The Tax Policy Center PETER ORSZAG, Brookings Institution: (In progress)—Forum. The American public is clearly frustrated with the current tax system. For example, a recent poll suggested that about 40 percent of the American public believes that they pay about the right amount in taxes—which is actually quite remarkable—but more than 90 percent believe that the tax code needs reform.
Nearly two-thirds say that the tax code should be simplified and made easier to understand. To be sure, the public may not agree on how the tax code should be reformed, but almost everyone wants it reformed in some way or another.
So we're particularly lucky to have an outstanding panel with us today to discuss the prospects and possibilities for fixing the tax mess. We'll start with Congressman Steny Hoyer, who is a member of Congress from Maryland and the House Democratic Whip. He has been examining various problems in the tax code and will discuss some of his initial conclusions about those problems, possible ways to reform the tax code, and the political prospects for change.
Next we'll have Michael Graetz, who is a tax professor at Yale Law School. He served as deputy assistant secretary of the Treasury for tax policy during the first Bush administration. He has a new proposal to replace the income tax with a value-added tax while retaining a version of the alternative minimum tax, limited to families with more than $100,000 of income.
Finally, we'll hear from Gene Steuerle, who is a senior fellow here at the Urban Institute and another of the co-directors of the Tax Policy Center. He served as deputy assistant secretary of the Treasury for tax analysis during the 1980s and was one of the key players during the landmark 1986 reforms, which were basically the last reform effort that actually worked.
He's also the author of a new book on tax policy entitled—I'll actually hold it up here—Contemporary U.S. Tax Policy, which is on sale in the Urban Bookstore right outside.
Each of our speakers will have about 15 or 20 minutes, and then we'll have plenty of time for questions for the audience, so with that, the Honorable Steny Hoyer.
REPRESENTATIVE STENY HOYER (D-MD): Peter, thank you very much, and I think I'm the one that kept you waiting, as I heard somebody say, "well, the last speaker is here." And the last shall be first, apparently, so I'm pleased to be here. Thank you very much, Peter.
Bob Reischauer, I understand, is not here, but I want to congratulate Bob on his service to this country and his leadership of this institute. Mr. Steuerle and Mr. Graetz, I'm glad to be with you. Don Alexander, it's always good to be with you, sir—former commissioner of the IRS.
First of all, let me start with a disclaimer. I am not the Congress's tax expert. I know that does not come a shock to any of you who watch tax policy at all. Having said that, however, I have been involved with tax administration for a long period of time, as either a member, ranking member, or chairman of the committee, on the appropriations subcommittee that oversees the Treasury Department and therefore the Internal Revenue Service.
There is today little debate: the Internal Revenue Code is Kafkaesque, a maze of complexity that confounds millions of Americans every single year. Our tax system, in many respects, is an embarrassment that treats many taxpayers unfairly.
At the very same time, it creates an opportunity and, some would argue, an incentive for those who would employ its complexity to avoid compliance. Who is responsible for this? We all are. Democrats, Republicans, every American who believes that the tax preference that he or she utilizes makes it extraordinarily important and worthwhile. Taken individually of course, nearly all of the tax preference items that clutter the code can be rationalized, and in fact were at some point in time. Collectively, however, they are a jumble of confusion that leads to unfairness and complexity, and the extraordinary difficulty of enforcement. And I believe that this has a corrosive effect and has had a corrosive effect on our democracy.
President Kennedy said more than four decades ago, and I quote, "For voluntary self-assessment to be both meaningful and productive of revenues, the citizen must not only have confidence in the fairness of the tax laws, but also in the uniform and vigorous enforcement of those laws."
You do not need a primer on the tax code's complexity, but a few facts will help frame this discussion. Today the IRS now prints more than 1,000 publications—forms and instruction booklets. In 1913, the tax code itself was a mere 500 pages in length; today, financial publisher Commerce Clearinghouse says that its standard federal tax reporter, which is Tax Guidance, has grown to more than 60,000 pages. Four common forms—Form 1040 and Schedules A, B and D—take an estimate 28 hours and 30 minutes to prepare, according to the IRS.
When the agency started tracking this information in 1988, the average paperwork burden was 17 hours and 7 minutes, approximately half of what it is now estimated to take. Even the simplest form in the IRS inventory—the 1040EZ—now requires—again according to the IRS—three hours and 43 minutes to prepare, up from an hour and 31 minutes in 1988, a relatively short period of time.
The costs of complexity are staggering. More than $100 billion a year in accounting fees and the value of taxpayers' time to complete returns it is estimated. According to Joel Slemrod of the University of Michigan, this is roughly equivalent to what our nation spends to operate the Department of Education, Homeland Security, and the Department of State—respectively 57, 32, and 9 billion dollars.
Not surprisingly, more Americans than ever rely on tax professionals, including myself, and as is observed so often, including almost all members of the Congress. It's now 56 percent, which is compared to 48 percent in 1990. But even tax professionals, as all of us know, cannot and do not guarantee accuracy.
The General Accounting Office (GAO), for example, recently found that 2 million taxpayers who used a preparer took the standard deduction when they would have been better off itemizing. And according to the IRS, tax preparers are responsible for nearly 70 percent of errors. I'm going to hear from my accountant, I'm sure, in this provision. (Scattered laughter.) And overclaims on returns claiming the earned income tax credit—federal policymakers cannot and should not blithely ignore this crisis of complexity because it carries enormous implications. As Paul O'Neill, the extraordinarily popular secretary of the Treasury pointed out two years ago, and I quote, "One of the unseen consequences of our tax code's complexity is the sense it leaves with taxpayers that the system is unfair and others pay less tax because of special advantages."
The fact is our tax system must be made simpler, fairer, and more efficient. To appreciate the need for a call to action, consider the scope of noncompliance. It ought to trouble every law-abiding American citizen and every member of the Congress and the president of the United States. It's one of the biggest challenges today to tax fairness that we face.
The IRS estimated earlier this year that there is a $311 billion annual tax gap due to underreporting, underpayment, and nonfiling. I'm going to say as an aside, only because from my perspective of the irresponsible fiscal policy we've been pursuing will that $311 billion not get us to balance if it were collected.
In March, Nancy Killefer, the chairwoman of the oversight board on IRS told the House Ways and Means subcommittee on oversight, and I quote, "Enforcement activities are still at an unacceptable level, simply because the IRS does not have the resources needed to accomplish its mission. It continues to be outgunned and outmanned." That same month Deputy Treasury Secretary Samuel Bodman informed the Senate Finance Committee that the IRS intended to walk away from more than 2 million delinquent tax accounts. That total is nearly $16.5 billion.
What message does noncompliance and lack of enforcement send individual taxpayers? For too many, the answer is clear: that they should roll the dice and cheat. In fact, an IRS survey in 2003 found that 17 percent of taxpayers, nearly one in five, believe that it's acceptable to cheat, up from 11 percent just four years earlier. Just in a four-year period of time we added about 40 percent to the number of folks who thought that cheating was acceptable. And for cheaters, of course, the chances of getting caught are very small.
In 2003, individuals were audited at rate of 6.5 per 1,000 returns. And 75 percent of those were computer generated nonpersonal audits, which shows you how small enforcement is. Compare that to the audit rate of 12.8 percent in '97 or even 9.9 percent in '98, the year Congress was considering and passing IRS reform legislation. Audits for businesses on the other hand were down from three per 1,000 to two per 1,000. Now, how many of you think that the fact that you would have two out of 1,000 chance of being audited would be a substantial check on your willingness to, if not cheat, at least to take chances on interpretations.
Let me add that none of us can ignore the effects of the IRS Reform Act. I was one of only four members, as some of you may recall, who voted against the legislation that passed the House in 1998. That bill contained many good provisions, as I said on the floor. It was improved in conference and I ended up voting for final passage.
