Good morning. Thank you for joining us today for the third joint hearing this Congress of the House Ways and Means Committee and the Senate Finance Committee. Prior to this Congress, our two committees had not met together for tax-related hearings in more than 70 years. Through this series of hearings, as well as ones we have held on our own and at the Joint Committee on Taxation, we’ve had very productive discussions about steps that we can take to transform today’s broken tax code from one that hinders, to one that fosters greater investment and job creation. After more than 43 consecutive months of unemployment over 8 percent, it is no secret that we are in a jobs crisis, and comprehensive tax reform is a part of achieving much-needed economic growth.
Today’s hearing focuses on capital gains in the context of comprehensive tax reform. For nearly its entire history, our income tax system has taxed capital gains differently than other income. Even in the years following the 1986 Tax Reform Act, when the capital gains and ordinary income rates were aligned, we still recognized that capital investments raise specific tax policy questions and, therefore, require various rules to distinguish between capital gains and ordinary income.
Today, the maximum capital gains tax rate is 15 percent, as compared to the maximum individual ordinary income tax rate of 35 percent. While the focus of this hearing is a longer term view on capital gains as part of comprehensive tax reform, we cannot forget that, absent Congressional action to stop the impending tax hikes we face at the year’s end, the maximum capital gains rate will increase to 25 percent and the maximum individual ordinary income tax rate will increase to 40.8 percent when certain hidden marginal tax rate increases are factored in.
The potential tax increases that we face next year would have a devastating effect on the economy. According to the Joint Committee on Taxation (JCT), a failure to enact a one-year extension of the low-tax policies first enacted in 2001 and 2003 – including an AMT patch – would result in a $384 billion tax increase. On the other hand, extending these policies on a permanent basis – or, as Republicans have called for, enacting comprehensive tax reform consistent with historical revenue levels – would prevent a tax increase of more than $4 trillion over the next decade. Clearly, those increases serve as a stark reminder that without action, more and more revenue that could be used to invest and hire will be taken out of the economy.
As we consider the economic impact of the tax burden associated with capital gains, it is critical that we focus on the total integrated rate, which is nearly 45 percent, not just the statutory rate of 15 percent. The capital gains tax is often, though not always, a double layer of taxation. For example, in the case of shares of stock, a company’s income is first taxed at the corporate rate. Then, when shareholders of the company later decide to sell their stock, they are subject to capital gains tax on the sale. But the value of the stock they sell already has been reduced by the fact that the corporation previously paid out a portion of its earnings as taxes. So, even if we make current low-tax policies permanent, the top integrated rate on capital gains is actually 44.75 percent – a 35 percent first layer of tax and a 15 percent capital gains tax. If we allow current low-tax policies to expire, the top integrated rate on capital gains will exceed 50 percent.
Along these same lines, I believe it is also important to mention that, regardless of what rate we apply to capital gains, we should strive to retain parity between the rates for capital gains and dividends. Just as we need to eliminate the “lock-out” effect that our worldwide tax system imposes on foreign earnings, we also should not restore the “lock-in” effect on domestic corporate earnings that makes it more tax-efficient to retain earnings inside a corporation when it might be more productive to push the cash out to shareholders so they can reinvest it elsewhere in the economy.
There are compelling arguments for providing a preferential tax treatment for capital gains, but we all know that there are important trade-offs to be considered with each piece in the complex process of comprehensive tax reform. One of the main objectives for this hearing is to examine the trade-offs inherent in different proposals for capital gains taxation. I look forward to hearing from our panel of witnesses who are assembled here today, and I thank them for their time. With that I will yield to my colleague, the Chairman of the Senate Finance Committee, for his opening statement.