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48–528—PDF 2007

S. HRG. 110–811

THE STEALTH TAX THAT’S NO LONGER A

WEALTH TAX: HOW TO STOP THE AMT FROM

SNEAKING UP ON UNSUSPECTING TAXPAYERS

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

JUNE 27, 2007

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

MAX BAUCUS, Montana, Chairman

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

DEBBIE STABENOW, Michigan

MARIA CANTWELL, Washington

KEN SALAZAR, Colorado

CHUCK GRASSLEY, Iowa

ORRIN G. HATCH, Utah

TRENT LOTT, Mississippi

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

CRAIG THOMAS, Wyoming

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

PAT ROBERTS, Kansas

RUSSELL SULLIVAN, Staff Director

KOLAN DAVIS, Republican Staff Director and Chief Counsel

(II)

C O N T E N T S

OPENING STATEMENTS

Page

Baucus, Hon. Max, a U.S. Senator from Montana, chairman, Committee

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

Grassley, Hon. Chuck, a U.S. Senator from Iowa ................................................. 2

WITNESSES

Degen, Frank, enrolled agent, National Association of Enrolled Agents,

Setauket, NY ........................................................................................................ 4

Burman, Dr. Leonard, director, Tax Policy Center, Urban Institute, Washington, DC ............................................................................................................. 5

Hassett, Dr. Kevin, director, economic policy studies, American Enterprise

Institute for Policy Research, Washington, DC ................................................. 7

Graetz, Michael J., Justus S. Hotchkiss professor of law, Yale Law School,

New Haven, CT .................................................................................................... 9

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Baucus, Hon. Max:

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

Bunning, Hon. Jim:

Prepared statement .......................................................................................... 33

Burman, Dr. Leonard:

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

Prepared statement .......................................................................................... 34

Response to a question from Senator Baucus ................................................ 60

Degen, Frank:

Testimony .......................................................................................................... 4

Prepared statement .......................................................................................... 61

Graetz, Michael J.:

Testimony .......................................................................................................... 9

Prepared statement .......................................................................................... 65

Grassley, Hon. Chuck:

Opening statement ........................................................................................... 2

Hassett, Dr. Kevin:

Testimony .......................................................................................................... 7

Prepared statement .......................................................................................... 76

Responses to questions from Senator Baucus ................................................ 82

Salazar, Hon. Ken:

Prepared statement .......................................................................................... 86

COMMUNICATIONS

American Farm Bureau Federation ....................................................................... 89

Spence, Mary Jane .................................................................................................. 92

(III)

(1)

THE STEALTH TAX THAT’S NO LONGER

A WEALTH TAX: HOW TO STOP THE

AMT FROM SNEAKING UP ON

UNSUSPECTING TAXPAYERS

WEDNESDAY, JUNE 27, 2007

U.S. SENATE,

COMMITTEE ON FINANCE,

Washington, DC.

The hearing was convened, pursuant to notice, at 10:03 a.m., in

room SD–215, Dirksen Senate Office Building, Hon. Max Baucus

(chairman of the committee) presiding.

Present: Senators Bingaman, Kerry, Wyden, Stabenow, Salazar,

Grassley, and Roberts.

OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. The hearing will come to order.

It’s like a bad horror movie. The unsuspecting victim thinks that

everything is all right. She is going along without a care in the

world. But a monster lurks around the corner; it is just waiting to

pounce.

That monster, of course, is the Alternative Minimum Tax, also

known as the AMT. It attacks more and more taxpayers every

year, and most of its victims are middle-income Americans.

At the AMT’s beginning, Congress tried to stop just 155 tax- payers with incomes above $200,000 from completely avoiding

taxes. It was an attempt to make sure that all taxpayers paid their

fair share.

Now the AMT has morphed into a terrible beast. It snares American families who are just trying to get by; it besets families who

are working hard and raising children.

The IRS reported that 3.6 million taxpayers paid the AMT in

2005. The Joint Committee on Taxation estimates that 4.2 million

paid it in 2006. Of these, 25,000 had adjusted gross incomes of less than $20,000. That’s right: less than $20,000. Only 80,000 taxpayers made more

than a million. More people making less than $100,000 pay the

AMT than people making more than a million. That does not make

much sense.

On top of all that, 2001 IRS numbers show about 4,500 people

with incomes of more than $200,000 still did not pay either the regular income tax or the AMT. The AMT has strayed from its original purpose. And the number of taxpayers attacked by the AMT

2

* For additional information on this subject, see also, ‘‘Present Law and Background Relating

to the Individual Alternative Minimum Tax,’’ Joint Committee on Taxation staff report, June

25, 2007 (JCX–38–07).

would have been higher if Congress had not stepped in with a

patch. This patch keeps the AMT somewhat at bay; it holds constant the number of taxpayers affected.

This patch expired at the end of 2006. Congress has not yet enacted a patch for 2007. Without the patch, the number of Americans affected by the AMT for 2007 will explode, from about 4 million to more than 23 million taxpayers.

Come April of next year, millions of taxpayers will get an unpleasant surprise if Congress does not act. In Montana, Congress’s

failure to enact a patch would mean that more than 6 times as

many taxpayers would have that burden, and millions of those 23

million taxpayers would be middle-income Americans. The Joint

Committee on Taxation projects that most of the 23 million taxpayers affected would earn between $50,000 and $200,000.

The problem of the AMT goes beyond just those paying the tax.

The AMT affects a lot of other taxpayers, too. It forces many taxpayers to have to calculate their tax liability twice, first under the

regular tax system, then again under the AMT.

The IRS guesses that the average taxpayer takes more than 30

hours filling out Form 1040, and that is more than one complete

day every year out of the lives of each and every one of these taxpayers lost forever. The AMT only increases that loss.

The tax was enacted to make sure that upper-income taxpayers

could not avoid paying any taxes at all. Now it is falling on middleincome families. We do not need two systems, we need just one—

one that works.

The AMT monster attacks no new victims this year if we in Congress do what we should do, that is, enact legislation to make sure

that it does not affect any new taxpayers for taxable year 2007.

Today’s hearing will focus on this monster lurking around the

corner, the individual AMT. We will try to figure out how to stop

it from sneaking up on unsuspecting taxpayers, and we will try to

figure out how we might even kill that monster once and for all.

And who knows? With the time that taxpayers save in not having

to calculate the AMT, they might even be able to get out and catch

a good movie.*

I will now turn to Senator Grassley.

OPENING STATEMENT OF HON. CHUCK GRASSLEY,

A U.S. SENATOR FROM IOWA

Senator GRASSLEY. This hearing is especially important in light

of my often-stated view that the Alternative Minimum Tax is generally not getting the attention it deserves in Congress.

The last increase in exemption amounts that Chairman Baucus

and I worked to put in place has expired, and new taxpayers are

being caught by the Alternative Minimum Tax right now.

Less than 2 weeks ago, taxpayers who make estimated tax payments made their 2nd-quarter payments.

Those taxpayers do not know if they are going to be protected by

an increase in the exemption as we usually do, and that uncertainty is going to increase until something is done in this session.

3

The AMT has been a complete policy failure that was created

with 155 taxpayers in mind in 1969, and could consume 23 million

taxpayers this year. Moreover, the tax has not decreased the number of people who are able to legally eliminate all of their income

tax liability.

The only thing that the Alternative Minimum Tax does successfully is pull in vast amounts of money for the Federal Government.

This is especially ironic in that the Alternative Minimum Tax was

conceived primarily to promote tax fairness, and not to raise revenue.

This tax is projected to balloon revenues by so much that the

Congressional Budget Office has projected that total Federal revenues will push through their 30-year historical average and keep

increasing.

The solution that I have advocated to the Alternative Minimum

Tax is Senate bill 55, the Individual Alternative Minimum Tax Repeal Act. That solution is to permanently repeal the tax without

offsetting the revenues that would not be collected as a result of

the repeal.

Revenues projected to be collected by the Alternative Minimum

Tax are revenues the tax was never meant to collect, hitting

middle-income people who were never intended to pay it, and it

would only be collected through error. To make offsetting a condition to repeal is to commit to reshape a problem without solving

the problem.

However anyone seeks to approach the Alternative Minimum

Tax, time is running out, and has already run out for millions of

taxpayers. Anyone who seriously recognizes the Alternative Minimum Tax as a problem they actually intend to solve will see the

need for immediate action.

I am going to be introducing legislation that will provide taxpayers a safe harbor from being punished for the fact that Congress has failed to deal with this issue. Right now, millions of

Americans do not know whether they should be paying an estimated tax because Congress has not passed AMT relief for this

year. In other words, there are many taxpayers who will be facing

a big tax bill if we do not pass relief.

By law, many of these taxpayers should be paying estimated tax

right now based on the fact, as the law is, that they are subject

to the AMT. Under my proposal, in computing tax for the purposes

of the penalties in the tax code dealing with estimated tax, a taxpayer would be permitted to disregard the Alternative Minimum

Tax if the individual was not liable for the Alternative Minimum

Tax for the preceding year.

So, if you did not have to pay the Alternative Minimum Tax last

year, we are not going to penalize you if you do not file estimated

taxes for AMT this year. Just because Congress cannot get its job

done does not mean that taxpayers should be punished.

Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, Senator.

I would like, now, to introduce the panel. The first witness is Mr.

Frank Degen, a representative from the National Association of

Enrolled Agents, who will discuss AMT from a practitioner’s perspective.

4

Then Dr. Leonard Burman, the director of the Tax Policy Center,

will discuss possible ways to fix the AMT and pay for it.

Next, Dr. Kevin Hassett, director of economic policy studies for

the American Enterprise Institute for Policy Research, will discuss

repealing the AMT.

Finally, Mr. Michael Graetz, a professor from Yale Law School,

will discuss the timing of AMT reform. I think he wants to discuss

AMT in the broader context of tax reform.

Thank you all for coming. And by the way, as you know, it is customary here to put all of your statements automatically in the

record, and urge you to limit your remarks to about 5 minutes. I

would just urge you to tell it like it is, say what is on your mind.

Tomorrow is another day.

Mr. Degen, why don’t you proceed?

