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73–997 2012

S. HRG. 112–422 

HOW THE TAXATION OF CAPITAL AFFECTS 

GROWTH AND EMPLOYMENT 

HEARING 

BEFORE THE

JOINT ECONOMIC COMMITTEE 

CONGRESS OF THE UNITED STATES 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

APRIL 17, 2012 

Printed for the use of the Joint Economic Committee 

( 
(II) 

JOINT ECONOMIC COMMITTEE 

[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress] 

SENATE 

ROBERT P. CASEY, JR., Pennsylvania, 

Chairman 

JEFF BINGAMAN, New Mexico 

AMY KLOBUCHAR, Minnesota 

JIM WEBB, Virginia 

MARK R. WARNER, Virginia 

BERNARD SANDERS, Vermont 

JIM DEMINT, South Carolina 

DANIEL COATS, Indiana 

MIKE LEE, Utah 

PAT TOOMEY, Pennsylvania 

HOUSE OF REPRESENTATIVES 

KEVIN BRADY, Texas, Vice Chairman 

MICHAEL C. BURGESS, M.D., Texas 

JOHN CAMPBELL, California 

SEAN P. DUFFY, Wisconsin 

JUSTIN AMASH, Michigan 

MICK MULVANEY, South Carolina 

MAURICE D. HINCHEY, New York 

CAROLYN B. MALONEY, New York 

LORETTA SANCHEZ, California 

ELIJAH E. CUMMINGS, Maryland 

WILLIAM E. HANSEN, Executive Director 

ROBERT P. O’QUINN, Republican Staff Director 
(III) 

C O N T E N T S 

OPENING STATEMENTS OF MEMBERS

Hon. Kevin Brady, Vice Chairman, a U.S. Representative from Texas .............. 1 

Hon. Michael C. Burgess, M.D., a U.S. Representative from Texas ................... 3 

WITNESSES

Dr. Kevin Hassett, Senior Fellow and Director of Economic Policy Studies, 

American Enterprise Institute, Washington, DC .............................................. 4 

Dr. Jane Gravelle, Senior Specialist, Government and Finance Division, Congressional Research Service, Washington, DC .................................................. 6 

SUBMISSIONS FOR THE RECORD

Prepared statement of Vice Chairman Kevin Brady ............................................ 26 

Prepared statement of Dr. Kevin Hassett ............................................................. 27 

Prepared statement of Dr. Jane Gravelle .............................................................. 50 

Letter, dated April 30, 2012, to Vice Chairman Brady from Kevin Hassett ...... 60 

Letter, dated April 25, 2012, transmitting posthearing questions from Vice 

Chairman Brady to Jane G. Gravelle ................................................................. 61 

Jane G. Gravelle’s responses to posthearing questions from Vice Chairman 

Brady ..................................................................................................................... 65 

(1) 

HOW THE TAXATION OF CAPITAL AFFECTS 

GROWTH AND EMPLOYMENT 

TUESDAY, APRIL 17, 2012 

CONGRESS OF THE UNITED STATES, JOINT ECONOMIC COMMITTEE, Washington, DC. 

The committee met, pursuant to call, at 10:00 a.m. in Room 216 

of the Hart Senate Office Building, the Honorable Kevin Brady, 

Vice Chairman, presiding. 

Senators present: Coats and Lee. 

Representatives present: Brady (presiding), Burgess, and 

Mulvaney. 

Staff present: Conor Carroll, Gail Cohen, Will Hansen, Colleen 

Healy, Patrick Miller, Robert O’Quinn, and Steve Robinson. 

OPENING STATEMENT OF HON. KEVIN BRADY, VICE 

CHAIRMAN, A U.S. REPRESENTATIVE FROM TEXAS 

Vice Chairman Brady. Good morning. Today is April 17th, unfortunately Tax Day, for Americans. In recognition of America’s 

hardworking taxpayers, it is appropriate that the Joint Economic 

Committee hold its first of two hearings on how taxes affect America’s economy. Today’s hearing focuses on the taxation of capital, 

and on Wednesday, May 16th, the second hearing will focus on the 

taxation of labor. 

My goal as Vice Chairman of this Committee is to ensure America has the strongest economy in the world throughout the 21st 

Century. To do that, we must get our monetary policy right and we 

have to get our fiscal policy right. A competitive tax code is more 

than just getting the rate right. It is about creating a pro-growth 

tax code that recognizes the importance of the cost of capital. 

There are two schools of economic thought on how taxation of 

capital affects long-term economic growth and job creation. The 

purpose of this hearing is to examine the empirical evidence offered 

by both sides of the debate. 

Some economists contend that taxes on capital have, at most, 

modest effects on the economy over time. These economists cite 

studies that show a large variation in both the size and direction 

of responses to tax changes. Therefore, these economists claim that 

the effects of tax changes on long-term growth and job creation are 

either insignificant or unpredictable. 

The Joint Committee on Taxation uses these arguments to justify 

the static scoring of proposed tax changes. Static scoring may acknowledge some behavioral changes among taxpayers due to 

changes in tax policy such as realizing capital gains before an in-
2 

crease in the tax rate on capital gains, but does not acknowledge 

any effect on the overall growth of gross national product over 

time. Under static scoring, tax policy is, by definition, impotent in 

stimulating or suppressing long-term growth and job creation. 

Other economists contend that tax policy has significant and predictable effects on economic growth and job creation. In particular, 

these economists find that business investment in new buildings, 

equipment, and software is highly responsive to changes in the 

after-tax cost of capital. 

From my Chamber of Commerce experience prior to serving in 

Congress, there’s little doubt, in my view, that tax policy affects 

business decision-making on Main Streets across America. States 

and local governments have long used tax incentives to attract investment, especially since U.S. businesses face global competition. 

Tax policy affects where businesses choose to locate and where they 

expand their operations. 

It is also common sense that the decisions of all businesses collectively of whether and how much to invest affects overall economic growth and job creation. In contrast, the assumption that 

changes in tax policy cannot affect long-term economic growth and 

job creation in predictable ways defies common sense. 

However, we should not rely on common sense alone. We must 

also look at the empirical evidence. In his written testimony, Dr. 

Hassett reviews major studies conducted by prominent economists 

in recent years on various aspects of taxation of capital: the corporate income tax, tax depreciation and expensing of business investment, taxes on capital gains, and taxes on dividends. The conclusions of these studies are remarkably consistent: Taxes on capital have significant adverse effects on business investment, economic growth, job creation, and the real wages of workers. 

Despite a growing body of empirical evidence on the adverse effects of taxing capital, President Obama and many Congressional 

Democratic colleagues are advocating a series of tax increases that 

will raise the cost of capital. These tax increases include: 

Imposing higher income tax rates on sole proprietorships, partnerships, and subchapter S corporation; 

Boosting the tax rate on dividends from 15 percent to 44.6 percent; 

Raising the tax rate on capital gains from 15 to 20 percent; 

Tripling the tax rate of traditional local real estate partnerships; 

Eliminating long-standing business expensing for energy manufacturing; and 

Lengthening tax depreciation schedules. 

If the empirical studies are correct, these tax proposals will reduce business investment, slow economic growth, and deter job creation. Moreover, these tax increases will hurt hardworking taxpayers by reducing their real wages over time. These are the very 

men and women which the President and some in Congress claim 

they want to help. 

The purpose of today’s hearing is to determine whether the empirical evidence supports these adverse economic assumptions, or 

whether we should continue to accept the static scoring currently 

used by the Joint Committee on Taxation. 
3 

I look forward to the testimony of our distinguished witnesses. I 

would ask Congressman Burgess if he has a brief opening statement. 

[The prepared statement of Representative Brady appears in the 

Submissions for the Record on page 26.] 

Representative Burgess. Yes. 

Vice Chairman Brady. I yield. 

