[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
PAYING DIVIDENDS: HOW THE PRESIDENT'S
TAX PLAN WILL BENEFIT INDIVIDUAL
INVESTORS AND STRENGTHEN
THE CAPITAL MARKETS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
OVERSIGHT AND INVESTIGATIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
MARCH 18, 2003
__________
Printed for the use of the Committee on Financial Services
Serial No. 108-12
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2003
89-079 PDF
For Sale by the Superintendent of Documents, U.S. Government Printing Office
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice JULIA CARSON, Indiana
Chairman BRAD SHERMAN, California
RON PAUL, Texas GREGORY W. MEEKS, New York
PAUL E. GILLMOR, Ohio BARBARA LEE, California
JIM RYUN, Kansas JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois CHARLES A. GONZALEZ, Texas
WALTER B. JONES, Jr., North MICHAEL E. CAPUANO, Massachusetts
Carolina HAROLD E. FORD, Jr., Tennessee
DOUG OSE, California RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois KEN LUCAS, Kentucky
MARK GREEN, Wisconsin JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania WM. LACY CLAY, Missouri
CHRISTOPHER SHAYS, Connecticut STEVE ISRAEL, New York
JOHN B. SHADEGG, Arizona MIKE ROSS, Arkansas
VITO FOSELLA, New York CAROLYN McCARTHY, New York
GARY G. MILLER, California JOE BACA, California
MELISSA A. HART, Pennsylvania JIM MATHESON, Utah
SHELLEY MOORE CAPITO, West Virginia STEPHEN F. LYNCH, Massachusetts
PATRICK J. TIBERI, Ohio BRAD MILLER, North Carolina
MARK R. KENNEDY, Minnesota RAHM EMANUEL, Illinois
TOM FEENEY, Florida DAVID SCOTT, Georgia
JEB HENSARLING, Texas ARTUR DAVIS, Alabama
SCOTT GARRETT, New Jersey
TIM MURPHY, Pennsylvania BERNARD SANDERS, Vermont
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
Robert U. Foster, III, Staff Director
Subcommittee on Oversight and Investigations
SUE W. KELLY, New York, Chair
RON PAUL, Texas, Vice Chairman LUIS V. GUTIERREZ, Illinois
STEVEN C. LaTOURETTE, Ohio JAY INSLEE, Washington
MARK GREEN, Wisconsin DENNIS MOORE, Kansas
JOHN B. SHADEGG, Arizona JOSEPH CROWLEY, New York
VITO FOSSELLA, New York CAROLYN B. MALONEY, New York
JEB HENSARLING, Texas CHARLES A. GONZALEZ, Texas
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
TIM MURPHY, Pennsylvania JIM MATHESON, Utah
GINNY BROWN-WAITE, Florida STEPHEN F. LYNCH, Massachusetts
J. GRESHAM BARRETT, South Carolina
C O N T E N T S
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Page
Hearing held on:
March 18, 2003............................................... 1
Appendix:
March 18, 2003............................................... 51
WITNESSES
Tuesday, March 18, 2003
Castellani, John J., President, The Business Roundtable.......... 37
Fisher, Hon. Peter R., Under Secretary for Domestic Finance,
Department of the Treasury..................................... 4
Gramm, Hon. Phil, Vice Chairman and Managing Director, UBS
Warburg, LLC................................................... 18
Lazio, Hon. Rick, President and CEO, Financial Services Forum.... 35
Moore, Stephen, President, Club for Growth....................... 41
Orzag, Peter, Joseph A. Pechman Senior Fellow in Economic
Studies, The Brookings Institution............................. 39
Rayburn, Bobby, First Vice President, National Association of
Home Builders.................................................. 44
Spriggs, William E., Executive Director, National Urban League
Institute for Opportunity and Equality......................... 42
APPENDIX
Prepared statements:
Kelly, Hon. Sue W............................................ 52
Oxley, Hon. Michael G........................................ 54
Fosella, Hon. Vito........................................... 55
Hinojosa, Hon. Ruben......................................... 56
Shadegg, Hon. John B......................................... 58
Castellani, John J........................................... 60
Fisher, Hon. Peter R......................................... 73
Gramm, Hon. Phil............................................. 76
Lazio, Hon. Rick A........................................... 79
Moore, Stephen............................................... 81
Orszag, Peter R.............................................. 93
Rayburn, James R............................................. 101
Spriggs, William E........................................... 112
Additional Material Submitted for the Record
Kelly, Hon. Sue W.:
``A Boon to Ordinary Investors; Eliminating the dividend tax
is just what the economy needs.'' The Washington Post,
March 11, 2003............................................. 118
Defending the Dividend, Securities Industry Association...... 121
Estimated Impact of the Major Components of the Bush
Administration's Growth and Jobs Plan on Housing and the
Economy, Mortgage Bankers Association of America........... 135
President's Jobs and Economic Growth Plan: The Benefits of
Ending the Double Tax on Dividends......................... 171
Pricewaterhouse Coopers letter to The Business Roundtable,
January 21, 2003........................................... 172
Report of Investigation of Enron Corporation and Related
Entities Regarding Federal Tax and Compensation Issues, and
Policy Recommendations, Joint Committee on Taxation........ 177
A Recommendation for Integration of the Individual and
Corporate Tax Systems, Department of the Treasury.......... 198
Strengthening America's Economy, The President's Jobs and
Growth Proposals, Council of Economic Advisors............. 225
Tax Break, Tax Notes, January 20, 2003....................... 234
PAYING DIVIDENDS: HOW THE PRESIDENT'S
TAX PLAN WILL BENEFIT INDIVIDUAL
INVESTORS AND STRENGTHEN
THE CAPITAL MARKETS
----------
Tuesday, March 18, 2003
U.S. House of Representatives,
Subcommittee on Oversight, and Investigation
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to call, at 3:10 p.m., in
Room 2128, Rayburn House Office Building, Hon. Sue Kelly
[chairman of the subcommittee] presiding.
Present: Representatives Kelly, Hensarling, Garrett,
Murphy, Brown-Waite, Barrett, Oxley (ex officio), Inslee,
Moore, Crowley, Hinojosa and Sherman.
Chairwoman Kelly. [Presiding.] The hearing will come to
order please.
The September 11 terrorist attacks and the end of the
telecom and Internet bubbles, the corporate accounting
scandals, and now the uncertainties accompanying war have left
Americans feeling uncertain about their economic future.
Business investment has been flat or down for about two years
now. Only consumer spending has kept the economy afloat. Now,
there are signs that consumer confidence is down to the 1992
levels.
President Bush's plan to eliminate the dividend tax is a
sound, common sense approach to growing this economy. Cutting
taxes and encouraging consumer spending and investment is the
way to go. We want to create jobs. We need to spur growth. That
will only happen by letting American investors keep more of
their own money and giving them incentives to invest it in this
economy.
For millions of individual Americans, encouraging
investment means encouraging the purchase of stock, which has
been the best long-term return of any investment. Half of all
American households, more than 84 million individual investors,
already own stock directly or through mutual funds. Today,
millions of Americans of all income levels receive dividends
from stock. In fact, 45 percent of all dividend recipients make
under $50,000 per year. I am going to repeat that, because that
is important for people to understand--45 percent of all
dividend recipients make under $50,000 per year. Three-fourths
make less than $100,000 per year.
The problem is that America has the second highest dividend
tax rates among the 26 most developed nations in the world,
second only to Japan. So it only stands to reason that if we
need more corporate investment, we need to reduce the tax rate
on the dividends which we receive from corporate stock. Those
dividends are already taxed when the corporation earns income.
It is fundamentally unfair for us to pay more taxes on that
income.
Another reason we need to end double taxation is to help
our seniors live more independent lives. More than half of all
dividend income goes to America's seniors, many of whom rely on
these checks as a steady source of retirement income. More than
nine million seniors would receive an average of $991 in tax
relief in 2003 if they did not have to pay income tax on those
dividends. Maybe there was a day when ending double taxation
would have helped a small handful of rich, privileged
Americans, but with 84 million individual investors owning
stock, those days are over and it is time to bring economic
thinking into the 21st century.
Our witnesses today will discuss the increases in corporate
investment, the hundreds of thousands of new jobs, and the
improvement in the quality of life for seniors and all
individual investors that will result from passing President
Bush's proposal to end the double taxation on dividends. But
there is yet another reason for ending double taxation of
corporate dividends. On December 12, 2001, I co-chaired the
first congressional hearing examining corporate fraud and
mismanagement at Enron.
Investigations by law enforcement and by this and other
congressional committees found that senior Enron management
intentionally twisted its corporate finances to hide billions
of dollars in debt from investors.
A massive and detailed report released last month by the
bipartisan Joint Committee on Taxation shines a special light
on Enron management's sordid actions. Part of the report lays
out how Enron raised over $800 million through hybrid financial
instruments called tiered preferred securities, which were
specifically designed to be treated as debt for income tax
purposes and as equity on their books. So Enron could deduct
corporate interest payments on its tax returns without
revealing its debt service on consolidated financial returns. I
have provided copies of this section of the report to the
members and to our witnesses, and I invite your attention to
the last two pages in which the Joint Economic Committee stated
four recommendations for dealing with tiered preferred
securities.
The very last recommendation states, and I quote, ``reduce
or eliminate the disparate taxation of interest and dividends
for both insurers and holders of financial instruments that
creates the market for hybrid financial instruments.'' By
providing more equivalence in the tax consequences of debt and
equity, this approach would eliminate tax considerations from
the process by which corporate taxpayers decide to obtain
financing.
Now, certainly the most important factor in Enron's demise
was plain old greed, but the lesson from this bipartisan
report, and it was hailed by members on both sides of the aisle
and in both parties in both Houses, if we do not want anymore
Enrons gaming the system to line their pockets, one step we can
take is to end the double taxation on dividends. Ending double
taxation is not a panacea for the stock market's ills, but it
would add to this committee's record as the home of sound
corporate governance on Capitol Hill.
Numerous Presidents as far back as Franklin Roosevelt have
proposed ending the double taxation of dividends, but the
proposal always seems to get caught up in outdated, tired class
warfare arguments. For the sake of our economy, for the sake of
our seniors, for the sake of our financial markets and our
investors, Congress should support the President's plan to end
double taxation of dividends.
Several members of the full committee who are not on this
subcommittee have asked to give opening statements today. I am
not sure that they are all here, but for those who are, I ask
unanimous consent that all members participating today can give
opening statements and insert them into the record.
With that, I turn to you, Mr. Sherman.
Mr. Sherman. As American troops head toward Iraq, it is a
shame that when Americans should be coming together, we have
these hearings which represent nothing more than something to
divide America along class lines--a declaration of class
warfare against American working families. Roughly 40 years
ago, the corporate income tax, the alleged first of the two
payments on corporate income, represented over 4 percent of our
GDP. Now, it is below 1.5 percent because we should be in this
Congress addressing the incredible loopholes that have made the
corporate income tax a fiction, and have given the lie to the
idea that corporate profits are taxed twice, for if this bill
goes forward they will be taxed not even once.
Now, this sneak attack, this class warfare against American
working families, is not being done under the cover of
darkness. Rather, it is under the cover of saying that anyone
who resists it is starting a class warfare division of
Americans. We in America had reached some consensus as to
dividing the burdens of government among the economic classes,
until the President came forward with this weapon of mass
destruction against that accommodation. You see, 70 percent of
the benefits from this will flow to the top 5 percent of
Americans. Stated another way, the top .02 percent of tax
filers will receive nearly as much benefit from this cut as 95
percent of Americans, and do not tell me about the elderly
without mentioning that 75 percent of the benefit goes to those
seniors with incomes of over $75,000, while those seniors with
incomes below $50,000 receive only 4 percent of the benefit.
This is class warfare covered by deft use of statistics;
covered by an attempt to intimidate those who would shine a
light on it by saying we are waging class warfare. Keep in
mind, a lot of Americans own stock, but an awful lot of those
own stock only through their 401(k) or IRA. They get no
benefits.
This is also an attack on the American economy. It is an
anti-investment proposal. It says if a corporation is thinking
of building a new factory, hopefully in America, and instead
they are pressured by their shareholders to distribute that
money so that the shareholders can afford the new $350,000
Mercedes, that is an improvement to the American economy. It
takes money available from corporate investment and moves it
further away from corporate investment. A policy this bad could
not stand the light of day. Fortunately, these hearings are
basically stacked with witnesses that will present pretty much
one side.
I yield back.
Chairwoman Kelly. Thank you.
We have three panels today, and I am hopeful that members
will keep to the five-minute rule.
Mr. Hensarling, have you an opening statement? Mr. Murphy?
Mr. Garrett, have you an opening statement? Ms. Brown-Waite?
Mr. Inslee, have you an opening statement? If there are no more
opening statements, then I will introduce our first witness,
Mr. Peter Fisher, Under Secretary for Domestic Finance at the
Treasury Department.
We thank you for testifying before us today, and I welcome
you on behalf of the committee. Without objection, your written
statements and any attachments that you have will be made part
of the record. You will now be recognized for a five-minute
summary of your testimony. As you I am sure know, when the
light changes color from green to amber, that is the time you
need to put your own timer on, because when it blinks red, your
time is over. Please begin, Mr. Fisher. We welcome you here
today.
STATEMENT OF HON. PETER R. FISHER, UNDER SECRETARY FOR DOMESTIC
FINANCE, DEPARTMENT OF THE TREASURY
Mr. Fisher. Thank you for the opportunity to be here today
to testify on the President's jobs and growth package.
Let me focus my summary on two issues and try to pick up a
third. First, the President's overall package is the right
prescription for the macroeconomic circumstances that we face
today, because it would support consumption and promote
investment on a balanced, enduring basis. Second, by enacting
the President's proposal to tax corporate income once and only
once, this Congress has the opportunity to make the single
biggest improvement in the efficiency of capital investment in
our economy.
First, our macroeconomic challenge. In my view, the United
States is not just facing another swing of the business cycle,
but the aftermath of the extraordinary events of the 1990s, as
you, Madam Chairwoman, described. The Federal Reserve monetary
policy, global economic integration, telecommunications
advances combined to fuel real prosperity and higher
productivity, but investors' overestimation of their impact
contributed to a stock market bubble. We continue to live with
the disinflationary consequences and the destruction of
trillions of dollars in household wealth as the bubble burst.
Under these circumstances, using fiscal policy to deliver
only a short-term stimulus would be a mistake. The American
people are smart enough to distinguish between a one-off
injection of cash and an enduring improvement in their
disposable income. When consumers refinance their mortgages at
lower rates, they gain an enduring improvement in household
cash flow. The same would be true of bringing forward to this
year the tax rate reductions the Congress has already approved
that are scheduled to come in later in the decade. Together
with eliminating double taxation of dividends, these
acceleration proposals would put cash in people's pockets right
away and in the future.
The scale of the President's package is central to
accelerating growth and job creation. Over the next decade,
U.S. economic output is projected to total $142 trillion,
generating something on the order of $27 trillion or $28
trillion in federal revenues. The President's jobs and growth
package would reduce taxes by $695 billion over that period,
scored with static macroeconomic effects. To have an impact on
our economy, fiscal policy needs to be large enough to move the
needle on the economy.
In the past year, Congress, under Chairman Oxley's and
Senator Sarbanes' leadership, took a major step toward
improving our capital markets performance. Better run, better
disclosing corporations make for better capital markets, but
there is more to be done to provide the right incentives for
corporate executives. By double taxing profits, but not
interest, our tax code encourages executives to retain earnings
instead of paying them to shareholders, to favor debt over
equity finance, and to dedicate some of America's leading minds
to tax alchemy instead of value creation.
By imposing a higher marginal rate on profit, our tax code
thins the vital blood of economic growth, risk capital. No
other major industrial nation taxes profits at such a punitive
effective rate. We have learned since recent testimony that the
Japanese have made some changes, so they are no longer number
one. We are, according to information I was told about from the
Japanese embassy. The President's proposal would reduce that
bias.
A prime benefit would be to raise the burden of proof on
corporate executives if they wish to retain profits instead of
sending them to shareholders. Under the proposal, shareholders
would be tax neutral between reinvesting profits in the best
projects a company could offer versus the best projects that
the market could offer. Today's tax code cordons off that
choice inside the company. Some corporate executives may prefer
today's tax code, which places a less onerous burden on them
for justifying their decisions to retain earnings. Yet
corporations exist to serve shareholders, and our tax code
should reflect this.
