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Camp Announces Hearing on How the Tax Code’s
Burdens on Individuals and Families Demonstrate the Need for Comprehensive Tax Reform ________ HEARING BEFORE THE COMMITTEE ON WAYS AND MEANS U.S. HOUSE OF REPRESENTATIVES ONE HUNDRED TWELFTH CONGRESS FIRST SESSION April 13, 2011 SERIAL 112-09
Printed for the use of the Committee on Ways and Means
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COMMITTEE ON WAYS AND MEANS
DAVE CAMP, Michigan, Chairman |
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WALLY HERGER, California |
SANDER M. LEVIN, Michigan CHARLES B. RANGEL, New York FORTNEY PETE STARK, California JIM MCDERMOTT, Washington JOHN LEWIS, Georgia RICHARD E. NEAL, Massachusetts XAVIER BECERRA, California LLOYD DOGGETT, Texas MIKE THOMPSON, California JOHN B. LARSON, Connecticut EARL BLUMENAUER, Oregon RON KIND, Wisconsin BILL PASCRELL, JR., New Jersey SHELLEY BERKLEY, Nevada JOSEPH CROWLEY, New York |
JON TRAUB, Staff Director
JANICE MAYS, Minority Staff Director
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C O N T E N T S
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WITNESSES
Alan Viard
Resident Scholar, American Enterprise Institute
Testimony
Annette Nellen
CPA, Director, Masters of Science in Taxation Program, San Jose State University
Testimony
Mark E. Johannessen
CFP, Managing Director, Harris – SBSB
Testimony
Neil H. Buchanan
Associate Professor of Law, The George Washington University
Testimony
Burdens on Individuals and Families Demonstrate
the Need for Comprehensive Tax Reform
U.S. House of Representatives,
Committee on Ways and Means,
Washington, D.C.
________________________
The committee met, pursuant to notice, at 10:02 a.m., in Room 1100, Longworth House Office Building, Hon. Dave Camp [chairman of the committee] presiding.
[The advisory of the hearing follows:
*Chairman Camp. The committee will come to order for a hearing on how the tax code’s burdens on individuals demonstrate the need for comprehensive tax reform.
We meet today to continue our dialogue about what I hope will result in a bipartisan path forward to reform our federal income tax system. While there has been a lot of valuable discussion about the impediments the tax code creates for America’s job creators, and we will certainly continue that discussion over the time ahead, today’s hearing will focus on the burdens imposed by the current federal income tax system on individual taxpayers and families.
Today’s hearing is especially timely since each one of us likely knows a family that is racing to file their taxes before this year’s April 18th deadline. And because of the thousands of amendments to the tax code enacted over the past quarter century, this race to the finish has become increasingly challenging over the years.
And since the Tax Reform Act of 1986, the last comprehensive tax reform enacted by the Congress, the code has become a maze of increasingly complex credits, deductions, exclusions and exemptions.
The challenges created by the tax code for job creators and families are rooted in a similar place. The tax code is too complex, too costly, and takes too much time to comply with. Whether it is the compliance with administrative burdens, or the impact of temporary and expiring tax provisions, today’s tax code is hampering the ability of individuals and families to plan their finances with reasonable certainty.
With nearly 4,500 changes in the last decade, 579 of them in 2010 alone, the code is too complex. Adding to that complexity is the fact that each tax code provision is a little bit like a cell. Each one has its own distinct features, characteristics, and life span. For example, over 200 federal tax provisions are scheduled to expire between 2010 and 2020. Whereas, in 1998, there were only 50 expiring provisions.
And while 20 years ago, it was mostly businesses affected by the temporary nature of tax provisions, now families and individual taxpayers are held captive to the calendar. For example, tax rates on ordinary income and on investments, the amount of the child tax credit, the deductions for state sales taxes and college tuition, just to name a few, are all temporary in nature.
Given the complexity created by the ever‑changing tax code, it is easy to understand why compliance with it has become too costly for American families. According to the National Taxpayer Advocate, in 2008 alone taxpayers spent $163 billion complying with the individual and corporate income tax rules ‑‑ that’s billion, with a “b.” These costs impede the ability of individuals and families to put together their household budgets.
And since provisions may change from one tax filing season to the next, it is no wonder that almost 9 out of 10 families either hire tax preparers or purchase software in order to calculate their taxes. This is a sad reminder that we now have a code that can only be managed if you happen to be someone who can hire an expert to deal with its challenges.
And not only is the tax code too complex and too costly, it takes too much time to comply with. Navigating through the tangled web of the tax code has resulted in taxpayers spending over six billion hours annually to comply with the code. Ask any family, and I am sure they will have a long list of better ways they could be spending their time.
Although it will require a lot of hard work on our part to achieve consensus on a solution, I think it is safe to say that we all agree that the current tax code is broken. We can do better. The members of the Joint Committee on Taxation had a very positive conversation with two key architects of the Tax Reform Act of 1986 during last week’s JCT roundtable discussion: Secretary James Baker and Congressman Dick Gephardt. Their message was clear. It will take the leadership of this Congress and the White House to get this done.
The American people deserve a tax code that is responsible and responsive to their needs. We can do our part by working together to make sure that this one is fairer and simpler for all families. And I look forward to hearing from our witnesses today.
And with that, I yield to Mr. Levin for his opening statement.
*Mr. Levin. Thank you very much, Mr. Chairman. The announcement for this hearing stated that, “Congress and the President need to work together to achieve a tax system that is fair, simple, and efficient. While some seem to prefer a business‑only approach to tax reform, we owe it to the hard‑working taxpayers we represent to ensure that they are not left out of this discussion.” I very much agree with that.
The kind of tax reform proposed in the Republican budget would reduce taxes for the very highest earners, and increase the burden on working families. These reductions for the highest earners come on top of the nearly $700 billion in additional tax cuts the Republican budget assumes for taxpayers with income above $250,000, almost 80 percent of which go to people making more than $1 million.
As we consider complexity in the individual tax system, we must be sensitive to the reasons provisions were enacted in the first place. Our goal should be to strengthen provisions that help working families send their kids to college, save for retirement, or simply make ends meet.
The Republican budget indicates that the individual and corporate rates will be reduced from 35 to 25 percent, but leaves it up to this committee, the Ways and Means Committee, to fill in the details. To do so in a deficit‑neutral manner, some estimate that we would have to eliminate more than $2.9 trillion worth of tax expenditures over the next decade.
The Child Credit, Earned Income Tax Credit, American Opportunity Tax Credit, and retirement savings accounts are primarily middle and lower income provisions. The need for simplification cannot be used as a rationale for irrational inequity, or for undoing progress that helped foster the growth of the middle class in this country.
So I look forward, Mr. Chairman and colleagues, to continuing this conversation, and hearing today’s testimony, and I join in thanking all the witnesses for participating. I yield back.
*Chairman Camp. All right. Thank you very much. We have four witnesses today: Alan Viard, resident scholar of the American Enterprise Institute in Washington, D.C.; Annette Nellen, CPA, director, masters of science in taxation program at San Jose State University in California; Mark Johannessen, a CFP managing director, Harris ‑‑ SBSB, McLean, Virginia; and Neil Buchanan, associate professor of law, the George Washington University, Washington, D.C. Thank you all for being here.
Under our rules, you each have five minutes. We have your written testimony. You each have five minutes to summarize your statement, whereupon, after the panel completes all of their testimony, we will go to Member questions.
So, Mr. Viard, you may begin. You have five minutes.
STATEMENT OF ALAN D. VIARD, RESIDENT SCHOLAR, AMERICAN ENTERPRISE INSTITUTE, WASHINGTON, D.C.
*Mr. Viard. Chairman Camp, Ranking Member Levin, members of the committee, it is an honor to be here today to testify about the tax code’s burdens on families and individuals. Let me note that the views I express today are my own, and do not represent the views of the American Enterprise Institute, or any other person or organization.
In keeping with the theme of this hearing, I will focus on the complexity affecting individual taxpayers with non‑business income. Of course, as the members of this committee are aware, there is also a significant degree of complexity affecting tax returns that contain business income, and that includes not only the corporate income tax returns that C corporations file, but also the individual income tax returns filed by owners of pass‑through firms.
But I will not discuss those today. Nor is there time to discuss all of the provisions that add to the complexity of the code. Mr. Chairman, you mentioned the billions of hours that taxpayers spend on their returns. I will have to focus today on three specific areas: the needless complexity of the incentives for saving, education, and families in their current design; the proliferation of income‑based phase‑outs in the code; and the alternative minimum tax.
And, as I will emphasize throughout my testimony, these problems can be addressed separately from such contentious issues as the appropriate level of revenue, the appropriate degree of progressivity in the tax code, or even the appropriate breadth or narrowness of the tax code.
I believe that these issues should be addressed as part of comprehensive tax reform, if such reform is adopted, but should also be addressed separately, if comprehensive reform does not occur. And I think it’s an opportunity for members of both parties to work together to eliminate this needless complexity.
The first area that I want to examine is the complexity of the current tax incentives for saving, education, and children. As Ranking Member Levin mentioned, these provisions play important purposes in the Internal Revenue Code. But their current design today suffers from needless complexity that actually undermines their efficacy.
These problems have been documented by such sources as the Joint Tax Committee, the National Taxpayer Advocate, and the 2005 President’s Advisory Panel on Federal Tax Reform. So I do not detail them here in my oral remarks. And even in my written testimony, I rely primarily upon the findings of those previous studies.
Just to state the matter briefly, the current tax system provides more than 20 tax‑preferred savings accounts and plans, multiple tax preferences designed to encourage education, and a wide array of incentives for families and children, including both a credit and a deduction for the children in typical households. The National Taxpayer Advocate, the President’s Advisory Panel, and the Joint Tax Committee have all proposed ways to consolidate these incentives, while still allowing them to fulfill their essential purpose, and also promote greater uniformity of rules across the handful of incentives that might remain.
Let me next turn briefly to income‑based phase‑outs. There are more than a dozen provisions in the tax code that phase‑out or phase‑down tax credits or exclusions or deductions, as income rises. These are measures that promote progressivity in the code. And, like other measures that promote progressivity, they increase the effective marginal tax rate that taxpayers face. But compared to changes to the explicit rate schedule, income‑based phase‑outs are generally an inferior way to promote progressivity. They make it more difficult for taxpayers to know the true marginal rate that they face, and they require taxpayers to complete an array of worksheets to apply the income‑based phase‑out that applies to each provision.
Moreover, there is no rhyme or reason as to how the income‑based phase‑outs work across different provisions. Some of them are indexed to inflation, some are not, and they treat family status in different ways, and so on.
So, in general, transparency and simplicity can be advanced by eliminating most of the income‑based phase‑outs, while making appropriate adjustments to the rate schedule to achieve any desired degree of progressivity.
The final problem I want to address is the alternative minimum tax, a parallel tax system that disallows some, but not all, of the tax preferences that can be claimed under the regular income tax. More than four million tax payers are currently subject to the AMT. If the annual patch that Congress passes to address the AMT were to expire, more than 30 million taxpayers would become subject to this parallel tax system.
The AMT represents an attempt to curtain the use of certain tax preferences, but it does so in a capricious and needlessly complex manner. Whatever preferences are desired in the tax system can be provided in the regular tax system. Whichever ones need to be curtailed can be curtailed within the regular tax system without having to put taxpayers through a second tax system with a completely separate set of rules.
In summary, Mr. Chairman, I believe that these are areas that can be addressed on a bipartisan basis, because they do not raise some of the contentious ideological and philosophical issues raised by such things as the level of revenue or the level of progressivity that the tax system has. Certainly this complexity is a problem that the American people face, but it’s also an opportunity for members of both parties to work together to give the American people a better tax system.
Thank you, Mr. Chairman.
[The statement of Mr. Viard follows:]
*Chairman Camp. Thank you. Thank you very much.
Ms. Nellen, you have five minutes.
STATEMENT OF ANNETTE NELLEN, CPA, DIRECTOR, MASTERS OF SCIENCE IN TAXATION PROGRAM, SAN JOSE STATE UNIVERSITY, SAN JOSE, CALIFORNIA
*Ms. Nellen. Good morning, Chairman Camp, Ranking Member Levin, and members of the committee. My name is Annette Nellen. I am a tax professor at San Jose State University. I am a member of the American Institute of Certified Public Accountants, and the chair of its individual income taxation technical resource panel. Prior to joining San Jose State, I worked at Ernst and Young and the IRS. My testimony today is based on my 20 years of experience working on tax reform and simplification.
Thank you for the opportunity to appear today and provide testimony on the serious complexity problems that burden individuals and families and weaken our tax system.
Our current tax law is often incomprehensible. Its complexity imposes burdens on individuals, in terms of time and out‑of‑pocket costs, and increases the tax gap. A tax system should follow the principle of simplicity. That is, the tax law should be simple, so that taxpayers can understand the rules and comply with them correctly and in a cost‑efficient manner.
As noted in our written testimony, there are several commonly‑encountered areas of the tax law that frustrate individuals, generate filing mistakes, and lead to missed opportunities to take full advantage of incentives. I will briefly address a few of these complexities, as well as some possible solutions to illustrate that much complexity can be avoided.
First, there are 14 tax rules that offer some incentive for higher education. While all the rules have a common purpose, the definitions, eligibility, and income phase‑outs vary. Further, use of one benefit likely precludes use of another, making it difficult to know which is the best incentive to use. This confusion leads some individuals to forgo the tax benefit all together, and some to claim credits beyond what they are entitled to. The AICPA recommends, at a minimum, consolidating the education provisions, and providing uniform definitions.
Another area in need of simplification is the kiddie tax, which was enacted in 1986 to prevent parents from shifting tax liabilities on investment assets to their children, in order to lower their rates. These rules can apply to children under the age of 18, or full‑time students up to age 23. Challenges with the kiddie tax include obtaining the required information and interaction with AMT and capital gains. The AICPA recommends using a separate rate structure for children subject to the kiddie tax.