OPENING STATEMENT OF HON. MICHAEL C. BURGESS, M.D., A 

U.S. REPRESENTATIVE FROM TEXAS 

Representative Burgess. I thank the Chairman for yielding. I 

thank our witnesses for being here. Obviously this is an important 

day in the lives of a lot of Americans. A little confession here: Because of the extra two days that we got this tax season, I actually 

got my taxes filed on time. I did not have to file an extension for 

the first time in probably two decades. After several terms in Congress, my income tax calculation is much less complex than it was 

when I ran a small business, a medical practice. But still, even 

with a relatively straightforward, straightline arrangement between wages and taxes, the tax forms that have to be completed 

are enormously complex. And, there is the hidden cost of the hours 

that are spent in preparation, plus the monies that I must pay to 

a tax preparer. Because even though my income situation is much 

more straightforward, I do not trust myself, nor do I trust anyone 

who wants to examine those returns, because we all know if you 

put 10 accountants in a room with tax data, they’re going to come 

up with 10 different figures. And as a consequence, no one can sign 

their name at the bottom with a clear conscience that they’ve done 

everything right when no one knows what actually ‘‘right’’ is. 

I am glad we are having the hearing today. Tax day is important 

to Americans. I think that there is a lot of the American electorate, 

a lot of the American people, feel that simplifying the tax system 

should be one of our highest priorities. The discussions that we are 

going to have today will cover what our tax system should look 

like, what form it should be, how much it should tax, what it 

should tax. 

And there are so many opinions about this. Some feel that tax 

revenue should be about funding the government, while others 

want to use it for achieving social goals. And however laudable 

those agendas may be, my personal feeling is the Tax Code is not 

the proper means for achieving those. 

My predecessor in Congress, Dick Armey, was the author of a 

book about a flat tax. I bought this book back in 1995 or 1996, and 

it seemed so straightforward I did not understand why it had not 

already been adopted and why we could not use it. 

For that reason, every year that I have been in Congress I have 

introduced H.R. 1040, which is a derivative of the flax tax that Mr. 

Armey introduced, but this one would be optional. You have the 

right to opt into the flat tax. You have the right to continue your 

life under the complexity of the Code. If you have responded to the 

signals given by the Tax Code and arranged your finances in a way 

that the Tax Code is your friend, then so be it. 

But if you want to simplify things, if you want to simplify your 

life, you can use a flat tax. And it is simple. You just put in some 
4 

personal information, your income, personal exemptions, a general 

personal exemption to put some progressivity into the system, you 

compute the tax and the amount already withheld and it’s done. 

It’s that simple. 

And for those who are worried about fairness in the Tax Code, 

for a family of four there would be no tax on the first $43,000 of 

income. That’s nearly double the federal poverty limit. 

The Chairman mentioned that he wanted to get it right. The tax 

rate that I’ve proposed is 17 percent. Now, look, if you just look at 

the headlines today, Mitt Romney is paying 15 percent, Barack 

Obama is paying 20 percent; if you average those two percentages, 

it’s 17 percent. 

It seems like we could do this if we just had the political will to 

take it. So, Mr. Chairman, even if we don’t implement a flat tax, 

we must have a simpler system that people can understand. For 

such a complicated subject as taxes, we don’t need more rhetoric. 

We don’t need more complexity. We need serious proposals and not 

election year theatrics. 

And I certainly look forward to the testimony of our witnesses 

today. And thank you for yielding the time. 

Vice Chairman Brady. Thank you, Dr. Burgess. 

I would like now to introduce our panel of witnesses, starting 

with Dr. Kevin Hassett. Dr. Hassett is a Senior Fellow and Director of Economic Policy Studies at the American Enterprise Institute. 

His area of research includes fiscal policy and the economy. Before joining AEI, Dr. Hassett was a senior economist at the Board 

of Governors of the Federal Reserve System; an Associate Professor 

of Economics and Finance at the Graduate School of Business of 

Columbia University. 

He has been a consultant to the U.S. Treasury Department, and 

an economic advisor to the presidential campaigns of George W. 

Bush and John McCain. 

Dr. Hassett received his doctorate in economics from the University of Pennsylvania. 

Our other witness today is Dr. Jane Gravelle. Dr. Gravelle is a 

Senior Specialist in the Government and Finance Division of the 

Congressional Research Service, known as CRS. 

Her area of research includes the economics of taxation. She has 

written extensively on the subject of tax policy and economic 

growth. In addition to her work at CRS, she is the author of numerous articles and books and professional journals, and she is the 

past president of the National Tax Association. 

Dr. Gravelle received her Ph.D. in Economics from George Washington University. 

I welcome you both today, and I would recognize Dr. Hassett for 

his testimony. 

STATEMENT OF DR. KEVIN HASSETT, SENIOR FELLOW AND DIRECTOR OF ECONOMIC POLICY STUDIES, AMERICAN ENTERPRISE INSTITUTE, WASHINGTON, DC 

Dr. Hassett. Thank you very much, Chairman Brady, Dr. Burgess, Mr. Coats. 
5 

The topic of this hearing is something that is near and dear to 

my heart. I have been working on these issues since graduate 

school. My dissertation was even one of the first papers that used 

cross-section analysis to estimate the impact of taxes on corporate 

investment. 

And it is an honor and a pleasure to be testifying next to my 

friend, Jane Gravelle. I can remember just after I graduated with 

my Ph.D. and started being a professor at Columbia, I wrote a 

paper about the user cost elasticity, joint with Jason Cummins, 

who is now at Brevan Howard, and Jane was our discussant at one 

of the first professional presentations I ever made. 

I can remember that at that presentation Jane criticized my 

work saying that the elasticities were too large. I would say that 

dispute between us has been going on ever since, and you will see 

some of it today. 

I think, Mr. Chairman, and Members of the Committee, that the 

biggest problem we have in the U.S. right now is that our corporate 

tax is totally out of whack with the rest of the world. 

If you go back into the 1980s, the OECD countries on average 

had corporate rates of about 48 percent, but they have been lowering them like mad and they are all the way down to an average 

that is about 25 percent today. 

While the rest of the world has been changing their corporate 

rates, we have been more or less standing pat. In fact, we are one 

of the last countries on earth to increase its rates, although we did 

it just a smidge under the Clinton Administration. 

In addition to having a high rate, there are several deviations 

from efficient design in our current system that are worth mentioning as we think about what a reform might look like. 

First, the double taxation of corporate income discourages investment in equipment and structures. The dividend tax raises the cost 

of funds to firms, and increases the hurdle rate for new projects. 

Second, the asymmetric treatment of debt and equity encourages 

heavy debt loads and increases the overall level of risk in the corporate sector. The tax system should not really encourage debt-finance over equity-finance. It increases the riskiness and increases 

the risks of bankruptcy. 

Now the relatively unfavorable position of the U.S. relative to the 

rest of the world, combined with our worldwide tax system, gives 

firms a strong incentive to move their profits and activities overseas. 

Now these data should provide food for thought for those who 

would contend that the reduction in double taxation or otherwise 

cutting the corporate rate disproportionately benefits the wealthy. 

The fact is that Scandinavian countries, France, much of the rest 

of the world where I think most political scientists would tell you 

the politics are significantly to the left of those here in the U.S., 

treat capital more favorably than we do. 

I would argue that is because the rest of the world has been 

more responsive to the academic literature, the academic literature 

that is exhaustively reviewed in my testimony, which is up to 23 

pages single-spaced by the end—I won’t try to go through it all 

here, I think that if you wanted to look at one thing, a nice place 

to start would be an OECD study by Arnold in 2008 that provided 
6 

an empirical analysis of the effect of tax structure on long-run 

GDP. 

The main findings include—and now I’m quoting them, and I will 

say when I stop quoting them: That property taxes, and particularly recurrent taxes, on immovable property seem to be the most 

growth-friendly taxes, followed by consumption taxes, and then by 

personal income taxes. Corporate income taxes appear to have the 

most negative effect on GDP per capita. This intuition is supported 

by the review of the literature that I conducted with University of 

Berkeley economist Alan Auerbach in 2005. And looking at a 

mountain of evidence, we concluded that if the U.S. were to switch 

to an ideal system, then we might expect medium-term output to 

increase between 5 and 10 percent. 

So that goes to really up the stakes of fixing our tax system. And 

I think that it is really a big, squandered opportunity. If you were 

to give me two faltering economies, one that had a really stupid tax 

system like ours, and another that had a perfect tax system, I’d 

rather take a faltering economy with the crazy tax system because 

it’s easier to fix. And yet, you know, through this mess we haven’t 

done that. We have put off fixing our problems. And I think we are 

suffering for that today. 