However, as I remarked then, many of the proponents of that legislation demonized the IRS to such a point that it not only demoralized the agency's professionals but sent an unmistakable and potentially debilitating message to the American people. That message was that paying one's taxes was not, as President Kennedy said, the annual price of citizenship, but an unfair burden imposed by an unfair government and government agency. The aggressive marketing of tax shelters by accounting, legal, and financial services firms is nothing less than a response to that very strong message sent by the reform package and the Grassley hearings.
Now, it's true. There's plenty of blame to go around to creating such a complicated tax code, as I said at the beginning. The finger is pointed at all of us. But leaders in the Republican Party, who have repeatedly proclaimed their commitment to tax reform and simplification must be measured by their actions rather than their rhetoric. Two months after President Bush took office, he told the American people in a Saturday morning address, and I quote, "Americans want our tax code to be reasonable and simple and fair. These are goals that unite our country and these are goals that have shaped my plan." So said President Bush. And Tom DeLay, the House majority leader, stated in April 2001, shortly after that address, that, and I quote, "We're pushing forward with our campaign to reform the tax code. We are making it fairer, flatter, simpler, and less burdensome to the American people." The facts, however, I would suggest to you, demonstrate otherwise.
Since 2001 Republicans have made 227 changes. Now, obviously there were some Democratic votes for that and you may think it unfair to say simply Republicans. But the overwhelming votes that passed these were Republican: 227 changes to the tax code and added more than 10,000 pages to it. That's in less than 40 months. In 2003, changes in taxes on dividends and capital gains in particular have been a nightmare for taxpayers. I don't mean that some haven't benefited. In terms of paying less, that obviously is correct. But in terms of the administration and figuring out how to do it, I think "nightmare" applies.
The IRS estimates that it takes seven hours 58 minutes, essentially one whole work day, just to complete schedule D for reporting the sale of any capital assets such as stocks or mutual funds or dividends received. Schedule C, for self-employed workers and sideline businesses, takes an estimated 10 ½ hours. And then there is the ultimate orgy in self-indulgence—that's my phrase that I applied to FSC—and complicating. The FSC bill, the ETI bill, the legislation that passed the House in June, would make an additional 109 changes in the tax code.
Now, ladies and gentlemen, I talked about the Reform Act that I voted against. One of the things that was said in the Reform Act and the report itself, that some of you I'm sure read, was that one of the problems was the fact that we changed the tax code as frequently as we did, and the inability of the IRS to catch up with those changes in a fashion that gave them the ability to efficiently monitor and oversee the implementation of those changes. When it comes to the issue of real tax reform, the majority party, the Republican Party's record, is one, in my opinion at least, in the last 40 months, of abject failure.
Next week, as many of you know, the Republican leadership has announced that it will be Tax Reform and Simplification Week. The press asked me about that last week. I said, it is ironic that we have spent 40 months complicating the tax code and we're going to spend two days in simplifying it. Is there any wonder that we have not accomplished simplification with that kind of ratio of focus? Let's be honest. After spending—well I just said that. Because I liked it so much I didn't have to read it. (Laughter.) They lifted it from me, and when they lift it from me it's got to be good, right? (Laughter.)
Today I believe there's an increasing momentum among taxpayers for real reform, and Democrats have an opportunity to lead on this issue when we regain the House majority in November. And that's why I am talking about it. Not because I have historically been the leader, although as you see, back in 1988, I was focused on this and focused on that before that as well. So I do not believe that I am a Johnny-come-lately to this effort. But along with leaders on the Ways and Means Committee, Mr. Rangel and others with whom I have talked, this is a critical issue for our country and for our taxpayers.
Let me outline a few other proposals that should be part of this effort. In the best of all possible worlds, my view, we probably ought not to have any preference items—in the best of all worlds. Now, that will not happen and everybody in this room knows it will not happen. I don't want to give up my mortgage deduction. I don't want to give up my charitable deduction. And no other American does either because they're not convinced that the tradeoff for that, of lower rates, will be maintained. If you could show them a net savings, they would initially say, well, that sounds good, but by the way, we know that you're not going to stay there.
But we don't live in the best of all possible worlds but there are some things that I think we ought to focus on. First, it is imperative that Congress address the middle class time bomb, the alternative minimum tax. Everybody knows that needs to be addressed more than anything else. I believe that the prospect of 30 million taxpayers being subject to the arbitrariness and unfairness of the alternative tax system by the end of the decade will be the impetus, hopefully, for fundamental tax reform.
Today taxpayers must calculate their tax liability by first deciphering a separate instruction booklet and then filling out a 65-line form, only to find that they may not in fact owe the AMT at all and have wasted their time. The AMT simply is not serving its original purpose. I supported the AMT; I thought it was a good reform. But it is clearly not today what we thought it was going to be when it was adopted. And Republican tax bills in 2001, 2003 have exacerbated its effect, as most of you know.
Second, we need to take a hard look at moving toward a return-free tax system. Such a system would allow the vast majority of American taxpayers to opt in to the return-free system by using a slightly revised W4 form. The IRS could calculate expected tax liability and then just the withholding to reflect the appropriate tax rate.
Third, it's illogical for the tax code to contain five tax breaks for families with children with each of the five defining qualifying child differently. As a result of these definitions, two families with the same income but with children of different ages can owe very different amounts of federal income tax. Any real tax reform should include the adoption of a uniform definition to reduce taxpayer error that results from these differing definitions.
Fourth, we need to simplify tax rules for small businesses, which along with the self-employed, they are the greatest tax compliance burden: nearly 60 hours per return. In 2001 alone, according to the GAO, small businesses overpaid their taxes.
Fifth, we need to get serious about stopping individuals and corporations from gaming the system. As David Cay Johnson said at the Urban Institute earlier this year, right here, "We have radically reduced our effort to go after serious tax cheating in America"—radically reduced our effort. We need to make sure that the IRS can do its job; that it's only fair to those who comply with their obligations.
Sixth, we need international tax reform. Now, because I have so much power, I hope all of you saw the front page of the Washington Post today talking about G.E. If I represented G.E. today I would increase my rates, having it just been said how brilliant I am. (Scattered laughter.) I agree with that objective. If we have some G.E. representatives in here, you don't have to identify yourself but congratulations. You did an excellent job on behalf of your client. Whether the Congress did an excellent job is, I think, subject to question. I call the FSC bill the worst tax bill that I had seen since—in my 23 years in the Congress of the United States, not because it doesn't have some good provisions in it, but because collectively it simply does not accomplish what our objective was in a way that is both financially affordable and fair and simple. John Kerry's proposal on international taxes is an important contribution, I think, in that it focuses on eliminating tax breaks that encourage Americans to move jobs overseas. Everybody talks about that wanting to be an effort that we make, although there was a lot of rationalization about that during the course of the FSC debate.
Seventh, we need real, substantive, congressional hearings that focus on these issues. Now, I know that will be a radical change from the present way we are dealing with tax bills: hearings, even meetings, maybe even conferences that everybody is invited to. That will be a stark reform from what has been the practice for the last 36 months. Actually, early on they did have conferences that we were invited to but that has been ditched because it was too complicated to have us Democrats in the room, presumably. But having hearings is critical. These are complicated issues even for experts. And the lack of hearings, putting together these bills in back rooms and then presenting them through the Rules Committee, essentially, is not good policy. Republican, Democrat, liberal, conservative, pro-tax, anti-tax, whatever, I don't think there's anyone in Washington who really believes that Congress is exercising true congressional oversight today.
With that said, though, presidential leadership on the issue of tax reform is essential. I told somebody, I'm going to talk about some things; I'm going to talk about tax reform, major tax reform. It will not happen because the most powerful members of Congress want it to happen. I don't care whether it's Tom DeLay. Dick Army and Billy Tauzin spent years spending substantial resources and going around the country talking about their vision of tax reform. Hardly any movement occurred. The only time, in my tenure, that I have seen real movement is when Ronald Reagan and Dan Rostenkowski got on the boat together and rowed together. And of course they were joined over in the Senate as well by a Democrat and a Republican. The fact of the matter is we're going to have presidential leadership on it.
