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74–395—PDF 2011

S. HRG. 112–413 

IS THE DISTRIBUTION OF TAX BURDENS AND 

TAX BENEFITS EQUITABLE? 

HEARING 

BEFORE THE

COMMITTEE ON FINANCE 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

MAY 3, 2011 

( 

Printed for the use of the Committee on Finance 

COMMITTEE ON FINANCE 

MAX BAUCUS, Montana, Chairman 

JOHN D. ROCKEFELLER IV, West Virginia 

KENT CONRAD, North Dakota 

JEFF BINGAMAN, New Mexico 

JOHN F. KERRY, Massachusetts 

RON WYDEN, Oregon 

CHARLES E. SCHUMER, New York 

DEBBIE STABENOW, Michigan 

MARIA CANTWELL, Washington 

BILL NELSON, Florida 

ROBERT MENENDEZ, New Jersey 

THOMAS R. CARPER, Delaware 

BENJAMIN L. CARDIN, Maryland 

ORRIN G. HATCH, Utah 

CHUCK GRASSLEY, Iowa 

OLYMPIA J. SNOWE, Maine 

JON KYL, Arizona 

MIKE CRAPO, Idaho 

PAT ROBERTS, Kansas 

JOHN ENSIGN, Nevada 

MICHAEL B. ENZI, Wyoming 

JOHN CORNYN, Texas 

TOM COBURN, Oklahoma 

JOHN THUNE, South Dakota 

RUSSELL SULLIVAN, Staff Director 

CHRIS CAMPBELL, Republican Staff Director 

(II) 

C O N T E N T S 

OPENING STATEMENTS 

Page 

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

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

Hatch, Hon. Orrin G., a U.S. Senator from Utah ................................................. 3 

Grassley, Hon. Chuck, a U.S. Senator from Iowa ................................................. 18 

WITNESSES 

Shaviro, Daniel, Wayne Perry professor of taxation, New York University 

School of Law, New York, NY ............................................................................. 5 

Hodge, Scott, president, Tax Foundation, Washington, DC ................................. 7 

Aron-Dine, Aviva, Ph.D. candidate, Department of Economics, Massachusetts 

Institute of Technology, Cambridge, MA ........................................................... 9 

Reynolds, Alan, senior fellow, Cato Institute, Washington, DC .......................... 11 

ALPHABETICAL LISTING AND APPENDIX MATERIAL 

Aron-Dine, Aviva: 

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

Prepared statement .......................................................................................... 37 

Responses to questions from committee members ......................................... 47 

Baucus, Hon. Max: 

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

Prepared statement .......................................................................................... 54 

Grassley, Hon. Chuck: 

Opening statement ........................................................................................... 18 

Prepared statement with attachments ........................................................... 56 

Hatch, Hon. Orrin G.: 

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

Prepared statement .......................................................................................... 96 

Hodge, Scott: 

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

Prepared statement .......................................................................................... 99 

Responses to questions from committee members ......................................... 113 

Reynolds, Alan: 

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

Prepared statement .......................................................................................... 117 

Responses to questions from committee members ......................................... 132 

Shaviro, Daniel: 

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

Prepared statement .......................................................................................... 141 

Responses to questions from committee members ......................................... 157 

COMMUNICATIONS

Center for Fiscal Equity .......................................................................................... 161 

National Committee to Preserve Social Security and Medicare .......................... 167 

(III) 

(1) 

IS THE DISTRIBUTION OF TAX BURDENS AND 

TAX BENEFITS EQUITABLE? 

TUESDAY, MAY 3, 2011 

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

The hearing was convened, pursuant to notice, at 10:11 a.m., in 

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

(chairman of the committee) presiding. 

Present: Senators Wyden, Nelson, Menendez, Carper, Hatch, 

Grassley, Snowe, Kyl, and Roberts. 

Also present: Democratic Staff: Russ Sullivan, Staff Director; Lily 

Batchelder, Chief Tax Counsel; Jeff VanderWolk, International Tax 

Counsel; Tiffany Smith, Tax Counsel; Tom Reeder, Senior Benefits 

Counsel; and Matt McFeeley, Intern. Republican Staff: Chris 

Campbell, Staff Director; Mark Prater, Deputy Chief of Staff and 

Chief Tax Counsel; Nick Wyatt, Tax and Nomination Professional 

Staff Member; Theresa Pattara, Tax Counsel; Curt Beaulieu, Tax 

Counsel; Antonia Ferrier, Communication Director; Aaron Taylor, 

Professional Staff Member; and Maureen McLaughlin, Detailee. 

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

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE 

The CHAIRMAN. The hearing will come to order. 

Anne-Robert-Jacques Turgot, the noted 18th-century French 

economist, said, ‘‘The more a man enjoys the advantages of society, 

the more he ought to hold himself honored in contributing to those 

expenses.’’ 

Turgot laid out a key measure for evaluating a tax system: determining whether the country’s citizens are paying their fair share. 

Americans want to see a fairer and more equitable tax system. 

In a recent independent poll, most taxpayers said they believe 

the taxes they currently pay are fair. But an article by the Associated Press detailing this new study also revealed a perception 

among average Americans that the wealthy do not pay their fair 

share. 

The perception is that the tax loopholes and benefits that exist 

do not benefit average Americans, and Americans do not know a 

lot about them. 

The wealthy folks can hire attorneys and accountants to find 

every credit and deduction, while average Americans cannot afford 

that time and that expertise. 

2 

One fact behind this perception may be the way changes to the 

code have affected people differently. Since 1986, Congress has 

made over 15,000 changes to the code. In most cases, these changes 

have not benefitted all taxpayers. 

According to IRS data, the 400 taxpayers with the highest adjusted gross incomes had an effective tax rate of just below 17 percent for the 2007 tax year. The average income for those taxpayers 

was $345 million per household. But the effective tax rate of folks 

earning between $1 million and $1.5 million was much higher at 

24 percent. 

How is that possible? The U.S. has a fairly progressive income 

tax system. The tax brackets rise with income. But we also must 

consider the tax incentives that affect a person’s tax liability and 

bring down tax rates. 

Two prime examples of this inequality are deductions and exclusions. Many of these incentives only benefit people who earn higher 

incomes, and the size of the benefit they receive is also dependent 

on income. 

Look, for example, at the charitable deduction. Only families who 

itemize their tax returns are able to take advantage of this deduction, and only one-third of taxpayers itemize their returns. That 

leaves two-thirds of all Americans unable to receive a tax benefit 

for charitable deductions. 

Among those who do receive the deduction, there is also a disparity. A taxpayer with a 35-percent tax rate saves 35 cents in 

taxes for every dollar given to a charity, while a taxpayer with a 

10-percent rate only saves 10 cents of every dollar. 

Take, for example, two taxpayers making $1,000 donations to the 

Alabama tornado relief efforts. This donation could cost a taxpayer 

with $35,000 in income $1,000 after taxes, because they almost certainly would not itemize. But the same donation would cost the 

taxpayer with $435,000 of income much less; that is, $650 after the 

benefit. 

We should also consider that the Tax Policy Center estimates 

that 47 percent of Americans did not pay income taxes in 2009. But 

that does not mean they did not pay any taxes at all. Many of 

these same folks paid payroll taxes, and they paid excise taxes. A 

large share of them are seniors, and many are families living in 

poverty. 

The general perception of inequity in the tax code may also stem 

from the fact that economic prosperity is not shared as widely as 

it once was. Over the last 30 years, households with incomes in the 

highest 1 percent have seen their before-tax income grow by 280 

percent. But over the same period, 90 percent of Americans have 

seen essentially no increase at all. This disparity is also apparent 

in after-tax income. These past 30 years have been very different 

from the 30 years before, when the economic growth was widely 

shared. 

As we focus on tax reform, we must ask whether our tax code 

has contributed to this disparity in income growth. We should consider whether our tax system should take these disparities into account in some way, and we must question whether our tax code can 

better promote economic mobility and opportunity. 

3 

So let us remember that the taxpayers are more likely to willingly pay taxes that they perceive as fair. Let us make our tax system work for all Americans, not just for those who can afford to 

pay high-priced attorneys and accountants. 

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

Senator Hatch? 

OPENING STATEMENT OF HON. ORRIN G. HATCH, 

A U.S. SENATOR FROM UTAH 

Senator HATCH. Thank you, Mr. Chairman. 

The debate that we will have here today on the distribution of 

tax burdens has a long and distinguished pedigree. From my perspective, I have not heard anyone get the better of the former 

Prime Minister Margaret Thatcher, who addressed this issue in her 

last speech before the House of Commons on November 22, 1990. 

This is how she responded to a liberal colleague who made the 

mistake of thinking that he could get one by her: ‘‘The honorable 

gentleman is saying that he would rather that the poor were poorer, provided that the rich were less rich. That way, one will never 

create the wealth for better social services, as we have. What a policy. Yes, he would rather have the poor poorer, provided that the 

rich were less rich. That is the liberal policy.’’ 

Now, this quote, more than 20 years old, is uncannily applicable 

to the subject of today’s hearing. 

Our examination of the burdens and benefits of the tax code is 

taking place in the shadow of a debate as to whether a group of 

people described as ‘‘the rich’’ are paying what others call their 

‘‘fair share.’’ 

The canned answer for those asking this question is that the rich 

are never paying their fair share and must pay more for the good 

of the whole. A certain percentage of the population obsesses over 

this issue, making sure that the so-called ‘‘rich’’ do not exceed their 

allotted share of the fruits of their own labor. 

How Washington politicians hope to determine this fair share in 

an even-handed way that does no harm to our economy and job creators remains a mystery to me. 

As we head into this debate, there are a few basic facts we need 

to acknowledge. According to the Urban-Brookings Tax Policy Center, in 2009 the top quintile of the population in terms of income 

distribution earned 53.4 percent of income, but paid 67.2 percent 

of all taxes. 

When we look at only Federal income taxes, the numbers show 

that the so-called ‘‘wealthy’’ are paying an even greater share relative to everyone else. According to the Tax Foundation, for calendar year 2008, the most recent year for which actual tax data is 

available, the top 1 percent of the population in terms of income 

paid 38 percent of all Federal individual income taxes. The top 5 

percent paid approximately 58.7 percent of all income taxes, while 

everyone else, the bottom 95 percent, paid 41.3 percent of Federal 

income taxes. 

I do not have to have a Ph.D. in math to understand that—I am 

pretty sure that 41.3 is less than 58.7 percent. 

4 

Meanwhile, the Tax Policy Center estimated that, for tax year 

2010, approximately 45 percent of households, or about 69 million 

households, ended up owing nothing in Federal income taxes for 

last year. 

Now, I am no linguist, but I think that the proper term for that 

level of income tax liability is zilch. 

Finally, the Joint Committee on Taxation estimates that approximately 51 percent of all households—this is an interesting figure 

to me, because just a couple of years ago, I think it was around 40 

percent. But the Joint Committee on Taxation estimates that approximately 51 percent of all households, which includes filers and 

non-filers, had either zero or a negative income tax liability for tax 

year 2009. 

Now, just think about that. More than half of all tax units—more 

than half of them—either paid no income taxes or got money back. 

There is a lot we can make of this information, and that is why 

we are having this hearing. I think many taxpayers are skeptical 

that the answer to our current fiscal problems is for them to sacrifice more when almost half of all households are not paying any 

income taxes. 

The other side argues that those 69 million households pay other 

taxes, like employment taxes, but that point avoids the larger 

issue. 

Those who promote higher income tax rates in the name of 

equality and deficit reduction need to come clean about what this 

entails. With the income tax base so narrow, meaningful reductions 

in our deficits would require far more than taxes on the rich. 