To think about what would happen if we were able to go after 

our big problems and fix it, or if we had done so in the past, in 

my testimony I do a simple calculation. I estimate what our fiscal 

situation might be today if the United States had implemented a 

fundamental tax reform 10 years ago. It was a counter-factual. 

And, assuming that we hit the high-end growth estimate that 

Auerbach and I mentioned, if that had happened GDP would be 

$17.1 trillion in fiscal year 2012, rather than the expected $15.5 

trillion under CBO projections. 

Moreover, if we assume that revenue stayed fixed as a percent 

of GDP and outlays stayed fixed in dollar terms, then the 2012 deficit would be $830 billion rather than the expected $1.1 trillion 

under the CBO alternative fiscal scenario, and the long-run budget 

deficit would be about $7 trillion over the next 10 years instead of 

$11 trillion. 

Those are big differences, and those are the differences that are 

attainable if we pursue a fundamental tax reform, and if 10 years 

from now people don’t look back, thankfully, to this Congress and 

celebrate that extra trillions of dollars of GDP and all that extra 

revenue, then we should feel some fault for that. 

Thank you very much, Mr. Chairman. 

[The prepared statement of Dr. Kevin Hassett appears in the 

Submissions for the Record on page 27.] 

Vice Chairman Brady. Thank you, Dr. Hassett. Dr. Gravelle. 

STATEMENT OF DR. JANE GRAVELLE, SENIOR SPECIALIST, 

GOVERNMENT AND FINANCE DIVISION, CONGRESSIONAL 

RESEARCH SERVICE, WASHINGTON, DC 

Dr. Gravelle. I would like to focus my attention on the corporate 

income tax where effects on international capital flows are more 

likely to have an output effect, given the evidence that savings is 

not very responsive to tax rates. 
7 

Much has been claimed for the economic benefits of lowering the 

corporate rate in a global economy by attracting capital from 

abroad. However, the consequences for economic growth in labor income are likely to be modest. My estimate suggests that a 10 percentage point reduction in the corporate rate from 35 percent to 25 

percent would induce an increase in U.S. output of less than twotenths of one percent. Even the most generous set of assumptions— 

and that is infinitely large elasticities—would lead to an increase 

of no more than one-half of one percent. However, labor income 

would expect—would be projected to rise by the same proportion. 

This estimate may actually be too large, or perhaps in even the 

wrong direction, because lowering the corporate rate would discourage debt inflows which are subsidized and more mobile than equity. In addition, other countries might react by lowering their tax 

rates. Also, these estimates measure long-term effects that would 

not be achieved in the short run. 

Now these small numbers should not be surprising, because the 

corporate tax is small as a percent of U.S. overall output. The revenue lost from this rate reduction is only six-tenths of one percent 

of output. 

Now these are output effects, but the gain in income to U.S. citizens is even smaller. Part of the output gain appears as profits to 

foreign suppliers of capital, and part of it is already income to 

multi-nationals that have brought capital back from abroad. The 

net gain in income is expected to be only about ten percent of the 

output gain, or two-one hundredths of one percent of U.S. output. 

No effect on employment would be expected. It is very important 

to understand that there is no need to undertake a permanent policy to create jobs. The economy will naturally create those. Job creation is a short-run demand side issue. Labor income, however, 

would rise by the same percentage change, less than two-tenths of 

one percent. Labor would receive a benefit equal to 20 percent of 

the revenue lost from the rate cut. And a reduction in the corporate 

tax rate of this magnitude would cost over $100 billion a year in 

investment and involves a significant revenue cost. 

Based on the analysis of output increases, additional revenues on 

the induced output would offset only about 5 to 6 percent of this 

revenue loss, largely from increased taxes on wage income. 

Claims for larger revenue feedback effects, or even revenue 

gains, are based on empirical studies that have methodological deficiencies. International profit shifting is sometimes cited but is not 

large enough. And, moreover, given that profits are shifted to jurisdictions with very low rates, they are unlikely to be affected by 

lowering the rate to 25 percent. 

Domestic profit shifting might occur as high tax rate individuals 

move their income out of unincorporated businesses or wages into 

lower tax corporations, especially given the low tax rate on dividends. This protection of the individual income tax base is an important justification for having a corporate tax whose rate is not 

much below the top individual rate. 

So this effect, while increasing corporate revenues, would reduce 

overall income tax revenues. One effect that would be more certain 

is that the revenue loss itself, if not offset elsewhere, would expand 
8 

the deficit and reduce the capital stock, as well as increasing costs 

for accumulated interest. 

Within 10 years, output reductions would be twice the size of increases from the international capital flows and would increase the 

revenue lost by 15 percent to 23 percent, according to my estimates. Over a 10-year period, interest costs are also estimated to 

increase the effects on the deficit by 25 percent. 

It is possible to envision some corporate base broadening that 

would offset the revenue loss from a small rate cut, but not one as 

much as 10 percentage points, unless we take some probably unpopular—very unpopular—base broadening. And in most cases 

these reforms would cause the marginal tax rates on capital income 

to rise. 

You could have a revenue-neutral combination of increasing 

taxes on the income of foreign subsidiaries and rate reductions 

which would be most likely to increase capital flows into the 

United States, but these results would still be small. 

Economists traditionally criticize the corporate income tax due to 

the distortions it produces, but these distortions have declined significantly with reductions in the corporate tax burden since the 

post-war period, which is about two-thirds, and are estimated at 

only one-quarter of one percent of output. These distortions, which 

mostly involve favoring debt in owner-occupied housing, could be 

largely eliminated with revenue neutral reforms. Thank you. 

[The prepared statement of Dr. Jane Gravelle appears in the 

Submissions for the Record on page 50.] 

Vice Chairman Brady. Thank you, Doctor, and I am pleased 

we are joined by Senators Coats and Lee today, as well as Congressman Mulvaney. Thank you. 

Let me lead off with, not a housekeeping question but in reading 

the testimony last night, there are obviously divergent opinions on 

the impact of taxes on capital and the corporate tax rate. There 

seems to be a consensus in the economic literature that the CobbDouglas Production Function provides a rough proxy for the private 

business sector of the American economy. 

The consensus is based on the empirical observation that the factor of income shares going to labor and capital tend to be relatively 

constant over time. Would you both agree that the Cobb-Douglas 

model is widely accepted within the economic literature? Doctor? 

Dr. Hassett. Mr. Brady, my old friend and mentor, Albert 

Andau was one of the inventors of the Life Cycle Hypothesis and 

gave his first macro lecture at Penn on the Cobb-Douglas Production Function. And the first sentence of that lecture is that CobbDouglas is very dangerous. 

And so I think that Cobb-Douglas is a very useful way to think 

about back-of-the-envelope big macro questions, but it also has 

some features that can lead you to conclude things that are unrealistic in some applications. And so I don’t want to make a sweeping 

‘‘yes’’ answer to that question. 

Vice Chairman Brady. Thank you. 

Dr. Gravelle. 

Dr. Gravelle. Well I use Cobb-Douglas in my models, so I do 

what a lot of people do. I think there’s some recent evidence that 

suggests that that substitution elasticity might be a little lower, 
9 

which would reduce the capital inflows, increase the share to labor, 

the relative share to labor. But I think it’s a pretty reasonable estimate. 

And it is backed up by a long period of Constant Factor shares, 

which is some important evidence, I think. 

Vice Chairman Brady. Could I ask, Dr. Gravelle, in your testimony you suggest that the max—the revenue maximizing rate on 

corporate tax is closer to 80 percent than it is 30 percent—— 

Dr. Gravelle. Right. That’s based—— 

Vice Chairman Brady. Yes, go ahead. 

Dr. Gravelle. That’s just from real capital flows. So it doesn’t include any of these other profit-shifting possibilities. But that’s just 

the constraints. 

Vice Chairman Brady. But when you’re looking at the revenue, 

just so I understand, are you only counting corporate tax revenue? 

Or are you—— 

Dr. Gravelle. That 85 percent number is only corporate tax. The 

numbers that I gave in my testimony count the effect on wages. 

