S. HRG. 109–982

KICK-OFF FOR TAX REFORM:

TACKLING THE TAX CODE

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

AUGUST 3, 2006

(

Printed for the use of the Committee on Finance

KICK-OFF FOR TAX REFORM: TACKLING THE TAX CODE

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38–164—PDF 2006

S. HRG. 109–982

KICK-OFF FOR TAX REFORM:

TACKLING THE TAX CODE

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

AUGUST 3, 2006

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

CHARLES E. GRASSLEY, Iowa, Chairman

ORRIN G. HATCH, Utah

TRENT LOTT, Mississippi

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

CRAIG THOMAS, Wyoming

RICK SANTORUM, Pennsylvania

BILL FRIST, Tennessee

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

MAX BAUCUS, Montana

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JAMES M. JEFFORDS (I), Vermont

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

KOLAN DAVIS, Staff Director and Chief Counsel

RUSSELL SULLIVAN, Democratic Staff Director

(II)

(III)

C O N T E N T S

OPENING STATEMENTS

Page

Grassley, Hon. Charles E., a U.S. Senator from Iowa, chairman, Committee

on Finance ............................................................................................................ 1

Wyden, Hon. Ron, a U.S. Senator from Oregon .................................................... 3

WITNESSES

Mack, Hon. Connie III, Chairman, President’s Advisory Panel on Federal

Tax Reform; and senior policy advisor, King & Spalding, LLP, Washington,

DC .......................................................................................................................... 5

Breaux, Hon. John, Vice-Chairman, President’s Advisory Panel on Federal

Tax Reform; and senior counsel, Patton Boggs, LLP, Washington, DC .......... 8

Garrett, Elizabeth, Member, President’s Advisory Panel on Federal Tax Reform; and Sydney M. Irmas professor of public interest law, legal ethics,

political science, and policy, planning, and development, USC Gould School

of Law, University of Southern California, Los Angeles, CA ........................... 11

Poterba, Dr. James, Member, President’s Advisory Panel on Federal Tax

Reform; and Mitsui professor of economics, Department of Economics, Massachusetts Institute of Technology, Cambridge, MA ......................................... 13

Walker, Hon. David, Comptroller General, U.S. Government Accountability

Office, Washington, DC ....................................................................................... 15

Gravelle, Dr. Jane, Senior Specialist in Economic Policy, Congressional Research Service, Washington, DC ......................................................................... 17

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Baucus, Hon. Max:

Prepared statement .......................................................................................... 43

Breaux, Hon. John:

Testimony .......................................................................................................... 8

Garrett, Elizabeth:

Testimony .......................................................................................................... 11

Prepared statement with attachment ............................................................. 45

Grassley, Hon. Charles E.:

Opening statement ........................................................................................... 1

Prepared statement .......................................................................................... 57

Gravelle, Dr. Jane:

Testimony .......................................................................................................... 17

Prepared statement .......................................................................................... 59

Responses to questions from committee members ......................................... 80

Mack, Hon. Connie, III:

Testimony .......................................................................................................... 5

Prepared statement .......................................................................................... 89

Poterba, Dr. James:

Testimony .......................................................................................................... 13

Prepared statement .......................................................................................... 92

Responses to questions from committee members ......................................... 98

Schumer, Hon. Charles E.:

Prepared statement .......................................................................................... 107

Smith, Hon. Gordon H.:

Prepared statement .......................................................................................... 110

Page

IV

Walker, Hon. David:

Testimony .......................................................................................................... 15

Prepared statement with attachment ............................................................. 111

Responses to questions from committee members ......................................... 214

Wyden, Hon. Ron:

Opening statement ........................................................................................... 3

COMMUNICATIONS

Americans for Fair Taxation ................................................................................... 225

American Society of Pension Professionals & Actuaries (ASPPA) ...................... 235

Employee-Owned S Corporations of America (ESCA) .......................................... 289

ESOP Association .................................................................................................... 294

Houk, Tom and Maggie Green ................................................................................ 297

National Association of Manufacturers (NAM) ..................................................... 310

National Association of Realtors ............................................................................ 318

Tittle, Martin B. ....................................................................................................... 325

United States Council for International Business ................................................ 328

(1)

KICK-OFF FOR TAX REFORM:

TACKLING THE TAX CODE

THURSDAY, AUGUST 3, 2006

U.S. SENATE, COMMITTEE ON FINANCE, Washington, DC.

The hearing was convened, pursuant to notice, at 10:35 a.m., in

room SD–215, Dirksen Senate Office Building, Hon. Charles E.

Grassley (chairman of the committee) presiding.

Present: Senators Wyden, Kyl, and Smith.

OPENING STATEMENT OF HON. CHARLES E. GRASSLEY, A U.S.

SENATOR FROM IOWA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. Thanks, everybody, for your presence, on time

and everything. We appreciate it very much.

You can see that the Senator from Oregon is sitting beside me;

obviously his interest in tax reform is well known to everybody, so

it is perfectly legitimate that he sits there.

But he is sitting in for Senator Baucus because of the sad news

that the Baucus family received on the death of Corporal Phillip E.

Baucus, who died in action in Iraq over the weekend. Our thoughts

and prayers go out to the Baucus family, and we can surely understand his absence from this hearing.

But also, I want you to know that Senator Baucus has been very

cooperative in every effort to move along three hearings, this being

the second one. The first one was not as pointed as this one is. We

will maybe have one in September on other aspects of the tax code,

but Senator Baucus has been very cooperative, in a bipartisan way,

of moving this along.

There is universal agreement that our tax code is complex. The

tax form instrument book is probably the most unwelcome piece of

mail many taxpayers get. The complexity means taxpayers cannot

be confident that they received all the breaks coming to them or

that they have not paid more than what they owe.

Now, add to the complexity of the regular tax system the creeping effects of the Alternative Minimum Tax, and, of course, you

have a recipe for disaster. As an example of the program from the

AMT side, if we do not extend the hold-harmless or ‘‘patch’’ for the

year 2007, 24 million tax filers, mostly families, will be affected by

the AMT. Twenty-four million families.

That is a large number of people. But because of the way the

AMT is structured, with no indexing, this AMT problem grows exponentially from year to year. The revenue loss for this year’s

patch was $34 billion, and it grows to $44 billion next year. So,

2

quite obviously, as far as AMT is concerned, we are facing a train

wreck.

Senator Wyden and I resolved, in a dialogue in this committee,

to remedy the AMT problem. Senator Baucus introduced legislation

to that effect, joined by Senators Kyl, Wyden, the Chairman, and

others. So there is no question that we all recognize it is a big

problem. It is a problem that the committee should focus on.

Let me say that I have no preconceived notions of which direction we go, whether we are talking about a flat tax, a national retail sales tax, or value-added tax, or a substantial modification of

the current system.

Let me also note that I instructed the Finance Committee staff

to develop simplification proposals in all income tax areas. The

staff are working on those proposals.

On a preliminary note, we did invite Treasury Department officials to today’s hearing. Treasury officials told us, at this time, they

did not wish to participate in the hearing so that they could have

a chance to review tax reform proposals with the new Secretary.

Treasury officials informed the committee that the Treasury

would be happy to participate at future meetings. We hope to have

hearings this fall on tax reform. We will look forward to Treasury’s

participation at that time.

In addition, I still expect Treasury and administration officials’

responses to the President’s Advisory Panel on Federal Tax Reform

that is the focus of today’s hearings, and that is something that I

made clear to the new Secretary at the time I had a private meeting with him, as well as the public meeting.

So today I would like to say that we are kicking off tax reform,

but we will be waiting to hear from one of those key coaches, the

new Secretary, as he draws the Treasury’s playbook. I know that

the Secretary is very dedicated to reforming the system, and I look

forward to hearing from him and his staff.

Today, we will hear from a couple of former Finance Committee

veterans who took the charge from President Bush to take the first

step at tackling the problems of the tax system.

Senator Connie Mack of Florida served several years on the committee and came back to public service to chair the President’s tax

reform panel. Senator John Breaux served on the committee from

1990 through 2004, almost a decade and a half, and served as vicechairman of the advisory panel.

Joining with us on the first panel is Elizabeth Garrett, who

served as Tax Counsel for former committee member David Boren;

and we also have Professor James Poterba. I appreciate the tax

panel’s months of study and analysis.

It seems the panel members were apolitical in their work. Some

of their recommendations were bound to be politically unpopular;

cutting the home mortgage interest deduction is just one example

we often hear about. But it is important to have a comprehensive

starting point, and I think they have provided that.

We have a couple of witnesses to provide an evaluation of the

Advisory Panel’s recommendations. We will hear testimony from

David Walker of the Government Accountability Office and Dr.

Jane Gravelle of the Congressional Research Service, whom I have

3

had a chance to visit with privately about this issue of tax reform

as well.

So we welcome you. But before we go to your testimony, we will

hear now from Senator Wyden.

OPENING STATEMENT OF HON. RON WYDEN,

A U.S. SENATOR FROM OREGON

Senator WYDEN. Mr. Chairman, thank you very much. I particularly thank you for your words about our special friend, Senator

Baucus, this morning. I think our hearts are all out to Senator

Baucus today. For those of us who know Max well, Max is all about

family. Family is everything to Senator Baucus.

So, our thoughts are with him today, our hearts are heavy, and

I appreciate your starting this morning’s hearing with a prayer for

Senator Baucus, because he is very much in our minds this morning.

Mr. Chairman, my thanks to you for scheduling this hearing. I

know that you want to aggressively tackle the issue of tax reform.

I have learned a great deal from you about how we could work on

this in a bipartisan way during the many discussions that we have

had about taxes in recent months.

I also want to say that I greatly appreciate the recent comments

of Alan Hubbard, the chair of the President’s National Economic

Council, who has stated that the President also believes that the

current tax system is broken.

Mr. Chairman—and I see my friend Senator Smith is here—I

want to work with Senators of both parties to make our tax system

simpler, fairer, and one where all Americans can accumulate

wealth.

Briefly, here is where I think we are on taxes in our country. For

millions of Americans, completing their taxes today is unmitigated

torture. There have been more than 14,000 changes in tax law

since the last reform effort, and it comes to more than three for

every working day in the last 2 decades.

So our citizens spend hours and hours tracking down a dizzying

array of tax forms, and they still collectively spend more on tax

preparation than the annual revenue of Wal-Mart, the largest company in America.

During a recent discussion of tax reform, my staff stacked up

next to me just a portion of the tax code, volume on volume, and

it dwarfed me at 6 feet, 4 inches. I do not think it has to be this

way.

Now, in my proposed tax reform legislation, the Fair Flat Tax

Act—I think we have given you one of these forms, Mr. Chairman—this is a one-page 1040 form. It has 30 lines in it. It took me

about half an hour to complete it.

I guess that is going to be a bit of a revolution, because they tell

me it has been a long time since a member of our powerful committee could fill out their taxes on a 1040 form.

The folks over at Money magazine did it in 15 minutes. I bring

this up only by way of saying that filling out a 1040 tax form in

America does not have to be water torture.

Next, it seems to me our committee needs to tackle the issue of

fairness. The current tax system is biased against hardworking

4

middle-class Americans who get most of their income from wages,

not investment.

Right now, the tax rate on a day’s wages can be more than 20

percent higher than the rate on investment income. I want everybody in the United States—every person—to be able to accumulate

wealth. I deeply believe in markets, and I think that the marginal

tax rate is extremely important.

So I am not interested in soaking anybody. I believe this committee can find a way to be fair to both the cop walking the beat

who makes most of his money from wages and the investor who is

taking risks in the stock market.

The reason I believe tax reform is possible is because we actually

have a model. That is the reform of 1986. Democrats and Republicans came together that year to get rid of the loopholes, to hold

down the tax rates, make the Code fairer, and let the market, and

not government, drive capital to its highest and best use.

I think we can build on the 1986 model. There are obviously new

challenges, and you have pointed to one of the biggest, the question

of the Alternative Minimum Tax. But with our friends, Senator

Mack and Senator Breaux, here, I would like to say there is an

awful lot in what the Commission has produced that this committee can build on on a bipartisan basis.

I mentioned my 1-page 1040 form. I have said in discussions

with Senator Breaux and Senator Mack that theirs is maybe a few

lines longer. For purposes of government work, we are the same.

We can do this. I have proposed a tax code with three brackets;

Senators Breaux and Mack have proposed four brackets. Again,

this is an area where we can come together.

I would also point out, Mr. Chairman—and you and I have

talked about this—that I started, for purposes of discussion, my

proposal with exactly the same brackets that Ronald Reagan proposed when he started in 1986. But I am very open to a whole variety of alternatives.