Those tax increases would hit squarely in the middle class, which 

the President proposes is off limits. 

As I said earlier, it is estimated that the top quintile of the population, in terms of income, pays more than 67 percent of all taxes 

to the Federal Government. 

Margaret Thatcher understood that, by artificially forcing equal 

outcomes through confiscatory taxation, we undermine the vibrant 

and dynamic economy that encourages productivity and the creation of resources and wealth; and, by doing so, we actually diminish the revenues that could otherwise be available or that would 

otherwise be available to the government to perform its limited 

constitutional functions. 

In short, the quest for social equality through government tinkering actually results in fewer resources and worse outcomes for 

the Nation as a whole and the poor in particular. 

There are some who have become so fixated on what other people 

have that they see the tax code as a sort of utopian sociological experiment and are willing to kill the goose that is laying the golden 

eggs. When we talk about raising income taxes, we need to be clear 

about what we are doing. We are not taxing wealth. We are taxing 

income and, by doing so, we are discouraging productivity, entrepreneurship, and risk-taking. 

The millionaire Thurston Howell III already has his money, and 

he is taking an extended vacation on Gilligan’s Island. Trust me, 

Thurston and Lovey do not care if you raise the income tax. The 

people who would care if income tax rates were jacked up in the 

name of social and economic equality are the people who are not 

5 

rich now, but might be in the future. It is the entrepreneurs and 

small business owners who would get hurt. 

In the name of socking it to Thurston and Lovey, it is the Skipper and Gilligan who really get whacked. Why would anyone take 

risks and work harder if they knew in advance they would not be 

allowed to enjoy the fruits of their own labors? 

What this hearing is fundamentally about is whether the tax 

code is a means of funding the basic and essential functions of a 

constitutional republic or whether it is a means for a small elite 

to create their vision of a utopia. 

I think the answers to these questions about the equitability of 

tax burdens and tax benefits will become apparent once we actually 

determine the purpose of the Federal tax code. 

I hope that in the end we can agree that it is a good thing for 

all people, rich and poor, to do better. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator. 

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

The CHAIRMAN. I would now like to introduce our witnesses. 

First is Mr. Daniel Shaviro. Mr. Shaviro is the Wayne Perry professor of taxation at New York University’s School of Law. Mr. 

Shaviro worked extensively on the Tax Reform Act of 1986, while 

serving on the Joint Committee on Taxation. 

The second witness is Mr. Scott Hodge, president of the Tax 

Foundation. 

After Mr. Hodge, we have Ms. Aviva Aron-Dine, with the Massachusetts Institute of Technology’s Department of Economics. 

Finally, we have Mr. Alan Reynolds, a senior fellow at the Cato 

Institute. 

Thank you all for coming. 

As is our regular practice, we will have your statements all included in the record, and I ask each of you to speak for about 5 

minutes. 

Mr. Shaviro? 

STATEMENT OF DANIEL SHAVIRO, WAYNE PERRY PROFESSOR 

OF TAXATION, NEW YORK UNIVERSITY SCHOOL OF LAW, 

NEW YORK, NY 

Mr. SHAVIRO. Mr. Chairman, Ranking Member Hatch, and members of the committee, thank you for the opportunity to appear 

today to discuss tax equity issues. 

My written testimony addresses three specific topics: the changes 

in U.S. income distribution since 1986, how tax expenditures affect 

the distribution of tax burdens, and the implications for tax rate 

design of curtailing tax expenditures. 

The Tax Reform Act of 1986, which I was very proud to work on, 

was designed to be distributionally neutral relative to prior law 

through the tradeoff between reducing tax rates and broadening 

the base. 

In assessing high-end distributional neutrality, the Treasury and 

Congress looked at only two high-income groups, those earning 

from $100,000 to $200,000 and those earning $200,000 or more. 

6 

In 2011, by contrast, the President’s Fiscal Commission examined how its proposal would affect each of the following groups: the 

80th and 90th percentiles, the 90th to 95th, the 95th to 99th, the 

top 1 percent, and the top 0.1 percent. 

A similar change in focus emerged during the 2010 debate concerning extending the Bush tax cuts for people at the top of the income distribution. Many on both sides of the debate argued that 

people at the very top were importantly different from those earning only, say, $250,000. 

This change reflects widespread public awareness of rising highend income concentration, a trend in which there is substantial 

academic consensus that does not depend on people’s policy preferences. 

Rising high-end income concentration has also been widely noticed in our society and has strongly influenced broader social and 

political attitudes, and I think it is, therefore, something that Congress, when evaluating tax reform and, more particularly, tax 

rates, is very likely going to want to think about. 

My second point pertains to the distributional effects of the big 

tax expenditures for middle- and upper-income taxpayers; for example, the home mortgage interest deduction, the exclusion for 

employer-provided health insurance, and the charitable deduction. 

Two things are clear. First, financial benefit from these items 

rises faster than income as you go from the bottom of the income 

distribution to the 99th percentile; but second, at the very top, the 

benefit shrinks as a percentage of income. 

This means that a 1986-style trade of lower rates or base-broadening would likely create winners at the very top, at least absent 

repealing items, such as the 15-percent dividend rate, that arguably are not tax expenditures. 

Congress could, if it chose, address those items’ distributional effects without entirely repealing them. For example, it could create 

or reduce dollar caps on items such as home mortgage loan principal and/or it could convert various deductions and exclusions into 

uniform rate percentage credits. These would very likely improve 

efficiency and revenue, while also addressing distribution. 

My third point concerns the relationship between repealing tax 

expenditures and deciding whether to reduce marginal tax rates. 

Often the two changes are grouped together 1986-style on the view 

that base-broadening alone would excessively increase tax revenues. 

But to view repealing tax expenditures as a tax increase requires 

forgetting the very point that often motivates calls for their repeal, 

which is that they are ‘‘spending through the tax code,’’ as the Fiscal Commission said. And, if you look at the House of Representatives’ fiscal year 2012 budget resolution, it is very much the same 

analysis of tax expenditures as really spending. 

The late economist David Bradford offered a powerful illustration 

of the point that tax expenditures are actually disguised spending. 

He described a pretended secret plan to reduce the budget deficit 

by formally cutting spending rather than taxes. In step one he said, 

suppose that we eliminate $50 billion of defense spending on needed weapons; and, step two, to make up for the loss of the weapons, 

we enact a new $50-billion weapons supplier tax credit. 

7 

What happens in the end is the Pentagon gets the very same 

weapons from the very same suppliers, effectively at the very same 

prices, but, by official measures, both spending and revenues have 

declined by $50 billion. 

Bradford’s pretended last step was that you then increase tax 

rates sufficiently to raise $50 billion of new tax revenues. When the 

dust has settled, the only thing that really changed is that tax 

rates are higher, but in terms of official measures, you have cut 

spending by $50 billion while tax revenues remained the same. 

Now, for any tax expenditure that similarly is disguised spending, although the label does not always fit items on official lists, 

repealing it as an economic substance is a spending cut, not a tax 

increase. 

Thus, while stand-alone tax expenditure repeal would increase 

officially measured tax revenues, it would not actually make the 

government larger in any meaningful economic sense, and that is 

presumably what people have in mind when they debate tax and 

spending levels in the Federal budget. 

Given how tax expenditures are officially misclassified, officially 

measured revenue neutrality, as distinct from budget neutrality, is 

really semantical and not related to the actual policies that are 

taking place. 

So tax rates should be cut as a part of tax reform if and only if 

that is Congress’s independent policy preference, not because basebroadening made it necessary. And Congress should also keep in 

mind that base-broadening generally reduces the efficiency loss 

from high tax rates given that it makes the taxes harder to avoid. 

Two final points I will just mention very quickly. First is that 

there really is no serious chance that rate cuts from where we 

stand today will raise revenue rather than lose it. 

And the second is that it is possible to have an economic growth 

dividend from cutting rates, but it depends on how it is done, and 

it is likely to be quite modest. 

Thank you. 

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

The CHAIRMAN. Thank you, Mr. Shaviro. 

Mr. Hodge? 

STATEMENT OF SCOTT HODGE, PRESIDENT, 

TAX FOUNDATION, WASHINGTON, DC 

Mr. HODGE. Thank you, Mr. Chairman, members of the committee. 

Since 1937, Mr. Chairman, the Tax Foundation’s mission has 

been to promote economically sound tax policy at all levels of government. We are guided by the immutable principles of economically sound tax policy. 

Taxes should be neutral to economic decision-making. They 

should be simple, transparent, and they should promote economic 

growth. An ideal tax system should only do one thing, and that is 

raise sufficient amount of revenues to fund government programs 

with the least amount of harm to the economy. 

I think by all accounts, the U.S. tax system is far from that ideal. 

8 

Over the past 2 decades, lawmakers have increasingly asked the 

tax code to direct all manner of social and economic objectives, such 

as encouraging people to buy hybrid vehicles, turn corn into gasoline, save more for retirement, purchase health care, buy a home, 

replace the home’s windows, adopt children, then put them in 

daycare, take care of grandma, purchase school supplies, go to college, and the list goes on. 

I would think that if we were starting from scratch to build a tax 

system, these are not the things that we would want a tax system 

to do. 

So the question before the committee is: Is the distribution of tax 

burdens and tax benefits equitable? I would say no, but not in the 

way that many of you might think. 

First, while it is well understood, as Mr. Shaviro mentioned, the 

major tax preferences largely benefit upper-income taxpayers, the 

real issue is the fact that these tax expenditures have harmful effects on the economy and the people whom they are intended to 

benefit. 

The biggest crises facing working families and the economy today 

are health care, housing, and State and local government finances. 

Yet, these are the very areas in which the government and the tax 

code are already the most involved. 

The cure for what ails these industries is not more subsidies, but 

to be weaned off the tax system. 

Secondly, as a consequence of trying to use the tax code to help 

the middle class, we have knocked nearly half—now, more than 

half—of all households off the tax rolls. We have turned the IRS 

into an extension of the welfare state, and we have created a growing class of Americans who are disconnected from the basic cost of 

government. 

As we get closer and now over the tipping point in which we 

have more non-payers than payers, we need to have a national discussion on whether it is fair or equitable to have millions of people 

enjoy the benefits of government and pay nothing to the costs. 

Good citizenship requires that we contribute at least something 

to the basic costs of government if we are going to enjoy the benefits of it. 

Finally, while some people would like to make the tax code more 

progressive, the fact is, according to the OECD, the U.S. has already the most progressive income tax system of any industrialized 

country. The top 1 percent of taxpayers pays a greater share of the 

tax burden than the bottom 90 percent combined. 

And Tax Foundation research shows that the majority of Americans now get more back in government spending than they pay in 

taxes, and that we are redistributing more than $826 billion annually from the top 40 percent of Americans to the bottom 60 percent. 

So we need an honest discussion over how much redistribution 

should be considered fair and equitable. And, whatever inequality 

we have in America today is being driven by demographic factors 

that are beyond the control of the tax code, such as the rise of dualearner couples, the rise of entrepreneurship, educational attainment, and the aging of America. 

And those taxpayers who are now shouldering the lion’s share of 

the tax burden in America today are what I call the successful midVerDate Nov 24 2008 15:03 Jun 05, 2012 Jkt 000000 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 R:\DOCS\74395.000 TIMD
9 

dle class. These are educated, dual-income families who are at the 

heart of the Nation’s successful entrepreneurial class. And we have 

to stop obsessing about the distributional tables that are static and 

do not take into account the mobility in America. 

Our research has found that nearly 60 percent of households in 

the bottom income quintile move up to higher quintiles over at 

least a 9-year period of time, and those at the top often move down 

to the bottom or lower within a short period of time. 

