[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
TAX REFORM
=======================================================================
HEARING
before the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
JUNE 8, 2005
__________
Serial No. 109-23
__________
Printed for the use of the Committee on Ways and Means
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COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
E. CLAY SHAW, JR., Florida CHARLES B. RANGEL, New York
NANCY L. JOHNSON, Connecticut FORTNEY PETE STARK, California
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM MCCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM MCDERMOTT, Washington
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. MCNULTY, New York
PHIL ENGLISH, Pennsylvania WILLIAM J. JEFFERSON, Louisiana
J.D. HAYWORTH, Arizona JOHN S. TANNER, Tennessee
JERRY WELLER, Illinois XAVIER BECERRA, California
KENNY C. HULSHOF, Missouri LLOYD DOGGETT, Texas
RON LEWIS, Kentucky EARL POMEROY, North Dakota
MARK FOLEY, Florida STEPHANIE TUBBS JONES, Ohio
KEVIN BRADY, Texas MIKE THOMPSON, California
THOMAS M. REYNOLDS, New York JOHN B. LARSON, Connecticut
PAUL RYAN, Wisconsin RAHM EMANUEL, Illinois
ERIC CANTOR, Virginia
JOHN LINDER, Georgia
BOB BEAUPREZ, Colorado
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana
DEVIN NUNES, California
Allison H. Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisory of June 8, 2005 announcing the hearing.................. 2
WITNESSES
Burch Center for Tax Policy and Public Finance, University of
California at Berkeley, Alan J. Auerbach....................... 9
Columbia University's Graduate School of Business, R. Glenn
Hubbard........................................................ 37
The Heritage Foundation, William Beach........................... 15
Office of Tax Policy Research, University of Michigan, Ann Arbor,
Joel B. Slemrod................................................ 42
Urban Institute, Leonard E. Burman............................... 19
SUBMISSIONS FOR THE RECORD
American Farm Bureau Federation, statement....................... 79
Ancona, Daniel F., ReformAMT, San Francisco, CA, statement....... 81
Anderson, Susan Schroeder, Mountain View, CA, letter............. 83
Aubut, Michael and Laura, Hopkinton, MA, joint letter............ 84
Barrett, Joyce, Talking Rock, GA, letter......................... 85
Bernstein, Rachelle, National Retail Federation, statement....... 86
Bickel, JP and Larisa, Cedar Rapids, IA, joint statement......... 88
Brown, Michael, Manchester, MI, statement........................ 89
Bullock, William, Reston, VA, letter............................. 90
Calderon, Dan, WCKV-TV Clarksville, TN, letter................... 91
Carlson, Timothy, Arlington, VA, statement....................... 91
Chesser, Craig, New York, NY, letter............................. 93
Chou, Jeffrey, Foster City, CA, letter........................... 94
Cole, John, Durham, NC, letter................................... 95
Coleman, Dorothy, National Association of Manufacturers,
statement...................................................... 97
Curcio, Joyce, Cumberland, RI, statement......................... 97
Daniels, Steve, Carson City, NV, letter.......................... 98
Delore, Eric, Alameda, CA, statement............................. 99
Dudley, Thomas, Andover, MA, statement........................... 101
Eden, Jeffrey, Lawrence, KS, letter.............................. 102
Eyster, Noel, Evans, WV, letter.................................. 103
Fermanis, Michael, New Orleans, LA, letter....................... 104
Fleisher, Mike, San Francisco, CA, letter........................ 105
Flores, Jolynne M., American Society of Pension Professionals and
Actuaries, Arlington, VA, statement............................ 106
Frank, Kevin, Cary, NC, statement................................ 110
Frisoni, Scott, Chicago, IL, letter.............................. 110
Fuchs, Brian, Thousand Oaks, CA, letter.......................... 111
Gaffney, Susan, Government Finance Officers Association,
statement...................................................... 112
Galitzer, Shari, Madison, WI, letter............................. 115
Garcia, Liles and Naomi, Aloha, OR, joint letter................. 116
Garille, Leonard, Southbury, CT, letter.......................... 116
Garner, Mark, Paso Robles, CA, letter............................ 116
Gorokhov, Mark, Germantown, MD, letter........................... 118
Greenstein, Howard, Reform Amt, San Jose, CA, letter............. 118
Griffin, Kayla, Arlington, TN, letter............................ 119
Guzak, Lauren, San Diego, CA, letter............................. 120
Hamerquist, Karen, Reform Amt, Orland, CA, letter................ 121
Hamor, Kathy, The Savings Coalition of America, statement........ 121
Hansen, Michael, Village of Lakewood, IL, letter................. 123
Hartley, Angela, San Diego, CA, letter........................... 124
Hartman, David, Lone Star Foundation, Austin, TX, statement...... 125
Hasegawa, Dawn and Jay Cena, ReformAMT.org, Cupertino, CA, joint
letter......................................................... 132
Hernandez, Kathryn, La Canada, CA, letter........................ 133
Kadillak, Tony, New York, NY, letter............................. 134
Keeling, J. Michael, The ESOP Association, statement............. 134
Keen, Todd, Westminster, MA, letter.............................. 138
Kelly, Debra and John, Amt Reform, San Leon, TX, statement....... 140
Kennedy, Sandra, Retail Industry Leaders Association, Arlington,
VA, letter..................................................... 141
Koenig, David, American Forest & Paper Association, statement.... 142
Kramp, Vivian, San Jose, CA, statement........................... 146
Krauss, Kirk, Felton, CA, letter................................. 146
Lachman, Hans, Mountain View, CA, letter......................... 147
Lacy, Leroy, Reformamt, Ben Lomond, CA, letter................... 147
Lacy, Linda, Mogadore, OH, statement............................. 149
Lapaglia, John, Hutto, TX, letter................................ 150
Lazar, William, Mountain View, CA, letter........................ 151
Linbeck, Leo, Americans for Fair Taxation, Houston, TX, statement 151
Lund, Hendy, Ben Lomond, CA, statement........................... 158
Masters, Timothy, ReformAMT.org, Boca Raton, FL, letter.......... 159
Mazingo, Steve, Fallbrook, CA, letter............................ 160
McGuire, Monica, AMT Coalition for Economic Growth, letter....... 160
Miller, Arthur & Rita, Reform AMT, Catonsville, MD, joint
statement...................................................... 163
Montague-Hill, Ashlyn, A Tax-paying, Marietta, GA, letter........ 163
Montgomery, Nield, Las Vegas, NV, statement...................... 164
Moyle, David, Beaverton, OR, statement........................... 166
Olson, Thomas, Bozeman Granite Works, Bozeman, MT, letter........ 167
Pang, Kimhoe, Cupertino, CA, letter.............................. 168
Pessemier, Bob and Susan, Money Metrics, Issaquah, WA, joint
letter......................................................... 169
Pintner, Steven and D., ReformAMT, Sunnyvale, CA, joint letter... 169
Priddy, Philip, Baton Rouge, LA, statement....................... 170
Pritchett, Michael, Network Appliance Inc., Barrington, IL,
letter......................................................... 171
Ralph, Gregory, San Diego, CA, statement......................... 171
ReformAMT.org, statement......................................... 172
Rekemeyer, Floyd and Robbin, Cedar Rapids, IA, joint letter...... 175
Reynaud, Becky, letter........................................... 175
Rieman, Garth, National Council of State Housing Agencies........ 175
Robinson, Marile, Aptos, CA, letter.............................. 178
Simmons, Monte, Dayton, OH, letter............................... 179
Simonard, Stephanie, Association of Americans Resident Overseas,
letter......................................................... 180
Speltz, Ron, Ely, IA, letter..................................... 180
Taylor, Daniel, Flossmoor, IL, letter............................ 181
Terpening, Ed, Redwood City, CA, letter.......................... 182
Thaxton, Christy, Pleasant Ridge, MI, letter..................... 183
The Honorable Rahm Emanuel, a Representative in Congress from the
State of Illinois, letter...................................... 183
Thompson, Phillip, Shoreview, MN, letter......................... 184
Tiedemann, Sunnye, Overland Park, KS, statement.................. 185
Timmons, Susan, Reform Amt, Tewksbury, MA, letter................ 188
Treacy, Claudia, Indianapolis, IN, letter........................ 189
Trowell, Christopher, Palm Coast, FL, statement.................. 191
Vasaturo, Ronald, Winnetka, IL, letter........................... 192
Veeck, Alan, Pittsburgh, PA, statement........................... 193
Wellston, Robert, Acworth, GA, statement......................... 194
Wertheim, Michael, Oakland, CA, statement........................ 196
Wienrich, Jeff, Gilbert, AZ, letter.............................. 197
Woodward, Raymond, Lombard, IL, statement........................ 198
Yomtov, Adam, Americans for Fair Taxation, Elmsford, NY, letter.. 201
Youskauskas, Heather and John, Eldersburg, MD, joint statement... 202
TAX REFORM
----------
WEDNESDAY, JUNE 8, 2005
U.S. House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to notice, at 10:00 a.m., in
room 1100, Longworth House Office Building, Hon. Bill Thomas
(Chairman of the Committee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
June 08, 2005
No. FC-11
Thomas Announces Hearing on Tax Reform
Congressman Bill Thomas (R-CA), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing on
tax reform. The hearing will take place on Wednesday, June 8, 2005, in
the main Committee hearing room, 1100 Longworth House Office Building,
beginning at 10:00 a.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only.
Witnesses will include scholars from Columbia University, University of
Michigan, University of California at Berkeley, and the Heritage
Foundation. However, any individual or organization not scheduled for
an oral appearance may submit a written statement for consideration by
the Committee and for inclusion in the printed record of the hearing.
BACKGROUND:
On January 7, 2005, President Bush established the Advisory Panel
on Federal Tax Reform. The Panel has been holding hearings throughout
the country to solicit the opinions of leading experts, academics, and
practitioners on reforming the tax code. Recognizing the burden imposed
by the current Federal tax code in terms of compliance and growth
incentives, the President's stated goal is to explore options to reform
the tax code to make it simpler, fairer, and more pro-growth. The Panel
shall report to the Secretary of the U.S. Department of the Treasury by
July 31, 2005.
More than 14,000 changes have been made to the tax code since the
last major reform effort in 1986. The tax code imposes economic
distortions that cost the U.S. economy as much as 50 cents for every
additional dollar raised, and causes taxpayers to waste 3.2 billion
hours and as much as $100 billion complying with an increasingly
complex system.
The 2005 Economic Report of the President noted: ``The current
Federal tax system is unnecessarily complex and distorts incentives for
work, savings, and investment. As a result, it imposes large burdens on
taxpayers and on the U.S. economy as a whole in the form of high
compliance costs and distortions in economic decisions.''
In announcing the hearing, Chairman Thomas stated, ``In
anticipation of recommendations from the Treasury Secretary on tax
reform, this hearing will be the first of several to inform Congress on
the need for and benefits of reforming the current tax code.''
FOCUS OF THE HEARING:
The focus of the hearing will be on attaining a broad overview of
the principle economic objectives of tax reform with a focus on
fairness, simplicity, and impacts on growth. In particular, the hearing
will explore: (1) ways to make compliance and understanding of the tax
code simpler for American workers and businesses, (2) economic
distortions and incentives imposed by the tax code, and (3) various
measures of tax burdens.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Please Note: Any person(s) and/or organization(s) wishing to submit
for the hearing record must follow the appropriate link on the hearing
page of the Committee website and complete the informational forms.
From the Committee homepage, http://waysandmeans.house.gov, select
``109th Congress'' from the menu entitled, ``Hearing Archives'' (http:/
/waysandmeans.house.gov/Hearings.asp?congress=17). Select the hearing
for which you would like to submit, and click on the link entitled,
``Click here to provide a submission for the record.'' Once you have
followed the online instructions, completing all informational forms
and clicking ``submit'' on the final page, an email will be sent to the
address which you supply confirming your interest in providing a
submission for the record. You MUST REPLY to the email and ATTACH your
submission as a Word or WordPerfect document, in compliance with the
formatting requirements listed below, by close of business Wednesday,
June 22, 2005. Finally, please note that due to the change in House
mail policy, the U.S. Capitol Police will refuse sealed-package
deliveries to all House Office Buildings. For questions, or if you
encounter technical problems, please call (202) 225-1721.
FORMATTING REQUIREMENTS:
The Committee relies on electronic submissions for printing the
official hearing record. As always, submissions will be included in the
record according to the discretion of the Committee. The Committee will
not alter the content of your submission, but we reserve the right to
format it according to our guidelines. Any submission provided to the
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written comments must conform to the guidelines listed below. Any
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guidelines will not be printed, but will be maintained in the Committee
files for review and use by the Committee.
1. All submissions and supplementary materials must be provided in
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including attachments. Witnesses and submitters are advised that the
Committee relies on electronic submissions for printing the official
hearing record.
2. Copies of whole documents submitted as exhibit material will not
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3. All submissions must include a list of all clients, persons,
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supplemental sheet must accompany each submission listing the name,
company, address, telephone and fax numbers of each witness.
Note: All Committee advisories and news releases are available on
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The Committee seeks to make its facilities accessible to persons
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call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
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materials in alternative formats) may be directed to the Committee as
noted above.
Chairman THOMAS. I want to welcome you all to the
Committee's first hearing on Federal tax reform since the
President appointed an advisory panel on Federal tax reform to
explore this important issue that is going to affect nearly
every American household. I know some folks are wondering why
we are holding hearings now on tax reform before the
President's panel issues its recommendations. As the one
Committee in the House that is charged with understanding and
evaluating the product from the President's panel, the Chair
thought it might be useful to begin an analysis of those kinds
of criteria that would be useful in making choices based upon
some of the panel's suggestions. The President has appointed a
highly qualified panel to examine the growing problem with our
current Tax Code, and I would really like to thank especially
the chairman and the vice chairman of this panel, former
Senators Connie Mack and John Breaux for their service. It
truly is a service. It will be a very difficult task in a
relatively short period of time for them to pull together the
alternatives as they have been asked to do. I do believe they
will do it, but before the release of the advisory panel report
and subsequently the U.S. Department of the Treasury
Secretary's recommendation, as I said, this Committee as the
tax writers in the House of Representatives really need to lay
the groundwork and provide some degree of uniformity of
comparison between approaches as we examine suggested changes
in the Tax Code.
You will hear over and over again that there are three
major priorities that we need to focus on. We have in front of
us a distinguished panel of economists. Although they will do
their best to try to sound as objective as they possibly can,
to a certain degree, there is some subjectivity as you discuss
the question for example, simplicity. We have seen significant
changes since the last major restructuring of the Tax Code in
1986. One of our witnesses will mention in his testimony that
the complexity of the current system has caused taxpayers to
spend 3.2 billion hours preparing their taxes in 2000. Or we
paid someone else to add to that 3.2 billion hours to prepare
our taxes. I think most people can find a more productive use
of their time. Of course the compliance cost is very expensive,
estimated as high as $135 billion. If that is the truth, what
we are saying is that it costs a dollar in compliance costs for
every $7 in Federal income taxes paid.
A second priority that will be discussed is fairness.
Clearly, from an objective versus subjective point of view,
this is as much as any in the eye of the beholder. However,
there are some metrics by which you can at least decide to
judge the question of fairness. I think this panel can be very
helpful in providing choices, even though you may choose from
among those choices, at least we have a common knowledge base
as we discuss what we mean by fairness. I guess a fundamental
one would be that similarly situated taxpayers should bear
similar tax burdens. Of course, the Code is limited, littered
with preferences and disincentives, credits and deductions
which make it difficult to truly compare in terms of fairness.
All of us would agree, that it makes no sense to use taxes to
fund the government raised in a way that discourages economic
growth. There will be some discussion over whether or not
certain types of taxes encourage economic growth, or, in fact,
don't have much effect. I hope Members will listen to these
discussions because once again, although some people feel very
strongly about a particular approach, it may be that the
difference between different approaches in terms of economic
growth is not that much.
In some instances, I think there may be significant
differences and we need to be aware of that as we take a look
at something in the area of a trillion dollars that may be
affected by particular options that we might choose that would
be raised or not raised that would stimulate the economy or not
stimulate the economy. The Chair is more than willing to accept
applications by Members of the Committee for some degree of
college credit for the discussion that we may be engaged in,
but frankly, we just have to have a particular understanding of
economic terms and approaches so that we can share a common
knowledge base as we begin to examine these various approaches.
The Chair appreciates the attendance today, as always, and
looks forward to Members' questions based upon the testimony
provided by witnesses. With that, I would recognize the
gentleman from New York for any opening statement he may make.
[The prepared statement of Chairman Thomas follows:]
Opening Statement of The Honorable Bill Thomas, Chairman, and a
Representative in Congress from the State of California
Good morning. Welcome to the Committee's first hearing on Federal
tax reform since the President appointed an Advisory Panel on Federal
Tax Reform to explore this important issue that affects nearly every
American household.
The President has appointed a highly qualified panel to examine the
growing problems with our current tax code and it has held many
hearings across the country and will soon be reporting its
recommendations to the U.S. Treasury Secretary. I'd like to thank the
Members of this panel--particularly the Chairman and Vice-Chairman,
former Senators Connie Mack and John Breaux--for their service, and I
look forward to reviewing the Panel's recommendations.
But before the release of the Advisory Panel report, and
subsequently the Treasury Secretary's recommendations, this Committee,
as the tax writers in the Legislative Branch, intends to lay the
groundwork and explore why we need to reform the tax code and the
benefits of comprehensive reform.
Today's hearing will focus on the three major priorities that
should be the driving force behind any tax reform we enact.
One priority should be simplicity. According to the President
Advisory Panel, more than 14,000 changes have been made to the code
since the last comprehensive overhaul in 1986. As one of our witnesses
will mention in his testimony, the complexity of the current system
caused taxpayers to spend 3.2 billion hours preparing their taxes in
2000. Clearly, there are more productive uses of Americans' time. The
annual cost of complying with today's Federal tax system has been
estimated to be $135 billion. In other words, it costs $1 in compliance
costs for every $7 in Federal income taxes paid.
A second priority is the fairness of the current tax code. Some may
suggest that ``fairness'' is simply in the ``eye of the beholder'' but
as we will hear today, there are some metrics that everyone should
agree with. For one, similarly situated taxpayers should bear similar
tax burdens. The current tax code is littered with preferences and
disincentives, credits and deductions so that tax burdens can vary
widely even among taxpayers with equal incomes.
Finally, the tax code should not discourage economic growth, as
many indicate that the current system does. Estimates of various tax
reform options indicate that the stakes are large--roughly $1 trillion
in present dollar terms, according to research done by one of today's
witnesses--but also that it would take some time for these benefits to
accrue.
The witnesses before us today will discuss these three priorities
in more detail. Professor Joel Slemrod will talk about the complexity
of our current tax code and how it could be simplified. Bill Beach will
discuss the inequities in the current code and Professors Hubbard and
Auerbach will address how the tax code distorts economic growth and how
tax reform could alleviate these distortions.
I now recognize the gentleman from New York, Mr. Rangel, for any
opening statement he may have.
Mr. RANGEL. Thank you, Mr. Chairman. The last time this
Committee had hearings on tax simplification and reform was in
1995 where the distinguished gentleman from Texas, Chairman
Archer led us into hearings. As a matter of fact, I tried to
get invited on his buses to go around the country to pull up
the Tax Code by the roots. Since that time, the Tax Code has
doubled in terms of pages and complexities. It just seems to
me, as I had thought with Social Security, that when you are
going to make changes with such complex legislation, that it
just screams out for bipartisanship, because if we are going to
have revenue neutrality in whatever we come up with, not that I
truly believe we are going to come up with anything, but
assuming that you and the President talk with each other and we
are going to have a bill, it would seem to me that we should
find some degree of agreement as to which deductions and which
credits are going to be eliminated, how we have got to handle
the dramatic differences in which we tax the very rich and how
the middle class has got caught in a trillion dollar package of
tax increases with the Alternative Minimum Tax (AMT).
However, I recognize that the chairman's style in
leadership is to try to do this with just Republicans, as we
find ourselves with the dilemma of Social Security and Central
American trade agreement, the only problem I have is not even
the Republicans on the Committee have the slightest idea as to
where we are going. So, I can't complain about lack of
bipartisanship there. It seems to me that this is such an
important issue that if we are talking about flat taxes and
value-added tax (VAT), that at some point the chairman may
share with us whether or not we are going to take the Social
Security reform bill and include that with a tax reform bill in
order to get some incentives for the Social Security bill to
have a new life. Now, I only know where you intend to take this
from your press conferences and appearances on television. I do
know that you want to expand Social Security beyond just
retirement and disability and survival. But, it might be that
we are going to have just one big reform package of Social
Security and taxes.
So, I hope the witnesses are prepared to deal with private
accounts and all those other things in Social Security, so at
the end of the day, the American people and the Congress as a
whole will have some idea where this august and powerful
Committee intends to go. I want to thank the witnesses, in
particular, for sharing their views with us. I only wish you
were on this Committee so that could you give us at least a
little more precise information as to where we should go. You
are the only people we have had in 10 years to talk about
reforming the Social Security system, and I hope and pray that
we don't double the Tax Code in terms of size and volume as a
result of this initiative. It is always interesting being on
this Committee because there is no telling what might happen
next. So, I thank the witnesses and we will see what happens.
Thank you, Mr. Chairman.
Mr. LINDER. Mr. Chairman.
Chairman THOMAS. I thank the gentleman.
Mr. LINDER. Mr. Chairman, I ask unanimous consent to have a
written statement as part of the record.
[The prepared statement of Mr. Linder follows:]
Opening Statement of The Honorable John Linder, a Representative in
Congress from the State of Georgia
The President's Advisory Panel on Federal Tax Reform has been
gathering testimony throughout the country and it is becoming clear to
all--finally--that the current code is unfair, it undermines economic
growth, and it places tremendous burdens on the American workers and
businesses.
The current system is a nightmare of complexity that punishes work,
saving, investment, risk-taking, and entrepreneurship. If there was a
nationwide competition to come up with the most complex and unfair
system that would be so indecipherable that even the agency that is
tasked to oversee it cannot completely understand it--this would be the
system that would be victorious.
Should we reform the tax system? Of course! Does it hinder economic
growth? Of course! Can the United States meet its commitments under the
current system? Of course not!
The GAO presented to this committee a study that shows that if we
continue to tax at the current percent of GDP and continue our
discretionary spending at its current percent of GDP, in just 35 years
from today the entire Federal revenue stream will be insufficient to
pay the interest on the debt.
We could, of course, raise taxes. Every tax increase in this
nation's history has slowed economic growth. How is this helpful? We
could cut discretionary spending. That has never garnered 218 votes in
the last 50 years.
What to do?
A study commissioned in 1997 from Harvard argues that, on average,
22% of the price system represents the embedded cost of the current IRS
system. You are paying the income tax costs, the payroll tax costs and
the compliance costs of every business entity that has had a roll in
delivering that good or service to you. In addition, the payroll tax,
part of that embedded cost, is the largest hidden tax component in the
prices of our goods and services and is the most regressive of the
existing taxes.
Our exports also go abroad burdened by this hidden tax component.
This makes us uncompetitive in the global economy and forces American
businesses to build plants in nations with a lower tax on capital and
labor. Those jobs are gone. America needs a tax system that is border-
neutral that ensures that imports receive the same tax treatment at the
checkout counter as domestically-produced goods.
The Tax Foundation produced a study that concludes that in 2004 we
spent 6.6 billion hours filling out IRS paperwork costing Americans
$203 billion. They predict that, due to complications passed in the
last few years, the cost in 2007 will be $350 billion. Studies show
that it costs the average small business $724 to collect, comply with
the code and remit $100 to the Federal Government.
There is no way to estimate how much we spend calculating the tax
implications of a business decision. The Director of the CBO tells me
of a study that says we lose 18% of our economy to making ``tax
decisions'' rather than ``economic decisions.'' Add all of this up and
it is costing us somewhere between $400 and $500 billion just to send
in about $1.5 trillion in income taxes. That is not inefficient. That
is stupid!
The IRS admits that the current code has driven at least $1.5
trillion into the underground economy. That is probably half of the
real number. Those dollars are not paying for the government services
that protect them.
Two recent studies have concluded that the amount of money held in
Offshore Financial Centers in dollar denominated deposits now is
between $9 and $11 trillion. Those are dollars that desire safety and
secrecy. They exist offshore because of the IRS.
Nibbling at the margins of our current system will fix none of the
above. Getting rid of the income tax, the payroll tax and the
compliance costs will fix them all.
Why do we not want the underground economy to participate in our
government? Why do we not want $10 trillion in our markets and banks?
Why are we timid when we know that bold change will dramatically
increase economic growth, investment, jobs and the values of our
markets and thus solve the legacy costs of old manufacturing?
We must replace the current tax system that punishes
entrepreneurship, success and thrift with a system that untaxes every
citizen on the purchase of necessities and then treats everyone exactly
the same.
America needs a tax system that is simple to understand and is not
vulnerable to the continual alteration and amendment. Even when the
current code is simplified, which was done in 1986 when many deductions
were eliminated and tax rates were drastically lowered to only two
levels, it is ultimately amended thousands of times. The end result is
a system that is not simple and is not fair.
This can only be achieved by a pure consumption tax. A tax on the
final purchase of new goods and services. With services becoming an
increasing player in our economy they must be taxed just as goods are
in 45 states today. Government ought to be neutral. It ought not pick
winners and losers. I spent 14 years as a dentist in our legislature
making a good living. It was never fair that I could make that living
without ever taxing my source of income when all of my neighbors had
to.
We owe it to our citizens to put in place a system that makes every
taxpayer a voluntary taxpayer paying taxes when they choose, as much as
they choose, by how they choose to spend. And we must give Americans
the privilege that a free society owes to its citizens. The privilege
of anonymity. No government agency should know more about us than we
are willing to tell to our family.
America needs a tax system that is fair and simple, protecting the
poor, treating all Americans the same, and is easy to understand. This
new system must be voluntary, not coercive or intrusive. It must be
transparent, eliminating hidden taxes and ensuring that all Americans
know what the government costs. Our reform efforts must also be border-
neutral so that our exports are free of the burden of the tax code and
can become competitive around the world. Finally, fundamental reform
must stop picking winners and losers through the tax code and ensure
the long-term solvency of Social Security and Medicare.
With today's hearing, our Committee hopefully will begin the
process of advancing such a tax code.
Chairman THOMAS. Without objection. Other Members who have
a written statement can certainly make it a part of the record.
Just respond briefly to the gentleman. I have written letters
to Members in the past and I have written them recently, every
Member, and have requested input as to where they might like
the Committee to go. Those letters are never answered. They
are, in fact, sent to you and you then send me a letter. I
continue to invite comments by Members as to where we might go.
If Members choose not to respond to the chairman, that is, of
course their privilege, but the accusation that there hasn't
been an attempt to reach out simply is not true. Let me also
say that at this point, one of the reasons we have such a
distinguished panel of economists in front of us, prior to the
President's panel presenting their options for tax reform, is
to begin a dialog among ourselves and with experts about
fundamental concepts of taxation before we look at particular
proposals so that we can have an opportunity to carry on a
dialog among ourselves.
The Chair will, as he has done consistently, reach out to
Members to participate in that. If Members choose not to do
that, that is the Members' choice, not that they have been
refused participation, but they choose on their own not to
participate. So, sometimes, notwithstanding the belief that
there is some preconceived notion, the Chair firmly believes
that the going is the goal, and that as you begin the process,
you begin to see options available to you that may not be able
at the beginning of the process. This hearing is primarily to
provide us with the tools to recognize and perhaps understand a
level of conceptual and communicative ability to discuss the
relative aspects of different approaches, weigh choices and
understand the outcome of those choices prior to making them.
With that, the Chair thanks you, given the very important
and diverse lives that you have, for your willingness to come
before the Committee for a period of time. Your written
statement will be made a part of the record and the Chair
invites you to address the Committee in any way that you see
fit over your prepared statement, but that the Chair hopes that
questions by the Members will stimulate some discussion among
the panel because once you read your testimony I find quite
interesting that a number of you have paired up on various
monographs and you certainly footnote each other, if you didn't
footnote yourself occasionally. It means you are very
conversant with each others' work. I thank you very much for
your time, as I said.
Chairman THOMAS. Starting with Dr. Auerbach and moving
across the panel.
STATEMENT OF ALAN J. AUERBACH, ROBERT D. BURCH PROFESSOR OF
ECONOMICS AND LAW, UNIVERSITY OF CALIFORNIA AT BERKELEY, AND
DIRECTOR, BURCH CENTER FOR TAX POLICY AND PUBLIC FINANCE,
BERKELEY, CALIFORNIA
Mr. AUERBACH. Thank you very much Mr. Chairman. It is a
great pleasure to be here again to talk about, again, about tax
reform. In my written comments I focus on the effect of tax
reform on competitiveness and economic growth. In particular, I
also highlight one popular objective that sometimes is
associated with what tax reform can do that I think is probably
misdirected. In the end, after I go through various issues, I
come up with what I hope are a useful list of recommendations
for how to think about tax reform as opposed to supporting any
particular proposal. If one starts talking about
competitiveness, and that is obviously a major concern, given
that the United States has been experiencing really massive
trade deficits, close to 6 percent of gross domestic product
(GDP) in the first quarter of this year. The first question one
has to address is exactly how we measure competitiveness. I
mean, we commonly think about competitiveness by looking at our
cost relative to the cost of foreign producers, but that is
actually a hard thing to do because exchange rates move around.
Of course, there has been a lot of discussion about
exchange rates, for example the exchange rate with China
recently. Given that exchange rates move around, it is not a
very stable measure of competitiveness, and I argue in my
testimony that a better approach to measuring competitiveness
is measuring our productivity, because the more we can produce
ultimately the higher standard of living we can have. We can't
consume more than we produce in the long run, although in
recent years we have come close to doing that. So, our
objective as a society in thinking about competitiveness should
be to have as high a level of productivity and a rising level
of productivity. When we focus on international trade, we would
should simply see that as a means for achieving a higher level
of productivity and a higher standard of living, rather than an
end in itself. That is, we shouldn't take a mercantilist
approach of trying to have trade surpluses or strong exports as
an end in themselves but simply as a goal toward achieving a
higher standard of living and a higher degree of productivity.
Now, productivity is caused by several factors, many of
which are influenced by the tax system in important ways. The
condiments generally emphasize three types of capital
accumulation as augmenting simple labor and the production of
higher levels of GDP: tangible capital, plant and equipment of
course, but also intangible capital, ideas, and further, human
capital, the education and training that makes workers more
skilled. We should focus on all three because all three are
important components of achieving higher productivity.
Sometimes we focus just on tangible capital, and I think that
is probably a mistake. Certainly if you look within any
category and across categories you can see that our tax system
does not treat the different forms of capital accumulation in a
uniform manner. That leads to a number of distortion of the
choices and makes our tax system less effective. Now, I focus,
although I discuss all three types of capital, I focus most on
tangible capital. I point out there that there are four
dimensions in particular. You can think of the types of effects
that the tax system has as four dimensions in which they vary.
First whether they are broad or targeted, second whether they
are temporary or permanent, third whether they are aimed at
savers or investors, and fourth, and perhaps the one I
emphasize the most, whether they apply to capital assets
already in place as opposed to prospective investments.
There is sort of a loose sense that things that are good
for capital are good for investment. We should really think
about these things separately. Some provisions, provisions if
you want to encourage investment and saving, then you want
provisions that are targeted toward investment and saving.
Sometimes you also have to give subsidies to existing assets as
well. That is not really something that helps you accomplish
additional capital formation and productivity. I also talk
about one thing that tax reform cannot do, and the reason I
single this out is it comes up over and over again in the tax
reform debate. There is a sense that some consumption tax
proposals, like a value-added tax or retail sales tax that
provide border adjustments, that is, don't tax exports and do
tax imports, that those systems somehow, by that provision,
help the trade balance. I, in my comments, in my written
comments I go through why that really isn't right. I think it
is generally accepted by economists that that is not an
important reason or an important way in which a consumption tax
proposal or other proposal will affect the trade balance. There
are other indirect ways, but not that. Then finally at the end,
and perhaps if I have time in a question and answer session, I
will go through the recommendations that I have. They are
listed at the end of my testimony. Thank you, Mr. Chairman.
[The prepared statement of Mr. Auerbach follows:]
Statement of Alan J. Auerbach, Robert D. Burch Professor of Economics
and Law, Director, Burch Center for Tax Policy and Public Finance,
University of California at Berkeley, Berkeley, California
I am pleased to have this opportunity to offer my views on the
effects of the tax system on economic growth and international
competitiveness and the role that tax reform can play in promoting
both. Today, I will discuss the design of effective tax incentives and
how the current tax system measures up. I will also highlight one
potential goal that tax policy cannot achieve. Finally, I will draw
some conclusions regarding the design of fundamental tax reform and how
potential reform plans should be evaluated.
What is Competitiveness?
The United States has experienced massive trade deficits in recent
years, with net imports in the first quarter of 2005 approaching 6
percent of GDP. This has led to concerns that U.S. producers may be
losing their ability to compete in the global marketplace. But how
should one define competitiveness?
The simplest definition of competitiveness, perhaps, involves a
comparison of domestic and foreign costs of production; U.S. producers
are ``competitive'' if their costs of production are lower. But this
measure of competitiveness suffers from two logical problems. First,
the costs of foreign producers, measured in U.S. dollars, depend on the
exchange rates between the dollar and the respective foreign
currencies. A low enough dollar would make all U.S producers
competitive according to this definition, even with no changes in
domestic or foreign production techniques or local labor costs. Thus,
U.S. producers could be competitive even in our weakest industries or,
at a different configuration of exchange rates, not competitive even in
our strongest. Second, the most fundamental economic concept of
international trade--Ricardo's principle of comparative advantage--
dictates that a country will export the goods and services in which it
is relatively competitive, and import the goods and services in which
it is not--even if it is extremely efficient at producing goods and
services in the latter category. By definition, a country cannot have a
comparative advantage in producing everything, and thus it cannot have
a uniform cost advantage. Thus, a comparison of domestic and foreign
costs, though perhaps intuitively appealing, is not a useful measure of
competitiveness.
A better approach to measuring competitiveness relies on a
comparison of productivity, the amount of goods and services produced
per worker hour. Higher productivity means a higher attainable standard
of living, for over the long term a society cannot consume more than it
produces. Our objective, as a society, should be a high and rising
standard of living. International trade is only a means to achieving
this ultimate objective; strong exports or a trade surplus are not ends
in themselves.
The Determinants of Productivity
Productivity per worker hour depends on a range of factors, many of
which are influenced by taxation. We should consider the impact of
taxation on human capital, tangible capital, and intangible capital--
the three types of capital that increase productivity by augmenting
basic, unskilled labor. All three types of capital are important
determinants of productivity and policies to foster capital
accumulation should be designed with all three types in mind (not just
tangible capital). Our present tax system does not treat the different
types of capital uniformly, thereby creating uneven incentives for
capital accumulation.
Tax Policy and Human Capital
The costs of accumulating human capital through education, on-the-
job training and workplace experience receive relatively favorable
treatment under current law. A primary cost of education and training
is forgone earnings--the earnings given up by staying in school or by
accepting a lower current salary in order to gain valuable job
experience--and this cost is effectively tax-deductible, because income
and payroll taxes are avoided when earnings are forgone. The
progressivity of the tax rate schedule offsets the benefit of being
able to expense costs immediately, for those who accumulate human
capital will have higher future incomes and thus face higher marginal
tax rates. But there is another aspect of the ``success'' tax that is
often ignored, that a progressive rate structure also provides
insurance against income uncertainty. Success may be the result of
education and hard work, but it also depends on luck: by choosing the
right field of study, working for a successful employer, or avoiding
debilitating illness. Indeed, recent research suggests that moving to a
less progressive rate structure might be undesirable, if one takes the
reduction in this insurance function into account.\1\
---------------------------------------------------------------------------
\1\ Shinichi Nishiyama and Kent Smetters, ``Consumption Taxes and
Economic Efficiency in a Stochastic OLG Economy,'' National Bureau of
Economic Research Working Paper No. 9492, February 2003.
---------------------------------------------------------------------------
The marginal tax rate reductions of recent legislation, then, have
offsetting effects on incentives for human capital accumulation,
increasing after-tax investment returns, but also increasing the
uncertainty of these returns. However, there is another important
aspect of recent policy that discourages human capital investment--the
fact that we are on an unsustainable fiscal path. That is, there is a
significant risk of large future tax increases. The decision to invest
in human capital relies on a very long time horizon, since the returns
to education and training may be realized only after several years. The
prospect of higher future taxes and the uncertainty regarding the form
and level of these taxes each discourage human capital investment. A
tax system's instability, in itself, discourages human capital
investment (and indeed, other types of investment as well), and it is
difficult to maintain a stable tax system when there is a large and
growing imbalance between taxes and spending.
Tax Policy and Intangible Capital
Intangible capital investments generally face more favorable tax
incentives than do investments in human capital. Not only can investors
write off such investments immediately, but qualifying investments are
eligible for the Research and Experimentation credit. Because the
immediate write-off, by itself, effectively eliminates the tax on new
investments, the combination of immediate write-off and the R&E credit
delivers an outright subsidy to investments in intangible capital. Does
such favorable treatment have any justification? The answer is yes,
because many intangible investments have the capacity to convey
positive ``spillovers'' to others in society. Put another way, if
investors cannot capture all the benefits of their investments, they
need some sort of compensation from the rest of society--those who also
gain from these investments--and a tax subsidy is therefore fair. The
right level and scope of the subsidy are difficult to determine,
however, for it is hard to identify the social payoffs to different
types of investments in intangible capital.
It should also be remembered that intangible capital depends on
more than research and development investment, and is influenced
substantially by government policy beyond the realm of taxation. Our
ability to achieve high levels of production relies on the clarity and
force of our legal system, the rationality of our regulations, the
flexibility of our employment relationships, and so forth. We should
view tax policy toward intangible capital as but one component of a
portfolio of policy tools.
Tax Policy and Tangible Capital
Incentives to invest in tangible capital, primarily plant and
equipment, are affected by myriad tax provisions. In thinking about the
nature of the provisions, it is useful to distinguish four dimensions
in which tax provisions may vary:
1. Are they broad or targeted?
2. Are they temporary or permanent?
3. Are they aimed at savers--those who supply the funds for
investment--or at the companies that actually spend the funds?
4. How do they apply to capital assets already in place, as
opposed to prospective investments?
