U.S. GOVERNMENT PRINTING OFFICE

71–879 DTP WASHINGTON : 2001

FUNDAMENTAL TAX REFORM

HEARING

BEFORE THE

COMMITTEE ON WAYS AND MEANS

HOUSE OF REPRESENTATIVES

ONE HUNDRED SIXTH CONGRESS

SECOND SESSION

APRIL 11, 12, and 13, 2000

Serial 106–115

Printed for the use of the Committee on Ways and Means

(

For sale by the U.S. Government Printing Office

Superintendent of Documents, Congressional Sales Office, Washington, DC 20402

ii

COMMITTEE ON WAYS AND MEANS

BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois

BILL THOMAS, California

E. CLAY SHAW, JR., Florida

NANCY L. JOHNSON, Connecticut

AMO HOUGHTON, New York

WALLY HERGER, California

JIM MCCRERY, Louisiana

DAVE CAMP, Michigan

JIM RAMSTAD, Minnesota

JIM NUSSLE, Iowa

SAM JOHNSON, Texas

JENNIFER DUNN, Washington

MAC COLLINS, Georgia

ROB PORTMAN, Ohio

PHILIP S. ENGLISH, Pennsylvania

WES WATKINS, Oklahoma

J.D. HAYWORTH, Arizona

JERRY WELLER, Illinois

KENNY HULSHOF, Missouri

SCOTT MCINNIS, Colorado

RON LEWIS, Kentucky

MARK FOLEY, Florida

CHARLES B. RANGEL, New York

FORTNEY PETE STARK, California

ROBERT T. MATSUI, California

WILLIAM J. COYNE, Pennsylvania

SANDER M. LEVIN, Michigan

BENJAMIN L. CARDIN, Maryland

JIM MCDERMOTT, Washington

GERALD D. KLECZKA, Wisconsin

JOHN LEWIS, Georgia

RICHARD E. NEAL, Massachusetts

MICHAEL R. MCNULTY, New York

WILLIAM J. JEFFERSON, Louisiana

JOHN S. TANNER, Tennessee

XAVIER BECERRA, California

KAREN L. THURMAN, Florida

LLOYD DOGGETT, Texas

A.L. SINGLETON, Chief of Staff

JANICE MAYS, Minority Chief Counsel

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records

of the Committee on Ways and Means are also published in electronic form. The printed

hearing record remains the official version. Because electronic submissions are used to

prepare both printed and electronic versions of the hearing record, the process of converting

between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process

is further refined.

iii

C O N T E N T S

Page

Advisories announcing the hearing ........................................................................ 2

WITNESSES

American Business Conference, Barry K. Rogstad ............................................... 256

American Farm Bureau Federation, and Oklahoma Farm Bureau, Steve

Kouplen ................................................................................................................. 66

Americans for Fair Taxation:

Hon. John E. Chapoton .................................................................................... 135

Leo E. Linbeck, Jr. ........................................................................................... 42

Angell, Wayne, Bear Stearns & Company, Inc. .................................................... 115

Armey, Hon. Richard K., a Representative in Congress from the State of

Texas, and House Majority Leader ..................................................................... 217

Association for Manufacturing Technology, James H. Mack ............................... 263

Barcroft Consulting Group, and National Retail Federation, John G. Wilkins . 98

Bear Stearns & Company, Inc., Wayne Angell ..................................................... 115

Bill Helming Consulting Services, Inc., Bill Helming .......................................... 309

Brookings Institution, Hon. Bill Frenzel ............................................................... 159

Center for the Study of Taxation, Patricia M. Soldano ........................................ 332

Chapoton, John E., Vinson & Elkins, LLP, and Americans for Fair Taxation .. 135

Christian, Ernest S., Washington, DC ................................................................... 163

Davis, Frank L., Jr., Alexandria, VA ..................................................................... 201

English, Hon. Phil, a Representative in Congress from the State of Pennsylvania ...................................................................................................................... 147

Entin, Stephen J., Institute for Research on the Economics of Taxation ........... 335

Foster, J.D., Tax Foundation .................................................................................. 168

Frenzel, Hon. Bill, Brookings Institution .............................................................. 159

Global Strategy Group, Inc., Jefrey Pollock .......................................................... 286

Hamilton, Billy, Texas Comptroller Office of Public Accounts ............................ 127

Helming, Bill, Bill Helming Consulting Services, Inc .......................................... 309

Howard, Jerry, USX Corporation ........................................................................... 260

Institute for International Economics, Gary Hufbauer ........................................ 177

Institute for Policy Innovation, Aldona Robbins ................................................... 315

J.C. Penney Company, and National Retail Federation, Del Threadgill ............ 140

Kotlikoff, Laurence J., National Bureau of Economic Research, and Boston

University ............................................................................................................. 91

Kouplen, Steve, American Farm Bureau Federation, and Oklahoma Farm

Bureau ................................................................................................................... 66

Linbeck Corporation, and Americans for Fair Taxation, Leo E. Linbeck, Jr. .... 42

Linder, Hon. John, a Representative in Congress from the State of Georgia .... 7

Luntz Research Companies, Frank Luntz ............................................................. 282

Mack, James H., Association for Manufacturing Technology .............................. 263

Martin, James, Horseshoe Bay, TX ........................................................................ 69

McCracken, Todd, National Small Business United ............................................. 51

Metcalf, Gibert E., National Retail Federation, and Tufts University ................ 106

Moore, James O., Smithtown, NY .......................................................................... 195

National Association of Manufacturers, and Tupperware Corporation, James

E. Rose, Jr. ........................................................................................................... 267

National Association of Realtors, Scott Rooth ....................................................... 57

National Bureau of Economic Research, and Boston University, Laurence

J. Kotlikoff ............................................................................................................ 91

National Retail Federation:

Gilbert E. Metcalf ............................................................................................. 106

Del Threadgill ................................................................................................... 140

John G. Wilkins ................................................................................................ 98

National Small Business United, Todd McCracken .............................................. 51

Oklahoma Farm Bureau, and American Farm Bureau Federation, Steve

Kouplen ................................................................................................................. 66

Page

iv

Peterson, Hon. Collin C., a Representative in Congress from the State of

Minnesota ............................................................................................................. 10

Pollock, Jefrey, Global Strategy Group, Inc. ......................................................... 286

Portman, Hon. Rob, a Representative in Congress from the State of Ohio ........ 274

Powell, James L., Fort McKavett, TX .................................................................... 312

Regalia, Martin A., U.S. Chamber of Commerce .................................................. 327

Robbins, Aldona, Institute for Policy Innovation .................................................. 315

Rogstad, Barry K., American Business Conference .............................................. 256

Rooth, Scott, National Association of Realtors ...................................................... 57

Rose, James E., Jr., National Association of Manufacturers, and Tupperware

Corporation ........................................................................................................... 267

Skarbek, Janet L., Cinnaminson, NJ ..................................................................... 129

Soldano, Patricia M., Center for the Study of Taxation ....................................... 332

Tauzin, Hon. W.J. ‘‘Billy,’’ a Representative in Congress from the State of

Louisiana .............................................................................................................. 221

Tax Foundation, J.D. Foster ................................................................................... 168

Texas Comptroller Office of Public Accounts, Billy Hamilton ............................. 127

Threadgill, Del, National Retail Federation, and J.C. Penney Company ........... 140

Traficant, Hon. James A., Jr., a Representative in Congress from the State

of Ohio ................................................................................................................... 226

Tupperware Corporation, and National Association of Manufacturers, James

E. Rose, Jr. ........................................................................................................... 267

U.S. Chamber of Commerce, Martin A. Regalia ................................................... 327

USX Corporation, Jerry Howard ............................................................................ 260

Wilkins, John G., National Retail Federation, and Barcroft Consulting Group 98

Worley, Steven, Colbert, GA ................................................................................... 191

SUBMISSIONS FOR THE RECORD

Adams, Charles, Williamsville, NY, statement ..................................................... 349

American Forest & Paper Association, W. Henson Moore, statement ................ 354

American Petroleum Institute, Michael Platner, statement ................................ 356

Apolinsky, Harold, Sirote & Permutt, P.C., joint statement ................................ 420

Argus Group, Dan R. Mastromarco, and Sirote & Permutt, P.C, Harold

Apolinsky, joint statement .................................................................................. 420

Associated General Contractors of America, Alexandria, VA, statement ........... 361

Barcia, Hon. Jim, a Representative in Congress from the State of Michigan,

statement .............................................................................................................. 365

Bell, Thurston, National Institute for Taxation Education, Hanover, PA,

statements ............................................................................................................ 389

Berthoud, John, National Taxpayers Union, Alexandria, VA, statement ........... 395

Burton, David R., Prosperity Institute, Alexandria, VA, statement ................... 404

Cain, Herman, Godfather’s Pizza, Inc., Omaha, NE, statement ......................... 366

Cargill, Barry, Small Business Association of Michigan, Lansing, MI, statement ...................................................................................................................... 409

Council of Smaller Enterprises, Cleveland, OH, statement and attachment ..... 365

Godfather’s Pizza, Inc., Omaha, NE, Herman Cain, statement .......................... 366

Hall, Hon. Ralph M., a Representative in Congress from the State of Texas,

statement .............................................................................................................. 369

Herbert, Glendale O., Pembrok Equity, New York, NY, statement .................... 399

Hodous, Robert P., Payne & Hodous, Charlottesville, VA, statement ................ 398

Kahn, Joseph M., Stanford University, Decisions and Ethics Center, Palo

Alto, CA, statement .............................................................................................. 370

Keating, Raymond J., Small Business Survival Committee, statement ............. 411

Klein, Lori, Taxpayer Protection Alliance, Phoeniz, AZ, statement .................... 413

Loftman, Bert, Atlanta, GA, statement and attachment ..................................... 378

Mastromarco, Dan R., Argus Group, joint statement ........................................... 420

Mitchell, Daniel J., Heritage Foundation, statement and attachments .............. 379

Moore, W. Henson, American Forest & Paper Association, statement ............... 354

National Federation of Independent Business, statement ................................... 385

National Grain Trade Council, statement ............................................................. 388

National Institute for Taxation Education, Hanover, PA, Thurston Bell, statements ..................................................................................................................... 389

National Taxpayers Union, Alexandria, VA, John Berthoud, statement ............ 395

O’Donnell, John B., Chula Vista, VA statement ................................................... 396

Payne & Hodous, Charlottesville, VA, Robert P. Hodous, statement ................. 398

Pembrok Equity, New York, NY, Glendale O. Herbert, statement ..................... 399

Platner, Michael, American Petroleum Institute, statement ............................... 356

Prosperity Institute, Alexandria, VA, David R. Burton, statement .................... 404

Page

v

Redefining Progress, San Francisco, CA, statement ............................................. 405

Schulz, Robert L., We the People Foundation for Constitutional Education,

Inc., Queensbury, NY, letter ............................................................................... 417

Sirote & Permutt, P.C., Harold Apolinsky, and Argus Group, Dan R.

Mastromarco, joint statement ............................................................................. 420

Small Business Association of Michigan, Lansing, MI, Barry Cargill, statement ...................................................................................................................... 409

Small Business Survival Committee, Raymond J. Keating, statement .............. 411

Taxpayer Protection Alliance, Phoenix, AZ, Lori Klein, statement ..................... 413

UWC-Strategic Services on Unemployment & Workers’ Compensation, statement ...................................................................................................................... 415

We the People Foundation for Constitutional Education, Inc., Queensbury,

NY, Robert L. Schulz, letter ................................................................................ 417

(1)

FUNDAMENTAL TAX REFORM

TUESDAY, APRIL 11, 2000

COMMITTEE ON WAYS AND MEANS,

HOUSE OF REPRESENTATIVES,

Washington, DC.

The Committee met, pursuant to notice, at 10:02 a.m., in room

1100, Longworth House Office Building, Hon. Bill Archer (Chairman of the Committee) presiding.

[The advisories announcing the hearing follow:]

2

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

FOR IMMEDIATE RELEASE CONTACT: (202) 225–1721

April 3, 2000

FC–20

Archer Announces Hearing on

Fundamental Tax Reform

Congressman Bill Archer (R–TX), Chairman of the Committee on Ways and

Means, today announced that the Committee will hold a hearing to consider fundamental tax reform proposals. The hearing will begin on Tuesday, April 11, and

be continued on Wednesday, April 12, and Thursday, April 13, 2000, in the

main Committee hearing room, 1100 Longworth House Office Building, beginning at 10:00 a.m. each day.

Oral testimony at this hearing will be from invited witnesses only. Witnesses will

include Members of Congress, prominent tax reform experts, well-known economists, and other interested parties. However, any individual or organization not

scheduled for an oral appearance may submit a written statement for consideration

by the Committee and for inclusion in the printed record of the hearing.

BACKGROUND:

In the past several years a host of legislative proposals have been offered which

would significantly change the kind of tax regime contained in the Internal Revenue

Code. These include the flat tax, the national retail sales tax, and the USA and Simplified USA tax. Other ideas not yet in legislative form abound. In 1995, 1996, and

1997, the Committee on Ways and Means held extensive hearings on many of these

specific proposals and more generally on the subject of fundamental tax reform.

Leading advocates of specific legislation introduced as well as economists, business

leaders, and Members of Congress testified. In particular, the Committee devoted

considerable attention to both H.R. 1040, the flat tax proposal introduced by the

Majority Leader Richard Armey (R–TX) and H.R. 1467 a retail sales tax proposal

introduced by Rep. W.J. (Billy) Tauzin (R– LA).

Since those hearings, a number of new legislative proposals have been introduced.

These include H.R. 134 by Rep. Phil English (R–PA) and H.R. 2525 by Rep. John

Linder (R–GA) and Rep. Collin Peterson (D–MN) among others. This hearing will

provide the opportunity for the Committee to consider these newer proposals as it

has with prior proposals.

In announcing the hearing, Chairman Archer stated: ‘‘Over the past 5 years, I’ve made cutting taxes and simplifying the tax code a top priority. Still, the tax code

is too complicated and confusing, and we need to get the IRS out of the lives of

American taxpayers. That’s why I’m proud to announce this three day hearing as

part of the first ever Congressional summit on fundamental tax reform. We’ll look

at a host of new ideas which will eliminate our current tax code and replace it with

something that is simpler and fairer. We need to rip the current tax code out by

the roots so that it can never grow back.’’

FOCUS OF THE HEARING:

The focus of the hearing will be on which tax system is best for America in the

new millennium, with a particular emphasis on tax reform proposals that have been

introduced since the last set of hearings in 1997. In particular, the Committee will

want to hear from witnesses as to the relevance of these proposals to the international marketplace in which our companies and individuals must live and comVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00008 Fmt 6633 Sfmt 6621 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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pete and whether these proposals meet the established criteria of being fair, simple,

enforceable, and compatible with the other parts of the tax regimes which exist in

America, namely State taxes.

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

Any person or organization wishing to submit a written statement for the printed

record of the hearing should submit six (6) single-spaced copies of their statement,

along with an IBM compatible 3.5-inch diskette in WordPerfect or MS Word format,

with their name, address, and hearing date noted on a label, by the close of business, Tuesday, April 25, 2000, to A.L. Singleton, Chief of Staff, Committee on Ways

and Means, U.S. House of Representatives, 1102 Longworth House Office Building,

Washington, D.C. 20515. If those filing written statements wish to have their statements distributed to the press and interested public at the hearing, they may deliver 200 additional copies for this purpose to the Committee office, room 1102 Longworth House Office Building, by close of business the day before the hearing.

FORMATTING REQUIREMENTS:

Each statement presented for printing to the Committee by a witness, any written statement

or exhibit submitted for the printed record or any written comments in response to a request

for written comments must conform to the guidelines listed below. Any statement or exhibit not

in compliance with these guidelines will not be printed, but will be maintained in the Committee

files for review and use by the Committee.

1. All statements and any accompanying exhibits for printing must be submitted on an IBM

compatible 3.5-inch diskette in WordPerfect or MS Word format, typed in single space and may

not exceed a total of 10 pages including attachments. Witnesses are advised that the Committee

will rely on electronic submissions for printing the official hearing record.

2. Copies of whole documents submitted as exhibit material will not be accepted for printing.

Instead, exhibit material should be referenced and quoted or paraphrased. All exhibit material

not meeting these specifications will be maintained in the Committee files for review and use

by the Committee.

3. A witness appearing at a public hearing, or submitting a statement for the record of a public hearing, or submitting written comments in response to a published request for comments

by the Committee, must include on his statement or submission a list of all clients, persons,

or organizations on whose behalf the witness appears.

4. A supplemental sheet must accompany each statement listing the name, company, address,

telephone and fax numbers where the witness or the designated representative may be reached.

This supplemental sheet will not be included in the printed record.

The above restrictions and limitations apply only to material being submitted for

printing. Statements and exhibits or supplementary material submitted solely for

distribution to the Members, the press, and the public during the course of a public

hearing may be submitted in other forms.

Note: All Committee advisors and news releases are available on the World Wide

Web at ‘‘http://waysandmeans.house.gov’’.

The Committee seeks to make its facilities accessible to persons with disabilities.

If you are in need of special accommodations, please call 202–225–1721 or 202–226–

3411 TTD/TTY in advance of the event (four business days notice is requested).

Questions with regard to special accommodation needs in general (including availability of Committee materials in alternative formats) may be directed to the Committee as noted above.

f4

NOTICE-CHANGE IN TIME

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

FOR IMMEDIATE RELEASE CONTACT: (202) 225–1721

April 10, 2000

FC–20–Revised

Time Change for Full Committee Hearing

on Thursday, April 13, 2000, on

Fundamental Tax Reform

Congressman Bill Archer (R–TX), Chairman of the Committee on Ways and

Means, today announced that the full Committee hearing on Fundamental Tax Reform, previously scheduled for Thursday, April 13, 2000, at 10:00 a.m., in the main

Committee hearing room, 1100 Longworth House Office Building, will begin at

10:30 a.m.

All other details for the hearing remain the same. (See full Committee press release No. FC

Chairman A

Today, we begin our Congressional Summit on Fundamental Tax

–20, dated April 3, 2000.)

RCHER. The committee will come to order.

f Reform, which will be a 3-day open discussion that will hopefully

lead to an overhaul of the archaic and meddling income tax code

that has outlived its useful life. Americans spend 6.1 billion hours

each year filling out the IRS forms and $200 billion in compliance

costs. And I am told that is a conservative estimate, and some national magazines say that it could go as high as $500 to $600 billion a year. All of that means that the tax code is too complicated

and confusing, unnecessarily so.

In addition, Americans treasure their privacy and their individual freedom, and the income tax is the most intrusive part of

the Federal Government in the lives of each American.

We had a witness not too long ago who sat right at the chair in

front of me, and as I asked other witnesses what would you give

not to have to deal with the IRS every year, she—a middle-income

lady from Connecticut—responded, ‘‘I would give my first-born

child.’’ Obviously, she had an untoward experience with the IRS.

But the IRS is not really at fault most of the time. The fault is

their responsibility to enforce a law that has grown from 16 pages

in 1913 to 2,840 pages today. And when you include all of the regulations, I believe it is in excess of 14,000 pages.

It is true the IRS has had its problems, but I am glad that Congress took action in 1998 to help at least fix some of those problems. Yet unless we face the fact that the income tax cannot be

fixed—and I believe that to be a fact, having participated in nuVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00010 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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merous efforts at reform in the 29-plus years that I have been here

in the Congress—there will always be a need for the IRS as long

as we have an income tax and a host of interpretation about what

is income on which no two economists completely agree.

Because of our income tax, American workers are caught in a tax

trap: The harder they work, the longer they work, the more they

pay, and that is wrong.

What are we taxing when we tax income? We tax work. We tax

savings. We tax upward mobility. We tax productivity. In sum, we

tax success. And that is just not right.

Most economists believe that the more you tax of something, the

less you are going to get of it. Do we really want less work, less

savings, less upward mobility, less productivity, and less success?

I don’t think so, not in America. And yet that is what is driving

our taxation program when we tax income as the base.

Last week, President Clinton celebrated our new economy, but

our new economy is shackled by an ancient tax code, a code that

gives us headaches, invades our privacy, and hurts our ability to

compete and win the international marketplace competition. Our

tax code simply can’t keep up with the economy and the rest of the

world in the 21st century.

We see that in the Internet tax debate. We see it in the WTO

decision on FSC, Foreign Sales Corporations. We see it in the flight

of U.S. corporations overseas to escape our tax code: Chrysler has

become a German corporation, Amoco has become a British corporation, and Bankers Trust has become Deutschebank, a German

corporation, because of our tax code.

We have heard a lot about corporate tax shelters recently, but

the ultimate tax shelter for U.S. firms is just to pick up and leave.

Do we really want that? I don’t think so.

So this summit is to show Americans that our horse-and-buggy

tax code won’t work in our Internet economy. It is time to work together to replace it with a fairer, simpler, and better system.

I now recognize Mr. Rangel for any statement he would like to

make.

Mr. RANGEL. I appreciate this opportunity, Mr. Chairman. For a

long time, you have been very concerned about the complexity of

the tax code and its unfairness to taxpayers. I would have thought,

however, that since the Republicans have shown an equal concern

about this very sensitive subject matter during all these years that

you have enjoyed the Majority, that we wouldn’t have had to wait

6 years just to have another hearing.

I would have hoped that, during this period of time that you

have enjoyed the Majority, a piece of legislation would have been

drafted, we would be holding hearings on specifics, and it would

not be a Republican idea but it would be Republicans and Democrats working together in trying to improve the tax system.

But, consistently, there hasn’t been just a lack of cooperation between our parties. There has been a lack of conversation between

our parties.

Take this hearing, for example. Why, if you had discussed this

with me or the Speaker had discussed this sensitive subject matter

with our Democratic Minority Leader, we would have said that

these hearings are far too important for the tax-writing committee

6

to be holding at the same time that we are debating and voting on

tax legislation on the House Floor. I don’t see how you expect Members of this Committee to be in attendance at hearings, to listen

to our Members and other witnesses, and at the same time expect

us to be on the Floor supporting our legislation or at least protecting our jurisdiction on the House Floor.

But I really don’t think that this hearing has anything to do with

legislation. I think this has to do with lack of a political legislative

agenda on which we can work together. And so, once again, we

have got to talk about pulling up the income tax code by the

roots—pulling it up by the roots and substituting it with what?

Substituting with ideas that we will hear about today? Is there a

bill? No. Have we had hearings? No.

We have a document here that is in front of the Members. It has

a concept called Americans for a Fair Taxation. Very well prepared.

What we don’t have is something that we will go into later. We

don’t have a statement from the Joint Committee on Taxation.

Now, I know how much you depend on the private sector to provide for progressive legislation, but the Joint Committee is nonpartisan. They are supposed to give revenue estimates on these

bills. One way or the other, we have got to get a document before

this Committee so we can see how much these concepts really cost

us.

Now, from time to time, Mr. Chairman, you will find some Members here, Republicans and Democrats. I hope our witnesses will

understand that our absence from these hearings is no disrespect

to the Chair, to our colleagues, or to the witnesses. It is because

the very same 3 days that we have scheduled hearings on tax reform are the very same 3 days that we have scheduled tax legislation on the House Floor.

Why it was done this way I really don’t know. But it is clear that

these hearings are for public consumption and not legislation. We

have no bill. We don’t expect to have a bill. We don’t expect to legislate in this area this year, or for the last 6 or 7 years. We never

expected to.

So there are so many other questions I have, but out of respect

to our two colleagues who have come here to testify. I would tell

you that the Chair has no plans for any legislation on this subject

matter, not this, not Social Security, not Medicare reform. But it

is interesting because it really closes out the years of the Republican Majority. This is how they started it off—with hearings about

pulling the tax code up by the roots. And, this is how we are going

to end it with hearings about pulling it up by the roots.

Thank you, Mr. Chairman.

Chairman ARCHER. We have two of our colleagues who will lead

off the testimony this morning. Are you gentlemen prepared to

speak about phantom legislation for which there is no bill before

the committee?

Mr. LINDER. No, sir, but we would be pleased to talk about H.R.

2525 that was introduced by a Republican and a Democrat on July

14th of last year.

Chairman ARCHER. So there is legislation before the committee

on which we are holding these hearings today.

Mr. LINDER. That is correct.

7

Chairman ARCHER. Would the gentleman also venture a guess as

to whether this is appropriate procedure to hold hearings on legislation before there might be any action on the legislation?

Mr. LINDER. It strikes me as the right thing to do.

Chairman ARCHER. Well, the Chair welcomes our two colleagues,

Mr. Peterson and Mr. Linder, to present their bill, H.R. 2525, and,

Congressman Linder, if you would lead off. First, welcome to the

Committee.

Mr. LINDER. Thank you.

Chairman ARCHER. I compliment both of you on the work on this

bill, and the committee is prepared to hear your testimony, and you

may proceed, Mr. Linder.

STATEMENT OF HON. JOHN LINDER, A REPRESENTATIVE IN

CONGRESS FROM THE STATE OF GEORGIA

Mr. LINDER. Thank you, Mr. Chairman. Mr. Chairman, I have a

prepared statement that I have submitted for the committee, and

I will summarize, if you don’t mind, the aspects of H.R. 2525.

It strikes me that if Congress had sat down in 1912 and said how

can we build a tax system that is destructive of capital formation,

that is inefficient, is unproductive, and is punitive, they couldn’t

over 88 years have come up with a better solution than we have

got today.

This is inefficient. We have seen studies from a variety of sources that for a small businessperson to collect, comply, and remit $1 in

business income taxes, it costs them anywhere from $4 to $7 to do

it.

It is unfair to young people. It is the single largest stumbling

block and impediment to getting from the first rung of the economic ladder to the second because, as you said in your statement,

the harder you work, the more you save, the more you invest, the

more we take.

It is undecipherable. As you know, the IRS tells us if you call

them asking for help in your tax return, 25 percent of the answers

you get are going to be in error. They don’t even understand it.

Our proposal is to abolish all taxes on income, to change the paradigm. Do not tax what we put into society but tax what we take

out in terms of personal consumption. Abolish all taxes on income,

the gift tax, the estate tax, capital gains tax, and the payroll tax,

which supports Social Security and Medicare and which is the largest tax that three-fourths of America pays, larger than their income

tax, and replace it with a one-time frank, transparent, at-thecheckout national sales tax. You spend $100, the first $23 goes to

the tax man, the rest goes to the merchant.

Under today’s system, if you earn $100 and you are in the average income withholding bracket of 28 percent, the Government is

going to take the first 36 bucks whether you spend it or not. So

everyone is going to have improved purchasing power.

We have learned from studies that there is no way for a corporation or a business to pay a tax. They don’t have a mechanism. I

have been built seven businesses, and there is simply not a secret

drawer where money piles up behind you that you find your money

for the corporate share of the payroll tax. There is not a secret

drawer for the income tax. It comes out of price. It is passed down

8

the line in price until somebody finally consumes the product, and

that person not only consumes the product but all the taxes that

have been embedded in it along the way.

What would happen to the system? Just imagine being the only

nation in the world selling goods and services into a global economy with no tax component in our prices. Exports go up. You, Mr.

Chairman, have said—you have quoted on this floor on several occasions that a research group interviewed 500 international corporations domiciled overseas, asked them what they would do if we

abolished all taxes on income and went to a sales tax. Eighty percent said they would build their next plant in America; 20 percent

said they would relocate to America. You referred to that actually

in your statement about all the companies leaving this country. Exports increase.

What would happen—— Chairman ARCHER. Congressman Linder, I am informed by members of the committee they are having difficulty understanding

your presentation—or hearing it, not understanding it.

Mr. LINDER. Okay.

Chairman ARCHER. Perhaps you are too close to the mike, or

maybe it is that the sound system just isn’t working well this

morning.

Mr. LINDER. Well, I will try it again. Is this better? Can you hear

it better? Collin says I talk too fast.

Mr. Chairman, for those who say that the sales tax is regressive

on the poor, let me say the most regressive tax they have is the

payroll tax that taxes, between what they and their corporation

pay on their behalf, 15.3 percent of everything they earn up to

$76,000. We not only get rid of that, we also get rid of the embedded cost of the IRS, and we believe at retail 22 percent of everything you pay is embedded business cost of the IRS. But we also

give to every family a rebate at the beginning of every month that

totally rebates the tax consequences of spending up to the poverty

line. So everyone will have increased purchasing power, and everyone will have increased freedom.

Can you imagine the privilege in a free society where no one

knows how much you make, how you make it, how you invest it,

if your investment makes money or loses, or how you spend your

money? You will have the privilege of anonymity again, which we

think is important in a free society.

There are 100,000 people today at the IRS who know more about

me than I am willing to tell my children, and I want them out of

my life, and yours, too. And I agree that they are just doing their

job, but nobody should know that detailed information about us.

In 1912, a Senator in the discussion of the 16th Amendment was

ridiculed and laughed off the floor of the Senate for making this

statement: ‘‘Mark my words, that before this is over, they will be

taking 10 percent of what everybody earns.’’ Oh, how I wish it were

so, giving fresh meaning, I think, to that wonderful country western song, ‘‘If 10 Percent’s Enough for Jesus, It Ought to Be Enough

for Uncle Sam.’’

We want to get rid of the tax on incomes entirely and tax what

people choose to spend.

[The prepared statement follows:]

9

Statement of the Hon. John Linder, a Representative in Congress from the

State of Georgia

Thank you Mr. Chairman and members of the committee. I appreciate the opportunity to testify today about H.R. 2525, the FairTax Act of 1999, which I introduced

along with Collin Peterson earlier in this Congress. Mr. Chairman, I ask that my

written statement and a series of articles discussing the FairTax be made a part

of the record.

The FairTax Act would repeal all individual income taxes, corporate income taxes,

payroll taxes, self-employment taxes, capital gains taxes, and death and gift taxes.

It would replace these with a 23 percent national retail sales tax on all new goods

and services sold to consumers. All sales of new goods and services to consumers

would be taxed once and only once, without any exceptions. Business inputs would

not be taxed since those items will ultimately be taxed when they are sold to consumers, thus adhering to the principle that goods be taxed once and only once.

Because there are no exceptions to the FairTax, and because we realize that those

Americans at the low end of the income scale spend a higher proportion of their income, the FairTax provides every household in America with a rebate of the sales

tax paid on necessities. Thus the FairTax is progressive, and every family is protected from tax on essential goods and services. The rebate would be paid monthly

in advance in an amount equal to the sales tax rate multiplied by the federal poverty level—that level of spending literally defined by the U.S. government as required to purchase necessities. For a family of four, the rebate level is $22,500—

meaning that every family of four will receive a check at the first of each month

for $431.25, the amount that family would pay in taxes on monthly poverty level

spending. If you spend more than the poverty level, you pay the sales tax. If you

spend less than the poverty level, you get to keep the rebate check anyway.

It would be a mistake to emulate the states’ attempt to achieve sales tax progressivity by exempting various categories of goods or services from tax because that

methodology doesn’t achieve progressivity at all. For example, affluent people buy

more expensive food, housing and clothing than do poor people, so when these categories of goods are exempted, affluent people benefit disproportionately. In addition, these exemptions add complexity and compliance costs to the system, and lead

to outrageous results. In any New York bagel shop, for example, a plain bagel is

tax-free but a bagel with cream cheese is taxable. Moreover, any one exception to

the sales tax will inevitably lead to efforts to exempt other products. Not only would

those efforts lead to a perversion of the sales tax just as lobbying today has perverted the income tax, but also when some goods or services are exempted, a higher

tax rate must be charged on those things that remain taxable to maintain the same

level of revenue. Such a preferential scheme is bad as a matter of economics and

unfair to those companies and workers who make the goods that remain taxable.

The FairTax will end the complexity of compliance with our current system.

Today, according to the Tax Foundation, we spend about $250 billion each year filling out forms, hiring tax lawyers and accountants and collecting information needed

only for tax purposes. These unnecessary costs amount to about $850 for every man,

woman and child in America. To the extent these costs are incurred by businesses,

those businesses hide them in the cost of everything that we buy. The Tax Foundation has estimated that compliance costs would drop by about 90 percent under a

national sales tax. Why? Because the present system requires that Americans must

provide over one billion information returns to the IRS annually. Americans file a

quarter billion tax returns annually. Under the FairTax, this would be an unpleasant memory.

The FairTax would be collected by states and retailers just as current state sales

taxes are. The FairTax gives retailers a 25 basis point commission for collecting the

tax and offers state sales tax authorities another 25 basis point commission to administer the tax. We believe that it makes the most sense for state civil servants

that have years of experience administering a sales tax to take that job. The

FairTax would then dismantle the IRS and create a sales tax bureau in the Treasury to administer the collection of sales tax from the states. The only tax collector

that the consumer would ever see is the smiling face behind the register at the local

grocery store.

Beyond simplicity, the FairTax holds the promise of ecomomic growth and a higher American standard of living. The FairTax would stop the punitive taxation of

work inherent in the income and payroll tax and end the multiple taxation of savings and investment. The FairTax would end the bias against investment in education. Economists anticipate the FairTax, because it is neutral toward savings and

investment, will lead to much higher levels of savings and investment which in turn

will lead to greater productivity and output. Dr. Dale Jorgenson of Harvard and Dr.

10

Laurence Kotlikoff of Boston University estimate, in two separate studies, that the

FairTax would increase GDP between 7 to 14 percent over the current system.

While clearly not endorsing the FairTax specifically, even our current Treasury Secretary, Dr. Larry Summers, concluded in some of his academic writings that a complete shift to consumption taxation might raise steady-state output by double digits.

Why is such growth predicted? Because by giving Americans their entire paycheck, American consumption is increased. And, by untaxing our business and corporations, American businesses will become more competitive with foreign businesses. Consider the recent WTO ruling that found the Foreign Sales Corporation

(FSC) export incentives to be a violation of WTO rules. Congress created FSCs with

the knowledge that our current tax system was undermining our ability to compete

abroad. The FairTax would solve this problem by removing the current tax burden

on American production and allowing American goods to be sold overseas with no

tax consequences embedded in the price. Further, the FairTax would apply to all

imported goods sold in America. In contrast, today foreign goods enter the U.S. market free of any significant tax burden. This places U.S. produced goods at a big competitive disadvantage. This disadvantage is made worse because most of our major

trading partners eliminate a big part of their tax burden on exports since their

value added taxes are border adjusted. They impose a large VAT on U.S. goods imported into their country. This disadvantage is built into our tax system, and it exports high paying U.S. jobs to our foreign competitors.

Unlike our perversions of the income tax, the FairTax is in compliance with the

WTO rules because it is an indirect tax, it. For the first time, American businesses

and American workers will be competing on a level playing field with our foreign

competitors.

The FairTax is simple, understandable and transparent. People understand the

FairTax. They don’t understand the present tax system. Even tax professionals and

tax administrators don’t understand the present system. Moreover, today a huge

proportion of the overall tax burden is hidden from the ordinary taxpayer’s view and

passed on to those who can least afford it. Under the FairTax, people will for the

first time actually understand their tax burden and have confidence that their fellow citizens are bearing their fair share.

Mr. Chairman and members of the Committee, the present system is broken beyond repair. It is costing the American people dearly in terms of opportunities lost

and a lower standard of living. It is time to start over. I believe that the FairTax—

as the only proposal today that ends the regressive payroll tax and allows American

workers to compete fairly with our foreign competition—represents the best alternative to the present system. I think that after you study the plan you will agree.

Thank you.

because I assume this bill is a bipartisan bill, inasmuch as Con-

[Attachments are being retained in the Committee files.]

Chairman ARCHER. I thank the gentleman for his testimony, and

f gressman Peterson is with you there at the witness table as a cosponsor of this legislation, we will be happy to now hear your testimony, Congressman Peterson.

STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF MINNESOTA

Mr. PETERSON. Well, thank you, Mr. Chairman, and members of

the committee, and it is bipartisan. We have four Republicans and

four Democrats on the bill, and we are hoping to add some more.

But we appreciate your calling this hearing and appreciate your

leadership on this issue.

Mr. Chairman, I have some materials that I would like entered

in the hearing record immediately following the testimony, if that

is appropriate.

Chairman ARCHER. Without objection, so ordered.

Mr. PETERSON. Thank you.

11

Mr. Chairman, not too long ago, it was inconceivable that this

committee would focus on a replacement as comprehensive as the

national sales tax, which is embodied in H.R. 2525. We had a few

lonesome voices like Democratic Member Sam Gibbons, who used

to rage against the tax system and say that there was a better way

to collect taxes. But it didn’t seem like there was enough time to

ever consider them, and each year we get into the tax policy game

of musical chairs that began to see which of the tax extenders

would remain standing. We saw a constant flow of new ideas for

credits and deductions that vied for the ultimate award to be enshrined in the Internal Revenue Code.

So I think we have come far as Republicans and Democrats to

be here today, and no group is more pleased, I think, that we are

having this hearing than the American people.

Now, why as a CPA, and especially a Democratic CPA, do I believe in the Fair Tax and why do I think this is the best replacement for the current system? I have watched the making of tax

laws as a practitioner on the outside. I have been here as a legislator now for 10 years under Democrats and Republicans. And

every tax simplification Congress has passed has added more pages

to the U.S. Tax Code and has made the system more complicated.

And that was under both Democrats and Republicans.

I have been highly critical of my own party on this point. I think

that the 1986 Tax Act was without a doubt the worst piece of legislation that has ever been passed in this Congress. It did lasting

damage to many Americans for no good reason. And it complicated

the code to the point where we can’t understand it a lot of times,

and it complicated our lives.

But, in all due respect, since the Republicans have taken over in

1994, you have added 547 pages of statute and 2,327 pages of regulations, just through 1999. So we have kind of got the same thing

going on here, and I think that is why it is so positive that we are

looking at legislation to replace the whole system here today.

When 49 practitioners last year were given the same information

and asked to complete a Federal income tax return, they came back

with 49 different answers. No matter what your intentions, you

know, we haven’t simplified the tax code, and it is time that I think

we admit that this system cannot be fixed in spite of all of our best

efforts.

I don’t think this system can be salvaged even if we all wanted

to do so. And I also don’t think that taxing income is the best way

for us to raise revenue in this country given the way the economy

is changing.

Mr. Chairman, I think Americans want true tax reform. Poll

after poll shows we are collectively disgusted with our system.

Members are hearing from their constituents about this. We are

now on the third edition of the Taxpayer Bill of Rights. Each taxpayer gripe hearing is like watching Halloween I, II, and III. Only

the names and witnesses change, but the plot does not. The unofficial annual holiday honoring the height of our enmity for our income tax system is just around the corner, April 15th.

Congress has voted to scrap the tax code once and is likely going

to do it again. But while something called tax reform just might

12

happen, the real question is this: By what criteria will its success

be judged? And what do we want to see in an ideal tax system?

I have come to the conclusion that the Fair Tax fits the bill for

a number of reasons.

First of all, there are no exemptions, so we might actually be

able to keep this simple and not give preference to one group or

another and not give rise to a whole horde of lobbyists descending

on your committee asking for special treatment.

It would help solve one of our biggest problems today, and that

is this trade deficit, the balance of trade deficit that we have. As

John said, the current tax system has an embedded cost that the

economists tell us is around 20 or 22 percent. That means that we

are exporting all of these taxes, American taxes, in the price of our

exports. One of the biggest pluses of this system is it will take that

out of the export stream, it will reduce the cost of what we are

charging for goods and services sold around the world by an average of 20 or 22 percent, and it will be GATT legal.

In addition to that, when imports come into this country, they

are going to be taxed the same as domestic goods and services if

they are used for personal consumption, just like goods and services that are made here in the United States.

It also eliminates the most regressive tax, the payroll and selfemployment taxes. These are, as I say, I think, the most regressive,

and they are the toughest thing for many of our farmers and small

businesses because in a lot of cases they pay more in those kinds

of taxes than they do in income taxes.

It makes equity capital more available and affordable because we

will no longer be taxing savings and investment.

It will be much easier to administer. We would only need to keep

track of the approximately 1.6 million retail and service businesses

in the U.S., as opposed to the more than 169 million individuals

who file tax returns and pay taxes now under the current system.

The Fair Tax plan makes sense, and it will work for the 21st century. I would be willing to predict that most States, if we pass this,

will get rid of their income tax because they won’t have an income

base to place it on, and piggyback on to our system for collecting

sales taxes in their State. If they do that, we would have a mechanism to tax Internet businesses the same as we tax businesses on

Main Street, which is something that we are going to have to do,

and there is no reason why we ought to prefer an Internet business

over one that has a store on Main Street.

So I think, understandably, the people so far don’t have a lot of

faith or confidence that Congress is going to come up with tax reform, and that is too bad. And when I explained this to my father,

he said, ‘‘Well, you know, that is never going to happen. That

makes too much sense.’’

I hear that from a lot of my constituents as well when I tell them

about it, but the Fair Tax is well thought out, it is well researched,

it is simple, and it is fair.

So let’s show the American people that we can take bold steps

and do what is right. Let’s move this Fair Tax through the Congress. Doing so would make the American people keep every penny

of their paychecks and have some say over how much tax they pay,

and really, I think, be a tremendous boom for the economy because

13

we would not tax—if you didn’t spend your money and you saved

it, you could keep it. And if you want to go out and buy a new Mercedes or a new airplane, you would pay tax and, you know, that

just drives the whole decisionmaking process in the right way.

So this, I think, the right solution to tax reform. I hope that we

can move this ahead in a bipartisan manner.

Thank you, Mr. Chairman.

[The prepared statement follows:]

Statement of the Hon. Collin C. Peterson, a Representative in Congress

from the State of Minnesota

Thank you Mr. Chairman and Members of the Committee. Mr. Chairman, I have

some materials I would like to have entered into the hearing record immediately

following my testimony this morning.

Mr. Chairman, not too long ago, it was inconceivable this committee would focus

on a replacement as comprehensive as a national sales tax. A few lonesome voices,

like Democratic Member Sam Gibbons, raged that there could be a better way to

collect taxes—but there was never enough time to consider them. Each year the tax

policy game of musical chairs began to see which of the tax extenders would remain

standing. The constant flow of new ideas for credits and deductions vied for the ultimate award, to be enshrined in the Internal Revenue Code. We have come far, both

Republicans and Democrats to be here today. But no group is more pleased than

the American people.

Why, as a C.P.A., and especially a Democrat C.P.A., do I believe the Fair Tax is

the best replacement for our current system? I’ve watched the making of tax laws

as a practitioner and as a legislator—under Democrats and Republicans—and every

tax ‘‘simplification’’ Congress has passed has added more pages to the US Tax Code

and made the system more complicated.

I have been highly critical of my own party on this point. I think the 1986 Act

was the worst piece of legislation ever passed. It did lasting damage to many Americans for no good reason and it complicated the Code and our lives.

But since the Republicans took over, you’ve added some 547 pages of statute and

2,327 pages of regulation—through 1999. When 49 practitioners were given the

same information and asked to complete a federal tax return they came back with

49 different answers. No matter what your intentions, you have not simplified the

federal tax code.

I don’t think we’ll ever fix this system. I don’t think this system can be salvaged

even if we wanted to do so. I also don’t think that taxing income is the best way

to raise the revenue this country needs.

Mr. Chairman, Americans want true tax reform. Poll upon poll shows we are collectively disgusted with our system. Members are hearing from their constituents.

We are now on the third edition of the taxpayer bill of rights. Each taxpayer gripe

hearing is like watching Halloween I, II and III. Only the names and witnesses

change. The plot does not. The unofficial annual Holiday honoring the height of our

enmity for our income tax system is just around the corner. Congress has voted to

scrap the Code once and likely will again. But while something called tax reform

just might happen, the real question is this: By what criteria will its success be

judged? What do we want to see in an ideal tax system?

I’ve come to the conclusion that the Fair Tax fits the bill because:

1) There are no exemptions, so we might actually be able to keep this simple and

not give preference to one group or individual over another.

2) It would help solve one of our biggest problems, our balance of trade deficit.

With our current federal tax system we are exporting the cost of the tax system in

most goods and services. The economists who worked on developing the Fair Tax

estimate that this cost averages about 20%. The Fair Tax would eliminate that cost,

and it would be ‘‘GATT legal.’’ In addition, imports coming into the U.S. would be

taxed the same as domestic goods and services if they are used for personal consumption.

3) It eliminates payroll taxes and self-employment taxes. These are some of most

regressive taxes we currently have and they are one of the biggest burdens for many

of our farmers and small business persons.

4) It makes equity capital more available and affordable, because we will no

longer be taxing savings and investment.

5) It will be much easier to administer—we would only need to keep track of the

approximately one point six (1.6) million retail businesses in the U.S., as opposed

14

to the more than one hundred sixty-nine (169) million individuals who file tax returns and pay taxes.

6) The Fair Tax plan makes sense and it will work for the 21st century. I would

be willing to predict that most states would piggyback on our system. We would also

have a mechanism to tax Internet businesses the same as business on main street.

Understandably, the people don’t have a lot of faith in Congress when it comes

to tax reform. As my Dad said when he heard about it, ‘‘That will never happen—

it makes too much sense.’’

The Fair Tax is well thought out, well researched, simple and fair. Let’s show the

American people that we can take bold steps and do what’s right. Let’s move the

Fair Tax through the Congress—doing so would let the American people keep every

penny of their paychecks and have some say over how much tax they pay.

Thank you, Mr. Chairman.

[Attachments are being retained in the Committee files.]

Chairman A

Mr. Camp?

RCHER. Thank you, Congressman Peterson.

f Mr. CAMP. No questions.

Chairman ARCHER. Ms. Dunn?

Ms. DUNN. Thank you very much, Mr. Chairman.

Gentlemen, thank you for coming to testify today. This is a fascinating hearing we have going on today, and I know that Ways

and Means members will be moving in and out of this meeting. But

it is great to be able to be at the head of the line to ask you questions. That usually doesn’t happen when you are in the bottom row.

But I do have a couple of questions I would like to ask you.

Could you explain to the committee how the national retail sales

tax compares to the more broad-based taxes that we see on sales

in Europe?

Mr. LINDER. Well, first of all, they typically have a value-added

tax, which adds a tax every time you add value to a product, from

the time you get the order to turn it into a bumper to put it on

a car, and it is a hidden tax. It is buried in the cost of goods and

services.

One of the first principles of this tax is that everything be transparent so that everyone would know when they buy something

what the tax was to the Federal Government.

This tax is only retail consumption. No taxes between businesses,

no taxes for farmers. If a farmer buys a tractor to work his land,

there is no tax. If he buys a hat to put on his head to do so, there

is a tax.

It taxes everything only one time, so a used house would not

have a tax in it, but a new house would. But it is only personal

retail consumption that is taxed.

Mr. PETERSON. John has explained it well. I think the thing that

also should be pointed out is that in Europe, they not only have

the value-added tax that is added at every level and added into the

price of the product so you don’t know what it is, it is also at different levels, depending on what type of goods and services it is.

But the other thing that they did is they kept the income tax,

so they have two taxes. They have the income tax and the valueadded tax. And I will tell you today that if we don’t get rid of the

income tax, I will not support this bill. The only way I support this

is to completely eliminate all of the current system and replace it

15

with this. The worst thing that we could have is to do what Europe

did, and that is, have an income tax and a sales tax.

Canada did the same thing, and my district is right up alongside

of Canada. That didn’t work very well because they weren’t able to

take the cost of goods and services out of their products because

they kept their income tax, they kept their Social Security tax, and

they added the GST tax on top of it.

So what we are doing here has not been done any other place,

and I think if we pass this, we will become the Hong Kong of the

world and this economy will boom, and it will be a great thing for

America.

Mr. LINDER. Let me add a point to that, if I might. Americans

are paying this tax today. They are paying the embedded cost of

the IRS at retail, about 22 percent, we have a study that says.

They are paying all the cost of businesses, the cost of businesses,

attorneys, and accountants to avoid the tax. There are payroll tax

costs. There are income tax costs. There are compliance costs, all

embedded at price.

Ours is the only bill that gets rid of all those taxes and gives

competition the opportunity to drive out of the price of goods and

services that 22 percent.

Ms. DUNN. I think it is really important to continue to make that

point, that this national retail sales tax would be a replacement for

the current income tax system. It would not be in addition to the

current income tax system. I think we have got to say that over

and over again. Mr. Peterson, you did say that, and people need to

realize that there has got to be a mechanism to get rid of the old

tax code before we move in a new tax code.

Is there anything like that being thought of right now?

Mr. PETERSON. Well, in our bill, we do call for the repeal or the

process to repeal the 16th Amendment so that it will never rise

again. So we have tried to address is, but, you know, I am a cosponsor of the bill to scrap the code, and I have been criticized or

it has been criticized that, you know, it is irresponsible to terminate the code without having a replacement. Well, we have a replacement. It is here today, and I am cosponsoring it.

You may disagree with some of the aspects of it, or you might

have your own way to replace it, but some of us that feel strongly

about this have come up with an alternative, and, you know, it is

time to get rid of this income tax code. It is so screwed up it cannot

be fixed.

Ms. DUNN. Let me ask you, gentlemen, how would your proposal

affect the national and the individual rate of savings in our country?

Mr. LINDER. Well, if you don’t tax—first of all, the average income earner who has a 28 percent withholding rate and a 7.65 percent share of the payroll tax will have an increase in take-home

pay the next day of 56 percent. We are all going to be savers. We

are all going to be investors. Because when you drive the embedded

cost of the IRS out of the price of goods and services and replace

it with this tax, the cost of living will be about a percent higher,

but we will all have an increase in take-home pay and we will all

be investors.

16

We believe the increase in savings is going to be huge. We think

the interest rates are going to go down 25 percent because of that.

Mr. PETERSON. You know, the American people, they are smart.

And when it becomes apparent, which it will almost immediately,

that if they spend money they are going to pay tax, if they save

money they are not going to pay tax, it is going to change the psychology of this country.

Now, we have tried to increase the savings rates with IRAs and

all this other stuff. It hasn’t worked. It has gone down. And I guarantee you that if this thing changes, as somebody who sat across

the desk and did taxes for people, they are going to figure this out

and they are going to save more. I don’t know how much more

but——

Ms. DUNN. So that means that every dollar that is invested or

saved by an income earner is not going to be taxed under your program.

Mr. PETERSON. That is correct.

Ms. DUNN. Thank you.

Thank you, Mr. Chairman.

Chairman ARCHER. Mr. Kleczka?

Mr. KLECZKA. Thank you, Mr. Chairman.

Let me thank both of you for appearing before the committee

today. In your presentation, you criticized the current tax code extensively and said little about the proposal, which I think, before

we move on it, the American public has to understand much better.

It seems that you are touting this plan as a 23 percent sales tax,

and I just question that calculation. Let me ask either one of you,

if this were to be the law of the land and I would go and purchase

a suit for $100, what would the sales tax be on that suit? The cost

of the good is $100. What would be added on for this national sales

tax?

Mr. LINDER. It is our design to have the sales tax included in the

cost of the good. Currently, your income tax—— Mr. KLECZKA. Okay, that is fine. Let’s say it is included in the

good. The cost of the good is $100.

Mr. PETERSON. It is $123. It is $23.

Mr. KLECZKA. That is not what we are told. We are told it is

30——

Mr. LINDER. If it was—— Mr. PETERSON.—dollars on $100——

Mr. LINDER. Let me explain to you, Mr. Kleczka, what the current system is. You are currently taxed on a tax-inclusive basis,

which is to say, the Government takes the first $36 of what you

earn, within what you earn. If you treat this on a tax-inclusive

basis——

Mr. KLECZKA. I am trying to compare it to the current sales tax.

If I buy something in Wisconsin now, then——

Mr. LINDER. It will be 29.9——

Mr. KLECZKA. Wait, could I finish? If I buy something in Wisconsin now, there is a 5.6 percent sales tax. It is the State sales

tax. It is a half percent county tax and 1 percent stadium tax, since

now the taxpayers are building stadiums. Okay? If I buy something for $100, that 5.6 is added on. Now, tell me what my total cost of a suit would be if the suit itself costs $100.

17

Mr. LINDER. The added-on Federal national sales tax would be

29.9 percent, and if you want to compare apples——

Mr. KLECZKA. Now, that is not the 23 percent we are told about.

Mr. LINDER. The tax-exclusive rate is 29.9 and the tax-inclusive

is 23 percent. If you want to treat the income tax on an exclusive

basis, which is to say, divide the amount of money you have to

spend into what the Government took out of it, you would be paying an effective sales tax rate of 56 percent today, so we are still

cutting it in half. You have to treat it either as an exclusive or an

inclusive tax.

Mr. KLECZKA. You know, what I am trying to do is go back to

my constituents and explain what this proposal is all about. And

my concern is, am I to tell them that the sales tax is 23 percent

or 30 percent? I suspect that in an attempt to sell this you are trying to minimize what the actual impact is, so you are saying 23;

however, the effective rate to be charged on goods and services is

actually 30.

So what I am going to do when I respond to any letters I get on

this issue, I am going to say what they have proposed is a 30 percent sales tax rate, and we are told by the tax experts around here

that to be revenue neutral, that tax rate would have to be 59 percent.

Mr. Peterson, would you like to respond to that?

Mr. PETERSON. Well, I don’t know where you get the 59 percent.

Mr. KLECZKA. To be revenue neutral. As it stands, your 30 percent would cost—would deny big revenues that are, you know, coming in today.

Mr. LINDER. We have three different studies that disagree with

you.

Mr. PETERSON. Yes, the people that did the studies from MIT

and Harvard and Stanford estimate that, as we said, the effective

tax rate is 23 percent when you figure out what the percentage is

of the total price of the goods and services. That is what it comes

out to be.

But we can argue——

Mr. KLECZKA. Okay. Well, the joint committee——

Mr. PETERSON. Figures lie and liars figure, but——

Mr. KLECZKA. The joint committee, which works for the committee or is assigned to the committee, did come up with that

amount.

Could you explain to the committee how local units of government and State governments are going to pay this sales tax? As I

read the proposal, all goods and services are taxed for governmental units. Could you explain how that works?

Mr. LINDER. Well, first of all, most governments are heavily

labor-intensive and they are going to have a huge savings on their

payroll tax just to begin with.

Mr. KLECZKA. Okay. How are they taxed? You forgot to finish the

point.

Mr. LINDER. If they buy something that they are going to use in

the business of running the city, they are going to pay a tax on it.

Mr. KLECZKA. So they are going to pay a 30 percent tax. Now,

how are they to treat their payroll? Let’s say the city of Milwaukee

18

has a $50 million payroll in a month, are they taxed at 30 percent

on that also?

Mr. LINDER. No, no, 7.65 percent of that payroll is going to be

coming out of their side and 7.65 coming out of their employees’

side.

Mr. KLECZKA. Okay. That is the FICA tax, is it not, and HI?

Mr. PETERSON. Well, yes, but we eliminate——

Mr. LINDER. We eliminate the Social Security and Medicare.

Mr. PETERSON. Eliminate the Social Security tax. Part of what

this bill does, it doesn’t just get rid of the income tax, it gets rid

of the payroll tax.

Mr. KLECZKA. Okay. And so how is the payroll tax to be funded—

I mean, the Social Security trust fund to be funded?

Mr. PETERSON. It is going to be funded out of the proceeds of the

sales tax, and that——

Mr. KLECZKA. Okay. But so——

Mr. PETERSON. The economists figured that in.

Mr. KLECZKA. So is income going to be sales taxed also?

Mr. LINDER. No.

Mr. PETERSON. No.

Mr. LINDER. Only what they spend.

Mr. KLECZKA. That is unclear.

Chairman ARCHER. The gentleman’s time has expired. There will

be additional opportunities.

Mr. Collins?

Mr. COLLINS. Thank you, Mr. Chairman.

If I understood you right, for this to be revenue neutral, based

on the estimated revenue of this year, about $2 trillion——

Mr. LINDER. 1995 is the last number we have.

Mr. COLLINS. 1995, okay. A couple of questions, then. How do

you treat accumulated savings prior to the implementation of this

tax?

Mr. PETERSON. They are not taxed. Savings aren’t taxed under

any circumstances.

Mr. COLLINS. If you take the funds out of savings and spend

them.

Mr. PETERSON. Okay. If you spend them on personal consumption, new goods and services that are used in personal consumption, then you would pay tax.

Mr. COLLINS. Even though they were accumulated after tax?

Mr. LINDER. Correct.

Mr. PETERSON. Right.

Mr. COLLINS. Okay.

Mr. LINDER. Let me make a point on that, Mr. Collins. If senior

citizens who have saved all their life and accumulated something

and paid tax on the accumulation and paid tax on the interest

earned and the capital gains earned, they are currently paying this

tax every time they spend something. They are currently paying

the embedded cost of the IRS. All we are saying is you get to take

your money out of your IRA with no tax consequences. There will

be no tax on your Social Security revenues or any income you have.

But you will pay a 23 percent inclusive sales tax when you buy

things, which is about what you are paying today.

19

Mr. COLLINS. Okay. Another question. How do you treat depreciation that businesses already have in place prior to the implementation? Because there would be no depreciation after the implementation.

Mr. PETERSON. Well, depreciation is not necessary or relevant because we don’t tax income. And so one of the problems that we

have had in talking to people about this is that they are so ingrained in thinking about the current system that they can’t conceive of us moving away and not having to worry about all this

stuff, depreciation and deductions and all of that. But because we

are not taxing income, it is irrelevant. The only thing that makes

any difference is what you are spending for your own personal consumption. So depreciation is important in doing your financial

statements for reporting, you know, but other than that, it won’t

make any difference.

Mr. COLLINS. But depreciation is your way of expensing—— Mr. PETERSON. But we aren’t taxing income anymore.

Mr. COLLINS. Before we run out of time, what about existing excise taxes? Do you eliminate those or replace those?

Mr. LINDER. No. We tried to draft a bill that merely replaces the

current system of taxing income to another system of taxing expenses without making policy decisions. It is my view that this bill

would fail on the floor of the House if we eliminated the excise tax

on tobacco. We would fail on that issue alone. So we decided we

will take on excise taxes at another time.

Mr. COLLINS. That would include the 12 percent excise tax on a

lot of major purchases?

Mr. LINDER. Correct.

Mr. COLLINS. It is already in place. It would stay there. Okay.

That is all. Thank you, Mr. Chairman.

Chairman ARCHER. Mr. Watkins?

Mr. WATKINS. Mr. Chairman, I have no questions of my two colleagues. I have for the next panel when we get to it.

Chairman ARCHER. Thank you.

Mr. Rangel?

Mr. RANGEL. Let me thank you for your efforts. I would say that

this Committee has not been responsive to your legislation ‘‘over

the years.’’ But we have a few months left, and who knows what

can happen.

The Social Security system, since there is no payroll tax contribution to it, would benefits be paid out of the general funds with

monies that would be collected from the taxes?

Mr. LINDER. The monies would apply to the Social Security trust

and the Medicare trust in the same manner they currently are because your employer would submit your income, what they paid

you in salary, and your earnings would still be credited to your account, and the 40 quarters for which you get your benefits out of

Social Security will still be the same as the current system. All we

are doing is gathering the money a different way.

Mr. RANGEL. So would the money be paid out by the Appropriations Committee rather than by the so-called Social Security trust

fund?

Mr. LINDER. The revenues that would come from the general

sales tax collections would be applied to the Social Security trust

20

and the Medicare trust in the same way they are now based on

earnings.

Mr. RANGEL. Now, since your sales tax is on top of the excise tax,

how would it apply to a gasoline tax?

Mr. PETERSON. Well, if you are buying gasoline for your own personal consumption, there would be this tax on gasoline like anything else.

Mr. RANGEL. On top of the excise tax?

Mr. PETERSON. On top of the excise tax, yes.

Mr. RANGEL. Now, Mr. Kleczka reviewed that. We have the Joint

Committee on Taxation, which is a bipartisan effort, Republican

and Democrat, and they have given an analysis of your bill. They

say that the tax-neutral rate is 59.5 percent over 5 years, and neutrality over 10 years would be 57 percent. You don’t argue with the

Joint Taxation Committee’s estimate.

Mr. LINDER. Sir, we have not seen that study yet. Is that fairly

recent?

Mr. RANGEL. Yes, it is April the 7th.

Mr. LINDER. We have some economists that will argue with that,

yes.

Mr. PETERSON. You know, it is hard for me to believe because the

retail consumption base in this country is 20 percent higher, according to our economists, than the income base. So it is hard for

me to believe that it is going to take 59 percent of a base of 20 percent higher than the current income base to raise the same amount

of revenue.

Now, I don’t know—I haven’t seen the study, but it would be

hard for me—I mean, I think we would raise so much money we

wouldn’t know what to do with it all.

Mr. RANGEL. Well, if this is to be considered a bipartisan effort,

don’t you think in 6 years that you guys would be entitled to a

Joint Committee Tax estimate of the cost so that you would have

plenty of time to bring in witnesses to defend it? I mean, if this

is serious, these questions should not be presented to you this late

in our legislative agenda.

Mr. Chairman, I ask unanimous consent that the Joint Committee’s evaluation of this legislation be placed into the record.

Chairman ARCHER. Without objection, so ordered.

[The information was not available at the time of printing.]

Mr. RANGEL. This concept is complicated, and you can bet your

life that most of the American people haven’t the slightest idea

what you are talking about. Are you saying that cities and States

have to pay taxes on hiring policemen, firemen, doctors, nurses;

that the health care that is provided has to be taxed; and, this is

going to be fair and equitable and across the board? The whole idea

of cities being able to piggyback on Federal income tax programs

or States being able to attach to our system would not work because the vehicle would be no longer there. And so, therefore, they

would have to now think of new ways for them to get the revenues

that would be necessary for them to run their local and State governments.

It is a revolutionary concept and one that merits not only hearings but an opportunity for the American people to be educated.

They then can weigh whether it makes any sense the proposal

21

works for them, and whether for local government or State governments.

But the most important thing, in my opinion, whether or not it

is a Democratic Congress or a Republican Congress, is how in God’s

name do you think you could possibly revolutionize the tax system

unless it is bipartisan in terms of the cooperative spirit that you

bring to this Committee. That bipartisanship has to come to the

Ways and Means Committee and has to come from the House.

Other than that, you are not realistically talking about revolutionizing the tax system. You may have an opportunity to express

views, but the only way that we can bring about any dramatic

change in pulling up the tax code by the roots and not increasing

its complexity, as the way we have done in the last 7 years, is to

make certain that at least we are reading from the same page in

how we are going to present it to the American people and, therefore, to the Congress and this Committee.

So I want to congratulate you for your special effort. I wish I

could give you some hope that we would be able to consider it in

this Committee. But as you know, soon we will have the Easter recess in order to celebrate the resurrection of our Lord and Savior,

Jesus Christ, as well as Passover, and then after that we will be

moving into Memorial Day for those who lost their lives. We will

go through June, probably be busy at Committee two or three days

a week, and then July 4th we have to close shop to celebrate our

independence.

Come August, of course, our conventions will be the main consideration, Republicans and Democrats. September we will come in for

a couple of weeks, and then in October, of course, we get down to

the campaign.

So how we squeeze this into our so-called legislative agenda, I

don’t know, but maybe, just maybe. If we can keep this idea alive,

we will find the bipartisanship that you two have enjoyed and

worked with over the years being conveyed to this Committee and

to the House and Senate. And, we can take a hard look at the income tax system as we know it and take a look at the changes that

we can make in a bipartisan way.

These hearings really complicate things because we have a lot of

legislation on the House floor right now. But, again, the absence

of Members should not be interpreted as an absence of concern of

the serious nature in which you present this legislation.

Thank you, Mr. Chairman.

Mr. LINDER. I thank the gentleman.

Chairman ARCHER. Mr. Crane?

Mr. CRANE. Mr. Chairman, I don’t have questions for our witnesses, but I would like to take advantage for an opportunity to express my appreciation to all of you for the support. I am sorry for

you absence, and I can’t tell you how exciting it is to be back again

and contemplate an opportunity to serve my country, my district,

my family and friends and colleagues. And I want to express appreciation to all of you, from my distinguished chairman here to my

ranking minority member, Charlie Rangel, for all of the input I got

from you folks. It was really reassuring and very helpful and beneficial, and I look forward to a very positive and dynamic future.

22

It is one of those things I am humbled by, but, on the other

hand, we dig in our heels, fight the good fight, keep the faith, and

we shall continue. Thank you again, all of you. Thank you.

[Applause.]

Chairman ARCHER. The gentleman from Illinois is to be congratulated for taking his life in his hands and moving forward in

a positive way, and I know all the members of the committee share

that view.

Mr. RANGEL. Would the gentleman yield?

Chairman ARCHER. Mr. Rangel?

Mr. RANGEL. I think you know the love and affection that we

have had for you over the years. You gave us a chance to display

it by indicating a unique type of courage for all of us. No matter

what shortcomings we have, we can never wrestle the demons to

the ground unless we have the courage first to admit it and then

to do something about it. So it was a bad setback, but you have

set a standard for all of us to follow. We welcome you back.

Mr. CRANE. Thank you.

Chairman ARCHER. Mr. English?

Mr. ENGLISH. Thank you, Mr. Chairman. I would like to also congratulate these two gentlemen for having the courage to offer a

truly revolutionary tax plan. And it has a number of features that

make it similar to the one that I have proposed in terms of the incentives. But the one that I think is particularly important and I

would like you to comment on is the whole question of border

adjustability.

We obviously, when we discuss tax reform, tend to focus on how

tax simplification benefits the individual taxpayer. The individual

taxpayer all too seldom recognizes that they have a big stake in tax

reform because of the impact of the tax system on their job, and

this is particularly true in export industries.

I wonder if you gentlemen would comment on how you think the

question of border adjustability, taking the taxes off of exports and

putting the tax on imports, would benefit the American economy

long term.

Mr. PETERSON. Well, as I said during my statement, I think that

one of the reasons we are running this huge trade deficit is because

we are exporting our tax system, which is expensive, and it adds

greatly to all of our products, even the farm products, the raw commodities that come out of my district.

So there is no question in my mind that if we can change this

system where we can wring the cost of the Internal Revenue Code

out of the system, which is 22 percent, that means that the price

of goods and services are going to be 78 percent of what they are

now. Obviously, we are going to sell a lot more, and it is going to

create more jobs.

You know, we are also going to tax the imports coming into this

country if it is used for personal consumption. So for the first time

in a lot of areas, we are going to put ourselves on the same footing

as these foreign countries, and we are not going to have our companies having to go overseas to manufacture products just to send it

back into this country because of tax considerations, which is happening now.

23

You know, I can’t quantify it, but I can guarantee there is going

to be a significant increase in jobs and commerce if we pass this

bill in the world market.

Mr. LINDER. Let me add something to that. I mentioned in my

opening statement that the chairman often refers to the poll done

by Princeton Group of foreign companies wanting to relocate here.

In addition to that, imagine how many United States corporations

dealing in overseas sales have dollars stranded all over the globe,

billions upon billions of dollars, because it is cheaper to borrow

here at 8 percent than it is to repatriate your dollars at 35 percent.

All that money would come home. Building on these shores

would be much more attractive both for foreign companies and our

domestic companies. So we would see a huge change in the global

balance of trade.

Mr. ENGLISH. Certain sectors of the economy tend to be more tax

sensitive in the sense that they tend to operate on thinner margins.

One of those, I sense, is manufacturing. And in the recent example

of the steel crisis that faced U.S. steel producers, do you feel that

a border-adjustable tax in that case would have allowed America’s

steel industry to thrive in the face of foreign competition?

Mr. PETERSON. Well, my district doesn’t include steel manufacturers, but I—— Mr. ENGLISH. That is why I am calling on you as an objective observer.

Mr. PETERSON. Well, I have got to believe that if you can take

22 percent of the cost of your production out of the price of your

product and if that steel coming into this country is going to go into

cars that are going to be used for personal use, it is going to be

taxed, I mean, it has got to go a long way to solving this problem.

One of the reasons that we are having trouble in the world market is we are trying to export our tax system, and it is an expensive

tax system, and it is a big penalty on everybody that is in the

world market.

Mr. ENGLISH. Thank you, Mr. Chairman. I have no further questions. And, again, I want to compliment the gentlemen for their excellent testimony.

Mr. LINDER. Thank you.

Chairman ARCHER. Mr. Stark?

Mr. STARK. Thank you, Mr. Chairman.

Gentlemen, thank you for providing a creative approach to

changing basically the whole way we handle commercial transactions in the country.

I would note that, Collin, you have introduced legislation to have

a refundable dependent care tax credit to help families, but that

obviously wouldn’t work anymore, and you would be willing to give

up helping people with their dependent care for this program.

Also, the 60 percent rate, I might add, probably comes because

somebody forgot to calculate what your rebates cost. You would be

giving rebates to every American in here, which amounts to about

$400 or $500 billion a year, and that is about 50 percent more than

we collect in taxes now.

But I am going to stick with the 60 percent rate here and discuss

the impact on Medicare. This would apply to doctors’ fees and

pharmaceutical drugs. Now, the Republicans on this committee just

24

voted a month or so ago to deny senior citizens a discount on their

prescription drugs. We Democrats all voted for it. And now we saw

in the paper the other day that senior citizens are paying 15 percent more if they are uninsured for their prescription drugs.

You guys would add 60 percent on top, so that prescription drugs

for my seniors, Zocor, for instance, would go from an average retail

price of $107 a month to $172 a month, or $780 a year more.

Prilosec for ulcers would go up $840 a year. Procardia for people

with heart problems would go up over $1,000 a year in cost. At the

same time, you would raise the Part B premium on Medicare automatically from $45 a month to about $73 a month. And this is most

interesting. We just celebrated the fact that the Part A trust fund

became solvent to the year 2023. Under your plan, increasing the

hospital cost 60 percent would make the Medicare trust fund insolvent in the year 2003. You guys just chop 20 years off the solvency

of the Medicare trust fund.

If you really want to scare the seniors, then just think about

those who had bought long-term care insurance. Nursing homes

cost over $100 a day. You guys would kick that up to $160 a day,

and the long-term insurance would no longer cover it.

While we talk about insurance, every American would have their

insurance bill automatically increased by 60 percent. Not only that,

they would have to increase the face amount because the repair

prospects for collision damage or storm damage under a homeowner’s policy would go up by 60 percent.

It seems to me that you are asking the average American to

spend an awful lot of money that they are not now spending, and

particularly those in the lower incomes, which I know you both understand. Congressman Peterson being an accountant knows that

lower-income people spend a far higher percentage of their income

in consumption than do people who are paid well like you and me.

We don’t spend so much. So we get a gift out of this. But people making $70,000 a year and less really get hammered because they

have to spend so much more of their income.

Now, I know that we kind of forget about middle-income people

and low-income people in Congress because we get these big salaries. But to think that we are going to rack them up with a 60 percent tax rate on what they spend hardly seems quite fair.

So aside from the fact that we are about to destroy Medicare

with this and that is interesting—you talked about lobbyists and

their costs. It seems to me, when I listened to you on National Public Radio, you did a good job. That is my commute program. I heard

you guys on the radio this morning while you were on television.

The lobbyists and the doctors and the accountants are going to

have to pay 60 percent of what they bill when they bill it to the

Government in cash while they wait for the collectibles to come in.

Now, I have a hunch that every lobbyist in Washington is going to

be in here fighting this bill.

So I think that while it is interesting to talk to people about lowering their income tax and their payroll tax, I think we’ve got to

tell them a little bit more about the other side of this coin. And I

would like to know how you plan to save Medicare, which would

now go broke in 2 or 3 years, when you have added 60 percent to

the cost. Have you got any ideas for that?

25

Mr. PETERSON. Well, this was not designed to save Medicare or

change Medicare. We are trying to just replace one tax system with

another.

Mr. STARK. If you would yield, I understand that. But unintended consequences—— Mr. PETERSON. And I disagree—you know, I do not agree with

the Joint Tax Committee, with all due respect, in this 60 percent

number. Now, we asked them a long time ago for this information,

and now I am getting it from the other side of the table before they

gave it to us. And I think that is a little bit unfair, and, you know,

we didn’t need to wait 6 months to get this information.

But I can understand that because—— Mr. STARK. Excuse me, Collin. It was given to the Republicans

a long time ago.

Mr. PETERSON. Well, I am not trying to get into Republicans or

Democrats. This is not why I am involved in this. You know, for

whatever reason, we didn’t get the information. So the first I heard

this is today. I cannot believe that the 60 percent figure is right.

I don’t know where it is coming from. You know, maybe people

want to put this in as bad a light because they are concerned about

protecting the current system or whatever else, you know.

But it depends on what you believe and how you believe in the

marketplace. I know that some of you think that the drug companies are making a lot of money.

Mr. STARK. I know that.

Mr. PETERSON. Okay. Well, then they are paying the maximum

corporate tax rate—— Mr. STARK. No. They are paying the lowest corporate tax rate of

any major industry in the country through all their deductions and

credit.

Mr. PETERSON. Well, but who gave them the deductions and

credits?

Mr. STARK. We did.

Mr. PETERSON. Okay. So if they are making a lot of money, they

are paying a lot of taxes, generally.

Mr. STARK. They should.

Mr. PETERSON. They should. But, you know, it—I think it is hard

to argue that the current tax system is fair or progressive as it relates to these different companies, and I think that we do penalize

people’s incentive to work and all these other things. I think it is

a much better policy in this country to tax when people spend

money and to not tax when they save money. I think that is in the

best interest of the country, and we do exempt on the bottom end

the people—if you are a family of seven, you are going to get $31,200 of your spending exempted from this tax completely.

So we have fairly well insulated the bottom end—— Mr. STARK. But you and I would get the same amount.

Mr. PETERSON. Right. Well, why not?

Mr. STARK. Well, what have we done to deserve it? I mean, the

taxpayers are already paying the—— Mr. PETERSON. You have the same necessities of life as anybody

else. I mean, everybody needs to have a place to live——

Mr. STARK. But I have got a lot more income than everybody

else.

26

Mr. PETERSON. Well, and if you save it, you won’t pay any tax,

which is, I think, a good thing because then that money is going

to be available—— Mr. STARK. Collin, I can’t sell that in my district. They don’t even

want to pay me, much less have me go home and defend—— Mr. PETERSON. Well, I can’t speak for your district, but I just

think it makes sense. You know, that is where I am coming from.

We can have a disagreement on that. But I really think that in the

best interest of the country this is a better system, a better way

to raise the money.

Mr. LINDER. Let me just say, the only thing I agree with what

you said is that the lobbyists will indeed oppose this.

Mr. STARK. Because of the—— Mr. LINDER. Because 60 percent of them make their living because of their intellectual capital in the tax code that we have

drafted over 88 years.

Mr. STARK. Well, whatever they are lobbying for, I mean, the interesting thing is having to pay the tax the day you send a bill to

the client, and if the clients are as slow-paying as some people I

know, you are going to really affect the cash flow. This would go

to every lawyer and physician. Think of the doctors coming to complain how long it takes Blue Cross to pay them or HCFA to pay

them. But when the doc does the operation and sends the bill, they

would have to pay 60—even Collin’s figure of 30, let’s split the difference and say 45 percent of that fee has to be paid in cash to the

Federal Government. Think about what this would do. And Collin

as a CPA knows that cash flow probably is more important to these

people in operating their practices. You would take a big cut out

of that because for people who are carrying receivables, 30, 60, 90

days, there would be a major problem. We would all be paying—— Chairman ARCHER. The Chair notes this is a very interesting

conversation, but the gentleman’s time has long since expired.

Mr. STARK. I thank the Chair for his indulgence, and I thank the

witnesses for——

Chairman ARCHER. The gentleman will have other time today,

frequently.

Mr. Lewis?

Mr. LEWIS. Thank you, Mr. Chairman.

With a national retail sales tax, what role would the IRS play?

I would assume that it would be diminished.

Mr. LINDER. We anticipate a small agency within the Treasury

Department that will contract with the various States and pay

them to collect the tax, just like 45 States are already doing with

their sales tax now.

Mr. PETERSON. So we sunset the IRS in this in, I believe, 2005.

We have 110,000 employees. We probably need, you know, 10,000

to do compliance, because one of the—the one issue where you are

going to have a problem is we don’t tax businesses, so you are

going to have a lot of people that are going to want to say they are

in business so they can buy a car or buy a plane for their business.

Now, that is already happening under the current system, but,

clearly, you are going to have that kind of pressure with this kind

of system, so we will need people out there to police this and to try

to make sure that these businesses are legitimate businesses and

27

they are not some kind of sham just to get around the sales tax.

So much diminished.

Mr. LEWIS. So the intrusion into individual lives would be greatly

diminished.

Mr. PETERSON. Right.

Mr. LINDER. Everybody in America would be a voluntary taxpayer, and they would pay taxes exactly when they choose and as

much as they choose by how they control their spending.

Let me speak just a little bit to the compliance question, which

I think was at the edge of your question. Currently the IRS says

they collect—they have a compliance rate of 75 percent. It is very

easy just to cheat on your tax return, lie on your income, and you

have a 99 percent chance of not being audited. Under our proposed

system, you have to have someone conspire with you to cheat. And

since 80 percent of the tax is going to be collected by 20 percent

of the businesses, such as Wal-Mart and Home Depot, they are not

going to be interested in helping you cheat because they have too

much to lose.

The States that currently collect the sales tax tell us on average

the compliance rate is 92 percent. So we not only capture the underground economy, but we think the compliance rate will be much

higher than currently.

Mr. LEWIS. Wonderful. Thank you.

Chairman ARCHER. Mr. Tanner?

Mr. TANNER. Thank you, Mr. Chairman.

I, too, thank you all for your innovation. I have long thought that

we could do some things here in Congress that would simplify the

tax code and would also give us a chance to realize some of the

principles of taxation that you all have expressed, and so I thank

you.

I have a couple of questions about the mechanics, I suppose.

There would be a 23 to, I think in your words, Mr Linder, 29.9 percent levy on the local payrolls of State and local governments under

this provision.

Mr. LINDER. Not on payroll.

Mr. PETERSON. Not on payroll.

Mr. TANNER. Well, on wages. There would be a sales tax paid on

wages of State and local government employees?

Mr. LINDER. On waivers? I can’t hear what—— Mr. TANNER. Wages.

Mr. LINDER. Wages? No, that is not my understanding.

Mr. TANNER. It is in this bill, as far as I can read.

Mr. LINDER. Correct.

Mr. TANNER. Am I incorrect?

Mr. LINDER. You are correct.

Mr. TANNER. I am correct?

Mr. LINDER. Yes.

Mr. TANNER. You said the difference earlier that would be—that

they would save money because payroll taxes would be eliminated

under your proposal.

Mr. LINDER. That is correct.

Mr. TANNER. There is a difference between the 20-something percent that would be levied on the wages of the local employees,

State and local government employees, and the amount of contribuVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00033 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
28

tion they are presently making to the payroll taxes, anywhere from

as much as 20 percent, depending on what number you used, to

maybe 15 percent.

Now, we have passed a law called unfunded mandates. I don’t

know how they pay for that if we impose that on the taxpayers of

the State and local governments. I am from Tennessee where we

have a sales tax-based system, so I guess I am more sensitive to

that than you are. Could you help me with that? Could you explain

how that would work?

Mr. PETERSON. Well, I think one of the reasons that this provision is in there—and this, I guess, depends on how you come at

this. But I think—I am convinced that if we take the income tax,

the corporate income tax, payroll tax off of businesses, then you are

going to have a reduction overall in the price of goods and services

of 20 to 22 percent. So what these people buy in local governments

are going to go down. The costs of goods and services are going to

go down 20 or 22 percent.

So if you believe that, then you are going to have a tradeoff here

basically that is going to be even if you believe that the rate is 29.6

percent.

Mr. TANNER. Do you have any data? I mean, that is the first

question——

Mr. PETERSON. Well, yes. Economists——

Mr. TANNER.—that is going to be asked by State legislators and

all of the government employees in the urban areas as well as the

little towns like I come from. How are they going to pay it?

Mr. PETERSON. Well, the economists from Harvard, MIT, and

Stanford that did the work on this say that the costs of goods and

services on average are going to go down 20 percent because we are

going to take the cost of the income tax and payroll tax system out

of the price of goods and services.

So we are trying to leave people——

Mr. TANNER. Well, you understand my question.

Mr. PETERSON. Yes, I understand——

Mr. TANNER. When I go home and the little town I live in is

going to buy a police car and they are going to pay this tax on that

police car, they want to know how they are going to come up with

it other than raising the local property taxes. They are going to pay

a sales tax on the salary of the five or six policemen we have.

Now, if the price of the paper that they buy comes down, I guess

it might make up for the tax they pay on wages of the policemen

and firemen. I don’t know. But I think we need to look at the unfunded mandates law if we think it is worthwhile and see how we

can relate it to this law.

The other question I had is what about the case of retail sales

over the Internet. Are they taxed under your proposal?

Mr. LINDER. Yes. Under this principle, we would not——

Mr. TANNER. You understand we just passed a moratorium on all

Internet——

Mr. LINDER. Well, we passed a moratorium on special access

charges, but the Internet is still susceptible to the same sales tax

that the catalogue sales are and Sears has been paying this for 60

years.

29

On this principle, we think that Government ought to be neutral

between competing parties, and if the fellow down the street puts

up a store and sells books out of it, participates in your community,

votes in your elections, and serves on your library board, he ought

not to be put at a 7 percent disadvantage to Amazon. So under the

principle that Government ought to be neutral, everything ought to

be taxed exactly the same. And Internet sales and catalogue sales

would be captured at the national level.

Mr. PETERSON. Well, and people are mixing—— Mr. TANNER. We have a moratorium until October of next year

on retail sales taxation over the Internet.

Mr. LINDER. The moratorium is only on special access charges.

Mr. PETERSON. Well, the Federal Government doesn’t charge

sales tax—— Mr. TANNER. That is not my information, but—— Mr. PETERSON. The Federal Government doesn’t charge sales

taxes on anything right now.

Mr. TANNER. Under your proposal, I understand it would.

Mr. PETERSON. Well, we would. But I am just saying right now— so when people talk about this, they get this mixed up between the

State issue and the Federal issue. We aren’t taxing anybody retail

sales at the Federal level. The only people that are taxing and

where it is an issue is at the State level.

Mr. TANNER. Right.

Mr. PETERSON. And they get this mixed up, and so I think a lot

of people don’t even really know what this is about. You know, they

are just reacting that they are against taxing the Internet, and I

am, too, in terms of taxing the Internet service and making this

available to people. I am against taxing that. But one of the positive things about this piece of legislation is that we will tax all

sales, wherever it is, and I think that the States will piggyback on

this system, because they will no longer have the income tax to

base their income tax system on. I think the States are going to

go away from the income tax, will piggyback on this, and then that

will help solve——

Mr. TANNER. Well, let me ask you one other question, so I can

explain it to people when they ask me because I am interested in

it. Under your bill, do you propose to tax the Internet access?

Mr. PETERSON. No.

Mr. TANNER. Well, now, I thought you said there were no exemptions earlier.

Mr. PETERSON. Yes, there will be a sales tax on all services if it

is used for personal use. So if you are using the Internet in your

house for your own personal use, you will pay a sales tax, like everything else. If you use the Internet in your business, you will not

pay a tax because businesses are not taxed under this at all.

Businesses——

Mr. TANNER. Internet access charges to individuals, non-business, would be taxed under this provision.

Mr. PETERSON. Right, because—— Mr. TANNER. So we would have to change the moratorium on——

Mr. PETERSON. And so is your phone bill, so is any other utility.

Mr. TANNER. I am just trying to find out what we are and are

not doing.

30

Thank you, Mr. Chairman.

Chairman ARCHER. Mr. Hayworth?

Mr. HAYWORTH. Thank you, Mr. Chairman. My colleagues from

Minnesota and Georgia, I appreciate you coming down today to talk

more about this, and I also take time to salute you because I hear

from several people in my district who are very captivated by the

notion of changing, reforming our system of collecting taxes.

My friend from Minnesota may have touched on this a little bit

in his answer to a previous question, but I think there is a legitimate concern that we need to address—and if it has been touched

on already, I apologize for raising the issue again—about the socalled sticker shock. When we make a transition from the current

taxation policy to this form of sales tax, there are those who say,

wow, take a look at perhaps a one-time escalation in price. Would

you agree that is a legitimate challenge in making this transition?

And what about that whole notion of sticker shock and a jump in

prices?

Mr. LINDER. We have a study out of Harvard that says that the

reduction in sales in the first year would decline by 8 to 9 percent,

and in the fourth year we will be spending more than we are currently spending under the current system because people would

have so much more discretionary income to spend with.

Mr. HAYWORTH. So the flip side is—and this was brought up at

a town hall. When there was a lament about the sticker shock,

somebody said, well, yes, but look at what you are taking home, because I think the epiphany for many of us comes when we enter

the world of work, get a paycheck and say, ‘‘The Government has

taken how much already? Gee, if I just took home what I earned.’’

And yet there is another question that arises, and I know our

friends, the retailers, will be along to talk about this. A lot of folks

tend to take the position, well, wait a minute, we have already become the tax collector for the State, for the county, for the city, all

these sales taxes. Please don’t make us the tax collector for Uncle

Sam. That is one heck of a responsibility.

But I wonder, too, about the percentage—will there be a temptation for different businesses to say, well, let’s pop the prices up to

an even percentage. It not only will be easier to figure, but there

will be a little bit in there for us in terms of care and handling.

Is that a legitimate concern?

Mr. LINDER. Yes, but we think the marketplace works. We really

trust that the competition will drive that embedded cost of the IRS

out of the price of goods and services. If we didn’t trust the marketplace, we wouldn’t be interested in this. For every retailer that

wants to put a few pennies extra in there, the guy down the street

is going to take a few pennies out because his interest is market

share. He is going to make more because he is going to sell more.

So we think we have a very efficient system. We think that we

are in a period of time right now when everything is penny-sensitive. The competition has never been keener. And we think that

will drive the price of goods and services down.

Mr. HAYWORTH. Gentlemen, how do we get from here to there?

I mean, is it just take over on an arbitrary date, or is there a transition period?

31

Mr. PETERSON. The only transition rule in this is going to be— you know, it is on the 1st of January. The only transition rule is

the inventory that you have on hand at that date you will get a

credit against the sales tax for that inventory because the price— the current price of the tax system is in those goods and services.

So we would, in fact, be collecting the tax twice on that. So that

would be the only transition rule.

We would go cold turkey on January 1st of—I think in the original bill it was 2001. Now it is probably going to have to be delayed

beyond that if we move this year. But it would be cold turkey.

Mr. HAYWORTH. One final point. I appreciate your advocacy of

this plan, but I also know that you take your oaths of office very

seriously and you are willing to come here as honest brokers and

advocates. As you look at the plan you have introduced, in all candor, what do you consider to be the limitations or the drawbacks?

Are there any things that concern you both in terms of what has

been drafted?

Mr. LINDER. I have two concerns. The first one is for the States

to administer and oversee the collection of taxes on services will be

much more difficult than on products. And the second concern,

which is very real with me, is that 15 years after this passes, we

are going to have a hard time finding employees because this economy is going to grow so rapidly. Every foreign company, is going

to want to build in our country because there are no tax consequences. Every investor in the world will be in our equity markets because there are no tax consequences. And we will have so

much growth that I am worried about finding employees.

Mr. PETERSON. You know, any piece of legislation has got things

that can be questioned or places that can be improved. And I think

there has already been some issues raised here today that ought

to be looked at. And I come at this with the idea that you folks can

help us make this a better situation. I think we ought to look at

the issue with the local units of government and see if there is a

better way to address that.

But I think that the biggest concern that we are going to have

in the implementation of this, as I said earlier—and we have got

big problems in the current system with compliance. But we are

going to have a significant problem because we don’t tax businesses. You are going to have people trying to create businesses so

they can avoid the tax. And that is going to be one of the biggest

challenges in implementing this, is setting up a system whereby we

can ferret out what is a legitimate business and give them a number and a way to control this. We are going to have to have some

kind of a system whereby we can make sure that when the Federal

Government gives you a number to be in business, that you are legitimate business, and then use that as an underpinning to make

sure that people don’t get around this law. That would be my biggest—I think that is the one place where you are going to have people trying to undermine this. And it can be handled, but it is going

to have to be thought out very carefully.

Mr. HAYWORTH. Well, again, gentlemen, I thank you. You are to

be commended, and there are many of my constituents in the 6th

District of Arizona who have more than a passing interest in this,

have a deep and abiding conviction that this could be the answer

32

in terms of tax reform. And I pledge to you as a committee member

we will take a close look at this, and, again, Mr. Chairman, I commend you for calling these hearings today.

Chairman ARCHER. Mr. Jefferson?

Mr. JEFFERSON. Thank you, Mr. Chairman.

I also would like to comment you members for taking a stab at

this issue of tax reform. But I have some questions about a part

of it that I think a lot of folks in the country are going to be concerned about.

We have done a lot in this committee and throughout the Congress to incentivize home ownership as a way of creating a wealth

of people and a way of providing for them a chance for what we

call the American dream.

We have also done a lot in our committee to try and build communities through incentives for rental property development, both

rehabilitation projects and new ones, and we have done low-income

housing credits for that, and we have done accelerated depreciation.

On the other hand, for home ownership, as you know, we have

allowed the deduction of mortgage interest payments, and these

have incentivized home ownership and have been probably the

principal incentive for the ordinary person in the whole tax code.

Now, if I understand the bill correctly, it will place a 30 percent

retail sales tax on purchases of newly constructed homes. It seems

to leave out old homes, although I am not quite sure, but it seems

to leave that out. But it also imposes a 30 percent sales tax on

rentals whether the apartment is new or old. And then it seems to

include sort of a new tax here under this definition of financial

intermediation services, the difference between the home mortgage

and the—I am sorry, the mortgage interest rate and the Federal

rate, there is a 30 percent tax on whatever that difference is.

So let me ask you this: Am I correct that your bill imposes a 30

percent retail sales tax on purchases of newly constructed homes?

Mr. PETERSON. That is correct.

Mr. JEFFERSON. And let me ask you this: Do you know if any

State imposes such a tax? I don’t think any State imposes such a

tax now, right?

Mr. PETERSON. No. But you have to, again, go back to the underlying principle that the economists tell us that 28 percent of a

home, a new home, is the embedded cost of the current tax system,

payroll taxes, corporate income taxes. So 28 percent of the cost of

that home is going to go away if we pass this bill. Then you add

30 percent back onto it, you are about where you started off.

Mr. JEFFERSON. Again, you have the discrepancy that exists between Joint Tax and those who are putting together this legislation

about what the rate will actually be.

Mr. PETERSON. Right.

Mr. JEFFERSON. But let’s assume it is a 30 percent rate. If someone buys a home for $200,000, is the tax on that $60,000? Is that

the way you would calculate it?

Mr. PETERSON. This is the one place—in all other instances, the

tax is paid up front, but in the case of homes, we think that is a

large enough purchase that it is not fair to ask the lenders to pay

that tax and have to collect it back over the length of the mortgage.

33

And so the way that it works on a new home is you pay tax on

the equity portion, whatever your down payment is, you would pay

the tax on that, and then you would pay the tax on the principal

part of your mortgage payment every month. So that would be

spread out over the length of the mortgage. On a $200,000 house, if you had $40,000 down, you would pay

the tax on that, and then you would pay the tax on the principal

as you paid off the principal of the rest of the mortgage.

Mr. JEFFERSON. So where does the taxpayer get this money

from? He has to borrow the money as part of the overall loan?

Mr. PETERSON. Well, he gets it—I mean, he has to borrow the 28

percent of the embedded cost of the tax system that is in the house

right now. He borrows that.

Mr. JEFFERSON. Well, you are talking about—— Mr. PETERSON. So it is the same—— Mr. JEFFERSON. Yes, but on top of that, in real terms, on top of the cost of the house, if the fellow is buying a house at $200,000,

the so-called embedded cost is already there. I mean, that is what

he is getting. Then he pays a mortgage on it now, and he pays his

mortgage interest rate over time. This sales tax thing is a new feature here. It is something you would have to borrow, it seems to

me, to add to his liability on this thing.

Now, let me ask you this: This intermediation charge, you agree

that is a new charge, the difference between—— Mr. LINDER. It is simply a way to get to how to charge for banking services, and we are trying to borrow—we are only charging sales tax on the service provided. If you borrow $100,000, there is

a service cost. We don’t pay the sales tax on $100,000 that you are

going to borrow and pay back, only on the service aspect that the

bank incurs in making that loan for you.

Mr. JEFFERSON. You calculate that as the difference between the

mortgage rate and the Federal rate. That is what it seems to be— and I don’t know that necessarily—those two necessarily jibe in

every case, but, anyway, that is the way it is calculated here. That

is another issue.

Does the bill impose—on apartment rentals, are you troubled at

all by the proposal that we would increase the cost of housing by

30 percent for somebody who is renting? Does that trouble you at

all? Or you think it isn’t a problem, especially for moderate- and

low-income people?

Mr. PETERSON. The price of building that apartment building is

going to be 30 percent less than it is currently because you are not

going to have all of those payroll taxes and corporate income taxes

to pay. So, theoretically, if the cost of that rental property is less,

then the amount that you have to charge for rent would be less as

well. Plus we exempt—like for a family of five, you don’t pay any

tax on $25,400, and part of that $25,400 is the rent that you would

pay on your apartment. So you are insulated from the tax on that

portion of it.

Mr. JEFFERSON. In the case of the new home purchase, you made

an explanation about getting rid of embedded costs. In the case of

rental, of course, it applies to old and new. So if a person is in a

rental unit now and it is an old unit, won’t that person just experience an increase in rent because of this proposal?

34

Mr. PETERSON. Yes.

Mr. JEFFERSON. I would think so. And in the case of a new one,

you could say the rent rate is just being established, so it is taken

off for the first time, perhaps. But in every case of—now, we have

made—we try to make it easy for people to find decent and affordable home ownership, rental properties through what we have done

in the tax code, through the low-income housing tax credit. We

made a big deal out of that over the years, and it has been—most

people say it has been effective in building communities.

I just wonder if you are going to put some housing out of the

reach of low-income families and without any sort of a provision before it, because we take the low-income housing tax credit away.

Mr. PETERSON. It is a legitimate concern, and I would just say

that I think that the things that are embedded in the code that we

can all agree are good public policy and are needed to get people

what we think they need and deserve, then they can withstand the

scrutiny of this Congress, and we can set up a program to accomplish the same thing with a direct appropriation. We don’t have to

do this through the tax code. So the low-income housing tax credit

incentives—I mean, we are wasting 50 percent of that money to

have these brokers sell these credits in the first place. We could

eliminate that.

I have worked with low-income housing tax credits. I see how

much of it goes to the people that sell the credits and don’t go to

the folks that actually invest in the properties. So, again, if that

is what we want to do to encourage home ownership for people in

rental property, we can have an appropriation, we can have a program that spends that money directly, and we can all vote on it,

and it will be out in front. And I think that is a better way to do

it.

Mr. JEFFERSON. Won’t you have to set up—— Chairman ARCHER. The gentleman’s time has expired.

Mr. JEFFERSON.—some bureaucracy to deal with all that stuff?

Chairman ARCHER. Mr. Becerra?

Mr. BECERRA. Thank you, Mr. Chairman. And I appreciate that

our two colleagues have stayed for such a long time answering so

many questions, and I appreciate also their proposal and their efforts to try to reform our tax code.

Mr. Jefferson raised some of the questions I was going to ask, so

let me just continue along those lines.

Inherent in your discussion is the fact that we have embedded

in the cost of items that we currently sell income tax rates—or the

income tax that we pay as individuals, other taxes such as the payroll tax, and that by eliminating those taxes and placing it all

under a sales tax, we can have at least a simpler, cleaner understanding of what our tax really is. So we take that $200,000 home.

Under your legislation there would be a tax of $60,000 on that

home that could be spread over the life of a mortgage in terms of

the paying of that tax.

My understanding from what you are saying as well is that because we are now eliminating income taxes, payroll taxes, all other

forms of taxes, those embedded taxes now being eliminated, we can

now actually reduce the cost of items that we purchase, so,

therefore——

35

Mr. LINDER. And we think the market will do that. We think

that $200,000 home will cost about $140,000 to build.

Mr. BECERRA. So you are saying it will cost about $140,000 to

build, so, therefore, you are actually saving a little bit. So even

though you are paying a tax, your cost really won’t be much different from what it was before.

Mr. LINDER. But you are going to be paying for it with your

whole paycheck. If you are the lowest-income earner right now in

a rental unit with a 15 percent withholding level and 7.65 percent

your share of the payroll tax, you are going to get tomorrow a 30

percent increase in take-home pay. Most people who buy homes,

the first consideration they have in going to the mortgage lender

is how much of your income—how much take-home pay do you

have? Can you afford to make the payment? And you are going to

have an increase in take-home pay.

Mr. BECERRA. Your proposal would try to put more money in people’s pockets at the beginning.

Mr. LINDER. That is correct.

Mr. BECERRA. A concern I have, though, is that if you are saying that the cost of that new home will be $140,000 instead of the

$200,000 now, then for someone to sell that home, a home builder

to sell that home, you would have to sell that at $140,000, when

before this tax may have been in place, someone would have purchased the neighboring home at $200,000. But now the home is

selling for $140,000. How do you tell the neighbor that purchased

the home for $200,000 under the old system that now his home is

really valued at $140,000 because the neighbor next door bought it

at $140,000?

It seems to me that what you have told all the neighbors is the

value of your homes has just dropped quite a bit.

Mr. PETERSON. Well, no, because under our plan, one of the principles is that things are only taxed once. So we only tax new property. So that home next door is not taxed when it is sold.

Mr. BECERRA. So do you mean to tell me that someone else will

now purchase the next year the neighbor’s home that cost the

neighbor $200,000 at $140,000?

Mr. PETERSON. Well, no, because if it was a new home, the tax

would be added on to it. It would be back up to $200,000. So you

would be in the same position as you were with a used home.

Mr. BECERRA. So let’s take this scenario. The year 2000 a home

was built, and under our current system, the homeowner purchased it for $200,000. The year 2001 we go into your new tax system, and you are saying that same home will really cost about

$140,000. The neighbor would buy that new home next door—a

purchaser would buy that home next door for $140,000.

Mr. LINDER. Plus taxes——

Mr. BECERRA. Plus the tax. Plus the tax.

Mr. PETERSON. $60,000.

Mr. BECERRA. $60,000. The neighbor that bought the home for $200,000 in the year 2000 now wishes to try to sell. I am a purchaser seeking a home in that neighborhood. I look at the home

that cost $140,000 plus the tax, but the purchase price is listed as

$140,000, and I now look at the homeowner who purchased the

home for $200,000 in the year 2000, that homeowner is not going

36

to sell it for $140,000. I am probably not going to be willing to

pay——

Mr. LINDER. First of all, both of these houses have tax costs in

them. One is visible and the other is invisible. But they are both

going to wind up costing about the same.

Mr. BECERRA. Yes, but—and you may be right that it may be invisible, but the prices are not invisible to people shopping for

homes, and I have a difficult time understanding how anyone as

a neighbor is going to want to see a $60,000 reduction in the value

of their home and someone else is going to, as a purchaser, be willing to shop for a home that is priced at $60,000 more than what

someone else bought the home.

Mr. PETERSON. As someone who has spent 20 years advising people and spending most of my life figuring out how to get around

the tax code, I can tell you what is going to happen with this. Used

houses will become very popular for a while because they are not

taxed. That is the psychology of the American people. If they can

find something that they can buy and not pay the tax, they are

going to just gravitate toward that. So I think you are going to actually see the used houses become more valuable for a while. Eventually it is going to sort out as the system goes into effect.

Mr. BECERRA. And, you know, we would have to roll the dice on

that, but I think the same problems you see with real estate you

would see with funeral services. You are going to tax people to go

bury their deceased relatives; doctors’ services, which were discussed; prescription drugs, a 30 percent tax on prescription drugs

for elderly who are right now on fixed incomes; nursing homes; the

Internet, which we here have agreed should not be taxed for at

least a few years until we figure out what, if anything, we should

do. Somehow we are going to have a total change in mind-set, and

then we are still rolling the dice.

I thank you for all your efforts and your time, and, Mr. Chairman, I thank you also for the indulgence on the time.

Chairman ARCHER. Ms. Thurman will inquire.

Mrs. THURMAN. Thank you, Mr. Chairman.

Just to reiterate the comments by my colleagues, we do appreciate the work that you have put into this. I am probably one of

the few members other than—well, I may be one of the only members here that has had to deal with a service tax ever before

through the State of Florida when Governor Martinez was Governor and tried to impose a service tax on the State of Florida and

the residents. And I have to tell you it was pretty nasty, very

nasty, and it was only at 6 percent. But what it was basically doing

was putting a sales tax on services, on everything that was defined

through the Federal SIC codes. So it became a rather—it actually

ended up being fairly embarrassing because it ended up being repealed within about a 6-month period of time.

But in saying that, there are a couple of things I would like to

ask about. Florida is also one of those States that does not have

a State income tax, although State income taxes would be

piggybacked somewhat on our income tax. So even though yours

may be 30 percent or 60 percent—whoever’s numbers you agree

with—what happens to a State if their income tax is no longer

37

available to them? I mean, replacing it with a sales tax, property

taxes?

Mr. PETERSON. Well, I think that, you know, first of all, I was

in the State legislature in Minnesota when we tried to tax services,

so I have been through that. But the thing that you need to understand is that those same people that are going to be collecting this

tax are paying a huge income tax, corporate income tax, payroll tax

burden, and I think a lot of them would be willing to have their

services taxed with the sales tax if they can get rid of that other

part of the system. So that is a new part of the equation that was

not there, you know, when we were just going to put the sales tax

on top of what is already there.

But in the case of the States that have income tax, I think it is

unlikely that any State will be able to maintain an income tax if

we don’t have a Federal income tax, and I think that is a good

thing. And I think what will happen is you will see States

piggybacking onto our sales tax system.

For example, in Minnesota, we exempt food, clothing, medicine,

you know, all of those kind of things. And because of that, we have

to have a 6.5 percent sales tax. If we taxed everything, like we are

doing in our bill, we could drop that to 2 percent and raise the

same amount of money.

So I think you are going to see States piggyback onto this Federal system, be able to drop their rates, and still collect more

money than they are collecting now.

Mrs. THURMAN. How do they piggyback onto this system? I am

not sure that I understand that.

Mr. PETERSON. Well, because your merchant is going to charge

you on your Federal sales tax, you know, 30 percent, whatever it

is. So the State will just add on another 6 percent, and then they

will get their revenue based on the same taxable sales as the Federal, and they just piggyback right on and it makes it simple.

Mr. LINDER. Let me make a comment on that, Mrs. Thurman.

We have had Governors tell us that they would love to see this because they would eliminate all their exemptions and exclusions, tax

everything equally just like ours does, and it is much easier for

them to administer and oversee. We are making the retailers be

cops today. They are picking out who gets taxed and who doesn’t,

and we shouldn’t ask that of our retailers. They should tax everything the same.

I practiced dentistry. Why should my profession be privileged to

operate in Georgia and not have pay to have a tax when the neighbor who is a jeweler has to collect the tax? So we are operating

under a principle that no industry should be favored over another

industry, no business section should be favored over another. Everybody should pay equally the same because they are all serving

consumers.

Mrs. THURMAN. Well, but the business is not paying the tax.

Mr. LINDER. That is correct.

Mrs. THURMAN. The customer is paying the tax. You can’t say

that it is a privilege by the business.

Mr. LINDER. It is a privilege not to have to collect it and turn

it in.

38

Mrs. THURMAN. However, in saying that, I mean, if I look at the

constituency that I represent of about—you know, the second poorest district, maybe just above that poverty line but still one of the

poorest districts, and a very old district. I mean, the three or four

things that they have to depend on, which has already been mentioned: housing, food, medicine, going to the doctor. And, you know,

what you are saying to them—and they are not necessarily paying

or receiving or paying a payroll tax or doing any of those kinds of

things. For them, what benefit is this to them?

Mr. LINDER. Well, there are two benefits. The first one is we are

going to drive the embedded cost of the IRS out of those things that

they are currently paying now.

Mrs. THURMAN. But is there an enforcement mechanism in this

bill to make sure that those things drop?

Mr. LINDER. No, we actually trust the market. We actually trust

the free market system to do that.

But, secondly, they are going to have a rebate at the beginning

of every month that is going to totally rebate the tax consequences

of purchasing the necessities, which the HHS determines every

year——

Mrs. THURMAN. For everybody?

Mr. LINDER. For everybody. We don’t need an agency determining who deserves it and who doesn’t, because then we are back

in the income business. Every household will get a rebate check at

the beginning of every month that will totally rebate the tax consequences of spending up to the poverty line. For a household of

five, that is about $25,000. Their check of about $500 a month

would totally rebate the tax consequences of spending up to that.

So we not only drive the current 22 percent embedded cost of the

IRS out of the purchase of milk and bread, but we also add a check

to that so they don’t pay the 23 percent sales tax on it.

Mrs. THURMAN. So who is going to pay that difference? I mean,

somewhere along the line throughout this——

Mr. LINDER. Who is going to pay the check?

Mrs. THURMAN. Well, no. I mean, if somebody is not paying and

it is above this—I mean, who gets squeezed in this?

Mr. LINDER. Actually, the consumption base is a very consistent

base over the last 40 or 50 years. Even in downturns of the economy, we have seldom had a turndown of more than 3 percent. So

the consumption base is a far more steady predictor of revenues

than is the income base.

Now, let me tell you who is going to get hurt the most: the guy

who is worth $300 or $400 million and he has got all his money

in tax-free municipals. He is going to have to pay taxes for a

change.

Mr. PETERSON. Plus the spending base is 20 percent higher than

the income base. People spend 20 percent more than they report in

income. So it is a higher base to start with.

Mrs. THURMAN. But I would imagine it also depends on what you

are spending on and what grouping you are in as to your needs.

Mr. PETERSON. Yes. But, again, you know, most seniors, a lot of

them have their homes paid for.

Mrs. THURMAN. Sure.

39

Mr. PETERSON. So that is not going to be an issue. And I think

with most seniors the amount that we have in here for the poverty

level spending is going to cover their drugs and food and clothing,

because most seniors are not spending a lot of money on clothing

either, probably.

So, you know, it is going to vary between people, but, I mean,

generally, I have had seniors—I have had town meetings and

talked this through with seniors. And once they understand it, you

know, I think most of them think it is a good thing, not so much

for them but for their kids, because what most seniors are concerned about is that their kids or grandkids get a chance to make

it in this world, and this takes the burden off of them. You know,

they have no taxes on their payroll. They get to keep their whole

check, and they decide whether they are going to spend it and pay

the tax or whether they are going to save it and start a business

or whatever, which I think is a better way.

Chairman ARCHER. The gentle lady’s time has expired.

Mrs. THURMAN. Thank you.

Chairman ARCHER. Mr. Doggett?

Mr. DOGGETT. Thank you, Mr. Chairman.

Mr. Linder, do I understand that the idea of this legislation is

to apply it to all forms of commerce with one simple rate?

Mr. LINDER. All forms of personal consumption.

Mr. DOGGETT. All forms of personal consumption. So that would

include any and all purchases that are made through electronic

commerce over the Internet?

Mr. LINDER. Yes.

Mr. DOGGETT. And I had thought prior to today that there were

not any individuals in the Congress that were advocating using

electronic commerce as a source of Federal revenues. But do I understand that it is the objective of you and all the supporters of

this measure to rely on electronic commerce, as well as other forms

of commerce, as a Federal revenue source?

Mr. LINDER. Yes. You were not here when I made the point. I

would like to make it again. We think Government should be neutral in respect of competition between businesses, and it ought not

give a 6 or 7 percent disadvantage to the fellow down the street

because he is selling it door to door instead of over the Internet.

I have said for some time that in respect of being neutral, Internet commerce should be taxed, anyway. I bought a Gateway computer just recently over the Internet, and I was taxed on it. And

the reason I was taxed on it is because Gateway has a store in my

district.

Mr. DOGGETT. And there may well be good arguments for that

point of view. But even those who have held that point of view in

the past, I have not heard anyone else advocating that, in addition

to State and local taxes, we should use the Internet and electronic

commerce as a major Federal revenue source. Indeed, as I understand, under your proposal, almost the exclusive Federal revenue

source would be to rely on taxation of all forms of consumption, including all consumption through the Internet.

Mr. LINDER. You understand the bill perfectly.

Mr. DOGGETT. Okay. And as far as the level of tax that you will

impose for the Federal Government on electronic commerce and

40

other kinds of commerce, what is the level that you think will be

necessary in order to fulfill the objectives of revenue neutrality?

Mr. LINDER. Since we are replacing income tax, which is tax-inclusive of what you earn, the inclusive basis is 23 percent of what

you spend. If you treat it as a sales tax, as a tax-exclusive rate,

it would be 29.9 percent.

Mr. DOGGETT. So under your—it would be what, now?

Mr. LINDER. 29.9 percent.

Mr. DOGGETT. Under your best-case scenario as a sponsor of this

legislation, then it would be 29, almost 30 percent that would be

imposed now for the first time as a Federal revenue source on electronic commerce along with these other sources. To an Internet

start-up company that is not earning any revenues at present, in

fact, is having losses, this is a real change in their tax situation,

isn’t it? They are not paying—— Mr. LINDER. No, actually not. Actually not.

Mr. DOGGETT.—taxes now. Now they will be involved.

Mr. LINDER. No. They only collect the tax. The consumer pays

the tax.

Mr. DOGGETT. I see. But if there is no income tax being imposed

on many of these Internet start-ups, they don’t have any tax to

pass on to their consumers at present, do they?

Mr. LINDER. They are paying the payroll tax. They are paying it

right now.

Mr. DOGGETT. All right. And I want to have some discussion

about the payroll tax with you as well. But you do see the more

we rely on electronic commerce, you feel, perhaps contrary to the

attitude of those who supported the Internet Tax Freedom Act, that

we should look at electronic commerce as a major source of Federal

revenue.

Mr. LINDER. I think we should treat it the same as the fellow

down the street. But let me repeat that the bill that we passed to

delay taxation on the Internet has nothing to do with sales taxes.

You can collect sales taxes on the Internet today if the local community chooses to do that. It is only the access charges we have

the moratorium on.

Mr. DOGGETT. Well, there is some dispute about the Internet Tax

Freedom Act and what it does and does not do. But it is pretty

clear that Governor Gilmore is seeking a tax-free zone on the

Internet—— Mr. LINDER. Yes, he is.

Mr. DOGGETT.—to the exclusion of any sales taxes, and you obviously disagree with him in his approach and feel that we should

apply a sales tax not only for the States but for the Federal Government on all this kind of commerce, just as you would to nonInternet commerce.

Mr. LINDER. That is exactly correct. I think the Government

ought to be neutral.

Mr. DOGGETT. Now, with reference to the payroll tax, if I might

ask you, Mr. Peterson, about that. There are many constituents

that I have had—and I am sure each of you as well—who have always viewed Social Security as a little different from other types

of Government programs. In fact, I have had even a few who have

said let’s get the Government out of Social Security. And that is

41

based in large measure on the feeling out there that people pay

into Social Security as a form of public or social insurance and that

they have a stake in Social Security and preserving Social Security

as a result of their own payments—much like premiums into a private insurance program.

Isn’t there a danger that if we eliminate entirely those kind of

payments and rely exclusively on general revenue to finance Social

Security that we will undermine that relationship between people

and Social Security and perhaps permit those who have never supported Social Security to undermine and destroy Social Security?

Mr. PETERSON. Well, I guess you could make that argument, but

I think a bigger concern is that down the road they are projecting

we are going to have 100 percent more people on Social Security

and only 17 percent more people working.

Now, I would argue that if we don’t change this system, we have

an unsustainable situation because, as you know, we have a payas-you-go system. And so, you know, if you look at that, you are

talking about a payroll tax of 30 percent. And I think that is a lot

bigger danger to the system than what we are talking about here.

So I would argue that one of the best things we can do for Social

Security and Medicare is to change the way we raise this money.

Instead of basing it on employment, which is diminishing in relation to the people that are retired, base it on what people spend.

I think that is a much better way to do it.

And this whole idea that somehow or another 7.65 percent or

15.3 percent equates into exactly what the Medicare and Social Security should be is not true. We have only set those rates to cover

what we projected in the future was going to be the needs of the

system, which is not necessarily related to what we are actually

paying people. My grandfather retired in the 1950s. He paid in like $2,000 and

lived to be 90 years old and drew out hundreds of thousands of dollars. And we have all kinds of examples of that.

So, you know, I understand where you are coming from, and

there has been a lot of rhetoric that has backed everybody into this

corner. But the truth of the matter is this is a pay-as-you-go system, and it is going to fall apart.

Mr. DOGGETT. I thank you for your response.

Chairman ARCHER. The gentleman’s time has expired—has long

since expired.

The Chair believes that it probably would be wise for the committee to stand in recess for about 45 minutes, and, gentlemen, all

of the members have inquired of you, so you are excused. And

when we return, we will have our first panel up as witnesses.

Mr. LINDER. Thank you, Mr. Chairman.

Mr. PETERSON. Thank you.

[Recess.]

Chairman ARCHER. The committee is not going to come to order,

but just for notifying those who are here, those two buzzers mean

we have a vote on the floor, and we will go vote, and when we come

back, whatever members are here, we will proceed with the hearing. But we will continue to be in recess until we return from this

vote.

[Recess.]

42

Chairman ARCHER. The committee will come to order.

The Chair invites the next witness panel to come have seats at

the witness table: Mr. Linbeck, Mr. McCracken, Mr. Rooth, Mr.

Kouplen, and Mr. Martin.

Mr. Linbeck, if you would be our lead-off witness, and I would

ask each of you gentlemen if you will identify yourselves for the

record before you commence your testimony. We will have that

available. And, Mr. Linbeck, welcome to the committee. In fact,

welcome to all of you. And, Mr. Linbeck, if you are ready, you may

commence.

STATEMENT OF LEO E. LINBECK, JR., CHAIRMAN, LINBECK

CORPORATION, HOUSTON, TEXAS, AND VOLUNTARY CHAIRMAN, AMERICANS FOR FAIR TAXATION, HOUSTON, TEXAS

Mr. LINBECK. Thank you very much, Mr. Chairman.

My name is Leo Linbeck. I am from Houston, Texas. I am chairman of Linbeck Corporation, a family-owned business engaged in

the construction industry. I am also serving as voluntary chairman

of Americans for Fair Taxation.

Americans for Fair Taxation was founded about 4 years ago for

the purpose of doing research, both market and academic, into

what could be an appropriate replacement system for the current

income tax system. We devoted considerable time and resources in

going to the consumer, the taxpayer, and asking them what it is

they value about the current system and what it is they dislike

about the current system and what they would believe to be an appropriate body of contents to be embedded in a new tax system, in

a replacement tax system.

This took about 3 and a half years and it engaged an iterative

process out of which we learned from the consumer what it is they

valued, and then we asked the academic community to give us

their analysis as to whether or not what we learned in the market

research was economically efficacious.

After having done that for the period of time I described, about

3 to 3 and a half years, we then took what we considered to be the

product that had been gleaned from that research and did market

testing. And we went to three cities in the first instance—Bakersfield, California, Traverse City, Michigan, and Charleston, South

Carolina—and did testing to determine if people know about the

system, what would their attitude be in respect thereto, and we

found that their attitude changed 21 points, which we were told by

experts, of which I am not one, that is a significant movement in

attitude.

We then tested the system in 31 different markets to discern if

people would, in fact, when they learned about it, want to become

involved in furthering the interest of that particular system. And

from that exercise we learned that they were very interested in

doing that to the extent that in a 3-week period we generated approximately 200,000 phone calls and hits on the website seeking

additional information.

We then did the third level of testing to determine if when people

knew about it and they were informed enough to become members

of Americans for Fair Taxation, would they, in fact, contact their

elected Representative to make known to their Representative their

43

wish to bring into law the Fair Tax. We were very pleased with the

results we generated from that effort, the results of which were

very, very significant. A Senator from New York received over

12,000 phone calls in 2 weeks, which he reported to me was an extraordinary response.

That is basically the background. It is an effort undertaken in

the private sector exclusively. There were three of us at the outset

who embarked on that research journey, and we are, as I said, private citizens. We are involved in business, civic, and charitable activities. But none of us are experts in the field of taxation.

What we learned at the end of the day is that there are four essential elements to the Fair Tax. Number one is that when people

understand that you eliminate the sales tax, that is by far the most

important factor in garnering their support. We learned, and did

not know at the outset, that a very small percentage of people

itemize, less than 30 percent of the taxpayers on average itemize.

And for the person who works for wages, we learned that approximately 60 percent of that non-itemizing group, the payroll tax is

the largest tax. And we found that when people understood that

the payroll tax would one of the elements of the existing system

that would be eliminated, it greatly enhanced their enthusiasm for

the total replacement of the income tax system.

The second most important feature is the rebate. The rebate is

framed in a manner that permits a family to receive in advance a

rebate equal to the amount of tax that will be due in that month

in the purchase of essential goods and services. We examined in

our research a variety of ways in which to deal with the problem

of the regressivity that is perceived to be embedded in a sales tax,

and found that a universal rebate on essential goods and services

was the most efficient.

The third element that is most important in the hierarchy of interest is that there be no exceptions and no exclusions. People are

very, very concerned about the complexity of the system they wish

to replace.

And, finally, the need for a constitutional amendment to be certain that there is not both an income tax and a sales tax.

Mr. Chairman, we appreciate the chance to be here with you

today. We look forward to any questions, and we urge the Committee on Ways and Means to favorably consider the Fair Tax and

move it on the track after hearings to a vote on the floor.

Thank you very much, sir.

[The prepared statement follows:]

Statement of Leo E. Linbeck, Jr., Chairman, Linbeck Corporation, Houston,

Texas and Voluntary Chairman, Americans for Fair Taxation, Houston,

Texas

I would like to thank you, Mr. Chairman and members of the committee for the

opportunity to testify before your committee on replacing the current tax system.

I am the Chairman of Linbeck Corporation and voluntary Chairman of Americans

for Fair Taxation (AFT). AFT is a grass roots citizens organization, based in Houston Texas, dedicated to replacing the current tax system with the FairTax. I am testifying today on behalf of AFT.

The FairTax

The FairTax was introduced on a bi-partisan basis by Representatives John Linder and Collin Peterson during the first session of this Congress. The FairTax will

repeal individual income taxes, corporate income taxes, all payroll taxes (including

44

Social Security, Medicare and self-employment taxes) and the estate and gift tax.

It would replace these taxes with a 23 percent national retail sales tax on all goods

and services sold to consumers.

Individuals will no longer file tax returns. Businesses will collect and remit the

sales tax in a manner similar to that in 45 states and the District of Columbia.

The FairTax is a tax on final consumption. Business to business transactions will

not be taxed since those goods and services will be taxed when the goods and services into which they are incorporated are finally sold to consumers. Education and

training expenses will be treated as an investment in human capital and not taxed.

Exports will not be taxed. Imported goods will be taxed when they are sold at retail

in the U.S.

The FairTax is Progressive

Unlike the present tax system which taxes many poor people, the FairTax will

literally untax every poor person in America. This is because the FairTax will provide every household in America with a rebate of sales tax paid on necessities. Thus,

the FairTax is progressive and every family is protected from tax on essential goods

and services. Because of the rebate, those below the poverty line will have negative

effective tax rates and lower middle income families will enjoy low effective tax

rates. The table below shows the annual allowances and rebate amounts.

Fair Tax Rebate Amounts for Calendar Year 2000

Single Person Single Person Single Person Married Couple Married Couple Married 

Family Size HHS Poverty

Level (1).

Fair Tax AnnualConsumptionAllowance.

Annual Rebate .... Monthly Rebate ... Fair Tax Annual

ConsumptionAllowance(Married Couple).

Annual Rebate .... Monthly 

1 $8,350 ................... $8,350 ................... $1,921 ................... $160 ...................... $8,350 ................... $1,921 ................... $162 $11,250 ................. $11,250 ................. $2,588 ................... $216 ...................... $16,700 ................. $3,841 ................... $323 $14,150 ................. $14,150 ................. $3,255 ................... $271 ...................... $19,600 ................. $4,508 ................... $374 $17,050 ................. $17,050 ................. $3,922 ................... $327 ...................... $22,500 ................. $5,175 ................... $435 $19,950 ................. $19,950 ................. $4,589 ................... $382 ...................... $25,400 ................. $5,842 ................... $486 $22,850 ................. $22,850 ................. $5,256 ................... $438 ...................... $28,300 ................. $6,509 ................... $547 $25,750 ................. $25,750 ................. $5,923 ................... $494 ...................... $31,200 ................. $7,176 ................... $598 $28,650 ................. $28,650 ................. $6,590 ................... $549 ...................... $34,100 ................. $7,843 ................... $65

A(1) Federal Register: February 15, 2000 (Volume 65, Number 31, Pages 7555–7557).

46

The rebate will be paid monthly in advance. The total annual rebate amount will

be equal to the sales tax rate times the federal poverty level. In addition, because

the federal poverty level for a two person household is not twice as high as that

for one person, an additional amount will be provided in the case of married couples

to prevent any marriage penalty.

The FairTax effective tax rates for families of four at various consumption levels

are shown in the figure below.

A family of four, for example, could spend $22,500 per year free of tax because

they will have received over the course of the year rebates totaling $5,175. $5,175

is the amount of sales tax paid on $22,500 in expenditures. A family spending

$45,000 per year will effectively pay tax on only half of their spending and, therefore, have an effective tax rate of 11% or half the FairTax rate.

It would be a mistake to emulate the states when they attempt to achieve progressivity by exempting various categories of goods or services from tax. First, this

does not achieve the advertised goal. When food is exempted, for example, not only

hamburger is exempted but also filet mignon; not only macaroni and cheese is exempted but also caviar and lobster. In fact, research indicates that 60 percent of

the gain from such exemptions goes to the top 40 percent of taxpayers. In addition,

these exemptions add complexity to the law as lines are necessarily drawn. Moreover, one set of exemptions will inevitably lead to lobbying to exempt other products.

Finally, exempting particular goods or services leads to higher tax rates on those

that remain taxable which is economically distorting and inefficient as well as unfair to those companies and workers in the sector that remains taxable.

Administration

The FairTax affords state governments the opportunity to administer the FairTax

within their states in return for a fee. The fee will be equal to ★ of one percent

of the revenue collected. Alternatively, the state could contract with another state

or simply elect for the federal government to collect the tax directly. In our view,

smoother administration and fewer start-up difficulties will result if the sales tax

is administered by civil servants that have years of experience administering a sales

tax.

Americans for Fair Taxation (AFT)

AFT worked hard to develop the FairTax. We engaged economic researchers at

leading universities throughout the country. We engaged professors of law. We conducted focus group research with demographically diverse groups of citizens in

many different geographic locations to determine what attributes the American people wanted in a tax system. The result of these efforts was the FairTax.

We have now begun the process of bringing the FairTax to the attention of the

public. AFT now has over 250,000 members. AFT’s grass roots support is growing

47

1Dale W. Jorgenson, Economic Impact of the National Retail Sales Tax, National Tax Research Committee. See also, ‘‘The Economic Impact of Fundamental Taxing Consumption,’’ Dale

W. Jorgenson, Testimony before the House Ways and Means Committee, March 27, 1996 and

‘‘The Economic Impact of Fundamental Tax Reform,’’ Dale W. Jorgenson, Testimony before the

House Ways and Means Committee, June 6, 1995. 2Laurence J. Kotlikoff, Replacing the U.S. Federal Tax System with a Retail Sales Tax: Macroeconomic and Distributional Impacts, National Tax Research Committee. See also, ‘‘The Economic Impact of Replacing Federal Income Taxes with a Sales Tax,’’ Laurence J. Kotlikoff, April

15, 1993, Cato Institute Policy Analysis. 3 $15,540 less 7.65 percent in employee Social Security ($1,189) and Medicare payroll taxes less 28 percent in federal income taxes ($4,351) leaves $10,000. 4 Economists generally agree that the employer share of payroll taxes is borne by the employee

in the form of lower wages. This figure assumes that employees bear the burden of the employer

payroll tax and that they are in a seven percent state and local income tax bracket. $20,120

less $5,634 in income tax (28 percent), $3079 in payroll taxes (15.3 percent) and $1,408 in state

and local income taxes (7 percent) leaves $10,000. 5 H.R. 2525 defines education and training to mean ‘‘tuition for primary, secondary, or postsecondary level education, and job related training courses.’’ It excludes ‘‘room, board, sports activities, recreational activities, hobbies, games, arts or crafts or cultural activities.’’ 6 If the states kept their income taxes rather than replacing them with a sales tax, then the

family would need to earn $10,753, about half of what they would need to earn today.

every day. We aim to soon have an AFT chapter in every State and Congressional

district in the country.

Economic Impact of the FairTax

The FairTax will have a dramatic positive impact on the standard of living of the

American people and lead to higher rates of economic growth. The current tax system punishes people who are trying to improve the financial position of their families by working, saving or investing. It is a huge barrier to upward mobility. The

FairTax will stop the punitive taxation of work inherent in the income and payroll

tax and end the multiple taxation of savings and investment. The FairTax will end

the taxation of investment in education.

Instead it will tax consumption. It has the broadest possible consumption base.

Therefore, the FairTax has the lowest possible marginal tax rate in a consumption

tax that protects the public from sales tax on expenditures to purchase essential

goods and service.

Economists anticipate the FairTax will lead to much higher levels of savings and

investment which in turn will lead to greater productivity and output. Work by Harvard economist Dale Jorgenson shows a quick 9 to 13 percent increase in the GDP.1

Similarly, Boston University economist Laurence Kotlikoff predicts a 7 to 14 percent

increase.2 The FairTax will eliminate the present tax system’s bias against savings

and investment. Thus, savings and investment will increase. A larger capital stock

means that people will have more capital to work with embodying the latest technology and their productivity will increase. Higher productivity, in turn, will increase real wages.

Businesses, in the final analysis cannot pay wages higher than the productivity

of their workers warrants. If they do, they will quickly go bankrupt. Thus, the key

to increasing real wages is higher productivity. The key to higher productivity is two

fold. Education and capital investment. The FairTax makes both education and capital investment more attractive.

Education

The FairTax is the most education friendly of any tax reform proposal and is

much more supportive of education than current law. The FairTax embodies the

principle that investments in people (human capital) and investments in things

(physical capital) should be treated comparably. The current tax system, in stark

contrast, treats education expenditures very unfavorably. Today, to pay $10,000 in college or private school tuition, a typical middle class American must earn $15,540 looking only at federal income taxes and the employee

payroll tax.3 The amount one must earn to pay the $10,000 is really more like

$20,120 once employer and state income taxes are taken into account.4

The FairTax does not tax education expenditures.5 Education can be paid for with

pre-tax dollars. This is the equivalent of making educational expense deductible

against both the income tax and payroll taxes today. Thus, under the FairTax, a

family will need to earn $10,000 to pay $10,000 in tuition, making education much

more affordable.6 The FairTax makes education about half as expensive to American

families compared to today.

Education is the best means for the vast majority of people to improve their economic position. It is the most reliable means that people have to invest in themVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00053 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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7 Border adjusted is a value added tax (VAT) term. Since VATs, unlike the sales tax, impose

a tax on all stages of production, a VAT must rebate the tax on earlier stages of production

when goods are exported to achieve a zero tax rate on exports. This is called border adjustment.

Because a sales tax does not impose any tax on goods unless sold at retail, there is no need

for a border tax adjustment rebate. 8 As with domestically produced goods, imported capital goods and other business purchases

would not be taxed immediately. But the output of goods produced by capital goods would ultimately be taxed when consumption goods were produced and sold. 9See Agreement on Subsidies and Countervailing Measures, Annex 1.

10The status of the flat tax, which is a subtraction method value added tax but administered

like an income tax, is unclear under WTO rules but it seems highly likely that it would be

deemed a direct tax given its similarity in appearance and administration to an income tax.

selves and improve their earning potential. Yet the tax system today punishes people who invest in education, virtually doubling its cost. Only the FairTax would remove this impediment to upward mobility. No other tax reform plan will do so.

The FairTax is More Fair than the Current Tax System

The FairTax is more fair than the present tax system. Rather than holding people

down by taxing them for working, saving, investing or getting an education, the

FairTax taxes people when they consume for their own benefit above the necessities

of life. The FairTax eliminates special preferences, credits and deductions for politically favored interests. It treats everyone the same. It has no loopholes.

International Competitiveness

Under the FairTax, imported goods and domestically produced goods will pay the

same U.S. tax. This stands in stark contrast to the present system, where U.S. companies and workers must pay income tax and payroll taxes but foreign goods enter

the U.S. entirely free of any tax other than whatever modest customs duties are levied.

The FairTax will, by its very nature, be border-adjusted.7 Exports will not be

taxed since they are not sold at retail in the U.S, but imports will be taxed when

sold at retail in the U.S. or when brought into the U.S. by a consumer.8

A national sales tax will comply with World Trade Organization (WTO) rules.

WTO is the successor to the General Agreement for Tariffs and Trade (GATT).

Under WTO rules, an indirect tax may be border adjusted while a direct tax may

not.9 Since a sales tax is indisputably an indirect tax, this border adjustment feature will pose no difficulty. Foreign value added taxes, also indirect taxes, are typically border adjusted. Income taxes are direct taxes and may not be border adjusted.10 Many on this committee may find this aspect of a national sales tax of particular interest since the WTO just found the Foreign Sales Corporation (FSC) export incentives to be a violation of WTO rules.

U.S. businesses will be much less likely to locate their plants overseas and foreign

companies will come to the United States. Americans will be employed building

these new plants and Americans will be employed in the new plants. America will

become the most attractive place in the developed world in which to do business.

We will attract more and higher paying jobs.

The FairTax is less Intrusive

The FairTax will be less intrusive. Rather than having to report almost every aspect of their lives to the federal government, Americans will be relieved of such intrusions. April 15th will be just another Spring day. The privacy of the American

people will be enhanced considerably when the FairTax is enacted.

The income tax is collected with a heavy hand. In 1995, the IRS assessed over

34 million civil penalties on American taxpayers in an effort to force compliance

with the tax system. Of these, about 4.1 million were forgiven. The present system

requires that we inform on each other. Americans must provide over one billion information returns to the IRS (primarily 1099s and W–2s). Under the FairTax, all

of this would no longer be necessary.

The FairTax respects the privacy rights of the American people to a vastly greater

degree than the income tax. No longer will Americans have to report the details of

their lives to the federal government. No longer will they have to confess to whom

they gave money, where they earned money, what medical problems they had and

so forth.

The FairTax will reduce Evasion

Under the income tax, evasion is a major, continuing and growing problem. Notwithstanding a much larger Internal Revenue Service (IRS), more burdensome information reporting requirements, increasing stiff and numerous penalties and a

49

host of legislative initiatives, the problem is getting worse. Based on IRS figures,

tax evasion has increased by 67 percent during the past 11 years. As a percentage

of Gross Domestic Product (GDP), tax evasion has reached 2.0 percent compared to

1.6 percent in 1981. Taxes evaded continue to be in the range of 22 to 23 percent

of income taxes collected. These IRS figures do not include taxes lost on illegal

sources of income. The tax gap now is about $200 billion.

Tax evasion will decline under the FairTax because the chance of evaders being

caught will increase and the incentive to cheat will decline. The FairTax will reduce

the number of tax filers by roughly 90 percent. Thus, if enforcement resources remain comparable, audit rates will rise. Moreover, since the audits will be much simpler than current audits, audit rates will rise still further. Therefore the chance of

evasion being detected will increase.

Since marginal tax rates are much lower under the FairTax than under present

law, especially for small businesses and sole proprietorships where disproportionate

evasion occurs today, the benefit to cheating will be lower. Today, if a self-employed

taxpayer fails to report $1,000 they will benefit by $433 ($280 because of the income

tax and $153 due to the self-employment tax). Under the FairTax, they would benefit by $230.

In short, the gains from evasion would decrease and the potential costs of evasion

from detection and enforcement would increase. Thus, the amount of tax evasion

can be expected to decline markedly.

Compliance Costs will Fall

The FairTax is a simple tax. The administrative burdens placed on businesses are

much less. In fact, they are comparable to tracking revenue for income tax purposes.

There will be no more alternative minimum tax, no more depreciation schedules, no

more complex employee benefit rules, no more complex qualified account and pension rules, no more complex income sourcing and expense allocation rules, no more

foreign tax credit, no more complex rules governing corporate acquisitions, divisions

and other reorganizations, no more uniform capitalization requirements, no more

withholding and the list goes on. Businesses will simply need to keep track of how

much they sold to consumers.

Compliance costs will, therefore, fall under the FairTax. Today, according to the

Tax Foundation, we spend about $250 billion each year filling out forms, hiring tax

lawyers, accountants, benefits consultants, collecting information needed only for

tax purposes and the like. These unnecessary costs amount to about $850 for every

man, woman and child in America. To the extent these costs are incurred by businesses, they must be recovered and are embedded in the cost of everything that we

buy. The money we spend on unnecessary compliance costs is money we might as

well burn for all of the good it does us. The Tax Foundation has estimated that compliance costs would drop by about 90 percent under a national sales tax.

The FairTax is Simple, Understandable and Transparent

The FairTax is simple, understandable and transparent. People understand the

FairTax. They don’t understand the present tax system. Even tax professionals don’t

understand the present system. Money magazine, for instance, each year asks 50

CPAs to fill out a relatively straight forward middle class family’s tax return. Each

year they get 50 or nearly 50 wrong answers. Of course, the answers are only wrong

if you believe the magazine’s tax advisors are better than the survey participants.

Today a huge proportion of the overall tax burden is hidden from the ordinary taxpayers view. Under the FairTax, people will for the first time actually understand

their tax burden and have confidence that their fellow citizens are bearing their fair

share.

The FairTax will help Charities

Charities will thrive as never before—for two reasons. First, the FairTax provides

the equivalent of a deduction, for itemizers and non-itemizers alike, against both the

income and payroll tax. Remember, all the charitable deduction does is allow someone to make their contribution from pre income tax dollars (but after payroll tax

dollars). The FairTax will enable all Americans to give to their favorite charity free

of income tax, free of payroll tax and free of sales tax. Second, total philanthropy

as a percentage of GDP has held steady at around 2 % for at least two decades.

As people become more prosperous, they give more to philanthropic causes. The

FairTax will enlarge the economy dramatically and will lead to a corresponding increase in charitable giving.

50

Pre-Tax Prices will Decline

Costs are one of the primary determining factors for prices. One of the costs that

businesses must recover if they are to stay in business is taxes. Dale Jorgenson of

Harvard University estimates that the income tax and payroll tax are embedded in

the price of goods and services to such an extent that they raise prices by 20 to 30

percent. His results are shown in the figure below. When these taxes are repealed

by the FairTax, costs will go down and competition will quickly drive prices down

20 to 30 percent depending on the product. In addition, although Dr. Jorgenson research did not consider these effects, higher levels of investment will make the economy more productive and the elimination of loopholes that distort the economy will

make it more efficient, These effects will be seen both in the form of higher real

wages and lower prices. Moreover, lower compliance costs will reduce costs and

prices still further.

The FairTax helps Homeowners

Homeowners will do very well under the FairTax. Homeowners will have the

equivalent of a supercharged mortgage interest deduction because under the

FairTax mortgage interest can be paid free of sales tax and free of income and payroll taxes. In terms of the current system, it would be as if the mortgage interest

deduction was allowable against payroll taxes. In addition, existing homeowners will

be able to make their principal payments with tax free dollars. Buyers of newly constructed homes will have to pay sales tax, just as they must pay for their house

from after tax dollars today, but the marginal tax rate is lower under the FairTax.

In addition, interest rates will fall by about 25 percent because lenders will no

longer have to charge a tax premium to make up for the tax on interest income.

Once interest is no longer taxable nor deductible, interest rates will quickly fall toward the current tax-exempt rate. Homeownership will be more affordable and prospective homeowners will be able to save their downpayment more quickly under

the FairTax.

Financial Markets

The FairTax will increase the market value of long-term financial assets such as

stocks, real estate and non-callable bonds. The price of those assets reflects the fact

that the future income stream of those assets will be taxed. When that tax is removed, the future income stream will increase and therefore the present discounted

value of those future income streams will increase as well. Thus, the market value

of the assets will increase considerably.

Conclusion

Support for the FairTax is growing rapidly. Once people understand the FairTax

and grasp all of the positive things it would mean for them and for the country,

they generally support it. AFT will continue to bring the FairTax to the attention

of the public.

AFT looks forward to working with this committee to pass the FairTax. It is in

your power to move beyond the current indefensible tax system and replace it with

a tax system more in keeping with what the public wants. We appreciate the opportunity to present our views to you today. Thank you.

f51

Chairman ARCHER. Thank you, Mr. Linbeck.

Mr. McCracken?

STATEMENT OF TODD McCRACKEN, PRESIDENT, NATIONAL

SMALL BUSINESS UNITED

Mr. MCCRACKEN. Mr. Chairman and members of the committee,

my name is Todd McCracken, and I am president of National Small

Business United, the Nation’s oldest small business advocacy organization.

NSBU was founded when the income was just 23 years old, with

only two pages in forms and several pages of instructions. NSBU

has not grown at the exponential rate of the income tax laws, but

we do now represent 65,000 businesses nationwide.

In 1997, our diverse bipartisan 32-member small business board

of trustees decided it was time for NSBU to take a hard look at

a new tax system rather than just continue to take easy potshots

at the system we have now. After a year-long process in which the

current system and various alternatives were held up and examined from all sides, our initially skeptical board finally selected the

Fair Tax as the best possible system for small businesses, without

a single dissenting vote.

Why? At every stage of a business’ life, it faces significant tax obstacles. At the start-up level, savings are taxed and start-up costs

are not deductible, and capital investments are made from after-tax

dollars and then taxed multiple times, when the income is earned

and when the underlying asset that generates that income stream

is sold. They are taxed when growing because the Government

takes an increasing share of income as more money is made. They

are taxed when exporting because U.S. taxes raise the price of our

goods relative to foreign goods. They are taxed when they add jobs

because our extraordinarily high payroll taxes increase costs of hiring. Family businesses are discouraged because they are taxed

when they are sold or passed on.

I would like to call special attention to the current payroll tax

burden that small businesses and their employees must endure. It

is an enormous tax that receives relatively little attention given the

share of revenues it accounts for. In fact, a survey by NSBU and

Arthur Andersen found that small businesses cite payroll taxes as

their most significant tax burden.

Payroll taxes, after all, must be paid whether a business is making money or not, and it is a tax on workers, the lifeblood of any

small business.

Finally, we have the extraordinary complexity of the current

code. I would submit to you that the entrepreneurial community is

more vexed by the labyrinth that our system creates than it is by

the amount of taxes paid. We are the only part of the taxpaying

public that sees every aspect of the tax system: tax withholding

and filing, estate taxes and capital gains taxes, among others.

Since the Fair Tax abolishes all Federal income, FICA, estate,

and capital gains taxes, it would allow small businesses to prosper

as never before in this country. The Fair Tax would allow businesses to begin with savings put aside with pre-tax dollars. It

52

would allow them to grow unfettered by the income tax and without an eye on the capital gains tax. It would allow them to hire

without discouragement from the payroll tax. It would allow them

to export, unfettered by punitive American taxes on our exports.

It would allow them to make capital investments unfettered by

hidden costs in the capital assets. It would discontinue the charade

of taxing income multiple times. Most importantly, it would repeal

the self-employment and payroll taxes which are the most despised

by entrepreneurs.

Small business owners would have greater access to capital, the

lifeblood of a free economy. Small business owners would be free

to pass their businesses on to their children.

Compliance costs would diminish. Individuals not in business

would never have to file a tax return again, and business returns

would be vastly simpler. More than 7,000 incomprehensible sections of the Internal Revenue Code would be exchanged for one

simple question: How much is sold to consumers? This question is

asked of retailers in 45 States in our Nation today. Ninety percent

of our $250 billion annual compliance bill would just disappear.

We are often asked why retailers should support this plan. No

single industry is more burdened by the multitude of State and

Federal tax laws than retailers. Retailers today are both tax collectors and taxpayers. Under the Fair Tax, there will be no more uniform inventory capitalization requirements, no more complex Government rules on employee benefits and retirement plans, no more

tax deprecation schedules, no more tax rules governing mergers

and acquisitions, and no more international tax provisions. Retailers will have ‘‘found’’ money in lower compliance costs. Retailers

will also receive an administration fee for complying with the

greatly simplified law.

It is for all these reasons that there is increasing support for the

Fair Tax among small businesses. In our most recent survey, we

found that a national sales tax had surpassed a flat tax as the preferred form of tax reform among small business owners. Even more

interestingly, support for a sales tax among retailers in the survey

was almost a high as support among manufacturers, though small

retailers still gave the flat tax their narrow support.

In conclusion, the Fair Tax would reinstate the novel concept

that Americans have a right to understand the law to which they

are subject. This would be a boon for small business that quite

often lack the legal and accounting staffs to be in compliance with

the tax code. It would enhance compliance costs so honest taxpayers pay less.

After the process that we went through, we are confident that as

this committee understands the essential differences in the proposal, you will favor the Fair Tax plan. We are confident that the

more you know about the Fair Tax, the more you will support it.

We want to thank you for the ability to appear here today, and

especially want to thank you for holding these very significant

hearings. You can do nothing more profoundly significant for the

small business community and the entire Nation than to continue

to push forward with fundamental tax reform.

[The prepared statement follows:]

53

Statement of Todd McCracken, President, National Small Business United

Mr. Chairman and Members of the Ways and Means Committee:

My name is Todd McCracken, and I am President of National Small Business

United (NSBU), the nation’s oldest national small business advocacy organization.

Mr. Chairman, NSBU was founded when the income tax was just 23 years old—

with only two pages in forms and several pages of instructions. NSBU has not

grown at the exponential rate of the income tax laws, but we now represent 65,000

businesses nationwide. We represent the varied tapestry of the America’s entrepreneurs, from immigrants seeking a more fertile environments in which to grow

their dreams to family businesses that have remained for generations. The average

size of our membership is 12 employees. We are nonpartisan. We do not ask whether the policies we endorse are republican or democrat: we ask whether the policies

enable entrepreneurs to thrive.

NSBU applauds this Committee for having the courage to explore the FairTax.

In February, a national survey conducted by American Express confirmed what

NSBU already knew. The survey showed that 74 percent of entrepreneurs consider

tax reform a top priority. But since the vast majority of Americans share commons

dislike for our present system, it is easier to demagogue the current system than

to reach consensus on what a new and more ideal system should look like.

NSBU leads entrepreneurial organizations not only by defining the principles on

which tax reform should be based, but lending our full support for a specific proposal: the FairTax national sales tax plan. In 1997, our 32-member small business

Board of Trustees decided that it was time for NSBU to take a hard look at a new

tax system, rather than just continuing to take easy pot-shots at the system we

have now. After a year-long process in which the current system and various alternatives—various flat tax plans and other forms of a sales tax among them—were

held up and examined from all sides, our initially skeptical Board finally selected

the FairTax as the best possible system for small businesses, without a single dissenting vote. If you knew this diverse group of independent-minded entrepreneurs

like we do, you would realize just how remarkable this vote was. After we all had

a chance to ask our questions and have them thoughtfully answered, this decision,

that many of us thought we could never reach, suddenly seemed obvious.

We would like to explain to the committee why NSBU, consisting of firms in all

sectors, including service firms and retailers, endorsed a national sales tax plan. We

want to contrast the FairTax with such plans as the flat tax and other sales tax

plans. And last, we want to suggest the next steps this committee should take if

it is serious about considering reform.

The Current System: Fundamentally Broken

Discouraging Entrepreneurs at Every Level. Most entrepreneurs—that is unless they make a career of selling tax shelters—correctly see our system as punishing each step towards the American dream. At every stage of a business’ life, it

faces significant tax obstacles. At the start-up level savings are taxed, and start-up

costs are not deductible. Capital investments are made from after-tax dollars and

then taxed multiple times, when the income is earned and when the underlying

asset that generates that income stream is sold. They are taxed when growing because the government takes an increasing share of income as more money is made.

They are taxed when exporting, because U.S. taxes raise the price of our goods relative to foreign goods. They are taxed when they add jobs, because our extraordinarily high payroll taxes increase costs of hiring. Family businesses are discouraged because they are taxed when they are sold. And finally, the owner gets to meet

the undertaker and the IRS on the same day as the government effects a leveraged

buy-out of the businesses.

The Burden of Payroll Taxes. But I think this committee is certainly familiar

with the current income tax code and the many compliance obstacles it creates. So,

I would like to call special attention to the current payroll tax (primarily FICA) burden that small businesses and their employees must endure. It is an enormous tax

that receives relatively little attention given the share of revenues it accounts for.

In fact, a survey by NSBU and Arthur Andersen found that small businesses cite

payroll taxes as their most significant tax burden.

The U.S. has made a fundamental shift toward payroll taxes in the last 30 years.

In 1995, 38 percent of all federal revenues came from payroll taxes, compared to

just 14 percent (of a lower tax bill) 40 years ago. From 1970 to 1990, business received nine social security (FICA) tax increases totaling 60%, three unemployment

(FUTA) increases totaling 94%, three FUTA base increases totaling 133%, and 19

FICA base increases totaling 677%.

54

At first glance, payroll taxes might seem to be an equitable form of taxation. The

unemployed are not taxed, and larger businesses with more employees are taxed

more than smaller businesses with fewer employees. However, most small businesses are much more labor intensive than their larger counterparts. Payroll taxes

cause these small businesses to be taxed at a higher effective rate than larger, more

capital-intensive firms. Moreover, holders of corporations organized under Subchapter ‘‘S’’ (which are almost always small) have been forced to pay both sides of

this tax, making for a substantial tax increase.

Businesses must pay their payroll taxes whether or not they make a profit. The

fact that this huge tax must be paid regardless of the financial condition of the company creates substantial problems. First, it discourages new businesses. Most new

businesses lose money in their early days, and payroll taxes amount to one more

debt that must be somehow financed. Second, it discourages employment. The only

way that a business in a financial bind can reduce payroll taxes is to reduce payroll;

this means fewer jobs or lower wages.