It's been 18 years since Congress last passed real tax reform, the Tax Reform Act of '86. It was not perfect but it was, in my opinion, a step in the right direction. It reduced preferences and the tradeoff was it reduced rates. Personally, I've always been a believer in the idea that if you reduce tax preferences you can and should reduce rates. That ought to be our objective.
The American people are acutely aware of the unnecessary complexity and dire need for real tax reform in America today. The time for tax reform, in my opinion, is ripe, is right; it's here. We should not tinker around the edges of the tax code but go to the heart of the problem. The American people need and deserve, our country needs and deserves, a tax system that is simpler, fairer, and efficient. Thank you very much for all you do to oversee this issue, to educate not only members of Congress but the American public.
Peter, thank you for this opportunity. Thank you very much. (Applause.)
MICHAEL GRAETZ, Yale Law School: Peter, I want to thank you and Brookings and the Urban Institute for sponsoring this event.
It's good to see so many people in the room. It's particularly good to see the Democratic whip in the room. It's good to have the Democrats joining in on what has largely been a Republican conversation so far. And in my view, if we're going to have serious tax reform, it will have to be bipartisan as well as having presidential leadership in order to be stable. And I think we do need stable reform.
So let me talk about some ideas. They come from this essay, which you have a citation to so anybody who's interested can read more details about it there. That essay actually itself came out of a book that I wrote entitled The Decline and Fall? of the Income Tax, although there was a question mark after the word "fall." The real lesson is never put a question mark in the title of a book. (Laughter.)
Let me begin by saying that I really think it's clear that the income tax is broken. This is not news. Congressmen Hoyer pointed out that it's too complicated—that it's too complicated for everyone. This is a mistake that is often made by people who look at tax reform. They well say, well, form 1040EZ is simple enough; the average American doesn't have to worry about the complexities. This is simply false. The dollars that are being spent, and the time that is being spent, and the frustrations of the average American are really huge under the current system.
Second, Congress, I'm fond of saying, has been using the income tax the way my mother used to use chicken soup, which is as a magic elixir for anything that ails the economy or society. If we need more education expenditures, let's have four or five education tax credits or deductions or savings accounts. My mom used to make one form of chicken soup but Congress is more creative than that. (Laughter.) They make four or five kinds each time they solve a problem.
But it's true of health care. It's true of long-term care. There's a very popular bipartisan proposal for tax breaks for long-term care. One lesson here is that the health insurance system in the United States has got to be about as bad as there is in the world, in the industrialized world. And in large part that's because we've relied on the tax system to do it, and long-term care will be the same story if we go down that path. So not only does it complicate the tax code, but it doesn't solve the problems which it is addressed to.
The other point about this is that it is a mistake to think about these tax breaks as special interest tax breaks. These are general interest tax breaks. These are tax breaks that everyone can use. They're directed to the middle class for education and health insurance and the like, so that they're not special interest breaks. And I'm not optimistic about getting rid of them.
Third, the income tax is now regarded by the public as the worst tax in the U.S. system. Since the 1980s it's been regarded as the least fair. Information and polling data and evidence on cheating is thoroughly depressing, as Congressman Hoyer has suggested. And one of the most depressing facts is that the attitudes of the young, in fact, are much worse on this than the attitudes of the old, or much more favorable to cheating, if you want to put it that way. I would put it as much worse. So we have a tax system that people don't believe in and they don't want to comply with.
Fourth, the IRS is incapable of enforcing the current system. It's not a matter of a few more auditors or a few more agents. It just is a job that can't be done, that can't solve the tax shelter problem under current law. The audit rates have been declining since the '60s. They now include letters they write as audits in order to get the numbers anywhere near the numbers that Congressman Hoyer has used. And they're auditing earned income tax credit taxpayers for reasons that are not crazy, but this is not the way the IRS should be spending its time. So the IRS can't do it's job and neither can the American people.
Now finally—and this is where I depart from many of the people in Congress—I am not optimistic about fixing the income tax. Even for those of us who regard the 1986 Tax Reform as quite successful, we have to concede now that it was not a stable solution. The base broadening that occurred in 1986 has largely been eroded. More base narrowing provisions have been enacted through both Democratic and Republican administrations and rates have been raised since the '86 act. So the idea of broadening the base and lowering the rates, which motivated the '86 act, is one that I really don't have much faith in as a longer-term solution.
So for me, the conclusion is that we need a new and better tax system, one that is far simpler, that is fair, and that is more conducive than the one we now have to economic growth and investment.
Now let me say that the proposals that have been on the table so far for major change in the U.S. tax system are essentially unrealistic. They are vehicles for railing against the current system and without offering what I regard as genuine alternatives. And this, I think, in addition to the lack of presidential leadership, is the reason that the Tauzin-Army road show, which put the national sales tax against the flat tax, failed. The flat tax is an origin-based consumption tax, which means that it taxes exports and it exempts imports. And this is anathema to American businesses. Economists will say there's no difference, it'll all work out with exchange rates over time. American businesses simply will not support a consumption tax that is origin based. We saw this in 1990 and subsequent years with ideas to impose an energy tax that was not border adjustable and it simply won't work.
The flat tax also redistributes the tax burden to middle and upper middle-income taxpayers. David Bradford has a variation on this that he calls the X tax, which is a progressive tax on wages at the individual level in an effort to try and offset the distributional problems of the flat tax. Bradford's plan, on the other hand, taxes only wages at the individual level and exempts all investment income. And again, I don't regard that as a stable solution.
And then finally, by keeping everyone in the system we can be sure that this postcard tax return, which is the high point of the flat tax story, will not stay short or simple for very long. Congress has just got too much taste for these tax breaks I've described earlier.
And then there's the fair tax, or the so-called fair tax. The so-called fair tax is a national sales tax intended to fully replace the income tax along with payroll taxes and everything else. There are a number of problems it has. I'm not going to go into detail, but first we just can't collect retail sales tax at these rates. It's too easy to put the money in your pocket if you're the retail seller. Second, this tax unacceptably shifts the tax burden down the tax brackets away from those with the greatest ability to pay toward middle-income taxpayers. The fair tax's biggest problem is that it's simply not fair. Third, like the flat tax, this tax would undermine the current system of both pension savings and health insurance, which are so important in the absence of other and better solutions.
Now there are lots of other proposals. There is, for example, something that was called "the five easy pieces," which Ernie Christian and Gary Robbins proposed, which were to lower capital gains rates and ordinary income tax rates, to eliminate the double tax on corporate earnings, to allow a 100 percent expensing of business investments, to expand the Roth IRA to all personal savings, and so forth. It sounds a bit like some of the administration's provisions, some of which have been enacted, some of which have been proposed. It moves the country in the direction of a consumption tax rather than an income tax. There are, again, shifts in the tax burden that are important, and this is sort of an incremental approach to getting the current system toward a consumption tax but it does not provide any simplification advantages for the people who need them, even if you like the idea of moving toward a consumption tax.
The only other large proposal that's been around in a few years was the Nunn-Domenici proposal, an effort by moderate members of the Senate, a Republican and a Democrat, to come up with a bipartisan solution. This was a progressive consumption tax combined with a value added tax. Nunn and Domenici found that in order to be realistic about it politically, they needed to keep a lot of income tax breaks, such as exemptions for state and local bonds and others that are not appropriate for the tax. They were proposing a consumption tax, but which would only be appropriate for an income tax, and so they create rates on certain kinds of income that are below zero. The proposal itself floundered on transition problems and its treatment of borrowing.
So we have to do something. The AMT is a train wreck. Everyone in the business knows that. We're going to have 35 or 40 million people having to deal with the complexities not only of one system, but of figuring their tax under two systems. That will create an incentive for noncompliance. And so we have to do something. And we have to do it fairly soon because no one frankly has come up with a realistic solution to the AMT problem that doesn't cost hundreds of billions of dollars of revenue, which we don't seem to be able to afford at the moment.