For example, it would be fine with me if we came together and

eliminated enough loopholes so that maybe the person with the

lowest income would pay 10 percent, the person with the middle income would pay 20 percent, and the person at the top would pay

30 percent, and we would have really drained this tax swamp that

is replete with so many loopholes. Then we would have a system

that was simpler, fairer, and one where everyone can accumulate

wealth.

We have a number of panel members whom I have talked to

many, many times over the last few months. Jane Gravelle slogged

through many numbers and iterations of my proposal; Mr. Walker

as well has been helpful on these issues.

I am just very pleased that we have Senators Mack and Breaux,

because I think, as they did so often when I had the pleasure of

serving with both of them, they showed us the way that we could

come up with responsible bipartisan approaches in this area. I look

forward to hearing from them and working with them to actually

get this done and get it on the President’s desk.

The CHAIRMAN. Thank you very much, Senator Wyden.

Senator Baucus has an expression of his views on this subject

that I will insert in the record as a statement from him.

5

[The prepared statement of Senator Baucus appears in the appendix.]

The CHAIRMAN. Senator Smith, since you have had some interest

in this, do you want a few seconds or a few minutes to say something?

Senator SMITH. No, Mr. Chairman. I am here to hear the witnesses, so I would go to them.

The CHAIRMAN. Yes. I got an e-mail that we might have a vote

at 11. If we do, I would request of the two Senators who are

present, that I will run and vote right away while the panel is

going on, and you preside, then I will come back and you go vote.

Is that all right?

Senator SMITH. Yes.

Senator WYDEN. Yes.

The CHAIRMAN. Then is it all right with Senators Mack and

Breaux if we go through the entire panel before we have questions?

You can wait?

Senator MACK. Yes.

Senator BREAUX. Yes.

The CHAIRMAN. Thank you very much.

So would you proceed, Senator Mack? And thanks to all the panelists, too. I probably forgot to say that. Thank you very much for

taking the time on a very important subject that is starting us

down a trail that is not going to be an easy trail, but it is a trail

that we must maneuver down and have a destination that we

make.

Go ahead.

STATEMENT OF HON. CONNIE MACK III, CHAIRMAN, PRESIDENT’S ADVISORY PANEL ON FEDERAL TAX REFORM; AND

SENIOR POLICY ADVISOR, KING & SPALDING, LLP, WASHINGTON, DC

Senator MACK. Thank you very much, Mr. Chairman. On behalf

of the entire panel—there are only four of us here this morning,

but on behalf of the entire panel—let me just thank you and the

committee for your interest in tax reform.

Before I provide a brief description of the options, I want to highlight the need for tax reform and to explain the framework under

which we operated.

As a member of the Senate Finance Committee for many years,

I had spent a lot of time working with the tax code, and I was

aware of its deficiencies. However, it is fair to say that in my service on the tax panel, conducting hearings, gathering information,

and reading comments, that confirmed just how bad the situation

really is.

Instead of the sleek and simple system designed to raise revenues for our national defense, social programs, and other vital public services, we have a system so complex that almost $150 billion

is spent each year by U.S. households, businesses, and the Federal

Government just to make sure taxes are tallied and paid correctly.

In 2003, 60 percent of filers hired a tax preparer. By the way, only

14 percent of Americans actually do it the old-fashioned way with,

I was going to say pen and paper, but maybe, appropriately, pencil

and paper.

6

Between 1986 and last November, there were over 15,000

changes to the tax code. Instead of a system that ensures that all

pay their fair share, we have a system so confusing that 2 million

taxpayers collectively paid over $1 billion more in taxes by simply

making a wrong decision about the basic choice of itemizing or taking the standard deduction. And while some people over-pay because of their confusion, the vast majority of people under-pay. The IRS has estimated that there is a net tax gap of $290 billion per year, which translates into a tax hike of more than $2,000 per

year for honest taxpayers. There is no easy answer to reducing the

tax gap, but an obvious and productive place to start is by reforming the Code so that it is easier to understand and to enforce.

Instead of a tax system that draws revenue efficiently from the

base of the Nation’s considerable economy, we have a tax code that

distorts basic economic decisions, sets up incentives for unwise and

unproductive investments, and induces people to work less, save

less, and borrow more. By some estimates, this economic waste

may be as high as $1 trillion each year.

In an increasingly global environment, our tax code also plays an

important role in the competitiveness of American business. Our

corporate tax rates are high, and even if companies can employ

strategies to lessen the effect of these rates, they are wasting valuable resources.

Now, let me say a few words about the panel’s framework. We

operated under a set of rules, some of which the President, through

Executive Order, imposed, and others that we adopted for ourselves.

In the former category, our options were to be revenue-neutral,

and we used the President’s baseline. The Executive Order also instructed us to develop options that were appropriately progressive.

Some panel members felt that the current distribution of Federal

income taxes was appropriate or that it should be more progressive, while others felt that the higher-income taxpayers shouldered

too large a share of the tax burden.

We quickly realized that we could have consumed all of our time

debating this question and still probably not reach a resolution. In

the end, we concluded that the appropriate burden of taxation was

an issue that elected officials should resolve.

The resolution of the burden question helps to illustrate, though,

how we viewed our role. We could have operated through the prism

of politics or the prism of economics and tax policy.

We chose the latter, recognizing that the administration and

Congress would have to deal with the political issues, and that our

options should be based on sound economic and financial principles.

Now, let me say a word about our options. We unanimously settled on two options, which we called the Simplified Income Tax—

some refer to that as SIT—and the Growth and Investment Tax,

GIT. We did not reach consensus and, thus, did not recommend a

national retail sales tax, a value-added tax, or a progressive consumption tax.

The simplified income tax plan dramatically simplifies our tax

code, cleans out targeted tax rates that clutter the system, and lowers rates. It does away with gimmicks and hidden traps like the

Alternative Minimum Tax.

7

It preserves and simplifies major features of our current tax

code, including benefits for home ownership, charitable giving, and

health care, and makes them available to all Americans.

It removes many of the disincentives to saving that exist in our

current code, and it makes small business tax calculations much,

much easier. It also offers an updated corporate tax structure to

make it easier for American corporations to compete in global markets.

The second recommended option, the Growth and Investment

Tax Plan, builds on the SIT and adds a major new feature, moving

the tax code closer to a system that would not tax families or businesses on their savings or investment.

It would allow businesses to expense or write off their investment immediately, it would lower tax rates, and impose a single

low tax rate on dividends, interest, and capital gains.

Both of these plans offer dramatic simplification, reducing the

number of lines, as Senator Wyden indicated a moment ago, on the

1040 form, in our case, from 75 to 32, and, I think as important,

the number of commonly used forms, schedules, and worksheets,

from 52 to 10. We make the tax code fairer by transforming deductions that are only allowed for a few into credits or deductions that

are available to all.

These are important accomplishments. But I also believe that the

most important thing that we can do is to ensure that the tax code

promotes growth and competitiveness.

The principle of freedom—that is, free markets and democratic

capitalism—is transforming the world. The growing economies of

China and India, along with the rest of the world, are providing us

with fierce competition.

Our current tax system distorts capital flows and impacts economic decisions, and our options respond to that challenge by reducing the cost of capital, lowering the corporate rate, moving our

international tax system to either a territorial or border-adjusted

one.

Expensing is especially important, as it would reduce the effects

of the tax rate on new investment from 17 to 6 percent, and it

makes us the best place in the world to invest.

In closing, Mr. Chairman, let me just pick up on the theme that

I think I heard this morning. The one thing that I remember and

cherish about this committee was the ability to work together.

It was not always easy, it was not always fun, but there was a

sense that the issues that we were dealing with were so important

that we had to find a way to work together. Clearly, you all have

continued to carry on that tradition, and I hope that that will continue as we work through tax reform.

Thank you very much, Mr. Chairman.

The CHAIRMAN. Thank you very much, Senator Mack.

[The prepared statement of Senator Mack appears in the appendix.]

The CHAIRMAN. Now, Senator Breaux?

8

STATEMENT OF HON. JOHN BREAUX, VICE-CHAIRMAN, PRESIDENT’S ADVISORY PANEL ON FEDERAL TAX REFORM; AND

SENIOR COUNSEL, PATTON BOGGS, LLP, WASHINGTON, DC

Senator BREAUX. Thank you very much, Mr. Chairman and

members of the Finance Committee, both Senator Wyden and Senator Smith. Thank you for having this hearing, because I thought

this report had been lost somewhere. I mean, we sent it. We

worked on it. We had 100 witnesses. We had hearings all over the

United States. We did this wonderful book. I learned a lot just by

reading the book that we produced about the tax code.

After we turned it in, the Secretary wrote on my book: ‘‘John,

thanks for your great work. Now it is up to us,’’ signed by the Secretary. Then I do not know where it went. I hope someone down

there really read it in great detail. But it never came back.

I mean, the purpose of a commission is to produce a product that

someone reacts to. We did a lot of work. The Chairman is absolutely correct. We did it not only in a bipartisan fashion, we did

it in a nonpartisan fashion, and we spent a lot of time doing it.

I do not think there is an issue of national importance like simplifying the tax code that you could have more agreement by the

Republicans and the Democrats that it should be done.

If the President of the United States stood before a joint session

of Congress and said, you know, I have asked for this report, here

it is, I now challenge Republicans and Democrats to do something

for the American people to simplify the Internal Revenue Code so

we do not spend $140 billion in complying with it, both sides of the

Congress would stand up and give him a standing ovation.

There is an agreement in any forum that you go to back in your

States—Rotary Club, Chamber of Commerce, a labor union meeting. If you stand up and say, by golly, I am going to go back to

Washington and simplify the tax code because it is too complicated,

too complex, and too expensive, you are going to find people saying,

yes, you are right. The last time we did it? 1986.

As Connie said, 15,000 amendments have been added to it, some

of which I am responsible for. I thought they were great. But that

is more than two amendments a day since the last time we did it.

How did we do it the last time? In a bipartisan fashion. A lot of

tough work. Some of you all were involved in it. But it was the last

time we did it. Certainly, Connie has listed the reasons why it

should be done again.

One of the papers asked our group—which contained real tax experts other than myself, certainly—how many of you on that committee do your own tax returns? Only one of us on the panel of experts did their own tax returns, and it certainly was not me. But

that was it.

If you have people who are experts, who live their lives teaching

this stuff, and they do not even do their own tax returns, something is wrong with it.

Sixty percent of the people have to hire somebody. Seventy-five

percent of the people that get the Earned Income Tax Credit, for

the poorest among us, have to go out and pay somebody to do their

tax return. There is something wrong with a system that does that.

So, anyway, we have some real tight restrictions on what we can

do. The President said, look, simplify it. Make sure it is reasonably

9

progressive. Make sure it promotes economic growth and job creation. Make sure you pay attention to charitable deductions. Make

sure you pay attention to mortgage deductions. Make sure you pay

attention to health incentives. And, oh, by the way, make it revenue-neutral. Whoa. I mean, that is not easy to do.

But since none of us were running for re-election, we made an

effort, and I think we came up with something that did what the

President asked us to do. But we made some tough political decisions. Like I said, we are not running, and maybe it is easier to

address those things.

We did away with the AMT. Everybody wants to do that. That is easy to say we are going to repeal it. It is $1.5 trillion over 10

years. If you are going to make it revenue-neutral, where is it

going to come from?

Priscilla, Connie’s wife—and I have said this before—had the

greatest comment about the Alternative Minimum Tax. She said,

‘‘Why do you all call it that?’’ He said, ‘‘What do you mean?’’

She said, ‘‘Well, number one, it is not an alternative. You have

to pay it. Number two, it is not a minimum tax, it is the maximum

tax. So it should not be called the Alternative Minimum Tax. It

should be called the Maximum Mandatory Tax.’’ [Laughter.]

But everybody here can agree, let us get rid of it. But how do

we pay for it if you are going to make it revenue-neutral? That is

the tough part. The easy part is getting rid of it.

So let me just address, briefly, some of the things that we have

tried to do in order to take care of, how do you do these fun things,

and then how do you pay for the fun things that have to be paid

for?

One of the things we did with regard to trying to change it is

that we made some changes in charitable deductions. Number one,

we felt that it was not being fairly spelled out because everybody

does not benefit from them, so we made some changes in the charitable deductions in order to make sure everybody is able to have

access to them, not just those who itemize.

Three-fourths of the deductions under the old system went to 12

percent of the taxpayers with incomes of over $100,000. We recommended everybody be available for those deductions after a 1

percent threshold of contributions.

Housing changes. Boy, this was an easy one. You start talking

about mortgage deductions, and what are you going to do with it.

