TAX REFORM: WHY DO WE NEED IT?
WHAT SHOULD WE DO?
Wednesday, October 6, 2010
CHRISTOPHER BERGIN President and Publisher, Tax Analysts
HON. RON WYDEN U.S. Senator (D-Ore.)
PAMELA F. OLSON Partner, Skadden, Arps, Slate, Meagher & Flom
WILLIAM G. GALE Senior Fellow, Brookings Institution Co-director, Urban-Brookings Tax Policy Center
MICHAEL J. GRAETZ Professor of Law, Columbia Law School
MR. BERGIN: Everybody, please find a seat. We will start in a couple of minutes.
OK, good morning. How is everybody? Welcome to the latest in the Tax Analyst series of discussions on key issues in tax policy. The topic for today is tax reform.
I'm Chris Bergin, the president of Tax Analysts, a nonprofit publisher of Tax Notes, Tax Notes Today, State Tax Notes, Tax Notes International, and many other fine print and online products on federal, state, and international taxation. This is our eighth year of conducting discussions on tax policy.
If you are new to our discussions, let me first say it's great to have you here. Since our topic today is tax reform, we thought it would be fitting to hold this conference on Capitol Hill, and I want to thank Senator Wyden and his staff and Senator Gregg and his staff for arranging the use of this really beautiful room, now officially known as the Kennedy Caucus Room, for us.
Let me take just a moment to explain our process today. I will make some brief opening remarks to introduce our topic. I will then introduce our distinguished panel of speakers sitting here to my left. Each of them will address our topic. I believe that we only have Senator Wyden for a short period of time, but he has agreed to take some questions after he speaks, and he will speak first.
Following that, we will go to our next three speakers for their presentations, and, after that, we will open up discussion to all of you, and I encourage all of you to participate. That's what this is about.
We will post an audiocast of this on our website later today, and a transcript of it there in the days ahead. For media purposes, we are on the record, so, when I recognize you, please tell us who you are. Also, please speak into a microphone.
For those of you in the audience, we will quickly get a handheld mic to you. I will moderate the discussion. We will end by 11:00.
Now to the subject at hand. Let me begin with a rhetorical question: Does anyone doubt that our tax system is broken? How is the tax system broken? Let me briefly count some of the ways.
First, it's so complicated that nobody understands it. For instance, low-income Americans who are eligible for things like the earned income tax Credit have to hire tax preparers just to file for their credits. And multinational corporations hire teams of lawyers who spend all year trying to comply with the law while getting the best tax deal they can for their clients.
Second, and largely because it's so complicated, our income tax system is fundamentally unfair. It's got all kinds of deductions, credits, write-offs, and loopholes which provide special tax breaks for special interests.
Third, our tax system isn't fulfilling its most important function, which is to raise enough money to finance government spending. Fortunately, Senators Wyden and Gregg have made major contributions to debate about reforming our tax system with their Bipartisan Tax Fairness and Simplification Act, otherwise known as the Wyden-Gregg bill. The two senators have been promoting it widely, and we thank Senator Wyden for taking time out of his busy schedule to be here today to tell us about it. So, it will be great pleasure in just a couple of seconds to first introduce Senator Wyden this morning.
We will then hear from three other distinguished speakers in the following order: Pamela F. Olson, who's a partner with Skadden Arps Slate, Meager & Flom, and former assistant secretary of the treasury for tax policy. William G. Gale, who's a senior fellow at the Brookings Institution and co-director of Urban-Brookings Tax Policy Center. And Michael J. Graetz, who's a professor of law at Columbia Law School. I'd also like to thank John O'Neill from Senator Wyden's staff and Jim Carter from the Budget staff, both of whom are in the audience.
So, now, without further delay, please welcome the Honorable Senator from Oregon, Ron Wyden.
SENATOR WYDEN: Chris, thank you very much for those kind and unquestionably inflationary comments, and I had long thought that some court is going to declare it to be cruel and unusual punishment to let Senate types inflict long speeches on you at the crack of dawn, and I'm looking around and some folks haven't gotten their coffee yet. So, I'm going to keep this brief.
And, also, you should really know you really are going to have a great time with this panel with Bill, Pam, and Mike, sort of a cavalcade of stars, who's who of tax law, and I think you're going to really enjoy this morning's program.
So, let me if I might just spend a few minutes and kind of set the table almost by way kind of giving you my sense of where events are, and you're going to be getting into the root canal work of tax reform here in a little bit, going through this provision and that provision.
And, also, where's John O'Neill and Jim Carter? I want to make sure everybody knows. There's John and Jim. These two are the bionic duo. They have spent hour after hour after hour advising Senator Gregg and I. So, if you really want to know what's going on, call them nights and weekends and take all their free time, but these two give public service a good name, John and Jim.
Here's where I think things are. The popular wisdom, if you'll look at all the prognosticators and the people talking 24/7 cable and the like, the general consensus is that the next Congress will be about small ball. That's generally the kind of popular consensus, that you will have close ratios or closer ratios between Democrats and Republicans, you will have a presidential campaign that will start -- you have the election first Tuesday in November. People sleep in on Wednesday. The presidential campaign probably starts Thursday for 2012. So, you have these close ratios, presidential campaign starting up, and then, of course, much of the country thinks that the United States Congress couldn't run a two-car parade, let alone reform the tax system. So, you have those three factors kind of conflating into this judgment that I offer up by way of studying the table, that most of the so-called experts think that the next Congress will be about small ball or, perhaps, they think it will be about no ball at all, that you'll just have gridlock and not much can happen.
I do believe that that's wrong, and I'm going to kind of outline why I think that's the case here just for a few minutes, and then, anxious to take some questions. Softball questions will be especially welcome, and we're going to have a great panel and a good discussion.
First, Monday was a huge, huge deal for the cause of tax reform. And Monday, the president, I gathered through a meeting with a Council of Economic Advisors, that he would be open to very substantial corporate tax reform if it was revenue-neutral.
Now, to me, if you accept that thesis, the first thing you have to do is go to S. 3018, which is our tax reform bill, which, in fact, does that. We are able to get the corporate, the rate for C corps, down from 35 to 24. As you all know, this is only one part of the business tax reform debate because we're down now to only about 20 percent of the companies in America being C corps with maybe 80 percent being Ss, and partnerships and sole proprietors. But this is a big, big deal because also when you have the president stepping up like that, and, let's face it, you cannot really get the attention you need for tax reform unless the president is speaking out.
Senator Gregg and I write op-eds for The Wall Street Journal and the like, and a few of our friends and my cousin reads that and sends me an e-mail: "Oh, my goodness, The Wall Street Journal is reporting on you and Senator Gregg." But the reality is that the president has the bully pulpit that allows you to get into the issue of tax reform in a way that really triggers public attention, and the fact that the president put it on the table so early, even during the period before the election of 2010, I think is a huge deal, and, of course, when you take a piece as substantial as the corporate reform side, you also are opening up the debate about the tax code generally.
For example, the way Senator Gregg and I got into that particular issue, we went about it as follows: If you go out to a coffee shop in America and talk to the blue-collar person, one of the first things they say is what in the world -- and they usually don't use a word quite that polite -- what in the world are you guys doing back there giving tax breaks for guys doing business overseas? That's outrageous. You got to get rid of it. Then you go to the American companies, of course, and they say we've got to have those overseas incentives because the corporate rate in America is so high relative to everybody else, that to compete in global markets, we have to have these incentives' deferral, and credits and the like.
So, that's where the conversation always stopped prior to the two years that Senator Gregg and I, led by John and Jim, tried to have a different conversation. And what we said, which I believe will be a conversation that you'll have early next year, is we went to the American business community and we said: what rate would it take in the United States in order for you to give up a number of those breaks for doing business overseas that the blue-collar person finds so objectionable? And that then launched a very extensive discussion which led Senator Gregg and I to come to the conclusion that if we came in with the corporate rate of 24, we could kind of systematically saw away much of those international tax incentives, breaks, whatever you wish to call them, that have so infuriated the blue-collar person.
Obviously, you're going to need some transition rules, as well. You can't move to something like this in 15 minutes, but the fact that the president put this on the table, A, philosophically is exactly where Senator Gregg and I were, B, and, C, it opens up the chance for the broader conversation with respect to how you get into the business of making a change in area and how it affects another I regard as a very encouraging prospect.
The second big deal, that because it was in the last few days of the Congress, is the great leadership being shown by my chairman, Senator Max Baucus. Max Baucus in the middle of the last week of the session when there was a lot going on brought in another significant array of tax experts for a very lengthy hearing we held in the Senate Finance Committee, which, to me, is also a signal that the Finance Committee is going to be digging into it. The fact that Chairman Baucus did this during the middle of the last week when everybody was rushing to deal with some of the other kinds of questions I thought was very constructive.
So, that is, I think, a little bit of a foundation for why ought to feel that this is different, it's off to a better start, and now what we've got to do is make sure that the debate really looks at what the alternatives are in a way that I think is going to lay out what this question is all about.
