HEARING ON TAX REFORM AND CONSUMPTION-BASED
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
July 26, 2011
Printed for the use of the Committee on Ways and Means
COMMITTEE ON WAYS AND MEANS
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
C O N T E N T S
Mr. Mike Huckabee
former Governor of Arkansas
Dr. Laurence J. Kotlikoff
Professor of Economics, Boston University, Boston, MA; accompanied by Dr. David Tuerck,
Executive Director, The Beacon Hill Institute, Professor and Chairman, Department of
Economics, Suffolk University
Mr. Bruce Bartlett
Columnist, Tax Notes, The Fiscal Times, Contributor, The New York Times
PANEL (Value Added Tax):
Mr. Michael J. Graetz
Columbia Alumni Professor of Tax Law, Columbia University
Dr. Rosanne Altshuler
Professor and Chair, Economics Department, Rutgers University
Dr. Robert J. Carroll, Ernst & Young LLP
Mr. Jim White
Dr. Daniel J. Mitchell
Senior Fellow, Cato Institute
Dr. Simon Johnson
Ronald A. Kurtz Professor of Entrepreneurship, Sloan School of Management, Massachusetts Institute of Technology, former Economic Counselor and Director of the Research Department at the International Monetary Fund
HEARING ON TAX REFORM AND CONSUMPTION-BASED
U.S. House of Representatives,
Committee on Ways and Means,
[The advisory of the hearing follows:]
The committee met, pursuant to notice, at 10:05 a.m., in Room 1100, Longworth House Office Building, Hon. Dave Camp [chairman of the committee] presiding.
*Chairman Camp. Good morning. And thank you all for joining us today.
Today is the ninth hearing that we have held on comprehensive tax reform, not counting the roundtable discussion held by the Joint Committee on Taxation, where we were joined by key architects of the Tax Reform Act of 1986. During our very first hearing of the year, which was also our first hearing on tax reform, we discussed the need to transform our tax code so that it would encourage, rather than inhibit job creation.
Six months later, as we continue to struggle in an economy where unemployment remains high, and growth is virtually stagnant, the need to overhaul Americans’ broken tax code has never been greater. Clearly, the tax code is too complex, too costly, and takes too much time to comply with. All this adds more burdens on families and employers, making it more difficult to create the jobs that 14 million men and women in this country need.
Since the beginning of our discussions on comprehensive tax reform, I have cited three things I am certain of, as we take on this endeavor. First, I have no illusions that this will be an easy task. But then, most things that are worth doing never are. Second, I don’t think this should be a partisan exercise. And third, and most importantly, we will talk to the American people: individuals, families, employers, both large and small, who are actually affected by the laws we pass here in Washington. They are the real experts, and that is why their voices are critical, as we explore and develop tax reform policy.
That brings us to why we are here today. Although our current tax system does include some elements that are consumption‑based, such as excise taxes, for the most part our tax code is thought of as being based on the taxation of income. To this point, our hearings this year, including the joint hearing we held with the Senate Finance Committee two weeks ago, explore tax reform with an eye toward maintaining an income‑focused tax base. We have explored how the current tax system works and, in many cases, doesn’t work for employers and families.
Today we are shifting gears just a bit to explore a different basis for taxation: consumption. We will examine two different consumption tax models that have emerged as potential alternatives to our current income tax system: the fair tax, and the value‑added tax. Our first panel will discuss the policy arguments for and against adopting the fair tax as a replacement for existing federal taxes. Our second panel will examine the advantages and disadvantages of a value‑added tax, or VAT, whether as a supplement to or a full replacement for existing taxes.
We have some terrific witnesses on our panels, and I would like to thank them for being here today. We are anxious to hear from them, and look forward to engaging in discussion. And with that, I will yield to Ranking Member Levin for the purposes of his opening statement.
*Mr. Levin. Thank you very much. First, I would like to join in welcoming this panel. You are very active and distinguished people. If I might, I would like to say a special hello to Mr. Huckabee, the Honorable Huckabee. It says H‑o‑n in front of your name, and we are glad to see you.
This hearing may take on a number of sparks, in view of the crisis that we face today, but I don’t want anyone to feel that we anything but welcome all of you here today.
Yesterday the Speaker put forward what he calls a two‑step approach, and I quote, “to hold President Obama accountable.” Under that proposal, the Speaker states that there will be, and I quote, “no tax hikes.” But what would the proposals before us today mean for millions of working American families? A tax hike.
At the same time, the Speaker’s proposal establishes a commission that cannot recommend reducing the deficit by ending tax breaks for people making over $1 million a year, or ending tax loopholes that encourage companies to shift jobs overseas, or shutting down tax havens. This prohibition on a commission even considering revenues, along with the spending caps in the Speaker’s proposal would mean major cuts in vital programs like Social Security, Medicare, and Medicaid.
So, today, while our nation is facing a severe crisis, the majority is holding this hearing on proposals that do not address this immediate crisis, and would raise taxes for millions of middle and low‑income families. And at the same time, they are insisting on a deficit package that protects tax breaks for very wealthy households.
What we must focus on right now , and I emphasize this, is avoiding a default that would risk another financial crisis and millions of jobs. It could delay the Social Security checks that millions of seniors depend on. It could permanently call into question the full faith and credit of the U.S., and make it even more difficult to reduce the deficit.
Our President has called again and again for a balanced approach to getting a handle on our nation’s debt. This committee has jurisdiction over many of the elements of such an approach. It is the committee in the House with jurisdiction over legislation on the debt ceiling. We on this committee have a solemn obligation, a solemn obligation, to step up to the plate and address the matter at hand; avoiding a default, and finding a balanced approach to deficit reduction.
Thank you, Mr. Chairman.
*Chairman Camp. Well, thank you, Mr. Levin. Today we will hear from two distinguished panels of witnesses. Our witnesses bring a wealth of knowledge with combined experience in government, academia, and the private sector.
Our first panel includes four experts on the fair tax embodied in this Congress in H.R. 25, as introduced by Representative Rob Woodall. Our second panel will include six experts on value‑added taxes. We begin with our fair tax experts.
First, I would like to welcome the Honorable Mike Huckabee. From 1996 until 2007, Governor Huckabee served as the 44th governor of Arkansas. He ran for the Republican nomination for President in 2008, and currently is the host of the television show, “Huckabee,” and the radio program, “The Huckabee Report.” Governor, we extend a warm welcome to you, and look forward to your testimony.
Next we will hear from Laurence Kotlikoff. Mr. Kotlikoff is a professor of economics at Boston University. He has authored or co‑authored 14 different books, and from 1981 to 1982, served as a senior economist on the President’s Council of Economic Advisors.
Mr. Kotlikoff is accompanied this morning by Mr. David Tuerck. Mr. Tuerck is a professor, and chairman of the department of economics at Suffolk University in Boston, Massachusetts. He is also the chairman of the Beacon Hill Institute, a research center that develops and performs economic and statistical analysis of current and emerging public policy issues.
And finally, we welcome Mr. Bruce Bartlett. Mr. Bartlett has served as the staff director of the Joint Economic Committee, as a senior policy advisor for President Reagan, and as the deputy assistant secretary for economic policy at the U.S. Treasury Department. Mr. Bartlett is currently a columnist for Tax Notes, and The Fiscal Times, and also contributes to the New York Times economics blog.
Thank you all, again, for being with us today. The committee has received each of your written statements, and they will be made part of the formal hearing record. Each of you will be recognized for five minutes for your oral remarks.
And, Governor Huckabee, we will begin with you. Welcome, again, and you are recognized for five minutes.
STATEMENT OF MIKE HUCKABEE, FORMER GOVERNOR OF ARKANSAS, HOPE, ARKANSAS
*Mr. Huckabee. Chairman Camp and Ranking Member Levin, members of the committee, it is an honor and privilege to be able to be with you today to talk about the fair tax.
Let me just begin with a personal observation. Having raised three children, all of whom are now adults ‑‑ and when they moved out my wife and I ended up with three dogs ‑‑ my kids think we replaced them with the dogs, they also think we treat the dogs better than we ever treated them. I tell them it’s because the dogs behave better than the kids ever did.
But I learned something about behavior, both from raising children and training dogs. And the basic premise is this. If you want a certain behavior, you reward it, and you will get more of it. And if you want to stop a certain behavior, you consequence it and you get less of it. It’s a principle of life that we all understand. The fair tax is based on the simple idea that we ought to reward good economic behavior, and we should not reward irresponsible and reckless economic behavior.
The sort of behaviors that will create a stronger economy, grow jobs, make it possible for people to be independent, is that we reward them for their work, we reward them for their investments, their risk‑taking. We reward them for saving something, because that puts something aside for those unexpected moments in life, so that they won’t be dependent upon somebody else’s charity, they will be dependent upon their own thoughtfulness in preparing for the unforseen circumstances that, frankly, all of us have experienced.
The fair tax doesn’t punish people for their productivity, and it does not reward them for their irresponsibility, and that is the essence of it.
I must be honest with you. I didn’t know what the fair tax was when I was campaigning four years ago. People would come up to me and say, “Do you believe in the fair tax?” I said, “Well, of course I believe that taxes ought to be fair.” They said, “No, the fair tax.” And I had no idea what they were talking about.
Somebody finally handed me a book and the bill, the fair tax bill. I read it. Made too much sense. So I read it again. And then I met with a group of economists to ask them, and to spend several hours peppering them with questions about how it would functionally work. And I came away as a strong proponent. And I wish I could take credit for some of the creation, but I am not the chemist that designed it, I’m just the pharmacist that is trying to dispense it.
And so, today I come with a sense of recognizing that the fair tax is, in fact, a transformational approach to the government getting revenue. It is revenue‑neutral, as it is designed. It is not intended to raise taxes or lower taxes. It is, I believe, an approach that could be equally embraced by Democrats and Republicans, because it accomplishes something both want to do. It helps people at the bottom end of the economic spectrum, because of a unique feature that is often overlooked or misunderstood, called the prebate. And it is fundamental to its effectiveness. But it also makes it possible to bring manufacturing jobs and other types of economic models back to the United States from its offshore infusion, because of the fact that people are not going to be punished for actually producing.
There are so many things that I would like to present, and I hope you will have an opportunity to look at some of the written testimony. But the fair tax, in many ways, I want to contend, works because of its fundamental idea that it is flat, it’s based on the consumption of things purchased at the retail level. It is fair, because it does not adjust itself to any particular demographic group. It is finite, because it’s a fixed rate with total transparency, which is one of the things that I find most appealing about it. There is an absolute transparency about what people would pay. And it’s family friendly, and it doesn’t penalize marriage or raising children, as sometimes the tax code does.
I think it’s clear to say that there are very few people, if anyone, in the entire country who understands the 67,000 pages of the tax code. It is extraordinarily convoluted. It is so convoluted that, for the most part, the reason that there are 35,000 lobbyists in this city are to influence the tax code, so that there can be winners and losers. What I would like to suggest is that the fair tax means that every American, in essence, becomes his or her own lobbyist, because there is no need to always be manipulating the tax code to create special favors for one against another.
All of us who watch sporting events know this one thing, that the guys in the striped shirts are not there to determine the outcome of the game, they are just there to make sure that the game is played fairly. When the guys in the striped shirts start determining the outcome of the game, we no longer respect them. The purpose, I believe, of the tax system is not to determine the outcome of the game, but to make sure that there is a fair and absolutely objective playing field. And that is what the fair tax does.
And I come today with over 75,000 online signatures of people who, just in the past 3 or 4 days, have urged me to appeal to you to give consideration to it, notwithstanding any political or partisan consideration.
And I thank you very much for the opportunity to be here.
[The statement of Mr. Huckabee follows:]
*Chairman Camp. Well, thank you very much, Governor.
Mr. Kotlikoff and Mr. Tuerck, you each have, together, five minutes. And you are recognized now. Thank you. Your written statements are part of the record.
STATEMENT OF LAURENCE J. KOTLIKOFF, PROFESSOR OF ECONOMICS, BOSTON UNIVERSITY, BOSTON, MASSACHUSETTS; ACCOMPANIED BY DAVID TUERCK, EXECUTIVE DIRECTOR, THE BEACON HILL INSTITUTE, PROFESSOR AND CHAIRMAN, DEPARTMENT OF ECONOMICS, SUFFOLK UNIVERSITY, BOSTON, MASSACHUSETTS
*Mr. Kotlikoff. Thank you, Chairman Camp and Ranking Member Levin, and members of the committee. We are honored by this invitation to testify today about the fair tax. This is one of several different ways we could implement consumption taxation.
We think the fair tax has a number of reasons to recommend it over the other alternatives. I want to talk to you about that. I, myself, have an alternative to the fair tax, which is called the purple tax, which I put forth recently. But today I am here to talk about the fair tax, together with my co‑author, David Tuerck.
So, the fair tax would replace the personal income tax, the federal personal income tax, and the federal corporate income tax, and the estate and gift tax with a federal retail sales tax that would tax all consumption goods and services, with the exception of imputed rent on existing houses at a 23 percent effective rate, a 30 percent nominal rate. And it would have ‑‑ as Governor Huckabee indicated, there would be a demigrant to make that tax progressive.
But I want to point out that, as an economist, my profession doesn’t believe that a consumption tax is regressive. I know that a number of you folks do believe that a consumption tax is regressive, even without a ‑‑ for ‑‑ leaving aside the issue of the rebate or the prebate, a number of you believe that a consumption tax is regressive. We economists don’t believe you’re right. We think you are looking at it the wrong way, we think you are measuring progressivity the wrong way. We think, when you look at it correctly, and measure progressivity against lifetime resources, lifetime ‑‑ think about lifetime tax burdens as a share of lifetime resources ‑‑ you will see that a consumption tax is actually more progressive than you think.
Now, what is a consumption, tax, actually? I think there is a lot of misunderstanding, not just about the progressivity, but what actually it is taxing. A consumption tax is really taxing what is used to pay for consumption. And what is used to pay for consumption are two things: wealth and wages, not just your current wages, but also your future wages.
So, your consumption over your lifetime is being financed, being paid for, by your taxes on your wealth ‑‑ well, by your wealth and your wages. So if you taxed your consumption, you’re, in effect, taxing what is used to pay for your consumption.
So, economists believe ‑‑ and this is just mathematically the case; it’s not really a belief, it’s just a mathematical proposition ‑‑ that a tax on wealth plus a tax on wages is equivalent to a tax on consumption. So if you’re an advocating of taxing wealth, and using the proceeds from taxing wealth to lower the tax rate on workers ‑‑ and I think a lot of Democrats would say, “That sounds very progressive to me, taxing wealth, using the revenues to lower the tax rate on wages” ‑‑ then you have to be, logically speaking, a proponent of consumption tax, because that is what a consumption tax does, it taxes wealth, and it uses the revenues to lower the tax on workers ‑‑ on wages.
Now, a fair tax, consumption tax, also, compared to an existing income tax, is much more favorable toward saving, insofar as it doesn’t prejudice you towards consuming in the present, relative to the future. That is what an income tax does.
If you look at this chart in our testimony ‑‑ my testimony, joint with David ‑‑ you will see that the national saving rate last year was exactly zero, except for a decimal place. It was 0.1 percent last year, that’s our national saving rate last year. Our domestic investment rate was 4.4 percent. So we’re not saving, as a nation. We are saving nothing as a nation. We are investing next to nothing. We need to have a tax system that gives people incentives to save, and also puts the burden on people fairly, so that we get equity, as well as the right incentives.
So, that is a couple points, of what exactly the fair tax taxes and its incentives. The other thing is it’s ‑‑ that we have in this testimony is a table on the ‑‑ we’re going to have two tables, one on effective tax rates, which show that the effective tax rates, marginal effective tax rates, are much lower under the fair tax than under the existing tax structure, and that the ‑‑ there is also a table showing you lifetime progressivity. And we show in this table that the fair tax on lifetime tax basis is actually more progressive than the existing tax system, basically because it does do this thing that I mentioned, which is tax wealth and use the proceeds to lower the tax on wages.
Let me now turn the time over to David that I took away from him. Sorry.
*Chairman Camp. Well, I will make an exception, Mr. Tuerck. I will give you a minute to sum up.
*Mr. Tuerck. Well, thank you. All economics professors are long‑winded, and I am no exception.
I think that Larry covered the main points about the issue of regressivity versus progressivity. He is right. No modern economist believes any longer that consumption taxes are regressive ‑‑ something for the analysts in Washington to start thinking about.
I am simply going to draw attention to one of the tables in our combined testimony that relates to the effect of the fair tax on investment. Economic theory tells us that consumption taxes untax net investment. That should be intuitively obvious, because of the fact that the corporate income tax goes away. So, lots of us have done estimates on this. I will tell you something about our estimates.
We show that in the first year of implementation, real GDP would go up by about eight percent. Domestic investment would go up by a whopping 75 percent, employment by 12 percent, real wages by 10 percent, and eventually consumption would go up, too, by about 6 percent. These are numbers on which there is widespread agreement by people who have modeled this issue. And it should be no surprise. You untax investment, you get more investment; you get more investment, you get more growth.
Thank you. And I thank the committee, too, for inviting me.
[The statement of Mr. Kotlikoff and Mr. Tuerck follows:]
*Chairman Camp. All right, thank you. Thank you both. Mr. Bartlett, you are recognized for five minutes.
STATEMENT OF BRUCE BARTLETT, COLUMNIST, “TAX NOTES”, AND “THE FISCAL TIMES”
*Mr. Bartlett. Thank you, Mr. Chairman. First of all, I would like to say that I do support, in principle, the concept of a consumption‑based tax system. But I think that many economists ‑‑ perhaps including those to my right ‑‑ gloss over the critical administrative aspects of consumption taxes, and they want to take all of the benefits that you would get from any consumption‑based tax system, and attribute them exclusively to the fair tax, which I think is wrong.
My main objection to the FairTax has always been one simple thing: it simply won’t work. It is a ridiculously pie‑in‑the‑sky proposal. Let me point to a couple of things.
It would abolish the Internal Revenue Service and all of the collection machinery that has been built up over the last 100 years for collecting taxes, and force the states to collect the Federal Government’s revenues for it. Now, this strikes me as unconstitutional, but I don’t want to argue that point. The main thing is that it won’t work. We tried this during the Articles of Confederation, and we ended up with the Constitution.
Secondly, the tax would apply to all governments. State and local governments would have to pay the tax to the Federal Government, as well as collecting the tax for the Federal Government. This makes no sense. The Federal Government would have to pay the tax to itself. The cost of every single thing the Federal Government buys will be 30 percent higher. But the proponents somehow or other assume that federal spending is fixed in nominal terms. So you get a huge cut in spending that helps finance this whole operation.