But that’s just from this constraint about how much capital can 

flow, both because of imperfect willingness to substitute, but also 

because of the natural limited ability of the economy to absorb a 

lot of capital because it has a fixed amount of labor. I mean, that’s 

just economics. 

Vice Chairman Brady. What happens—if you increase the corporate tax rate to 80 percent, what’s the after-tax rate of return on 

corporate capital? Clearly you’ve dramatically driven up that cost. 

Dr. Gravelle. Well I presume if you drove the tax up to 80 percent, you would get some kind of world-wide equilibrium, but I 

would have to work on that to tell you how much that would be. 

But it would obviously be a lot smaller after-tax rate of return than 

we have now. 

Vice Chairman Brady. Do you know what happens when you 

do that, what happens to output? What happens to wages and the 

capital stock, if you raise—— 

Dr. Gravelle. I would—yeah, I would think there would be—a 

10 percentage point change is worth .2, so you can—I mean, you 

can probably roughly multiply that, you know, every 10 percentage 

points. So you would get up to 2, 3 percent, I guess. 

Vice Chairman Brady. We will probably follow up with you on 

that. 

Dr. Gravelle. Okay. 

Vice Chairman Brady. With written questions. 

Dr. Gravelle. I just can’t quite do that in my head right now. 

Vice Chairman Brady. Can I ask, Dr. Hassett, before we move 

on, on the tax burden. The empirical data which you cite repeatedly in your testimony suggests that additional investments typically result in high real wages. There’s sort of, in Congress people 

forget about the impact on wages and workers. 

If taxes on capital affect the level of investment, shouldn’t they 

also affect the level of real wages? 

Dr. Hassett. Yes, they absolutely should. And, you know, the effects—and this is discussed at length in both the recent CRS report 

and in my testimony—the effects you see in the data are very 

large. 
10 

You see capital flows in response to tax differentials, and then 

you see big increases in blue collar wages. There have been a number of papers that have confirmed this finding. The CRS itself has 

taken our data. You know, we’ve shared it with them and replicated the results when they use our specification. They have their 

own favorite specification at CRS where the effects are smaller, or 

insignificant even in one. 

But I think that that balance of the evidence is that there pretty 

large wage effects. And I think that the wage effects that we see 

are a challenge to the traditional type of theories that Gravelle and 

her colleagues use. 

I think that one of the reasons why we see these big effects is 

that multi-nationals have a lot of good will. They have patents. 

They have cool ideas that they can move around. They can locate 

the smartest people, and the most valuable intellectual property, 

and the most attractive tax haven, and then have every subsidiary 

around the world transfer price their profits to that tax haven. 

When that kind of activity happens, it is really elastic and it is 

really good for that—for the market conditions in that tax haven. 

And so I think in the old kind of models that traditional tax people 

used, especially when I was in graduate school, which is a long 

time ago now, then pretty much the model you would have of the 

economy could be that there’s this big iron machine making Chevettes. And that if output goes up, it’s because we’re making a whole 

lot more Chevettes this year. 

But I think that in today’s world, it’s we have iPads. We didn’t 

have iPads before. The guy who invented the iPad is making lots 

and lots of money, and the countries that are smart enough to 

align their taxes to take advantage of that cool idea reap some of 

the rents that the company has, too. I think that that’s the kind 

of story that would be consistent with the size of the effects that 

we and other scholars, including people at Oxford, the University 

of Michigan, have been seeing in the data. 

Vice Chairman Brady. All right. Thank you, Doctor. 

Senator Coats. 

Senator Coats. Thank you, Mr. Chairman. Thank you both for 

your testimony. 

I am not an economist, so I am not going to delve into deep economic theory, but in listening, Dr. Gravelle, to you indicating in 

your statement that other countries might lower their corporate tax 

rates if we lowered ours, is that not a good thing? 

Dr. Gravelle. Well, if we—— 

Senator Coats. I almost came to the conclusion that you 

thought it would be to their benefit to raise their tax rates, that 

it would have less of a negative effect by raising than lowering. I 

would be pleased to have you help me sort that thinking out. 

Dr. Gravelle. Well first is the reason that we should be concerned about other countries lowering their tax rates, from our perspective is that if they do that any gains in capital flows that we’re 

attracting from them are going to be lessened. So that is why it is 

important. 

And also, I guess the world-wide lowering tax rates on corporate 

income first was caused by the United States, I think most people 

would say, I certainly would say, in our ’86 tax rate cut. 
11 

Senator Coats. But 35 countries that we compete with around 

the world have lowered their rates from a previous average of 48 

percent to now the current average of 25 percent. 

Dr. Gravelle. Yes. 

Senator Coats. Are all their analysts and economists and policymakers wrong? 

Dr. Gravelle. Well I said to the people at the OECD, I said, why 

don’t you put some numbers on this? I mean, they—they did a 

presentation. I said, corporate taxes need to be lowered. I said, 

well, where’s the numbers? That’s what I did. 

I mean I tried to estimate, as best I could, what the effects would 

be and you’re just not going to have dramatic effects from something that is so small relative to the economy. It’s just not reasonable to think so. 

Senator Coats. Well isn’t there at least some effect, if it’s not 

dramatic, isn’t some effect positive? 

Dr. Gravelle. Well the effect I found was positive. It was just 

very small. 

Senator Coats. Well—— 

Dr. Gravelle. It was almost—— 

Senator Coats [continuing]. These days we’re looking for small 

stuff. 

Dr. Gravelle. Right. 

Senator Coats. I mean, anything we can get is better than 

nothing. 

Dr. Gravelle. I guess the other question you have to ask is, you 

know—I think that’s fine. I mean, I’m not opposed or supportive of 

keeping the corporate tax where it is or lowering it, but I think 

that one has to be concerned about replacing revenues. So you have 

to decide how you’re going to do that. 

Senator Coats. But why do you think our 35 competitors globally all came to a different conclusion than you have? 

Dr. Gravelle. I don’t know. Because maybe they had multi-nationals lobbying them who succeeded? I don’t know. But I do know 

that this kind of analysis that I have done has not happened when 

those countries were making their decisions. The other thing is—— 

Senator Coats. Well then why wouldn’t they then raise the 

rates back up? If they’ve seen that it hasn’t had a positive effect. 

I almost take from your testimony that you think raising our corporate tax rate would have less of a negative effect than lowering 

it? 

Dr. Gravelle. Well probably if you raised our corporate tax rate 

and used the revenues to reduce the deficit, it would. I mean, what 

you do about the deficit is very important. 

Senator Coats. But what about our competition worldwide with 

the 35 other countries? 

Dr. Gravelle. What about it? I mean, what is the problem? If 

we—— 

Senator Coats. The problem is that our corporations, as Dr. 

Hassett said, are paying double taxes. They’re paying taxes on 

earnings, and then the stockholders are paying taxes on dividends—— 

Dr. Gravelle. Well that happens—— 
12 

Senator Coats [continuing]. And we’re not competitive with the 

rest of the world, and our money is flowing out to these other—— 

Dr. Gravelle [continuing]. That happens—that happens in any 

country that has a classic corporate tax. But, you know, I don’t 

know why other countries made their choices. The impression I 

have with European countries is that they are much—they have 

much more mobile capital. They’re much more worried because 

they’re like, you know, they’re right next to each other and they 

felt also some concerns about plants moving to the new Eastern 

Bloc countries. 

We are separated in lots of ways in ways that they aren’t. 

Senator Coats. Do you ever contemplate the fact that if 35 of 

our competitors are lowering or have lowered their rates—and I 

think a pretty solid majority of Americans feel that lower corporate 

tax rates are better—that you want to maybe reexamine your theories? 

Dr. Gravelle. Senator, I put infinite elasticities in this model. 

They can’t get any higher than infinity. And still, I got an effect 

but I didn’t get a large effect. And I didn’t get a large effect because 

real capital flows are constrained by the economic circumstances: 

by your preferences for products, by your labor supplies, by what 

you combine it with. That’s what the model says, and it’s a reasonable model. 

Senator Coats. My time is running out. Let me ask Dr. Hassett 

to tell me where I’m off base here. 