For example, for the last two months, if you ask people in the United States about taxes, they'd be saying oh, those guys in Washington are debating -- I forget which Bush it was, I think it's George W. -- we're debating George W. Bush's program against Barack Obama's program. And you have had oceans of newsprint and hours and hours of news alerts on 24/7, this is happening, somebody breathed about tax reform, the Bush proposal, and the like.
Well, the fact is I think that's the wrong debate to be having, a debate between the George W. Bush tax proposals and some of what has been discussed by the president's folks. The reason why is if you go with one of those two systems, the proposal of George W. Bush or some of these other ideas that have been floated in the administration, what you will do is you write into stone a broken tax system for years and years to come.
In other words, if we want to in this country sign up almost permanently, no current Congress can ever permanently bind a future Congress, but if you want to write into stone a flawed, discredited tax system with all the problems Chris just outlined, we'll say that those are the only two alternatives because you go with both of those, we will have thousands and thousands of pages, we will spend enormous amounts of time with preparers and the like, and, in my view, very little will change.
So, what we have said is the relevant comparison is not George W. Bush's ideas against Barack Obama's ideas, but the relevant comparison is how the economy grew during the Reagan years when Democrats and Republicans worked together and how there was much more anemic growth during the 2001 to 2008 period.
And let me just give you those numbers. When President Reagan and Democrats worked together, 16 million new jobs were created, and there was a 17.6 percent expansion in payrolls. From 2001 to 2008, when you had a partisan tax discussion, when you were just looking at these issues in a partisan way, there were 3 million new jobs created, and there was a 2.3 percent expansion in payrolls. Also, in addition in that period, the size of the anemic job growth, real median income declined by 5 percent during that period.
So, why would you want to re-up for a program with those kinds of numbers? Wouldn't you want to say take a look at what happened when Democrats and Republicans said let's be pro-growth, let's be pro-simplicity, and let's be pro-fairness, which is really the three legs of the tax reform stool, growth, fairness, and simplicity, and build on that? And, so, I'd like to think that we're making some real headway in terms of advancing that approach.
One other key point to all this is it's very clear that if you want to reduce the deficit, one key plank of deficit reduction has got to be grow the economy. In other words, you cannot turn the deficit around in a meaningful way just with the efforts that are going to be made in the entitlement area and the spending area and the like. You're going to have to have economic growth, and that's why those numbers that I've outlined are so important.
I also think that the next Congress is going to want to know how do you grow the economy without adding to the federal deficit? And this is an example of a revenue-neutral way to do it. You're not paying for job growth by going out and starting a bunch of new programs and pumping lots of additional government money. You're saying to the country instead of coming up with vast new sums of money, what we're going to do is go out and take scores and scores of those narrow tax breaks and use that money to lower rates for individuals and businesses that can create growth.
I mean, we know, for example, that there's a significant demand problem in our country. No surprise the conference board just last month came and talked about that consumer pessimism. Well, one of the ways we think you can get the consumer back into the marketplace is through some of the changes we make on the personal side of the tax code. We tripled the standard deduction; we get rid of the alternative minimum tax. Those are opportunities for the middle-class person to get back into the market.
Now, two other points, and then we're just going to throw it open to some questions. Three separate reports have given us good reviews with respect to growth, the revenue and analyses, and the structural underpinnings in the legislation.
Bill Gale is here, who's been involved in one. The Heritage Foundation, I will confess that I don't quote the Heritage Foundation every single morning in every one of my bills. It says that we will create 2 million new jobs per year. So, we've gotten a very good review from them, and the Manufacturers Alliance, which we think is a special kind of trampoline for us in this discussion because a lot of the manufacturers or S corporations, we keep the top rate at 35 percent. We also have a very generous write-off for them in terms of expensing. So, we've got a very favorable review from the Manufacturers Alliance, as well.
So, I think the stars have aligned to make this the best chance for tax reform in a long time. To paraphrase Bill Bradley, and every once in awhile he has reminded me that I'm another tall Democrat on the Senate Finance Committee, and I went to school on a basketball scholarship. My jump shot is not quite Bradley-like, but I went to school on a basketball scholarship, too, and he told me once, just remember tax reform is absolutely, totally, and completely impossible until 15 minutes before it comes together. And I think that's true.
I think all the popular wisdom is going to be it can't be done, especially can't be done at a time like this, a polarized electorate, and the like. I will tell you starting with the promising words of the president this past Monday, the leadership that's being shown by my chairman, the opportunity to grow the economy without adding to the deficit, a chance for Democrats and Republicans to just put down the swords briefly and say the big challenge is not sparring with the other guy on the side of the rostrum in some committee room, the big challenge is going to go after these special interest groups. The special interest groups all of whom will go to the American people in the course of a tax reform debate and say if you take away that particular tax break that we've been able to get, western civilization is going to end. That will be their argument. Their argument, in fact, will be not only will it be devastating to take away their tax break, but they'll say those guys in Washington, they're never going to lower rates. What's going to happen is they're going to take away the tax break that you care about and then you won't see low rates. Or maybe they'll take away the tax break that you care about and lower rates for about 20 minutes, and then when you turn around, they'll jack them up again.
So, that's why this is going to take Democrats and Republicans coming together, it's why the president's leadership is so welcome. I have the best partner in this effort, Senator Gregg. He's on the Deficit Commission. We're very hopeful that the Deficit Commission is going to look favorably on all of this, and we've spent a lot of time with them, as well, and I do believe that after a quarter century, the Congress is ready to take this on once more.
And let's throw it open to your questions. Thank you.
All right, I'm told that there are hand-held mics moving around. And maybe Chris can just point people out, too, while we're waiting.
MR. BERGIN: Sure. We'll start over here.
MS. LOBEL: Thank you. Marty Lobel. It's not very often you're called a moderate, but my curiosity is aroused. Why didn't you just eliminate all tax subsidies? Eric Toder, my friend next to me, has done some studies (inaudible) about $1.2 trillion. The deficit's about $1.4 trillion. We could take two-thirds of that $1.2 trillion, lower tax rates for everybody; use the other $400 billion to lower the deficit. Wouldn't that be far more sTimulative to our economy?
SENATOR WYDEN: Senator Gregg, when we were asked a question that was an offshoot of what you asked, said, we're trying to get a bill passed, and the reality is if you have a one-page 1040 form, which is what we're offering, 29 lines long, Pam, I think the Bush Commission's 1040 form was, what, about 32 lines long, 33 lines long? I mean, the reality is for government work, this is pretty close, and I think if we can make a reform this bold and this transformational, that would be a huge plus for the cause of tax reform, and if people have ideas that are politically viable that can go beyond that, I think there'll be a lot of Democrats and Republicans very receptive. But I think we felt this was about what the water temperature could absorb.
MR. BERGIN: Nina?
MS. OLSON: Hi. Nina Olson, National Taxpayer Advocate.
SENATOR WYDEN: And if any of you want to see somebody who has consistently been on the merits making (inaudible) suggestions for taxes and tax reform, Nina Olson, our advocate, and we really appreciate the great work you're doing.
MS. OLSON: Thank you, sir. The last day-and-a-half, I have been a target of an e-mail campaign, a petition from taxpayers all over the United States asking that the IRS give a receipt for taxes paid that shows how your tax dollars are being applied, to what they're being applied, and in reading the petition, it actually is an interesting concept to say people don't understand what they're getting for their taxes, which fuels or enables people to say I don't get anything from government.
That ties into my question to you, which is: How do you cut through that attitude, which I see as a major impediment to tax reform? And I know you say "pro-growth, pro-simplicity, pro-fairness," but what's a message that would cut through that distrust?
SENATOR WYDEN: Two good points. First, Nina, with respect to a general proposition that it's going to be important to get to the public better information about where their tax dollar goes, sign me up. And it may well be appropriate to do that as part of a tax reform effort. I've not spoken to Senator Gregg about it or adding it to anything, but the general proposition, I think, is a good one, and there's no question that right now when people look at the spending and the bailouts and the like, they want a sharper pencil applied to federal budgets. They want to know where the money goes. So, the general proposition of that petition, put me down as in favor of it.
In terms of how you're going to do something like this, to just kind of backtrack, I start with presidential leadership. I mean, presidential leadership, that picture in 1986 of Ronald Reagan with Dan Rostenkowski and Bill Bradley standing there with Jim Baker, I mean, you go back through these kinds of studies, and a lot of people think that's just not possible today. I understand that. I mean, I've watched this Congress. I'm not kind of going starry-eyed and just saying oh, this is going to be a piece of cake, but I think that also if you have these closer ratios between Democrats and Republicans, both sides are going to have to produce some results.
In other words, it's not going to be enough to just say it's the other person's fault, you're going to actually have to have some pro-growth, pro-jobs results, and I think this would be an opportunity for both sides to get key elements of their philosophical plank. Democrats talking about fairness and talking about the middle class. Republicans talking about some of the business incentives. This is an opportunity for both sides to get much more of their agenda, I think, than meets the eye, but presidential leadership is going to be key, and if you have that, then you can have a different conversation with the country.