The impact on capital efficiency of freeing this boxed-in
capital may be huge. Each year, American firms invest over $1
trillion in fresh capital and generate $700 billion to $800
billion in corporate profits. Think of the capital gains
utilization and job creation if we accelerate and re-target
this investment. The financial and economic markets will reap
huge collateral benefits.
Let me conclude by saying if dividends are suddenly a tax
efficient way for paying shareholders, executives will have
fewer arguments to justify cash mountains and share buy-backs,
which a critic may be tempted to note, offer the insider
benefit of boosting the value of executive stock options.
Because the President believes that profits should be taxed
once, but only once, the company's payment of tax actually
accrues as an asset to shareholders. In such a world where
corporations paying tax on dividends reduces shareholders' own
tax liability, the rationale for corporate inversions would
dissipate.
Thank you, Madam Chairman. I look forward to the
committee's questions.
[The prepared statement of Hon. Peter R. Fisher can be
found on page XX in the appendix.]
Chairwoman Kelly. Thank you very much, Mr. Fisher.
I have just a couple of questions for you. How many new
jobs do you think would be created over the next five years by
eliminating the double tax penalty on dividends? And how much
economic growth do you see that as promoting?
Mr. Fisher. There are a number of different studies, the
administration's numbers that the CEA has put out, that 1.5
million approximately new jobs, 1.4 million by the fourth
quarter of next year. I know that there are studies by the
Business Roundtable suggesting that perhaps 500,000 jobs will
be added to total jobs over the coming years. There are a
number of different estimates.
Let me, though, stick my neck out a little bit. Forecast
models are very bad at dealing with changes in behavior. What
we are trying to do is re-engineer a profound change in
behavior on the part of corporate executives. When we do that,
I am confident we are going to have a bigger impact on job
creation than anyone's forecast, anyone's model is prepared to
project. I think both in terms of job creation in our economy,
the numbers we are looking at from static modeling, will
understate it, and they will understate it because they do not
take into account the break in habit from accelerating the
investment process.
Chairwoman Kelly. If the tax penalty on dividends was
removed, would it reduce the use of Enron-style accounting
gimmicks and improve corporate governance, as it appears from
the report by the Joint Committee on Taxation?
Mr. Fisher. Yes, I think it would have a profound impact,
especially if we do it as designed by the President. If you go
back to the mid-1960s, 75 percent of large companies paid
dividends in America. Today, it is about 25 percent. If we can
re-direct corporate America to cash-flow rather than managed
earnings, that will be the biggest thing we can do to improve
corporate governance and avoid a lot of the shenanigans, some
legal, some illegal, which we know have gone on in corporate
America.
I think that we also by leveling the playing field between
debt and equity, we will increase equity in the system,
reducing the risk of bankruptcy, and we will reduce the risk of
what I call managed stock option plans. We know stock options
are a legitimate tool of employee compensation, but where I
think some companies have gone too far is using the stash of
retained earnings to justify share buy-back programs, to
engineer share prices higher to offset the dilutive effect of
stock options they have granted. This became a self-justifying
prophecy. We need to lean against that and make corporate
management either justify their investment internally or pay
the money out to shareholders.
Chairwoman Kelly. I have another question for you. I think
I still have a little time here.
As I said in my opening statement, more than eight million
seniors would get almost $1,000 in additional income a year if
they did not have to pay income tax on the dividends. What
impact do you think that would have on their lives? And do you
think that corporations would be more likely to increase their
dividend payouts or would it stop seniors from getting short-
changed by the dividend penalty that they now pay? That is
really a triple question.
Mr. Fisher. Yes, I am trying to keep track of all that. We
know that 40 percent of tax filers, as you have said, a high
number of them that receive dividend income have incomes under
$40,000, and among seniors, 40 percent of dividend recipients
have incomes below $30,000. Keeping the dividend income streams
coming, and reducing the tax burden, is a very short-run effect
which gives them a boost to their income.
Again, I want to go back to thinking about if we can unwind
the clock either 10 or 20 or 30 years, and double or triple the
number of dividend checks that are mailed, we will have a much
greater impact than any of these static numbers we are looking
at. While we do not expect that to happen in any one or two
year scenario, over time as corporations have a reduced
incentive to hang onto earnings, a greater incentive to pay
dividends out, then there will be even more dividend checks
flowing to seniors and other Americans.
Chairwoman Kelly. One more quick question. If we end the
double taxation on dividends, how do you see that as changing
the incentives on the pool of retained earnings? I think you
talked about that--the incentives regarding the behavior with
the pool of retained earnings. You talked about that in your
testimony a little bit.
Mr. Fisher. I think that what it will do--I want to be very
clear. The President's proposal is about leveling the playing
field. We have taken some criticism from some quarters that it
is complicated. One provision that I admit adds to the
complexity is that we want it to be a level playing field
between retained earnings and dividends. So I think it does not
distort the incentive structure. It means management of
companies should make economic judgments about whether they
want to reinvest in their business or pay the money out to
shareholders. But it equalizes the hurdle rate, if you will, on
internal investment and external investment. That will speed up
the investment process.
Let me just add, if I could, that one of the great
strengths of our economy that the rest of the world is envious
of is the efficiency of our investment process. Here, we have
something which we know creates a huge distortion in that
process. I know of no principled argument in favor of our
current structure. There are arguments about transition costs,
but I do not hear anyone arguing in favor of the current
structure that we have. If we can eliminate this, we are going
to accelerate investment, business formation, and job creation
in America.
Chairwoman Kelly. Thank you. My time is up.
Mr. Inslee?
Mr. Inslee. Thank you, Mr. Fisher.
When did you or your department determine that this was
such a tremendous idea? When did you make that decision?
Mr. Fisher. I have been, about me personally, I have since
the mid-1990s, and observing the acceleration of retained
earnings inside corporate America, it then seemed to me most
clear that this was creating a major distortion in our capital
structure.
Mr. Inslee. Just roughly, when did your administration
propose this in the last year or so?
Mr. Fisher. The President proposed it the first week of
January of this year. There were many discussions between our
tax policy shop over the last year, working on different reform
proposals.
Mr. Inslee. And there have been some changes since then in
our both world and economic conditions, haven't there?
Mr. Fisher. There continue to be a lot of uncertainties
about the economic outlook.
Mr. Inslee. Let me just mention a couple of them. Number
one, we are starting a war in a couple of days and it is going
to cost $100 billion just to start. And then it is going to on
for years as we occupy Iraq--in the billions of dollars. We
have had a recession which have reduced federal revenues
dramatically, which since your department came up with this
grand scheme, has left the U.S. economy in shambles because we
have over a $300 billion deficit this year likely, in part
because of the previous revenue reductions that your
administration passed.
I want you to think about the fact that since you came up
with this idea, we have had a war; we have got people from my
district who got on the USS Rodney Davis, it is a frigate, last
weekend to go steam into harm's way, and the 8th hospital unit
of the Bangor Military Naval Hospital. They believe, like John
F. Kennedy, that we should be willing to, ``pay any price, bear
any burden, meet any hardship, support any friend, oppose any
foe, in order to assure the survival and the success of
liberty.''
But your administration believes that while we have a war
overseas, it is okay to have a fiscal party at home. A lot of
my constituents believe this is grossly irresponsible. It would
be the first administration in American history to propose a
major league tax cut in the middle of starting a war. I would
like you to respond to their concerns as to how that is
responsible, when we ask our men and women to go into harm's
way next week, that you want to have this fiscal largesse at
home.
Mr. Fisher. Sir, I do not think it is irresponsible. As I
look back over the history of the last 50 years, I see that
federal task revenues as a share of GDP in our economy peaked
at 21 percent in 1944--the last year of the Second World War.
From 1960 to 2000, through five Democratic and five Republican
administrations, federal revenues as a share of GDP has
oscillated in a corridor between 17 and 21 percent, with a very
tight average around 18.5 percent.
Mr. Inslee. So you think it is responsible even though we
start a war, we increase our expenditures over $100 billion, we
increase our deficit over $300 billion--it is still
responsible, you believe, to grow our federal deficit at the
same time you are handing out tax cuts? You believe that is
responsible, to have deficits in the $300 billion range, at the
same time you are increasing expenditures to a war; at the same
time you want to increase these tax cuts? You believe that is
responsible fiscal behavior?
Mr. Fisher. I think fiscal policy needs to focus on making
sure our economy grows both now and over the coming 10 years.
Mr. Inslee. So how do you explain it to our children? How
do you explain it to our children?
Mr. Fisher. There is nothing more important to our
children's financial success than that we grow this economy
over the coming decades as rapidly on a sustainable basis as we
can. That is where federal revenues come from, to pay for all
of the priorities which Congress votes when you enact outlays.
Mr. Inslee. Let me explain and convey to you my three
children's belief. They are not happy that your administration
is putting onto their shoulders a chronic debt burden. They are
not happy that 14 percent of all the taxes they pay goes to pay
the debt tax. Fourteen percent of all the taxes my son, who is
a carpenter, pays goes to pay a debt tax to service the debt
that you are increasing, you are exploding on his shoulders. He
does not think it is responsible. I do not think it is
responsible either, and if you want to go ahead and comment, go
ahead.
Mr. Fisher. We disagree, I guess, sir.
Mr. Inslee. We agree that we disagree. Thank you very much.
Chairwoman Kelly. Thank you.
Mr. Oxley?
Mr. Oxley. Thank you, Madam Chairwoman.
It is good to have you here again, Mr. Fisher, and also I
want to ask unanimous consent that my full statement be made
part of the record, and also while I am at it, welcome our
former colleague and friend, Senator Gramm, who will be on the
next panel, as well as former member and a member of this
committee, Rick Lazio, who will be on the third panel, along
with some other distinguished members.
I am sorry my friend from Washington left. I was interested
as to why he might oppose 431,000 jobs in the private sector,
higher wages, I assume for his constituents, as well as mine;
tax relief, particularly for senior citizens; a very positive
impact on the stock market--as a matter of fact, probably a 10
percent increase minimum. I know that the gentleman from
Washington state voted for the Sarbanes-Oxley proposals, which
brought about better corporate governance. Clearly, as you
indicated, Mr. Fisher, the impact on corporate governance would
be a very positive one by eliminating the double taxation on
dividends, creating a much better climate and a much better
incentive within the corporate structure; and of course
international competition, which means more exports for the
United States.
So that is a pretty good record of what we can accomplish
by eliminating the double taxation of dividends. I guess I
would not want to be on the other side of that issue. I feel a
lot more comfortable with a pro-growth package that would
provide the kind of incentives and the kind of positive
developments that would be brought about.
I asked Chairman Greenspan when he was here two or three
weeks ago about his opinion on the elimination of double
taxation of dividends. He was very positive--as a matter of
fact, so positive that we did a ``dear colleague'' quoting
directly from Chairman Greenspan. We may do the same with your
testimony, and we appreciate the efforts.
Let me ask you, as you know, the telecom and high-tech
sectors have been hit particularly hard. They are not making
any money. Their earnings dropped precipitously in 2001 and
2002. As a result, they may not be able to take advantage of
the dividend exclusion proposal, which would disincentivize
their shareholders. Has there been some consideration given to
expanding the proposal to permit companies in these
circumstances to apply their average tax liability over, say, a
five-year period to guide issuance of tax-free dividends to
their shareholders?
It appears that of all of the sectors, perhaps, in our
economy, the tech sector and telecom have been hit the hardest,
and reflected certainly in their earnings and in their growth,
and obviously a negative effect on their shareholders. Has
Treasury given any thought to that proposal?
Mr. Fisher. I do not believe there has been work done on a
five-year carry-back, carry-forward. I know there is some work
going on there in the tax policy shop. I do not think, though,
they have been looking at it on that long a horizon, but I
would be happy to talk about it with them and get back to you.
Mr. Oxley. There has been some discussion about something
less than a five-year?
Mr. Fisher. We have heard from a lot of people wanting us
to focus on that. There are discussions. I am not sure what the
reaction is to the different proposals. I have not yet heard of
any as long as five years, but I would be happy to get back to
you, Mr. Chairman, after talking with our folks in tax policy.
Mr. Oxley. Getting back to the issue of corporate
governance, you and I were comrades-in-arms on some of these
issues. As we look back on an Enron, for example, and as you
know, this committee had the first hearing on Enron. It became
quite evident, I think, to the committee that Enron was in a
situation where they were desperately trying to bury and hide
debt through SPEs--special purpose entities. To what extent do
you think the tax code may have lent itself to some of the
rather strange behavior that took place at Enron, particularly
over the last year and a half?
Mr. Fisher. I think there are at least three different
channels, I would say, of regrettable incentive structures that
the tax code puts in play. One is simply the debt equity ratio
issue of encouraging companies to be more levered than they
might otherwise be, given the tax disadvantage currently in
place. The remedy would address, if we unwound this, we would
get companies and give them another incentive to focus on cash
flow, rather than managed earnings. I think that that is now we
are getting toward the heart of some of the issues that came up
in Enron, where they went further and further off into the
wilderness of managed earnings.
The third is managing tax liability as aggressively as they
apparently did, is another sort of third dimension that this
comes up. The remedy the President has put forward, this plan
puts in place, as I was beginning to elaborate, is that it is
really a fundamental change in thinking that corporate America
would have to go through to think of the payment of corporate
taxes as a shareholder asset. Instead of having every incentive
to maximize tax shelters of every flavor and stripe, once we
put in place what the President has proposed, the company has
an incentive to think of the taxes they pay at the corporate
level as offsetting taxes for the shareholder, and there as a
shareholder asset.
So in those three different channels, I think we would be
driving really at the heart of some of the behavioral problems
that came up.
Mr. Oxley. Thank you.
Thank you, Madam Chairwoman.
[The prepared statement of Hon. Michael G. Oxley can be
found on page XX in the appendix.]
Chairwoman Kelly. Thank you.
In the absence of subcommittee Democrats, I am turning to
Mr. Hensarling.
Mr. Hensarling. Thank you, Madam Chair. I hope I am not
supposed to give their side of the story.
[Laughter.]
Chairwoman Kelly. No, take your pick. You can do whatever
you want. This is an educational forum, if you will.
Mr. Hensarling. Mr. Fisher, one of my colleagues from
across the aisle, who is absent now, spoke quite passionately
about his children and future deficits. I, too, am a father. I
have a one-year-old and another on the way, and I am very
concerned about leaving them a legacy of debt, because I want
to leave them a legacy of freedom and opportunity.
The gentleman spoke about deficits. Can you tell me how the
tax relief in the President's package is scored for fiscal year
2004? Isn't it approximately $100 billion?
Mr. Fisher. Yes, it is about $100 billion. Yes, about $100
billion in terms of the jobs and growth package.
Mr. Hensarling. And the administration has proposed roughly
a $2.2 trillion budget for fiscal year 2004, is that correct?
Mr. Fisher. Yes. That is my understanding.
Mr. Hensarling. So if I do the math correctly, is the tax
relief less than 5 percent of the proposed spending?
Mr. Fisher. That sounds right. That sounds about right, but
maybe even a tad less.
Mr. Hensarling. Might it be a fair conclusion then that
over 95 percent of the problem appears to be on the spending
side and not the tax relief side?
Mr. Fisher. I would certainly share that view with you.
Mr. Hensarling. The $100 billion is under static scoring,
is that correct?
Mr. Fisher. Yes.
Mr. Hensarling. Okay. The administration has not employed
dynamic scoring, but I assume that you believe that your tax
relief package will indeed have some consequences on human
behavior.
Mr. Fisher. Yes.
Mr. Hensarling. I assume the administration has looked at
past tax relief, say, in the Reagan administration or the
Kennedy administration, since we heard JFK's name mentioned
earlier. If you look at the history of earlier tax relief
packages, can you tell me what their impact was on economic
growth and tax revenues?
Mr. Fisher. I do not have those figures on the top of my
head. We know they were positive and they had a dynamic effect.
I am confident this package will, too, but I do not have the
figures from 1962, 1964 and the early 1980s in my head. But I
think you and I agree, it is going to have a positive impact,
lower the loss of federal revenues considerably, and increase
the job creation.