Broad versus Targeted
One of the key principles of tax design is that taxes should have
as broad a base as possible, so as to permit the lowest possible tax
rate for a given revenue requirement. A broad-based, low-rate system
promotes efficiency by limiting the distortions of economic decisions,
and may also be simpler and easier to administer than alternative
systems.
Why deviate from this appealing norm? For example, why implement an
investment tax credit for investment in equipment, as we did prior to
1986? One argument is that the favored investment provides significant
social spillovers, basically the same rationale as for the favorable
treatment of investments in intangible capital. But there is no
convincing empirical support for the argument that certain types of
equipment investment generate such positive spillovers, so this
argument is weak. A second defense of targeted provisions is that they
offset existing benefits available to other investments. For example,
prior to the changes introduced by the Tax Reform Act of 1986, some
argued that real estate investment enjoyed a variety of tax benefits,
so that the investment credit simply leveled the playing field. While
such an argument may have had merit, at least before 1986, it is
extremely difficult to get such offsets right, as the tax provisions
one must weigh in seeking balance are typically quite different.
Temporary versus Permanent
No tax provision is truly permanent, because each year brings the
possibility of new tax legislation. But some provisions are explicitly
temporary. The bonus depreciation provisions introduced in 2002 and
enhanced and slightly extended in 2003 had this characteristic; indeed,
bonus depreciation has now expired.
Why adopt temporary provisions? The strongest potential
justification is as a stabilization device, to dampen swings in the
economy. For example, bonus depreciation was introduced while the
economy was still recovering from the 2001 recession, which had been
characterized by a steep drop in equipment investment. Historically,
adjustments of the investment tax credit were often motivated by
similar concerns. There is plenty of evidence that fluctuations in
investment incentives altered the path of investment, but no evidence
that such effects served the purpose of stabilization.\2\ Very short-
lived provisions, such as the bonus depreciation scheme, are especially
tricky to implement because they provide more powerful incentives for
longer-lived assets, allowing investors to lock in ``cheap'' capital
for a long time. The variations in incentives across assets depend on
how temporary the provisions are, making the tailoring of provisions to
provide uniform incentives extremely difficult in a dynamic tax
environment.
---------------------------------------------------------------------------
\2\ Alan J. Auerbach and Kevin Hassett, ``Tax Policy and Business
Fixed Investment in the United States,'' Journal of Public Economics
47(2), March 1992, pp. 141-170.
---------------------------------------------------------------------------
Saving versus Investment
With the existence of international capital flows, saving and
investment can occur in different countries. That is, savers in the
United States can supply funds for foreign investment, and businesses
in the United States can attract funds for their investment from
abroad. If U.S. capital accumulation is our goal, is it U.S. saving or
U.S. investment we should be encouraging?
The argument for encouraging U.S. saving is straightforward, for
increasing saving expands national wealth, whether this wealth is
invested abroad or at home. An increase in U.S. saving would also
contribute to a reduction in our trade and current account imbalances,
for, as discussed further below, the share of our domestic production
not claimed by domestic investment or government and private
consumption is available for export.
The argument for encouraging U.S investment, as opposed to U.S.
saving, is less obvious, unless one subscribes to the view that such
investment generates large social spillovers, a view that I have
already dismissed. In the end, though, there is less distinction than
there may appear to be between policies that encourage saving and
policies that encourage investment, because investment and saving tend
to move together.\3\ Thus, policies that encourage saving encourage
investment, and policies that encourage investment encourage saving.
---------------------------------------------------------------------------
\3\ Martin Feldstein and Charles Horioka, ``Domestic Saving and
International Capital Flows,'' The Economic Journal 90(358), June 1980,
pp. 314-329.
---------------------------------------------------------------------------
New Capital versus Old Capital
Some people seem to believe that provisions that benefit capital
necessarily benefit investment, but capital and investment are
distinct. Provisions may reduce the tax burden on existing capital more
or less than they reduce the tax burden on new investment. If
stimulating investment is our aim, then we should seek to reduce the
tax burden on investment. Although reducing the tax burden on existing
capital at the same time may be unavoidable, doing so may actually
discourage saving and investment, for example, by increasing asset
values and stimulating the consumption of goods and services.
Historically, proposals and actual policies have varied
considerably in their relative treatment of old and new capital. The
following diagram illustrates this variation, with provisions favoring
old capital more toward the left, and those favoring new capital more
toward the right.
[GRAPHIC] [TIFF OMITTED] T4645A.001
A reduction in the corporate tax rate lowers the tax burden on both
new and old capital, though it may help old capital more to the extent
that depreciation deductions are more favorable for new assets and
shield more of their income from taxation. An investment tax credit, on
the other hand, provides no benefit at all to existing capital. Moving
in the other direction, a reduction in the capital gains tax rate
favors old capital substantially more than new capital. A cut in the
capital gains tax rate reduces the tax burden not only on future income
from existing assets but also on these assets' past income--gains that
have already accrued but have yet to be realized.
Focusing tax provisions on new capital makes the provisions more
efficient at achieving their goal, but there are limits to the
feasibility of doing this. For example, an incremental investment tax
credit, applicable to investment in excess of some base level, would be
an even more cost-effective way of encouraging investment. But though
the incremental ITC has occasionally been proposed, the determination
of its base investment level is complex and involves potentially
perverse side effects of the type that have plagued the R&E credit over
the years.
The way a tax provision is implemented also affects the extent to
which it favors old or new capital. For example, phasing in a reduction
in the corporate tax rate rather than adopting the reduction
immediately concentrates more of the overall benefit on new capital.
Because investment decisions are forward looking, a prospective
corporate tax cut may be almost as effective at stimulating investment
as an immediate one. But the phase-in procedure will save revenue and
limit windfalls to capital already in place, the source of current
income. By this logic, the dividend and capital gains tax reductions of
2003 get things almost exactly backward. If investors believe that the
scheduled sunset after 2008 will occur, then the tax reductions will
have almost no impact on the incentive to invest while still providing
substantial tax benefits to the owners of existing assets.
Finally, it is important to look at substance rather than form in
estimating the extent to which a tax provision favors new or existing
capital. Provisions labeled ``savings incentives'' appear aimed at the
generation of new savings, and hence targeted at new capital. Any
provision that provided a tax benefit only for new saving would indeed
be an incentive to save. But many tax incentives for ``saving'' are
available to individuals who simply transfer existing assets into a
qualifying account. Such asset transfers do not constitute new saving,
and the associated tax benefits represent windfalls to existing assets.
Legislators should keep this caveat in mind when considering the
expansion of such schemes.
Measuring the ``Bang for the Buck''
As just discussed, capital income tax provisions vary in the extent
to which they provide windfalls to existing capital rather than
incentives for new investment. For a given investment incentive, a
provision that limits windfalls will have a lower revenue cost and
hence a higher ``bang for the buck''--a greater investment stimulus per
dollar of lost revenue. But comparing the revenue lost by different
provisions is tricky because the provisions may vary in their timing.
Provisions that provide ``front-loaded'' incentives may appear more
costly over a short revenue window than comparable provisions that are
``back-loaded.'' A familiar recent example is the comparison between
traditional IRAs and Roth IRAs. The two types of accounts offer similar
tax benefits to depositors when calculated over the long term, but the
tax benefits of the Roth IRAs are received by a depositor over time
(through the exemption of earnings from tax), while the traditional IRA
delivers its benefits through an immediate tax deduction. Thus, over a
short period, say a ten-year budget window, the Roth IRA will appear
less expensive and seem to have a bigger bang for the buck than the
traditional IRA even though this is not the case.
Another example comes from the Tax Reform Act of 1986, which
reduced the corporate tax rate while repealing the investment tax
credit. As discussed above, the investment tax credit is focused more
on new capital than is a corporate tax rate reduction, so trading in
the ITC for a tax rate cut seems like a move in the wrong direction, at
least in terms of potential bang for the buck. But the ITC is a front-
loaded incentive, which makes it appear more expensive over a short
time period than a corporate tax rate reduction with a similar impact
on the incentive to invest. As the 1986 reform aimed at short-term
revenue neutrality, the process was biased against the ITC.\4\
---------------------------------------------------------------------------
\4\ Indeed, the one-year revenue effects of these two tax
provisions were roughly offsetting. See Alan J. Auerbach and Joel
Slemrod, ``The Economic Effects of the Tax Reform Act of 1986, Journal
of Economic Literature 35(2), June 1997, pp. 589-632.
---------------------------------------------------------------------------
What Tax Reform Cannot Do
There are, of course, many things that tax reform cannot
accomplish, but there is one objective so closely tied to tax reform in
the minds of some that it deserves explicit attention, lest reform
efforts be misdirected. Tax reform cannot reduce the trade deficit, at
least not through the tax treatment of exports and imports.
The trade deficit, by definition, equals the amount by which
domestic investment spending plus non-investment purchases by
government and households exceed domestic production, i.e., GDP; we
must import the excess of what we spend over what we produce
domestically. Unless we reduce domestic investment spending--clearly
not an objective of tax reform--the only ways to reduce the trade
deficit are to increase domestic production or to reduce spending by
government and households. Either one of these changes--increasing
production or reducing non-investment spending--amounts to an increase
in U.S. national saving, so reducing the trade deficit (assuming we
don't sacrifice domestic investment) requires an increase in national
saving. Thus, tax reform must increase national saving in order to
reduce the trade deficit.
Tax reform can increase national saving by expanding the economy's
productivity, and hence the size of potential GDP, as well as by
encouraging saving directly, encouraging households to spend less and
save more of their current income. (Other government policies, too, can
reduce the trade deficit, notably deficit reduction policies that
reduce government spending and, through tax increases that reduce
household disposable income, reduce household spending.) But tax reform
cannot increase national saving simply by its treatment of exports and
imports.
Some consumption tax proposals, such a value added tax or a retail
sales tax, incorporate border adjustments--they are not imposed on
exports, but are imposed on imports. Other proposals do not include
border adjustments; they do not relieve the tax on exports and do not
tax imports. In comparing the approaches with and without border
adjustments, some have argued that inclusion of border adjustments
would reduce the trade deficit by making our exports cheaper abroad and
our imports more expensive at home. But, with no other differences in
economic fundamentals in the United States or abroad, border
adjustments will simply strengthen the dollar, putting importers and
exporters in the same competitive positions no matter which approach is
adopted.\5\ Ironically, the stronger dollar that border adjustments
would induce would also provide windfalls to foreigners holding dollar-
denominated assets--the very ones who have financed our recent trade
deficits.
---------------------------------------------------------------------------
\5\ See Alan J. Auerbach, ``The Future of Fundamental Tax Reform,''
American Economic Review 87(2), May 1997, pp. 143-146.
---------------------------------------------------------------------------
In summary, tax reform can help the trade balance, but only
indirectly, through its impact on national saving. The decision whether
to include border adjustments as part of a tax reform package should
hinge primarily on other factors, such as simplicity, compliance costs
and ease of administration.
Implications for Fundamental Tax Reform
On the basis of the preceding discussion, I offer the following
guidelines for tax reform design.
1. In thinking about the sources of productivity, keep all forms of
capital, not just tangible capital, in mind.
2. With few exceptions, avoid narrowly targeted tax provisions.
Such measures may be justified in exceptional cases, but more often are
a source of complexity and distortion.
3. Focus on incentives. Provisions formally associated with
``capital'' or ``saving'' do not necessarily encourage capital
accumulation very much. Providing windfalls to existing assets does not
stimulate investment or saving.
4. Take future revenue consequences into account. Proposals can be
tailored to minimize short-run revenue costs or maximize short-run
revenue gains with little impact on the proposals' economic effects or
long-run revenue consequences. The attractiveness of these proposals
should not hinge on such cosmetic alterations.
5. Pay close attention to the design of transition provisions.
Phase-in provisions can be an effective method of focusing tax benefits
on investment rather than on existing assets. But the piecemeal
application of tax incentives can also introduce opportunities for tax
arbitrage, where individuals receive tax benefits simply by
transferring existing assets to achieve tax-favored status.
6. Do not conceive of tax reform as providing simple solutions to
the U.S. trade deficit.
7. Remember that the objectives of tax reform will be undercut if
the overall fiscal system is unstable. Tax reform and broader fiscal
reform are complementary.
Chairman THOMAS. I thank you very much, Dr. Auerbach. Mr.
Beach.
STATEMENT OF WILLIAM BEACH, DIRECTOR OF CENTER FOR DATA
ANALYSIS, THE HERITAGE FOUNDATION
Mr. BEACH. Thank you very much, Mr. Chairman. My name is
William Beach, and I am from the Heritage Foundation. I do
appreciate the decision by your staff to assign me the one
topic which is only true if it is the eye of the beholder that
is making the decision. I think there are some rules, though,
that we can apply to the whole business of justice. Attaining a
simple fair and pro-growth tax system involves disciplined
thinking of by policy makers about a number of important
changes to current law. I would like to draw your attention to
some of the considerations you should make when thinking about
fairness. If you lived in a simple political and tax world,
which none of us do, then every change to the Nation's tax law
would have to pass the test. Does the change treat equals
equally? Does it reinforce vertical proportionality of the tax
system? That is as your income rises do you pay more tax? Does
the change to tax policy disturb the peaceful and lawful work
of taxpayers toward their economic and social goals?
Unfortunately, we do not live in this perfect world even though
this model is a key to the survival of good policy in a
political environment awash with conflicting interests. Also,
unfortunately, the analytical tools you have at your disposal
for evaluating the equity elements of proposed changes are
rather crude, unfortunately, easily abused and not well suited
for answering many of these key equity questions. Nearly every
tax bill is challenged to prove that it is fair. Fairness,
however can and probably does mean something different to each
person who thinks about it. I imagine that there are
differences on this subject even on this Committee.
Chairman THOMAS. Mr. Beach, There are some people who are
not able to hear you clearly. If you will, pull that mike down
closer to your mouth. Thank you very much.
Mr. BEACH. Thank you very much. I imagine that there are
differences on this subject, even on this Committee. Since you
cannot entertain an infinite number of different definitions of
fairness but must instead be governed by a definition that
enjoys wide support and also allows you to make decisions on
fairness, it is appropriate to start with the question of what
is tax fairness. In a moment or two, I am going to try to
answer that. I think we can all agree that tax fairness at
least means that everyone pays their fair share. That is the
total amount of taxes a person pays is proportional to their
economic ability to pay taxes. Thus taxes paid are proportional
to income or consumption or to some other measurement of our
use of government. Tax fairness also should mean, and I think
generally does mean the tax policy enacted today will act on
each person's taxable income so as to disadvantage no type of
taxpayer over another achieving their economic ends. This
forward equity of the Tax Code is crucial but seldom noted
fairness consideration. Vertical equity, horizontal equity and
forward equity are crucial. Three elements of equity. For
example, do tax changes made today raise barriers to women
reentering the work force years from now after raising a
family, or to immigrants starting micro businesses or to
retirees pursuing part time work? Do policy changes make it
more or less difficult for young people to achieve their goals?
Now economists, and many on this panel, have developed
techniques for analyzing how tax policy changes effect
taxpayers and non taxpayers. This family of techniques is known
as distribution analysis, and provides policy makers with crude
but sometimes effective tools for determining whether their
policy changes meet the test of vertical horizontal and forward
equity. I would suspect that in the course of your
deliberations over the next several months, maybe even over the
next year you will have presented to you tables that show the
distribution of proposed changes. There are many things that
the Members need to keep in mind when looking at those tables.
First off, against which kind of a concept is the tax policy
change distributed? Most often it is income. So, you will see
tables that will have on the vertical axis income, and it will
be broken up into 20 percentiles or deciles or some sort of
measurement. Ask yourself what income is being looked at here?
Does it include, for example, only income in the year that the
analysis is made, salary and wages, or does it include net
worth or does it include the imputed value of your house?
Crucial because one group will tell you, here is what this tax
policy change will mean. They may use a different definition of
income than another group. So, it is crucial that the Committee
think what is the definition of income that we want to look at
consistently from policy change to policy change.
Second, some people will say, oh, it is not appropriate to
use income since it is so difficult to define. Let us use
consumption. Well, consumption is, after all, a fairly public
thing. We consume things at a grocery store. We all observe
other people consuming it. Surely this must be more fair than
income. Yet, if you think about consumption, our big
consumption happens when we are young, when we are buying
houses, when we are paying off education, when we are raising
families. When we reach middle age like myself, family's gone
and I am now building net worth. My consumption falls. As I
retire, I use up my savings. So, there is even a question, does
consumption measure what we are trying to look at when we look
at tax policy changes. This whole business of fairness, and I
will conclude with this, needs to be governed by principles.
First off, look at vertical, horizontal and what I call forward
equity. I think that is crucial. Then you need determine how
are you going to measure from one proposal to the next
proposal, what happens to the distribution of income or the
distribution of tax burden or the incidence of tax burden. That
means you have to do some things behind closed doors, and that
is, decide the metric you are going to use to evaluate the
policy changes that will be presented to you by many, many
people in this town. Thank you very much.
[The prepared statement of Mr. Beach follows:]
Statement of William Beach, Director of Center for Data Analysis, The
Heritage Foundation
The President's call for fundamental tax reform combined with this
committee's continued interest in repairing and improving our tax code
provides an enormous opportunity for expanding the social and economic
well-being of all Americans. Attaining a simple, fair, and pro-growth
tax system, however, involves disciplined thinking by policy makers
about a number of important changes to current law. I would like to
draw your attention to some of the considerations you should make when
thinking about fairness.
Let me ask you to hold a mental construction in mind for the next
few minutes. It is this: in a perfect tax world, every taxpayer at each
income level would be treated equally and the more people made in
taxable income the more tax they would pay. In this world, as well, the
taxes levied to raise the necessary revenues for needed government
would not interfere with the equal right of all taxpayers to use their
labor and capital in such a way as to achieve their economic and social
goals.
That simple mental construction is crucial to the work you do day
in and day out and especially to the product we all hope will flow from
this committee once the President's Advisory Panel on Federal Tax
Reform completes its work. You need to have a model against which you
can evaluate the horizontal, vertical, and forward equity of changes to
our current tax code.
If you lived in this simple tax world, then every change to the
nation's tax law would have to pass the test: does the change treat
equals equally, does it re-enforce vertical proportionality of our tax
system, and does the change disturb the peaceful and lawful work of
taxpayers toward their economic and social goals.
Unfortunately, we do not live in this perfect world, even though
this model is a key to the survival of good policy in a political
environment awash with conflicting interests. Also unfortunately, the
analytical tools you have at your disposal for evaluating the equity
elements of proposed changes are rather crude, easily abused, and not
well suited for answering these key equity questions.
As I observed, nearly every major tax bill is challenged to prove
that it is fair. Fairness, however, can (and probably does) mean
something different to each person who thinks about it. I imagine there
are differences on this subject even on this committee. Since you
cannot entertain an infinite number of different definitions of
fairness but must instead be governed by a definition that enjoys wide
support and also allows you to make decisions on fairness, it is
appropriate to start with the question: What is tax fairness?
I think we all can agree that ``tax fairness'' at least means that
everyone pays their fair share. That is, the total amount of taxes a
person pays is proportional to their economic ability to pay taxes.
Thus, taxes paid are proportional to income or to consumption or to
some other measure of our use of government.
``Tax fairness'' also should mean (and I think generally does mean)
that tax policy enacted today will act on each person's taxable income
so as to disadvantage no type of taxpayer over another in achieving
their economic ends. This forward equity of the tax code is a crucial
but seldom-noted fairness consideration. Lawmakers should consider
whether policy change facilitates individual economic, social, and
personal choices that set in motion a sequence of activities that lead
to goals a person sets for him or herself. For example, do tax policy
changes made today raise barriers to women re-entering the workforce
years from now after raising a family, or to immigrants starting micro-
businesses, or to retiree pursuing part-time work? Do policy changes
make it more or less difficult for young people to achieve their goals?
Economists have developed techniques for analyzing how tax policy
changes affect taxpayers and non-taxpayers. This family of techniques,
known as distribution analysis, provides policy makers with crude but
sometimes effective tools for determining whether their policy changes
meet the tests of vertical, horizontal, and forward equity.
Distribution analysis, however, often flounders on two, central
problems: 1) what should we use to measure tax incidence against and 2)
how does the passage of time affect the distribution of taxes.
What policy makers frequently want to know is simply enough stated
(how will tax policy change affect the economic well-being of
taxpayers), but just as frequently is hard to answer. How do you
measure the relationship between tax policy and economic well-being?
Because we cannot measure all of the things that affect a taxpayer's
well-being, economists often settle on proxies for those data we cannot
obtain or activities we cannot observe. Certainly, the most common of
such proxies is income.
However, what is income? Most people think of income as the total
amount of money they make each year. But, does that amount count the
income from previously taxed income, like interest on a savings account
or dividends from an investment? Is ``income'' the total amount that is
spent on all goods and services and leisure? Does it include net worth?
Do we count non-cash compensation when distributing the effects of a
tax policy change?
Even if we could settle on an income concept that most analysts
would accept, how good are the income data that we would use to create
distribution tables. For example, the U.S. Census Bureau obtains a
pretty good idea about household and individual income at each
decennial census. During the intervening decade, Census regularly
surveys the population and produces updates to its decennial estimate
of income (most notably the March supplement each year) that form the
basis for so much of our economic work on taxes.
This important dataset, however, is composed of only 60,000
households out of total population of over 110,000,000 households.
While that survey size assures statistical significance on most
demographic concepts, it produces at best a crude representation of the
types and ranges of income, particularly among high-income households.
What about distributing tax policy changes by consumption?
Consumption generally is a public act, and the very fact that
consumption leaves highly visible footprints means that using it for
distributional purposes avoids many of the definitional problems
surrounding ``income.'' If we were to use consumption as the metric
against which to measure the fairness of a tax system, we would assume
that levels of tax payments would follow levels of consumption.
Simple enough, but what do you do with young taxpayers? They are
consuming very expensive education that they pay off over time, buying
homes to start a family that are paid through mortgages, buying their
first car, their furniture, and raising children (by itself an
expensive proposition). Short-term and long-term consumption get mixed
together in real life, which raises problems for distributional
analysts.
Anyway, consumption patterns tend to follow the cycle of life: high
consumption and debt early on, followed by increases in net worth and
less consumption in middle life, which ends with low consumption and
depletion of savings over retirement. If a tax system followed that
pattern of consumption, would it be fair? Probably not.
Finally, some analysts argue that we can learn a great deal about
the fairness of a tax system by studying the actual marginal tax rates
faced by taxpayers across income. If a tax system meets the vertical
and horizontal tests for fairness, then marginal tax rates will be
roughly the same for all taxpayers in each income class.
However, our current tax policy is, if anything, one of targets,
not of equal treatment. That is, Congress has decided to use the tax
system to achieve specific social and economic goals, which has
resulted in a significant decay in vertical equity. To illustrate this
point, I have provided in my full testimony a wonderful graph prepared
by Kevin Hassett of the American Enterprise Institute, a tax economist
well known to this committee. Dr. Hassett compares the current tax code
to tax law in 1986 and 1988 and how tax policy has affected the
marginal income tax rates faced by a family of four. While this graphic
shows many things, its single most important message is how targeting
tax relief has produced significant equity distortions in the code.
As Dr. Hassett's chart shows, drifting away from a tax system
governed by principles has led to tax law that is less just. Achieving
a significantly better tax code obviously involves major legislative
efforts. Having guiding principles before the members of the House and
the Senate should help them extract our tax code from the dramatic
difficulties into which it has fallen.
[GRAPHIC] [TIFF OMITTED] T4645A.002
Chairman THOMAS. Thank you very much, Mr. Beach. Dr.
Burman.
STATEMENT OF LEONARD E. BURMAN, CO-DIRECTOR OF TAX POLICY
CENTER AND SENIOR FELLOW, URBAN INSTITUTE
Mr. BURMAN. Chairman Thomas, Ranking Member Rangel and
distinguished Members of the Committee, thank you for inviting
me to testify on the principles that should guide reform of the
tax system. I applaud the Committee for taking on this
crucially important subject. I came to Washington 20 years ago
to work at the Treasury Department on what became the Tax
Reform Act 1986 (P.L. 99-514). Although it was far from
perfect, that reform was guided by the bedrock principles of
fairness, simplicity and economic efficiency. Although some
parts of the final bill weren't simple, it clearly made the tax
system fairer and more efficient. I would be delighted to see
if we would could repeat the trick again today while also make
the tax system simpler. In my testimony, I focus on how the
income tax system affects low and middle-income taxpayers and
the potential effects of tax reform on those populations. Low-
income families depend heavily on the income tax system.
Although they don't benefit from traditional deductions and
credits, most do benefit from refundable tax credits which are
available even if a tax filer doesn't owe income tax.
In fact, the refundable Earned-Income Tax Credit (EITC) is
the largest source of cash assistance for low income families
bigger in the aggregate than Temporary Assistance for Needy
Families (TANF) or food stamps. The Economic Growth and Tax
Relief Reconciliation Act of 2001 (EGTRRA, P.L. 107-16) also
substantially increased the refundable child tax credit. Both
of these credits encourage work and help families with children
meet basic needs. Since the EITC and the child tax credit phase
in with earnings they encourage labor force participation among
low income single parents. These two refundable tax credits now
represent a very large portion of income for low income
households with children. The typical household with one
eligible child and income between $10,000 and $15,000 receives
tax credits worth $2,523 or almost 23 percent of income in
2005. A household with 2 children and the same income would
receive $3,764 or almost 35 percent of income in those credits.
Even at incomes of $25,000 to $30,000 the EITC and child tax
credit boost income by more than 15 percent for families with
two or more children.
The great value of these credits also poses a risk for tax
reform. Any new tax reform that eliminated or reduced these
credits would devastate low income households unless new
spending programs were created to provide cash assistance. For
middle income families, a complex hodgepodge of tax benefits,
all with separate eligibility rules and income tests, creates
enormous variation in effective tax rates. As documented in my
written testimony, similar families can receive very dissimilar
tax treatment. Income phase-outs for credits and reductions in
the AMT create hidden taxes and needless complexity. The best
thing the tax reform could do for these families would be to
consolidate income support programs and simplify eligibility.
To the extent possible, the hidden rates created by phase-outs
in the AMT should be replaced by explicit adjustments to the
tax rates schedules or financed by closing loopholes. For
example the phase-out of the child tax credit of incomes over
$110,000 adds 5 percentage points to marginal tax rates in that
income range. A better and equally progressive option would be
to eliminate the phase-out and raise statutory tax rates
slightly starting at the same income level.
Many tax reform proposals which shift away from a tax based
on income to a tax based on consumption. Although these
proposals are often motivated by concerns about complexity and
efficiency, they would almost inevitably shift tax burdens on
to middle and/or lower income groups. Consumption is a much
larger share of income for lower- and middle-income households
than for those with high incomes. Families earning less than
$30,000 spend virtually all of their income, while those with
incomes over $200,000 spend less than 40 percent. Compared with
the comprehensive income tax, the consumption tax would exclude
two-thirds of income from the tax base for the highest income
households. Thus, a consumption tax rate would have to be three
times as large an income tax rate to keep the same tax burden
on those families. Otherwise the tax burden would inevitably
shift on to lower and middle income households. Despite the
concerns about equity, a consumption tax might still be
worthwhile if there were huge economic benefits. There aren't
likely to be. Most of the claimed benefits of switching to a
consumption tax come from base broadening and the large tax
imposed on existing capital during the transition period to a
new tax. Base broadening could just as well be done under the
income tax and the lump sum tax on old capital that excites
economists, that is a big tax on senior citizens doesn't seem
like it is going to happen from my perspective.
Beyond that, it is not a given that a consumption tax would
raise economic efficiency more than a similarly comprehensive
income tax would. Exempting capital income from tax necessarily
means that you have to raise the tax burden on labor, so you
are reducing distortion on one margin, the discouragement of
savings, but you are increasing it on another by discouraging
work. The economic evidence suggests that those things about
balance out. The overall efficiency gains are likely to be very
small. One last point, just that a surprising effect of
switching to a consumption tax in the real world is that it
might not even encourage saving, and that is because currently,
certain kinds of savings accounts, retirement savings accounts
receive special tax breaks, 401(k)s, pensions. If you
eliminated those tax breaks and said everything was tax free,
everything received the same tax treatment, it is possible that
workers would end up saving less than they do currently. There
is more in my written testimony but I would be happy to answer
your questions in the questions and answers.
[The prepared statement of Mr. Burman follows:]
Statement of Leonard E. Burman, Co-Director of Tax Policy Center and
Senior Fellow, Urban Institute
Chairman Thomas, Ranking Member Rangel, and distinguished members
of the Committee. Thank you for inviting me to testify on the
principles that should guide efforts to reform the tax system.
I applaud the committee on taking on this crucially important
subject. I came to Washington 20 years ago to work for the Treasury
Department on what became the Tax Reform Act of 1986. Although far from
perfect, that reform was guided from the start by the bedrock tax
policy principles of fairness, simplicity, and economic efficiency.
Although some parts of the final bill were simple and some weren't, it
clearly made the tax system fairer and more efficient. I would be
delighted if we could repeat the trick again today, while also making
the tax system simpler.
Although I think people exaggerate when they claim that the 1986
Tax Reform has been fully undone in the intervening two decades, the
tax code is once again in need of reform. It is needlessly complex. It
is riddled with loopholes. It imposes vastly different tax burdens on
people with similar abilities to pay. And it does not raise enough
revenue to finance current government operations, much less the growing
costs of the retirement of the baby boom generation.
In my testimony, I will focus on how the income tax system affects
low- and middle-income taxpayers and the potential effects of tax
reform on those populations. I have six main conclusions:
First, despite its flaws and some recent erosion, the
income tax is highly progressive. In other words, low- and middle-
income families bear much smaller proportional tax burdens than those
with high incomes. This mitigates the effects of other regressive
taxes, such as federal payroll and excise taxes and state and local
sales taxes.
Second, the income tax code is an important source of
income support for low-income households.
Third, tax reform could help low- and middle-income
households by reducing their tax burdens further--both by lowering
their rates and by simplifying and consolidating tax benefits to which
they are entitled.
Fourth, some so-called fundamental tax reform proposals
could shift the tax burden away from those most able to pay to those
least able.
Fifth, the claimed economic gains from such proposals are
speculative at best, based solely on theoretical models that have
little relationship to economic reality.
And, last, systemic tax reform presents the ideal
opportunity to bring our fiscal system back into balance. If it closed
loopholes under the income tax and used the revenues to reduce the
budget deficit, such reform would spur economic growth by making the
tax system more neutral, increasing national savings, and lightening
tax burdens on future generations.
I. Current Situation
The President's executive order establishing the Advisory Panel on
Tax Reform called for revenue-neutral tax reform that would advance
these objectives: ``(a) simplify Federal tax laws . . . (b) share the
burdens and benefits of the Federal tax structure in an appropriately
progressive manner . . . and (c) promote long-run economic growth.''
Although I think revenue neutrality is a misplaced priority given our
current fiscal situation, the President's objectives stand on the
bedrock principles of public finance--simplicity, fairness, and
economic efficiency.
Let's first consider the President's all-important desire to share
the burden progressively and look at how the current Federal tax code
affects low- and middle-income Americans. Its glaring flaws
notwithstanding, the current income tax does have many strengths. To
start, it is highly progressive. In 2005, the Tax Policy Center
estimates that 87 percent of the individual income tax will be paid by
the highest-income 20 percent of households ranked in terms of cash
income. (Table 1.) Almost 61 percent will be paid by the top 5 percent.
By comparison, the bottom 40 percent of households receives more in
refundable tax credits than they pay in taxes on average. Collectively,
the bottom fifth receives net tax credits worth 5.5 percent of income;
the top 1 percent pays taxes averaging 20.1 percent of income.
Although the estate tax and the corporate income tax are also quite
progressive, federal payroll taxes are regressive, consuming a much
larger share of income for low- and middle-income households than for
those at the top.\1\ And here's the rub: since payroll taxes are the
second largest share of revenue after the individual income tax, and
much larger than the other federal taxes, the overall tax system is
less progressive than the income tax. Including state and local taxes--
which rely much more heavily on regressive sales taxes--some analysts
conclude that the overall tax system is not progressive at all.\2\
---------------------------------------------------------------------------
\1\ The progressivity of the estate tax is understated somewhat in
the table because it is distributed in terms of cash income. Some
people who are quite wealthy can have very modest cash incomes--for
example, because most of their income is in the form of unrealized
capital gains. If households are ranked in terms of economic income
(including the imputed income generated by unrealized assets), then 98
percent of the estate tax falls on the highest-income 5 percent of
households.
\2\ See McIntyre, Bob. 2004. ``Overall Tax Rates Have Flattened
Sharply Under Bush: Total Federal, State & Local Rate on Richest Now
Only Slightly Higher than on Middle Ranges,'' Citizens for Tax Justice,
April 12. Available at http://www.ctj.org/pdf/fsl2004.pdf.
---------------------------------------------------------------------------
Recent federal tax changes have provided important benefits to
lower-income households. The Economic Growth and Taxpayer Relief Act of
2001 (EGTRRA) increased the child tax credit (CTC) and made it
partially refundable, expanded the earned income tax credit (EITC),
increased the standard deduction for married couples, and created a new
10-percent tax bracket.\3\ Legislation enacted in 2003 and 2004 sped up
the effective date for some of these provisions. Nonetheless, by
cutting top individual income tax rates, phasing out the estate tax,
cutting the corporate income tax, and expanding opportunities for tax-
free saving, the 2001-2004 tax cuts on balance made the tax system less
progressive. Measured as a share of income, the top tenth of one
percent of taxpayers--that's one in one thousand--got tax cuts 18 times
as large as the bottom fifth got. (Table 2.)
---------------------------------------------------------------------------
\3\ See Leonard E. Burman, Elaine Maag, and Jeff Rohaly, 2002,
``The Effect of the 2001 Tax Cut on Low- and Middle-Income Families and
Children,'' available at: http://www.taxpolicycenter.org/publications/
template.cfm?PubID=410465.
---------------------------------------------------------------------------
Table 2 also shows that households in every income class benefited
from the tax cuts, but that view is misleading. Since none of the tax
cuts were offset by tax increases or spending cuts elsewhere, it is
impossible to say who the winners and losers are. If the resulting
budget deficits lead to cuts in programs mostly benefiting middle- and
lower-income households, then they and their children will be the big
losers. If burgeoning debt starves businesses of capital, tomorrow's
families may bear the brunt. If instead middle-class benefits are
politically too popular to curtail and Congress can't or won't cut
spending, then high-income people may end up worse off than they would
have been without the tax cuts.
The bottom line is that it is impossible to assess the winners and
losers from tax changes that are not revenue neutral: we cannot gauge
the effects of the 2001 to 2004 tax cuts until we see how Congress
ultimately finances them.\4\
---------------------------------------------------------------------------
\4\ See William G. Gale, Peter Orszag, and Isaac Shapiro, 2004,
``Distribution of the 2001 and 2003 Tax Cuts and Their Financing,'' Tax
Notes, June 21, pp. 1539-1548.
---------------------------------------------------------------------------
A. How the income tax affects low- and middle-income households
The tax system is a mixed bag for low- and middle-income
households. On the one hand, it is overly complex. Tax filers must fill
out numerous worksheets and forms to claim tax credits for working,
children, child care, education, and many other activities. On the
other hand, these programs provide significant income support for
households that are struggling to meet essential needs. A better tax
system would not make families jump through so many hoops to get this
support, but tax reform that just swept all of these subsidies away to
help broaden the tax base would eviscerate income support for low- and
middle-income households.
1. Refundable tax credits for low-income families
Low-income families rely particularly heavily on the income tax
system. Although they do not benefit from traditional deductions and
credits because most do not owe income tax, they do benefit from
refundable tax credits, which are available even if a tax filer does
not owe income tax.
In fact, the refundable EITC is the largest source of cash
assistance for low-income families--bigger in the aggregate than
temporary assistance for needy families (TANF) or food stamps. EGTRRA
also substantially increased the refundable child tax credit in 2001.
In 2005, families could claim a refundable child tax credit up to 15
percent of earnings over $10,800.\5\
---------------------------------------------------------------------------
\5\ The threshold is indexed for inflation.
---------------------------------------------------------------------------
Both of these credits encourage work and help families with
children meet basic needs. Since the EITC and CTC phase in with
earnings, they encourage labor force participation among low-income
single parents. The phase-out of the EITC can discourage a spouse from
working, but since most EITC recipients are single heads of household
this isn't a major concern.\6\ Research suggests that, on balance, the
EITC encourages work among recipient households.\7\
---------------------------------------------------------------------------
\6\ See Nada Eissa and Hilary W. Hoynes, 2004, ``Taxes and the
Labor Market Participation of Married Couples: The Earned Income Tax
Credit,'' Journal of Public Economics, Vol. 88, pp. 1931-1958.
\7\ See Nada Eissa and J. Liebman, 1996, ``Labor Supply Responses
to the Earned Income Tax Credit,'' Quarterly Journal of Economics, Vol.
111, pp. 605-637; and B. Meyer and D. Rosenbaum, 2001, ``Welfare, the
Earned Income Tax Credit, and the Labor Supply of Single Mothers,''
Quarterly Journal of Economics, Vol. 116, pp. 1063-1114.
---------------------------------------------------------------------------
These two refundable tax credits now represent a very large portion
of income for low-income households with children. The typical
household with one eligible child and income between $10,000 and
$15,000 receives tax credits worth $2,523, or 22.9 percent of income,
in 2005. (Table 3.) A household with two children and the same income
receives $3,764, or 34.5 percent of income, in refundable child tax
credits and EITC. For the average household with three or more
children, the credits are worth almost $4,000, or 36 percent of income.
Families with incomes between $15,000 and $20,000 receive even larger
tax benefits, though they amount to a smaller share of income. Even at
incomes of $25,000 to $30,000, the EITC and CTC boost income by more
than 15 percent for families with two or more children.\8\
---------------------------------------------------------------------------
\8\ Very low-income households without children qualify for a small
EITC, but not the CTC. It is worth an average of $229 for recipient
households; only 3 percent of childless households qualify.
---------------------------------------------------------------------------
A very large percentage of households with children receive these
benefits. Almost 74 percent of one-child households and 83 percent or
more of households with two or more children benefit from the CTC or
the EITC or both. Participation is lower for very low-income households
because more of them do not have earnings, and for higher income
households because more of them have incomes above the phase-out
thresholds for the credits. But, among eligible households,
participation is very high.\9\
---------------------------------------------------------------------------
\9\ See Leonard E. Burman and Deborah Kobes, 2003, ``EITC Reaches
More Eligible Families Than TANF, Food Stamps,'' Tax Notes, March 17,
p. 1769.