Another point of confusion stems from use of due dates that are not what an individual would expect. For example, an individual with a foreign financial account who needs to file a special form known as FBAR, must file it by June 30th, an odd due date in the tax system. We recommend October 15th, the extended due date for Form 1040.
Another significant area of complexity affecting a growing number of individuals each year is the AMT. The AICPA recommends that the AMT be repealed. A second tax system is unnecessary. It is burdensome in terms of record‑keeping, calculations, and the confusion it causes individuals when, for example, they think their state taxes are deductible, only to find that they are not, because they are an AMT.
In addition, phase‑outs complicate tax calculations and planning. For example, the $1,000 child credit starts to phase out or reduce once a married couple’s income reaches $110,000. However, income levels and measures of income for the phase‑outs vary among incentives, leading to confusion. We understand phase‑outs exists to prevent higher‑income individuals from reaping full benefit of any favorable tax rules. In effect, though, phase‑outs disguise an individual’s true marginal tax rate and make it difficult to know if a tax incentive is truly available to you.
The earned income tax credit is another area of complexity. Any reform effort should take into account the difficulties of administering this significant program, and reduce its complexity.
Lastly, much frustration is due to the numerous temporary provisions in our tax law. Many temporary provisions are routinely allowed to expire for a period of time, then are temporarily reinstated. This leads to confusion, frustration, and often, less than ideal use of an individual’s financial resources.
For example, when the AMT patch is not in place at the start of a year, many individuals must include AMT in their quarterly estimated tax payments. Or, when the exclusion for employer‑provided education expires, employers might stop offering the benefit, or employees may opt out, due to the tax consequences, as they cannot rely on the provisions being retroactively reinstated.
The AICPA looks forward to assisting you in reducing the many compliance and planning burdens that the tax system imposes on individuals and families. Thank you for this opportunity to testify. I look forward to your questions.
[The statement of Ms. Nellen follows:]
*Chairman Camp. Thank you very much.
Mr. Johannessen, you have five minutes.
STATEMENT OF MARK E. JOHANNESSEN, CFP, MANAGING DIRECTOR, HARRIS SBSB, MCLEAN, VIRGINIA
*Mr. Johannessen. Chairman Camp, Ranking Member Levin, and esteemed members of the House Ways and Means Committee, thank you for inviting me here today to speak to you on behalf of the Financial Planning Association. My name is Mark Johannessen. I am a certified financial planner at Harris SBSB, a firm in McLean, Virginia. In addition to being a planner, myself, I served on the Financial Planning Association’s board of directors for six years, and served as elected president in 2008.
Much of the difficulty in understanding our tax system arises from the ever‑changing provisions of the code. In 1986, the goal of tax reform was to make the code more fair and simple. Since that time, there have been tens of thousands of changes and additions, each with its own set of rules, requirements, and phase‑outs. Congress as also added provisions that are designed to encourage certain behaviors. Many of these changes have the support of financial planners, such as tax preferred savings vehicles for medical, education, and retirement needs. Nonetheless, all tax incentives should be regularly reviewed by this committee to ensure they effectively meet Congress’s policy goals.
Even with my additional education, training, and experience, I know that only professionals completely dedicated to understanding the principles of the tax code are able to complete a tax return for all but the most simple of filings. If the interplay of various provisions confuses trained financial professionals, imagine the plight on the average citizen. Today, the most basic tax provisions are in a constant state of flux. The inability to predict, even in the medium term, the future rates in income, capital gains, and dividends, makes financial planning more challenging and expensive for consumers. All too often I have observed consumers holding off on making important plans while they wait for Congress to act.
I have some specific examples in the time I have remaining. It is well referenced so far, the complexity that AMT, the alternative minimum tax, brings to the average taxpayer, with 30 million folks ultimately possibly being affected if no patch is enacted ear year. So I will limit my time to discussing the financial planning issues.
Under current law, the top rates on dividends will nearly triple, from 15 to 43.4 percent in January 2013. The long‑term capital gains rate will also increase from 15 to 20 percent. This is already affecting investment decisions, as individuals shift their choices to maximize their after‑tax profits. In some cases, we are seeing investors choosing stocks that will produce more capital gain, or perhaps tax‑free investments like municipal bonds. And the impact on the capital markets of a permanent tax code should not be overlooked.
Starting in 2010, a greater number of taxpayers were allowed to convert their traditional individual retirement accounts, their 401(k)’s and 403(b)’s, to an after‑tax Roth account. For most investors, the question that determines whether to undertake this conversion is whether one will be higher or lower income taxes in their retirement. Many people can estimate their likely income bracket, but they must also make a best guess about what the tax rate will be ‑‑ will be in their retirement.
And then, finally, in 2010, individuals faced another decision of whether to elect to pay the entire tax on their conversion in 2010, or split it over ‑‑ through 2011 and 2012 returns. Because rates were scheduled to increase, many decided to take the tax hit in 2010. And this caused general confusion, as we approached the end of the year.
Charitable contributions have become one of the provisions of the tax extenders exclusions, where exclusions from income up to $100,000 can be distributed or transferred directly to a charity. And if we can look at 2010 alone, when the extension didn’t occur until December 17th, I believe many, folks had already made their minimum required distributions at that time, and so it somewhat muted the actual impact for charities and for our clients to take advantage of a tax advantage.
Estate planning is another area well addressed, I am sure, by this committee.
So, in closing, in its effort to appeal to constituent concerns, Congress has killed the code with its kindness, loading it up with thousands of special breaks and exemptions. While the goal to encourage certain behaviors is laudable, the sheer magnitude of these special breaks and exemptions has made the income tax system unmanageably complex. I would urge this committee to work together to pass tax reform. Thank you.
[The statement of Mr. Johannessen follows:]
*Chairman Camp. Thank you.
Mr. Buchanan, you have five minutes.
STATEMENT OF NEIL H. BUCHANAN, JD, PH.D., ASSOCIATE PROFESSOR OF LAW, THE GEORGE WASHINGTON UNIVERSITY, WASHINGTON, D.C.
*Mr. Buchanan. Chairman Camp and Ranking Member Levin and members of the committee, I am an economist and a professor of tax law at the George Washington University. Thank you for giving me the opportunity to address the committee today.
At the risk of stating the obvious, there are many areas of the Internal Revenue Code that could benefit from rationalization and simplification. In areas in which multiple provisions have accumulated over time, such as retirement savings and education incentives, the same incentives and benefits surely could be provided in a simpler fashion.
That being said, I hope through my testimony to warn the committee of some red herrings, issues that need not be addressed as you work to simplify the lives of Americans who honestly try to comply with the tax laws. Clearing away some tempting distractions will, I hope, provide more clarity and time for the committee to focus on genuine tax simplification.
First, the committee should be wary of reducing tax complexity without reducing what we might call overall complexity. A simple way to reduce the complexity of the tax code, after all, would simply be to stop running certain benefits through the tax code, and instead, run them through some other agency of the government. The mortgage interest deduction, which is about housing, could be turned into a benefit run by the Department of Housing and Urban Development. The Earned Income Tax Credit, which is a benefit to workers, could be run by the Department of Labor. Doing either of those things, however, would do nothing to make the lives of American taxpayers less complicated. If anything, compliance burdens would become even more onerous, as our citizens would now have to deal not just with the IRS, but with newly created administrative arms of other cabinet departments, or mini IRS’s, which would also add to federal spending, by the way.
The IRS has the advantage of being a single agency with which citizens interact, and it is the logical agency to provide incentives and benefits, the eligibility for which are conditioned on income levels. In addition, decades of experience have shown that the IRS and its employees possess the expertise, dedication, and experience, notwithstanding years and years of chronic underfunding, to handle the administration of important benefits that we administer currently through the tax code.
Second, reducing the number of tax brackets is not an important aspect of simplifying taxes, and it has the undesirable effect of making the tax code less progressive. Some analysts have asserted that the existence of multiple brackets is confusing, making it more difficult for taxpayers to figure out how much taxes they owe each year. In fact, all of the work and uncertainty involved in tax compliance is related to what happens before tax rates even become relevant. That is, once a taxpayer has determined his or her taxable income, it takes merely a few seconds ‑‑ and I repeat, seconds ‑‑ to look at the relevant table to determine the tax owed. We could have 10 or 20 tax rates without increasing the compliance burden. The taxpayer’s uncertainty is in figuring out what to include, exclude, deduct, credit, and so on, not in dealing with different tax rates.
Third, as a related matter, the existence of so‑called phase‑outs is not inherently complicated, either. Again, the difficult part of the process is in figuring out whether a person is eligible for a particular provision. The arithmetic involved in the phase‑outs is a relatively simple after‑thought, and the IRS is perfectly capable of providing simple tables to assist the taxpayer in determining how a phase‑out alters the final tax computation.
I should add the qualification that phase‑outs can pile up, with a different phase‑out for each of several different tax provisions, which does complicate compliance somewhat. I offer an example of how to deal with this problem in my prepared testimony.
In addition, it is important to remember that phase‑outs serve two important purposes. First, they are a way to means-test benefits, benefits that, after all, cost the Federal Government money. Second, phase‑outs avoid abrupt all‑or‑nothing changes to tax benefits, with a taxpayer suddenly losing all of a benefit after hitting an income limit or some other arbitrary threshold.
My message today, Mr. Chairman, therefore, amounts to taking three items off the list of possible approaches to tax simplification.
First, taking policies out of the tax code and out of the IRS’s jurisdiction can make citizens’ lives more complicated, rather than less so, as it would simply relocate the complexity that our citizens face, rather than actually reducing complexity.
Second, the number of tax rates is a non‑issue, as far as complexity and compliance burdens are concerned.
And third, the existence of phase‑outs is nearly a non‑issue, and the complexity of phase‑outs can be all but eliminated by harmonizing phase‑outs across all provisions that Congress chooses to means-test.
The committee’s work is daunting, involving important work in eliminating and combining duplicative and sometimes ineffective tax benefits. That work will be difficult enough without becoming distracted by false promises of reduced complexity.
I hope that my testimony will prove useful in directing the committee away from those distractions. Thank you.
[The statement of Mr. Buchanan follows:]
*Chairman Camp. All right. Thank you. Thank you all very much.
The President’s Economic Recovery Advisory Board issued a report in August of 2010, also known as the Volcker Report. And in that they also underscore how complex our tax code is, and even say that the cost of compliance is about 1 percent of GDP annually and that those costs are actually more than 12 times the IRS budget, really about $.10 on every dollar of income tax that is collected.
I am interested in one particular area right now. Mr. Viard, in your testimony you note there are over 20 tax preferred savings accounts and plans in the code. And the Volcker Report also talks about those, as well. And I just wanted to talk with you a little bit more about them.
From a tax administration standpoint, what is the impact of having so many different savings accounts and plans, in terms of IRS oversight and taxpayers’ ability to really assess those and use those plans?
*Mr. Viard. Well, thank you, Mr. Chairman. I think that the proliferation of accounts creates complexity at several different levels. The IRS has to promulgate regulations governing each of these accounts, and the rules are different, with respect to the income limits and the contribution limits, as to how much can be put into the account, and also the rules for withdrawal, what types of withdrawals incur penalties, and such not.
But I think the biggest grounds for concern arises at the individual taxpayer level. It is very difficult for taxpayers to choose between these accounts. And one of the interesting findings that I mention in my written testimony which comes from the National Taxpayer Advocate’s 2004 report, is that 30 percent of taxpayers who were eligible for a 401(k) and chose not to participate in it cited the complexity as one of the reasons for not participating.
So, I think one of the real grounds for concern is that the social purposes that are intended to be achieved by these provisions is undermined if the provisions are too complicated for taxpayers to take advantage of them. And, as you mentioned, Mr. Chairman, this problem has been documented, you know, numerous times by the Volker panel, the National Taxpayer Advocate, the Joint Tax Committee, the President’s Advisory Panel. So it is a long‑standing problem. And I think we know the general approach that can be taken to simplify these accounts, in terms of consolidating them, and making the rules more uniform.
*Chairman Camp. Mr. Viard and Professor Nellen, you both, in your testimony, point out that we have multiple tax breaks for higher education, and that there are inconsistent rules and criteria for these tax breaks, and that they cause complexity. Does the current design of these incentives, the complexity of them, and the fact that many of them expire frequently reduce their effectiveness? And I guess I would like to hear from both of you your thoughts on that.
*Ms. Nellen. Yes, I would say it is the confusion that the taxpayers would have as to what is available to them. The IRS instructions actually explaining these 14 provisions is an 86‑page publication which is just daunting.
They also ‑‑ these incentives try to do a few different things. Some of them are actually designed to encourage you to save for higher education. And others are going to be used when you are currently incurring costs of higher education. They could be consolidated into do you want to have just one credit, or should it be a deduction. Some of the provisions can be used together, some of them cannot.
And I know there has been studies by the GAO and TIGTA that there are people that are overlooking these provisions, I think probably just being overwhelmed by them. If a person is not getting assistance from a paid preparer knowledgeable in these, they are probably going to be overlooked. Your comment earlier about a good number of individuals also use software, the software actually might not be pointing out, “Gee, maybe you should be saving for education,” or, “Maybe you have, you know, a choice here and you should be planning next year to try and use this particular incentive.” So, I think being left to an 86‑page publication is just overwhelming.
In addition, many of these individuals would also be dealing with trying to get other forms of financial aid through what might be offered at the university, through state or Federal Governments. So it’s just adding to the overall complexity, because a tax code is one place they can get some educational support. But there are other places, as well.
*Chairman Camp. All right, thank you.
*Ms. Nellen. Thank you.
*Chairman Camp. Mr. Viard?