Mr. Hensarling. One last question, can you go into further
detail about how we in the U.S. tax capital and savings vis-a-
vis other industrialized nations, and what the consequences of
that has been on the availability and cost of capital in the
U.S.?
Mr. Fisher. I think all other OECD industrial countries
have worked through different formulas to integrate--it is
called tax integration--personal income tax and the corporate
income tax, to avoid effects such as the double taxation we are
looking at. So they have all been working at it, and it is just
in the last few weeks we learned that Japan has actually moved
ahead of us, so we are now taxing capital at the highest rate,
as they have put through some credits to try to offset.
So we know it has a dampening effect on investment here,
and all the perverse corporate incentives that we have been
discussing, and other countries do not put this dampener in
their investment process. We should take it out.
Mr. Hensarling. Thank you, Mr. Fisher.
Mr. Fisher. Thank you.
Mr. Hensarling. Madam Chair, I yield the balance of my
time.
Chairwoman Kelly. Thank you.
Mr. Hinojosa?
Mr. Hinojosa. Thank you, Chairwoman Kelly.
I want to ask for unanimous consent to let my opening
remarks, statement be made a part of the record.
Chairwoman Kelly. So moved.
[The prepared statement of Hon. Ruben Hinojosa can be found
on page XX in the appendix.]
Mr. Hinojosa. Thank you.
Under Secretary Fisher, I apologize that I was unable to
come in while you were making your statement. I was at another
meeting and I just could not get out of it.
Mr. Fisher. I understand, sir.
Mr. Hinojosa. Currently, the interest payments on many of
the State and local government bonds are exempt from federal
income taxes, while capital gains on stocks and securities are
not. This system is in place to stimulate private investment in
our communities and schools, and makes it easier to build
roads, schools, and other projects. So that is something that
is very important to us, especially who come from congressional
districts with large rural areas and school districts that need
to have the sale of these government bonds so that it can keep
all these projects that I mentioned to you.
Will the elimination of taxation on capital gains and
retained earnings for private securities harm these communities
I mentioned, and result in more costly municipal and state
construction projects? And will the reduction in taxation of
dividends reduce the amount of funding available for community
investment?
Mr. Fisher. Sir, I do not believe that it will. I think it
is very important to understand the different characteristics
of municipal bonds and municipal borrowing from equity
securities. While in an absolute sense, we see a diminishing of
their relative advantage in terms of tax advantage of munis
vis-a-vis equity dividends, investors recognize the profound
difference between the safety and stability of a government
bond issued by a state and local government, and the risks of
equity securities, particularly after the last few years we
have been through with the wild swings in the equity markets.
So when investors approach this, they do not think of these
as fungible instruments. They might think of a diversified
portfolio where, in order to have a very safe and secure
revenue stream, you might have some government bonds and
municipal securities. A balanced portfolio might also include
some equity investment, but it would be quite odd to think of
those two instruments as comparable, given how different the
risk characteristics of them are.
So while in some absolute mathematical sense, the tax
advantage decreases for municipal securities, these are such
profoundly different instruments I think it mistakes how
investors approach them to think there would really be an
increase in the cost of financing State and local projects.
Mr. Hinojosa. Let me tell you why I am not very clear on
the reason that you give. In talking to some of our friends in
New York about this problem, their comment was that once you
take out the capital gains, then you do not have the advantage
of these tax exempt bonds that they are investing in and
getting a high return, for comparing tax exempt bonds. By
taking out the capital gains on those stocks, will they still
be attractive to the investors in New York?
Mr. Fisher. Yes, I believe they will. It has to do with the
risk to principle, is one issue, and therefore the volatility
of the instruments. Someone who wants to hold a municipal
security is looking for something that is very safe and secure,
and in which the principle amount is not subject to
fluctuation, and which gives them a regular income stream in
the form of the interest. An equity instrument is subject to
all the risks of the market going up and down, and to the risk
the company does not declare a dividend. That is in the
discretion of management.
So the two instruments have fundamentally different risk
characteristics, which make it extremely unlikely that
investors think of them in fungible terms.
Mr. Hinojosa. Investors also want the highest return
possible. It is not just the risk, it has got to be balanced.
Mr. Fisher. Investors are always struggling to find the
highest risk-adjusted returns. That is, to simply say, I want
an instrument that pays me the largest interest payment, that
will turn out to be a very risk bond, for example, of some
company that does not have a very good credit rating.
Mr. Hinojosa. You and I both know that they are going to be
low-risk, because in many cases they are guaranteed by
somebody, especially in Texas where the State permanent school
fund guarantees those bonds.
But let me go to another question. I do not believe that I
am sure that there is going to be a high enough interest rate
to still make it as attractive as you seem to be anticipating.
In your written testimony, you said that the deficits projected
are manageable and declining. At their peak, the immediate
future, they are below U.S. historical experience. They compare
favorably with fiscal conditions in other G-7 countries. Our
debt remains modest by historical and international
comparisons, and as a share of U.S. credit market it is at a
50-plus year low.
My research indicates just the opposite. In 2001, the U.S.
enjoyed a $127 billion surplus. In 2002, our budget went into a
$158 billion deficit. CBO forecasts that the President's new
tax cuts and his other budget initiatives would produce
deficits of $1.82 trillion over the next 10 years. The CBO
projects a deficit of $287 billion in fiscal year 2003, that we
are in, and a deficit of $338 billion in fiscal year 2004.
Chairwoman Kelly. Mr. Hinojosa?
Mr. Hinojosa. Yes, ma'am.
Chairwoman Kelly. Can you please conclude as quickly as
possible. Ask your question.
Mr. Hinojosa. In conclusion, how can these deficits be
characterized as manageable and declining?
Mr. Fisher. Looking at the 10-year forecasts that we are
working with, that both CBO and OMB have done, we are looking
at deficits as a share of our economy--that is the normal way
we look at them; as a share of GDP--they are in a range inside
our experience and consistent with other G-7 countries. So
right now, we are looking at less than 3 percent of GDP. That
is a very typical deficit-to-GDP ratio. The projections over
the coming decade is that they are around here just a little
beneath 3 percent, and then decline over the rest of the
decade. That declining trend is one of the reasons that I think
both financial markets and we at the Treasury responsible for
debt management see these as entirely manageable. So I think
that when we look at it scaled to our capital markets, as my
testimony alluded to, scaled to our credit markets, we see
these as entirely manageable.
Mr. Hinojosa. I thank you for your response, and thank you,
Chairwoman Kelly.
Mr. Fisher. Thank you.
Chairwoman Kelly. Thank you.
Mr. Murphy?
Mr. Murphy. Thank you, Madam Chairman, and welcome here.
Mr. Fisher. Thank you.
Mr. Murphy. I was talking with some folks on the street,
and I agree oftentimes constituents, people around America know
a heck of a lot more than we inside the Beltway give them
credit for. This guy described himself this way. He said, I am
just an average American Joe Sixpack that pounds nails and cuts
wood during the day, mows my lawn in the summer, and cheers for
the Steelers in the fall. He said, we are pretty tired of the
Beltway bullfeathers, although he described it a little more
colorfully. He said, all I want to know is this--with these
plans, what is it going to do to my money in retirement? What
is it going to do to my kids' college fund? What is it going to
do for job opportunities for my kids? And what is it going to
do to put food on my table and keep a roof over my head, for
now and in the years to come?
How would you respond to him?
Mr. Fisher. I would say the single most important thing,
both for his family finances and for our government's, is to
get our economy growing and creating jobs over the next 10
years. As I said in my written statement and alluded to in my
summary, I am concerned that we have a little more to confront
here than just another swing of the business cycle. If I really
thought we just were looking at sort of a normal business cycle
issue then maybe we would not need to do something on the scale
that the President has proposed. But I think we need to
overcome some greater obstacles. So getting the growth rate up,
and nothing over the coming 10 years will do a better job of
that than speeding up the investment process.
Mr. Murphy. In plain speak, do you believe this plan will
essentially boost the value of what people have saved in
whatever kind of market funds or something else they put away
for college or their retirement? And how much do you think it
will increase it by?
Mr. Fisher. There are estimates of the impact. We have not
done one at the Treasury, but the estimates of impact on stock
market valuations range from 5 percent to 15 percent positive
impact.
Mr. Murphy. Over how many years? Annually?
Mr. Fisher. No, that is a one-off effect of doing this, but
that is a pretty substantial boost, even just a 5 percent
boost. So I think it is going to raise equity valuations and
the value of investment.
Mr. Murphy. Does this translate also to you saying that you
cannot affect the job market unless you affect the stock
market?
Mr. Fisher. I think the effect comes back indirectly. What
I would say is, businessmen and consumers want to see something
that will be enduring support, so we need something that is
going to drive investment higher so there are more jobs for his
kids. We need something that is going to provide consumers with
the confidence to buy something--a big ticket item--to keep
their consumption on track. We need to do both of those things.
That is what the President is trying to do.
Mr. Murphy. Another avenue here--I heard someone say that
those who oppose the President's plan are opposing a plan that
forces corporations to pay their fair share of taxes. Could you
respond to that? Does that sound about right? I guess they are
referring to the way companies have, I think you were saying
before, to keep money to finance buy-backs; they incur debts to
falsely pay dividends to keep their stock value up, et cetera.
They will find other loopholes to not pay taxes. Does this have
any way of helping to keep companies more honest in what they
are paying?
Mr. Fisher. Yes, as I have said, I think it does. I even
know one commentator who thinks this will overall increase
corporate tax payments because of the incentive effects that if
they pay the taxes, then their shareholders do not have to. I
think it has a powerful impact on just the other side of
getting us away from tax shelters and corporate inversions and
the like, reducing the incentives for gaming the system by
corporations.
Mr. Murphy. What do you mean by ``gaming'' the system?
Mr. Fisher. Aggressive tax shelters. We know there is a
fine line between what the system permits and what then goes
over the line--not tax avoidance, but tax evasion. Obviously,
there are a lot of people out there who are trying to always
push up against that line. We want to try to reduce the whole
incentive to be playing that game to begin with.
Mr. Murphy. Will this then lead to some job loss for
attorneys and accountants whose whole job is to find ways to
not pay taxes?
Mr. Fisher. Yes, if it is successful, it would do that.
Mr. Murphy. I am for that. Thank you.
Chairwoman Kelly. Thank you, Mr. Murphy.
Mr. Garrett? Mr. Barrett, have you questions?
Mr. Barrett. Thank you, Madam Chairwoman.
Mr. Fisher, just one quick question. I was reading an
article in the Wall Street Journal that quoted Glenn Hubbard,
of course, the head architect of the Bush tax package. It talks
about urging people to invest more and pushing down the cost of
capital. The part that intrigued me, that I really liked, he
said a dividend tax cut is a way to raise wages. Tell me how
that would work?
Mr. Fisher. By lowering the hurdle cost of investment, we
make it easier for firms. Firms then have a choice of what to
do with that additional capital, that additional expense. Now,
over time--I think this is in the context Glenn would be
discussing that--that drives us to higher productivity. We are
going to get more investment, and it is really productivity
that leads to enduring improvement in our incomes. It may not
change it--if you think about just one person, are they going
to get a raise the day this thing is passed--no, I do not see
it that way. But this is the key to unlocking productivity
gains to beget more investment in our economy, more
productivity. That is what leads to a higher level of income
for all of us.
Mr. Barrett. Thank you, Mr. Fisher.
With that, Madam Chairwoman, I yield back the balance of my
time.
Chairwoman Kelly. Thank you.
Ms. Brown-Waite?
Ms. Brown-Waite. Thank you very much.
One of the things when I got elected was I promised I would
not fall in love with a place that people sent me to work at,
namely D.C. So I go home every weekend, and I talk to people in
the community, talk to seniors. I can just tell the rest of the
panel and the rest of the members here that my seniors will
appreciate having the dividend not be taxed. When you look at
the figures, more than half of the dividend income goes to
seniors, and that means about five million seniors nationwide
would receive an average tax cut of somewhere around $900 in
2003. That is a substantial impact. That is money that they are
going to use in the community. If you cannot see how these jobs
are going to be created, how it stimulates the economy, then I
do not think you understand Economics 101. It is when people
have more money in their pocket that they actually spend it.
I was just wondering if you all have done a breakdown of
State by State how much it would mean to seniors, to the
residents in each State?
Mr. Fisher. I think we have done that. I do not have it
with me. Let me double check that we have done that analysis
and we will try to get it to you as quickly as we can. I do not
have it with me or in my head.
Ms. Brown-Waite. Have you extended that to number of jobs
created as a result of the tax break for each state? I saw some
figures that came from a research organization, but I did not
know if you all had official figures.
Mr. Fisher. I am going to have to double check. I think we
may be able to do a State by State analysis, but I do not have
it in my head or with me. So let me try to get back to you on
that.
Ms. Brown-Waite. I can just tell you that the seniors in
Florida are looking forward to paying lower taxes as a result
of this. Thank you.
Mr. Fisher. Thank you, ma'am.
Chairwoman Kelly. Thank you.
If there are no more questions, the chair notes that some
members may have additional questions for Under Secretary
Fisher and they may wish to submit those in writing. So without
objection, the hearing record will remain open for 30 days for
members to submit written questions to him and place their
responses in the record.
Mr. Fisher, there have been some requests by members of the
committee for some additional information, so please feel free
to--I will officially request that those figures get to us.
Mr. Fisher. Yes.
Chairwoman Kelly. We are very grateful that you were
willing to be here with us today. You are excused with the
committee's great appreciation for your time.
Mr. Fisher. Thank you very much. It was a pleasure.
Chairwoman Kelly. With the agreement of the members, I want
to recognize Mr. Hensarling of Texas for the purpose of
introducing our next witness.
Mr. Hensarling. Thank you, Madam Chair.
It is indeed a distinct honor and privilege to introduce
our next witness. In many respects, Madam Chair, we are getting
three witnesses for the price of one, for there is Dr. Phil
Gramm; there is Senator Phil Gramm; and there is Vice Chairman
Phil Gramm. Dr. Phil Gramm was a professor of economics, who
taught economics to thousands of students at Texas A&M
University over 12 years. Thousands of students learned about
supply, demand, money, banking, and Seays Law due to his
inspiring teaching. I was honored to be one of those students.
He went on to have an almost quarter-century public service
career in Congress, first as a Congressman and then as a
Senator. He is indeed uniquely qualified to speak to us about
economic growth, since he was the co-author of the Reagan
economic program in the House, a program that cut marginal tax
rates, increased government revenues, and caused one of the
largest economic booms in American history to take place.
As a Senator, he was responsible for the Gramm-Rudman
legislation, and was one of the last people in this city to
actually put binding restraints on federal spending. I hope he
explores in his testimony the relationship between economic
growth and the growth in government spending. Once again, I was
honored to be his aide for many years during these years.
Finally, there is now Vice Chairman Phil Gramm. Senator, we
are very happy you finally decided to make an honest living.
[Laughter.]
Senator Gramm. So am I.
Mr. Hensarling. We have the perspective of an investment
banker.
So Madam Chairman, I do think indeed we are getting three
witnesses for the price of one, to the panel. We have an
academician, we have a great public servant who is committed to
principle, tenacity, courage; and finally we have an investment
banker. But to me, he is a teacher, a friend, and a mentor. I
am honored to introduce him, and one statement to the witness:
Senator, for 25 years, I have answered your questions;
turnabout is fair play.
[Laughter.]
Thank you, Madam Chair.
Chairwoman Kelly. Thank you.
STATEMENT OF HON. PHIL GRAMM, VICE CHAIRMAN AND MANAGING
DIRECTOR, UBS WARBURG LLC
Senator Gramm. Madam Chairwoman, members of the committee,
Mr. Chairman, Congressman Hensarling, let me thank you for that
wonderful introduction. If I had never done any of those things
other than taught you, I would have had a life well spent, and
I want to thank you very much.
I want to thank you for inviting me to come today. I cannot
imagine what is more important than getting America back to
work, than rebuilding confidence in our equity markets, than
rebuilding the foundations of our retirement program. To the
extent that I get to play a small role in advising you on that,
I am very flattered and very grateful.