---------------------------------------------------------------------------
The great value of these credits also poses a risk for tax reform.
Any tax reform that eliminated or reduced these credits would devastate
low-income households, unless new spending programs were created to
provide cash assistance. In fact, although many tax incentives are
probably less effective than comparable spending programs, the EITC and
CTC have a lot to recommend them. Despite being overly complex, the
EITC is a very efficient way to provide cash support for low-income
households.\10\ Most recipients of the tax credits would be filing
returns anyway to get refunds of withheld income taxes, and much of the
information about income eligibility is already reported on tax
returns. The refundable credits also avoid the stigma associated with
traditional welfare programs. And, despite the complexity, filing a tax
return is often easier for low-income working families than waiting in
line at a welfare office during working hours.\11\
---------------------------------------------------------------------------
\10\ Most EITC recipients use paid preparers to file their tax
returns. See Elaine Maag, 2004, ``Tax Preparation for Low-Income
Households, Knowledge of the EITC,'' Tax Notes, August 2, p. 555. This
is in part a function of the complexity of the EITC relative to the
functional capacity of some recipients and partly due to the popularity
of refund anticipation loans offered by some tax return preparers.
\11\ Janet Holtzblatt and Janet McCubbin, 2004, ``Issues Affecting
Low-Income Filers,'' in Henry J. Aaron and Joel Slemrod, eds., The
Crisis in Tax Administration (Washington, DC: The Brookings Institution
Press): 148-188.
---------------------------------------------------------------------------
2. Tax subsidies for middle-income families
Middle-income families benefit from an ever-growing panoply of
social programs that have been injected into the tax code. Among them
are credits for childcare expenses, credits and deductions for
education, a tax credit for adoption expenses, and itemized deductions
for mortgage interest, charitable contributions, state and local
income, sales, and property taxes, and exclusions from income for such
employer-provided fringe benefits as pensions and health insurance. The
nonrefundable tax credits are often of limited value to lower-middle-
income taxpayers because they have limited tax liability, and the
deductions and exclusions are worth the most to those with the highest
incomes. The value of a deduction is equal to the deduction amount
multiplied by the marginal tax rate for those who itemize deductions.
Since higher income households tend to have more and larger deductions
and also the highest marginal tax rates, they get the largest benefits
from deductions and exclusions.
The consequences of this hodge-podge of targeted tax benefits are
complexity and inequity. Households with similar ability to pay tax can
end up owing much different amounts, depending on how many hoops they
jump through to qualify for credits and deductions. Table 4 shows that
there can be considerable variation in average tax rates for similar
families with comparable incomes. The variation arises from differences
in use of credits and deductions and whether households are eligible
for benefits (for example, based on the age of children). A homeowner
in a high-tax state can pay much less tax than a renter in a low-tax
state, for example. Variations among lower-income families with
children can be enormous, depending on whether they qualify for the
EITC and CTC.
Table 5 shows that there is even more variation in effective
marginal tax rates--that is, the amount of additional tax paid on a
dollar of additional income.\12\ The negative tax rates for lower-
income families and individuals arise from the phase-in of eligibility
for the EITC and CTC. The positive tax rates arise from the statutory
tax brackets, the phase-out of eligibility for benefits, and the
individual alternative minimum tax, which raises effective marginal tax
rates for most taxpayers who must pay it.\13\
---------------------------------------------------------------------------
\12\ For a discussion, see Leonard E. Burman and Mohammed Adeel
Saleem, 2004, ``Income Tax Statistics for Sample Taxpayers, 2003,'' Tax
Notes, January 19, pp. 413-418. The Table shows the marginal tax rate
on earnings. Marginal tax rates on other forms of income would often be
different. Marginal tax rates are calculated by increasing income by a
small amount and calculating the increment in tax liabilities after
credits per dollar of additional income. The marginal increase in
income is the maximum of $100 and the minimum of one percent of AGI and
$1,000. This is done to smooth out some kinks in explicit and implicit
tax rate schedules. The effective marginal tax rates might not add up
exactly because of rounding or because the formulae for them are not
exactly continuous.
\13\ See Leonard E. Burman, 2005, ``The Expanding Reach of the
Individual Alternative Minimum Tax: Testimony submitted to the United
States Senate Subcommittee on Taxation and IRS Oversight of the
Committee on Finance,'' May 23, available at http://www.urban.org/
UploadedPDF/900812_Burman_052305.pdf.
---------------------------------------------------------------------------
A major source of variation arises from the notion that every tax
incentive must be progressive: the EITC, CTC, education tax incentives,
and many other provisions phase out at certain income levels. A major
reason why ever more taxpayers must pay the AMT is the phase-out of the
exemption allowed to calculate taxable income for AMT purposes, which
raises effective marginal tax rates by 25 percent. Although phase-outs
reduce the revenue losses from each provision, they also add complexity
and make it hard for some families to know in advance whether they will
be eligible for a subsidy and. if so, how much. As noted, these phase-
outs create hidden tax surcharges that are tantamount to higher
statutory tax rates.
To return to the AMT for a moment, a special problem is that it
will affect more and more middle-income households in coming years. By
2010, almost all married taxpayers with incomes between $75,000 and
$100,000 and with two or more children will be subject to this
pointlessly complicated tax. Its effect, like that of the phase-outs,
is to raise marginal tax rates on most families subject to the tax.
The best thing that tax reform could do for low- and middle-income
families would be to consolidate income-support programs and simplify
eligibility. To the extent possible, the hidden taxes created by phase-
outs and the AMT should be replaced by explicit adjustments to the tax
rate schedules or financed by closing loopholes. For example, the
phase-out of the CTC at incomes over $110,000 adds 5 percentage points
to marginal tax rates in that income range. A better and equally
progressive option would be to eliminate the phase-out and raise
statutory tax rates slightly starting at the same income level.
II. Effects of tax reform
The consequence of moving so much economic support into the tax
system is that ``tax reform'' could lead to a massive cut in income
support for low- and middle-income families. Base broadening is
equivalent to slashing cash transfers.
Base broadening is a good idea, but policymakers would need to
adjust refundable credits and tax rates to hold low- and middle-income
households harmless, on average. Even then, there would be many winners
and losers.\14\ Arguably, it might make sense to consolidate cash
assistance programs in the tax code into a couple of refundable
credits. For example, a 20-percent work tax credit for the first
$10,000 of wages for each nondependent, non-student, adult worker, and
a $1,500 per child fully refundable child tax credit would provide
about the same amount of assistance to a single mother with two
children and $20,000 of earnings as current law. If eligibility for the
work credit was based solely on work (and not the presence of children)
and all children were eligible for the child tax credit, then
administration and compliance would be vastly simplified. All workers
would be eligible for the work credit, whether or not they had
children, and all households with children would be eligible for the
child benefit, regardless of income.\15\
---------------------------------------------------------------------------
\14\ That is an inevitable consequence of revenue-neutral tax
reform so not necessarily an impediment.
\15\ Jonathan Barry Forman, Adam Carasso, and Mohammed Adeel
Saleem, forthcoming, ``Designing a Work-Friendly Tax System: Options
and Trade-offs,'' Tax Policy Center Discussion Paper Number 20.
---------------------------------------------------------------------------
To make that work, tax rates would have to be adjusted to raise the
same amount of revenue (effectively ``taking back'' the credits from
higher income households).
But barring such an offset, even fundamental income tax reform
could end up hurting the most vulnerable members of society.
1. Consumption taxes
Many tax-reform proposals would shift away from a tax based on
income to a tax based on consumption. Such proposals include the value
added tax; the flat tax, which is effectively a subtraction-method VAT
in which the wage portion of the tax is collected from workers rather
than firms and which is somewhat progressive since it exempts some
portion of wages; a national retail sales tax, which is collected
entirely at the retail stage; and a consumed income tax, which is a
progressive variant on the consumption tax.
Although these proposals are often motivated by concerns about
complexity and efficiency, they would almost inevitably shift tax
burdens onto middle- and/or lower-income groups. Consumption is a much
larger share of income for lower- and middle-income households than for
those with high incomes. Data from the Consumer Expenditure Survey
suggest that families earning less than $30,000 (in 2003 dollars) spend
virtually all of their income while those with incomes exceeding
$200,000 spend less than 40 percent.\16\ (Table 6.) This pattern is
most pronounced for necessities, such as food, housing, and clothing.
Families earning $10,000 to $20,000 spend three-quarters of their
incomes on those items, compared with one-sixth of income for those
earning more than $200,000.
---------------------------------------------------------------------------
\16\ Many researchers have commented on the implausible ratio of
consumption to income for those with very low incomes. Income is
probably underreported, especially for low-income households, which is
a special risk because the focus of the survey is consumption rather
than income. It also excludes gifts from friends and relatives.
---------------------------------------------------------------------------
Proposals for consumption taxes often include measures to reduce
their regressivity, such as demogrants--cash transfers to offset the
tax due on a basic level of consumption--for low-income households, tax
exemptions for some necessities, or even progressive rates. All of
those options raise issues, but most salient is that effective
consumption tax rates for high-income households would have to be very
large to be as progressive as the current tax system. Compared with a
comprehensive income tax, a consumption tax would exclude two-thirds of
income from the tax base for the highest-income households. Thus, a
consumption tax rate would have to be three times as large as an income
tax rate to keep the same tax burden on high-income households.\17\
Otherwise, the tax burden would inevitably shift onto at least some
lower- and middle-income households.
---------------------------------------------------------------------------
\17\ In fact, our tax system is far from a comprehensive income
tax, so conceivably a shift to a comprehensive consumption tax could be
accomplished with much more modest rates, but that assumes that the
political pressures for exemptions such as for fringe benefits,
mortgage interest, charitable contributions, and so on, could be
avoided under a consumption tax. It is worth noting, in that context,
that the President has insisted that any tax reform retain incentives
for homeownership and charitable contributions.
---------------------------------------------------------------------------
Another way to look at a consumption tax is as an income tax with
an unlimited exemption for capital income and no deduction for
interest.\18\ In other words, the tax base would be wages rather than
income. Wages, like consumption, decline as a share of income as income
increases. (Table 7.) Wages and salaries make up 28 percent of income
for households with incomes over $1 million in 2005, compared with 68
percent for households with incomes between $75,000 and $100,000. Among
households headed by someone under age 65, almost 80 percent of income
is wages for those with incomes between $30,000 and $75,000, compared
with 32 percent for those with incomes over $1 million. Under a wage
tax, more than two-thirds of income of the highest-income households
would be exempt. In other words, they would either face very high tax
rates or end up paying less tax than under an income tax.
---------------------------------------------------------------------------
\18\ Although this equivalence holds in the long run under certain
circumstances, there are significant differences in the two tax bases
in the short run. A new consumption tax would increase the price of all
consumer goods or reduce the real value of old capital, placing a large
burden on older people. A new wage tax would effectively exempt all
capital income from tax, effectively granting a large windfall on older
people who are living off of their accumulated savings.
---------------------------------------------------------------------------
In principle, it is possible to design a progressive ``consumed
income'' tax that would maintain the same distribution as current law
(on average). But the Treasury Department, after examining such
proposals, concluded that they would be much more complex than current
law and basically unworkable.\19\ The implication is that a real-world
consumption tax would inevitably shift the tax burden away from those
with the highest incomes to those with more modest incomes. Although
some proposals would protect the poor through a demogrant that would
simply squeeze middle-class households even more.
---------------------------------------------------------------------------
\19\ See Eric Toder, 1995, ``Statement of Eric Toder, Deputy
Assistant Secretary (Tax Analysis), Department of the Treasury, Before
the Senate Budget Committee,'' February 22.
---------------------------------------------------------------------------
Despite concerns about equity, a consumption tax might still be
worthwhile if there were huge economic benefits. But there aren't
likely to be. Most of the claimed benefits of switching to a
consumption tax come from base broadening and the large tax imposed on
existing capital during the transition to the new tax.\20\ Base
broadening--that is, eliminating all credits and deductions--is
probably no more politically feasible under a consumption tax than
under an income tax. In fact, in his executive order establishing to
the Advisory Panel on Federal Tax Reform, the President insisted that
incentives be maintained for homeownership and charitable
contributions. Most likely, these two tax breaks are simply the tip of
the iceberg.
---------------------------------------------------------------------------
\20\ See David Altig, Alan J. Auerbach, Laurence J. Kotlikoff, Kent
A. Smetters, and Jan Walliser, 2001, ``Simulating Fundamental Tax
Reform in the United States,'' American Economic Review, Vol. 91, pp.
574-595; and Don Fullerton and Diane Lim Rogers, 1993, Who Bears the
Lifetime Tax Burden? (Washington, DC: Brookings Institution Press).
---------------------------------------------------------------------------
As for the transition, switching from an income to a consumption
tax would effectively devalue all existing capital. For example, if the
income tax were replaced with a VAT or a national retail sales tax, the
prices of all taxed goods and services would immediately rise by the
amount of the VAT. The Federal Reserve Board could tighten the money
supply to prevent this price increase, but the resultant increase in
interest rates would reduce the value of existing capital. In either
case, old people would find that their savings could buy much less than
they did the day before the new tax regime was announced. Although such
a lump-sum tax is doubtless efficient--effectively, the government is
raising revenue by confiscating a portion of outstanding wealth--it is
unlikely to be politically feasible.
But if the government provided transition relief (for example, by
continuing to allow companies to take depreciation deductions on old
capital), tax rates would have to be much higher to make up the lost
revenue. Old people would come out ahead, since their capital assets
are worth the same amount as before and all future income from those
assets is tax-free. But most other groups end up worse off because the
higher taxes more than offset gains from a more efficient tax base.\21\
---------------------------------------------------------------------------
\21\ See Altig, et al., 2001.
---------------------------------------------------------------------------
In fact, it is not a given that a consumption tax would raise
economic efficiency more than a similarly comprehensive income tax
would. Exempting capital income from tax would eliminate the tax
penalty on saving, but raise the burden on labor. The reason is simple:
if the return to saving is exempted from the tax base, then taxes have
to increase on what is left, which is wages and salaries. If labor
supply is very sensitive to taxation, and saving is not sensitive, then
a consumption tax could harm the economy in the long run (and in the
short run too if there is transition relief).\22\ In fact, the economic
evidence seems to suggest that both labor supply and saving are
relatively insensitive to taxes, so any efficiency gains are likely to
be modest.
---------------------------------------------------------------------------
\22\ See William C. Randolph and Diane Lim Rogers, 1995, ``The
Implications for Tax Policy of Uncertainty About Labor-Supply and
Savings Responses,'' National Tax Journal, Vol. 48, pp. 429-446.
---------------------------------------------------------------------------
The models discussed so far are largely based on empirical evidence
about responsiveness of savings and labor supply to taxation, but there
is another line of argument that relies almost entirely on theory to
argue that taxing capital would never be optimal. The relatively simple
version of this theory was advanced by Peter Diamond and James
Mirrlees.\23\ They showed that if there are no restrictions on
commodity taxes and if economic profits either do not exist or can be
taxed away, then it would never be optimal to tax capital or other
inputs to the production process. But, as, Joel Slemrod points out,
that the underlying assumptions behind this oft-cited economic result
are extreme.\24\ Tax authorities cannot measure economic profits (that
is, those profits over and above the ``normal'' or required return to
capital) and, even if they could, it would be politically problematic
to apply a 100-percent tax to them.
---------------------------------------------------------------------------
\23\ See P.A. Diamond and J.A. Mirrlees, 1971, ``Optimal Taxation
and Public Production I: Production Efficiency,'' American Economic
Review, Vol. 61, pp. 8-27.
\24\ See Joel Slemrod, 1990, ``Optimal Taxation and Optimal Tax
Systems,'' Journal of Economic Perspectives, Vol. 4, pp. 157-178.
---------------------------------------------------------------------------
Similarly, there are many constraints on commodity taxes. For
starters, it would be virtually impossible to tax household production
(e.g., caring for children, cooking, house cleaning, home repairs,
gardening, etc.)--a requirement for production efficiency in the
Diamond-Mirrlees set up. Policymakers might also blanch at the notion
of assessing high taxes on necessities, such as insulin, even though
such taxes are highly efficient since people's demand for life-saving
drugs is quite insensitive to price.
A more recent line of argument has been advanced in separate papers
by Christopher Chamley and Kenneth Judd.\25\ Although mathematically
elegant, these models rest on even less realistic assumptions about
policy than the Diamond-Mirrlees model. In these models, individuals
live forever and have perfect foresight. Exempting capital income from
tax in the long run is economically efficient, but only after the
government has levied the maximum feasible tax on capital long enough
to endow the government with a huge surplus, from which it can finance
all future government operations without taxing capital or labor! If
people do not live forever or have unlimited ability to borrow, capital
owners might strongly object to that transition path. And I would bet
that there would not be many votes in Congress for establishing the
government endowment fund, much less any feasible mechanism for
preventing government from tapping into principal to pay for increased
cash transfers or more spending. (Consider the Social Security trust
fund as a less ambitious experiment on the feasibility of financing
future operations with government endowments.)
---------------------------------------------------------------------------
\25\ See Christophe Chamley,1986, ``Optimal Taxation of Capital
Income in General Equilibrium with Infinite Lives,'' Econometrica, Vol.
54, No. 3, pp. 607-622; and Kenneth L. Judd,1985, ``Redistributive
Taxation in a Simple Perfect Foresight Model,'' Journal of Public
Economics, Vol. 28, pp. 59-83.
---------------------------------------------------------------------------
Moreover, these models ignore human capital--that is, investments
people make in themselves to build skills that will pay future returns
through higher wages. Larry Jones, Rodolfo Manuelli, and Peter Rossi
showed that if it is optimal to exempt the returns on physical capital,
then it is also optimal to exempt the returns on human capital.\26\
Indeed, the logical extension of the Judd-Chamley models is that wages
should also be exempt from tax. So in this economic utopia, nothing
would be taxed!! But, if Congress cannot build a huge endowment, this
model provides no practical guide to public policy.
---------------------------------------------------------------------------
\26\ See Larry E. Jones, Rodolfo Manuelli, and Peter Rossi, 1997,
``On the Optimal Taxation of Capital Income,'' Journal of Economic
Theory, Vol. 73, pp. 93-117.
---------------------------------------------------------------------------
Incredibly, a follow-up paper by Judd argued that in general the
optimal tax rate on capital should be negative. In short, not only
should capital not be taxed, but tax incentives for investment are
warranted. To derive that result, the paper resurrected the heroic
assumptions of the Diamond-Mirrlees model.\27\
---------------------------------------------------------------------------
\27\ See Kenneth L. Judd, 1997, ``The Optimal Tax Rate for Capital
Income is Negative,'' NBER Working Paper No. 6004.
---------------------------------------------------------------------------
Utopian models aside, there are other concerns about consumption
taxes. If capital is exempt from tax, high-income people will seek out
tax shelters to make wages look like capital (as they already do with
capital gains). Self-employed people and small businesses will have an
incentive to incorporate, pay the owner a low wage, and accumulate
large untaxed profits. Some entrepreneurs already do this to avoid the
payroll tax.
Not every theoretical argument favors consumption taxation.
Shinichi Nishiyama and Kent Smetters argue that a progressive income
tax is equivalent to a kind of insurance that is not available in the
marketplace; it basically smooths after-tax income.\28\ As income
varies over time, taxpayers pay lower taxes (as a share of income) in
bad years than they do in good. The progressive income tax could be
viewed as a flat-rate income tax bundled with an insurance policy that
pays off when income falls, offsetting part of the income tax burden.
For risk-averse taxpayers, this can be quite valuable.
---------------------------------------------------------------------------
\28\ Shinichi Nishiyama and Kent Smetters, Forthcoming,
``Consumption Taxes and Economic Efficiency with Idiosyncratic Wage
Shocks,'' Journal of Political Economy.
---------------------------------------------------------------------------
Perhaps most surprising, in the real world shifting from an income
to a consumption tax would not necessarily increase saving, at least
not for middle-income families. Currently, middle-income families save
mainly by contributing to pensions and 401(k)-type plans. Employees
have an incentive to participate because they avoid income tax on
contributions. Nondiscrimination rules give employers an incentive to
induce lower-income workers to participate. But, under a consumption
tax, all saving is exempt from tax so there is nothing special about
pensions. Without the inducement of a subsidy, many workers would
choose to keep all of their savings in less restrictive accounts. But
behavioral economics (the study of how real people, rather than homo
economicus, behave) suggests that without the restrictions that apply
to pension plans people would be much less likely to contribute without
the inducements offered by employers and tax savings and more likely to
withdraw balances before retirement.
There are also some connections between income taxes and other
programs that help low-income families. Many tax and expenditures
programs for low-income people (e.g., food stamps and EITC) phase out
as income rises. But it does not make sense to phase them out based on
consumption or wages only. Would we want to preserve an income tax only
for low-income families?
Finally, a federal switch to a consumption tax would undermine
state governments' ability to raise revenue. States rely much more on
consumption taxes (mostly retail sales taxes) than the Federal
Government does. But if the Federal Government imposed its own retail
sales tax, the combined federal and state rates could be quite
high.\29\ In consequence, compliance with state sales taxes would fall
sharply. But at the same time, if the Federal Government is no longer
collecting income taxes, it would be very hard for the states to
maintain their own income tax systems. Further, many of the claimed
benefits of simplifying the consumption tax would be lost if states
continued to collect income tax. As a result, states would likely have
to sharply curtail services, which could further harm low- and middle-
income households.
---------------------------------------------------------------------------
\29\ See William G. Gale, 2005, ``The National Retail Sales Tax:
What Would the Rate Have to Be?'', Tax Notes, May 16, pp. 889-911.
---------------------------------------------------------------------------
III. Conclusion
Tax reform would be a singular accomplishment if it made the tax
system simpler, fairer, and more conducive to economic growth. Good
starting points would be fixing the income tax to reduce incentives for
inefficient tax sheltering, eliminating or retargeting the individual
alternative minimum tax, consolidating income--support programs for
low- and middle-income taxpayers, and eliminating complicated
eligibility rules and phase-out provisions, adjusting tax rates to
raise the desired level of revenue.\30\
---------------------------------------------------------------------------
\30\ More specific proposals to simplify the tax system are in
Leonard E. Burman and William G. Gale, 2001, ``A Golden Opportunity to
Simplify the Tax System,'' available at: http://taxpolicycenter.org/
publications/template.cfm?PubID=7599.
---------------------------------------------------------------------------
But tax reform poses risks for vulnerable populations that have
come to rely on the tax system for substantial income support.
Broadening the base by eliminating refundable tax credits, for example,
would devastate low-income families. Switching the base of the tax
system from income to consumption would shift the tax burden away from
those most able to pay onto those who are less able. Meanwhile, the
claimed economic benefits from such a radical shift reflect
questionable unproven assumptions.
Rather than radical tax reform, a surer path to economic growth is
to reduce the deficit, which would increase national savings directly
(by reducing public dissaving). Tax reform would be an ideal
opportunity to address the deficit. Even revenue--neutral tax reform
spells tax increases on many Americans. The losers from tax reform may
be more willing to shoulder the greater burden if they knew that their
children would pay lower taxes and enjoy a healthier economy as a
result. And the best way to reduce the deficit would be to close the
loopholes that allow businesses and high-income individuals to avoid
their fair share of tax.
Table 1. Current-Law Distribution of Federal Taxes by Cash Income Percentiles, 2005 \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Share of Total Average Effective Tax Rate
--------------------------------------------------------------------------------------------------------------------------------------------------------
All
Cash Income Cash Individual Payroll Corporate Estate All Individual Payroll Corporate Estate Federal
Class \2\ Income Income Tax Tax \4\ Income Tax Tax Federal Income Tax Tax Income Tax Tax Income
\3\ Tax \5\ Tax
--------------------------------------------------------------------------------------------------------------------------------------------------------
Lowest 2.4 -1.4 2.2 1.1 0.2 0.4 -5.5 7.5 1.2 0.0 3.2
Quintile
--------------------------------------------------------------------------------------------------------------------------------------------------------
Second 6.3 -1.9 6.9 2.7 0.4 2.2 -3.0 9.1 1.1 0.0 7.2
Quintile
--------------------------------------------------------------------------------------------------------------------------------------------------------
Middle 11.4 3.1 14.6 4.1 1.6 7.8 2.6 10.6 0.9 0.0 14.2
Quintile
--------------------------------------------------------------------------------------------------------------------------------------------------------
Fourth 19.7 13.2 25.5 8.9 0.9 17.5 6.5 10.8 1.1 0.0 18.4
Quintile
--------------------------------------------------------------------------------------------------------------------------------------------------------
Top Quintile 60.5 87.0 50.7 82.3 93.6 72.0 14.0 7.0 3.4 0.4 24.7
--------------------------------------------------------------------------------------------------------------------------------------------------------
All 100.0 100.0 100.0 100.0 100.0 100.0 9.7 8.3 2.5 0.2 20.7
--------------------------------------------------------------------------------------------------------------------------------------------------------
Addendum
--------------------------------------------------------------------------------------------------------------------------------------------------------
Top 10 Percent 44.9 73.2 30.5 74.4 89.5 56.5 15.9 5.6 4.1 0.5 26.1
--------------------------------------------------------------------------------------------------------------------------------------------------------
Top 5 Percent 33.7 60.8 17.1 67.2 83.8 44.4 17.6 4.2 4.9 0.6 27.3
--------------------------------------------------------------------------------------------------------------------------------------------------------
Top 1 Percent 18.6 38.3 4.6 50.8 58.0 26.6 20.1 2.0 6.8 0.7 29.6
--------------------------------------------------------------------------------------------------------------------------------------------------------
Top 0.5 14.7 30.8 2.8 44.5 49.1 21.5 20.5 1.6 7.5 0.8 30.4
Percent
--------------------------------------------------------------------------------------------------------------------------------------------------------
Top 0.1 8.5 18.0 1.0 32.0 28.8 13.0 20.7 1.0 9.3 0.8 31.9
Percent
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Urban-Brookings Tax Policy Center Microsimulation Model (version 0305-1), Table T05-0700, http://www.taxpolicycenter.org/TaxModel/tmdb/Content/
Excel/T05-0070.xls.
(1) Calendar year.
(2) Tax units with negative cash income are excluded from the lowest quintile but are included in the totals. Includes both filing and non-filing units.
Tax units that are dependents of other taxpayers are excluded from the analysis. For a description of cash income, see http://www.taxpolicycenter.org/
TaxModel/income.cfm
(3) After tax credits (including refundable portion of earned income and child tax credits).
(4) Includes both the employee and employer portion of Social Security and Medicare tax.
(5) Excludes customs duties and excise taxes.
Table 2. Effect of 2001-2004 Tax Cuts on Effective Federal Tax Rates, by
Cash Income Class, 2005 \1, 2\
Effective Federal Tax Rates (in Percent) \3\
------------------------------------------------------------------------
Cash Income Class Pre-EGTRRA Law Current Law Change
------------------------------------------------------------------------
Lowest Quinti3.5 3.2 -0.2
------------------------------------------------------------------------
Second Quintile 9.1 7.2 -1.9
------------------------------------------------------------------------
Middle Quintile 16.4 14.2 -2.2
------------------------------------------------------------------------
Fourth Quintile 20.3 18.4 -1.9
------------------------------------------------------------------------
Top Quintile 27.3 24.7 -2.6
------------------------------------------------------------------------
All 23.1 20.7 -2.4
------------------------------------------------------------------------
Addendum
------------------------------------------------------------------------
Top 10 Percent 28.8 26.1 -2.7
------------------------------------------------------------------------
Top 5 Percent 30.1 27.3 -2.7
------------------------------------------------------------------------
Top 1 Percent 32.7 29.6 -3.1
------------------------------------------------------------------------
Top 0.5 Percent 33.7 30.4 -3.3
------------------------------------------------------------------------
Top 0.1 Percent 35.5 31.9 -3.6
------------------------------------------------------------------------
Source: Urban-Brookings Tax Policy Center Microsimulation Model (version
0304-3), Tables T04-0113 and Table T04-0096.
\1\ Baseline is pre-EGTRRA law. Includes provisions in EGTRRA, JGTRRA,
and WFTRA affecting the following: marginal tax rates; the 10-percent
bracket; the child tax credit; the child and dependent care credit;
the AMT; the standard deduction, 15-percent bracket, and EITC for
married couples; tax rates on long-term capital gains and dividends;
pension and IRA provisions; expansion of student loan interest
deduction (excludes other education provisions); and estate tax
exemption, rates, and state death tax credit.
\2\ Tax units with negative cash income are excluded from the lowest
quintile but are included in the totals. For a description of cash
income, see http://www.taxpolicycenter.org/TaxModel/income.cfm
\3\ Average federal tax (includes individual and corporate income tax,
payroll taxes for Social Security and Medicare, and the estate tax) as
a percentage of average cash income.
[GRAPHIC] [TIFF OMITTED] T4645A.003
Table 4. Variation in Average Tax Rates by Marital Status and Number of Children, 2005
----------------------------------------------------------------------------------------------------------------
Percentile
Cash Income Class Tax Units Mean Standard ---------------------
Deviation 5th 95th
----------------------------------------------------------------------------------------------------------------
$15,000 to $20,000
----------------------------------------------------------------------------------------------------------------
Married Filing Jointly 2,368,415 -4.03 9.14 -27.93 0.0
----------------------------------------------------------------------------------------------------------------
Singles and HOH 8,502,452 -3.35 10.82 -27.04 5.90
----------------------------------------------------------------------------------------------------------------
MFJ 0 Children 1,867,464 0.03 0.41 0.00 0.00
----------------------------------------------------------------------------------------------------------------
MFJ 1 Child 210,763 -13.79 7.11 -19.99 0.00
----------------------------------------------------------------------------------------------------------------
MFJ 2+ Children 290,188 -23.02 10.41 -31.63 0.00
----------------------------------------------------------------------------------------------------------------
Singles and HOH 0 Children 6,291,330 2.59 2.59 0.00 6.60
----------------------------------------------------------------------------------------------------------------
Singles and HOH 1 Child 1,212,148 -15.59 3.97 -19.96 -8.32
----------------------------------------------------------------------------------------------------------------
Singles and HOH 2+ Children 998,974 -25.97 4.44 -31.54 -19.47
----------------------------------------------------------------------------------------------------------------
$50,000 to $55,000
----------------------------------------------------------------------------------------------------------------
Married Filing Jointly 1,630,697 3.29 3.25 -2.06 7.93
----------------------------------------------------------------------------------------------------------------
Singles and HOH 2,120,734 8.55 3.98 1.15 13.20
----------------------------------------------------------------------------------------------------------------
MFJ 0 Children 851,275 4.91 2.69 0.00 8.06
----------------------------------------------------------------------------------------------------------------
MFJ 1 Child 336,897 3.61 1.74 0.39 5.74
----------------------------------------------------------------------------------------------------------------
MFJ 2+ Children 442,525 -0.07 2.49 0.39 5.74
----------------------------------------------------------------------------------------------------------------
Singles and HOH 0 Children 1,566,384 10.03 3.00 4.40 13.30
----------------------------------------------------------------------------------------------------------------
Singles and HOH 1 Child 375,533 5.87 2.24 2.55 8.98
----------------------------------------------------------------------------------------------------------------
Singles and HOH 2+ Children 178,817 1.26 3.35 -6.75 6.11
----------------------------------------------------------------------------------------------------------------
$100,000 to $105,000
----------------------------------------------------------------------------------------------------------------
Married Filing Jointly 825,856 7.92 2.89 3.62 12.29
----------------------------------------------------------------------------------------------------------------
Singles and HOH 219,668 13.24 4.20 2.40 18.40
----------------------------------------------------------------------------------------------------------------
MFJ 0 Children 383,282 9.58 2.55 4.97 12.65
----------------------------------------------------------------------------------------------------------------
MFJ 1 Child 169,704 7.85 2.19 4.76 11.47
----------------------------------------------------------------------------------------------------------------
MFJ 2+ Children 272,870 5.62 1.98 2.12 8.96
----------------------------------------------------------------------------------------------------------------
Singles and HOH 0 Children 182,038 13.73 4.00 5.75 18.42
----------------------------------------------------------------------------------------------------------------
Singles and HOH 1 Child 28,181 10.91 4.49 2.40 15.37
----------------------------------------------------------------------------------------------------------------
Singles and HOH 2+ Children 9,449 10.69 3.88 1.28 15.73
----------------------------------------------------------------------------------------------------------------
Source: Urban-Brookings Tax Policy Center Microsimulation Model (version 0305-3a).
Notes: MFJ refers to married filing joint returns; HOH refers to returns filing as head of household
Table 5. Variation in Marginal Tax Rates by Marital Status and Number of Children, 2005
----------------------------------------------------------------------------------------------------------------
Percentile
Cash Income Class Tax Units Mean Standard ---------------------
Deviation 5th 95th
----------------------------------------------------------------------------------------------------------------
$15,000 to $20,000
----------------------------------------------------------------------------------------------------------------
Married Filing Jointly 2,368,415 -0.89 7.21 -14.95 7.61
----------------------------------------------------------------------------------------------------------------
Singles and HOH 8,502,452 7.72 15.97 -14.93 25.86
----------------------------------------------------------------------------------------------------------------
MFJ 0 Children 1,867,464 0.33 2.38 0.00 0.00
----------------------------------------------------------------------------------------------------------------
MFJ 1 Child 210,763 -2.66 12.52 -33.83 15.95
----------------------------------------------------------------------------------------------------------------
MFJ 2+ Children 290,188 -7.43 14.80 -40.00 6.05
----------------------------------------------------------------------------------------------------------------
Singles and HOH 0 Children 6,291,330 9.16 15.33 0.00 17.39
----------------------------------------------------------------------------------------------------------------
Singles and HOH 1 Child 1,212,148 7.53 16.12 -14.99 25.96
----------------------------------------------------------------------------------------------------------------
Singles and HOH 2+ Children 998,974 -1.12 16.81 -40.00 21.02
----------------------------------------------------------------------------------------------------------------
$50,000 to $55,000
----------------------------------------------------------------------------------------------------------------
Married Filing Jointly 1,630,697 15.59 9.31 0.00 24.98
----------------------------------------------------------------------------------------------------------------
Singles and HOH 2,120,734 21.79 7.31 14.97 30.95
----------------------------------------------------------------------------------------------------------------
MFJ 0 Children 851,275 16.30 11.52 0.00 27.72
----------------------------------------------------------------------------------------------------------------
MFJ 1 Child 336,897 15.39 3.35 14.79 22.25
----------------------------------------------------------------------------------------------------------------
MFJ 2+ Children 442,525 14.38 7.26 14.79 22.25
----------------------------------------------------------------------------------------------------------------
Singles and HOH 0 Children 1,566,384 23.87 6.91 14.97 33.82
----------------------------------------------------------------------------------------------------------------
Singles and HOH 1 Child 375,533 16.16 4.22 14.97 27.21
----------------------------------------------------------------------------------------------------------------
Singles and HOH 2+ Children 178,817 15.45 5.74 6.05 30.72
----------------------------------------------------------------------------------------------------------------
$100,000 to $105,000
----------------------------------------------------------------------------------------------------------------
Married Filing Jointly 825,856 22.24 5.69 14.98 28.19
----------------------------------------------------------------------------------------------------------------
Singles and HOH 219,668 25.78 6.50 24.97 30.58
----------------------------------------------------------------------------------------------------------------
MFJ 0 Children 383,282 23.28 5.39 14.99 26.40
----------------------------------------------------------------------------------------------------------------
MFJ 1 Child 169,704 22.66 5.69 14.99 32.63
----------------------------------------------------------------------------------------------------------------
MFJ 2+ Children 272,870 20.51 5.70 14.98 27.00
----------------------------------------------------------------------------------------------------------------
Singles and HOH 0 Children 182,038 25.96 4.99 24.98 29.75
----------------------------------------------------------------------------------------------------------------
Singles and HOH 1 Child 28,181 24.00 12.50 14.98 33.52
----------------------------------------------------------------------------------------------------------------
Singles and HOH 2+ Children 9,449 27.61 4.85 14.98 30.95
----------------------------------------------------------------------------------------------------------------
Source: Urban-Brookings Tax Policy Center Microsimulation Model (version 0305-3a).
Notes: MFJ refers to married filing joint returns; HOH refers to returns filing as head of household.
Table 6. Consumption as a Percentage of Income, by Type
----------------------------------------------------------------------------------------------------------------
All
Income Expenditures Food Housing Clothing Necessities
----------------------------------------------------------------------------------------------------------------
$1-10K 254 52 81 10 143
----------------------------------------------------------------------------------------------------------------
10K-20K 137 25 45 5 75
----------------------------------------------------------------------------------------------------------------
20K-30K 104 18 31 4 54
----------------------------------------------------------------------------------------------------------------
30K-40K 87 15 24 4 43
----------------------------------------------------------------------------------------------------------------
40K-50K 75 13 21 4 37
----------------------------------------------------------------------------------------------------------------
50K-75K 68 11 18 3 32
----------------------------------------------------------------------------------------------------------------
75K-200K 56 8 15 3 26
----------------------------------------------------------------------------------------------------------------
Over $200K 37 5 9 2 16
----------------------------------------------------------------------------------------------------------------
Source: Tax Policy Center calculations based on Consumer Expenditure Surveys from 1993:1 to 1998:2
Note: Income is composed of earned and unearned income, and government transfers.
All items in 2003 dollars.