A payroll tax amounts to a tax on employment. Today, businesses and their employees pay about 15% out of every wage dollar (below the cap) in FICA taxes.

Through this substantial hike in the cost of hiring and working, the payroll tax reverses the needed incentives in the American economy. Taxing businesses for hiring

an employee clearly discourages increased employment, which is damaging to the

unemployed, the business, and the economy. And, of course, payroll taxes are the

most regressive taxes we have, where only earned income (as opposed to investment

income) is taxed, and only earned income up to a certain, annually adjusted level

is taxed.

Unnecessary Complexity. Small firms are accountable to a protean system that

is so complex simply because we choose to tax savings and investment. We waste

an estimated $3.70 in compliance costs for every dollar we pay in taxes. We endure

the lion’s share of the $250 billion in annual compliance costs, when we cannot pass

these essentially fixed costs on to consumers as larger firms can. We endure the

lion’s share of the more than 34 million civil penalties issued.

Our current tax system is certainly a testament to the indomitable spirit of American entrepreneurs, but it is not enlightened tax policy.

The FairTax: The Best System for Small Business

The FairTax is enlightened policy. Since the FairTax abolishes all federal income,

FICA, estate, and capital gains taxes, it would allow small businesses to prosper as

never before in this country. By instituting a 23 percent tax on all end-use goods

and services, the FairTax would sweep away the burdens of the current tax system

and create a new dawn for American entrepreneurship and economic growth.

The Fair Tax would allow businesses to begin with savings put aside with pretax dollars. It would allow them to grow unfettered by the income tax, and without

an eye on the capital gains tax. It would allow them to hire without discouragement

from the payroll tax. It would allow them to export, unfettered by punitive American taxes on our exports. It would allow them to make capital investments unfettered by hidden costs in the capital assets. It would not penalize good years and

bad by implementing the best of income averaging, a zero rate of tax. It would discontinue the charade of taxing income multiple times. Most importantly, it would

repeal the self-employment taxes which are the most despised by entrepreneurs.

The Fair Tax would tax Americans on income, but only at the point that they consume that income, not when they invest and save. Small business owners would

have greater access to capital, the life-blood of a free economy. Small firm owners

would be able to pass their business on to their children.

Simplicity and Lower Compliance Costs. Compliance costs would diminish.

Individuals not in business would never have to file a tax return again, and business returns would be vastly simpler. More than 7,000 incomprehensible sections of

the Internal Revenue Code, would be exchanged for one simple question: how much

is sold to consumers? This question is asked of retailers in 45 states of our Nation

today, so the additional burden on these businesses would be negligible. Ninety percent of our $250 billion annual compliance bill would disappear.

Greater Visibility and Understanding. As complexity disappears, we would reinstate the novel concept that Americans have a right to understand the law to

which they are subject. Moreover, they will immediately see and understand the tax

rates and any changes that occur. The mentality of ‘‘Don’t tax you; don’t tax me;

tax that fellow behind the tree’’ would be gone. The current complexity of the code

leaves most Americans, rightly or wrongly, feeling that they bear an unfair share

of the tax burden. The poor believe that advantages must lie with those who are

more well-off. The wealthy see their high marginal rates and eliminated deductions

and feel singled out by the tax system. And the middle class assume that credits

55

for the poor and loopholes for the wealthy mean that they alone should the country’s tax burden. While there are both fallacies and accuracies in each group’s assumptions, the unfortunate side effect is a polarization of the country and a universal

feeling of victimization. And it should be clear to any rational observer that this

feeling leads to tax avoidance and cheating on an unprecedented scale. If we can

remove these hard feelings about the tax code, we can markedly improve compliance

and give a boost to national comity at the same time.

The FairTax would do just that, by making visible the taxes now buried in goods

and services. We would have a uniform tax for all the world to see and understand.

How would the rich guy avoid some taxes? Only by saving and investing, which

helps us all. But some day, he or his descendants will spend his profits, and taxes

will be collected. At the same time, those less fortunate will receive a rebate lowering their total tax bill and effective tax rate, even if they don’t save a nickel. This

is a system all Americans can understand and be united behind—and voluntarily

pay. The tax system would achieve greater enforceability with less intrusiveness.

Today, more than $200 billion in income taxes, over 20 percent of the total collected,

are not voluntarily paid.

Economic Growth. Almost every researcher who has examined the FairTax have

concluded that the U.S. will experience significantly higher economic growth rates

if this plan is enacted. Specifically, Harvard’s Dale Jorgenson predicted a quick nine

to thirteen percent increased in the GDP, while Boston University’s Laurence

Kotlikoff predicts a seven to fourteen percent increase. Essentially, this growth will

happen because the tax code will no longer discourage work, investment, savings,

and education. Even studies that start with more pessimistic assumptions, like that

by Nathan Associates for the National Retail Institute, predict greater long-term

economic growth, though to a smaller degree than others predict.

There are those, of course, who fear that the FairTax will discourage consumption

and thereby cause a drop in economic growth. The FairTax is, after all, a tax on

consumption, and we always get less of whatever we tax (like work, savings, investment, etc.). But there are several salient facts that mitigate, even eliminate, this

fear. First, institution of the FairTax would mean that consumers have their entire

paycheck to spend, free of any tax withholdings or FICA payments. Consumers

would be able to spend this greater income on goods that cost no less than they do

currently, because economists tell us that the elimination of taxes currently embedded in the price of goods and services will cause that price to go down dramatically.

At the same time, the elimination of the tax on interest income will cause interest

rates to drop dramatically, probably by about 25 percent. Taken together these two

consequences of the FairTax should actually have the effect of increasing consumption.

But there are additional reasons why prices should fall and thereby encourage additional consumption. Since the FairTax will encourage savings and investment,

greater investment dollars will be available to improve the productivity of American

business, causing prices to drop still more. Greater productivity is likely to lead to

greater corporate profits, which is likely to lead to improved stock market gains.

The last few years have proven what stock market gains can mean for consumption

and continuing economic growth. So, we have been persuaded that these very appropriate concerns are nevertheless unfounded.

Improved Work-Force. Any current survey of the small business community

will show finding and keeping qualified workers is their greatest challenge. Businesses cannot find enough workers with specific educational backgrounds, nor can

they find sufficient workers with broad-based educational backgrounds. To further

compound matters, most small businesses cannot create and maintain their own

education and training initiatives the way some larger businesses can. The FairTax

comes to the rescue by essentially ‘‘un-taxing’’ education. Currently, a middle class

taxpayer must earn $15,540 (ignoring state taxes) to pay $10,000 in tuition. Under

the FairTax, only $10,000 must be earned, because education is not taxed.

Improved International Trade Position. The current tax system buries taxes

in all sorts of goods and services. But this becomes an especially big problem in the

international arena. These embedded taxes mean that American goods and services

are more expensive than they otherwise would be, thereby hurting American exports. But it is even worse than that. Many of our competitors impose a Value

Added Tax (VAT), which is rebated at the border. That means that we have foreign

goods coming into the U.S. which have no embedded taxes, competing with domestic

goods with very high embedded taxes. The FairTax reverse this position, creating

much greater incentives for goods and services to be produced in the U.S. and making those products much more competitive abroad.

Retailers Aided by FairTax. Why should retailers support it? No single industry is more burdened by the multitude of state and Federal tax laws than retailers.

56

Retailers are today both tax collectors and taxpayers. Under the FairTax, there will

be no more uniform inventory capitalization requirements, no more complex government rules on employee benefits and retirement plans, no more tax depreciation

schedules, no more tax rules governing mergers and acquisitions, and no more international tax provisions. Retailers will have ‘‘found’’ money in lower compliance costs.

Under the FairTax retailers will also receive an administration fee for complying

with a greatly simplified law. The FairTax actually compensates the industry for

compliance burdens. Moreover, the FairTax will encourage uniformity among increasingly disparate state taxing schemes that have pitted small retailers against

large direct mailers. As we have seen with state income taxes, states will face great

pressure to bring their system into line with the federal standard. The FairTax

could lead to a way out of the current stalemate on the internet and sales taxes.

It is for all these reasons that there is increasing support for the FairTax among

small businesses. In the most recent survey NSBU conducts with Arthur Andersen,

we found that a national sales tax had surpassed a flat tax as the preferred form

a tax reform among small business owners. Even more interestingly, support for a

sales tax among retailers in this survey was almost as high as support among manufacturers, though small retailers still gave the flat tax their narrow support.

While respected economists haggle over the dimensions of the economic benefits,

they are unanimous in their view the FairTax would greatly enhance economic performance by improving the incentives for work and eliminating the current bias

against saving and investment. Even the National Retail Institute’s study by Nathan Associates shows that the economy would be one to five percent larger under

a sales tax than in the absence of reform.

The FairTax Versus the Alternatives

The major alternative to a national sales tax is, of course a flat tax. And, while

a sales tax and a flat tax are both improvements over the current system, and both

are essentially consumption-based taxes, the sales tax is clearly preferable to small

business for two key reasons.

The Flat Tax. First, a sales tax is vastly simpler to administer than a flat tax.

While a flat tax creates uniform rates, it still leaves the question of determining income, and still leaves business owners with the need to hire tax advisers and accountants to sort through those remaining rules. And, of course a flat tax leaves in

place the requirement for businesses to withhold and file taxes (of both payroll and

wage taxes) on behalf of their employees. This system is the source of more civil

penalties on small businesses than any other.

Second, a flat tax would have to leave in place the pillars of the income tax system we have today: tax withholding, a central enforcement agency, and the need

to define and determine taxable income. Given this scenario, it is not a stretch to

imagine that we could readily creep back to the same system we have now. Congress decides to allow an additional deduction or allowance for this or that. How

to pay for it? Let’s increase the rate, but only for people above a certain income

level. Once the dam breaks, there is no turning back. With a sales tax, the entire

income infrastructure is dismantled. It is very hard to conceive of it being easily reconstructed; it has an inherent integrity that is much more difficult to breach.

But not all sales taxes are created equal. The FairTax holds special appeal

for the small business community for two reasons. First, it eliminates the payroll

and self-employment taxes that are the most burdensome on small businesses, and

which are easily the most regressive taxes this country has ever imposed. This

elimination both greatly helps small business (we discussed the payroll tax burden

at length above) and makes the FairTax system much more progressive than competing sales tax plans.

Second, a key pillar of the FairTax is its uniformity. Rather than picking and

choosing among end-use products to tax, it taxes everything. Going down a different

path, and exempting certain goods or services from taxation would be very dangerous and greatly diminish the support the FairTax has from the small business

community.

Conclusions

Defenders of the income tax system fondly quote Oliver Wendell Holmes who said,

‘‘taxes are what we pay for a civilized society.’’ But this phrase does not stoically

celebrate the ’income tax’ per se and was made before the income tax even existed.

What Holmes should have added is that a civilized society must also collect taxes

in the most civilized manner.

The income tax is the antithesis of a civilized system for entrepreneurs. Unlike

many unwise state sales taxes, the FairTax would fully exempt any business inputs

from taxation, i.e. all business-to-business transaction would be free of tax. In this

57

way it would remove the mythology that businesses pay taxes as opposed to their

owners, employees or consumers. It would make all taxes visible. It would convey

the true cost of government to every American on each purchase they make, precluding government from raising taxes other than by changing the rate for all. Quite

simply, it would allow businesses to keep the entire profit from their operation and

transfer the emphasis of taxation away from income-producing activities to consumption.

The FairTax would reinstate the novel concept that Americans have a right to understand the law to which they are subject. This would be a boon for small businesses that quite often lack the legal and accounting staffs necessary to be in compliance with the tax code. It would enhance compliance so honest taxpayers pay

less.

Mr. Chairman, if we can get entrepreneurs who, by genetics I suppose, are independent minded, to agree upon this plan, than your committee can do so also. But

in order to do so, you must put aside politics and predilection. We are confident

that, as this Committee understands the essential differences in the proposals, you

will favor the FairTax plan. Now here is what I ask of you.

First, this Committee must not consider its job done in one hearing. These plans

deserve further introspection. Hearings should be conducted on all relevant topics

affecting tax reform. We are confident that more you know about the FairTax, the

more you will support it.

Second, the Joint Tax Committee and other institutions that analyze distribution

should change their means of portraying the burden of consumption taxes. Why do

we persist in scoring taxation of savings and investment as a gain? Income is not

income until it is consumed. Why not present distributional tables as an alternative

on taxes paid over consumption?

Third, we urge all members of this committee to understand the issues presented

here. One of the reasons taxes have risen in this nation is because so much is hidden from the consumers on which all taxes ultimately fall. Do not fault the FairTax

because it makes these taxes visible.

We want to thank you for the ability to appear here today, and we especially want

to thank you for holding these very significant hearings. You can do nothing more

profoundly significant for the small business community and the entire nation, than

to continue to push forward with fundamental tax reform.

Chairman A

Mr. Rooth?

RCHER. Thank you, Mr. McCracken.

f STATEMENT OF SCOTT ROOTH, REALTOR, CASHIERS, NORTH

CAROLINA, CHAIRMAN, PUBLIC POLICY COORDINATING

COMMITTEE, AND MEMBER, TAX REFORM WORKING GROUP,

NATIONAL ASSOCIATION OF REALTORS

Mr. ROOTH. Mr. Chairman, members of the committee, my name

is Scott Rooth, and I am realtor from Cashiers, North Carolina. I

am here today on behalf of 760,000 members of the National Association of Realtors, NAR. Currently, I serve as chairman of the

Public Policy Coordinating Committee and as a member of the Tax

Reform Working Group.

In the tax reform debate, NAR supports the goals of tax reform

and substantial simplification because, as self-employed individuals, our members face significant compliance challenges. We emphasize, however, that the tax rules that apply to home ownership,

especially since 1997, are among the simplest to administer in the

entire tax system. NAR continues to aggressively oppose the flat

tax, and as for today’s hearings, the National Association of Realtors has taken no official position on H.R. 2525, the Fair Tax proposal advanced by Americans for Fair Taxation. We neither oppose

nor support it at this time. We understand that we have been inVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00063 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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vited here today to share some concerns that we might have and

we have identified to Mr. Linbeck.

Some may say that we are here today to protect a special interest. Even if that is true, consider the magnitude of your decisions

about how to tax real estate in a new tax system. Today, more than

two-thirds of all Americans own their own home. This is an alltime high. The fastest growing category of homeowners is our minority population. Last year, 43 percent of first-time home sales

were to minorities and immigrants.

Individuals in every income class own homes. Notably, lower-income families have a greater proportion of their net worth tied up

in the home. Federal Reserve data shows that even at the $10,000

to $25,000 income range, 51 percent own their own homes. Real estate is the most widely held asset in our economy. Thus, real estate

affects the largest number of households and voters in this country.

NAR believes that changes to the tax system will inevitably have

a substantial impact on the value of those homes. We urge you to

be very careful in how you make decisions about the taxation of

homes and other real estate.

Depending upon how you do the computation, the Fair Tax would

impose a sales tax of either 23 or 30 percent on the purchase of

a new but not an existing home. NAR has grave reservations about

any sales tax plan that would tax the purchase and sale of a home.

We embrace and salute Chairman Archer’s publicly stated view

about the consumption tax systems, and he has clearly stated that

the purchase of a home should be treated as an investment and not

be taxed.

NAR rejects any proposition that the purchase of a home should

trigger a tax. We believe taxing the sale makes housing more expensive and makes it harder to afford. A tax of 23 to 30 percent,

paid at the time of the sale, adds substantial costs to an already

expensive transaction. In today’s market and under today’s tax

laws, newly constructed housing is more expensive than existing

housing by a factor of approximately 20 percent. Under the Fair

Tax model, the sales tax cost will fall squarely on this higher cost

of new housing.

To test our perceptions about sales tax on homes, we held focus

groups in three cities in this country. In one such focus group in

San Diego, our random sample pulled up one strong supporter of

a sales tax plan. But at the end of debate at the end of the day,

even that proponent was absolutely opposed to any tax on homes.

And I quote his final summation, ‘‘A home is what we are, it is

what we work for.’’

The Fair Tax imposes a sales tax on all consumer retail services,

as we have already heard today, everything from real estate commissions to contract and document preparation, termite inspections, appraisals, painting and fix-up maintenance, legal advice, on

and on, would be added on to the cost of this transaction.

Rental income housing we have already heard referred to. We

are absolutely opposed to any tax on rental income housing as it

makes moving up to home ownership even more difficult.

One very attractive feature of the Fair Tax plan is that it imposes Federal tax only once. This is a worthwhile objective. The

Fair Tax model relieves all businesses from paying any payroll, inVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00064 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
59

come, or sales tax. Thus, investors in either residential or commercial rental property would pay no sales tax on their purchase of

these income-producing properties.

Similarly, if a business occupied the building, these businesses

would not be required to pay tax, and this is a good thing for our

investment group of properties.

How do we get there from here? Ladies and gentlemen, transition is the key in our business. The 1986 Tax Act was a debacle

in our industry. It was also a debacle that almost led to the end

of the savings and loan industry in this country. We urge you to

look very closely at the transition issue of this bill.

Only in the last 2 to 3 years has investment real estate regained

its footing, and from 1988 to about 1992, even real estate residential values fell. And because of this depression in commercial real

estate, the resulting tax credit crunch was almost the end of our

industry.

We thank you very much for allowing us to speak here today. We

look forward to addressing your questions, and thank you, Mr.

Chairman.

[The prepared statement follows:]

Statement of Scott Rooth, Realtor, Cashiers, North Carolina, Chairman,

Public Policy Coordinating Committee, and Member, Tax Reform Working Group, National Association of Realtors

Mr. Chairman and members of the Committee. My name is Scott Rooth. I am a

Realtor from Cashiers, North Carolina. I appear here today on behalf of the NATIONAL ASSOCIATION OF REALTORS... (NAR) where I presently serve as Chairman of the Public Policy Coordinating Committee and as a member of the Tax Reform Working Group. NAR represents 760,000 real estate professionals engaged in

all aspects of the real estate business. About 80% of our members are residential

sales agents and brokers, and about 20% are principally engaged in commercial brokerage, leasing and management.

NAR and Tax Reform

Since 1995, NAR has been actively involved in the tax reform debate. Our focus

then was on the flat tax. NAR continues to aggressively oppose the flat tax, because

it would repeal the mortgage interest deduction (MID) and the deduction for state

and local property taxes. We believe, and economic studies confirm, that eliminating

the MID causes the value of homes to drop, thereby destroying equity and wealth.

The loss of value nationally is about 15% and as much as 25% in high cost states

such as California. The study that the respected econometric analysis firm of Standard & Poors/DRI performed indicated that the loss in home value under the flat tax

was permanent. NAR viewed this as simply unacceptable and so opposed the flat

tax.

In conjunction with our work on the flat tax, NAR adopted a series of tax reform

principles and guidelines designed to clarify our own thinking and to enumerate the

features of a tax system that would treat real estate fairly. Those principles and

guidelines are attached as Appendix A of these comments. The principles and guidelines delineate the elements of real estate transactions and investment in real estate

in order to assess the impact of proposed replacement-type tax systems on our industry. The flat income tax falls short under the criteria enumerated in those principles and guidelines. By contrast, Chairman Archer’s publicly stated view that the

purchase of a home should be treated as an investment and not subject to a consumption tax is completely consistent with those guidelines.

The principles and guidelines include elements applicable to both income and consumption tax models. NAR has no preference for one type of tax system over another. We believe that both income and consumption tax models could be crafted

that would be practical for our industry.

Simplification

NAR shares Chairman Archer’s perspective that the current income tax system

is overly complicated and burdensome. Its complexity is particularly crushing for

small businesses. We support tax reform’s goals of substantial simplification, beVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00065 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
60

cause, as self-employed individuals, our members face significant compliance challenges.

The tax rules that apply to homeownership, however, are among the simplest

rules for individuals to comply with in the entire tax system. All that an individual

must do in order to comply with the MID rules is to take the Form 1098 that the

lender provides and transfer the MID and property tax numbers on Form 1098 to

Schedule A of the Form 1040. This is no more difficult than entering an individual’s

wage and salary from Form W–2 or providing the amount of interest and dividends

from Form 1099. Even if seller financing is involved, a settlement services provider

such as a title company or attorney can usually provide an amortization schedule

to the buyer and seller so that both parties can determine the amount of mortgage

interest paid each year. Accordingly, we can think of no rationale based on simplification for eliminating the MID and property tax deduction in any income tax

model.

The FairTax, H.R. 2525

In the context of today’s hearings, the NATIONAL ASSOCIATION OF REALTORS has taken no official position on the FairTax proposal advanced by

Americans for Fair Taxation (AFT) (H.R. 2525). We neither oppose nor support it. We understand that we have been invited here today to share with you the

issues we have identified as NAR’s Tax Reform Working Group has studied the plan

and met with Mr. Linbeck and his AFT associates.

Why Does Real Estate Matter in the Tax Reform Debate?

Some may say that all we are doing here today is protecting a special interest.

If so, it is a ‘‘special interest’’ that affects the two-thirds of all Americans who own

their home. This homeownership rate is an all-time high. By contrast, during the

decade of the 1980’s, homeownership rates actually declined, dipping to about 62

percent. Given the progress over the past five years in not only reversing the decline, but actually reaching the highest homeownership rate in our history, it is difficult for us to understand why we would want to do anything to disrupt housing

markets by changing the tax system.

Individuals in every income class own homes. Notably, the lower the family’s income, the greater the proportion of their wealth is tied up in their homes. According

to the Federal Reserve, even at the $10,000 household income level, almost 35% of

households own a home, but only 8% of these households own stock. By contrast,

the wealthiest 1% of households own 43% of all direct stock holdings, and their

homeownership rate is 94%. The chart in Appendix B shows the rates of ownership

and median values of some family assets by income and age categories. Simply stated, real estate is the most widely held asset of any category of household wealth

in our economy.

It is worthwhile to compare ownership of a home with ownership of securities. In

today’s high-flying stock market, high Dow Jones averages mask some real turmoil.

Of the 1,000 stocks tracked by the Wall Street Journal’s Shareholder Scoreboard,

442 display a negative return for all of 1999. By contrast, of the 138 Metropolitan

Statistical Areas (MSA) NAR monitors, only 12 showed a decline in median prices

from 1998 to 1999. The worst performing housing market lost only 7% of its value.

Again, it is difficult for us to understand why we would want to do anything to disrupt housing markets by changing the tax system. (Appendix C presents a series

of statistics on various aspects of homeownership and some comparisons with assets

such as securities.)

Even if you believe that real estate is a special interest, it is the special interest

that affects the largest number of households and voters in the country. If you believe as NAR does that changes to the tax system can have a substantial impact

on the value of those homes, then we believe you should tread very carefully when

considering tax legislation that could negatively affect that most valuable of all possessions.

Achievements in Housing Among Minorities

The fastest growing category of homeowners is our minority population. Last year,

35% of first-time homebuyers were minorities and immigrants. Minorities and immigrants are highly motivated towards homeownership. 67% of African-Americans and

65% of Hispanics rank homeownership as a top priority. There is great understanding that homeownership is the way that Americans build wealth and savings.

In 1999, NAR was a leading sponsor of the Congressional Black Caucus Foundation’s Summit on Housing and Wealth Accumulation. By the end of 1999, we had

achieved the highest number of minority homeowners in American history. At that

61

time, a record 5.9 million African-American and 4.2 million Hispanic families had

achieved the goal of homeownership.

Today, one in ten Americans were not born in the United States. We have made

great progress in helping these families to achieve homeownership. Again, therefore,

we are compelled ask why we would want to do anything to disrupt housing markets, particularly for minorities and immigrants by changing the tax system.

How Do You Get There From Here?

For NAR, the overriding question about any tax reform is ‘‘How do you get there

from here?’’ Real estate professionals are particularly sensitive about transition because of the violent fallout from the 1986 Tax Reform Act. That bill pulled the rug

out from under real estate investments, because it changed the tax rules for existing

real estate investments in midstream without adequate transition. The result was

a depression in real estate, a near-collapse of the financial system and a loss in

value to existing assets. Only in the last two or three years has investment real estate regained its footing. From 1988 to about 1992, even residential real estate values fell or were flat because of the depression in commercial real estate and tight

credit.

The FairTax provides no mortgage interest deduction (MID) because the MID is

part of an income tax system, but not a consumption tax system. The loss of the

MID will inevitably create additional transition problems. Contrast a home bought

the day before the new tax system went in place, and a home purchased the day

after. The home bought the day before the new tax system was implemented would

no doubt change in value the day after the new system was implemented, because

the two homes, even if they were identical, would not be on the same playing field.

The MID matters a very great deal, and transition would be essential for all homes

that were purchased under the current system.

What is the Tax Rate?

The FairTax is intended to replace the existing income, estate and payroll systems

with a retail sales tax. Depending on how you do the computation, the FairTax

would impose a tax of 23 or 30 percent on all goods and services. The tax rate under

the FairTax, stated in H.R. 2525 at 23%, is what is called an ‘‘inclusive’’ rate. This

in contrast to the way we usually think about sales taxes which today are stated

in what is called an ‘‘exclusive’’ rate. What does this mean?

The way we are accustomed to think about sales taxes is in a tax ‘‘exclusive’’ manner. If a good costs $100 and the sales tax is 6%, then we pay $106.00, with $100

to the seller, and $6 to the taxing authority. The tax ‘‘inclusive’’ method works differently. The example that follows illustrates the inclusive and exclusive methods

by using the stated FairTax rate of 23%.

Two examples based on $100 can assist in understanding the tax ‘‘inclusive’’ and

tax ‘‘exclusive’’ methods. First, think of a seller who wishes to charge no more than

a total of $100 for a product, including both the sales price and the tax. If the seller

is to remit 23% of that total $100 retail cost to the government, then the seller will

receive $77 as follows:

Price charged to purchaser $100

Sales Tax at 23% $23

Proceeds to seller $77

This is the tax ‘‘inclusive’’ method. The 23% tax is included in the retail purchase

price the buyer pays.

Now think of a seller who wishes to realize or net $100. If we were to apply the

tax ‘‘exclusive’’ model used today, the seller would have to charge a total of $129.87,

as follows:

Total gross purchase price: $129.87

LESS: 23% sales tax $28.87

Net proceeds to seller $100.00

Effective rate for purchaser: 30%

The FairTax uses the tax ‘‘inclusive’’ method, so that the seller receives less than

the stated $100 purchase price. Today’s sales tax uses an ‘‘exclusive’’ method, so the

seller receives the full $100.

Buying and Selling a Home

The FairTax would impose a sales tax of either 23% or 30% on the purchase of

a new (but not an existing) home. AFT’s theory does not include existing homes in

the tax base, because today they have already borne the incidence of the income tax.

In the future, if the FairTax were adopted, when a home that had been subject to

the sales tax was sold, it also would already have been taxed.

62

We have expressed grave reservations to AFT and other sales tax advocates about

any tax system that would tax the purchase of a home. We believe the imposition

of a tax is a substantial barrier to affordability. A tax at 23% or 30% paid at the

time of the sale, adds substantial costs to an already expensive transaction.

NAR’s informal economic analysis of the sales tax model showed that the imposition of a sales tax causes the value of a home to drop. The drop is not as dramatic

as under the flat tax, and, unlike the flat tax, the value of homes does eventually

restore itself to where it would have been in the absence of the sales tax. (Under

the flat tax, the decline in the value of homes is permanent and never recovered.)

Under a sales tax, the value of homes does not decline as much when existing

homes are excluded from taxation, as under the FairTax, but there is still a decline.

Because homes represent so much of our national wealth, we have a fundamental

question as to whether it is wise to substantially erode that wealth in the pursuit

of tax reform.

We have another specific concern about taxing new homes. In today’s market and

under today’s tax laws, newly-constructed housing is more expensive than existing

housing by a factor of about 20%. Since both new and existing housing are subject

to the same tax laws today, there appears to be a premium on the cost of new housing, even net of today’s tax. Under the FairTax model, then, the 23% or 30% sales

tax cost will fall heavily, indeed, on this higher-cost housing. The Committee will

need to assess the impact this will have on housing starts and the economy.

NAR chose not to rely on future predictions of economic models (beyond our informal preliminary analysis). To test our concerns about the present, rather than make

guesses about the future, we went directly to Americans, both homeowners and prospective homeowners. We conducted focus groups in Cincinnati, San Diego and

Philadelphia. The focus group participants were chosen at random. In San Diego,

our random sample happened to draw a man who was active in the national sales

tax grass roots movement. He came to the meeting remarkably well informed about

the current tax system and about the philosophy of a national sales tax. He was

persuasive to the group about the merits of changing to a national sales tax. After

some general discussion, the facilitator asked how the group would feel about taxing

the purchase of a home. This fellow was shocked, as were other members of the

group. At the end of the meeting, the group took a straw vote about supporting a

sales tax that imposed tax on the purchase of a home. The vote against such a

model was unanimous. Even the persuasive sales tax advocate said that he could

never support a tax on the purchase of a home. Another participant summed up the

feelings well: ‘‘A home is what we are, it’s what we work for.’’

Predicting the Future

AFT responds to our concerns about a 30% increase in the cost of a home by saying that interest rates will be lower. They also say the purchaser will have more

cahse, because that person will no longer be paying income and payroll taxes.

Our Working Group members have differing views about how the economy will

perform and whether interest rates will really decline. This is because market performance is subject to numerous forces beyond the scope of the tax system. When

Congress makes tax law changes, it is of course essential that it get the best possible economic information and forecasting on the likely outcome of the changes. Despite their sophistication, however, these prediction models have not necessarily

come to fruition.

The economic models that drove the tax cuts in 1981 and 1986 assured declining

deficits and more revenue collections for the government. The impact of the 1981

tax cuts was an increase in the deficit. After 1986, there was a depression in real

estate and a slowdown in the economy because of problems in the financial system

caused by the real estate depression. The result was even bigger deficits as the government supported the collapsing financial system. The tax rate increases in 1993

were accompanied by cries of alarm that there would be a significant recession and

more deficits. Since 1996, the economy has exploded, and the government is in a

surplus for the first time in more than a generation. Markets rely on more than the

tax system.

Similarly, we have differences among ourselves about employer behavior in the

future. To devise a crude example, say that an employer today pays an individual

$50,000, for a net of $35,000 or $40,000 after all payroll, state and federal withholding. If the FairTax were adopted how much will that employer continue to pay

the employee? Will the employer continue to give the employee the same net pay

of $35,000 to $40,000? Or will the employer still pay the gross $50,000 salary? Will

the elimination of income and payroll taxes benefit the employer, the employee or

both? We disagreed among ourselves. You may, too.

63

Taxes on Services

We have a further concern about the impact of the FairTax 30% sales tax on real

estate sales transaction. The FairTax imposes the sales tax on all retail (but not

business to business) services. Real estate sales commissions would be taxed, as

would services provided for title searches, contract and document preparation, termite inspections, appraisals, painting and fix-up maintenance, legal advice, tax advice and settlement or escrow fees. Each of these services would be subject to the

23% or 30% tax. Again, the cost of completing the housing transaction just went up.

In states that have attempted to impose sales taxes on services, Realtors... have

joined with other service providers from dry cleaners to newspaper delivery providers to doctors and lawyers to oppose sales taxes on services. We believe that the

imposition of sales taxes on the services associated with the purchase and sale of

property will put a significant cost burden on prospective purchasers that would yet

another barrier to homeownership.

What about Renters?

Under the FairTax, rents paid by consumers for their residences are taxed as consumption. Under the current system, we acknowledge that renters do not receive

any of the tax benefits enjoyed by homeowners or landlords. Many, many renters

would like to own a home, but find numerous barriers to affordability. Paying rent

is certainly a form of consumption, but we are troubled about imposing such a heavy

tax on one of life’s fundamental necessities.

What about Investors in Real Estate and Other Business Activities?

One very attractive feature of the FairTax plan is that it seeks to impose tax once

and only once on any activity or purchase. This is a worthwhile objective to pursue.

The FairTax model achieves this result by relieving all businesses from either income or sales taxation. Thus, investors in real estate, whether the investment is in

residential rental property or in commercial space, would pay no sales tax on their

purchase of these income-producing properties. Similarly, if a business occupied the

building, that business would not be required to pay sales tax on its rent, because

business-to-business activities are not taxed under the FairTax model. Outside the

context of real estate, the local bookstore would not pay income or sales tax on its

revenues or on any of the inventory or supplies used in the business, nor would

Barnes and Noble.

This single-level tax, applied only to retail consumption by end-users of goods and

services (i.e., individuals) appeals to those interested in capital formation for business. A single-level tax is certainly a valid economic model. Even under current law,

a significant amount of investment real estate income is taxed only once at the federal level, because real estate is often held by individuals or in partnerships. Inevitably, the Committee will have to make a political decision about whether exempting all business-to-business transactions from a sales tax is the best method of

achieving the highly desirable goal of single-level taxation.

Conclusion

In the words of a former member of this Committee, America was built on real

estate. We like it that way and look forward to working with the Committee to improve the tax system.

Appendix A

REAL ESTATE-BASED TAX REFORM PRINCIPLES AND GUIDELINES

Tax reform has been a major political theme since 1995. Tax reform supporters

advocate complete elimination of both the current income tax code and the Internal

Revenue Service. They would replace the current system with either a revised,

broad-based, low-rate income tax model or a consumption tax. Advocates stress that

any system adopted would be designed to be more fair and more simple than current law. Despite criticisms of the IRS, little consideration has been given to date

to the mechanics of administering a new tax regime.

Anticipating that a variety of proposals will continue to emerge and that any reform process will be evolutionary, the National Association of Realtors... has developed guidelines and principles to use in evaluating proposals as they emerge. The

guidelines are intended to provide a systematic means of evaluating both income

and consumption taxation models. No principle would apply to every feature of any

proposal. These guidelines are intended to cover a range of possibilities based on

the elements of real estate transactions that potentially give rise to taxable events

under current law and that could give rise to taxable events under income and consumption tax models. Not surprisingly, the guidelines list many principles that reVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00069 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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spond to features of the current income tax system, and only a limited number of

applications to a consumption tax model.

A real estate investment has three distinct phases: acquisition, holding period and

disposition. In addition, numerous services are associated with these phases of investment. Accordingly, these guidelines are organized to reflect those phases. Furthermore, a real estate investment is capital intensive, so the guidelines are based

on the premise that the risks inherent in capital investment will be recognized in

any tax system. In an income tax system, those risks would be recognized with a

meaningful differential between the treatment of ordinary income and capital gains.

A consumption tax system would properly recognize the risks of capital investment

by treating real estate investment as a form of savings, and not consumption.

The National Association of Realtors... believes that the present income tax system, despite its flaws, has helped create a home ownership system that is unequaled

in the world. Similarly, investment real estate is the most widely-held capital asset

in the nation. In all income groups, the ownership of both residential and investment real estate is widely distributed.

Finally, the critical question in any tax reform effort, no matter what model is

adopted, is ‘‘How do we get there from here?’’ Any changes to the tax system, whether incremental or sweeping, must include careful planning for adequate transition.

REAL ESTATE-BASED TAX REFORM PRINCIPLES AND GUIDELINES

Tax reform proposals generally fall into two categories: income tax models and consumption tax models. The features of those models vary, so not every principle below

would apply to every proposal. The National Association of Realtors... believes that

a workable tax system should:

Acquisition

• Treat home ownership as investment, and not as consumption.

• Encourage savings and tax-based incentives for home purchases.

• Eliminate penalties for using savings for home purchases.

• Treat services associated with the purchase of real estate as part of the investment costs of the transaction, and not tax those services.

Holding Period

• Preserve mortgage interest deduction benefits.

• Treat debt financing for owners of investment property as a business expense.

• Provide cost recovery rules that reflect a viable economic life for real estate investment for both owners and tenants.

• Allow netting of income from real estate activities against other income

streams.

Disposition

• Maintain a meaningful tax differential between ordinary income and gain from

sales of capital assets.

• Apply capital gains provisions equally among all investments, including real estate.

• Tax only true economic gain.

• Defer recognition of gain on disposition of all real estate until reinvestment

ceases.

• Preserve loss carry forward principles.

• Treat services associated with the sale of real estate as part of the investment

costs of the transaction, and not tax those services.

Real Estate Operations

• Preserve independent contractor status for real estate professionals.

• Preserve (or establish) the principle that ordinary and necessary business expenses, including interest, should be deductible under an income tax model, and

nontaxable under a consumption tax model.

Transition

Provide transition rules to preserve owner equity and eliminate adverse effects on

real estate assets in service at the time of enactment.

APPENDIX B

OWNERSHIP OF ASSETS BY INCOME AND AGE

Stock Retire Acct Home Stock Retire Acct Home

All Families Income 48.8% ................................. 48.8% ................................. 60.2% ................................. $25,000 .............................. $24,000 .............................. $100,00Less than $10,000 7.7% ................................... 6.4% ................................... 34.5% ................................. $4,000 ................................ $7,500 ................................ $51,0010,000–24,999 24.7% ................................. 25.4% ................................. 51.7% ................................. $9,000 ................................ $8,000 ................................ $71,0025,000–49,999 52.7% ................................. 54.2% ................................. 68.2% ................................. $11,500 .............................. $13,000 .............................. $85,0050,000–99,000 74.3% ................................. 73.5% ................................. 85.0% ................................. $35,700 .............................. $31,000 .............................. $130,00100,00 or more 91.0% ................................. 88.6% ................................. 93.3% ................................. $150,000 ............................ $93,000 .............................. $240,00Age of head Less than 35 40.7% ................................. 39.8% ................................. 38.9% ................................. $7,000 ................................ $7,000 ................................ $84,0035–44 56.5% ................................. 59.5% ................................. 67.1% ................................. $20,000 .............................. $21,000 .............................. $101,0045–54 58.6% ................................. 59.2% ................................. 74.4% ................................. $38,000 .............................. $34,000 .............................. $120,0055–74 58.9% ................................. 58.3% ................................. 80.3% ................................. $47,000 .............................. $46,800 .............................. $110,0065–74 42.6% ................................. 46.1% ................................. 81.5% ................................. $56,000 .............................. $38,000 .............................. $95,0075 or more 29.4% ................................. 16.7% ................................. 70.0% ................................. $60,000 .............................. $30,000 .............................. $85,00

ASource: Federal Reserve Board, Survey of Our Summer Finance.

66

Tax Notes on Homeownership

• Home largest asset for most families.

• In 1998, 66% of households own a home, while only 49% own any stock, either

directly or indirectly.

• Median value of home for owners is $100,000; while median value of stock holdings in only $25,000 (1998).

• Housing wealth is more evenly distributed across the income distribution than

any other asset, except for vehicles. The Federal Reserve Board reports that the

wealthiest 1% of households own 43% of all direct stock holdings, but only own 9%

of all value of personal residences.

• Although minority households have lower homeownership rate, for those that

do own, their home is an even larger share of their wealth than for majority households.

• Homeownership rate of minority households in 46.8% compared to 71.8% for

white households in 1998.

• Although homeownership declines with income, for those that do own, their

home is an even larger share of their wealth the lower is household income.

• For households earning less than $10,000 annually, less than 8% own any

stock, direct or indirect, while 34.5% own their own homes.

• For households earning less than $10,000 annually who do own stock the median value of stock holdings is only $4,000, while those homeowners earning less

than $10,000 have a median home value of $51,000.

• For much of the current elderly their largest source of retirement wealth is

their home.

• In 1998, 77% of households aged 75 plus own a home, while less than 30% own

any stock, either directly or indirectly.

• Median value of home for owners aged 75 plus is $85,000; while median value

of stock holdings in only $60,000 for those who own stock (1998).

• High Stock Market masks many losing stocks while most housing markets

share in national gains.

• Of the 138 MSA monitored by NAR, only 12 displayed a decline in median

prices from 1998 to 1999. The worst performing housing market lost only 7%.

• Of the 374 IPO’s issued between June 1999 and April 2000, 99 are trading

below their issue price as of April 4, 2000 (that is they lost money), with an average

decline of 36%.

• Of the 1,000 stocks tracked by the Wall Street Journal’s Shareholder Scoreboard, 442 display a negative return for all of 1999.

Mortgage facts (from 1997 American Housing Survey):

• Of the 65.5 million homeowners in the US, 39% own their home free and clear

(no mortgage). So that’s 40 million with a mortgage, of which about 30 million claim

take the MID.

• Over 7 million have more than one mortgage (may include home equity loans

and lines of credit).

About 3 million only have a home equity line or loan without a regular mortgage

Chairman A

Mr. Kouplen?

RCHER. Thank you, Mr. Rooth.

f STATEMENT OF STEVE KOUPLEN, PRESIDENT, OKLAHOMA

FARM BUREAU, ON BEHALF OF THE AMERICAN FARM BUREAU FEDERATION

Mr. KOUPLEN. Chairman Archer and members of the committee,

my name is Steve Kouplen. I am a farmer from Okmulgee County,

Oklahoma, where I operate a cow-calf operation on some 2,000

acres. I am president of the Oklahoma Farm Bureau and am here

today on behalf of the American Farm Bureau Federation.

Farm Bureau members are ready for fundamental tax reform.

They have become increasingly frustrated with the current tax system and disheartened that every attempt to change the system

makes the system even more complex.

67

The current tax system forces farmers and ranchers to consider

the tax consequences of each input purchase, commodity sale, capital asset purchase, or capital asset sale. Farmers and ranchers

should be making decisions based on the economics of the situation,

not the consequences of the tax situation.

After a lifetime of hard work and paying taxes, farmers and

ranchers are faced with double taxation through capital gains and

estate taxes. If they sell equipment, livestock, and other assets at

retirement, they find the Federal Government ready to take a

share as capital gains taxes. These taxes often discourage retirees

from reallocating assets to a more appropriate mix for their retirement years. Young producers lose the opportunity to purchase assets that they can use more economically than current owners.

Planning for the transfer of assets at death has become a timeconsuming and costly activity. Many family farms are multi-generation family farms. Transferring farms and ranches from one

generation to the next without a huge tax load is critical to the financial success of these farms. Many farms are lost when death

taxes force farmers and ranchers to sell part or all of their business

to secure enough cash to pay death taxes.

Farm Bureau supports replacing the current Federal income tax

system with a new tax that encourages, not penalizes, success and

encourages savings, investment, and entrepreneurship. It should be

transparent, simple, and require a minimum of personal information.

It must be fair to farmers and ranchers in payroll taxes, the alternative minimum tax, the capital gains tax, and personal and

corporate income taxes. A consumption tax must not tax businessto-business transactions or services unless sold for final consumption.

The American Farm Bureau Federation supports H.R. 2525, the

Fair Tax Act of 1999 and any other tax reform proposals consistent

with Farm Bureau policy.

The national sales tax plan sponsored by Representatives Linder

and Peterson is a bold attempt at fundamental reform. By ending

the Federal individual and corporate income taxes, capital gains

tax, estate tax, and payroll taxes for Social Security and Medicare,

many of the concerns that Farm Bureau members have with the

current tax system would be eliminated. These changes would have

far-ranging impacts on day-to-day farm and ranch management

and the transfer of farms and ranches from one generation to the

next.

If H.R. 2525 is enacted, attention should be given to two potential problems that are of concern to farmers and ranchers. First, a

national sales tax will need to be meshed with existing State and

county sales taxes. Second, only the 5 percent of the farmers and

ranchers who sell directly to consumers should be required to keep

records and remit sales tax money to the proper collection agency

in order to avoid a heavy compliance burden.

We look forward to working with you to promote fundamental

tax reform that will be good for farmers and ranchers and good for

the citizens of our country.

Thank you, Mr. Chairman.

[The prepared statement follows:]

68

Statement of Steve Kouplen, President, Oklahoma Farm Bureau, on Behalf

of The American Farm Bureau Federation

Mr. Chairman and members of the committee, good morning. My name is Steve

Kouplen, and I am president of the Oklahoma Farm Bureau. I have a Hereford cowcalf operation on 2,000 acres in Okmulgee County, Oklahoma. I am appearing here

today on behalf of the American Farm Bureau Federation (AFBF) and the Oklahoma Farm Bureau. AFBF represents more than 4.9 million member families in all

50 states and Puerto Rico and produce nearly every type of farm commodity grown

in America.

Farm Bureau members are ready for fundamental tax reform. They have become

increasingly frustrated with the current tax system and disheartened that every attempt to change the system to benefit farmers and ranchers makes the system even

more complex. Simple ideas, such as income averaging for farm and ranch incomes

that vary greatly year to year, become almost incomprehensibly complex when

changes are passed by Congress and regulations issued by the Internal Revenue

Service (IRS).

The national sales tax plan sponsored by Reps. John Linder (R–GA) and Collin

Peterson (D–MN), H.R. 2525, is a bold attempt at fundamental reform. By eliminating the federal individual and corporate income taxes, capital gains tax, estate

tax and payroll taxes for Social Security and Medicare, they would address the hundreds of concerns that Farm Bureau members have with the current tax system.

These changes would have far-ranging impacts on day-to-day farm and ranch management and the transfer of farms and ranches from one generation to the next.

The current tax system forces farmers and ranchers to consider the tax consequences of each input purchase, commodity sale, capital asset purchase or capital

asset sale. Tax planning has become a normal part of everyday decision making.

Farmers and ranchers should be making decisions based on the economics of the

situation, not the tax consequences of the situation.

After a lifetime of hard work and paying taxes, farmers and ranchers are faced

with double taxation, with the capital gains tax at retirement and the estate tax

at death. If they sell equipment, livestock and other assets at retirement, they find

the federal government as a silent partner ready to take a share as capital gains

taxes. These taxes often discourage retirees from reallocating assets to a more appropriate mix for their retirement years. Younger producers lose the opportunity to

purchase assets that they can use more economically than the current owners.

Planning for the transfer of assets at death has become a time consuming and

costly activity. Many family farms are multi-generation family farms. Transferring

farms and ranches from one generation to the next without a huge tax load is critical to the financial success of these farms. Asset transfer decisions that were delayed because of the capital gains tax are further complicated by the estate tax.

Many farms are lost when death taxes force farmers and ranchers to sell part or

all of their business to secure enough cash to pay death taxes.

These problems would all be swept away by the tax reforms as proposed by

H.R.2525.

If H.R. 2525 is enacted, attention should be given to two potential problems that

are of concern to farmers and ranchers. First, a national sales tax will need to be

meshed with existing state and county sales taxes. State Farm Bureaus have

worked for decades in their respective states to develop a state sales tax system that

treats farmers and ranchers fairly. They want to avoid having to start over again

on basic sales tax issues with state governments.

Second, only about 5 percent of the farmers and ranchers sell directly to consumers. These should be the only ones that have to keep records and remit sales

tax money to the proper collection agency. Farmers and ranchers buy billions of dollars of inputs for production purposes that are also purchased by consumers for final

use. This includes a wide range of items from pickup trucks to lumber for building

repairs to hand tools. They do not want to get caught in the compliance burden that

may be necessary to ensure that all retail sales taxes are properly collected.

Farm Bureau Policy

Farm Bureau supports replacing the current federal income tax system. The new

tax code should encourage, not penalize, success and encourage savings, investment

and entrepreneurship. It should be transparent, simple and require a minimum of

personal information.

We support a replacement tax system if it meets these guidelines:

(1) Fair to agricultural producers;

69

(2) Implemented simultaneously with the elimination of all payroll taxes, self-employment taxes, the alternative minimum tax, the capital gains tax, death taxes and

personal and corporate income taxes;

(3) Revenue neutral;

(4) Repeals the 16th amendment; and

(5) Any flat tax proposal or other reform proposal not based on gross revenue received.

We support requiring a two-thirds majority for imposition of new or additional

taxes, or for the increase of tax rates. A consumption tax must not tax businessto-business transactions or services unless sold for final consumption.

At an American Farm Bureau Federation Board of Directors meeting in March

of this year the board took specific action to support the Fair Tax Act of 1999 and

any other tax reform proposals consistent with Farm Bureau policy.

We look forward to working with you to promote fundamental tax reform that will

be good for farmers and ranchers and for all citizens.

Chairman A

Mr. Martin, you are clean-up hitter in this group, and if you are

RCHER. Thank you, Mr. Kouplen.

f prepared, you may proceed.

STATEMENT OF JAMES MARTIN, HORSESHOE BAY, TEXAS

Mr. MARTIN. Yes, sir. Mr. Chairman and members of the committee, my name is James Martin, and I am grateful for the opportunity to testify today. I am the former general vice president of

the Ironworkers International Union. I also served as deputy chairman of the Dallas Federal Reserve Board. I would like to ask that

my written statement and a recent op-ed article that I co-authored

with Gale Van Hoy, the executive secretary of the Texas Building

and Construction Trades Council, be made part of this hearing.

Chairman ARCHER. Without objection, any printed material or

statement by any one of the witnesses will be inserted in the record

in full.

Mr. MARTIN. Thank you, sir.

The tax system is one of the primary reasons that so many people are having such a hard time getting ahead financially. The existing tax system is holding the working men and women of this

country back. I believe that the Fair Tax, introduced on a bipartisan basis as H.R. 2525, is the best plan to make our tax system

better.

American workers are disgusted with the present tax system.

They want to see fundamental change. They see loopholes and special provisions in the tax law that benefit politically powerful interests but these are not available to ordinary people. They see accountants and lawyers putting together intricate deals that take

advantage of these loopholes. They have seen tax reform after tax

reform passed by Congress, and yet the situation only gets worse.

In the meantime, the taxes taken out of their paycheck seem to remain about the same or even go up every year. The Fair Tax would

eliminate all loopholes and all of these games. It is a straightforward tax system that would eliminate the ability to gain advantage through tax shelter deals.

Most Americans don’t understand the current system. For that

matter, I am not convinced anyone really understands the current

tax system, including the people that try to administer it at the

IRS. It is just too complex. I believe that the American people have

70

the right to understand the tax system. A system that is so complex that virtually no one understands it is going to lead to unfairness. The Fair Tax would give us a simple tax system that anyone

can understand.

The current tax system holds people down. The only way for

most people to get ahead is to get an education or training, go to

work, and to save. Yet this is precisely what the current tax system

punishes. Work is taxed more heavily than any other form of income due to the combination of high payroll taxes and the income

tax. Under the current tax system, we generally have to pay for

education or training for ourselves or our children with after-tax

dollars. You have to save with after-tax dollars unless you are willing to tie up your money until retirement. The Fair Tax taxes only

consumption. Education and training are treated as an investment

in people and are not taxed. Wages and salaries are not taxed. And

savings is not taxed.

The Fair Tax would eliminate not only the income tax but also

payroll taxes. For many people, the payroll tax is a bigger burden

than the income tax. It is a regressive tax that taxes only wages

and taxes people earning less than $76,200 more heavily than

those earning more. The Fair Tax is the only tax reform plan to

address this problem. No other plan would repeal payroll taxes.

Workers would be able to keep their entire paycheck. There would

be no withholding of income or payroll taxes. What we earn is what

we would receive in our paychecks.

Americans also want more control over their own financial future. They want to be able to make choices for themselves and

their families rather than have the decisions made for them in

Washington. They want to be able to save or go to school or get

training without having to deal with complex tax provisions or pay

a large tax.

The current tax system imposes a heavy burden on American

workers and businesses exporting to foreign markets and on U.S.

workers and businesses competing with imported goods in the U.S.

markets. In contrast, foreign goods enter the U.S. market free of

any significant tax burden. This places U.S.-produced goods at a

big competitive disadvantage.

Our tax system is one of the major reasons that we have such

a large trade deficit. This disadvantage is made worse because

most of our major trading partners eliminate a big part of their tax

burden on exports since their value-added taxes are border adjusted. This disadvantage is built into our tax system, and it exports high-paying jobs to our competitors. We should be exporting

goods, not good jobs.

There is nothing that can be done about this problem if we keep

the income tax, but the Fair Tax fixes the problem. The U.S. will

stop shooting itself in the foot. For the first time, foreign-produced

goods will bear their fair share of the tax burden. U.S.-produced

goods and foreign-produced goods will be subject to the same tax

when they are sold retail in the U.S. Exported U.S. goods will bear

no tax burden. This will make American firms and American workers more competitive both in domestic markets and abroad. It will

enable us to create and preserve more high-quality and high-paying

71

jobs, and it will improve the standard of living of American workers.

We need to rethink the tax system. It really is broken beyond repair. It is time to do something about it. The Fair Tax is legislation

that deserves support, and I would urge you to pass this legislation.

I thank you, and I would be glad to answer any questions, Mr.

Chairman.

[The prepared statement follows:]

Statement of James Martin, Horseshoe Bay, Texas

Mr. Chairman and members of the committee, I am grateful for the opportunity

to testify today. I am the former General Vice President of the Ironworkers International Union. I also served as Deputy Chairman of the Dallas Federal Reserve

Board. I would ask that my written statement and a recent Op-Ed article that I

coauthored with Gale Van Hoy, the Executive Secretary of the Texas Building and

Construction Trades Council, be made a part of the hearing record.

The tax system is one of the primary reasons that so many people are having such

a hard time getting ahead financially. The existing tax system is holding the working men and women of this country back. I believe that the FairTax, introduced on

a bipartisan basis as H.R. 2525, is the best plan to make our tax system better.

American workers are disgusted with the present tax system. They want to see

fundamental change. They see loopholes and special provision in the tax law that

benefit politically powerful interests but are not available to ordinary people. They

see fancy accountants and lawyers putting together intricate deals to take advantage of those loopholes. They have seen tax reform after tax reform be passed by

Congress and yet the situation only gets worse. In the meantime, the taxes taken

out of their paycheck seem to remain about the same or go up every year. The

FairTax would eliminate all loopholes and all of these games. It is a straightforward

tax system that would eliminate the ability to gain advantage through tax shelter

deals.

Most Americans don’t understand the current system. For that matter, I am not

convinced anyone really understands the current tax system, including the people

that have to try to administer it at the IRS. It is just too complex. I believe that

the American people have the right to understand the tax system. A system that

is so complex that virtually no one understands it is going to lead to unfairness.

The FairTax would give us a simple tax system that anyone can understand.

The current tax system holds people down. The only way for most people to get

ahead is to get an education or training, to work, and to save. Yet this is precisely

what the current tax system punishes. Work is taxed more heavily than any other

form of income due to the combination of high payroll taxes and the income tax.

Under the current tax system, we generally have to pay for education or training

for ourselves or our children with after-tax dollars. You have to save with after-tax

dollars unless you are willing to tie up the money until retirement. The FairTax

taxes only consumption. Education and training are treated as an investment in

people and are not taxed. Wages and salaries are not taxed. Savings is not taxed.

The FairTax would eliminate not only the income tax but also payroll taxes. For

many people, the payroll tax is a bigger burden than the income tax. It is a regressive tax that taxes only wages and taxes those earning less than $76,200 more heavily than those earning more. The FairTax is the only tax reform plan to address

this problem. No other plan would repeal payroll taxes. Workers would be able to

keep their entire paycheck. There would be no more withholding of income or payroll taxes. What we earn would be what we receive in our paychecks.

Americans want more control over their own financial future. They want to be

able to make choices for themselves and their families rather than have the decisions made for them in Washington. They want to be able to save or go to school

or get training without having to deal with complex tax provisions or pay a large

tax.

The current tax system imposes a heavy tax burden on American workers and

businesses exporting to foreign markets and on U.S. workers and businesses competing with imported goods in the U.S. markets. In contrast, foreign goods enter the

U.S. market free of any significant tax burden. This places U.S. produced goods at

a big competitive disadvantage. Our tax system is one of the major reasons we have

such a large trade deficit. This disadvantage is made worse because most of our

major trading partners eliminate a big part of their tax burden on exports since

72

their value added taxes are border adjusted. This disadvantage is built into our tax

system and it exports high paying jobs to our competitors. We should be exporting

goods not good jobs.

There is nothing that can be done about this problem if we keep the income tax

but the FairTax fixes this problem. The U.S. will stop shooting itself in the foot.

For the first time, foreign produced goods will bear their fair share of the tax burden. U.S. produced goods and foreign produced goods will be subject to the same

tax when they are sold at retail in the U.S. Exported U.S. goods will bear no tax

burden. This will make American firms and American workers more competitive

both in domestic markets and abroad. It will enable us to create and preserve more

high quality, high paying jobs. It will improve the standard of living of American

workers.

We need to rethink our tax system. It really is broken beyond repair. It is time

to do something about at. The FairTax is legislation that deserves support and I

would urge you to pass this legislation.

Thank you. I would be glad to answer any questions you may have.

Chairman A

Mr. Rooth, you have said you are neutral on H.R. 2525. Is there

RCHER. Thank you, Mr. Martin.

f any structural tax reform proposal that you positively support?

Mr. ROOTH. Not at this time, Mr. Chairman.

Chairman ARCHER. And do you have any specific recommendations that you might make to the committee as to what sort of avenues we might look into in order to get to ultimate structural tax

reform?

Mr. ROOTH. As I had mentioned, our chief concerns are in any

form of taxation on the first-time home buyer, on the taxing of

rental rents, on the transition rules. 1986 was a devastating event

in our industry because most people assume that this is a longtime investment purchase. And to change the rules in midstream

can be an earth-shattering event for them.

Chairman ARCHER. Well, I certainly agree with that, as the leader of the opposition to the 1986 Tax Reform Act and citing in the

debate the very things that we learn from hindsight in advance as

to what would happen to real estate and the S&Ls.

Mr. Linbeck, how would you respond to Mr. Rooth’s specific objections to the Fair Tax?

Mr. LINBECK. Well, Mr. Chairman, I understand the concern that

he has expressed, but I suggest that the elements of the Fair Tax

relating to the sale of new homes and the manner in which the producer price is predicted to go down on average by about 20 percent

would suggest that the cost of that new home including the tax

would not go up. But of equal importance, if I may, is that one

needs to look at the purchasing power side of the equation as well.

As I am sure he knows, the essential components of a person’s ability to purchase a home are typically the interest rate that one has

to pay, the amount of spendable income that they have to apply to

the debt service on the home that they purchase, and the amount

of time that one has to save in order to pay the down payment on

a new home.

Under the Fair Tax, there is virtually unanimous expectation

that interest rates will go down, and if interest rates go down, then

that means the debt service for a comparable home would go down.

If a person receives in their paycheck 100 percent of what they

73

earn, then they are better able and equipped to pay the debt service that is applicable to the home they choose to buy.

And, finally, under the existing law, research suggests to us that

it takes a person on average between 7 and 8 years to save for the

down payment on a new home. Under the Fair Tax, since there is

no tax on either the payroll level or the income level, a person can

save for that down payment in between 4 and 5 years.

So in considering all of those factors together, it seems to us that

the environment for purchasing new homes will be improved, that

it will not deteriorate, as suggested by the analysis put forward

earlier.

Chairman ARCHER. Are there any probative economic studies

that show what we might see in the decline of long-term interest

rates if the Fair Tax were adopted?

Mr. LINBECK. Yes, sir, there is a position paper that is the product of the research effort that spells out the more technical details

of that. But the shorthand response is that the tax wage is eliminated between tax-exempt and taxable bonds. So it is assumed— and it seems to be appropriately so—that the interest rates will

come down at least by the difference between taxable and tax-free

bonds.

Chairman ARCHER. Well, would you estimate that to be 100 basis

points, 150, 200? Or what range?

Mr. LINBECK. Well, in the current environment, that is probably

175 to 200 basis points, and that is leaving aside the risk issue,

assuming the risk on the security is comparable as between those

that are compared. But, in addition, it is commonly believed that

there will be more money in the system in order to provide additional capital, thereby driving interest rates down still further.

One of the reasons driving that, of course, will be that corporations that have earned income overseas who are now deterred from

repatriating it because of the tax that would apply would be able

to bring it back, thereby relieving the burden that they currently

place on the domestic capital markets for the need for their cap ex

expenditures.

Chairman ARCHER. Thank you.

Mr. Kleczka?

Mr. KLECZKA. Thank you, Mr. Chairman.

I think the more we learn about this national sales tax bill, the

more questions are raised. Mr. Rooth, you have been in the homeselling, home business, so you probably know more about it than

any member of the committee. Under this proposal, it is guessed,

hoped, prayed, that the price of the home is going to go down about

20 percent, a newly constructed home is going to go down by 20

percent, and so a 30 percent add-on sales tax under this proposal

won’t be that burdensome.

In my experience around here—and I can cite right off the top

of my head—every time we put more dollars into student loans and

grants, we find that the more we give the kids to help offset their

educational costs, the more the tuition goes up. Okay?

In your experience or in your knowledge of this bill, is there anything that is going to guarantee that those homes are going to go

down by 20, 25 percent for new construction? I just fail to believe

that.

74

Mr. ROOTH. Well, for someone to step forward and try to crystal

ball what the economic impact will be I think is next to impossible.

How an employer treats their wages I think is difficult for us to

predict. In certain conditions of labor, I am sure that they will be

maintained because of prior contractual arrangements.

But I would say to you that in 1981, in 1986, and again in 1993,

we tried to predict the outcome of changes in the tax provisions

and estimate what it would do to the rental income or the residential real estate market and the commercial real estate markets,

and we were wrong on all three attempts, 1986 being almost a

doom-and-gloom situation.

So I think it is difficult for anyone in our business to predict the

impact that this might have.

Mr. KLECZKA. Well, we know one thing. If this would become

law, there would be a 30 percent add-on at closing.

Mr. ROOTH. Right, and one of the things that concerns us a great

deal I alluded to in my oral comments, and that is the impact of

the services fee on every aspect of the closing of the transaction,

whether it be attorney’s fees, title fees, impact doc fees, appraisal

fees, home inspector fees. There is a plethora of different fees at

closing in that transaction. And for the first-time home buyer, that

is a very important component because we are looking at a down

payment and what they have to put to the transaction.

Mr. KLECZKA. Are those fees taxed today?

Mr. ROOTH. No, they are not.

Mr. KLECZKA. Mr. Linbeck, what would be the business tax

under this proposal?

Mr. LINBECK. The business tax? There is no tax on business-tobusiness transactions.

Mr. KLECZKA. So it would totally repeal the corporate income

tax?

Mr. LINBECK. Yes, and also the——

Mr. KLECZKA. So businesses would pay no tax at all.

Mr. LINBECK. That is correct.

Mr. KLECZKA. How would a person be advantaged, let’s say, in

the 15 percent income category or even 28 percent income category? That person would not pay income taxes anymore, but he

or she would be paying 30 percent at minimum, and Joint Tax tells

the committee, to be revenue neutral, that tax would almost have

to approach 59, 60 percent. So how does a person who currently

pays 28 percent be advantaged by paying in excess of 30 percent

on every good and service that person needs to survive?

Mr. LINBECK. That is a very good question, and it is one that

concerned us a great deal. And we spent an enormous amount of

time researching this, and we found that the person in that income

category today is paying the biggest tax in the payroll tax, and the

rebate tacked on top of the payroll tax in effect brings that person

to the point when they have to buy products that no longer have

the embedded income tax in them is completely tax free at the poverty level and below. Those that are above the poverty level continue to get the benefits on a gradated basis.

Mr. KLECZKA. That poorer person would get a rebate every

month?

Mr. LINBECK. Yes.

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Mr. KLECZKA. And so they would—right now I file a once a year

my taxes. In fact, today I mailed them in with a check, okay? And,

you know, I am not ready to commit hara-kiri. It is something you

have to do as an American citizen. But under this new system, that

poorer person would have to file something every month to get

their monthly rebate, would they not?

Mr. LINBECK. No, sir. Under the provisions as embedded in the

bill, they would make a request once a year to the Social Security

Administration, which request is a postcard with their Social Security number on it. The Social Security Administration runs that

through the system to make certain it is a valid Social Security

number and that it has not already been used. And then based on

family size as promulgated by Health and Human Services, the rebate is automatically dispatched to them at the beginning of each

month.

Mr. KLECZKA. So every month they get a check, and there is no— and it doesn’t bear any relationship to their actual purchases.

Mr. LINBECK. That is correct.

Mr. KLECZKA. So for that month that they received a check, for

whatever reason they didn’t buy much, but they, nevertheless, get

that same check every month.

Mr. LINBECK. That is correct.

Mr. KLECZKA. Well, that is a heck of a deal. Could you explain

to the committee how this tax on local and State government

works? The authors of the bill didn’t even realize that the payroll

of the municipalities would be taxed as national sales tax. Now,

maybe you know more about the bill than the authors, but are you

aware that payroll is taxed under this proposal?

Mr. LINBECK. I am not aware of the specific mechanism by which

it is taxed. I am aware of the principle that the tax on products

that are consumed are taxed regardless of their origin or who produces them. And in the area of Government services, they are

taxed just like if they were produced by the private sector. But I

am not personally familiar with the mechanics by which that

would——

Mr. KLECZKA. So you are not aware that the payroll of any municipality would have applied to it a 30 percent national sales tax?

Mr. LINBECK. There is a paper that is prepared as part of the information on the Fair Tax that deals with the technicalities of that.

Mr. KLECZKA. Well, that is more than a technicality. That is a

big, big liability for our municipalities. Right now if you would exclude workmen’s comp and unemployment comp, the major contribution on that payroll by local municipal government is the

FICA tax. Well, that is going to be taken off, and in lieu of, we are

going to be asking Milwaukee and Cleveland and all cities to pay

30 percent of their gross wages. That is one big one for the property taxpayers in this country. So they are shedding a 7 percent

plus liability, and we are replacing it with a 30 percent.

Mr. LINBECK. And that is a proper concern, and that is why there

was specific research done on that in order to make certain that

there was a level playing field as between services provided by

Government and services provided by the private sector, the intent

being that there would be no differentiation between the tax outcome as between public and private services.

76

I apologize for not knowing the specific technicalities of it, but

there is a position paper that has been prepared by researchers——

Mr. KLECZKA. Well, see, our dilemma is we are asked to support

this critter, and we have to know those things because that is of

big, big importance back home.

Mr. LINBECK. And I would encourage you, if there is any prospect

of your support, that you become familiar with the technical side

of it.

Mr. KLECZKA. Well, that is more than technical. That is one of

the mainstays of this bill.

Mr. LINBECK. The principle is that there is a level playing field

of taxation as between public and private service providers.

Chairman ARCHER. The gentleman’s time has expired.

Mr. KLECZKA. I thank the chairman.

Chairman ARCHER. Ms. Dunn?

Ms. DUNN. Thank you very much, Mr. Chairman.

I want to welcome you, gentlemen. Thank you for coming and expressing your point of view. I think it is a fascinating discussion,

and we all have lots and lots of questions. And we also have questions on behalf of the folks we represent at home, so I think it is

a wonderful opportunity for us to get you all together.

Mr. Rooth, I wanted to ask you a question. In your testimony,

you said that you oppose the flat-rate flat tax that has been discussed by folks as we reform the tax system, and I was going to

ask you, because in some discussions of that tax, there are bills

that would exempt interest deductibility, and so that would still be

provided. And despite that, you still oppose the flat tax.

Mr. ROOTH. It is difficult to oppose the ‘‘flat tax’’ because without

a bill on the floor for me to speak directly to, it——

Ms. DUNN. Well, just assume it is a flat tax with deductibility

continuing for mortgage interest and charitable donations and

maybe medical expenses.

Mr. ROOTH. I would say that it is an issue that we would take

very serious looks at. There are economic impacts on rental income

housing, and home purchase would be the most important thing

that we would consider. I am also concerned about transition issues

in the depreciable items.

Ms. DUNN. And then when we were talking about the national

retail sales tax, did you say that you would expect a full exemption

for the purchase of homes because they would be considered investments?

Mr. ROOTH. In my comments to the chairman, we feel that the

purchase of a home, because of its significant nature, is an investment.

Ms. DUNN. Do you prefer the current tax system for the taxation

of purchasing homes?

Mr. ROOTH. Yes.

Ms. DUNN. Okay. Thank you.

I wanted to ask Mr. Linbeck, what are you finding out there

among folks you are talking with about the Fair Tax? Are you finding a building consensus behind this as people begin to understand

how it works? And if you are finding that, what do you see as the

movement through the Congress? Are we now in an education peVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00082 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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riod? What do you see the process being for the success of your program?

Mr. LINBECK. As I mentioned, we have conducted market research for the last several years in order to discern what, in fact,

was the embedded attitude of the electorate in respect to this issue.

Since we have learned what we believe that to be, we are now

involved in an educational effort. We expect over the next 30 to 90

days to ratchet that up to the extent that the 50 major markets in

this country will be exposed to the availability of the Fair Tax, and

the whole thrust of the AFT effort is to inform the electorate and

then leave it up to them to decide whether or not they wish to support it and manifest that support through their contacting of the

people that they vote for.

I only vote for one Congressman and two Senators, and it would

be presumptuous of me to expect a response from people for whom

I don’t vote.

But if they hear from enough of the people that send them to

Congress and they have a persuasive enough basis on which they

form their position, we think it is going to be a very strong

groundswell of support for the Fair Tax. Our research suggests

that. And most recently, when the four essential elements that I

shared in my oral testimony are known to the electorate, over 70

percent of the people support it.

So we are very encouraged by that, but, again, we think the success or failure of the Fair Tax undertaking will be the degree to

which the constituents in the grassroots in the country become energized by the prospect of its passage.

Ms. DUNN. I think that is very realistic, and I guess I would urge

all of you who are involved in this discussion not to give up hope

that there may not be all the members of the Ways and Means

Committee here or that people aren’t talking to us out in the districts. The discussion is important, and as part of the educating

process, it has to be taking place now.

Frankly, I think that because we don’t have a lot of time left in

this year, there is not a lot of legislative time, because I am waiting

for the freshness of the new administration, I think there will be

great attention paid to this as we move through this year and move

into next year.

But I think there are benefits of the Fair Tax, as there are benefits of other forms of tax as replacements for this totally outdated

income tax system that we penalize people with today.

Let me ask one more question, and whoever on this panel can

answer it, I would appreciate it. We have talked a lot about the effects of the Fair Tax on border adjustment, and I am wondering if

somebody could address this once again in this panel. How would

products made in the United States benefit from a national retail

sales tax?

Mr. LINBECK. Well, I am not an expert in this or anything else,

but I will take a crack at it based on what I have learned from our

research. And it is a timely question in that there has recently

been a WTO finding that the existing international trade vehicles

that have been used by exporters does not conform to GATT or the

World Trade Organization rules, thereby disadvantaging exporters

under those rules.

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It is our understanding and belief that in the regimen of the Fair

Tax, all of the embedded taxes occasioned by the current system

would be purged from their cost structure, and, therefore, they

would be able to export their products into an international market

on a much more competitive basis. And it has been suggested in

some of the companies with whom we have visited who are heavily

involved in export that the 20 to 25 percent lowering of their producer price would have a dramatic impact on both their ability to

increase their market share and maintain their margins, but also

penetrate new markets that heretofore have not been available to

them because of the tax disadvantage that they are burdened with.

Mr. MCCRACKEN. If I could add just briefly, it will also encourage

businesses to continue to be in the United States and to come to

the United States to produce the products. It creates enormous incentives to do things here as opposed to abroad.

Ms. DUNN. That is a really good point. We have been stuck with

the FSC ruling right now, and some of the other problems we have,

the H–1–B visa cap and so forth that causes people to start looking

toward going overseas to be competitive.

Thank you very much. Thank you, Mr. Chairman.

Chairman ARCHER. Would it not also prompt the return of all of

the companies that have gone offshore for tax reasons that are currently operating in tax havens like Bermuda and the Cayman Islands and Aruba and other places?

Mr. LINBECK. Well, it is our belief that it would remove the incentive for them to take that kind of a step. Whether it would immediately cause them to return, only they could answer that. But

all of the incentive for them to be located in an external domicile

would be removed. And as a matter of fact, all of the advantages

of being domiciled in the U.S. would return to them, which is a

good skilled labor force, availability of capital, good mature markets, and a secure economic system. So my instinct is that the vast

majority of those who were driven offshore by virtue of the tax system would return quickly.

Chairman ARCHER. Thank you.

Mr. Tanner?

[No response.]

Chairman ARCHER. Ms. Thurman?

Mrs. THURMAN. Thank you, Mr. Chairman.

We have been given kind of a grouping of editorials that have

been written across the country in support of your tax or replacement. One of the things that I found interesting, especially because

we are now sitting in a situation where we have the Joint Tax coming in and saying it could be anywhere between 30 to 57 percent,

are we going to go back out and resell this? I mean, when you talk

about going nationally, are you going to tell them about potentially

this costing 30 to 57 percent?

Mr. LINBECK. Is that addressed to me?

Mrs. THURMAN. That would be addressed to you, and it would be

addressed to the business—anybody that wants to respond to this.

Mr. LINBECK. I will try to respond. Our objective is that whatever the tax is, that it be revenue neutral. Our undertaking of this

effort was totally bipartisan. We have undertaken the research on

a bipartisan basis. All of our polling was doing by a joint venture

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of a Republican and Democratic pollster. Our commitment to the

effort is that it be consistent with two principles: that it be bipartisan and, number two, that it be revenue neutral.

The research that we have received suggests the rate that we

have been promulgating. If at the end of the day and if the base

is consistent with what we understood to be the broadest possible

base the rate is higher, that is the rate that we will use. We are

not really trying to sell the rate but, rather, the principle.

Mrs. THURMAN. But it does sound much better to be able to say

a 23 percent sales tax versus a 30 or a 57 percent.

Mr. LINBECK. Absolutely, it does. And, also, one ought to bear in

mind that it is a replacement tax.

Mrs. THURMAN. Correct. Let me just give you some examples of

some things, and any of you can talk about this. But we did some

calculations quickly just to figure out, say, a couple making

$50,000, using dependent care credit, with two children, and they

are using standard deductions. Their income tax would be about

$2,810; the employee’s share on the payroll tax, $3,825; employer

share, $3,825—with a total of $10,460. That sounds a little outrageous, I agree.

Then you go down, though, and you say the proposal is consuming, say, 30 percent of the $50,000, or at a rate of 30 percent,

which is the lowest rate that has been given tough, is at about

$15,000, and then the rebate, which would be the 0.23 times the

1,750, which would be the poverty, comes to a total of about

$11,078. So what you really would be is you would have a net tax

increase of about $618. So, actually, you would be ending up paying

more in a tax under a sales tax than you would under the current

system.

And then if you went to somebody—and then if you went to a 57

percent rate, which Joint Tax has said——

Chairman ARCHER. Would the gentle lady suspend for one moment? My presence is now being mandated on the floor of the

House of Representatives, so I am going to leave for a while, and

Congressman Hulshof will preside.

Mr. HULSHOF. [Presiding.] Thank you.

Chairman ARCHER. The gentle lady may commence. Sorry.

Mrs. THURMAN. So then at 57 percent at $50,000, it is $28,500.

The rebate would be $3,922, with a tax of $24,578, with the net tax

increase then being $9,579.

I don’t know how to particularly—then if you talk about issues

of taxing food and medical and drugs and all of those kinds of

things, how do I sell this to either the $50,000 person a year making $50,000 and/or the senior who is now going to be picking up

a cost that is not being shared by them? And then you can go on

with a $30,000 single mother.

I mean, simplification is good. I understand the reason. But

when you look at it from a dollar, a pure dollar, of who is going

to pick up the cost of this, I have some concerns in who this is

being shifted to. Maybe somebody can talk to me about that because I need to be able to explain that at home.

Mr. LINBECK. If you are asking me——

Mrs. THURMAN. Oh, whoever would like to take——

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Mr. LINBECK. I will be glad to give you my thoughts on it, and

they consist of the—if the numbers are correct and someone ought

to be able to sit down with the person who understands the Fair

Tax and all of its complexity and simplicity and the income tax and

its complexity and simplicity and come to an understanding of

what the comparison is, then we ought to have a common basis for

moving forward.

In all candor, I couldn’t follow all of the numbers in my head to

know what the variation may or may not be as between the findings that were expressed—— Mrs. THURMAN. It is based on two very simple things. One would be the consumption of $50,000 at a 30 percent or 57 percent, depending on where we are under Joint Tax, and what payroll—and

what the difference would be what they paid a day and what they

pay under the—what your system would be including the rebate.

And it seems to be quite different.

Mr. LINBECK. I would encourage you to invite someone in who

understands the system and see if you can work through those

numbers with those persons, and it does not ring true to me, based

on what I have previously discerned from the research, but it is

very possible that we have made an error in it. And if we have,

that can be corrected. But if not, then that will inform us all.

Mrs. THURMAN. Then I would just say to you that I will be glad

to open my office if you would like to send somebody and show me

where we are wrong.

Mr. LINBECK. Well, I am not sure we can show you where you

are wrong, but we can show you where the calculations come out.

Mrs. THURMAN. Thank you.

Mr. HULSHOF. Mr. Portman?

Mr. PORTMAN. Thank you, Mr. Chairman. And I want to commend the panel for taking the leap off the cliff, with the exception

of our friend from the realtors who is not there yet, with at least

coming up with what I view to be a very creative and innovative

approach. I think it has problems, and I am going to ask you about

some of those problems. But our current system is too complex, too

complicated, and the compliance costs are a big hit on our economy

and individual Americans who are filling out their taxes even as

we speak. And then, finally, it does penalize savings and investment in a way that is counterproductive to economic growth. So we

need a new approach to taxes.

My concerns with the Fair Tax are some of those you have already heard. I think the percentage that would be paid is the key

issue. It affects really so many other issues related to it, including,

of course, the compliance, the possibility that there could be enormous compliance issues with the many transactions which would

occur every day. Also, of course, it affects what the States might

do. The States do tend to piggyback on us. They do that with our

Federal taxes. I think they would tend to do it with this tax. And

so the rate that we are talking about, whether it is 24 percent or

65 percent—as Pricewaterhouse has said, there is a range, depending on compliance, depending on other assumptions about economic

growth. I think you have to add what the States are going to do

currently with regard to their income taxes and corporate income

taxes on top of that, and you end up having a fairly onerous perVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00086 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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centage. So that is one of the issues that I have, and I won’t get

into that because I think you probably heard a lot about that earlier this morning. And we can go back and forth on what that percentage might be, but I think it is important as to, again, so many

other issues.

My understanding is that today about 60 percent of the taxes are

paid by the top 10 percent, somewhere between 55 and 60 percent.

Is that your understanding? I am talking about Federal income

taxes, forgetting the payroll tax. You know, people say we don’t

have a very progressive system. The top 1 percent pay about 25

percent of the taxes; the top 10 percent pay about 30 percent of the

taxes.

Have you all looked at the Fair Tax in terms of this analysis?

And it is really building on the question from the gentle lady from

Florida that you just heard. But what would the top 10 percent of

wage earners in this country pay as a percentage of the Fair Tax?

Mr. MCCRACKEN. Well, I understand that—actually, that is a

very difficult question to answer because it is based not on what

you earn or what you are worth; it is based on what you consume,

on basically what you take out of the economy. So it is going to

vary widely. Bill Gates could pay billions of dollars this year in

taxes if he consumed that much, or he could pay nothing in taxes

this year if he chose to reinvest everything he makes back into the

economy into creating jobs.

So it is very different from the income tax, and it is hard to look

at in quite the same——

Mr. PORTMAN. It is very different, but although the analysis will

depend on certain assumptions, it shouldn’t be as difficult as you

indicate because Bill Gates will still get a salary, so will Rob

Portman, so will everybody else. And the question is: Of the top 10

percent of wage earners, what percentage will they pay in terms

of the Federal sales tax?

Now, again, our current system is very progressive, and this is

one of the issues that all of us who are interested in tax reform

have to deal with. And those who think it is not, again, I believe

are wrong. When you get into tax reform, you will find out it is

very difficult to end up with the same distribution you have now

if you really believe in fundamental reform unless you are going to

go to a tiered system.

But I just wondered if you had a number on that, what the top

10 percent of wage earners would pay as a percentage of the Fair

Tax?

Mr. MCCRACKEN. I don’t. Do you want——

Mr. LINBECK. No, I have seen no data, to my knowledge, there

is no data available because it does, as Mr. McCracken pointed out,

depend on the behavior of the individual in respect to their spending habits. And over a lifetime, one can make those calculations

with a reasonably high degree of certainty, and it is my understanding that given the rebate and the elimination of the payroll

tax and the stripping away of the tax embedded in products and

services that we buy, the Fair Tax will be as progressive if not

more progressive than the current system.

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So, in general, that is the principle we think underlies the plan,

but we cannot tell you what the idiosyncratic outcome would be for

an individual taxpayer.

Mr. PORTMAN. Well, I am not looking for the idiosyncratic or individual. I am going on average. And you do have to make certain

assumptions, which I know you have made, with regard to purchases, and GAO has done that and other groups have done that

over the years. It is very difficult to do. I know the Treasury Department, I think under Ronald Reagan, tried to do that. And

where you have to start, is purchases and income. I just think it

would be helpful to know that, frankly, to be able to respond to

some, I am sure, of the critique that you got this morning, and the

most recent question indicates that we will be concerned about

that. There is with every fundamental tax reform proposal, whether it is a flat tax, the Fair Tax, or some hybrids that are out there.

A couple other questions, if I could. One, there is obviously a

compliance issue when you have got, let’s say for argument’s sake,

a 30 percent sales tax. There is going to be an incentive for folks

to figure out a way to barter or figure out a way to deal with it

outside the tax system that is not there currently. In my own county, we have 5.5, 6 percent sales tax, the counties that I represent,

and taking it up to 30 percent is going to change people’s behavior.

So there is a compliance issue there.

The bigger compliance issue that I worry about, though, is the

rebate. I look at the earned income tax system, where we are told

by the Treasury Department there is probably a 20 to 22 percent

mispayment. Some would say that is fraud. Others would say it is

error. It is probably a combination of a lot of things. But it is an

enormously difficult rebate system for the IRS to enforce. They

aren’t structured to do it.

Who would enforce your rebate system? You know, when you get

something in the mail, at the IRS now, that says I am eligible for

the EITC, for the most part a check then goes from the taxpayers

to that person because, frankly, it is very difficult to audit and

have appropriate compliance. When there is auditing and compliance, it can get very difficult for the agency that does that because

you have millions of taxpayers and, frankly, you are going into

issues that are very intrusive and personal to people in terms of

their income. How would you determine whether people who applied for the rebate deserve the rebate?

Mr. LINBECK. Well, first of all, there is no means test. It is a universal rebate. But the mechanism to implement the rebate is driven by the Social Security Administration and the use of the Social

Security number. So if the subject person seeks a rebate, they send

a card to the Social Security Administration on which they have

placed their Social Security number. If there are multiple beneficiaries of the rebate they wish to claim, they list each of those Social Security numbers.

The Social Security Administration runs that through the system

to see if each of those are a valid Social Security number, or if

there are duplicates of that same number, that triggers an inquiry

as to who is the legitimate holder of that number. That then triggers the rebate on a periodic basis every month in an amount equal

83

to the number of the tax times the Health and Human Services determination as to the poverty level for that size family.

Mr. PORTMAN. Well, having—— Mr. HULSHOF. I must say to my friend that your time is—— Mr. PORTMAN. I am sorry. With the indulgence of the Chair, let

me just finish up that point and just say that it is much simpler

having just one flat rate based on whatever the poverty rate is for

that number of individuals. I will say, though, there are still going

to be major compliance issues, and we ought not to overlook those

and we should be concerned about those.

I have lots of other questions, but, again, I want to commend you

all for taking the leap and for making this innovative proposal.

Mr. HULSHOF. The gentleman’s time has expired. As I yield to

my friend from Texas, I know that one of the issues that he has

been pursuing quite vigorously in this committee is the end of abusive corporate tax shelters, and I would suggest that were the Fair

Tax to be implemented and business income no longer being taxed,

it would eliminate these corporate tax shelters that you have been

so——

Mr. DOGGETT. I will have to take up another agenda, and I am

glad Mr. Linbeck is here to add support to that.

Mr. HULSHOF. I yield to the gentleman.

Mr. DOGGETT. Let me begin, though, with my neighbor, Mr. Martin. I appreciate the service that you provided our community in

central Texas, and I know that you are approaching an age when

Social Security is important to you and many of the people that you

work with. And one of the concerns that I have about this, James,

I was down at the Archives last week, and just down from where

the Declaration of Independence is there for everybody to look at,

they now have up a quote in connection with an exhibit from

Franklin Delano Roosevelt. And the essence of it is that he set up

a payroll contribution system for Social Security so that every

American would feel that they have a stake in Social Security and

that no politician would ever be able to take that Social Security

system away from them.

Isn’t there a danger, as you heard me ask the sponsor of this

measure this morning, that if we totally eliminate what has become a burdensome payroll system, no doubt, but if we totally

eliminate that system, we may set up a way that those who don’t

support Social Security will be able to undermine it because no

longer will each American feel that they are paying in something

specifically for that system?

Mr. MARTIN. Mr. Doggett, my own opinion on that is that if the

transfer system is done in a proper manner and it is clear and it

is able to be understood by the rank-and-file working American,

that they will feel secure with it. They will be looking at overall

totals, and they will be listening to Congress and various administrations tell them how much is in there and how long the fund is

solvent for. And I think if those numbers are consistent, I think

that they will have the same degree of either concern or satisfaction that they do now.

Mr. DOGGETT. I appreciate it.

Mr. Linbeck, I wish that we had more citizens that were as interested in affecting public policy as you obviously are, because I have

84

heard from a number of constituents there in Austin that you have

either talked with personally or others of this effort have talked to

personally.

There are several concerns, and mine are similar to the ones that

I raised this morning also. I gather that you envision that after

this act is put into place, electronic commerce will provide a significant source of Federal revenues.

Mr. LINBECK. It is our expectation that it would. The expectation

under the Fair Tax is that all terminal transactions, by whatever

distributional means, will be subject to the tax. So that would be

brick and mortar, Internet transactions, and mail transactions.

Mr. DOGGETT. And your goal is to try to get this tax into place

just as soon as you can as a replacement for the income tax.

Mr. LINBECK. Yes, sir.

Mr. DOGGETT. And so I gather, therefore, that you would not support extending the Internet tax moratorium until 2006.

Mr. LINBECK. I would personally support not having any tax on

the Internet medium.

Mr. DOGGETT. Sure, the access.

Mr. LINBECK. The access.

Mr. DOGGETT. But I am talking about taxes on transactions.

Mr. LINBECK. But to tax the transaction, I would support taxing

immediately, as long as it was an evenhanded application. I think

the dislocation occurs and the unfairness occurs when you have different means of distribution taxed on a different basis, or at least

not enforced in a uniform fashion.

We contemplate that under the Fair Tax there would be uniform

application of the tax so that everyone has a level playing field

from which to embark on their economic activity.

Mr. DOGGETT. I am accustomed, from my perspective, at least, to

getting advice from the majority leader, Mr. Armey, that I consider

to range from bad to worse. But I was listening to his comments

on Sunday about your proposal on Fox News, which I am sure you

saw——

Mr. LINBECK. No, sir, I didn’t.

Mr. DOGGETT. Well, he was asked if he supported your bill, and

he said ‘‘no, it doesn’t work and, furthermore, it is regressive and

it adds inevitably to the tax code, making it equally as complex as

today’s income tax.’’ And he also said that no country has ever

made a successful change from an income tax to a sales tax, and

that when Canada went to a higher sales tax, the use of cash in

the Canadian economy tripled in just 6 months. I am quickly summarizing the latter part of his testimony. The first part was a direct quote.

I am just going to ask you if Mr. Armey has finally gotten something right.

Mr. LINBECK. Well, I must admit, if the Fair Tax had the attributes he ascribes to it, I wouldn’t be for it. I don’t know what

he is looking at, but the provisions that are embedded in House bill

2525 do not appear, through my own observation nor the research

that has been undertaken, to have those kinds of outcomes. I would

certainly not be in favor of any system that didn’t have a preferential option for the poor. And in my judgment, the Fair Tax is

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the only bill currently being considered that represents that kind

of an option.

Mr. DOGGETT. What about the specific issue—my last comment,

Mr. Chairman—that he raised? I know I covered a lot of it, but

greater reliance on a national sales tax in Canada greatly increased the underground economy, and he specifically said the use

of cash in the Canadian economy tripled in just 6 months, as an

indication of too much sales tax resulting in an underground economy.

Mr. LINBECK. Well, I have no frame of reference for his data. But

it is my understanding that in Canada the problem arose because

they promised to eliminate the income tax and replace it with a

sales tax. When they passed the sales tax, they kept the income tax

as well. And if that is a correct understanding of the facts, then

it is not surprising to me that people would take extreme measures

to find whatever relief from the burden that was imposed on them

with both tax systems that was available to them. But our research

suggests to us that there is no reason to believe that there would

be a higher incidence of evasion or leakage or cheating under a

transparent uniform sales tax at the Federal level than there is

under the present income tax system. And we have made no assumptions in the body of the research that suggests that it would

be less. We have just assumed it would be the same.

Mr. DOGGETT. Thank you very much. And thank all of you.

Mr. HULSHOF. Mr. Lewis?

Mr. LEWIS. Thank you very much, Mr. Chairman.

Mr. Rooth, what would be the impact of this legislation on minority home ownership?

Mr. ROOTH. Excuse me, on which home ownership?

Mr. LEWIS. On minority.

Mr. ROOTH. Minority?

Mr. LEWIS. Right.

Mr. ROOTH. As we have stated earlier, and I have a handout that

I will be happy to include to any of the members that we have

done, that basically we find that minority spending is a huge part

of our economy here in housing, that the priorities of home ownership are highest among minorities and far higher than all Americans combined. Anything that restricts that purchase, we are going

to have great difficulty with.

The actual impact of this legislation on the first-time home buyer

or on minority home buyers is next to impossible to predict. As I

have mentioned earlier, we have been wrong in every other prediction we have ever made. But I am very concerned about the impact to such a large amount of our population.

Mr. LEWIS. Are you troubled by the possibility of a 30-percent increase on renter apartments, on new home construction?

Mr. ROOTH. I am absolutely concerned with it on new home construction because we have already demonstrated that there is an

excess cost of new home construction of 20 percent today. So if we

were to add another 30 percent to that, that could conceivably be

a 50-percent impact. But the rental housing sector is probably what

concerns me the most because if I can rent you an apartment today

for $500 a month, there is nothing to say that I can tomorrow afford $650 or $700 a month because I can’t predict what the emVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00091 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
86

ployer is going to pass on to me in my paycheck. Unless I have a

contract about my employment, I cannot guarantee that I am going

to get my full paycheck.

Mr. LEWIS. Thank you, Mr. Rooth.

Mr. Linbeck, are you concerned that 2525 will impose an increase, a dramatic increase on purchase of prescription drugs, hospital bills, doctor bills, and nursing home care when home care is

already going higher and higher and you come and you are suggesting that you are going to add more of a cost?

Mr. LINBECK. Yes, sir. I would be very concerned about it if I believed that would be the outcome. I am persuaded by the rigor and

the intensity of the——

Mr. LEWIS. But I want you to persuade me. I want you tell me

how we are going to, with 2525, how can we keep the cost of prescription drugs, doctor bills, nursing home care from going up, up,

up?

Mr. LINBECK. In my judgment, the prescription drug issue, as

well as other health care issues, will be subject to the same type

of market forces, in terms of stripping away the costs that are currently embedded therein by the current system, thereby lowering

the cost at the producer level, the net outcome of which, we believe,

based on the research we have been given, is that the price that

the consumer pays will not be higher, including the tax, than it is

today. But on top of that, the purchaser of the products will have

more money in their pay environment. Their gross pay will be their

net pay. In addition, they will get the rebate in an amount equal

to the tax on essentials, and in most of the Health and Human

Services information, with which I am familiar, health care is a

component of the cost that they use in determining what the cost

of living would be for the poverty level.

So it is our understanding and belief that there will not be a disadvantage, particularly to the poor, but rather an advantage to the

poor under the Fair Tax in purchasing the essentials.

Mr. LEWIS. But the costs of health care is not just something that

should be the concern of the poor, but is middle income, working

people, so much of their limited income is going to try to pay doctor

bills, and buy prescription drugs, to provide nursing home care.

Mr. LINBECK. And it is our belief, Congressman, that those costs

at the producer level will come down. Let’s look at that particular

doctor who is dispensing that care. They will no longer have to administer the current tax system in the management of their office.

They will no longer have to keep track of any of that information,

so the compliance costs will go down very substantially. It is expected that those costs will be passed along to the consumer, to the

patient that they are treating.

Mr. LEWIS. But if I am doctor running an office and I have

nurses and others assisting, I have to collect those taxes, right?

Mr. LINBECK. Yes.

Mr. LEWIS. But you do believe that health care should be accessible, affordable and it should not be out of the reach of any of our

citizens. When you come along and put up another tax, additional

costs, you are moving health care further and further away from

working Americans.

87

Mr. LINBECK. If we believed that was the outcome, we would be

gravely concerned about it. We believe the outcome will be contrary

to that assumption, and that it will, in fact, not go up in cost over

where it is today.

Mr. LEWIS. Thank you.

Mr. LINBECK. Yes.

Mr. LEWIS. Thank you, Mr. Chairman.

Mr. HULSHOF. Mr. Watkins?

Mr. WATKINS. Thank you, Mr. Chairman. To a couple of you, Mr.

Rooth and Mr. Kouplen, I have a background in both of those

areas; first, in agriculture, as Mr. Kouplen knows, and then later

on in building and real estate. So I have got a couple of questions

I would like to take up with both of you.

I know in the agriculture area, a lot of us have worked very hard

because of blatant double taxation on estate tax, trying to get more

relief and more relief in that area, and we have made some headway, but we have not got it repealed yet, and we realize that is

something a lot of farm families are very interested in doing.

I also recognize, if we stop and look through I think in detail,

that if we have a tremendous just total change of direction, agriculture would probably end up being in the tax structure overall

we could be hurt in agriculture a great deal. So I think we have

to be very careful on how we go into it.

A bill I am working on, and Ken Hulshof, my good friend from

Missouri, I know probably would be interested in this bill, and I

am working on it with staff and others. But one of the things in

agriculture right now, we have an age problem, a population that

is out there getting closer to 60 years of age, and not only with

that, it is very difficult for maybe their offspring to enter, but along

with that situation, many of them cannot get out. Now, let me

share with you it is a capital gains situation. It is a fact that I

know from experience.

I will use the example that maybe 30 years ago a farmer may

have bought land at $200 an acre. Today it may be $700 an acre.

He has been farming with the inflation of that land. And I understand that. I have been there. I understand. And as a result, now

he is 70 years old. He cannot sell and pay capital gains tax and

pay his debts. He doesn’t have the money, and so he is locked. And

these are some of the most patriotic, hardworking, 15-, 16-hour-aday families, husbands and wives, out on that farm.

I am working on a bill that will allow us, hopefully, at least what

we are allowing for, $500,000 on a piece of real estate—if you happen to have capital gains, you can go up there—for that to be for

a farm, home, and the surrounding land. That would allow a lot of

relief for a lot of farmers out there if they were allowed to do just

as our city cousins were able to do with a $500,000 home. Now, I

think we should get hopefully a little bit better situation worked

out than that, but I am going to be going full bore trying to get

something like that.

Do you feel like that would be a great help to a lot of our farmers? Now, I know you have got 2,000 acres, but you take $500,000,

for a lot of farmers, they have got several hundred acres, and it

would be a big help I think.

88

Mr. KOUPLEN. I think the Congressman is right on target with

that. As you know, the most appealing aspects of this proposal is

the elimination of the capital gains tax and the death tax or estate

taxes. And you know, as well as those of us in agriculture, the situation that we have been in over the last couple of years, is a very

tough situation. We are a very capital-rich industry and a cashpoor industry. And like you say, the age of our farmers and ranchers in this country is getting to be 60/65 years on average. When

they do decide they want to sell, they find out they have a silent

partner in the Government. A lot of them decide they cannot afford

to sell. Instead they hold on, and sooner or later when the death

tax situation arises, their heirs find out that they must sell a great

portion of it. This makes that farm economically unfeasible because

they have had to sell that much of it. just to keep what is left.

So that aspect of it and compliance costs are the main aspects

that we like in this plan, and that is what we would look for in

the Farm Bureau in any plan that comes from your committee.

Mr. WATKINS. On that, let me say that I just don’t foresee an

overhaul of the tax deal for some for several years. Maybe when

a new President comes in, there may be some opportunity with the

Congress and all to get something overhauled, but I don’t see it

coming down otherwise.

Let me ask you about real estate, having been a builder. I was

sitting on the other side of the aisle when the Tax of 1986 came

in. I told them it was probably the most un-American tax bill that

ever came down through here because, really, it was nearly wiping

out that opportunity of getting the home, the American dream.

What kind of happened to the real estate industry right after

that? Are there any lessons that we should learn here? Do we need

something on the record?

Mr. ROOTH. I think the most important thing that we learned

and the thing that we have got to focus on with any new tax plan,

and let me say that our membership is much in support of the simplification, whatever it might be. Transition is a word that I want

each and every member of this committee to remember. Because

what we did not have in 1986 was a good transition plan. Anything

that happens overnight in a major investment sector like real estate has the tendency and the possibility of a severe impact and

ripple on the economic climate of this country. So I would encourage you, in any bill that you do, that we have got to have adequate

thought about transition.

1986 was as severe as it was primarily because of the loss of passive loss and some of the credit issues that came out. But had we

had a sound transitional period of 2 to 5 years, I feel we could have

survived it in a much better light.

Mr. WATKINS. I think that is a very good point, as we look at it.

Thank you, Mr. Chairman.

Mr. HULSHOF. I thank the gentleman.

Mr. WATKINS. He has been wanting to do that all along.

Mr. HULSHOF. I appreciate the gentleman, and before I let the

panel go, just a couple of quick comments. I was flipping through

an old Farmer’s Almanac recently, and I came across this passage

that said, ‘‘If Patrick Henry thought taxation without representation was bad, he should see it with representation.’’

89

[Laughter.]

Mr. HULSHOF. And I think were this a town meeting back in the

9th Congressional District of Missouri, if I were to take a quick

survey, as some of you talk about focus groups, probably a third

of those in attendance would invariably say, ‘‘We like the ideal, Mr.

Linbeck, of such as H.R. 2525’’; another third might say, ‘‘We like

a flat income tax’’; and the other third is not yet sure of what sort

of system they would like to go to. But what that says is that twothirds of those in attendance think that we should do something

radically different than the present tax code.

Mr. Kouplen, let me just echo the comments of Mr. Watkins. As

the only son of a Missouri farm family, we continue to try to work

within the existing tax structure to make it easier to pass that

family farm on to the next generation. We put the elimination of

the death tax on the President’s desk last fall, as well as the capital gains rate and relief from the alternative minimum tax, and

unfortunately we didn’t get that tax relief to you. But we continue

to work on those efforts.

Just two quick questions, Mr. Linbeck, because I need some

health in that proverbial town meeting that I have talked about.

I think it makes economic sense, the argument that you have

made, that were we to move to this retail-type of tax, that there

would be pressure on interest rates to go down. And you and the

chairman, the real chairman, were discussing how many basis

points that would be, and yet I felt the same thing would happen

if and when Congress began to balance its books; that is, to balance

the Federal budget, that the pressure would be on interest rates to

come down.

And yet as we have seen the economy continue to expand, the

chairman of the Federal Reserve, and I am not being critical, but

in an effort to gain, get arms around the monetary policy, the pressure has been just the opposite, that interest rates, of course, have

gone up. So what can you tell me, Mr. Linbeck, that I can talk to

my constituents about to assure them that were we to make this

fundamental reform, that we would, in fact, see interest rates dropping rather than going in the other direction.

Mr. LINBECK. The only comfort I could suggest in respect to that,

and bear in mind I am not Alan Greenspan, and I cannot talk in

terms that he talks in and perhaps that is a blessing or not. You

will have to make your own judgment on that. But in my judgment,

the fact that there will be a lot more money in the capital markets

by virtue of the issues that I raised; number one, the repatriation

of the earnings of corporations who work overseas, they will be able

to bring that money back and no longer have to borrow from the

capital markets to meet their Cap X expenditures, the elimination

of the tax wedge from interest rates that exist today. There is no

reason to believe that people will not loan money at the tax-free

rate that they are loaning it today if there was no consequence to

them having done so.

And finally, when everybody gets their entire paycheck, let us assume for the sake of discussion that the average person has about

a 23- to 27-percent withholding from their current paycheck in the

combination of payroll check and income tax withholding, hereafter, they would get 100 percent of that in their paycheck. If they

90

only save 10 percent of that increment, that is a 2-percent to 2.5-

percent increase in savings on the total payroll that we currently

have in the country. That is a very substantial incremental increase in funds to go into the capital markets.

For those three reasons, I think it is reasonable to assert that

there will be a lowering of the interest rates coming out of the Fair

Tax passage.

Mr. HULSHOF. Last question for you, and I know we have got

other panelists waiting and some on time constraints, so I will cut

my questioning short, but with this final question, and I recognize

in your written testimony, Mr. Linbeck, you talk about charitable

contributions.

Mr. LINBECK. Yes.

Mr. HULSHOF. And I agree with you to the extent that I think

we are Americans, we are a charitable people. And when we see

that there are those that need, we open up our pocketbooks or volunteer our time or our talents. And yet I also recognize, as someone who itemizes our family, and I muddle through our tax forms

because I want the same experience that you have each April 15th,

but I also believe that there are some who are motivated, perhaps

to give to certain charities or certain philanthropic organizations

because of their ability to take some sort of a deduction.

And so my concern is that there may be some significant charities that all of us will continue to give to, but that we might, the

incentive is that perhaps there are some other charities that we do

make a donation to simply because we are going to at least get at

least a small tax benefit. Do you believe that is not the case?

Mr. LINBECK. Well, obviously, we are concerned about that prospect, and that is why we commissioned specific research on that

issue. It was instructive to me to learn that there was a similar

concern surrounding the infamous 1986 Tax Act that has been referred to lovingly earlier.

It seems to me that the evidence that was put forth then suggested from the charitable community that if they lowered the rate

to the degree which they were going to lower the rate, that would

have an adverse impact on charitable giving. As a matter of fact,

the exact opposite occurred. There was an increase in charitable

giving. There seems to be only one direct correlation: the more

money people have in their pocket, the more money they give to

charity.

I think it is also noteworthy that for the people who don’t

itemize, the people who tithe to their church, and that is the principal beneficiary of the eleemosynary activities at that level, they

are giving after-tax and after-payroll-tax dollars. Just imagine how

liberating it will be to them for the first time to have their whole

paycheck from which they can extract those funds they wish to give

to their church or the charity of their choice. Our belief is, and the

evidence suggests very strongly, that if anything, there will be an

uptick in charitable giving, not a depressing impact from the Fair

Tax.

Mr. HULSHOF. Thank you, Mr. Linbeck.

Mrs. THURMAN. Mr. Chairman, I have to comment on a comment

you made.

Mr. HULSHOF. Surely.

91

Mrs. THURMAN. Because, Mr. Kouplen, I just want you to know,

though, in 1997—even though the last tax package did not get up

to the President—the one in 1997 did, and it was a very bipartisan

act, and we did lower the capital gains, and we did take care of

some of the inheritance tax, and there are floating proposals out

there. So I just could not let that go by.

Mr. MCCRACKEN. Can I add one more quick point on the issue

of the charitable deduction?

Mr. HULSHOF. Mr. McCracken?

Mr. MCCRACKEN. It is important to realize that, in fact, charitable giving would be tax preferred under the Fair Tax; that is to

say, you would not pay additional sales tax if you gave money, as

opposed to spending it. So you would pay a tax if you spent the

money. You wouldn’t pay the tax if you gave to a charity. And that

is the case for a whole range of different kinds of attributes we discussed here today, whether it is rent or other things.

It is important to realize that anything for which there is not a

deduction in the Code now, it is essentially taxed because we were

paying for it with after-tax dollars. And so just because it is taxed

under the Fair Tax, doesn’t mean it is a brand-new tax that we are

not paying right now.

Mr. HULSHOF. I thank the panelists for your patience. You are

excused with the thanks of this committee.

I will call the next panel to step up, and I will yield to the chairman, Mr. Archer.

Chairman ARCHER. The chair invites the next panel to be seated

at the witness table.

Gentlemen, welcome to the committee. Dr. Kotlikoff, I understand you have pressing engagements elsewhere, so to accommodate that, the chair will recognize you first, and you may proceed.

STATEMENT OF LAURENCE J. KOTLIKOFF, PROFESSOR OF ECONOMICS, BOSTON UNIVERSITY, AND RESEARCH ASSOCIATE, NATIONAL BUREAU OF ECONOMIC RESEARCH

Mr. KOTLIKOFF. Thank you, Mr. Chairman.

Chairman Archer and other distinguished members of the Committee on the Ways and Means, I am honored by this opportunity

to discuss with you the Nation’s need for tax reform and the role

that consumption taxation, particularly a Federal retail sales tax,

could play in enhancing the economy’s economic performance and

improving its distribution of resources.

Chairman ARCHER. Dr. Kotlikoff, can I remind all of the witnesses, again, if you will identify who you are and whom you represent, in that event, before you start your testimony, for the

record, please.

Mr. KOTLIKOFF. I am Larry Kotlikoff. I am a professor of economics at Boston University and a research associate of the National

Bureau of Economic Research.

Our Nation’s economy has been performing remarkably well in

recent years, but our economic success is no reason to be complacent about a tax system that is extraordinarily complex and highly

distortionary and that plays a critical role in an overall fiscal system that is like to visit enormous burdens on our children and

grandchildren.

92

I think the Congress and the administration are under the impression that our fiscal house overall, generally speaking, is in good

order; that we are running large surpluses and that those surpluses are going to be enormous for as far as the eye can see and

that they are going to take care of the fact that close to 80 million

baby boomers are going to be retiring starting in 8 years, and then

in about 11 years, starting to collect Medicare benefits on top of the

Social Security benefits they will be collecting in 8 years.

Well, that is not the case. Suppose you take more realistic projections than the CBO baseline; namely, suppose you don’t assume

that Federal purchases, as a share of GDP, will decline by 20 percent over the next 10 years and by 30 percent over the next 30

years. If you, instead, assume that Federal purchases are going to,

grow with the economy, then according to a Federal Reserve and

CBO generational accounting study that will be published in the

American Economic Review next month, we cannot afford to cut

taxes, as some of the members of this committee advocate, and we

cannot afford to raise spending, as some other members advocate.

Instead you need to have an immediate and permanent 25-percent

hike in the Federal income tax in order to keep our children from

paying even higher tax rates.

Now, why am I saying all of this in the context of tax reform?

Well, the key distributional question that confronts our country is

how are we going to be treating the next generation compared to

ourselves. And consumption taxation has the advantage that it will

place a larger burden of paying for the Government’s bills onto rich

and middle-class elderly, as well as middle-aged people, and place

less of the burden on today’s younger people as well as future generations.

Now, let me indicate why it is that a consumption tax would be

generationally more equitable. The reason is that the current elderly and those who are about to retire, the baby boomers, have one

primary economic activity in front of them, which is consuming.

This is a fine activity, but it is not one that is subject to federal

taxation, apart from some excise taxes.

So moving to a consumption tax would place a larger burden on

the elderly, in general. But the poor elderly, those who are living

off of Social Security, would be fully insulated from a consumption

tax because the Social Security benefits are indexed to the Consumer Price Index. So what we are talking about is asking the rich

and middle-class elderly, who have received enormous transfers

over the years from Medicare and Social Security to help bail out

their children and grandchildren.

A retail sales tax is a transparent consumption. Its adoption

would greatly reduce compliance costs because you won’t have an

army of lawyers, and accountants, and tax planners spending their

entire working lives trying to lower people’s taxes. And you won’t

have people like me spending 3 days trying to get our tax returns

together. That is a terrific plus. An retail sales tax would also reduce enforcement costs because the effective marginal tax rates

will be lower.

We have had some discussion back and forth this morning about

how high the tax retail sales rates would be. And I think that the

number 59 percent has been cited, and the number 30 percent, and

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23 percent. I think there is some comparison here of apples and oranges. The 59 percent is a tax-exclusive number, while the 30-percent number is a tax-inclusive number. I think the right number

to use here is the tax-inclusive number because you want to compare it with the Federal income tax, plus the payroll tax, both of

which are calculated on a tax-inclusive basis.

If you consider the Federal income tax and the payroll tax for

somebody who has low income, there is a 15-percent federal income

tax, plus a 15-percent payroll taxes (employer plus employee). Also,

a lot of low-income people get the earned income tax credit, and

when they earn a dollar, they lose roughly 20 cents on the margin.

So, effectively, they are in a 50-percent marginal tax bracket.

So, the comparison is 50 percent versus 30 percent for those lowincome people because the 30 percent is really what I think a comprehensive retail sales tax at the Federal level would generate in

terms of a tax-inclusive rate that could be compared with the alternative that we now have. And If you also consider middle-income

and high-income people, you find that they are paying close to 40-

to 50-percent tax brackets at the margin.

So with a retail sales tax we would end up with a lower effective

tax rate because we are going to be broadening the base. Consumption is a much bigger base than the payroll tax base, and it is also

probably as big as the income tax base when you take into account

all of the exemptions and deductions from the income tax base. So

in some fundamental sense, it must be the case that effective tax

rates if you are shifting to taxing all of consumptions.

And in the process of broadening this base, we are going to be

eliminating all kinds of distortions. We talked about saving distortions and labor supply distortions, but we are also going to get rid

of the lock-in effect on the sale of appreciated assets, the subsidy

to health insurance, which is helping to speed up the rise in health

care costs, differential tax treatment of investment in different

kinds of capital, the tax advantage to debt versus equity, the marriage penalty, the subsidy to home ownership. And I could go on,

but you get a sense that there are some major efficiency gains here

to be had.

Chairman ARCHER. Dr. Kotlikoff, sadly enough, your time has expired sometime back. But if you want to add something for a very

short period of time, the chair will be glad to receive it.

Mr. KOTLIKOFF. I appreciate that.

The knee-jerk reaction to the consumption tax by the public is

that it is regressive because the public compares consumption to

current income. But economists think lifetime income is the correct

resource measure, and consumption is roughly proportional to lifetime income. So one should think about a consumption tax as being

a proportional tax. In contrast, the payroll tax, which would be replaced under the Fair Tax proposal, is regressive relative to lifetime income. Take Bill Gates; his payroll taxes are a pittance relative to his lifetime income.

The Fair Tax gets rid of a very regressive tax. It also gets rid

of the income tax, which is progressive on a lifetime basis, but has

lots of exemptions for certain activities that the rich engage in

more than the poor. All in all, I agree with Leo Linbeck that the

Fair Tax proposal, though I have some suggestions to improve it

94

relative to what is being proposed, would improve

intragenerational equity, and as I said, it would certainly improve

intergenerational equity. Hence the Fair Tax would be a lot fairer

than what we have now.

Thank you.

[The prepared statement follows:]

Statement of Laurence J. Kotlikoff, Professor of Economics, Boston

University, and Research Associate, National Bureau of Economic Research

Chairman Archer and other distinguished members of the Committee on

Ways and Means:

I’m honored by this opportunity to discuss with you the nation’s need for tax reform and the role that consumption taxation, particularly a federal retail sales tax,

could play in enhancing the economy’s economic performance and improving its distribution of resources.

Our nation’s economy has been performing remarkably well in recent years, but

our economic success is no reason to be complacent about a tax system that is extraordinarily complex and highly distortionary and that plays a critical role in an

overall fiscal system that is likely to visit enormous burdens on our children and

grandchildren.

The complexity of the tax code doesn’t just drive taxpayers crazy. It also costs

them a significant amount of time—time that could be spent working or time that

could be spent enjoying life. Having just spent three days doing my taxes, I have

a refreshed sense of the substantial costs to the man in the street and the nation

as a whole of complying with the federal income tax code.

The distortions of our tax system also diminish the nation’s well being, but in

ways that are less transparent. Today, almost all American households are in combined federal, state, and local marginal income tax brackets of roughly 50 percent.

Because governments are collectively confiscating half of every dollar most workers

earn, most workers work many fewer hours than they would were their tax payments independent of their labor earnings. And since the government is confiscating

half of every dollar of income most savers earn on their non tax-favored retirement

accounts, many Americans choose to spend today rather than save for tomorrow.

Tax Reform’s Importance for Fiscal Sustainability and Generational Equity

Eliminating complexity and distortions would be cause enough for reforming the

federal income tax, but there is a much more pressing reason: notwithstanding recent wishful projections about future government surpluses, our fiscal house is not

in order. Indeed, getting it in order would require not cutting federal income taxes,

as some in this chamber advocate, but immediately and permanently raising them

by over 25 percent. That assessment comes not from academia, but from the Congressional Budget Office and the Federal Reserve Bank of Cleveland. A joint CBOCleveland Fed generational accounting study, to be published next month in the

American Economic Review, shows that such a tax hike is needed to achieve

generational balance—a situation in which our children and grandchildren will face

tax rates that are no higher than those we face.

The 25 percent or greater requisite tax hike is derived under the assumption that

growth in federal purchases of goods and services keeps pace with growth in the

overall economy. This responsible assumption can be contrasted with the irresponsible one underlying the projection of very large surpluses over the next few decades. The irresponsible projection, whose surpluses are routinely cited by advocates

of tax cuts and spending hikes, assumes that, as a share of GDP, federal spending

will decline by 20 percent by the end of this decade and by 30 percent by roughly

2040.

Who am I to say that the federal government won’t shrink to this extent relative

to the economy? Just a parent of a two and a nine year old who knows that such

shrinkage is highly unlikely and that basing policy on that assumption amounts to

gambling with our children’s future—an enterprise worthy of neither this Congress

nor this administration.

Our long-term fiscal position is bleak for one straightforward reason. Right now

there are about 35 million older Americans. But waiting in the wings are 78 million

baby boomers who will start collecting Social Security checks in just eight years and

Medicare benefits in just eleven years. Over the next 30 years, the number of elderly will increase by 100 percent, while the number of workers will rise by only 15

percent. This enormous disparity in the growth of the number of elderly and in the

number of those who will support them would be much greater still if the recently

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1The lifetime net tax rate is defined as the present value (to birth) of taxes paid over the

lifetime net of the present value (to birth) of transfer payments received over the lifetime divided by the present value (to birth) of lifetime labor income.

convened Technical Panel of the Social Security Advisor Board is correct in its assessment that the baby boomers will live substantially longer then the government’s actuaries now predict.

What does tax reform have to do with addressing the generational imbalance in

U.S. fiscal policy? Essentially everything. To see this, let’s start with what a tax reform would tax. Since the federal government is currently taxing wages and capital

income, the only meaningful reform would involve taxing consumption on a comprehensive basis (as opposed to levying, as it currently does, a few excise taxes).

And each of the major tax reform proposals advanced in recent years does precisely

that.

The retail sales tax clearly taxes consumption. But so does the Flat Tax. Just ask

Robert Hall, one of the originators of the proposal, who describes his Flat Tax as,

effectively, a Value Added Tax. A value added tax taxes output less investment (because firms get to deduct their investment.) Now investment equals saving, so taxing output minus investment is taxing output minus saving, which is taxing consumption, since output minus saving equals consumption.

The Flat Tax differs from a VAT in only two respects. First, it asks workers, rather than firm managers, to mail in the check for the tax payment on that portion

of output paid to them as wages. Second, it provides a subsidy to workers with low

wages. The first difference is one of form, not substance. The second is more important, but doesn’t negate the basic fact that the Flat Tax taxes consumption.

So what does taxing consumption have to do with achieving a generationally equitable fiscal policy? Again, essentially everything. The reason is that the current elderly as well as the baby boomers, who will shortly retire, have one primary economic activity left to accomplish—consumption. And under a consumption tax, they

will pay a lot more in future taxes than they would under the current tax system.

Although the elderly as a group would share in the burden of a consumption tax,

the poor elderly—those living exclusively on Social Security benefits—would not because their benefits are indexed to the consumer price level and are thus guaranteed in real terms.

To recapitulate, given the likely path of government spending and the inevitable

aging of our society, our children and our children’s children are in for extremely

rough sledding. Indeed, the CBO–FED study suggests they will face lifetime net tax

rates 1 that are 80 percent higher than those we face if nothing is done. This

generational imbalance, rather than the treatment of the rich versus the poor within a generation, is the fundamental issue of economic justice facing us today. Consumption taxation can address that issue by asking the current and near-term elderly to do their fair share in helping to achieve generational balance.

Consumption Taxation and Economic Efficiency

Consumption taxation is needed not just to help our children. It is also needed

to simplify the tax code and reduce effective marginal tax rates. The Fair Tax proposal is a case in point. This proposed reform would eliminate both the personal and

corporate federal income taxes as well as the payroll tax, and replace them with a

federal retail sales tax plus a rebate based on each household’s demographic characteristics. Compliance costs would be vastly lower under a retail sales tax. So would,

it seems, enforcement costs. The reason is that a broad based sales tax, with no exemptions for housing or any other forms of consumption, would feature much lower

effective marginal tax rates than those we now face and, therefore, much smaller

incentives to evade taxation.

The lower effective marginal tax rates under the Fair Tax would also mean much

smaller economic distortions than currently exists. This reflects the proposition,

which is well known to economists, that the welfare costs of distorting economic incentives rises with the square of effective marginal tax rates.

In addition to substantially reducing saving and labor supply distortions, a comprehensive retail sales tax would eliminate a myriad of other distortions such as the

lock-in effect on the sale of appreciated assets, the subsidy to health insurance associated with the deductibility of premium payments, the differential tax treatment

of investment in different kinds of capital, the tax advantage to debt over equity

finance, the marriage penalty, and the subsidy to home ownership.

Is Consumption Taxation Regressive?

Consumption taxation has a bad rap among the general public. It’s viewed as regressive when, indeed, it’s nothing of the sort. To economists, consumption repVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00101 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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2This sentence and the one preceding it assume the price level will rise with the adoption

of the Fair Tax. If the Federal Reserve used its monetary policy to maintain the consumer price

level, the adoption of the Fair Tax would entail a decline in the level of producer prices and,

thus, the nominal wages and capital income received by productive factors. Under this scenario,

government transfers, if they weren’t reduced in nominal terms, would end up maintaining their

purchasing power, while factor payments would not. I.e., the same real redistribution toward

the poor would arise.

resents the primary measure of economic well-being. So it makes sense to compare

households’ taxes with their levels of consumption to determine whether those who

are better off pay more than those who are worse off. But consumption is financed

not just by current income, but by lifetime resources, which consists of lifetime earnings, lifetime inheritances and gifts received, and initial net worth. So comparing

a household’s taxes with its command of economic resources requires comparing its

taxes with lifetime resources, not current income.

Since lifetime resources are either consumed or bequeathed and since bequests

will, themselves, ultimately finance consumption, taxing consumption is like taxing

lifetime resources. If consumption is taxed at a fixed rate, as in the case of the Fair

Tax and the Flat Tax proposals, the consumption tax will be proportional to lifetime

resources; i.e., the tax would be neither progressive nor regressive, but rather proportional.

So if there were no system of taxation to begin with and we introduced a consumption tax, someone with twice the level of lifetime resources as someone else

would pay twice the amount of tax. But we aren’t starting from scratch. Instead,

we are starting from a tax system with some very progressive and some very regressive elements. When measured relative to lifetime resources, the personal income

tax is highly progressive, while the payroll tax is highly regressive. And the corporate income tax is essentially proportional to lifetime income since it reduces the

net returns to all households no matter the size of their lifetime resources. The fact

that the current tax system is not strongly progressive and may even be regressive

is the reason that moving from the current system to the Fair Tax, with its progressive rebate, could end up raising the overall degree of tax progressivity.

The lifetime resource perspective leads naturally to comparisons of tax burdens

within a cohort, since the lifetime resources of the young and old will be quite different simply because of their ages. Among the elderly, the Fair Tax would be particularly progressive because a federal sales tax would lower the purchasing power

of the rich elderly who live off their assets, but not the poor elderly, whose primary

means of support—Social Security benefits-would be automatically raised in response to a sales-tax induced increase in the price level. Hence, the Fair Tax features not just a demographic rebate, but also, implicitly, a rise in Social Security

benefits. If government transfers to the poor young were also effectively indexed to

the price level, the adoption of the Fair Tax would also trigger a rise in those transfer payments as well.2

Were the very staid and well established businessmen and women who advocate

the Fair Tax to proclaim that their tax reform 1) levies a tax on the holdings of

wealth, 2) provides a highly progressive tax rebate, and 3) implies an increase in

Social Security benefits and, most likely, transfers to the poor, they would probably

be viewed as members of a vast left-wing conspiracy. But this is precisely what they

are recommending.

The fact that a consumption tax is, in part, a tax on wealth is well know to public

finance economists, but not to the general public. The reason is that when a consumption tax is levied, it lowers the amount of actual consumption that can be purchased with a given amount of wealth since some of the wealth must be spent on

the consumption taxes. Stated differently, the imposition of a consumption tax visits

an immediate real capital loss on wealth holders because their assets no longer have

as large a claim on current or future consumption.

My sense is that the Fair Tax would be more progressive than the current system

when assessed on a cohort-by-cohort basis and measured relative to lifetime income.

However, knowing the actual degree to which the Fair Tax would enhance

intragenerational progressivity requires additional empirical research based on lifetime models of consumption and saving. Such research is now underway, and I

would expect that a year from now we’ll have a pretty clear picture of the policy’s

potential impact on the distribution of resources within each generation.

The Long-Term Impact of Consumption Taxation on the Economy

In contrast to the limited empirical analysis of consumption taxation that has

been conducted to date, consumption taxation has been studied extensively with

large-scale life-cycle simulation models. My own research and that with Alan

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3See Kotlikoff, Laurence J., ‘‘Replacing the U.S. Federal Tax System with a Retail Sales

Tax—Macroeconomic and Distributional Effects,’’ mimeo, December 1996 and Altig, David, Alan

J. Auerbach, Laurence J. Kotlikoff, Kent Smetters, and Jan Walliser, ‘‘Simulating Fundament

Tax Reform,’’ forthcoming, The American Economic Review, 2001. 4Gokhale, Jagadeesh, Laurence J. Kotlikoff, and John Sablehaus, ‘‘Understanding the Postwar

Decline in U.S. Saving: A Cohort Analysis,’’ The Brookings Papers on Economic Activity, no. 1,

1996, 315–90.

Auerbach, Cleveland Fed David Altig, Kent Smetters, and Jan Walliser indicates

that the Fair Tax would raise the economy’s living standard over the long term by

roughly 15 percent.3 This long-run increase in output is generated by a major longrun increase in capital formation and a modest increase in labor supply.

Part of the reason that consumption taxation stimulates saving and labor supply

is its improved incentives to work and save. But the primary reason involves the

shifting of fiscal burdens away from young savers and onto old spenders. It is a little know, but extremely important fact that the elderly in our country have much

higher propensities to consume out of their remaining lifetime resources than do the

young and certainly than do the unborn, whose propensities to consume in the

present is, of course, zero. The fact that the elderly consume their remaining resources at a higher rate than other generations is precisely what the standard economic theory of saving—the life cycle model of Nobel Laureate Franco Modigliani—

predicts. This explanation for this prediction is intuitive; the elderly are closer to

the end of their lives than are the young and are, therefore, running short on time

to spend their resources. To compensate, they have to spend at a faster rate.

As described in Gokhale, Kotlikoff, and Sablehaus (1996), essentially all of the decline in the rate of U.S. saving in the postwar period can be traced to the government’s five-decade long policy of taking ever larger sums from the young and giving

them to the old.4 This intergenerational redistribution, carried out primarily

through Social Security, Medicare, and Medicaid, has led to a dramatic rise in the

absolute and relative consumption of the elderly. Since 1960, for example, the

elderly’s share of economy-wide consumption has increased more than four times

fast than has their share of the population. Typical 70-year olds are now consuming

roughly twice the amounts consumed by typical 30-year olds. In 1960, by contrast,

70-year olds consumed less than three quarters of the amounts consumed by 30 year

olds.

In shifting to a consumption tax, the U.S. would shift more of the tax burden onto

the current middle class and rich elderly and partly reverse the postwar process of

taking from the young and giving to the old. In addition to depressing national consumption and raising national saving, the switch to consumption taxation would, as

indicated above, ameliorate our grievous imbalance in generational policy.

The simulation studies also show substantial long-run welfare gains for all lifetime income classes from switching to consumption taxation. Indeed, under the Fair

Tax, the initial upper income elderly are the only ones to suffer welfare losses during the transition.

Tax Rates

Simulation analysis and a variety of empirical calculations suggest that the retail

sales tax rate needed for revenue neutrality under the Fair Tax, assuming no decline in the real value of government purchases, would be roughly 30 percent when

measured on a tax-inclusive basis. This tax rate could be expected to decline by 3

or so percentage points over time as the economy expands. Moreover, if the Fair Tax

were structured to include the consumption of existing housing services in its tax

base, the initial Fair Tax rate would probably be about 3 percentage points lower.

This could be accomplished by assessing the tax on the imputed rent on housing,

where the calculation of imputed rent is based on a fair market valuation of housing

real estate. This valuation could be done by local municipalities in the course of appraising houses for local property taxes.

A tax-inclusive consumption tax rate of 30 percent translates into a tax-exclusive

consumption tax rate of 43 percent. While the 43 percent rate sounds very high,

proper comparison of the Fair Tax tax rate with the current payroll and income tax

rates requires evaluating the consumption tax rate on a tax-inclusive basis. Even

a 30 percent tax rate may sound like a high rate. But one needs to bear in mind

that middle and upper income households in America are typically in combined income tax and payroll tax marginal tax brackets of 40 percent or more and that low

income Americans are typically in even higher tax brackets once one considers the

phase out of the earned income tax credit. Hence, given the state of U.S. marginal

taxation, 30 percent is a low number.

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Transition Issues

Shifting to a consumption tax requires thinking carefully about transition issues.

In the case of the Fair Tax, one would want to make sure that the vast sums that

have been accumulated tax free in retirement accounts not avoid taxation. How this

could be accomplished fairly and quickly is not altogether clear. But what is clear

is that the large amount of revenue to be raised here could help limit the size of

the Fair Tax Rate. Note that this problem doesn’t arise under the Flat Tax because

the Flat Tax maintains an explicit tax on labor income and retirement account withdraws are included in the labor income tax base.

While the Flat Tax deals with this transition issue much more easily than does

the Fair Tax, the Fair Tax avoids the potential for special transition rules that

would favor existing business capital under a Flat Tax and, thereby, dissipate the

tax’s implicit taxation of existing wealth.

Transparency and Perceived Fairness

The Fair Tax would be easily understood by the general public, and it would be

clear to all that everyone—rich and poor alike—pays the tax. In contrast, under the

Flat Tax, wealthy individuals who have no labor income will appear to be paying

no tax when, in fact, they will implicitly do so through the revaluation downward

of the market value of their assets, assuming no special transition rules in behalf

of those assets.

Conclusion

The Fair Tax has a lot to recommend it. It would most likely help the poor more

than the rich. It would substantially improve the economy’s economic performance.

It would save Americans enormous amounts of time complying with the bewildering

provisions our current tax code. And it would redress the grave intergenerational

imbalance America still faces with respect to its fiscal policy.

Chairman A

Mr. Wilkins?

RCHER. Thank you, Dr. Kotlikoff.

f STATEMENT OF JOHN G. WILKINS, MANAGING DIRECTOR,

BARCROFT CONSULTING GROUP, ON BEHALF OF THE NATIONAL RETAIL FEDERATION

Mr. WILKINS. Thank you, Mr. Chairman. My name is John Wilkins. I am managing director of the Barcroft Consulting Group, and

I am here on behalf of the National Retail Federation. My statement reports on the findings of a PricewaterhouseCoopers study, of

which I was principal author.

Nine years ago, Mr. Chairman, I testified before this committee

on international competitiveness, and I observed that a greater reliance on taxing consumption and a lesser reliance on taxing income would be healthy for the economy. I continue to hold that

view, but I do not subscribe to abandoning the income tax altogether and replacing it with a sales tax. Our study shows that

there could be very harmful results in the short run as a consequence of that action.

In the early 1990s, Coopers & Lybrand undertook to develop an

economic model that combined the personal income tax and the corporate income tax models that are used by the Joint Committee of

Taxation’s staff and the Treasury’s staff for revenue-estimating

purpose, combining those with a large-scale macroeconomic forecasting model, retaining the best features of all three models.

Unlike many other models, the model includes foreign trade and

other international transactions. The model permits the economy to

be in disequilibrium, which is important during transition periods.

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The model’s database includes 100,000 households and 15,000 corporations; whereas, other models sometimes have only a handful or

sometimes only one. The model tracks 85 different industries, producing 85 different products.

However, the most distinguishing feature and important characteristic of the model is that it focuses on the near term. It forecasts detailed information on the performance of the economy on a

year-by-year basis as the economy makes the transition to a national sales tax regime. And the model shows that this transition

may not be nearly as smooth or as simple as we may like.

Much of the discussion today surrounding the sales tax is centered on the tax rate. On the usual tax-exclusive basis of State

sales tax rates, the rate for H.R. 1467 would be 18.8 percent if

there were 100-percent compliance, there were no exemptions or

transition rules and only revenue and not the budget were required

to be kept in balance. The Fair Tax rate would be somewhat higher

because it also repeals the payroll tax.

Since tax changes will affect the spending side of the budget, as

well as the revenue side, a more meaningful measure of budget

neutrality would raise that 18-percent rate I mentioned to 24 percent. However, that rate would still rely on what I would consider

an unrealistic assumption that compliance will be 100 percent. If

compliance turns out to be no better than it is under the Federal

income tax, then that rate would have to go up further to 29 percent. And if financial services, rental housing and employer-provided fringe benefits are taken out of the base, as many believe

would eventually be the case, then the budget-neutral tax rate goes

up to 37.5 percent. Last, if States add on their income tax and their

sales tax in a piggyback fashion, which would undoubtedly be the

case, then the rate facing consumers would be 53.6 percent and

could rise to 64 percent, if compliance slips down to the level applicable to proprietors’ income.

In the long run, the economy will perform better under a sales

tax. By 2010, we predict that real GDP would be up some $178 billion, real personal consumption will be up $16.5 billion, national

savings will be up thanks to higher personal savings and higher

corporate savings. These salutary accomplishments are similar in

direction, if not magnitude, to the long-term findings of other studies you will hear about.

It is the short-term results, however, that concern me. In the

short run, there will be a speed-up of consumer purchases in anticipation. This will cause a temporary economic downturn when the

tax actually becomes effective. The economy will shrink by 1.1 percent in the first year of the tax and GDP will remain below the

baseline until the fourth year. Personal consumption will be lower,

in real terms, until the ninth year; corporate profits will be about

2 percent lower, on average—although some will be higher and

some will be lower than that throughout the tenth year. After that

period, we see profits rising. Employment will be lower than expected through the fourth year of the tax with 1.5 billion jobs lost;

prices are predicted to rise by roughly the tax rate, although eventually the price rise will subside as the economy picks up steam;

and investment will increase some 7 percent, with roughly a third

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of that financed by foreign capital. Corporations will finance about

half of their new investment through retained earnings.

In conclusion, keeping within my 5 minutes, Mr. Chairman,

while it is important, very important, to seek a fairer and simpler

tax structure—as you have explained—to replace the incredibly

complex code we have today, swapping the income tax for a sales

tax is an experiment that could bring our flourishing economy

down. It is not one we ought to be trying now.

Thank you, Mr. Chairman.

[The prepared statement follows:]

Statement of John G. Wilkins, Managing Director, Barcroft Consulting

Group, on behalf of National Retail Federation

Mr. Chairman and Members of the Committee:

I am managing director of the Barcroft Consulting Group and I am here on behalf

of the National Retail Federation. My statement reports on the findings of a study

undertaken by PricewaterhouseCoopers (‘‘PWC’’) for the National Retail Federation

Foundation. I was principal author of that study, which examines the economic impact of substituting a national retail sales tax (‘‘NRST’’) for the federal income tax.

Introduction

Nearly nine years ago, I testified before this committee on the issue of international competitiveness and the role of income taxation. In that statement, I noted

that the United States relied less on consumption and more on income taxes to finance government than virtually all of the other industrialized nations—even when

state retail sales taxes are included in the equation. Although our income tax structure is by no means a pure income tax—having some elements of a consumption

tax mixed in with an income tax—I nonetheless observed that a greater reliance on

taxing consumption and less reliance on taxing income, would be healthy for the

economy by spurring savings and helping keep income tax rates low. That was 1991

and this is 2000. And I continue to hold that view.

While I applaud the desire of the chairman to replace the current tax code with

something that is simpler and fairer, I do not, however, subscribe to abandoning an

income tax altogether and replacing it with a national sales tax. As our study

shows, this could have very harmful short-term and mid-term economic results. In

light of the remarkable economic achievements of the past decade, it would be foolish to simply get rid of a tax structure under which the economy is flourishing and

replace it with an untried system with uncertain economic consequences.

The PWC study, largely completed last year when I was director of

PricewaterhouseCoopers’ national economic consulting group, focuses on the economic impact of replacing the income tax with a national sales tax similar to the

Fair Tax proposal. The proposal examined was H.R. 1467 rather than H.R. 2525,

which had not been introduced at the time of the study. One significant difference

is that H.R. 1467 does not repeal federal payroll taxes while the Fair Tax, H.R.

2525, does and consequently requires a higher tax rate.

What follows is a discussion of (1) why the PWC dynamic model is particularly

capable of recognizing the effects of a national sales tax on the economy in general

and on retailers in particular; (2) why the proposed national sales tax rate could

eventually be much higher than proponents advertise due to likely exclusions, the

need for budget neutrality, and transition rules; and (3) what impact this kind of

tax would have on short-term and long-term economic growth, consumption, corporate profits, employment, and trade.

The Dynamic Estimating Model

In the early 1990s, Coopers & Lybrand undertook to develop an economic model

that was missing from the arsenal of tax analysis tools available to government

economists and others concerned with the potential economic impact of fundamental

tax reforms. The traditional microsimulation models used by the staff of the Joint

Committee on Taxation (‘‘JCT’’) and the Treasury Department’s Office of Tax Analysis for revenue estimating purposes are based on large samples of individual and

corporate taxpayers and consequently are ideal for analyzing the impacts of tax law

changes on the taxpayer population. These models are not, however, capable of analyzing the impact of fundamental tax reforms on the economy. For such analysis

economists turn to macroeconomic models. Unfortunately, macroeconomic models

are rarely designed for tax analysis: they frequently have only two or three proVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00106 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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ducing sectors; some have only a single household or a handful of households to represent the entire population of taxpayers and consumers; and most examine the

economy only when it is in equilibrium, with labor and other resources artificially

restricted to be at full employment.

The PWC model was designed specifically for analysis of tax reforms, such as the

replacement of the income tax with a NRST. In order to retain the benefits of the

microsimulation models used by the JCT and the Treasury, the PWC model has

three prongs, incorporating two microsimulation models with a macroeconomic forecasting model. The two microsimulation models are an individual income tax model

with 100,000 separate tax return records and a corporation income tax model with

15,000 synthetic tax return records. The third prong of the overall model is a macroeconomic forecasting model that provides year-by-year short-term forecasts of the

economy as well as mid-term and longer-term forecasts. Importantly, the PWC

model has the following traits that distinguish it from most other models: • The PWC model contains an open economy, allowing changes in foreign trade,

cross-border investment flows and exchange rate adjustments. Many models are restricted to closed economies that ignore the existence of foreign trade and other

international transactions. • The PWC model permits the economy to be in disequilibrium during transition

periods. Most other models artificially force the economy to always be in equilibrium, with no unemployment of labor and other resources—even during periods

of transition from an income tax to a sales tax. • The PWC model’s database includes records for 100,000 households and 15,000

corporations. Most models include only a handful of households and corporations.

Sometimes only one household represents the entire household sector. • The PWC model tracks 85 different industries, producing 85 different products

for intermediate and final sales.

Most models represent the entire producing economy with only two or three industries frequently producing only two or three different classes of goods.

The most important distinguishing characteristic of the PWC model is that it focuses on the near and intermediate term. The key feature is the model’s ability to

forecast detailed information on the performance of the economy on a year-by-year

basis as the economy makes the transition from an income tax structure to a sales

tax structure. The PWC model shows that this transition is not nearly as smooth

and simple as some sales tax proponents would like. It is this ability of the model

to provide short-term transition results on an annual basis that provided the main

impetus for its construction.

The PWC model has been used successfully to evaluate a wide range of tax proposals, from the recommendations of the Kemp Commission to the national sales

tax. The model was also used to produce dynamic revenue estimates for the January

1997 symposium on dynamic revenue estimating sponsored by the staff of the Joint

Committee on Taxation.

Required Tax Rates

Much of the discussion surrounding national sales taxes centers on the required

tax rate. This rate depends obviously upon the tax base—all consumption or some

portion of consumption after certain exclusions. It further depends upon the amount

of taxes to be replaced on a neutral basis. It also depends upon the degree of compliance—100 percent or some lesser fraction as is the case with the income tax. Lastly,

it depends upon mitigating provisions such as increased social security benefits for

the elderly designed to prevent too much double taxation of their lifetime earnings,

family allowances designed to prevent some of the associated redistribution of tax

burden and other transition rules designed to lessen short-term economic disruptions.

Tax Exclusive and Tax Inclusive Tax Rates. The discussion of tax rates is confused

by the practice of proponents of the NRST to couch the rate in so-called tax inclusive terms. Sales tax rates are usually considered on a tax exclusive basis. Under

this normal tax exclusive concept, for example, a $30 tax on a $100 item is considered to represent a 30 percent tax rate. The consumer would pay the retailer $130,

$30 of which would be forwarded to the tax authorities.

Proponents of national sales taxes like to measure the tax rate in this example

by dividing the $30 tax by the tax inclusive price, which is $130. The tax rate calculated this way would be only 23 percent (30/130). Under the tax inclusive rate

concept, confusion is likely to arise when a customer is quoted a 23 percent tax inclusive rate on a $100 purchase and finds the sales clerk asking for $130.00 ($100

plus $30 tax) rather than the expected $123.00 ($100 plus $23 tax). The confusion

will be reinforced by the fact that all state sales taxes are always quoted on the

normal tax exclusive basis.

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Revenue Neutral vs. Budget Neutral Tax Rates. A second concern in determining

the appropriate rate for a national sales tax that would replace other existing federal taxes involves the concept of neutrality. Most believe that any replacement tax

ought to be neutral: the government should be left as well off under the replacement

tax as it is under the current tax structure. Independent of its political appeal, neutrality focuses the spotlight on the economic pluses and minuses that could result

from restructuring the tax system as opposed to the consequences of making the

government bigger or smaller, which can be done without restructuring the tax system.

There are two ways to identify neutrality (revenue and budget) and two ways of

measuring neutrality (static and dynamic). Revenue neutrality means that the replacement tax raises the same revenue as the current tax. Budget neutrality means

that the replacement tax leaves the overall budget surplus (or deficit) unchanged.

Budget neutrality is the better measure because it recognizes that, by influencing

the price of government purchases, interest rates, or transfer payments, for example, tax changes can affect the spending side of the budget as well as the revenue

side.

Static measurement of budget neutrality fails to take account of how a replacement tax influences the budget by accelerating or retarding economic growth. Dynamic measurement of budget neutrality corrects this shortcoming by taking into

account macroeconomic effects, such as a short-term change in the level of employment, that can affect government spending and revenue. The dynamic measure of

budget neutrality is the most meaningful concept for a replacement tax.

These concepts can be illustrated as follows. According to the PWC model, a very

broad-base national sales tax, such as the Tauzin-Traficant proposal to replace the

current federal personal and corporate income taxes, the federal estate and gift tax,

and most federal excise taxes would require a tax exclusive rate of 18.8 percent

under the somewhat unrealistic assumption of 100 percent compliance and revenue

neutrality. This rate would be a 15.8 percent rate on a tax inclusive basis, reasonably close to the 15 percent claimed by the sponsors. In order to maintain budget

neutrality—even on a static basis—the rate would have to be raised from 18.8 percent to 24.5 percent. This is because the federal government would want to fully

maintain the purchasing power of all transfers payments (social security, welfare,

unemployment, etc.) in order to protect the elderly, the poor, and other transferees.

In order to do so, these transfer payments must be increased by the amount of the

tax on the goods and services they would purchase. Holding recipients of federal

government transfer payments harmless in this manner while maintaining real federal spending on goods and services requires a budget-neutral NRST rate of 24.5

percent (or 19.7 percent on a so-called tax-inclusive basis)—still figured at an unrealistic 100 rate of compliance.

On a dynamic basis, this 24.5 percent budget neutral tax rate could be lowered

slightly to 24.1 percent by the tenth year of the tax, thanks to a somewhat improved

economy; however, there are still other concerns involving base erosion and compliance that need to be factored in before an ultimate budget neutral tax rate can be

determined.

Compliance. Most experts concede that it is difficult to estimate the rate of compliance under a NRST. What is not in dispute, however, is that the compliance will

be lower the higher the NRST rate. Moreover, while state sales tax rates appear

to have relatively high rates of compliance, these compliance rates are not comparable to the NRST. State sales tax compliance is high because the sales tax rates

are relatively low—typically 4 to 6 percent—and their tax bases are relatively narrow. Unlike the value added tax, there is an incentive on the part of both consumers

and sellers to avoid the tax. Individuals could easily avoid the NRST in a number

of ways, such as disguising personal consumption expenditures as business costs

that would not be subject to tax.

If tax compliance is no better than the 83 percent overall compliance rate under

the federal income tax, the budget neutral tax rate would have to be raised from

24.1 percent to 29.0 percent. If compliance matches compliance rate for proprietors

under the federal income tax, then the budget neutral rate would be raised another

5.9 points to 34.9 percent. Keep in mind that the compliance rates under the income

tax are strengthened by forced compliance of withheld tax on wages and by numerous checks and balances payer-provided information returns and audits.

Exemptions and Allowances. Many have observed that enactment of a NRST

would encourage many special exemptions from the base. Three of the most frequently mentioned are:

• removing consumption of financial sector services entirely from the base, since

the taxation of such services is, at best, extremely complicated and would be difficult to administer;

103

• removing rental housing services and the resale of existing homes from the tax

base so as to continue a current-law tax preference and to mitigate problems arising

from unequal treatments of owner-occupied and rental housing; and • removing employer-provided fringe benefits from the tax base so as to vastly

simplify the tasks of businesses, which would otherwise be untaxed.

The effect of removing these items from the NRST base would cause the budget

neutral tax rate to rise to 37.5 percent with compliance equal to overall income tax

compliance and to 45.1 percent with compliance equal to income tax compliance of

proprietors.

Effect of State and Local Tax Piggybacking. Once states lose their ability to piggyback their income taxes off the federal income tax, it is anticipated that many would

elect to instead piggyback their revenue needs by adding a state sales tax rate to

the federal rate. For consumers, this would further boost the overall rate on consumption to 53.6 percent assuming overall income tax compliance and to 64 percent

assuming proprietor’s income tax compliance. These figures assume the above exemptions and allowances would be established.

The PWC model is not alone in estimating tax rates for the NRST that are considerably higher than proponents frequently cite. A National Bureau of Economic Research study place the tax rate at 27.3 percent if payroll taxes are not included in

those taxes to be replaced and 45.4 percent if payroll taxes are also replaced. A

Joint Economic Committee (‘‘;JEC’’) study concluded that the NRST rate would have

to be at least 32 percent unless imputed items of consumption, like ‘‘rent’’ that the

national income accounts assume homeowners pay themselves were also included in

the base. Furthermore, if food, medicine, and physician’s services were excluded (as

is commonplace among many state sales taxes) the rate would have to rise from 32

percent to 49.3 percent. Alternatively, they found that if all services were excluded

from the base but food and medicine continued to be taxable, the rate would have

to rise to 64.6 percent.

Impact of the NRST on the Economy

In the long run, the economy will perform somewhat better under a NRST. The

results of the PWC model show: • By 2010 real GDP will be higher by $178 billion (1.8 percent) and will remain

above baseline throughout the forecast period. • By 2010 real personal consumption expenditures will be higher by $16.5 billion

(0.3 percent) and will remain above baseline throughout the forecast period. • Throughout the forecast period national private savings is higher than under

the baseline thanks to higher personal savings as consumers delay consumption and

higher corporate savings as businesses reinvest a large portion of undistributed corporate profits.

These salutary accomplishments are similar in direction to findings of other studies. Only the magnitudes may differ. It is in the short run that the PWC study finds

harmful results.

Economic Growth. Gross domestic product (‘‘;GDP’’), the value of all goods and

services produced in the country, would increase in real terms in anticipation of the

enactment of the NRST, as consumers speed up purchases they would otherwise

make at a later date.

The aftermath of the speedup is a sharp economic downturn in the year the tax

becomes effective. Instead of achieving an expected 2.0 percent rate of real growth

in 2001, the assumed first year of the tax, the economy would shrink by 1.1 percent.

Although the economy would begin to grow again in subsequent years, it would take

until the fourth year of the tax for GDP to reach its pre-NRST level. Before the

economy fully recovered, the cumulative loss in real GDP (measured in 1992 dollars)

would reach $180 billion and annual employment would dip by 1.5 million jobs. By

2010, real GDP under the NRST would be 1.8 percent above the level that the current income tax would have achieved. Given a growth forecast of about 2.3 percent

per year, the 1.8 percent of additional GDP represents only a 9-month speedup in

economic growth over a ten-year period.

Consumption. Personal consumption expenditures in real terms would be below

the current-law baseline until the ninth year after the NRST was introduced. During the 2001–2008 period, the cumulative decline in consumer spending (measured

in 1992 dollars) would exceed $500 billion. Over the first five years of the tax, consumption would be 1.5 percent lower on average than it would be under currentlaw tax; and over the second five years, consumption would be down 0.2 percent

from expected levels.