I was kind of surprised, with the mortgage deductions. They tell

us, the experts who testify, that over 70 percent of the taxpayers

that filed tax returns in 2002 did not receive any benefit from the

mortgage deduction.

I did not know that. I sort of assumed almost everybody got it.

But over 70 percent did not get any benefits from the mortgage deduction. Why? Because they are not itemizing or they are not buying a home.

Many countries do not have it: Canada does not have it, the U.K.

does not have it, Australia does not have it. Yet, home ownership

is very high.

Now, we recommended that the home mortgage deduction be retained, but we tried to make it be shared more evenly. What we

did was recommend that the mortgage deduction be replaced with

10

a home credit available to all homeowners, and that would be equal

to 15 percent of the mortgage interest paid by the taxpayer on a

loan secured by the taxpayer on their principal residence to construct a home, to acquire it, or to substantially improve it.

But we put a limit on it. We said there should be some type of

limit here. We are trying to find some money to pay for these

things, so we put a limit on it. We said that the home credit would

be based on the average cost of housing within that taxpayer’s

area, and that would result in current limits being between approximately up to about $412,000 homes.

The interesting thing was that the estimates we got said that between 85 and 90 percent of all the mortgages in 2004 would have

been unaffected by what we recommended. That is a huge number

that would not be affected by our recommendation.

The last thing I will say is in health care. We all know, and

members of this committee know quite, quite well, it is one of the

largest expenditures—in fact, it is the largest tax expenditure—the

preference for health care.

So we tried to put some limitations on it. We continued the deduction for employer-provided health insurance. It was $141 billion

a year, but we tried to make some limitations and caps on it. We

capped it to about $11,500 a year for families. It is about the same

we had as members of Congress, and Federal employees.

The final thing was, we addressed State and local tax deductions.

If you want to hear from New York and California, start saying you

are not going to be able to deduct your State and local taxes on

your Federal income tax. But again, we were not running for office

again, so we could talk about these things without fear.

What we said was, why should someone in Arizona be paying for

benefits that someone in California gets because of higher State

and local taxes? They may have trash pick-up every day, twice a

day, electric lines buried underground, all the services that they

are paying high taxes for that the people in Arizona are not benefitting from, or Oregon, or Louisiana, for that matter. But we are

subsidizing it because we are paying on the Federal taxes for the

high State taxes. I mean, I think that that does not make a lot of

sense.

Politically, it is very difficult. But if you are going to do away

with AMT, you are going to have to find some revenues to pay for

all of this, and these are some of the tough suggestions that we

made.

A final note. Congratulations for even having a hearing. This is

the first body that really has done that, and I am just delighted

that you all have recognized that this is something that needs to

be addressed, and I wish you much success.

Thank you.

[The prepared statement of Senator Breaux appears in the appendix.]

Senator WYDEN. Thank you both, Senator Breaux and Senator

Mack. I know we are going to have questions in a moment.

Ms. Garrett, welcome.

11

STATEMENT OF ELIZABETH GARRETT, MEMBER, PRESIDENT’S

ADVISORY PANEL ON FEDERAL TAX REFORM; AND SYDNEY

M. IRMAS PROFESSOR OF PUBLIC INTEREST LAW, LEGAL

ETHICS, POLITICAL SCIENCE, AND POLICY, PLANNING, AND

DEVELOPMENT, USC GOULD SCHOOL OF LAW, UNIVERSITY

OF SOUTHERN CALIFORNIA, LOS ANGELES, CA

Ms. GARRETT. Thank you very much.

I am pleased to have been asked to discuss our recommendations

with you today. One of our reform proposals, the Simplified Income

Tax, used the current income tax system as a starting point for reform, but worked to significantly simplify its provisions.

I would like to underscore three characteristics of this simplified

tax that I believe relevant as you craft legislation.

First, we applied a rigorous burden of proof to tax expenditures,

because it is not worth the revenue loss if a tax benefit subsidizes

behavior that would occur even without the subsidy.

Instead, policy makers create a windfall for a few at the expense

of all taxpayers, the tax code becomes more complex, and ordinary

taxpayers perceive the system as skewed in favor of those with political clout.

However, we did not recommend eliminating all tax expenditures, but we did advocate changing the structure of many that we

would retain. Namely, the Simplified Income Tax changes most individual-level tax benefits from deductions to credits, and we

worked to simplify them.

A more effective individual tax system would restructure most

tax expenditures as credits available to all taxpayers, and with refundable features in some cases so that even those without tax liability would benefit.

For example, we recommended adopting a simple refundable

Saver’s Credit to encourage lower-income Americans, even those

who do not pay taxes in a particular year, to save for a better future for their families.

We eliminated the duplicative and overlapping system of standard deduction, personal exemption, child tax credit, head of household filing status, and Earned Income Tax Credit, all of which have

different phase-out ranges and eligibility rules. We proposed, instead, two credits designed to work together, a family credit and

a refundable work credit.

The combination of eliminating tax expenditures in many cases,

in both the business and individual system, and restructuring

those that are retained as tax credits, some refundable, will enhance both the fairness and simplicity of the system.

This was one reason for our recommendation to restructure the

subsidy for mortgage interests so that it is taken as a credit. Our

recommendation ensures that more Americans can enjoy the tax incentive for home ownership, and that the benefit is targeted to

lower- and middle-income Americans seeking to buy modest homes,

perhaps their first homes.

Second, although we did not expect that our plans would be

adopted without change by Congress, some parts are packages that

must be enacted together, in our view. One key package is our proposal to encourage savings. It includes a simplified Save at Work

12

plan, which combines all the current employer-provided retirement

plans into one.

Importantly, and crucial to improving the savings rate, these accounts have different default rules than do most current plans.

Under the auto-save feature of our proposal, employees would be

automatically enrolled in diversified retirement plans.

When they left their job, their savings would be automatically

rolled over into a tax-deferred vehicle, unless they chose otherwise.

The other two accounts, Save for Retirement and Save for Family,

have limitations on withdrawals, so they can be used only for certain life events, such as retirement, education, purchase of a home,

and health-related expenses.

We did not support providing tax benefits to accounts that could

be used for any purpose. Such a structure does not promote longterm savings and will primarily provide a benefit to savings that

would have occurred anyway.

A key component of our savings package is the refundable Saver’s Credit I mentioned. This aspect of the package will encourage

new savings by people who desperately need to save, but lack the

resources to do so.

Finally, we would repeal all of the other tax subsidies for savings

currently in the Code. The three simple accounts, plus the Saver’s

Credit, would replace the plethora of current vehicles, all with different rules, requirements, and eligibility.

One caveat on savings proposals. You must determine, to the extent possible, all the revenue implications of the design of savings

vehicles, implications that may well occur outside any 5- or 10-year

budget window.

Proposals that reduce the ability of the government to raise the

revenue that it needs in the future must be considered with great

caution, especially if the revenue bite occurs around the same time

that the retirement entitlements will be facing severe fiscal strains.

When tax revenues cannot sustain necessary government programs, the resulting deficit financing has significant deleterious effects on the national savings rate. Thus, a savings proposal that results in higher deficits is counterproductive.

The final noteworthy characteristic of our reform plans is that

both have progressive rates. This reinforces the longstanding tradition in this country of progressivity in the tax code as part of its

fundamental fairness. Even a pure consumption tax, which was not

among our recommendations, can have progressive rates.

As our country is increasingly characterized by growing and profound inequalities of wealth and opportunity, a progressive tax system, as well as government programs designed to increase economic and educational opportunity for all Americans, is one method to redress the inequities.

Progressivity means more than just a progressive rate structure,

although that is a necessary component. It also means eliminating

or scaling back tax expenditures that disproportionately benefit the

well-to-do; using credits—some refundable—rather than deductions

for those tax expenditures that remain in the Code for individuals;

and minimizing things like the marriage penalty, that play a role

in discouraging some women from entering the workforce.

13

In conclusion, I appreciate the opportunity to testify here today.

I ask that my longer comments be made a part of the record.

I look forward to answering any of your questions.

Senator WYDEN. Ms. Garrett, thank you. I know you have done

a lot of good work on this over the years, and we appreciate it.

Ms. GARRETT. Thank you.

[The prepared statement of Ms. Garrett appears in the appendix.]

Senator WYDEN. Dr. Poterba, we welcome you.

STATEMENT OF DR. JAMES POTERBA, MEMBER, PRESIDENT’S

ADVISORY PANEL ON FEDERAL TAX REFORM; AND MITSUI

PROFESSOR OF ECONOMICS, DEPARTMENT OF ECONOMICS,

MASSACHUSETTS INSTITUTE OF TECHNOLOGY, CAMBRIDGE,

MA

Dr. POTERBA. Mr. Chairman, thank you for inviting me to testify

before your committee today. It was an honor to work with the distinguished members of the President’s tax panel and our very dedicated staff, many of whom are here today. I am delighted to be able

to share some of the results of our analysis with you.

The justification for tax reform often focuses on simplifying the

tax code, on improving the fairness of the distribution of tax burdens, and on trying to improve economic growth.

While many will tell you that all three objectives can be achieved

simultaneously, in practice there are often tensions between them.

One of the reasons the tax code is complicated is to recognize the

many disparate circumstances of taxpayers. Simpler tax systems

may treat different individuals in similar ways and create what

some might point to as unfairness.

One of the difficulties in trying to promote economic growth is

that it often involves reducing the tax burden on capital income.

That, again, may run into questions of fairness, at least in some

people’s minds.

I would like to suggest that, as you think about the various options for tax reform, you recognize that the economic growth consequences of changing our tax system can be substantial. Academic

studies that have compared tax systems based on consumption

with those based on income suggest that in the long run there may

be as much as a 5-percent difference between the size of our economy under the two systems. That is a dramatic effect of public policy and one that we should keep in mind as we think about various

options for tax reform.

Previous studies probably overstate the actual gains from tax reform, because the current system is not a pure income tax. It includes a number of favorable provisions regarding saving. Moreover, many of the reform options that are likely to be considered

are not pure consumption taxes.

Nevertheless, even if existing studies overstate the gains by a

factor of two, there would still be very substantial benefits to longterm economic reform of the tax code.

What are the prescriptions one follows to try to encourage maximal economic growth with the tax system? First, one tries to keep

tax rates low to avoid distortions in economic activity.

14

Second, one tries to place similar tax burdens on different activities to avoid creating an uneven playing field across assets or

across activities individuals might engage in, thereby distorting

their behavior.

Finally, most of the research on tax structure suggests that low

tax burdens on capital income can promote long-term economic

growth. Capital taxes are, in fact, the most important ones for determining the amount of capital accumulation, which in turn has

an important influence on long-term growth.

The tax system today not only places high tax burdens on some

types of capital investment, it levies different tax burdens on different types of capital, and thereby distorts both the allocation of

capital and the total amount of investment and saving.

Estimates suggest, for example, that current tax rules result in

an effective tax burden of about 26 percent on all corporate investments. In the non-corporate sector, the burden is about 17 percent.

In owner-occupied housing, it is nearly zero. That, of course, tilts

the allocation of capital away from what we would see in a world

without taxes, toward more owner-occupied housing and away from

corporate investment.

We see the same thing within the corporate sector, where different assets are taxed at different rates and, as a consequence, are

favored more or less by the current tax code.

The provisions that the President’s tax reform panel focused on

in the Growth and Investment Tax—in particular, the combination

of expensing for business investment and limitations on interest

deductions—are designed to level the playing field across asset categories and to provide strong incentives for economic growth. In

fact, of the two proposals the panel offered, the GIT was judged to

have the larger long-term impact on economic growth.

Let me say a word about expensing, which is the dessert in this

proposal, and a word about the interest deduction limits, which are

the spinach.

The expensing provisions are very simple. A firm that made any

investment in plant, equipment, or R&D, would basically be able

to deduct immediately the costs of that investment. That would

have the effect of making the government a partner both on the

outlay and the income side of any project, and it would remove the

distortions associated with the current tax structure. The result

would be essentially a zero effective tax burden on new investment

of all types, leveling the playing field and promoting long-term investment.

While providing expensing, the Growth and Investment Tax also

places limits on interest deductions. It is extremely important to

pair these limitations with expensing. If we adopt expensing without such limits, then a firm that can finance a new project with

debt and claim an interest deduction would discover that some

projects that did not make sense on economic grounds in a no-tax

world would be attractive. Providing both expensing and interest

deductions would result in more investment than in a setting without any taxes, and this is inefficient. This would be like returning

to the situation before 1986, where some projects—called tax shelters at the time—did not make sense on economic grounds absent

taxes, but were attractive in the after-tax environment. That is

15

why it is important to do these two things together. There are various ways to link interest limitations and expensing. We discuss

those in our report.

