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91–847 PDF 2004

S. HRG. 108–381

RETHINKING THE TAX CODE

HEARING

BEFORE THE

JOINT ECONOMIC COMMITTEE

CONGRESS OF THE UNITED STATES

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

NOVEMBER 11, 2003

Printed for the use of the Joint Economic Committee

(

(II)

JOINT ECONOMIC COMMITTEE

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

SENATE

ROBERT F. BENNETT, Utah, Chairman

SAM BROWNBACK, Kansas

JEFF SESSIONS, Alabama

JOHN SUNUNU, New Hampshire

LAMAR ALEXANDER, Tennessee

SUSAN COLLINS, Maine

JACK REED, Rhode Island

EDWARD M. KENNEDY, Massachusetts

PAUL S. SARBANES, Maryland

JEFF BINGAMAN, New Mexico

HOUSE OF REPRESENTATIVES

JIM SAXTON, New Jersey, Vice Chairman

PAUL RYAN, Wisconsin

JENNIFER DUNN, Washington

PHIL ENGLISH, Pennsylvania

ADAM H. PUTNAM, Florida

RON PAUL, Texas

PETE STARK, California

CAROLYN B. MALONEY, New York

MELVIN L. WATT, North Carolina

BARON P. HILL, Indiana

DONALD B. MARRON, Executive Director and Chief Economist

WENDELL PRIMUS, Minority Staff Director

(III)

CONTENTS

Page

OPENING STATEMENTS OF MEMBERS

Senator Robert F. Bennett, Chairman ................................................................... 1

Representative Pete Stark, Ranking Minority Member ....................................... 8

Representative Ron Paul ......................................................................................... 23

WITNESSES

PANEL I

Statement of Senator Arlen Specter, a U.S. Senator from Pennsylvania ........... 3

Statement of Representative Jim McDermott, a Representative in Congress

from Washington .................................................................................................. 4

Statement of Representative John Linder, a Representative in Congress from

Georgia .................................................................................................................. 6

PANEL II

Statement of Dr. Michael J. Boskin, Senior Fellow, Hoover Institution,

Stanford University, Stanford, CA ..................................................................... 9

Statement of Cliff Massa, Manager, Patton Boggs LLP, Washington DC .......... 11

Statement of Edward J. McCaffery, Professor of Law and Political Science,

University of Southern California Law School, Los Angeles, CA .................... 13

Statment of Robert S. McIntyre, Director, Citizens for Tax Justice, Washington, DC ............................................................................................................. 15

SUBMISSIONS FOR THE RECORD

Prepared statement of Senator Robert F. Bennett, Chairman ............................ 35

Joint Economic Committee Reports:

‘‘The Tax Reform Act of 1986: A Primer’’ ....................................................... 37

‘‘Constant Change: A History of Federal Taxes’’ ............................................ 39

‘‘A Portrait of the Personal Income Tax Burden in 2001’’ ............................. 46

Prepared statement of Representative Pete Stark, Ranking Minority Member 48

Prepared statement of Representative Ron Paul, a Member of Congress from

Texas ..................................................................................................................... 48

Prepared statement of Senator Arlen Specter, a U.S. Senator from

Pennsylvania ........................................................................................................ 50

Prepared statement of Representative John Linder, a Member of Congress

from Georgia ......................................................................................................... 61

Prepared statement of Dr. Michael J. Boskin, Senior Fellow, Hoover

Institution, Stanford University, Stanford, CA ................................................. 64

Prepared statement of Cliff Massa, Manager, Patton Boggs LLP, Washington

DC .......................................................................................................................... 91

Prepared statement of Edward J. McCaffery, Professor of Law and Political

Science, University of Southern California Law School, Los Angeles, CA ...... 109

Prepared statement of Robert S. McIntyre, Director, Citizens for Tax Justice,

Washington DC .................................................................................................... 113

(1)

RETHINKING THE TAX CODE

WEDNESDAY, NOVEMBER 11, 2003

CONGRESS OF THE UNITED STATES, JOINT ECONONOMIC COMMITTEE, Washington, DC

The Committee met at 9:30 a.m., in Room 628, Dirksen Senate

Office Building, the Honorable Robert F. Bennett, Chairman of the

Committee, presiding.

Senators present: Senators Bennett, Sessions, Sununu.

Representatives present: Representatives Paul, Stark.

Staff members present: Melissa Barnson, Gary Blank, Ike

Brannon, Daphne Clones-Federing, Sean Davis, Jason Fichtner,

Nan Gibson, Colleen Healy, Brian Higginbotham, Brian Jenn, Tim

Kane, Rachel Klastorin, Donald Marron, John McInerney, Tom

Miller, Wendell Primus, Diane Rogers, Frank Sammartino, Rebecca

Wilder, Jeff Wrase.

OPENING STATEMENT OF SENATOR ROBERT F. BENNETT,

CHAIRMAN

Senator Bennett. The Committee will come to order. Before

making my prepared opening remarks, I’d like to say that we’re

going to be very strict on time during this hearing, because in the

wonderful world of Senate scheduling, I have to be on the Senate

floor at 10:30 to begin managing the Agriculture Appropriations

bill. We had no idea when that would come, but the stars have

lined up that it comes exactly at the same time as we have scheduled this hearing. I apologize that that’s the way it is.

In May of this year, under the prodding of Senator Specter, the

Senate overwhelmingly approved legislation acknowledging the serious problems of our current tax code and called for a Congressional review of ways to overhaul the antiquated system.

It is especially gratifying to me, because tax reform has been a

central piece of my agenda in the Senate, and it’s been a little frustrating to not see it move much more rapidly than it has. But 70

members of the Senate agreed that the Joint Economic Committee

should be the key point for this debate, and today’s hearing is a

direct response to that vote. It is a part of a series of hearings and

studies and related events that the Joint Economic Committee is

undertaking to help the Congress find a path to real tax reform.

The present tax system is unduly cumbersome, inefficient, and

incomprehensible. Over the years, through revision after revision,

the tax code has become a confusing, burdensome web that hampers economic growth, places undue burdens on American busiVerDate 03-FEB-2003 10:18 Apr 07, 2004 Jkt 091847 PO 00000 Frm 00005 Fmt 6601 Sfmt 6601 91847.TXT SSC1 PsN: SSC1
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nesses, and needlessly complicates the lives of the American people.

As I reflect upon all of the debates held over the years on tax

policy, I realize that there is one word that comes up over and over

again, and that word is fairness. Every time we make a change in

the tax law, we are told that it is necessary to make things more

fair.

But what we have done is tipped the tax code this way and that

to encourage one activity, and discourage another. And every time

we do this, the tax code gets bigger and more complex.

I find it ironic that in the name of fairness, we have created a

system that is unfair to everybody.

Today, during this hearing, I hope we can start with a clean

sheet of paper. Let’s not talk about tax cuts or mere adjustments

to specific parts of the existing system. Let’s talk about creating

from scratch, a system that is simple, that is fair, and once established, a system that will endure for years to come.

We’re not prejudging the issue; we’re not coming to the hearing

with recommendations already in mind. This is an opportunity to

listen and learn and look at the issue from a different perspective.

Whether one is in favor of getting more tax dollars out of the

rich, or using the tax code to spur faster economic growth, or implementing a flat tax for all individuals, everyone can agree that

the existing code is so badly broken that the principles of simplicity, fairness, and efficiency are not being met.

If we can achieve the goals I have just laid out, then another

challenge begins. We must ensure that the new tax system endures.

Businesses cannot make intelligent plans if the tax system constantly changes. That slows economic growth and that slows job

creation.

For individuals, the shifting sands of the existing tax code create

painful uncertainty. People who want to buy a house, take out a

loan, put money aside in a savings account, or make an investment, need and deserve to know that there won’t be any surprises

coming up after the next election.

Now, that’s the predicate for the hearing today. And we have assembled a balanced group of witnesses that will present diverse

views about how the government should tax its citizens.

[The prepared statement of Senator Robert F. Bennett appears

in the Submissions for the Record on page 35.]

Senator Bennett. And for our first panel, we are pleased to

have as a distinguished guest, Senator Arlen Specter of Pennsylvania, who was the primary sponsor of the Sense of the Senate

Resolution that brings us here today, and who has for years been

a champion of tax reform. We’re also pleased to have Representative Jim McDermott of Washington and John Linder of Georgia,

and we thank all of you for joining us here today. With that, I recognize the arrival of Mr. Stark, the Ranking Member, and have

him give whatever opening statement he might have.

Mr. Stark.

Representative Stark. Mr. Chairman, I’d be glad to withhold

on the opening statement and let our colleagues proceed. I’ll send

them an autographed copy later.

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Senator Bennett. I’m sure they will frame it and put it on their

walls. Thank you, Mr. Stark. We appreciate it.

Senator Specter, we appreciate your leadership in getting us

here, and we look forward to hearing what you have to say to us.

PANEL I

OPENING STATEMENT OF SENATOR ARLEN SPECTER,

U.S. SENATOR FROM PENNSYLVANIA

Senator Specter. Thank you, Mr. Chairman and Ranking Member, Congressman Stark. I urge this Committee, this distinguished

Joint Economic Committee, to take a forceful, unambiguous stand

in support of the flat tax, because if this Committee doesn’t get the

ball started, nobody will.

These issues have been pending before the Ways and Means

Committee in the House and the Finance Committee in the Senate

for years, and, understandably, they are preoccupied with many,

many subjects as we speak: Prescription drugs, the Energy bill,

and a host of other issues on Medicare, and, as you, Mr. Chairman,

have already outlined, the serious situation on tax complexity.

And my prepared statement, which I know will be made a part

of the record, goes into great detail on the problems. I studied the

flat tax back in 1995 when Congressman Dick Armey introduced it

in the House in the Fall of 1994. And in the Spring of 1995, I introduced legislation for a flat tax and have reintroduced it every year

since, and it is currently pending as Senate Bill 907.

And as you, Chairman Bennett, have noted, I offered the resolution to have this hearing, and you and I have discussed it privately,

and somebody has got to take the ball and carry it down-field in

an official way. And this Joint Economic Committee has a unique

opportunity to really do this very, very important work.

The flat tax would enable taxpayers to file their return on a postal card in 15 minutes, compared with voluminous hours now. This

is a carefully worked out program by two distinguished professors

from Stanford, Professor Hall and Professor Rabushka, where the

flat tax is neutral at 19 percent.

My proposal adds one percent to that to retain modest deductions on home mortgages up to $100,000 and charitable contributions up

to $2500, because those two items are so deeply ingrained in the

American taxpayer psyche. But I would be glad to see those two

eliminated and going back to 19 percent, or see some variation, depending on what this Committee wants, just to move forward on

the flat tax principle.

The flat tax does not have any tax on interest, on dividends, on

capital gains, or on estates. There is no depreciation. Everything is

expensed in the first year.

The flat tax does not benefit the wealthy. As my statement outlines, with a group of income levels, a married couple with two children and $35,000 income will have a savings of $176.

The tax structure is outlined for the upper brackets and it is

about the same, or a slight increase, so put to rest the notion that

the flat tax is going to benefit the rich at the expense of the poor.

We hear a great deal of talk about having the tax flatter and

fairer, but we have not come to the point of really saying we’re

4

going to oppose the flat tax. Mr. Chairman, I see that my yellow

light has just started on, and I’m going to do something very unusual in a filibuster-prone body, and yield back about a minute of

my time. Thank you.

[The prepared statement of Senator Arlen Specter appears in the

Submissions for the Record on page 50.]

Senator Bennett. Thank you very much, Senator Specter, both

for your statement and your leadership.

Representative McDermott.

OPENING STATEMENT OF REPRESENTATIVE JIM McDERMOTT,

A MEMBER OF CONGRESS FROM WASHINGTON

Mr. McDermott. Thank you, Mr. Chairman. I want to thank

you and Representative Stark for having this hearing. I really wish

that the Committee were talking about the deficit, because I think

we ought to be paying more attention to that and how it affects our

economy by increasing interest rates and reducing savings and inflating the value of the U.S. dollar, which has made the American

products less competitive overseas.

Next year’s deficit may top $500 billion, and there’s not an organization in the governmental agency of Washington that knows

when we will return to a balanced budget. President Bush inherited a government that took in about 20 percent of GDP in revenue

and spent a little less than that. He inherited a budget surplus

that could have been used to shore up Social Security and pay off

the deficits that piled up during the Reagan-Bush era.

We have quite a different picture today, and mostly due to three

rounds of tax cuts in Fiscal Year 2003, revenues dropped to 16.6

of GDP, while our deficit exploded. Revenues now are at the lowest

levels since 1959, which was near the end of the Eisenhower Administration.

I want to be sure everyone knows that taxes in America are not

high. The U.S. tax revenue as a percentage of GDP, is among the

lowest in the developed world. Only two OECD members have

lower taxes.

Now, I understand that the hearing is about rethinking the tax

code, and the Ways and Means Committee held a host of hearings

about this same issue in the mid-1990s under Chairman Archer. At

one point during the hearings in 1995, the Chairman said he was

convinced that the tax code needed to go a flat tax.

He even said he was going to introduce legislation to do it, but

after all the hearings and the rhetoric, he never even introduced

the bill.

Today, income taxes, as a share of GDP, are at the lowest level

since 1991, but payroll taxes, which takes the heaviest bite from

the lower income workers, rose to its biggest share of federal revenue. This is unfortunate because it means our tax system has become more regressive over the past few years. In other words, poor

people are bearing more of the tax burden today than in an awful

long time.

Now, everybody knows that you can do two things with money:

You can save it or you can spend it. Rich people have more to save

than poor people, and if all that we do is impose taxes where peoVerDate 03-FEB-2003 10:18 Apr 07, 2004 Jkt 091847 PO 00000 Frm 00008 Fmt 6601 Sfmt 6601 91847.TXT SSC1 PsN: SSC1
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ple spend money, then poor people are going to spend a larger

share of their paycheck on taxes than rich people are.

A system based on consumption taxes hardly seems fair to me.

Legislation has been introduced in the past to convert our tax system to one that relies solely on consumption tax. Representative

Linder, who will talk in a minute, has introduced legislation to

abolish the IRS and force the Federal Government to rely on a national sales tax.

This proposal would involve an extraordinarily regressive shift of

tax burden from the affluent to everybody else and would be a boon

for the wealthy elite. His proposal would tax all purchases of goods

and services in our economy, including food, healthcare, home

rents, and new home purchases.

The Joint Committee on Taxation did an analysis of H.R. 2525,

and the study indicated that in order for the bill to be revenue-neutral over ten years, the estimated national sales tax rate would be

between 36 and 57 percent. In other words, the price of blood

transfusions, prescription drugs, and a pair of sneakers would all

increase between 37 and 57 percent.

I don’t know how anybody could think that is fair. I don’t know

how you could sell that proposal to the Baby Boomers, just when

they are about to live on a fixed income.

There have been several flat tax proposals floated in the past. As

you have heard, Dick Armey was a staunch proponent of the flat

tax. Mr. Armey introduced a bill to create a flat tax, consisting of

a permanent 17-percent rate.

The Treasury estimated his bill would cost $138 billion each

year.

The rate would need to be closer to 21 percent. At this rate taxes

would double for the American working poor while they would be

cut in half for millionaires. Every time someone talks about a flat

tax, my question to them is, what about pensions, health care,

home ownership and charitable giving?

The Health Insurance Association of America states that one of

the consequences of flat tax bill is likely to be a rapid increase in

the number of people without private health insurance. One economist estimated there would be eight million more people without

health insurance if a flat tax were enacted.

James Poterba, an economist at MIT, estimated that eliminating

the current tax benefits for purchasing homes would result in a 17

percent decline in the value of the U.S. housing market.

Payroll taxes? A flat tax would eliminate the deduction that employers pay for their share, amounting to a massive tax increase

on businesses of all size.

Furthermore, it is a bit naive to think that the pressures that we

currently have to change the tax code for public policy reasons

would go away with the new tax regime. I think it is highly unlikely our tax code would not just become as complex over time as

it is today.

I believe we have to stress a few important things—the first fundamentally is the cold question of fairness, as you have indicated.