Third, housing. If you buy a new house, you are going to have to pay 30 percent more. But if you buy a used house, you don’t have to pay anything. This strikes me as administratively impossible, whatever its virtues may be.
The problem of evasion is always glossed over. The reason why ‑‑ I mean we all know we have a very serious evasion problem right now, when we have a huge amount of taxes withheld from people’s paychecks and so on. But under the fair tax, you would eliminate all that machinery, you would collect taxes at exactly one point in the entire economic system: at the retail outlet. There is too much incentive for people to go to the wholesale level and buy out of the factory door. The retail store owner has just as much incentive to evade the tax as the buyer, they just do their sales off the books.
The idea of having a national retail sales tax has been studied by other countries. They always rejected it, because there would be too high a degree of evasion. Instead, they have all favored the value‑added tax, which is a form of consumption tax that will work. We know it works because every other country except us has one. It was designed to deal with all of the administrative and evasion problems that are inherent in the nature of a retail sales tax.
Finally, I want to mention something about the rebate, which the FairTax supporters say is necessary to offset the regressivity of the tax. But, as the George W. Bush administration’s tax reform report pointed out, this would involve the creation of the largest entitlement program in the history of the United States. They estimated that its cost would be $800 billion per year in 2005 dollars. And these checks would go out to people with Social Security numbers on a monthly basis.
Now, as this committee knows perfectly well, we have a huge problem of people with fake Social Security numbers now. Can you imagine what it will be like if, by getting a fake Social Security number, you can get monthly checks from the government? Large checks, too. This is just a license for abuse waiting to happen.
A couple of technical points. Getting rid of the corporate income tax may sound very good to the corporate community, but what’s going to happen to all their unused depreciation the day the corporate income tax disappears? They have nothing to deduct it against. And if you think this isn’t a problem, it is.
When Professor Kotlikoff talks about taxing wealth, you have to understand that the people whose wealth would essentially be taxed by this proposal are the elderly. They saved all during their lifetimes when there was no broad‑based consumption tax, and in retirement they had this anticipation that they would be able to withdraw that saving, tax free. But, in fact, they will have to pay a 30 percent tax on everything at that point.
Thank you very much.
[The statement of Mr. Bartlett follows:]
*Chairman Camp. Thank you. Thank you all very much. Governor Huckabee, as you know, our nation’s unemployment is unacceptably high. And how would the fair tax, if we adopted that, how would that bring about more jobs in this country?
*Mr. Huckabee. Well, Congressman, one of the ways that it will happen, manufacturing has moved offshore in large measure because corporations are having a difficult time, and job creators have a difficult time when they are competing with countries with a lower tax rate. If our tax rate is zero, and there is no tax assessed at the production level, then it is obvious that we then become more competitive.
If we have a zero capital gains tax, capital not only that has been parked offshore ‑‑ and it has been estimated that there is as much as $14 trillion of U.S. money ‑‑ that’s as much as the debt ‑‑ $14 trillion parked offshore to protect it from the tax code, legally and legitimately. But what would happen if that money came back to the United States because there was no penalty for parking it here? That would certainly be a far better situation.
Let me ‑‑ if I could, very quickly ‑‑ give this anecdotal mention, because it was one of the things that sold me on the fair tax. I was in New Hampshire four years ago, and visiting with a gentleman who was working at a machine shop, working two shifts because he wanted to help his daughter through grad school at Cornell. And he said that was costing $53,000 a year, which caused me to gasp.
But he said ‑‑ this is a guy with a high school education, working two shifts ‑‑ he said when he took on the second shift he thought he would make twice as much money. But, as it turned out, it put him in a different tax bracket, and a lot of what he was making in the second shift was going to taxes, not to his daughter. He said, “I don’t understand this.” And the honest answer is neither do I. Why should you punish a person who is working twice as hard?
Truth is, if he quit both jobs, then his daughter would qualify for some assistance that he and her would not qualify for under the current tax code. I think, for most of us, regardless of our political persuasion, that seems insane.
*Chairman Camp. I have a question for both you and Mr. Kotlikoff. Different states have different laws and rules. For example, in Michigan, my home state, there is a sales tax, but the sales tax doesn’t apply to groceries, for example. Under the fair tax, groceries are not exempt. How would that impact stores in Michigan?
And if they don’t currently collect sales taxes, would they now be required to do that? And would there be any transition rules or similar relief available to help sort of ease the administrative burden on those businesses and employers?
And either one of you can answer. If, Mr. Kotlikoff, you want to go first ‑‑
*Mr. Kotlikoff. Yes, they would be required to collect the tax at the store. Whether there was some transition relief would be up to you folks to provide, if you felt it was necessary.
But let’s think about the people coming into the store to actually buy these consumption goods: the food, the bread, eggs. Well, they are going to get ‑‑ if they are working, they are going to get a paycheck that has no income tax withheld from it. And there is also going to be no FICA tax withheld. So they are going to have more wherewithal. And they are also going to get a monthly rebate check.
We are sending out lots of checks to lots of people, older retirees, through Social Security, Bruce, and we do have some fraud, I’m sure. But I don’t think it’s a reason to eliminate Social Security, for example.
So, just to answer ‑‑ back to your question, I think it’s not going to be ‑‑ you know, all the prices of all the goods and services are going to uniformly go up because of this. People are still going to need to buy groceries, and I think that store will still be able to function.
*Chairman Camp. But you envision the collection point being at the grocery story?
*Mr. Kotlikoff. At the store, yes. We’re going to go from about ‑‑ with the fair tax, one would go from about 120 million tax‑paying entities to about 700,000. So that’s really relevant to the issue of enforcement and evasion. If you have an entire IRS ‑‑ I’m not particularly so keen on abolishing the IRS. I think we have a lot of people there that could be used to enforce the fair tax, if that’s what you folks implement.
So, if you go to 700,000, rather than 120 million tax returns, you have a lot more ability to enforce that ‑‑ the tax collection, because you have fewer tax payers.
*Chairman Camp. Okay, Governor?
*Mr. Huckabee. Congressman, if I could address the administrative issue, as a governor for 10‑1/2 years, I mean we certainly understand how to collect taxes. But the reality is that every business owner who is collecting taxes has that set up electronically, and it is programmed in. And the idea that this is going to be a monstrous task is simply not the case. This is not Mom and Pop jotting down on a pad, this is a computer program that easily can be programmed, and the states and localities would be getting basis points for their collections.
So they’re going to get, in essence, a cash windfall as a result of their part of the collection process. And that will make it more attractive to them, because they are not doing it without some compensation for their administrative efforts.
*Chairman Camp. All right, thank you. Mr. Levin is recognized.
*Mr. Levin. Well, this is called a fair tax. By the way, people worked for their Social Security. It’s not a hand‑out from the government.
But I want to get to one of the basic issues here relating to the so‑called fair tax. And, Mr. Bartlett, I read from your special report dated December 24, 2007 on why the fair tax won’t work. And I just want to get to this issue of regressivity. So I’m just reading from this tax report of yours.
But what if a worker is currently paying less than 23 percent of his income in federal taxes? In this case, he is clearly worse off under the so-called FairTax. The prices of the things he buys will rise by more than his income rises, from the elimination of elimination and payroll taxes. Conversely, if one is wealthy and in a tax bracket above 23 percent, that person would be much better off. His income and payroll taxes would fall by much more than the prices of goods and services he consumes would rise.
I want to ask you about this, because here we are in this battle over raising the debt ceiling. And the majority position in the House is no taxes, that you can’t touch the tax rates for people who are making over $1 million. This is annual income of $150,000. Most of that is income over $1 million.
So, just reading this analysis of yours, it seems to me that it is clear that for people who already are doing very, very well, in most cases this helps them, while for middle‑income taxpayers who would not receive a check in most cases, from the government, this would mean an increase in their taxes. I don’t see how you escape this.
And, therefore, I think it is absolutely (what should I say?) – inappropriate, to be charitable, to call this a fair taxation proposal. Could you comment on that?
*Mr. Bartlett. Let me make a point that is very seldom discussed by FairTax supporters, although Professor Kotlikoff alluded to it.
If you impose a sales tax, the Federal Reserve accommodates this tax — then the price level is going to rise by the amount of the tax. If it’s a 23 percent or 30 percent sales tax, the price of every single consumption good is going to rise by 30 percent. So, while it’s true you will have more cash income because you will no longer have to pay income and payroll taxes, the cost of everything you buy is going to cost more. That’s where the burden of the tax comes from.
Now, alternatively, if you assume that the Federal Reserve will not accommodate this one‑time inflation rate that would be the highest in our history, then real wages have to fall, because they always make the argument that the prices of goods will fall by enough to compensate for the tax. They basically make two simultaneous and contrary arguments: the prices will fall, but then they will rise. But if you assume a fixed price level, then wages have to fall. Otherwise, the producers will not be able to reduce their prices. Their costs have to be lower.
*Mr. Levin. So who bears the burden of this? From your analysis, the very wealthy more or less, in most cases, are helped, while many, many mostly middle‑income tax brackets are hurt. Isn’t that correct?
*Mr. Bartlett. The burden is borne by consumption. And so, it depends on what your consumption is relative to your income. People with low incomes consume virtually all of their income. People in the middle bracket save some. That would not be taxed. People in the upper brackets save almost all of their income. So it would be proportional to your consumption.
*Mr. Levin. Yes, so I think this is an unfair tax proposal. Thank you.
*Chairman Camp. Mr. Johnson is recognized.
*Mr. Johnson of Texas. Thank you, Mr. Chairman. Governor, welcome.
Governor, as you well know, there has been a lot of debate when it comes to the real fair tax rate. And Mr. Bartlett argues the true rate is not really 23 percent but 30 percent. How would you answer that charge on a true rate?
*Mr. Huckabee. Well, I think the economists are probably better equipped to get into the specifics. They are trained for that.
But I would say that one of the things that is being missed is that there is an embedded tax in everything that we purchase that is hidden. It is estimated to be approximately 22 percent of everything that we buy, because if we buy a loaf of bread, the taxes that were built in to the people who planted the wheat, harvested the wheat, manufactured the process, delivered it, all the taxes that go into the process are hidden. And the consumer doesn’t know that that tax is embedded.
When that tax is taken out of the process, and it is paid at the consumption level, you already have a dramatically different situation, in terms of the price of the goods that will likely go down. Plus, when the consumer goes to purchase that item, the consumer is going with his or her entire paycheck. Most Americans have never gone to the marketplace with their entire paycheck. Their paycheck has all the extractions from the Federal Government, and they never see what their paycheck is.
But the other thing, it provides a more stable funding for Social Security, because it is based on the consumption that all of us make, not just the wages that wage‑earners are making, which is, I think, another good reason for the fair tax to be a strong consideration.
*Mr. Johnson of Texas. Mr. Bartlett, you care to respond?
*Mr. Bartlett. Well, it is very confusing. So if you just eliminated all existing federal taxation and it just disappeared forever, then clearly, all prices and wages would eventually fall by the amount of the tax, and you would be better off. But if you then put the tax back on in a different form, then the prices go back up again.
So, at times, the FairTax people make it sound like it’s all a wash. Okay? You take out the income taxes, prices fall by 23 percent. You put a 23 percent tax on. Then everything is exactly is the way it is right now. No change in the price level.
But if that is true, there is no need for the rebate, because there is no regressivity to offset. Everything has been a wash. You get more take‑home pay, you pay a little bit more at the checkout of exactly the amount that is now being withheld for the goods and services you buy. You are no worse off. So there is no need for the rebate because there is no regressivity. And the truth is that, obviously, there is regressivity. You can’t have a consumption‑based tax system without it.
And whether having some kind of monthly check that goes to every person in the United States is the way to deal with that is a debatable point.
*Mr. Johnson of Texas. Well, you stated in your testimony that, given that tax revenues have averaged around 18 percent of GDP since World War II, what, in your view, would the fair tax have to be to generate that level of revenue?
*Mr. Bartlett. I honestly don’t know, for this reason. For as long as I have heard of the FairTax, which is more than 20 years, they have always said that arate of 23 percent would equal current revenues, and not increase them and not reduce them. But during that time period, revenues have been as high as 20.6 percent of GDP in the year 2000. And right now they are about 14.8 percent of GDP.
So, if it would equal revenues in 2000 at 23 percent, then it would have to be a massive tax increase today. Either that, or it never would come anywhere close to have equaled the revenues that we had in the year 2000. If they were honest, the rate would vary, depending on taxes as a share of GDP. But they always say, year after year, it is always 23 percent.
*Mr. Johnson of Texas. Governor and Professor, would you care to comment?
*Mr. Kotlikoff. Yes, I would. First of all, let me say I am not, you know, the fair tax guys that Bruce is alluding to. Well, I’m not one of them. I am a professional economist, okay? And I am here to talk to you folks as a professional economist, not as “the fair tax guy,” all right? Let’s just start there.
Now, a lot of ‑‑
*Mr. Johnson of Texas. So you don’t want to pay a fair tax.
*Mr. Kotlikoff. What? Well, I want to tell you what I know, as an economist, okay?
*Mr. Johnson of Texas. Okay.
*Mr. Kotlikoff. And a lot of the statements that have just been made would not get through my course ‑‑ that Bruce just made, and even a couple that Governor Huckabee made were not really appropriate about the fair tax, because we don’t really think that the current tax system is embedded in prices. We don’t think the current prices embed the current taxes.
We do think that if you put on a fair tax, prices will go up. If the Fed accommodates ‑‑ we think the Federal Reserve determines the price level. It does.
*Chairman Camp. I’m going to have to stop you here, because the five minutes has expired. Mr. Rangel is recognized.
*Mr. Rangel. Thank you, Mr. Chairman, and thank you, experts, for sharing your views with us. But I just want to take this opportunity to thank Governor Huckabee. He was kind enough to invite me to his very popular TV show, and was more than fair to me in the differences that we had politically.
And I really thought I had you when I gave you the scenario of a debate between how you protect the vulnerable. And I put on one side the naked and the thirsty and the hungry and those who were jobless, and wanted to protect these people. They were unemployed and they were poor. And then I put on the other side that we can kind of protect them a little better if we made an appeal to the very rich, and kind of said, “Could you help us out a little bit to protect the vulnerable?” And I really thought I had you.
But you went to Divinity School, and you came up with some verses that I never heard of, where the rich were entitled to empower the whatever, humanity, and that the poor was here to stay. Could you restate that? Because most of that was done when I was asked to leave the show.
*Mr. Huckabee. Congressman, it is a pleasure to see you again. I hope you will come back to the show.
But in the meantime, let me just say that what I believe you are referencing is ‑‑ my understanding of the scripture is that ‑‑ do we have an obligation to the poor? Absolutely. Should we reach out and help people and lift them up? Absolutely. One of my reasons for the advocacy for the fair tax is because I believe that, ultimately, it does more to give people the opportunity to rise above where they have come from.
I did not grow up with a silver spoon. I grew up dirt poor, paid my own way through college, paid my way through graduate school. First male in my entire family lineage to graduate high school, much less go to college. I have lived the American Dream, and I didn’t live it by having all of the aspects of attempting to get to the next rung on the ladder pushed back by a tax system that punished me for trying to get to the next rung on the ladder.
I feel a great sense of personal responsibility to help those who struggle, and continue to feel strongly.
*Mr. Rangel. But?
*Mr. Huckabee. If I did not feel the tax system could be improved, I wouldn’t be here today. I believe this approach does, in fact, empower the people at the lowest part of ‑‑
*Mr. Rangel. Well, thank you ‑‑
*Mr. Huckabee. ‑‑ the spectrum.
*Mr. Rangel. ‑‑ Governor Huckabee. I am going to have to go back to the scriptures. Because if the tax burden is what I am talking about with the sick, the poor, and the lesser among us ‑‑
*Mr. Huckabee. No, I don’t ‑‑
*Mr. Rangel. ‑‑ I got a learning to do. Mr. ‑‑ let me ask the fair tax people, quickly.
This rebate this, does the rich get a rebate, as well as the poor?
*Mr. Tuerck. Everybody gets the rebate, depending on the ‑‑
*Mr. Rangel. Very ‑‑ okay.
*Mr. Tuerck. ‑‑ composition of their family.
*Mr. Rangel. That’s good enough for me. How much ‑‑ would the rebate be called an entitlement program, or what name would you have? Just “rebate”?
*Mr. Tuerck. I think “rebate” does just fine. It’s no more an entitlement than the existing ‑‑
*Mr. Rangel. No, okay, that’s good. And that would mean that ‑‑ would the governors operate the rebate, or the Federal Government?
*Mr. Kotlikoff. Federal Government.
*Mr. Rangel. And who would pay the people to operate this massive trillion‑dollar rebate to everybody, including the rich? Who would pay that?
*Mr. Kotlikoff. I would leave the IRS in place until we got everything working.
*Mr. Rangel. Okay. Now, how about those who would eliminate the IRS completely?
*Mr. Kotlikoff. Well, I think ‑‑
*Mr. Rangel. Because that goes over big in every community.
*Mr. Kotlikoff. I think we’ve got to ‑‑ you know, if you start picking on every little detail of ‑‑
*Mr. Rangel. No, no, that’s not a ‑‑ IRS is more than a detail in my community.
*Mr. Kotlikoff. Yes, I agree. And I agree, and I think it’s ‑‑ all right, it’s more than a detail. I think abolishing the IRS is not a clever idea, and not something I support ‑‑
*Mr. Rangel. Mr. Tuerck, do you agree that we have to keep the IRS?
*Mr. Tuerck. No, I don’t agree that we have to keep it. But somebody has to send out the checks.
*Mr. Rangel. Good. I just want to make certain I’m not the only guy out here. So, with you, we will have the IRS plus this massive program to give back money and not collect it. Right? Right. That’s okay.
*Mr. Kotlikoff. I would have the IRS hand out ‑‑ yes, the rebate, exactly.
*Mr. Rangel. Oh, I see. They would be the giver and the taker.
*Mr. Kotlikoff. Yes.
*Mr. Rangel. Okay.
*Mr. Kotlikoff. The way they are now.
*Mr. Rangel. Mr. Bartlett, one question I want to ask you. Because when I saw your background, you worked for every Republican that I have ever served under, including my friend Jack Kemp, and Reagan, and Bush. And they gave tax cuts, and they said that these tax cuts paid for themselves, and went beyond that, and created jobs.
And yet, when you look at the ledger, it seems as though the tax cuts that were given by President Bush and Reagan actually were part of the deficit, and not the job creation. What were your observations?