Dr. Hassett. I just would like to add that, you know, the way 

I think that an economist should go about addressing your question 

is, or as a scientist, any scientist, is that models are naturally very, 

very simple. They have to be, because that is why it is a model. 

You can’t model the whole world. There are just too many variables. 

And that when the model is inconsistent with observation, then 

you question both the observation and the model. And I think that 

it is appropriate to do both. And I think that the model might be 

wrong; the observation might be wrong; but sort of some humility 

about both possibilities is something that I think I don’t see in the 

CRS report. 

That’s my one criticism of it; that I think that its prior way of 

looking at the world being the correct one doesn’t adjust as new 

evidence comes in, at least as much as I would do if I were doing 

the exercise. 

Senator Coats. Just a last question. My time is up. But you 

seem to think it tilts in a different direction? 

Dr. Hassett. Yes. I’m must more of just an empirical economist, 

and I look at the data and use traditional econometric techniques 

to see what the data tell me. And then I talk to you about what 

I think I find, and sometimes you like it, and sometimes you don’t. 

But I’m not a person who has spent as much time with the general 

equilibrium type models that Gravelle uses. Those models are often 

very useful for thinking about effects you wouldn’t have thought of, 

and helping you think about what regressions to run. 

And so it’s not that those models have no use. But I think that 

in this particular application, there is just so much in the world— 

I talk about this a little in my testimony—that if you believe the 
13 

Laffer curve results that Brill and I have, and the wages results 

that Aparna and I have, then everything else that’s going on in the 

world—and I list a bunch of things—kind of makes sense. 

And if you don’t believe it, and if the CRS is right and our reports are incorrect, then it creates a lot of puzzles like those that 

you were addressing. 

Senator Coats. I just wonder why all the rest of the world is 

coming to a different conclusion than Dr. Gravelle, but in any event 

my time is up. 

Vice Chairman Brady. Thank you, Senator. Representative 

Mulvaney. 

Representative Mulvaney. Thank you, Mr. Chairman. 

I’m going to try real hard to do something that politicians are not 

really good at, which is not asking a stupid question. It has been 

a lot longer than I studied economics than it has been for most of 

you, and my mind is clouded by law school and business school on 

top of that. So I am going to try and keep it real simple for my 

own purposes. 

Let’s talk about Dynamic Scoring for a second, because it strikes 

me that while you all seem to disagree on some of the outcomes, 

aren’t we having a dynamic discussion in terms of using a dynamic 

model to discuss the impacts of tax changes? 

And if that is the case, even though you seem to disagree on the 

outputs—Dr. Hassett would suggest the impact of a tax reduction 

would be significant; Dr. Gravelle you would say it is not—but 

those are both dynamic statements, aren’t they? And shouldn’t we 

be looking for some place that we can agree on, that we need to 

move away from this zero-impact model that the CRS currently has 

toward something that perhaps allows for a range of outcomes that 

reflects perhaps that a scope or a scale of possible outcomes reflected by you folks here today? 

Why aren’t we having that discussion? I’ll start with you, Dr. 

Gravelle, since you’re CRS. Why—Does CRS oppose dynamic scoring? 

Dr. Gravelle. No, no. And my model has results. I mean, it has 

effects. It’s just the effect are small, as is the provision you’re 

changing. They’re both small. 

Representative Mulvaney. Sure. 

Dr. Gravelle. So you wouldn’t expect huge effects. 

Representative Mulvaney. But that would be different than 

the static model we’re required by law to use now? 

Dr. Gravelle. But the Joint Tax Committee uses a model that 

has micro responses. They have, for example, very, very large capital gains realization response, which is probably why they haven’t 

scored the Buffett Rule, you know the Buffett Tax, as being very 

high. 

They have a rule that they keep output—labor and capital inputs, total GDP constant. But they have done studies in the past, 

and so has CBO, but the problem with those studies is they just 

depend on what you’re doing about the deficit. 

I mean, they have the same kinds of results that I do. You know, 

if you look at a tax cut in isolation like the corporate tax, you’re 

likely to find an increase. You can argue about whether it should 

be five—you know, a half of a percent, or two-tenths of a percent, 
14 

or the size of the revenue, whatever, but they have those. But then 

if you don’t pay for it, if you run the deficit, then you do a crowding 

out of capital which can end up worse. 

So both CBO and JCT have done studies, and the problem is 

they aren’t—you know, the assumptions are what matter as far as 

the magnitude. So I think they have probably decided it is safest 

just to keep that constant. 

Representative Mulvaney. And I think I would probably tend 

to agree with that, that it’s—you say it’s safest. It sounds to me 

like you could spin it a different way and say it’s just too hard to 

do it another way. 

Dr. Gravelle. Maybe too hard. Maybe not-ready-for-prime-time. 

I mean, I don’t know. 

Representative Mulvaney. But I share the same frustration 

that Dr. Hassett has, which is that the net result is that we use 

a model that doesn’t seem to tie to reality. You can go back and 

look at the tax reductions of the ’80s and see that it clearly was 

not a zero impact. You can look at tax increases in the ’90s and 

make the same determination. 

So I guess, what is CRS’s position on moving away from a static 

model into a dynamic? 

Dr. Gravelle. Well I think my position would be I think I want 

to do whatever leads you to the truth the best. The problem is the 

‘‘truth’’ is elusive and depends on what assumptions you are making. 

Representative Mulvaney. Does the static model give us the 

truth? 

Dr. Gravelle. I don’t think so, no. How could it? It would be a 

point observation that you would never expect to find. But the 

question is: Is it better for policymaking when you have differences 

depending on the various assumptions you make, not only about 

deficit financing, but by short-run monetary policy, about the size 

of elasticity. There’s no consensus about a lot of that. 

Representative Mulvaney. Dr. Hassett, because I tend to 

agree with Dr. Gravelle in that sense that once you start moving 

to a static model—excuse me, away from a static model to dynamic, 

the debate will simply switch from whether or not we should have 

static versus dynamic to a discussion over what sorts of multipliers 

we’re going to use. And we will have the same lack of consensus 

that we have now. 

Is it possible, do you think, to develop a system that would allow 

us to use a dynamic system that would provide for say a possible 

range of outcomes that would at least give us a better look into the 

future as to what the impact of tax changes would be? 

Dr. Hassett. Yeah, sure. And in fact Bill Thomas assembled a 

blue ribbon panel to discuss dynamic scoring, which I served on a 

long time ago. 

Dr. Gravelle. So did I. 

Dr. Hassett. Yes, that’s right. And they introduced a couple— 

John Diamond, who is down at Rice, helped develop a model for the 

Joint Tax to do dynamic scoring. CBO has worked on it. 

I think that the capability is now, you know, I like to say in 

Washington: All proof proceeds by induction. Something is true 
15 

today because it was true yesterday. And so actually these models 

have been around long enough that they are true by induction. 

And so maybe that we could start to use them. Because right 

now focusing all of our budget rules and everything on the zero effect, which everyone knows is false, seems incorrect to me. And, 

you know, the argument in favor of it has always been, well, if we 

allow dynamic scoring then we will lose fiscal discipline, and the 

deficit will get too high. 

Well the existing system has not really done a good job of enforcing fiscal discipline. And so I think that we should look for, you 

know, more reasonable ways to score. 

Representative Mulvaney. Thank you. Thank you, Mr. Chairman. 

Vice Chairman Brady. Thank you. 

Senator Lee. 

Senator Lee. Thank you, Mr. Chairman. 

Dr. Hassett, some have suggested that the compliance costs associated with the corporate income tax in America tends to rival the 

actual yield, the revenue yield, to the government. Do you have any 

opinion on that matter? 

Dr. Hassett. Yeah. There are estimates, and I think that the 

CRS has probably talked about these, too, but there are estimates, 

especially for the international tax code, that the compliance costs 

are enormous relative to the amount of revenue. 

And it’s, you know, relative to the kind of forces that are discussed in my testimony sort of make sense because, you know, the 

companies can spend a lot of money on smart people who then help 

them locate the intellectual property in just the right place, and 

then they arrange, you know, fully legal activity in a way that gets 

more money in the low tax place. And firms are really able to do 

that. 