A 20 percent tax to someone making $20,000 is much different

than a 20 percent tax to someone making $200,000.

6

Secondly, a tax system must bring in enough revenue to pay for

government expenditures.

Third, our IRS code should try to provide as much efficiency in

our economy as possible and, lastly, we should try to reduce the

complexity of the code by doing things such as reforming the alternative minimum tax, which is increasingly creeping into the pocketbooks of middle income families.

Thank you, Mr. Chairman.

Senator Bennett. Thank you very much.

Representative Linder.

OPENING STATEMENT OF REPRESENTATIVE JOHN LINDER,

A MEMBER OF CONGRESS FROM GEORGIA

Mr. Linder. Thank you Mr. Chairman and Mr. Stark.

I appreciate the opportunity to comment on the fundamental tax

reform. I believe that the Congress should judge any such bill following on fundamental tax reform on how it follows eight key principles. It should be fair and it should protect the poor and treat everyone else the same. It should be simple and easy to understand

by everyone. It should be voluntary and not coercive or intrusive.

It should be transparent. We should all know what the government

costs us. It should be neutral at our borders. It should be industry

neutral. It should strengthen Social Security and have manageable

transition costs. I believe my bill, H.R. 25, meets all those tests.

I will first begin by commenting on the flat tax. The tax you have

today, that you come to know and love, is a flat tax on income—

ninety years later. As long as we know how people make money,

how much they make, we can find the way to get the rest.

My proposal eliminates all income taxes and payroll taxes, replaces them with a national retail sales tax. It is fair, it is understandable, and it totally untaxes the poor.

If you get rid of the income tax, the payroll tax, the gift tax, the

estate tax, capital gains tax, the alternative minimum tax, and replace it with a one-time national sales tax of 23 percent, it will be

revenue neutral.

We have spent $25 million over the last eight years on economic

and market research. The most compelling study was out of Harvard done by Dale Jorgenson, who is head of economics, and he

said that 22 percent of what we are currently spending at retail is

the embedded cost of the current code.

That is to say, we are losing 22 percent of our purchasing power

to the embedded cost of the current code. If we were to get rid of

the code, repeal the code, get rid of the IRS, and let competition

drive those costs out of the system, and replace it with an embedded 23 percent, it would increase the cost of living by one percent,

but everybody would get to keep their whole check, they would be

voluntary taxpayers paying taxes when they choose, as much as

they choose, by how they choose to spend.

What would happen in our economy? Well, we know that, in the

first year we would have a 26 percent increase in exports. In the

first year we would have a 76 percent increase in capital spending.

We know that from 1945 to 1995 real wages, take home pay, increased in exact correspondence with increases in capital spendVerDate 03-FEB-2003 10:18 Apr 07, 2004 Jkt 091847 PO 00000 Frm 00010 Fmt 6601 Sfmt 6601 91847.TXT SSC1 PsN: SSC1
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ing—we spend today anywhere from $250 billion to $500 billion

just complying with the current code. Hardly efficient.

We know that, for small businesses to remit $100, collect and

remit $100, it costs them $724 to do so. We would have the largest

magnet for capital in the history of the world. There are today anywhere from $500 billion—a low estimate—to $2 trillion—in funds

stranded overseas because it is cheaper for American businesses to

borrow at five percent or six percent than to repatriate at 35 percent—all those dollars would come to our shores and put a new liquidity into our markets and creating new jobs.

We have had problems with government, with companies going

offshore recently. They are not going off because they are angry or

mean. They are going off because they cannot deal with the tax

code. We would have those companies flocking to our shores as well

as all the wealth in the world into our capital markets because

there would be no tax consequences. We would create huge numbers of new jobs.

There is a recent book out called ‘‘Reefer Madness’’ that says

prostitution, pornography, illicit drugs and illegal labor constitute

a trillion dollar economy. Those dollars would be taxed at the retail

checkout by the Fair Tax.

We believe that we would have no deficits today and indeed have

increased revenues. A study done from 1945 to 1995 shows that the

consumption economy is a much more steady predictor of activity

than the income economy and, indeed, we would have had increased revenues in 10 of the last 11 quarters instead of declines

that Mr. McDermott spoke about.

Lastly, to protect the poor, we say that every household should

get a check at the beginning of every month that totally rebates the

tax consequences of spending up to the poverty line. That would

give people spending at or below the poverty level a 22 percent increase in purchasing power that would totally untax them on necessities because that is the definition of poverty level spending.

That is spending necessary to meet, to buy, our necessities.

It would save Social Security. Over the next 75 years, we are

going to increase the number of people on Social Security by 100

percent. We are going to increase the number of people paying for

it by 15 percent. I don’t care how much you set aside, that is something that is irretrievably broken and cannot be fixed.

Under our system, the revenues to Social Security and Medicare

will double in the next 14 years by doubling the size of the economy.

Lastly, the transition costs are doable. The only transition rule

in my bill is that any inventory on hand on December 31, the value

of it can be used as a credit against sales in the following year because we think things should only be taxed once, since we have at

any given time, a $1.3 to $1.4 trillion in inventory in this country,

a fourth of that is about $350 billion. That would be the total transition cost.

I say let’s unleash the American people, the economy, turn them

all into voluntary taxpayers and we will have a new system that

will be endurable.

Thank you, Mr. Chairman.

8

Senator Bennett. Thank you very much. We appreciate the

range of opinions we have got here and the thoughtfulness that has

gone into the presentations and recognize that you have other responsibilities. You are welcome to join us here on the dais, if you

wish, either one of you, but you are also excused if you feel you

have to move on.

Mr. Linder. Thank you very much.

[The prepared statement of Representative John Linder appears

in the Submissions for the Record on page 61.]

Mr. McDermott. Thank you.

Senator Bennett. Thank you.

Representative Stark, do you want to do your opening statement

now or shall we go on to the next panel?

OPENING STATEMENT OF REPRESENTATIVE PETE STARK,

RANKING MINORITY MEMBER

Representative Stark. Mr. Chairman, I would just summarize

it if I may and ask that you include it in the record. I want to

thank you for this hearing. It is a topic about which those of us

on the tax writing committees have puzzled over a long time and

under various philosophies and suggestions for revising the tax

code.

I had a guy years ago who wanted to give every American some

stock—every American, and I cannot even remember that one,

but——

Senator Bennett. Who got to pick the company?

Representative Stark. I do not know what he was going to do.

Probably a mutual fund.

But my question now is this. Ken Keyes, who is still around town

and used to be staff director of the Joint Committee on Taxation

and represents as a staff person, many of the Republicans on the

Ways and Means Committee suggested that the time to do tax reform is when we are running a big surplus, because then we have

got some money to patch over the inequities or the transition problems that will invariably come up in changing any kind of a commercial tax system that affects commercial intercourse in this

country.

So, while it is a topic about which I have great interest, my only

suggestion is that this might not be the best time because I think

one of the ways to get political support for any kind of tax reform

is to get some tax relief.

And at this point, I have to join with most of my Democratic colleagues in saying that our plate is kind of full in terms of tax relief

and we may be looking for a little revenue down the line. But, it

is a topic that is not going to go away. It is going to be with us

and I appreciate the opportunity to hear from my colleagues and

we have an excellent panel ahead of us. Thank you very much.

[The prepared statment of Representative Pete Stark appears in

the Submissions for the Record on page 48.]

Senator Bennett. Thank you, sir. Your statement will, of

course, be included in the Record in its entirety.

We now turn to our second panel. I believe we have been able

to attract a wealth of knowledge on the subject of tax reform. We

have Dr. Michael Boskin from Stanford University where he is a

9

professor of economics. He has served as Chairman of the President’s Council of Economic Advisors.

Cliff Massa is currently a tax attorney for Patton Boggs, and has

served as Chairman on the Committee on Value-Added Taxes at

the American Bar Association, and Professor Ed McCaffery joins us

from the University of Southern California and is author of a book

called ‘‘Fair, Not Flat: How to Make the Tax System Better and

Simpler.’’

Finally we welcome Robert McIntyre, the executive director of

Citizens for Tax Justice.

So I think we have a mixed but balanced body of opinion here.

We look forward to hearing from all four of you.

Before you came in, Congressman Stark, I indicated that, in the

genius of Senate scheduling, I have to be on the floor at 10:30 a.m.

to manage the Agriculture Appropriations Bill and so, if I can trust

you, and I think I can and no one else has shown up, the Vice

Chairman does not appear, I will leave the witnesses to your tender mercy at that point and I think the Republic will still stand

among those who get concerned about a Republican dealing with

a Democrat thusly.

Let’s go in the direction that I have indicated. Mr. McCaffery has

apparently not shown up yet. So he is on his way, and we will start

at this end of the table, then, Dr. Boskin, you go first and then

move across.

PANEL II

OPENING STATEMENT OF DR. MICHAEL J. BOSKIN,

SENIOR FELLOW, HOOVER INSTITUTION, STANFORD UNIVERSITY

Dr. Boskin. Thank you, Chairman Bennett, Ranking Member

Stark—a pleasure to be back before the Joint Economic Committee.

I was asked to make some comments about how we would design

a tax system if we could start de novo. What would be the basic

principles we would use and what would the tax system look like?

Of course, moving from the current one to that one raises a variety of issues of transition and so on, so I am sure you are aware

that the desirable properties of a tax system have been debated

since the dawn of political philosophy.

Adam Smith had four canons of taxation: equality, certainty, convenience in payment and economy in collection—that is, equity, efficiency and administrative simplicity, the things that we still debate today. And that was two-and-a-quarter centuries ago.

I have five big tests that I like to apply to tax reform to put taxes

and tax reform into the context of the overall economy and society.

The first is, will tax reform improve the economy, and I will

spend the bulk of my remaining time on that, but also, second, will

it affect the size of government? There are many people who believe a new tax device might just be used to raise revenue and after

closing the deficit perhaps grow the government, and that should

be a separate debate. So we will talk about tax reform of roughly

the same revenue.

Third, will it affect federalism? Fourth, will a new tax structure

likely endure and over time, and fifth, will tax reform contribute

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to a prosperous stable democracy by making sure we have an abundance of taxpayers relative to people receiving payments from the

government. We see as Europe progresses with their demography

and very generous social welfare states, that they get into some

very awkward politics of budget policy as a majority of the population receives benefits rather than paying taxes.

In designing a tax system there are some key decisions that have

to be made. The key decisions that have to be made are four—what

is the tax base, should it be income or consumption? Our current

system is a hybrid of the two. Should we tax people or transactions?

What should be the tax rate or rates? A flat tax? Progressive

rates? And at what level should they be levied? What is the unit

of account? Should we use the family? The individual? Or should

we tax transactions?

And what time period should we use? Should it be an annual

tax? Should we tax individual transactions as they occur daily or

should we have a longer horizon view of equity and efficiency?

I will say a few words about each of these. Modern tax theory

as it has developed in Academe across America primarily but also

importantly, in the U.K., is often called ‘‘optimal taxation.’’ It came

to the conclusion that the best tax system would be a system with

broad bases and low rates and would integrate the personal and

corporate tax, and probably tax consumed income rather than taxing savings twice or three times as in separate corporate and personal income taxes.

This occurs for a couple of reasons, but let me just start by emphasizing that economists, starting in ECON 1, teach that the

harm done to the economy from taxes goes up with the square of

the tax rates, so if you double tax rates—you quadruple the cost

of the distortions in the economy to how much people work or save

or invest or innovate.

That puts a pretty severe cap on how high tax rates can get before they cause substantial harm.

There are many ways to do this sort of taxation, to tax consumption. You can tax consumption or income in a personal tax or impersonal tax. It could be done at the business level. It could be

done at the personal level or some combination of the two. So because consumption and saving are the two uses people have for

their income, if we taxed income minus savings, if we had sort of

a super IRA where people could deduct all of their savings, you

would by this deductible saving method, wind up taxing consumption.

Alternatively, you could do this with a business tax that allowed

immediate writeoff of investment. The business tax expensing

method, would combine a labor income tax at the personal level

and a capital income minus investment tax at the business level—

and that would wind up taxing consumption. Finally, as was said

earlier this morning, retail sales or direct value-added taxes are alternative methods of getting to the same result of taxing consumption.

Each of these approaches has its strengths and weaknesses. The

retail sales tax would probably do the best job of getting at the underground economy. A personal consumed income tax could have

11

more variations in its features to accommodate personal circumstances. It could have progressive rates if that were desirable.

But the main thing is that the rate or rates be low.

A flat rate has a lot of advantages in simplicity. It eliminates the

need to process lots of information and lots of data and can greatly

simplify the tax code, for example, deductible interest and taxable

interest at the same rate means that the two things would net and

you would not have to keep track of it as it would not be taxed at

all in the flat tax.

So these are some of the approaches. I would just make a couple

of other statements about rate or rates. It is important to take a

longer time horizon than just an annual tax. We used to have income averaging in the tax code. It was abolished in 1986.

Over a lifetime, a consumed income tax or consumption tax,

would tax lifetime income other than bequests, because over your

life you consume your income, and many of us believe that a consumed income tax would do a better job of measuring long run average income than would an annual income tax, because of that

fluctuation.

I would also say that the studies that have been done in Academe suggest that the gains from such a tax reform, 7.5 to 15 percent increase in per capita consumption, a decade’s worth of per

capita consumption—are quite large and would indeed be of an

order of magnitude that would be hard to find in any other type

of public policy reform.

Thank you.

[The prepared statement of Dr. Michael J. Boskin appears in the

Submissions for the Record on page 64.]

Senator Bennett. Thank you very much.

Mr. Massa.

OPENING STATEMENT OF CLIFF MASSA, MANAGER,

PATTON BOGGS LLP

Mr. Massa. Thank you, Mr. Chairman. Good morning, Members

of the Committee.

In your invitation I was asked to comment on fundamental tax

reform, what might replace the current system, as well as how you

could hold it, if you could ever do it.

My perspective is as a trained tax lawyer, but really a tax policy

lobbyist for most of the last 20 years, and I have spent a lot of time

on these subjects, including chairing the VAT committee of the

ABA tax section, which came up, believe it or not, with principles

that all of the tax lawyers agreed to. They are attached to my

statement and I will come back to them.

But it is based on that experience that I would recommend that

the individual and corporate income tax systems as we know them,

simply be scrapped and be replaced with, and the term I use is a

business activities tax, provided that the principles that I am going

to cover as quickly as I can, are the ones that implement that system.

If we do not implement a new system with a reasonable set of

principles, most of them can morph eventually into the current

mess that we have now, and I would simply say, if that is where

12

we are headed, stay where we are. At least we understand the current mess.

The second question quickly, are there ways to assure that you

can hold on to tax reform once you have it?

I know there are proposals for constitutional amendments and

super-majorities, and they may have some benefits. My own sense

observing the scene for a while is that, if the public and policy

makers can actually summon the will to change the system and to

change the system using the kinds of principles that I will get to,

that probably is the strongest protection that you have for maintaining the reform in the first place, because the pressures for

screwing it up come from individuals and businesses, people that

I and people like me represent—that is the summary.

The principles I refer to for implementing any kind of new tax—

and particularly for a consumption tax—basically are these.

They are slightly restated versions of what the Tax Section Committee approved in January 2000. That position, by the way, was

not adopted by the ABA House of Delegates. Frankly I was surprised we got it through the Tax Section and I am satisfied to have

had hundreds of tax lawyers, except for one audible ‘‘no’’ in the

room, agree to it.

But those principles are these—first, that any tax system that is

imposed on consumption should use the most comprehensive definition of economic value-added we could come up with, should apply

only one rate of tax to that base, provide no exemptions, exclusions,

credits, deductions, anything which is going to favor one group or

penalize one group over any other.

Second, all kinds of businesses and organizations need to be in

the system. Individuals would be out as remitters and collectors

and businesses would simply do what they do now, which is to collect taxes from us in our various roles as consumers or employees,

but particularly consumers, and remit—so that all business organizations ought to be in the system, regardless of their corporate

versus non-corporate form or anything else.