Table 7. Wages and Salaries as a Percent of Income, by Cash Income Class, 2005 \1\
----------------------------------------------------------------------------------------------------------------
All Tax Units 65 and Over \4\ Age Under 65
--------------------------------------------------------------------------------------------------
Cash Income Tax Units \3\ Wages Tax Units \3\ Wages Tax Units \3\ Wages
Class ----------------------- and ----------------------- and ----------------------- and
(thousands of Salaries Salaries Salaries
2005 dollars) as a as a as a
\2\ Number Percent Percent Number Percent Percent Number Percent Percent
(thousands) of Total of (thousands) of Total of (thousands) of Total of
Income Income Income
----------------------------------------------------------------------------------------------------------------
Less 19,560 13.5 43.5 4,083 13.8 4.7 13.5
----------------------------------------------------------------------------------------------------------------
10-20 25,611 17.7 48.6 7,774 26.2 5.3 17,837 15.5 67.0
----------------------------------------------------------------------------------------------------------------
20-30 19,953 13.8 61.5 4,450 15.0 6.7 15,503 13.5 76.9
----------------------------------------------------------------------------------------------------------------
30-40 15,289 10.6 67.5 2,570 8.7 7.0 12,719 11.1 79.7
----------------------------------------------------------------------------------------------------------------
40-50 11,738 8.1 67.8 2,043 6.9 11.3 9,696 8.4 79.6
----------------------------------------------------------------------------------------------------------------
50-75 20,700 14.3 67.1 3,918 13.2 15.5 16,782 14.6 79.1
----------------------------------------------------------------------------------------------------------------
75-100 11,936 8.3 68.0 1,969 6.6 16.9 9,967 8.7 78.1
----------------------------------------------------------------------------------------------------------------
100-200 14,432 10.0 66.6 2,014 6.8 17.1 12,418 10.8 74.6
----------------------------------------------------------------------------------------------------------------
200-500 3,797 2.6 53.0 664 2.2 14.1 3,133 2.7 61.4
----------------------------------------------------------------------------------------------------------------
500-1,000 642 0.4 40.2 120 0.4 11.6 523 0.5 46.8
----------------------------------------------------------------------------------------------------------------
More than 335 0.2 27.9 68 0.2 10.7 267 0.2 32.0
1,000
----------------------------------------------------------------------------------------------------------------
All 144,573 100.0 58.5 29,690 100.0 12.7 114,884 100.0 68.6
----------------------------------------------------------------------------------------------------------------
Source: Urban-Brookings Tax Policy Center Microsimulation Model (version 0305-3a).
\1\ Calendar Year.
\2\ Tax units with negative cash income are excluded from the lowest income class but are included in the
totals. For a description of cash income, see http://www.taxpolicycenter.org/TaxModel/income.cfm
\3\ Includes both filing and non-filing units. Tax units that are dependents of other taxpayers are excluded
from the analysis.
\4\ For married couples, at least one spouse is age 65 or over.
Chairman THOMAS. Thank you very much, Dr. Burman. Dr.
Hubbard.
STATEMENT OF R. GLENN HUBBARD, DEAN, COLUMBIA UNIVERSITY'S
GRADUATE SCHOOL OF BUSINESS, NEW YORK, NEW YORK
Mr. HUBBARD. Thank you very much, Mr. Chairman, Ranking
Member Rangel, and Members of the Committee. This is an
important subject and I appreciate your willingness to listen
to five economists. I also appreciate Mr. Rangel's admonition.
I visited with you all in 1995, but I swear I bear no
responsibility for the complexity. I think this is a big
subject because policy normally works around the edges and this
isn't around the edges. Potential gains in-household incomes
annually from true fundamental tax reform could be as large as
9 percent. True, fundamental tax reform could reduce
significantly complexity cost the chairman alluded to and
maintain tax fairness. There is an elephant in the room in the
discussion of fundamental tax reform, and that is really
capital taxation and business taxation issues generally.
Capital income taxation as we currently implement it in the
United States lies at the core of the efficiency costs of the
current tax system, complexity and tax avoidance strategies
that frankly undermine fairness.
Beyond capital accumulation, the way we tax business and
capital in the United States also discourages risk taking and
entrepreneurship, and we have recent cross country evidence to
suggest very strong links to economic growth and to wages and
competitiveness. I would submit to you that an interesting
place for you to start as you look at alternative proposals are
proposals that try to tax economic activity or income once. I
would suggest a family of two-tier systems, a business tax and
a household tax. Under the business tax, I would have a
business tax, not a separate corporate tax that is based on
sales, less purchases from other firms, less compensation, less
a portion of capital spending. That would be depreciation under
an income tax, expensing under a consumption tax. On the
household tax, I would suggest a household tax on compensation.
That kind of system can be as progressive as you like. You can
have exemptions, you can have rates under the top rate. It is
not difficult to replicate the progressivity of the current
code.
I would also caution, and we can come back to this in
questions and answers, the distinction between an income tax
reform and consumption tax reform is not as large as you might
hear from economists. The flip side of that is also the
consumption tax reform is--can't possibly be that much more
regressive if at all than income tax reform. That is a critical
point on both efficiency and fairness. What are some good
outcomes as a consequence of this family of tax reforms? No
taxation of investor level returns, that is, you would collect
the tax on businesses once at the business level. No tax
distinction between debt and equity which has enormous
efficiency cost. We have also seen the pernicious role of that
tax distortion in corporate governance scandals. This does not
again mean the capital income isn't taxed, only that it is
taxed once at the business level. Second implication of these
kinds of reforms would be a move toward a more territorial tax
system for multi national companies enhancing our
competitiveness and substantially enhancing simplicity. If we
were to go to the consumption tax version of this, there would
be a substantial additional stimulus to business investment
spending from equipment expensing.
What are some big challenges here? One is the tax treatment
of interest at the business level. Virtually any fundamental
tax reform prototype you look at, income or consumption tax
would disallow some or all interest deductions while not taxing
interest income for investors. That is a big change. Special
provisions in the business community would need to be swept
aside. Transition costs are always mentioned to you as a big
issue. Respectfully, I don't agree. We can come back to this. I
think the transition costs of many tax reforms are relatively
modest. Household tax challenges have to do principally with
broadening the base. I assume in your discussions you would
also discuss eliminating the AMT as well. It is possible to
have a household tax that has roughly the same distribution as
you have now. That distribution would not be accomplished with
ever higher rates but with broadening the tax base.
Can we get there from here? Absolutely. Recent tax changes
that this Committee has played a central role in point the way.
Reductions in marginal tax rates, investment incentives and
reduced taxation of dividends and capital gains all under the
stewardship of this Committee were exactly the right way, and
the distributional concerns can be easily satisfied so that
high income taxpayers pay the same or greater burden as they
currently do. Compromises could be a more scheduler version of
what I have suggested, maybe small but not zero taxation of
capital at the investor level. Just to close, I would like to
leave you with a quick thought on the infrastructure, if you
will, as you analyze any of these proposals, remembering that
the growth effects are potentially large as you look at revenue
estimates I would invite you to consider that. Second,
following up on what some of the colleagues have said before,
that you remember distributional analysis needs to take into
account the fact that you can do many things in the Code at
once. Finally, the obvious admonition of don't let the best be
the enemy of the good. There are many of these proposals that
are very close in terms of their effects. Thank you, Mr.
Chairman.
[The prepared statement of Mr. Hubbard follows:]
Statement of R. Glenn Hubbard, Dean, Columbia University's Graduate
School of Business, New York, New York
Thank you, Mr. Chairman, for the opportunity to appear before the
Committee today to discuss options for fundamental reform of the
Nation's tax code. The discussion that you and the President are
leading offers an opportunity for public policy to improve living
standards for all Americans, while providing a simpler and fairer tax
code. Indeed, given recent estimates that annual gains in household
income made possible by tax reform are as high as nine percent, few
policy changes you evaluate are as significant.
CAPITAL INCOME TAXATION AS A PROBLEM
The bulk of the considerable efficiency gains from fundamental tax
reform are achieved by reducing the burden of capital income taxation,
which arises from the multiple layers of taxation on certain forms of
productive business investment. Capital income taxation is also at
center stage in the complexity of the present tax system (for example,
measurement of capital gains and depreciation and the numbing
complexity of tax rules governing multinational companies).
President George W. Bush has pursued an agenda of reducing the
efficiency and complexity costs associated with capital income
taxation. Yet fundamental tax reform--moving from the current tax
system to a broad-based income tax or consumption tax with a simpler
structure and lower marginal rates--would be on the watch list for
action even without the President's interest. Part of this emphasis
reflects the concerns of economists and policy mavens that tax reform
could improve the efficiency of the economy and generate extra income
for U.S. citizens. But practical factors in policy debates loom much
larger--the perceived declining competitiveness of U.S. firms, the low
rate of saving by most Americans, and the growing reach of the
alternative minimum tax into the lives of millions of middle-income
households.
These real-world pressures supported President Bush's tax cuts of
2001, 2002, and 2003. By means of his tax cuts and discussions of tax
reform, President Bush has quietly made the case for a simpler tax
system that would remove or at least sharply reduce the current-law tax
bias against saving and investment. Indeed, the president's framing of
the tax reform debate has corralled the real-world pressures for reform
into a discussion of a consumption tax as a way of flushing out the
familiar ``simpler, fairer, flatter'' goals of tax reform. And one
would hope that this discussion will focus on how to broaden the tax
base to make the marginal tax rates on investment (and work and
entrepreneurship) as low as possible.
So, if capital income taxation is the ``elephant in the room'' of
tax reform discussions, why is fundamental tax reform so difficult to
accomplish? This framing will likely provoke loud outcries that
consumption-based tax reform is unfair or, in the language of
economists, ``regressive.''
One ``fairness'' concern about any fundamental tax reform that
would broaden the tax base and reduce marginal tax rates is that top
rate reductions would benefit only a handful of affluent taxpayers.
This ``snapshot'' distributional analysis calls to mind the imagination
of Tevye the Milkman in Fiddler on the Roof, who in the song ``If I
Were a Rich Man'' thinks of one staircase just going up and another
just going down. But in the same way that actual staircases allow for
both upward and downward mobility, the tax system sees considerable
income and tax rate mobility on the part of households. As a result,
the reductions in marginal rates made possible by tax reform affect
many more individuals than a snapshot would suggest.
In 2003, the White House Council of Economic Advisers used Treasury
Department Data on households for the years 1987 to 1996 to study how
households change income tax brackets over time (see Council of
Economic Advisers, 2003, Exhibit 5.4). More specifically, the
economists used the data to ask what tax rates would households have
faced had President Bush's Economic Growth and Tax Relief
Reconciliation Act of 2001 been in place over this period. The
tabulations revealed that more than half of taxpayers were in a
different tax rate bracket at the end of the period and that the upward
and downward mobility was significant: Two-thirds of taxpayers in the
lowest bracket had moved to a higher bracket after ten years, and four
times more taxpayers were subject to one of the top two tax rates in at
least one of the ten years than was indicated by the initial snapshot.
Another significant ``fairness'' concern about tax reform in the
form of a consumption tax is the claim that such a tax would exempt
income from saving from tax. To the extent that higher-income and
wealthier houses save more, a shift to a consumption tax might appear
to favor these households. Such an argument is intuitive--but wrong
(see Hubbard, 2005). A broad-based consumption tax need not be more
regressive than a broad-based income tax. The real challenge for tax
reform is to accomplish either one.
BENCHMARKS FOR TAX REFORM
I suggest as benchmark tax reforms systems that would tax income
once. To facilitate comparison between ``income tax'' and ``consumption
tax'' versions of reform, I focus on two-part tax systems, with a
business tax and a household tax. While I describe examples with a
uniform rate of tax, it is easy to introduce progressivity with
multiple tax brackets and an exemption in the household tax.
Proposals for fundamental tax reform typically suggest moving to
either a more pure income tax or a more pure consumption tax. Although
these two proposals appear to be on opposite ends of a spectrum, the
purer income tax and the purer consumption tax may affect economic and
corporate financing decisions in similar ways. Moving to a purer tax
system of either type also would reduce tax-planning opportunities
because tax-minimizing strategies often involve combining transactions
with different tax treatments (that is, part of the transaction
receives pure income-tax treatment, while another part receives
consumption-tax treatment) or by taking advantages of disparities in
tax rates across investors.
Broad-Based Income-Tax Reform
For economic and corporate financing decisions, the critical
element of fundamental reform of the income tax is the integration of
the corporate and the personal income-tax systems. In theory,
integrating the systems would eliminate two distortions from the
current tax system. First, integration would eliminate the distinction
between corporate and noncorporate businesses by abolishing the double
taxation of corporate income. Second, this reform would remove the
differential taxation of debt and equity financing.
The U.S. Treasury Department's study of corporate tax integration
(see U.S. Department of the Treasury, 1992) presents several
alternative approaches to integrating the individual and corporate tax
systems. One proposal, the Comprehensive Business Income Tax (CBIT)
seeks is to tax business income once. CBIT is a business-level tax on
the return to capital of businesses. Broadly speaking, the business-
level tax base under CBIT is revenue from the sale of goods or real
assets less wages, material costs, and depreciation allowances for
capital investments. To conform to standard income accounting
principles, the CBIT base uses depreciation allowances that follow as
closely as possible economic depreciation. CBIT does not distinguish
whether investment is financed by debt or equity. That is, in contrast
with the current tax system, CBIT would not allow businesses to deduct
interest payments from their tax base. Because CBIT taxes business
income at the entity level, there is no need for investor-level taxes
on capital gains, interest, or dividends received. CBIT can be thought
of as the capital income tax component of a broad-based income tax that
collects taxes form labor income through a household-level wage tax.
Converting the Income Tax into a Consumption Tax
Converting CBIT into a consumption tax turns out to be quite
straightforward. Instead of measuring business income through
depreciation allowances, a consumption-tax version of CBIT would allow
businesses a deduction for capital investments when assets are
purchased. This ``expensing'' adjustment converts the combination of
CBIT and a wage tax into the flat tax proposed by Hall and Rabushka
(1983).
Having described CBIT and the flat tax in this way, we can see that
the flat tax does not exempt all of what is commonly called ``capital
income'' from taxation (see also Gentry and Hubbard, 1997, 1998). Under
the business cash-flow tax component of the flat tax, the present value
of depreciation allowances for one dollar of current investment is one
dollar, while the present value is less than one dollar under the
income tax. For an investment project, the tax savings from
depreciation allowances represent risk-free flows, which the firm would
discount at the risk-free rate of interest. For a marginal investment
(in which the expected rate of return just equals the discount rate),
the upfront subsidy to investment provided by expensing equals the
expected future tax payments. It is only in this sense that the
``return to capital'' is not taxed under a cash-flow tax or a
consumption tax. But returns attributable to entrepreneurial skill or
risk bearing are, in principle, taxed equivalently under fundamental
income or consumption tax reform prototypes.
To summarize, then, I use the term ``fundamental tax reform'' to
represent tax proposals with the following characteristics:
1. It is a combination of a business-level tax (with either cash
flow or business income as the base) and a household wage tax.
2. For an income-tax version of reform, depreciation allowances
are as close to economic depreciation as possible; for a consumption-
tax version of reform, businesses will deduct capital expenditures.
3. The business-level tax does not distinguish between debt and
equity financing.
4. In order to minimize the differences in marginal tax rates
across business entities and investments, firms carry net operating
losses forward with interest.
5. There are lower marginal tax rates with a single marginal tax
rate across business entities and households; the household tax can
have a personal or family exemption.
Fundamental income tax reform and consumption tax reform contribute
to economic efficiency by accomplishing corporate tax integration.
Returns to business investment would be taxed once at the business
level and not again at the household level. Both reforms eliminate
financial distortions under current law (that arise from the tax bias
against corporate equity and dividends--see, for example, Gertler and
Hubbard, 1993) and organizational distortions under current law (that
arise from the tax bias against C corporations). Both reforms are
consistent with a ``dividend exemption'' or territorial tax system for
multinational companies, and this consistency is desirable (Devereux
and Hubbard, 2003).
The consumption tax version of tax reform offers an added benefit:
the benefit of expensing of business investment will stimulate
investment, capital formation, and economic activity. Such a business
tax system would also be simpler. While expensing entails a greater
revenue cost than depreciation, one must be careful to note that over
the long run, the difference is only the time value of money on
depreciation allowances (that is, comparing the value of allowances all
at once--expensing--versus allowances taken over time--depreciation).
Substantial efficiency gains estimated for corporate tax
integration (see, for example, U.S. Department of the Treasury, 1992;
Altig, et al., 2001; and Hubbard, 2003) do not capture all the possible
sources of economic gains. First, as noted above, expensing offers an
incremental gain. Second, reductions in marginal tax rates can increase
growth through human capital investment (as in Lucas, 1988) and
entrepreneurial risk taking (Gentry and Hubbard, 2004; and Cullen and
Gordon, 2002). A third channel arises if base broadening in tax reform
permits a lower business tax rate. Lee and Gordon (2005) estimate using
cross-country data that a lower corporate tax rate is associated with
more rapid economic growth, a correlation they attribute to a lower
corporate tax encouraging more entrepreneurial activity.
THE WAY FORWARD
Mr. Chairman, this Committee has the opportunity to reform the
nation's tax code in ways that will enhance living standards, improve
tax fairness, and reduce the enormous complexity that wastes billions
of dollars each year. Reform of business taxation will be a major
element of the overall reform debate, particularly given the
overarching interest of tax reform in reducing tax burdens on saving
and investment to promote economic growth.
As you evaluate options for tax reform, I urge you to focus on
prospects for improving growth. You can address tax fairness concerns
as well by broadening the tax base of both the business and household
tax systems. I also urge you to include estimated effects on economic
growth and incomes of tax reform in your evaluation of revenue and
distributional impacts of tax reform. While many interests will
approach you for ``transitional relief,'' the case for large
``transition costs'' of tax reform for businesses as a whole is more
difficult to make than is often thought (see, for example, the
discussion in Hassett and Hubbard, 2001). Finally, as you know well, it
is possible to implement tax reform as a series of steps, necessitating
caution in evaluating a ``horse race'' among proposals for fundamental
tax reform.
Thank you, again, Mr. Chairman, for the opportunity to appear
before you today on the important subject of fundamental tax reform. I
look forward to your questions.
______
REFERENCES
Altig, Davie, Alan J. Auerbach, Laurence J. Kotlikoff, Kent A.
Smetters, and Jan Walliser. ``Simulating Fundamental Tax Reform in the
United States.'' American Economic Review 91 (June 2001): 547-595.
Bradford, David F. ``A Tax System for the Twenty-First Century.''
In Alan J. Auerbach and Kevin A. Hassett, eds., Toward Fundamental Tax
Reform. Washington, D.C.: AEI Press, 2005.
Council of Economic Advisers. Economic Report of the President.
Washington, D.C.: U.S. Government Printing Office, 2003.
Cullen, Julie Berry, and Roger H. Gordon. ``Taxes and
Entrepreneurial Activity: Theory and Evidence for the U.S.'' NBER
Working Paper No. 7980, 2000.
Devereux, Michael, and R. Glenn Hubbard. ``Taxing Multinationals.''
International Taxation and Public Finance 10 (2003):469-487.
Gentry, William M., and R. Glenn Hubbard. ``Distributional
Implications of Introducing a Broad-Based Consumption Tax.'' In James
M. Poterba, ed., Tax Policy and the Economy, vol. 11. Cambridge: MIT
Press, 1997.
Gentry, William M., and R. Glenn Hubbard. ``Fundamental Tax Reform
and Corporate Financial Policy.'' In James M. Poterba, ed., Tax Policy
and the Economy, vol.12. Cambridge: MIT Press, 1998.
Gentry, William M., and R. Glenn Hubbard. ``Tax Policy and
Entrepreneurial Entry.'' Working Paper, Columbia University, 2004.
Gertler, Mark, and R. Glenn Hubbard. ``Corporate Financial Policy,
Taxation and Macroeconomic Risk.'' RAND Journal of Economics 24 (Summer
1993): 286-303.
Hall, Robert E., and Alvin Rabushka. Low Tax, Simple Tax, Flat Tax.
New York: McGraw-Hill, 1983.
Hassett, Kevin A. and R. Glenn Hubbard, eds., Transition Costs of
Fundamental Tax Reform. Washington, DC: AEI Press, 2001.
Hubbard, R. Glenn. ``Economic Effects of the 2003 Partial
Integration Proposal in the United States.'' International Tax and
Public Finance 12 (2005):97-108.
Hubbard, R. Glenn. ``Would a Consumption Tax Favor the Rich?'' In
Alan J. Auerbach and Kevin A. Hassett, eds., Toward Fundamental Tax
Reform. Washington, D.C.: AEI Press, 2005.
Lee, Young, and Roger H. Gordon. ``Tax Structure and Economic
Growth.'' Journal of Public Economics 89 (2005):1027-1043.
Lucas, Robert E. ``On the Mechanics of Economic Development.''
Journal of Monetary Economics 22 (1988):3-42.
U.S. Department of the Treasury. Integration of the Individual and
Corporate Tax Systems: Taxing Business Income Once. Washington, D.C.:
U.S. Government Printing Office, 1992.
Chairman THOMAS. Thank you very much, Dr. Hubbard. Dr.
Slemrod.
STATEMENT OF JOEL B. SLEMROD, PAUL W. MCCRACKEN COLLEGIATE
PROFESSOR OF BUSINESS ECONOMICS AND PUBLIC POLICY, PROFESSOR OF
ECONOMICS, AND DIRECTOR OF THE OFFICE OF TAX POLICY RESEARCH,
UNIVERSITY OF MICHIGAN, ANN ARBOR, MICHIGAN
Mr. SLEMROD. Thank you for the opportunity to address this
Committee. I have been asked to talk about tax complexity and
simplification. Certainly, one objective of tax reform should
be to simplify the tax system. The complexity of the current
system is one reason why the cost of collecting taxes is so
high. In the written testimony I have submitted to this
Committee, I provide details underlying my estimate that this
cost now comes to $135 billion per year, more than 10 percent
of revenues raised and more than 1 percent of GDP. The major
part of this cost is the over 3 billion hours of taxpayers'
time. Equivalent to 1.5 million extra Internal Revenue Service
(IRS) employees. The $135 billion is the value of the resources
used up each year in the process of collecting taxes and the
amount of resources that could, if taxes could be collected
costlessly, be freed up for whatever else Americans would
prefer to use their time and money for. The negative
consequences of tax complexity though go beyond dollars.
Complexity causes a capricious and inequitable distribution of
tax burdens because it rewards those who have the means and
inclination to find all the tax angles and leaves the dutiful
among us holding the bag. It undermines trust in the fairness
of the tax system which may, in turn, undermine voluntary
compliance. It reduces the transparency of the tax system,
which I believe is inimical to a properly functioning
democracy.
Because of these consequences tax simplification deserves
to be taken seriously. Supporting tax simplification in the
abstract is like supporting motherhood and apple pie. We must
move beyond simple support for simplification and address how
and how much to simplify the tax system. In so doing, it is
critically important to consider three separate aspects of the
tax system, the rate structure, including whether it should
have one rate for all or is graduated, base integrity, that is,
whether the base is messy or clean; and third, base choice,
whether the base is income or consumption or something in
between. Another fundamental point is that the simplest way to
collect tax is not the best. There are almost always tradeoffs
between simplicity and the other criteria we use to evaluate
our tax system. We could have exactly the same tax burden for
everyone, Bill Gates and everyone else. Most of us, maybe all
of us, would judge that very, very simple tax system to be
very, very unfair.
As another example, loosening enforcement would save both
administrative and compliance costs but would also unfairly
shift the tax burden toward those who view paying what they owe
as a civic duty. Can a messy tax base be justified by an appeal
to fairness? In some cases, yes, but most of the deductions,
the credits and the adjustments in our current tax system
cannot be justified in this way. A thorough going pruning of
these programs would I believe not only significantly simplify
the tax system, but would also be good for the economy. I have
no suggestions for how to stiffen congressional resistance to
the special interest pleading that opposes such a pruning,
although I suspect a thorough going, rather than a piecemeal
reform provides Congress with the opportunity to shrug its
shoulders and say we are doing it to everyone.
One key to simplifying the tax system is thus, to minimize
fine tuning the tax liability of individuals and fine tuning
the economy by subsidizing and rewarding activities deemed to
be especially valuable. Note, though, that is illusory
simplification and probably not simplification at all if the
same set of subsidies and rewards is reconstructed outside the
tax system. If we are going to have these subsidies and rewards
in any event, arguably they should be implemented through the
tax system rather than by operating separate bureaucracies.
Simplifying the tax system enough along these dimensions
would allow us to take advantage of large scale withholding by
businesses through a return free income tax system where as
many as two-thirds of individual taxpayers need not file tax
returns at all. Do we need a consumption tax instead of an
income tax to get a less complex tax system? I think not.
Replacing the income tax with a consumption tax base is neither
necessary nor sufficient for significant tax simplification.
European experience with a consumption based VAT shows that
consumption taxes can be as costly to operate as real live
income tax. Adopting a consumption tax is not necessary for
simplification because a clean base return free structurally
improved tax system can achieve a lot.
I do not mean to dismiss the potential inherent simplicity
advantages of basing tax liability on consumption rather than
income. There are certainly structural problems that will not
go away with income tax reform. We should not though fall
victim to a grass-is-greener fallacy for a few reasons. With
more than a trillion dollars at stake, there will be plenty of
people of who will find loopholes in the consumption tax
system. The transition to a consumption tax system even to one
that eventually would be much simpler can be incredibly complex
and riddled with loopholes that erode both revenues and
fairness. In conclusion, the potential benefit from tax
simplification is substantial. Choosing the right path to a
simpler tax system requires facing up to several difficult
trade offs. It should not be surprising because dealing with
tax complexity requires addressing the most fundamental
questions about the relationship between government and the
people it serves. How activist the government should be, how
intrusive it should be and when should it settle for rough
justice. Thank you.
[The prepared statement of Mr. Slemrod follows:]
Statement of Joel B. Slemrod, Paul W. McCracken Collegiate Professor of
Business Economics and Public Policy, Professor of Economics, and
Director of the Office of Tax Policy Research, University of Michigan,
Ann Arbor, Michigan
One-third of Americans say that complexity bothers them more than
anything else about the tax system. This is more than twice as many who
say their biggest complaint is ``the large amount of taxes they paid.''
Half of Americans rate the system as ``very complex,'' and someone
holding that belief is 10% more likely to favor scrapping the income
tax for another system. In this testimony I address the cost of
collecting taxes under the current system, what causes this cost, and
what kinds of tax reform promise to simplify and reduce the cost of
collecting taxes.
Tax complexity has many dimensions. To suggest its magnitude, some
count the number of pages or words in the tax code or forms. Others
stress that even tax experts rarely agree on the true tax liability for
a tax return of even moderate complexity, or note that it often takes
several years to finally resolve the tax liability of a big
corporation.
In my view the most informative measure of tax complexity is the
resource cost of collecting taxes. This is equal to the IRS budget plus
the value of the time and money spent by the taxpayers and third
parties to the collection process (such as employers who withhold tax
for their employees.) Measuring the IRS budget is straightforward, but
measuring the other components of the collection costs--known as
compliance costs--is not. What do we know?
A recent comprehensive study done by IBM Business Consulting
Services under contract to the IRS concluded that, in tax year 2000,
the 125.9 million individual taxpayers had a total compliance burden of
3.21 billion hours and $18.8 billion in monetary expenditures. This
translates into an average burden of 25.5 hours and $149 per taxpayer.
Although self-employed taxpayers represent only about 25% of all
individual taxpayers, they experienced approximately 60% of the time
and money burden. As a result, the average time and money burden of
self-employed taxpayers (59.5 hours, $363) was substantially greater
than that of those taxpayers with only wage and investment income (13.8
hours, $75). Not surprisingly, the average compliance burden was also
consistently higher among taxpayers who have more complex tax returns;
for example, non-self-employed taxpayers who itemize their returns
spend an average of 21.3 hours and $114 on tax compliance, compared
with 11.4 hours and $63 for non-itemizers. The current system is not,
however, complicated for everyone, and is generally not that
complicated or costly for the tens of millions of taxpayers who file
Form 1040EZ or 1040A; survey evidence suggests that 30% of taxpayers
spend fewer than five hours on all tax matters over an entire year. By
applying a range of dollar values to each hour of time burden, IBM
estimated that the annual resource cost of compliance for individual
taxpayers is between $67 billion and $99 billion.
A series of analyses by the Office of Tax Policy Research at the
Ross School of Business at the University of Michigan, under contract
to the IRS, have examined the compliance cost of large and medium-sized
businesses. In 1996 the total compliance cost for the 1,500 largest
companies exceeded $2 billion, or over a million dollars per company;
for Fortune 500 companies, the average cost was nearly $4 million. For
businesses smaller than the biggest 1,500, but with assets in excess of
$5 million, in 2002 the total compliance cost came to about $22
billion. There is clear evidence that business compliance costs are
regressive--costs as a percentage of company size are higher for
smaller companies than they are for larger companies. For instance,
companies with between $100 million to $250 million of assets have only
about seven times higher compliance costs than companies with between
$5 million to $10 million of assets, even though they are between 10
and 50 times bigger.
In written testimony I submitted to this committee on June 15,
2004, I drew on these and other studies to estimate the total annual
cost of collecting the federal income tax in 2004. My best estimate
came to $135 billion per year. Of this total, $85 billion consists of
the total compliance cost borne directly by individuals (including sole
proprietorships), and another $40 billion relates to business. Adding
an IRS budget of about $10 billion produces the overall collection cost
estimate of $135 billion. This is 14.5% of individual and corporation
income tax receipts in fiscal year 2004, and about 1.2% of 2004 GDP.
The $135 billion annual cost of complexity is the value of the
resources used up in the process of collecting taxes, and the amount of
resources that could--if taxes could be collected costlessly--be freed
up for whatever else Americans would prefer to use their time and money
for. This is an economic cost of collecting taxes that should be added
to the cost incurred when the tax system discourages people from
working as much as otherwise, businesses from investing as much as
otherwise, and so on.
The negative consequences of tax complexity, though, go beyond what
can be estimated in dollars. Complexity causes a capricious and
inequitable distribution of tax burdens because it rewards those who
have the means and inclination to find all the tax angles, and leaves
the dutiful among us holding the bag. Moreover, the unfairness
complexity causes--and the complexity itself--undermine trust in the
fairness of the tax system, which may in turn undermine voluntary
compliance. Complexity reduces the transparency--who bears how much
burden and why--of the tax system, which I believe is inimical to a
properly functioning democracy.
The rapid computerization of tax matters--in 2003 over two-thirds
of self-prepared returns were done with software on a computer,
compared to less than 20% in 1993--is a double-edged sword. Although it
has undoubtedly facilitated the tax collection process, I am concerned
that computerization also may erode taxpayer understanding of the
formula that turns the inputted items into what one owes the
government. Tax return software may be helping to turn the tax system
into a black box--a more efficient black box, to be sure, but a black
box nevertheless.
Given a $135 billion annual resource cost, plus unquantifiable but
significant negative effects on equity and even the functioning of
democracy, tax simplification deserves to be taken seriously. We must,
though, move beyond platitudinous support for simplification and
address how, and how much, to simplify the tax system. As we begin what
I hope will be a serious discussion of how we should tax ourselves, it
is critically important to separately consider three important aspects
of the tax system: 1) rate structure, including whether the rate
structure has one rate for all or is graduated, 2) base integrity, that
is whether the base is messy or clean, and 3) base choice, whether the
base is income or consumption, or something in between.
Another fundamental point is that the simplest way to collect tax
is not the best, and there are almost always tradeoffs between
simplicity and the other criteria we use to evaluate our tax system.
For example, consider the following simple tax system. Start with the
annual revenue needs of about a trillion dollars and divide that by the
130 million or so individual taxpayers; this division yields about
$8,000 per return. Here's a tax system: everybody owes $8,000 per year,
period, including Bill Gates, a single mother earning $10,000 per year,
and everyone else. Most of us, maybe all of us, would judge that very,
very simple tax system to be very, very unfair.
As the example illustrates, in part tax complexity reflects a
belief that simpler systems can cause an unfair distribution of the tax
burden. Achieving a progressive distribution of the tax burden--one in
which taxes as a fraction of income are higher for higher-income
families--requires measuring, reporting and monitoring a measure of
well being, such as income.
A simpler, or less costly, tax system may compromise the fairness
of the tax burden in other ways. For example, loosening enforcement
would save both administrative and compliance cost, but would also
shift the tax burden toward those who view paying what they owe as a
civic duty. Thus, the simplicity of a tax system can be assessed only
with respect to a standard of enforcement and, ultimately, fairness.
For this reason even the most thoroughgoing simplification imaginable
that also meets our shared standards of fairness would cut the resource
cost of collection by no more than in half or, at most, two-thirds.
Can a messy tax base be justified by an appeal to fairness? In some
cases, yes. A deduction for involuntary medical expenses arguably
improves how well taxable income measures a family's true well-being
and thereby improves fairness. But most of the deductions, credits, and
adjustments in our current system cannot be justified in this way. The
fact is that the U.S. income tax system is an awkward mixture of a
revenue-raising system plus scores of incentive and reward programs. A
few of these programs may be justified, but most cannot, and a
thoroughgoing pruning of these programs would, I believe, not only
significantly simplify the tax system but would also be good for the
economy.
Cleaning the tax base may be the hardest aspect of tax reform to
achieve politically, because nearly every bell and whistle has a
constituency behind it. Many observers and many taxpayers are cynical
about the ability of Congress to keep its collective hands out of the
cookie jar, leading some to question the wisdom of cleaning up the tax
system only for it to get dirty again. The most cynical of all expect
base-cleaning tax reform to happen precisely so the base exceptions can
be introduced again for political rewards. I have no suggestions for
how to stiffen Congressional resistance to special interest pleading,
although I suspect that a thoroughgoing--rather than piecemeal--reform
provides Congress with the opportunity to shrug its shoulders and say
``we're doing it to everyone.'' In any event, if tax reform needs to be
revisited every twenty years, so be it; that strikes me as a much
better outcome than pursuing only policies that are likely to last
forever.
Flaws in the political system also underlie an argument one hears
in favor of a costly tax system--that it undermines big government. The
idea is that the political system is flawed in such a way that we do
not get the size of government we want--we get something bigger.
Although the government cannot be downsized directly, the argument
continues, it does contract when its source of funding gets more
expensive. From this perspective, making the tax system more painful
and more costly is a good thing. This argument (along with the separate
and also controversial argument that it would make the tax burden more
visible) lies behind the suggestion to abolish employer withholding and
remittance of employees' income tax liability, which certainly makes
the system much less costly to administer fairly. I don't buy this
argument at all, because it relies on several arguable or dubious
assumptions--that the political system systematically spends ``too
much,'' that spending responds more to raising the cost of funds than
to direct political reform and that, if the muck-up-the-tax-system
strategy is effective, the benefits of reducing spending exceed the
higher costs of raising revenue. Whether one agrees with this argument
or not, the important point is this: before we embark on serious tax
reform we'd better get straight whether the objective is to make the
tax system more, or less, costly. I recommend the latter, and so turn
next to tax simplification.
One key to simplifying the tax system follows from the causes of
tax complexity: minimize fine-tuning the tax liability of individuals
and fine-tuning the economy by subsidizing and rewarding activities
deemed to be especially valuable. Note, though, that this is illusory
simplification--and probably not simplification at all--if the same set
of subsidies and rewards is reconstructed outside of the tax system. If
we're going to have these subsidies and rewards in any event, arguably
they should be implemented through the tax system rather than by
operating separate bureaucracies--by having just one financial account
between the government and the people.
Simplifying the system enough along these dimensions would allow us
to take advantage of large-scale final withholding by businesses
through a return-free income tax system. Twenty years ago in its famous
report that preceded the Tax Reform Act of 1986, the Treasury
Department noted that, with significant base cleaning, as many of two-
thirds of individual taxpayers need not file tax returns at all. Thus,
base cleaning alone can, for the majority of taxpayers, achieve the
ultimate simplification--no return at all--that is a natural feature of
either a value-added tax (VAT) or a retail sales tax. This is, to be
sure, a ``populist'' simplification, in that it would simplify the
system for those (many) people whose tax matters are already relatively
simple.
Structural changes to the way we now tax corporations, including
multinational corporations, also have potential to simplify the tax
system. Rationalizing the separate entity-level taxation of
corporations (and the double taxation of dividends that accompanies it)
would simplify tax matters by reducing or eliminating the need for
complicated rules delineating when income passes from the corporation
to the shareholder. This sort of reform, known as integration, has long
been advocated by supporters of a comprehensive income tax, and is not
inherently related to the choice of a consumption versus and income tax
base, although it accomplished by all of the leading consumption tax
proposals.
Although abandoning progressivity or thoroughly cleaning the tax
base (or, for that matter, a rationalization of how we tax corporation-
source income) would to my mind certainly qualify as fundamental
reform, in recent years the idea of fundamental reform has become
linked to basing taxation on consumption rather than income. Do we need
fundamental reform in this sense to get a less complex system?
No. Replacing the income tax with a consumption base is neither
necessary nor sufficient for significant tax simplification. European
experience with the VAT has shown that a consumption tax is not
sufficient for simplification: real-life VATs can be as costly to
operate as real-life income taxes. Adopting a consumption tax is not
necessary for simplification because a clean-base, largely return-free,
structurally-improved income tax system can achieve a lot.
Recall that the three key aspects of tax systems--clean or messy
base, progressive rate structure or not, and income or consumption
base--are separate issues. A consumption tax can have a clean or a
messy base, and can feature flat or graduated rates. So can an income
tax. Most consumption tax proposals not only adopt a new base but also
radically clean the base and sharply curtail progressivity.
By arguing that a consumption base is neither necessary nor
sufficient for tax simplification, I do not mean to dismiss the
potential inherent simplicity advantages of basing tax liability on
consumption rather than income. All other things equal, and with some
exceptions, tax systems are simpler when the base is cleaner, when the
rate structure is flatter, and when the base is consumption. Although a
reformed income tax can substantially simplify the system, it leaves
some potential simplification opportunities on the table. Consumption
taxes can dispense with the accrual accounting required for income
taxation--depreciation, inventory accounting, and so on--and its
inherent problems in an inflationary environment. Consumption tax
systems need not measure real capital income; any system of taxing
capital income is prone to inconsistencies that reward complicated
transactions such as tax shelters and tax-oriented financial products.
These structural problems will not go away with income tax reform.
We should not, though, fall victim to a ``grass-is-greener''
fallacy, for a few reasons. With more than a trillion dollars at stake,
there will plenty of people looking for inconsistencies in a
consumption tax system, and some will be found. Consumption taxes based
on taxing retail sales are probably not administrable at our usual
standards of equity and intrusiveness. Depending on how it is handled,
the transition to any consumption tax system, even one that eventually
would be much simpler, can be incredibly complex and riddled with
loopholes that erode both revenues and fairness.
Abolishing the federal income tax would also eliminate the
availability of a fairly reliable measure of the financial standing of
families (as well as businesses) that is widely used throughout the
economy. If individuals did not have to file income tax returns, they
would still need to keep some records. But which ones? For example,
what records would they have to provide mortgage lenders or college
financial aid officers? Many federal transfer and other programs now
rely on an annual measure of comprehensive income, for which labor
income alone will not suffice. If many states continue to levy
comprehensive income taxes, the compliance cost saving is reduced if
taxpayers of those states still have to calculate income. To the extent
that alternative ways of verifying income would arise, these new costs
need to be netted out to obtain the true cost saving from moving away
from an income base.