*Chairman Camp. And if you could, just answer briefly because time has expired.
*Mr. Bartlett. Well, I think the Reagan tax cut in 1981, which I had some personal involvement with, was exactly the right thing to do under those economic circumstances. But I think it’s wrong to assume that just doing the same thing over and over again, you’re going to get the same results.
I think current economic circumstances, you would not get any economic benefits from any tax cut that I am aware of, because our fundamental problem is a lack of aggregate demand, and tax cuts are essentially passive.
*Chairman Camp. All right, thank you. Mr. Tiberi is recognized.
*Mr. Tiberi. Thank you, Mr. Chairman, and thank you for holding this hearing today on the fair tax.
Professor, kind of expanding upon Mr. Rangel’s questioning, can you envision ‑‑ or how do you envision the Federal Government being involved ‑‑ giving you a little bit of time to respond to this ‑‑ in the manner of either sending out these rebates, or some enforcement mechanism? Is it the IRS, or is it something different? Either one of you, or both.
*Mr. Kotlikoff. I mean I envision the states doing ‑‑ the Federal Government working with the states to collect the tax, and the Federal Government, whether it’s through the IRS or some other agency, mailing the rebate checks or distributing those to all Americans. So Bill Gates is going to get the same‑sized check as somebody with his size family.
But the check is going to be big enough so that poor people won’t have to pay any sales tax on net. That is very important. This is going to produce a zero net tax liability for poor people. That is one of the reasons why this is a progressive tax structure.
There is a table two in this testimony that we have that shows very clearly that Congressman Levin’s statements about progressivity are not correct. It shows a very clear table of progressivity. It shows that Mr. Bartlett’s statements are not correct, either, about the progressivity of the system.
Let me just say one thing about this which may get your attention. Suppose you have Warren Buffet here, and he has $30 billion. Suppose that Mr. Rangel were sitting here in front of Mr. Buffett. Mr. Buffett has $30 billion. And you ask Mr. Buffett and Mr. Rangel, “Gee, Mr. Buffett, if you were to spend your $30 billion today on 30 billion steaks, maybe you could buy them at $1 a steak. How many steaks would you get?” Mr. Buffett would say, “Thirty billion steaks.”
Now, Mr. Buffett, what if you had to face a 30 percent retail sales tax? How many steaks would you get? Well, you do the calculation, find out he had ‑‑ got 23 percent fewer steaks. In effect, the sales tax taxes Mr. Buffett’s wealth. That’s why I keep saying that the sale tax is a tax partly on wealth and partly on wages.
So, are we taxing wealth right now under the current system? No. Mr. Buffett’s wealth is not taxed. We don’t tax principal. We tax the income from it. If Mr. Buffett actually realizes his capital gains, which he probably doesn’t ‑‑ he probably borrows against it to do consumption. So do a lot of other rich people.
So, you have to realize that the rich aren’t paying a lot of taxes in the system ‑‑ you know that as well as I, Mr. Rangel. But if you have a way to tax their wealth ‑‑ and even if they don’t spend their wealth today, whenever he does spend it he is going to be facing this tax. And present value, he is going to be out 23 percent of his wages. That’s why the effective tax rate is 23 percent. That’s the rate we need to use to compare the current income tax with the fair tax, because it’s an apples‑to‑apples comparison.
That’s why you want to look at the effective tax rate, not the nominal tax rate.
*Mr. Tiberi. Let me try to take this back. The governor mentioned about the IRS, and mentioned about the ‑‑ or mentioned the tax code, and how lengthy it was. This obviously is very much simpler than our current system. Would you need the current bureaucracy that we have in place? Wouldn’t you just need something much smaller? Professor?
*Mr. Tuerck. We have done some estimates of the impact on administration of the system. And it is vastly more expensive to have the existing income tax system, when you count all the compliance costs that taxpayers have to bear, compared to the fair tax.
The only reason the fair tax architects want the states to collect the money is because almost all states have a sales tax, and it would be a simple extension of that mechanism to collecting the fair tax and passing it on to the government.
But on the other hand, it would be perfectly okay too if the Federal Government could do it more efficiently. So I’m with Larry on that. Why not let them ‑‑ whoever can do it more efficiently, they should collect the tax.
And I have to say one thing about Mr. Bartlett’s comments. His analysis is a welter of confusion in mathematical error. There is no new burden on state and local governments. There is no burden on the Federal Government. There is no basis for the rebate in whatever happens to prices. The rebate is there to make ‑‑ take this from a proportional tax to a progressive tax.
In fact, there is so much that we could begin with here as a baseline to ‑‑ that would eliminate this confused thinking, that would take us much further along toward getting to a good answer to this problem. And I would hope that there would be a future hearing some time where your economists would look at the discussion that has gone back and forth between Mr. Bartlett and me and Larry on this, and start from a baseline where we have at least the basic algebra correct. Thank you.
*Mr. Tiberi. I yield back.
*Chairman Camp. Thank you. Mr. Stark is recognized.
*Mr. Stark. Thank you, Mr. Chairman. Thank you for holding this hearing. I guess I have my credentials. Somebody down there said they were poor; I was, too. As a youngster ‑‑ I never slept alone until I was married. And that defines how the Stark family got along in the deep depression.
The value‑added tax, or fair tax, as you call it, I would just like to talk a little bit about why I would oppose it.
One, I would no longer be able to go to Europe and meet with American CPAs as they studied the value‑added tax and complained about the complexities that it imposed on American companies. Those are nice trips, and they are interesting. But I would like to just talk about some of the issues that would affect the Uniform Commercial Code.
A transfer of title. Where do you pay the tax then, when the title transfers, or when you collect? How every lawyer who provides a service to a client would owe the tax, at the time he provided the service or she provided the service, not at the time when they collected the money. So, you would suddenly find an awful lot of our professionals ‑‑ lawyers, dentists, others ‑‑ who may not collect in cash on the spot suddenly owing tax immediately, yet not having collected the revenue to pay for it.
So, in dealing with the Uniform Commercial Code that we are used to in this country, bankers would have a problem getting title to goods to lend against. All of these things would have to be restructured for the value‑added tax to work. And that is one of the problems that I see in providing this.
I wanted to ask the chairman if ‑‑ is this a provision that might be in your suggestions for tax reform?
*Chairman Camp. We are ‑‑
*Mr. Stark. You don’t know yet, but ‑‑
*Chairman Camp. We are holding a number of hearings on tax reform, and this is one of them.
*Mr. Stark. So this is just one of the things you
*Chairman Camp. Yes.
*Mr. Stark. Okay. So, I don’t know. I would ask Mr. Bartlett. What would you have to do to accommodate all of the changes in the way we conduct business in this country, if you had a fair tax or value‑added tax?
*Mr. Bartlett. Well, it would be extremely difficult, but I presume we could get some guidance from other countries as to how they operate. And I believe that Mr. White from the GAO may be able to talk about that.
But let me make a point, a more general point, which is that one of the reasons why the FairTax is administratively difficult is because it will tax all services. Now, no state makes any effort to tax more than a tiny fraction of services because there is no tangible exchange. There is no good involved. So it is ridiculously simple to go to somebody who is doing some work for you, whether it is a lawyer or a doctor or somebody who is doing landscaping for you, and say, “Let’s just do this off the books. I will pay you cash,” and there will be nothing for Uncle Sam, because there will be no records.
*Mr. Stark. Well, it’s also ‑‑ in Europe, where they have it, they talk about tax collection. In other words, if the tax collector doesn’t find you, you don’t pay. So the European tax collectors have to run around from door to door, see if you bought a new car, remodeled your house, and then levy a tax and extract it from you. Here we still, for the most part, have a voluntary tax system. And I think, under a fair tax or a VAT, that would disappear and no longer ‑‑ did ‑‑ were ‑‑ how many of you on the panel here have been paid for your research in the area of fair tax or value‑added tax? Just two of you? Okay.
Governor Huckabee, you didn’t collect anything for all the good work you are doing?
*Mr. Huckabee. I have received not a penny from anyone associated with the fair tax. It is simply a position I have taken out of my wonderful charity for the United States of America, and my consideration for the fine Members of Congress.
*Mr. Stark. Well, I want to thank you particularly for your kind words about me some weeks ago. I hope they don’t come back to haunt you. And thank the witnesses for participating today. Thank you, Mr. Chairman.
*Chairman Camp. Thank you. Mr. Davis is recognized.
*Mr. Davis. Thank you, Mr. Chairman. It was interesting, hearing the scripture tossed around here earlier. Different people try to fit these perceptions into their sense of world view. The thing I would remind everybody is we are told not to add to or take away from the Word.
And it reminds me of something the chairman likes to say: “The tax code is 10 times bigger than the bible with no good news.”
*Mr. Davis. Which brings me to a question when we relate to this issue of process, the huge cost of tax compliance. And compliance in any tax system is going to be an issue, because there are those who are going to attempt to comply with the plan in the most advantageous way to themselves, and then there are those who will simply try to skirt the system.
And I guess the question I would like to start with, Professor Kotlikoff, is because all systems have a certain amount of non‑compliance, first, who is going to enforce the fair tax? And is this a job for ‑‑ that current IRS employees might handle?
*Mr. Kotlikoff. Well, I have nothing against the current IRS employees. I think they are pretty efficient. They come on the phone these days.
I mean, look. Lots of the ‑‑ the vast majority of the sales are going to be in places like Wal‑Marts, where there is not going to be much issue of compliance. So then the question is ‑‑ and you are reducing dramatically the number of taxpayers, from 120 million down to 700,000.
So then the question is how do you go after ‑‑ deal with compliance where somebody comes up to mow your lawn. And that kind of issue arises under the income tax. These people that are selling services aren’t reporting their ‑‑ for cash ‑‑ aren’t reporting their income under the income tax. So the question is whether the evasion will be worse, and whether the compliance ‑‑ the cost of getting people to comply will be higher.
We think the cost will be smaller. We think the evasion should be smaller, because we are going to have more people to dedicate to a smaller number of taxpayers to work on that problem.
But there is also some new ways you can think about dealing with evasion. I mean suppose you tell the home owner who is getting his lawn mowed: “When you get your lawn mowed, you are supposed to get a receipt with a bar code and the amount that you paid for the lawn.”
You are supposed to put that into the mail box, and also the person who mowed your lawn is supposed to put it in the mail box, so the IRS or whatever agency can then compare.
*Mr. Davis. Just as an aside, would that not give us something similar to what we had to un‑do with the 1099 situation earlier?
*Mr. Kotlikoff. I do not know about the 1099 situation you are referring to.
*Mr. Davis. I am referring to buried in the health care bill was that all business transactions over $600 would require the filing of 1099s, which would have inundated the very retail outlets that we are talking about.
I am not sharp shooting you with the question, but coming down to a deeper process issue, any time we reduce complexity, we reduce cost of compliance, because the overhead component is reduced, and in that case, money in the economy.
I am just trying to understand how we would have a legitimate enforcement mechanism from a process standpoint ‑‑ I am an engineer, not a politician.
I am interested in how the flow would work in order to cut that cost and ‑‑
*Mr. Kotlikoff. The stores, the retail outlets, would be responsible for collecting the taxes and mailing it in.
Again, most of the sales collection or tax collection would be done by big outlets like Wal‑Mart.
It is likely to be an easier collection process than we now have with millions and millions of taxpayers having to decide really what income they want to report under income taxes. It is pretty much a voluntary tax the way it is set up.
Nobody is checking my expenses or income very carefully from one year to the next. The Government is relying on me to be honest, basically, which I am.
*Mr. Davis. Governor Huckabee?
*Mr. Huckabee. What I would like to point out is there is an extraordinary amount of underground economy that is currently not taxed.
I doubt that many gamblers, prostitutes, pimps, and drug dealers are filling out 1040 forms and sending in their due tax.
When you base taxation on retail consumption, people who purchase things in the marketplace, even if they are drug dealers, prostitutes, pimps and others, are going to be paying the tax like the rest of us who honestly pay our taxes.
Dishonest people are still going to be dishonest. We have a greater level or mechanism of collecting tax, and the compliance issue is a huge one.
It has been estimated that as much as $500 billion a year is spent just complying with the Tax Code in this country. That is money that does not produce a thing except paperwork.
That is why I think FairTax brings simplicity to a system that is overwhelmingly complicated.
*Mr. Davis. Thank you all very much. I yield back.
*Chairman Camp. Thank you. Mr. Lewis is recognized.
*Mr. Lewis. Thank you, Mr. Chairman, for holding this hearing. I appreciate any opportunity we have to discuss comprehensive tax reform.
However, I must express my disappointment that we are not gathered here to discuss the most pressing issue of the day, the ongoing debt ceiling negotiation.
What worries me even more is that House Republicans seem to be making a habit of this.
Last week, the House Republicans allowed FAA authorization to expire, freezing airport projects nationwide, sending hundreds and thousands of hard working Americans home indefinitely.
We are just days away from August 2, yet we are here talking about everything but the debt limit. There seems to be no sense of urgency to help get Americans back to work.
Mr. Bartlett, you have been around for a while, in two Administrations. You are a very smart, gifted man.
Could you tell us about the dangers of not raising the debt ceiling, what it will really mean for workers and their families if we do not raise the debt ceiling?
*Mr Bartlett. The worst case scenario, quite frankly, is that the financial markets will completely seize up the way they did when Lehman Brothers collapsed, except it would be far worse.
The market for U.S. Treasury securities is essentially the foundation upon which the entire world financial system rests. It is the one asset that everybody has always believed has zero risk of default.
You introduce into that system the tiniest little risk of default, and all of a sudden you have enormous problems.
The rating agencies have repeatedly said our debt may be downgraded, and this sets in motion a number of forces, because there are certain banks that are only allowed to hold AAA rated debt. If it goes down to BB, they have to get rid of some things.
There are many securities that use U.S. Treasuries as their backing. If the Treasury security falls in price, they have problems. It becomes a ripple effect that we may not know the full consequences of unless it happens.
Everybody thought the fall of Lehman — certainly the Treasury and the Federal Reserve — was not that big a deal, otherwise they would have bailed them out. They said let it go. We know what happened. Financial markets seized up.
I think we could see something potentially worse if we allow a default to occur.
*Mr. Lewis. Thank you very much.
Professor, do you care to respond?
*Mr. Tuerck. Yes. I envision a meeting with the President and the Majority Leader of the Senate and the Speaker of the House in which they say we have come up with a way to raise more revenue, to increase the fairness of the tax system, and have spending cuts, too.
If you want to come up with that plan, adopt the FairTax. If you impose the FairTax rate at the statutory rate we have today, the Government would bring in about $200 billion more than it is currently bringing in. That would be the new revenue.
We would create jobs, ten percent growth in jobs. Spur investment. Then we would have the revenue increases that the President wants, and we could get the spending cuts that the Speaker of the House wants.
That is the way to solve this problem. We could end this whole discussion right now, and I suggest that is the way we do it.
*Mr. Lewis. Let me ask your friend here who is assisting you.
*Mr. Tuerck. I think I am assisting him, actually.
*Mr. Lewis. If a family of four at the poverty level lost the benefit of the EITC and child credit, had to pay 23 percent more for everything they purchased, would they really be better off?
*Mr. Kotlikoff. That is addressed in table two, Congressman Lewis. Let me say my sensibilities about the poor are identical to yours. I think if you spent time with me, you would understand that I have the same views.
*Mr. Lewis. There are some numbers that came out today or maybe late last night that the gap has widened. The rich are getting richer and the poor are getting poorer.
*Mr. Kotlikoff. I am concerned about that. I have cited this carefully. It is included in a framework where the EITC, the child tax credit, all the provisions of the Federal income tax are incorporated. I have done my homework on this.
In Table 2, if we look at the table, if we look at a married couple earning $30,000 ‑‑ not Table 2 ‑‑ sorry, it is Table 2.
A family that is now middle aged, $30,000. Their lifetime average tax rate under the current system is 15.3 percent. That incorporates the EITC and the child tax credit.
Under the FairTax, it is 3.4 percent. I did not know the answer before I did the calculation, just so you know. I did get paid for the research, but I did not know the answer, and the research is what the research shows.
I said let’s take this framework, which is a lifetime life cycle framework. Let’s look at the taxes that this couple is going to pay every year for the rest of their lives.
Let’s figure out as a share of the present value of the remaining lifetime resources the labor income and their initial wealth, what is their tax rate, the average tax rate under the current tax system, and then let’s do it again under the FairTax.
It turns out to be lower under the FairTax. If you look at the results in Table 2 of the testimony, you will see that this is actually a highly progressive tax, and it does lower the taxes on working people because it is coming up with another source of revenue, which is Warren Buffett’s steak dinners.
That is what I am trying to get across here. This is embedding a wealth tax. If I came to you and said you Democrats here on this panel, how would you feel about having a 23 percent effective tax on wealth and use the proceeds, a tax on all the wealthy people in this country, use the proceeds to lower the taxes on workers?
You would say that is fantastic, it will never get through. No Republican would ever propose it.
That is what Republicans are proposing in the FairTax. That is mathematical. You take any first rate economist from any top department, ask them that question, and he will say that is the answer.
*Chairman Camp. Thank you. Mr. Reichert is recognized for five minutes.
*Mr. Reichert. Thank you, Mr. Chairman.
Professor, I do agree with you. Mr. Chairman, thank you for holding this.
This debt ceiling discussion is certainly centered around as we watch taxes and spending, and I think everyone recognizes there needs to be tax reform. We would like a simpler tax code and tax process.
I think more than anything, Americans across this country recognize that we have a spending problem. We are spending money we do not have.
As we look at tax reform as a part of our economic solution, financial solution, I was listening to Mr. Bartlett who mentioned used houses were not taxed and new homes are taxed.
I want to ask the Professor and Mr. Bartlett what would be the impact to new construction of homes under this plan if used homes are not taxed and new construction is taxed?
Home buyers would be obviously directed toward buying used homes. Is that not correct? What would be the impact to new construction in the home buying industry?
*Mr. Kotlikoff. The price of new homes would go up in the marketplace relative to ‑‑ I mean old homes would go up in the marketplace, so it would lead to a capital gain on old homes.
That is why under the purple tax plan I have put forward, I tax housing uniformly, no matter whether it is new or old, by taxing the imputed rent, the consumption services from the housing.
Whether it is new housing or old housing, under the purple tax, which is a modification of the FairTax proposal, this problem that I see with the FairTax gets corrected, and we have a bigger tax base, and also tax imputed rent on yachts, private airplanes.
I think all consumption should be taxed. That is what is part of the purple tax.