Let me start by defining the problem. In the 20th century,
we had two different kinds of business downturns. In the middle
and late part of the 20th century, we had a series of inventory
cycles--seven of them--and they all worked basically the same
way. Somewhere, signals got crossed between people that were
selling things and people that were producing things. We would
over-produce. There would be a buildup of inventories. It would
be discovered. Orders would go back up the production chain to
cut back on production. Businesses would re-trench. People
would be laid off and we would have an economic downturn.
Economists could never predict when they were going to happen,
but we understood a lot about them once they started.
In the early part of the 20th century, we had a series of
financial panics. They were generated by the fact that we had a
very difficult time converting checking account demand deposits
into currency, and we had an agricultural economy so you had
huge seasonal variants in the demand for money.
I give you that little history lesson because one thing
everybody should know in this debate is that the downturn that
we are beginning to recover from is very different than
anything we experienced in the 20th century. The downturn we
suffer from was a speculative boom and a breaking of that
speculative bubble. We do not know for sure whether all the gas
is out of it. We do not have good precedents in recent history
as to how post-speculative booms work in terms of recovery.
So the first point I want to make is that we are kind of in
uncharted waters here. I would urge you to be cautious and
forward-leaning in terms of addressing this downturn and
guaranteeing a strong recovery.
Secondly, Madam Chairwoman, as you mentioned, this has been
a very different kind of recession. Consumption has never
declined. We are in the midst of a housing boom in the midst of
a downturn. Our downturn has been produced by one thing and
that has been a collapse in investment. Now, what I think that
should tell us is if you want to get the economy growing again,
you have got to affect investment. The old pump-priming where
we give people money hoping they are going to spend it is not
going to be very effective in a recession where consumption has
never declined. The problem is investment, and if your policy
does not affect investment, it is not going to have much of an
impact.
Now, in terms of the President's stimulus package, despite
all the media hype and all the politics, the plain truth is it
is not very big--2.4 percent of projected current services
spending, which means what you would spend if you created no
new programs and did not change anything over the next 10
years. You could literally take 2.4 percent of projected
current services spending and fly it over cities in airplanes
and throw the money out and would have no substantial impact on
this economy. If this stimulus package is going to affect
anything, it has got to get people to invest not the money they
get from your tax cut, but to invest money they have already
got that they are not putting to work.
I think there are two things in the President's package
that are very important in doing that. One of them you have
talked a lot about, and that is the dual taxation on dividends.
Eliminating the dual taxation on dividends will change the
after-tax rate of return on investment and will, in and of
itself, change the value of equities on the American market.
The lowest figure that Secretary Fisher talked about was 5
percent. That does not sound very big until you realize that a
5 percent change in equity values is $350 billion. So we are
talking about a substantial impact simply by eliminating a
current bias in the tax code.
There are a couple of other things that I think are
important. Number one, the current system basically encourages
companies to invest internally even when the rate of return of
investment in the market is greater than it is inside the
company. That creates a wasting of capital and inefficiency,
and eliminating this bias will go a long way toward correcting
that, and ultimately will correct it.
By eliminating the bias against dividends, companies will
pay more dividends and you will make the internal conditions of
companies more transparent. I had an old accounting professor
long ago who said, cash flow is real; profits are a fiction.
Letting companies exhibit cash flow by paying dividends
probably will do more for corporate transparency than any law
you could pass.
Number four, the double taxation of dividends encourages
businesses not to incorporate, even though they could get
access to more capital; they could grow; they could create
jobs. But by incorporating, they end up having to pay a dual
taxation on dividends and they are disadvantaged. It cannot
make sense to let tax policy dictate corporate structure.
Finally, the elimination of the dual taxation on dividends
will eliminate the non-economic use of debt. How many companies
that have had problems during the current downturn overused
debt and underused equity because the cost of debt is tax
deductible and the cost of equity is not?
Those are all sound reasons why this ought to be done.
There is one other policy I wanted to touch on, Madam
Chairwoman, and that is accelerating the reduction in rates.
Let me just focus on one--the highest rate, 38.6 percent. That
is in reality the small business tax rate in America, because
38.6 percent is the tax rate paid by proprietorships,
partnerships and subchapter S corporations filing as
individuals. That tax rate and the revenues collected from it
generate revenues 85 percent of which come from small business.
Small businesses create most of the jobs in America.
Probably dollar for dollar, the greatest stimulant in the
President's package is accelerating those reductions in
marginal rates, specifically the highest rate, from all four to
the present, and from all six to the present. It does not
change the long-term revenue stream of the government even in a
static sense because it is going to go into effect anyway, and
it ought to be made retroactive to January 1 and done now.
There is no question about the fact that had Congress known how
weak this recovery was going to be, how uncertain it was going
to be, we would never have strung the tax cut out as we did.
So I want to urge this committee to move forward. And let
me address just two other issues, if I may. First of all, the
question about revenues, and I think at least when I was here
that I had as good a record on being concerned about the
deficit as anybody. But when you are losing five times as much
revenue from a recession as the static cost of the stimulus
package, I think it makes sense to act, not to sit passively
by.
Secondly, if you take the Wilshire 5000, which is the
broadest index of equity value in America, and you go back to
the high water mark in 2001, and you compare that to today, we
have lost $6.7 trillion in equity value; $6.7 trillion in
equities that form the foundation of the life savings of our
people; that form the foundation of our retirement programs.
Whatever we can do to rebuild that equity value is going to
produce many times more revenue than we are talking about in a
static sense in this stimulus package.
So I think it is very important that we act on it. I think
the figure that over the next three years that we would have
the potential of creating an extra two million jobs is not out
of reach. I think it might be achievable. And I think this
stimulus package should be adopted.
Finally, in terms of this war, I did not see any evidence
in 1991 that the war had any significant economic impact, and
the economy is twice as big today as it was in 1991. I think
the war is very important and I think it is something we ought
to be concerned about. It is something we ought to be worried
about and praying over. But this economic problem is something
that is vitally important, and I do not think simply because we
are staring a war in the face that we ought to forget the fact
that unemployment is rising, that equity values have declined
by $6.7 trillion, and that there is a lot of work to do
economically. That is why I want to congratulate this
subcommittee on holding this hearing, even when so much of our
thought is on the war.
[The prepared statement of Hon. Phil Gramm can be found on
page XX in the appendix.]
Chairwoman Kelly. Thank you so much, Mr. Gramm. Is it okay
if I call you ``Senator'' still?
You have been one of the key players in all of the tax
debates over the past 20-plus years. You have talked about some
of the lessons that those debates have given you, about
economic growth and federal revenues that we should apply to
the debate over ending double taxation of dividends. Which
fears that were raised by the President's opponents are not
valid, based on past experience? You have heard some people
earlier today talk about some of their fears. Which of those
fears do you feel are not valid?
Senator Gramm. Well, first of all, I think that our first
fear ought to be about the economic recovery. Let me make it
clear right now, I believe the economy is going to recover no
matter what we do. I think the economy is going to recover. It
is going to overcome the illness and the absurd prescription of
the doctor. But it is going to recover slower if we do not try
to do something to stimulate it. For the people who are going
to be affected over the next three years, I think we can make
their lives better and I think we can strengthen the economy
dramatically. So it is not a question of, is America going to
recover economically--we are. The question is the speed of the
recovery and how it is going to be affected.
I would say this, Madam Chairwoman, and I do not want to
get into a political debate. I have gotten out of political
debates. But I would take the concern about the deficit more
seriously if the people raising it had the same standard for
spending money as they do reducing taxes. I think basically
that is the test. In the end, I think that given the state of
the economy and given the nature of this downturn we have, and
how much uncertainty there is about it--and I can tell you,
working today in New York, working with people who want to make
investments, that have powerful economic ideas, there is still
a great deal of uncertainty. And whatever we can do to allay
some of that uncertainty, I think we should do.
Chairwoman Kelly. Thank you.
Mr. Hinojosa?
Mr. Hinojosa. Thank you, Chairwoman Kelly.
Senator, it is a pleasure to see you again.
Senator Gramm. Thank you.
Mr. Hinojosa. Coming from Texas and seeing how you worked
and worked so effectively, it is a pleasure to see you back on
the Hill, and especially before this committee so that we can
ask you some questions. Possibly the questions I am going to
ask you may appear to be softball pitches because you come from
Texas, but truly I want to ask you a question that is not very
clear, and I certainly do not necessarily agree with the
President's plan to stimulate the economy. Being the great
economics instructor that you were at Texas A&M, I am going to
focus my question on housing. Housing seems to be an industry
that has created lots of jobs and continues in spite of the
decrease of the GDP, which was projected to be at 3 percent and
now will be 1.5 percent, according to some experts.
Nine national housing lobbies have expressed concern that
President Bush's proposal to eliminate the taxation on
individual dividends would undermine the country's most
successful program producing and rehabilitating affordable
housing. The low-income housing tax credit gives investors a
dollar for dollar reduction in taxes in return for investing in
such housing, which you and I know is greatly needed down in
South Texas. The dividend exemption could make all tax credits
less attractive to investors and could move investment from tax
exempt government bonds to dividend-paying stocks, thus
reducing the allure of the low-income housing tax credit and
endangering affordable housing programs in the United States.
What are your views on this contention?
Senator Gramm. Let me say, Congressman Hinojosa, I thank
you for your kind comments. I have always appreciated my
friendship with you and with your family.
I have very strong views on this. Let me just begin with
some history. When we cut taxes under President Reagan by 30
percent, these same arguments were raised in 1981; that by
lowering the highest marginal rate from 70 percent to a 30
percent reduction from that rate, and ultimately with the 1986
Act, by lowering it all the way initially from 1981 at 70
percent to 28 percent, there was concern that the deductions
you get for your mortgage interest would be lowered in value;
there was concern about the marketability of municipal bonds--
you raised that earlier. But let me say, in both those cases,
both the 1981 tax cut and the 1986 more simplification--but in
neither case was housing affected in a negative way and in
neither case was there a perceivable impact on municipal bond
sales and on the viability of that market.
The logic that you are quoting people as saying basically
is the logic that if you wanted to make deductions more
valuable, you would make the tax rate 100 percent. All I am
saying is, in my career in 1981, in 1986, in 2001, when we cut
taxes, we did not see any of these dire predictions come true.
Remember this, the municipal bond market is a market that is
driven by the fact that income is tax free. Even with the
elimination of dual taxation on dividends, you are still
talking about a 35 percent tax rate.
So it is a concern that I do not see any evidence to
substantiate it. If you just ask yourself the logic, this logic
is used every time we reduce taxes. All I am saying is, I
cannot speak for all of the history of mankind, but from 1981
and 1986 and 2001, it just did not happen.
Chairwoman Kelly. But Senator----
Mr. Hinojosa. I am going to finish my question. Is that
Okay, Chairwoman Kelly?
Chairwoman Kelly. As long as it is a short one.
Mr. Hinojosa. It is a short one.
I will come back in the next round and ask you, so be
thinking about it. How could it be that from 1980 to 1996, when
we had this huge gap between house ownership between minorities
and the average American, and we started producing a lot more
jobs and reducing the unemployment rate down to its lowest;
produced the most millionaires in that period from 1990 to
2000, that national policies were to have taxes at about the
rate that they are at now and to pay taxes on these dividends.
So they must not have been too bad, because we paid off our
deficit.
Senator Gramm. That is right. We cut taxes in 1995, if you
will remember on the budget summit agreement with the
President. We cut taxes. We cut the capital gains tax rate. We
controlled spending and we started moving, beginning in 1995
toward a balanced budget. You know, everybody wants to claim
credit for what happened. Really, from 1982 until about 2001,
we were living in a golden age. I do now know if people knew it
then, but I tell you, looking back at it now, in terms of the
quality of consumer goods, in terms of the economic development
reaching people that had not been reached in 30 years under
Democrat or Republican Presidents--in the 1990s, this economic
expansion started reaching those people and you and I have seen
it all over South Texas. Creating millionaires did not create
enough, but it created a lot of them.
Mr. Hinojosa. Madam Chair, I reserve the right to come back
in the next round and continue my question and his answer.
Chairwoman Kelly. Mr. Hinojosa, there will not be a second
round with this witness. However, if you would like to submit a
question in writing, you certainly are able to do that.
Mr. Hinojosa. Thank you.
Chairwoman Kelly. Mr. Oxley?
Mr. Oxley. Thank you, Madam Chairwoman.
Senator Gramm, welcome. It is good to see you again and we
hope this is the first of several appearances before the
Financial Services Committee. Let me express my gratitude to
you for your leadership, both in the House when we were
colleagues here, and in the Senate, and particularly your work
on what became known as the Sarbanes-Oxley bill, and your
efforts working with me to make certain that we did not go too
far in our efforts to seek more corporate accountability.
To that end, in your testimony you say that eliminating the
current bias against the payment of dividends will make the
internal condition of corporations more transparent. I am
wondering if you could help us with some details and elaborate
on how ending the tax penalty on dividends will improve
corporate governance and reduce the use of gimmicky off-shore
tax shelters. Do you share with me the belief that some of
these problems that developed in Enron in particular and other
corporations in general in some ways were brought about by the
rather odd way that we deal with corporate taxation, and
specifically the double taxation of dividends?
Senator Gramm. Here is basically my point, that when you
have the tax code discriminate against equity financing, and
discriminate against dividend payment--let me just give you an
example. If I am running a company and I earn a profit, and I
pay it out to my shareholders, I have got to pay corporate
income taxes on it and then they have got to pay individual
income taxes on it, the effective tax rate pushes over 50
percent--up to 60 percent. But if I simply take it and
repurchase my stock or if I take it and invest it internally,
even though the rate of return inside my company may not be as
high as my investors could get by investing somewhere else,
they still can be better off economically. I think that when
you have a policy that is biased against equity, then you get
the instability that comes with these very heavy debt burdens;
when you have a policy that discourages the payment of
dividends, dividends give people information about companies.
Companies cannot pay dividends unless they have got a positive
cash flow. The ability to exhibit that tells you a lot about
the health of the company.
I just think that there just is no intellectual argument in
favor of the dual taxation on dividends. The only debate about
it is that people would like to have the money to spend. I have
never heard anybody say that it is a good, sound economic
policy. I am not claiming that the dual taxation of dividends
was the source of all of our problems in corporate governance,
but I am saying that allowing dividends to be paid by
eliminating the bias in the tax code has a lot of other
positives, and a big one is increased transparency. If my
company is paying me dividends, I know they have got money from
somewhere. My old accounting professor was trying to make a
point, and as most professors do, overstated the point, but
profit has to do with all kinds of complicated calculations--
write-offs, depreciations, et cetera. Cash flow has to do with
money coming in, the money you are paying out, and the money
you can then pay out in dividends. That is as real as real gets
in the world we live in.
Mr. Oxley. If that is the case, and you particularly make a
strong point that it is very hard intellectually to argue
against the elimination of double taxation, why has it never
been seriously tried until now? I know that I think Charles
Schwab really raised the issue with the President at the
economic summit down in Texas. But obviously, this is the kind
of issue that has been around for a long time. When Chairman
Greenspan sat there where you are and testified two or three
weeks ago and I asked him those same questions, I started out
by saying I can remember studying Econ 101 in college, and that
my professor at that point was talking about the double
taxation of dividends and how inefficient it was and an odd
situation. And yet, now 40 years later, we are still engaged in
that debate.
Is it just that it is so difficult? You were on the Ways
and Means Committee over here in the House. Is it just because
it is there and the inertia is such that we just cannot move
it?
Senator Gramm. I think it is hard to do because it is an
easy issue to demagogue. It is an easy issue to take yourself
back to the 1950s where only rich people owned stock. I think
it is important. A question was asked earlier about corporate
taxes. Corporations do not pay taxes. Corporations collect
taxes from consumers, but they do not pay them. This idea that
corporations are paying this tax, ultimately it is their
customers that pay it when it is passed to the consumer.
I think it is just a hard thing to eliminate and I think it
would be good if we could work out a consensus to do something
about it. You know, there is this age-old debate about how big
should government be and how much of society's resources should
go through government. I respect that. I have a strong opinion
about it, but I respect other people's opinion. But the way we
collect that revenue ought to be in a way that has the least
damaging effect on the economy, because whether you want people
to spend their money or whether you want the government to
spend it, you want the pie to be as big as possible. So there
ought to be some way to have this debate where everybody should
end up on the same side of this particular issue.
Mr. Oxley. Thank you.