You know, there’s a whisper number around town amongst tax 

planners that multi-national tax rates are about 17 percent on foreign income. And they’re able to do that because they’re moving all 

these parts around. But the movement of the parts—so in the end, 

you spend a lot of money moving the stuff, and then the end result 

for the U.S. is that there’s not much money left here. 

Senator Lee. It has also been suggested that corporations tend 

to pass along, pass downstream, so to speak, their costs, both their 

compliance costs and what they actually pay in corporate income 

taxes such that individuals end up paying for those, just in terms 

of higher prices for goods, or higher prices for services in some instances, or perhaps they pay for it through diminished wages or diminished job opportunities. 

Do you share that view? 

Dr. Hassett. Yeah. The passing-on-to-workers result is really 

powerful in the evidence that Aparna and I have looked at. In fact, 

we have looked at other tax rates, too. And, you know, when I say 

the result it almost feels like I am some radical left-winger because 

the data seem to say that no matter what you try to tax, in the 

end it is the little guy who pays for it. 

Senator Lee. The 99 percent. 
16 

Dr. Hassett. Yes. In the sense that if you try to tax the capital, 

then they move it around, and then the wages go down and you 

are hurting the little guy. 

So basically all the taxes—the capital is very elastic, very moveable, and the labor is not. And I think that, you know, sales tax, 

just about any kind of tax that you can think of is mostly being 

passed on to wages and the workers. 

Senator Lee. But I guess the difference is that when it is passed 

on to the workers, or passed on to the consumer, or whatever the 

case may be, it is veiled. 

Dr. Hassett. Correct. 

Senator Lee. It is more opaque. You cannot really see what is 

happening. 

Dr. Hassett. And indeed on that point, I had a piece in The 

Washington Post on tax day a couple of years ago, which we can 

send to your office, which I commend to you, that makes even the 

direct point in kind of a chilling way. Which is, that Congress is 

really virtuous about redistribution with the income tax, and so 

they’re always arguing about the top 1 percent of this, and it’s as 

if everyone in the Democratic Party on the Hill is the absolute defender of people who are in the bottom half of the income distribution, but that stops as soon as you stop talking about the income 

tax. 

And if you look at total taxes paid by Americans, then, you know, 

there’s a lot less redistribution than you might think. But we tend 

to tax the little guys with taxes that are hard to attribute. So sales 

taxes, property taxes, gasoline taxes, cigarette taxes, you can imagine with the incidence of those would look like. 

I have a study where we sort of summed all those things up and 

found that pretty much everybody in the U.S. was paying about 30 

percent of their income in taxes—even people relatively far down 

on the income distribution—and it was as you get down to the 

poorer people, they are paying these taxes which aren’t labeled 

‘‘rich’’ and ‘‘poor’’ because they’re indirect and hard to attribute. 

Senator Lee. Right. But when we’re talking about income 

taxes—specifically, Federal Income Taxes—and most pointedly here 

Federal Corporate Income Taxes, those do get passed on to the consumer and to the worker. 

Dr. Hassett. Sure. 

Senator Lee. So in a sense, would it be fair to say that, you 

know, there are at least a couple of functions played by our tax system? 

First, that it is there to collect revenue for the government. Obviously we need money to operate. But it should be there, I suppose, 

to communicate accurately to the public, to the Electorate, to the 

Voters, the cost of government so that people will understand that 

there is a relationship between how much government we have and 

the economic well being of an individual. 

Would you agree with me if I were to say that our tax system 

performs that second function very poorly, and is perhaps even impeded in its ability to perform that second function by virtue of 

having a very significant corporate income tax? 

Dr. Hassett. Yes. Absolutely. 
17 

Senator Lee. That would diminish rather than enhance the capacity of the tax system to perform that second function of communicating to the public what it costs? 

Dr. Hassett. Right. We have all these hidden taxes, all this hidden revenue, incidents that are poorly understood, and a public debate about taxes that is really far from the truth in so many ways. 

The tax system is so complex—I can finish with this—that, you 

know, I have a Ph.D. in Tax Economics. That is what I’ve been 

working on my whole life. I’ve got many papers in tax journals. 

I will not do my own taxes. I will not do it. It is unthinkable for 

me to try to do it because they are just too complicated. And I 

know that if I mess it up, then they’re going to come after me hard 

because I should have known better because I’ve got a Ph.D. in 

Taxes. So I am too fearful to do my own taxes, and I think it is 

just a shame that our system has reached that point. 

Senator Lee. That is fascinating. Thank you very much. I see 

my time has expired. 

Vice Chairman Brady. Thank you, Senator. That reminds me 

of the question you asked in this same room as we were talking 

about the complexity of the Tax Code. 

Senator Lee asked one of the witnesses who was here with a 

BioTech company that helped break essentially the Human Genome, you know, a brilliant scientist. And Senator Lee asked him 

about making the Tax Code more simple. 

And he said, Oh, no, that’s too complicated for me. He didn’t 

want to really address that. It really is complex in a major way. 

I want to follow up Dr. Gravelle’s line of questioning with Senator Coats. In your testimony, and in your conversation with Senator Coats, you suggest the tax on capital gains and dividends can 

be safely ignored because they are such a small share of output. 

Are you referring ‘‘output’’ to the U.S. economy? 

Dr. Gravelle. Well what I mean was that, given the evidence— 

those are savings sides. In other words, they’re not at the level that 

can attract global capital flows. And because of the evidence that 

I’ve looked at, it indicates that savings is not very responsive to tax 

rates. 

In fact, it can actually go either way because of income and substitution effects. But empirically, there’s not much evidence. I 

didn’t want to talk about those partly because I think the effects 

they have would be extremely small and uncertain. And also 

they’re a lot smaller than the corporate tax. 

The dividends—I think I have some numbers in my paper, but 

they’re like a half a percent. Corporate tax is not large, but still 

is 2 percent. So that was the main reason, both because of the effect and the size. 

Vice Chairman Brady. Well I want to make the point that if 

you’re looking at the impact of a tax, you would look at not the 

broad GDP but on the tax base itself. In this case to make sure 

you’re not looking at the wrong base, you would, if you were calculating the marginal after-tax return on corporate investments, 

you’d compare the tax on dividend and capital gains to the amount 

of the earnings subject to the tax, rather than the broad economy. 

Dr. Hassett, I made the comment at the outset that there is a 

great deal of interest in Washington on fundamental tax reform. 
18 

My view is that, while a lot of discussion is about the rate, what 

that number should be, our goal should be to have the most progrowth tax policy in our tax code possible, recognizing the importance of cost of capital. 

That is generally defined ‘‘gross return on investment that is 

needed to cover replacement costs and taxes, while providing a 

positive rate of return.’’ Do people make an investment if they don’t 

expect to be able to cover all the expenses related to that investment? 

I mean, just within the business community, within economics? 

Do they make the investment if the rate of return is—— 

Dr. Hassett. No, but they sometimes make mistakes and don’t 

earn the investment that they expect to. But, yes, this is again the 

literature that I think has converged to a broad consensus. 

Back in the day when we were first arguing about the user costs, 

there were a lot of people who found that these variables didn’t 

have a big effect on investment. But now there have just been hundreds of studies that find that firms really do think that way, I 

think in part because business schools train folks to get their user 

cost formulas right to get the tax variables in the right place. 

And so absolutely if you change the user costs, you see responsiveness that’s, you know, pretty large but not enormous to 

changes in the user costs. It’s clear that businesses are weighing 

the pluses and minuses with each machine purchase. If you make 

it easier to buy a machine by giving accelerated depreciation, it has 

an impact on purchases of that type of machine. 

Vice Chairman Brady. Does the economic literature you’re referencing, does it tend to be constant over time when referring to 

after-tax rate of return on capital? 

Dr. Hassett. Is the after-tax rate of return on capital constant 

over time? I think that it’s not clearly so. I’d have to get back to 

you on this one. I’d have to look at it. But, yeah, I think that 

around big tax changes then you can see it takes a while for the 

capital stock to adjust. So I would have to get back to you on that. 

Vice Chairman Brady. Okay, great. Thank you. 

[Letter, dated April 30, 2012, to Vice Chairman Brady from 

Kevin Hassett appears in the Submissions for the Record on page 

60.] 