So I've tried to come up with a plan that is revenue neutral and it is generally distributionally neutral. That is, it does not redistribute the tax burden down to middle- and lower-income taxpayers but is far simpler and more conducive to economic growth than the current system. So let me describe the proposal. There are really five pieces to it. I would not describe it as five easy pieces for lots of reasons, of which the most important is that nothing is easy when one talks about tax reform.
But here they are. The first involves the individual income tax. And so what I recommend with the individual income tax is that we increase the AMT exemption to $100,000 and we index the amount for inflation so we don't get in the same situation that we're not in down the years, that you lower the AMT rate to 25 percent and you repeal the regular income tax.
All the talk about fixing the AMT—it turns out somewhere between 2008 and 2012, depending on whose numbers your use, the AMT is producing more money than the regular income tax. So the question I always have is why are we going to repeal the AMT? Why don't we repeal the regular income tax? That should be a solution whether or not you adopt the rest of what I'm about to say. But I've used the AMT as an example. Now, I have to say, if I were designing the system, there are opportunities for base broadening that are not in the AMT that could occur, but the basic idea is a low rate, 25 percent rate income tax only on high income earners, people with over $100,000 of income. And even under the AMT, I remind you, keep the deductions for charitable contributions, home mortgage interest, medical expenses, and you keep in the system incentives for both pension savings and health insurance provision, in part because I'm not getting rid of the payroll tax.
On the corporate tax side I would lower the corporate rate to 25 percent. It is very important if one is serious about simplifying small business taxes to have the individual rate and the corporate the same because that way the corporate form doesn't matter. I, in my proposal, would eliminate the double tax on dividends. I would have done that in a way that the Treasury recommended in 1992. Congress has done something quite different but the idea is to tax corporate income only once.
I have five minutes. Good, okay.
And then I would enact a value added tax—this is the third piece—to replace the revenue that's lost. My estimate is that it requires about a 14 percent VAT to replace the revenues I've given up.
The fourth piece is to replace the earned income tax credit and to provide low- and moderate-income taxpayers offsets for the value added tax through payroll tax offsets, which I describe in the article and will not describe here.
And the fifth piece is to tax recipients of bequests and gifts either through a separate inheritance tax or through this income tax at 25 percent. And it'll pick up about half the revenues of the prior estate tax.
Let me just go quickly through some slides. I'm going to take about a couple minutes. Let me just—well, one minute on this one. As you can see, the income tax became the mainstay of the tax system in the '40s, in the Second World War. And while the proposal that I'm advancing may seem radical, it in fact is a return to the system that the U.S. had pre-World War II, except that the value added tax is a much better tax on consumption than the tariffs that we relied on during the early part of the century. Let's move on. This is just a wealth distribution chart. This shows the difficulties—the reason not to redistribute the tax burden down the bracket.
This is approximate words in the Internal Revenue Code—this is my favorite chart. If you're only going to take one away from here, this is the one to take. Note it's year 2000; it hasn't been updated for the last 10,000 pages that have been added. (Laughter.) I'm fond of saying that the tax code—the blue is the code and the yellow are the regulations—the tax code is now six times longer than "War and Peace" and considerably harder to understand. (Laughter.)
Go to the next slide. This is an important slide. This shows you consumption taxes, or percentages of GDP in the OECD countries, in Europe, and in the United States. And the one way in which our system is really out of line with the systems elsewhere in the world is that we rely so much less heavily on consumption taxes than the rest of the world. If you add in the proposed 14 percent U.S. VAT that I propose, you'll see that it gets us very much to the same rates that are prevalent elsewhere in the world, including state sales taxes, which are down in the yellow part of that box.
Now let's get to figure 7. Figure 7 is the payoff chart. This is what happens to tax returns. And you get rid of 100 million tax returns with this proposal. You'll see that you have 22 million individual income tax returns, 5.5 million business returns, which is corporate tax returns which we now have, and 8 million value added tax returns. You end up with fewer returns than the IRS was dealing with 1946, which means that it gives the IRS actually a chance of doing its job.
The last two charts that I'll look at are really just designed to show that this proposal works as a matter of keeping revenue basically the same.
Let me conclude—I know Peter's anxious for me to do so—with just describing its advantages. So it would remove 100 million returns from the tax system. More than a 150 million people would have nothing to do with the income tax or filing returns. Their taxes would all be collected through business. As Billy Tauzin was fond of saying, "For them, April 15th would just be another spring day." It would be far more favorable to savings, to investment and economic growth. Most Americans will owe no tax on their savings. Taxes on savings and investment are reduced for everyone. And yet there are incentives maintained for pension savings and the like. It would greatly improve compliance. In particular, those who are not paying income taxes would pay taxes when they spend. A value added tax is very much like a sales tax, for those of you who are not familiar with it. And so people who are not paying income tax—drug dealers, for example—would pay it when they buy their cars and so forth. It would reduce the IRS workload so it could do its job and it is fair—it does not shift the burden down the income scale.
So that's the idea. Thank you for allowing me to present it.
EUGENE STEUERLE, Urban Institute: Well, it's an honor for me to be here and present along with Representative Hoyer, who I've always respected for a long time, a local as well as a national leader; and also Michael Graetz, who I've worked with I feel like many years because we always seem to be writing the same thing at the same time and wondering who's going to say the same thing first. He's certainly one of the leaders in the tax field; and my co-director of the Tax Policy Center, Peter, who is, as many of you know, one of the most prolific and well-versed individuals in tax and budget policy.
I should say about Michael that Michael and I both essentially had the same job at the Treasury, only he was head of the legal staff and I was head of the economic staff, and ever since then we've both decided we had learned a lot, and so ever since then I've been essentially practicing law and he's been practicing economics. (Laughter.)
I'd like to take off from where Representative Hoyer did with respect to the Washington Post article. It was on General Electric this morning. And the point of the article was that General Electric had succeeded not only in losing a tax break but, through its lobbyists, getting more back in a tax bill before Congress than they were going to lose, pointing out the remarkable success of the lobbyists. And I think hidden in that article is one of the reasons why a good tax policy is so hard to develop these days, and that is the lobbyists. And by that I don't mean to say that we're not going to have lobbyists in this town; we've always had lobbyists, we've always had special interests, but I think what is unique, at least in my experience over the last 20 or 30 years, is that today the lobbyists design the bills first.
It used to be that we had some attempt to design a bill, either in the administration or in the Congress, that we'd put forward on the basis of principles—not that there weren't compromises made—and then we made, really, the next set of compromises with the lobbyists, who do inform the process. But when the lobbyists start the process, it's very hard to come in the back door and work on the second draft by saying, well, let's try to put a principle back in the system, which, by the way, is going to withdraw some benefit from somebody. My friends at Tax Notes magazine are fond of quoting one lobbyist in town who claims that in this same bill that this Washington Post article is referring to, that if you're a lobbyist in this town and you don't have something in this bill, you are a bad lobbyist. That's how bad it's gotten.
But let's not let ourselves, the public and the press, off the hook. Let's face it; we love to read stories. I mean, we are into tabloid journalism, and we love to read stories that make us whine. We love to whine. We love to read about losers and we especially love to read stories about who were the losers, and the Post article tries to argue that, well, just the fat cats, or those other people are the ones who are getting all these benefits. Well, in fact, this particular bill is dealing with some extremely complex issues of international taxation, and as long as we pretend we can't tell the public anything about them—all we can tell about is you're going to lose, or you might be a loser—then we really encourage our members of Congress to design bills where they never recognize losers.
And so we've actually been going through that since about '97 to 2004. If you look at on the expenditure or the tax side of the budget, every bill is put forward only to recognize winners. That's why the budget has gone so far out of whack is we're afraid to recognize that basically people pay for what they get. Government budget is a balance sheet. There are two sides to the balance sheet. What we get over here we pay for over here. And we tell our members of Congress, we the public don't want to hear that and then we're surprised when the lack of transparency works through to these tax bills.