And I'll be frank with you, I wanted that conversation with the debate about American healthcare. I thought what the conversation should have been all about is both sides had a good point. I think Democrats, my party is right on universal coverage. You can't fix this unless you get everybody covered. And I thought Republicans had good points with respect to choice and competition and markets, and I think had those two been fused together, it might well have been a different debate. That's done. It's over. Here's a chance to bring the country together, take steps on a major effort to make ourselves more competitive in a tough, global economy, and allow our people to have a higher quality of life, and we have a model for it. I mean, it's one thing in terms of the healthcare debate where people said it hadn't been done for 100 years. This is something where there's an actual model. I mean, there are people who can step up, and, in effect, fill a lot of those roles from the 1980s.
That was a longer answer than you wanted.
MR. JOHNSTON: Senator, David Cay Johnston, I'm a columnist for Tax Notes.
SENATOR WYDEN: Oh, my goodness, all the stars of all tax reform. Go buy David's book.
MR. JOHNSTON: If you really want to simplify the system and encourage economic growth, why retain it in lower rates? Why not go whole hog and propose that we eliminate the corporate income tax and make all corporations flow-through entities?
SENATOR WYDEN: The question of making all corporations flow-through entities, David, I'd probably start with the point I gave to Marty Lobel in terms of the art of what is doable, but you start also with the fact that 81 percent of the businesses now essentially meet the test you're talking about. In other words, I looked yesterday, and maybe Nina was in one of your publications, so, your stuff is getting read. I think when you take the Ss, LLCs, partnerships, and sole proprietors, sort of the person who owns a hot dog stand on the corner, I think you're actually at 82. So, you're a pretty far way down the road just from that standpoint, and I think that this is going to be a big lift to force the tradeoff that Senator Gregg and I are talking about.
And I think, right now, we will have a coalition of blue-collar people who will say if you're talking about getting manufacturing going again in the United States and taking away those breaks for doing business overseas and using that money so that America can get back into manufacturing again, I can tell you, David, I've been going to labor halls and lots of meetings with blue-collar folks, and people are responding to that. It is a discussion that we haven't been able to have.
In fact, if you counted the number of times that somebody, particularly on my side of the aisle, stands up and says we're going to take away the tax breaks for shipping jobs overseas, and then people say how do you do it? How are you going to do that? Where is it going to come from? How is it going to be paid for? The conversation has ended, and now, we're able to actually consummate the discussion and say yes, we are serious about giving a boost to those who manufacture in the United States. We're going to do it in a responsible way, by taking away those incentives for going overseas, and take that money home and use it in a way that's going to strengthen the American economy and put blue collar folks back to work.
And you've been writing on these subjects, so, I'm going to take what you and Marty have written on this, if there's a chance to go further, I'm interested.
MS. ROGERS: I'm Diane Lim Rogers of the Concord Coalition. You're certainly right that a really great way to reduce the budget deficit is by encouraging pro-growth tax reform, but a much more reliable way of reducing the deficit through tax reform would be to actually raise revenue through the base-broadening that you're proposing. I'm wondering if you've ever entertained proposing a revenue-raising tax reform as opposed to revenue-neutral.
SENATOR WYDEN: When you get into this tax reform, you know, issue, it's very clear that lots of ideas are going to get debated. There's no question about that. This is the place to start. This is the place where it seems to me you can gain some credibility with the American people again on a major economic issue. If you can walk the country through, how you get from this mess we've got today, what Chris talked to people about, the thousands of pages, the astronomical amount of time everybody spends in the spring pulling all this together, if you can walk people through how you get from the mess we have today to a one-page, you know, 1040 form -- I think the folks at Money magazine took our one-page 1040 Form at one point and filled out their taxes in, like, 45 minutes. I think that is going to be transformational.
Now, I know when the Senate and the House both, and the Finance Committee and the Ways and Means Committee, get into this, there are going to be lots of different issues, and I'm open to looking at a variety of ways to improve on this. To me, if you can start, you know, here, you get a new credibility in terms of American economics. Let's face it, after TARP and the events of this last, you know, year, to have something that would bring us together around a major economic issue, I think, would have very beneficial effects, not just in terms of the direct kind of consequences of getting the middle class back in the marketplace with, you know, the demand, the changes that we think will increase, you know, demand and get the middle class back in the economy, but the value of having Democrats and Republicans come out and actually show, as was done when Dick Gephardt, Bradley, Rostenkowski got together with Reagan, I think people pretty much looked at that and said Ronald Reagan is making the tax code as progressive as Dick Gephardt called for? I mean, people, just kind of slap yourself in the forehead and say, "we're going to see what we can do with this," and then you look at those job creation and payroll numbers and you see it paid off.
MS. MATHIAS: Anne Mathias with the Washington Research Group. Just a question on, you know, this sounds great for the next session, but how are we going to deal with difficult issues in the lame duck? Is this spirit of cooperation and bipartisanship going to descend in six weeks?
SENATOR WYDEN: Here we got another of what I call the down-to-earth-planet-reality kind of questions, because certainly after the election and the lame duck, people are going to want to say, you know, what the next steps are. Let me make sure you understand exactly what I'm for: What I'm for is using that period to make sure there's a bridge to tax reform. In other words, if somebody wants me to sign up in the lame-duck session for time immemorial to a broken system, they're going to have a lot of trouble getting me to do that.
If there are -- thank you -- options advanced that will provide relief to the middle class, responsible incentives for business investments, certainly I like the expensing, you know, provision that Senator Gregg and I have a version of which Democrats have been supportive of, I'm open to all that. But to me what needs to come out of this period between now and the end of the year is establishing a bridge to tax reform.
MR. BERGIN: Anybody from this side of the room? This is the quiet side of the room.
SENATOR WYDEN: We worked the left and now we got to go to the right. And now the center's asked. We need a mic.
MR. STEUERLE: Senator Wyden, as I've told you personally, I congratulate you on being one of the few people who really attempts to do major reform and not simply think of reform as status quo plus change.
SENATOR WYDEN: If all of you just get together after this meeting, you'll come up with some recommendations yourselves that'll get the Congress going. You got such a great group of people in Gene and one person after another.
MR. STEUERLE: So my question is a little bit of a follow-up on Diane Lim Rogers but not quite the same. We're now spending about $30,000 a household, collecting about $20,000 in taxes, so we have a huge gap there. We have a Social Security system that's broken, we have a tax system that's broken, and I would say for the last 13 years or more every major enactment, almost every minor enactment by Congress essentially has never identified who's going to pay. That's either people who have tax increases or spending cuts, and that includes tax reform, by the way, any systemic reform has losers and winners, and none of us quite know how Congress is going to move to a world where they actually start going back toward recognizing that some people are going to have to pay to get our systems into order.
And so I'm asking a very tough question: What processes need to be changed in the Congress or maybe within the executive branch, that actually make more possible the identification of actual losers, the things the press love to play on, right, the things they'll attack you on? What processes are going to have to be put into place to let these types of reforms move forward?
SENATOR WYDEN: Well, Gene, first the Library of Congress -- I understand Max Shedoff may be here, too. Is Max here? Max did wonderful work for us when he was at the Library of Congress. Now he's at AARP, and Max can tell you how many hours, Gene, he spent working with us, he and Jane, you know, Gravelle, trying to, you know, drill down into our numbers and get us to the point where they could, in effect, in their analysis, say that we were revenue neutral. But Heritage, the manufacturers, and Bill can tell you they all came to pretty much the same conclusion. So we've got essentially four sets of independent experts who said that, you know, we are essentially paying for this bill.
Now, the fact is if you're going to do it, you got to go in there and eliminate scores and scores of particular narrow provisions. In fact, when you look at this, the question is more what got left rather than what did you eliminate. I mean, we keep your house, we keep your charity, we keep your medical, and we essentially keep your savings and investment, but when you're done with that and your 29, you know, aligns, Gene, you basically have lots of other stuff, most other big things sort of on the cutting room table. And we did the same thing on the business side.
So there's lots of pain here. I'm not going to minimize what these special interest groups can do in a world where you can narrow cast. I mean, you know, communications today really plays to special interest groups who would love to prevent something like this from happening. I understand that. I mean, they'll have magazines and media, and there probably will be TV stations that will be devoted just to keeping some very narrow tax break. I understand that.
But that's why having presidential leadership and having a bipartisan, you know, effort moving early, I think, can still trump that. But that's what it's going to take to come up with anything that is close to revenue neutral. But you got essentially four independent experts who said that, you know, we're basically there with S. 3018.
MS. SCHULTZ: Hi, Senator. I'm Cathy Schultz. I'm with the National Foreign Trade Council. I think that for corporations to look at tax reform -- I mean we obviously understand that our tax code needs to be reformed. But I think the political rhetoric of always talking about companies taking jobs overseas is very unhelpful as we start this debate. And I'm curious as to when you started to look at this whether you considered a different type of system as you looked at it so the companies can be competitive. Did you consider looking at a territorial-type system? Have you looked at other options so that U.S. companies can compete in a global marketplace and continue to move forward, because, you know, that is the reality of where companies are today?
SENATOR WYDEN: We certainly did, and it is a hugely time-consuming kind of drill. And Jim and John have become sort of near professors, tax professors because of the amount of time they spent on territorial issues, and I'm sure that'll come up in any debate about tax reform as well.