*Mr. Viard. I would really echo those comments, and particularly underscore the point about the limited role of preparers and software. You know, once the year is complete, and I have taken advantage of whatever provisions I may have availed myself of, of course a preparer or a software can help me compute my tax liability correctly, and to file the return properly. But it is much more challenging for the taxpayer to know what to do during the year, which options are available, which ones can be used without sacrificing the opportunity to use others, and which one will actually be most effective for the taxpayer’s particular situation.
Even if a preparer or software does offer advice on this, the advice may be ‑‑ may change from year to year, depending upon changes in the taxpayer’s circumstances, and of course, the legislative changes that you have mentioned, Mr. Chairman. So, I think the simple proliferation of these has surely undermined their effectiveness in achieving Congress’s goal of promoting education.
*Chairman Camp. All right. Thank you. Mr. Levin may inquire.
*Mr. Levin. Well, thank you very much for your testimony.
You know, Ms. Nellen, I think your reference to education is a good example. Clearly, we need simplification. But it cannot be at a cost of meeting needed purposes. There is a reason for a credit so people will save, and for a grant for those people who cannot afford it. And sometimes they are confused, and maybe that is one of the reasons why H.R. 1 reduced Pell Grants by $6.5 billion. We can have credits to stimulate savings. I don’t think that means we eliminate grants for people whose kids need help to go to college. I think we need to emphasize simplification, and remember what its purpose is.
I think also ‑‑ let me just ask you. Do you know the percentage of taxpayers who use either 1040EZ or 1040A? Do you have any idea?
*Ms. Nellen. Actually, I just looked at that last night. It’s about 60 percent, I think, use 1040. I think it’s 28 percent use 1040A and 12 percent use the 1040EZ from data based ‑‑ from the IRS ‑‑ on 2009.
*Mr. Levin. Yes, our data shows that about 41 percent use the EZ or A, while 59 percent use 1040. Do you know the percentage of those who file the 1040 and use the standard deduction?
*Ms. Nellen. Yes, actually, approximately two‑thirds of individuals claim the standard deduction, rather than itemize.
*Mr. Levin. So, it is clear. The vast majority of taxpayers use one of the more simplified forms, or they use 1040 and use the standard deduction, right?
*Ms. Nellen. Right.
*Mr. Levin. All right. I think we are all agreed about the AMT and the need to simplify it.
Let me just say a word about the phase‑outs quickly, because I looked at your chart, Mr. Viard, and welcome your testimony. It was perhaps more modulated than some people expected. But it is interesting to look at this. The majority of the phase‑outs passed in the later 1990s when the now‑majority was in control. It may well be that phase‑outs are often used for budget purposes, to make sure that the cost is kept down, no?
*Mr. Viard. Well, I think you are right, Mr. Ranking Member, that that is one of the motivations that underlie the use of income‑based phase‑outs. But, of course, it is always possible to avoid the use of the phase‑out and then to make an adjustment to the rate schedule instead, to keep both revenue and distribution roughly unchanged.
I mean, I think the relevant issue in each instance is: Do we have a reason, on policy grounds, why particular income groups should be denied the incentive for this particular type of behavior? If there is no reason to deny the incentive to a particular income group, then I think a phase‑out is unwarranted.
And if there is a concern, then, that a particular group, be it a high‑income group or any other, is receiving a larger tax reduction than would otherwise seem appropriate, then, of course, an adjustment to the rate schedule can address that in a manner that is more transparent and that still allows this group to benefit from the incentive for the behavior that Congress has decided to encourage.
*Mr. Levin. Mr. Johannessen, you end up by saying Congress has killed the code with kindness. Let me just say we have a problem with simplification, with complexity.
I just think we need to be careful in our rhetoric. A couple of weeks ago someone said in testimony, “Government is a disease.” And you do not say quite the same thing. I am not sure we have killed the code with kindness. That would seem to mean that the kindness was somewhat irrelevant. I do not think you mean that.
A lot of the provisions in our tax code ‑‑ take the mortgage interest deduction for example. Without it, the state of Michigan where, that Mr. Camp and I come from, and I think where most of us come from, would not have the middle class that it does today. Employer‑based health insurance would never have been created on a broad basis in this country without the exlusion. My time is up.
*Mr. Camp. Time has expired. Mr. Herger is recognized.
*Mr. Herger. Thank you, Mr. Chairman. I would like to thank our witnesses for your testimony.
When so many middle class families have to hire professional help just to figure out what they owe in taxes, it is clear that something is wrong. And I hope this committee can work in a bipartisan way to clear away some of this unnecessary complexity.
Mr. Viard, I would like to explore the issue you raised about the phase‑out of tax deductions and credits leading to high marginal rates. According to the Tax Foundation, when you add up the income tax, the payroll tax, the phase‑out of the earned income tax credit, a family of five making $48,000 a year faces an effective marginal tax rate of 42 percent. In other words, $.42 of each additional dollar they earn goes to paying federal taxes. It is my understanding that once the new health insurance exchange subsidies take effect, some low to middle income families could face a total marginal rate of well over 50 percent. And that is without taking into account state and local taxes, or non‑tax benefits like food stamps that are tied to income.
Mr. Viard, what is the economic impact of these high marginal rates?
*Mr. Viard. Well, thank you, Congressman. You have pinpointed an important problem that arises, or can arise from the use of income‑based phase‑outs. Because the marginal tax rates are not being explicitly and openly adopted in the Internal Revenue Code, it becomes possible, I think, for them to be set at levels that are higher than would ever be agreed to if they were presented explicitly on the table. If we were to say, “Do you want a 42 percent marginal tax rate,” I think that members of this committee and Members of Congress would think long and hard as to the advantages and disadvantages of that. But with the use of income‑based phase‑outs, these marginal tax rates are often difficult to detect, and they vary across different households, depending upon their circumstances and which tax breaks they are claiming.
In general, marginal tax rates have the potential to discourage the earning of income ‑‑ that is to say to discourage work, to discourage saving, to discourage doing things in taxable form, instead of in tax‑exempt form.
One thing that we do not understand well is how important the phase‑outs are in affecting behavior. Precisely because they are complicated, some people have suggested that people may not be aware of them, and that, therefore, their behavioral impact may be smaller than from explicit marginal tax rates. I am wary of that argument. Although I agree that most taxpayers do not understand precisely the rate they face, which is a problem of transparency, the proliferation of these income‑based phase‑outs, I think, contributes to the attitude that any attempt to earn additional income may trigger undesired tax consequences. So it creates an area of uncertainty that I think has its own set of disincentive effects.
*Mr. Herger. Would that same reasoning also apply to the phase‑outs you have described at the higher end of the income tax scale?
*Mr. Viard. Yes. I think that at every income level, you would anticipate some disincentive effects, and the amount of those effects depends upon which choices are available to the taxpayers in question. At high income levels, there may actually be greater scope for disincentive effects, because those taxpayers may have a variety of techniques available to them whereby they can reduce their taxable income. And the phase‑outs may prompt them to take steps to take advantage of those strategies and lower their taxable income.
*Mr. Herger. Thank you. That is very discouraging. It is very discouraging to those who would like to work their way up the income level to better themselves.
So, what I would like to ask both you and Professor Nellen is this. Would it be possible for us to reform the tax code in a way that achieves two goals at once: simplifying the tax system and making it easier to understand, while also eliminating these hidden marginal tax rates that have such a negative impact on the incentive to work?
*Ms. Nellen. I think some simplification certainly is possible. For example, on these phase‑outs, there are a few areas of complexity. One is that most of them start at a different dollar amount. But also, what that dollar amount is is not always defined the same way. Some of them are based on what your adjusted gross income, or AGI, is. Some are based on what is your modified adjusted gross income.
The definition of modified adjusted gross income can actually vary from incentive to incentive as to what that calculation is, just making it more difficult, for example, for a practitioner to explain to a client, “This is how this is going to affect you.” Instead they will just say, “I need to go double‑check what the calculation is and run the numbers.” So, some simplification could occur, just by standardizing the deduction as to how do you define what your income level would be. And it probably should just be maybe adjusted gross income, a dollar amount that is clearly right on the tax return, to then base the phase‑outs.
Some of the incentives, perhaps ‑‑
*Chairman Camp. I am sorry, his time has expired.
*Mr. Herger. And thank you. It sounds very, very complicated to me. Thank you.
*Chairman Camp. Mr. McDermott is recognized.
*Mr. Levin. Jim?
*Mr. McDermott. Okay. Thank you, Mr. Chairman. I noticed from the sparsity of the audience that the tax lawyers must be sitting in their office watching this, rather than being forced to come up here and look at this.
And I ‑‑ as I look at the complexity of the tax code, it seems to me that those folks who have money have plenty of people figuring it out for them. They don’t have any trouble figuring it out. And I am sure that they ‑‑ most of the complexity in the code is derived around the issue of how to get me out from under some of it. So, I do not worry about the people at the top of the tax code very much, because I figure they will be taken care of quite well.
So, my question to you is which of the tax provisions affect the middle class and below would you try and uncomplexify?
[No response.]
*Mr. McDermott. First, if you had one. I mean I assume this hearing is on the level, and it is really about making it better for the middle class in the country, rather than for the people in the top one percent or one‑tenth of one percent.
So, for the middle class, which one would you try and decomplexify?
*Mr. Viard. Well, Congressman, I think that the area that seems the most promising, in terms of simplification, is to address the savings and the education and the family incentives. As Ranking Member Levin mentioned, these provisions are significant to the middle class. And I think it is the middle class households that are affected by the complexity that I and the other witnesses have described.
So I think that would be a promising area to begin, in order to provide simplicity for middle class taxpayers.
*Mr. McDermott. And give me your solution. I mean we are gathering ideas here. This is a hearing. So I would like to hear your ideas about how you would decomplexify it.
*Mr. Viard. Well, to take the savings accounts, for example, the basic approach that I think holds the most promise is one that has been outlined in various forms by a number of people before me, and that involves simply consolidating the 20 different types of accounts.
We fundamentally want to encourage saving through employer‑based plans. We want to encourage saving by individuals for retirement. And we want to encourage saving by individuals for a range of other purposes, such as health and education. Those three purposes can probably be achieved by offering three different types of tax preferred savings accounts ‑‑
*Mr. McDermott. You mean replace?
*Mr. Viard. ‑‑ instead of 20.
*Mr. McDermott. Replace three with three new ones?
*Mr. Viard. No, I’m sorry, replace the 20‑some accounts that currently ‑‑
*Mr. McDermott. Ah, with three.
*Mr. Viard. ‑‑ serve those 3 purposes with 3 accounts. And then try to make the rules as uniform as possible across them. The President’s Advisory Panel on Federal Tax Reform outlined a reform along these lines. And options have been discussed by other groups, as well, that are very similar.
*Mr. McDermott. Why ‑‑ explain to me why this committee ‑‑ I mean nobody sits on this committee to think of how you can make the plans more complex. So, why did 20 plans get developed? Explain to me that process.
*Mr. Viard. I am not certain about the answer to that, Congressman. The accounts have arisen over the years. I think there has been a tendency at each point to address some specific problem in isolation from the accounts that already existed. I think the same process has occurred, for example, on the education incentives.
What I think this hearing offers is the opportunity to sit back and say, “Regardless of how we got here, let us take a look at these 20 different accounts, and see if they actually serve 20 different objectives.” And I think the answer is pretty clear that they do not. And we now have a range of organizations of diverse ideological backgrounds, and those that are not ideological, saying there are opportunities to simplify these, to step back and say, “Yes, let us not be shackled by the history of how these have developed,” but instead, try to find ones that will most effectively and simply achieve the purposes that Congress has set forth.
*Mr. McDermott. Mr. Buchanan, do you have any comments? Dr. Buchanan?
*Mr. Buchanan. Yes. Thank you, Mr. McDermott. I agree with most of what Mr. Viard just said. I do think that the Congress has enacted a lot of responses to individual concerns. If we think that people are not saving enough for health emergencies, for example we create health savings accounts, and similar benefits.
I do think that it makes sense to stop and shovel out the stables every now and then, because there is a lot of accumulated mess. It is appropriate to go back and combine various benefits into thematic groups, or take the different groups and combine them into one type of tax credit. If we believe that saving needs to be increased for retirement, then we should have one and only one retirement savings incentive.
*Chairman Camp. All right. Thank you. Mr. Johnson is recognized.
*Mr. Johnson. Thank you, Mr. Chairman. I think the word is “simplify.” I understand that word better than I do that other one they are using over there. Don’t you all?
Ms. Nellen, I appreciate your comments regarding the standard mileage rates. You rightly said in your testimony, “The IRS can increase these rates as it did last in 2008, when gas prices surged to $4.” I paid $4 yesterday, so it is there. As you may know, last month I called on the IRS to increase the mileage rates due to higher travel costs brought on by surging gas prices.
This headline by CNN Money has it right: “Gas prices in the firing range of an all‑time high.”
So, for the sake of those who use these rates, particularly our nations’ small businesses, I would hope that the IRS does the right thing and provides relief from the near‑record gas prices by increasing the mileage deduction. And I hope you would agree with me on that one.
But let me ask you a question. Since about 90 percent of the budget cost of earned income tax credit is in the form of outlays, rather than credits for actual tax liability, it appears the provision effectively is a credit against payroll tax, rather than income tax. Would you agree that a simpler way to deliver this tax benefit would be to reduce payroll tax liability in the first instance, rather than requiring taxpayers to engage in this circular flow of tax credits within the government?
*Ms. Nellen. Thank you, Congressman. On the earned income tax credit, you are correct, that that is really refunding all or some portion, or maybe even beyond what the Social Security is.
Actually, I had provided a paper on that topic to Joint Committee when they did the simplification study back in 2001. I and others had suggested that perhaps, if they could just not have to give the money in the first place, because they are giving it through their payroll withholding, but to stop that payroll withholding, so they would actually also have it on a weekly regular basis, that could simplify what the earned income tax credit is intended to do, and that would cause a few complexities for employers.