Chairwoman Kelly. Thank you.
Mr. Chairman, I am glad you brought up the name of Charles
Schwab. I have here, and with unanimous consent, will enter
into the record a copy of a March 11 Washington Post op/ed
written by Charles Schwab, entitled, A Boon to Ordinary
Investors: Eliminating the Dividend Tax is Just What the
Economy Needs. So without objection, I will enter that into the
record.
[The following information can be found on page XX in the
appendix.]
Chairwoman Kelly. We go now to Mr. Moore.
Mr. Moore. Thank you, Madam Chairwoman.
Senator Gramm, in January 2001 I believe the projected
surplus by CBO was about $5.6 trillion. Does that sound about
right, sir?
Senator Gramm. For over a 10-year period, that is about
right. My mind fades, but it was big.
Mr. Moore. Right. I was speaking to a high school
government class about the virtues of fiscal responsibility and
balanced budgets and paying down debt last year. Even where I
am on the other side of the aisle, I am not going where you may
think I am going, because I voted for the President's tax cut.
I thought it was the right thing to do and I still think it was
the right thing to do two years ago. But at that time, we had a
$5.6 billion projected surplus. I was talking to this group of
high school students, and I said, how would you define
``projected surplus?'' This girl raised her hand and she said,
``Maybe yes; maybe no.'' A pretty good definition, isn't it?
Because as it turned out, what we hoped would happen, what we
projected would happen, did not happen, did it? Over the 10
years, we did not have a $5.6 trillion surplus.
Senator Gramm. It did not happen, and it did not happen
really for several reasons. The economy got weaker.
Mr. Moore. I understand.
Senator Gramm. Number two, we spent a whole lot more money.
Mr. Moore. My point is, when you project something, you
hope it happens, but it will not necessarily happen. Isn't that
correct?
Senator Gramm. It is like an old woman once gave advice
that when you are borrowing money, and you want a good analogy,
write down on a handkerchief in indelible ink what you have to
pay back, and then write down in fruit dye on the other part of
it, where your revenues are coming from, and then wash it and
see what is guaranteed.
Mr. Moore. Fair enough.
Senator Gramm. When you are predicting the future, you do
not know.
Mr. Moore. Exactly right. My point is, we were in surplus
mode, and I am not blaming anybody for this. I am not blaming
the President or the other party for this. I am just saying we
were in surplus mode; now we are not. That is correct, isn't
it?
Senator Gramm. There is no question about it.
Mr. Moore. And the President--and I am not blaming anybody
for this; I am not making any political commentary on this--I
am just saying we are or appear to be on the advent of a war
right now, some sort of military action.
Senator Gramm. The only thing I would say on that is----
Mr. Moore. I have not asked the question yet. I am just
asking. Thank you. With all respect, I do get to ask the
questions here.
We appear to be ready for a military adventure of some
sort, and we do not know what it is going to cost. I do not
think you know, and I am not going to try to pin you down on
that, because you cannot know, I do not think, or anybody. The
President has even said we cannot really project what that is
going to cost. Would you agree with that, in fairness?
Senator Gramm. I do not think anybody knows what it is
going to cost, but in 1991 it did not have any significant
impact on the economy.
Mr. Moore. Of course, this is 10 years later, and we still
do not know what it is going to cost.
Senator Gramm. Well, the economy is twice as big as it was
10 years ago.
Mr. Moore. Right. We are in deficit mode. The President is
proposing tax cuts, and I support some tax cuts, although I
have some concerns about the size of the President's proposal.
And we are, under the President's budget, at least $320-plus
billion still in deficit, in his budget proposal. Isn't that
correct?
Senator Gramm. I do not think that--$320 billion sounds
high to me, but it is too big to suit me.
Mr. Moore. Okay. It is too big to suit me, too. I think we
agree on that.
And I do not disagree either with your characterization of
the taxation of dividends, in concept at least, because I do
have this--I am from Kansas, sir, and I called the state
department of revenue in Kansas when the President first
proposed this dividend elimination. I talked to analyst there,
and I said, do you have any idea what kind of impact this might
have on collection of revenues in Kansas if this passed? He
said, as a matter of fact, we just did an analysis of that and
it is going to cost the state of Kansas $51 million. Well,
Kansas is a relatively small state compared to Texas or
California or others, and $51 million does not sound like a
bunch of money. But when you are in a $750 million revenue
shortfall, it is a lot of money to our new governor and to our
legislature.
I submit that it is going to cost some other states a lot
more money percentage-wise than it is Kansas in terms of this
$51 million. Is that a concern or should it be a concern?
Senator Gramm. Well, we have to believe that the
elimination of dual taxation on dividends is going to create
investment in America. Some of that will be in Kansas. How
large it will be relative to the lost revenue I think is
something you could speculate on. But let me make it clear that
if we have this deficit and we did not have the current
economic downturn that we are in, I would not be in favor of
moving up these tax rate reductions. I think in that
circumstance, we should be debating eliminating this
inefficiency in the tax code and paying for it by either
controlling or cutting spending, or by offsetting it somewhere
else. I think the only reason it makes sense as a package is
that we are in a downturn that is costing us five times as much
as the revenues that we are talking about in terms of the
economic growth package. That is the only reason it makes sense
to me as a whole right now.
Mr. Moore. Thank you, Senator.
Chairwoman Kelly. Thank you.
We go to Mr. Hensarling.
Mr. Hensarling. Thank you, Madam Chair.
Senator Gramm, in your testimony I believe you said that
the aggregate value of the President's proposed tax relief is
less than 2.4 percent of the projected current services federal
spending. There obviously continues to be great concern about
deficits. In my own earlier math dealing only with fiscal year
2004, I came up with less than 5 percent. Can you tell us how
you calculated the 2.4 percent?
Senator Gramm. I took current services spending over the
next decade. I took the value of the tax cut over the decade
and divided. It is a little more front-end loaded because you
are moving the rates forward to January 1, so in the first year
it is more. In other years it is lower, but the average is 2.4
percent. I also would note that the deficit that comes from the
increases in spending that the President has proposed is bigger
than the deficit that comes from the tax cut the President has
proposed, and yet many people who say the tax cut is too big
say spending is too small. Yet if that is the case, how can the
basis of concern be the deficit?
Mr. Hensarling. I assume the 2.4 percent is based on static
scoring?
Senator Gramm. That is based on static scoring; how much it
costs if no behavior changes; and of course it is based on how
much government costs if no behavior changes, but we are in the
midst this year of increasing government spending.
Mr. Hensarling. I appreciate the fact that you are no
longer in the politics business, but I do appreciate the fact
also that you are still in the policy business. So let me put
it this way, there appears to be at least one alternative
economic growth package and it talks about targeting tax
relief. Wearing any of your three hats, have you perhaps looked
at the alternative economic plan or do you have an opinion
about targeted tax relief?
Senator Gramm. I think people are getting confused between
a stimulus package and just trying to give money away. What we
are trying to do here is to get people to invest. A lot of
people have trouble accepting that if America is going to be
saved, it is going to be saved at a profit; that if you want
people to invest their money, you have got to provide them with
incentives to do it. The strength of the President's proposal
is not in its aggregate value, as I said during my testimony.
If you took the amount of money the President is talking about
and simply threw it out of airplanes over the major cities of
this country, you would have a very modest impact.
The reason that I believe the two major parts of it will
have a significant impact, and that is elimination of the dual
taxation on dividends and accelerating these marginal tax
rates, especially the highest rate, which is the small business
rate--is that you are going to induce people that have got lots
of money, that are not now investing it, to invest it. I think
that is the hope we are talking about. I think it is a
realistic hope. I do believe the stimulus package will help the
economy and will stimulate investment if you pass it. Nobody
knows by how much. So you know, there are uncertainties about
it, but I think given the risk that we are facing, it is a risk
you ought to take. At the same time, you ought to be very
careful about the money you are spending.
Mr. Hensarling. The same alternative growth package has tax
relief in one year only it front-loads all the tax relief. Do
you have an opinion on that impact on the economy and job
creators?
Senator Gramm. It is bigger in the first year than the
President's, but again it is not aimed at investment. It is
aimed at stimulating consumption, which has never declined to
begin with. So you might very well get people to spend the
money you give them, but that is not what the effort is. The
effort is to get people to spend money they already have that
they are not spending. That is what a stimulus proposal is
about. It seems to me, if you want to measure the impact of a
stimulus proposal, it is how many dollars do you get people
that they have to spend based on the number of dollars that you
have that you spend.
If the best argument you can make is, well, if we give it
to them, they will spend all of it, why don't you just drop it
out of airplanes? By focusing on investment, that is where the
problem is, and if we are going to get a substantial response,
if we are going to put people to work, it has got to be in
investment. Unfortunately, if you want to get into a debate
about, well, equity and things of that nature--equity is
growth. Equity is jobs. I think that is where people get
confused. I think it is why we have such a hard time debating
these subjects, but it is something I have watched for a
quarter of a century, and it is not likely to be wished away.
Mr. Hensarling. Thank you, Senator.
Thank you, Madam Chair.
Chairwoman Kelly. Thank you.
Mr. Crowley?
Mr. Crowley. Thank you, Madam Chair.
Senator Gramm, both sides recognize your great service to
this country and we are very pleased to have you here before us
this afternoon.
Senator Gramm. Thank you very much.
Mr. Crowley. I know that you have probably gone over a
little bit of the time, Madam Chair, so I will try not to keep
you much longer than necessary.
Senator, you said on the second page of your statement--I
was not here for your statement; I read through it afterwards--
and I will just quote from the double taxation on dividends
portion of your statement, the last paragraph and the last
sentence, ``And finally, the elimination of dual taxation on
dividends is both an effective stimulant and sound economic
policy which will speed up the recovery and increase long-term
growth.'' I am assuming the growth you are talking about is job
development. Would that be correct?
Senator Gramm. When I am talking about economic growth, I
am talking about job creation and real income of workers.
Mr. Crowley. Let me just read a statement from the Wall
Street Journal, in fact, which is not known to be a liberal
newspaper. A quote from a January 17 article of this year, and
I quote, the elimination of taxes on dividends will diminish
the abilities of businesses to take tax incentives on capital
investment in R&D, things that actually create jobs, and
basically saying that, my interpretation of it, that this
stimulus package will not, through the reduction of the double
taxation of dividends, create new jobs. In fact, I was just
handed an article from today's--I am sorry--the March 13 Wall
Street Journal that says that four Senators, including two
Senators from the Republican side, Senators Olympia Snowe and
Senator George Voinovich of Ohio, will not support the
President's tax cut proposal.
Is the Wall Street Journal wrong? Are these Senators wrong
as well?
Senator Gramm. Let me tell you what would be right. What
they are saying is that if you lower tax rates that the R&D tax
credit is not as valuable. Well, why don't you make tax rates
100 percent and then we could just grow the economy like
``hello?'' The problem is that then people would not have
anything to invest. It takes a good idea to limit--I must be
getting old using words like ``hello''--but it takes a good
idea to sort of an absurd limit. I have supported the R&D tax
credit. I support the deductibility of mortgage interest rates.
I support the tax exempt nature of municipal bonds. But the
idea that making people pay more taxes helps the economy by
making those deductions more valuable, I think is taking a good
idea and just extending it to where it is illogical.
I would say this, and I would ask you to look at it. In
1981, we cut the marginal rate from the top rate from over 70
percent down to the 50 percent range, and then ultimately we
cut it in 1986 to 28 percent. I have never seen any evidence to
substantiate that that had a negative effect on municipal
financing or home ownership. The point is, there is an income
and a substitution effect. When people had more money, it is
true that the value of the deduction was less, but they had
more money to spend and housing was something they wanted, and
they spent more money on housing.
So I think you can take a little point and stretch it to
the limit, but I just do not see any economic foundation to any
belief that elimination of the dual tax on dividends would do
anything other than help the economy.
Mr. Crowley. Let me just reclaim the time, and that is, I
come from a city, New York, where we have lost almost 250,000
jobs--about half are related prior to 9-11. So this is not all
9-11-created; 500,000 jobs statewide. We have seen two million
jobs lost throughout this country in the last over two years. I
see very little in terms of immediate stimulation in this
package--maybe long-term, but not immediate. It is not going to
put people back to work.
Let me just ask you this question, do you have--I know you
are not in the political realm anymore--do you have any
reservations or are you uncomfortable in any way at the timing
of this tax proposal, given the fact that we are poised to be
in war. There are 300,000 young men and women sacrificing their
time away from family right now, many of whom will be asked to
make the ultimate sacrifice in defense of this nation. Do you
have any reservations or concern about the timing of the
calling for this tax cut, that will affect in essence the
wealthiest in this country?
Senator Gramm. Let me try to give you a totally honest
reaction to that. First of all, it is not as if we ought to be
raising their taxes because they are going to sacrifice for
America. I mean----
Mr. Crowley. It is not their taxes I am talking about.
Senator Gramm. I understand that. Let me just make this
point. In 1991 when we had the Gulf War, I do not see, other
than bringing down oil prices, which was a rich bounty to the
economy of the 1990s, I just did not see any real economic
impact coming from the war. If we did not have this lingering
downturn, I do not think you could make a case for part of this
economic growth package right now. I think you could make a
case on dual taxation on dividends, but I think the rest of it
you could not take a case for. But the fact that we are getting
ready to have a war probably this week does not change the fact
that we have got some real economic risk out there.
If you read the testimony, you know I made the point that
this recession is different than the ones we had in the 20th
century. We do not totally understand it. There are a lot of
uncertainties about it. I am confident that the economy is
going to get better. If I did not think so, I would not have
gone to work for an investment bank. I would have gone to work
for a law firm where you can make money on people's misery.
But I think there is reason to be cautious about the
economy, is all I am saying. I think that I would be for it,
given the fears I hear from people in New York who are talking
about investing money, the fears they have got about the
economy, I would be a little forward-leaning knowing what I
know now if I were in public office, in trying to sort of put
on a little insurance in terms of this recovery. I think it is
going to be fine. I think the recovery is going to occur no
matter what we do. I think we can speed it up, but there is
enough that is new and different about it that I would just
urge in thinking about it. It is obvious in listening to you
that you are thinking about it and that you are looking at a
lot of different things.
I think there is a reason to be cautious about this
downturn because it is so different than any other one we had
in the 20th century; that we just do not know how it is going
to behave. That makes me a little bit nervous.
Chairwoman Kelly. Thank you.
Mr. Murphy?
Mr. Murphy. Thank you, Senator. I wonder if you could just
continue that thought--it makes you a little bit nervous, how?
Senator Gramm. Well, because, you know, we have had some
speculative bubbles historically. We had the South Sea bubble.
We had the tulip bubble. But they were in the 17th and 18th
centuries. I do now know anything about them. If any economist
has looked back at speculative bubbles and how they behave, I
am not aware of it.
So all I know is during my lifetime of awareness, the kinds
of recessions we have had were things that I knew something
about. They were inventory cycles. We could never predict them,
but we knew how they behaved. If we were at this point in an
inventory cycle, we would have a pretty great deal of certainty
about what is going to happen.
This is a different kind of downturn, subject to different
kinds of behavior. While I would bet money that things are
going to be all right, I still, if I were in your position, I
would be cautious--the reason I would vote for the stimulus
package, even if I had questions about dual taxation of
dividends or even if I had questions about accelerating this
tax cut, is because of the economic uncertainty. I think this
economic growth package is a good plan overall in terms of
economic effect. I think there is one other part of the
President's package that is not part of this that is good, and
that is that $15,000 IRA-type investment where you can invest
up to $15,000 for a couple. You could put after-tax money in,
but the buildup for college education, retirement, house,
housing, buying your own home is tax-free. I think that is a
good policy as well. But I just would be cautious given the
uncertainties of this downturn we are in.
Mr. Murphy. Thank you. You made a statement in your opening
statement I would like you to also elaborate on this, if you
would. This has to do with the impact upon small businesses,
which you portrayed as the basis of really so many jobs in our
economy. You said the elimination of double taxation of
dividends will help small businesses that are currently
discouraged by tax policy from adopting a corporate structure,
even if it would allow them greater access to capital.
Do you see that small businesses are willing to--this would
give them that incentive to jump in and take some of those?
Would it be more risk, less risk for them? I would like for you
to comment.