I also deal with one of Bruce’s concerns in the purple tax, if I might just take a second to mention it. He is concerned and I think there is a concern about evasion, because the tax rate under the FairTax is 30 percent, relatively high.
What I propose in the purple tax is to have a FairTax at 17.5 percent nominal rate, 15 percent effective rate, and then take the FICA tax and make that progressive. Get rid of the ceiling on the FICA tax and exempt the first $40,000 of the employee part of the FICA tax from taxation. Get rid of the first $40,000 employee based taxes or the first $40,000 of earnings.
Now you have a progressive FICA tax, a lower rated FairTax, two progressive elements, and also a 15 percent inheritance tax. That is what the purple tax plan is.
I think we need to think broadly about consumption taxation. We can implement it in a lot of different ways. We should not say just because somebody is trying to talk about the merits and demerits of the FairTax, you are the FairTax guy, therefore, you are the enemy.
Let’s try to understand what we really care about. We care about incentives. We care about fair treatment between generations. We want to make sure we can get our fiscal policy in order.
*Mr. Reichert. Professor, under a clean FairTax, this old versus new language would apply to homes, it would apply to boats, it would apply to yachts. Would it apply to commercial construction? Would your purple tax cover commercial construction?
*Mr. Kotlikoff. No. Construction for buildings that are used in production of goods and services, that is not taxed. It is just consumption of goods and services by households and purchases of consumption items by governments and non‑profits. All of consumption, what the national income accounts record as consumption. That would be the tax base.
I am saying take the FairTax, if you like the FairTax, think about maybe modifying it so that all of housing consumption services are subject to taxation, so that all the services from private jets and yachts are subject to taxation.
*Mr. Reichert. Used cars, new cars?
*Mr. Kotlikoff. I have an excise tax I have to pay every year to my local town in Massachusetts; yes.
*Mr. Reichert. Thank you, Mr. Chairman.
*Chairman Camp. Thank you. Mr. Neal is recognized.
*Mr. Neal. Thank you, Mr. Chairman.
Mr. Bartlett, one of the arguments our Republican friends have made here over decades is that tax cuts pay for themselves.
I noted in the blog you recently wrote that indeed, you suggest that tax cuts do not pay for themselves.
As a Treasury official who served with President Reagan, can you explain to the committee why you do not believe that tax cuts pay for themselves?
*Mr. Bartlett. First of all, nobody in the Reagan Administration said that the Reagan tax cut would pay for itself. The documents that the administration sent to Capitol Hill in February of 1981 all showed standard revenue losses based on Joint Committee/Treasury methodology that has been around forever.
In fact, if you check Congressional Budget Office documents from that time period and keep in mind the CBO was then headed by Mrs. Rivlin, I believe, it showed revenue losses almost identical to those projected by the administration.
The argument that we were making when I was working for Jack Kemp was that you would not lose as much as the static revenue loss because if you got some growth in the economy, that would enlarge the tax base and you would get back some of that money.
Eventually, Larry Lindsey, an economist who is probably known to this committee, wrote a book and he concluded you got back maybe a third. You lose two‑thirds. I think that is pretty standard public finance theory.
The only tax cut that I have ever heard anybody credibly assert pays for itself is occasionally you can cut the capital gains tax. But that is because capital gains involves gains that may have taken place over a long period of time, and if you realize them all at once, then you can get an unlocking effect and possibly pay for itself.
In general, tax cuts lose revenue. I do not know anyone who really argues that point.
*Mr. Neal. Thank you. Governor Huckabee, the Treasury Department and the Joint Committee on Taxation have concluded that a rate significantly higher than 23 percent would be necessary for FairTax to be fiscally neutral.
I cite the examples of Joint Tax and Treasury because they tend to be made up of Democrats and Republicans who in the next life want to be known for their honesty, as they secure a position in the private sector.
They have suggested that ‑‑ by the way, they are not paid for their advocacy, as you know, other than by the taxpayer ‑‑ rate would actually have to be closer to 50 percent to make up for lost revenue.
I have listened to Dick Armey and others over many years talk about transition costs, and they are substantial.
*Mr. Huckabee. I have never heard the 50 percent figure, and I think that would be frankly one of the issues that one of the economists could better address.
I do know that politically speaking, the simplification of the Tax Code would be much preferable to a Tax Code that is beyond anyone’s comprehension.
What I believe is without the ability to refute is that the complications of our current Tax Code make it so that business owners no longer are making business decisions. They are making tax decisions.
*Mr. Neal. Even Dick Armey, as the Majority Leader, stated as he offered his sales tax proposal at the time, which is a bit different than what we are discussing here ‑‑ Dick Armey used to say not only would there be a substantial transition cost that was slightly enormous, but he also stated we had to be in the vicinity of 28 to 30 percent.
*Mr. Tuerck. Congressman?
*Mr. Neal. Yes, just a moment for me to question Professor Kotlikoff, but go ahead.
*Mr. Tuerck. I would make this simple. Our research is on line. It is simply a matter of going to the National Income and Product accounts and going through the statute and figuring out what the base is, and then figuring out what the rate is.
We could all sit down over a spreadsheet and resolve this question in a few minutes. To be more realistic, in a few days.
We came up with a rate of 23.82 percent for a hypothetical 2007 tax year. We re‑did the calculation and in 2010, we think a lower rate would work.
It is not rocket science. It is simply getting the base correct, which we think we have done. I would like to see the other calculations that lead to a different rate.
*Mr. Neal. Professor Kotlikoff, I appreciate your testimony. You mentioned the phrase “transitional cost.” That is a fair statement. There is a transitional cost, and that has been part of the discussion we have had for a long period of time.
You mentioned lawn care as an example. Are you satisfied in Wellesley, Sudbury, Gloucester, Haverhill, Springfield and Worcester, these people there cutting lawns during the Summer, they are all currently complying with IRS regulations?
*Mr. Kotlikoff. No, I am sure they are not. I am saying we have to think out of the box. Technology is available now, I think, to help us to enforce even their paying taxes.
*Chairman Camp. Time has expired. Thank you. Dr. Boustany is recognized.
*Mr. Boustany. Thank you, Mr. Chairman. I am glad we are having this hearing. I am finding it helpful given that I am certainly getting a lot of calls from constituents back home in Louisiana about the FairTax. I am finding this very helpful to flesh out some of the issues.
I want to explore the issue of small business compliance and potential burdens on small businesses if we go to this type of tax system.
Right now, we are very concerned about jobs and job creation, especially with small businesses, as we look at our economy.
Mr. Bartlett, as I understand it, small businesses across the U.S. would be responsible for collecting this FairTax. In addition, small businesses would have to maintain certain segregated accounts for the payment of taxes, and larger sellers would actually have to provide a security deposit equal to or greater than $100,000 or 1.5 times the seller’s average monthly tax liability during the previous six calendar months.
Given all that, if we went to this type of system, talk to me a little bit about the compliance burden on small businesses and the impact this might have on jobs.
*Mr. Bartlett. It is hard to say what the impact on jobs would be. There is no question there will be a vast increase in the compliance burden on small businesses. Basically, to reduce the compliance burden on individuals, you have to increase it on businesses.
They are the ones who are going to be responsible for being the IRS’ tax collectors. They are going to have to collect the revenue and transmit it to the Treasury.
As we know, we already have enormous problems in that area, in the small business area, where they are having great difficulty complying with the taxes. It is very well known.
They have to collect already Social Security and payroll taxes and transmit them. And often times, small businesses need that cash flow and they use it to cover other expenses, and they end up being in trouble with the IRS.
There is no question there will be an increased burden on small businesses. No question.
*Mr. Boustany. Thank you. Professor Kotlikoff?
*Mr. Kotlikoff. Under the FairTax proposal, you are getting rid of the FICA tax, so they will not have to comply with that.
I presume they would be able to get software that would help them deal with segregation of the accounts.
I do not see this as a huge thing. I go to a lot of small stores. They are in operation, even though they are paying the Massachusetts’ sales tax when I buy something.
This is just going to be an extra sales tax that is collected. It is going to be the software’s job to get this right. It is not going to be the actual owner, that he is actually going to have to do calculations. It will all be automated, I believe.
The Federal Government can certainly assist small businesses with that technology if need be.
*Mr. Boustany. Governor Huckabee, you have traveled around the country a great bit and spoken to many, many people across this great country of ours. Have you heard those concerns in the context of FairTax among small business owners?
*Mr. Huckabee. Congressman, small business owners love the FairTax because of the simplicity of it. Right now, they are eaten up with complying with an incredibly impossible to understand Tax Code that requires them to hire lawyers and accountants at a good deal of their profit.
The FairTax means anyone can figure out 23 percent. It does not take a lawyer and accountant to come up with figuring that.
This idea that it is complicated, I would contest that. I think it is quite the opposite. It is the simplicity of it that causes small business owners, with whom I have spoken all over the country, to embrace this, because they would rather put their money into putting products on the shelves and employees on their floors as opposed to sending checks to accountants and lawyers in order to help be a part of this half a trillion dollar compliance cost that we currently have with the 67,000 page complex Tax Code.
*Mr. Boustany. Thank you. Professor Kotlikoff, the goal of the FairTax is to remove the taxes embedded within prices and replace them with a clear simple tax of 23 percent.
Give me a little breakdown again on the price/wage issue. It came up earlier.
*Mr. Kotlikoff. The notion that prices in the current system, tax system, embed the current tax system, is not correct. Supporters of FairTax have come up with that proposition. It is not based on economics. It is just not right.
The basic story is this, there is a price level, a price for let’s say a chicken, and the retail price level is set by the Federal Reserve by how much money it has in the economy, and what is going to happen is if we went to FairTax, workers would receive more pay in their checks because they would not have to pay the FICA tax or the income tax. They would also get the prebate check.
Then they are going to go the store, and the prices will be 30 percent higher, as Bruce indicated, that is correct, and then the question is are they worse off or better off.
The answer is if you look at Table 2 and other calculations, you find out that working people, poor people, are better off. They pay less taxes over their lifetime, measure of present value lifetime tax rate, under this FairTax system, than they do under the current system. They also have lower marginal effective tax rates.
The marginal effective tax rate on saving becomes zero under the FairTax. Our national savings rate is zero this year ‑‑ last year. It was 15 percent in 1965. We have driven it down to zero.
That is why we are importing so much capital from abroad, from China and other places. That is why we are running the current account deficits we are, because our national saving rate is so low.
You have better incentives and more prospects for growth from this system.
As David was indicating, having no corporate income tax, and as the Governor was indicating, is going to be a great boom.
*Chairman Camp. Thank you. Time has expired. Mr. Becerra is recognized.
*Mr. Becerra. Thank you, Mr. Chairman. Thank you all for your testimony. It is a great conversation to have, and we will need to have a conversation like this if we ever hope to be able to reform the Tax Code, although I am not sure how fair this so‑called “FairTax proposal” is. It is converging more on the fairy tale side of fair than real fairness.
My understanding is there is no country, no state, that has ever implemented anything along the lines of this so‑called “FairTax proposal,” probably because it is unworkable for the reasons that have been discussed, and that I think Mr. Neal pointed out.
How do you get compliance up to a point where you really have everyone paying truly their fair share.
Mr. Bartlett, I know you have done a number of studies on this. I know you worked in the administration and Government and outside of it in the past.
Are you familiar with any country or any place in the world ever where a proposal like the so‑called “FairTax proposal” has been put in place?
*Mr. Bartlett. No country to my knowledge has anything remotely like this. They have studied the idea of something like a FairTax, and in every case they concluded that a value added tax makes more sense if that is the route you want to go.
*Mr. Becerra. That is because it is a lot easier to try to get compliance.
*Mr. Bartlett. I do not want to jump on what they will be talking about on the next panel, but the VAT is easier to administer and much harder to evade because it is embedded in the prices.
Let me make another point, which is ‑‑
*Mr. Becerra. Very quickly.
*Mr. Bartlett. There are no two states that have exactly the same sales tax base, and no state has a sales tax base that is anywhere near as comprehensive as the FairTax.
*Mr. Becerra. Take a state like mine, California, which has a fairly high sales tax rate, but it is still under ten percent. To buy a house in California, you are looking at $200,000 to $500,000, depending on what part of the state you live in, to have to pay a 30 percent tax on top of the price of that home, or whether it is just to buy a computer or car, all of a sudden, you are calculating 30 percent more on a tax.
If you go to a state like Virginia that has a far lower sales tax than my state of California, I think it is around five or six percent, you go to 30 percent, all of a sudden, somebody making $50,000 is looking at how you purchase that house or that new dishwasher or clothes washer, it makes it a little bit more difficult.
As interesting a conversation this is, it is still academic. We are a week away from something that is not academic, and that is this whole discussion of whether or not the country will pay its debts.
I am hoping I can get you all to concentrate a bit more on the revenue aspect of this crisis that has been manufactured, because the reality is we have always found a way to get past this issue of paying our bills, yet this time, it seems like we have hit an intractable resolution to this.
Mr. Bartlett, you wrote an interesting article recently, where you talked about what happens when you deal with the Tax Code, tinker with the Tax Code, and make it sound like it is going to do one thing and have it do something totally different.
Back in the early 2000s, we were running budget surpluses. President Bush at that point told us we could actually reduce the size of those surpluses by returning money to the American people for the taxes they had paid because we had these massive surpluses, $5.6 trillion in surpluses over the coming ten years. These tax cuts were passed.
You wrote this article that points out that not only as a result have we drained the Treasury of trillions of dollars of revenue, which now makes these deficits far larger, but at the same time, we did not see the commensurate growth in the economy that would help produce jobs that would help produce more revenue by people paying more taxes.
Can you comment a bit on what you found?
*Mr. Bartlett. Yes. There is an article in the New York Times this morning on exactly that point. I note that according to the CBO, the Bush tax cuts reduced Federal revenues by about $3 trillion below what they would have otherwise been, and you got about another $3 trillion loss of revenues due to slower than expected economic growth. And then you have about $6 trillion of additional spending for unpaid wars and various things of that sort.
You went from a $6 trillion surplus to a $6 trillion deficit, which is a turnaround of $12 trillion.
I think the argument is very commonly made that we cannot raise taxes because it will destroy the economy. That same identical argument was made in 1982 when Ronald Reagan put forward the largest peacetime tax increase in American history. We had massive growth thereafter.
The same argument was made in 1993 when President Clinton raised taxes. We had a very strong economy.
The argument for the Bush tax cuts, at least one of them, was we would have faster growth. We had the worse ten years, economic years, since the Great Depression.
It seems at least superficially the relationship is the opposite. Higher taxes actually raised economic growth and tax cuts caused the economy to collapse.
I am just saying you can make that argument based on history.
*Chairman Camp. Thank you. Dr. Price is recognized.
*Mr. Price. Thank you. I want to thank the panelists as well. This has been an exciting conversation to have. I want to commend the chairman for holding this hearing because I think it is important to talk about solutions, and I believe this is one of those types of programs that could truly be a solution for our country.
The current tax system, as so many have said, is incredibly broke and it is remarkably complex. The costs of compliance are massive. It has the Government picking winners and losers, which all of us say we do not want, which makes the FairTax, I think, the national retail sales tax, remarkably attractive.
It is simpler. The cost of compliance is less. It certainly is much more fair.
As the Governor pointed out in his comments, we say we want success. We say we want hard work. We say we want vision. We say we want entrepreneurship. We say we want savings. We say we want job creation.
Yet, in our tax system, we punish every single one of them. Every single one of them. Again, I think that makes the FairTax something that we all ought to take a very serious look at.
It rewards savings. It rewards hard work. It rewards entrepreneurship. It rewards job creation.
In addition, it does a couple of things that I think are important to point out. One is that it captures all the underground economy that we currently are not capturing right now. That is estimated to be a third of our economy by some folks.
It would decrease the cost of doing business by 23 percent, virtually overnight. I beg to differ with Mr. Bartlett. I will touch on that in a moment.
It is a less regressive system. It is more fair to individuals at the bottom end of the economic spectrum.
I am excited by having this conversation. I am concerned that some to be imprisoned by their past deeds and comments. I an enthused and excited by folks actually gaining a greater understanding of what I believe to be, as Mr. Tuerck said, a solution to the challenges that we have right now.
Mr. Bartlett mentioned that the proponents of this say that it decreases the cost of services or goods by 23 percent, adds in 23 percent, so the consumer sees basically a wash, which I think is accurate.
Why on earth would you need the rebate if that is so? The fact of the matter is we believe the rebate is appropriate because the current system is unfair. The current system is remarkably regressive and punishing those individuals at the lower end of the economic spectrum.
That is the reason the rebate is needed, and then those individuals actually have a much more fair system.
Mr. Tuerck, I want to touch on Table 2, because I think it is incredibly important.
*Mr. Tuerck. Which table? I am sorry.
*Mr. Price. Table 2. This is the one that talks about lifetime tax rates. This is for young adults, middle aged, seniors, married, individuals, single households.
For every single line that you have here, whether it is $10,000, $50,000, $100,000, $250,000, et cetera, for every single line compared to the current system and their lifetime tax rates compared to the FairTax, every single one of them has individuals paying less under the FairTax system. Every single one. How can that be?
*Mr. Tuerck. First of all, that is Larry’s table, so I am going to ask him to comment on that.
We did our own calculation and we broke individuals down by spending deciles, which is in a way mirroring Larry’s own approach, and what we find is that the people in the lowest spending deciles would all gain, and more so over time as the economy expanded, and the people who would lose were the ones in the top spending deciles.
That reflects current economic thinking about the way to address the progressivity/regressivity issue.
I would only add to that I wonder what this committee would say if somebody walked into this room and said I have a plan for broadening the base, cutting the rate, and by every economic standard imaginable drilling the economy, what do you think about that?
That is what the FairTax does. It has a broader base, and therefore, it has a lower rate, and if you read any economics textbook, I do not know whether you believe them or not, but if you read them, moving toward a consumption tax un‑taxes net investment and expands the economy.
*Mr. Price. I could not agree more. Mr. Kotlikoff, everybody here wins. How is that possible?
*Mr. Kotlikoff. There is a tax on wealth associated. This is really a tax, on what happens to workers, what happens to their lifetime tax payments as a share of their lifetime labor income.
It assumes some wealth holdings, but the super wealthy in this country, a lot of them do not pay any taxes, and they would pay taxes under the FairTax.
Whenever they buy their yachts or their jets, homes, cars, villa’s, they would pay taxes on what I am proposing on the imputed rent from those services, from those durables. When they bought expensive restaurant meals, they would pay tax.
This is a Democrat’s fantasy, this proposal.