Finally, the greatest difficulty in tax reform, the one that you

confront as policymakers and that we did not have to confront to

some degree as analysts, is the transition from the tax system we

have today to an alternative that would be widely agreed upon as

better.

Making a politically feasible transition requires finding ways to

ease the pain in the short run for those who have benefitted from

the current tax code, while trying to move toward a system which

looks more attractive over the long term.

I am convinced that we can do that by thinking carefully about

transition relief, and I welcome today’s hearing as a starting point

for a broader discussion of tax reform.

Thank you.

Senator WYDEN. Doctor, thank you very much for your input.

[The prepared statement of Dr. Poterba appears in the appendix.]

Senator WYDEN. As you know, there is so much going on, I suspect our Chairman has been derailed for a few minutes on the

floor. So what I would like to do is take a short break so that Senator Smith and I can go vote, and Chairman Grassley and I will

both be right back.

[Pause.]

The CHAIRMAN. I promised Senator Wyden I would be back in 10

minutes, but there are a lot of press people that are interested in

my views on a certain tax bill. [Laughter.] You know you never

argue with people who have a barrel full of ink.

Mr. Walker?

STATEMENT OF HON. DAVID WALKER, COMPTROLLER GENERAL, U.S. GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, DC

Mr. WALKER. Mr. Chairman, members of the Senate Finance

Committee, thank you for the opportunity to be here this morning.

I assume that my entire statement will be included in the record.

The CHAIRMAN. Yes.

Mr. WALKER. Therefore, I will move to summarize.

The CHAIRMAN. Yes, it will.

[The prepared statement of Mr. Walker appears in the appendix.]

Mr. WALKER. I have been asked by your very capable staff to

focus my remarks on the individual income tax, but I would note

that many of my remarks relate to broad-based tax reform and are,

therefore, applicable to any potential reform of the corporate tax

system as well.

The President’s Advisory Panel on Federal Tax Reform has taken

a major step in beginning the debate over much-needed and longoverdue comprehensive tax reform. The panel suggested two alternative proposals for coordinated reform of the individual and corporate income taxes, and thereby served to advance the public debate over how best to simplify these taxes. Their proposals include

the desirable combination of a broader tax base and lower tax

rates.

16

The following are key points included in my longer statement.

The debate about the fundamental design of the tax system is occurring at a time when our Nation faces large and growing structural deficits.

Under current policy, the gap between revenues and spending

will widen over the next several decades. The individual income tax

has long been the single-largest source of Federal tax revenue,

amounting to $927 billion in 2005.

Concerns regarding the complexity, economic efficiency, and overall equity of the individual income tax have contributed to calls for

substantial restructuring of the individual income tax, or for its

partial or full replacement with some form of consumption tax.

The individual income tax also causes taxpayers to change their

work, savings, investment, and consumption behavior in ways that

serve to reduce economic efficiency and taxpayer well-being.

Taxpayer noncompliance with the current individual income tax

is another major factor that should motivate reform. From tax year

2001, the IRS estimated that noncompliance with the individual income tax accounted for about 70 percent of the $345 billion gross

tax gap. Reducing this gap can improve the Nation’s fiscal stability,

and each 1 percent reduction in the tax gap would likely yield

about $3 billion annually.

In moving forward on tax reform, policymakers may find it useful

to compare alternative proposals based upon some standard principles and common dimensions. Among these are: whether a proposed tax system will generate sufficient revenue over time to fund

whatever spending path is chosen—because, in the final analysis,

we need to have enough revenues to pay our current bills and deliver on our future promises; whether the tax base is as broad as

possible so rates can be as low as possible; and whether it further

promotes economic growth and individual compliance.

I might note that this document, which, as you know, Mr. Chairman, was published last September—a copy of which we sent you

and all the other members of the Senate Finance Committee—

could be helpful in this regard.

Fiscal necessity prompted by our Nation’s current imprudent and

unsustainable fiscal path will eventually force changes to our

spending and tax policies. We must fundamentally rethink existing

policies, and everything must be on the table.

Tough choices will have to be made about the appropriate degree

of emphasis on cutting back Federal programs versus increasing

tax revenue. Tax reform, if it broadens the tax base, could reduce

the difficulty of raising a given amount of revenue by reducing the

associated economic efficiency cost.

Such a reform also likely would reduce inequities, compliance

burdens, and administrative cost. The recent report of the President’s Advisory Panel on Federal Tax Reform recommended two

different approaches, and I think they need to be seriously considered.

Although each plan provides for significant simplification, neither of them addresses the Nation’s large and growing fiscal imbalance. We must address that imbalance. It threatens our future.

One approach for getting the process to comprehensive fiscal reform started could be the establishment of a credible, capable, biVerDate 11-MAY-2000 15:02 Oct 29, 2007 Jkt 095484 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 38164.000 SFIN1 PsN: SFIN1
17

partisan commission that is not unreasonably constrained with regard to its scope.

The Commission would examine options for a combination of

both entitlement and tax reform, building on the excellent work

that has already been done by the tax reform panel, as well as

other commissions on Social Security and other issues.

As policymakers consider proposals for reform of the individual

income tax or the entire system, I would recommend that they consider this document.

In closing, Mr. Chairman, this past weekend, I personally completed my 2005 Federal tax return, by hand, with pen and calculator, and no software was involved. For the record, as I told Senators Breaux and Mack, I filed timely extensions.

I prepared it by hand and without assistance, but as you know,

I am a certified public accountant. I must tell you, I found the process to be incredibly complex, confusing, and extremely frustrating.

To add insult to injury, I, along with millions of other Americans,

was unhappy to find out that I had to pay a 10 to 15 percent surtax on my income because of AMT. I would respectfully suggest

that if every individual member of Congress was required to do

what I did this past weekend, we would have tax reform next year,

and we surely need it.

Thank you, Mr. Chairman.

The CHAIRMAN. I do not accept the challenge. [Laughter.] Dr.

Gravelle, a couple of months ago you wrote a paper for me that I

asked you to, and I have never acknowledged that back to you by

letter or by phone, I am sure. So, I thank you very much for doing

that. I found it very helpful.

Dr. GRAVELLE. You are welcome.

STATEMENT OF DR. JANE GRAVELLE, SENIOR SPECIALIST IN

ECONOMIC POLICY, CONGRESSIONAL RESEARCH SERVICE,

WASHINGTON, DC

Dr. GRAVELLE. The President’s Advisory Panel presented two

proposals, a direct consumption tax, with a top rate of 30 percent,

and an income tax, with the top rate of 33 percent, designed to be

both revenue- and distributionally-neutral.

Both proposals would eliminate itemized deductions, while allowing credit for mortgage interest, the deductions for charitable contributions and health insurance for all taxpayers.

Both proposals substitute credits for personal exemptions and

standard deductions. Both would allow greatly expanded tax-preferred savings plans.

The consumption tax would allow expensing of all investment,

while disallowing existing deductions for inventory, basis, and most

depreciation and interest. It also includes a tax on passive capital

income at the individual level.

The income tax plan would eliminate taxes on dividends and

most capital gains from corporate stock, simplify depreciation, and

allow expensing for many small business costs, and alter the international tax regime. Those, I think, are the major points that I will

talk about.

Let me, first, discuss the issues associated with the consumption

tax. The consumption tax has two important advantages. It signifiVerDate 11-MAY-2000 15:02 Oct 29, 2007 Jkt 095484 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 38164.000 SFIN1 PsN: SFIN1
18

cantly simplifies tax compliance and administration for business,

and produces efficiency gains through smaller and more even taxation of the returns to capital investment.

Consumption taxes are also often advanced because of their effects on economic growth. A recent Treasury study estimates these

effects.

There are reasons, however, to view the growth benefits with

some skepticism. The inter-temporal models that allow significant

growth effects require heroic assumptions about the ability of ordinary individuals to perform complex calculations. Let me say, it is

an enormous order of magnitude harder than doing your tax return. I think maybe Jim could do it, and maybe me, in this room.

Indeed, the model that produced the largest results does not permit marriage, childlessness, differences in taste, progressive taxes,

an open economy, or differential tax rates at the State level, features we know to exist.

I like to say sometimes it requires asexual reproduction, but the

people who review my work at CRS always get upset about that

word. [Laughter.]

These models are largely not empirically tested. Where empirical

evidence exists, the model’s responses are larger than suggested by

the evidence.

In addition, if one actually believes the theory behind these models, the shift to Roth-style savings plans in the proposal should reduce saving, an effect not considered by Treasury.

Finally, even with the use of these models, the growth effects are

small relative to normal growth in the economy, possibly because

the tax rate on capital income is only about 14 percent. In other

words, the tax reform does not provide a path out of our budget difficulties.

There are also three potentially serious problems with the consumption tax. First, the proposal would lose revenue in the long

run, even compared to the lower baseline used in the study which

makes the 2001 and 2003 tax cuts permanent, because the estimates rest on an assumption of a major shift from deductible, taxpreferred plans to back-loaded or Roth-style plans.

Second, the consumption tax will be considerably less progressive

than the current income tax, in part because of the tax-preferred

savings benefits which are obscured in the short run, but more importantly because of the shift from an income to a consumption

base. The appearance of distributional neutrality arises because

the tax has been distributed in the panel study as if it were an income tax, not a consumption tax.

A third major difficulty with the proposal is transition problems,

although they actually are not as difficult as what you would face

with, for example, a value-added tax. Taxpayers would lose 100

percent of their deduction for basis on the sale of assets and recovery of inventory costs, as well as much of the depreciation of existing assets.

For a newly acquired building, 95 percent of future depreciation

deductions would be lost. Firms would also lose much of their deductions for interest, a problem for firms with long-term, noncallable debt, of which a significant amount exists.

19

Since there is no tax adjustment for debt repayment, taxes on

the sale of assets could easily exceed 100 percent of the equity recovered. Providing full, or even significant, transition relief is prohibitively costly, as inventories alone are close to $2 trillion.

Turning to the income tax reform, there are also some important

simplifications, especially for businesses and high-income individuals in this tax plan, although lower-income taxpayers may find

their affairs more complicated.

In translating the income tax to a more detailed proposal that

deals with small, but important, deductions, however, some of

these simplification gains may be lost. For example, we cannot easily restore itemized deductions for extraordinary casualty losses,

medical expenses, or employee costs because there are no itemized

deductions. This problem would also occur with the consumption

tax.

The income tax plan also has some of the revenue sufficiency and

distributional issues of the consumption tax, although to a lesser

degree. There are also some more limited efficiency gains in a number of areas, although probably little effect on growth. The change

to the international tax rules may increase inefficiency, and even

exacerbate tax sheltering.

There are also some transition problems which are small compared to the consumption proposal, but, nevertheless, significant

for some homeowners. Whether the more limited gains from

changes under the income tax plan are worth the cost is unclear.

Historically, it has been difficult to make major changes in the tax

code because of the disruption in taxpayers’ affairs.

Nevertheless, there are some limited aspects of the proposals

that do seem to have many advantages and few drawbacks. The

proposed floor on charitable contributions has a salutary effect with

target efficiency and tax administration and simplification. Encouraging automatic enrollment in employer retirement plans is likely

to facilitate savings.

A ceiling on deductions on employers’ health insurance plans appears to reserve the benefits of reduced adverse selection in health

insurance markets, while reducing both moral hazard effects and

differential treatment of taxpayers. It may be that the greatest contribution of the panel study is to identify some possibilities for

more limited reforms.

Thank you.

[The prepared statement of Dr. Gravelle appears in the appendix.]

The CHAIRMAN. Well, thanks, all of you, very much. We appreciate your participation. Obviously, those people who have been on

the Commission for as long as it served last year, we thank you

for your work.

Now, I am going to ask the first question. If I say I am asking

questions of the panel, it will be any or all of you who want to answer, but I would appreciate at least two points of view on a question.

The first one comes because the Advisory Panel’s recommendations covered so much ground: international, corporate, individual,

deductions, et cetera. So the question concerns cherry-picking, that

20

we might take some reforms but not others. Sometimes that is a

Congressional necessity. So, your comments on that.

Are there reforms that can be moved independently or separately

from others? For example—and you can take any example you

want—the new Family and Work Credits. Second, if there are reforms that can stand on their own, what would be your recommended priorities for the committee in that regard? Just jump

in, whoever wants to.

Senator MACK. Well, let me start by saying that there are a

number of areas, I think, where you do have the ability to reach

and say, I will take this and put it into a plan different than what

we had come up with. One of those probably is the real estate decision that we made, to put a cap, establish a credit.