Third, a topic that is current these days in both the Finance

Committee and the Ways and Means Committee, the destination

principle—in other words, impose this tax on imports and not impose it on exports. All of the current argument about replacing ETI

which replaces FSC, which replaced DISC, is a function of the fact

that we have been trying for years to illegally use the income tax

to subsidize exports. We know the rules do not permit that, so

under a consumption-based tax, we can, in fact, use legal border

adjustments.

Fourth, the efforts to offset whatever is perceived or actually is

the regressivity of a system of consumption taxes ought to be just

dealt with directly. Write the checks to whomever the government

decides needs to have those benefits.

There are some complexities that have to be dealt with. Ours is

not a simple economy, so a fifth principle is that, in some areas,

and financial intermediation is one, it is difficult to find the price,

but we have to dig in and come up with some alternative mechanical rules in those services where it is just not clear that this is the

price charged.

13

And finally, keep the bookkeeping and the rules as simple as possible. There are going to be pressures to leave small businesses out

and others out because it is too complicated to deal with. I would

be very leery of allowing that kind of thing to happen.

Among the options that are available, very quickly, I would see

the spectrum of four major proposals as these:

The flat tax could be better than what we have, but it sets right

back up the opportunity for people like me and our clients to mess

the system right back up. The more people you leave in the system

in an attempt to compute income, the worse off you are.

Sales tax, a little better, but it is rife with the ability for revenue

to be lost when it is not all collected at the retail level at the last

minute. The European style value-added tax, better yet, because

you have every business in the economy in the system to varying

degrees.

My personal favorite is what is called a Business Activities Tax,

which is basically a European style value-added tax computed with

a subtraction method, and if time permits, I can get into more details.

But those are my views, based on practice and working with a

lot of tax lawyers. If we keep it simple and do it correctly, a new

system can be worthwhile. If we do not follow principles like these,

let’s not even start.

[The prepared statement of Cliff Massa appears in the

Submissions for the Record on page 91.]

Senator Bennett. Thank you very much.

Mr. McCaffery.

OPENING STATEMENT OF EDWARD J. McCAFFERY,

PROFESSOR OF LAW AND POLITICAL SCIENCE, UNIVERSITY

OF SOUTHERN CALIFORNIA LAW SCHOOL

Mr. McCaffery. Thank you very much, Mr. Chairman.

Let me begin with a true conversation I had with my 12-year old

daughter before I left for California. I told Cathleen that I was

going to Washington to testify.

‘‘Oh, no, Daddy, you didn’t do something wrong, did you?’’ she

said.

‘‘No, honey, I am testifying about fundamental tax reform.’’

‘‘I know, Daddy, that is what I meant.’’

[Laughter.]

Mr. McCaffery. I have learned since my first days of talking

about tax reform to try to keep things short and simple, perhaps

especially in a complex field.

Fundamental tax reform, the subject matter of these hearings, is

a topic near and dear to my heart. What follows is my attempt to

distill decades of critical reflection into ten easy-to-digest truths:

Number one, fundamental tax reform is needed. I hold this truth

to be self-evident, that the current tax system is a disgrace.

Two, simplification can only occur with fundamental tax reform.

I hold this truth, too, to be self-evident, or at least abundantly

clear after too many decades of incrementalism.

Three, fundamental tax reform is possible. Many followers of tax

policy draw a despairing lesson from the Tax Reform Act of 1986.

At the time this Act, which broadened the income tax base and

14

lowered its rates, seemed the last best hope for some semblance of

sanity in tax on earth.

Less than two decades later, the tax system is as complicated as

ever. Perhaps fundamental tax reform, like federal budget surpluses, are doomed not to persist.

But this is the wrong lesson to be learned. The 1986 Act chose

one of two routes for tax reform laid out in the classic Treasury

study, Blueprints for Tax Reform: Namely, that of perfecting the

income tax by broadening its base. Sophisticated foresight would

have shown then what hindsight has since proven: this was the

wrong means to take to the right end.

Four, fundamental tax reform must center on the tax base. It is

easy enough to get blinded by the rates when thinking about tax,

but one way or another total taxes in America are going to be pretty close to one-third of our gross domestic product, on average, because this is what government at all levels is spending.

Truly fundamental tax reform, any tax reform that has any

chance of effecting permanent gains in equity, simplicity, efficiency,

and accountability, must take the question of the tax base or the

‘‘what’’ of taxes at its heart.

Five, the tax base is logically distinct from its rates. The simplest

analytic truths can get lost in the fog of tax. Reduced to its essence,

any tax consists of the product of a base and a rate structure.

There ought to be, as I shall continue to argue, broad and bipartisan consensus on the base question, yet confusion over the analytics has impaired reasonable compromise. Liberals miss the point

that redistribution can be effected under any base by choosing an

appropriate rate structure.

Conservatives deserve their part of the blame for the intellectual

stalemate, by continuing to link flat rates and consumption taxes.

Finally, academics, by lumping all consumption taxes together,

have not served the public discourse.

Six, fundamental tax reform must begin with the elimination of

all direct taxes on capital, meaning a move to a consistent consumption base. An income tax, under the Haig-Simons definition

that Dr. Boskin put up on the board, is supposed to tax all consumption plus all savings.

John Stewart Mill pointed out that this is a double tax on savings; Professor William Andrews, before the Blueprints study,

pointed out that the worst problems in the income tax come with

its taxation of savings. Consider again the choices confronting policymakers before the 1986 Act.

The path chosen was that of perfecting the income tax.

The other path laid out was to abandon the attempt to have an

income tax and to move to a consistent consumption tax. That was

the right path to have taken.

But it does not mean giving up the claims for fairness in tax, or

the attempt to tax the yield-to-capital in the hands of the socially

fortunate.

Seven, all consumption taxes are not created equal. Here is a

point where the academy has led policymakers astray.

There are two broad forms of consumption tax. In one model, the

tax is imposed up front and never again, a wage tax like Social Security or a prepaid or yield-exempt consumption tax.

15

The second form of consumption tax imposes its tax on the back

end, like a sales tax, a cash-flow, or qualified account model. Under

flat rates, the two consumption taxes are equivalent. Under progressive rates, they are not.

Eight, a consistent progressive, postpaid consumption tax is a tax

on the yield-to-capital, under just the circumstances in which it is

fair and appropriate to tax such yield. Individuals save for two reasons:

One, as Dr. Boskin alluded to, is to smooth out their labor earnings, to take uneven labor market earnings and translate them into

a consistent consumption pattern.

The other reason they save is to do better or to do worse.

An income tax double taxes all savings, not differentiating between good and bad savings. A prepaid consumption tax ignores all

savings, not differentiating between the savings that enable the

lifestyles of the wealthy and all other forms.

A postpaid consumption tax splits the difference by allowing people to smooth and taxing at higher levels only those who enhance

their lifestyles through capital.

Finally, the last two points: Actual tax policy, as we read today

in the front page of The Wall Street Journal, is moving towards a

flat prepaid consumption tax.

And, finally, implementation of a consistent progressive, postpaid

consumption tax is practical and the case for it is compelling. There

are two simple ways to do it:

One, keep the basic income tax system in place, but repeal the

limits on savings accounts: The unlimited savings accounts model

of the Nunn-Domenici plan.

Two, a three-step plan consisting of a sales tax, a rebate, and a

supplemental consumption tax. The two routes lead to the same

place.

And, finally, under either means for getting to a consistent postpaid consumption tax and consistent with the principled basis of

such a tax, we could and should repeal all capital gains taxes

under the income tax, all rules for the basis of investment assets,

all rules about maximum contributions to and minimum distributions from savings accounts, the corporate income tax, and the gift

and estate tax.

We should do it. It is high time to stop the insanity of tax.

[The prepared statement of Edward J. McCaffery appears in the

Submissions for the Record on page 109.]

Senator Bennett. Thank you very much.

Mr. McIntyre, you get the last word.

OPENING STATEMENT OF ROBERT S. McINTYRE, DIRECTOR,

CITIZENS FOR TAX JUSTICE

Mr. McIntyre. Thank you, Mr. Chairman. I think I am here for

balance. We heard from the semi-right, the center-right, and the

far, far, far-right, plus me and Jim McDermott, so there you go.

People have talked today about some of the basic principles of

tax reform—fairness, simplicity, economic efficiency—and my testimony touches on those. But I want to emphasize the most important thing that we are not doing with our tax system: raising

enough money to pay for the government.

16

That is the catastrophe we are facing right now. Last year, income taxes fell to their lowest level since before World War II as

a share of the economy. Now income taxes are generally how we

pay for most of the government, outside of Social Security.

And when they fall to the levels that they have fallen to, and

there does not seem to be any relief in sight, we are looking at

funding one-third of the non-Social Security part of the government

with borrowing. That is what it looks like for the next ten years

and beyond.

You cannot sustain that. We cannot do that as a country. Something has to give. We will either see our economy take a big nosedive as we use up investment capital to fund government consumption, or we will have to cut back on basic public services that we

need, whether it be defending the country or taking care of the elderly or healthcare, all things that all of us want.

So the situation that we have put ourselves in right now is not

sustainable. Any tax reform proposal that says, well, we will be

revenue-neutral, or, even worse, say, the Linder Plan for a sales

tax that cuts revenues in half, that says we will lose a lot of revenue, I think you should dismiss out of hand.

If we cannot fix our revenue problem, it is not worth doing anything else to the tax code. That ought to be the number one thing.

Now in terms of having a system that raises enough money to

fund the government, does it fairly, efficiently, and reasonably simply, we have had that system. Ronald Reagan and Bill Clinton put

it together for us.

It began under Reagan, who after a terrible start in his first year

when he did everything wrong, realized his errors and spent the

rest of his time in office doing penance for them. He came back the

year after his 1981 loophole bill with the biggest loophole-closing

measure in history at the time, led by Bob Dole and signed by Ronald Reagan.

The next year, he raised taxes again. The next year, he raised

taxes again. And the next year he raised taxes again. And in 1986

he gave us the biggest reform of the income tax that we had ever

seen, a new tax system that taxed most income at the same rates.

Capital gains even were treated the same as other income. It was

a huge triumph for truth, justice, and the American way—with one

exception: it did not raise enough money to pay for the government.

And so we had tax increases in 1987 and 1989 and 1990, under

Bush I, the President’s father. Not big ones, but some. And then

Bill Clinton came in and finished the job that Reagan started. He

pretty much kept the Reagan base, but he raised the rates up

enough to pay for the government.

When the economy boomed, particularly for people at the upper

end of the income scale in the late 1990s, those rates kicked in

with a vengeance or with a goodness, and all of a sudden, we saw

the first balanced budgets since the year 1969, the year I turned

21. So I had my adult lifetime without a balanced budget until

then. Some of you guys might have seen some earlier, but we are

all getting pretty old.

So there is a lesson there. It can be done. That was a bipartisan

effort, by the way. You had Dan Rostenkowski and Bob Packwood

and Ronald Reagan, so, two-to-one Republican, but bipartisan,

17

leading the way for something that was terrific. And then you had

something a little less bipartisan in 1993. Okay, it was partisan.

In any event, it can be done.

That is the direction I think we ought to go in. In contrast, these

consumption tax ideas inevitably will lead to a hugely more regressive tax system.

You hear people endorsing the so-called progressive consumption

tax. Well, yeah, you can make the rates work out arithmetically to

come up with a progressive system. The problem is that the top

rate has to be 200 or 300 percent. That is not going to happen. So

in practice that is a non-starter for me.

The other proposals, flat tax, Dick Armey style, or national sales

tax, which we have heard two different proposals for, all of them

would take such high rates that the public would not tolerate them,

and in the meantime, they would be hugely unfair, and there

would be huge tax evasion because the rates would be so high.

So, my advice is to scrap everything that you have done since

1993, and go home. Thank you.

[The prepared statement of Robert S. McIntyre appears in the

Submissions for the Record on page 113.]

Senator Bennett. Thank you all. This has been very provocative, and it is the kind of dialogue that we would hope for.

Let me—if my fellow Committee members would indulge me—let

me engage in my round of questioning, and then I will turn the

gavel over to Senator Sessions who was the first Senator to arrive,

and we are going to stay on the Senate side as I go deal with the

Agriculture bill.

Mr. McIntyre, I am very interested in your comments, but let me

give you some numbers out of my own personal experience. We are

all prisoners of our own personal experiences.

I was involved in starting a business, incorporated on the first

of September 1984. And that was what The New York Times and

some others referred to as the ‘‘decade of greed,’’ because the top

personal rate was 28 percent and with an S-corporation, that

meant that we could have the federal tax rate, effective rate on our

earnings in that corporation at 28 percent, so we got to save 72

cents out of every dollar we earned.

Now if you have ever started a business, you know that in a

struggling business the worst thing that can happen to you is to

earn some money, because the Feds want theirs in cash right now,

and you do not have cash. You have got to have that money that

you have earned in inventory or receivables or other things to grow

the business.

And you either have to sell some stock or you have to borrow

some money from the bank in order to pay your taxes. Now, yes,

you want to earn some money, but you are doing everything you

can to try to make it look on the books as if you are not.

And we did it legally. The folks at Enron chose a different route,

but we did it legally to find ways to report no income so that we

could save that money. But when the company started to grow, we

got to save 72 cents out of every dollar that we earned, and because

we were an S-corporation it was not taxed twice. It all ended up

on our personal account, so that statistically we were all rich.

18

Actually, the amount of take-home pay I got stayed exactly the

same even though the company’s money showed up on my 1040.

That made absolutely no difference to my family—all of a sudden

it was showing that I was a millionaire, but I did not get to keep

any of that money. It all stayed in the company, but for tax reporting purposes, that is the way it was.

Now we grew that company. We started out with four full-time

employees. I was number five when I was recruited as the CEO.

We grew that company into 4,000 employees, listed on the New

York Stock Exchange. At one point it had a market cap of close to

three-quarters of a billion dollars.

That is not there now. It got caught in all of the problems of the

1990s, but my point is, as I look back on it, if we had started that

company in 1994, instead of 1984, we would have had a top effective rate of 42 percent after the Clinton tax increases of 1993, plus

the Medicare item, coming back to us as an S-corporation.

The difference between 28 percent and 42 percent in terms of the

survival of that company is very, very great. And I suggest to you

that that company, founded in the ‘‘decade of greed’’ with a 28-percent top marginal rate and top effective rate, would not have been

able to create the 4,000 jobs that produced the rivers of revenue to

the government in the 1990s.

We could afford 42 percent as an effective rate in the 1990s, once

we were established. But the great engine of growth in this country

has always been the growth of small business. We created jobs

while United Airlines, General Motors, and others were

downsizing.

Having lived through that experience, I have a hard time believing that long-term economic growth has been benefitted by the two

step increases from the 28 percent up to the 42 percent, the first

one by Bush I and the second one by Clinton, and that we—I am

perfectly agreeable to some of the things Ronald Reagan did in his

tax increases because he kept the marginal rates down, and he

raised the gas tax. I think we probably ought to do that again. Grover Norquist will have a heart attack to hear me say that, but for

our infrastructure of roads, bridges, et cetera, we need more money

in the Highway Trust Fund to build those things we need. And

user fees to me make sense.

But income taxes impact small business where jobs are being created in a way that too many people who have never gone through

the experience of creating a small business do not understand.

So having given my five minutes, would you and some of the others react, and then I will flee, so that I am free from hearing your

criticism.

Mr. McIntyre. Well let me just say that I am sure, had you

started your business in 1994, that being as smart and hardworking as you are you would have been successful anyway, like

so many other businesses were.

Senator Bennett. Flattery will get you nowhere.

Mr. McIntyre. As you know, after the 1993 tax legislation, when

many of its opponents predicted that the economy would be destroyed forever by raising tax rates on one percent of the population, our economy went into its longest sustained boom in peacetime in our history, including a business investment boom.

19

So, I think you could have been part of that wave. Certainly,

most other businesses were.

Senator Bennett. My own reaction to that is that the business

cycle is alive and well, and President Clinton was very fortunate

to have become President when the cycle was going up.

Mr. McIntyre. Well, fine, call it irrelevant, then.

