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TAX REFORM:

CAN OR SHOULD YOU HAVE TAX REFORM WITHOUT INCREASING TAXES?

TAX ANALYSTS
Washington, D.C.

Friday, October 7, 2005
PANELISTS:

CHRISTOPHER BERGIN, Moderator
Tax Analysts

BILL GALE
Brookings Institution

IRIS LAV
Center on Budget and Policy Priorities

DANIEL MITCHELL
Heritage Foundation

BILL NISKANEN
Cato Institute

DAVID WALKER
United States Government Accountability Office

OTHER SPEAKERS:

DON ALEXANDER
Akin Gump Strauss Hauer & Feld

ROBERT L. BIXBY
Concord Calition

HOWARD GLECKMAN
Business Week

JOHN IRONS
Center for American Progress

MAYA MacGUINEAS
New America Foundation

JOE MINARIK
Committee for Economic Development

VAN OOMS
Committee for Economic Development
* * * * *
PROCEEDINGS
(9:05 a.m.)

MR. BERGIN: Good morning, everybody. I'm Christopher Bergin, the president of Tax Analysts, which is the nonprofit publisher of Tax Notes magazine, Tax Notes Today, State Tax Notes, Tax Notes International, and many other print and online publications. Welcome to the fifth in Tax Analysts' series of roundtable discussions on tax reform and thank you for coming on this rainy day.

When President Bush said he would make tax reform a high priority in his second term, and then when he appointed a panel to study the issue, we at Tax Analysts decided that we could provide an important public service by highlighting the key issues that any serious reform effort would have to address. We decided to bring these issues to life through a series of roundtable discussions with people like you, leaders in the tax policy community, and may I say at this point that it seems tax reform is headed to replace Social Security on the front burner at least now.

In our first roundtable in April we had a stimulating discussion on the question of what lessons we can learn from the Tax Reform Act of 1986. In our second discussion in June we asked what role can tax reform play in promoting economic growth. That question too prompted a stimulating discussion. At our third roundtable in July we asked what role should simplicity play in tax reform. Once again we had a lively debate. In our fourth discussion last month we asked what's fair when it comes to paying taxes. Not surprisingly, we had a diversity of views on that one, as well.

Today we ask perhaps the most controversial question that we have yet dealt with: Can or should we have tax reform without increasing taxes? Based on my conversations with today's speakers and simply from looking at the folks gathered around in this room, I expect that we'll hear some difference of opinion and that's good because that's what these discussions are, a forum.

For those of you who are new to our process here's how it works. I will open things up with some brief remarks to introduce our subject. I will then introduce our distinguished panel of four speakers. Each of them will address aspects of our topic for no more than 10 minutes. After that we will open up the discussion and you are all encouraged to participate. Whether you are sitting around the table or anywhere else in the room just wave and I will find you.

We're recording this event and we'll post the transcript to our website as we did with our previous roundtable discussions. Also 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 have handheld mics that we will quickly get to you. I will moderate the discussion and we will end at 11:00 so let's get started.

Some might wonder why in a series about tax reform we are even asking the question we are asking today. Up until now we have been exploring issues that really center on reform. What is tax reform? Is it politically possible? Can it promote economic growth and if so how? Who should pay taxes and how much should they pay? But as we've explored these issues we've often seen our discussions turn to basic questions that relate to tax reform, questions like what's the proper role of government, how big should it be, what should it do, and how should we pay for the government we want to have.

I did not raise those questions. They were raised instead by some people whom I see sitting in the room today and by others who participated in our previous discussions. But they make perfect sense because the number one job of a tax system, and some could rightfully argue the only job of a tax system, is to fund the government.

And lurking alongside those basic questions about government is the 800-pound gorilla of fiscal policy in the room, the budget deficit. Now, you could argue for reducing the deficit and argue for balancing the budget without arguing for higher taxes. You can argue, and perhaps we will hear that argument today, that we should address our fiscal problems on the spending side, that we should restructure government enough, reduce its size and scope enough, to bring spending in line with revenues but increasing taxes will hurt, perhaps seriously, on economic growth. Nothing wrong with that argument.

You can also argue that opposite and I suspect we'll hear some of that today as well. Entitlements are growing too quickly and will grow even faster with the coming retirement of the baby boom generation. We are fighting a long-term war and addressing the not- so-short-term effects of two devastating hurricanes. To address record budget deficits solely on the spending side is impossible. It seems to me that is a fair position as well.

What I don't think you can do, however, is argue that we can have it all, not pay for it, and still balance the budget. I don't know any realistic scenario under which we create enough economic growth and spur enough revenues to fund the federal government and balance the budget solely that way. But I'm willing to be proven wrong on that point because the first thing I would do if I found that out was try it at home.

What does all this have to do with tax reform? Lots, actually. After all, tax reform is no small matter. Reforming the current system will take a huge effort. Replacing it in, say, a large shift away from income to a total consumption base will take an even larger effort. So the question is should we make such an effort to overhaul our tax code and in the process not address the fiscal problems we have. Should we not in a debate about basic tax reform ask fundamental questions about what government should do and how we should pay for it?

It seems to me that we need to at least acknowledge the 800- pound gorilla that's been in the room at each one of our roundtable discussions, the deficit, so I'm excited about the wonderful panel of speakers we've assembled. I look forward to their comments and to the discussion we will have for the next two hours.

Let me introduce our speakers who are seated around the table in the order they will speak. Bill Gale is a senior fellow at the Brookings Institution. Bill Niskanen is the chairman of the CATO Institute. Iris Lav is a deputy director at the Center on Budget and Policy Priorities. Dan Mitchell is a senior fellow at the Heritage Foundation. So let me get out of the way and turn to Bill Gale. Bill.

MR. GALE: Thanks, it's a pleasure to be here. I think this is a great discussion to have. Chris mentioned the 800-pound gorilla and that reminded me of something that I wrote recently in Tax Notes, actually, where I was talking about the deficit as the elephant in the room and then I decided to change it to the 800-pound gorilla in the room but I ended up changing it to the 800-pound elephant, which is some baby elephant.

Anyway so we have to be careful of how we mix our metaphors here. I want to mention five points to start this discussion. The first is what does revenue neutral mean, in particular revenue neutral relative to what. The president has instructed the tax reform panel to be revenue neutral not with respect to current law but rather with respect to the president's baseline. That baseline incorporates making the tax cuts permanent which is a major, major policy in itself.

It's 2 percent of GDP in revenues, it would burn a fiscal hole three times as big as the Social Security shortfall, and if you think that the major medium-term fiscal issue facing the country is whether to make the tax cuts permanent this puts that under the rug and assumes it will happen and starts from that revenue level but, being a risk taker, I'm going to venture back in the world of metaphors in saying that that's like closing the barn door after the horses have already left.

So we need to be careful what we're talking about as the baseline when we talk about whether we're revenue neutral or revenue increasing. Current law would generate revenues that are about 10 percent higher than the administration's baseline.

So we should maybe even forget words like revenue neutral or revenue increasing or revenue reducing and think in terms of explicit revenue numbers. And one of the things that would be interesting to come out of this is what each person here thinks the long-term revenue as a share of the economy ought to be. That would be a much more interesting issue than whether we think it should be revenue increasing or revenue reducing.

The second point is that the notion that we need to raise revenues, which is a notion that I favor, makes tax reform more important, not less important, and by tax reform I mean structural changes to the tax system, the base, the rates, the deductions, et cetera. And so saying we need to raise revenues not only is not downplaying the importance of reform. It's adding another reason why we should focus on reform issues.

If you have a big tax system that needs to raise a lot of money it's even more essential that it be efficient and equitable and simple than if it's a tiny tax system. A tiny tax system that's a mess, well, who cares. It's not really raising that much money anyway. We don't need the money. If we don't need the money that's not really a big issue but if you need to raise a lot of money it's really important that you do it in a simple, equitable, and efficient manner.

The third comment, and probably the bulk of my time will be spent on this, is a link between taxes and spending, revenue and spending. It's a simple fact that we're either going to have to change the rules so that we raise more money or that we cut spending or both. David Walker is here so I will let him give you all the gory details but what it means essentially is that if we don't cut spending we don't have an option. We will have to raise revenues.

Someone inevitably at this point mentions Stein's Law, which at the risk of misstating is essentially if something's unsustainable it will stop. And I got to mention I think Herb Stein was a genius but this law gets misused so often that I just have to mention it here. If you're driving a car off the edge of a cliff at 60 miles an hour that's an unsustainable situation and it will stop but you will die in the process. And if you think about the fiscal situation what has to happen to stop the unsustainable budget trends is we either have to raise revenues or cut spending.

So blithe appeals to Stein's Law here doesn't get us out of the situation. It just emphasizes the fact that we have to cut spending or raise taxes. So I would actually change around the title of this discussion. Chris said basically should we consider revenue raising as part of tax reform. I would change it around to say, given the inevitable discussion of revenue raising, should tax reform also be part of that discussion and I think the answer is yes but realize the primal issue here is our government's out of balance and we have to either adjust revenues or spending to make that meet.

I'll make one other comment here on the revenue and spending levels and that is we often hear the starve the beast theory that if you cut taxes spending will follow. I think Bill Niskanen might talk about that a little bit. I'm just going to say that has not worked the last 25 years. It certainly has not worked the last four years. On top of that right now we have what is another 800-pound gorilla in the room which is the no new taxes pledge which 80 percent of the Republicans in Congress have signed, the president has signed.

What's astonishing is that more than 80 percent of the sitting members of Congress who signed the no new taxes pledge also voted for the Medicare bill in 2003. About the same share voted for the highway bill last year and I haven't done the calculation yet for the transportation bill that passed earlier this year but I'm guessing it's about the same.