The overall drop in consumption and the subsequent pickup as the economy recovers masks many important details. Consumption changes will vary greatly according

to income levels and according to items of consumption. Changes in consumer purVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00109 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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chases reflect the fact that the NRST generally shifts the tax burden away from

higher income families and toward lower income families. Although the poorest of

the poor may be roughly compensated for their loss of the refundable earned income

credit by repeal of the payroll taxes, the moderately poor and many in the vast middle class must have higher overall tax burdens in order to balance those with the

highest incomes whose consumption taxes would be far smaller than their income

taxes. Households with incomes in the bottom fifth of the income scale would have

to reduce their purchases of durable goods by 13 percent on average for the second

five years after introduction of the NRST and purchases of nondurable goods by 6

percent. In contrast, households with incomes in the top fifth of the income scale

would increase their purchase of durables by an average of 2.4 percent and their

purchases of nondurables by 0.3 percent for that same period.

Saving and Investment. In nominal terms, the net private saving of U.S. residents

and businesses under the NRST would be about 18 percent higher than under current law for the ten-year period, 2001–2010. Government saving is assumed to be

virtually unaffected (that is, the NRST is assumed to be a budget-neutral replacement for current-law taxes that would be repealed). For that same period, personal

saving would be higher by about 15 percent. The nominal dollar increase in private

saving would come about equally from personal saving and corporate saving. Corporations would be expected to finance about half of all induced new investment

through their own saving, by retaining approximately 15 percent of the repealed corporate income tax. The remaining 85 percent of the corporate income tax would be

distributed to shareholders in the form of increased dividends.

Over the ten-year period, 2001–2010, induced gross private domestic investment

would add another 7 percent to the amount of nominal investment under current

law. This increase in investment is nearly twice as large as the increase in gross

national saving. Consequently, roughly half of all induced investment is foreignowned investment flowing into the United States in response to lower financing

costs and the elimination of the Federal corporate tax on equity income. Although

most of the growth in real investment occurs in the business sector, most of the increase in nominal investment can be attributed to the rise in the price of residential

investment due to the tax on new construction under the NRST.

Corporate Profits. On average, corporate profits are about 2 percent lower over the

ten-year period, 2001–2010; however, there are notable exceptions for certain industries and certain years. In the aggregate, profits return to the level expected under

current law by the year 2010, and are expected to improve thereafter.

Employment. Due to the near term decline in consumer spending, private sector

jobs and civilian employment are expected to be lower than they would be under

current law through the fourth year of the NRST. The near term estimate would

indicate a drop of 1.5 million jobs. Thereafter, jobs and employment will pick up.

The labor force is expected to expand by about 1 percent as potential second earners

and others are lured into the workplace by vastly lower taxes on wages and salaries

and entrepreneurial income.

Anticipatory Consumption Speedup. Introduction of a NRST is expected to create

a speedup in purchases of goods and services between the time the tax is announced

and the time it becomes effective. If the NRST were imposed as of January 1, 2001,

a surge in personal consumption of both domestically produced and imported goods

and services would occur in 2000. In addition, equipment investment would accelerate to take advantage of depreciation deductions in the year 2000 before the income tax is repealed. Together, these factors produce a temporary drop in personal

saving and a temporary rise in the real rate of economic growth in 2000. Real GDP

in 2000 is estimated to be 2.8 percent above the level that would have been obtained

in the absence of a proposed NRST. Thereafter, real GDP is depressed by $180 billion from 2001 through 2003. By 2004, real GDP has recovered to pre-tax change

levels, and remains above the pre-tax change baseline throughout the remainder of

the forecast period.

After the speedup in spending in 2000, personal consumption expenditures remain

$500 billion lower than they would otherwise be until the year 2009. In other words,

during the first eight years of the NRST, consumption would be depressed as families and individuals respond to the tax by saving more and spending less. It is only

after disposable income increases sufficiently that consumption picks up enough to

pass the pre-tax change baseline level.

Real investment in equipment is down in 2002 from the pre-tax change baseline

due to the tax-motivated speedup of investment into 2000. Thereafter, equipment

investment is higher as businesses respond to a lowered cost of capital. Real investment in non-residential structures is down in 2003 and 2004, but picks up significantly after 2004. However, real investment in residential structures remains below

pre-tax change baseline levels over the entire 2002–2010 period.

105

Prices. Prices for consumer goods and services quickly rise by the amount of the

tax, and then some. The portion of the price increase in excess of the tax is due

in part to the higher cost of imports (from the weaker dollar) coupled with the ability of some domestic producers of competing goods to hike their price to that of imports. Consumer prices similarly rise 25 percent—roughly the nominal rate of sales

tax, unadjusted for any exemptions or transition rules—by 2002 and gradually drop

from that peak to a level that remains about 18 percent above the pre-change baseline.

Examined on a year-over-year basis, these price increases generally amount to a

large, one-time hike in prices as the NRST is imposed, with some moderation of this

increase in the longer run. Due to a weaker dollar, merchandise import prices increase by nearly 4 percent shortly after the NRST is imposed and are 6.5 percent

over baseline levels in 2010. Merchandise export prices are also above baseline levels. In 2001 and 2002 they are nearly 3 percent above the baseline. However, due

to lower interest rates, which reduce business costs, export prices are only slightly

greater than baseline levels for most of the remainder of the forecast period. The

overall impact on prices is measured by the change in the GDP deflator, which initially rises 20 percent above the baseline price level before settling back to a 13 percent price rise relative to the baseline.

The notion espoused by some that pre-tax prices would drop some 20–30 percent

under a NRST (so that after-tax prices would not rise and may even decline) is a

peculiar one. This could only happen if all of the personal income tax, the corporation income tax and payroll taxes are currently embodied in retail prices. Tax incidence—that is, who actually bears the ultimate tax burden—is an elusive question

that has been the focus of many economic papers, because the answer is not clear.

However, the general consensus among economists is that perhaps a portion of the

corporate income tax may be passed on to consumers in the form of higher prices,

but that the majority is ultimately paid by corporate owners in the form of lower

after-tax profits and by employees in the form of lower compensation. Most economists concede that personal income taxes and payroll taxes are ultimately borne by

labor and are not passed on to consumers in the form of higher prices.

Nominal Output. In nominal terms, personal consumption expenditures are expected to be above their baseline level by $1,582.9 billion per year on average for

the 2006–2010 period. This represents an increase of 18.3 percent over the average

that would have occurred in absence of the NRST. Note, because prices would be

18.5 percent higher, on average, for this period, this nominal increase is consistent

with a slight real decline in real consumption expenditures during this same period.

Trade. Merchandise exports and imports are both impacted by the NRST. Exports

are made relatively cheaper to foreigners because the dollar is somewhat weaker

under the NRST. Imports are subject to the NRST and are also more costly for U.S.

consumers to buy due to the weaker dollar. As expected, in real terms, exports grow

about 4.3 percent over the baseline during the last five years of the forecast period,

2006–2010; and imports drop an average of about 1.6 percent during that same period. In nominal dollar terms, both exports and imports are larger than under current law due to the sharp price increases for imports discussed above. Real net merchandise exports increase by $448 billion (in 1992 dollars) over a ten-year forecast

period. However, over the same ten-year period, net merchandise exports in nominal

dollars decline by $68 billion relative to the baseline. This nominal merchandise

trade deficit helps to finance domestic investment.

Conclusion

If a NRST is enacted, the U.S. economy would lag behind for at least three years

and employment would dip by more than one million jobs. Beneficial effects would

not be felt for at least five years after adoption. While it is admirable to seek a fairer and simpler tax structure to replace the incredibly complex income tax code, trading an income tax in for a national sales tax is an experiment that could bring serious harm to a flourishing national economy. Uncertain long-run benefits are far insufficient to risk the short-run setbacks in virtually all sectors of the economy.

Chairman A

Our next witness is Dr. Metcalf. You may proceed, Doctor.

RCHER. Thank you, Mr. Wilkins.

f

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STATEMENT OF GILBERT E. METCALF, PROFESSOR OF ECONOMICS, TUFTS UNIVERSITY, MEDFORD, MASSACHUSETTS,

AND RESEARCH ASSOCIATE, NATIONAL BUREAU OF ECONOMIC RESEARCH

Mr. METCALF. Thank you. I am Gilbert Metcalf, a professor of economics at Tufts University and a research associate at the National Bureau of Economic Research.

I appreciate the opportunity to speak before this committee on

the topic of tax reform, and I would like to focus, first, on the issue

of fairness or progressivity, and second on the issue of the relative

merits of a national retail sales tax versus alternative consumption

tax proposals.

First, the issue of progressivity. As has been noted before, consumption taxes look very regressive when households are distributed by annual income. People tend to earn the highest incomes in

their life around middle age and the lowest incomes in their youth

and old age. And consequently, in an annual income analysis, lower

income groups are likely to include some young and elderly people

who are not poor in a lifetime sense. Similarly, higher income

groups are likely to contain some people at the peak of their age

earnings profile, for whom peak earnings are a poor measure of annual ability to consume.

In previous research, I have considered the distributional impact

of a replacement of the personal and corporate income tax with the

national sales tax, and while the analysis does not capture the precise nature of the Fair Tax proposal, it is close enough to demonstrate a number of key points. That research, summarized in my

written testimony, shows the following:

First, using an annual income analysis, a national sales tax, with

family allowances similar to the Fair Tax, would look highly regressive. But when a lifetime income analysis is undertaken, when

we think of people’s resources over their entire lifetime, then the

tax reform looks much more distributionally neutral.

And this lifetime distributional neutrality of the sales tax depends importantly upon the family allowances that the Fair Tax

proposes or allowances similar to the ones that the Fair Tax proposes. And without these, the sales tax reform looks moderately regressive, even on a lifetime basis.

A second aspect of a consumption tax reform bears mentioning,

and there has been some allusion to this. In the shift from an income to a consumption tax, existing wealth is subjected to a onetime wealth tax. This by itself provides a great deal of progressivity.

So let us see how this works. Existing wealth is subjected to the

national sales tax at the time that it is spent. So imagine that I

have a million dollars in existing savings and a national sales tax

at a 30-percent rate is imposed, if I spend that million dollars immediately, I will pay $300,000 in sales tax and consume $700,000

in goods and services. The same result arises if instead of a sales

tax I am subjected to a 30-percent initial wealth tax. The retail

sales tax effectively taxes away 30 percent of that initial wealth,

and this example generalizes. No matter when I spend that wealth

on consumption or even if I die and leave that money to my chilVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00112 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
107

dren, I end up, under the retail sales tax, in exactly the same boat

as under a one-time tax on initial wealth.

In addition to adding progressivity to the reform, this one-time

tax adds efficiency, since this is a lump-sum tax, which is the most

efficient of all taxes.

Next, let me turn to the second point, the relative merit of a

sales tax versus other forms of consumption taxes. It seems to me

that one of the greatest difficulties that the proponents of the flat

taxed faced was the perception that rich people would avoid taxation, since they were not subject to taxation at the personal level,

and that problem is eliminated under a sales tax.

And we have talked about the transparency of the sales tax as

one of its virtues. This transparency extends to the problem of

transition giveaways. Unlike other forms of consumption taxes, any

efforts to provide advantages to certain sectors or to grandfather

existing capital from the wealth tax I just mentioned, would be

highly visible.

And so to the extent that Congress wishes to enact a clean tax

reform, and I hope that is the intent of this committee, this visibility provides support for that effort. Avoiding the transition compensation to old capital will allow a lower tax rate, greater progressivity and larger efficiency gains from the reform.

There has been a lot of discussion of the appropriate tax rate. Let

me focus on tax-inclusive tax rates to be comparable to income tax

rates. The 23-percent tax rate is achieved in the Fair Tax proposal

that I have seen by subjecting Government purchases to the sales

tax and assuming that Federal spending will be held constant.

This, in effect, subjects Government to a substantial spending cut,

and I think needlessly mixes issues of tax reform with the issue of

the appropriate size of Government.

I calculate a tax rate of roughly 33 percent would be required to

achieve a revenue-neutral reform; yet, as Dr. Kotlikoff has noted,

even a 30-percent rate or 33-percent rate leaves a middle-income

worker facing a 15-percent Federal tax rate and 15.3-percent payroll tax rate unaffected at the margin.

Second, the experience at the State and local level with sales tax

is that there is enormous pressure to exempt certain goods and

services from taxation, and Congress must resist this temptation at

the Federal level. The rebate on spending on amounts up to the

poverty level appropriately addresses distributional concerns and

further exemptions would only reduce the efficiency gains from the

reform, while adding complexity to the administration of the tax.

So, in conclusion, consumption tax reform is one of a number of

attractive options for improving the current tax system, and of

course other possible options would be to simplify the current income tax. The Fair Tax proposal, here before you today, has many

attractive features. But I think its success depends, importantly, on

its being a clean reform with few transition rules and tax-base exemptions.

Thank you.

[The prepared statement of Mr. Metcalf follows:]

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1This research is presented in Metcalf (1997).

2More precisely, the numerator is the change in real disposable inicome resulting from the

change in the tax law. If a new tax is imposed, the change in disposable income might occur

because prices have gone up so that a given income purchases fewer goods and services or it

might occur because have fallen. 3Table 8–2, page 290 of Gale, Houser, and Scholz (1996).

Statement of Gilbert E. Metcalf, Professor of Economics, Tufts University,

Medford, Massachusetts, and Research Associate, National Bureau of Economic Research

Introduction

I appreciate the opportunity to submit written testimony to the Committee on

Ways and Means on the very important topic of fundamental tax reform. Just over

four years ago, I had the privilege of participating in an Issues Seminar on tax reform hosted by this committee at Airlee House in Virginia. While the bills before

this committee may be different than those under consideration four years ago, the

issues have not changed.

Much of my research on the topic of tax reform has focused on distributional considerations. The main result from that research is that the focus on annual income

as a measure of individual welfare significantly biases distributional analyses of

consumption taxes towards making them look more regressive than they are when

an individual’s lifetime earnings possibilities are taken into account. In this testimony, I’d like to review why annual and lifetime income perspectives lead to such

different results and then to present some findings from research that I have conducted using the Consumer Expenditure Survey.1

II. Background

An incidence analysis attempts to answer the question of who bears the burden

of a particular tax. Any attempt to evaluate the ‘‘fairness’’ of a tax (or a change in

the tax system) requires knowing whose disposable income is changed and by how

much in response to the tax. Economists often refer to taxes as ‘‘regressive’’ or ‘‘progressive.’’ There is often some confusion as to the meaning of these terms and so

it is worth defining them carefully. The definition that most economists use relies

on the average tax rate—the ratio of tax liabilities to income.2 A tax is said to be

regressive if the average tax rate falls with income. It is proportional if the average

tax rate is constant and it is progressive if the average tax rate rises with income.

Low income people pay a higher (lower) fraction of their income in taxes if the tax

is regressive (progressive).

Early tax incidence studies used the results of partial or general equilibrium models to inform judgments about relevant incidence results. In effect, these studies

used existing research results to generate plausible assumptions about the incidence

of specific taxes. Pechman (1985) represents the classic example of this type of research. The time frame for analysis is one year, and Pechman assumes that consumption taxes are passed forward and borne by consumers in proportion to their

expenditures. Taking this approach, Pechman finds that consumption taxes are

quite regressive. A recent study by Gale, Houser, and Scholz (1996) confirms this

view. In an analysis of a shift from the current income tax to a flat tax they find

that the lowest income group would see their average tax rate increase by 2.2 percentage points (81% increase) while the highest income group would see their average tax rate decrease by 7.1 percentage points (17% decrease).3 Similarly, Feenberg,

Mitrusi, and Poterba (1997) find that there would be a substantial shift in tax burden to the poor in shifting from the income tax to a retail sales tax using annual

income to rank households.

An alternative approach utilizes estimates of lifetime income as a measure of the

taxpaying unit’s economic well-being. Invoking Friedman (1957) and the permanent

income hypothesis as well as life-cycle considerations, economists have long recognized that annual income may not be a very good measure of an individual’s potential to consume. With perfect capital markets, individuals should be grouped according to the present discounted value of earnings plus gifts received. This theory

makes the difficulties with the annual incidence approach readily apparent. People

tend to earn the highest incomes in their life around middle age and the lowest incomes in their youth and old age. Consequently in a cross section (annual) analysis,

lower income groups are likely to include some young and elderly people (as well

as some people with volatile incomes who have obtained a low realization) who are

not poor in a lifetime sense. Similarly, higher annual income groups are likely to

contain some people at the peak of their age earnings profile for whom peak earnings are a poor measure of annual ability to consume.

To see why a lifetime approach makes a difference, imagine a world with identical

people with identical skills and an identical pattern of earnings over their lifetime.

109

Figure 1 illustrates the lifetime income and consumption paths of a typical person

in this imaginary society. Income is initially low and rises to a peak in the middle

years. It than falls as this worker gradually cuts back on work and enjoys more retirement leisure. Consumption is constant over the lifetime. In early years individuals borrow against future income to finance consumption that exceeds income. Savings occurs in the middle years, first to repay borrowing from the early years and

then to finance consumption in the retirement years. In this stylized example, I’ll

assume that all savings are consumed so that at death there are no assets remaining.

Next assume that there is one person of each age in this society. Otherwise people

are identical. Figure 1 now has an additional interpretation. In addition to it indicating consumption and income patterns over an individual’s lifetime, it also shows

income and consumption patterns for our society of individuals at any one point in

time. Now consider an annual incidence analysis of a national sales tax. Since consumption is constant across all individuals, tax payments will also be constant. But

since income varies (based on where people are on their lifetime income schedule),

the average tax rate (taxes as a fraction of annual income) will fall as income rises.

The tax will look very regressive. But this is clearly wrong. Individuals are exactly

the same in this hypothetical society and over their lifetimes will earn exactly the

same amount of income and pay exactly the same amount of taxes. A lifetime incidence analysis will correctly conclude that this tax is proportional.

110

4The rebate is adjusted so that a married couple with no children would receive the same

rebate as two unmarried individuals sharing a household (a marriage penalty elimination adjustment). 5 Using 1991 data, Feenberg, Mitrusi, and Poterba (1997) estimate that a tax rate of nearly

29 percent would be required to replace the income and payroll taxes. Both my estimated tax

rate and those of Feenberg et al. are measured as a percentage of the producer price. To compare the average income tax rate, we can re-express the tax rates as percentages of consumer

prices. Expressed that way, the required tax is 23 percent.

III. A Distributional Analysis of a Sales Tax Based on the Consumer Expenditure Survey

H.R. 2525 (introduced by Rep. John Linder (R–GA) and Rep. Collin Peterson (D–

MN)) would replace the personal and corporate income tax, all payroll taxes, the

self-employment tax, and the estate and gift tax with a national retail sales tax. The

tax is levied on a destination basis, meaning that imports are subject to the tax

while exports are exempt. H.R. 2525 (otherwise known as the ‘‘Fair Tax’’) would provide families with a rebate of sales tax on spending up to the federal poverty level.4

In previous research (Metcalf (1997)), I used data from the 1994 Consumption Expenditure Survey (CES) to measure the distributional impact of a replacement of

the personal and corporate income tax with a national retail sales tax rate. While

the analysis does not capture the precise nature of the Fair Tax proposal, it is close

enough to demonstrate a number of key points. Ignoring payroll taxes in my analysis will likely bias the analysis towards making the reform appear less progressive.

Thus the results I present can be viewed as lower bounds on the progressivity of

the reform.

First let me note that after making adjustments for consumption expenditures

that are difficult to tax, I calculated that a tax exclusive tax rate of roughly 18 percent would be required for a broadbased retail sales tax replacing the income tax

to be revenue neutral. Adding payroll taxes and the estate tax to the proposal would

increase the required tax exclusive tax rate to 30 percent.5 This tax rate assumes

that Congress will hold the real level of government spending fixed. This could be

done by exempting government spending from the tax. If government spending is

taxed (as is proposed in H.R. 2525), then nominal government spending would have

to increase to keep real spending constant. (See Table 1 below for details.)

Table 1. Aggregate Consumption and Taxation

(1) (2) (3)

Taxes Replaced By Retail Sales Tax

Personal Income Tax 544.5 544.5 544.5

Corporate Income Tax 144.0 144.0 144.0

Payroll Taxes 428.8 428.8

Estate and Gift Tax 15.2 15.2

Total Income Tax 688.5 1,132.5 1,132.5

Retail Sales Tax Base

Personal Consumption

Expenditures

4,698.7 4,698.7 4,698.7

Adjustments to Personal

Consumption Expenditures:

Indirect Taxes (266.9) (266.9) (266.9)

Owner Occupied Housing(280.2) (280.2) (280.2)

Imputed Financial Services(146.0) (146.0) (146.0)

Non-Profit Activities (236.6) (236.6) (236.6)

Farm Food (0.5) (0.5) (0.5)

Net Foreign Spending 19.8 19.8 19.8

Consumption Tax Base 3788.3 3788.3 3788.3

Family Allowance (1500.0)

Net Consumption Tax

Base

3788.3 3788.3 2288.3

Retail Sales Tax Rate

(Tax-Exclusive)

18.2% 29.9% 49.5%

111

6Feenberg, Mitrusi, and Poterba (1997) estimate that a rate exclusive tax rate of 45.4 percent

would be required. 7The size of the tax shift for this lowest income decile indicates one of the problems of the

annual income approach. It tends so magnify average tax rates as income is likely to be poorly

measured and also low relative to consumption. It is for this reason ftha tPechman (1985)

dropped th ebottom half of the lowest income decile from his analysis. The median change in

tax rate for this decile is 32.9%. Except for the lowest decile, median and mean tax rates are

fairly similar. 8The Suits Index is a tax-based analogue to the Gini Coefficient. It ranges from –1 to 1 with

negative values indicating a regressive tax and positive values a progressive tax. The Suits

Indexc for the income tax that I report is not comprable to estimates of the Suits Index reported

elsewhere for the personal income tax since I attribute the corporate income tax to households

in this study.

Table 1. Aggregate Consumption and Taxation—Continued

(1) (2) (3)

Retail Sales Tax Rate

(Tax Inclusive)

15.4% 23.0% 33.1%

ASource: Metcalf (1997)

Those adjustments do not allow for the family rebate based on poverty level. The

Fair Tax Proposal exempts from taxation spending up to the poverty level. Based

on 1994 poverty levels, this rebate would (in effect) exempt $1.5 trillion from the

Retail Sales Tax base. This raises the required tax rate from 30 to nearly 50 percent 6 . On a tax inclusive basis (comparable to an income tax rate), this is a rate

of 33 percent.

My first analysis considers a shift from the current income tax to a broad based

retail sales tax. The tax base is quite comprehensive. Housing services are not taxed

per se but are taxed at the time of purchase of the house. The same approach is

used for other durable goods. Medical services are included in the tax base as are

other services. Table 2 (and Figure 2) shows the distribution of a shift from the income tax to a broad based income tax using both an annual and a lifetime income

incidence approach. The second column shows the change in average tax rate

(change in tax as a percentage of annual income) for households ranked by annual

income. Based on the annual income approach, the tax reform is very regressive.

Tax liabilities increase for the bottom 70% of the income distribution and decrease

for the top 30%. The changes are quite substantial with the lowest income decile

seeing their average tax rate increase by 64 percentage points.7 Meanwhile the top

decile’s average tax rate falls by 7%. Another way to measure the regressivity of

the tax reform based on annual income is to note that the Suits Index falls from

0.202 (income tax) to ¥0.217 (retail sales tax) as a result of the reform.8

Column 3 redoes the analysis using a lifetime income analysis. The variation in

changes in average tax rates across lifetime income deciles falls markedly relative

to the annual income analysis. The reform is still regressive—the lowest 70% of the

income distribution face tax increases while the top 30% enjoy tax decreases. However the differences are not nearly as large as when measured using annual income

to rank households. Moreover, the change in average tax rates is much smaller with

the lowest lifetime income decile facing an average increase in their average tax

rate of 5.7 percentage points while the top decile’s average tax rate falls by 2 percentage points. Ranking households by lifetime income, the Suits Index now falls

from 0.068 to ¥0.010 with this tax reform.

112

Table 2. Distribution of a Broadbased Retail Sales Tax: No Family Allowance

Decile Annual Lifetime

1 64.3 5.7

2 24.4 4.0

3 17.4 1.0

4 11.5 1.0

5 7.3 1.2

6 2.3 0.4

7 3.9 0.4

8 ¥0.6 ¥2.0

9 ¥0.9 ¥1.3

10 ¥7.0 ¥2.0

ATable reports change in average tax rate from reform

ASource: Metcalf (1997) This analysis repeals personal and corporate income tax and replaces it with a national retail sales tax.

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9This analysis differs from the Fair Tax proposal in not making a marriage penalty adjustment.

Next, I add the family allowances based on poverty levels.9 Table 3 and Figure

3 presents the results.

Table 3. Distribution of a Broadbased Retail Sales Tax: Family Allowance

Decile Annual Lifetime

1 40.9 2.2

2 19.1 1.5

3 14.2 ¥0.9

4 9.6 0.2

5 6.6 0.8

6 1.5 0.0

7 4.4 0.1

8 ¥0.3 ¥2.0

9 ¥0.1 ¥0.3

10 ¥5.8 0.1

ATable reports change in average tax rate from reform

ASource: Metcalf (1997) This analysis repeals personal and corporate income tax and replaces it with a national retail sales tax.

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Compared to Table 2, the tax is modestly less regressive on an annual basis. However it continues to look very regressive. The Suits Index for the sales tax with rebate is ¥0.155 indicating considerable regressivity (relative to the income tax system it replaces for which the Suits Index equals 0.202). The story changes dramatically when I rank people by lifetime income (last column). Now there is no clear

pattern to the change in average tax rates. The change ranges from a decrease of

2 percent (decile 8) to an increase of 2.2 percent (decile 1). Ranking households by

lifetime income the Suits Index for the sales tax with rebate (0.054) is nearly the

same as for the current income tax (0.068). If you compare Table 2 to Table 3, it

is easy to see that rebates based on the poverty threshold can offset any remaining

regressive aspects of a national sales tax when ranking households by a measure

of lifetime income. These results indicate that it is not impossible to structure a consumption tax that is broadly progressive.

IV. Other Issues

The distributional analysis above is a ‘‘steady-state’’ analysis and ignores transitional considerations. In any switch from an income to a consumption tax, there is

the potential for a lump sum tax on old capital. One difficulty with previous consumption tax proposals has been that these losses have been compensated through

transition rules that cost significant amounts of revenue and require higher tax

rates. Much of the efficiency gains from a consumption tax reform are lost if such

transition rules are enacted. The benefit of the retail sales tax is that it makes it

more difficult to incorporate these kinds of transition rules and so increases the

probability that the reform will indeed be efficiency enhancing.

One other consideration worth mentioning is the current debate over taxation of

internet sales. While this is not a distributional issue, it is an important issue of

fairness and it will be important to treat internet transactions just like any other

retail sales transaction. If the federal government can do this correctly, it increases

the odds that state and local governments will also treat these sales correctly under

state and local sales taxes.

V. Conclusion

It is quite possible to design a distributionally neutral consumption tax reform.

Doing so, however, requires an understanding of the difference between annual and

lifetime income. Measuring lifetime income is conceptually easy but in practice impossible. This raises hurdles to the use of lifetime income for distributional analysis

in policy circles but it does not negate its importance as you take up the important

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topic of fundamental tax reform. Thank you for the opportunity to comment on this

issue.

References

Feenberg, Daniel R., et al. ‘‘Distributional Effects of Adopting a National Retail

Sales Tax,’’ Tax Policy and the Economy, 1997, 11: pp. 49–90.

Friedman, Milton. A Theory of the Consumption Function.. Princeton, NJ: Princeton University Press, 1957.

Gale, William, et al. ‘‘Distributional Effects of Fundamental Tax Reform.’’ In Economic Effects of Fundamental Tax Reform, ed. Henry Aaron and William Gale, 281–

315. Washington, DC: Brookings Institution, 1996.

Metcalf, Gilbert E. ‘‘The National Sales Tax: Who Bears the Burden?,’’ Washington, DC: Cato Institute. Cato Policy Analysis No. 289, Dec. 8, 1997.

Pechman, J. Who Paid the Taxes: 

f1966–85?. Washington DC: Brookings, 1985.

Chairman ARCHER. Thank you, Dr. Metcalf.

Dr. Angell?

STATEMENT OF WAYNE ANGELL, CHIEF ECONOMIST, BEAR

STEARNS & COMPANY, INC., NEW YORK, NEW YORK

Mr. ANGELL. I am Wayne Angell, chief economist at Bear

Stearns, and formerly, Mr. Chairman, 8 years as a member of the

Board of Governors of the Federal Reserve system.

I believe the case for fundamental tax reform rests on whether

the current tax system poses a serious risk to the continuation of

our current prosperity through the first decade of the 21st Century.

Piecemeal amendment of our tax code cannot alter the one fundamental problem facing our economic expansion, our national shortfall of saving. Only the national undersaving or overconsumption

stands in the way of our continuing prosperity.

As the chart on page 2 of my testimony indicates, just maintaining our national saving rate is far less than optimum in a new-era

economy that relies on investment spending to continue to rise as

a percent of GDP. Our savings shortfall has accelerated over the

last 3 years to 4 percent of GDP, and of course that then would

be our current account trade deficit.

Without fundamental tax reform, the gap between national saving and investment is likely to continue to widen. The new era of

business focus on cutting costs by relying on increased nonresidential capital goods investment that have risen from 9 to 14 percent

of GDP over the last decade is likely to continue to increase equity

market wealth and to depress the household saving rate. Depressed

domestic saving is currently balanced by the expectation of higher

equity prices that is part of the ingredient and the inflow of saving

from abroad.

Now, I do not join the scare-mongers who suggest that our rising

trade deficit cannot go on forever. Our rising trade deficit can go

on as long as global investors, including, in particular, U.S. investors are willing to hold an ever-increasing ratio of their wealth in

the United States. Nevertheless, it is correct that our rising trade

deficit makes our economic expansion more vulnerable to any adverse news, period; that is, if the Federal Reserve were to make an

inflation mistake during the 5- or 10-year period ahead, the interest rate consequences would be much worse.

116

I hope you will choose fundamental tax reform. Take away the

current tax system disincentive to save. All Americans will benefit

by participating in the wealth-creating process that begins by the

decision to abstain from spending income and thereby to save. Far

too long, we have lived with the incorrect assumption that imposing higher tax rates on individual incomes can reduce income and

equality.

If we desire equality of incomes, we need a new consumptionbased tax system that will provide more encouragement to save for

those who are poor and who would like to become wealthy. The acceleration of capital goods investment is a first step toward improving income equality, for it is rising capital investment that is driving the increase in labor productivity and rising real wages that directly contribute to the capacity of working families to save.

If a nation undersaves, then real interest rates will move higher.

As long as our national saving does not match our spending on capital goods, real interest rates must move enough higher to offset

the increased exchange rate risk faced by global investors. If global

savers approach satiation by an overconcentration of loans and investments in the United States, then the full tax burden on saving

must be shifted to borrowers.

Alan Greenspan is right on target in recognizing the inflation

risk that would be associated with a low Fed funds rate, while real

corporate bond rates are rising. Nothing would endanger this expansion more than for the FOMC to peg the Fund’s rate below the

level consistent with Triple B corporate bond rates. Corporate bond

market yields reflect our shortfall of saving while the demand for

capital goods is rising. Unfortunately, to the extent that rising real

interest rates dampen investment spending, labor productivity cannot accelerate to the optimum economic equality level.

The Americans for Fair Tax Proposal—the Fair Tax—is the superior starting point for fundamental tax reform. First, the Fair Tax

proposal directly deals with our, one imbalance, under-saving. The

23-percent national retail sales tax would dramatically increase

household savings rates. And I would be happy to respond to questions as to why I differ from the other panelists in regard to that

rate.

Second, only the Fair Tax proposal has a perfect offset for the

growth slowdown that would occur if a national saving rate were

to quickly rise to the national investment rate around 20 percent

GDP. By eliminating the cost of Government in the prices of goods

we export, the growth of exports accelerates. By subjecting imported final goods to the sales tax, domestic production of goods

would crowd out imported goods. That would mean that imported

goods would compete fairly and squarely under the same burden of

Government cost as domestic-produced goods. Both would be subject to the 23-percent uniform sales tax rate.

During the adjustment period, consumer spending would likely

fall, exports would leap upward and imports would fall. After the

adjustment period, growth rates of consumer spending, exports and

imports, would tend to normalize at a rate somewhat higher as is

consistent with the higher capital spending induced by lower interest rates and lower interest volatility.

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Without fundamental tax reform, our expansion is apt to encounter an increasing risk of being aborted by a policy mistake. Let us

not wait too long to act now as the current balance between rising

inflow of saving and an increasing trade deficit could change from

global balance to global imbalance. The longer we delay in dealing

with this tax impediment to saving the more risky our future.

[The prepared statement follows:]

Statement of Wayne Angell, Chief Economist, Bear Stearns & Company,

Inc., New York, New York

Mr. Chairman, members of the committee, thank you for the opportunity to testify

on the subject of fundamental tax reform. I believe the imperative case for fundamental tax reform rests on whether the current tax system poses a serious risk to

the continuation of our current prosperity through the first decade of the Twentyfirst Century.

The focus of my advice is (1) do not underestimate our potential for achieving a

very long period of growth at a rate approaching five percent and (2) do not ignore

the potential for an economic policy breakdown to precipitate an abrupt end to this

expansion. Just as we have benefited enormously from new high technology capital

investment, so also would an end of this expansion with a likely collapse of labor

productivity growth be unusually difficult for workers and investors alike.

Although our current expansion, at nine years, is the longest expansion in our history, it is far short of achieving the 4.3 percent average annual growth rate over

36 quarters from 1963 to 1972. The estimated average growth rate over the last

nine years ending in the first quarter of 2000, at 3.6 percent, is a good beginning

for an expansion that has a potential to go on another nine years. If we succeed

in growing another nine years by continuing the 4.4 percent average rate of the last

four, then we would achieve an 18-year average growth rate of 4 percent.

Undersaving as a risk to this expansion

Piecemeal amendment of our tax code cannot alter the one fundamental problem

facing our economic expansion—our national shortfall of saving. The continuation

of our accelerating prosperity is dependent on the means to finance non-residential

capital investment that is growing at twice the rate of growth of gross domestic

product. Without fundamental tax reform our current under-saving requires an inflow of capital from abroad that has its counterpart in a rising trade deficit.

Only the national undersaving (or overconsumption) stands in the way of our continuing prosperity. As long as economic growth remains on this current track of four

straight years of growth rates approaching 4–1⁄2% percent, the current system of tax

rates will provide more revenue than projected growth of government expenditures.

Some, including Alan Greenspan, seem to be suggesting that the correct approach

is to rely on rising public saving to offset the adverse impact of rising equity market

wealth on household saving. This is an austerity approach, which I believe actually

increases the risk of difficulty in funding our under-saving.

But, as the chart below indicates, just maintaining our national saving rate is far

less than optimum in our new era economy that relies on investment spending to

continue to rise as a percent of GDP. Adding 1999-government investment of approximately 2–1⁄2% of GDP to the private investment shown in the chart brings national investment spending to 20 percent of GDP. Subtracting government investment from government spending increases national saving to 16 percent and implies

an inflow of saving from abroad of 4 percent of GDP. One constant in our equation

is that the balance of payment is balanced; saving (capital) inflows equals the current account deficit.

Without fundamental tax reform the gap between national saving and investment

will get worse. The new era business focus on cutting costs by relying on increased

non-residential capital goods investments, that have risen from 9 to 14 percent of

GDP over the last decade, is likely to continue to increase equity market wealth and

depress the household saving rate. Depressed domestic saving is currently balanced

by the expectation of higher equity prices that is part of the ingredient in the inflow

of saving from abroad.

Now I do not join the scaremongers who suggest that our rising trade deficit cannot go on forever. Our rising trade deficit can go on as long as people who live

abroad are willing to finance it. However, it is correct that a rising trade deficit

makes our economic expansion more vulnerable to any adverse news period that

would cause global investors to lose confidence in the exchange value of the dollar.

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That is, if the Federal Reserve were to make an inflation mistake during the five

or ten year period ahead, then the interest rate consequences would be much worse.

I hope you will choose fundamental tax reform. Take away the current tax system

disincentive to save. All Americans will benefit by participating in the wealth-creating process that begins by the decision to abstain from spending income and

thereby, to save. Currently, our saving rate is too dependent on the higher income

and higher wealth segment of our citizens. Why not shift to a consumption-based

tax system that will enhance the incentive of all income groups to participate in the

rewards of wealth creation.

For far too long we have lived with the incorrect assumption that imposing higher

tax rates on high-income individuals can reduce income inequality. First, marginal

income tax rates including the double taxation of corporate profits directly subtract

from saving by reducing the capacity of taxpayers to save. Second, marginal tax

rates, which include some very high marginal rates on low income households as

the earned income tax credit is phased out, tilt the preference of households to

spend a higher proportion of their disposable income. If we desire equality of incomes, we need a new consumption-based tax system that will provide more encouragement to save for those who are poor and would like to become wealthy.

It is essential to understand that in a market system economy, prices will adjust

so as to correct imbalances. Scarcities lead to higher prices that ration out scarce

goods and provide incentives to produce more of that good. And that includes saving

as a scarce good.

The tax burden on saving is fully shifted to borrowers

If a nation under-saves then real interest rates will move higher. It is important

to note that the current move toward a larger government surplus, an increase in

government saving, has led to a somewhat lower interest rate on Treasury securities, while corporate bond interest rates have increased. As long as our national saving does not match our spending on capital goods, real interest rates must move

enough higher to offset the increased exchange rate risk faced by global savers. As

global savers approach satiation by an over-concentration of loans and investments

in the United States, then the full tax burden on saving must be shifted to borrowers. For two decades we have filled the shortfall of national saving by an inflow of investment and lending from abroad. But a continuation of the domestic saving shortfall will continue to require higher real interest rates to both attract saving inflows

and to offset the adverse wealth effect on domestic saving. Eventually, an inflow of

saving from abroad becomes ever more risky as foreign savers contemplate the equity and exchange rate risk of being so heavily weighted in the United States.

For a country mired in under-saving, high marginal tax rates on the return to

saving must necessarily lead to higher returns on saving until either the higher return is sufficient to restore the saving balance or until the entire tax rate is fully

passed forward to borrowers. In either case, higher marginal tax rates on saving are

completely frustrated by none of the tax falling on savers and all of the tax falling

on borrowers.

Increasing income inequality vs. increasing income equality

As long as the return on capital goods accelerates with the new technology induced productivity of capital we need more saving. That means that, one way or another, the return on capital will rise. A higher return on capital will continue to increase income inequality. Under the current tax system our income distribution pattern will continue to flow toward augmenting the income of the wealthy that have

higher savings rates. This process toward inequality of incomes is likely to continue

until that domestic saving imbalance is reduced.

The continuation of the acceleration of non-residential capital goods investment

is a first step toward improving income equality. For it is rising non-residential capital investment as a percent of GDP that is driving the increase in labor productivity and rising real wages that directly contribute to the capacity of working families to save. This is the growth solution.

The sub-optimum growth solution

It seems to me that too many policy makers have become overly pessimistic concerning the likelihood of increasing saving by fundamental tax reform. Consequently, they are looking toward sub-optimal growth and a sub-optimal federal

debt ratio. Central banks and monetary authorities around the world are going to

need more Treasury securities than are likely to be available to facilitate the dollar’s

reserve currency role. This committee has a wonderful opportunity to restore a more

optimistic vision by recommending fundamental tax reform.

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Given our current tax system there is no alternative to increasing real rates of

interest. Rising real rates of interest tends to work more quickly toward limiting

investment spending than in increasing saving rates. Unfortunately, to the extent

that rising real interest rates dampen investment spending; labor productivity cannot accelerate to the optimum economic equality level.

Alan Greenspan is right on target in recognizing the inflation risk that would be

associated with a low Fed funds rate while real corporate bond rates are rising.

Nothing would endanger this expansion more than for the FOMC to peg the funds

rate below the level consistent with rising Baa corporate bond rates. Corporate bond

market yields reflect our shortfall of saving while the demand for capital goods is

rising.

And, if this committee helps to restore policy maker’s confidence that household

savings could be counted on to rise sufficiently to close the imbalance, then they

would be free to consider some optimum federal debt level as a contrast to the political proposal to pay down the national debt.

More importantly, Alan Greenspan should no longer be so concerned that rising

household wealth from equity market gains would lower national saving. As he now

sees it, rising equity prices increase wealth faster than the increase in income.

Thereby consumer spending rises faster than income and the savings rate falls.

Fortunately, the revised Federal Reserve de-emphasis on the level of equity market prices has lessened the risk that global investors might, at some point, reduce

the inflows of saving into the U.S. equity market and that could pull the down the

dollar. Ultimately it is the dollar exchange rate risk that could jeopardize the

FOMC’s freedom to lower interest rates as they did in the fall of 1998 during a period of deflation risk. It is imperative that, as our inflation rate approaches zero,

the FOMC maintain its domestic policy focus so as to avoid deflationary episodes

such as occurred in 1986, 1990 and 1998.

Fundamental tax reform

From my perspective as a Wall Street economist, the Americans for Fair Tax proposal—the FairTax—is the superior starting point for fundamental tax reform.

First, the FairTax proposal directly deals with our one imbalance—undersaving.

Household behavior responds to a change in relative prices. The 23 percent national

retail sales tax would dramatically increase household savings rates.

Second, only the FairTax proposal has a perfect offset for the growth slowdown

that would occur if the national saving rate were to quickly rise to the national investment rate around 20 percent of GDP. By eliminating the cost of government

from the goods we export, the growth rate of exports accelerates. And, by including

imported final goods in goods subject to the sales tax, domestic production of goods

would crowd out imported goods. That would mean that imported goods would compete fairly and squarely under the same burden of government cost as domestic produced goods—both would be subject to the 23 percent uniform sales tax rate.

During the adjustment period, consumer spending would likely fall, exports would

leap upward at about the same rate that resources can flow into export industries,

and imports would fall. After the adjustment period during which saving and investment converge to the same percent of GDP, growth rates of consumer spending, exports and imports would tend to normalize. These new normal rates of growth of

GDP, exports and imports would be somewhat higher as is consistent with the higher residential and higher non-residential spending induced by both lower interest

rates and by lower interest rate volatility.

Conclusion

Without fundamental tax reform our expansion is apt to encounter an increasing

risk of being aborted by a policy mistake. The 4.3 percent expansion over the 36

quarter period ending in 1972 came to an end as the Federal Reserve made the policy mistake of shifting its focus of monetary policy toward increasing economic

growth. Undoubtedly, the Congressional stand-pat policy on leaving top marginal

tax rates at 70 percent after lowering rates in the 1963–64 Kennedy round of tax

rate cuts from 90 to 70 percent, contributed to the FOMC focus on using money creation to maintain economic growth.

Let us not wait too long to act now as the current balance between rising inflow

of saving and an increasing trade deficit could change from global balance to global

imbalance. And, if fundamental tax reform is not done, then you may end up tempting other policy makers to do what they cannot do. Surely, the FOMC cannot successfully control economic growth. Nor can the FOMC successfully control equity

market asset values. The longer we delay in dealing with this tax imbalance the

more risky our future.

f120

Chairman ARCHER. Thank you, Dr. Angell. I am struggling with

how to best use my time to take advantage of all of the talent that

is represented at the witness table today. It is not often that we

have access to this sort of economic talent.

Do you gentlemen agree with the general concept that the more

you tax of something the less you are going to get of it?

Mr. ANGELL. Yes.

Chairman ARCHER. Does anyone disagree with that?

Mr. WILKINS. I am sorry. Could you repeat it.

Chairman ARCHER. Do you agree with the general thesis that the

more you tax something the less you are going to get of it?

Let the record show all witnesses are nodding assent.

And do you disagree that the income tax, as a base of taxation,

taxes work, savings, productivity and incentive? Does any one of

you disagree with that?

No. The answer is apparently they all agree with that. Then why

are we using a system that reduces work, reduces productivity, reduces savings and reduces incentive? I don’t understand it? And

yet is not factored in, and I will be glad to get your responses. I

am going on a little here with a soliloquy, but I am curious, Mr.

Wilkins, as to whether the survey, the study that you mentioned

that was done by Pricewaterhouse, included any of these basic factors.

Mr. WILKINS. Yes. Income tax is certainly put in there carefully,

Mr. Chairman. The argument, of course, you are making are an argument against any income tax, but it is also a good argument for

keeping tax rates as low as possible. An income tax that has relatively low rates is going to have relatively lesser impact on the

disincentives that you just talked about.

Chairman ARCHER. Yes, it is true that the higher marginal rates

create a greater disincentive. But any taxation of income will operate the same way even if it could be done at the flat tax level. By

the way, flat tax is dead. It has basically been assigned to oblivion

by its own creator, Professor Hall, but even if you could do a flat

tax, it would still be true that the more hours you work, the more

you are going to pay in taxation. It just does not increase incrementally by the graduated tax structure. And you are still taxing work.

You are still taxing at a lower rate, and I agree it would be better,

you are still taxing work effort.

Mr. WILKINS. Let me just make one more comment in response

to your question, Mr. Chairman, and that is our study does not differ a great deal with many of the other studies that show there are

going to be positive benefits in the long run from switching from

an income tax to consumption tax. What our study shows is that

there are some very dangerous effects in the short run in getting

there. You are giving an enormous incentive to saving and a disincentive to consumption, and by golly they both work. GDP drops

and consumption drops just the way you might expect them to.

Chairman ARCHER. No, no. I did listen very carefully to your

presentation, and I noted that you distinguished between the shortterm and the long-term. But I am wondering, even if in the long

term, these studies have any way of factoring in work effort and

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productivity, and how it is burdened by the income tax and how it

is freed up by abolishing the income tax? And I doubt very much

that those factors have been adequately put into the models. Additionally, and I want to develop a few more points and then I want

to get responses from all of you. The cost of compliance with the

income tax is to be $250 billion estimated and some say it could

go as high as $500- to $600 billion a year. But being a conservative,

I will take the lower number and work off of $250 billion. It means

that some of the brightest and best minds in this country are

spending full time coping with this tax code, which produces no

wealth. And if those minds were freed to go into the marketplace,

and their ingenuity, and use their mental capabilities were designed to produce wealth, would we not also have a bigger GDP?

Is that factored into all of these studies? I rather doubt it. And so

I think the studies are flawed because they are unable to cope with

a lot of these intangibles as to the truth benefits that will come.

And then, finally, I want to ask each one of you, which I have

done to a number of other witnesses, not today, but in previous

hearings, what would you pay, Dr. Kotlikoff, not to have to deal

with the IRS every year?

Mr. KOTLIKOFF. That is a good question.

Chairman ARCHER. What value, in dollars, would you assign to

that, personally?

Mr. KOTLIKOFF. Probably somewhere between $3,000 to $5,000.

Chairman ARCHER. I take it you do your own income tax from

your testimony, and if you do, I am there with you, and I am in

the process of trying to handle that right now.

Mr. KOTLIKOFF. Right.

Chairman ARCHER. What would you pay, Mr. Wilkins, not to

have to deal with the IRS every year?

Mr. WILKINS. I apparently haven’t had as bad an experience as

Larry Kotlikoff has had with the IRS. It certainly would be nice not

to have to deal with them on a personal level, and I have had to

deal both with my own taxes, my elderly mother’s taxes, and other

taxes, but it would not be worth that much to me. I think I have

probably wasted hundreds of dollars, but not thousands of dollars

of my time.

Chairman ARCHER. You must have a very cheap tax prepayer.

Dr. Metcalf, what would you assign as a value that you would

pay not to have to deal with the IRS every year?

Mr. METCALF. Well, I am the wrong person to ask, I am afraid,

for two reasons. One is that my income is fairly simple, as a professor. But, second, as a public finance economist, I am rather embarrassed to say I get some consumption value out of filling out tax

forms. So it helps me in thinking about it to talk to my students.

So I am an outlier, I am afraid.

Chairman ARCHER. So it is a learning experience, and you benefit from it.

Mr. METCALF. Yes, sir.

[Laughter.]

Chairman ARCHER. Dr. Angell?

Mr. ANGELL. Chairman Archer, I am one of those fastidious taxpayers that really wants to do it exactly right, and there is a lot

of personal pride and integrity in that. I would happily pay $25,000

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compensatory costs to not have to go through that process. But I

would like, in addition, $80,000 of punitive costs in regard to the

entire intrusion into my life. And even though I want to do it most

accurately, I do not like that kind of big Government in my personal financial life.

Chairman ARCHER. Well, you alluded to what was going to be my

next question. How much value do you attach to your personal freedom and privacy? Thomas Jefferson said in his second inaugural

address that one of his most notable achievements while in public

office was the removal of the Federal tax collector from any direct

contact with the American citizen because he understood, probably

more than any other American, the value of individual freedom.

Now, put that into your hopper. Dr. Kotlikoff, how much is your

individual freedom and privacy worth?

Mr. KOTLIKOFF. I had one minor audit that was pretty much an

even split with the Feds, so to me it is not so much an issue of private freedom. I think the Government is going to have to collect

taxes no matter how we do it. I do not get exercised over the existence of the IRS, to tell you the truth. I am just concerned about

the next generation, and the fact that we are not looking ahead to

the retirement of all of these baby boomers and distributors. I am

also concerned that tax inefficiencies have been getting worse over

time.

I think that if more Democrats really looked at this tax proposal,

they would see that it is really very much a Democratic proposal.

It is getting rid of the regressive payroll tax. It has got a very progressive rebate. And it is going to presumably maintain the real

spending power of Social Security beneficiaries, food stamp beneficiaries and people on Welfare.

I also has an implicit wealth tax, as Gil Metcalf was just describ- ing. today, if you are Bill Gates and spend your $80 billion or so

on consumption, you don’t pay any taxes on it. But under the retail

sales tax you would. And if you don’t spend you wealth yourself,

you give it to your kids, and they spend it, plus some interest,

they’ll pay taxes on it. And in present value, it is equivalent to a

one-time wealth tax on $80 billion. That, to me, is very progressive.

Mr. Linbeck does not seem like part of a vast left-wing conspiracy, but he actually is. And it is really time, I think, for the

Democrats to recognize that what is being proposed here is something they should be advancing.

Chairman ARCHER. Okay. I think there is merit to what you are

saying. I also think that when you talk about the Baby Boomers

and the problems that we are going to have in the next century

which has not started yet we have got to be concerned about two

things—savings had productivity. We have got to start presaving,

and we have got to increase productivity. And those are the only

two answers to the problems that are looming ahead.

Mr. KOTLIKOFF. Let me just say, if I could, respond on the issue

of saving.

I have studied in simulation models with other economists the

whole way consumption taxation increases saving. And part of it

has to do with these economic incentives, that you are not facing

a double tax on saving. But a large part of it has to do with the

fact that you are putting a bigger burden on the older people who

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are the big spenders in this economy. Their propensity to spend, to

consume, out of their remaining lifetime resources is two to three

times higher than that of younger people. The reason our national

saving rate is so low, to be quite honest, is because we have been

spending five decades taking ever larger sums from young savers

and giving it to old spenders. The consumption of old people, relative to young people, in the post-war period has roughly doubled.

This is exactly what economic theory predicts, which is older people, because they have fewer years left to go, are spending at a

more rapid clip. So when you put more of the burden onto the old

people and away from the young people, you are really taking from

spenders and giving to savers. That is the real reason, in these

simulation models, based on the standard life cycle and neoclassical

model of economic growth, that you actually get a crowding in of

capital, you get more saving, and you get the national output to go

up by about 15 percent in the long run.

Chairman ARCHER. That is also, I think, very helpful and very

interesting.

Let me just pursue with Mr. Wilkins how much value you put

on privacy and individual freedom in your own life. Is it also down

there around $100?

Thank you, Dr. Kotlikoff. I understand you have to leave.

Mr. WILKINS. You are speaking to someone who just got through

filling out the census long form, so I have a little different view.

Back to thousands of dollars on this, several thousand dollars. I

really do share your view that it would be very nice not to have

somebody looking over our shoulder all of the time and have some

more privacy.

I will have to say that I am a little concerned about my neighbor

down the street. I would just as soon they continue to look at him

for a while.

Chairman ARCHER. Dr. Metcalf, is this also a learning experience

for you so it really is something that you are benefitting from?

Mr. METCALF. Well, I did the short census form, so I am not so

exercised.

No, I think as an individual I share your concerns certainly

about privacy. As an economist, in addition, I think I share your

frustration that income is enormously difficult to measure. And if

we could tax consumption, a lot of that intrusion, the need for intrusion goes away. And if we were in a world without taxes, initially then, I think we would certainly want to choose a consumption tax. And the real frustration, I suspect, is that we are in a

world with one tax, we want to switch to a world with a better tax.

So there are clear benefits of making that shift, but there are real

costs in how we get from A to B that are what you have to struggle

with and how to deal with.

Chairman ARCHER. And, Dr. Angell, you said if I asked, you

would explain why you disagree with the other panelists and why

you believe a 23-percent rate is the appropriate rate.

Mr. ANGELL. Yes. But it is not just that disagreement. I disagree

with Mr. Wilkins’ notion that the short run would provide slower

growth. I think just the opposite. I think we would come out of the

gates very, very fast with the transition to the America for Fair

Tax proposal. That would occur because consumer spending slowVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00129 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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down would be very significant and abrupt in the tax year that you

made the transition. But that would free up resources to enable our

companies to crowd out imports, and it would also free up resources to move into the export industry. And we have got American companies or global companies and they know how to do it,

and they simply do it wherever it is best to do it. So I would expect

to come out of the gate at 6-percent real growth rate.

Chairman ARCHER. I see.

Mr. ANGELL. Now, expecting, thereby, that we have a very strong

economy, that then is going to lead to higher consumer spending.

That is we are going to have an incremental increase in consumer

spending because people’s perception of their lifetime income will

be so much higher. Alan Greenspan talks a lot about the wealth

effect that comes from equity price increases that causes consumer

spending income ratio to rise. But I think there is another wealth

effect that has been overlooked, and that is this new technology

economy develops such increases in labor productivity and such improvement in job opportunities, that the human capital that is estimated by the young worker is a whole lot different than it would

be if we were in an economy that was really lost in the doldrums.

So we need to be freed up to save the money, to fuel the capital

spending that we are doing, and I expect that will then produce

high tax receipts.

Now, I would also want to question whether the income tax is

passed backward onto the wage earner or forward to consumers. I

think the corporate income tax is largely passed forward to consumers. But if my firm received a thousand-dollar asset management fee and we had to put a 23-percent sales tax on it, and it

would be $1,230, I don’t think there’s any chance that my bonus

arrangement with the company would be the same as it is now,

and the firm would not need to pay me the same amount they paid

me now because I always take into consideration my after-tax income in deciding whether or not I wish to remain employed.

Thank you.

Chairman ARCHER. I am grateful to the responses from all of

you, and I have imposed on my colleague, Mrs. Thurman. Thank

goodness she is the only one that I have imposed on. Mrs. Thurman, it is your turn.

Mrs. THURMAN. Mr. Chairman, I just want you to know that the

one question that I might have had, the guy left already.

[Laughter.]

Mrs. THURMAN. So you did a very good job on that.

I have a couple of questions, and, you know, Dr, Angell, I was

listening, and I was sitting here thinking if I were a business person, and I am a business person in the office that I run, and I

think about the cost of running my office and what this would

incur if I had to have an electrician come in, and it is going to be

an extra 30 percent or if I am going to have somebody check the

plumbing or you are going to have an electrical bill or whatever

other kinds of services that are being provided to me, that is going

to raise the cost of every service that is provided.

So if you take that into effect, then this assumption that it is

going to, just because the payroll taxes are going to come down and

the employer might save some money there, that it is going to be

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passed onto the worker or not passed onto the worker, I mean, I

don’t know where we get into a better situation here at all, not to

mention the fact that they say the accountants and all of these people are going to be taken out.

Well, you know what, I remember in the State legislature when

the businesses came to us and said, ‘‘Look, you have got to raise

the amount of money that we are going to—that we are collecting

these taxes for you because we needed another proportion of this

so that we can continue to do the paperwork and the constant

thing.’’ The same thing with the doctor’s office, the hospitals. I

mean, you know, they are overburdened with insurance things.

Now we are going to add this idea that they are going to have to,

you know, bear the cost of 30 percent on every billing that they do,

and somebody is going to have to take care of that paperwork.

Mr. ANGELL. But a lot of it is passed backward already; that is,

we are a Nation, using international comparison, we are a Nation

of very high tax compliance. But, we are increasingly low tax compliance in regard to nannies, and craftsmen who are working and

who are insisting on cash payment.

Mrs. THURMAN. Are you suggesting that would get rid of that

problem?

Mr. ANGELL. No, I’m saying it is already there. What I am saying

is if the Federal Reserve continues to do its job well, then people

say I do not have the ability to pay more, and so consequently

when the worker has a reduction of the payroll tax, the worker has

a reduction of the income tax, the worker is willing to do the work

at a lower rate than otherwise would be the case. And that include

Government workers.

Mrs. THURMAN. I am not so sure when they have to pass along

to themselves a 30-percent on every payment that they are making.

But let me go to Dr. Metcalf—or maybe, Mr. Wilkins, can you respond to that, though, as far as the paperwork and the kinds of

things. I mean, you seem to be this lone voice out there suggesting

that this may not be the best thing to do at this time.

Mr. WILKINS. I suggest it is not best to do this on a big-bang

basis because it will hurt the economy quite a bit. I disagree with

Dr. Angell, I think in degree more so than in direction. We find the

incentives in a national sales tax work extremely well, so well that

consumption drops, savings increases and the economy temporarily

goes in the tank. That is what has us worried. That is what has

retailers worried. They may like the long-run situation, but they

may not be here in the long run. That is the concern.

On the paperwork, I think you are right. There is going to continue to be paperwork to do this. Unfortunately, most of that burden is going to be on retailers under this new law.

Mrs. THURMAN. And States, particularly if that is where the collection point is.

Mr. WILKINS. If States are the ones that are going to have to collect the tax, since the Feds will not be collecting any more, that is

right. I would concede that it is probably not nearly as difficult or

as big an overall job as we would probably have with the income

tax. But the burden of collecting it is clearly shifting to States and

to retailers.

126

If I could just mention, Mr. Chairman, one point about cutting

the tax rate and pushing it on to individuals, I do not understand

why we would think that cutting the income tax is all going to go

ahead into prices. We don’t see that happening. And the only anecdotal evidence I recall is the 1986 act, when we cut the rate from

50 percent to 28 percent, almost in half, I do not recall my accountant or my lawyer or my physician cutting his prices that I had to

pay. So I guess, I only base it on anecdotal evidence, but I guess

I do not see it the same way Dr. Angell would see that.

Mrs. THURMAN. Mr. Chairman, do I have time for another? Okay.

Dr. Metcalf, in your testimony that was given to us earlier on

page 15, you go through it. Actually, the title of it starts with rebating the payroll tax and then goes on. And the last paragraph,

you just need to explain it to me a little bit. ‘‘There are important

distributional considerations that I have not considered in this

analysis. Transitional gains and losses will be substantial in any

tax reform, and in particular reform that shifts from income to consumption taxation. A shift without any transitional rules from income taxation to a national sales tax will [among other things] induce a transfer from the current elderly to the current young. It

is also worth noting that this study does not take into consideration the broad economic gains that might be expected from converting to a consumption-based tax system. Low-income Americans

may very well realize gains in after-tax income from the tax shift

if the economy improves and wages rise,’’ which is contrary to

somewhat what we are hearing here, that wages actually could go

down.

Can you explain that to me a little bit.

Mr. METCALF. There are a lot of ideas embedded in that, and I

do not have what you have in front of you. I am not sure what it

is that you have. But let me speak first to the transition issue.

Two examples, in my comments I noted that there is this windfall tax on existing—a one-time wealth tax, so to speak. And many

of the problems of previous consumption tax reforms has been an

effort to try to create transition rules to somehow avoid this onetime wealth tax. And to my way of thinking, that simply decreases

the efficiency gains of the reform. It requires a higher tax rate because you are giving money back. This issue of transfers from the

current elderly to the current young is the point also that Larry

Kotlikoff was making, that if we go to a sales tax, the current elderly have a much higher propensity to consume, therefore will be

paying more in taxes than under the current system.

Whereas, younger people that have more saving ahead of them

and therefore will be paying less in taxes relative to the current

tax system, which taxes both consumption and savings, which is

what an income tax is.

Mrs. THURMAN. But it also could mean that the younger, being

myself, with a mother, ending up paying for that extra consumption by that elderly, costing me and shifting that burden even further.

Mr. METCALF. Well, it is true that we go through phases of high

consumption and low consumption. And my kids are teenagers, so

I feel like I am in a high-consumption phase right now.

Mrs. THURMAN. I have two in college.

127

Mr. METCALF. Yes. But, clearly, you have years of saving ahead

of you; whereas, if you were 70, you probably would not.

Chairman ARCHER. Mrs. Thurman, have you completed your

questioning?

I came on this committee when Wilbur Mills was chairman of the

committee, and it was operated very differently in those days. But

I remember, in the middle of the afternoon, he would be here by

himself and all of the other members would be absent. And I was

told so often that is how he became so knowledgeable about the

Code because he was always here and very few other members

were present at hearings. And on afternoons like this, where I have

the opportunity, without imposing on too many other members to

explore in greater detail with wonderful witnesses all types of concepts, I understand the benefit that comes from it.

I thank all of you for your presentation today, and I know that

I have learned, and I do wish that there had been more other members here to learn from you.

You are excused.

Our next panel is invited to come to the witness table, the final

panel for the afternoon. Mr. Hamilton, Ms. Skarbek, Mr. Chapoton,

and Mr. Threadgill.

As usual, all of your written statements, without objection, will

be inserted in the record. And to the degree that you can, if you

will synopsize those in your oral presentation, it would be appreciated. And if you will identify yourselves before you begin to testify, for the record, that would be very helpful.

Mr. Hamilton, would you commence.

STATEMENT OF BILLY HAMILTON, DEPUTY COMPTROLLER,

OFFICE OF THE TEXAS COMPTROLLER OF PUBLIC ACCOUNTS, AUSTIN, TEXAS

Mr. HAMILTON. Mr. Chairman and members, I am Billy Hamilton, and I am deputy comptroller of public accounts for the State

of Texas. Carole Keeton Rylander, the Texas Comptroller of Public

Accounts, was delighted to receive an invitation to testify before

this committee regarding the fundamental tax reform measures

under consideration today. Unfortunately, her schedule didn’t permit her to be in attendance, and so she asked me to testify on her

behalf.

My comments today are directed only to the feasibility of State

administration of the Fair Tax proposed by H.R. 2525. I do not intend to comment on the economics or any other aspects of the proposal.

The Texas Comptroller’s Office has administered a sales and use

tax since 1961, and I have been involved with administration of the

tax since 1982. Last year, the Texas Comptroller collected about

$13 billion in sales tax revenue for more than 600,000 businesses.

I offer my experience with sales tax administration, as well as the

size of the Texas sales tax program, as the basis of qualification to

speak on the administerability of H.R. 2525.

As you know, H.R. 2525 would permit States to collect and administer the Fair Tax on behalf of the Federal Government. In my

opinion, Texas would be well-equipped to administer the Fair Tax

based on our experience in administering our own sales tax. Even

128

though the base rate and other characteristics of the Fair Tax are

significantly different from the Texas sales tax, it would be feasible

for our office to collect the Fair Tax by expanding and enhancing

the systems we currently have in place.

For example, we would expand our current system for registering

Texas retailers to include registration of sellers under the Fair Tax,

615,000 businesses are currently registered as sellers in Texas.

Under the Fair Tax, we estimate that about 1.5 million Texas businesses would have to be registered; expand our taxpayer assistance

efforts to respond to a larger volume of telephone, letter and e-mail

inquiries from sellers who collect the Fair Tax and individuals who

pay it; expand our Revenue Processing Division to process more returns and tax payments on a more frequent basis and to remit tax

collections to the Federal Government on an almost daily basis; expand our current audit team and train all auditors to examine

businesses for both the Fair Tax, as well as the Texas sales tax;

and, of course, expand our information technology systems to collect and maintain computerized records critical to the effective administration of a consumption tax like the Fair Tax.

The expansion of our systems to administer the Fair Tax in this

manner I have just described would be sizable. Under the Fair Tax,

we would serve approximately 900,000 more filers than we do currently. We estimate that serving that many additional taxpayers

would require between 1,100 and 1,600 more full-time employees.

The Texas Comptroller currently employs about 2,700 people on a

full-time basis.

In spite of this expansion, the compensation for electing the Fair

Tax that would be provided to the States under the terms of H.R.

2525 would likely cover our projected costs. As a first approximation, we estimate the cost to the Comptroller’s Office for collecting the Fair Tax at full implementation, would be between $100- and

$150 million a year. I emphasize, however, there would be significant costs to begin collection, including the cost of facilities to

house the additional processing facilities, the capital costs of information technology and revenue processing equipment and the costs

of notifying, registering and educating taxpayers on the new tax.

However, these seem to be manageable within the amount that is

allowed under provisions of the bill.

In closing, I believe that if the Fair Tax is to become a reality,

the United States Government would be well-served to make use

of the existing expertise of the States. Many States have administered consumption taxes since the 1930s and have developed particular capabilities in this area. We also have extensive experience

in dealing with the affected businesses. As long as the administrative fee paid to the States is adequate in relation to the costs of

collection, I see no reason that the State of Texas could not effectively administer this tax.

Thank you, Mr. Chairman.

[The prepared statement follows:]

Statement of Billy Hamilton, Deputy Comptroller, Office of the Texas

Comptroller of Public Accounts, Austin, Texas

My name is Billy Hamilton, and I am the Deputy Comptroller for the State of

Texas. Carole Keeton Rylander, the Texas Comptroller of Public Accounts, was delighted to receive an invitation to testify before this committee regarding the FundaVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00134 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
129

mental Tax Reform measures under consideration today. Unfortunately, Comptroller

Rylander’s schedule did not permit her attendance, and she has asked me to testify

here on her behalf.

My comments today are directed only to the feasibility of state administration of

the Fair Tax proposed by H.R. 2525. I do not intend to comment on the economics

or any other aspects of the proposal.

The Texas Comptroller’s office has administered a sales and use tax since the

1960’s, and I have been involved with administration of the tax since 1982. Last

year, the Texas Comptroller collected $13 billion in sales tax revenue from more

than 600,000 businesses. I offer my own experience with sales tax administration,

as well as the size of Texas’ sales tax program, as the basis of my qualification to

speak to you about the administerability of H.R. 2525.

As you know, H.R. 2525 would permit states to collect and administer the Fair

Tax on behalf of the federal government. In my opinion, Texas would be wellequipped to administer the Fair Tax based on our experience in administering our

own sales tax. Even though the base, rate and other characteristics of the Fair Tax

are significantly different from the Texas sales tax, it would be feasible for our office

to collect the Fair Tax by expanding and enhancing the systems we currently have

in place. For example, we would: • Expand our current system for registering Texas retailers to include registration of sellers under the Fair Tax (615,000 businesses are currently registered as

sellers in Texas; under the Fair Tax, 1.5 million Texas businesses would have to

be registered); • Expand our taxpayer assistance efforts to respond to a larger volume of telephone, letter and e-mail inquiries from sellers who collect the Fair Tax and individuals who pay it; • Expand our Revenue Processing Division to process more returns and tax payments on a more frequent basis and to remit tax collections to the federal government on an almost-daily basis; • Expand our current audit team and train all auditors to examine businesses for

both the Fair Tax and the Texas sales tax; and • Expand our information technology systems to collect and maintain the computerized records critical to effective administration of a consumption tax like the Fair

Tax.

The expansion of our systems to administer the Fair Tax, in the manner I’ve just

described, would be sizable. Under the Fair Tax, we would serve approximately

900,000 more filers than we do currently. We estimate that serving that many additional taxpayers would require 1,100 to 1,600 more full-time employees. The Texas

Comptroller currently employs about 2,700 people on a full-time basis.

In spite of this large expansion, the compensation for collecting the Fair Tax that

would be provided to states under H.R. 2525 would likely cover our projected costs.

As a first approximation, we estimate that the cost to the Texas Comptroller’s office

for collecting the Fair Tax at full implementation would be $100 to $150 million per

year. I emphasize, however, that there would be significant costs to begin collection,

including the cost of facilities to house the additional processing facilities, the capital costs of information technology and revenue processing equipment, and the costs

of notifying, registering and educating taxpayers on the new tax.

In closing, I believe that if the Fair Tax is to become a reality, the U.S. government would be well-served to make use of the existing expertise of the states. Many

states have administered consumption taxes since the 1930s and have developed

particular capabilities in this area. We also have extensive experience in dealing

with the affected businesses. As long as the administrative fee paid to the state is

adequate in relation to the costs of collection, I see no reason that the State of Texas

could not effectively administer the Fair Tax.

Chairman A

Ms. Skarbek?

RCHER. Thank you, Mr. Hamilton.

f STATEMENT OF JANET L. SKARBEK, CINNAMINSON, NEW

JERSEY

Ms. SKARBEK. Thank you, Mr. Chairman. My name is Janet

Skarbek. I was asked here today to specifically address the viability of administering a national sales tax from the perspective of a

130

professional that deals with State sales tax administration every

day.

I started my career as a CPA working at the IRS Regional Inspector’s Office. After receiving a Master’s of Taxation from

Villanova University’s Graduate Tax Program, I went to work for

a Big 6 accounting firm where I was responsible for the management of sales and use taxes for clients in the Mid-Atlantic region.

I am currently employed by a Fortune 500 company, where I am

responsible for sales tax compliance and administration.

I have not been asked to speak about the economic impact of the

proposed national sales tax, nor have I been asked to provide an

opinion as to the overall feasibility of such a plan. My testimony

will specifically address business administration and the related

concerns raised by such a tax. The views I express in this testimony are my own and should not be construed as representing any

official position of my employer.

In my opinion, the administration of the national sales tax would ‘‘probably’’ be simpler and easier than administering the current income taxes and payroll taxes it proposes to replace. I emphasize

‘‘probably’’ because the detailed procedures that businesses would

be required to follow, with regards to documentation, have yet to

be established. These details will be essential in determining the

potential administrative costs to businesses.

The national sales tax, as proposed, would not duplicate most of

the larger problems that businesses currently encounter when dealing with the States’ sales taxes. However, there are a few issues

that will need to be addressed.

Under current State sales tax administration, businesses are required to either collect the sales tax or the appropriate exemption

documentation from their customers. The documentation that most

States require vendors to collect from their exempt customers includes: the purchaser’s name, address and registration number, the

seller’s name, a description of the property being purchased, a

statement that the property being purchased meets the requirements for the exemption, and a signature from the purchaser.

Whereas, the currently proposed national sales tax merely requires businesses to accept copies of their customers’ registration

permits in good faith. The States are very aware that their tougher

documentation requirements can be defeated by individuals using

copied or forged certificates. Making cash purchases with such illegal documentation generally results in the lack of any audit trail.

Due to the fact that the proposed national sales tax rate is higher than any current State sales tax rate, I strongly believe that further rules and regulations would be developed to remove the current control weaknesses. The burden that those potential rules and

regulations would place upon business is unknown. The simpler solutions tend to allow more tax evaders to slip through, while the

more tedious solutions tend to put a larger responsibility on businesses.

Under most current State sales tax systems, if an individual purchases a product in a State and is not charged sales tax in that

State, that individual is legally required to self-assess that State’s

tax. For example, if you live in Virginia and you purchase a table

from L.L. Bean, L.L. Bean does not currently have nexus with VirVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00136 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
131

ginia and is therefore not required to collect Virginia’s sales tax.

Upon receiving your table from L.L. Bean, you are supposed to

check your receipt and make sure you paid sales tax. If sales tax

was not paid, you are legally required to self-assess that tax. And

I am sure everyone in this room reviews all of their receipts and

makes sure to self-assess tax when legally required.

Now let’s face it, the State sales tax system is not working when

it comes to individual’s self-assessing the tax. The proposed national sales tax would also require individuals to self-assess when

sales tax was not originally paid to the seller. One such example

occurs when orders are placed over the Internet and shipped from

locations outside the United States into the United States.

Due to the fact that individual self-assessment does not work for

the States, it is doubtful that compliance would increase at the national level. I am confident that this hole would also be plugged by

future rules and regulations. The question then arises as to the

burden these controls would place upon businesses.

In closing, the administration of the national sales tax would

probably be simpler and easier than administering the current income taxes and payroll taxes, depending upon the procedural requirements. Every issue I have addressed in my testimony today

is further addressed in my written statement.

I appreciate the opportunity to speak at this first-ever Congressional Summit on Fundamental Tax Reform. The testimony heard

over the next 3 days from the members of Congress, the economists

and the business leaders on improving the IRS, as well as on the

various tax reform proposals, can only serve to improve our future

tax system. But I am afraid you have your work cut out for you.

[The prepared statement follows:]

Statement of Janet L. Skarbek, Cinnaminson, New Jersey

I was asked here today to specifically address the viability of administering a national sales tax from the perspective of a professional that deals with state sales

tax administration every day.

I started my career as a CPA working at the IRS Regional Inspector’s office. After

receiving a Master’s of Taxation from Villanova University’s Graduate Tax Program,

I went to work for a Big 6 Accounting Firm where I was responsible for the management of sales and use taxes for clients in the Mid-Atlantic region. I am currently

employed by a Fortune 500 company, where I am responsible for sales tax compliance and administration.

I have not been asked to speak about the economic impact of the proposed national sales tax, nor have I been asked to provide an opinion as to the overall feasibility of such a plan. Therefore, I will limit my testimony to specifically addressing

business administration questions and the related concerns raised by such a tax.

In my opinion, the administration of the national sales tax will ‘‘probably’’ be simpler and easier than administering the current income taxes and payroll taxes it

proposes to replace. I emphasize ‘‘probably’’ because the specific details and mechanisms of how the tax will actually be administered leaves too many unanswered

questions. The simplicity of the tax itself is without question. However, the procedures and compliance requirements that still need to be drafted will significantly

impact the ease and simplicity of administering this tax from a business standpoint.

Potential Costs

The costs to administer a national sales tax are unknown because the business

requirements and documentation procedures have yet to be determined. However,

if the procedures are similar to those imposed by states with sales taxes, the costs

of administering the proposed tax should be significantly less than the costs of administering the current income taxes and payroll taxes. Between employees and accountants used to track the information and prepare the returns, and the attorneys

needed to interpret and argue the gray issues contained in the massive tax codes,

132

American businesses spend billions of dollars every year complying with their federal tax burdens

States collect more in sales tax than they do from the combination of the individual income tax, corporate income tax, and property taxes. This fact usually surprises people because so little time and money is spent administering the sales tax.

Sales taxes are generally quite simple to administer. However, some of the states

have goofed up the simplicity, by adding new exceptions every year.

Also note that not all current costs associated with administering the payroll

taxes would be completely eliminated under the new proposal. The proposed tax

would merely change the source of funding for social security payments, but would

not change how the social security payments are calculated. Therefore, companies

would remain responsible for tracking wages. W–2’s and yearly filing for the selfemployed would still be essential.

For the businesses that are already collecting at least one state’s sales tax or the

necessary exemption documentation from customers, most companies are already familiar with the basics of sales tax administration. The education of these businesses

on the national sales tax would be fairly straightforward (again depending upon the

procedural requirements). For those businesses new to sales tax (such as direct mail

and internet retailers, banks, and insurance companies), they would have a larger

learning curve.

Problems encountered by businesses currently administering the states’ sales taxes

The national sales tax as proposed would not duplicate most of the larger problems that businesses currently encounter when dealing with the states’ sales taxes.

The first and foremost complaint that businesses have with the current states’ sales

tax systems is that: • —all of the 45 states that impose a sales tax have different rules regarding

what is taxable, when it is taxable and the amount of tax. Even when a state’s tax

appears to be similar to another state’s, their respective courts often interpret those

laws differently.

It’s fairly simple to become proficient administering one state’s sales tax, but administering to several of them is a very difficult feat. The national sales tax would

be just that—‘‘national.’’ As proposed, there are no regional or local zones that

would be established with different guidelines (tax rates or exemptions) to complicate the national sales tax.

Another area that concerns many small and large businesses is nexus. Nexus, for

sales tax purposes, is the minimum connection that must exist between a vendor

and a state before that state can require the vendor to collect sales tax. A salesman

or an independent contractor can create nexus for a business. Making deliveries to

a customer in a state using a company truck can create nexus for a business. Nexus

would not be a major concern for businesses if the states applied the same interpretation of what constituted ‘‘minimum connection’’ in the creation of nexus. However,

the states are not consistent in their criteria. Some states take the position that if

a company’s salesman visits one customer in their state, that is sufficient to create

nexus. Other states take the position that it takes 10 visits to create nexus. There

is no across the states standard to easily assess whether a business has nexus with

a state. As proposed, the requirement that a business collect the national sales tax

is not dependent upon a business’ nexus with any specific state.

The topic that raises the blood pressure of more sales tax administrators on a

daily basis is the topic of drop-shipping for customers. This occurs when a business

sells to one customer and that customer requests that the products be shipped directly to their customer. The problem is that many of the states take the position

that if a business is not registered in a state, they cannot provide the documentation

(generally a resale certificate) that would otherwise allow the sale not to be subject

to the state’s sales tax. The basic underlying premise for the sales tax is ‘‘the sales

tax should only be paid by the ultimate consumer purchasing the product.’’ However, this goes out the window in the states that take the position that only registered businesses can provide the necessary exemption documentation to support

their stance that they are not subject to tax. When this occurs double taxation can

take place on property that is drop-shipped into those states. First, it would be paid

by the company that is not registered in the state. Next, it would be paid by the

ultimate consumer purchasing the product.

This places businesses that have nexus with such states at competitive disadvantages with those that do not have nexus with such states. For example, assume

Company A has nexus with State Q and Company B does not have nexus with State

Q. Company A would have to collect sales tax on shipments for a customer that has

no nexus with State Q and is not registered with State Q when shipping to their

customer’s customer located in State Q. However, if Company B made the same sale

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and shipments, they would not be required to collect the tax. As proposed, a company’s nexus with a state would not put it at a competitive disadvantage with companies that did not have a minimum presence in the state.

Many states tax the property and services that are purchased by businesses. Determining what purchases are taxable in a state, which ones qualify for an exemption, and how to obtain such exemptions is an ongoing concern for many businesses.

The national sales tax would not result in nearly as many problems because according to Chapter 1, Section 102 ‘‘(n)o tax shall be imposed under Section 101 on any

taxable property or service purchased for a business purpose in a trade or business.’’ However, the definition of the statement ‘‘purchased for a business purpose in a

trade or business’’ needs to be more fully developed. The proposed definition is ‘‘purchased by a person engaged in a trade or business and used in that trade or business—(1) for resale, (2) to produce, provide, render, or sell taxable personal property

or services, or (3) in furtherance of other bona fide business purposes.’’ The definition needs to be further defined because opposing opinions on the taxability of various business purchases still remain. For example, would a business lunch be taxable? My interpretation is that they would not be taxable. However, there are those

that disagree with that interpretation. All such questions and gray areas need to

be eliminated.

Compliance

Under the current state sales tax systems, non-compliance will generally fall into

one of three categories:

1) underpaying the tax because of a mistake,

2) underpaying the tax due to a difference in opinion from the states on the many

gray areas of the laws, or

3) underpaying the tax intentionally.

The regulations that are developed in order to reduce these compliance problems

could make the tax difficult or easy to administer from a business standpoint. The

current proposed national sales tax is more lenient on what a seller can accept as

exempt documentation in lieu of the tax, than what the states currently require.

Most states require that the purchaser provide the seller an exemption certificate

that includes the:

a) purchaser’s name, address, and registration number,

b) the seller’s name,

c) a description of the property being purchased,

d) a statement that the property being purchased meets the requirements for the

exemption (i.e. resale, exempt business purpose, etc...), and

e) a signature.

The proposed national tax merely requires the vendor to receive in good faith a

copy of a registration permit from the purchaser and for the seller not to have at

the time of the sale reasonable cause to believe that the buyer was not registered.

Due to the fact that the proposed national sales tax rate is higher than any current

state sales tax rate, the controls should be at least as tough as those imposed at

the state level.

The first non-compliance category listed above is underpaying the tax because of

a mistake. Most mistakes made by businesses and individuals are the result of a

lack of knowledge that something is taxable. The simpler a tax is the less likely that

mistakes will be made.

The states have made parts of their sales/use tax laws so complex and difficult

to follow, that there is close to 100% non-compliance with some sections. This is the

case with the sections relating to individuals self-assessing use tax. According to

most current state sales tax systems, if an individual purchases a product in a state

and is not charged sales tax, the individual is legally required to self-assess that

states use tax. For example if you live in Virginia and you purchase a table from

LL Bean—LL Bean does not currently have nexus with Virginia and is therefore

not legally required to collect Virginia’s sales tax on their shipments to Virginia customers. Therefore, you would be required to self-assess the tax.

The states’ sales tax systems are not working when it comes to individuals selfassessing. Most Americans don’t even know that they are legally required by most

states to do this. The proposed national sales tax is much simpler and this problem

would be much smaller because a business’ lack of nexus with a state would not

effect the fact that it would generally need to collect the tax from these customers.

Whether a business had nexus with a state would be irrelevant to the fact that the

national sales tax would be required to be collected by the vendor in most situations. Therefore, essentially more businesses would be collecting the tax when shipping products directly to individuals’ homes and fewer individuals would have the

need to self-assess the tax. In addition, the marketing advantage that many direct

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marketers and internet retailers without nexus in a state have over other businesses physically present in a state would not exist under the national sales tax

(when the direct marketers or internet retailers have a physical presence in the

United States).

The second area of non-compliance falls under the category of underpaying the

taxes due to a difference of opinion from the states on the many gray areas of the

laws. The fact that the national sales tax as proposed is based on the presumption

that many businesses would not be subject to the national sales tax and that all

purchases by individuals (with very few exceptions) would be taxable eliminates

most of the gray areas that would come under contention.

The third area of non-compliance is due to those individuals that intentionally underpay the tax. There will always be individuals attempting to illegally outmaneuver paying their fair share of taxes, just like there will always be individuals

trying to create new and more potent computer viruses. With any tax system, it’s

a matter of trying to stay one step ahead of the law breakers.

There are several areas where the details of the internal controls that will be used

to stop those intentionally trying to make purchases without paying tax are not currently defined under the proposed ‘‘Fair Tax Act.’’ These internal controls will be

essential to determining the ease with which businesses can meet their tax responsibility. Here are five areas that need to be further developed.

1) What controls would be established to stop importers from shipping their goods

over our borders and selling them tax free on a black market?

2) What controls would be established to ensure that Americans traveling over the

borders and purchasing their goods without the tax and bringing them back into the

United States will self-assess the tax? Chapter 1, Section 103(b) provides that ‘‘(i)n

the case of taxable property or services purchased outside the United States and imported into the United States for use or consumption in the United States, the purchaser shall remit the tax imposed by Section 101.’’ Section 101(c) provides that if

a consumer imports taxable property directly, they would pay both the sales tax and

any import duty together at the same time at customs. Section 101(d) states that

‘‘(t)he person using or consuming taxable property or services in the Unites States

is liable for the tax’’ except when the person pays the tax to the person selling the

taxable property or service and receives a qualifying receipt. The compliance for individuals self-assessing the states taxes is almost non-existent. What controls would

be instituted to increase compliance?

3) What controls would be established to tax goods purchased over the internet

and shipped directly to customers from locations outside the United States?

4) What controls would be in place to locate individuals that register non-existent

companies (where no actual business is taking place) in order to obtain the documentation to provide vendors in order to make personal purchases tax free?

5) What controls will be in place to stop individuals from utilizing their companies’ certificates of registration in order to make tax free personal purchases? This

is another area where states know the problem exists. However, if the person makes

the purchase with cash, the audit trail is generally non-existent.

The regulations and controls that would be established in answer to the above

questions could be very simple or very complex for businesses to follow. The simpler

solutions tend to allow more tax evaders to slip through. The more tedious solutions

tend to put a larger burden on businesses.

For example, in response to question number 5, a simple procedure could be established that:

1) a company must designate a specific employee(s) to be responsible for the tax

documentation,

2) the employee would be required to register and sign a document that they will

not illegally use the tax documentation to make personal purchases tax free, and

3) the employee provides a copy of the documentation to each vendor that the

company makes non-taxable purchases from.

However, this simple procedure leaves open several loop holes. First, if the designated employee actually uses the tax documentation for personal purposes there

would be very little in the way of an audit trail to weed out such occurrences. The

records at her employers would show no indication of the misdeed. Second, what

would stop a dishonest clerk at the vendors from making another copy of the tax

documentation and then making tax free purchases with the documentation and

cash. This would essentially be untraceable.

An example of a slightly tougher solution that would rely more heavily on businesses would establish that:

1) every company that registers receives a booklet of exemption certificates containing sequential numbers, the company’s name, and identification number,

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2) every company would be responsible to keep a log of the exemption certificate

number and what vendor they gave the exemption certificates to.

This procedure, although not fool proof, would result in fewer employees utilizing

such certificates for their own purposes. An audit of the log and purchases made

by the company from specific vendors would show any certificates that were missing. Copying of certificates by vendors for their own use would also be less likely

since the certificates would be printed by the government.

This then raises the question of ‘‘when is a seller relieved of liability when collecting documentation?’’ Section 103(d) provides that when the vendor accepts a

copy of the registration certificate in good faith and has no reasonable cause that

the purchaser was not registered that this is sufficient to relieve the vendor of liability. The issue of ‘‘what constitutes the acceptance of documentation in good faith’’

is an area where the states and businesses currently hold varying opinions. For example, what happens if the government establishes a set of guidelines to indicate

that a certificate is valid and a clerk at a store accepts one that is missing a little

identifying insignia in the bottom corner? Would the store that mistakenly accepted

the counterfeit documentation be subject to the tax that they should have collected

from the customer? The mere fact that vendors would now be required to look for

this insignia would place a large responsibility on vendors.

You can see from the above, that the details of what would be required of a business in the day to day activities of compliance would be essential in determining

the full impact a national sales tax would have on businesses.

What agency (agencies) would administer the tax?

Section 401 provides that states which maintain a sales tax and which enter into

a cooperative agreement with the federal government can choose to administer the

federal tax for 1⁄4 of one percent of the revenue they collect and remit to the federal

government. They also have the ability to contract out the work to another state.

Title III, Section 302 would establish within the ‘‘Department of Treasury a Sales

Tax Bureau to administer the national sales tax in those States where it is required.’’ Specifically, those states that cannot or choose not to collect the national

sales tax.

The current national sales tax proposal suggests that the states should administer

the tax because of their previous experience administering a sales tax. Just because

a state has experience, does not mean that it is good at what it does. There are

states that are great administrators and states that are very poor.

It would be simpler to have all administrative responsibilities fall under the Sales

Tax Bureau than under the 45 states that currently impose a sales tax. Imagine

the IRS administration problems under 45 different roofs. It would be best to have

one organization responsible for administering the tax and to make sure the individuals in that organization are well educated and trained. If there were several agencies administering the tax, the administrative controls would be significantly diluted. In addition, for businesses operating in more than one state, there is confusion as to which agency would have control over the returns.

Conclusion

In closing, I appreciate the opportunity to speak at this first ever Congressional

Summit on Fundamental Tax Reform. The testimony heard over the next three days

from the members of Congress, the economists, and the business leaders on improving the IRS, as well as on the various tax reform proposals, can only serve to improve our future tax system. I

Chairman A

Mr. Chapoton?

RCHER. Thanks, Ms. Skarbek.

’m afraid you have your work cut out for you.

f STATEMENT OF HON. JOHN E. CHAPOTON, PARTNER, VINSON

& ELKINS, LLP, ON BEHALF OF THE AMERICANS FOR FAIR

TAXATION [FORMER ASSISTANT SECRETARY FOR TAX POLICY, U.S. DEPARTMENT OF THE TREASURY]

Mr. CHAPOTON. Thank you, Mr. Chairman. My name is John

Chapoton. I am a partner with the law firm of Vinson & Elkins,

and I am here on behalf of the Americans for Fair Taxation.

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Mr. Hank Gutman and I have a statement that we have submitted for the record, and I would like to just give a brief summary

of the points that we have made, again, focusing on the administrative points.

I think a starting point, when you assess or evaluate any tax system, is how understandable the rules are and how predictable the

outcome of calculating the tax is. I think when you look at our

present income tax, you have to say that it does not meet that test

very well. We have all sorts of special rules, we have phase-ins, we

have phase-outs, we have disputes on what has to be capitalized,

what doesn’t have to be capitalized, we have rules for determining

ordinary income and capital gains. So it is complex and, unfortunately, efforts at simplification have failed. It absolutely becomes

more complex every year.

I think it is reasonable to conclude, I think it is really cannot be

doubted that the Fair Tax that is before you today would eliminate

most of these complexities and would, thus, eliminate the administrative costs that those complexities bring with them. There are objections voiced to the national sales tax, the distribution issues, the

transition issues. Would the rate be so high that Americans would

object? There are other objections. I think the Fair Tax deals with

those in a very straightforward and open manner. I want to just

talk about the administrative points, however.

One thing we ought to keep in mind is that consumption taxes

are used, in one form or another, very widely in the world. All of

our trading partners, I guess for all of our trading partners, most

of them certainly have consumption taxes, most in the form of

value-added taxes. Some 17.8 percent of the OECD countries—tax

rate of the OECD countries are in consumption tax form.

And of course the States, as we have heard today so many times,

depend a great deal on sales taxes to raise their revenues. Six

States, including the State of Texas, my State, depends on the

sales tax for most of its revenues. So sales taxes are easily understood. They generally or the perception is that they work well.

Most businesses selling to retail customers collect and report the

tax today and it is a familiar tax. So there is strong evidence that

if the Federal Government decided to do so, it could administer a

national sales tax.

The Fair Tax or any other national sales tax, though, would, of

course, have to be a higher rate than we have experienced in any

State sales tax to this date. And as the rate goes up, we know the

incentive to avoid or evade the tax goes up by imaginative interpretation or simply by cheating. The rate of tax measures the potential reward for evading or simply avoiding the tax. So the rate of

the tax is an important question in administration and enforcement of the tax. We discuss several specific areas in our paper. But

what jumps out at you, as you review these issues, is that for the

most part, these difficult issues that will be presented in a national

sales tax are areas that present huge complexities in the income

tax today, and the compliance problems that go with that.

Take a single example, but a very important example. That is

mixed-use property or mixed-use service; that is, where a person

buys a service or a good and uses it partially in business and partially personally. That will be a difficult administrative problem in

137

the sales tax. But it is a very difficult problem in the income tax

today, determining when an expense is personal or business. It is

the subject of much litigation and it is a constant thorn in the side

of the income tax. So that is just one example. There are many others that the Fair Tax or any national sales tax will have problems

to deal with, but they are not increased problems, they are problems that we already have to deal with. And, indeed, in many instances, I think it is possible to argue that the Fair Tax would lessen those problems.

I think the key point is that when you look at the administration

and enforcement of a sales tax, it is just how many taxpayers

would be taken out of the system all together. Today, everybody is

in the system. We have 120 million individual income tax returns,

some 22 million business returns and over 200 million total returns. Only retail businesses, only a portion of today’s business returns, would be in the system, if you will, in a sales tax, and that

would only be a fraction of the total returns filed by individuals,

trusts, and partnerships and businesses today.

So in enforcement terms, this means there would be far fewer opportunities to evade or avoid the tax. Fewer taxpayers would have

the opportunity to bend the rules or simply cheat, even if they were

inclined to do so, and even if they were doing so now under the income tax. Under the income tax, everyone has the chance. You

have the chance in the privacy of your own home to claim excessive

deductions or ignore small amounts of income. And the more individual taxpayers hear about others bending the income tax rules,

that the wealthy are not paying their share or because of tricky

schemes by so-called investment schemes and investment bankers,

people are less inclined to pay their own fair share. That is a problem with any uneven tax, and I am afraid an uneven tax is what

we have today.

Of course, small cash-based business, the street vendor, the contractor who comes to your house for a single job will be a problem

under a sales tax. They will collect the tax on what they sell and

not have the incentive to pay it over or they may give you a wink

and a nod and say they won’t collect the tax if you will hire them

to do the job. But the clarity of the rules will, under a sales tax,

would make that more difficult, and probably it would make them

easier to catch and penalize. Lack of understanding of the rules

would not likely be a very compelling defense.

And more important for today’s discussion, this is not a new

problem. This is the group of taxpayers, the small cash-based businesses, that is the single largest component of the so-called tax cap

under the income tax today. There is no reason to think this would

be more of a problem under the sales tax, and it might even be

easier to address, given the transparency of the tax.

So, Mr. Chairman, let me just conclude by saying that this committee and the Congress may decide not to go the sales tax route

for any number of reasons, for economic reasons, for transition considerations, but I think enforcement and administration questions

should not prevent the very serious consideration and study of the

Fair Tax.

[The prepared statement follows:]

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Statement of Hon. John E. Chapoton, Partner, Vinson & Elkins LLP, on behalf of the Americans for Fair Taxation (Former Assistant Secretary for

Tax Policy, U.S. Department of the Treasury)

Dear Mr. Chairman and Members of the Committee:

We are pleased to have the opportunity to submit this statement on behalf of

Americans for Fair Taxation. We commend Chairman Archer and the Committee for

undertaking a serious study of a national retail sales tax as embodied in the

FairTax. We have been asked to comment on the administration of the FairTax.

One key element in the evaluation of any tax system is whether the rules are understandable and the outcome of the calculations predictable. Our current income

tax system clearly fails to meet these criteria for most individual taxpayers and for

many large corporate taxpayers as well. Features of the individual income tax that

increase its complexity include elections, distinctions between capital and ordinary

gain or loss, valuation questions, capitalization of certain business costs, recordkeeping requirements, rules restricting favorable tax treatment, itemized deductions, the alternative minimum tax, the earned income tax credit, and a large number of phase-in and phase-out provisions. Attempts to simplify the income tax have

failed, and indeed, the Code annually grows more complex. The FairTax would

eliminate these complexities, and the administrative costs associated with them.

In considering a national sales tax, the Committee should be aware of the important role that consumption taxes already play both within the U.S. and globally.

Consumption taxes are an important source of revenue for governments generally;

this is an area where the U.S. has lagged behind other nations. The success of so

many other governments in administering consumption taxes should indicate to the

Committee that the U.S. can successfully administer a comparable tax.

Internationally, countries ranging from Albania to Zambia, including almost all

our major trading partners rely heavily on consumption taxes. These are typically

in the form of value-added taxes, which have essentially the same economic effect

as retail sales taxes. The administration and enforcement of these levies are not

problem-free, but there is reason to conclude those problems may not be as great

as we are encountering with our individual and corporate income taxes.

Of the 29 OECD countries, only the U.S. does not have a value-added tax. Among

OECD members, the United States has the lowest general consumption tax collections as percentage of total taxes (7.9% in 1996) other than Japan (5.3%). The average share of taxes raised from general consumption across all OECD countries is

17.8 percent. At the federal level, the U.S. collected $70 billion in consumption

taxes, in the form of excise taxes, during FY 1999.

139

In the U.S. today, consumption taxes, including both general and specific sales or

excise taxes, are used by every state and many local governments. In 1999, approximately 32 percent of all state and local taxes, or more than $262 billion, were collected this way. Forty-five states have general sales taxes. In 1998, general sales

tax revenues accounted for more that half of total tax collections in Florida, Nevada,

South Dakota, Tennessee, Texas, and Washington. When selective sales or excise

taxes are included, these same states all collect more than 70 percent of their revenues through consumption taxes.

Apart from some current issues with e-commerce, existing sales tax administrative systems seem to work reasonably well. Indeed, a number of significant current

income tax system problems do not exist under a sales tax. The income tax and

trade complexities we are currently facing with Foreign Sales Corporations (FSCs)

are merely one example of the difficult issues that we must regularly address. These

income tax structural problems would go away under a consumption tax system.

The marriage penalty issues and corporate tax shelter concerns—two tax policy

issues attracting much attention today—would largely disappear under a sales tax

regime.

For tax year 1997, IRS reports that 63.5 million individual tax returns were

signed by paid tax return preparers. This is more than half of the 120.8 million individual income tax returns filed. This is, of course, in addition to the substantial burdens imposed on individual taxpayers who prepare their own returns. Under the

FairTax, this burden on individual taxpayers would be eliminated. The only new administrative burden would be the annual need to register families to qualify for the

family consumption allowance.

Most businesses selling to retail consumers collect and report sales taxes today.

While their sales tax administrative burdens would become somewhat more complex

(at least until state and local tax systems are brought into conformity), this would

be more than offset by the fact their income tax burdens would disappear. A variety

of other new burdens would be imposed on businesses making retail sales, but many

of these would substitute for burdens already required under existing state and local

sales taxes. Indeed, the FairTax contemplates that the myriad of existing sales and

local tax bases would over time be brought into conformity with the newly defined

federal sales tax base. This by itself would be a major simplification for retailers—

especially those operating in multiple jurisdictions.

Certainly there are issues of tax administration that must be addressed. A variety

of services, including financial intermediation services, and other products not generally subject to sales taxes today would become taxable. Devising the appropriate

tax structure will be a complex undertaking; many of our trading partners are wresVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00145 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
140

tling with these issues today. Additional work will be required in this area. Another

area of potential administrative difficulty is presented when property with both taxable and nontaxable uses (‘‘mixed use property or services’’) is purchased. Apportionment is required under the FairTax. However, this requirement is unlikely to be

any more burdensome than distinguishing between business and personal expenses

under current law.

The Federal Government and state and local governments would be required to

pay sales taxes on their purchases, which would be a new administrative burden.

Governmental entities will be required collect tax on their sales as well.

It is reasonable to assume that total state government tax administration costs

would rise under the FairTax because they would largely be responsible for collecting the new federal sales tax in addition to their own sales taxes. In recognition

of this, the FairTax provides for a 0.25-percent payment to states for administering

the tax. While we have not studied whether this amount would be sufficient to cover

the increased costs of administration, a cost reimbursement feature is an important

tool for assuring that states provide adequate support to collect all taxes that are

due under the new system. There are, however, potentially significant administrative cost savings if a uniform tax base were to be adopted across all taxing jurisdictions.

It is very important to keep in mind that administrative costs in general, and

compliance costs in particular, are likely to rise as the rate of tax increases. Pressure to avoid taxes—through imaginative interpretations of the rules or by simply

cheating—increase as the tax rate goes up. The rate of tax measures the potential

reward to a person contemplating avoidance or evasion. If the rate becomes excessive, enforceability could undoubtedly become a problem. However, these enforceability concerns may not be as significant as those that currently exist under the

federal income tax.

Enforceability is more of a problem if opportunities for avoidance are presented

by the mechanics of the tax, such as through exceptions and special rates. The

states, for example, generally exempt a variety of goods and services. The FairTax,

by contrast, has virtually no exclusion and no special rates. It contemplates a very

comprehensive tax system. We want to emphasize as strongly as possible, the critical importance, from an administrative standpoint (as well as an economic standpoint), of keeping the tax base as broad as possible, and thus the rates as low as

possible.

In sum, the FairTax provides the opportunity to reduce administrative burdens

on taxpayers. As with the consideration of any new tax regime, and as we continually face under current law, there will be questions and problems to be solved. We

believe that these administrative questions can and should be seriously addressed.

Administrative issues should not stand in the way of further serious consideration

of the FairTax.

Chairman A

Mr. Threadgill?

RCHER. Thank you, Mr. Chapoton.

f STATEMENT OF DEL THREADGILL, VICE PRESIDENT OF

TAXES, J.C. PENNEY COMPANY, DALLAS, TEXAS, AND CHAIRMAN, NATIONAL RETAIL FEDERATION TAXATION COMMITTEE

Mr. THREADGILL. Thank you, Mr. Chairman and members of the

committee. My name is Del Threadgill, and I am vice president and

director of Taxes for the J.C. Penney Company and the current

chairman of the National Retail Federation’s Taxation Committee.

The National Retail Federation is the world’s largest retail trade

association, representing an industry of 1.4 million establishments,

employing more than 22 million Americans or about one in every

five workers, with sales in 1999 of more than $3 trillion.

I am here today to express the retail industry’s strong opposition

to a national retail sales tax, as proposed. Our principal concern is

that no one really knows what the full impact of replacing the enVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00146 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
141

tire Federal income tax structure with a consumption-based sales

tax will have on our economy. It has never been done before in any

major industrialized Nation, let alone the world’s largest economy.

As evidenced by the comments from the previous panel, even the

experts disagree over the impact from such a radical change. At a

time when our economy is experiencing its longest period of sustained growth in history, do we really want to bet the ranch on

some untried tax policy experiment?

Americans are truly dissatisfied with the current tax system, and

rightfully so. The retail industry cannot and will not defend the income tax as it currently stands. It is entirely too complicated and

cumbersome. As for fairness, it is hard to understand why a tax

system that determines a person’s contribution to the cost of Government based on his ability to pay is less fair than a system that

is based on what he spends.

Yesterday, the National Retail Federation released a study of

congressional tax reform proposals. That study was prepared by

the nationally recognized economic consulting group within

PricewaterhouseCoopers. PWC utilized an economic model capable

of estimating both the short-term and long-term consequences of

tax reform; in other words, what will happen in the short run, as

opposed to 10 years from now.

Retailers thought it imperative to know what might happen to

the economy and consumers in the short run as well. PWC was instructed to use their expertise to determine what they believed to

be the correct answer. There was no predisposition given to PWC

as to what the retail industry expected to see from the study. We

simply wanted to know what the facts were.

The PWC findings should be of concern to both taxpayers and

lawmakers alike. While it did show the economic gains at the end

of a 10-year period under a national retail sales tax, it is the interim period that causes the heartburn. The study clearly shows

that there will be short-term chaos in the economy and in the retail

industry.

In the best-case scenario, the study found, one, that the required

budget-neutral tax rate would range from 24 to 65 percent, depending upon the number of exemptions and the rate of taxpayer compliance.

Second, serious economic disruptions would occur under a national retail sales tax, at least in the short run. The economy would

be depressed for a period of at least 3 years, consumer spending

would be depressed for at least 8 years with consumer purchases

down over $500 billion and up to a million-and-a-half American

jobs would be eliminated. The question we have as an industry is

how many smaller retailers and other small businesses would still

be around to enjoy the long-term benefits of a national sales tax

after this transition period.

And, third, a national retail sales tax would redistribute the Federal income tax burden from higher income to middle-income families, with the purchasing power of low-income households being

down 8 to 14 percent under a national retail sales tax.

Retailers believe that a national retail sales tax would exacerbate the underground economy, become a Pandora’s box of

carveouts and exemptions for Washington’s special interests, burVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00147 Fmt 6633 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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den small business and require additional IRS or a like-minded

agency’s oversight. The retail industry would encourage lawmakers

to take a measured approach to tax reform to ensure that a new

system is both fair and equitable for everyone.

Thank you, Mr. Chairman.

[The prepared statement follows:]

Statement of Del Threadgill, Vice President of Taxes, J.C. Penney Company, Dallas, Texas, and Chairman, Taxation Committee, National Retail

Federation

Mr. Chairman and Members of the Committee:

Good afternoon, and thank you for the opportunity to testify before this Committee today.

My name is Del Threadgill, and I am Vice President and Director of Taxes for

the JCPenney Company and the current Chairman of the National Retail Federation’s Taxation Committee.

The National Retail Federation is the world’s largest retail trade association, representing an industry of 1.4 million retail establishments, employing more than 22

million people—about 1 in every 5 American workers—with sales in 1999 of more

than $3.0 trillion.

I am here today to express the retail industry’s strong opposition to a proposed

National Retail Sales Tax (NRST). Our principal concern is that no one really knows

what the full impact of replacing the entire Federal income tax structure with a consumption-based sales tax will have on our economy. It has never been done before

in any major industrialized nation, let alone the world’s largest economy.

As evidenced by the comments from the previous panel, even the experts disagree

over the impact from such a radical change. At a time when our economy is experiencing its longest period of sustained growth in history, do we really want to ‘‘bet

the ranch’’ on some untried tax policy experiment.

Americans are dissatisfied with the current tax system, and rightfully so. The retail industry cannot and will not defend the income tax as it currently stands. It

is entirely too complicated and cumbersome.

As for Fairness, it is hard to understand why a tax system that determines a person’s contribution to the cost of government based on his ability to pay is less fair

than a system that is based on what he spends.

Yesterday, the National Retail Federation released a study of Congressional tax

reform proposals. The study was prepared by the nationally recognized economic

consulting group within PriceWaterhouseCoopers (PWC). PWC utilized an economic

model capable of estimating both the short-term and long-term consequences of tax

reform. Models utilized by some national sales tax proponents are only capable of

estimating the long-term effects of tax reform (i.e. what happens at the end of a 10-

year period.)

Retailers thought it imperative to know what might happen to the economy and

consumers in the short-term as well. PWC was instructed to use their expertise to

determine what they believed to be the correct answer. There was no predisposition

given to PWC as to what the retailers expected to see from the study. We simply

wanted the facts.

The PWC findings should be of concern to taxpayers and lawmakers alike. While

it did show some modest economic gains at the end of a 10-year period under a

NRST, it is the interim period that causes the heartburn. The study clearly shows

that there will be short-term chaos in the economy and the retail industry.

In a ‘‘best-case’’ scenario, the PriceWaterhouseCoopers (PWC) study found:

1) The required budget-neutral NRST tax rate would range from 24–65%,

depending on the number of exemptions and the taxpayer compliance rate.

• a seperate Congressional Joint Economic Committee report confirms PWC’s

findings by estimating that a NRST rate of 19–65% would be necessary.

• 2) Serious economic disruptions would occur under a National Retail Sales Tax.

• the economy would be depressed for three years—with GDP down $180 billion.

• consumer spending would be depressed for eight years, with consumer purchases down $503 billion.

• up to 1.5 million American jobs would be eliminated.

• the question arises as to how many retailers and small businesses would still

be around to enjoy the modest long-term benefits of a NRST?

3) A National Retail Sales Tax would redistribute the federal income tax

burden from higher income to middle and low-income families.

143

• the purchasing power of low-income households would be down 8–14% under a

NRST while high-income households would not be affected.

Retailers believe that a NRST would exacerbate the underground economy, become a Pandora’s box of carve-outs and exemptions for Washington special interests,

burden small businesses, and require additional IRS or like-minded agency oversight.

The retail industry would encourage lawmakers to take a measured approach to

tax reform to ensure that a new system is fair and equitable for everyone. Americans may not like the current Federal income tax or the IRS, but they may like a

National Retail Sales Tax even less.

Chairman A

The chair has no questions for this panel.

Thank you.

RCHER. Thank you, Mr. Threadgill.

f Ms. Thurman?

Mrs. THURMAN. Mr. Hamilton, were you around when the service

tax was contemplated and passed in Florida?

Mr. HAMILTON. Yes, ma’am, I was.

Mrs. THURMAN. Did you have any experience in talking with the

comptroller there as to the issues, or the Department of Revenue,

the issues that they had and concerns of the collection of these

taxes?

Mr. HAMILTON. Yes, ma’am. And one of my good friends was the

commissioner of revenue until very recently there, and we actually

imposed service taxes in the same period in Texas.

Mrs. THURMAN. Are yours still in place?

Mr. HAMILTON. We had the good sense not to tax advertising,

and that seems to have been a very important thing not to do.

[Laughter.]

Mrs. THURMAN. So you now have services.

Mr. HAMILTON. Yes, ma’am.

Mrs. THURMAN. Everything but advertising?

Mr. HAMILTON. Well, as with most things on the Texas sales tax,

it is a hit or miss. Generally, things like information services, data

processing services, miscellaneous retail services, which would be

like repairs of shoes and whatnot, telecommunication services, just

a fairly wide range, but not all services.

Mrs. THURMAN. But those were all taxed.

Mr. HAMILTON. Yes, ma’am.

Mrs. THURMAN. Because one of the things we heard through our

Department of Revenue was the burden that it was going to put

on them, as well as to Mr. Threadgill on the issue of retailers of

the collection.

But I want to go to Mr. Chapoton.

Mr. CHAPOTON. In the bill, actually, and I am asking these questions because actually Mr. Linbeck was in my office the other day,

and he told me to ask these hard questions, so hopefully this isn’t

hard. In one of the parts, you talk about tax to be separately stated

and charged. Now, I don’t have a real big problem with some of it

because even today, you know, I go into the store, I purchase something, I know it has a sales tax. If they tell me I am spending $100,

I get charged my 6 percent or 7 percent. At the end of the day, I

know I am going to pay $107. But there is an interesting one in

here that I don’t understand. And it says you pay the property or

144

services’ price exclusive of tax, the amount tax paid, the property

or service price inclusive of tax, and then the fourth one, and I

don’t know what this means, the tax rate, which is the amount of

tax paid, per paragraph 2, divided by the property or service price

inclusive of tax, per paragraph 3.

Just to kind of get to the simplicity issue that everybody is going

to pay this, I need to understand what does that mean?

Mr. CHAPOTON. Well, I think that is part of the danger of reading

statutory language. I think what it is trying to say is it is a taxinclusive rate. And so that, and this point was made earlier today,

that when you look at the tax, it is not, if you have a dollar, it is

not 23 percent of a dollar, it is 23 percent of $1.23. Do you understand that?

It is like the income tax today. It is a tax-inclusive rate.

Mrs. THURMAN. Right.

Mr. CHAPOTON. You do not pay the income tax out of other income, you pay it out of the income you are taxed on, and this is

the same thing. So I am not sure I have even seen the exact, specific language you are talking about, but it is clear to me that is

what it is trying to do.

Mrs. THURMAN. Is there a reason for that? I mean, why wouldn’t

you just put down this is the tax you are paying, end of story—

I mean, just like we do today. I mean, I am just curious.

Mr. CHAPOTON. You could do it either way, really. You could do

it either way. It changes the rate, but you could do it either way.

Mrs. THURMAN. Mr. Hamilton, let me go back to another question. When you said you did the services, how many additional people did you have to put on to collect the services tax that——

Mr. HAMILTON. I think we added about 20 people.

Mrs. THURMAN. That is it?

Mr. HAMILTON. Yes, ma’am. I mean, it was fairly straight—I

should have mentioned earlier that the one group of services that

we didn’t tax were professionals, like lawyers, doctors. That might

have been a problem, too, or maybe not. But at any rate, they

weren’t taxed. But it didn’t require a lot of additional people because a lot of where the services were being delivered, people were

already registered for either the Texas sales tax or the Texas corporate franchise tax or one of our other taxes. So we were able to

find them.

Mrs. THURMAN. But you think there would be a lot of other people that might have to be registered under this?

Mr. HAMILTON. Yes, ma’am, about 900,000 extra. But a lot of it

is because it is picking up a wider band of services than our sales

tax. It picks up the professions, for one thing, the lawyers,

doctors——

Mrs. THURMAN. Do you see that as an increased cost to the

State?

Mr. HAMILTON. Increased in—well, the administrative costs there

would definitely be a significant administrative cost to the State,

if, for no other reason, than the rapid processing of the returns and

the money that would be required, and I think a more extensive

audit and enforcement effort to deal with what Buck was referring

to.

145

Mrs. THURMAN. Right. And I would go to that as an enforcement

issue because even today, with your flea markets and any other

things that are out there, how do you deal with those issues?

Mr. HAMILTON. Well, as with most sales taxes, the majority of

the tax is collected from very large retailers, the J.C. Penney’s and

the Wal-Marts and whatnot. The way that we deal with flea markets, and gun shows and a lot of itinerant peddlers is we have enforcement officers—that is our term—compliance officers in other

States, that do routine canvasses of the shows when they are in

progress. And they will go through and register every one of the

taxpayers or anyone that is there that is making sales, ensure that

the tax is being collected. There are marginal problems with that.

It is certainly true, but that is part of the requirement on all of our

enforcement offices that they do so many canvasses of those types

of shows every year.

Mrs. THURMAN. But, Mr. Threadgill, that is a part of the problem

that you have in those two is this underground economy that is

going to start not just only in the flea markets and other areas like

that, but the sale. I mean, is that the—because you raised that

issue.

Mr. THREADGILL. Certainly, the concern is, in coming up with

what the rate would need to be to be revenue-neutral or budgetneutral, making sure what is included or not included in the base.

And I think Mr. Chapoton mentioned the fact that a lot of cashbased businesses and what happens to those, and as the rate gets

higher, the chances of those going underground becomes more and

more.

I know in the Canadian experience, when they instituted their

GST tax, there was a study a couple of years later that a number

of businesses went underground, and that was a 7- or 9-percent

GST-type sales tax, on top of their income tax. But there was a

study that a lot of businesses, cash-based businesses, went underground.

Mrs. THURMAN. Mr. Chairman, I appreciate the fact that you

have given us the opportunity to learn a lot today. And I want to

say my thanks to all of the witnesses, those who are still here, for

your sincerity in trying to answer our questions and to let you all

know that no matter what we are asking in questions, we all

should take seriously what is before us on any of these proposals.

Because I think the one thing we all do agree, that we have got

to simplify for the American people, however we do that, the tax

code. So I appreciate, Mr. Chairman, your time and the time of our

witnesses.

Chairman ARCHER. The chair adds his gratitude to all four of

you, as well as to all of the other witnesses that have been before

the committee today. Thank you very much.

There is no further questioning that I know of and no further

witnesses today, so the committee will stand adjourned.

[Whereupon, at 4:18 p.m., the hearing was adjourned, to reconvene on Wednesday, April 12, 2000, at 10:00 a.m.]

(147)

FUNDAMENTAL TAX REFORM

WEDNESDAY, APRIL 12, 2000

HOUSE OF REPRESENTATIVES, COMMITTEE ON WAYS AND MEANS, Washington, D.C.

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

1100 Longworth House Office Building, Hon. Bill Archer (Chairman of the Committee), presiding.

Chairman ARCHER. Today we continue with our tax summit on

structural tax reform and what alternatives we might look at to replace the current archaic code which we commenced yesterday.

And leading off this morning is one of our own colleagues, a

member of the Ways and Means Committee and gentleman from

Pennsylvania, Mr. English.

And Mr. English, we are happy to have you with us this morning

on the other side of the witness table, and we will be pleased to

hear your presentation as to what you think is an appropriate alternative.

STATEMENT OF HON. PHIL ENGLISH, A REPRESENTATIVE IN

CONGRESS FROM THE STATE OF PENNSYLVANIA

Mr. ENGLISH. Thank you, Mr. Chairman.

I appreciate the opportunity to appear here today. I believe that

the current tax system is broken. I believe it is one of the reasons

why our economy is having trouble competing internationally and

I believe it is one of the reasons why so many taxpayers question

the legitimacy of their government.

I believe that we need to find a better way of applying taxes and

generating the revenue to do what we need to do. And I want to

especially congratulate you, Mr. Chairman, for raising that issue at

this time. By getting involved now, I think we have an opportunity

to shape the debate for the future.

A couple of years ago, when I came to Congress, I became aware

of some of the problems with the current tax system simply by

talking to constituents.

I was dissatisfied by many of the alternatives that were being offered including the flat tax and the idea of a national sales tax.

And I have spent a lot of time working to develop an alternative

based on the old Nunn-Domenici proposal which was described at

the time as a consumed income tax.

I have introduced the Simplified USA Tax Act because I want to

reform the American tax system in a way sensible to the average

citizen and that will pass the test of time.

148

Not only do we need a tax system that is fair and sensible, we

need one that is stable. As bad as the current system is—and I am

one of its severest critics—the last thing we need to do is enact reform that is so radical and experimental that Congress will be

faced with revamping it all over again in a few years.

The Simplified USA Tax is revolutionary in that it addresses the

strongest points of concern with the current system while, at the

same time, addressing concerns about the equity of other tax reform proposals being considered.

SUSAT is based on principles that I feel are vital to any meaningful reform, imposing a simple tax to encourage efficiency, ensuring that income is taxed only once wherever possible, establishing

trade equity for American products, taking the double tax burden

off of savings so as not to discourage individuals from saving, providing incentives for investment in good-paying jobs in physical

capital and in human capital. And including an accommodation

with respect to the Social Security Payroll Tax, the most regressive

tax of all.

In my tax reform proposal USA stands for ‘‘unlimited savings allowance.’’ Everyone is allowed an unlimited Roth IRA in which

they can put the portion of each year’s income they save, after paying taxes and living expenses.

After five years, all funds in the account may be withdrawn for

any purpose, and all withdrawals, including accumulated interest

and other earnings and principal are tax-free.

Nothing could be simpler and nothing could give people a better

opportunity to save, especially young people. Because only new income earned after enactment of SUSAT can be put into the USA

Roth IRA, young people starting to move into their higher earning

years are the ones who will benefit the most for the longest time.

The Tax Code should give everyone the opportunity to keep what

they save and, if they wish, to pass it along to succeeding generations. Therefore, the death tax would be repealed under my proposal.

Under a new tax code, tax rates, in my view, should be lower,

especially for wage earners who must now pay both an income tax

and a 7.65 percent FICA payroll tax on the same amount of wages.

It is my intention that the final tax rates under SUSAT, after all

adjustments are made, will be as low as possible, consistent with

budget limitations.

At present, the USA Tax starts out with quite low rates, 15 percent at the bottom, 25 percent in the middle, and 30 percent at the

top.

These rates are reduced even further by allowing wage earners

a full tax credit for the payroll tax that is withheld from their paychecks under current law.

I do not propose to repeal the payroll tax because to do so would

imperil Social Security.

However, I do allow a credit for it, and when the credit is taken

into account, the rates of tax on workers’ wages are very low, and

the seven percent to 17 percent range for nearly all Americans.

Under the simplified USA Tax, the tax rate on the first $40,000

of taxable income from wages cannot exceed 7.35 percent which is

the basic USA rate of 15 percent less 7.65 percent.

149

Under the current Code, the combined payroll tax/income tax

rate is 22.65 percent.

On the next $32,000, the rate cannot exceed 17.35 percent which

is the middle USA rate of 25 percent less the payroll tax credit.

Under the current code, the combined payroll tax/income tax rate

is 35.65 percent. The Simplified USA Tax provides tax relief for all

Americans, especially when they own their own home, give to their

church, educate their children, and set aside some savings for a

better tomorrow.

Under this proposal, everyone gets a deduction for the mortgage

interest on their home and for charitable contributions they make.

Child support is also deductible.

Generous personal and family exemptions are also allowed under

this proposal.

The Simplified USA Tax is simplicity itself. The tax return will

be short, only a page or two for most of us. But more to the point,

the tax return will be understandable. For the first time in a long

time, America’s tax system will make sense to citizens who will file

their tax returns and pay their taxes.

SUSAT also contains a new and better way of taxing corporations and other businesses, that will allow them to compete and

win in global markets in a way that exports American-made products, not American jobs.

If enacted in the United States, we have some reason to believe

this innovative approach to business taxation will soon become the

worldwide standard by which other countries model their systems.

All businesses, corporate and non-corporate, are taxed alike at an

eight percent rate on the first $150,000 of profit and 12 percent on

all amounts above that small business level.

This system would be border adjustable. It would also address

the territoriality problem which is at the core of our fight with Europe over FSC. If we were to pass this business portion alone of

my tax system, it would address the FSC problem and, at the same

time, it would allow us to import a foreign tax base.

The new revenue from the import tax will be, we estimate, about

$160 billion, a large portion of which will never become a cost to

the U.S. economy. We do not know exactly how much will be shifted back to the foreign companies that sell in the U.S. market, but

both basic economics and common sense tell us that a large portion

will be absorbed by foreign sellers and therefore will never enter

the U.S. economy.

I think the point here is that the amount is large and that the

Simplified USA Tax provides a correspondingly large tax cut for

Americans. At the same time, it gets rid of the AMT, the death tax,

and depreciation.

Mr. Chairman, wrapping up, for too long, the Tax Code has been

an albatross around the neck of the economy. This is not very

smart and it is certainly not fair to those citizens whose standard

of living are substantially lower as a result.

It is time to restore people’s faith in the integrity and competence of their tax system, and in the process take a major step

toward helping U.S. companies compete in the global marketplace.

150

SUSAT is the product of a great deal of work by many people

and I want to compliment them here. I am proud to be the sponsor

of H.R. 134.

I invite the Committee to look in a bipartisan fashion at this

issue and consider providing the American people the fair and sensible tax system that they deserve.

Mr. Chairman, I appreciate the opportunity to testify.

[The prepared statement follows:]

Statement of the Hon. Phil English, a Representative in Congress from the

State of Pennsylvania

Good morning, Chairman Archer and my distinguished colleagues on the Ways

and Means Committee. I appreciate the opportunity to testify before you today on

the issue of fundamental tax reform. I commend the Chairman for scheduling these

hearings as we agree that this is an issue whose time has come.

I have introduced the Simplified USA Tax Act, H.R. 134, because I want to reform

the American tax system in a way sensible to the average citizen and that will pass

the test of time. Not only do we need a tax system that is fair and sensible, we need

one that is stable. As bad as the current system is—and I am one of its severest

critics—the last thing we need is to enact reform that is so radical and experimental

that Congress will be faced with revamping it all over again in a few years.

The Simplified USA Tax is revolutionary in that it addresses the strongest points

of concerns with the current system while at the same time addressing concerns

about the equity of other tax reform proposals being considered. The Simplified USA

Tax is based on principles that I feel are vital to any meaningful reform:

• Imposing a simple tax to encourage efficiency

• Ensuring that income is taxed only once

• Establishing trade equity for American products

• Taking the double tax burden off of savings—so as not to discourage individuals

from saving

• Providing incentives for investment in physical capital and human capital

• Including an accommodation with respect to the Social Security payroll tax—

the most regressive tax of all.

In my tax reform proposal, USA stands for ‘‘Unlimited Savings Allowance.’’ Everyone is allowed an unlimited Roth IRA in which they can put the portion of each

year’s income they save after paying taxes and living expenses. After five years, all

funds in the account may be withdrawn for any purpose and all withdrawls—including accumulated interest and other earnings and principle—are tax free. Nothing

could be simpler and nothing could give people a better opportunity to save; especially young people. Because only new income earned after enactment of the Simplified USA Tax can be put into the USA Roth IRA, young people starting to move

into their higher-earning years are the ones who will benefit the most for the longest time.

The tax code should give everyone the opportunity to keep what they save, and

if they wish, to pass it along to succeeding generations. Therefore, the federal estate

and gift taxes would be repealed under my proposal.

Under a new tax code, tax rates should be lower, especially for wage earners who

must now pay both an income tax and a 7.65% FICA payroll tax on the same

amount of wages. It is my intention that the final tax rates under the Simplified

USA Tax Act, after all adjustments are made, will be as low as possible consistent

with budget limitations. At present, the USA Tax starts out with quite low rates—

15% at the bottom, 25% in the middle, and 30% at the top. Then, these rates are

reduced even further by allowing wage earners a full tax credit for the 7.65% Social

Security and Medicare payroll tax that is withheld form their paychecks under current law. I do not propose to repeal the payroll tax because to do so would imperil

Social Security, however, I do allow a credit for it and when that credit is taken

into account, the rates of tax on workers’ wages are very low—in the 7% to 17%

range for nearly all Americans.

Under the Simplified USA Tax Act, the tax rate on the first $40,000 of taxable

income from wages cannot exceed 7.35% which is the basic USA rate of 15% less

the 7.65% payroll tax credit. Under the current code, the combined payroll tax/income tax rate is 22.65%. On the next $32,000 (up to the maximum payroll tax base

of $72,000), the rate cannot exceed 17.35% which is the middle USA rate of 25%

less the 7.65% payroll tax credit. Under the current code, the combined payroll tax/

income tax rate is 35.65%.

151

The Simplified USA Tax Act provides tax relief for all Americans, especially when

they own their own home, give to their church, educate their children and set aside

some savings for a better tomorrow.

Under this proposal, everyone gets a deduction for the mortgage interest on their

home and for the charitable contributions that they make. In addition, the Simplified USA Tax Act allows for a deduction for tuition paid for college and post-sec- ondary vocational education. The annual limit would be $4,000 per person and

$12,000 for a family.

Generous personal and family exemptions are also allowed under this proposal. On a joint return, the family exemption is $8,140 and there is an additional $2,700

exemption for each member of the family. Therefore, a married couple with two children pays no tax on their first $18,940 of income.

The Simplified USA Tax is simplicity itself. The tax return will be short, only a

page or two for most of us, but more to the point, the tax return will be understandable. For the first time in a long time, America’s tax system will make sense to the

citizens who file the tax returns and pay the taxes.

The Simplified USA Tax Act also contains a new and better way of taxing corporations and other businesses that will allow them to compete and win in global

markets in a way that exports American-made products, not American jobs. Experts

who have studied it believe that, if enacted by the United States, this innovative

approach to business taxation will soon become the worldwide standard by which

other countries will model their systems.

All businesses, corporate and non-corporate, are taxed alike at an 8% rate on the

first $150,000 of profit and at 12% on all amounts above that small business level.

All businesses will be allowed a credit for the 7.65% payroll tax they pay under current law. All costs for plant, equipment and inventory in the Unites States would

be expensed in the year of purchase. All export sales income is exempt, as is all

foreign-source income, and all profits earned abroad can be brought back home for

reinvestment in the United States without penalty. Because of a 12% import adjustment, all companies that produce abroad and sell back into U.S. markets will be

required to bear the same tax as companies that both produce and sell in the U.S.

The new revenue from the import tax will be about $160 billion, a large portion

of which will never become a cost in the U.S. economy. We do not know exactly how

much will be shifted back to the foreign companies that sell into the U.S. market.

But both basic economics and common sense tell us that a large portion will be absorbed by foreign sellers, and, therefore, will never enter the U.S. economy. A middle ground estimate would be $80 to $120 billion. The point is not the exact amount.

Rather, it is that the amount is large and that the Simplified USA Tax Act provides

a correspondingly large tax cut for Americans.

For too long the tax code has been a needless drag on the economy. This is not

very smart and certainly is not fair to those citizens whose standard of living are

lower as a result. It is time to restore people’s faith in the integrity and competence

of their tax system and, in the process, take a major step helping U.S. companies

compete in the global marketplace.

The Simplified USA Tax Act is the product of much work by many people over

a period of years. I am proud to be the sponsor of H.R. 134 , a simplified version

of the USA Tax first introduced by Senators Nunn and Domenici in 1995. I hope

that this committee will be able to work in a bipartisan fashion to provide the

American people the fair and sensible tax system that they deserve.

Thank you Mr. Chairman for the opportunity to testify before you today. I would

be happy to answer any questions you may have at this time.

SIMPLIFIED USA TAX

The Simplified USA Tax (SUSAT) would completely replace the current income

tax system, both corporate and personal. SUSAT consists of two parts:

• An 8 to 12 percent business tax paid when income is produced.

• A 15, 25, and 30 percent progressive rate tax paid by individuals when

they receive wages, interest, dividends and other income.

Wage income and capital income are taxed exactly the same. Income from equity

capital is no longer taxed more heavily than income from debt. Incorporated businesses are no longer taxed more heavily than unincorporated ones. Most importantly, income that is saved is no longer taxed more heavily than income that is

consumed. Both are taxed exactly the same.

To further assure equal treatment of wage income—whether consumed or saved—

a full income tax credit is allowed for the current OASDHI (Social Security and

Medicare) payroll tax. Because of the payroll tax credit, wage earners will immediately begin paying less taxes.

152

The business tax is internationally competitive. Imports are taxed, but export

sales of American-made goods and services are not. Further, U.S. companies are no

longer penalized when they make money abroad and bring it home to reinvest in

America.

Both the individual tax and the business tax are extremely simple. Only a few

steps exist in order to calculate the taxes. All are clearly stated and readily understandable, thereby relieving taxpayer confusion and leaving little opportunity for the

IRS to interfere.

Moreover, because SUSAT repeals federal estate and gift taxes, the IRS will no

longer take away a part of anyone’s lifetime savings.

The USA Tax for individuals is simplicity itself; a truly minimalist approach that

achieves a great deal without a lot of complex rules. Basically, all anyone needs to

do is (1) add up their income, (2) subtract a few simple deductions, (3) apply USA’s

low tax rates to the balance, (4) take credit for employee-paid OASDHI payroll tax

and income taxes withheld by employers, and (5) pay the additional amount, if any,

that is due.

153

154

1Like the present corporate income tax, however, the USA Tax exempts all religious, charitable and other nonprofit organizations described in section 501(c) of the current code.

USA Roth IRA: The Centerpiece of the Individual Tax

The USA Tax would eliminate the double tax on income that is saved, and, therefore, make taxes a neutral factor in the choice between consuming income immediately or saving it in order to consume later.

USA accomplishes this feat in the simplest and fairest way possible by allowing

everyone to contribute after-tax income to a USA Roth IRA patterned after the one

in Section 480A of the current code with certain modifications. Although called an

‘‘IRA,’’ the USA version is in reality a universal savings vehicle that can be used

for any purpose, not just retirement. • Everyone is eligible to contribute all or any portion of their current year’s taxable

income to a specially denominated account (like present IRA accounts at all banks

and financial institutions). • Because no deduction is allowed, the person must first pay the tax on all income

and then contribute to the USA Roth IRA. Further, all contributions must be made

in cash. • Because all money that goes into the USA Roth IRA represents post-effective date

after-tax income, no additional tax is imposed either on the accumulated principal

amount or on the earnings on principal inside the account. • Accumulated principal and earnings on principal can be withdrawn at any time

and for any purpose.

OVERVIEW OF USA BUSINESS TAX

The USA business tax is a cash flow tax on all forms of business organization,

corporate or noncorporate.1 The calculation of a business’s tax liability for the year

is a simple five-step process:

1. Add up total sales during the year from operations in the United States;

2. Exclude sales of goods and services for export;

3. Deduct all purchases from other businesses, including expensing of capital

equipment, inventory items, supplies, etc.;

4. Apply the rate schedule to the remaining gross profit to determine tentative tax;

5. Subtract from tentative tax a credit for the 7.65 percent employer-paid OASDHI

payroll tax.

The ‘‘gross profit’’ tax base in No. 4 is the amount the business earns on a cash

basis after expensing its capital equipment and paying its suppliers, but before paying its employees, stockholders and its creditors. Because the USA business tax allows no deduction for wages, dividends or interest, it collects a uniform tax on all

forms of income—labor and capital. Such ‘‘neutrality’’ is essential to basic fairness

and economic efficiency. Under international treaties, it is also an essential ingredient of the important export and import features of the USA Tax.

The most important operational components of the USA business tax, in comparison to the current code, are

set forth below.

Item Business Taxation USA Tax IRC of 1986

1 Corporations Taxed Separately from Individuals .... Yes Yes

2 All Business Entities Taxed as Corporations .......... Yes No

3 Deduction for Dividends Paid ................................... No No

4 Deduction for Interest Paid ....................................... No Yes

5 Deduction for Compensation Paid to Employees ..... No Yes

6 Credit for Employer-Paid FICA Payroll Tax ............ Yes No

7 Requires Depreciation of Capital Investment .......... No Yes

8 Allows Expensing of Capital Investment ................. Yes No

9 Deduction for Contributions to Qualified Employee

Plans.

No Yes

10 Taxes Foreign-Source Income on A Worldwide

Basis.

No Yes

11 Applies Territorial Rule to Exclude Foreign-Source

Income Derived from Operations Abroad.

Yes No

12 Taxes Export Sales of American-Made Products &

Services.

No Yes

13 Taxes Imports of Foreign-Made Products &

Services.

Yes No

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The USA business tax rate schedule is as follows:

Gross Profit Rate

$0 to $150,000 8%

Excess over $150,000 12%

REPEAL OF ESTATE AND GIFT TAXES

Not only does The Simplified USA Tax allow all Americans a fair opportunity to

save and invest, it repeals the federal estate and gift taxes and, therefore, allows

them a fair opportunity to pass their accumulated savings on to their children and

succeeding generations.

This repeal applies across the board to everyone and to all assets presently owned

and acquired in the future, whether held in USA Roth IRAs or held outside such

accounts.

bringing this alternative before the Committee. I doubt that we will

Chairman ARCHER. Congressman English, thank you so much for

f have adequate time this morning to fully explore all of the details,

but I look forward to examining them in great detail.

And so, at this time, I have no questions.

Mr. Rangel?

Mr. RANGEL. Mr. Chairman, I did not have the opportunity to

make an opening statement.

Chairman ARCHER. Nor did I.

Mr. RANGEL. But I want to apologize to my friend and colleague,

Congressman English. He has put a lot of work in trying to get a

better way for us to raise the revenue that is necessary to run our

government.

We can see that the timing of this type of hearing makes it very

difficult for the Members to listen to his ideas. At the same time,

we are trying try to protect our jurisdiction on the House Floor.

So I do not know whether this was thought out by our leadership. Yesterday, while we were here listening to the merits of a federal sales tax, there were people on the House Floor—get this, Mr.

English—a Republican by the name of Mr. Terry who brought a bill

up on the Floor to approve the President’s increase in taxes. But,

he recommended that they vote no against it.

The Republicans brought up the bill to show what the tax raises

would be. When I asked why they did it, they said because the

President’s taxes were as a tiger in a cage, and that they wanted

to kill the tiger before it got out.

So you can see, from a tax point of view, that did not make much

sense.

Now, while we are here are trying to figure out the complexities

of your bill, they have got another revenue-Constitutional issue, on

the House Floor saying that we cannot close tax loopholes unless

we have two-thirds vote in support.

Well, people may support that but we cannot do it sitting here

listening to you.

Tomorrow, at long last, we get a chance to pull up the tax code

by the roots. That is, to abolish it. To sunset it and say there is

no more tax code for anybody. It is all over.

156

But then I read the fine print. It will not be the Ways and Means

Committee that would be replacing the old tax code.

Guess what?

It will be a private commission, not even Congressional. They

will come out and they will have the hearings. They will listen to

you. They will listen to me. And, they will listen to the private sector. Maybe they will listen to our Chairman, but only four Members of Congress will be there. Then, they will report back some

legislation. Guess what it is supposed to be for? For new taxes.

So they are changing the rules just when I have reached almost

the top of my game. They have turned everything over to the private sector. The Ways and Means Committee’s jurisdiction is being

taken away on the Floor and given to outsiders.

So please do not be disappointed because the Members are not

here. They are trying to protect their jurisdiction. They are on the

Floor. They are listening, and it is very difficult.

But you have done a tremendous job over the years.

Mr. ENGLISH. Thank you.

Mr. RANGEL. And I just hope that we in the Congress will have

a chance to listen to your ideas and that they will not get some

cockamamie private sector group to study your legislation. The

Constitution says it is the Ways and Means Committee, and as

long as I am around, we will do the tax law.

So you keep sticking with us and not those private groups.

I want to thank you, Mr. Chairman.

Mr. ENGLISH. And I would like to thank the gentleman for being

here despite all of the distractions and let me reassure him there

are no caged tigers in my proposal. Thank you.

Mr. RANGEL. Thank you.

Chairman ARCHER. Well I have listened to the gentlemen’s comments, and I am beginning to wonder that whatever activity we

have in this room, there will always be some reason to complain

about it.

I hear complaints about procedures. I hear complaints about substance. I hear complaints about me personally. It just seems to be

‘‘there you go again.’’

Mr. Crane?

Mr. CRANE. Thank you, Mr. Chairman.

I simply want to commend my colleague, my distinguished colleague, Phil English, for his tax proposal and we have had several

and we will continue to get hearings on several, as you know, and

any one of them is superior to the existing obscene code.

So any chance we have to move forward, you can count on me.

And thank you for appearing and testifying.

Mr. ENGLISH. I thank the gentleman.

Chairman ARCHER. Mr. Weller?

Mr. WELLER. Well thank you, Mr. Chairman. I want to commend

you for your leadership in bringing these hearings to this Committee room.

I also want to commend my colleague, Mr. English, for having

the courage and the commitment of time and effort to put forward

his own reform proposal. Because one thing I have learned is that

in every provision in the Tax Code there is always a reason it was

put there and there is somebody who wants to keep it there.

157

I have learned that over the last several years serving on this

Committee. So I salute you for your proposal.

You know, one of the top priorities of this Congress, the Republican majority, is bringing fairness to the Tax Code. And of course

I know that is your goal of your proposal is making the Tax Code

more fair.

And I am just really proud that, you know, last week the President signed our effort to bring fairness to the Tax Code by wiping

out the Social Security earnings penalty on seniors between the age

of 65 and 70 who want to continue working or who are forced to

continue working.

And I am also very proud that the House overwhelmingly

passed—and in fact 48 Democrats voted with, rejected their leadership’s pressures and voted with every House Republican to wipe

out the marriage tax penalty with the passage of H.R. 6.

And our legislation—which eliminates the marriage tax penalty

essentially wipes it out for 25 million married working couples who

on average pay $1400 more in higher taxes just because they are

married—is a big victory if you want to bring about tax fairness.

And I am so pleased that the Senate has moved quickly. The

Senate at this moment is of course considering their proposal

which is pretty similar to H.R. 6, the Marriage Tax Elimination

Act, which wipes out the marriage tax penalty.

My hope is that the House and Senate can reconcile their differences relatively soon, and we can put on the President’s desk another major initiative which will benefit 50 million married working individuals who suffer the marriage penalty just because they

are married.

Mr. English, I was just wondering from the perspective of your

tax proposal, how do you address the marriage tax penalty in your

proposal?

Mr. ENGLISH. We would effectively dramatically reduce it because of the structure that we have put in place. I will leave it to

others to describe where a marriage tax penalty might creep in.

I have retained multiple tax rates and the implication of that is

there is always a danger of a marriage tax penalty being reintroduced.

I would welcome the gentleman to take a look at my proposal

and come back to us with any suggestions he might have of addressing that problem in our code.

As the gentleman knows, because he has immersed himself in

this issue more than anyone, it is very difficult to completely eliminate the marriage tax penalty and there is always a potential when

you have progressive taxation that when people get married, as a

couple they will end up paying more taxes than they did as two individuals.

I am not sure we have addressed that as fully as we should in

this tax proposal and I would welcome the gentleman’s input.

Mr. WELLER. Well, you know, Mr. English, one of the things I

have observed also is, particularly in the last seven-and-a-half

years, there has been a desire by some to target tax cuts, target

tax relief, which means you pick and choose politically who benefits.

158

It usually means very few get very little in tax relief and unfortunately that targeting has caused more so- called marriage tax

penalties in the last few years than any other consequence of the

code.

Of course the biggest consequence of the Tax Code is for joint filers. You know, a married couple. They are both in the work force.

Their combined income usually pushes them into a higher tax

bracket, creating the marriage tax penalty.

But if you talk with those who are tax preparers, they will tell

you that there are over 60 marriage tax penalties in the code, primarily resulting from means’ testing and targeting of tax cuts because the income eligibility is never twice that for married couples

filing jointly compared to that of a single filer.

And clearly as we look at bringing fairness to the tax code, not

only do we want to eliminate the marriage tax penalty for joint filers, but we need to look at those so-called targeted provisions because they create a lot of consequences for those who work hard

and happen to be married.

Mr. ENGLISH. I thank the gentleman. I would point out to him

that what we tried to do was eliminate many of these targeted provisions which after all are adjustments for other problems in the

Tax Code.

What we tried to come up with was a clean and very simple tax

system that in the process does eliminate many of those marriage

penalties that you discussed, and makes the Tax Code far simpler.

We found that the complexity in the Tax Code did not arise from

multiple rates as much as from many of these very complicated and

overlapping policies that were loaded into the Tax Code.

So as a result we think we have gone a considerable distance toward finding an equitable and global approach to these problems.

And I thank the gentleman.

Mr. WELLER. Well your point is a good one.

You know particularly in education one of our goals is to make

college more affordable. That is why we have worked to expand opportunities with the student loan interest deduction. And of course

for married couples, not only is there a marriage tax penalty on the

income eligibility for joint filers, but if you have got a couple kids

getting married right out of college, they are paying off their student loans, you know they are eligible for the full student loan interest deduction. But once they choose to get married, they discover

that interest deduction is cut in half because they have to share

it as if they were just one person.

And that is just not fair and that is just one more reason that

as we look at tax reform, I think we really have to take a good look

at the so-called targeting and preferences and means’ testing and

how it is created marriage tax penalties as well as other consequences that just are not fair.

Mr. ENGLISH. The gentleman makes an excellent point. Let me

say that instead of providing many of the targeted tax breaks for

tuition that had existed and that we have recently put into law,

what we have tried to do is consolidate these into a substantial deduction that would be available per student, $4,000 per student up

to $12,000 total for a family.

159

And we think that when you run the TRAPs on that, the tax relief is very substantial to families and makes up for some of the

other adjustments that we have tried to make in the last few years

to help use the Tax Code to support higher education.

Mr. WELLER. My last question—— Chairman ARCHER: The gentleman’s time has expired.

Mr. WELLER. Thank you, Mr. Chairman.

Chairman ARCHER. Mr. English, thank you for the work you

have done on this and giving us another alternative to look at. And

unless you have something important to say, you are excused.

Mr. WELLER. Thank you, Mr. Chairman.

Chairman ARCHER. Our next panel will please come to the witness table. Congressman Frenzel, Mr. Christian, Dr. Foster, and

Mr. Hufbauer.

While you are being seated, I officially welcome each of you to

the Committee. Certainly some of you are no strangers to this room

and to this Committee, and we are particularly happy to have you

back in our presence and to hear your sage comments.

The Honorable Bill Frenzel is no stranger to any of us up here

at the dias having been seated up here for many years yourself,

and we are particularly happy to have you back and to listen to

your wisdom which has always been present whenever you speak

in this room.

And so we welcome you again, and if you will lead off, we will

be pleased to hear your testimony.

STATEMENT OF THE HON. BILL FRENZEL, GUEST SCHOLAR,

BROOKINGS INSTITUTION [FORMER MEMBER OF CONGRESS]

Mr. FRENZEL. Thank you, Mr. Chairman.

Chairman ARCHER. And I think Mr. Rangel also wants to welcome you.

Mr. RANGEL. I want to welcome all of you, particularly, my friend

Congressman Frenzel. Please give my best to your lovely wife,

Ruth, and I want tell you how much you have been missed around

here.

The one thing that makes serving in Congress exciting is the

memories of the good old days. Thank you for coming back.

Mr. FRENZEL. Thank you——

Mr. RAMSTAD. Mr. Chairman? Mr. Chairman?

Chairman ARCHER. Mr. Ramstad, I apologize.

Mr. RAMSTAD. Not at all, Mr. Chairman.

Chairman ARCHER. Mr. Ramstad has a very——

Mr. RAMSTAD. I just want to join in the chorus of singing the

praises of my predecessor, somebody I am proud to call my mentor

and my friend, and without whose tutelage, I would not be sitting

here today. Somebody who distinguished himself on this panel for

16 years serving the Third Congressional District of Minnesota.

He also served as ranking member of the Budget Committee and

the House Administration Committee.

Bill Frenzel is, as one person who introduced him put it best, if

you look up in the dictionary, the word ‘‘statesman,’’ you will see

Frenzel’s picture.

It is a pleasure, Bill, to welcome you back to the Committee.

[The opening statement of Mr. Ramstad follows:]

160

Opening Statement of Hon. Jim Ramstad, a Representative in Congress

from the State of Minnesota

Mr. Chairman, thank you for commitment to reforming our deeply flawed tax system and for giving the American people a public forum through this week of hearings to examine the options available to us.

We already know that the current system flunks the critical tests of efficiency,

simplicity, flexibility, political responsibility and fairness.

Americans spend billions of dollars complying with an incomprehensible system

that discourages saving and investment. Our tax code robs Americans of time, privacy, economic opportunities and incentives to be innovators.

Our complex tax code puts American businesses at a disadvantage with their foreign competitors, robbing them of the opportunity to create jobs and find new markets for American products.

We want Americans to work and save for their family’s future. But as you point

out, Mr. Chairman, our tax system tells Americans that the more you work and

save and succeed, the more you pay.

I appreciate the opportunity to examine alternatives which meet the important

goals of rewarding work, encouraging savings and improving our competitiveness

abroad.

Again, Mr. Chairman, thank you for convening these critical hearings. I look forward to hearing the testimony today.

Mr. M

Chairman A

CCRERY

RCHER

. Mr. Chairman, I would say me too.

. Let me just add one other thing since we are

f getting into this friendly colloquy here.

The last major battle I think that you and I and Phil Crane

fought on the Floor of the House was the opposition to I think the

ill-considered Tax Reform Act of 1986, and unfortunately we barely

lost that battle but I think history will show that we were right.

And maybe the next major battle that we participate in, whether

from the inside or the outside, we will win. So we are happy to

have you before the Committee.

Mr. FRENZEL. Thank you Mr. Chairman and Committee members. You have brightened the life of an old man by putting wings

on the dog, and I am really pleased to be back here in this marvelous room with you distinguished Committee members.

Mr. Chairman, on this Committee all of us who have ever served

here have been very frustrated with the Tax Code. We have seen

the complications, the difficulties, and looked for ways to improve

it. We have always been frustrated in what we have tried to do.

Size and complexity are major problems for our constituents, but

they are less serious than the perverse incentives that have worked

their way in the Code. They have gotten into the Code for good reasons, but there are a couple that have always bothered me, and led

me in the chase for some kind of responsible tax reform.

The most prominent of these has been the inadequate incentives

for savings. Secondly, I have followed international taxation for

some time and been disappointed that we have had more incentives

to import than to export.

I have also been concerned about regressivity and job creation

disincentives in our Social Security taxes. And of course, the general layering of the Code as we try to repair it has been a problem

as well.

H.R. 134, Mr. English’s bill, answers these problems.

I have tried to follow this bill and its predecessors over a period

of at least ten years since I left the Congress, and was interested

161

in the original Nunn-Dominici proposal which was one of the predecessors of this bill.

