code that 
can be simplified to make it easier for people to complete their tax 
returns. Committee Member Rob Portman (R-OH) introduced a comprehensive 
tax simplification bill in the 107th Congress, the ``Tax Simplification 
Act of 2002'' (H.R. 5166).
      
    The Houghton simplification package includes bills that would 
repeal the Alternative Minimum Tax (AMT), reducing the number of AMT 
taxpayers by 114 million, and saving approximately 463 million hours of 
tax return preparation time; establish a uniform definition of a child 
that is based on residence, relationship, and age; and change the term 
``Head of Household'' filing status to ``Single Parent or Guardian'' 
filing status, a term that is less likely to cause a mistake in 
choosing a filing status. Other proposals that would simplify the tax 
laws include: the ``Taxation of Minor Children Simplification Act'' 
(H.R. 4135), the ``Education Tax Credit Simplification Act'' (H.R. 
4136), the ``Small Business Tax Modernization Act'' (H.R. 4137), the 
``Personal Holding Company Tax Repeal Act'' (H.R. 4138), and the 
``State Business Law Tax Conformity Act'' (H.R. 4139). With the 
exception of AMT repeal, all of the foregoing proposals are low-cost or 
revenue-neutral. Chairman Houghton also introduced a House resolution 
to require all future tax bills to contain a simplification title.
      
    In announcing the hearing, Chairman Houghton stated, ``The load 
that we place on taxpayers to understand the tax system is, in a word, 
heavy. Hard working Americans like Bob Sweeney, a New York City 
firefighter, and Robert Klaassen, a Kansas attorney with 13 children, 
are being forced to contend with a tangled, shadow tax system: the 
Alternative Minimum Tax.''
      
    ``Millions of others are unable to navigate the complex series of 
rules which determine eligibility for common tax benefits such as the 
dependency exemption. I hope this hearing and the bills I introduced to 
simplify the tax code will persuade the Congress to take action to 
simplify the code.''
      

FOCUS OF THE HEARING:

      
    The hearing will focus on simplification of the current tax system.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Please Note: Any person(s) and/or organization(s) wishing to submit 
for the hearing record must follow the appropriate link on the hearing 
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June 29, 2004. Finally, please note that due to the change in House 
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encounter technical problems, please call (202) 225-1721.
      

FORMATTING REQUIREMENTS:

      
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noted above.

                                 

    Chairman HOUGHTON. Good afternoon, ladies and gentlemen. We 
are delighted to have you here. Thank you very much to the 
witnesses for being here. I am going to make an opening 
statement, then Mr. Pomeroy will, and then Mr. Portman will. 
So, let me just begin.
    In some ways our tax system represents what one might call 
the pinnacle of our civilization. Spanning 7 million words of 
statute law and interpretive regulation, it is arguably the 
most intricate law of all time. Future archeologists looking 
back might view the Rosetta Stone of the tax law and will 
marvel at its ability to reconcile competing objectives, such 
as the need to treat similarly situated taxpayers in similar 
fashions. Yet, unlike complex and natural systems made by God, 
our tax system does not always work in harmony. In written 
testimony that we are making available today, Professor Joel 
Slemrod estimates that this year individuals will spend $85 
billion to comply with the complex rules that govern our tax 
system. Businesses will spend an additional $40 billion. This 
natural overhead expense is an extraordinary 14-and-a-half 
percent of income tax receipts.
    Many experts have offered recommendations to simplify the 
Tax Code, and they have reached at least one consensus: 
Congress somehow must repeal the Alternative Minimum Tax (AMT). 
If we do not repeal this tax, it will, within in a short period 
of time, swallow the ordinary tax system. This clearly will be 
a disaster. It will double the work necessary to calculate 
income tax for tens of millions of Americans. It will also make 
planning difficult or impossible, and it will shift part of the 
tax burden of this country onto the shoulders of individuals 
like Bob Sweeney, a New York City firefighter; Robert Klaasen, 
a father of 13; and Nina Doherty, a casualty of the high-tech 
economy you will be seeing. We will be hearing from Mr. Sweeney 
and Ms. Doherty today on our first panel. Unfortunately, Mr. 
Klaasen could not be here, but he has provided some written 
testimony.
    Chairman HOUGHTON. Now, Mr. Sweeney fell into the AMT 
because he pays relatively high State taxes because he has 
work-related expenses that the AMT treats as suspect. Mr. 
Klaasen pays AMT because of his large family and high medical 
expenses. Ms. Doherty faces AMT because she was restricted from 
selling the stock of a small company that later went bankrupt, 
as sometimes small companies do.
    Another area of agreement among experts is that the 
definition of a qualifying child should be made uniform. The 
inconsistent rules, millions of Americans face a difficult 
challenge to determine whether their care of a child makes them 
eligible for tax benefits or not. As Professor Elizabeth 
Maresca will testify, they often get it wrong, and these 
mistakes can have severe consequences. Congress can and should 
make the definition of a child uniform. That should not be too 
difficult.
    In addition to our individual witnesses, we are honored to 
have testify four former Commissioners of the Internal Revenue 
Service (IRS), very distinguished citizens of this country. 
Collectively their experience spans the Administrations of five 
Presidents, and they have more detailed knowledge of the tax 
system, I must assume, and its functioning than any other group 
that I know of. I look forward to their testimony in how to 
simplify the Tax Code.
    In April of this year, we introduced a comprehensive 
package of 10 pieces of legislation that would substantially 
simplify the Tax Code for virtually every individual and small 
business. Subcommittee Member Rob Portman, seated to my right, 
also has introduced legislation that would repeal the AMT and 
make the definition of a child more uniform. Ranking Member 
Pomeroy, who is here on my left, shares my interest as well, 
and I hope to work with them closely.
    Our tax system isn't perfect, but that always is a given. 
We should not let the academic pursuit of a perfect system that 
may never exist blind us to the work that we can do now, right 
now, to improve life for ordinary taxpayers. So, our witnesses 
today remind us of the importance of that objective.
    Chairman HOUGHTON. I am now pleased to yield to the Ranking 
Democrat Mr. Pomeroy.
    Mr. POMEROY. I want to thank the Chairman and congratulate 
him on convening this hearing and assembling this outstanding 
list of witnesses. I suppose that Congress in Presidential 
election years is not known for the pursuit of good governance 
necessarily, and I don't mean to heap that burden on one party 
or the other; I just think that it gets to be extraordinarily 
political around here, and we lose our way a little bit in 
terms of what good governance really ought to hold us to.
    Well, tax simplification is pure good governance, and it 
hasn't had a more worthy champion over the years than Chairman, 
Amo Houghton. So, it would sure be wonderful in your remaining 
months in Congress if we could pass the ``Houghton Memorial Tax 
Simplification Straighten It Up Act.'' Count me in. There is a 
lot that we can do both big and small, and the fact that we 
can't perhaps in one fell swoop fix everything should not 
detract us from at least identifying glaring issues and 
beginning our work on them. I am very pleased to work with my 
colleague Representative Rob Portman in that regard as well.
    One of the issues that will come under discussion today, 
perhaps one of the most expensive, difficult issues that we 
will be encountering, is the AMT issue. My friend and colleague 
from Springfield, Massachusetts, Richard Neal, has been the 
leader in early identification of this as an emerging problem; 
he saw it before many of us did in terms of something that we 
are going to have to deal with, and he has led the effort to 
date. So, his participation in the course of our discussion 
today is going to be very valuable. With that, Mr. Chairman, I 
would just conclude by saying you once again have led the way 
in terms of something that the Committee on Ways and Means has 
got to get real serious about. If we don't provide the 
leadership, nobody is going to provide the leadership in terms 
of building a Tax Code that basically is a sustaining revenue 
basis for this country. Thank you for holding this hearing. I 
yield back.
    Chairman HOUGHTON. Well, thank you. I would just like to 
add something here. This is sort of a personal feeling, that 
ever since I was on this Committee with Jake Pickle, I think 
this has been the most bipartisan Subcommittee I have known. We 
have always worked that way, and we have always worked our 
differences out. I think it is productive not only for us in 
Congress, but also, I think, for the witnesses. So, what I 
would like to do is to turn to Mr. Portman for an opening 
statement.
    Mr. PORTMAN. Thank you, Mr. Chairman. I hate to start on a 
discordant note after that comment, but I must say as an 
anthropology major, I find your comparison of the Tax Code to 
the Rosetta Stone as an insult to the stone.
    Thank you for having this hearing. Mr. Pomeroy, thank you 
for your comments; Mr. Neal for your contributions over the 
years on the AMT. This is an incredible issue. I think, in all 
seriousness, the Chairman is right, our Tax Code in many 
respects does represent who we are. It is our attempt to 
balance all these competing interests, and I think we have 
failed in that. I think we have created such a complex Tax Code 
that it has a negative impact on our economy and a frustrating 
impact on our service and on our taxpayers.
    You have been in the trenches on this over the years, Mr. 
Chairman. I appreciate the work you have done on it. I think 
you should take some comfort in the fact that we are making 
some progress. Last night in this very Committee room we passed 
out of this Committee legislation to simplify the International 
Tax Code in some significant ways, not as far as many of us 
would like to go, but there are some significant 
simplifications that you had been promoting for years that are 
included, including the foreign tax credit market baskets, and 
the interest allocation rules that will help make it a little 
bit easier to work through some of our tax complexities. As you 
have mentioned, I have also introduced legislation in this 
area. Many of the provisions that I have introduced have been 
included in your legislations, your bills, as well, Mr. 
Chairman. I think one reason both of us have pushed for 
simplification is because of its impact on the system.
    We are going to hear from taxpayers today. I look forward 
to it. The taxpayer frustration I hope everybody understands 
and is obvious, but sometimes less obvious is its impact on the 
IRS itself. Maybe that doesn't motivate people to push for 
simplification, but it does me, because our tax system itself 
is under such incredible stress because of complexity. The IRS 
has a lot of problems, but a huge one is complexity. We are 
going to hear from four former Commissioners today, at least I 
see four here with us, and I look forward to talking to them 
about that. They have all been through it for years. As Co-
Chairman of the National Commission on Restructuring the IRS, 
we were not supposed to look at simplification, but we did, 
simply because as we began to peel back the layers of the onion 
and get into the myriad of problems that the IRS was then 
experiencing, one clearly was its inability to administer the 
enormous complexity that we in the Congress have put upon it 
through our Tax Code.
    So, there are lots of reasons to push for tax reform and 
tax simplification. One is there is a decreased level of 
voluntary compliance with more complexity. I firmly believe 
that from my own experience with my constituents. One of them 
called me once and said, Congressman, I would like to pay my 
taxes, but I just can't figure it out. I won't give you his 
name, nor did he give me his name, but this happens in all of 
our offices, I am sure. People just get so frustrated, they 
literally cannot figure it out. I'd like to touch on increased 
compliance costs. You talked earlier, Mr. Chairman, about the 
University of Michigan studies which are very disturbing in 
terms of the amount of time, effort, and money put into our tax 
compliance system.
    Reduced perception of fairness in the Federal tax system. 
Being so complex, there is a concern about fairness, and I 
believe that this contributes to this lack of voluntary 
compliance. Finally, as I said before, the increased 
difficulties with the administration of tax laws themselves is 
problematic. Of course, there is the frustration of taxpayers. 
So, I thank you very much, Mr. Chairman, for holding this 
hearing, and look forward to the testimony from our witnesses 
and look forward to taking that testimony and trying to put 
forward some legislation. As the Chairman said earlier, this is 
the art of the possible here in Congress, but at least it moves 
us toward simplification. I do think the bill last night is a 
small step in the right direction, at least on the 
international corporate provisions. Thank you, Mr. Chairman.
    Chairman HOUGHTON. Thank you very much, Mr. Portman. Mr. 
Neal, would you like to make a statement?
    Mr. NEAL. Thank you, Mr. Chairman. Just a note. I think 
that you are absolutely right when you say that this has been 
the most bipartisan Subcommittee, and indeed you have been one 
of the most bipartisan Members of Congress. The sad commentary 
on all of this is that year after year there are fewer people 
like you. We have been talking here about AMT for a long time. 
We have talked about simplifying the Tax Code. I think that 
simplification ought to be the middle ground in this 
institution. It is something that can be done. On the AMT, I 
will just let the witnesses know that I have been at this for a 
long period of time. I have never been involved in an issue of 
my public career of 31 years where more people patted me on the 
back, thanked me, said, great job, and did less about it. It is 
because of the financial realities and what ideology now does 
in this institution, the intransigence that develops. I think 
that this is a problem that gets worse year after year after 
year, and trying to bring it up has been most difficult. I will 
tell you, as it relates to stock options, an awful lot of fine 
people as well as those with a certain number of children are 
really being hurt by AMT, and this institution can do something 
about it if it only had the will. Thank you.
    Chairman HOUGHTON. Thank you very much. Mr. Johnson, would 
you like to make an opening statement of any kind? All right. 
Thank you very much.
    Let us go to our first panel. We have Robert Sweeney of the 
New York City Fire Department of Douglaston--that is in the 
Queens. Nina Doherty, Sales Engineer at Rivermine Software; and 
Elizabeth Maresca, Associate Clinical Professor at Fordham 
University School of Law, and Supervising Attorney, Tax 
Litigation Clinic; and Jeannette Parshall, director of Premium 
Tax Services at H&R Block's office in Wheaton, Maryland. So, we 
will start with you, Mr. Sweeney.
    Mr. POMEROY. Mr. Chairman, if I might, just at the outset, 
Mr. Sweeney and Ms. Maresca are from New York City. Our Ranking 
Member Charlie Rangel had hoped to be here to greet you and 
introduce you as you testify. He is otherwise detained in light 
of his schedule. He has asked me to give you a special welcome 
to this Committee. We are very pleased you could take the time 
to testify. Thank you, Mr. Chairman.
    Chairman HOUGHTON. I thought you were going to say they 
were from North Dakota originally.
    Mr. POMEROY. You are welcome any time.
    Chairman HOUGHTON. Well, anyway. Go ahead, Mr. Sweeney. 
Thank you, Mr. Pomeroy.

           STATEMENT OF ROBERT SWEENEY, NEW YORK CITY

             FIRE DEPARTMENT, DOUGLASTON, NEW YORK

    Mr. SWEENEY. Good afternoon, Chairman Houghton, Ranking 
Member Pomeroy, and Members of the Committee. My name is Robert 
Sweeney. I am a New York fireman. I work for the New York City 
Fire Department, and as Assistant Chief I have supervisory 
responsibility for all the firehouses in the borough of Queens. 
We would like you to know that the New York City firefighters 
appreciate the support of Congress. However, I am here today to 
discuss what may be unintended consequences of the AMT. My tax 
accountant Dr. William Stevenson asked me to accept your 
invitation to come before you and explain how the AMT has 
affected my family in the negative way.
    It is my understanding that the AMT negatively affects 
large numbers of middle-class taxpayers like me who earn less 
than $150,000 per year, and will in future years affect many 
more millions earning even less. While I cannot explain to you 
how the AMT works, I can tell you how it affects my wife, my 
three children, and me. As I understand it, Congress has 
permitted us firemen to deduct various unreimbursed job-related 
expenses. A firefighter's job-related expenses include things 
like union dues, firehouse taxes, dry cleaning of uniforms, 
educational expenses, and many other out-of-pocket 
expenditures. Last year my unreimbursed expenses were about 
$5,500. My family also had some modest investment fees which 
Congress has made deductible. Not only did we lose all of our 
miscellaneous firefighters' expense deductions and investment 
expense deductions, but we also lost some of our State income 
tax and real estate tax deductions as well.
    My tax accountant tells me for the second year in a row 
that the AMT has taken these lawful deductions from us. We have 
received no tax benefits for the job-related expense deductions 
that were made a matter of law by Congress many years ago. The 
AMT cost my family about $10,000 over the last 2 years. The 
extra tax we have paid has reduced what we could spend for our 
children's education and well-being. I also learned from my tax 
accountant that, when the AMT is calculated, we do not get the 
full benefit of deductions or credits for our children.
    It seems to me that this tax is affecting people who cannot 
afford it. It seems to me that ordinary people should not be 
subject to a tax that they have never heard of, that is too 
complicated to calculate, that is impossible to plan for, and 
that drains their ability to care for their family. It is an 
honor to appear before you today, and I hope in some small way 
I helped you progress and fix the negative consequences of the 
AMT on middle-class families like mine. Thank you.
    [The prepared statement of Mr. Sweeney follows:]
      Statement of Robert Sweeney, New York City Fire Department,
                          Douglaston, New York
    Good afternoon Chairman Houghton, Ranking Member Pomeroy and 
members of the Committee. My name is Robert Sweeney. I am a New York 
Fireman. I work for the New York City Fire Department and as Assistant 
Chief I have supervisory responsibility for all the fire houses in the 
borough of Queens. We would like you to know that New York City 
Firefighters appreciate the support of Congress; however, I am here 
today to discuss what may be unintended consequences of the Alternative 
Minimum Tax.
    My tax accountant, Dr. William Stevenson, who is an enrolled agent, 
asked me to accept your invitation to come before you and explain how 
the Alternative Minimum Tax has affected my family in a negative way. 
It is my understanding that the AMT negatively affects large numbers of 
middle class taxpayers like me who earn less than $150,000 per year and 
will in future years affect many more millions earning even less.
    While I can't explain to you how the Alternative Minimum Tax works, 
I can tell you how it affects my wife, my three children and me. As I 
understand it, Congress has permitted us firemen to deduct various 
unreimbursed job related expenses. A firefighter's job-related expenses 
include things like union dues, professional literature, dry cleaning 
of uniforms, educational expenses and many other out of pocket 
expenditures. Last year my unreimbursed expenses were about $5,500. My 
family also had some modest investment fees which Congress has made 
deductible. Not only did we lose all of our miscellaneous fire 
fighter's expense deductions and investment expense deductions, but we 
also lost some of our state income and real estate tax deductions as 
well.
    My tax accountant tells me, for the second year in a row, that the 
Alternative Minimum Tax has taken these lawful deductions from us. We 
have received no tax benefits for the job related expense deductions 
that were made a matter of law by Congress many years ago. The 
Alternative Minimum Tax cost my family about $10,000 over the last two 
years. The extra tax we have paid has reduced what we could spend for 
our children's education and well being.
    I also learned from my tax accountant, that when the Alternative 
Minimum Tax is calculated, we do not get the full benefit of the 
deductions or credits for our children. It seems to me that this tax is 
affecting people who cannot afford it. It seems to me that ordinary 
people should not be subject to a tax they have never heard of, that is 
too complicated to calculate, that is impossible to plan for and that 
drains their ability to care for their family.
    It is an honor to have appeared before you today and I hope in some 
small way I have helped you progress and fix the negative consequences 
of the Alternative Minimum Tax on middle class families like mine.

                                 

    Chairman HOUGHTON. Thank you very much, Mr. Sweeney. Ms. 
Doherty, please.