STATEMENT OF FRANK DEGEN, ENROLLED AGENT, NATIONAL

ASSOCIATION OF ENROLLED AGENTS, SETAUKET, NY

Mr. DEGEN. Thank you, Mr. Chairman and members of the committee, for inviting the National Association of Enrolled Agents to

testify before you today.

My name is Frank Degen. I am an enrolled agent, and I speak

on behalf of NAEA, the premier organization representing the interests of the 46,000 enrolled agents across the country.

The Internal Revenue Code requires a taxpayer to calculate his

taxes twice, once under the regular tax calculation and then again

under the AMT calculation. The taxpayer’s liability then defaults

to the larger of the two.

Given this process, one could argue that the AMT should more

truthfully be termed the ‘‘mandatory maximum tax.’’ Alternative

Minimum Tax almost sounds benign, while ‘‘mandatory maximum

tax’’ sounds so much closer to the truth.

The AMT’s lack of inflation-indexed income exemptions presents

Congress with an increasingly unpleasant trade-off. To minimize

budget pain, Congress has passed 1- and 2-year patches instead of

engineering a permanent fix. As a result, long-term tax planning

is made virtually impossible for millions of taxpayers.

To further emphasize the disadvantages to taxpayers and tax

practitioners resulting from the atmosphere of uncertainty and surprise surrounding the AMT, I would like to offer three real-life observations.

Bill and Liz are air traffic controllers. Their tax liability was increased an extra $6,400 solely due to AMT. Why? Because the AMT

calculation does not allow their five exemptions—Bill, Liz, and

their three girls—and their Schedule A taxes. Bill said to me, ‘‘This

is crazy. I don’t have any tax loopholes.’’

Laura is a mid-level executive in New York City. Her income tax

return is relatively straightforward: no K–1s, no passive activity

bonds, no other tax preferences. When I told her that the AMT calculation on her return created a balance due of $1,050 rather than

refund of $6,450, a net change of $7,500, she asked me a question

for which I had no answer: ‘‘Didn’t Congress say it was lowering

taxes?’’

And Karen has four children. She files as head of household,

claims the deduction, and has an AGI of $75,000. Imagine her surVerDate 11-MAY-2000 14:46 May 04, 2009 Jkt 000000 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 48528.000 SFIN1 PsN: SFIN1
5

prise when I told her she has an AMT liability. Her only comment

was, ‘‘I read in the papers the AMT was supposed to be for rich

guys.’’ I suspect few in the halls of Congress would argue that she

is rich or that she is resorting to sophisticated tax planning to reduce her Federal income tax liability.

It is time Congress enacted a lasting solution to the AMT problem. We believe the best way to untie this Gordian knot is a complete repeal of the individual AMT. Chairman Baucus and Ranking

Member Grassley have introduced a bill that would do just that.

I also commend Senator Schumer, from my home State of New

York, for co-sponsoring the bill. Repealing the full AMT would be

a huge step in simplifying the tax code.

Practically speaking, NAEA admits that full repeal of the AMT

may be a bridge too far. At the same time, we believe that any proposal short of full repeal must satisfy three criteria. (1) It must

limit the AMT’s scope. It should affect only taxpayers Congress believes are engaging in the most egregious tax avoidance. (2) It must

be permanent. One-, 2-, or even 5-year temporary fixes are not desirable. (3) It must be indexed. The lack of indexing is the root

cause of the current AMT problems.

In closing, I would like to take a moment to make a broader

point about tax return preparation, which is that producing an accurate return is often a complex exercise. A preparer must be able

to properly interpret and apply the tax code, especially when AMT

comes into play, and therefore the preparation of complex returns

should not be left to amateurs. One wonders about the number of

inaccuracies on tax returns that are a consequence of the AMT.

Congress could act to improve competence in the tax preparation

industry by enacting S. 1219, the Taxpayer Protection Assistance

Act introduced by Senator Bingaman. It appears reasonable to assume that greater accuracy in tax return preparation leads to

greater taxpayer compliance.

As always, NAEA and its members stand ready to work closely

with Congress in assessing the merits of various AMT proposals.

I thank you once again, and stand ready to answer any questions

later.

The CHAIRMAN. Thank you, Mr. Degen, very much.

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

The CHAIRMAN. Dr. Burman?

STATEMENT OF DR. LEONARD BURMAN, DIRECTOR,

TAX POLICY CENTER, URBAN INSTITUTE, WASHINGTON, DC

Dr. BURMAN. Thank you, Mr. Chairman, Ranking Member Grassley, members of the committee, for inviting me to share my views

on the individual Alternative Minimum Tax.

A few years ago, my colleagues and I wrote a paper titled ‘‘The

AMT: Out of Control.’’ It is really out of control now. If Congress

does not act, virtually everyone in this room, along with 23 million

Americans, will owe AMT next year. A lot of the AMT’s victims are

solidly middle-class, not the millionaires who were its originally intended target.

In my testimony I show that a family with four kids under age

17 earning $75,000 with no itemized deductions will see their tax

6

double in 2007 because of the AMT. Their tax planning mistake in

the AMT world was having four kids.

Last night, I checked the IRS website to see whether this family

would have enough tax withheld to pay the AMT. No. Assuming

one parent earns all the income, the IRS advises them to claim 11

exemptions on the W-4 form that employers use to set withholding,

and promises that the family will get a $25 refund at the end of

the year.

Actually, under current law, that family would be under-withheld by almost $2,000. Senator Grassley’s proposal would help that family, or at least prevent them from paying penalties, but there would

be a rude shock at tax time.

The smart money says that Congress will patch the AMT for another year or two to make sure that the hypothetical family will

not be affected. The latest patch expired last year. This stop-gap

approach leads to endless confusion. How much estimated tax and

withholding should I pay? What is my tax bracket? Would I benefit

from the tax credit for hybrid vehicles if I bought one? Is it safe

to ignore the AMT, as the IRS does in its withholding calculator?

Is the IRS prescient, or just clueless like the rest of us? We know

the answer to that.

Why should 23 million Americans have to guess about their tax

situation? Some people say that the AMT is not such a bad tax system so we should just let it take over. Actually, the AMT is a terrible tax system. The AMT exemption, which you deduct from income to calculate AMT, phases out at a 25-percent rate. This boosts

the effective tax rates in the phase-out range by a quarter, so instead of the advertised 26- and 28-percent rates, many AMT taxpayers face effective rates of 32.5 or 35 percent. The AMT hits almost everyone with incomes between $200,000 and $500,000, but

not so many millionaires, resulting in the highest rates not always

applying to the highest-income people.

Unlike the regular income tax, the AMT is not indexed for inflation, so people’s average tax bills can increase, even if their incomes do not grow at all in real terms. The AMT hammers married

couples, and especially families with kids. In 2007, married couples

will be 15 times as likely as singles to owe the AMT.

Some claim that software and paid preparers make AMT complexity no big deal, but there are at least three problems with this

argument. First, as the AMT consumes the middle class, we will

have more and more people who do their taxes by hand, or try. Second, even with software it is complex, as I explain in my written

testimony. Third, you might want people to understand how the

tax system affects them. With the AMT, the tax system becomes

an inscrutable black box.

Some argue that the AMT is a blue State tax, only one party’s

problem. Although it is true that taxpayers in relatively highincome, high-tax coastal States were more likely to owe AMT than

those in the interior, the AMT is going to hit people in all States

hard if it is not fixed.

Even back in 2004, lots of red States had AMT hot spots, zip

codes where 10 percent or more of the residents owed the tax. The

AMT hits middle- and upper-income families with kids, soccer

moms. It is in all of your interests to do something about it.

7

So what should we do? Well, some members of the committee

have suggested the solution will be to repeal the AMT and not

worry about the $800 billion in revenues foregone. They argue that

the AMT taxes people who were never its intended target, and thus

AMT revenues should never have been counted on. The real baseline should assume no AMT.

Those members might have, but did not, raise that argument in

2001 when large projected AMT revenues greased the skids for the

ensuing tax cuts. In fact, the AMT masked much of the cost of the

tax cut, since people who pay it do not get the full income tax rate

reductions. Eliminating the AMT after it has helped finance the

largest tax cuts in history amounts to a major bait-and-switch if

the lost revenue is not offset.

Fortunately, there are many options to reform or repeal the AMT

that would not increase the deficit. My favorite option, and probably one shared by everyone on this panel, would be to eliminate

the AMT as part of fundamental tax reform.

But given political reality, the best alternative may be a simple surtax of 4 percent of adjusted gross income over $200,000 for joint

returns, and $100,000 for others, which would raise enough to offset the revenue lost from repealing AMT.

The surtax would be simple and progressive. The vast majority

of AMT-paying taxpayers would pay lower taxes. Only the richest

1 percent would pay higher taxes, on average, and they would lose

far less than they gain from the 2001 to 2006 tax cuts. Moreover,

most of the taxpayers who lost a large share of their tax cut due

to the AMT would now receive the full benefit.

Some critics have complained that the surtax would raise effective tax rates and discourage work and saving. But since the current AMT has even bigger implicit surtaxes built into it, most affected taxpayers would face lower rates under the alternative.

Many other fiscally responsible options are outlined in my written testimony. Repealing the State and local tax deduction would

more than pay for repeal, although that raises other issues.

I understand that fixing the AMT is not easy. If it were, it would

have been done a long time ago. I applaud the committee for taking

the first steps towards what I hope will be a permanent solution.

The CHAIRMAN. Thank you very much, Dr. Burman.

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

The CHAIRMAN. Dr. Hassett?

STATEMENT OF DR. KEVIN HASSETT, DIRECTOR, ECONOMIC

POLICY STUDIES, AMERICAN ENTERPRISE INSTITUTE FOR

POLICY RESEARCH, WASHINGTON, DC

Dr. HASSETT. Thank you, Mr. Chairman and Ranking Member

Grassley. I would like to join my colleagues on the panel in commending Senator Grassley for looking for ways to protect taxpayers

from the uncertainties caused by the AMT.

I think my testimony really has four parts. The first is a discussion of the uncertainty and the cost to taxpayers of that uncertainty. And I used the example that I drew from Dr. Burman’s

website that he included in his testimony, so I will not march everyone through that.

8

The three additional points in my testimony that I would like to

march you through, if you would be so kind, are the following.