But it's important for people to know exactly how we arrived at this point. Let me just kind of go back through it. Whether your organization or anyone else cares for, you know, the analysis, the reality is as you go into a coffee shop in America and the blue-collar person says, "They're giving them" -- that's how they say it -- "They're giving them tax breaks to go overseas. That's wrong when Joe and Barb lost their jobs down on, you know, Southeast 6." Now that's just a statement of fact. Let me just kind of make it not anything other than just a statement of fact.
Then, of course, when legislators like myself and Senator Gregg go to companies, the companies say the reason we had to have those tax breaks for going overseas is because the United States has the second-highest, you know, rate in the world. We had to have that or else we wouldn't be competitive. And if we didn't have the operations overseas that have a synergy with the operations in the United States, we'd have fewer total jobs -- and you know their argument, you know, very well.
So the question, then, is do you stop the debate right there? You've heard from the blue-collar person, and you've heard from the company that feels that it needs those breaks. Do we just stop the debate there, or do you go and have a conversation with business folks and labor folks and others about something that could break the paralysis?
And that's what we did. We said, "where would you have to have the American right, and under what circumstances, in order to give up some of those incentives which are so grating to blue-collar people in every coffee shop in America?" That's how we arrived at the position that we arrived at. And I think no matter whether you stay with the system we have or go to a territorial system, at some point you're going to have that conversation.
And I don't profess that the approach we've taken is the last word and quite the contrary, in fact. I've gotten many of those large companies that you're talking about, you know, in Oregon, and my whole goal -- and I think Senator Gregg's as well -- is we wanted to get to the point where folks would have that conversation, where labor folks and business folks and others would say, you know, this is a pretty good place to start from. We're open to having a discussion that plays out this way. And when you have that discussion, I think both what we've recommended and the question of territorial approaches will be on the table.
And that's a big part of tax reform, folks. I mean that's what -- that's what's going to go on when and if a bill goes forward. People are going to talk about how do you fit the pieces together? That's what they did in the 1980s, and a number of factors have changed.
I think, for example, in the '80s, because of the nature of who is on the Finance Committee, some of the energy subsidies which no longer have the support they have, you know, today. They were kept in place in the '80s, and I think there'll be more support for getting rid of those and using that money in order to create broader reforms and incentives.
Senator Gregg and I made that judgment and it was something we felt was a change from the '80s to today. But those will be what the kinds of discussions will look like, when and if we can get the reform.
Let me take one other, and then you're going to have such great, great panelists. How about over there on that side? Yeah.
MS. DIXON: Hi. It's Kim Dixon at Reuters. A two-part question, it's more of a political question. You talked about strategy --
SENATOR WYDEN: Politics? I don't believe that I'm going to talk about politics.
MS. DIXON: You said you wanted to use the lame duck as the jumping off part to make it a bridge towards tax reform, and you said, "If someone wants me to fix a broken system," and I've missed the rest of it, but I assume --
SENATOR WYDEN: No, if someone in the lame duck says, "Ah, you know you've just got to sign up essentially permanently for a flawed, discredited, broken system for the indefinite future," they're going to have a lot of trouble convincing me to go along with it. If somebody wants to talk about how some approach for a shorter period of time or something of that nature -- that helps the middle class, that's sensitive to business needs, is going to be adopted as a bridge to tax reform that's a different, different story.
But I just don't want to see at a time when there is opportunity for something transformational, particularly with the president's statement Monday the president's statement Monday, folks, is a big, big deal for reformers. I can tell you, when we heard about it, there were whoops all up and down the corridor because that, in my view, was the president of the United States, a pivotal figure based on the history, opening up the opportunity for real reform. And the statement he made, actually the text of what he said, is very much in line with what Senator Gregg and I proposed.
He said, I'm interested in major corporate tax reform that is revenue-neutral. That was what the president said on Monday. Well, there is a bill that does that, S. 3018. And to get into it you have to have the discussion that I had -- probably more than you want to hear this morning -- with respect to making changes in the overseas breaks and using that money to hold down rates. So that to me is a signal that there is
real interest in the White House in significant tax reform. I think what the President did Monday and what Chairman Baucus did 10 days or so ago, are both big statements.
MS. DIXON: Just a quick follow-up. So far it's just Wyden and Gregg, and no one has come out and sort of embraced the plan formally. But what are you hearing from your colleagues behind the scenes? Is there anything to make you optimistic in terms of support that you may be getting either within your party or outside your party?
SENATOR WYDEN: We do have several other supporters. Senator Begich of Alaska's been putting, you know, a lot of, a lot of time into it. But, yes, I mean we are having a significant number of Democrats and Republicans come up to us and say that they are interested in this issue.
Now, Senator Gregg, of course, is on the Deficit Commission which will give us real opportunity there. Erskine Bowles and Alan Simpson are the respective co-chairs of the deficit commission. Both of them have been very interested in this idea and have spent a lot of time with us. The commission staff has spent a lot of time with us, and I'm very encouraged by this.
I think the opportunity to deal with a major plus for the cause of creating good-paying jobs, boosting manufacturing, helping the middle class, putting cash in middle class pockets is something that's going to attract people and politics. And it sure gets you out of some of the pettiness and the partisanship and into the kind of discussion that I think is going to leave people with a better feeling about public service.
More than anything, our doors are open to you. John and Jim are going to be sticking around. You got a great panel ahead of you, and just, just stay tuned. I think for reformers this is an exciting time, and for all those who are predicting small ball in the next Congress, tax reform is the one issue that I think can turn those predictions on its head.
Thanks for having me. (Applause)
MR. BERGIN: Thank you, Senator. You're very generous with your time, and we appreciate it. As the senator said, we do have a terrific panel, so I'm going to get to it right away.
First up is Pam Olson, and she'll address us for a few minutes.
MS. OLSON: Thank you, Chris. We were told to take seven to eight minutes, so I confess that the only reason I came was to hear Senator Wyden and my two co-panelists, Michael Graetz, so maybe I'll take less time than that.
First, I think that what Senators Wyden and Gregg have done is very important for the leadership that they've shown and being willing to tackle tax reform and being willing to tackle it on a bipartisan basis. I think that we have to put the partisanship behind us if we're going to move the country forward economically, and I really congratulate them for doing it.
I also congratulate Jim and John, who I've had the chance to spend some time with talking about the plan for their hard work on it, because it really was a herculean task to go through the tax code the way that they did to identify problems in the tax code, to identify things that needed to be fixed, and then to figure out as between competing ideas -- and I know that they had a lot of competing ideas -- which of them should make it into the plan in order to meet the goal of something that they could both agree to and that was going to be revenue-neutral.
One of the things I think is very important I think for us as a country to do as we go forward is to look not just at tax reform by itself but to look at spending at the same time. And so I think we've got to put those two sides together, and what that suggests to me is that while the revenue neutrality that they worked against is an important discipline in the process, that ultimately what we have to have is a tax system that is going to produce enough revenues to pay for what we want to spend. And right now those two things are pretty badly out of alignment in that regard.
And I think what the president has done with creating the deficit reduction commission to look at both taxes and spending is a very important thing, and I certainly hope that we'll see some more positive movement when they present their report.
And I also think, you know, that some of the work that's been done just on the Republican side, Paul Ryan's "Roadmap for America" is an important effort to look at both spending and the tax system, put the two sides together, and figure out, we make the numbers balance.
One of the things that's always interesting as we have these tax reform discussions is that we tend to focus only on the income tax system. So we look at the income taxes that we collect from individuals and the income taxes we collect from corporations, and we don't look at the rest of the revenue picture, and we actually have, you know, well over 50 percent of the country's revenues coming from other systems, particularly Social Security and Medicare, which I think contribute something around 40 percent of the revenues that the federal government takes in.
You know, we tend to look at them by themselves because they're supposedly free-standing systems. We have a Social Security trust fund, we have a Medicare trust fund, and as long as you believe those are real and you think that we really are funding benefits that we're going to be paying in the future, that's fine, it's a very progressive system. If we look at the reality of it, it's a pay-as-you-go system. The Social Security trust funds are nothing more than promises to raise taxes in the future. And then I think you ought to be thinking about whether you ought to throw Social Security in, and Medicare taxes, and some of the other items into the mix as we consider tax reform.
Also in that regard, there was an article in The Wall Street Journal op-ed, actually in The Wall Street Journal a month or two ago, written by an owner of a small business who talked about the taxes that he had to pay on his workers' salary and how much they amounted to and the effect that that had on him of trying to continue to operate, to pay reasonable salaries, and to cover all of the expenses associated with it. And that, of course, includes healthcare.
And so, you know, I think we need to sit down and take a hard look at the burdens that we're putting on employers and the impact that that might have on employment in this country. And that would suggest, as well, that perhaps we look at reforming some of the other parts of the tax system.
In terms of the specifics of the Gregg and Wyden plan, I think there are a lot of positive elements. It certainly has some similarities to the 1986 tax reform effort when we went through the Code and cleaned out a lot of the detritus, broadened the base, lowered the rates, lots of good things that they have put into the proposed bill in that regard. The, particularly the lowering of the corporate rate to 24 percent is a very positive step and one that's very important for us as a country to think about doing as we look at where we stand in terms of what our corporate rates are relative to the rates in other countries.