STATEMENT OF NINA DOHERTY, SALES ENGINEER, RIVERMINE SOFTWARE, 
                       FAIRFAX, VIRGINIA

    Ms. DOHERTY. Mr. Chairman, Members of the Committee, my 
name is Nina Doherty, and I would first like to thank you for 
the opportunity to speak with you today. I am married, a 
working mother of three, living in a modest northern Virginia 
suburb with my husband of 17 years. Today I work full time for 
a small software company, and I am sharing my story with you in 
the hope that it will shed light on how AMT treatment of 
incentive stock options can have a devastating impact on 
average, hardworking people like me. In 1994, I became the 
first employee of a small startup telecommunications company. 
Part of my compensation included incentive stock options. Seven 
years later I found out to my huge shock that there could be an 
egregious impact from exercising stock options due to 
unintended consequences of the AMT.
    Back in March of 2002, before I learned of the AMT, I 
exercised some stock options, and it appeared that all my hard 
work and sacrifice and working for this startup would pay off. 
My company was going public, as many did at the time, and it 
was everyone's perception that the stock value would remain 
stable or maybe even grow. Unfortunately, shortly thereafter 
the stock market tumbled, and my paper stock value was reduced 
to nothing. Despite the dwindling stock value, I never thought 
to sell my stocks even after my restrictions lapsed in 
September 2000. I continued to hold on to my stock because I 
was told by my financial adviser, before I ever exercised any 
options, that due to the way the law was written with regard to 
capital gains tax penalties, it was more beneficial for me to 
hold on to it for at least a year. In April of 2000, while on a 
Girl Scout trip with one of my daughters, I got a call from my 
accountant about the taxes he had just prepared. He told me 
that because of the AMT, I owed a lot of money, but he didn't 
want to tell me how much until I got back to town. Alarmed, I 
asked him to tell me right there and then, and that is how I 
found out that I owed tax equal to 100 percent of our annual 
family income. I was dumfounded, and, quite frankly, so was my 
accountant. Now my family is facing potential financial ruin as 
a result of this massive penalty.
    Unfortunately, the highly complex nature of the AMT 
befuddled both my highly trained financial adviser and my 
accountant, a situation affecting family after family across 
the country. It wasn't just the complicated Tax Code that led 
me to hold on to the stock. The spirit and the intent behind 
the ``incentive'' in the incentive stock option is that 
employees like me are encouraged by law to hold on to our stock 
for a longer period of time to help our companies grow by 
investing in the future. Certainly it was never the intent to 
hurt the very people that contributed to a company's success. 
Despite this, countless families are facing financial ruin due 
to the AMT International Organization for Standardization (ISO) 
issue, and mine is not a unique story. The big problem with 
paying the AMT is that the tax prepayment is simply a 
prepayment of tax--or, the tax payment is simply a prepayment 
of tax. When this all was in the sixties, the volatility of the 
stock market was not anticipated by Congress, and there was no 
evidence at the time that prepaying this would create hardship. 
Unfortunately, many families like mine cannot afford to prepay 
this tax.
    There was no actual gain for victims like me, this tax will 
generate a useless tax credit, meaning that our prepayment of 
this tax is nothing more than an interest-free loan to the 
government. By today's law we can only recover the tax 
prepayment and credits at about 3,000 per year, which for our 
family means 30 plus years. For many people the credit will 
exceed their life expectancy. Recently the IRS levied our bank 
account, seizing $30,000 my husband had in savings from a loan 
against his 401(k). The money was needed to do repairs on our 
10-year-old house and replace our failing minivan. Next we 
received official notice that there was a Federal lien filed by 
the IRS on any and all property that we owned. With this and 
the past 3 years of worry about this problem, there has been a 
terrible strain on my family and my marriage. Every day this 
issue is like a dark cloud over our heads, and we wonder if we 
should just declare bankruptcy.
    My family and I respectfully urge those of you on the 
Committee to take immediate action on correcting this injustice 
through a repeal of the AMT ISO provision, or through targeted 
and principled measures that will help those of us currently 
facing this problem, and also prevent similar results from 
occurring in the future. For families like mine, time has run 
out. The IRS is enforcing the strict letter of the law, 
threatening to take our homes and retirement funds to collect 
money despite the fact that we never had any actual gain. 
Please don't allow this injustice to continue. Taxpayers 
deserve fair treatment in connection with simpler rules, and we 
appreciate your current consideration of a solution that is 
fair and just. Again, thank you for your time.
    [The prepared statement of Ms. Doherty follows:]
     Statement of Nina Doherty, Sales Engineer, Rivermine Software,
                           Fairfax, Virginia
    Mr. Chairman and Members of the Committee: My name is Nina Doherty 
and I would like to first thank you for the opportunity to speak with 
you today.
    I am a married working mother of three living in a modest Northern 
Virginia suburb with my husband of 17 years. Today, I work full time 
for a small software company. I am sharing my story with you in the 
hope that it will shed light on how the Alternative Minimum Tax 
treatment of Incentive Stock Options can have a devastating impact on 
average hard working people like me.
    In 1994, I became the first employee of a small start up 
Telecommunications Company. Part of my compensation included Incentive 
Stock Options. Seven years later, I found out to my huge shock that 
there could be an egregious impact from exercising Stock Options due to 
unintended consequences of the Alternative Minimum Tax.
    Back in March 2000, before I learned about the Alternative Minimum 
Tax, I exercised some stock options and it appeared that all my hard 
work and sacrifice in working for a start-up would pay off. My company 
was going public as many did at that time, and it was everyone's 
expectation that the stock value would remain stable and perhaps even 
grow. Unfortunately, shortly thereafter, the stock market tumbled and 
my ``paper'' stock value was reduced to nothing. Despite the dwindling 
stock value, I never thought to sell them even after my restrictions 
lapsed in September 2000. I continued to hold onto my stock because I 
was told by my financial advisor before I ever exercised any options 
that due to the way the law was written with regard to capital gains 
tax penalties, it was more beneficial for me to hold it for more than 
one year.
    In April of 2001, while on a Girl Scout trip with one of my 
daughters, I got a call from my accountant about the taxes he had just 
prepared. He told me that because of the Alternative Minimum Tax, I 
owed a lot of money, but he didn't want to tell me how much until I got 
back into town. Alarmed, I asked him to tell me right there and then--
and that is how I found out that I owed tax equal to 100% of our annual 
family income! I was dumbfounded, and quite frankly, so was my 
accountant. Now my family is facing potential financial ruin as a 
result of this massive penalty.
    Unfortunately, the highly complex nature of the Alternative Minimum 
Tax code befuddled both my highly trained financial advisor and my 
accountant, a situation affecting family after family across this 
country.
    And it wasn't just complicated code that led me to hold onto the 
stock. The spirit and intent behind the incentive in an Incentive Stock 
Option is that employees like me are encouraged by law to hold onto our 
stocks for a longer period of time, to help our companies grow by 
investing in the future. Certainly, the intent was NEVER to hurt the 
very people that contributed to a company's success. Despite this, 
countless families are facing financial ruin due to the ISO AMT issue--
mine is not a unique story.
    The big problem with paying the AMT is that the tax payment is 
simply a prepayment of tax. When this law was written in the sixties, 
the volatility of the stock market was not anticipated by Congress and 
there was no evidence at that time that prepaying this tax would create 
hardship. Unfortunately, many families like mine cannot afford to 
prepay this tax. Because there was no actual gain for victims like me, 
this tax will generate a useless tax ``credit'', meaning that our 
prepayment of this tax is nothing more than an interest-free loan to 
the government. By today's law, we can only recover the tax prepayment 
in credits at $3,000 per year, which for our family means 30+ years--
for many people the credit will well exceed their life expectancy.
    Recently, the IRS levied our bank accounts, seizing $30,000 that my 
husband had in savings from a loan against his 401(k). This money was 
needed to do repairs on our ten year old home and replace our failing 
minivan. Next we received official notice that there was a Federal lien 
filed by the IRS on any and all property that we own. With this and the 
past three years of worry about this problem, there has been terrible 
strain on my family and my marriage. Every day this issue is like a 
dark cloud over our heads and we wonder if we should just declare 
bankruptcy.
    My family and I respectfully urge those of you on the Committee to 
take immediate action on correcting this injustice, through a repeal of 
the AMT/ISO provision, or through targeted and principled measures that 
will help those of us currently facing this problem, and also prevent 
similar results from occurring in the future. For many families like 
mine, time has run out: the IRS is enforcing the strict letter of the 
law--threatening to take our homes and retirement funds to collect the 
money despite the fact that we never had any actual gain.
    Please don't allow this injustice to continue. Taxpayers deserve 
fair treatment in connection with simpler rules, and we appreciate your 
current consideration of a solution that is fair and just.
    Again, thank you for your time.

                                 

    Chairman HOUGHTON. Thank you very much. Those are two 
extraordinary stories. Ms. Maresca.

 STATEMENT OF ELIZABETH MARESCA, ASSOCIATE CLINICAL PROFESSOR, 
FORDHAM UNIVERSITY SCHOOL OF LAW, AND SUPERVISING ATTORNEY, TAX 
             LITIGATION CLINIC, NEW YORK, NEW YORK

    Ms. MARESCA. Good afternoon, Mr. Chairman and Members of 
the Subcommittee. My name is Elizabeth Maresca, and I am an 
associate professor at Fordham Law School and the supervising 
attorney of its Low-Income Taxpayer Clinic. It is my pleasure 
to talk to you today about the tax simplification legislation 
regarding a uniform definition of ``qualifying child.'' This 
change will benefit both taxpayers and the IRS, and it will 
make our tax system much more fair and efficient. Fordham Law 
School's Low-Income Taxpayer Clinic has been in operation for 
about 4 years, and over that time we have represented hundreds 
of low-income taxpayers. One of the most frequently recurring 
problems in our representation of these taxpayers stems from 
the multiple definition of ``qualifying child.'' Simplicity in 
this area will go a long way in reducing the burdens on many 
taxpayers who are working hard to support their families and 
naturally claim their children on their tax returns, as 
Congress has long intended that they should. The current law 
uses some financial measurements which impose unrealistic 
recordkeeping obligations on taxpayers, and these requirements 
are specifically daunting for low-income workers who often do 
not have bank accounts and are likely to pay for their food and 
clothing and shelter with cash and money orders. Under current 
law they are required to record all their outlays for these 
items and be able to document the support of their children in 
their household.
    Removal of the financial analysis which is currently under 
the law is especially important because it removes the 
recordkeeping requirement, but also because of the unique 
complications under which low-income people live. They usually 
have a financial safety net, and they may rely on such things 
like New York City has a free breakfast and school lunch 
program for their children. They may shop at a food pantry in 
their neighborhood. They may receive groceries or clothing from 
a local charitable organization. Many have free health 
insurance for their children from New York State. At other 
times, of course, the family receives subsidized housing either 
from the State or the Federal Government, food stamps, or 
Temporary Assistance for Needy Families (TANF). When you 
combine all those sources of income into the household, it is 
very difficult, if not impossible, to determine how it affects 
their eligibility for claiming their children at issue.
    However, under the proposed definition for qualifying 
child, all of my clients will be able to know if they qualify. 
They need to know the age, the relationship, and the residency 
of the children under their care. It is easy to determine, and 
it is also easy to document. A further problem that occurs in 
my work is that the IRS' staff also has difficulty interpreting 
the current legislation. When the IRS pulls a return for audit 
for a low-income taxpayer who has claimed the earned income 
credit, they freeze the refund for that return and all 
subsequent tax refunds. Often the audit of the tax year takes 2 
to 3 years to complete, which means that the taxpayer is 
waiting up to 3 years for 3 tax refunds which he desperately 
needs to support his family.
    If you use the uniform definition of qualifying child, it 
will make it much easier for the IRS to interpret and make the 
audit process to go much more quickly, the refunds will be 
released sooner to the taxpayers, and a significant burden will 
be reduced. One final area that perplexes my clients is their 
reliance on the paid tax preparer. In my experience, many of 
these tax preparers cause more problems than they solve because 
they, too, have difficulty interpreting the legislation as it 
applies to the client. Simplifying the law will enable the 
taxpayers and their tax preparers to correctly report on the 
original return. A correct original return reduces audit 
burdens on the IRS. Simplifying the law will reduce the audit 
burdens and get the refunds to the taxpayers faster. Increase 
compliance, reduce administrative burdens, and decrease of the 
length of the IRS audit is very important results of the 
proposed legislation. I would like to thank you for the 
opportunity to speak to you today, and specifically for 
presenting my views based on my clients' experiences.
    [The prepared statement of Ms. Maresca follows:]
 Statement of Elizabeth Maresca, Associate Clinical Professor, Fordham 
  University School of Law, and Supervising Attorney, Tax Litigation 
                       Clinic, New York, New York
    Mr. Chairman and members of the Committee, my name is Elizabeth 
Maresca. I am Associate Professor of Law at Fordham University School 
of Law and the Supervising Attorney of its Low-Income Taxpayer Clinic. 
It is my privilege to testify before you and urge you to adopt this 
much needed tax simplification proposal which will replace the current 
multiple definitions of a qualifying child with a single, sensible 
Uniform Definition of a Qualifying Child. This change will benefit both 
low income taxpayers and the IRS, as it makes our tax system more fair 
and efficient.
    Fordham Law School and its Clinical Program are located at Columbus 
Circle in the heart of Manhattan. The Low Income Taxpayer Clinic has 
been in operation for fours years and we have served hundreds of low 
income taxpayers. Most of our clients are the working poor who have 
been denied their earned income tax credits by the IRS. The typical 
client seeks our representation after he or she has made repeated 
attempts to correspond with the IRS regarding the disallowance of their 
EITC, dependency exemptions and head-of-household filing status. All 
too often, the IRS is unable to respond to these requests in a timely 
manner or responds with a form letter requesting more documentation 
which the taxpayer does not have and has no ability to obtain.
    One of the most frequently recurring problems in our representation 
of low income taxpayers stems from the multiple definitions of 
qualifying child in the tax code. Simplicity in this area will go a 
long way in reducing the burdens on the many low income taxpayers who 
are working hard to support their families and naturally claim their 
qualifying children on their tax returns, as Congress has long intended 
they should.
    In my work, we represent taxpayers who are in controversies with 
the IRS over the correctness of their tax returns. The proposed 
legislation will reduce the number and the complexity of IRS audits and 
reducing a significant burden on the millions of taxpayers who claim 
the tax benefits connected to their children.

A. THE COMPLEXITY OF THE CURRENT LAW MAKES IT DIFFICULT FOR TAXPAYERS 
INTERPRET THE LAW AS IT PERTAINS TO THEIR CHILDREN

    Current law uses financial measurements which impose unrealistic 
record keeping obligations upon taxpayers, requiring extensive record 
keeping on everyday household budget matters. These requirements are 
specifically daunting for low-income workers, who often do not have 
bank accounts and are likely to pay for food, clothing and even shelter 
with cash or money order. Under the current law, they are required to 
record each modest outlay for food, clothing, heat, electricity, phone 
service, rent and other expenses. Many Americans rely on cancelled 
checks or electronic banking records;however, for many of my clients it 
can be quite a challenge to document that they have paid their rent, 
although they may have lived in the same apartment for some years 
without any problem. In addition to living without access to banking 
services and relying upon check cashing stores, it is very common for 
low-income workers in NYC to live in shared apartments for which they 
are not on the lease or have an oral arrangement with a landlord. Often 
they have moved once or twice since the tax year at issue and have no 
way to contact the landlord for proof that they paid their rent during 
the tax year under audit.
    Removal of the financial analysis currently required under the law 
is an especially important change for the low-income taxpayer. This is 
true because not only because it removes a burdensome record keeping 
requirement, but also because of the unique complications that often 
characterize their financial situations. Many low-income workers are 
compelled to rely upon some type of financial safety net to supplement 
their low wages. They may rely upon something as simple as New York 
City's free breakfast and lunch program for school children. Many shop 
at food pantries or receive groceries or clothing from religious or 
community based organizations. The family may participate in programs 
such as New York State's free health insurance for children. Of course 
at times the family receiveseasily identified government assistance 
such as subsidized housing, food stamps or TANF. Many cases present the 
more difficult situation in which another member of the household, who 
is not part of the nuclear family we represent, may receive Social 
Security Insurance or Disability Insurance benefits. In these 
situations, it is difficult if not impossible to determine how these 
funds are used and thus how they affect the client's eligibility for 
the claiming the children at issue.
    All too often, my clients cannot determine what their household 
expenses were during the tax year at issue, what other assistance they 
received and how it all plays into the total amount of support for the 
child or household. Most are not aware that these other sources of 
financial support affect their rights to claim their children under the 
tax laws.
    The proposed definition of qualifying child, and the requirements 
for documentation, is very welcome and user friendly to the low-income 
worker. All of my clients know the age, relationship and residency of 
the children under their care. The proposed legislation allows the low-
income taxpayer to easily determine, and obtain the documents to prove, 
that their children and other children under their case are their 
``qualifying child'' under the tax laws.
    The proposed legislation simplifies the record keeping requirements 
under the tax code. The taxpayer needs only a few pages to establish 
the three-part test under the proposed legislation--a birth 
certificate, or other legal document to prove relationship and age; and 
a letter from a school, landlord, health care provider or clergy to 
establish residency. In New York, these are the simplest documents to 
obtain and often the taxpayer can gather them within a few days at 
little or no cost. Further, they are more than sufficient to permit the 
IRS to enforce the law and ensure that taxpayers meet their legal 
obligations.

B. THE COMPLEXITIES OF THE CURRENT LEGISLATION CAUSE SIGNIFICANT DELAYS 
IN RETURN PROCESSING CAUSING DELAYS IN ISSUING THE TAX REFUNDS DUE TO 
THE LOW-INCOME WORKERS AND THEIR FAMILIES

    It has been my experience that the IRS, their auditors, Appeals 
Officers, paralegals and attorneys also have difficulty applying the 
current legislation to the low-income family. The IRS' inability to 
easily apply the law has an extremely negative affect on the low-income 
worker as it delays the completion of the IRS audit. While one tax year 
is under audit, the IRS freezes all subsequent tax refunds. The 
taxpayer often has to wait 2 to 3 years for their much needed tax 
refunds for the year under audit and the subsequent tax years. These 
delays cause a significant financial hardship on low-income workers and 
their families.
    The audit process will be sped up by the proposed legislation 
because the documents needed to establish the taxpayer's eligibility 
under the laws will also be reduced. Currently, there is a myriad of 
documents requested and required to establish the taxpayer's 
eligibility to claim their children. As stated earlier, these documents 
often do not exist or cannot be obtained. If they do exist it will 
often take the taxpayer significant effort and time to gather them. The 
documents which will be required under the proposed legislation are 
easily obtained and are much less voluminous. Consequently, the burden 
to the taxpayer will be significantly reduced.
    Unifying the definition of qualifying child will reduce record 
keeping requirements and simplify the return preparation process. More 
importantly, the proposed legislation reduces the burden on the 
taxpayer and the IRS after the return is filed. The proposed 
legislation will decrease the time it takes the IRS to complete the 
audits, which will in turn allow the Service to release the taxpayer's 
much needed refunds in a timelier manner.

C. COMPLEXITIES OF THE CURRENT LEGISLATION CAUSE MANY LOW-INCOME 
WORKERS TO PAY FOR PRROFESSIONAL SERVICES TO PREPARE THEIR TAX RETURNS

    The current complexities in this area impose another unneeded 
burden on my clients by compelling many of them to hire a tax-return 
preparer, despite the fact that all their reportable income is often 
contained on a single Form 1099 or Form W-2. Although their return is 
only 3 pages and 10 to 12 lines on a Form 1040, too many of my clients 
that have paid over a week's salary to a tax preparer for a return that 
should take only about 30 minutes to prepare. Further, in my 
experience, these tax preparers are all too often ``fly-by-night'' 
operators who cause many more problems than they solve and introduce 
errors that plague both the taxpayer and increase the audit burden on 
the IRS. Simplifying the law will enable both the taxpayer and these 
professionals to correctly report on the original return. Correct 
reporting reduces the incidents of audits and math-error notices, 
reduces the burden on the taxpayer and allows the refundable credits to 
be paid to family much more quickly.

D. CONCLUSION

    The proposed legislation for a uniform definition of qualifying 
child enjoys wide-support. For the millions of families claiming the 
benefits of the earned income credit, dependency exemption, child tax 
credit and head-of-household filing status, the proposed legislation 
will increase compliance, reduce administrative burdens, decrease the 
length of the IRS's audit of these issues and enable the IRS to release 
tax refunds in a more-timely manner to a community who desperately rely 
on these funds for their families survival.
    I wish to thank the Subcommittee for the opportunity to present my 
views on the simplification of the tax code and specifically on the 
proposed legislation for a uniform definition of qualifying child.

                                 

    Chairman HOUGHTON. Thank you very much, Ms. Maresca. Ms. 
Parshall.