First, I would like to address the question, is the AMT an efficient

tax? Second, I would like to talk about, who pays the AMT, but

also, who benefits from the exclusions and exemptions and so on

that put people on the AMT? Three, how do I think we could fix

it?

And on the third step, Mr. Chairman, rather than put a sort of

partisan marker down on the field, what I really tried to do in my

testimony was put all the bargaining chips on the table so that people could look at these chips and decide what they, themselves,

might like to do. Hopefully this testimony will help foster a permanent reform that folks could work out together once they see these

parameters.

So, first, is the AMT an efficient tax? Some have argued that it

is actually desirable to move more taxpayers onto the AMT, as it

is a tax that has lower rates and a broader base. These people who

argue this, however, forget, as Dr. Burman mentioned, that the exemption phases out, which creates a very broad range with very

high marginal tax rates.

If you could turn to the first figure in my testimony, if you have

it before you, I actually show, based on work from my colleague,

Alan Viard at the American Enterprise Institute, a chart that

shows the difference between the effective marginal tax rate for

people on the AMT and the effective marginal tax rate for people

in the ordinary code. You can see, from about $50,000 in income

up to around $300,000 on the chart, for virtually everyone the AMT

has a higher tax.

So if we were to switch to the AMT and repeal the ordinary code,

as some have argued, then we would basically be passing a marginal tax rate hike on many, many Americans, which is, I think,

undesirable, we would all agree.

Who pays the AMT? On this question, I think that the most important observation—and I will move you to that chart, the second

chart in the section where I provide calculations that were performed for me by the Tax Foundation—is that the 1-year tax savings by decile from special tax provisions is very much loaded in

the top decile.

So if you look at this chart, that top bar shows that probably

maybe almost 70 percent of the revenue lost to the things that

throw you on the AMT are benefits to the top decile.

Now, I think that that is interesting, because what it means is

that, if you are considering a reform that is protecting those, say,

protecting the State and local deduction rather than a permanent

reform of the AMT that repeals it, then raising marginal rates on

the top as my colleague, Dr. Burman, proposes, effectively is giving

people money with your left hand and then taking it back with

your right, which seems to me to be introducing needless complexity into the code.

So how do I think we should reform the AMT? I think the logical

reform should eliminate or cap deductions and exclusions and then

use the revenues gained from this to reduce marginal tax rates, or

to leave them where they are, if that is the objective. This would

9

produce a simpler tax code and one that interferes with economic

activity much less than today’s convoluted code.

Now, the final table in my presentation is a chart that I prepared

that provides some guidance to the kind of trade-offs that would be

present if you were to pursue a strategy like this. The first measure to go in the chart is the State and local tax deduction and the

special treatment of State and municipal interest payments.

Eliminating these measures effectively solves the AMT problem—the total number of taxpayers on the AMT would stop growing—and does so with a slight revenue gain, allowing Congress, if

they wanted to, to proportionately lower tax rates significantly.

Just as an example, I show that the top rate goes from 35 percent down to 33.5 percent. I do not think this committee, of course,

has to decide to proportionately reduce everyone’s tax rates. It is

just that that seemed like an easy way to capture what you could

buy from the elimination of it in an intuitively friendly way.

Next, if we cap mortgage interest deductions, and I just picked a number of $100,000, we gain more revenue with which we could

further reduce marginal rates. And as you read across the table,

you can see that by eliminating these things we get marginal rates

down tremendously.

In fact, in a revenue-neutral reform we could get the top rate all

the way down to 26 percent and the bottom rate all the way down

to 7 percent. Again, that is revenue-neutral.

Of course, this table is not meant to be a blanket policy recommendation; rather, it is a guide to the trade-offs that this committee should consider while reforming the AMT.

If you cap these things at some level, you will gain some revenue,

a lot less than if you eliminate it, but that might be enough revenue so you could, for example, leave marginal rates where they

are today but not lose any revenue.

The biggest lesson from this table, I think, is that designing a

tax system that raises the same amount of money as the current

system that does not have a rapidly expanding AMT and does not

have higher marginal rates than we face today is really child’s

play, and I would urge this committee to work together to make

such a reform a reality.

The CHAIRMAN. Thank you very much, Dr. Hassett.

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

The CHAIRMAN. Mr. Graetz?

STATEMENT OF MICHAEL J. GRAETZ, JUSTUS S. HOTCHKISS

PROFESSOR OF LAW, YALE LAW SCHOOL, NEW HAVEN, CT

Mr. GRAETZ. Thank you, Mr. Chairman, Senator Grassley, members of the committee.

I want to begin by just saying that I was a young staffer for the

Treasury Department in 1969 when the Minimum Tax came into

law, and I sat in the Ways and Means Committee room and in the

Senate Finance Committee room as it was discussed.

And while those committees did pore over these famous 155 taxpayers, who were so highly publicized, everyone on the committee

was aware that the kind of minimum tax they were talking about

would indirectly cut back on itemized deductions. That is exactly

what the minimum tax does today.

10

Now, its reach has grown far broader than anyone imagined. I

agree with that entirely. It is true that this was a back-door way

rather than a front-door way of cutting back on those deductions.

But people did know that that is exactly what it was going to do.

I began my written statement with a thought experiment, and

the thought experiment is this: let us assume that Congress, without changing anything else in the tax law, just renames the regular

income tax the Alternative Maximum Tax and renames the AMT

the regular tax. That is the way they work today. You pay the regular tax if it is higher than the AMT, and assume we do nothing

else.

My question is, would we be sitting here talking about repealing

the AMT under those circumstances or would we be sitting here

talking about repealing the regular tax? The AMT, it is true, affects 25 to 30 million people if we do nothing. The regular tax, on

the other hand, affects 150 million people, and we should also

worry about them.

The essential point of this experiment is to make clear that whoever is under one of these taxes, this occurs because of the linkage

between the two taxes. So in 2001, when we lowered tax rates

under the regular tax but did not change the tax rates under the

AMT, we moved people to the AMT.

In the 1980s, when we indexed the regular tax brackets for inflation but we failed to index the AMT tax bracket for inflation, we

created the problem we are faced with today.

If we indexed the AMT for inflation, the exemption would be around $70,000, which is just less than the patch has been over recent years. So, these two taxes are related. The problem that we

are in today occurs because all of the tax cuts in the 2001 Act were

focused on the regular tax side and not on the AMT side.

My point is this: in 2010 those tax cuts on the regular side all

expire, and so do the ones that were enacted in 2003. So the question is, why should we be worrying about the AMT today when we

have all of these questions about the regular tax going forward?

I use the example that everyone has used, because it is so important to the AMT, of State and local taxes to make the point that,

under the regular tax you get a full deduction for State and local

taxes, while under the AMT you get no deduction for State and

local taxes.

The President’s Tax Reform Commission recommended no deduction for State and local taxes. The Tax Reform bill that has been

offered by Senator Wyden, a member of this committee, and Rahm

Emanuel in the House limits drastically the amount of deductions

for State and local taxes, and in fact changes the deduction to a

10-percent credit. There are real questions, real important policy

questions—I go through some of these in my statement—as to

whether there ought to be a deduction at the Federal level for

State and local taxes or whether there should not, whether it subsidizes high-tax States at the cost of low-tax States.

I point out in my statement, Senator Baucus, that Montana

ranks 46th in State and local taxes. I do not understand why you

should want to put higher tax rates on the people in Montana in

order to subsidize the high tax rates that Senator Kerry—to pick

one who is not here—has in Massachusetts. Senator Grassley, your

11

State ranks 26th. So, there is a serious question about whether we

should add tax rates, as Dr. Burman has suggested, rather than

limiting the deduction for State and local taxes.

I want to be clear. Do not misunderstand me. I agree with many

of the points that Senator Grassley made, that, Mr. Chairman, you

made in your opening statement, that my colleagues on the panel

have made. The minimum tax is horribly complex, it creates uncertainty. The people who have estimated tax problems really should

be protected in the way Senator Grassley has suggested.

But I do not think that you can consider the AMT as if it is a

stand-alone item apart from all of the other things that expire in

2010. It just does not make sense to me. And I am very skeptical

of all of these charts that are showing current law versus AMT.

They are assuming no patch on the AMT, although I would assume

we are going to have a patch on the AMT. I would hope so.

And they are assuming that the tax rates are either extended or

not extended, depending on which chart you look at. I think Dr.

Burman’s revenue estimates assume that the tax rates expire, all

the changes expire in 2010, as current law provides. Dr. Hassett’s

charts, I think, assume the opposite.

So I think you have to be careful about these comparisons, because there is tremendous uncertainty in the regular tax today due

to the sunsets that will be occurring in 2010.

I talk in my statement about other issues. I talk about the marriage penalties and the head of household issue under the Alternative Minimum Tax. In my statement, I talk about the home

mortgage interest deduction. I believe the provision under the AMT

is a better provision than the provision under the regular tax,

which allows people to use home equity borrowing much more liberally than the AMT provision does.

My only point is that all of these issues are complex. They are

going to all be on the table in 2010. I think that the best thing this

committee could do in the interim is to extend the patch, index the

patch for inflation through 2009 or 2010, depending on your judgment as to when you are going to have to take these issues on, protect the people who are not now on the AMT from coming into it,

and support Senator Grassley’s safe harbor for people who may

otherwise have estimated tax penalties. Then in 2010 you will be

in a position, or in 2009 with the new administration, with all the

issues on the table, to ask questions of the sort that Dr. Burman

has put forth about tax rates, and State and local taxes, and that

Dr. Hassett has put forth about all of the itemized deductions,

which are necessarily implicated when one thinks about the AMT.

Thank you, Mr. Chairman.

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

The CHAIRMAN. Thank you very much. That is very helpful.

I think we can all assume, and I think we can believe that we

are going to find a patch here, as basically you have all said or implied, so that taxpayers who are not paying AMT in 2006 will not

have to pay in 2007. I think that is pretty much a given.

I have a couple of questions, though. One is, how do we pay for

it? We have these very rigid pay-go rules. I am going to ask, and

I know some of your suggestions, but I would like you to give us

some suggestions that are politically realistic, for this year and

12

next. I mean, we have to find ways that are realistic here, not that

are unrealistic.