Senator Bennett. And I do not think——

Mr. McIntyre. At least we paid for the government.

Senator Bennett. Well, you know, I have heard that the boom

of the 1990s was because Clinton got elected in 1992, and I have

heard that the boom of the 1990s was because Newt Gingrich got

made Speaker in 1994, and I frankly do not think either one of

them had that much to do with it. I think it had far more to do

with the American entrepreneurial spirit than it did with who was

sitting in either the White House or the Speaker’s chair.

Mr. McCaffery.

Mr. McCaffery. Yes, Chairman, I wanted to comment on your

story before. I think that another way to sort of simplify and try

to see some forest through the weeds and shrubs and microcosms

of tax is to think that it is a matter of timing.

I am an advocate of at least moderate progressivity. I do not

think you need the absurd and unsustainable rates that my colleague to the left, I suppose, said. But I think it is a question of

when is it that we should impose progressive rates on individuals.

The current tax system imposes those rates when they work,

when they save, when they give, and when they die.

Those are bad times to do it. There is no reason to tax someone

who is building up a business, who is saving, who is working hard.

Those are mutually beneficial win/win activities.

We can tax people when they spend. And when they spend, we

can impose progressive rates. So if you are working hard and building up a business, if you are carrying an estate to your grave, there

is no reason to tax you.

So I think we should systematically eliminate all taxes on the

build-up of investment assets and wait until and unless people

cash it out in personal consumption.

Senator Bennett. I would love to stay and participate, but I

have to go worry about country of origin labeling.

Senator Sessions, I give you the gavel and let you carry this forward.

Senator Sessions. [Presiding.] Thank you, Mr. Chairman. You

know, we have all seen those little old ads for ‘‘When E.F. Hutton

speaks, people listen,’’ well, when Bob Bennett speaks on the economy, people in the Senate listen. He is certainly doing a great job

as Chairman of this Committee and I am pleased to fill in. I know

you have an unfortunate conflict this morning.

Mr. Stark.

Representative Stark. Well, I think, Mr. Chairman, that perhaps Dr. Boskin and others wanted to respond to the Chairman’s

comment and I would withhold for a second.

Dr. Boskin. Yes, I would just make the technical important

point that as debates occur, including the one over whether 42 percent or 28 percent was a better tax rate, it is important to remember that a large number, a vast majority of businesses, not a vast

20

majority of GDP generated, but a vast majority of businesses pay

taxes on the personal forms as either LLCs or partnerships or sole

proprietorships or S-corporations.

So it is important when we get into the rhetoric of taxation and

the political debate to understand that when we are talking about

taxing the rich we are also talking about taxing small business.

Mr. Massa. And I would add that I think it is more than coincidence that the explosion of concern about tax shelters, the amounts

of money that are spent on tax lawyers, financial planners and accountants, has gained attention again in an era when rates have

gone up and people are happy to have those rates high.

The amount of money that is spent on and, from my perspective

I would say wasted on tax lawyers and accountants and financial

planners, even on perfectly legal tax planning, is enormous. And it

occurs because the base is income and because the rates are high.

So whatever the revenue generating potential of high rates is,

the potential for encouraging more and more people to go find

sketchier and sketchier ways to avoid those rates is just, it is there.

And the only people who actually end up making quite good livings

out of it are people in my business, unfortunately.

Senator Sessions. Any other comments?

[No response.]

Senator Sessions. Well I do remember that ‘‘60 Minutes’’ show

in Italy over 20 years ago at least where people were cheating. The

tax rates were 60 or 70 percent and they were unhappy with the

cheating, so they raised the rates to 90 percent.

Mr. Stark.

Representative Stark. Thank you, Mr. Chairman.

As I say, all of the incidents that my friend, Mr. McIntyre indicated, I guess I participated in those reforms, increases, decreases

in rates, and I do not know if the dialogue was any different in

those days in over 30 years of changing the tax code, than it is

today.

Well-to-do people who paid substantially more in taxes complained the loudest, and basically I do not think I ever heard anybody suggest they ought to pay more for the privilege of living here

or enjoying what we enjoy in this country. So I think that greed

and selfishness are alive.

I am concerned with how we are going to pay, whether you want

to think about paying for six or eight or ten more years in Iraq,

whether you want to think of paying for Social Security so that the

youngsters here at the table can enjoy the same generous Social

Security benefits I now enjoy.

I think all of those things. We do not have the money. I am enjoying low interest rates as all of you are. I do not see how we can

continue to con our foreign investors into buying our debt when our

income stream is decreasing and we are going to see this problem

extend to states.

I am terribly concerned about our unwillingness to deal, to even

really discuss under Republican leadership any revenue changes,

much less increase. I mean, this abject, almost paranoiac psychotic

fear of suggesting that we might increase revenues I find disappointing and, at some point, I guess I could, in a sense of black

humor, find it humorous.

21

But it is going to come home to roost one of these days and it

will come home politically. And I think it is inevitable that this

country is going to need more revenue. And I do not think the discussion here is how to get more. I think the idea is that we are

going to relieve some of these magical entrepreneurs from their unholy tax burden.

I happen to be subject to that and I do not mind it. There are

others who do not.

I am curious and, Mr. Massa, one of the things that all of these

programs that we heard about earlier from our colleagues and we

have heard from Mr. McCaffery and others talk about, I do not suspect any of you have been in business, as the Chairman has, so

that you are probably not concerned nor have given a great deal

of thought to what the disruption in the normal commercial intercourse, what would happen to our way of doing business?

One of the reasons I oppose the VAT so strenuously is because

I have enjoyed the opportunity to go to Italy and France generally

every year. I find it much better to study the VAT in April and

May than I would in February or January, but I have spent a lot

of time in those countries looking at the VAT and looking at the

extent to which people cheat, and hide income, and make stupid

decisions because of it just as they do in this country because of

what our tax code does.

But there would be a tremendous change. I do not know if any

of you understand this, but the transfer of title to goods changes

by the whole thing.

You are a lawyer, Mr. Massa, you probably understand this far

better than I do, but it would completely disrupt how we sell goods

and how we store them and who pays taxes.

One of the things, I have been a client from time to time, of Patton Boggs. Other than their extensive lobbying, they have sheltered

some of my taxes for me and have done a hell of a job.

But think of this, and I am a slow pay. Think of the lawyers and

accountants and everybody else in this country. Let’s say the VAT

was 30 percent. You would have to pony up 30 percent cash the

day you sent me my bill. And you do not know when you would

collect from me.

The doctors, Dr. Paul, would have to pay their 30 percent on

their doctors bills the day they did the surgery. And then if Medicare did not pay him for a long time—and I just suggest that as

the disruption, admittedly we would get used to it and figure out

a way to handle it, but I do not ever hear any of these people who

talk about how this is all going to fit into a commercial tradition

in this country that serves us quite well.

That is what you learn at the Stanford Business School and for

those of you who went to other—Bob Jones West, as I call it, but

it is a good school. And it teaches people a vocabulary, how to operate business, how to sound sophisticated, how to make presentations on their computers so that they can go into board meetings

and tell people how to steal without getting caught.

All of this stuff would change dramatically and I guess my bottom line is, is it worth it?

We have got a code that can be changed. I would, as I told the

Chairman earlier, I could see supporting if I had to politically, a

22

modest federal retail sales tax if it were dedicated to pay, say for

health care or education. That may be the only way we will get

funding for some of those issues and I could compromise and make

a deal.

But I wonder if this idea of completely changing the tax code

would, one: get us the money to operate; and, two: whether our

commercial system could function?

Mr. Massa. Mr. Stark, on the second, I think the issue of how

painful would it be to get from here to there and how disruptive

it would be is a real one. It is often in the tax section committee

discussions we had referred to as, you know, transition rules and

there was another small fortune to be made by those of us who

would try to work on the transition rules.

My personal view is that it is worth the hassle and there are

going to be a lot of it, because looking at clients with whom I am

familiar and just other stories, so much of what their professional

tax planners, their corporate tax officers, do is unproductive and so

much of the thinking that goes through a CFO or a CEO’s mind

is, ‘‘All right now, this is what I want to do. What is the tax implication? Do I want to go through a corporate inversion? Do I want

to locate a plant here or pick some other country?’’—is being driven

by the income tax.

But yes, it would be very disruptive to begin ripping that out of

the system.

My personal hope is that we understand that this is dead weight.

It is wasted resources, it is diversion of money into a lot of bright

minds, leaving myself aside, a lot of bright minds who could actually be doing something productive for the economy.

But I do not underestimate the difficulty of trying to pull out 90

years worth of thinking in the business community and reorient

the commercial system, but I do think it is worth it.

Dr. Boskin. I would just make two comments repeating points

I made briefly in my opening statement. The harm done to the

economy by the misallocation of resources by altering savings, by

sheltering, goes up with the square of the tax rate.

So there is a big difference between adding a consumption tax on

top of the existing tax system and replacing the existing hybrid of

income and consumption taxation, corporate and personal income

tax, with a consumed income tax or some other variant.

I do agree that there is a pretty big range in how disruptive that

transition would be with a broad-based VAT being the most disruptive—retail sales taxes, you have federalism issues—my point

three, but you still have the fact that most people pay sales taxes

in their states.

When people talk about a broad-based sales tax they are talking

about extending to services which most states really do not tax, so

there are issues there.

But in a consumed income tax, either of the deductible saving

method or of the expensing method, we could indeed wind up, in

my opinion, much simpler than what we have now.

Senator Sessions. Mr. Paul.

23

OPENING STATEMENT OF REPRESENTATIVE RON PAUL,

A MEMBER OF CONGRESS FROM TEXAS

Representative Paul. Thank you, Mr. Chairman.

I get asked frequently at home about what is happening on tax

reform and there was a lot of talk about tax reform, especially after

1994, and my answer has generally been that nothing—we hardly

even talk about it.

So I am delighted to have at the hearings today at least know

that there are a couple of people still thinking about it—not that

it makes me very optimistic that we are going to have it soon.

But certainly in 1994, with the new Congress, there was some

enthusiasm for true tax reform and that helped motivate me to get

involved in politics once again.

But I respect all the qualifications, the academic credentials that

you all have.

The only credential that I have that I am very proud of dealing

with taxes is that each year I win the National Taxpayer Union’s

Award for the Taxpayer’s Best Friend.

Which means that I vote for the least amount of taxes and the

least amount of spending of anybody in the Congress, and the people in my district sort of like that.

I would take challenge with Mr. McIntyre’s statement when he

said we do have a revenue problem. But it depends on how you

look at it. I think we have a spending problem. You know, two trillion bucks. Not a bad sum of money to run a country. It would be

plenty if we were doing the right things and limiting our government to constitutional functions and maybe not pretending we are

the policemen of the world and the savior of everybody who wants

something in this country—$2 trillion would be way too much.

So we have a revenue problem in that there is much too much

taken out of the economy and I would like to see a heck of a lot

returned.

But still, even with our discussion, it always frustrates me because to me it comes down to the principles of the technical aspects—should it be consumption tax and what kind of consumption

tax? Should it be a flat tax and what kind of a flat tax? And it just

goes on and on.

And I really think that misses the entire point. Because if you

had a sales tax to cover the revenues and say we go and cover the

revenues for the current spending because my argument is not

going to win, we are going to continue spending.

So sales tax might not be 20, it might be 28 or 30. The only argument I can give for that that is really practical, is it would cause

the most horrendous tax revolt. People just would not pay it.

Like Mr. Stark points out, you know—cough up. And they are

not going to cough up on an automobile with 30 percent or so. So

there would be a great revolution and then maybe we would get

down to serious business. Maybe the people would decide, you

know, ‘‘I did not know I was paying so much for my government.

I would like a little less government and a little more freedom, a

little more chance to keep my own revenues.’’

But the tax, there is another tax that nobody ever talks about

that is probably the most important to me, and that is the inflation

tax. Last year we spent—the national debt went up approximately

24

$550 billion, if you count everything that we borrowed. That is a

horrendous amount, but nobody sweats it really.

We fuss about it a little bit, but I think this is an outcome of

some of our conservative friends who preach that, in the 1980s it

was a very, very popular philosophy and that was the philosophy

of the supply siders.

Part of that philosophy I really strongly endorse, and that is, get

the rates down, because rates, you know, that is how you win NTU

awards—get the rates down.

So I am always for lower, lower rates and I think they are very

beneficial. But they taught one other thing that I think we as conservatives in the last 20 years have totally accepted—do not sweat

the deficits. Deficits do not really matter.

But how do we get away with it? We get away with it because

we tax the people through inflation. If we do not have enough revenues, if we do not have these patsies from overseas and there are

a lot right now who will loan back just about everything we need,

but if we come up short like we are and if we think interest rates

should be lower than the market says they should be, we have that

money machine and we have the money machine there, that monetizes the debts, buys these securities, and then who pays? Well, nobody pays.

Except for the fact that prices will go up and some people argue

that this is a great tax. The politicians love it because nobody sees

it. Everybody gets taxed and they figure it is probably very fair.

Everybody’s prices go up the same—which is the fallacy, which is

a myth.

Because the cost of living goes up for middle income and especially low middle income much more so than anybody else. So middle class people get wiped out.

It is very regressive, so taxes on education and medicine and

services and energy and food—that goes up. So the real tax hits the

middle class and low income people and we go merrily on.

So I do not see the solution with the tinkering. And I am for tinkering in one direction, less taxes, less IRS, less tax on income—

and but, if we fail to address the subject of trying to finance this

government that is pretending that we can police the world and do

all these things around the world about the deficit and, at the same

time, add on new welfare programs here at home, I see very little

hope for your suggestions.

I would like you to just comment on that and see if I am not saying something worth thinking about in that we should think the

bigger picture and that is more important than the tinkering with

the tax code. Any comments?

[The prepared statement of Representative Ron Paul appears in

Submissions for the Record on page 48.]

Mr. McCaffery. Well, I definitely agree we should look at the

big picture. In terms of inflation, all the taxes that we are sort of

obsessed with are now pretty well indexed for inflation. That was

a Reagan era change.

Before that change, there used to be a tax increase every year

and then the government could pretty much cut taxes.

25

But your comments do make me think. One thing I often teach

my students is the very simplest tax system would be a printing

press—if the government just printed money to pay its bills.

Now, the problem with that, nobody would fill out forms, there

would not be high rates, the problem with that would be that you

would have a tax working through the economy falling on individuals through the monetary effect, through the inflation effect.

The reason we buy all the complexity we buy with payroll taxes,

personal income taxes, corporate income taxes, gift and estate

taxes, is that we believe in some sense of individuated justice. We

believe that somehow or another we should make determinations

on the basis of individuals’ ability to pay.

To me that then gets back to the question of when should we

make those decisions? I do not think when people work, I do not

think when people save—the first book I wrote showed that I do

not think when people get married is an occasion when their taxes

should go up. I do not think when people give, I do not think when

people die. I think if we are going to buy the complexity of an individuated tax system, we should get it right and we should tax people when they spend.

A comment on other than finding out Mr. Stark is a representative from my home state as I know and I could tell from his comments he has a very safe seat, so that he is not particularly worried about raising taxes, so I am delighted to hear that.

But getting back to a comment in colloquy that Mr. Stark had

with Dr. Boskin. I do not think if we have a sales tax or VAT, that

should be one-stop shopping because of that rate problem.

So I think we can have a national sales tax as part of a consumed income tax at a moderate rate, maybe 10 percent, that

would then take care of the consumption taxes for the masses, we

could give them a rebate to give them in effect a zero bracket or

a family allowance, then we could have a supplemental consumed

income tax for those who make $70,000 or $80,000 along the NunnDomenici lines—a proposal very similar to Michael Gretz’.

Senator Sessions. As you think about sales tax, let me add one

other thing as long as you brought up California, that the public

ought to be concerned about and that is us politicians.

I mentioned earlier how much difficulty any of us would have

voting increased taxes, but that is not true on sales taxes. We have

increased under the clean up tax for the Superfunds, we have increased that an eighth, a quarter—without anybody looking or

knowing about it.