This is a group that will not raise taxes. They've cut taxes enormously supposedly in order to create deficits that then put pressure on spending. Then they turn around and raise spending enormously. If this group is not qualified to do it, and this is whose rhetoric is smaller government, then we really have to be wary of the notion that we're just going to cut spending.

If we were just going to cut spending I would guess we would have already done it in the face of massive deficits and Republican control of the White House and the Congress. In fact if you look back in history in the last 20 years the budget deals that have worked are those that raise taxes and cut spending. That is a shared sacrifice. And that's also why I think no new taxes does not lead to a starve the beast strategy to what I call a coordinated fiscal discipline view, which is that you can't have fiscal discipline on one side of the budget and not on the other side. So if congressmen are giving away goodies every day and if they're giving them away on the tax side they're going to be under a lot of pressure to give them away on the spending side too.

In contrast when we had budget rules that capped discretionary spending and made entitlement and tax changes have to be self- financing a congressman could say to any lobbyist that came in, "I think you have a wonderful idea; I just need to know how to pay for it." And that actually worked to restrict tax cuts and spending increases but in a party whose ideology is just that we're not going to raise taxes and the budget rules should only apply on the spending side there's no evidence that that has ever worked or in particular that it works now.

So if we don't cut spending we're going to have to raise taxes is the bottom line here so it's important to have this discussion. Let me add there's also a link between the structure of spending and the structure of taxes. I've so far been talking about the level of spending and the level of taxes. My colleague, Len Burman, co- director of the Tax Policy Center at the Urban Institute, had what I thought was part tongue-in-cheek but part a fabulous idea which is let's let the people that hate taxes design the tax system and let's let the people that actually think government spending is useful design the spending system and let's as a population say okay, it's going to X percent of GDP on both of those so we have budget balance and then we can adjust the structure according to the way the two groups might want it.

I think that would be very helpful because right now we're running all the social policy through the tax code which makes tax reform very difficult to do but I don't think you could run that same social policy through the spending side of the budget right now for political reasons. So the point is just that paralysis on the spending side also generates paralysis on the tax side and we may need to think about spending reform as part of some grand deal to make tax reform work.

The last link between taxes and spending I want to point out is that if you look at survey evidence that asks the population do you want lower taxes, well, guess what, they say yes, 80 percent say yes. If you ask the same people do you want lower taxes if it means cuts in Medicare, Medicaid, Social Security, education, environment protection, inner city development, et cetera, they say no, they don't want lower taxes in exchange for cuts in those things. They want to keep those things.

So when the issue is framed as a "here's the taxes and here's what they pay for" question people generally support existing levels of government spending. And that fact combined with the fact that most government spending is in Social Security, Medicare, Medicaid, defense, and net interest means it's going to be extremely difficult to cut spending. So we need to think seriously about raising revenues.

Last two points. One is, raising taxes coupled with tax reform could be a good thing for the long-term performance of the economy. The thing about tax cuts is having two effects, lower marginal tax rates having two effects. They provide incentives to work, save, invest, blah, blah, blah, but they also increase the budget deficit. The budget deficit is a drag on economic growth, it contributes to low national saving, it contributes to the current account deficits we have and we're facing, et cetera.

Imagine a base-broadening, rate-reducing tax change that also raised revenues, and I'll come back to that in a second, but if you did that you would have the positive direct effects of the tax cuts on people's behavior and you would have positive effects of the tax cuts on the deficit; that is, it would reduce the deficit, raise the surplus, which would increase national saving, and push us in the right direction.

The flipside of this is that every study that has been done, including one by Alan Auerbach, by analysts at the CBO, and other places including my own, I'll mention, shows that if the Bush tax cuts are made permanent and financed by deficits over the median term they will reduce the long-term performance of the economy. And that's important to note because we hear so often that tax cuts generate growth. We have to remember, the corrosive effects of the tax cuts on the budget deficit reduce economic growth and counter the otherwise favorable effects. So a base-broadening, rate-reducing tax that also raised revenue could contribute positively to economic growth.

Last point, how do we do this? How do we raise revenue? There are two obvious ways. One is to clean out deductions in the individual income tax and the other is to impose a supplemental VAT and I'm sure we'll talk about this more so I'll just stop there. Let me just mention, linking the spending and tax side again, we might want to consider a VAT that is explicitly earmarked to healthcare spending in a way to try to impose some rationality on both sides of that debate. Thank you.

MR. BERGIN: Thanks, Bill.

Bill Niskanen.

MR. NISKANEN: Sure. Good morning, friends. Should raising revenue be part of the current tax reform debate? And my answer is no for the following reasons.

One, the criteria for raising tax revenue are almost entirely different from the criteria for tax reform. Specifically, there is no reason for either households or the federal government to raise revenue when spending is temporarily high, revenues are temporarily low, or when current spending generates substantial future benefits. The primary criterion for tax reform in contrast is to reduce the deadweight loss from a given level of tax revenues. Addressing these two topics in the same forum at the same time is likely to confuse both issues.

Second, current conditions do not call for a tax increase. Current federal spending is 20.4 percent of GDP, only slightly above the 19.9 percent long-term average, primarily due to the Iraq war. Near-term federal spending will increase to finance the relief and recoveries from Hurricanes Katrina and Rita but both of these conditions are temporary. My guess is that the total federal spending for Iraq and the hurricanes will be around 1 percent of GDP and that spending for each of these two activities will almost surely decline by the end of next year.

It is especially inappropriate to increase taxes in response to an adverse supply shock because the tax increase would delay the recovery from the shock. Current federal revenues are 18.1 percent of GDP. That's only slightly below the 18.3 percent long-term average, and revenues have increased recently at a quite rapid rate.

Third point, tax reform should be addressed first separately from the issue of total revenues and thus on a revenue neutral basis. The case for increasing federal revenues should be addressed later as part of the evaluation of programs that threaten a substantial increase in federal spending.

Iraq and Katrina are not long-term fiscal threats. One of the few benefits of the war in Iraq is that the US government is less likely to do something as outrageous again soon. The major pending threats to a roughly stable federal spending share of GDP are Social Security, Medicare, and Medicaid, the consequences of the projected increase in the ratio of retirees to workers, the increasing demand for medical care, and the relative inflation of medical care. Only in this context is there any prospect for making an intelligent choice between increasing taxes and changing the structure of these programs to reduce expected future spending.

Fourth, back to square one. In my opening remarks I stated that the criteria for raising tax revenue are almost entirely different from the criteria for tax reform. There are a few secondary relations between increasing tax revenues and tax reform, however, that should be recognized and addressed. The case for tax reform should be based upon a static revenue neutral basis, a static revenue neutral basis, rather than using someone's favorite dynamic scoring model.

First, this will reduce a lot of unnecessary controversy. Second, it would slightly increase tax revenue over time initially from base-broadening and later from the output effects of lower marginal tax rates, an outcome that was characteristic of the responses to the 1986 reform.

Since some slight increase in the revenue share of GDP is probably necessary to stabilize the spending share over the several years I have done a number of different tests of the starve-the-beast hypothesis and at least in a sample since 1981 there has been a significant negative relation between the first difference in the spending share and the current revenue share, a finding strongly inconsistent with the starve-the-beast hypothesis.

My own estimate is that an 18.9 percent revenue share is probably necessary to avoid a progressive increase in the spending share. That compares with a current revenue share of 18.1. These two conclusions will probably lead to my permanent exclusion from the supply-siders club and so be it.

Third, any broad-based tax reform should be paired with a supermajority rule on future rate increases because such a tax reform reduces the marginal costs to the economy of increasing taxes. The 1986 tax reform, for example, was followed by small rate increases early in the administrations of both George H. W. Bush and Bill Clinton. A supermajority rule, of course, would change both the level and the composition of government spending. My own estimates are that a 60 percent voting rule on fiscal issues, for example, would lead to an increase in spending for domestic government services and a larger reduction in transfer spending and a substantial increase in total output and average net income. This is more than enough to provoke an interesting discussion and my thanks for you attention.

MR. BERGIN: Thank you, Bill.

Iris.

MS. LAV: Thank you. So I would say that I think we're agreeing that federal revenue ultimately needs to increase although potentially not on the magnitude and the question is should this tax reform be the catalyst and for that a couple of things.

I think that when we see these GAO graphs and what we all know around this table is that by 2022 under current policies, making the tax cuts permanent, all the revenue we have will only cover defense, Social Security, Medicare, Medicaid, and interest on the debt. I think Bill mentioned that. So there wouldn't be room for anything else. So we do have a big problem, and the problem is coming not way out in the future but like, 15 years from now and that it's been 20 years since we managed to do a tax reform in this country so this may be indeed an opportunity but I do agree that we cannot solve this problem of this magnitude only on the revenue side or only on the expenditure side. I think we do need the kind of balanced deal that Bill Gale mentioned.

But today my primary topic is going to be the interaction of federal tax reform and state tax policy. Chris, when you said a lot of people think the purpose of revenue is to fund government, which is what I think, they often mean to fund federal government and forget the fact that the way we provide government in this country is to have the federal government very often give money to states and localities which they very often have to match or have to administer or have their own funds in order to accept and that's how we make government. And so it's important to think of all three levels of government when we even decide if something is revenue neutral or revenue raising because something that is revenue neutral at the federal level could be very substantially revenue losing at the state level.

So I want to talk about two different kinds of points. One is an expenditure point and is a tax structure point. The expenditure point is that if we don't raise revenues, if we allow these deficits to continue under the current path, it inevitably means passing down part of that deficit to states and localities. So if you look at, for example, domestic discretionary spending, which is often discussed, well, we'll just take a 2 percent cut for that or a 5 percent cut and we'll fund the hurricane, about a third of that kind of spending is grants and aid and state and local governments so when that gets cut you squeeze states and localities.