Second, I think it is wise, basically, considering the patch, to

think about tax reform in 2009 and 2010, as you are doing. I would

like you to kind of address some of the suggestions there that you

also think are politically realistic, not just pure tax theory.

So I will start with you, Dr. Burman. I know your suggestion is

the 4-percent surtax as the pay-for here, but if you could just give

me, what is realistic here as we enact the patch? And then a couple

of thoughts about 2009 and 2010. Get realistic.

Dr. BURMAN. Options that pay for just a 1- or 2-year patch?

The CHAIRMAN. Yes.

Dr. BURMAN. I am probably the least well-qualified person in this

room to tell you what is politically realistic. I came up with the 4-

percent surtax based on the cold reception that my proposal to repeal the State and local tax deductions got from the Ways and

Means Committee.

The problem is, any kind of reform would involve winners and

losers. You cannot replace an irrational tax with a rational one

without changing the distribution of burdens, and the losers are always very vocal.

This committee has looked at options to close loopholes to improve the IRS’s ability to enforce the tax. I think the proposal to

require reporting on basis for sales of capital assets is a good one.

The CHAIRMAN. That does not raise much revenue.

Dr. BURMAN. Yes. It does not raise very much revenue. The hard

thing is, the thing that would actually help both with compliance

and enforcement would be to simplify the tax system. Right now

we have a whole host of different tax benefits.

The CHAIRMAN. We are going to do that this year?

Dr. BURMAN. I guess the answer is, I do not have a simple solution to your question here.

The CHAIRMAN. All right.

Dr. Hassett?

Dr. HASSETT. Thank you, Mr. Chairman. I think that, if you are

looking for revenue, you could look in the places where there is a

lot of it sitting. There is already a cap on the mortgage interest deduction of $1 million, and I do not think a marginal rate hike is

something that you would call a politically easy lift this year.

But lowering the mortgage interest deduction cap some makes

very good sense in terms of economic policy, and it could get you

revenue. Depending on how far you went, it could get you a lot of

revenue.

The CHAIRMAN. Do you think that is realistic?

Dr. HASSETT. Dr. Burman has a paper on his website that I

think had 23—did I count it right?—different proposals to do this.

And all we can do is explore the parameters that are there.

The CHAIRMAN. Mr. Graetz, we will let you get a whack at this.

Mr. GRAETZ. Mr. Chairman, I have to say I admire generally the

reinstatement of the pay-go rules. I think this is a great improvement in our fiscal situation by the Congress.

The CHAIRMAN. I see all the panelists nodding their heads in

agreement.

13

Mr. GRAETZ. Although I have to say, in this context, I am somewhat less concerned with it as is Senator Grassley, because no one

really ever expected this revenue to be collected. You have this

short window here of 2 or 3 years where you have to do something.

There are no easy offsets.

You have been talking about compliance changes. I agree with

the idea of reporting of basis. There are some credit card reporting

options that have been suggested that may be more robust in terms

of revenue, depending on how you go, and other compliance options. You have been talking about taxing high-income persons who

get capital gains treatment rather than ordinary income treatment.

The CHAIRMAN. What do you think of that?

Mr. GRAETZ. Well, I think it is odd. I think there are some difficulties.

The CHAIRMAN. What is odd about it?

Mr. GRAETZ. I think it is odd that people who are making that

much money off of essentially labor income should be paying lower

rates than their secretaries are, to put it baldly. I think it is good

that you are considering changing it. I think you have to be careful

not to trap others in doing it.

I think you are also on the right track when you are thinking

about whether publicly traded partnerships ought to be taxed as

corporations, since the corporations they are competing with are

certainly paying tax at the corporate level. There is some actual

money in some of those areas.

I also think that Dr. Hassett and Dr. Burman are right, but none

of Dr. Burman’s suggestions are very pleasant politically. The suggestion of reducing the home mortgage interest deduction is not

one I see people standing up and cheering about on the committee,

although there are other ways to go.

I do think the AMT, by limiting the way in which you can use

home equity interest, is a good solution. Perhaps limiting the deduction to one house instead of two might be a good idea, if one

simply exempted members of Congress. [Laughter.]

The CHAIRMAN. Senator Grassley?

Senator GRASSLEY. Anybody who wants to answer my question

may. Considering the fact that there are very wealthy people

today—and I think my staff gave me a figure that I used in a

speech—that there might be 2,300 people today who ought to be

paying the Alternative Minimum Tax with high enough income,

people who were intended to pay it who are not paying it, since we

are ruining the middle-class, and since it is not working for the

people it was intended to hit, why not just do away with it? Any

one of you.

Dr. BURMAN. I would cheer if the AMT went away. I think it is

terrible tax policy. The problem is that we did count on that revenue. The President says he is going to balance the budget by 2012,

and he is assuming that there is going to be, on his baseline, something like 45 million people on the AMT producing revenues for the

government.

In 2001, both the House and the Senate were well aware that the

AMT was in the baseline. It was contributing revenues that made

the budget situation look better—it was already good back then. In

addition, it was known that the AMT was going to take back a sigVerDate 11-MAY-2000 14:46 May 04, 2009 Jkt 000000 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 48528.000 SFIN1 PsN: SFIN1
14

nificant fraction of the tax cuts that were enacted because the cuts

basically doubled the number of people on the AMT. That would

have been a good time to raise the issue about whether this should

have been counted, to revise the baseline and say, actually, the deficit situation—or surplus back then—was not as good as we expected, and, furthermore, the cost of the tax cuts is going to be

about a third higher than we expected.

I think the problems now are more serious than they were then.

In 2010, the baby boomers are going to start retiring. The demands

on the government, as this committee well knows, are going to be

enormous, and basically we need the revenue.

Senator GRASSLEY. What you just said is, regardless of the fact

that today government revenues, as a percentage of gross national

product, are 18.6 percent of the GNP, where they have been for 30

years—a level of taxation that we have accepted as something not

hurting the economy, something that people will accept—are you

suggesting we need to go way above 18.6 percent of GNP?

Dr. BURMAN. Actually, unless you can figure out something radical to do to control entitlement spending, you are going to have to.

Senator GRASSLEY. I cannot disagree with you on a statement

about entitlement spending.

Go ahead, Dr. Hassett.

Dr. HASSETT. Yes. Senator Grassley, I am very sympathetic to

your views. The one concern that I would have is, if we just repealed the AMT, more or less in defense of these itemized deductions that economists do not like that do not add to economic efficiency, that we are going to end up having higher marginal rates

in the ordinary code than we want.

So I think that ultimately these heavy political lifts are going to

have to be addressed. We are going to have to limit things like the

mortgage interest deduction to get the revenue to keep marginal

rates where you, Senator Grassley, I know, want them to be.

Senator GRASSLEY. Anybody else want to jump in before I go to

my next question?

Mr. DEGEN. Senator Grassley, I do think I will make a comment.

I view this a little bit differently. I am not part of academia. I see

taxpayers, and I hear about reducing the mortgage interest deduction. The American dream is to own your own home.

The government, whether right or wrong, has made an implied

promise to people that we will help you own this home by giving

you a deduction for your mortgage interest. A $100,000 mortgage

is not very extreme in this day and age.

I am sure in Montana you see very high mortgages. I just happened to be out in Oregon a couple of weeks ago, and I could not

believe the price of housing there. I live in New York on Long Island, where housing is very high. So a $100,000 cap—I think we

have to think about the taxpayer also.

I think part of, as I said, the American dream is to own your own

house. Right now, people buy homes with the idea that the government is going to help them. So certainly, if you were ever going to

introduce a cap, number one, it could not be retroactive, there

would have to be some grandfathering or where you are.

But I seriously think $100,000, if it ever came to pass that you

decided to reduce the $1 million level, you have to be realistic in

15

terms of, do you want to help the American dream survive where

people can buy their own home?

I just wanted to say one more thing. You mentioned about the

political thing. I think what you need to do, if you do not mind me

saying this, is lock this committee and lock the Congress in a room,

and you come out and you speak with one voice. It has to be bipartisan. The people do not see that enough. I do not have any answers.

I cannot advocate for Dr. Burman’s position, though to me it

sounds reasonable, this 4-percent surcharge. But I hope, though,

that this committee, and the Congress in general, tries to act not

in a ‘‘we got you’’ on the other side of the aisle, but in a sense of

bipartisanship. Then people will appreciate whatever you do. If you

do it together, they will accept it.

Mr. GRAETZ. Senator Grassley, if I could just respond to your

question. I think that there are provisions under the Alternative

Minimum Tax which we have talked about a lot today that are

really bad provisions: the failure to index the exemption, the marriage penalties, and so forth. On the other hand, there are provisions under the regular income tax that are also really bad provisions.

The Joint Committee, in its pamphlet for the hearing today,

points out that 62.7 percent of the revenues under the Alternative

Minimum Tax relate to the disallowance of the State and local tax

deduction.

I think an unlimited deduction for State and local taxes, frankly,

is something that is not appropriate if the choice is to have higher

tax rates, which is the choice that is going to be faced in 2010

when the rates under the regular tax will automatically go back up

to nearly 40 percent.

And so, if you ask me, do I want a 40-percent rate with a full

deduction for State and local taxes or a lower rate—it is even 35

percent in the phase-out range—without such a deduction, I actually prefer the AMT rule to the regular tax rule.

Now, I am not saying that this is an issue that you can deal with

in the current context, but, because of the way the 2001 and 2003

legislation was structured to expire in 2010, you are going to have

to address that issue, I think, in 2010. If you repeal the AMT

today, you essentially pre-judge it in favor of higher rates, and that

is what I am concerned about, frankly.

The CHAIRMAN. Thank you very much.

Senator Bingaman?

Senator BINGAMAN. Thank you all very much.

Sort of following on with your suggestion that, whatever we do,

we should do it with a view toward a more significant reform of the

tax code that is going to be essential as we approach 2010, is the

right approach, as I understood you, Mr. Graetz, to enact another

patch for a couple of years, index it, kick the can down the road

in that way with the AMT, and then begin a more serious, in-depth

look at how to restructure the entire tax code, hopefully to eliminate an AMT at that point?

Mr. GRAETZ. Senator Bingaman, that is exactly where I would

urge the committee to go, and to do it in a way so that we do not

16

create this 1-year estimated tax problem that Senator Grassley

talked about.