Senator Gramm. Currently, if I am running a company and we
are beginning to grow, up to a point, I have an incentive to
stay away from the full-fledged corporate structure because of
the double taxation on dividends, because I can be taxed as an
individual with a proprietorship or partnership or subchapter S
corporation. Once I start growing, then I begin to get into a
conflict between the improved access to capital I can get
through full incorporation versus the tax advantages I get by
staying a subchapter S or by staying a partnership or
proprietorship.
All I am saying is that no rational society would let the
tax code dictate the structure of the business firm. It would
let the market do that. That is one of the reasons why the dual
taxation on dividends is such bad policy.
Mr. Murphy. Thank you.
I yield back the rest of my time.
Chairwoman Kelly. Thank you.
Mr. Garrett?
Mr. Garrett. Thank you, and professor in light of the
splendid introduction that you received, my first question I
guess is are there any grades currently being held back that
have not been delivered as of this date?
Senator Gramm. Well, if Congressman Hensarling had had poor
grades, I would think about going back and changing them. I do
not know if after all these years that they would let me do it.
In fact, I would say in all of my years as a college professor,
I only changed one grade, and it ended up being for now a
Democrat member of Congress. So they do not always work out.
[Laughter.]
Mr. Garrett. You made a statement in your introductory
comments with regard to the history. I found that interesting
as far as that we are in the speculative phase right now in the
equity markets, and that may be part of the cause of where we
find ourselves now, and how that differs from what over history
it was like. Right now, I am reading a book about the history
of going into the late 1920s into the Florida speculative
housing boom, and how you had the ups and the downs and the
little panicky phases at that time as well. So maybe we have
had certain--and I am not as good on history as you are--but
maybe we had certain little periods like this in the past that
we could look to.
Senator Gramm. The Great Depression was a financial panic,
and I do not think Alan Greenspan would disagree with this,
that in part because of bad government policy, became a full-
fledged depression. This is a different kind of downturn, this
speculative bubble. I do not see any significant chance of it
becoming worse in terms of becoming of depression proportions.
It is just not recovering as quickly as we might recover that I
think the whole debate is about.
I do not think there is or should be any realistic debate
about, is America going to recover; is investment in American
equities the best investment you can make. I think the answer
is yes. The question is, how quickly is it going to recover,
and what could we do to speed it up. I think that is the
debate.
Mr. Garrett. Okay. And in that, you continue with your
opening remarks with regard to how in this period of time, you
have seen the consumption remain strong. So for that reason,
you do not want to necessarily go down the road of the
consumption-driven alternatives. And yet, a lot of the--I will
not use the word ``rhetoric''--but a lot of the language that
we hear as far as proponents, and from the proponents of the
tax measure is that the average family of this size will
receive around $1,000 or $1,100 back, and that is one of the
strong reasons why we should be supporting it. Obviously, that
$1,000 or $1,100--and I am a supporter of this, I just wonder
how we pin this down--that $1,100 is not, I do not think, the
same classification where you are talking about the 85 percent
language later on and it is really going to the investment
side. That $1,100--that is really going to the consumer, the
consumption side, correct?
Senator Gramm. Well, there are two different debates here.
The one debate is the so-called equity debate. It is always
skewed by the fact that half of Americans pay very, very little
taxes in income taxes. So it is so easy to stand up and say 50
percent of Americans will get 5 percent of the benefits. Well,
50 percent of Americans pay about 5 percent of the taxes. So
all you are saying in saying that is the tax code is
progressive, and not saying--but it confuses people.
The real debate is what gets the economy growing so people
are making more income so they can pay taxes with it? I think
that that is where we get pulled off the track into this debate
about the distribution of the tax cut. The truth is, this
economic growth package will make the tax code more progressive
than it is. But the reason you ought to vote for it is it gives
us a good chance of making the economy bigger than it is going
to be over the next three years, so everybody will benefit. I
do not think we ought to worry about somebody profiting by
investing. I do not understand loving capitalism and hating
capitalists. I do not understand this preoccupation that
somebody might somewhere benefit by doing something productive.
If we do not let people benefit, they will not do it.
Mr. Garrett. I will just close, then, on this. I think that
point you made just 30 seconds ago as far as the progressive
nature of this tax cut is a message that I hear here, and I
have heard with the Secretary of Commerce in the past, but it
is a message that seems to be lost in the entire discussion and
maybe goes back to that last point that you made before with
regard to those who are attacking this plan never look at the
spending side of the equation, and the fact that that is really
a larger cause than the tax cut side of the equation.
Thank you for your testimony.
Senator Gramm. Just always remember this when you are
debating this issue, that 19 percent of Americans when they are
polled believe they are in the top 1 percent of income and 40
percent believe they are in the top 5 percent of income. So
when people are talking about the top 5 percent, 40 percent of
Americans believe they are in the top 5 percent and they are
voters. So I would never be afraid of this issue.
Finally, as sort of a solicitous comment, if this were a
society where people somehow were set forever in some kind of
class based on economics, maybe all this silly argument would
make sense. But I do not know each of your backgrounds, but I
know Congressman Hensarling's background and his father was a
chicken-raiser. My dad was a sergeant in the United States
Army. Congressman Hensarling is a member of the United States
Congress and grew up scooping chicken manure out of coops. My
dad was a sergeant in the Army. I am an investment banker and a
former United States Senator. This class warfare stuff in
America is an absolute farce and joke. It is hard for me to see
how people can say it with a straight face.
That is the end of my sermon.
Chairwoman Kelly. Thank you very much.
Mr. Sherman, have you any questions for this witness?
Mr. Sherman. I do indeed.
Senator, rest assured I love capitalists. My father was
executive vice President of a New York Stock Exchange-listed
company, but I am frankly embarrassed by this class warfare
attack against working families. Only in a room like this could
we refer to this exemption of dividends as a progressive tax
cut, when I can remind the subcommittee that you take all the
benefit for 95 percent of Americans--all those with incomes of
under $140,000--and it just barely equals the benefit to the
top 2 percent; no, correction--the top .02 percent.
We had the chair of the full committee sit here and say
that Alan Greenspan endorses this proposal--I was here. He said
he endorsed this proposal if it was revenue-neutral. Senator,
other than dynamic storing and other drug-induced fantasies, I
would like someone to tell us how this is a revenue-neutral
proposal.
We have concluded or are about to conclude the second
panel. We have yet to hear from a witness who opposes this
program or would oppose any give-away to the wealthiest. That
is why Peter Fisher sat there in the same seat the Senator is
and said he had not heard of anyone who supports the present
system for taxing dividend income. You know, he could have sat
here until now--he may have said that twice--taxing it twice?
Taxing it twice. Well, he has not obviously listened to any
Democrats and he could have sat here and listened to both the
first full two panels and he would not have heard anybody. But
there are many advocates of the present system--myself
included--but I guess according to Peter, he had not heard my
opening statement, although he was sitting there, or I am among
the people that do not exist.
This proposal went over on the markets like a thud. The
President announced it; the markets did not go up. Why? Perhaps
there is an understanding that this is going to hurt the
economy, or perhaps just an understanding that it is going to
hurt the economy, then it is going to hurt the Republican
Party, then it is going to get repealed so you cannot count on
it as a long-term fixture of American tax policy.
The Senator pointed out to us that 40 percent of Americans
think they are in the top 5 percent, which means the success of
this proposal politically is based on Americans being off by a
factor of seven. That may not last. You may invest in stocks
today assuming that a political party that believes that this
is a progressive tax proposal will remain in power. It is just
possible that Americans will not continue to be ignorant of the
fact that seven out of eight Americans who think they are in
the top 5 percent are not.
Now, if you can bet on continued ignorance of economic
facts by the American people, then you can bet on this
continuing to retain its level of popularity. But what I want
to point out here is the interesting shell game. When you can
lower taxes on the ultra-wealthy by saying that we need to
favor investment over consumption, then you trot out that
argument and justify a low rate on capital gain income, which
spends just like regular income, except it spends more because
it is not subject to the same tax.
But when you want to lower taxes on the wealthy and give 70
percent of the benefit to the top 5 percent, then you are
neutral as to whether the money remains locked in the
corporation available exclusively for business investment, or
whether it gets distributed to those who may decide not to
reinvest in other stocks, not to re-deploy the money into other
investments, but buy that new $350,000 Mercedes. As a matter of
fact, I do not think it is a mere coincidence that Mercedes
comes out with a $350,000 car and then there is pressure to
exempt dividends from taxation. If only Mercedes limited their
cars to $100,000, it would place less political pressure on
this House to come up with ways to make sure that the top one-
tenth of 1 percent can afford the latest imported toy.
Chairwoman Kelly. Mr. Sherman, if you have a question,
would you ask it please, because your time is up.
Mr. Sherman. My time is up. The flaws of this proposal
cannot be summarized in a mere five minutes.
Thank you. I yield back. If the Senator wants to respond,
he can----
Chairwoman Kelly. Senator Gramm, if you would like to
respond, please feel free to do that.
Senator Gramm. We had a debate about luxury taxes and taxed
yachts. I would have to say that I do not know how the Senator
from Maine, the Democrat majority leader at the time voted on
the yacht tax, but he discovered something. That is, people
build those yachts and they make a good living at it. We came
back and repealed the yacht tax. Now, I do not ever intend to
own a yacht. I do not intend to own a Mercedes. But I just
would say this, that the Joint Committee on Taxation and
everybody with any degree of knowledge that has looked at the
President's proposal concludes that it makes the system more
progressive. I can tell you why.
Accelerating the marriage penalty, accelerating the child
exemption--those are costly benefits that go directly----
Mr. Sherman. Senator, if I can just interrupt--all the
benefits that go to working families out of this bill are
temporary. They take something that would have happened two
years from now and for two years the law is made more
progressive. The dividend cut and the estate tax repeal are
permanent, so the benefits that go to the wealthiest 1 percent
continue to be true next decade, the decade after, the decade
after that.
Senator Gramm. The President's proposal is to make all the
provisions permanent.
Mr. Sherman. But some are going to be permanent anyway
because that is existing law.
Senator Gramm. Anyway, Madam Chairman, thank you very much
for giving me the opportunity.
Mr. Sherman. Thank you, Madam Chair.
Chairwoman Kelly. Thank you very much, Senator. We are very
pleased to have had you here on your maiden flight testifying
before this committee here on the House side. I want to note
that some of the members may have additional questions for you
that they may wish to submit in writing. So without objection,
this hearing will be held open for the next 30 days for members
to submit those written questions.
Senator, we once again thank you so much for your
appearance here today. This panel is now excused.
I want to introduce the third panel as they are seated.
First, we will welcome our former colleague in the House on the
Banking Committee, the Honorable Rick Lazio, a proud New Yorker
and now the President and CEO of the Financial Services Forum;
John Castellani, President of the Business Roundtable; Peter
Orszag, Joseph A. Peckman Senior Fellow in Economic Studies at
the Brookings Institution; Stephen Moore, Senior Fellow in
economics at the CATO Institute and President of the Club for
Growth; William Spriggs, Executive Director of the National
Urban League Institute for Opportunity and Equality; and
finally, Bobby Rayburn, First Vice President of the National
Association of Home Builders.
I want to thank you gentlemen for testifying before us
today and I welcome you on behalf of the full committee. Mr.
Lazio, it certainly is a pleasure to have you back with the
committee again. Without objection, your written statements for
all of you will be made part of the record. You will have five
minutes for your oral testimony, and we will begin with you,
Mr. Lazio.
STATEMENT OF HON. RICK LAZIO, PRESIDENT AND CEO, FINANCIAL
SERVICES FORUM
Mr. Lazio. Thank you, Madam Chair. It is wonderful to be
back and to see you again, Madam Chair, and my other
colleagues. I appreciate very much the opportunity to be here
and to share this table with some distinguished speakers. I
hope I can shed some light on our feelings on behalf of the
Financial Services Forum on the proposal as it particularly
relates to the exclusion of dividend income.
The Financial Services Forum which I have the pleasure of
being the chief executive officer of, is composed of the chief
executive officers of some of the largest and most diversified
financial institutions in the United States. The purpose of the
forum is to promote policies and enhance savings and investment
in the United States and that ensure an open, competitive and
sound financial services marketplace that contributes to the
long-term growth of the American economy.
We believe that ending the double taxation of dividends
will benefit investors, strengthen the capital markets, and
improve our prospects for long-term growth. The measure will
stimulate the economy in the short term. However, we strongly
believe that longer-term positive consequences are most
important.
The most obvious benefit to ending the double taxation of
dividends, which has been referred to earlier, is the promotion
of a steady dividend payment to investors. Within normal ranges
of share prices and business performances, individual investors
receive cash in hand with reasonable certainty, and immediate
ongoing return on shareholding. This flow of funds enhances the
lives of American families, retirees and other individuals in
our society. Currently, many shareholders receive the benefit
of stock ownership only when they sell their stock. Clearly, it
is desirable to increase investor benefits in a manner that
does not require stock sales to achieve. Ending the double
taxation on dividends also gives the average investor a simple
basis on which to evaluate equities--the value of the dividend.
Double taxation of dividends results in the inefficient
allocation of our nation's resources. Companies are penalized
for returning funds to shareholders. Under current law,
businesses are incented to reinvest earnings, which often could
be put to better use elsewhere. Eliminating these perverse
incentives leads to a more efficient capital market and a far
more productive economy. Further, this measure would make
American firms more competitive in the international arena by
lowering overall the cost of capital.
It has been clear for some time, Madam Chair, that double
taxation has created a bias in favor of debt, as opposed to
equity capital because of the deductibility of interest
payments. We have seen over and over again that excessive
levels of debt become problematic during an economic downturn.
Firms with too much leverage do not have sufficient flexibility
to cope with adverse market conditions, to the detriment of
their shareholders. Eliminating the double taxation of
dividends removes the bias toward corporate debt, encouraging
more equity in capital structures, which allows firms to
weather adversity and protect investors in difficult times.
Double taxation encourages corporations to engage in share
repurchases because current law permits the distribution of
earnings in this manner at lower capital gains rates.
Investors, however, do not realize the cash benefit of the
share repurchase until they sell their stock. Eliminating the
double taxation of dividends makes it more likely that
shareholders will receive higher dividends and realize
corporate gains without having to sell their stock.
Because the tax code discourages payment of dividends,
publicly traded companies often are focused on goals that can
become problematic. Under present circumstances, shareholder
value tends to be equated with an appreciation of stock price
by many firms. Regrettably, we have also observed too many
companies resorting to accounting manipulation to inflate
earnings and stimulate stock price appreciation. Correcting
this bias against dividends will cause both firms and their
investors to emphasize cash flow and cash dividends as true and
more appropriate measures of true value.
In summary, Madam Chair, removing the double taxation of
dividends results in significant benefits to individual
Americans and American families. The measure will restore
balance to the manner in which publicly traded firms are
managed by removing incentives to issue excess debt, repurchase
shares, invest retained earnings in sub-optimal investments,
and designing unproductive strategies just to avoid taxes and
inflate earnings.
We believe that eliminating the double taxation of
dividends will cause firms to focus on creating true value for
shareholders and other stakeholders. Share prices of dividend-
paying stocks tend to be less volatile, and thus are a
stabilizing force in the capital markets and that certainly has
been the case over the last few years, and that is empirically
provable. Eliminating the dividend tax will contribute in a
major way to restoring and increasing confidence in our markets
and contribute to long-term productive growth in the economy.
Finally, this proposed change would correct the fundamental
lack of fairness in the tax code by ending the bias against
equity capital and dividends, and increasing the
competitiveness of United States firms.
Thank you, Madam Chair.
[The prepared statement of Hon. Rick Lazio can be found on
page XX in the appendix.]
Chairwoman Kelly. Thank you, Mr. Lazio.
Mr. Castellani?
STATEMENT OF JOHN J. CASTELLANI, PRESIDENT, THE BUSINESS
ROUNDTABLE
Mr. Castellani. Thank you, Madam Chair.
I am pleased to be here this afternoon on behalf of the
chief executive officers who make up the Business Roundtable.
The Business Roundtable is an association of CEOs of major
corporations that have a combined workforce of 10 million
employees in the United States and $3.7 trillion of annual
revenues. Although we are in the business of creating jobs and
contributing to economic growth, we have serious concerns about
our ability to do so in these times with a fragile economic
environment.