States get about 27 percent of their revenue from the federal government. If you look at state and local governments together it's close to a fifth of their revenue comes from the federal government. So we have that issue. And, of course, we have the Medicaid issue, which is a tug of war between the federal government and the states as to who's going to pay for what and all the costs are going up.

But less well understood than maybe the expenditure part of this are the connections between the state and federal tax systems and what happens when you change federal taxes. Most states use federal definitions of income and most of them also adopt federal definitions of exclusions and deductions so the basic structure of most states' personal and corporate income tax closely mirrors the federal. When you change federal taxes in certain ways the changes flow down to change state taxes but sometimes with unusual results. So, as I said, a change that's revenue neutral or even revenue raising at the federal level could be revenue losing at the state level.

Let's take one example. Let's say there was a desire to eliminate taxes on interest dividends and capital gains and you paid for it in maybe three ways. You slightly raise the rate on high- income people because those incomes were not going to be included, you retained what we call Pease and PEP, the recapture of some deductions for high-income people, and you eliminated the deductibility of state and local taxes against federal taxes. That's not an implausible scenario among all things that are floating around.

Well, what happens to the states? The states follow federal definitions of income so they lose a lot of money when you no longer tax capital gains and interest and dividends. Changing rates does not affect states. They don't get that increase. They have their own rates. They don't follow Pease and PEP, so they don't get that increase and they don't allow a deduction for their own taxes. So none of the revenue raising would flow through the states, only the revenue losing part would, and in fact if we want to talk about it later it could be worse than that because of the impact of losing the deductibility of state and local taxes on people's interest in paying state and local taxes.

So I would make a radical proposition which is that when we're looking at federal tax reform we would actually consider the revenue implications for the entire revenue system together, federal, state, and local, something that almost never happens.

So what would that mean in some of the things that have been proposed for federal tax reform? What about a Graetz-like plan to exempt the first $100,000 of income from income taxation? Well, that wouldn't force states to give a comparable exemption but it would very much change the way the federal government operated. Would they actually care about compliance at all for people under $100,000? Would they do the document matching? Would they drop all the definitions and deductions and rules that applied to low- and middle- income people? Would states actually be able to pick that up themselves or if people really didn't file federal returns would states have a major compliance problem because in general when you do your state income taxes, if anyone does their own taxes any more, you copy the information from the federal to the state so there would be a major problem of nonfiling and underreporting of income. Is anybody thinking about that?

And, of course, there is the value-added tax, which has already been mentioned. And, of course, in the Graetz plan they make up for that revenue with the value added tax, something that would not make up for the revenue at the state level, and couldn't, would go the other direction. And the recently released Committee on Economic Development plan also has a value added tax but that's not instead of, it's on top of, so it's revenue raising.

A federal value added tax is just incredibly problematic for state and local government. That is their tax base. The retail sales tax accounts for about a third of state general revenue and the combined state and local tax rate last year was about 8.6 percent, their sales tax rate, and in a lot of states it's close to 10 percent. So if you have a VAT in the 10 to 15 percent range you're talking about asking people to pay 25 percent combined retail sales tax potentially or VAT at the cash register and I think there's a lot of question whether that is indeed acceptable.

States often need to raise sales taxes. That's actually the tax that people like. I mean, I have some regressivity problems with it but it's actually the tax that people are willing to let states raise, that and the cigarette tax.

So basically you hear that oh, when people write about the VAT in the context of federal tax reform they wave their hand and say well, states have two choices. They can keep their retail sales tax or they can conform to the VAT, which would indeed improve the retail sales tax, which has many problems.

And then they say, well, look at Canada. It works. Well, Canada is not the United States. In Canada the federal government guarantees to provinces a certain level of revenue if their own revenue runs short. That's not what we do here, to say the least.

And also the piggyback on the VAT in Canada, they don't actually piggyback on the VAT. The federal government gives them an estimate payment, something like revenue sharing, based on their estimated consumption. So that would be like revenue sharing in this country which no state with any sense would want to rely on given the way that would do. So I think there's a real worry that the VAT would drive out the sales tax, drive it down, at least at a minimum prevent it from increasing, and that that is a fairly serious problem if we care about providing services.

So let me just say that the federal policy makers often act as if the federal tax system is a world unto itself but a better way to look at it is if we have one intertwined and interrelated tax system that provides revenue for public services at the federal, state, and local level, and if you don't look at it that way then you're shifting the locus of deficit and affordability. So, again, my radical proposal is to look at all three levels of government together.

Thank you.

MR. BERGIN: Thank you, Iris.

Dan Mitchell.

MR. MITCHELL: The first thing I have to do is go prepare my excommunication papers against Bill Niskanen from the first church of supply-side economics but I suppose I'll go ahead and give my remarks before I get to that.

The first question to answer before we even get to the question for the program is, is tax reform worthwhile, but before you can even answer that question you have to say what kind of tax reform. From my perspective a single-rate consumption-based tax or at least significant steps in that direction is what I mean by tax reform and that's something that I think is very much worthwhile but it's very critical to stress that that's what tax reform means because if we do something like 1986 which moves away from a consumption-based tax or if you do something like NCPA just proposed, normally my good friends but they proposed something to much more the Haig-Simons approach along with busting the wage-based cap on Social Security then obviously the entire calculation from my perspective would change on these matters.

But, assuming we're talking about moving to some sort of Hall- Rabushka type system or at least in that direction, then yes, tax reform is worthwhile. And then if you come to that conclusion you ask what are the necessary conditions.

Well, politically you presumably have to have a relatively small number of losers compared to winners. That might not matter to all of us as we're sitting around intellectualizing about these issues but I can assure you that for the people on Capitol Hill that's going to be a very important issue.

And if we look at the 1986 tax reform bill, and keep in mind what I just said about not wanting to increase the double taxation on capital to finance tax reform, that obviously means you can't just raise taxes on business to finance lower tax rates on individuals and so that's off the table. And so if you want tax reform and if you want a consumption-based style tax reform and if politically you think that you can't have a big class of losers in order to make the whole thing work then the question of this day is actually backwards, should tax reform be a tax increase. I would propose it differently. The only way we can have tax reform is if it's a tax cut.

Now, having come to that, there's a very important qualification, whether you're doing dynamic or static revenue estimating. Obviously no one in this room is going to agree on what the different rules are, what the different sensitivities are, what the different elasticities are, but I would think that most people in this room would agree that if you had something where you move more toward a consumption-based tax system, significantly lowered marginal tax rate, that there is going to be some effect and that effect is going to be larger over time.

Where you cut that cake and how you slice it and what your measures are is obviously going to be very much of a challenge but if, again, we want tax reform and if we want the right kind of tax reform and if we want to figure out a way for politically this tax reform to succeed it has to be a tax cut or at least the pool of winners has to be sufficiently large and that means that you certainly can't do a tax increase and you have to have some sort of a dynamic revenue forecasting in there.

I'm not talking about anything grand. If you even assume three- tenths of 1 percent increase in economic performance, especially over time that's going to be very, very significant. And if you're going to assume that what you're looking for in the long run is improving America's fiscal policy then you're not going to worry too much about what you're seeing in years one and two and three. You're going to be much more concerned about what you're seeing years 5, 10, and beyond and so I don't want to let the tail wag the dog. I want to try to get in place a better tax system that will help our economy grow, make America more competitive, and if it turns out that we're going to have a slightly bigger deficit in years one through three I'm not going to lose any sleep about that.

And I suppose I should throw in my oh, by the way, qualifier on this. This is not in any way a stereotypical supply-side view that government spending doesn't matter. Government spending matters a lot. As a matter of fact the only reason I care about deficits is that they are a symptom of an underlying problem of much too large government and if you were actually to ask me to predict what's going to happen on tax reform I think the odds of tax reform actually occurring are extremely low because our erstwhile Republican friends in Congress and the White House have done an absolutely terrible job in controlling government spending.

It's not just that they haven't controlled it. They have made the problem much, much worse whether you're looking at what Bill was mentioning, the highway bill, Bill over there was mentioning the Medicare expansion, you have education bills. They have not found a government program that they don't want to increase funding for and that I think not only greatly undermines the actual likelihood of tax reform, it also, I think, had a negative effect on the possibility of getting Social Security reform as well.

Now let me go ahead and just digress back to the topic of today's program, which is can tax reform be a tax increase. I obviously think that that would kill tax reform politically but let me just explain why.

Transparently raising taxes on individuals, I think, is a nonstarter. Even if it was for a tax reform plan that I looked at and said yes, in the long run it's a good idea, it doesn't matter what Dan Mitchell says, it doesn't matter, frankly, what most of us in this room say. What matters is what politicians think they can get away with.

I also think that raising taxes on businesses is unlikely because I think tax reform today is motivated by different things than tax reform in 1986. I think there's much more sensitivity to the notion that we want to fix the tax base so that we're not double- taxing savings and investment as much and that's a lot of the impetus for tax reform that obviously is going to make an 1986-style approach much less likely.

I do think that there is some small possibility, I would say a small danger, others would say a small possibility, that a VAT could somehow make all these different pieces fit together. I think that's a danger because I think a VAT would increase the size of government significantly in the long run and I also think that the long-run possibility of having a better personal and corporate income tax system as the price of accepting a VAT, which some of my friends sometimes say, I think that's completely unrealistic. If you look at the tax systems in Western Europe their personal and corporate income tax rates and burdens tend to be higher than they are in the US and oftentimes if you look at the political debates in Europe when they're talking about raising the VAT they have the same class warfare type people over there that we have here, and every time you want to raise the VAT people start whining about oh, the distribution of the tax burden, we better raise individual taxes as well to preserve an existing distribution of taxes, so you wind up getting the worst of all worlds with that kind of situation, not to mention the fact I think it was Bill who mentioned the no-new-taxes pledge. Thank goodness for good old Grover because I don't think Republicans would even go along with a VAT as a result of his guerilla-type activities.