Now, one reason the tax reform is also hard to achieve is that we now have—as the previous speakers have noted quite well—so much on the tax reform agenda. You know, the Keynesians want us to use the tax code to provide stimulus and the supply-siders want us to provide tax breaks, particularly on capital income and for high-income taxpayers in order to lower marginal rates and provide incentives. The consumption taxers want us to remove the taxation of savings. The progressives want us to help the poor more and tax the rich more at the same time. The capital formation advocates really want to do anything we can to remove taxes on capital. The capital gains and estate tax advocates basically don't believe in any tax that looks large at any one point in time on wealth. And the budget wonks—and I would include myself in them—really worry about the deficit.
And so, when we come to tax bills, we often have all these other agendas that we face at the same time. And in truth, although the various parties I just mentioned are often conflicting among each other, they do unite with respect to one thing: they often pay very little attention to what we often think of as traditional tax reform principles. And by traditional tax reform principles I mean such things as equal justice, or roughly equal treatment of people in equal situations, efficiency—make tradeoffs where we know things like five or six educational incentives are inefficient; why don't we have one or none and put them in the educational budget—and simplicity. Those principles always get the short shrift in this debate.
In effect, many of these principles, such as equal treatment of equals, really don't violate, necessarily, the other agendas. You don't necessarily have to give up on providing stimulus once in a while, or lowering taxes on capital for that matter at times without still facing up to the issue of whether you can try to provide equal justice in the tax system.
Representative Hoyer made mention of Kennedy several times in listing principles. The Kennedy administration did propose a tax bill that had, as one component, several features of tax reform. It also had the major item of tax "deform," the investment credit, which helped finance the Tax Reform Act, by the way, of '86 by being eliminated. It also turns out that under President Kennedy, the Keynesians dominated the debate, and when Congress went to the president and said, well, do you want your tax reform or do you want the stimulus, he said, to heck with the tax reform; let's get the stimulus out to the people, and that's more politically popular, and the Kennedy round of tax reform quickly abandoned tax reform as well.
So, at times we just simply need to be able to control this agenda. If we want to pay attention to tax reform principles, we have to put them near the top of the list. They can't come along second or third or fourth, and for whatever reason, whether it's a business or government or anything else, it's very hard to state primary goals and then worry about secondary and tertiary goals or give them much attention. If we want good taxes, a good tax system, we have to place it in the primary status that Representative Hoyer would make it.
Still another problem I have—or that I see with trying to enact tax reform is that there is so much in the tax system now. In many cases now when I speak to audiences I talk about tax reform like expenditure reform. If I said, are you in favor of expenditure reform, how many people would raise their hand? Well, I presume all of you would at some level, but then try to think about it: what do you mean by expenditure reform? Does that mean that you want to do something with education or with housing or with pensions? What does it mean? Well, you actually now have the same problem in the tax system. If I say, are you in favor of tax reform, yes, you may be in favor of simplification, but you can't really dodge these other issues such as the fact that in the tax system, implicitly or explicitly, we do have pension policy, we do have housing policy, we do have a weighed subsidy policy; we have all sorts of policies that essentially have to be addressed and to which we have to pay attention.
And it's hard work. It's hard work going through all these. You can say, well, let's eliminate all tax breaks. Well, it turns out, for instance, in housing, that the principal tax break is the nontaxation of the imputed rental value from owning a home, those of you who understand that. It means it's better to own than to rent as long as there's an income tax system. It's not because of the mortgage interest deduction; it's because it's better to own than rent. And once you're in that type of world and you decide, well, gee, maybe this favors the rich more than the poor, maybe I'd like to do something about the poor and the middle class, you've got to get back into the issue of doing housing policy. Now, you can do it on the expenditure side of the system, you don't necessarily have to do it on the tax side, but you've got to deal with it.
And that means that when you go through tax reform, you've got to go through these items one at a time and think about what you're going to do, using the tax system as a backup in the expenditure system. When we did tax reform in '84 and '86, we involved hundreds of people in both the Treasury and the IRS and the Joint Committee on Taxation on trying to struggle through all of these very difficult issues. And I know Michael says, to some extent, that we can't do tax reform as we did in '86. But if you look behind even his proposals you'll see he struggled with a lot of these issues on this side as well and tried to deal with them.
It is hard work, and let's get around the notion that all we have to do is adopt some simple form of taxation and not do that hard work.
Now, the other thing that's happened to the tax system these days is that we really have, if you want to think about it, three tax systems. We have one for the poor, we have one for the middle class, and we have one for the rich. Now, the tax system for the poor is really not a tax system; it's an expenditure system. It's dominated by the earned income credit and the child credit, and even the budget, for the most part now, treats these as expenditures. They are direct expenditures—the refundable portions of them are direct expenditures. If you're going to do tax reform you've got to decide what you're going to do with these weighed subsidies. You have to decide how these weighed subsidies are going to fit in with the rest of the welfare system. You can have middle-class tax reform and omit deductions and exclusions out the wazoo; you've still got to decide what you're going to do about whether you want a weighed subsidy system.
For the middle class we have to deal with all these deductions, exclusions, and credits, and they've got zillions of them. I could show you graphs that make the Clinton health reform look simple compared to what we've now done with the pension policy in terms of the dozens and dozens of types of tax breaks that you can have. And for the rich we have a system which largely doesn't tax you as long as you accrue your income and don't realize it, with one exception: we might tax you at the business level. So, trying to solve the problem for the middle class doesn't solve the problem for the poor, and trying to solve the problem for the poor with earned income credits isn't going to get at this question of how to tax the rich.
Now, the lack of principled policy development—I referred to both before in speaking about the fact that the lobbyists start dominating the process. My sense is we have to move back to the world. I don't know how to do it without the leadership that Representative Hoyer talks about, but I think it's congressional leadership as well as presidential leadership to put on the table first principles, to start having testimony again where people start talking about tax policy development. From the very beginning we start on the base of principles: what are we trying to achieve and how can we best achieve them?
I'll give you another example of a bill that didn't start out with principles, although in some ways it has some good features. There's a pension bill before Congress now that's bipartisan and is put forward by two of the most respected members of the House of Representatives, Democratic and Republican. But it was not designed on the basis of principles to start with; it was designed by the lobbyists saying I've got this need—many of them legitimate—and here's what we have. Well, by the end of the day the bill gives a lot away and does nothing that anybody has ever proven or even done any analysis to say, we're actually going to solve the major problem of the pension system, which is getting pensions to the majority of the population that has very little in the way of pension benefits. So, again, you've got to start with principles, whether it's in the administration or the Congress.
Now, there are two ways that I think we have possibilities—or two horses on which we might ride in terms of getting tax reform. And here I'm basically referring to what are the forces in society that I believe are going to demand change, or what are we—why are we as a public going to demand change?
The first—again, mentioned by my colleagues—is the alternative minimum tax. The alternative minimum tax is growing so fast that the public is going to demand some sort of reform, and it's going to demand it in part because the alternative minimum tax says that having children is a tax break and deserves the same treatment as other tax shelters. And at some point when we get 10 (million) or 15 million taxpayers on the roll, as my colleagues, Len Burman and Bill Gale, have pointed out so well, I think that they're going to rebel.
The second issue that's going to force taxes back on the agenda, for better or worse, is the budget. I've done some analysis, others have done some analysis, but my analysis says that if you add together what we've now promised merely in terms of elderly programs and defense spending and you take where we are in terms of the current tax system and the promises we've implicitly given to the public about maintaining it, by the year about 2011 there's nothing—nothing left over for the rest of the government. All the revenues are spent. We'll close down the EPA, we'd close down the Energy Department, close down highways, close down Housing; Community Development's gone, Homeland Security I guess we have to abandon, food stamps we certainly wouldn't have, the Justice Department would close us shop, and even the lights in Congress would have to be clicked off. That's what our current budget promises the public, and we are going to be making $100 billion if not trillion-dollar changes in that budget very soon.