*Chairman Camp. Thank you. Time has expired. Mr. Thompson is recognized for five minutes.
*Mr. Thompson. Thank you, Mr. Chairman. I have a couple of questions on the particulars of the FairTax, that maybe one of the professors could answer.
Internet purchases would be taxed?
*Mr. Kotlikoff. Yes, if it is consumption.
*Mr. Thompson. Would churches be taxed?
*Mr. Kotlikoff. Consumption, non‑profits; yes.
*Mr. Tuerck. Church payments to their employees would not, as I recall. I can get that answer to you. I may be wrong on that.
*Mr. Thompson. Churches would or would not be taxed?
*Mr. Tuerck. To that extent. As I recall, I will have to check, payments to their employees would not be taxed.
*Mr. Thompson. The taxes to their employees would not be, but any of their purchases would be?
*Mr. Tuerck. That is correct. That is what I recall.
*Mr. Thompson. Corporations, how are they handled? They are taxed?
*Mr. Kotlikoff. There is no corporate income tax. Corporations are not buying consumption.
*Mr. Thompson. No corporate tax. What if I worked for a corporation and the corporation buys me my car. Is that purchase taxed?
*Mr. Kotlikoff. I think the way the FairTax would handle that is it would assess taxes and the corporation would have to affirmatively show that this was used for business purposes.
I think they would take the money at the dealership, the tax would be charged.
*Mr. Thompson. From who? Who would they take the money from?
*Mr. Kotlikoff. From the corporation that buys the car. They would send the corporation excise tax for the car, and then the corporation would have to show this was actually used for business purposes.
*Mr. Thompson. If I am not working for a corporation and went down and bought a car, I would be taxed?
*Mr. Kotlikoff. Again, I am proposing the taxes on durables, on homes, cars, be done like an excise tax, computed rent, tax on what we call the imputed services from these durables, like the car, you would be paying each year. You pay a tax on it.
*Mr. Thompson. I just am having a hard time understanding how this is at all progressive if I as a regular person buy a car and I am taxed but the corporations avoid that.
*Mr. Kotlikoff. Corporations ‑‑
*Mr Thompson. Let me finish my question so you know how to answer.
*Mr. Kotlikoff. Yes, sir.
*Mr. Thompson. If I worked for a corporation, somebody else, I guess nobody pays the tax, and people who get meals, computers or cars from their employer, which would probably be wealthier people, getting back to what Mr. Lewis was talking about, that division between the rich and the poor, they would be ‑‑
*Mr. Kotlikoff. I see your concern. I think the way to handle that would be to basically tax the purchases. If the corporation pays to give lunch to its employees, that should be subject to tax.
*Mr. Thompson. It sounds pretty confusing.
*Mr. Kotlikoff. If it buys lunch for its employees, it should be subject to taxation.
*Mr. Thompson. It does not look very progressive nor very fair to me. Everyone gets the same rebate and everybody pays the same tax rate, unless of course, somebody else is buying your stuff for you, then you get a break.
Mr. Bartlett, you had talked about the problems associated with default or the threat of default and what this would do to our economic system.
Would higher interest rates be part of this?
*Mr. Bartlett. People on Wall Street, and there is a report out from J.P. Morgan that has been widely cited, have said that interest rates would probably rise by about 60 basis points. That is .6 percentage points in the event of a default.
I really think that focusing on interest rates may understate what really may happen. My great fear is a complete nuclear-type meltdown.
*Mr. Thompson. I do not want to understate. I just want to point out that if it is a little bit or a lot, that means car loans, the price of a car loan goes up, the price of a home loan goes up, the price of a small business loan goes up.
This all impacts regular people working, trying to make a living. It would be an incredible increase on them personally, on their finances.
The article that you referenced, I was trying to read through it. You talked about what is commonly called the “Bush tax cuts,” and you mentioned that they did not pay for themselves.
Did they bring us a higher rate of economic growth?
*Mr. Bartlett. No, they did not.
*Mr. Thompson. They did not pay for themselves, and we did not see any economic growth as a result of those Bush tax cuts?
*Mr. Bartlett. That is correct.
*Chairman Camp. Thank you. Ms. Jenkins is recognized.
*Ms. Jenkins. Thank you, Mr. Chairman, for holding this hearing, and thank you all for being here. I find this very helpful, and I am sure the American people do, too.
As our committee continues to hold hearings on fundamental tax reform, one motivation we have behind our efforts is to stimulate economic growth through lower taxes and to lessen the burden on the taxpayers, and to reduce complexity.
FairTax advocates have claimed that after implementation of the FairTax, the economy would grow at 10.5 percent. Exports would grow by 26 percent, and investment by 41 percent, and employment would be nine percent higher, and that real pre‑tax wages would increase by 11.5 percent.
I would just like each of the panel members to maybe comment for us about the claims and why they believe that we might see increased exports, increased employment, and growth in GDP and investment in the economy.
If the Governor would like to go first.
*Mr. Huckabee. There has been a lot of talk about this system would be complex. The reality is it is not complex, not compared to what we have now.
Are there some complications? Of course, there are. Always when I say if we compare the complications to the complications of the current Tax Code, I cannot imagine how anyone would defend the current Tax Code against the proposals of FairTax, which is in its worse description much simpler.
The reason that some of these numbers that the economists have come up with ‑‑ again, as I said at the beginning, I do not pretend to be the chemist, just the pharmacist, I cannot tell you how they arrived at some of the numbers, but I trust their numbers are carefully researched.
It makes perfect sense to me that if you simplify anything, it is going to be less expensive.
The reason so much of what you see in the FairTax is effective is because it does simplify things for the individual, who now stays up until midnight rushing down to the post office on April 15 trying to get the tax form in the mail, or generally goes to a tax preparer, and hopes they get it right, and often CPAs are trying to figure out every year all the changes in the Tax Code that may come from this city.
Would it not be much simpler if in fact there was a pretty straightforward approach, here is the percentage of tax on the things you purchase.
It is the transparency of it that makes it more effective. When I hear people say things will cost more, we cannot even say that unless you equally say people show up at the marketplace with their entire paychecks, something they have never done before.
It is not going to change dramatically except for the people at the lowest end of the economic spectrum, as has been pointed out. They are going to come out better off.
*Ms. Jenkins. Thank you.
*Mr. Kotlikoff. Congresswoman, the calculations for the growth of the economy are based on simulating a large scale life cycle model that takes into account people’s incentives, but also what we economists call “income effects.”
We have to realize that this decline in the national saving rate that has occurred over five or six decades now, has corresponded to a major increase in the absolute and relative consumption of the elderly.
There has been a huge transfer from young savers to old spenders, systematically, through time, through the retirement programs we have been running.
If you really want to understand why consumption has gone up, why national saving has gone down, why investment has gone down, it has to do with this redistribution from the young savers to old spenders.
Why are people who are older spenders? They are closer to the end of their lives.
When you have the FairTax and you go to a consumption tax, the older people hold disproportionate amounts of the wealth, they are going to be hit with a relatively higher tax burden, so their consumption is going to be reduced relative to that of younger people.
Part of the advantage of FairTax is it un‑does some of the redistribution away from the young towards the old that we have been engaged in in this economy, and it gets the older people to consume less, and consequently, the total economy consumes less, saves more, and there is more investment. More funds to be invested.
In addition, there are better incentives to save because you move away from an income tax which discourages saving to one that is neutral with respect to consuming today versus tomorrow.
The third thing is that you eliminate the corporate income tax, so that companies, international companies, are thinking about whether to invest here or there, gee, if we invest in the U.S., there is no corporate income tax any more.
These three elements are the main reason why you see in these simulations some very significant effects through time. It is not supply side magic. It is not that at all. There is no supply slide gobbledy‑gook here. I am not a supply side nut.
I think a lot of those folks have done a lot of disservice to economics. This is just old fashioned economics that delivers the goods if you actually look at what has gone on in terms of who gets what under this system.
*Ms. Jenkins. Thank you. I yield back.
*Chairman Camp. Thank you. I also want to thank Governor Huckabee for being here before I recognize Mr. Pascrell. I understand you have a plane to catch.
I would just say some members may wish to submit questions in writing to you that have not had an opportunity to question you, if you could be kind enough to respond in writing, and they will be part of the formal hearing record.
*Mr. Huckabee. Mr. Chairman, I would be delighted to. I want to thank all of the members for the opportunity to be here. I wish I could stay. Unfortunately, the airlines will not hold the plane for me. Maybe for you, but not for me.
*Chairman Camp. No, that is not the case at all.
*Mr. Huckabee. I appreciate very much the opportunity to be here, and thank you for your kind attention.
*Chairman Camp. Thank you very, very much, Governor. Mr. Pascrell is recognized.
*Mr. Pascrell. Mr. Chairman, I have heard a lot mentioned today of the current tax system. I certainly hope that the two of you remain. Of course, you are not speaking for the poor.
We have had a lot of people come in front of us that want to make life a lot better for the poor. We have seen it over decades.
I do not have to bring to your attention the figures that came out this morning, and the gap has grown greater, and this foolish proposal that is before us makes the matter hideous in my eyes.
The poor and the middle class do not make the Tax Code Moby Dick.
Two thousand of the 2,300 pages are there because folks who have want to keep what they have. They have every right under the law to do that.
The Tax Code. A lot of folks have to hire lawyers to keep what they have. It is a shame they have to hire all those lawyers.
You are saying that if we put this into effect in this nation, we will not go through that.
The tax cuts of 2001 and 2003 did not increase employment in the United States of America. Did not increase productivity in the United States of America, the trickle down that was promised then is promised now and has never worked.
Why in God’s name do we continue on that path which does not make any sense? Further more, it was not until 2005 that we even increase the revenue. Right, Mr. Bartlett? Is that correct?
*Mr. Bartlett. I believe that was the first year that revenues, nominal revenues, were higher than they had been in 2000.
*Mr. Pascrell. Then we saw what happened after that.
*Mr. Bartlett. We had a crash.
*Mr. Pascrell. Let’s be clear. A national sales tax would be nothing more, in my perception, than an enormous windfall for the very wealthy of this country. Plain and simple, the wealthy do not spend as much as lower income families and the middle class. They just do not, as a percentage of their income.
Mr. Bartlett, how much more would the national sales tax have to be in order to be revenue neutral? How much more would it have to increase?
*Mr. Bartlett. Actually, you have a panelist on the next panel who can answer that better than me, Rosanne Altshuler, who was a chief economist for the Bush administration’s Tax Reform Panel. They did calculations on exactly this subject that showed you ‑‑
*Mr. Pascrell. What did they conclude?
*Mr. Bartlett. It depends on how much evasion you think you would get if it was about the same as the median state, 39 percent or 47 percent.
*Mr. Pascrell. My next question is this, what would be the effect on the debt? Someone asked you about this very briefly before. If we were to create the largest entitlement program, and it would become the largest entitlement program, it would supersede Social Security and Medicare, if we had this prebate program they are talking about in FairTax, what would happen to the debt of this nation?
*Mr. Bartlett. The prebate is in the base. They have calculated that cost. It is not over and above.
*Mr. Pascrell. What does it do to the debt?
*Mr. Bartlett. It would increase Government spending is what it would do.
*Mr. Pascrell. What would it increase the debt exactly?
*Mr. Bartlett. The estimates of the cost of the rebate that the Bush Tax Reform Panel made were there would be upwards of $800 billion a year.
*Mr. Pascrell. What did President Bush say about this plan, by the way? Back in the mid‑2000s.
*Mr. Bartlett. About the FairTax?
*Mr. Pascrell. Yes.
*Mr. Bartlett. I do not know that he ever said anything about it. I could be mistaken. He certainly did not endorse it. He did not endorse his own tax reform.
*Mr. Pascrell. As a former Reagan Treasury official, how many times did Mr. Reagan raise the debt ceiling?
*Mr. Bartlett. It was either 17 or 18 times, I believe.
*Mr. Pascrell. Can you briefly explain how the value of a Treasury note affects the life of every day Americans?
*Mr. Bartlett. As I said before, it is the foundation upon which much of the financial system rests.
If you go to the market to sell corporate bonds, for example, they are historically priced off the equivalent Treasury. It is absolutely essential to have some asset for which there is no default risk in order to establish prices for a great many other financial products.
*Chairman Camp. Thank you.
*Mr. Pascrell. Thank you, Mr. Bartlett.
*Chairman Camp. Mr. Paulsen is recognized.
*Mr. Paulsen. Thank you, Mr. Chairman. I appreciate the panelists taking the time to talk about consumption tax. We have had a multitude of hearings in the Tax Committee laying the foundation for tax reform.
This is the first chance we have really had to engage in some of the consumption tax ideas, and FairTax being one.
I like some of the concepts that were brought forward about the transparency, about driving investment. We are all, I think, in favor of promoting job creation, which is so desperately needed when we have 18,000 jobs coming out a month.
I do have some concerns. Tell me how this would work. The impact of tax reform for those who are already retired is something we are paying attention to, and how do you encourage retirement savings in the long run.
If the FairTax gets implemented, how do you transition or move forward for the folks that have already essentially worked all their lives and paid income tax. They move into a new system where now they are going to pay under consumption, and they only have their retirement savings.
How do you kind of make that work for them? Mr. Kotlikoff, first.
*Mr. Kotlikoff. It is a good challenge. You have people with 401(k) accounts who have not paid taxes yet on those balances. I think you would have to tax those during the transition so we would get the right amount of revenue from them, a fair amount of revenue from them, and not just give them carte blanche or scott free.
You have to have that occur. Capital gains that have not been realized, I think they would have to be realized and subject to taxation.
You are immediately taxing consumption. Again, I think it should be all consumption, including imputed rent on housing and other durables.
Is this going to absolutely help everybody? It is not going to be a free lunch; no. I am saying the people who are really going to get hurt differentially are the rich.
If I came here and told Mr. Pascrell that I was advocating a tax on wealth, using the tax revenues to lower the tax on wages, you would think I am a pretty far left person, economist. You might. Some other people might.
I am saying please let’s talk after the hearing and converse, and let me try to persuade you what economics has to say. There are lots of things said about the FairTax that is not about economics. Lots of statements that are not being made by economists.
It is a really progressive tax structure. I think it is more progressive than the current system.
*Mr. Paulsen. Mr. Tuerck, do you have any follow up on that, just in terms of retirement savings or promoting retirement savings as a part of the Tax Code?
*Mr. Tuerck. I am currently drawing down some of my pension, which I did not pay taxes when it was being accumulated. Now the IRS is taking a chunk of that as I draw it down. In my case, it would be a wash.
Either I am going to let the IRS grab a chunk of it and I might end up paying more for consumption goods because the price has gone up. It seems to me it is neutral in that respect.
Larry makes a persuasive argument and he does it better than anybody else that this is a tax on the wealthy. I think there would be people who have saved over their lifetime who would find this is a burden, and that is part of his argument, as I understand it.
*Mr. Paulsen. I know you have characterized it as being a tax on the wealthy. Governor Huckabee had to leave. I think there is an exemption for educational services as part of the proposal.
How do you avoid having a situation where folks come forward and say, we would like to exempt this? How do you avoid that in the long term?
*Mr. Kotlikoff. What I propose, no exemptions of any kind. I am an educator and I am urging that we tax educational expenditures. I think a good chunk of what people pay for in college is consumption, not education, from what I can tell.
The rebate is there to deal with concerns about proclivity. If somebody says look, let’s exempt bread and eggs. Well, the rebate is here to make sure that poor people, anybody living at the poverty line or lower, is going to have enough money from the rebate to cover all their FairTax payments at the store.
So that would be the way that you can try and avoid having the tax undone. And the whole idea of the FairTax is to have one tax break that everybody can look at and say everybody is paying this tax rate, so that if we spend more money on anything or anybody, that tax rate has to go up.
Under the current system, nobody knows when we spend more money down here in congress who’s paying the bill. The whole connection, the whole value of having a single tax rate has to do with trying to connect our spending to our revenue source in a very concrete manner.
*Chairman Camp. All right. Thank you. Mr. Larson is recognized.
*Mr. Larson. Thank you, Chairman Camp, and thank the panelists for being here this morning. Let me start, first of all, with Mr. Bartlett; and I know others have gone down this line of questioning. But defaulting on the federal debt I believe you said would be analogous to what transpired when Lehmans went down, except on ‑‑ perhaps Lehmans on steroids. In the Reagan Administration you took a balanced approach, both in terms of dealing with debt ceilings but also making cuts, but also balancing them off of revenues. Is that pretty much how this current situation should be approached?
*Mr. Bartlett. Well I personally would favor a balanced approach. I think one of the biggest problems we have right now is that revenues are too low. They are less than 15 percent of GDP and have been for the last three years. So if there is any truth to the idea that low taxes spur growth, we should be growing like crazy, and obviously we are not. We have other problems.
One point I would like to make that hasn’t really quite come out here is when Professor Kotlikoff talks about the importance of national savings, he is of course correct, but the deficit is negative saving. Therefore, if we raise revenues in such a way as to reduce the deficit, that will add to national savings; and, that was what happened, frankly, during the Clinton Administration. That is why we had budget surpluses and the added saving is what created a lot of the economic growth that I wish we still had.
*Mr. Larson. Another question that comes up often, and I’m glad that we have two economists here, et cetera. And let me say I think the current system that we operate under is flawed.
Mr. Neal has been trying to simplify this system for some time now in a number of his proposals, but there’s a debate that rages on here with respect to the very fragile recovery that we’re in in terms of both cuts and taxes. Now, people will say, and I don’t disagree with them, that raising taxes at this time in a frail economy is not a wise thing, because of the fragility.
Is cuts a wise thing, or do cuts result in hurting a fragile economy. Do cuts that result in layoffs and people on unemployment and furthering what has to come out of the federal proceeds, how would you categorize those as the difference between the two?
*Mr. Tuerck. You mean cuts in spending or cuts in taxes?
*Mr. Larson. Cuts in general; taxes, you know, being raised or cuts to programs that lay off people.
*Mr. Tuerck. I’m sure that all spending cuts hurt people, and in many cases people that we don’t want to hurt. But the problem is that we’re having the wrong conversation. I personally don’t have a clue as to whether canceling some of the Bush tax cuts would affect the economy one way or another, but I do know that we have a hopelessly convoluted tax system where we can’t get the base straight, when what we ought to do is we ought to change the base into a consumption base, so that then we know that we’re on taxing and growing the economy.
*Mr. Larson. Let’s say that could be if we would be willing to look at a hybrid. Or how long of a transition period do you think that that would take?
*Mr. Tuerck. I think that the transition would require a lot of adjustments.