And last but not least I do have to say that since there are obviously two pieces to the fiscal pie, there is the spending side, there is the tax side, we're mostly focusing on the tax side but since we're talking about it in the context of fiscal balance on the spending side if we simply went back to the kind of spending control that we had in the mid-1990s and maybe this requires, as Bill has said before, divided government as opposed to Republicans controlling everything. But if we simply controlled the growth of government spending, not spending cuts, Bill, when you're talking about these polls, people are being given inaccurate information, so that it grew at 3 percent a year you'd wind up balancing the budget in five, six, seven years depending on what growth rate of government spending you want to have. You don't have to do significant cuts. You just have to do cuts off this, cuts off this phony base line that controls the way budgets are decided here in Washington, DC.

So in conclusion if we going to get tax reform and if it's going to be worthwhile it's not going to be because there's a tax increase. If anything the only way we can get it is if it's a tax cut.

MR. BERGIN: Thank you, Dan. We're glad to have at the table here today David Walker, who's a comptroller general, and I'm going to turn to him next as our fifth panelist.

MR. WALKER: Thanks. First let me address the question can you do tax reform in a revenue neutral manner. The answer is yes, it was done in TR '86 although for different reasons, and that's the charge that the president has given his tax reform panel. The question is should you. I think it's a timing difference. If you don't do it now you're going to do it later and I'll show you the numbers.

I'm a certified public accountant and one of the things you have to be good at when you're a certified public accountant is basic math. There are lots of people who aren't very good at basic math. And you also have to be a student of history as to what's likely to happen based upon historical growth rates and things of that nature.

I also fill out my own tax return intentionally because it is a painful experience. It is mind-numbingly complex. It is a massive bait-and-switch effort. It is losing credibility fast with the American public and we desperately need tax reform, desperately need tax reform, because there are significant compliance costs, there is significant economic inefficiency, and it's undercutting credibility with the public.

I do agree we need to consider the ripple effect. There's increasing inter-dependency in government. I do agree we need to go to a more consumption-based approach. I don't think there's any doubt about that. How you get there, when you get there, can matter but let me tell you why I think too many people are in denial.

Here are the slides. We've got several reports that we recently issued that are available. The first slide deals with the largest tax preferences. The technical term is tax expenditure. I don't want to get into ideological debate. That's the legal term for it. Healthcare is 102 billion but if you added the exclusion for payroll taxes, it's 150 billion and it's the fastest growing tax preference and I would respectfully suggest it's fueling our healthcare problems, not helping with our healthcare problems.

The next one shows where we've been and where we are with regard to deficits as a percentage of the economy. It's not a positive trend especially when you consider that we have the strongest economic growth rate of any industrialized nation last year and that only 100 billion of the $567 billion operating deficit last year had anything to do with Iraq, Afghanistan, or incremental homeland security costs.

The next one is something that people don't want to talk about but if you go to the financial statements of the US government and if you look at the MDA, management discussion analysis, you look at the financial statements, you look at the footnotes, it's not all pulled together in one nice, neat spot like this is but if you pull all these numbers together you'll find we've gone from total liabilities and unfunded commitments of $20 trillion in 2000 to 43.3 in 2004. That's because we have largely cash-based budgeting and we assume that things are going to end in 5 years or 10 years or don't worry about things beyond that. The number this year is going to go up. It's only a question of how much is it going to go up.

If you look at the next page you'll see that these numbers don't compare favorably to the total net worth of every American. The total net worth of every American including home equity is estimated to be 48.5 trillion. We're going to be close to that number when the numbers come out for fiscal 2005.

And if you look at the last chart you'll see, and this is one of several simulations that we run, this is the worst of the simulations that we run but it's not totally implausible because what this assumes is that discretionary spending grows by the rate of the economy over time, that the estimated cost for Social Security and Medicare are the intermediate cost estimates as determined by the trustees of Social Security and Medicare, and that all tax cuts are made permanent.

The numbers just don't add up. In the final analysis we're going to have to do several things and the sooner the better. First, provide more transparency about where we are and where we're headed because our financial condition is worse than advertised. It's got much worse in the last several years. We're on an imprudent and unsustainable fiscal path. We are not discharging our stewardship responsibility to our children and our grandchildren.

Secondly, we're going to have to stop digging because we're digging at or near record rates. We're going to have to reestablish budget controls on both sides of the ledger. If you try and just stop the bleeding on the bottom line you can't exempt one side of the ledger. We're going to have to consider the long range affordability and sustainability of both spending and tax proposals before they're enacted into law. We're going to need triggers on mandatory spending to force reconsideration of mandatory spending, meaningful reconsideration, and we're going to need entitlement reform, spending constraint and restructuring, and tax review and reform, all three. The gap is so great even under the optimistic scenario we have a large, growing structural deficit. And the gap is so great there's no way you're going to grow your way out of the problem and you're going to have to end up doing a combination of these three.

Now, the democratic process is, all right, what's the waiting, what's the timing, but that's really what it's all about, what's the waiting and what's the timing. It's not a matter of if. It's a matter of when.

Thanks.

MR. BERGIN: I think it was Iris who was talking about PEP and Pease. We all in this room know what PEP and Pease are but if you do your own return and you're affected by them you have a different name for them. I think you make an excellent point. It's a voluntary tax system and it's all bait and switch and if you do your own tax return you just sit there and feel like a sucker if you're a regular wage earner.

Before I go to questions and answers I'm going to ask the panel if they want to respond to anything that they've heard. I see Bill waving a finger at me so he can go first.

MR. GALE: All right, thanks. Like David Walker I do my own taxes and my reaction is mainly I can understand what this tax provision is doing when you're adjusting for capital gains or PEP and Pease or a certain portion of charitable giving or self-employment tax or some of that. I understand what the tax rule is and I can see how doing these various steps generates that tax rule but I just can't imagine that the population at large thinks of it as anything other than just an arbitrary set of the government says hop on one leg and hum the Marseille and then you get a tax deduction and so it really does have a —

MR. BERGIN: Or you don't.

MR. GALE: Or you don't. If you do it too many times then the AMT kicks in and then you lose all of it.

MR. BERGIN: By that time you've sent the children upstairs.

MR. GALE: So just a couple of quick comments. Bill Niskanen, by the way, welcome back to the real world. Maybe he —

MR. BERGIN: But he's out of the church.

MR. GALE: Right, when he mentioned the budget rules I didn't mention it but I want to underscore the importance of the budget rules. Dan mentioned this, too. We can't do tax and fiscal reform without the rules and I think the rules in the '90s were a good base. So I find myself in agreement with Dan Mitchell on that point and, lest anyone get confused by that, I find myself in disagreement with Dan on two points.

One is I think the polls that ask about spending policy they do at least get in there the notion that taxes pay for something and that there's a trade-off. If you just ask people do you want lower taxes it's not really a very interesting question because, of course, people want lower taxes, other things equal. Who wouldn't? But what's notable is when you add the link between taxes and spending you get a jump and not a tiny jump. You get a jump from 80-20 to 20-80 and so framing the discussion that way, even if there's an issue of whether we're talking about growth rates versus levels, inflation adjusted growth rates, population adjusted growth rates, whatever, framing it as an issue between smaller government and smaller taxes and bigger government and bigger taxes has an enormous impact on how people think about taxes. That's the main point.

The other point of disagreement with Dan is that it is not obvious that a consumption tax that reduces revenue is going to raise growth. It's true that a revenue-neutral consumption tax that does not give transition relief and that is a well-designed consumption tax will raise economic growth. There's no question about that. Any model that doesn't show that is generating something weird.

It's also possible that the model, as a recent article in JPE showed, could reduce individual welfare at the same time that it raises economic growth and the reason is that removes the automatic stabilizer function of a progressive tax system. And this is an article by Kent Smetters, who's at Wharton, and a guy at CBO whose name escapes me right now, but what they did was show that even though you do get an increase in growth in this very stylized tax reform you get a reduction in individual welfare because of the loss of the wage insurance function that a progressive tax system provides.

But the other issue, though, is if you cut taxes you increase the deficit and that digs into national saving and that reduces economic growth, so it's true, as Dan said, that the effect gets bigger over time for these things but it gets bigger and negative, more negative, over time because the cumulative effects of the deficit are eating away at the capital stock. That's what the literature says. It's important to distinguish between a revenue- neutral tax reform and revenue-reducing or revenue-increasing tax reform.

Lastly I have a question for Iris. Maybe you could clarify this. The way I understand it is that the income tax is a great thing for the states because it conforms the state income taxes to the federal system and therefore makes the state income taxes easier to comply with and easier to administer. So the question is why isn't the same thing true of a value added tax. Why wouldn't that then generate the states to conform with it, and then why wouldn't the value added tax have the same advantages of conformity and compliance for state sales taxes that the federal income tax has for state income taxes?

MS. LAV: Well, I think it's the reason that tend to estimates rather than anybody really piggybacks. Value added taxes require borders. You have to figure out what was done in the jurisdiction when you have the credit invoice version of a VAT, which is what most people talk about. Then you have a situation where you have to figure out what's exported from the state, what's imported into the state, and it gets very complicated. You might be able to do that but what you really can't do is do that for local governments. You just end up insane.

So local governments are a big chunk of our sales taxes now. Maybe about a quarter of total sales taxes are local government. So you could have the state collect it and give it to the local government, maybe, but it's not divided evenly among local governments in the states. So there are lots of problems that nobody has entirely figured out how to solve and even Charles McLure said you can't really do it for local government.

And then the other factor, which is maybe less of a concern long term, is the disruption factor. If every state and every locality has to reenact their taxes in a fundamental way it can really cause tremendous disruptions. In 1986 actually tax reform worked the other way for state and local governments. They got a windfall. But anything that actually changes the structure within the income tax they can deal with.