It costs us about $135 billion a year to collect the trillion
dollars or so of income tax revenue. The complexity that contributes to
this cost also undermines the fairness of the tax burden and erodes the
transparency of the tax system. Some of the cost arises because we have
high standards for the fairness of our tax system, and would remain
under any system that meets those standards. Some of the cost occurs
because we use the tax system for many things other than raising
revenue, and could be eliminated if the tax base were cleaned of these
features. Some of it occurs because of structural problems--some
fixable, and some inherent--in the income tax system. Moving to a
consumption tax base addresses some but not all of the sources of
complexity.
The potential benefit from tax simplification is substantial, but
choosing the right path to a simpler tax system requires facing up to
several difficult tradeoffs. This should not be surprising, because
dealing with tax complexity requires addressing the most fundamental
questions about the relationship between government and the people it
serves: how activist should the government be, how intrusive should it
be, and when should it settle for rough justice?
______
Key References
Guyton, John L., John F. O'Hare, Michael P. Stavrianos and Eric J.
Toder. 2003. ``Estimating the Compliance Cost of the U.S. Individual
Income Tax.'' National Tax Journal 56(3) (September): 673-88.
Slemrod, Joel. 1996. ``Which is the Simplest Tax System of Them
All?'' in H. Aaron and W. Gale (eds.), The Economics of Fundamental Tax
Reform, Washington, D.C.: The Brookings Institution, 355-91.
Slemrod, Joel. 2004. Testimony Submitted to the Committee on Ways
and Means, Subcommittee on Oversight, Hearing on Tax Simplification,
Washington, D.C., June 15.
Slemrod, Joel and Jon Bakija. 2004. Taxing Ourselves: A Citizen's
Guide to the Debate over Taxes. Third edition. Cambridge: MIT Press.
Chairman THOMAS. Thank you very much. We went through the
examinations of fairness, simplicity and growth in 1986 when we
were examining it. The question I am going to ask, I always
like to try to get five economists to agree, and sometimes I
have to go pretty high up on the abstract level to get
agreement. I hope I don't have to go up too high. It seemed to
me that back then, in looking at fairness, simplicity and
growth, it was basically, without a whole lot of discussion how
to change the then-present income tax structure to make it
fairer, simpler, and provide growth. We all look for analogies
we are more familiar with. I know in auto racing, everybody
wants fast durable and cheap. The builder says I can give you
two of the three. Which two do you want?
You have indicated there is a clear requirement to trade
off to a degree. My question is not that. Obviously we are
going to have to deal with that. My question is this: in the
roughly two decades since we last went through the simplicity
fairness and growth juggling, do you believe that both
academically and in the real world, we have discovered, we have
understood, we have conceptualized so that we have more tools
today available? We may examine particular options and discard
them and go back to something that we would may want to deal
with, but do you believe that examining the various options is
worth the Committee's effort to perhaps get out of the
conceptual framework they have and examine some others because
the value of that means we have a better chance to get a better
trade off to produce a better product in blending fairness,
simplicity and growth? Anybody respond to that?
Mr. HUBBARD. If I might, Mr. Chairman, I think that would
be an excellent activity. One reason I was suggesting a family
of two-tier taxes that nests income and consumption taxes, you
could show yourself what the gains in economic activity are,
what the distributions of the tax burden are there. I mean,
that is, the tradeoff, of course, is something economists can't
help you with. Those are your political judgments. I think
there has been an abundant body of academic work over the past
two decades that would help inform that, including some very,
very recent papers, so I do think it is worth the candle.
Mr. BEACH. Mr. Chairman, on the very last page of my
submitted testimony is a graphic. It is the only graphic of my
testimony. It shows how many tools you have invented since 1986
and how well you have used them. There is a line on this
graphic which looks at the marginal tax rates that a
hypothetical family of four faced in 1986 as their income
changed. Then it compares it to in 1988, and then to today.
There has been a vigorous application of well meaning tools,
but it has created a situation in which it is very difficult to
say that the current system is a fair and just system. So,
there is the sort of catch-22 of having good tools, well
meaning and the application kind of moving against the
principles. I would say the principles, as Alan and I were
talking just before the hearing, that principles are pretty
much the same as 20 years ago. The tools are more vigorous but
you have to be governed by the principles in order to establish
a fair and just system.
Chairman THOMAS. My concern is that as we begin to learn
some of these new concepts, we latch on to them in ways that
perhaps limit us in our ability to be as facile as we need to
be in a comparison. This is where you are going to need to help
us. For example, on page 7 of Dr. Burman's testimony, he makes
this statement, and I wonder if anyone here strongly disagrees
with you or if all of you tend to agree with it, in which he
says the flat tax, which is effectively a subtraction method
VAT, in which the wage portion of the tax is collected from
workers rather than firms and which is somewhat progressive
since it exempts some portion of wages. Anyone disagree with
that statement? Because you see, we have begun to engage in a
discussion between a flat tax and value-added taxes. Sometimes
people don't walk across models to understand that with some of
the minor changes, Dr. Hubbard, as you suggested, you can turn
one thing into another and improve on the simplicity or the
fairness or the growth issue. My goal is to not get people
locked up in terminology which doesn't allow them to be
flexible enough to understand, regardless of what label is
placed on it, the fundamentals need to be examined because you
are going to get tradeoffs no matter which basic concept you
are dealing with. Dr. Auerbach for a final statement.
Mr. AUERBACH. Yes, Chairman Thomas, there is one difference
that some people point to as a difference between a value-added
tax and a flat tax. It relates to a point in my testimony which
is the lack of border adjustments under of the flat tax. It
makes it look to some people less like a consumption tax or a
value-added tax. Some people have seen that as a disadvantage.
As I suggested in my testimony, that really is not an important
difference. So, in viewing--I think it is right to view the
flat tax as basically a subtraction method value-added tax
except for the progressive portion for low income wage earners.
Chairman THOMAS. Thank you. To the degree all of the
economists were talking about or open a border adjustable tax
is taken care of in the situation of one country versus another
based on currency fluctuations and a number of other factors so
that it all works out in the wash as we say. Thank you very
much. Gentleman from New York.
Mr. RANGEL. Thank you. If we ever get seriously involved in
reformation we can't do it without you, because I came to the
Congress to close up all the tax loopholes. How little did I
know that so many would be incentives, and so the targeted jobs
credit empowerment zones, earned income tax credits, incentives
to hire people for jobs, incentives for education, incentives
for employers who provide health care, mortgage interest
deduction, business deductions for their equipment. There is a
long list of things and a lot of them are political. A lot of
them are special interests. A lot of them are well intended. If
we went toward a flat tax, a consumption tax or national resale
tax, are any of you prepared to distinguish between what has no
economic benefit and what is purely political and what is
special interest? Because that is one way I see that you can't
do this without winners and losers. We would have to make--we
would need you to help us not to make political decisions so
that we can work together, assuming it was possible for us to
work together. Since all of this is academic you don't have to
worry about that. How would we handle those credits and
deductions that have no economic benefits at all? Would you,
any of you be able to help us to make that decision? Yeah, you
because you mentioned it, Doctor.
Mr. SLEMROD. The one thing I think you should have a high
hurdle for arguments that go against a clean base, not only for
simplicity purposes, but just because most of the deviations, I
think, do not have a good economic justification.
Mr. RANGEL. Well, just for academic reasons, where would
you put the deduction of mortgage interest?
Mr. SLEMROD. Myself, I think the tax system should not
embed a favoritism toward owning a house versus renting a
house.
Mr. RANGEL. Where would you put charitable contributions.
Mr. SLEMROD. I think a justification, a subsidy for charity
is fine, but not the way it is done within the current tax
system where the subsidy is higher for high income people.
Mr. RANGEL. Where would you put religious institutions?
Mr. SLEMROD. I would keep the rules for determining a
charity that gets the subsidy the same as it is now.
Mr. RANGEL. You mean some churches could be taxed?
Mr. SLEMROD. No. The same rules about what qualifies as a
deductible charitable contribution.
Mr. RANGEL. Okay. Where would you put research and
development?
Mr. SLEMROD. Research and development, I think most
economists, and I imagine a majority of this panel would find
an economic justification for.
Mr. RANGEL. Where would you put the earned income tax
credit?
Mr. SLEMROD. On the list that we need to take very
seriously the impact of the tax system on vertical equity and
that many of--can I--I am willing to answer all your particular
questions, but can I stop for a second and say that this string
of questions illustrates why consideration of any radical tax
reform such as a flat tax does many, many things. In fact, a
flat tax has a fundamental change on the three aspects of the
tax system I said we should keep separate. It changes the rate
structure radically and therefore the distribution of tax
burden. It cleans the base up radically and gets rid of almost
all of the provisions on the list I have heard so far and maybe
on the rest of the list. It moves from an income tax base to a
consumption tax base. These are separable things. So, we would
could consider cleaning the base, we can consider change the
rate structure and we should consider cleaning up the base, be
it income or consumption. A flat tax for example, or a value
added tax would get rid of every one of the provisions every
one of the subsidies you have mentioned so far.
Mr. RANGEL. We would need you to help politically to
justify it in terms of Republicans and Democrats working
together to ease the political pressure of the losers, right?
Mr. SLEMROD. I imagine that there would be more consensus
among the economists on a panel like this on those issues than
you might expect.
Mr. RANGEL. So, if the chairman and I continue to send
letters to each other, we would be moving forward in a very
dramatic way, wouldn't you think? Are there any other comments?
No. I ran out of time. Thank you so much.
Chairman THOMAS. Mr. Burman, do you want to briefly
respond?
Mr. BURMAN. One of the things that strikes me is that we
have a tax system now where basically people owe, middle income
people owe a fair amount of income and tax to the government.
Then if they jump through a whole bunch of hoops, they can get
a bunch of it back. So, we make it sound like we are giving
people a mortgage interest deduction, a charitable deduction
and all of these things. In fact, you know, we are saying that
certain people get a benefit. Other people don't. People are
working really hard to determine their tax liability. Really,
as Joel said, there really ought to be a very high hurdle on
the tax breaks that you put into the Code because you have to
raise taxes elsewhere to pay for it. So, it is not like, you
know, there has been this notion lately that tax cuts benefit
everybody. They have to be paid back one way or another, future
deficits or higher taxes.
Chairman THOMAS. My concern is as we try to incentivize
people, I am just very concerned about having people chase
asset benefits through the Code as we change it and you are not
getting a real value, but you clearly are rewarding particular
people in particular ways when you don't think you are.
Gentlewoman from Connecticut wish to inquire?
Mrs. JOHNSON. Thank you, Mr. Chairman. I thank the panel
for their really excellent presentations. It is extremely
helpful to have sort of fairness laid out in a vertical,
horizontal and forward manner and to hear this discussion of
simplicity versus fairness. I find very troubling economists--
this is gross generalization--economists general disregard for
the relationship between tax benefits and incentives for
actions that we as a society value, because I think the record
demonstrates their power. For example, look what is happening
to people when they roll over their 401(k). They are not saving
it. They are not putting it in an annuity. Too often it is not
going to be there for retirement security. On the other hand,
the tax incentives to save are having people save. We have had
testimony that if there was an opt out rather than an opt in
many more people would save. You look at low income housing.
There is a lot of reasons why low income housing is higher risk
to build than other kinds of housing. It certainly takes more
careful management. The incentive to combine--the incentives
that the low-income housing tax credit puts out there to
combine good quality construction with good management to
provide affordable housing is kind of--has been the primary way
now we are creating affordable housing.
So, I don't see how you--I mean, I don't want to ignore the
power of tax incentives to produce things that a market economy
wouldn't necessarily produce. It is hard at market rates to
produce affordable housing. Now you can subsidize them through
rent subsidies or you can subsidize them by lowering the cost
of construction and not be into rent subsidies all those years.
Let me just conclude by saying there is an EITC demonstration
going on now for effectiveness. My district happened to be one
of those districts. It was resisted. It is a very progressive
view. One of the things that the IRS told me in talking about
it was that tax incentives are less costly to administer and
reach a larger portion of the population they are intended to
reach as opposed to administered programs which are more
expensive to administer and tend to reach a narrow number,
narrower number of the eligible individuals. We certainly see
that over and over again in health programs for children. So,
you know, if you say the EITC and the child credit are serious
income expanders for low income families and we would have to
think about doing it a different way, well, the other way may
be much more costly and much less effective. So, I just want to
put my marker down to--you have got to have better information
for me to convince me that tax credits aren't powerful and
important in structuring a society that has the income you need
when children are young, that plans for retirement, that is
able to produce affordable housing and so on. So, if any of you
would like to comment on that, I would be interested in your
thoughts.
Mr. HUBBARD. If I might, Mrs. Johnson, I think that most
economists believe these tax provisions are powerful. The
question--they do stimulate the desired activity almost always.
The question is are they the best way of doing that either in
terms of economic efficiency or costs. You mentioned some
economists won't agree on all these things. Savings incentives
an area, me speaking only for myself on the panel, I believe
the Tax Code has had a very constructive and powerful and
potent effect, and I think you all deserve a lot of credit for
that. I would not put the low income housing tax credit in that
camp. I think there are more efficient ways for the taxpayers
to address low income housing if that is something that you
politically want to do. So, I don't think it is a disagreement
that these aren't effective. I think people think they are
effective in terms of stimulating the activity. The question,
given your political judgment that you want to do that, is
whether there are better ways to do it that are also perhaps
more fair.
Mrs. JOHNSON. Well, I do think we need to have a better
discussion about what are the other ways to achieve affordable
housing. section 8 has really bottomed out. So, that is a
longer discussion. My time is up and I am sorry Mr. Chairman.
My red light is on. It is yellow there, but----
Mr. BURMAN. I would just like to make one clarification. I
think the EITC and child tax credit do a huge amount of good.
My suggestion in the testimony actually is that there are ways
you could simplify them so that a lot of the compliance
problems they are looking at in Hartford would go away. If the
EITC was really focused as a work subsidy and it wasn't tied
into where the children live, who provides the support, and the
child credit were just tied to presence of children, it would
actually be a lot easier for the IRS to administer and make
sure the money goes to families that need the help.
Mrs. JOHNSON. Thank you.
Chairman THOMAS. Thank you very much. Gentleman from
Michigan, Mr. Levin wish to inquire?
Mr. LEVIN. Thank you, Mr. Chairman. I am tempted, Dr.
Auerbach, to talk about the Ricardo principle of comparative
advantage, but let us do that some other time. So, let us talk
about fairness, because we started talking about that. I do
think, and I think the chairman, you would agree that we have
to find some principle other than fairness is in the eye of the
beholder. Mr. Beach, you suggested one standard and that is
that everybody pays their fair share, that is the total amount
of taxes a person pays is proportional to their economic
ability to pay taxes. So, let me ask any of you who want to, to
comment on this article in the New York Times on Sunday about
tax fairness.
About tax fairness, surely it would apply to the principle
that Mr. Beach and others have outlined. The article says the
share of the Nation's income earned by those in this uppermost
category has more than doubled since 1980 to 2.7 percent. The
share of income earned by the rest of the top 10 percent rose
far less, and the share earned by the bottom 90 percent fell.
Then this analysis relates to fairness. I quote, ``Under the
Bush tax cuts, the 400 taxpayers with the highest incomes, a
minimum of 87 million, in 2000, the last year for which
government will release such data, now pay income, Medicare and
Social Security taxes amounting to virtually the same
percentage of their income as people making $50,000 to
$75,000.'' Again, I quote, ``those earning more than $10
million a year now pay a lesser share of their income in these
taxes than those making $100,000 to $200,000.'' Now, I would
ask the five of you, if you use the principle Mr. Beach
outlined, how in the world is our Tax Code as recently amended
fair?
Mr. BEACH. If I could just lead off, because I made that
statement, I think there is almost complete agreement, complete
agreement in the tax economics community on the validity of
that particular measure of equity. That is, for example,
someone makes ten times more than me, they should pay ten times
the tax. It is a simple way of looking at proportionality. Now,
we get into the question, how has the Tax Code produced the
sorts of things we are seeing across income, not just at the
top but at the bottom and at the middle, with this; anomalies
where people similarly situated in income pay very much, very,
very different kinds of taxes?
Mr. LEVIN. I agree. But one problem is the parity within
income groups. We have this huge discrepancy between and among
them. I wanted you to comment on that. Dr. Auerbach, maybe we
can quickly go down the row.
Mr. AUERBACH. There is no doubt that incomes have been
rising at the top faster than in the rest of the income
distribution. There is a dispute in the economics profession
how much of it is associated with the tax system, how much of
it is associated with other economic factors. I think it is
certainly relevant when one designs tax policy to think about
the pretax distribution of income. The fact that income is more
unequal in the United States now than it was say 20 years ago
obviously should be cause of concern and also should be
relevant as we think about the appropriate progress of the tax
system.
Mr. BEACH. Just as a footnote to what I was saying, Mr.
Congressman, another factor that this Committee has to deal
with, as you do tax reform, you're going to have to deal with--
what every Committee on the Hill is dealing with is that Baby
Boomers are reshaping income distribution, and some of the
rapid growth at the top is the fact that my generation is at
its key top-earning capacity. We are making probably as much as
we will ever make, so you have to sort that out as you go
through, what has the Tax Code done to prevent these anomalies?
Mr. BURMAN. Table 2 shows the effect of the 2001-2004 tax
cuts on the overall distribution of tax rates. You can see that
the biggest proportion of reduction in rates applies to very,
very wealthy people; top tenth of 1 percent get a 3.6-percent
cut of share of income as compared to 2.2 percent for people in
the middle. Now one thing that the testimony also notes is that
we really don't know who the winners and losers are of these
tax cuts because they're all financed by deficits. But overall,
it could actually turn out to be a lot worse if it turns out
that the deficits are closed by cutting many programs that help
low- and middle-income families. It can be high-income people
end up worse off in the long rung if the deficits are closed
off by keeping the new middle class tax rates and raising rates
at the top. I wish there was a principle in general that tax
changes ought to pay for themselves, especially when you look
at the looming deficits that are facing us now and the
projections for the future; they are just horrifying.
Mr. LEVIN. I don't know, Mr. Chairman, if they can
continue.
Chairman THOMAS. Briefly.
Mr. HUBBARD. An observation and on your question about the
New York Times story, I do think that most of the discussion
that we have in economics suggests that the big gains in pretax
incomes are just that, and Tax Code, as far as I know, plays a
relatively small role. The New York Times story failed three
tests that an editor could have easily used to pull such a
story. One is it failed to account for distribution of business
tax burdens. Second, that it assumed the AMT was permanent as a
part of the President's tax agenda. He said exactly the
opposite. Third is that it totally abstracted from any effects
on economic growth and incomes. It was simply an unreasonable
calculation of it, on its face
Mr. SLEMROD. I would like to take issue with Mr. Beach's
characterization that there is a consensus among economists
that a fair distribution of tax burden is the same as a
proportional. I think that is not true at all. I think, in
fact, I think the consensus is that conclusions about fairness
are not a matter of economics. If anything, the economic theory
of taxation suggestions that if pretax income is getting more
concentrated, as it certainly has over the last two decades,
the proper response of the tax system is to become more
progressive.
Mr. LEVIN. Thank you.
Chairman THOMAS. Thank you very much. You've restored my
faith in the panel for not continually agreeing. We need to
hear learned opinion. Gentlemen from California, wish to
inquire?
Mr. HERGER. Yes, thank you, Mr. Chairman, Mr. Beach, one
option that has been--which has received attention in the tax
reform discussion has been some form of a VAT. As I understand
the concept, a VAT is applied at every stage of consumption
from wholesale to retail and is passed along until it becomes a
hidden and cloaked component of price, much like the cost of
transportation or raw materials. In my view, the single largest
drawback to evaluate a VAT is the fact that as a tax hidden
from consumption, government can repeatedly and steadily
increase the taxes without attracting the ire of the public. In
fact, Europe and the United States had roughly comparable
amount of taxes collected prior to Europe's introduction of the
VAT in the 19sixties, but since that time, taxes have
skyrocketed in Europe and have remained basically steady here
in the United States. My question, shouldn't the experience of
Europe with a VAT caution us in today's debate about
fundamental tax reform?
Mr. BEACH. Well, yes, I would certainly agree with what
you've said. I just would add one thing that what Europe did
was, well, what many European countries did was adopt this
credit VAT and, at the same time, not do anything with
eliminating their income taxes. Maybe countries had that, and
so the combination of the two was a fairly steady increase in
overall tax burden as countries decided, well, the VAT must
fall most heavily on low-income people, so we have to raise the
top income-tax brackets or top two-thirds of income tax
brackets in order to achieve some distributional equity. If we
were to eliminate income taxation in the United States by
repeal of the operative amendment to the constitution, the VAT
would probably be a positive thing if we could get rid of the
income tax. I would strongly urge the Congress not to put both
of them in place. Just look at the complexity issues,
compliance issues. You may decide to tax one kind of candy bar
but not another kind of candy bar. I used to do tax analysis
for the State of Missouri. And every year, my greatest fear was
to see all the sales tax lobbyists knock on my door. It is an
extraordinarily difficult exercise to go through, and then it
shuts off economic growth, Congressman. If you look at the
growth rates of Europe, for many years, they have slowed down.
Part of that is aging and financial problems, but clearly, I
think a lot of economists, perhaps everybody even on this
table, would agree that their tax system has something to do
with those growth rates. So, I think there is a lot of serious
thinking that the Congress must do before it goes down the
route of recommending and adopting a credit form of the VAT.
Mr. HERGER. You mentioned that it might not be as bad, even
though I think it would be, bad anyway because of the hidden
tax factor, the fact that the consumer is not aware of the
taxes they're paying, and that you mentioned that perhaps if we
did away with income tax, wouldn't you agree the chances of us
doing away with the income tax are, very, very slight? To
change our constitution, we know, would take a two-thirds vote
in the House, three-quarters of the State legislatures or two-
thirds of the State legislatures and again three-quarters
ratifying. I mean, the chances of that happening are pretty
slight.
Mr. BEACH. I see no likelihood of that happening in my
lifetime, sir.
Mr. HERGER. The proponents of that also argue that it has a
few advantages, namely, business assets, expensing, border
neutrality and taxing savings-only ones. Can't this be done in
many other ways such as through a flat tax or national retail
sales tax? Wouldn't these methods at least keep taxation
transparent?
Mr. BEACH. Yes, as Glenn Hubbard has said in his testimony
and as others have written, there are many ways of achieving
those goals besides going to a credit form of the VAT. Most of
the consumption taxes we have entertained, the flat tax, which
is, as the chairman said, is a subtraction VAT because it
recognizes the expenses of other firms as deductible; all of
those have in some fashion or another the attributes, the
positive attributes, of the VAT.
Mr. HERGER. Thank you very much, thank you, Mr. Chairman.
Chairman THOMAS. The Gentleman would yield on his remaining
time?
Mr. HERGER. Yes.
Chairman THOMAS. Mr. Beach, would you make the same
criticisms of the subtraction method Mr. Shaw made of the
credit, i.e., a comparison between Europe and Japan? I think
the subtraction form of the VAT works a little better because
you have an income-tax base you're working with. When you say
VAT tax, you carefully qualify your tax as a credit.
Mr. BEACH. Yes.
Chairman THOMAS. Value-added, which was appropriate given
the example of Europe, but to examine that tax in their
entirety, in the various forms that they have, you would have
to look at other methods of determining a VAT, and then you
would have to compare cultural differences and ask yourself if
you wind up with the same criticism. That is the only point I'm
making.
Mr. BEACH. That is very, very true, and I believe that that
is a valid consideration, every time we look at other countries
and their tax systems, to look at all the differences which
come in and surround those tax systems; culture being one, the
application of traditional law being the other, and the way
they have raised up their different tax systems from all kinds
of behaviors is the third.
Chairman THOMAS. Thank you. Gentleman from Maryland wish to
inquire.
Mr. CARDIN. I thank you, Mr. Chairman, and I thank you for
conducting this hearing, and I thank our panelists for their
testimony. I would like to see us simplify the Tax Code. I
think that is an important standard for us to reach, a goal for
us to try to attain, but I also want to encourage growth, and I
think that is an issue we need to talk about and savings. I
have been working a long time in Congress to try to encourage
personal savings in this country, so I think that is a very
important goal. I think when we talk about tax reform you have
to look at it as revenue-neutral; otherwise, it no longer takes
off the mantle of being real true tax reform but as a reason to
cut taxes or to raise revenue. I want to concentrate on another
objective that I have, and that is, I believe ability to pay
should be a factor in paying taxes. I think the progressiveness
of our tax structure or regressiveness is something that we
need to be mindful of. One would argue as to whether our
current tax structures is properly progressive or not, and we
could get into that debate. I would certainly not want to see
us do a major tax reform and find out we end up with a more
regressive way of collecting taxes here in our National
government. So, let me start with Dr. Burman, see if he has any
thoughts, how do you maintain as least as progressive of a tax
structure as we have today if we were to abolish the income tax
as we know it? Can it be done?
Mr. BURMAN. Well, obviously, Glenn and I disagree on this,
but I think it would be extremely difficult to do it in the
context of the consumption tax. There have been proposals for
so-called consumed income tax where you start with the income
tax base and then you subtract savings from the base. Then
there is a progressive schedule of tax that people know more
about than I do. The Treasury Department looked at this in the
mid-nineties. They examined it and basically concluded it would
be unworkable; it would be more complex than the current tax
system. The tax rates at the top, if your tax base is
consumption, would have to be a lot higher than the tax rates
are now, and that raises a lot of issues. It sounds like we are
measuring consumption as an easy thing whereas measuring income
isn't. I think, as Joel mentioned, if you're exempting savings
from tax, then there is a tremendous incentive for high-income
people to try to make wages and salaries look like savings, and
they will find ways to do that. You have to do very complicated
rules to avoid that, so there is--I think a consumption tax as
progressive as the current system would be a very difficult one
to attain.
Mr. CARDIN. It is clear that whenever you bring in income
to a non-income tax, you're going to add complexity. That is a
given. We understand that. However, it would be difficult to
find a tax structure that is more complicated than our tax
structure. It is pretty hard for the average taxpayer to
understand all the different lines on a tax return. One
suggestion that has been made on the consumption tax is that we
just exempt a certain level of consumption through the form of
a tax refund. Is that workable? Can that be done? If there is a
way of putting that into a tax structure, that actually in fact
could calibrate a new tax structure to make it no less
progressive than the current and still maintain a degree of
simplification. Mr. Auerbach, you seem to be interested in
that.
Mr. AUERBACH. The flat tax or versions of that so-called
graduated flat tax or an X-tax can give you any desired degree
of progressivity toward the bottom through very high exemption
levels. Basically, it is like a VAT except wages and salaries
are taxed to individuals rather than to the businesses. Then
you can have an exemption or a rebate, a tax rebate to lower
income individuals. You can even layer an earned tax credit on
top of it to keep a significant degree of progressivity at the
bottom. I think the real challenge for any consumption tax
proposal that one included is maintaining progressivity at the
top. That is, you can get progressivity between low-income
individuals and middle-income individuals. What is very
difficult to do is to, if you're looking at the top percent of
the income distribution, for example, is to preserve the same
burden at that level. That is very difficult to do through a
consumption tax alone.
Mr. CARDIN. So, you have to combine with some form of
income-related taxes if you want to maintain the
progressiveness at the higher end.
Mr. AUERBACH. There have been proposals to do that, for
example, to do a consumption tax of one form or another up to
$100,000, for example, followed with some sort of income tax
maintained. It is a significant tradeoff though that keeps the
complexity. Most of the complexity of the income tax is at the
top. It is among high-income individuals and corporations. So,
if you seek to keep that piece as really the only way of
maintaining progressivity at the top, you're also losing a
large share of the benefits of moving to a consumption tax. I
think that is a decision you have to make. I'm not sure that
there is any way around that.
Mr. CARDIN. Thanks. Thank you, Mr. Chairman.
Chairman THOMAS. Just briefly on that. Obviously, if you're
talking about changing the fundamental system, i.e., income
versus consumption, should you at the same time take into
consideration what other aspects, pensions or others, that are
based on income that you're going to have to rethink
statutorily? Or should you not worry about that because it will
take care of itself if you come up with a new system? Just
briefly because I've been given the idea that somehow to go
from an income tax to a consumption tax, you ignore all the
laws that are based upon income to produce a pension system and
others. You're going to have to take that into consideration;
at least understand you're going to have to deal with it.
Mr. SLEMROD. I agree, Mr. Chairman. It is not only other
parts of the law; it is other parts of the economy that have
come to rely on income measurement from income tax returns,
such as financial aid officers and mortgage loan officers. If,
in the absence of an income tax system, some other system of
measuring well-being arises, we have to net out the cost of
that.
Chairman THOMAS. Not that the result wouldn't be useful or
appropriate. You are just going to have to think about it.
Okay, the gentleman from Louisiana wish to inquire?
Mr. MCCRERY. Yes, thank you, Mr. Chairman. I would like for
you to talk about the goals of a tax system. Several of you
mentioned fairness, and you tried to describe what fairness
would mean. In your discussions of fairness, you didn't say
much about economic growth and how economic growth might factor
into fairness. For example, if we have a tax policy that
encourages capital formation, job creation, and we have a lower
unemployment rate in the country, so more people have jobs,
isn't that fairer than a tax system which discourages job
creation, say, Europe, for example? Many countries in Europe
have very high unemployment. They have very burdensome tax
systems, very high benefit structures, Federal Government
benefit structures, but the tax system seems to inhibit
economic growth and job creation, so it seems to me that would
be unfair for people who want to work and have jobs. So,
shouldn't we factor in the growth policies inherent in a tax
system as part of the fairness discussion?
Mr. HUBBARD. I would think absolutely, Mr. McCrery. I think
probably the biggest reason you're here at the table is exactly
economic growth. In fact, in fairness, you know, when
economists talk about the subject, there are really two topics
that get conflated, and one--I think Alan Auerbach made this
point very well--concern for low-income taxpayers as opposed to
a concern for inequality itself. There are many ways you can,
through the Tax Code or spending, address the needs of low-
income individuals, much of which falls under the rubric of
fairness. At the top, it comes with enormous costs in economic
growth. The most stimulating margins for investment, for
entrepreneurship, for risk-taking are taxpayers at the top, not
the bottom, of the income distribution. So, I would urge you
very carefully to think about what it is, your concern for
poverty as opposed to a concern for inequality, but yes, I
think your concern is well placed.
Mr. MCCRERY. Anybody else want to make comments on that?
Mr. BURMAN. You're absolutely right that there is a
tradeoff, and if you just focused on one or the other, you
would end up with counterproductive results. One thing that
actually people in our panel and the rest of the people in our
profession have failed the people on this Committee is that
there is no consensus yet on what the growth effects are. Glenn
believes that people are very sensitive to taxes at the top.
There is a lot of evidence that suggests that they're not so
much, but I think the hardest thing about your job is that your
going to evaluate the evidence and make these tradeoffs, but it
is not either/or. You have to look at both of them.
Mr. SLEMROD. Can I say briefly, Mr. McCrery, I think
fairness is a code word for the fact that the objective is not
only to maximize GDP--we could probably all agree that if we
find some Tax Code that would increase GDP from $11 trillion to
$14 trillion but, in so doing, all the income went to one
person, that wouldn't be appropriate. So, we care not only
about GDP but about its distribution. As your question
suggests, we should care not only about distribution of income
today but in the future and the economy growth more. Otherwise,
incomes will be higher and what we don't agree as economists is
how to trade off total GDP in a way with the distribution, and
we need to hand that over to you to do that----
Mr. BEACH. I think, Congressman, we know a lot more today
than we did 20 years ago about how the passage of time effects
individuals who are subject to a certain tax regime. So, it
would be, I think, appropriate for you to drop into the
economics community and say, Well, what do we know about
savings and the role of taxes on savings, because we know more
today than we did 20 years ago? What do we know about the
barriers taxes raise to entrepreneurship and on the reentry of
women into the work force? Those are the kinds of equity
concerns that are tied into economic growth, but we can answer
better today than when we did last time.
Mr. MCCRERY. Earlier this year, our Joint Committee on
Taxation here in Congress released a report analyzing three tax
changes, each one costing about $500 billion over 10 years. One
was a reduction in individual tax rates; another corporate tax
rates; and another was personal exemption increases, the
personal exemption. The Joint Tax Committee found that, of
those three, the largest economic benefit was realized by the
cut in the corporate tax rate. Also, that particular change had
more feedback which reduced the actual costs, so to speak, to
the Treasury. Is that plausible that that would be the winner
among those three? Dr. Auerbach, you're nodding.
Mr. AUERBACH. Yes, it is. I mean, nobody would increase the
personal exemption as a way of stimulating growth or capital
formation. That is, there as an element of fairness as a part
of an overall tax system.
Mr. MCCRERY. Agree that that is a plausible result? Thank
you.
Chairman THOMAS. Gentleman from Michigan, Mr. Camp, wish to
inquire?
Mr. CAMP. Thank you, Mr. Chairman, thank you all for being
here. We have heard a lot of discussion about the potential
problems with our current system and certainly with a variety
of the reforms, VAT tax, sales tax, flat tax, et cetera. I say
this somewhat rhetorically, but can anyone imagine a system in
whatever shape worse in terms of complexity and impact on
family budgets and savings rates than the current one we have?
I think it was Dr. Slemrod who, in your written testimony, you
have quite a bit about the complexity of the current system and
the compliance burden, particularly with the self-employed. I'm
wondering about certainly the issue you mentioned about
computer programs making some of these calculations easier and
making it more difficult. How much emphasis should we put on
simplification if we start looking at ways to reform the Tax
Code?
Mr. SLEMROD. I think you should think about simplification
not as an end in itself but as a way to make the taxpayer, to
make the burden on taxpayers lower because of compliance costs
and other things. The estimates suggest that the cost, the
resource cost is quite high. So, that, and that could be
significantly lowered with clever simplification, and I think
there are unfairness issues built into the system because of
the complexity. Some people profit from it. Other people lose
from it. So, I would urge you, in thinking about simplicity, to
always think about it ultimately in its effect on the cost of
the economy and the fairness in which the tax burden is
distributed among the population.
Mr. CAMP. I think you mentioned particularly those large
businesses which have economies of scale deal with the
complexity problems. It is the smaller--or medium-sized
businesses that really have the higher burden, compliance
burden, there.
Mr. SLEMROD. You know that economists don't agree on much,
but I think this is a case where everyone who has studied
compliance costs pined that the costs are regressive. The
businesses, bigger businesses have lower compliance costs as a
share of their scale than smaller businesses. Although, it must
be said that small businesses are problematic for just about
every tax system there is. Many VAT systems, for example,
simply exempt small businesses, which is certainly a way to
lower the compliance costs, but have other problems for the
structural integrity of the tax system.
Mr. CAMP. Mr. Beach, with regard to fairness, which
obviously is an important consideration as all of you have
mentioned, you talked about the lifetime consumption patterns
and how those vary, and obviously, that affects the tax burden.
How do we really sort that out with regard to tax fairness as
we look at tax reform?
Mr. BEACH. Well, it sort of depends on how you want to
define the tax base from which you draw the revenues. Keeping
in mind that to tax individuals at certain stages of life means
to tax a different composition of their income versus their
savings versus their consumption pattern. If we were to, in the
illustration I used in my testimony, rely strictly on
consumption, it is the case that individuals who are very young
are taking on large packages of consumed things, buying a
house, raising a family, paying for education. If we just
looked at the total value, net present value of their
consumption and taxed that, it would be very, very unfair. So,
that needs to be taken into consideration. We're coming up with
Social Security reform, Medicare reform. We have got to be very
careful now to recognize that the assets of people in their
fifties, perhaps, are going to be very useful from a public
policy standpoint when they're in their seventies, so perhaps
we have to think about pulling tax burden off of those saved
assets. Look, we save a lot in our houses these days. To what
extent is the public purpose achieved here by recognizing that
people may have to negotiate some of those equity things that
we are currently not thinking about as perhaps pulling out of
the tax base and allowing people to use them for other
purposes. So, yes, clearly, a consideration, there are
individuals here in the audience who spend their careers
looking at the lifecycle of taxation and a lot of good
literature on that, Congressman.
Mr. CAMP. Thank you very much. Thank you, Mr. Chairman.
Chairman THOMAS. Thank you. The gentleman from Georgia, Mr.
Lewis, care to inquire?
Mr. LEWIS OF GEORGIA. Thank you very much, Mr. Chairman.
Let me take a moment to thank each Member of the panel for
being here today. Dr. Burman, I would like for you to assess
something, comment on the evolution of the AMT. Is it true that
the AMT was designed to address a situation which arose in 1966
where 155 taxpayers making over $200,000 per year paid no
income tax? If you just fast-forward to today, 3.8 million
taxpayers were hit by the AMT in 2004, and now it has been
paid, not by the richest, but by the hardworking taxpayers with
four kids making $65,000 per year. Does this seem fair to you?
Is this really the intended target for the AMT? Would you agree
that any talk of real tax reform must include a real fix for
the AMT problem? It should be done now, not putting it off down
the road to some weeks or months or years later. I've seen
figures that said that, by 2010, 35 percent of all taxpayers
will be subject to the AMT. If we don't address this growing
problem, aren't we in effect subsidizing tax cuts for the very
rich on the backs of the middle class? Isn't this really a
sneaky backdoor tax increase on the middle class?
Mr. BURMAN. Congressman, I agree that the AMT has very
little justification in current law. It was supposed to be a
tax law on the rich, and increasingly, it is a tax on the
middle class. Already, people earning, you know, between
$100,000 and $500,000 are much more likely to be on the AMT
than people earning over a million dollars. By the end of the
decade, something like 90 percent of households with two or
more children with incomes between $75,000 and $100,000 will be
on the AMT. They were never the intended target. The problem
with the AMT is that it brings in so much revenue. If you just
eliminated the AMT, under current law, it would cost something
like $700 billion, it would reduce Federal revenue by $700
billion over the next decade. If the President's tax cuts are
extended, it reduces revenues by about $1.2 trillion.
Chairman THOMAS. Dr. Burman, if it would only cost us $700
billion, I'd do it today. I think we are over a trillion and
moving quickly, but that is okay. So, it is even greater.
Mr. BURMAN. It is over a trillion against the President's
baseline, if the tax cuts are extended.
Chairman THOMAS. We are assuming certain things, yes, of
course.
Mr. BURMAN. I can't really say much to defend the AMT. It
is increasingly a tax on the--AMT, it is pointless complexity,
for most people, and it really does not have much to do with
tax shelters, which was its original purpose.
Mr. LEWIS OF GEORGIA. Would other Members of the panel like
to respond?
Mr. SLEMROD. I agree with Len that if one could find a way
to maintain the distributional implications without the
complexity of the AMT, we should get rid of it.