*Mr. Larson. How long would you say that might take?
*Mr. Tuerck. I think we could transition to a FairTax within a year or two.
*Mr. Larson. Within a year?
*Mr. Tuerck. Yes.
*Mr. Larson. And during that time, what would you do with the existing tax system?
*Mr. Tuerck. Well the existing tax system would go away and we would then impose the tax on consumption to replace those revenues; and the date we impose it, if the statutory 23 ‑‑
*Mr. Larson. So I’m trying to figure this out. Just so within a year’s time we would move out of the Internal Revenue system and go to a collection of consumption taxes; and how would that end up in a neutral situation. Don’t you think you ought to give yourself a little more time than that?
*Mr. Kotlikoff. I give it as much time as needed.
*Mr. Larson. Well then let me ask you this, because that’s where I was leading. I would think that you would need more time. Would you be willing to put in your consumption tax and have that consumption tax be dedicated only to reducing the deficit as you try to figure out just in fact what its implications will be and have an economic model that’s out there?
*Mr. Kotlikoff. Well, as I’ve indicated, I have this proposal called the Purple Tax, which retains the FICA tax, makes it progressive, very progressive, as a FairTax that basically half the level, at a 15 percent effective rate, and has an inheritance tax of 15 percent.
So 15 percent solution is a very simple tax structure. I think it is more progressive than the current system. I think it will generate at least two percent more of GDP than the current system. We need more revenue. So why don’t you folks pass that today?
*Mr. Larson. But as you are working the modeling out with that specific tax, would you let that money all go while you are running almost tandem systems to reduce the national debt?
*Chairman Camp. All right. Time has expired. Mr. Marchant is recognized.
*Mr. Marchant. Thank you, Mr. Chairman, and I appreciate the fact that the chairman is having these hearings with the goal of a simpler tax code, a lower tax rate, and as a result of that having increased revenues to the government. I think that that is something this panel should discuss at length and I appreciate the fact we are doing that.
I would like to talk about an average family in my district and how this FairTax proposal would affect that family. Let’s say it is a man and wife. They are both working. One is a school teacher. One is a fireman. They have two kids. They have a gross income of about $8,000 a month. Will they have any FICA tax withheld?
*Mr. Kotlikoff. No FICA tax.
*Mr. Marchant. Will their employer have FICA tax?
*Mr. Kotlikoff. No FICA tax.
*Mr. Marchant. So their income would go up about 7‑1/2 percent. Their take home would be about 7‑1/2 percent higher.
*Mr. Kotlikoff. Well, it would be 15.3, because the employer portion is also going to be available to be handed out to the employee.
*Mr. Marchant. Is that in the proposal?
*Mr. Kotlikoff. Well economists think the employers aren’t paying our taxes for us out of the goodness of their hearts. We think workers pay both the employee’s share and the employer’s share. And then when you eliminate the FICA tax, all 15.3 percent is going to end up in the hands of the employee.
*Mr. Marchant. Okay. And so then whatever tax rate they had, let’s say 20 percent.
*Mr. Kotlikoff. Right.
*Mr. Marchant. Will they lose their mortgage deductions?
*Mr. Kotlikoff. Well there won’t be any mortgage deductions, because there won’t be any income tax against which you can adjust it.
*Mr. Marchant. There shall be no income taxes so perhaps they’ll get 25 percent. Maybe they will get $20,000 of income tax they won’t pay.
*Mr. Kotlikoff. Yeah. And this Table 2 in this testimony dealt with all the issues of mortgage deductibility and the earning of tax credit and the child tax credit.
*Mr. Marchant. Well a lot of the people that are going to be watching this hearing in my district are not going to have the ability to have those tables. So would their take‑home pay be as high as $20,000 more a year?
*Mr. Kotlikoff. Well, you know, it is a hypothetical. I don’t want to be imprecise and give you the wrong answer to that specific question. But if we looked at the table that I have here, which was ‑‑ what was the income of the family?
*Mr. Marchant. Around 4,000 each a month.
*Mr. Kotlikoff. So we are talking about 8,000. So we are talking about ‑‑
*Mr. Marchant. About $96,000.
*Mr. Kotlikoff. A hundred thousand a year, so let’s look at a married couple who’s 45 with a couple kids and a house, a moderate size house, mortgage deduction. They are currently paying 24 percent of their lifetime resources to the Federal Government in FICA and income taxes under the current system. Under the FairTax, it would be 14.7 percent.
*Mr. Marchant. I am trying to talk about their month to month.
*Mr. Kotlikoff. Yeah. Their month to month take home pay would go up.
*Mr. Marchant. So will this family qualify for a prebate?
*Mr. Kotlikoff. Everybody gets a prebate. Yes, they would.
*Mr. Marchant. So what number of checks would the Federal Government be cutting a month?
*Mr. Kotlikoff. One month to that family based on their household size.
*Mr. Marchant. Okay. So how many is that? Would that be a hundred million rebate checks a month?
*Mr. Kotlikoff. Well, yeah. It might be 130 million checks. Every American household will get a check.
*Mr. Marchant. So adding to the in the last ‑‑
*Mr. Kotlikoff. You could send electronically, by the way.
*Mr. Marchant. Right. I understand. And then when they go to the grocery store they are going to pay 23 percent more.
*Mr. Kotlikoff. Well, they pay 30. The nominal rate is 30 percent. In effect every dollar that you spend, 23 cents out of that dollar is going to go to taxes. So that’s what it cost.
*Mr. Marchant. How about utilities?
*Mr. Kotlikoff. Yeah. That’s also consumption.
*Mr. Marchant. Rent.
*Mr. Kotlikoff. Rent, yes.
*Mr. Marchant. Gasoline.
*Mr. Kotlikoff. Yes.
*Mr. Marchant. So everything that they consume then they will pay the extra 23 to 30 percent on.
*Mr. Kotlikoff. Yes.
*Mr. Marchant. And the theory being that this family, together with the amount of money that they keep, that they were paying plus the prebate are going to come out.
*Mr. Kotlikoff. Better off.
*Mr. Marchant. Better off or hold?
*Mr. Kotlikoff. Better off. And I didn’t know the answer to the question until I did the calculations. And this is my best judgment based on pretty careful, serious. You know. It wasn’t a two‑day study, either.
*Mr. Marchant. Well, I have a tremendous number of people in my district that support the FairTax. I’ve read every book that I can available on the FairTax, and the prebate is my single largest mechanical problem that I haven’t been able to work through, but this will help me in answering the questions that I get on that.
*Chairman Camp. All right. Thank you. Time is expired. Ms. Black is recognized.
*Ms. Black. Thank you, Mr. Chairman. I want to go back to the prebate, rebate, whatever the acronym is for that, but I am not sure that I understand exactly know the information gets to the government to identify what their income is. If you don’t have an income tax, how does the information get from the employer to the government to know what that salary is and how to figure that?
*Mr. Tuerck. It doesn’t have anything to do with the salary. It has to do with the composition of the family, whether it is a married couple, how many kids they have. And then that is a mechanical formula. And once that is determined, then that determines the size of the prebate, the philosophy being that if that family were at the poverty level they would pay no taxes under the FairTax.
*Mr. Kotlikoff. So the prebate doesn’t depend on your income. If you have a family of four, you get one size demograph. That is the word that Pat Moynihan used to use, I believe, when he advocated the negative income tax, he quoted a demograph, a monthly payment. So if you have got a family of four, you get one size. If you have got a family of three, it would be a smaller check, but it wouldn’t depend on your income.
*Ms. Black. So then how does that help those who are at the lower income?
*Mr. Kotlikoff. Because for people that are low income, it is going to be a much bigger deal than for Bill Gates as a proportion. So progressivity is always tax is a proportion of resources, and so that’s why this would be progressive as conventionally defined in terms of what progressivity means.
*Ms. Black. All right. That makes sense. That clears that piece up. This may or may not be a question that you as an economist can answer, but I am curious. In all of the information that I have here I can’t find anything that indicates what percentage of those are not paying any tax whatsoever at this point in time. We keep hearing there is about 47 to 50 percent of the people who pay nothing. Is that something that you can help with?
*Mr. Tuerck. Close to 50 percent of individual taxpayers pay no personal income tax. That is correct, close to that.
*Mr. Bartlett. Yes, that is correct. But I want to make a point here that is relevant to your point, which is that if you are right now at a poverty level income, you have a negative tax because of the earned income tax credit. You get a check from the government and pay zero. Okay? And for most people in the bottom quintile, that rebate or the EITC is more than enough to compensate for your payroll taxes as well. So that you are literally paying zero, but you may still be getting more on top of that.
But just keep in mind that if you are under the FairTax, if you are now at the poverty level income, the rebate compensates you for your consumption, but you are going from negative to zero, which is a tax increase, you see. You are not getting the EITC anymore. And keep in mind also, there is a lot of confusion about the difference between consumption and income.
If you look at the Consumer Expenditure Survey, you will see that people in the bottom quintile spend about twice as much as their income. So the tax base that applies to consumption for people with low income is going to be higher, precisely because a lot of those people are the elderly who are drawing down saving.
That’s the point Professor Kotlikoff keeps getting at when he talks about taxing wealth. That’s basically where the incidence of that wealth tax comes from.
*Mr. Kotlikoff. Let me respond, if I could.
*Ms. Black. Yes, thank you.
*Mr. Kotlikoff. We have I think some segment of very poor people who might, because the EITC might end up with a somewhat higher tax rate, but at the table incorporated the EITC. And there is not a whole lot of selves here where the average tax rate actually goes up under the FairTax. It basically goes down. There is a lot of very poor people that don’t get the ITC because they don’t have kids or they’re not working.
We have to also think about in terms of the tax burden on older people, poor older people, the older people are going to get this rebate, just like everybody else; and their social security benefits are also going to be CPI indexed. So they’re going to get an extra bonus here, because when the price level goes up, their Social Security benefits are going to rise by 30 percent, and then they are also going to get the rebate.
So this is actually going to redistribute toward the poorer elderly away from the rich and middle class elderly, and get a bigger burden, tax burden on the rich and middle class elderly; and, therefore lower the burden on younger people. We have had a mass of redistribution away from younger people towards older people. That is a large part of this deeper conversation we need to have about how to fix the fiscal system of the country.
*Chairman Camp. All right. Thank you. Mr. Reed is recognized.
*Mr. Reed. No questions.
*Chairman Camp. All right. Mr. Berg is recognized.
*Mr. Berg. Thank you, Mr. Chairman. Two questions: one question is on stability.
I mean what we want is a revenue source that is stable. That is how we need to plan, and I guess my question is how would you compare the stability of, again, just one of the new consumption tax versus our current revenue.
*Mr. Tuerck. Well consumption taxes are going to be more stable than the current tax system, because consumption is more stable of the economic cycle than income is. I don’t have ‑‑ maybe Larry’s done some estimates of the difference it makes; but, we found for example, that if you have the 23 percent FairTax in effect in 2010, which is obviously a period of depressed economic circumstances, then we would have brought in more revenue than needed in order to pay the government’s bills; and that’s just largely because consumption was better than the rest of the economy.
*Mr. Kotlikoff. Well, I concur with that. The consumption is more stable than income. It is more stable than investment, so it is a more stable tax base and more reliable.
*Mr. Berg. Then my follow‑up question really relates to the transactions that would be conducted by local and state government. I understand the individual, but as we go into local and state government, and they’re paying an additional 23 percent tax, how does that filter through the formula.
It seems to me that they’re not paying income now; they would pay this. And so many of them are exempted now, but that would have an increased cost in local services or state services.
*Mr. Kotlikoff. Well in our calculations for revenue neutrality, we incorporate paying back, compensating the governments state and federal for the extra taxes that they’re going to incur. So that the idea is to keep this revenue neutral and not to force governments to have a bigger burden through the back door.
*Mr. Tuerck. It is a little tricky. The tax base at the state and local level would go down, slightly, and that would represent a temporary boon to state and local taxpayers. But the states and local governments could compensate for that by adjusting their tax codes. They would have to do that, but an easy fix, for example, would be for the state to impose its own sales tax on top of the FairTax rate.
That would adjust for that part of the problem, and then they might have to also make some adjustments in their income tax rates. At the end of the day after everything was worked out everybody would be whole. Everybody would be where they started out.
*Mr. Kotlikoff. Let me just say we spent with several other economists at Suffolk University, we spent a good part of the year very carefully trying to figure out what tax rate would be relatively neutral. And we didn’t know the answer before we sat down, and whatever the answer was going to come out, we were going to report it. And so when other people testify about the sales tax, let’s make sure that the methodology was the same.
I mean we use the same methodology as Bill Gale, who is a major critic of the sales tax. He reviewed our study. He said it is the same methodology. There are some different assumptions here and there, but I think this is a very careful study. It is on line, available to anybody to look at.
*Mr. Berg. Thank you. Thank you, Mr. Chairman.
*Chairman Camp. Well, thank you, and I want to thank our first panel for their testimony today. It has been very helpful, and I hope we will be able to engage with you as we continue this discussion on fundamental tax reform.
Members may wish to submit additional questions to you in writing for inclusion in the formal record, and I would just ask that you be prompt in responding to those questions if you do receive them. Again, let me thank you again for being here today, and I would now invite our second panel to come to the witness table.
We are pleased to welcome our second panel, which features six individuals who are highly regarded as experts in value added taxes. First I would like to welcome and introduce Mr. Michael Graetz. Mr. Graetz is the Columbia alumni professor of tax law at Columbia Law School, and is a professor emeritus of law at the Yale Law School. In addition to his teaching career, Mr. Graetz served at the Treasury Department from 1990 to 1992.
And, second, we will hear from Rosanne Altshuler. Ms. Altshuler is a professor in the economics department at Rutgers University. She has previously served as the director of the Urban Brookings Tax Policy Center as a Senior economist to the President’s Advisory Panel on Federal Tax Reform in 2005, and as a special advisor to the Joint Committee on Taxation.
And, third, we welcome back Robert Carroll, a principal with Ernst & Young’s quantitative economics and statistics group in the National Tax Department. Before joining Ernst & Young, Mr. Carroll served as the deputy assistant secretary for tax analysis at the Treasury Department.
And, fourth, we will hear from Jim White, the director of tax issues for the U.S. Government Accountability Office. As a Director of Tax issues, Mr. White is responsible for work on IRS, tax administration and tax policy. He has been with GAO since 1990.
And, fifth, we welcome Dan Mitchell, a senior fellow at the Cato Institute. Prior to joining Cato, Mr. Mitchell was a senior fellow with the Heritage Foundation and previously served as an economist for the Senate Finance Committee. And, finally, we welcome back Simon Johnson, the Ronald A. Kurtz professor of entrepreneurship at the Massachusetts Institute of Technology. He is also a senior fellow at the Peterson Institute for International Economics in Washington, D.C., and from March 2007 to August 2008 Mr. Johnson was the economic counselor and director of the research department at the International Monetary Fund.
Thank you all for your time today. The committee has received each of your written statements, and they will be made part of the formal hearing record. Each of you will be recognized for five minutes for your oral remarks. There will be a yellow light one minute out in which you can sum‑up before the red light comes on.
Again, I look forward to hearing from all of you. Mr. Graetz, we’ll begin with you. You are recognized for five minutes.
STATEMENT OF MICHAEL J. GRAETZ, COLUMBIA ALUMNI PROFESSOR OF TAX LAW, COLUMBIA UNIVERSITY
*Mr. Graetz. Thank you, Mr. Chairman. Thank you, Mr. Levin and members of the committee for inviting me to testify on this important subject.
We know our tax system is broken. Nobody argues with that. The question is what should we do about it. Until World War II we had a consumption tax on most Americans, and an income tax only on high income individuals. And it was only the revenue needs of the Second World War that extended the income tax to the masses. Today, the U.S. is a low tax country, but we are not a low income tax country. So we have sacrificed our advantage from our low taxes by having income taxes that are comparable to those of other nations in the OECD.
The biggest difference between the U.S. and everybody else in the world is that we have no national level consumption tax, which 156 nations, at last count, do have. We know the problems with the income tax. The congress uses the income tax the way my mother used to use chicken soup — as a solution to every ill facing the country. We know that we haven’t solved the nation’s health problems. We haven’t solved the nation’s education problems. We haven’t solved the nation’s energy problems, despite the many billions of dollars a year in tax deductions and credits that go in those directions. The Tax Reform Act of 1986 was a great success; it gave the income tax a good cleansing, but it has not proved stable. We can cleanse it again, as many people have proposed, and as most of the conversation around this committee has suggested over the last couple of years. But we know that the tax code is going to get dirty rather quickly again.
The other thing that has happened since the 1986 Act is that we are now a world economy. Given the internationalization of the world economy, in my view, we need to have a low income tax, particularly a low corporate tax rate in order to attract jobs to the United States, to attract investment to the United States, and to allow American workers and businesses to compete worldwide.
I have advanced a tax reform plan in my book, One Hundred Million Unnecessary Returns: A Simple, Fair and Competitive Tax System for the United States. I am certainly happy to get a copy for any member or staff person that would like to read it. I know some of you have. Let me just review the pieces of my proposal.
First, add a value added tax, which is basically a retail sales tax with withholding. The idea that you would not have withholding on an income tax strikes me as foolish. We are the only OECD country that does not have a value added tax. Sometimes it is called a goods and services tax.
Second, use the revenues from that tax to finance an income tax exemption of $100,000 and to lower substantially the rates above that amount. Third, lower the corporate income tax rate to 15 percent; and, fourth, replace the earned income tax credit and provide low and middle income families with tax relief from the VAT burden through payroll tax offsets and through debit cards that allow them to avoid VAT on their purchases.
This plan has many advantages over existing law. It would be more favorable to savings and investment, and economic growth in America. It would take advantage of our status as a low tax country: a 15 percent tax on corporate income would be among the lowest in the world. It would solve the problems of transfer pricing, and other tax planning that goes on in the international community.
Third, it would eliminate more than a hundred million of the 140 million tax returns the IRS gets every year. 150 million Americans would never have to face the income tax. Fourth, there would be less temptation under such a small income tax for Congress to view tax exclusions, deductions and credits as if they were solutions to America’s problems. We know they’re not.
Fifth, a value added tax would be border adjustable under WTO international trade rules, which means that it could tax imports and exempt exports, which an income tax cannot. Given the size of our trade imbalances, we would likely produce hundreds of billions of dollars in additional revenue from taxes on imports alone over the next 10 years.
Sixth, it would avoid most of the difficult issues of transition that virtually all of the other tax reform proposals have. And, finally, by using taxes that are common throughout the world, it would fit well with international standards.