That's not all bad. If you look closely at when we've had principle tax reform development, it actually hasn't been in periods where Congress and the president have had a lot to give away; it's actually in periods like '82 to '86 when times were really tough. There's something about times being tough that when policymakers finally have to go to the public and say, yes, we are going to recognize there are losers in this system, we have to make somebody pay, they actually revert back to principles, because then they have a reason for those principles: I don't want to do it but I have to do it, and here are the principles. It turns out that when times are easy and there's a lot to give away, that principles are the first thing to go and it's basically who gets to the trough first.
So I think that AMT reform and budget reform are basically the horses upon which future tax reform may ride, as difficult as those issues are even in and of themselves.
So in conclusion I'd like to argue that tax reform is possible. It's been done before, not very often. It takes very, very hard work. It takes a willingness, not just of our elected officials but of us the public, to recognize that we pay for what we get. Still, there are opportunities before us if we just recognize the forces that are going to lead the legislation in the very near future.
I'd ask you, to conclude—not by being a pessimist, however—you may remember the definition of a pessimist. That's someone who, when he or she smells the scent of flowers looks around for a casket. (Laughter.)
Thank you.
(Applause.)
PETER ORSZAG, Brookings Institution: All right, we have some time now for questions and answers, if the panelists could put on their microphones. I have lots of questions but because of the limited time I'll actually hold those, although that is a threat: if you don't ask questions, I will. If you could please identify yourself. Hold up your hand. If you have a question, identify yourself, ask a question, and we will allow our panel to respond.
Yes, sir, in the back.
Q: (Off mike)—several hundred million dollars of additional transfers that you would give to low-income persons to make up for the VAT. Part one of the question: given that the IRS says it has a very difficult time dealing with negative taxes and to hold those persons harmless you're going to have to have those transfers going in addition to the amount that is now going in the earned income tax credit; you're going to be taking that part of the administrative difficulty of the IRS and raising it to a higher level. Have you given any thought to how you would pull that one off?
A second thing that I'd just note for purposes of perspective, you had a chart that showed consumption taxation in the United States versus consumption taxation in the OECD countries and in the European Union. If you did an equivalent chart for what has been defined in a couple of academic papers as social welfare spending, you would find that there is an equivalent difference between the OECD countries and Europe more narrowly and the United States, which is to say the countries that have the highest reliance on consumption taxation have to do more on the outlay side to make up for that reliance on consumption taxation, which is regressive. So that just gives another dimension to the problem that would be created by putting a 14 percent value added tax on top of people who right now have very modest incomes, don't pay income taxes, and actually get negative taxes from the earned income tax credit.
MICHAEL GRAETZ, Yale Law School: Let me answer the second one first. If you look at social spending—I've done this in another book—if you look at social spending in Europe and you look at the U.S. and you include the way the U.S. does its social spending through tax expenditures, you find that they're very close. The difference disappeared. And so it's just a different way in which we're doing social spending. So I don't think that—you know, ours looks like it's a lower tax rate and so forth, because we're doing a lot of it through tax expenditures. But I don't think that's the difference, although it is true that Europe is running a lot of things through their budget, particularly health and education, higher education expenses, that we're not running through our budget, and maybe we would but there's no reason why we necessarily would if we haven't in the past just because we change our tax system.
On the first question, I have given a lot of thought both how to protect against the regressivity of the value added tax on people who are now not paying income taxes, and to protect the loss from the earned income tax credit without having people file tax returns. And I describe this in the article in some detail, although with all of this, the parameters and the details need to be sorted out with the advantage of a Treasury or a joint committee model to make sure that you're getting it right.
But the basic idea is quite straightforward, and it is that you would give people essentially relief, and in some cases refunds, of payroll taxes through their employer as a way to make up for this. Now, in order to do that without filing returns, I give up a tremendous amount of complexity that now exists with the earned income tax credit. I base it on wages and numbers of children. And so you get a larger allowance the number children you have and you get an allowance if you have low enough wages. And I don't say, well, what if you've got some tax-exempt income, as the earned income tax credit now does, and start taking it back. In the interest of simplicity you have to make some broad cuts, and I've chosen to do it that way.
The basic point, I think, is that you can deliver the earned income tax credit benefits, the wage subsidies of the earned income tax credit, and relief from the value added tax through this kind of mechanism without having to have the filing of returns. And it's in the article; I don't want to take more time explaining it unless people want me to.
PETER ORSZAG, Brookings Institution: Another question? Yes, sir, right there.
JOHN DAVIS, University of Wisconsin: This is directed to Professor Graetz again.
It seems to me the plan that you propose in some sense kind of ignores legislative dynamics. And by that I mean we might start now with an AMT that hits upper-middle-class and high-income taxpayers, but looking forward, Congress is fond of tax expenditures. I mean, Eugene's book talks about that at the very beginning. They like tax expenditures; they like to use income taxes as a social tool. What's going to stop Congress looking forward to expand the AMT down to lower income levels and then go back to where they were before? I mean—
MICHAEL GRAETZ, Yale Law School: Well, the idea—I agree with your basic premise; that is, if you keep an income tax, or if you have a consumption tax in the form of a flat tax or Bradford's X tax that requires everyone to file individualized returns, then Congress is going to start giving away a lot of individualized benefits. It is my view that if you limit the income tax to high-income individuals, you will find that there's not nearly so much support in Congress for having tax credits and tax breaks that only apply to the people with $100,000 or more of income. If you go back to the Clinton administration, most of the tax breaks, or many of them that were enacted during the Clinton administration, phased out at $100,000 or so of income. So the idea is to collect those taxes through business taxes in the form of a value added tax.
Now, if your question is, well, what's going to stop Congress from lowering the threshold from $100,000, then I turn to Congressman Hoyer and say, how would you like to get up on the floor of the House of Representatives and say, I'm going to now extent this income tax down to everybody? It took the Second World War for Congress to do that. That is, we had this system of consumption taxes on the masses and income taxes on the top slice of America up until the Second World War. And actually, Roosevelt would have gone to a consumption tax—a different consumption tax—for the masses, but in order to finance the war, Congress extended the income tax to the masses.
I don't think, short of some major event of that sort, that this is the speech a congressman would want to make. But we have a congressman in the room, so—(laughter).
PETER ORSZAG, Brookings Institution: And actually, I think Gene has an additional question.
EUGENE STEUERLE, Urban Institute: Well, I was actually going to turn the question over to Representative Hoyer. I guess I don't—there's a lot about Michael's plan that I think is nice. I mean, basically the VAT is a clean tax if you think you can do it in some way, and that's the base on which a lot of it's built. I don't agree with him that we're going to stop Congress from enacting legislation. They're not going to sit back: well, the last Congress got it right; I guess I don't have to show up anymore. (Laughter.) It just doesn't work that way. Whether it's a new recession or a new crisis, or whatever else, Congress feels like they have to act. And we do get real bracket—(inaudible)—we can avoid it, in the types of taxes you propose, Michael.
So the question I have for you, Representative Hoyer, is if the issue is partly process—you know, getting a process that at least cuts back on some of the ways in which we give away the future, we add complexity to the system, and so on and so forth, are there process reforms that might work that could get us to a more principled tax policy development, whether we do all the way towards broad reform or even, after enacting a broad reform, try to move forward to the future?
REPRESENTATIVE STENY HOYER (D-MD): I suppose the answer to that is yes except for the fact that our experience with process reforms is that if the objective is not facilitated by the process, the process is changed, or the process is ignored in terms of requirements, whether it's waivers or budget bills. It seems to me the discipline—and I want to comment on one of the things that was said earlier—but it seems to me the discipline, with respect to revenues, is absent.