If you're saying let's throw out the retail sales tax, let's enact value added taxes, let's figure out how to do all of these complicated in state, out of state, export/import stuff it's a huge disruption and I think you're going to lose a lot in the transition as well.

MR. GALE: So the equivalent of states and localities in European countries just get some share of the national VAT in those countries?

MS. LAV: I believe so.

MR. MITCHELL: In most European countries there's almost no such thing as state and local government in terms of independent decision making. Even in Germany, which has the closest thing to a federal system, the lenders simply get money from the central government and then in effect administer central government programs.

Let me go ahead and make a comment on Bill's comments. I'm not going to pretend that the American people are where I want them to be after five years of both Republicans and Democrats saying that government should be your mommy and daddy, wipe your nose, and tuck you into bed every night. I'm worried that some of the in effect social capital of the country in terms of an independent self-reliant citizenry is being eroded but nonetheless I still think that if you actually ask the question honestly "do you want government spending to grow by 7 percent a year and pay this much more taxes or grow 3 percent a year and pay this much less taxes" I think you'd probably get better answers on some of those questions than what we see when people are simply asked "do you want to cut government spending or cut taxes." I think that misleads people but that's a public opinion question.

On the deficit issue keep in mind that especially in the short run growth drives deficits, not the other way around. If you look at how fast revenue poured in last year, for instance, that reduced deficits significantly. The causality, I think, is very important.

In the long run there's a different debate and that's probably getting much more into a whole separate topic than we want to talk about right here but if we have a tax system that gives us better growth and we combine it, again, I'm not a Jack Kemp supply-sider but if we combine it with the kinds of spending discipline that we had in the mid-1990s which didn't have anybody starving in the street last time I checked, I'm sure that would have been on the nightly news, I think that you can have the best of all worlds. Just a question of whether we want to have a better performing economy.

MR. BERGIN: Bill.

MR. NISKANEN: Three points. One is that revealed behavior by voters and individuals is very different from what you get in polls. My own study of presidential elections dating back to about 1896 finds that there's a significant negative relation between the popular vote for the candidate of the incumbent party and the rate of spending increase over the prior four years, a significant negative relation between spending growth and the popular vote for the candidate of the incumbent party.

Sam Pelzman did a similar study on votes for candidate of the incumbent party for governor, a combined times cross section sample, a much bigger sample, and he finds the same effect, a significant negative relation between spending growth in the state since the prior election and the popular vote for the candidate of the incumbent party.

Third is that my own study of interstate migration finds a similar effect, that net out-migration is a positive function of the rate of spending growth in the state, that people in both their voting behavior and their migration behavior are voting against big government at both the federal level and the state level and they have done it for a very long period of time. I think this revealed behavior is very much more important to take into account than what you get from opinion polls because I think you can get almost any answer you want from opinion polls depending upon the way you phrase the question.

Second, to reinforce my point about the importance of supermajority rule, I was asked this summer by a member of the president's commission on tax reform to look at the relationship between the relative size of government and the VAT rate in the OECD countries. Looking at all of the OECD countries that included VAT, which is almost all of them, what I found is a very simple, very significant relation that the relative size of government in these countries is 22 percent of GDP plus the VAT rate. It's about as simple as that. Governments which have a 25 percent VAT rate have a 47 percent total government spending share of GDP. It's a very strikingly simple relationship.

The implications of that are that there may be a very good case for the VAT but if we have something as broad and as untransparent as the VAT we have to accompany it with a supermajority rule on rates.

Third, I'm glad David is here because he illustrates a point that Ronald Reagan made many years ago when he was a little bit irritated with economists when he said that economists are people who are good with numbers but without enough personality to become accountants.

MR. BERGIN: David.

MR. WALKER: I would agree that in the short term economic growth has a lot to do with what the deficits are going to be; however, in the long term demographics are destiny. 2008, the first baby-boomer reaches 62 and is eligible for Social Security. 2011, the first baby-boomer reaches 65 and is eligible for Medicare. Even when we had short-term surpluses that were temporary projected surpluses back in the late '90s and early this part of the millennium we knew we were going to return to long-range deficits because of demographics. That's what the long-range simulation showed.

We did not take a prudent course. And in fact one of the most irresponsible things I would argue that's happened in decades was the passage of the Medicare prescription drug bill. The highest risk and most imprudent thing that you can do is increase entitlements in spending over the long term.

The cost of that bill was over $8 trillion in current dollar terms. That's how much money you'd have to have today invested at Treasury rates to deliver on the promise, and that's just for the 75- year cost factor. That's how much you have to have today. In the final analysis the numbers have to add up. They're nowhere close to adding up in the long term and economic history shows that the kind of growth rates you'd have to have in order to make these numbers add up have never occurred before.

We may be the world's engine of economic growth but we're not the only player on the field and in a knowledge-based economy when we're 25 in the world in K through 12 education and we're losing a lot of the best and brightest because of tightening on visas, they're not coming here any more for post-secondary education, that's going to have a real effect on us over the long term.

MR. BERGIN: I'll go to you, Don, in a second. Let me just make two quick observations and I'll open it up to the people around the table in the audience.

We seem to agree that the beast didn't get any smaller. It got a lot bigger and it's about at the door. I think I hear agreement on that. The other thing, Iris, is that I think you're absolutely right and I greatly appreciate your point of view. We have had five of these on tax reform and I don't think we've addressed state and local issues more than briefly and so your perspective is right on the button here for this one. It took us five to get around to it so I apologize for that.

With that I'm going to start with Mr. Alexander but to set a good example, Don, as you always do, would you state your name so you remind everybody that they need to?

MR. ALEXANDER: Don Alexander, former tax collector and, Mr. Moderator, I have to disagree with your characterization of the Internal Revenue Code and our system as being a voluntary system. It's not a voluntary system. People do file their own tax returns. They self-assess. Most of them do. I'm reading the paper lately and apparently one of our local citizens didn't.

And I agree with David Walker. I try to make out my own tax return and it is almost impossible. The system is almost broken and I agree with David Walker again. We badly need to reform it. The GAO issued a very thoughtful and worthwhile report on tax expenditures. The Internal Revenue Service has to administer at least half of our discretionary expenditures. It can't do it. It simply can't do it. The job is too big of that agency or any agency and it's getting worse all the time.

You've been talking about hey, let's not spend more. How about spending through the Internal Revenue Code, that's the way we spend these days. Let's not confine our desire to reduce spending to appropriated funds because the way that things slip through these days except for that bridge in Alaska is to have the Internal Revenue Code take on another provision permitting a deduction, a credit, some sort of benefit, for something that has nothing whatever to do with the proper computation of taxable income.

So hopefully we will have tax reform and hopefully some of the ideological things we've heard about today won't block it. As far as the double taxation of business income is concerned I'm a little confused why business income conducted through an entity that is a pass-through entity, as most new businesses are, LLCs, partnerships, and the like, has a double tax. Maybe Mr. Mitchell can explain that to me. Feel free.

MR. MITCHELL: I'm not talking about LLCs or partnerships. I'm talking about the fact that capital gains taxation is double taxation if you believe in a consumption-based tax system.

MR. ALEXANDER: Capital gains is double taxation? Explain that to me.

MR. MITCHELL: How is capital gains double taxation? A capital gain is a market expectation of a higher after-tax return in the future. That income in the future when it actually materializes will be taxed. That's one of the ways it's double taxation. The death tax is clearly a form of double taxation. I mean, I would think that —

MR. ALEXANDER: On unrealized appreciation, that's double taxation —

MR. MITCHELL: Well, if you don't believe in a capital gains tax, if you recognize that that's double taxation, then no, it's not some loophole in the system. It's just protecting against double taxation.

MR. ALEXANDER: That is a fascinating view of double taxation but let's go into something else. If you don't have tax reform and you continue to spend through the Internal Revenue Code the system isn't going to work. The system isn't going to work because at the moment we do have a very large and growing tax gap. Taxes may be levied automatically but they're surely not collected automatically.

The suggestion that this jump in revenues is all attributable to these magnificent economic principles of the current administration is silly. The Internal Revenue Service is now enforcing the law. That has two effects. Number one, it brings in more money now that should be paid now. Number two, it brings in and has brought in a very large amount of money that should have been paid earlier but was not paid. One tax shelter caught by IRS has produced almost $4 billion in new revenue.

MR. BERGIN: Howard.

MR. GLECKMAN: I'm Howard Gleckman from Business Week and I feel like I'm in a AA meeting. I do my taxes, too. I'm curious about something. This goes back to the question that Bill Gale asked at the very beginning. Maybe we could do this with a show of hands. How many people here think we can run the government at 20 percent of GDP 25 years from now?

MR. MITCHELL: If I'm in charge, yeah.

MR. GLECKMAN: Well, no, I mean, how many people think we're going to be doing that? Do you think we will be?

MR. MITCHELL: No, I would be delighted if we were even only at 25 percent of GDP 20 or 25 years from now.

MR. GLECKMAN: So for the transcript let the record show nobody thinks we can run the government at 20 percent of GDP. Dan says 25. How about 30? Well, how about let's do 25? I feel like an auctioneer.

MR. BERGIN: Do I hear 30? Do I hear 30?

MR. GLECKMAN: So somewhere between 25 and 30, is that the —

MR. BERGIN: I think that's what you hear. Maya, you look like —

MS. MacGUINEAS: No, I'm trying for a little bit lower than 25. I think between 20 and 30. Everyone agrees it would be about 20.

MR. NISKANEN: Let me remind you about an historical fact. In 1929 total government spending at all levels was 10 percent of GDP, only 2.6 percent of GDP to the federal government, almost all of which was for the military or the deferred costs of prior wars like veterans benefits and interest payments, 7-some percent by state and local governments. That was a government fiscal policy of a responsible nation, I think, and it was very healthy. We can do it on 10 percent. I don't think we can do it much lower than that.