Even the IRS, in their Fortunate 400 rankings, found only 15 

percent of those in the Fortunate 400 were on that list for the entire 15-year period of time. There is a lot of churning at the top. 

Let me close by suggesting that we need to develop a new way 

of thinking about equity in the tax code. We need to strive to build 

a consensus around some basic simple concepts. 

First, an equitable tax system should be free of most of the credits and deductions and not try to micromanage individual or business behavior. 

Second, every citizen should pay at least something toward the 

basic cost of government. And an equitable tax code should be simple and have the lowest rates possible. Finally, we need a tax code 

that is conducive to long-term economic growth, because that is the 

key to fixing the long-term fiscal health of this Nation. 

Thank you, Mr. Chairman. I appreciate the opportunity, and 

would welcome any questions. 

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

The CHAIRMAN. Thank you, Mr. Hodge. 

Ms. Aron-Dine? 

STATEMENT OF AVIVA ARON-DINE, Ph.D. CANDIDATE, DEPARTMENT OF ECONOMICS, MASSACHUSETTS INSTITUTE OF 

TECHNOLOGY, CAMBRIDGE, MA 

Ms. ARON-DINE. Thank you, Mr. Chairman. Thank you, Ranking 

Member Hatch and members of the Finance Committee, for having 

me here today. 

As Professor Shaviro talked about and as Chairman Baucus also 

discussed, over the past 30 years, the income distribution in the 

United States has become increasingly skewed. While the incomes 

of the top 1 percent more than tripled over this period, income 

growth for low- and middle-income Americans slowed to a sputter. 

The lesson I draw from these facts is that, as we are making decisions about our tax system, we should work to promote economic 

opportunity, especially for those who have struggled the most with 

the economic changes of recent decades. We should certainly avoid 

policy steps that would worsen inequality and hardship. 

That leads me to the two concrete policy recommendations I 

would like to offer. First, I would recommend that you preserve and 

strengthen the Earned Income Tax Credit and the refundable child 

credit. As I believe you have heard from other witnesses in recent 

weeks, there are many provisions in our tax system where we either do not know if they are working or we even have evidence that 

they are actively counterproductive. 

By contrast, study after study has found that the EITC accomplishes its goal of getting low-income people, especially single mothers, to join the labor force. For instance, economists who studied 

10 

the EITC expansions of the 1980s and 1990s found that these improvements to the EITC induced well over half a million people to 

enter the workforce. 

The EITC and the refundable child credit are also well-targeted 

and extremely effective at reducing poverty, especially for children. 

Together, these tax credits now lift 7.2 million people out of poverty, including 4 million kids. 

Weakening either of these credits would increase inequality, poverty, and hardship, while strengthening them by simplifying the 

rules surrounding qualifying children and by improving the very 

small EITC available to workers without children would make the 

credits even more effective at encouraging and rewarding work. 

Now, some have recently expressed concern about the fact that 

the EITC and the child credit eliminate income tax liability for 

many low- and moderate-income families. In particular, I know 

there is concern about this estimate that 51 percent of Americans 

owed no income tax in 2009. 

Let me first note that the 51-percent figure was a temporary 

spike due to the recession, the now expired Making Work Pay 

Credit, and partial income tax exemption for unemployment benefits. In a more typical year, more like 35 to 40 percent of households would owe no income tax. 

Basically, tax benefits did exactly what they were supposed to do 

during the recession. They expanded to help struggling families, 

and they will automatically contract as the economy improves. 

But more importantly, the question is really just whether the tax 

treatment of low- and moderate-income Americans is fair or whether it would be better if this group paid substantially more in taxes. 

In thinking about this, it might be helpful to know some additional 

facts about these people. 

First, according to the Tax Policy Center, 60 percent of those not 

owing income taxes are either elderly people or individuals whose 

incomes are so low that they are less than the sum of the standard 

deduction and personal exemption. 

What that means is that 60 percent of those not owing income 

taxes would not owe taxes even without the EITC and or the child 

credit. 

If, in your judgment, those people should owe income taxes, you 

would need to either pare back the tax exemption for Social Security benefits or reduce the standard deduction or personal exemption, the sum of which is already below the poverty line. 

The other 40 percent of people not owing income taxes is mostly 

low-income workers with children who benefit from the EITC. 

These are working parents who play by the rules, but whose earnings leave them below twice the poverty line or, in many cases, in 

poverty. 

I know that some people worry that because these families do not 

owe income taxes, they do not have enough skin in the game, 

enough of a stake in ensuring that government operates as costeffectively as possible. But, in fact, the working families who benefit from the EITC have quite a bit of skin in the game, even in 

the narrow sense of paying Federal taxes. 

CBO has found that the poorest 20 percent of households pay 4 

percent of their incomes in Federal taxes, on average, while the 

11 

next income group pays 10 percent of its income in Federal taxes, 

and that is after netting out any benefits from refundable credits. 

All of these families also pay a significant amount in State sales 

taxes and often State income taxes, too. And the fact that these 

households do pay significant taxes is probably not even the most 

important way in which they have skin in the game. As working 

adults raising children, low- and moderate-income working parents 

have a tremendous stake in the future of our society and in having 

government operate efficiently and effectively. 

My second brief recommendation is that equitable tax reform 

needs to raise revenue, and it can and should do that in a progressive way. 

We have seen from recent efforts that closing our large projected 

deficits through spending cuts alone would mean making deep cuts 

in social insurance and the safety net, and that would exacerbate 

inequality, poverty, and hardship. 

But fortunately, there are policy options on the table that would 

raise enough revenue to let us avoid the most damaging of these 

budget cuts and take a more balanced approach to deficit reduction. 

I agree with both Professor Shaviro and Mr. Hodge that there 

are ineffective tax expenditures that could be trimmed and that 

could raise revenue. I believe that increases in high-income marginal tax rates can also play a role in an equitable approach to tax 

reform and deficit reduction, particularly in light of the fact that 

CBO data show these households have seen the largest reductions 

in their tax rates over the last several decades. 

Returning top tax rates just to their 1990s levels could raise more than $80 billion per year, and that is $80 billion that would 

not have to come out of programs for the elderly, low- and 

moderate-income families, or other valued public services. 

Thank you again for allowing me to speak to you today, and I 

look forward to answering your questions. 

[The prepared statement of Ms. Aron-Dine appears in the appendix.] 

The CHAIRMAN. Thank you very much, Ms. Aron-Dine. 

Mr. Reynolds? 

STATEMENT OF ALAN REYNOLDS, SENIOR FELLOW, 

CATO INSTITUTE, WASHINGTON, DC 

Mr. REYNOLDS. I am going to focus on facts, changes in average 

tax—— 

The CHAIRMAN. You might want to pull your microphone up a little closer, Mr. Reynolds. We want to hear you. 

Mr. REYNOLDS. Does that work? 

The CHAIRMAN. That works. 

Mr. REYNOLDS. I am going to focus on changes over time in average tax rates, top marginal tax rates, and revenues as a share of 

GDP. 

This is referred to in three tables at the back of my prepared testimony, and those tables are designed to explain why revenues 

from the individual income tax have remained near 8 percent of 

GDP for decades, even though the average income tax rates were 

cut in half since 1979 for the middle and fourth quintiles, and even 

12 

though, since 2003, average income tax rates for the bottom two 

quintiles, the bottom 40 percent, have been negative. 

From 1951 to 1963, for example, the lowest individual income tax 

rate we had was either 20 or 22 percent and the highest was 91 

or 92 percent, and yet that system brought in only 7.8 percent of 

GDP. 

From 1988 to 1990, the lowest income tax rate had been cut to 

15 percent and the top tax rate to 28 percent, and that tax system 

brought in 8.4 percent of GDP. 

So we, obviously, cannot just equate rates and revenues. 

Since both individual and total revenues have long been a surprisingly constant share of GDP, aside from recessions and booms, 

the growth of real revenues over time mainly depends on growth 

of the tax base, GDP. 

On the left side of my table 1 is average tax rates by quintile and 

the top 1 percent from 1979, 1989, 1999, and 2007. Those are all 

cyclical peak years. And what you see there is that, at the bottom 

quintile, the rate, of course, has been below zero because of the 

Earned Income Tax Credit and the child credit. 

For the second quintile, the average tax rate since 1979 has fallen 110 percent, the middle quintile 56 percent, fourth quintile 39 

percent, and, at the top 1 percent, yes, the average tax rate fell too, 

by 15 percent largely because of the inclusion of more dividends 

and capital gains, which are taxed at a lower rate. 

I cite—in my prepared remarks—some studies which find that 

the amount of taxable income reported by the top 1 percent is extremely sensitive to changes in marginal tax rates, particularly 

capital gains and dividends, but also income in general. It is true 

that this is not true of the whole population, as Ms. Aron-Dine 

points out, but it is true of the top taxpayers. 

So my second and third tables focus on some obvious effects of 

tax rate changes on behavior, and the reason is to explain this paradox that revenues seem to have remained the same even though 

there have been huge cuts in average tax rates for the bottom 80 

percent. Why is that? Behavioral responses tell us. 

Table 2 focuses on capital gains, long-term capital gains, and it 

says that, from 1987 to 1996 when the capital gains tax was 28 

percent, realized gains accounted for only 2.5 percent of GDP. 

When the tax rate was cut to 15 percent, it was 5 percent of GDP. 

You double the tax base and you are going to collect virtually the 

same amount of money. 

Interestingly, the next column shows that, among the top 1 percent which we have heard so much about today, capital gains when 

the rate was high accounted for only 17.7 percent of their income, 

but 28 percent more recently when the tax rate was 15 percent. In 

other words, high-income people report more capital gains when 

the rate is low. If you are doing a trade from one stock to another 

stock, you think twice if that trade is going to cost you 28 percent 

before you even make the trade. So you do not make the trade, and 

you keep the stocks you own and only sell them if you have offsetting losses. 

The third table deals with the top 1 percent in some detail, and 

what you see is—I have put figures in bold—whenever the capital 

gains tax rate went down, a lot of capital gains were reported. 

13 

When the individual income tax rate went up, i.e., 1993, salary income actually was fairly stagnant. It was unchanged from 1990 to 

1994. 

When the tax on interest income went up, the top 1 percent reported less interest income in 1993, 1994, and 1995, and so on and 

so on. But the main thing you want to watch is capital gains, because that dominates the CBO numbers. And capital gains have 

tripled—they doubled when the rate was cut to 20 percent, and the 

capital gains of the top 1 percent tripled after the tax was cut to 

15 percent. 

The same thing happened to dividends, and that can only be explained by a response to tax rates. There is no other explanation. 

They tripled, rising from an average of $30,000 in 2008 dollars to 

$83,000 by 2007. 

My testimony closes with two factual points about tax expenditures. First of all, it is a common misconception that the 1986 tax 

reform was paid for by reducing deductions. That is not true. The 

deductions were shifted from itemized to standard, but the total deductions were the same 23 percent of AGI before and after the reform. 

The second point is that, in tax expenditures discussions, including the Senate Budget Committee’s compendium and the Deficit 

Commission recently, they make the mistake of thinking that the 

tax expenditure item for capital gains and dividends is a measure 

of the revenue that would be gained if capital gains or dividends 

were taxed at ordinary tax rates. 

As JCT has explained to this committee, that is not true. That 

assumes no behavioral response, and the data I have shown show 

you have to take behavioral response into consideration. 

If you double those tax rates, the top 1 percent would report less 

income, and they would pay less taxes, and they would look like 

they had less income in these data, but it is misleading. 

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

The CHAIRMAN. Thank you all very much. 

I have a simple question to ask each of the four of you. And that 

is, in your judgment, to what degree has the code either contributed to or ameliorated maldistribution of income in the United 

States over the last 30 year? 