So go ahead and index it through 2009 or 2010 and begin looking

at the provisions under both of these taxes and asking which ones

of them are appropriate and which ones are not, in order to decide

what to do when all of the 2010 legislation expires. I am agreeing

with Dr. Burman to a large extent, that you cannot have a huge

budget hole going forward, so you are going to have to do something in 2010 that is revenue-neutral. I am much less concerned,

frankly, about the revenue to pay for the patch than I am about

what happens in 2010.

I have argued before this committee and elsewhere in the past

that we ought to be thinking more seriously about consumption

taxes as a way to get people out of the income tax. I have had a

proposal that we have a consumption tax that would allow us to

finance a $100,000 exemption from the income tax and eliminate

150 million people from the income tax altogether, which I think

also should be on the table going forward. But it can only be done

in the context of a 2010 look at this, or 2009.

Senator BINGAMAN. Let me ask Dr. Burman and Dr. Hassett if

you have any thoughts about that course of action as sort of the

least bad of the various options before us.

Dr. BURMAN. If I felt confident that there would be tax reform

in the new few years, I think it would definitely be worth waiting

for. Our tax system is broken, and the AMT is just one example

of the things that are wrong with it. It is too complicated. The AMT

is too complicated. We have a hodgepodge of tax credits, deductions, phase-ins, and phase-outs.

Kevin talked about the specific tax provisions that, in a lot of

cases, do not satisfy their intended purpose. You could actually

argue that the mortgage interest deduction has made it harder for

low- and middle-income people to own their homes.

I understand the transition problems that Mr. Degen talked

about. But the President’s Tax Reform Panel made proposals, and,

while I did not agree with every aspect of them, they would have

made things a lot simpler and they dealt with a lot of fundamental

problems in the tax system. I would love for this committee and for

the country to engage on that issue.

Senator BINGAMAN. Dr. Hassett?

Dr. HASSETT. As an observer of this committee, Senator Bingaman, I would have to say that it is something of the gold standard

of bipartisan cooperation, and I would trust your judgment on what

is best to do and would not object at all to a patch until you felt

that you had to deal with this, say, after the next general election.

Economically, that would be acceptable, absolutely, because it

would remove the uncertainty that I am so concerned about.

Senator BINGAMAN. All right. I will stop with that, Mr. Chairman.

The CHAIRMAN. Thank you very much.

Senator Roberts?

Senator ROBERTS. Thank you, Mr. Chairman.

And Mr. Degen, thank you for your comments in regards to the

mortgage interest deduction. I cannot think of anything that we

need to mess with less than that during the recent housing slump

17

and the economy the way it is. But you make a very interesting

point in regards to home building and being part of the American

dream, which I think is entirely accurate.

Mr. Chairman, thank you very much for holding this hearing,

what I call the ATM hearing, because you have to go to the ATM

to pay the AMT. [Laughter.] This is such an unfair tax, very overly

complicated, that does not even do what it was intended to do. My

witnesses, in terms of my own hearings in Dodge City, my home

town where I attend the coffee klatch, keep reminding me that I

am sticking them with the Alternative Minimum Tax, so they try

to stick it to me. That cost to me is much less than the AMT is

to them.

In Kansas, if we do not do anything with a patch—which I think

is a good recommendation, to do it for 2 years and then take a look

at where we are in 2010—we are going to go from 22,000 to

140,000 people in Kansas who pay AMT. They are not going to be

very happy, to say the least.

So I have joined the Chairman and the Ranking Member in what

we call the Baucus-Grassley-Roberts bill in some sections of this

committee, along with a lot of others, but what we call in Kansas

the Roberts-Baucus-Grassley bill, to repeal the AMT. I really want

to thank Senator Grassley for speaking to this in great detail on

the Senate floor.

I take issue with those folks who think we need to offset a tax

that was never intended to be collected at the level that is being

collected today. Unfortunately, it is a revenue stream that we have

gotten used to.

I want to thank all the witnesses for your views on how to deal

with AMT. I think we can all agree that there needs to be a longterm solution, but I have serious concerns about some of the proposals that would impose newer and higher taxes on some taxpayers to pay for tax relief for other taxpayers.

That does not seem to me to be a very good idea, especially raising taxes on those who make the investments in our economy and

are the job creators. That does not seem to be a very wise way to

pay for a tax that was never intended to be imposed on the vast

majority who are paying it now.

Just a couple of questions in the 2 minutes that I have. Mr.

Degen, there are estimates that it takes the average taxpayer

somewhere in the neighborhood of 63 hours to calculate their AMT

liability. What does it cost taxpayers who have to calculate their

income tax liability twice? Can you place a dollar amount in any

way on the cost of this?

Mr. DEGEN. I really probably cannot, Senator, except to say it

does cost. That is sort of a non-answer. But certainly, from a professional tax preparation standpoint, people typically charge by the

complexity of the return. So I am just going to throw out a number.

If it was an extra $25 charge, I mean, considering all the people

that have this, then the cost would be a large amount.

The other bad part about it is, often the AMT is not properly calculated because of all the loopholes. We talked about mortgage interest.

Senator ROBERTS. Right.

18

Mr. DEGEN. There are some add-backs on there that many, many

people do not do properly, so there is cost to the Treasury on that.

But I really cannot give you an exact dollar figure, except to say

that it would be rather substantial.

Senator ROBERTS. Dr. Burman, in your testimony you advocate

for what you call a surtax, but what I call a tax increase.

By the way, I do not call it ‘‘tax cuts,’’ Mr. Chairman, because

obviously we then get into, immediately the following words are

‘‘for the rich.’’ But if you say ‘‘tax relief,’’ that is a whole different

connotation. So, my advice to all who would want to listen is to call

it tax relief, although I am sure that will not be taken by every

member.

But a tax hike of 4 percent to apply to families who earn over

$200,000 and individuals earning over $100,000, 90 percent of

small businesses who file their taxes as individuals would be hit

by that. That is at least what we have indicated.

If you take the fact that small businesses actually create 60 percent of the jobs in this country, I am really worried about something like that. Do you have any comments that you would like to

make about that?

Dr. BURMAN. First of all, for most people it would not be a tax

increase because most people currently on the AMT would pay

lower taxes. Most of them would face lower marginal tax rates as

well. Dr. Hassett pointed out that marginal tax rates under the

AMT can be quite high and it discourages work and saving, much

more so than the 4-percent surtax that we are suggesting.

Senator ROBERTS. Right.

Dr. BURMAN. On the issue of small business——

Senator ROBERTS. I am not advocating that either. Do not misunderstand me.

Dr. BURMAN. I understand that, sir.

On the issue of small businesses, we have not looked at that specifically in this context, but in other contexts we looked at the distribution of, say, the 2001 to 2006 tax cuts and how they affected

small businesses.

Senator ROBERTS. You mean tax relief? Pardon me. Go ahead.

Dr. BURMAN. Yes. The tax relief enacted from 2001 to 2006.

Senator ROBERTS. Right.

Dr. BURMAN. The vast majority of the small businesses, the ones

actively involved in business and not just reporting a little bit of

consulting income under Schedule C, were in lower brackets and

were not affected by the tax rate cuts at the very, very top.

So overall, I would say that the surtax was our attempt to reflect

something like political reality. It was in some sense a response to

press reports——

Senator ROBERTS. I think you have that right, but not in the way

you are advocating.

Dr. BURMAN [continuing]. About—considering the surtax proposal would actually lower marginal tax rates on most taxpayers.

Senator ROBERTS. My time has expired. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you very much, Senator.

Senator Kerry?

19

Senator KERRY. Mr. Chairman, thanks for having this hearing.

I want to pick up on a couple things Senator Roberts said. But first

of all, this is long overdue and it is sort of a classic procrastination

of Washington, that we have been sitting around here for several

years seeing this train wreck coming down the road and nobody

has done anything.

This is a tax that was designed, in 1969, for 155 people—155

people—who earned more than $200,000 a year and did not pay

any taxes at all, and everybody was outraged. So there was a specific effort to try to make sure we had a fair tax system in America,

that the wealthiest people did not walk away with larger amounts

of money than seemed fair relative to what the average American

was paying in their tax rate.

Now we are going to have 23 million Americans sucked into this

unwittingly and inadvertently. I mean, it is just a no-brainer that

we have to respond to this. Now, Senator Roberts is leaving. I regret that, because I think it is important to have a dialogue about

this. That is all right. You can escape. [Laughter.]

Senator ROBERTS. There is a mark-up in the HELP Committee

to help people in Massachusetts. [Laughter.]

Senator KERRY. Good. Well, we want you to do that.

The problem is that there has just been an unbelievable—I

mean, I love this game that gets played with the word ‘‘relief ’’

versus ‘‘cut’’ and how words have supplanted thinking around here,

and they have also supplanted any fair standards of what we do.

In the 1980s, the top 1 percent of income earners in America

earned somewhere in the vicinity of 10 percent of the income of our

Nation. In the 1990s, it went up to about 16 percent. Now it is 22

percent. Twenty-two percent of the income of our country is earned

by the top 1 percent, and they are walking away with larger and

larger amounts of money.

Fifteen years ago, Forbes magazine, I think, had millionaires on

the front. Now we have 400 billionaires. The spread between average working folks and what the rate is that they are paying, the

rate of their taxation, the rate that a secretary pays versus the rate

that a CEO pays, is obscene. Obviously, with much larger amounts

of money, that rate is producing much larger income to people.

I do not know what the cut-off is now on 1 percent. What is a

1 percent income earner today? Above what level? What is the floor

in that income now from 1 percent? Three hundred and fifty-thousand, something like that, and upwards.

I do know this. I do know that people earning more than $1 million a year got at least $32 billion worth of tax cuts last year. I

also know that people like Warren Buffett and Bill Gates, who earn

among the largest amounts of money in our Nation, did not think

they should get that cut.

They believe deeply that tax relief ought to go more broadly to

people in the economy, and they would make more money, in fact,

if that happened because it would produce greater purchasing

power, greater wealth, greater investment broadly into our economy.