But I think that could be worked out. And there is probably some other improvements to the earned income tax credit that could simplify that. But if you could, just stop, you know, taking their money, only to give it back to them at the end of the year. That, hopefully, could simplify the process.
*Mr. Johnson. Yes. There is a whole bunch of things like that, isn’t there? I mean ‑‑
*Ms. Nellen. Well, earned income tax credit is a good example of that, because it is, in essence, refunding the Social Security ‑‑
*Mr. Johnson. We need her to help us simplify the tax code. What do you think? Thank you for your comments. Mr. Chairman, I yield back.
*Ms. Nellen. Thank you.
*Chairman Camp. All right. Thank you. Mr. Neal is recognized.
*Mr. Neal. Thank you, Mr. Chairman. Professor Nellen, I understand that you are testifying today on behalf of AICPA. And I have to say that your statement in support of repeal of alternative minimum tax is music to my ears. I have staked a career here on that issue.
I first filed a bill years ago that would, at that time, have repealed AMT when it only cost a few billion dollars. Now it has overtaken the regular income tax collections. Some of us have argued that the decision in 2001 not to deal with AMT saved the overall cost of the Bush tax cuts, and that the drafters did so knowingly. In fact, in 2001 a Treasury Department economist warned, “Indexation of AMT parameters, however, would not completely eliminate the sizeable increase in the percentage of AMT taxpayers through 2010 because of the post‑2001 growth in Tax Reform Act provisions.”
Even with indexation, the percentage ‑‑ indexation. Even with the percentage of taxpayers subject to AMT would increase by more than 200 percent between 2000 and 2010. So, while the lack of indexation has always been a contributor to the AMT problem, massive cuts in the regular tax were a major contributor, as well.
You have suggested that all new tax bills require the impact of AMT to be revealed [sic]. Can you explain how this provision would work, and why AICPA believes it is important?
*Ms. Nellen. Thank you, Congressman. When there are new provisions added ‑‑ the child credit would be an example of that that was added, I think, roughly 10 years ago. And when you are going to give individuals what then was a $500 credit ‑‑ now it is a $1,000 credit, temporarily up to $1,000 ‑‑ that would then generate the question, “Well, now your regular tax has gone down even lower. Is that going to make you more likely to pay AMT?”
If that is the case, then I think it needs to be evaluated. Do you want to put in the child credit in the first place? Because that is actually then causing the AMT to do what it should do. If your tax goes below a perceived minimum, you are going to owe the AMT.
*Mr. Neal. Okay. The growth in Tax Reform Act at that time neither fostered significant growth or tax reform, largely because there was no scrutiny of what the provision in the long term meant. And today, AMT, as I have already indicated, now is the tax code, in so many ways.
Mr. Viard, you were nodding your head, so I am going to give you a crack at this, as well.
*Mr. Viard. Well, Congressman, first let me applaud you for your work in trying to repeal the AMT, which I think is the ultimate solution to this problem. But I do agree with this proposal to have the AMT impact of new provisions looked at. And I think it is particularly important, because it almost helps emphasize why the AMT is a flawed provision to begin with.
If a new tax break is being offered, and a decision is being made not to allow it under the AMT, whether it be to reduce the revenue loss or whatever other purpose might be served, I think that it is appropriate for members of this body and for members of the public to ask themselves, “Why is the provision not being allowed under the AMT?”
If it is intended to serve an important public objective, then should it not be available to all taxpayers, not just those who are subject to one of two parallel tax systems?
And if it does not serve a valid purpose, if it is abusive in some sense, if it is a loophole that we want to curtail, then why is the provision being adopted in the first place?
So I think that this suggestion offers a good way to focus that question, and hopefully lead to the answer that we really want this provision to either be available under both systems or none. And then, following that logic, I think, would lead one to conclude that the ultimate solution is to simply repeal the AMT, as you have proposed.
*Mr. Neal. Mr. Johannessen, you are also nodding in the affirmative.
*Mr. Johannessen. I am nodding to the affirmative because I reflected back on the somewhat lack of transparency that the AMT code has allowed public policy makers to hide behind. While speaking and saying, “We are lowering taxes on one front,” it is actually increasing on the other.
So, yes, I am agreeing with exactly what they are suggesting here.
*Mr. Neal. Do any of you know what the cost of the 2001 bill would have been, if covered through 2010 with AMT?
*Mr. Viard. I believe that there would be roughly a $600 billion or greater cost for the AMT relief. It may be larger than that. It is certainly a significant item.
*Mr. Neal. Yes. Thank you very much. And, Mr. Buchanan, lastly, our Republican friends have expressed a willingness to use the vote on the debt ceiling as leverage to advance some policy goals. In your opinion, as an economist, would the economic benefit of moving a 25 percent top rate for individuals be worth flirting with default on the debt?
*Chairman Camp. And time has expired, so just answer quickly, please.
*Mr. Buchanan. Nothing would be worth threatening the creditworthiness of the United States.
*Mr. Neal. All right, thank you.
*Chairman Camp. Mr. Nunes is recognized.
*Mr. Nunes. Thank you, Mr. Chairman. I actually want to pick up where Mr. Neal left off. And maybe we will start with you, Mr. Viard.
In terms of the top rate ‑‑ this can go to all of you throughout the five‑minute period that I have if we were to simplify most of the code ‑‑ so, in other words, as you said, go from 20 different types of savings accounts down to 3, and take a lot of the inequities out of the code as much as we possibly can ‑‑ and I don’t know what this Congress can do, and I do not know what the Senate would agree to, and I do not know what the President would sign, so this is basically hypothetical, but if you could simplify the code, what should the top marginal rate be, and how would you structure the code, if you could?
*Mr. Viard. Well, Congressman, I think it is actually important to draw a distinction between simplification and base‑broadening. The type of simplification that we are discussing here today I think would not necessarily lead to significant reductions, or necessarily to any reduction in the statutory rates.
For example, if you did simplify the 20 tax preferred savings accounts into 3, that does not necessarily mean that they would be less generous.
*Mr. Nunes. Right.
*Mr. Viard. That would be a decision that Congress would have to make, and particularly the members of this committee. So you could decide to have 3 accounts instead of 20, to make it easier for middle class and other households to use them. But if they have the same revenue loss, then you actually do not achieve rate reduction.
Rate reduction, instead, requires a much more significant fundamental set of policy choices associated with base‑broadening, things that probably, you know, go far beyond what we have been discussing in our testimony.
Someone would have to make decisions, for example, does one curtail the tax preference for home mortgage interest? Do you curtail the preference for employer‑provided health insurance? Do you curtail or eliminate the state and local tax deduction?
*Mr. Nunes. What do you think, Mr. Viard? I mean you have worked on these tax issues a long time. I have worked with you on a couple different tax issues over the years. What road do you think the Congress should go down? Do you think we should broaden the base and really simplify the code?
*Mr. Viard. I do believe that the base should be broadened, Mr. Congressman, although I think that even a base ‑‑ even an income tax with a broader base is inferior to consumption taxation.
But personally, I do see areas for broadening the base, in terms of eliminating the state and local tax deduction, restructuring the preferences for employer‑provided health insurance and home ownership in ways that are more effective in providing basic health insurance, and allowing people to become home owners, rather than encouraging the spread of expensive homes and expensive health insurance policies. And I think if you adopt those type of measures, you can lower rates, certainly by several percentage points.
Again, though, I do want to stress those reflect fundamental policy debates that clearly are unrelated, at least at first glance, to the simplification that we are discussing here today.
*Mr. Nunes. Ms. Nellen?
*Ms. Nellen. Yes, I do agree with that. You know, generally though, a broader base and lower rates does also help the tax law meet additional principles of good tax policy. Things would be more transparent. If you are removing certain provisions, that makes it more clear, you know ‑‑ well, the tax law won’t affect your decision‑making as much as ‑‑ it should not be affecting your decision‑making. Make it more neutral.
So I think there should be consideration, as happened in the 1986 act, of lowering the rates and broadening the base. That is one way to get simplification. But as Mr. Viard says, there are ways to get simplification. So far as what the ideal marginal tax rate should be is certainly an important policy debate and should be considered. Distributional effects, as well, among the different income categories.
*Mr. Nunes. Thank you. Mr. Johannessen?
*Mr. Johannessen. I can tell you that last year was the first year in my 20 years of working with clients actually say what I have often heard in economic theory, which says as we approach a higher and higher tax bracket at the top, that people will be disincentivized for additional units of work.
And so, probably four or five different clients came to me last year and said, “How can I, next year, reduce my income, either by working less or by not creating, something that otherwise I might be creating?”
And so, I don’t know what the idea rate is. I do know that, as we approach 39.6 this year, it began to get people’s interest pretty significantly.
*Mr. Nunes. Thank you. Mr. Buchanan?
*Mr. Buchanan. When we discuss base broadening and rate reduction, that is usually done in the context of wanting to be revenue neutral. And I am a bit confused by that discussion in the context of the broader context here. Because, as I understand it, part of the concern overall ‑‑ especially later this afternoon, apparently ‑‑ is going to be about reducing long‑run deficits. And so I am not sure whether or not the ‑‑
*Mr. Nunes. So you would prefer the code to stay complex, rates to stay where they are at, and not broaden the base?
*Chairman Camp. All right.
*Mr. Buchanan. No, absolutely not. What I would prefer is that we broaden the base, and think about how that would affect revenues, and therefore, the long‑run deficit picture.
*Chairman Camp. All right, thank you.
*Mr. Nunes. I yield back. Thank you, Mr. Chairman.
*Chairman Camp. Mr. Becerra is recognized.
*Mr. Becerra. Thank you, Mr. Chairman. Thank you for your testimony.
Let me see if I could ask you all to help me do something. Mr. Viard, give me a number between one to three. Just give me a number between one to three.
*Mr. Viard. Two.
*Mr. Becerra. Two? Ms. Nellen, give me a number between 1 and ‑‑ is it Nellen? Ms. Nellen, a number between 1 and 800.
*Ms. Nellen. Seven hundred.
*Mr. Becerra. Seven hundred. Now, Mr. Johannessen, a number ‑‑ just give me a top or bottom.
*Mr. Johannessen. Top.
*Mr. Becerra. Top? Okay. Let us see. Here is a tax code. Number 2, 700, and top. So top is here, we are looking at section 1361 of the tax code, “Effect of Election on Corporation.” I suspect this particular section dealing with corporations won’t affect most individual tax filers. And I suspect we could go through this routine about 1,000 times and most of this random selection of a provision in the tax code would not affect most tax filers.
In fact, if you take a look at the forms that are available to tax filers, the 1040EZ, the 1040A, and the 1040 itself, most tax filers can file using the simple tax form, the 1040EZ, or the 1040A. The 1040EZ, if I am looking at it properly ‑‑ and I have it right here ‑‑ it has 13 items to be filled out. That is it, 13 items.
Now, the 1040, of course, is the one used by folks who have higher incomes. That has a lot of additions, a lot of supplemental filings with it. But the 1040EZ, which the IRS, in its instructions to tax filers, says to them, “You can use this 1040EZ form if your taxable income is below 100,000” ‑‑ and, by the way, 87 percent of the 143 million‑plus American tax filers earned less than $100,000 ‑‑ is “your filing status is single, or if you are married and file jointly, if you are under the age of 65 and not blind” ‑‑ that is a pretty easy one to determine ‑‑ “you are not claiming any dependents, and your interest income is $1,500 or less,” with today’s interest rates, you are probably having to earn pretty good interest to collect $1,500 in interest, some probably $50,000 in a savings account of some sort, or some kind of something that gains you an income, an interest income.
So, probably not a lot of folks who are at $100,000 or below, 87 percent of filers, who really have to go beyond the 1040EZ with 13 questions, or perhaps the 1040A. The reality is that the more than 2,300 pages in the tax code aren’t for people who earn $100,000 or less. It is for those who make more who need to use the 1040, because they have lots of different ways to reduce their tax burden, to the point where Warren Buffett has said that he likely pays a lower income tax rate than do the assistance and secretaries that work for Warren Buffett.
And, as the Bloomberg Business Week article of April 7th said, the top 400 income tax returns ‑‑ so the 400 wealthiest Americans, by income ‑‑ while their rates, their statutory rates, might be in the 30 percent, their effective rate, what they ultimately paid after they used all of these tax shelters and so forth, was just under 17 percent. That is higher than a lot of those middle income families that would file the EZ, 1040EZ, form. In fact, those 400 percent richest Americans pay at a lower rate than the next set of wealthy Americans, who pay probably about 23 percent. So the richer you get, the lower your taxes.
And the poor average worker, who makes ‑‑ who gets a paycheck every week or every month, doesn’t have to worry about trying to sneak through some of the tax code, because his or her money is automatically taken out of the paycheck.
And so, as we talk about complexity, I think we have to remember something. The complexity is created not by the average American making $100,000 or less, it is created by all those folks who make much more money who want to keep as much of their money with them as they can. And the reason you have 2,300 pages is not so that you can help the average stiff who works every day 9:00 to 5:00, it is to help the guy who doesn’t use the 1040EZ who is trying to shelter as much as he can.
And so, I hope that as you keep coming to testify before us, you will help us make sure we navigate this so we do not hurt the middle class as some try to protect the wealthiest Americans, who are doing very well on their own.
*Chairman Camp. All right.
*Mr. Becerra. Thanks very much.
*Chairman Camp. Thank you. Mr. Tiberi is recognized.
*Mr. Tiberi. Thank you, Mr. Chairman. Mr. Viard? I kind of want to say “Oh”, based upon your bio and your days at Ohio State. But you were there after I graduated.
You may have seen yesterday an Ernst & Young report come out. Are you familiar with that at all? It was a report regarding our tax code.