It is not a simple bill but it does some things right. One of the

reasons that we have had trouble in the past with any kind of tax

reform bill is it presents such a big, ugly bundle that it is easy to

form a majority against it.

If you are going to truly reform the Code, you have to change

alot of things, and those changes hurt an awful lot of people.

I want to talk about four aspects of H.R. 134. The first one is

international. H.R. 134 has the international parts right. We

should not tax foreign income. We need to relieve taxes on exported

goods and services and we need to assess taxes on imports to

equalize the burdens that the domestic producers bear.

The FSC has been a pretty lonely incentive for us, and it is weak

compared to the combination of incentives offered by many of our

foreign competitors. Now, even its existence is in peril.

H.R. 134 provides powerful savings incentives. Once the taxes

are paid on income going into the investment account, there is no

additional tax on inside buildup or on withdrawals.

Congressman English has used the simple mechanism of the

Roth IRA to solve one of he major complexity problems of the original USA Tax.

Third, H.R. 134 relieves problems of regressivity and disincentives of job formation caused by our high Social Security taxes.

We have made the Tax Code, the Income Tax Code, more progressive over the last 30 years, but because the Social Security

taxes are levied on the first dollar of earnings, the overall tax burden has probably become more regressive.

And, of course, other than in times of full employment, which we

are enjoying now, those taxes can be a real job creation disincentive.

So I believe that Congressman English in H.R. 134 has done a

pretty good job of giving us some simple principles which can be

put into a total tax reform bill.

I would like to note here that tax rates under this tax bill can

be flattened or made even more progressive. Congressman English

has structured it to make it roughly equal to the current burden

tables. I think that is the right place to start even though you may

not want to finish there.

Mr. Chairman, I commend this tax bill because it gives some

promise for achieving the things that I have always thought were

most important in tax reform.

It is probably an exaggeration to call it simple because life is not

simple, and it does not tear the system out by the roots as you, Mr.

Chairman, have always wanted to do, but it does rough up the system pretty well.

I think it can do the tax reform job, and I believe it is workable

and understandable, at least for a starting place for this Committee.

And I thank you and the Committee for your kind words and for

allowing me to testify today.

[The prepared statement follows:]

162

Statement of the Hon. Bill Frenzel, Guest Scholar, Brookings Institution,

(Former Member of Congress)

Mr. Chairman and Members of the Committee:

It is, as always, a pleasure to return to the scene of one’s former crimes. I appear

here today on my own behalf and my testimony does not represent the opinions or

conclusions of The Brookings Institution. I congratulate the Chairman and the Committee for holding these Tax Reform hearings. The time is ripe.

You are all, as was I, very fortunate to be able to serve on this distinguished and

historic committee. I hope you are less frustrated than I was about our ability to

produce a Tax Code in which our country can have more confidence.

The need for major surgery on the U.S. Tax Code has been obvious for years. Over

the years, complications and ‘‘simplifications’’ alike have created a system of bewildering, and indefensible, size and complexity. Nobody intended that it be so cumbersome, but it got that way for a variety of reasons well known to the committee

(we live in a complex society and economy; politicians run on platforms of change;

its easier to amend than to delete; simplicity and fairness are sometimes in conflict).

Whatever the reasons, today many taxpayers cannot comply (without help) with the

Code, and tax collectors have great difficulty enforcing it.

But, size and complexity are problems that are less serious than the perverse incentives that have worked their ways into the Code. Four that I have found particularly troublesome are: (1) inadequate incentives for saving; (2) more incentives to

import than to export; (3) regressivity and job creation disincentives in our Social

Security taxes; and (4) the endless layering of good, and, at the time, necessary, adjustments which have led to unacceptable complexity. Each of you could list many

more.

The origins of most of these policies go long way back in history. They undoubtedly made good sense when enacted. Now, the world has changed, and it will continue to change even more swiftly. Regulators are already having difficulty keeping

up. Relatively small, targeted Tax policy changes, like the ones this committee has

regularly made in the past, are not able to keep pace with the speed of change. I

believe that you must make bold and massive changes to meet the new challenges.

But size and boldness usually mean a tax package so full of fish hooks that no

one will touch it. I, myself, was, for many years in this Committee, a supporter of

the theory of ‘‘creeping incrementalism.’’ Later, I have come to believe that BandAids, even giant ones like TRA 1986, are more likely to extend the problems than

they are to solve them.

H.R. 134, the Simplified USA Tax, appears to me to be a workable solution to the

Tax Reform dilemma. In the interests of full disclosure, I must admit I was exposed

to the general concept nearly 10 years ago when I attended, with about a dozen accountants, tax lawyers and economists, a series of brainstorming sessions which

began with David Bradford’s ‘‘Consumed Income Tax’’ and went through to the original Nunn-Domenici USA Tax.

That original Nunn-Domenici proposal was an important milestone in the development of H.R. 134, but, like many of its ilk, it was too complicated. The cleverest

of us could not have explained it to our constituents very quickly or concisely. That

kind of bill is an easy victim for interests, which want to retain the old code, or

for partisan squabbling.

H.R. 134 cannnot be called simple, but it is understandable. It is a suitable vehicle for the Committee’s Tax Reform efforts. I can’t review the whole bill, but here

are some of the aspects, which appeal to me:

1. H. R. 134 has the international parts right. We should not tax foreign

income; we need to relieve taxes on exported goods and services; and we

need to assess taxes on imports to equalize the burdens on domestic producers. We have had only the lonely FISC as an export incentive. It’s a weak one

compared to the combinations of incentives offered by many of our foreign competitors, and now, its existence is imperiled.

2. H.R. 134 provides powerful savings incentives. Once the taxes have

been paid on income going into the investment account, there is no additional tax on either inside build-up or on withdrawals. Congressman English

has used the relatively simple mechanism found in the Roth IRA to solve the major

complexity problem of the original USA Tax. Withdrawals from these after-tax savings accounts can be made for any purpose.

3. H.R. 134 relieves problems of regressivity and of disincentives to job

formation caused by Social Security taxes. Since I first came to Washington,

the income tax Code has become more progressive as more people at lower levels

of income have been taken out of the code completely. But, because the Social Security taxes are levied on the first dollar of earnings, the overall tax burden has beVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00168 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
163

come more regressive. And, in times of less than full employment, those taxes are

a real jobs disincentive for employers.

I personally support progressive income tax rates, with a couple of caveats. The

present highest rate is too high. The EITC which I supported originally has been

expanded to a point where it could be better managed and enforced as an appropriation entitlement rather than a tax entitlement.

It should be noted that tax rates under the Simplified USA Tax could be flattened, or made even more progressive than present rates. Congressman English has

structured it to make it roughly equal to the current burden tables. That may not

be the place you want to finish, but , to me, it’s the right place to start.

Finally, Mr. Chairman, I recommend H.R. 134, the Simplified USA Tax, for the

Committee’s consideration because it gives real promise of achieving most of the

things I have always sought in Tax Reform. It may be an exaggeration to call it

simple, because life is not simple. It isn’t perfect, because there is no such thing

as a perfect tax bill.

And it doesn’t tear the system out by the roots as you have always wanted to do,

but it does rough up the system pretty well. Not only will it do the Tax Reform job,

but its is workable and understandable. Those two virtues may be able to stand as

proxies for the simplicity which has always been so elusive.

Chairman A

Mr. Christian?

RCHER. Thank you, Mr. Frenzel.

fSTATEMENT OF ERNEST S. CHRISTIAN, ESQUIRE,

WASHINGTON, D.C.

Mr. CHRISTIAN. Thank you, Mr. Chairman, Mr. Rangel, Members

of the Committee.

Congressman English’s simplified USA Tax is, in my opinion, a

landmark achievement. I say that from the perspective of having

spent about 25 years in the Treasury Department and in the private sector working on these concepts.

He is to be greatly commended.

His bill shows how the Tax Code can be simplified without having to repeal the deductions for either home mortgage interest or

charitable contributions.

It shows how the double tax on savings and investment can be

removed without enacting a consumption tax.

How tax equity for working men and women can be achieved by

allowing them a credit for the payroll tax they already pay.

It shows how the archaic tax barriers to U.S. competitiveness in

world markets can be removed in a way that protects and enhances

American jobs.

Marginal tax rates can be lowered, a laudable goal.

Progressivity can be preserved.

Transitional dislocations can be avoided.

Congressman English’s bill Simplified USA embodies some new

approaches. One is to include in the tax base of the United States

of America, for the first time in history, all amounts derived by foreign-owned companies from selling goods and services in our market.

The result of this shift may be to reduce, by something in the

area of $100 billion per year, the tax burden borne by U.S. labor

and U.S. capital, an enormous, implicit tax cut for the American

economy paid for by foreign-owned companies that presently derive

income from the U.S. market on nearly a tax-free basis.

164

The largest beneficiaries of this implicit tax cut would seem to

me to be the wage earners of America. They receive a full credit

for the payroll tax they now pay.

Simplified USA is a plain-language, stripped-down version of the

current income tax, individual and corporate. It is concentrated on

the main goals of tax reform.

The basic amendments necessary to achieve these results are

neither unfamiliar nor shocking. First-year expensing of plant and

equipment is already allowed under the current Code for small

businesses.

It only remains for Simplified USA to make expensing universal,

which it should be.

There is nothing radical about removing the double tax from personal saving and thereby taxing saved income no more heavily

than consumed income.

The Roth IRA already does this under the current Code for retirement savings. Simplified USA uses exactly the same simple

mechanism for all savings.

There is also nothing new or radical about the idea of not imposing U.S. tax on the income that American companies derive from

developing new markets abroad, or about the related idea of not

taxing exports of American made goods.

The Foreign Sales Corporation provision, commonly known as

FSC in the current Code is a flawed attempt to go halfway toward

these goals in the international competitiveness arena, but FSC

has run afoul of the WTO. Simplified USA, Congressman English’s

bill, does the job correctly in a way that is consistent with U.S. tax

traditions and treaty obligations.

There is also nothing radical about bringing foreign-owned companies into the U.S. tax base, and using he revenue to cut taxes

on American citizens. Europeans and others have been doing this

same thing in reverse to the United States for decades.

The truly remarkable thing about Congressman English’s bill,

Simplified USA, is that it has figured out how to level the international playing field in a way that is consistent with American tax

tradition and history.

I submit, for your consideration, Mr. Chairman and members of

the Committee, that the usual reasons for not proceeding with tax

reform do not apply to the USA tax by Mr. English.

Genuine tax reform within the basic framework that he has outlined, which can be improved, is an available option for the Congress to choose if the Congress wishes to do so.

I strongly recommended Simplified USA to you as a great place

to start on the road to genuine tax reform.

Thank you very much for your attention.

[The prepared statement follows:]

Statement of Ernest S. Christian, Esquire, Washington, D.C.

Introduction To Simplified USA Tax

The Simplified USA Tax by Congressman Philip English (H.R. 134) is a landmark

achievement that shows how genuine tax reform can become a reality without resorting to radical experimentation. The tax code can be simplified without repealing

the deductions for home mortgage interest and charitable contributions; the double

tax on saving and investment can be removed without enacting a ‘‘consumption’’ tax;

tax equity for working men and women can be achieved by allowing them a credit

for the payroll tax they pay; the archaic tax barriers to U.S. competitiveness in

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world markets can be removed in a way that protects and enhances American jobs;

a simple deduction for the cost of post-secondary education can, for the first time

in history, help put investments in human capital on a par with investments in

physical capital; marginal tax rates can be lowered; progressivity can be preserved;

and transitional dislocations can be avoided.

Simplified USA embodies a new approach that has the effect of including in the

U.S. tax base for the first time in history all amounts derived by foreign companies

from selling goods and services in the U.S. market. It seems to me that the result

is an enormous tax cut for the U.S. economy—perhaps $100 billion per year or more—paid for by foreign companies that presently derive income from U.S. markets on a nearly tax-free basis.

The biggest beneficiaries of this tax cut would seem to me to be the wage earners

of America who receive a full credit for the payroll tax they pay now.

How Simplified USA Works—Structural Framework

Like current law, Simplified USA consists of a business tax and a personal tax

with multiple personal rates. The illustrative tax rates below trace back to H.R.

4700 in the 105th Congress and were carried over without change into H.R. 134

when Simplified USA was reintroduced in the 106th Congress.

(1) A Business Cash Flow Tax is paid by corporations and other businesses. The

rate is 12% of gross profit. Profit is computed using cash accounting; capital equipment is expensed because the income it produces is fully taxed when received; no

deduction is allowed for interest or dividends paid for the use of capital, or for wages

paid for labor, but a full credit is allowed for the 7.65% OASDHI payroll tax which

is the equivalent of a deduction for about 65% of wages up to $72,000 per year for

each employee. Export income and all foreign-source income is excluded from tax.

A 12% import tax is collected when foreign-based companies sell into the U.S. market.

(2) A Progressive-Rate Personal Tax is paid by individuals when they receive interest, dividends, wages, salaries, and gains. The two bottom rates are 15% and 25%

and the top rate is 30% on taxable income computed after deducting a Family Allowance of $8,000, personal exemptions of $2,700 per family member, home mortgage interest, charitable contributions and post-secondary education expenses of up

to $4,000 per family member. Individuals are allowed a full tax credit for the employee’s share of the 7.65% OASDHI payroll tax withheld from their wages and, if

the amount of that credit exceeds their USA income tax for the year, the excess is

refunded. All individuals are also allowed an unlimited USA Roth IRA for personal

saving—except that, unlike the current Roth IRA, saving is not limited to retirement and can be withdrawn for any purpose. Because tax is paid on the money

going into this special savings and investment account, there is no additional tax

on the inside build-up in the account or on withdrawals from the account. For the

first time in history, the double tax on all personal savings will be removed and everyone will be allowed to save for whatever purpose they desire.

Simplified USA is a plain-language, stripped-down version of the current income

tax (individual and corporate) that is concentrated on the main goals of tax reform—

which are (1) to be evenhanded as between labor income and capital income; (2) to

be neutral in a person’s choice to consume income or save; (3) to remove the archaic

barriers to international competitiveness; and (4) to be neutral as between equity

and debt financing and evenhanded among all forms of business organization.

The basic amendments necessary to achieve these results are neither unfamiliar

nor shocking. First-year expensing of plant and equipment is already allowed for

small businesses and probably would have been made universal long ago except for

revenue limitations under the current code.

The idea of removing the double tax from personal saving—and thereby taxing

saved income no more heavily than consumed income—has been around a long time.

Since the enactment of the Roth IRA in 1997, the simple yield-exemption approach

to removing the double tax is now familiar and standard fare. With the Roth IRA

already very much part of the tax landscape, it only remains for Simplified USA

to make it universal by eliminating the dollar caps, the income limitations and the

restriction to retirement savings.

For decades, Treasury reports and bipartisan Congressional studies on corporate/

shareholder tax integration have recommended uniform treatment of all forms of financing and all forms of business.

There is nothing new about the idea of excluding foreign-source income from taxation or about the related idea of not taxing exports. The Foreign Sales Corporation

(FSC) provision in the current code is a flawed attempt to go halfway, but FSC has

run afoul of the WTO and it remains for Simplified USA to do the job correctly in

a way that is consistent with U.S. tax traditions and WTO requirements.

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The Road to Simplification

Once the basic amendments necessary to achieve neutrality and international

competitiveness are made, some of the most complex portions of the code become

moot. Substantial simplification automatically occurs. Simplified USA also undertakes to eliminate an array of miscellaneous deductions, credits, exceptions and exceptions to exceptions that are unnecessary when the basic rules are correct to start

with. But Simplified USA does not make a fetish out of repealing long-standing and

familiar deductions under the misguided belief that they are the source of complexity in the code.

The existing and long-standing exclusions from income for parsonage allowances,

combat pay, municipal bond interest or employer-paid health insurance are not the

reason that Form 1040 is monstrously long and incomprehensible. Simplified USA

retains these and several other exclusions and deductions that are easily understood

and of nearly universal application without any special eligibility requirements and

that do not require any side calculations. What, for example, is complicated about

the deduction for home mortgage interest? All the homeowner does is take one number off the annual statement from the mortgage lender and put that one number

on one line of the tax return.

Simplified USA will reduce the size and complexity of the tax code by about 75

percent and the personal tax return (long Form 1040) will be only a few pages—

about like it was in 1960 before four decades of complexity ruined it.

Neutrality Between Saving and Spending

Simplified USA taxes income (whether saved or consumed) only once. It does that

by taxing income when received (first tax) and then excluding the earnings on aftertax savings from a second tax.

The current code’s bias against income that is saved is easily illustrated by a simple example: Mr. Jones earns $100, pays a $40 income tax, and has $60 after-tax

income left over. If he uses the after-tax $60 to buy a car to drive to work (in lieu

of paying bus fare), he will not have to pay tax on the value of the transportation

services the car provides him; nor should he. After all, he has already paid tax on

the $60 once. On the other hand, if instead of buying the car, Mr. Jones saves the

after-tax $60, he will have to pay bus fare (having no car) and he will have to pay

tax on the interest earned by the $60 of savings. This is not a correct result. It biases Mr. Jones’s choice against saving.

Simplified USA produces the correct result: once Mr. Jones has paid his tax, he

is not taxed again, either on the interest earned by his after-tax savings or on the

value of the transportation services provided by the car.

International Competitiveness

Simplified USA is carefully crafted to allow American companies to compete and

win in world markets without in any way providing a tax incentive for American

companies to move their plants and jobs offshore. In fact, it makes the United

States of America a very attractive place to be for the purpose of conducting a

worldwide business.

Simplified USA does this by the combination of three things. First, it replaces the

current archaic and inconsistent worldwide tax rule with a territorial rule consistent

with modern practice in other countries. Thus, when necessary, U.S. companies will

be able to invest and compete directly in foreign markets without having to pay U.S.

tax on the profits they make in some other country’s economy and bring home for

investment in America. Second, export income will be excluded from U.S. tax. Thus,

a U.S. company can stay home, manufacture in the U.S. and sell into a foreign market without paying U.S. tax. Third, an import tax will be imposed at the same rate

as the regular USA business tax rate—12%. Thus, while a company may operate

abroad when necessary to gain foreign-market sales that cannot be reached by exports from the U.S., if it goes abroad for the purpose of selling back into the U.S.

market, it will have to pay a U.S. tax at the border without the benefit of any deductions.

International competitiveness will flourish under Simplified USA, but there will

be no runaway plants.

The Way Border Tax Adjustments Work—A Major Shift in the Tax Burden

The border tax adjustments in USA have been borrowed from the European VAT

(which is a form of sales tax) and appended to the business portion of the USA Tax

in a WTO-permissible way—but when appended to a business cash flow tax like the

USA business tax, the border tax adjustments operate quite differently from they

way customarily are thought of in the VAT context.

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Because the USA business tax is a tax on net cash flow instead of a tax on goods,

USA excludes from tax the revenues derived by a business from exports. This full

exclusion of export revenues is similar to the partial exclusion provided by the Foreign Sales Corporation (FSC) rule in the current corporate income tax which the

USA business tax resembles in many ways.

Except for exports, USA includes in the tax base all GDP—which, in turn, is equal

to the sum of all returns to labor (wages and salaries) and all unreinvested returns

to capital (interest and dividends).

By means of an import adjustment, USA also includes in the tax base an additional amount which represents the amount of goods and services that are produced

by foreign-sited labor and capital but sold into the United States market. The 12

percent import tax might appear to make imported products more expensive, and,

in some cases, it will, but both neoclassical economic theory and common sense say

that in many more instances involving a very large portion of the total dollar value

of imports, the foreign companies who sell these imports into the U.S. market will

have to absorb all or a major part of the 12% import tax. They will do this by adjusting their pre-tax price downward so that the after-tax price to the U.S. purchaser is the same or nearly the same amount that purchasers had previously been

paying. When foreign companies do lower the pre-tax prices, they are, in effect, paying the U.S. tax and when a company pays a tax (whether it be U.S. tax or home

country tax), the burden of that tax will ultimately be borne by its employees (in

the form of lower wagers or fewer jobs) and its shareholders and debtholders (in the

form of lower returns to capital).

As of the end of 1999, imports were $1.3 trillion involving an almost uncountable

number of U.S. buyers and foreign sellers of an almost uncountable variety of imported goods and services. Out of all this, no one knows how many of the foreign

companies will be ‘‘price takers’’ who will absorb all or part of the import tax or how

many will be ‘‘price setters’’ who will not absorb any of the import tax. Therefore,

no one knows the precise dollar value of the import tax that will be passed back

to foreign labor and capital, but we do know that much of it will be. The U.S. market is, after all, the largest market in the world and the pressure on foreign companies to absorb at least a part of the tax will be large. Only those who sell a unique

product for which there is no substitutable alternative will be totally immune from

that pressure, but there are not so many of those situations and, even when they

do exist, what may be a unique product today may not be tomorrow.

The point is not to be precise about the exact amount of import tax that will be

borne by foreign labor and capital. Rather, the point is to know that the dollar

amount is large and that even if 60 percent of the $160 billion import tax revenue

increase is borne by foreign labor and capital, that mans that the U.S. economy has

received roughly a $100 billion per year tax cut.

Payroll Tax Credit—An Offset to Implicit and Explicit Taxes on Wages

Not only is the payroll tax credit an historic breakthrough in fairness, it is essential to the evenhanded treatment of labor and capital that is the hallmark of Simplified USA and the foundation on which genuine tax reform must be built.

A. Implicit Withholding Tax Offset by Payroll Tax Credit

Like the current corporate income tax, the USA business tax is an implicit withholding tax on dividends. (Unlike the current corporate income tax which favors

debt over equity, the USA business tax also serves as an implicit withholding tax

on interest as well.) This implicit withholding on interest and dividends arises because the business pays tax on its as gross profit without any deductions for interest

paid or dividends paid.

Like the current employer-paid OASDHI payroll tax, the USA business tax also

serves as an implicit withholding tax on wages—because the business pays tax on

its gross profit without deducting wages.

But for the credit that Simplified USA allows for the 7.65% employer-paid payroll

tax (which reduces the implicit withholding), the implicit withholding on wages up

to $72,000 per employee per year would be 19.65% (12% + 7.65%); whereas the implicit withholding on wages in excess of $72,000 and on interest and dividends

would be only 12% (the USA business tax rate).

With the payroll tax credit, the implicit withholding tax is uniform as follows:

Wages up to $72,000 Wages above $72,000 Interest and Dividends

12% 12% 12%.

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B. Explicit Tax Offset by Payroll Tax Credit

When wages, interest and dividends are received by individuals, the remainder

of the tax on that income is collected from the individual, and, in the case of wages,

all or part of that tax may be withheld at the source by the employer as under current law.

In the case of wages up to $72,000, however, current law imposes an additional

7.65% employee-paid OASDHI tax that is explicitly withheld at the source by the

employer.

Simplified USA allows the employee a credit for the 7.65% OASDHI tax explicitly

withheld from wages. With this credit, wages, interest and dividends are all taxed

equally, the only variation being the rate bracket of the particular individual—15%,

25% or 30%.

Resisting Analogies—Simplified USA Is Sui Generis

The Simplified USA Tax combines some elements that may also be found, variously, to some extent, and in different forms, in taxes said to be based on cash flow,

net income, consumed income or business value added, but because Simplified USA

is a hybrid, none of those analogies is altogether accurate or especially illuminating.

Simplified USA is best understood as the current income tax amended to allow

(1) first-year expensing of capital equipment, (2) an unlimited Roth IRA for everyone

that applies to all saving (not just retirement saving) and (3) a credit for OASDHI

payroll taxes. Internationally, it adopts a ‘‘Super FSC’’ for outbound transfers (exports) and a ‘‘Super § 482’’ adjustment on inbound transfers (imports).

If one insists on putting Simplified USA into some preexisting generic category,

the USA Tax on individuals is an ‘‘income tax’’ and the USA Tax on businesses is

a ‘‘business cash flow tax’’ (a concept which is well-known and long-standing in the

tax literature).

Chairman A

Our next witness is Dr. Foster. We will be pleased to receive

RCHER. Thank you, Mr. Christian.

f your testimony.

STATEMENT OF J.D. FOSTER, PH.D., EXECUTIVE DIRECTOR

AND CHIEF ECONOMIST, TAX FOUNDATION

Mr. FOSTER. Thank you, Mr. Chairman. It is a pleasure to appear before the Committee again.

Tax reform obviously raises a great many issues. I am going to

focus on two in the international area.

The U.S. currently imposes tax on our citizen’s foreign earnings

and allows a limited tax credit against foreign income taxes paid.

Most tax reform proposals, such as Simplified USA, wisely drop

this policy, taxing instead only economic profits earned at home, a

system known as territoriality.

In the global economy, companies hire, produce, and sell globally.

The companies that best integrate these activities over functions,

product lines, and geographic areas, are the most successful.

Current tax policy distorts our companies’ pattern of investment

so they cannot maximize their global efficiency. The price of this

lost efficiency is jobs at home and abroad, and the price gets higher

every year.

If current policy is so wrongheaded, why do we keep it? Because

of misperceptions and misleading statements.

Our international tax policy is a tax based form of protectionism

and nothing more.

Protectionism seeks to bar foreign production that out-competes

domestic production. Recognizing that protectionism is unsound, we

have had a long history in this country in support of free trade.

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However, our tax policy erects tax barriers to international investment by our citizens in the usually mistaken belief that it

would otherwise occur at home. This tax barrier to international investment is solely intended to protect jobs at home. The result,

however, is that our current policy prevents our companies from

maximizing their productivity, thereby costing us jobs.

Worse, the lost jobs are most likely to be higher-wage, high-productivity jobs because therein lies our competitive advantage. So

we protect a few relatively low-wage jobs at the expense of other

higher-wage jobs—the typical result of protectionism.

Most tax reform proposals, including the English proposal, embrace free trade by allowing U.S. companies to achieve their greatest efficiencies globally and so create more high wage jobs at home.

Fundamental tax reform also opens the way for border tax adjustments or BTAs in the form of an export rebate and a new import levy.

An export rebate excludes from tax the profits made on the export of domestic production. If the United States adopted

territoriality, then export rebates naturally address concerns that

territoriality would induce U.S. companies to shift operations overseas. A company would pay no U.S. tax on goods and services sold

abroad, whether those goods are produced at home or abroad.

Once markets adjust to the new tax regime, the value of the tax

rebate would shift back to U.S. labor in the form of higher wages

or back to U.S. capital in the form of higher returns, permitting an

expansion of the capital stock and therefore increasing employment

and output for foreign markets.

The counterpart to the export rebate is the import levy. Initially,

some of this levy would increase the price of imports. The vast majority of these price increases would quickly disappear, however, as

U.S. consumers and businesses substituted domestic for foreign

production.

This in turn would force foreign suppliers to absorb much of the

tax. Thus, both the export rebate and the import levy would encourage the creation of high wage jobs at home.

Business taxes, in almost all instances, fall on labor and capital,

but especially capital. If we imposed a BTA import levy, it would

also fall on capital and labor. However, if would fall on the capital

and labor of the countries producing goods and services sold into

the United States.

In other words, a BTA import levy effectively imports tax base

from abroad, shifting some amount of the domestic tax burden to

foreign workers and foreign capital owners.

For example, if the U.S. had a trillion dollars, of imports a year,

and we imposed a 12 percent import levy, that would raise $120

billion in receipts. Even if the net shift of this tax liability to foreign taxpayers were only half the suggested amount, that would

still mean a $60 billion annual cut in taxes for U.S. citizens.

The important point here is that the BTA import levy shifts U.S.

tax burden onto foreign taxpayers, providing U.S. citizens with a

very significant effective tax cut, without reducing revenues to the

U.S. Treasury one cent.

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One might expect that the Europeans and our trading partners

would not care for our shifting our tax burden onto their citizens

very much.

I would note, however, that many of our trading partners have

tax systems that allow them to do that very thing to us, and they

have been doing it to us for decades. One way to look at this is we

are recapturing tax base that they have been stealing from us for

decades.

Tax reform creates a welcome occasion to abandon a counterproductive protectionist tax policy and allow our workers and our

companies to maximize their productivity. It also means that we

can implement border tax adjustments that would further improve

the competitiveness of U.S. labor and U.S. companies.

In both cases, the clear result is higher employment and higher

wages.

Thank you.

[The prepared statement follows:]

Statement of J.D. Foster, Executive Director and Chief Economist, Tax

Foundation

My name is J.D. Foster and I am the Executive Director and Chief Economist of

the Tax Foundation. The Tax Foundation is a non-partisan, non-profit research and

education institution. It was established 63 years ago to provide the American people and policy makers with relevant, timely, and accurate information and analysis

on fiscal policy matters at the federal, state, and local levels.

The sustained interest in tax reform should come as no surprise. More than any

other aspect of government the federal income tax directly and repeatedly influences

Americans’ lives. We may be most aware of this now during the tax season, but

every week our lives are touched and our decisions colored by the income tax. How

much should I save in my 401(k)? Should I sell some stock and pay the capital gains

tax to buy the stock I would prefer? Should I go to college, to graduate school or

night school to get a better job and earn a higher salary if it means a much higher

tax rate? Should I take out a home equity loan to buy a car? Should I buy a home

or rent? If I rent and lose the home mortgage interest deduction, can I afford to

make as big a charitable contribution to my church, synagogue, or mosque?

The income tax is like an old machine tilling the fields of the economy, reaping

a harvest of revenue for the federal government. Fourteen years ago the Congress

performed a major overhaul through the Tax Reform Act of 1986. In the intervening

years the Congress has passed hundreds of changes in the nature of ongoing maintenance. But it has also passed scores of changes asking the old machine to do even

more: To supplement welfare spending, to encourage saving for education, and so

on. Meanwhile the fields have changed steadily as has the pressure to produce, putting ever greater demands on the tax machine. Even under ordinary circumstances,

another major overhaul would be past due today.

Circumstances are far from ordinary, however. The growing breadth of the economy combined with the rapid escalation of computing power have spawned a degree

of complexity in the tax code affecting both individuals and businesses that was unthinkable not long ago. This complexity has led to a growing animus and distrust

of the tax system, the Internal Revenue Service, and the federal government in general.

It is unwise to impose upon citizens any system that is torturously complex and

affects so many areas of their lives. This complexity of the code leads to a sense

of imbalance and unfairness. Some instances are obvious, like the marriage penalty

which the Congress is seeking to address this year. Others are a matter of perception. We come to believe our neighbor knows of some twist to the tax code that allows him to pay less tax than we do.

Circumstances are also extraordinary because there is a growing sense that an

income tax is not the best type of tax for any country. At issue is not whether the

income tax machinery can be made to work better, but whether it is the right machine for the job. When the income tax was advanced and adopted, it was well understood that it overtaxed saving and investment. It was also understood that this

bias would reduce economic growth, but this was considered a reasonable price to

pay for the redistribution of income and wealth for which the income tax is so adept.

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Today, the prosperity foregone is unacceptable and the transfer of income and

wealth can be achieved by other means. Further, the income tax’s deleterious effects

on international competitiveness that could essentially be ignored fifty, forty, or

even twenty years ago cannot be ignored today.

To be sure, the federal income tax is not about to collapse. There is no crisis. We

could skip fundamental tax reform, choosing instead to make repairs minor and

major and keep this old machine running a while longer. We could also have set

aside welfare reform, and foregone its many benefits. We could postpone Social Security Reform and Medicare reform. We could choose to do all these things, but that

would not be the wise or rational choice, not when the lives of millions of Americans

can be bettered by sound reforms.

What Is ‘‘Fundamental’’ Tax Reform?

The phrase ‘‘fundamental tax reform’’ is now code in tax policy. To some it stands

for a specific proposal, like the Flat Tax or the National Sales Tax or the Simplified

USA Tax. To some it stands for a threat to stability and the status quo. To others

it stands for an alternative set of principles that should guide tax policy and that

undergird most tax reform proposals: principles such as simplification, fairness, and

economic neutrality. As these principles are nearly universally applauded, it is immediately clear how extensive the changes must be for legislation to rise from being

a run-of-the-mill tax bill to the level of ‘‘fundamental’’ reform. The 1997 Taxpayer

Relief Act, for example, included a great many provisions, but no one would argue

that this constituted ‘‘fundamental’’ reform.

Neutrality and Saving

One distinguishing feature of fundamental tax reform is the meaning of the word

‘‘neutrality.’’ Does one mean neutral within the framework of a classical income tax,

or neutral in some other sense? Our current system is a mutated income tax that

often taxes the returns to saving even more heavily than would be appropriate

under a normal income tax. The unintegrated corporate income tax, the capital

gains tax, and the gift and estate tax are monuments to excessive taxation. On the

other hand, the federal income tax contains many features consistent with a consumption tax, such as the pension and savings provisions that effectively ensure

that only one level of tax is paid at the individual level on labor income that is

saved.

Given its current usage, at the individual level ‘‘neutrality’’ today clearly means

taxing all labor income once and only once, uniformly and consistently. In other

words, for individuals fundamental tax reform means shifting the tax base from a

combination of labor and capital income, to labor income. For businesses, it means

taxing only profits earned in the United States. Neutrality for businesses also

means only taxing economic profits rather than financial profits, which is achieved

by allowing businesses to expense their purchases of plant and equipment. Thus,

it means changing a fundamental principle on which the tax system is based.

Neutrality and Education

Neutrality also means imposing no higher a tax burden on human capital income

than on physical capital income. In the e-world, a well-educated work force is vital.

The ‘‘e’’ in e-commerce could just as well represent ‘‘education’’ as ‘‘electronic.’’ The

New Economy is built on technology, communications, and information, all of which

have value only to the extent employees, investors, entrepreneurs, and managers

can use the technology to communicate and process the information productively. In

other words, it depends on people with the education to use the tools effectively.

The tax code should not create a bias in favor of education, neither should it have

a bias against education as it often does today. Neutrality means businesses should

be able to expense their physical capital acquisitions. It also means individuals

should be able to deduct in full the costs associated with their education. We already do this to an extent insofar as local school systems are funded with federally

tax-deductible property taxes. This same treatment should extend to all reasonable

expenses incurred by individuals seeking to invest in their own human capital.

Pursuing Fundamental Tax Reform

Defining the goal of tax reform leaves a remarkable number of options from which

to choose. For example, one can ‘‘scrap the code’’ as many advocate, suggesting that

remedial action is infeasible or impractical, and replacing the income tax with some

apparently new system. I say apparently new because, in fact, none of the main proposals advanced to date are truly as new and revolutionary as their advocates would

have us believe.

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The Congress could achieve the essential substance of the Simplified USA Tax,

for example, by allowing an unlimited Individual Retirement Account and other pension savings, while allowing businesses to expense all of their purchases of plant

and equipment. Similarly, while the Federal government has no experience with

broad sales taxes, it collects numerous targeted excises while most states collect

general sales taxes. Thus even a National Retail Sales Tax, clearly the most radical

of the popular proposals, and the most problematic, is not entirely alien. The ‘‘revolution’’ in fundamental tax reform is not the novelty of the new tax system, per se,

but the shift in the tax base from a mutated definition of income to consumption.

An alternative to ‘‘scrapping the code’’ would be to ‘‘clean the code.’’ It is entirely

possible to achieve all the goals of fundamental tax reform by radically amending

the existing system. For example, step one would be to allow people to save as much

as they want in tax-deferred accounts, without regard to their current incomes or

to when they choose to take the money out of the accounts for consumption. Alternatively, one could tax all labor income however employed, and forego taxing all

forms of future capital income.

Step two would be to eliminate the Alternative Minimum Tax and all the other

horrors of current law. The true source of complexity in the tax code is not the home

mortgage and the charitable contribution deductions, and the others listed on Schedule A. For individuals the true complexity lies in the phase-in and phase-out of the

Earned Income Tax Credit, the phase-out of the other tax credits and other bells

and whistles enacted in recent years, the phase-out of itemized deductions, the

phase-out of personal exemptions, the Alternative Minimum Tax, and the modern

nightmare that is Schedule D for capital gains and losses. For businesses the true

complexity lies in the system of depreciation allowances, the taxation of foreign

source income, and the special rules and rulings that go into defining taxable income.

Step three would be to allow individuals a deduction for personal expenses associated with education—to put human capital formation on par with physical capital

formation.

Step four would be to allow businesses to expense their purchases of plant and

equipment.

Step five would be to tax only income earned in the United States, rather than

seeking to cast an extraterritorial net in a feat of veiled protectionism.

A great many other steps would be needed to ‘‘clean the code’’ properly. The federal income tax is very much like a vast mansion that has collected dust and all

manner of rubbish over decades of relative neglect, and in many areas may have

fallen into disrepair. It is possible to clean the mansion again, to repair the walls,

and to modernize the facilities. Whether one should level the income tax edifice and

start over or just give it a thorough cleaning is a tactical and political decision. The

former may be more unsettling though more thorough; the latter may appear easier,

but it is less certain to achieve the desired result.

A No-Cost Tax Cut

Some level of compliance and administrative costs are inevitable with any tax system. Any amount in excess of the minimum wastes the nation’s resources. It is, in

effect, a tax with no offsetting benefit. Reducing those costs is therefore equivalent

to a tax cut in that it leaves more resources in the private sector. But it is a tax

cut that, at worst, leaves the Federal government with no fewer resources than it

had before.

Estimates of the compliance costs associated with the Federal income tax often

reach into the hundreds of billions of dollars. Four years ago the Tax Foundation

concluded that a lower-bound for such an estimate was $157 billion. Today, that figure might be closer to $175 billion. This is a lower bound, so the actual figure is

almost certainly much higher. For argument’s sake, suppose it is $200 billion.

Using the same methodology employed to find the lower bound for compliance

costs for the income tax, in 1996 the Tax Foundation estimated the compliance costs

associated with the Flat Tax and the National Retail Sales Tax. In both cases the

analysis showed that compliance costs would fall by about 95 percent once the new

plan was fully phased-in, assuming the new tax system was enacted in its pure

form. The reduction associated with the Simplified USA Tax would be comparable.

Thus, even if transition issues and political considerations caused the percentage reduction in compliance costs to drop to 50 percent, that still means an effective tax

cut of $100 billion annually, or $1 trillion over 10 years. That is an enormous

amount of saving and should by itself be enough to compel legislative action.

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The International Dimension of Tax Reform

The foregoing discussion reveals many sound reasons for pursuing fundamental

tax reform, including simplification, reducing compliance costs, improving the neutrality of the tax code so that it is less of a hindrance to economic growth, and reducing the intrusive aspects of the tax system into citizens’ lives. Each of these has

been discussed extensively in numerous forums, including this Committee. However,

the international dimensions of tax reform, particularly the change in the tax treatment of foreign source income and the imposition of Border Tax Adjustments have

until recently received far less attention than they deserve.

Protectionism and the U.S. Tax on Foreign Source Income

Subject to a vast array of special provisions, tests, and rules, the essential features of U.S. international tax policy are that the U.S. imposes federal income tax

on U.S. citizens’ foreign earnings. The U.S. also allows a limited tax credit against

any resulting tax liability for foreign income taxes paid. This policy goes under

many names, the most common of which is ‘‘worldwide taxation,’’ the most accurate

of which, however, is ‘‘extraterritoriality.’’ Most tax reform proposals wisely move

away from extraterritoriality to a system whereby only economic profits earned in

the United States are subject to U.S. taxation, a system known as ‘‘territoriality’’.

Extraterritoriality violates tax neutrality as the term is commonly used. A nonneutral tax system is hurtful to wage and job growth because it directs our national

resources of land, capital, and labor away from their most productive and beneficial

uses. A driving motivation for tax reform must be the recognition that a more neutral tax system is in our best interests, and this is true whether the issue is economic risk-taking, education outlays, the level of saving, the level of investment, the

forms of investment, or the locations of investment.

The immediate effect of extraterritoriality is to distort the pattern of international

investment by U.S. companies and therefore to reduce their competitiveness at

home and abroad. This loss of international competitiveness translates into lower

shareholder returns, but it also means a loss of jobs and lower wages at home. One

obvious consequence of the global economy is that companies must hire, invest,

produce, and sell globally. The companies that are best able to integrate each of

these activities across product lines, across functions, and across countries are the

most successful. A U.S. tax policy that distorts the pattern of activity of U.S. companies inhibits them from maximizing their efficiency. Space limitations prevent me

from elaborating on these points. However, I have written about these matters elsewhere in greater detail, (See ‘‘Promoting Trade, Shackling our Traders,’’ Tax Foundation Background Paper No. 21).

If extraterritoriality is so harmful to U.S. interests, it is reasonable to ask why

it remains the basis for U.S. international tax policy. The answer is that its true

nature has largely been hidden behind fear mongering claims and misleading statements. Extraterritoriality is a sophisticated, tax-based form of protectionism. Tariffs, quotas, and other devices seek to erect a wall against foreign goods that are

in some way less expensive or of better quality than domestically produced goods.

The only motivation for such policies is to protect the businesses and the their employees who cannot compete fairly with foreign goods. While some benefit from such

policies, consumers and other businesses that buy these goods must accept either

lower quality or higher prices and, on balance, the nation suffers a loss.

The United States has long and consistently been the world leader in the fight

for free trade and open markets. This has been a bi-partisan policy and a sound policy as history has proven time and time again. Free trade countries prosper; closed

economies stagnate. Free trade encourages each nation to do those things it does

best while giving consumers the widest array of choices at the lowest possible prices.

There are, of course, always bumps in the road and occasional backsliding. But the

broad support for free trade is remarkable, and well-founded.

The essential goal of extraterritoriality is to ensure that U.S. companies pay at

least as much income tax on their foreign activities as they would if those activities

had taken place in the United States. This sounds reasonable at first blush, but if

this principle is reasonable, why should we not require U.S. companies to be subject

to the same labor laws abroad as at home? Certainly our stricter labor laws protect

our workforce, but they also raise labor costs and therefore put U.S. workers at a

competitive disadvantage. Why not subject these companies to the same environmental laws they face at home? Again, our more stringent rules generally protect

the environment, but they also raise producers’ costs. Indeed, we have in recent

years heard calls for exactly such policies, and it is no coincidence that these same

voices have also consistently been at the forefront of the fight against free trade.

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Proponents of extraterritoriality will argue that if the U.S. fails to tax the foreign

income of U.S. companies, then the tax code will create an incentive for those companies to shift their operations to lower-taxed, foreign jurisdictions. The proper way

to express this, however, is that eliminating the tax would eliminate a disincentive

for companies to invest globally and most efficiently, unfettered by U.S. tax policies.

Classic protectionism seeks to erect barriers to the importation of goods and services to protect jobs at home. Extraterritoriality seeks to erect barriers to international investment by U.S. citizens in the usually mistaken belief that this investment would otherwise occur at home. Thus this tax barrier to international investment is also intended to protect U.S. jobs.

Perhaps the most unfortunate aspect of the protectionism of extraterritoriality is

not that it unfairly protects U.S. jobs, but that it may cost U.S. jobs, on balance,

and reduce wages, on balance. As noted above, U.S. companies organize their operations on a global basis. Each element, subsidiary, and division performs a specific

set of roles and company management strives to optimize the efficiency of each piece

of the corporate whole. The effects of a lost or foregone opportunity in one area will

negatively affect the efficiency of many of the company’s operations, including those

based in the United States. Sometimes these secondary effects are minor and can

be overcome; sometimes they are highly significant. Thus a lost or foregone opportunity due to the U.S. imposition of a protectionist, extraterritorial tax policy will

often reduce employment in a company’s other operations throughout the world, including in the United States.

The U.S. has one of the best educated, most productive work forces in the world.

If a U.S. company were considering an increase in its foreign operations, it is very

likely those operations would represent lower-wage, less productive jobs. On the

other hand, the U.S. operations that would support these low-wage jobs would tend

to be higher wage, high productivity jobs, such as those associated with research

and development, and support functions such as accounting, finance, marketing, and

management. Thus extraterritoriality protects a few low wage jobs at the expense

of other, higher-wage U.S. jobs.

The Many Roles of Border Tax Adjustments

Fundamental tax reform permits the adoption of Border Tax Adjustments (BTAs),

in the form of a rebate upon export of the U.S. business tax and the imposition of

the U.S. tax on the value of imports. BTAs are a common feature of many national

tax systems and are an important feature of the Simplified USA Tax.

The importance of BTAs to tax policy is better recognized today in the United

States thanks to the recent World Trade Organization (WTO) ruling against the

U.S. Foreign Sales Corporation (FSC) provisions. The FSC is an important, though

relatively modest attempt to grant an income tax rebate on U.S. exports. Fundamental tax reform and BTAs solve the FSC problem by, in effect, making the export

rebate total, universal, and WTO compliant.

The role and consequences of BTAs, however, go well beyond replacing the FSC.

Their major effects are to enhance prospects for U.S. companies and U.S. workers

to compete globally; to offset similar provisions adopted by our trading partners, further enhancing our international competitiveness; and effectively to ‘‘import’’ tax

base from abroad, thereby reducing the federal tax burden on U.S. citizens without

reducing revenues to the Federal government. I will address each of these, briefly,

in turn.

Export Rebates

An export rebate allows a U.S. producer to exclude from taxable income the profits made on the export of domestically produced goods and services. If the United

States adopted territoriality, then export rebates naturally address any remaining

concerns that territoriality would induce U.S. companies to shift some operations

overseas. If the United States adopted both territoriality and export rebates, then

a company would pay no U.S. tax on goods sold abroad whether those goods are produced at home or abroad.

Business taxes are generally and ultimately borne by the factors of production,

namely labor and capital. To be sure, there are instances in which a new tax can

be shifted, at least temporarily, onto consumers. But in an increasingly global and

competitive world economy, consumers have a great ability to opt for alternative,

lower-priced goods and services, and this is especially true in the United States because there is very little we do not ourselves produce in quantity. Consequently,

consumers can effectively resist bearing business taxes, and hence they are shifted

back on to labor and especially on to the owners of capital.

Upon initial introduction, an export rebate would allow U.S. exporters either to

enjoy higher profits on their exports or to charge lower prices in an effort to capture

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a greater market share. Once markets at home and abroad have adjusted to the new

tax regimes, the relative prices of U.S. exports would largely return to their previous levels, and the value of the tax rebate would be shifted back to U.S. labor and

U.S. capital. Any shift of the rebate to U.S. labor would be in the form of higher

wages. Most of the shift of the rebate, however, would be in the form of higher returns to capital that the market would translate into a larger capital stock permitting more output for foreign markets. In other words, the export rebate would be

immediately beneficial, but it would be even more so in the long run by raising

wages, increasing jobs, and increasing the competitiveness of U.S. exporters.

Import Levies

The counterpart to the export rebate is the import levy on the full value of all

imported goods and services. When first introduced, some of this rebate would

doubtlessly appear as an increase in the price of imports. The vast majority of these

price increases would quickly disappear, however, as U.S. consumers and U.S. businesses substituted domestically produced goods and services for foreign goods and

services. In large measure, the ability to substitute domestic for foreign production

would force foreign suppliers to absorb much of the tax.

As with the export rebate, once markets have fully adjusted, most domestic prices

would return to their pre-tax reform levels at least insofar as the effects of BTAs

are concerned. Once the adjustment has been completed, importers of foreign goods

and services would have shifted some of their demand to U.S. producers, with obvious beneficial effects for domestic job and wage growth. Thus both the export rebate

and the import levy have the same effects in terms of raising U.S. economic activity

by increasing the international competitiveness of U.S. labor and U.S. companies.

On Offsetting Exchange Rate Adjustments

One counterargument against the foregoing analysis is that exchange rates would

adjust to offset any price effects of Border Tax Adjustments. I believe this argument

is essentially correct. What I do not know, and what nobody knows, is how long this

exchange rate adjustment would take to occur. It could be instantaneous or, more

likely, it could take many years.

Economists know a great deal about the fundamental forces of exchange rate determination over the long run. They also know a great deal about many of the forces

that cause exchange rates to evolve over time. For example, we know that exchange

rates move to clear the markets for foreign exchange and that these markets are

buffeted by changing international capital and trade flows, by changing expectations

about how these flows will adjust in the future, by changes in tax policies, and by

changing expectations of relative inflationary pressures.

Given all these factors it should not surprise that economists enjoy little success

predicting exchange rate movements over the next day or two, and they do no better

forecasting when exchange rate movements will take place and how far they will

move in the short and medium terms. This is especially true within the context of

fundamental tax reform. Whatever influences BTAs might have on exchange rates

would almost certainly and for a long time be overwhelmed by the shifting patterns

of trade and capital flows into and out of the United States in response to changes

in the incentives to save and invest.

What we can say is that if exchange rates move to offset fully the competitive benefits of BTAs, then the worst that can happen is that these benefits will not materialize. Such an adjustment would likely take a long time to occur, however, and

unless and until it does the benefits will manifest themselves and they could be very

substantial.

‘‘Importing’’ Tax Base

The tax base is the amount that is subject to tax. In the case of the income tax,

for example, the tax base is the total of labor and capital income generated in a

year. The federal gasoline excise tax base is the amount of gasoline purchased by

consumers in a year. The tax base is often manipulated to exclude certain items and

in the case of the income tax to include others more than once. The net of these

manipulations yields an amount which, when subjected to the tax rates, produces

tax revenue. The growing Federal tax take in recent years primarily result from the

growth in the economy, which is another way of saying it results from the growth

of the tax base.

Repeating a basic principle, business taxes in most instances fall on capital and

labor, the factors of production. If the U.S. were to impose an import levy in the

form of a Border Tax Adjustment, this levy would also fall on capital and labor.

However, it would fall on the capital and labor of the countries producing the goods

and services for importation into the United States. In other words, a Border Tax

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Adjustment import levy effectively imports tax base from abroad, shifting some

amount of the domestic tax burden to foreign workers and foreign capital owners.

To give some idea of the magnitude of these effects, suppose once tax reform has

been enacted with its Border Tax Adjustments that the U.S. imported $1 trillion of

goods and services a year. Assuming a 12 percent levy, that would imply $120 billion in import levy receipts. If, when all adjustments were completed, U.S. consumers resisted all efforts by foreign exporters to raise prices to compensate for the

import levy, then the U.S. would have effectively imported $1 trillion of tax base

and shifted $120 billion of tax liability onto foreign taxpayers.

Of course, in some instances foreign producers would be able to force U.S. consumers to bear some of the tax in the form of higher prices, and in rare instances

U.S. consumers would bear all of the tax. Clearly, however, such situations would

create powerful incentives for affected consumers to shift consumption toward lowerprice domestic goods and services. Thus much of the expected decline in imports

from imposing an import levy would occur in precisely those areas where consumer

resistance to the tax-induced price hikes was incomplete.

Even if the net shift of tax liability to foreign taxpayers were only half the amount

of the hypothesized upper-bound, this would still imply a reduction in taxes paid

by U.S. citizens of $60 billion annually. Whatever the figure in a given year, the

important point is that the Congress has within its means the ability to shift tax

burden onto foreign taxpayers, providing U.S. citizens with a very significant effective tax cut, without reducing revenues to the U.S. Treasury one cent.

Given the reaction of many of our trading partners to our Foreign Sales Corporation provision, one might reasonably expect them to object to the adoption of Border

Tax Adjustments. True, they would not likely be happy over this development, but

they would have no cause for complaint. Many of our trading partners, especially

the Europeans, have employed such BTAs for decades as part of their consumption

tax systems. In other words, they have been importing tax base from the United

States for many years, effectively imposing their tax burden on U.S. citizens. By

adopting BTAs, the U.S. would simply be recapturing U.S. tax base these trading

partners have claimed for all these years.

Conclusion

There is a great deal to commend comprehensive, fundamental tax reform. Most

of the problems associated with the federal income tax are well established and virtually all of them can be effectively addressed through sound reform. Fundamental

tax reform can dramatically reduce complexity and compliance costs. It can free individuals from much of the intrusiveness that is the hallmark of the income tax.

It can put people and education at least on par with machines by making the tax

system neutral with respect to human and physical capital formation. It can free

the economy to create more and better jobs, higher wages, and more wealth.

Fundamental tax reform also creates a welcome occasion to abandon a counterproductive protectionist policy of taxing foreign source income in favor of a policy

that will allow U.S. companies to maximize their international competitiveness and

thereby contribute even more to the promise of greater prosperity at home.

It goes even further by creating the opportunity to consider implementing Border

Tax Adjustments that would further improve the competitiveness of U.S. labor and

U.S. companies.

And, not to be overlooked, it creates a powerful opportunity to provide American

taxpayers with an effective tax cut, both in the reduction of compliance costs and

in the importation of foreign tax base. This tax cut potentially could total in the

hundreds of billions of dollars annually, without reducing receipts to the Federal

Treasury. This is literally, money left on the table that the Congress can sweep up

and bestow on the U.S. taxpayer.

Chairman A

Our last witness, Gary Hufbauer, welcome back to the ComRCHER. Thank you, Dr. Foster.

f mittee. We will be pleased to hear your testimony.

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STATEMENT OF GARY HUFBAUER, REGINALD JONES SENIOR

FELLOW, INSTITUTE FOR INTERNATIONAL ECONOMICS

Mr. HUFBAUER. Thank you very much, Chairman Archer and

members of the Committee. Thank you for inviting me to testify

this morning.

Chairman ARCHER. Mr. Hufbauer, would you just briefly identify

yourself for the record?

Mr. HUFBAUER. Sure. I am Gary Hufbauer at the Institute for

International Economics here in Washington, D.C.

The United States has a dysfunctional tax system for business

activity and in other areas as well, but I am going to concentrate

on business activity.

Our system poses burdens that are unknown to competitor firms

based in Europe, Asia, Latin America. It is true today that the U.S.

economy is the marvel of the world. Every place you travel, you

hear this.

But our magic ingredients are being adopted by our competitors

abroad. Those ingredients are an open economy, a flexible labor

force and the Internet.

Meanwhile, we continue to be handicapped by our tax system.

We follow an antiquated and impractical general rule. We tax the

worldwide income of our firms, but we do not tax the income of

firms abroad which are shipping goods and services into the United

States.

This rule dates from the earliest days of the Internal Revenue

Code when international commerce was in its infancy and of course

multinational corporations were unknown.

Successive Congresses, in their wisdom, have modified that general rule, at least in terms of U.S. business operating abroad, so

we have the foreign tax credit and we have deferral and we had

the DISC and we have the FSC. But these tensions, which date

back to 1918, have created the extraordinarily complicated tax system that we are coping with today.

The problems were highlighted by the recent ruling by the WTO

against the Foreign Sales Corporation.

As my colleagues on this panel have pointed out, European countries routinely shift their tax burden abroad. They routinely exempt their exporters from value added tax, which amounts to about

$100 billion a year. And of course European firms use foreign sales

subsidiaries, saving at least another $10 billion a year.

By comparison, the Foreign Sales Corporation, as Congressman

Frenzel pointed out, was a tiny little measure, saving about $3.5

billion a year for U.S. exporters.

Meanwhile, we face the problem of international tax competition.

At one time that was called ‘‘the runaway plant problem.’’ Ross

Perot, with his gift of sound bytes, rechristened it ‘‘the great sucking sound.’’ That was exaggeration, but it is true that we live in

a world where international tax competition is growing more important. We also face the new issue of Internet sales, especially

business-to-business sales which our present tax code is incapable

of handling.

The Simplified USA business tax would eliminate the steep tilt

against U.S. exports because U.S. companies, like their European

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1Gary Clyde Hufbauer assisted by Joanna M. van Rooij, U.S. Taxation of International Income: Blueprint for Reform, Institute for International Economics, 1992. 2Gary Hufbauer, ‘‘A Critical Assessment: The World Trade Organization Panel Report (dated

8 October 1999) and Report of the Appellate Body (dated 24 February 2000), United States—

Tax Treatment for ‘‘Foreign Sales Corporations’ ’’ ’, Institute for International Economics web site

www.iie.com, March 11, 2000.

competitors and their Asian competitors, would pay no tax on exported goods and services.

And it would eliminate the tax motive for ‘‘runaway plants’’ and

that motive may get stronger in the years ahead. Under the simplified USA business tax, any firm that produced abroad, whether

it is an American firm or a Latin American firm or whatever,

would be taxed when it sells goods and services into the U.S. market.

Following these general principles, the simplified USA tax would

handle the very rapidly growing business-to-business E-commerce.

At a stroke, the Simplified USA Tax would deal with some of our

most pressing international competitiveness problems.

Thank you very much.

[The prepared statement follows:]

Statement of Gary Hufbauer, Reginald Jones Senior Fellow, Institute for

International Economics

Chairman Archer and members of the Committee, thank you for inviting me to

testify. The United States has a dysfunctional system for taxing business activity.

The corporate income tax is enormously complex, it invites firms to establish production abroad and sell goods and services back into the U.S. market, it discourages

U.S. exports, it is an open sesame for international tax shenanigans, and it is not

equipped for E-commerce. Like learning Latin, learning the Internal Revenue Code

is great mental discipline for young lawyers. Otherwise, it is a curse.

The U.S. system imposes burdens on business unknown to our competitors in Europe, Asia, or Latin America. Today the U.S. economy is the marvel of the world.

But other countries are learning the magic ingredients: a flexible labor force, an

open economy, and the internet. To stay competitive in the world, we need a dramatically simplified system of taxing business activity. Representative Phil English

(R.–PA) has pointed the way with his Simplified USA Tax, drawing on the concepts

pioneered by former Senator Sam Nunn (D–GA) and Senator Domenici (R.–NM). My

testimony concerns the international aspects of business tax reform.

The United States follows an antiquated and impractical general rule: it taxes

worldwide business income. This rule dates from the earliest years of the Internal

Revenue Code, a time when U.S. international commerce was in its infancy, and the

term multinational enterprise had not been coined. Under the general rule, when

a U.S. company makes and sells products in France, the U.S. taxes the income. In

the converse case, France does not tax the income of French firms operating in the

United States.

The worldwide tax approach was born in a different era as a method of administrative convenience, but it is defended today by emotion not logic: ‘‘Every U.S. corporation should pay U.S. tax, whether it operates in Indiana or India, New Mexico

or old Mexico.’’ Carried to its extreme, the general rule would render U.S. firms totally non-competitive in a global economy, both as exporters and producers.

Successive Congresses, in their wisdom, have modified the general rule with practical exceptions, ranging from the foreign tax credit, to deferral, to the Domestic

International Sales Corporation (DISC) and the Foreign Sales Corporation (FSC).

But the tensions stretching back to 1918 between the impractical general rule of

worldwide taxation and the practical exceptions have generated an extraordinarily

complex system for taxing the international income of U.S. firms and the U.S. income of foreign firms. The administrative burden is a nightmare for the IRS and

business alike.1

These problems were brought into focus by the recent WTO Appeals Court decision against the Foreign Sales Corporation. Elsewhere, I have severely criticized

this decision.2 It ignores legal history and it misreads the WTO text. But Congress

must now reckon with a WTO decision that tossed aside the tax bargain painstakingly negotiated between the United States and Europe twenty years ago.

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3Gary Clyde Hufbauer and Carol Gabyzon, Fundamental Tax Reform and Border Tax Adjustments, Institute for International Economics, January 1996.

European countries (and many others) routinely exempt their exports from value added tax. This saves European exporters about $100 billion a year of tax payments

on export sales. European firms routinely sell these same exports through tax-haven

sales subsidiaries located in exotic places like Bermuda and Hong Kong. This saves

European exporters another $10 billion a year of corporate income tax. By comparison, the Foreign Sales Corporation saves U.S. exporters about $3.5 billion a year.

Most of the 6,000 firms that use the FSC are small and medium-sized exporters

with little or no production abroad.

As the FSC decision illustrates, the WTO honors an archaic tax distinction that

has no economic basis. WTO rules allow corporate taxes measured by value added

(Europe) to be excused on exports and imposed on imports. But WTO rules forbid

similar adjustments for corporate taxes measured by income (United States)—even though the distinction between the two tax bases is more form than substance.3

Meanwhile, old and new problems fester in the world of international taxation.

One old problem is the ‘‘runaway plant,’’ re-christened by Ross Perot as ‘‘the great

sucking sound.’’ Will U.S. firms pull up stakes and move abroad, and then sell back

into the United States—free of U.S. corporate tax? Legislators in many countries

understand that low business taxes are a good way of attracting investment, and

econometric evidence bears out their sentiments. Perot exaggerated for political effect, but the possibility of fierce tax competition in a global economy cannot be lightly dismissed.

A new problem is E-commerce. Will U.S. firms be taxed on their internet sales

to customers abroad? Can foreign firms sell into the U.S. market free of tax?

Congress could, in a single historical stroke, level the field of export taxation, end

anxiety about runaway plants, resolve much of the looming debate over E-commerce, and discard volumes of tax complexity. It could achieve all these goals by

replacing the corporate income tax with the Simplified USA tax.

Under the Simplified USA business tax, taxable income would be determined by

subtracting permitted deductions from taxable receipts. Taxable receipts cover revenue from sales in the United States, but not exports or production abroad. Permitted deductions cover all costs of business purchases from taxpaying U.S. firms.

Payments for imports are either not permitted as a deduction or are taxed directly.

By excluding exports from taxable receipts, and by either excluding imports from

deductible expenses or taxing them directly, the Simplified USA business tax provides ‘‘border tax adjustments’’—just as in Europe, but without adopting a sales tax.

When U.S. firms sell into foreign markets, their receipts would not be counted in

taxable income, and therefore would not be taxed by the United States. The steep

tilt in export tax practices would be leveled because U.S. companies, like their European, Asian and Latin American counterparts, would pay no tax on exported goods

and services.

The Simplified USA business tax would eliminate the tax motive for runaway

plants. Any firm that produces abroad and sells in the U.S. market would effectively

pay the same tax as a competitor located in the United States. When U.S. or foreign

firms sell goods and services into the U.S. market, the U.S. importer would be liable

for the Simplified USA tax (alternatively, no deduction would be permitted for the

purchase of imported goods and services). For example, shoes made in Brazil and

retailed by Walmart in Denver would pay Simplified USA tax, and so would sophisticated software written in Bangalore and sold to Citigroup in New York. The

United States would collect the Simplified USA business tax on about $1.3 trillion

annually of imported goods and services.

When U.S. firms both produce and sell abroad, they would pay tax to the host

country, not the United States. In fact, under current law, the U.S. Treasury collects

practically no corporate tax revenue on active business conducted abroad by U.S.

firms. But this practical outcome results from the interaction of outlandishly complex rules dealing with foreign tax credits, foreign losses and deferral. The same

outcome would be a straightforward result of the Simplified USA tax. U.S. firms

would compete on a level tax playing field, whether they produced in China, Germany, Mexico, or anyplace else.

How would the Simplified USA tax handle E-commerce? As explained, businessto-business E-commerce (B2B) would not be included in taxable receipts, and B2B

imports would be taxed directly (or deductions for imports disallowed). B2B is by

far the largest dollar volume of E-commerce transactions. At a stroke, the most immediate E-commerce tax problem would be resolved.

America’s first income tax began 1861 to pay for the Civil War. The Union im- posed a 3 percent tax on incomes over $800.00 a year, which exempted most wage

180

earners. The tax rate was raised to 5% in 1862 on incomes over $10,000.00. Shortly

after the Civil War the income tax was repealed, the Bureau of Internal Revenue

remained in existence. Budget-balancing statement have turned to income tax even

in peacetime to replace revenue lost by import and export duties. That was the purpose of the income tax passed by congress in 1893 and ruled unconstitutional by

the Supreme Court in 1895. President Taft pushed a constitutional amendment to

revise that decision, and an income tax was passed as soon as the 16th Amendment

was ratified in 1913 by only 31 states.

The new income tax was a luxury tax. Top rates remained below 10 percent and

most Americans didn’t pay at all. Then came World War I, which raised the federal

budget from $1 billion in 1916 to $19 billion 1919; income tax rates rose to 3 percent

on $2,000 and 70 percent on $1 million. After the war, Treasury Secretary Andrew

Million reduced the top rate to 25 percent and got most taxpayers off the rolls by

raising the minimum income subject to tax. But he also cooperated with the Congress to create preferences, exemptions, deductions and other tax breaks. The income tax had gotten the federal government deeper into the business of allocating

economic resources, mostly out of public view.

During World War II, as federal spending rose from $9.6 billion in 1940 to $95

billion in 1945, income tax rates were raised 19 percent on $2,000 and 88 percent

on $220,000, and the number of taxpayers rose from 14 million to 50 million.

The World War II tax is recognizable ancestor of today’s federal income tax. The

$500 per dependent exemption of 1944, raised to $600 in 1947, was a generous allowance no income tax. Over time, inflation eroded the value of the exemption. The

Republican leaders of the 1950’s feared voter’s resentment of the rich and did not

reduce top rates. In the 1960’s, JFK stimulated the economy by reducing taxes significantly.

The experiment in maintaining the wartime’s high tax rates during peacetime in

order to pay for the cold war and redistribute money to the middle class and poor

worked-both economically and politically-for a generation and then stopped working

economically. In the 70’s, runaway inflation, fueled in part by Lyndon Johnson’s refusal to raise taxes to pay for the Vietnam War, propelled ordinary families into tax

brackets intended for the rich, while the myriad tax breaks available to the wealthy

made a mockery of fairness. As state, local, and other tax rates also rose, a middleclass tax revolt helped fuel the Reagan Republic victories of the 1980’s and 1994.

Politicians have been struggling ever since to reduce income tax rates to peacetime

levels that the public and the economy will tolerate.

Quoting the Federalist papers #35 penned in 1788 by Alexander Hamilton, ‘‘There

is no part of the administration of government that requires extensive information

and a thorough knowledge of the principles of political economy, so much as the

business of taxation. It might be demonstrated that the most productive system of

finance will always be the lest burdensome.’’

In a few days, I have been able to gather signatures from disgruntled American’s

who support the Fair Tax plan. Be it known that these signatures cross all lines

of division in that they represent ditch diggers to lawyers, truck drivers to stockbrokers, Black, White, Hispanic, and Asians. To further discern a more accurate

consensus of the people, all you need do is refer to the petition filed by the people

of Arizona. On Thursday, July 2, 1998, 170,000 Americans required of this congress

to abolish income tax and establish a National Sales Tax. The Fair Tax Plan before

you at this time is what the people want and require of you now.

One thing that amazes me is that the national news media has all but ignored

this legislation. The rhetoric we as Americans have been subjected to implied that

the wealthy in this country do not pay taxes, and that the tax burden has been

shouldered by the ‘‘working poor and middle class.’’ To this I quote the designed

Commander of Bastognne in his response to the Nazis to surrender in World War

II ‘‘Nutz.’’ Figures recently released by the National Revue project quiet a different

notion. The quintile of taxpayers from lowest to highest to outlined as such:

Lowest –2%

Low 1%

Middle 7%

High 16%

Highest 78%

When confronted with the truth in these matters of income tax and this Administrations quest for an America steeped in fairness, it is apparent that we are trying

to shoot a game of pool with a nylon rope.

I would like to thank the members of this committee for the opportunity to address you regarding the Fair Tax plan, and close with another quote from Alexander

Hamilton’s Federalist Papers #36:

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‘‘It has been asserted that a power of internal taxation in the national legislature

could never be exercised with advantage, as well from the want of a sufficient

knowledge of local circumstances, as from as interference between the revenue laws

of the union and of the particular States. The supposition of a want of proper knowledge seems to be entirely destitute of foundation. If any question is depending in

a State legislature respecting one of the countries, which demands a knowledge of

local details, how is it acquired? No doubt from the information of the members of

the county. Cannot the like knowledge be obtained in the national legislature from

the representatives of each State? And is it not to be presumed that the men who

will generally be sent there will be possessed of the necessary degree of intelligence

to be able to communicate that information?’’ I hope so!

If William Jefferson Clinton so feels the pain of the American people, let him with

unanimous consent of US Congress and Senate sign the Fair Tax Plan now. I implore you to preserve our freedom, our liberty, and Save this Union by Passing this

legislation NOW!!

Thank you.

[Attachment is being retained in the Committee files.]

Chairman A

Again, my thanks to each one of you.

RCHER. Thank you, Mr. Hufbauer.

f I have several questions. I had not intended to get into this today

but you have prompted my inquiry.

The USA Tax was originally designed as a consumption tax, as

I recall, and introduced by Senator Domenici, is that not correct.

And is it under the revisions that have been presented today still

a consumption tax?

Mr. CHRISTIAN. It, Mr. Chairman, it does not double tax saving,

and by an economist’s definition, that is what a consumption tax

is.

The difference between the original USA and the simplified USA

in this respect is straightforwardly as follows:

Under the proposal sponsored by Senator Domenici and Senator

Nunn, a deduction was allowed for personal saving. When income

was earned, if that income was saved, the tax was deferred because

a deduction was allowed, and then the tax was imposed when the

original amount saved——

Chairman ARCHER. Mr. Christian, because time is limited today,

I personally do not feel that I have the time to get into all of those

details.

I just simply wanted to know whether this is still a consumption

tax?

Mr. CHRISTIAN. By an economist definition, yes.

Chairman ARCHER. But it does tax savings once?

Mr. CHRISTIAN. That is correct.

Chairman ARCHER. Which, by my definition, would not be a

straight out consumption tax.

The mere fact you eliminate double taxation means that there is

still a single tax on savings, and a true consumption tax does not

tax savings at all.

And I am not trying to make an argument against it; I am just

trying to understand it.

The payroll tax credit that is a part of the system, as it is presented today, I assume that is refundable?

Mr. CHRISTIAN. That is refundable, that is correct.

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Chairman ARCHER. All right. So in effect, what you are really

doing is you are replacing payroll taxes with general income tax

revenues coming out of the Treasury?

Mr. CHRISTIAN. There is no change in the payroll tax itself.

Chairman ARCHER. No. I understand that. But you are offsetting

the burden of the payroll tax with general Treasury money?

Mr. CHRISTIAN. That is correct.

Chairman ARCHER. Okay. Why not simply abolish that part of

the payroll tax and let the general Treasury make a contribution

each year in an amount equal to what the payroll tax would have

been directly into the Social Security fund?

Would not that be much simpler than having everybody have to

deal with a refundable tax credit? Because that is the end result.

Mr. CHRISTIAN. You could do it that way.

Chairman ARCHER. You are reducing the revenue in the general

Treasury fund by your tax credits, which is the equivalent of the

Treasury writing a check to the Social Security Trust Fund.

And it just seems to me that would be far simpler, the end result

is the same.

Rather than going through all of this bit of the tax credit, having

the payroll tax withheld, so people foregoing that amount of their

paycheck until the end of the year when they can get a refundable

tax credit, why not just wipe out the employees’ side of the payroll

tax, and at the end of the year, have the payroll records which are

being sent in determine the amount of money and let the Treasury

just write a check to the Social Security Trust Fund?

Would that not be much simpler?

Mr. CHRISTIAN. You could do that, Mr. Chairman.

The thought behind this approach was to not mess with Social

Security at all, not touch it, and not get into the business of the

Treasury writing checks out to people that are not related to their

incomes—other than as part of what amounts to a tax refund—— Chairman ARCHER. Okay, but the Treasury will be writing

checks to people in this refundable tax credit. But the people will

have to wait for the entire year before they get their check.

And it just seems to me that in the name of simplicity, which we

are always searching for in the Tax Code, that rather than dealing

with all of these multiplicity of tax credits that have to be enforced

and administered by the IRS, that we just simply abolish that.

Workers would love it, and simply make the transfer in one transfer, rather than a multiplicity of transfers coming out of the general Treasury.

That is just a thought that I had.

I must say to my friend and counselor and comrade-in-arms, Bill

Frenzel, that one comment that you made disturbs me a little bit.

And that is when you said there can be open upward mobility for

the marginal tax rates. That strikes terror into my heart because

we saw exactly that happen after the ’86 Act reduced the rates, and

then there was upward mobility for the rates in ’90, and then there

was further upward mobility for the rates in 1993, and I just worry

a little bit about deja vu all over again, so you might want to comment on that.

Mr. FRENZEL. I do want to comment on that, Mr. Chairman. You

are right. That was one of the reasons we opposed the Act, because

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with the bubble in there, we knew that top rate was going to go

up again. And, as you suggested, it did go up a couple years later.

I have indicated in my testimony that I believe the top rate is

too high now, but also I have indicated that I believe in a system

of progressive taxation.

And I only suggest that any tax rate can be raised or lowered

and of course is that kind of a system. You can structure it anyway

you want.

Mr. Chairman, if I could go back to your original question to Mr.

Christian?

Chairman ARCHER. Sure.

Mr. FRENZEL. About whether it is an income tax or a consumption tax. One of the early developers of this bill was a David Bradford, a professor at Princeton who served in the CEA, I believe. He

always called it a ‘‘consumed income tax’’ and I do not know if that

is a euphemism, or whether it helps, but that was his description

of some of his early thinking.

Chairman ARCHER. I do remember that. I thank you for reminding us of it.

Can you tell me what deductions under the current law are

eliminated in the USA Tax?

Mr. CHRISTIAN. One very prominent deduction that is eliminated

is the deduction for state taxes.

Chairman ARCHER. State income taxes?

Mr. CHRISTIAN. All state taxes, yes, sir.

Chairman ARCHER. Well, sales taxes are already non-deductible.

Mr. CHRISTIAN. They are non-deductible.

Chairman ARCHER. But would it also eliminate property taxes?

Mr. CHRISTIAN. Yes.

Chairman ARCHER. Okay. So no state income taxes or local property taxes would be deductible?

Mr. CHRISTIAN. That is true.

Chairman ARCHER. All right. What else?

Mr. CHRISTIAN. There are a number of miscellaneous deductions.

I cannot recall any further right now, Mr. Chairman. There are

quite a few small ones. Everything other than charitable and home

mortgage interest, I believe, of the miscellaneous itemized deductions is repealed.

Chairman ARCHER. What about the child credit the Hope Scholarship credit, the EIC credits?

Mr. CHRISTIAN. All of the credits, those that you mentioned, the

child credit, the earned income tax credit, and the others are repealed. There are only two credits under the bill. That is for the

payroll tax paid and income tax paid through withholding or estimated tax.

Chairman ARCHER. What about deduction for health expenses?

You did not mention that?

Mr. CHRISTIAN. The personal itemized deduction or the business

deduction?

Chairman ARCHER. No, personal.

Mr. CHRISTIAN. Personal. The medical deduction is not there

under this version of the bill.

Chairman ARCHER. So the deduction currently in the Code for

medical expenses to individuals is no longer available?

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Mr. CHRISTIAN. It is replaced by the Roth-IRA savings mechanism. It is no longer available.

Chairman ARCHER. Okay.

Can you think of any other salient deductions under the current

code that are not available?

Mr. CHRISTIAN. No, Mr. Chairman, not at the moment.

Chairman ARCHER. What portion of the stream of federal tax revenues is border-adjustable under your plan?

In other words, today the entire cost to the federal government

is included in the price of the products that are exported which has

been estimated to raise the price of those products by 20 to 25 percent on average.

What portion of that cost that is represented by the federal tax

burden has become border adjustable under the USA proposal?

Mr. CHRISTIAN. The business taxes are approximately, including

unincorporated business, about $320 billion. Personal income taxes

are about 8.5 or 9.

It is the business tax that is border adjusted. The business tax

does not apply to exports.

Chairman ARCHER. Can you just roughly say what percentage of

the total stream——

Mr. CHRISTIAN. About 25 percent, I believe.

Chairman ARCHER. How much?

Mr. CHRISTIAN. It would be, the numbers I gave, the mathematical result is about 25 percent.

Chairman ARCHER. About 25 percent of the federal cost of taxation will not be passed through in the price of the product?

Mr. CHRISTIAN. That is certainly correct.

Chairman ARCHER. Okay. Thanks.

And I assume you still have tax exempt foundations?

Mr. CHRISTIAN. The organizations, such as universities, schools,

et cetera, that are exempt under present law, continue to be exempt from the business tax under the USA.

Chairman ARCHER. And how do you go about taxing foreign imports mechanically?

Mr. CHRISTIAN. The mechanics under this version, the English

Bill, is there is an import tax imposed at the border on the importation of goods from abroad.

Chairman ARCHER. So then the Customs Service then does that

when the product enters the country?

Mr. CHRISTIAN. Well, it is primarily the importer. The importer

or the importer’s agent is a U.S. taxpayer subject to U.S. tax jurisdiction. They are the ones who owe to the Internal Revenue Service

the import tax.

Chairman ARCHER. So mechanically it becomes a burden of the

importer?

Mr. CHRISTIAN. It becomes a payment responsibility of the importer.

Chairman ARCHER. All right. And lastly, how do you avoid the

double taxation of corporate income, or am I mistaken? I think that

is what the presentation was that you eliminated the double taxation?

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Mr. CHRISTIAN. The double tax on saved income is eliminated by

means of the Roth-IRA mechanism. I think you are asking about

the two-tier tax where——

Chairman ARCHER. What about dividends? You have got your

new uniform business tax type operation on corporations to replace

the current corporate income tax which, by the way, I think is a

very positive step forward.

What about the taxation of corporate dividends to the owners of

the corporation?

Mr. CHRISTIAN. Those are taxed, as are interest payments and as

are wages——

Chairman ARCHER. Okay, okay. So you do not eliminate the double taxation of corporate earnings?

Mr. CHRISTIAN. In the sense you are asking it, that is true, Mr.

Chairman.

Chairman ARCHER. Okay, all right. I am not trying to pick at

you. I am just trying to understand this bill.

Mr. CHRISTIAN. I am grateful for the attention, Mr. Chairman.

Chairman ARCHER. I need to know what the proposal is.

Mr. Rangel?

Mr. RANGEL. Mr. Chairman, I have to go on the House Floor to

protect our Committee’s jurisdiction. But, before I leave, I want to

ask Bill Frenzel a question, since he enjoys the expertise of former

Members, as well as an advocate of tax reform.

If we were going to dramatically change the tax system, would

you agree that the American people should first be educated about

the replacement proposal before they would expect the Members of

Congress to have the political courage to eliminate the code?

Mr. FRENZEL. Mr. Chairman, Congressman Rangel, I agree with

that. I do not think you can make major changes in the tax code

without some kind of a national debate and without the pretty full

cooperation between the Executive and the Legislative branches of

the government.

Mr. RANGEL. Now, assume we accept, as a matter of fact, that

the composition of the Congress currently gives the Republicans a

very slight margin for the Majority. And, that if there are any

changes as a result of the election in November and the Democrats

win the Majority. Our advantage too would be slight. Would you

agree, if we are going to make any progress at all towards reforming the existing system, that it has to be done in a bipartisan way?

Mr. FRENZEL. It has been my observation, Congressman Rangel,

that your statement is correct. It is very difficult to pass a major

piece of tax legislation without cooperation between the parties and

the Congress, and between the branches of government as well.

Mr. RANGEL. Well, I do not know really what is going to happen,

and no one else does in November. But there is one thing I can tell

you as a friend that Democrats have learned in being in the Minority. That is: we can be in the Majority and not cooperate and do

absolutely nothing, or we can reach out to the minority and work

with the other side in trying to find out how we can move the country and the Congress toward a better system.

I think that, no matter who wins, the best thing for the country

and the coming campaign is to state upfront that we cannot do it

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alone. There is not going to be any Democratic way to reform the

tax code and there certainly is not a Republican way to do it.

But working together, we can find a way. And I think if we had

the confidence of the American people, then it is no profile in courage to do the right thing in this Committee and on the Floor and

the Senate.

But we miss people like you because we could differ and we could

fight and then when it was all over. We could still talk about the

areas that we agreed on and how we can make progress, and that

has been missing.

And while we miss it from a friendship point of view. I think,

more importantly, the lack of talking together the lack of cooperation means really that the Congress has not been productive. We

have taken advantage of that for political purposes on both sides

of the aisle. No one knows what impact that will have in November, but it certainly has not done well for us as a body.

The whole idea that we would turn over our tax writing authority to a non-congressional committee bothers me a great deal.

But in any event, please do not go too far away. We always need

you to remind us when we were working well together. And I

thank you for hanging in there always.

Mr. FRENZEL. Thank you, Mr. Rangel. If I could comment just

briefly. The three largest tax reforms that I can remember were

’54, ’69, and ’86, and in each case we had a president and a Congress of different parties, and they both managed to work together.

In ’86, even when the Congress did not take my good advice on

that bill, there was very close cooperation between the parties, as

you will recall. I hope we can get back to that kind of cooperation.

Maybe this is an issue that will help draw us back to that kind of

working arrangement.

I thank you very much, but I assure you that other than an occasional bit of testimony, I am not looking to threaten any member’s

position on this Committee.

[Laughter.]

Mr. CRANE: [PRESIDING]. Thank you.

Mr. Collins?

Mr. COLLINS. Mr. Chairman, the only comment I have is to the

previous member who questioned, and that is talk is cheap.

Mr. CRANE. Any responses?

[Laughter.]

Mr. CRANE. Mr. Portman?

Mr. PORTMAN. Thank you, Mr. Chairman.

I have got so many questions and I appreciate the comments

from my friend from New York. I do not know why he is against

the Commission, but as I told him earlier, I think it is exactly the

way to do what he wants to do which is educate the public, which

is to make it bipartisan and which is to get outside expertise, and

then give it as a recommendation to Congress and this Committee

just like IRS reform and other things would go through the normal

process.

And I think it would be a tremendously positive and helpful step

in getting tax reform.

I want to commend all four of you. It is great that you have come

up with this plan. I have talked to Ernie a lot about it and J.D.

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some. And I have been, as you know, struggling with some of these

issues too since IRS reform because you cannot reform the IRS

without a simpler tax code.

I do not come out quite with this proposal but I think there are

positive things in it.

I have a few questions, and I guess the two key issues of course

are first, what would the rate be. You have got some rates here.

I guess my question to you would be, and you all have impeccable integrity. So many of these folks who have come before us

have come up with rates that just are not accurate, and without

knowing what the rate is, whether you are for a Fair Tax or a flat

tax or a USA tax, or something that I have talked to you about

Ernie, more that I am thinking about that has to do with a VAT

tax and some other aspects, the rate is absolutely critical.

The rate is absolutely critical, and I wonder about these rates.

So without questioning you about them today, I would just say I

hope that you can come up with current estimates of the rates.

Maybe these are them. They seem a little low to me based on what

we have done with some other analysis.

I hope you will use Joint Tax models so that we can compare apples to apples.

The second question I would have is border adjustability. Do you

have good legal analysis which shows you that somehow we would

be able to tax imports at 12 percent, that we would be able to cut

out the export tax, and not have it be considered by the WTO to

be discriminatory.

There is no precedent for this. No other country does it. And as

you know, the VAT tax is something that is tested, battle-tested,

and we know that we can border adjust, and why do you think this

would be border adjustable.

Mr. HUFBAUER. Congressman, I wrote a little monograph on this

and I will send a copy to you.

Mr. PORTMAN. I would appreciate that.

Mr. HUFBAUER. It is called Fundamental Tax Reform and Border

Tax Adjustments.

Of course, you do not know how the WTO will rule until the case

is actually before it. Nobody can say with 100 percent confidence.

But the Simplified USA Tax, in its business aspects, as proposed

by Congressman English, is very similar to existing systems which

have been ruled to be border tax adjustable. Thus I think the

chances are very good that the U.S. would prevail in any litigation

that occurred on this issue.

Mr. PORTMAN. Well those are two sort of fact issues. I mean, it

is difficult to know factually when there is not a precedent. As you

said, the chances are it would but it is a big risk because it is an

incredibly important part of the proposal. And the second is it at

an $80,000 level where you have to kick in the 30 percent tax rate?

These are obviously going to be the deciding points on what kind

of tax reform makes sense.

If I could ask a couple of other questions quickly that go to some

of the things that Chairman Archer was I think trying to get at.

The refundable tax credit experience with the EITC has been

miserable. And I would appreciate, Ernie, your response to that,

whether you could look at something where maybe you have a

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more sort of honest direct transfer, as the President’s proposing

now in Social Security. Everybody has a transition cost in the Social Security proposal.

Because to have the IRS in the position of enforcing a refundable

payroll tax credit I think would be very difficult.

Also, what do you do with folks who are on the EITC now? I assume you eliminate the EITC?

Mr. CHRISTIAN. Mr. Portman, the earned income tax credit, as it

exists today, is eliminated. The earned income tax credit, as it exists today, is a great problem of complexity, it is a great problem

of fraud. None of those considerations seem to me to, in any way,

apply to the credit that exists under the English Bill. It is very

straightforward. There are no threshold requirements or anything

of that nature, and the big difference is as follows:

Under the English Bill, a credit is given for a tax that has been

paid. That tax is fundamental to the system. It has been around

a long time. It is well-tracked. The payroll tax is a simple mechanism for tracking—— Mr. PORTMAN. Ernie, if I could because my red light is already

on.

The challenge here, as I see it, is I think there will still be some

compliance issues but I agree with you, it would be better because

you will have a record of what the FICA tax would have been.

But as you know, with the EITC, about 85 percent of it is refundable as to payroll, about 50 percent as to income. You still end up

with some people who pay no payroll taxes in effect, no income

taxes in effect, and get the EITC.

How do you take care of those people, the working poor who currently get EITC?

Mr. CHRISTIAN. I do not know how anyone would be working and

not paying payroll tax, but perhaps that is possible.

Mr. PORTMAN. No. I am saying the EITC is so generous that it

takes care of all of the payroll taxes, it also credits all of the income taxes that some individuals pay and yet those people get a

transfer from the government. They are working people but you are

not covering those people. And I just wonder how you would cover

them?

Mr. CHRISTIAN. The welfare element is definitely not present in

this credit.

Mr. PORTMAN. I am sorry?

Mr. CHRISTIAN. I said the welfare element that is present in——

Mr. PORTMAN. No, I am not talking about welfare, I am talking

about the EITC. You need to address that problem, or you need to

say you are not addressing it, I guess.

Mr. FOSTER. Mr. Chairman, I would like to take a quick shot at

this to put it in a framework.

The refundable part of the EITC is often considered to be a taxbased system of welfare. And in fact, that is how CBO scores it.

It is not treated as a tax, it is treated as an outlay.

This tax system, like many tax systems, provides a framework

within which we can make changes.

The Chairman was asking earlier about deductions that might be

in or out of the system. If a deduction was deemed politically necessary or worthwhile, it can be put back in.

189

The system as current designed does not have the earned income

tax credit. There is absolutely no reason in the world it could not

be added on, much as one adds on an extra piece of equipment on

a car.

This is a frame work for taxing within which we can make adjustments with rates, higher rates, lower rates, more progressive,

less progressive, adding in deductions, taking them out, or adding

in credits or taking them out.

Mr. PORTMAN. I understand that, J.D., and we need to do that.

With the indulgence of the Chair, I looked at the ’86 experience,

what has happened since then, and that is the great fear the

Chairman has, and again, I really applaud you and Congressman

English for taking the leap and proposing this.

On the EITC, it is just a very simple question really and not a

simple answer, but you are covering most of the current recipients

of EITC because you are covering payroll.

You are not covering, though, folks who currently not only have

their payroll taxes offset by EITC, but also their income taxes, and

some folks who have both income and payroll tax, and still get a

transfer from the government under this Program for the Working

Poor, and I think you need to address that. There are lots of ways

to do it and I will not make suggestions, but I think it needs to

be addressed. Otherwise you have a hole that I think the states

and localities and others are not going to be able to fill.

I have some questions on the pension side and on the health care

side that maybe we can talk about later. I think they are very important because you do not have an employer match here, so you

do not have a 401K type proposal, although you say in the materials, it preserves the 401K.

Mr. CHRISTIAN. It is preserved.

Mr. PORTMAN. I would like to talk to you about the fringes, as

well.

Thank you.

Thank you, Mr. Chairman.

Mr. CRANE. Thank you.

Mr. English?

Mr. ENGLISH. Thank you.

And on that point, Mr. Christian, do you want to comment on the

401K situation?

Mr. CHRISTIAN. Yes, sir.

Your bill, as you know, following up Mr. Portman’s point, the bill

does retain the 401K provision. And it retains the ability for the

employer to match. The difference is that the contribution to the

401K under the English approach is not deductible, whereas it is

presently. That is the difference between—the employer match is

not deductible under this proposal.

But the 401K and that mechanism still exists and employer

matching is encouraged.

Mr. ENGLISH. And I thank you.

Mr. Frenzel, you heard the exchange with regard to EITC and

the excellent points that my colleague from Ohio made with regard

to the hole that he identified that I frankly have been very much

aware of, because I have a lot of people on the EITC in my district.

190

In your testimony, I believe that you commented that perhaps

rather than treating this as a tax program, we should—and I hate

the notion of tax program—rather than trying to deal with this

through the Tax Code, maybe this could be most efficiently administered as a program through the federal government, an expenditure.

Can you comment on that

Mr. FRENZEL. Yes. I was a strong supporter of the EITC when

it was first effected here, and I thought the concept was wonderful.

But it was a very small program at that time.

Nowadays, because the program has gotten big and because people have found out how to game the system, it has been my judgment that we would do far better to make that into an appropriations entitlement, rather than a tax entitlement, where it could be

enforced much better, and probably managed better.

That is a personal comment on my part.

Mr. ENGLISH. And one that I agree with.

Thank you, sir.

Mr. Foster, in your testimony, you touch on the notion that by

establishing this border adjustable system, which I believe, having

researched it, is GATT consistent, that we are, in effect, importing

a foreign tax base.

Would you care to comment on that further?

Mr. FOSTER. Yes, sir.

If you start from the proposition, as I do and most economists do,

that business taxes ultimately fall on labor and capital, when you

have a border tax adjustment import levy, that levy, too, falls on

labor and capital. The question is on whose labor and whose capital.

Now some of this import levy obviously gets translated into higher prices to consumers, and in some cases, that is permanent. But

in most cases, consumers will substitute domestic for foreign production so that they are able to resist the attempt by the importer

to raise prices. When they are able to effectively resist those price

increases, the tax then gets pushed back onto the foreign producer

of those goods and services sold into the United States.

Well, if they are being pushed back into the foreign lands, that

obviously means that the BTA import levy is paid by the foreign

labor and capital. Another way of expressing that is we are importing their tax base.

Mr. ENGLISH. And on that point, Mr. Portland made the excellent

point that none of our tax competitors have quite this kind of a tax

system as is being proposed here, but many of them do have border

adjustable systems.

How many of them, would you say that we compete with, what

proportion of our industrialized competitors have border adjustable

systems?

Mr. FOSTER. Well, probably 90 percent or more because we are

talking all of Europe, Japan, and Canada.

Mr. ENGLISH. And we are at a competitive disadvantage with

them.

Finally, Mr. Hufbauer, you make an excellent point that this tax

system would eliminate the tax motive for runaway plants. That is

something that resonates in a district like mine.

191

Would you care to elaborate?

Mr. HUFBAUER. Sure.

The runaway plant phrase, as you well know, Congressman,

dates back to the Burke-Hastke bill of the early seventies.

The idea was that a U.S. firm would shut down its operation, for

example, in Ohio, and would move to, for example, Mexico or

Singapore, and would ship exactly the same goods back to the U.S.

And it would do this for a lot of reasons. Wages were often cited.

Other reasons as well. Taxes were often mentioned as part of that

business decision.

To the extent that taxes are part of that business decision, under

the simplified USA tax no firm escapes taxes in the U.S. market

by moving its production to a foreign country, because when the

goods are shipped back into the U.S. market, they would be taxed

just as if they had still be produced in Ohio. That is, in my view,

a huge improvement over the situation that we have today.

Mr. CRANE. I thank you gentlemen, and I am impressed with the

quality of the testimony today. We appreciate your participation.

Mr. Hulshof?

No questions from Mr. Hulshof.

Well, then, this panel has concluded its work and I want to

thank you all and congratulate you for your presentations.

And any additional material you may have, submit in writing

and it will be part of the permanent record.

Now, with that, I think we are going to change the schedule as

it was originally presented, because we are going to break for

lunch.

So I would like to call our last panel up first, because our next

two panels—well our next one in line is not available, and the one

after is going to be longer in session than we have left before the

lunch break—so I would like to invite Mr. Steven Worley from

Lawrenceville, Georgia, and Mr. James Moore from Smithtown,

New York, and Frank L. Davis, Alexandria, Virginia. I do not think

he is yet here, but if he appears after you two have made your

presentations, we will listen to his.

And gentlemen, we will proceed in the order I presented you, and

if you can limit your oral presentations to roughly five minutes,

any additional remarks will be made a part of the permanent

record, and we will start with you, Mr. Worley.

STATEMENT OF STEVEN WORLEY, COLBERT, GEORGIA

Mr. WORLEY. Thank you, Mr. Chairman.

My name is Steven Worley. I am actually from Colbert, Georgia.

I am a horse breeder and I am also in the construction industry.

America’s first income tax began in 1861 to pay for the Civil

War. The Union imposed a three percent tax on incomes over $800

a year, which exempted most wage earners.

The tax rate was raised to five percent in 1862 on incomes over

$10,000. Shortly after the war, the tax was repealed but the Bureau of Internal Revenue remained in existence.

Budget balancing statesmen have turned to income tax even in

peace time to replace revenues lost from imports and export duties.

That was the purpose of the income tax passed by the Congress in

1893 and ruled unconstitutional by the Supreme Court in 1895.

192

President Taft pushed a constitutional amendment to revise that

decision and an income tax was passed as soon as the 16th Amendment was ratified by only 31 states.

The new income tax was a luxury tax. Top rates remained below

ten percent and most Americans did not pay at all, and then came

World War I, which raised the federal budget from $1 billion in

1916 to $19 billion in 1919.

Income tax rates rose three percent on $2,000 and 70 percent on

one million dollars.

After the War, Treasury Secretary Andrew Million reduced the

top rate to 25 percent and got most taxpayers off the rolls by raising the minimum income subject to tax. He also cooperated with

Congress to create preferences, exemptions, deductions, and other

tax breaks. The income tax had gotten the government deeper into

the business of allocating economic resources, mostly out of public

view.

During World War II, as federal spending rose from $9.6 billion in 1940 to $95 billion in 1945, income tax rates were raised 19 percent on $2,000 and 88 percent on $200,000. The numbers of taxpayers rose from 14 million to 50 million Americans.

The World War II tax is the recognizable ancestor of today’s federal income tax.

The Republicans of the 1950s feared voter resentment of the rich

and did not reduce top rates.

In the 1960s, John Fitzgerald Kennedy stimulated the economy

by reducing taxes significantly. The experiment in maintain the

War-time high tax rates during peace time in order to pay for the

Cold War and redistribute money to the middle class and the poor

worked both economically and politically for a generation, and then

it stopped working economically.

In the 1970s, runaway inflation, fueled in part by Lyndon Johnson’s refusal to raise the taxes to pay for the Vietnam War propelled ordinary families into tax brackets intended for the rich,

while the myriad tax breaks available to the wealthy made a mockery out of fairness.

As state, local, and other taxes rose, the middle class tax revolt

helped fuel the Reagan Republican victories of the 1980s and 1994.

Politicians have been struggling ever since to reduce the income

tax rates to peace time levels that the public and the economy will

tolerate.

Quoting the Federalist Papers Number 35, penned in 1788 by Alexander Hamilton, ‘‘there is no part of the administration of government that requires extensive information and a thorough

knowledge of the principles of the political economy so much as the

business of taxation. It might be demonstrated that the most productive system of finance will always be the least burdensome.’’

In just a few days, I have been able to gather signatures from

disgruntled Americans who support the Fair Tax plan. Be it known

that these signatures cross all lines of division in that they represent ditch diggers to lawyers, truck drivers to stockbrokers,

Black, White, Hispanic and Asians.

To further discern a more accurate consensus of the people, all

you need to do is refer to the petition filed by the people of Arizona

on Thursday, July 2, 1998. One hundred and seventy thousand

193

Americans required of this Congress to abolish income tax and establish a national sales tax.

The Fair Tax before you at this time is what the people want and

require of you now.

One thing that amazes me about the national news media has

all but ignored this legislation. The rhetoric we, as Americans,

have been subjected to implies that the wealthy in this country do

not pay taxes, and the tax burden has been shouldered by the

working poor and the middle class.

To this I quote the besieged Commandeer of Bastognne in his response to the Nazis to surrender in World War II ‘‘Nutz.’’ Figures

recently released by the National Revue project quiet a different

notion. The quintile of taxpayers from the lowest to highest is outlined as such:

The lowest wage earners pay—2 percent.

The low 1 percent.

The middle 7 percent.

The high 16 percent.

The highest wage earners 78 percent.

When confronted with the truth of these matters of income tax,

and this Administration’s quest for an America steeped in fairness,

it is apparent that we are trying to shoot a game of pool with a

nylon rope.

I would like to thank the members of this Committee for the opportunity to address you regarding the Fair Tax plan, and close

with another quote from Mr. Alexander Hamilton’s Federalist Papers Number 36. ‘‘It has been asserted that a power of internal taxation in the national legislature could never be exercised with advantage, as well

as from the want of a sufficient knowledge of local circumstances,

as from as interferences between the revenue laws of the union and

of the particular States. The supposition of a want of proper knowledge seems to be entirely destitute of foundation. If any question

is depending in a State legislature respecting one of the counties,

which demands a knowledge of local details, how is it acquired? No

doubt from the information of the members of the county. Cannot

the like knowledge be obtained in the national legislature from the

representatives of each state? And is it not to be presumed that the

men who will generally be sent there will be possessed of the necessary degree of intelligence to be able to communicate that information?’’

I certainly hope so.

If William Jefferson Clinton so feels the pain of the American

people, let him with unanimous consent of this Congress and Senate sign the Fair Tax Plan now. I implore you to preserve our freedom, our liberty, and save this Union by passing this legislation.

[The prepared statement follows:]

Statement of Steven Worley, Colbert, Georgia

America’s first income tax began 1861 to pay for the Civil War. The Union imposed a 3 percent tax on incomes over $800.00 a year, which exempted most wage

earners. The tax rate was raised to 5% in 1862 on incomes over $10,000.00. Shortly

after the Civil War the income tax was repealed, ominously, the Bureau of Internal

Revenue remained in existence. Budget-balancing statesmen have turned to income

tax even in peacetime to replace revenue lost by import and export duties. That was

the purpose of the income tax passed by congress in 1893 and ruled unconstitutional

194

by the Supreme Court in 1895. President Taft pushed a constitutional amendment

to revise that decision, and an income tax was passed as soon as the 16th Amendment was ratified in 1913 by only 31 states.

The new income tax was a luxury tax. Top rates remained below 10 percent and

most Americans didn’t pay at all. Then came World War I, which raised the federal budget from $1 billion in 1916 to $19 billion in 1919; income tax rates rose to 3

percent on $2,000 and 70 percent on $1 million. After the war, Treasury Secretary

Andrew Million reduced the top rate to 25 percent and got most taxpayers off the

rolls by raising the minimum income subject to tax. But he also cooperated with the

Congress to create preferences, exemptions, deductions and other tax breaks. The

income tax had gotten the federal government deeper into the business of allocating

economic resources, mostly out of public view. During World War II, as federal spending rose from $9.6 billion in 1940 to $95 billion in 1945, income tax rates were raised 19 percent on $2,000 and 88 percent

on $200,000, and the number of taxpayers arose from 14 million to 50 million.

The World War II tax is the recognizable ancestor of today’s federal income tax.

The $500 per dependent exemption of 1944, raised to $600 in 1947, was a generous

allowance to the parents of the baby boom generation. It meant the average family

paid almost no income tax. Over time, inflation eroded the value of the exemption.

The Republican leaders of the 1950’s feared voter’s resentment of the rich and did

not reduce top rates. In the 1960’s, JFK stimulated the economy by reducing taxes

significantly.

The experiment in maintaining the wartime’s high tax rates during peacetime in

order to pay for the cold war and redistribute money to the middle class and poor

worked-both economically and politically-for a generation and then stopped working

economically. In the 70’s, runaway inflation, fueled in part by Lyndon Johnson’s refusal to raise taxes to pay for the Vietnam War, propelled ordinary families into tax

brackets intended for the rich, while the myriad tax breaks available to the wealthy

made a mockery of fairness. As state, local and other tax rates also rose, a middleclass tax revolt helped fuel the Reagan Republican victories of the 1980’s and 1994.

Politicians have been struggling ever since to reduce income tax rates to peacetime

levels that the public and the economy will tolerate.

Quoting the Federalist Papers #35 penned in 1788 by Alexander Hamiliton,

‘‘There is no part of the administration of government that requires extensive information and a through knowledge of the principles of political economy, so much as

the business of taxation. It might be demonstrated that the most productive system

of finance will always be the lest burdensome.’’

In a few days, I have been able to gather signatures from disgruntled American’s

who support the Fair Tax plan. Be it known that these signatures cross all lines

of division in that they represent ditch diggers to lawyers, truck divers to stockbrokers, Black, White, Hispanic, and Asians. To further discern a more accurate

consensus of the people, all you need do is refer to the petition filed by the people

of Arizona. On Thursday, July 2, 1998, 170,000 Americans required of this congress

to abolish income tax and establish a National Sales Tax. The Fair Tax Plan before

you at this time is what the people want and require of you now.

One thing that amazes me is that the national news media has all but ignored

this legislation. The rhetoric we as Americans have been subjected to implies that

the wealthy in this country do not pay taxes, and that the tax burden has been

shouldered by the ‘‘working poor and middle class.’’ To this I quote the besieged

Commander of Bastognne in his response to the Nazis to surrender in World War

II ‘‘Nutz.’’Figures recently released by the National Revue project quiet a different

notion. The quintile of taxpayers from lowest to highest is outlined as such:

Lowest –2%

Low 1%

Middle 7%

High 16%

Highest 78%

When confronted with the truth in these matters of income tax and this Administrations quest for an America steeped in fairness, it is apparent that we are trying

to shoot a game of pool with a nylon rope.

I would like to thank the members of this committee for the opportunity to address you regarding the Fair Tax plan, and close with another quote from Alexander

Hamilton’s Federalist Papers #36:

‘‘It has been asserted that a power of internal taxation in the national legislature

could never be exercised with advantage, as well from the want of a sufficient

knowledge of local circumstances, as from as interference between the revenue laws

195

of the union and of the particular States. The supposition of a want of proper knowledge seems to be entirely destitute of foundation. If any question is depending in

a States legislature respecting one of the counties, which demands a knowledge of

local details, how is it acquired? No doubt from the information of the members of

the county. cannot the like knowledge be obtained in the national legislature from

the representatives of each state? And is it not to be presumed that the men who

will generally be sent there will be possessed of the necessary degree of intelligence

to be able to communicate the information?’’ I hope so!

If William Jefferson Clinton so feels the pain of the American people, let him with

unanimous consent to the U.S. Congress and Senate sign the Fair Tax Plan now.

I implore you to preserve our freedom, our liberty, and Save this Union by Passing

this legislation NOW!!

tory lesson, too.

[The attachment is being retain in Committee files.]

Mr. CRANE. Thank you, Mr. Worley. That was a very good hisf Mr. WORLEY. Thank you, sir.

Mr. CRANE. Mr. Moore.

[Pause.]

Mr. Moore?

STATEMENT OF JAMES O. MOORE, SMITHTOWN, NEW YORK

Mr. MOORE. Oh!

I am not here to castigate you guys for what you are doing in

Congress. I am here to offer some solutions for the problems of us

taxpayers which I am sure is within the realm of possibilities of

what you fellows do in writing the laws that govern how we operate in the United States of America.

Good morning, Mr. Chairman. I want to thank you and your

Committee for having this much-needed hearing and for the privilege of my having the opportunity to offer ways in which to possibly achieve its stated purpose ‘‘to make taxes fair and as easy as

possible,’’ which is an almost universal desire of every taxpayer in

our country.

People with whom some items have been discussed have called

them radical in their diversity, but since there is a connotation of

negativity in it ‘‘extensive changes’’ should be more appropriate.

Our Constitution is generally thought to be possibly the best document human beings have ever written. One reason had to do with

its intent. freedom for people’s self help with minimal government

interference. As President Eisenhower is credited with having said,

a government should do for its people only those things they cannot

do for themselves.

And was based on the fact that our Constitution does not require

government to feed, clothe, house, educate, nor provide health care

for its people. However, ours does so today in some ways with

funds collected from people equitably but too often unfairly distributed.

Particularly, if not living to receive the benefits paid for. Two examples: Social Security and Medicare, Monies are collected equitably in that the same appropriate percentage is applied to each

person up to the same earning limit but only on wages.

Unfairness is due to the fact that monies paid by a great many

people for promised benefits but who do not live to receive them

but is kept by the government.

196

In other cases, some of the monies goes to spouse and/or children

meeting some requirements but there is no provision for any other

beneficiary. That is taxation without recompense.

This is my second trip to Washington to testify to a government

entity. The first was an IRS hearing on December the 4th, 1987,

at which I proposed changes in IRA withdrawals which correctly

requires withdrawals to commence at age 70-and-a-half.

As explained in my written statement which has been sent to

you, it enable selective withdrawals if owning two or more IRAs

and eliminate the requirement that custodians make sure withdrawals were made from each one.

Provisions of Notice 88–38 effected this change and was signed

12 years ago today, and thus coincidentally I am celebrating it in

the City where it was signed.

Although that trip benefitted a great many people and

custodians, what this Committee intends to do is very much more

important; that it would benefit every citizen in this country and

possibly even non-citizens who pay income tax.

It would change April 15th from a dreaded day to just one that

happens to be the day the easily-done-tax-return is due in the

amount fair assessment has required to be paid.

What a relief. I am absolutely sure it is a doable government operation provided fair is a must.

Again, thanks for this opportunity to testify and I feel sure others who testify will have proven same thing I feel is certain. Fair

and easy taxes will come sooner than later. Income tax is the only

way to correctly collect from people fairly because it is based on one

basic fact. ability to pay. No other tax reaches that commitment.

I have asked two gentlemen to come to see me in a telephone call

to Al Crenshaw yesterday afternoon, and to Howard Gleckman this

morning, because I know them both from my twelve-years-ago visit

to Washington, and they both promised to be here but they had

commitments elsewhere that’s made them uncertain as to whether

or not they could.

But anyway, the complete story is told in the statement that I

sent you previously, and originally I was going to bring with me

two other supporting documents. The statement says there are no

enclosures, which was true. However, the staff told me the two

things that I wanted to bring with me to give to you today they

felt it better that I send them to you. So therefore, those two

addendums are also in the package that was received by you folks

from me recently.

Gentlemen, it’s up to you. We want fair taxes, properly assessed,

and so simple that the one that I proposed I believe could be prepared on two 81⁄2 × 11 sheets of paper with all the instructions necessary and the forms required to be incorporated in that. And a kid

who is in the 4th grade and knows how to add, multiply, subtract,

and divide can do it without a calculator.

Thank you, very much.

[The prepared statement follows:]

Statement of James O. Moore, Smithtown, New York

Mr. Chairman and the committee members, I am Jim Moore from Smithtown,

New York but born in Birmingham, Alabama 84 years ago last Wednesday. And as

a Financial Planner, the difficulties of my clients regarding tax returns have served

197

to make me aware of the need for reforms intended to be achieved by this committee

resulting in both simplification and fairness in income tax laws. Therefore I am

grateful for this opportunity to offer some suggestions for your consideration and action which might be analogous to the statement credited to Mark Twain, ‘‘Everybody

talks about the weather but nobody does anything about it.’’ The analogy to you

would be almost everyone COMPLAINS about income taxes but this committee is

proposing to ‘DO’ something about it.’’ As a patriotic citizen concerned about my fellow taxpayers, I want to congratulate Congressman Archer and this committee for

that ‘‘DO SOMETHING’’ attitude and attempt!

Although not considering myself to be a tax expert, the following brief biographical sketch may serve to explain how this patriotic citizen has developed some suggestions for tax revision to do what Congressman Archer stated as basis for this

hearings to ‘‘make taxes fair and easy as possible’’ and also to have said ‘‘to examine

proposals to replace the current tax code.’’ As I will explain in my summary, I am

against replacement.

My high school diploma was received in 1932 at age 16 from Lyman Ward Military Academy in Camp Hill, Alabama. My graduation at age 34 in 1950 from NYU

as a night school student after returning in 1945 from overseas service during WWII

and also have a continuing 60 year connection with the 7th regiment in New York

as first an active member and then in its Veterans Association including seven

years on its Governing Board and a 44 year working career, the last 37 with a large

international oil company before retirement in preparation for an active retirement

in that field of endeavor.

Activity as a Financial Planner made me greatly aware of the need for revisions

to provide the ‘‘fair and easy’’ income tax laws called for by the Congressman Archer. One such needed change had to do with IRS regulations for the requirement

that persons who are owners of IRA’s must commence withdrawals upon reaching

age 70 1⁄2 in which I concur but did NOT agree that those with multiple IRA’s had

to withdraw from each of them. Therefore, at an IRS hearing on December 4, 1987,

with support from ICI, AARP, ACLI, Senator D’Amato, Congressman Carney and

mutual fund companies, etc. I proposed that investors could aggregate their value

and based on age, determine total required to be withdrawn and then make withdrawal from one or more to maintain the best investment resulting balance. The

IRS Notice 88–38 issued on April 12, 1988 effected that procedure. And, the 100%

vote of congress eliminating the $1 penalty reduction of Social Security for wage

earners would have been a non-starter if my suggested tax revisions had been in

effect as set forth in the following summary:

SUMMARY:

The varied tax problems of my Financial Planning clients gave me a much broader knowledge of intricacies of the tax laws than I would have gotten in just preparing my own tax returns. That resulted in proposed revisions set forth in the

below verbatim copy of the statement I made at the tax hearing of Congressman

Carney and Senator D’Amato on September 5, 1985. The notes thereon show the

continuing effort to get public and then hoped for Congressional interest in effecting

the much needed revisions of personal tax laws. Although affecting businesses, problems of its taxation are not addressed. Its monetary items must be increased to reflect inflation over the last 15 years to get to their equivalents of 1985 amounts.

Statement for tax hearing of Congressman Carney and Senator D’Amato at

Ward Melville High School, Setauket, NY on thursday, September 5,

1985—by James O. Moore, Smithtown, NY

My name is Jim Moore from Smithtown and I am on Social Security. (Will be 70

on April 5 next year).

Almost everyone agrees (1) the current Tax System is ridled with inequities that

favor special interests (2) is so voluminous and confusing that experts in the IRS

sometimes give different rulings on he same question and (3) now feel tax simplification is essential.

Many tax simplification proposals are being considered. Some include proposals

that are anathema to Elected Officials and Legislators of this State. Understably,

they want to comply with the wishes of their Constituents BUT, when Legislators

are Congressmen and Senators, they have a HIGHER duty to Legislate for the

whole country even to the extent of voting for programs that are good for the country but not liked by local Constituents!!

With this as basis for your decisions in House and Senate on Tax simplification,

herewith is a program for personal tax returns on a basis that treats EVERYONE

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equally and fairly. The proposed exemptions and tax rates may require adjustments

to assure they are revenue neutral and do not RAISE taxes in totality.

First: all income received would be repotable including social security, SSI, Welfare (including value of housing allowance and clothing) but payments from social

security would not be reportable until all contributions by individual and spouse

have been recovered. Cola’s would be included at full rate and the special social security calculations would be eliminated. Municipal bond interest, capital gains, tax

shelters, etc. would be reportable fully as income. however, income credited but not

withdrawn would not be reported until withdrawn as is now done with IRA accounts return of principal, of course, would not be reportable. This would apply to

savings accounts, mutual funds, cash and stock dividends held in brokerage accounts etc etc.

Second: no deductions for anything!!!! including contributions to religious & charitable groups, interest, taxes, etc etc. Third: states should eliminate sales tax on any item costing less than $25, and

neither they nor the Federal government should consider value added tax as it is

the most harmful to the poor.

Fourth: eliminate all tax shelters, (not just those the administration deem bad)

so that economic viability rather than tax advantages would be basis for investments.

Fifth: family income should be basis for personal exemptions and currently sug- gest $5,000 for first. $4,000. Second, $3,000. Third and $2,000. All others. A family

of four would pay no tax until income exceeded $14,000. approximating current poverty income level. A suggested flat 20% rate or better still, graduated scale of 10

to 40% might be used or whatever is needed to give a revenue neutral income. Social security taxes may also require adjustment. But, in order to have everyone con- tribute to this great country for the privelege of living here, assess 1⁄2 of 1% on gross income so that the family of four would pay $70, on its $14,000. Exemption. This

would be returned to the states from which taxpayer files his return to offset no

sales tax on $25.00.

This is an eminently fair and even handed program which should eliminate the

feeling that ‘‘That guy makes X number of dollars and pays no taxes. Why should

I pay so much?’’ Also, it would end confusion on tax laws, reduce the volume upon

volume of tax laws; Myriads of pamphlets, files and paperwork, cut irs staff considerably and save money for government, business and individuals in the multi-millions of dollars. I believe such a program would be welcomed by all taxpayers and

businesses except those whose livelihood depends on the present unfair system!!!!

Note: Subsequent to this statement, a 6–5–86 letter to 8 people (Congressmen, Senators & Pres. Reagan) added provision for a $5,000 allowance for fringe benefits.

Thus any amount paid by employers for pensions, INS, etc. would be reported on

W–2’s BUT only any amount in excess of $5,000 allowance would be taxable income.

However, if amount paid by employer is less than $5,000 or none at all, the taxpayer could purchase protection desired or invest in IRA’s etc. and deduct up to

$5,000 on tax return. Senator Bradley’s 10–9–86 reply called this an ‘‘intriguing

idea!!!’’ Seniors could apply this against medical expense as well as insurance premiums.

Added in 1994: If health care revisions provide for deductibility of health care

costs, they would be eliminated from fringe benefits allowances for everyone not just

seniors.

The first note refers to a 6–5–86 letter to 8 addresses on adding fringe benefits

deduction and the ‘‘added in 1994’’ item on Health care relates to my 8–25–94 article on ‘‘Declaration of Independence from Socialized Medicine’’ printed in local

Smithtown Messenger. It proposed 100% deductibility of medical expenses, including health insurance premium less reimbursement by the insurance company for

claims. Then in 1999, I offered some ideas to economic Security 2000 to be discussed

at its January Forum in D.C. but suggested tax revisions would solve some of the

problems of Social Security for which forum was being held.

Referring only to items in the 9–5–85 statement, everyone with whom I have discussed items therein have agreed they WOULD provide the fairness intended but

said IMPOSSIBLE!! Why? Because they felt politicians would not agree to them and

said the effort was as useless as Don Quixote jousting at windmills. I have never

felt that way. Instead, I believe such revisions ARE possible, and like the Lone

Ranger, want to help people in distress. Taxpayers?

My optimism is based on the fact that the IRS amended its regulations on IRA

withdrawals as covered above while I was continuing this now 15 year effort at tax

revision.

In connection with the vexing tax problem, I have recently initiated an effort towards formalization of an organization to be called COFEHATT, which is the acroVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00204 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
199

nym for ‘‘Citizens Organization For Equitable Health and Tax Treatment.’’ However,

we intend to go one step further than ‘‘equitable’’ which can apply by treating everyone the same at inception but be UNFAIR in distribution. Thus, our additional requirement is ‘‘FAIR.’’ Implementing the suggested revisions, while keeping the laws

FAIR, the biggest benefit is the simplification which enables everyone to prepare tax

returns perhaps by IRS using the equivalent of two 11 by 8 1⁄2 sheets of paper to

explain and provide form on which to prepare the return.

It is our view that the ability to pay is the only criterion on which to base taxes

and that ability is predicated on income which should be generic and include in it

every source which would be wages, commissions, profit from self-employment, profit from sale of material assets or securities, dividends on investments and interest

on savings and finally ALL bonds whether commercial or municipal.

We feel absolutely sure that neither a FLAT nor National Sales Tax is fair. If we

are wrong, please let us know since we do NOT want COFEHATT to provide erroneous information and lose our credibility. The flat and sales tax could be instantaneous but our proposal cannot be done in one ‘‘fell swoop’’ prohibited by contractual

termination dates and some must be put into effect incrementally or they would be

calamitous disaster to our economy.

If the committees’s review of proposals received from all participants in this hearing finds ours to be FAIR, we hope some of our suggestions will be incorporated in

laws that will provide the intended benefits to ALL OF US.

However, should any proposal be either NOT ‘‘doable’’ for reasons other than fairness or NOT considered fair we would also appreciate being advised accordingly just

as we hope for your opinion regarding our position on FLAT and NATIONAL

SALES TAX.

It has been gratifying to make a second trip to Washington on thus two matters

so important to every citizen and also even to every non-citizen taxpayer and much

appreciated.

My thanks to your staff as well for ‘‘squeezing me in’’ after initially being told

there was no vacancy.

Our is a wonderful country and I am proud to have served it militarily and as

a contributor to some degree in other ways.

assured that your full statement and any other accompanying docu-

[The attachments are being retained in the committee files.]

Mr. COLLINS: [presiding] And thank you, Mr. Moore. You can be

f ments that you have presented will be entered into the record.

Mr. Hulshof, do you have any questions, please?

Mr. HULSHOF. Thank you, Mr. Chairman.

Let me first extend my appreciation, Mr. Worley and Mr. Moore,

for your efforts in being here today.

Mr. Worley I think you, if I am not mistaken, were here through

the entirety of yesterday’s hearing as well.

Mr. WORLEY. Yes, sir.

Mr. HULSHOF. I noticed you probably had better attendance than

many of us did, but I appreciate the fact. Just as a general point,

let me say that even as we are here discussing fundamental tax reform, that elsewhere on the Capitol grounds about 10,000 American citizens are gathered to express their viewpoints about certain

matters that Congress will be taking up.

It just reminds me again of what an awesome thing that we

have, a representative form of government, that citizens are allowed to come before a Committee such as this, or to stand on the

steps of the United States Capitol and to express their opinion freely.

Whether it means petitions, Mr. Worley, as you have submitted

for us and gathered here, I think again it is just an extraordinary

testament to the type of government that we have.

200

Let me say—and, Mr. Worley, I am going to ask you a couple of

questions because there was something in your written testimony,

and as you mentioned it today, that really struck me.

You pointed out that one thing that amazes you, as it does me,

is that some that report the news nationally have not really given

a full focus of attention as we are of these series of hearings.

In fact, let me just quote you again because I think it bears repeating.

‘‘The rhetoric’’—and this is you writing, I assume?

Mr. WORLEY. ‘‘The rhetoric we as Americans have been subjected

to implies that the wealthy in this country do not pay taxes and

the tax burden has been shouldered by the working poor and middle class’’ to which you paraphrased the word ‘‘nutz.’’

Let me ask you about that. Because we have had a variety of different opinions already over this day-and-a-half talking about, for

instance, whether we should have the fair tax as you support, Mr.

Worley.

We have had flat tax proponents. I suspect Congressman Armey

will be here to talk about that.

Mr. Moore, as I understand it from your testimony you do not

support a national sales tax or a flat tax, but a different type of

tax. I know my colleague, Mr. English, has got his idea.

Again I think it is useful that we debate and discuss these

things. One thing that is frustrating for me especially, Mr. Worley,

being on this Committee, having the honor of serving on this Committee, is the rhetoric that seems to percolate among other Members, that if we try to provide tax relief, for instance, we are ‘‘giving

tax breaks to the wealthy,’’ when in fact we may be trying to simplify the tax code.

Can you give us any guidance as a—and I do not mean this in

a derogatory term—but as a common, ordinary citizen who watches

what we do, how do we pierce that rhetoric so that we can have

an honest discussion about the best policy?

Mr. WORLEY. If I knew that, I would probably be the President

of this Nation.

I do not see, without a grassroots organization, or just by citizens

like myself stepping forward and talking to other citizens, and saying this is what is going on and this is what we can do if we will

take it upon ourselves to do that. I do not know that the national

news media is going to give us any kind of regard in this.

I do not know what we could do to cause them to do this other

than a revolt. Now that certainly, if a million Americans came to

the Halls of this Congress and said we demand tax reform, it would

certainly gather some sort of attention from the national news

media.

Mr. HULSHOF. Let me ask you, how did you first get involved, or

have your interest peaked by this piqued by this and the fact that

you would try to collect signatures on a petition, and then come

from Georgia, or your home to come to the Halls of Congress?

I mean what has motivated you to become an activist in this

area?

Mr. WORLEY. As an American Citizen, I have been abused by the

Internal Revenue Service. I purposely left out my personal probVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00206 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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lems with them from this because I did not want to make it just

a personal matter.

My personal problems with the Internal Revenue Service are neither here nor there. This is a total problem throughout the country

and it affects every American. And we have got to do something.

If you have a car and it breaks down, you fix it. Well we have

been fixing our problem with the Internal Revenue Service and our

taxation of income for years now, and we are still broken.

So maybe it is time that we junk the old car and go buy a new

one.

Mr. HULSHOF. Well again I see my time is up. The red light is

on. Let me just again—and I see Mr. Davis has also joined us here

with the panel. But let me just again express my appreciation that

each of you would take the time, and probably at your own expense, too, to come here to help enlist our support on these various

different ideas of the way we collect revenue in this country.

Again, I think it is just testament to the type of Nation that we

have that you would have the opportunity to come here and have

your voices heard.

So thank you for that.

Mr. WORLEY. Thank you.

Mr. MOORE. Thank you.

Mr. COLLINS. Thank you, Mr. Hulshof.

I know Chairman Archer will be back in just a few moments, but

I wanted to take the time and the opportunity to extend my appreciation to Mr. Worley, being a fellow Georgian, for coming and

bringing a lot of common sense with him to address this Committee, and also the list of names who signed your petitions.

And I am sure if you had more time and had travelled a lot more

throughout Georgia you would have had a stack that would have

been much, much taller because I hear about this quite often as I

am travelling throughout the Third District of Georgia, which goes

from Clayton County down to Muskogee County, which you are

very familiar with.

I also understand from your opening that you are in the concrete

business?

Mr. WORLEY. Yes, sir.

Mr. COLLINS. And you have had 18 years of experience in the

ready-mix concrete business. And having pushed many a wheelbarrow of concrete and finished some myself, too, I appreciate the

work and the hard work that you have endured.

We will take Mr. Davis’ testimony at this time, and Mr. Chairman will be back very shortly.

Mr. Davis?

STATEMENT OF FRANK L. DAVIS, JR., ALEXANDRIA, VIRGINIA

Mr. DAVIS. Thank you, Mr. Chairman.

Mr. Chairman, Members of the Committee, my fellow Americans:

It is a privilege to be asked to testify this morning. My name is

Frank Davis. I am a retired Naval Reserve Aviator, having spent

28-and-a-half years in Active and Reserve Service to my country.

I consider myself still serving, albeit in a somewhat different capacity, but with the same goal in mind. Protect my country from

all enemies foreign and domestic.

202

As you might expect, I consider that the duty of every citizen.

I am co-founder and Executive Vice President and National Director of Legislative Affairs for the National Retail Sales Tax Alliance.

The National Retail Sales Tax Alliance is a nonpartisan, nonprofit, grassroots organization working to replace the federal tax

system with a National Retail Sales Tax and abolish the Internal

Revenue Service.

I cannot think of a more fitting goal in life than to bequeath my

country, my children, and my grandchildren a free society without

an income tax and without an IRS.

I am a citizen activist. I speak as a very concerned private citizen. My remarks reflect both my own thinking in this matter and

the advice and counsel of countless thousands of American citizens

who are likewise concerned about the ship of state.

For example, the Internet has proven very helpful to the National Retail Sales Tax Movement and tax reform in general.

FReeRepublic.com is an especially helpful site for keeping a

pulse on the American public with respect to fundamental tax reform.

A number of prominent public servants have provided outspoken

leadership for the National Retail Sales Tax tax reform movement

and are noted in my extended remarks.

I want to personally thank you, Chairman Archer, for your foresight and leadership these past five years. Notice, if you will, ladies

and gentlemen, that this is a bipartisan movement. It is not about

partisanship. It is about doing what is right for America.

In addition, articles published in influential opinion journals

have contributed to the dialogue. I highly recommend Dr. Allen

Keyes’ article ‘‘The Case For Repealing The 16th Amendment To

The United States Constitution. Abolish The Income Tax!’’ published in Human Events Magazine on April the 17th, 1998.

I also commend to the Committee the testimony for the record

of Mr. Charles Adams, Historian.

A number of well-known organizations are invaluable in our

work and are noted in my extended remarks.

The National Retail Sales Tax Alliance supports both H.R. 2001

and H.R. 2525. We know that neither bill will pass in its present

form. We also know that there may well be additional NRST bills

added to the mix and that there will be provisions added and subtracted until such time as the Committee has reached consensus

and a measure goes to the Floor of the House.

My promise to all Americans, to you Mr. Chairman, to the Committee and the Congress and to all interested parties is this:

The National Retail Sales Tax Alliance will work to ensure that

America gets a modern, national retail sales tax system which will

meet America’s needs for the 21st Century and beyond.

Mr. Chairman, there are at least three fundamental reasons why

the Income Tax System must be replaced with a national retail

sales tax:

Freedom.

Economic Growth.

And a quality of treatment under the law.

203

America is the only nation in world history whose founding was

based on the notion that certain unalienable rights are handed

down from God to the People and then are loaned to government.

Since the dawn of man, governments have claimed that rights

are handed down from God to government, the Divine Rights of

Kings, and then loaned to the people. And this is a very important

distinction.

To the degree that America has become the great Nation is it

today and has the capacity to even become greater, the concept of

a citizen’s unalienable rights is very important. This concept differentiates the United States from every other country in the

world. Every U.S. Citizen’s unalienable rights are guaranteed by

our Founding Fathers in the Declaration of Independence and the

Constitution.

Why then does the United States have a tax system which severely restricts its citizens’ Constitutional rights, artificially limits

their ability to work, save, and invest and exacerbates class warfare by dividing them one from the other on the basis of types and

amounts of income?

These perverse disincentives to succeed and resultant lowerthan-it-should-be U.S. economic growth in recent years are fueled

by our oppressive Income Tax Code.

It defies comprehension.

The United States of America has a Tax Code based on the 19th

Century Marxist class warfare notion of ‘‘from each according to

their ability, to each according to their need.’’

Do we really want to begin the 21st Century with a tax system

based on class envy and warfare? Which punishes those who work,

save, and invest and rewards those who do not?

Do we want to retain a tax system that annually invades our privacy and usurps our Constitutional rights?

Or do we truly want to be free people?

Mr. Chairman, I would submit that we can never be a truly free

society so long as we allow the income tax and the Internal Revenue Service to exist.

If we are to restore to American Citizens those freedoms guaranteed by the Constitution, we must replace the federal tax system

with a national retail sales tax and, in the process, abolish the Internal Revenue Service.

And while we are at it, we must also repeal the 16th Amendment

to the Constitution to complete the tax reform process and to ensure that America will never have to suffer another tax.

Dr. Keyes refers to the income tax as a slave tax inherently incompatible with freedom. Abolishing it is therefore not just economically feasible; it is a moral imperative if we are to meet our

obligations to bequeath liberty to future generations.

Mr. COLLINS. Mr. Davis?

Mr. DAVIS. Yes.

Mr. COLLINS. I hate to interrupt you, but your entire statement

will be entered into the record. You have kind of exceeded your

time already, but we will give you about another minute to wrap

it up if you could, please.

204

Mr. DAVIS. Well let me go straight to a letter that I have, an

anonymous letter, which will take about a minute to read that was

sent to me:

Dear Friends and Buddies,

Most of you know that one of my most treasured beliefs is that

we are a free people. I am deeply saddened that every day we lose

more of those freedoms as the government usurps them in the

name of protecting us from ourselves.

Our current tax code is extremely damaging in that it punishes

success—the very thing this country was founded on and so many

lives were lost over—and it requires disclosure of every aspect of

our lives for public consumption.

My spirit is personally so broken by this that, after doing our

taxes, I realize I am chipping my—and she said it in French—joy

of life; I can’t pronounce it—and very life away and have become

enslaved by the government.

I have decided to end it.

I am selling our business and will not continue to contribute to

this folly. It was a grim realization. Although we have a lot to contribute to this country and its future with our technology information and teaching, it is not worth the payback anymore.

I give up.

The American dream has vanished. I am joining the ranks of the

crushed in spirit, the squashed, the oppressed. And yes, if you are

wondering, I am depressed about the whole thing. A good cry sometimes helps, but that has been way too common of late.

And in a short note to Mr. Archer:

‘‘Please record my support FOR the National Retail Sales Tax to

replace the tax code in this country. We must abolish the oppressive tax code and REPLACE it. The FLAT TAX does not accomplish replacement of the complexities of the code; it merely masks

them and simplifies computations. Therefore I urge you to please

support the FAIR TAX/National Retail Sales Tax.

‘‘I also urge you to abolish the illegal agency known as the IRS.’’

I will close with that.

Thank you, Mr. Chairman. Thank you, Members of Congress, for

your time.

[The prepared statement follows:]

Statement of Frank L. Davis, Jr., Alexandria, Virginia

Mr. Chairman, Mr. Rangel and Members of the Committee; my fellow Americans.

It is a privilege to be asked to testify this afternoon. My name is Frank Davis. I

am a retired Naval Reserve Aviator, having spent 28 ‡ years in active and reserve

service to my country. I consider myself still serving, albeit in a somewhat different

capacity, but with the same goal in mind: protect my country from all enemies, foreign and domestic. As you might expect, I consider that the duty of every citizen.

I am a co-founder and the Executive Vice President and National Director of Legislative Affairs for the National Retail Sales Tax Alliance. The National Retail Sales

Tax Alliance is a nonpartisan, non-profit grass roots organization working with likeminded individuals, think tanks, other public interest advocacy groups and businesses to replace the federal tax system with a National Retail Sales Tax (NRSTA)

and abolish the Internal Revenue Service.

I cannot think of a more fitting goal in life than to bequeath my country, my children and my grandchildren a free society without an income tax and without an

IRS.

I am a citizen activist. In my testimony today, I will relate to the committee the

viewpoint of a very concerned private citizen. My testimony reflects both my own

205

1Dr. Alan Keyes. The Case for Repealing the 16th Amendment. Abolish the Income Tax!

Human Events, April 17, 1998. 2Patrick Buchanan, ‘‘A tax whose time has gone?,’’ Tribune Media Services, April 17, 1991. 3Patrick Buchanan, ‘‘Brave new world: no tax forms, no IRS,’’ Tribune Media Services, April

15, 1994; Patrick Buchanan, ‘‘Sales tax alternative,’’ The Washington Times, July 14, 1997, p.

A12.

thinking in this matter, and the advice and counsel of countless thousands of American citizens, who are likewise concerned about the ship of state.

For example, the Internet has proven very helpful to the NRST movement; we are

able to mine a rich field of pertinent research, communicate with and share opinions

with expert economists and political scientists and more important, find each other.

In this regard, FReeRepublic.com is an especially helpful site for keeping a pulse

on the American public with respect to fundamental tax reform.

A number of prominent public servants have provided outspoken leadership for

the NRST tax reform movement. I want to personally thank you, Chairman Archer,

for your foresight and leadership these past five years. Also, now retired Congressman Dan Schaefer, who was the primary sponsor of the first NRST legislation introduced on March 7, 1996. Senator Richard Lugar has long been an advocate of the

NRST. In the present Congress, leaders such as Congressmen. W.J. ‘‘Billy’’ Tauzin,

Jim Traficant, John Linder and Colin Peterson, along with the cosponsors of their

respective Bills, are to be congratulated. Congressmen Largent and Cox also deserve

recognition for their efforts in tax reform.

Notice, if you will, that this is a bipartisan movement. It is not about partisanship, it is about doing what is right for America.

In addition, articles published in influential opinion journals have contributed to

the dialogue. I highly recommend Dr. Alan Keyes’ article, The Case for Repealing

the 16th Amendment Abolish the Income Tax! published in Human Events magazine on April 17, 1998.1

Well known organizations such as The Americans For Fair Taxation, the Tax

Foundation, the Tax Education Association, Heritage, the CATO Institute, The

Argus Group, Citizens for an Alternative Tax System, Citizens for a Sound Economy, and the National Taxpayers Union have proven to be invaluable in our work.

And there are others.

Curiously enough, the article that constitutes my ‘‘defining moment’’ in respect of

fundamental tax reform was also published on April 17th—in 1991. Pat Buchanan’s

nationally syndicated column that day was entitled ‘‘A tax whose time has gone?’’ 2

That is the day I became a tax reform citizen activist. Mr. Buchanan has since published two more articles favorable to the National Retail Sales Tax.3

A quick word about the National Retail Sales Tax Alliance. NRSTA does not support either H.R. 2001 or H.R. 2525; we support both bills. We know that neither

bill will pass in its present form. We also know that there may well be additional

NRST bills added to the mix, and that there will be provisions added and subtracted

until such time as the Committee has reached consensus and the measure goes to

the floor of the House.

Our promise to all Americans, to you, Mr. Chairman, to the Committee and to

all interested parties is this: The National Retail Sales Tax Alliance will work to

ensure that America gets a modern National Retail Sales Tax system which will

meet America’s needs for the 21st Century and beyond.

Mr. Chairman, there are at least three fundamental reasons why the income tax

system must be replaced with a National Retail Sales Tax: freedom, economic

growth and equality of treatment under the law.

America is the most envied nation in the world. Not only are we envied by the

world’s governments, we are envied by the world’s people. America is the only nation in the history of the world whose founding was based on the notion that certain

unalienable rights are handed down from God to the people, and then are loaned

to government. Since the dawn of man, governments have claimed that rights are

handed down from God to government [Divine Right of Kings] and then loaned to

the people, a very important distinction.

How important? To the degree that America has become the great nation it is

today, and has the capacity to become an even greater nation, the concept of a citizen’s unalienable rights is very important to keep in mind as we consider fundamental tax reform. This concept differentiates the United States from every other

country in the world. Every U.S. citizen’s unalienable rights are guaranteed by our

founding fathers in the Declaration of Independence and the Constitution.

Why, then, does the United States have a tax system which severely restricts its

citizen’s Constitutional rights, artificially limits their ability to work, save and inVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00211 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
206

4Keyes, op. cit.

5Laurence J. Kotlikoff, ‘‘The Economic Impact of Replacing Federal Income Taxes with a Sales

Tax,’’ CATO Policy Analysis No. 193, April 15, 1993. 6 Americans for Fair Taxation Policy Paper, ‘‘The Impact of a National Retail Sales Tax on

Interest Rates,’’ April 21, 1997. 7Tax Foundation Special Brief, ‘‘Compliance Costs of Alternative Tax Systems II, House Ways

and Means Committee Testimony,’’ March, 1997, pp 8, 9.

vest and exacerbates class warfare by dividing them one from the other on the basis

of types and amounts of income?

These perverse disincentives to succeed, and the resultant lower (than it should

be) U.S. economic growth in recent years, are fueled by our oppressive income tax

code. It defies comprehension—the United States of America has a tax code based

on the Nineteenth Century Marxist class warfare notion of ‘‘from each according to

their ability, to each according to their need.’’ Do we really want to begin the 21st

Century with a tax system based on class envy and warfare, which punishes those

who work, save and invest and rewards those who don’t? Do we want a tax system

that annually invades our privacy and usurps our Constitutional Rights? Or do we

truly want to be a free people?

We can never be a truly free society so long as we allow the income tax and the

IRS to exist.

If we are to restore to American citizens those freedoms guaranteed by the Constitution, we must replace the federal tax system with a National Retail Sales Tax

(NRST), and in the process abolish the Internal Revenue Service. While we are at

it, we must also repeal the 16th Amendment to the Constitution to ensure complete

tax reform and to ensure that America will never have to suffer another income tax.

Dr. Keyes refers to the income tax as a. . . ‘‘slave tax—inherently incompatible

with freedom. Abolishing it is therefore not just economically feasible, it is a moral

imperative if we are to meet our obligation to bequeath liberty to future generations.’’ 4

Under the NRST, Americans would no longer have to annually divulge to a faceless bureaucrat their most private and personal financial information. How much

money an American earns becomes his or her own private business. Taxes will be

paid on the basis of how much a person ‘‘takes out’’ of the economy rather than how

much a person earns. Under the NRST, those who consume the most, will pay the

most in taxes. All Americans will be encouraged to work, save and invest, and government interference in their personal economic activities will cease. That, my fellow Americans, is Freedom.

The next question before us is: Why does the United States have a tax system

that discourages and penalizes those activities which grow the economy?

The progressive income tax system punishes those personal and business activities that encourage economic growth. The more a person works, saves and invests,

the higher his or her taxes become. Likewise, the more successful his or her business, the higher his or her tax bill (which is passed along to the consumer in the

form of higher retail prices).

And there is the matter of hidden taxes and compliance costs in the business income tax. The current tax system holds both people and business back, rather than

encouraging them to move forward and become even more successful.

The change to a National Retail Sales Tax will cause (and these are very conservative estimates) the Gross Domestic Product rate of growth to double and the national personal savings rate will triple.5 America will become the investment

‘‘sponge’’ of the world—attracting billions of dollars invested elsewhere, further expanding the investment pool of capital available for business expansion and job

growth. Interest rates will decline by 2 basis points, making it easier and less expensive for business to borrow money for growth and expansion and for individuals

to qualify for home loans and other big ticket items.6 The NRST will eliminate compliance costs for individuals and reduce business compliance costs by a factor of

90%. 7 And, those who chose to participate in the underground economy will pay

taxes at the check out counter, just like everyone else.

And the economic benefits of a switch to the National Retail Sales Tax do not stop

with these gains. Picture even lower unemployment, more and better jobs for people

willing to work, higher wages, and more robust export markets.

In respect of exports, let me say that the recent WTO ruling declaring the Foreign

Sales Credit provision of the current tax code illegal presents a challenge to America

that the National Retail Sales Tax handles very well. The National Retail Sales Tax

is a territorial border adjustable tax; meaning it is not applied to exported goods

and is applied to goods imported for sale in America. The NRST is legal under the

207

8 Rep. Bill Archer (R–TX), Chairman, House Ways and Means Committee, ‘‘Opening Statement of Chairman Archer Fundamental Tax Reform Hearing,’’ June 6, 1995. 9 Ibid.

terms of the WTO. The NRST levels the playing field between domestic and foreign

companies in respect of tax policy—it treats them exactly the same.

The NRST, when implemented, will cause America, in your own words, Mr. Chairman, to become ‘‘the economic juggernaut of the world.’’ 8 Foreign capital will flow

into America and expatriated capital will return to America. As you know, with a

NRST, jobs and companies that have ‘‘gone offshore’’ will relocate to America. Foreign businesses will locate new facilities here. In your words, Mr. Chairman, the

NRST will ‘‘allow our nation and its people to soar to unparalleled prosperity in the

next century.’’ 9

The final point I’d like to make is that America’s founding fathers guaranteed

that the Rule of Law (as opposed to the Rule of Man—the ‘‘Divine Right of Kings’’—

prevalent throughout the world prior to America’s founding) would apply in America. The phrase ‘‘Equal Justice Under the Law.’’ is chiseled in granite over the entrance to the Supreme Court Building, reminding us of the absolute importance of

this founding principle.

The progressive income tax makes a mockery of the Rule of Law. The Rule of Law

provides for equality of treatment before the bar of justice. We are violating one of

America’s basic founding principles by continuing to keep a progressive income tax

system in place.

The progressive income tax system, which divides us into economic classes for the

purpose of levying taxes, is conceptually wrong and at its core, un-American. You

will recall that the founders were opposed to income taxes, and insisted that the

country finance itself through excise taxes and tariffs.

In 1913 the 16th Amendment to the U.S. Constitution, the single worst piece of

legislation ever passed by any Congress, was adopted. It fundamentally altered the

relationship of the American people and their government, as the founders in their

infinite wisdom knew would happen. The government became the master, and the

people became the slave. Dr. Keyes addresses his remarks about the morality of the

slave tax to this very point.

But it got worse. The instigators of the first legal U.S. income tax could have

adopted a flat rate income tax, but they chose a different course and thereby

changed the American political landscape. They accepted the second plank of the

Communist Manifesto as the core principle of the U.S. tax system in 1913, and

adopted a progressive rate income tax system. Thus, the progressive income tax system, with its built in appeal to those who practice the art of divide and conquer

by encouraging class warfare became institutionalized in America. The progressive

income tax intentionally pits Americans of different economic classes one against

the another, and is used by demagogues for their own political gain.

How can America enter the 21st Century with a 19th Century Marxist tax system

in place? And why would we want to?

Eighty seven years of tinkering has produced an unknowable tax code full of social engineering experiments. This social engineering has served only to make the

code more complex and further disunite the American citizens. Tax policy should be

focused on raising the funds necessary to operate government, not as a laboratory

to ‘‘fix’’ this or that perceived social problem.

Americans are the most generous people on the face of the earth; social programs

that we agree upon (within Constitutional bounds, of course) should be funded from

the spending side of the federal ledger, not the taxing side.

As we are guaranteed equality of treatment before the bar of justice, all Americans must be guaranteed equality of treatment before the bar of economic justice.

The best way to do that and to put an end to class warfare is to tax consumption,

not earnings. With, and only with a consumption tax such as a single rate National

Retail Sales tax, can we Americans be guaranteed equality of treatment under economic law.

I call upon the Congress to eliminate the social engineering in the tax code by

adopting the National Retail Sales Tax. With the NRST, the economic class warfare

that has so divided this country over the past 87 years will eventually go away—

everyone will be working, saving and investing and we won’t have time to be envious of ‘‘the Joneses.’’

Americans believe that all men are created equal by their Creator, and have an

unalienable right to be treated equally by their government. The progressive income

tax violates that fundamental principle.

208

Mr. Chairman, we are all stakeholders in America. As such, we should be enjoying equality of treatment under the law. As I have gone to great lengths to point

out, we are not.

The NRST, because it is applied uniformly and taxes everyone at the same rate,

will be a constant reminder to each of us that we are a stakeholder, and that taking

an interest in the affairs of this nation is an important duty of citizenship. By demolishing the myth that there is a ‘‘Free lunch,’’ the National Retail Sales Tax can

become a unifying theme for all Americans.

Accordingly, I call for all Americans to unite, to come together and demand of our

elected officials that the income tax system be replaced with a simple, fair, flat National Retail Sales Tax and that the IRS be abolished.

Mr. Chairman, I have in my possession (Appendix 1) an eloquent message from

a taxpayer, who prefers to remain anonymous, that neatly sums up the frustrations

millions of Americans have about our tax and regulatory system. I would like to

read it for the record.

America will never be a truly free society so long as we allow the income tax and

the IRS to exist. America will never realize its true economic potential so long as

we allow the income tax and the IRS to exist. Americans will never be treated with

equality so long as we allow the income tax and the IRS to exist.

What better way to restore Americans’ Constitutional freedoms, invigorate America’s economy through more robust economic growth and ensure that every American is treated with equality?

Isn’t that what our Grand Vision of America is? One Nation, under God, with liberty and justice for all?

Thank you, Mr. Chairman for allowing me to testify.

Dear Friends and Buddies,

Most of you know that one of my most treasured beliefs is that we are a free people. I am deeply saddened that every day we lose more of those freedoms as the

government usurps them in the name of protecting us from ourselves. Our current

tax code is extremely damaging in that it punishes success (the very thing this

country was founded on and so many lives were lost over) and it requires disclosure

of every aspect of our lives for public consumption.

My spirit is personally so broken by this, that after doing our taxes I realize I

am chipping my [joy of life] and very life away and have become enslaved by the

government. I have decided to end it.

I am selling our business and I will not continue to contribute to this folly. It was

a grim realization. Although we have a lot to contribute to this country and its future with our technologoy info and teaching, it is not worth the payback anymore.

The exhaustion of teaching, the aching legs and feet, the sleepless nights waking

up with leg pains after teaching all day, the stress of it, the technology ‘‘Keep-up’’

issues have all mounted too high unless there is big bucks in it. Running our own

business has meant learning too much about regulations, forms, accounting etc. and

handing over in excess of 63% of our earnings. And that is before property and gas

and sales tax, let alone how to finance retirement and pay for college and all that.

I give up. The American Dream has vanished. I am joining the ranks of the

crushed in spirit, the squashed, the oppressed. And yes, if you were wondering, I

am depressed about the whole thing. A good cry sometimes helps, but that has been

way too common of late. Oh well.

[The following is a personal letter to the Committee, from the same taxpayer]

To the House Committee on Ways and Means:

Please record my support FOR the National Retail Sales Tax to replace the tax

code in this country. We must abolish the oppressive tax code and REPLACE it. The

FLAT TAX does not accomplish replacement of the complexities of the code; it merely masks them and simplifies computations. Therefore I urge you to please support

the FAIR TAX/National Retail Sales Tax.

I also urge you to abolish the illegal agency known as the IRS. It was not properly

established according to our constitution and has powers way beyond those ever envisioned by our forefathers. The IRS simply MUST be eliminated, as everyone in

good conscience must admit.

May this committee please take this challenge to right the wrongs perpetuated

for many years by this agency called the IRS. We need a constitutional, noninvasive, and non-‘‘targeted’’ tax code, that treats us with equality. And enact a tax

code that preserves life, liberty and the pursuit of happiness. . . not one that causes

us to fear running afoul of the IRS and requires keeping every scrap of evidence

from every sector of our lives, should it ever be demanded.

Thank you for your time

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210

211

212

213

214

215

216

next Monday when people, when most people finalize their tax

Mr. COLLINS. Thank you, Mr. Davis. I expect by the close of day

f forms and write their checks, that we will be able to get many,

many more letters and also a lot more signatures on petitions.

Mr. English?

217

Mr. ENGLISH. Mr. Chairman, I have no questions. But I want to

thank these gentlemen for taking the time to exercise their sacred

right to petition Congress and to testify.

We appreciate your willingness to come forward and share your

views. And, frankly, I hope you are able to motivate many more of

our fellow citizens to get involved in this debate, to provide their

ideas, but to push this institution to reform a tax code which has

become an octopus which has reached into virtually every part of

our life.

I thank you for being here.

Mr. DAVIS. Thank you.

Mr. COLLINS. Thank you, Mr. English.

Mr. Hulshof, do you have any further questions for Mr. Davis?