Everybody agrees there is a growing gap. Everybody agrees the 

wealthier have more money, and the middle-income wage earners 

just have not earned very much. 

But a question I have is, to what degree has the code contributed 

to that growth in maldistribution of income? The second question 

is, to what degree has the code diminished or ameliorated that maldistribution of income? 

Whoever wants to go first can go first, but I am going to ask each 

of the four. 

Mr. Reynolds, you raised your hand first. 

Mr. REYNOLDS. Yes. My data talk to that point, because we show 

increasing progressivity, and that progressivity in the tax code was 

primarily through the Earned Income Tax Credit, through doubling 

of exemptions in 1986, through the child credit in 2003. So that is 

ameliorated. 

14 

The other point I want to make is that the numbers you are citing about the top 1 percent, those are the numbers in my data. 

They are pre-tax, pre-transfer income. So they tell us literally nothing about the distribution of after-tax disposable income. They do 

not include my Social Security as income, but it is income, and they 

do not tell you anything about how much taxes I pay—and I probably will not do that either—but it is a lot. 

The CHAIRMAN. I am sorry, say again. 

Mr. REYNOLDS. You cannot tell anyone’s taxes from pre-tax data, 

and the—— 

The CHAIRMAN. No. But I am not—— 

Mr. REYNOLDS [continuing]. Numbers are pre-tax data. 

The CHAIRMAN. I am just focusing on income tax right now. 

Mr. REYNOLDS. Well, disposable income, if you take into account—there are measures of disposable income that take into account taxes and transfers, and I see no great change in inequality. 

The CHAIRMAN. All right. My time is ticking away. Who wants 

to come next? Mr. Hodge? I will go down the line there. 

Ms. Aron-Dine? 

Ms. ARON-DINE. I agree with Mr. Reynolds both that the EITC 

has ameliorated wage stagnation and, also, that the tax code does 

not have that much of a role in pre-tax inequality. But the tax code 

and changes in the tax code have contributed to after-tax inequality, and the CBO data do speak—— 

The CHAIRMAN. After-tax inequality? 

Ms. ARON-DINE. Income inequality, yes. And the CBO data do 

speak to that, because they give us growth in income, both before 

and after taxes. 

So if we focus, for example, on the top 1 percent, their incomes 

grew by 241 percent before taxes, but they actually grew more than 

that, 280 percent, after taxes because their tax rate fell so much. 

To put that in numbers, their incomes would have grown by $850,000, which is a lot, if the tax code had stayed the same, if 

their effective tax rate had stayed the same. But because their effective tax rate fell, their after-tax income actually grew by more 

like $1 million, with the tax code chipping in the extra $150,000. 

The CHAIRMAN. So on a net basis, you think the code contributed 

to inequality. 

Ms. ARON-DINE. Contributed to the concentration of income at 

the top and to after-tax inequality. 

The CHAIRMAN. Mr. Hodge? 

Mr. HODGE. I am a little dizzy with the numbers. I do not think 

that—— 

The CHAIRMAN. You will want to pull your microphone closer, 

please, Mr. Hodge, or turn it on. 

Mr. HODGE. Turn it on. There we are. I believe that most of what 

is driving inequality today in America is beyond the reach of the 

tax code. Inequality is being driven by a couple of factors, including 

the rise of dual-earner couples. 

People in the middle can launch themselves from the middle of 

the income scale to the top simply by saying ‘‘I do.’’ They can also 

rise to the top by getting a college education. The rise of education 

in America and the returns to education are also contributing to inequality in a large way. 

15 

The rise of entrepreneurship—and this may be one area in which 

the tax code may have had a contributing factor, but in a positive 

way, and that is the creation of S corporations, LLCs and partnerships, and the explosion of entrepreneurship that we have seen 

over the past 20 years. 

In 1980, there were only about 11 million tax returns that had 

some business income. Last year, there were close to 30 million, 

and that is because we have had an explosion of entrepreneurship 

in America today. And, as you know, those individuals or business 

owners file their business taxes on their individual tax return, not 

a corporate return. That has a contributing factor to the impressions or illusion of growing inequality, when really what you have 

is more than half of all business income in America today being 

taxed on the individual side of the tax code. 

And then, lastly, we have the aging of America as the babyboomers are now reaching their peak earnings potential before they 

move into retirement, and that pig-through-the-python, that bubble, I think, is also contributing to the impression or illusion of inequality. 

I do not think that raising taxes will move us back to an equal 

position. It will not force people into getting a divorce, losing their 

education, et cetera. 

The CHAIRMAN. I want to give Mr. Shaviro a chance. 

Mr. SHAVIRO. Well, thank you. The tax code is not a main player 

in the story, which is a lot of the demographics, technology, things 

like that. The tax code has contributed, though, in the sense that, 

if there were higher rates that were effective—and that is, obviously, an important question—then it could have ameliorated aftertax inequality. 

Mr. Hodge mentions entrepreneurs, and they are important, but 

I want to mention a lot of the story has to do with things like the 

financial sector, and CEO compensation going up, and things like 

that. 

Salaries have really been the big driver of rising high-end income 

inequality. 

The tax code can ameliorate that. That is all we are talking 

about, not eliminating it, but ameliorating it if there are slightly 

higher rates that are relatively effective. 

And I would have to endorse, by the way, Mr. Reynolds’s point 

that capital gains are unusually responsive to tax rates, but ordinary income tends to be considerably less responsive. 

So the tax code can play a role, but it is not at the center of the 

drama. 

The CHAIRMAN. Thank you very much. 

Senator Hatch? 

Senator HATCH. Thank you, Mr. Chairman. 

Ms. Aron-Dine, in your written testimony, you state that ‘‘the 

Federal tax system, considered as a whole (including individual 

and corporate income, payroll, and excise taxes), is only modestly 

progressive.’’ 

However, as Mr. Reynolds notes in his written testimony, a 2008 

study produced by the Organization of Economic Cooperation and 

Development, the OECD, found that, ‘‘Taxation is the most progressively distributed in the United States.’’ 

16 

Given the high level of progressivity of the U.S. tax system 

versus the rest of the industrialized world, to what are you comparing our tax system when you say it is ‘‘modestly progressive?’’ 

Ms. ARON-DINE. So let us focus just on international comparisons 

in that particular OECD study. What it found was that highincome people in the United States pay a very high share of income 

taxes, which they do, in large part, because they have a very high 

share of income, much higher than in most other developed countries. 

But the study also continued to look at what the entire U.S. fiscal system, taxes and spending, does to ameliorate inequality as 

compared with the entire system, taxes and spending, in all of 

those other countries. And, when you look at those data and you 

look at the ranking of countries in terms of what they do to ameliorate inequality through their whole system, the U.S. is actually at 

the bottom. 

In that sense, our system is actually among the least progressive. 

We do less than all but one or two other developed countries to 

ameliorate inequality through our tax system and our spending 

system considered as a whole, and that is from that same 2008 

OECD report. 

So, it is one of the senses in which I would say we have a system 

that, as a whole, is only modestly progressive compared to other 

countries. 

Senator HATCH. Thank you. 

Mr. Reynolds, you were—— 

Mr. REYNOLDS. Well, that study includes payroll taxes and other 

things. So it does get to the issue. And it is not just because we 

have a higher amount of income. 

The ratio of the top 10 percent’s income to the amount of taxes 

paid is 1.35. In other words, it is 35 percent more taxes paid than 

income. In Sweden, the top 10 percent get the same amount of income as they pay in taxes. 

So, as far as you are talking about the tax system doing redistribution, the U.S. far outclasses anybody else. It is true that, on 

the spending side, it is another matter all together. But the big 

welfare states of Europe finance spending not with progressive 

taxes, but with flat rate value-added taxes, flat rate payroll taxes 

that are much higher than ours, and with relatively flat rate income taxes as well. 

They have very high average tax rates and relatively high—and 

the ones with high marginal tax rates, such as France and Japan, 

get far less revenue from those steeply progressive rates than we 

do. 

Senator HATCH. Mr. Hodge and Mr. Reynolds, the Joint Committee on Taxation recently informed us that 51 percent of all 

units, tax units, that is, did not have any income tax liability in 

2009. 

Now, do you think it is fair that more than half of all tax units 

did not pay any income taxes, while the remaining 49 percent of 

the tax units are stuck with the entire income tax tab? 

Should not all tax units pay at least some income tax? 

We will start with you, Mr. Hodge, and then Mr. Reynolds, and 

anybody else who would care to respond. 

17 

Mr. HODGE. Yes, Senator. I believe that everyone who enjoys the 

benefits of government should pay at least something, some modest 

amount to the cost of government. It is an essential part of citizenship to be invested in this Nation, and I think paying income taxes 

is one key to that. 

Senator HATCH. Mr. Reynolds? 

Mr. REYNOLDS. I was fortunate to be the research director for 

Jack Kemp’s Tax Reform Commission, and I can report that every 

member of that commission—and they were a very interesting, distinguished group—was quite upset about the erosion of the tax 

base and the civics involved, and the civics are that it makes people think the government is free and, therefore, they demand too 

much of it, and that just does not make sense. 

Senator HATCH. Mr. Shaviro? 

Mr. SHAVIRO. I think it is a mistake to focus on one tax and one 

year in looking at this point, because people pay income taxes in 

other years, and they pay other taxes in that year. 

And, also, I think the other point I want to make is that—are 

we saying that people who have too little income to have anything 

left after the standard deduction and personal exemption should 

pay some income tax, and I do not know. I mean, that is a judgment Congress will have to think about. 

Senator HATCH. All right. 

Ms. ARON-DINE. Just to put more of a point on that last point, 

it is easy to say everyone should pay something, but in terms of 

practical policy, what that would mean is either lowering the personal exemption or lowering the standard deduction. The sum of 

those is already below the poverty line. 

So it would mean saying people in poverty should pay income 

taxes, should pay more taxes than they do today. It would mean 

raising taxes on elderly people, many of whom do not pay income 

taxes. 

I think we want to think about the actual consequences that that 

would have for actual people. 

Senator HATCH. What bothers me is that we have jumped from 

about 40 percent of tax units to now 51 percent. 

Ms. ARON-DINE. And as I discussed, I think—— 

Senator HATCH. In just 2 years. 

Ms. ARON-DINE. Right. And a lot of that is that we saw the worst 

recession in the post-war period during those 2 years, and Congress 

enacted measures, such as the Make Work Pay Credit and the partial income tax exemption for the UI benefit, that did deliberately 

pull some people out of the income tax, lowered their liability, because they were struggling in those years. 

Now that those measures have expired and once the economy 

starts to recover, those tax benefits will naturally contract, and we 

will probably go back to something more like the levels we saw in 

earlier years. 

Senator HATCH. My time is up, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator. 

Senator Grassley? 

Senator GRASSLEY. Mr. Chairman, before you start the clock, I 

would like to ask unanimous consent. In three instances, I would 

like to insert something into the record. 

18 

The CHAIRMAN. Without objection. 

[The submissions appear in the appendix on p. 59.] 

Senator GRASSLEY. And I would prefer to make a statement than 

to ask questions. 

OPENING STATEMENT OF HON. CHUCK GRASSLEY, 

A U.S. SENATOR FROM IOWA 

Senator GRASSLEY. Whether the distribution of tax benefits and 

burdens is equitable is a very important topic. However, there is 

a more important question we should be debating. What is the purpose of the Federal income tax? 

We cannot talk about whether taxpayers are paying their fair 

share if we do not know why we want them paying taxes in the 

first place. 