*Mr. Viard. I don’t think I saw that report, Mr. ‑‑
*Mr. Tiberi. All right. Well, it had to do with the corporate tax code and pass‑through entities. About a month ago we had a hearing here with respect to pass‑through entities. And today, the President is going to tell us something. He has talked before about doing corporate tax reform. And some in the Administration have talked about doing only corporate tax reform.
In your view, looking at our tax code today, if we did only corporate tax reform, and did not deal more comprehensively across the board, would that create inequities, in your opinion, more inequities than we have today?
*Mr. Viard. I think that would depend on how that reform was done. I certainly think that dealing only with the corporate income tax, you know, would be only a partial solution to the problems that affect our tax system today. There are clearly reforms that are needed for individual taxpayers of the type we have been discussing here, as well as some that we have not been discussing. As I said at the beginning of my testimony, I was not going to discuss the problems faced by individual owners of pass‑through firms. But, in fact, those regimes are needlessly complex.
I think it was interesting that the tax provision that Congressman Becerra chose at random was a provision pertaining to S corporations. And it is clear that we have some very complicated regimes governing pass‑through entities. We have a partnership regime, we have an S corporation regime, each of which is complex in itself, and each of which differs from the others.
And I think that it is absolutely right, as Congressman Becerra pointed out, that the individuals directly affected by this are high‑income individuals, in many cases. And so, I do not know that we need to feel compassion that they are struggling with this complexity.
But what I think all of us need to worry about is whether, as, you know, citizens and as members of an economy, whether the efforts of those individuals should be devoted to dealing with intricate tax provisions, or instead, should be devoted to business purposes, to the hiring of new workers, to the creation of new products that are demanded by consumers.
*Mr. Tiberi. That is where I was ‑‑
*Mr. Viard. And I hope that simplification ‑‑
*Mr. Tiberi. And that is where I was heading, actually, because the report that came out yesterday showed that a majority of business job creators and business owners were pass‑through entities, including S corps, and that if we raise the top rates on them, at the same time we were reducing corporate rates, we would actually impact a number of job creators in a negative way. And not only the complexity issue that has been talked about today, but also raising the rate, would have an impact on our economy.
And so, Mr. Johannessen ‑ did I say that right? For someone who gets his name mispronounced every day, I am sensitive to the way you pronounce your name. You said something in response to Representative Nunes I would like you to say again, with respect to something you have heard this year from some of your clients with respect to the tax code. Can you repeat that again?
*Mr. Johannessen. I believe what I said was that for the first time in my 20 or so years, that folks actually were asking what they could do to minimize their earnings potential because they wanted to try and avoid being pushed into the 39.6 percent tax bracket.
*Mr. Tiberi. That is the biggest headline that should come out of this hearing today. My mom and dad came to America, as I have said before, for a better life. And in America, it was endless potential. And when you have people, job creators, entrepreneurs, people who are trying to better themselves, take the tax code and go to one of their advisors and say, “How can I work less so I don’t get penalized by my government,” that is an incredible statement.
Representing the AICPA, Ms. Nellen, have you or any of your members heard that, or do you see a problem within our tax code that creates this thought process?
*Ms. Nellen. Congressman, I have not personally heard that. I have heard stories of that. I do think, in looking at the rates, I think it is ‑‑ going to hear more of that, because there are some additional rates coming into effect, Medicare tax coming into play at 3.8 percent on certain investment income. I think some might question, “Well, what exactly is my marginal rate?” And I think, just seeing additional taxes does perhaps also raise the question Mr. Johannessen is hearing from his clients.
*Chairman Camp. All right. Thank you.
*Mr. Tiberi. Thank you. I yield back.
*Chairman Camp. Mr. Pascrell is recognized.
*Mr. Pascrell. Thank you. Mr. Buchanan, good morning.
*Mr. Buchanan. Good morning.
*Mr. Pascrell. There is nothing more notoriously and pointlessly complex than doing your taxes twice. And you know my friend Mr. Neal has referred to the, you know ‑‑ in my own district, tens of thousands of people, we ‑‑ New Jersey ranks number one in AMT filings. There is a reason for that. And my own district, which is a moderate income to low income, it ranks within the 50th in the entire nation in AMT’s filed.
So, there have been numerous attempts, numerous attempts, to index the AMT, to patch it. There have been numerous attempts to repeal it. It is almost biblical. The common theme was that all of these policies were going to be paid for. So, the President’s 2012 budget paid for the AMT patch for three years by eliminating tax breaks for specific oil companies and millionaires ‑‑ very specific, rather than what we usually do on both sides of the aisle, eliminating loopholes, which can mean anything under the sun.
So, the Republican budget, Mr. Ryan’s budget, bootstraps the $1.5 trillion AMT repeal to the extension of the millionaire tax breaks. I find that to be most interesting. At a total cost of $4.2 trillion, according to the Tax Policy Center. That budget also looks to lower the top rate to 25 percent.
Mr. Buchanan, an AMT repeal was included in the 4.2 trillion tax break in the Ryan budget. Very specific. How much more would it cost to lower the top individual rate and top corporate rate to 25 percent? You have any idea?
*Mr. Buchanan. It would be in the trillions.
*Mr. Pascrell. Well, the answer is $2.9 trillion over 10 years, in addition to the 4.2 trillion already in the Ryan budget. That is quite a bit of money, isn’t it, Mr. Buchanan?
*Mr. Buchanan. Yes, sir.
*Mr. Pascrell. For a budget that is supposed to get us to the Promised Land.
*Mr. Buchanan. Yes, sir.
*Mr. Pascrell. It is not getting us to the Promised Land.
What are the options of paying for this rate reduction? What tax credits or deductions will have to be eliminated? All of them.
The President’s debt commission has a top rate of 25 percent. But it eliminated all tax expenditures, did it not?
*Mr. Buchanan. Yes.
*Mr. Pascrell. Okay. If we eliminated many of the complex tax preferences, such as the earned income tax credit, a favorite of President Reagan, or child tax credit, or the mortgage interest deduction, while extending the Bush tax cuts for top earners to pay for a rate reduction, wouldn’t lower and middle income individuals have a higher tax liability in the end, Mr. Buchanan?
*Mr. Buchanan. Yes, sir.
*Mr. Pascrell. Or else where would the money come from, Mr. Buchanan?
*Mr. Buchanan. I could not tell you. As far as I can tell from these plans, it boils down to saying, that one way to simplify is to raise the net tax burden on those making less than 200,000 a year.
*Mr. Pascrell. Of course it has to come from some place.
*Mr. Buchanan. Yes.
*Mr. Pascrell. Or else we will do what we did for eight years, not pay for anything.
*Mr. Buchanan. As I understand it, and my earlier response to Mr. Nunes was based on this when we are talking about eliminating these various preferences, we are broadening the base. But, as you describe, this is in a context where we are broadening the base in order to make up money that is being lost in terms of the rate reduction and the elimination of the AMT.
*Mr. Pascrell. Thank you so much, Mr. Buchanan.
*Chairman Camp. All right.
*Mr. Pascrell. And I yield back, Mr. Chairman.
*Chairman Camp. Thank you. Mr. Davis is recognized.
*Mr. Davis. Thank you, Mr. Chairman. I would like to follow up on Mr. Herger’s question for Dr. Viard and Ms. Nellen about how phase‑outs might actually discourage work and earnings. I serve as the chairman of the Human Resources Subcommittee. We are looking at some of the arcane and complex interlocking relationships between the silos of the various programs that create some real challenges, I think, for the folks who want to get out of poverty, or want to get off of assistance and build themselves a future.
And we know the tax code has many provisions for low‑income families. As Ms. Nellen’s testimony indicates, however, there is no consistent structure to ensure that the tax provisions work together more harmoniously or holistically. You know, meanwhile, parents who qualify for those tax benefits may, in addition, receive food stamps, welfare, Medicaid, and other benefits that also vary, based on income.
Given all that, it has got to be bewildering for parents to try to figure out if working and earning more will actually make them better off. With all these program interactions, it seems that some families with very moderate incomes can actually face an effective tax rate of more than 100 percent, meaning that they are made worse off if they work and earn more, which is counterintuitive to what the goal is, to begin with.
My question is this. Have any of you reviewed how phase‑outs for tax and non‑tax benefits discourage work, since earning more may cause someone to lose both tax benefits and other benefits as well? And should we be looking at this more holistically, so low‑income and modest‑income parents can actually end up better off from working and earning more?
*Ms. Nellen. Congressman, that is a good question. I think it is important to think about when the taxpayer would also even be aware that they have actually lost the deduction. A lot of times that might not happen until they are filing their return. As they are proceeding through the year, they might be thinking, “Oh, there is a particular incentive, I am going to qualify for that,” and might not find out ‑‑ you know, for example, even getting a year‑end bonus might be enough to kick them out of that, and they didn’t know that earlier on in the year. So that is one problem with the phase‑outs. It is not something you always plan for.
Now, some individuals, high income, know that they are beyond all the phase‑out levels, they don’t even think about getting those. But I think people that ‑‑ in the levels where you are intending to get those benefits, it is just the uncertainty because of that phase‑out.
And sometimes they do not know that unless it has happened once. Then they are more likely to pay attention to it, and either, you know, just count on, “I am not going to get that particular incentive” ‑‑ I am not sure it will ‑‑ it is probably too complicated to say, “I am not going to earn more money,” because they might lose one incentive, but not another one, because the phase‑out levels are all different.
*Mr. Davis. Mr. Viard, you would like to comment?
*Mr. Viard. Yes, Congressman. I think you are right about needing to take a holistic approach to this. And it is very complicated, because just as we have a proliferation of phase‑outs on the tax side, we also have a proliferation on the spending side.
There are numerous different anti‑poverty programs. You mentioned some of them: the food stamps, public housing, temporary assistance to needy families, and so on. And any given household could, at least in principle, be eligible for a number of them. And some of the same complexity problems and marginal rate problems arise there, as well.
I think that if we did try to consolidate, you know, along both sides of the system, that we at least could make more informed and transparent choices about the marginal tax rates.
The one note of caution I do want to put into the discussion, though, is this. It is difficult to avoid high marginal tax rates in these low‑income programs, because you really face a difficult trade‑off. If you choose to have low marginal tax rates, you either need to reduce the benefits that are paid to the households with the very lowest incomes, or you need to have the benefits continue into higher income ranges at a greater cost.
And so, one of the forces that has driven policy‑making towards these high marginal tax rates is the desire, on the one hand, to provide adequate benefits to those at the very bottom, but on the other hand, to have those benefits phase out before the programs become too costly. So it is a very difficult trade‑off ‑‑
*Mr. Davis. Wouldn’t it, then, make more sense to step to a third‑way choice on that question, and actually look at the process itself? One thing I have noticed dealing with integrated systems that have very little information error, is there is no system in the whole of government to be able to roll up, for example, a recipient of benefits to see what they get across the board.
And so, I suspect you could get away from that. I mean, just from a CPA’s perspective, would it be helpful if we had statutory language that would allow data to be matched and shared across agencies and programs? Because we don’t now, and I think that is one of the reasons we have 10 percent improper payments with our entitlement programs at the moment.
*Ms. Nellen. Well, certainly so far as transparency, having the data would be more useful to help answer these particular questions. And it is just in different locations, when does it come together into one format? But transparency would say, “Let’s bring all that together, and analyze what is actually there, and where people are getting their particular benefits.”
*Mr. Davis. It’s going to be one of the questions we are going to have in the coming months as we talk about entitlement reforms. Thank you, Mr. Chairman.
*Ms. Nellen. Thank you.
*Chairman Camp. Thank you. Mr. Stark is recognized.
*Mr. Stark. Thank you, Mr. Chairman. I have to make this comment, with due regard for the expertise of the other witnesses. But I have some notes here from my staff ‑‑ I won’t tell you which one ‑‑ that says that Mr. Viard is the one heavy hitter from the GOP witness list. Congratulations. That is a high compliment from the Democratic side.
*Mr. Viard. Well, thank you, Mr. Congressman, but I do not claim any expertise greater than my fellow witnesses here.
*Mr. Stark. Okay. I guess that what we want to hear from all of you is how we could simplify, as Mr. McDermott has suggested, the code for the majority of the taxpayers, which I guess is in the 90 percent, who use the simplified forms. There is discussions of not taking money out of their paycheck every month. But I guess I would ask the witnesses.
Wasn’t that initiated because so many people ended up at the end of the year not setting any money aside, then they had a tax liability, and then they were in the soup? I mean they just didn’t have the money to pay their tax? Was that not the basis of the payroll withholding? Go ahead.
*Ms. Nellen. Congressman, the reference actually was to the earned income tax credit, not to regular tax payments. Those should be done through withholding, to ensure that they are done.
But so far as an earned income tax credit, if what happens is that the person from paycheck to paycheck ‑‑
*Mr. Stark. Right.
*Ms. Nellen. ‑‑ is paying FICA tax, only to get that returned at the end of the year through a somewhat complicated process, is there a way they could not have that FICA tax withheld in the first place.
*Mr. Stark. Well, I want to thank the panel for their contributions. And as I say, it is going to be a difficult question for this committee, to figure out how we can simplify the tax return without, say, doing away with the interest ‑‑ home owner’s interest deduction, things like that, which politically would be a fire storm that none of the politicians could weather. Thank you for your contributions today.
Mr. Neal, would you have further questions? I would be glad to yield the balance of my time.
*Mr. Neal. I am okay. Thank you.
*Mr. Stark. Thank you. I yield back, Mr. Chairman.
*Chairman Camp. Thank you. Mr. Buchanan is recognized.
*Mr. Buchanan of Florida. Yes. Thank you, Mr. Chairman, for holding this important hearing today. And I want to thank all our witnesses up front.
There is a lot of discussion on C corps and having the highest rates in the world. I guess Japan lowered its rates, so that leaves us the highest rate, and I have heard the President and many members on this committee talk about lowering corporate rates so we can be more competitive here and abroad.