Vice Chairman Brady. Representative Mulvaney. 

Representative Mulvaney. Very briefly, just a couple of followups on a different topic. 

Dr. Hassett, you mentioned something that I have tried hard to 

explain to folks back home and I do a lousy job of it, so I am hoping 

you can help me. You mentioned something I believe to be correct, 

which is that our current relatively high level of corporate tax rates 

encourages debt, encourages debt financing. 

Could you expound on that a little bit, please? 

Dr. Hassett. Sure. And I think this is something we agree 

about, that because interest is a deductible expense for firms, and, 

you know, a dividend is not, then there’s a tax advantage for firms 

to borrow to finance a new enterprise as opposed to, you know, 

have issue equity. 

And this tax advantage for debt can actually, depending on 

where interest rates and inflation are, and so on, can get you a 
19 

negative user cost for 100-percent-debt financed investment. 

Which, you know, maybe at times we want it because we think 

that if investment is going to slow because people are too cautious, 

or something, but the fact is that a reduction of user cost is something that I almost always celebrate. 

But when the Tax Code encourages firms to be heavily debtladen, then if their plans fail a little bit, they have negative surprises on profits, well then all of a sudden the bondholders are lining up and throwing them into bankruptcy and trying to get their 

cash out. And so I think this is one of the bigger distortions in the 

corporate tax. 

There are some arguments for it. Especially tax lawyers tend to 

favor it. But I think economists generally view that as one of the 

larger problems with the Corporate Tax Code. 

Representative Mulvaney. Certainly, and I think everybody 

acknowledges the risks it exposes the businesses to in the business 

cycle. 

Dr. Gravelle, you mentioned in discussing one of the possible impacts of lowering the Corporate Tax Rate of discouraging debt 

flows. 

Dr. Gravelle. That just shows that there is never an easy answer to anything. Because it is true that our favoritism to debt 

causes all the things that Kevin mentioned, they can also have adverse effects for the flow of capital because debt is far more substitutable across countries than equity. 

And there were a couple of Treasury researchers who looked at 

this effect of debt, and they concluded that if you lowered the Corporate Tax Rate you would actually reduce the flow of capital in 

the United States. 

So it makes it difficult to decide what to do about debt. Because 

on the one hand it is causing this debt/equity distortion; on the 

other hand, it might be attracting capital from abroad. 

Representative Mulvaney. And finally—and I know this is off 

the top, but Dr. Hassett said something in his testimony just a few 

minutes ago that’s perhaps one of the most eye-opening things I 

have heard since I have been in Congress, and that is a tough list 

to make. 

It is, that he did not prepare his own taxes, despite the fact that 

he has a Ph.D. in Tax Economics. So, Dr. Gravelle, I have to ask 

you the question: 

Do you prepare your own taxes? 

Dr. Gravelle. Yes, I do. 

Representative Mulvaney. Good. 

Dr. Gravelle. And without a big fear. 

Dr. Hassett. I would let her do mine. 

[Laughter.] 

She’s better organized. 

Representative Mulvaney. Do you do Geithner’s, as well? 

[Laughter.] 

Dr. Gravelle. No, no, no. But on the other hand, Kevin’s might 

be a little more complicated than mine, because I am mostly a 

wage earner with some passive investments. So... 

Representative Mulvaney. Thank you all both very much for 

coming today. 
20 

Vice Chairman Brady. Thank you. Senator Lee. 

Senator Lee. Dr. Hassett, if you were king for a day and you 

could change our Tax Code, what would you put in its place? 

Dr. Hassett. I mentioned this in my testimony, Senator, and 

after checking Ethics rules found that I was able to promise to 

send you all a book that is about to publish by our top tax economist, Alan Viard. He has written it with another tax economist, 

Bob Carroll. And it lays out a Progressive Consumption Tax called 

an ‘‘x-tax’’ in the kind of gory detail that people who are going to 

write tax law actually need to see. 

Mr. Viard, many people know, writes a regular column in Tax 

Notes, and is very schooled in tax law and has sort of looked at 

where all the dead bodies are buried, if you’re trying to make something like this law. 

So I think that the most ready for prime time conservative tax 

reform out there is a Progressive Consumption Tax called the xtax, and that our book is coming out in a few weeks and is going 

to show everybody exactly how they can make it happen. 

Senator Lee. You referred to that in your written testimony, I 

believe, as part of the—kind of a variation of the VAT? 

Dr. Hassett. It is—all consumption taxes you could sort of think 

of as a variation of the VAT. The Hall-Rabushka Flat Tax is, as 

well. In fact, if you’ve ever seen Bob Hall give a presentation about 

it, one reason—you know, one reason he calls it the ‘‘flat tax,’’ they 

decided on that design, is they think that a Value Added Tax, as 

it’s structured in Europe, would be very unpopular in the U.S. And 

so he kind of moves the places where collection happens around a 

little bit to make it conform more to the U.S. system. And so it 

looks a lot more like what we do, but the economic effect of it 

would be very similar to that if we had a sales tax, or VAT. 

The Viard enterprise is exactly the same thing. So it looks a lot 

like what we do, but by moving things around and exempting capital from taxation and so on, you end up with something that looks 

very much like a Value Added Tax, which is a good thing when 

you’re running tax reform models because the Value Added Tax is 

the type of tax that gives you the biggest economic growth effect 

and welfare effect in the long run. 

Senator Lee. So this type of model would render obsolete this 

debate that we have had recently about what to do about capital 

gains, as far as at what rate you tax that because it would be focused on consumption rather than income—— 

Dr. Hassett. Right. 

Senator Lee [continuing]. Or capital gains. 

Dr. Hassett. That’s correct. That’s correct. And, you know, I 

think that there is so much to commend an approach like that, 

both distributionally since it is a progressive consumption tax; then 

the folks who have that as their number one issue, they can come 

to the table and help you set the rates. 

There are also interesting transitional distributional effects. If 

Warren Buffett were to go out and buy an airplane today, he would 

not pay a consumption tax on it. But if all of a sudden you have 

a consumption tax, then he would. And so his old wealth is being 

taxed. 
21 

There are just many, many reasons why I think that in some 

Congress soon it is quite likely that there is going to be a big tax 

reform again. Because, again, I gave you the scale of the challenge, 

or the target of what we could get if we had done it 10 years ago, 

where we would be today, how much better it would be. 

I think that if the economy continues to be weak, that something 

like that x-tax should get broad bipartisan support. 

Senator Lee. Okay. And I assume you would say that, going 

back to my two-part analysis earlier of the purpose of the Tax Code 

having two purposes, to raise revenue and communicate adequately 

and accurately to the electorate the true cost of government, I assume your insistence would be that this would perform that second 

function much better? 

Dr. Hassett. It would be, yeah, much more transparent what 

was happening, that’s correct. 

Senator Lee. Okay. Dr. Gravelle, what would you do if made 

king, queen, czarina for the day and you could do anything to our 

tax code? 

Dr. Gravelle. I probably wouldn’t do a lot different from what 

we have now. We just—CRS just released a report where we looked 

specifically at base broadening and individual income tax reform. 

And tax reform looks—and fundamental tax reform looks a lot easier when you talk about it in generalities than when you talk about 

specifics. 

So, for example, ideas such as eliminating tax expenditures by 

taxing Medicare, which would be a disaster for low-income people, 

by taking capital gains at death, by taxing pensions. We have a list 

of the 20 top tax expenditures. You start looking at those, and you 

see that they are very hard. 

Now Kevin, the thing Kevin talked about, the Progressive Consumption Tax, I mean that would be a very radical change and 

there would be some big windfall gains and losses—a very difficult 

transition to that tax. 

And I think once you start looking at this, you might want to 

rethink whether that is a good way to go. 

With respect to the Corporate Tax, I just think we need to be 

careful, because Corporate Tax doesn’t have as many tax expenditures. And if you do something about depreciation or things like 

that, you are actually going to increase the cost of capital on a revenue neutral change. 

So also I found that if you eliminated every tax expenditure, you 

could only reduce the Corporate Tax by about 5 percentage points. 

So I think you have to look very realistically at exactly what you 

have to do with tax reform before you decide which way to go. 