So I look forward to this debate, Mr. Chairman, because we need

to fix our tax code, which is seriously, seriously broken, whatever

20

27,000 pages and numbers of volumes it is now reaching. It is

wrong.

So anyway, with respect to this fix, Dr. Burman, let me just ask

you, to what degree is our thinking on the politics of this adversely

and sort of strangely affected by the revenue stream created by the

tax cuts themselves that have created this unfairness?

I mean, we are living in this vice of a tax cut structure where

we see this revenue stream, and if you were to begin to focus on

some of that, would you not have a much easier fix with respect

to the AMT?

Dr. BURMAN. Well, it is certainly true that the tax cuts doubled

the number of people on the AMT. They lowered regular tax rates

and they did not do anything about the AMT but for a temporary

fix, which has been extended a few times. So without the tax cuts,

it would cost half as much to eliminate the AMT or to reform it.

Senator KERRY. So the tax cuts themselves had a perverse impact of pushing more Americans at the lower end. So the tax cut

was not really a pure tax cut. It, in fact, was a tax increase for X

number of Americans. Correct?

Dr. BURMAN. That is actually not true. I do not think anybody

actually paid more tax as a result of the combination of the tax

cuts and the AMT.

Senator KERRY. They still wound up with net less.

Dr. BURMAN. Yes. On net, just about everybody got at least something, at least until you account for how you are going to pay back

the revenues lost.

Senator KERRY. So let me ask you, I think you already addressed

the question of the replacement for the regular tax system. You

stated that your favorite option is to replace it with the 4 percent.

Let me step beyond that for a minute. Would it be better to repeal the AMT than to try to reform it and exempt the middle class?

Dr. BURMAN. My preference would be to get rid of it. I do not

think the AMT makes a lot of sense, as a matter of policy. There

might be some elements to the AMT that should be in the regular

income tax, but they should just be incorporated there. I do not

think even millionaires should have to figure out their taxes under

two different systems. I think people should be able to understand

how the tax affects them.

Senator KERRY. Have one simple approach.

Dr. BURMAN. Yes.

Senator KERRY. And what would be the impact of repealing the

State and local deduction? What would the impact be on State and

local governments?

Dr. BURMAN. It would be a very progressive change, because

right now the people who are getting the most benefit from the

State and local tax deduction are very high income people. If you

are on the AMT, you do not get the full benefit—or even sometimes

any benefit—from the deduction.

It is kind of a funny way to help States because the States that

get the most benefit are the ones that have the largest tax bases.

High-income people are paying lots of tax. They get to deduct their

State and local tax at 35-percent rates, while a lot of low- and middle-income people do not even itemize deductions and thus do not

get any benefit from it at all.

21

There is a concern that, if you got rid of the State and local tax

deduction, it would make it harder for States to raise enough revenues to finance their governments, so basically high-income people

would want to leave. The evidence I have seen is not very convincing on that score, but the strongest argument made for the deduction is that it makes it easier for States to finance necessary

services.

Senator KERRY. I have exceeded my time. I appreciate it, Mr.

Chairman. I will come back.

The CHAIRMAN. Thank you. It is an interesting subject. In this

very room, it was that issue which spurred the major efforts in this

Congress to pass the 1986 tax changes. On that very issue, Senator

Packwood was chairman, sitting right here, and he counted the

votes before he asked for a recorded vote on whether to repeal the

State and local tax deduction. He counted those votes. I was sitting

right in this room.

He realized that he did not have the votes, so he banged the

gavel down, he adjourned the committee, recessed it, went out and

had that famous pitcher of beer with Bill Dieffenderfer, his top tax

person, and they started thinking, ‘‘Now what? Now what are we

going to do?’’

And Joint Tax then pulled the basic 1986 tax reform off the

shelf. For 2 or 3 days in this back room here, we started looking

at the degree to which that made sense, and that was the basis of

the 1986 law.

But it was that one issue, repeal of the State and local tax deduction, which was the catalyst to cause that major shift, and it resulted in the 1986 tax reform.

Senator Stabenow?

Senator STABENOW. Well, thank you, Mr. Chairman. Thank you

very much for holding this hearing and giving us an opportunity

to not only speak about what is happening with the AMT, but more

broadly on tax reform. It has been very helpful. I think it makes

sense.

We know we need to have some kind of a patch, but you have

been able to connect the various issues together in a way that I

think causes us to need to look at broader reform, and I appreciate

that very much.

As a practical matter, I would just say that I come down on the

side of feeling that the mortgage interest deduction has been very

important. Mr. Degen, you spoke about that, in terms of home ownership. I think for the average person, home ownership may be the

only way in which they gain substantial savings.

I mean, most people start in terms of retirement savings or

building up resources through equity in a home, so that is an area

that is of concern to me if we were to look at making changes.

But I am wondering, Mr. Degen. As a practitioner, just kind of

take us back from the broad view in this important discussion on

tax reform back to the practical realities of AMT. What do you

think the average person thinks about the AMT?

Are they even really aware of it as they should be? I know in

talking to my constituents, I do not think many people are even

aware when they are bumping up into this, or how it works. From

22

a perspective of a majority of taxpayers, what is their view? What

are people thinking about this?

Mr. DEGEN. I think the best comment I can give you is, there is

a glaze over their eyes when I try to explain to them. You have all

these very intelligent staffers sitting back there. If any of them

can, in 25 words or less, explain to somebody what the AMT is, I

am willing to listen.

Senator STABENOW. Right.

Mr. DEGEN. But I think it comes to a couple of things, Senator.

Some people are simply unaware of it. As much as it is publicized

in the political arena—newspapers in my area constantly do articles on it—a lot of folks—especially people who have professional

tax preparers—are not doing it on their own, they ask you to do

a service for them, so many people are still not aware of it.

We live in a very funny society with our tax system. Most taxpayers do not view your work as either good or bad because you

saved them money or you knew all these things. ‘‘How much is my

refund?’’ is the first question you get from somebody. So if they got

a refund, similar to last year, maybe their refund should have been

$5,000 higher and they were subject to AMT, but they do not care.

Do you know what I am saying? So there is that level.

You do try to explain to people. I try to be up front and tell people, this is what is happening. Some of them become quite angry.

Many of them are just sort of frustrated. You know what would be

nice? I would say to people, ‘‘Congress created the problem.’’ And

I am not trying to blame you, but it is the reality.

I say, ‘‘Write to your Congressmen and let them know what your

feelings are.’’ Very few of them do. I think some of them are exasperated. You cannot fight city hall, you know. It is just like, ‘‘no

one will listen to me,’’ that kind of thing.

So, surprisingly, I think, to answer your question in a roundabout manner, not as many people are fully aware of it, and fully

aware of the impact on them if you do not explain it to them.

Just one more thing. Some preparers do not even bother to tell

folks about it because, number one, they have to spend too much

time trying to explain it, and number two, they do not want to irritate the taxpayer, so they just say, here is your bottom line, and

let it ride like that.

Senator STABENOW. Could you talk a little bit more about what

is most troubling to you in terms of the execution of the AMT and

if there is any particular piece or way again that people find most

troubling?

Mr. DEGEN. Well, I think people who prepare this on their own,

certainly do not always do it accurately. We talked about the mortgage interest. In AMT, you are only entitled to certain of your

mortgage interest as a deduction. You have to add back, and many

people are not aware of that. They do not do it.

People refinance their homes for more than what we call acquisition debt and they are not entitled to take some of the AMT. Most

folks, certainly self-prepared people, are unaware of it. And quite

frankly, I am going to tell you the truth, I think many practitioners

just sort of ignore it. So, I think there are a lot of errors in that

way.

23

And then, of course, you do get problems with, say, legal settlements. Now, Congress did try to help on that, with the passage of

the American Jobs Creation Act, with a discrimination suit where

you could net attorney fees.

But still, in other types of legal settlements, you have to report

the gross income, the gross settlement on the front of your tax return, and then on Schedule A you have to take a deduction, subject

to the 2-percent ‘‘haircut,’’ we call it, for the legal fees. Often if you

have a large legal settlement, the miscellaneous deductions create

this huge AMT liability.

There is a very famous story that many of you may have heard

about, a policewoman, I think it was in the city of Detroit, actually,

who filed a discrimination suit and she won, like, $3 million or

something, so the legal fees were $1 million.

Then the judge reduced the reward to her—not the lawyer—and

it turned out that after she calculated her income tax she had to

pay more in income tax because of the AMT than she actually received as her portion of the settlement. That is insanity. I think

she got $300,000 finally and she paid $400,000 in income tax. So

those kinds of things are certainly frustrating.

Senator STABENOW. Yes.

Mr. DEGEN. While not many taxpayers, I will be honest with you,

have that type of legal settlement, it just blows your mind when

you hear those kinds of things.

Senator STABENOW. Yes.

The CHAIRMAN. Thank you very much, Senator.

Senator STABENOW. Thank you.

The CHAIRMAN. Senator Salazar?

Senator SALAZAR. Thank you very much, Chairman Baucus, for

putting the spotlight on this important problem that affects so

many people all over our country. For me, it is amazing when you

look at some of the historical statistics and you realize this tax was

put in place to deal with 155 people, and now we are talking about

millions of people around our country.

I know that in my State, if we do not do something about the

AMT problem going forward, that we are going to be having about

200,000 people in Colorado who are going to be ensnared by this

tax that is very difficult to comprehend, and most people, frankly,

do not comprehend it. So, I am hoping that we can do something

about it.

I have a couple of questions for Dr. Burman, Dr. Hassett, and

Mr. Graetz. I would like you to quickly respond to these two questions.

The first question is, if we do, as Senator Bingaman and others

have suggested, a patch, how do we pay for it? The reality is, we

are looking at $115 billion, I think our staff has calculated.

We just went through a major debate here on energy relative to

how we pay for incentives for our new energy package on the floor

last week. It is tough to come up with the $28 billion that we included in that package. So where do we come up with the $115 billion that we need for this package, for this patch?

Second, with respect to the systemic problem that we have,

which is essentially a tax system that is broken, you have lots of

processes, lots of people who have talked about it. The President

24

has his commission. Everybody who is running for President is out

there talking about how they are going to simplify our tax code, et

cetera.

What process would you recommend for us to embark upon if we

are really going to bring about some kind of systemic reform? So

why don’t each of you take about a minute to respond to each of

those questions so each of you get a chance, starting with you, Dr.