But can you lower corporate rates ‑‑ I pose this to all the witnesses ‑‑ without not dealing with all these pass‑through entities? I am someone who has been in business for 30 years. But in the 1980s everybody had a sub‑S, and then everybody moved to ‑‑ at least a lot of the entities that I had were LLC’s, which are all pass‑through entities.
Do you see any scenario, based on your expertise, where they would lower corporate rates, but not at the same time lower rates for pass‑through entities? Because a lot of those folks are the job providers.
And, Mr. Buchanan, I will start with you, first.
*Mr. Buchanan. Compliments on your name, Mr. Buchanan.
*Mr. Buchanan of Florida. Thank you.
*Mr. Buchanan. Yes. I do agree that there is a lot of slippage between the different types of business entities. And, therefore, changing the C corp rules is going to create incentives for people either to move into or out of being a C corp, and instead, becoming a pass‑through entity.
The permeability isn’t perfect, of course, because at this point there are people who argue that C corps have no reason to exist under the existing incentives for pass‑through entities, and yet C corps do continue to exist. But I certainly agree with you, Mr. Buchanan, that the business tax reform would need to be thought of as an integrated whole.
*Mr. Buchanan of Florida. Yes, and if you just take that one step further, when you are looking at trying to raise rates on the rich, basically a lot of those are job providers. So, if you are looking to lower rates on C corp, and then you have to deal with pass‑through entities, that goes right down to the individuals. So that is the point.
Mr. Johannessen?
*Mr. Johannessen. You know, I would rather cede my time to my colleagues here on the panel.
*Mr. Buchanan of Florida. Okay.
*Mr. Johannessen. They probably have more expertise in that area.
*Mr. Buchanan of Florida. Yes. Ms. Nellen?
*Ms. Nellen. One thing. The rates, actually, as to which is higher, the individuals or the corporations, has changed over time. And people do react to that. Prior to the 1986 act, the rate on individuals was higher than corporations. That switched after the 1986 act, which actually then brought about an increase in the number of pass‑through entities, particularly S corporations and partnerships. And I would guess flipping that again would cause, again, some change in behavior.
So, we have a record of showing that when one side or the other ‑‑
*Mr. Buchanan of Florida. But how could you, in a competitive world like we all live in, have two people competing in the same industry ‑‑ a C corp, in theory, could do a lot less in revenues and a pass‑through entity could do a lot more. And if the C corp was paying a lot less in taxes than the S corp or the LLC, how does that work in our competitive environment, in terms of doing business? To follow your logic ‑‑
*Ms. Nellen. Well, I think some pass‑through entities perhaps would move to the corporate forum. But you also have, with C corps, that they are still subject to double taxation, which is another issue that really needs to be addressed, along with the consideration of lowering the rates.
*Mr. Buchanan of Florida. Mr. Viard, did you want to comment on that?
*Mr. Viard. Yes.
*Mr. Buchanan of Florida. Just the idea of lowering C corp rates here and abroad ‑‑
*Mr. Viard. Well, I think ‑‑
*Mr. Buchanan of Florida. ‑‑ and dealing with everything else – my opinion is you have got to deal with them all. But go ahead.
*Mr. Viard. Well, I think, Congressman, yes, this question highlights, again, some of the complexities that have crept into the Internal Revenue Code in ways that maybe were not intended. I think that, in general, C corporations are taxed more heavily than pass‑through entities, because there are two levels of tax. Yet there are circumstances in which C corporations can actually be used as, you know, tax avoidance devices, particularly if earnings are not being distributed and gains are not being realized.
So, what this ultimately tell us is that we do want ‑‑ ideally, at least ‑‑ a holistic solution, something that will try to unify the treatment of different business enterprises, and allow the choice of business form to be made without reference to tax considerations. So the different firms, as you say, in the same industry or in different industries can actually compete on a level playing field, be subject to a single level of tax that is really uniform across different types of entities.
*Mr. Buchanan of Florida. And one other quick question, as I have got a few minutes, or a minute left, or whatever it is, the IRS says the average person takes 21 hours to fill out their return. In fact, I was reading something where the USA editorial page had commented that, for the new iPad, they get one page of instruction and the 1040 form has 172 pages of instruction.
What would be one or two things that, in terms of tax simplification, would you suggest or do? And we will start on the other end. Mr. Viard?
*Mr. Viard. Well, again, I think the thing that most cries out is really trying to consolidate these different incentives for savings and education and children, which really, you know, do not have a rhyme or reason to them at this point. Crept up over the years, and you have multiple accounts and incentives that are serving only one or two purposes. And ‑‑
*Mr. Buchanan of Florida. Ms. Nellen, what would you ‑‑
*Chairman Camp. I am sorry, the time has expired. Mr. Paulsen is recognized.
*Mr. Paulsen. Thank you, Mr. Chairman. I also want to thank all of you for being here today as a part of this hearing. I find it very interesting.
I will start with Mr. Johannessen, if I could. As a part of the work you do, you obviously advise clients, and we have so many provisions that are set to expire in 2012, which we have heard about, many of those you referenced: dividends, capital gains, and these issues that do affect decisions that go into the future. And a lot of these are in flux right now.
How do you advise your clients just knowing that there is the frequency of the changes that are out there, and the provisions that expire? How do you go about actually advising your clients short‑term, long‑term?
*Mr. Johannessen. Right. Planners, by our nature, are used to changes in people’s plans. We live in that world of uncertainty. But from a longer‑term perspective, the way that we are building our plans today, which ‑‑ you know, many times we are looking at folks’ retirement, or their estate ‑‑ is by taking the code as we know it exists today, the top tax brackets, and kind of planning out into the future, as legislated. And we have a software that helps us, do that in that environment.
In the short term, it requires a lot of looking at numbers, reviewing numbers, trying to make best guess of the direction of where the congress and, the economy is going. And so, it requires a lot of time and energy. Last year, in particular, with Roth, and as we were heading towards a new tax bracket, whether we would have folks convert or not, you know, that was a significant back‑and‑forth dialogue.
*Mr. Paulsen. So it seems like it is pretty clear that, given the sense that you have all talked about, that individual taxpayers are frustrated with the complexity in the forms they fill out, whether it is the phase‑out provisions or anything else, as a profession you are also navigating the waters and having complex calculations and staff, and everyone trying to advise your client. So it is part of that whole complex situation, right, as a part of ‑‑
*Mr. Johannessen. Yes. You know, I think what most intrigued me about this testimony today is the idea of a more permanent structure than the one that has been in flux. When you look at the wave of folks moving towards retirement, just the Baby Boomers alone, and to have some sense of how to plan. Someone mentioned earlier the 21 hours to prepare the average tax return. That is more time than most people do on their financial planning. But then again, most spend time on their family vacation than they do on their financial planning.
And so, to be able to have a more permanent structure, where people can peg towards what their retirement lifestyle needs to be with taxes built in, is hugely important, with the sheer number of people working towards retirement, this will be an issue for, not only seniors today, but the Baby Boomers as they move through the pipeline.
*Mr. Paulsen. And, Ms. Nellen, maybe you have a different relationship with your clients. But do they face similar issues? I mean demographics are a fact, and we cannot change demographics. Can you comment on that?
*Ms. Nellen. Yes, Congressman. I think part of it with practitioners is just being able to explain to their clients as to what the rules are today, what they might be tomorrow, or in ‑‑ you know, two years out, three years out, and the uncertainty of being able to plan in that context. It does make it quite difficult, having to caveat answers about, “Should I invest this way or that way? When should I sell my business, this year? Next year?” A lot of caveats have to be put in place, and I think the client ‑‑ and I’m not sure what that means.
But I agree. Permanency would certainly help. Less choice, where they do not have to choose between, you know, 14 different provisions, but it was very clear if I do this I will get this particular education incentive, or get this retirement saving, whatever it might be. Added certainty, I think less choice or options would be helpful.
*Mr. Paulsen. Okay. And Professor Nellen, I know you recently wrote an article for the AICPA that I think was called, “Rethinking the Income Tax Calculation.” There is a lot of talk about tax expenditures right now in the context of overall tax reform, and broadening the base, and eliminating a lot of these tax expenditures.
But, you know, and you discuss this as a part of what you wrote, there is a complicated interaction of the rules that affect income tax calculations, and there is the question of what ultimately is a tax expenditure. Can you just explain that interaction a little bit, as this conversation, I think, is going to occur, obviously, and this committee is a part of tax reform. Do you have any suggestions on how we can move forward, keeping in mind some of the issues?
*Ms. Nellen. Well, we hear a lot about this $1.1 trillion of tax expenditures out there. I am not sure everybody knows exactly what a tax expenditure is. Generally that does not include the standard deduction or personal exemption. Those are viewed as part of a standard income tax system.
So far as I think other misconceptions out there, I think there is a lot of thought that corporations get most of those incentives, where actually, the bulk of those dollars is actually for individuals.
Also, when we hear $1.1 trillion of tax expenditures, that is actually income tax. Some of those would actually generate, I guess, additional payroll tax, too. If, for example, certain employer‑provided exclusions were to be considered all or partly taxed, it would also general some payroll tax.
But I think, to talk about tax expenditures, it would be helpful if there was a broader understanding of what those are, so the public would understand what that is getting at, who uses those tax expenditures, and how do they affect what the tax rate is.
*Mr. Paulsen. All right, thank you.
*Chairman Camp. Thank you. Mr. Marchant is recognized.
*Mr. Marchant. Thank you, Mr. Chairman. I represent a largely suburban district, very professional, upper middle class. And I would tell you the largest reason why these professionals have to seek assistance with their tax return is the alternative minimum tax. The largest deduction most of my constituents have are their property taxes and their house payment. So, I don’t think we can have any meaningful discussion about simplifying the tax code without having a discussion about the AMT, especially in my district.
Mr. Viard ‑ is that how you say it? Is there a way to calculate the amount of money that is gained by virtue of the alternative minimum tax? Is there a baseline where you can say if there were no alternative minimum tax, here is the amount of money that was collected, but because we are collecting the alternative minimum tax on top of it, it represents what percentage of the total tax collected?
*Mr. Viard. It is certainly possible to compute that number, Congressman. And, in fact, the Urban‑Brookings Tax Policy Center, which is probably the most authoritative source of data about the AMT and about many other tax topics, has computed that.
I do not have that number with me, offhand. But one interesting fact is that we have reached a point where it is actually cheaper to repeal the regular income tax than to repeal the AMT. Now, the bulk of the revenue that is being collected each year would be raised under either of these tax systems. And only a modest portion is the increment that arises from having two of the systems, as opposed to one. But nevertheless, at this point, in that particular sense of the term, you know, the AMT has become the “bigger tax system.”
*Mr. Marchant. Is there a largest deduction across the nation for AMT payers, the single largest deduction that they lose?
*Mr. Viard. They lose the state and local tax deduction in its entirety. So it is the property taxes, as you mentioned, and also either the income or the sales tax, which itemizers have a choice to deduct. They also lose their personal exemptions.
And that is kind of an interesting fact, because Professor Nellen mentioned there is ‑‑ you know, we do not normally think of the personal exemption as being a tax expenditure. We think of it as being part of the normal tax system. And yet it is not part of the alternative minimum tax. The AMT treats the per‑person exemption, the $3,700 for the taxpayer and the spouse and the dependents, as if it were a tax preference, and eliminates that under the AMT.
*Mr. Marchant. Is that the most common thing that they lose?
*Mr. Viard. Those two are the biggest single items.
*Mr. Marchant. Mr. Johannessen, I found your testimony to be especially good, because when you go to your specific examples of dealing with the AMT, I think that is what hits most of the families in my district. They think they are planning all year long on what tax they may owe. And then most times they have paid ‑‑ in my district — most times they have paid in too much.
And so, they are getting big checks back, but they are curtailing their spending during the year. The government is keeping more of the money than they actually need, but taxpayers are curtailing their spending out out of precaution. And it is my contention that if that money was available in the economy to be spent, that we would have an acceleration of the economy. Thank you, Mr. Chairman.
*Chairman Camp. Thank you. Mr. Rangel is recognized.
*Mr. Rangel. Thank you, Mr. Chairman, and welcome all of you. Thank you for sharing your views with us today.
During the President Reagan and President the‑first‑Bush administration there was a dramatic reduction in taxes. Some people believe that it ‑‑ that reduction in revenue was responsible substantially for the increase in our deficit. Others have taken the position that any reduction in taxes pays for itself and, in fact, creates jobs and increases revenue.
How many of you believe that the reduction in taxes that had been enacted was responsible in part for the tremendous deficit that we are suffering now?
So, the two in the middle, your belief that tax cuts pay for themselves and grow the economy, and create jobs?
*Mr. Johannessen. No, sir. Actually ‑‑
*Mr. Rangel. Now, let me ‑‑ ladies first. Ms. Nellen.
[Laughter.]
*Ms. Nellen. Thank you, Congressman.
*Mr. Rangel. Besides, she is smiling, so I don’t think she will believe your answer.
*Ms. Nellen. I am not sure what the answer is. I think there are many factors that come into play that would affect that. I will leave that to the economists, to know if it actually ‑‑
*Mr. Rangel. Why didn’t you put up your hand?
*Ms. Nellen. ‑‑ is increasing ‑‑
*Mr. Rangel. Let me reframe the question just for you. There is reason to believe that dramatically reducing taxes not only pays for itself, but increases revenue. If you are confused, argue the point of how it is going to create revenue, since you are a tax expert, and you do not do like we do, hope for the best, or put a spin on something. It is just hard for people to believe from the math that you can dramatically reduce taxes and then tell the IRS, “You are in for a boom year.”
*Ms. Nellen. Right.
*Mr. Rangel. Right what?