The chief executive officers of the Business Roundtable
feel that the U.S. economy is not growing to its potential.
Consumer demand and consumer confidence are shaky. The
confluence of our nation's war on terrorism, the potential war
with Iraq, and the decline in stock prices have resulted in
diminished assets and savings and have led to consumer
retrenchment. Our CEOs feel that business investment will only
return when there is sufficient consumer demand to exhaust the
existing capacity in the U.S. economy. Only by increasing
demand will we return to a level that supports investment and
more importantly supports job growth.
We feel we need to ignite consumer confidence and stimulate
consumer spending, and that is why we are urging the enactment
of President Bush's economic growth and jobs package as
reflected in H.R. 2. If enacted, we believe that it will
significantly stimulate the economy in the short term, as well
as boost long-term economic growth. PricewaterhouseCoopers
recently conducted a study for us using a widely supported
macroeconomic model that is housed at the University of
Maryland. The study showed that if H.R. 2 was enacted this year
by July 1, it would create an average of 1.8 million jobs in
each of the next two years and an average of 1.2 million jobs
per year in the next five years. It would boost gross domestic
product in the U.S. economy by 2.4 percent by the end of 2004.
The plan would boost incomes and jobs and help all sectors
of the economy, including housing and capital markets. Working
consumers will have more money to spend and more confidence to
spend it on goods and services. By accelerating the 2001-
enacted rate cuts, the marriage penalty reduction and the child
tax credit increase and by eliminating the double taxation of
dividends, the proposal will not only provide immediate boost
to the U.S. economy, it will also add millions of jobs and
again increase confidence and economic growth.
As importantly, the single element of eliminating the
double taxation of dividends will have the most positive impact
on long-term economic growth. That provision alone will create
by the model's projections 500,000 jobs per year for the next
five years. It will also have an additional number of important
and multiplying effects. First, it will spur consumer spending
by increasing the after-tax income of stock investors.
Shareholders will benefit because they will no longer bear the
unfair burden of paying taxes twice on the same income, and
they will benefit again when companies boost their dividend
payments. By our estimates, we would expect a 4 percentage
point increase in dividend payout ratios over the next 10
years.
Second, eliminating the double taxation of dividends will
improve corporate governance in a number of ways. Companies
will have less incentive to engage in structured financing
transactions that have little or nor business purpose. We can
expect better transparency in the reporting of corporate
earnings because investors will reward companies that pay tax-
free dividends. And companies will be less likely to take on
excessive debt and risk bankruptcy in pursuit of lower taxes.
Third, while it is difficult to predict stock market
reaction, even the most conservative analysts predict increases
in stock prices. All three combined will not only benefit the
broad spectrum of the economy that receives dividends,
particularly those people who depend on them in their
retirement, but it will also benefit all of those funds which
are invested in equities, including 401(k)s, IRAs, and public
and private pension funds.
The positive effect on stock prices that would arise from
the elimination of the double taxation of dividends would, for
example, translate into a potential increase of $4,200 per
401(k) participant and $110 billion in the aggregate of all
401(k) plans. On the defined benefit side, millions of
Americans would see substantial improvement in their retirement
security and companies would have additional operating capacity
to invest, resulting in more profits and increased stock
prices.
The Roundtable urges the Congress to move quickly to enact
an economic growth plan that will give both an immediate boost
to the economy and put people back to work. The President's
plan is the best means for creating jobs, encouraging business
investment, strengthening the capital markets, enhancing
corporate governance and igniting economic growth. It is the
right prescription for an ailing economy.
Thank you.
[The prepared statement of John J. Castellani can be found
on page XX in the appendix.]
Chairwoman Kelly. Thank you, Mr. Castellani.
Mr. Orszag?
STATEMENT OF PETER ORSZAG, JOSEPH A. PECHMAN SENIOR FELLOW IN
ECONOMIC STUDIES, THE BROOKINGS INSTITUTION
Mr. Orszag. Thank you, Madam Chairwoman.
I would like to make five points in my five minutes, so if
I stick to one point per minute, I should be fine.
The first point is that the administration's tax proposals
will exacerbate the long-term budget outlook. We have heard a
lot about the effect of the proposals on the deficit, but let's
just look at CBO's numbers in 2013. This is after any temporary
downturn would presumably be over, when the economy is at full
employment, and as Senator Gramm said, in that kind of setting
he would be reconsidering the forms of various tax provisions.
At that point, the tax cut that the administration is proposing
would amount to 1.8 percent of GDP, and the cost would increase
thereafter because many of the provisions are so back-loaded
that their full cost is not apparent even in 2013.
If you look out over the next 75 years, the tax cuts the
administration is proposing would amount to 2.3 percent to 2.7
percent of GDP. That may sound abstract, but just to put that
in context, the Social Security deficit over the next 75
percent is 0.7 percent of GDP, so these tax cuts are more than
three times as large as the entire Social Security deficit over
the next 75 years.
The Medicare part A deficit is 1.1 percent of GDP, so even
if you add Social Security and Medicare part A, that is 1.8
percent, that is still smaller than the size of these tax cuts.
So these are large.
The Committee for Economic Development, a leading business
organization, has put it in common sense terms. The first step
in climbing out of a hole is to stop digging. We already face
very large long-term deficits because of the retirement of the
baby boomers. We do not need to make them worse. Second, on the
economic effects, the long-term economic effects of the
proposal, it is very important to remember that these are not
revenue-neutral proposals. If it were a revenue-neutral
proposal it would be a very different ballgame. Because it is
not revenue-neutral and because it does expand the budget
deficit, there is a positive effect from the improved
allocation of capital across sectors, but a negative effect
because of the increased budget deficit which reduces national
savings, which is the flow of financing for investment. You
have to weigh the two effects against each other. You cannot
just look at the positive effect.
An organization that did that, Macroeconomic Advisers,
whose model by the way is the one that is used by the Council
of Economic Advisers to produce its own numbers--in other
words, it is the model used by the administration--has found
that the negative effects from reduced national savings because
of those larger budget deficits will outweigh any positive
effects from the improved allocation of capital across sectors,
so the long-term impact from the proposal is negative.
I understand that the Business Roundtable model shows
somewhat different results than Macroeconomic Advisers. In my
opinion, although the details are a bit sketchy in terms of
exactly what that model is or how it was applied, I think it
was mis-applied for this purpose, and I would be happy to
answer questions about that.
The third point is on the distributional effects. We have
heard a lot about the average tax cut. I think it is very
important to remember that averages can be quite misleading.
The average of my one-year-old son and Senator Gramm is a 30-
year-old who is about four-feet tall. That is not particularly
insightful. Instead, you have to look at the distribution of
people. When you do that, you see that half of tax filers would
get a tax cut of $100 or less; two-thirds of tax filers would
get a tax cut of $500 or less; and 78 percent of tax filers
would get a tax cut of $1,000 or less.
Similarly for the elderly, and here I think it is very
important. We cannot just look at the number of elderly who
benefit, because if an elderly couple had a penny in stocks and
received a penny in dividends, they would be counted as
receiving dividends. You have to look at the amounts that are
involved. When you do that, what you see is that two-thirds of
the elderly would get $500 or less from the administration's
growth package, and for the dividend proposal alone, the two-
thirds of the elderly who have incomes below $50,000 in income
would receive just 4 percent of the total tax cut. It is only
when you throw in the elderly who have very high incomes that
you start to get those numbers up.
Fourth point, small businesses--58 percent of tax returns
with small business income are in the 15 percent or lower tax
bracket. Senator Gramm talked a lot about the top tax bracket.
Only 2.3 percent of small business tax returns are in the top
tax bracket. So most small businesses are not facing that 38.6
percent rate. Furthermore, more than half of those 2.3 percent
have a very small share of their income coming from small
business income. They are not really small businesses in any
meaningful sense.
Finally, on corporate tax reform, I think it is very
important to realize again this proposal is not revenue-
neutral. What that means is that as Chairman Greenspan has
emphasized, if you did it as a revenue-neutral proposal, there
is just that unambiguous positive effect, rather than the
positive effect and the negative effect from the expanded
budget deficits. From a political economy perspective, you are
basically giving away the candy with this proposal. If you
think that corporate tax reform is going to involve both
spinach and dessert--the spinach of closing down corporate tax
loopholes and the dessert of giving away some tax preferences,
you want to combine them in a single package to make the
package as a whole politically viable.
What this proposal does is gives away the dessert without
forcing corporations or the tax code as a whole to eat the
equivalent of the spinach. It thereby undermines any chance of
getting real corporate tax reform.
Thank you.
[The prepared statement of Peter Orszag can be found on
page XX in the appendix.]
Chairwoman Kelly. Thank you.
Mr. Moore?
STATEMENT OF STEPHEN MOORE, PRESIDENT, CLUB FOR GROWTH
Mr. Moore. Thank you.
I support the President's tax plan. I wish it were bigger,
but I think it is a good tax plan. I would like it to include a
capital gains cut, although there is a capital gains reduction,
in that we should cut the capital gains rate to 15 percent.
Every time we have cut the capital gains tax for the last 40
years, we have gotten more revenues, not less.
We also ought to do what Senator Gramm talked about and
President Bush is talking about, which is the expansion of the
IRAs. That would have a dramatic impact on increasing the
investment and savings rate in this country. I thought I would
just spend a couple of minutes just talking about some of the
points that were made in earlier testimony and some of the
questions, and try to clear up some of the points.
First was the effect on the budget deficit. I hope that the
Congress will focus on the most important deficit that we have
right now, which is not the budget deficit, it is the growth
deficit. The budget deficit that we are facing right now is a
ramification of the growth deficit that we face. We have gone
from 3 to 4 percent real economic growth rate in the late 1990s
to closer to 1 to 2 percent right now. That accounts mostly for
the increase in the budget deficit that we have seen. So the
Bush tax cut, if it increases growth, which I think it will,
can have a very dramatic impact on reducing the growth deficit,
and thereby the budget deficit.
Just to punctuate that point, if we could grow the economy
just by 1 percentage point faster than is currently projected,
that will erase about $1.5 trillion of deficits over the next
10 years. So increasing growth can have a very substantial
impact on the deficit.
Second of all, it was brought up several times about the
impact of this tax cut on States and localities. I must say I
am absolutely baffled about how anyone can make the argument
that cutting taxes by $750 billion over the next 10 years could
possibly hurt State and city governments. We are talking about
taking money out of Washington and putting into the pocketbooks
of state and local taxpayers, where it never comes to
Washington in the first place. That can only have a very
salutary and healthy effect on states and localities. Of
course, the best example of that is when we did the Reagan tax
cut, which was about three times larger than this tax cut. It
led to the most prosperous period in state and local finance in
history. Senator Gramm touched on that as well.
A third point that was made was that now is not the time--
that we are on the eve of war and that a time of war, should we
really be cutting taxes. I would say again the best example of
how a tax cut can actually help us win this war is what
happened in the early 1980s with the Reagan tax cut, where
basically President Reagan said we are going to do two things.
We are going to have a massive increase in defense buildup to
win the Cold War, and we are going to cut taxes. I think the
evidence is now very clear that the tax cuts helped generate
the economic growth that led to the victory in the Cold War. In
fact, the Soviets now say that the reason that we won the Cold
War was because of the superiority of our economy, and not just
our military.
Fourth and final point is about the revenue loss. I think
this is such an important point to make because everybody is
throwing around all these numbers about what the tax cut is
going to cost. I would just urge you all to think about the
fact that every time we have cut taxes over the last 40 years,
we have always--always, 100 percent of the time--we have always
overestimated how much revenues we are going to lose from the
tax cut, in every single case. That was true when Kennedy cut
taxes in the 1960s. It was true in the 1980s when Reagan cut
taxes.
The starkest example and the most recent example was what
happened in 1997 when we cut the capital gains tax. If you look
at the official revenue estimates that came out of this
institution, the Joint Tax Committee, they estimated, Madam
Chairwoman, that we were going to lose $50 billion over the
next five years if we cut the capital gains tax. In fact what
happened is we gained $100 billion in revenue. So oftentimes
when we look at these static-based revenue estimates, they tend
to be very wrong. We ought to move towards a more dynamic
estimation model that takes into effect the economic growth
consequences of tax cuts. So I would urge you to pass the Bush
tax cut, grow it, and do it as fast as possible.
[The prepared statement of Stephen Moore can be found on
page XX in the appendix.]
Chairwoman Kelly. Thank you, Mr. Moore.
Dr. Spriggs?
STATEMENT OF WILLIAM E. SPRIGGS, EXECUTIVE DIRECTOR, NATIONAL
URBAN LEAGUE INSTITUTE FOR OPPORTUNITY AND EQUALITY
Mr. Spriggs. I am going to try and behave, Madam
Chairwoman, because Steve just finished in under five minutes,
so I am going to try and do the same thing.
Chairwoman Kelly. I appreciate that.
Mr. Spriggs. I want to thank you for allowing me to
testify. I do appreciate that this panel does have a diversity
of views, and thank you very much for the diversity reflected
here.
I represent the National Urban League, which is the
nation's oldest and largest community-based organization
dedicated to moving African Americans into the economic and
social mainstream. We are very happy that the President and the
Congress recognize that the economy is in a slump. However, we
are very concerned about the consequences of some of these
proposed fiscal policy changes and their unintended
consequences as well.
The President has proposed excluding dividend income from
the taxes of individual taxpayers. Now, as currently
constructed, the proposal would allow for the tax
redistribution of corporate earnings on which the corporation
has paid taxes. This, then, sets up actually our dichotomy,
because there is going to be a different interest in terms of
those who are institutional investors for whom the tax does not
mean anything anyway, and the corporate directors and officers,
who will be making the decision, for whom the tax does mean
something. So we will have a difference between the motivation
of officers and directors, between do they maximize shareholder
after-tax income, or do they maximize the corporation's after-
tax income? Those two lead to, I think, not ending the type of
uneasiness that investors have as to what our corporate
leaders' motivations, since there would still be this conflict
in what is to be done.
Now, one of those key areas in which there are differences
between what the corporation has in terms of tax liability
results from acts of Congress to help encourage certain types
of investment by corporations which benefit low-income
communities in part, and the Secretary of Treasury talked about
other loopholes for corporations as well, but I think that some
of these are very well thought out items. They include such
things as the low-income housing tax credit, the tax credit for
the rehabilitation of historic structures, and the empowerment
zone tax incentive, the renewal community tax incentives, the
new market tax credits, tax credits for employee-provided child
care, tax credits for holders of qualified zone academy bonds--
all of these things help low-income neighborhoods.
I think that it is misleading, as we have heard before, to
argue that the relative marginal tax difference for
shareholders leads to corporations making decisions about
whether they will use equity financing or whether they will use
debt finance, then to argue that the change in the relative tax
rates has nothing to do with whether businesses would decide to
take advantage of these tax credits. Either the relative
marginal tax rates matter and do something, or they do not
matter.
Now, if we live in a world where we are going to be
consistent and we are going to say that these marginal tax
rates do matter, then there will be negative impacts on these
programs. Does that mean that they are going to be eviscerated?
No, but it means that their costs will be increased. I think it
does mean that we have to think about what are the collateral
costs of ending the dividend tax.
The low-income housing tax credit I am going to mention a
little bit more because of its size. That is $15.1 billion over
the next four years in terms of tax expenditures. So by
comparison to the other ones, this is huge. Then also if you
look at it relative to where does the money come from for low-
income housing tax credits, almost all of the money comes from
corporations taking advantage of this tax credit. Then you look
at what does it mean for the low-income housing tax market--the
development of units--and it has a huge impact. Most of the
growth has been attributable to that tax credit.
Now, there has been much said about no one would
ideologically be opposed to double taxation. Corporations are
legal entities unto themselves. The assurance that an investor
has is that the corporate officers ought to look after the
health of that individual, that corporation. The income from a
corporation therefore is not like the income from a
partnership. The liability implications are very different
between a partnership and a sole proprietorship. So this is not
double taxation.
In any event, even if one bought the idea that there was
double taxation, there is no reason to buy into the idea that
what we should do is end the tax on the individual as opposed
to treating the dividend as an expenditure in the same way that
we treat wages. So I do not think that ideologically the
argument is there.