We are in a situation where people are talking about increasing 

taxes on higher-income people, because supposedly they can afford 

it. And they probably can afford it. But I get sick and tired of the 

demagoguery that goes on in Washington about taxing higherincome people. 

According to the Joint Committee on Taxation’s latest analysis, 

49 percent of the households are paying 100 percent of the taxes 

coming into the Federal Government, while 51 percent do not pay 

any income tax whatsoever. 

How high do the taxes have to go to satisfy the appetite of people 

in this Congress to spend money; and, particularly, how high do 

marginal tax rates have to go to satisfy those clamoring for higher 

taxes from the wealthiest? How high to satisfy you? And you know 

who you are. 

Investors Business Daily had an article. Even if the government 

confiscated all the income of people earning $250,000 a year, the 

money would fund the Federal Government today for just 140 days. 

Funding the government should be one, if not the primary goal of 

the income tax laws. 

Note here that I am specifically focusing on income taxes. This 

is because payroll taxes are not supposed to be used to fund government. Social Security and Medicare taxes are, in fact, insurance 

premiums. Individuals who pay them expect a benefit when they 

get to a certain age. 

It is clear that some people believe that the tax code should be 

used to reduce the growing income disparity between lowest and 

highest income quintiles. This assumes a key objective of the Federal Government through the Federal income tax laws should be to 

ensure that income is distributed equally throughout the citizenry. 

These folks actually believe that the Federal Government is the 

best judge of how income should be spent. That is not what our 

founding fathers had in mind. 

In addition to considering the purpose of the tax revenue, we 

ought to have some principles of taxation that we abide by. I abide 

by the principle that 18 percent of the GDP of this country is good 

enough for the government to spend, because that is what it has 

been on a 50-year average. That leaves 82 percent in the pockets 

of the taxpayers for them to decide how to spend, because, if 535 

of us decide how to divide up the resources of the country, we 

19 

would not have the economic growth that we have. We would be 

Europeanizing our economy, and that is bad. 

In evaluating whether people are paying their fair share, experts 

frequently look at whether a proposal improves the progressivity of 

the tax system. Critics of lower tax rates continue to attempt to use 

distribution tables to show that tax relief proposals disproportionately benefit the upper income. 

We keep hearing that the rich are getting richer while the poor 

are getting poorer. This is not an intellectually honest statement 

as it implies that those who are poor stay poor throughout their life 

and those who are rich stay rich throughout their life. 

We have a 2007 report from the Department of Treasury on income mobility, 1996 to 2005. I quote: ‘‘Key findings: There was considerable income mobility of individuals in the U.S. economy during 

1996 through 2005, as over half of the taxpayers moved to a different income quintile over this period. Roughly half of the taxpayers who began in the bottom income quintile, 1996, moved up 

to the higher income group, 2005. 

‘‘Among those with the very highest incomes in 1996, the top 1⁄100th of 1 percent, only 25 percent remained in that group in 

2005. Moreover, the median real income of these taxpayers declined over this period. 

‘‘The degree of mobility among income groups is unchanged from 

the prior period, 1987 through 1996. Income growth resulted in rising incomes for most taxpayers over the period of 1996 to 2005. 

Median incomes of all taxpayers increased by 24 percent after adjusting for inflation. The real income of two-thirds of all taxpayers 

increased over this period. 

‘‘In addition, the median income of those initially in the lower income groups increased more than the median income groups in the 

higher incomes.’’ 

I will skip something, because I want to make one last statement 

here and then put the rest in the record. 

I welcome this data on this very important matter for one simple 

reason. It sheds light on what America really is all about—vast opportunities and economic mobility. 

I will put the rest of the statement in the record, Mr. Chairman. 

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

The CHAIRMAN. Thank you, Senator. 

Senator Kyl, you are next. 

Senator KYL. Thank you, Mr. Chairman. 

I compliment Senator Grassley on what he just said. I note that 

the title of the hearing here is ‘‘Is the Distribution of Tax Burdens 

and Tax Benefits Equitable,’’ and, of course, the answer to that 

question has to depend entirely on what we mean by equitable, 

what our definition is. 

What measures or criteria do we use to answer that question? 

And I find it astonishing that some are inferring here that the purpose of the tax code is to ameliorate income inequality. I mean, 

that is an astounding proposition. 

As Senator Grassley said, the key point is, what is the purpose 

of the tax code, and it should be simply to raise the revenue that 

the Federal Government needs. 

20 

To assume that somehow we in Washington have either the morality or the ability to judge how best people should spend their 

money is an astonishing proposition in and of itself. But then to go 

further and say that the purpose of the Federal law should be to 

ensure that income is distributed equally is incredibly foolish. 

The factors that determine income inequality are—and I think 

most of the panelists agreed to this point. Mr. Shaviro said, ‘‘Well, 

I think the tax code can play a role, but it is not at the center of 

income disparity.’’ I think that was an exact quotation there. 

Education, marital status, work habits, other habits, personal decisions in life, individual preferences, and all of those things are 

what really determine the disparity in income in this country, and 

many, many, many other factors. 

And at best, we can make a modest change in that, but I submit 

that, if the purpose here of the hearing is for us to figure out how 

to use the income tax code to somehow make everybody equal in 

this country in terms of income, it is a fool’s errand, it is immoral, 

it is not what we should be about, and we ought to quit right now. 

While I have a couple of minutes, let me ask a couple of questions here. 

Mr. Reynolds, I was fascinated by the charts that you referred 

us to on the elasticity of taxable income studies indicating behavioral responses to changes in marginal tax rates. 

You note that they are mostly concentrated at the top of the income scale; that when tax rates are high, these taxpayers engage 

in activities that produce less reportable income. I think everybody 

agreed with that proposition. When taxes are lower, there is more 

of an incentive to engage in activities that produce reportable income. 

As you point out, this provides an explanation of why the top income earners’ incomes rose when tax rates fell. More income was 

reported because the penalty for producing income was lower. 

Now, first question. In the years immediately following the 2003 

cut in individual dividends and capital gains tax rates, did Federal 

revenues increase or decline? 

Mr. REYNOLDS. Well, remember, there is a lot going on. We are 

also expanding the Earned Income Tax Credit with that bill. We 

are adding a $1,000 child credit. We are adding a 10-percent tax 

rate. All of those plans were not revenue-positive, they lost revenue. 

It is rather remarkable that in the last 2 years, in 2006–2007, 

that we are back to 8 percent, the normal 8 percent-plus share of 

GDP that I said tends to happen. 

I did not actually predict that. In 2001, I wrote a Wall Street 

Journal article saying ‘‘a little bang for a lot of bucks.’’ In other 

words, I thought the revenue losers would offset the revenue 

enhancers, which are the lower rates on capital gains and dividends, arguably, and the lower rate at the top in general. More income is reported when the penalty for doing so is reduced. 

Senator KYL. The figures I have are, in 2005, revenues—Federal 

revenues—increased 14.6 percent, 11.7 percent in 2006, and 6.7 

percent in 2007. 

Mr. REYNOLDS. Sounds plausible. 

21 

Senator KYL. When capital gains tax rates were cut in 1997 and 

in 2003, did capital gains revenue rise or fall and how did the actual revenues compare to projections? 

Mr. REYNOLDS. Excuse me. Are you talking about the latest capital gains rate reduction? 

Senator KYL. No. In 1997, the first time, and in 2003. 

Mr. REYNOLDS. Yes. Revenues, of course, soared from capital 

gains. Those numbers are in my table 2, although maybe not exactly. It shows that the capital gains as a share of individual revenues were 9 percent of GDP both in the post-1997 period and post2003, whereas previously they were 7, 6.9 percent. 

I am doing this only as a share of GDP. Doing it in real dollars 

would be even better. In a sense, every time we reduce the capital 

gains tax rate, there is such a revenue flood that, while the economy is doing well, that there is a temptation to do something like 

the child credit or something like that, and it has made the system 

extremely and precariously reliant on the stock market, among 

other things. 

Senator KYL. But if I could. And I think both you and Mr. Hodge 

tried to make this point. A lot of what we are trying to accomplish 

here is to effect policy that is good for the country, not just that 

will produce revenue. And you can make mistakes doing that. You 

can also have a very positive effect, including promoting economic 

growth through lower tax rates. 

Mr. Acting Chairman, thank you. 

Senator HATCH [presiding]. Senator Menendez is not here. 

Senator Roberts? 

Senator ROBERTS. Thank you, Mr. Chairman or Ranking Member 

or co-chairman, your eminence. [Laughter.] 

Senator HATCH. I like the last one most of all. 

Senator ROBERTS. I am going to follow up and ask you all to respond to the question raised by Senator Kyl. What is the purpose 

of the tax code? Is it to raise revenue to support essential government functions, or do we see it as being a major mechanism for 

wealth redistribution? I do not mean that as pejorative. 

If it is the latter, is that an appropriate role for the tax code? 

And I am going to confer an honorary doctorate of economics on all 

of you. So you are all doctors. That will be from the University of 

Kansas. And, if you want to go on with a Ph.D., we will add in income redistribution. 

So you are all doctors now. Let us just start from Dr. Shaviro. 

Mr. SHAVIRO. Well, I guess I am a doctor now. I am a jurist doctor, but then every lawyer could say so, too. 

If all we want to do is raise revenue—we do not care at all about 

the distribution of wealth—the obvious thing to do would be to 

have a uniform head tax in which every American, be it Bill Gates 

or a homeless person, pays exactly the same amount. 

No one agrees to that. So at this point, we are really talking in 

matters of degree, where really the question is—the phrase that is 

often used is the ability to pay, how well-off one individual is, how 

able to contribute to the cost of government, compared to another 

person. 

And, as soon as you back off believing in a uniform head tax 

where everyone pays the same thing—which actually Margaret 

22 

Thatcher had an experience with that I recall—then we are really 

all in the same ballpark and not fundamentally disagreeing about 

what the enterprise is about. 

Senator ROBERTS. Dr. Hodge? 

Mr. HODGE. I do not believe the tax code should be used for social and economic engineering. I think the tax code has one purpose. As you mentioned, that is to raise a sufficient amount of 

money for the Federal Government. 

But economic growth ought to be the key question here. Will we 

and do we or can we have a tax system that is conducive to longterm economic growth? 

The OECD released a very important study 2 years ago showing 

that high corporate income taxes and high personal income taxes 

are the most harmful taxes to long-term economic growth. 

Unfortunately, as we have talked about here, the United States 

has one of the most progressive personal income tax systems, and 

I think, as we all know, we have one of the highest corporate income tax rates among OECD nations. Both of those are contributing to our slow economic growth. 

Senator ROBERTS. Dr. Aron-Dine? 

Ms. ARON-DINE. I particularly appreciate it, since I like getting 

my Ph.D. a couple years early. 

Senator ROBERTS. I know you are close, you are very close. 

Ms. ARON-DINE. I am working on it. 

I mostly agree with Mr. Shaviro that I think what we want is 

for our tax and spending systems together to accomplish a set of 

social goals. 

I think we have agreed that those goals include helping families 

who are coping with situations of hardship, providing a safety net, 

and I think we have agreed that people at the top can afford to pay 

more for that. 

You can call that redistribution or not, but it really does imply 

a progressive tax system. 

Senator ROBERTS. So you are for both, right? 

Ms. ARON-DINE. Yes. 

Senator ROBERTS. I have to move on, because I am running out 

of time, and I have a couple of questions for Dr. Hodge, as well. 

Please, Dr. Reynolds? 

Mr. REYNOLDS. Taxes do not redistribute income. They just reduce it. The redistribution occurs through refundable tax credits, 

such as the EITC, which, interestingly enough, although it is $55 

billion, is not counted in most of these studies of income inequality. 

It is like it does not exist. Neither are most transfer payments. 

