SEN. BAUCUS: (Sounds gavel.) The hearing will come to order. Yale law Professor Michael Graetz said, quote: "The tax law is the primary link between the nation's citizens and their government. Many more people file tax returns than vote in presidential elections." And the numbers bear him out. For the last presidential election, 10 million more people filed income tax returns than cast presidential ballots.
And individual income tax returns are the primary source of the nations' revenue. Individual income tax collections account for about half of the revenue that the federal government collects. And as the former head of the Joint Committee on Taxation testified in 2001, the burdens of complexity fall particularly on individual taxpayers. So it's only fitting that today's tax reform hearing focuses on tax reform for individuals.
The IRS estimates that it takes people an average of 26.4 hours to complete the individual tax form. That's more than a complete day just to figure out how much you owe the federal government -- clearly, too long. And that's only the average. Some people take a lot longer to figure out their taxes, and that number doesn't count up all the time actually spent. Most of us don't just sit down and work out our taxes in one sitting. Most taxpayers spend a lot of time gathering information. People spend days, even weeks, compiling information before sitting down to fill out a tax form. On top of that, many people have to calculate the alternative minimum tax.
Why is filing your taxes so complicated? One reason is because the tax code has multiple functions. The government raises revenue with taxes, and then the government also uses the tax code to implement social policy as well as economic policy.
For example, through the earned income tax credit people are raised out of poverty. Through college education credits and deductions, college is more affordable and accessible. And through tax cuts, Congress can give a boost to the economy during hard times.
As we begin the task of tax reform, we will have to determine priorities. How can we make the tax code more fair? How can we make it more simple? How can we reduce its drag on the economy? And can we do all these things at the same time?
On April 15, I began this series of hearings with a broad overview of tax reform. Today we will consider what our priorities should be in the individual area. Future hearings will address small businesses, corporations, international competitiveness among other topics.
So let us see if we can't make the primary link between the nation's citizens and their government just a little less painful. Let us see if we can't make the primary source of the nation's revenue a little more fair. And let us see how we can lessen the burdens of the tax code on Americans, individual taxpayers.
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SEN. BAUCUS: Thank you all very, very much.
Clearly, if we're going to have significant reform, there's going to have to be significant agreement. Dr. Gale made the point that if this becomes partisan, we're not going to get very far. And I just very much hope that this committee can lead the way in working together and try to find ways to address, you know, how we properly reform the code. The concern I have, frankly, is American competitiveness and are we -- the degree to which, the last two witnesses touched on it -- have a system which is biased against savings or not. It think it's an honest question.
One the other hand, we also want a system that's sufficiently progressive as well as simple, et cetera. And so I'm wondering, as you all listen to each other, where is there some common ground? And I -- you didn't anticipate that question; it might be hard to kind of figure that out at this point.
But where is there some common ground? Just stop and think about what we need to do, because I'm trying to figure out a way so we can make significant changes in the way that make most sense, make the code more simple, help promote growth, you know, just -- you know, current social -- requisite amount of social policy that seems to make sense here.
I agree very much with the basic tenor of the witnesses, namely, we've got income tax base which is -- it's corroded. I mean, it's just falling apart. We have -- we, Congress -- administration, too -- makes the code more complex every year with all the new changes and so on and so forth. It's hard to say no to groups that come in and say, "Well, the general rule might make sense, but, you know, we're the exception; we're a little different than the general rule."
So let me just start out by trying to figure out an area, an outlet -- anyone go who wants to go first -- and where do you think you might all want to agree? Where do you think you might agree -- because to start building towards some commonality here. Who wants to take it?
MR. GALE: I'll --
SEN. BAUCUS: Okay, anyway.
MR. GALE: I'll take a crack at that.
SEN. BAUCUS: Okay. Mr. Gale.
MR. GALE: I think we're -- knowing all the witnesses fairly well, I think it's obvious that we agree that the current system is a mess, that the -- in particular -- particularly in two ways. One is that the complications that we have are not worth the benefits. The issue isn't how complicated is the system; the issue is, are the complications that we have worth what we get for it? J.D. talked about education. That's a perfect example of a mess. There's a separate education subsidy for every income level, basically. We don't need to have that. We ought to be able to conform that. We ought to be able to clarify that.
The other area where I think we're in agreement is that the uneven taxation of all sorts of things creates bad things, that you want -- Steve wants to go to a comprehensive consumption-based, I would personally prefer a comprehensive income base. The difference between those two views is nowhere near as big as the difference between either of those systems and the current system.