But when you do that—and I am sure you all understand this—

it has effects on the issue of distribution. So I think, again, that

is something that we attempted to do as we were going through

these various choices, again, sort of starting out with the premise

that we were going to keep the distribution basically as it is now

and let you all decide what changes you want to make in that regard.

But that is an example. You could take that out. You have an

option, again, with real estate. You could not have a cap and just

change it completely to a credit, but I think you would find out that

that is a fairly expensive move.

I will stop at that and let some of the other members hop in.

Senator BREAUX. Let me just say, very briefly, there are some

things you can do, but everything you do has an effect on something else. So when you do what Connie says, you have to look at

the whole picture. It is difficult.

I think, however, Mr. Chairman, an area of consolidation, I think

that is something you could do without having to do everything. We

have 15 different ways to encourage savings. Do we need 15 different ways, making it more complicated? We have so many ways

to save that are incentives, and yet we have the lowest saving rate

of the industrialized nations.

So thinking about trying to consolidate all of these various

means that have been enacted over the years and making it simpler is something I think could be done without having to do everything all at once.

Ms. GARRETT. Thank you, Mr. Chairman. In my written testimony, I addressed this issue of cherry-picking, because I think that

is a concern. I wrote there of the savings packages that I also

talked about here.

Then I also mentioned what Jim did in his testimony, which is,

if you want to adopt expensing, it must be accompanied by the

elimination of the interest deduction if that expensing is debtfinanced. So I think those are packages. That is, as Jim said, the

spinach with the dessert. I think most businesses would prefer to

have both expensing and the interest deduction.

I think you can look at the individual tax recommendations that

we made through the Simplified Income Tax and take lessons from

that. I think the move from deductions to credits, some of which

are refundable, is something that is worth looking at very seriously.

21

You might even want to take it further than we did and think

about making the charitable deduction a credit as well. I think the

package of Family and Work Credits is one that is very attractive.

I did not talk about, in my testimony, some of the changes we

made on the business side of the Simplified Income Tax, but thinking about taxing business on the basis of its size as opposed to its

form, I think, is something to think about. It should not be the case

that, just because you are an LLC versus an S corporation, versus

a C corporation, if you are otherwise similar, you should face different tax treatment.

I think integration, which is something Treasury has written

about, others have written about, and we talked about, would be

something you could think about.

It is true that any change you make has ripple effects, but I do

not think any of us thought you were going to take our report and

enact it without making some changes.

Dr. POTERBA. Let me make two points. One concerns the imperative of distributional neutrality that we worked with. If one moves

away from the constraint that new tax law must have the same

distributional burden as the existing tax law, then you get a lot

more discretion in thinking about individual parts of the proposals

we put forward.

If one works with a distributional neutrality constraint, then you

need to find various reform suggestions that might go together in

such a way that the burdens and the costs will fall on roughly the

same households.

For example, one might think of various kinds of AMT relief and

pair that with changes in the State and local tax deduction, because in many cases the same taxpayers who are confronting the

AMT today are the ones who are benefitting from the State and

local tax deduction.

Similarly, there are some places where the simplification provisions that we discussed may not have very large distributional consequences, and those are elements that one could, I think, view as

modular components that could be drawn out of the report.

There are a number of provisions that we suggested in both the

Simplified Income Tax and the Growth and Investment Tax that

could be taken separately.

The CHAIRMAN. Mr. Walker, go ahead.

Mr. WALKER. Very quickly. On the individual income tax side, I

think the concept of broadening the base through limiting and targeting tax preferences, holding rates down as much as possible,

clearly has strong merit.

I would note that the revenue neutrality standard that was met

here was based on the President’s baseline and policy proposals,

which is much lower than CBO’s. Even CBO’s does not come close

to dealing with our long-range fiscal imbalance, which we have to

keep in mind.

I do think there is clearly a need to consolidate the number of

savings vehicles that we have, to move towards automatic savings

mechanisms for retirement, and to tighten up on pre-retirement

distributions.

For the first time since 1933, which was not a good year for the

United States or the world, Americans spent more money than

22

they made last year. So, obviously, the proliferation of savings incentives has not gotten the job done, but it has clearly increased

complexity tremendously.

Dr. GRAVELLE. I guess I mentioned two or three in my testimony,

but I think there are a lot of things in here, such as some more

possibilities for reforming charitable contributions beyond the floor.

I think simplifying IRAs is a nice idea, but to move everything

to Roth is raising revenue in the short run and losing it in the long

run, and that is something to be very concerned about.

One of the things that I think there is probably little justification

for that raises a little bit of revenue, is graduated rates for corporations. Graduated rates are designed to reflect distributional effects,

but the owners of small corporations are richer than the owners of

large corporations, on average.

I think it would simplify the tax form if you did an exclusion

rather than an alternative rate for capital gains and dividends, if

you are going to have relief. Personally, I also do my tax return,

just like Dave does, with a calculator at the kitchen table, no Turbo

Tax. I really hate running into the phase-outs and all of that stuff.

If the only way you could do it would be to raise the rate, that

would certainly make things easier. But I would be happy to go

through the proposal and write you a memo and give you a list of

other ideas, if you would like.

The CHAIRMAN. Thank you.

[The list appears in the appendix on p. 86.]

Senator MACK. Mr. Chairman?

The CHAIRMAN. Yes?

Senator MACK. I think there was a second part to your question,

at least the way I interpreted it.

The CHAIRMAN. There was. A matter of priority if you were going

to do these things.

Senator MACK. Right.

The CHAIRMAN. Is that what you are referring to?

Senator MACK. Yes. Yes. I just wanted to make a comment with

respect to that. The way I took the question was, what do you

think is the most significant thing in the plan that would create

higher levels of growth? I think it is expensing. That is an area

that we pursued.

We believe that the way we have constructed it, it is like a subtraction-method VAT, similar to the Japanese, which is a borderadjusted program. So again, I think that is an important area that

I would encourage you to focus on. I realize it has difficulty in the

transitions.

I might say that we do have money in our plan that basically allows for transition. I would say it is not adequate. But I also would

say that we did not assume any revenue from a border adjustability perspective, so that is another source of funds for the future.

The CHAIRMAN. All right.

My second question deals with the issue of debt financing for corporations and the possibility of encouragement of businesses getting into bankruptcy. I also have an interest in this area because

of efforts to close tax loopholes over a period of time.

Under the present system, it seems to me that there is that encouragement—I think your report says so—and also, dealing with

23

the international competitiveness of our businesses in a global

economy.

So I would like a comment on the point that you are making in

regard to debt financing, the encouragement of the tax code for

debt financing, at this point.

Dr. POTERBA. Yes, Senator. I think you are exactly right. The

current tax system does create incentives for debt financing. Such

financing puts firms at a greater risk of financial distress and

other concerns.

The two plans have different effects on the incentives for debt

versus equity finance. The Growth and Investment Tax, the one

that comes with expensing, is based in some ways on the comprehensive business income tax that Treasury worked on in the

early 1990s.

That plan delivers neutrality between debt and equity finance,

and would try to remove the financing distortions that are built

into the current tax code.

The Simplified Income Tax is a more complex animal from the

standpoint of business taxation. It provides a dividend relief provision, partial integration for domestic earnings, along with a higher

tax burden than the GIT on individual interest, some dividends,

and capital gains. It still would allow corporate interest deductibility. It is difficult to exactly determine the net effect of these provisions, and the circumstances would likely vary by firm. This proposal would still create an uneven playing field for debt versus equity.

One of the issues that we did not discuss at length in the panel

report, but which the panel viewed as important, is the rise of various kinds of financial engineering opportunities that create hybrid

securities, many of which carry the tax advantages of debt, but

have risk characteristics which look far more like equity. These innovative products are increasingly blurring the lines in our system

between debt and equity finance. The historical distinction between

encumbrances on the firm as debt, and residential value claims as

equity, is no longer clear.

Ms. GARRETT. Mr. Chairman, if I could just add to that. You also

mentioned in your comments the international tax system, which

I think is extraordinarily important with respect to our competitiveness, especially as we move increasingly into a global economy.

My own view of our report is, that is one area where we needed

to do more work. My observation, as someone who used to work for

a Senator, is that was always the case with international tax. We

spent a lot of time on individual taxes, business taxes, and then

international tax was sort of an afterthought.

So one of the things I would urge this panel to do is to use our

report as a starting place, but to understand there is significantly

more work that needs to be done. We drew some on the Joint Tax

Committee’s work and recommended largely a territorial system,

which I think needs very serious consideration.

I think you have to be careful not to let rhetoric about outsourcing of U.S. jobs drive the agenda, and to look at that issue in

a very sensitive and sophisticated way. Some jobs leave this country then create more jobs in this country, and better jobs in this

24

country, so I think you have to be very careful not to let rhetoric

drive the process.

Then the final thing I would say concerns your need for new revenue—and I share Mr. Walker’s very strong concern about the fiscal future of this country. We face serious fiscal problems in the future because of entitlement programs and other programs; I think

we have to start considering a value-added tax as an additional

source of revenue.

That is what most of our competing nations do for additional

sources of revenue. I talk about a VAT in my testimony. But I

think that is a very important additional consideration for you as

you think about international competitiveness and the need for additional revenue.

The CHAIRMAN. Yes. A follow-up. You said that you are glad we

brought up international competitiveness. Maybe I misinterpreted,

but I thought part of your recommendation was taking that into

consideration, and one of the motivations for your recommendation.

Am I wrong?

Ms. GARRETT. No. That is exactly right. That is what drove our

suggestions on the international tax system: the need to be more

competitive. You need to look both at our tax burdens here in the

U.S. and also how we tax the activities of our businesses abroad.

That is, I think, what has to be the driving force with respect to

the international tax system.

The CHAIRMAN. On the same point, then, the Simplified Income

Tax plan would replace our current deferral regime with a territorial one. One of the many issues that will need to be examined

in considering international reform is transfer pricing.

The panel report notes that effective transfer pricing enforcement

is even more important in a territorial system than the current system, and suggests this issue be addressed by devoting additional

resources to examining that. Commissioner Everson identified

transfer pricing associated with intangible assets as one of the

most significant compliance problems the IRS faces.

With this background, two questions. Why should this committee

consider moving to a tax system that intensifies the pressure

placed upon transfer pricing enforcement?

Second, given the difficulty that the IRS faces in the current deferral regime, is it realistic to expect enhanced enforcement to adequately address the increased importance of transfer pricing issues

with territorial regimes?

Ms. GARRETT. I could give you a couple of quick reactions, and

there may be other reactions. I think that, as you think about your

recommendations with respect to international tax, you have to

take very seriously the challenges of transfer pricing. Those are

challenges we face now. As the report points out, those are challenges that do not disappear; rather, they may be exacerbated.

As you think about how those issues will be resolved and how

they will affect your recommendations, I think you have to give

very serious consideration to the resources that are made available

to the Internal Revenue Service.

The IRS has to have the resources to police the system that you

put in place. The IRS tends to be the least-liked agency, I think,

in the government by taxpayers. It is often easy to gang up on the

25

IRS. But if one moves to a system where enforcement is important,

then resources have to be made available to the IRS to police that

system.

The CHAIRMAN. You go ahead. Then we will get Mr. Walker and

Dr. Gravelle.

You will have to talk to Senator Wyden now, because I have just

got a few minutes to go vote. Go ahead.

Dr. POTERBA. Mr. Chairman, of all the topics that our panel addressed, the issue of international taxation was probably the one

where we heard the greatest differences among our witnesses. We

heard recommendations both for territorial and for worldwide tax

systems defended with great fervor.

The reason there is disagreement is that there is a fundamental

trade-off between two different distortions. On the one hand, if you

go with a territorial structure, you create incentives for transfer

pricing to move income out of the U.S. and to place it in low-tax

international jurisdictions that will operate as tax havens.

On the other hand, if one works with a worldwide tax base and

uses a deferral system, as we have today, you create distortions in

the financial decisions of firms with respect to deferral, keeping income abroad in the operations country, or repatriation. Since bringing earnings home generates a tax, the repatriation decision is a

taxable event.

Many argue that the distortions associated with repatriation

today are substantial. The panel ultimately decided that those considerations warranted a territorial-type structure. We took some

solace from the fact that many of our major international trading

partners have also moved over time toward the territorial structure.

I do not think that our recommendation in any way minimizes

the concerns about transfer pricing, which the Chairman’s question

raised, because, in fact, many of those other nations are worrying

today about precisely these kinds of transfer pricing issues.

I think the solution, if there is one, is to go very carefully, and

with substantial enforcement, in the direction of the territorial system.

Mr. WALKER. With regard to the Chairman’s question, Senator

Wyden, on transfer pricing, I spent 21 years in the private sector,

including with some of the largest professional services organizations in the world.