*Ms. Nellen. You reduce the rates, reduce everything, that would be hard to believe that would increase revenues. Actually ‑‑
*Mr. Rangel. Let me just ‑‑
*Ms. Nellen. ‑‑ it gets measured here as a tax cut ‑‑
*Mr. Rangel. I guess I am going to have to rely on you to defend this theory, Mr. Johannessen.
*Mr. Johannessen. You ‑‑
*Mr. Rangel. The other three ‑‑ I mean the other two ‑‑
*Mr. Johannessen. Right.
*Mr. Rangel. You are.
*Mr. Johannessen. The reason I didn’t raise my hand is because it seemed like during some of those times that you referenced in your time line there we also raised expenses while cutting taxes. And any financial planner would suggest to you that a client is more likely to have a successful outcome when the revenue coming in is greater than the expenses going out of any family budget.
And so, there have been times in your time line where we were bringing in less revenue, bringing the base down, and raising our ‑‑
*Mr. Rangel. How many times have you been accused of having a two‑handed argument? Of course if you reduce spending it reduces the deficit. But I am only dealing with what has been said categorically. Reduction of rates brings in a increase of revenue. You say, “Heck no, not unless you reduce spending.”
In other words, it takes both, I would assume, because we are going to be presented with a budget that reduces revenue and reduces spending.
*Mr. Johannessen. I ‑‑
*Mr. Rangel. And I think that shatters the myth that it pays for itself. It does not pay for itself, unless you do something else, reduction and spending.
*Mr. Johannessen. Correct. One of ‑‑ it would make me not popular necessarily with my clients is that I would actually advocate for modest increase in tax rates, tax revenue.
*Mr. Rangel. You would do that as an American that is concerned about your country. To hell with the client. If you just know that you don’t want a disaster ‑‑ who disagrees with Mr. Johannessen that ‑‑ what? No, Mr. Buchanan is with us. Thank you, Chairman. No, I don’t need the help.
*Mr. Viard. Congressman, can I ask a question?
*Mr. Rangel. Yes.
*Mr. Viard. You are absolutely right, Congressman, that tax cuts ‑‑
*Mr. Rangel. Let me ‑‑
*Mr. Viard. ‑‑ normally do not pay for themselves ‑‑
*Mr. Rangel. He threw me off. I just want to ask the question. During the time for our country, Republican and Democrat ‑‑ so you suggest that to reduce the deficit we should reduce the spending and increase the revenue with a tax increase. Is there anyone that disagrees with that?
[No response.]
*Mr. Rangel. Okay. Now, I am so sorry, Mr. Viard. Your thoughts were?
*Mr. Viard. Well, I ‑‑ you are absolutely right, Congressman, that the typical tax cut does not pay for itself. I do think it is important to realize that if there is a marginal rate reduction in the tax cut, that you normally do get an increase in economic activity, and that there is some revenue feedback from that.
But the revenue feedback is not large enough to offset the direct revenue loss. And, therefore, you do have a net reduction in revenue from the tax rate cut, even though it is not as large of a revenue loss as it would be if there had been no behavioral response.
*Chairman Camp. All right, thank you.
*Mr. Rangel. What is it ‑‑
*Chairman Camp. Time has expired. Mr. Berg is recognized.
*Mr. Berg. Well, thank you, Mr. Chairman. I would like to actually weigh in on that debate. In North Dakota we have reduced the income tax. We did that last year. We reduced the corporate income tax. We reduced the tobacco tax. And all of those have brought in more revenue.
So, you know, again, I think the focus of this debate here today is how do we simplify our taxes, and how do we move to that place where it is easier for people to pay their taxes and simplify.
I enjoyed Mr. Buchanan’s statement that every now and then you have got to clean out the barn, as I would call it in North Dakota. And for people that have done that, there is a lot of build‑up there. And that is, quite frankly, what we did two years ago in North Dakota.
We had two tax forms, one that you could take a lot of deductions on — we had about two percent of the filers on there — and then we had a streamlined one that basically said, “No deductions; here is what your gross income is, here is what your state tax is.” We lowered the overall rate and did away with the long form, if you call it. And again, I think that is what we are talking about nationally here, too: How do we again go back to cleaning out the barn, get to, if you will, a short simple form, knowing that, as time progresses, different policy changes come in for deductions and different things. So, you know, I really like that.
The other thing that is such a challenge is just the uncertainty. The uncertainty out there, it is impossible for small business to have confidence in our economy, so they are sitting on their hands. They are not hiring. Everyone out there is worried about this deficit spending, knowing it is going to impact the taxes that they pay and that it is going to be a barrier to that growth.
And so, I guess I would just kind of simplify this. Mr. Johannessen, how difficult is it when all these rules are changing as you are advising your clients?
*Mr. Johannessen. You know, we do that all the time, so for us it is not difficult. For the average citizen, though, I think it is very complex. Studies would tell you that probably two percent of the population actually use a certified financial planner.
But we work in it all the time. And it is a matter of trying to scenario‑plan and look down the road. The issues that our clients face certainly are not life and death. They are trying to help our clients make smart financial decisions. And so, it is complex. There is a number of different areas that each year you have to look through.
One of the concerns, that I have kind of on the larger picture is the potential impact on these variable rates on the capital markets. Whether it is in last fall’s fall‑off of returns in municipal bonds, as some portion of the public left municipal bonds as a result of the changing tax code, and how folks can game the system with regards to capital gains, and what investments they are either getting into or getting out of, right at the time that there is an inflection point with capital gains rates or ordinary income rates. I think that needs to be a part of the discussion, a couple of the things that we are thinking about every day.
*Mr. Berg. Well, that is an excellent point. Sometimes we forget about the impact of deficit spending on what the long‑term markets are going to do, and what impact it will have, even apart from tax code. So thank you. I yield back.
*Chairman Camp. Mr. Roskam is recognized.
*Mr. Roskam. Thank you. Mr. Buchanan, in your testimony you made an argument that said that the phase‑outs do not increase complexity. Can you walk us through your thinking on that? It is in conflict to what other experts say. It seems intuitively difficult to track. What is it, in your experience, that animates the hope that, literally, phase‑outs do not exacerbate the problem with complexity?
*Mr. Buchanan. My argument was that Mr. Viard’s list of phase‑outs is a concern, because that are 20 different phase‑outs with 20 different starting points and ending points and phase‑out rates. That is complicated.
The concept of having a means‑tested phase‑out is not inherently complicated, because 99 percent of the actual, in terms of doing tax planning and figuring out which benefits or tax provisions apply comes before you would ever even think of a phase‑out, or think of the tax rate that may or may not be phased out.
*Mr. Roskam. Okay. I am sure you said it well and clearly, and everybody here got it except for me.
*Mr. Buchanan. Okay.
*Mr. Roskam. So the first part of your reply was that something was complicated, as it relates to phase‑outs, and then you transitioned into “but it is not.” Where was the nexus?
*Mr. Buchanan. The nexus is if you have 20 different phase‑outs with 20 different sets of rules for each of those phase‑outs, that is complicated. We could have one phase‑out that says, “Here is a range of tax provisions that are phased out,” but it begins at the same income level for all of them, and it ends at the same income level for all of them. Let us say that the ending point of the phase‑out was $250,000 a year, if I made more than $250,000 a year, would that I am not going to be eligible for any of those provisions, so ‑‑
*Mr. Roskam. I understand. So they all phase‑out. That is your argument?
*Mr. Buchanan. Yes.
*Mr. Roskam. Okay. Wouldn’t it be better if there weren’t any phase‑out, though?
*Mr. Buchanan. No, I do not agree with that. I think that the importance of ‑‑
*Mr. Roskam. Well, it is less complex. What you are accepting is a level of complexity, and you are making the argument that it is better to endure the complexity, because of some other greater good. You are not arguing that it is less complex, though.
*Mr. Buchanan. Actually, what I am saying is that the phase‑out complexity is so minuscule as to not be an important part of the simplicity debate.
*Mr. Roskam. Okay. Thank you. Can I just ask the other three panelists to take a step back and look at a bigger picture?
And I think it is interesting. There is nobody on the panel, there is nobody on this side of the microphones that is arguing for the status quo, right? There is no constituency that says, “Wow, is our tax code fabulous.” Nobody is saying that.
Take a step back, the other three, and give us some top lines on fundamental goals, or jurisdictions around the world that have attributes that you think are worth admiring and replicating and trying to draw from. That is commonly called a softball.
[Laughter.]
*Ms. Nellen. Congressman, that is a good question. I think it is worth taking a look at.
One comparison point would just be how many provisions are in the particular income tax, as far as deductions, credits, exclusions. Do they all need to be there? I would venture to say that our system probably has far more than most would.
Also, we have a situation where, as we noted in testimony, so far as education incentives, there is 14 different ones there. So when one is added, often we are not removing another one, we are just saying, “Here is one more way you might be able to qualify for something.”
I think it might be that ‑‑ I don’t know if other countries do this, but I would guess they might think, “Well, if we are going to add one, maybe we should be thinking that that is replacing another one.”
But I would say certainly be looking at just what is feasible, so far as understanding and explaining to individuals.
Also, just one comment. So far as complexity, we should think of it not only in compliance, but also in tax planning is there complexity there. And certainly phase‑outs do cause complexity in both those categories.
*Mr. Johannessen. Congressman, this is more my opinion than the position of the Financial Planning Association, but as I think about the underground economy that exists in our country, and recognizing that a consumptive ‑‑ or consumption tax is somewhat regressive and maybe not popular, I do believe that some level of consumption tax, in order to gain access to those monies that are kind of living in that underground economy that certainly are not even a part of any of these discussions that we are having today and being filed on a tax return, is perhaps a way to ‑‑ or would be an important part or element of the discussions.
*Chairman Camp. All right. Thank you. Time has expired. Ms. Black is recognized.
*Ms. Black. Thank you, Mr. Chairman. And my question goes to the fact that there have been some members on this committee that have asserted that the tax code is not complicated for those that they say are just average working middle class Americans. And one colleague even pulled the code out to try to show his point that the tax code is really there for those who have a larger income or maybe even a business where they are making a larger income.
And I wanted to go to you, Ms. Nellen, because I noted in your testimony you did talk about the complexity, and how difficult it might be for just an average working American. And I want to make that point, as I was sitting here thinking about one of the average working Americans in my district. That may be a family of five with three kids, combined salary of $75,000 a year. We have child care tax credits, we may have one of them that is getting ready to go to school, so we want to know about the education credit. We might also be saving a little bit, and we have to make sure that we are applying that properly to whatever our tax liabilities are. Perhaps a savings plan for retirement might be a part of that.
I am going to give one case that just happened to me ‑‑ and this is a real‑life situation. I was in my district, in a rural part of my district, and I went to a restaurant, a very small restaurant, and just going around, shaking hands, saying hello to folks, saying, “How are things going? Can you tell me what’s happening in your life? How is it?”
And one young gentleman who was, I would say, maybe his early thirties, says, “You know, I just got a promotion in my job,” and I said, “That’s great.” And he goes, “Well, you know, it would be great, except that now I am in another tax bracket. I am working harder, and I am bringing home very little more than what I was bringing home before.”
And so, Ms. Nellen, can you help me? Is, what I am saying to you, actuality, where people who are just average, everyday working people are having difficulty in understanding how to make out their forms and what their tax liabilities are?
*Ms. Nellen. Yes. Congresswoman Black, I agree. I think the complexity is well beyond those who are high‑income and can afford people to help explain it. That doesn’t mean it should be tolerated, just because they can afford to take care of it, but a lot of the complexity is in the provisions which ‑‑ many of which are designed for low‑income. For example, there is a saver’s credit which is designed for low‑income individuals. It is fairly complicated to get through, so far as what you need to do to obtain it.
The earned income tax credit certainly is only designed for low‑income wage earners. So far as the provisions regarding education, retirement plans, other saving vehicle that could be there, different ways that they might ‑‑ you know, whether it is funding medical insurance, whatever it might be, I think does raise a significant amount of complexity that is hitting people who are making certainly under, you know, $80,000.
And I think another part of the complexity is that, again, if they are going to use software, or they are going to someone who is just going to prepare their return without asking, “Well, gee, you know, are you saving for college,” those questions are not always getting asked if they are just having their return done for, you know, some low, low fee. They would really need more than that, or they wade through, you know, pages and pages of IRS documents.
So, I appreciate your raising that. The complexity is, I think, very heavy for middle and low‑income tax ‑‑
*Ms. Black. Thank you. And I know my time is brief here, and I want to just jump up to the next category of someone I actually was visiting with this past week before I got on the plane to come here. He owns a business, and it is not a huge business, but he does make an income of $250,000 a year, he told me. He said, “But, Diane, you know what? If there are benefits out there in that code that really could help me, I can’t find them. And I am paying my fair share, and I am paying what I think, you know, as hard as I am working, is a big share.”
And so, there is also a complexity, from what I am hearing from my small business owners who make that income of about $250,000, saying, “There may be tax breaks in all of these books that are here, but frankly, I don’t know, and the people I am paying are not really able to find me these significant breaks, where what we are hearing in the media is that I am somebody who is really getting these big, huge breaks, and I am not paying anything.”
And then the last thing that I do want to ask each of you, define for me ‑‑ I keep hearing this over and over again ‑‑ “wealthy,” that the wealthy should pay more. Can you give me a definition of what you would consider wealthy?
And, Mr. Buchanan, I would like to start with you.
*Mr. Buchanan. Obviously, there is no clean‑cut cut‑off to define the word “wealth.” A person can be relatively wealthy or relatively not wealthy. But, frankly, I think that when you reach the point that you ‑‑
*Chairman Camp. If you could just quickly answer. Is there a dollar figure?
*Ms. Black. Yes, what is “wealthy?” Give me a number.
*Chairman Camp. Because time has expired, and we want to get through the four answers, and then we will move on.
*Ms. Black. Please.