Burman. So, how do we pay for it? How do we fix the problem systemically?

Dr. BURMAN. I do not know that I have anything more than what we said earlier. It is not hard to come up with $50 billion if you

want to.

Senator SALAZAR. What is your recommendation, though? You

are king for a day. How do you come up with $50 billion? These

guys struggle with it all the time. You come up with it.

Dr. BURMAN. You could turn the State and local tax deduction

into a credit.

Senator SALAZAR. All right. I got your answer. Now, how about

systemically? You have been around these issues a lot longer than

I have. I am new to this committee. How do you fix the systemic

issue?

Dr. BURMAN. I came to Washington to work on what became the

Tax Reform Act of 1986, and that started with President Reagan

asking the Treasury Department to put together a proposal and

then leaving them alone. The Treasury Department has the expertise to do the analysis of the revenue cost.

Senator SALAZAR. Was the President involved in that, sleeves

rolled up, trying to make that happen?

Dr. BURMAN. Actually, I think one of the things that made it effective was that the President really did not put a lot of restrictions

on it. He wanted to cut marginal rates, as that is what had really

bothered him when he was a young actor. This was President

Reagan. Everything else was on the table. They actually proposed

repealing the State and local tax deduction. It died in Congress because it had no political support.

Senator SALAZAR. Yes, but it started in the House. All right.

Dr. Hassett, how about you? Two questions.

Dr. HASSETT. Yes. Thank you. I will be very quick. I agree with

Dr. Burman, that I would go after the State and local tax deduction. Again, my rationale is something that I think should appeal

to someone who says things like you did, Senator Kerry, that if you

are concerned that the wealthy are not paying enough tax, given

how much their incomes have gone up, it might be politically

unfeasible to raise their marginal tax rates, and certainly the

President would probably veto.

But economists say it is the marginal rate that matters, and if

you do away with these base-narrowing things that throw people

on the AMT, then that is all right with us. That is all right with

us. So you can get revenue and increase the average tax of wealthy

individuals without raising, necessarily, their marginal tax rates.

That is what I would do.

Senator SALAZAR. How do we fix the systemic problem?

Dr. HASSETT. And I would fix the systemic problem by trying to

recognize what I just said, and then sitting down together and

25

looking for a bipartisan agreement on it. So, for example, by capping, saying we are going to end deductions to these rich people,

then you could leave the marginal rates where they are today.

Senator SALAZAR. Talk to me a little bit about process. We have

had lots of processes that have ended up in no man’s land in terms

of solutions. So what process do you think might work for us to get

our hands around this broken system?

Dr. HASSETT. I think the process should involve this committee,

that you agree to go sit somewhere and work out a deal.

Senator SALAZAR. Mr. Graetz?

Mr. GRAETZ. I would agree with the basic pay-fors. I would cap

the State and local tax deduction or do something to limit it. I

would, as I said earlier, limit the home mortgage deduction to one

home, except for members of Congress who have to have two, and

those sorts of things. I think there are lots of things you can do,

but they are not easy to do.

On the process, I think this is a really important question. The

1983 process for Social Security, which was a bipartisan group led

by Mr. Greenspan and Senator Moynihan, was very successful. And

I think the reason it was successful was that it had the support

of the President—so I do not think there is any point in doing this

until you have a new President in 2009, frankly—and it combined

the expertise of people like Alan Greenspan and others along with

politicians so that there was enough information for the politicians

to see all of the options and enough political wisdom to go forward.

Senator SALAZAR. Thank you very much.

Mr. GRAETZ. I just want to say one more thing, if I may. I also

participated in the 1990 budget negotiations which were held at

Andrews Air Force Base and blew up, frankly, because of the abandonment of President Bush by some members of his own party in

the House.

That process, for all of its failings, was also a very successful

process because it included members of the administration, members of the Treasury Department, the key staff—CBO staff, Joint

Committee staff, the Finance Committee staff and the like—and

the leadership of both the House and Senate committees. That is

another way to go.

Senator SALAZAR. Thank you very much. My time has expired. I

would only make one request of you, and that is that if you have

suggestions on process on how we make a systemic fix, I would appreciate it, and I am sure other members of this committee would

as well.

It seems to me there are processes that end in failure, and we

have a history of those, and we have processes that have led to successes, and we may be able to learn from that. Thank you very

much. Thank you.

The CHAIRMAN. Thank you, Senator. I think, basically, Mr.

Graetz, you put your finger on it about the only process that works.

That model, I think, is the only successful model in recent times.

But it had the added benefit, however, if I recall correctly, that the

Social Security trust fund was going to go belly-up in 6 months.

So, that helped focus the mind and it helped both sides kind of

work together, shake hands, both ends of Pennsylvania Avenue and

26

so forth, because we needed a fix. It was a combination, as you

know, of lowering benefits and raising taxes.

Basically, Jim Baker called Tip O’Neal and said we Republicans

will agree to raise taxes if you Democrats agree to lower benefits

on Social Security. That was the handshake, with a 6-month gun

at everyone’s head, and we got it done.

I do not know that we need an emergency like that again. The

tax code clearly is heading for collapse, but it is that general process, I think, that is about the only one in this town that works.

Thank you very much.

Senator Wyden?

Senator WYDEN. Thank you, Mr. Chairman.

Just to pick up on the Chairman’s remarks, I mean, the tax code

is broken. There have been 14,000 changes since the last effort. It

comes to three for every working day. I am going to ask you what

I have asked 15 previous witnesses here and at the Budget Committee.

And just to give you some background on it, I have introduced

the Fair Flat Tax Act, and it is essentially an updated version of

what was done in 1986. We have a 1-page 1040 form, folks, with

30 lines. People at Money magazine completed their taxes on this

in a half-hour.

And just so people understand the bipartisan prospects, the

President’s Commission calls for a form that is, like, 35 lines long.

So for purposes of government work, we could work out a bipartisan agreement on simplification like this.

The legislation gets rid of the AMT and basically keeps progressivity and cleans out the clutter in order to hold down rates for everybody.

Now, I think I am at 15 unanimous votes for the 1986 kind of

frame, and I hope to make it 19 after I ask this question of all of

you.

But set aside my legislation. We are not talking about a specific

bill. But for the basic concept of updating 1986, where you clean

out the clutter, keep progressivity, hold down rates, and simplify

the code, I have 15 witnesses on record, I think, in favor of that,

and I would like to make it 19.

I am going to start with you, Professor Graetz, because I think

you have already said favorable things about the Fair Flat Tax in

the past, so I might get to 16 and that gives me a chance to warm

up with the other three. Just on the question of, do you think the

basic concept of 1986 ought to be updated as the basis for reforming the tax code?

Mr. GRAETZ. Senator Wyden, I am going to hedge a little bit, I

am afraid. I believe that the Fair Flat Tax is a great improvement

over current law, let me be clear about that, and that cleaning up

the law would be a major improvement from where we are. I have

to say that having watched the Tax Reform Act of 1986 unravel

over the last 20 years—and I have written two pieces on this and

have a book coming out in January which discusses the Fair Flat

Tax and other alternatives in some detail—I really think that we

need to be even more radical, frankly, than you are.

I have argued that we should enact a value added tax to get 150

million people out of the income tax altogether, and then the rates

27

would obviously be different, but something like the Fair Flat Tax

at the top that was limited to people with over $100,000 of income,

really would return us to where the Nation was before the second

world war when we relied more heavily on consumption taxes than

we did on income taxes. It would allow much lower tax rates going

forward under the income tax, which I have to say, in a globalized

and technologically advancing economy, given the competition

around the world, I think is extremely important.

Our corporate rate now is the highest rate among rates in Europe, and they are all coming down. We have a high corporate tax

rate compared to other countries, and we simply cannot afford to

fund our government going forward by just relying on the income

tax. We are the only country in the OECD that does not have a

broad-based national-level consumption tax. But I would combine

that with what you are doing, and I think there is a lot of room

for combination.

Senator WYDEN. I will count you as 15 and a half out of 16.

Mr. GRAETZ. You can certainly count me in that category.

Senator WYDEN. Thank you. And thank you for your scholarship.

I have read a lot of your work.

Mr. GRAETZ. Thank you for your efforts.

Senator WYDEN. Dr. Hassett?

Dr. HASSETT. Senator Wyden, baseball fans remember the moment when Babe Ruth pointed at the stands and hit a home run,

and tax geeks like Dr. Burman and myself remember the 1986 Act

with similar relish. [Laughter.] It was the high point of tax policy,

at least in my lifetime, but I can think of things that would be a

lot better. Despite that, I will give you a vote.

Senator WYDEN. Great. And I will give you a commitment to

work with you. I know you have spent a lot of time on this.

Look, clearly we can improve on this. Chairman Baucus and I

have had a number of conversations about steps you can take if

you can get to the Promised Land about how you keep from sliding

back and allowing some of the special interest loopholes to be created. So I think your point about looking at ways to improve is

something I am very receptive to.

Dr. Burman, you and I have talked about this subject as well,

and I would appreciate your answer.

Dr. BURMAN. You can count me as a vote for a TRA 86-type approach. I applaud your leadership on this issue. Professor Graetz

pointed out that TRA has unraveled to a large extent, but it has

not completely. Rates are still lower than they were before the Act

was enacted. The corporate tax, although there has been some

backsliding, is not anywhere near as much of a mess as it was in

1986. We have learned a lot since then, so obviously focusing on

the process is important. The other thing is, as Dr. Hassett has

pointed out, bipartisanship is tremendously important.

One of the things that made the 1986 Act work was President

Reagan, a Republican, Dan Rostenkowski, a Democrat, and Bob

Packwood working together, and members of the committee, across

party lines, working together.

We really need presidential leadership. Somebody is going to

need to explain to people why shaking things up a lot and ineviVerDate 11-MAY-2000 14:46 May 04, 2009 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 48528.000 SFIN1 PsN: SFIN1
28

tably raising some people’s taxes is in their interests in the long

term.

The reason for reform is that we need a tax system that works.

If you look at the enormous revenue challenges we have facing us

when the baby boomers retire, the current tax system just is not

up to the challenge.