    STATEMENT OF JEANNETTE PARSHALL, DIRECTOR, PREMIUM TAX 
             SERVICES, H&R BLOCK, WHEATON, MARYLAND

    Ms. PARSHALL. Mr. Chairman, Representative Pomeroy, Members 
of the Subcommittee, thank you for the invitation to appear 
today. Mr. Chairman, I want to commend you, Mr. Portman, and 
your colleagues for making tax simplification a priority. I 
know that among your proposals are some suggested by H&R Block. 
I hope that all of H&R Block's 2004 simplification suggestions 
can be included in your record.
    I have been an income tax professional, working as one, for 
28 years. My practice today centers in Wheaton, Maryland, where 
I prepare over 100 tax returns each year, and directing H&R 
Block's premium tax office that prepares 2,000 returns. Most of 
my own clients are suburban professionals with complex returns. 
Much has changed since I started. For the first 14 years, I 
prepared returns by hand using a manual calculator. Today I 
wouldn't dream of completing a tax return without continual 
training and computer technology that does comparative 
calculations to ensure that clients pay the lowest legal tax.
    Consider some of the complexity taxpayers face today. We 
have over 600 forms, schedules, and instructions; 5 different 
definitions for child; multiple rates and dates for capital 
gains; a plethora of pension plans, each with different rules 
and consequences; ever-changing criteria for the earned income 
tax credit; and, of course, there are multiple education 
deductions and credits. We have a nonrefundable child credit 
and a fully or partially refundable child credit. The 
worksheets to sort out the order are mind-boggling. We have 
sunrises and sunsets; phase-ins and phase-outs.
    Tax software and professional preparation enable taxpayers 
to manage some of this complexity. Today 85 percent of tax 
returns are prepared with a computer, compared to 16 percent in 
1990; and 56 percent of taxpayers used a tax professional, 
compared to 48 percent in 1990. Of course, complexity is not 
the only reason to seek professional tax help. Convenience, 
speed, anxiety reductions, life changes such as marriages, 
births and moves, and, increasingly, annual financial advice 
all play a part. Complexity is a major factor.
    Of course, not every taxpayer faces serious complexity. 
Two-thirds of taxpayers do not itemize their deductions; 40 
percent of taxpayers are able to use short forms. Millions of 
self-preparers use software like Tax Cut to make life simpler, 
and wage-earners generally have a lighter burden than self-
employed taxpayers. There are understandable reasons for some 
complexity as tax laws are tailored for fairness, to fit 
available funds, or to favor certain activities like education, 
homeownership, or retirement savings. Some complexity can also 
bring tax relief. Most of my clients pay less Federal income 
tax as a result of recent complex legislation. If complexity 
has benefits, it also exacts a price. Some taxpayers overpay as 
a result of complexity and confusion. When Congress enacts so 
many changes so frequently, it is hard for taxpayers, tax 
professionals, or the IRS to fully absorb or appreciate them. 
In the 18 years since the Tax Reform Act 1986 (P.L. 99-514), 
Congress has made 7,662 changes to the Internal Revenue Code 
(IRC), averaging more than 425 a year. Most taxpayers can't 
keep up.
    Mr. Chairman, we live in a more complex world than the one 
in which I started preparing tax returns in 1977. The Tax Code 
reflects that. The issue of simplification is not new. Henry 
Bloch, who started our tax preparation firm almost 50 years 
ago, testified repeatedly in favor of simplifying the Tax Code 
through the seventies and early eighties. So, the 
simplification effort is ongoing. We can still do more, and we 
should. On behalf of H&R Block, I appreciate the opportunity to 
support your efforts.
    [The prepared statement of Ms. Parshall follows:]
    Statement of Jeannette Parshall, Director, Premium Tax Services,
                      H&R Block, Wheaton, Maryland
    Mr. Chairman, Representative Pomeroy, Members of the Subcommittee:
    Thank you for the invitation to appear today.
    Mr. Chairman, I want to commend you, Mr. Portman, and your 
colleagues for making tax simplification a priority. I know that among 
your proposals are some suggested by H&R Block. I hope that all of H&R 
Block's 2004 simplification suggestions can be included in your record.
    I have been a professional tax return preparer for 28 years. My 
practice today centers in Wheaton, Maryland, where I prepare over 100 
tax returns each year and direct an H&R Block office that prepares 
2,000 returns. Most of my own clients are suburban professionals with 
complex returns.
    Much has changed since 1977, when I started.
    For the first 14 years, I prepared returns by hand, using a manual 
calculator. Today I wouldn't dream of completing a return without the 
help of continual training and computer technology that does 
comparative calculations to ensure that clients pay the lowest legal 
tax.
    Consider some of the complexity taxpayers face today:

      Over 600 forms, schedules, and instructions.
      Five different definitions for a child.
      Multiple rates and dates for capital gains.
      A plethora of pension plans, each with different rules 
and consequences.
      Ever changing criteria for the Earned Income Tax 
Credit.Multiple education deductions and credits.
      A nonrefundable child credit and a fully or partially 
refundable additional child credit. Plus worksheets to sort out the 
order when a taxpayer has refundable and nonrefundable credits.
      Sunrises and sunsets; phase-ins and phase-outs.
      And, worst of all, the AMT, which is impossible for even 
the most-well-educated taxpayer to understand.

    Tax software and professional preparation enable taxpayers to 
manage some of this complexity. Today, 85 percent of returns are 
prepared with a computer compared to 16 percent in 1990; and 56 percent 
of taxpayers use a tax professional compared to 48 percent in 1990.
    Complexity is not the only reason to seek professional tax help. 
Convenience, speed, anxiety reduction, life changes (marriages, births, 
moves), and, increasingly, annual financial advice all play a part. But 
complexity is a major factor.
    Of course, not every taxpayer faces serious complexity: two-thirds 
of taxpayers do not itemize their deductions; 40 percent of taxpayers 
are able to use short forms; millions of self-preparers use software 
like TaxCut' to make life simpler; and wage earners 
generally have a lighter burden than self-employed taxpayers.
    There may be understandable reasons for some complexity as tax laws 
are tailored for fairness, to fit available funds, or to favor certain 
activities like education, homeownership, or retirement savings. And 
some complexity can also bring tax relief. Most of my clients pay less 
Federal income tax as a result of recent, complex legislation.
    But if complexity has benefits, it also exacts a price.
    Some taxpayers overpay as a result of complexity and confusion.\1\ 
And when Congress enacts so many changes so frequently, it is hard for 
taxpayers, tax professionals, or the IRS to fully absorb or appreciate 
them. In the 18 years since the 1986 tax reform act, Congress has made 
7,662 changes to the Internal Revenue Code, averaging more than 425 a 
year. Most taxpayers can't keep up.
---------------------------------------------------------------------------
    \1\ A March 2002 General Accounting Office report showed missed 
deductions and credits alone may have caused over 2 million Americans 
to overpay their Federal taxes by an average of over $400 each. A 
January 2002 GAO report found that small businesses overpaid their 
taxes by $18 billion over the prior two years because of tax return 
errors. An October 2002 Treasury report found 600,000 low-income 
taxpayers didn't claim the refundable portion of the child credit, 
costing them an average of $390 each. A March 2004 Treasury report 
found tens of thousands of farmers overpaid taxes by an average of over 
$500 because they did not take advantage of income averaging. See also, 
Eric Toder, et al., ``Estimating the Compliance Cost of the U.S. 
Individual Income Tax,'' 61 National Tax Journal 673 (September 2003).
---------------------------------------------------------------------------
    Mr. Chairman, we live in a more complex world than the one in which 
I started preparing returns in 1977. The tax code reflects that. But 
the issue of simplification is not new. Henry Bloch, who started our 
tax preparation firm almost 50 years ago, testified repeatedly in favor 
of simplifying the tax code through the 1970s and early 1980s. So the 
simplification effort is ongoing. We can still do more, and we should.
    On behalf of H&R Block, I appreciate the opportunity to support 
your efforts.

                                 

    Chairman HOUGHTON. Thank you, Ms. Parshall. That was 
wonderful testimony. It was wonderful testimony for everyone 
here. I am going to turn to Mr. Pomeroy now to start the 
questioning.
    Mr. POMEROY. It was wonderfully succinct testimony, Mr. 
Chairman, and I think brought us a very good idea about the 
havoc this complexity is wreaking in ordinary people's lives 
that try to do the right thing, but find a Tax Code that is 
absolutely bewildering, unjust, and otherwise increasingly 
regressive as it takes away some of the deductions we put in 
place for working families. Mr. Sweeney, when did you fall onto 
the AMT alternative as a tax obligation?
    Mr. SWEENEY. I believe about 2-and-a-half years ago. I have 
been promoted up through the ranks, and my salary has gradually 
increased, I felt the implications of the AMT.
    Mr. POMEROY. Is this a problem with some of your officers?
    Mr. SWEENEY. Yes. My colleagues at my rank, they suffer the 
same consequences also. That is correct.
    Mr. POMEROY. You all would be paying the same high local 
taxes, and some of the things that would result----
    Mr. SWEENEY. Right. A lot of our common deductions are not 
allowed or not accepted under the AMT, so it affects all of us 
pretty much along the same lines.
    Mr. POMEROY. Well, you are on the vanguard. There will be 
35 million of us joining you soon if we don't make some 
changes. So, you are bringing us, I think, the early glimpse of 
what Congress will expect from constituents, broad swaths of 
middle-class family constituents, saying, what is this about?
    Mr. SWEENEY. I don't know the exact numbers, but I would 
tend to believe that every year the numbers would increase up 
the lines until basically the whole middle class would be 
involved under the AMT umbrella.
    Mr. POMEROY. Ms. Doherty, your situation is very 
disturbing. There have been legislative proposals surfaced to 
address that issue specifically. Are you aware of anything 
percolating along now that might be responsive?
    Ms. DOHERTY. Well, one of the things I have found is that 
the IRS has not been able or has not been very responsive in 
terms of the O and C (offer and compromise) process or 
effective tax administration. What I am finding is that my 
friends that have gotten all the way through process that are 
in a similar situation, they get a nice note saying, thank you 
for your application, but we want all the money. So, basically 
the IRS is not using these tools. I have heard that there is--
--
    Mr. POMEROY. What is the O and C that you are referring to?
    Ms. DOHERTY. Offer and compromise. They make their offer, 
and unfortunately it is being rejected, and the IRS is still 
trying to collect the entire amount even though there was 
actually no gain. I understand that there is a bill in the 
Senate that would help the IRS, give them a little bit more 
latitude and be able to utilize the tool of the O and C in 
effective tax administration, so, especially in particular as 
it applies to the AMT ISO issue. I would be very grateful to 
see support of that bill.
    Mr. POMEROY. In the meantime, I hope you will be able to 
continue to work with the IRS to resolve it. You are still a 
two-income family?
    Ms. DOHERTY. Right. We are a two-income family, but it is 
very--it is discouraging when we are trying to kind of catch 
up, and the IRS is just clamping down, and we feel kind of like 
we have no option but to pay the money that we don't have.
    Mr. POMEROY. Well, you can't get blood from a turnip. Is 
that an old saying?
    Ms. DOHERTY. That is right. My husband hails from Ireland, 
so he would definitely agree with you on that statement.
    Mr. POMEROY. Well, thank you for being so candid with the 
personal dimensions of what this stock option has done to you.
    Ms. DOHERTY. Well, I think it is important.
    Mr. POMEROY. We need to know. All too often we can deal 
with broad policy, and the kind of family based horror story 
you have brought to our attention is important.
    Ms. DOHERTY. This is not a unique story. There are 
thousands of families like mine, some in much worse situations. 
So, I feel that I represent those people.
    Mr. POMEROY. Thank you. In light of my time elapsing, Ms. 
Parshall, thank you very much for your testimony. One can just 
tell listening to you, you have prepared a lot of returns, 
dotted I's, crossed the T's, and taken excellent care of your 
clients' tax needs. One of the things that I have had a chance 
to visit with your firm about over the years is the growing 
dimension of the vending-related services, like the loan in 
advance of refund and these kinds of things. Are you finding as 
a preparer that you are under a lot of pressure to sell extra 
stuff?
    Ms. PARSHALL. Not from the company. I don't personally have 
that issue. I deal mostly with high-income professionals. The 
company is not pushing the refund anticipation loan. That is 
something like fifth on the list of options that we are told to 
present. What I find is clients come in, they want it. I say, I 
think it is a lousy idea, because I do, and I am very honest 
with them about it. If you can manage without the money, don't 
do this. The sad fact of life is there are people who do need 
the money tomorrow. I find that hard to understand, you may 
find that hard to understand, but it exists.
    Mr. POMEROY. No. I find it pretty easy to understand. I 
like the market having choices, but I am very anxious about 
abuse of sales, and in the trust relationship between a 
preparer and the clients, I am anxious about what might be 
abuse there.
    Ms. PARSHALL. We have full disclosure of all aspects of the 
refund anticipation loan, and, as I say, we do not push it. 
Again, we have to provide the service that the client wants. I 
can't make his decisions for him.
    Mr. POMEROY. Thank you very much. I yield back, Mr. 
Chairman.
    Chairman HOUGHTON. Thank you very much. Now, Mr. Johnson. 
Oh, Mr. Portman.
    Mr. PORTMAN. Oh, no. Go ahead.
    Chairman HOUGHTON. Mr. Johnson.
    Mr. JOHNSON. Thank you, Mr. Chairman. I appreciate that.
    Ms. Doherty, because AMT taxes are actually prepaid taxes, 
shouldn't you eventually get that money back when you use your 
AMT credits?
    Ms. DOHERTY. Well, if I live long enough, yes, I will get 
it back. The AMT ISO provision operates as a prepayment of tax 
based on presumed tax, based on the regular Tax Code. The 
problem is this prepayment, in order for it to equal what would 
be due under the regular Tax Code, and for that to work, my 
stock would have had to have risen and risen and gotten greater 
to equal what I would have to prepay. Now, in the real world 
that we live in, unfortunately stocks are stable or they drop, 
or in my case my company went bankrupt and the stock actually 
became worthless. So, certainly there is no way that the 
effective tax rate that I am paying would be equal to what gets 
paid under AMT rules. So, now we have a gap between the AMT 
payment versus regular Tax Code, and that becomes the AMT 
credit. Unfortunately, that AMT credit cannot be realized right 
away, so mine will take 30 plus years. I suppose there are some 
people that might get it back quickly, but I know a number of 
people whose credit will not be returned in their lifetime. I 
am not exaggerating. It won't even be back in their children's 
lifetime in theory. So, I really appreciate you asking that 
question, because it is really important that we find a way to 
get this prepayment of tax back to the hardworking individuals 
that are having to pay it.
    Mr. JOHNSON. There are companies in the same boat that, we 
are just giving the government a loan, only it is permanent for 
the most part.
    Ms. DOHERTY. Exactly.
    Mr. JOHNSON. She spoke of, Mr. Chairman, a bill over in the 
Senate, happens to be John Kerry's, but I have got a companion 
bill here that would allow individuals who are stuck in AMT to 
recoup about 50 percent of their credits each year depending on 
what they pay in taxes, 50 percent of their tax bill. I think I 
would like to see that move forward. Ms. Parshall, you talked 
about the complexity of taxes. Frankly, we just--what did we 
add, 150 pages last night? I don't think there is any--any tax 
consultant that knows the Tax Code totally. That is why you 
have got specialties out there. Would you like to speak to 
that? How in the world can we live when we keep complicating 
our lives?
    Ms. PARSHALL. Well, there are a bunch of things. Overall 
total simplification is down the road, but there are smaller 
bites that can be accomplished. Ms. Maresco talked about the 
single definition for child.
    Mr. JOHNSON. In my opinion, you try to take small bites out 
of this Tax Code, and you just complicate it further. So, I 
think probably the Chairman agrees with me, you almost have to 
take the whole thing out and throw it out and start over. That 
is a hard thing to do, because you have got so many forces 
pushing against you from all angles. You guys out there in the 
consultant world can make it happen if you will just get after 
it.
    Ms. PARSHALL. Well----
    Mr. JOHNSON. That is why you are here today.
    Ms. PARSHALL. Yes, sir.
    Mr. JOHNSON. Would you like to make another comment?
    Ms. PARSHALL. Well, there are a few things that can be done 
without small bites as it were, the unified definition of a 
child, a couple of things on the educationline. For example, on 
education credits and deductions, we have one income level at 
which one phases out, a different income level at which the 
other phases out. Couldn't that be even just a little uniform 
there? Capital gains, I don't know how many rates we have now. 
We used to have a deduction. A deduction was a lot simpler. Now 
we have all these rates. So, there are some little things that 
can be done in the interest of simplification without throwing 
out the baby with the bath water.
    Mr. JOHNSON. We would like to do that. I wish you would 
talk to the U.S. Senate about it.
    Ms. PARSHALL. They haven't invited me, sir.
    Mr. JOHNSON. Thank you, Mr. Chairman. I appreciate the 
time.
    Chairman HOUGHTON. Mr. Johnson, I think you bring up a good 
point. Obviously the Tax Code is outdated, it is cumbersome. 
This is why we are having this hearing. We just can't wait for 
nirvana; we have got to do something in the meantime. That is 
the whole purpose of this hearing.Would you like to say 
something, Mr. Portman?
    Mr. PORTMAN. Thank you, Mr. Chairman. Thanks to the 
witnesses for helping us today to think through some of these 
issues. Mr. Sweeney and Ms. Doherty, your comments are 
consistent with what we are hearing back home from our 
constituents about the way in which the AMT has now affected 
more and more of our families. In my own district, people 
making $50,000 a year with four kids are beginning to have to 
calculate their taxes in both ways. Your story, Ms. Doherty, is 
so compelling.
    I do have legislation to repeal the AMT altogether, 
personal and corporate. I have felt that, since I got elected, 
it is impossible to do this, because that is probably about, 
conservatively speaking, $600 billion in revenue loss over the 
next 10 years. It is more and more of a revenue raiser for our 
government, because people like you are now paying it. So, the 
question is, how do you go at it in a way that is reasonable to 
get it done rather than just rail against it and say we should 
repeal it, which I believe, on a philosophical basis, we have 
got to figure out how to get at it.
    So, again, your testimony is helpful in figuring out ways--
I like the idea of indexing it. We should have done that 
initially. I like the idea of dealing with some of the 
individual issues like the options issues. I just think it is 
unfair, because I think if some of these provisions in the Code 
which are tax preferences, deductions, credits, and so on, 
aren't appropriate, we should get rid of them. We shouldn't say 
we are going to pick some and have winners and losers, and then 
end up making people calculate their taxes both ways. It is the 
accountants employment of the last 10 years and going forward. 
Even accountants I have talked to would much rather be doing 
something else than figuring out our taxes under these two 
different regimes. For the IRS, think about that, it is a 
nightmare for it. You essentially have two taxes. The 
enforcement is obviously a huge problem. I appreciate your 
compliance with our Tax Code, Ms. Doherty, but I imagine this 
has been tough for you going through with offers of compromise 
and so on.
    On the AMT, Ms. Maresca, I know you didn't get into that as 
much as you did some of the other issues, but have you looked 
at this from an academic point of view in terms of what are 
some smaller steps we could take? As you know, in our tax 
relief bills in 2001, 2002, and 2003, we essentially did hold a 
harmless provision where people wouldn't be getting into the 
AMT because of the tax relief we put in place. I think it was 
$8 billion worth of relief over 10 years in 2003 just to do 
that, which is nothing, but just to keep it from getting worse. 
Have you looked into this in your academic work?
    Ms. MARESCA. I haven't spent a lot of time working with the 
AMT. I do know a lot of my colleagues pay the AMT. I can say 
that my understanding is that there--some things need to be 
adjusted for inflation, and that is part of the issue. Again, I 
don't know the revenue consequences, so I can't really speak to 
it.
    Mr. PORTMAN. On uniform definition of a qualified child, I 
have got legislation out there introduced last Congress. There 
are five different definitions for dependency, exemption, as 
you know now, for the child credit, for dependent care, head of 
household, and so on. You would provide for one definition; is 
that correct?
    Ms. MARESCA. That would----
    Mr. PORTMAN. Have you looked at the legislation?
    Ms. MARESCA. Yes. One definition is that that removes the 
financial measurements because that often is the most 
impossible to prove. When you are in audit, and your earned 
income credit is frozen, the earned income credit, the purpose 
of it is to raise families with children out of poverty. It is 
not raising them out of poverty if they can't get it. If I have 
a client that comes in with a 2001 tax year with $4,000 that is 
frozen, I just have them do their 2003 returns--2001 is frozen, 
2002 is frozen, 2003 is frozen. So, a gentleman may make 
$10,000 a year, he has got $12,000 of frozen refunds. The IRS 
just can't work through them any faster, and I think it is 
mostly because the clerks at the service center are confused, 
by the way, and they don't know what to do with the paperwork 
that comes in, so they either do nothing or just issue a 
notice, or a notice of deficiency.
    Mr. PORTMAN. Of your clients, what percentage would you say 
are affected by the definition of child?
    Ms. MARESCA. At least 40 percent. Maybe up to 50 percent.
    Mr. PORTMAN. Forty or 50 percent?
    Ms. MARESCA. Yes.
    Mr. PORTMAN. That is the earned income tax credit (EITC), 
but it is also on----
    Ms. MARESCA. Well, generally they qualify under the EITC. 
The new definition of qualifying child removed the financial 
requirements. So, they qualify, they have qualifying children. 
What they don't have is a dependent exemption or head of 
household filing status or perhaps a child tax credit. The way 
it works when you are poor is you don't really need those 
things because if you make $10,000 or $12,000 a year, the tax 
effect is maybe $200. So, often we amend the returns just to 
remove those items, forego that possible $200 just to get the 
refundable earned income tax credit back to them.
    Mr. PORTMAN. Well, Ms. Parshall, this question is for you, 
too. I will follow up in writing because my time has expired, 
unless we have a second round.
    Mr. PORTMAN. Again, I want to thank each of the panelists 
for being here and helping us to work through some of these at 
least bites at simplification so that we can come up with a 
fair Tax Code. Thank you, Mr. Chairman.
    Chairman HOUGHTON. Mr. Tanner.
    Mr. TANNER. Thank you, Mr. Chairman. I am sorry I am late. 
This is one of the few jobs that you have three different 
places to be all at 3:00 p.m. or 2:30 p.m., and nobody thinks 
anything of it. It is just sort of routine. Anyway, I am sorry, 
Mr. Chairman. Thank you.
    I would like to ask Ms. Parshall, what--in your experience, 
what is the single most important priority that you see that 
Congress could do with respect to your clients to simplify 
things? I know that is a very broad question, but what I am 
talking about is I read an article that a tax columnist wrote I 
guess it was last week, and it said that the 1986 tax bill was 
sort of a benchmark, and it really did do some things that 
simplified the Tax Code. There was some unintended consequences 
in the real estate business and elsewhere, but that it did to 
some degree simplify the Tax Code, and that every day since 
then the Tax Code has become increasingly more complicated. 
Would you agree with that, number one? Number two, what would 
be your suggestion if you were sitting where Chairman Houghton 
is?
    Ms. PARSHALL. Well, let us take the easy one first. The 
simplification would be to throw out the AMT. I had more 
clients with AMT this past tax year than I had had in my first 
27 years of preparing tax returns. I have yet to see the AMT 
credit work for anyone. So, it is a form I am filling out that 
they are getting charged for, which I then throw out because I 
don't want to charge them for a form that isn't doing them any 
good. So, that would be the simplest thing. That to me is the 
major complex--in my particular practice I am not doing many 
earned income credit returns. I am dealing with higher-income 
professionals with complex returns, and they are the people who 
are being hit hardest. People in States like New York, which 
has high local taxes, they are getting hit hard. The higher 
your local tax, the more chance there is of you going into AMT 
territory. The Federal tax rate has gone down, local tax rates 
have gone up, and they meet at AMT.
    Addressing 1986, I would have to disagree about 1986 being 
a simplification. In 1987, when I did tax returns for the 1986 
tax year, I was still working by hand with a thick lead pencil 
and a pink pearl eraser, and my desk had more crumbs from the 
eraser that year than any year before or since. That was the 
year when they took away tax shelters, we had phase-ins of 65, 
40, I have lost track. Everything got phased in. Yes, it has 
gotten worse since then, but I don't think 1986 as being a 
particularly simple year for tax.
    Mr. TANNER. I was quoting a tax columnist that I was 
reading.
    Ms. PARSHALL. He was not out in the trenches, quite 
possibly.
    Mr. TANNER. Okay. Thank you, Mr. Chairman.
    Chairman HOUGHTON. Well, clearly we have some issues to 
deal with. General George Catlett Marshall used to say two 
things: one, don't get into the minutiae; and second, don't 
fight the problem. We seem to be fighting the problem. I hope 
that we can help you come up with a solution. Thank you very 
much for your testimony. Now we will have the second panel.
    Mr. POMEROY. Mr. Chairman, as the second panel comes 
forward, I would ask your permission to enter a statement from 
Rich Neal in the record. I didn't realize he had to go, or I 
would have yielded some of my time to him to make this point. 
Here is a very good statement about the AMT and the need to do 
something, and I will put it in the record, if you don't mind.
    Chairman HOUGHTON. Absolutely. Thank you very much. We will 
do it.
    [The information follows:]