Mr. HULSHOF. No. Thank you.

Mr. COLLINS. Thank you.

Mr. Archer, do you have any questions, sir?

Chairman ARCHER: [presiding] No, sir.

I simply want to thank all of the witnesses for coming and presenting their views. We are very grateful for that. We know some

of you have come from a long way and together, some way or another, we are going to work our way through and find an answer.

Mr. COLLINS. [presiding] Thank you, gentlemen.

Mr. Worley, we do appreciate you sitting through the entire service of yesterday and today.

Gentlemen, that concludes this panel and we will now recess for

lunch. Thank you. For those of interest, 1:00 o’clock will be our

time to reconvene.

[Whereupon, at 11:55 a.m., the Committee recessed, to reconvene

at 1:23 p.m., the same day.]

Chairman ARCHER. The Committee will come to order.

Continuing with our hearing, we have our next panel of our colleagues: the Honorable Dick Armey, and the Honorable Billy Tauzin, and the Honorable James Traficant, to talk about their individual perspectives and potential alternatives for the current income tax.

Welcome, gentlemen. We will start off with our friend Dick

Armey. We will be pleased to hear your testimony and your recommendations.

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

MAJORITY LEADER

Chairman ARCHER. Thank you, Mr. Chairman.

First let me appreciate you and your leadership in this whole

area of tax law. I have said many times, and I am happy to say

again, never could we have had a finer Chairman of the Ways and

Means Committee more devoted to a professional commitment on

the tax code.

I have had my own interest in the matter for some time, and particularly in January of 1994 when I focused on the issue at a level

I had not done before.

I wrote the Flat Tax Bill. He later wrote his National Sales Tax.

We teamed up, as you know, and have spent the better part of the

last two years travelling across the country speaking frankly to

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very large audiences where we have had a clear commitment to

end this nightmare called the current tax code.

In our presentations before those audiences, we always start off

with a discussion of the burdens of the existing code. I have on the

billboards up here an example of how we make the presentation.

For example, we divide the difficulties of the existing code up between myself and Billy, and we point out that families pay more

in taxes, food, clothing, and shelter, and now we also add transportation, combined.

Americans work an hour and fifty-seven minutes of every day to

pay federal taxes. Taxes are at peacetime record highs. And I think

one of the very big issues. $200 billion in annual compliance costs

for the current tax code.

Billy, when he opens his presentation, then will present further

facts. And by this time what we see in the audience is a congealed

understanding. Yes, this current tax code is a horrible mess in our

lives. It confounds us. It complicates our lives. It costs us time,

money, and energy, and it is generally all-around depressing and

we want to be rid of it.

I think, Mr. Chairman, you yourself have seen in your own travels that there is a fairly clear agreement among the American people. We want to be rid of this current tax code.

The next part of our presentation then focuses on:

All right, once we agree that we want to get rid of the current

tax code and replace it with something that is of better service and

less intrusion in our lives, where do we go?

It is at that point that I present what I still will argue is the best

alternative, the flat income tax, based on my desire to have a tax

code that does not intrude government organization into the affairs

of the family or the business.

No family or business decision about how to use your income—

whether it be consumption, savings, or investment—should be

made on the basis of tax considerations but should be on family

and business considerations.

So our tax code to be correct in my estimation should be fair. It

should be simple. It should be easily understood and easily complied with.

It should eliminate double taxation and accept a standard of fairness that I believe is the unique American definition of ‘‘fairness.’’

‘‘Fair’’ is when you treat everybody the same as everybody else.

And it should forsake the sophistry that underlies so much of

what we have in our current tax code, overburdened as it is with

efforts of social control and income redistributions, a sophistry that

we hear pronounced so many times as the false distinction between

earned and unearned income that would give rise to a justified

sense of it is fair to treat some forms of income differently than

others.

The flat tax is very simple. It says to the individual. Take your

total income earned in a given accounting period, deduct from it a

generous family allowance—for a family of four that could be as

high as $33,800—multiply the remainder by 17 percent, and your

taxes are filed.

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If you are a business, you take your total business income, deduct your business expense, multiply the remainder by 17 percent,

and your taxes are filed.

We can cut that compliance cost down by 95 percent with this.

Now let me just say, the flat tax is filed on a form like this, the

size of a postcard, 10 lines. In the original iteration of the flat tax

I had written it so that we would put an end to withholding tax. Your joint tax scorekeepers whacked me for $10 billion on that.

In those deficit days, that seemed like a terrible burden. I took it

out. But I would tell you, Mr. Speaker, when you mark up the flat

tax in your Committee to bring it to the Floor, I would encourage

you to follow my original advice and drop the withholding tax.

You will have a chance in this Committee—and this is very important for us to understand—by Constitutional authority we will

write the modern, up-to-date, civilized respectful tax code for the

American people in this Committee.

When this Committee does that work, you will find the flat tax

is a bill easily written, congenial to the taxpayer, and one that you

will get a fulfillment of what I think is one of the great, heroic

American ideals. voluntary tax compliance.

I look forward to your proceeding with this. I encourage this

Committee to move forward. Certainly you will be fair and you will

be judicious as you judge all of the alternative ways in which you

might write a new tax code for America. And I stand fully confident

that when you begin this prospect in earnest you will find, as I

have found, the only way to do this job is to do it with the flat income tax.

Thank you.

[The prepared statement follows:]

Statement of the Hon. Richard K. Armey, a Representative from the State

of Texas, and House Majority Leader

Mr. Chairman, I appreciate your affording my colleague Representative ‘‘Billy’’

Tauzin and me the opportunity testify together. We have traveled to over 40 ‘‘Scrap

the Code’’ debates to educate the American people on tax reform. Our effort has

been intended to elucidate the details of two major alternatives to our current tax

system to the public. I commend you for your own commitment to this cause. I know

from our years of hard work together on this issue and our many conversations that

we share the same goal for tax reform. I want to take this opportunity to thank

you again for your leadership, friendship and advice on this issue.

The Tax Code is Broken

Mr. Chairman, there is an emerging consensus among the public policy community, members of Congress, and the public that our current tax system is broken

and needs to be scrapped and replaced with a system that is fair, simple, low, and

honest. This growing consensus centers around the belief that the current tax code

is complex; inhibits saving, investment and job creation; imposes a heavy burden on

families; and pollutes Washington’s political culture. It cannot be fixed or replaced.

It must be scrapped.

At the beginning of the 20th century, federal taxes accounted for less than 3 percent of U.S. gross domestic product (GDP) and the entire tax code and regulations

filled just a few hundred pages. Today, federal taxes account for 20 percent of GDP,

and a complete set of federal tax rules spans over 46,000 pages. I’d like to focus

my remarks today on the problems with the current tax structure and how my bill,

H.R. 1040, The Flat Tax, corrects these problems.

Current Code: Complex

This year, the tax code itself is 2,840 pages and about 2.8 million words. Taxpayers have to choose from 481 forms, a rise of 20 percent from 403 forms in 1990.

The system is steadily growing more complex, causing over half of individual taxVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00225 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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payers to use a tax preparer for their income tax return, up from less than 20 percent in 1960.

Even the well trained are stumped by the complexity. Unsurprisingly, the IRS receives over 110 million phone calls a year from taxpayers asking for assistance. In

1999 the IRS was only able to answer 73 percent of the phone calls correctly. The

inability of the IRS to answer over 25 percent of calls signals an inherent failing

of the current system.

In 1998, Americans spent 5.7 billion hours filling out IRS forms—equal to 2.7 million workers doing nothing but IRS paperwork. With spring in the air, my family

wants our time together to be better spent than digging deep in drawers searching

for receipts or trying to make sense of complicated forms. I am confident there are

many families like mine who are forced to sacrifice time with their loved ones to

spend time making sense of the maze of forms and paperwork.

The Tax Code is Unfair

The unfairness of receiving a penalty for a wrong answer given the tax codes’

complexity strikes at the heart of the American principles of fairness, justice, and

equality before the law.

In one typical case, according to the non-partisan General Accounting Office, it

took the IRS 18 months to correct an erroneous $160,000 assessment to an individual who was actually due a refund. The American people deserve fairness and

they deserve to be rewarded for their honesty, integrity, and responsibility.

Yet the current tax code gives rise to legions of tax lobbyists fighting for their own

particular deduction, credit, or other special preference in the law. Besides contributing vastly to the complexity, taxpayers with similar incomes can pay vastly different amounts. How much you pay in taxes is correlated to how much time you

have to study and learn the tax code, and whether or not you have a lobbyist in

Washington.

Record Peacetime Tax Burden

The total tax burden is at 20.7 percent of GDP—a post-World War II high. In fact

the tax burden is a major impediment to our new digital economy. Some may argue

that rising tax burdens as real incomes increase is the appropriate outcome of our

current tax system. However, a progressive tax system is designed to make the rich

pay a higher amount than the poor—not to increase the total tax burden on all citizens. The disincentives imposed by implicit and explicit marginal tax rates are

growing and these disincentives reduce savings, investment, and growth.

The only legitimate purpose of a tax code is to raise revenue, and do that while

doing the least harm to the economy and to the people. Yet the high burden imposed

on us by the tax code also punishes us financially for activities and values that we

should encourage.

—If we marry, we pay higher taxes than when we were single. We save for our

children’s education, only to pay taxes on savings from those earnings. We work

hard to do more for our family, only to pay a higher tax rate on every new dollar

that we earn. We die and pass our farm or business to our family, only to have them

break up the business due to the punitive ‘‘death tax.’’

The Flat Tax Solution

The legislation I reintroduced this year with Senator Shelby of Alabama, (H.R.

1040) scraps the entire income tax code and replaces it with a flat-rate income tax

that treats all Americans the same. This plan would simplify the tax code, promote

economic opportunity, and restore fairness and integrity to the tax system. The flat

rate would be phased-in over a three-year period, with a 19—percent rate for the

first two years and a 17-percent rate in subsequent years.

Individuals and businesses would pay the same rate. The plan eliminates all deductions and credits. The only income not subject to tax would be a generous personal exemption that every American would receive. For a family of four, the first

$35,400 in income would be exempt from tax. There are no breaks for special interests. No loopholes for powerful lobbies. Just a simple tax system that treats every

American the same.

Simplicity

The flat tax replaces the current income tax code, with its maze of exemptions,

loopholes, and targeted breaks, with a system so simple Americans could file their

taxes on a postcard-size form. The Tax Foundation estimates that a flat tax would

reduce compliance costs by 94 percent, saving taxpayers more than $100 billion in

compliance costs each year.

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Fairness

The flat tax will restore fairness to the tax law by treating everyone the same.

No matter how much money you make, what kind of business you’re in, whether

or not you are married, or even when you die, you will be taxed at the same rate

as every other taxpayer.

Prosperity

Because the flat tax treats all economic activity equally, it will promote greater

economic efficiency and increased prosperity. When saving is no longer taxed twice,

people will save and invest more, leading to higher productivity and greater takehome pay. When marginal tax rates are lower, people will work more, start more

businesses, and devote fewer resources to tax avoidance and evasion. And because

tax rules will be uniform, people will base their financial decisions on common-sense

economics, not arcane tax law.

Lower Taxes

The flat tax was not designed to be revenue neutral. It reduces unfairness. Because of the high tax overpayment, there is room to provide tax relief. And the flat

tax would provide significant tax relief. When the rate is reduced to 17 percent in

the third year of the proposal, there would be significant further tax reduction.

But the flat tax does have a progressive element. Under the flat tax, the more

you earn, the more you pay. In fact, because of the high family exemption, the more

a taxpayer earns the greater the share of his income he pays in tax. A family of

four earning $35,000 would owe no tax under the proposal. A family of four earning

$50,000 would pay only six percent of its income in income taxes while a family

earning $200,000 would pay 14 percent.

The flat tax is pro-family. The flat tax eliminates the marriage penalty and nearly

doubles the deduction for dependent children. By ending the multiple taxation of

saving, the flat tax provides all Americans with the tax equivalent of an unlimited

IRA. This will make it easier for families to save for a home, a vacation, a college

education, or retirement.

The flat tax also has a powerful political virtue in that it excites the public. The

crucial importance of this should not be underestimated. Policy experts can and do

sit in a room and write their version of the ideal tax code but it will remain a purely

academic exercise if they cannot rally public enthusiasm for change.

In fact, a Zogby poll shows that the following breakdown:

Percent

Favorable

Percent Unfavorable

Democrats 60 31

Republicans 75.1 19.1

To the many Americans who have grown profoundly skeptical of the federal government, politicians, and lobbyists, the flat tax has spectacular appeal because it

offers the American people a straightforward deal. It also rids Washington of many

of the special interests’ reason for existing: the current, unfair tax system.

The flat tax scraps the current code and gives taxpayers a new code that is simple, low, fair and honest. America deserves no less.

Chairman A

Congressman Tauzin, you may proceed.

RCHER. Thank you, Congressman Armey.

f STATEMENT OF HON. W.J. ‘‘BILLY’’ TAUZIN, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF LOUISIANA

Mr. TAUZIN. Thank you, Mr. Chairman.

Mr. Chairman, you asked us to focus today on three points.

The first was the fairness and simplicity of the alternative plans.

The second was the impact on trade and commerce.

And the third was the compatibility with state tax collection systems.

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Let me first acknowledge that I am accompanied today by Jim

Traficant, my chief Co-Sponsor, who I am always pleased to share

a podium with. He will also be available to answer any questions

you might have.

Let me touch upon those three points. Without going into all the

great reasons why we need to scrap the code, I adopt your great

admonition that it is time to pull it out by its roots and destroy

it so it never returns again.

Moving to a consumption tax does that. It allows us to get rid

of the income tax code completely, to abolish the IRS, and to move

to a simple, fair tax code.

Why is consumption taxes on retail sales fair?

First of all, let me suggest to you that there is something about

an income tax code that is hidden from the American public that

is not very apparent until you examine it closely.

At your desk, in addition to the wonderful little book I have written entitled the National Sales Tax. April 15th Just Another Day,

is also a copy of an article by Dale Yargenson, the Chairman of the

Department of Economics of Harvard University, in which Dale

Yargenson points out something that I think Americans are not

aware of. That is, that the income tax, the fact that we currently

tax income on individuals and corporations and businesses, adds

about 25 percent to the finished product cost of everything made

in America.

So the pervasive effect of income taxes, however you style them—

complex, simple, or flat—is that they add to the cost of products

made in America.

So the perverse effect of an income tax code is that it punishes

an American worker for buying his own products. It punishes those

products in export trade, and it rewards him only when he buys a

foreign product that comes in very often exempt from foreign VAT,

value added taxes.

So when you think about income taxes in comparison to consumption taxes, you need to think about a single consumption tax

at the retail level compared to not one but two taxes on the same

money. the tax we pay from our paycheck that comes out as withholding, and the tax we pay in higher American prices for everything we make because income taxes have added 25 percent to the

cost.

Take local bread for example. Studies indicate that 35 percent of

a loaf of bread is income-tax related. If you get rid of the income

tax, according to Dale Yargenson, you reduce the cost of a loaf of

bread by that much in a competitive marketplace.

A loaf of bread, instead of costing $2, should rightfully cost $1.30.

When you put a sales tax on the back of it at the retail sale, you

still have a much lower price for bread than you have in America

today. It is eminently.

In our plan that Jim Traficant and I have devised, you remember

that this is a plan that we introduced years ago and have reintroduced every Congress. In this plan we go even further to make it

fair.

We also repeal all of the payroll taxes that are collected from a

worker’s income up to the poverty line so that all income under the

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poverty line is not only free of income taxes under our plan, but

also free of the payroll tax.

Now that is an extra 15 percent that goes into the workers’ income and fully makes up for the effect of the sales tax on all the

products you buy to take care of your family with income earned

under poverty.

Now think about that. You have got more money to spend. you

have got all of your paycheck, plus your payroll taxes that are no

longer going to the government. And you are buying products made

in America that can cost as much as 25 percent cheaper. That is

pretty fair. Pretty simple. It puts you in charge of how much taxes

you pay instead of a government that writes a code and regulatory

structure of 7 million words and nobody can understand anymore.

On trade, Dale Yargenson points out that if we got rid of the income tax and so reduced the cost of American products by 25 percent, the export trade from the United States would jump 29 percent annually and would be at least 15 percent higher than it is

every year thereafter.

In short, we would eliminate the trade deficit. American products

would go out tax free. No income tax effect on them. And they

would be taxed once in the place of destination instead of being

taxed in America and also taxed there. A 29 percent jump in exports.

Dale Yargenson also indicates if we were smart enough to do

what we recommend in a consumption tax at retail sale, we would

also increase investment in jobs and manufacturing in this country

by a factor of 80 percent. A huge increase in jobs, in manufacturing, a huge increase in exports, a simple plan that works for

Americans that is fair, it is decent, it cuts the cost of American

prices, and also rewards workers for buying their own products instead of punishing them.

That is a pretty good deal and one we ought to consider in this

room. What a great gift we could give to this country if we ever

pull that off.

Now you asked also about compatibility with state collection systems. The good news is that 45 states currently have sales tax collection systems. Under our plan, those states do the collecting. We

would encourage the last five to put up a collection system, but if

they do not we of course would set one up in those five states.

But in 45 states, the states would do the collecting. Our bill provides them with a one percent commission to cover the cost of the

collection. Our bill rewards the retailer with a half of one percent

to make sure the retailers’ cost are covered in the collection system,

and the balance is then remitted to the Federal Treasury.

Here is the good news on the collection system, how easy it

works. In most sales tax jurisdictions, 80 to 90 percent of the sales

taxes are paid by 8 percent of the retailers. The bulk of it is done

by the big national retailers.

Under our plan, they can remit directly to the Federal Treasury

if they want it on a national retail basis. In short, the minimum

amount of sales tax collection is then left to the states for which

they are paid a commission and for which the retailers are paid a

commission.

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One final thought and then I know my time is up. We even in

our bill make provision to help the retailers with the software they

might need to make their collection systems for the federal sales

tax compatible with whatever plan may exist in their states for

state sales tax collection.

Mr. Chairman, I yield back.

[The prepared statement follows:]

Statement of the Hon. W.J. ‘‘Billy’’ Tauzin, a Representative in Congress

from the State of Louisiana

Mr. Chairman, it is my honor to address the Committee on the benefits of a national retail sales tax and my proposal, H.R. 2001, the National Retail Sales Tax

Act of 1999. I first introduced this legislation, along with my friend, former Congressman Dan Schaefer in the 104th Congress. Since then I have been joined in this

effort by Congressman James Traficant and others, that understand the economic

benefits of a national retail sales tax. I look forward to working with you and the

members of the Committee to overhaul our current system and lift the burden of

the income tax from the shoulders of all Americans.

The federal government’s outdated, flawed and unfair income-tax system has become a nightmare for all Americans. It has grown from 14 pages in 1914 to more

than 2,000 pages of law, 6,000 pages of regulations and hundreds of thousands of

rulings and interpretations. Tax preparers and income-tax experts who routinely

testify before Congress admit that even they do not fully understand all of the provisions and ramifications of the Internal Revenue Code.

Since I last appeared before this committee in 1997, Majority Leader Armey and

I have taken our message of tax reform to tens of thousands of people in over thirty

cities on the ‘‘Scrap the Code’’ tour. At every stop on our tour we have been met

by hundreds of Americans yearning to learn more about the major alternatives to

the current code.

While Congressman Armey and I may differ on which tax-reform bill is best for

America, we agree that Americans work too hard for their money, have too little

to show for it and should not have to tolerate our inherently-unfair and overly-complex federal income tax code. What’s worse is that the federal income tax code tells

Americans how to live their lives—encouraging some types of actions and discouraging others.

Mr. Chairman, you have asked that these hearings focus on: whether our respective fundamental tax reform proposals are simple, fair and enforceable; the relevance of these proposals to the increasingly global marketplace; and, their compatibility of our proposal with State tax laws. First, let me briefly explain my proposal,

H.R. 2001, the Tauzin-Traficant National Retail Sales Tax Act of 1999 (NRST).

My legislation would eliminate the personal and corporate income tax code—including taxes on capital gains and savings, inheritance and gift taxes, and all nontrust funded excise taxes, abolish the Internal Revenue Service and replace them

with a 15 percent national sales tax on the retail purchase of all goods and services.

Simple, Fair, Enforceable

Unlike the current income tax code or even the flat tax, the national retail sales

tax requires no federal individual tax returns of any kind. Americans are forced to

spend in excess of 5 billion hours trying to calculate the amount of income taxes

owed to the federal government. This is absurd. Individual Americans will pay their

taxes when they make purchases of retail goods and services. No receipts, no tax

returns, no audits, no hassle.

All goods and services for consumption would be taxed at the same rate—no exceptions. If we exempted food, clothing, and housing—which represents a substantial amount of the American economy—the rate would have to be significantly higher. The broader the NRST base the lower the rate. Exempting entire categories of

goods or services would inevitably lead to an administrative nightmare of definitions.

The NRST will empower all Americans by giving them the choice as to how much

tax they pay. Our present income tax system takes our money through withholding

before we even receive it. Most of us now consider that our wages are really the

‘‘take-home pay’’ that we get net of all the deductions. Under the present system,

it doesn’t matter if one of us is more frugal than the other because we all pay the

same amount of tax. In fact, if we are more frugal than our neighbor we are actually

going to pay more and more tax because our earnings on our savings will be taxed

each year.

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With the national retail sales tax we receive all of the money we earn. Our checks

are increased by the amount previously deducted for federal income tax. With this

money in hand, we have the power to determine the amount of federal tax we pay

based on how much we choose to spend. The more you consume the more you will

pay in taxes. The less you consume the less you will pay in taxes. The American

people, not Congress or the IRS, will have the power.

Also because of the way that the present income tax system hides the amount of

taxes we pay in the price of goods and through withholding, I don’t think any of

us can really tell how much tax we are paying to the federal government. By eliminating the individual and corporate income tax, the estate and gift tax and all nontrust fund excise taxes and replacing them with a simple national retail sales tax,

all of us will see the amount of federal tax we pay each time we make a purchase.

Critics of the NRST often claim that it is regressive—that the poor have to devote

a greater percentage of their income to pay the NRST than do the rich. Under H.R.

2001, a tax credit would be allowed for thousands of households with incomes below

the poverty line. This assures that all workers below the poverty level will pay no

taxes. The formula will be made adjustable for non-working spouses and children

by reducing FICA deductions on every paycheck.

Enforcement is an serious issue for any tax plan. Will there be people who try

to evade the national retail sales tax? Yes. There are always going to be people who

refuse to pay any tax. The current code has become so complex that it makes it easier for people to cheat the system..

Under the NRST there will be dramatically fewer collection points to watch. Instead of having to audit and collect information on 250 million taxpayers and millions of businesses, the government will have to watch a smaller number of collection points. All but five states levy state sales taxes. The other 45 states and the

District of Columbia already have the mechanisms and experience in place to enforce the sales tax. Local administration and collection will translate into better

compliance rates. States will also have an incentive to enforce the tax because the

more they collect, the more they receive to cover their administrative costs.

The NRST would ensure that the underground economy, those individuals and

businesses that don’t file income taxes, would pay their fair share. The underground

economy encompasses not only illegal sources of income, such as drug dealing, gambling, and prostitution, but also the ordinary citizen who accepts a lower price for

cash payments and doesn’t report the income or the businessman who keeps two

sets of books and pockets a portion of the sales or takes improper deductions.

Relevance to the International Marketplace

Currently, Americans, in effect are taxed twice by the IRS. Americans pay a federal tax on their income, and pay what amounts to a ‘‘hidden’’ sales tax (believed

to be as high as 15 to 20 percent) on the retail purchase of all goods and services.

The federal government calls this the ‘‘corporate income tax’’—as if it were really

paid by corporations. But, in reality, consumers pay this tax in the price of goods

they buy. So under the present code, American income is literally taxed coming and

going. The net effect of the NRST, is to eliminate two taxes and replace them with

one clearly defined tax on goods and services sold at the retail level.

This ‘‘hidden’’ sales tax makes it harder for American goods to compete overseas.

Due to the income tax and its burdensome compliance costs, American products produced for export leave the U.S. at a 15–20 percent competitive disadvantage.

What’s worse is that products imported into the United States enjoy a 15–20 percent competitive advantage over our American-made products. Most industrialized

countries simply exempt products for export from most of their taxation. This exacerbates our trade deficit and translates into millions of lost American jobs. Mr.

Chairman, that’s unfair to American workers, products and companies.

Members of this committee are well aware that the World Trade Organization

(WTO) has determined that the Foreign Sales Credit (FSC), a portion of the income

tax code created to mitigate the effects of the income tax code, constitutes an illegal

subsidy. In its October 8, 1999 Panel Report on FSC’s, the WTO found that ‘‘...the

United States is free to maintain a world wide tax system, a territorial tax system

or any other type of system it sees fit. This is not the business of the WTO. What

it is not free to do is to establish a regime of direct taxation, provide an exemption

from direct taxes specifically related to exports, and then claim that it is entitled

226

1 Adoption of a national retail sales tax would eliminate the need for Foreign Sales Corporations. Under the NRST, no tax will be placed on a product exported from the United States.

In addition, since the NRST is designed to only tax consumption, all purchases made for business purposes would NOT be subject to the 15 percent tax. As our country becomes more and

more dependent on foreign markets for our goods and services it is becoming increasingly clear

that we must fundamentally modernize our tax code to increase U.S. competitiveness around

the world.

to provide such an export subsidy because it is necessary to eliminate a disadvantage to exporters created by the US tax system itself..’’1

There will also be what some economists call the ‘‘sponge effect.’’ The U.S. is the

world’s largest market and has the best infrastructure of any country on earth.

When the income tax is replaced with the national retail sales tax, it will become

the world’s largest tax haven and a ‘‘sponge’’ for capital from around the world.

Compatibility with State Tax Laws

Currently, 45 States and the District of Columbia levy sales taxes (Alaska,

Deleware, Montana, New Hampshire and Oregon do not). These states have the experience and mechanisms in place to administer the NRST. Under the Tauzin-Traficant plan, States would collect the 15 percent national sales tax from the retailers

within the state and remit the tax to the United States Treasury. Participating

States may keep 1.0 percent of their collections to offset their collection expenses.

Similarly, any business required to collect and remit the sales tax would be permitted to keep 0.5 percent of tax receipts to offset compliance costs.

In closing, I believe that we should re-examine the basic ideas on which this government was founded. Our Founding Fathers insisted on the use of indirect taxes

on individuals and specifically forbade direct taxes like the income tax. We have an

opportunity to eliminate the income tax, the IRS, tax returns, audits, and the penalties on our work, savings and investments and replace them with a national retail

sales tax. We must free Americans from the trappings of the income tax code.

The beauty of the national retail sales tax is its simplicity and fairness. Those

who spend the most will pay the most. Those who spend the least will pay the least.

No more income tax forms. No more compliance costs. No more hidden taxes. No

more loopholes for the corporations and the rich.

What’s important now is to begin a national dialogue and a dialogue within this

committee on tax reform. This debate isn’t simply about a flat tax vs. a national

sales tax. This is about fundamental tax reform vs. preserving the status quo. Revolutionary change, such as scrapping the federal income tax and abolishing the IRS,

will never happen unless Americans demand it.

Mr. Chairman, thank you again for holding these hearings and for your leadership on this critical issue.

Chairman A

Congressman Traficant.

RCHER. Thank you, Congressman Tauzin.

fSTATEMENT OF HON. JAMES A. TRAFICANT, JR., A

REPRESENTATIVE IN CONGRESS FROM THE STATE OF OHIO

Mr. TRAFICANT. I would just like to amplify upon Mr. Tauzin’s

statement and commend you, Chairman, for your leadership.

I believe if there is a possibility of changing a tax code that is

un-American, it has the greatest shot with Bill Archer as Chairman.

I want you to know that your reform bill made a dramatic impact

in America. I want to thank you for working with me on two of

those issues, in changing the burden of proof and judicial consent.

I wanted to give you one statistic before I give you my statement:

Seizures of farms, homes, and businesses in 1997 were 10,037.

In 1999, they were 161. Thanks to you, Chairman Archer. And I

want to thank the Republican Party for working with me.

227

One point I would like to amplify upon Billy’s statement is that

the Consumer Price Index plays a big part in the analysis of this

particular bill. If there is any upward trend in cost, then there

would be a reciprocal upward allotment in the cost of living allowance for seniors which are going to be very much panicked over

this legislation.

Where I can help I believe Mr. Tauzin and the Congress is in trying to get hardcore democrat opposition to look at the salient points

of this legislation, because it will have to have some Democrat support or they will continue to be at the back of the bus in the minority for many, many years, because the time has come.

I want to talk about attitude. General tax attitude.

If you fix up your home, you pay more taxes. If you let it run

down in America, you pay less. I am not talking about a federal

system, am I? But if you work real hard and you are very industrious, you get hit over the head and pay more taxes.

If you do not work, you get a check.

We must reward people for industry and work. But here is a

point I would like to amplify upon what Mr. Tauzin has stated I

think very eloquently. Let me say this. I have great respect for the

Majority Leader. I believe a flat tax is absolutely necessary—not an

income tax, but a flat tax on final retail sales consumption—for the

following reason.

In my District we make the Cavalier, and Phil English is right

across the border and his people work there as well. That Cavalier

carries a 25 percent disadvantage against the Toyota that is imported from Japan.

For the first time in history you would have a border-adjusted

tax. My Cavalier is made with a 25 percent overload from the tax

code, gets shipped to some other country overseas and they put a

value-added tax on that baby.

Then they come in under an agreement of some trade of some

sort with basically free access to our market, and then we are worried about keeping our Cavalier plant in Lordstown, Ohio, Mr.

Chairman.

So I think when you look at the final retail sales tax, here is a

big issue. And here is one concern I have. I support that 15 percent

national retail sales tax, but ask you to ensure that is going to be

enough.

Now I heard this 30 and 50 percent crap, and this opposition

crap I think is distorting it to the American people, but I think you

will come up with that particular number that is necessary.

But I think what is most important that we all take a look at

is that FICA and senior citizens. I think if there can be an improvement to our bill, and I would ask the Chairman to look at

these machinations as you look at changing the code, that rather

than have the opportunity to politically scare seniors, which I believe will be an opposition tactic and I predict it, to leave FICA

alone as we do and put a study in there with that transition that

would allow for a study and a natural transition to, if it in fact

proves to be worthy in that regard.

But I think we leave open the opportunity to quantify income.

And that is how we in fact evaluate those that are in hard times

and those that are in good times. So I know that you are working

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on that, and you are working on many of those issues. But I would

like to just close by talking about the attitude of our tax scheme.

When people work hard, they get penalized in America. That is

not the type of scheme we need. We should be rewarding industry

and industrial strength.

And finally, I think American companies will come back home.

I think they will relocate in districts like mine, and I would ask

for special legislation to help my District.

With that, I thank you for allowing me the opportunity to appear

with two of the most distinguished Members of Congress, and I am

glad Mr. Portman has shown.

Thank you, Mr. Chairman.

[The complete statement of Mr. Traficant follows:]

Chairman ARCHER. I am grateful to all three of my friends who

are at the witness table today because all three of you want to put

your shoulder to the wheel to drive this tax system to where it is

not an odium on the American people, and rather that it can be

transferred into a position to where it can be a strength.

All taxation, no matter how we collect it, is not a happy thing

for the American people. There is no tax system that is going to

be perfect without complaint. But the system should be fairer. It

should be simpler. And what you, Congressman Tauzin, and you

Congressman Traficant said, it should be one that is designed to

improve our competitiveness in the world marketplace which in the

next Century is going to be essential to meeting the needs of the

American people.

It must furthermore level the playing field between foreign products and services entering this country and those that are manufactured and produced and ideated in this country.

And if we go through tax reform and we do not do the latter, we

will have missed the golden opportunity for future Americans. And

so I thank you for what you have presented today, all of you.

I say to my friend, Dick Armey, you have designed a system that

is much, much better than the current income tax system and I applaud you for that.

I do wonder if—and I would like your response to this—is there

upward mobility on the rate structure in your system?

Mr. ARMEY. Well, Mr. Chairman, let me just say, no. There is a single rate. Now if I make $100,000 a year, I pay 17 percent of

that. If my good friend Sam Donaldson makes $500,000 a year for

talking about what I do, he pays 17 percent of that. Now he will

pay more in taxes than I will, but we will pay the same rate.

There is an adjustment at the low end in that the standard deduction is a larger share of the percentage of total income for low

income earners than it is for high income earners, so there is some

progressivity put in there. But it must be understood. When I

wrote the flat tax, I said somebody has got to be stubborn about

this.

The first point about which you must be stubborn is it can only

be one rate. Immediately upon trying to introduce two rates, you

will bring complexities to the tax code that will make it an unbearable thing.

And if I might say one other thing, when I tried to write a tax

code I wanted to fulfill a variety of objectives. simplicity, honesty,

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fairness, neutrality. I have not found any effort to put border

adjustability into any tax code that does not first violate the principle of neutrality and does not also simultaneously trespass

against all the other principles, and would not in fact in the long

run be eliminated and made ineffective by adjustments and exchange rates.

So I do not place a lot of store in efforts to achieve border

adjustability in the tax code. I think that is—I think it is an objective that is, first of all, errant, and secondly comprises the rest of

your effort.

Chairman ARCHER. But relative to my specific question, there is

no provision in your bill to prevent future Congresses from raising

the rate and going to marginal rates in your system, is there?

Mr. ARMEY. No. Let me just say that first of all as we saw in

1986, it is impossible for any Congress to protect America from a

future Congress.

We do put a provision in that says it takes a two-thirds vote of

both the House and Senate to either increase the rate, reduce the

family exemption, or add any complexities back into the system.

But that is about the best protection you can get, and in the end

it stands upon the ability of the American people to hold their

Congress’s feet to the fire.

As we saw in 1986, future Congress’s can fowl up anything.

Mr. TAUZIN. Mr. Chairman, might I—— Chairman ARCHER. Mr. Tauzin, I know you were a little nervous

there in wanting to get into this question of border adjustability,

so what is your response?

Mr. TAUZIN. Well first let me agree with Dick on this two-thirds

provision. We have it in our bill as well.

Let me say, this is how it works today under GATT. Many of our

trading partners have value-added taxes in their tax system. If you

go buy something today in London you will be charged a valueadded tax. But if you bring it to America, you get that value-added

tax back. It is rebated.

The effect of that is to allow those countries under GATT to sell

their products in the American market value-added tax free.

Chairman ARCHER. Will you suspend for a moment?

Mr. TAUZIN. Yes.

Chairman ARCHER. When the gentleman mentions GATT, he is

talking about currently the WTO.

Mr. TAUZIN. The General Agreement on Trades and Tariffs.

Chairman ARCHER. Yes, which has been replaced by the WTO.

Mr. TAUZIN. Yes, the WTO.

Chairman ARCHER. Correct.

Mr. TAUZIN. The bottom line is that under these trade agreements, value-added taxes can be rebated back when the sale is

made to another country.

So in effect the foreign product comes in and is purchased valueadded-tax free. We can’t do that with our income tax code under

those agreements.

Our income tax code adds this 25 percent to the cost of the automobiles made in America to any product we make in America. It

is shipped overseas and, guess what, the value-added tax is then

assessed on those products overseas.

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So they pay both the income tax in America and the value-added

tax overseas. Whereas the foreign product pays whatever income

tax they have in that country with the value-added taxes rebated.

That is a natural advantage to the foreign product.

And let me say it again, Mr. Chairman. When you get rid of the

income tax, you get rid of that 25 percent hidden tax on American

products both consumed in America and shipped overseas.

So suddenly if you do this, if you go to a national sales tax, the

American exported product gets taxed only once with the VAT tax

overseas, instead of being taxed here in America first for the 25

percent burden, as Mr. Traficant pointed out, and then getting

taxed twice.

You do achieve border adjustability.

Now let me concede to Mr. Armey. Nobody can say what is going

to happen in future trade agreements, future exchange rates, but

it is inconceivable to me that we can suffer this huge trade deficit

with 19,000 American jobs lost for every $1 billion of that trade

deficit, and not adjust our own tax code to deal with it. And we can

and we should, if we adopt a national sales tax.

Chairman ARCHER. Do you believe—and, Mr. Traficant, I will

recognize you in a minute—do you believe that it is fairer for foreign products to be able to enter this country under an income tax

system and pay no share of our cost of government or to have to

hear some of the burdens of this society?

Mr. TRAFICANT. Absolutely not, Mr. Chairman. This is a Final

Retail Sales Tax Act. That Cavalier made in Lordstown is only

taxes at 15 percent if it is bought in America.

If that baby is exported, it carries no 15 percent and would only

be subject, as Billy said, to the VAT or the taxes of those particular

countries.

I know you are working feverishly on leveling the playing field,

but that is an awful big part of that. But let us also look at the

double taxation.

Now we sell that Cavalier, or we sell that Toyota that is made

overseas. It comes in. It carries now that 15 percent tax just like

the Cavalier.

Now we pay $20,000 for the car. Now it is $23,000. We sell it

in four years for $12,000. Now $12,000 of that car we did not use.

So there is a deduct for the unused portion of the consumption that

we originally paid.

So we are not taxing everybody twice, which we are also doing.

We take that dollar on income. We pay an income tax on it. We

put it in the bank. We take it out to buy the car, pay a tax on the

interest, then pay a sales tax on the car with a 24 percent cost factor due to the tax code.

So I think the only reasonable tax scheme that has to be thoroughly investigated is one which adjusts that border-tax issue, or

our trade deficit will continue to balloon because our free enterprise system is designed to produce at the lowest cost, thus forcing

our manufacturers into Mexico, forcing them over into China to

produce an item which we could perhaps produce in America competitively by reducing that heavy load.

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Chairman ARCHER. I am trying to understand the disconnect between what Mr. Armey is saying and what the two of you are saying.

He says that he is leveling the playing field with his proposal.

You are saying I take it that he is not leveling it?

He is further saying that your proposal creates an unlevel playing field which benefits the United States of America, and that

unlevel playing field runs contrary to what he is attempting to

achieve in his tax proposal.

I am just trying to understand the difference between you.

Mr. TAUZIN. Let me try. Mr. Armey’s proposal does level the

playing field of paying taxes in America. It is a flat rate. Everybody

pays the same once you take your family deduction.

I applaud that. I think it is a much better plan than our current

income tax code.

But there is another playing field outside of the one that we play

on here in America. That is the global economy. In that playing

field, simply flattening income tax rates will not do anything about

the inequity of American products being taxed twice in global

trade, and foreign products only being taxed once when they are

brought to America.

That is the second playing field, if you will, that ought to be leveled.

Now you can argue about whether our bill levels it fairly or not,

but it aims at leveling it. It aims at not only leveling the playing

field inside our country with the simple flat rate everybody pays

above the poverty line because we take care of income under poverty, but it also levels the playing field at the border which is the

second one that as you pointed out, Mr. Chairman, may be the

most important in the long run as this country goes more and more

into global economic trade.

Mr. TRAFICANT. Mr. Chairman, I would like to amplify on that.

There is a third playing field. And let me say this. I think Mr.

Armey has done a great service, and it may be his legislation enacted into law, because I do not know if America is progressive

enough yet to take a hard look. It takes years to make changes.

But there is a third playing field no one is looking at, and Mr.

Armey’s tax scheme does not even attempt to challenge it let along

our current system. That is. The underground economy that avoids

the payment of income tax, that many times is selling drugs on the

street and getting an SSI check, where we are sponsoring literally

with our tax dollars, subsidizing individuals who are paying no

taxes.

Remember this. If that drug dealer buys a car, he is going to pay

the same tax as Mr. Armey will, or Mr. Archer will. Every final retail sale is taxed with provisions to protect those on the bottom,

and with the Consumer Price Index being calculated each year and

adjusted for a COLA increase for those at the top.

So are we concerned about our seniors? We must be. We must

be very careful.

Second of all, we are concerned about those at the bottom end

of the ladder. I have many of them. But why should I continue to

have an underground economy that goes untaxed with the continuing complication of submitting any forms when we can do away

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with forms and truly simplify it and raise revenue from all transactions.

That is the third playing field that I think is not being addressed

by Congress and should be a salient point in the discussion.

Chairman ARCHER. Mr. Armey, you are outnumbered there. You

certainly deserve to have an opportunity to respond.

Mr. ARMEY. Let me comment on both things.

I know this Committee is going to seriously undertake the task

of writing a new tax code and I applaud you for that. I think this

Committee should try to write a national sales tax, or even try to

write a national value-added tax. I think you ought to try.

But in this process of doing that, I think you ought to take a

hard scholarly look at border adjustability. It is a very complex and

difficult subject fraught with a lot of misconception, almost mysterious at times, and you should have if you are going to try to sacrifice one of the what I think precious principles of tax law and engage in social engineering and income redistribution scheme called

border adjustability, then I think you ought to have some very

sober assessment as to whether or not it would work.

Because border adjustability is about trying to redistribute income between Americans and foreigners, and trying to encourage

Americans specifically to buy American-made products as opposed

to foreign. Those are social engineering objectives.

I think you will find when you study it thoroughly that it is ill

advised and does not achieve the desired results.

Now the question of the underground economy must also be understood. It is wrong to say that you will capture the underground

economy with a sales tax and you will not do so with an income

tax.

In a world of income tax, a person who otherwise earns his income honestly pays income tax on his income and then buys cocaine from someone who earns his income dishonestly who does not

in turn pay income tax on his ill-gotten gains through the peddling

of cocaine.

In a sales-tax world, a person who otherwise earns his income

honestly does not pay sales tax on his purchase of cocaine and the

person who receives the income dishonestly may in fact pay sales

tax on his purchase of an automobile.

But I can tell you, if the guy is smart enough to figure out how

to acquire and sell cocaine and avoid taxes in that, he will figure

out how to avoid paying his sales tax. Indeed, empirically speaking,

we know as a matter of fact that every nation state in the world

that has ever tried to implement a national sales tax has found the

size of their underground economy has in fact grown.

The most recent case is Canada where they found that the use

of cash in the Canadian economy doubled within six months of

their implementing a national sales tax. Because the fact of the

matter is, a national sales tax does not capture the underground

economy; it encourages it to grow larger.

Now I too am concerned about the underground economy. There

are two aspects of the underground economy. I think my flat tax

addresses the one that breaks your heart the most.

The first part of the underground economy, the one we like to

talk about, is people dealing in illegal transactions—contraband,

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dope dealers, bank robbers, people like that. Well obviously that is

a question of criminal law not tax law.

The second, and the one that breaks your heart, is the guy who

looks at the current tax code—he is otherwise normally very honest

in his dealings in life and would love to be a person who would fulfill all of his contract with America by saying, yes, I will voluntarily pay my taxes but the tax code is so unfair in the way it gives

breaks to people other than myself that I have a right to give myself a break.

It is so complex in terms of all the data points it must track, that

they are never going to find me if I do give myself that tax break.

And that person succumbs to the temptation to, while otherwise

is almost perfectly honest in his life, cheat on his taxes because it

is a corrupt system and administered in a nonfair way by meanspirited people. And besides that, they are treating my brother-inlaw different than they are treating me, so I have got a right to

give myself a break.

The flat tax ends that. The flat tax, you know I have a simple,

decent, honest, fair tax code that is perfectly well understood not

only by me but by my 8th grader, and it treats my brother-in-law

exactly the same as it treats me so I have no excuse to cheat on

such a fair system. And besides that, it has to track so few data

points they would catch me if I did.

And you will get rid of most of the underground economy, but

you will have to take care of the drug dealers with another method.

Chairman ARCHER. I have got one last question to ask for both

of you, and then I have presumed too much on the time of the

other Members.

Mr. Armey, what percent rate on your flat tax is required to give

us revenue neutrality, to raise the same amount of revenues we

currently raise from the income tax?

Mr. ARMEY. Let me say first of all, I appreciate that. I never

strived for revenue neutrality when I wrote the flat tax. I wrote the

flat tax in 1994, and I was perfectly content to get within $30 billion of total expenditures. That is based on my personal belief that

the Federal Government is already too big and spends too much of

our money and spends it too wastefully.

So given the formula the formula that I worked out at the time

and the size of the personal exemption that I chose to give to the

family, I came up with 17 percent. That is something that would

be wholly in the discretion of the Committee of course as you wrote

the bill.

I believe that if I went back in these surplus times and went

through the scoring process to rewrite the flat tax, that I might

come up with a different rate and it might be lower than 17 percent.

It troubles me a little bit. As you know, you can read about the

flat tax on my web site at flattax.house.com, or you can buy and

read my book in which case we would both profit, or you can find

out.

There is a tendency on the part of people to believe that a flat

tax must be 17 percent. I know the Canadians are talking about

that and one or two other countries are talking about it. So we

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should never get ourselves fixed to a percentage as the necessary

percentage.

My own view is in these surplus times we could get the level of

revenue neutrality we have found acceptable, given our other budgetary patterns and still be under 17 percent, but that would have

to be something the Committee would have to work out.

Chairman ARCHER. Well, Mr. Armey, that is all very interesting,

but on that basis, Mr. Tauzin could say, well, we are only have a

ten percent sales tax. We are going to arbitrarily pick that, and

give a tax reduction to everybody.

And do not bother us with trying to duplicate current revenues.

But as this Committee begins to pursue alternatives to the current tax system, we must put them all, as you say, on a level playing field.

Mr. ARMEY. Umm hmm.

Chairman ARCHER. So we must know what the rate is on your

proposal to duplicate current revenues, which is the level playing

field on which we compare every proposal.

Mr. ARMEY. I would be more than happy to have you apply that

test with the apparatus of your joint tax committee and your scoring apparatus. When you mark up the flat income tax, I know you

will apply that test, and you will come up with a rate. Whatever

that rate is, it will be still welcomed by the American people.

By the same token, should you decide to mark up a national

sales tax, or a national value-added tax, again, this committee

making that mark would have to determine what that rate would

have to be.

Chairman ARCHER. Well, it just so happens that the Joint Committee has done an updated analysis of your proposal, and the rate

on that is somewhere around 26 percent to duplicate current revenues.

If we went with a 17 percent rate, which I continue to still hear

promoted by the advocates of the flat tax, we are going to run massive deficits and we will more than use up the amount of tax relief

that is provided for in the budget that we are voting on tomorrow.

Mr. ARMEY. Well, the first thing I would ask you, Mr. Chairman,

is give me the joint tax committee’s report, and I will, within a day

or two, find out what their mistakes are. I do not believe they have

evaluated my flat tax. We will take a look at it but I have not seen

any scorekeeping on the flat tax that has ever come anywhere near

that figure.

Treasury, a few years ago, came out with a figure like that.

Within a day-and-a-half, we showed them their mistakes and they

retracted their study because in fact, under their study, they found

out that they could get—when made the adjustment for the errors,

they came back to 17 percent.

Chairman ARCHER. Your proposal is in statutory language and it

has been specifically been submitted to the Joint Committee.

Mr. ARMEY. Well, I will have to go over their work.

Chairman ARCHER. And the Joint Committee’s estimates in the

end, whether it is the AFT proposal, whether it is a Tauzin-Traficant proposal, whether it is the USA proposal, will be judged based

on the Joint Committee’s estimates.

Mr. ARMEY. No doubt about it.

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Chairman ARCHER. And I have debated with them for many,

many years about their estimates on capital gains and a lot of

other things and I have always lost.

And whatever they say will be the criteria for what we do in this

Committee. And the proponents of the flat tax have got to get honest with the American people, along with the proponents of every

other proposal, and admit to a rate that will duplicate current revenues.

And to make comparisons on rates that do not do that is not

level playing field.

Mr. ARMEY. Well, Mr. Chairman, let me just say I have not seen

the joint tax committee’s evaluation of it. I have not seen any evaluation like this from them or anyone else except the errant one

that the Treasury Department retracted three or four years ago.

I would be happy to look at it.

The last thing that I want in arguing for a decent, honest, simple, neutral tax code is for me to make arguments that are not

themselves honest.

I reserve the right, when joint tax works, to look at that. It is

possible they have not in fact scored my bill as I wrote it or think

I wrote it, and if they point some error in the interpretation of the

bill that causes such an aberration in the scoring, I would be happy

to address that in a rewrite of the bill, as I am sure the Committee

would be.

But I do not think it is appropriate for you to suggest that I have

not been honest on the bill based on some scoring made by the

Joint Tax Committee that I have not seen.

Chairman ARCHER. Well, the Treasury scoring is not what we

abide by in the Congress, as you well know. So that needs not be

referred to.

What we do abide by is the Joint Tax Committee scoring, and

they have never scored your proposal as being revenue neutral at

17 percent.

Mr. ARMEY. I have never asked them to.

Chairman ARCHER. From the beginning until today. And the argument in the past has been, no, we know it is not revenue neutral, we wanted to give tax relief to the American people.

That is fine. But if we are going to compare on a level playing

field, then we have got to have a percent that will duplicate current

revenues. Then if want to give tax relief, we can make an adjustment.

Mr. ARMEY. Mr. Chairman, I have never at any time since I first

rewrote the flat tax in 1994 ever suggested it was my objective to

be revenue neutral. I have always allowed that it would be the

Committee’s objective to do that, should they ever decide to mark

it up.

And I have always been more than willing to work with any

agency or persons that wanted to try to score this code.

If the Joint Tax has scored my proposal and come out with a conclusion that it would take 26 percent to get revenue neutral, I

would like to look at that. I believe they have made a mistake.

I think I have a right to challenge their scorekeeping. You certainly exercise that right. But I do not appreciate having it suggested in here that I have been out before America being dishonest

236

about this proposal, especially in light of the fact that I have not

even seen this scorekeeping and have not had a chance to evaluate

it.

Four years ago, when the Treasury Department made these pronouncements, in a day-and-a-half, we had them retracting their

study because they were wrong. And I fully accept the possibility

that the Joint Tax Committee has as much chance to be wrong as

I do, but I certainly will not have my integrity impugned on the

basis of a study I have not seen.

Chairman ARCHER. Let me say to my friend, I am not impugning

your integrity because I think you have honestly said that the 17

percent is short and that you want to give a tax relief to the American people.

But if we are going to compare alternative plans before this Committee, then we cannot have every proponent say, oh, well I intended to give tax relief.

We have got to have a rate that compares on a level playing

field. And the ultimate determinator of that will be the Joint Tax

Committee, not the Treasury. And irrespective of what arguments

any of us might have with them, they will be the supreme court,

as they always are.

And we must follow that and go with it.

Mr. ARMEY. I think, Mr. Chairman, if you do not mind, we find

ourselves in perfect agreement. I am offering you a form, a structure within which to write the tax code. It will be scored by Joint

Taxes, as will everybody else’s.

And I am going back to where I began this conversation, when

this Committee sits down and goes about the business of writing

a new tax code, you will, even if you try to write a national sales

tax or a national value-added tax, quickly come to the conclusion

that your time is better spent forsaking that impossible task and

writing the flat tax.

Chairman ARCHER. Mr. Tauzin, what percent on your sales tax

will duplicate current revenues?

Mr. TAUZIN. Here is how we calculate it, Mr. Chairman?

Chairman ARCHER. Do you have a Joint Committee estimate yet?

Mr. TAUZIN. I do not think we do. But it is a very simple formula. I will describe it to you, and I would do what Mr. Armey has

suggested it, submit it to the Joint Tax Committee.

Chairman ARCHER. Yes, I think that would be very helpful.

Mr. TAUZIN. Yes. I think they have done some work on the Fair

Tax you heard yesterday.

Ours does not repeal all the payroll taxes, nor does it contain an

extra rebate, so it will differ dramatically from any scoring you already have on the Fair Tax.

Let me tell you how we came to it.

We took the total amount of taxes we repealed, the income tax,

the gift tax, inheritance taxes, certain amount of excise taxes, we

added to it the commissions that would be paid to the state and

the retailers for collecting our tax, we divided that total into the

total consumption as reported by the Department of Commerce,

and we came up with a percentage.

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Pretty simple formula. The percentage you come up with, if you

do that work, will be 12.9 percent, 12.9 percent national retail sales

tax would duplicate the income lost from all the taxes we repealed.

We did not stop there. Because our plan also repeals the payroll

savings tax on all income earned under poverty.

We took that amount of taxes, divided that into the amount of

total consumption, and you get a two percent rate. That is the

amount of sales tax it would take to compensate Social Security,

Medicare for the loss of payroll taxes collected on all income under

poverty.

That two percent was added to the 12.9 percent to arrive at our

15 percent national rate. That is the rate that according to this

simple math, replicates the amount of income that would be produced from the following totals.

The income tax repeal on individuals and corporations, from the

gift taxes we repealed, from the death taxes we repealed, from the

commissions we pay to the states, and for the payroll taxes we repeal under the poverty line.

Add up all those totals, divide it into the total consumption as

reported by the Department of Commerce, and you will get a little

less than a 15 percent rate.

Chairman ARCHER. I would appreciate it if you would get a copy

of your proposal to me so that I can get it scored by the Joint Tax

Committee.

Mr. TAUZIN. Count on it, Mr. Chairman. We will do that immediately.

Chairman ARCHER. And then just finally, before I yield to other

members, Mr. Armey, does your proposal repeal the death tax too?

Mr. ARMEY. Yes, it does. It ends all forms of double taxation.

Chairman ARCHER. Okay, thank you.

Okay, Mr. Doggett.

Mr. DOGGETT. Thank you very much.

Mr. Armey, if I understand correctly, despite your obvious affection for Mr. Archer and Mr. Tauzin and Mr. Linder, you are unalterably opposed to their proposal for a national sales tax.

As you told Fox News on Sunday, ‘‘it does not work and furthermore it is regressive and it inevitably adds to a tax code that is

equally as complex as today’s income tax.’’

Does that remain your opinion?

Mr. ARMEY. My opinion is that, first of all, the current tax code

must be forsaken, we have got to get rid of it, get behind it. The

best way to do that, the most effective way to do that is the flat

tax. It is the only proposal I know of that can be written, can be

enacted, and can be complied with by the taxpayers.

Mr. DOGGETT. But I have accurately quoted your interview with

Fox. And that remains your position.

You think that their idea is a very bad idea that this Congress

should reject?

Mr. ARMEY. I think their idea is a much better idea than the current tax code as we know it. I believe that in the effort to actually

sitting down, writing it out, enacting it, that you will find it is an

impossible task.

Mr. DOGGETT. Thank you.

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And there was some reference to a Joint Tax Committee analysis

of your proposal. The only one I have seen, Mr. Chairman, is the

one yesterday that said that this sales tax would have to be at a

59 percent level.

Is there one now available analyzing this flat tax too?

Chairman ARCHER. I am told that three is and I am requesting

a copy of it in writing which I will be happy to.

Mr. TAUZIN. Mr. Doggett?

Mr. DOGGETT. Thanks. I am going to get to you in just one

minute because I have got some questions I want to ask you too,

Billy.

And as far as you mentioned a markup, has a markup been set

on this flat tax yet. Mr. Armey was referencing a flat tax markup.

Chairman ARCHER. I am not sure to what he refers.

Mr. DOGGETT. Okay. Well, let me move on to something else

then. Am I correct in understanding, Mr. Armey, that you remain

opposed to requiring the Section 527 political bank accounts, like

Mr. DeLay has set up to disclose their contributors and expenditures on the same basis that all of us, as federal candidates and

political action committees already do?

Mr. ARMEY. No. I have never said I am opposed to that. I think

I would be happy to have that kind of disclosure and for the 527,

for the labor unions, for any number of other organizations that are

out there now mucking around in our world with relative anonymity spending other people’s money.

What I am opposed to is just taking part of the issue to the floor

without this Committee exercising its jurisdiction on it.

Mr. DOGGETT. As far as 527 political organizations, whether the

money comes directly out of a labor union treasury from the Chinese government, from a corporate treasury, or from anyone else,

do you think that this problem of them taking unlimited amounts

of money and not telling what the source was is a problem that requires prompt action by this Congress and a floor vote?

Mr. ARMEY. I have mixed emotions about that. For the most part,

if the 527 complies with the performance requirements of such an

establishment, that is, does what is legally done under the law

given their charter, I am not sure that I have a need to know

where they receive their resources.

If in fact though, we want to make that disclosure requirement,

I would be happy to live with it, as long as it was evenly imposed

on all such organizations.

Mr. DOGGETT. But basically you do not think the fact that they

hide their contributors is a problem that this Congress needs to

deal with soon?

Mr. ARMEY. From my point of view, I do not care who is paying

your bills if you are minding your manners.

Mr. DOGGETT. Okay. And with reference to another issue that

you have expressed an opinion on, do I understand it is your view

that instead of the House acting promptly to address the problem

of abusive corporate tax shelters, as recommended by the American

Bar Association Tax Section and the Treasury Department, that it

remains your view that this Congress should instead encourage

corporate tax, I believe in your words, ‘‘avoidance is necessary and

legal and legitimate.’’

239

Mr. ARMEY. Tax avoidance is legal; tax evasion is illegal. This

government writes the laws. We ask the American people, whether

through individual or corporate behavior, to comply with the laws.

If they comply with the laws that we write, we have no complaint

about them.

If we want to rewrite the law, we should do so. That is why we

have a Ways and Means Committee, that is why we have a Senate

Finance Committee, and it is our prerogative and our duty to write

the law.

Mr. DOGGETT. But, again,—— Mr. ARMEY. But as we write the law, we should never exercise

any prerogative to complain about the legal compliance with the

law we write.

Mr. DOGGETT. In terms of your priorities, you do not see abuse

of corporate tax shelters as something this House needs to move on

promptly to address?

Mr. ARMEY. I believe that is addressed. Chairman Archer has addressed that repeatedly and recurringly and consistently throughout all his efforts—— Mr. DOGGETT. You see nothing further that needs to be done

in——

Mr. ARMEY. I did not say that. I am saying that I am not on this

Committee and I am not an expert of it. I have a Chairman though

that is distinguished in the respect that he commands across the

nation is unparalleled in his understanding of the Tax Code, and

I am more than happy to work with him and this Committee as

they move forward.

Mr. DOGGETT. As far as tax avoidance, does your proposal that

you are advancing here in front of the Committee, repeal those sections of the Internal Revenue Code that currently prohibit tax

avoidance?

Mr. ARMEY. Tax avoidance is legal, is a legal activity. Anybody

has a right to minimize their tax burden within the existence of the

law. This accounting 101. Everybody knows that.

Tax evasion is illegal activity. I do not believe that tax evasion

should be tolerated, and tax avoidance is a basic right of every taxpayer.

Mr. DOGGETT. You indicate that your concern in your written testimony with the many pages and the millions of words that are in

the Tax Code.

Can you advise us of how many hundreds or thousands of pages

have been added to the Tax Code during the time you have been

majority leader?

Mr. ARMEY. I have no idea, but I can tell you it is impossible to

do much of anything with this existing code except to abolish the

separate parts like we did with the marriage penalty or like we did

with the earnings limitation, cut it out. It is like cancer. You cut

out the lump completely and throw it away.

But this is one of the problems with the existing Tax Code. You

cannot either lower it or raise it without making it more complex.

Mr. DOGGETT. Is the number of pages or sections or pounds or

words that have been added to the Tax Code during the time you

have been majority leader something you could advise the Committee on?

240

Mr. ARMEY. I do not know the answer to that. It is roughly the

same as the number of pages that have been increased since you

have been on this Committee.

Mr. DOGGETT. Well, I have only been on it for about a year-anda-half. But in the last six years, you have added much more than

that, have not you?

Mr. ARMEY. I have no idea.

Mr. DOGGETT. No idea?

Mr. ARMEY. I do not count such things.

Mr. DOGGETT. Mr. Tauzin, let me see if I can get one idea from

you, and I only have one question for him, Mr. Chairman.

Do I understand that under your proposal, that you would view

as a significant federal revenue source, particularly in future years,

electronic commerce?

Mr. TAUZIN. No, we have not addressed the issue of electronic

commerce.

Mr. DOGGETT. Well, you are going to tax, as a federal revenue

source, all the sales over electronic commerce, are you not?

Mr. TAUZIN. No, we have not addressed that issue at all in the

plan. The plan was written before electronic commerce even began.

If you will let me answer.

Mr. DOGGETT. You cited some testimony and then you can elaborate on that. Your written testimony——

Mr. TAUZIN. Well, I am trying to answer you, Mr. Doggett, give

me the courtesy of an answer.

Mr. DOGGETT. Sure, if you would, sir. Your written testimony indicates you do not want to exempt anything, that it is important

that it be a broad-based tax. So if you would tell us if you plan to

or to not impose a sales tax on electronic commerce?

Mr. TAUZIN. Let me try it again. Let me try it again.

When the Joint Taxation Committee reviewed the Fair Tax plan

you heard yesterday, they stated very clearly that the estimate did

not assume that retail Internet sales would be subject.

We have not made an assumption one way or the other because

Internet retail sales now amount to less than two percent and 80

percent of those are in services that are not subject to sales taxes

today.

So let me make the point to you. The plan we wrote was written

to the advent of the beginning of this electronic commerce technology phenomenon.

If the decision of this Congress is, at any point, to subject Internet sales, goods or services, to taxation by any jurisdiction, that is

a decision we will make separate and apart from the decision we

make on changing the income tax code to a consumption tax code.

We did not assume Internet commerce sales in our numbers.

They were not in our 15 percent projection. If Internet commerce

becomes a major part, as it certainly will be, we will have to address that as a separate issue as written——

Mr. TRAFICANT. Will the gentleman yield.

Mr. DOGGETT. Mr. Tauzin, as written, and as presented to the

Committee today, your bill contains no exemption for Internet commerce sales, does it?

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Mr. TAUZIN. Let me say it again. The bill was written prior to

the advent of Internet sales and sales taxes on the Internet even

becoming an issue.

Let me make a point to you. If the decision of our Congress, at

some point, was to reject a recommendation of the Commission that

we created, that is, recommended no taxes on Internet, if we reverse that decision and decided that the states and localities did

have a right to collect the sales tax on those, or if we wanted to

impose the national sales tax on those numbers, those numbers

would then be calculated——

Mr. DOGGETT. I appreciate that. But you understand, of course,

since you referred to the Joint Tax Committee, that when scoring

the Fair Tax, they included Internet sales and said it would be substantially higher than 59 percent sales tax if you did not include

Internet sales.

And if we passed your bill as you presented it today, it would impose a sales tax on every bit of E-commerce in this country today.

Mr. TAUZIN. Let me say it again. The assumptions we made in

our bill were based upon the current economy. The current economy without the advent of substantial——

Mr. DOGGETT. In what year?

Mr. TAUZIN. I am sorry?

Mr. DOGGETT. In what year?

Mr. TAUZIN. We started the bill in 1996, I think it was.

Mr. DOGGETT. We had pretty good E-commerce going down our

way in 1996.

Mr. TAUZIN. Yes. No. You did not have any E-commerce?No, sir.

In fact, a browser was presented to the American public in 1995.

If you had a lot of E-commerce going in 1996, Texas was substantially ahead of the world.

Mr. DOGGETT. It usually is.

Mr. TAUZIN. It usually is. And guess what Texas did, sir? Texas

does not have any income tax, it has a sales tax. And when Mr.

Armey talking about there being no great country in the world that

has ever gotten rid of the income taxes and adopted a sales tax and

done well with it, he neglected to say that the great country of

Texas has made that decision and has done fairly well with it.

In fact, the states that have gotten rid of their income taxes and

have gone to sales taxes do substantially better economically than

the states who either have income taxes or a combination of the

two. Texas is a good example why we ought to do this for the country.

Why does it make sense to locate in a state which has an income

tax that is going to add to the cost of doing business, when you can

locate in the great State of Texas and pay no income taxes, and

simply have others pay the taxes when they buy your products?

Texas understands that.

Mr. Doggett, you ought to understand it too, sir.

Chairman ARCHER. That is a good place to terminate this.

Mr. TRAFICANT. Mr. Chairman, I want to make one quick response, if I could, to my fellow Democrat.

Our bill would repeal corporate income taxes, shelters would not

be a big problem.

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Second of all, if this Committee would ever decide to tax the

Internet, it would raise more revenue with our bill.

And I think that the numbers you are throwing around are very

arbitrary, and I do not think they come from sound, pragmatic information.

Now let me just close by saying this. You had about ten minutes.

One thing I think is important in this process, whether you are

Democrat or Republican. We are trying to help the American people. And one thing we do not want to do is scare the American people by pushing partisan concepts.

And I would just like to say that I believe that our plan, at 15

percent, is tentative. And I have talked to the Chairman myself. I

believe that it is something we can work out and make manageable

at a figure much lower than a flat income tax.

Chairman ARCHER. Let me speak just briefly to what my colleague, Mr. Doggett, alluded to which appeared to me to be an effort to say that Republicans have complicated the Tax Code.

Now maybe I am misreading the inquiry.

First, the number of pages that we have to comply with and the

number of words that we have to comply with is primarily being

churned out by regulations out of the Treasury and the IRS. And

they are spewing out by the hundreds of thousands.

The number of additional pages to the Tax Code that have occurred in the last six years, I regret. But the gentleman from Texas

realizes that the only tax bill that has been passed was the one in

1997 that was negotiated with the Administration which insisted

on provisions that I could not prevent that thoroughly complicated

the Code and required many, many extra pages.

Now you cannot have it both ways. On the one hand, you cannot

say the Administration is responsible for the wonderful economy,

but the Congress is responsible for extra pages in the Tax Code.

That does not wash.

And so let the record be very clear about that.

Mr. English?

Mr. ENGLISH. Thank you, Mr. Chairman.

And Mr. Chairman, I want to compliment your performance

chairing this hearing in that you have given a great deal of time

for a variety of views to be heard and you have not strictly honored

the time limits.

I am going to keep my remarks brief. I want to compliment these

two gentlemen for the exceptional job they have done and the majority leader has done of framing the issues of tax reform.

You were not present earlier today when we heard testimony

with regard to my tax proposal which has some similarities to

yours.

And on the business side, there are some clear similarities that

I would like you to comment on.

Mr. J.D. Foster from the Tax Foundation described the value of

border adjustability very clearly.

And Mr. Tauzin, you and Mr. Traficant have also made a strong

case for it here.

Mr. Foster talked about, in effect, importing the tax base of our

competitor countries when exports are taxed.

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Mr. Hufbauer, on the second panel, talked about how a border

adjustable tax eliminates the tax motive for runaway plants.

I know, Mr. Traficant, that has been the source of a lot of your

interest in some of these issues.

I wonder if either of you could comment on the effect that your

plan would have on the cost of capital for businesses trying to compete in the international marketplace?

Mr. TAUZIN. Well, let me turn your attention, Mr. English, to the

study done by Dale Yargenson at Harvard University.

Mr. ENGLISH. I am familiar with it.

Mr. TAUZIN. He indicates in there that, in the long term, in the

long run, producer prices in America would fall by almost 25 percent relative to prices under an income tax code.

Now, when producer prices fall and you are shifting away from

a tax code that penalizes savings and investment to one that rewards savings and investment, and only taxes consumption, the

combination of consumer prices falling, which means lower cost to

produce products, and the combination of an incentive for savings

and investments, because there are no taxes on interest earned or

investment portfolios or capital gains any more, both combined to

increase savings rates and to lower the cost of capital to those people who want to invest and dramatically increase manufacturing

opportunities in the country.

In fact, his conclusion is, production would increase in all industries and the rise of production of investment goods would be much

more dramatic.

The combination would be, according to Dale Yargenson, absolutely phenomenal.

Mr. TRAFICANT. I would like to just quickly respond thereto, Mr.

English, and appreciate all your efforts that you have done on this.

Mr. ENGLISH. And we appreciate yours, sir.

Mr. TRAFICANT. I think that our bill will send a clear message

to the world that if you are going to play in the biggest marketplace, the flea market of the world, it might be good to put some

roots in there, rather than look at 15 or 16 or 17 percent when the

Chairman is done, ultimately looking at the numbers and the

prices.

And that Toyota may not be shipped into America, it is going to

be built in America because they are going to want to take that

competitive advantage away that American firm is going to have.

When we drop the prices, the capital and the use of capital will

raise. When you are not taxing savings and investment, there is

going to be more savings, thus there is going to be more capital,

thus we are going to have a downward spiral on inflation with a

built-in hedge against inflation which will provide more capital the

normal way, through commercial loans that are caused by savings,

not by borrowing and foreign debt.

Mr. ENGLISH. That make excellent sense.

Let me also quickly, gentlemen, ask you one last time so we can

clarify.

Neither of you are here advocating Internet taxation, are you?

Mr. TAUZIN. Let me say that again. No, we have not.

Mr. ENGLISH. That is all you need to say.

Mr. TAUZIN. No, we have not.

244

I do want to correct the record that the Tax Committee report

that the gentleman referred to on the Fair Tax, that is not our

plan. That is a plan that was presented yesterday did make an assumption that Internet sales taxes would apply to the Internet.

We made no such assumption.

We leave it to the good sense of your Committee in drafting a

national sales tax plan along with the other members of Congress

who are going to have to make that difficult decision to decide it.

But if we decide it as a Congress, that goods and services sold

on the Internet were going to unfairly compromise in competitive

terms, goods and services sold within our states and that are currently taxed, if we wanted to rationalize a system, you can do it

within a national sales tax context a lot easier than you can trying

to let 1700 jurisdictions tax the Internet.

So while we make no judgment on that, Phil, we do not recommend it. We make the point that at least if you want to make

a decision on that, the national sales tax is a place where you can

reasonably and rationally make those decisions.

Mr. TRAFICANT. One thing I would just like to add briefly is if

that ever did happen, and we were to tax that Internet sale activity, it would be very hard to avoid the tax and to have an underground economy, would not it?

So I think that is a decision your Chairman and your Committee

makes, and our bill would be, in my opinion, an enhancer for revenue, but we do not have it as a part of our construct.

Mr. ENGLISH. Mr. Chairman, I have plenty of other questions,

but I think out of courtesy, I will leave them to another time.

Thank you.

Chairman ARCHER. I overlooked, in my preliminary comments, a

compliment to our colleague, Mr. Traficant, who was kind enough

to compliment me on the IRS Reform Act, and without his persevering efforts, I do not believe we would have shifted the burden

of proof, because he drove that issue or the levying on someone’s

homestead without a court order.

And those two vital provisions in that reform were driven by

Congressman Traficant, and I was pleased to be able to be a vehicle to carry his ideas into law.

Mr. TRAFICANT. Thank you, Mr. Chairman.

Those were some of those additional pages too, were not they?

Chairman ARCHER. Yes.

Mr. TRAFICANT. Those very good things.

Chairman ARCHER. Yes. Yes.

Mr. Collins?

Mr. COLLINS. Thank you, Mr. Chairman.

You know, Mr. Chairman, I think it is interesting and good that

we have the dialogue among members especially as we have seen

here this afternoon. I have enjoyed listening to three Texans in the

dialogue. I have always heard that things are big in Texas. Some

people produce big ideas, some people produce big talk.

You know, I came here in the elections of ’92. I remember the

first yea here, the approach to the budget and deficit reduction was

a large tax increase. I do not how many pages it added to the Tax

Code, but I do know it some somewhere around $250 billion over

five years, and it taxed additional benefits on Social Security. It

245

took the cap off the Medicare earnings for tax. It added an additional marginal rate. It also added a surtax in retroactive taxation

for the first time in history and a 4.3 percent fuel tax increase for

deficit reduction. That was the approach of that budget of 1993.

I also know that in the beginning of 1995, when a new majority

was formed in this town by the people across this country, that the

CBO, the Congressional Budget Office, reported that based on the

way the government was running, based on the previous majority,

the deficits over the next ten years from that date would be somewhere around $3 trillion negative cash flow.

Spending was wild. It was about as wild as the approach to the ’93 tax reform and budget.

I also know that the only tax relief that the American people

have seen was in 1997 and then our seniors last week with the

signing of the earnings limit repeal.

But I do know too that at the beginning of 1999, the Congressional Budget Office came back to the Congress and said, look,

based on the way the government is now operating, the approach

that we have taken to the budget process and to attempted taxation relief, a strong economy that has made by the people of this

country that the projections were over the next ten years, we would

have $3 trillion positive cash flow. Now a lot of people use the word

‘‘surplus,’’ but it is a positive cash flow.

And even came back the first of this year and said there would be another trillion, a $4 trillion positive cash flow.

I think that is quite substantial in comparison to any type of regulations the IRS may have added to the pages of the Tax Codes.

You know, I hear a lot and receive a lot of E-mail about the proposed Internet tax.

I think one of the reasons the people get up in arms so about a

proposed Internet tax is because they do not want an additional

tax. It is not that they are not looking for a fair tax, they just do

not want an additional tax. They are already taxed too much as it

is.

And I have always felt like that excessive taxation comes from

excessive spending. We still have some spending that we need to

address, even as the majority.

Mr. Chairman, I appreciate the gentlemen that have been here

to offer their proposals on a flat income tax and a flat national

sales tax.

And to quote a good friend of mine from my district that used

to serve in the Congress of the United States, at home I have

friends for the flat income tax and I have friends for the flat sales

tax. And, Mr. Chairman, I am for my friends.

We thank you for this dialogue, we thank you for this hearing,

and we appreciate our colleagues coming with their comments and

their proposals.

Thank you, Mr. Chairman.

Chairman ARCHER. Thank you, Mr. Collins.

Mr. Becerra?

Mr. BECERRA. Thank you, Mr. Chairman. And let me thank my

friend, Mr. Tauzin, for being such a sturdy character and being

able to sit there and take all the questions. We thank you for your

patience.

246

Mr. TAUZIN. Thank you, sir.

Mr. BECERRA. Let me go back to the Internet tax because I think

it is an important point to make. And I think you were trying to

be thoughtful in your response to that. That at the time you were

proposing this, we did not know the impact that the Internet would

have and the growth of sales on the Internet.

I think everyone agrees that it is going to continue to grow. And

right now, Congress has agreed on a moratorium on taking any action with regard to taxing the Internet.

In your written statement, in your testimony, you do say exempting entire categories of goods or services would inevitably lead to

an administrative nightmare of definitions.

If now, if what you are saying is that because we were expecting

the Internet to become such a major player in retail sales, you did

not take it into account, can you reconcile that with your statement

that if you start having exemptions of categories of goods or services, that this will inevitably lead to an administrative nightmare

of definitions.

How do you reconcile that now?

Mr. TAUZIN. Well let me explain to you what we meant by that,

what we mean by that.

The concern was that there are categories of purchases, like food

and drugs, that might or should be subject to an exemption. Because those are items that are used by all of us regardless of our

income and because those items tend to be necessities in life that

the people at the bottom there has been a disproportionate share

of their income in order to purchase.

Many states give exemptions for food and drugs and other items.

All of those states have experienced bureaucratic nightmares with

their exemption program. Is Cheetos a food or an entertainment?

Who knows what it is?

So they have come with some bizarre descriptions of what is a

food that is exempt and what is not. And we have tried to avoid

that by simply providing the 15 percent rebate into a worker’s salary for the amount of money that otherwise would have gone into

the Social Security Medicare Trust Fund from payroll taxes.

We make that up with a two percent add-on to the retail sales

tax.

In effect, we found a simple way of compensating people at the

bottom for the taxes they would pay on necessities like food and

drugs.

Mr. BECERRA. Now, let me keep you focused at this stage, and

I am not asking you this is what you would do in your legislation.

But at this stage, now knowing what you know about the

Internet——

Mr. TAUZIN. Let’s talk about it.

Mr. BECERRA.—yeah, what is your sense right now. How would

you treat the Internet in your legislation?

Would it be taxed so that there are no exemptions, or at this

stage, are you saying that maybe there is a need for an exemption

for Internet retail sales.

Mr. TAUZIN. Let’s talk about it.

First of all, understand that one of the reasons for a national

sales tax that I think is superior to a flat income tax is the border

247

adjustability question. The problem is that American workers are

penalized when they buy their own products and rewarded when

they buy foreign products.

If you want to keep to that border adjustability you have to at

least make room in your plan for the notion that you cannot let

American consumers buy foreign goods over the Internet and escape the border adjustable tax.

So you probably have to take that into the consideration in the

context of a formal plan that we would eventually adopt taking into

account Internet sales.

Mr. BECERRA. But then how would you account for the difference

between prescription drugs that are produced here in America

versus abroad? Would you now make an exemption for seniors on

Medicare who are on fixed income who have to purchase drugs to

now have the exempted from the tax, or will they have to pay a

tax?

Mr. TAUZIN. I do not think that is the issue because our plan provides a rebate whether you buy a foreign drug or a domestic drug.

You still get the 15 percent rebate, and we are still producing products in America, according to the Harvard study, at 25 percent less

cost than we are producing them today.

In effect, we are producing products in America that cost less

and you have more money to buy them with, so you still come out

better.

The issue you raise, though, which is a real one, is if you go to

a national sales tax base, in order to achieve border adjustability,

you must apply the tax to foreign imported product, then must you

simultaneously apply it to a domestic product that is purchased

over the Internet as opposed to purchased in a brick and mortar

store?

And the answer is, you may well have to. You may end up with

that conclusion. Because to exempt it might create a problem with

WTO.

Mr. BECERRA. So what I hear you saying is. Probably look at an

exemption so that you can compete with foreign sales, but not an

exemption if it is a retail sale over the Internet domestically?

Mr. TAUZIN. No, what I am saying is I think you have to apply

the same rule to both.

Mr. BECERRA. But then you would exempt domestic sales as

well?

Mr. TAUZIN. If you ended up deciding you wanted to exempt all

domestic sales on the Internet from the national sales tax, I think

you would have to exempt the foreign imported purchases as well.

Therefore, I think you would probably have to do what the Joint

Tax Commission did. You would probably have to assume that they

are all either subject to taxation or not.

And that is, as I said, is a decision we are going to collectively

have to make.

Mr. BECERRA. But then what you are going to end up with is a

higher tax rate on your sales tax because, as the Joint Tax Committee has said, that with the AFT proposal, which is similar to

yours, as a consumption tax, they assume that the Internet retail

sales will be taxed, and if they are not, that means the tax rate

you would have to impose on sales would have to be even higher.

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So you are going to have to impose a higher rate which is a higher rate for that drug purchase by that senior for those prescription

drugs or for funeral services or for medical services.

If I go have a surgery, a lifesaving surgery, I will have to pay

taxes on that, that someone who has got the good fortune to be able

to purchase on the Internet will have those particular purchases

exempted from the tax.

Mr. TAUZIN. That is my point. I think you either have to come

to the conclusion that you exempt them all, in which case you have

a reduction in income not just to the federal system, but to all the

state and local jurisdictions.

You have to come to a conclusion that you have to rationalize the

tax collection across the board. I think we end up, at some point,

deciding the latter, but that is a decision we all have to make.

If you do exempt them across the board, of course you need higher rates on that which is not exempted. That is why we start with

the proposition that you ought to at least start with the notion that

the fewer exemptions the better, because that applies a uniform

treatment to all parties in the marketplace.

And secondly, that you ought to keep the rate as low as possible

so that you spread the burden across the spectrum of consumers.

Always keep in mind that we protect those at the bottom.

And I appreciate your reminding me of that because my friend

from Texas asked Mr. Armey to reiterate his quote on the news

show this weekend.

I heard him this weekend, and I almost called him up because

he is never said that in any of our debates, because he knows better than to say that the plan we have presented is a regressive tax

plan.

You can have a sales tax that is regressive if you do not take

care of people under poverty. But we do. It is not regressive.

You know what is regressive? What is regressive is an income

tax code that adds 25 percent to the cost of every drug, every piece

of bread, every bottle of milk that a family buys to take care of

themselves. That is what goes on today.

Mr. BECERRA. And that is a notion that ultimately, if we were

to move towards a different system, would be tested because it still

stands to be seen if rates, prices on goods or services would actually go down.

Mr. TAUZIN. Let’s talk about that for a second.

Mr. BECERRA. Well, I know I am running out of time.

Mr. TAUZIN. I think we got time.

Mr. BECERRA. All right, but before we go there, let me ask you

this.

When do you think you will have some sense about what you will

do when your legislation with regard to Internet retail sales?

Mr. TAUZIN. Well, first of all, I would not do anything in the legislation to make that decision until we collectively make it as a

Congress.

You would have to decide whether, if you were going to national

sales tax, whether you wanted higher rates on the goods you do not

exempt in order to exempt goods on the Internet.

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I do not think you would make that decision. I think we would

end up deciding to cover them all equally at some point, but that

would be a decision we would make jointly.

Let me mention, let me answer the question you asked about

whether prices would fall. The answer is at your local Wal-Mart

today. Wal-Mart and K-Mart compete bitterly right now for your

and my dollars.

I understand they are operating on extremely small margins.

And if it was not a competitive marketplace, they could probably

raise their prices 25 percent, and you and I would have to pay it

if the only place we could go is to one or the other.

But because we have a competitive marketplace, they have to operate on small margins. They cannot gouge us. Competition does

that.

If Wal-Mart all of a sudden tomorrow, because we repealed the

Income Tax Code, is now able to buy goods for substantially less

than they did last week, and they try to sell them to us at the

same price as they did last week, they will find out that K-mart

is taking their business away.

Mr. BECERRA. But how are they purchasing them for less if they

are going to have to pay to purchase the goods that they are going

to sell are taxed?

Mr. TAUZIN. Ah, but they do not. Read the bill. The bill is only

a retail sales tax. There is no tax on the wholesale, there is no tax

on the purchase of raw materials.

Mr. BECERRA. Where is the savings on the goods that was produced?

Mr. TAUZIN. I am sorry?

Mr. BECERRA. Where is the saving on the good that is produced?

Mr. TAUZIN. Here is where it comes from. In an income tax

world, even a flat income tax world, the two professors who devised

Mr. Armey’s plan, Dr. Holland Rebushka have admitted this I

think in testimony to this Committee.

When you apply a tax on the earnings of individuals and the

earnings of corporations, you are effecting applying a VAT tax. You

are taxing the value added to the product as it goes through the

various stages of production.

At the very end, the consumer pays it all. It all ends up in the

price of the finished product. And you and I pay that tax at the

end.

Mr. BECERRA. Right. But you are talking about a wholesale product that has not gone through that whole——

Mr. TAUZIN. But this is my point to you. If you repeal income

taxes, and you only apply the tax in our plan at the very finished

product retail end, there are no taxes collected along the manufacturing process.

For example, the farmer does not pay a tax on the purchase of

seed and fertilizer because that is a tax for the purpose of producing a product. There is no tax on those things under our plan.

There is no tax on the purchase of the tractor designed for business or the rental for office space. The tax does not apply to the

miller, it does not apply to the baker, it does not apply to the

wholesaler. The tax is only collected, under our plan, at the very

end of the retail point of purchase.

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Mr. BECERRA. Well, let’s take food.

Mr. TAUZIN. Okay.

Mr. BECERRA. Anything grown in a field that is picked. Say there

is some——

Mr. TAUZIN. Let’s take wheat.

Mr. BECERRA. Wheat, or any kind of crop. There are only so

many taxes that will be charged and that is only a certain percentage. In the case of particular states, whatever it might be, whatever the sales tax might be in that process.

How do you get to the point where you are reducing the price by

the 30 or so percent——

Mr. TAUZIN. Twenty-five percent.

Mr. BECERRA. Twenty-five percent. You are ultimately still going

to have a price for that product which you are expecting to be able

to lower as a result of the elimination of income taxes along the

stream are all these various taxes.

But ultimately you are talking a lot about being able to reduce

wages to make up a lot of the difference since employees are no

longer paying income taxes. You are assuming you will be able to

reduce wages of employees to reduce the cost of employers in providing a particular good or service.

Mr. TAUZIN. No, we are not. And that is what—you have got to

look at Dale Yargenson’s study to see that. He does not calculate

a loss, a reduction in the wages. In fact, under our plan, the wages

go up by 7.5 percent.

Because you not only get your total wage, you also get the 7.5

percent your employer was formerly sending to the payroll system.

Mr. BECERRA. I thought you kept the payroll system? I thought

you kept the payroll tax?

Mr. TAUZIN. Pardon me?

Mr. BECERRA. I thought you kept the payroll tax?

Mr. TAUZIN. You keep it above the poverty line. We only repeal

it below the poverty line. So if all income earned up to the poverty

line, the worker gets his full paycheck plus that 7.5 percent his employer was sending in.

See, you have got a lot more money now to go buy your bread

and your milk and your drugs.

In addition, because the businesses will no longer be paying

taxes on the income earned on the raw materials, the wheat, eventually the flour, eventually the bread, eventually the packaged bed

products, eventually the donuts at Krispy Kreme, wherever you are

going, because none of the taxes are collected on the value-added

to those products and all the compliance cost is done away with,

all the lawyers and accountants the businesses have to hire to comply with the Code.

That saves you 25 percent——

Mr. BECERRA. But where are the taxes on strawberries? How

many levels of taxation are there on, say, strawberries that are

picked and then shipped directly to a grocery store?

Mr. TAUZIN. They are processed. Strawberries are first, you

know, there are farmers who grow them. They have to buy fertilizer, they have to own land, they have expenses. Farmers pay

taxes.

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If a farmer does not have to pay a tax on the income he makes

from the sale of his strawberries, that reduces the cost of the

strawberries to the consumer.

If the guy——

Mr. BECERRA. Where I think the disconnect between what you

are proposing and what will ultimately happen is that you are saying a quarter of the cost of all goods and services will be eliminated

by this particular change in the Tax Code?

Mr. TAUZIN. Yes.

Mr. BECERRA. And I think that is a big leap of faith. That folks

are out there saying, well, if I am going to pay this new higher tax

for a prescription drug, to bury my father, to have that medical

surgery that I need to stay alive, I want to know how I am paying

for it.

And you are asking a lot of folks to believe that all of a sudden,

we are going to see major drops in the cost of a lot of these products and services.

I know I have taken up a lot of time, Mr. Chairman.

Mr. TAUZIN. All I can tell you, Mr. Becerra, is that is the nature

of our free market competitive system.

Let me be honest with you. If there is a product out there and

if it is a cable service, and you have got no competitor to it, you

know, there is no direct broadcast satellite with local programming

into your town, and so you are bound to buy a cable if you want

your local program, I say that is a monopoly provider of service,

and our bill will not lower the cost there. Because any monopolist

can charge whatever he wants all the time in our marketplace.

But whenever you reduce the cost to any competitive player in

a competitive marketplace, you will eventually reduce the cost to

the consumer. Otherwise, somebody will take his business from

him.

That is the nature of competitive bread businesses and strawberry businesses.

Let me make a final——

Mr. BECERRA. Before you make that final point, I agree with

what you just said.

If you can reduce the cost to the producer, certainly in a competitive world the charge for that product will be lower for the consumer.

Mr. TAUZIN. I think that is correct.

Mr. BECERRA. But the consumer’s saying, you are telling me to

swallow, in some cases, a 30 to 60 percent tax on these products

and I am wondering if producers are going to be able to reduce the

cost that much so that I will not pay more.

That is where the leap of faith comes in.

Mr. TAUZIN. That is a fair question. The only thing I can tell you

is, again, that it is going to be different depending upon how many

stages of production are in a product.

For bread, it is about 35 percent. That is not my number. That

is numbers derived by people who have studied this carefully.

Dale Yargenson is not—the School of Economics at Harvard is

not the bastion of conservative thought. We are talking Harvard

University here.

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They are telling us the average reduction in producer prices is

25 percent of you get rid of the Income Tax Code.

Do you know what that says to you and I? That says that we are

being punished, as workers in our society, for buying the products

we make in America by 25 percent.

That is terrible.

Mr. BECERRA. You know, and we can always cite studies that

show that it would be different than the 25 to 30 percent drop in

the price.

The difficulty I think a number of folks have is that when you

need an operation, you cannot ask, well did the price drop on the

cost of that operation, which will now, under your tax scheme, be

taxed?

I will have to pay a tax on the $7,000 charge for that hospital bed, the $7,000 charge for that surgeon, the $5,000 charge for that

anesthesiologist and all of that is going to be taxed at a very high

rate, and I have got to hope for my life threatening surgery that

I need, the lifesaving surgery that I need, that in fact the prices

will have dropped.

And that could apply to the senior on fixed income who needs

prescription drugs.

That could apply to my father who passes away and I have got

to pay for funeral expenses if I do not have money. That is the difficulty I think folks have.

And you have been gracious and I thank you for the—— Mr. TAUZIN. Let me, let me just say one final thought.

Mr. BECERRA. Sure.

Mr. TAUZIN. You see, the perniciousness of our current Income

Tax Code is that it hides the truth from all the folks you have just

described who go buy those services today.

The ugly truth is that they are buying those services with aftertax dollars. They have already paid taxes on their income, they

have paid it on their savings, they have paid it, in some cases, on

their Social Security even. And then they go buy those services.

And the ugly truth is they are paying the same taxes all over

again, because the services and the goods they are buying made in

America contain all this hidden income tax cost.

That is the ugly truth, and if you face that ugly truth that we

are paying twice on the same dollars every time we buy necessities

of life in this country, unless you buy a foreign product, then you

come to the realization that you would be much better off paying

it only once at the end instead of paying it once on your income,

and then once on the purchase.

Mr. BECERRA. I do not think any American is deceived by the notion that we are going to be able to just get rid of the Tax Code

and not have to pay taxes.

I think every American believes that it is an obligation to keep

this country a civilized society.

Mr. TAUZIN. I agree with you. But if you had a choice of paying

once instead of twice, what would you choose?

Mr. BECERRA. I choose to pay the lower, whichever is lower, and

I think most people will say, at the end, I do not care which system

it is, it is the one that reduces my taxes most.

Mr. TAUZIN. That is right.

253

Mr. BECERRA. And I do not know if the consumer will say that

it is fairer to pay it one time at a high rate versus many times at

a smaller rate.

I think we have to ultimately assure the American people that

they are not going to be further taxed by having gone to a system,

even if it is simpler.

Mr. TAUZIN. That is a fair evaluation. I thank you for it.

Mr. BECERRA. Thank you.

Thank you, Mr. Chairman, for the time.

Chairman ARCHER. Thank you, Mr. Tauzin.

Mr. TAUZIN. Thank you, Mr. Chairman.

Chairman ARCHER. We appreciate your input.

The colloquy you just had with Mr. Becerra I think is fundamental and is very constructive and important for us to hear.

If I may just engage my colleague a moment further, the points

you are making are matters of concern that we have got to address

if we go in this direction.

I think it is important to note that fundamentally what we all

should try to achieve I think in how we tax is to create the greatest

opportunity for the greatest productivity and the greatest competitiveness in the world marketplace so that we can have an economy

that not only grows, which it is currently doing nicely today, but

which creates better jobs, better paying jobs.

We have full employment today. Hopefully, that will continue for

a long period of time.

But the important thing now is how do we elevate these jobs,

how do we have more in the family paychecks for all Americans,

and how much less does our tax system create inefficiencies, nonproductivity, waste, as it were.

We talk about waste in federal spending, but we have to also

talk about what waste there is in our tax system. We need to come

to grips with all of these and to make sure how it is going to affect

an individual product is important but perhaps not subject to precise quantification.

I would add a couple of things, and I will be glad to have a response from you because this will all go in the record and I think

that will be very helpful to consideration in the future:

That when we pay taxes, both the cost of the tax and the compliance costs are a cost of doing business. They must be recovered one

way or another. They are either going to be recovered by the investor getting a lesser return on their investment, or by labor being

paid less, or by the consumer being paid more.

There are really only three places for this to go.

Most people believe that in most products that it will be passed

on to the consumer in the price of the product rather than going

back against the investor and lowering wage rates.

To that degree, it must be recovered. But when we say there is

an average 20 to 25 percent, that does not mean that is the same

on every product. And the loaf of bread might be different than

medical care. And medical care might be different than purchasing

an insurance policy or whatever the rest of the activity is.

And yet when we talk about a loaf of bread, which is a good one

because it is a staple in all of our lives, what the farmer gets in

the wheat is minuscule compared to what the expansion of that

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price is through all of the middle men, the processor, and everything else. And those people really are on the front line in bearing

the burden of the income tax, both compliance costs as well as the

tax itself.

I cannot, nor can Mr. Tauzin, for sure tell you what it is going

to be on a loaf of bread. But we can tell you some averages. Because the one thing that is pretty basic is that compliance costs for

the current income tax which must be borne by our society are a

minimum of $200 billion a year. Fortune Magazine says they could be as much as $500- to $600

billion a year.

Now that is all wasted effort and somebody has got to pay for

it. It is not creating wealth. It is not creating bread, or any other

thing of real value in our lives. It is just a part that has to be administered under this tax system.

If we can cut that down by 90 percent, then the burden of any- where from $180 billion to perhaps $2– or $3– or $4 billion dollars

is going to be removed as a cost in the total economy. How it will

relate to any individual product we cannot absolutely be sure.

But I think as we seek, and this would be my overall objective,

and I think most of us would agree with it. We may not agree how

to get there. But that we should be very careful as we spend the

taxpayers money to assure that it is being spent efficiently.

By the same token, we should have as efficient a tax system as

we possibly can. That is a long number of words that I have put

out there, but I would be glad to have your response.

Mr. BECERRA. Mr. Chairman, I think most folks who may have

just heard your remarks would be nodding right now in full agreement.

Certainly any time that we are using money in the stream of the

economy just to pay for administration, above and beyond what is

necessary to get that product to market, is certainly an inefficiency

and we should try to eliminate the total cost, or at least reduce it

to the degree possible.

In fact, I think Mr. Tauzin and everyone else who has come before this Committee is completely genuine in their efforts to try to

come up with a system that just works better, whatever it might

be.

Obviously there are different beliefs about how we best do that.

My concern with any system, including the one we have now which

I agree is extremely cumbersome and every year we talk about its

cumbersomeness but we make it more cumbersome, my belief is

that whatever we do we have to be able to face every American and

say we have tried to do it by a change in the Code so that it helped

you.

I am not certain yet that I have heard a proposal yet that lets

me say it helped you—and by the ‘‘you’’ be able to reference as

many Americans as possible. I am not sure if I have heard a proposal that includes as many ‘‘you’’s as possible.

That is where I would be concerned. Because we get into this notion of what is on paper. It looks good on paper, but when you play

it out the terms we use ultimately are very different. As I always

say, it looks really good in the war room when the generals move

the war ship here and the tank there, it looks really good, but on

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the battlefield the folks that have to fight the war look at it a little

bit differently.

A quick example. I know that many folks, the Chairman referenced this full employment. Full employment means that we

have some 7—8 million Americans right now who are not working

because about 4 percent of America is not employed, and that includes only those who are actively searching.

I mention that because my father when he was still employed— now he is retired—used to be among those folks who would only

be partially employed because his work in road construction was

temporal. During rainy seasons he could not work because there

was no road construction that would take place.

So for three months out of the year, or sporadically throughout

the year whenever it would rain he could not work. He would always work. He would find something else to do to earn some

money. But he could not work in the field that he most practiced.

And while he was unemployed and had to either get unemployment compensation or try to find a second job, he really was not

unemployed. He was seeking out work. So those who are out there

meaningfully trying to find a full-time, well-paying job should not

be lost in the shuffle when we talk about full employment.

There are a lot of folks out there.

And in the same vein, as we try to reform the tax code to make

it better and fairer and more efficient, I think we have to remember that the bottom line is the guy that does have to go in for the

surgery. Are we going to make it easier for him to survive not just

the surgery but the cost of the surgery afterwards?

And as we buy the loaf of bread or buy the dental service or bury

our deceased loved ones, have we made the tax code work better

for them?

I do not think anyone approaches this without a real thoughtfulness and desire to improve our taxation system. But it is a lot bigger bear than most people would believe.

Chairman ARCHER. Well you have stated I think very well what

we should all strive for. My comment about full employment was

based on the economists saying we now have full employment. Not

to think that individuals are not sometimes covered up by the average and are still out there looking for work.

But the important thing is that we give the greatest economic opportunity to all Americans who want to get out and work, to be

able to work, and then not be content to simply have a job but to

improve——

Mr. BECERRA. That is right.

Chairman ARCHER.—The quality of that job and the amount of

pay.

Mr. BECERRA. That is right.

Chairman ARCHER. I feel so strongly that we must win the battle

of the global marketplace to be able to do that in the next Century.

Mr. BECERRA. I agree.

Chairman ARCHER. Thank you very much. You are excused.

[Laughter.]

Chairman ARCHER. The next panel, and the final panel for the

day, is Mr. Rogstad, Mr. Howard, Mr. Mack, and Mr. Rose who will

please come to the witness table.

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A hearty welcome to each of you. Thank you for your perseverance in waiting in the back of the room until you come and give

us the benefit of your input. We are most happy to have you.

Mr. Rogstad, if you would, lead off. I think all of you know the

general rules under which we operate, which is please identify

yourself for the record before you testify and, if possible, do not follow in the Chair’s footsteps. Try to limit your oral comments to five

minutes, if at all possible and, without objection, your entire printed statement will be inserted in the record.

Mr. Rogstad.

STATEMENT OF BARRY K. ROGSTAD, ECONOMIST AND

PRESIDENT, AMERICAN BUSINESS CONFERENCE

Mr. ROGSTAD. Thank you, Mr. Chairman. I am Barry Rogstad, an

economist and President of the American Business Conference. The

ABC is a nonpartisan coalition of chief executives of fast-growing

American businesses.

I applaud this Committee for conducting these hearings and

highlighting recent progress toward fundamental tax reform, and I

thank you for the opportunity to comment here today in particular

in support of Congressman English’s Simplified USA Tax Bill.

My comments are made from two perspectives:

First, as an economist and as a member of the team who worked

with Senators Domenici and Nunn in the development of the first

USA Tax legislation introduced in 1995.

And, as a representative of mid-size growth companies who have

a keen interest in tax restructuring and the contribution that it can

make to the growth and competitiveness of the American economy.

Today I am more convinced than ever that the USA Tax is the

best and most workable framework for achieving fundamental tax

reform.

I say that because:

One, it specifies the correct tax base, assuring that all income is

taxed and it is taxed once and only once.

Secondly, I think it drastically improves the neutrality in the tax

code with respect to the impact of taxes on the behavior of individuals, households, and businesses.

And thirdly, and I know this is controversial, it allows for a progressive rate structure and other provisions that, quite frankly in

my judgment, are necessary to achieve the political consensus required for final passage of any tax reform legislation.

I am here to support the bill introduced by Congressman

English, H.R. 134. Congressman English recognized the USA Tax

is a vastly superior method for treating international business

transactions and, most importantly, incorporates the correct treatment of individual saving and business investment.

The English Bill improves upon the original proposal by addressing provisions that were viewed by some as overly complex. These

concerns focused on the need to assure that saving was taxed once

and only once. Congressman English avoids this perceived complexity while removing the double tax on savings by relying on the

now well established Roth IRA framework.

We want to thank Congressman English and look forward to his

continued leadership of the USA Tax Reform.

257

From the perspective of American growth companies, I would

like to mention five important issues that basic tax reform must

address, and how the USA Tax succeeds in addressing each.

Of greatest importance is the level of saving and investment as

the foundation of continued economic growth and improved standard of living of our citizens. The current income tax, as you well

know, is biased against saving and investment and in favor of the

consumption uses of income. We continually ask ourselves as citizens and businesses, what is the rationale for a national policy that

reduces the level of our Nation’s seed corn that determines how our

country, its businesses and its citizens, prepare for the future?

Secondly, it is increasingly important in our ‘‘new economy,’’ that

we correctly tax human capital. We have come to recognize that it

is the skills and knowledge of our citizens that underscore productivity growth and our competitive advantage as a Nation.

Thirdly, the international implications of the USA Tax are very

significant to American businesses and their ability to compete on

a level playing field. Tax policy should seek to ensure that these

businesses make decisions based on market and operating conditions and not features contained in national tax regimes. Congressman English’s bill achieves this result.

Fourthly, moving towards a simpler and understandable tax system is an important objective of the business community. By moving from accrual accounting toward cash flow accounting, the USA

Tax reduces the complexity and compliance costs which businesses

now face. Expensing of all investment outlays not only assures the

correct specification of net income from capital in the tax base but

would be the single most important step in my judgment to the

simplification of our tax code.

Finally, growth companies, many of them knowledge intensive

and with little collateral on which to borrow, are critically dependent on equity financing. The current tax code, as you know, by favoring borrowing over equity investment generates a higher cost of

capital for growth companies. Bringing neutrality to debt and equity financing is a significant forward step achieved by the English

bill.

A couple of final comments just about the ramifications of the

first three of these points on the international marketplace.

First of all, on the saving question it is very difficult to argue

today in this rather remarkable economy that the low level of personal saving is a key problem. However, it certainly is. It is now

and will continue to be the core determinant of long-term growth.

I would suggest to you that one way of looking at the roughly

$340 billion current account deficit we incurred in 1999 is that we

are dependent to that amount on foreign saving. If we want to remove that dependency, tax reform is in order.

Secondly, this question of correctly taxing labor income can be a

great opportunity for tax reform. Tax reform is about getting the

tax base correct. By proposing to expense capital outlays, the USA

tax correctly specifies the net return to capital.

Neutrality in tax reform requires that we focus on taxing net income to human capital as well so that we tax the returns to capital

and labor equally.

258

I would suggest to you that the net income to human capital is

gross income minus the cost of producing that which are essentially

outlays for training and investment.

Congressman English’s bill allows up to $12,000 a year per

household for deductions for education outlays. I would suggest to

you that at some point in the deliberations about tax reform you

will see fit to deduct all expenses for investment in human capital,

the same way that we do for physical capital.

Finally, I just want to mention the international tax provisions

of this.

As you know, the English bill is territorial in nature. I think

territoriality provides a generic approach to dealing with the FSC

dilemma that we now face.

I think border-adjustability is an appropriate way for us to unilaterally level the playing field with foreign competitors.

I thank you, sir.

[The prepared statement follows:]

Statement of Barry K. Rogstad, Economist and President, American

Business Conference

Mr. Chairman and Members of the Committee:

I am Barry Rogstad, an economist and president of the American Business Conference (ABC). ABC is a nonpartisan coalition of chief executives of fast growing

midsize companies. The American Business Conference has never been a recipient

of a Federal Government grant or contract.

I applaud the Committee’s actions to hold this series of hearings on fundamental

tax reform, and its current focus on the effects of our tax code on the functioning

of American businesses in the international market place. By holding this series of

hearings you recognize that the current tax code remains a failed instrument. Nobody understands it. Everybody thinks it is unfair. It is systemically biased against

saving and investment. It extracts revenues from the economy in a hideously inefficient and expensive way. And through the specific focus of this hearing, the Committee highlights the blindness of the code to the competitive realities of our fast

moving global economy.

I was pleased to testify before this Committee in 1995 during an earlier series

of hearings on fundamental tax reform. At that time my remarks focused on the

path breaking efforts of Senators Domenici and Nunn with the introduction of the

USA Tax. The ABC is very proud of its role in the development of that proposal.

Congressman Phil English has improved upon this original formulation by introducing the Simplified USA Tax, H.R. 134. As an alternative to our current tax system, Congressman English recognized the USA Tax is a vastly superior method for

treating international business transactions, and most importantly, incorporates the

correct tax treatment of individual saving and business investment.

The original USA Tax, in attempting to assure that saving was taxed once and

only once, was perceived by some as overly complex. The English bill avoids this

perceived complexity while removing the double taxation on saving by relying on the

Roth IRA framework. This approach in H.R. 134 is technically correct and fully understandable to the taxpayer. It provides a workable blueprint from which to address the core challenges of tax reform. We also recognize that there is additional

detail and refinement required before the Congress can achieve final consensus. We

applaud Congressman English for his efforts and look forward to his continued leadership in tax reform.

My remaining comments reflect the perspective of midsize growth companies toward basic tax reform.

First and foremost, American business leaders understand the singular importance of saving and investment to continued national economic growth and an improved standard of living for our citizens. The current income tax is biased against

saving and investment and in favor of consumption. They ask, ‘‘What is the rationale for a national policy that reduces the level the ‘‘seed corn’’ that determines how

our country, its businesses and its citizens prepare for the future?".

H.R. 134 removes that bias by taxing the consumption and saving uses of income

in the same manner. It accomplishes this by taxing all income once and only once.

259

The English bill does not, and this is a key point, offer a subsidy to saving, it merely

removes the double taxation on saving that now occurs.

Concern over a low level of national saving is a tough argument to make during

these remarkable economic times. Yet it is, and will remain, a core determinant of

the nation’s future economic performance.

Given the international focus of this hearing, a comment on the contribution of

foreign saving to the current U.S. economic expansion is in order. In 1999 the current account deficit of the United States was approximately $340 billion. This deficit

was ‘‘financed’’ through net foreign saving being invested in this country of an

equivalent amount. If our objective is to lower or eliminate the trade deficit, we

must address the serious shortfall in our own saving behavior. The shortfall in our

national saving could become severe and obvious in the face of any significant reduction in foreign saving and investment. Said more directly, the correct tax treatment

of saving and the trade deficit are directly related.

Business leaders also support the integrated structure of the Simplified USA Tax,

and the correct specification of the tax base contained in the proposal.

The structure of H.R. 134 provides for an integrated alignment of the business

and individual elements of tax system. Tax revenues are the returns to capital and

labor services. Taxes can be collected where these factor incomes are produced, at

the business level; where they are earned, at the individual level; or as is done

under the Simplified USA Tax, at both levels. This two-tier, split-rate approach,

combined with a credit for both the employer and employee shares of the payroll

tax, assures that all sources of taxable income are treated equally. Income from

wages is treated the same as income from interest, dividends, and asset sales. And

all forms of income are treated the same in both the business and individual components of the Simplified USA Tax. This treatment assures both fairness and understandability by the American people.

I believe the true revolution in tax reform is to achieve the correct tax base. The

properly defined tax base is the net return to capital and labor services: or the gross

returns less the costs of producing these returns. Tax policy has been replete with

discussions on how to achieve the right definition of net returns to capital. The approach taken in the English bill correctly incorporates the best of these by expensing investment outlays immediately.

However, economic efficiency and fairness require that we achieve the same neutral treatment in the taxation of labor services. Investments in human capital, primarily outlays for education and training, are costs of producing higher gross returns to labor and should be expensed. These and other intangible investments are,

as you know, becoming the core of our ‘‘new economy’’ and our comparative advantage as a nation. The English bill recognizes that tax reform must include the expensing of these investments in human capital. It provides for up to $12,000 in annual deductions for education per household. I would suggest future deliberations

by the Congress on this issue may well remove limitations on qualified training and

education outlays entirely.

The international implications of the USA Tax are very significant to American

businesses and their ability to compete on a level international playing field. Public

policy should seek to insure that businesses, both US and foreign-based make decisions based on market and operating conditions only, and not on the subsidies contained in national tax systems. Congressman English’s bill achieves this result.

The USA Business Tax is territorial. An American-based business would not include in its gross tax base the proceeds from sales made by subsidiaries outside the

United States. It would also not deduct the purchase of goods or services outside

the United States. For their part, foreign businesses with a commercial presence in

this country would include in their tax base amounts received for goods sold or services provided in the United States and would subtract amounts paid for goods acquired and services provided in the United States.

To repeat, for an American company, territoriality would free entrepreneurs to

base their international strategies on business opportunities rather than on tax considerations. From a public policy standpoint, adopting a territorial system would be

the best approach to resolving the current dilemma regarding the Foreign Sales

Corporation (FSC) provisions in the code. It would also vastly simplify the tax structure and the agenda of this Committee.

The USA Business Tax is also border adjustable. Goods made here and shipped

abroad would receive a tax rebate. Goods made abroad and imported and sold in

the United States would be subject to tax. This provision would align the tax system

of the United States with that of most of our major trading partners while insuring

that all products sold in this country carried their appropriate share of the tax burden.

260

Simplification of the tax code is a longstanding objective of tax reformers. By moving from accrual accounting towards cash flow accounting, the USA Tax eliminates

the maze of complexities and the high compliance costs which businesses now face.

H.R. 134, by providing for expensing of all investment outlays, leads to the correct

and desired impact on the cost of capital for American businesses. Its adoption

would achieve a greatly simplified tax structure.

The English bill would have other positive effects on the cost of capital. The current tax code, by favoring borrowing over equity investment, generates a higher cost

of capital for growth companies. These companies, frequently knowledge-intensive

and with little collateral on which to borrow, are critically dependent on equity financing. Bringing neutrality to debt and equity financing is a significant forward

step achieved by the USA Tax.

The Simplified USA Tax introduced by Congressman English explains why tax reform is both necessary and possible. Perhaps now the USA Tax will get the second

look it so richly deserves.

Congressman English has championed a plan that does not discriminate against

saving and investment, is simple, efficient, and understandable, is easy to administer, readily accommodates a progressive rate structure, offers a full credit for the

FICA tax, and reflects international competitive realities by excluding from taxation

export sales and income from foreign sources. It is fully worthy of further consideration by his colleagues on this Committee and in the Congress.

I would be happy to answer any questions you may have.

Chairman A

Mr. Howard.

RCHER. Thank you, Mr. Rogstad.

f STATEMENT OF JERRY HOWARD, VICE PRESIDENT, TAXES,

USX CORPORATION, PITTSBURGH, PENNSYLVANIA

Mr. HOWARD. Thank you, Mr. Chairman.

My name is Jerry Howard and I am Vice President of Taxes for

USX Corporation. Though I currently reside in Pittsburgh, I

worked for the USX Marathon Group in the 7th Congressional District in Texas, and we found the 7th District to be one of the best

represented districts in the country.

I appreciate having the opportunity to have worked with you and

members of your staff for an extended period of time.

This is an opportune time to discuss fundamental tax reform. I

appreciate the opportunity to address the Committee on this issue.

USX Corporation operates primarily in the integrated energy and

steel businesses. Our 1999 sales of over $29 billion ranks us within

the top 25 industrial companies in the United States.

Both our energy and steel businesses are capital intensive and

face strong foreign and domestic competition. U.S. tax laws have an

important bearing on our ability to compete in world markets.

We have several serious concerns with the current Federal Income Tax on businesses. We believe the current tax system is anticompetitive, acts as a disincentive to investment, and is unduly

complex.

We support fundamental tax reform that addresses these concerns. Any new tax system should be a replacement for the current

income tax system and should not result in additional taxes on

business.

The Simplified USA Tax proposed by Representative English is

a significant move in the right direction. We agree with the fundamental concepts of his proposal since they address many of our concerns.

261

For example, most industrialized countries rely mainly on border-adjustable taxes in which export income is exempted and imports are taxed.

In the U.S., however, export income is taxed and imports are not.

As a result, U.S. companies are at a disadvantage both at home

and abroad.

The Simplified USA Tax corrects this inequity by exempting export income and taxing imports.

The present U.S. income tax system acts as a disincentive to

making capital investments because of the long cost recovery periods. Since real capital costs are not fully recovered, there is a tax

on the capital investment itself. This makes capital acquisition

much more costly for U.S. businesses.

The Simplified USA Tax eliminates the increased cost on capital

by allowing an immediate writeoff of capital investments.

The current U.S. income tax system is overly complex, requiring

companies to hire a large number of accountants and attorneys in

order to determine the amount of taxes owed and to resolve disputes with the IRS.

While there will always be some complexity and uncertainty in

any tax regime, the Simplified USA Tax will be significantly easier

to understand and administer than the present income tax law.

The aforementioned provisions of the Simplified USA Tax represent significant improvements to the current U.S. tax system.

However, the following issues require further study:

As I mentioned, the Simplified USA Tax includes a tax on imports which will help make U.S. companies more competitive in the

global marketplace. That being said, it must be recognized that

there are certain items that must be imported since domestic supply cannot meet demand.

One notable example that directly affects USX is crude oil. The

imposition of a new nondeductible tax on imported crude oil could

cause the cost of refined products to increase and result in higher

costs to consumers.

Due care should be taken to ensure that consumers and U.S.

companies are not unduly harmed by this measure. A national energy policy which promotes increased domestic oil and gas production and enhances refining capacity in the United States would

lessen our demand on imports.

A major issue in developing any new tax system to replace the

present income tax law involves transition rules for costs that have

been incurred or credits generated during the period that the

present system has been in effect but that will not be deducted or

taken into account by the time the new system is put in place.

Accordingly, transition rules should be fair and equitable.

In conclusion, a new tax system modeled around the Simplified

USA Tax would be a significant improvement over the present system. It would eliminate the competitive disadvantage inherent in

the current system and allow U.S. companies to compete more effectively with our foreign competitors.

We believe that a national energy policy that promotes increased

domestic oil and gas production and enhances refining capacity,

coupled with fair and equitable transition rules, will cause the new

system to achieve its intended results.

262

USX welcomes the opportunity to participate in the process.

Thank you.

[The prepared statement follows:]

Statement of Jerry Howard, Vice President, Taxes, USX Corporation,

Pittsburgh, Pennsylvania

Mr. Chairman, my name is Jerry Howard, and I am Vice President-Taxes for USX

Corporation. Though I currently reside in Pittsburgh, I worked in the 7th district

of Texas for a number of years and found it to be one of the best represented districts in the country. I have appreciated the opportunity to work with you and members of your staff over an extended period of time. We also applaud the members

of this Committee who announced their opposition to the Administration’s budget

proposal to impose a tax on the recipients of tracking stock. This ill-conceived measure would cause severe harm to companies with tracking stock outstanding and reduce business expansion while generating no benefits.

This is an opportune time to discuss fundamental tax reform and I appreciate the

opportunity to address the Committee on this issue.

USX Corporation operates primarily in the integrated energy and steel busi- nesses. Our 1999 sales of over $29 billion rank us within the top 25 industrial companies in the United States.

Both our energy and steel businesses are capital intensive and face strong foreign

and domestic competition. U.S. tax laws have an important bearing on our ability

to compete in world markets.

We have several serious concerns with the current federal income tax on businesses. We believe the current tax system is anti-competitive, acts as a disincentive

for investment, and is unduly complex.

We support fundamental tax reform that addresses these concerns. Any new tax

system should be a replacement for the current income tax system and should not

result in additional taxes on business. The Simplified USA Tax proposed by Representative English is a significant move in the right direction. We agree with the

fundamental concepts of his proposal since they address many of our concerns.

Competition Concerns

For example, most industrialized countries rely mainly on border-adjustable taxes,

in which export income is exempted and imports are taxed. In the U.S., however,

export income is taxed while imports are not. As a result, U.S. companies are at

a disadvantage both at home and abroad.

The Simplified USA Tax corrects this inequity by exempting export income and

taxing imports.

Incentive for Investment

The present U.S. income tax system acts as a disincentive to making capital investments because of the long cost recovery periods. Since real capital costs are not

fully recovered, there is a tax on the capital investment itself. This makes capital

acquisition more costly.

The Simplified USA Tax eliminates the increased cost on capital by allowing an

immediate write-off of capital investments.

Complexity of Current Tax Law

The current U.S. income tax system is overly complex, requiring companies to hire

a large number of accountants and attorneys in order to determine the amount of

taxes owed and to resolve disputes with the IRS because the laws are so difficult

to interpret and administer. While there will always be some complexity and uncertainty in any tax regime, the Simplified USA Tax will be significantly easier to understand and administer than the present income tax law.

The aforementioned provisions of the Simplified USA Tax represent significant

improvements to the current U.S. tax system. However, the following issues require

further study.

Oil and Gas Imports

As I’ve mentioned, the Simplified USA Tax includes a tax on imports, which will

help make U.S. companies more competitive in the global marketplace. That being

said, it must be recognized that there are certain items that must be imported since

domestic supply cannot meet demand. One notable example that directly affects

USX is crude oil.

The imposition of a new non-deductible tax on imported crude oil could cause the

cost of refined products to increase and result in higher costs to consumers. Due

263

care should be taken to ensure that consumers and U.S. companies are not unduly

harmed by this measure. A national energy policy which promotes increased domestic oil and gas production and enhances refining capacity in the U.S. would lessen

our demand for imports.

Transition Rules

A major issue in developing any new tax system to replace the present income

tax law involves transition rules for costs that have been incurred or credits generated during the period that the present system has been in effect, but that will

not be deducted or taken into account by the time the new system is put into place.

Accordingly, transition rules should be fair and equitable.

Finally, a word about compatibility of the USA Tax with other tax regimes.

Compatibility with Other Tax Regimes

Presently, the tax base for most state income taxes uses federal taxable income

as the starting point. Thus, any new federal tax regime developed to replace the current federal income tax will not be compatible. States should be able to modify their

tax systems to use the new federal tax base as the starting point, making modifications and other adjustments necessary to generate the same tax revenues from businesses as are currently collected.

Conclusion

In conclusion, a new tax system, modeled around the Simplified USA Tax, would

be a significant improvement over the present system. It would eliminate the competitive disadvantage inherent in the current system and allow U.S. companies to

compete more effectively with our foreign competitors. We believe that a national

energy policy that promotes increased domestic oil and gas production and enhances

refining capacity, coupled with fair and equitable transition rules, will cause the

new system to achieve its intended results. USX welcomes the opportunity to parthe Chair is going to be right back.

ticipate in the process.

Mr. KLECZKA [presiding]. I have no questions of this panel, and

f Has Mr. Mack testified? Oh, I am sorry.

Mr. Mack, welcome. You do not win the prize for coming the

longest distance, you know, being from McLean, Virginia. Welcome

to the Committee and we look forward to your remarks.

STATEMENT OF JAMES H. MACK, VICE PRESIDENT, GOVERNMENT RELATIONS, ASSOCIATION FOR MANUFACTURING

TECHNOLOGY, MCLEAN, VIRGINIA

Mr. MACK. Thank you, Mr. Chairman.

I am Jim Mack, and I am here representing U.S. producers of

machine tools and related manufacturing technology.

Our industry is the principal enabler of America’s high productivity levels which are the key to our current prosperity and its

continuation into the foreseeable future.

Our industry translates the dizzying advances in information

technology into the design of new manufactured products and the

factory floor automation that more efficiently produces them.

However, our current tax code actually discourages American

manufacturing companies from acquiring new manufacturing technology and from producing new products in the United States.

It encourages international mergers and acquisitions that transfer to foreign sources the ownership of technology, the development

of future technology, and decisions as to whether American jobs

will stay in America. The territoriality and border-adjustability features of the USA Tax would reverse that trend.

264

Some have criticized the USA business tax because, in order to

make it border adjustable in conformity with WTO rules, labor

costs would no longer be deductible.

The fact is, Mr. Chairman, that labor costs are not entirely tax

free today. The current payroll tax is a heavy burden on businesses

and on their employees—most particularly on skilled craftsmen

and skilled factory workers. It acts as an incentive against hiring

new workers. By providing a credit for the 7.65% employer-paid

FICA tax, the USA Tax actually reverses the regressive impact of

the payroll tax.

Congressman English’s USA Tax is good sound tax policy and

AMT—The Association for Manufacturing Technology, strongly

supports it passage.

The USA Tax also meets all the requirements that the WTO laid

out in requiring you to repeal the Foreign Sales Corporation (or

FSC) and, therefore, would be a good starting point when looking

for solutions as FSC replacement.

FSC helps make U.S. exports more competitive in world markets.

Many AMT members, both large and small, have FSCs. However,

unless you act by October 1st, or unless a settlement is reached

with the European Union by that date, billions of dollars in U.S.

exports will be subject to retaliatory compensation by the EU and

possibly by others.

Simply repealing the FSC would deprive U.S. companies of a powerful incentive to export and effectively amount to a $4 billion

a year tax increase on U.S. exports.

On the other hand, simply replacing FSC with a slightly different

version could be inconsistent with the WTO decision and could lead

to European retaliation.

Mr. Chairman, we know that coming up with a replacement for

FSC that is consistent with the WTO ruling will be extraordinarily

difficult. Therefore, we believe that the best possible solution is to

move to a territorial, border-adjustable system of taxation like the

USA Tax which would not tax export income at all but would impose a tax on imports.

This is the system used by all of our major trading partners. The

WTO Dispute Resolution Panel clearly pointed the way in that direction when it stated that we could not couple territorial treatment of exports with a system of taxing the worldwide income of

our companies.

Now we are not naive enough to believe that fundamental tax reform like the USA Tax can be enacted by the first of October. However, if you can achieve a bipartisan momentum for the USA Tax

approach, you and the Administration would have a powerful incentive—a powerful club, if you will—to persuade the European

Union to reverse its current headlong dash toward an October 1st

trade war with the United States.

Absent such bipartisan momentum, the Administration unfortunately has very little negotiating leverage, and the prospects for

averting disaster on October 1st are very bleak.

Passage of a border-adjustable cash flow territorial cash flow tax

that allows for expensing of capital purchases like the USA Tax is

one of AMT’s top legislative priorities. We strongly support Congressman English’s USA Tax as the best possible tax system for

265

U.S. manufacturers and their workers in an increasingly competitive (and even hostile) global trading environment. It is also the

best possible replacement for FSC.

The time for fundamental tax reform is long overdue. The need

to replace the FSC provides an excellent opportunity to begin the

process of real reform rather than simply searching for a shortterm fix. Thank you.

[The prepared statement follows:]

Statement of James H. Mack, Vice President, Government Relations,

Association for Manufacturing Technology, McLean, Virginia

I. INTRODUCTION

My name is James H. Mack, Vice President of Government Relations at AMT—

The Association For Manufacturing Technology—a trade association whose membership represents over 370 machine tool building firms with locations throughout the

United States. Pursuant to House Rule XI, clause 2(g)(4), I am obligated to report

to you that AMT has received $219,000 in fiscal years 1997–2000 from the Commerce Department’s Market Co-operator Development Program to help pay for our

export offices in China and Mercosur.

I appreciate the opportunity to testify before the Committee in support of Fundamental Tax Reform. My comments will also address how Congress could use fundamental tax reform to respond to the World Trade Organization’s (WTO) dispute resolution panel ruling that the Foreign Sales Corporation (FSC) violates WTO rules

and must be repealed by October 2000.

II. STATUS OF THE U.S. MANUFACTURING TECHNOLOGY INDUSTRY

The majority of AMT’s members are small businesses. According to the 1997 U.S.

Census of Manufacturers, 69% of the companies in our industry have less than 50

employees. They build and provide to a wide range of industries the tools of manufacturing technology including cutting, grinding, forming and assembly machines, as

well as inspection and measuring machines, and automated manufacturing systems.

Everything in this hearing room, except for the people, was either made by a machine tool or made by a machine made by a machine tool. Several years ago, the

Reagan and Bush Administrations, responding to strong encouragement of over 250

Members of Congress, provided temporary import relief for our industry, based on

the threat posed to our national security from Asian machine tool imports. They did

so because of their recognition that a strong machine tool industry is vital to America’s military and economic security.

Our industry is very cyclical. Price pressures are very strong, and profitability is

relatively low—even in good years. Today, despite the extraordinary performance of

our overall economy, domestic consumption of machine tools is nearly 30% lower

than a year ago. Imports represent about half of domestic consumption. And American-made machine tools comprise only 13% of world supply. About 30% of our industry’s output is exported. If, as we believe, successful competition in the global

marketplace is the key to a strong and healthy economy, then we need U.S. policies

that reflect that goal. I think most would agree that our current business tax policy

is inconsistent with that goal.

III. THE USA TAX

The anti-investment, anti-export biases of the current tax code are well documented. Our tax code discourages saving and productive capital investment in the

United States; it discourages exports; and it makes it hard for U.S. companies to

directly compete in foreign markets. America urgently needs a tax system rebuilt

from the ground up around a new set of design principles to compete and win in

world markets.

Your colleague, Cong. English (R–PA), has introduced legislation which replaces

our current tax system with a cash flow tax that would be both border-adjustable

and territorial and would provide for the expensing of capital purchases. Its enactment would, for the first time, truly level the international playing field for U.S.

companies in world markets, including the United States.

The USA tax combines a low-rate business tax which allows expensing of capital

equipment with border-tax adjustments and territoriality to produce an ideal result—a neutral, evenhanded tax that treats all business alike (whether corporate or

noncorporate, capital intensive or labor intensive, financed by equity or by debt,

266

large or small) and which, for the first time, is tilted in our favor when we compete

in our own and foreign markets.

The key to our current prosperity, and its continuation into the foreseeable future,

is improved productivity. Our industry is the principle enabler of America’s high

productivity levels. Our industry translates the dizzying advances in information

technology into the design of new manufactured products and the factory floor automation that more efficiently produces them. However, our current tax code discourages American manufacturing companies from acquiring new manufacturing technology and from producing new products in the United States. It encourages international mergers and acquisitions that transfer to foreign sources the ownership of

technology, the development of future technology, and decisions as to whether American jobs will stay in America. The territoriality and border-adjustable features of

the USA tax would reverse that trend.

Some have criticized the USA business tax because, in order to make it border

adjustable in conformity with WTO rules, labor costs would no longer be deductible.

The fact is that labor costs are not entirely tax-free today. The current payroll tax

on wages up to $72,000 is a heavy burden on businesses and their employees—most

particularly on skilled craftsmen and factory workers. It acts as an incentive hiring

new workers.

By providing a credit for the 7.65% employer-paid FICA tax, the USA Tax reverses the regressive impact of the payroll tax. Under current law, the first $72,000

of employee compensation is taxed. Under the USA Tax, employee compensation

under $72,000 would be partially taxed (at a 4.35% rate) and employee compensation over $72,000 would be fully taxed (at a 12% rate).

Cong. English’s USA Tax is good sound tax policy, and AMT strongly supports its

passage. The USA Tax also meets all the requirements that the WTO laid out in

repealing the FSC, and would, therefore, be a good starting point when looking for

solutions to FSC replacement.

IV. FSC REPLACEMENT

As I stated earlier, a WTO dispute resolution panel has ruled that the FSC law,

which allows U.S. exporters to exclude part of their export income, violates WTO

rules and must be repealed by October 2000.

FSC helps make U.S. exports more competitive in world markets. Many AMT

members—both large and small—have FSCs. However, unless Congress acts by October 1, or a settlement is reached with the European Union (EU) by that date, billions of dollars in U.S. exports will be subject to retaliatory ‘‘compensation’’ by the

EU and possibly by others. Simply repealing the FSC would deprive U.S. companies

of a powerful incentive to export and effectively amount to a $4 billion per year tax

increase on U.S. exports. On the other hand, simply replacing FSC with a slightly

different version could be inconsistent with the WTO decision and could lead to European retaliation.

Mr. Chairman, we know that coming up with a WTO-compatible replacement for

FSC that is consistent with the WTO ruling will be extraordinarily difficult. But we

do believe the best possible solution is to move to a territorial, border-adjustable

system of taxation, like the USA tax, which would not tax export income at all but

would impose a tax on imports. This is the system used by all of our major trading

partners. The WTO dispute resolution panel clearly pointed the way in that direction when it stated that we couldn’t couple territorial treatment of exports with a

system of taxing the worldwide income of our companies.

Now, we are not na ̈ıve enough to believe that fundamental tax reform, like the

USA Tax, can be enacted by October 1. However, if you can achieve a bipartisan

momentum for the USA Tax approach, you and the Administration would have a

powerful incentive to persuade the European Union to reverse its current headlong

dash towards an October 1 trade war with the United States. Absent such bipartisan momentum, the Administration has very little negotiating leverage, and the

prospects for averting disaster on October 1 are very bleak.

V. CONCLUSION

Passage of a border adjustable, territorial cash flow tax, like the USA Tax, is one

of AMT’s top legislative priorities. We strongly support Cong. English’s USA Tax as

the best possible tax system for U.S. manufacturers and their workers in an increasingly competitive (and even hostile) global trading environment. It is also the best

possible replacement for FSC. The time for fundamental tax reform is long overdue.

267

The need to replace the FSC provides an excellent opportunity to begin the process

of real reform rather than simply searching for a short-term fix.

Chairman A

Mr. Rose, you are cleanup hitter today.

Thank you.

RCHER. Thank you, Mr. Mack.

f STATEMENT OF JAMES E. ROSE, JR., SENIOR VICE PRESIDENT,

TAXES AND GOVERNMENT AFFAIRS, TUPPERWARE CORPORATION, ORLANDO, FLORIDA; AND BOARD MEMBER AND

CHAIRMAN, TAX AND BUDGET POLICY COMMITTEE, NATIONAL ASSOCIATION OF MANUFACTURERS

Mr. ROSE. Thank you, Mr. Chairman, and Members of the Committee:

I am very pleased to have the opportunity to testify on the need

for fundamental reform of our federal tax laws. My name is Jim

Rose. I am Senior Vice President for Taxes and Government Affairs

at Tupperware Corporation. I also serve as a Board Member of the

National Association of Manufacturers and chair its Tax and Budget Policy Committee.

I am testifying today on behalf of NAM, 18 million people who

make things in America. The NAM is the Nation’s largest and oldest multi-industry trade association representing 14,000 members,

10,000 of which are small and mid-sized companies, and 350 member associations serving manufacturers and employees in every industrial sector and in all 50 states. Headquartered in Washington,

D.C., the NAM has 10 additional offices across the country.

The NAM has long supported fundamental tax reform. The NAM

has a long-standing belief that our current tax system is fundamentally flawed and is a major obstacle to realizing the full potential of our economy.

The solution calls for a new tax system that encourages work, investment, and entrepreneurial activity. Importantly, the new tax

system should be competitive with our foreign trading partners.

Specific changes should include:

Incentives for savings and capital formation;

Avoiding multiple tax system like the AMT;

No net tax increase on businesses;

Elimination of double taxation of corporate earnings;

And fair and equitable transition rules.

NAM members generally favor a system in which only income

sourced within the United States is taxed by the United States.

This is commonly referred to as a territorial tax system. Any territorial tax system should embody simple sourcing rules to determine where income is earned. Importantly, a territorial system

should encourage U.S. activities including R&D and headquarter

functions. This is accomplished, among other ways, by not taxing

foreign royalties.

These priorities reflect the significant challenges U.S. manufacturers face in today’s world economy.

While U.S. manufacturers enjoy a stable political environment

and a creative and energetic workforce, they are at a significant

disadvantage in the highly competitive world economy.

268

For example, the cost of borrowing in the United States is often

higher than that of other countries, reflecting our remarkably low

U.S. savings rate.

The high cost of borrowing, when combined with our relatively

slow depreciation schedules, result in a less attractive recovery of

U.S. invested capital. Over time, this will result in a less competitive U.S. asset base and, ultimately, the loss of U.S. jobs.

Other signs of an uneven playing field have emerged.

A significant negative trade balance exists that continues to increase. While NAM is a staunch advocate of open trade and is certainly not looking for protective trade barriers, U.S. manufacturers

need and deserve a tax system that is competitive with those of our

major trading partners.

In a nutshell, their tax systems are all border adjusted and many

are territorial. Our tax system is neither. That is, it is neither border adjusted nor territorial.

The need for a new tax system has been heightened in recent

months with the World Trade Organization’s finding that Foreign

Sales Corporation constitute an illegal export subsidy.

An example might be helpful in understanding how U.S. exporters are disadvantaged in the global marketplace. Let us take a hypothetical Country A.

Country A’s tax burden consists of an income tax and a VAT.

Companies that manufacture in Country A receive rebates of its

15% VAT when their goods are exported to the U.S.

Conversely, an exporting NAM member, and around 80% of its

14,000 members do export, does not receive a tax rebate when its

products are exported from the U.S. Instead, it finds that its products are subject to the 15% VAT of Country A when they are imported into Country A.

Incidentally, the 15% may actually exceed the normal profit margin of the exported item.

Since the U.S. does not have a VAT system, and thus does not

impose a VAT on imported goods, imported goods from Country A

into our market come in tax free.

The Country A example incidentally has been adopted by virtually all of our major trading partners. As you can well appreciate,

this tax environment significantly favors foreign imports and discourages U.S. exports.

The story gets worse. Foreign companies competing with U.S.

manufacturers often operate with a territorial tax system that does

not tax foreign source income.

Territorial systems of our competitors can essentially eliminate

the home country income tax burden on export sales. It is important to note that FSC-type benefits would be allowable under WTO

rules in the context of a territorial tax system.

Furthermore, our U.S. tax system subjects foreign earnings of

U.S. companies to U.S. taxation when these earnings come back to

the U.S. and in certain other circumstances.

While the U.S. Tax Code does include a foreign tax credit system

to reduce this burden, the very complicated foreign tax credit rules

typically result in incremental U.S. taxation when these funds

come back to the U.S.

269

Accordingly, U.S. companies are inevitably discouraged from investing in the U.S.

The U.S. world-wide taxation system is having another negative

effect on our economy. Increasingly, U.S. companies often large and

well known, are being acquired by foreign companies.

While nontax business reasons often exist in these transactions,

the more favorable tax systems of the acquiring foreign companies

heavily influence the structure of these mergers.

For example, an NAM member last year testified before this

Committee that the U.S. tax system was an important factor in

why their U.S. company was acquired by its German-based merger

partner.

Among other factors, the German-based acquirer benefitted importantly from Germany’s territorial tax system.

The scenario has been repeated at an alarming rate in recent

years. A recent study covering 1998 acquisitions involving U.S. and

foreign entities concluded that approximately 85% of the combined

value of the acquisitions resulted from foreign entities acquiring

U.S. entities.

This trend will result in a loss of American jobs as, after an acquisition or merger, the headquarters of an the acquiring entity

typically survives and expands while the headquarters of an acquired entity often is reduced in size and sometimes eliminated, effectively moving jobs offshore.

Furthermore, R&D facilities and even plant locations can be affected by these decisions.

In summary, American companies have well trained employees,

products, and technology to win in the global marketplace, but the

U.S. Tax Code has stacked the deck against us and in favor of our

foreign competitors, both here at home as well as abroad.

The NAM is very pleased to participate in this dialogue over restructuring the U.S. Tax Code and applauds this Committee’s efforts to fundamentally rewrite our tax code.

While NAM strongly supports fundamental tax reform, at this

time it has not endorsed any specific proposal. However, the proposals under consideration have many attractive features.

Mr. Chairman, we certainly welcome the opportunity to work

with this Committee to develop a new tax system which is simpler

and encourages work, investment, and entrepreneurial activity

and, importantly, one that is competitive with the tax systems of

our foreign trading partners.

Thank you, Mr. Chairman.

[The prepared statement follows:]

Statement of James E. Rose, Jr., Senior Vice President, Taxes and Government Affairs, Tupperware Corporation, Orlando, Florida; and Board

Member and Chairman, Tax and Budget Policy Committee, National Association of Manufacturers

Mr. Chairman and members of the Committee, I am very pleased to have the opportunity to testify today on fundamental reform of the federal tax laws. My name

is James Rose and I am senior vice president for Taxes and Government Affairs at

Tupperware Corporation. I also serve as a board member of the National Association of Manufacturers (NAM) and chair its Tax & Budget Policy Committee.

I am testifying today on behalf of the NAM—‘‘18 million people who make things

in America.’’ The NAM is the nation’s largest and oldest multi-industry trade association, representing 14,000 members (including 10,000 small and mid-sized companies) and 350 member associations serving manufacturers and employees in every

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industrial sector and all 50 states. Headquartered in Washington, D.C., the NAM

has 10 additional offices across the country.

The NAM has long supported fundamental tax reform, reflecting our belief that

the current tax system is a major obstacle to realizing the full potential of our economy. The solution calls for a new tax system that is simpler and encourages, rather

than penalizes, work, investment and entrepreneurial activity, and importantly, a

tax system that is competitive with our foreign trading partners. Specific changes

endorsed by the NAM include incentives for savings and capital formation; a single

tax system for businesses, with no additional components like the alternative minimum tax and no net tax increase on businesses; elimination of the double taxation

of corporate earnings; and fair and equitable transition rules.

Moreover, our members generally favor a system in which only income earned

within the United States is taxed within the United States. This is commonly referred to as a territorial tax system. However, as increasing globalization of the

economy often makes it difficult to determine the point where income is ‘‘earned,’’ any restructuring proposal should embody simple sourcing rules. Importantly, such

a proposal should also encourage U.S. activities, including R&D and headquarters

functions.

These priorities reflect the significant challenges U.S. manufacturers face in the

world economy in which they must compete to survive. U.S. manufacturers enjoy

many advantages including a stable social and political environment and a creative

and energetic workforce. Nonetheless, U.S. manufacturers are at a significant disadvantage in the highly competitive world economy. In particular, the cost of borrowing in the United States often is higher than that of other countries. This differential reflects the remarkably low U.S. savings rate, as compared to that of other

countries. A higher cost of borrowing, when combined with relatively slow tax depreciation schedules, results in a less attractive recovery of U.S. invested capital. Over

time, this will result in a less competitive U.S. asset base and ultimately a loss of

U.S. jobs.

Other signs of an uneven playing field have emerged, including a negative trade

balance that continues to increase. The NAM is a staunch advocate of open trade

and is not looking for protective trade barriers. What is needed, however, is a U.S.

tax system that is competitive with those of our major trading partners. The need

for a new system has been heightened even more in recent months with the World

Trade Organization’s finding that foreign sales corporations constitute an illegal export subsidy.

Let me give you an example of how U.S. exporters are at a disadvantage in the

global market. The tax burden on a foreign product often consists mainly of a combination of income tax and a Value Added Tax (VAT). A foreign exporting company

that manufactures products in Country A typically receives a rebate of the 15 percent VAT when its goods are exported. The tax burden of a U.S. product consists

mainly of income tax. An exporting NAM member (and around 80 percent do export)

receives no tax rebate when its products are exported from the United States but

finds that these products are subject to a 15 percent VAT when they are imported

into Country A. In some cases, the 15 percent tax on the value of the goods may

actually exceed the normal profit margin of the item. As the United States does not

use a VAT and therefore does not impose such on imported goods, domestically produced goods that are exported sustain the full effect of the U.S. tax burden plus the

VAT of Country A, while imported products sustain only a portion of this heavy tax

burden. This has the effect of significantly favoring foreign products within the

United States and discouraging U.S. exports.

The story gets worse. Foreign companies competing with U.S. manufacturers often

operate within a territorial tax system that does not tax foreign source income. Accordingly, the territorial systems of our competitors can essentially eliminate the

home country income tax burden on export sales. The U.S. tax system subjects foreign earnings of U.S. companies to U.S. taxation when this money comes back to

the United States and in certain other circumstances. The federal tax code does include a foreign tax credit system to reduce this burden. However, too often the very

complicated foreign tax credit rules result in incremental U.S. taxation when these

funds are returned to the United States. In this environment, U.S. companies are

inevitably discouraged from investing in the United States.

The U.S. worldwide tax system is having another impact on our economy. Increasingly, U.S companies, often large and well known, are being acquired by foreign corporations. Last year a representative from a well-known NAM member company testified before this Committee that the U.S. tax system was an important factor in

why their U.S. company was acquired by its German-based merger partner. Among

other factors, the German-based acquirer benefited from Germany’s territorial tax

system.

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This scenario has been repeated at an alarming rate in recent years. For example,

a recent study covering 1998 acquisitions involving U.S. and foreign entities concluded that approximately 85 percent of the combined value of the acquisitions resulted from foreign entities acquiring U.S. entities. Why should we be concerned?

One reason is the loss of American jobs. After an acquisition or merger, the headquarters of the acquiring party typically survives and expands, while the headquarters of the acquired entity often is reduced in size, and sometimes eliminated,

effectively moving jobs off-shore. As part of this restructuring, R&D facilities and

even plant locations can be affected by these decisions.

In summary, American companies have the well-trained employees, the products,

and the technology to win in the global marketplace, but the U.S. tax code has

stacked the deck against us and in favor of our foreign competitors—here at home

as well as abroad.

The NAM is pleased to participate in the dialogue over restructuring the U.S. tax

code and applauds Congressional efforts to fundamentally rewrite the tax code. At

this point in the debate, the NAM has not endorsed any specific proposal. However,

we welcome the opportunity to work with you to develop a new tax system that is

simpler and encourages not penalizes work, investment and entrepreneurial activity

and one that is competitive with the tax systems of our foreign trading partners.

Chairman A

The Chair is grateful to each of you for your outstanding conThank you.

RCHER. Thank you, Mr. Rose.

f tribution to our deliberations on fundamental tax reform.

The points that you have made I think are pertinent, and I am

hopeful that the Committee will take them under advisement and

ultimately into implementation.

Mr. Kleczka?

Mr. KLECZKA. No questions, Mr. Chairman.

Chairman ARCHER. Thank you very much, gentlemen. You are

excused.

The meeting will stand adjourned.

[Whereupon, at 3:40 p.m., the hearing was adjourned, to reconvene on Thursday, April 13, 2000, at 10:30 a.m.]

(273)

FUNDAMENTAL TAX REFORM

THURSDAY, APRIL 13, 2000

COMMITTEE ON WAYS AND MEANS,

HOUSE OF REPRESENTATIVES,

Washington, D.C.

The Committee met, pursuant to recess, at 10:35 a.m. in room

1100, Longworth House Office Building, Hon. Bill Archer (Chairman of the Committee) presiding.

Chairman ARCHER. The Committee will come to order.

Today is the final day of our hearings on structural reform, and

I believe it is going to be an interesting one.

We begin by receiving testimony from our own colleague, Mr.

Portman, who has a deep interest in tax reform. Then we will hear

from two pollsters, one republican and one democrat, on what the

American people are thinking about structural reform. Thirdly, we

will receive testimony from Mr. William Helming and one of my

long-time friends, Jimmy Powell, about a very interesting tax reform proposal that Mr. Helming has developed. Finally, we will

hear the views of the U.S. Chamber of commerce and testimony on

the death tax and on the elements of fundamental tax reform.

Mr. Rangel?

Mr. RANGEL. Thank you, Mr. Chairman.

I don’t know how we slipped up and let a Democrat get on one

of these panels, but I will have to stick around and see that. This

is going to be the most exciting hearing, because my dear friend

and fellow Committee member, Mr. Portman, will be testifying. I

say that not just out of a sense of affection but because, realistically, he probably is the only one that will be around here, as relates to witnesses, in order to do something about the tax code.

Most of the other people are just giving some ideas of their frustrations before April the 15th.

I have known about Mr. Portman’s concern about the structure

of our tax code and the constant contributions he makes to make

it a better instrument to guide the collection of revenue. I really

look forward to his testimony this morning and look forward to

working with him no matter what the political composition will be

of this committee next year.

Thank you.

Chairman ARCHER. Mr. Portman, welcome to a new position at

the witness table, but not to a new presence in this room. We will

be happy to receive your testimony.

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STATEMENT OF HON. ROB PORTMAN, A REPRESENTATIVE IN

CONGRESS FROM THE STATE OF OHIO

Mr. PORTMAN. Thank you, Mr. Chairman. It is a little daunting,

but I appreciate your words and Mr. Rangel’s and my colleagues

who have the patience and fortitude to be here this morning.

I am delighted to get a chance to testify briefly. I have sat

through, as you know, a number of the witnesses’ testimony with

this series of hearings on tax reform, and I think it has been very

informative, I think it has been very thoughtful, and I want to commend the chairman for having these hearings and opening up a

discussion. I have learned a lot about various alternatives, and I

guess what I hope is that we can at least all agree that we must

replace our current code with one that is simpler, one that is fairer,

and one that is less intrusive.

This morning, Mr. Chairman, I would like to switch gears just

a little bit even from the testimony I had planned to present and

talk a little bit more about why we need to change our process,

maybe how to get to structural tax reform, rather than focusing so

much on why a specific tax reform plan does or doesn’t make sense.

I think over the next two to five years we have a tremendous opportunity to move forward on tax reform. Unlike some in this room

and elsewhere, I believe it can happen. In fact, I believe it must

happen if America is to be prosperous in the increasingly-competitive new century.

In 1996 and 1997, thanks to the chairman’s support and others,

I had the opportunity to serve as co-chairman on the National

Committee on Restructuring the IRS. I served on that with Bill

Coyne, who is with us this morning. It was a blue ribbon panel of

experts, as you know, convened by Congress to recommend reforms

to improve taxpayer service at the IRS.

I want to touch on this commission only because I think it relates the to the topic here today in two regards.

First of all, the Commission in its work found the complexity of

the tax code was one of the major—and I would say the major—

problem facing the Internal Revenue Service. It is consistent with

the hearings that we have had and the focus of this committee on

tax reform.

Second, because I think it says a lot about process—that is, how

to achieve reform—in the Commission we rolled up our sleeves,

spent literally a year auditing the IRS, kind of turning the table

and getting to the root of the key problems at that agency.

It was a complex and very difficult task, but after careful, thorough review we recommended the most comprehensive overhaul of

the IRS in 45 years. And, although some of those recommendations

were viewed as controversial at the time, and although the Administration was initially opposed to our findings, at the end of the

day, I think, based on the Commission’s work and the credibility

that the Commission’s research brought, we were able to enjoy

broad, bipartisan support and we got these important reforms enacted into law.

Throughout our work on the IRS Restructuring and Reform Commission, there was one cross-cutting problem that kept resurfacing.

Of course, I am talking about complexity of the tax code.

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It was an evolutionary process. When we first started out, folks

weren’t focused too much on the complexity. We were focused more

on the inner workings of the IRS. But on a bipartisan basis, Mr.

Chairman, commissioners came to conclude that the code, itself,

was the greatest problem facing a very, very troubled agency.

This isn’t news to members of this committee, but it provided, I

think, a clear basis for reform because we found convincing evidence that there were enormous organizational challenges that the

tax code poses to the IRS.

Again, although tax simplification was not our mandate, I think

we pushed the envelope a bit in our recommendations, because the

problem was so pervasive.

As you know, our recommendations included the tax complexity

analysis because of that which subjects all perspective tax bills to

a Joint Tax Committee analysis to determine complexity for the

taxpayer and for the IRS. We also recommended getting the IRS

formally involved in the tax-writing process, to comment on the administrative challenges, which we are trying to get even today from

the IRS as an independent agency looking at this issue.

We also made recommendations—some members of this committee remember those, because some were controversial—on 60-

odd specific code sections that could be simplified, including the alternative minimum tax, to reduce needless complexity. Some of

these reforms, incidentally, were included in the 1997 Taxpayer Relief Act.