California, when I first moved there, sales tax was about three

percent. It is now 8.5. I have never had a letter complaining even

though I do not have anything to do with it.

But what I am saying is, it is so easy politically to ratchet that

up a quarter here, a half there, and—think about that as whether,

I guess as politicians, to pay the bills we would love it—but it is

a concern that I have about administering these consumption

taxes. Thank you.

Dr. Boskin.

Dr. Boskin. I will just make three points, one with respect to

what Mr. McCaffery and Mr. Stark just said. What I was referring

to earlier was adding a consumption tax on top of the current sysVerDate 03-FEB-2003 10:18 Apr 07, 2004 Jkt 091847 PO 00000 Frm 00029 Fmt 6601 Sfmt 6601 91847.TXT SSC1 PsN: SSC1
26

tem so that the size of government got to European levels, that is

indeed how Europe financed going to half of GDP going through

the government relative to our one-third—and one of the reasons,

our economic performance, despite its ups and downs, has been

much better than Europe’s—is because we have a lighter hand of

government. Some would say too light. I personally think it is probably still too heavy.

But in any event, a major part of our success is we did not go

the European route, it would have caused much higher unemployment and much slower growth.

Secondly, inflation—Mr. McCaffery is right. We did index the

brackets, but we never indexed the definition of income so we still

tax nominal interest, not inflation adjusted interest. We still deduct

nominal interest. We use historic cost depreciation, we tax nominal

capital gains so sometimes even though it is a lower rate and with

deferral, sometimes you will pay positive capital gains taxes on real

losses.

So it is important to understand that is a big part of the complexity. One advantage of a consumption or a consumed income tax

is avoiding all these inflation adjustments.

And let me answer Mr. Paul’s question about the deficit in my

own views. I think that, unfortunately, there is no simplistic answer to what are the economic effects of deficits. The effect of the

economy on the budget is larger, surer and faster than the effect

of the budget on the economy.

So if we have a downturn or a recession or slowdown or a stock

market collapse, there is a big hit to revenues and, conversely, in

a boom, with bracket creep and a variety of other things.

I personally believe that not only the level and structure of taxes

and of spending, but the deficit does eventually have some impact

on investment, but it is far less than dollar-for-dollar and it varies

over the business cycle.

We should indeed not only accept a deficit or a decline in a surplus and run a deficit in a recession or in the early part of an expansion—we might, when we get into a situation as we recently

did, where the Fed had used up most of its ammunition, want to

supplement monetary policy with a tax cut to try to stimulate the

economy.

So I think that was the right thing to do and I am not particularly concerned about the deficit right now. I think it is the right

policy.

I think out the other end, five or seven years from now, putatively into a long expansion, we ought to be in a situation where

the budget is getting close to balanced.

I would also suggest that we do not in our budgeting separate

out capital expenditures from current expenditures. And if we are

in a period where we have a big increase in government investment—in the military, let’s say for example, when you have a big

expansion of things that can be viewed as investment, it may well

be desirable to fund that at least partly with debt as many states

do and spread the cost of financing over a longer period than just

the current year.

Representative Paul. May I make one brief comment? I think

you miss my point about the inflation tax, when we create new

27

money the value of the money goes down. I am talking more not

about bracket creep, but the cost of living hitting low middle income and poor people a lot worse than rich people. That was the

point I was trying to make. Thank you very much.

Senator Sessions. Thank you.

Senator Sununu.

Senator Sununu. Thank you. Let me state at the outset that

the beauty of sitting on a committee with Pete Stark and Ron Paul

is that I become the centrist.

[Laughter.]

Senator Sununu. Let me also note that it made it just a little

disappointing to find out that, as a member of the Ways and Means

Committee, Pete Stark does not do his own taxes—but I am pretty

sure if he checks with his lawyers at Patton Boggs, there is nothing

that prevents him from writing a bigger check and sending a little

more into the federal government.

Dr. Boskin, I think you said, and I am sorry I did not hear your

opening testimony and it is a lot of testimony, which is a good

thing to have, and I will read it, but you said that the cost, I think

the cost of the system increases with the square of the rates.

What about the impact on growth, or are you using those

changes interchangeably? In other words, what is the impact on

forecasted growth rates or the relationship between growth rates

and tax rates?

Dr. Boskin. That is a very good question, Senator. There are

two aspects to that. One is in an economy that is not at full employment, higher taxes will be a drag on the economy, prevent it

from getting back to full employment on its own rapidly enough

and that can be fairly substantial and that is why I personally favored a tax cut in the recent circumstances with interest rates

down to one percent, the Fed about out of ammunition.

With respect to long term growth over decades, the basic issue

is how is it affecting a broad measure of capital accumulation and

investment? Saving and investment in plant and equipment and in

human capital and so on.

So the advantage of moving to a consumed income tax or tax on

consumption is it gets rid of the double or triple taxation that we

have now on saving and investment in the economy.

A progressive rate structure would still affect human investment

and slow growth as people invested in themselves and drove themselves into a higher tax bracket—but a flat rate consumption tax

or a flat rate consumed income tax would be relatively neutral with

respect to savings and investment versus consumption and would

not have an effect on growth above and beyond the shifting of the

resources from the private sector to the government and then you

would have to reflect the differential efficiency with which the private sector did its activity versus the government.

So I would say if we ranked the order, the most pernicious taxes

with respect to long term growth are those that affect saving and

capital accumulation, and the higher the rates the more the harm,

as I said earlier, going up on the square of the rate. While the cost

of the distortions go up with the square of the tax rates, you cannot

take the growth rate and multiply it by some tax rate squared and

28

get an answer, it is more subtle and more complicated than that

and I will not bore you with the mathematics here.

Senator Sununu. With regard to federalism, you raise that as

a concern when we look at proposals for tax reform. What kinds

of approaches either strengthen federalism or harm it the least?

Dr. Boskin. I think there is concern on the part of mayors and

governors that the federal government launching into a tax vehicle

that has primarily been the preserve of state and local governments, like a sales tax, would make it harder for them to collect

the revenue they need to collect.

And I think they have historically opposed these types of suggestions and also a value-added tax, which they see as closely related

to a retail sales tax.

I think those are the big concerns that mayors and governors

have and I think are most likely to affect federalism.

If we could get a broad-based tax that everybody would agree on

and each individual state legislature would be happy to piggyback

on the federal tax system because they thought it was really good,

that might enhance federalism in some way, certainly increase the

overall efficiency of the combined state and local and federal tax

system.

But I think the primary concern is a new tax device that invades

the province that has usually been preserved for state and local

governments.

Senator Sununu. Well, that is the historic norm. To what extent do you think that the practicalities of, I think as you just described, leaving consumption taxes to the states and at the federal

level focusing on taxing income, either at the corporate or the individual level, to what extent is that maybe no longer the best

model?

And when we are talking about the practicalities or the issues

of taxing internet commerce right now and the degree to which you

have greater and greater volumes of interstate commerce, both at

the business and the individual level, and so that may be taxing

models based on states that can control and monitor consumption

that initiates in their borders and is completed in their borders—

it is just becoming tougher and tougher. Do we have the model

mixed up?

Dr. Boskin. You are exactly right. A lot of things, such as the

mobility of the population, the mobility of economic activity are

rendering that old model less and less relevant. You will still get

a lot of argument from governors and mayors about federal sales

tax for example.

But I do believe that the basic issue is the concern at the state

and local level for being able to raise sufficient revenue to pay their

bills and they believe that, if the federal government had a sales

tax, for example, it would make it harder for them to raise their

own because people would see the aggregate.

I think that is a legitimate concern if you see it decreasing.

Senator Sununu. But if the federal government got out of the

business of taxing income at the individual and corporate level,

would that not create an opportunity for the states to address

whatever——

29

Dr. Boskin. I think that is exactly right. A big difference between replacing the income taxes or greatly reducing them with a

consumption tax at the federal level and just adding it as another

tax device—I think part of what you hear from governors and mayors is not just the type of tax, but the resistance of the population

to an increase of the overall level of taxation, I think you are exactly right about that.

Senator Sununu. Mr. Massa, I guess along those lines, which

do you think is more of an abomination? The complexity in the corporate income tax or the individual income tax? In other words,

which of these is in most need of reform, either from a policy standpoint or from an economic standpoint?

Mr. Massa. I wish I could separate them that way, Senator. I

cannot, since so much of the corporate community is now taxed and

the individual community through Subchapter S and so forth, I do

not think there is a way to say that. There are different kinds of

problems and complexities to be solved.

My personal view is they are both a mess and they both need

work. But I cannot rank it that way.

Senator Sununu. From a political perspective, let’s stop talking

about the theory. How do we get this done? I have only been

around for six years, and I think I talked about tax reform in the

first, ‘‘political’’ speech that I gave, and I do not feel like we are

any further along.

I think that, in some ways, if you look at the tax package that

is in the Energy Bill, if you look at the sunset provisions that exist

in some of the 2001 tax reform, I think you could argue that we

are further away from the goal of simplification.

So from a practical standpoint, I will let each of the four of you

at least offer some political advice. What is the best way to move

forward? Incrementally? Do you have to have a national dialogue

and build consensus? Do you need to put three people in a room

and do not let them come out till they agree on a solution? What

is, practically speaking, in your opinion, the path forward. We will

start with Mr. McIntyre.

Senator Sessions. We are interested in your answers, but if you

can keep them as brief as possible, because we could talk a lot

about that.

Mr. McIntyre.

Mr. McIntyre. How do we get to a better tax system? I think

you probably have to elect some different people than have been

running things for the last decade-and-a-half, because none of the

current crowd has any interest in real tax reform.

Mr. McCaffery. Well, I will briefly plug my book, ‘‘Fair, Not

Flat.’’ I think part of the answer is that we need public education.

The people have to get involved.

As I often say in my books, tax is too important to leave to the

people who understand it. We probably need political

entrepreneurialship; we need Presidential leadership. I think history has really shown that we need a John F. Kennedy, the first

great tax-cutting President. We need a Ronald Reagan. We need

someone who is not going to pander and add complexity to the code

by adding token, you know, deck chairs to this Titanic, but we need

someone who is really going to take it on as an issue.

30

So I think public understanding, and strong leadership at the

Presidential level.

Mr. Massa. I have given up on being an incrementalist. I do not

think it works. The only winners are people in my profession and

others.

I think that if it is worth doing, you say we are going to start

again, here is the clean sheet of paper, adopt some principles. I

have suggested some, and you can come up with your own and adhere to them and just say ‘‘new system, old system,’’ but

incrementalism, I think, just makes it worse.

Dr. Boskin. I have a slightly different perspective on this. I

think there are issues which are timeless like tax reform, that

every once in a while percolate up, and if you are ready to take advantage of it when the political process is right, as it was in 1985

and 1986, then you can get something substantial done.

I will remind you, for those of you who were not around back

then, what happened in 1986 was not what was originally proposed

and originally discussed, and, indeed, the original discussion was

for rates of 15, 25, and 35 percent and a very different tax law that

was defeated in the House, originally, and then was eventually

passed.

And in the end, what happened was Senators Packwood and

Bradley hammered out a compromise in private. They had been

working on tax reform for a long time, and spent a lot of time. I

was privileged to advise both the Ways and Means and Finance

Committees at the time.

And that is sort of how we took the general interest in tax reform, pushed by President Reagan and the concern in the population, and transformed it into what I thought was a very good tax

reform, far from perfect, but a very good one.

So I think that the answer is all the things people have been saying: Concern of the population, Presidential leadership. But you in

the Congress have to have a core of people who have developed a

set of principles and ideas about what you want to come to, so that

when you actually get to the legislation, you mold it into the right

kind of reform. I think that there may well be an opportunity in

the not-too-distant future.

It may not be this year, it may be in 2005, but in the meantime,

what you might think of is, in part, evaluating individual proposals

that come along, by whether they move us in the right direction or

not.

Senator Sessions. There is no doubt we can make this system

simpler. That is indisputable, I would say, and I would think it is

also fair to say that the taxes we impose could be less hurtful to

the economy. There is no doubt in my mind that a tax is detrimental to an individual’s standard of living.

It reduces the amount of money they have to spend as they

choose. It also reduces the amount of money a business has to

spend as they choose, so it is detrimental to both, but we do need

a certain amount of revenue, and the question is, let’s get it in the

simplest way possible, with the least possible adverse impact to the

economy and jobs and people’s ability to save and build for the future.

31

I do remember when I came here in 1997, about 40 Senators

signed legislation to end the tax code as we know it, by 2000, was

it? Is that the year? I have often wondered why that did not go

anywhere. I really think maybe Mr. Forbes, who ran on that and

did not win, maybe somehow that took the steam out of the issue,

the momentum there.

And so I would just say that it is a very real issue. I agree with

Mr. Paul that I am still hearing that when I am out there. People

are telling me it is too complicated, so I know we can fix that.

Tax rates, I believe, should be as low as possible.

Dr. Boskin, you mentioned that and their lack of competitiveness

with the United States, and you noted that it is because, your opinion, it is there at 50 percent of GDP going to the government,

where we are a third. I asked Mr. Greenspan about that at my first

hearing here. I was somewhat nervous to ask him about it, and I

asked him about three businessmen who had been interviewed in

USA Today, and they asked why our economy was better than Europe’s, and they said unanimously, ‘‘the United States had less

taxes, less regulation, and a greater commitment to the free market.’’

I said, ‘‘Do you agree?’’ And Mr. Greenspan looked up and he

said, ‘‘I absolutely agree.’’ So I have sort of taking that as marching

orders.

Now, Mr. Schroeder of Germany just last week—I am looking at

the Associated Press—said, pointing to the acceleration of United

States economy, 7.1 percent growth last quarter, pointing to the acceleration of United States economy after tax cuts there, Schroeder

hopes to give German growth a boost in 2004 by moving an $18

billion tax cut up. So I think the message is out there that a vibrant, free market is good for the economy, as much as possible.

Let me ask this: I was present at one of those great debates between Congressman Tauzin and Armey over the flat tax and the

consumption tax in Mobile, Alabama. It was a fascinating debate,

and there was a very packed house. People were very engaged and

interested. I would like to ask you this:

Is there a conflict between these two ideas? Can there be a merger? I believe Mr. Tauzin’s view was, if you leave any income tax

in, and you throw a sales tax on top, the income tax will grow and

will just be a way to increase revenue.

But what are your opinions? Do you have any thoughts about

that? Would this make the economy healthier, if we could do it in

a restrained and effective way? And is there a conflict at all between these two issues?

Mr. McCaffery.

Mr. McCaffery. Well I think we should get—and I think there

is a consensus here for the most part, that we should get to a consistent consumption tax. I favor a postpaid consumption tax, which

is on the sales tax model with some progressivity, but I think we

should only do it—I think Mr. Stark’s concern about the ease of

raising a sales tax is a legitimate one, so we might move to a single

consumed income tax.

But I think, as Mr. Massa said and as Dr. Boskin said, tax reform has to be fundamental, and I think part of this package

should be to eliminate all direct taxes on capital, so we are getting

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rid of the corporate income tax. I guess Senator Sununu asked

about that. I personally think it is about one-fourth the magnitude

of the personal income tax.

The problem with the corporate income tax is that nobody knows

who pays it. It is a hidden tax. It either falls on workers or it falls

on capital, generally, or in some combination. It is not individuated.

Get rid of the corporate income tax, lock, stock, and barrel, get

rid of the gift and estate tax. You do not need it under a consistent

consumption tax, because you can tax the heirs when they spend.

Get rid of capital gains, get rid of all this other stuff. If you do

that, I do not think there is a tension between a moderate national

sales tax and a supplemental income tax, putting aside the very

important political economy points that Mr. Stark pointed to.

Senator Bennett. Any others comments?

Mr. Massa. I would encourage that there not be two, simply because there is more opportunity for messing up two systems. The

written statement emphasizes a bit the desirability, from what I

think is an administrative and complex point of view, of simply

taking individuals out of the system.

It reduces the amount of returns and makes the IRS job easier.

But I think it also substantially reduces the pressure points that

members of the Congress face. Turn businesses into the tax collectors and remitters through a sales tax, or a value-added tax or the

business activities tax.