    Thank you Mr. Chairman and Mr. Pomeroy for the opportunity to join 
you today. As you know, tax simplification is something we find easy to 
talk about, yet hard to achieve. For the last three Congresses, I have 
authored a bill on tax simplification, which would include a paid-for 
repeal of the Alternative Minimum Tax (AMT).
    The AMT is shifting from a ``class tax'' to a ``mass tax.'' 
Congress, Joint Tax, CBO, and even the Bush Treasury Department have 
acknowledged that by the end of this decade, the number of taxpayers on 
the AMT will explode and eventually ensnare over 30 million American 
taxpayers.
    If we do nothing, more than three-quarters of taxpayers with 
incomes between $75,000 and $100,000 will be caught by the AMT. More 
than one-third of those with incomes between $50,000 and $75,000 will 
be caught by the AMT.
    Contrast this with the fact that by the end of this decade, the AMT 
will only affect one-quarter of households with incomes greater than 
$1,000,000. Does this sound like tax fairness and equity--imposing 
extra taxes on three-quarters of those making $75,000 a year, but only 
one-quarter of the millionaires?
    I understand the reasons for the original imposition of the AMT, 
but it has outgrown its usefulness.
    The AMT is unfair for middle class families, not allowing parents 
to claim exemptions for their children and imposing significant 
marriage penalties. Again, if we do nothing, the AMT will hit 97% of 
all families with two children earning between $75,000 and $100,000 by 
the end of the decade.
    We cannot continue the piece-meal, short-term AMT relief we had 
done the last few years. In fact, just last night, the Committee passed 
$4 billion in permanent AMT relief for businesses, but only a short-
term extension through next year to protect individuals and their 
personal non-refundable tax credits, like the dependent care or elderly 
and disabled tax credits.
    I am also pleased that you will be hearing today from individuals 
impacted by the AMT on incentive stock options. I cannot understand why 
Congress has allowed such punitive taxes on these stock options, which 
provide long-term, employee ownership in companies, particularly in the 
fast-growing technology sector. The AMT has put many of these employees 
in a tax trap, owing 10 to 100 times their annual income in taxes to 
the IRS on phantom income, which they will never see. I first offered 
legislation in 2001 to try to fix this problem, and since then, I have 
been joined in this effort by our colleague Sam Johnson. Unfortunately, 
we have not yet been successful.
    Perhaps, Mr. Chairman and Mr. Pomeroy, hearings such as this will 
help highlight the problem, educating our Members, and building support 
for fixing the problem. Thank you again for the opportunity to join you 
today.

                                 

    Chairman HOUGHTON. Now, the second panel is the Honorable 
Mortimer Caplin, Commissioner of the Internal Revenue Service 
between 1961 and 1964; the Honorable Sheldon Cohen, 
Commissioner of the Internal Revenue Service 1965 to 1969; the 
Honorable Donald C. Alexander, Commissioner of the Internal 
Revenue Service between 1973 and 1977; and the Honorable Fred 
Goldberg, Commissioner of Internal Revenue Service 1989 to 
1992. So, we are honored to have you gentlemen here. Mr. 
Caplin, would you begin your testimony. Thank you.

STATEMENT OF MORTIMER M. CAPLIN, COMMISSIONER, INTERNAL REVENUE 
                       SERVICE, 1961-1964

    Mr. CAPLIN. Mr. Chairman, it is a privilege to be with you 
today. I want to commend the Chairman for calling this hearing 
on a subject vital to all Americans, tax simplification. The 
Nation relies on a self-assessment system to raise trillions of 
dollars each year in support of the country. This type of 
system is dependent upon the willingness of the American 
taxpayer to honestly report his income and deductions and 
compute his own taxes or her own taxes, and our level of 
success is something admired throughout the world. The 
willingness to comply depends upon the taxpayer's trust in the 
system and their belief it is being administered fairly across 
the board, that their neighbor down the street is paying his or 
her fair share. American taxpayers don't like to be suckers. 
When they hear of an annual $311 billion tax gap, this hardly 
provides any reassurance and hardly encourages compliance. We 
see today broad evidence of a lack of confidence in the tax 
law, a disrespect for the administration of the law, a tendency 
to play the audit lottery--without revenue agents out there to 
audit returns--and a readiness to engage in extreme tax 
avoidance and fraudulent tax evasion plans.
    The current Commissioner is trying to counter this. He has 
put greater emphasis on enforcement and looking into evasion 
schemes of all sorts. Congress is confronted, obviously, with a 
monumental task to try to enact comprehensive tax reform. I am 
a believer in undertaking a comprehensive effort, although I 
respect the attempts to make some corrections here and there. 
Some suggest scrapping the system in its entirety, replacing it 
with a complete substitute, perhaps some form of consumption 
tax sales or value-added tax. Then there are those who ardently 
support the very simple flat tax. No deductions, only a single 
rate of tax on income from wages, but not from capital, not on 
interest or dividends or rents or capital gains.
    Now, I don't see such a monumental change in the 
foreseeable future, particularly with the uncertain revenue 
raising capacity of a brandnew system like that. The financial 
and economic risks at stake in a large and complex society such 
as ours, and the sweeping transitional problems that would face 
individuals and business taxpayers, as well as the tax 
administrators who for years and years would be auditing old 
returns under one system and having to switch to another. 
Meaningful simplification would be extraordinarily difficult 
and, we know, would be challenged by competing interests, 
individuals, businesses of all sorts. It would require forceful 
Presidential leadership and that would be seriously needed. You 
need a carefully chosen commission to make a study of this. You 
need adequate staffing and a readiness for hearings. I think it 
is worth the effort, because regardless of the outcome, and 
this has happened before, there would be a body of knowledge 
and background that would help us in later studies. This 
happened back in 1954, the studies that were done and which 
played a big part in the 1954 Tax Code. Wilbur Mills, he held a 
series of hearings beginning in 1959, and they were very 
fruitful in terms of the later laws. I think that output is 
worth the effort to accumulate that knowledge and learning.
    I am reminded of 40 years ago when Senator Russell Long, 
who later became Chairman of the Senate Finance Committee, took 
up the challenge and offered very bold legislation, a 
simplified tax method. It was close to a gross income tax, a 
broadening of adjusted gross income tax--and there were no 
personal deductions--a lower tax rate, capital gains treated 
the same as ordinary income. Although it never passed, it did 
show that a simple one-page tax return could be prepared. In 
honor of Senator Long, I like to call it the ``Long Short 
Form.'' It could be done. Well, close to 20 years ago, a very 
successful effort was undertaken that was preceded by many 
hearings and many studies and finally wound up as the Tax 
Reform Act 1986. It was simple and complex at the same time. It 
was not an easy piece of paper to work with but it did create a 
fairer and more equitable law, thanks to President Reagan who 
was behind it and Chairman Dan Rostenkowski of the Ways and 
Means Committee and Chairman Bob Packwood of the Senate Finance 
Committee. They got together somehow. It was bipartisan. It was 
remarkable.
    We have seen, unfortunately, over the years that the 1986 
act has been whittled away and we are nearly back where we 
started from. I do think it stands as a monument to the art of 
the possible. It could be done. I say, in the same tradition, 
we ought to undertake a project along comparable lines. I have 
laid out in my paper seven steps that I regard as guidelines--
and I see I am running over my time--but it is based upon a 
broad-based tax return with lower rates across the board, 
elimination of the AMT by broadening the tax base, severely 
broadening the tax base to make the revenue available. It would 
treat all forms of income alike. Equal tax treatment where 
people have equivalent incomes. It will go a long way to 
restore confidence in the honesty and integrity of our tax 
system and I think it would serve our Nation well.
    [The prepared statement of Mr. Caplin follows:]
      Statement of The Honorable Mortimer M. Caplin, Commissioner,
                  Internal Revenue Service, 1961-1964
    My name is Mortimer Caplin, of the Washington law firm of Caplin & 
Drysdale.
    I served as U.S. Commissioner of Internal Revenue from 1961 through 
1964, during the Kennedy and Johnson Administrations, and have 
specialized in tax law for over 50 years--as a professor at the 
University of Virginia School of Law and as a lawyer, representing a 
wide variety of business and individual taxpayers.
    It is a privilege to appear before the Oversight Subcommittee and I 
commend the Chairman for focusing on the issue of ``tax 
simplification.'' It is an effort owed to all taxpayers of this country 
who, year after year, are overwhelmed by complex tax laws, complex 
returns, and complex administration as they struggle to meet their 
annual tax obligations. At the very least, they are entitled to the 
hope and expectation that some relief is at hand.
    Our nation's ability to raise trillions of dollars annually to 
support the functioning of our government rests primarily on a 
voluntary self-assessment tax system--one dependent upon the 
willingness of taxpayers to honestly report their incomes and 
deductions and accurately compute their taxes. Their willingness to 
comply depends in no small part on their trust in the system and their 
belief that the law is being administered fairly and across-the-board, 
with their neighbors down the street paying their fair share of taxes, 
too. Will Rogers once opined that people want ``just taxes'' more than 
they want lower taxes, wisely adding: ``They want to know that every 
man is paying his proportionate share according to his wealth.'' 
American taxpayers do not like to feel they are suckers.
    However, word of an annual $311 billion tax gap--from 
underreporting, underpayment and non-filing--hardly provides 
reassurance and hardly encourages compliance. To counter this, IRS 
Commissioner Mark W. Everson, while still striving for improved 
taxpayer service, is now placing heightened emphasis on the enforcement 
aspect of tax administration, particularly focusing on tax shelters, 
tax fraud and other tax abuses. He often quotes President John F. 
Kennedy's 1961 tax message to Congress, ``Large continued avoidance of 
tax on the part of some has a steadily demoralizing effect on the 
compliance of others.'' And this is the very condition that we face 
today--lack of confidence in our tax laws, disrespect for the 
administration of these laws, tendencies to play the ``audit lottery,'' 
and a ready willingness to engage in extreme tax avoidance and evasion 
schemes of all sorts.
    While our tax laws and the IRS will never be loved, the respect of 
our citizenry must be earned and public confidence in the system 
restored. At the very least, the public is entitled to reassurance of 
the law's fairness, honesty and openness; and, to this end, the issues 
of complexity and the difficulties of compliance come to the forefront.
Complexity and Alternatives
    How often it is that we hear the anguished cries of taxpayers and 
tax professionals, ``If only the tax law and tax administration could 
be simplified!'' This same theme is heard in the 1997 Report of the 
National Commission on Restructuring the Internal Revenue Service as 
well as in RRA 98 section 4022, ``Tax Law Complexity Analysis.'' The 
Report, for example, states:

          ``The Commission found a clear connection between the 
        complexity of the Internal Revenue Code and the difficulty of 
        tax law administration and taxpayer frustration.''
          ``. . . The Commission found that significant noncompliance--
        both inadvertent and intentional--results from various 
        obstacles within the current system, including the cost of 
        compliance and the complexity of the tax law. Reducing taxpayer 
        burden by simplifying the tax laws and administration must 
        start with the Congress and the President.''

    These challenges have not been met even partway. Complexity reports 
required by the statute have done little to ease the problem. Frequent 
changes and added complexity continue.
    Needless to say, complex laws lead to complex administration and a 
highly dissatisfied public--hardly the atmosphere for steadfast 
compliance. Taxpayers repeatedly throw up their hands in utter defeat, 
voice disdain for both the tax system as well as the entire government, 
and frequently follow up by deciding in their own favor every 
conceivably uncertain question that may arise. Until greater efforts 
are made to address basic roots of the problem--extraordinary 
complexity and murky transparency--the nation's fisc suffers and the 
IRS is left ``holding the bag,'' with unfair criticisms and a highly 
unpopular reputation.
    Congress is confronted with a gigantic task in seeking fundamental 
simplification. Some suggest that the income tax be scrapped in its 
entirety and replaced with a complete substitute--perhaps some form of 
consumption tax, a federal sales tax or value added tax. And then there 
are those who ardently back the very simple ``Flat Tax''--widely 
heralded to require only a postcard return, with no itemized 
deductions, and only a single rate of tax to be imposed on income from 
wages but not from capital (whether interest, dividends, rents or 
capital gains).
    Such an entirely new system of taxation, however, is not likely in 
the foreseeable future--particularly with its uncertain revenue-raising 
capacity, the risks at stake in a large and complex economy like ours, 
and the sweeping transitional problems that would confront individual 
and business taxpayers as well as tax administrators. Some form of 
consumption tax might well be suitable now to complement our income tax 
system, but not to substitute for it.
    Realistically, to significantly ease complexity, Congress must 
think in terms of modification of the income tax law and then 
contemplate its complete revision.
Overhaul the Income Tax
    ``Simplification'' and ``fairness'' must be kept at the heart of 
any new proposal. Congress, in my view, could provide unprecedented 
relief to taxpayers and, at the same time, could help revitalize public 
faith in the running of our government by focusing on a broad-base, low 
graduated rate income tax system.
    Today, our tax laws are riddled with a vast array of targeted tax 
preferences and incentives that complicate compliance, erode our tax 
base and necessitate increased tax rates to meet the nation's revenue 
demands--special deductions and credits, exemptions and exclusions, 
deferrals, special rates and other preferred treatment for particular 
industries, groups or individuals. Aside from issues of fairness, such 
provisions create unbelievable complexity often leading to distortion 
of normal decision-making and encouragement of tax-motivated, non-
economic behavior. Tax avoidance and abuse are inevitable byproducts.
    We also see the tax laws excessively used, again and again, to 
promote a wide variety of social and economic objectives. The result: 
tax base erosion, shifting of the tax burden, added complexities, and 
further fueling of taxpayer frustration. Much too often, Congress finds 
this ``backdoor financing'' route significantly more convenient, albeit 
more revenue costly, than the better-monitored process of direct 
appropriations.
    A meaningful simplification effort would be an extraordinarily 
difficult undertaking, one of lengthy duration and certain to be 
sharply challenged by competing forces of all dimensions--business, 
political, economic and otherwise. Forceful Presidential leadership, as 
in the Reagan years, clearly would be needed; and appointment of a 
carefully chosen commission undoubtedly would be required, with 
adequate staffing and preparation to undertake extensive hearings. 
Regardless of the final outcome, the related studies and analyses would 
produce long-range benefits to future enactments of the country's tax 
laws.
    Some 40 years ago, Senator Russell Long, who became Chairman of the 
Senate Finance Committee, took it upon himself to lead a charge to 
provide true simplification for individual taxpayers. He offered bold 
legislation that called for an across-the-board ``Simplified Tax 
Method.'' It was close to a tax on gross income (``simplified taxable 
income'')-- no personal deductions; lower rates; capital gains to be 
taxed in the same manner as other income. And its special charm was 
that the program was optional. A taxpayer had the choice of using the 
regular income tax (``the old way,'' with all its complexities), or the 
new simplified method. All you had to do was to make a 5-year renewable 
election, with the right to terminate in the event of bankruptcy, 
disability, or adverse changes in the Code or regulations. While the 
legislation was never adopted, it did illustrate how individual income 
tax compliance could be made truly simple with hardly any 
recordkeeping. An instant tax return was a real possibility. And, in 
honor of the Senator, I've always liked to refer to it as ``The Long 
Short-Form''!
    Close to 20 years ago, one of the most successful efforts for basic 
income tax reform was achieved in the Tax Reform Act of 1986, under the 
leadership of President Ronald Reagan, with the full backing of 
Chairman Dan Rostenkowski of the House Ways & Means Committee and 
Chairman Bob Packwood of the Senate Finance Committee. Subsequent 
legislation has whittled away many of the 1986 Act's achievements on 
fairness and simplification. But the legislation still stands as a 
monument to ``the art of the possible''--broadening the tax base by 
eliminating many tax breaks and loopholes, lowering the rate structure, 
taxing capital gains in the same way as ordinary income, and embracing 
the principle that ``those with similar amounts of income should pay 
essentially the same amount of taxes.''
    In the same tradition of the 1986 Act, Congress could begin the 
process now to simplify tax reporting, ease administration, and restore 
taxpayer confidence in the entire tax system. To this end, I suggest 
setting in motion the enactment of tax changes along the following 
lines:

    1.  Focus on tax return simplification by eliminating as many 
complexities as possible within the parameters of reasonable revenue 
costs.
    2.  Curtail the use of the tax law as the first responder for 
solving our social and economic problems.
    3.  Eliminate the bulk of special preferences, creating a sizably 
broadened tax base.
    4.  Restore a straightforward graduated rate structure, free of 
disguised rate increases inherent to floors, bubbles, phase outs, 
clawbacks, and the like.
    5.  Tax capital gains in the same manner as ordinary income.
    6.  Lower all graduated rates across the board.
    7.  Repeal the alternative minimum tax (``AMT'') for individuals as 
well as corporations, offsetting the enlargement of the tax base.

    We as a people would be better served by a broad-base, low rate 
income tax system, with only the most limited of tax favors. Such a 
straightforward regime, aimed at treating all forms of income alike and 
providing equal tax treatment for persons with equivalent dollar 
incomes, would clearly be simpler, fairer and more efficient for the 
people at large.
    Such a transparent system, free of bells and whistles, would go a 
long way to restore faith in the integrity of a sound tax system that 
is so vital to the security and well-being of our nation.

                                 

    Chairman HOUGHTON. Thank you Mr. Caplin. Mr. Cohen.