And, finally, we recommended and passed in law that there be

an annual meeting of the seven committees with IRS oversight

coming together with Ways and Means and Finance on both sides

of the Capitol to ensure this agency gets more consistent guidance

from the Hill.

So these reforms underscored the connection we saw between the

problems with the IRS and complexity of the tax code.

Now, my thinking today is, you know, how do we get from point

A to point B. How do we get to this fairer, simpler tax code?

I think a Tax Reform Commission makes a lot of sense, and the

purpose of this commission would be to keep the ball rolling, to

help educate the public about the problem—and Mr. Rangel talked

about that yesterday—and the alternatives, and also take some of

the rough and tumble of partisan politics out of the process to bring

some non-partisan expertise to bear on the problem in a focused

way with a specific time table.

I do urge my colleagues to support the legislation on the floor

today because it does have this commission as part of the so-called

‘‘sunset the code’’ idea. I think it is a much more responsible piece

of legislation this year as a result of that. It is an 18-month commission.

I know, again, some commissions have had a checkered past in

this town, but others have worked very well, and the IRS Commission is the model upon which the commission we will vote on today

is based—15 members appointed by both parties, both Houses, and

the President, short time table, and report to Congress. It does not

take away, in any sense, the responsibility of the Ways and Means

Committee or the Finance Committee to work through a tax reform. Just like the IRS Commission, it makes a recommendation.

276

We then go through normal procedures, subcommittee and committee, to come up with a proposal that the Ways and Means Committee and the Finance Committee think is appropriate to bring to

the floor.

But I think we need to have this kind of outside expertise

brought to bear on this issue. Obviously, before we even have the

recommendation, the committee has a lot of work to do, and it is

doing it well this week, in laying out the framework for tax reform

we can all agree on.

I think part of this framework must be broad support, and that

means it must be bipartisan. And this is really for two reasons.

First, it is reality. It is going to be difficult for either party to ramrod a tax reform plan through Congress on its own. But second,

and very importantly, is stability. We need to ensure that future

Congresses and administrations don’t throw out the tax code every

time party control switches.

I think if there is anything in the code that is worse than the

complexity, it is the changes to code, and we have seen thousands

of them since 1986. People are looking for certainty and consistency, so that kind of a broad-based, two-thirds support I think is

absolutely critical.

Revenue neutrality—I would just urge that any tax reform plan

we come up with must deal with the current revenue estimates.

We have heard, as you know, Mr. Chairman, lots of testimony

here this week on various estimates of what rates could be, but I

think we have got to be able to compare apples to apples, which

is, let us deal with the issue of reducing the scope and size of the

Government separately, which I support, but, with regard to tax reform, I think we have got to focus on keeping it revenue neutral

and how do we come up with the best way to raise the revenue to

meet our needs.

And finally, of course, fairness. I think we have to recognize the

progressivity of the current code. It is extremely progressive, and

the top 10 percent pay 60 percent of the income taxes in this country. For political reasons, I think a very regressive tax has no

chance of passing, so I don’t think that we can throw the distribution tables too far off. At the same time, we must deal with the reality that our current code does penalize savings and investment,

our current code does add enormous complexity, which is a waste

of time and money and energy, and this is where, frankly, we have,

I think, the most potential to make a huge difference in terms of

economic growth in this country and, again, moving into the next

century with prosperity.

I think, Mr. Chairman, again, all of us have different ideas. You

know I have some specific ideas on tax reform. I thought about

talking about them today, but I think that is less useful, frankly,

than it is talking about process at this point and moving the ball

forward.

I appreciate your allowing me to testify here today and I urge us

to take that next step, move forward on a bipartisan basis to put

together a plan for reform, and I thank you for your patience this

morning.

Chairman ARCHER. Thank you for your input. The committee, I

think on a bipartisan basis, welcomes it.

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[The prepared statement follows:]

Statement of Hon. Rob Portman, a Representative in Congress from the

State of Ohio

Thank you, Chairman Archer, for holding this series of hearings on tax reform.

It’s been an informative and thoughtful discussion, and I’ve appreciated the opportunity to learn about the various alternatives to the current tax code, which I hope

we can all agree should be replaced by a simpler, fairer and less intrusive system.

This morning, though, I would like to focus, not so much on why a specific tax

reform plan does or doesn’t make sense, but on the process of how we might bring

structural tax reform about within the next two to five years. Unlike some, I believe

it can happen-in fact, I believe it must happen if we are to continue our current

prosperity into an increasingly competitive 21st Century.

In 1996 and 1997, thanks to the Chairman’s support, I had the opportunity to

serve as co-chairman of the National Commission on Restructuring the IRS—a blue

ribbon panel of experts convened by the Congress to recommend reforms to improve

taxpayer service at the IRS. We rolled up our sleeves and spent a year literally auditing the IRS—to get to the root of the key problems at the agency. It was a complex and difficult task, but after careful, thorough review, we recommended the

most comprehensive overhaul of the IRS in 45 years. Although some of the recommendations were controversial at the time, and although the Administration was

initially opposed to our findings, at the end of the day, based on the Commission’s work and the credibility it brought, we enjoyed broad bipartisan support and got

these important reforms enacted into law.

Throughout our work on the IRS Restructuring Commission, there was one crosscutting problem that kept resurfacing. I’m talking, of course, about the overwhelming complexity of the tax code. On a bipartisan basis, Commissioners came

to conclude that the tax code ITSELF was the greatest problem facing a very, very

troubled agency. This isn’t news to the Members of this Committee. But it provided

another clear basis for reform, because the Commission found convincing evidence

of the enormous organizational challenges the tax code poses to the IRS.

Although tax simplification was not our mandate, we pushed the envelope a bit

with our recommendations because the problem was so pervasive. Among our recommendations:

1) Tax complexity analysis-subject all prospective tax legislation to a Joint Tax Committee analysis to determine its complexity for the taxpayer and the IRS.

2) Get the IRS formally involved in the tax writing process to comment on the administrative challenges posed by the proposed tax law changes.

3) Recommendations on 60-odd specific code sections that could be simplified to reduce needless complexity-some of these reforms were implemented in the 1997

Taxpayer Relief Act.; and

4) An annual meeting of the 7 committees with IRS oversight responsibility to ensure that the agency gets more consistent guidance from the Hill.

These reforms underscored the connection between the problems of the IRS and

the complexity of the code itself. But I believe they’ve also had the effect of helping

to convince Members of Congress and the public that we’ll never get at the real root

of the problems at the IRS unless we address the tax code itself.

Now, I know what you’re thinking—despite the amount of rhetoric devoted to tax

code reform, little seems to get done (raise your hand if you remember the Tax Reform Act of 1986). While the general notion of tax reform has broad bipartisan support the devil, as always, is in the details. So how do we get from Point A—the current code—to Point B—a simpler, fairer tax code that actually makes sense for a

21st Century economy? Let me offer a few suggestions.

First, let’s establish a Tax Reform Commission. The purpose of the Commission

would be to keep the ball rolling, to help educate the public about the problem and

the alternatives, to take some of the rough-and-tumble of partisan politics out of the

process and to bring some non-partisan expertise to bear, in a focused way and with

a specific timetable.

That’s why I urge my colleagues to support the legislation that’s on the floor

today—which not only contains the ‘‘sunset the code’’ idea that we’ve debated in the

past—but in the meantime also establishes a non-partisan NATIONAL COMMISSION ON TAX REFORM AND SIMPLIFICATION. It is modeled on the successful

National Commission on Restructuring the IRS.

I know that Commissions have a checkered past in this town, but we proved that

they can work. The Commission will have 15 members—three appointed by the

President, four each appointed by the Senate Majority Leader and the Speaker, and

two each appointed by the House and Senate Minority Leaders. It will have a short

278

timetable ¥18 months—to complete its work and make a report to Congress on

ways to fundamentally reform and simplify the tax code. The Commission’s recommendations will cut through some of the clutter and give the Ways and Means

Committee a specific starting-point for more general debate.

But even before we have a specific plan before us, this Committee should take

the lead by laying out a framework for tax reform that we can all agree on. Any

framework for tax reform should include these three elements:

1. BROAD SUPPORT, meaning, of course, it must be BIPARTISAN:Taxes are

some of the most intensely partisan issues we consider in this Congress—and

there are real and legitimate differences between the tax policy viewpoints of both

parties. But, as we consider structural tax reform, we need to have a plan that

can draw bipartisan support. Why? (1) Reality—neither party has the ability to

ramrod a tax reform plan through Congress on its own; and (2) Stability: Ensure

that future Congresses and Administrations don’t throw out the tax code when

party control switches. There have been thousands of changes to the Code even

since 1986, and it’s the constant changes—as well as the complexity—that causes

such compliance headaches.

2. REVENUE NEUTRALITY: Any tax reform plan that stands a realistic chance

of becoming law cannot significantly increase or decrease federal tax receipts. I’m

not going to mention specific plans, but there have been tax reform plans that

have advertised a certain rate that is predicated on significant reductions in the

federal budget. Our focus should be on developing a vehicle for reforming the tax

code—we can find plenty of other opportunities to have the debate over reshaping

the size and shape of the government.

3. Finally, FAIRNESS: I think we have to recognize the PROGRESSIVITY of the

current code and—for both fairness and for political reasons—I just don’t see a

regressive tax passing. We can’t have a plan that throws the distribution tables

too far off by shifting too great a percentage of the overall tax burden onto one

income level or another. An important, but overlooked, part of ensuring tax progressivity, in my view, is to reduce compliance costs and burdens for taxpayers—

particularly lower-and middle-income taxpayers. If we can lower or eliminate altogether the costs of complying with the code for a substantial number of taxpayers,

we’ll have a much fairer and less intrusive system.

As some of you know, I’ve been working on my own ideas for how we might accomplish those goals. And I know other Members of this Committee have offered

thoughtful plans for reforming the tax code. I commend Chairman Archer for having

these hearings to increase the awareness and understanding of the challenge of tax

reform.

Now, let’s take the next step—on a bipartisan basis—to make tax reform a clear

policy goal for this Congress.

Chairman A

Mr. Rangel?

Thank you.

RCHER. I have no questions.

f Mr. RANGEL. I am a little afraid of the idea of a commission having such broad powers in determining philosophically how we

should collect the revenues that would run our country.

With Social Security, I joined with the Chairman in believing

that a commission was the right way to go. Philosophically I don’t

think there is that much diversity in terms of how do you fund a

system once you have already decided the health care that you

want to provide. But whether we are talking a value-added tax, a

Federal sales tax, or a progressive income tax, I think we are elected to make those type of decisions.

But I am attracted to the idea of bringing together groups of professionals, excluding Members of Congress, have them review and

analyze the different systems that have been offered to the Congress, and to report back to the Ways and Means Committees the

pros and cons of it.

279

But it just seems to me that I would not want presented to the

Ways and Means Committee, to the House, or however you work

this out, something that philosophically may be diametrically opposed to what I think should be happening. Members are elected

to express their views of their constituents, are would need to know

what direction the commission would be going and have an impact.

There is enough good ideas in what you are saying and I think

that your presentation is positive. We should have more outside

views, so that we don’t waste a lot of times just with hearings,

where experts can come together, study a situation, and then report back to the Congress.

I want to thank you for your thoughtfulness. We will continue to

rely for you for direction in assisting us. We hopefully will move

forward in bringing some resolution to this problem.

Mr. PORTMAN. Thank you. I will.

I would just make one quick comment, and that is that the educational element to this that you mentioned—I believe it was at

yesterday’s hearing—I think would be a tremendous benefit that

would come from a commission.

In the IRS Commission case, as Mr. Coyne knows, we held hearings around the country, and I think that would be appropriate.

A lot of it is going to be exactly what you say, which is bringing

experts in and also bringing people from everyday life who are affected by these massive changes that are being recommended to

talk about the impact it would have on our businesses, on individuals, families, and so there would be an educational aspect to this

and there would also be a lot of analysis, and at the end of the day

there may not be a consensus recommendation. It may be just

that—it may be just information that Congress can use.

Ultimately, of course, I said earlier—which is obvious—this committee and the elected representatives would have the final say.

Mr. RANGEL. Thank you.

Chairman ARCHER. Does any other Member wish to inquire? Mr.

Neal?

Mr. NEAL. Thank you, Mr. Chairman.

Mr. Portman, you know of my regard for your opinions, and I am

delighted with much of your testimony, but let me ask you a couple

of specific questions that I think might focus part of this discussion.

A certain amount of the tax reform debate relies upon the old notion that the grass is always greener on the other side of the fence.

Certainly, retail sales tax supporters found that out when joint tax

Tuesday estimated that it would take a 60 percent sales tax to replace all Federal taxes.

I react favorably to Mr. English’s philosophy when he said yesterday that the last thing we need is to enact reform that is so radical and experimental that Congress will be faced with revamping

it all over again in but a few years.

Let me ask you this. I know you have an interest in simplification, especially in the pension area. I have introduced a bill, which

even Mr. Archer has commented on favorably, that would eliminate

200 lines from individual income tax forms. Mr. Houghton has another version of that and has worked on international tax simplification, as well.

280

Do you think it is really possible that the committee, or at least

some of us, could hammer out a practical, reasonable, wide-ranging

tax simplification proposal? And do you think that would satisfy

many of the complaints about complexity in the current system?

The 1986 Tax Act was intended to promote fairness, simplicity,

and economic efficiency. Regardless of how well the committee

achieved any of these goals, it has spent the last 15 years unraveling at least part of it.

Do you think that we would be any more successful this time, or

do we need a completely different tax system?

Mr. PORTMAN. I guess I think both. I have always believed that

it is worth the committee’s time and the Oversight Subcommittee,

on which I serve, to focus on simplification. Every day we ought to

be trying to simplify the tax code. At the same time, and I think

this gets to your question maybe more directly—if we just do that,

we will not have done enough. Because of the forces in this town

and elsewhere to find special breaks and provisions in the tax code

that help individuals and help businesses, we will end up with the

same complexity problems, which is why we need, also, to have debate on and movement toward a more fundamental tax reform

measure which would, indeed, replace the current code.

I also think we have to realize that, as long as we are just taxing

income, we are, in effect, taxing success and taxing productivity,

and all the economists with whom I have talked and you have

talked, right, left, or center, agree that moving from something that

penalizes savings and investment and the next dollar earned to a

system that taxes consumption more would make sense from an

economic perspective.

In our current code, with all the simplification you or I might

want to do, you can’t get at that economic reality. What we can get

at is the compliance cost, which I salute you for. I think your bill

is a movement in that direction. But I think we need to go on both

tracks.

Mr. NEAL. Thank you, Mr. Portman.

Thank you, Mr. Chairman.

Chairman ARCHER. Mr. Thomas?

Mr. THOMAS. Thanks, Rob.

One of the concerns I have is that all of our focus is on the hated

IRS, for a lot of good reasons, and a lot of the programs look at

the domestic picture and the internal role of the tax code, because

we have structured ourselves so long in that way.

You and I and others know that our tax code, vis-a-vis other

countries, has significant impact on trade.

It used to be that no one really wanted to look at Medicare or

other major Federal programs because it was, as they used to say,

the ‘‘third rail.’’ Although President Clinton probably doesn’t want

to have credit for starting the debate by putting out a plan that

was examined in great detail and wound up being found lacking,

I think a significant education process went on among Americans

and those institutions—the media and others—in examining an

area that had not been at the forefront of exploration, the Medicare

system, and, beyond that, the health care system and the delivery

structures that go with it.

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My concern about not wanting to put something forward—and

you always do the best you can—is not so much to worry about failing, but that, absent something concrete about which debate could

turn, we aren’t going to get the kind of educational process among

the American people that I think we need. A sterile, academic discussion of options isn’t the same as, ‘‘This is what we have. This

is what you are going to get. What do you think of the difference?’’ That focuses the debate.

The fact that we would fail, say, the first time around is less important to me than how far have we advanced the American people’s understanding that we need something new, notwithstanding

what it was they just lost.

Having been on a commission recently dealing with Medicare— yours was a bit more successful than ours—we, nevertheless, I

think, elevated to a degree the discussion, because we put forth a

specific plan.

Commission, us, somebody—esoteric, academic debates don’t create the intensity to choose. Something out front that could be an

alternative does.

Reaction?

Mr. PORTMAN. I couldn’t agree with you more. It is an actionforcing event. And let me say I didn’t use Thomas-Breaux, which

was the Medicare Reform Commission, as my example, I used the

IRS one because I am closer to it, but it is a perfect example of

what I am talking about. A major difference, as you know, between

the IRS Commission and Thomas Breaux was the two-thirds requirement. Wasn’t it a two-thirds requirement for a recommendation to be made from the Commission?

Mr. THOMAS. Yes. It was 11 out of 17.

Mr. PORTMAN. We had a different set of rules under which we

worked. Now, in the end we did get a two-thirds majority, but I

think it was too bad that at the end that effort was torpedoed by

representatives from the Administration.

But, by the same token, it certainly focused debate and it certainly moved the ball forward, and I think it is a good example.

People, again, say commissions don’t work. Well, they have a

checkered past. Some have, some haven’t. But I can tell you these

two examples of the IRS Commission and the Medicare Commission I think would lead us to be favorably disposed toward a commission approach to this.

IRS reform is difficult and Medicare reform is extremely controversial and can become very political, but nothing is bigger than

tax reform because it is going to affect every single person in America, every business, and how we transact every business transaction.

As Mr. Rangel said, it is fundamentally government how we collect our taxes.

I think Chairman Archer has, through the last few years, done

incredible work in moving the ball forward, because we wouldn’t be

here at these hearings. We wouldn’t have the headlines that we are

getting. But we need to now move it to the next level, and I think

it is helpful to take it out of this politically-charged environment.

Frankly, the Administration hasn’t been able to come to the plate

on it.

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If you look to the history of tax reform, it has always been led

by Treasury. They have the expertise. They have the ability to understand how it would be implemented. This Administration has

not taken the lead on that, unlike the Reagan Administration in

1986. That may or may not happen in the next Administration.

The wonderful thing about this commission is that, while it includes the Treasury Department—and actually the Secretary of the

Treasury would make an appointment—and includes the Administration, it does not rely on them. Instead, it relies on Congress and

the Administration, bipartisan, bicameral, moving ahead on it.

So I agree with your observation, and I think the Medicare Commission is another good example.

Chairman ARCHER. Mr. Portman, thank you very much.

Mr. PORTMAN. Thank you, Mr. Chairman.

Chairman ARCHER. Our next panel is Frank Luntz and Jefrey

Pollock.

Welcome, gentlemen. If you will identify yourselves for the

record, you may proceed with your testimony. And, if possible, we

would appreciate your holding your verbal testimony to five minutes. Your entire printed statement, without objection, will be inserted in the record.

Dr. Luntz?

STATEMENT OF FRANK LUNTZ, PRESIDENT AND CHIEF EXECUTIVE OFFICER, LUNTZ RESEARCH COMPANIES, ARLINGTON, VIRGINIA

Mr. LUNTZ. Mr. Chairman, for the record, my name is Frank

Luntz. It is an honor to be here. Having had the opportunity to

present to a number of you in your offices and in various places on

the Hill and now being before this tremendous chamber, I can tell

you that distance only makes the heart grow fonder.

I am sorry that the ranking member is not here. I would have

informed him that in our polling for New York, on more than one

occasion, he is the most popular and respected political figure in

the State. When we asked him why, the number one reason was

his voice. I was looking forward to hearing his voice after we spoke

today.

I begin with a single finding from my—

Chairman ARCHER. Dr. Luntz, would you identify your official position in our world, for the record, before you commence?

Mr. LUNTZ. My official position is the president of the Luntz Research Companies. Thank you, sir.

I begin with a single finding from a survey my firm completed

just last week. When asked to choose the one government agency

or institution Americans hated the most, it should come as no surprise that they chose the IRS. In fact, the IRS was chosen more

than every other Government agency combined.

Mr. Chairman, that is just one reason why up to 80 percent of

Americans want fundamental tax reform and why so many Americans want to rid themselves of this complicated, confusing, and corrupt tax system.

I ask the members of this committee to answer one question that

we asked the American people—which would you rather have happen to you, have your wallet or purse stolen or be audited by the

283

IRS? Of Americans, 45 percent chose the wallet or purse stolen, 45

percent chose the IRS audit, and 10 percent actually said they

couldn’t tell the difference between the two.

Now, if you ask the American people to set a fair tax rate, most

Americans would agree to something around 20 percent. But what

frustrates Americans the most is not the income tax rate so much

as it is the complexity of the system and the perception that the

rich have expensive tax attorneys and fancy accountants to navigate the IRS code.

In public opinion research we have done in terms of tax reform,

Americans have four essential requirements

Number one, fairness. Americans want to know that the family

with the expensive mansion on top of the hill is paying his or her

fair share. Fairness does not mean soak the rich, but it does mean

the wealthy must pay their fair share.

Number two is simplicity. People do not want to pay accountants

to prepare their taxes, yet an increasing percentage of working

class families now need to because the system is so complicated

and so frustrating.

Number three, uniformity. Working families dislike having tax

advantages parceled out to those who hire expensive lobbyists and

tax lawyers. Americans want a Federal tax system that treats billionaires like Bill Gates exactly the same as bus drivers like Ralph

Cramden.

Consistency—Americans hate how the tax code changes from

year to year. With all due respect, they want a tax code that you

all up there can’t tinker with from year to year.

Tax reform is a middle class issue because it is the middle class

who work the longest and hardest and feel the most short-changed

by not finding all the tax deductions they are entitled to. I ask you

to think about just how often you all are affected by the tax code.

When you wake up in the morning and drink your first cup of

coffee, you pay a sales tax. You start your car, you pay a gas tax.

You drive to work, you pay an automobile tax. At work you pay an

income tax. You turn on the lights, you pay an electricity tax. You

flush the toilet, you pay a water tax. You get home at night, you

pay a property tax. You turn on your TV, you pay a cable tax. You

make a phone call, you pay a telephone tax. Even when you die,

you pay a death tax.

Two-thirds of Americans believe that they are over-taxed and

they want a break, and that is why tax reform, Mr. Chairman, is

so universally popular and that is why, in particular, they want an

end to the marriage penalty and an end to the death tax.

It doesn’t matter whether you are a republican or democrat.

Americans believe that a recently-married couple should not pay

more in taxes just simply because they decided to get married. It

is one of the most sacred and important institutions in our society,

and you are going to have a difficult time finding anyone who believes that they should have to pay more just because a man and

a woman tie the knot.

Similarly, it was Benjamin Franklin, my favorite founding father, who said, ‘‘There are only two certainties in life—death and

taxes.’’ But I don’t think even Ben Franklin would have known that

both those occurrences would have come at the same time.

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My colleague, Jef Pollock, has more numbers to share with you,

so I will close with the following observation: most Americans believe you can fix the tax code, instill fairness and consistency, and

still maintain and strengthen programs like Social Security and

Medicare. They believe you have got the power to do it all, and

they want you to do it all.

And the people that I polled are not the Internet paper billionaires, they are not the high-priced lawyers. They are struggling to

make ends meet. They sacrifice their own needs and give everything they can to their children. All they want to know is that you

hear them and that you care, so prove it with a new tax code that

is consistent, flat, fair, and tinker-proof.

Thank you, Mr. Chairman.

Chairman ARCHER. Thank you, Dr. Luntz.

[The prepared statement follows:]

Statement of Frank Luntz, President and Chief Executive Officer, Luntz

Research Companies, Arlington, Virginia

I begin with a single finding from a survey my firm completed just last week.

When asked to choose the one government agency or institution they hated the

most, it should come as no surprise they chose the IRS. In fact, they chose the IRS

more than every other government agency—combined In fact, according to a colleague of mine, Democratic pollster Peter Hart, few things frighten Americans more

than receiving an IRS notice in the mail.

Mr. Chairman, that’s just one reason why up to 80% of Americans want fundamental tax reform, and why so many Americans want to rid themselves of this

complicated, confusing and corrupt tax system. In fact, for most Americans, the

point of least favorable contact between them and Washington occurs sometime late

in the afternoon of April 15 when they deliver their tax return to the friendly local

post office.

I ask this Committee to answer a question I put to the American people: would

you rather have your wallet or purse stolen or be audited by the IRS? Among Americans, 45% would rather be audited, 45% would rather have their wallet or purse

stolen, and 10% said there was no difference!

Now, if you asked Americans to set a fair tax rate, most would readily agree to

something around 20 percent. But what frustrates Americans most is not the income tax rate so much as it is the complexity of the system and the perception

that the rich have expensive tax attorneys and fancy accountants to navigate the

Internal Revenue Code.

In the public opinion research we have done in regard to tax reform, Americans

have four essential requirements for any new tax code:

1) Fairness. Americans want to know that the family in the mansion at the top of

the hill is paying his fair share. Fairness does not mean soak-the-rich, but it does

mean the wealthy must pay their fair share.

2) Simplicity People do not want to pay accountants to prepare their taxes, yet an

increasing percentage of working class families now need to because the system

is so complicated and frustrating.

3) Uniformity Working families dislike having tax advantages parceled out to those

who hire expensive lawyers and lobbyists. Americans want a tax system that

treats Bill Gates no better than Homer Simpson.

4) Consistency Americans hate how the tax code changes from year to year. With

all due respect, they want a tax code that stops all of you from tinkering with

it.

Tax reform is a middle class issue, for it is the middle class who work the longest

and the hardest and feel the most shortchanged by not finding all the tax deductions they are entitled to. I ask you to think about just how often the working men

and women of America are taxed in their day-to-day livesa...

When you wake up in the morning and drink that first cup of coffee, you pay a

sales tax. When you start your car, you pay an automobile tax. Drive to work, you

pay a gas tax. At work, you pay an income tax—and a payroll tax. You get home

at night, you pay a property tax. Flip on the light—you pay an electricity tax. Turn

on the TV—you pay a cable tax. Call a friend, you pay a communications tax. Brush

your teeth, you pay a water tax. Even when you die, you pay a death tax.

285

In short, two-thirds of hardworking American believe they are overtaxed,

and they want a break. That’s why tax reform is so universally popular, and why,

in particular, Americans want an end to the so-called marriage tax and the death

tax.

It doesn’t matter whether you are a Republican or a Democrat. Americans believe

that a recently married couple should not pay more in taxes simply because they

decided to get married. The institution of marriage is one of the most sacred and

important in our society, and you would have a difficult time finding anyone who

believes the government should penalize a man and a woman simply because they

choose to tie the knot and start a family.

True, it was Benjamin Franklin, my favorite Founding Father, who said there

were two certainties in life: death and taxes. But I do not believe even Dr. Franklin

could have told us that both would occur at the same time. Perhaps that is why

only a fraction of Americans believe they will ever be impacted by the death tax,

and yet a clear majority want that tax eliminated—now.

My Democratic colleague has more numbers to share with you, so I will close with

the following observation. Most Americans believe you CAN fix the tax code, instill

fairness and consistency into the system, and still maintain and strengthen programs like Social Security and Medicare. They believe you have the ability and the

power to do it all.

And the people I poll are not the Internet paper billionaires. The people I poll

don’t have the high priced lawyers and fancy CPA’s at their beckon call. The people

I poll still struggle to make ends meet. They still burn the candle at both ends to

put food on the table and keep a roof overhead. They still sacrifice their own needs

and giving everything they’ve got to make sure their children have every opportunity for a brighter future. All they want to know is that you hear them and that

you care. So prove it, with a new tax code that is consistent, flat, fair and ‘‘tinker

proof.’’

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Chairman A

STATEMENT OF JEFREY POLLOCK, PRESIDENT, GLOBAL

RCHER. Mr. Pollock?

fSTRATEGY GROUP, INC., NEW YORK, NEW YORK

Mr. POLLOCK. Thank you, Mr. Chairman.

My name is Jef Pollock. I am the president of Global Strategy

Group, a public opinion research firm for the democrats.

287

Hemlines go up. Hemlines go down. Los Angeles has forsaken

the martini lunch for a sobering shot of oxygen. Public opinion

waxes and wanes. But what is the one thing everyone has consistently agreed upon since Truman beat Dewey? Taxes, Mr. Chairman, are too high, and the system we endure too complex.

Over 40 percent of Americans have considered Federal income

taxes to be too high since the 1940s, and for the last 30 years that

figure has risen to 60 percent, though admittedly it is down from

its high of 69 percent in 1969.

How much is too much? As my republican colleague, Dr. Luntz,

has stated, almost two-thirds of Americans say the highest percentage we should have to pay for all taxes combined—that is Federal,

State, and local—should be less than 20 percent of their income.

And who is getting their free ride? According to most Americans,

it is the rich.

Fully two-thirds of the Nation believe that those in the upper income bracket pay too little in taxes, and almost half of all Americans say this is the aspect of our tax system that bothers them the

most.

Still, on a more personal level, less than half of the population

believes that the amount of taxes they will pay this year is ‘‘fair.’’

Americans are focused on their persistence that our tax code

needs overhaul. Dr. Luntz is correct to demonstrate that Americans

are frustrated with their increasing reliance on accountants. The

middle class think they are being squeezed by a complex system.

An impressive 61 percent of Americans believe the Federal income

tax system needs major changes or a complete overhaul.

The components of this overhaul encompass cutting taxes, simplifying the process, and regulating the power of the IRS, but,

while these suggestions sound succinct, they come with strings attached, further complicating the process of reform.

Simplicity—two-thirds of Americans find the Federal system too

complicated; yet, although the system of taxation is considered too

complex, Americans are unwilling to give up deductions to simplify

it, and they oppose, by a 57 to 34 percent margin, replacing the

system with a simpler nationwide sales tax.

Regulation—a vast majority of Americans, 68 percent, believe the

IRS has more power than it needs. There is no ‘‘other side’’ to this

issue. Right or wrong, they feel the IRS should be better regulated.

Tax cuts—Americans are equally in support of a tax cut for all

Americans, as well as a cut for moderate to low income households.

However, while 72 percent of Americans favor a cut in Federal income taxes, it is not their highest priority. A plurality, 39 percent,

placed a high priority on Congress passing a significant Federal income tax, but only 21 percent say it is the top priority. And more

than a third, 38 percent, say it should be a low or not a priority

at all.

In addition, when our firm, Global Strategy Group, frames the

question pitting tax cuts against generic spending, Americans prefer tax cuts. But when you ask people about cutting tax as opposed

to spending on programs, Americans choose, of course, to fund the

programs they most enjoy.

288

So, although they are concerned about their own purse, the point

of contributing to the Government’s coffers is clearly understood

and accepted.

The task that lies before you all is great. Americans are not

happy with the current tax system, and, although they do offer solutions, the solutions are not without their own complexities.

While Americans overwhelmingly want reform, they do not want

it at any cost. They will not trade tax reform for a cut in specific

spending programs, and they will not sacrifice deductions for a simplification in the tax codes; however, they will likely be receptive

to a discourse on how to reform the code, and we can be pretty certain they will embrace a plan to equalize the tax contributions of

all Americans and certainly to reduce the power of the IRS.

As we approach April 15th, Americans are struggling to complete

their tax forms accurately and on time. There is no better time to

reassess the tax code and deliver a simpler, fair system that addresses the perceived inequality of taxation and the inappropriate

power of the IRS.

Let us put last century’s opinion on this issue to rest forever.

Thank you, Mr. Chairman.

Chairman ARCHER. Thank you, Mr. Pollock.

[The prepared statement follows:]

Statement of Jefrey Pollock, President, Global Strategy Group, Inc., New

York, New York

Hemlines are up, hemlines are down. La Vida Loca replaces Duck & Cover. L.A.

has forsaken the martini lunch for a sobering shot of oxygen. The Watergate has

become just another fashionable address. Public opinion waxes and wanes.

But what’s the one thing everyone has consistently agreed on since Truman beat

Dewey? Taxes, Mr. Chairman, are too high. And the system we endure, too complex.

Over 40% of Americans have considered federal income taxes to be too high since

the late 1940s. And for the last thirty years, that figure has risen to 60% (though

it is down from it’s high of 69% in 1969).

How much is too much? As my Republican colleague, Dr. Frank Luntz has stated,

almost two-thirds of Americans say the highest percentage we should have to pay

for all taxes combined—that’s federal, state and local—should be less than 20% of

their income.

And who’s getting the free ride? The rich. Fully two-thirds of the nation believes

that those in the upper income bracket pay too little in taxes. And almost half of

all Americans say this is the aspect of our tax system that bothers them the most.

Still, on a more personal level, less than half of the population believes that the

amount of taxes they will pay this year is ‘‘fair.’’

Now, although everyone likes to gripe vaguely about situations they perceive to

be out of their control, Americans are focused in their persistence that our tax code

needs an overhaul. Dr. Luntz is correct to demonstrate that Americans are frustrated with their increasing reliance on accountants: the middle class think they’re

being squeezed by a complex system.

An impressive sixty-one percent of Americans believe the federal income

tax system needs major changes or a complete overhaul.

The components of this overhaul encompass cutting taxes, simplifying the process

and regulating the power of the IRS. But while these suggestions sound succinct,

they come with strings attached—further complicating the process of reform.

Simplicity: Two-thirds of Americans find the federal tax system too complicated.

• Yet, although the system of taxation is considered too complex, Americans are

not willing to give up deductions to simplify it. And they oppose (57% to 34%) replacing the system with a nationwide sales tax.

Regulation: A vast majority of Americans (68%) believe the IRS has more power

than it needs.

• There is no ‘‘other side’’ to this issue. Right or wrong, they feel the IRS should

be better regulated.

Tax Cuts: Americans are equally in support of a tax cut for all Americans as well

as a cut for moderate to low income households.

289

• However, while 72% of Americans favor a cut in federal income taxes, it is not

their highest priority. A plurality of Americans (39%) place a high priority on Congress passing a significant federal income tax cut; but only 21% say it is the top

prority. And more than one third (38%) say it should be a low priority or not a priority at all.

• In addition, when our firm, Global Strategy Group, frames the question pitting

tax cuts against generic spending, Americans prefer tax cuts. But when you ask people about cutting taxes as opposed to spending on programs, Americans choose to

fund the programs they enjoy. So although they are concerned about their own

purse, the point of contributing to the government’s coffers is clearly understood and

accepted.

The task that lies before you all is great. Americans are not happy with the current tax system and although they do offer solutions, the solutions are not without

their own complexities.

While Americans overwhelmingly want reform, they do not want it at any costs.

They will not trade tax reform for a cut in specific spending programs, and they

will not sacrifice deductions for a simplification of the tax codes. However, they will

likely be receptive to a discourse on how to reform the code, and we can be pretty

certain they will embrace a plan to equalize the tax contributions of all Americans

and reduce the IRS’s power.

As we approach April 15th, Americans are struggling to complete their tax forms

accurately and on time. There is no better time to reassess the tax code and deliver

a simple, fair system that addresses the perceived inequality of taxation and inappropriate power of the IRS. Let’s put last Century’s opinion on this issue to rest forever.

All polls cited in this testimony were conducted nationwide, and all polled only

adults. Thus, the opinions cited are representative of voters across the country.

Sources include:

ABC News/Washington Post Poll, 3/9 ¥3/11, 2000, M of E 3%.

AP Poll conducted by ICR, 3/26 ¥3/30, 1999, M of E 3.1%.

Gallup Poll, 4/17 ¥4/19, 1998.

lllll, 3/5 ¥3/7, 1999, M of E 5%.

lllll, 7/17 ¥7/18, 1999, M of E 5%.

lllll, 1/13 ¥1/16, 2000.

Gallup/CNN/USA Today Poll, Margin of Error 3%.

lllll, 4/6 ¥4/7, 1999, M of E 3%.

lllll, 7/16 ¥7/18, 1999, M of E 3%.

FOX News/Opinion Dynamics Poll, 3/10 ¥3/11, 1999, M of E 3.3%.

NBC News/WSJ Poll, 7/24 ¥7/26, 1999, M of E 3.2%.

Pew Research Center Poll, 2/9 ¥2/14, 2000, M of E 3.5%.

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291

292

293

294

295

f296

Chairman ARCHER. If I may inquire, where did you grow up?

Mr. POLLOCK. I grew up in Mr. Coyne’s home State of Pennsylvania, northeast Philadelphia.

Chairman ARCHER. Well, as a Texan, I greatly enjoyed your

statement that ‘‘the task that lies before ya’ll is great.’’ And I

thought perhaps you might have grown up in Texas.

Mr. POLLOCK. Too many clients in the south, Mr. Archer.

Chairman ARCHER. I would like to ask both of you what, if any,

difference exists between the polling data that each one of you has

been able to put together.

Mr. LUNTZ. I would say that, for the most part, it is actually

quite similar, though on some of the details it does differ because

the focus does differ, and I would acknowledge to the Members

that, depending on how you word the question, you can get a different result.

I think we would both agree that the IRS is quite unpopular. I

think we would both agree that the public does support the concept

of tax reform. The question is always in the details of that tax reform.

Today, more than at any other time, Americans believe that

there should be a consistent rate, rather than this progressive rate,

and that opinion did not exist five years ago, but it has existed for

about the past two or three years, and that opinion continues to

grow.

And I think we also would agree that the public does want to ensure that any tax reform not subject programs like Social Security

and Medicare to any kind of disruption.

Mr. POLLOCK. I would agree with Dr. Luntz and say that the

devil is in the details. When you look at questions about things like

a flat tax, for example, that is when things get very complex, because when you ask Americans straight out they tend to like it, but

once you ask them any single question that starts to whittle way

at deductions, they basically flip out. They say, ‘‘No. Forget it.’’ And

so it just takes one little push to push them over the edge, so the

simplicity sometimes is deceptive in the questions.

Mr. POLLOCK. And the surprise is actually republicans and democrats, alike, whenever we test the death tax, it is one of the taxes

that Americans hate the most, even though it is a tax that very few

Americans feel that they will ever face. That is what makes it quite

interesting. They are not responding from their own personal benefit; they are responding from the principal belief that Americans

should not be taxed at death.

Chairman ARCHER. I am a little bit curious as to what appears

to be a dichotomy between the results that Americans don’t think

higher-income people are paying enough, number one, and the comment that today a majority of them don’t like the progressive rate

structure. How do you explain that difference?

Mr. LUNTZ. It is very easy, actually. It is all the deductions that

you all have passed for various people that frustrate Americans. It

is not the rate; it is the idea that the rich will have accountants

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and lawyers and people that can find in the loopholes within the

current tax code that enable them to avoid having to pay taxes.

Mr. POLLOCK. And it is interesting, Mr. Chairman. Among Americans, 45 percent say that the taxes they pay are fair, so it is not

as if it is 70 percent saying that it is unfair, or something like that.

I would agree with Dr. Luntz that it is the deductions, and that

is the complexity that they feel.

Frank had a very good line about Bill Gates and Ralph Cramden,

that Bill Gates has all these attorneys and accountants and etc.

who can get him out of taxes. I am not picking on him particularly,

but that is the concept that Americans feel.

Chairman ARCHER. Thank you.

Mr. Thomas and Mr. Neal.

Mr. THOMAS. Actually, I believe it was Bart Simpson, wasn’t it?

Ralph Cramden is someone I recognize. I figured you were trying

to go for the now generation with Bart Simpson.

Thanks to both of you, but I, too, like the chairman, am kind of

puzzled by the presentations, and then am curious about why and

how questions are asked.

Do you have any relevant poll data if you ask American people

whether rich people are happier than poor people?

Mr. LUNTZ. In fact, sir, we have looked at that, and the most

happy people in America are the middle class.

Mr. THOMAS. And would you say that people are worth a million

dollars that find themselves in the middle class, often?

Mr. LUNTZ. The people who are worth a million dollars would

probably define themselves as being upper middle class.

Mr. THOMAS. Well, you can put all kinds of descriptive terms in

front of it, but I think even Bill Gates thinks he is middle class,

so I have difficulty, again, to deal with that kind of description.

Do you think people believe that the rich people get breaks—that

is, it is easier to beat the system if you are rich rather than poor?

Mr. POLLOCK. Absolutely.

Mr. THOMAS. I think you get the point. You can go through a series of stereotypical statements, and people will ascribe a certain

profile to the rich.

I think I could save you a lot of money and tell you without polling that people think rich people don’t pay their fair share of the

taxes.

Looking at this other chart—and I am using yours. Yours is

Powerpoint and it has a few more. That is the only reason.

Although Americans don’t like the income tax system, they oppose replacing part of it with a nationwide sales tax. Well, I don’t

like one, and now you are going to give me two. Did you try a question that said ‘‘replacing it in its entirety,’’ an either/or question,

rather than, ‘‘If you don’t like one, how about two?’’

Mr. POLLOCK. It is a good question, but, to be very clear, none

of these are—I am pulling from independent polling data, so, as

you will see, this is, you know, Gallup or—

Mr. THOMAS. Yes, but it is the same fraternity.

Mr. POLLOCK. That is true. I agree.

Mr. LUNTZ. Mr. Chairman, you know that fraternities right next

to each other never get along.

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Mr. THOMAS. And then, of course, as you said, Mr. Luntz, in

terms of the way you asked the question, if I said, ‘‘Would you like

to get rid of the income tax which would do away with the IRS and

replace it with a different tax,’’ you have now loaded the question,

I think, sufficiently that people would go for whatever the rest of

the sentence was if you threw in getting rid of the IRS.

So I am just kind of curious as to what you could provide us with

that would be slightly less entertaining, perhaps, but a bit more

enlightening, because when people don’t like the current tax system, don’t like the complexity, don’t like the IRS, but want to hang

on to their deductions, you kind of just say, ‘‘Don’t wet your finger.’’

We had better sit down and build the best scientific economic revenue package we can, and then go out and have people all agree

that the unknown is not as acceptable as the known, notwithstanding the fact that I absolutely hate the known.

You folks are going to be in the boat with us, and we are going

to be using you, but I would really love to see somebody try to cipher a series of questions with pull-out sections that substitute

back in, that, in essence, asks the same question with variables,

and then repeat it in different circumstances to try to begin to

build a base of at least relative directional signals.

To your knowledge, has anybody begun doing this, or are we

going to have to pay for it?

Mr. LUNTZ. We have done this, to some degree, and what we get,

quite frankly, are mixed signals—that the public is frustrated with

what they have now, they are scared about what you may give

them. The problem, quite frankly, is their lack of faith in people

here to give them a system that truly is flat, simple, and fair. They

believe that, because of the outside influences, they are afraid that

the actual new product might be more disruptive than what they

have now, even though they fundamentally don’t like what they

have now.

Mr. THOMAS. Well, Mr. Luntz, you made the assumption the flat

tax is the one that we would look at. What about one that got rid

of all income taxes and allowed us to be competitive in the arena

of today, and especially tomorrow, in world trade.

Mr. LUNTZ. I used the word ‘‘flat’’ to indicate both a sales tax and

an income tax. I am not speaking just of the income tax. Flat rate

means that everybody pays the same rate, regardless of whether it

collects it based on what you spend or what you earn.

Mr. THOMAS. Even that, from a semantical point of view, makes

it difficult because of the identity of the various plans and the

terms that we use, so we are even more into a semantic jungle.

Thank you very much, Mr. Chairman.

Chairman ARCHER. Just very quickly, to piggy-back on the line

of questioning of Congressman Thomas, I notice in one of the

charts that you have given us, Dr. Luntz, that you ask the question, ‘‘Should Congress completely overhaul the Federal tax system

that includes abolishing the IRS and replacing the five different income tax rates with a single rate.’’ It seems to me that is an

oxymoron, because if you have still got an income tax, even with

a single rate, you still have the IRS. I don’t know how you can do

both.

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Mr. LUNTZ. We were trying to get at not making a choice between income tax and the sales tax. The way the you read the

question, you have assumed that it is an income tax rate.

One of the challenges in polling and to present to you all is to

be neutral in terms of the income tax or the sales tax and try to

judge the public’s generic support for a fundamental overhaul of

the system. So perhaps we have not achieved that by the question.

Chairman ARCHER. But if I were to answer the question—and,

as you know, I want to abolish the income tax, which I have publicly stated for a long time, and I want to get the IRS completely

and totally out of every individual’s life, but if I were to answer

this question and say that the IRS forever will be out of my life

and I only have to pay a single income tax rate, I might be intrigued to embrace that. But I can’t get both. I can’t have a single

income tax rate and have the IRS out of my life, because I have

still got to keep the records for seven years, and they are still going

to audit me, and I have still got all of the exposure, although in

a more simple form than the current code.

Mr. Neal?

Mr. NEAL. Thank you, Mr. Chairman.

Dr. Luntz, I agreed with much of your testimony, but I want to

ask you a question.

You said that the American people view the IRS as ‘‘corrupt.’’ Did you use that term when you tested the question?

Mr. LUNTZ. No.

Mr. NEAL. No?

Mr. LUNTZ. We asked them, ‘‘What institution do you dislike the

most? What Federal Government institution or agency do you dislike the most?’’ Mr. NEAL. Let me just, if I can, address that question and the

use of that term ‘‘corrupt.’’ That word did more to poison the way

that we talk to each other in this institution than any other word

I have witnessed in the 12 years I have been in the House. That

word was used to poison the well of the institution across the way

and the way we talk and treat each other in the House.

Now, if we use that word all of the time around here to speak

to each other or use that word when we wish to change an institution and its behavior, we only bring the debate to a new low, and

that is the danger of using that term.

I would recommend to everybody here Joe Kline’s piece in the

New Yorker about a year ago, ‘‘The Town That Ate Itself,’’ in which

he went back and talked to Republican Members who used that

word and now say they regret using that word because of what

happened in the institution.

So if we didn’t test that word, I don’t know why we would throw

that word into the testimony today.

Mr. LUNTZ. Because, Mr. Congressman, I would invite you, because this is not a partisan issue, to join me in focus groups and

face-to-face sessions with Members, and the words that they use,

not to describe the IRS but to describe the tax code.

Mr. NEAL. Right. I don’t dispute that. I don’t dispute that, Doctor.

Mr. LUNTZ. It is the language—

Mr. NEAL. It is the word.

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Mr. LUNTZ. But it is the word that is used by the American people to describe what they perceive as a system that is out of control. And I invite you to join me in—

Mr. NEAL. I would like to do that. But let me ask you a quick

question here. There is a Wall Street transaction called ‘‘exchange

funds’’ that exactly accomplished that. Ralph Cramden’s wife, Alice,

has to sell her stock and then pay capital gains tax. What happens

when Bill Gates goes into an exchange fund and, in effect, trades

stock and pays no tax? Is this exactly the situation you referenced

when you were speaking earlier about the way the American people perceive the tax code?

Mr. LUNTZ. No. I was merely using Ralph Cramden as a pop culture figure, although I would correct you. Ralph Cramden and Alice

were so poor that they could never own stock, so they could never

sell it and have to pay the capital gains.

Mr. NEAL. They were just blue collar democrats.

Mr. LUNTZ. Actually, they were the first blue collar republicans.

They were just before the Reagan democrats came into being.

[Laughter.]

Mr. NEAL. I would suggest, Mr. Chairman, that the transaction

I made reference to—maybe Mr. Pollock could comment upon it, if

he would.

Mr. POLLOCK. There is no doubt, Congressman Neal, that there

is a feeling that the rich do get benefits. I don’t think that is exactly—I mean, in terms of questioning, that is not something that

hits them.

When you do focus groups—and I am sure you have seen this up

north—people, especially the middle class more and more, are angered by the capital gains tax and that it is no longer a tax on the

rich, exclusively.

But, from a rhetorical battle, if we were taking it out of the policy and into the rhetoric, it hasn’t crossed the threshold yet where

they say, ‘‘Oh, yeah, that is a tax where we, the middle class, really

need to change it,’’ but it is coming. It is coming. There is no doubt

about it.

And with ever-increasing use of Ameritrade where the middle

class and everybody is getting involved in trading, you are absolutely correct, that tax increases in prominence to them.

Mr. NEAL. I will close on this note, Dr. Luntz, that the Reagan

democrats, which I represent, have come back home.

Thank you.

Mr. LUNTZ. I will allow you to have the last word. I hope so.

Chairman ARCHER. I am hoping that we can wrap up this panel

before we go to vote, so that when we come back we can take the

next panel.

Ms. Thurman has requested time and Mr. Coyne has requested

time.

Well, I guess we can’t do that. All right. Ms. Thurman?

Ms. THURMAN. I will try to make this quick, and maybe you all

can just give us these answers in writing.

One, I would like to know, from both of you, what the demographics were of your poll, who the people were that you polled—

you know, income, where they are.

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Mr. POLLOCK. They are all nationwide. They are all general population.

Ms. THURMAN. But it would be good to have that information

available to us.

Mr. POLLOCK. Sure.

Ms. THURMAN. Secondly, Mr. Pollock, when Dr. Luntz made the

statement that everybody agreed that we ought to get rid of the

death tax, your polling does not show that. Can you give me just

a brief explanation of what you found, because it also would be

counter to what Dr. Luntz has shown about the high-paying person.

Mr. POLLOCK. They are not mutually exclusive, unfortunately,

and, unfortunately, one question doesn’t cover it. What Dr. Luntz

is talking about is, in a series of questions, when you ask people,

‘‘Would you like to get rid of X tax, Y tax, Z tax,’’ when you put

them all together at once you will see that inheritance taxes and

also the marriage penalty, both of which Americans favor, in general, getting rid of, don’t rank higher, of course, than getting rid

of an income tax or getting rid of a local property tax, which bothers them much more than do those. Of course, they hurt them a

lot more financially, so it makes sense.

So it is not dichotomous. You can have both in Americans’ minds.

It is just, when you put them all together, if I have to choose one

or two, inheritance tax or, as they like to call it, ‘‘death tax,’’ and

the marriage penalty, they are not going to be number one and

two. But when you ask them individually, certainly people do think

it is unfair.

The marriage penalty to me, when I have seen things, tests even

more egregiously, where people say, ‘‘Just because I am getting

married doesn’t mean I should have to pay more in taxes.’’

Ms. THURMAN. Okay.

Mr. POLLOCK. Did that adequately address, Frank?

Mr. LUNTZ. And I would just say that we actually have tilted the

question, because I could not believe that Americans would actually

believe that someone like Bill Gates should not have to pay a higher percentage of his savings and investment, and we tilted questions so anti-death tax. But if you go out—and, again, I invite you,

as well, to come to these sessions that I do—Americans just believe

it is a matter of principle that, even if you are rich, you should not

lose up to half of your savings and income just because you die.

Ms. THURMAN. And then, I think, maybe taking off on Mr. Archer’s last question, when he talked about getting rid of the IRS

and then the different income tax rates, but also then to the polling

that Mr. Pollock saw that says, ‘‘But don’t take away my deductions,’’ so rate would be one issue. And then, if you added in to that

same question, do you think you would get a different result if you

said, ’but don’t take away my deductions,’ as well?

Mr. LUNTZ. When you start to mention deductions, home deduction being the most popular of all, you start to—

Ms. THURMAN. Child credit.

Mr. LUNTZ. Yes. You start to see people begin to peel away. But

in the end they are prepared to pay more if you could simplify the

system. If you could say to Americans that we will guarantee that

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this will take you either no time, in the case of a sales tax, or 15

minutes, in the case of—

Ms. THURMAN. As long as it only goes to 20 percent.

Mr. LUNTZ. Once you start getting above 20 percent in taxation,

you start to have Americans chafe at it. That is correct.

Ms. THURMAN. Okay.

Mr. LUNTZ. But simplification is so important.

Ms. THURMAN. I think we all agree on simplification. I think that

is the one thing that we do agree on.

Chairman ARCHER. We are clearly not going to have time for the

Members who do wish to question to do that, so the Chair is going

to have the committee stand in recess so that we can go vote, and

then we will return.

[Recess.]

Mr. CRANE [presiding]. We will resume.

We apologize for the interruption, but that is the way this place

is run.

I now would like to yield to our distinguished colleague from

Pennsylvania, Bill English.

Mr. ENGLISH. Thank you, Mr. Chairman. I appreciate the chance

to pursue a line of questioning that occurs to me, reading with interest the testimony of these two witnesses.

You have provided some very interesting insights on how the

public views tax reform and where it sees it as a potential priority.

I wanted to get a sense of whether either of you had done any polling on international taxation.

I know, Mr. Luntz, you have done more polling on trade issues

than, I think, anyone in your profession of my acquaintance, so I

am wondering, have you polled on the idea of a fair and equal tax

on the imports and stop taxing exports—in other words, border

adjustability?

Mr. LUNTZ. Yes. Of course, no American will understand it as

border adjustability. It is much too complicated. But when you

begin to explain to them the defensive position that our products

are put in by the Federal tax code and the advantage that foreign

products have, again because of our tax code, not only do they become frustrated with it, they demand immediate change.

I would acknowledge that it is not one of the highest priorities,

but, in terms of your question, the public believes that, at a minimum, our products should not be put at a disadvantage, and preferably our products should have an advantage over foreign products, and nothing in our Federal tax code should undermine that

advantage.

Mr. ENGLISH. Mr. Pollock?

Mr. POLLOCK. I wish I had more to add, Congressman English,

but Dr. Luntz has done much more on the subject than I have.

Mr. ENGLISH. Let me say one of the keys to broadening the debate and broadening the support for fundamental tax reform, in my

estimation, is starting to include international tax issues framed in

terms that working people understand.

My colleague, Mr. Traficant, who testified yesterday, I think has

done a good job of taking that message back to Youngstown, Ohio.

I have tried to do the same thing in Pennsylvania.

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I think that international taxation, specifically border

adjustability, moves people, and I have gotten that sense from discussing it at town meetings and actually just unscientifically trying

to get a reaction in terms of a show of hands.

I would invite both of you to consider polling on this point, and

also polling on the question of, as one of our witnesses yesterday

testified, my proposal specifically would end the tax incentive for

run-away plans. I think that is something that would resonate very

much with the general public.

On a separate point, Dr. Luntz, I see from the polling that the

Luntz Group did that the fairness quotient of the taxation of alcohol and beer is perhaps in a different category from other taxes.

Only 20 percent feel the taxation of beer is unfair.

I wonder, in polling, have you communicated to the people you

poll the fact that 43 cents on every dollar that they pay for the

draft of beer in a place like Eerie, Pennsylvania, is taxed? This gets

to the question of the visibility of taxation. I wonder, if people are

aware of what the level of excise tax is, would those numbers

change?

Mr. LUNTZ. They probably would change. In fact, in my presentation, in my testimony I spoke of all the different areas that we

are taxed. Mr. Congressman, most Americans aren’t aware that,

from the moment they wake up in the morning until the moment

they go to sleep at night, everything they do, everything they consume, every part of their lives are taxed. If they were made aware

of just how much they were taxed, they would say, ‘‘To heck with

everything.’’ Mr. ENGLISH. And do you think that insight would convert into

opposition, potentially, to a value-added tax if it were applied?

Most people don’t know what a VAT is, but if it is described to

them, how would you expect them to react? Or do you have any

polling on this point, imposing a very broad and visible tax on the

public?

Mr. LUNTZ. In fact, if it were consistent, if it were obvious, if it

were clear, if it were applied evenly, and if it got rid of the IRS,

the American people would support it.

Anything that simplifies, makes more consistent, makes flatter

and fairer, any type of tax like that would be supported over the

current system.

Mr. ENGLISH. So people don’t view it as a priority to know how

much they are being taxed, as long as they have a sense that the

tax system is fair?

Mr. LUNTZ. One of the great reforms that I would wish this committee would consider would be to remove withholding. If Americans knew exactly how much they paid in taxes, this committee

would be cutting taxes every single year.

Mr. ENGLISH. Thank you, Congressman.

Mr. POLLOCK. Congressman, I have done focus groups in Westmoreland, close to your home, and in that county I have talked to

people about taxes. The fact is, we also have to remember that

there is mass confusion about what all of their taxes are. I don’t

know what I am paying in property. Add the property tax into this

mix, which is, to many people, extraordinarily egregious, property

tax, income tax, sales tax, whatever it is, they are confused as to

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what tax they are paying at any given time, so certainly they don’t

know that 43 cents of their draft is going to a tax.

Mr. ENGLISH. Very good.

Mr. CRANE. The time of the gentleman has expired.

Dr. Luntz, I have given up on alcohol, but I have increased, escalated my consumption of sugar, but that is still a better deal, right,

tax-wise? [Laughter.]

Mr. LUNTZ. I am not sure how much they put on sugar. I do

know that people have paid millions of dollars to keep that sugar

tax either lower or higher than it is today.

Mr. CRANE. Okay.

Ms. Dunn?

Ms. DUNN. Thank you very much, Mr. Chairman.

I wanted to make one comment, based on Mr. English’s question,

and that is that politics has become so personal these days, and

communicating is also required to be personal for people to be able

to connect government policy to what really happens in their everyday lives. And it seems to me that, if we ever began talking in

terms of the number of dollars that people pay in taxes, whether

it is that huge gas tax or the beer tax or property tax or death tax,

and we have got people thinking about what they could purchase

for their families’ better quality of life for those dollars, that we

could end up with a mutiny. I hope that never happens.

It is shocking, Mr. Luntz, when you go through your list of the

taxes that people pay. I mean, if they are confused about what

taxes they pay, they pay every tax on everything every hour of

every day. It has really gotten to be way too much, I think.

I want to ask you a couple of questions. One, I would like to ask

you gentlemen what you have learned, either from your survey research or from focus groups, what single people are thinking about

our tax system.

For example, we have succeeded in reducing taxes in lots of

areas. We have provided for education credits when dollars are set

aside in education accounts for their children, we have provided for

capital gains taxes to be relieved on the purchase of a house. For

a single person, that house is still the same amount of money and

it still takes the same number of people mowing the lawn and trimming the trees and to pay for all the costs of owning a home. We

provide for a child tax credit. We have provided for a child care

credit. We have provided for an end to the marriage penalty. It

goes on and on and on what we have done for families who have

children.

Are the singles starting to feel a little left out on this tax system?

Mr. LUNTZ. Congresswoman, you have done a lot for hard-working taxpayers, and I can assure you that they appreciate it. The

great frustration for single taxpayers now can be summarized in

two words, ‘‘payroll tax.’’

Americans, particularly those who are just starting off their careers, are shocked when they find out just how much money is

taken out of their paycheck every two weeks and how little confidence they have that they will actually get that money back at

the end of their careers when they are receiving Social Security or

other benefits.

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It is not surprising that more young Americans believe in the existence of UFOs than believe that Social Security will exist by the

time they retire, and that payroll tax every two weeks is a frustration to them and they would like some relief.

Mr. POLLOCK. There is also the current—I wish Congressman

Johnson were here, because the current fad, of course, is to talk

about the gas taxes. And when I say ‘‘fad,’’ it is only to say that

they are talking about it right now. People really want to talk

about the gas tax. It is impacting them. They are seeing it. They

are seeing it on a daily basis. In Connecticut, people are seeing

prices over $2. So the gas tax right now, which single people are

looking at, also, because many of them are commuters—young people using a lot of their car—the gas tax is something that bothers

them. It bothers them more on a State level, though, certainly.

Ms. DUNN. Well, if I could have one change in our tax system— and the chairman is not here right now to hear this—but for all

singles, the group of which I am one, I wish we could just make

one exemption in capital gains for the sale of a home, because the

huge difference between 250,000 and 500,000, which is what the

couple gets, means that somebody like me, if I choose to sell my

house—and there are many of ‘‘me’s’’ around this Nation—that we

pay a capital gains, especially if we have been living in an inflationary period for any length of time.

Let me just ask you to augment what you both have said about

the death tax. I am very interested in public perception of this, and

I am very intrigued by the fact that folks you have researched are

fair about this tax. I am wondering, as we consider whether this

should be brought up as a stand-alone bill—and somebody every

now and then will question the Bill Gates factor—I wonder if you

could talk more in-depth on why death tax needs to die.

Mr. LUNTZ. We have done this specifically. In fact, because of the

challenges that have been raised by people in both parties, we attempted to weight the question as strenuously against to death tax

as we could, emphasizing that these people probably have avoided

taxes, that they have got high-priced accountants and lawyers to

help them avoid taxes, that they are so rich that they can afford

not to have to pay it. No matter how hard we weight it, by two to

one, at a minimum, Americans want to get rid of this tax, because

they just don’t understand why you should be prevented from

handing down the things that you have saved and invested to the

next generation of Americans, and how in this country you should

have to lose up to half of your savings and investments just because you have been successful.

Congresswoman, I can’t weight it any more against it. By at least

two-to-one, people want the total elimination of the death tax.

Mr. POLLOCK. It is more of a common sense thing for Americans.

When they are thinking about the death tax, and also, as I brought

up before, the marriage tax, it just seems to them to be silly. Why?

Why, on X occasion, one of great happiness and one of great sadness, does the Government get the opportunity to then come in and

tax them on that occasion?

In that respect, that is where Americans are looking and saying, ‘‘You know, this just isn’t fair,’’ whereas the other things—as I

point out, Americans will say, ‘‘Okay, we understand we have to

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fund Government programs. We understand that our taxes do go

to something,’’ but those, in particular, stand out as things that

just don’t seem right.

Ms. DUNN. Thank you very much.

Mr. CRANE. Thank you.

Mr. Coyne?

Mr. COYNE. Thank you, Mr. Chairman.

Dr. Luntz, I was wondering, does it surprise you that your findings of last week indicate that the least-liked Government agency

is the IRS, when politicians of every stripe, in order to make political points, continue to malign the work and the function of the Nation’s revenue collection agency? Does that surprise you?

Mr. LUNTZ. It has nothing to do, quite frankly, with what is said

here or with politicians; it has to do with the fact that when Americans get that IRS tax form it scares them.

Mr. COYNE. Yes. So that is your explanation?

Mr. LUNTZ. Americans are afraid of the IRS. Absolutely. They

are scared of the IRS. Even today, even with the work that you

have done to change the system, Americans are still afraid of the

IRS.

Mr. COYNE. So if people were to say things about you going

around the country, that you were stealing money out of their

pocket and they were over-loading the U.S. Treasury by their collections, how popular do you think you would be?

Mr. LUNTZ. Maybe a little more popular than I am without people saying that.

Mr. COYNE. Well, I just think it is, in large part, a result of the

maligning of the function and the role of the collection agency in

this country that they are the least-popular agency in the Government, if that is what your findings show.

Mr. LUNTZ. I think I should make this as a formal offer to this

committee, that I would be happy—and we can’t do it within the

beltway. We have to do it a little bit outside, but maybe a place

like Baltimore, which ‘‘American Demographic’’ has labeled as the

most representative city in America. I and my colleague will make

this offer to you, at our own expense, to bring you to the public and

have you listen to how they articulate their fear of the IRS. It is

not the way, in this case, that we word the questions, and it is not

what you say about them. It is how Americans fundamentally believe that there is an agency that can penetrate their lives and do

things to them that they have no control over in an unjust and immoral fashion.

I would invite this committee, for each of these issues—the death

tax, the marriage penalty, the IRS—to bring Members out there so

you can watch from behind the mirror as real, live people respond

to these questions. I think you might find it useful.

Mr. COYNE. Well, it might surprise you to know that everyone in

this Congress goes back to their Districts every weekend.

Mr. LUNTZ. I am sure.

Mr. COYNE. And that we mix with the people, and we know what

the people are saying, and we know that, as you pointed out in

your testimony, no one likes to pay taxes, but most people, the majority of the people, recognize that it is a necessity if we are to have

any kind of civil society, and that when you continually malign—

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whether it is the IRS or the Defense Department or whoever it is,

seem to me naturally they are not going to have a very high rating

in public opinion tolls like you took.

Mr. Pollock, in your testimony you cite Dr. Luntz’ survey showing that two-thirds of Americans say that the highest percentage

we should have to pay for taxes, combined, all taxes combined,

should be less than 20 percent of income. Do you know of any survey that tells us what services taxpayers are willing to give up to

achieve a 20 percent rate?

Mr. POLLOCK. Congressman Coyne, that is an excellent question.

And the point, of course, is nothing. And Americans are hypocritical in public opinion. There is no doubt about it. They don’t

make that rationalization. They want cuts, but not at the expense

of their government programs. So the question is correct. And, unfortunately, that is the way the American public responds.

Mr. COYNE. Well, do you have any specific programs that Americans choose to fund rather than getting a tax cut, in your surveys?

Mr. POLLOCK. Absolutely. The ones that have been bandied

about—and I believe that these have become prominent because, as

you are pointing out, politicians all over are talking about them—

but shoring up Medicare and Social Security certainly come before

a tax cut in the voters’ minds, improving spending on education,

for example, as long as it is targeted spending, as long as it makes

sense and not wasteful spending on education, and certainly some

spending on health care. Those are the four that have come up that

I have seen in the last six months in terms of both surveys and

focus groups where people are saying, ‘‘Okay, we have got to spend

on these things no matter what.‘‘

Mr. COYNE. Does either of your polling show what are some of

the reasons that Americans oppose a national sales tax?

Mr. LUNTZ. No.

Mr. POLLOCK. No. I haven’t seen any.

Mr. COYNE. Thank you.

Mr. CRANE. Mr. Portman?

Mr. PORTMAN. Thank you, Mr. Chairman.

I want to thank Frank Luntz for the information that he is giving us today and has given us over the years on this and other

issues, because it is very helpful, and these polls and the focus

groups do focus us a little bit more on what the key issues are and

what our constituents care about.

I want to ask a question about tax reform, since that is the focus

of the hearings.

I understand that when you ask people whether they agree or

disagree that overhaul of the Federal tax system, including the

abolishing of the IRS, and replacing five different income tax rates

with a single rate, that is popular, people agree with it. But when

you do your polling, Frank, about what people care about, tax reform never shows up near the top. Why is that? I mean, is it the

good economy? Is it the sense of frustration, that they know that

nothing will happen with it? Or is it that for most people it is just

not a very important part of their daily lives?

Mr. LUNTZ. Half of it is the good economy, but there is another

half. It bothers me. It troubles me to even say this, but they have

308

heard about tax reform and they have heard about tax cuts for so

long that they feel that they will never receive it.

We talk about these things and make these promises, and then,

when we don’t deliver, it undermines the credibility of the institution and the promise, so that most Americans believe that if the

President or Congress were to offer them a tax cut or tax reform,

it would never actually happen.

It is one way that you could instill a sense of confidence in this

institution and in this body, to actually deliver on making their

lives easier, simpler, and providing them with more money at the

end of the day than they otherwise would have had.

Mr. PORTMAN. Over the last few years, you know, as we have

helped to provide some relief, including the child tax credit, significantly, we have, in essence, begun to push the progressivity of the

code even further so that the top 10 percent of income earners are

paying something like 60 percent of the Federal income tax now.

Again, it doesn’t include payroll tax, although that is also somewhat progressive because of the cap. But it is an issue that, frankly, republicans, I think, are probably of two minds about. One is

we want to provide tax relief to middle income Americans, but second is, as you increasingly move middle Americans to a lower and

lower Federal income tax rate and you increasingly move folks who

are at the bottom of the economic ladder off the tax rolls altogether—I think it is about six million Americans who don’t pay income taxes today who did a few years ago, because of the changes

that we have made—and as you enrich the EITC program where

more and more folks are getting a refund rather than paying not

just payroll taxes but income taxes—and some folks, as you know,

are paying income tax, payroll tax, then getting a check from the

Government in the form of the EITC that covers both of those,

plus. They are actually getting something back. You begin to lose

kind of a constituency for tax reform, or at least for tax relief.

I don’t know if my question to you is do you agree with me or

not on that. That would be the one question, I guess. Is that one

reason that there isn’t as much interest in tax reform, as well as

maybe tax relief?

Second is: what does that mean for the prospects of tax reform

going forward?

Mr. LUNTZ. Americans tend to respond to big ideas in terms of

great change, and it seems very difficult to ask Americans to accept

the same tax structure today that they had 50 years ago, when we

have new technology and great inventions that are changing the

way things operate; that Americans would expect that their laws

and the things that govern them would be updated as times

change.

If you can attach yourself to that outlook towards the future, I

think you would be much more successful.

Support for tax reform will increase significantly in our next economic downturn as Americans become frustrated and their wallets

and purses become tighter. It would be nice if you could pass tax

reform before they were demanding it of you.

Mr. POLLOCK. To be very clear about one thing that Frank said,

this concept that Americans are upset, or when they think about

the concept of a tax cut they don’t actually believe it will happen,

309

there is a lot of talk of it, but it doesn’t happen, I conducted a

bunch of focus groups in Connecticut where Governor Rowland

gave back to all Connecticut individuals basically a per child, you

got $50 a head, and even though it seems like a trivial amount—

and even the voters were saying that it is silly to get a $50 check—

they were all incredibly satisfied just because somebody had actually delivered upon giving them a check, getting them an actual refund, and they gave him a lot of credit for it, even though they

thought the amount was trivial.

So I think Frank is absolutely right when he says it is about 50

percent good economy and 50 percent they don’t believe it is going

to happen.

Mr. PORTMAN. Again, thank you all very much. We look forward

to continuing to get your input as we try to pursue reform and simplification.

Mr. CRANE. Well, Dr. Luntz and Mr. Pollock, we appreciate your

testimony. I think that is—unless Mr. Thurman has a question

yet?

Ms. THURMAN. Did you all test the debt versus taxes at all? It

just has not been talked about much, and I am just kind of curious

how that plays in this.

Mr. LUNTZ. I have not done it but it has been done, and the public right now is more concerned about the debt.

Mr. POLLOCK. Right now, when you look at it, the public will

take paying off the national debt over tax cuts on a numerical

level, and if you need the numbers I can get them to you.

Mr. CRANE. Very good. Well, we thank you for your presentations. That will terminate this panel.

The committee, however, will now stand in recess until 1:00 p.m.

Mr. LUNTZ. Mr. Crane, welcome back.

Mr. CRANE. Thank you.

The committee will come to order.

The Chair apologizes for being a couple of minutes late, but we

will commence at this time.

I welcome each one of you. We are delighted to see you, and we

will look forward to your presentation.

Mr. Helming, would you lead off?

Mr. HELMING. I would be more than happy to, Mr. Chairman.

STATEMENT OF BILL HELMING, ECONOMIST AND BUSINESS

CONSULTANT, BILL HELMING CONSULTING SERVICES, INC.,

OLATHE, KANSAS

Mr. HELMING. I assume that it is appropriate to suggest that my

written document will be submitted for the record, and I will just—

Mr. CRANE. Without objection, your entire written statements

will be included in the record, and you can synopsize verbally, if

you will.

Mr. HELMING. Yes. I will do so.

It is, indeed, an honor and a pleasure to be here. I have been

self-employed for 27 years, a business consultant and economist. I

work out of my home, along with my wife, in Olathe, Kansas. We

have been working on this tax plan, the Helming national consumption tax plan, for 16 years. We have been advancing it with

310

the help of a lot of people, including the two other panelists here,

and literally thousands of people across the country.

We have been working on it as private citizens, paying our own

bills to get it done.

I think the most important introductory thing, Mr. Chairman,

would be that, as a practical matter, I have been conducting focus

groups for 16 years, literally a major cross-section of the U.S. public, finding out what they liked and what they didn’t like about this

plan and the other plans.

Bottom line: why fundamental tax reform?

Basically, the present tax code penalizes or greatly restricts success, hard work in human capital, saving and investment, economic

growth, productivity, risk-taking, and the transfer of family-owned

small businesses from one generation to the next. I have designed

this plan to try to send the right signal and to reward each of those

things as opposed to penalizing them.

As you know, Mr. Chairman, the marginal tax rate on labor,

under the current Federal tax code, is 35.6 percent. When you put

it all into one pot, it is 35.6 at the margin. The Helming two-tiered

consumption tax plan is 30.4, or 15.2 in tier one at the business

level, 15.2 on tier two at the retail level, times two is 30.4. That

is basically a 14 percent differential. I tend to be real conservative.

Let us say it is a 10 percent differential.

That means that the economy would double in growth in 10

years, compared to the way we are operating now under the

present tax code, or the cost of goods and services would come

down by 10 percent. In the real world, it would be some combination of the two.

Basically, the major benefits of such an approach would be a

stronger growth economy; more jobs; higher wages; more take-home

pay; lower cost of goods and services; lower interest rates by a significant margin—15 to 25 percent—eliminates the IRS from the

wage-earner’s perspective; major simplification; and major advantages—in this case, competitive advantages in the global market

and trade arena; and a very visible tax.

Why is this possible? Well, it is very fundamentally because,

under such a plan, we are no longer double taxing income, investment, or saving, while at the same time we are taxing labor and

capital pretty much equally, which Aldona Robbins is going to

speak to in a few minutes, which, obviously, under the present tax

system, we do not do.

It is also possible for you to get these many benefits for the economy and the working Americans of this country because it has a

much broader tax base and a uniform tax rate.

The Helming NCT plan is specifically designed to achieve all of

these specific benefits. This will particularly benefit lower-and middle-income wage earners.

I came to the conclusion some time ago, and certainly believe it

strongly today, that the status quo in terms of our current tax code

is unacceptable. If we can accrue such tremendous benefits for the

common working person in America and the working families, as

well as for the business community, then it is clearly time to seriously embrace fundamental tax reform.

311

Very honestly, all of these competing plans are going to have essentially the same impact on the economy, in terms of favorable

benefits. Where the real differences come in is how they are structured as it relates to how they specifically are perceived to impact

businesses, wage-earners and consumers, and that comes in the

structure of the tax reform proposals.

So, basically, the Helming NCT plan represents an excellent and

viable compromise, Mr. Chairman, and a common ground for real

fundamental tax reform because of its structure. It reflects many

of the best aspects and strengths of the other competing proposals,

while avoiding their weaknesses relative to perceptions in fairness,

political viability, simplicity, and compliance issues.

Very simply stated, my plan is a two-tiered plan. Tier one is a

uniform and border adjustable activities tax at 15.2 percent, wherein the tax is levied on what businesses add to output—i.e., internal

labor costs and the return to capital (profit). It applies to all businesses, the self-employed, and nonprofit organizations and institutions and all Federal, State, and local government agencies, and accounts for 57 percent of all Federal Government revenues raised.

Tier two is a 15.2 percent sales tax levied on consumer purchases

except for the necessities of life, which I will define briefly in just

a moment. The tier-two sales tax raises 43 percent of the total federal taxes.

I also want to emphasize that this plan envisions the entire repeal and replacement of the complete federal tax code as we know

it today. All income taxes, the payroll taxes, the self-employment

taxes, and all excise, railroad retirement, gasoline—in other words,

nothing is left out.

It is essentially revenue neutral at two levels at 15.2 times two,

to raise the same amount of revenues.

John Meagher just informed me today that the joint committee

on taxation did complete the scoring on my tax plan, and their

numbers came out very close to the numbers that we have been

using.

We deal with regressivity specifically by exempting the necessities of life. I define those as food at the grocery store, food mart,

and vending machine, all prescribed medical costs, and all home

purchases and/or those who rent.

On the business side, all capital purchases and exports would be

tax exempt for the business. The competitive position of U.S. businesses and the U.S. economy in the global marketplace would be

substantially improved over what it is now. The reason for this is

that we would be exempting exports and taxing, as I know you

very well understand, imports on a border-adjustable basis. That,

itself, would raise 10 percent of the total revenues. Basically, it

would encourage many multi-national companies to come home,

stay home, and hire more U.S. workers.

Progressivity and freedom of choice are primarily an outcome of

how much and when consumers choose to spend, save, invest, or

reduce debt with their income over and above the necessities of life.

Bottom line, Mr. Chairman, in terms of my verbal comments—

and I am looking forward to any possible questions that you might

want to ask—I come to this conclusion: if we can benefit the U.S.

economy in such a dramatic way and also benefit the common

312

wage-earner no positively in the United States and, the working

families of America, which clearly all the studies, including Aldona

Robbins and her husband, Dr. Robbins, and a number of others

who have helped me with this long and involved process and helping me get to this point then, I simply ask this rhetorical question.

If so many people can be benefitted, then why don’t we embrace

fundamental tax reform along these lines?

Thank you very much.

[An attachment is being retained in the Committee files.]

Mr. CRANE. Thank you, Mr. Helming, Mr. Powell, we will be

pleased to receive your testimony.

STATEMENT OF JAMES L. POWELL, LIVESTOCK PRODUCER,

FORT MCKAVETT, TEXAS

Mr. POWELL. Mr. Chairman, I come here today as a livestock producer. My interest in the Helming national consumption tax is to

seek its passage and produce change in the method that Federal

and State governments tax the hard-earned incomes and lifetime

savings of individuals and families.

Unless income, State, gift, and capital gains taxes are eliminated, the small business owner, the family farmer will continue to

be liquidated at a precipitous rate.

The evidence provided by the U.S. Census Bureau, the USDA

National Statistical Service, each decade is compelling. These numbers bear serious consideration.

In 1940, the rural population, those living in communities of

2,500 or less citizens, was 43.5 percent of the total. In 1990, the

rural population was 24.8 percent of the total.

The employment status of civilian workers employed in agriculture in 1940 was 17.1 percent of the total workforce. By 1990,

the number of agricultural employees had decreased to 1.6 percent

of the total population. The number of farms producing agricultural

products had been reduced from 65 percent from 1940 to 1990. The

size of those farms had increased 163 percent—corporate farms on

the increase. In the last five years, those farms have increased 6

percent, while the individual, family, and partnership farm have

decreased in number.

This benign trend began in the 1930s and will continue until

some time in the future. Population increases in this country and

a disruption in foreign nations that import agricultural products

into the U.S. will create the beginning of food shortages, much like

the oil shortage that developed in the 1970s.

The loss of population in agriculture and the large increase in

size of farms reflect a deterioration in U.S. agriculture.

There are a number of indicators of deterioration. It is clear that

agriculture is not the preferred choice of many youths. The minimum economic unit today in my area is about 6,000 acres, a value

of about $1,800,000. In 1940, the minimum economic unit was

about 2,250 acres, a value of less than $50,000. Today, to transfer

this unit to heirs after exclusions requires a heavy estate tax. An

education can equip the young heirs with an opportunity for employment in industry that now offers a much higher income than

agriculture. That is more appealing to them than coming back to

the farm for an inheritance that will burden them with an enorVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00318 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
313

mous estate tax after they have paid a hefty income and/or capital

gains tax.

This country is losing its agricultural young, as is shown by the

increase in the average age of the person in agriculture from 53.3

years to 54.3 years of age in only five years, from 1992 to 1997.

Another indicator of deterioration of agriculture is the parity

index of farm commodities. The index is based on farm goods sold

in 1914 equalling 100. That index has declined in the last eight

years from 51 in 1990 to 42 in 1998, a reduction in the dollar return on goods produced of 5 percent.

That loss of income and persistent demand for payment of death

taxes has caused the operating debt of the farm community to increase from $77 billion in 1980 to $80 billion in 1997, an increase

of 3 percent.

Yet another indicator is an increase in agricultural imports for

consumption. Food imports have increased 63 percent during the

current Administration from 1990 to 1995. Imports will compete

with domestic products and require those products to sell at a price

close to or below production cost. The future of this country’s food

supply will gradually become questionable.

With these negative trends confronting agriculture, it is easy to

understand the exodus of productive people from family farming

and the subsequent development of corporate farming and increased importation of farm products to supply to U.S. consumers.

The solution for agriculture and small business to the problem

that has just been described is the National Consumption Act. It

will release the unbearable income, estate, capital gains tax from

those few who now pay and place the tax more fairly on a much

broader-based population.

All imported products will bear a fair share of the tax burden

and release all U.S. exports, agricultural and industrial, from

taxes, thereby stimulating the economy.

All the citizens of the United States would be better served by

State and Federal governments if the Helming national consumption tax were implemented.

If I might be permitted, might I quote one brief vignette? Before

coming here this week, an employee, after hearing the explanation

that my mission was to encourage the elimination of the income,

State, and capital gains taxes so that many of us would not eventually join the ranks of the defunct, said to me, ‘‘Tell them I never

received a paycheck from a poor man.’’

Thank you.

Mr. CRANE. Thank you, Mr. Powell.

[The prepared statement follows:]

Statement of James L. Powell, Livestock Producer, Fort McKavett, Texas

Mr. Chairman, ladies and gentlemen of the Ways and Means Committee I come

here as a livestock producer. My interest in the Helming National Consumption Tax

is to seek its passage and produce a change in the method that federal and state

governments tax the hard earned incomes and lifetime savings of individuals and

families. Unless income, estate, gift and capital gains taxes are eliminated the small

business owner and family farmer will continue to be liquidated at a precipitous

rate.

The evidence provided by the U.S. Census Bureau and U.S.D.A National Statistical Service each decade is compelling. These numbers bare serious consideration.

In 1940 the rural population, those living in communities of 2500 or less citizens,

314

1 U.S. Census Bureau. ‘‘Statistical Abstract of the United States.’’ 27 July 1999. Online. http:/

/www.census.gov/prod/www/statistical-abstract-us.htm. Table #1412. 4 April 1999. 2 U.S. Census Bureau. ‘‘Statistical Abstract of the United States.’’ 27 July 1999. Online. http:/

/www.census.gov/prod/www/statistical-abstract-us.html. Table #1430. 4 April 1999. 3 U.S. Census Bureau. ‘‘Statistical Abstract of the United States.’’ 27 July 1999. Online. http:/

/www.census.gov/prod/www/statistical-abstract-us.html. Table #1100. 4 April 1999. 4 U.S. Census Bureau. ‘‘Statistical Abstract of the United States.’’ 27 July 1999. Online. http:/

/www.census.gov/prod/www/statistical-abstract-us.html. Table #1441. 4 April 1999. 5 U.S. Census Bureau. ‘‘Statistical Abstract of the United States.’’ 27 July 1999. Online. http:/

/www.census.gov/prod/www/statistical-abstract-us.html. Table #1102. 4 April 1999.

*Parity Price—‘‘price for a commodity or service that is pegged to another price or to a composite average of prices based on a selected prior period. As the two sets of prices vary, they

are reflected in an index number on a scale of 100. For example, U.S. farm prices are pegged

to prices based on the purchasing power of farmers in the period from 1910 to 1914. If the parity

ratio is below 100, reflecting a reduction in purchasing power to the extent indicated, the government compensates the farmer by paying a certain percentage of parity, either in the form

of a direct cash payment, in the purchase of surplus crops, or in a NONRECOURSE LOAN.

The concept of parity is also widely applied in industrial wage contracts as a means of preserving the real value of wages. (Barron’s definition of parity price as written in the Barron’s Financial Digest) 6 U.S. Census Bureau. ‘‘Statistical Abstract of the United States.’’ 27 July 1999. Online. http:/

/www.census.gov/prod/www/statistical-abstract-us.html. Table #1116. 4 April 1999. 7 U.S. Census Bureau. ‘‘Statistical Abstract of the United States.’’ 27 July 1999. Online. http:/

/www.census.gov/prod/www/statistical-abstract-us.html. Table #1113. 4 April 1999. 8 U.S. Census Bureau. ‘‘Statistical Abstract of the United States.’’ 27 July 1999. Online. http:/

/www.census.gov/prod/www/statistical-abstract-us.html. Table #1441. 4 April 1999.

was 43.5% of the total. In 1990 the rural population was 24.8% of the total.1 The

employment status of civilian workers employed in agriculture in 1940 was 17.1%

of the workforce. By 1990 the number of agricultural employees had decreased to

1.6% of the population.2 The number of farms producing agricultural products had

been reduced by 65% from 1940 to 1990. The size of those farms had increased

163%.3 Corporate farms are on the increase. In the last 5 years those farms have

increased .6% while the individual, family and partnership farms have decreased in

number.4

This benign trend began in the 1930’s and will continue until sometime in the

future. Population increases in this country and a disruption in foreign nations that

import agricultural products in the U.S. will create the beginning of food shortages,

much like the oil shortage that developed in the 1970’s. The loss of population in agriculture and large increase in size of farms reflect

U.S. agriculture deterioration. There are a number of indicators of deterioration. It

is clear that agriculture is not the preferred choice for many youths. The minimum

economic unit today in my area is about 6,000 acres, a value of $1,800,000. In 1940

the minimum economic unit was about 2,250 acres, a value of less than $50,000.

To transfer this unit to heirs after exclusions requires a heavy estate tax. An education can equip the young heirs with an opportunity for employment in industry

that now offers a much higher income than agriculture. That is more appealing to

them than coming back to the farm for an inheritance that will burden them with

an enormous estate tax after they have paid a hefty income and/or capital gains tax.

This country is losing its agricultural young as is shown by the increase in the average age of the person in agriculture from 53.3 years to 54.3 years of age in only

5 years, from 1992 to 1997.5 Another indicator of the deterioration of agriculture

is the parity index * of farm commodities. The index is based on farm goods sold

in 1914 equaling 100. That index has declined in the last eight years from 51 in

1990 to 42 in 1998, a reduction in the dollar return on goods produced of 5%.6 That

loss of income and persistent demand for payment of death taxes has caused the

operating debt of the farm community to increase from $77 billion in 1980 to $80

billion in 1997, an increase of 3%.7 Yet another indicator is an increase in agricultural imports for consumption. Food imports have increased 63% during the current

administration, from 1990 to 1995.8 Imports will compete with domestic products

and require those products to sell at a price close to or below production costs. The

future of this countries food supply will gradually become questionable.

With these negative trends confronting agriculture it is easy to understand the

exodus of productive people from family farming and the subsequent development

of corporate farming and increased importation of farm products to supply the U.S.

consumer. The solution, for agriculture and small business, to the problem that has just been

described is the National Consumption Tax. It will release the unbearable income,

estate and capital gains tax from those few who now pay and place the tax more

fairly on a much broader base of the population. All imported products would bear

a fair share of tax burden and release all U.S. exports, agriculture and industrial

315

from taxes thereby stimulating the economy. All of the citizens of the United States

would be better served by state and federal governments if Helming National Consumption Tax were implemented.

If I might be permitted may I quote one brief vignette. Before coming here this

week an employee, after hearing the explanation that my mission was to encourage

the elimination of the income, estate and capital gains taxes so that many of us

would not eventually join the ranks of the defunct, said ‘‘Tell them I never received

a pay check from a poor person.

STATEMENT OF ALDONA ROBBINS, VICE PRESIDENT, FISCAL

Mr. CRANE. Ms. Robbins?

’’

f ASSOCIATES, AND SENIOR RESEARCH FELLOW, INSTITUTE

FOR POLICY INNOVATION

Ms. ROBBINS. Thank you, Mr. Chairman.

I am Aldona Robbins, vice president of Fiscal Associates and senior research fellow at the Institute for Policy Innovation. I want to

thank you for the invitation to appear at these hearings.

As the committee has heard during the last two days, there are

lots of ways to implement fundamental tax reform. While the proposals have important differences, I would like to focus on some of

what they have in common.

First, the tax bases of most reform proposals are basically the

same. Now, someone might say, ‘‘Wait a minute. Doesn’t a sales tax

tax consumption, a business tax business, an income tax income?’’ The short answer is yes, but those distinctions really refer more to

where the tax is collected than to what is ultimately being taxed.

Government gets its revenue by taxing the income going between

households which provide labor and capital services and businesses

which provide goods and services. Because the two flows—the value

of the goods and services that businesses produce and the value of

the labor and capital services provided by households—are made

up of the same dollars, all taxes can be viewed as being paid out

of income earned by labor and capital.

A second area of commonality is the tax rate. To raise a given

amount of revenue and holding exemptions constant, most reform

proposals should yield similar effective rates.

What is more, those that look to replace Federal revenues

should, likewise, end up with average rates close to the current

system.

I would like to highlight some findings from a project in which

we have rearranged the national income and product accounts to

analyze the current tax system, as well as alternatives, on the

basis of factor incomes.

Currently, the effective average Federal tax rate—and this includes all Federal taxes—on the income of private business, labor,

and capital is 26.5 percent. The marginal rate on factor income is

36.2 percent.

Suppose we were to replace the entire system of Federal taxes

with a comprehensive sales tax, which provides every family with

a refundable credit equal to the poverty line. In that case, the effective average Federal tax rate on the income of private business,

labor, and capital would be about 24 percent and the marginal rate

would be about 29 percent.

316

What about a generic business cash flow tax with or without border adjustment in the same refundable credit? Again, the average

rate on factory income would be about 24 percent and the marginal

roughly 29 percent.

The effective rates of the alternatives are lower than current law

because the proposals have broader, more uniform tax bases and

a single rate. The rates of the alternatives are the same because

they both end up taxing the same dollars but at different collection

points.

Compliance is assumed to be the same as under current law. The

effective tax rate would be the same, regardless of what the stated

rate might be.

If the Joint Tax Committee says that the required rate is really

going to be 30 percent instead of 24, it simply means that the current law rate must be higher than the 26.5 percent that we had

calculated.

Doing so, however, would not change either the conclusions regarding the effective rates or the relative comparisons.

I would like to close with some comments about economic effects.

There are efficiency gains to be had in reform of the current system. Both capital and labor pay higher rates on the next dollar of

income than on the average dollar, and—although I didn’t present

verbally these results, they are in my written remarks—capital is

taxed more heavily than labor.

A single rate which would treat capital and labor the same, as

well as lower marginal rates, would encourage greater saving and

investment, lead to a more efficient use of resources, and result in

increased output.

There are, to be sure, important differences among competing

proposals for fundamental tax reform, but we should not lose sight

of the fact that the economic ramifications of proposals that broaden the base, remove the bias against capital, and lower marginal

rates are essentially the same.

Thank you.

Mr. CRANE. Thank you, Ms. Robbins.

[The prepared statement follows:]

Statement of Aldona Robbins, Vice President, Fiscal Associates, and Senior

Research Fellow, Institute for Policy Innovation

Mr. Chairman and members of the Committee, I am Aldona Robbins, Vice President of Fiscal Associates and Senior Research Fellow at the Institute for Policy Innovation (IPI). Thank you for the invitation to appear at these important hearings

on tax reform.

Calls for tax reform stem from growing dissatisfaction with record tax burdens,

the complexity of the present code, and worries that Americans aren’t saving

enough. As the Committee has heard during two days of testimony, there are a myriad of ways to implement fundamental tax reform. Some, like a national sales tax,

represent a radical departure from the current system. Others, like a factor payment or generic business cash flow tax, are less so.

While fundamental tax reform proposals have important differences, they also

have much in common. My remarks today will focus on some key similarities.

First, the tax bases of most reform proposals are basically the same. Someone will

undoubtedly protest, wait a minute, a sales tax taxes consumption, a business tax

taxes business, and an income tax taxes income. Those distinctions, however, really

refer more to the point of collection than to what is ultimately being taxed.

Anyone who takes an introductory economics course usually goes through an accounting exercise called the circular flow describing the workings of a market economy. Businesses acquire the services of labor and capital from households to

produce goods and services. Households exchange their labor and capital services for

317

1This requires rearranging the Commerce Department’s National Income and Product Accounts to better reflect taxes. Details will be forthcoming in a study by Gary and Aldona Robbins entitled Road Map for Tax Reform from the Institute for Policy Innovation this spring. 2 In 1999, private businesses produced 75.8 percent of the $9.3 trillion in GDP.

3This includes federal, state and local government, government enterprises, domiciles (which

is people employed in domestic service and the value of home ownership) and nonprofit institutions. 4Table 3 contains the components of labor income for 1999.

5 Capital income is gross capital compensation less capital consumption allowance. Table 3

contains the components of capital income for 1999.

the goods and services produced by businesses. But, it is important to remember

that the same people who make up households also own and operate the businesses.

Labels merely serve to distinguish among economic activities.

Government gets its revenue by taxing the income going between households and

businesses. Here it is important to note that the two flows—(1) the value of the

goods and services that businesses produce and (2) the value of the labor and capital

services provided by households—are made up of the same dollars. A tax on the sale

of goods and services reduces the income that would otherwise be paid to labor and

capital. A tax on factor income reduces what workers and owners of capital can buy.

Because both flows measure the same thing, that is, total economic activity, all

taxes can be viewed as being paid out of income earned by labor and capital.

A second area of commonality is the tax rate. To raise a given amount of revenue,

and holding exemptions constant, most reform proposals should yield similar rates.

What is more, those that look to replace federal revenues should likewise end up

with average rates close to the current system.

Demonstrating these propositions requires some complex accounting to attribute

all taxes to factor income.1 Some taxes easily translate into this framework while

others require more work. For example, people pay personal taxes on income received for labor and capital services in the form of wages, interest, dividends and

so forth. The employer and employee shares of payroll taxes come out of labor compensation. Less obvious are taxes seemingly levied on business, but they, too, affect

the dollars flowing to factors. For example, the corporate income tax reduces the

pool of money available to pay dividends or other forms of capital compensation to

shareholders. Even sales and excise taxes, which are seemingly levied on the purchases of goods and services, come out of factor income because they reduce the

funds available to pay the factors.

Table 1 summarizes the average and marginal tax rates on labor and capital in

private businesses. Accounting for three-fourths of the economy, the private sector

pays close to 90 percent of U.S. taxes.2 Table 2 contains average and marginal rates

for the rest of the economy.3

On average, taxes at all levels of government claim about a third of labor income

in the private sector. Federal taxes amount to 25.9 percent and state and local taxes

to 7.4 percent.4 Private business capital pays almost half its income in taxes. The

average tax rate at the federal level is 27.6 percent and 21.6 percent for states and

localities.5

Private business capital and labor pay even higher marginal tax rates. Out of the

next dollar of income, labor pays 44.4 percent in taxes ¥35.6 percent to the federal

government and 8.8 percent to states and localities. The marginal rate on capital

is 60.6 percent ¥37.6 percent to the federal government and 23 percent to states

and localities.

Combining capital and labor, taxes claim an average 38.5 percent of private business income. Federal taxes claim 26.5 percent while state and local taxes take 12.1

percent. That implies that any proposal aiming to replace all federal taxes would

need a tax rate of somewhere between 25 and 30 percent on all U.S. income, depending on the level of personal exemptions.

Summarized below are tax rates for current law and two general approaches to

tax reform—a comprehensive sales tax and a generic business cash flow tax, with

and without border adjustment—which are assumed to replace all federal taxes. Average and marginal rates are expressed as a percent of private business income.

Tax Rates on Private Business Income

Tax Regime Average Federal 1 Marginal Federal 2 Total Marginal 3

Current Law 26.5% 36.2% 49.8%

Comprehensive Sales

Tax

23.9% 29.2% 42.7%

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Tax Rates on Private Business Income—Continued

Tax Regime Average Federal 1 Marginal Federal 2 Total Marginal 3

Generic business

Cash Flow, border adjustment

23.9% 29.2% 42.7%

Generic Business

Cash Flow, no border

adjustment

23.9% 29.2% 42.7%

AThe three proposals assume each family receives a refundable credit equal to the poverty line times the

tax rate. The revenue collected is based on a single rate on private business income and labor compensation in

the rest of the economy. There are no special tax breaks and all double taxes are eliminated. 1Federal taxes as a percent of private business income (gross labor income plus gross capital income less

capital consumption allowance). 2Federal taxes on the next dollar of private business income as a percent of private business income.

3Federal, state and local taxes on the next dollar of private business income as a percent of private business income.

Because the tax bases for the three proposals are the essentially the same, the

effective tax rates needed to raise the same amount of federal revenue as under current law also would be the same. Replacing all federal taxes would require an effective average rate on private business income of about 24 percent and a marginal

rate of about 29 percent under either the sales tax or the business cash flow tax,

with or without border adjustment. These effective rates are lower than the 26.5

percent under current law because the proposals have broader, more uniform tax

bases.

Even though the rate is flat, the system is progressive. In this example, each family would receive a refundable credit equal to the poverty line. While families below

the poverty line would face the same marginal rate as everyone else, they still

would better off than under current law. Because they would get money back, their

average tax rate would be negative, and they would not have to pay FICA taxes.

A last point about the summary table. The calculations assume that compliance

would be the same as under current law. The effective tax rate would be the same

regardless of what the stated rate may be. If the Joint Tax Committee says the required rate is 30% instead of 24%, it simply means that the current law rate must

be higher than the 26.5% calculated in the table. Doing so would not change either

the conclusions regarding effective rates or the relative comparisons.

I would like to close with some comments about economic effects. There are efficiency gains to be had in reform of the current system. First, both capital and labor

pay higher rates on the next dollar of income than on the average dollar. Second,

capital is presently taxed more heavily than labor. A single rate, which would treat

capital and labor the same as well as lower marginal rates would encourage greater

saving and investment, lead to a more efficient use of resources and result in increased output.

There are, to be sure, important differences among competing proposals for fundamental tax reform. But, we should not lose sight of the fact that the economic ramifications of proposals that broaden the base, remove the bias against capital and

lower marginal rates are essentially the same.

Table 1.—Components of Average and Marginal Tax Rates on Private Business Labor and Capital, 1999

All Government

Labor Capital

Average Marginal Average Marginal

Total 33.3% 44.4% 49.1% 60.6%

Personal 1 14.2% 25.3% 19.5% 28.0%

Corporate profits 0.0% 0.0% 11.3% 14.3%

Indirect business 25.7% 5.7% 18.3% 18.3%

Payroll 3 13.5% 13.5% 0.0% 0.0%

Federal

Total federal 25.9% 35.6% 27.6% 37.6%

Personal 11.4% 21.1% 15.6% 23.0%

Corporate profits 0.0% 0.0% 9.5% 12.2%

Indirect business 1.2% 1.2% 2.4% 2.4%

Payroll 13.3% 13.3% 0.0% 0.0%

State and local

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Table 1.—Components of Average and Marginal Tax Rates on Private Business Labor and Capital, 1999—

Continued

All Government

Labor Capital

Average Marginal Average Marginal

Total state and

local

7.4% 8.8% 21.6% 23.0%

Personal 2.8% 4.2% 3.9% 5.0%

Corporate profits 0.0% 0.0% 1.8% 2.1%

Indirect business 4.4% 4.4% 15.9% 15.9%

Payroll 0.2% 0.2% 0.0% 0.0%

* Taken from Gary and Aldona Robbins, Road Map for Tax Reform, Institute for Policy Innovation, forthcoming Spring 2000. Basic data from the National Income and Product Accounts, April 2000 release. 1Personal income taxes for labor are on wages and salaries. Personal income for capital include taxes on interest, dividends, capital gains, rent, royalties and so forth and estate taxes. 2 Indirect business taxes levied on output, like sales taxes or excise taxes, are apportioned roughly two-thirds

to labor and one-third to capital based on their respective shares in the production process . Indirect business

taxes levied specifically on capital like property taxes are attributed only to capital. 3 Employer and employee contributions for social insurance.

Table 2.

—Average and Marginal Tax Rates by Major Producer, 1998 & 1999

Average Tax Rates

Private Business 1 Households 2 Institutions 3 Govt enterprieses 4 General go

1998 1999 1998 1999 1998 1999 1998 1999 1998 

Capital 47.5% 49.1% 8.1% 8.0% 26.2% 26.4% na na na Federal 26.3% 27.6% –10.1% –10.2% 3.6% 3.7% na na na State and local 21.2% 21.6% 18.2% 18.2% 22.6% 22.7% na na a Labor 33.2% 33.3% 22.4% 30.9% 28.1% 27.6% 14.8% 14.9% 15.2% Federal 25.8% 25.9% 19.3% 27.8% 25.2% 24.8% 12.2% 12.3% 12.5% State and local 7.3% 7.4% 3.1% 3.1% 2.9% 2.9% 2.6% 2.6% 2.7% Total ProducerIncome

38.0% 38.5% 8.5% 8.8% 28.0% 27.6% na na na 

Federal 26.0% 26.5% –9.2% –8.9% 24.1% 23.7% na na na State and local 12.0% 12.1% 17.7% 17.7% 3.9% 3.9% na na na 

Marginal Tax Rates

Capital 58.5% 60.6% –1.4% –1.9% 28.7% 29.0% na na na 

Federal 35.8% 37.6% –18.4% –18.8% 5.8% 6.0% na na na State and local 22.6% 23.0% 17.0% 16.9% 23.0% 23.0% na na na Labor 43.9% 44.4% 35.5% 43.5% 39.6% 39.5% 24.7% 24.9% 25.5% Federal 35.2% 35.6% 30.7% 38.8% 35.2% 35.1% 20.8% 21.0% 21.5% State and local 8.7% 8.8% 4.8% 4.7% 4.4% 4.4% 3.9% 3.9% 4.0% Total ProducerIncome

48.8% 49.8% –0.3% –0.4% 39.0% 39.0% na na na 

Federal 35.4% 36.2% –16.9% –17.0% 33.7% 33.6% na na na State and local 13.4% 13.5% 16.6% 16.5% 5.3% 5.3% na na na 

1 Corporate and noncorporate businesses.2Labor services supplied by domestics and the imputed value of capital services received by those who own their own homes.3Mainly the nonprofit sector including hospitals, schools and churches.4Government-operated businesses which provide commercial services such as the Postal Service, Tennessee Valley Authority and state-controlled liquor stores. 5Functions normally associated with government including defense, police, education, and welfare.

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Table 3.—Sources & Uses of Private Business Funds, 1999

Sources $billions As % of Priv. Bus GDP

Total sources of private business funds 7,062.3 100.6%

Private business GDP 7,018.5 100.0%

Taxable private business GDP 7,007.9 99.2%

Untaxable, in kind compensation 10.6 0.2%

Subsidies 43.8 0.6%

Uses

Total uses of private business funds 7,062.3 100.6%

Gross labor income 4,195.2 59.8%

Compensation of employees 3,967.2 56.5%

Untaxable employee payments in kind 10.4 0.1%

Compensation of private business employees 3,956.8 56.4%

Wages and salaries 3,386.5 48.3%

Employer contributions for social insurance 279.9 4.0%

Other labor income 290.4 4.1%

Indirect business taxes on labor 228.0 3.2%

Gross capital income 2,867.1 40.9%

Corporate profits with IVA and CCA 763.3 10.9%

Profits tax liability 225.3 3.2%

Dividends 331.6 4.7%

Undistributed profits 162.1 2.3%

Inventory valuation adjustment (IVA) (13.0) –0.2%

Capital consumption adjustment (CCA) 57.2 0.8%

Net corporate interest paid 140.8 2.0%

Proprietors’ income with IVA and CCA 646.7 9.2%

Untaxable in kind proprietors’ income 0.2 0.0%

Proprietors’ net interest paid 93.8 1.3%

Other proprietors’ income with IVA and CCA 3.7 0.1%

Rental income of persons with CCA 62.4 0.9%

Other private business net interest paid 57.7 0.8%

Consumption of fixed business capital 796.4 11.3%

Business transfer payments 39.4 0.6%

Payments to persons

Payments to rest of world

Indirect business taxes and fees on capital 387.8 5.5%

Statistical discrepancy –125.1 –1.8%

AU.S. Department of Commerce, National Income and Product Accounts, Tables 1.9, 1.15, 1.16 & 8.21, April

2000.

ful to each of you for the work that you have done, for coming to

Mr. CRANE. The Chair applauds and congratulates and is gratef the committee today and sharing with us your ideas, but Gary and

Aldona Robbins have been well-known to me for many years and

do excellent work in modeling what impact our decisions are going

to have on the economy and on jobs, and James Powell is a tough

Texan rancher, the kind of vibrant individual this country was

founded on, and Bill Helming, you have spent many years in the

vineyards developing your program, and without any desire for personal gain, but to do something for the good of this country. I respect all three of you, and I am grateful that you are here before

us today.

Tell me, let me ask you a couple of questions. I don’t have time

to examine all the details, but we have it in writing and we can,

at another time, look through it. But can you synopsize why you

believe your plan is better than AFT?

Mr. HELMING. Mr. Chairman, better than what?

322

Mr. CRANE. Than the Americans for Fair Taxation that we heard

the first day of this week?

Mr. HELMING. Yes. Well, I would simply say two major reasons— and, again, from the perceptions of the common person that I interface with, Mr. Chairman.

Number one, the rate differential is a dramatic difference in

terms of the perception on the part of the taxpayer. The AFT Tax

rate is simply too high.

And then, secondly, the consumer and at the J.C. Penney level,

the consumer is under the impression, and rightly so, that businesses aren’t paying their fair share. That is the perception, and

that is a major problem from a structural standpoint, not from an

economic standpoint, but from a structural standard, in terms of

political viability of what I am proposing versus what is being proposed under the AFT plan.

Those are two major, critical issues.

Mr. CRANE. All right. Thank you very much.

Mr. HELMING. Could I just add one thing?

Mr. CRANE. Sure.

Mr. HELMING. In my findings over the last 15 or 16 years, when

it is all said and done, taking the typical taxpayer across America,

it is very clear to me after that period of time that the removal of

the entire tax code, including the FICA payroll taxes and the selfemployment taxes and getting the IRS out of the lives of the wage

earner—not the business owner, but the wage earner—those two

things are very popular among the common people in this country.

Mr. CRANE. Yes. All right. Thank you.

Now I am going to ask you a more difficult question. What are

the flaws in your program?

Mr. HELMING. Well, I think perhaps a potential concern that

might be raised would be the exemptions that I build into the plan

to deal with regressivity. In other words, a potential concern or

question might be, well, okay, if we start out with food and shelter

and medical, then who is to say that your committee and others in

Congress might suggest something else?

Well, my response to that is as follows: first of all, there is a very

well-established precedent at the State level, basically all 50

States, that for some time at the State level they exempt the very

things that I am talking about, so it is a well-established precedent.

Secondly, I would envision that the tax—if you go to manipulating, if you will, the social engineering issue and Congress says,

‘‘We are going to build in another exemption, or another two or

three,’’ well then that is going to raise the rate, and every American from Watts to Harlem is going to know what change in the

tax rates is and that is under consideration and there will be a lot

of negative response to that.

Lastly, to the potential concern that I raised, my response and

suggestion would be that any change in the new Federal tax code

be required by a super majority of the U.S. Congress.

Mr. CRANE. Well, I think you have been very up front. I know,

when I talk about structural tax reform in my town meetings, I

have to say up front there is no tax system that is perfect.

Mr. HELMING. That is right.

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Mr. CRANE. No matter how we collect taxes, there are going to

be objections, there are going to be flaws, there are going to be

problems, and one day when I spoke very strongly, as I do, about

the need to get rid of the income tax in one of my town meetings

and suggested the concept of an alternative, a man got up in the

back of the room, raised his hand, and I recognized him, and he

said, ‘‘I don’t like your ideas.’’ And that is the first time anyone had

ever said that to me. And I said, ‘‘Well, I am curious. Why?’’ And

he said, ‘‘Because we still have to pay taxes.’’ And I said, ‘‘You are

right. We would love for that day to come when we didn’t have to

pay taxes, but the Government has bills to pay, and therefore we

have to collect taxes.’’ So we should continue to seek the best way, and I thank you for

your input.

I am now going to recognize Mr. Coyne for any questions that he

might like to make.

Also, I have got to excuse myself for a very few minutes, and if

you will preside during my absence I will return shortly.

Mr. HELMING. Thank you.

Mr. COYNE [presiding]. Thank you, Mr. Chairman.

Ms. Robbins, your testimony notes that the fundamental proposals for tax reform do not make poor families pay more taxes.

What about middle class and high-income families? What happens

with their total tax bills, the middle class and upper-income families?

Ms. ROBBINS. When I refer to proposals, I am really talking

about the example that we structured here with the refundable

credit up to the poverty line.

I don’t have distributional information with me at this point. I

think, as you know, Congressman, when we are talking about

broadening the base, there are going to be some deductions that

are going to be lost and some people are going to be worse off. Others will be better off.

I think, overall, though, the objective of tax reform is to try to

get out as many of the distortions that exist in the current system

and broaden the base, bring down the tax rates, and generate

more—ultimately, the greater growth that would result, I believe,

from tax reform would, long run, make everyone better off, but certainly starting out of the gate there are going to be winners and

losers.

Mr. COYNE. So you have no data that would show that middle

class—

Ms. ROBBINS. We have not constructed that information as yet.

This project is still under way, so we will eventually have distributional tables.

Mr. COYNE. Okay. The economy is in its longest period of expansion in the Nation’s history, and the current tax system doesn’t

seem to have hampered that amazing achievement for all of us, or

most of us. Do you think a sudden fundamental change to the tax

code could threaten that prosperity that we have been experiencing?

Ms. ROBBINS. I have done some looking at the current recovery

and have compared it, for example, to the 1960s, which, up until

February, when we passed, I think, 106 months in the 1990s, the

324

1960s had been the previous longest expansion. It is interesting on

the tax issue that the average tax rates in the 1990s are higher

than they were in the 1960s. That is because we have programs

like Social Security and Medicare that are larger today, and also

because State and local governments have expanded over time.

So the average rates in the 1960s were actually lower, but what

was interesting is that during the 1990s the marginal tax rates had

been lower than they were in the 1960s, but they have been

trending up, so right now we are getting close to marginal rates of

where they were in the 1960s.

I guess what I am concerned about and keeping an eye on are

leading indicators, such as the stock market and investment, to see

if perhaps this recovery might not be starting to stall. If it is, then

I think the tax rate issue is certainly one area that needs to be revisited.

I would argue that anything you can do to bring down marginal

rates will be added insurance to keep this recovery going even further.

Mr. COYNE. Well, I guess I am not speaking so much of rates as

I am any structural change in the code that would come about by

saying that in the year 2003 or 2004 we are going to have an altogether different method for revenue collection.

Ms. ROBBINS. Right.

Mr. COYNE. And aside from the progressive income tax that has

served us very, very well over the years.

Ms. ROBBINS. I guess, again, it would matter on what kind of disruptions that are being discussed, although I think if you look historically, when there have been changes to the tax code, the economy is remarkably resilient and does make adjustments pretty

quickly.

Mr. COYNE. Thank you.

Ms. ROBBINS. You are welcome.

Mr. COYNE. John?

Mr. TANNER. I am sorry I got here late.

Mr. Helming, I was reading your proposal, and in it do you—we

had a hearing two days ago, I guess it was, and there was a proposal for a national sales tax—

Mr. HELMING. Yes.

Mr. TANNER.—that would apply to the cities and counties and

States in this country on not only their purchases, but also on the

wages paid, as a service.

I was reading yours. Is yours similar to that, that you tax local— Mr. HELMING. No, sir. The plan that you have before you and

that I presented here today is for the Federal level, only, but I can

speak to the State level, if you would like me to.

Mr. TANNER. Yes.

Mr. HELMING. The 15.2 tax rate at tier one and tier two is required to achieve revenue neutrality for raising the same amount

of revenues as we do now.

I don’t know if you were here when I spoke to that. The marginal

tax rate on labor under the current code is 35.6 percent, and under

this plan it is 30.4, about a 14 percent differential.

If you were to take the same formula and applied the tier one

and tier two to be revenue neutral—in other words, strip out all

325

income tax for those States that have income taxes and sales taxes,

property and real estate and property taxes—you would basically

have a 7.6 percent total, or divided by two, 3.8, so you would add

3.8 to 15.2, and you would basically have a 19 percent rate to cover

and replace all federal and state government taxes.

You see what I am saying? That would replace all Federal and

State taxes.

Mr. TANNER. I think I heard you say that you favor the super

majority bill to raise taxes?

Mr. HELMING. Well, to change anything in the tax code.

Mr. TANNER. To change anything.

Mr. HELMING. I mean, what I am suggesting, assuming our Nation and our American people are so fortunate to have a fundamental tax reform embraced, my suggestion would be then part of

the law which you and your colleagues would be writing would be

a requirement that any structural change or change in the rate in

any manner would require a super majority of the U.S. Congress.

Mr. TANNER. What about foreign money, raising the debt ceiling?

Would you also favor super majority to do that?

Mr. HELMING. I am sorry. I am having a hard time hearing you.

Mr. TANNER. To borrow money to raise the debt ceiling, would

you favor a super majority to borrow money?

Mr. HELMING. I guess I probably would, but I haven’t thought

about that one near as much.

Mr. TANNER. Well, would you agree that there is pressure in the

here and now to not raise taxes more so than the pressure in the

here and now from those yet unborn who are getting the debt that

we are leaving them to just simply borrow more money, rather

than paying for our consumption today? Would you have a problem

with that?

Mr. HELMING. Yes, sir, I sure would.

Mr. TANNER. So if one believed that the pressure to not raise

taxes today is greater than the pressure from those that are not

here yet to not borrow from them, it seems to me the super majority that we ought to be talking about as relates to the tax code

ought to be to borrow money rather than to pay for what we do

today.

I think we should think about the efficacy of what we are doing

with respect to our Nation’s debt rather than what we are doing

with respect to the tax code as it relates to the here and now, but

that is just another— Mr. HELMING. I guess my emphasis, Congressman, is that, when

we look at a structural change and a fundamental change in the

revamping of the current tax code, as many others have already

said and as I have been saying for some time, if it is done properly,

you know, everybody in the economy essentially wins. I mean, certainly the common wage-earner is going to benefit from a fastergrowing economy, lower interest rates, lower cost of goods and

services.

Mr. TANNER. I agree.

Mr. HELMING. And so I don’t think we can walk away from that.

I think, as long as we can do it and raise the required amount of

money to stay within the budget limitations, it seems to me we

ought to be doing it.

326

Mr. TANNER. I agree. It is curious this super majority thing

keeps coming up, but no one wants to talk the fact that—

Mr. HELMING. The reason I bring that up is that, you know, one

of the very nice features about the structural aspect of this twotiered system is that it is levied across the entire economy—the

business sector and obviously the consumer sector—and if Congress

decides, for whatever reason or reasons at some point, assuming we

were to implement such a plan, that it wanted to change it, it

seems to me that ought to require a major hill to climb before it

was changed. That is all I am trying to suggest.

Mr. TANNER. I understand the super majority thing. The process,

though, has always intrigued me because no one talks about it in

relation to borrowing money. They only talk about it in relation to

raising taxes.

Would you require a super majority to declare war?

Mr. HELMING. Well, I think the Constitution says that is up to

the President in one sense—

Mr. TANNER. No, it is up to the Congress to declare war.

Mr. HELMING. It is really up to the Congress. Yes.

Mr. TANNER. When you go down that road, what about a super

majority to elect people to come here to make these decisions? I

mean, when you start talking about super majorities—we had a

vote on it this week, and I don’t want to argue about it, but it has

just always caught my attention when people talk about a super

majority as it relates to the tax code but not to borrow money or

do anything else around here. I wish—

Mr. HELMING. I wouldn’t quarrel with you that a super majority

conceptually is a good idea.

Mr. TANNER. You think it is?

Mr. HELMING. Yes, I do for my tax proposal

Mr. TANNER. Well, that is an interesting conception.

I yield back the balance of my time.

Mr. ARCHER [resuming Chair]. Mr. Coyne, thank you for presiding in my absence.

Again, we thank all three of you for coming and presenting your

proposal. It is clearly a well-thought-out proposal, and it is going

to be very helpful to us as we try to find our way through to the

final solution of what we can get past in structural tax reform.

Mr. HELMING. Mr. Chairman, my next step is to get it introduced

into Congress, but it is a pleasure to be here.

[The following was subsequently received:]

May 3, 2000

Congressman John Tanner

1127 Longworth Building

Washington, D.C. 20515

Dear Congressman Tanner:

Let me start by thanking you for being present during my presentation at the Tax

Reform hearings conducted by the House Ways and Means Committee on April

13th. I am writing to clarify an answer I gave to you regarding having a two-thirds

majority rule as it pertains to the tax code and specifically my proposal.

I need to tell you that I was having difficulty hearing questions coming from the

committee. I had to have Chairman Archer repeat himself a couple of times earlier

during the Q & A. Upon review of the written transcript, I saw that I missed the

concern you were trying to convey in the context of your question. I’ll briefly make

a couple of points that hopefully will better answer your question.

327

I am aware that some in congress have advocated a two-thirds rule for raising

taxes. I am sure there are many motivations that cause these individuals to take

their positions. For those who sincerely think that such a move would help solve

the inequities in the current system, I think they would be disappointed by the results. I am in the camp that believes the current code can’t be fixed by tinkering

with it and that we should take advantage of the good times to phase in a new,

revenue-neutral code.

As a two-thirds rule could pertain to a new tax code, I think one could argue for

it. As it might pertain to my proposal, the two-thirds rule would be used to primarily keep the overall structure in tact for a longer period of time. Should an industry lobby for special treatment or exempt status, for example, the overall tax

rate levied at the business and retail levels would go up. The two-thirds rule would

make it harder for that kind of change to occur and there would be a good chance

the voters would take a more active role in letting their positions be known. The

rule would apply to raising taxes, but under my plan, the rule also applies to lowering the tax rate.

My motivation for having a two-thirds rule as part of my proposal, is to ensure

that the tax code will not change too much or too often. The idea is to enact a code

for the citizens, businesses and government that will be predictable and consistent,

that will remain in tact through the rigors of political and economic change.

I hope this better explains my position. Again, thank you for your time at the

hearings and I hope well have an opportunity to talk more about my proposal in

the future.

Sincerely,

BILL HELMING

cc: Bill Archer

Mr. C

Our next panel is Dr. Regalia, Ms. Soldano, and Mr. Entin, if you

John Meagher

RANE. Thank you so much. You are excused.

f will come to the witness table.

We are glad to have all three of you with us today. I think you

probably, having sat in the room, know the general format that we

try to follow, which is that your entire written statements will be

put in the record without objection, and if you will attempt to synopsize verbally within the five-minute limit, we would appreciate

it.

Dr. Regalia, if you would start off.

STATEMENT OF MARTIN A. REGALIA, VICE PRESIDENT AND

CHIEF ECONOMIST, U.S. CHAMBER OF COMMERCE

Mr. REGALIA. Mr. Chairman, my name is Marty Regalia, and I

am vice president and chief economist of the U.S. Chamber of Commerce.

The Chamber appreciates the opportunity to comment on fundamental tax reform, and I will summarize my testimony briefly.

Over the years, dissatisfaction with the Federal tax system has

resulted in the enactment of significant code changes in about 11

of the last 25 years. Even these changes, however, have not really

fixed anything, and the discontent over the code continues.

The current tax system is plagued by a number of shortcomings.

The system is cumbersome and excessively complex and results in

high compliance costs and produces a perception of unfairness, as

well as a lack of trust that not only undermines compliance with

the law, but respect for the Government.

328

The system levies multiple layers of tax on income, capital acquisitions, savings, and investment, and, as such, it is biased against

savings and investment that is crucial to our continued economic

growth.

It contains relatively high marginal rates, which are economically distorting, foster tax avoidance, and reduce compliance.

It suffers from a multitude of exclusions, exemptions, deductions,

and credits, which often cause decisions to be tax driven, rather

than made on the basis of sound economic reasoning.

Clearly, the system is in need of substantial reform, or even replacement.

The Chamber’s members are currently evaluating a number of

the proposals, and, while they have not yet selected a single approach or endorsed a specific proposal, they believe that, whatever

system is developed, it should address as many of the following

issues as possible:

The tax system needs to be simple and clear, understandable,

and relatively easy to apply.

It should eliminate or substantially reduce the incidence of confiscatory multiple levels of taxation on capital savings and investment and on productivity growth.

The system should have low marginal rates which imply a relatively broad base with relatively few exemptions.

It should level the playing field in terms of our international

competitiveness. It should do this by avoiding duplicative taxation

and other jurisdictional problems and by adopting a territorial approach that is border adjustable.

Fundamental changes to our tax system must also be accompanied by appropriate, sensible transition rules. They must be

clear-cut, of sufficient duration to allow a chance for the change to

be properly interpreted, understood, and applied, and provide an

orderly movement into the new tax structure without the application of undue costs.

The business world and our whole economic environment are

rapidly evolving, in part due to new technologies and electronic

commerce. Whether the system is reformed or replaced, it must be

consistent with this new economy and afford sufficient flexibility to

accommodate change with a minimum of tinkering.

The task of designing and implementing a substantial reform is

daunting, but the rewards are continued economic growth and a

higher standard of living. We look forward to working with you and

the other members of the committee to achieve this end.

Thank you.

Mr. CRANE. Thank you, Dr. Regalia.

[The prepared statement follows:]

Statement of Martin A. Regalia, Vice President and Chief Economist, U.S.

Chamber of Commerce

The U.S. Chamber of Commerce is the world’s largest business federation, representing more than three million businesses and organizations of every size, sector

and region, and we appreciate this opportunity to comment on reforming or replacing the federal tax system.

INTRODUCTION

Over the years, dissatisfaction with the federal tax system has resulted in the enactment of major tax code changes in 11 of the last 25 years: 1976, 1978, 1981,

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1982, 1983, 1985, 1986, 1990, 1993, 1997 and 1998, with other changes in between.

Yet, perhaps due in part to the sheer frequency of changes, taxpayer discontent

seems to have mounted. Not only do critics cite the weight of the overall tax burden,

but they also point to the way the tax is collected—specifically, the system’s high

marginal tax rates; its double, triple and sometimes quadruple taxation of the same

income; its high level of complexity; its inherent anti-saving bias; its special provisions for certain economic activities; its high cost of compliance; and its hindrance

of faster long-term economic growth.

As a result, from time-to-time, tax reform proposals have been put forth that

range from relatively straightforward alterations of the current tax code to complete

replacement of the income tax system with an entirely new system of taxation.

GENERAL OBSERVATIONS

The primary purpose of a tax system is to raise revenue to provide for essential

public goods and services. While there may be some debate over what constitutes

an essential public good or service, and thus over how much an economy should be

taxed, most would agree there are certain principles that a ‘‘good’’ tax system should

embody:

Efficiency—A tax system is efficient when the cost of collection and compliance is

low relative to the amount of revenue raised. For example, spending $10 to collect

$100 in tax revenues is more efficient than spending $50 to raise $125.

Neutrality—The distortion to economic decision-making should be minimal. How

is economic decision-making altered by the tax consequences of a particular activity?

Are sound economic fundamentals driving economic decisions, or are individuals

basing their decisions largely on the tax ramifications?

Simplicity—Ease of understanding and fulfillment should be widespread, allowing

ordinary citizens to handle their own taxes with a minimum of outside assistance.

Firms, large and small, should be able to easily understand and accurately apply

the tax code to their businesses.

Fairness—Are those in similar economic circumstances paying similar taxes? This

notion, termed ‘‘horizontal equity,’’ is relatively straightforward. Another type of

fairness that is more difficult to measure, ‘‘vertical equity,’’ suggests that those who

are in dissimilar circumstances should pay appropriately different amounts of tax.

These are very

Certainty—Are changes to the tax code capricious, frequent or unanticipated? Do

households and businesses know much will be due and when? Can they readily

project their tax liability in coming years under various sets of circumstances? Are

they responding to the current tax code or arranging their affairs in anticipation of

the next change to the tax laws?

At times, some of these principles may be at odds, but, in general, the best tax

systems would score reasonably well on these criteria.

In addition to the above characteristics, the designers of a new tax system must

also address a number of questions; for example, the degree of ‘‘progressivity’’ or

‘‘regressivity.’’ A regressive tax structure exists when lower-income individuals pay

a higher proportion of their income in taxes than do higher-income taxpayers. Conversely, in a progressive tax structure, higher-income individuals pay a greater proportion of their income in taxes than do individuals with lower incomes.

A key issue to understanding and redesigning our tax system is to recognize that

it provides incentives for businesses and households to behave in particular ways.

As such, it can be used to promote specific social goals or advance political agendas.

Often, these social or political goals run counter to the aforementioned principles

and force tradeoffs. The result can be a tax code that violates the principles of sound

taxation and imposes numerous unintended consequences. This can cause significant economic damage. In designing a tax system for the new millennium, we

should be aware of any incentive structure we may create and the likely response

from the dynamic marketplace.

Another key point for those wishing to construct a new system, or significantly

alter the existing one, is the choice of the tax base. Should we, for instance, tax income or consumption? If we choose income, should it be income less a personal exemption (of how much?), or income less a personal exemption less savings? Should

we subtract out charitable contributions? Mortgage interest? State taxes? If we believe that consumption should be taxed, should we tax sales (some, all, or retail?)

or ‘‘consumed income’’?

Moreover, choices made about the tax base will have a significant influence on

the tax rate. As we narrow the tax base—i.e., as we exclude more and more activity

from taxation—tax rates will have to rise to garner the same amount of tax revenue,

at least in a conservative, static sense (i.e., ignoring any impact on economic

330

growth). Other questions also arise: Should a single tax rate be used, or are multiple

tax rates preferable? Should different rates apply to households and businesses?

Finally, another important consideration for any tax proposal is how to get from ‘‘here to there,’’ and over what period. Regardless of the long-term benefits that may

accrue from a new tax system, making the transition from the current income tax

to a different tax regime will undoubtedly create ‘‘winners’’ and ‘‘losers.’’ How these

winners and losers are treated could make the difference between moving to a new

system and keeping our current system. Transition rules in many proposals have

not been developed yet, but they will be of paramount importance and should be

examined closely, prior to adopting any new system.

CURRENT TAX CODE

The current tax system, overall, is steeply progressive. Families who find themselves in the highest quintile (top 20 percent) of pretax annual income bear 77 percent of the income tax burden, and 53 of the overall federal tax liability when income, social insurance and excise taxes are included. At the same time, families who

are in the lowest 20 percent have an effective income tax burden of negative two

percent, due to refundable tax credits, and those in the second lowest quintile have

an effective income tax burden of only one percent. Together, those in the lowest

two quintiles, while making up 40 percent of the population, bear only 12 percent

of the overall tax liability, i.e., income, social insurance and excise taxes. (Congressional Budget Office, Budget Options, p. 43, March 2000.)

A degree of progressivity may achieve some measure of ‘‘fairness’’ in the eyes of

some, via certain social goals, such as redistribution of income or wealth, or be reflective, in part, of ability to pay. However, just as taxes are necessary to operate

our ‘‘government of the people, by the people, [and] for the people,’’ from which everyone derives benefits, good government is founded upon input and involvement

from the citizenry. When so many pay so little, if anything, towards the operation

of our government, they are not very concerned as to how the revenues are spent—

after all, it is not ‘‘their’’ money; it’s someone else’s. They feel disinterested in, and

disenfranchised from, ‘‘the system,’’ at the same time as those who pay a disproportionately high rate of taxes fell cheated and oppressed by the system. A good example of this apathy is reflected in low voter turnout for political elections, and pervasive ignorance of political processes. A tax system that requires some fair, material

participation from all segments of society in the funding of government invites their

interest and participation in how our government and our country operate. Government is enhanced by an engaged citizenry. A system designed to replace the current

federal tax code and structure should reflect these ideals.

The current federal tax system is cumbersome and too complex. A tax system cannot be perceived as fair if it is overly complicated. Unless the average person can

understand how the tax system works and prepare necessary tax paperwork without

an undue amount of education and research, it will be held in disdain. A tax system

that is so cryptic that only the privileged few can understand it does not gain the

trust of the people—it seems to be written in a secret language by, and to serve

the purposes of, an elite minority. Most people are unable to understand the tax

laws and complete their own tax returns—well over one-half of all tax returns are

prepared by tax professionals. This results in a lack of trust that not only undermines respect for government and compliance with the law, but renders the law

more difficult to interpret and enforce. Difficulty in interpretation and enforcement

breeds uncertainty and problems in administering the law, and results in a drain

on the revenues, either through direct reduction due to non-compliance, or exorbitant expenses incurred in educating people in proper reporting and treatment of

transactions; drafting and issuance of lengthy regulations; auditing of tax returns;

and litigation of disputes. A new tax system needs to be simple and clear, understandable and easy to apply, and with a minimum of computations to undertake and

tax forms to complete.

Currently, our federal tax system levies multiple layers of taxation on capital acquisition, savings, and investment. As such, it is biased against savings and investment that is crucial to sustaining our economic growth. Take, for example, a business owner who operates his or her own corporation, For that individual, such layers of taxation can include: the income tax on corporate earnings; the personal income tax and FICA taxes on wages paid by the corporation; personal income tax

on the sales of the investor’s corporate stock; capital gains tax on subsequent reinvestments made with those funds; and gift, estate, and transfer taxes levied upon

the remaining assets transferred by this unfortunate taxpayer to others. When

added together, some income faces an effective tax confiscation in excess of 90 percent, a truly draconian figure. A new tax system should reduce the incidence of such

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confiscatory cumulative taxes, and encourage productivity, savings and investment.

A fair tax system must encourage and reward those who help grow our economy.

INTERNATIONAL COMPETITIVENESS

On the international competitiveness front, a tax system should be ‘‘border-adjustable’’ and mesh well with international tax treaties entered into with our trading

partners. For instance, U.S. corporations doing business outside our borders should

not be placed at a competitive disadvantage by multiple taxation of the same transactions or activities, or being subject to tax rates which are unfavorable when compared to those levied upon our foreign competitors. If the United States taxes its

domestic businesses on their world-wide income, i.e., taxes the income of transactions or acitivites occurring in foreign countries in which U.S. corporations conduct their business, and they are also subject to tax by foreign jurisdictions, it

places those entities at a competitive disadvantage vis-a-vis their foreign competitors. If the United States taxes those transactions or activities at a competitively

unfavorable rate, our companies are disadvantaged. And, when our companies are

disadvantages, their employees, owners and our country, overall, are likewise disadvantaged. A business, whether a corporation, partnership, sole proprietorship, or

in some other legal form, is nothing more than people, and when the business is

hurt, the people that ‘‘make it up,’’ are also injured.

Our current federal tax system protects certain of our businesses from international competitive disadvantage through the Foreign Sales Corporation (‘‘FSC’’)

rules. Likewise, many international tax treaties provide for elimination or reduction

in the effect of duplicative taxation. However, recently, the World Trade Organization (‘‘WTO’’) has ruled that the Internal Revenue Code’s treatment of FSCs violates

the WTO’s conventions, constituting an illegal subsidy to U.S. firms. The underlying

bases of this dispute and preservation of border-adjustability must be addressed and

resolved in any replacement tax system to make the playing field level in terms of

international competitiveness. Accordingly, our federal tax system must either be

crafted in such a manner to integrate with existing international treaties or be coordinated with the drafting and adoption of new ones.

CONCLUSION

While proposals have been advanced for the reform or replacement of our current

federal tax code, neither our membership, nor the public, has yet reached a consensus as to which approach makes the most sense for America. Accordingly, we advocate additional study of these proposals and their expected impact on the taxpayers, and our economy, as a whole, before any one ‘‘best’’ system can be devised,

embraced, and advanced. Nonetheless, one thing we can says it that the current system offers much room for improvement, whether that be through major retooling or

redesign, to achieve: simplicity; fairness; low marginal rates with a broad tax base

with few deductions; reasonable progressivity; incentives for productivity, savings,

and investment and the fostering of international competition. At the same time,

the government must control its spending appetite so as to require the smallest

amount necessary to provide the goods and services demanded by the public, and

collect the taxes in a reasonable, cost-efficient and effective way.

Fundamental changes to our tax system must be accompanied by appropriate,

sensible transition rules. They must be clear-cut; of sufficient duration to allow a

chance for the changes to be properly interpreted, understood and applied; and provide an orderly movement into the next tax structure without undue costs.

We must also keep in mind that the business world and the ways which we structure and conduct transactions are evolving at a frenetic pace. The advent and development of new technologies, including electronic commerce, are altering the playing

arena and the rules of the ‘‘game’’ with dizzying speed. A new tax system must be

carefully crafted to encompass and accomplish its intended purposes. At the same

time, it must be sufficiently flexible to accommodate change with a minimum of tinkering. Reasoned study and foresight must be applied to designing the system, so

that in the winds of change we do not have to face the prospect of scrapping that

system and returning to square one. Let’s not rush to judgment; let’s do it right.

Vital to reaching a broad consensus on the outcome of this debate, is the principle

that everyone who is able to, should contribute to our system of government, in return for its benefits and protections, and have a stake and interest in the government. Only through the expression of such interest can the consensus we seek be

discovered.

f332

Mr. CRANE. Ms. Soldano will you now give us your testimony?

STATEMENT OF PATRICIA M. SOLDANO, PRESIDENT, CENTER

FOR THE STUDY OF TAXATION, COSTA MESA, CALIFORNIA

Ms. SOLDANO. Mr. Chairman, I am Patricia M. Soldano, Center

for the Study of Taxation. I am here today as president of the Center for the Study of Taxation, but, more importantly, as someone

who has heard from numerous families about the effect of the gift,

estate, and generation skipping tax, also called the ‘‘death tax,’’ has

had on them and their businesses. Allow me to share some death

tax facts and some horror stories with you today.

To pay a tax because someone dies at the highest rate in our tax

system on assets that have already been taxed before is the reason

that 69 percent of the general public believes that the death tax

is unfair—more unfair than payroll tax, income tax, gasoline tax,

sales tax, property tax, cigarette tax, alcohol/beer tax, and even

capital gains tax.

Why is the death tax so unpopular? Because it is a tax on the

American dream. Hard-working entrepreneurs who build their family businesses and support our Nation’s economy hope that some

day they will be in a position to will their life’s work to their children and not pay a 55 percent tax. Within the last few years, new

voices have called for the elimination of the death tax, including

the National Association of Women-Owned Businesses, the National Black Chamber of Commerce, the National Indian Business

Association, U.S. Hispanic Chamber of Commerce, U.S. Pan Asian

American Chamber of Commerce, National Association of Neighborhoods, and the Texas Conference of Black Mayors.

These minority groups have just started to build their businesses

and they want to be able to pass on their assets to their children,

the benefit of years of hard work, without a 55 percent tax or an

80 percent generation-skipping tax if they wish to give to their

grandchildren, and these people are represented by 47 percent of

the female Members of Congress, who have supported repeal of the

death tax as cosponsors of the bipartisan Dunn-Tanner bill, and I

would like to thank Congresswoman Dunn and Congressman Tanner for their work on H.R. 8 and their tireless effort to repeal the

death tax.

These women and minorities are real people who are adversely

impacted by the death tax. Money that they could use to send their

children to college or pay their family’s expenses is, instead,

snatched by Washington. One unlucky victim of this tax is Lynn

Marie Hoopingarner of West Hollywood, California, who writes to

me, ‘‘My family has recently experienced a triple tax. My grandfather paid income taxes on his income when he earned it. When

he passed away two years later, it was taxed again. My mother

than suddenly passed away this past spring, and it was taxed

again—effectively, an 88 percent tax.’’ In addition to the inherent unfairness and inappropriateness of

the death tax, it actually costs the American economy a job. Yes,

the death tax does eliminate jobs. How many? In a survey recently

done by the Center for the Study of Taxation and the Policy InstiVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00338 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
333

tute of New York, 365 businesses responded to a survey that they

had already lost 14 jobs per business in the last five years due to

the cost of planning for this tax and actually paying the tax. That

is 5,100 jobs in the last five years just within the 365 survey base.

In the next five years, they anticipate losing, on average, 80 per

business jobs. That is 80 jobs for 365 businesses—that is 15,000

jobs in the next five years.

In a recent survey of the National Association of Women Business Owners, NAWBO, there were similar results. Within the survey respondents of 272, on average 39 jobs have been lost in the

last five years per business, again for paying and planning for this

tax, and in the next five years, on average, 103 jobs will be lost per

business. That is 28,000 jobs just within that survey respondent

group.

Carri Bell, a NAWBO member who owns a business in Oklahoma

City, wrote in her response to us, ‘‘I just settled my father’s estate

and paid three-quarters of the total estate for taxes and fees. Sold

all of our stock and bonds and had to borrow. When I die, there

are no more disposable assets left, so the business will have to be

sold.’’ The death tax also impacts our global competitiveness. Since the

United States has the second-highest death tax rate of any country

in the world, second to Japan at a 70 percent rate—which you

should know doesn’t kick in until a $15 million exemption—the

death tax affects the competitiveness of U.S. companies. Family

businesses have to plan for the death tax by buying expensive life

insurance, selling assets, borrowing or restructuring their business.

It is expensive, time-consuming, energy-wasting, and constant, year

after year.

Many small-to mid-size family businesses sell out early to corporations who are not faced with the death tax, ending the opportunity of the family to carry on with the business and the livelihood of the family.

In closing, I would like to tell you the story of Ida Prichard of

Seattle, Washington. In her own words, she writes: ‘‘I am 77 years

old. My history of work, thrifts, and efforts to save money is unbelievable. Here is my reward. All of my Social Security, plus more,

goes for income taxes. I live off my teacher’s pension, as I do not

want to cash my investments. If I died today, I would pay about

$200,000 in death tax. I am helping a great niece go to college. I

have two great nephews coming up. All are bright children. I would

like to help them, not the IRS.

‘‘I had a newspaper route in college. I worked for 50 cents an

hour doing office work under the program of President Roosevelt.

I have lost money in investments.

‘‘I went to work when I had a death sentence with lung cancer

in 1967. I didn’t miss a day when I was told that I was only going

to live three months.

‘‘I am still working. I have a tenant and I tutor ESL students.

I do almost all my own work and cooking. I have never had a bill

I didn’t pay. The way things are now, what the nursing home

doesn’t get—if i am that unfortunate—the IRS will. What did I

make all this effort for? Our laws need to be changed, but I have

no clout.’’

334

Gentlemen and gentlewomen of this committee, I urge you to repeal the death tax. As the committee continues to actively consider

proposals to reform the tax system, I urge the committee to recognize that outright repeal of the death tax should be a principal

component of any proposal. Let us show the American people that

their Government has a heart. Let us show the hard-working

American people like Ida Prichard that they can pass away knowing that their life’s hard work will benefit their families. Finally,

let us show them, the so-called ‘‘little guys,’’ that they do have clout

and their Government is listening.

Thank you.

[The prepared statement follows:]

Statement of Patricia M. Soldano, Center for the Study of Taxation, Costa

Mesa, California

I am here today as the President of the Center for the Study of Taxation, but

more importantly as someone who has heard from numerous families about the effect that the gift, estate and generation skipping tax (‘‘the death tax’’) has had on

them and their businesses. Allow me to share some death tax facts and horror stories.

Most of you are already familiar with how the death tax effects mid to small sized

businesses because you have heard from those families but you may not be aware

of just how much it hurts. The facts show that 88% of the revenue generated by the death tax comes from estates $20 million or less! So yes, the very wealthy are generating some of this revenue but most of it comes from families who own small and

medium sized businesses that cannot afford to pay the tax upon the death of a family member without selling off most of the bequeathed assets.

To pay a tax because someone dies, at the highest rate in our tax system, on assets that have already been taxed is the reason that 69% of the general public believes the death tax is unfair. More unfair than payroll tax, income tax, gasoline tax, sales tax, property tax, cigarette tax, alcohol and beer tax, or even

the capital gains tax. Why is the death tax so unpopular? Because it is a tax on ‘‘the American dream.’’ Hardworking entrepreneurs who build their family businesses and support our

nation’s economy, hope that someday they will be in a position to will their life’s

work to their children without paying a 55% tax.

Within the last few years many new voices have called for the elimination of the

death tax including:

National Association of Women Business Owners

National Black Chamber of Commerce

National Indian Business Association

U.S. Hispanic Chamber of Commerce

U.S. Pan Asian American Chamber of Commerce

National Association of Neighborhoods

Texas Conference of Black Mayors

These minority groups have just started to build their businesses and they want

to be able to give to their children the benefits of their years of hard work without

a 55% gift tax or an 80% generation skipping tax if they wish to gift to their grandchildren. And they are represented by (among others) 47% of the female Members

of Congress who support repeal of the death tax, as co-sponsors of the bipartisan Dunn-Tanner bill, HR–8.

These women and minorities are real people who are adversely impacted by the

death tax. Money that they could use to send their children to college or to pay

other family expenses is instead snatched by Washington. One unlucky victim of

this tax, Lynn Marie Hooopingarner of West Hollywood, CA writes to us, ‘‘My family

has recently experienced a triple tax. My grandfather paid income taxes on his income when he earned it. When he passed away two years ago it was taxed again.

My mother then suddenly passed away this past spring and we were taxed again.

Effectively an 88% tax rate.’’

In addition to the inherent unfairness and inappropriateness of the death tax, it

actually costs the American economy and jobs. Yes, the death tax eliminates jobs.

How many?

• In a survey done last year by the Center for the Study of Taxation and Public

Policy Institute of New York, 365 businesses that responded to a survey have alVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00340 Fmt 6601 Sfmt 6621 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
335

ready lost 14 jobs per business in the past five years due to the cost of planning

and paying the death tax, that is 5,100 jobs just within those 365 businesses and

they anticipate losing on average 80 jobs per business in the next 5 years, or in excess of 15,000 jobs just within the survey group.

• In a recent survey of members of the National Association of Business Owners,

(NAWBO) there were similar results. Within the survey respondents of 272, on average 39 jobs have been lost in the past five years per business or 1,000 jobs in total

and 103 are expected to be lost in the next five years for a total of 28,000 jobs.

Carri Bell, a NAWBO member, who owns a business in Oklahoma City, wrote on

her response, ‘‘I just settled my father’s estate and paid 3⁄4 of the total estate for

taxes and fees. Sold all of our stock and bonds and had to borrow. When I die there

are no disposable assets left—so the business will have to be sold.’’

The death tax also impacts our global competitiveness. Since the United States

has the second highest death tax rate in the world, second only to Japan at 70%,

the death tax affects the competitive advantage of U.S. companies. Family businesses have to plan for the death tax by buying expensive life insurance, selling assets, borrowing, or restructuring their businesses. It is expensive, time consuming,

energy wasting and constant, year after year. Many small to mid sized family businesses sell out to larger corporations who are not faced with the death tax ending

the opportunity of the family to carry on the business and livelihood of the family.

In closing I would like to tell you the story of Ida Pritchard of Seattle, Washington

in her own words. She writes: ‘‘I am 77 years old. My history of work, thrifts and

efforts to save money is unbelievable. Here is my reward! All of my social security

(plus more) goes for income tax. If I died today, I’d pay about $200,000 in death

tax. I am helping a great niece to go to college. I have two great nephews coming

up. All are bright children. I would like to help them—not the IRS. I had a newspaper route in college. I worked for 50 cents an hour doing office work under the

program set up by President Roosevelt. I have lost money in investments. I went

to work when I had a death sentence with lung cancer in 1967. I didn’t miss a day

when I was told I could only live three months at the most. I am still working. I

have a tenant and I tutor ESL students. I do almost all my own work and cooking.

I have never had a bill I didn’t pay on time. The way things are now what the nursing home doesn’t get (if I’m that unfortunate) the IRS will! What did I make all

this effort for? Our laws need to be changed but I have no clout.’’

Gentlemen and gentlewomen of this committee, I urge you to repeal the death

tax. Let’s show the American people that their government has a heart. Let’s show

the hardworking American people like Ida Pritchard that they can pass away knowing that their life’s hard work will benefit their families. And finally, let’s show

them, the so called ‘‘little guys’’ that they do in fact have clout and that their government is listening.

Mr. C

Mr. Entin?

Thank you.

RANE. That lady sounds like my kind of American.

f STATEMENT OF STEPHEN J. ENTIN, PRESIDENT AND EXECUTIVE DIRECTOR, INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION

Mr. ENTIN. Thank you, Mr. Chairman, members of the committee. My name is Stephen Entin. I am the president of the Institute for Research on the Economics of Taxation. Thank you for this

opportunity to discuss fundamental tax reform.

I am speaking on my own behalf, but I will present to you today

a tax system developed by the Institute’s late founder, Dr. Norman

B. Ture. It is a simple saving-deferred cash flow tax for individuals,

which he called the inflow-outflow tax. It has two chief attributes.

First, it gets the tax base right, using the correct measure of income for tax purposes, one that maximizes economic efficiency and

yields the optimal growth of income.

336

Second, it shows the taxpayers the cost of government more

clearly than any other system.

Other advantages of the tax are that it uses concepts familiar to

most taxpayers, it easily incorporates tax relief for the lowest-income citizens, and it greatly simplifies the tax system.

A good tax reform would have two main objectives—namely, economic neutrality and high visibility. The current income tax is biased against saving and investment. The bias depresses productivity and wages and keeps people’s income some 10 percent or

more below their potential.

Neutrality requires that the tax system treats saving on par with

consumption in one of two ways: saving should be tax deferred

until it is withdrawn for consumption, as with the deductible IRAs

and pensions; alternatively, income saved should be taxed, but the

earnings should be tax free, as with Roth IRAs and tax-exempt

bonds. All saving should get one or the other treatment.

In addition, the extra layers of tax on saving imposed by the corporate income tax and the estate and gift tax must be eliminated.

Visibility requires that the tax system show the voting public

what they are paying for government so that they may make an

informed decision as to how much government spending to support.

Ideally, all citizens, except the very poor, should pay something to

help fund the outlays of the Federal Government in order that they

understand that the resources used by the Government are not free

or costless.

Taxes should be collected directly from individuals, not be hidden

at the business level. In fact, all taxes are paid by individuals, not

by businesses and not by goods.

There should be an annual filing that lets taxpayers see their

total tax payments for the year. People will not know their total

tax bill if it is collected in dribs and drabs at the cash register.

Of the several tax plans you have looked at this week, an individual cash flow tax is the best way to achieve the dual objectives

of neutrality and visibility. The inflow-outflow tax is based on a few

clear principles that determine what is and is not taxed.

The tax would be imposed on individuals at a flat rate, with a

basic exempt amount to protect the poorest citizens. There would

be deductions to assure neutral treatment of saving and to properly

attribute income for tax purposes to the people who ultimately receive and consume it.

All forms of labor compensation would be taxable.

Saving would be deductible—that is, tax deferred—and the reinvested earnings would grow on a tax-deferred basis. All distributions from saving would be taxed at the individual level when the

saver or the heir sold the assets to raise money for consumption.

Transfer payments made to other people, either voluntarily, as

with gifts or charitable contributions, or involuntarily, as with alimony payments or State and local taxes, would be deducted from

taxable income. Gifts and transfer payments received would be

added to the recipients’ taxable income.

Cost of acquiring human capital, such as tuition, and other costs

of earning income would be deductible.

The inflow-outflow tax would be far simpler than the current tax

system. Expensing saving and taxing all returns would eliminate

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capital gains calculations. There would be no corporate income tax

or estate tax. Investment by unincorporated businesses would be

expensed, not depreciated, eliminating complicated capital cost recovery rules.