Senator WYDEN. Mr. Degen?

Mr. DEGEN. Senator, I come from New York, and we like to

argue. I think the basic concept of what you said is absolutely correct. But we have to be careful. What a lot of ordinary taxpayers

now perceive as tax planning, like the mortgage deduction we

talked about—they view others as having tax loopholes—but, when

it works for them, it is tax planning.

Senator WYDEN. We keep all of those. All of the middle-class

breaks for saving, mortgage, charity, and health. All of that is kept.

Mr. DEGEN. Well, if that, in fact, is the case, then I would support it, with one caveat. I think you would have to write into the

legislation that there can be no changes to this new Internal Revenue Code for X number of years, because what will happen is, like

you said, three changes a day since 1986. Is that what you said,

something to that effect?

Senator WYDEN. Fourteen thousand since the last time, three for

every working day.

Mr. DEGEN. All right. So, three for every working day. So there

is nothing to prohibit that again after your tax act passes—assuming it is ever enacted. So there has to be something in that legislation.

The CHAIRMAN. I would like to ask the witnesses the degree to

which you agree with Mr. Graetz. I mean, he makes the basic

point, if I understand him correctly, that the U.S. is the only

OECD country without a significant consumption tax, and, in view

of globalization and the immense pressures that American companies have and Americans have in facing the competition worldwide,

that we as a country almost need to move to more of a consumption-based tax.

He pointed out, which I had not realized, that prior to World War

II there was much more of a consumption element to our tax system than today. But if I may start with you, Dr. Hassett, and then

go the other way. What do you think about that?

Dr. HASSETT. Yes. I absolutely agree.

The CHAIRMAN. And I would like to ask, when you agree, state

why.

Dr. HASSETT. Alan Auerbach of Berkeley, who is a frequent advisor of Democrats, and I have a book we published where we reviewed the literature on fundamental tax reform. In our summary,

we said our read of the literature was that if you switched wholesale to a consumption tax, it would buy you about 10 percent of

GDP over 10 years, or GDP would be about a trillion dollars higher

today if we had done it 10 years ago.

So I think that the economics literature is very decisive that a

consumption tax is better. The problem, again, is that many of the

decisions that you make when you introduce a consumption tax are

politically difficult.

The CHAIRMAN. Right.

29

Dr. Burman?

Dr. BURMAN. Economists have always found the idea of a consumption tax attractive because it does not double-tax savings, so

it encourages saving and theoretically makes the economy grow.

There is a lot of debate, however, about the size of the effect.

The big concern about a consumption tax is it tends to be regressive. Low-income people consume more than their entire incomes.

They actually get help from family members and others. Highincome people only consume a tiny fraction, maybe 30 percent, of

their income, so you would basically be exempting 70 percent of income from tax.

One question is, why are consumption taxes so popular in Europe? They are certainly not indifferent to the concerns of low- and

middle-income people. An answer is, they do a lot more for lowand middle-income people through the spending side of the budget,

so for example, people get free health care.

If you were to combine something like a value added tax with

something that would make health care available to low- and middle-income people, that could be a progressive change overall. But

I have concerns about the distributional effects of a stand-alone tax

change—about whether you would be raising tax burdens on lowincome people.

The CHAIRMAN. Mr. Degen?

Mr. DEGEN. Yes. I would agree with Dr. Burman. The regressive

nature of the tax lends me to be against that type of thing. So you

could build in some type of exemption or whatever. I do not know

the particulars. But the regressiveness is not to my liking.

The CHAIRMAN. All right.

Mr. Graetz, you get a rebuttal.

Mr. GRAETZ. Thank you. I just want to make two comments. One

is that you do have to deal with the regressiveness of a consumption tax at the bottom. The proposal that I have offered and that

I am detailing in my forthcoming book does that. It does it in a

number of ways I will not bother the committee with. But it actually responds to the regressivity at the bottom.

And you have to, in order to not give a big tax cut at the very

top—which I agree this is not the moment for—also retain some

small income tax at low rates on the very wealthy, but they are

also going to pay consumption taxes and so, since they are paying

a consumption tax and an income tax, you can keep those rates

lower. And you can lower the corporate rate, which is borne, I

think, in an open economy largely by consumers anyway, and it is

a very bad tax and has the potential to really hurt the American

economy going forward over the decades.

The CHAIRMAN. What about transition costs?

Mr. GRAETZ. By keeping the income tax at the very top, you really avoid the transition problems that exist when you go to a full

consumption tax. There are a number of proposals that have been

advanced, both in the political arena and in the academy for a full

replacement of the income tax by the consumption tax. That creates major transitional problems. I do not urge that.

The CHAIRMAN. Now we have both consumption as well as income taxes. We have both.

30

Mr. GRAETZ. You would have both, but you only have the income

tax, as we did before World War II, for the very highest-income

Americans. If you have a $100,000 exemption from the income tax,

you basically only have the people who are now subject to the AMT

at a high exemption level that we are talking about.

The CHAIRMAN. What were the consumption taxes prior to the

war?

Mr. GRAETZ. Well, the consumption taxes prior to the war were

tariffs, and they were very bad consumption taxes because they

were tariffs. If you go through the history of the U.S., we raised

most of our money through——

The CHAIRMAN. I know. Ninety-seven percent prior to the Civil

War.

Mr. GRAETZ [continuing]. Through consumption taxes.

The CHAIRMAN. Correct.

Mr. GRAETZ. And the income tax did not come in until the second

World War. The great development in thinking about taxing consumption is the invention of the value added tax, which was, I

think, invented at Yale. Some people think it was invented in

France. But if you go back to the work of Thomas Adams in the

1920s, I think he thought of the idea earlier.

But it is a kind of consumption tax that allows us to tax consumption in the United States; it does not tax exports. It taxes imports. It works. Its compliance costs are a third or less of what the

income tax compliance costs are.

The businesses that are collecting it are collecting it throughout

the world. You have to protect small businesses, you have to protect low-income people. You have to create a system that is appropriate to the United States and not borrow the system from abroad.

The CHAIRMAN. It also gives a boost to exports, rebates to exports. Is that correct?

Mr. GRAETZ. But I think it is a good tax.

The CHAIRMAN. Although it adds a tax, it allows a rebate for

exports——

Dr. BURMAN. It does, but it basically just makes it neutral between exports and imports. It is actually one of the biggest misconceptions about a VAT, and it is shared by virtually everybody

who is not an economist. But it is not an export subsidy, and that

is why it is allowed under GATT.

The CHAIRMAN. Yes. That is why it is allowed.

Mr. GRAETZ. It is not a subsidy for exports, unlike the corporate

income tax, which may be borne in part by consumers. If you use

it to buy down the corporate income tax, putting aside exchange

rates, which people say will adjust, you may get a benefit.

The CHAIRMAN. Senator Wyden, further questions?

Senator WYDEN. Thank you, Mr. Chairman. I thank you for all

the time, too, Mr. Chairman.

Can I ask just one question about this consumption tax issue?

Some of you may remember that Al Ullman from Oregon, who was

chairman of the Ways and Means Committee for quite some time,

arguably lost his seat as chairman of the Ways and Means Committee because he was for a consumption tax. The people of my terrific State have voted against sales taxes about 8,970 times, and

that is just barely an exaggeration.

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What I would be interested in, because I think the Chairman has

asked you about a lot of important issues relating to this and sort

of how it would evolve as actually implemented, but what has

changed in your view since the time of Al Ullman?

Now, arguably that was more than a quarter-century ago when

he first proposed it. What are the changes that have taken place

that make it, in your view, more attractive today than it was 25

years ago?

Mr. GRAETZ. Senator Wyden, let me respond to that. I have to

say, I think the history on Al Ullman’s failure to win reelection had

more to do with the fact that he did not even own a home in his

district at the time and had lost touch with the people of Oregon

than it did with the value added tax, so I think there is a little bit

of urban myth about Al Ullman’s failures.

But putting Al Ullman aside, the economy has changed dramatically. After the second world war, the United States had all the

money there was in the world and our corporations and our economy were dominant in the world economy.

What you have today is a situation where income can move very

quickly—all of the compliance issues that we have talked about,

that you will talk about if you get into the private equity issues in

more detail when you find out how they are really organized offshore. The way in which American capital is now organized is multinational and not domestic in the way that it was a quarter of a

century ago when Al Ullman was talking about this issue.

This is due to a change in technology which allows money to

move quickly and without a lot of paperwork around the world, and

it is due to the globalization of the economy coming together at

once. The income tax rates around the world, including the corporate rate, were much higher.

In 1986 when the Tax Reform Act was enacted, the U.S. went

to the lowest income tax rate in the world. We are now second

highest in the OECD because the other countries have moved to

lower rates. If you look at what is going on in Europe today, they

are lowering their corporate rates even more.

So given the choice, for example, of a company like DaimlerChrysler to be headquartered in Germany or to be headquartered

in the U.S., they have chosen, in many instances, to be headquartered abroad.

The question is whether we are going to own operations abroad

or whether somebody else is going to own operations abroad, and

whether we are going to attract capital from abroad or whether

somebody else is going to attract that capital from abroad.

These were just not issues in the 1970s to anywhere near the

same extent that they are today. In order to attract that capital,

we need low income taxes, in my view, low income taxes on capital,

which we can only pay for and only keep distributionally fair by

having another revenue source.

I just want to say one more thing about this, because I think this

is extremely important. We are a low-tax country, Senator. We are

the second lowest-tax country in the OECD, but we do not take advantage of our low-tax status by having low income taxes because

we rely entirely on income taxes and do not rely on consumption

taxes in the way that the rest of the world does.

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And so we basically have given ourselves a disadvantage by not

taking advantage of our status as a low-tax country and taxing consumption, and thereby reducing taxes on capital, both capital invested here and, I think, capital invested by Americans abroad, because otherwise I think we are going to find our economy in great

difficulty.

Senator WYDEN. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, all of you. This has been a very

thoughtful discussion. I deeply appreciate all four of you. You have

contributed so much to this, and I suspect we are going to have a

lot more conversations like this down the road. But this has been

very helpful, very constructive, and I very much appreciate your

help.

The hearing is adjourned.

[Whereupon, at 11:42 a.m., the hearing was concluded.]

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