 STATEMENT OF SHELDON S. COHEN, COMMISSIONER, INTERNAL REVENUE 
                       SERVICE, 1965-1969

    Mr. COHEN. Mr. Chairman and Members of the Committee, tax 
simplification is something we talk about regularly and do very 
little about. It is always our second or third priority. 
Shakespeare puts it better than I do. He said, frankly, the 
fault dear Brutus, is not in our stars but in ourselves. That 
is, we won't do it and we all recognize it. There is a 
constituency of one for simplifications. The Commissioner of 
IRS and his staff are very interested in this and it would make 
their lives easier and their work easier and they would enjoy 
it. The rest of us will always opt for some deduction or some 
credit when faced with that versus simplification.
    Many of you are going to talk about a change to some new 
tax system. Mr. Caplin just mentioned that. Of course, they 
don't take into account the complications and disruptions that 
would cause, and the uncertainty. One little thing: at the end 
of the day, if you enact that system and it is perfect, what 
gives you the right to think that your confreres, years from 
today, won't corrupt that system just as they have done this 
one. If we don't have the discipline to fix this one, we don't 
have the discipline to enact the new one that will be better. 
Now, you need to face up to the issue of dealing with the 
expenditure of funds through the tax system. That has become a 
corrupting influence and a complication. Rather than expend 
money for a variety of public goods, we don't collect money 
from people who do those public goods. We think that saves 
money. That doesn't, really. We have the wrong agency 
administering the thing, whether it is housing or public 
welfare or whatever it happens to be. The wrong agency is 
administering it and the cost is there. We just don't get a 
good administration, so we pretend we get it at a bargain. 
Anything you can draft as a spending program, I can draft as a 
tax program. You are asked to do that regularly and you do do 
it regularly. The budget rules of the last years have pushed 
you in that direction. They have been enacted for good reasons, 
but as tax evaders do you kind of use the same techniques to 
get around the rules.
    There are two ways to move to simplification. That is, the 
grand move that has been described to you. The second 
alternative technique is the shorter, the targeted move. I am 
not a grand person. I would take on the smaller targets and I 
would pick the targets of opportunity. Wilbur Mills had a 
wonderful idea; and that is, pick out five or six good areas, 
have small groups plan the attack, and then deal with those 
five or six areas. I have outlined in my paper the five or six 
areas that I would pick. You could pick four, five others, but 
don't make the target too big. If you make the target too big, 
you take on all the dragons, all of the lobbyists, all of the 
problems of the world. Now the problem, of course, is with the 
present lack of money to even it out, you have to have 
basically revenue-neutral kind of reform, and that makes it 
much more difficult because you are going to have some losers 
and some winners. The losers will moan and groan. The winners 
won't win so much, but they are going to be on your side. They 
will be with you, but not ardently with you, and that makes it 
very difficult. I think I will just stop there. I don't want 
you to have to listen to the same ideas. I will be glad to 
answer any questions.
    [The prepared statement of Mr. Cohen follows:]
       Statement of The Honorable Sheldon S. Cohen, Commissioner,
                  Internal Revenue Service, 1965-1969
    Mr. Chairman and Members of the Subcommittee, I am pleased to 
appear before you today at your request to testify on the issues 
relating to Tax Simplification. My testimony today represents my own 
views and not those of my firm or any of its clients.
    Because of the press of the short time since you requested my 
testimony, I will use an outline instead of fully written testimony. 
Should you wish me to amplify any of my ideas presented here, I would 
be pleased to do so for your record.
    Tax Simplification is something all of us talk about but few of us 
do much about. I have been practicing in the tax area for 52 years and 
it comes up regularly but only on rare occasions does anything 
affirmative happen.
    Shakespeare, as usual, put it more aptly than I can. He said ``the 
fault, dear Brutus, is not in our stars, but in ourselves.'' (Julius 
Caesar, I, ii, 134). We all say how much we want and need 
simplification. Only the Commissioner of the Internal Revenue and his 
staff mean it and try to do something about it. The rest of us try to 
rationalize why we should pay less and others more. And you on the 
Committee try to please your constituents who are asking for some 
deduction or credit or rate cut or similar benefit--but rarely talk 
about simplifying the law except in most general terms. Some of those 
who do talk about simplification will urge you to change to an entirely 
new tax system--but they never take into account the complications and 
disruption it would cause to move to any new system. And if we do not 
have the discipline to make this system simple and direct--what right 
to we have to believe that any proposed new system will not be 
corrupted too? (In Pogo's words--``We have met the enemy and it is 
us.'')
    Many of us have been concerned for a number of years because of the 
multiple roles we expect our tax system to play. For example, a portion 
of the federal financing of urban renewal and development is 
accomplished by enacting a complex series of tax credits and deductions 
that must be administered by the IRS. These policies should be financed 
through expenditure programs administered by experts in the field. I 
realize that because of budget restraints enacted over the years, it is 
easier not to collect a tax then it is to get an expenditure bill 
through the Congress. They are the net equivalent of each other. What 
can be drafted as a spending program can be also drafted as a tax 
program. Nevertheless, using the tax system as a surrogate for 
expenditure programs is an inefficient means to accomplish the desired 
policy and weakens a national asset--our formerly smooth-running, well-
administered tax system. Although from Congress' perspective, it may 
have the advantage of showing lower expenditure levels than really 
exist.
    The Congress will periodically go into a binge of preaching 
simplification--but when faced with a real issue you will opt for, what 
you conceive as, equity. You can not have simplification and equity. 
That is hard to say--but it is true. A simple law is not equitable as 
it has arbitrary lines. Cross the line and the result changes. An 
equitable law needs fluid lines so it has to be more complex. We face 
this issue regularly and most of us choose equity. We must, in order to 
move toward simplification, choose to be arbitrary on occasion, much as 
that connotes bad things in other situations. An illustration in the 
current news is to allow the charitable deduction for some standard 
deduction users. Thus negating a measure (the standard deduction) 
enacted for simplification reasons.
    There are two essential ways to move toward simplification. The 
major tax act with major changes (i.e., like the 1986 Act)--or smaller, 
more targeted area changes. I have been practicing in and out of the 
government for over 50 years. I saw the Code recodified twice: once in 
1954 when I was one of its draftsmen and again in 1986 each time with 
some success--but most of it eroded in the years that followed.
    I am a devotee of the smaller fix not the giant move. Wilber Mills, 
back in the 1970s, began studies to do this type of reform. I would 
suggest that the Committee pick a few areas which affect the largest 
number of taxpayers and those least able to cope with complex Code. 
Those areas would be the first to attempt to simplify. The areas I 
would start with are the EITC, AMT, dependency definitions, educational 
benefits and savings incentives. These effect great numbers of people 
and would have the most bang for your buck. For example, in the areas 
of educational benefit and savings incentives, you often have multiple 
provisions to provide benefits that present confusing choices to the 
taxpaying public and impose additional tasks on the IRS.
    Dr. Lawrence Woodworth and I designed the first deadwood bill in 
the late 1960s. Our idea was to eliminate the provisions of the Code 
which by their terms were superseded and outdated. There was no 
opposition to the bill--but no enthusiastic support either. It took 
until 1976 to pass that bill. There were no sponsors and no real 
opposition, as a simplification bill had no monetary benefit directly 
and merely reduced paperwork and reading for people. No one up here 
seemed interested.
    Suggest a new deduction or credit and you will have many co-
sponsors. Suggest a technical change or simplification and you have 435 
skeptics.
    A revenue neutral change will cause some losers and some winners 
among the taxpayers. So the losers will lobby you against the idea and 
the winners will get so little they will be quiet. Thus simplification 
has little support--but would make administration easier and therefore 
make everyone's life a little easier.
    I hope this Committee will suggest an effort to the full Committee. 
I don't believe new major studies are necessary. Many practicing 
lawyers and accountants would be willing to work with you--I am sure 
many professors would likewise pitch in. What is lacking is the 
determination, grit and leadership to pull it off. Now is a good time 
to start. I would be pleased to assist.

                                 

    Chairman HOUGHTON. Those are very interesting and we will 
get back to them. I see your five areas. Don Alexander.

   STATEMENT OF DONALD C. ALEXANDER, COMMISSIONER, INTERNAL 
                   REVENUE SERVICE, 1973-1977

    Mr. ALEXANDER. Thank you, Mr. Chairman and Members of the 
Subcommittee and thank you, Commissioner Goldberg. Let the 
record show that Commissioner Goldberg and I share one red 
light while our two predecessors share one each.I want to 
commend you, Mr. Chairman, on your nine bills that you have 
very recently introduced to try to take some of the steps that 
Commissioner Caplin and Commissioner Cohen mentioned, going at 
simplification in nine--I would like to say the word ``easy,'' 
but I can't--nine steps. It would be a major step forward if 
all those bills were enacted and I think it is quite unlikely 
that they will be.
    I wish I could be more optimistic. I wish I could be more 
optimistic about the success of the reintroduction of your last 
year's bill, Congressman Portman, which would have had a 
sweeping effect on the complexity of our current law. I am 
dedicated to Congressman Pomeroy's efforts and Congressman 
Johnson's to try to simplify our retirement system, which is 
badly in need of it. Well, let's talk about the 1986 act. We 
all have. I might as well chip in. I think it was a great 
expedition, started off by President Reagan in his 1984 State 
of the Union address, where he pointed out that he wanted to 
simplify the entire Tax Code so all taxpayers, big and small, 
would be treated more fairly, and he thought that would have a 
very good effect on compliance. I think he was right on all 
counts. In 1986, we did manage to do a lot of good and we 
didn't do it in little bitty steps, but we did one great big 
step, and we did one thing that was really bad and that was the 
alternative minimum tax. That was a terrible idea. It was 
necessary in 1986 because it was thought to be the only way to 
raise the necessary money so the rest of the act could go 
through, and also because we were still worried about those 165 
taxpayers with incomes of more than $200,000 that had been 
mentioned in 1969 by the then-Secretary of the Treasury as not 
paying any income tax. Why not give them an AMT?
    Now, I think the small step versus big step concept that 
you have heard about from this panel might deserve a little 
more from me, and I think it is going to get much better and 
bigger from Commissioner Goldberg. I don't think you are going 
to be able to do reform in small steps. I wish you could. I 
hope you could do something about having a uniform definition 
of who is entitled to claim a child. Of course, we are not 
redefining a child but redefining the relationships that the 
taxpayer has to the claimed child. There is no need and no 
sense in having the different definitions that you have heard a 
little bit earlier from the people that have to cope with this 
system. That is something you ought to be able to do. Whether 
you could do it separately, I don't know. I think the big bang 
theory has much going for it. Maybe we can do what we did in 
1986 again, and this time do it right. How we can do that 
without raising rates, I am not sure. We can narrow the base if 
we are willing to do another thing that Commissioner Cohen 
mentioned.
    In the past decade the present Congress have used income 
tax the way Mike Graetz's mother employed chicken soup, as a 
magic elixir to solve all of the Nation's social difficulties. 
One problem is that each Congress wants to have its own stamp 
on the solution for the child. So, each Congress wants to have 
a nice child credit. Each successive Congress doesn't want to 
rely on the lifetime learning credit, so it has to enact 
something like the Hope credit. In addition to that, I just 
want to second what Commissioner Cohen said. Let's stop, at 
least, using the Internal Revenue Code to try to solve all of 
our social and economic problems. Let us give those to the 
agencies of jurisdiction.
    [The prepared statement of Mr. Alexander follows:]
       Statement of The Honorable Don C. Alexander, Commissioner,
                  Internal Revenue Service, 1973-1977
    My name is Donald C. Alexander, and I am appearing today in my 
personal capacity as a former tax collector and a long-time tax 
practitioner.
    First, I want to commend this Subcommittee for having this hearing 
and for seeking to reduce the burden that complexity imposes upon 
American taxpayers. As Chairman Houghton stated when he introduced nine 
simplification proposals on April 2, 2004, ``if our system becomes too 
complex for the ordinary citizen, then noncompliance will no doubt 
accelerate.'' Chairman Houghton further pointed out that ongoing 
simplification of the tax system should be a top priority of Congress. 
Cong. Portman showed his dedication to the goal of simplification when 
he introduced the sweeping recommendations contained in his Tax 
Simplification Act of 2002, H.R.5166.
    In his third State of the Union Address on January 25, 1984, 
President Reagan said:

          Let us go forward with an historic reform for fairness, 
        simplicity, and incentives for growth. I am asking Secretary 
        Don Regan for a plan for action to simplify the entire tax 
        code, so all taxpayers, big and small, are treated more fairly. 
        And I believe such a plan could result in that underground 
        economy being brought into the sunlight of honest tax 
        compliance. And it could make the tax base broader, so personal 
        tax rates could come down, not go up. I've asked that specific 
        recommendations, consistent with those objectives, be presented 
        to me by December 1984.

    The 1986 Act was indeed a triumph in many ways. The tax base was 
indeed broadened, the rates were greatly reduced, and many of the 
ornaments in the Internal Revenue Code were dropped or greatly 
curtailed. Unfortunately, however, the alternative minimum tax on 
individuals was not removed but instead was expanded to become the 
monster that it is now. More and more individuals fall within it for 
its unindexed exemption becomes more inadequate each year. Both 
Chairman Houghton's current proposals and Congressman Portman's 2002 
proposal would curtail or repeal the alternative minimum tax. 
Unfortunately, such action, while necessary, is very expensive. 
Congress and the Administration must fix this problem and at last 
reverse the trend toward the individual alternative tax becoming the 
primary tax for individuals.
    Much of the relief in the 1986 Act has been eroded, and an example 
of such erosion is the misnamed Taxpayer Relief Act of 1997. In that 
Act we saw fit to provide a full deduction for unreimbursed travel 
costs of certain Federal employees, to give an above-the-line deduction 
for expenses of certain governmental officials compensated on a fee 
basis, to provide Roth IRAs and above-the-line deduction for interest 
on education loans, to retroactively reinstate an exclusion for 
employer-provided educational assistance and to provide education IRAs, 
among other things.\1\ Why not give the Department of Education some 
more money, to strengthen and expand Pell Grants, and broaden their 
scope? But doing the sensible thing requires outlays and does not 
reduce taxes, and there is the problem.
---------------------------------------------------------------------------
    \1\ Of course we should encourage education, and we have the 
Department of Education to do just this.
---------------------------------------------------------------------------
    Simplification is a goal to which many have aspired recently. 
Unfortunately, however, the tax laws have become more complicated and 
the consequent burden on taxpayers and the IRS has increased year by 
year. While some of the Code's complexity stems from duplication and 
overlap,\2\ much is due to cramming the Code with ornaments that don't 
belong in a rational tax system. As Michael Graetz told us in 2001:
---------------------------------------------------------------------------
    \2\ Such as multiple definitions of a child.

          In the past decade the President and Congress have used the 
        income tax the way my mother employed chicken soup: as a magic 
        elixir to solve all the nation's economic and social 
        difficulties. If the nation has a problem in access to 
        education, child care affordability, health insurance coverage, 
        or financing of long-term care, to name just a few, an income 
---------------------------------------------------------------------------
        tax deduction or credit is the answer.

    2001 Erwin N. Griswold Lecture before the American College of Tax 
Counsel: Erwin Griswold's Tax Law--And Ours, The Tax Lawyer, Vol. 56, 
No. 1, at 178 (Fall 2002).
    We seem to be addicted to using the tax system as a means of 
promoting all sorts of good things\3\ by spending through the Internal 
Revenue Code. Thus we avoid the political difficulty of voting for 
additional expenditures and give the benefit of an ostensible reduction 
in taxes. It's a two-fer.
---------------------------------------------------------------------------
    \3\ As well as discouraging a few bad things.
---------------------------------------------------------------------------
    The earned income credit is based on a very fine concept: an income 
supplement to encourage the poor to work rather than to remain on 
welfare. I thought this great idea should be administered by the then 
Department of Health, Education and Welfare. Milton Friedman, who 
favored a negative income tax, thought otherwise and he persuaded the 
then Administration to adopt the EITC. I predicted that it would be 
very difficult for the IRS to administer and that the Internal Revenue 
Service was not the right agency to engage in social work. Obviously, I 
lost, and it doesn't help to say that the predicted problems have 
occurred.
    Although the Internal Revenue Code had been used long before the 
1970s to favor certain activities\4\ we have now developed this into an 
art form. In addition to the enormous welfare program that the IRS must 
administer, it also administers major segments of our housing 
incentives, our education incentives, our health incentives, our child 
care needs and all sorts of narrowly-focused economic incentives.
---------------------------------------------------------------------------
    \4\ And even particular individuals.
---------------------------------------------------------------------------
    That is why alternative tax systems like a national sales tax\5\ or 
so-called ``flat tax'' to replace much or all of the individual income 
tax seems attractive at first sight and could be made to be reasonably 
progressive if we care anymore about the ability to pay. One can be 
reasonably certain, however, that the apparent simplicity would likely 
evaporate soon when various claimants to favored treatment pressed 
their case with Congress and the Administration.
---------------------------------------------------------------------------
    \5\ A credit-invoice value added tax would be far superior to a 
national sales tax, but those with long memories have not forgotten 
Chairman Ullman.
---------------------------------------------------------------------------
    Expenditures through the Internal Revenue Code are similar to 
regular spending programs for they are intended to achieve policy 
objectives that have little or nothing to do with a system designed to 
produce the needed amount of revenue by applying a tax rate to an 
income tax base. The major difference between a tax expenditure and 
regular government spending is that under the tax expenditure approach, 
instead of the government sending out a check to the recipient, the 
recipient pays less in tax\6\ For example, we now have a national 
concern about the dire effects of obesity. We could address this 
problem by creating a direct spending program to subsidize weight loss. 
Or, we could provide a tax expenditure designed to produce the same 
result but place the administrative problems on the IRS.\7\ In theory, 
it may not matter whether a government uses direct spending or a tax 
expenditure to achieve a policy goal. As the Institute on Taxation and 
Economic Policy has pointed out, however, tax expenditures are 
evaluated far differently from other government spending:
---------------------------------------------------------------------------
    \6\ If the tax expenditure is refundable, the lucky beneficiary 
receives a check in addition to, or in lieu of, a tax deduction.
    \7\ Would the IRS simply accept the taxpayer's word? Or would it 
weigh a representative sample of taxpayers at the beginning of the 
taxable year and at the end of the year? What about growing children? 
What about pregnant women? How large a weight increase is permitted? 
How could you achieve the goal but also discourage anorexia?

      Unlike most government spending programs, tax 
expenditures are usually open-ended: they have no built-in budget 
limits, and generally there is no annual appropriations review or 
oversight process. Anyone who meets the statutory criteria for 
eligibility can get the subsidy.
      Direct spending usually requires a government agency to 
weigh the worthiness of an application from any potential beneficiary. 
In contrast, most tax expenditures require no action other than the 
filing of a tax return.
      Tax agencies typically have little expertise, or 
interest, in assuring that tax-expenditure programs are working as they 
should. By contrast, government agencies tend to look closely at the 
effectiveness of their direct spending initiatives.
      Basic facts about who benefits from tax expenditures--and 
what they do with their subsidies--are often hidden behind the cloak of 
tax return secrecy, while the beneficiaries of conventional spending 
programs are usually to identify.

    Tax Expenditures: Spending by Another Name, Institute on Taxation 
and Economic Policy Brief #4, April 2004.
    As a result of these flaws, tax expenditures frequently prove to be 
expensive subsidy programs for which there is little or no oversight. 
Furthermore, they complicate the tax laws by straining the tax system's 
administrative resources; they generally involve unlimited or uncertain 
costs; they evade periodic budgetary review;and they are administered 
by an agency unfamiliar with the substantive problems addressed by the 
subsidies and unable to coordinate particular tax expenditures with 
subsidy programs administered by agencies having jurisdiction.
    It may be politically correct and socially popular to spend through 
the Internal Revenue Code, but doing so violates the basic tenets of 
classic tax policy: fairness, efficiency, and simplicity. Furthermore, 
the tax system should be designed to impose and to collect taxes, not 
to administer social programs. Therefore, if we can muster the 
political will, we should replace tax expenditures with nontax outlays.

                                 

    Chairman HOUGHTON. Mr. Goldberg.