MS. MacGUINEAS: Well, wait a minute. We don't really want to go back to the lifespan that we had at that point in time or the healthcare we had at that point in time, do we, Bill? I mean, I think that the world has changed tremendously. Do we want to ride on dirt roads. I mean, you have to think of what the world is. I mean, we didn't have a demographic explosion which is driving a lot of that so if we want to fix the expenditure side we're going to have to figure out a better way to deliver healthcare, probably, but I think that we have a different world.

MR. BIXBY: Howard, there's a sub-question to your question which is important. By the time you get out to 20, 30, or so are you talking about primary government spending or primary government spending plus interest because if you're running these big deficits, if you look at David's chart, interest becomes a huge part of federal spending.

MR. GLECKMAN: Oh, no, I'm including interest.

MR. BIXBY: But that has a take on whether we do what we need to do to run more balanced budgets in the short term.

MR. MINARIK: Twenty-five percent interest, 20 percent other spending, will you guys go over that?

MR. GLECKMAN: Just to close the circle in, so if we're talking about something like 25 percent of GDP, 20-25, but that's going to imply some fairly dramatic cuts somewhere, particularly healthcare spending.

MR. BIXBY: And right along the line, I mean, it's going to require a much better job of enforcing fiscal discipline from now so we're not running huge deficits to keep the interest costs as well the entitlement costs from exploding.

MR. WALKER: Howard, I don't know if you've had a chance to look at this publication and, those of you that haven't, I would encourage you to do so. Basically this came out on February 16th and it's a compilation of the work that we've done over decades. The premise of this booklet is we're on an unsustainable fiscal path. Tough choices are going to be required.

The other premise of this is a vast majority of the federal government spending programs and tax policies are based upon conditions that existed in the United States and the world in the 1950s and the 1960s and they've never been subject to fundamental review, re-examination, reconsideration. And one of the things that we have to do is quit assuming that the base is okay, and debating we're going to cut 2 percent here or there. I mean, you don't need humans to do across-the-board cuts.

We need to start making some intelligent decisions about re- examining the base of the government so yes, I think you can't just reduce the rate of growth. We're going to have to re-engineer the base of spending and re-engineer the base of tax policy because a lot of it is based upon outdated conditions and assumptions.

MR. GLECKMAN: Just to close the circle, so what we're saying then is we're going to need somewhere between 4 and 7 percent of GDP more in revenue than we're getting now and, to go back to Bill's question, I mean, that's a lot of money. That's $500 billion a year, $600 billion a year, in today's dollars. Where are we going to get it?

MR. BERGIN: Is what we're saying that we are in real trouble and the average American is just worried about what it costs at the gas station? Somebody ought to tell the average American what's going on.

MR. GLECKMAN: And if we're going to design a new tax code we've got to think about how we're going to get a tax code that's going to generate another 4-$500 billion a year.

MR. BERGIN: Remind everybody to state their name, please.

MS. MacGUINEAS: I'm Maya MacGuineas, the New America Foundation and the Committee for a Responsible Federal Budget. Thank you to the speakers. It's been really interesting. I had a interesting response where I put myself firmly in the camp of somebody who believes that revenues will have to go up just for the reasons we've been talking about that out of share of GDP it's pretty impossible to imagine bringing the government down especially in the long run to where we currently are. And I think when you think, like Bill says, that revenues will go up it's more important to have a more efficient tax code so I think fundamental tax reform becomes more important which is why I actually became convinced of the argument that fundamental tax reform and revenue increases should be separated because I don't really like to spend my time thinking about what politicians will do. I think those of us outside of that world can influence the debate by putting forward better ideas but it's just going to be very difficult to fundamentally reform the tax code in a worthwhile way while also raising revenues.

It makes more sense to have a fiscal grand bargain where you raise taxes probably in the short run, if you look at where the problem is where we are below historical norms, that's on the revenue side right now, while controlling spending in the long run. But I'm troubled wherever tax increases take place by this whole no-new-tax pledge. I think that really stands in the way of sensible policies and you can see how in Social Security reform, for instance, that caused the other side to dig in their heels on no fundamental entitlement reform, which we also need to have.

But about tax expenditures, which is my new obsession, I wonder if there is some way if you think about tax expenditures as a tricky way to put spending programs through the tax code and call new spending tax cuts how should we measure the size of government? Should some of it actually take into account the full size of tax expenditures as part of the size of government? And so then my idea I came up with while listening to speakers is could we have tax reform that broadened the base, got rid of some tax expenditures, and actually call that a spending cut? If you were to switch tax expenditures and recognize them on the spending side of the budget then doing something like the important point of looking at the healthcare expenditure and reducing it could actually shrink the size of government while increasing revenue. So I was curious whether that could go anywhere?

MR. BERGIN: Anybody? Joe.

MR. MINARIK: Joe Minarik, Committee for Economic Development, and in answer to Maya's question I seem to recall over the eight years from 1993 to 2000 dealing with a bunch of people who were trying very hard to change things, that people thought were taxes, call them spending and vice-versa. It didn't seem to work very well but you're welcome to try. I have tried to make it a rule not to get into the middle of religious disputes but, Bill, I'm really glad to have you back. I've always wondered when you look at the way traditional religious figures have been treated. They always seem to be quoted selectively and I do recall Ronald Reagan once when he was confronted with a question of the possibility of a tax increase saying the president should never say never.

And thinking about the tax pledge in that context makes me wonder. Some things Ronald Reagan said don't seem to be carried forward by the folks of his ideological perspective. Having welcomed Bill back, I want to jump on you for something. There has been a recent fad of people saying that over the last 40 years we had average revenues of 18-something percent in GDP and average spending of 20-something percent of GDP, and we're not far off of that on either side so therefore all we need is a small adjustment.

It's worth remembering, though, the last 40 years we have had a public debt that has been growing at the beginning of an unsustainable rate. So we're not just lowering the bar. We're burying the bar and then patting ourselves on the back for having traversed it.

Another topic, there have been some references to the experience of 1986 and the possibility of having tax reform that contributes to a deficit reduction. It has struck me since that time that if you look at what happened in 1986 you might describe that as a zero coupon investment in deficit reduction in the sense that it took a tax code that probably did not have the legs to be used for deficit reduction in the future and turned it into one that could even though that law itself was deficit neutral and I'd like to think of it in that context looking backwards.

Another point I'd like to talk about with respect to something Dan had to say, looking at what has happened this year on revenues, there's a sense very early on in the administration midsession review. As a matter of fact I think it's the first sentence other than the president's message which said because of faster economic growth the deficit this year has declined remarkably. You then page back about five pages and you look at the table that has the economic assumptions and there are two lines on economic growth.

One of them is the February budget, projected economic growth in 2005, 3.5 percent. Economic growth in the midsession review, 3.5 percent. There was no increase in economic growth relative to what was projected in the budget by the time of the midsession review. The additional revenues did not come because economic growth was faster, it was the same, which raises the point that when we're looking at revenues over a short period of time we have to be very, very careful about changes in revenues that are due to purely cyclical effects, which are temporary, and changes in revenues that are due to more enduring effects. And at this particular time I think looking at the numbers this year so far would make people a lot more optimistic than might be justified.

That having been said, when I hear talk about how much more revenue we will get in the long run because of changes in policy there are two things that come to my mind. One, and this is a relatively cheap point, I think of the young working head of a family who decides that this year I'm going to cancel my life insurance policy so I save the premium and use the premium to go on vacation. So he takes the vacation and then at the end of the year he's still alive. Was he smart? I think most of us would say that the answer is probably no. He survived that bet for one year one year but he has exposed his family to considerable risk. I think that reducing taxes or even engaging in revenue neutral tax reform at this particular point might fall into that category in terms of behavior.

And I'd like to make one more point in that regard and that is Bill suggested that any model these days will tell you that a deficit neutral or deficit decrease in consumption tax would increase economic growth. Now, on the deficit decreasing side I absolutely agree. I am very uncomfortable myself with model projections suggesting faster economic growth because of changes in the tax system in any significant measure.

One vision of the alternative of the tax system these days is that we could possibly achieve a zero effective tax rate on capital. A zero effective tax rate on capital, this reasoning continues, is a different world and everything works differently in that world and it's qualitatively different from anything we have experienced and it would provide a stronger economy.

I think if you think instead of the effective tax rates on capital not as zero as a separate world and anything else as totally different, qualitatively different, and instead think of effective tax rates on capital as a continuum and if you go back to the period in the immediate aftermath of World War II and think about what has happened to tax rates since that time we have had tremendous and significant reductions in tax rates.

If you think of a baseball bat we have gone from the fat end of the bat and we are way, way down towards the handle right now, putting that in perspective; however, when you run your models to try to think of what the implications of changes in the tax system are you are running your models based on the shape and size of the fat end of the bat. Those are not necessarily applicable to what happens when we go further and further down the handle. So I just suggest that we ought to be a little bit careful about drawing optimistic conclusions about further reductions in effective tax rates.

I'm going to say two more things real quickly and then I'm going to stop and I'm going to ask Bill some questions again. One-year historical models with respect to steady growth and popular votes for president and also the size of government with respect to a VAT, I wonder if you can possibly control for some factors. In the first case, looking back over the last century when spending has increased at the federal level, more in the last half century than the previous half century, I would imagine that in a lot of presidential terms when spending went up it went up because the economy was extraordinarily weak.

And I would also imagine that if we look across European countries if you assume that those governments over time have been fiscally responsible. There will be an identity between spending and taxes just because they're paying for what they buy and if that's true then one of their major taxes, if they spend more, is likely to be larger. And so I'm not sure whether for either of those instances you can draw conclusions of causation.