Transfer pricing is extremely complex. There is no question that

the IRS is out-gunned with regard to transfer pricing. They need

more human, technological, and financial resources focused on this.

It is an issue that exists today that needs to be focused on.

At the same point in time, administrability and enforceability are

only two of the elements that need to be considered. You also have

to consider economic efficiency, competitiveness, equity, simplicity,

a variety of other factors, in order to be able to make a judgment

as to, in the aggregate, what is the best way forward.

Dr. GRAVELLE. The panel would tax royalties on a current basis,

even associated with active businesses. I think that was directed

at reducing tax sheltering in the international economy.

But they chose to move from deferral and repatriation, with its

problems for active income, to exemption instead of worldwide taxVerDate 11-MAY-2000 15:02 Oct 29, 2007 Jkt 095484 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 38164.000 SFIN1 PsN: SFIN1
26

ation. You could have eliminated those repatriation decisions by

moving to current taxation of active income.

I think that a territorial tax, inevitably, has to create bigger

transfer price problems than current taxation of foreign-source income. And, in addition, current taxation of foreign-source income is

economically efficient.

If we make an investment in a low-tax country because it has a

low tax rate, we are earning a lower social rate of return than we

would if we made that investment in the United States. That is

something called capital export neutrality and it is, clearly, the

way to move efficiently. So, I do not think efficiency is served by

moving to a territorial tax, either.

Senator WYDEN. Well, my apologies to all of you for having to

duck out for the vote. It is a crazy day, even by Senate standards.

I obviously have missed the earlier discussion.

I think what I would like to do is begin with this topic that I

have discussed with Senator Mack and Senator Breaux even recently. When I got on the Senate Finance Committee, I said I was

interested in tax reform and basically spent the better part of the

year scrubbing the Code from top to bottom, and obviously followed

the work that you all did very closely.

The more that I looked at the tax system, the more convinced I

was that the basic principles of what brought everybody together

in 1986, from Ronald Reagan, to Bill Bradley, Bob Packwood, Dan

Rostenkowski, that those principles are still very sound today.

What I have sought to do in my Fair Flat Tax Act is basically

look to an updated, modernized version of what was done in 1986.

It seems to me what they said in 1986, in a bipartisan way, is, we

are going to eliminate a boat-load of tax breaks on both the personal and the corporate side.

We are going to try to get a break to the person in the middle,

but we are going to figure out a way to hold down rates for everybody, and we are going to simplify the system. That is essentially

the architecture of what was done in 1986.

My question, to start with, for Senators Mack and Breaux, is, do

you all share my view that what was done in 1986—not all the details, but the basic 1986 framework—would still be a pretty good

model?

Senator Mack?

Senator MACK. I think it probably would. There were things that

I disagreed with in the 1986 tax proposal. One of the most significant for me was the notion that we were going to tax capital gains,

for example, at ordinary income tax rates.

If I remember correctly, the top rate at that time was 28 percent.

But, frankly, when you added in a couple of other features, the rate

probably was in the neighborhood of 30, 31.

I think that the 1986 Act also kind of points out a process that

works. Both you and the Chairman talked about the importance of

bipartisanship. When Secretary Baker testified before the Commission, he made it very clear that without bipartisanship, there

would not have been a 1986 Tax Reform Act.

So I think, generally, the notion that was taken in 1986 is a road

map, to use an over-used word these days, for how one can get both

the process and some of the policy issues to kind of come together.

27

But as I said, one of the big discussions and debates we had within

our Commission was about this issue about taxation of capital.

Again, you and I have talked about that.

I am one of those who feels very strongly that the lower the capital rate, the greater the growth. I am sure there are people who

strongly disagree with that. So if I were putting together a plan,

I would have no tax on capital, dividends on capital gains, and so

forth.

But if we are going to end up with a package somewhere, I know

that I am going to have to compromise on my principles to some

degree if we are going to get a plan. So, I hope that addressed your

question.

Senator WYDEN. It does.

Senator Breaux?

Senator BREAUX. I think the short answer is yes, that the framework of 1986 would be something you could work on. Equally important to the framework of the substance, also, is the framework

of the methodology they used. It was bipartisan.

I think you certainly have been around long enough to know that

you are not going to do just a Republican tax reform simplification

bill, or just a Democratic tax reform simplification bill. It is going

to have to be both sides together.

If I could make a suggestion, I would think that you also have

to have the White House as part of this effort. I would suggest, if

you could get the Chairman and the Ranking Members of the Tax

Committees to really join together and request the administration,

in the next State of the Union address, to call on the Congress to

work in a bipartisan fashion to get this done, that that would be

the motivation. The administration is supportive of an effort.

Then if you can have the Congress, both Republicans and Democrats, saying, yes, we are willing to do it again, you would hear a

huge round of applause from the American people. You know they

are working together to simplify something that everybody agrees

is too complicated. That is a win-win from a political standpoint,

and it would be a win from a substantive standpoint.

Senator WYDEN. I think both of you have given very thoughtful

answers. I have had a number of those conversations with the administration as well. This is something where you can bring people

together. You look, for example, at the Social Security debate we

have had.

I can tell you, I think we all know, those of us who serve in public life, you are not going to see any rallies outside a Congressperson’s office with people carrying signs saying, ‘‘I love the tax

code.’’ They did on Social Security. So this is an area, in my view,

where people can come together.

I want to ask one more question of the Senators, then I am going

to get all the rest of the panel members into the act.

For you, Senator Mack and Senator Breaux, the discussion about

this is always, this is impossible. Tax reform? It cannot be done.

These special interest groups are too powerful. The differences are

too stark. It just cannot happen.

But I was struck, when I looked at what you all did, at how

much common ground there already is in areas like simplicity.

Looking at the brackets, I mentioned you all have four brackets, I

28

have three brackets. I am open on these kinds of things. I think

Chairman Grassley would say, when you work in the Senate Finance Committee, you have to be open on this.

But is it not fair to say that it is popular wisdom that this cannot

be done, that there is no common ground? It is just not accurate

when you look at what is actually out there on issues of simplicity,

the number of brackets, a variety of areas where there is common

ground.

I think, Senator Mack, you are right on the question of capital

and wages. This is obviously going to be one where you have to figure out an approach that brings both sides together.

But I would like to get both of you on the record on the proposition of whether you think there is a fair amount of common

ground here for Democrats and Republicans on this committee to

go to work.

Senator MACK. The answer is, absolutely, there is. First of all,

let me just go back to 1986. They said exactly the same thing when

we went through the 1984, 1985, 1986 period on tax reform. Exactly the same thing. So I think that the 1986 Act makes the case

that, in fact, this can be done.

But I am going to venture, maybe, into another area. I think that

people are also saying that because, frankly, there have been very

few areas in which Democrats and Republicans have chosen to

work together over these past years.

As you know, and most members know, there is great talk about

the level of discourse that takes place in the Senate, in the House,

the confrontations that take place, the personal relationships that

have deteriorated.

So part of what people are saying is, the attitude of the Congress, House and Senate, is not likely to produce a bipartisan effort. So, I think there is great skepticism on their part.

Clearly, there are huge issues. If you go to address, for example,

the mortgage interest deduction and our proposal with respect to

that, it is interesting that so many people around the country assumed, when they heard what we had proposed, assumed that we

had proposed doing away with any mortgage interest deduction. So

that is a huge issue.

You are going to have enormous pressure from all of the groups

that we dealt with back in 1986 to retain that. Again, this is a personal opinion of mine. It does not necessarily reflect the panel.

My feeling is, if you really are going to address the issues of simplification, and fairness, and growth, you have to modify the way

we treat mortgage interest deduction.

It is indefensible. As John indicated earlier, there are countries—

England, Australia, Canada—that have no mortgage interest deduction and have about the same ownership rates as we do, one

country greater than we do.

Second, it is an enormous distortion. The present code is an enormous distortion with respect to people making decisions about

where they are going to invest.

Nobody should be surprised at the huge second and third vacation home market that has developed around our country. So, I

think it is imperative. You are going to run into enormous forces

29

to keep that from happening, but I do believe it can be done. Absolutely.

Senator BREAUX. I think it is clear from history that it can be

done, and Connie mentioned the fact that we did it in 1986. How

did we do it? Well, we joined hands and both sides were going to

take political hits.

It is obviously very clear that you cannot touch the tax code

without punching some special interest in the face. Then they go

out and hire somebody like me to help them. That is what we are

all facing. But we all know that.

That is why it has to be done together, in a bipartisan fashion.

I cannot over-emphasize my strong feeling that you have to get the

administration on board to make the request for Congress to do it

in a bipartisan fashion. Every couple of decades, it is time to do it,

and this is the time.

Senator WYDEN. Let me start at this end so I can get the rest

of you into this discussion. I would like your sense of how low tax

rates have to go to get people to say, all right, I will start giving

up some of these individual breaks that I have been interested in

in the past.

Let us just get a kind of general sense, on the basis of what you

have done, how low you think the rates have to get so that people

would be open to giving up various breaks. To the extent that you

can do it in a way that keeps some sense of fairness in terms of

the rates, that would very helpful.

Dr. Gravelle, why don’t you start? Let me, again, express my

thanks for all the help you have given to me, slogging through vast

amounts of paper and charts to help me put together my proposal.

Dr. GRAVELLE. You are welcome. I do think that, for the vast majority of taxpayers who never see tax rates, they either take the tax

off a table or they do Turbo Tax. So I think you could probably

trade off between rates and base broadening for a lot of people

without a great deal of trouble. So I do not see that as a really big

barrier.

But as for a number, we began some years back and we had tax

rates at 50 percent. During World War II, we had tax rates of 90

percent. I mean, our rates are really very low today by historical

standards, and also by worldwide standards, the tax burden, at

least, that we bear.

So I would think you would be able to raise the rates, or you

would be able to trade off either way, broadening the base or

changing the rates if you needed to do that to deal with the AMT,

phase-outs, or those kinds of problems that are facing us.

Senator WYDEN. Any sense of a number? I know Senator Bradley, Senator Packwood, and probably John Mack—and Connie remembers those discussions—ended up, I think, somewhere between

14 and 28 percent.

I suggested that I had started with the brackets Ronald Reagan

proposed, but we wanted to end up at 10, 20, and 30; 10 for the

most modest income, 20 in the middle, 30 at the top. I would certainly be interested in looking at that.

I think part of all of this is to get a sense of how low the rates

have to get for people to say, all right, I can swallow giving up

those breaks. Do you want to take any other crack at it?

30

Dr. GRAVELLE. No.

Senator WYDEN. All right.

Dr. GRAVELLE. I really have no idea.

Senator WYDEN. All right.

Mr. Walker?

Mr. WALKER. I think it is important to put this in context, Senator. Number one, 70 percent-plus of Americans pay more in payroll taxes than income taxes when you recognize the reality that,

even though the employer pays half of the payroll tax, the individual bears the economic cost and burden. It is part of their compensation.

So, 70 percent of the people are paying more money in payroll

taxes than income taxes to start off with, and most Americans care

about, what is the net spendable bendable? How much do they take

home to be able to spend on food, housing, or whatever?

Secondly, do not under-estimate the degree of frustration and the

degree of relief that Americans would find if you could really

streamline and simplify this. Yes, you would be able to reduce the

rate somewhat and maintain revenue neutrality, and I think they

would love it.

Okay, now, how low do you go? I think part of the problem with

that is, we are not raising enough revenue to pay our current bills

and deliver on our current promises now.

One of the biggest problems we have right now is, we have this

false theory that every tax cut is going to stimulate economic

growth and they are going to pay for themselves. That is just flat

false. So we need to recognize reality here.

Let me tell you, there is one word that is needed, and you, and

Senator Grassley, and a few others are trying to provide it. It is

called leadership. We have a huge leadership deficit in this country.

I totally agree with Senator Breaux that you have to get the

President of the United States, and you have to get bipartisan leadership on both the Senate Finance Committee and the House Ways

and Means Committee.

Anything is possible if you get committed leadership. If you focus

on the people rather than the special interests, there is a huge winwin here. But it is going to take leadership.

Senator WYDEN. Dr. Poterba?

Senator MACK. I wonder if I could just interrupt for a second.

Mr. Chairman, I am going to have to go. I have a flight to make.

So, I apologize for having to leave before you all were through asking questions.

The CHAIRMAN. Well, we thank you for your 2 years of work on

this. Thank you very much. Of course, you will be busier next year

if things go as I have them planned, whether the President has it

planned that way or not.

Dr. POTERBA. Senator, if I were to give you a number, it would

be 30 percent. If you get below 30, I think people may sense that

they are in a different tax world than the one they have lived in

in the past.