Mr. AUERBACH. Yes, I think one of the problems with the AMT
is that it codes this with the regular income tax. You could
conceive of a tax reform based on the AMT as the primary tax
system rather than the regular individual income tax. There are
some elements of the AMT that present a broader tax base than
the regular tax. The problem is that there are various defects
in the AMT that cause it to affect more and more people over
time, but you could take a path of repealing the regular income
tax and fixing the AMT and keeping that. The current system is
clearly not the place you want to be in the long run with both
tax systems co-existing.
Mr. LEWIS OF GEORGIA. Do any of you have any idea, could
you explain maybe to me how a consumption tax would affect the
elderly? These are people who have worked all their lives, and
now they live on a fixed retirement income. How would a
consumption tax affect the elderly? Would it have adverse
impacts on the elderly.
Mr. AUERBACH. It would depend on the type of consumption
tax adopted. For example, if you adopted a VAT, the price
level--the prices would likely go up to reflect the higher cost
of the value-added tax. Social Security benefits are now
calculated would--or are price level indexed, and therefore,
recipients of Social Security benefits would be protected
against the increases in the VAT, the cost of living through
the value-added tax. Other types of consumption tax, that tax
consumption directly, for example, would not necessarily
provide that protection. Then there are still other types of
consumption taxes which would provide some sort of explicit
exemption or transition relief for people who have previously
accumulated assets. So, that, really, it is, you have to look
at the details of the consumption tax rather than just the
concluding that a consumption tax taxes elderly. It is more
complicated.
Mr. LEWIS OF GEORGIA. I know my time is up, but could this
lead to double taxation for the elderly, for a certain segments
of the society?
Mr. AUERBACH. It could, and as one of the other people
pointed out and unfortunately, that is one of the quote-unquote
economic benefits of consumption tax. Sometimes, in studies
that people do, including some that I've done, estimate the
growth effects of consumption taxation, some of the consumption
taxes studies, do impose double taxation on the elderly and
holders of previously accumulated wealth. If you try to relieve
some or all of that double taxation, it may be a fairer tax
system to the asset-holders, and it may also be one that
provides lower growth opportunities.
Mr. LEWIS OF GEORGIA. Thank you. Thank you, Mr. Chairman.
Chairman THOMAS. Thank you. Gentleman from Pennsylvania,
Mr. English, may inquire.
Mr. ENGLISH. Thank you, Mr. Chairman. Dr. Hubbard, I
noticed that several of the panelists have discussed in their
testimony the size of the trade deficit in recent years which
is, frankly, a matter of great concern to me, representing as I
do a manufacturing district. I know one possible reason among
several for our disadvantage in this area may actually be a
matter of trade policy. I've come to realize that every one of
our major trading partners employs a border-adjustable tax
system for their imports and exports. We do not. Taking into
consideration that some of our largest trading partners also
fail to apply free-market principles to their economic and
monetary policies, what would be the impact on economic growth
here in the United States if we were to utilize a border-
adjustable tax system? In particular, could you discuss for us
the short--and medium-term impacts of moving to that kind of a
system?
Mr. HUBBARD. Well, I think, first, in understanding the
current account deficit, it is important to look at the really
big trends, which are the fact that we have some large
economies in the world, particularly in Asia that are not able
and/or willing to absorb domestic savings. The United States
has investment being more desirable here currently than saving
is. I think that there are a number of tax policies that
inhibit competitiveness, the corporation income tax itself, the
lack of a territorial tax system. The Tax Code probably is not
the single biggest feature if I were to think of public
policies, I would put the tort system easily equal to that. I
don't think you should expect a border-adjustable tax per se to
have large positive benefits. I think the positive benefits
come from the tax reforms that would in fact cut the tax burden
on American corporations, and I agree with you; those are
highly desirable.
Mr. ENGLISH. Intuitively, I'm trying to go from, the
macroeconomic, to more of a microeconomic perspective. If we
are imposing a tax burden on our exports that is substantially
greater than the tax burden being carried by the products that
are from our trading partners, whether it is competing in our
market or in their market or in a third market, doesn't that
over time, particularly in manufacturing where there tends to
be a relatively thin profit margin, doesn't that tend to be a
significant negative factor?
Mr. HUBBARD. I think it is a significant negative factor,
Mr. English. I just don't think it is that much related to
border-adjustments, per se. I think it would be worthwhile your
considering cutting the rate of corporation income tax. It
would be worthwhile for the Congress generally to consider tort
reform. All those things would help American manufacturers
greatly. My gentle pushback would be that border adjustability
per se is not the source of those gains. It is the reforms.
Mr. ENGLISH. I know, Dr. Auerbach, you've also taken a
position on this. Would you give us an insight into how you
think border adjustability might or might not have an impact on
our trade balance?
Mr. AUERBACH. I agree with what Dr. Hubbard just said,
which is that there are things you can do in tax reform, in
particular, encourage national saving, which would reduce the
trade deficit. That could come from any number of tax reforms,
border adjustments or not. Border adjustments appear to make
our exports more competitive, but I think the economists
generally agree that the result would be an appreciation of the
dollar. So, that would undercut the apparent benefits of border
adjustment. I should say, I mentioned in my testimony, it is
sort of ironic because the main beneficiaries of border
adjustments would be the holders of foreign holders of U.S.
dollar denominated assets.
Mr. ENGLISH. Here, again, aren't you applying a
macroeconomic analysis to what in many cases is a microeconomic
problem that individual products when they face, you know, when
they are sold at 12-percent more--let's say the cost of the tax
system, relative to similar products in a third market or in a
foreign market or even in our market if imports are coming in,
in effect, without the cost of our tax system built in, isn't a
12-percent differential or some such fairly significant for
individual products?
Mr. AUERBACH. It certainly is significant. I don't disagree
with that. All I'm saying is that that imbalance, whatever it
is, would not be affected by introducing--by the active border
adjustment. That is, it might be affected by lower costs, lower
corporate income taxes, lower costs of production. It won't be
affected by the simple fact of border adjustment taxes, that
is, relieving the tax on exports, extending it to imports,
simply because the exchange rate will adjust, and whatever
benefit would have been conveyed by the reduced tax on exports,
for example, or the higher tax on imports would be undone by an
offsetting appreciation of the dollar, which makes our exports
more competitive--less competitive and makes imports more
attractive to us. So, the producers facing this disadvantage,
you suggest in your hypothetical example would continue to face
that disadvantage in the presence of border adjustments if
other provisions were the same. Of course, tax reform can lower
costs in many ways, make producers more competitive in many
ways; it is simply not the border adjustment activity. It is
everything else that goes on, in addition.
Mr. ENGLISH. Thank you. Thank you, Mr. Chairman.
Chairman THOMAS. Thank you. Gentlemen from Kentucky, Mr.
Lewis, wish to inquire.
Mr. LEWIS OF KENTUCKY. Thank you, Mr. Chairman. Dr.
Hubbard, would you describe the tax legislation enacted in 2001
as simply changes to the Tax Code or would you say they have
been incremental steps toward a more pro-growth tax system?
Mr. HUBBARD. Well, I think they are certainly both. They
are important changes in the Tax Code. Each is pro-growth and
also consistent with fundamental tax reform. Review what you
did, you cut marginal rats in the first tax act. You introduced
investment incentives, albeit it temporary in the second; and
third, the reduction in dividend and capital gains taxes. I
think these are all good steps. I would prefer to see a bit
more of a continuation in those steps and cleaning up the base
of the tax to pay for the reforms. Yes, I think they are
excellent steps for tax reform.
Mr. LEWIS OF KENTUCKY. Are we seeing results from that tax
legislation through--are seeing a decrease in the deficits
because of the growth in the economy because of the tax cuts?
Mr. HUBBARD. I think it is certainly the case that economic
activity was bolstered by all three tax cuts, focusing on the
second, on the investment incentives. I think they played a
particularly powerful role in the investment recovery. I think
the cuts in marginal rates and dividend capital gains taxes
have been important. Taxes don't, in and of themselves, don't
pay for themselves. They certainly contributed to economic
activity but not sufficient to pay their costs.
Mr. LEWIS OF KENTUCKY. Yes, thank you, that is all.
Chairman THOMAS. Thank the gentleman. Gentleman from
Massachusetts, Mr. Neal, wish to inquiry.
Mr. NEAL. Thank you, Mr. Chairman. Dr. Burman, we have all
suggested, and for many years here now, the difficulty that the
AMT presence. What do you think the economic impact might be of
repealing the AMT?
Mr. BURMAN. I guess it would depend on how you did it. If
it was done in revenue-neutral fashion, say by closing
loopholes, broadening the base, I think the economic impact
would be positive. Most of the people who are on AMT actually
face higher marginal tax rates under the AMT than they do under
the regular tax system. That means that there are disincentives
for working and saving. The AMT is a source of pointless
complexity. Some of the compliance costs that Joel counted up
is that everybody has to fill out the AMT form. By the end of
the decade, it will be 30 million household will have much more
costly tax compliance than they do now. Also, to the extent
that you think that economic incentives in the Tax Code have
some purpose, the fact that people don't know whether they are
going to benefit from those incentives depending on whether
they are on the AMT or not in the year is a bad thing. So, I
mean, I can't tell you how much it would help, but the science
would definitely be positive.
Mr. NEAL. I think the chairman indicated that it was his
estimate that it might cost more than a trillion dollars to
repeal the AMT.
Chairman THOMAS. Would the gentleman yield briefly?
Mr. NEAL. Yes.
Chairman THOMAS. When it was a $300 billion problem, it was
hard to deal with. Now that its $700 billion moving toward a
trillion, it seems that we might be able to deal with it.
Mr. NEAL. Is it the position of the entire panel that it is
worth getting rid of the AMT?
Mr. BEACH. If I could just say, Congressman, one of the
things that concerns me and, sitting next to the world's
leading expert of the AMT here, one of the things that concerns
me is, how is behavior changing today among taxpayers who are
not yet subject to the AMT in anticipation of their being
subject to the AMT? That is one of the costs that is hidden
here, but the Committee should recognize that people may be
changing dramatically, maybe family formation organization, and
they may be changing their decisions to buy certain kinds of
properties that would trigger an AMT. So, these are the kinds
of issues that surround that, and you ought to also be aware
and I think we are probably all should be concerned about its
effects.
Mr. NEAL. Suggestions from the panel on how we fix a $700
billion problem, maybe a $1 trillion problem, Dr. Burman?
Mr. BURMAN. One of the original purposes of the AMT was to
discourage tax shelters, and before 1987, the biggest AMT
preference item, the thing that was added back was the
difference between tax rates on capital gains and ordinary
income. Virtually any kind of individual income tax shelter you
can think of is designed to take advantage of the lower rates
on capital gains. So, one thing you could do, and I discuss
this in my testimony before a financial services Subcommittee a
couple weeks ago is, you could restore the differential,
restore capital gains as a preference item under the AMT--they
would be taxed the same as other income--and then use the money
that was brought in by that to allow people to claim their
children as deductions against the AMT, index the threshold and
the rates for inflation--so people don't get thrown on the AMT
just by inflation--and making some other changes. It would
reduce the number of people on the AMT by 2010 by 30 million to
3 million tax returns. I wouldn't eliminate the AMT all
together. You could eliminate the AMT by just building, by
adjusting the tax rates to offset the revenue that you've lost.
It is an unattractive prospect politically because you're
replacing a hidden tax with an explicit tax, but in fact, we
are taxing people anyway. By the way, the reason I emphasize
revenue neutrality is that, if you finance this through
deficits, I think the positive effects on the economy would
unbalance the negative. It would push up interest rates over
the long run, and it would crowd out private investment.
Mr. NEAL. Dr. Hubbard, Member of the Bush Administration,
you indicated it was not the position of the Administration to
make sure that AMT was a permanent part of the tax structure.
Didn't you say that earlier?
Mr. HUBBARD. I did, and first, let me note, the AMT is a
cautionary tale of what happens when you focus so much on a
handful of distributional objectives. We now find ourselves in
a complicated box because of that original jihad. I think it is
important to replace the revenue loss of the AMT. There is no
principled reason for having an AMT. You, in your wisdom,
legislate tax preferences. You shouldn't be in the business of
taking them away. I would not put as candidates what Dr. Burman
said of getting rid of all the pro-growth features in the Tax
Code. I think probably better would be State and local tax
deductions, home mortgage interest deductions, base broadeners
that might have the similar distribution that your trying to
achieve. That's what I would suggest you look at.
Mr. NEAL. Your indication was that the Administration did
not foresee this as being a permanent part of the tax
structure. Do you have any indications of when the
Administration might send a recommendation over to the
Congress? We have questioned the Secretary of the Treasury many
times since he's been here, and we all acknowledge it is a
problem. I don't know that the Administration has suggested
anything in terms of getting rid of it yet.
Mr. HUBBARD. Of course, the President has a tax reform
panel that will advise Secretary Snow. It would be hard to
believe that any fundamental tax reform that came out the
Administration wouldn't involve some serious restructuring of
the AMT.
Mr. NEAL. Thank the Chairman.
Chairman THOMAS. Thank the gentleman. Gentleman from
Wisconsin wish to inquire?
Mr. RYAN. I do, Mr. Chairman. Dr. Hubbard, I was intrigued
by some of the things you said in your opening statement on
transition costs. See if I can summarize this. I just want to
ask you to elaborate on this. Whether we go toward an income
base or consumption base, all roads kind of lead to the same
position if we adopt the principle of taxing income once at its
source, meaning no taxation on savings and investments, they're
on very similar tax bases. Correct?
Mr. HUBBARD. That's correct. The difference between a
fundamental income tax reform along the lines of what the
Treasury did in the early nineties or the American Law
Institute and something like the flat tax would be very modest.
It would be the time, value of money on depreciation
allowances. That is it.
Mr. RYAN. Exactly. So, let's go into the transition cost
issue. Anybody else, I would be interested. We in this
Committee will deal with an avalanche of interests coming to
this Committee trying to protect preferences they have in the
Code. We'll probably hear of a lot of concern about transition
costs. Give us the economic, your economic assessment of
transition costs, how best to deal with those things. It seems
to me you just allow a carryover of past credits and
depreciation schedules, things like that moving into a new
system where you sort of have a grandfather period, and that
ought to settle the issue. If I'm oversimplifying, let me know.
Mr. HUBBARD. You have a fundamental choice. You can
grandfather in some we hold harmless from the past. I have
argued and some others have argued as well that the whole
notion of transition costs may be overstated for industry in
general. For example, the movement to expensing would reduce
corporate equity values, but reducing dividend and capital
gains taxes goes the other way. I think, on balance, transition
costs may be more modest. Where they're going to be large and
where you will definitely hear from people are special
provisions in the Code. Those, I think, you know, economists
would generally argue to resist such temptations. Those will be
the really large changes, and that of course will be the core
of your----
Mr. RYAN. From a macroeconomic standpoint, it ought to be
superior for the U.S. economy as a whole.
Mr. HUBBARD. There is no silver bullet here. If you keep a
grandfathering system, you may think of that as simple, but it
actually creates enormous tax planning opportunities. On the
other hand, the cold turkey method that I'm suggesting is
simpler, won't create the tax planning, will cause some rough
justice. So, there is no silver bullet for you in that.
Mr. RYAN. Anyone else wish to comment on that?
Mr. BEACH. Also the tradeoff of higher rates during the
transition, or higher rates permanently if you bring in
grandfathering as well, taught us in the 1986 situation, where
we ultimately began to see the value of trading certain
preferences for lower rates, and that may be the discussion you
have on this.
Mr. SLEMROD. I agree that there are very large tradeoffs to
face in determining how to do this transition. If you, for
example, as you suggested, allow depreciation to consider past
assets, and moving to expense is an enormous revenue cost. If
you try to keep the old rules on with the new rules, as has
been suggested, you have two parallel systems which can be very
complex. So, all of the tradeoffs that one faces in designing a
new system come up in thinking about the transition to a system
that we might all agree is better.
Mr. RYAN. One more question, Dr. Auerbach. I want to ask
you to elaborate on the exchange-rate argument. We hear this
quite often about border adjustability, and the exchange rates
will wash out the benefits. Is that not a measurement of long-
term exchange-rate fluctuations versus medium--or short-term
advantages or disadvantages that are attributed to border
adjustability? Do those happen in the same time equation or
not, meaning if, in the next 1 to 5 years, we border adjust our
taxes, does that not give us a competitive advantage that would
not be fully washed away from adjustments in the exchange
rates?
Mr. AUERBACH. No. I think in this case--this is theory,
because we don't have a clean experiment where we have said,
let's have border adjustments and now let us get rid of them.
Our theory tells us pretty certainly that the exchange-rate
adjustment would be immediate. So, the producers would never
see the advantage.
Mr. RYAN. Anybody else wish to comment on that point? All
right, thank you very much.
Chairman THOMAS. Gentleman yield the time he has briefly?
Mr. RYAN. Yes.
Chairman THOMAS. I think everyone understands the tradeoff
between credits and deductions in a lower rate. My question,
strictly based on historical analysis, is how long are you
going to keep the lower rates? They didn't even last 5 years
the last time the tradeoff was made. So, there has to be some
commitment to a long-term exchange rather than a short-term
one. Gentlemen from Louisiana, Mr. Jefferson, wish to inquire?
Mr. JEFFERSON. Thank you, Mr. Chairman. The President has
laid down at least three markers with this tax reform panel.
One is that he wants them to come up with a revenue-neutral
result. Second is he wants them to not affect home mortgage
deductions. Third is he doesn't want to effect charitable
deductions. Do you think, starting out with these premises,
that there is a chance to achieve true tax reform?
Mr. BURMAN. One of the two big sources of efficiency gains
from tax reform is broadening the base. The fact is that, you
know, if you went to say a flat tax or a consumption tax, there
would be as much pressure to put things like charitable
contributions, home mortgage interest deductions into the Code
as there is under the income tax. Obviously, it is upon this
Committee and the Congress to decide what goes into the
package. It is actually a poor signal that, even before you
started, that there are two of the largest tax expenditures off
the table for significant reform.
Mr. JEFFERSON. Any other comment on it?
Mr. HUBBARD. I wouldn't put it quite that way. I think
there is a legitimate argument to be made for charitable
deductions, for home mortgage interest deductions. I at least
didn't hear the President say it was off the table. He said it
was there. We already have a cap on the home mortgage interest
deduction. I think it is possible to have revenue-neutral and
distributionally neutral pro-growth reform that has what the
President had in mind, and it eliminates the tax on savings at
the investor level. I think all those things can be
accomplished.
Mr. JEFFERSON. Let me ask another question. This business
about pro-growth and revenue-neutrality, you all made comments
that the budget deficits are retardant to economic growth and
that we need to fix that. How can we accomplish these goals,
both these goals simultaneously, a revenue-neutral approach to
reform and attacking these deficits? It seems that one has
quite an effect on the other.
Mr. HUBBARD. You're leaving out one part of the equation,
which is spending, and I would invite you to look at the
CBO's----
Mr. JEFFERSON. Let's assume we keep the idea of spending.
We don't do anything with it. Let's assume you keep it just
like it is----
Mr. HUBBARD. You just eliminated the chance for adjustment,
Congressman, because if you look at the CBO's analysis of the
fiscal picture over the next 25 or 30 years, it is entirely a
spending story. That is, revenue shares and GDP are roughly
constant. Suspending is accelerated. The fiscal crisis facing
the country----
Mr. JEFFERSON. The revenue share of GDP, you know, it may
be constantly going forward, but has been cut quite
substantially from about 20 percent to now somewhere around 16
percent. So, it isn't accurate to make that point.
Mr. HUBBARD. Congressman, Social Security and Medicare
alone will consume about 10 percentage points of GDP more in 30
years than they do today under current law. The Federal tax
share in GDP let's say were 18 percent, was a target. That size
of a tax increase is what you're looking for. That is 50
percent if you're looking at this as a tax problem. I would
submit humbly to you that it is a spending problem.
Mr. JEFFERSON. If it is a spending problem, and we are the
Committee on Ways and Means, it seems that we have got to
figure something out with respect to that. If we are making a
tax policy here as opposed to taking care of the requirements
of government, you can't leave the requirements out. At some
point down the line, I suppose, there may be some changes made
to Social Security and Medicare, whatever you're talking about
is the entitlement programs that are driving spending. If we
approach this tax reform without regard to the budget deficits,
what I'm hearing from every panelist here is that it is quite
an impossible task to have a revenue-neutral approach to this,
and that means we're locked into deficits, even if you make
changes in the spending and even if you didn't go any farther
than this today. Here we are spending X on Social Security,
Medicare, and X on everything else, and we still have deficits.
If you stop spending on those things right now, today, we
couldn't fix the deficit with a revenue-neutral approach. I'm
just trying to figure out if we have made decisions already
with respect to our taxing program that have us locked on to a
kind of a slope now that won't permit us to make genuine tax
reform without reviewing everything that has happened in the
last few years and everything that may happen in the future and
not just starting now and looking forward.
Mr. SLEMROD. Congressman, I agree with the thrust of your
comment, that putting on the table incentives for homeownership
and charity are in a way constraining the clean base that tax
reform could achieve. Your second point, that putting on the
table at the beginning that the tax reform has to be revenue-
neutral is also constraining in a big-picture approach to the
fiscal challenges that the country faces. So, I'm very
sympathetic to that line of questioning.
Mr. BEACH. Congressman, I was disappointed to hear that
that was the opening gambit. However, as you know, being an
observer of Washington, making a good tax bill is hard enough.
Reforming the Tax Code is almost impossible. It might be
useful, for discussion purposes, leaving up to this Committee--
as the President said, revenue-neutrality, home-owner
deductions are off the table and charitable deductions remain
neutral. I doubt very seriously whether we can have a tax
reform and maintain those three principles in place.
Mr. BURMAN. I think it would be better if tax reform were
an opportunity to deal with the deficit problem. The problem
with revenue-neutral tax reform from, a political problem, is
that any kind of sensible reform is going to raise taxes on
millions of people. You couldn't have a sensible tax system
that would look like the current one. It would be a hard sell
if you're not raising taxes overall. I think if tax reform were
packaged with telling people that the consequences of tax
reform is going to be lowering the taxes of our children,
reducing this crushing debt burden, I think that would be
positive. You could do tax reform in a way that you could raise
revenue without diminishing economic incentives. There is still
a lot of corporate tax breaks that have companies chasing tax
incentives rather than doing their business, and you could
raise a lot of revenue that way.
Chairman THOMAS. The Chair was intending to end the hearing
at 12:30 p.m. We have a number of Members who wish to inquire.
The Chair would offer, with unanimous consent, that the
remaining Members voluntarily limit their inquiries to a 3-
minute timeframe. Is that acceptable? If it is, then everybody
probably can make it. With that I recognize the gentleman from
Georgia.
Mr. LINDER. Thank you, Mr. Chairman.
Chairman THOMAS. Thank you very much, Members.
Mr. LINDER. We have a Tax Code today that is in fact a flat
tax on income, 93 years later. We flattened it out again in
1986 only to have amended it 14,000 times since then. Does
anybody believe for a moment that future Congresses will keep
their hands off it? Does anybody believe for a moment that we
can broaden the base? We have removed 50 percent of the income
earners from the income tax roles essentially. Are we going to
put them back on? I doubt it. Dr. Slemrod, you said keep it
clean. That would take a supermajority to change it. Do you
think that we could pass that? I doubt it. Let me get to your
compliance cost. You and I have discussed this one other time.
You say $135 billion. Does that take into consideration the
cost of the considering the tax implications of a business
decision?
Mr. SLEMROD. The $135 billion figure that I refer to is the
collection cost, the time and money that the taxpayers put in,
the IRS budget, and third parties such as employers doing
withholding. It doesn't take into account the cost to the
economy when the tax system distorts decisions such as business
investment decisions or labor supply decisions.
Mr. LINDER. Nor does it take into account business or
opportunity costs.
Mr. SLEMROD. It does take into account the opportunity
costs of the taxpayers' time that they put into dealing with
their taxes.
Mr. LINDER. Why does your 3.2 billion figure differ so
largely from the Tax Foundation's 6.6 billion hours figure?
Mr. SLEMROD. I am not--I don't know how to reconcile the 3
billion with the 6 billion hours' figure. There was a very
extensive study done by IBM Consulting which came up with a
number at 3 billion. I think that we can probably agree that
whether it is 3 billion hours or 6 billion hours, it is a lot
of hours.
Mr. LINDER. It is too much. Dr. Burman, you talked a good
bit about protecting the poor. We have got a study from 1997 by
Dale Jurgensen who argues that 22 percent at the producer price
level represents a tax component, and the poor are paying that.
If you were to get rid of all tax on income for consumption
tax, that would go out of the system, prices would be lower,
and a rebate would totally untax them. What is wrong with doing
that?
Mr. BURMAN. I don't quite understand.
Mr. LINDER. Twenty-two percent of the price system today
represents a tax component. People who are living at or below
the poverty level are losing 22 percent of their purchasing
power to the current system.
Mr. BURMAN. What you are saying is that there is--the
efficiency cost of the tax system shows up in prices. I mean I
don't argue that there is an efficiency cost that shows up. The
fact is that the current system does a lot to help low-income
people. They get, you know, as I noted in my testimony, low-
income families get $4,000 or $5,000 a year in tax breaks. You
know, a lot of these are families that are working full time
and struggling to get by. It makes a huge difference. In a flat
consumption tax or a flat rate tax, without some kind of cash
grant to low-income people, I think they would be in big
trouble.
Mr. LINDER. Mr. Beach, one quick question. Mr. Chairman,
may I?
Chairman THOMAS. Very briefly.
Mr. LINDER. You say that a consumption tax
intergenerationally hurts young people who purchase more at a
young age. Dr. Kotlikoff has published that cross-generational
taxes are very progressive because for the first time in
history we tax wealth instead of just wages. Would you comment
on that?
Mr. BEACH. Well, I think you need to keep that as one of
your considerations, is how does the tax burden change as life
goes forward, as we go through the life cycle? Lawrence
Kotlikoff is very, very gifted on this. He is talking about an
intergenerational effect. I think I was talking about an
intragenerational effect. It will be something you will be
thinking about, I am sure.
Chairman THOMAS. Thank the gentleman. Gentleman from
California, Mr. Becerra. You will pass? Gentleman from Texas,
Mr. Doggett. We had agreed to limit our comments to 3 minutes.
Mr. DOGGETT. Thank you very much. Thanks to the panel. You
are here with us, of course, on the month of D-Day, and I refer
not just to the very important historic event, but that this is
the D-Day month, as our Chairman and the Ranking Member on the
Subcommittee on Social Security have indicated, when we will
see a legislative proposal before the Committee to implement
the President's Social Security proposal. Let me just ask you
first if there is anyone on the panel who thinks the idea of
having individuals put part of their Social Security taxes into
private accounts, if they oppose that idea.
Mr. AUERBACH. I----
Chairman THOMAS. I take it that there is no one that
opposed that concept.
Mr. AUERBACH. I think you--one needs to say more. I think
it certainly should not be viewed as a way to get a higher rate
of return or as a solution to the funding problem. It has other
potential advantages and those can be discussed.
Mr. DOGGETT. Okay. You have, I assume, some objection to
it.
Mr. AUERBACH. I have some concerns about lending money,
essentially offering a margin loan to individuals who may have
very little experience in capital markets, and I think
considerable protections would have to be given to them.
Mr. BURMAN. I think there are a lot of issues associated
with that and Alan's point, as well as just the fact that----
Mr. DOGGETT. Because my time has been limited I will let
you amplify on it more later, but I assumed you might be one
Member of the panel who had questions about it. Of course, we
have been told also that this proposal won't be able to stand
on its own, that it will need to be cloaked, covered, combined
with, merged with some kind of action on taxes, which is I
suppose the only reason that all of you have been called here
this morning. As far as tax simplification, since we know that
the length of the Tax Code has almost doubled under Republican
leadership here in the House, are there any proposals that the
Republicans have added in the last decade that have added to
tax complexity that you propose specifically should be
repealed? I assume you have some and I would be delighted to
have you amplify on them. Is there anyone else who sees--on the
panel who sees specific measures that the Republicans have
added complexity in the length the Tax Code that you would want
to see repealed?
Mr. BEACH. Congressman, it may shock you to learn that the
Heritage Foundation doesn't distinguish between Democrats and
Republicans with respect to----
Mr. DOGGETT. Well, I will settle for just what the Congress
has done in the last 10 years while the Republicans have been
in the majority.
Mr. BEACH. We would eliminate many of those credits which
are in the Code right now.
Mr. DOGGETT. Many of the tax credits?
Mr. BEACH. Yes. Deductions, of course, if we had the right
kind of alternative system in place. We are on the record on
that.
Mr. DOGGETT. Thank you very much.
Chairman THOMAS. The gentleman's time has expired.
Gentleman from Colorado, Mr. Beauprez, wish to inquire?
Mr. BEAUPREZ. Thank you, Mr. Chairman. As a small
businessperson all my life until I came to Congress a couple of
years ago, believe me, I would love to spend considerable time
with you gentlemen. I am going to be very brief and yield to my
colleague from Georgia, though, in just a moment. What shocks
me as I look at this, whether it is the 1.6 billion work years
by your calculation, Dr. Slemrod, or about twice that from the
Tax Foundation, it is a staggering amount. I submit to you, Dr.
Burman, that if we want to eliminate the deficit, as I
desperately would like to, I would like to see those couple
billion work years put to use in this country actually
producing something other than just trying to figure out how
many dollars to send to Washington. With that statement, I am
going to yield to the gentleman from Georgia, who I think has
put more time and effort into this subject matter than almost
any other Member of Congress I can imagine.
Mr. LINDER. I thank the gentleman. I have spent a good bit
of time over the last 10 years on this. Dr. Burman, you said in
your printed statement that it is not likely to see any
economic benefits from moving to a consumption tax. Over 10
years, you are the first economist I have ever heard say that.
Is that a hunch or is that a study?
Mr. BURMAN. Well, there is a lot of evidence. I don't know
that I--I think I said that I thought the economic benefits
were relatively small. Most of the benefits come from the
transition tax on old people which I think would be hard to
implement, and from base broadening which you can do under the
regular income tax. The fact is that the other economic effects
are mixed. You cut taxes on savings, you increase taxes on
work. Dr. Auerbach and his colleagues have done some research.
They show small economic improvements from switching to a
consumption tax, but it is not going to turbocharge the
economy. There are other economists find larger effects.
Mr. LINDER. Merrill Lynch, Cap Gemini, McKenzie and Boston
Consulting Group have concluded between the two of them, that
there is between $9 and $10 trillion in offshore accounts right
now. They are seeking both safety so they are in dollar-
denominated deposits, and they seek secrecy. As long as we keep
the IRS in place, will that money ever find its way into our
economy? If we get rid of the IRS will that money find its way
into our economy?
Mr. BURMAN. I am not an expert on the business issues. I
mean, I know doing things to reduce the tax incentives that
create these corporate tax shelters would, in my view, would
improve economic efficiency and deal with some of those
problems. I don't know that that is specifically a problem with
the income tax versus consumption tax. It is with these
asymmetries that you tax some kinds of income different from
others and you create these incentives for tax sheltering.
Mr. LINDER. Anyone else care to comment on the offshore
money? Thank you. Thank you, Mr. Chairman.
Chairman THOMAS. Thank the gentleman. Gentleman from North
Dakota wish to inquire?
Mr. POMEROY. Yes, Mr. Chairman. I would follow up on some
questions asked by Congressman Levin. As he referenced the New
York Times article, the richest are leaving even the rich far
behind. The analysis states in this article, and I will just
quote: ``The Times analysis also shows that over the next
decade the tax cuts Mr. Bush wants to extend indefinitely would
shift the burden further from the richest Americans with
incomes of more than a million or so. They would get the
biggest share of the breaks in total amounts and in the drop in
the total amounts and in the drop of their share of Federal
taxes paid.'' I would ask the panel, have you had a chance to
analyze the work of the New York Times reporters that wrote
this analysis, and do you agree or take issue with it?
Mr. BEACH. Congressman, if I could just say, in that
particular article--and I believe that is the one by David K.
Johnson that you are referring to?
Mr. POMEROY. Yes, sir.
Mr. BEACH. He says in there that the Heritage Foundation
looked and approved of these numbers. I would like to just
clarify that we have not done that yet. Len and I were talking
just a moment ago before the hearing that he is going to share
the data with me. Len Burman's operation supplied a great deal
of that data for that analysis. I will point out in addition to
what Glenn has said about the defects of the study, I did note
that it did not rely on an estimate of the macroeconomic
effects of the Bush tax cuts.
Mr. POMEROY. Dynamic scoring. I have 3 minutes. That is all
I get from you. Len?
Mr. BURMAN. The dynamic effects of the 2001 to 2004 tax
cuts have been looked at by the CBO and Joint Committee on
Taxation and they conclude that this sort of depends on how you
close deficits. The effect of the deficits could offset a lot
or even all of the economic benefits, and that the trends that
David was talking about in the study I think are unmistakable.
Mr. POMEROY. You know, maybe this is not an economics-type
question, but I am trying to rank the biggest problems facing
our country. You have got the financial deficit, you have got
the trade deficit, you have got the structure of the Tax Code.
Do you have a--how would you rank those issues? Anyone care to
venture? Dr. Hubbard.
Mr. HUBBARD. Well, to me, if you are restricting it to
economic policy--because I can surely think of some noneconomic
policy concerns that are more uppermost in my mind. In terms of
economic policy concerns, the entitlement problems in the
United States are clearly the largest. That is the fiscal
debate over the next many years that you all will have to have.
Mr. AUERBACH. One should keep in mind that these are
complementary solutions to existing problems. If, for example,
one of the ways you contemplate dealing with Social Security is
by uncapping or raising the cap on the payroll tax, that is
going to represent an increase in marginal tax rates. It would
make it even more important in an individual tax reform to
reduce marginal tax rates to make room for that increase. So,
dealing with Social Security, dealing with other entitlements,
in a sense makes it even more important that the tax system be
as efficient in pro-growth as possible.
Mr. SLEMROD. In one sense, I think tax reform ranks up with
these other problems in that it is the most common point of
contact between the government and its citizens. As I said in
my closing remarks, how we do tax reform affects how activist
the government is, how intrusive it is to its citizens. So, it
is hard to put a dollar value on those things but I think it is
a very important aspect of government.
Chairman THOMAS. The gentleman from Connecticut, Mr.
Larson, wish to inquire?
Mr. LARSON. Thank you, Mr. Chairman. I would like to go
back to a question that Mr. Neal asked before, and, Dr. Burman,
I believe you answered; and I wanted to be clearer on this.
With regard to addressing the AMT and looking at its potential
growth, I believe you said going to 30 million, how do you get
that back down? You had some specific recommendations. Did I
hear that right?
Mr. BURMAN. We have a number of different options we have
looked at. One is restoring capital gains as a tax preference
and using that as a way to take the AMT off the middle-class
families. Dr. Hubbard mentioned the idea of repealing State and
local tax deduction. That raises issues. That would--under
current law that would raise enough revenue to pay for
eliminating the AMT. You could also build the explicit taxes in
the AMT into the regular tax system.
Mr. LARSON. Dr. Slemrod, do you agree with that? Or how
would you approach the AMT issue?
Mr. SLEMROD. I think both of the options that Dr. Burman
mentioned are worth considering. Eliminating the State and
local income tax deduction isn't something that I would put on
the top of my list for tax reform, but I think it should
certainly be considered in a package which cleans the tax base.
Mr. LARSON. Following along with what Mr. Pomeroy had to
say with regard to--Dr. Hubbard, you mentioned entitlements. I
think the question was specifically as it related to rank
ordering in terms of economic impact, either the national debt,
the trade deficit, or in fact the structural nature of our tax
system. Given those three options, how would you rank order
those in terms of importance? Or would you? Or would you come
up with something else? Let's start with Dr. Auerbach.
Mr. AUERBACH. Well, I think--I don't really think there is
a need to rank them. You have to deal with--if you are going
to, for example, deal with Social Security and Medicare, there
may be benefit cuts, there may be tax increases. The impact of
those tax increases, for example, would be very much influenced
by the underlying tax structure in which they occur. So, even
if dealing with--I think clearly dealing with the imbalance
between spending and taxes is the first order of business. As
you are doing it, a tax reform is complementary to that effort;
and so even if it isn't as important in itself, it is part of
the overall task.
Mr. LARSON. Anyone else care to comment on that?
Mr. SLEMROD. Another reason not to make the sharp
distinction is that cleaning up the tax base you are
essentially dealing with scores of expenditure programs that
are working through the tax system. If by eliminating some of
those they just come up, you know, are reproduced outside the
tax system, we may not be accomplishing what we thought we
were.
Mr. LARSON. So, the panelists were pretty much in
agreement, though, when it comes to dealing with cleaning up
the basis. It is just a question of how you get to cleaning it
up, whether you go to a flat tax or a VAT or whether or not you
use the existing system but make the clean-up throughout. Is
that fair to say? Thank you.
Chairman THOMAS. That certainly makes our job easier.
Gentlewoman from Pennsylvania wish to inquire.
Ms. HART. I do, Mr. Chairman. Thank you all for being here.
I think we could all design a system that we think would work
the best and they would all be different. So, we are going to
have to try to figure out, I think on two levels, what isn't
working and, of course, on the other level what might work
better. I want to start with Dr. Hubbard. You mentioned in a
Business Week article that tax reform needs to reduce the
Code's bias against savings and earnings. Can you give a couple
of examples of what specifically foremost in the Code really
demonstrated that bias?
Mr. HUBBARD. Well, as I said in my remarks, I think the
elephant in the room really is capital income taxation, both
for capital accumulation in your question and for risk-taking
and entrepreneurship. We double tax and in some cases triple
tax, some returns on saving. We have a Tax Code that distorts
how businesspeople make investment decisions. It would be
possible for us to have a tax system that is neutral with
respect to those decisions.
Ms. HART. Would the rest of the panel agree with his
statement that it does have a pretty well demonstrated bias
against savings and earnings? Dr. Slemrod?
Mr. SLEMROD. I think there would be wide agreement among
economists that the way we tax corporate source income needs to
be rationalized. I would add that although there are examples
of double taxation in addition to single, there are also
examples of zero taxation. I would include in a rationalization
of the tax system emphasis on corporate tax avoidance.
Ms. HART. Mr. Beach, your light is on. Did you have a----
Mr. BEACH. My light was actually not on. I always have a
comment. Yeah, I would definitely say, as Glenn has mentioned,
that this capital taxation is key to growth; and the key to
growth is the key to a lot of problems that the Congress faces.