The tax would be territorial, both for simplicity and to end the

tax disadvantages that American firms encounter when they compete abroad. Savings invested abroad would not be deductible.

There would be no tax on foreign-source income and no complicated

foreign tax credit.

Fundamental tax reform should replace the individual and corporate income taxes, the estate tax, and the excise taxes.

The payroll tax should be addressed by Social Security reform.

The two reforms would reinforce one another. Social Security reform would increase private saving. Tax reform would encourage

the investment of the added saving in the United States rather

than abroad, giving Americans the twin benefits of greater income

in retirement and higher productivity and wages while they are

working.

Thank you.

Mr. CRANE. Thank you, Mr. Entin.

[The prepared statement follows:]

Statement of Stephen J. Entin, President and Executive Director, Institute

for Research on the Economics of Taxation

Mr. Chairman, members of the Committee, I appreciate the opportunity to discuss

fundamental tax reform with you today. The tax system presented in this paper was

the last work of Dr. Norman B. Ture before his death in August, 1997. It is his concept of an ideal, highly visible, and reasonably simple income tax that is neutral

in its treatment of saving and consumption uses of income. It is a simple cash flow

tax imposed on individual income. the tax is saving-deferred to account for the cost

of earning capital income. The multiple layers of tax on estates, gifts, and corporations are eliminated. These correctly measure net income, eliminate the current income tax bias against saving and investment and provide substantial tax simplification. Dr. Ture developed this proposal with the help of his staff at IRET.

Two purposes of a good tax system—raising revenue and ‘‘pricing’’ government

Any restructuring of the nation’s tax system should be based on a set of clear tax

principles, which should be uniformly applied to the exercise. Those who would redo

the tax system should start by recognizing the two key purposes of a tax system,

1) to obtain revenue to pay for government goods, services, and activities, and 2)

to let the citizen-taxpayers know how much they are paying for government, so that

they may decide in an informed manner how much government activity the wish

to support with their votes.

Four principle attributes of a good tax system—neutrality, visibility, fairness, and

simplicity

A good tax system should fulfill its first objective, raising revenue, in a manner

that does the least damage to the economy. The attribute required to achieve that

objective is ‘‘neutrality.’’ A neutral tax must be unbiased across economic activities,

and especially, not overly penalize work in favor of leisure, nor tax income used for

saving and investment more heavily than income used for consumption.

The second objective, letting voters know the cost of government, may be achieved

by a tax system with the attribute of ‘‘visibility’’ or transparency to the taxpayers.

A very large segment of the population must be made keenly aware that government costs money if government spending is to be held to levels at which its benefits

match its costs. Toward that end, taxes should be paid directly by individuals. Taxes

should not be hidden by being levied on business and buried in the prices of goods

and services where voters may not see them. Nor should taxes be collected piecemeal, a few cents or dollars at a time, as with sales taxes, because doing so hides

the annual total from the voters and disguises the cost of government.

Additional principles or attributes of a good tax system include fairness (properly

defined), and reasonable simplicity, clarity and understandability. These features

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lead to a low cost of compliance and enhanced willingness to pay on the part of the

taxpayers and to easy administration and enforcement of the tax rules by the government.

Neutrality. Neutrality means measuring income correctly and levying taxes evenly

on all uses of income by all income producers, without bias, to avoid distorting economic activity.

A neutral, unbiased tax system would begin with a sensible definition of income

subject to tax. Income is a new concept, revenues less the cost of generating those

revenues. It is well understood that a business cannot reasonably be said to have

a profit until its revenues exceed its costs of production (properly measured). It

should be just as obvious that a worker cannot be said to have income until his

earnings exceed the amounts he spent on acquiring the education, skills and tools

that enable him to perform his job. Nor can a saver be said to have income until

his returns on the saving exceed the amounts he spent to acquire the assets that

generate the revenues. The full value of all costs of earning revenues should be subtracted from revenues before any tax is imposed.

Once income is accurately measured and allocated among taxpayers, it should be

taxed even-handedly. Neutral treatment requires that all income be taxed at the

same rate. It is improper to tax some income at a higher rate than other income,

either through graduated tax rates or by imposing multiple layers of tax on some

types of income but not on others.

No tax system can easily avoid penalizing labor relative to leisure. However, keeping tax rates as low as possible and avoiding graduation avoids the worst of this

distortion.

Making the tax system even-handed or neutral across various types of saving and

investment, and between saving and investment and consumption, requires several

steps. Multiple layers of tax on capital must be avoided, and the basic income tax

bias against saving and investment must be eliminated by correctly treating saving

and investment as costs of earnings income. In particular:

• The tax system must either allow savers to deduct saving or to exclude the returns on saving from taxable income.

The income tax, by taxing both income that is saved and the returns on that income, taxes saving and investment more heavily than consumption. There are two

ways to restore neutrality. One approach is to exclude all saving from taxable income while taxing all returns on the saving—a saving-deferred tax. This is the

treatment currently allowed to a limited degree with pensions and deductible IRAs

and tax exempt bonds. Other costs of earning income must also be expensed as incurred. Investment outlays must be deducted in the year the outlay is made (expensed), rather than depreciated over time or otherwise delayed or ignored.

• The dual taxation of Schedule C corporate income at the corporate and individual level must be eliminated.

Corporate income should be recognized as belonging to the shareholders, and

should be taxed either on individual tax returns or corporate tax returns, but not

both. One way to eliminate the extra layer of tax on corporations is to pass corporate earnings on to share-holders for tax purposes as is done for income generated

in proprietorships, partnerships, and sub-Chapter S corporations. Alternatively,

shareholders could be given a credit against the personal income tax for corporate

taxes paid on the income of their shares. These arrangements are called ‘‘corporateindividual income tax integration’’. Another solution is to switch to a non-income

type of tax system, such as a VAT or sales tax.

• The transfer tax on estates and gifts must be eliminated.

Most of an estate is saving that has already been taxed, often repeatedly. If there

is tax-deferred saving in an estate, such as assets in a decedent’s IRA or 401(k)

plan, current law makes the heirs pay income tax on those assets beginning shortly

after the inheritance. Therefore, the estate tax is always an extra layer of tax on

saving. The estate and gift tax should be eliminated, and any part of an estate that

was tax-deferred saving should remain tax-deferred as long as the heirs continue

to save it.

Several types of tax systems would serve to exclude saving and investment or

their returns from tax, end the bias against saving and investment, and simplify

the tax system. These ‘‘neutral’’ taxes include the unbiased income taxes (savingdeferred and yield-exempt) described above, retail sales taxes that exempt investment goods and business supplies from tax, and value added taxes that allow expensing of investment goods and other intermediate products and services purchased from other businesses at each stage of production.

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Since several types of taxes are equally ‘‘neutral’’, choosing among them requires

an assessment of their other characteristics and how well they stack up against

other important attributes of a good tax system.

Visibility. Visibility requires that the tax system reveal clearly to the citizen/taxpayer what he or she must pay for government goods, services, and activities. Taxes

are the ‘‘price’’ we pay for government; taxes ‘‘cost-out’’ government for the taxpayer.

Ideally, all citizens should pay something to help fund the outlays of the federal government in order that they understand that the resources used by the government

are not free or costless. However, compassion dictates that the very poor should not

be subject to tax. Therefore, taxes should be levied on the largest number of people

consistent with compassionate treatment of those who cannot afford to pay.

At what stage in the flow of income should taxes be collected? At the business

level, after it has made its payments to other firms but before its remaining revenues are paid out to its workers, savers, and investors? When the revenues are received by the workers and owners of the capital as earnings? Or when some portion

of their income is spent on consumption?

Goods and services do not pay taxes. Businesses do not pay taxes. Only people

pay taxes. All taxes, in fact, are taxes on income. Sales and excise taxes either depress sales of the taxed products, reducing the incomes of the people who provide

the labor and capital used to make them, or they reduce the purchasing power of

that income when the workers and savers attempt to spend it. Taxes collected by

businesses fall in reality on the income of the businesses’ shareholders or other owners, lenders, workers, or customers in the form of lower returns or wages or higher

prices.

Since taxes are really paid by people out of income, they should be collected from

people out of income. People see their tax liability most clearly when they pay an

individual tax on the (properly defined) income that they have received, with a clear

accounting, annually, at tax time. Taxes should not be hidden from taxpayers by

being imposed on businesses as either corporate taxes, manufacturers excise taxes,

or value added taxes. Similarly, taxes should not be hidden by being collected in

bits and pieces over the course of a year as the taxpayer goes shopping, as either

sales taxes or value added taxes.

Fairness. Fairness is often stated as making the rich pay a higher share of their

income in taxes than the poor. Most people would agree that there should be some

amount of income exempt from tax to shelter the very poorest citizens. Such an exempt amount imparts progressivity to the tax system. Only people above the exempt

amount pay tax, and the more one’s income exceeds the exempt amount, the greater

is the tax as a percent of total income (which is the definition of progressivity). However, imposing further progressivity by means of graduated rates above the exempt

amount is not consistent with fairness if one considers the effort it takes to earn

additional income. Income is correctly understood to be the earned reward for supplying labor and capital services to the market. Except in rare cases, income closely

matches the contribution of the effort and services provided by individuals to additional output. Therefore, graduated tax rates hit people harder the more they contribute to the production of goods and services. The added effort required to earn

additional income, and the notion of equal treatment under the law, strongly urge

that a proportional (single rate) tax on income (above the modest exempt amount)

is the fairest.

Simplicity. Ideally, a tax system should be easy for the government to administer

and enforce and should be easy and inexpensive for taxpayers to comply with. Such

a tax system would have to be simple enough for people to understand and to follow.

A simple tax system must start with a simple, clear and logical definition of income. A simple and logical definition of income would make it possible to write clear

regulations and instructions for taxpayers to follow and tax collectors to enforce.

Furthermore, if people understood clearly what is and is not taxable, and agreed

with the logic of the system, they would feel comfortable that they and their neighbors were paying the appropriate amount of tax. They would have a greater sense

that the tax system was fair,and a greater willingness to comply.

Unfortunately, the current tax system is neither simple, nor logical, nor understandable. Much of the complexity in the current tax code stems from its ad hoc

approach to defining taxable income. The code is not based on any clear understanding of what constitutes income or an accurate measurement of income, nor any

set of coherent principles regarding the imposition of tax. Additional complexity

arises from the multiple layers of tax to which some types of income are subject and

the multiple points of collection at which the taxes are imposed. The lack of guiding

principles and resulting chaotic definition of income make for difficulties in administration and compliance, because neither the IRS nor the taxpayer can figure out

clearly what is in or out of the tax base.

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Most complexity is found at the business level or with respect to specialized investments of individuals. Taxation of wages and ordinary individual interest and

dividends is fairly straightforward. Simplification should not go so far as to eliminate tax filing by individuals, as with a sales tax or VAT; that would sacrifice visibility to an unacceptable degree, and is not necessary to achieve significant simplification.

A tax proposal that conforms to the attributes and principles of a good tax system.

As mentioned, there are several types of (largely) neutral tax systems. Most

achieve varying degrees of tax simplification. Unfortunately, most fail to do a good

job with respect to visibility, which is one of the most critical attributes of a good

tax system.

The following is a tax proposal that conforms to all the attributes and principles

of a good tax system. It is called the inflow-outflow (I–O) tax.

Overview. The I–O tax system is an individual-based saving-deferred tax with a

number of additional deductions from revenue necessary to properly measure and

allocate the income for tax purposes. Inflows—an individual’s revenues from work,

saving, and transfer payments received—would be taxable. Outflows associated with

earning the revenues (such as net saving, investment, and some education outlays),

and income transferred to others (either voluntarily by gift or as mandatory tax payments) would be deductible. Net taxable income would, in effect, consist of revenues

utilized for the individual’s own consumption.

For neutrality and visibility, net labor and capital income would be taxed once

and only once on individual tax returns. For fairness, there would be personal allowances to shelter the poor from tax. For neutrality and fairness, there would be a

single tax rate imposed on income above the exempt amount. The single rate would

eliminate the graduated tax rate bias against work, education, risk taking, and success, and would treat all individuals alike under the law.

The I–O tax attributes income to the correct taxpayer. For visibility, income

should be taxable to the final recipient of the income. People should be taxed only

on the income over which they retain control and of which they enjoy the benefit.

If one taxpayer gives revenue to another, either voluntarily (as by gift or charitable

donation), or due to legal obligation or government coercion (alimony, fines, taxes),

the donor should deduct that revenue from his or her taxable income, and the recipient should add that revenue to his or her taxable income.

The I–O tax defines income properly. Income is a net concept, revenues less the

cost of generating those revenues. Among the costs of generating income are: training and education in the case of labor income; the cost of acquiring income earning

assets (saving and investment) in the case of income from capital. Costs of generating income must be deductible in full—expensed, not deferred (unless compensated by payment of interest to maintain present value).

Details of the I–O system follow. An illustrative sample tax form is appended.

Labor income. Individuals would pay tax on labor income (wages, salaries, selfemployment income, and the value of non-pension fringe benefits) and pension receipts. The employer would report the total to the taxpayer on a W–2 form, as it

does for cash wages and pension withdrawals under current law.

Transfers received. Individuals would pay tax on the taxable portion of social security. (All payroll taxes would become deductible in this tax system; therefore, over

a phase-in period equal to a full working lifetime, all social security benefits would

eventually become taxable.) Individuals would also pay tax on welfare and other

transfer payments received from state and local governments and charities, insofar

as they exceed the exempt amounts. (In practice, those who receive charity would

usually be too poor to owe tax, and would not have to file a return.)

Income from saving and the net saving deduction. Individuals would deduct their

saving (a cost of earning future income) from taxable revenues, and pay tax on all

returns on saving (whether principal or earnings on the principal or earnings of an

unincorporated business) when withdrawn. Reinvested returns would be tax-deferred.

In effect, all saving would be treated like current-law tax-deferred pensions or

IRAs. All income that individuals transfer to financial intermediaries or other businesses through lending or the purchase of shares would be deductible by the savers.

Only those earnings withdrawn or received by lenders, shareholders, or owners of

an unincorporated business (and not reinvested) would be taxable, and would be reported on the individual tax returns. The ‘‘inside build-up’’ of the saving in saving

accounts, brokerage accounts, mutual funds, corporate shares, or unincorporated

businesses would not be taxable. There would be no separate calculation of capital

gains; they would be covered in the proceeds from the sale of assets (whose full cost

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was deducted at the time of purchase). The proceeds would remain tax-deferred if

reinvested. For example, trades within a brokerage account would not be reportable

unless money was withdrawn from the account.

Pension contributions by employers and employees currently excluded from employees’ incomes would remain deductible saving. Since all saving could be deducted

in this system, all current-law restrictions on the amounts allowed as contributions

and withdrawals under employer-sponsored pension plans would be eliminated.

The deduction for saving would be for net saving. Borrowing would be considered

‘‘dissaving’’ and be considered taxable revenue to be netted against amounts saved.

However, borrowing would result in an immediate tax liability only if used for consumption. Borrowing used to buy assets such as stocks or a machine for one’s business would not result in more taxable income because the investment outlays would

be deductible saving. Also, repayment of debt and interest paid on debt would be

part of deductible saving. (But see alternative treatments of home purchases,

below.)

Each financial institution with which the taxpayer had dealings would report the

taxpayer’s net saving or dissaving for the year as a single number on a 1099 form,

like those currently in use to report interest or dividends on Schedule B. There

would be no need for the taxpayer to track all of his or her deposits and withdrawals over the year to calculate the net amount. There would be no separate

Schedule D for capital gains.

Deductions of transfers paid. Charitable contributions would be deductible by the

donor. (As indicated above, the charitable gifts would be taxable to the ultimate recipient, who would seldom have sufficient income to owe tax. Current law simply

allows the charitable deduction and ignores the other side of the calculation.)

All payroll and state and local taxes would be deductible as income over which

the taxpayer has lost control and transferred to others. State and local taxes are

involuntary outflows. They largely fund welfare and other aid to the poor (income

transfers akin to charitable contributions to persons below taxable levels of income)

or education (a transfer that pays for the cost of the recipient’s acquisition of human

capital), all of which could be considered to be reasonable deductions. Law enforcement and fire protection are services to the taxpayer, but constitute remedies for

or protection from casualty losses, and ought not to be considered beneficial income.

There are some local government services that accrue to the individual taxpayer or

homeowner, such as water, sewer, and trash pick-up, but these are often billed separately, in which case they would not be deductible.

Deductions of cost of acquiring human capital. Individuals would deduct some portion of the cost of training and education. Tuition and other training costs are already largely deductible in the form of property taxes at the local level that pay for

primary education, and state income taxes that assist state universities. Tuition

paid directly by the student could be considered for similar treatment. However,

there is also a ‘‘consumption’’ or general living element of education; it is not all

a cost of earning future income. Some rough adjustment must be made in what will

always be a gray area.

Treatment of home ownership. We do not recommend ‘‘pure’’ inflow-outflow treatment of the owner-occupied home, which would be to treat it (as in the national

GDP accounts) as an investment yielding income in the form of shelter. Pure treatment would include the imputed rent from the owner-occupied home in taxable income, plus the mortgage borrowing that financed the home; it would allow a deduction for the purchase price of the home, the repayment of mortgage principal and

interest, and outlays on maintenance.

This pure approach to the treatment of owner-occupied homes is difficult to calculate. The alternative approach to neutral treatment of saving—no deduction for

the purchase of the asset, but no tax on the returns, is an easier alternative, and

the I–O tax would adopt it in this instance. Neither the imputed rent nor the mortgage borrowing would be taken into the homeowner’s income. In exchange, there

would be no deduction of the purchase of the home, outlays for maintenance, nor

repayment of mortgage principal and mortgage interest.

Treatment of businesses. There would be no separate taxation of businesses in a

saving-deferred tax. Taxation of business income would be completely ‘‘integrated’’

with the taxation of other income received by the savers, be they corporate shareholders or partners or proprietors of non-corporate businesses. Businesses would be

treated like pensions or IRAs owned by the savers: income that individuals transfer

to businesses through lending or the purchase of shares would be deductible by the

savers; only those business earnings distributed to lenders and shareholders (and

not reinvested) would be taxable and would be reported on the individual tax returns. ‘‘Inside build-up’’ of saving in the business would not be taxable.

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The non-tax status of business in the inflow-outflow tax is not arbitrary. The rules

of the inflow-outflow tax naturally render a business a non-taxable entity. Businesses would not be taxable because their deductible outflows would always equal

their inflows.

Business inflows include revenues from sales of goods and services and income on

financial investments, plus borrowing from lenders and sales of new shares to stockholders. Business outflows include operating costs—wages, purchases of materials,

inventory, outlays on research and development, rent and royalties paid, and all

outlays for investment in plant and equipment, structures, and (unlike current law)

land—plus state and local taxes and federal payroll taxes, interest payments to

lenders and dividend payments to shareholders. These outflows are all costs of earning income or transfers of capital income to lenders and shareholders for taxation

on their returns. Any left-over revenues saved by the business should be considered

tax-deferred saving by the shareholders. Nothing would remain to be taxed at the

business level. Consequently, there would be no need for businesses to file income

tax returns, eliminating most of the accounting, auditing, and costs of enforcement

and compliance in the current tax system.

In this system, the deduction for business investment would effectively be passed

along to the savers who lend money to, buy shares in, or otherwise invest in the

business. Savers would fully deduct their purchases of stocks and bonds. These proceeds of stock and bond issues, plus what we now call retained earnings, would just

equal the operating costs and (deductible) capital investment and net saving of the

business, eliminating taxable business income. This pass-through of the deduction

for investment would be an advantage for start-up businesses that have little income as yet from previous investments against which to take a deduction. It effectively eliminates the problem of net operating loss carry forwards that delay and

reduce the value of deductions for investment and raise the cost of capital under

current law.

Territoriality. The I–O tax would be territorial, imposed on income generated

within the United States, not on income earned abroad. There would be no deduction for saving invested abroad, and no tax on the returns. There would be no credit

for foreign taxes paid on foreign income repatriated to the United States. Territorial

taxation would greatly reduce the confusing treatment of foreign source income that

cripples American firms attempting to compete abroad.

The I–O tax would not be ‘‘border-adjustable’’, that is, it would not be forgiven

on exports and imposed on imports, because it is collected at the individual level

on individual income. The producers of U.S. exports worked and earned their income

in the United States, and should be taxed just as all other U.S. producers, while

the producers of U.S. imports worked and earned their income abroad, where it is

subject to foreign taxes.

Conclusion

The inflow-outflow tax is a neutral, highly visible tax system. It correctly measures income, providing revenue to the government with minimal disruption to the

economy. It allocates income for tax purposes, appropriately, to the final recipients

of the income, thereby informing the citizen-taxpayer of the tax cost of government.

The I–O tax also achieves a significant degree of tax simplification compared to current law, and reduced costs of administration and compliance. The I–O tax achieves

these results in a superior fashion compared to most other major tax reform proposals. It is deserving of serious consideration by policy makers and students of political economy.

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English?

Mr. CRANE. Are there inquiries of this panel? Mr. Coyne? Mr.

f Mr. ENGLISH [presiding]. Thank you, Mr. Chairman. I am sorry

I wasn’t here for the entire testimony, but I did read the written

testimony previously, and I must say this is an enormously distinguished panel.

Dr. Regalia, I was particularly intrigued by your comments on

border adjustability, and I am especially pleased to see the Chamber’s support of border adjustability, given the fact that I sense

that the business community is not monolithic on this issue, but

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your testimony, I think, points the way that, on balance, trade fairness is an important component on tax reform.

Would you care to elaborate on that?

Mr. REGALIA. Well, Congressman English, I think, having

worked for the Chamber for seven years, the one thing that I could

testify to unequivocally is that the business community is not monolithic on anything, but on the area of border adjustability I think

that the recent problems that have occurred with the FSC and with

the WTO have heightened the concern of this issue tremendously,

and that there is perhaps a greater understanding now of the

issues that arise because of a lack of border adjustability, the conflicts between a world-wide tax system and a territorial tax system,

and the implications that can have, not just for the businesses that

trade directly abroad, but for everyone that deals with those businesses and with businesses that deal with those businesses. It is

truly a broad-based economic issue at this point.

I think that the various—I mean, all in the business community

are waiting to hear, with bated breath what solutions will be proposed to the current situation, and I think we are heartened to see,

in many of the specific tax proposals that are out there, the willingness of all the authors of those proposals to address this problem

in a very clear-cut and economically-sound manner.

Mr. ENGLISH. Mr. Entin, I saw you took the contrary position.

Given your public policy pedigree, that should give me second

thoughts about my own support for border adjustability. Why is it

that you feel that taking the tax off of exports, the embedded tax,

and placing it on imports tilts the playing field in any way? Doesn’t

it level it?

Mr. ENTIN. I have discussed territorial tax in my plan, but I

haven’t specifically stated anything about border adjustability. This

has to do with the point of collection.

For example, in your plan you have a business level collection

and an individual level collection. Your business level collection is

border adjustable. It is natural, when you have taxes on that level,

that it be border adjustable. If, however, you are taxing the individual before the individual goes to the store, it is natural for it not

to be explicitly border adjustable because the very mechanics of

where you have collected it more or less arrive at the same point.

Let me explain that a little bit more clearly.

These taxes are generally taxes on income less saving, which

equals consumption, or, if it is at the business level, it is on revenues minus investment, which equals consumption.

To measure consumption by taxing individuals, I want you to

take your income, subtract your saving, pay tax on your consumption, then take your after-tax money to go shopping, and when you

arrive at the store you may buy a domestic product or an imported

product. There is no added tax on either one. I am being neutral.

If, however, I make the individual wait until he goes shopping

to take out my tax, he is taking his pre-tax money to the store, and

at that point I levy a consumption tax on the sum of his purchases

of domestic goods and his purchases of imports. The two together

equal, again, the amount he has consumed, and I am taking the

exact same tax from the exact same people. So I am being neutral

in either case.

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Whether something is border adjustable or not in an explicit

manner depends on where you have chosen to make the collection

point more than on anything else.

Mr. ENGLISH. I guess my concern is, when you show up in a store

and there are two products on the shelf and one of them has in the

pricing the embedded tax of doing business in the United States

and the tax of whatever jurisdiction you are in, and the other item

does not have those taxes built in, isn’t there at least some price

advantage to the foreign-produced product as opposed to the domestically-produced product?

Mr. ENTIN. I don’t think so, for three reasons. In the length of

time allowed for any response, I am not sure I can go through all

three.

Mr. ENGLISH. I am chairing the meeting, so I will give you a little extra time.

Mr. ENTIN. Okay.

Mr. ENGLISH. I am very interested.

Mr. ENTIN. If you are thinking about Europe and its VAT, remember, they have a corporate income tax, a personal income tax,

payroll taxes, and VAT. If you take out VAT, what is left is still

as big a tax burden as our total tax burden because they tax a lot

more than we do, so there are still taxes embedded, if you want to

think of it that way, in the imports.

If, however, you take a slightly different look at what is going on

in the production process, you have to realize that workers work

for an after-tax wage. Let me take two workers. One works for Boeing on planes that are exported, and one works in the corner grocery store and sells to the local population. They both know they

are paying tax when they go to the store. When you impose a sales

tax or a consumption-based tax, either one, the workers know they

are paying tax on what they consume.

Since they want to work for a satisfactory after-tax wage, they

have conveyed that attitude toward their employer and they have

asked for a wage that reflects the fact that when they go shopping

they have to pay tax. And that is as true for the export worker as

for the domestic worker. So there are taxes imbedded in exports,

even with a border-adjustable tax. All of this stuff gets passed

around.

I come back to the basic point I made earlier. If I am taxing an

individual’s income minus his saving, either before he goes to the

store or after he goes to the store, I am probably taking just the

same tax liability from the worker under the two systems.

The third point is that exchange rates adjust and washout the

effect of border adjustability sooner or later. If you remove the tax

on business, that added layer of tax on capital formation that occurs when you tax the corporate level and the individual level, and

if you end the bias against saving and investment, then I think we

are going to be a lot more competitive because we are going to have

so much more investment in plant and equipment in this country

we are going to be the more efficient producers of a lot of things.

But suppose we did become the most efficient producers of a lot

of things. Would we be running a big trade surplus? No, because

for people to be able to buy our goods they would have to sell to

us.

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The objective of tax reform should be to make us very, very efficient, very productive, and give us very high wages and very high

incomes, and that is true whether we were the only country in the

world or whether there were other countries with which we were

trading across the border.

Mr. ENGLISH. And, Mr. Entin, I have to say on that particular

point I entirely agree with you. And this is a side of trade policy

that really doesn’t get introduced into the debate.

Dr. Regalia, would you like to respond to Mr. Entin’s points with

regard to border adjustability?

Mr. REGALIA. Well, not having reviewed all of them in detail, I

would have to say I think I probably agree with them. I think that

the issue of border adjustability comes up more when you have two

vastly different tax systems. If you were to institute a truly territorial tax system in the U.S., tax income once and only once, that

there would be less of an issue of border adjustability, given the

various taxing points.

Mr. ENGLISH. I agree.

Mr. REGALIA. But when we go down the road of two very different tax systems, two very different or multiple collection points,

many of which are layered on top of each other, then these issues

become much more important.

As you start to correct one issue, I think it helps to correct the

other, and I think that I would not disagree.

Mr. ENGLISH. I have one concern on the exchange issue, and I

am not sure I can articulate this very well, but I am concerned that

the tax burdens fall disproportionately on certain sectors of the

economy.

For example, tax differentials have more of an impact on manufacturing and certain kinds of manufacturing than they do on certain kinds of services, and that, whereas much of the economy

might not be affected dramatically by the border adjustability

issue, I, who represent a largely manufacturing District, still have

got to be concerned that manufacturers, where you produce a large

volume of products with very thin profit margins, would be particularly sensitive to tax differentials, and the border adjustability argument might be stronger in arguing that this is a policy we need

in order to maintain our manufacturing base.

I hope that is an articulate argument. Do you care to react to it?

Does that make any sense?

Mr. ENTIN. I think you are right to point out that we have been

seeing somewhat of a shift away from manufacturing towards services and that some of the manufacturing industries have appeared

to be struggling. That is a valid point.

I think one of the reasons they are struggling, aside from just the

general drift of technological advance being stronger in the intellectual property area than in the heavy manufacturing, is that we

have a tax bias particularly against heavy manufacturing.

The depreciation allowances that we have in place today are so

seriously damaging to investment incentives for long-lived assets,

the very sorts of assets that steel and railroads and the manufacturing sector employ, that we put a bias in the economy against

producing those goods in this country and in favor of importing

them.

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If you move to any of the consumption-based taxes, where business investment is expensed rather than depreciated and where the

corporate tax layer is stripped off, you would be moving to a system

where the change from current law is greatest for those heavily-impacted sectors. I think they would improve more than the other

sectors under this type of tax reform. That may solve your problem.

Mr. ENGLISH. That is an interesting argument.

One of the common points I have seen between a number of leading tax reform proposals—Mr. Armey’s flat tax, for example—I

have a simplified USA tax. One of the common points is moving to

expensing as an alternative to depreciation.

Would both of you agree that this expensing issue may be probably one of the most important things we do from a competitive

and growth standpoint in tax reform?

Mr. REGALIA. I would think it would, and I also think it is going

to be one of the areas that require the most innovation when it

comes to transition rules because of the relationship between old

capital and new capital.

Mr. ENGLISH. That is right.

Mr. REGALIA. And when you are disadvantaging—when old capital is so disadvantaged, if you were then to remove those impediments to the new capital, you would create a situation where you

could significantly impair the ability of the older firm to grow, and

I think it is one of the areas that is most important.

I look through much of the testimony the last couple of days and

almost everybody mentioned—the savings and investment disincentives in our current code—one of the primary things that you want

to fix, and it is one of the most—as I said, it will require the most

innovation in constructing transition rules to address that.

Mr. ENGLISH. I have always adhered to the radical thesis that

the savings rates would be affected by changes in tax policy. Do all

three of you agree with that?

Mr. REGALIA. I think, contrary to a long bit of what I have read

in economic theory, I think, in practice, I would have to say yes,

I think that it would affect the savings rates, and I think that

while we empirically have been unable to verify that it is a result

of the fact that we are drawing our sample from a system that has

had this corruption for years and years and years, and so the data

is unable to tell us the real answer.

I think it would make a difference. I think we saw that with

IRAs. Originally, when I worked at the Federal Reserve Board, we

contended that IRAs would change how you saved but not how

much you saved, and I think we have seen over the years that even

the very small IRAs that we have allowed have probably boosted

savings more than any of us thought early on, and that after an

initial phase we would have to say the switching was minimal and

the amount of net new savings was more than we had anticipated,

and I think that would be proven for fundamental innovations to

the tax code, as well, that we would improve savings more than

any of our economic models would lead us to believe.

Mr. ENGLISH. Ms. Soldano, any comment?

Ms. SOLDANO. Congressman English, our issue is death tax only.

It is the only thing that our organization focuses on.

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Mr. ENGLISH. Okay. And I agree with your position and I recommend to you the writings of one of my constituents, Professor

Hans Senhold, who is retired from Grove City College, whose book,

‘‘Death and Taxes,’’ is still the most succinct argument and one of

the best for repealing the tax.

Ms. SOLDANO. I agree.

Mr. ENGLISH. Mr. Entin?

Mr. ENTIN. One reason that economists have failed to understand

the effect of the tax burden on saving is that they got mixed up

between levels of saving and the rate of saving.

If saving goes up, the level of saving goes up, incomes rise, and,

as incomes rise, so does consumption. Both saving and consumption

tend to rise. The saving rate as a percent of the higher income may

not be much higher, but the level of saving is going to be a great

deal higher under these tax systems, and for some years the rate

will be higher, as well.

I think economists got confused between levels and rates, and a

lot of the people who said that better tax treatment of saving would

not be a significant incentive are simply mistaken. You would see

a result.

Mr. ENGLISH. Doctor?

Mr. REGALIA. I was just going to say one of the most, I think,

interesting aspects of the simplified USA tax is the deduction for

investment in human capital, not just physical capital. In today’s

economy, there is a whole theory of economics on endogenous

growth theory that speaks to this issue of saving rate and growth

rates in the economy versus levels of savings and level of growth

in the economy.

I think that one of the things we are beginning to see is that the

new economy, the information age, if you will, which uses and relies so heavily on intelligence, training, human capital attributes

will find that the benefits to increasing our human capital may exceed even the benefits from increasing our fiscal capital, and I

think that is a very innovative and important aspect of some of

these proposals that are outstanding right now.

Mr. ENGLISH. Thank you. I think not only is it good economics,

but it is also good as a selling point for the plan.

I want to thank all three of you for participating today. I have

just had an experience similar to what Mr. Archer had on a November morning in 1994. I have awakened to discover myself

chairing the Ways and Means Committee, so I want to take this

opportunity to adjourn.

Thank you very much.

[Whereupon, at 2:14 p.m., the hearing was adjourned.]

[Submissions for the record follow:]

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Statement of Charles Adams, Historian, Williamsville, NY

Mr. Chairman and Members of the Committee:

The economics of our income tax is under assault by some of our best economists

and tax men, and for good reason. We have learned much about how best to tax

to collect public revenues. The clear consensus of the unbiased economic studies

demonstrate our income and payroll taxes are a drag on the economy, slow economic

growth, produce chronic inflation, discourage savings and enterprise, and put America at some disadvantage in world trade with those nations, especially the miracle

economies, who have moderate, simpler tax systems-systems that encourage and

promote capitalism.

Our criticism should not stop there, however. While there is just about nothing

right with our current system economically-speaking, not everything wrong with our

current system has to do with relatively recent science of economics. Instead, it has

to do with the spiritual values that were at the core of the founding of America.

The current system denigrates these values in several respects. It has trampled on

our liberties, it is wasteful, and it is destructive of economic and personal rights.

A national sales tax, if it replaced the income tax, would rid the nation of the evils

our income tax has produced. It will also comply with the Constitutional command

of uniformity. If we were to pursue this course, our descendants in centuries to come

would look back upon us, as we look back upon our Founders, with admiration for

delivering future generations from a tax that was oppressive, tyrannical, and corrupt.

Let us place the current tax system in historical context. We do not need to go

too far for our research. Adam Smith in The Wealth of Nations, sets forth four signs

of a bad tax system:

• a large bureaucracy for administration.

• a system that puts taxpayers through ‘‘odious examinations...and exposes them

to much unnecessary trouble, vexation, and oppression.’’

• a system that encourages evasion.

• a system that obstructs the industry of the people, and discourages enterprise

which might otherwise give ‘‘employment to great multitudes,’’ i.e. jobs.34

How well has our tax system adhered to the admonitions of Adam Smith? Does

it pass Adam Smith’s test for a bad tax system? The answer is clearly ‘‘yes.’’ His

test defines our system today. The FairTax national sales tax would return us to

these core values that have stood the test of time.

Looking at a Distant Mirror

Taxes were at the core of the world’s great uprisings. And taxes and the onerous

methods of collecting them were at the core of the founding of America.

The Statue of Liberty was a gift from the French to commemorate the 100 year

anniversary of American independence. She stands at the entrance to New York’s

harbor as an inspiration to the nation and the millions of immigrants who arrived

from Europe by ship before the jetage, ‘‘yearning to breath free.’’ She was really a

gift from the Romans. The same Goddess of Liberty was depicted on Roman coins,

just like she was on our gold coins and early 50’s piece; she was honored with a

number of temples, and Roman writers proclaimed, ‘‘Liberty is a possession on

which no evaluation can be placed,’’ and ‘‘Freedom is beloved above all things.’’ 1 Yet

the coins and temples disappeared almost 200 years before Rome’s official demise

when the Emperor Diocletian enslaved the Roman people to ensure tax compliance,

and he achieved this end by chaining every taxpayer to his land, shop, or job. One

leading Roman historian acknowledged that Diocletian’s tax system did indeed save

Rome, but he never asked ‘‘whether it was worth while to save the Roman Empire

in order to make a vast prison for scores of millions of men. ‘‘ 2

The Romans did not submit to this tax enslavement without resistance, so the

Roman state resorted to brutal, savage punishments. Zisimos, a Greek writer during

this period, tells us that the scourge and rack were used against taxpayers; and to

make the system work, fathers were compelled to prostitute their daughters, and

even children were sold into slavery.3 As one Roman declared, ‘‘Let us flee to some

place where we may live as free men.’’ 4

This viciousness of the Roman state towards its citizen taxpayers is what we need

to focus upon, because it soon infected the relation of the people with one another.

Salvian, the Bishop of Marseilles at Rome’s fall, describes the evil, the decadence

and cruelty that the tax system had created. As he said, any individual with any

sense of human decency would seek out another homeland.5 ‘‘Rome was like a mother cancer cell that passed its vicious propensities on to its children.’’ 6

A similar pattern appeared in Imperial Spain a thousand years later. Spain, like

Rome, taxed itself to death. To enforce a similarly abusive, excessive tax system,

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Spain fell back on ‘‘applying the screw’’ to reluctant taxpayers.7 ‘‘Applying the screw’’ was not a figure of speech, like the Roman scourge it was an instrument of

torture. Unlike Rome Spanish taxpayer resistance was disastrous for the state. Over

six major tax revolts erupted during the height of Spain’s glory and there is little

doubt these revolts drained the strength of the Crown and permitted Britain,

France, and the Netherlands to take over much of what was the greatest empire

of all time.

Spanish taxpayers responded with the same brutality meted out by the tax bureau. In 1520, taxpayer deputies, summoned by the Crown, promised their constituents there would be ‘‘no new taxes.’’ However, the financial goodies promised by the

king were too tempting so they voted for new taxes. Riots erupted throughout Spain.

In Segovia, an angry mob seized the local deputy and as they led him off for execution, his plea to receive the last sacraments was denied-there was to be no forgiveness in this life nor the life to come. I wonder, what would these angry taxpayers

have done to members of Congress who approved Clinton’s taxes? Or to George

Bush who breached his promise of ‘‘no new taxes?’’ The response of Spanish taxpayers included evasion and emigration. The Spanish

operated the most massive system of tax fraud and evasion ever known, notwithstanding that the Crown threatened evaders with the death penalty. All trade from

the New World was engaged in one gigantic smuggling operation. If that wasn’t

enough, people fled from Spain in great numbers. As one historian observed, ‘‘In

place of wondering at the depopulation of villages and farms, the wonder is that any

of them remain.’’ 8

The use of cruel and savage punishments to enforce taxes has repeated itself often

throughout the course of Western history. In France a hundred years of violence

against taxpayers and even tax collectors, culminated in the French Revolution in

which the tax man came out on the short end-indeed, the whole lot of them were

shortened about 10 to 12 inches apiece after the man who ran the guillotine had

finished his work-no tears were shed when their heads flopped into the basket.

In the 18th Century, Sir Robert Walpole, Britain’s first prime minister, used ‘‘vicious punishments’’ to enforce his tax system. He was, as one biography described

him, ‘‘In no way squeamish about the liberties of the individual,’’ and he used ‘‘sav- age punishments, and the full authority of the Crown to make the public conform

to his system [of taxes].’’ Eventually, riots spread throughout Britain, as an ‘‘expression of a profound and cumulative hatred of a system oppressive, tyrannical, and

corrupt [with power].’’ 9 When Sir William Blackstone wrote his great treatise (still

in print), Commentaries on the Laws of England (1765), there was no praise for

Walpole’s tax enforcements, they were ‘‘arbitrary’’ and ‘‘hardly compatible with the

temper of a free nation.’’ 10 That same condemnation would easily apply to our income tax laws today. It was less than 25 years after the riots in Britain over Walpole’s tax laws that the British colonists in North America sensed the same sort of

tax policy coming their way, and they were willing to resort to violence and even

treason against the Crown’s taxes.

The Founders of America were well aware of the history summarized above. The

great sage of the Enlightenment, Montesquieu, in his The Spirit of Laws (1751), inspired the Framers of the Constitution, and much of its form can be traced to this

great book. He was a tax-philosopher historian. If our current tax makers and we

as a people had been schooled in his studies, as the Framers of our Constitution

were schooled, we may not be having the tax troubles that now infect our whole

social order. He taught emphatically that excessive taxation produces slavery; noting that men living in a liberty oriented society will foolishly submit to excessive

taxation. He added a further observation, that excessive taxes will require, ‘‘extraordinary means of oppression.’’ And from that, ‘‘the country is ruined.’’ 11 This conclusion of Montesquieu was not a theory, it was plainly visible to him as a fact in the

governments of his day and of those in history. With Montesquieu we are not dealing with logic, we are dealing with what Oliver Wendell Holmes had in mind when

he said, ‘‘A page of history is worth a volume of logic.’’ 12

The leading writer for the American Revolution was Thomas Paine. ‘‘Without the

pen of Paine, ‘‘ said John Adams in poetic rhyme, ‘‘Washington would have wielded

his sword in vain.’’ Washington had Paine’s pamphlets distributed to his troops to

read when they were in Winter Quarters during the dark days of the war. America

was a land of liberty, wrote Paine, because it was a land of low taxes. Excessive

taxes produced tyranny, he wrote, caused by the foolish and naive attitude of the

people toward their government by believing that ‘‘government is some wonderful

mysterious thing.’’ And when the people believe that illusion, ‘‘excessive revenues

are obtained.’’ 13

What drove men to revolution was simply overtaxing and overblown governments.

In short, when a government is just, ‘‘taxes are few.’’ And revolution was necessary

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and justified to bring about a government ‘‘less expensive and more productive,’’

which would bring about ‘‘peace, civilization and commerce. ‘‘ 14

Direct Taxes: the Most Burdensome Type

The most pernicious of all taxes are the arbitrary,’’ said David Hume, the great

Scottish philosopher, ‘‘They are commonly converted, by their management, into

punishments on industry...It is surprising, therefore, to see them have place among

any civilized people.’’ 24 Alexander Hamilton, a leading proponent of the Constitution

who favored broad taxing powers, had no use for arbitrary taxes. ‘‘Whatever liberty

we may boast of in theory, it cannot exist in fact while [arbitrary] assessments continue.’’ 25

The Framers of the Constitution thought they had provided against any arbitrariness in taxation by commanding that all tax laws be UNIFORM, i.e. the same for

all. But the uniformity command disappeared in the 20th century when the justices

who upheld this condition, all died and were replaced with justices willing to make

that provision an ‘‘empty shell’’ as legal scholars have described the present state

of affairs.26 The Congress can now adopt abusive, discriminatory, arbitrary taxation

to the extreme, thus fulfilling James Madison’s fear expressed in The Federalist, No.

10;

Yet there is, perhaps, no legislative act in which greater opportunity and temptation are given to a predominant party to trample on the rules of justice. Every shilling with which they overburden the inferior number is a shilling saved to their own

pockets.

Madison concluded by arguing that ‘‘The Majority...must be rendered unable to

concert and carry into effect schemes of oppression.’’ The Constitutional command

of uniformity for all taxation was one means to achieve that end, but once the Court

made that command an ‘‘empty shell’’ the U.S. Congress has with impunity ‘‘trampled on the rules of justice,’’ with tax rates deliberately made unequal, and with exemptions and other tax favors for the best lobbyists, just as Madison had predicted.

Besides the disastrous consequences of both arbitrary taxation and excessive taxation, Montesquieu focused on another archenemy of liberty-direct taxation, which

he described as being ‘‘natural to slavery, ‘‘ unlike indirect taxes, or a ‘‘duty on merchandise is more natural to liberty, because it is not so direct a relation to the person.’’ 27

This observation was over two thousand years old. The Greeks discovered it by

observing the many empires of the world—all were despotic, tyrannies. And all had

direct forms of taxation, like wealth taxes, income or production taxes, poll taxes,

and the like. The Greeks concluded, tyranny was the consequence of direct taxation.

Except in times of war, direct taxes must be avoided if liberty is to be preserved.

Cicero, the great Roman lawyer, also condemned direct taxes as a danger to

Roman liberty. He said:

Every effort must be made to prevent a repetition of this [direct taxes]; and all

possible precaution must be taken to ensure that such a step will never be needed...But if any government should find it necessary to levy a direct tax, the utmost

care has to be devoted to making it clear to the entire population that this simply

has to be done because no alternative exists short of complete national collapse.28

Why, you may ask, is direct taxation so bad? Why did the Greeks and Romans

have so much contempt and hatred for what we have lived under most of this century? They came to this conclusion from history. They saw the tax system of the

Pharaohs of Egypt and the enormous oppressive bureaucracy the Pharaohs maintained to collect taxes; they may also have noticed that no word even exists in the

Egyptian languages that means freedom or liberty. Freedom and liberty just didn’t

exist where direct taxes were in operation. In the past century, with the income tax,

the people of America have seen their liberties slip away, one by one, year in and

year out. Even in the socalled protaxpayer Reagan years, the power of the IRS over

everyone’s life increased dramatically. Over 150 penalties were put in operation to

increase the tax, almost double the tax, for the slightest slipup by the taxpayer.

Reagan and the Congress of his era may have reduced rates, but they increased IRS

muscle in the process. Their process of ever increasing powers, creating a musclebound bureaucracy, reminiscent of so many ugly tax bureaucracies of the past, is

what the Greeks and the Founders were warning us about.

This concept did not go unnoticed by the Framers nor by Montesquieu. At the

Constitutional convention, Madison echoed the Greeks on the matter of direct taxes.

He said, almost as a matter of fact, they would only be introduced during an ‘‘extraordinary emergency.’’ 29 It was inconceivable they would ever be a permanent,

peacetime measure, for the reasons both Montesquieu and the ancient Greeks propounded.

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What was inconceivable then, has not been inconceivable in the 20th century. We

have made direct taxation the order of the day and we have reconfirmed, for future

generations, that the Greeks were right. Direct taxes do produce tyranny. When the

Readers’ Digest wrote a series on the abuses of power by the IRS, they entitled the

series, ‘‘The Tyranny of the IRS.’’ Unlike wise men, we have had to learn from history the hard way-by reliving what others warned us about.

One of the high points in Thomas Paine’s life was his arrest and charge of seditious libel while in Britain. The charge came about because of his book, The Age

of Reason, in which he condemned kingships, especially Britain. To his defense came

one of the world’s greatest lawyers, Thomas Erskine. He paid dearly for the defense

of Paine, having been dismissed by the King from his post as AttorneyGeneral. The

following is taken from his speech in 1792, which seems to explain how our liberties

have been lost to enforce our income tax system.

...arbitrary power has seldom or never been introduced into any country at once.

It must be introduced by slow degrees, and as it were step by step, lest the people

see its approach. The barriers and fences of the people’s liberty must be plucked up

one by one, and some plausible pretenses must be found for removing or hoodwinking, one after another, those sentries who are posted by the constitution of a

free country, for warning the people of their danger.30

Our Current Tax System: Vexatious, Odious, Heavy and Direct

Let us leave the past and the Founders and see what shadows of the past are

cast upon us with our income tax.

Are our taxes arbitrary? There never was a tax law more arbitrary than our current income taxes. In the 1950’s, Congress decided that the top bracket should be

91%; Kennedy thought 70%; Reagan 28%; and Clinton wants to jack it back up to

around 40%. And as for exemptions, tax credits, and other tax goodies, they vary

from legislature to legislature-arbitrariness to the utmost extreme making a field

day for tax lobbyists and a joy to the tax makers on the Ways and Means Committee.

Are our taxes direct? Today we have nothing but direct taxes, which make everyone both a tax collector and a taxpayer. The IRS with more than 112,000 employees

it he largest tax bureaucracy in the world since ancient Rome. Its tentacles reach

out and have hold on more than 200 million people.

In the 1950s it was routine for an IRS agent to begin his audit by telling the taxpayer, ‘‘Ours is an honor system, which is the only way it will work in a free society.’’ Supreme Court Justice Jackson, a former chief counsel for the IRS, said at this

time that instances of selfserving mistakes and outright evasion were rare-and that

was at a time when the infamous ‘‘Information’’ returns were nonexistent.15 Banks

did not report anything to the IRS about the affairs of their customers. Nothing that

went through a bank account was photographed and held in storage for Big Brother

to see. Interest income was not reported; dividends were not reported; real estate

transactions and income was not reported; stock transactions were not reported; income from independent workers was not reported. Only wages were reported and

that was done to enable workers to file for a tax refund. U.S. Customs did not demand to know how much money or travelers checks you were carrying, nor did they

punish and confiscate amounts in your possession which were unreported. The tax

system was an honor system, and it worked.

The danger that income taxes may produce a massive espionage system and destroy much of the liberty of the people was a distinct possibility at the time America

adopted its first income tax. Even the experts were aware of the risk, but they were

quick to argue it would not be a possibility with the long traditions of freedom of

the American people. The danger became apparent because of the income tax system in Prussia, which, according to one German legislator who opposed the system,

covered the country with ‘‘a perfect system of espionage.17 In an income tax audit,

a taxpayer who was involved with securities, would be asked ‘‘How many stocks did

you sell this year? On what day and at what exchange did you sell them? What is

the price of each? What is the name of each company in which you have securities?’’

This was considered oppressive, the ‘‘espionage’’ that income tax advocates in America in 1914, assured the people, would never happen here.

We have also have had to resort to savage punishments to make the income tax

system work. Backing up the espionage is the fear of punishment—severe, long term

prison terms which hang over the heads of all taxpayers. Every March and April

prosecutions are published as front page items, to put terror and to intimidate every

taxpayer as the tax return season is in full force.

Some punitive measures are, at times necessary for tax enforcement, but have we

gone too far? Are we outofstep with a free society? With the rest of Western civilizaVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00358 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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tion? Outside of the former Soviet Union no nation treats its tax offenders with such

harshness.

The destruction of these values by our income tax would come as no surprise if,

in our education, we had learned that most great empires taxed themselves to

death, spiritually as well as economically. The Founders as well as the ancient

Greeks and Romans warned future generations about the tyranny that would befall

any nation that adopted a tax system like we have endured. Their words speak from

the past, like the ancient prophets from Biblical times.

The evolution of our direct income tax system from an honor to a spy system has

taken almost 50 years, in slow degrees, ‘‘as it were step by step,’’ under plausible

pretenses used to hoodwink the sentries ‘‘posted by the constitution,’’ i.e., the Supreme Court decisions, like Boyd v. United States, a tax case which declared unconstitutional a statute that gave the revenue bureaucracy the power to order a taxpayer to bring in his books and records for examination. Said the Court:

And any compulsory discovery by extorting a party’s oath, or compelling the production of his private books and papers, to convict him of a crime or to forfeit his

property, is contrary to the principles of a free government. It is abhorrent to the

instincts of an Englishman; it is abhorrent to the instincts of an American. It may

suit the purposes of despotic power; but it cannot abide the pure atmosphere of political liberty or personal freedom.31

That was in 1885. The case has been cited over 3000 times. Finally, in 1983 it

took a the Supreme Court acknowledge that the Court had ‘‘sounded the death knell

for Boyd.’’ 32 Year in and year out, with each new piece of tax legislation, the IRS

has been given increasing powers to spy, punish and intimidate taxpayers on a level

associated with a totalitarian state. The Supreme Court, like Pontius Pilate, had the

duty to prevent this abuse of power-but like Pilate, the justices have washed their

hands before the multitude.33

Finally, not long ago on the MacNeilLehrer news hour on PBS, an essayist was

finishing what would otherwise have been a fine talk, except he concluded his remarks with an assertion I have heard frequently since early grammar school days-

‘‘America is the freest country in the world.’’ That may have been true in times past,

but it is not true today, not by a long shot. There are many countries in the free

world that grant their citizens far greater freedoms than we enjoy in America. Not

only are we slipping to some degree in world commerce, we have slipped a great

deal more in matters of liberty and freedom. And the reason? Our income tax and

our government’s zeal to enforce it at all costs, including our liberty if it gets in the

way. As a free nation, we are a third string operation, thanks to our tax system.

How Does the FairTax Address these Problems if the Direct Tax?

What needs to be done to restore our leadership and ranking among free nations?

The answer is easier than you may think. We need to go back to our roots, to the

ideals and passion for liberty that was the driving force behind the formation of this

nation. The Founders had no use for direct taxation as a permanent revenue device.

They believed, as did the ancient Greeks and Romans, that it was a great danger

to liberty. They were right and we are living proof of how right they were.

Without an income tax there would be no need to photograph everything going

through your bank account; no need for your bank to notify the government about

your cash account or other financial dealings; no need for your interest, dividends,

stock sales, real estate transactions, and baby sitters to be reported to Big Brother.

No need for Customs to search travelers to make sure they were not carrying too

much money with them; no need for judicial terrorism, savage punishments, and

psychopathic judges. The laundry list of government intrusions would be minimal.

In one fell swoop, the totalitarian muscle behind our tax system would disappear.

1. Justinian Digest, L.xvii; Naphtali Lewis and Meyer Reinhold, ed., Roman Civilization, Sourcebook II, The Empire (New York, 1966) p. 539

2. M. Rostovtzeff, The Social and Economic History of the Roman Empire I (Oxford, 1971) p. 53132.

3. Salvian, On the Government of God, ed. Eva M. Sanford (New York, 1930) pp.

141–49

4. Rostovtzeff, Roman Empire, I. p. 398

5. Ferdinand Lot, The End of the Ancient World and the Beginning of the Middle

Ages (New York, 1961) p. 175

6. Charles Adams, For Good and Evil: The Impact of Taxes on the Course of Civilization (Lanham, MD, 1993) ch. 11

7. ibid., p. 187

8. Martin Hume, Spain, Its Greatness and Decay (1479–1788) (Cambridge, 1898)

p. 221

9. J. H. Plumb, Sir Robert Walpole, vol. 2 (Clifton, NJ, 1973) p. 238–39

354

10. William Blackstone, Commentaries on the Laws of England vol. I (London,

1765), ch. 8, p. 308

11. Baron de Montesquieu, The Spirit of Laws, vol. 1 (Dublin, 1751) Book XIII,

ch. 8, p. 261

12. New York Trust Co. v. Eisner, 256 U.S. 345, 349 (1921)

13. Thomas Paine, The Rights of Man (Pelican, N.Y., 1969) p. 206

14. The Writings of Thomas Paine, vol. III (New York, 1906) pp. 81, 183, 189

15. Gerald Carson, The Golden Egg (Boston, 1977) p. 252

16. D. Saunders, ed., The Portable Gibbon, The Decline and Fall of the Roman

Empire, (New York, 1973) p. 375

17. Edwin Seligman, The Income Tax (New York, 1914) p. 264

18. ibid. pp. 27172

19. Diogenes, The April Game (Chicago, 1973) pp. 12021

20. Thomas Paine, ‘‘Dissertation on the First Principles of Government,’’ Common

Sense and Other Political Writings (New York, 1953) p. 174

21. Blackstone, Commentaries, I, 307

22. Adam Smith, The Wealth of Nations (Harvard Classics, 1909) p. 563

23. See Adams, For Good and Evil, p. 386

24. David Hume, The Philosophical Works, vol. 3 (London, 1882) pp. 35660

25. Harold Syvelt, ed., The Papers of Alexander Hamilton vol. III (New York,

1962) p. 104

26. ‘‘The Uniformity Clause,’’ 51 U. of Chicago Law Review 1193 (Chicago, 1984);

44 Tax Law Review 563 (New York, 1989)

27. Montesquieu, Spirit of Laws I, Bk. XIII, ch. 14, p. 266

28. Cicero, On Duties Il; see Cicero, On the Good Life, trans. Michael Grant (New

York, 1971) p. 162

29. James Madison, Records of the Debates in the Federal Convention of 1787,

Documents Illustrative of the Formation of the Union of the Amerlcan States (Government Printing Office, Washington, 1927) p.

30. James L. High, ed., Speeches of Lord Erskine, vol. 1(Chicago, 1876) p. 536; also

found in 22 How St. Tr. 358, 443 (1792)

31. Boyd. United States, 116 U.S. 616, 63132 (1885)

32. United States v. Doe, 464 U.S. 606, 618 (1984)

33. Matt. 27:24

34. Smith, Wealth of Nations, 

fp. 500

Statement of W. Henson Moore, American Forest & Paper Association

Mr. Chairman and Members of the Ways and Means Committee, I am very

pleased to have the opportunity to address this Committee concerning the issue of

fundamental tax reform.

The American Forest and Paper Association (AF&PA) is the national trade association representing producers of paper, pulp, paperboard and wood products, as

well as growers and harvesters of this nations forest resources. As President and

CEO of AF&PA, I see evidence on a daily basis of how the U.S. tax code negatively

impacts the forest products industry as we compete in the global economy.

The members of AF&PA encompass the full spectrum of US businesses. They

range from large integrated corporate operations to small private tree farms long

held within a family. All our members are dedicated to business practices that foster

responsible environmental stewardship at home and abroad. Many of our members,

large and small, strive to maintain a competitive presence in the global market.

As good as our economy is, the provisions of the current tax code are a major obstacle to a level playing field between the U.S. forest products industry and our competitors around the world. Our taxes are higher than those of competing nations.

When added to trade barriers to exports of our products, the US worldwide system

of taxation functions as a major obstacle to competition.

We are fortunate in this country to possess vast forest resources that have actually been growing over time. Our nation’s 500 million acres of timberland contain

over 36% more wood fiber today than they did fifty years ago despite continuously

growing demand. Unfortunately, in recent years, a greater proportion of our national wood and paper needs have been supplied not from our own industry, but

from imports.

The importance of our forest products industry is reflected not only in our record

of environmental stewardship but also in the fact that we supply more than $230

billion to the nations gross domestic product; we rank sixth among domestic manuVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00360 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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facturing sectors. We employ 1.5 million people and rank among the top ten manufacturing employers in 46 states. The forest products industry represents more than

seven percent of U.S. manufacturing output, and provides a basic renewable resource that supports a unique and vital forest-based economy.

However, the U.S. forest products industry faces serious international competitive

threats, particularly from countries where new capacity growth exports are not

taxed and where forestry, labor and environmental regulatory requirements are not

as strict as those in the United States.

Our industry has an enviable environmental record. Members of AF&PA subscribe to the Sustainable Forestry Initiative, a program that assures the practice of

sustainable forestry through the perpetual growing and harvesting of trees while

protecting wildlife, plants, soil and water quality. However, unless we can improve

the investment climate for forestry in our own country, more trees will be grown

and harvested in other countries, many of which have less environmentally sensible

practices than we do in the US. Improvements in our tax system will be beneficial

not only to U.S. workers and U.S. companies—they will support U.S. environmental

goals as well.

Our industry is one of the most capital intensive industries in the world. For the

last 10 years, the pulp and paper industry has been the most capital-intensive sector in the United States. Extensive capital requirements for environmental protection cost 13 percent of the capital investment. This percentage is expected to more

than double in the coming five years.

Unfortunately, the US tax system discourages investment by the domestic forest

products industry. Moreover, competing countries are using their tax codes to foster

the growth of the industry, benefiting non-US competitors. Our US tax system

raises greater disincentives to corporate investment in manufacturing and corporate

forestry activities than that of any major competitor country. Our effective corporate

tax rate is the second highest among these competing countries. Corporate capital

gains are taxed at higher effective rates in the US than in most competitor countries. And even within the U.S., the identical asset—timber—is taxed as widely disparate rates, creating disincentives for holding timber in corporate form.

And it is not much better for our members who operate their businesses in the

non-corporate form. Some 9.9 million private individuals and firms own over 390

million acres of forestland in the United States. It typically takes anywhere between

30 and 80 years to grow and nurture trees before they can be harvested and converted to useful products. To make and maintain investments in forestry necessitates tax treatment that recognizes the long-term nature of growing trees. Under

the current tax system that excludes capital gains treatment for corporations and

imposes onerous passive loss rules on individuals, the effective tax rates for forestry

investments are a disincentive to domestic investment. I don’t believe we should be

sending investment and jobs overseas, not when we have immense unrealized opportunities at home.

Passive loss limitations intensify the capital drain during the long period of

growth of trees. These rules force many landowners to carry these costs until they

have a timber sale, instead of deducting these costs annually. For some landowners,

these passive loss provisions require landowners to carry these expenses for more

than 25 years.

US estate tax laws, with rates as high as 55%, force many who inherit familyowned tree farms either to sell these properties for commercial development, or to

prematurely cut their trees in order to pay the tax bill.

Our association has not endorsed any specific tax reform proposal. We applaud

efforts to simplify our US tax structure. The real question is how to get there from

here. In the end, any system of taxation is a formula. The preference for one tax

system or formula over others is dependent on what is included in the tax base and

where the rate of taxation is set. The other important element of any new system

will be whether the transition rules necessary if we move to a new tax base enable

taxpayers to make the transition gradually and in a way that is perceived to be economically fair.

Our industry supports the work of the committee in setting out to reform the tax

code and to institute a system that is fairer and simpler for the American taxpayer.

As this effort moves forward, we will work with you to accomplish those goals and

to assure that any new tax system supports U.S. workers and companies in our efforts to remain successful in increasingly global markets.

f356

Statement of American Petroleum Institute, Michael Platner, Washington,

DC

INTRODUCTION

Background

This testimony is submitted by the American Petroleum Institute (API) for inclusion in the printed record of the April 1 1, 12 and 13, 2000, Ways and Means hearings on fundamental tax reform proposals introduced since the last set of hearings

on the subject in 1997. API represents more than 400 companies involved in all aspects of the oil and gas industry, including exploration, production, transportation,

refining, and marketing .

Several new consumption tax proposals have been introduced recently as complete

substitutes for the current federal income tax system. This statement will focus on

the business tax aspects of 1 ) the Simplified USA Tax Act (‘‘USA Tax’’) offered by

Rep. English; 2) the Fair Tax Act, or national sales tax (‘‘NST’’), offered by Reps.

Linder and Peterson; and 3) a European-style credit-invoice value added tax

(‘‘CIVAT’’). API takes no position at this time as to whether the current income tax

system should be completely replaced, but there is no doubt that as presently codified, it imposes wasteful and unnecessary burdens on the economy. We commend

the Committee and the sponsors of these and previous proposals for their efforts to

improve our tax system and for moving toward the taxation of consumption rather

than the taxation of income.

Problems with Current Income Tax System

Over the years, changes to the Internal Revenue Code (‘‘Code’’) and accompanying

regulations have created the most complex income tax system in the world. Because

of this complexity, unreasonable compliance and collection costs (both to the government and to taxpayers) impair the efficiency of the system; obscure or conflicting

aspects of the Code and regulations fail to operate as intended; and administrative

implementation of complex provisions often takes years, creating long periods of uncertainty for taxpayers as to their tax obligations.

The current income tax system is biased against savings and investment, and in

favor of consumption. Income generated by corporations is taxed twice. For example,

in the case of a dividend, once when the income from which the dividend is generated is earned and again when the dividend is received by the shareholder. Moreover, because recovery of capital costs is spread over time there is effectively a tax

on the capital investment itself.

Our income tax system is neither ‘‘territorial’’ nor ‘‘border adjustable.’’ Therefore,

it does not allow domestic and foreign produced goods’ to compete on an equal basis

in domestic or foreign markets. Rather, the U.S. foreign tax system acts to inhibit

American competitiveness. U.S. corporations are taxed on worldwide income, while

many foreign corporations are not. U.S. anti-tax deferral rules are the most restrictive in the world; unnecessarily complicated mechanics of the foreign tax credit limitation further reduce the effectiveness of the credit as to a means to avoid double

taxation; and the volume and frequency of changes in the foreign tax area continue

to add compliance costs and destabilize the ability of U.S. businesses to compete

worldwide.

Most of our trading partners have some form of value added tax (‘‘VAT’’)—almost

exclusively a CIVAT-that permits the tax, under the rules of the World Trade Organization (‘‘WTO’’), to be rebated on exports. Our income tax cannot be rebated on

our exported goods (domestically produced goods must bear the imbedded costs of

our income tax as well as local taxes imposed in foreign markets), while goods imported into the United States do not bear the VAT imposed in their country of origin. Attempts to remedy this disparity in the tax treatment of U.S. versus foreign

exporters within the confines of the current U.S. tax system have been mostly unsuccessful. The recent decision of the WTO, which held that certain tax breaks offered to U.S. foreign sales corporations (‘‘FSCs’’) constituted illegal export subsidies,

only served to highlight the difficulty in preserving the global competitiveness of

U.S. businesses under our income tax system. Whatever comes out of this tax reform process should have as one of its goals enhancing the ability of U.S. companies

to compete internationally.

357

Guiding Principles in a Properly Designed Tax System

In general, API believes that properly designed consumption taxes are preferable

to income taxes. In studying consumption taxes over a number of years, we have

developed a set of principles by which we evaluate alternative consumption tax proposals. They include the following:

• Minimize economic distortions;

• Ensure that foreign and domestically produced goods compete equally in the

marketplace;

• Permit the current deduction of capital expenditures;

• Impose only one rate or as few rates as possible;

• Facilitate recovery of taxes in the marketplace;

• Exclude from the base separately stated excise taxes, including sales and use

taxes, royalty payments to federal and state governments, and non-cash exchanges;

• Be relatively easy to comply with and administer; and

• Make the tax rate or amount of tax clear to the ultimate consumer.

Concerns with Changing to a New Tax System

While we are supportive in principle of moving towards the taxation of consumption, we urge the Committee to proceed with caution. Because the income tax has

been embedded in our economy for more than eighty years, business decisions have

been, and continue to be, premised on economic assumptions spawned by that system. Therefore, any radical change will have profound implications on business

structure, business financing, and business operations themselves, and these implications must be thoroughly understood before moving to any new system. This is

especially true in the capital intensive oil and gas industry, where the results of decisions may take a decade or more to manifest themselves.

For example, the tax treatment of imports of all basic commodities for further

manufacturing will have significant ripple effects on the economy. Because more

than half of the crude oil used in the United States is imported, this issue is of

major concern to our industry. One of the proposals, the Simplified USA Tax Act,

imposes a nondeductible import tax that would increase the price of energy to consumers. We believe that any import tax should be imposed in a manner that is designed to put the new tax system in parity with the VATs of our trading partners.

In order to survive, our industry must operate where we have access to economically recoverable oil and gas reserves. Since the opportunity for domestic reserve replacement has been substantially foreclosed by both federal and state government

policy, the tax treatment of international operations is critical to our continued ability to supply the nation’s hydrocarbon energy needs. In addition, since our industry’s projects require large amounts of capital and are high risk, long lead-time ventures, the tax treatment of the financing and structuring of these ventures is an essential element of decisions whether to proceed. We are concerned about the impact

of these proposals on our access to efficient sources of capital, whether through traditional capital markets or through partnerships, joint ventures, or other business

structures.

Not only must the federal tax implications of any proposal be considered, but

state tax integration, U.S. financial accounting treatment, and securities market effects must also be thoroughly understood. Finally, consideration must be given to

the United States’ role in the global economy. A unilateral change in the basic taxation of inbound and outbound transactions by the United States will require that

new treaties be negotiated in order to maintain the protections afforded U.S. companies by the current income tax treaty system. These protections include: elimination

of double taxation due to overlapping exercise of authority; facilitation of business

transactions between countries that might otherwise be inhibited by overly intrusive

national taxation; reduction of high rate withholding taxes imposed by many countries on payments to foreigners of items such as dividends, interest, rents and royalties; and other provisions designed to lessen the burden on international commerce

of varying national taxation systems.

The USA Tax, NST and CIVAT, all of which are different forms of consumption

based taxation, fully or partially satisfy several of APl’s eight evaluation criteria

outlined above. However, each also falls short in meeting some of the criteria or

leaves issues of concern unresolved. A discussion of each of these specific proposals

follows.

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THE SIMPLIFIED USA TAX ACT OF 1999 (H.R. 134)

General Characteristics

The USA Tax satisfies several of the API criteria for evaluating taxing systems.

It would encourage the investment in durable business assets by allowing the immediate deduction of capital expenditures. API also favors this proposal for recognizing

that excise taxes should be excluded from the tax base and for establishing one tax

rate for business.

Several aspects of the USA Tax appear easier to comply with and administer than

the present income tax system. Allowing immediate expensing of capital equipment

is a great simplification compared to the current complex depreciation rules. Since

the USA Tax is also a ‘‘territorial’’ system, businesses would no longer have to incur

many of the administrative and compliance costs of the current system relating to

foreign operations. In certain respects, the USA Tax would help to minimize economic distortions as compared to the current system. Our present income tax system contains a large number of complex deductions and credits, many of which create competitive distortions in particular business sectors. Different rules apply depending upon whether a business operates in corporate or partnership form. The

USA Tax is more neutral because it would allow far fewer deductions and would

apply to all business sectors and forms of business organizations, but there is considerable uncertainty as to how the taxation of partnerships would affect the industry practice of forming joint ventures for high cost, high risk projects.

Deductibility of the Import Tax

There are also several areas in which the English proposal does not meet APl’s

criteria. The proposal would impose a 12 percent tax on the value of imports. Because the proposed tax would not be deductible, when an importer sells an imported

good in the United States, the importer would be subject to the 8 to 12 percent consumption tax on the already paid import tax. This double taxation would create an

unwarranted economic distortion by precluding foreign and domestic goods from

competing equally in the marketplace. Consideration should be given to whether the

imposition of an import tax is appropriate at all on intermediate purchases of goods

that will be incorporated into a final product. This is especially the case for raw materials, such as crude oil, that generally have already been subject to high foreign

taxes (which would no longer be creditable against U.S. tax obligations under the

USA Tax proposal).

The USA Tax system is particularly detrimental to importers by failing to allow

the import tax to be either deducted in arriving at the taxable base, or fully credited

against net liability as is the case with most credit-invoice VAT systems. While most

commentators focus on the payroll tax credit as the key to border adjustability, the

real focus should be on the national tax treatment provisions of the WTO because,

as currently drafted, the USA Tax appears to penalize imports. If a destinationbased system such as the USA Tax is ultimately adopted, this major error must be

corrected.

Tax Visibility

API is concerned that the USA Tax is not structured in a manner that would facilitate recovery in the marketplace. As is the case with the current income tax, the

USA Tax would be imposed on the net income of a seller of goods, rather than on

the product sale. Such a system also makes the amount of tax less clear to the ultimate consumer than would be the case with a tax that could be separately stated

as a specific percentage of gross sales price.

Treatment of Non-Cash Exchanges, State Taxes, Payroll Tax Credit

Further analysis and discussion is warranted regarding many other aspects of the

USA Tax proposal. For example, API believes that non-cash exchanges should be

excluded from the tax base. Under current law, tax-free exchanges are a common

and important part of the oil and gas business. Inventory exchanges of equivalently

(or nearly equivalently) valued barrels of oil or product are everyday occurrences involving extremely high volumes that permit the efficient transportation and supply

of crude oil and product throughout the country. Certainly, compensatory cash payments for value differences on these exchanges should be taken into account for tax

purposes, but the full value of the exchanged products must not be considered as

a taxable transaction. In addition, careful consideration must be given to the consequences of the proposed elimination of deductions for state income taxes and the

replacement of the wages-paid deduction with a payroll tax credit.

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CREDIT-LNVOICE VALUE ADDED TAX

In General

A CIVAT on sales of all goods and services appears to more closely adhere to the

principles API has identified for a properly structured consumption tax. A CIVAT

is imposed as a multistage sales tax collected at each point in the production and

distribution process. A business subtracts the tax paid on its purchases, including

capital goods, from the tax due on its sales. If the difference is a positive number,

the business remits that amount to the government. If it is negative, as may occur

in the case of exported goods, the business claims a refund. Compared to the current

income tax, the CIVAT has the advantage of encouraging saving and investment.

It does not burden capital outlays, nor does it discriminate against U.S. industry

either in the U.S. or abroad.

Effective and Neutral Revenue Source

From an economic standpoint, a separately stated CIVAT on the sale of goods and

services appears to be the least damaging way of raising revenue. It does not burden

capital outlays, nor does it discriminate against U.S. industry either in the United

States or abroad. It does not favor either capital or labor intensive industries.

Wages, rent, interest and profits, i.e., the return of entrepreneurship, each bear the

same direct tax burden. A CIVAT levied at the same rate on all consumption should

not cause a significant distortion in consumption choices since the relative cost of

goods and services would be the same after imposition of the tax as before. A broadbased CIVAT would not unduly burden the products of any one sector of the economy. Any regional distortions would tend to be minimized since no specific product

or geographic region of the country would be the focus of the tax. A uniform CIVAT

applied to goods and services would induce fewer distortions within particular industries than other taxes.

Border Adjustability

A CIVAT is neutral with respect to goods produced domestically and abroad. Not

only are U.S. manufactured goods not burdened with the tax when they are exported, but imports must also bear the same tax as comparable domestically produced goods. This border adjustment feature of the CIVAT-permitted under WTO

rules-means that the tax does not handicap U.S. manufacturers, nor does it act to

distort consumer’s decisions whether to buy domestic or imported goods. Some

economists argue that border adjustable taxes are not necessary because monetary

exchange rates will adjust to accommodate the change in U.S. taxation. While this

may be true in the long run (and not everyone agrees), in the short run the adjustment period could be very harmful to U.S. competitiveness.

Differences with Other Tax Systems

Under the CIVAT, the tax liability of a firm is equal to the tax imposed on its

sales net of a credit for the tax it has previously paid on purchases for business use.

Under a subtraction-method consumption tax system like the USA Tax, liability is

determined by applying the tax rate directly to the firm’s value added, or the difference between its sales and its purchases. CIVAT is a tax on a product while a

subtraction-method consumption tax system is based on a business’s books of account, similar to the current income tax system. From that underlying distinction

flows a number of practical differences that API concludes favor the CIVAT.

Most commentators agree that while a single rate consumption tax, without exemption, is preferable, the overwhelming weight of political experience shows that

the United States would not adopt a single rate consumption tax with no exceptions.

Not one of the 45 countries that currently collect consumption taxes has a singlerate, no-exemption tax. Most have both exemptions and multiple rates. The CIVAT

readily accommodates these features. Because the tax a business pays on purchases

is credited against the tax it owes on sales, businesses. are encouraged to register

as taxpayers and to get invoices from their supplier to document the tax paid. Also,

a CIVAT would reach previously untaxed income in the underground economy, since

all consumer consumption would be taxed when goods and services are purchased.

NATIONAL SALES TAX PROPOSAL (H.R. 2525)

In General

Most NST proposals are relatively easy to understand since they are similar to

the various sales tax systems in place in 45 out of the 50 states. The NST is intended to replace the current income tax, estate and gift tax, and most general revenue federal excise taxes. Under the plan offered by Reps. Linder and Peterson, the

360

tax would be imposed at a 23 percent rate on the sale of goods, including both tangible personal property and real property, and services, including financial intermediation services such as brokerage fees, banking fees, and insurance fees. Although the NST is intended to be compatible with current state sales tax systems,

none of the 45 states currently utilizing such a system tax services as extensively

as is envisioned under H.R. 2525. A great deal of work will have to be done with

the various state taxing authorities before they will become convinced to administer

a uniform NST on behalf of the federal government.

Businesses would collect tax on all their taxable sales of goods and services and

remit the tax to the government. Since purchases of inventory for resale are not taxable, the complex inventory rules of the current income tax system would be eliminated. Purchases of equipment and real property used in the production of taxable

goods and services would also not be taxable, so there would be full expensing of

capital assets. As noted above in the discussion of the USA Tax, the ability to immediately expense capital assets is extremely important to a capital-intensive business

like the oil and gasindustry.

Border Adjustability and Territoriality

Like a CIVAT, the NST is neutral with respect to goods produced domestically

and abroad. Not only are U.S. manufactured goods not burdened with the tax when

they are exported, but imports must also bear the same tax as comparable domestically produced goods. This border adjustment feature of the NST, which like the

CIVAT should be permitted under WTO rules, means that the tax does not handicap

U.S. manufacturers, nor does it act to distort consumers’ decisions whether to buy

domestic or imported goods. The NST, like the USA Tax and CIVAT, is a territorial

system, which would help put U.S. multinationals on a level playing field with their

international competitors.

Definitional Problems

Although it appears to be the intent of NST proponents that businesses above the

retail level will be outside the tax system, this likely will not happen. While H.R.

2525 improves on prior national sales tax legislative proposals in its attempt to define what constitutes a tax exempt good or service ‘‘purchased for a business purpose in a trade or business,’’ uncertainties remain. For instance, while the proposal

would exempt purchases used in a trade or business ‘‘(1) for resale, (2) to produce,

provide, render, or sell taxable property or services, or (3) in furtherance of other

bona fide business purposes,’’ it is unclear whether items such as financial services,

pollution control, environmental remediation, or many other kinds of purchases

would be covered by that definition. Such questions would then have to be resolved

during the often- confrontational audit process between the taxpayer/tax collector

and the sales tax administering authority.

Excise Tax Concerns

H.R. 2525 would not repeal the retail and manufacturer excise taxes, which include a federal excise tax of 18.4 cents per gallon on gasoline, 19.4 cents per gallon

on aviation gasoline, 24.4 cents per gallon on diesel fuel and kerosene and 21.9

cents per gallon on aviation fuel. In addition, the proposal would not repeal the environmental trust fund taxes, many of which are imposed on products produced by

the oil and gas industry. The preservation of these excise taxes in conjunction with

the adoption of the NST is of particular concern to our industry because these excise

taxes constitute a significant portion of the retail price of our products and would

be included in the base upon which the sales tax is calculated. State excise taxes

would also be included in the base, as proposed, and this would again be a major

problem for our industry.

TRANSITIONAL ISSUES

In General

While transitional issues will arise in the context of all tax reform proposals, they

become especially critical where, for example, there is a significant shift in the basis

of taxation from income to consumption. Capital intensive industries, such as the

petroleum industry, have made long-term investment decisions relying on the existing tax structure. Changes in that structure would impact different companies, often

in direct competition, in an arbitrary and often inequitable manner. The most obvious examples of transitional issues occur in the areas of capital outlays and borrowings.s For example, a capital asset (or inventory) purchased immediately prior

to the enactment of certain of the consumption-based taxes would be denied recovery of all but a miniscule fraction of its cost, whereas the same asset purchased imVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00366 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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mediately following enactment would be permitted an immediate 100 percent recovery against the tax base. In a similar manner, borrowings based on the anticipation

of an interest deduction could become a significant burden on a highly leveraged

business after enactment of a consumption tax.

Depreciation

The proposed USA Tax partially addresses the transition issue but stops far short

of providing the equitable relief necessary for business taxpayers. The issue of unrecovered basis is addressed in the Simplified USA Tax Act through a system of amortization that substantially lengthens the recovery period under current law. This

lengthened and arbitrary classification of unrecovered costs into four groups appears

to be based on misconceptions regarding complexity and revenue costs. Continuing

the current method for unrecovered basis of assets placed in service prior to tax reform would be preferable to inserting another new capital cost recovery regime. Permitting current law business deductions to be carried out, thus honoring prior business plans and commitments, is necessary to avoid inequitable distortions.

Interest on Pre-Reform Debt

Transitional rules that consider only lost depreciation deductions fall far short of

measures necessary to ensure the success of tax reform. A continuation of current

law interest deductions for pre-reform debt can be as vital to a business as cost recovery. If the interest deduction is offset by interest income on the particular prereform debt (i.e., pre-reform obligations continue to be both tax deductible to the

debtor and taxable to the lender), there would be no significant revenue impact to

the Treasury. Ignoring a continuation of the interest deduction results in arbitrary

windfall gains and losses without any apparent justification.

Carryovers of Other Tax Attributes

Among other items of significant impact to business are net operating loss and

capital loss carryovers, business, foreign tax and minimum tax credit carryovers, as

well as other pre-reform adjustments, such as those required under Section 481 of

the Code. The USA Tax attempts to solve this problem with a further complex overlay to the depreciation recovery rule. Operating and capital losses are simply a result of the annual accounting convention for tax payment determinations. Their

carry forward is a valid claim on future tax payments that would take into consideration the length of business cycles in various industries and other issues of timing.

There is no valid distinction between unused business credits and future deductions

for depreciation and, in fact, credits are a specific and distinct congressional incentive upon which businesses have relied. The Alternative Minimum Tax was intended

as an advance payment of federal income tax. Therefore, unrecovered credits require

a reimbursement mechanism. Transitional rules must include a provision clearly

permitting the Internal Revenue Service to make appropriate adjustments to ensure

that no taxpayer takes a double deduction for any cost, nor suffers double inclusion

of any income.

SUMMARY

Reform of the current U.S. tax system is a worthy goal, especially the movement

from taxation of income to taxation of consumption. Each of the alternative consumption tax proposals makes important contributions to the reform effort. Any

major upheaval such as complete replacement of the current income tax system will,

however, require careful analysis of all possible implications. We have lived with the

present tax system for over eighty years, and businesses have structured their affairs within it. Any fundamental change, unless carefully orchestrated, could cause

massive turmoil, particularly in the transition period from the old system to the

new. At the same time, it should be emphasized that while API has identified a

number of concerns regarding the prospect of comprehensive tax reform, none of

these problems are insurmountable.

Statement of Associated General Contractors of America, Alexandria, VA

Mr. Chairman and Members of the Committee on Ways and Means:

The Associated General Contractors of America (AGC) has endorsed the FairTax

f national sales tax (currently embodied in H.R. 2525) that is promoted by the Americans for Fair Taxation. This federal legislation would eliminate the death tax, selfemployment taxes, corporate and individual income taxes, the alternative minimum

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tax, the capital gains tax and replace these taxes with one simple, single rate, national sales tax on the personal and final consumption of goods and services at the

retail level only. It would not affect social security benefits, but simply change the

funding mechanism. It would not affect those Federal excise taxes used to fund construction programs. In this endorsement, AGC joins other significant national business groups including the National Small Business United (the nation’s oldest small

business organization) and the American Farm Bureau Federation among other notable groups.

AGC is the nation’s largest and oldest construction trade association, founded in

1918. AGC represents more than 33,000 firms, including 7,500 of America’s leading

general contracting firms. AGC’s general contractor members have more than

25,000 industry firms associated with them through a network of 101 AGC chapters.

AGC member firms are engaged in the construction of the nation’s commercial

buildings, factories, warehouses, highways, bridges, airports, waterworks facilities,

waste treatment facilities, dams, water conservation projects, defense facilities,

multi-family housing projects, site preparation, and utilities installation for housing

developments.

SUMMARY:

The FairTax national sales tax will, in one broad stroke, accomplish the entire

Federal tax agenda for the AGC. The FairTax eliminates the methods of accounting

and long-term contract accounting problems faced by contractors. No earnings would

be taxed and, equally important, once the FairTax is in place, no business-to-business transactions would be taxed.

The fundamental reform will provide the legislative vehicle for total elimination

of death taxes. The death tax is one of the most onerous obstacles to family business

continuity and growth. At a minimum, an estate over $675,000 (gradually increased

to $1 million by 2006) will be subject to a federal death tax rate of 37% and an estate over $3 million will be taxed at 55%. In the capital intensive construction industry, most firms easily have assets of the current death tax exemption amount.

More than 70% of family businesses do not succeed to the second generation and

87% do not survive to the third generation. Few have the liquid assets to pay death

taxes if their heirs were to inherit the business today. Comprehensive tax reform

of this magnitude is a strong vehicle for full elimination of the death tax.

Additionally, several beneficial economic consequences would follow from the

FairTax. Replacing the income tax with a national sales tax will dramatically improve the standard of living of the American people. The FairTax would significantly

enhance economic performance by improving the incentives for work and entrepreneurial activity and by raising the marginal return to saving and investment. Entrepreneurs and small business owners would be given greater access to capital, the

life-blood of a free economy. Investment would rise, the capital stock would grow,

productivity would increase and the output of goods and services would expand. The

economy would create more and better paying jobs for American workers and takehome pay would increase considerably.

The cost of construction supplies will fall. Today, construction materials bear a

heavy, hidden component of tax. Approximately 25 percent of the cost of materials

are taxes that have been imposed upstream in the companies producing those materials, according to Dale Jorgenson, who is the President of the American Economics

Association and Chairman of Harvard University’s Economics Department. When

taxes are removed, competition will drive material costs downward.

The cost of capital will fall, enabling construction firms to make greater investments in productivity and inducing further infrastructure investments. The construction industry is capital intensive, requiring large investments in heavy equipment. For instance, a 150-ton crane used in bridge construction can cost more than

$1 million. A scraper can cost $700,000 and a large bulldozer can cost more than

$800,000. By eliminating the capital gains taxes and any tax on investment and

savings, the FairTax will enable contractors to make the needed investments in

equipment and supplies before tax, not with what remains after the government has

exacted a toll.

Workers would benefit. Because the FairTax repeals both the income tax and payroll taxes, workers would enjoy the full fruits of their labor. What an employee

earns would be what the employee would receive in his or her paycheck. Workers

would respond to a national retail sales tax by increasing the amount of work effort

they want to undertake. A reasonable projection is that if the current federal income

tax system were to be replaced by a national retail sales tax, total hours worked

that people in the United States would choose to work would increase by 8.25 percent.

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There are more advantages. The FairTax would reduce fixed compliance costs by

as much as 90 percent. By imposing taxes at the cash register, the FairTax would

wholly exempt individuals from ever having to file a return. Business-to-business

transactions would be fully exempt. The Tax Foundation estimates that the FairTax

would reduce compliance costs by 90 percent—more than any other tax plan. In addition to reducing compliance costs, The FairTax would reinstate the principle that

Americans have a right to understand the law to which they are subjected.

In sum, AGC believes that the FairTax is good for construction and good for

America. We strongly support this proposal and urge Congress to seriously consider

the FairTax as a replacement to our current tax code maze.

ADDITIONAL DISCUSSION:

Construction is as vital to our economy as it is has been to our historic growth

as a nation. While statistics are always moving targets, there were 487,783 construction firms in 1997. Total civilian employment based on IRS records was

142,836,000; construction directly accounted for more than 6.1 million civilian employees who paid salary and wages of $28 billion. There were $593 billion in total

receipts. Construction firms had assets of $315 billion in 1997, broken down roughly

as indicated below.

What is Wrong with Our Tax System?

Apart from paying high direct and indirect taxes, our current tax regime places

disproportionate burdens on construction, stemming from the unique nature of the

our industry as a capital intensive, long-term, high-risk and often family-owned and

operated effort.

Through the income tax, behavior that is essential to building—work, saving and

investment—is punished. High marginal tax rates weaken the link between effort

and reward. Multiple layers of taxation on work, saving and investment reduce capital for new investment. A regressive levy of payroll and self-employment taxes frustrates expansion. Finally, although families own most construction firms, estate

taxes (at rates as high as 55%) due at death prevent owners from passing their

firms on to their children.

While construction is inherently capital-intensive, firms are hampered by the capital gains tax, which doubly taxes investment income while punishing losses which

cannot be predicted. Capital gains taxes discourage reinvestment to keep businesses

growing and operations competitive. Moreover, because the industry is largely investment and reinvestment in capital assets over many years, capital gains can result more from inflation than appreciation, even when a firm is sold.

The tax system through inadequate capital cost recovery allowances, the alternative minimum tax and the passive loss limitations, makes investment in structures more expensive and reduces demand for structures being built.

The cost of capital will fall, enabling construction firms to make greater investments in productivity and inducing further infrastructure investments and allowing

their customers to make greater investments in structures and other products of the

construction industry. The construction industry is capital intensive, requiring large

investments in heavy equipment. For instance, a 150-ton crane used in bridge construction can cost more than $1 million. A scraper can cost $700,000 and a large

bulldozer can cost more than $800,000. By eliminating the capital gains taxes and

any tax on investment and savings, the FairTax will enable contractors to make the

needed investments in equipment and supplies before tax, not with what remains

after the government has exacted a toll.

The FairTax would exempt the poor from paying any federal income, payroll or

sales tax altogether. In fact, this means that poor people that spend less than the

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2See, ‘‘The Economic Impact of Fundamental Tax Reform,’’ Dale W. Jorgenson, Testimony before the House Ways and Means Committee, June 6, 1995; ‘‘Looking Back to Move Forward:

What Tax Policy Cost Americans and the Economy,’’ Gary Robbins and Aldona Robbins, September, 1994, Policy Report Number 127, Institute for Policy Innovation; ‘‘The Economic Impact

of Taxing Consumption,’’ Laurence J. Kotlikoff, April 15, 1993, Cato Institute Policy Analysis.

Also see ‘‘The National Sales Tax: Moving Beyond the Idea, Tax Notes, March 21, 1996, David

R. Burton and Dan R. Mastromarco. 3Kotlikoff also simulated an economy in which income taxes at all levels of government were

replaced by a comprehensive retail sales tax and found that the stock of U.S. capital would increase by as much as 49 percent.

poverty level amount on taxable goods and services will enjoy a negative tax rate.

For three quarters of Americans, payroll taxes are a larger burden than income

taxes. Payroll taxes are imposed from the first dollar of wage income earned, although the earned income tax credit mitigates this burden to some degree. The AFT

plan would repeal the Social Security and Medicare payroll taxes

The sales tax imposes tax on the private use of economic resources, not on social

use. When an individual buys a good or service for personal consumption purposes,

he will pay tax. When that money is used for a social purpose such as investing

in a job producing plant, conducting research to develop new technologies or find

new medicines or is given to a charity, the individual will not pay tax. If an investor

liquidates his investments to fund consumption, a tax is imposed.

Virtually all economic models project a much healthier economy if a national sales

tax replaces the current tax system. These models typically project that the economy

will be 10 to 14 percent larger in 10 years.2 Real investment also will spike upward.

Harvard University economist Dale Jorgenson forecasts that ‘‘real investment would

leap upward. As a direct result of this dramatic increase in real investment, the capital stock will rise as well. Kotlikoff forecasts that by the fifth year after replacement, the capital stock will be eight percent larger. By the 10th year, the capital

stock will be 15 percent greater. Over the long run, the capital stock will be a full

29 percent larger than under the current income tax regime.3

The federal tax will point the direction to sound state sales tax policy Many state

sales tax schemes improperly tax business inputs and therefore cascade. When

states repeatedly tax purchases between and among firms, all firms are disadvantaged, but especially disadvantaged are small firms. The more small firms are utilized in the chain of production, the more the enterprise—from raw materials to consumption—the more they will pay in taxes. Under such an ill-advised scheme, a

company has every incentive to vertically integrate, rather than contract out—even if contracting out were more efficient. The normal tendency of small firms who have

struggled under such cascading tax schemes would be to associate this negative

characteristic with all plans that are called ‘‘sales’’ taxes—even a national sales tax.

However, the AFT believes it wholly inappropriate to adopt a system that has cascading taxes. If a business buys a good or service from another business, such a purchase would not be taxed. Since no business to business inputs are taxes, and no

profits or income is taxed, businesses pay an effective rate of zero.

While these are the highlights, there are more advantages. Hidden taxes would

become visible and more difficult to raise. By placing the tax on the receipt for consumer purchases and by repealing upstream taxes, it would convey the true cost of

government to every American on each purchase they make. This not only adds integrity to the tax system, but it will also keep taxes lower.

One of the best attributes of the FairTax is that it will cause a drop in interest

rates and reduce the carrying costs of debt. Under the FairTax, conservative estimates predict that mortgage interest rates will fall by 25 to 30 percent or about two

points on a 30-year conventional mortgage. To put this in the context of housing,

for a $150,000 thirty-year home mortgage at an interest rate of 8 percent the

monthly mortgage payment would be $1,112.64. On that same mortgage at a 6 percent interest rate the monthly payment would be $907.64. The two-point decrease

in interest rates in this instance would result in a $73,800 cost savings to the consumer.

Conclusion

The true tax reform debate will not take place in Washington. Rather, it will take

place at the grass roots level. A consensus is growing that America can and must

adopt a better system of collecting the revenues necessary to fund the federal government. Which alternative is best is the question now on the national agenda. The

FairTax would be simple, inexpensive, understandable, administrable, visible, equitable, pro-growth and respectful of privacy rights. The AGC has endorsed the

FairTax as the most sensible alternative to a broken system. We encourage you to

help make this tax plan a reality by becoming actively involved.

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Statement of Hon. Jim Barcia, a Representative in Congress from the State

of Michigan

Thank you for the opportunity to submit this statement on the FairTax national

sales tax plan. I am a cosponsor of H.R. 2525—a bill distinguished in its Congressional support by an equal balance of Democrats and Republicans.

Mr. Chairman, our Congress is one of the most prodigious legislative bodies in the

world, but one would be hard pressed to find any public law more despised than

our Internal Revenue Code. If we assembled ten different individuals in Bay City

or Saginaw, Michigan—the heart of the Midwest—and asked them what they

thought of the tax system today, we would get ten different answers. None would

be favorable and none would be incorrect. The answers that I have heard are that

our system is too invasive of our privacy, heavy-handed, too costly, overly complex,

burdensome, punitive, invisible, anti-competitive, unfair, destructive of our collective

and individual prosperity.

What would the FairTax do for the American people in my view? It would reduce

the wasteful administrative overhead of our system: record keeping, the cost of advice, the cost of filling our returns, and the cost of audit. Under any tax system,

we have to have tax collectors and payers. However, the FairTax would eliminate

entirely the collection, record keeping and reporting responsibilities of individuals.

This is much better than filing a postcard sized return as the flat taxers boast. In

fact, most taxpayers now file a return very similar to a postcard sized return in the

Form of the 1040EZ. Under the FairTax, 112 million taxpayers can simply let April

15th pass as a beautiful Spring day. Congress will give them a permanent extension. No returns, ever. No other tax plan can claim this.

The FairTax would repeal the payroll tax, which is the most regressive tax of all.

It takes a 15.3% bite out of every single dollar earned, but only applies to the middle class wage earner; at high incomes it falls to 2.9 percent. Moreover, it only applies to wages, not dividends and interest.

The FairTax is the plan that will restore the fundamental notion of fairness, notice of the law, and privacy rights on which this country was based. Our nation deserves better than the monstrosity of law we created in the last century. As we look

to the next millennium, we should have a clear vision of what an ideal tax system

hosting three days of hearings on Fundamental Tax Reform proposals. Please allow

should look like. The FairTax is that system.

Good morning Chairman Archer and members of the committee. Thank you for

Statement of Council of Smaller Enterprises, Cleveland, OH

f this document to serve as written testimony supporting Fundamental Tax Reform

and the Fair Tax, or the national retail sales tax proposal (HR 2525).

This testimony is submitted on behalf of the nation’s largest chamber of commerce. The Greater Cleveland Growth Association and it’s small business division,

The Council of Smaller Enterprises (COSE), represent over 16,000 businesses in

Ohio and over 250,000 lives in its health insurance plan. Based in Cleveland, Ohio,

our health insurance plan was adopted over 25 years ago to give our members, their

employees and families access to high quality, affordable health care benefits. We

are often cited and studied as a national model for health insurance purchasing cooperatives. We support the Fair Tax model because it promotes fairness and simplicity, improves the competitiveness of American businesses, and will increase the

standard of living for the American people.

The Fair Tax plan as introduced in HR2525 (Linder, (R–GA) and Peterson, D–

MN) would repeal the federal personal income, corporate income, estate, gift, capital

gains, self-employment, payroll, social security and Medicare taxes and replace them

with a 23% sales tax on all new goods and services. This tax would be collected at

the point of final purchase for consumption. Every taxpayer will be subject tot he

same tax rate with no exceptions and no exclusions. Since the Internal Revenue

Service would be abolished under the Fair Tax plan, the 23% rate is intended to

raise the same amount of federal funds as raised by the current federal tax system.

In addition, the rate is calculated to pay for a universal rebate for essential goods

and services and pay for a fee to retailers and state governments collecting the tax.

The universal rebate to all registered in the Social Security system would replace,

in effect, the exclusions on clothing and food, for example, that states make for their

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sales taxes. The universal rebate is proposed to be calculated as the sales tax rate

times the poverty level income adopted by the government for different family sizes.

Proceeds from the Fair Tax would become the primary general revenue source for

the United States government. Social Security and Medicare would be funded from

this revenue stream. The bill as proposed is estimated to be revenue-neutral for its

first full year in effect. The new tax system will then go into effect one calendar

year after the repeal amendment is ratified, with a transition phase beginning with

the ratification of the amendment.

The COSE Board of Directors endorsed the Fair Tax on October 12, 1999 (see attached Resolution). Our members, primarily entrepreneurs and business owners,

agreed that the current system cannot be reformed. It must be replaced. COSE believes HR 2525 is a positive non-partisan proposal that will fix the current system

by taxing citizen on what they spend, not what they earn.

Thus, the time for change has come. Even former IRS Commissioner Shirley Peterson acknowledged that the current tax system should be changed. Head of the

IRS in 1992, Commissioner Peterson noted that ‘‘we have reached the point where

further patchwork will only compound the problem. It is time to repeal the Internal

Revenue Code and start over.’’ COSE believes there are valuable member benefits to the adoption of the Fair

Tax. Employees will be able to take home their entire paycheck. Businesses will not

have to pay capital gains, payroll, income taxes or many other taxes which hurt

business growth. The elimination of the estate tax burden will help family businesses grow. Finally, more capital will be available to business owners since investment will not be taxed.

On behalf of over 16,000 businesses in Ohio, we urge you to support the Fair Tax

proposal. COSE believes it is the most sensible method to revise our current complex and ever-changing tax code. Thank you for your time and consideration.

Attachment is being retained in the Committee files.

Statement of Herman Cain, Godfather

f’s Pizza, Inc., Omaha, NE

Thank you Mr. Chairman and members of the committee. I appreciate the opportunity to testify before your committee about fundamental tax reform. I am Chairman of Godfather’s Pizza, Inc.

The current tax system is broken and no amount of tinkering around the edges

is going to fix it. It is too complicated. It is too unfair. It holds people down economically. It destroys hope and opportunity. It needs to be replaced.

A replacement system should satisfy six principles. First, it should promote economic growth by reducing marginal tax rates and eliminating the tax bias against

savings and investment. Second, it should promote fairness by having one tax rate

and eliminating all loopholes, preferences and special deductions, credits and exclusions. Third, it should be simple and understandable. Fourth, it should be neutral

rather than allowing the government to manipulate and micromanage our economy

by favoring some at the expense of others. Fifth, it should be visible so people understand their actual tax burden and so it clearly conveys the true cost of government. Sixth, it should be stable rather than changing every year or two so people

can plan and so the system remains simple and understandable.

In my view, there is more than one plan that would satisfy these principles to

varying degrees. There is more than one way to vastly improve over the current tax

system. One proposal that would be highly constructive is the flat tax. It would improve the tax system in all six areas. I, however, have concluded that the FairTax,

introduced on a bi-partisan basis by Reps. Linder and Peterson as H.R. 2525, meets

the six principles that I outlined.

The FairTax would repeal individual income taxes, corporate income taxes and

the estate and gift tax. It is the only proposal to repeal all payroll taxes (including

Social Security, Medicare and self-employment taxes). These taxes are a regressive

tax on jobs and upward mobility and it is time to address them. The FairTax would

replace these taxes with a 23 percent national retail sales tax on all goods and services sold to consumers.

Individuals would no longer file tax returns. April 15th would be just another day.

Businesses would collect and remit the sales tax. In addition, the FairTax would

provide every household in America with a rebate of sales tax paid on necessities.

The FairTax would encourage Economic Growth

A national retail sales tax would significantly enhance economic performance by

improving the incentives for work and entrepreneurial activity and by raising the

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1 $155.40 less 7.65 percent in employee Social Security ($11.89) and Medicare payroll taxes less 28 percent in federal income taxes ($43.51) leaves $10,000. 2 Neither the flat tax nor the USA Tax would remedy the current bias against education.

3 $15,540 less 7.65 percent in employee Social Security ($1,189) and Medicare payroll taxes less 28 percent in federal income taxes ($4,351) leaves $10,000. 4 Economists generally agree that the employer share of payroll taxes is borne by the employee

in the form of lower wages. This figure assumes that employees bear the burden of the employer

payroll tax and that they are in a seven percent state and local income tax bracket. $20,120

less $5,634 in income tax (28 percent), $3079 in payroll taxes (15.3 percent) and $1,408 in state

and local income taxes (7 percent) leaves $10,000.

marginal return to saving and investment. Entrepreneurs and small business owners would be given greater access to capital, the life blood of a free economy. Investment would rise, the capital stock would grow, productivity would increase and the

output of goods and services would expand. The economy would create more and

better paying jobs for American workers and take-home pay would increase considerably.

Although the magnitude of the economic growth generated by a flat rate, neutral

tax system causes lively debate among economists, virtually all agree that the large

marginal tax rate reductions in the FairTax combined with neutral taxation of savings and investment, will have powerful positive effects on the economy.

The FairTax would be Fair

The FairTax would provide every household in America with a rebate of sales tax

paid on necessities. Thus, the FairTax is progressive and every family is protected

from tax on essential goods and services. Because of the rebate, those below the poverty line would have negative effective tax rates and lower middle income families

would enjoy low effective tax rates.

The burden of paying the FairTax is fairly distributed. It is, in fact, much more

fairly distributed than the income tax. Wealthy people spend more money than

other individuals. The FairTax will tax them on their purchases and as a result,

they pay more in taxes. If, however, they use their money to build job creating factories or stores, or to finance research and development to create new products, (all

of which help improve the standard of living of others), then those activities will

not be taxed. The FairTax is premised on the notion that it is fairer to tax individuals when they consume for themselves above the essentials of life, rather than

when they invest in others or contribute to society.

The FairTax in effect gives a supercharged charitable contribution deduction because people can give to their favorite charity free of any income tax, payroll tax

or sales tax. The charitable deduction today allows people to make their contributions with pre income tax dollars (but after payroll tax dollars). For the three-quarters of Americans that do not itemize, most must today earn $155 to give $100 to

their favorite charity or to their church.1 Under the FairTax, they must earn only $100 to give $100 since under the FairTax what you earn is what you keep and

charitable contributions are not taxed.

Education is one of the keys (along with savings and hard work) to an improved

standard of living. That certainly was true in my case. The FairTax is education

friendly and is dramatically more supportive of education than current law. The

FairTax embodies the principle that investments in people (human capital) and investments in things (physical capital) should be treated comparably. The current tax

system, in stark contrast, treats education expenditures very unfavorably.

Education is the best means for the vast majority of people to improve their economic position. It is the most reliable means that people have to invest in themselves and improve their earning potential. Yet the tax system today punishes people who invest in education, virtually doubling its cost. Only the FairTax would remove this impediment to upward mobility. No other tax reform plan would do so.2

Today, to pay $10,000 in college or private school tuition, a typical middle class American must earn $15,540 looking only at federal income taxes and the employee

payroll tax.3 The amount one must earn to pay the $10,000 is really more like $20,120 once employer and state income taxes are taken into account.4

The FairTax does not tax education expenditures. Education can be paid for with

pre-tax dollars. This is the equivalent of making educational expense deductible

against both the income tax and payroll taxes today. Thus, under the FairTax, a

family will need to earn $10,000 to pay $10,000 in tuition, making education much

more affordable (not considering state income taxes on education). The FairTax

makes education about half as expensive to American families compared to today.

The FairTax would improve upward mobility but no longer punishing work, savings, investment or education. It would better enable people to improve their lives.

It would no longer hold people back.

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The FairTax would be Simple

The FairTax is a simple tax. Individuals who are not in business would have absolutely no compliance burden, nor would they be subject to the discretionary interpretation of the current convoluted tax code. As for businesses, it puts much fewer administrative burdens on businesses. In fact, filling out a FairTax return is comparable to filling out line one (gross revenue) of an income tax return. There would

be no more alternative minimum tax, no more depreciation schedules, no more complex employee benefit rules, no more complex qualified account and pension rules,

no more complex income sourcing and expense allocation rules, no more foreign tax

credit, no more complex rules governing corporate acquisitions, divisions and other

reorganizations, no more uniform capitalization requirements, no more complex tax

inventory accounting rules, no more income and payroll tax withholding and the list

goes on. Businesses would simply need to keep track of how much they sold to consumers.

Compliance costs will, therefore, fall under the FairTax. Today, according to the

Tax Foundation, we spend about $250 billion each year filling out forms, hiring tax

lawyers, accountants, benefits consultants, collecting information needed only for

tax purposes and the like. These unnecessary costs amount to about $850 for every

man, woman and child in America. To the extent these costs are incurred by businesses, they must be recovered and are embedded in the cost of everything that we

buy. The money we spend on unnecessary compliance costs is money we might as

well burn for all of the good it does us. The Tax Foundation has estimated that compliance costs would drop by about 90 percent under a national sales tax.

The FairTax would be Neutral

Under the FairTax all consumption would be treated equally. The tax code punishes those that save and rewards consumption. Under the FairTax, no longer would

the tax system be in the businesses of picking winners and losers. The tax code

would be neutral in the choice between savings and consumption, neutral between

types of savings and investment and neutral between types of consumption.

The FairTax would be Visible

The FairTax is highly visible, and because there is only one tax rate Congress

would be raising the rate on all taxpayers at the same time. Moreover, all citizens

would be subject to the tax increase, not just a targeted few. It will be much harder

for Congress to adopt the typical divide-and-conquer, hide-and-disguise tax increase

strategy it uses today. The FairTax would explicitly state the contribution to the

Federal government each and every time a good or service is purchased.

The FairTax would be Stable

The FairTax would be more stable than the present system for two reasons. First,

because it is so simple and transparent, it would not invite tinkering in the way

that the current system with its thousands of pages of code and regulations does.

People will resist attempts to make it more complex and attempts to favor special

interests because they will understand what is going on. Second, taxing consumption is a more stable source of revenue than taxing income. There are fewer ups

and downs in the consumption base.

A recent study showed that for the years 1959 to 1995, the FairTax base was less

variable than the income tax base. Why? When times are unusually good, people

will usually save a little more. People tend to smooth out their consumption over

their lifetime. They borrow when young, save in middle age and spend more than

their income in retirement.

Impact on Restaurants and Retailers

I would like to discuss briefly the impact of the FairTax on my industry, restaurants in particular and retailers in general. The FairTax could have a positive

impact on these industries.

Like other firms, retailers will enjoy a zero corporate tax rate and their shareholders will not be taxed on dividends received from the retailer or capital gains

on their investment in the retailer. Compliance costs could be lower. Moreover, over

time, most states will conform their sales taxes to the federal sales tax, reducing

the costs of complying with multiple rules in each state and their political subdivisions.

If people are willing and able to purchase more goods and services in a healthy

economy, then they will spend more money at retailers and eat out more. There is

nothing that hurts restaurants more than a slow economy and nothing that helps

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them more than a good economy. In this sense, the FairTax could help restaurants

and retailers.

Consumption is taxed once under both an income tax and a national sales tax.

Consumption purchases must be made from after-income-tax and after-payroll-tax

dollars today. The primary difference between a sales tax and an income tax is that

the income tax double or triple or quadruple taxes on savings. Consumers will see

their paychecks increase by nearly two trillion dollars. Since the FairTax is not a

tax increase but is revenue neutral, the repeal of the income and payroll taxes will

provide consumers with the money necessary to pay for the sales tax.

Instead of having to comply with the complexities of the income tax, payroll tax,

and various other taxes, there will be one sales tax on all goods and services. The

firm will simply need to calculate on a monthly basis its total retail sales. Retailers

will receive an administration fee for complying with the sales tax. The fee is equal

to ★ of one percent of the revenues collected and remitted.

In summary, this is what the Fair Tax could mean for retailers:

No more uniform inventory capitalization requirements;

No more complex rules governing employee benefits and retirement plans;

No more tax depreciation schedules;

No more complex tax rules governing mergers, acquisitions and spin-offs;

No more international tax provisions;

No more income tax or payroll tax withholding;

No more employer payroll tax; and

No more corporate tax.

I would also point out that restaurants in particular have grave concerns that any

national sales tax would treat restaurant food differently from food purchased at a

grocery store. Food consumed away from home is no longer a luxury, it is an essential part of the American lifestyle. The FairTax would not discriminate between the

two.

Conclusion

People want to be able to dream and to pursue their dreams. As Dr. Benjamin

E. Mays, late President Emeritus of Morehouse College said, ‘‘It isn’t a calamity to

die with dreams unfulfilled but it is a calamity not to dream.’’ The current tax system not only destroys the ability of people to achieve their dreams, it causes many

people to give up dreaming altogether.

We need a better tax system—a tax system more appropriate for a free society.

The current tax code can not be reformed to achieve the stated objectives, it MUST

be replaced. Please use the power of the Congress to correct a tax code that has

simply gotten out of control and taken away people

f’s freedom.

Statement of Hon. Ralph M. Hall, a Representative in Congress from the

State of Texas

Thank you for allowing me to submit my testimony to the Committee on Ways

and Means on the important subject of reforming our nation’s tax system. I am a

cosponsor of H.R. 2525, the FairTax Act of 1999, legislation introduced by our colleagues, John Linder and Collin Peterson.

H.R. 2525 would repeal the federal income tax in its entirety, including all individual, corporate, payroll taxes, self-employment taxes, capital gains, gift and estate

taxes. It would impose a revenue neutral national sales tax on all new goods and

services at the point of final consumption. Most importantly, the FairTax would provide for a rebate in an amount equal to the sales tax on essential goods and services. No American would pay taxes on their purchase of these necessities.

Mr. Chairman, I support H.R. 2525 because it is fair to all Americans, it eliminates the complexity of our current system, it encourages savings and investment,

and it is a much more efficient way to raise federal revenues than the current system.

Under the FairTax, every taxpayer starts out on a level playing field. There are

no advantages to be gained by gaming the system. Those who profit from the current complexities in our tax code by sheltering income will no longer have an unfair

advantage. Essentially, all taxpayers will make their own decisions about how much

in taxes they will pay, in that they are only taxed when they purchase a product.

The FairTax would help improve the economic security—and thus the standard

of living—for most Americans because it rewards savings and investment. Today,

our country has one of the lowest rates of savings in the world. Under H.R. 2525,

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our rate of savings should dramatically improve because the money Americans

choose to save or invest will no longer be subject to any tax. This economic incentive

to save should result in more taxpayers saving and investing in our economy. Additionally, lower income families also will benefit because they will be able to keep

all of their paycheck, without any costly tax deductions.

Finally, Mr. Chairman, the FairTax is a tax that every American can easily understand. It eliminates the enormous complexity that is inherent in our current tax

system while providing a stable and efficient means to raise the necessary revenues

to fund federal programs. And most importantly, because it is so understandable,

H.R. 2525 will help restore integrity to our country’s tax system.

I urge this committee not only to review the FairTax and other proposals that will

be discussed during these hearings, but also to act to change forever a system that

is overly burdensome, impossibly complex and inherently unfair. In short, our current system does not work for the average taxpayer. Mr. Chairman, the hearings

this week are critical if we as policy makers are serious about restoring confidence

in the federal tax system. I welcome this debate of the various proposals to reform

our present system, and I thank you for holding these hearings.

Thank you for the opportunity to contribute to these hearings on replacing the

Statement of Jospeh M. Kahn, Stanford University, Palo Alto, CA

f income tax. I am providing this statement on behalf of the Stanford University Decisions and Ethics Center. From 1996 to 1997, I had the privilege of coordinating a

team of economic researchers within the Decisions and Ethics Center analyzing the

impact on households of a change from the current income tax regime to the National Retail Sales Tax (NRST) proposed by the group Americans for Fair Taxation.

This proposal is now embodied in H.R. 2525.

Herein, I present the main findings of our study. The study was based on the

1996 income tax code, and assumed that the tax regime change would take place

in 1998. Though the income tax code continues to change each year and the proposed date of changeover to the NRST remains in the future, I would not expect

any major changes in the study’s general conclusions.

1. Summary of Main Findings

The Decisions and Ethics Center at Stanford University investigated the impact

on households of a change from the current tax regime to the national retail sales

tax (NRST) proposed by Americans for Fair Taxation. Under this proposal, all federal income and payroll taxes would be repealed, federal revenues would be replaced

by the NRST at a (tax-inclusive) rate of 23%, and all families would be granted a

rebate for the amount of taxes paid at the federal poverty line. Our study focused

on individual families over their remaining lifetimes rather than statistical aggregates in a single year. Our analysis yielded several major conclusions regarding the

impact on families of a change to the NRST tax regime.

The current tax code is complex and there is probably no change which can guarantee that everyone would be better off. However, we find that most families would

enjoy higher real lifetime consumption under the NRST than under the current regime. This is due to several factors, including lower tax burdens on many households, lower compliance costs, lower marginal tax rates, and increased economic

growth and efficiency.

Some wealthier seniors may experience a reduction in purchasing power under

the NRST. However, their own financial well-being may not be the only issue they

consider in their decision to support a particular tax regime. Other factors, such as

the effect on their grandchildren or on the poor, may take precedence in their decision.

This statement highlights the following points:

• Incentives to work and to save tend to be higher under the new regime—over

20% higher for many households. This is primarily due to the replacement of high

marginal income tax rates with a flat rate on consumption.

• Middle-class families tend to be financially better off under the change. A combination of factors including lower compliance costs, lower marginal tax rates, and

increased economic growth and efficiency contribute to improve their prospects.

• Existing homeowners tend to benefit under the change, despite the removal of

the mortgage interest deduction. This is because existing owner-occupied homes

would increase in value, while existing mortgages would become more affordable.

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• Low-income families tend to be significantly better off financially under the

change. They would effectively pay none of the national sales tax under the change

because they would receive rebates which cover the amount of taxes paid at poverty

level. In addition, any federal benefits they receive would be indexed to match possible increases in after-tax consumer prices.

• Younger households tend to be financially better off after the change, benefiting

from improved economic conditions over their entire careers.

• Middle-and lower-income seniors tend to do better financially under the change.

Social security payments would be indexed to a tax-inclusive price index, holding

recipients harmless against any changes in after-tax prices. Additionally, the NRST

rebate would more than make up for any losses in after-tax purchasing power of

pension benefits for these seniors.

• Some wealthier seniors would tend not to benefit from the redistribution of the

tax burden. This is because wealthier seniors have a larger portion of financial assets whose after-tax purchasing power may decline under the new regime. However,

for many seniors the removal of income taxes from asset earnings and retirement

account disbursements, the exclusion of their existing homes from the NRST, and

the repeal of the estate tax would more than make up for any initial loss in asset

values.

• Considered over a lifetime, the progressivity of the NRST would be similar to

that of the current income tax regime. The progressivity of the NRST would be

achieved through use of a rebate and replacement of regressive payroll taxes.

2. Study Methodology

Our goal was to translate the economic effects of a change in the tax regime into

understandable impacts on individual households. Traditional methodologies, which

examine statistical averages for a single year and aggregate very different households, lack vital data and often do not reveal important and key information.

In our analysis, we focus on specific households, considering the impact of the actual tax code. Further, we examined households over their entire remaining lifetime

rather than focusing on a single year. Examining a variety of family profiles, we

develop critical insights into the effects of a change in the tax regime. We then varied individual household characteristics and economic assumptions to ensure that

our conclusions are robust.

Taxes affect the household either directly, or indirectly through the economy (see

Figure 1 below). Direct taxation on the household includes individual income taxes

(including the earned income tax credit), property taxes, and the employee portion

of payroll taxes.

Indirect taxes are collected from businesses (including corporate income taxes, the

employer portion of the payroll tax, sales and service taxes, excise taxes, and corporate property taxes). Businesses serve as intermediaries between workers, investors, and consumers. So all indirect taxes and other costs on business are ultimately

paid by households: through reduced wages and benefits, lower investment returns,

and higher prices. Economists cannot agree about how the indirect tax burden is

allocated among these three economic activities. However, it is certain that all indirect taxes and other costs are ultimately paid by households.

Figure 1. All Taxes Fall on Households

In addition to the visible tax revenues collected by government, there are several

effects of taxation which are hidden, or less visible. These include seigniorage (the

inflation tax), compliance burden of the tax code, economic distortions, and slower

economic growth.

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1 A tax-inclusive rate is used for easier comparison with the current income tax rates, which

are for gross (tax-inclusive) income. A 23% tax rate on gross sales corresponds to a 30% tax

rate on net sales. The middle federal income tax bracket in 1996 was 31% of gross income, corresponding to a 45% tax rate on net income. 2 In figure 2, the solid line represents Cleavers who have chosen never to purchase a home.

Only Cleavers with combined average career income above about $40,000 per year are considered homeowners in this graph.

Our method accounted for the combination of direct, indirect, and hidden taxation

in an integrated framework. Differences in direct taxes were computed by applying

the tax code to a household’s financial situation, directly affecting the funds available for investment and consumption. Changes in indirect and hidden taxes were

distributed to household economic activities of work, investment, and consumption.

The taxes’ magnitude and incidence result in changes to the after-tax market prices,

wages and investment returns available to the household.

Resulting changes in the household’s annual finances lead to different levels of

real consumption and investment, which carry through to affect the household’s finances over its remaining lifetime. These changes are then integrated to produce

a summary measure of the effect on a household’s remaining real lifetime consumption.

3. Economic Assumptions

We compared the effects on real lifetime consumption of replacing the 1996 Federal Income Tax code with the National Retail Sales Tax proposed by Americans for

Fair Taxation (AFT). Throughout, we attempt to match AFT’s proposed tax rate of

23% (tax-inclusive) 1 on all final goods and services, to exclude from taxation any

resale of existing consumer-owned housing, and to include a rebate to all families

based on federal poverty levels for a given family size. We have also followed AFT’s

proposal that Social Security is indexed to a consumer price index which includes

the NRST.2

We should note that we analyzed only law-abiding households, those attempting

to comply with the actual tax code. Our conclusions would not remain valid for

households engaged in criminal enterprises, or otherwise able to evade their current

income taxes.

Our base case economic assumptions include a 3% inflation rate under the status

quo (with nominal tax brackets indexed for inflation), incidence of direct taxes entirely on the household, employer payroll taxes incident on workers, corporate income taxes incident on investors, an NRST distributed two-thirds to consumers and

one-third to factors of production (divided between workers and investors by their

value share in the economy), a 2% increase in economic efficiency (real purchasing

power) from lower compliance costs (i.e., significantly less resources used to deal

with filing complex income tax forms), a 1% increase in economic efficiency from

other economic effects such as lower marginal tax rates, and a minor 0.05% increase

in real wage growth under the NRST due to effects such as increased investment.

We tested variations in these base case assumptions to ensure the robustness of

our results. We found that perhaps the most significant change in the level of improvement for many families is if the replacement tax rate is changed. Replacing

the current income tax with a consumption tax, one might expect at least the modest macro-economic improvements mentioned above at any revenue-neutral tax rate.

However, at the time of this analysis there was some uncertainty as to the rate.

A lower or higher tax rate would obviously lead to either a better or a more modest

improvement (respectively) in most families’ real life-time consumption than is calculated at 23%. For low-income families, any differences from the base case results

tend to be small, as a proportionately-changed rebate makes up for any change in

the NRST tax over the bulk of their expenditures. Differences would be more

marked for middle and higher-income families, though the shape of graphs and general conclusions that we present would remain valid over a range of possible rates.

4. Effects on Typical Households

We began our study with an analysis of the finances of a typical middle-class family—the ‘‘Cleavers.’’ The Cleavers are a married couple, aged 40. They own their

home and are struggling to meet their mortgage payments while raising their two

children (ages 10 and 11). Both parents are employed outside of the home. Some

key financial information about the Cleavers is shown in Table 1 (below).

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Table 1

The Cleavers’ 1998 Household Financial Snapshot (in 1996 dollars)

Budget Item Amount

Household Gross Wages $46,439

Taxable Investment Earnings $615

Visible Income, Employee Payroll, and Property Tax Burden($10,686)

Mortgage Payments ($8,385)

Charitable Contributions ($471)

Other Household Consumption (excluding

Value of Employer-Provided Health Care Plan)

($24,453)

Remaining Income for Savings $3,060

Value of Employer-Provided Health Care Plan $4,800

Employer Contribution to Tax-Deferred Retirement Savings Plan$929

In Figure 2 (below), we find that families with the Cleavers’ household profile

would be financially better off under the NRST regime. Even over a wide range of

incomes from poverty level, about $16,000 per year for the Cleavers’ family of four,

to the higher income levels families with this profile would be better off than under

the current income tax regime.

A combination of factors including lower tax burdens, lower compliance costs,

lower marginal tax rates, and increased economic growth and efficiency would allow

middle-class families like the Cleavers to enjoy higher real lifetime consumption

under the NRST than under the federal income tax.

Effect on Homeowners

One issue of concern to many middle-class households is the effect of the change

on the value of their homes. Because the sales tax would apply only to new homes,

the market value of owner-occupied homes would increase under the new tax regime

(to the point where newly constructed homes would not be disadvantaged from the

viewpoint of prospective home buyers). Also, homeowners with fixed-rate mortgages

would find it easier to make their mortgage payments under the NRST regime. This

is because if enough of the NRST falls on consumers, after-tax consumer prices

would rise to some extent. So mortgages could be paid off with less valuable dollars.

Figure 2. Lifetime Improvement under NRST for the Cleavers*

It is also possible that mortgage interest rates would decline, which would further

benefit existing and prospective homeowners (though this effect is not included in

our base case analysis). Since many middle-aged families already own their homes

and tend to have substantial outstanding fixed-rate mortgages, they would be relatively better off under the NRST regime. Figure 2 (above) illustrates the relative

improvement of current homeowners.

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Variations with Income

Low-income Households

A critical factor in examining low-income households is the status and amount of

government subsidies (including transfer payments) that they receive. These include

Supplemental Security Income and food stamps.

The working poor not receiving government subsidies tend to be better off under

the NRST regime. This enhancement of their financial condition is due to the rebate

system, which effectively exempts the working poor from paying any of the NRST.

The repeal of the payroll tax allows this group to take home their entire paycheck

and avoid the substantial payroll taxes (less earned income tax credit) that they face

under the current federal tax system. They are also relieved of the indirect effects

of replaced corporate income and payroll taxes that currently decrease their wages

and increase the prices they pay as consumers. Figure 3 (below) illustrates the improvement that would be experienced by low-income families with other characteristics similar to those of the Cleavers.

Figure 3. Lifetime Improvement under NRST for Low-Income Cleavers

Currently, most government transfer payments (such as food stamps, Supplementary Security Income, and Medicaid) are indexed for inflation. It is possible that

these transfer payments would be indexed to an after-tax consumer price indicator

(CPI) that includes the NRST. If so, families would receive both indexed transfer

payments and the NRST rebate.

Figure 4 (below) illustrates the improvement under the NRST for the ‘‘Lowes,’’ a

low-income family with four children. The Lowe household receives enough government subsidies each year to bring them to 100% of poverty line consumption (about

$22,000 annually for the Lowe family of six). A combination of rebate and full indexing of benefits would lead to substantial financial improvement for low-income families like the Lowes. In effect, indexing benefits to a CPI that includes the NRST

would over-compensate for the change, as the rebate alone already reimburses the

entire tax. Even if their subsidies were indexed to a CPI that only partially or not

at all included the national retail sales tax, the rebate effectively exempts these

families from the NRST, ensuring that they would still be roughly even or financially better off. Under welfare reform that occurred after this study took place, we

expect that those families with household gross wages averaging in the lowest range

of figure 4 over their entire remaining careers would be unusual cases.

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Figure 4. Lifetime Improvement under NRST for a Low-Income Family

Receiving Government Subsidies

High-Income Households

Working households with higher incomes would no longer be subject to progressively higher marginal income tax rates, and tend to improve under the NRST regime. The top end of the Cleavers’ graph in Figure 2 illustrates their improvement.

6. Variations with Age

We found that age is an important factor in determining the effect of the NRST

on households.

Young Households

Younger households, as illustrated by the ‘‘Juniors,’’ tend to be financially better

off after the change. The Juniors are a married couple, aged 25. They both work,

and hope to buy a home and start a family someday. They are just now beginning

their careers, and would experience most of their working lives under the new regime.

A combination of factors including lower compliance costs, lower marginal tax

rates, and increased economic growth and efficiency would allow younger families

like the Juniors to enjoy higher real lifetime consumption under the NRST than

under the federal income and payroll tax regime. Figure 5 (below) illustrates the

improvement in lifetime consumption for the Juniors over a wide range of income

levels.

Figure 5. Lifetime Improvement under NRST for a Young Family

Elderly Households

The ‘‘Seniors’’ represent a typical retired couple. We find that the impact of the

NRST depends critically on the amount and composition of their savings. Because

the sales tax applies only to new homes, the value of the elderly’s home equity tends

to increase under the new tax regime. Also, portfolios with a higher proportion of

their wealth in tax-deferred status (such as in IRAs and ‘‘401(k)’’ plans) and in unrealized capital gains would do relatively better under the NRST, since these holdings

would no longer be subject to federal income tax.

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Some wealthier seniors would tend not to benefit from the redistribution of the

tax burden. This is because wealthier seniors have a larger portion of financial assets whose after-tax purchasing power may decline under the new regime.

However, for many seniors the removal of income taxes on asset earnings and retirement account disbursements, and the exclusion of their existing homes from the

NRST, along with the repeal of the estate tax more than make up for any initial

loss in asset values. Most elderly couples with moderate or limited financial resources would be significantly better off under the NRST (see figure 6). The rebate

in place would already cover all taxes on essentials (including some formerly hidden-taxes built-in to today’s prices). Provisions to fully index Social Security for any

increase in after-tax consumer prices would then more than compensate for any loss

on these families’ modest savings. And for those households with estates over

$1,200,000, the removal of estate taxes could more than make up for any loss of the

estate’s purchasing power.

Figure 6 shows these effects on the Seniors for a wide range of net worth (including home equity and private pension funds). As a point of reference for this figure,

the median family net worth for a household whose head was between 65 and 74

years of age in 1992 was listed as $103,600 (Federal Reserve Bulletin , October

1994). This suggests that the majority of seniors are described in the lower range

of wealth in figure 6, and would experience considerable improvement under the

NRST.

Figure 6. Lifetime Effect of NRST for the Seniors under a Range of

Financial Profiles at Retirement

While some wealthier Seniors may experience a reduction in purchasing power,

their own financial well-being might not be the only issue they consider in their decision to support a particular tax regime. Factors such as the effect on their grandchildren or on the poor may take precedence in their decision.

7. Effects on Marginal Tax Rates

Under the NRST regime, marginal tax rates on work and savings would be substantially lower for many households, increasing their incentives to work and save.

This is primarily due to the replacement of high marginal income tax rates with

a low flat rate on consumption.

We measured the incentives to work, computing the additional (after-tax) real

goods and services that a household could consume by working additional hours. For

example, suppose that the Cleavers are contemplating working an extra hour a year

for each year over the course of their remaining careers. And suppose that after all

taxes under the existing tax regime, they could purchase a total of 4 pairs of shoes

with their additional pay. If, under the NRST, they could instead purchase 5 pairs

of shoes for that same extra work, then their marginal incentives will have increased by 25%.

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Figure 7 (below) shows that although the marginal incentives may decrease for

some low-income households, a broad range of households experience significantly

increased incentives. Incentives to work rise by over 20% for many families, depending on their earnings. On an economy-wide level, these improved incentives would

lead to higher economic growth and efficiency.

Figure 7. Effect on Cleavers’ Marginal Incentives to Work

8. Regressivity Analysis

There is a common perception that consumption taxes are regressive, which would

be supported in a myopic single-year analysis of the tax system.

The argument is that:

In a given year wealthy people save a higher fraction of their income than poor

people, so the wealthy would pay a lower fraction of their income in consumption

taxes.

However, a lifetime analysis reveals that most or all of the saved income of a

household is eventually consumed in retirement or by the heirs, at which time it

is subject to the consumption tax. So over a lifetime, a consumption tax—without

a rebate—is roughly flat across income categories.

Under the NRST, a consumption tax is combined with a rebate which refunds all

taxes up to poverty-level consumption. This clearly makes the NRST a progressive

tax.

9. Conclusions

Because the combination of the current tax code and government subsidies is extremely complex, there is probably no change that can guarantee everyone to be better off. But under the National Retail Sales Tax proposed by Americans for Fair

Taxation, several factors would allow most families to enjoy higher real lifetime consumption than under the current federal income and payroll tax regime.

These factors include:

• a rebate which would keep the amount of taxes paid by most households similar

to or lower than the current income tax regime, and would effectively exempt lowincome households from the NRST,

• indexing of Social Security, which would effectively hold recipients harmless

against possible after-tax price increases,

• lower compliance costs,

• lower marginal tax rates, and

• increased economic growth and efficiency

Some wealthier seniors would tend not to benefit from the redistribution of the

tax burden. However, their own financial well-being might not be the only issue that

wealthier seniors consider in their decision to support a particular tax regime. Other

factors, such as the effect on their grandchildren or on the poor, may take precedence in their decision.

I would like to again thank the committee for the opportunity to contribute this

testimony. Additionally, I should like to recognize a number of individuals that were

helpful in this effort. This research has benefited from discussions with William W.

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Beach, Dale W. Jorgenson, James M. Poterba, and Gary Robbins. David R. Burton

and Laura D. Dale have contributed a number of questions and valuable discussions. I am grateful for the dedicated assistance of Roberto Szechtman and Ellynne

T. Dec, along with Decisions and Ethics Center research assistants J. Eric Bickel,

William F. Carone, Alexis G. Collomb, Jeffrey D. Cornwell, George K. Ferguson,

Kenneth B. Malpass, and Marcia F. Tsugawa. Our lifetime model and methodology

are an extension of work by Stephen M. Malinak, Frederick V. Giarrusso, and Jeffrey K. Belkora, along with suggested improvements from Paul B. Skov, James M.

Knappenberger, Derek D. Ayers, and Michael M. Reeds. Special thanks to Elizabeth

C. Brierly for editing large portions of this report. Research guidance was provided

by Frederick V. Giarrusso and Center Director Ronald A. Howard. The Decisions

and Ethics Center gratefully acknowledges help from those volunteers, and a gift

from the National Tax Research Committee that enabled this research effort.

Sincerely,

f Joseph M. Kahn

Statement of Bert Loftman, M.D., Atlanta, GA

Mr. Chairman and Members of the Ways and Means Committee:

My name is Bert Loftman, and I am a physician based in Atlanta, Georgia. I

greatly appreciate the opportunity to present testimony regarding the impact of

the FairTax on the US health care delivery system. I am privileged to be the only

witness testifying on this subject. I can assure you that I speak for a great many

physicians with whom I have discussed the FairTax. I am hopeful that, at some

point, there will be formal resolution by the physician groups. Attached to this written testimony is a paper of mine from 1994 titled, ‘‘Health Care Reform, An Historic

Perspective.’’ This will supplement what I say here.

During the past few years, Congress has wrestled with the many problems inherent with our current health care system, and for good reason. The costs of health

care delivery have escalated exponentially. While it is often argued we have the best

heath care in the world, we have a selective system. Too many Americans are without health care.

What are the root causes of this and how do you, as policymakers, address these

causes? I suggest that one of the key causes is our tax system that separates the

health care recipient from the real costs of health care. In doing so, we hold health

care up as one of the few major U.S. industries that is not responsible to consumers.

To turn a phrase, our health care system is in the intensive care unit.

What are the problems? To begin with, this system has driven up the costs of

health care. In 1965,health care was 5 percent of the U.S. economy. Now it has risen

to over 15 percent. There are rising numbers of uninsured. These number about 40

million or 15 percent of the population. For them, individual health insurance is

very expensive. They must compete with the third party payer systems of employerbased health insurance and Medicare. In the private and governmental sectors,

most people have employer-based-insurance. They face the portability problem,

where they must change insurance plans when they change jobs. They also face the

job lock problem where they remain in unsatisfactory jobs because of the health insurance coverage in their current jobs.

A few years ago, the third-party payers paid the providers of health care with traditional fee for service or indemnity insurance. Now they pay with a system known

as managed care. With this system, the insurance companies make what they consider the appropriate health care choices. The problem is that many patients would

rather choose the quality of their own health care and this dissatisfaction has led

to political unrest. Many health care reform discussions center about moving away

from employer-paid health care.

One way is a single payer system; but those countries with socialized medicine

are experiencing many difficulties. To date, this has not been a popular solution in

the US. Another way is to use the income tax codes to offset the employer-based

health care exclusion that began during World War II. I refer you to a paper that

I wrote a few years back on the history of how this occurred. These tax code changes

include tax equity where the income tax exclusion of employer-paid health care are

removed or individually paid health care receives the same treatment. Another innovative way is medical savings accounts that Congress legislated with the KennedyKassebaum Bill. These have not proved as popular as the proponents predicted. A

major reason was the many restrictions that were placed upon them.

Enter the FairTax into this debate. It is true that The Fair Tax would greatly

impact the U.S. health care system. However, first we should consider what it would

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not do. The Fair Tax is designed to be revenue neutral and would make no changes

in Medicare or Medicaid. It would leave intact the federal safety net for the elderly

and the indigent. Most importantly, I believe, The Fair Tax would remove the income tax exclusion that employer-based health care now enjoys. This would not require employers to drop their benefit of health care coverage. However, the incentive

for health care coverage would no longer be exclusively employer-based.

What would the FairTax do? More people would likely begin to choose individually-based health care coverage. They would probably choose non-cancelable policies. This would help bring down the numbers of uninsured as people retained their

individually owned health insurance policies, even when they were sick. As people

chose individually owned health insurance, the insurance industry would begin to

respond with more individually based insurance policies. People would likely begin

to look more favorably at low cost non-managed care insurance policies. In other

words, they would begin to favor catastrophic insurance policies.

Of course, there is tax-free savings for health care and other wants. When people

have savings, they can begin to see the advantages of low cost catastrophic coverage.

This would begin to connect people to the cost of their own health care and this

would begin to bring the cost of health care down. Thus the Fair Tax would not only

move us away from employer-based healthcare with its portability and job-lock problems; the Fair Tax would likely also lower the cost of health care and bring down

the number of uninsured. Regarding managed care, individuals would own their

own policies and have a choice of whether they had prepaid managed care or catastrophic indemnity insurance coverage.

Congress also wrestles with Medicare and its problem of escalating costs.When

Congress legislates to control these costs, it fosters patient and physician unrest.

This is because when Medicare makes the choices, it is a form of rationing. Consider

that in 1965 when Congress enacted Medicare, many people retired without health

care coverage because most was employer-based. They also retired without adequate

savings because the income tax is anti-savings. Under the FairTax, people would

begin to retire with individually owned catastrophic health care coverage. Perhaps

with the Fair Tax, many people would choose not to change their health care coverage when they retire.

The Fair Tax would not solve all the problems of the U.S. healthcare delivery system, and I don’t want to leave this impression. Many people would still choose not

to obtain health care coverage. However, we must compare the FairTax to the

present system and not to an ideal. We must only ask if it helps us get to the idea.

In reality, there would likely be less uninsured than the current 40 million people

without coverage. Many people would probably still prefer a corporate health care

system that manages their care. If so, the Fair Tax does not discourage this.

The FairTax would likely effect the US health care delivery system in a way that

would lower costs, decrease the numbers of uninsured, help alleviate the portability

problems, give patients choice and defuse the politics of our health care system.

I would make a suggestion regarding professional or trade organization as the

American Hospital Association, the American Medical Association, the American

Nurses Association, the American Pharmaceutical Organization, etc. These organizations heavily lobby Congress but they have been silent on the impact of taxation

on the health care delivery system. Congress should ask them to study this issue

and poll their members so they can take a stand on tax reform as health care reform.

A physician’s first duty is to do no harm. I believe it is the job of Congress to

do the same. Our current US health care system of employer-based health care does

great harm. I hope that when you ponder HR 2525 with its Fair Tax and repeal

of the 16th Amendment that you consider its favorable impact on the health care

delivery system.

are my own and do not necessarily reflect those of The Heritage Foundation.

Attachment is being retained in the Committee files.

I wish to thank the committee for the opportunity to testify. The views I express

Statement of Daniel J. Mitchell, Heritage Foundation

f Mr. Chairman and members of the committee, the current tax code of the United

States is irreversibly broke and should be repealed. The tax laws undermine the

country’s prosperity by imposing needlessly harsh venalities on work, savings, and

investment. Many taxpayers face confiscatory tax rates and often are forced to pay

more than one layer of tax on their income, while the politically well-connected can

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take advantage of special deductions, credits, preferences, shelters, and loopholes to

minimize their own tax liability. The result of this double standard is a tax system

that not only penalizes productive behavior, but also violates the fundamental constitutional principle of equal treatment under the law.

For both moral and economic reasons, the current code should be replaced by a

single-rate, consumption-based tax. The good news is that there are two major plans

that meet these criteria: the flat tax and the national retail sales tax. Replacing the

current system with either—but not both—of these two taxes immediately would restore the principle of fairness to the tax system because both would treat all taxpayers equally. Both the flat tax and a national sales tax would replace today’s discriminatory tax structure with a single low rate. In addition, either plan would

eliminate the current tax code’s bias against savings and investment and promote

the kind of capital formation that America needs to boost workers’ incomes and ensure long-term economic growth. In addition, because both tax reform proposals

would be simple to administer, the ultimate result would be a dramatic downsizing

of the Internal Revenue Service (IRS) bureaucracy and billions of dollars in compliance costs saved each year.

How is it that these different types of taxes could produce such similar results?

The answer lies in the fact that the flat taxed and sales tax are almost identical

in purpose and principle. Both rest on the fundamentally should principle that all

income should be taxes at one low rate and only one time (what is known as a ‘‘con- sumption base’’), and that the tax should be collected in the last intrusive way possible. The only significant difference between the two is the collection point. A flat

tax is collected up front, imposing a single layer of tax on income when it is earned,

and a sales tax imposes one layer of tax when the income is spent. In both cases,

income is taxes, but only once and presumably at a very low rate.

WHAT DO THE FLAT TAX AND A NATIONAL SALES TAX HAVE IN COMMON?

Most taxpayers assume that the flat tax and a national sales tax are radically

different ways to fund the federal government. Because one tax is collected from the

paycheck and the other is collected at the cash register, this assumption is understandable. Yet by almost every standard, the flat tax and a national retail sales tax

represent two sides of the same coin. The common features of the flat tax and national sales tax are: • A single flat rate. Under both plans, income is taxed at one low rate. This

would ensure that the government treated taxpayers equally and would address the

problem of high marginal tax rates. The single low rate would promote faster economic growth by minimizing tax penalities on work, risk-taking, and entrepreneurship. • Adoption of the flat tax or a national sales tax also would end the discriminatory treatment caused by a tax code that grants preferences or imposes penalties on certain behaviors and activities. Either reform would

change the code so that all taxpayers—and all income—are treated the

same under the law.

WHY THE FLAT TAX IS A CONSUMPTION TAX

• To many Americans, consumption taxes are those collected as the cash

register—such as the state sales tax—or value-added taxes like those they

might encounter on a trip to Europe. The national Retail Sales Tax, needless to say, is an example of a consumption-based tax. Yet it also is possible

to collect a consumption tax through an income tax structure. This s why

economists and public finance experts consider the flat tax a consumption

tax. Why? Because, unlike the current tax code, a flat tax does not impose

greater penalities on income that is saved and invested that on income that

is consumed. A tax code that does not discriminate against savings and investment is considered a consumption-based tax system, regardless of

whether taxes are collected at the paycheck or at the cash register. In this

respect, the flat tax is a version of a consumption tax.

WHY DOUBLE TAXATION IS DETRIMENTAL

To understand double taxation, consider a taxpayer who has 410 of disposable

after-tax income. That taxpayer has a choice; either to spend the income immediately or to defer consumption by investing it. Consuming the money immediately

yields $100 of benefit immediately, but investing it would yield a return that could

allow the taxpayer to consumer, say, $115 a year from now. The decision to invest

obviously varies according to individual preferences about the value of consumption

today compared with consumption in the future, but let us assume a taxpayer would

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be willing to give up $100 of consumption today in exchange for $100 of consumption one year later. In this example, of course, the taxpayer will choose to invest.

In addition to making the taxpayer better off in the future, this decision also has

a desirable impact on the economy by increasing capital.

Today’s system of multiple taxation, however, undermines capital formation. If the government decides to tax the return earned on the $100 investment, the hypothetical taxpayer in the above example may wind up sacrificing $100 of consumption

today to gain only $105 in after-tax consumption one year from now. Fewer individuals under this scenario would choose to invest, opting instead for immediate consumption and thereby depriving the economy of their capital. In addition, under today’s system, taxpayers can look forward to paying two additional layers of tax on this $100 investment; capital gains and death taxes. Double taxation, therefore, significantly undermines savings,investment, and future economic growth, and—because every economic theory, even Marxism, acknowledges that capital formation is

the key to faster growth and higher wages—is particularly self-destructive.

WHAT ARE THE BENEFITS OF A SINGLE-RATE TAX SYSTEM?

• Fairness. The tax code is riddled with discrimination. They are right. The government either imposes tax penalities or grants tax preferences depending on the

source, use, or level of income. All of these special provisions violate the principle

that all citizens should be treated equally by the law. The flat tax and a sales tax

would restore fairness in the system by ensuring that all taxpayers, all income, and

all products are treated the same. • Economic growth. Both the flat tax and a sales tax would minimize the tax

rate imposed on productive behavior and eliminate the myriad forms of double taxation in the current code. Consequently, either one would boost the economy’s potential growth rate and cause permanent increases in economic output. How much the

economy would benefit is not easy to predict, but many economists project that,

within 10 years, the economy would be 5 percent to 10 percent larger than it would

be under the current tax structure. • Higher incomes. A low tax rate increases the incentives to work and the desire to work longer hours. Tax reform also makes workers more productive because

companies would be more willing to invest in upgrading their production capabilities,giving their employees better machinery, tools, equipment,and technology. As

the attached chart illustrates, this capital-drive increase in productivity is tied closely to higher wages. • Job creation. Tax reform also will make employees more valuable to business,

thereby increasing wages for those already working and stimulating the creation of

new jobs. The combination of lower taxes and faster growth will make it more profitable to hire certain workers particularly those with low skill levels who previously

may have been considered unemployable. • Increased wealth. The value of income-producing assets (everything from

stocks and bonds to office buildings and pet stores) is determined by market expectations of future income discounted by inflation, risk, and taxes. Once a lower tax

rate rate is put in place, whether through the flat tax or a national sales tax, and

double taxation is eliminated, income-producing assets will become more valuable

(that is, there will be an increase in the present value of the future after-tax income

stream generated by those assets).

• Savings and investment. Tax reform to eliminate these penalties on capital

formation would increase the incentives to save and invest. Moreover, a flat tax or

sales tax would make the United States a magnet for capital from around the world.

• Lower interest rates. Tax reform will reduce interest rates between 25 percent and 35 percent, according to a study published by the Kansas City Federal Reserve Bank.

• Lower compliance costs. Because both the flat tax and a national sales tax

would eliminate the bewildering complexity of the current system, tax reform would

slash the $157 billion annual costs of complying with personal and corporate income

taxes.

• Smaller IRS, more civil liberties. The current tax code gives the IRS sweeping, virtually unlimited power to monitor people’s lives, track their assets, and review their expenditures. Although neither the flat tax nor a national sales tax can

be expected to rid the United States of the IRS or eliminate every possible conflict

with the government, the dramatic simplification that either reform would bring

about would significantly reduce the size, scope, and power of the IRS bureaucracy.

• Less political corruption. The tax code today is the result of 97 years of special deals, loopholes, and preferences. Each one of these loopholes benefits a special

inters. The flat tax or a national sales tax would remove from the tax system the

corrupting process of exchanging loopholes for political support.

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• No social engineering. One of the most attractive features of both the flat tax

and a national sales tax is that politicians no longer would be able to use the tax

code for purposes of social engineering. The flat tax would eliminate all the biases

and preferences in the income tax, and a sales tax is designed so that all products

and services would be taxes at exactly the same rate.

RESPONDING TO THE CRITICS OF TAX REFORM

• Criticism: Implementing a national sales tax would create the risk that the

United States might end up like Europe, with both income and consumption taxes.

• Response: Advocates of a national sales tax properly vow that complete and

irreversible elimination of the income tax must occur before such a plan can be enacted. The only certain way to prevent future politicians from pulling a bait-andswitch on a trusting public, however, would be to amend the Constitution by repealing the 16th Amendment, which gives Congress the power to impose an income tax,

and expressly forbidding direct taxes or income. This presumably would mean the

abolition of Social Security and Medicare payroll taxes as well.

• Criticism: Neither the flat tax nor the sales tax will capture the entire underground economy.

• Response: This is true but meaningless. A drug dealer is not going to report

his income under the flat tax and certainly will not collect taxes on the ‘‘products’’

he sells under a national sales tax system. But the current system does not capture

this money either, so this argument hardly serves as a reason to reject ax reform.

At the very least, the flat tax and a national sales tax would reduce the level of

tax evasion by people who are trying to protect their income from unfair and excessive taxation today.

CONCLUSION

The current U.S. tax system is an unmitigated nature. On both economic and

moral grounds, the tax code should be repealed and replaced with a system that

treats all taxpayers—and all income—fairly and equally. Both the flat tax and a national sales tax satisfy this standard, and both would improve the economy’s performance substantially.

Because plans for the flat tax and a national retail sales tax are so similar, lawmakers have no reason to champion one at the expense of the other. Advocates of

tax reform would seek instead to highlight the benefits and similarities of the two

plans, and, when the opportunity arises, rally behind the one that has garnered

more political and popular support.

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Statement of National Federation of Independent Business

fINTRODUCTION

The irony of tax reform is that even as it proponents have grown more insistent,

the tax code itself has simply grown. It’s larger and more complex today than when

Hall and Rabushka first offered their ideas to the world. So while others may argue

the relative merits of a flat income tax verses a national sales tax, NFIB has focused its attention at the real problem for America’s small business owners—the

current IRS Code.

The fact is, the current income tax code is far too complex. The tax code is a quagmire of confusion that forces taxpayers to bear tremendous costs just to comply with

it—about $200 billion annually, or $700 for every man, woman, and child in America. Consider this: There are 7 million words in income tax laws and regulations.