Senator Lee. So every loophole, every deduction, every credit, 

everything under the current system would allow you to reduce 

that only by 5 percent? 

Dr. Gravelle. On the Corporate Tax, only about 5 percentage 

points, yeah, to maybe 30 percent. Maybe a little less. That’s the 

long-run revenue neutral, not the short-run. The short-run has 

some budget scams in it. 

Senator Lee. Okay. Thank you. 

Vice Chairman Brady. Thank you. 
22 

Before we conclude, let me ask, because like other members of 

this Committee we do a lot of town halls. Dividend income is an 

important part of seniors’ lives. The President in his budget has 

proposed tripling the tax on dividends. 

My question is perhaps more direct. 

Dr. Hassett, when taxes on dividends go up, do businesses give 

more dividends? Less? The same? Is there an impact? 

Dr. Hassett. Yeah, that’s the one area of the literature that I 

didn’t go into in my testimony, but there’s a big literature on this 

that I’ve also participated some in. 

I think that when, back when we were discussing the dividend 

tax and thinking about whether it should be reduced, I can remember testifying before maybe Ways and Means and Senate Finance— 

I don’t remember the exact committees—but there are a number of 

testimonies. And one of the key things that I thought motivated the 

dividend tax reduction back then was the problem that when you 

have a high dividend tax, then it gives companies an incentive to 

just hold the cash rather than pay a dividend. 

And then every now and then, repurchase shares. But I—and I 

said this back then—I really don’t trust managers. I would rather 

they give the cash to the investors, and that they didn’t have an 

excuse not to, because I think that the bigger the pile of cash that’s 

piling up in the firm, the more likely you are to have bad things 

happening with management. 

And so I thought that the dividend tax reduction, one of the 

strongest arguments for it—there are user cost arguments, too— 

was that it would increase dividend payouts, and that that had 

good corporate governance implications. And I think that there is 

no dispute in the literature at all that that effect was seen, that 

dividends skyrocketed when the dividend tax cut went down. And 

I think that we could expect that that would reverse itself radically 

if the dividend tax were to go back up. 

Especially if one considers that it seems like now that the dividend tax cut has occurred once, and has been proven quite effective 

in the literature, that if you were to repeal it, the dividend tax cut, 

then I think that the firms would logically expect that the dividend 

tax would go down again at some point in the future as soon as, 

say, Republicans had enough power to make it happen. 

So if you think that the dividend tax is going to be lower, then 

you should set dividends today to zero, basically, waiting for that 

dividend tax reduction. That’s what shareholders would want you 

to do, unless they weren’t taxable. 

And so I think that if something like the Buffett Rule, and the 

dividend tax, and the capital gains tax, and all those things are allowed to go back to old high rates, then we will see a really steep 

reduction in dividend payout, a big reduction in capital gains realization, and a lot of movement towards things like municipal bonds 

which still pay tax pre-interest. 

Vice Chairman Brady. Sure. 

Dr. Hassett. I think, you know, as a last point, that if you look 

at the Buffett Rule proposal, it sort of shows how crazy a policy can 

get if you don’t think through these things. 

But the Buffett Rule proposal that everyone is talking about this 

week exempts municipal bond interest from the calculation. No one 
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has ever explained to me why it is that if a millionaire pays a 

lower tax than a secretary because he gets muni bonds, that’s fair. 

But if it’s because he gets dividends, it’s not. 

And I would like to ask the drafters of the bill if they exempted 

muni bonds because Berkshire Hathaway owns so many municipal 

bonds. You know, I mean it’s the Buffett Rule because it’s so good 

for Buffett, but it doesn’t make any economic sense at all. 

Vice Chairman Brady. Thank you, Doctor. 

I want, as a courtesy particularly to the Democrat members of 

the Committee who could not attend the hearing today, and to 

allow for a full discussion of the economic issues raised today, I am 

going to keep the record of this hearing open for written questions 

to the witnesses until Monday, April 23rd, of this year. And I am 

asking both witnesses to respond to those written questions by 

Monday, April 30th. 

With that, thank you very much for your testimony today. The 

meeting is adjourned. 

Dr. Hassett. Thank you, Mr. Chairman. 

[Whereupon, at 11:03 p.m., Tuesday, April 17, 2012, the hearing 

was adjourned.] 

(25) 

SUBMISSIONS FOR THE RECORD 
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PREPARED STATEMENT OF REPRESENTATIVE KEVIN BRADY, VICE CHAIRMAN, JOINT ECONOMIC COMMITTEE

Today, April 17th, is Tax Day. In recognition of America’s hardworking taxpayers, 

it is appropriate that the Joint Economic Committee holds the first of two hearings 

on how taxes affect America’s economy. Today’s hearing focuses on the taxation of 

capital and on Wednesday, May 16th; the second hearing will focus on the taxation 

of labor. 

My goal, as Vice Chairman of the Committee, is to ensure America has the 

strongest economy in the world throughout the 21st Century. To do that, we must 

get our monetary policy right and our fiscal policy right. A competitive tax code is 

more than just getting the rate right. It’s about creating a pro-growth tax code that 

recognizes the importance of the cost of capital. 

There are two schools of economic thought on how taxation of capital affects longterm economic growth and job creation. The purpose of this hearing is to examine 

the empirical evidence offered by both sides of the debate. 

Some economists contend that taxes on capital have, at most, modest effects on 

the economy over time. These economists cite studies that show a large variation 

in both the size and direction of responses to tax changes. Therefore, these economists claim that the effects of tax changes on long-term growth and job creation are 

either insignificant or unpredictable. 

The Joint Committee on Taxation uses these arguments to justify the static scoring of proposed tax changes. Static scoring may acknowledge some behavioral 

changes among taxpayers due to changes in tax policy, such as realizing capital 

gains before an increase in the tax rate on capital gains, but does not acknowledge 

any effect on the overall growth of gross national product over time. Under static 

scoring, tax policy is, by definition, impotent in stimulating or suppressing longterm growth and job creation. 

Other economists contend that tax policy has significant and predictable effects 

on economic growth and job creation. In particular, these economists find that business investment in new buildings, equipment and software is highly responsive to 

changes in the after-tax cost of capital. 

From my chamber of commerce experience prior to serving in Congress, there’s 

little doubt that tax policy affects business decision-making on Main Streets across 

America. States and local governments have long used tax incentives to attract investment, especially since U.S. businesses face global competition. Tax policy affects 

where businesses choose to locate and expand their operations. 

It is also common sense that the decisions of all businesses collectively of whether 

and how much to invest affect overall economic growth and job creation. In contrast, 

the assumption that changes in tax policy cannot affect long-term economic growth 

and job creation in predictable ways defies common sense. 

However, we should not rely on common sense alone. We must also look at the 

empirical evidence. In his written testimony, Dr. Hassett reviews major studies conducted by prominent economists in recent years on various aspects of the taxation 

of capital: the corporate income tax, tax depreciation and expensing of business investment, taxes on capital gains, and taxes on dividends. The conclusions of these 

studies are remarkably consistent—taxes on capital have significant, adverse effects 

on business investment, economic growth, job creation, and the real wages of workers. 

Despite a growing body of empirical evidence on the adverse effects of taxing capital, President Obama and many Congressional Democrats are advocating a series 

of tax increases that will raise the cost of capital. These tax increases include: 

• Imposing higher income tax rates on sole proprietorships, partnerships, and 

subchapter S corporations; 

• Boosting the tax rate on dividends from 15 percent to 44.6 percent; 

• Raising the tax rate on capital gains from 15 percent to 20 percent; 

• Tripling the tax rate of traditional local real estate partnerships; 

• Eliminating long standing business expensing for energy manufacturing; and 

• Lengthening tax depreciation schedules. 

If the empirical studies are correct, these tax proposals will reduce business investment, slow economic growth, and deter job creation. Moreover, these tax increases will hurt hardworking taxpayers by reducing their real wages over time. 

These are the very men and women which the President and Democrats in Congress 

claim that they want to help. 

The purpose of today’s hearing is to determine whether the empirical evidence 

supports these adverse economic assumptions, or whether we should continue to accept the static scoring currently used by the Joint Committee on Taxation. 
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I look forward to the testimony of our distinguished witnesses. 
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