MR. NISKANEN: Bill Niskanen in response, my study of the popular vote for the president does control for other conditions like the unemployment rate and, importantly, it controls for wars. One of the important findings of that study is that the popular vote for the candidate of the incumbent party declined sharply if there is a war during the election year. Roosevelt, for example, got fewer votes in 1944 than he did in 1940 even though American forces were rolling across Northern France and clearly winning the war on both fronts. And the current Bush, for example, in the absence of the Iraq war should probably have had 57-58 percent of the major party popular vote. This is Ray Fair's estimate. My estimate is he'd get about 51 percent of the major party popular vote, which was the case.

Bush got an unusually low margin as incumbent president given a moderately strong economy in 2004 so I did control for the variety of other conditions and Sam Pelzman in his study of the popular vote for the gubernatorial candidate of the incumbent party does control for it otherwise.

My very brief study, which took a half a day, of the relation between government size and VAT rates did not control for anything else and it is quite plausible that the causation goes from a decision to spend to the decision to choose a VAT rate rather than the other way around but I think it is a caution at least about what we ought to be concerned about if we ever have a broad-based, nearly invisible type of tax like the VAT.

MR. BERGIN: David.

MR. WALKER: Can I come back to something that Maya said? We need more transparency over the tax preferences and tax expenditures. They do involve a tremendous amount of money. They're not in the budget. They're not in the financial statements of the US government. If you aggregate the total value of tax preferences or expenditures over the last 10 years you'll find in more than half the years they exceeded total discretionary spending.

Secondly, I think we need to understand the difference between whether certain tax cuts or preferences stimulate the economy, which the answer is yes in certain circumstances, versus whether or not they pay for themselves. They are two fundamentally different things and people tend to aggregate those things together especially when you're starting off in the hole of about 4 percent of GDP, 3 and a half to 4 percent of GDP.

And then last I think we need nothing less than a fundamental cultural transformation in government. I mean, government is basically a lag indicator. Government basically reacts. The executive branch doesn't have a strategic plan. It's never had one. And so by definition you're in a situation where you're constantly reacting and you're just incrementally looking at the base.

Let's look at Katrina, what happened with Katrina. In the absence of some plan and some rationalization of what are we trying to accomplish and how best to do it and at what level of revenues what we do is if there's a problem like Katrina we do three things. Number one, we throw money at it, the more the better because it shows we care. Secondly, we throw tax preferences at it, the more the better because it shows we care, and we create new players whether it be individuals or organizations to try to be able to show that we're taking this seriously when none of those necessarily are going to have the intended impact.

We could be wasting a tremendous amount of money because one of the reasons is we don't have metrics. We don't have key national outcome-based indicators, social, safety, security, economic, environmental, to understand what spending programs and what tax policies are working and which aren't. We don't have a clue on behalf of many. How can you run the largest and most important enterprise in the world on that basis?

MR. BERGIN: Dan.

MR. MITCHELL: Well, actually I think there is a plan in the executive branch as to who do we have to give money to to try to keep our popularity up but that's a separate question.

As the bishop of a dwindling church I want to turn to my pope, Milton Friedman, and ask David and Bill Gale a question here. At some point in the past Friedman said that he'd rather have a budget of like a trillion dollars with a deficit rather than a $2 trillion budget that's balanced. So let me pose a question to the two of you. What do you think would be better in terms of economic growth, economic performance: a budget at 40 percent of GDP that's balanced or a budget of 25 percent of GDP with a deficit of, say, 3 percent of GDP? I mean, if you had to pick one of those in perpetuity which are you going to pick?

MR. GALE: You'll notice that Dan's numbers don't add up and they're off by at least 12 percent of GDP. So this is like you ask your son —

MR. MITCHELL: Are you still beating your wife is what I'm trying to ask.

MR. GALE: Exactly. Would you rather be a chemist or Michael Jordan? He says oh, Michael Jordan. Well, then I advise you to quit school and play basketball all day long. So you can get a false choice so I'm not going to answer this particular question because it's a nonquestion. Nobody faces the choice between —

MR. MITHCELL: Well, then let me rephrase it. Would you agree that a government of 5 percent of GDP bigger is probably going to have a weaker economic performance than a government that's 5 percent of GDP smaller?

MR. GALE: No, a government that spent money building quality levees in New Orleans would spend more money.

MR. MITCHELL: Can you identify a government that acts that way?

MR. GALE: You just asked me about a government 5 percent bigger. I think government spending can be part of the solution. I think it can be part of a better society. I think it can improve outcomes. I think there are vast areas of the economy where a more intelligent, not necessarily bigger but a more intelligent, structure of government intervention would make a huge difference, infrastructure, healthcare, environment, inner city pop to mind immediately as just massive nuggets of gold sitting there waiting to be picked up in terms of effective government policy and the list goes on and on and I disagree completely with the notion that the way to help to make the economy run is to strangle the government.

I think an economy with a weak public sector is an economy that's asking for trouble. And we can go through historical precedents if you want but I think there have been real improvements from government spending on social issues, on environment issues. I think they could be expanded dramatically, I think they should be, and in particular areas like healthcare I think the benefits of doing that intelligently would far outweigh the costs. I just object completely to the notion that less government is always better. I think that's completely wrong.

MR. BERGIN: David.

MR. WALKER: I think that's a false choice. I don't think either one of those outcomes is acceptable but what I would say is my answer would be as small a government as possible in order to discharge its responsibilities and one that pays its bills and has a balanced budget over time. I don't buy it that we want any government of any size of GDP that is running structural deficits. I think that's fundamentally imprudent. And guess what. So does George Washington.

I mean, go back and read the founding fathers. They would be appalled at where we are today from the standpoint of fiscal irresponsibility.

MR. MITCHELL: I think they would also be appalled at the things that the federal government is doing, but let me ask you the follow- up question I asked Bill. Do you think that there are any negative implications of having government get bigger?

MR. GALE: That's not what you asked me, just to be clear. There can be negative implications in government getting bigger, of course, but that's not the question that you asked me.

MR. MITCHELL: Well, let me ask the question then. Assume that it's not you making the decision. I think Bill assumed that but let's assume that politicians would be making the decision. Do you think that if politicians made the government 5 percentage points bigger than it is now or 10 percentage points bigger as a share of GDP than it is now that's going to have a good or a bad effect on economic performance, all other things being equal? Either one of you.

MR. GALE: So we're now running deficits of 10 percent of GDP or 5 percent?

MR. MITCHELL: No, I'm just saying that if government gets —

MR. GALE: You just said all other things being equal.

MR. MITCHELL: No, let's assume it's all revenue financed if you want. Do you think that we'll have a weaker economy if government's 10 percentage points bigger?

MR. GALE: A budget neutral expansion in government spending, I think there's enormous potential to do that well. Whether it would happen that way I don't know.

MR. WALKER: I come back to what I said. I think you want a government that is small as possible so that means you want to minimize the size of government. That doesn't mean reduce it. It means minimize the size of government in order to discharge its responsibilities, which are things that otherwise would not be done by the private sector and are in the broader public interest, but I also believe that you have to be able to pay your bills in order to be able to deliver on your promises over time.

MR. BERGIN: I think that's an excellent point. There are times you may have to borrow for emergencies but you've got to pay your bills. We all have to pay our bills here and I'm not arguing that the government is a business but I think that's the simple point.

Iris.

MS. LAV: I think the whole idea of some arbitrary size of government, coming back to no-tax pledges, the no-new-tax pledge and the Grover Norquist thing, the thing that's wrong with it is it just is out there. It doesn't consider any circumstances of government and what has to be paid for at any given time and when the two things collide as we saw in Virginia a year and a half, two years ago, several members of the legislature who had made no-new-tax pledges voted for the tax increase because they judged education spending to be more important than the no-tax pledge and they told Grover to go away, that basically that they had to govern and he didn't and that he said they were going to retaliate but fundamentally they didn't, even though there was an attempt to unseat these people it didn't happen.

And that's the same sort of thing when we're talking a little bit in the abstract about percent of GDP and how big it ought to be. We all could agree that certain things the government has done with the highway bill and I think there's a lot of agreement on the table that the Medicare prescription drug wasn't the best idea in the world and so forth and so on that government shouldn't do I think we have to be tolerant of a little bit of inefficiency in government, not a lot of inefficiency but just because it's a human institution. But I think that at any given point in time we have to figure out what it is we need to do and what it takes to fund it. It's just a little too abstract to say 25 percent, 30 percent.

And finally I think the point is that the reason the no-new-tax pledges were overridden was that there was a sense of emergency. I mean, states have to balance their budgets. I'm not considering the federal government should have a rigid balance budget requirement but I am saying there was a sense of urgency.

And part of the problem here is that if we wait until 2030 to make some of these adjustments we've got this huge 5-6 percent of GDP interest costs to deal with and part of the question is how to get this chart that we've all talked about and you provided into the public and the policy makers so that the sense of urgency today and we don't wait until 2030 and we don't have to swallow this big interest expense.

MR. OOMS: Van Ooms from the Committee for Economic Development. Some of you may know CED released a report a few days ago and, as Iris mentioned, explicitly recommending a value added tax as well as a large set of changes to the income tax. I want to make a couple of comments about that about the way it's been characterized and also in relationship to the discussion that's gone on here today.

The cover of Tax Notes this week refers to the report on page 13, which we have in front of you, by saying CED pushes add-on VAT as long-term money machine. I don't know how the "as" is to be interpreted there.

Bruce Farman was the one in fact who said we needed a long-term money machine. We didn't in fact say that in the report although we did say we're going to need some more revenues. And we ran some simulations that I think are rather compelling in that regard but I did want to clarify that.

Our trustees at CED or business leaders are old-fashioned folks who really feel they want to deal with the real world as they find it to a large extent. It's not that they don't think we should improve government, it's not that they don't think that we can cut spending, it's not that they don't think that we can spend smarter, all of which we have recommendations for and have made a number of recommendations for, but within a fairly broad set of parameters and this is where I come to the discussion around this table today. They think that we really have to confront the world more or less as we find it.