As you consider a system—what is a tax system? A tax system is to get you revenues to do something. It's not an abstract, we have taxes just to have taxes. We have taxes to accomplish objectives, and if we are for those objectives, presumably we are for paying for them. And if we're for paying for them, we need to then pay for them with a system that is fair, simpler, and more efficient, which is my proposition. On the other hand, currently we've been in a process for a long period of time now where paying for them was not the driving force of the consideration of revenues; it was the unfairness of the system and the fact that we were taking your money unfairly.
Now, let me go back to—so I'm not convinced that process per se will get us to the objective, other than, as I pointed out and you pointed out as well, certainly having hearings and vetting proposals would be a definite step in the right direction so that we could have, rather than relatively private, as you point out, lobbyists—and those of you who have heard me talk, I'm a proponent of lobbyists. The Constitution guarantees that we can go to Congress for regressive grievances. That's a constitutional right. Lobbying is a constitutionally protected—and we all have a special interest—somebody said the general interest—I guess Michael—and I agree with that as well. But we all have a special interest and we have the right to come and say—and if you're "G," my criticism is not of "G," my criticism is the Congress. Not that somebody would come and say, look, we want a better break, but we needed to have a process, in that perspective, which gave a much broader consideration and vetting, not only with members of Congress but with the American public and with experts like here as to what those processes were.
Let me say something, though, about the—there's not much political or compulsion in the Congress to give breaks to those over $100,000. I think that's in error. (Scattered laughter.) In fact, we just extended the child tax credit to people $250,000, and the rationalization of that was, well, you Democrats have now said that $250,00 is middle income and below. That's on the theory that the $200,000 or thereabouts, the Kerry proposal or other Democrats' proposal, that that would be the middle-class tax breaks; under that we would keep. So I think there has been and continues to be a real political—
MICHAEL GRAETZ, Yale Law School: All I meant was that if the income tax only applies to high-income taxpayers and you're going to give some break for education or whatever, it's much less likely to be politically appealing to do it through an income tax when the only people who are going to benefit are those above $100,000. Surely if you've got a tax system that applies to everyone and people below a certain level have tax benefits, then there's going to be pressure to send those up the line. I don't disagree with that.
REPRESENTATIVE STENY HOYER (D-MD): Let me suggest that the converse is that nobody really talks about cutting the taxes that the majority of Americans pay, and that's the FICA tax, which, as I understand it—and some experts here—but I use this all the time so please correct me if I'm wrong—that more Americans pay more FICA tax than they do income tax.
MICHAEL GRAETZ, Yale Law School: Yeah, it's on the chart.
REPRESENTATIVE STENY HOYER (D-MD): And if that's the case, then nobody is talking about cutting the FICA tax. When I say nobody, that's not correct. There have been proposals to do that, which I think have some merit to them, frankly, because essentially the FICA tax, as all of you know, is general revenue, and we use it as general revenue, and we're spending all of it for general revenue, essentially; that is, the excess that that tax produces above and beyond, theoretically, what would be its obligation if you look at the Social Security system as a pass-through payment.
But let me leave it at that. I think process is important.
PETER ORSZAG, Brookings Institution: We have lots of questions. I just want to add that—I'm going to exercise my prerogative and just add one question, which is that this whole discussion has been in a sort of revenue-neutral context. By any reasonable projection we face a massive long-term fiscal gap. Gene made the point that you can't sort of do two things at once; you can't do tax reform and address some other objective at the same time. Yet, given the scale of the long-term fiscal gap, is it really worth it—for example, Michael, your proposal is revenue neutral. Is it really worth it to exhaust the policy process getting that reform while not addressing the long-term fiscal problem? And if it is the case that we do need to address the long-term fiscal problem at the same time, should we be thinking about revenue-increasing tax reforms rather than revenue-neutral tax reforms, and if so, doesn't that make the whole thing all the more difficult? Are there any reactions to that?
EUGENE STEUERLE, Urban Institute: In part, as I say, the experience—when I came to town in the '70s, the argument was we had a lot of revenues, we had huge bracket creep and we were going to buy tax reform. And we went year after year and it got more and more deformed. Then we went into the '80s and we said, oh, my gosh, we've got these huge deficits; we'll never get any tax reform, and we got actually first a lot of base-broadening, led in part by Senator Dole, who ran from it when he was running for president, but in fact he led the Congress in many ways—he and Senator Baker and some others led the Congress in doing a lot of base-broadening at the time that really got at the deficit. And then we did tax reform in '86, which was roughly revenue-neutral.
So I don't think that the budget deficit actually—at least historically speaking—is necessarily a mark against us. It doesn't mean we have to deal with it, but I don't think it's necessarily a mark against reform. I don't think we buy reform when times are good, as I argued. In fact, at least historically, the experience is we buy a lot of special breaks for people and do it in a way that's not very even.
REPRESENTATIVE STENY HOYER (D-MD): Well, I think you have a crisis. I think the deficit that confronts us is America's single-largest problem that impacts on every other problem we have. And the reason we have a crisis is in the '80s when we went through the Reagan tax cuts and then the tax increases—Bob Dole, the tax collector for the welfare of society, according to Newt Gingrich—when we raised taxes in '82 and then subsequently a number of times, we didn't have the Social Security cohort about to hit the wall. We now have it about the hit the wall in just a few years, and that makes our challenge really much greater today than it was then. We were also collecting 15.6 percent of GDP in revenue, which is the lowest point since when? Fifties. So I think Peter's point is I think we cannot discreetly deal with one or the other; we need to deal with both, in my opinion, because of the crisis that confronts us is such that I think we're going to have to deal with revenue. Call it revenue enhancement, call it tax increase—nobody likes to talk about tax increases. Americans are just going to have to come to grips with what we want to buy, and if we want to buy A, B, C, and D, my proposition is it is immoral not to pay for that and simply expect the next generation to pay for it. It is moral to expect my granddaughter to pay for an aircraft carrier because she amortizes that over a long period of time and she uses it, but we are amortizing operating costs over a long period of time, which is why New York went bankrupt, and I don't think we're going to be immune from that, as rich a country as we are. And I hear the rationalization that we're at, what, 3.8 percent of GDP in terms of our deficit that we're running now, somewhere in that neighborhood, but when you're dealing with $400 billion, give or take, it is going to have an adverse impact on the economy and, longer term, on the ability of America to be successful.
PETER ORSZAG, Brookings Institution: Mike.
MICHAEL GRAETZ, Yale Law School: Let me just make two comments, because I know there are a lot of people who have questions. One is that our experience, beginning in 1990 through the '90s, is that budget rules are very important to this process. I know there are people who would disagree with that, but I think the PAYGO rules that came in in the '90 budget agreement that were then extended during the Clinton administration were extremely important to keeping a lid on, and this current ETI-FSC bill may be a test of that. But it's somewhat disheartening that Congress has not even been able to agree on budget rules in the current climate.
The other thing I want to say—and I tend to agree with Gene that there's no reason that you can't do some of this—do both. I want to make one other general comment. That is, if you're really worried about long-term deficit problems, you're really much better off having two tax instruments instead of one so that you don't have to have very high rates on income in order to pay for your proposals. If you want to lower the FICA taxes, we can get into that, but there are lots of things people might want to do. But the idea that the U.S. does not have a consumption tax in order to go forward is really a mistake. Now, I tried to set the consumption tax rate rather high at 14 percent and the income tax threshold rather high, and that was done in an effort to put pressure on base broadening rather than rate increases for deficit reduction.
That is, I do not detail here any major base broadening in order to get the 14 percent rate. But I, for example, would bring corporate taxes much more closer to book income as a base rather than taxable income as a base, which is a big base-broadening effort, you know, with the exception of depreciation and some other specific things that I think you have to treat differently under the tax system. It would solve the tax shelter problem and allows you to have lower rates. I think there's a lot of room in my plan for addressing some of these deficit problems gradually, if you want to do so, without breaking either the exemption level or the rate structure in general that I'm proposing. Now, you may need a slightly higher rate on the value added tax or you might want to put in higher rates somewhere in the income scale, although I'm reluctant to do that.