I think that one of the eventual fatal flaws of the flat tax—and

you have already heard testimony along this line this morning—

let’s have it a flat tax, except I will raise the rate a little bit, and

I want that mortgage deduction and I want that—what was the

other one this morning—charitable contributions.

When Senator Long was the Ranking Member in 1986, he told

my distinguished partner, Mr. Boggs, do not worry about not having anything to do after the 1986 Act. You all are going to spend

10 or 15 years putting it right back, because we are still taxing

people.

That is exactly what has happened. My personal as well as lawyer views are, do not do two systems, and I would personally prefer

that individuals simply not be in the system, not be in the system

as remitters. We are the only ones that actually pay the taxes. Just

do not have 130 or so million returns remitting taxes.

Dr. Boskin. Let me just make a very simple point: As a practical

matter, we have both right now, because most states have substantial sales taxes.

Senator Sessions. That is an interesting thought, and I was

going to say that it really does require creating two complex systems, and a lot of the complexity that we complain about, really is

an attempt to achieve fairness. Some say it is loopholes and benefits for corrupt reasons, and there may be some of that, but sometimes people are clever to get around a tax and beat a tax, and you

have to amend the law to make sure that they are not escaping

their rightful liability because one person is paying and another

one is not in a very similar way.

So perhaps having two systems to defend and protect and complicate, would be unwise.

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Mr. Stark.

Representative Stark. Mr. Chairman, without the votes to

move ahead on either side of the aisle with any changes, I find this

fascinating, but I just come back to my concern. What are we going

to do about the deficit? And I do not think we can make any of

these changes quickly enough to deal with that.

And I am afraid that is going to be a very tough political strategy

for all of us. How do we get some more revenue some time in the

next four years, let’s say, without you and I having to vote for it?

[Laughter.]

Representative Stark. If we can figure that one out, if our

panel of experts here——

Senator Sessions. Seven percent growth, continue that level. It

is a dream, anyway, but not likely.

Representative Stark. That is what I think we are going to

have to find, and I am not finding it here this morning. Thank you

very much.

Senator Sessions. Thank you.

Mr. Paul.

Representative Paul. Briefly, I would say that our problem is

that we are trying to make taxes enjoyable and make everybody

comfortable about it.

[Laughter.]

Representative Paul. And it is not going to happen.

We are trying to tinker and change a tax code and get the revenues that everybody wants, but unfortunately, I am a pessimist on

this. I think that the tax problem that we face is merely a symptom, and unfortunately whether we do go with direct taxation, excessive spending, or we go the inflation route by devaluing the

value of the dollar, we always hit the poor and the middle income

the worst.

Thank you.

Senator Sessions. Dr. Boskin, you mentioned something that I

am not sure of the effect of the economy on the budget. That has

become very real to me now that I am on the Budget Committee.

We saw, what, an $80 billion turnaround in the estimates of how

large the deficit was going to be. And part of that, it strikes me,

is when the stock market is down and people sell stock, they don’t

take a gain.

They are offsetting some, at least, revenue. Small businesses,

mid-size businesses, where the entrepreneurs may be making large

incomes, can plummet substantially and I am looking at the Joint

Economic Committee’s numbers that says in the year 2001, the top

50 percent of taxpayers paid 96 percent of the income tax. So we

have created, have we not, a very, very economy-driven revenue

stream to the government?

And when the economy’s growth ceases and drops even a little

bit, we will find a larger impact adversely to our income to the government? And when the economy goes up a little bit, we are likely

to see a larger increase in revenue to the government? Is that a

fair analysis?

Dr. Boskin. That is correct. It is heavily due actually to the progressive rate structure, and it is also due to who gets the income

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and where it is accruing if a lot of it is in capital gains and bonuses

and stock options and other things tied to stock performance.

Senator Sessions. Well, if a corporate executive gets a $200,000

bonus and pays the maximum tax rate on it, well. But if his corporation is not doing well, he does not get a bonus at all and he

pays no tax, or at least none on that money.

Dr. Boskin. You are exactly correct. This is driven home most,

unfortunately, in Mr. Stark’s and my home state of California and

Mr. McCaffery’s, where we have a very progressive personal income

tax. And of course, California, Northern California, was the epicenter of the technology industry and the bubble in the stock market, where all the stock option income, and capital gains were

taxed in full under the California income tax, not at a lower rate.

So 9.3 percent more or less came off the top and went straight to

Sacramento.

When the bubble burst, revenues collapsed substantially. So it

creates a kind of a political economy problem that Mr. Paul mentioned and Mr. Stark mentioned. If the revenue is pouring in and

you can’t constrain yourself on the spending side, it is hard to constrain yourself, and then you are going to be in a very difficult situation the next time there is a downturn, because you will have

these spending programs which have been matched to super-normal revenue. That is what happened in California, and we are

struggling to get out of that at the moment.

Senator Sessions. That is a valuable insight, too.

Mr. McCaffery, I would ask, but maybe we will do it by written

questions, some questions about the death tax, the estate tax.

We have got some analysis now that indicates that if you do not

obtain a complete, stepped-up basis, it has very little revenue cost

over ten years. We need to be looking at that. If that could be

eliminated, that would be a tremendous savings in terms of paperwork burden and unwise allocation of resources, I think.

Representative Stark. Mr. Chairman.

Senator Sessions. I think I got your attention, Mr. Stark.

Representative Stark. Does that chart say that 50 percent of

all Americans earn less than the top one percent? In other words,

what I am reading in that chart, it says the top one percent of all

Americans earn more than the bottom 50 percent, combined? Is

that what that chart says?

Senator Sessions. No, it says that they—because they are paying at the top rate, and don’t have the personal exemptions, they

don’t pay as much tax.

Representative Stark. Just the gray bars, what they earn.

Mr. McIntyre. That is why they call them rich.

[Laughter.]

Dr. Boskin. Let me just repeat what was said earlier, that in

these data are a lot of businesses, not just people.

Senator Sessions. Very good. Anything else for the agenda?

[No response.]

Senator Sessions. We stand adjourned. Thank you very much.

[Whereupon, at 11:24 a.m., the hearing was adjourned.]

(35)

Submissions for the Record

PREPARED STATEMENT OF ROBERT F. BENNETT,

CHAIRMAN

Good morning and welcome to today’s hearing on ‘‘Rethinking the Tax Code.’’

In May of this year, the Senate overwhelmingly approved legislation acknowledging the serious problems in our current tax code and called for a congressional

review of ways to overhaul the antiquated system. This was especially gratifying to

me since tax reform has been a central piece of my agenda in the Senate. Seventy

members of the Senate agreed the Joint Economic Committee should be the key

point for this debate, and today’s hearing is a direct response to that vote. It is part

of a series of hearings, studies, and related events the JEC is undertaking to find

a path to real tax reform.

The present tax system is unduly cumbersome, inefficient, and incomprehensible.

Over the years, through revision after revision, the tax code has become a confusing,

burdensome web that hampers economic growth, places undue burdens on American

businesses, and needlessly complicates the lives of the American people.

As I reflect on all of the debates held over the years on tax policy, I realize that

there is one word that comes up over and over again—and that word is fairness.

Every time we make a change in the tax law, we are told that it is necessary to

make things more fair.

What we have done is tip the tax code this way and that way to encourage one

activity, and discourage another. Every time we do this the code gets bigger and

more complex. I find it ironic that in the name of fairness for some we have created

a system that is unfair for everybody.

Today, during this hearing, let us get out a clean sheet of paper. Let’s not talk

about tax cuts or mere adjustments to specific parts of the existing system. Let’s

talk about creating from scratch a system that is simple, that is fair, and once we

have accomplished that, a system that will endure for years to come.

We are not prejudging the issue. We are not coming to the hearing with recommendations already in mind. This is our opportunity to listen, and learn, and

look at the issue from a different perspective.

Whether you are in favor of getting more tax dollars out of the rich, whether you

believe the tax code should spur faster economic growth, or whether you think we

should implement a flat tax for all individuals, we can all agree that the existing

code is so badly broken, that the principles of simplicity, fairness, and efficiency are

not being met.

If we can achieve the goals I have just laid out, then another challenge begins.

We must ensure that the new tax system endures. Businesses cannot make intelligent plans if the tax system constantly changes. That slows economic growth and

that slows job creation. For individuals, the shifting sands of the existing tax code

create painful uncertainty. People who want to buy a house, take out a loan, put

money aside in a savings account or make an investment need—and deserve—to

know that there won’t be any surprises coming after the next election.

Today we have a balanced group of witnesses that will present diverse views

about how our government should tax its citizens.

For our first panel, we are pleased to have as a distinguished guest Senator Arlen

Specter of Pennsylvania who cosponsored the Sense of the Senate Resolution that

brings us here today and who has for years been a champion of tax reform. We also

welcome Representatives Jim McDermott of Washington and John Linder of Georgia

and thank them for joining us today.

Our second panel brings a wealth of knowledge on the subject of tax reform. Dr.

Michael Boskin is a Stanford University professor of economics, and previously

served as chairman of the President’s Council of Economic Advisors. Cliff Massa is

currently a tax attorney for Patton Boggs, and has served as chairman of the ComVerDate 03-FEB-2003 10:18 Apr 07, 2004 Jkt 091847 PO 00000 Frm 00039 Fmt 6601 Sfmt 6621 91847.TXT SSC1 PsN: SSC1
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mittee on Value Added Taxes at the American Bar Association. Professor Ed

McCaffery joins us from the University of Southern California, and is the author

of ‘‘Fair Not Flat: How to Make the Tax System Better and Simpler.’’ And finally

we welcome today Robert McIntyre, the executive director of Citizens for Tax Justice.

I look forward to hearing each witness’s thoughts on the challenges before us

today. And I ask all of you to join me in a bipartisan spirit as we engage in this

important task.

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PREPARED STATEMENT OF REPRESENTATIVE PETE STARK, RANKING MINORITY MEMBER

Thank you, Chairman Bennett for holding this hearing on ‘‘Rethinking the Tax

Code.’’ While we’re at it, we should be rethinking President Bush’s tax cuts. Three

rounds of tax cuts since 2000 have contributed significantly to empty treasury coffers and ballooning federal budget deficits for the foreseeable future.

President Bush would have us believe that taxes are an unnecessary burden—unless, of course, they’re supporting the commitments he’s made in Iraq. But taxes are

a necessary means to meeting important responsibilities, such as providing affordable health care and prescription drugs, educating our children, or protecting the

homeland.

Unfortunately, federal income tax revenues are no longer sufficient to meet the

basic obligations of the federal government, even as non-Social Security spending

has been falling. By the year 2000, federal spending on all programs except Social

Security had fallen to just 15 percent of the nation’s GDP, down from an average

of 16.8 percent for the previous four decades. Meanwhile, federal revenues (excluding Social Security) have fallen to about 12 percent of GDP, their lowest levels since

1942—before Medicare, Medicaid, aid to education, and a host of other popular programs were created.

In addition to bankrupting the federal government, the recent tax cuts have also

shifted the distribution of taxes. The combination of income tax cuts that disproportionately benefit higher-income families, elimination of the estate tax, and unchanged payroll taxes, means that lower- and middle-income families are shouldering more of the tax burden.

The President’s tax cuts have also made the tax system much more complex.

Many provisions slowly phase-in or abruptly phase-out, and all provisions sunset by

the end of the decade, increasing the costs, of tax planning and compliance. And

since Congress failed to fix the alternative minimum tax (AMT) problem, an increasing number of taxpayers will be forced to calculate their taxes twice.

We hear the cries for reform in order to simplify the tax code, but most proposals

for ‘‘fundamental tax reform’’ involve replacing the current income tax with a broadbased consumption tax. As our witness Robert McIntyre has observed, ‘‘Virtually

any flat-rate tax plan that adds up must, by simple arithmetic, produce huge tax

cuts for those with the highest incomes and therefore big tax increases on almost

everyone else.’’

While a consumption tax might address complexity issues with the Internal Revenue code, replacing the income tax with a consumption tax raises serious questions

about fairness. None of the progressive consumption taxes proposed so far would

keep taxes the same for the highest income families. However, proposed higher sales

taxes would be damaging to low- and moderate-income families because they spend

a larger percentage of their income on necessary consumer goods. Their ability to

‘‘choose’’ how much of their income they spend is a dubious notion. Low-income families would be the biggest losers unless the earned income tax credit remained in

place.

Most consumption tax proposals would eliminate long-standing provisions in the

tax code that give favorable treatment to housing, employer-sponsored health insurance, state and local taxes, and charitable giving. Eliminating these subsidies could

be detrimental. If employers could no longer deduct the cost of health insurance, for

example, workers would face higher costs for insurance and the ranks of the uninsured would grow even larger. Retaining these subsidies would mean higher tax

rates on other consumption.

These are just some of the hard questions that need to be addressed before Congress leaps into a radical overhaul of the tax code in the name of reform.

Thank you Mr. Chairman and I look forward to the testimony of our witnesses.

PREPARED STATEMENT OF REPRESENTATIVE RON PAUL, A MEMBER OF CONGRESS FROM TEXAS

I would like to thank Chairman Bennett for holding this much-needed hearing,

and also thank our panelists for devoting their time and energy to study our tax

system and educate members of this committee. The statements and articles submitted certainly are provocative, too provocative, I fear, for Congress and the administration. I say this because we’ve been debating tax reform, or at least pretending

to debate it, for years.

In fact, some very powerful members of Congress have advocated real changes in

our tax laws in recent years, all to no avail. We’ve heard about the flat tax, the

national sales tax, capital gains taxes, alternative minimum taxes, etc., but we’ve

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made zero progress toward coherent tax reform. The two most recent overhauls of

the tax code, in 1986 and 1997, produced only more complexity and frustration. Tax

simplification and basic fairness seem almost completely out of reach as a political

and legislative matter.

As members of Congress we’ve all heard how frustrated the American people are

with the tax code and the IRS. They hate the complexity of the tax laws, the hate

the time it takes them to fill out the forms, they hate living in fear of an audit,

and they hate paying so much. They bombard our congressional offices with complaints about taxes and the IRS, but nothing ever changes.

We also hear from our nation’s businesses about the tremendous compliance costs

associated with the tax code. Countless man-hours and millions of dollars are consumed every year by companies large and small around the country, all trying to

comply with the rules concerning withholding for employees, corporate income tax,

and accounting issues.

So while I’m eager to hear from our panelists today, I hope that we can start from

the premise that the current approach is not working. If we as legislators don’t

make some fairly radical changes, this committee surely will find itself holding another tax reform hearing ten years from now.

We should remember that no rational discussion of tax reform or tax policy can

ignore the other side of the equation: government spending. We cannot talk about

tax reform without talking about a federal government that will spend roughly $2.3

trillion in 2004. We need to ask ourselves why the federal government increases

spending by 3 or 5 or 7 percent each and every year. We need to recognize that the

federal government’s voracious appetite for tax dollars is the real problem; taxes are

just a symptom. Unless and until Congress changes the spending culture in Washington, tax reform will remain a political shell game. With the federal government

hell-bent on collecting and spending $2.3 trillion, the only ‘‘reform’’ available is tinkering with the code to shift the tax burden around from one group to another.

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PREPARED STATEMENT OF CONGRESSMAN JOHN LINDER, A MEMBER OF CONGRESS FROM GEORGIA

Mr. Chairman, thank you very much for giving me a chance to testify before the

Joint Economic Committee this morning on the need for fundamental tax reform

generally, and H.R. 25, the FairTax, my fundamental tax reform proposal specifically. I appreciate having the chance to share with the Committee my thoughts on

this pressing issue.

In debating any fundamental tax reform proposal, I believe that the Congress

should judge any such bill by the following key principles:

1. Fair: It must protect the poor and treat everyone else the same. No exemptions—no exclusions—no advantages.

2. Simple: It must be easy to understand for all Americans—no matter one’s education, occupation, or station in life.

3. Voluntary: It must not be coercive or intrusive.

4. Transparent: We should all know what the government costs. There must be

no ‘‘hidden’’ taxes.