 STATEMENT OF FRED T. GOLDBERG, COMMISSIONER, INTERNAL REVENUE 
                       SERVICE, 1989-1992

    Mr. GOLDBERG. Thank you, Mr. Chairman. I would like to echo 
my colleagues' sentiment in congratulating each of you and 
congratulating you collectively on your bipartisan efforts to 
simplify the Tax Code. I think that you--each of you on the 
panel, more than most, is seriously committed to this all 
important agenda. I am submitting a more detailed written 
statement for the record and will limit my comments to three 
areas. As a child of the sixties I believe we can have it all, 
so I am going to talk about having it all. I think in the short 
term, there are clear legislative priorities that are worth 
pursuing. The first is to enact a uniform definition of child 
and to simplify the earned income tax credit. The second is to 
simplify the appalling, unworkable array of education-related 
incentives. The third is to continue, under the leadership of 
Congressman Portman and Congressman Cardin, efforts to simplify 
the rules governing tax-favored savings and simplify and reform 
rules governing international taxation.
    Each of these areas merits prompt attention. Many affect 
tens of millions of Americans and represent our country's core 
values: family, work, education and savings. It is possible to 
make meaningful improvements quickly and with relatively modest 
revenue laws. Without change, we remain in the worst of all 
words. A complex system that distorts behavior is perceived as 
unfairly favoring the wealthy and leaving many working families 
unable to take advantage of the benefits that the Tax Code 
purports to offer. Second, a great deal of simplification can 
be accomplished in the short run through administrative 
actions. The current Administration deserves high marks for its 
recent efforts; however, much more can and should be done. 
Additionally, initiatives in the areas of form design, filing 
requirements, tax accounting and international tax would be 
particularly welcome.
    Simplification also requires changes in the way the IRS 
does business. Without question, the Bush Administration's 
split refund proposal is the most significant effort in this 
area. This universally acclaimed proposal would dramatically 
simplify savings and financial management by literally tens of 
millions of taxpayers and provide a platform for other policy 
initiatives in years to come. It has no material budget cost. 
Given its overriding importance, I encourage you to monitor the 
IRS in its efforts to carry out a commitment made by this 
Administration. Finally, I urge you and your colleagues to 
address the opportunity for fundamental reform. Each of us has 
referred to that area. In my judgment, the Federal income tax 
has served the Nation well for close to a century, but it is 
showing its age. The piling of complex provision on top of 
complex provision, coupled with changes brought about by 
technology, sophisticated capital markets, and global 
competition have left much of the system unworkable, and, in my 
judgment, beyond repair.
    True simplification requires fundamental change. Now, a 
simplification is a worthwhile objective. It does not provide 
sufficient impetus for tax reform. However, the tax system's 
perfect storm is on the horizon. Nothing can be done to delay 
or prevent its arrival later this decade. All of the following 
are certain to happen. The AMT is devouring our income tax. 
Temporary tax cuts enacted since 2001 will expire and the baby 
boomer generation will start retiring. The pressing need to 
deal with these issues creates a unique opportunity for 
fundamental tax reform. The question is whether Congress and 
the Administration will seize that opportunity in a bipartisan 
fashion or whether we will continue our futile efforts to patch 
the current rules. Simplification that could be accomplished in 
this broad framework are striking. One approach would be to try 
again what was tried in 1986: reduced rates, eliminate 
preference items. Unfortunately, the experience of the past 18 
years suggests that reforms along these lines may be short 
lived. The alternative is more fundamental change, proposals 
ranging from mandated conformity between book and tax 
accounting to a comprehensive business income tax.
    Others advocate replacing some of all the individual income 
tax or corporate tax or the payroll tax with a value-added tax, 
national sales tax or flat tax. All of these ideas have been 
around for a long time. They merit serious bipartisan 
consideration. Pretty much any combination would greatly 
simplify the system while reducing distortions and improving 
economic efficiency. I want to emphasize they can be 
accomplished in ways that maintain, increase, or decrease 
revenues and can be implemented in ways that maintain, increase 
or decrease the progressives of our system. Mr. Chairman, the 
system is far more precarious than many acknowledge and the 
benefits of decreased complexity far outweigh the cost of 
change. I congratulate you and your colleagues for your 
efforts.
    [The prepared statement of Mr. Goldberg follows:]
    Statement of The Honorable Fred T. Goldberg, Jr., Commissioner,
                  Internal Revenue Service, 1989-1992
    Chairman Houghton, Ranking Member Pomeroy, distinguished Members of 
the Subcommittee, thank you for the opportunity to participate in 
today's hearing on tax simplification. I am appearing at your request 
as a former IRS Commissioner. I am speaking on my own behalf and not on 
behalf of any client or other organization.
    Before beginning my remarks, I would like to note, as we say 
farewell to President Reagan, that the Tax Reform Act of 1986 
demonstrates how much can be accomplished in reforming the tax laws 
under the right circumstances and with the right kind of visionary and 
bi-partisan leadership. For reasons I note below, the opportunity for 
fundamental reform will come around again later this decade; the 
question is whether those in charge will rise to the challenge.
    I would also like to compliment you, Mr. Chairman, for your efforts 
to simplify our tax laws and for the noteworthy simplification 
proposals you introduced earlier this year. Likewise, your colleagues 
Congressman Rob Portman and Congressman Benjamin Cardin should be 
acknowledged for their long-standing commitment to simplification and 
their ongoing and successful efforts to simplify the rules governing 
tax-favored retirement savings. Ways & Means Committee Chairman Thomas 
and other members of the Ways & Means Committee, including Congressmen 
Neal, Johnson and Ramstad have also put forward meaningful 
simplification proposals.
    Unfortunately, despite these efforts, tax simplification remains 
everyone's favorite orphan. All of us involved in the tax system--
Congress, the executive branch, practitioners and taxpayers--proclaim 
our affection for this child of our dreams, but few are willing to 
adopt her as our own. The benefits of meaningful simplification include 
a more transparent and ``fair'' system; improved compliance and far 
less ``tax shelter'' activity; reduced burden, frustration and 
compliance costs for taxpayers; and more effective and less costly tax 
administration. To date, little has been done to reap these benefits 
and the prospects for substantial progress appear dim.
    What I find so discouraging is the gulf between what can be done 
and what's being done. It's not as though we are lacking for ways to 
simplify the system. Proposals introduced by you and your Congressional 
colleagues; the Bush Administration's pending budget proposals; the 
Joint Committee's comprehensive and compelling tax complexity report of 
three years ago; the joint recommendations of the AICPA, the Tax 
Executives Institute, and the Tax Section of the ABA--there is no end 
to the good ideas; what's lacking is their enactment into law.
    I will limit my remarks to three topics: short-term priorities, 
administrative action, and long-term opportunities.
    Priorities. Given budget constraints and limited legislative 
resources, it is important to focus on those areas with the greatest 
potential impact. My recommendations:
    (a) Enact a uniform definition of ``child'' along the lines of your 
proposal, Mr. Chairman, and simplify the Earned Income Tax Credit. 
These proposals have been around for a long time; they would be of 
great benefit to millions of Americans who are ill-equipped to deal 
with the absurd complexity of the current rules. Numerous different 
definitions of ``qualifying child'' appear throughout the tax code, 
causing needless taxpayer confusion when attempting to claim benefits. 
Further, the Earned Income Tax Credit provisions contain complex and 
lengthy requirements that exclude many deserving individuals and 
necessitate significant record-keeping. Individuals in complicated 
family situations face additional complicated rules. To ease taxpayer 
confusion and reduce Earned Income Tax Credit and other tax filing 
errors, the Bush Administration has proposed simplification in both of 
these areas; its five related simplification measures would provide 
important relief to low-income families. There is hope for enactment 
this year, and the time has come to get it done.
    (b) Simplify the appalling array of education-related incentives. 
Taxpayers are faced with many options to alleviate the costs of higher 
education. However, the mere number and perplexing intricacies of these 
benefits make it extremely difficult for taxpayers to choose and 
interpret the ideal option. The complexity is understandable but 
unnecessary, and the confusion it causes is intolerable. As evidenced 
by the Administration's recent proposals to consolidate benefits, 
simplify rules for expenses, increase the number of qualifying 
taxpayers, and standardize definitions throughout the code, the case 
for simplification in this area is compelling.
    (c) Simplify the rules governing tax-favored retirement savings. 
Congressmen Portman and Cardin have provided bi-partisan leadership in 
this area, with many successes to their credit. But more can and should 
be done. For example, while recent legislation has improved 
portability, there is still far too much friction in the system as 
workers' jobs and circumstances change. Likewise, the current IRA 
regime should be replaced by some form of the Administration's RSA 
proposal and a revised and permanent refundable Savers' Credit. These 
proposals would demonstrate that good policy and tax simplification go 
hand-in-hand. The so-called Roth IRA model (no current tax deduction 
and no tax on distribution) is vastly simpler than the traditional IRA 
(current tax deduction and tax on distribution). Taking savings out 
from under the tax system is far easier, and provides far greater 
certainty, than excluding wages and running the savings through the tax 
system. The combination of RSAs and a refundable Savers' Credit has the 
compelling virtue of universality and is of greatest benefit to low and 
middle income taxpayers.
    (d) Simplify and reform the rules governing international taxation. 
This is where the tax system is the most outdated, complex, and 
generally unworkable. Simple rules may be incompatible with a global 
environment in which many taxpayers are governed by different and 
conflicting tax regimes, but actions can and should be taken to 
minimize the extraordinary complexity of our current system. Economic 
activity has changed most rapidly in the international arena, and yet 
the underlying rules were created over four decades ago. While patched 
repeatedly, these rules are in need of serious overhaul. For example, 
the rules governing the foreign tax credit, passive foreign investment 
companies, and Subpart F income are complicated to interpret and apply. 
They should be substantially updated and simplified. I commend your 
efforts on a bi-partisan basis in this area, Mr. Chairman.
    Each of these areas merits prompt attention. Many affect tens of 
millions of Americans and represent our country's core values--family, 
work, education and savings. It is possible to make meaningful 
improvements quickly and with relatively modest revenue loss. As 
recently noted by tax professionals and behavioral economists, too much 
complexity and too many options create legislatively sanctioned 
planning opportunities for the few who are well advised, while 
bewildering most taxpayers. We are left with the worst of all worlds: a 
system that is perceived as unfairly favoring the well off, while 
leaving many individuals unable and unlikely to take the benefits the 
tax code affords. The simplification measures I described have vast 
potential to reduce opacity, ease compliance burdens and enforcement 
costs, and curb the corrosive effect of the current complex system.
    Administrative Action. A great deal of simplification can be 
accomplished through administrative action by Treasury and the IRS. The 
current Administration deserves very high marks for its focus on 
simplification and its accomplishments over the past several years. In 
2002, the Administration adopted multiple tax form simplification 
measures. It eased the filing burden on millions of small businesses by 
raising the gross receipts and assets threshold for filing Schedules L, 
M-1, and M-2 on certain corporate returns. Also in 2002, the Treasury 
and the IRS increased the limit for filing separate schedules for 
interest and dividend income. This has permitted millions to avoid 
having to file an additional schedule and allows many to file Form 
1040EZ when this would have otherwise been disallowed. The INDOPCO 
regulations, guidance regarding the cash method of accounting, 
procedures to stream-line Section 9100 relief and remedy inadvertent S 
Corp failures provide a few additional illustrations.
    Once again, however, much more can and should be done. Additional 
regulatory initiatives in the areas of tax accounting and international 
tax would be particularly welcome, although there are targeted 
opportunities throughout the Code and existing regulations.
    It is important to note the Bush Administration's simplification 
initiatives are not limited to guidance, form changes, and the like. 
They also include changes in the way the IRS does business. Without 
question, the Administration's ``split refund'' proposal is the most 
significant initiative in this area. There is a substantial need to 
increase household savings in America, and tax refunds are an important 
potential source. The ``split refund'' proposal could maximize this 
benefit of tax refunds for many families.
    Specifically, the Administration's 2005 Budget provides for the IRS 
to permit taxpayers to have their refunds wired to more than one 
account. The average IRS refund check is more than $2,000; for many 
families, this is the biggest single cash payment they receive during 
the year. The Administration's proposal has been universally acclaimed 
and--if implemented--would dramatically simplify savings and financial 
management by millions of taxpayers. Given the importance of this 
proposal, you should monitor closely the progress the IRS is making in 
carrying out the Administration's policy.
    Long-Term Need/Long-Term Opportunity. The Federal income tax has 
served the nation well for close to a century. The system, however, is 
showing its age. The piling of complex provision on top of complex 
provision--coupled with changes brought about by technology, 
sophisticated capital markets and global competition--have left much of 
the system unworkable and (in my view) beyond repair. True 
simplification requires rethinking the tax base and restructuring much 
of the system.
    While simplification is a worthwhile objective, it does not provide 
sufficient grounds for fundamental tax reform. (Perhaps it should, but 
it won't). However, the tax system's ``perfect storm'' is on the 
horizon. It will arrive this decade and nothing can be done to prevent 
or defer its arrival. All of the following are certain to happen:

          Unless modified, the AMT will devour the tax system. Without 
        changes to the tax laws, by 2014, the number of taxpayers 
        subject to the AMT will increase by a factor of fourteen 
        relative to the number of taxpayers subject to the AMT in 
        2003--from 3.3 million in 2003 to over 46 million in 2014 
        according to Treasury Department estimates. By 2013, the cost 
        of repealing the AMT will exceed the cost of repealing the 
        regular individual income tax. It is worth remembering that the 
        AMT was enacted on account of concerns about high income 
        individuals avoiding all income tax. Now its reach extends to 
        the middle class, which is clearly not what Congress intended.
          The temporary tax cuts enacted since 2001 will begin to 
        expire. Some temporary (and limited) AMT relief expired last 
        year and more expires this year. Across-the-board rate cuts, 
        the increased child credit, marriage penalty relief, and 
        various savings incentives expire in 2010. Phase-out of the 
        estate tax expires in 2010. The reduced tax rate on capital 
        gains and dividends, enacted in 2003, will expire at the end of 
        2008. The ten year cost (2005-2014) of making permanent the 
        rate cuts, reduced rates on dividends and capital gains, and 
        estate tax repeal would be more than $850 billion.
          In 2008, the first of the populous Baby Boomer Generation 
        turns 62, the earliest age at which Social Security benefits 
        can be claimed. Without substantial change in the system, 
        Social Security outlays will exceed payroll revenues during the 
        next decade, demonstrating that the so-called Trust Fund is 
        indeed a fiction and placing additional demands on general 
        revenues. By 2014, Social Security and Medicare outlays will 
        account for 42% of all federal spending and 8.4% of GDP.

    The pressing need to deal with these issues creates a unique 
opportunity for a fundamental reconsideration of our tax system. The 
question is whether Congress and the Administration will take advantage 
of that opportunity or continue futile efforts to patch the current 
system, a system that is beyond repair.
    The simplification that could be accomplished in this broader 
framework extends far beyond the few proposals I have discussed today. 
For example, many initiatives have been proposed to reduce complexity 
(as well as distortions caused by the current system) in the context of 
enterprise income taxation. The Treasury's 1992 exploration of a 
comprehensive business income tax (``CBIT'') is one such measure. Under 
CBIT, with the exception of small businesses in terms of gross 
receipts, all business entities would be subject to a uniform, 
comprehensive entity level tax rate regardless of their corporate or 
noncorporate form. Generally, CBIT would not impose further taxes at 
the owner level and would equate the treatment of debt and equity. 
Redefining the tax base in this manner, imposing a single rate of tax, 
and exempting small businesses would dramatically simplify the system 
and improve economic efficiency by reducing tax-based distortions.
    Another alternative at the enterprise level would be to mandate 
modified conformity between financial accounting and federal income tax 
rules. While some tax provisions permit or require conformity to 
financial accounting standards, many do not. This undermines financial 
accounting transparency, complicates IRS enforcement efforts, and 
increases the number of times a taxpayer must evaluate adjustments and 
compute income. Unifying various tax and financial accounting standards 
could alleviate many of the burdens imposed on both taxpayers and the 
IRS, promote transparency, and help deter tax shelter activities, 
without disturbing the distinct objectives of each regime.
    In the context of taxes on individuals, similar opportunities 
exist. One alternative would be to try--again--what was attempted in 
1986: reduce rates and eliminate tax preference items. Unfortunately, 
the experience of the past 18 years suggests that reforms along those 
lines are short-lived and that more fundamental change is required. 
Proposals to replace some or all of the income tax and the payroll tax 
with some form of consumption tax (e.g., a value added tax, national 
sales tax, or flat tax) have been around for a long time. They merit 
serious, bi-partisan consideration during the years to come.
    Whether in the context of individual, business entity, or 
international taxation, simplification efforts must be taken seriously. 
The system is far more precarious than many acknowledge, and the 
benefits of decreased complexity far outweigh the costs of change. 
Important changes can be accomplished in the short-run through targeted 
legislation and administrative initiatives. By the end of this decade, 
the coming storm creates the potential for fundamental change. I would 
like to commend this Subcommittee for your attention to this issue.
    I would be happy to answer any questions.

                                 