We have to take a government more or less as we find it whichever party is in charge. That is to say, we are unlikely to move to a philosopher king where we can snap our fingers and move the spending ratio of GDP up or down by about 5 or 10 percentage points, which is the way this discussion has to some degree proceeded today.

So if you really think you're dealing with the real world then you come back to Howard's question earlier which is what's the realistic outlook even after you do a lot of things on the spending side with respect to the need for revenues. And what we found was, not surprisingly, I think, if anyone has really looked at the numbers, that even if you do a lot on the spending side you still are going to end up needing revenues in terms of the numbers essentially that David Walker has presented here today.

It doesn't mean that you don't have to do a lot on spending. You have to do an enormous amount on spending just to keep things from getting completely out of hand. And eventually, of course, we do have to probably transform the healthcare system and the pension system in the United States because those numbers just keep going up isotonically. So we all know that. But the question is in the real world that we're looking at, given the possibilities for policy change, what are we looking at over the next 10, 15, 20 years.

And the conclusion we came to is we're looking at a situation where after doing as much as we can on spending we're still going to need some additional revenues. One of the reasons for that which Iris referred to just a couple of moments ago is that historically one of the ways in which fiscal regimes get really out of whack and get into a lot of trouble is by not recognizing early enough that you have a problem, by having a dysfunctional government that cannot deal with the problem so that the deficits continue to grow, the debt service continues to grow, it feeds upon itself, and the debt service begins to explode and that is what drives an enormous increase in the ratio of spending to GDP rather than the programmatic side.

One of the major virtues of doing something on revenues in a timely manner and not waiting until it's gotten completely out of hand is that you can keep that debt service burden from growing as rapidly as it otherwise does and you can thereby buy some time which, again, not being an idealist about what we can do about the healthcare system, it buys you some time to actually try and do something about spending smarter in terms of healthcare and other programs.

Let me just say in closing that the CED report is available outside and I'd be happy to talk to anybody else. Joe will autograph the copies but I'd be happy to talk to anybody about it and I hope you will take a look at it. Thank you.

MR. IRONS: Just one question, one point. My name is John Irons. I'm with the Center for American Progress. I just have one quick point and then one question, perhaps.

The quick point is that I'm thoroughly in the we need more revenue camp but I think there's a question about who the revenue comes from and the distribution does matter and the question is where do you raise the money from, and you can't have reform that raises revenue from people at the top end while still keeping people at the lower middle end either reducing their taxes or keeping them the same. So I think distribution is a part of this mix and this hasn't been mentioned today so I thought I would throw it out there.

And the question that I want to ask which is I think half serious, I'm not quite sure how serious a question it is, but it's more to conservative people on the panel. The question is would you rather see revenues increase under current leadership, current conservative president, conservative Congress, or would you rather put that off until there's perhaps a change in philosophy at the top and then do revenue increase. If we assume that some revenue increase is inevitable do we do it now or do you want to see it done later?

MR. BERGIN: Bill.

MR. NISKANEN: My preference is to address the question of revenues in conjunction with addressing what we do about Social Security and Medicare and so forth. When we either have a Democratic president or the Democrats control at least one house of Congress. Those are the only conditions, I think, in which the Democrats will acknowledge there's a problem. They have not been willing to acknowledge there's even a problem with Social Security and Medicare when they think that they're in a strictly bipartisan opposition.

We had a lot of support for major reform in Social Security during the Clinton administration at both the congressional level and the White House level but that all disappeared with one of the impeachment hearings initially and then with the election of George Bush. So my preferred schedule is that we don't take up the question of what to do about Social Security and Medicare and the revenues until probably '07, when I think the Democrats will control at least one house of Congress, or '09, when they're very likely to be elected president.

So that is still a fairly early time period but I want the revenue question to be addressed in response to the particular problems of these programs that have these huge deferred implicit liabilities.

Final point, I don't think that it is very productive to talk about the optimal size of the government in the abstract. Yes, it does depend very much on what the money is spent for. Yes, it depends very much upon how the money is raised. But we cannot, I think, make an intelligent decision or have any basis for consensus by saying whether 20 percent or 10 percent or 50 percent is better unless we specify where the money is spent and how the money is raised.

I think these issues should be addressed program by program. That's the only way that you can address it intelligently and I think that the problem is that we have to address the revenue side and the program side in the same context.

Now I want to agree with Iris on one matter and disagree with her on another matter. I want to agree with her that we have to think about a very different structure of the way we provide healthcare if we're going to keep this thing under control. The biggest thing that has happened in this area in the past 50 years is that we now spend something like 85 percent of healthcare spending through third parties. That was not the case 50 years ago or 40 years ago, for that matter, and that's the biggest change that we have to think through and reevaluate.

Second, I think, however, I disagree with you on the fact that expected lifetimes are significantly longer is a big policy-relevant change. For the most part we are younger longer, not older longer, and what we have to do is to change our rules both in the public sector and the private sector to recognize, to reflect, that we are younger longer rather than older longer. We are not necessarily going to be an increased burden on whoever's paying the taxes at the moment if in fact we can work longer, we're healthier, and so forth, rather than this image somehow that we're all going to be in nursing homes for the last five years of our lies.

So let's address these issues program by program, recognizing that we have to address both the revenue side and the structure of the program concurrently. Let's do it fairly soon. I don't think there's any meaningful prospect of doing it, however, until we have a government that is more balanced on a partisan basis. In this respect I must acknowledge that I think the current Bush administration is one of the worst administrations in my adult lifetime.

MS. LAV: Can I respond quickly to the younger longer? We in this room are younger longer. If your job is working in a mine or scrubbing floors or lifting things that are 100 pound weight you are not younger longer and it's a really difficult problem to adjust the policy to take care of us and take care of them at the same time.

MR. NISKANEN: But at the same time there are far fewer people in those kinds of jobs. The number of people who are at physically challenging jobs is a much smaller proportion of the population than it's ever been.

MS. LAV: It is but it's very hard to create policy that takes care of both.

MR. BERGIN: I can actually make a point here, having worked in a copper mine. The conditions that miners work in are safer now than they were in the '20s or the '30s. We were very well protected back in a prior life when I dug ditches.

MS. LAV: It's hard to do when you're 65.

MR. BERGIN: I believe you were here first. I'll get to you, Dan, I promise.

MR. BIXBY: Bob Bixby with the Concord Coalition. I am of the church of deficit hawks and we welcome all newcomers. We'll be having a revival meeting soon. By the way, I do my own taxes also but I am a lawyer so that's a problem.

I agree with Bill Niskanen in the idea of combining these, I mean, looking at them together. I have a problem looking at tax reform in the abstract. If the reason to do it is to make the system more efficient or close loopholes that's fine. I don't see any reason why that should be revenue neutral.

I mean, if you're closing loopholes that shouldn't exist why not do that and if it raises revenue, fine, but fundamental tax reform ought to be considered in context with the growing healthcare and pension problem, Social Security, the entitlements because I don't see how you can really do it otherwise.

We're going to need more revenues and I don't see that it's politically feasible to do a tax reform commission report that calls for higher revenues without at the same time addressing the long-term spending problem because (a) I think it would be politically problematic and (b) I think it would take pressure off making some harder choices on the spending side.

So I think in the long term you need to have both of those things on the table at once and I do think they should both be on the table because we're going to have to make some aggressive changes, I think, in the entitlement programs and we're going to have to raise revenue.

In 1995 there was this Kerry-Danforth commission and it was called The Entitlement and Tax Reform Commission. It had the right title but as soon as they got going it was all on entitlements and not hardly anything on tax reform because it was just too big a thing to get our arms around. But 10 years later I think that's really the type of thing we need is to consider them in the abstract because I don't see how you get the revenues if you don't put the spending cuts on the table.

One thing just on Dan's point about the size of government, we could argue about whether we should be balancing at 30 percent of GDP or balancing at 18 percent of GDP but I don't think anybody in their right mind would think that we should tax at 18 percent of GDP and spend at 30 percent and that's about where we're headed because, as Dan points out, the deficits will kill you before you get too far. So, I mean, that's just the basic fundamental problem that we need to address. We're not raising enough revenue to pay for the commitments and, bringing those two things in line, I think you can't really do tax reform unless you consider that fundamental problem.

MR. BERGIN: Dan, I'm going to finish with you.

MR. MITCHELL: Well, I was just going to respond to the question for the conservative members of the audience about who would I rather have raise taxes and I agree with Bill that having complete Republican control has not been a good thing. It's proving Lord Acton's point about power corrupts and absolute power corrupts absolutely though I'm talking about philosophical corruption, not Tom DeLay type stuff, which I don't know anything about.

I also think there's another component of that in addition to what Bill said. Parties like to try to deflect what they perceive as their weakness and, for instance, when you had Democrats completely in charge of everything during Bill Clinton's first two years we got a tax increase but we also had remarkably slow growth in government spending. And if we actually mimic that for the next five or six years we'll probably have a balanced budget.

So Democrats realized that it would be a vulnerability if not only were they raising taxes but also raising spending and so they did everything they could to be responsible on the spending side and likewise I think one of the reasons why Republicans have been increasing spending faster than LBJ is they feel well, we don't want to be accused of being coldhearted, evil people, and so there probably is something to the fact that if we had bipartisan government and even though I obviously wouldn't ever want a tax increase but at least if that was going to happen I'd want to get something out of it and I certainly wouldn't trust Republicans to do it right if they were in complete control of the process.

MR. BERGIN: Let me end this on time. I thank everybody here, the panelists, another great discussion. I will consider having the next one either under a tent or in a church. It seems to be appropriate. Thank you, all.
(Whereupon, at 11:01 a.m., the PROCEEDINGS were adjourned.)

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