The Tax Policy Center, pursuant to a contract with the Pew Charitable Trust, has estimated the plan. They’ve determined some preliminary numbers. They have given me permission to share them with the committee today. Basically, they estimate that for the year 2015, my plan is revenue neutral with a value added tax of under 12‑1/2 percent, a 15 percent corporate income tax rate, a 16 percent tax on married couples between $100,000 and $200,000 of income, and a 25 or 26 percent rate on families above $200,000. This shows that you could dramatically reduce income tax rates.
My proposal is also distributionally neutral; that is, unlike the so‑called FairTax, it does not shift the burden of taxes down the income scale. Given its widespread application around the world, it is clear that the U.S. can readily administer a value‑added tax. I have been working over the last two years with a number of VAT managers, accounting firms, and law firms around the world in an effort to design a model value added tax for the United States. And I would be happy to share some of that learning with the committee.
[The statement of Mr. Graetz follows:]
*Chairman Camp. Thank you. I am afraid we are going to have to keep the hearing moving, and your time has expired. So we will move on to Ms. Altshuler.
You have five minutes.
STATEMENT OF ROSANNE ALTSHULER, PROFESSOR AND CHAIR, ECONOMIC DEPARTMENT, RUTGERS UNIVERSITY
*Ms. Altshuler. Thank you, Chairman Camp, ranking member Levin and members of the committee, it’s an honor to appear before you today.
CBO analysis shows that the government began this year with the projected budget deficit of almost 10 percent of GDP, and its future growth is driven by rising healthcare costs, an aging population, and the interest payments on an ever increasing public debt. Reducing the deficit to an economically sustainable level will require both the scaling back of expenditure programs and an increase in tax revenues.
In work I’ve done with economists at the Tax Policy Center, we find that raising significantly more revenue from our current tax system, however, would be politically difficult, and likely damaging to economic growth. The substantial near and long term fiscal pressures facing the Federal Government require that we both reform our income tax system and consider new revenue sources, including federal taxes on consumption.
That is a type of consumption tax that is similar to a retail sales tax, but it is collected in smaller increments throughout the production process. That is part of the tax systems of nearly 150 countries around the world, including all OECD member countries except the United States. Adding a VAT to the U.S. federal tax system could help address the medium and long term revenue shortfalls forecast for the United States. That is particularly effective in raising substantial amounts of revenue in a relatively efficient manner, and has proven to be an administrable tax.
If we were to adopt a VAT, we could rely on the experience and best practices of other countries in setting up and administering the tax. In addition to these attributes, the VAT has a number of other advantages. First, a portion of the revenues from a VAT could be used to finance reductions in statutory income tax rates, as Michael Graetz has just told us.
Two, tax systems: a VAT, and an income tax, with low tax rates, may be superior from an efficiency and administration perspective to an income tax system with higher statutory rates. Second, given the size of projected future budget deficits, adding a VAT to our current system to generate revenues for deficit reduction alone would likely have positive effects on economic growth.
Third, a preannounced and phased‑in VAT might stimulate the economy by encouraging consumption in anticipation of the imposition of the tax. Finally, while the states are likely to protest, a properly designed VAT may actually help force them to redesign or improve their retail sales taxes.
There are a number of issues that need to be addressed in designing and implementing a VAT, and I will hit on a few of these issues in my remaining time ‑‑ distributional issues. The VAT is equivalent to a retail sales tax, but it is collected at different stages of the production process. Since higher income households save more than those with lower or moderate incomes, the burden of the tax increases with current income, reducing the overall progressivity of the tax system.
The additional VAT burden, however, can be relieved for low and middle income households through refundable credits. This approach to relieving the VAT burden is more effective than exempting food and other necessities from taxation or applying preferential rates, since it can be targeted to lower and middle income households rather than all households.
TPC has recently released a report that illustrates the impact of a five percent VAT in the distribution of income. While regressive in the absence of a rebate, the authors show that the impact on low and middle income households could be offset by allowing a rebate in the form of a refundable credit claimed on income tax returns. With the rebate, the VAT is progressive throughout almost the entire income distribution.
The TPC study shows that one should not look at the distributional impact of the VAT in isolation. The progressiveness of the complete federal tax system with that rebate, for example, must be taken into account. What about revenue? Well, policy analysts point out that given the fixed administrative costs of the VAT, if the U.S. adopts a VAT, it should be at a fairly substantial rate. Work again out of the Tax Policy Center suggests that with a ten percent rate, a VAT with a broad base and a rebate to offset the regressivity of the tax could raise about two percent of GDP.
It is important to think about how any tax instrument we use to raise additional revenue will affect economic growth. Recent work from economists at the OECD suggested the VAT is more pro‑growth than personal and corporate income taxes. Revenues from the VAT could be used to buy down the deficit and/or reduce individual and corporate statutory tax rates.
Large and persistent deficits can have negative affects on economic growth by reducing national savings, driving up interest rates, and increasing our reliance on foreign investors. A single rate VAT on a broad base at a rate of ten percent could go a long way towards reducing the economic burden of our large and growing debt.
Using some VAT revenues to buy down statutory income tax rates would also have positive effects on growth. Lower marginal income tax rates on individuals and businesses would strengthen the incentive to save, invest, work and innovate, while making our tax system more efficient. The fiscal challenges ahead are daunting. The VAT on its own cannot solve the country’s fiscal problems, and introducing a VAT has its own problems.
If we adopted the VAT, we would have to institute some form of rebate to offset its regressivity and make every effort to adopt the broadest possible base. We would need to increase IRS resources for administration, and be attentive to a range of compliance issues. But, we must recognize that near and long‑term fiscal pressures require that we raise more revenue from our tax system. The VAT is an efficient revenue raiser that is likely to be significantly less damaging to economic growth than increasing personal and corporate statutory rates.
Thank you. I am happy to answer any questions.
[The statement of Ms. Altshuler follows:]
*Chairman Camp. Thank you, Ms. Altshuler.
Mr. Carroll, you are recognized for five minutes.
STATEMENT OF ROBERT CARROLL, ERNST & YOUNG
*Mr. Carroll. Thank you. Chairman Camp, ranking member Levin, distinguished members of the committee, I thank you for the opportunity to testify today regarding considerations for value added tax in the United States.
The U.S. faces serious fiscal challenges over the next several decades as the federal deficit and debt are projected to rise to unsustainable levels. At the same time, many view the existing tax system as overly complex, and an obstacle to economic growth. These issues have led to some discussion of a value added tax.
Some view a VAT as a possible source of additional revenue to help reduce the deficit and stabilize the debt. Others view a VAT as a means to help improve the competitiveness of the U.S. by providing revenue to permit a reduction in the corporate income tax rate, or a reduction in the scope of the income tax system.
VATs are the norm in most of the countries. More than 150 countries rely on VATs, and in these countries VATs account for nearly one‑fifth of total government revenue. Consideration of a VAT in the United States is not a new issue. VATs have been discussed and considered in the U.S. for more than four decades. A VAT was considered by a task force appointed by President Nixon in 1970 and an advisory panel appointed by President Bush in 2005.
A VAT in the U.S. would raise a number of issues, and they can have very different economic effects depending on a number of key considerations. For example, would the VAT be a replacement tax or an add‑on tax? Which features of the income tax would be replaced by a replacement VAT? How would the revenue from an add‑on VAT be used? Would it be used to reduce the deficit, reform the existing tax system, or fund additional spending?
Would the VAT apply broadly to consumption, or would a large portion of household consumption be excluded from the VAT base? Answers to these questions would have a significant impact on the economic effects of a VAT. A broad‑based VAT that replaces the worst features of the income tax has the potential to provide significant economic benefits. A VAT is fundamentally a tax on consumption, and does not tax the return to saving and investment, thereby reducing the cost of capital and increasing investment.
Greater investment means more capital formation, and ultimately higher labor productivity and living standards than otherwise would be the case. Estimates suggest that the economic gains from replacing all or a portion of the income tax with a consumption type tax, such as a VAT, could be significant. One study found that complete replacement of the individual and corporate income taxes could increase the size of the economy in the long run by six to ten percent.
The December 2007 Treasury Department study on approaches to make the U.S. more competitive found that replacement of the corporate income tax with a VAT could increase long run output by two percent to two point five percent. But it is important to emphasize that these potential, economic benefits arise from a VAT that is replacing all or the worst features of the income tax.
A deficient reducing, add‑on VAT could have significantly different economic effects, using the revenue from an add‑on VAT to reduce the deficit would put downward pressure on long‑term interest rates, as deficit financed government spending is replaced with VAT financed government spending. And deficits that would otherwise crowd out private savings are reduced.
Lower long‑term interest rates would reduce borrowing costs for both households and businesses, and eventually boost output; however, the rise in prices that would accompany an add‑on VAT would also likely lower consumer spending. And there is evidence that consumer spending and employment would be permanently reduced.
Another key consideration is how broad a VAT base would actually be in practice. The VATs in most other countries and the state sales taxes in the U.S. are generally not broad‑based and exclude significant amounts of consumption from the tax base through exemptions and preferential rates. They might be better termed partial VATs. A more narrow base requires a higher tax rate to raise a given amount of revenue, and can lead to differential taxation of consumption. Both can reduce the economic benefits of a VAT, and adversely affect the sectors of the economy that are taxed.
Additionally, an add‑on VAT, while possibly addressing the nation’s long‑term fiscal imbalance, would represent a new tax with additional compliance costs. Businesses would have to collect the VAT on behalf of the government, keep and maintain records of their VAT payments and collection, and prepare VAT returns. The extent of these costs would depend on factors such as the number of transactions involved, the complexity of the VAT base, rate structure, definitions and administrative enforcement regimes.
VATs can also impose extra, non‑recoverable costs on businesses. Under a VAT, businesses act as tax collectors. A business is liable for VAT on its gross sales, but receives credits for a VAT previously paid on its purchases. There may be circumstances, in which VAT crediting may be incomplete, thereby imposing a direct tax cost on businesses. Because the gross flows are so large, imperfections in the VAT system can be greatly amplified.
Finally, the transition as a VAT is introduced would be crucial. Introduction of a VAT involves a lump sum tax on existing assets, plus there could be large, near‑term economic effects as the economy adjusts to a large, new revenue source. In summary, the specific design of a VAT is critical to its economic effects. All VATs are not equal, and they could have very different economic effects depending on key design elements.
I thank you again for the opportunity to testify, and look forward to responding to any questions you may have.
[The statement of Mr. Carroll follows:]
*Chairman Camp. Thank you, Mr. Carroll.
Mr. White, you are recognized for five minutes.
STATEMENT OF JAMES R. WHITE, DIRECTOR, TAX ISSUES, GOVERNMENT ACCOUNTABILITY OFFICE
*Mr. White. Thank you. Chairman Camp, ranking member Levin and members of the committee, I am pleased to be here to discuss value added taxes. Others will discuss the economics of a VAT.
I would note in passing, though, that a VAT and a retail sales tax are both consumption taxes. The economics are essentially the same. The administration is different. I will focus on how a VAT is administered. Specifically, five countries’ experiences with a VAT: New Zealand, Australia, Canada, France and the United Kingdom. They represent a range of VAT designs from relatively simple to complex, including some with both national and provincial taxes and some that recently enacted a VAT.
I will discuss, one, how VAT designed choices such as the number of tax rates and exemptions affect compliance, administrative costs and taxpayers compliance burdens; how Canada combined a national VAT with provincial consumption taxes; how countries transition to a VAT, and some possible lessons for the U.S. My main point is that VATs, like income taxes and sales taxes, require a robust administrative presence. I illustrate a simple VAT on page 3 of my statement.
Each business in the chain that produces and sells furniture to a consumer owes a VAT of ten percent on its sales, but gets a credit for VAT paid on its purchases of inputs. The figure shows how the tax is paid by each company in the chain add up to a VAT of ten percent on the price the consumer pays, exactly equivalent to a sales tax of the same rate.
In my example, each business is taxed at the same rate. There are no exemptions. However, even such a simple VAT has compliance risks, which I show on page 5. Unscrupulous businesses may not collect VAT owed or may not remit it to the government, by for example, not reporting cash sales or falsely reporting imports. Or, they may over claim credit for tax paid on inputs.
Some of these compliance risks, such as under reporting cash, are also problems with an income tax. Others, such as fraudulent refunds are probably more of an issue with a VAT, because unlike our current income tax, most of these VAT credits are refundable.
Under a VAT, large numbers of businesses such as start‑ups are legitimately entitled to refunds making it a challenge to detect refund fraud. In fact, some VAT fraud schemes are common enough to have earned names. One is called “carousel fraud,” because goods move in a circle between countries with tax cheats collecting VAT but not remitting it to the government. Not surprisingly, adding complexity to a VAT through tax preferences increases the challenges of tax administration and loses revenue.
France and the United Kingdom built so many exemptions, special rates and other preferences into their VATs that it is estimated they collect less than half the revenue they could have with a very simple VAT. While all taxes require an administration system, there is some evidence from our study countries that VATs are easier to administer than an income tax.
The U.K. found its VAT cheaper to administer, measured as a percent of revenue collected, than the U.K. income tax. New Zealand with a relatively simple VAT found many fewer errors on VAT returns than on income tax returns. As with other taxes, the VAT compliance burden on taxpayers is mostly driven by recordkeeping requirements, the number of times a year returns must be filed, and the time needed to deal with audits.
Studies in the U.K., Canada, and New Zealand show VAT compliance cost as a percent of sales are greatest for small businesses and much lower for large businesses. For this reason, some countries exempt small businesses from VAT. Interestingly, however, many small businesses in Australia and Canada volunteer to be subject to VAT. Some want credit for taxes paid on their inputs. Some fear being outside the system will cost them customers. Large businesses don’t like the extra recordkeeping required when dealing with exempt businesses.
Canada shows how a VAT can work in a federal system. Some provinces adopted a provincial VAT and harmonized it with the federal VAT. Others adopted VATs but with different exemptions and other preferences. Still others kept their provincial sales taxes. Canada shows those different options are workable, but the amount of burden on businesses to comply vary depending on the amount of harmonization.
Australia, Canada and New Zealand all introduced their VATs since 1986. All three had the advantage that their VATs replace preexisting national consumption taxes. Nevertheless, implementation took up to two years, required significant resources for outreach, and the country still had difficulty getting businesses to register for the VAT system before the implementation date.
In summary, one lesson about VAT design is that like our income tax, tax preferences reduce revenue and add complexity, compliance risks and compliance burden. Having said that, tax design is influenced by criteria in addition to administerability, such as revenue needs, the effect on the economy and distributional concerns.
That concludes my statement. I’d be happy to answer questions.
[The statement of Mr. White follows:]
*Chairman Camp. Thank you, Mr. White.
Mr. Mitchell, you are recognized for five minutes.
STATEMENT OF DANIEL J. MITCHELL, SENIOR FELLOW, CATO INSTITUTE
*Mr. Mitchell. Thank you, Mr. Chairman, ranking members, and members of the committee.
In my summation of my testimony I want to focus on what I would call the real world versus the theory. I agree with the theory that a value added tax, compared to our current income tax, is a less destructive way of raising revenue. It doesn’t do as much damage per dollar raised. And so, in theory, if you replaced or got rid of other taxes, or if you somehow paid down deficits or debt with the value added tax, you might get some benefits.
But if you look at the experience in Europe and other countries, you find that this is not what happens. The question that I always pose is, why on earth would we want to copy the fiscal policy of Greece, Portugal and other countries that are now teetering on the edge of financial collapse? Because what you find in those countries ‑‑ and I’ll walk through some of the data ‑‑ is that they did not reduce other taxes. They did not reduce deficits and debt. Instead, the VAT became, as it is sometimes referred to, a money machine or for larger government.
Now, to touch on the theory for just a little bit, the shortcut way of understanding a VAT is that it is a system that doesn’t allow for the deductibility of wages at the business level. You can get into the details on credit, invoice, subtraction method; but, if you think about a tax system that doesn’t allow deductibility of wages, that is really what a VAT is all about, and it is important to realize what that means.
It means that, in effect, you have an entirely additional system for taxing income. If you don’t allow businesses to deduct the wages and salaries they pay their workers, their employees, you have a withholding tax that is in addition to the income tax that they already pay. Now, in the language of public finance economists, the VAT is a consumption tax, but this term requires some elaboration.
A consumption, or consumption based tax does not mean, necessarily, that the tax is actually paid by consumers. It simply means that it’s a tax system where there is no double taxation of income that is saved and invested. The Social Security payroll tax is a consumption based tax, since it is not imposed on dividends, interest and capital gains.
Likewise, the flat tax, popularized by a former house majority leader, Dick Armey, is a consumption tax, since dividends, interest, capital gains are not subject to a second layer of tax. In short, a consumption tax is a system where income is taxed only once. It might be taxed only one time when the income is earned. It might be taxed only one time when the income is spent. And this is in contrast to our current system, the Haig‑Simons or comprehensive income tax system, which does have pervasive double and triple taxation of income that is saved and invested.
Now, because a VAT does not have all this double taxation, it often gets favorable reviews from economists, but that is only if you assume that you are getting rid of other taxes. That’s not what anybody is talking about. A VAT is always being discussed as an add‑on tax. And what would it mean?
Well, if you look at the experience from Europe, you will see that an add‑on value‑added tax basically leads to two things. It leads to higher, overall tax burdens, and it leads to a higher burden of government spending. If you look at the OECD data, you will see that government spending in Europe back in the mid‑60s before a VAT became pervasive was not that different than government spending in the U.S., when measured as a share of GDP.
But, ever since the VAT was adopted government spending in Europe has increased dramatically. Of course they’ve had higher payroll taxes, energy taxes and things like that. So it is not always a one to one relationship, but the correlation still exists. The other thing that you find in Europe since the adoption of a value‑added tax is that we do not see any improvements in fiscal balance.
If anything, deficits and debt have gotten much higher in Europe since the adoption of the value‑added tax. In some sense, they are confirming what Milton Friedman said back in the 1990s, that governments will spend everything that the revenue system will generate, plus as much as they can get away with.
Another one of the big assertions about a value added tax is that you can use it to reduce or lower other taxes. Well, let’s look at what happened in Europe. Let’s look at what happened to taxes on income and profits as a share of GDP in Europe. Ever since the VAT was adopted, the tax on income and profits in Europe as a share of GDP has gone up, not down.