It is extremely difficult to get enough base broadening to cut

rates that much precisely because of the concentration of income

tax revenues among the higher-income part of the population.

31

A lot of revenue is being collected in the current high-rate brackets. As you try to find ways to move the tax rates on those brackets

down significantly, you really have to do base broadening of a kind

that will touch on many popular deductions and exclusions from

the income tax base.

It may be easier to do larger tax reforms than smaller ones. Singling out any particular provision and saying we are going to lower

rates and finance the rate cut on the back of a particular change,

whether it is State and local deductibility, or the mortgage interest,

or employer-provided health insurance, assures a battle with a particular special interest group.

Making several base-broadening changes at once offers the potential to get a larger total reduction in rates, which may look more

attractive for the rank-and-file taxpayer, and makes it more complicated to determine exactly where the plan leaves any given taxpayer.

Commissioner Rossotti, a member of our panel, worked very hard

to tell people that you have to look at the full picture and recognize

that the benefits of tax reform are often mixed in with the costs.

It is critical not to focus just on the components of reform that lead

to higher taxes.

Senator WYDEN. Very helpful.

Ms. Garrett?

Ms. GARRETT. Yes. I think it is very difficult to focus only on

rates or to give you a number. I think it may be a little bit dangerous to do so, with all due respect.

One reason is, as you have heard, it ignores a tremendous tax

burden, the payroll tax burden. So if you are just focusing on income tax rates, you lose track of that. My concern is the same as

yours, that is, our tax rate on labor. There, payroll taxes are an

issue you really have to look at.

One thing we found, and this is what Jim alluded to, is that we

would eliminate these ‘‘sacred cows’’ or scale them back and think,

‘‘Wow, so tomorrow when we get the revenue estimate, rates are

going to be really low, because, look, we went after health care, we

went after mortgage interest deduction, we went after State and

local taxes.’’

Then we would get the revenue estimates back, and the rate had

not moved very much. So one of the things you learn is, even when

you go after the sacred cows, you just do not get the bang on the

rate that you would like.

Then the final thing I would say is, I think fairness is more complicated than just the rate. It is sort of a ‘‘sound bite’’ part of the

fairness debate, and it is important. I do not want to say it is not

important. But I think there is a lot more to fairness that people

understand, and they are things like, who is benefitting from the

expenditures? What do we do with respect to the millions of Americans who do not pay tax and, thus, to the extent that there are incentives in the Code for savings, et cetera, do not benefit from

that? Refundable credits are a way to deal with that.

Having said that, I think we ought not to focus on rate very

much. It does not mean rate is inconsequential. For example, I

think the national retail sales tax is an absolute non-starter in

terms of policy. One reason is, to be revenue-neutral, even under

32

the President’s baseline, the rate for a national retail sales tax

would have to be extraordinarily high and unsustainable. We estimate it at 34 percent. That is probably a low estimate.

So I do not want to say that rates are entirely irrelevant. I think

that with national retail sales tax, which has a number of problems, the rate is one of the biggest ones.

Senator WYDEN. Senator Breaux?

Senator BREAUX. I have no idea on the rate. I think we are all

in the same ballpark. Ours was, what, 33 percent, I guess, on one

of the plans. It is all interconnected.

If you lower the rates, you are going to have to get rid of some

of the things that people think are really important. You are going

to have to bite the bullet. That is why it has to be done in a bipartisan fashion. But that is the ballpark area, 15 to 30.

Senator WYDEN. All right. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you.

I am going to have just 5 minutes of questions, and if other members do not show up, we are going to adjourn. I could keep you here

for the next 2 hours with all of the questions that need to be asked,

and you are probably fortunate that more members did not come.

We had those votes and everything.

Presumably, we may have the same group of people back here

January of next year as we start with a new Congress down this

road in a more comprehensive way than we had planned for this

year.

My first question would be in regard to the capping of tax-free

benefits of health insurance, and particularly the point that the

committee made, that this is a cause of the increase in health care

costs. I would appreciate any of your views on the health tax proposal of the panel, and also the impact of tax benefits on health

care costs.

Senator BREAUX. Well, very briefly, we continue to allow for a deduction in our recommendation for the purchase of health insurance, but we thought that a limitation would be the appropriate

way to be fair to everyone.

The tax preference for health care is our largest tax expenditure. It is huge. It is $141 billion, 12 percent of all the Federal income

tax revenues in the year 2006. It is huge. Yet, we still have 40 million people-plus who do not have health insurance in this country.

So what we recommended is that we continue to allow, of course,

the employers to be able to deduct the costs of their employee compensation, and employees continue to be allowed to not count it as

taxable income.

We said, simply, that we are going to put a cap on it, and the

amount of that exclusion would be limited. What we did was picked

the number of $11,500 for families and $5,000 for single individuals. That was the national average when we did the report.

If you want a plan that costs more than that, you are certainly

entitled to do it, but the government is not going to pay for it. We

picked something that is an average for all Federal employees and

members of Congress. It is true that an unlimited deduction encourages people to buy more than they actually need.

You lose a connection between the cost if you know it is going

to be deductible and it is not going to end up costing that much.

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So we are trying to say, look, this stuff costs. If you want to have

no deductibles, no co-payments, that is fine, but that is not necessarily the best policy for individuals.

This recommendation would connect people better to the costs of

their health care, and I think it still allows for a very generous deduction.

Ms. GARRETT. Just briefly, Mr. Chairman, I think that this recommendation illustrates two important ways that we approach the

individual tax system. One is, we did cap the exclusion.

The idea there was, we want to encourage people to have health

coverage and to have reasonable health coverage, but to the extent

that someone wants a high-end plan, that is not something that

government should subsidize because those subsidies come at a

cost of higher tax rates. So that was something we tried to do with

the home mortgage subsidy, and we tried to do it here as well.

Second, we always tried to expand the coverage, so that here we

tried to expand the incentive beyond those who received their

health benefits through their employers to all Americans who purchase health plans.

A couple of things I would highlight for you to think about. First,

we increased the cap by inflation, I believe. I think you should

think about whether to increase it by inflation or the cost of health

care, which can be a different rate. To be honest, I think revenue

concerns led us to pick inflation; it was a lower indexation. But I

think you need to think about that carefully.

The second thing I would say is, I think this is a very important

change and a beneficial change, and one I would support even if

you did not need to raise revenue. I think it is the right policy decision. But it will not be a panacea for the health care problems in

the country, so it should be viewed as only part of the solution.

Dr. POTERBA. Mr. Chairman, I think that offering a quantitative

estimate of U.S. health care cost growth that can be pinned specifically on the current tax treatment of employer-provided health insurances is very, very difficult. There are many links in the chain

between the tax code and the amount of insurance households purchase, and then between that insurance coverage and the services

that doctors choose to provide, and that consumers choose to purchase.

But I think the underlying analysis that Senator Breaux has outlined is unimpeachable. The distortion we create with the current

system encourages over-consumption of health insurance, it insulates the consumer from the price of health care purchased from

the provider, and it surely leads to greater outlays on health care

than we would have in a world which created a level playing field,

and health insurance and health outlays were treated in a more

symmetric way with other household purchases.

The CHAIRMAN. Mr. Walker?

Mr. WALKER. Mr. Chairman, first, I agree fully that you should

not do anything to limit the deduction to the employer for health

care. Doing so would be totally counterproductive, because that

would provide an incentive for employers not to provide health care

to their employees, and they would just pay it in the form of cash

and let the employee be on their own.

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There are various proposals that have come out throughout the

year saying, gee, it is easier to limit the employer deduction than

take on the individual exclusion, but it would be totally wrong and

counterproductive.

Second, I think the Commission was too easy. I think we have

to limit the individual income tax exclusion to a much greater extent than is being proposed. Health care costs are out of control.

If there is one thing that could bankrupt America, it is health care.

We need to improve the transparency and accountability mechanisms with regard to the true cost of health care.

The fastest-growing cost for the Federal Government and State

governments, the fastest-growing cost for employers in the private

sector, the number-one competitiveness challenge, is health care.

So, we need to do much more than this. We need to have much

more comprehensive health care reform.

I think the question is not if you limit this. The question is, how

much and as a part of what reform? As part of comprehensive tax

reform? As part of comprehensive health care reform? Because we

need to do both. It is absolutely essential.

Frankly, I would have limited it more. One of the reasons wages

are not going up as much, one of the reasons that pensions are declining, is because compensation costs in the form of health care

are crowding out other forms of compensation.

One of the reasons that is happening is because of the special tax

preferences accorded to health care, which might have made sense

in the 1940s right after World War II, but do not make sense

today.

Dr. GRAVELLE. Well, as I indicated in my testimony, I think

there is kind of a mixed bag with respect to the health proposals

in terms of efficiency. I am sort of inclined to like the notion of

some kind of limit on employer health care.

I think having employer plans is crucial to preserve, because I

think it is the one thing in the private health market that deals

with the severe problem of adverse selection that naturally occurs

for people with bad health histories not being able to get health insurance. Whether you can do a dollar cap, technically, I am not

sure. That is something for tax administrators.

The other thing you could have done is make the tax deduction

contingent on plan features. So, say you only get the deduction if

you have a certain co-payment or a certain deductible. I mean, that

would be another way to do the same sort of thing.

I also think you cannot ever deal with the exclusion. I think that

is impossible to allocate the benefits to individual employees in

terms of doing it as an exclusion.

The deduction for individuals—my theory would say that that is

going to increase health costs because more people are going to

have insurance coverage.

I am not sure how much of an effect that proposal is going to

have though, because I think there is some empirical evidence that

low-income people are unlikely to respond by buying health insurance anyway.

A lot of them do not have tax liability and really would not get

any benefit from a deduction anyway, so I think that would have

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some effect. Whether it would be a major effect, I kind of suspect

not.

The CHAIRMAN. All right. I am going to thank you, for my part.

Senator Wyden has some more questions, and he will finish the

hearing, because I have a 12:30 meeting I have to get to. Thank

you all very much for participating.

Senator Wyden?

Senator WYDEN. Mr. Chairman, thank you. As you leave, again,

let me just thank you for all of your willingness to discuss this

issue and to just say how much I will look forward to working with

you on a bipartisan basis on this.

The CHAIRMAN. You bet. Thank you.

Senator WYDEN. Just a couple of other questions I am going to

ask. I am sure when Chairman Grassley said that Senator Wyden

had some additional questions, you all looked at your watches and

said, my God, we are going to be here until breakfast time tomorrow.

I just have a few additional matters I want to get into, and I will

let you all get off to your business.

Mr. Walker, one of the things that has been striking to me about

this health care issue is that it has been possible to put a valuation

on the value of the benefits that the workers get.

It appears that it is upwards of $150 billion a year, essentially,

the break that the worker gets on their health care. But I have not

been able to locate anywhere exactly what the value is to business

of being able to deduct the cost of health care.

As far as I can tell, the costs to the business that are deductible

get clumped into business expenses generally, so we have been calling all of those who have expertise in this area to try to see if we

can get a sense of what the number is as it relates to the business

write-off for health care. I am curious if you have any information

on that.

Mr. WALKER. I assume you mean the value of the deduction for

the employer. Is that what you mean?

Senator WYDEN. Correct. Yes.

Mr. WALKER. I do not have it off the top of my head, but I will

go back and ask my staff. They probably do have it, and I will be

happy to provide it for the record.

Senator WYDEN. Senator Breaux?

Senator BREAUX. If you take a look at page 79 of our report, Mr.

Chairman, we address that. These are not my figures; we got them

from tax experts within Treasury, obviously

The first paragraph on that page says, ‘‘Taken together, the tax

preferences for health care represent the largest tax expenditure

and will have an out-sized impact on health care spending in

America. The United States has the highest per capita health care

spending in the world, $1.5 trillion, or $5,400 per person in the

year 2002. The tax benefit associated with health care will cost approximately $141 billion, or 12 percent of all Federal income tax

revenues this year. The largest component of this cost is an employee exclusion for the employer-provided health insurance and

medical care, which is a tax expenditure of $126 billion.’’

So this is telling us that the costs for the employees, non-taxable benefits, is $126 billion. I do not know if that is correct to extrapoVerDate 11-MAY-2000 15:02 Oct 29, 2007 Jkt 095484 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 38164.000 SFIN1 PsN: SFIN1
36

late that from $141 billion leaves $15 billion. It may be, but we

could get more information, maybe, from Treasury on that.

Mr. WALKER. If I can, Senator. We will provide it for the record.

There are several preferences you have to look at.

Senator WYDEN. Right.

Mr. WALKER. That is the value of the deduction to the employer,

which is what you ask, which I do not recall off the top of my head.