*Mr. Buchanan. I think the $250,000 a year cut‑off is sensible.
*Ms. Black. Is wealthy. Okay.
*Chairman Camp. All right.
*Ms. Black. Mr. Johannessen?
*Mr. Johannessen. I think a similar number, $250,000, is probably reasonable.
*Ms. Black. Okay.
*Ms. Nellen. It sounds fine.
*Mr. Viard. And I don’t think there is any single answer. I think, obviously, somebody who makes $250,000 is wealthier than somebody who makes $100,000, who is wealthier than somebody who makes $50,000.
*Ms. Black. But when we talk about the millionaires who are getting the breaks, we, I think, confuse wealthy with those that we see on television, like the GE’s. So, thank you.
*Chairman Camp. None of you characterized how that income was earned, which I thought was interesting. So, Mr. Schock, it is your time.
*Mr. Schock. Yes, I was just going to say, first of all, thank you all for being here. Most of the good questions I was going to ask have been asked, I think, three times already.
But since Ms. Black asked such a great question, and I was actually quite taken aback by your answers, I guess my question is this. Assuming you all recognize that the lion’s share of small businesses file as either sub‑chapter S or limited partnerships, and pay that as personal income tax, isn’t it dangerous to assume that somebody who makes “more than $250,000” is “rich,” and that hiking a tax on filers of over $250,000 would put an undue burden on precisely those small businesses who have created 7 out of the 10 jobs in the last 2 years?
*Mr. Johannessen. I would generally agree with that, but there are opportunities within small business to help defer some of those ‑‑ the tax liability if the business owner decides to take the stance and help his or her employees set up a savings program for their retirement.
So, though I generally agree with you that it could be a risk, there are also ways for them ‑‑ and I would love to have the opportunity to talk to Ms. Black about her constituents who have that question. But there are opportunities for them to ultimately reduce the income for that business owner.
*Mr. Schock. You mean if they give it to their employees?
*Mr. Johannessen. To themselves and to their employees.
*Mr. Schock. Well, let me ask a different question. Is anybody up here advocating increasing the corporate tax, the current rate for corporations?
*Ms. Nellen. No.
*Mr. Schock. No one. Okay. So, I guess I am a little dumbfounded that we would actually suggest increasing the tax on filers of over $250,000 if the lion’s share of those filers are actually small business owners.
And if we don’t think it is a smart thing to increase the tax on corporations, why is it a good thing to increase the tax, or a justifiable increase in tax, on the largest share of small business owners in America? Why is it okay for GE and for IBM not to pay a higher tax, but it is not okay for the local grocery store or the car dealer?
*Mr. Viard. Well, Congressman, I definitely share your concern about how an increase in the ‑‑ at these high income levels would affect the owners of pass‑through firms. Of course, some of those pass‑through firms are small, some of them are large. But all of them are certainly part of the investment that takes place in the economy that sustains employment opportunities and wages.
I do think that should be separated from the question of whether someone who makes $250,000 is rich. I think someone who makes that income level is rich, and that is true, whether they own a pass‑through business or not. But the fact that they are rich does not necessarily mean that we should increase the marginal tax rate that applies to them. You know, at a minimum, we need to be aware of the impediment that that creates, in terms of incentives to invest in pass‑through firms.
*Mr. Schock. Anyone else?
*Mr. Buchanan. Mr. Schock, I think it is important to remember two things about this.
First of all, $250,000 a year for the owner of a small business is not their revenue, it is their income. So we are not talking about somebody who takes in $250,000 and then has to pay it out to employees’ salaries, and that kind of thing. We are saying, net of all their business expenses, what is their income? At the end of the year, afteryou add up what you have made from the firm, it is $250,000.
Second of all, if you raise the rate ‑‑
*Mr. Schock. But let me just understand you. That is the money they then use to reinvest in their business.
*Mr. Buchanan. Right. But what ‑‑
*Mr. Schock. And the corporations that I did not hear you saying you were advocating higher taxes on ‑‑ I am assuming we don’t want to raise taxes on them because to take money away from a corporation’s pot of money with which they reinvest. So why is it okay to take more money away from a small business owner, but not a big business owner?
*Mr. Buchanan. Well, in part, because C corporations have the two‑part tax that we talked about before. So you are not actually comparing the same things.
*Mr. Schock. They are not both the same pot of money that is used to reinvest in the entity?
*Mr. Buchanan. No, the point is that, for a C corporation, they pay the corporate income tax, and then they can ‑‑
*Mr. Schock. No, I understand. I understand. Okay.
*Mr. Buchanan. Okay.
*Mr. Schock. Finally ‑‑ I am almost out of time ‑‑ I am interested in the lowest wage earners in America. Mr. Viard, maybe perhaps you could address this.
I have got a lot of poor folks in my home town. And when I talk to them a lot about the incentives to go out and work, get a higher‑paying job, some families who are trying to get two jobs, for example, the way I understand it now is there are some disincentives for folks in the lower end of the income scale when they hit a certain threshold. Could you maybe speak to that ‑‑
*Chairman Camp. Just a quick answer and then we will move on, because time has expired.
*Mr. Viard. Yes, there are very high marginal tax rates applicable to some of these households, because they lose a number of tax‑related benefits and also, in some cases, benefits from spending programs.
*Chairman Camp. All right. Thank you. Ms. Jenkins is recognized.
*Ms. Jenkins. Thank you, Mr. Chair. Thank you for having this hearing. And thank you, each, for your contribution today.
Much of the focus in the headlines and inside Washington has been focused on tax reform to make our corporations more competitive, internationally. However, we should also focus on helping American families prosper. Could each of you just briefly discuss first of all, how the tax code impacts or distorts the daily decisions that families make, and, secondly, how simplifying the individual tax code could help individuals and families be more successful and help them make rational choices and remove some of the economic distortions which hamstrings their financial security?
We will start with the heavy hitter.
*Mr. Viard. Okay. The ‑‑ I mean I think there is a number of impacts that the tax system has on people. There is the almost unavoidable work disincentive, of course.
But the provisions that we have been discussing today I think have more far‑reaching and adverse effects, because it means that when households are engaging in decisions like trying to prepare for ‑‑ to send their kids to college, or in trying to save for retirement, that they are just forced to deal with an additional layer of complexity that does not need to be there, that they really have to think about the tax code, front and center, if they want to make, you know, the best decisions that they can for themselves concerning how to go about, you know, what ought to be much simpler activities.
*Ms. Jenkins. Thank you. Ms. Nellen?
*Ms. Nellen. Thank you, Congresswoman. The ‑‑ I think clarity would actually help. For example, if there is a desire in the tax law to encourage people to save for their retirement, perhaps there should be, you know, one particular way of doing that, so it is very clear, “Oh, if I put this $1,000 into this account, I am going to have it just earn interest tax free, or perhaps I am going to get a deduction for some portion of that.”
I think today they are looking at, “I would like to save for retirement. I am not sure if I am going to have positive or negative tax implications of doing it particular ways.” So I think just the added clarity would be a big benefit to, actually, all taxpayers.
*Ms. Jenkins. Okay.
*Mr. Johannessen. Congresswoman, I would like to see a day some day when that more than two or three percent of the public actually think about this stuff on a daily basis. I would like to get there. And this being financial literacy month, would love to help educate folks and create incentives for them to actually think about this and do their planning.
But, unfortunately that is not the way it is today. Folks think about this stuff on or about April 15th, and then quickly forget about it after they have either stroked the check or are now in some kind of payment mode.
So, I would hope that we can get to a point where we do that, but it is ‑‑ we are not there yet.
*Mr. Buchanan. In addition to what Ms. Nellen mentioned, in terms of planning for retirement, planning for health care spending, planning for a college education, I think that perhaps one of the greatest effects on what we would call everyday Americans is this sense that they do not really know what is going on.
An earlier comment indicated that people thought, “There are provisions out there that I could be benefitting from, but darn it, I cannot find them.” And I think one of the costs of complexity is a sort of “morale cost,” an important burden on the citizens of this country. Essentially, the more pages that are there in the Code, and the less time I have to read them, the more I have a sense that I am somehow getting left behind.
*Ms. Jenkins. Okay. Thank you all. I yield back.
*Chairman Camp. Thank you. Dr. Price is recognized.
*Mr. Price. Thank you, Mr. Chairman. I appreciate you sticking around. I want to thank the panel.
And I want to try to touch on one item that has been talked about, which is this notion that if you decrease tax rates, you do not increase revenue. The three cases that are cited most frequently are President Kennedy’s tax reductions, President Reagan’s tax reductions, and President Bush 43’s tax reductions.
Do any of you disagree that the reductions were followed by an increase in revenue to the Federal Government for each of those three Administrations?
*Mr. Viard. Well, I don’t believe, Congressman, that they caused revenues ‑‑
*Mr. Price. That is not the question, because it is a very complex situation.
The question is, the tax reductions occurred. Did the Federal Government see an increase in revenue? Anybody disagree with that?
[No response.]
*Mr. Price. Great.
*Mr. Viard. If I can clarify, Congressman, you mean the revenue was higher ‑‑
*Mr. Price. Higher after the tax reductions than before.
*Mr. Viard. ‑‑ some subsequent ‑‑ in nominal terms, I think ‑‑
*Mr. Price. Yes.
*Mr. Viard. ‑‑ that certainly was true, sure.
*Mr. Price. Okay. And then we can argue about ‑‑ or we can discuss — why, indeed, that occurred. But there was an increase in revenue to the Federal Government following tax reductions by each of those Administrations: Kennedy, and Reagan, and Bush.
We are talking about the burden of the taxes. I have not heard anybody talk about the progressive nature of our tax system. The top 1 percent pay about 40 percent of the taxes ‑‑ of income earners, the top 10 percent about 70 percent, the top 50 percent about 97 percent of the taxes. Is ‑‑ do any of you believe that that progressive nature is harmful in any way to our economic system, or to our society?
*Mr. Viard. There is always a trade‑off, Congressman, between the degree of progressivity and the impact on incentives. As the tax system becomes more progressive, it features higher marginal rates for those who are at the high end of the spectrum. And that does create disincentives for work. Under an income tax system, as opposed to a consumption tax system, it also creates disincentives for saving and investment, which is a very critical distortion.
And as you have said, Congressman, the individual income tax today is quite progressive. I should note that the numbers you give are the for the individual income tax ‑‑
*Mr. Price. Yes.
*Mr. Viard. ‑‑ not for the tax system, as a whole.
*Mr. Price. Right.
*Mr. Viard. And the overall tax system is somewhat less progressive than the individual income tax in isolation.
But I think that there are a lot of misconceptions. People think that the high‑income groups are not paying taxes. And obviously, we can debate. Should they pay more? Should they pay less? But we need to face the reality that they are paying substantial taxes now, they are facing significant marginal tax rates. There are disincentive effects.
And we also need to realize, I think, that as we try to close our fiscal gap, that increasing taxes only for the top two or three percent will not close that gap.
*Mr. Price. Yes.
*Mr. Viard. Obviously, if we are willing to accept the disincentive effects, that could be part of the response that we adopt.
*Mr. Price. Thank you.
*Mr. Viard. But certainly not the whole thing.
*Mr. Price. Does anybody on the panel disagree with the statement that Mr. Viard made, and that is that if you increase the tax rates there is a disincentive to saving, and a disincentive to investment?
*Mr. Buchanan. I don’t disagree categorically, but I think that the evidence on the degree of response is ambiguous, at best. And the best evidence indicates that the responses are quite small.
*Mr. Price. I think that is debatable. We have been talking a lot about the burden regarding the income tax system for individuals and for families.
I am of the belief that our tax system currently punishes all the things that we say that we want. We want hard work, we want success, we want entrepreneurship, we want risk‑taking, we want savings. All of those things that we say that we want, yes, we punish them with our current tax system.
Wouldn’t it be simpler and a less burden to society if we did away with the income tax system, and went to a consumption tax system? Wouldn’t that be much simpler and a lesser burden ‑‑ understanding that you take into account those at the lower end of the economic spectrum with the prebate and the like?
*Mr. Viard. Well, Congressman, I believe that consumption taxation is superior to income taxation. I would like to see the income tax system, both individual and corporate, completely replaced by a progressive consumption tax. It would eliminate the disincentives for saving and investment. The work disincentive, of course, would still exist, but the disincentives for saving and investment would be eliminated. And a significant degree of the complexity of the current tax system could also be removed.
It would not be, you know, a panacea to create a completely simple system, but there are a number of complexities relating to income measurement and to depreciation and such not that would simply be swept away in their entirety by using consumption as the tax base.
*Mr. Price. Anybody else want to weigh in on the consumption tax? Ms. Nellen?
*Ms. Nellen. I think a former question regarding what do other countries do, I think countries tend to have both an income tax and a consumption tax, in the form of a VAT.
The focus of this hearing being on simplification, I do want to just point out that any tax could be complicated. And I think on a consumption tax, when you talk about, “Well, gee, we are going to exempt this, this, and this,” then you get to defining those exemptions, you have got a fairly complex provision.
Or, if you want to say, “We want to encourage people to buy this, so we are going to have a lower rate on that particular item,” so any tax could be complicated. I wouldn’t ‑‑
*Mr. Price. My time is running ‑‑ but I do want to say for the record that an income tax and a consumption tax is the worst of both worlds, which I strongly oppose. Thank you.
*Chairman Camp. All right, thank you. Time has expired.
I want to thank all four witnesses for your testimony and for your willingness to answer questions today, and helping inform the committee. This hearing is now adjourned.
[Whereupon, at 12:21 p.m., the committee was adjourned.]
QUESTIONS FOR THE RECORD
The Honorable Mr. Pascrell
Response: Mr. Buchanan
SUBMISSIONS FOR THE RECORD
Jay Wiedwald
Grande Harvest Wines
Marc Nelson Oil Products
Sukup Manufacturing
US Chamber of Commerce