5. Border-Neutral: Our exports must be unburdened by any tax component in the

price system, while imports carry the same tax burden at retail as our domestic

competition.

6. Industry-Neutral: It must be neutral between businesses and industries.

7. Strengthens Social Security: Fundamental reform must address the long-term

solvency of Social Security.

8. Manageable Transition Costs: It must not be costly or difficult to implement.

My FairTax proposal, which eliminates all income and payroll taxes and replaces

them with a national retail sales tax, meets these criteria. The FairTax is a compelling proposal that would benefit the U.S. economy, businesses across the nation, and

all American taxpayers.

The FairTax plan is fair. It contains a monthly rebate of the sales tax for every

household, which would totally rebate the tax consequences of spending up to the

poverty line. This rebate mechanism ensures that every household can buy necessities taxfree, and it totally untaxes the poor. All Americans receive equal, fair

treatment. If Bill and Melinda Gates want to move to a farm and grow their own

groceries and live off the rebate, what do we care? We’ll borrow his money and create jobs.

The FairTax plan is simple. It totally eliminates the more than 10,000 pages of

complexities in the current income tax code once and for all, replaces them with a

simple uniform sales tax.

The FairTax plan is a voluntary tax system. Every citizen becomes a voluntary

taxpayer, paying as much as they choose, when they choose, by how they choose to

spend.

The FairTax plan creates transparency within the tax code. It eliminates the hidden tax component from the prices of goods. According to a Harvard study, the current tax component in our price system averages 22 percent, meaning that the least

well off among us lose 22 percent of their purchasing power.

Any system that burdens business with any payroll tax, income tax, or compliance

costs embeds that cost in our price system. By abolishing the IRS and abolishing

the income paradigm in favor of a consumption paradigm we let the market drive

the tax component out of the price system.

Moreover, knowing how much we pay in federal taxes on every purchase we make

would make all Americans more aware of the cost of government. The next time

someone wants to raise taxes, they will not be able to be sell such a bad idea with

the old argument that it only applies to the ‘‘wealthiest amongst us.’’ The rationale

for any future tax increase must necessarily be so compelling that my mother would

be willing to pay it.

The FairTax plan is border-neutral. Under a national sales tax, imported goods

and domestically produced goods would receive the same U.S. tax treatment at the

checkout counter. Moreover, our exports would go abroad unburdened by any tax

component in the price system.

The FairTax plan is industry-neutral. There is not a good reason that our neighbor who builds a bookstore, hires our kids, votes in our elections and supports our

community should be placed at a seven percent disadvantage against Amazon.com.

Governors have a keen interest in this due to the loss of hundreds millions of dollars

in revenue to Internet and catalogue sales. A national retail sales tax would collect

these revenues, and in doing so help the states.

Nor is there a good reason why I, as a dentist, didn’t have to collect a sales tax

in Georgia while my neighbor, the retailer, did. The first principle of government

tax policy ought to be neutrality.

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The FairTax plan would also strengthen Social Security’s longterm future. The arguments about partial private investments saving Social Security seem to miss an

important point—we will increase the number of retirees in the next 30 years by

100 percent and increase the number of workers supporting them by 15 percent.

That system will only survive by dramatically reducing benefits, increasing taxes,

or increasing the number paying into it, or some combination of both.

Under the FairTax, Social Security benefits would be paid out of the general sales

tax revenues. The sales tax would be collected from roughly 285 million Americans

and 51 million visitors to our shores. Revenues to Social Security and Medicare

would double, as we expect the size of the economy to double, in 13 to 14 years

under the proposal.

The FairTax plan has manageable transition costs. The only transition rule we

envision is to allow retailers to use inventory on hand on December 31 as a credit

against collecting taxes on sales in the new year, on the principle that things should

be taxed only once and goods produced before the transition would already have the

current tax embedded in them.

According to the U.S. Census Bureau, at any given time, U.S. businesses have

about $1.1 trillion in inventory on hand at any given time. Not collecting taxes on

that inventory would cost the treasury about $300 billion. Compare that to any estimates of transition costs just trying to bring some private investment into Social

Security alone. According to the Social Security Administration, the 75-year unfunded liability in Social Security is nearly $5 trillion. Remember this proposal fixes

Social Security in 13 to 14 years.

Beyond the above arguments, what will the new paradigm do in our present economy? Passing the FairTax does several things that will directly affect the U.S. economy:

1. We currently spend anywhere between $250-500 billion a year on compliance

with the tax code. Most of that is spent by corporate America and high-income investors. The savings that accompany a simpler tax system will go to bottom lines

and investment for job creation.

2. Corporate America spends additional billions calculating the tax implications

of business decisions. The savings generated by the FairTax will go to the bottom

line.

3. Eliminating the income tax will bring long-term interest rates down to municipal bond rates, ultimately reducing interest rates by 30 percent. That is good for

corporate profits and the market.

4. What do you think will happen to the stock market if all the world’s investors

could invest in our markets with no tax consequences?

5. Having no complicated depreciation schedules, no Alternative Minimum Tax,

no credits and deductions to confuse investors,, and no tax or compliance costs forces

a whole new look at corporate accounting. Only three numbers have meaning: earnings, expenses and dividends.

This will make it much easier for shareholders and investors to evaluate and

monitor all publicly-owned companies.

6. Deficits spook the market. Instead of declining Federal revenues because an income-based tax system depends on ever growing incomes, the Federal government

would collect higher revenues under the FairTax, as revenues would track consumption. A study from 1945 to 1995 shows that the consumption economy is a far more

predictable revenue base than the income economy, which has much higher amplitudes of volatility.

7. The FairTax would bring a 26 percent increase in exports in the first year as

well as a 76 percent increase in capital investment. Capital investment increases

lead to increases in productivity and then increases in real wages.

How does the FairTax compare to other fundamental tax reform ideas? The

FairTax is decidedly simpler and fairer than flat tax proposals.

The U.S. instituted a flat tax in 1913. Since then, it has been amended over and

over, resulting in the very plan you are working to correct today. In 1986, we eliminated many itemized deductions and drastically lowered tax rates to only two levels.

We have amended the code over 6,000 times since then.

I know that you recognize the need for a more fundamental change—we have

walked the flat tax path before, to no avail, and it simply does not make sense to

implement the same mistake again.

Some other sales tax proposals leave in place the payroll tax—the largest hidden

tax component in the prices of our goods and services. The FairTax would completely eliminate these hidden taxes, allowing competition to bring prices down an

average of 20-30 percent and increasing the transparency of the tax system.

The FairTax has the following other benefits:

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• Because of the tax component incorporated into prices under the current income

tax code, we are already paying the equivalent of the FairTax!

•The FairTax eliminates payroll taxes, which are the most regressive of existing

taxes.

•The FairTax is a tax on accumulated wealth. However, the holders of accumulated wealth are already paying it. It’s just hidden.

In closing, thank you for the opportunity to testify. I’ll be more than happy to answer any questions the Committee members may have about H.R. 25, the FairTax.

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TEN FACTS ABOUT FUNDAMENTAL TAX REFORM

[By Edward J. McCaffery, University of Southern California, California Institute of Technology]

The older I get, the less time I seem to have to read, or to pay attention to anything at great length. I presume, or hope, that this is because I am busy, not on

account of any biological decline. In any event, I have learned since my first days

of talking about tax reform to try to keep things short and simple, especially in such

a complex field.

Fundamental tax reform, the subject matter of these hearings, is a topic near and

dear to my heart. What follows is my attempt to distill decades of critical reflection

into ten easy to digest truths.

1. Fundamental tax reform is needed. I hold this truth to be self-evident: The current tax system is a disgrace. It is too complicated, too inefficient, too unfair. Its

unpopularity, itself a problem, is fully warranted. Among the many deficiencies of

the status quo, its very complexity and the lack of transparency in its principles

holds tax hostage to the whims of politicians and the fads of academics.

2. Simplification can only occur with fundamental tax reform. I hold this truth

too to be self-evident, or at least abundantly clear after too many decades of

incrementalism. The current tax system is flawed at its root. Federal tax policy is

an incoherent and inconsistent blend of conflicting policy elements, effected through

a confusing mixture of income, payroll, corporate income, and gift and estate taxes.

It is hard to see any forest through its weeds and shrubs and micro-organisms. If

we are to obtain simplification—and any hope for political accountability and economic stability in tax can only come with simplification—we must revisit first principles, and create a consistently principled tax system.

3. Fundamental tax reform is possible. It is easy to lose hope for a better future

and thus to cling to a hopeless present.

In particular, many followers of tax policy draw a despairing lesson from the epochal Tax Reform Act of 1986. At the time, this act, which broadened the income

tax base and lowered its rates, seemed the last best hope for some semblance of sanity in tax on earth (Birnbaum and Murray 1987). Less than two decades later, the

tax system is as complicated as ever. (McCaffery 1999). Perhaps fundamental tax

reform, like federal budget surpluses, is doomed not to persist.

But this is the wrong lesson to be learned. The 1986 act chose one of two routes

for tax reform laid out in the classic Treasury study, Blueprints for Tax Reform

(Bradford et. al., 1984)—namely that of ‘‘perfecting’’ the income tax by broadening

its base and lowering its rate structure.

Sophisticated foresight would have shown then what hindsight has since proven:

This was the wrong means to have taken, not a wrong end to pursue.

4. Fundamental tax reform must center on the tax base. It is easy enough to get

blinded by the topic of tax rates when thinking about tax. But one way or another,

total taxes in America are going to be fairly close to one-third of GDP, on average,

because this is what government spending (at all levels) is. Truly fundamental tax

reform—any tax reform that has any chance of effecting permanent gains in equity,

simplicity, efficiency and accountability—must take on the question of the tax base,

or the ‘‘what’’ of taxes. And here we must come to see that the current system is

an incoherent mishmash of conflicting bases.

5. The tax base is logically distinct from its rates. The simplest analytic truths can

get lost in the fog of tax.

Reduced to its essence, any tax consists of the product of a base (what is being

taxed) times a rate structure (how much it is being taxed). There ought to be, as

I shall continue to argue below, broad and bipartisan consensus on the base question. Yet confusion over the analytics has impaired reasonable compromise.

Liberals miss the point that redistribution can be effected under any base by

choosing an appropriate rate structure.

Conservatives deserve their part of the blame for the intellectual stalemate, by

continuing to link flat rates and a consumption base.

Finally, academics, by lumping all consumption taxes together, have not served

the public discourse.

If we set aside disputes over the appropriate rate structure, and focus instead on

the base question under at least moderately progressive rates, as we have had for

nearly a century now, we can at last begin to see fundamental tax reform in a new

and better light.

6. Fundamental tax reform must begin with the elimination of all direct taxes on

capital, meaning a move to a consistent consumption base. Now we start getting to

the heart of the matter.

An income tax, under the so-called Haig-Simons definition of income, is supposed

to tax all consumption plus all savings, the two all-encompassing and mutually

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1There is important work showing that the supra-normal rate of return to capital may be captured under a postpaid, but not a prepaid, consumption tax. (Bankman and Griffith, 1992, Warren, 1996). In my more general argument, this fact serves as one of the reasons to prefer, on

normative grounds, a postpaid to a prepaid consumption tax. (McCaffrey 2003).

exclusives uses of ‘‘income’’ (McCaffery 2002). John Stuart Mill pointed out in the

mid 19th Century that this leads an income tax to be a ‘‘double tax’’ on savings;

Professor William Andrews of Harvard Law School observed in 1974 that the worst

problems with the so-called income tax come in its commitment to taxing savings

(Mill, 1848; Andrews, 1974).

Consider again the choices confronting policymakers at the time of the Tax Reform Act of 1986. The path chosen, as noted above, was that of ‘‘perfecting’’ the income tax. It failed, both because it did not really perfect the income tax (McCaffery

2003), and because no one really wanted it to do so, in any event.

The other path laid out in Blueprints was to abandon the attempt to have an income tax altogether and move instead to a consistent consumption tax. This is the

right path to take. It means eliminating all attempts to tax savings directly under

the income tax—having unlimited savings accounts, no capital gains taxes, no taxlaw concept of ‘‘basis.’’ It also means eliminating the adjutants or ‘‘backstops’’ to the

income tax’s porous and flawed commitment to taxing capital, namely the corporate

income and gift and estate taxes (McCaffery, 2003). But it does not mean giving up

the claims for fairness in tax, or the attempt to tax the yield to capital in the hands

of the socially fortunate.

7. All consumption taxes are not created equal. Now here is a point where the

academy has led policy-makers astray.

There are two broad forms of consumption taxes.

In one model, the tax is imposed up-front, and never again: a wage tax, like social

security, or so-called pre-paid or yield-exempt consumption tax. ‘‘Roth’’ IRA’s work

on this model (pay tax now, never again).

The second form of consumption tax imposes its single tax on the back-end: this

is a sales tax, a postpaid, cash-flow or ‘‘qualified account model’’ consumption tax.

Traditional IRAs work this way (no tax now, only later).

Under flat or constant tax rates, the two principal forms of a consumption tax are

equal. Both taxes are single taxes on individual flows of wealth.

But this equivalence does not hold under non-constant or progressive rates.

8. A consistent, progressive, postpaid consumption tax is a tax on the yield to capital, under just the circumstances in which it is fair and appropriate to tax such

yield.

The simple analytic truths lead to a different understanding of the traditional

choices of tax policy, as I have been attempting to explain in my academic work

(McCaffery, 2003). Better understanding points the way out of the current morass

of tax policy politics, and towards a grand compromise.

Consider where the debate stands.

For some time now, conservatives have been clamoring for a flat consumption tax.

Flat consumption taxes of all sorts are indeed broadly equivalent—none effectively

tax the normal yield to capital under any conditions. And so the choice among a

Hall-Rabushka style flat wage tax, a national sales tax, or a value-added tax (VAT)

is largely one of administrative convenience (Slemrod & Bakija, 2000).1

Liberals for their part are opposed to any such tax, both because of its flat rate,

and because of the thought that a consumption tax ignores the yield to capital altogether, and that such yield is the domain of the socially fortunate. So liberals insist

on maintaining, even strengthening, a progressive income tax, with its corollaries,

the gift and estate and corporate income taxes.

But once we assume that we are going to have at least some progression in the

rate structure, the traditional understanding of consumption taxes is no longer accurate. The two forms of consumption taxes, prepaid and postpaid, differ under progressive rates. Now there are three—not two—alternatives. The differences come in

when the tax falls, and how this impacts choices of work, savings, education, and

so on.

One, an income tax falls on all labor market earnings and savings, at the time

they come into a household. Savers are hurt by the ‘‘double taxation’’ of savings,

whatever the intended or actual use of the savings. Individuals, like the highly educated, who see their earnings come in relatively short concentrated bunches, are

hurt by the timing of the imposition of progressive rates.

Two, a prepaid consumption tax falls on labor market earnings alone, again at

the time they come into a household. Once more, people whose earnings profiles are

uneven throughout their lifetimes are hurt by the timing of the imposition of the

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progressive rate structure. But—and here is the rub for most liberals and even moderates—those who live off the yield to capital are never taxed.

Three, a post-paid consumption tax does not come due at the time of initial

inflows, but rather at the time of outflows, when money is spent in consumption.

This means that a progressive postpaid consumption tax stands between an income

tax, which double taxes all savings, and a prepaid consumption tax, which ignores

all savings. A consistently progressive postpaid consumption tax treats savings differently depending on its use.

We can think of two broad uses of savings. One is to smooth out consumption profiles, within lifetimes or across individuals—to translate uneven labor market earnings into smooth consumption flows. We do this by borrowing in our youth and saving for retirement in midlife. A second use of savings is to shift consumption profiles, up or down. An upward shift occurs when the fruits of our own or another’s

savings allow us to live a ‘‘better’’ lifestyle than we could on the basis of our own

labor market earnings, alone, smoothed out over time. A downward shift occurs

when beneficence or bad fortune means that we will live at a lower lifestyle than

we otherwise could, again on the basis of our smoothed out labor market earnings

profile alone.