And so the current system layers taxes more than once on some types of income. It completely exempts other types of income or consumption. So I think if you could get it simple and even, you'd probably get a long way toward a consensus.
SEN. BAUCUS: Okay.
MR. Burman, you had your hand up?
MR. BURMAN: Yeah, I -- the other thing I think -- I suspect we agree on is that if you could broaden the base and lower the rates --
SEN. BAUCUS: First of all, on the last point, does anybody specifically -- do people -- the other three of you basically agree with what Dr. Gale said?
MR. FOSTER: I basically agree with him. The distortions we now have in the tax code are not worth the price in terms of complexity and lost economic growth. Ultimately the debate will fall on to whether or not we should have comprehensive consumption or comprehensive income as the starting point. The starting point is critical. But I think if left to our own devices we can probably come up with a fairly decent consensus that would meet none of our preferences perfectly but would be far preferable to what we have currently.
SEN. BAUCUS: Okay. Dr. Burman?
MR. BURMAN: I think -- I mean, one key point is that whatever tax system we have, if you can broaden the base and lower the marginal rate while -- I -- there's probably some disagreement on this, but I would obviously like to maintain a level of progressivity, but, you know, meeting those objectives -- a lower rate means whatever flaws there are in the tax system will have less of a cost on the economy. There's an economic theory that says that the higher the rate is, basically the cost to the economy grows in proportion to the square of the rates. When you double the rate, the cost quadruples.
You might want to go to a comprehensive consumption tax, but if you have a high rate, there's a strong incentive to convert -- make ordinary income look like capital income and be exempt from tax. There will be tax shelters under any system, and those take a huge cost out of the economy. So whatever system you have, if you can keep the rates low, the overall cost to the economy is a lot lower.
SEN. BAUCUS: Okay.
Dr. -- Mr. Entin?
MR. ENTIN: I'd like to talk a little bit more with Bill Gale about exactly which elements of the uneven treatment of capital he's going to get rid of, and then if you could get a lower rate than the difference between the income and the consumption base might not be too bad, depending on how far he's willing to go in that regard. And he did mention the importance of getting the tax on capital lowered.
You had mentioned whether this can be bipartisan. I don't see why growth and higher wages are necessarily a partisan issue when in 1979 and 1980, when I was on the Joint Economic Committee staff, Congressman Bud Brown, who was my boss, and Senator Lloyd Bentsen, who was the chairman of the committee, got together and we had a two-year bipartisan report.
We were faced with a very serious inflation-related hit on capital formation in the country. Productivity was falling and wages were going down. And that report focused on the effects of inflation on the tax treatment of capital and why we needed to reverse that in some way or other. Now, Senator Bentsen preferred to give the reduction in the tax on capital in the form of faster depreciation allowances to the business when they actually did the investment, and I think Mr. Brown would have been just as happy dealing with it either at the business end or at the shareholder end, in the case of the corporation, and, of course, with a proprietorship they're one and the same.
That little difference apart, and I have to say I think markets make the difference moot because, as has been pointed out, people pay taxes, not businesses per se; they're legal fictions. But they found a way to do it, one way or another and they worked together on it and it had quite an impact on the political debate at that time. I think this is a good bipartisan pro-growth issue.
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SEN. BAUCUS: Thank you, Senator.
I'm just curious your thoughts on, assuming government needs revenue, all things being equal, the more efficient way to raise it -- I know we've talked about individual, talked about corporate and capital and so forth. But just -- and we've got to think about a lot of issues here but just, all things being equal, is there a -- tend to a more efficient way to raise revenue compared to other ways?
MR. ENTIN: Any of the saving consumption neutral taxes would have about the same economic consequence, which is less damaging than using a tax system which taxes saving, taxes the returns on saving, adds the corporate tax and adds an estate tax. The neutral taxes do less damage per dollar of revenue raised.
SEN. BAUCUS: And what would neutral be, an example -- neutral tax?
MR. ENTIN: The business activities tax, the VAT, the flat tax, the sales tax or the consumption-based income tax where you put down your income, subtract your net saving and pay tax on the difference, which is my favorite and is described in the testimony. Any of those are really the same tax base.
SEN. BAUCUS: Okay.
MR. ENTIN: But they're collected in different ways. Some would have it collected at the cash register.
Some would have it collected in stages as you pass from one level of production to another. That's called the value-added tax. The flat tax, that's a slightly different way.
It's not the collection process that's the problem with the inefficiency in the tax system. It's the damage that the tax system does for every dollar raised in discouraging saving, investment and work effort. The economic cost for each dollar that you spend is about another $1.50. Every dollar of spending you do costs about $2.50, even more if it's a tax on capital. And that's the inefficiency you need to address.