So, yes.
Ms. HART. It is a timing light I see. That is okay. You get
the green light anyway. You know, ultimately I think a lot of
us probably in this Committee like the idea of a flat tax, and
I know some of you have expressed your interest in continuing
benefits for people who are low income. I think it is mostly--
Dr. Burman, just real quickly, could you tell me if there is a
way we could do a flat tax without hurting the low-income?
Mr. BURMAN. Actually I don't think it is hard to protect
low-income people. You could, as several panelists I think have
mentioned, you could include something like the earned income
tax credit or even child tax credit as part of a flat tax. The
bigger concern is the shift in tax burden from high-income
people on to middle, which would be harder to avoid.
Ms. HART. Okay. Dr. Auerbach, do you have a thought on
that? I mean without--obviously, if you have a flat tax you
wouldn't want to have any tax credits. So, is there a way to
maybe do something else?
Mr. AUERBACH. Well you could--well, you say you wouldn't
want to have tax credits. There is nothing structurally about a
flat tax. It includes a tax on compensation. So, anybody who is
working and being paid wage and salary income could be given
tax credits. Whether you choose to is a different issue.
Ms. HART. Okay. Thank you, Mr. Chairman.
Chairman THOMAS. Thank you. Gentleman from Illinois wish to
inquire?
Mr. EMANUEL. Yes. Thank you, Mr. Chairman. You know, I
appreciate you holding this hearing. One way--some of you have
mentioned, obviously, your comments about the complexity, or
difficulty rather, of getting something done on tax reform. One
way to look at this is if you could not do--although I think it
is worthy of looking at the entire Code--is to take both the
home mortgage, the earned income tax credit, the per child and
dependent, college savings and then retirement, the four kind
of pillars of middle-class life, and reforming the Code in each
of those areas to bring simplicity and the access to a middle-
class dream, make it closer. The ideas of--there are five
separate different education breaks. You can make them a single
break at $3,000 per child rather than $4,000 per family, with
some service notion attached to it that would bring simplicity
to the higher education component. We have, in the last 30
years, we have done 16 separate different vehicles in the Tax
Code for savings; one universal 401(k) that is portable and
brings simplicity as well as progressivity and maintains, kind
of square, both simplicity and progressivity. You could make
the mortgage deduction available not just to those who itemize
but to those who don't, and I think it would bring a great
piece of the American dream closer.
Then last, something I have introduced myself, which is a
simplified family credit that took the EITC and the per child
and the dependent care, eliminate 200 pages of the Code and
bring it down to about 12 questions. Although I think it is
worthy of looking at the task of taking the entire Code now and
trying to bring simplicity to it, I think all those are
attainable and would bring tremendous simplicity to the Code, I
think would accomplish maintaining I think principles, whether
it is you work for a living--that is the earned income tax that
rewards work over dependency--the access to college education,
and so forth. I don't want to repeat myself. Do you think that
is worth at least looking at if we could not see universal tax
reform as an attainable goal, from a political standpoint or
economic, and not get an agreement that taking at least a look
at those four areas: homeownership, retirement security, access
to higher education, and then obviously revaluing the principle
of work over dependency?
Mr. HUBBARD. I think it is clear the areas you have
mentioned are worthy of enormous simplification. In many of
those areas, we don't treat the American people like adults. We
have too many opportunities. You shouldn't kid yourself that
that is going to be a major increase in economic growth. If the
reason for the discussion is simplification, I agree with you.
It is a worthy agenda. If your agenda is economic growth, I am
afraid that would fall way short of the mark.
Mr. EMANUEL. Two points. One is I run tax clinics in my
congressional office from January 1 to close to April, and we
have resulted in--I know I am over the time, Mr. Chairman, and
I will be very quick. We have ended up returning to people a
little over a million dollars when it comes to the earned
income tax. Some people think there is about $8 billion--I am
just using one of the areas I talked about--that, you know,
there is about $8 billion worth of fraud there. I would suggest
that complexity is the problem, not fraud. I believe that if
you brought simplicity to that area, and I do believe, to tell
you the truth, if you were end up, whether it is on home
ownership, college savings, or retirement security, and also
the earned income tax, I think that would lead to economic
growth. My colleague and I have talked often about the
consumption tax. I think it would be ironic that we would go to
Europe, which has the most lethargic economic growth over 20
years compared to the United States, and use that as a tax
model of bringing economic growth when one of the things that
everybody always talks about is how in the last 20 years we
have had huge economic growth and we haven't had the
consumption tax. Europe has had a consumption tax and they have
had the worst growth of any industrialized area. Thank you, Mr.
Chairman.
Chairman THOMAS. Thank the gentleman. I do think as we look
at the Tax Code that it really is unfair that if there appears
to be something there, but that the burden of getting there
denies it to a number of people is something that we have to
look at. Gentleman from Indiana, Mr. Chocola, wish to inquire?
Mr. CHOCOLA. Yes. Thank you, Mr. Chairman. Thank you all
for being here. I represent a district that is heavily reliant
on manufacturing. I used to be in the manufacturing business in
a very capital-intensive business. Something we haven't talked
a lot about this morning is really how tax policy impacts when,
where, and how capital is invested. I think we would all agree
that the more capital available to invest in our economy the
better. We can't have that conversation on tax reform in a
vacuum because other countries are trying to compete for the
same capital we are. Just briefly--probably, Dr. Hubbard, I
would start with you. If you could comment on really some of
the policies we have of double taxation, tax corporate profits,
tax distribution of dividends, what that has on our
competitiveness worldwide; and how capital is allocated, and
also what the full taxation of U.S. foreign income has on our
competitive ability to compete in a global economy.
Mr. HUBBARD. Well, two aspects. One, I think the tax
treatment of business investments still needs work. I think it
is possible, through any of the tax reforms various people have
talked about today, to substantially lower the tax part of the
cost of capital for business investment, and I would encourage
you to do that. It is also important, though, to think about
multinational companies. I would urge you not just to think
about domestic investment as being the touchstone of reform. We
as Americans own our multinationals as well, and I think we
also want a Tax Code that makes sure that they have the ability
to compete in foreign markets as well as here at home. So, I
would urge you to consider both of those.
Mr. CHOCOLA. Anybody else have any comments on that?
Daimler Chrysler has a very large facility in my district. Does
our Tax Code impact why it is called DaimlerChrysler rather
than ChryslerDaimler?
Mr. BEACH. Congressman I think everyone--well, several of
us have said that lowering the corporate income tax rate in
line with the rest of the world is a good move. It is expensive
but it is very pro-growth and it does address some of the
problems that manufacturers in this country have had in
competing with foreign companies. I think it does explain in
part perhaps why you have that DaimlerChrysler.
Mr. CHOCOLA. I mean just as a general concept, we would all
agree that whenever we consider tax reform we consider how do
we make U.S. companies more competitive in a global marketplace
is a very critical aspect of this whole discussion.
Mr. SLEMROD. I am going to have to demur slightly on that,
because making a company more competitive than a foreign
company isn't the same as nor will it necessarily lead to
making our citizens better off. Competitiveness is a buzz word
that most economists would counsel that we have to be careful
about using. Getting tax reform that is fair and simpler and
pro-growth is the right way to think about it. I don't think
focusing on the competitiveness of our companies adds anything
to those criteria.
Mr. CHOCOLA. Well, a policy that helps create U.S. jobs by
allowing companies to be more competitive in a global
marketplace which results in more U.S. jobs is a good thing. I
think we can agree on that.
Mr. SLEMROD. You are getting closer on that. Yep.
Mr. CHOCOLA. Thank you, Mr. Chairman.
Chairman THOMAS. Thank all of you. The Chair is mindful
that although this is the first hearing, that the Chair may
call on some of you in a kind of a seminar I structured around
particular aspects that we have developed here today for
Members. I hope if at all possible you would make yourself
available. The Chair thanks you, thanks you for your
contributions and knows that ongoing work with you and your
colleagues can only make us better at some very difficult
judgments that we are going to have in front of us. With that,
the Committee stands adjourned.
[Whereupon, at 12:42 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
Statement of American Farm Bureau Federation
Farm Bureau believes there is a better way for the Federal
Government to raise the money it needs to operate the government. We
support replacing the current federal income tax system with a new tax
code that encourages savings, investment and entrepreneurship. The
replacement system must be fair to agricultural producers and should
meet the following objectives:
Be revenue-neutral so as not to produce a tax increase.
Eliminate payroll taxes and self-employment taxes.
End death taxes and capital gains taxes.
Eliminate personal and corporate income taxes and the
alternative minimum tax.
Change the Constitution to prevent the reinstitution of
the income tax.
Require a two-thirds majority vote in Congress to raise
taxes.
Be transparent and require a minimum of personal
information.
A replacement income tax should be based on net income.
A consumption tax should not tax business-to-business
transactions unless for final consumption.
U.S. farmers and ranchers operate in world markets. About 22
percent of the agricultural commodities produced in the United States
move into international markets. Roughly 11 percent of the food
consumed in the United States now comes from foreign sources. Farm
Bureau favors even greater reliance on the global marketplace and
favors continued reductions in trade barriers through trade agreements,
but tax policy should not place U.S. products at a competitive
disadvantage in either domestic or international markets.
Horizontal equity is the concept that two taxpayers with the same
amount of income and tax filing status should have roughly the same tax
load. Due to the capital intensive nature of production agriculture and
the unevenness of income due to weather variability and price
fluctuations, farmers and ranchers can often pay more taxes than others
with the same income. Any new or revised taxing system must address
horizontal equity.
COMPLEXITIES, BURDENS, UNFAIRNESS AND DISTORTIONS OF THE CURRENT TAX
SYSTEM
Achieving international tax competitiveness and horizontal tax
equity for farmers and ranchers will require substantial changes in the
current federal tax system. Farm Bureau believes that removing
complexity, reducing burden, eliminating unfairness and limiting
distortions are best achieved through a complete rewrite of the federal
tax code. Until a replacement code is enacted, the following issues
should be addressed through incremental reform.
Death Taxes--Because of the capital intensive nature of farming and
ranching, many operations are multi-generational. Current income from
farm land is usually quite low at about five percent or less per year.
As land continues to increase in value for reasons other than its
productive agricultural value, multi-generation farms can face large
estate tax bills at times when their incomes are small. When the forced
sale of farm assets is the result, the economic viability of farms and
ranches can be ruined.
Owners of other businesses that are less capital intensive and
generate more income per dollar of assets do not suffer as much from
the death tax. Analysis completed by Farm Bureau in late 2003 indicated
that farm estates liable for death taxes will increase from four
percent in 2001 to eight percent in 2011, assuming a unified credit of
$1.3 million in both years. Roughly twice as many farm estates
currently pay death taxes compared to estates in general, a clear
distortion.
Permanent repeal of the death tax continues to be Farm Bureau's top
tax priority. Increasing the unified credit has removed the burden from
some producers, but as long as this tax structure remains the chance
exists for a future Congress to lower the unified credit and/or
increase the tax rate. As long as the death tax remains, farmers and
ranchers will be forced to continue some level of estate planning as a
way to protect assets against future tax liability.
Capital Gains--For agriculture, the capital gains tax is a tax on
transferring assets from one form to another. While tax rates have been
reduced to a maximum of 15 percent, this is still a tax on asset
transfers that most other taxpayers do not pay. Frequently a problem at
retirement, the tax occurs any time a farmer or rancher wishes to
redirect assets from one enterprise to another. Capital gains taxes
have to be paid on the assets sold even though the operator wants to
invest all of the proceeds back into the business. As with the death
tax, the proper approach to the capital gains tax is to repeal it. This
would reduce both complexity and the amount of record keeping needed.
Alternative Minimum Tax (AMT)--The AMT clearly adds to the
complexity of tax filings. Many farmers and ranchers who include tax
management in their business planning find they may owe AMT after
irreversible business decisions have been made. Farm Bureau supports an
end to AMT.
Variable Income Issues--Progressive tax rates can push farmers and
ranchers into higher tax brackets when they have a good income year.
Cash accounting and income averaging provides some help to farmers and
ranchers dealing with wide swings in gross income and net income. Cash
accounting continues to be an effective way to simplify tax record
keeping and reduce the compliance burden, while also contributing to
horizontal tax equity. Income averaging is helpful, but is not a
substitute for cash accounting, and should be extended from three to
five years.
Matching Income and Expenses--Under the current system, there is
often a total mismatch between gross income and depreciation. Taxpayers
can be forced to carry depreciation forward or try to increase gross
income to use available depreciation. Direct expensing would simplify
the code and create horizontal equity. Congress has moved toward direct
expensing with Section 179 expansion and bonus depreciation. Farm
Bureau supports further expansion of Section 179 and indexing the
provision for inflation. Bonus depreciation should be continued with a
full year's depreciation allowed for purchases made any time during the
year.
Retirement Savings--Farmers and ranchers invest much of their
savings in their farming or ranching operations and use part of the
value of the operation as a retirement plan. This is unlike employees
who have employer-sponsored retirement plans that can be funded on a
tax-deferred basis. Self-employed professionals can use tax deferred
401K, SEP and IRA plans. Farmers and ranchers who use their businesses
to finance retirement are doing so with after-tax dollars and are not
treated equally.
Disaster Payments--Weather disasters are a fact of life for most
farming and ranching operations and introduce tax complexities not
found in most other businesses. The help provided by Federal Government
disaster assistance programs can be diminished by requiring payments to
be taxable income in the year received. Taxes are owed, even though the
taxpayer continues to struggle with the economic consequences of the
disaster. Farm Bureau supports not taxing payments associated with
weather disasters. Breeding livestock are sometimes sold during weather
disasters with the proceeds treated as capital gains. Farm Bureau
supports deferring taxes until two years after the disaster has ended
and a ten-year carry forward for income from a forced sale of livestock
with no taxes owed if livestock is replaced during that period of time.
Application of Self-employment Taxes--Problems with the federal tax
system are not confined to income taxes and estate taxes. Farmers and
ranchers also struggle with issues associated with taxes for Social
Security and Medicare. In most years, more farmers and ranchers pay
more money in self-employment taxes than they pay in income taxes.
Defining income for self-employment taxes is complicated. For example,
cash rent and payments for idling land in the USDA Conservation Reserve
Program are a return to capital, not wage income. The IRS wrongly
characterizes these payments as farm income subject to self-employment
taxes for Social Security and Medicare.
Health Care Plan Deductions--After years of effort by Farm Bureau
and other groups, the self-employed can now deduct 100 percent of
health care plan costs from their adjusted gross income. However, the
deduction does not reduce self-employment income for taxes for Social
Security and Medicare. Employees with employer-provided health care
plans can reduce their income for payroll tax purposes by placing money
spent for health care in flexible spending accounts. A deduction in
both income and self-employment taxes for health care plan costs would
help both farmers and ranchers achieve horizontal equity with other
taxpayers.
Statement of Daniel F. Ancona, IV, Santa Barbara, California
First of all, thank you very much for undertaking the important and
awesomely challenging work of simplifying the U.S. tax code. Based on
my experience with the Alternative Minimum Tax and the studies of
taxation and economics that I've undertaken since being affected by it
in 2000, I believe this to be among the most important work going on
currently in the Congress. It's easy to get lost in the details and the
thousands of pages of the tax code, but how we decide to pay for our
government is an issue of fundamental import to our democracy.
I am not generally an anti-tax zealot, as it seems obvious to me
that the taxes we pay and the government they fund have clearly played
a significant role in what has made this country great. Yet the
complexity of how we go about collecting those taxes seems to have
grown out of control, partially through the deliberate rigging of the
system by unscrupulous individuals and organizations, but even more so
because of structural and organizational phenomena that can only be
effectively counteracted by the work of committees such as yours.
I've included, below, a timeline of the exact details of my
personal AMT disaster. In summary: four years ago, I was charged
$55,000 worth of tax on money I literally never saw due to a botched
Incentive Stock Option transaction. It was as if I walked into a casino
and was taxed on the money I might have won but did not. I spent
hundreds of hours on the phone with numerous branches of the IRS trying
to resolve this, but only found relief after I finally found an
accountant (after six tries) who understands the AMT credit--and, when
the IRS classified me as a ``hardship case'' because I was cut to half
time at my job. Therefore, the IRS has postponed further collection
actions against me. Oddly--the IRS did not consider me losing my
business, being plunged into debt and having to move 350 miles a
hardship!
This tax severely punishes the risk-takers, technologists and
companies that are willing to democratically share the fruits of the
market through incentive stock options. If these people and companies
are truly the growth engines of the new economy, while they don't
require special treatment, they certainly ought not to be subject to an
arbitrarily cruel, unusual and specific tax. Indeed, I was in the
process of trying to start a technology company and create such jobs
when this tax cut my dream short.
I've never tried to game the tax system, I've never looked for
loopholes or been anything other than perfectly honest in dealing with
the IRS and the California Franchise Tax Board, yet my good faith
attempts at resolving this have been met with bureaucratic
inflexibility, stonewalling and buck-passing, wage garnishments and a
credit-rating ruining series of liens. I'm quite happy to pay my fair
share every April 15th, but I don't believe that ought to cause
personal financial devastation.
If there's an upside to this situation, perhaps it's this: there's
a saying that goes ``you may not take an interest in politics, but at
some point, politics might take an interest in you.'' My AMT disaster
occurred in 2000, and by the end of 2002 it was one factor (admittedly
of many) driving my engagement in the political process. Since then I
have volunteered hundreds of hours in city, state and national
campaigns and in building local party organizations.
I've never asked for special consideration in resolving my AMT
problems in return, and I'm certainly not doing so now. I simply have
come to the conclusion that greater citizen participation can mitigate
problems like this; problems that are essentially inevitable in a
society and economy as complex as ours.
But for this to work, the leaders have to be willing to listen, and
your presence on this committee indicates that you are among those who
are willing to do so. So again I thank you for your work, for the
opportunity to enter this testimony into the public record, and for
your help in finally resolving this matter equitably.
______
AMT Disaster Timeline--Daniel Ancona
As of June 2004
January 1999--I leave a startup that had been absorbed by Platinum,
Inc. to join pre-IPO email company Critical Path (CPTH) as a software
engineer. As a signing bonus I'm granted 20,000 Incentive Stock Options
(ISOs) at a price of around $1, to vest completely over four years with
a one year cliff.
Early Spring 1999--In preparation for the public offering, a 5:2
reverse split leaves me with 8,000 shares.
Spring 1999--CPTH goes public, opens at $16 and spikes to $67 on
the first day of trading. Price goes to above $120 a few months later.
January 1999--At an all hands meeting, the CPTH management team
tells the assembled employees ``The end of the boom is coming and we
all know it, but we have a real business model and we'll be one of the
companies left standing.'' I vest one quarter of my shares and begin
working nights on my own startup.
July 2000--I prepare to leave CPTH to pursue my own startup full-
time, having vested 2173 shares. Believing the company's fundamentals
to be sound and this to be the optimum capital gains strategy, I sell
around half my shares to live on while I get my company started and
execute an ``exercise and hold'' of the remaining shares, priced at
$67.
Neither the accountant nor the broker I was working with at the
time cautions me against this transaction, but (unbeknownst to me at
the time) this is the transaction that triggers the AMT. I was charged
AMT tax at 26% on the amount of money I would've made IF I'd sold the
stock that day, which would've netted me $135,000 or so. But I HELD
half the stock instead of selling it, thinking this was actually the
more conservative move. I was literally charged tax on money that I
never saw.
January 2001--After around five months of intense work, I decide
that the timing is bad for my startup and I begin looking for work.
About a week later, the SEC announces it's investigating CPTH officers.
CPTH would later go on to be #2 in shareholder lawsuits--behind Enron--
but as of this writing the investigation is ongoing, and no plan for
victim compensation has been announced.
The stock drops from the mid twenties down to $2 in a matter of
weeks. The stock I had left as my insurance pillow is suddenly almost
worthless.
Early April 2001--I get my tax bill for 2000. I owe around $46,000
to the IRS and around $12,000 to the FTB, on top of my regular taxes,
due to the AMT.
Mid April 2001--I fire my accountant and broker, and begin looking
into bringing suit against them but am cautioned against it. I begin
negotiations with the IRS and FTB.
January 2001 to April 2001--I attempt to find a job, sending out
more than 80 resumes. I finally find a job at UC Santa Barbara and
move, but not before nearly running completely out of money and
narrowly avoiding complete bankruptcy.
Fall 2002--I receive my first OIC denial from the FTB and am faced
with a lowest offer of $400 per month over five years.
January 2003--I receive my first OIC denial from the IRS and am
faced with a lowest offer of $1100 per month over 46 months.
Summer 2003--After three more tries, I finally find an accountant
who understands the AMT credit. He refiles my 2001 and 2002 taxes to
take this into account, cutting my total liability by around $10,000.
November 2003--Due to NSF and Iraq-war related budget cuts, I'm cut
to half my former salary at my university job.
January 2004--I convince the IRS and FTB of my layoff-related
hardship, and they both grant 1 year reprieves against further
collection action. I plan to continue to file for the AMT credit over
however many more years it takes to pay off the original loss.
Mountain View, California 94041
June 17, 2005
To the members of the Committee on Ways and Means:
Thank you for taking the time to read this letter. I believe the
Alternative Minimum Tax (AMT) and its treatment of pre-taxation on
Incentive Stock Options is wrong. I feel that this tax, which was
originally created because 155 wealthy businessmen didn't pay any
taxes, was not intended to financially ruin the middle class worker. It
is an unfair tax and should be abolished immediately. This tax has
caused our family undue stress and anguish.
Here is my story: In 1995 I joined a start-up high tech company
called VeriSign. I was hired as an Executive Assistant to the President
and my salary was $45,000. Over the years, I was granted Incentive
Stock Options (ISO). I tried to regularly exercise and hold my ISOs for
one year in order to pay long-term capital gains on the stock. In July
2000, I decided to leave my job so that I could plan my wedding and
also start to plan a family. I had stock that needed to be purchased
when I quit my job in July of 2000, so I exercised the stock. As
everyone knows, the stock market then suffered the worst stock market
downturn in history! At the time, I did not sell my stock in hopes that
the market may recover. Had I known about the AMT, I would have sold
the stock immediately. I come from a middle class background; my father
worked for AAFES (Army & Air Force Exchange Service) and my mother was
a nurse. I could not go to my parents for advice regarding my stock
options because they had no experience with stock. I tried to get a
financial advisor but had a difficult time finding one since, at the
time, here in the Silicon Valley, financial advisors would only take
people with large portfolios. My only financial advisor was the broker
that I used through VeriSign, who was biased since they worked for
VeriSign--they suggested I hold my stock. Many people had similar
situations to mine. My tax preparer told me that I would be subject to
the Alternative Minimum Tax and that I could receive a tax credit and I
could use that to offset a sale later on. Unfortunately, my tax
preparer wasn't aware that I would only be able to recover $3000 per
year in my AMT tax credit. At the time, most tax preparers hadn't had
much experience with AMT and therefore, could not give any detailed
advice on how to handle the stock. At that time, my salary for 2000 was
$50,747 and my taxes paid to AMT were $408,627--over 8 times my annual
salary on money that I did not have nor received!! I had to take all
the stock and sell it and take a loan in order to pay my taxes. On top
of that, I had to pay lawyers and accounts in excess of $20,000 to help
me to understand AMT and to try to fix this problem. The amount of
stress was and is still unbelievable.
I never received any benefit from my ISOs--in fact, I now have a
tax credit that I will never be able to use in my lifetime. Since AMT
is also a self-reported tax, I have many sleepless nights thinking
about how I shouldn't have reported the stock to the IRS, how it
doesn't pay to be honest, etc. I personally know many people did not
report this tax because they felt that the chances of being audited
were very slim. At the time, I did consider this but having spent my
entire life working and paying taxes, I knew in my heart that I was not
the kind of person to lie to the government.
AMT was never intended to trap the little guy. It was originally
intended to make sure the very rich, who years ago had tons of
loopholes to hide their money, would pay taxes. This law is flawed on
so many levels:
1. It's self-reported, the IRS has no way to track who reports and
who doesn't;
2. You are pre-taxed on gains that have never been realized;
3. After paying AMT, you are given a tax credits that never gains
any interest (on the flip side, if we owe the IRS money, we have to pay
interest plus penalties);
4. The AMT tax credits will never be fully used--mine is $408,627
and it would take me 136 years to use this credit.
The mental anguish over this tax is unbelievable. I know that many
people think that those of us who were caught in the AMT ISO trap were
greedy but that isn't the case. I personally feel that my lack of
understanding ISOs and the stock market along with the confusing way
that AMT is calculated helped to get me in this AMT mess. I just didn't
have the knowledge to fully understand the ramifications of this law.
Those of us who found out the hard way had to make a decision, either
report it or not--many did not. I chose to report the tax even though I
felt it unjust and unfair. However, my honesty only got me a huge AMT
bill while others walked away and didn't report their AMT. Those who
didn't report, wait for the statute of
limitations to go by and then breathe a huge sigh of relief when they
find they haven't been audited. The IRS has no way of tracking stock
sales and exercises and they rely solely on the taxpayer to supply this
information--this seems awfully stupid to me as it can lead to under
reporting, etc. of this and other taxes.
I am working with a law firm to try to recover some of the AMT that
I've paid. My amended returns have been with the IRS for over two
years. The IRS holds amended returns ``hostage'' so they can sit out
the statute of limitations instead of making decisions regarding our
arguments for getting credits back faster. I believe they do this
because they are afraid to do the ``right'' thing and call this law
unfair. The IRS refuses to respond to my amended returns. The only
recourse that I have is to take the IRS to court--which means spending
another $15,000-25,000 of money that I don't have--and then knowing
that the courts don't want to make the ``fair'' decision but want to
make the ``constitutional'' decision (following the law). If I did go
to court--I could be tied up in court for another 5 years. The only way
to get justice is for the law to actually change.
I hope that my letter puts a ``face'' on what this horrible law has
done to the average person. I am not an executive, I am not a founder
of a company, I ended my career at VeriSign as a Project Manager--
nothing fancy. If you saw my tax returns for the last 10 years--you
would see that I never made over $75,000 a year in actual salary. I
always paid my taxes on time. I'm a responsible, citizen who has voted
in every election since I turned 18. I believe that my government will
do the right thing. However, in the future, I would never accept stock
in lieu of salary like I did at VeriSign. I don't ever want to be in a
position of having to make decisions that will ruin my financial life
and the life of my family.
I hope and pray that the Ways and Means Committee will have the
courage to listen to all the comments from people like myself and make
some real changes in this law. We did what we thought was right, we
reported our stock exercises and then ended up paying millions of
dollars in pre-tax to the government on stock that we never saw any
financial gain. It's wrong. Plain and simple. If it happened to you or
to one of your family members--you would be outraged. Time is running
out for those of us who couldn't pay their AMT--if the Ways and Means
Committee does nothing--many will loose everything they ever worked
for--their savings, 401Ks, their children's education funds, their
homes. Please do something about this before these honest citizens end
up homeless.
Sincerely,
Susan Schroeder Anderson
Hopkinton, Massachusetts 01748
June 22, 2005
Dear Chairman Thomas and Committee Members,
During 2000, my (then) fiancee, Laura Perkins, exercised and held
ISOs from her company based on advice she received from our accountant.
This exercise subjected Laura to the Alternative Minimum Tax (AMT),
substantially increasing her 2000 Federal tax liability. Instead of
receiving a return of approximately $1,050, Laura owed the IRS $174,272
on what was considered a paper gain. This was a substantial debt given
that Laura's W-2 wages for that year were $84,997. Prior to finding out
the magnitude of her 2000 tax liability because of AMT, Laura had
exercised more shares in January 2001 and, based on guidance from our
tax accountant; she also planned to hold these shares. However, in
March 2001, our accountant explained to us the huge tax obligation
Laura had for 2000 because of the shares she exercised that year. To
pay this debt ($174,272), Laura sold 8000 shares of stock.
After Laura and I wed in September 2001, our accountant again
described ways of minimizing our 2001 tax liability based on the
January 2001 exercise. Our accountant calculated our approximate 2001
AMT liability as approaching $1 million if we held all the shares
exercised in 2001. This liability was greater than the value of all the
shares we currently had available to sell. Realizing our only option
was to heed our accountant's advice, we sold the remaining shares of
the 2001 exercise. The continued decline in the stock price caused us
to realize only 20% of the stock's original value. Originally, we had
planned on selling the shares exercised in 2000 but knew that, due to
AMT, this was not an option. The proceeds from the sale of all the 2001
shares were now considered real ``income'' and would be subject to our
actual tax rate instead of being considered for AMT as unrealized
gains. This would still create a huge tax amount, but it was one that
we could possibly pay by leveraging other assets.
In February 2002, our accountant did the final calculation for our
2001 taxes and determined that our liability was much larger than we
could afford. We knew we would have to use the proceeds from the
earlier mentioned sale (as this is why we sold them). We also took out
multiple margin loans against our balance of shares to pay our
anticipated 2001 liability. (We filed an extension in April that
resulted in late fees) While we continued working on our taxes
throughout the summer we were advised that our liability was $20,000
more than originally filed. We didn't have any more money to send and
at the same time the stock we had margined against was falling through
the floor causing us to get weeks of margin calls and eventually the
brokers began to sell whatever shares of stock we had left.
To satisfy all of our creditors (that were due to our taxes) we
decided to refinance our house. We refinanced through a local bank and
even though we expressed our desire to have it go through as quickly as
possible it still took them more then a month and a half to finally be
ready to settle the new mortgage. (Due to the huge volume of
refinancing activity) Once we closed on the new mortgage we filed our
final 2001 taxes, paid in full.
While dealing with this financial mess, we planned for, and paid
for, our September 2001 marriage. We have now paid our 2000 and 2001
taxes--for a grand total of $294,278 in Federal Taxes, and well over
$5,000 in accountant fees to help us understand these complicated
provisions of the tax code. This amount greatly exceeds our annual
salaries for that timeframe, and we will probably never see the
majority of the tax we paid on theoretical stock gains. We live
paycheck to paycheck and have to decide which household bills we will
pay late even though my wife has worked for her employer for more than
20 years. We abided by the tax code, and because of the burden placed
on us due to phantom (never realized) stock gains, we struggle to
resume our middle class life we enjoyed prior to filing our taxes under
AMT. Please take our case into consideration when you are reviewing
possible changes to AMT.
Thank you for your time and consideration,
Michael and Laura Aubut
Talking Rock, Georgia 30175
June 3, 2005
Dear Sirs,
I would like to submit my request that you seriously consider
abolishing the Internal Revenue Service and establishing a national
sales tax as the means to collect taxes.
I am a mother of five and a grandmother of eight. I am sixty-eight
years old and have been paying payroll taxes since I was eighteen years
old. I want my heirs to have a more fair, more humane, system to pay
taxes.
I do not begrudge contributing to the support of our government. I
do begrudge the method of collection.
I begrudge that criminals who do not earn money legally and have no
payroll check, do not pay taxes. I begrudge that wealthy people can
afford tax experts to find loopholes to see that they do not pay as
much in taxes as a person who earns a fraction as much. I begrudge that
illegal aliens do not pay taxes.
A national sales tax would address these faults.
Most of all, I think, a national sales tax would immediately raise
the happiness levels of all working Americans. We would have a choice.
We would be free of the oppression of the IRS. Sirs, can you imagine
what American would be like if all it's workers were happy?
I have studied the plan of Americans For Fair Tax (AFFT). I agree
with their findings:
Creates jobs where IRS destroys them
Cuts the cost of goods and services
Dramatically lowers tax rates on lower and middle class
Raises the same amount of revenue for the Federal
Government
Will bring jobs back to America
There are many more reasons for a national sales tax. I hope at
least one of the persons testifying in this hearing will cover them
all. I also hope each one of you will commit to a thorough study of the
AFFT.
I beg you to take advantage of this window of opportunity afforded
this Country. An opportunity to give back the dignity to it's workers--
the dignity and work ethic that my parents and grandparents enjoyed--
before worker's hard earned money was illegally taken from them--before
social security taxes.
My children and grandchildren will be able to afford health
insurance. They will have more money to save and invest without double
taxation.
Please do the right thing for America and the working people.
Abolish the IRS and institute a national sales tax.
Sincerely,
Joyce Ann Barrett
Statement of Rachelle Bernstein, National Retail Federation
The National Retail Federation is the world's largest retail trade
association, with membership that comprises all retail formats and
channels of distribution including department, specialty, discount,
catalog, Internet and independent stores as well as the industry's key
trading partners of retail goods and services. NRF represents an
industry with more than 1.4 million U.S. retail establishments, more
than 23 million employees--about one in five American workers--and 2004
sales of $4.1 trillion. As the industry umbrella group, NRF also
represents more than 100 state, national and international retail
associations.
Summary of Comments
Members of the National Retail Federation believe that the most
important aspect of any tax reform measure is its impact on the economy
and jobs. Consumer spending represents two-thirds of GDP, and one-in-
five Americans are employed in the retail industry. The NRF believes
that replacing our current tax system with a consumption tax, or adding
a consumption tax to our current tax system, will present an
unnecessary risk to our economy. The NRF believes that a reform of the
income tax, by providing a broad base and low rates, will bring the
greatest economic efficiency and will not cause the economic
dislocations inherent in the transition to a new tax system.
The NRF believes it is better to engage in substantial reforms of
the income tax that are designed to eliminate some of the major
complications in the current Internal Revenue Code and stimulate
economic growth, without causing major economic dislocation.
As many of the witnesses who appeared before the President's
Advisory Panel on Federal Tax Reform admonished, a fundamental goal of
reform must be to ``do no harm.'' According to a study of major tax
reform proposals performed for the NRF Foundation, transitioning to a
consumption tax system will lead to a decline in the economy for
several years and a loss of jobs, without stimulating much additional
economic growth for a ten-year period. The United States should not
experiment with a brand new tax system that will put our economic
future at risk.
The NRF also opposes using tax reform as a guise to fund increases
in government spending. Many witnesses appearing before the Advisory
Panel suggested adopting a VAT or National Retail Sales Tax (NRST) in
addition to the income tax to provide a revenue source to pay for
growing entitlements, health care reform and modifications to the
income tax. The NRF believes policymakers need to be forced to make
choices with respect to how taxpayer dollars are spent, rather than
being provided with a money machine to finance entitlements and other
government programs.
Proposals to Replace the Income Tax with a Consumption Tax
Various options for replacing the income tax with a consumption tax
were presented to the Advisory Panel, including proposals for an NRST,
VAT, Flat Tax, and consumed income tax. Economists generally agree that
the economic impact of various forms of consumption taxes is similar,
although the application of the taxes may differ.
In 2000, PricewaterhouseCoopers prepared a study on Fundamental Tax
Reform for the NRF Foundation.\1\ The study examined the impacts of
replacing the income tax with an NRST or a Flat Tax. The study's
conclusions are in line with the testimony of many of the Advisory
Panel's witnesses--although replacing the income tax with a consumption
tax might bring long-term economic growth, there could be very harmful
short-term and mid-term economic results.\2\ The study also found that
the economic growth that occurred during the ten-year modeling period
was relatively modest compared to the disruptions to the economy during
the transition years. Specifically, the study found that following the
enactment of an NRST, the economy would decline for three years,
employment would decline for four years, and consumer spending would
decline for eight years. The study found that following the enactment
of a Flat Tax, the economy would decline for five years, employment
would decline for five years and consumer spending would decline for
six years.
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\1\ PricewaterhouseCoopers LLP, Fundamental Tax Reform:
Implications for Retailers, Consumers, and the Economy, April 2000. The
study is available on NRF's website: http://www.nrf.com/content/
default.asp?folder=govt&file=pubs.htm
\2\ The PwC model was developed specifically to analyze tax reform
plans. It combined microsimulation models for individual and corporate
income taxes with a macro-economic forecasting model, which allowed it
to provide short-term transition results on an annual basis. Id at p.
119.
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In addition to the overall impact of consumption taxes on the
economy, retailers are particularly concerned with the impact of
consumption taxes on our customers. Consumption taxes are highly
regressive and will raise the tax burden on lower and middle-income
Americans. This occurs because lower-income households tend to spend a
higher portion of their incomes, so they will pay a higher tax relative
to income level under a consumption tax than will upper income
households.
Many witnesses appearing before the Advisory Panel suggested that
the regressive nature of consumption taxes can be addressed through the
drafting process. It is impossible to speculate with respect to all of
the drafting variations that might be developed to address this
problem, but it cannot easily be fixed if the current tax system is
replaced on a revenue neutral basis. If taxes are cut for the wealthy,
which will occur if savings are not subject to tax, then taxes will be
increased on lower and middle income taxpayers. To illustrate, we
critique a few proposals that have been presented to the Advisory
Panel:
H.R. 25, a proposal to replace the income, payroll, and
estate and gift taxes with an NRST, attempts to address regressivity in
two ways. First, it repeals the payroll tax. Second, it provides a
rebate of the sales tax up to the poverty level. A January 2005 study
\3\ of the distributional impact of H.R. 25 found that if that bill
were enacted, families with income less than $18,000 a year would get a
tax cut, and families with income over $100,000 would get a tax cut.
However, families with incomes between $18,000 and $100,000 a year
would have a tax increase. Families earning between $18,000 and $35,000
a year would have the largest percentage increase in taxes.
---------------------------------------------------------------------------
\3\ The study was performed for the National Retail Federation by
the Barcroft Consulting Group.
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The BEST \4\ proposal would replace the income and estate
and gift taxes with a combination of an NRST and a business transfer
tax (BTT). The proposal includes a rebate of the sales tax up to the
poverty level, which is supposed to operate similarly to the rebate in
H.R. 25.\5\ The proposal does not include repeal of the payroll tax, so
it will cause even more of a tax increase on those earning less than
$90,000 a year than was the case with H.R. 25.
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\4\ This proposal was presented to the panel by David Burton, who
indicated that it is expected to be introduced as a bill in the Senate.
\5\ It is unclear whether the rebate will be based on the tax rate
for both the NRST and BTT, or only the tax rate for the NRST. If it is
the latter, the proposal will be even more regressive.
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The Four-Piece Fair and Balanced Proposal \6\ would
impose an income tax only on upper income Americans, but would also
impose a 10-14% VAT. To address the regressivity of the VAT, the
proposal includes a refundable payroll tax offset. This proposal would
impose a tax increase on lower and middle-income seniors, who are
currently in a consumption stage of their lives and who receive no
benefit from the payroll tax offset, since they generally do not work.
---------------------------------------------------------------------------
\6\ This proposal was presented to the panel by Michael Graetz.