If we look just at the tax on corporate income as a share of GDP in Europe, you will see that it has gone up, not down. By contrast, in the United States, which doesn’t have a value added tax, the overall tax burden on income and profits has stayed relatively flat over the last 40 or 50 years, and our tax burden on corporations as a share of GDP has actually fallen. So, the assertion that a value added tax can somehow lead us to a better tax system certainly hasn’t applied in any countries in the world right now, although I will say that in some of the more recent countries, like Australia, Japan, that have adopted a VAT or goods and services tax, you don’t find the same problems.
But, I am out of time, and so I will stop there. Thank you very much.
[The statement of Mr. Mitchell follows:]
*Chairman Camp. Thank you, Mr. Mitchell.
Mr. Johnson, you are recognized for five minutes.
STATEMENT OF SIMON JOHNSON, RONALD A. KURTZ PROFESSOR OF ENTREPRENEURSHIP, SLOAN SCHOOL OF MANAGEMENT, MASSACHUSETTS INSTITUTE OF TECHNOLOGY
*Mr. Johnson. Thank you, Mr. Chairman.
I would like to make three points that have not come out in the discussion so far. First of all, while I support the VAT on efficiency grounds in terms of the ability to raise revenue as the previous panelists have indicated ‑‑ and I broadly would agree with the numbers they put forward ‑‑ I think we should stress that the VAT is an inherently regressive tax.
Income distribution in this country has become much more skewed since the tax reform of 1986. These are striking and dramatic numbers, and this is a very hard trend to reverse in many ways. It is certainly possible, as some of the previous panelists said, to address the regressivity of VAT through various forms, some sort of refundable tax credit, and also addressing, perhaps, Social Security payments.
But I would point everyone to the report made by President Bush’s advisory panel when they looked carefully at this issue. Even when trying to address this issue, they present numbers that show you the amount of tax being paid at the top of income distribution goes down dramatically. And the amount of tax being paid in the middle of the income distribution goes up. So I think this is a very serious issue that has to be taken fully on board.
The second point is, and I don’t think this has been mentioned so far, is the way that financial services are treated in a VAT system has to be viewed carefully. The one problem with the European VAT system is that it has typically ‑‑ because it is a relatively old system and this problem wasn’t especially thought through ‑‑ it is under taxed financial services.
The IMF proposed in light of the financial crisis at the behest of the G20 a new form of taxation, which is called, rather memorably, the FAT financial activities tax. So we have the VAT and the FAT. I didn’t pick the name. It was after I left the IMF. But the point of the fact is to redress this balance, and the latest thinking, although this has not been done fully and properly in any country so far, but it is doable, is to have a version of FAT that would fully integrate with VAT and would result in a fair, equitable taxation on the same basis of financial services.
Now, in this context and completely consistent with that FAT, I would stress that we should also be addressing the excess leverage in the financial system in this country, and I would commend to you a speech made recently by the President of the Minneapolis Fed, Mr. Cocha Lakota, who goes through in detail why the tax code is encouraging excessive leverage for the corporate sector, particularly for the financial sector. This can be addressed at the same time as moving to a VAT, plus FAT, system.
The third point I would like to make or the question I think I would like to raise is when exactly is the fiscal crisis that we need to address with tax reform? And, of course, there are several possibilities. One is the crisis next week, which I certainly hope we will avert. I don’t think that is going to happen. We’ll see.
Another is a crisis over the next 10 years, and that, of course, is part of the discussion around the CBO’s forecast window, but the numbers there are quite string. If the CBO is correct, and they certainly are the projections that we all use, the United States under reasonable assumptions will have a small, primary surplus at the end of the 10 years. This is not a dramatic budget crisis by any means.
There is a budget problem, which has already been mentioned, which is in the longer term spending. And the IMF also has very good, comparative numbers; but, this is mostly about increase in medical cost, medical spending over a 30‑year period. On this scale we stand out relative to other countries. So I think the good news part of this is that we have time for proper tax reform.
At the same time as we are thinking about tax reform and thinking about the appropriate level and extent of a consumption tax, or a VAT plus financial activities tax, I would stress we need to think about the changing nature of our society over these 30 years. The society is aging in a way that needs the robust provision of public goods, for example, for education and health, for children and for lower income people. And we also live in a very dangerous world in which having a robust income base for military spending is absolutely important.
One very important feature of these consumption taxes ‑‑ this is actually mentioned also in the last panel, at least in passing, is that consumption goes down less than does income when you have a major crisis. Now to the extent that we don’t reduce the risks in our financial system, I am very worried about future crises that will damage the receipts from income tax and cause a big increase in debt.
The reason why debt has surged over the past four years is primarily due to the effect of banks, big banks in particular, blowing themselves up at great cost to the American taxpayer. Thank you.
[The statement of Mr. Johnson follows:]
*Chairman Camp. All right. Thank you.
We expect a series of votes in about 15 minutes that will last about an hour. So, as a result, Mr. Levin and I have yielded back our time and we are going to go to a three‑minute questioning period.
So at this point, Mr. Rangel, you are recognized for three minutes.
*Mr. Rangel. I just want to ask Mr. Johnson. All the time during his testimony I was thinking of a possible crises, if the congress and the President can’t get together.
Now, Mr. Johnson, I think some people believe that if we do have a default that we’ll have a smaller government; and I think I read somewhere that you had indicated that a default would increase the size of government. Is that correct?
*Mr. Johnson. Yes, Mr. Rangel, that is my opinion, because government debt as a triple A rated securities, the basis of our credit system, so much of the private sector depends on credit one way or another. If you have any kind of government default, and that could be next week ‑‑ it could be at any point ‑‑ you’ll destroy the credit system. You make the private sector smaller. And the government, whatever you think about it, has an ability to operate. You saw this in the great depression, even as the private sector crumbles around it.
So, ironically, one effect, and tragically, I could say, because I certainly don’t want to default, and I would argue very strongly against anything that would take you down the road. But one ironic effect would be to make the private sector much, much smaller. Therefore, government as a share of GDP will become bigger while GDP was getting smaller.
*Mr. Rangel. Thank you, Mr. Johnson. I yield back the balance of my time.
*Chairman Camp. Thank you, Mr. Rangel.
Mr. Davis, you are recognized for three minutes.
*Mr. Davis. Thank you, Mr. Chairman. I would like to ask a hypothetical question, open it up to the panel. If the VAT were imposed, how wide ranging should this be if you were to do something like this in the United States? I have heard a range of different opinions here.
I mean should some products and services be excluded as they are in the current retail economy from sales tax or professional services? You know. How are you concerned that implementation of VAT will be no different than our current tax code in terms of complexity and compliance issues that exempt certain income and taxes others. I’d just like to throw it open to the group there.
*Mr. White. That’s a very good question; and, as I mentioned, the European VATs are quite complex. They’ve got a lot of exemptions, special rates, other tax preferences or tax expenditures built in, so many that they lose roughly half the revenue that they could have collected from a simpler version. So that the overall point is that just like an income tax, you can add a lot of complexity with exemptions, deductions, special rates, those kinds of ‑‑
*Mr. Davis. So hypothetically you could have a simpler VAT with a lower rate and actually make more money.
*Mr. White. New Zealand is an example of a country that’s got a much simpler VAT; many fewer exemptions, fewer special rates.
*Mr. Davis. Anybody else?
*Mr. Graetz. Mr. Davis?
*Mr. Davis. I will come back to you, Mr. Johnson. We will get Mr. Graetz and come back to you briefly.
*Mr. Graetz. We have been looking at this very carefully, and the VATs to use as your models are Singapore, South Africa, New Zealand, Australia and Canada.
Talking about Europe is non‑sensical, because Europe’s VATs are ancient and because of the European treaties. They can’t change them without agreement throughout Europe, so Europe is really not the right comparison. These are all modern value added taxes. They are very broad‑based. They are very simple. Their compliance costs are relatively low.
Singapore has a very large exemption for small businesses. If I were recommending an exemption for small businesses, I would say that any business under $500,000 of receipts doesn’t need to come into the VAT, unless it elects to come into the VAT. Some of them will elect to come in because they will get refunds, because of where they are in the chain. I agree with Mr. Johnson, Professor Johnson, that the financial services problem is a big one, under many VATs.
Financial services transactions with businesses are over taxed, and their transactions with customers, with retail customers, are under‑taxed, and we have come up with some solutions that we think will work on that front. These problems of implementation are solvable and the advantages of having a value added tax are large and eliminating, if we can eliminate a large part of the income tax in the process and get our corporate rate down.
You can’t solve the corporate income tax problem in this country by tinkering with the international tax rules. It’s not going to work.
*Mr. Davis. I am sorry, Mr. Johnson, but the clock has run out on me there. Hopefully, someone else will pick up on this.
*Chairman Camp. Mr. Neal is recognized.
*Mr. Neal. Thank you, Mr. Chairman.
Dr. Altshuler, the relationship of the VAT or proposed VAT and exports is a lot of conflicting advice on whether or not the VAT actually would help our exporting industries.
*Ms. Altshuler. Well, I think as you know we economists don’t think that the border adjusting attacks will have an affect in the long‑term on trade. What we think will happen is that there’ll be exchange rate adjustments that will take away any advantage or disadvantage that we would gain from adopting a board or adjustable tax.
That said, it’s possible that during the transition period there could be advantages or disadvantages in terms of trade; and, if you were to do what I think we would all advise that you should not do and adopt a VAT that has lots of holes and lots of exemptions, you’d create a system in which there would be some disadvantages and advantages in terms of export and import. But, again, a reason to adopt the VAT is not because it will be a positive for trade or negative for trade.
*Mr. Graetz. An export driver. Can I make just one quick comment on that, Mr. Neal? Not all exchange rates are moving freely. As we know, China does not, and exempting exports and taxing imports from a country like that might make a real difference, in addition to its other advantages and compliance.
*Mr. Carroll. I would just add to that. The economic theories would suggest that it’s the relative price levels between nations that would adjust for countries where there are flexible exchange rates that would happen through the flexible exchange rates, for countries with fixed exchange rates or where they’re pegged. It would probably happen in other ways, but it would happen much more slowly. There was a lot of inflexibility in labor contracts and so on, but I would agree with Rosanne that it would still happen, but it would happen more slowly.
And I would just reiterate one of the points that Rosanne made, that border adjustments could have significant differential effects if you were to enact a narrow base such as they have in Europe, or even as they have at the state level in this country through kind of the partial sales taxes that are in effect.
*Mr. Neal. Mr. Chairman, given DOHA and the fact we have three pending bilateral agreements, I think this would be worth pursuing as we go forward. So I think these panels have been helpful, and I think something along those lines could be more helpful.
*Chairman Camp. All right. Thank you.
Ms. Jenkins is recognized for three minutes.
*Ms. Jenkins. Thank you, Mr. Chairman. Thank you all for being here.
I think most of us in this room acknowledge that the current tax code is broken. Pro growth tax system should be simpler, more efficient, fair. A simple tax code is essential in my belief to promoting economic efficiency and reducing the interference of taxes with families’ everyday business making decisions. It seems that the layering of a VAT tax in addition to this already complex personal and business tax would only produce an ever more burdensome tax code.
Instead of promoting widespread economic growth promised by fundamental tax reform, it would promote two sectors above all others: accountants and tax lawyers. That continues to be highly contentions and controversies over virtually every aspect of that includes a laundry list: the determination of what activities fall within the scope of that; the delineation of exempt and zero‑related supplies; the characterization of supplies and determination of where they’re provided; treatment of the composite supplies; apportionment of input taxes to tax exempt supplies as VAT tax is immune from controversy. I’d just like you all to comment briefly or elaborate on which aspects of that tend to invite controversy and litigation, and are there any particular cases that should caution the United States from following other countries in an acting VAT.
*Mr. Graetz. Well, I would say two things. One is I do think if you have a broad base, these issues are much, much simpler. New Zealand and those countries, Singapore, are not having a great controversy over their value added taxes; and, if you used the revenues from a value added tax to remove 150 million Americans from the income tax and you use it to get a 15 percent rate on income above $100,000 and 25 percent above $200,000, which is distributionally neutral and can have a 15 percent corporate income tax rate, we will have put the United States in a much better position, and I think you’ll find that the amounts of money that are being spent by businesses on tax planning and tax advice, this is the only sector in which the current system creates jobs is the tax planning, tax return preparation, tax advice sector. And I think a value added tax from all experience, if it is used to buy down the income tax significantly, would make a big difference, a positive difference.
*Ms. Jenkins. Thank you, Mr. Chairman.
*Chairman Camp. Thank you. Ms. Black is recognized.
*Ms. Black. Thank you, Mr. Chairman, and I know that my time is very limited with just three minutes, but having just had the presentation prior to you on the FairTax, and what I would like each of the panelists to do as briefly as you can with a little comment on why you would support or not support the difference between the VAT and the FairTax.
So maybe we could start on this end, since Mr. Johnson seems to be left out. Mr. Johnson, let’s do that and go down.
*Mr. Johnson. Yeah. I actually would echo again what President Bush’s advisory panel said, which is they came out strongly against FairTax or national sales tax. So they were split, but they were rather more favoring the VAT in terms of how you administer the system, in terms of the compliance risks that you have, in terms of the burden that you have on small business; and, of course, in terms of the inherent regressivity and how easy it is to do with it. You are creating a massive new entitlement plan with the prebates. Why would you want to do that when we have enough difficulty managing our existing structure?
*Ms. Black. Thank you. Mr. Mitchell?
*Mr. Mitchell. And if we could repeal the 16th Amendment and put it so deep under the ground that no Supreme Court could possibly let an income tax ever spring up to haunt us again, then either a VAT or some sort of national retail sales tax would be a less destructive way of raising revenue. That’s not going to happen, and therefore I hope that we keep a VAT or a national retail sales tax deep under the ground.
*Ms. Black. Thank you. Mr. White.
*Mr. White. As I noted, both a sales tax and a VAT are consumption taxes, so the economics is the same for the two. The administration of them is quite different; and so you’ve got different issues concerning compliance, non‑compliance, risks of non‑compliance.
That would have to be addressed. I would note that with a sales tax, our experience has been with relatively low rate sales taxes. I don’t think around the world there’s been any experience with very high rate sales taxes and the compliance risks there.
*Ms. Black. Thank you. Mr. Carroll?
*Mr. Carroll. I would make the same point. I think one of the two major differences that I would highlight, some of which have already been made, one is the collection of a retail sales tax that is focused at the retail level. That makes evasion a much more significant problem, and so that is one area.
The second point I would make is it is probably the case that would be much more likely to have base erosion with the retail sales tax than with the value added tax, and it is much more likely that the experience that we would follow over time would be more typical of what we have seen at the state level where there has been a very significant erosion of the base by excluding various consumption items.
Maybe the third point I would make, it is much more likely we would tax, we would include some intermediate inputs in a sales tax base but not in a VAT, and that would lead to cascading and undermine the efficiency benefits of the sales tax.
*Ms. Black. Time is running out. Ms. Altshuler?
*Ms. Altshuler. I’ll echo what everybody else said. Well, not what everybody else said, but I was the chief economist for the tax reform panel. We looked closely at the FairTax. We looked fairly at the FairTax. The FairTax is not a FairTax and it just doesn’t work.
*Chairman Camp. All right. Thank you.
Mr. Herger is recognized for three minutes to conclude this session.
*Mr. Herger. Thank you very much, Mr. Chairman. I want to thank our witnesses. I feel the consumption part tax of the VAT is very admirable. I have some very strong concerns about the lack of transparency, and also the fact that it hides the true cost of government from voters.
Mr. Mitchell, you mentioned in your testimony that value added taxes are typically built into the price of goods and services. Can you elaborate on why this is a problem?
*Mr. Mitchell. If the tax system is supposed to be the price of government, and you want prices to be transparent so voters can understand what they’re getting and whether it is worth it, then you want a tax system that is very visible. You don’t want it hidden. And we certainly have seen in Europe ‑‑ I included a chart that I took out of a European Commission report that just was released, showing that just in the last couple of years alone value added tax rates have jumped by something like two percentage points.
And, of course, because they’re such broad‑based taxes, that is a huge increase and a burden on the people of Europe. And one of the reasons why that tax is always so easy to raise is precisely because it is hidden. And one of my concerns is if we put in a VAT at five or ten percent in the U.S., as we get further and further into this entitlement tsunami, we will try to keep up with that wave by just raising the VAT rate one or two percentage points every other year. And, of course, we will make the same mistake that the Europeans made, higher taxes, following higher spending, leading to more stagnation, leading to higher deficits and debt.
As I said in my oral testimony, I don’t want a copy of the fiscal policy of countries that are on the verge of collapse, especially when we have ‑‑ if want a single rate consumption based tax, we already have a harabuska system that would be much easier and safer to implement.
*Mr. Graetz. Mr. Herger, Canada separately states their value added tax just like a retail sales tax. There’s no reason why in legislation if you want people to know what they’re paying. You just don’t have it separately stated, just like a retail sales tax. And Canada’s spending has gone down and its rate actually went down. So, you know, there are ways to control these issues.
*Mr. Herger. I admire what Canada has done. I also remember back in the days when I am old enough to remember when you bought gasoline, and you had when you filled your tank exactly how many cents of tax you were paying. We don’t see that anymore. My concern is future congresses that will hide it. So, therefore, again I share your concern, Mr. Mitchell. I thank you. It could be right if we had the perfect people in. Regrettably, we more times than not do not have that be the case. But, Mr. Chairman, again I thank you for this hearing, and I thank each of the witnesses.
*Chairman Camp. All right. Thank you. I heard the bells. We are having a series of votes, and we are having a series of votes on the floor. So I want to thank you all.
Members who did not get a chance to question may want to submit some questions to you in writing. If you would be kind enough to respond to those promptly, we could make those part of the formal hearing record. And I would very much appreciate you all being here. This was a very strong panel, and I really appreciate the good information that you brought to the committee.
Thank you. This hearing is now adjourned.
[Whereupon, at 1:20 p.m., the committee was adjourned.]
Member Questions For The Record
Member Submissions For The Record
Public Submissions For The Record:
American Manufacturing Trade Action Coalition
Americans for Fair Taxation
Bay County Florida Executive Committee
Bobby L. Austin
Center for Fiscal Equity
David E. Miller
David H. Leake
Dr. Nanette Parratto-Wagner
Dr. Roger Sdao
E.Ray McKee Jr.
Hugh J. Campbell
James M. Bennett
John J. Riehecky
Linda M. Jolicoeur
Linda Scott Cummings
National Association of Small Business Investment Companies
National Debt Awareness Center
National Retail Federation
Orient American Ore Co. LLC
Paul D. Wheaton
Retail Industry Leaders Association
Richard T. Ainsworth
Sal Tranchina Jr.
Steven M. Puma