Savings incentives. Our savings incentives are too numerous and too complicated, and they've included some provisions to radically simplify those provisions and make them more accessible, provisions in the employee plan area that would incentivize people to keep their money in the system, rolling it from one plan to another as they change employers. That would also be positive. They've got lots of consolidations of credits, elimination of the AMT, both corporate and individual, reduce rate on dividends. Those things I think are all good things and important things.
Now, I do have some concerns about the bill, and I'll put it in the same category as what I started out on the positives. And that's similarities to 1986 tax reform. I think there were lots of problems with 1986 tax reform effort. Among those problems is that we perfected the double-tax system and drove a wedge between incorporated and unincorporated business. This would preserve that wedge, as we heard in some of the questioning that's already occurred.
One of the interesting things that is in the bill is a limitation on interest expense for corporations that's intended to minimize some of the disparity between debt and equity and make debt financing less attractive relative to equity financing. I think it's important to minimize the advantage that debt financing has over equity financing, but I don't think we can do it by an inflating index on corporate interest deductions.
There are some untouched sacred cows that I would encourage us to look at as we move forward with tax reform. The biggest one to my mind is healthcare. The healthcare reform effort, in my view, was a missed opportunity, I'm sorry to say. I think what we need to do is adopt some changes that are actually going to bring down costs, and I think you've got to do that by focusing on the consumer side. And right now with our tax expenditure, for healthcare, we have people who are virtually insensate to what health care costs them. And one of the ways of beginning to introduce some awareness of those costs and some discipline in the system I think would be to do something with that deduction for healthcare.
Housing, same thing. Obviously, the housing thing has been raised before, raised by the 2005 tax reform panel, and I think that would get a collective raspberry, but it's another thing that we ought to take a look at.
Another concern that I have about the bill is the removal of more taxpayers from the tax rolls. I'm all in favor of simplification, and I'm all in favor of not having more people have to file than is absolutely necessary, but I think that it is bad civics for us to have too many people off the tax rolls. So that concerns me.
The worldwide tax system concerns me. The shipping jobs overseas rhetoric is, I think, the reason that the blue-collar guy in the coffee shop thinks that our tax system is designed to favor people who are doing business abroad. I think that's actually not the case and that a major change to our worldwide tax system of the kind that is included in the bill could do significant damage to the United States as a country that is a good place for headquarters to be located. So I think we need to move very carefully in that area.
There is a report out in the last couple of weeks by Cambridge Energy Research Associates, Daniel Yergin and David Hobbs, on one of the provisions that's in the bill is also in the president's budget that would put restrictions on dual-capacity taxpayers' ability to claim a foreign tax credit. And I would encourage you to take a look at that study because it paints a very clear picture of what can happen with the U.S. tax system and its impact on U.S. Companies and their ability to do business abroad. I'd like to have some guys like Yergin and Hobbs do a study like that for all of corporate America as we look at our global engagement and whether our tax system fosters that global engagement or hinders it.
Finally, I just want to again congratulate Senators Wyden and Gregg for the work that they did, and, Jim and John, for your efforts in that, because it is so important to plant the seeds here. And I can't not think about some of the work that's been done in the past and some of which I see reflected in the efforts that they've undertaken, the 2005 tax reform panel report. And if you've never read a report on tax reform, you should go read that. I mean it's actually a good read. I know I'm a tax geek, but it's actually a good read.
The president's economic board that just put out a report on tax reform in the last few weeks is actually another good read, not as good as the 2005 report because it doesn't have pictures, but it's a good read as well.
Nina Olson's Taxpayer Advocate Report has done a lot of good work in the reform and simplification effort. The Office of Tax Policy has done a lot of simplification efforts. I see Jim Nunns is here this morning, helped to lead a lot of those efforts and a lot of those ideas I see floating around in some of the tax reform proposals that have gone forward.
And then also the efforts that have been undertaken over the years to study tax expenditures by the GAO, the Joint Committee, Treasury's Office of Tax Policy, also are all very important things and give us a good roadmap of the kinds of things that we need to be thinking about as we try to advance the tax reform debate.
MR. BERGIN: Thank you, Pam. Next, Bill Gale.
MR. GALE: Thank you, Chris. I want to start by congratulating Senators Wyden and Gregg on their efforts to pursue tax reform, and for all of us who know how Washington works, that means particularly thanking Jim and John, who have certainly borne the brunt of those activities.
I also want to start with a slight correction on something Senator Wyden said. He gave me credit for doing the Tax Policy Center report on the Wyden-Gregg bill, but that was actually Eric Toder and Jim Nunns. I was very proud to have read the analysis, but I did not contribute to it. That was all them.
So, let me start with a joke that has -- you've probably heard this joke, but you probably never heard it applied to tax policy before. There's an inmate in a jail and he's sitting around eating dinner, talking to fellow inmates, and he says, "you know, this food is not very good." And the other one says, "yeah, and there's not enough of it." And that's basically our tax situation. The taxes we have are not very good, and we don't have enough of them. So, we need more taxes, but we also need better taxes, and typically tax reform is talked about in a revenue-neutral manner, and we can continue to talk about that, but the thing to emphasize now is that's not enough. We need more taxes, and the reason we need more taxes has to do with the question that Nina asked and a point that Pam made, which has to do with government spending.
There's only two reasons to have taxes to begin with. One is to finance government spending, and the other is to correct an externality in the market. And so the question about where people's money goes when they pay taxes, how the government spends it -- it's a really important question, but it's not a mystery, okay? In a typical year, 70 percent of all spending -- federal spending -- goes to one of five things: defense, Social Security, Medicare, Medicaid, and net interest. And by the end of the decade, that's going to be up around 80 percent of all federal spending.
And that's important for two reasons. One, it means all the discussion about, you know, pick your favorite topic -- waste, fraud, and abuse; foreign aid; the Department of Education; the National Parks -- you could shut down -- you know, if you could find waste, fraud, and abuse, put it outside. There's other things -- you could shut them down and it wouldn't make a dent in federal spending. And so if you want to talk about federal spending, we need to talk about those big five items, and of course you really can't control net interest, aside from the others, so you're really talking about those four items: Social Security, Medicare, Medicaid, and the military. And if we're not able to cut those forms of spending for whatever reasons, we're not going to make a big dent on the spending side. We're going to have to consider increases in revenues, not just reforms in the structure of revenues.
And let me just add, these are not independent things. If the tax system has to get larger, it's even more important that it be well designed to start out with. So, if you have a poorly structured tax that's only raising 1 or 2 percent of GDP, you know, who cares? If you're trying to raise 20 percent or 25 percent of GDP, then the structure really matters. So, I'm not saying revenue-neutral tax reform isn't important. It's very important to get the structure right.
But we need to do more than that. We're going to need to raise revenue in the future, and consistent with what everyone's saying, we're going to need to raise revenue in ways that help the economy or at least do minimal damage to the economy. The last thing we want to do, as Senator Wyden said, is take a dysfunctional system and expand it and make it even larger.
So, Chris gave me eight minutes. I think, by my estimate, I've used 2 minutes, so in the next 6 minutes we're going to raise 6 percent of GDP --
MR. BERGIN: My clock is broken.
MR. GALE: Yes, that's correct. We're going to raise 6 percent of GDP in 6 minutes and we're going to do it in ways that help the economy. We're going to do it in three ways.
The first one is tax expenditures. Everything you want to do in tax reform starts with the base, all right? You want a simpler system, simplify the base. You want a fairer system, tax things -- different points of income and consumption -- at the same rate? That's a base issue. You want to raise revenues? There's an enormous amount of money in tax expenditures. You want to cut rates? Well, you got to raise revenue to finance the cutting in rates, so you need to broaden the base. And most important, if you want to reduce the distortions the taxes have in the economy, you need to clean up the tax base. The various subsidies for all sorts of things are designed specifically to shift resources into one sector, shift resources into a different sector. That's what you want to get away from if you want to reduce the distortions that the tax system creates in the economy.
So, broad-based low rate is where you need to go, and in our system when you talk about broad-based, what that means is going after tax expenditures. There are a number of ways to do this. I won't go into that. We can talk about that in Q&A if people want. But tax expenditures -- there are easily 2 percent of GDP that we could get from that that would help the performance of the economy, not hurt the performance of the economy.
All right, the second area is energy taxes. There are two economic ways of thinking about this. One is that consumption of dirty energy creates externalities. It's a classic function of government to correct externalities via Pigovian taxes. All estimates suggest that the gas tax, for example, is too low to reflect the externality that's created by gasoline consumption. But the right way to do this is a carbon tax or actually all greenhouse emissions taxes. But that might be hard to get to for political reasons. It's a whole new tax system that has to be implemented. In the meantime, though, we could raise a fair amount of money in the gasoline tax. Every dollar in gasoline tax raises almost 1 percent of GDP on a gross basis, maybe about .8 percent of GDP once you account for reductions in other taxes that excise -- you know, taxes cause those changes.