    Chairman HOUGHTON. Thank you very much. Of course, the 
question is not that we don't have a problem; the question is 
how do you get at it? Do you do the targeted, do you do the 
grand, do you do a combination? One of the things that we had 
suggested, that if you get rid of the AMT in one swipe, it 
costs you about $600 billion. If you phase it in, start it 
now--got to start--then it costs you about $260 billion. The 
pain isn't so great there, and it has enormous impact. If we do 
nothing--you have seen these figures, but 3, 11, 14, 17 million 
people a year just cutting right into the system. So, the 
question is, how do you get at it not only from a financial 
standpoint but from a political standpoint? What are those 
marks that we must look at now specifically rather than just 
waiting for the whole system to change? I would appreciate any 
other comments that you have. I know that, Mr. Cohen, you feel 
we shouldn't wait for the grand plan and do the targeted. What 
is the most important targeted thing we could do? Tell us.
    Mr. COHEN. AMT is the broadest----
    Chairman HOUGHTON. Would you phase it in or cut it out?
    Mr. COHEN. You have boxed yourself in. When you went to 
indexing you took--Congress over the years--I have been 
practicing tax law for 52 years, 53 years--Congress over the 
years kept the percentage of Gross Domestic Product (GDP) that 
was taken out through the tax system pretty consistent, but it 
would change it every 4 to 5 years, and when it would change 
it, there was a little juice, if you will, to spread amongst 
those provisions where you needed to spread the income. Now, 
having indexed the system, you don't have any surplus revenue 
to spread to the people, to the losers.
    Chairman HOUGHTON. I understand that. What do you do about 
it?
    Mr. COHEN. You have to bite the dang bullet.
    Chairman HOUGHTON. I would like to find what the bullet is 
to bite.
    Mr. CAPLIN. You may need a surplus to even play with 
offsetting tax increases.
    Chairman HOUGHTON. Or you could index the AMT.
    Mr. ALEXANDER. It would curtail the increase.
    Mr. GOLDBERG. I am with Mr. Portman on this issue. I would 
simply repeal the damn thing. I think we are fooling ourselves. 
By the end of this decade, the combination of expiring 
provisions, retirement of the baby boomers, the other pressures 
on the entitlement system, are going to require that we rebuild 
our fiscal house. In the meantime, as we heard today, there are 
real people suffering real costs and I wouldn't screw around 
with it. I would just repeal it. You can sunset the repeal in 
2010 and deal with that when you deal with all of the sunset 
provisions. I think we are monkeying around and just ought to 
do it.
    Mr. ALEXANDER. That is the time bomb that goes off. You 
have to remember that it does go off. We are going to have to 
find some money somewhere and that is going to be really 
difficult. If we take all the little ornaments--that most 
people would agree are ornaments and don't belong in the 
Internal Revenue Code--out, then some of those have 
constituencies that are going to be very unhappy about the 
removal of their particular ornament and they are going to let 
you know about it. So, that is going to be a real problem for 
you. If, on the other hand, you address the AMT the way it 
should have been addressed way back in 1986, that is, what if 
we don't cut the rates by the last 2 percentage points, do we 
need this monster? Can we get by with a little monster that 
might grow, but might take 100 years to grow up to be a big 
monster? Maybe we could have done it, but we didn't.
    Chairman HOUGHTON. I am going to turn to Mr. Pomeroy.
    Mr. POMEROY. Mr. Chairman, the explorer Ponce de Leon 
roamed all over the Southwest looking for the fountain of 
youth. Hell, he should have gone to the IRS building. It is 
obvious that the commissioners have tapped into it there. The 
vitality and energy you still exhibit as our witnesses, there 
must be something in the water over there. The Native Americans 
I am proud to represent back in North Dakota have a culture of 
listening to the elders. I believe that the Committee on Ways 
and Means ought to have you in about every month just to hear 
your opinion about putting a historic context on what we are 
wrestling with.
    Mr. CAPLIN. Tax collections is one of the lifeblood of the 
Nation. When you live in that environment, they roll right 
through us and keep each of us going.
    Mr. GOLDBERG. I think we are all meaner than snakes.
    Mr. POMEROY. I have enjoyed this panel enormously. I would 
ask you a couple of other issues. We are heading toward a train 
wreck. In the absence of pressing leadership, we are going to 
have another fiscal disaster on our hands and we will have to 
do something, and maybe this gets to the perfect storm that 
will pave the way for very substantial tax clarification, 
simplification. This business of the budget. We are in a fiscal 
disaster and that means there is no money to address everything 
that the constituencies are asking us to address. That is going 
to place enormous pressure on the Tax Code. I have seen it 
build in the 12 years that I have served in Congress, and I 
believe that is going to build a great deal in the years ahead. 
Second, I would like your answers on this one. Our political 
system is more expensive than it has ever been and more 
dependent upon campaign fundraising, which places really the--
those seeking some agenda in the Tax Code in a very powerful 
position, especially if they have financial resources to play 
significantly in a political year to drive a legislative 
agenda. Have you noticed an acceleration of these tax changes 
as we moved into the modern era of campaign finance reform?
    Mr. CAPLIN. I think the fact that the Washington Post has 
devoted a specific portion of its paper to following the 
activities of new lobbying firms and new additions, this has 
become an unbelievable industry in the time I have been here.
    Mr. COHEN. Once the genie gets out of the bottle and people 
learn there are more effective ways in dealing with these 
issues than trying to deal with the substance of the issues--
that is, going to you folks for legislative solution--once that 
genie is out of the bottle, then, of course, everybody knows 
how to do it now so everybody joins. So, you have lobbying from 
A to Z on every particular issue from every particular point of 
view. You can't--it is hard to stuff that genie back in the 
bottle.
    Mr. POMEROY. I believe the demise of the legislative 
process around here is in no one's interest. Certainly not a 
partisan interest, not an ideological interest. The place 
doesn't work like it needs to work in a transparent and fair--
we are the world's greatest democracy and it doesn't function 
like that. Rather than substantive issue addressing through a 
straight-up legislative process, you simply buy your way into 
the Chairman's mark.
    Mr. COHEN. I remember Mr. Mills, when he was Chairman of 
this Committee, in an executive session putting down a number, 
saying we won't talk about that because the issue was a very 
narrow-based issue. That can't happen today. Number one, we 
have all open hearings as opposed to closed executive sessions, 
as we used to have then. Two, the lobbyists won't let it 
happen. They are sitting there and they are watching. So, if a 
Congressman or Senator has promised to bring the issue up, he 
has to do it and he has to act serious about it, and all that 
takes time and energy and some of it works.
    Mr. POMEROY. Well, the hearings are public, the 
deliberation on a bill is public. Basically our work product 
generates from a mark brought in from somewhere. I don't mean 
to talk about this Committee or particular leadership of this 
Committee generally. There is no transparency in terms of what 
is plunked down in front of us at the beginning of a hearing. I 
am out of time, but I would like you to comment on these 
issues, demise of the legislative process or the role of 
campaign financing in terms of the provision of the Tax Code.
    Mr. ALEXANDER. I am not sure that things are demonstrably 
worse than they were back when I was working for IRS. Back 
then, I was greatly concerned about highly successful lobbying, 
in fact, highly successful lobbying that in my judgment 
prevented the IRS from being able to produce a better computer 
system than my distinguished predecessors had--well, they had a 
great computer system at that time, and we still haven't gotten 
our new computer system. One of our problems was from very 
successful lobbying in my time. I don't know about your time.
    Mr. GOLDBERG. I don't know if is as grim as you describe. I 
think the work that Congressman Portman and Congressman Cardin 
have done really has made the retirement system better than it 
otherwise would have been; 1986 isn't all that long ago, and 
there were folks who really did a remarkable job. I don't think 
it is hopeless. I think we have to keep in mind that the 
government is laying claim to 35 percent of the income of all 
workers at the high end and all businesses at the high end. 
That is a big profit share and I have my 100 shares of IBM. So, 
the stakes are very real and very serious. We have exactly what 
we designed is my response to your question. I think the issue 
is whether it is possible to put a collective good where it 
belongs to design a system that reduces these kinds of 
pressures. I don't think there is a final solution. I think 
Jefferson's notion of a revolution every 12 years is a good 
idea. It is trying to strip it off and start over, 
recognizing----
    Mr. CAPLIN. He wanted to do it every 10 years.
    Mr. GOLDBERG. I am more conservative. I don't think we have 
a choice. I think when you look at everything that is out 
there, the entitlement programs are fiscally a mess. I think 
that we are going to be forced to deal with the reality that 
all of us folks want to face today, and I think in that 
context, I think it is possible to do enormous good and I think 
you and your colleagues show that it is possible to work on a 
bipartisan basis for the good of the country.
    Mr. POMEROY. If I believed it was hopeless I wouldn't be 
here. I do think we have to understand very clearly the 
pressures so that as we look for that perfect storm moment, we 
know how to put it together. Thank you all very much.
    Mr. CAPLIN. I taught tax law for some 30 years and the 
general approach over this period of time was you had a 
problem, you worked it out with the IRS. You didn't call on the 
Hill. This was the worst thing you could do in a controversy, 
try to go to the Hill. Today the style is changed. The tendency 
is to go up to the Hill and deal with the Congressmen and put 
it into law.
    Chairman HOUGHTON. Mr. Portman.
    Mr. PORTMAN. Thank you, Mr. Chairman. I thank the witnesses 
for their testimony and their perspective, because Mr. Pomeroy 
is absolutely right. It is good to get that historical 
perspective as we think we are dealing with these new issues. 
Most of them have been dealt with before, some successfully and 
some not so successfully. We do get things done around here on 
a bipartisan basis that is focused on the public good. Mr. 
Pomeroy has been a big part of that. On the retirement 
legislation, some of his provisions went in almost as he wrote 
them, as opposed to the way perhaps the Committee Members would 
have, and it is a tribute to him working with the folks in the 
retirement community that know about these issues. So, we do 
have some hopeful examples, Earl.
    On taxes, I guess my feeling is as we said earlier, the AMT 
philosophically is not something we should have in our system, 
and yet you have this huge revenue loss due to the fact that it 
is taking more and more revenue every year and that would be, I 
suppose, a microcosm of the bigger issue we face. If we are 
going to go to big bang tax reform, which I support, over the 
next couple of years, then maybe we ought to stop the 
tinkering, allow the pressure to build, and then do the right 
thing, whatever that is. On the other hand, if it is just not 
going to happen for all kinds of reasons as it hasn't for 18 
years, it is our responsibility as Members of this Subcommittee 
to try to figure out ways to simplify in small ways. Again last 
night, I would argue we did some of that. Yes, we complicated 
the Tax Code in certain ways with that legislation that is 
going to be on the floor later this week. On the international 
side, we actually put in place some reforms that make some 
sense, that simplify the Tax Code and will help with compliance 
costs and our competitiveness.
    So, having said all that, let me ask you if I can, a 
question about a specific reform proposal, and this would be 
something that would be in the big bang category. I want to get 
the input of all four of you if I could. Starting with 
acknowledging that we currently have not one tax system, but 
several tax systems. We have a gift and estate tax law system. 
We have an AMT tax system. We have an income tax system for 
individuals. We have a corporate tax system. I would start by 
removing all of those. So, having none of the existing systems 
in place. Then putting in place a consumption tax. My personal 
preference would be a value-added tax, because I think it is 
much more easy to administer, much more efficient and much more 
likely to be successful in our complicated economy. Instead of 
millions of transactions a day, you would have thousands of 
transactions a day. The value-added system, as you know, is 
used by all of our competitors now with the possible exception 
of one country in the developed world, and so we have a lot of 
experience on that. That value-added system, the VAT (Value 
Added Tax) tax would take the place of the corporate income tax 
system in essence. There wouldn't be a corporate tax--solving 
one of our many competitiveness issues we talked about last 
night in this Committee room.
    Then you would have another tax system on top of the value-
added tax system, and it would be a flat rate for individuals 
who have income, defined under the current definition of 
income. It is very complicated, but it would be wage income and 
so-called unearned income. You would choose a number. I would 
choose $125,000 because that is roughly the top 5 percent. You 
would index that to inflation if you did this based on the 
numbers that I have had run for me. If you had a rate that was 
in the high teens for the VAT tax, high teens, maybe low 
twenties for the low rate, you could end up with revenue 
comparable to the revenue we have today. I am not taking into 
account the enormous impact positively on the economy this 
could have and should have in terms of compliance costs being 
reduced and encouraging savings and investment. You would have 
95 percent of the people currently dealing with the IRS and the 
Tax Code no longer involved with that. I just wonder what you 
think about that just as a big bang idea. I am jumping way 
ahead. I believe in Mr. Caplin's idea of a commission, and I 
think it needs a lot of legitimacy, and why people like you 
want it. What do you think about that?
    Mr. CAPLIN. I am intrigued by that very much. I know 
professor Michael Graetz of Yale has written on this, and he 
has a book that goes into that. I really think that this so-
called $311 billion annual tax gap understates the picture. 
That estimate deals with so-called legal income only. It 
doesn't touch illegal income. You reach far over $500 billion 
very easily if you start expanding the study. I think we need 
another sieve in collecting taxes. I think there ought to be 
some form of VAT or sales tax underneath the income tax system. 
I think it ought to be explored. I think it is worthy of 
consideration.
    Mr. COHEN. Well, I am not a VAT or consumption tax person. 
The British experience is interesting. I have spent time with 
the British folks who administer the VAT. I spent several days 
with them. The Auditor General of Britain just issued a report 
on the VAT. I think there is a 17 percent evasion of the 
British VAT. It is approximately equal to our evasion of income 
tax. If you forgive me a moment of personal reflection, I was 
driving back once in the late sixties from the airport from 
Santiago, Chile, and a car passed us and it had a little 
platform built on the back of the trunk. I didn't pay attention 
to it until I saw two or three like it. I turned to the 
economic counselor at the embassy who was driving and I said, 
What is that? He said, ``That is a truck.'' The excise tax on 
automobiles imported into Chile was 300 percent. The excise tax 
on trucks was 50 percent.
    So, you get into the same definitional problems some have 
with the income taxes. The British had this described to me 
vividly, running through the definition of everything, because 
you won't enact a VAT that is pure and one-rated; you will 
enact the VAT that has got exemptions and multi-rated. By the 
way, I think there is one or two in the world that are pure. 
So, those are the problems. You see, nothing is pure because, 
as I said, that genie is out of the bottle. We now know how to 
deal with these issues. All of us good guys or bad guys, as the 
case may be, will come at you with these problems and you are 
going to have to deal with them.
    Mr. CAPLIN. We had that same problem with the excise tax.
    Mr. COHEN. We repealed all excise taxes while I was in 
office, all except three or four, because they were too costly 
to administer.
    Mr. PORTMAN. Good point in keeping it broad. I think you 
need to have it broad based and keep the rate lower, too.
    Mr. ALEXANDER. Back to the VAT, I think that Professor 
Gratz's VAT would be a VAT that would replace the income tax on 
individuals below a fairly sizeable income level. Whether the 
income level was $200,000 as one of the Presidential candidates 
was suggesting should be the tip point. I am not sure. I think 
a credit-invoice VAT--it would have to be a credit-invoice and 
not a subtraction VAT. Subtraction VATs aren't much better than 
our old excise taxes were. I think a credit-invoice VAT would 
work--sure it will get loused up after a while. We are better 
at complicating things than we were a few years ago. It might 
take us a little while to complicate the VAT. If you zero rate 
it for food, you could have a VAT that makes sense from the 
standpoint of ability to pay. Then you might have an income 
tax, if you wanted to supplement that with an income tax for 
higher income individuals. You might keep an income tax, or you 
could change the VAT, of course, for corporate entities. You 
would have to deal with the fact that I guess you dealt with 
last night, that some businesses are conducted as subchapter 
(C) entities and some are pass-through entities. I know that is 
a problem that concerns the Chairman, and rightly so.
    Mr. PORTMAN. Just one quick comment on that, and Mr. Tanner 
has been patient, and the Chairman, but I would want to repeal 
the corporate income tax, which is going to be controversial, 
and that is different from the proposal by Professor Gratz, and 
that would require additional revenue. That amount of revenue 
is shrinking as a percentage of our total revenue.
    Mr. COHEN. The corporate income tax was a third of our 
income tax when we were in office. It is now around 10 percent.
    Mr. GOLDBERG. Just a couple of observations. One, you could 
look at the consumed business income tax, comprehensive 
business tax replacement for the corporate tax. I think the 
difficulty with value-added tax is the overall progressives of 
the tax system. As I am probably the far-right guy on this 
panel, I am little uncomfortable raising that, but I think it 
is terribly important. Another piece you want to put in the mix 
is what you are going to do with the payroll tax. We need to 
deal with entitlements. I think if you would replace the 
payroll tax, for example, with the consumption tax, it is a 
much more progressive levy. I think you would want to put that 
in the mix of what you are thinking about. Having said that, 
the path you are describing is the right and probably the only 
plausible path to go down in the years ahead.
    Mr. PORTMAN. Thank you, Mr. Chairman.
    Chairman HOUGHTON. Thank you. Mr. Tanner.
    Mr. TANNER. Thank you, Mr. Chairman. I also want to thank 
all of you for being here. I have enjoyed thoroughly this 
panel. It has been something that I think we need to do more 
of, and that is talk to people who have been there. People who 
are sitting up here today think they are inventing the wheel 
oftentimes instead of realizing that mostly everything that has 
been talked about has been talked about before, just by 
different people.
    I think I get the consensus that we are in a mess and we 
need to do something rather dramatic with our Tax Code, our tax 
system. I think I am correct in assuming we all believe we are 
in a place we don't want to be with respect to our Tax Code. If 
that is true, I want to ask how we bridge the gap that we have 
immediately to that day when we have the consensus, both inside 
and outside, to enact a big bang tax reform. Here's where we 
are. This country now owes in hard dollar numbers about $4 
trillion. This country--we on your behalf have raised the debt 
ceiling $2 trillion in the last 36 months. Last year this 
government spent $370 billion more money than we had, 70 
percent of which was bought not by American citizens but by 
foreigners. The central bank of Beijing has increased the 
holdings of our paper by over 100 percent over the last 26 
months. China and Japan, Asia, we will say, owns almost over 
$900 billion of our paper. We will approach a $500 billion 
deficit this year; could go more, depending on what happens in 
Iraq.
    The best that we have been able to discern from the budget 
that we passed, assuming a 4 percent rate of growth in the 
economy, is to cut that in half in the next 5 years. That means 
we are going to borrow another trillion dollars if we reach 
that goal, assuming a 4 percent rate of growth in the economy. 
Now, Commissioner Goldberg said we have to face reality. This 
reality is that we are spending far more money today than we 
have. We are borrowing money from virtually anyone in the world 
that will lend it to us. When that day comes when they don't 
see the world as we do, they will have enormous leverage, in my 
judgment, owing to the policymakers that sit on that day, 
because we will owe them so much money that they will be able 
to exercise undue influence, if you will.
    Now, my question is, with that background--and I don't 
think anyone would dispute what I have said, it is right out of 
the Treasury reports on where we are--with that background, 
Commissioner Goldberg, you said we needed to repeal the AMT 
right now. I would love to do that. With this background and 
putting that much more on the red-ink pile we are building, how 
do we get--in this interim, how do we keep from going another 
trillion or $2 trillion in the red? This is just an aside; I 
believe it is the largest tax increase in history. The reason I 
say that is because at 5 percent, $2 trillion is going to cost 
the American taxpayers $100 trillion a year, every year. Five 
percent is fairly cheap if China, for example, Japan, Saudi 
Arabia or anybody else we owe money to, said we don't want the 
interest check, we want the money; then I know of no other way 
we get it than to auction it to whoever will buy at whatever 
price it takes to refinance.
    I just think this is a national security matter. I have 
talked a lot about it on the floor. I have written op-eds about 
this foreign holding. It is true that the deficit has been as a 
percentage of our GDP this high before. What is different is 
most of that debt was bought by Americans; war bonds, savings 
bonds. This debt is being financed by foreign interest. I think 
that is a huge difference, number one, from the national 
security standpoint. Number 2, under our present budget we are 
operating on, we will never get back to balance. If the best we 
can do in 5 years is cut it in half, assuming 4 percent rate of 
growth in the economy, which is not a small number, and then if 
we make the tax cuts of 2001 permanent, knowing the baby 
boomers are going to retire in 2012, if you can figure out how 
2 and 2 is going to make 4 in that situation, I sure would be 
glad to know it, and I just can't get there. I made my speech.
    Chairman HOUGHTON. Let me interrupt, though, because one of 
the parts of this piece of legislation that we have is 
literally phasing in the elimination of the AMT, so by the end 
of 2013 you wouldn't have any AMT at all, but you would start 
working on it. It would be $10 billion in 2006 and $26 billion 
in 2008 and so on and so forth. So, that you don't take it in 
one great huge lump, because I don't think the system can 
handle that. You are going to get at it in some way, and it 
would be nice to have a value-added tax and I think that would 
be great. We could do it. From a political standpoint, you can 
see what happened in Canada when that went through and the 
Conservative Party went from 150 to 1. Now, maybe it will come 
back on June 28. There has got to be some way of starting that 
process and also starting the education. Maybe you ought to ask 
the question.
    Mr. GOLDBERG. Mr. Tanner, I think there are serious 
structural issues relating to the entitlements program and 
relating to the tax system. I think one of the difficulties we 
have is we run the government as a cash-method person and the 
rest of the world doesn't function as a cash-method person. I 
believe at the end of the day, long-term financing is going to 
be necessary as part of a restructuring. That is just what is 
going to happen.
    I think the current deficits as a percentage of GDP are 
actually materially lower than they were 20 years ago. I think, 
while foreign ownership of debt is an issue--and I agree with 
you, it is in some sense a national security issue--I think the 
fundamentals of our political economy and society are such that 
I don't think people are going to take a hike. I can't sit here 
and listen to these folks tell the stories they have been 
telling you. I can't listen to the stories about the EITC 
recipients who are just being torched, and say in the scheme of 
the issues we are facing, yes, the deficit is a terrible 
problem, but I think it is so broke that there is an 
opportunity to do some very good things for very real people 
over the next 2 or 3 years while those responsible for policy 
figure out how we are going to restructure these various 
programs.
    Frankly, I think fixing the AMT over the next years, fixing 
the EITC, fixing the definition of a child, those are rounding 
errors in the context of the difficulties we are facing. When 
you try to strike a balance, I don't understand why you don't 
strike the balance the same way, and say we know this thing is 
messed up for the reasons you are saying, but in the short one, 
get off these people's backs.
    Mr. COHEN. Politically we have gotten ourselves in the 
view, or many people into the view, that it is a dirty word to 
say raise taxes. When President Johnson was in office, I was 
one of those people who told him 2 years before he did to raise 
taxes, because I could see what was happening. In any event, he 
did have a surtax in 1968. That year was the first surplus in 
many, many years and it was the last surplus before those 3 or 
4 years in the nineties. There is such a thing as saying you 
have to pay the piper. You could either keep the present 
corrupt system that we have designed, or you can go honest and 
tax yourself what you need to tax yourself in order to do the 
right thing. Getting rid of the AMT is the right thing, and the 
only thing to do it is to pay for it. Now, whether you pay for 
it over 3 years or 5 years or over 1 year, you need to sit down 
and say we need to address this now. Let us see politically 
whether we can do it in 3 years or 2 years or if it is going to 
take us 7 or 8 years, but you need to deal with it.
    Mr. CAPLIN. In the olden days, we tried to present tax 
packages in a balanced way. If we cut rates or something, we 
tried to really close special privileges or preferences. We 
tried to balance it out. We seem to have forgotten that in 
recent years. I think we ought to stick to this balancing of 
our tax legislation. Also we have the whole question of Social 
Security. What are we doing about that? We had commissions 
before. They have made recommendations. We need to follow up in 
terms of what has to be done.
    Chairman HOUGHTON. Well, gentlemen, I hope we continue to 
tap into your knowledge, because this thing is not going to go 
away and we are not going to be able to solve it this 
afternoon. I thank you on behalf of all of us for your wisdom 
and guidance. I hope that Ms. Doherty and Ms. Maresca and Ms. 
Parshall have gotten something out of this discussion in 
addition to your own testimony. So, we thank you very much.
    [Whereupon, at 3:55 p.m., the hearing was adjourned.]
    [Submissions for the record follow:]
          Statement of Timothy J. Carlson, Arlington, Virginia
    I am writing to request your help in a serious and urgent matter 
threatening to destroy me and thousands of other hardworking, 
productive taxpayers. The IRS has filed liens on my friends' assets, 
and is weeks--if not days--away from filing liens on my assets also. 
After the IRS is done with me, I will be penniless with no apartment or 
car, and no matter how hard I work I will have to live on less than 
$1,000 a month for many years, despite having already prepaid over 
$850,000 in excess of any tax actually owed, a tax rate of over 350%. 
And all this because I was honest.
    Please allow me to provide some background on who I am, to give 
some context for the situation I describe below. My father was a 
minister and my mother a stay-at-home housewife in a small town in 
Minnesota. I worked my way through college and law school pursuing the 
American dream. I am currently the Broadband Communications Group Team 
Leader for Legal Affairs at Texas Instruments. Prior to that I was 
General Counsel for Telogy Networks, an entrepreneurial software 
company. I am Vice President of Childhelp Virginia (a child abuse 
prevention and treatment organization) and have worked for years with 
World Vision (an international charity) in its children's programs. 
Prior to the situation described below, I donated tens of thousands of 
dollars to World Vision Africa AIDS Orphans projects, DC Inner City 
work, and to Childhelp. For years I have supported my retired parents 
by contributing to the mortgage for their modest retirement home in 
Minnesota, and have helped to pay for high school and college tuition 
for several other family members.
    I describe my life merely to show the kind of hardworking, 
productive people being negatively affected by the unintended effects 
of the Alternative Minimum Tax (AMT) as applied to Incentive Stock 
Options (ISOs). I also hope to show you that the ripple effects go far 
beyond the victims themselves, but also affect their families, their 
ability to work with and support charitable organizations, and of 
course their ability to engage in productive and entrepreneurial 
activities.
    After three years of struggling to work out a compromise with the 
IRS, the IRS has rejected my offer in compromise (OIC) for my 2000 tax 
liability (more than $1.6 million with penalties and interest). In a 
letter I received on June 18, 2004, Joel Goverman, Area Director for 
the Small Business Self-Employed Office in Baltimore, assured me that 
the IRS has conducted ``a thorough review of [my] particular issue . . 
. before preparing a final response.'' Yet, upon even cursory analysis, 
the stated reasons for rejecting the offer are so illogical and 
irrational as to approach the bizarre. I mean no disrespect to Mr. 
Goverman, who I realize is just the messenger in this situation and I 
apologize in advance if my writing becomes too colorful or strident, 
but the situation is so strange I hardly know how to convey it 
otherwise.
    The first reason stated for rejecting my OIC was that ``based on 
the financial information you submitted, we have determined you can pay 
the amount due in full.'' Mr. Goverman concurred with this analysis and 
suggested that the Taxpayer Advocate did as well. However, given the 
facts, this is nothing short of Kafkaesque. I have nowhere near the 
$1.6 million that the IRS currently seeks. The Taxpayer Advocate 
determined that the IRS was overestimating my ability to pay by more 
than $650,000. I earn less than $175,000 a year and have already 
offered all of my tangible assets to the IRS. For years the IRS has 
insisted I have money I simply do not have.
    Even if I could pay the amount in full, the IRS could, and should, 
accept my offer based on something called Effective Tax Administration. 
``Effective Tax Administration,'' as Mr. Goverman (and published 
regulations) noted, ``is only applicable if . . . requiring full 
payment would create an extreme hardship, or if collection of the full 
liability would be unfair, inequitable and would adversely impact 
voluntary compliance by other taxpayers.'' The second reason stated for 
rejecting my OIC was that ``we have determined that [to accept your 
OIC] would have a negative impact on compliance by the general 
public.''
    After years in law school and practicing law, I can not understand 
the ``logic'' of the assertion that accepting my offer will ``have a 
negative impact on compliance by the general public''). What taxpayer 
is going to look at my case and think
    OK, let me get this straight, I have two choices:
    Choice One, under the regular tax code I am not required to pay any 
tax when I exercise ISOs. The regular tax code encourages long term 
investment by offering more favorable long term capital gains rates if 
hold the stock for at least one year. Of course, if I report under the 
AMT code I will owe prepayment taxes that will destroy me and my 
family, but if I do not report the transaction the IRS is unlikely to 
catch it because the government has no ``checks'' or information 
reporting requirements in place to find out about the exercise. If I 
don't report under AMT I'm not really cheating the system because I 
haven't realized a dime in profits yet because I haven't sold the 
stock, and I intend to fully pay my regular taxes once I do so. 
Technically, I suppose this is wrong. But, by not reporting I avoid 
destroying my life and, in the end, I still fulfill my duties as a 
citizen and a taxpayer when I sell my stock and then report and pay my 
fair share of tax.
    Choice 2, under the ISO AMT provisions, if I report my ISO exercise 
and disclose those phantom profits then I will be complying with an 
unintended quirk in the tax code that makes me prepay based on tax 
rates that exceed 350% of my actual income. I can always ask the `more 
friendly' IRS to please recognize the irrationality at work and give me 
a `break' by making me overpay `only' 200% rather than more than 350%. 
After all, the legislative history relating to offers based on 
effective tax administration tells the IRS it has broad discretion to 
accept offers based on public policy.
    Of course, the IRS will reject my offer despite the legislative 
directive. It will charge me interest and penalties on the amount I am 
unable to pay, liquidate all my assets and garnish my wages for several 
years, leaving me destitute and destroying any incentive I have to 
work. It does not matter that the IRS position of not compromising any 
AMT liability is based on some secret memo that it will not disclose to 
taxpayers and their representatives. The AMT I am able to prepay 
through borrowing and selling other assets, will become a `credit' that 
will take hundreds of years to recoup at the $3,000 per year maximum.
    ``So in conclusion, I guess the IRS policy makes a lot of sense; I 
really should report my ISO exercise and be forced to pre-pay tons of 
taxes on income I haven't received yet. It's okay that this will mean 
that I'll lose my house and car, because I will have millions of 
dollars of tax `credits' that I can recoup in $3,000 per year 
increments. And really, I want to work more than 60 hours a week to 
live on less than 1/5 of my salary while the rest goes to build up more 
useless tax credits. My family will understand that I can no longer 
contribute to sending the kids to college, and that I will need their 
help in the years to come because I can no longer save for my own 
retirement. I will have the satisfaction of knowing that I reported 
honestly, while those who snubbed the law and did not report their AMT 
liabilities enjoy their ``ill-gotten'' gains.''
    As is obvious from the imaginary internal dialogue above, in fact 
this policy to blindly force an outdated, unfair and unjust law in no 
way encourages compliance, but rather presents taxpayers a Hobson's 
choice--use `self-help' by not reporting ISO exercises or face the 
blind, financially devastating, life-altering enforcement of an unjust 
and unintended tax law.
    Mr. Goverman suggested that a special Effective Tax Administration 
Group in Cincinnati had reviewed my file and determined that my offer 
did not meet the criteria because ``the position that the tax law 
itself is in [sic] inequitable is not a basis for an ETA offer. As you 
are aware, the authority to change the tax law rest [sic] with 
Congress.'' Unfortunately, with the exception of the last clause, which 
properly notes that Congress has the authority to change the law, his 
statement is patently false. The Cincinnati committee never received my 
file because an IRS agent who acts as ``the gatekeeper'' saw my tax 
liability was due to the AMT/ISO problem and sent it back. This agent 
said that the IRS does not have the authority to accept any compromise 
of an AMT liability because only Congress can change the law. The agent 
could not cite any authority for his statement, nor could he explain 
how compromising an AMT liability was any different than compromising 
any regular tax liability.
    Moreover, my request for an offer in compromise is not based on the 
blanket assertion that the AMT law is inequitable. I have only ever 
asked the IRS to focus on the individual circumstances of my case. The 
only way I could have had the money to pay this exorbitant tax was if I 
would have sold the stock before it started dropping in value. 
Unfortunately, a sale at that point could have subjected me to the risk 
of insider trading in violation of SEC guidelines. It is difficult to 
find a time when I could have sold the stock without risking a possible 
investigation by the SEC or state attorneys generals because of my 
position and the rapid and continued decline in the stock's price. How 
can the government stated public policy to encourage strong corporate 
governance practices if taxpayers must choose between complying with 
tax law and securities law?
    Accepting my offer in compromise (and, truthfully, those of many 
others who were caught by the AMT/ISO labyrinthine rules) will 
encourage voluntary compliance. Further, it would and would be more 
fair and equitable than forcing hard-working, middle class people into 
bankruptcy to pay a tax on phantom gains they did not receive because 
they continued to invest in their employers and the economy as the 
government encouraged when it created ISOs. Congress has already 
recognized that the stock market crash in 2000-2001 was a unique event 
divorced from the normal market risk that investors assume. Congress 
has enacted a number of tax cuts and other reforms to stimulate the 
economy and provide relief to ailing taxpayers. It should do the same 
for the hardworking individuals and families who have been financially 
ruined by the ISO AMT rules as a result of that crash.
    My case as described above is not imaginary, and the facts are not 
hyperbole. And, tragically, I am not alone. Thousands of similarly 
bizarre cases have arisen across the country. The IRS decision to 
blindly enforce an outdated, misguided and misapplied AMT/ISO tax 
provision (which became even more absurd in the context of the market 
bubble burst) is ruining the lives of good citizens in practically 
every state in this country.
    I would never have believed this could happen in America if I 
wasn't living through it. I encourage you to first (1) as an interim 
measure, instruct the IRS to accept reasonable offers in compromise for 
ISO AMT liability to prevent honest taxpayers from being destroyed by 
this tax before proper legislation can be passed, and then (2) adopt 
focused legislation amending the AMT as it relates to ISOs to restore 
fairness and justice to a system gone severely awry. Like me, ISO AMT 
taxpayers are willing to pay taxes on actual gains and recognize the 
risks of losing an investment in the stock market. Our actions and 
intentions were honorable and consistent with Congressional policy, and 
hurt no one but ourselves. In fact, our faith in our companies and 
refusal to foist losses an unsuspecting public is exactly the kind of 
behavior the government should encourage--not punish. I am not asking 
the government to replace my lost investment; I am simply asking the 
government not to collect taxes as if the investment was never lost.