So it is not taxes that redistribute income. The redistribution occurs through spending programs, which are huge. Transfer payments are now over $2 trillion. Private wages and salaries are 

about $5 trillion. Again, we have to take that into account. 

So taxes are not redistributive. 

Senator ROBERTS. I appreciate it. 

Dr. Hodge, again, this is a subject that my colleagues have said 

it is useless to bring up. I do not know how many times they have 

told me that, but I am going to do it again in the 35 seconds that 

I have left. 

Actually, I will go over. I am sorry about that, Your Eminence. 

23 

In 2007, the Federal deficit stood at $161 billion and had declined from a high of $412 billion in 2004. That is quite a reduction. That does not play well into the bookshelf theory in concrete 

that we were—we, the editorial, we, the Congress—were spending 

money like drunken sailors and poor Marines or whomever. 

But at any rate, the question that I have is that I thought that 

some of that was a result of the 2001–2003 tax relief. I do not say 

cuts, I say relief. 

Mr. Hodge, can you expand on the idea that lowering tax rates 

does not necessarily result in a loss of revenue; the Federal Government can, instead, increase tax revenues? 

Mr. HODGE. I think when you lower the most harmful taxes to 

the economy—and that is high marginal tax rates, as we did by 

lowering the top personal tax rates, as well as capital gains and 

dividends rates—the economy can grow and, to some extent, that 

will help replace some of the—or offset some of the revenue losses 

that might be expected in a static basis. 

And I think, while there is a lot of debate on whether tax cuts 

sort of pay for themselves, I do think that lowering tax rates—lowering marginal tax rates—can increase economic growth, and that 

can have a positive impact on revenues over time, and I think we 

saw that during that period of time. 

Senator ROBERTS. I appreciate that. My time has expired. Thank 

you. 

Senator HATCH. Thank you. 

I would like to note for the record that today is Senator Wyden’s 

birthday. Happy birthday, Senator Wyden. 

Senator WYDEN. Thank you, Senator Hatch. I just have been 

thinking about the comment my older daughter made the other 

day. She said that she had been studying the United States Senate, 

and she figured out that I am in the only profession on earth where 

I am actually one of the really young guys. [Laughter.] 

Now, go figure the reports from the young generation. But I 

thank you and my colleagues for your thoughtfulness. 

Senator HATCH. You are next. 

Senator WYDEN. Thank you, Senator Hatch. 

For our witnesses, I come to this by way of saying that a major 

part of tax reform is to establish new policies that are going to help 

grow a bigger economic pie in the United States. 

That is something that I think would help bring us together. And 

towards that end, there is new Commerce Department data, it has 

been cited recently in the Wall Street Journal by David Wessel, but 

the new data shows that U.S. multinational corporations, which 

employ 20 percent of all U.S. workers, have been cutting workers 

in the United States while hiring them abroad. 

In particular, the new data shows that over the last decade, U.S. 

multinationals have cut their U.S. workforce by 2.9 million jobs, 

while creating 2.4 million jobs overseas, and this is a dramatic 

turnaround from the 1990s, where significantly more jobs were 

added in the United States than overseas. 

So let me kind of steer you clear of particular bills and the like. 

My own view is that, if you were to slash rates for doing business 

in the United States while keeping progressivity, you would adVerDate Nov 24 2008 15:03 Jun 05, 2012 Jkt 000000 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 R:\DOCS\74395.000 TIMD
24 

dress that issue, and I have essentially proposed that with Senator 

Coats. 

But just from a policy standpoint, let me ask you, Mr. Hodge, 

and you, Ms. Aron-Dine, this question. Should not any reform of 

the tax code, both from the standpoint of growth and putting us in 

a position where we can actually increase progressivity as well, 

eliminate or at least reduce the perverse incentives that encourage 

shipping jobs overseas? 

We can steer clear of debates about territorial taxes and the like. 

My own view is that, if you slash rates dramatically for doing business in the United States, you eliminate some, not all, some of the 

debate about territorial taxes. 

But just from a policy standpoint, for you, Mr. Hodge, and you, 

Ms. Aron-Dine, should not reform of the tax code eliminate some 

of those incentives for shipping jobs overseas? 

Mr. HODGE. Well, Senator, I do not know of any incentives in the 

tax code that encourage U.S. companies to ship jobs overseas. 

Senator WYDEN. How about deferral? 

Mr. HODGE. I do not believe that that is an incentive to ship jobs 

overseas. I think that the drivers here are two things, only one of 

which the U.S. Government can do something about. 

One is the dramatic decline in U.S. competitiveness on our corporate tax rate. As you know, we have one of the highest corporate 

tax rates in the world, and every other—in fact, 75 countries have 

cut their corporate tax rates in just the last 4 years alone, and 

most of those have also been turning toward a territorial tax system, the most recent being Great Britain and Japan, and they have 

both done it to encourage the repatriation of foreign profits from 

abroad. 

So the sooner that we can cut our corporate tax rate dramatically, as you have suggested in your tax reform legislation, but also 

turn to a territorial system as our major trading partners have 

done, we will put not only the U.S., but U.S. companies, on an 

equal footing with our global competitors, and that, I think, will be 

the key to turning around this problem that you see and many people worry about. 

Senator WYDEN. Ms. Aron-Dine? 

Ms. ARON-DINE. Thank you. I think you may want to ask Mr. 

Shaviro, also, as this is, I think, his exact area of expertise. 

But I will just make two comments. One is that I think the really 

striking example of how loophole-ridden and problematic our system of international taxation is is that Joint Tax says that we 

could raise revenue either by taxing income in real time—eliminating deferral—or by going to a fully territorial system. Either 

would raise more money than the loophole-ridden system we have 

now. And so I do think there is a lot of room for improvements. 

I also think, in response to what Mr. Hodge said, that, in thinking about the problems caused by our corporate tax code, we want 

to think about effective tax rates rather than just the statutory tax 

rate, and that a lot of the inefficiency in the allocation of investment comes from the fact that different investments in different 

companies are subject to vastly different rates, again, because of all 

the special preferences in the code. 

25 

So I think there is absolutely room for growth-promoting corporate business tax reform, and that possibly could also raise revenue. 

Senator WYDEN. My time is up. I just hope that—and you four 

are all specialists—that we can come together around policies that 

will increase the economic pie in the United States. 

If you increase the economic pie, you lift a lot of boats, and I like 

to think—Mr. Hodge makes the point about territorial taxation. I 

am very open to talking about that. I could not figure out a way 

to do it and avoid some of the gaming problems with transfer pricing, but to me, if you can get those business rates down substantially here in the United States, they can come together around increasing the economic pie. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you. 

Senator Carper? 

Senator CARPER. Thanks, Mr. Chairman. 

Lady, gentlemen, welcome. We are glad you are here. Thanks for 

helping us out. 

I sort of look through these issues of changes in the tax code 

through a prism of—a little bit through four prisms. One is, is it 

fair, whatever we are considering; two, how does it affect budget 

deficits; three, how does it affect the economy in terms of providing 

a nurturing environment for job creation and job preservation; and, 

number four would probably be predictability, how does it affect 

predictability from year to year or how does it reduce uncertainty? 

I am almost tempted to throw in a fifth one, which would be simplicity. Having just worked on our own family’s taxes, that has a 

certain allure to me. 

A month or two ago, we had another panel before us, some really 

bright folks as well, and one of them was a guy named Michael 

Graetz. I do not know if you all know him at all. And right now 

he is a professor of law at Columbia. He was a witness. 

And he suggested that a properly designed value-added tax could 

be implemented in such a way to preserve the progressivity of the 

income tax system that we currently have in place, and he and others have proposed using the revenues raised from a VAT to reduce 

income taxes on earners below a certain level, as well as reducing 

taxes on corporations. 

To be honest with you, I have not, in the past, thought a whole 

lot about a VAT, and I thought his assessment was interesting, and 

we had a really good discussion on what he was suggesting. 

I would just ask you. Setting aside any positive economic effects 

from enacting a value-added tax, could each of you just give your 

thoughts on the desirability of a VAT in the context of ensuring 

that our tax system’s burdens and benefits be equally distributed? 

And what are your thoughts on a progressive consumption tax? 

And start at the end, take it away. 

Mr. SHAVIRO. I have personally written about how I think replacing the income tax with a progressive consumption tax is, in principal, a good idea. I do not think it is an idea that is going anywhere, so I am not actually pursuing it these days in my work. 

26 

But it has the ability to combine redistribution with reducing a 

lot of these bad effects in economic growth that people are concerned about. 

I think a VAT really is a necessary part of the long-run fiscal solution for the U.S. And people say it is a European thing. In fact, 

it is a universal thing, an OECD country thing, basically, countries 

around the world. 

My feeling is, at least in my optimistic days, is that I feel that 

we will find a way—— 

Senator CARPER. Do you have those days often? 

Mr. SHAVIRO. Not that often. [Laughter.] 

Senator CARPER. Is this one of them? 

Mr. SHAVIRO. When I think we are going to solve the budgetary 

problems we have—another thing I have written about a lot—I 

think a VAT has to be part of the solution, but obviously it has to 

be part of a solution when there is kind of a negotiated treaty, as 

it were, about what the new state of affairs will look like. 

There is an old joke that the left hates the VAT because it is regressive, and the right hates the VAT because it is a money machine, but as soon as they exchange viewpoints, they will make a 

deal. 

So I think there is really a deal to be made, and the VAT would 

likely be a part of it. 

Senator CARPER. Thanks. 

Mr. Hodge? 

Mr. HODGE. I had a very senior British tax official tell me that, 

if you want a perfect tool for funding big government, a valueadded tax is that tool. It is perfectly hidden from view, and you can 

dial up the rate at any time. 

Interestingly enough, the British just dialed up their value-added 

tax rate this year to raise more revenue. 

While I agree that consumption-based taxes are more economically efficient than income-based tax systems, I would not want to 

add one to the current system unless we could eliminate the corporate, individual income tax rates or income tax systems, pour lye 

on them so they do not return, and then we can have a value-added 

tax. 

Senator CARPER. Thank you. 

How do you pronounce your name? 

Ms. ARON-DINE. Aviva Aron-Dine. 

Senator CARPER. Thank you. 

Ms. ARON-DINE. In response to your question about a VAT, a 

VAT, in itself, as you know, is very regressive. And so I think it 

really just depends, first, what it pays for and, second, whether you 

can find a way to shield the very poorest families from being too 

burdened by that. 

In response to your question about a progressive consumption 

tax, the difference between a progressive consumption tax and the 

system we have is that it would not tax income from wealth at all. 

I have a lot of concern about that, because wealth is extremely 

concentrated, even more so than income. One percent of American 

households has a third of all wealth. And so, if you get rid of taxes 

on that income, on income from wealth, somebody else is going to 

have to make up that revenue, and I just do not see how that could 

27 

possibly make sense in light of our deficit problems and in light of 

the increases in inequality. 

Senator CARPER. Thanks. 

Mr. Reynolds? 

Mr. REYNOLDS. I am not an enthusiast for VAT for a lot of reasons. Look, we have a spending problem. Spending has gone from 

19 percent of GDP to 24 or 25. There is no good way to finance 

that. That is a burden. That is a threat to taxpayers any way you 

look at it. 

The VAT—all taxes fall on labor and capital, on individuals as 

suppliers of labor and capital. That is true of the VAT, too. 

The VAT, in incidence, is rather similar to a payroll tax over a 

lifetime. Yes, it exempts savings. And, if we totally exempt capital, 

we will probably put a higher tax on labor. So like you, I am not 

for that. 