What that means is if you raise the gas tax by 25 cents a year for 10 years, you'd have 2 percent of GDP, right? Now, you think about that, that is a lot of money relative, for example, to what the corporate tax raises, and it's a much simpler and environmentally clean way to do it with good political side effects as well. So, while the perfect solution here is a carbon tax, the good solution is increasing the gas tax. If we increase the gas tax we can always then get a carbon tax someday in the future and use some of that money to reduce the gas taxes, which we just increased. But there's no reason -- there's no economic reason not to do that.
I mentioned there were two economic ends. One is the externality of carbon emission. The other is that we -- when we look at GDP, there's no measure in there for the quality of the environment -- the air we breathe, the water we drink, etc. If we thought about that, if we actually included that and took that as seriously as part of our quality of life as we do output figures, we would see that environmental taxes would have other benefits as well. So, energy taxes is area 2.
Area 3 is a consumption tax. The economic case here is simple. Once we get back to full employment, we need to save more and consume less. We need to invest more of our GDP. There are various ways to do the consumption tax, but the tried and true measure here is a value-added tax. I imagine Michael might talk about that, so I'm not going to say much more about that, except to say that there's easily 2 percent of GDP there.
All right, so that's 6 percent of GDP, and I'll sum up.
I want to close on a theme that Senator Wyden mentioned a couple of times, which was political reality. I phrase this as "let's not let the perfect be the enemy of the good."
We talk a lot about -- in the fiscal discussions, we talk about how everything has to be on the table. You know, there are some people that love the mortgage interest deduction, and we say, "sorry, that's going to be looked at, that has to be looked at." There are some people that say, "you can't touch Social Security." You say, "no, no, you got to look at that." Everything has to be on the table, because as soon as you start taking stuff off the table, the table goes away. Everything comes off the table and there's nothing left. So, everything's got to be on the table.
And sort of speaking to the tax reform community, what has to be on the table for us is giving up the pursuit of the perfect tax reform, all right? We had one major tax reform in 50 years, in the Tax Reform Act of '86. One, despite all the brain power that has been focused on this. I remember Larry Summers once said in a talk that there's no issue that he's aware of where the quality of the intellectual input is in such variance with the quality of the policy output as tax policy.
And so we need to accept that, I think, as a constraint and not let the perfect tax reform become hostage to fiscal consolidation. And the reason is: long-term systematic deficits have very large, very corrosive effects on the economy. The effect of a deficit of 6 percent of GDP going forward is going to far outweigh the beneficial effects of anybody's perfect tax reform, whether it's flat tax or Wyden-Gregg or anything else. So, we need to get to a fiscal solution, and just speaking as part of the tax reform community that used to -- we used to sort of parse these tax reform bills forever and pick them apart, and we're all very good at that, but we're going to have to give that up just as much as home owners are going to have to give up some of their mortgage interest deductions and Social Security advocates are going to have to give up some of their Social Security benefits.
So, I think this is doable. I think it's really important. I welcome this discussion. I particularly welcome a discussion on tax policy that does not focus on the question of what share of the Bush tax cuts do we extend and for how many years, because there are a lot of other issues involved.
And so I just want to thank you, Chris, and Tax Notes for having this conversation. Thanks.
MR. BERGIN: Thanks, Bill. Next up, Professor Graetz.
MR. GRAETZ: Thank you, Chris. Thank you, Tax Notes, for sponsoring this event. Of course, along with everyone else, I want to thank Senators Wyden and Gregg and Jim and John for their work. I want to thank the audience for staying around this morning.
I have set forth my main ideas on tax reform in a book. It's called A 100 Million Unnecessary Returns: A Fair, Simple, and Competitive Tax Plan for the United States. If you are a member of congressional staff or the press, I'm happy to give you a copy. If you're a corporate lawyer or lobbyist, it's available on Amazon.com. For those of you who don't know what the plan is, let me just briefly outline it. It's not all I'm going to say today, but I want to get it on the table.
And the linchpin to tax reform, at least in my view, going forward is a value-added tax, and I propose enacting a value-added tax. It's used by more than 150 countries worldwide. We are the only OECD country that does not have such a consumption tax. And I would use the revenues produced by a value-added tax to finance an income tax exemption of $100,000 and to lower rates above that substantially. An income tax exemption of $100,000 eliminates 150 million people from the income tax and eliminates 100 million returns, therefore, the title of the book.
I would also lower the corporate tax rate. I really believe that 24 percent is not low enough and that we need to go down to 15 or 20 percent for reasons I'll explain in a minute. And then I would replace the earned income tax credit and provide offsets for the regressivity of the value-added tax at the bottom through a system of payroll tax offsets and the use of debit cards which would exempt people from paying value-added tax at the cash register. All of these ideas are outlined in the book.
The proposal has lots of advantages. It would encourage savings and investment in the United States. It would stimulate economic growth. It would create additional opportunities for American workers. It would simplify the income tax dramatically by removing all of these people from the tax rolls and free 150 million Americans from ever having to deal with the IRS.
A 15 to 20 percent corporate income tax would be extremely favorable to investment in the United States by both domestic and foreign investors with only relatively high-income Americans filing tax returns. The politics of tax expenditures would change dramatically. Most of the big tax expenditures are benefits. Broaden middle class. They are not special interest provisions. And we have failed in getting rid of tax expenditures for that broad middle class, and so the solution is to get rid of the income tax for that broad middle class. This would return the income tax to its status as a relatively small tax on a relatively high-income group of Americans, a status that the income tax had, in this country, until the Second World War when we collected much of our revenue through very bad consumption taxes, namely tariffs.
And finally, and I think extremely importantly by using taxes that are worldwide use throughout the world. This system would mesh very well with international trade and tax treaties and issues, something that most of the other consumption tax proposals that had been floated in the recent years failed to do.
When I published the book, when I designed the plan, I designed it to be revenue neutral and to be distributionally neutral in general in an effort to test it against the current system. This is a long tradition, as you've seen, in the tax reform context, one that Senator Wyden and Gregg -- Senators Wyden and Gregg -- have followed. It is the case, as Bill has pointed out, that our nation's financial situation is now perilous. We are in a situation regarding our debt that we have not been in since 1950.
The Congressional Budget Office has estimated the kind of debt in which interest on the federal debt will swamp other expenditures. We've been talking for recent years about Medicare, Medicaid, and Social Security, but I urge you to look at the Congressional Budget Office's long-term projections of interest cost. Those interest payments will be made to foreigners, 50 percent. When we were last in this position, we were coming out of the Second World War. We were entering a boom economy. We had all of the money there was. Japan and Europe were shambles. Today we're in a very different world economy, and we can no longer afford a tax system that disadvantages Americans, American companies, and the American people in a worldwide global economy.
So, let me start with the corporate tax. I'm going to just mention a few things in the minutes that I have. Let me start with the corporate tax.
I think the corporate tax is extremely important. The U.S. in 1986 had the lowest corporate tax rate in the industrialized world. Today it has the highest. Japan's is a little higher, but they've announced a reduction, so we'll soon move from second to first place. We will have the highest tax rate in the industrialized world.
And the debate between people in the audience -- Pam and Senator Wyden -- about international tax issues is crucial in today's economy, and I've spent a lot of time writing and thinking about these issues. In 1986 they weren't terribly important. They are now of central importance in the U.S. tax system, and in today's global economy you cannot appropriately tax international income. You can debate a worldwide system. You can debate a territorial system. The problems are much more fundamental than that.
The basic idea of corporate residence is uncertain and mobile. They don't call them multinationals for nothing. The basic idea of a source of income is incoherent in economics. There is no such thing as a source of income, and these are the two building blocks on which our international tax system rests. We have enforcement problems relating to transfer pricing that have been struggled with for over 20 years without what anyone could describe as great success.
If you look at the question of interest deductions in the United States, which Pam mentioned, we allow interest deductions with our corporate rate at the top. Any corporation that thinks about this for three minutes wants to put its deductions here and its income abroad. It wants to borrow in the U.S. to invest abroad. We've struggled with interest allocation regs. I can't tell you how many hours when I was at the Treasury I spent on netting rules of one sort or another. We have had no success.
Under the current system, what we're doing is, we're allowing those deductions and we're subsidizing. We are in fact subsidizing investment abroad, which is funded through borrowing, and the Chinese, who are getting a 15 percent tax rate, just to take an example -- I don't mean to pick on the Chinese, but they're a good example with their 15 percent tax rate -- by not allowing the interest deduction because we've already allowed it, they're collecting 45 percent on corporate profits under certain assumptions. So, it depends on the example.
I did an eight-page article with some examples of this in the Bulletin for International Taxation for those of you who are interested in it.
You cannot solve these problems. The only way to solve these problems, in my view, is to have a low statutory corporate rate, and so I think this is crucial, and then the question becomes how low does it need to be in order to have a real solution to these issues?
On the individual side, you know, people will pay taxes at the cash register. I think they will know more about their taxes at the cash register than they know about their income tax. If you ask people at the Yale Law School what their income tax was last year, they tell you they got a refund of a thousand dollars. And so that's good.
So, you know, we can talk about citizenship. I have written elsewhere about my father, who used to take over the dining room table in our house from February 1st until April 15th in order to do his taxes. He was really engaged in a civic endeavor. Today people are sitting at their computers and engage with TurboTax or going to tax return preparers and it is simply another commercial transaction, and so I think we have to think about civics in a very different way than we have historically.