REPRESENTATIVE STENY HOYER (D-MD): Can I make a comment on that, Peter? I'll do it briefly so we'll get to the questions.
First of all, obviously I very much agree with you on the PAYGO plan, and I don't want my response to process—to disabuse anybody of the theory that I believe the PAYGO rules, adopted in 1990 and '97, where they overwhelming majority of the Republicans—193 Republicans voted for PAYGO rules affecting both expenditures and taxes, but currently the concept of, frankly, the majority, in the House at least, is that there is no such thing as a tax expenditure. We all talk about tax expenditures. I think all of us agree that there are tax expenditures. But that is a concept that is anathema, frankly, to, I think, Tom DeLay in terms of saying that a tax cut or a tax expenditure is in fact to be treated as an expenditure for anything else that you buy in government.
And because of that dichotomy, there is the rationalization that you do not have to compute and offset that cost, which is why they've taken the position on PAYGO that they've taken, that the pay as you go should affect only government expenses, not tax expenditures.
PETER ORSZAG, Brookings Institution: All right, I think we have time for two more questions.
Ron?
RON GEBHARDTSBAUER, American Academy of Actuaries: The academy did a paper back when tax reform was being talked about a lot, saying that if we had consumption tax or a flat tax or a sales tax or a VAT tax that it would discourage—or it would take away the encouragement of employers to have pensions and health plans for their employees, but I think—and this is a question for Michael—I think because you keep the income tax above $100,000, the alternative minimum tax, that you still have a way for encouraging the decisionmakers at the big employers or the business owners at small employers to still have a pension plan. So I think maybe that solves that concern we had on the health area. What would encourage employers still to have health insurance? Would it not be included in—
MICHAEL GRAETZ, Yale Law School: I did not include it in the income tax base, and the payroll tax would not include it either. So you have a broad-based constituency to keep it. Now, I have to say, as a matter of policy, I'd like to do something else with health insurance, but I don't think you can do something else without having a solution to it and give up the employer-based system that we have. But it is important—and this is one of the reasons that I think keeping the income tax at the top end in addition to its distributional advantages is important—is that I do think it protects against the demise of the private pension system that is inherent, I think—I agree with the actuaries—in a flat tax or in a pure value added or sales tax system, and it does protect on the health insurance front, for the same reason under the income tax and a combined reason under the payroll taxes.
PETER ORSZAG, Brookings Institution: Okay, last question.
LARRY SEIDMAN, University of Delaware: I really like two elements, Michael, of your plan. I think we need a value added tax. I think even with fiscal discipline, with revenue needs coming up in the next decade we're going to need revenue, and the least worst way to get it is the VAT. So I agree very much and I like your progressive component, retaining that at the top. But my amendment would be—and it's a serious one—would be that I think we need to keep several refundable tax credits delivered through the household tax system: the earned income tax credit, a savers' tax credit, and a health insurance tax credit, the kind that Gene Steuerle has written on. I have read very carefully over and over that part of your article on how you would try to make up for the earned income tax credit. I know you're concerned about it but—maybe I'm missing it. It just doesn't seem to me that you are able to offset the regressivity of the VAT itself and can preserve the earned income tax credit and so on.
So there's a compromise position. It could be retain a few of the refundable tax credits, along with the rest of your proposal with that and the progressive component on top.
MICHAEL GRAETZ, Yale Law School: Well, I regard that as the famous nose in the tent. (Laughter.) The whole camel will be in the tent soon. I mean, for me it is very important—very important to get that 150 million people out of the system of filing tax returns. I will concede that the payroll tax offset is a rough approximation. I think it does it for virtually everyone you're worried about with regard to the earned income tax credit and with regard to offsetting the regressivity, such as it is, of the value added tax. It does not protect—if you want a savers' credit, it does not protect against that.
My suggestion is match savings for low-income people. You don't need a tax credit for that. Just have a match of savings. If they put X dollars in the right account, the government throws X dollars in the right account. That's what they're doing with the savers' credit if they're depositing it in a bank. There have been proposals for that before.
If you want to enhance savings, note that I've at least gotten rid of any tax on savings for low- and moderate-income people, which is not trivial, in my view. And if you want to do health insurance through the tax code, you and I are just in different places. I mean, I really think we need to—I understand the idea of offsetting the distributional problems of the current health insurance exclusion through health credits. You know, if we're going to stick with the existing income tax and go forward the way we have, then maybe health credits are important and make some sense. But for me you've got to get rid of these—you've got to get these people out of the system. And that means that you do have to confront your health policy outside of the tax credit system.
And I think they don't work. I really think they don't work. They haven't worked and they certainly won't work with things—I mean, the next one is going to be long-term care. We're going to solve our long-term care problem through some minor health long-term tax credit, and it's going to solve that problem just like we've solved the health insurance problem in this country.
PETER ORSZAG, Brookings Institution: I think we're going to get some very brief concluding remarks from Gene and from Mr. Hoyer.
EUGENE STEUERLE, Urban Institute: I think this last question and answer points to the very difficult issue that—it's not enough, I think, just to say we're going to take something out of the tax system and throw it in the expenditure system. I mean, when we're talking about the complexity of life for the American taxpayer, it's also the complexity of life for the American citizen facing all these other systems. And they're mutual problems. In fact, one of my biggest protests with respect to process is we have no part of the government, no part of the government at all that really examines taxes and expenditures together. It should probably sit in OMB; it doesn't. But I don't think you can sort of dodge that particular problem. Mike and I might reach a compromise but we'd still have to figure out on the side what we're going to do.
I'd like to just add to that support for what Representative Hoyer says about PAYGO. And the analogy was to what happened in 1990, '93, and Rudy Penner and I have written an article on this recently. And one thing we did conclude that's very clear is when you had this type of process reform, it was backed—as the representative has claimed, it was backed by an initial agreement to really do something. A lot of the hard-fought gains in the budget reform in '90, '93 took place in '90, '93, and PAYGO was a backup system that enforced that.
So you really need that leadership up front to be able to get at a good set of rules like PAYGO to operate well.
REPRESENTATIVE STENY HOYER (D-MD): And the PAYGO was a very bipartisan accomplishment. That's why I pointed out 193 Republicans voted for it in '97, to reauthorize the PAYGO affecting both the—expenditures both tax and things we buy.
Let me thank all of you. I really do believe we have a crisis, and I think we need to deal with both; we need to deal with the crisis of fairness. We are a country that, compared to most, voluntarily complies with our tax system, but that compliance is eroding, and eroding relatively substantially and relatively quickly in terms of the comparisons for a number of decades and recently.
Second, we have a crisis in terms of a budget deficit, for which the revenues are collected to pay for what we buy. And we're not collecting enough revenues. The fairer and simpler the system, the more able your elected representatives will be to collect the necessary revenues to make the expenditures that the public wants us to make. And that I think is an important point. It is not a mistake that for half a century Americans have essentially supported those who have bought what we're buying, whether it's on the defense side, the entitlement side, or the nondefense discretionary spending side.
So we need to, I think, address this, and I think the proposals that have been made are very useful. My very, very close friend, as you know, Ben Cardin, who is, I think—you were speaking of Portman and Cardin in terms of the pension bill, I presume—both very substantive legislators. Ben Cardin shares your view that the consumption tax, or some form of consumption tax, is an alternative that certainly bears very careful scrutiny and is possibly a better alternative.
Having said that, I think we clearly need to—and it must be done in a bipartisan way, as it was done in '86—move to a system that is fair and simpler if we're going to have a system that works.
MICHAEL GRAETZ, Yale Law School: Can I say one sentence in conclusion?
PETER ORSZAG, Brookings Institution: Okay one sentence.
MICHAEL GRAETZ, Yale Law School: In conclusion, that is, I would urge people in this room—you're very important to this process—not to let the perfect be the enemy of the much, much better.
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