Finally, as to cost, I think we raise the issue of cost
because over the projected life of this budget, the 10-year
period, this is going to cost $388 billion. That is more money
than we are going to spend on the U.S. Department of Education
for at least four years. That is more money than we are going
to spend on the Department of Labor and Small Business
combined. So it is the issue of priorities. Where could that
money best be spent? If we try to solve the problem for these
many tax credits, which are important to low-income
neighborhoods, and increase the cost of this, isn't there a
more effective way of achieving some of these same ends?
So I would hope that you would think seriously about the
size, the magnitude of this proposal, as well as its collateral
cost.
[The prepared statement of William E. Spriggs can be found
on page XX in the appendix.]
Chairwoman Kelly. Thank you, Dr. Spriggs. Although you did
not make it to your goal on timing, I appreciate your
testimony.
Mr. Rayburn?
STATEMENT OF BOBBY RAYBURN, FIRST VICE PRESIDENT, NATIONAL
ASSOCIATION OF HOMEBUILDERS
Mr. Rayburn. Thank you, Madam Chairwoman, for the
opportunity to testify today on the impacts of the President's
economic growth package. My name is Bobby Rayburn and I am a
homebuilder and developer from Jackson, Mississippi. I am also
the First Vice President of the National Association of Home
Builders, which I am here today to represent.
First, I want to say that NAHB supports President Bush and
the Congress in their efforts to achieve an economic stimulus
package that will provide near-term stimulus to consumer
spending and capital investment, including more housing
consumption and production. We were disappointed that the
stimulus package did not contain a housing component,
specifically the proposed homeownership tax credit. This
proposal has bipartisan support in the Congress and has been
part of the administration's budget for the previous three
years.
The primary focus of my testimony today is on the impact of
the administration's proposal to eliminate the double taxation
on corporate earnings on the low-income tax credit program. The
distribution of a dividend from tax corporate earnings to a
shareholder, who then pays tax on the dividend, is double
taxation of the corporate earnings. One of the ways
corporations reduce the impact of the double taxation and
increase corporate earnings is to buy low-income housing tax
credits. Unfortunately, the dividend exclusion proposal reduces
the value of tax credits like the low-income tax credit. The
value of tax credits is reduced compared to today's value of
tax credits, because corporate earnings that are exempted from
tax by the credit are taxable to the shareholder and will not
increase the cost basis of the shareholder's stock when the
corporation retains the earnings.
Affordable housing uses a variety of financing sources,
including the low-income housing tax credit, home funds,
Federal Home Loan Bank affordable housing program, and revenue
bonds. These projects operate on very narrow margins. States
try to serve the lowest income tenants possible and locate
affordable properties in areas where development frequently is
difficult, such as rural and inner-city areas. Even a modest
change in the value of the credit and the resulting reduction
in the amount of equity the credit can generate will have
adverse consequences to the low-income housing program.
Two studies have been published that analyze the impact of
the administration's dividend proposal on the low-income
housing tax credit program. The first study prepared by Ernst
and Young predicted that there would be a reduction of 40,000
low-income housing tax credit units per year, which is a 35
percent reduction from the current level of 115,000 units. The
Mortgage Bankers Association published a second study that
predicted the dividend proposal would actually benefit the
production of low-income housing tax credits and have virtually
no negative effects at all. We are still reviewing this
particular study.
It is our view that the Ernst and Young study overstates
the impact of the credit. The emphasis on units produced fails
to reflect the full range of the impact on the dividend
proposal on the operation of the low-income housing tax credit
program. NAHB estimates that a more realistic decline in the
value of the credit is from 10 to 15 percent, rather than 21
percent. We also believe that there will be significant
revisions in state priorities for the low-income housing tax
credit programs. Tenants at the upper end of the eligible
income will be sought, and fewer properties will be built,
particularly in hard to develop areas.
There are several approaches that could be used to protect
the credit. The first approach would be to exempt the low-
income housing tax credit from the dividend proposal. This can
be done within the structure of the administration's proposal
by treating earnings corresponding to the low-income housing
tax credit as taxed earnings. Other solutions would be to
exempt all or part of the dividends received by the
shareholders from the tax and by providing the corporation with
a deduction for dividends paid.
The other approach to protecting the low-income housing tax
credit would be to make up for any adverse impact on the
program by expanding availability and the market for the
credit. The first step in this approach would be to eliminate
restrictions on the individual's passive loss reductions and to
provide them with exemption from alternative minimum tax. Since
the individual market for the credits is not as efficient as
the corporate market, the amount of the credit that can be sold
to raise equity, as well as the amount of the credits that can
be dedicated to individual properties would need to be
increased.
Madam Chairwoman, that concludes my remarks. NAHB looks
forward to continuing to work with you, the members of your
committee, the Ways and Means Committee, and the Treasury
Department to keep the low-income housing tax credit program
operating at today's levels well into the future.
Thank you.
[The prepared statement of Bobby Rayburn can be found on
page XX in the appendix.]
Chairwoman Kelly. Thank you, Mr. Rayburn.
Mr. Castellani, I have a question for you. You cited the
Joint Committee on Taxation report for ending the double
taxation of dividends. The Business Roundtable was among the
first groups to encourage new measures for honest corporate
governance last year. I wonder if you could quickly elaborate
on the link between the double taxation of dividends and the
use of the Enron-style accounting gimmicks that I spoke about
in my opening statement.
Mr. Castellani. I would be delighted to. As you know, we
have been, particularly with this committee's leadership,
working on trying to restore the confidence of the American
investor in our system of corporate governance. I think the
Sarbanes-Oxley Act has gone a long way in doing so. Part of the
issue, which has been alluded to and discussed by several of
the folks who have been testifying here, has been what the
impact of the double taxation of dividends has been on
corporate behavior.
Since the tax code as it currently exists benefits debt
financing over using equity to raise funds, stocks have not
been valued as in the past, based upon their future dividends.
When dividends are not paid, investors have to value stocks
based on a corporation's earnings statement, which in the case
of Enron could have been manipulated or can be manipulated to
make a company appear to be more profitable on paper than it is
in reality.
In addition to removing this incentive to cook the books,
which I guess, was the case with Enron, eliminating the double
taxation of dividends will put more money in the hands of
individuals because shareholders at all levels will demand
that, and it will give an incentive to those companies that do
pay dividends. So again, cash will be paid out; cash will
become a premium; cash flow will become a premium; corporations
that pay dividends will be rewarded, and the kind of paper
manipulation that we saw in the Enron case will be further
inhibited because shareholders will be looking for true cash
flow.
Chairwoman Kelly. Thank you.
Mr. Lazio, I wonder if you would discuss how States like
New York, Texas, Florida will benefit from this tax plan?
Mr. Lazio. I would be happy to, Madam Chair. As you know,
because I know you spend a lot of time with the people of the
New York City prudential marketplace getting to know how those
markets work and understanding what the problems and concerns
are in the banking and securities market and the insurance
industry, this is going to have a very significant impact on
the employment base in the New York metropolitan area and the
tax base. In New York alone, it is estimated that just the
dividend exclusion would return about $2 billion in the first
year. I think Texas is about $1.6 or $1.7 billion. I can get
that exact number--and Florida is about $1.4 billion. So very
significant returns to those states just on this one element of
dividend exclusion.
It is not difficult to see why, for two reasons. First of
all, it obviously has the immediate impact of providing higher
after-tax income for those individuals that depend on dividend
income. That is skewed to, frankly, older Americans who benefit
disproportionately on this initiative. The second, longer-term,
and in my opinion more important reason is that it does overall
strengthen corporate management, that it provides superior
financing for expansion, for acquisitions. That, in turn, leads
to jobs, higher income and more tax revenue.
The real question, it seems to me, is between immediate
consumption today and lowering taxes so that we can get higher
growth numbers later. It is very difficult to see how we are
going to create the kinds of jobs that Americans are calling
for in the shorter, intermediate run unless we get on a higher
growth path. We are not going to do that at 1.5 or 2 percent.
Chairwoman Kelly. Thank you.
Mr. Orszag and Mr. Moore, I have seen the two of you
before, talking with each other about the various economic
issues. I am going to fire this question to the two of you and
let you answer it. I want to know what the record of the
impacts on economic growth--now, you both presented two
different views here--the impacts on economic growth and on
federal revenues from the cuts in taxes on savings and
investment, specifically the 1997 capital gains tax cut. By the
way, Mr. Moore, I ran on my maiden flight for Congress was to
zero the capital gains tax, so I am right there with you on
that.
I would like to know--the 1997 capital gains tax cut, the
1981 Reagan tax cut, and the Kennedy tax cut in the early
1960s. Mr. Orszag, let's go with you first.
Mr. Orszag. Okay. You want to know what the impact was on
the economy of those proposals?
Chairwoman Kelly. Yes.
Mr. Orszag. First, with regard to the 1997 capital gains
reduction, I think it is very difficult to interpret the data,
given that that was occurring in the midst of a stock market
boom. Some may argue that the capital gains tax reductions is
what caused the stock boom--which is what Mr. Moore will argue.
But the stock market boom was occurring before that capital
gains reduction, and if the capital gains tax reduction caused
the boom, then it led to the bubble that everyone is
complaining about now. So there is sort of an inconsistency
there. But I think it is difficult to interpret because we were
in the midst of such a strong stock market performance at the
time, so there is a natural upswing in capital gains from year
to year as the stock market continued to increase, which could
outweigh the effect from a reduced rate.
With regard to the early 1980s tax cuts, there is an
ongoing debate about what the effect was. A couple of things
are relevant. First, it is important to realize that we
reversed about a third of the tax cut in 1982. So in 1981 we
cut taxes; in 1982 we came back with TEFRA and reversed about a
third of the tax cut that remained in place because of concerns
about the long-term deficit. That is in marked contrast to what
appears to be occurring now, when circumstances have changed,
but we are not trying to reverse course to take that into
account.
Secondly, there is a lot of movement between personal
income and small business income that makes it difficult to
interpret the data. Some people have looked at what happens to
personal income returns following a reduction in personal
income tax rates. What you see is a significant amount of
shifting from income from small businesses onto personal tax
returns, which does not necessarily correspond to any change in
the underlying economy.
The bottom line is I think it is a very difficult question.
I think people who give an unambiguous answer that is either
unambiguously positive or unambiguously negative are probably
oversimplifying the situation. There is an ongoing academic
debate about it.
Chairwoman Kelly. Thank you.
Mr. Moore?
Mr. Moore. We have a much better tax system today than we
did 20 years ago. I do not think there is any question about
that. When I first arrived in this town, we had a 70 percent
top marginal tax rate; you could get tax deductions for
investing in windmills and bull sperm and all sorts of things.
I think the two Acts that we did in the 1980s were very
positive--the 1981 Act which cut the top rate from 70 to 50
percent, and all the rates, by the way, and indexed for
inflation.
And then, I am a big believer in what we did in 1986. I
know there is some disagreement about that, but we brought the
top rate down from 50 to 28 percent. The reason I mention that
is that I do not think there is any question that nobody wants
to go back to 70 percent rates. In fact, when you cut the rate
from 70 to 50 percent, you are going to have an extremely
strong supply side effect. You are not going to get the same
kind of supply side growth effect when you got from 39 to 35
percent that we did when we went from--well, when Kennedy went
from 91 to 70 percent, and then Reagan went from 70 to 50
percent. So we should not oversell the supply side effects from
cutting these rates by a few percentage points.
I guess my advice to you, Madam Chairwoman, is we ought to
move toward the promised land in tax policy, and that is a flat
tax type of regime where you have a single rate, where you are
taxing consumption, you are taxing income only once, but once,
with as little leakage as possible. The thing that I like about
the President's approach to tax policy is if you look at what
he has done over the last two or three years on tax policy, he
has basically said we are going to get rid of the death tax,
which is a double tax on savings; we are going to get rid of
the dividend tax, which is a double tax on savings; we are
going to expand IRAs; we are going to cut the rates. And all
those things, I am in favor of.
I probably would be in favor of some of the things that
Peter is in favor of in terms of broadening the base at the
same time, but I think the dividend tax cut is probably the
jewel of this package. If we took out the dividend tax cut, I
probably would not be very enthusiastic about the rest.
Mr. Orszag. We did agree on something.
[Laughter.]
Chairwoman Kelly. Thank you.
Dr. Spriggs, do you agree with the Home Builders'
assessment of the flaws in the Ernst and Young study? Have you
reviewed the MBA study, and if so, I would like to know what
your judgment is on that.
Mr. Spriggs. I have not reviewed the MBA study. I have
reviewed the Ernst and Young study. I am not sure that they
have, in fact, overstated, because again part of this has to do
with how the gap financing takes place for low-income housing.
Low-income housing tax credit picks up a portion of it, and
then what happens is the local government steps in with a bond.
Those bonds are going to cost more money. I think unambiguously
the dividend break means that those bonds are going to have to
cost more money. Given the current situation of where states
are right now, it is unlikely that they will make it up in some
other way. So I am not sure if you look at the totality of the
issue that Ernst and Young have overstated what the likely
impact would be.
Part of this has to do with the growth pattern we see in
the willingness of corporations to pay for the credit keeps
going up. Part of that was reflected in making the credit
permanent. So corporations could lock this into their tax
strategy. This changes their tax strategy. We saw when it had
to be annually reauthorized that corporations were not as
willing to pay as much.
So I think there are a number of issues within the Ernst
and Young that actually make them understated, which I think
will probably wash out with whatever the Home Builders think is
overstating it.
Mr. Lazio. Madam Chair, could I give some feedback on that
as well?
Chairwoman Kelly. By all means.
Mr. Lazio. As you know, I was very active in housing issues
and the tax credit in particular during my years in the House.
Just a few observations--first of all, the thought that somehow
the yields or municipal bonds would have to necessarily
increase because an equity would be more attractive to an
investor because of its tax free flow-through, I think probably
overstates the case. Right now, you have, for example, taxable
and non-taxable bonds. The spread is very small between taxable
and non-taxable bonds. The reason why people invest in
municipal instruments is for preservation of capital; for
security for a long-term investment, in that sense. And there
is a trade-off involved in that. So I just do not see that the
same investor that invests in a municipal security or bond is
going to be attracted to a more volatile equity simply because
of the tax treatment of dividends.
The second thing is, less than half of the earned income of
the S&P 500 is paid out in dividends. Unless there is an
enormous increase in the amount of dividends that we paid out,
and I do believe in speaking to some of our members, for
example, that companies will call for higher dividends if this
passes, which will be very good for shareholders, and that is
across the quadrants. There is still going to be plenty of room
for companies to invest in tax credits.
Finally, less than 1 percent of all corporate tax right now
is offset by way of housing tax credits. So they are an
exceedingly valuable housing tool. I think the case that is
made that somehow that they are going to be overwhelmed or
eviscerated because of this provision is overstated.
Chairwoman Kelly. Thank you very much.
Mr. Spriggs. If I can be allowed just one point, though, I
think again this is inconsistent to argue that on the one hand
marginal tax rates matter, and then to argue that they do not
matter. Yes, there is a risk premium, but we are changing the
size of that risk premium by making these things deductible. I
think we have to look at it from the real world perspective.
When Microsoft decided for the first time in its history that
it would give an eight cents dividend, for Bill Gates that is
$96 million. Now, under this proposal that is $96 million tax
free. There is a huge difference for those who are making these
investments, in terms of how much money we are talking about.
So I think it is inconsistent, and I think we should be
consistent about whether relative tax rates matter or not in
terms of investment decisions.
Chairwoman Kelly. Thank you, Dr. Spriggs.
I want to thank all of you for testifying today. Without
objection, I want to enter into the record the Business
Roundtable's study that was done by Pricewaterhouse, the Ernst
and Young study, and the MBA studies that are referred to
today, and the SIA report ``Defending the Dividend,'' which was
issued January 31, 2003.
I note that some members may have additional questions for
this panel they may wish to submit in writing. Without
objection, the hearing record will remain open for 30 days for
members to submit written questions to these witnesses and to
place their responses in the record.
The third panel is excused, with the great appreciation of
the committee. I want to briefly thank all of the members and
the staff for their assistance in making the hearing possible.
This hearing is adjourned.
[Whereupon, at 6:04 p.m., the subcommittee was adjourned.]
A P P E N D I X
March 18, 2003
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