The use of tax expenditures is just awful. Let me just be clear about it. I dare anybody in two hours to teach Yale or Columbia law students how the incentives for education savings and higher education benefits work. It cannot be done. I tried in two hours to teach the new healthcare credit just a few weeks ago. That's fun. Read it. Just read the credit. Don't read the bill, just read the credit. These things are enormously complex. They don't work well, and we really have to find a way to move away from them.
I am running out of time. I want to say that the regressivity of a value-added tax can be solved. The progressivity at the top can be solved with rates on an income tax that are lower than our current rates when you have a value-added tax, because high-income people spend as well as low-income people and so forth.
There are other revenue sources that one can look at. If I were asking Senator Wyden a question about the long term, my question is do you really believe that we can rely on the income in payroll taxes that we now have and fund our government going forward over the medium and long term? This was Diane Lim Rogers's question earlier today, and he said, "We got to start somewhere," and I appreciate that answer. But it's not a solution over the medium and longer term.
There are other sources of revenue. There are two other big sources -- Bill mentioned one -- and those are taxes on energy -- carbon taxes or gasoline taxes. I participated in the negotiation of the nickel increase in the gas tax in the 1990 budget summit. I just finished a book on energy policy, looking back at the history of gas taxes in the 1970s, and subsequently I won $20. I will admit this: I did not declare it. If anybody wants to come after me, this is why I will not take high office in the United States. I couldn't get through the Senate Finance Committee's rigorous investigation of tax returns. I did not declare it, but I did win $20 from Alan Blinder when President Clinton proposed the BTU tax in 1993, and I bet him he wouldn't get more than a nickel on the gas tax and he got 4.3 cents on the gas tax.
So, Bill wants to put in $2.50 over the next years and raise 2 percent of GDP, and good luck, Bill.
You know, I do believe we ought to have a carbon tax and a gas tax. I also believe that the money from that is going to have to go back to the American public, and you're not going to actually have net revenues from it.
The other tax source that people are talking about is a securities transactions tax. This has also got a life and was on the table in the 1990 budget negotiations. Secretary of the Treasury Brady actually was quite interested in such a tax. There are lots of problems with it. I'm happy to discuss those in a question-and-answer session, but the biggest problem is that it needs to be implemented essentially worldwide in order to work. I don't think you can impose a tax on securities transactions in the United States alone and expect it to work.
Let me just close by saying that, you know, I understand the political problems of the plan that I have offered. On the other hand, I do think that it has a lot in it for the average American. I think it has a lot in it for the American economy. As I said, it would give us the lowest -- among the lowest corporate tax rates in the world. It would give us an income tax that the American public could live with, and I think that we're going to have to do something far more dramatic in the years ahead than simply a reprise of the 1986 tax reform, as difficult and as important as that was and as difficult and important as the work that Senators Gregg and Wyden are now engaged in.
MR. BERGIN: Thank you, Michael. I'm going to stand here for two reasons: so I can see people, we're going to go to a question-and-answer period now, and so I can help the shy part of the room here ask questions because we can see each other now. I want to start off with one of my own for the panel. Anybody can take this if they want. When Bill was talking, I agree with him about a gas tax, and personally, as a citizen, I'm willing to pay one. But I kept adding it up, and it came to $2.50 in ten years and, I don't know, there could be a revolution over that one. My question for the panel is, and not to bring up the Bush tax cuts, I apologize for that but I'm going somewhere, if they are not extended, all of them, does that help or hurt the effort for tax reform with the average citizen?
MR. GRAETZ: Well, I'm prepared to take a cut at it. I think it helps in the sense that is to not extend them. I think that -- I guess what I would say is, I think they need to be extended for a year. They may need to be extended for political reasons for two years. But I don't think they should be extended permanently. I think they create a false sense among the American people about the level of taxation that the country can have and produce adequate revenues. And I think that it's time to level with the American public and one way to do that is to extend these for a couple of years and say: You know, we've got a serious fiscal problem. I agree with Bill and Pam, you've got to talk about spending as well as taxes. And I don't mean to suggest we should only talk about taxes, we need to think about how -- what we're going to spend and how much, but we also need to have a base of revenue that's adequate going forward. And so I would only be interested myself in a temporary extension.
MR. BERGIN: You guys? OK. I've taken my -- please remember to just tell us who you are because we're recording this.
MR. ENTIN: I'm Steve Entin with the Institute for Research and Economic Taxation. We ran the bill through a service price and tax calculator. The service price goes up under this bill. We have a good cut in the corporate tax rate but we have longer asset lives, and the expensing, and we have higher tax rates on capital gains and dividends. The service price does not go up as much as it would if the upper end of the Bush cuts expire. But it goes up more than the proposal's offer by President Obama with the 50 percent expensing and the 20 percent caps on dividends and capital gains, let alone its 100 percent expensing provision. When service price goes up, investment wages and jobs go down; when service prices go down, you get the growth effects you'd like to see. To turn the bill into a pro-growth bill you'd have to keep the current depreciation and expensing. Or if we go to longer asset lives, we'd have to start paying interest on the deferred portions. On the capital gains and dividend side we'd need a 50 percent exclusion, not 35. If not, this bill is going to cost jobs not create them. I don't know, Pam, if the Treasury routinely does service price calculations. I don't think they have since the '86 Act. I remember being at Treasury then and asking them to do that and it turned out economic policy had to do it, tax policy was too busy trying to write the bill. But it didn't happen and service prices went up in '86 and investments stalled out for three years. I don't want to see that again. The VAT -- I heard comments from Bill that the VAT will increase saving. VATs increase in saving only if they replace taxes that are worse on saving. If you add a VAT to the current system people have less incentive to work and save more or less equally, whereas in the higher income tax people have less incentive to work and a lot less incentive to save. But as an add-on tax it doesn't increase savings and growth. Comments?
MR. BERGIN: Anybody?
MR. GALE. Yeah, I think the first thing -- when you say the service price I think you mean what is usually referred to as a user cost capital? Yeah, I think it's correct to say that the user cost would go up under the Wyden-Gregg bill. I've done some very rough calculations; I think some other people have done calculations as well that are consistent with that. On the VAT and the saving issue, there's two aspects to saving, there's private and public. The revenue increase, of course, would raise public saving and enhance national saving through that channel. And if the -- remember there's two ways to increase savings: You can actually think of it as people encouraging putting more in their account, or you can think of it as people spending less. And if people -- consumption goes down saving is going up. So, in that regard I think there would be an increase in national saving. I don't think that's controversial.
MR. BERGIN: Okay, who is next? There we go.
MS. BLANCHARD: I'm Kim Blanchard, I'm a private practitioner. I had a question, or actually an observation and a question, about the energy tax that a couple of you spoke about. I'm obviously in favor of a carbon tax for a lot of reasons, and I'm also sensitive to the fact that it's a long shot to get it to raise as much money as Mr. Gale would like, but it occurred to me that there might be -- we might be underestimating the amount of money we could raise from it. And I don't know whether somebody's tried to quantify what I would call the double-dip effect, and that is, if I understand it correctly, today we under-tax traditional sources of energy and we provide subsidies, direct and indirect, for alternative forms of energy in the tax code and outside the tax code. And the reason we provide subsidies for alternative forms of energy is that the markets are not efficient in terms of bringing those to market. I have some personal experience with this and I can tell you that it's true. If you raised the tax on traditional energy consumption high enough, it strikes me that the markets would compensate by bringing alternative and less dangerous forms of energy to the forefront. There's a lot of technology being developed out there but it's just not currently marketable at the low prices of energy that we enjoy today. So I guess it's a long way of asking a question whether anybody has really fully priced the double-dip benefit of raising a tax on energy and not having to subsidize alternative research into more eco-friendly technology.
MR. GRAETZ: You know, you're absolutely right in the fundamental analysis, that is one of the reasons as I say, I've just spent a lot of time writing this book on energy policy going back into the '70s, and in particular into the Carter administration's efforts to promote alternative forms of energy. And I was amused when I read the paper on the plane down here to see that the solar panels are now back on the roof today, having been put on the roof of the White House by Jimmy Carter in 1977 and then removed by Ronald Reagan when he became president, who regarded them as something of a joke. But in any event, there clearly has been a 30-year period in which there's been some effort in terms of U.S. policy to try and substitute alternative fuels and the history of both the tax side and the subsidy side, and particularly the tax subsidy side, which includes things like ethanol and black liquor and other wonderful stories, is not one that would give you great confidence in our ability to make sensible policy. But the point that you make which is that increasing the price of fossil fuels to reflect their cost, their real costs in terms of pollution and greenhouse gases in particular, would make alternatives, non-fossil fuels, much more viable in the marketplace and would reduce, if not eliminate the need, for large subsidies if the price differential were adequate enough. And we have -- one of the big failures of energy policy is that we have never asked fossil fuels to bear their price. We've done everything we could to keep the price low, and it's a complicated problem because energy is so important to the U.S. economy and cheap energy in particular has been important to the health of the U.S. economy. But the basic point you make is sound, and that is that increasing the price would have what you describe as a double benefit. And I think that's understood analytically by a lot of people who've looked at these issues but may be under-appreciated by the leadership, and the Congress, and by the American people.