                                 

   Statement of Efrain Rodriguez, Jr., Father's Rights Association of
                      New York, Mahopac, New York
    I am Efrain Rodriguez, Jr., President of the Father's Rights 
Association of NYS.
    I thank the Committee for allowing us the opportunity to be a part 
of this system of government.
    There has been a bill, H.R. 86 which would call for, among other 
things, the ability of a parent who is paying Child Support to be able 
to deduct such support from their Federal Income Tax. I am not sure if 
this bill is still active or whether it has been re-numbered.
    Sir's, the Child Support System in this country is a train wreck. 
While the Father's Rights Association agrees with its tenet, it is the 
way it is administered and assessed that cause the most frustration and 
sadness for Non-Custodial parents, many who have to choose between 
paying their support and supporting their own basic needs. We have many 
members who are forced to move in with family and friends who cannot 
pay their own rent or provide for their own basic needs. And with the 
current Poverty Level of $12,123, where can a parent go and live on 
that? Also, in most states, Child Support is based on a parents Gross 
Income and taken from their Net Income with make that number almost 
untenable, especially when that number does not take into account that 
payers personal expenses.
    Therefore, the Father's Rights Association of NYS respectfully asks 
that the Ways and Means Committee consider hearings on the impact Child 
Support has on the payers, the so-called ``Dead Beats'' who for what 
ever reason cannot come up with their support obligation and still 
maintain their own standard of living. We are NOT an organization of 
``deadbeats'' who are trying to shirk their parental responsibility to 
our children. We just want the same opportunity as everyone else to 
live and grow with our children and not have to choose between being a 
parent and supporting oneself at the very bare minimum.
    Further, we propose the following changes to the current Tax 
Formula:
    Any parent who pays Child Support be allowed to deduct that amount 
that is paid to supporting their children from their Federal and local 
taxes. This will serve two purposes; encourage more parents who 
currently not paying their support to give an added incentive to paying 
and, this will take that ``bitter taste'' put of the mouths of parents 
who feel that they pay this support and have nothing to show for it, 
especially the inability in many states to know what the custodial 
parent does with the money.
    Thank you for your time and attention to this very important 
matter. If there is an opportunity to speak to the committee in person 
I am available to do so.

                                 

           Statement of David R. Klaassen, Marquette, Kansas
    Thank you for allowing me to provide this written statement 
explaining how the Alternative Minimum Tax has affected my family and 
how it continues to affect my family today.
    My name is David R. Klaassen. I am a resident of McPherson County, 
Kansas, duly admitted and licensed to practice law in the State of 
Kansas and before the United States Tax Court, the United States 
Bankruptcy Court for the District of Kansas, the United States District 
Court for the District of Kansas, the Eighth and Tenth Circuit Courts 
of Appeal, and the Supreme Court of the United States. I am a solo 
practitioner and maintain my business office at 2649 6th Avenue, 
Marquette, Kansas 67464. The focus of my practice is representing 
individuals and businesses in financial distress or facing bankruptcy 
throughout the State of Kansas.
    My wifes name is Margaret. Margaret and I are the parents of 
thirteen children. The ages of our children range from six years old to 
24 years old. Our youngest just started school at Marquette Elementary 
School in Marquette, Kansas, where all of her brothers and sisters have 
gone before her. This Fall, five of our children will be attending 
Marquette Elementary School and three of our children will be attending 
Smoky Valley High School in Lindsborg, Kansas. All of our children who 
have graduated from high school have graduated with honors and gone on 
to Bethany College which is also located in Lindsborg, Kansas. Three of 
our children will be in college at Bethany this Fall. Our two oldest 
children have graduated from Bethany with honors and gone on to 
graduate school. Our oldest child is in medical school and our second 
oldest child is pursuing a graduate degree in business. To date, it 
does not appear that there is a bad apple in the whole batch and 
Margaret and I are very proud of each of them.
    In 1987, our second oldest child, Aaron, was diagnosed as having 
cancer. While we were not very successful at first, we ultimately won 
the battle for his life thanks to a bone marrow transplant in 1991 from 
one of his younger brothers. Well prior to 1994, Margaret and I 
liquidated any interests we had in outside investments and retirement 
accounts to help pay for the costs associated with Aaron's treatment 
which were not covered by our health insurance. The only investments 
which Margaret and I now have are in our home and in our family. We are 
not involved in any tax shelters or other investment activities which 
are normally associated with triggering the AMT.
    In 1994, Margaret and I were entitled to and claimed 12 total 
personal exemptions on our federal tax return. This increased to 13 in 
1995, 14 in 1996 and 1997, and 15 in 1998, 1999, 2000, and 2001. In 
2002 and 2003, our total personal exemptions fell to 14. Our joint 
adjusted gross income for each of these tax years was well below the 
threshold amount established by Section 151(d)(3)(C) of the Internal 
Revenue Code which would otherwise reduce the total exemption amount we 
could claim. Despite this fact, the subtle mathematics of the AMT in 
effect has reduced the total exemption amount to which we are entitled 
each year. In this manner, the AMT has become a penalty on large 
families solely because of their size. I doubt that this was an 
intended purpose of the AMT. However, it is in this very manner that 
the AMT has cost my family in excess of $25,000.00 over the past ten 
years.
    While Aarons cancer has given us some experience with the AMT and 
its treatment of medical expenses, it appears that our most significant 
experience with this aspect of the AMT is happening this very year. 
Since 1991, Margaret and I decided that we would try to maintain the 
health insurance policy we had at the time of Aaron's bone marrow 
transplant as long as we could just in case his cancer reappeared and 
we had to go through another round of chemotherapy and radiation. 
During the year of 1991, this cost us $263.82 per month. However, the 
premiums steadily increased reaching $1,441.20 per month in 2003. In 
January of this year, we were notified by our health insurance carrier 
that our premiums were increasing to $2,063.47 per month in April of 
2004 and that Aaron would no longer be covered by our policy after he 
reached the age of 23 that same month. We cannot pay such high monthly 
premiums for any extended period of time. Unfortunately, at this very 
same time, I was diagnosed as having prostate cancer. The sad point is 
that if we are unable to continue to pay our current health insurance 
premiums and must drop our current health insurance coverage, our AMT 
bill will increase significantly at the very time when we are facing a 
substantial increase in our out-of-pocket medical expenses. Once again, 
I doubt that this was an intended purpose of the AMT.
    We have sought relief for our situation with the AMT through the 
Internal Revenue Service's administrative appeals process, the United 
States Tax Court, and the Tenth Circuit Court of Appeals. In 1999, the 
Tenth Circuit ruled against us. However, in his concurring opinion, 
Circuit Judge Kelly made the following comments:

    A.  The legislative history supports an argument that the original 
purpose of the AMT, one of the more complex parts of the Internal 
Revenue Code, was to insure that taxpayers with substantial economic 
income pay a minimum amount of tax on it.

    For a variety of reasons, the number of moderate income taxpayers 
subject to the AMT has been steadily increasing. From a fairness 
perspective, many of these taxpayers have not utilized I.R.C. '57 
preferences (or other more arcane AMT adjustment items) to reduce 
regular taxable income but are caught up in the AMT's attempt to impose 
fairness. In the interest of progressivity, the regular tax already 
reduces or phases out itemized deductions and personal exemptions based 
upon income; surely Congress never intended a family of twelve that 
still qualified for these items under the regular tax to partly forfeit 
them under the AMT.
    That said, we must apply the law as it is plainly written, despite 
what appears to be the original intent behind the AMT. The solution to 
this inequity, must come from Congress, as the tax court rightly 
concluded. Klaassen v. C.I.R., 182 F.3d 932 (10th Cir. 1999) 
(unpublished) (concurring opinion of Circuit Judge Kelly).
    Please help us to obtain from Congress an equitable solution to 
these unintended effects of the AMT.
    Thank you again for allowing me to present this written statement 
to you. If I can be of any further assistance to your Committee, please 
let me know.

                                 

     Statement of Alan Veeck, Reform AMT, Pittsburgh, Pennsylvania
    I strongly urge you to support legislation that would modify or 
repeal the Alternative Minimum Tax (AMT), especially as it applies to 
incentive stock options (ISOs). Although unintended, the AMT adjustment 
for ISOs has had a significantly detrimental, and in some cases, 
devastating, financial impact on individuals like me who exercised ISOs 
before the stock market downturn of 2000. Due to a severe depression in 
stock prices, many taxpayers who exercised ISOs in that year face AMT 
liabilities that are far larger than the exercised stock was worth in 
2001 and beyond.
    Affected taxpayers face huge tax bills, some in the hundreds of 
thousands and millions of dollars, on income that they will never 
receive. Although taxpayers can use their AMT payments as credits 
against future income, they will likely never recover the AMT credit 
because of the way the current law is written. Moreover, collecting 
credits into the future is hardly a consolation for those facing 
unbelievable cash crunches due to the magnitude of the tax. This result 
is vastly inconsistent with Congressional intent in enacting the AMT. 
Instead of assuring that ``the rich pay their fair share of taxes'', 
the AMT on ISOs is literally leaving middle-class Americans like me in, 
or near, financial ruin.
    Here is my story: in April 2000, I exercised 6,000 options that I 
earned with the company that I helped to build in Pittsburgh--
FreeMarkets, Inc. My exercise price was about $5/share, so I had to 
scrape together $30,000 to exercise these options. My plan was to hold 
the shares for a minimum of year, but more realistically several years 
because I truly believed in the long-term success of my company, and in 
this way I could recognize profits from stock sale as capital gains as 
opposed to income. I always do my own taxes, so when I fired up 
TurboTax and input my financials, I was more than a little shocked to 
find that I owed the IRS $85,000, and state and local taxing 
authorities about $10,000. This amounted to 110% tax on my earnings, 
when I have realized no actual cash gain! In analyzing my available 
solutions, even if I exercised my next set of options and sold the 
entire lot (12,000 shares), I would not be able to meet my tax 
obligation for the 2000 tax year.
    Quite obviously, this is an absurd situation. I have always, and 
will continue to, pay my taxes like every other red-blooded, patriotic 
American. I fully agree with the concept of paying my ``fair share'' on 
realized cash gains. But the AMT is forcing me and my family of five to 
face real financial ruin. My mother and father pulled significant money 
from their retirement savings to loan me money to pay the government so 
that my family did not have to sell its most important possessions. I 
haven't had to borrow money from my parents since I was sixteen!
    Your support for AMT reform is crucial, as this unfair and 
unintended tax is beginning to affect more and more honest, hard-
working taxpayers in the lower and middle income brackets.
    Thank you for your consideration of this very important issue.

                                 
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