There are 703 tax forms. There are 101,295 pages of IRS laws and regulations. The

IRS sends out about 8 billion pages of forms and instructions each year, the equivalent of paper made from 293,760 trees, according to a 1995 study. The amount of

paperwork the IRS receives each year would circle the Earth 28 times. One billion

1099 forms are mailed each year tracking interest and dividend income. The private

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sector pays $250 billion just to comply with income tax laws. The average cost of

compliance for small-and medium-sized corporations is $7,240 for every $1,000 in

taxes they pay. Nearly 60 percent of all taxpayers seek assistance to file their tax

returns each year, more time than it takes to build every car, truck, and van produced in the United States. When Money magazine asked 46 professional tax preparers to calculate a hypothetical family’s tax return in 1997, they responded with

46 different answers. As Albert Einstein once said, ‘‘the hardest thing in the world

to understand is the income tax.’’ The fact remains that real tax reform will not occur at the same time the tax code

is expanded and complicated even further. We need to abolish the current code first

and then replace it with a code that offers lower taxes, encourages work and savings, is fair to all taxpayers, foregoes social engineering, contains no hidden taxes,

and is difficult to change.

SMALL BUSINESS AND THE TAX CODE

So why are small businesses leading the charge to scrap the IRS Code? The answer is simple. Small businesses—more than any other segment of our economy—

are the favorite target of the IRS Code and the IRS. When tax reformers raise the

issue of tax code complexity, they are talking about the burden placed on America’s

small businesses.

Most taxpayers don’t even itemize. They receive their W–2 form, take the standard deduction, and send in their 1040EZ. But all small business owners find themselves buried under the most complex areas of the tax code. An while big corporations have the luxury of accounting offices and high priced tax professionals, many

small business owners still file their our returns. Any way you slice it, it’s America’s

small businesses that shoulder the brunt of tax code complexity.

Tax Code Complexity and Small Business

Small businesses historically pay about one-tenth the income taxes collected by

the federal government. That was about $60 billion in 1994. But the burden of the

tax code on small businesses is much higher.

THe Center for the Study of American Business reported small firms with fewer

than 20 employees spent more than $5,000 per employee in 1992 to comply with

federal regulations. Paperwork costs alone—mainly comprised of tax-related paperwork—cost these small firms more then $2,000 per employee, or twice as much as

the paperwork costs imposed on firms with 500 or more employees.

Why are small businesses disproportionately affected? One reason is that the most

complex parts of the tax code are targeted directly at small business owners. Take,

for instance, this example:

The individual Alternative Minimum Tax is a remarkably complex and obtuse

provision in a tax code not known for its clarity. It literally requires taxpayers to

calculate their taxes twice, and then pay the larger amount. Compared to the regular income tax, the MAT imposes lower marginal tax rates on a broader income

base. It’s sort of a perverse ‘‘Flat Tax.’’

Who did Congress have in mind when it created the AMT? American’s small business. Of the AMT’s 27 different adjustments and so-called tax preference items—

deductions disallowed or reduced—16 are business related. Keep in mind, we’re

talking about the individual Alternative Minimum Tax. (Corporations have their

own ATM.)

How complex is the AMT? Line 8 says, ‘‘Enter the difference between regular tax

and AMT depreciation.’’ That means small business owners have to recalculate the

value of their depreciation allowances using either ‘‘the straight line method over

40 years with the same mid-month convention used for the regular tax’’ or the

‘‘straight line method over the property’s class life with the same convention used

for the regular tax’’ or the ‘‘150 percent declining balance method, switching to the

straight line method for the first year it gives a larger tax deduction, over the property’s class life.’’ All depending on the type of property involved, of course. And they

have to do this calculation for every depreciable asset they own!

Understand? Neither do small business owners. There are 26 other adjustments

necessary to calculate AMT taxable income.

Worse yet, the AMT has the side effect of hitting taxpayers when they can least

afford the bill. A business suffering from lower-than-expected revenues is more likely to fall into the clutches of the AMT than a thriving business. The AMT literally

kicks a small business ‘‘when it is down.’’ As your cash flow goes down, you AMT

tax bite goes up!

The current tax code is full of ‘‘AMTs.’’ Depreciation schedules, death taxes, accounting methods—all fall heaviest on the individual with business-related income.

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The only solution America’s small business owners have to these problems is to

eliminate the 101,295 pages and seven million words of IRS rules and regulations

which make up the current IRS code. Scrapping the IRS tax code is one of NFIB’s top tax priorities.

WHAT SHOULD THE NEW CODE LOOK LIKE?

Although NFIB is not promoting a specific replacement tax plan, NFIB proposes

the following Seven Points of Principle that should be considered when developing

a new tax code fair to small business: • Lower Taxes—to create jobs and opportunities • Fosters growth—encourages work and savings • Fair—for all taxpayers

• Simple enough—all taxpayers can understand

• Neutral—no ‘‘social engineering’’

• Visible—no hidden taxes

• Stable—difficult to change

Some have asked to move beyond these seven principles and outline what sort of

tax code small businesses would like to see. Here are some additional guidelines

from surveys of our members, and the results from the Small Business Summit

NFIB held in June of 1998:

Reduce the Overall Tax Burden

Any discussion of tax reform should only be held within the context of an overall

tax cut. Revenue neutrality destroyed whatever benefits may have been derived

from the 1986 Tax Reform Act. We should learn our lesson and not be shackled into

thinking we have to raise Peter’s taxes to cut Pauls. By embracing a tax cut as part

of reform, we can minimize the concerns raised about winners and losers.

Moreover, this principle wraps up fairness and complexity all in one. If all income

and/or consumption were taxes at the same rate, then much of the perceived unfairness of the current system would be eradicated. Furthermore, distinctions between

types of income—earned, unearned—disappear, making the code much less complex.

One important note is to observe that the single rate principle should not exclude

two-tiered plans—like Senator Ashcroft’s plan—that take payroll tax rates into consideration. While the Ashcroft plan ostensibly includes two rates—10% and 25%—

taxpayers only see a single unified (income plus payroll tax rates) of 25% on their

income. Taken as a whole, taxpayers still face just one marginal rate.

Tax Income Only Once

When tax reformers talk about ‘‘fostering growth’’ through the tax code, they really mean reducing the current tax on investment and savings. Right now, the tax

code is biased against savings and investment because it taxes investment incomes

twice or three times.

Here, we have growth and complexity together. Taxing income once means eliminating death taxes. That reform alone would make a dramatic improvement in reducing tax code complexity and riaising economic growth. It also means eliminating

the double taxation of interest and dividends. There is overwhelming evidence regarding the negative relationship between taxes on cabins and investment and economic growth. As taxes on savings go up, economic growth does down.

Visible to All Taxpayers

This is an ‘‘anti-VAT’’ principle, pure and simple. The VAT is uniformly hated by

small businesses because it is a hidden tax. They’ve seen the damage the VAT has

done in Canada and Europe, and they fear the same results here in America. Back

in 1985, we asked our members, ‘‘Do you favor or oppose creation of a value-added

tax as a replacement for the current income-tax system?’’ Six out of ten said ‘‘No.’’

Our members voted against the VAT because the fear it would be used to supplement, rather than replace, the current income tax code. I believe the case against

the VAT has strengthened since then.

Conclusion

‘‘Reckless’’ and ‘‘irresponsible’’ are the works President Clinton used to describe

our plan to abolish the IRS tax code. With all due respect to the President, what

is truly irresponsible is a tax code that is anti-work, anti-savings, and anti-family.

What’s reckless is continuing to live with seven million words that such the life

right out of our economy.

President Clinton has indicated that small-business owners want to create ‘‘fiscal

anarchy’’ by scrapping the code and then figuring out what to do next. Bust small

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employers understand that sometimes the old law must be put to rest before a new

law can take its place. The time for fundamental tax reform is now!

NFIB thanks the Committee for focusing on this and listening to the views of

America

The National Grain Trade Council appreciates this opportunity to provide its

’s economic engin

Statement of National Grain Trade Council

—small business.

f views on the recent adverse international activities related to Foreign Sales Corporations or FSCs.

The mission of the National Grain Trade Council is to advocate and protect the

principles and merits of open and competitive markets for the production and distribution of agricultural commodities. The National Grain Trade Council represents

commodity exchanges, boards of trade, national marketing associations and more

than 40 individual agribusiness companies.

The Issue

As you know, the World Trade Organization has ruled against the United States

use of the Foreign Sales Corporation (after 15 years of use) labeling it an illegal

subsidy. The WTO Appellate Body upheld this Panel ruling. The WTO labeling of

the United States use of FSCs as a subsidy has resulted in adverse rulings related

to the United States Agreement on Agricultural Exports. Under World Trade Organization procedures, the United States is expected to withdraw the illegal subsidy

by October 1, 2000.

History

This problem has previously required Congress’ attention and time. The United

States began using a Domestic International Sales Corporation (DISC) in 1971. The

purpose of the DISC was to allow United States exports to be more competitive by

adjusting the level of taxes on exports to be more like those of our competitors. As

discussed below, the U.S. has to compete with countries that do not tax any economic process beyond their borders (a territorial process) while U.S. corporations

are subject to income tax on their worldwide income. Additionally, the countries

with a territorial process employee a value added tax (VAT) and charge the VAT

on imported goods and services but exempt or rebate the VAT on exported goods

and services. This is the root of the unfairness.

In 1972 the European Communities requested dispute settlement consultations

regarding the DISC measure, alleging that the DISC constituted an export subsidy.

The United States also requested consultations with France, Belgium and the Netherlands contending that if the DISC measure were an export subsidy then the tax

exemptions provided by those countries for foreign-source income were also export

subsidies. The Panels found that both the DISC measure and the European tax systems had characteristics of an export subsidy prohibited under the General Agreements on Tariffs and Trade (GATT) of 1947. This dispute went on for many years.

In 1984 the United States replaced the DISC provisions with the FSC provisions.

The United States enacted the FSC in response to a 1981 decision of the Council

of the General Agreement on Tariffs and Trade providing that countries need not

tax foreign-source income, including income from export transactions, and the failure to do so does not constitute a prohibited export subsidy. Acceptance of the GATT

Council’s 1981 decision by the European Community and the United States, as well

as other parties to the GATT was instrumental to resolving the more than decadelong dispute between the EC and the United States. However, in 1997 the European

Union again challenged, through the WTO, the United States use of FSCs calling

them export subsidies.

WTO Ruling

The WTO Appellate Body has ruled against the United States’ reliance on the

1981 GATT understanding and instead uses the definition of a subsidy where ‘‘government revenue that is otherwise due is foregone or not collected.’’ This in turn

has led the Appellate Body to use the ‘‘but for’’ test. That is, would revenue otherwise be due the government ‘‘but for’’ the enacted tax law.

In other words, if a government chooses to write its tax laws such that it has no

authority to tax economic processes outside its borders, the foregone revenue is not

a subsidy. Whereas if the government writes its tax laws such that it has the right

to tax worldwide the economic process but chooses only to tax the economic process

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that occurs within its borders, the result is a subsidy. This is clearly form over substance and results in an unfair playing field for American exporters.

United States Impact

Without the FSC, American exporters are not able to compete fairly with exporters of other countries. This inability to compete will have a greater adverse impact

on agricultural exports than nonagricultural exports. This is due to the very low

profit margins related to agricultural commodities and the international buyer’s

view of purchasing the commodity product, which by its definition is no different

than a competitor product, at the lowest price. We expect this would lead to lower

US agricultural exports resulting in greater domestic supplies and further depressing US farm prices and the overall US farm economy.

Real Issue

The FSC is not the real issue. We are really talking about a trade issue that is

fixed through various tax provisions. We can and perhaps will enact United States

tax laws that equalize the international tax playing field and remain WTO compliant. That will require time and thoughtful analysis.

What the WTO Panel and Appellate Body are not recognizing is that there are

different economic playing fields in each country and neither is superior to the

other. Tax deductions and incentives must be viewed in their entirety. All taxes,

both direct and indirect must be accounted for in determining fairness. Substance

and not form must be the basis of comparing tax systems

Thank you for your attention to this matter.

Statement of Thurston Bell, National Institute for Taxation Education,

fHanover, PA

Mr.Thurston P. Bell submits the following witness testimony. Mr. Bell is the Executive Researcher for the National Institute for Taxation Education. His findings

are hereby respectfully submitted to the committee and contain the most unique testimony from one of the most qualified advocates for the people regarding IRS actions and behavior. His appears to be the lone voice calling for reasoned

comunication and procedural compliance by the Tax Resistance movement and IRS

alike.

Mr. Bell’s active investigation and research during the last seven (7) years includes direct correspondence with the IRS and intervention on the behalf of individuals whose cases have previously been the most protracted and belligerent exchanges between citizens and their government.

He is at the forefront in assisting the growing numbers of people who have lost

all faith in the IRS and the current means of collecting revenue. This makes him

the most moderate and realistic voice in this arena of Law and Public Policy.

His research and reform efforts have aided the IRS in identifing and correcting

areas wherein complete breakdowns in procedure had occurred in some IRS districts. He is creidited with helping the service in some districts achieve renewed

compliance with statutory, regulatory, and published procedures contained within

the agency’s Internal Revenue Manual.

Mr. Bell’s past efforts and continuing work demonstrate his good faith intent in

providing testimony before the committee. Furthermore, he is commited to resolving

the growing resentment of ‘‘The People’’ for their IRS. This ‘‘Us vs. Them’’ mindset

has been exaserbated by decades of IRS activity in complete disregard of some 25

to 27 clearly delineated procedural requirments and the agency’s denial of the people’s administrative due process rights.

The following expose of the foundations of the problems and questions that this

committee seeks to resolve, must be considered if the congress wants to truly address and fix the tax problem, achieve the chairman’s goals, and take decisive action

to restore public trust and the appearance of legitimacy in the taxation activites of

the U.S. Treasury Department.

Chairman Archer, and the Honorable Members of this Committee:

Thank you for your time in consideration of my testimony. My name is Thurston

P. Bell. I am the Executive Researcher with the National Institute for Taxation

Education.

Upon my discovery of this Hearing and its notice to the Public that all interested

parties provided written testimony for consideration and entry into the Committee’s

records, I decided to afford myself of this unique opportunity to communicate with

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a body which could affect change regarding a subject which has absorbed the past

7 years of my life.

I sincerely hope that by sharing my unique experience with, and exposure to,

rarely seen or discussed historical documents, I will capture the attention of this

vigilant Committee and spark thoughtful consideration of, as well as further inquiry

into, the foundations of taxation and the history behind the reasoning of the prior

Congresses as you debate future taxation schemes like the National Sales Tax.

It is also my hope that this testimony will further increase the progressive communication between the U.S. Congress and a growing dissatisfied and distrusting

sector of the Public that has been denied due process of law by the Executive

Branch’s and its revenue collection activities.

The IRS’ abusive behavior alone caused the overwhelming growth in the tax resistance community and a national mindset of ‘‘tax avoidance’’ appears to be spurring the decision to reconvene these hearings. Therefore, it is time for the two governing parties (we, the People, and our representatives in Congress) to come together and consider our separate positions in order to mediate a reasonable and survivable remedy for individuals as well as the Public.

Unfortunately, over 30 years of IRS abuse has made the disenfranchised and disaffected citizenry notably belligerent. Since animosity is so pervasive in the growing

Tax Resistance sub-culture of our society, a mindset fed by the convoluted and

seemingly endless conspiracy theories proffered by assumed leaders within this

‘‘movement,’’ the voice of these individuals and their ‘‘leaders’’ must be precluded

from these reasonable and civil hearings. Subsequently, the other side in this issue,

as embodied in this Committee, is doomed to continue to grope for some way to reduce tensions and preserve the Public Peace without coming to a full understanding

of the root cause of the tensions inflamed in the populace.

Therefore, in an effort to move this Committee forward to some resolution of action that will be meaningful to all Americans, I am providing this testimony to span

this communication chasm between the two sides.

As I understand, this Committee hopes to draft a law that would create a new

means of economic stabilization, without adversely effecting the fiscal engines of the

States, permanently remove the IRS from the lives of the individuals that make up

the United States of America and, finally, the income tax would be removed the at

the root—so that it never grows back.

This appears to be a reasonable set of goals for fixing this problem, yet, to understand how to fix a system that has a problem, or has become a problem, the system

must be understood and seen for what it is, how it functions, and the purpose for

which it was created.

Economic Stabilization

In 1947, Mr. Beardsly Ruml, who was at that time the Governor of the New York

Federal Reserve Bank, explained our current system of income taxation before the

American Bar Association. He was also the man who created the system of wage

withholdings from the pay of those receiving wages as the means of painlessly collecting the income tax.

In Mr. Ruml’s speech, he explained that the main function of the income tax was

for the purposes of economic stabilization, and that none of the money collected as

income tax goes to the operation of government. This full text of his speech can be

read at:

In 1973, as shown in an internal IRS Memorandum of the Western Regional Offices, the IRS clearly admits, in its upper echelons of operation, that it understands

that the IRS is the administrative arm of the economic stabilization program.

(see:www.nite.org/docs/croasmun—report.pdf)

There is little doubt that anything has changed the substantive nature and purpose of the income tax over the past 27 years, as nothing had previously changed

in the 26 years between Mr. Ruml’s public admissions and the IRS’ 1973 internal

scheming of a plan to avert economic disaster. The looming disaster began when

tens of thousands of people began to claim ‘‘exemption’’ from the withholding of income taxes from their ‘‘wages.’’ This action on the part of the people threatened to

derail the stabilization program created by Mr. Ruml.

The first point that this Committee must understand, as it considers any new taxation proposals, is that the income tax is all about ‘‘stabilization’’ of a paper currency that is inflated by both the spending practices of the U.S. Congress (in support of a seemingly ever expanding and reaching Federal Government) and the

Banking practice known as Fractional Reserve Banking.

In short, tampering with the primary means of economic stabilization system

risks the possible extended interruptions of the currency removal stream. Such an

event would adversely effect the Power of the U.S. Congress, the ability of the FedVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00396 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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eral Government to operate and provide for the benefits granted to American Society, and, finally, the benefits enjoyed by those controlling and operating the banking

sector of our society.

Considering the function and purposes of the income tax, there is a very good reason for the Chairman’s claim that the Code is still ‘‘...too complicated and

confusinga...’’ Such is the natural result of a system devised: 1) to hide the existence

and exclusive attributes of Blind Trusts; 2) to complicate the operation of Corporations—the primary income tax shelter—so that the average individual can not incorporate and thereby eliminate his exposure to tax liabilities, and 3) to have a taxation regime that favors special interest groups and corporations over individuals.

Still, the vital nature of this taxing scheme—economic stabilization—appears to

be the prime reason why the Honorable Chairman might spend the remainder of

his illustrious career in the U.S. Congress searching for, and yet never discovering,

a solution to the problem of the income tax. He will not be alone, as Mr. Ruml in

his 1947 speech was looking for a way to eliminate the corporate income tax. He

never was able to do this or claim that it was possible given the realities of paper

money and private benefits received by those in control of the fractional reserve

banking system.

If my recollection of the reports of the 1997 committee hearings are accurate, then

many Economists respected by you, Mr. Chairman, publicly explained therein the

potentially disastrous effects of a National Sales Tax (NST). The consensus was that

a NST would have to be increased sharply within months of its implementation in

order to keep the economy from disintegrating, or at least experiencing hyperinflation. It appears certain that as long as this nation and the Congress embrace

paper money, or a non-intrinsic valued currency, there will have to be an income

tax.

State Fiscal Engines

It has been communicated that the proposals before this Committee are to be considered in light of how they will effect the fiscal engines of the State Income Taxes.

This is very important given that many States, like New York and California, depend upon their Individual and Personal Income Tax systems as great fiscal engines

to operate their local system of Government. Most of the states’ income tax laws are

dependent on the construction and continued survival of the present Federal Internal Revenue Code.

The income taxes imposed within the several states are completely dependent

upon the Federal Definition of ‘‘Gross Income’’ as found in 26 USC § 61 (the Internal

Revenue Code), and without that statutory definition all of the state income taxation regimes would fail immediately.

This Committee must therefore take notice that any taxation regime which might

replace and/or do away with the Federal Definition of ‘‘Gross Income,’’ and its active

and enforceable nature and subjugation to the Federal Judiciary, will destroy, if not

greatly hamper the operation of this great fiscal engine as used by the States.

This leaves any taxation options outside of an income tax to be untenable at this

time.

Intrusion upon the Individual

This present situation is antithetical to the statement of the Honorable Chairman,

that his goal is to end the intrusion of the Federal government (IRS) into the lives

of individuals. Again, in order to do this, those who deal with the IRS and work

with taxpayers on a daily basis cannot ignore the history of the systems intrusion,

and this committee cannot maintain any hope of discovering and enacting a viable

replacement without knowing this history.

So far, history shows us that the earliest known instance of any realization of this

intrusion of the Federal Government into the lives of the individual is found in the

Page 37 interview of Mr. W.D. Williamson in the New York Times November 29,

1936 issue.

Mr. Williamson worked with the Social Security Board in the creation of the Social Security Program. His comments are very revealing:

‘‘the biggest value of the tax, he added, would be to introduce the majority

of the 26, 000,000 workers to the ‘‘privilege’’ of contributing directly and consciously to the cost of government.

‘‘It will treat them as adult citizens. Able to bear the thought of contributing to

their government, instead of treating them as children and collecting from them in

hidden taxation.’’ He said.

He added that the plan extends Federal income taxes ‘‘in a democratic fashion’’ to the lower-income brackets, the government at the same time agreeing

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to undertake the new function of paying old-age benefits to the taxpayers.’’ (emphasis added)

This article and the transcript of its content are posted at: www.nite.org/ref/ny—

times.pdf and www.nite.org/ref/ny—times.htm

This comment was made in regards to the first income tax to be placed upon the

people, the Social Security Tax, and you see the government reaching into the lives

of every individual, including those in the lower income brackets.

It is clear from the above noted article that in order for the Honorable Chairman

to reach his worthy goal—getting the IRS out of the lives of individuals—he is going

to have to end the direct federal taxation of the people—the root cause of government’s intrusion into the citizen’s life.

For now, since the income tax is one of the two foundational pillars supporting

the present monetary system, and thus our economy, the current tax system’s reach

into our lives is necessary for the continued operation and health of the economy

that fuels our society and international markets.

Given the realities of the dependency of state taxation regimes and the stabilization of the currency—both dependent upon the current taxation of gross income—

there appears to be no end in sight to the intrusion of the IRS in the lives of ordinary Americans. Therefore, the National Institute for Taxation Education (NITE)

seeks to encourage this Committee to support, in the strongest terms, the reinstitution of proper operation of the Treasury Department and the IRS, in the enforcement of tax laws.

Enforcing the agency’s compliance with the laws as written by Congress will ensure citizens receive the rights and remedies contained within the Statutes, regulations, Internal Revenue Manual, and Publications governing the IRS Administration. If Congress will do this, then the long process of rehabilitating the agency’s

reputation with the enraged citizenry can begin. Such action on the part of the Congress will deter the agency from continuing its errant intrusions and allow for the

proper and lawful administration of the current tax system until such time as a viable taxation alternative is discovered.

This is the area in which the NITE is presently working. The previous actions

of the Congress and Senator Roth’s Senate Task Force indicate that there may be

a possibility of cooperation within government and the IRS. Yet the immense efforts

on the part of individuals have netted very small reforms within the agency’s stilted

‘‘culture,’’ as noted by Former Treasury Secretary Rubin. Therefore, Congress must

take an active role in properly educating its Staff personnel who handle IRS matters

before the People can have any glimmer of hope that the service will one day soon

comply with the law in every instance involving a taxpayer controversy.

Since replacement of the current system appears to be an impossibility

at this time (and given the parameters of this Hearing as well as the fact

that the IRS and the Congress are both in need of a rebuilding of the people’s confidence on the matter of taxation) I would encourage this Committee to examine pervasive culture or mindset noted by former Sect.

Rubin, and endorse the IRS adjusting its operations by making a concerted

effort to reform and comply with the laws and procedures. NITE, and most

of its members, believe that this is the most reasonable and constructive

activity in the interim.

Proper implementation and notification of the public as to the procedures enacted

into law, and as set forth by the Secretary, will reduce building public tensions and

re-establish legitimacy of the official behavior of the IRS, and the Congress, in the

hearts and minds of the people.

If the People quietly accept that they cannot expect the laws enacted to be enforced, then the legitimacy of government will ultimately fail and the economy will

soon thereafter follow. The People are beginning to recognize that there is a dual

issue in the subject of taxation—the stability of Economy and the Legitimacy of Government.

Even if an alternative ‘‘workable’’ tax scheme is instituted, there is still going to

be the matter of Justice and proper implementation of the law by the IRS. There

is a serious question of whether or not the IRS will be able to properly enforce and

comply with the requirements of a new laws in the future when it fails so miserably

at complying with the currently enacted laws today.

We must face the fact that the Office of Personnel Management will most likely

recruit its personnel for the new Revenue Agency from the cadre that worked within

the IRS before its dismantling. Thus the old ‘‘mind-set and culture,’’ noted by former

Secretary Rubin a couple of years ago, will be re-established within the new agency

by the re-hiring of the old IRS employees.

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If this mindset and culture transfers to any new taxation agency, the result may

well be a rose being called by any other name, or in this case a whip. Justice is

not endemic to change, and cannot be assumed to be so.

The Root of Income Taxation

The beginning of reduction in tensions between the people and the government,

without radical change, can only be found in operating the income tax that we presently do have, within the present day laws and procedures as written. This is something that the IRS has failed for decades in doing. However, the enactment of 1998

Internal Revenue Service Reform and Restructuring Act opens the door to laws that

appear to force the IRS to follow proper administration. This would not have come

about but for the people and reformers being supported by the Congress today.

The institution of Justice by present means is as immediate justice as the law will

allow, short of the tax laws complying with the original precepts of income taxation.

Any changes in the income tax laws should from now on be examined under the

original precepts and criteria of income taxation:

A. The receipt of Benefits; and;

B. The Ability to Pay.

Anything short of these criteria has been deemed, from the time of the first

English Income Taxation Program over North America, as instituted by George the

III, as immoral and unjust.

Removal and eradication of the Income Tax

It is well understood, and hard to argue against the Chairman’s desire to ‘‘...rip

the current tax code out by the roots so that it can never grow back.’’ Yet, the notion

of this gives rise to the realization that the Committee has a very difficult task before it, as the Congress would have to initiate the repealing of the 16th Amendment,

as well as the Income Tax, to assure that the Income Tax is never placed upon the

people again.

Only in this circumstance would the people be safe from income taxation, as the

subject to income taxation would return to the rule of the U.S. Supreme Court in

the Pollock case. Such an action to secure an assurance that the tax would not return would require a two-thirds vote of both houses and the States to achieve. There is therefore

great doubt that such could be done. When this difficulty is examined under the fact

that the elimination of the 16th Amendment would also remove the present day authority of the Social Security Tax in 26 USC § 3101, which is an income tax, any

will of the Congress to repeal the 16th Amendment should vaporize. The subsequent

political backlash would probably mean that nobody in the Congress and Senate

would be re-elected.

In some ways the difficulty of taking action on this matter is a good thing. It provides an assurance to the American People, as it keeps the Congress from doing

something brash or impulsive that would send the economy into shock.

The ‘‘something brash’’ I refer to would be best described as the enactment of a

National Sales Tax. Such a tax would have to grow very quickly to control inflation

and our economy would end up suffering the effects of under-consumption. Or, in

the alternative, if the tax rate were too little, then hyperinflation would ensue. Historically, National Sales Taxes cause governments to go into greater debt to their

centralized banks to cover deficits. This is an important point in light of the private

ownership of the Federal Reserve Bank.

In regards to the National Sales Tax, throughout the current debate I have yet

to see any discussion of the fact that in 1922 congress also considered a national

sales tax. The Honorable Committee might wish to read the reasons leading to the

rejection of this tax. Such a scheme was turned down apparently due to the severe

failure of the French National Sales Tax that plunged the nation into 4 Billion

Francs of debt to the banks. There is also the fact that the Treasury Secretary and

his friends (the Banking Class Elite who had the ability to pay) were not paying

their income taxes as the Secretary cried for some tax to be instituted to cover

shortfalls.

It is my understanding that the 67th Congress 3rd Session, that Congressman

James Frear of Wisconsin stated the following in response to Treasury Secretary

Andrew Mellon’s urging for the imposition of a National Sales Tax:

‘...both houses presumably felt that the sales tax urged by you [Andrew Mellon,

Secretary of the Treasury and President of Gulf Oil] was a vicious tax placed upon

what both rich and poor ate, wore, and used, not exempted, and that it was an unjust, heavy burden to place on the backs of those who grub to make ends meet, and

who were thus asked to bear the rich man’s burden of excess profits you had successfully urged for repeal. I refer to the vast army you sought to tax, and who have

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no income tax to pay, but are glad to eke out a bare existence. All of these would

help disproportionately to pay your proposed sales tax, whereas if you [Mellon] contribute the income tax you are properly supposed to pay, as one of the richest men

of the world you would pay into the treasury according to Kline’s estimates on 300

Million dollars of wealth, an annual tax running well into the seven or eight figures.

If any evidence of a sales tax failure, due to enforce under-consumption is desired,

then the present French National Deficit of 4 Billion Francs is a warning. ‘I do not believe in ’soaking the rich’ because they are rich, but in common with

the overwhelming majority who make up the country a belief exists that taxes

should be laid according to ability to pay, and this is the teaching of every recognized authority in the history of every prosperous people. Your sales tax proposal

would pinch the poor by taxing their necessities, and was believed to be unjust and

vicious in principle and was defeated in Committee by a vote of 19 to 5.’ ’’ What has changed in 88 years since to cause us to return to considering the siren

song of the National Sales Tax? Why does this Committee, or at least the Honorable

Chairman, continue to posture politically by acting as though there is a solution to

the tax problem short of complete monetary reform?

These proceedings appear to smack of political grandstanding by both parties for

the appeasement of the evermore-distrusting masses, which are continuing to grow.

This may be a noble and necessary effort in order to keep the Public Peace, but

nothing will replace good faith efforts of this governmentally omnipotent Congress

to assure JUSTICE in the enforcement of the standing law, and provision of meaningful administrative due process of law, as set forth by the U.S. Supreme Court.

Remedial Congressional Actions

There appears to be no immediate solution to the problem of the Income Tax at

this time as there is no ‘‘national will’’ to reform our monetary system or reduce

the size of Centralized Government. Yet these were the fundamental reasons for the

imposition of the income tax and the creation of the IRS—the most powerful and

foreboding agency of the U.S. Government.

In all fairness to the Establishment, I find myself concurring with the words of

Federal Reserve Chairman Alan Greenspan on the subject of taxation and monetary

stability. In 1999, he provided the Congress with two options on what to do with

the opportunities afforded it by the Budget Surplus.

Chairman Greenspan’s advice that elimination of the marginal tax rates, and thus

taxation upon the poorest Americans was one of the most reasonable statements on

taxation and justice that I have seen. I was shocked to see the Fed. Chairman, an

official who I used to see as an adversary, encourage the U.S. Congress to embrace

the opportunity to bring this Nations Income Tax law into line with one of the two

original tenants of income taxation; The Ability to Pay. To eliminate the Marginal

Tax Rates does not eliminate the income tax, but then again Mr. Chairman, for 5

years you have been unable to eliminate the Income Tax. Also, remember, that as

long as there is paper currency, the Congress cannot and will not eliminate the income tax that is so desperately needed to keep this monetary system afloat.

What such an action does do, is move the taxation regime to be directly in line

with the original tenants of income taxation by releasing the poorest of Americans

from subjugation to the complexity of the so far obfuscated IRS Administrative process. Such an action is in the interest of Justice, which originally governed income

taxation. I say this is, just as the poor are most often lacking in the educational

stature to be able to adequately defend themselves from IRS Administrative claims,

nor are they able to afford professional and competent assistance to guide and aid

them in prevailing against IRS claims.

Just the dollar amounts alone, in the face of the cost of a professional to aid the

uneducated person in the defense of their money creates an appearance that making

a defense is a waste of time and money. This makes for a situation which is neither

fair nor justifiable, and a situation for which nobody has any will or idea as to how

to fix. The elimination of marginal tax rates is an action would be in line also with

the Chairman’s goal of getting the ‘‘...IRS out of the lives if the American taxpayers.’’ It might not free all Americans, but it will be a start. And who knows, perhaps the savings to the lower tax rates will trickle up to the middle class in the

form of lower child care costs. It is hoped that this Honorable Committee finds

agreement with the first option given by Chairman Greenspan, and begins moving

towards justice, so that we will one day reach it. If we do not have justice in this

Society, debts and government programs will soon mean nothing.

A Just tax system is what is best for America. In light of the 25 procedural and

rights violations discovered in the great majority of tax cases examined by the National Institute for Taxation Education, the injustice is clear. Nevertheless, NITE

can only wonder as to what reasoning will be used to support the issuance of new

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powers to the Treasury Department for a new tax, when it is so clearly not complying with the laws that the Congress has already enacted. The greatest fear and

trepidation surrounding this issue of a new tax is that fact that no tax, once enacted, has ever been repealed.

History will show that those who realized the income tax would be with us for

the foreseeable future also predicted that the most likely event is that the people

will be saddled with yet another tax on top of the income and sales taxes that already burden them. At this time, Congress is unwilling to provide any guarantee

to the contrary and unable to muster the political will to do abolish the income tax,

as this would also require the elimination of Social Security.

Chairman Archer and the Members of this Honorable Committee, thank you for

hearing me and placing my words into the record.

THURSTON BELL,

f Executive Researcher

Statement of John Berthoud, National Taxpayers Union, Alexandria, VA

The 300,000-member National Taxpayers Union commends the Committee for

holding additional hearings on fundamental tax reform.

We have long favored replacement of the current income tax system with a simple

tax that would clear away many of the tax obstacles to economic growth. Congress

can and should consider many approaches for replacing the current tax law in favor

of a better system.

We understand that the hearings scheduled for this week will focus on ‘‘tax reform proposals that have been introduced since the last set of hearings in 1997,’’

including ‘‘H.R. 134 by Rep. Phil English (R–PA) and H.R. 2525 by Rep. John Linder

(R–GA) and Rep. Collin Peterson (D–MN).’’

For many years our Board of Directors has been on record that fundamental tax

reform can be accomplished by several different approaches. We have already endorsed the flat tax introduced by Rep. Dick Armey and the national sales tax proposal by Rep. Billy Tauzin. In this spirit, we are pleased to announce our support

for H.R. 2525, the FairTax.

We commend Rep. English for introducing H.R. 134. Clearly a great deal of

thought has been put into this proposal, and it contains many attractive features.

We are still studying this proposal.

The FairTax proposes to replace the entire income tax system with a simple federal sales tax on new goods and services sold to consumers. The FairTax would repeal all federal personal income, payroll, corporate income, self-employment, capital

gain, estate, death, and gift taxes.

The FairTax meets a number of basic requirements of NTU policy for support of

a sales tax, including that the tax would:

• be applied only once and would be visible at the point of final purchase for consumption;

• completely replace all income, death, and gift taxes;

• free individuals from filing tax returns or income reports with the federal government; and,

• ensure fair treatment of low-income taxpayers.

As you know, the imposition of federal personal income taxes in 1913 has led to

a number of economically, politically, and socially destructive outcomes. Government’s obsession with trapping and extracting revenue from every earned dollar has

spawned high rates that penalize productivity, multiple layers that punish saving

and investing, and hideous complexity that burdens the economy with over $200 billion in compliance costs alone.

In the meantime, federal receipts have grown an astonishing 175,000 percent over

the past 85 years, making the current tax system the biggest boon to bloated government in our nationÕs history. The Tax Code itself has become a political

trading vehicle for rent-seeking special interests, while more American citizens fear

the Internal Revenue Service as a threat to their civil liberties than any other federal agency.

If America is to remain prosperous and free in the next century, the current system of taxation must be scrapped in favor of an alternative that is simpler, fairer,

more visible, more economically efficient, and less burdensome. The FairTax proposal would fulfill all of these requirements. Most Americans would no longer face

the anxiety of income tax filing seasons, as federal taxes would simply be collected

from purchases.

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The FairTax offers several unique advantages not offered by other tax reform proposals.

Taxpayers would get to keep their entire paycheck, pension, or Social Security

benefits without any tax withholdings. Since the income tax would be replaced by

a consumption tax, this feature would let citizens save money much faster for those

important family needs such as a new home, college education, or retirement nest

egg.

Since the income tax would be eliminated, we could abolish the IRS along with

all individual tax filings. Individuals would never again have to fear an audit or seizure. Today’s tax system also has enormous hidden taxes, as documented in a recent

study by Bryan Riley for National Taxpayers Union Foundation. These hidden taxes

add as much as 20% to 25% of the price of everything we buy in the stores today.

The FairTax makes the cost of government fully visible to all taxpayers. No taxes

are hidden in the form of payroll taxes or corporate taxes. By being aware of the

true burden of taxes, Americans can once again rationally debate the size of government without having to take politicians at their word.

Another advantage of the FairTax is that it would completely untax the poor and

those who rely on just Social Security. The FairTax includes a monthly tax rebate

to ensure that all Americans can afford to buy their necessities tax-free.

That’s a stark contrast to the existing tax system that collects hundreds of billions

of dollars in taxes buried in the cost of things we purchase. Under current tax laws,

even minimum-wage workers pay over 15% from their paychecks for payroll taxes

when you count both the employee and employer share of the tax.

Another important advantage of the FairTax is that this reform should be easier

to keep intact should it become law. As you know, in 1986 Congress and the President adopted a tax reform plan that lowered the top income tax rate to 28%, but

it lasted less than five years, and the top rate today is over 40%.

Since the FairTax would scrap the entire income tax apparatus, including the

IRS, it would be much more difficult to reimpose an income tax. We also believe

that once people get used to keeping their entire paycheck, pension and Social Security benefits, they will never want to go back to the old system.

Congress can and should consider many approaches toward repealing the current

tax law in favor of a better system. Other proposals for a flat tax or consumption

tax would address many of the problems weÕve outlined, and NTU has endorsed several such plans. We look forward to debate and concerted action on the

FairTax and other tax system alternatives in the near future.

Statement of John B. O

f’Donnell, Chula Vista, CA

I am pleased the Congress is finally recognizing the destructive nature of the

present personal income tax. There is the common misconception that the sixteenth

amendment authorized the income tax but as is evidenced by the Supreme Court

ruling in Stanton v. Baltic Mining Co., 240 US 103 (1916) the sixteenth

amendment—

‘‘... conferred no new power of taxation but simply prohibited the ...

power of income taxation from being taken out of the category of indirect

taxation to which it inherently belonged...‘‘

Unfortunately, court rulings on the tax system have become so befuddled that

courts find in some districts the tax is a direct tax authorized by the sixteenth

amendment while in others it is an indirect tax that applies only to the exercise

of licensed privileges. Such confusion within the courts should of itself be sufficient

to declare the statutes in violation of due process for persons of only reasonable intelligence, without the law expertise one can expect of jurists.

However, because others will undoubtedly present better arguments on the problems of the present system, I will address only the issue of economic performance

that is affected by this and other forms of transaction taxes.

The current assumption that some form of consumption tax is the only alternative

to an income tax is disheartening. I have posted on the internet an analysis entitled

Three Steps to Economic Freedom at: http://www.geocities.com/CapitolHill/1067/

c00r4.html that demonstrates some of the more egregious fallacies of generally accepted economic premises.

In this pamphlet I describe a ‘‘Monopoly Tax’’ that could also be called a ‘‘Limited

Liability License Fee’’ that would provide all needed government finance while imposing no burden on American citizens. Further, the method actually causes optiVerDate 20-JUL-2000 12:27 Jun 28, 2001 Jkt 060010 PO 00000 Frm 00402 Fmt 6601 Sfmt 6602 C:\CMORCOM\HEARINGS\71879.TXT WM1 PsN: WM1
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mum growth in capital. The details of why this is true are a bit complex to present

in this brief, but the essential feature of this system is that it effectively changes

taxes collected by government that resolve to ‘‘variable’’ costs of production into

costs that resolve to ‘‘fixed’’ costs of production.

Although economists usually recognize taxes that resolve to fixed costs of production are superior to transaction taxes that effectively create a ‘‘wedge’’ between

prices paid by purchasers and the price received by sellers, they seem somehow forgetful when it comes to applying this obvious principle to their tax proposals.

The rationale behind the impost and a demonstration of the economic effect of its

causing growth when properly constructed is presented in the on line pamphlet. As

a brief introduction of the tax/fee, it is based on the capital value of limited liability

license holders [corporations] with the amounts of the fee adjusted to maximize the

growth rates of their value.

I have calculated an approximation of the tax receipts using the FY 2000 budget

as if it were funded by the Monopoly Tax. Some obvious compromises must be used

since there has not been the accumulation of empirical evidence that would be developed as described in the article. However, the scale of things can be derived from

existing data.

First comes an estimate of the asset value that would be subject to the tax. Using

the Wilshire 5000 equity value of approximately $14.0 trillion and a guess that debt

supported by those equities is $6.0 trillion gives a total subject to the tax of $20.0

trillion. Although it would be nice to apply the progressive rates as described in my

proposed system, that will have to wait for the empirical data from actual application.

Lacking that data, consider a uniform [or average] tax rate of 0.8% per month.

While 0.8% per month may appear large to some, consider that:

1. It is not unusual for the market value of these equities to increase by more

than 1% DAILY.

2. It is also not much different than the charge states and/or localities charge people for the ‘‘privilege’’ of owning a home.

3. And, if that is not enough to dissuade those who find the amount excessive,

consider that most, or even all, of the amount to be collected by this tax [Or limited

liability license fee.] would have been paid as income and payroll taxes ‘‘in the name

of their employees’’ but, because those taxes are eliminated it becomes just a change

in accounting these taxes that had been called ‘‘wages’’ but were never seen by the

so-called wage earner. [There would, of course, need to be enough time for contracts

to adjust nominal wage rates to reflect the new system.]

For the uninitiated, most personal income taxes and other payroll taxes are collected by corporations that would instead pay the monopoly tax while nominal

wages [Not after tax wages which likely will actually increase.] are reduced. In further note of this consequence, it may be necessary to remind some that wage rates

are not set in a vacuum and the elimination of those liabilities called taxes on wages

would substantially affect negotiated nominal wage rates.

Initially, other taxes paid by these corporations would also be eliminated changing

only the form [From ‘‘variable’’ to ‘‘fixed’’ costs.] and not the actual amount of taxes

paid by or through these corporations. Subsequent amounts would be determined

[as demonstrated in ‘‘Three Steps, etc.’’] by maximizing the growth rates of corporate value and the overall economy.

The yearly amount that would be collected by such a tax would then be $0.16 trillions per month times 12 months, or $1.76 trillions per annum. This is only $6 billion less than the $1.766 trillion budget for FY 2000. Not a bad approximation for

such a crude estimate.

A significant consequence would be the replacement of a very complex system of

government revenue raising that imposes a myriad of forms, rules and other burdens on many millions of people and wastes untold hours of effort to comply with

these burdens that could better be applied to useful production with a system that

is simple for both the companies affected and the bureaucrats tasked with enforcement. [There are about 7,–8,000 companies in the current Wilshire 5000 index. This

could expand to perhaps 10 times as many as some of the larger companies choose

to decompose themselves into several smaller units to reduce their tax liability.]

Although a rigid proof of the above is a bit more complicated than this simple example, it is also true that ALL the present taxes collected hinder economic activity

and differ only in the way that hindrance occurs, while the above method is recognized by economists as at least neutral or ‘‘non-distortionary’’ in its effect on an

economy and, by those willing to examine the arguments presented in the more

complete pamphlet, actually can be optimized to cause the greatest rate of capital

formation given all other conditions existing.

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I hope when it comes time to examine substitute methods for the failing income

tax system that this process will be considered.

Thank you,

f John B. O’Donnell

Statement of Robert P. Hodous, Payne & Hodous, Charlottesville, VA

The Hon. Bill Archer, Chairman, and Hon. Members of the Committee:

I appreciate the opportunity to provide these comments for your record regarding

the need to replace the current Internal Revenue Code with an uncomplicated rational new code. The starting point for this effort should be the proposal for a flat

tax. The three basic concepts of the flat tax as applied to individuals are one tax

rate, no deductions and large exemptions to eliminate taxes on those least capable

of paying them.

A variation of the income tax is preferable to a sales tax, which is considered to

be one of the most regressive forms of tax. Implementation of a high-rate national

sales tax could be a substantial shock to the economic system. Aspects of the fair

tax proposal are intended to minimize this impact and the regressive nature of the

tax. However, in minimizing the regressive impact and shock of implementation of

a high-rate national sales tax, we again begin to build complications into a new system. In addition, sales taxes can end up with many exemptions and variations

which lead to significant complications for merchants trying to apply such taxes.

Minimizing these difficulties by harmonizing the system with the various state sales

tax provisions would be a nightmare. In short, while a national sales tax or fair tax

may seem simple at first blush, it has many pitfalls and complications which will

be hard to overcome.

Applying the three flat-tax principles mentioned above should be just the beginning. To do nothing more than flatten and simplify individual rates, exemptions and

deductions leaves most of the complicated provisions of the current Internal Revenue Code still in place. For business entities we would still have varying tax treatment for different types of entities. Such varying treatment leaves in place the increasingly complicated series of choices for formation of business entities. The basic

choices still remain sole proprietorship, general partnership and corporation. Efforts

over time to obtain more favorable tax treatment have lead first to the S corporation, then the limited partnership with an S corporation general partner. Now we

have added limited liability companies, single member limited liability companies,

registered limited liability general partnerships and registered limited liability limited partnerships. Development of these entities is driven solely by taxes. The drive

for new types of entities can be eliminated by treating all entities the same.

Only implementing the three flat tax principles would still leave us with the estate and gift taxes with all of their related complications. We would still have charitable lead trusts, charitable remainder trusts, estate freezes, generation-skipping

transfers and differences in basis depending upon whether property is received by

gift or inheritance. Adding to the problems are the nightmare of dealing with various types of tax-favored deferred benefit plans and the tax dodge presented by different income and estate and gift tax treatment afforded life insurance in an irrevocable trust.

There are many other complications created by the current code which can easily

be eliminated using the flat tax as a starting point. The current code is a hodgepodge of social programs, complicated administrative and bureaucratic procedures

and special tax breaks, all of which should be eliminated or minimized in drafting

a new code. There must be a commitment to true simplification.

There are seven basic guidelines which should be used in creating a new code.

The tax law should be understandable. It should be economically neutral and not

encourage one economic decision over another. Administrative requirements should

be minimized. The burden of taxation and supporting our government should be reasonably allocated. The focus should be on raising money for the functioning of government, and various provisions encouraging different types of social efforts or actions should be eliminated. Taxes should be paid directly by individuals whenever

possible. Finally, all income should be taxed in the same manner.

I undertook to write a new tax code using these guidelines to see how uncomplicated the tax law could be. I have been successful. The code I have written starts

with the flat tax and then goes on to eliminate some provisions and simplify others

as the principles are applied to the whole tax law. In addition to taxing all income

in the same manner, this code:

• Eliminates the distinctions between types of business entities

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1SOI Bulletin, Winter 1998–1999. 2 U.S. Budget for Fiscal Year 2000, Analytical Perspectives.

• Eliminates the marriage penalty

• Provides one type of retirement account with greater individual freedom

• Eliminates special accounting provisions

• Eliminates estate and gift taxes

• Replaces excise taxes and special funds with a low-rate comprehensive sales tax

• Eliminates special litigation procedures

• Eliminates the need for regulations and rulings

All of this is done while still eliminating or at least lowering the tax bills of the

persons who can least afford to pay taxes. I have included this code in a book in

which I also address problems in the current tax code and deal with objections to

the suggested changes. The tax code is just 30 sections, and the whole book, including the code, is only 180 pages. The book is Let’s REALLY Change Taxes. I would

be happy to provide a complimentary copy of the book to any member who would

like one. My business address is Payne & Hodous, 412 East Jefferson Street, Charlottesville, Virginia 22902, and my business phone number is 804–977–4507.

I would encourage you to stay with an income tax system as the basic means of

raising the money for the functioning of government. I also encourage you to use

the concept of the flat tax as the beginning of a truly rational and uncomplicated

tax system.

Again, thank you for the opportunity to provide these comments.

Statement of Glendale O. Herbert, Pembrok Equity, New York, NY

Robert P. Hodous

f Mr. Chairman and members of the committee, I am grateful for the opportunity

to testify today. I am the owner of Pembrok Equity, a New York real estate brokerage firm. Many myths surround the current debate over tax reform alternatives,

perhaps more myths than truths.

Many opponents of a national sales tax have stated that it would be bad for homeownership, since the rental of an apartment or the purchase of a home would be

taxed but the mortgage interest deduction would be eliminated. This is a myth. If

such myths prevail, they will constitute a triumph of rhetoric over reason. In fact

the FairTax, introduced on a bipartisan basis by Reps. John Linder and Collin Peterson as H.R. 2525, would have a positive impact on the real estate industry and

help make the American dream of owning real estate a reality for many Americans

sooner. As a realtor, I am pleased to submit this testimony outlining the positive

effects of the FairTax on real estate.

Point 1: Mortgage Interest Will be Paid for Out of Pre-Income and Pre-Payroll Tax Dollars, Which is Much More Advantageous than Today

Yes, the sales tax eliminates the mortgage interest deduction, but when we hear

this comment, we should ask ourselves this question: what becomes of the deduction? These deductions would not ‘‘disappear’’ in a negative sense. Rather, they

could not exist in the sales tax world since there would be no income tax against

which the deduction could be applied.

More importantly, however, they reappear in a different and stronger form: the

non-taxation of mortgage interest. Under an income tax, the mortgage interest deduction serves the purpose of ensuring interest payments are made against pre-income tax dollars. Unless one does not have the income to offset or does not itemize,

the mortgage interest deduction accomplishes well the purpose of offsetting income

taxes paid on the mortgage interest. In fact, in 1996, there were 29.4 million taxpayers who took the mortgage interest deduction, for a total itemized deduction

amount of $220.2 billion.1 The tax expenditure associated with this deduction in fiscal year 1999 is estimated to be $53 billion.2

However, it is important to note that as large as it is, the deduction is seriously

limited today for lower wage earners (read first time homebuyers trying to latch on

to the American dream) in the respect that it only serves to negate the income tax.

Today, mortgage interest payments must be made from after payroll tax dollars,

which comprises a significant segment of the taxes Americans pay. As a national

aggregate, in fiscal year 1997 individual income taxes were $737.5 billion, and payroll taxes were $539.4 billion, or 42 percent of the combined total. Many taxpayers,

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3Most economists believe that the employer-employee split is really a fiction; that employees

really do bear the full 15.3 percent. However, I make this adverse assumption in order to arrive

at a conservative estimate of the advantages of the Fair Tax. 4For an more detailed discussion of the impact on a national sales tax on interest rates, see

John E. Gobb, Economic Review, Federal Reserve Bank of Kansas City, ‘‘How Would Tax Reform

Affect Financial Markets?,’’ Fourth Quarter, 1995. He estimates a 25–35 percent drop (p.

27).Jorgenson.

especially lower income individuals, who are purchasing their first home pay a

greater portion of their tax liability in payroll taxes than income taxes.

Let us again see the world through the eyes of our fairly average homebuyer. Re- call the median family money income in 1997 was $44,568. Recall further that if

that income were all wage income, then that couple would have paid $6,819 in combined payroll taxes on those wages (employer and employee share). Even if that couple did not itemize (which they certainly would because of the mortgage interest deduction), the income taxes that they would pay if they filed married filing jointly

would be $4,856, or 29 percent less than the payroll taxes. In other words, the couple would have paid more payroll taxes than income taxes. When the couple takes

a mortgage interest deduction, the couple cannot take that deduction against the

most significant form of taxes that apply to them—payroll taxes.

Now let us consider what happens under the Fair Tax. Under the Fair Tax plan,

mortgage interest is simply not taxed—not at all. Therefore, like current law, homebuyers would pay mortgage interest out of pre-income-tax dollars. But more to the

point, since the Fair Tax repeals both the payroll taxes and the income taxes, the

effect of not taxing their interest payments is to ensure that the payments are made

with both pre-income and pre-payroll tax dollars. This will significantly advantage

home buyers relative to current law by reducing the costs of their loan. Since the

interest must be paid with after payroll tax dollars, a taxpayer today must earn

$108.28 to pay $100 in mortgage interest today if only the ‘‘employee’’ share of the

payroll taxes are considered. If the employer payroll taxes are considered 3 (or if the

taxpayer had a sole-proprietorship), he or she must earn $118.06. Under the Fair

Tax, that taxpayer would only need to earn $100 to pay $100 in mortgage interest.

Let us examine the relative advantage of not taxing interest payments vs. the

mortgage deduction against income in more detail. We again will use the median

purchase price of a previously occupied home, $146,000. But we add the fact that

mortgage interest rates are about 7–3/4 percent and that the median term of all

loans was about 27 years.

If we were to model our typical married couple above, with a typical home purchase, with a typical interest rate, with a typical term of years in a simple graph,

we could compare how much today’s mortgage interest deduction benefits the home

buyer to relative to the full non-taxation of interest on mortgages under the Fair

Tax. Over the course of the 27 year term, an interest rate of 7.75 percent would

add $202,834 to the required payoff of the loan. To completely pay off their loan,

our couple will have to earn $407,103 once employee payroll taxes and income taxes

(at the lowest 15 percent rate) are taken into account. Considering the impact of

employer payroll taxes would make the figure higher. Under the Fair Tax, in contrast, the couple would only need to earn $392,444 or four percent less.

This is not the end of the advantages, however. Our family’s disposable income

will probably go up by the 7.65 percent employer payroll tax and interest rates, and

since interest is no longer taxable, interest rates will come down by about one quarter as they settle toward the municipal bond rates. These two factors would save

our couple over $142,764, which consists of $92,055 in additional wages and $50,709

in reduced interest costs. If we were just to consider the interest rate reduction, the

cost of homeownership would be $341,735 or 16 percent less that under current law.

In short, homeownership under the Fair Tax is vastly more affordable.

Point 2: Mortgage Interest Will Fall

Home mortgage interest rates will fall by 25 to 30 percent (i.e., about two points

on a 30 year conventional mortgage). A legitimate question is ‘‘why?’’

The answer is that current mortgage interest rates include a tax premium, which

is the amount lenders pay in taxes on the income received. The magnitude of the

wedge can be seen by comparing the interest rates on taxable bonds to tax-exempt

municipal bonds of comparable risk and term. The impact of elimination of the tax

wedge or tax premium on interest is evidenced each day in the Wall Street Journal.

Tax-exempt municipal bonds tend to yield about 30 percent less than taxable corporate bonds of similar term and risk. The decline in interest rates will occur entirely because of the elimination of the tax wedge or premium on interest and will

happen independently of the impact of the sales tax on savings and investment.4

401

5 ‘‘Probably’’ because their will also be an increased demand for that savings for investment

purposes that will have a countervailing effect.

Investors will simply no longer need to charge a tax premium to achieve a particular

after-tax rate of return.

Moreover, interest rates will probably fall further because the supply of capital

for borrowing will increase.5 That is because a national sales tax is neutral toward

savings. Because the attractiveness of savings relative to consumption will increase,

investors will choose to save and invest more of their money rather than use it to

consume immediately. The after-tax return on their investment makes deferring

consumption worthwhile. In contrast, the current income tax is biased against savings and investment. The income tax double, triple and often quadruple taxes savings.

Economic studies show that savings are responsive to changes in tax treatment

and that savings rates are closely correlated to the return on savings.

Point 3: Lower Marginal Rates Will Reduce the Costs of Principal Payments

to Home Buyers

Sometimes the rhetoric surrounding tax reform loses site of the fact that home

principal payments are taxed today. As one editorial put it ‘‘if you bought a $150,000

house, you’d have to pay $22,500 more in taxes.’’ More in taxes? We forget that taxpayers today must pay for the principal in homes with after income tax and after

payroll tax dollars. The interest is deductible but the principal is not.

Under the FairTax, existing homes would never be subject to the sales tax. Similarly, homes built after the FairTax was put in place would only be taxed once when

first sold and would never be subject to sales tax again. In other words, used homes

are not subject to sales tax, only newly constructed homes are. With respect to new

homes, under the Fair Tax as with current law, principal payments would be taxed

but under the FairTax the income earned to pay for that principal would not be

taxed by the income tax or the payroll tax. Moreover, since the Fair Tax lowers marginal rates new home buyers would face lower after tax costs of their principal payments.

Given the fact that a consumption tax taxes purchases, but the income tax takes

the money before we purchase, how can we compare the two as they affect the

homebuyer? The only proper comparison is to ask ourselves this question: how much

money would a purchaser have to make to earn to pay for the principal in the

home? As noted, today, a purchaser of a home must make principal payments with

after tax dollars. A taxpayer who is in a 28 percent bracket, and pays a 15.3 percent

payroll tax, would have to earn $176,000 to purchase a home of $100,000 devoid of

the interest charge. They would have to make $265,000 to pay cash for a new home

of $150,000. Under the FairTax, a $100,000 existing home would cost $100,000

after-tax since no sales tax would be imposed. A $150,000 existing home would cost

$150,000. At a marginal rate of 23 percent, a $100,000 new home would cost

$130,000 after tax and a $150,000 new home, $195,000. So, the cost of making equity payments decreases as well under the Fair Tax compared to current law.

402

6Statistical Abstract of the United States, 1998, Table 1203. The median price of a previously

owned home was $124,100. See Table 1204.

Point 4: Individuals Will be Able to Save for the Purchase of a Home Much

Faster, Which Will Increase and Accelerate the Volume of Home Sales

Since the Fair Tax does not tax savings and investment and makes the payment

of the tax largely elective, it will enable new home buyers, second home buyers or

buyers stepping up, to save for their purchase faster. Buyers will be able to qualify

for a mortgage faster and existing owners will be able to sell their homes faster.

Why can individuals save so much faster? First, the Fair Tax removes the enormous disadvantage to savings and investment under our income tax system. Today,

savings and investment income is greatly disadvantaged. Wage and salary income

is included in the income tax base when it is earned originally. If that income is

consumed, the benefits of consumption go untaxed. However, if what is left of the

wages and salaries is saved (for example, for a new home), the earnings are taxed

as the income from that investment is generated. Then, if the income-producing

asset, such as a stock or bond, equipment or real property interest is sold for more

than it was purchased, the benefit of the capital investment—the capital gain—is

taxed a third time. Corporate income (including capital gains) is taxed at the corporate level and again when it is paid to shareholders as dividends. Inter-corporate

dividends are also subject to tax, creating yet another level of taxation.

A principal advantage the Fair Tax has over an income tax, therefore, is that the

downpayment can be saved without fighting against the cascading taxes on savings.

To illustrate the effects of the current taxes on savings and investment, let’s construct a typical fact pattern and then analyze the effects. Let’s take a married couple who wants to purchase a new home of $146,000, which was the 1997 median

new home price (the FairTax would tax the sale only of newly constructed homes).6

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7See Economic Report of the President, February 1999, Table B–33. 8 U.S. Bureau of Economic Analysis, reported in Economic Report of the President, February

1999, Table B–32. 9See, The Economic Impact of the National Retail Sales Tax, Dale W.

Let us further assume that that couple will need to save $14,600 (10 percent) for

the downpayment. Since the median family money income 1997 was $44,568 7 , let’s

further assume that that is the amount our couple earns. Today, the personal savings rate nationwide, as a percentage of disposable personal income, is about 2.1

percent.8

Our income tax system attacks their ability to save at the very beginning, when

our prospective buyer earns their income. Our family will be taxed on their earnings

at the 15 percent rate under the income tax plus payroll taxes. To save $14,600

after-tax that family must earn, at the margin, an additional $18,875 (looking only

at the employee share of payroll taxes and income taxes). They would have had to

earn $22,688 if they were in the 28 percent tax bracket, a more typical bracket for

homeowners.

If the $44,568 of our family’s income was all wage income, then that couple would

have paid $3,409 in employee payroll taxes on those wages. Note also that their

wages were also about $3,409 lower because of the employer payroll tax. Economists

generally believe that the employer share of the payroll tax is borne by the employee in the form of lower wages. After the standard deduction and two personal

exemptions, the couple would pay income taxes of $4,856. Hence, using a standard

deduction, the couple would have paid $8,265 in taxes on $44,568 leaving our family

$36,303 after taxes. 2.1 percent of that disposable income is $762.

Today, assuming they earn 8 percent on their savings, they are in the 15 percent

bracket and save $762 each year at the beginning of the year, they would be able

to save their down payment by early in the 13th year.

Under the AFT plan, their disposable income will increase to $47,977 because of

the repeal of all payroll and income taxes. Assuming they continue to save 2.1 percent of this amount, they would save $1,008 each year. Assuming they would earn

a lower 6 percent on this amount, then they would be able to save a $14,600 downpayment in the 11th year. Note, however, that the acceleration effect is much more

pronounced if they were in the 28 percent tax bracket. Even if we add 23 percent

to this amount, they would be able to save $18,961 in the 13th year. This, however,

is unrealistically pessimistic since the repeal of all income and payroll taxes will reduce producer prices. Harvard’s Dale Jorgenson estimates that construction prices

will fall by 25 percent.9

What does this mean in national aggregates? It means that we would accelerate

the purchase of homes, increasing the velocity of those sales. It also means that realtors would make more money faster since there would be many more home sales

crunched into a smaller period of time. More sales mean more commissions.

Point 5: The Fair Tax Makes Housing More Affordable by Repealing Upstream Taxes

Housing today is taxed much more heavily than most people realize. Like other

firms, homebuilders pay corporate taxes and payroll taxes, not only on their own

accord, but in the form of taxes embedded in the goods they purchase to build

homes. These upstream costs would disappear.

Research by Harvard economist Dale Jorgenson shows that producer prices in the

construction industry will fall 25 percent under the Fair Tax plan since the income

tax and payroll tax is embedded in the price of everything we buy. In this case, new

housing prices will be approximately the same price including the sales tax as they

are today and the relative price of new and used housing will remain roughly comparable to what they are today. If Jorgenson is wrong and the sales tax causes

prices to rise, then existing home prices will rise immediately to reflect the fact that

they are not subject to tax. Although this would result in a one-time, quick windfall

gain to owners of existing houses, the relative price of new and old homes will be

comparable.

Conclusion:

The combination of these factors means that the Fair Tax would be highly beneficial to real estate. The Fair Tax would:

• reduce the tax burden on interest;

• lower interest rates and make homes more affordable;

• lessen the pre-tax earnings a buyer must earn to pay for a home;

• quicken the pace of saving for a downpayment and the pace of home sales;

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1Middle Series, U.S. Bureau of the Census, Statistical Abstract of the United States, 1996,

Tables 814 and 17, pp. 15 and 17. 2Dale W. Jorgenson, Economic Impact of the National Retail Sales Tax, National Tax Research Committee, generally showing that producer prices will fall 20 to 30 percent because of

the repeal of income and payroll taxes. 3Statistical Abstract of the United States, 1998, Tables 845–847, pp. 533–534. In 1997, pri- vate pensions had assets of $4,846 billion and state and local pension funds had assets of

$2,100. In 1996, Individual Retirement Accounts had assets of $1,347 billion. In 1997 section

401(k) and other defined contribution plans had assets of $1,730 billion. 4 In short, by repealing the corporate tax, the tax on dividends and the tax on capital gains,

the net of income tax future income stream of corporations will increase and the capitalized

value of the that future income stream will increase as well. 5 U.S. Bureau Labor Statistics, Statistical Abstract of the United States, 1998, Table 798, p.

514.

• make homes more affordable by eliminating the taxes embedded in upstream

producer prices.

As you review competing tax reform plans, let us keep in mind one factor. The

income tax is not the perfect system for real estate and those that say that real estate might be hurt simply because the mortgage interest deduction is removed are

performing a very shallow analysis. It takes a little more effort to see the truth.

I am pleased to support the FairTax as a means of assisting more Americans in

achieving the American Dream of owning real estate.

I am David R. Burton, President of the Prosperity Institute. I am pleased to subStatement of David R. Burton, Prosperity Institute, Alexandria, VA

f mit this testimony on behalf of the Prosperity Institute. We would like to take this

opportunity to present our analysis of the impact of the leading national sales tax

plan on senior citizens. This plan is called the FairTax.

Senior citizens are becoming a larger portion of the overall population. In 1970,

those over 65 years of age were 9.8 percent of the population. By 1999, seniors were

12.7 percent of the population. In 2015, seniors will account for 14.7 percent of the

population and in 2020, they will account for 16.6 percent.1

Under the FairTax, senior citizens, like others, will receive a cash rebate effectively exempting consumption up to the poverty level from tax. The sales tax rebate

is equal to the sales tax that would be paid on expenditures up to the federal poverty level. Because the federal poverty level for two persons is not twice the level

for one persons, the FairTax provides that married couples would receive an extra

rebate amount to prevent any marriage penalty. The rebate is paid monthly in advance. Thus, poor seniors will pay no sales tax. A household spending twice the federal poverty level (or more in the case of a married couple) would pay an effective

tax rate of 11–1⁄2 percent.

Because income and payroll taxes are embedded in the price of everything we purchase, it is not clear that prices, even including the sales tax, will increase by very

much.2 They may not increase at all because pre-sales-tax prices may fall once the

income and payroll taxes are repealed. Nevertheless, the FairTax makes sure that

the Social Security benefits indexing formula would be adjusted so that benefits will

increase to the extent, if any, that the sales tax results in higher tax inclusive

prices. The income tax imposed on Social Security benefits will be repealed.

The income tax imposed on investment income and pension benefits or IRA withdrawals will be repealed. Pensions funds, IRAs and 401(k) plans have assets of well

over $11 trillion.3 An income tax deduction was taken for contributions to most of

these plans and the earnings on these plans have accrued free of any income tax.

All beneficiaries and owners of these plans expected to pay income tax on them

upon withdraw and would not be required to do so since the income tax would be

repealed by the FairTax.

Repeal of the corporate and individual income tax and the estate and gift tax will

have a substantial positive impact on the stock market.4 Those seniors that own

stocks either directly or through mutual funds, Individual Retirement Accounts,

401(k) plans or otherwise will experience significant gains. More seniors own stocks,

mutual funds or have IRAs than other age groups.5 In addition, unrealized capital

gains that would have been subject to the income tax when realized will no longer

be taxed.

The FairTax imposes a sales tax on newly constructed homes but exempts existing homes and other used property from any sales tax. Currently, equity payments

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6Statistical Abstract of the United States, 1999, Table 1215, p. 726.

7 ‘‘The Economic Impact of Replacing Federal Income Taxes with a Sales Tax,’’ Laurence J.

Kotlikoff, April 15, 1993, Cato Institute Policy Analysis; Dale W. Jorgenson, Economic Impact

of the National Retail Sales Tax, National Tax Research Committee. See also, ‘‘The Economic

Impact of Fundamental Taxing Consumption,’’ Dale W. Jorgenson, Testimony before the House

Ways and Means Committee, March 27, 1996 and ‘‘The Economic Impact of Fundamental Tax

Reform,’’ Dale W. Jorgenson, Testimony before the House Ways and Means Committee, June

6, 1995; ‘‘Looking Back to Move Forward: What Tax Policy Costs Americans and the Economy,’’

Gary Robbins and Aldona Robbins, Policy Report No. 127, September 1994, published by the

Institute for Policy Innovation; ‘‘Replacing the Federal Income Tax with a Consumption-Based

Tax System,’’ prepared by Nathan Associates for the National Retail Institute (1996). 8 ‘‘Examining a Change to a National Retail Sales Tax Regime: Impact on Households,’’ November 1996.

on homes must be paid from after-income tax earnings (i.e. principal payments are

not deductible). The purchase of existing housing is thus subject to the income tax.

Owners of existing homes may experience large gains due to the repeal of the income tax and implementation of the FairTax. Seniors and those nearing retirement

age have dramatically higher homeownership rates than other age groups. (80 percent compared to 66 percent on average).6 Homes are often a family’s largest asset.

Under the FairTax, the estate and gift tax would be repealed. The need for small

businesses and farmers to engage in expensive estate planning, involving attorneys,

complex estate freeze transactions and expensive life insurance plans in anticipation

of future estate and gift tax liability would disappear. Heirs would no longer need

to sell the business or farm out of the family or borrow heavily, putting the business

at risk, to pay the estate tax.

Replacing the current tax system with a national sales tax would make the economy much more dynamic and prosperous.7 Budget pressure on entitlement spending, already significant, will become much more pronounced once the baby boom

starts retiring. The economic growth a sales tax would cause would make it substantially less likely that federal budget pressures will result in Medicare or Social Security benefits reductions.

According to work by Stanford University economist Joseph Kahn, those seniors

with a net worth over $400 thousand (nearly four times the median) may see a reduction in their purchasing power. The largest decline in purchasing power, about

3.5 percent, is for those with net worth above about $700 thousand. The primary

reason for this effect is that wealth spent for consumption purposes that is held in

non-tax deferred accounts like IRAs will be taxed when spent under a sales tax and

would not be taxed further under an income tax.8 Kahn assumes, contrary to Jorgenson, that prices will rise.

Most seniors will be better off were the FairTax to replace the current system.

ENVIRONMENTAL

Statement of Redefining Progress, San Francisco, CA

TAX

fREFORM: AN IDEA WHOSE TIME HAS COME

[This testimony is largely excerpted from the monograph, Tax Waste, Not Work:

How Changing What We Tax Can Lead to a Stronger Economy and a Cleaner Environment, by M. Jeff Hamond, published by Redefining Progress (RP). For more information about RP’s work on tax shifting or to order a copy of the monograph, call

(800) 896–2100.]

Despite the sustained overall strong performance of the American economy—such

as a high rate of job creation, declining deficits, and low inflation and unemployment—the nation is still struggling with several important long-term problems.

Among the most serious of these are the payroll tax and the exploding growth of

entitlement programs; the emergence of global climate change as a significant environmental and economic threat; the lack of economic opportunity in our inner cities;

and the dislocation and hardship that are being caused by major economic transformations (such as the rapid growth of information technologies) even as they provide exciting new opportunities. Each of these problems has caused many scholars

and activists to look for solutions, but so far few good ideas have moved from theory

to actual policy.

A Fresh Approach to Some Old Questions

A new approach to fiscal and environmental policy—a resource-based tax shift—

holds the potential for improving many of the country’s problems simultaneously,

406

while attracting support across the political spectrum. This approach would reduce

current taxes on labor, innovation, and capital formation and replace the revenue

with new levies on pollution and waste. Total federal revenue would be unchanged

and the current distribution of the tax burden across income groups would be preserved.

A revenue-neutral tax shift of this type could be accomplished through the use

of new taxes or tradable emission permits, but the basic idea—that the new revenue

should be used to reduce existing taxes—would be the same under either mechanism. Many of the potential benefits of this policy idea are dependent upon this

‘‘revenue recycling.’’ Because other taxes are being reduced, this proposal is not a

new revenue source to buttress government expenditures. It would simply replace

a portion of federal revenues—perhaps 5 to 10 percent—with revenues from environmental taxes or permits.

The proposed new tax system is designed to be revenue-and distributionally-neutral because the way in which a free society decides to distribute the burden or

spend public tax dollars should be a separate issue from that of the method used

to raise the revenue. This distinction is not meant to be an endorsement of the current tax distribution or size of government. Rather, it is meant to emphasize the

fact that the tax shift is neither a tool to increase government (in fact, it could do

just the opposite), nor to shift the tax burden to the rich or the middle class.

This new approach to public policy could create a powerful alliance among those

concerned with problems such as high taxes on capital formation or on the average

family; the need for additional investments in human capital and research and development (R&D); the threats to the global environment; the costly regulatory burden on private industry; fiscal irresponsibility; the complexity of international tax

rules; and job creation in inner cities. It would provide a rare opportunity to enact

tax cuts on both labor and investment income. By so doing, it would attract support

from both ends of the political spectrum and potentially create incentives for more

investment in both human and physical capital—an economic stimulus package with

no revenue cost. Given the mounting interest in fundamental tax reform, the weaknesses of the tax reform plans that have been offered, and the growing international

momentum for addressing the threat of climate change, such a proposal could not

come at a better time.

The Tax Shift Concept

The current tax system sends the wrong signals to virtually everyone. It discourages work, enterprise, and capital formation while it encourages sprawl, pollution,

waste, and the inefficient use of resources. There is almost unanimous agreement

that the tax system needs reform.

There are really two sides to the tax reform debate—and they aren’t ‘‘liberal’’ versus ‘‘conservative.’’ Rather, they are what should be taxed and what should be

untaxed—and the next attempt at major tax reform should focus on both. Look at

it this way: When the government wants to promote a social goal, what does it do?

It reduces income taxes—via credits, preferences, and deductions—on particular activities that the government thinks will help accomplish that objective. Retired Sen.

Bill Bradley (D–NJ) calls this practice ‘‘government by tax break,’’ and it helps explain why the tax system is the part of government that people hate the most. But

what if the government can accomplish social goals both through what it taxes as

well as what it untaxes?

Common sense dictates that you get less of what you tax and more of what you

don’t. Since higher rates of saving and investment can drive faster economic growth,

many recent tax proposals focus on reducing taxes on capital income in the hopes

of creating more saving and investment. Yet in an effort to keep total revenue relatively stable, some of these proposals would increase taxes on labor in order to

untax capital. This action would have the perverse result of raising taxes on modest

and average income people—and if common sense applies, this in turn would result

in less labor.

The argument works the other way as well: Higher taxes on capital holders

should not be used to finance tax cuts for working people, because these tax increases penalize the investment and entrepreneurism that creates new jobs and opportunities. Such a policy untaxes labor in order to tax capital. In an economy that

needs more of both human and physical capital, considering only these two options

presents a false choice.

Make no mistake: A tax code is primarily a means of raising revenue. But it also

sends powerful messages through what it does, and does not, tax. In this light, why

not develop a socially useful tax system that would tax those things the country

needs less of, and untax those things of which society wants more? This idea is

being tried around the world, and even the British news magazine The Economist

407

has endorsed such an approach. Tax Waste, Not Work suggests bringing this concept, commonly called environmental or resource-based tax shifting, to the United

States.

This type of tax reform could lead to a cleaner environment at the same time that

incentives are provided for more work and investment. Just as importantly, it could

be designed without a regressive shift of the tax burden if regressive taxes like the

payroll tax are reduced to offset the new levies. Revenues could be gained from taxing carbon dioxide emissions, air and water pollution, or consumption of virgin materials. Emission permits could be auctioned to firms, which would also raise substantial revenue; similarly, fees could be charged for the use of certain assets held

in common by the public. On the tax reduction side, payroll, individual, and corporate tax rates could all be reduced—without increasing the deficit or forcing huge

cuts in government services.

While such a shift from taxing ‘‘goods’’—the creation of wealth through labor and

investment—to ‘‘bads’’—the depletion of wealth through pollution and environmental degradation—cannot be a magic bullet for every economic and environmental ill, it does offer a promising chance for promoting work and investment

while concurrently moving toward the types of market-based policies that would be

an improvement over the current regulatory structure.

Deflecting Past Critiques

The idea of using market-based policies such as taxes or emission permits to deal

with environmental problems has been a staple of the academic literature for decades. But these policy tools have been widely criticized in the United States for a

number of reasons—all of which a tax shift would address:

• Environmental taxes and permits have often been pushed as tax increases,

rather than as a lever for reducing other taxes. A tax shift, however, would substitute higher taxes on some things with lower taxes on others, with the objective

of leaving most individuals paying roughly the same amount in total. Only recently

has this idea for ‘‘revenue recycling’’ been receiving attention from academics and

public policy groups. For example, the World Resources Institute’s Green Fees report and Ernst Ulrich von Weizsacker’s book, Ecological Tax Reform (both published

in 1992), broke new ground in this area; an interesting body of literature has followed these front runners, discussing the potential benefits of such ‘‘recycling.’’

• The business community has lobbied against these so-called ‘‘green taxes’’ in the

past, fearing that they would cost jobs, reduce economic growth, or detract from U.S.

competitiveness. But a tax shift, by reducing other taxes with high distortionary

costs, should greatly reduce or eliminate these concerns.

• Environmental taxes and permits have been criticized for their regressive nature—that is, for affecting the poor and middle classes relatively more than the

well-off, since lower income families spend a larger percentage of their income on

energy. Yet under a tax shift, other regressive taxes could be reduced to maintain

the current distribution of the tax burden.

• Past critics could point to the potential risk of being the first industrialized

country to advance these proposals in a major way. But now there are models to

look to, as several countries have adopted ‘‘green taxes’’; and others, including Denmark, Great Britain, and Costa Rica, have passed mild tax shifts.

The Rationales for Change

Philosophic Rationales

A tax shift policy sends a powerful message from the perspective of restoring legitimacy to public finance: Individuals should be able to keep more of the fruit of their

toil, but should pay for the costs that they impose on others. This change would restore both a coherent rationale and a sense of values to the nation’s tax system. Tax

shifting also offers the potential to draw public revenue from resources already

owned in common (e.g., public lands, the broadcast spectrum), thereby enabling all

citizens to receive dividends from the use of common assets.

To the extent that it replaces the current tax structure, a shift to resource taxes

would also restore the notion that the costs of today’s actions should not be borne

by future generations. This would bring a sense of ‘‘honest accounting’’ back to government. In other words, rather than paying taxes based upon their work or saving,

people should increasingly pay taxes based upon the resources they consume and

the pollution they cause. Thus, society ‘‘pays’’ for the problems it passes on to its

children, rather than passing on the burden.

Finally, by providing incentives for people and businesses to invest in energy efficient vehicles, homes, and equipment, a tax shift empowers people to reduce their

own tax bills in a way that the current system does not.

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Economic and Fiscal Rationales

While tax shifting is a relatively new idea, the economic rationales for pursuing

it are numerous and rest on several long-standing pillars of mainstream thought.

• The current tax system imposes significant efficiency costs and therefore retards economic growth. Replacing a portion of these economically inefficient taxes

with ‘‘corrective’’ taxes (which have lower efficiency costs, or ‘‘deadweight losses’’)

could reduce the overall economic cost of the tax system. It could also yield several

important economic benefits, ranging from more job creation and/or higher wages

to new investments in energy efficiency and higher economic growth. Redefining

Progress has sponsored research that concludes that, depending on incidence assumptions and revenue recycling choice, approximately three-fourths of industry

and workers stand to gain from environmental tax reform, in terms of reduced tax

burden and increased competitiveness.

• Current market prices for many goods do not take the social and environmental

costs of production or energy consumption into account. Adding the costs of these

externalities into the price system, via the tax code or emission permits, would

make the economy more efficient. Despite disagreement about how (and by how

much) energy prices ought to be raised, most economists would agree that energy

prices ought to be higher—and that higher prices would not be as costly to the economy as some critics claim.

• The academic literature has shown that the most efficient use of any revenues

from environmental levies would be to reduce other taxes. While there is disagreement over whether tax cuts on work or investment are more likely to yield economic

gains, it is this potential for lowering current taxes that is likely to be the most appealing part of this proposal for many individuals, private firms, and elected officials.

Environmental Rationales

Another motivating force for a tax shift is that it would provide a least-cost approach to reducing pollution, waste, and the long-term threat of climate change. In

the summer of 1995, the Intergovernmental Panel on Climate Change (IPCC)—a

group of more than 2,200 scientists and economists from nearly 60 nations—declared that ‘‘the balance of evidence suggests that there is a discernible human influence on global climate,’’ signaling the growing scientific consensus on the issue.

In 1998, over 2500 economists, including eight Nobel laureates, signed a statement

that global climate change carries with it significant environmental, economic, social, and geopolitical risks, and that market-based policies offer the most efficient

solution for slowing the effects of climate change.

The view that climate change is not an economic problem is changing as the staggering costs of dealing with its effects become more apparent. Despite greater energy efficiency in the United States, global emissions of carbon dioxide are projected

to grow by 54 percent over the next 20 years. In response, the U.S. government has

begun to shift its view of the climate change problem. In July 1996, the Clinton Administration announced its support for the adoption of binding yet flexible targets

to reduce global carbon emissions. In 1997, the United States negotiated the Kyoto

Protocol, along with 160 other countries, under which it agreed to reduce its greenhouse gas emissions by 7 percent between 2008 and 2012. A tradable emission permit system will be instrumental in achieving these goals.

Industry leaders, policy makers, academic economists, and many members of the

environmental community have also shown growing support for market-based approaches to environmental policy. The Clinton administration, presidential candidate George W. Bush, and many members of Congress have all stated that climate

change is a problem. Various business sectors—most notably insurance and finance—are increasingly viewing climate change as a threat to economic performance, public health, and geopolitical stability. The focus of these interests has not

only been on the climate change issue, but also on pollution, congestion, and solid

waste. The possibility of addressing these problems with less regulation creates the

potential for new alliances between business, environmentalists, labor unions, tax

reformers, and elected officials at all points along the political spectrum.

Tax Shift Efforts at the State Level

Broader acceptance of environmental tax shifting as a concept has gained momentum at the state level. Environmental and tax reform groups in California, Florida,

Maine, Massachusetts, Minnesota, New Hampshire, Oregon, Pennsylvania, Texas,

Vermont, Washington, and Wisconsin are working on moving specific reforms in

their respective states. Proposed bases for increased taxes include land use, vehicle

miles traveled, large livestock property, water pollution, and energy emissions, with

proposed decreases in payroll, income, sales, and corporate taxes.

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Although legislators remain wary of tax shifting, perhaps because of reflexive suspicion of any tax measure, all U.S. states have at least some environmental tax provisions, and several have recently considered or are considering new measures to

shift taxes toward environmentally harmful activities. In Minnesota, the legislature

introduced the Economic Efficiency and Pollution Reduction Act (EEPRA) in 1997,

which would have combined a carbon tax with an offsetting reduction in property

and payroll taxes. The House Environment Committee debated the bill, but it was

withdrawn without a vote. Environmental tax reform has been suggested as an instrumental base for education finance reform in New Hampshire. A court order

mandating increased aid to education, combined with enduring reluctance to introduce a sales or income tax, has made pollution taxes a politically viable alternative

to increased property taxes. In neighboring Vermont, a proposed legislative tax shift

study lost by one vote in the House in 1999.

It should also be noted that environmental taxes are much more widely accepted

in Europe than in the United States. Consider these examples:

• In Denmark, green taxes are being used to reduce income taxes and employers’

social security contributions.

• In Finland, lower taxes on income and labor are being offset, in part, by green

taxes, such as a landfill tax, and increased energy taxes.

• In the Netherlands, part of the regulatory tax on energy is being allocated to

a reduction in employers’ social security contributions.

• In Sweden, a 1991 tax reform resulted in higher environment-related taxes and

lower marginal income tax rates.

• In the United Kingdom, revenue from a new landfill tax is being used to reduce

employers’ social security contributions by 0.2 percentage points.

The Potential Benefits of Change

The following are the most important potential benefits of this fresh approach to

fiscal policy, each of which is examined in Tax Waste, Not Work.

1. Job creation could be spurred, take-home pay increased, and/or incentives to

enter the workforce enhanced as a result of lower payroll taxes.

2. Reducing taxes that carry large efficiency losses could enhance economic efficiency, thus improving the economy’s overall capacity to create jobs and wealth.

3. The collective threats of climate change (i.e., economic, health, environmental,

and political) could be addressed through a proactive solution.

4. Environmental benefits such as less pollution and waste could be realized

through market-based solutions, with less reliance on heavy-handed government

regulation such as vehicle emission standards.

5. Businesses and individuals would have a greater incentive to make new investments in technological innovations or energy efficiency, thus exerting a new measure of control over their own tax burdens.

6. The taxation of capital and business income could be greatly simplified or reduced without shifting the tax burden down the income scale.

7. New incentives would be created for investment in R&D and the development

of the businesses and technologies of the future, helping U.S. companies gain competitive advantage in new markets.

8. Inner cities could become more attractive business locations because of their

abundant labor and available scrap materials.

9. Changes in energy prices could reduce congestion and make mass transit investment more viable for private investors, possibly reducing the need for public

subsidies.

10. If there is a general consensus that taxing waste, and not work, is reasonable,

public trust in government—and compliance with the tax system

f —will increase.

Statement of Barry Cargill, Small Business Association of Michigan

Mr. Chairman and Members of the Ways and Means Committee of the

United States House of Representatives:

My name is Barry Cargill; I am Vice President for Government Relations of the

Small Business Association of Michigan. We are sometimes recognized by our acronym SBAM. We are a state based small business trade association representing

8,000 small businesses in Michigan. We represent all types of small business, from

manufacturing businesses to retailers.

The FairTax is an issue that was heatedly debated by our members and Board

of Directors. In the end, our Board of Directors unanimously approved the FairTax

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as the best alternative to replace the current system. Education is key to understanding benefits of the FairTax. In fact, the more that our members learn about

the FairTax, the more enthusiastically they support it.

Todd McCracken of NSBU is scheduled to testify in support of the National Sales

Tax proposed by Citizens for Fair Taxation (The Fair Tax Plan) and we would like

to associate SBAM with his comments.

SBAM shares the position of NSBU and supports the FairTax as the best alternative for comprehensive national tax reform. The debate over spending our projected federal budget surpluses masks the fact that small businesses struggle under

the burden of a troubled federal tax system. The Fair Tax abolishes the current system by replacing all federal income, payroll, death and capital gains taxes. In place

of the abolished taxes, the Fair Tax proposes to institute a 23 percent tax-inclusive

sales tax on all end-use goods and services.

One of the key reasons we support the plan is that it will reduce compliance costs

unlike any other tax alternative. Small businesses must use complex tax accounting

rules to keep track of income, inventories, types of expenses, depreciation, various

employee benefit regulations, payroll taxes (including Social Security, Medicare, and

unemployment taxes) and file the necessary accounting and information returns.

This takes precious time away from trying to grow the business and become more

profitable.

Apart from the level of compliance costs, there is something fundamentally different in the effect of these compliance costs on small firms. First, small firms pay

higher compliance costs as a percentage of revenues. In many cases, compliance

costs such as those associated with pension plans, payroll taxes, software, accounting system are fixed costs with regressive effects on small companies. In most cases,

small firms must endure the same panoply of laws and regulations as larger firms,

the same recordkeeping and system requirements. However, small firms have less

revenue against which these costs can be spread. Secondly, small firms do not have

the same capabilities to push these costs forward on consumers or customers. When

a large firm has associated revenue costs, they often simply push these costs forward in the prices of goods and services. When small firms incur such costs, they

result in lower wages, lower returns on investment and fewer opportunities for entrepreneurs. Under the Fair Tax, only one question is relevant to small

businesspersons. How much did I sell to customers? By reducing overhead to answering that single question, the FairTax would reduce compliance costs by about

90 percent, freeing capital and entrepreneurial energy.

Another reason we support the FairTax is that it shifts the emphasis of taxation

away from saving and investment and productive activity.

Payroll taxes constitute more than one-third of all federal revenue collections.

Since 1970, business received nine social security (FICA) tax increases totaling 133

percent, and 19 FICA base increases totaling 677 percent. Additionally, payroll

taxes are a tax on employment and thus discourage hiring employees. Employees

are the winners when the tax system encourages rather than discourages employment.

The death tax presents families with the problem of liquidating the family business in order to pay for the taxes on inheritance or to drain valuable resources from

the business to establish costly and confusing trusts. Only 40 percent of all small

businesses make it to the second generation and only 10 percent to the third.

Capital gains incentives have traditionally, and inaccurately, been seen as a tool

only of venture capitalists and wealthy investors. However, we must remember the

vast networks of informal investors in the small business community. Research conducted by the Small Business Administration (SBA) shows that informal equity investors in small firms are a much larger financing factor than venture capital.

Eliminating capital gains taxes would lead to a boon in small business investment.

We would note that Members of this Committee will likely read some testimony

by large retailers that believe the FairTax would hurt retail sales. Their statement

appears to suggest that there will be a sticker shock to a national sales tax. We

disagree with this assessment from several perspectives and wanted an opportunity

to advance these points.

First, like other firms, retailers will enjoy a zero corporate tax rate and their

shareholders will not be taxed on dividends received from the retailer or capital

gains on their investment in the retailer. Like other firms, they will enjoy much

lower compliance costs. Instead of having to comply with the complexities of the income tax, payroll tax, and various excise tax, there will be one sales tax on all goods

and service. The firm will simply need to calculate on a monthly basis its total retail

sales. Retailers will receive an administration fee for complying with the sales tax.

There will be no more uniform inventory capitalization requirements. There will be

no more complex rules government employee benefits and retirement plans that

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serve as a barrier to providing employees with retirement plans. There will be no

more tax depreciation schedules. Do large retailers really want to continue these onerous laws?

Second, consumers will see their paychecks increase by over $1.1 trillion. Finally

consumers will have more money to spend. Since the plan is revenue neutral, the

repeal of the income tax will provide consumers with the money necessary to pay

for the sales tax. Sales taxes were originally installed at the state level in the 1930’s

because in times of economic fluctuation, consumption is a more stable source of revenue collection.

Third, retailers will make more money in a prosperous, growing economy. All respected economic projections predict a much healthier economy. People are willing

and able to purchase more goods and services in a healthy economy. Typical estimates are that they economy will be 10 to 14 percent larger within 10 years and

consumption will grow very substantially. Some studies show the potential gains to

be much higher. Real wages will increase.

We would note that in a study prepared by Nathan Associates (March, 1996) for

the National Retail Institute, which by its own admission made every conceivable

adverse assumption, the economy will grow three percent more in ten years than

it would have under the income tax. The increase in consumption will be 1.15 percent less in the first year relative to what it would have been under the income tax.

Consumption will be higher in the fourth year and every year thereafter than it

would have been under the income tax. The study assumed that every dollar in new

U.S. investment must come from the U.S. rather than foreign investors and assumes a very low effects of higher investment on productivity. It assumes no gain

in productivity from lower compliance costs.

As this Committee reviews the FairTax proposal, keep in mind that consumption

purchases must be made from after-income-tax dollars today. The primary difference between a sales tax and an income tax is that the income tax doubly or

triply taxes savings. How much tax on savings is too much? How much of a tax on

investment is too much? What is wrong with developing a tax system that fully

eliminates the tax on savings and investment and gives consumers the choice to either spend or invest the fruit of their labor?

There are other factors. For one, consumer interest rates will fall dramatically,

probably by about 25 percent, and consumer’s ability to finance consumption will

be higher. In the case of interest that is presently deductible, the fall in interest

rates and the lack of deductibility is just about a wash for most people. Since consumer interest is not deductible under present law, this effect will be strong with

respect to credit card or consumer loan financed purchases. Finally, the committee

should not dwell on the rate. The FairTax does not raise more money than our current system ,it just makes the taxes we pay visible. The relative purchasing power

of the dollar will remain the same; in fact, estimates are that real wages would increase. We should not be opposed to truth in advertising the cost of the Federal government.

The FairTax is a refreshing alternative to the current quagmire of taxes and regulations. It would reduce complexity and allow Americans to understand the tax system to which they are subject. It will lower compliance costs. It will make the taxes

we pay visible. It will help our international competitiveness. It will help America’s

entrepreneurs become more prosperous, more vibrant and an even greater job generator. This will help consumption as well as wages. And when the economy does better, we will see even more surpluses so the tax rate can be lowered.

Thank you for the opportunity to present the views of Michigan small business.

We encourage this committee to hold additional hearings on the FairTax. We are

confident that the more that is learned about the proposal, the better it will sound

to you and the American public.

On behalf of the Small Business Survival Committee (SBSC) and its more than

Statement of Raymond J. Keating, Small Business Survival Committee

f 50,000 members across the nation, I appreciate this opportunity to spell out SBSC’s

position on the ‘‘Fair Tax Act.’’

SBSC is a non-partisan, non-profit advocate for small business owners across the

nation. On a wide array of policy issues impacting the small business community

and the economy in general—including taxes, regulations, trade, and government

spending—SBSC consistently argues from a principled, free-market perspective.

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As you know, the ‘‘Fair Tax Act’’ would eliminate all income, payroll, estate and

gift taxes, and replace them with a national retail sales tax of 23 percent. The general revenue rate would equal 14.91 percent, with the remaining 8.09 percent going

for Social Security and Medicare hospital insurance. No tax would be paid on products or services purchased for business, investment or export purposes. And except

for some isolated exceptions, the tax would be collected and remitted (monthly) by

the seller. In states that already levy a sales tax, the state would administer the

federal sales tax, keeping .0025 percent of the amount collected for administrative

costs. In states that do not impose sales taxes, the federal government would administer the tax.

A ‘‘family consumption allowance’’ would be rebated each month to each family/

individual in the amount equal to the product of the sales tax rate and the monthly

poverty level. The Social Security Administration would mail the monthly rebate,

or provide rebates through smart cards.

SBSC supports throwing out the current messy, complicated, unfair and antigrowth tax system that entrepreneurs, businesses and individuals currently labor

under in favor of a national retail sales tax. On several occasions, we have outlined

the key principles that should buttress any serious effort at tax reform: • Low Flat Tax Rate to Promote Economic Growth. The lower and more

proportional, or flatter, the tax rate system the better. Obviously, a low tax rate

boosts incentives for working and risk taking. • No Taxation of Capital. Taxing returns on investment and savings makes absolutely no economic sense. First, taxing returns on capital is an example of double,

triple or more layers of taxation. Second, since investment and entrepreneurship are

the primary engines of economic growth, taxing the returns on such activities is

counterproductive. Along these same lines, it must be remembered that labor is

powerless without capital, and therefore, taxing capital hurts labor. • Inflation Factor. The detrimental effects of inflation should be factored into

any tax system’s design. No additional incentive for the monetary authority to inflate should be provided by the tax system, and taxpayers should not be penalized

due to inflation. Therefore, tax brackets should be indexed for inflation. • Clarity. The best tax system makes clear how much is owed, who pays, and

when the tax is being paid. • Simplicity. Tax payments should be made as easy and as simple as possible

for the taxpayer without any loss of clarity. • Limited Bureaucracy and Intrusiveness. The fewer tax collectors and the

more limited their powers the better. • Minimize Incentives for Tax Avoidance. Taxes should be low enough so as

not to provide significant incentives for avoidance. • No Additional Boost to Government Spending. A tax system’s design

should not make it any easier for government to increase expenditures.

How does a national retail sales tax—or the Fair Tax—score according to these

fundamental principles?

• Low Flat Tax Rate to Promote Economic Growth. Obviously, income

would not be taxed under this plan and consumption would be taxed at the final

retail level at a flat rate of 23 percent. By not taxing work, saving, investing, and

risk taking at all, pro-growth incentives and the economy would receive major

boosts.

For critics saying that such a tax would be regressive, in fact a small amount of

progressivity would be introduced into the system through the family allowance rebate. SBSC’s only concern is to lower the proposed 23 percent tax rate.

• No Taxation of Capital. The Fair Tax would do away with cases of double,

triple or more layers of taxation by not taxing returns on investment and savings

at all. Incentives for saving, investment, and risk taking would skyrocket, with entrepreneurship, economic growth, and job creation receiving a significant boost.

• Inflation Factor. The inflation question may seem somewhat murky regarding

the Fair Tax, but in the end, a retail sales tax provides little incentive for the government to inflate. One need only remember that inflation is a monetary phenomenon, caused by money supply outpacing money demand.

• Clarity. It remains difficult to imagine a clearer tax system than the Fair Tax.

Whenever one buys something, the tax owed becomes immediately clear and is paid

at that moment.

• Simplicity. The Fair Tax would be far simpler than an income tax system for

individuals and many businesses. However, some questions remain for retail businesses as to whether a national retail sales tax eases or adds to their tax compliance

burdens. However, since most states already levy a sales tax, additional compliance

costs would be minimal, well worth the elimination of federal income and death

taxes.

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• Limited Bureaucracy and Intrusiveness. The Fair Tax would allow the IRS

to be disbanded and replaced with a much smaller, less intrusive bureaucracy to collect sales taxes in the very few states that do not impose sales levies. • Minimize Incentives for Tax Avoidance. One of the most serious questions

regarding the Fair Tax relates to tax evasion. A national sales tax rate of 23 percent, especially when combined with state and local sales taxes, and a seemingly

easy ability to avoid sales levies, creates a very real and significant temptation for

tax avoidance. Obviously, the best way to deal with this issue is to cut the size of

government and lower the tax rate. • No Additional Boost to Government Spending. Indeed, regarding its effect

on government spending, the Fair Tax actually should act as a restraint on the

growth of government. Every time a purchase is made at the retail level, the cost

of government becomes clear with the fair tax. Indeed, little evidence exists that retail sales taxes are a major impetus to the growth of government. In contrast, the

current income-and asset-based federal tax system fuels the growth of government

and hides the total cost of government from most taxpayers.

As you can see, throwing out our current tax code in favor of the Fair Tax would

be a major pro-growth, pro-entrepreneur reform. However, the biggest danger regarding the move from our current income-and asset-based tax system to a retail

sales tax like the Fair Tax is the looming threat that in the end U.S. taxpayers

could be saddled with both a sales tax and an income tax. Therefore, before a national retail sales tax is implemented, the 16th Amendment to the U.S. Constitution, which allows for the imposition of an income tax, must be repealed. Without

repealing the 16th Amendment, the chances that politicians—who seemingly always

seek to expand the power and resources of government—would eventually impose

both a sales tax and an income tax are too great.

If the 16th Amendment were repealed, from an pro-economic growth viewpoint,

a retail sales tax is far preferable to any kind of income tax.

Again, I appreciate this opportunity to address the ‘‘Fair Tax Act.’’ Feel free to

contact me at SBSC with any questions or comments.

Mr. Chairman, Honorable Members of Congress, Ladies and Gentlemen:

Fundamental tax reform is an issue that is now sweeping the nation. In a recent

Statement of Lori Klein, Taxpayer Protection Alliance, Phoenix, AZ

f poll taken by the Tax Education Association (TEA) 81.7 percent of the electorate

now feel that tax reform must be given high priority in the upcoming elections. The

study showed that although the IRS has attempted to create a new image for itself,

the public consensus is that the agency is still as unpopular as ever. According to

the poll, 75% feel the IRS has too much power and 88.6% want to see the agency

further reformed or eliminated altogether. It also showed that only 16.2% believe

that our current income tax system is fair.

The Taxpayer Protection Alliance is a group of citizens from Arizona who are

dedicated to achieving fundamental tax reform, which is non-other than the total

elimination of both our state personal and corporate income tax over the course of

four years. Currently, we have a petition initiative calling for the abolition of our

state income tax coupled with a voter referendum, which does not allow politicians

to raise our taxes without voter approval. The ballot measure also calls for all federally elected officials from Arizona to pledge in writing to vote to abolish the federal

income tax and replace it with a national retail sales tax on consumption and have

it duly noted by their name on the ballot as ‘‘Accepts IRS elimination pledge.’’

As many testifying here today have noted, removal of the federal income tax system to be replaced with a national sales tax has a myriad of benefits to our economy

and personal freedom. I would like to address today however, the benefit of the

states adopting similar measures throughout the nation to coincide with the elimination of the current progressive income tax on the federal level.

THE ARIZONA ECONOMY

While Arizona’s employment rate is low and the economy is strong, things could

be much better. Many people who have jobs have low-paying service sector jobs. Arizona ranks near the bottom of the states in annual per capita income. About half

of all jobs held by Arizonans are in the bottom third of industries ranked by average

annual pay, according to economist Debra Roubik of VisionEcon. 16% of all highpaying jobs in Arizona are high-tech manufacturing jobs, and 14% are in high-tech

services (ATTACHMENT 1). These are the jobs being created by the ‘‘new economy.’’

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These are the jobs in the sector of the economy with the greatest promise for the

future.

THE IMPACT OF ELIMINATING INCOME TAXES ON THE STATE ECONOMY

A study for the Arizona Association of Industries by Deborah Roubik of

VisionEcon, published in January 2000, and cited in the Arizona Business Gazette

and other publications, verified findings suggested by the classic work of Timothy

Bartik in 1991 regarding the effect of state taxes on local economy. She found that

for every 1 percent decrease in the state corporate income tax rate there is a 0.3

percent increase in new job creation, compounded annually. Furthermore, she found

an inverse correlation between the marginal personal state income tax and hightech service jobs as a percentage of jobs in the state. That is, the lower the income

tax rate, the greater the percentage of high-tech service jobs, and vice versa (ATTACHMENT 2).

The marginal state corporate income tax for a multi-state corporation in Arizona

is 3.5%.

Elimination of the state corporate income tax can be expected to generate an increase in job creation of approximately 1.2% per year, compounded annually, and

increase the number of high-paying, high-tech manufacturing jobs, according to

economist Debra Roubik.

Elimination of the personal income tax will assure that a significantly greater proportion of those additional jobs that are created will be in the high-paying high-tech

service fields.

Arizonans are losing out to residents of other states when it comes to growth in

earnings and higher paying jobs. Arizona’s residents are losing out to states like Nevada, Texas, Washington, and Florida, where the absence of income taxes create

jobs with substantive earning potential—jobs with a future. Although Arizona has

a low unemployment rate, far too many Arizonans are just barely ‘‘getting by’’ in

low-end jobs without much of a future.

ELIMINATING THE ARIZONA PERSONAL AND CORPORATE INCOME

TAXES IS THE MOST EFFECTIVE AND EFFICIENT SOCIAL WELFARE PROGRAM OUR STATE CAN EVER PUT INTO PLACE.

SALES TAXES AS A REPLACEMENT FOR THE STATE INCOME TAX

A recent economic study by VisionEcon, using Arizona Department of Revenue

Annual Reports, demonstrates that, using historical trends, the projected annual increase in sales tax revenue generated by the typical growth patterns in the Arizona

tax base (Arizona employment is projected to continue growing by almost 2% more

than the national average), could be used to painlessly reduce income tax collections

every year. The result would be a ‘‘revenue neutral’’ elimination of the income tax

in just seven years. This does not include any dynamic analysis. That means it does

not take into account the added revenues we would get from the boom in economic

activity and job-creation coming about from reducing or eliminating the income tax.

It also does not take into account revenues from luxury tax and estate and property

tax revenues (ATTACHMENT 3).

Thus using dynamic scoring, it is plain to see how easily the state’s revenue

stream can accommodate elimination of the personal and corporate income tax.

Furthermore, in an Arizona Republic news article dated April 2, 2000 it was reported that approximately $4.2 billion in sales tax revenue goes uncollected each

year as a result of over 600 exemptions in the state sales tax, most of which were

enacted after intense lobbying from special interest groups.

This revelation came as news to most Arizona residents in the private as well as

the public sector. Few were aware that these exemptions were ever passed into law.

And these exemptions are almost double the revenues currently collected from the

state income tax. Some of these special interests who benefit from these exemptions,

need them to offset the effects of the income tax—that’s the tradeoff. Special interests are holding the average Arizona citizen and businesses hostage to the income

tax. IS THIS TAXATION WITH REPRESENTATION?

Governor Hull, in the same Republic article pointed out that it is politically extremely difficult to overcome the will of those special interests. But, if the Taxpayer

Protection Act was in effect, since many of those exemptions may have had to get

voter approval in order to go into effect, they may have required an increase in some

other tax to offset the exemption. The special interests would have thus been cut

out of the loop—instead, today we see the voters cut out of the loop. Furthermore,

many special interest groups would not find it necessary to seek exemptions if they

didn’t have to pay personal and corporate income taxes.

WE WOULD BE BETTER OFF AS A NATION WITHOUT THE INCOME TAX

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The income tax is based on a fundamentally flawed and immoral idea that the

state has a prior claim on the fruits of another person’s labor or property. A person’s

labor or idea’s are his/her property and the state has no right to seize those assets,

according to the precepts of our Founders. Thomas Jefferson’s view of government

as the servant and the citizen as the master has been turned upside down in large

part due to the income tax. The income tax inevitably places the citizen on the defensive and takes away his very freedom and privacy. His legal rights are further

jeopardized, when, if found in error on a tax form, he/her is now guilty until proven

innocent.

Furthermore, the laws and constitution have been so weakened in our country,

that it is perfectly acceptable for the government to extort billions and trillions in

income tax dollars and redistribute the wealth with no accountability to those that

they’ve robbed. If your neighbor came to your house and took half of your property,

he would go to jail. However, if the government does the same and gives it to the

neighbor down the street who chooses not to live a productive life—it’s justified.

What kind of lunacy have we become accustomed too. This kind of unfair tax system

corrupts the very soul of the nation. Not only does it, by its very nature, corrupt

the political process, it corrupts the integrity of its citizenry, by creating an environment whereby they feel unfairly assaulted and violated by their government. They

then try to avoid the tax as we’ve seen with the highest non-compliance to date.

The income tax does not respect the boundaries of a free society and has no place

in a free society. It is frankly Un-American. We can rename the House Ways and

Means Committee, the House Committee on Un-American Activities. (Just kidding)

The Taxpayer Protection Alliance calls for the complete abolition of the income

tax, the Sixteenth Amendment, and the IRS. We would hope that this committee

would adopt legislation introduced by Rep. John Linder (R–GA) and Rep. Petersen

(D–MN). Then we can rest assured that we might usher in a new Millennium of

freedom and prosperity for all Americans. We could do away with taxation without

representation. We could then claim we are the nation that believes in ‘‘life, liberty

and the pursuit of happiness.’’ Our Founders would accept nothing less, why should

we?

(Testimony written by Taxpayer Protection Alliance Treasurer, Jeffrey A. Singer

and Executive Director, Lori Klein, 3431 W. Thunderbird Avenue, Suite 302–PMB,

Phoenix, AZ, 85053, (602) 866–2394)

[Attachments are being retained in the Committee files.]

Statement of UWC-Strategic Services on Unemployment and Workers

f ’

Compensation

Comprehensive Tax Reform Must be Sensitive to Sound Unemployment Insurance

Policy

UWC-Strategic Services on Unemployment and Workers’ Compensation, the only

business organization specializing exclusively in public policy advocacy on national

unemployment insurance (UI) and workers’ compensation issues, urges Congress to

Address UI payroll tax issues, including repeal of the 0.2% Federal Unemployment

Tax Act (FUTA) surtax and UI administrative financing reform, when considering

any fundamental federal tax reform proposal. UWC supports a strong UI program

through which employers provide fair and affordable insurance benefits for a temporary period of time to workers with a strong attachment to work and who are

temporarily and involuntarily jobless when suitable work is not longer available.

Several proposals have been introduced in the 106th Congress to significantly

change the current federal tax system. Many of these proposals will repeal sunset

the Internal Revenue Code (IRC) including the FUTA. Rather than dissolving the

federal/sale, we urge Congress to repeal the unnecessary 0.2% FUTA surtax and

enact UI reform as contained in H.R. 3174, The Employment Security Financing Act

of 1999, introduced by Representative Jim McCrery (R–LA). H.R. 3147 is supported

by 36 co-sponsors, as well as a broad based coalition of 32 states and more than

100 business organizations. These measures would ease the tax burden on employers by 25% while providing critically important UI administrative financing reform.

The Dangers of Sunsetting FUTA

The FUTA was enacted in 1935 and made part of the IRC. The FUTA is the basic

controlling federal law for UI, The FUTA provides the basic framework for the state

UI system, as well as the revenue for the state agencies which administer the UI

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program and provide a public labor exchange. The FUTA also permits states to receive loans if their UI trust funds are depleted, and it provides and extension of UI

benefit duration during periods of high and rising unemployment.

We seriously doubt that a new, equally simple, equally enforceable and similarly

equitable system for UI/ES could be re-created and enacted in place of the FUTA.

Completely repealing the FUTA will jeopardize the safety net for workers and employers. Important financial and legal protections for workers will be at risk, and

employers will face added payroll taxes. Both workers and employers will be hurt

by repealing the federal protection against ‘‘raid’’ on state UI benefit trust fund reserves.

Not one of the proposals being considered at this hearing address these

issues. Thus, until a viable solution is debated, proposals to ‘‘scrap the

Code’’ should not include provisions that would eliminate FUTA.

Repeal the 0.2% FUTA surtax

Under current law, employers pay the FUTA tax at the rate of 0.8% of taxable

payroll ($7,000). This tax rate is 25% too high as a result of a 0.2% ‘‘temporary’’

surtax which is no longer needed. The tax is being collected only because inclusion

of FUTA surpluses in the unified federal budget allows the federal government to

meet budget targets for unrelated spending programs. The practice of counting

FUTA dollars for spending on other programs, leaving only an IOU behind, is contrary to the very reason Congress placed these funds in the Unemployment Trust

Fund.

Congress originally imposed the surtax in 1976 to pay for a temporary federal program of supplemental UI benefits. This program expired long ago. The deficit created by this program was retired in 1987, but the surtax has been extended until

2007. The FUTA accounts within the trust fund all exceed their maximums, making

this surtax unnecessary. The revenue form the surtax is not needed for the UI/ES

program. Only 50 cents out of every FUTA dollar is being spent as intended for the

administration of the UI/ES, program and no additional funds are necessary to fund

the 50% FUTA share of extended benefits.

The FUTA surtax adversely affects nearly every employer. The money collected

from employers for this surtax inhibits hiring low wage workers and siphons away

dollars that would be better spent on jobs in rural areas, and facility and equipment

enhancements to provide a better work environment and increase productivity and

competitiveness.

24 years of a ‘‘temporary’’ tax is too long! Congress should act quickly to

repeal the 0.2% FUTA surtax by (1) including it as part of the business tax

incentives in the minimum wage bill currently in conference and (2) enacting H.R. 3174 (discussed below).

Enact UI Administrative Financing Reform (H.R. 3174)

Although complete FUTA repeal is not desirable, FUTA reform is overdue. The

present UI/ES program is not working effectively. Workers are under-served, employers are overtaxed and state UI/ES agencies and under-funded. Under the current system, the federal government collects 100% of the FUTA receipts but returns

only 50% to the states. Shortchanging the funding to administer UI has led to workers collecting more weeks of unemployment benefits during the tightest labor market

in recent history, and states are forced to reach into general revenues and employer

pockets (through add-on payroll taxes) to make up for the shortfall.

H.R. 3174 is specifically designed to solve this problem. It will restore integrity

to the UI trust funds. Not only is the0.2% FUTA surtax repealed, but he remaining

trust fund dollars will be returned to the states—in full! This will allow states to

provide the necessary resources to better serve UI claimants, job seekers, veterans

and employers. H.R. 3174 will combat UI fraud and abuse by providing states with

adequate funding.

H.R. 3174 is consistent with the concepts of tax simplification being presented at

this hearing. Unnecessary paperwork will be eliminated as employers will only have

to complete and submit a single UI tax form rather than two separate federal and

state UI tax forms. Equally important, state legislatures—rather than Washington

bureaucrats—will be responsible for determining how much is necessary to run their

own state UI programs. This will provide added flexibility and accountability—without taking away any protections from jobless workers.

UWC urges swift enactment of H.R. 3174. It is a win for workers, employers

and states and is the right direction for UI reform. For more information,

please contact Vince Sampson at (202) 682–1515.

f417

Statement Robert L. Schulz, We the People Foundation for Constitutional

Education, Inc., Queensbury, NY

Mr. Chairman:

Mr. Chairman, I would like to thank you for the opportunity to submit these remarks for the record of the hearing on fundamental tax reform. I am Robert Schulz,

and I am Chairman of the We The People organization from northern New York

State. I have been very actively pursuing the cause of good government for 20

years—at the local, state, and federal level. The organizations I chair are devoted

to educating citizens about problems of governmental wrongdoing, especially when

government behaves in violation of the state or federal constitutions or in violation

of the law. I also chair a group called the All-County Taxpayers Association in New

York State.

For more than a year now, we have been focusing in particular on issues of illegal

operations of the federal income tax system. We have been learning from many

sources about numerous aspects of those illegal operations. And for over a year, we,

in turn, have been informing millions of people across the country about what we

have learned—reaching as many citizens as we can by using various media: radio,

newspapers, the internet, newsletters, and even television. I am a talk-radio host

on a national radio network and also on a regional talk-radio show in Albany, NY.

You may be aware that last July, we held a symposium at the National Press Club

here in Washington to examine issues of illegal operations of the federal income tax

system. The symposium was broadcast live by C-Span and rerun several times over

the next few days. We held another conference at the National Press Club last November to further discuss the income tax issues and what to do about them. Although we asked the leaders of our three branches of government to send knowledgeable representatives to our meetings at the NPC to refute allegations and arguments being presented, they did not respond and did not even acknowledge our requests. That has led us back here to Washington this week for a third time, to deliver a Remonstrance to the leaders of our three branches enumerating the people’s grievances over the illegal operations of the federal income tax system. We have provided each of you a copy of the Remonstrance. Thousands of copies of the video

tapes of the July symposium and the November conference have gone out and are

now circulating all across the country—many in public lending libraries for all to

borrow. A number of other individuals have been broadcasting and publishing for

years about the problems I am going to tell about, and now millions of citizens are

aware of them.

Well, what ARE those issues; what ARE those grievances; and what are the remedies? I will summarize as succinctly as I can.

Congressional hearings for years have been the forum for horror stories by citizens who have suffered all kinds of abuse at the hands of the IRS. Our grievances

include those outrageous and arrogant behaviors by the IRS perpetrated by its

agents, policies, and procedures. We are particularly distressed at the utter lack of

respect for due process and the denial of due process in IRS procedures, including

the unwillingness of the IRS to provide information about our due process rights,

the denial of our rights to see the evidence against us, to confront and cross-examine

those who have testified against us, and denial of our rights against illegal seizure

of our property by the IRS because of an unconstitutional anti-injunction law, 26

USC Section 7421.

But as bad as these behaviors are, they are only a small part of it; the problems

are much deeper and they started early in the 20th century. Our grievances largely

deal with issues of hoax, fraud, and deliberate deception.

It has been well established since 1985, and unrefuted, that the 16th amendment,

the so-called income tax amendment, did not even come close to being legally ratified in 1913. It was, indeed, fraudulently declared to be ratified by a lame-duck Secretary of State, Philander Knox, and just a few days before he left office to make

way for the Wilson administration. Knox’s motive is easy to see. He had for many

years been attorney for Carnegie, Rockefeller, Morgan, and the Vanderbilts, and had

put together the largest of their cartels. He was paving the way for the Federal Reserve Act that was passed later in 1913. The central bank would want a more reliable flow of revenue to assure payment on the debt that the government would be

incurring. Knox had already had practice in this method by his role in taking over

the tax collection systems in Honduras and Nicaragua to assure payment of loans

to those governments. Senator Nelson Aldrich, spokesman for Rockefeller and Morgan, had pushed the income tax amendment through the Senate in 1909, and, as

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a result of a meeting he convened at his vacation ‘‘cottage’’ among several of the

nation’s most powerful bankers representing Rockefeller, Morgan, and the Rothschilds, he designed the Federal Reserve legislation that passed in 1913, under the

guise of banking reform.

The research that conclusively revealed the fraudulent ratification of the 16th

amendment was done by Mr. Bill Benson, a former investigator for the Illinois Department of Revenue who spent a whole year among the archives of all 48 states

and the federal government. Here are some of his findings. [See ‘‘Examples of States

That Failed to Ratify the 16th Amendment’’ on page 5.]

What has been the government’s response to Benson’s work? Well, one senator,

until recently a presidential candidate, tried to pay Mr. Benson—offered to make

him a millionaire if he would only not publish the results of his work, turn over

all 17,000 certified documents he had obtained from the archives, and agree never

to talk about his research again. However, to Mr. Benson, our republic is not for

sale. He published, and every member of Congress received a personal copy of his

two-volume report. I am sure he would be happy to provide a copy to any member

of this committee. It is not out-of-date. It is history.

Other responses by Congress have been produced by the Congressional Research

Service in the form of a report written in 1985 by Thomas Ripy about the 16th

amendment issue and in a 1996 report by John Luckey titled ‘‘Frequently Asked

Questions Concerning the Federal Income Tax.’’ Neither report mentions or addresses the key issue of fraudulent ratification of the 16th amendment. They are, therefore, non-responses.

The courts have refused to address the fraud issue, calling it a political question

for Congress, even though fraud is clearly a matter for the courts and is not subject

to the normal statute of limitations. Congress has said that it is a matter for the

courts. We say it is an issue for both Congress and the courts, and it must be addressed. The government must not stonewall on this issue any longer.

The IRS has addressed the 16th amendment question in it’s publication titled ‘‘Why Do I Have to Pay Taxes?’’ This is sort of a mini-version of the Luckey Report,

and can be found on the Internet. Its answer to the argument that the 16th amendment was not properly ratified is to state that the 16th amendment was ratified on

February 3, 1913, and then to quote the words of the amendment. This, of course,

is a non-response to the question and means nothing. It is pathetic and insulting

(and the date is wrong; it was February 25).

Another major issue and grievance is that the IRS operates in such a way as to

collect income taxes from almost all citizens even though no law or regulation requires most citizens to file and pay income taxes nor to have those taxes withheld

from the money they earn. The IRC and its regulations make liable for the income

tax only ‘‘foreigners here and citizens abroad,’’ but not most of us, unless we have

income earned abroad. This has been demonstrated of late by those, especially employers, who have carefully studied and exercised the rules as written and have succeeded in making the IRS abide by them.

The standard response of the IRS to the liability argument is to quote 26 USC

Sections 1,6001,6011,or 6012, which the IRS uses as the all-encompassing filing requirements. Section 1 imposes the tax on ‘‘taxable income;’’ Section 6001 says,

‘‘Every person liable for any tax imposed under this title...shall keep such records...

make such returns...and comply with such rules and regulations as the Secretary

may prescribe;’’ Section 6011 says, ‘‘When required by regulations...any person made

liable by any tax imposed by this title shall make a return;’’ Section 6012 says, ‘‘Returns... shall be made by...[e]very individual having...gross income which exceeds

the exemption amount...’’

These, again, are non-responses that merely beg the original question of just who

is liable. The crucial question becomes: What is ‘‘gross income?’’ And when we follow

the disjointed, disconnected, and deceptive trail through the code and its regulations, we find in CFR 1.861–8(f)(1) that gross income is income derived from foreign

sources, i.e., foreigners here and citizens abroad. When we follow the trail of withholding law to find out what kind of income is subject to withholding, it takes us

to the same place and the same conclusion: foreigners here and citizens abroad. The

same is true regarding liability for the Social Security tax, derived from the International Labor Agreement of the 1930s. All three trails lead to the same result.

Congressional response to the question of just who is liable is exemplified in a

1989 letter from Senator Inouye to a tax consultant constituent who asked about

the precise provisions of the IRC that render an individual liable for income taxes.

The letter says: ‘‘Based on research performed by the Congressional Research Service, there is no provision which...requires an individual to pay income taxes.’’ The

letter goes on to say that Article I Section 8 of the U.S. Constitution gives Congress

the power to lay and collect taxes, and then makes the astonishing assertion that,

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‘‘Accordingly, the IRC need not specifically state that individuals shall be liable for

income taxes because it is inferred from the Congress’ authority to so levy and collect.’’ This letter would have us believe that there is no need to bother with the inconvenience of actually writing laws or regulations or anything like that! Further,

the letter then points out that Section 7201 et al. sets forth penalties for failure to

pay taxes owed. The key word is ‘‘owed,’’ but the letter does not explain how it is

determined what taxes are actually owed or by whom. Once again, we are given a

non-response that simply begs the question, along with a heavy-handed threat of

prosecution. The letter tries to give us the impression we can be prosecuted for not

doing something that no law or regulation requires us to do.

It is significant that employers are learning of the scam, as they are key to the

whole system, along with the denial of due process rights for individual citizens. The

IRS uses the false statements from employers (W–2s and 1099s) as prima facie proof

that employees have earned gross income that is taxable. The IRS then makes it

impossible in their procedures for an employee to challenge the incorrect testimony

of the employer by refusing to issue summons so the employee can confront and

cross-examine the employer. Tax law 26 USC Section 3402 does not protect employers from submitting false information. But the IRS has bullied and coerced employers since the 1930s to do so. Employees are then coerced into filing tax returns

based on false information submitted by employers and to ‘‘voluntarily’’ and unknowingly waive their 5th amendment rights when they sign their 1040 forms, in

order to get some small portion of their money refunded.

What are the remedies? First, a national sales tax is not the remedy, and we

would not like to see the abuses by the illegal operations of the IRS used as an excuse for imposing such a tax. Excise taxes are most appropriate when used as luxury, sin, or amusement taxes, not when used to tax the necessities. Moreover, a national sales tax will be avoided by those who can use vertical integration strategies,

and the people who can least afford it will end up paying a disproportionate share.

The issue of the fraudulent ratification of the 16th amendment must be addressed, not evaded, by Congress and by the courts. Besides that, Congress must

act to remove the obstructions that prevent citizens from invoking the protections

of their constitutional rights when dealing with the IRS in both administrative and

judicial proceedings. The due process issues and abuses must be resolved. The remedy is to make the IRS and its agents obey the tax code and regulations and respect

citizens’ constitutional rights to due process, especially in administrative procedures.

Denial of due process is the main factor in the abuses by the IRS, because it prevents people from defending themselves against those abuses. Three changes to the

code can go far towards accomplishing this goal. All are in Chapter F (Administration): Sections 6326,6404(b), and 7421. Sections 6326 and 6404(b) effectively enable

errors or abuse by IRS employees to go uncorrected and obstruct the IRS Commissioner from properly controlling employees. Section 7421, as already mentioned, prevents judicial intervention and review of illegal seizures of property by the IRS in

violation of our constitutional rights. No statute can overrule the Constitution.

Many of the horror stories and abuses you hear about might be averted if it were

not for the obstructions to correcting erroneous or malicious actions of subordinates

by those above them or by the courts.

EXAMPLES OF STATES THAT FAILED TO RATIFY THE 16TH

AMENDMENT

Philander Knox had received responses from 42 states when he declared the 16th

amendment ratified in February, 1913. It was required that 36 of the 48 states at

that time approve it. Of the 42, Knox acknowledged that four had rejected the

amendment, bringing the number down to 38 that he said approved it.

In Kentucky, the legislature acted on the amendment without even having received it from the governor. (The amendment was sent to the governor of each state

in 1909 for transmittal to their state legislatures.) The version of the amendment

that the Kentucky legislature made up and acted upon deleted the words ‘‘on income’’ from the text of the amendment, so they were not even voting on an income

tax! When they straightened that out, the Kentucky senate rejected the amendment.

Yet Philander, inexplicably, counted Kentucky as approving it.

In Oklahoma, the legislature changed the wording of the amendment so that its

meaning was the opposite of what was intended by Congress, and this was the

version they approved and sent back to Knox. Yet Knox counted Oklahoma as approving the amendment, despite a memo from his chief legal counsel, Reuben Clark,

that states were not allowed to change the amendment in any way.

Attorneys who have studied the subject have published that if any state could be

shown to have violated its own state constitution or laws in its process of approving

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the 16th amendment, then that state’s approval would have to be thrown out. With

that in mind, let’s look at some other states.

The state constitution of Tennessee prohibited the Tennessee legislature from acting upon any proposed amendment to the U.S. Constitution received from Congress

until after the next election of state legislators. The intent, of course, is to give the

proposed amendment a chance to become an issue in the state legislative elections

so that the people can have a chance to influence the outcome. It also provides a

cooling off period to reduce the tendency to approve ideas just because they’re

trendy. You can probably guess that I am about to tell you that the Tennessee legislature did not hold off on voting for the 16th amendment until after the next election, and you would be right—they didn’t. That means they violated their own state

constitution; their approval is and was invalid, and it brings the number of approving states down to 35, one less than required for ratification.

Texas and Louisiana violated provisions in their state constitutions prohibiting

the legislatures from empowering the federal government with any additional taxing

authority. Now our number is down to 33.

Thirteen states, including Tennessee again, violated provisions in their constitutions requiring that a bill be read three times over a period of at least three days

before voting on it. This is not a trivial requirement. So we must subtract a dozen

more states, bringing our number down to 21.

Several states returned unsigned, uncertified, or unsealed documents back to

Knox, and did not rectify their negligence even after being notified and warned by

him. The most egregious offenders, were Minnesota, Ohio, California, Arkansas, and

Mississippi. Minnesota did not send any copy at all, only a note from the governor’s

secretary, so Knox could not have known at all what they voted on. Four of these

five states were already disqualified above, leaving California to be subtracted,

which brings our number down to 20, which is 16 fewer that the number required.

These last five states, along with Kentucky and Oklahoma, have particularly strong

implications with regard to the charge of fraud against Knox, in that he absolutely

knew they should not be counted.

We could go on, but with the number down to 20, this is a suitable place to rest.

Benson’s findings show beyond doubt that the 16th amendment was not legally ratified and that Secretary of State Philander Knox did not just commit an error, but

committed fraud, when he declared it ratified in February 1913.

Very truly yours,

f Robert L. Schulz

Statement of Harold Apolinsky, Esq., Sirote and Permutt, and Dan R.

Mastromarco, The Argus Group

Mr. Chairman and Members of the Ways and Means Committee:

We are pleased to submit this testimony which analyzes the impact of the leading

national sales tax plan, the FairTax on nonprofit organizations. We believe that a

shift to a consumption approach would in fact be extremely beneficial in several respects. It will improve economic growth—the primary determinant of charitable giving. It would remove the bias against non-itemizers. It would enhance the resources

both itemizers and non-itemizers have by ensuring that they can make their contributions with pre-payroll tax dollars. This paper presents these arguments.

Background Discussion:

Some 150 years ago, Alexis de Tocqueville marveled at Americans’ propensity to

‘‘found seminaries, build churches, distribute books... [He]... often admired the extreme skill they show in proposing a common object for the exertions of many and

inducing them voluntarily to pursue it.’’ If he would visit America for a third time,

he would find that charitable, nonprofit organizations continue to play a vital role

in meeting needs unmet by the private sector or by governmental agencies. From

centers of learning, to health care facilities, to poverty relief organizations, to public

policy research institutions, these institutions are an indispensable part of the

American economic and social landscape—and thankfully so. Last year Americans

donated more than $100 billion to charities, churches, foundations and other humanitarian causes.

When it comes to evaluating various tax reform proposals, it is right to consider

its effect on charities. When considering the effects of shifting to a consumption tax

system on the economy, on businesses and on individual taxpayers, we must be

careful to ensure the continuing ability of charities to perform their essential role

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of facilitating charitable acts. We must ensure that, under any tax system, the good

works of charities are not diminished.

However, some recent observers of American history incorrectly assume a vast

change. They believe that if charitable donations are not deductible then charitable

organizations could not exist; indeed, charity itself might cease to exist. The reason

they always give is that the level of charitable giving in this country has a one-toone elasticity tied to the tax code and tax deductions so the steeper the rate of tax,

the more pain one feels, the more inclined they are inclined to be ‘‘charitable.’’ Their

conclusions are axiomatic as a syllogism:

1. steep marginal income tax rates and very high death taxes improve the volume

of gifts by reducing the relative cost of giving versus consuming.

2. Reducing those rates will concomitantly reduce giving.

3. A consumption tax must reduce charitable giving since it renders irrelevant a

deduction against income, thereby eliminating any advantage to giving.

While this is the crux of the main argument, other arguments are advanced. The

relative cost of capital for nonprofits will increase, since a consumption tax may irradiate the distinction between tax-exempts and for-profits on income from passive

or related sources.

These arguments have acquired a choristic-like following. The Independent Sector,

along with the Council on Foundations, released a report on April 28, 1997 entitled

‘‘The Impact of Tax Restructuring on Tax Exempt Organizations,’’ which was intended to criticize consumption tax proposals. The report concluded that under a

sales tax contributions to tax exempt groups would decline by at least $33 billion

or 35%. They estimated that proposals which eliminate the charitable deduction

would lower annual contributions on the order of 10 percent to 20 percent.

The First Misconception: A Deduction is Necessary

Large and small donors are not ignorant of the tax ramifications of their actions,

but neither are they primarily influenced by them when doing charitable deeds. Individuals give to charities not for tax deductions, but because they believe in the

charitable works they support. There is, of course, much anecdotal data. In the early

1900’s, before any death tax and with very low income taxes, the Vanderbilts endowed Vanderbilt University, the Stanfords endowed Stanford University and the

Dukes endowed Trinity College in Durham, North Carolina.

The empirical data also suggest that there is, in fact, little linkage between the

tax deduction and nonprofit giving.

Giving actually increased after marginal rates were significantly reduced in 1981

and again in 1986 and after the elimination of the charitable deduction for nonitemizers in 1986. Total giving increased (in inflation adjusted dollars) every year

between 1983 and 1989.

The linkage assumed by researchers is not tempered by the importance of economic growth in charitable giving. A tax of 90 percent on income, for example, will

lead to enormous growth in charitable giving as would an extraordinarily high death

tax rate. Apparently, the higher the rate, the higher the marginal incentive to give

and the lower the cost of giving. At a 90 percent tax rate, giving—as opposed to

consuming—would only cost 10 cents on the dollar. Hence to benefit charities, we

need to have a tax policy that makes holding onto the proceeds of our labor is as

painful as holding on to a hot pan.

If such a linkage were mandatory for charitable acts, legitimate questions should

be raised as to whether or not one’s donation truly constitutes a charitable act. Let’s

take a taxpayer who is in a 40 percent income tax bracket. Assuming the taxpayer

is not subject to other restrictions governing charitable donations, and assuming the

taxpayer itemizes, if the taxpayer gives ‘‘x’’ dollars to charities, his taxes will be lowered by ‘‘x’’ times 40%. However, this simply means that other taxpayers’ taxes

would have to be increased to make up the difference of the taxes foregone. Thus,

by saying the taxpayer is inclined to be ‘‘charitable’’ because his taxes would be reduced by ‘‘x’’ times 40%, we are saying that the taxpayer is inclined to be charitable

only since he can, in part, be charitable with other taxpayers’ money. If taxes escalate by income bracket, then we are saying something more. We are saying that the

economic votes cast by higher wage-earners are more important than those cast by

non-itemizers or lower wage-earners. The government might as well develop a

matching program, where the wealthier you are, the greater the government values

your opinion on where to spend your eleemosynary resources and the greater your

matching resources from the pool of unwitting and unrecognized accomplices. Or alternatively, the wealthier you are the more other taxpayers need to subsidize your

generosity in order to prompt it.

Thankfully, this is not the case. Acts of giving are often spontaneous, compassionate impulses. Moreover, the data suggest correlations of greater significance

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1Giving USA, 1997. AAFRC Trust for Philanthropy, 1997. See, http://www.cae.org/Trends/

sk03.htm. 2 Voluntary Support of Education 1996, Council for Aid to Education. See, ‘‘http://www/

cae.org/Trends/sk14.htm. Other indicators include the stock market. The trough in giving between 1971 and 1984 coincided with a poorly performing stock market during the 1974–1982

period and two recessions. The dips and rises of the stock market are said to be mirrored by

charitable support within a year 3 A quote attributable to Maimonides [Moses ben Maimon[ (c. 1170) seems particularly apt. ‘‘Anticipate charity by preventing poverty; assist the reduced fellowman, either by a considerable

gift or sum of money, or by teaching him a trade, or by putting him in the way of business

so that he may earn an honest livelihood, and not be forced to the dreadful alternative of holding out his hand for charity. This is the highest step and the summit of charity’s golden ladder.’’ 4 Jorgenson, National Tax Research Committee. See also, ‘‘The Economic Impact of Fundamental Taxing Consumption,’’ Dale W. Jorgenson, Testimony before the House Ways and Means

Committee, March 27, 1996 and ‘‘The Economic Impact of Fundamental Tax Reform,’’ Dale W.

Jorgenson, Testimony before the House Ways and Means Committee, June 6, 1995. 5Kotlikoff, National Tax Research Committee. See also, ‘‘The Economic Impact of Replacing

Federal Income Taxes with a Sales Tax,’’ Laurence J. Kotlikoff, April 15, 1993, Cato Institute

Policy Analysis. 6 Robbins, currently a principal in Fiscal Associates, is former Chief of Applied Econometrics

at the U.S. Treasury Department, ‘‘Looking Back to Move Forward: What Tax Policy Costs

Americans and the Economy,’’ Gary Robbins and Aldona Robbins, Policy Report No. 127, September 1994, published by the Institute for Policy Innovation, p. 31, p. 47.

than a deduction. Active civic participation is more important to a healthy nonprofit

sector than the presence of any tax credit or deduction. Benefactors are far more

influenced by the desire to contribute to charitable causes. Most importantly, perhaps, income growth has more to do with boosting charitable contributions than tax

incentives.

How much does economic growth influence charitable giving? It has been said by

researchers that as the fortunes of the country go, so goes the contributions to philanthropic causes. In fact, after years of analysis, we can be a whole lot more specific: as the Gross Domestic Product changes, so goes approximately 2% of the total

value of the goods and services to philanthropic causes. Total philanthropy as a percentage of GDP has held steady at around 2% for at least two decades.1 Although

the tax code has changed frequently and dramatically over the past 23 years, giving

as a share of personal income has hovered around 1.83 percent. This measure

reached as high as 1.95 percent (in 1989) and as low as 1.71 percent (in 1985, the

year before non-itemizers ability to deduct charitable contributions was permitted).

The narrow range has persisted even through the top marginal rate has fluctuated

in that period between 28 and 70 percent.

Because of the importance of the relationship between giving and income, slight

shifts in GDP represent considerable dollars in charitable giving. For example, one

quarter of 1 percent of GDP at $8.8 trillion (the estimated 1999 level) equals $22

billion.2 As GDP goes, so eventually does voluntary support.

So at least the data—as opposed to theory—suggest that to properly consider the

effect of tax reform on charities, we must consider the effect of tax reform on economic growth. Giving is more dependent on how much donors have to give than how

much the government will match their contributions with the taxes of middle income taxpayers.

Contrary to the assertions of the anti-consumption tax choral group, one of the

most constructive steps that can be taken to improve the rate of economic growth

would be to replace the current tax system with a consumption tax. It is the nearly

universal opinion of economist that a consumption tax, like the FairTax, for example, would reduce the tax bias against work, savings and investment, improve the

productivity and competitiveness of U.S. firms and improve the real wages of American workers. Replacing the income tax with the Fair Tax will dramatically improve

the standard of living of the American people.3

Economic studies have been done on this as well. Work by Harvard economist

Dale Jorgenson shows a quick 9 to 13 percent increase in the GDP after passage

of the Fair Tax 4 ; similarly, Boston University economist Laurence Kotlikoff predicts a 7 to 14 percent increase.5 These gains are in addition to the increases that

would have been achieved under current income tax law. Most of these gains come

in the first decade. Work by economist Gary Robbins shows that replacing the current tax system with a flat tax system that taxed capital and labor income equally—

such as the sales tax or the flat tax—would increase the GDP 36.3 percent and increase private output by 48.4 percent over the long run.6 Even a study by Nathan

Associates funded by the National Retail Institute, shows that the economy would

be one to five percent larger under a sales tax than in the absence of reform.

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7Steve Moore, Director of Fiscal Policy Studies at the Cato Institute, points out in a Washington Times article (June 18, 1997) that ‘‘the last time the [Independent Sector] tried to measure the impact of tax code changes on charities, it predicted that the 1986 Tax Reform Act

would trigger an $8 billion decline in charitable contributors in 1987. Instead charitable giving

rose by $6.4 billion, or 7.6 percent after the top rate fell from 50 percent to 28 percent.’’

Those that state that charitable contributions would go down after a consumption

based tax approach may still choose to make their arguments. However, to be valid

they must succeed in explaining why, after eligibility for itemized deductions was

constricted, charitable contributions historically rose.7 They must also address the

issue of economic growth since virtually every economist who opines that deductions

are needed for charitable contributions, also makes the case that a consumption tax

would improve economic prosperity.. Either there is no linkage between economic

growth and contributions or a consumption based approach will not improve the

economy—both of which are against the prevailing economic wisdom.

Moreover, it is not enough to point out only that the cost of giving goes down because of the charitable deduction. If the cost of giving is a determinant, they must

also address why their enthusiasm for the current income tax system’s tax benefits

is not dampened by the fact the FairTax lowers the costs of contributions. It does

so in two respects.

To begin with, even if we assume that taxpayers are encouraged to give only because of the charitable contribution, the vast majority of contributors today do not

receive any tax advantage for their donations. The charitable contribution is limited

to those who happen to itemize (typically those who are affluent enough to own real

estate). According to the IRS, Statistics of Income, there were only 30,587,000

itemizers in 1996 out of 111,694,000 taxpayers.

Since only itemizers may take the charitable contribution, only about 27%, or onequarter of all taxpayers, are even eligible to take the charitable deduction. The relative ratio of itemizers to non-itemizers has remained relatively stable over the near

term.

The most important question with respect to the charitable constitution is not

how the tax code treats a contribution, but rather how much a taxpayer has at his

or her disposal to contribute. In other words, what must a taxpayer earn in order

to make that contribution? This is where the income tax system severely restricts

the ability of a non-itemizer to make a charitable contribution. The graph below

simply depicts the effect of the income tax and the payroll tax on the earnings of

a taxpayer who does not itemize, but who is in the 28 percent tax bracket. The combined effect of the 15.3 percent payroll tax (assuming the employee bears it) and

the 28 percent marginal tax bracket means that the taxpayer must earn $176 to

make a $100 contribution to charity. In other words, the government effectively imposes a $76 excise tax on the taxpayer’s gift to the charitable organization.

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8This provision is defined in Internal Revenue Code section 170(a) and the regulations thereunder. 9This complex provision is contained in IRC section 170(e)(3).

10 IRC section 170(e)(1). 11See, Budget of the U.S. Government, Fiscal Year 1999. 12 $47,129—$7,100 (standard deduction for married filing jointly) = $40,109. The income tax

on taxable income of $40,109 = $6,433.

Of taxpayers who are eligible to itemize, an interaction of complex additional restrictions apply to further erode the benefit of the deduction. For example, if a donor

contributes appreciated property that is considered ‘‘ordinary income-type property,’’ 8 as opposed to long term capital gain, the donor must reduce the gift by the

amount of ordinary income that would have been recognized if the property were

sold. Hence, gifts of inventory, art works, letters and other similar property created

by or for the taxpayer, are generally severely limited to exclude appreciation. Corporations are limited when making contributions of inventory or depreciable real

property to one-half of the ordinary gain that would have been realized if sold.9

Moreover, the value of gifts of tangible personal property and gifts to certain private

foundations, must be reduced by the ‘‘total amount of the gain that would have been

long-term capital gains if the property were sold for its then fair market value on

the date it was contributed.’’ 10 Furthermore, individuals are subject to a deduction

ceiling based on the type of property contributed and the type of charity to which

the contribution is made—a ceiling that can be as low as 20 percent of the individual’s adjusted gross income. These are just a few of the restrictions.

Even if a charitable contribution is allowed, it of course only entitles the donor

to make the gift after payroll taxes. The U.S. Office of Management and Budget estimates the total tax revenues lost from charitable contributions 11 (known in tax

jargon as tax expenditures) to be $2.7 billion for education, $2.4 billion for health,

and $17.1 billion for other purposes, for a total of about $22 billion. However, it is

important to note that as large as this tax expenditure is, the charitable contribution is limited in one other significant respect: it only serves to negate the income

tax. Under the current system, even if a taxpayer itemizes and even if he can qualify to take the deduction, the charitable deduction only off-sets one type of tax that

he pays among the taxpayer’s total tax liability—the income tax.

These payroll taxes, be they employer-and employee-combined payroll taxes or

self-employment taxes paid by our nation’s more than 17 million entrepreneurs,

comprise a significant segment of the taxes Americans pay today. As a national aggregate, in 1997 individual income taxes were $737.5 billion. Payroll taxes were

$539.4 billion, or 42 percent of the combined total. Many taxpayers, especially lower

income individuals, pay a greater portion of their tax liability in payroll taxes as

opposed to income taxes.

To graphically illustrate what benefit is provided by the charitable deduction

today, let us see the world through the eyes of a fairly average couple. In 1995, the

median family income of a married couple was $47,129. If that income were all wage

income, then that couple would have paid $7,210 in combined payroll taxes on those

wages (employer and employee share). Even if that couple did not itemize (which

they certainly would because of the mortgage interest deduction), the maximum income taxes that they would pay if they filed married filing jointly would be $6,433,

or 10 percent less than the payroll taxes.12 In other words, the couple would have

paid more payroll taxes than income taxes. Even if that couple itemizes, and the

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13Most economists believe that the employer-employee split is really fiction and that employees really do bear the full 15.3 percent. However, we make this adverse assumption in order

to arrive at a conservative estimate of the advantages of the Fair Tax.

couple takes a charitable contribution deduction, the couple cannot take that deduction against the most significant form of taxes that apply to them—payroll taxes.

The graph below depicts what an itemizing taxpayer must earn today to donate

$100 to charity.

Now let us consider what happens under the FairTax consumption tax. Under the

Fair Tax, charitable contributions are not taxed—not at all. They are neither taxed

to current itemizers nor to non-itemizers. Therefore, like current law, donors would

donate earnings out of pre-income-tax dollars. More to the point, since the Fair Tax

repeals both the payroll taxes and the income taxes, the effect of not taxing their

contributions is to ensure that the payments are made with both pre-income and

pre-payroll tax dollars.

Even for those who believe the deduction is important, this should significantly

advantage charities relative to current law by reducing the costs of contributions.

A taxpayer today must earn at least $108.28 to contribute $100 if only the ‘‘employee’’ share of the payroll taxes is considered. If the employer payroll taxes are

considered 13 (or if the taxpayer had a sole-proprietorship), he or she must earn

$118.06. Under the Fair Tax, that taxpayer would only need to earn $100 to contribute $100.

The relative advantage of allowing a deduction against income vs. not taxing income or wages is depicted in the graph below. In this graph, we see that the cost

of charitable giving will actually go down considerably under the Fair Tax. Hence,

even if taxpayers are wholly motivated to give due to tax treatment, the Fair Tax

lowers the cost of charitable giving and increases the resources available for donations. In other words, the cost of charitable giving relative to alternative uses of the

funds will go down.

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14The Internal Revenue Service, SOI indicates that while the total contributions, gifts and grants received by nonprofits was about $110 billion in 1994, this was divided between contributions directly from individuals and corporations ($49.2 billion), from affiliated organizations

($8.7 billion) and from government grants ($52 billion). 15There are a total of 28 different nonprofit exemptions. 501(c)(3)’s are religious, educational,

charitable, scientific or literary organizations, testing for public safety organizations, etc. When

we refer to ‘‘nonprofits’’ as opposed to other tax-exempt, we generally refer to these 501(c)(3)’s. 16Summary of 1998, SOI Bulleting, Report by Cecelia Hilgert.

However, this is not the end of the advantages. With the adoption of the FairTax

corporations may become major contributors to charity. Under the current system,

total charitable contributions for corporations may not exceed 10 percent of taxable

income. Repealing this limitation will free up corporations to give more.

Second Misconception: The Relative Cost of Capital Will Rise

Charitable giving represents a significant and thankfully growing outlay. Total

charitable giving in 1997 was estimated to be $143.5 billion in 1997, which represents the second consecutive year of growth and the largest growth spurt since

1989. However, it is important to bear in mind that individual charitable contributions, while certainly important, are only a portion—and not a major portion—of the

resources that fund eleemosynary organizations today.14

The major source of nonprofit income is not contributions at all, but an item

called ‘‘program service revenue,’’ which includes commercial activities. Tax-exempt

organizations constitute a significant portion of the Gross Domestic Product (GDP),

more than 10 percent of GDP today, and their growth rate has outstripped the GDP

and the private sector. Moreover, all tax-exempt nonprofits, particularly 501(c)(3)

nonprofits,15 are increasingly reliant on commercially oriented as opposed to donative oriented sources of income. This activity is concentrated in the largest nonprofits. When nonprofits rely on commercial sources of revenue, they derive that

revenue primarily from the service industries. On this income, little tax is paid either because the nonprofits declare the income as substantially related to their exempt function or because they are able to successfully allocate deductions to the unrelated income.

To place this in perspective, in 1994, the latest year for which IRS statistics are

available, the total revenue for 501(c)(3)’s was $589 billion. These nonprofits had

$993 billion in combined assets in 1994. As a percentage of total receipt contributions, gifts and grants of all types (including from governmental entities) comprised

only 18% of the total resources. Direct contributions were only about $50 billion, or

8.4 percent of the total. Program service revenue was $422 billion, or about 72 percent of the total resources of nonprofits.

In fact, organizations with assets of $50 million and above rely on contributions,

gifts and grants for only 11 percent or their income in 1991. This figure held steady

in 1994, according to the IRS.16 This can be contrasted with organizations with

under $100,000 in assets, which relied on gifts, grants and other contributions for

52 percent of their revenue. The $50 million asset group derived 76 percent of their

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income from ‘‘program service revenue’’ as opposed to 33 percent of the $100,000

asset class organizations. There is a steady increase in reliance on ‘‘program service

revenue’’ as the size of the nonprofit, measured by asset holding or gross income,

increases.

Additionally, commercial type activity is concentrated in 501(c)3’s. Gross profits

from sales and service is the largest source of income for 501(c)3’s. If income is ‘‘substantially related’’ to the exempt purpose, it is not considered unrelated business income activity and is wholly exempted from taxation. While the tax paid by nonprofits have increased over the last decade, the increase has not kept pace with the

growth of nonprofit’s commercial sources of revenue.

The Fair Tax consumption tax does nothing to alter the non-contribution resource

base of nonprofit organizations. If the nonprofit earns income that is program service revenue, it is not taxable. It should also be pointed out that if the nonprofit

earns unrelated business income—income that is not substantially related to its exempt purpose—that income would also be tax free to the nonprofit under the Fair

Tax.

Conclusion

We maintain that the Fair Tax would have extremely beneficial effects on charities and philanthropic giving. The Fair Tax will improve the primary determinants

of charitable giving—economic growth and real income. The Fair Tax would remove

the bias against taxpayers who want to contribute today by enabling every taxpayer

to make donations with tax free dollars. The Fair Tax would enhance the resources

both itemizers and non-itemizers have to give by ensuring that they can make their

contributions with pre-payroll tax dollars.

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