MR. GALE: Let me just --
MR. BERGIN: Go ahead, Bill.
MR. GALE: I agree with everything Michael just said. One of the proposals out there is not just to put on a carbon tax or a gas tax, but to establish a lower level for the price of gasoline or carbon precisely so that even if the marketplace -- market price -- fluctuates there's a guaranteed continual incentive for alternative energy sources. And so instead of having -- just slapping a tax on carbon or gas the proposal would be, you know, the price of gasoline won't -- inclusive of the tax -- won't fall lower than $3 a gallon. So if the market price goes up, the tax goes down and vice versa. And so I sort of accept -- I think that all those comments Michael's answering and your questions are right on point. Let me just add too, I fully accept the notion that in a current environment thinking about moving to a $2.50 gasoline tax is not a likely outcome. But if you think about it, there is no feasible solution right now that is politically realistic. And so that doesn't mean we won't get to a solution, it just means when we do it will be something that's currently considered to be impossible. And you know from Alice in Wonderland that impossible things can happen. And so if we're going to solve this, an impossible thing has to happen. So when people tell me you can't raise the gas tax by $2.50 and you raise 2 percent of GDP that way, I think my response is, "Okay, fine, tell me a different way to raise 2 percent of GDP." And I think when we get to the debate to -- "here is my plan to close the gap and here's your plan and let's discuss the relative merits and demerits of that," then we're having a real discussion. But if it's just, "You can't touch the gas tax, you can't touch the mortgage deduction, you can't touch Social Security, then we're not really talking about anything. So if anybody has other ideas for ways to raise this revenue let's hear them or ways to cut spending. You know, let's get them on the table.
MR. BERGIN: Yeah, I agree. That leads me to another question I had. When I was listening to the senator talk about the '86 Tax Reform Act, it was very nostalgic for me, you know, Rostenkowski and Gephardt and Ronald Reagan. Can we expect anything more than something like a reprise of the '86 Act, just cleaning out the closet again? Can we expect something bolder? I would ask the three of you.
MS. OLSON: Well, I think we have to have something bolder because I don't think we can find enough revenues through the income tax space to cover what we're spending. And so I think we have to be looking at something different and we'll eventually have to move in that direction.
I just want to go back to the tax expenditure point once again. You know, this is something that we spent a lot of time looking at when I was at the Treasury Department. And lots of people have spent lots of time looking at it. And, you know, the problem with all of this stuff, which we try to do through the tax Code is that we turn the Internal Revenue Service into the administrator of all sorts of policies that it is simply incapable of administering. And for no other reason than that we ought to stop doing that. But we also have through this system a bunch of things that are completely uncapped, so we have absolutely no control on what we spend on various things when we do it through the tax Code.
MR. BERGIN: Yeah, I agree. And now it's going to be healthcare, right, Nina? Eric? But tell us who you are anyway even though we know you.
MR. TODER: I have a different question, also, admittedly, a bit political, for Michael Graetz.
You mentioned that 150 countries in the world have a value-added tax, but what you didn't say is if you look across these countries -- and GAO did some studies of representative countries -- maybe roughly 50 percent of consumption is, when you take into account special rates and exemption, is actually taxed under these systems. So I guess my question is if you do rely on the VAT as the main way of taxing the middle class instead of an income tax, why would you think that the Congress of the United States would be less inclined to have a VAT full of holes than it currently is to having an income tax that's full of holes?
MR. GRAETZ: Well, this is a good and important question, but let me say something about your observation, which is correct, that consumption taxes -- if you look around the world -- have far narrower bases than one would expect. A lot of that is historical. That is, if you look at European consumption taxes, which have been around since the early '70s, in particular, you find that largely to be true.
On the other hand, if you look carefully -- and I've been doing this lately in an effort to get a handle on the question you just asked -- if you look carefully at what we would describe as the modern value-added taxes, which would be countries like Australia, Canada, Singapore, South Africa, Malaysia, a handful of those -- New Zealand, I think being the best if you're looking for the most improved value added. I think Bert and Ernie used to have prizes and one of the prizes was always Most Improved. And New Zealand would be most improved value-added tax. Those bases are actually quite broad. New Zealand's is, in fact, 100 percent, basically 100 percent of consumption when you look at it.
You know, again, I come back, I don't think that the incentives on the Congress, and by which I mean political incentives to the broad American public from creating a whole series of exemptions for things like food and the like, you know, where you have to ask whether food is consumed on premises or off premises, or whether the Easter bunny -- the chocolate Easter bunny -- is food or a toy. Those kinds of exemptions make no sense. They were originally put in largely, as our state sales tax basis demonstrate, for distributional reasons, to solve regressivity issues. They're very bad at that, as you know well. And, therefore, there are other methods of dealing with the distributional problems without advantageous treatment of particular forms of this consumption or that consumption.
And so I think it's very important to at least begin from a slate which has a value-added tax that lives up to the best of the world's standards. If Congress wants to move away from that, obviously Congress will, but they're not particularly good reasons for moving away from it and the way that they were historically thought to be the necessity of moving away from it for broad distributional reasons or other reasons. Now, if you're talking about, you know, favoring a constituent here or there or something like that, then, of course, there may be those problems. But they don't have the kind of political payoffs, I think, that individual tax expenditures which, you know, show up on your tax return and I claim this deduction or that credit, would have. And so I'm actually optimistic.
I guess part of it is that I want to take Bill's point seriously and that is, you know, impossible things will have to happen. And I don't think that a broad base and a value-added tax is nearly as impossible as many of the other ideas that have been suggested.
MR. BERGIN: Okay. So here's to impossible things.
Oh, we've got one over here? Okay.
MR. MORRIS: Thank you. My name's Marty Morris. I represent the Federation of Tax Administrators.
The consumption tax area has traditionally been limited to the states and local governments. When you talk about imposing a broad-based VAT that will have an impact on their tax receipts by raising the cost of consumption, it will also have an implication for the regressivity of the broad spectrum of taxes that would include property taxes and all the rest. When you deal with this to solve a federal problem how do you address the impact on the state budgets and the overall regressivity of the entire spectrum of taxes, from the federal level down to the local level?
MR. GALE: Okay. So the traditional story is that the states would rise up in arms if the federal government had a value-added tax. And they may well do that, but I would argue that it's not a well-advised move on their part for several reasons.
One is, as Michael mentioned or hinted at, the states' sales taxes were very poorly designed. They exempt all sorts of stuff. They tax all sorts of business transactions that they shouldn't. Something like 40 percent of revenues from state sales tax comes from business purchases. The right number there should be zero. And, of course, they can't get at Internet sales.
A federal value-added tax would give them the opportunity to piggyback their state value-added taxes, that is convert their state sales tax to a state value-added tax, in the same way they piggyback on the federal income tax. And so the federal government would essentially do all the information collecting for them and they could charge their surtax or however they wanted to do it. You could capture Internet sales in a federal value-added tax because, you know, it's all in the country. And it would give the states a historic opportunity to reform these incredibly poorly thought-out sales taxes.
So they may not -- I mean, I know there's like huge sound and fury about this, but if I were thinking about the states and trying to look with a really sort of nonjudgmental eye about what would be best for them, I think they should welcome this.
MR. GRAETZ: Can I just add a few things to what Bill just said? (inaudible) one thing is that one should look to the Canadian experience here, where retail sales taxes and value-added taxes at the federal level -- retail sales taxes at the provincial level and federal value-added taxes have lived together quite well. And over time, the states have done -- the provinces have done exactly what Bill suggests, which is to conform and harmonize to the federal tax. And so I think that's very encouraging and it's a real-world example of this point.
The other thing to be said here is: remember Medicaid. That is, that when you talk about what is producing this gap between federal revenues and spending, Medicaid and Medicare health expenditures are playing a very big role. And the states might well be better off with the federal government finding a funding source for its share of Medicaid payments than essentially pushing more and more of those payments onto the states, which is another alternative, which is why Bill's point is so important about thinking about the spending side as well as the tax side.
It's also worth saying that if one is worried about regressivity, one needs to think about the progressivity of the expenditures that may well be cut, including, importantly, Medicaid, but also Medicare and Social Security. So that when one thinks about the distributional problems of a value-added tax, let us not forget Franklin Roosevelt's wisdom which was to impose a flat-rate payroll tax on the first dollar of wages to fund a Social Security system which is progressive in its distribution of benefits. And so I think that both of those pieces have to be kept in mind.
MR. GALE: Just to add, Marty Sullivan -- this is (inaudible) tax event -- Marty Sullivan has a very nice piece in Tax Notes from sometime in the spring on the Canadian VAT.
MR. BERGIN: It is an excellent piece. Well, to pick up on one of the themes that the panel has come up with, if we believe in anything at Tax Analysts, it is the impossible. We've reached the end of our time. Thank you all for coming and staying and listening. Thanks to Senator Wyden and thanks to this magnificent panel.
(Whereupon, at 11:00 a.m., the PROCEEDINGS were adjourned.)
* * * * *