High marginal tax rates are to be avoided. Devices that deliberately lose revenue are to be avoided. The elephant in the room 

is the 10-percent tax rate, which loses something like $700 billion 

over the next 10 years—no marginal impact whatsoever—and does 

not help poor people because poor people do not pay taxes in this 

country. It just gives me $800, $900 more a year, thank you very much. 

Take it away from me. 

Senator CARPER. Thank you. Thanks, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator. 

Senator Menendez? 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Ms. Aron-Dine, let me ask you: we heard a lot recently—it seems 

like we have heard it here today, to some degree—about the share 

of Americans not owing any income taxes, and we have heard they 

have ‘‘no skin in the game;’’ that they are takers. 

And listening to the rhetoric used makes it sound like a significant portion of Americans are simply sitting around doing nothing, 

waiting for the tax man to bring riches. It seems to me that the 

reality is far different. 

I look at this, and I look at the single parent who works two jobs, 

probably more hours than anybody on this panel even or maybe sitting up here—although I know we spend a lot of hours here, as 

well—with no vacation, at the minimum wage. They barely make 

ends meet, despite spending almost every waking hour working. 

Now, are these families takers? Or consider the Army sergeant 

with 6 years of experience, the backbone of our military—they have 

a salary scale of about $31,500. If they have a family, chances are 

they are below the threshold for owing Federal income taxes. 

I think we can all appreciate how difficult it is to raise a family 

at $31,500, certainly in New Jersey. So, do you think this family 

does not have a stake in our society? 

Ms. ARON-DINE. I think I agree with you that this family has a 

tremendous stake in our society. They pay other taxes besides income taxes. But more importantly, as you said, they have a stake 

in society as working people, as parents, and the EITC and the 

child credit, which are what eliminate their income tax liability, 

are tremendously successful as work supports, and I think we 

value the fact that they do that. 

28 

I also wanted to just draw a connection between your question 

and the previous question about Michael Graetz’s plan. I know you 

heard from Michael Graetz recently and that he proposes phasing 

out income tax liability for something like 90 percent of people and 

replacing that with a VAT. 

Now, that has pluses and minuses, but, if you were to do that, 

it would not then make sense for someone to say 90 percent of people are not paying income taxes, because that would have been the 

whole point of the change. 

And so really we need to look at the whole system together, not 

focus on one isolated task, and I think we also need to think about, 

as you say, the other ways that these families contribute and the 

reasons why we provide them with some help through the tax code. 

Senator MENENDEZ. I am sure the Army sergeant would like to 

be making a lot more, and would be happy to pay some taxes along 

the way. 

Ms. ARON-DINE. Right. 

Senator MENENDEZ. Let me ask Mr. Shaviro this. The Tax Policy 

Center estimates that the Republican budget’s specific tax proposals, other than making the Bush era tax cuts permanent, would 

cost $2.9 trillion over the next 10 years, and that cost would be on 

top of the $3.8 trillion cost of making the Bush tax cuts permanent. 

Roberton Williams of the Tax Policy Center has noted that, even if the $2.9 trillion was offset, the net result would be ‘‘very likely 

to make the tax code much more regressive than it is today.’’ 

Measures to lower the top rates to 25 percent and repeal the 

health reform law’s payroll tax increase on people with incomes 

over $250,000 are tilted heavily toward the most affluent households. It is difficult to imagine a politically plausible series of tax 

expenditure reforms that would not only raise enough money to offset most of these new costs, but would also raise so much of that 

money from higher-income households that the overall result would 

not be regressive. 

Do you think the proposal in the Republican budget plan to devote every dollar of revenue raised by curbing tax expenditures— 

many of which are utilized by middle-class families—to finance tax 

cuts for high-income households could suggest that the plan’s framers regard a dramatic downward distribution of the tax burden as 

a higher national priority than stronger deficit reduction? 

Mr. SHAVIRO. Well, I do not want to criticize their motives, certainly, sitting where I do, but I do think that the tax rate reductions they proposed were unwise, especially in view of the overall 

deficit posture. 

And I note, in some ways, I have an easier job than the members 

of Congress; namely, I can say things that are unpopular, and I do 

not get into trouble for it. 

I was pleased that the Ryan budget identified tax expenditures 

as a problem and said that they are really spending, but they certainly did not name any of them that they wanted to get rid of. 

So that was kind of interesting, although, again, I could understand the motivation. 

Senator MENENDEZ. Let me ask you this—let me name one. We 

have record profits—and I am happy for them to make profits, I believe in profits—but we have record profits in the oil industry. Do 

29 

we continue to give, over 10 years, about $30 billion in tax breaks? 

Is it something that is a good public policy? 

Mr. SHAVIRO. I think those tax breaks are probably, for the industry, unwise. I actually remember when I was a Joint Committee 

on Taxation staffer, someone wanted, in a JCT pamphlet, to call 

some of these tax breaks ‘‘The Drain America First Energy Policy’’—and they were not allowed to put those words in the pamphlet—the idea being we would rather kind of have the oil still 

there than use it up now due to tax breaks. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator. 

Senator Thune? 

Senator THUNE. Thank you, Mr. Chairman. And I appreciate this 

hearing and its focus, and I thank you all for making time to join 

us today. 

Mr. Reynolds and Mr. Hodge, I would like to direct a question 

to you. There is this perception out there that the top tax brackets 

do not pay their fair share of income taxes due to the Bush era tax 

cuts in 2001 and 2003. 

And yet, in fact, the share of Federal income taxes paid by top 

earners in this country has actually increased since these tax cuts 

went into effect. 

How do you explain that? 

Mr. HODGE. I think, Senator, first and foremost, we have used 

the tax system to try to relieve the tax burden on the lowest income people by expanding refundable tax credits to such an extent 

that we are now sending out more than $100 billion in refundable 

tax credits to people who owe no income taxes. 

And, as we have seen in the recent estimates by the Joint Committee on Taxation, more than half of all Americans pay no income 

taxes. And so the only people left to pay income taxes are these 

high earners. 

And so, even though rates have come down, their share has gone 

up, in large measure, because we are knocking so many people off 

the tax rolls. 

Senator THUNE. Your testimonies talk about how taxpayers often 

respond to higher taxes by investing more income in tax-exempt activities or by avoiding income that is more heavily taxed. 

If tax rates were to rise on upper-income taxpayers, do you suspect the Federal Government would collect as much as anticipated 

in revenue, or would it collect less? 

Mr. REYNOLDS. My table 3 kind of addresses that point. As Scott 

said, the revenues have gone up even though rates have gone 

down. Revenues have gone up because rates have gone down. 

Nobody has to realize a capital gain in a taxable account. You 

can keep it in an IRA or 401(k), or you can just not realize it and 

have an unrealized gain. Nobody has to hold dividend-paying 

stocks in a taxable account. 

Nobody has to pay tax on interest instruments because they can 

always buy tax-exempt bonds. 

So it is not really a matter of loopholes. It is just obvious behavioral responses to tax rates. And, when it comes to high incomes— 

on earned income, I am kind of a classic example. I have delibVerDate Nov 24 2008 15:03 Jun 05, 2012 Jkt 000000 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 R:\DOCS\74395.000 TIMD
30 

erately reduced my earned income by about 90 percent because my 

investment income puts me in the top tax bracket. 

Senator THUNE. What would happen if rates were to go up on 

capital gains and dividends in terms of the effect on the amount 

of revenue raised? 

Mr. REYNOLDS. It depends on how much. They are already going 

to go up a little, 3.8 percentage points, because of the health bill. 

I think that will be a—it might be revenue-positive. I do not 

think the evidence is quite clear. If you get up around—if you were 

to go to, say, 23.8 percent, which has been proposed, on capital 

gains, I am pretty sure that would lose revenue over time. 

We do not have enough evidence on dividends, but the fact that 

dividends tripled in the top 1 percent after the rate was cut is pretty astonishing. 

Most of that money, at some rate, would just disappear, and then 

the top 1 percent would look poorer on paper because we do not 

count unrealized gains or we do not count the interest on taxexempt bonds, and we do not count the dividends that are being 

collected in a Roth IRA. 

Senator THUNE. The tipping point that you alluded to earlier 

where the Joint Tax Committee, with their report now, has come 

out and said that we have reached that point where 51 percent of 

Americans do not have income tax liability, which strikes me, at 

least in the time that I have been here, as maybe the first time 

that has happened. 

That is a trend. We continue to see more and more people who 

do not have tax liability, fewer and fewer people in this country 

who are actually paying at least some Federal income taxes. 

And in your testimony—it was you, Mr. Hodge, who referred to 

what some economists are calling the fiscal illusion, the idea that, 

when individuals perceive the cost of government to be less than 

what it really is because they are not bearing the burden of paying 

for it, they tend to demand more of it. 

Do you believe that the expansion in the size and scope of government we have seen in recent years is directly related to the 

rapid rise in the percentage of Americans who owe no Federal income tax, or are these factors coincidental? 

Mr. HODGE. I do think that, when Americans feel or perceive 

that government is cheap, they are going to demand more of it. 

And right now, they have been convinced that, if we only tax the 

rich, we can provide you more benefits. 

And so with that kind of a bargain, we will all accept more government if someone else is going to pay for it. If an enterprising 

politician says ‘‘We are going to tax Canadians in order to provide 

you health care,’’ everyone is going to be in favor of it. 

And so right now, when you have half of all Americans with really no skin in the game, they are going to demand more government. And for those who say that they are paying other types of 

taxes, this is not exactly true. 

Because of the generosity of refundable credits, the Joint Committee has found that 23 million people get more in refundable 

credits than their employee’s share of the payroll tax, and 15.5 million get more in refundable credits than both shares of the payroll 

tax. 

31 

So these refundable credits are wiping out, not just their income 

taxes, but also their payroll taxes, too. That is only the tax side of 

the ledger. If we include spending, these people are getting considerably more back from government than they pay in taxes. That, 

I think, is inequitable. 

Senator THUNE. I see my time has expired. Thank you, Mr. 

Chairman. 

The CHAIRMAN. If you have more questions, go ahead. 

Senator THUNE. Let me just follow-up. You discussed the fact 

that what we call tax expenditures can distort economic activity; 

for example, causing more demand for things like housing and 

health care, where there is preferential tax treatment. 

And I guess my question is, as you know, there is a major part 

of the administration’s health reform law that consists of tax credits that will go into effect in the year 2014. 

Do you expect that these credits are going to make the market 

for health-care related services more efficient or more distorted? 

Mr. HODGE. I think it is going to be more distorted. I think we 

all understand that health care right now suffers from the thirdparty payer problem, and that is when someone else, whether it is 

an insurer, an employer, or the government, is paying the bills, we 

are all going to demand even more of it because it is cheap to us, 

and that distorts the marketplace. 

And the marketplace—it is the competitive market where we are all consumers that gives us iPads for $499 and other cheap products that actually become cheaper over time while the quality goes 

up. 

In health care, that does not happen, and it is all because of this 

third-party payer system. As we expand these credits, then we will, 

I think, see an erosion of costs, and the quality will go down. 

Senator THUNE. Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator. 

Ms. Aron-Dine—well, strike that one. 

A question I have, just generally, is, how do we increase American competitiveness and create more jobs in America with the 

code—and there are lots of efforts and lots of ways, clearly. 

But unemployment is still too high. Global mobilization is fiercely upon us. A lot of companies are scrambling, in one respect, to 

maximize returns to their shareholders, but a lot of Americans— 

most Americans would like to have as many jobs as possible in the 

U.S., not overseas. 

I know that is awfully simplistic, but the real basic question is, 

what can we do with the tax code, in your judgment, to help create, 

on the margin, generally, more jobs in the United States? Not getting into whether it is manufacturing jobs or financial service jobs 

or whatnot, whether moving eventually to a VAT with an income 

tax layered on top of it. I think that is what most European countries do. Would that help or not help? 