Once again, whereas an ideal income tax double taxes all savings, whatever their

use, and a prepaid consumption tax ignores all savings, again whatever the use, a

consistent progressive postpaid consumption tax splits the difference, in a principled

way, and by design. It allows taxpayers to lower their taxes by smoothing, but it

does fall on the yield to capital when such yield is used to enhance lifestyles. This

reflects simple, commonsensical attitudes about life, income, and savings. It can

lead to a dramatically simpler tax system that is at the same time far fairer.

Consider for example the role of a separate freestanding gift and estate tax system within this construct. The current system aims to ‘‘backstop’’ the income tax,

which tax is (in ideal theory) supposed to burden savings, by levying a hefty tax

on those decedents who die with large estates. This tax is obviously desired as a

matter of fairness. But its very existence encourages the rich to consume more, and

die broke, whether the spending is on themselves or their heirs. In contrast, a consistent progressive postpaid consumption tax never taxes savings directly. Saved assets have a zero basis. These can be passed on to heirs on life or at death, without

the moment of transfer triggering tax. On the other hand, spending by the heirs will

generate tax, and under the progressive rate structure. A consistent progressive

postpaid consumption tax does not need, in principle, a separate gift and estate tax,

because the very design of the tax entails an accessions or inheritance tax.

A similar argument can be made against a separate corporate income tax. The

problems with this tax begin with its uncertain incidence: since corporations are not

real people, they do not really pay taxes. A corporate tax falls on workers and consumers, on capital generally, or on some combination thereof. But to the extent it

does falls on capital, it does not do so in any individuated way. Savers bear the burden of the corporate income tax whether they are rich or poor, saving for lifetime

needs or emergencies or to support a high-end lifestyle. Once again, under a consistent, progressive, postpaid consumption tax—which falls on the yield to capital

as a source of personal consumption—such a tax is not needed.

9. Actual tax policy is headed towards a flat prepaid consumption tax. In fact,

when we observe the status quo, we see a slow but steady movement towards a flat

or flattened prepaid consumption tax. Second taxes on capital have long been fairly

easily avoided (McCaffery 2000). Recent legal changes, such as the lowering of the

capital gains rate and the exclusion of corporate dividends from income, and more

recent proposals, such as those for more expansive Roth-style savings accounts, continue and confirm the trend. These changes are moving and will move the United

States ever farther towards a wage tax, in which the yield to capital is never taxed.

This is the wrong place to go, in the name of fairness. But whereas most liberals

today, laboring under the traditional understanding of tax, feel that they can only

counter the trend by insisting on retaining the status quo, a better understanding

of tax shows that a consistent progressive postpaid consumption tax is an attractive

option, for just the reasons liberals oppose consumption taxes—because such a tax

does, whereas a prepaid consumption tax does not, reach the yield to capital.

10. Implementation of a consistent, progressive, postpaid consumption tax is practical, and the case for it is compelling. Academics tend to be idealists who get nothing done. These traits are reflected in the endless discussions over transitions from

an ideal income to a consumption tax. But we do not have, and have never had,

an ideal income tax. The current tax is so far on the path towards a consumption

one that transition concerns should not deter the movement towards principled consistency.

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There are two broad ways to implement a consistent, progressive, postpaid consumption tax.

One is to keep the basic income tax system in place, but repeal the limits on savings accounts: adopting unlimited IRA or savings account treatment, as in the

Nunn-Domenici USA tax plan. These savings accounts must be on the postpaid

model.

Two is to take advantage of the analytic equivalence of sales taxes and postpaid

consumption ones, and replace the income tax with a three-part plan, consisting of:

• A national sales or value-added tax at a modest, sustainable rate, say 10 to 15

percent;

• A system of rebates to effect a ‘‘zero bracket’’ under the national sales tax, say

$500 per person, which would offset $5,000 of taxable consumption (at a 10 percent

rate);

• A supplemental ‘‘consumed income tax’’ for the wealthiest Americans, modeled

along the lines of the existing income tax with unlimited deductions for savings.

This tax could apply to households consuming say $80,000 a year or more, and

would back out the national sales tax rate.

The net result of this three-step plan would be to have a zero bracket of $20,000

for a family of four; followed by a 10 or 15 percent bracket extending to $80,000

of consumption; followed by 20 or 30 percent brackets, and so on, but effected by

a consumed income tax with rates starting in again at 10 or 15 percent (to add to

the national sales tax).

The choice of which mechanism to choose comes down to administrative and political concerns, including the wisdom of having two taxes rather than one. But the

simple analytic fact of the matter is that the two broad choices lead to the same

place: a consistent, progressive, postpaid consumption tax (McCaffery 2002).

Under either means for getting to a consistent postpaid consumption tax, and consistent with the principled basis of such a tax, we could and should repeal:

• All capital gains taxes under the income tax;

• All rules for ‘‘basis’’ of investment assets;

• All rules about maximum contributions to and minimum distributions from the

savings accounts;

• The corporate income tax; and the

• Gift and estate tax.

Taxes would, at last, rest on a simple and consistent principle: tax people when

they spend, not when they work or save. Simplicity, transparency, and efficiency

would be enhanced; fairness would not be abandoned. Such a tax system would

apply to the yield to capital, when but only when it is appropriate to do so. The

rich would not be let off the social hook; their tax would come due when, as, and

if they spent wealth on themselves. Progressivity could be maintained, even

strengthened.

Here, at last, would be something fundamental, to get us off the treadmill of incrementally increasing complexity.

We should do it. It is high time to stop the insanity of tax today.

REFERENCES

Andrews, William D. 1974. A Consumption-Type or Cash Flow Personal Income

Tax. Harvard Law Review 87, 1113-1118.

Bankman, Joseph and Thomas Griffith. 1992. Is the Debate Between an Income

and a Consumption Tax a Debate about Risk? Does it Matter? Tax Law Review 47,

377-406.

Bradford, David F. and the U.S. Treasury Tax Policy Staff. 1984. Blueprints for

Basic Tax Reform, 2d. ed., revised (Arlington Virginia: Tax Analysts).

Birnbaum, Jeffrey H. and Alan S. Murray. 1987. Showdown at Gucci Gulch: Lawmakers, Lobbyist and the Unlikely Triumph of Tax Reform. (New York: Random

House).

McCaffery, Edward J. 2003. The Fair Timing of Tax. USC Law School, Olin Working Paper 03-21, available at: http: // papers.ssrn.com/sol3/papers.cfm?abstract—

id=441344

McCaffery, Edward J. 2002. Fair Not Flat: How to Make the Tax System Better

and Simpler. (Chicago: University of Chicago Press).

McCaffery, Edward J. 2000. A Voluntary Tax? Revisited. National Tax Association

Papers and Proceedings.

McCaffery, Edward J. 1999. The Missing Links in Tax Reform. Chapman University Law Review, 2, 233.

Mill, John Stuart. 1848. Principles of Political Economy. (W.J. Ashley, ed.; London: Logmans, Green & Co. 1909).

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Slemrod, Joel and Jon Bakija. 2000. Taxing Ourselves, 2d ed: A Citizen’s Guide

to the Great Debate over Tax Reform. (Cambridge, Mass: MIT University Press).

Warren, Alvin C. Jr. 1996. How Much Capital Income Taxed Under an Income

Tax is Exempt Under a Cash Flow Tax? Tax Law Review, 52, 1-16.

PREPARED STATEMENT OF ROBERT S. MCINTYRE, DIRECTOR,

CITIZENS FOR TAX JUSTICE

Thank you for the opportunity to appear before the Committee today to discuss

fundamental tax reform. This is an issue near and dear to my heart. Since 1976,

I have devoted my career to promoting fairer taxes and to keeping the public informed about the meaning of various tax change proposals. That is also the mission

of my group, Citizens for Tax Justice.

In my view, our nation’s current tax policies are a disaster: morally, fiscally and

economically. In my brief testimony today, I want to discuss what I think should

be the principles of fundamental tax reform, illustrate how they have been applied

in real life, and touch on what I see as false paths to reform.

I. PRINCIPLES OF FUNDAMENTAL TAX REFORM

Tax reform experts have traditionally pointed to three basic goals for a good tax

system: fairness, simplicity and economic efficiency. l would add one more essential

ingredient: revenue sufficiency. All four are interrelated.

Principle 1: Revenue sufficiency. The fundamental goal of any tax system is to

raise the money needed to pay for public services. Our current tax system is failing

miserably in this regard.

In the just-completed fiscal year, combined federal personal and corporate income

taxes fell to only 8.3 percent of the economy, their lowest level since before World

War II and a third lower than in fiscal 2000—with no relief in sight.

• Personal income taxes have fallen to their lowest level as a share of the economy in more than 50 years.

• Corporate taxes have plummeted even more than personal taxes. In fact, at only

1.2 percent of the economy over the past two fiscal years, corporate income taxes

are at their lowest level since the 1930s, except for one year during Ronald Reagan’s

first term. The most recent OECD data show that U.S. corporate taxes as a share

of the economy are now virtually the lowest in the industrialized world.

Some of the recent tax shortfall and the resulting huge budget deficits reflect the

weak economy, but most of it is self-inflicted. President Bush’s personal income tax

cuts enacted in 2001 and 2003, for example, are expected to total $197 billion next

year. The decline in corporate taxes mainly stems in about equal parts from President Bush’s big corporate tax cuts enacted in 2002 and 2003 and the huge amount

of offshore tax sheltering that corporations now engage in with congressional tolerance. Counting tax breaks that have been on the books for longer, corporate taxes

are now almost 60 percent below the 3 percent of GDP they averaged from 1950

through 2000. To put that in perspective, if corporate taxes had equaled that 3 percent of GDP average last year, then revenues would have been $180 billion higher

than they actually were.

For the foreseeable future under current policies, a third of the regular government will be financed with borrowed money. Obviously this can’t be sustained for

very long, either fiscally or economically. Such excessive borrowing endangers essential government programs and robs investment capital from our economy that we

will need to sustain growth.

So a central goal of fundamental tax reform must be to address our huge revenue

shortfall. Correspondingly, any ‘‘reform’’ proposal that purports to be ‘‘revenue-neutral’’—let alone revenue-losing!—should be dismissed out of hand.

Principle 2: Fairness. Tax fairness is not only morally right, it’s also essential to

maintaining public support for the tax system. Traditionally, fairness has been dividend into two important elements: horizontal equity and vertical equity.

First of all, taxpayers with similar incomes should pay similar taxes, no matter

how they happen to earn their money. It’s not fair to tax wage-earners more heavily

than investors, and it’s not fair to tax investors in, say, fake synthetic coal, more

heavily than investors in non-tax-sheltered activities.

Second, taxes ought to be based on people’s ability to pay them. Those who have

benefitted most from our society should pay the highest share of their income in

taxes to support our country. Those who are struggling should pay the lowest rates.

Unfortunately, our current tax system violates both of these principles of fairness.

An array of loopholes favors some taxpayers and some kinds of income over others.

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And the progressivity of our tax system has declined markedly over the last quarter

century.

According to Congressional Budget Office data, the effective tax rate on the bestoff one percent of Americans dropped by 16 percent from 1977 to 2000, despite rapidly rising incomes at the top end that normally would have produced higher effective tax rates. Since 2000, according to calculations by the Institute on Taxation and

Economic Policy, President Bush’s tax cuts have lowered the effective tax rate on

the wealthiest by another 17 percent. In combination, that’s a 30 percent drop.

This sharp decline in progressivity has a lot to do with our government’s revenue

shortfall, by the way. If the effective tax rate on the top one percent were as high

today as it was in 1977, the government would collect more than $200 billion in additional revenue in 2004.

Principle 3: Simplicity. In a complicated world full of would-be tax avoiders and

their highly paid advisors, no tax system can be completely simple. But a tax system

that is generally understandable and that is devoted to raising revenue fairly would

be much simpler than the one we have today. Unfortunately, the past decade or so

has seen rapid growth in tax complexity, largely because lawmakers have chosen

to use the tax code as a vehicle for numerous programs unrelated to fair tax collection. Some of these ‘‘tax expenditures’’ have noble goals; others would never be seriously considered if they were proposed as part of the regular budget process. But

all these programs make tax filing and tax enforcement far more difficult than they

need to be.

Principle 4: Economic efficiency. Most of us would be reluctant to endorse central

planning as an ideal economic system. Instead, we’d probably insist that letting

market forces drive consumer and business decisions is usually the best way to

maximize our economic well-being. Virtually the entire economics profession agrees.

But our tax code is increasingly becoming an ad hoc tool of central planning, as we

lard the code with more and more ‘‘incentives’’ to shift economic activity into areas

that have gained congressional favor. In contrast, an even-handed, level-playingfield tax code without favoritism for some business activities over others would improve the allocation of capital and enhance economic growth.

II. TAX REFORM PRINCIPLES IN ACTION:

A fair, revenue-sufficient tax code is certainly difficult to achieve, but history

shows us that it’s not impossible. In fact, we came rather close to having such a

tax code for a brief period a decade ago, due to the efforts of President Reagan,

President Clinton, and to a lesser degree, the first President Bush.

After a dismal start with his loophole-laden, budget-busting 1981 tax act, President Reagan dramatically shifted gears. For the rest of his time in office, he devoted

his tax policy primarily to closing unwarranted loopholes and boosting revenues.

Reagan’s tax reform drive began with the loophole-closing 1982 tax bill and reached

its fulfilment in the 1986 Tax Reform Act.

To be sure, Reagan’s post-1981 tax changes did not come close to bringing revenues in line with spending, nor did they fully restore the progressivity that the 1981

act had sharply eroded. But the tax code Reagan bequeathed to his successors was

as close as our country may have ever come to a horizontally equitable, simple and

economically efficient tax system. Its major flaw was that its upper-income tax rates

were much too low.

Reagan’s successors, the first President Bush and President Clinton, retained

most of the Reagan reforms, at least initially, while addressing the continuing revenue problem. Bush I increased the top income tax rate in 1990, although he unfortunately resurrected the Reagan-repealed capital gains tax loophole at the same

time. President Clinton further increased the tax rates on the highest earners in

his 1993 legislation. When incomes boomed at the top of the income scale in the

second half of the nineties, those higher tax rates helped give us our first balanced

budgets since 1969.

I suggest that would-be tax reformers take the Reagan tax code of 1986, supplemented by the Clinton tax rate hikes of 1993, as an excellent paradigm for future

fundamental tax reform. (Most of what’s happened to the tax code since 1993, on

the other hand, I suggest you spurn.)

III. FALSE PATHS TO REFORM:

On the other side of the tax reform issue are those who totally repudiate the

Reagan-Clinton legacy. Specifically, they would scrap the progressive income tax in

favor of a flat-rate consumption tax. One version of this approach calls for a highrate national sales tax. Another is the flat-rate wage tax promoted by former presiVerDate 03-FEB-2003 10:18 Apr 07, 2004 Jkt 091847 PO 00000 Frm 00118 Fmt 6601 Sfmt 6621 91847.TXT SSC1 PsN: SSC1
115

dent candidate and publisher Steve Forbes along with former House Majority Leader Dick Armey.

These and similar proposals are designed to drastically reduce taxes on the

wealthiest people, both by lowering their tax rate and by exempting a large share

of their income from tax. The plans would also increase taxes dramatically on

middle- and low-income Americans, especially if they came even close to raising

enough money to pay for the government.

Proponents of consumption taxes often argue that their plans would discourage

consumer spending, promote savings and thereby increase long-term economic

growth. But unbiased experts who have examined these claims generally find little

if any economic improvement from switching to a regressive tax system. Indeed,

since these consumption tax proposals would require tax rates that are implausibly

high to avoid even bigger deficits, their net effect would probably be to reduce total

national savings.

IV. CONCLUSION: CURRENT PROSPECTS FOR REFORM

I wish I could reasonably hope that the current management in the White House

and Congress will rush to repeal the Bush tax cuts, crack down on offshore corporate tax sheltering, reinstate the estate tax and otherwise take us back to the

days when a fair, progressive tax system paid the government bills and even started

to reduce the national debt. But despite my pessimism that you’ll listen to my advice, I do recommend that you take all these steps.

Æ