SEN. BAUCUS: Dr. Gale?
MR. GALE: Thank you. There's sort of a local answer and a global answer.
The global answer might be more of a if you could do anything you want not subject to political constraints, then I think a lot of what Steve said applies.
If you're starting from the current system in a world with political constraints and a variety of other concerns that we've heard about, I think the best way to get to efficiency is to remove the uneven taxation of similar activities. What that means is going after forms of income that are sheltered, removing the shelter, going after forms of income that are taxed two times, removing the double taxation, making sure everything gets into that base.
I hate to sound like a broken record, but that comes back to the first thing I mentioned, again, which is broadening the tax base, and then using that as an instrument for reform is probably the most efficient way right now.
SEN. BAUCUS: Could you -- Dr. Burman, do you want to address that?
MR. BURMAN: I just want to say that it'd be easy to come up with an efficient tax system, but it wouldn't be fair. I mean, Steve Entin made it sound like that the reason that rich people are rich is because they work harder than poor people. I make 10 times as much money as my dad ever did and I do work hard, but so did he. I was just lucky. I had great parents and I've had a good education.
So I think there is a role in the tax system in mitigating economic inequality as well, and that's really the trade-off.
SEN. BAUCUS: Dr. Gale, I'm curious about how you'd merge the payroll tax with the income tax.
MR. GALE: You can do it in a number of ways. The basic idea is that you could -- or a simple way to do it is if you don't want to merge the systems because the payroll tax pays for Social Security benefits, you can administratively get the same effect by offering a credit, a refundable credit, in the income tax system for payroll taxes paid.
SEN. BAUCUS: And that, you think that's a good idea, you suggest that?
MR. GALE: I think that -- it's in the testimony; yes, I think that is a direction that we should be looking at, reforming the system in the sense of taxing all income once and taxing it under the same sort of low rate structure.
SEN. BAUCUS: All our discussion here has been assuming the relative confines of the United States of America. We'll have other hearings on international competitiveness. But if there are any -- or do any of you have any thoughts about how we're doing as Americans versus agree we might be shooting ourselves in the foot -- shouldn't we be paying more attention to how other countries structure their systems as we have this discussion here today on the individual side?
Dr. Burman?
MR. BURMAN: Right. Yeah, I think we do. But it's not so much that we're competing with other countries on the tax side, it's that we're, you know, affecting the efficiency of our own companies. Probably the biggest area in which we fall short is that we have a corporate income tax system that has among the highest rates in the world, and we collect relatively little revenue as a share of GDP because there's so many loopholes, preferences, deductions.
And economists would probably mostly agree that the ideal thing would be to collect corporate tax and basically collect it from individuals as an integrated tax system. But if we're not going to do that, there seems to be a preference to have this two-level tax system in the U.S.
The better thing would be to broaden the base, try to lower the rates, and we could easily do that and bring it in line with corporate taxes and among our major trading partners.
SEN. BAUCUS: Anybody else?
MR. ENTIN: You have to be careful about base broadening. If you end up double counting some income, you have said, all right, put down your income on line one, double it on line two, and then send in half the amount that you were sending in before, as far as the rate is concerned, you haven't done anything.
So be careful which of these loopholes that you close. We closed a lot of loopholes in '86 and I'm not sure there are that many left.
On the international side, we're not really competing with other countries. What we're doing, even if China did not exist, is we have a tax system that is very much biased against anything using physical capital and, to some extent, against education and training. And we're hurting ourselves that way.
If we went to a neutral system, we'd have gone as far as we need to go, both domestically and in the international arena, and at that point the only thing we could do better would be to shed some of our spending obligations so that we could lower the rates. But if people want the spending to go through the government, they'll have to have the higher rates.
SEN. BAUCUS: One thing I take away from all of you so far is base broadening and a lower -- you know, lower the rates, broaden the base in some way or another. Is that right? I assume Dr. Gale thinks that. Do others of you think that's -- you talked about a consumption tax with a broad base.
MR. ENTIN: I want to change the base from income, as Professor Simons (sp) and others since have defined it, and to get more toward a consumption base. I'll still make it progressive for you, but I don't want the double taxation and triple and quadruple taxation you sometimes have on saving and investment. That is a sense, narrowing the base, but you get a bigger capital stock and you get a bigger economy, and in that sense, the base is broadened.
SEN. BAUCUS: My time has expired, but the question I have is transition costs, too, to move from one income tax system to a consumption-based system. And some suggested that's additional cost we just have to bear, and I don't know how valid that is.
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