Some suggest that at least a VAT allows exports, a center for exports under a VAT system, which we do not have in America. We 

had it before this Foreign Sales Corporation/Extraterritorial Income (FISC/ETI) was declared illegal in the WTO. 

But just generally, irrespective of whether it could be passed this 

year or next year, in your general view, what does it take? What 

32 

do we do in the code? We have to have revenue, clearly, for government services, fair and moderate and balanced and all that. 

But what could we do with the code to help promote more jobs 

on the margin? 

Mr. SHAVIRO. Well, I think having a less distortionary income tax 

with less preferences in it. Also, having, I think, some shift from 

income to consumption, although it does raise distributional concerns. 

Also, I think the case can be made for a lower domestic business 

rate, really a corporate rate, that would tend, over time, to bring 

more capital to the U.S. and increase earnings and/or wages and/ 

or jobs. It would not, I think, have an immediate or dramatic response. 

One effect that you get from that is that multinational companies, when deciding where to claim their revenue, where their income was earned, would be more likely to say the U.S. if the tax 

rate is lower. 

If we do lower the business rate, I think for it to be credible in 

the long run, you really have to pay for it. And in addition, there 

is a real issue of how that interacts with the top individual rate. 

We have not had the situation for decades where the corporate 

rate is much lower than the top individual rate, but I think we are 

headed to that world. 

When you get there, what you basically have is owner-employees 

who pay themselves too little salary. So you kind of have to figure 

out how to make the tax code and individuals work if there is a 

lower corporate rate. 

Having a corporation actually becomes a tax shelter, potentially, 

if you just want to avoid high individual rates when the two rates 

are different. There were mechanisms to deal with this in the law 

30 years ago. It is something we might have to revisit if we go 

there again. 

The CHAIRMAN. Maybe it is just the vogue today, but a lot of 

businessmen tell me, ‘‘Make my company’s rates lower, and I will 

pay more in personal rates.’’ 

Mr. SHAVIRO. Yes. 

The CHAIRMAN. I am diverting. Basically, just make it simpler, 

with incentives for U.S. as opposed to foreign companies, and that 

will help. 

Mr. SHAVIRO. Well, a lower U.S rate would tend to increase investment in the U.S., and income that is reported by businesses 

which have enormous discretion—they will report more as U.S. income. 

The CHAIRMAN. Right. Mr. Hodge? 

Mr. HODGE. I think the quicker that we make our corporate tax 

system look like the rest of the world, the sooner we will be more 

competitive. 

The U.S. has a Niemen Marcus tax system for corporations in a 

world in which everyone else has Wal-Mart tax systems. Seventyfive countries have cut their corporate rate in the last 4 years 

alone, and many of those have moved to a territorial tax system. 

As I mentioned to Senator Wyden, Britain and Japan were the 

latest to do that, and those countries are becoming more competitive at our expense. And the sooner that we cut our corporate tax 

33 

rate dramatically and change to a territorial system that looks like 

the rest of the world, the sooner the U.S. economy will recover, and 

the more competitive we will be, and the more jobs will stay here. 

The CHAIRMAN. But if we cut the corporate rate significantly, we 

have to pay for it. Most people think it has to be revenue-neutral. 

So, if it is a significant cut, 25–26 percent, that is a lot of revenue. 

How do we make it up? 

Mr. HODGE. Senator, I would suggest that, instead of looking at 

this in a revenue-neutral way, we look at it in a budget-neutral 

way. I would cut corporate welfare spending, for instance, as a 

means of offsetting some of those revenue losses. I would eliminate 

some of the tax expenditures on the corporate code, although that 

only allows you to lower the rate to about 29 percent. 

The CHAIRMAN. That is right. There is not a lot there, I do not 

think. 

Mr. HODGE. Right, right. So that is why I think you need to look 

on the spending side of the ledger, but also I think we need to understand that our high rate is essentially losing revenue as income 

gets shifted overseas, as profits do not stay in the United States. 

Lowering rates will actually increase revenue. 

The CHAIRMAN. This is a difficult forum to negotiate in, to talk 

in. There is not a lot of time. 

Ms. Aron-Dine? 

Ms. ARON-DINE. I just want to underscore what Mr. Shaviro said, 

that corporate reform really would have to be paid for. If not, I 

think you are well-aware that our deficits and debt over the long 

run are themselves economic concerns, and simply cutting the rate 

and adding to those deficits and debt is not likely to be growthenhancing. 

I actually think if you cleaned up the code, as Mr. Shaviro suggested, and eliminated some of that preferential treatment for certain kinds of corporate deductions, that could actually itself add to 

the benefits of anything else you did through corporate reform. 

The CHAIRMAN. Let me ask this question. Do you lower the corporate rate specifically, then have the larger pass-throughs be 

treated as corporations—the large pass-throughs, because there are 

some pass-throughs that are making a lot. It is individual, not corporate, and they are businesses. We are talking about business income here. 

Why not have the large pass-throughs’ business income pay a 

corporate rate and have a lower corporate rate? 

Ms. ARON-DINE. It is outside my area of expertise. It certainly 

sounds to me like an idea worth considering. 

The CHAIRMAN. Mr. Reynolds? 

Mr. REYNOLDS. Many countries with much lower corporate rates 

than we have collect a lot larger share of GDP from corporate 

taxes. 

The CHAIRMAN. That is right. We are very low on a percentage 

basis. 

Mr. REYNOLDS. I know. We do not collect much from it. That 

should tell you something, that there is transfer pricing going on, 

and there is debt. How do you get the effective rate below the statutory rate? You borrow up to your eyebrows. Do we want that? Is 

that a good thing? Not when times get bad, it is not a good thing. 

34 

The CHAIRMAN. Would you limit the deductibility of debt? 

Mr. REYNOLDS. I would just question the static revenue estimates. That is a major reform, and that is interesting. I would like 

to make an additional point. The countries, the BRIC countries, 

what did they do? 

Remember, a lot of businesses are still taxed as individuals. 

Brazil cut their top tax rate from 55 to 27.5 percent individual rate. 

India cut it from 60 to 30; South Korea from 89 to 36; Russia from 

60 to 13; Singapore from 55 to 20. 

You want to know how to compete with those countries? It is not 

by raising the highest tax rates. 

The CHAIRMAN. I am way over my time. 

Senator Hatch? 

Senator HATCH. Thank you, Mr. Chairman. 

I think all four of you have been very interesting for me today, 

and I think everybody else, for that matter. 

As to Senator Wyden’s exchange with Ms. Aron-Dine, we need to 

be careful about the use of the term ‘‘loophole.’’ 

The foreign tax credit system is designed to eliminate double taxation of U.S.-based companies’ foreign income. Likewise, deferral is 

a complicated and perhaps not a perfect system. In fact, I am sure 

it is not perfect, and going to a better system, it seems to me, 

would be a wise move for us. 

Now, it modifies the unique U.S. system worldwide—tax system 

worldwide—it modifies that system so that U.S.-based companies 

are not on a level playing field with foreign-owned companies. 

Now, these are not loopholes. They are broad-based policies that 

we are trying to take care of. Perhaps not perfect policies, but nevertheless, not loopholes. So I just want to mention that. 

Ms. Aron-Dine, you recommend expanding the EITC. Now, how 

would that increase the percentage of those who do not pay taxes? 

Ms. ARON-DINE. In my testimony, I specifically recommended potentially expanding the EITC for people without children, and this 

is the one category of people—we are talking about people not paying income taxes. These people actually begin to owe income taxes 

before their earnings reach the poverty line. 

That is because the maximum EITC for them is about $450, 

which is not enough to eliminate their income—to offset their income tax liability, even when they are still in poverty. 

So that is why I think this group potentially deserves your attention if you are thinking about ways to improve the tax code. 

Senator HATCH. Let me ask Mr. Hodge and Mr. Reynolds this. 

I would like to focus on income mobility, and, while I am sure 

many would like to claim that the rich are getting richer, I would 

like you to comment on two findings by the Treasury Department’s 

Office of Tax Analysis. 

First that, of the richest 1 percent in 1996, 75 percent were in 

a lower income group by 2005. And second, during that same timeframe, the median income of the lowest income quintile increased 

by 90.5 percent, while the median income for the highest income 

quintile increased by only 10 percent. 

Could you comment on that, Mr. Hodge, Mr. Reynolds, and others as well, if you care to? 

35 

Mr. HODGE. I think the study very clearly showed that, for the 

lowest-income individuals in particular, that real wage growth was 

the driver for them to move from the lowest quintile into higher 

quintiles over that period of time. 

More interestingly, I think, also, is to look at the incidence at the 

top, where what we find is that it is really one-time events that 

often move people into the top deciles or even the top 1 percent or 

.1 percent, where it is the sale of a business, it is the sale of stocks, 

it is a 1-time event that launches them from maybe an upper middle class income to an exceptionally high income tax, then they 

move down after that. 

So, once they have sold their business—they have made $1 mil- lion or $10 million—over time, they move back down toward where 

they were because that 1-time event is gone, and we find in a study 

that we did at the Tax Foundation that more than half of all socalled millionaires were only on that list once. 

In a similar study that the IRS does on the Fortunate 400, looking at the wealthiest 400, of that 400 people, only 15 percent were 

on that list more than once. So it is really these one-time events 

that tend to drive people into those upper income brackets. 

Senator HATCH. Mr. Reynolds? 

Mr. REYNOLDS. Often, when we compare rich and poor, we are 

looking at the same people at different stages of their life. It is a 

snapshot, and life is a motion picture. 

I have been in the bottom 10 percent and the top maybe even 

1 percent if I sold a lot of stock, and I enjoyed it all. It is a matter 

of getting old and putting some money away. 

But we do tend to forget that rather obvious point. There is plenty of mobility over a lifetime. I have a chapter on this topic in my 

book ‘‘Income and Wealth.’’ I am not here to sell books, but there 

is a lot of bad data on that topic, as a lot of other topics. 

Ms. ARON-DINE. If I could just make two points. One is that I 

certainly would not dispute that there is mobility, and particularly 

that some of this is related to age. But when some economists 

looked at data where they looked at people’s earnings over 10 

years, as they looked at a whole 10-year period and they looked at 

people of comparable ages, they found that there was still very substantial inequality, and, for male earners, a rise over time just like 

you saw in a snapshot picture. 

So I do not think it makes these disparities that we have been 

talking about go away even if you look over a longer period. 

The other thing I think we should keep in mind is intergenerational mobility—the potential for people from low-income 

groups to see their kids do much better—and the level of intergenerational mobility is not as high as I at least would like. 

A child born into the bottom quintile of the distribution has a 35- 

percent chance of getting to the middle income or better, but a 42- 

percent chance of staying stuck at the bottom. And I think there 

are things we could do to provide more opportunity that would be 

very worth doing. 

Senator HATCH. My time is up, Mr. Chairman. I think I am going 

to have to leave. 

The CHAIRMAN. Thank you all very much. This is a long, involved 

process. I think, clearly, the corporate and individual tax code has 

36 

to be reformed, and I am uncertain how long it is going to take. 

But these hearings help a lot, and I want to thank you very much 

for your very thoughtful analysis and taking the time to come and 

talk to us and answer our questions. 

The hearing record will be left open for several days. Today is 

Monday. At least until the end of the week. So, if Senators have 

questions, I will ask them to get them to you by the close of business today, and, if you could get the responses back by the end of 

the week, I would deeply appreciate it. 

Thank you very much. The hearing is adjourned. 

[Whereupon, at 11:56 a.m., the hearing was concluded.] 

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