There is the individual income tax exclusion, for the fact that individuals never pay income tax on the value of employer-provided

and paid health care, no matter how much money they make, how

wealthy they are, and how generous their plan is.

Number three, they never pay payroll taxes on it either, since

there is an exclusion from the taxable wage base as well. If you add

up all three of those, you are probably over $200 billion in the current year. So, I will provide something for the record.

Senator WYDEN. That would be very helpful, Mr. Walker.

[The information appears in the appendix on p. 222.]

Senator WYDEN. I think in the combination of your answer and

Senator Breaux’s, I just missed that figure. My sense was that the

difference between $141 billion and $126 billion did involve the employer component, but I also sensed, as I tried to look at it—what

Mr. Walker is talking about—there are some other aspects of this,

and it gets us up over $200 billion. So, we are going to want to

work with you all on it.

The second question that I wanted to ask you about involves

some exceptionally important work that Senator Baucus has been

involved with, and that is the tax gap question. Chairman Grassley

has been very interested in this as well.

What the two of them have pointed out is that the current tax

system fails to collect at least $350 billion a year of taxes that are

owed, but not collected. Obviously, the under-collection of taxes

from some taxpayers means that they are not paying their fair

share, and everybody else has to pay higher taxes to make up for

those who are not paying their fair share.

So, closing the tax gap could also raise an additional $1 trillion

or more that you could essentially look at on this question that I

was talking about, in terms of lowering rates.

Why do we not just go down the row, and I would like to start

with Dr. Gravelle on this one, how you would look at this issue

that Senator Baucus and Senator Grassley have really led us on,

which is closing the tax gap and how it fits in to the debate about

tax reform.

Dr. GRAVELLE. Well, that is probably in Mr. Walker’s expertise

more than mine. I think the places where we have the missing taxable income are the places where we do not get our hands on it before it goes to people, so the more withholding that you can do of

any kind of income probably would help with the tax gap.

Other than that, I think it is small businesses that are a major

part of that. There is also the underground economy, and I guess

you are probably never going to collect much on drugs and prostitution, and things like that.

I do not know whether the tax gap includes these international

tax shelters. If it does, though, I think we need some bigger guns

37

in court on the part of the IRS to go after these international tax

scams.

Senator WYDEN. That is a very valid point. We all saw the report

that was done by the Investigations Committee; again, a bipartisan

report talking about the enormous sums of money that are wasted

with these offshore tax shelters. You can be assured, I am going

to follow up on that. I know colleagues on both sides of the aisle

will.

Mr. Walker?

Mr. WALKER. Senator, I, within the last several months, had the

opportunity to testify before this Committee about the tax gap. The

latest estimate, as I recall, is about $345 billion, but that is as of

several years ago, of which about 70 percent relates to individual

income taxes.

There are several issues. One, we have recommended additional

reporting, in addition, additional withholding; both would help to

reduce that tax gap. Furthermore, we reinforced at that time that

simplification was essential to make real progress in this area. I

think there are millions of Americans who really do not know

whether they have done it right or not.

We have also done work with regard to tax preparers and found

problems with regard to tax preparers. Obviously, a vast majority

of Americans, as we have heard today, go to tax preparers because

they cannot begin to try to do it themselves.

So I think simplification would help with regard to the tax gap,

but it is not a magic bullet. We still have to take other steps to

make sure that people are disclosing income, to look at issues like,

what is the basis for capital gains.

Right now, when you sell stock or some other capital asset, you

get a reporting to the government on the gross proceeds, but you

do not have any idea what the basis is, and obviously, you pay income tax on the difference. So, there are opportunities to make

more progress here.

Senator WYDEN. Dr. Poterba?

Dr. POTERBA. Senator, I think that it is very important to do

whatever we can to collect what the current statutes stipulate and

to try to improve enforcement.

Estimates I have seen suggest that additional dollars spent on

enforcement probably yield more than a dollar in revenue return,

so we may not be devoting enough resources in that direction. I

know, of course, there are considerations about individual freedom

and intrusion of rights that must be considered in deciding on the

optimal level of enforcement.

There are two things to suggest here. One, expansion of thirdparty reporting is likely to be very important as a way of trying

to expand the information base that the IRS has available as it

tries to identify the parts of the economy where current compliance

is relatively low.

Second, it is essential to preserve taxpayer confidence in the system. Voluntary compliance is our norm. Our system critically relies

upon individuals choosing to comply for virtually everything other

than simple W–2 reporting.

Senator WYDEN. Ms. Garrett?

38

Ms. GARRETT. Let me just emphasize that I think there are more

than just revenue concerns here at stake, there are fairness concerns. Those people whose income is mainly from their labor, from

employment, their taxes are withheld. There is not a tax gap there.

The tax gap occurs other places.

To the extent that ordinary Americans who are paying their

taxes think that others are getting away with something, that undermines the legitimacy of the system.

The last thing I would say is, I think it is very important to go

after the tax gap, for both revenue and fairness concerns. But I

think we also have to be careful and not think that is going to solve

all the problems. It is a little bit like ‘‘waste, fraud and abuse.’’

We hope we can get rid of the deficit by eliminating ‘‘waste,

fraud and abuse,’’ but we know we really cannot do that. You cannot solve the structural and other problems facing this country

solely by closing the tax gap.

Senator WYDEN. I spent a lot of years sitting next to Senator

Breaux, where we heard people say that the magical solution for

everything is just getting that ‘‘waste, fraud and abuse.’’

Senator BREAUX. We heard one person suggest to me about closing the tax gap, that we ought to just have the person tell the IRS

how much they made, then let the IRS tell them how much they

owe, and it would be real simple. But we did not accept that suggestion.

I think the complexity of the Code contributes to the gap. I

mean, very rarely could you ever get two tax preparers who come

up with the same decision on what is owed for the same taxpayer.

Because of the complex nature of the Code, they can look at it

different ways, approach it different ways, and come up with different conclusions for the same taxpayer. No wonder we have a

gap, because of the complexity.

The simpler it gets, the easier it is to understand, the more difficult it is to cheat. It is so complicated, it makes cheating easy.

Therefore, the simplification really would help address this problem.

Senator WYDEN. I think you all are spot-on on this simplification

issue. It has been stunning this year, the number of reports, journalists and others who would essentially send a tax form to a variety of preparers, and they would all come back with wildly different kinds of responses. So, your point is on target.

My last question. I think I would like to engage Dr. Poterba and

Dr. Gravelle on the question and maybe some of the rest of you

would like to participate in this, too. But the differences, I think,

were clear between Dr. Poterba and Dr. Gravelle on the question

of consumption taxes and their impact on economic growth.

I ask this again because Senator Baucus has really done some

very important work in terms of looking at the tax code and what

it is going to take to make us competitive in these tough global

markets.

I am certainly interested in any ideas you all have about various

proposals and what they do for economic growth. So, why do we not

start with Dr. Gravelle and Dr. Poterba on this one, but I would

invite the rest of you to participate. This will be about it, for the

purposes of the morning.

39

Dr. Gravelle?

Dr. GRAVELLE. Well, I think the simple evidence that we have

seen through history is, people are not very responsive in their savings or their labor supply to marginal tax rates. They certainly are

not responsive on the order of magnitude, I believe, that comes out

of these inter-temporal models.

In the short run, in the inter-temporal models that the Treasury

used, one of them was the asexual model. That is the one that had

the biggest effects. That depicts everybody as one single, infinitely

lived, identical individual that looks through to their descendants,

their grandchildren, and their great-grandchildren and has an infinite time horizon.

The other, I think, is probably a little more pragmatic. It is

called a life cycle model. But in both of those models, in the short

run, the response of the labor supply to the interest rate is what

is driving the short-run response.

I would like to quote Charlie Ballard, who has a general equilibrium model, who commented when the Joint Tax Committee

studied this. He said, ‘‘Anybody who believes they can project the

effects of a tax change based on the response of workers to the interest rate, is shooting in the dark.’’

There is absolutely no evidence of this. I do not know about you,

but I do not go home and reconsider my labor supply over my lifetime based on what the interest rate is, and I doubt very many

other people do.

It is something that falls naturally out of the micro-models that

we do to look at individual behavior. But I think there is a big

move now in the economics profession—at least I hope there is—

to think about sort of bounded rationality models, models where

people cannot make these complex calculations with perfect information.

The default argument is exactly in that framework. You cannot,

on the one hand, believe that people are super-rational, and at the

same time believe that whether they sign a paper or not is going

to determine a major part of the savings in their 401(k) plan. So,

I think we have to look at the simple evidence.

The simple evidence says, for many years, none of these things

changes very much. I think we have to expect limited growth responses from these tax changes, and I think we need to step away,

as an economics profession, from mathematically tractable and fun

models to do and solve and assign graduate students problem sets

with, into something that more realistically depicts how people behave.

That is why I am very, very skeptical that we would get very

much. Plus, the tax rate right now, on average, is only 14 percent.

So, it is not like we have a 90-percent tax rate on capital income

right now.

Senator WYDEN. Dr. Poterba?

Dr. POTERBA. Senator, I think Jane and I agree on many things

and disagree on some. The place where we agree is that the analytical framework for trying to pin down precisely the economic

growth effects of even quite fundamental tax reforms is, if not

wanting, at least imprecise. Many of the models that are currently

used allow for a wide range of possible estimates, and their results

40

are quite likely to depend on some assumptions that we make,

many of which are, frankly, difficult to test, and some of which may

be difficult to square with the realities of behavior that we see. One

should not put tremendous faith in any specific number on growth

effects.

The place where Jane and I differ is, I am more convinced that

taxes affect behavior than she is. I think we can look at the historical record and find a number of times when tax reforms, major

changes in tax rates, have produced quite stark changes in behavior. The dividend pay-out response of U.S. corporations after the

2003 reduction in dividend tax rates would be the most recent case

in point.

Another example is the sharp increase in female labor supply, especially in high-income households, after the 1986 Tax Act reduced

the tax rates on secondary earners in high-income households. The

sharp changes in capital gains realizations around major changes

in tax rates, say, in 1986, is yet another. Taxpayers clearly are

thinking about rate structures as they make their decisions.

The open question is how this evidence links up with the basic

issue of how much economic growth we could expect from tax reform. Some behavioral responses may not translate into the kinds

of long-term investment that would promote economic growth.

My instinct is that by lowering rates and by trying to keep the

U.S. tax burden on capital competitive with the tax burden found

in our major international competitors, we can ensure that our capital base in this country is preserved. This in turn is a groundspring for long-run productivity growth.

Therefore, I am more optimistic than Jane is that, by putting in

place a tax system which is favorable towards investment, we will

manage to achieve higher rates of long-term economic growth. If

you try to pin me down to a precise number on it, though, I will

come back and be on Jane’s side and say it is very hard to give

you a specific estimate.

Senator WYDEN. Mr. Walker, Ms. Garrett, Senator Breaux, anything on economic growth and consumption tax?

Senator BREAUX. I agree with both Dr. Poterba and Dr. Gravelle.

Senator WYDEN. There you are. Which is why the Breaux touch

is always so magical. [Laughter.]

Dr. GRAVELLE. Senator, I disagree with his interpretation of

those studies that he referenced, as far as his interpretation of

their meaning.

Senator WYDEN. Well, you all have been very, very helpful.

Chairman Grassley, I think, has given us a sense of what is ahead.

Today’s kick-off for tax reform is, in my view, a sense of what is

ahead over the next 6 months.

The next 6 months are absolutely key if we are to have what

Senator Breaux told us about a couple of hours ago, which is, by

next year, the President saying he would like to see the Senate Finance Committee go after this issue on a bipartisan basis.

I thought and I felt going into the hearing, and I have not heard

anything else, that there are key consensus principles for bipartisan tax reform and they are in front of us if we can kind of hold

off the politics and be willing to work together.

41

Simplifying the tax system is certainly something that has broad

support, giving all persons the opportunity to accumulate wealth,

giving markets the chance to drive the economy, not government,

and being sensitive to issues of the deficit. A lot of those principles

were not very different than what they did in 1986.

So, the fact that we have been able to bring leaders like yourselves together is exactly what I had been hoping that we could do.

With Chairman Grassley and Senator Baucus leading us, I think

over the next 6 months we can put this in place and then go to

work.

So, we will have some additional questions for you. I think both

Democratic Senators and Republican Senators would like to pose

some questions in writing. But you all have given us a very good

launch this morning. You will probably be getting lots of calls from

me, and others, in the days ahead. We thank you very much for

coming.

With that, the Senate Finance Committee is adjourned.

[Whereupon, at 12:45 p.m., the hearing was concluded.]

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