---------------------------------------------------------------------------
Consumption Tax as an Addition to the Income Tax
Several witnesses that appeared before the Advisory Panel suggested
that a VAT be enacted as an add-on to the current income tax system, as
a means to finance social security, pay for repeal of the alternative
minimum tax and other income tax reforms, and fund other governmental
priorities. This model is similar to that used in many European
countries.
Adopting a VAT in addition to the income tax will lead to a higher
overall level of taxes as a percent of GDP, which will not foster
economic growth. An early NRF study of an add-on VAT found that GDP
would decline for four years after enactment and consumer spending
would decline even longer \7\ Projections will change depending on how
the VAT is designed, but the study demonstrates that even when the VAT
does not replace the income tax, there may be economic dislocations for
a multi-year transition period.
---------------------------------------------------------------------------
\7\ Cambridge Research Institute, Value Added Tax, June 1980. This
study was performed for the NRF's predecessor, the American Retail
Federation, the last time that serious consideration was given to
enacting a VAT in addition to the income tax.
---------------------------------------------------------------------------
The best evidence that a VAT will lead to substantial growth in the
level of federal taxation comes from the European example. Dan Mitchell
of The Heritage Foundation published a recent analysis of the European
experience with VATs \8\ According to Mitchell, in the mid-1960's,
before any European country adopted a VAT, the burden of government in
Europe was only slightly higher than it was in the United States. In
Europe tax revenues were about 30% of GDP, while in the United States
tax revenues were about 27% of GDP. Forty years later, taxes in Europe
amount to approximately 41% of GDP, while taxes in the United States
remain at about 27% of GDP. The VAT proved to be a very easy tax to
raise to fund increased government spending because it is built into
the price of goods and hidden from consumers. As Mitchell points out,
this explosion in social welfare spending has also created a drag on
European economies.
---------------------------------------------------------------------------
\8\ Mitchell, Daniel J. A Dangerous ``VAT'' of New Tax Revenue,
Heritage Foundation, February 24, 2005.
---------------------------------------------------------------------------
Many of the witnesses appearing before the Advisory Panel warned
that adding a consumption tax to the income tax will unnecessarily
increase the overall level of complexity of our tax system.\9\The dual
tax system may be particularly, burdensome for small businesses, which
have enough trouble meeting the burdens of collecting and remitting
payroll and income tax withholdings.
---------------------------------------------------------------------------
\9\ For example, see remarks of Martin Feldstein at May 17, 2005
hearing of Tax Reform Advisory Panel.
---------------------------------------------------------------------------
Conclusion
We urge this Committee to develop legislation that would reform the
income tax to simplify administration of the system and encourage
economic growth, without shifting the burden to those that can least
afford to pay.
Statement of Larisa and JP Bickel, Cedar Rapids, Iowa
An article published in the Cedar Rapids Gazette on Saturday,
December 15, 2001, describing Senator Grassley's efforts to reform the
Alternative Minimum Tax, ``Grassley offers relief from `unfair tax' ''
really hit home with my family. My husband and I are 30 and graduates
of Luther College in Decorah, Iowa. My husband has worked for McLeodUSA
since graduating (for over 7 years) and I have worked at a private
school. We have been very careful to live within our means.
We have lived a very conservative lifestyle and thought we were
planning responsibly for the future of our family. We have a son who is
five years old who was born prematurely with a hearing loss and
multiple other issues that have required hearing aids (which insurance
does not cover), physical therapy, occupational therapy and speech
therapy to this point. Shortly after our second son was born I
hospitalized after requiring an emergency hysterectomy. Because of our
prior financial planning and saving, we had always been able to meet
his needs financially. The ATM tax has overwhelmed us financially, when
we could have been able to me other unexpected expenses in life.
In the fall of 2000, we vested a portion of my husband's McLeodUSA
stock options for the first time when the stock was at $18. We borrowed
almost $40,000 to pay for the stock. As the article outlined, we did
not sell any of the options in anticipation of ``holding the stock for
one year after exercise in order to avoid taxation at the ordinary
income on the value at the point of exercise.'' As a result, we paid
approximately $80,000 in alternative minimum taxes. We were able to pay
for about one-third of this out of our own savings, but then had to
take out a home equity loan for the remaining two thirds.
The stock's present value is approximately $.09 per share--which is
after the stock went through a reverse split of 17 to 1--leaving us
with nothing of value to sell and burdening us with the reality that we
took a $50,000 loan for the alternative minimum tax which is
essentially an interest free loan to the government because we can not
simply obtain a refund of the overpayment. We also owe $40,000, the
purchase price of the stock, which is now essentially worthless. The
reality is that this situation has been devastating for us. We are
overwhelmed by the burden of the debt created by paying this tax.
Because of paying this tax, we are unable to start a college education
fund for our son, provide the financial resources needed to fund the
special help he will require during his primary school years, and fund
our retirement account. We are forced to live at a barely subsistent
level.
We want you to know that this is financially and emotionally
devastating to our modest-income family. We thought we were doing
everything right to become financially independent and now our reality
is far from that, with an incredible debt in store for the future. This
alternative minimum tax is devastating to those affected in the modest-
income level, as well.
We thank Senator Grassley and others immensely for their efforts to
help right this situation. Please let us know if there is anything we
can do to assist you in this matter.
Statement of Michael Brown, Manchester, Michigan
To House Ways and Means Committee on Tax Reform:
I am an average middle class American living in Michigan (District
7) and working in the high tech computer industry. I have been employed
by Network Appliance for over 7 years. Upon my hiring, I was granted
ISO stock options as part of my compensation package. During the
internet boom in the stock market, my ISO stock options had a
theoretical paper value of approximately $2M. I never saw this money
due to the dramatic rise and then crash of the stock market valuations.
In the year 2000, I had income of $100,000.
However, when my accountant calculated out what I owed due to AMT,
the amount equaled $371,000 . . . 371% tax rate. This is due to
unintended consequences of the AMT laws and over-inflated valuations of
stock which created phantom gains. Furthermore, this was exacerbated by
the dramatic crash of the stock market. I was absolutely certain the
accountant was wrong, because how could tax rates exceed my entire
income! I checked with many attorneys and tax accountants to find that,
in fact, the accountant was correct and it was due to a little known
tax called Alternative Minimum Tax, which is basically an interest-free
loan to the government that gets credited back to you at $3,000 per
year.
So, I entered the paperwork that says I owe $371,000, however I did
not have the money, nor do I have it today. In, fact that stock that
was valued at $150 per share was now trading at $5 per share and my
option price was $4.28 per share. So, my stock value that was left was
less than $10,000. As you can see the AMT is not working the way it was
intended. I conducted a lot of research into the tax, the history, and
joined an organization that is made up of many other hardworking,
honest taxpayers that this has affected.
What I found was very interesting. The root development of the AMT
was due to 155 taxpayers in 1968 that made over $200,000 and paid zero
tax. I can completely understand that something had to be done, however
what really confuses me is how in the year 2003 over 4000 people made
over $200,000 and paid zero tax!!! Obviously, the AMT is not the way to
address this loophole these folks have found. My wages are currently
being garnished by the IRS and I am only allowed to take home $332 per
week. I am borrowing money weekly to stay afloat financially and going
into more debt by the day . . . My life is being destroyed by a huge,
unfair tax burden and since I am also raising 2 children, I am barely
able to buy them groceries, let alone put money away for their college
education.
I have filed for an installment agreement with the IRS and that was
denied. I have filed an appeals with the IRS and that was denied. I am
currently looking for help in any fashion to pay the IRS a reasonable
amount to move on and get on with my life. When the accountant did my
taxes without AMT for 2000, the tax would have been $10,000 extra over
what I paid thru the year. However, even when I offered to pay the IRS
$1,000 every month for the next 7 years, ($84,000) they refused and
continue to take my paychecks except the $332 per week they think I can
live on. Please support reforming AMT especially with regards to how
ISO stock options are treated. http://www.reformamt.org Thank you.
Reston, Virginia 20194
June 21, 2005
Although Congress has responded to many of the corporate fraud
problems brought to light by incidents at WorldCom and others and the
relationships between corporations and Investment Banks Congress has
not yet addressed the impact on taxpayers who subsequently faced
excessively high AMT bills with no means of satisfying their debts. I
was an employee of WorldCom and this is my story.
Smith Barney (who had obvious conflicts of interest because it
owned a great deal of WorldCom stock and had a ``too cozy''
relationship with WorldCom executives while managing the employee stock
program) urged me and other employees to hold our WorldCom stock at all
costs. Smith Barney did not offer us diversification and collaring
strategies; in fact it actually discouraged such practices. Jack
Grubman, Smith Barney's now infamous former telecom analyst, constantly
barraged us with reports.
Even as the stock slid with other telecoms (long before the massive
fraud and lack of regulation about Corporate/Banking relationships
became known), Smith Barney and WorldCom inundated us with information
encouraging us to continue holding our WorldCom stock and simply borrow
against it with margin loans.
I was originally a UUNET employee and that was who granted
incentive stock options to me. MFS bought UUNET and then WorldCom
bought MFS. I exercised options for a dollar or so even though WorldCom
stock was trading significantly higher than that. I didn't know about
the AMT and followed the advice I received to hold the stock for a year
to pay a lower capital gains tax. Of course, the rest is history. The
stock started to fall along with the tech market, but eventually
crashed completely due to the fraudulent activities that are now
legendary.
I never saw any money from the stock and now I have spent years
dealing with the IRS which wants to collect over $240,000 (taxes,
penalties, interest from 1999) on money I never had. The ``gain'' was
simply in my account as WorldCom stock. Between tech layoffs and job
searches, I have managed to earn enough money to pay untold thousands
in ``legitimate'' taxes and have had the IRS take my refunds every
year. So far, I've paid about $70,000 or so towards this bill, which
was originally about $165,000, but with mounting penalties and
interest, I still owe much more than I did originally.
So many taxpayers were caught in the AMT/ISO trap, but the
government makes so much noise, continues to prosecute, and passed
regulations to supposedly punish the evildoers and protect the
taxpaying citizenry, but the government seems to have missed this
point. Many of us are now suing WorldCom and/or Smith Barney, but it
would really help if the government provided some AMT relief for
victims of corporate fraud.
The way the AMT is interacting with ISOs is squashing innovation.
Along with some other ex-uunet'ers, I recently founded a startup. Our
tech jobs proved unstable, our 401(k)s were wiped out and all other
accounts were liquidated. Luckily, with the appreciation of our homes
and low interest rates we were able to borrow against our last assets
to start a business in June 2003. Money is tight and the road is rough
but we continue to strive to build a company to give people jobs which
would actually increase the tax base far beyond what would be taken in
by ruining us.
However, so many facing AMT/ISO problems can't start their own
business. You can't borrow money when the IRS puts liens on your credit
report and it's hard to concentrate with the knocks at the door to
receive the latest registered mail from the IRS constantly threatening
to seize all you have left.
Quite frankly, it seems un-American. The AMT is crushing a very
innovative segment of American society by devastating these (more often
than not) technology-savvy folks who are caught in a situation that was
not their fault. Will they want to try again? Will they be able to?
Congress should amend the law to afford relief to individuals who,
like me, not only lost their investments, but their jobs as a result of
corporate fraud and still face huge AMT liabilities or who have useless
credits on their AMT account. Again, it just seems plain wrong, and
defies common sense and fairness, to ask victims of fraud to pay a tax
on a future capital gain that will, most likely, never materialize.
Paying tax on money you never made is just wrong, is it not?
I am currently being told by an IRS agent (who has come to my house
to tell me such news), that they are going to seize my home. I have met
with them and nothing changed. They seem unwilling, or unable, to work
anything out that would allow me to keep my home and not disrupt my
business as we work out of the home as well. All I got were flippant
comments like, ``didn't it seem to good to be true?'' etc. alluding to
the stock gains of the tech bubble. Actually, I agree. It did seem too
good to be true which is why I was positioning to sell the stock before
the bottom fell out. My only option seems to be selling my home,
completely disrupting my family and business, and/or accepting a
payment plan that allows me a ``living wage'' that is nowhere near the
realities of even renting an apartment in the greater Washington, DC
area.
Thank you for your consideration.
Bill Bullock
WCKV-TV
Clarksville, Tennessee 37040
June 10, 2005
Dear Ways & Means Committee,
As the owner of a small business I have studied the various
alternatives being proposed to reform our tax system. The FairTax
proposal (HR 25, S 25) is the only one that clearly, simply, and fairly
provides the best solution. I have looked for the loopholes in the
FairTax and I cannot find them.
Furthermore, as a first generation Minority, I have come to
appreciate how the FairTax takes care of those at the lower end of the
income spectrum. Additionally, as one who diligently pays his fair
share of taxes, I am most excited that the FairTax would finally
capture taxes from those who currently cheat the existing IRS-based tax
system.
Please seriously consider approving the FairTax so we can free our
economy to be competitive in the world as well as providing for the
needs domestically.
Thank you for your diligent consideration.
Sincerely,
Dan Calderon
President
Statement of Tim Carlson, Coalition for Tax Fairness, Arlington,
Virginia
The Coalition for Tax Fairness first would like to thank Chairman
Thomas and the Ways and Means Committee for the opportunity to present
the urgent need for legislation addressing a tax crisis caused by the
Alternative Minimum Tax Treatment of Incentive Stock Options.
The Problem
Tens of thousands of American families are being financially
destroyed by tax rates exceeding 100%--and reaching as high as 500% or
more--of their entire income. These Americans belong to the
hardworking, entrepreneurial group of workers that are the engines of
the U.S. economy. They were caught in the ``Perfect Storm'' of events
in early 2000, trapped by a complex, unintended anomaly in the tax code
that subjected them to colossal taxes on phantom ``income'' they never
will receive.
Engineers and administrative assistants owe $200,000 or more, and
mid-level executives owe $1,000,000 or more on stock on which they
never saw financial gain. It is almost unbelievable this is happening
in America.
The Irony
These Americans are being driven into bankruptcy and ruin as a
result of:
an element of their compensation, incentive stock options
(ISOs), that was intended to reward their hard work, sacrifice, and
investment in their company;
their honesty in reporting a tax element on phantom gain,
that the IRS cannot independently discover or track (those who didn't
report are paying nothing);
their compliance with SEC insider trading laws and
company ethics policies;
their decision not to sell inflated stock and foist
losses on the unsuspecting public;
the AMT--a tax provision that was intended to ensure the
ultra-rich paid some tax;
a tax provision that didn't contemplate the effects of an
economic meltdown.
The Tax Code Complexity and Resulting Unfairness
While one can argue that many provisions of the AMT create
unfairness and undermine confidence in the tax system, by far the most
severe and devastating impact to individual taxpayers has occurred as a
result of the AMT treatment of incentive stock options. The complex
interaction between the incentive provisions of the regular tax code
and the prepayment provisions of the AMT code as applied to ISOs
created a crisis of unfairness in the economic meltdown of 2000.
Taxpayers who followed the incentives Congress put in place, worked
hard and invested in their companies, and followed the law, are being
forced to pay tens of thousands, hundreds of thousands, and even
millions of dollars in taxes based on phantom income, literally ruining
them financially.
In normal economic times, the ISO provisions of the regular tax
code and AMT code interact awkwardly, but in general balance the
competing incentive and prepayment goals. However, in the challenging
economy of early 2000, the conflicting provisions became a volatile mix
that trapped, destroyed and is continuing to destroy tens of thousands
of American taxpayers and their families, impacting hundreds of
thousands of people and hundreds of companies. The tax prepayment
provisions of the AMT levied on phantom income are forcing taxpayers to
make gargantuan, permanent interest-free loans to the government.
Those who cannot sell other assets, or borrow by leveraging other
assets, to fully pay these excessive taxes are driven to bankruptcy;
many have quit working altogether as they face decades of what amounts
to indentured servitude to the IRS; those who are working are having
huge portions of their income taken by the IRS to prepay taxes they'll
never really owe; others have fled the country. All these significant
tax overpayments create useless AMT ``credits'' that will never be
recovered or returned in the taxpayer's lifetime. People's financial
lives are destroyed, as they lose their homes, retirement accounts,
education accounts and future income, solely to build up massive tax
overpayments that trickle back a maximum of $3,000 per year.
Distortion of Business and Personal Decisions and Congressional Intent
Congress created incentive stock options as a tool for businesses
to attract and retain talented employees, and to provide employees an
incentive for long-term investment in companies. To that end, ISOs were
not taxed upon exercise (unlike nonqualified stock options) and
employees receive the long term capital gains rate if they hold the
stock at least two years from date of grant and one year from date of
exercise.
The AMT, however, imposes a ``prepayment tax'' upon exercise that
generates a credit offset on expected future gain. The critical
failings of the current AMT model lie in the fact that (i) the AMT code
did not contemplate the possibility of a major decline in stock value
between exercise and the expiration of the ISO holding period, (ii) the
AMT code did not provide for a proper ``true up'' of credits to actual
tax owed upon sale, especially when the value at exercise greatly
exceeds the value at sale, and (iii) the prepayment rate (28%) was not
synchronized with the current capital gains rate (15%), forcing
employees to generate overpayment credits even when the stock maintains
its value between exercise and sale.
The inconsistencies of these provisions in the current tax code are
resulting in the following undesirable distortions of business and
personal decisions:
businesses have lost a key component of entrepreneurial
incentive as employees are viewing ISOs as a ``trap'' rather than a
reward for hard work and investment in their company. (In a Select
Revenue Measures Hearing September 2004, Chairman Jim McCrery responded
to Rep. Zoe Lofgren's statements regarding this ISO AMT crisis by
stating ``incentive stock options [] are around in your district, but
certainly everywhere across the country, that is a tool that companies
can use and they want to use; and employees like it, so we ought not
discourage the use of that through the tax treatment on the alternative
minimum tax.'');
employees who exercised incentive stock options in the
past have virtually all their financial decisions distorted by ISO AMT,
as they are borrowing and selling assets to prepay tax on money they
never will have, quitting work because they cannot earn a living with
the extent of wage garnishment from the IRS, and losing the retirement
assets they worked their entire lifetime to acquire;
employees who were able to pay their ISO AMT taxes and
now have huge AMT credits, are spending thousands of dollars with
accountants and financial advisors to try and manage their financial
affairs to get some of these massive overpayments back in their
lifetime;
employees who have incentive stock options now are either
not exercising them at all, or are exercising them and immediately
selling to avoid being trapped and financially destroyed--just the
opposite of what Congress intends;
employees who receive incentive stock options do not view
them as a benefit and encouragement to build value in their company,
but rather as a dangerous trap that should be either never exercised at
all or sold immediately upon exercise;
the IRS is spending tremendous resources fighting
taxpayers in offers in compromise, Tax Court, District Court, Appeals
Court, and Bankruptcy Court in attempts to collect unfair taxes from
people who have no money with which to pay the disproportional tax;
this is neither an efficient use of resources, nor is it right.
The Critical Need for a Timely Solution
This crisis began for many taxpayers in 1999. Those honest
taxpayers who reported their ISO AMT ``income'' and trusted in the
system to work to bring about some measure of fairness, have been
sorely disappointed. The IRS has refused to grant any offer in
compromise unless it is based on ``inability to pay,'' meaning that
hardworking Americans trapped by this unintended result are losing
everything they have ever worked for their entire lives--and also
having their future wages garnished. The Tax Court recently affirmed
the IRS's refusal to consider fairness or proportionality, stating that
Congress must be the one to fix this problem. As a result, these honest
Americans who have done nothing wrong, are being treated as tax dodgers
or tax avoiders, in spite of having overpaid tens of thousands,
hundreds of thousands, and millions of dollars in taxes.
After four years of struggle, the appeal process for these
taxpayers is now coming to a close, and these hardworking Americans are
on the brink of financial ruin. If immediate action is not taken this
year in 2005, the solution will come to late to prevent loss of homes,
retirement savings, education accounts--all due to an unexpected and
unintended result of a complex tax code applied to an unprecedented
time of economic crisis.
These Americans Are Only Asking for Fair and Just Treatment
These Americans have worked hard and lost everything. They are not
asking for a return of the value they lost--they are merely asking not
to be destroyed by being unfairly taxed on money they never received.
They have waited more than four years for relief, borrowing money to
prepay taxes on phantom income, paying high interest rates so they can
lend that money interest-free to the IRS, following the laws and
working within the system to try to bring about justice, all the while
facing imminent financial ruin.
This issue has been highlighted as a critical taxpayer issue in,
among others, the following venues:
The June 2004 Ways and Means Oversight Subcommittee
Hearing
The September 2004 Select Revenue Measures Subcommittee
Hearing
The National Taxpayer Advocates 2002, 2003 and 2004
Reports to Congress
Numerous Bi-partisan House and Senate Bills in the 107th
and 108th Congresses
Countless newspaper and magazine articles over the last
four years
CBS Broadcasts the last two years highlighting the Speltz
family from Iowa, (destroyed by an over $200,000 ISO AMT tax bill on
stock sold for a loss).
The Coalition for Tax Fairness thanks Chairman Thomas and the Ways
and Means Committee for the opportunity to present the urgent need for
legislation addressing the ISO AMT tax crisis. CTF urges the Ways and
Means Committee to support much needed immediate relief for these
American taxpayers trapped by a complex tax provision and subjected to
an unintended, devastating, and unfairly disproportionate taxation
caused by the AMT treatment of incentive stock options.
New York, New York 10016
June 20, 2005
Dear Chairman Thomas and Committee Members:
I incurred a devastating Alternative Minimum Tax of over $125,000
when I exercised options in my employer, whose stock became nearly
worthless before I could sell my shares. It was my first ever stock
option exercise and even though I was in a finance profession, I was
unfamiliar with the details of AMT and how it worked. I have since
found that few tax practitioners have a good working knowledge of AMT
either. Those who do seem to universally abhor it due in part to its
complexity, but more importantly due to the way it imposes cash taxes,
often astronomical taxes, on gains that only exist on paper and may
permanently evaporate before any realization occurs. Even in cases
where the ultimate loss realized is total, the present AMT code
perversely compounds the loss because most or all of the taxes paid on
the paper gain can be impossible to recover. This of course is a severe
and blatant violation of any principle of fairness the tax code may
otherwise strive to achieve.
I exercised my options in December 1999 with the intent of selling
the stock after my company announced earnings in February. I exercised
early because (a) my company's captive broker did not reliably execute
trades in a timely manner; (b) I had time to do the exercise and
account setup paperwork and I knew I would have very little time after
the end of the year; and (c) even as a finance professional, I never
suspected AMT would have such a hugely devastating, unfair effect--
taxing me on gains I never actually realized.
I didn't realize that by exercising in one calendar year and
holding the stock for sale just a short time later, but in a different
calendar year, I was automatically subjecting myslf to AMT. By the time
I should have been able to sell, my company prohibited me from selling,
and I was stuck with the stock, which was rapidly diminishing in value.
I had exercised the options on margin, and to pay off the margin debt I
had to sell my house.
AMT turned what could have been just a lost opportunity to make
money on stock options into a devastating, life-changing event that
gutted my savings and cost me my home. All this to pay tax on phantom
gains that had evaporated by the time I filed my income tax return the
next year. This is truly the most twisted, broken, and unjust aspect of
the tax code.
Craig Chesser
Foster City, California 94404
June 8, 2005
To the Honorable Members Ways and Means Committee:
Thank you for giving me the opportunity to write to you concerning
tax reform. Specifically, I would like to address the Alternative
Minimum Tax.
My name is Jeffrey Chou, and I have a wife and 2 daughters--one is
4 years old, and the other is 1 year old. We currently face an AMT
bill, from exercising Incentive Stock Options, which is greater than
all our assets.
In 1996, I left a secure, stable job at a large company to help
start a communications company as an engineer. My compensation
consisted of an annual salary of $80,000 and Incentive Stock Options.
Cisco Systems eventually acquired us. It was a happy time for my
family, thinking that my hard work in helping to build a company would
finally pay off.
In 2000, we decided to exercise my stock options, and were advised
to hold the stock for 1 year. We did not and do not live extravagant
life styles. We live in a 3 bedroom townhouse--I drive a 1997 Toyota,
and my wife drives a 1998 SUV. We have good credit and have always paid
our taxes in full and on time. In April 2001, following my exercise of
the Incentive Stock Options, we faced federal and state taxes of $2.4M,
more than 6,000% of our normal income tax and more than everything we
owned. We also faced an ethical and moral dilemma. As we sought
professional help to deal with this tax liability, several CPAs advised
us not to comply with the law--to simply omit reporting the exercise
and the tax. We discovered that the AMT on exercising stock options is
a self-reported tax. Many of my friends and colleagues took this
approach, did not report their exercise of stock options, and to this
day, live happy lives.
However, we decided to ``do the right thing'' and comply. We had
faith that our country, in return, would also ``do the right thing''
and not ruin its honest tax payers. Since then, the IRS has sent us
threatening letters, placed a lien on our names, attempted to levy our
accounts, and actually visited our house demanding payment. The IRS
rejected our Offer In Compromise and we appealed. The appeals officer
admitted to us that our offer was in good faith and was reasonable, but
that he still could not accept it. Today, we are in IRS collections.
I do know that those who did not report are certainly glad they
didn't. And I also know that among the many honest people I have met
over the last 3 years whose situation is similar to mine, few or none,
if faced with the same choice, would comply again. Why volunteer for a
100% guarantee of ruin, when you can win the audit roulette 99.9% of
the time? My friends, if caught, will simply claim ignorance of the
law. I am told it will be hard to prove that they were not ignorant of
the law given how many tax experts are unaware of the consequences of
the interaction of the AMT with Incentive Stock Options.
You may ask ``Why didn't you sell?''
We are not sophisticated investors. I am an engineer; and my wife
is a stay-at-home mom. We listened to advice that told us to hold for 1
year. At the time, I had no knowledge of diversification or hedging
strategies. I worked 12 hour days trying to build products and meet
schedules. At night, I returned home to help my wife with our new born
daughter. That was my life. In addition, our CEO, all throughout 2000,
even as late as December, kept touting Cisco's optimistic future,
saying ``we will be the most powerful company in history'', ``we are
growing 30 to 50% every year'', and ``we are breaking away from our
competitors.'' At the time, he was never wrong before, so I felt no
sense of danger for my job, for my company, or for the stock. I had
faith in my company and its leaders.
I sincerely ask Congress to help those in my situation. We are all
honest tax payers who want to do what is right for the country. Most of
us are hard working Americans who helped build a company and who wanted
to remain part of that company instead of ``cashing in.'' We also want
to pay our fair share of taxes--but please tax us like any other
investor--tax us when we realize our gains, not on what we might have
gained.
I believe things happen for a reason. If I can be a small part in
helping to correct this injustice, the faith I have in this great
country is justified.
This is the highest priority of my life. Please do not hesitate to
contact me any time for any reason.
Thank you.
Jeffrey Chou
Durham, North Carolina 27705
June 20, 2005
Dear Chairman Thomas and Committee Members:
My name is John Cole, and I am writing to you to share my story of
a severe problem related to the Alternative Minimum Tax (AMT) and the
way it is has been applied to employee stock options. If you will bear
with me I would like to begin by providing some personal background
information.
I was born in 1958, and grew up in Durham, NC. In 1977 at the age
of 19 I moved to the San Francisco Bay Area, and for the next dozen
years had a variety of blue collar jobs including home construction,
cooking and waiting tables in restaurants, and working for moving
companies. In 1989 at the age of 31 I went back to California Community
College where I studied Computer Science for two years. When I was 18 I
had attended College for 1 year, but had no clear direction and did not
do well, which ultimately led to my withdrawing from school and heading
West. However, the second time around I was highly motivated and
extremely focused, and although I did not earn a degree I took 2-3
classes a semester while working, and maintained a perfect 4.0 average.
I was determined to provide myself with a solid foundation so that
I could break into the growing world of hi tech, but being over 30
years of age with no job experience turned out to be a significant
drawback: I applied for literally scores of entry level jobs and was
consistently turned down, most often without ever having opportunity to
interview with anyone.
Nonetheless I persevered and finally in March of 1992 was able to
land a job initially paying $10/hour with a small startup software
company, and over the next 3 years was able to grow within that outfit
to where when I left I was the Senior Systems Engineer, and was the
primary Technical Account Manager for many corporate customers which
had site licenses for our e-mail package, including several large firms
based in New York City, also Motorola and Ford Motor Company. It was
the norm during that period to work 70-80 hour weeks, but I loved it:
It was a period of tremendous personal growth for me, and coincided
exactly with the emergence of the Internet as a public phenomenon.
In January of 1996 I joined another software startup located in
Silicon Valley. As was common practice at that time as part of a
standard compensation package in addition to a base salary I was issued
a modest number of Incentive Stock Options (ISOs) which would vest over
a 4 year period. This was a model which allowed employees to feel they
had a stake in the company, and again I worked on average well above a
standard 40 hours/week, doing my part to help make the company a
success.
In May of 1998 the company was acquired by Cisco Systems, and my
startup options converted to Cisco options numbering roughly 3,000
total. A drop in the bucket compared to what management was issued, but
a very healthy number for a rank-and-file employee like me. And over
the next two years the stock split 2-for-1 twice, and 3-for 2 once, for
an effective 6X increase, bringing my ISO total to 18,000!
Due to the death of my sister after a long battle with cancer I
decided in March of 2000 to leave Cisco and take some time off, stay
close to home, and spend time with my mother, who was then 85. It just
so happened that my leaving Cisco coincided precisely with the high
water mark for the stock market, with the result being that the ISOs I
had to ``use or lose'' within 90 days triggered a huge paper gain which
ultimately resulted in over $225,000 in AMT liability. Unfortunately by
the time the tax came due in April of 2001 the value of the stock had
dropped by roughly 80% from its high point a year earlier, with the
result being my tax bill exceeded the value of the stock assets that
triggered it!
I never sold any of the stock, never had any money whatsoever pass
through my hands, never in any way benefited from owning the stock, yet
I was about to be wiped out simply from exercising and holding on to
what appeared to be an excellent investment in a very good company with
real products used by organizations of every kind worldwide!
I filed my year 2000 Federal return with an installment plan, but
it was rejected due to the large amount of the tax liability. I called
the IRS and attempted to expedite processing of my case, but was told I
was ``in the queue and would just have to wait to be contacted by
someone in IRS Collections''. For the next year while waiting for that
contact on my own initiative as a sign of good faith I made monthly
payments which ultimately totaled over $67,000 toward my pending tax
bill! Finally in late June 2002 I was contacted by a local Revenue
Officer who was unwilling or unable to discuss anything other than
collection of my assets, so I engaged a former IRS Collections Officer
practicing as an ``Enrolled Agent'' and submitted an Offer In
Compromise (OIC) in July 2002.
Cisco, Nortel and other large employers in the RTP area of North
Carolina had not only stopped hiring, they had laid off thousands of
workers, flooding the local job market with highly qualified job
seekers. The tech job market had completely dried up, and not for lack
of trying I had been unable to secure work. Save for a failed attempt
to establish myself as an independent consultant which resulted in only
a single paying job I remained largely unemployed for over 2 years and
my tax bill (which had grown due to penalties and interest) exceeded my
net worth by roughly 150%, yet my OIC was rejected at the field level
due to an insistence that I could pay it off in total!
I was actually told in a letter from the IRS Offer Specialist
handling my case that ``Mr. Cole has the ability to pay the taxes
outstanding in full and should withdraw his offer from consideration. .
. . no offer amount is sufficient, and no offer would be accepted''.
The Asset/Equity and Income/Expense tables the Offer Specialist used to
justify that claim contained several computational errors, but the most
egregious was that my ``ability to pay'' was substantiated by the Offer
Specialist counting my remaining Cisco stock asset both as a source of
ongoing monthly income, (to the tune of over $5,000/month), as well as
a lump sum asset. In other words, the stock was counted twice, with
ongoing income from it assumed after it was liquidated!!
My representative pointed out this flawed logic to the Offer
Specialist, but to no avail: The OIC was rejected at the field level. I
appealed, and after another 13 months the IRS Appeals office finally
accepted my OIC, but only after adjusting it to a dollar amount that
reflected my net worth at that time, with terms of 50% of the
settlement amount to be paid within 30 days, another 25% within 120
days, and the final 25% within 240 days. I was able to make the first
(50%) and second (25%) payments, but I have not been able to find more
gainful employment, and at this point am unsure exactly how I'm going
to make the final 25% payment, which is due mid August, 2005.
I filed and paid all my state and federal taxes for the last ten
years, and have no outstanding tax issues other than these problems
associated with ISO transactions from the year 2000. I was finally able
to find full time employment in August 2003, yet ironically back at
Cisco, working in a group which has been outsourced to a vendor which
pays less than a \1/3\ what I was making when I was previously a direct
Cisco employee. I am grateful to have the job, yet the income barely
pays my basic living expenses, and now on top of dealing with the final
OIC payment I'm also trapped in a cycle of credit card debt, with high
interest rates and monthly service charges. I have been trying to build
on being back in the tech workplace and find more gainful employment,
but to date have been unable to do so. I guess I'm one of the few lucky
ones who have been able to secure an OIC settlement, but at this point
it doesn't feel that way; I just don't know how I'm going to make ends
meet going forward.
The payments I made proactively toward my year 2000 tax bill and
the OIC settlement amount total up to about $180,000. Ironically, I
have an AMT Credit available which can offset regular income tax for
years to come, yet the IRS would not consider that credit as an asset
to be considered as part of an OIC settlement, and due to the
relatively small yearly income I make now I can't take significant
advantage of that credit. The one thing that could help me stay afloat
would be to return some or all of that AMT credit sooner. I implore you
to consider that avenue of relief.
Thank you for taking the time to consider my case, and of those in
similar situations.
Sincerely,
John Cole
Statement of Dorothy Coleman, National Association of Manufacturers
The National Association of Manufacturers, the nation's largest
industrial trade association representing small and large manufacturers
in every industrial sector, applauds current efforts to develop
proposals to reform the nation's tax laws. The U.S. manufacturing
sector accounts for about 13% of GDP and 11% of U.S. jobs. Because of
the importance of manufacturing to our nation's economy, NAM supports
the thoughtful consideration of an appropriate and timely path to make
the tax code fairer and simpler. In developing a tax reform plan,
policy makers should be guided by principles that will promote economic
growth and job creation.
To this end, the NAM recently adopted the following principles on
tax reform. These principles, which reflect NAM's long-standing
policies on fundamental tax reform, will serve as a framework for the
NAM to use in evaluating proposals and developments as the tax reform
debate moves forward. Specifically, any reform plan should:
Encourage savings and investment while minimizing the
double taxation of corporate earnings;
Include rules that permit U.S.-based manufacturers to
compete on a level playing field in the global marketplace;
Recognize the important role of research and technology
investment in the growth of U.S. jobs and innovation;
Eliminate both the individual and corporate alternative
minimum tax rules, which are inherently complex and unfair;
Strive to raise the required amount of revenue for the
government without distorting a business's decision to invest capital
and hire new workers;
Include broad and strong transition rules that provide
fair and equitable treatment for taxpayers who have committed
substantial resources based on current law;
Not result in a net increase in business taxes; and
Incorporate rules that make it easier for Treasury to
administer the law and for taxpayers to comply with the law.
Unnecessary complexity is not productive from an economic perspective
and undermines taxpayers' confidence in the fairness of the law.
Members of the National Association of Manufacturers believe that
the current tax code represents a major drag on our economy and look
forward to working with policy makers to move towards a simpler and
fairer tax code that promotes economic growth.
Statement of Joyce E. Curcio, Cumberland, Rhode Island
My name is Joyce Curcio and I am submitting this statement on
behalf of my husband, Matthew Curcio. We, along with so many others,
have been affected by the Alternative Minimum Tax and I would like to
share with you our particular story.
Matthew and I were living in San Francisco in 1998 when he obtained
a position with Biomarin Pharmaceuticals based in Marin County, CA. He
was a biochemist, earning roughly $50,000 per year. He also received
Incentive Stock Options (ISOs). The market was doing fairly well at
that time and Matthew thought about cashing in on some of the options.
He was advised by a financial consultant for the company to hold onto
the options which he did. Subsequently, the market took a large drop
and the value of that stock was lowered considerably.
When tax time April 2000 came along, it came as a shock when we
were told by our CPA that we now owed @$20,000 to the state of
California and @$60,000 to the Federal Government. How was it possible
to be taxed on so-called ``income'' that was never realized? We were
completely incredulous as to why this was happening.
We paid off the state to satisfy that debt. The IRS bill was
something we could not even fathom paying. We continued to receive
threatening letters, with warning of liens, garnishing of wages and
ultimate financial ruin. As long as we have been working citizens, we
have duly paid our taxes, every year and in full. However, this tax
seemed so unfair and unjust that we simply had to fight it. We
contacted a tax attorney and looked into the OIC program. Subsequently,
we moved back east to be closer to our families. Due to the move, as
well as the slow process of this negotiation, our case is still in OIC
in 2005. Our lives are literally at a standstill. We will owe a hefty
legal bill when all of this is resolved. We are not able to purchase a
home due to our this outstanding tax bill and our ``bad credit''. The
stress and strain this has put on ourselves is unimaginable.
Please, I urge you to take action and reform this outdated tax code
and lift the burden for so many hard-working American like ourselves.
Carson City, Nevada 89701
June 20, 2005
Dear Chairman Thomas and Committee Members:
I would like to take this opportunity to answer some of the
questions raised at the tax hearing.
How the ISO/AMT tax code affects compliance and your understanding of
the tax code
As reported in the Taxpayer Advocate 2004 annual report to
congress, section one, page 2, ``The Internal Revenue Code (IRC) now
consists of substantially more than a million words.``There are only
790,871 words in the bible (1611 King James Version), which is much
more readable than the IRC.
This fact alone demands professional assistance in tax matters. In
my attempts at reading the IRC, I came to realize that it's the result
of many years of tinkering--at times in the name of tax code
simplification, yet on each of these attempts, word count and
obfuscation have risen. Taxpayers who use professional assistance
assume those professionals both understand tax law and have the
taxpayer's interests at heart. But if that professional assistance
fails, it's the taxpayer who pays, and pays dearly.
In my case, I sued the CPA who masked my AMT liability, and delayed
the timely filing of my return. The lawsuit resulted in a substantial
settlement, in spite of the fact he wasn't paying his insurance
premiums. The CPA never completed my return. The lion's share of this
settlement was sent to the IRS. It only covered about \1/5\ the Federal
AMT liability.
With IRS interests and penalties, I'd expect the settlement to have
been consumed by now. All this to prepay taxes on income never
received, to generate credits I will never recover.
The State of California has an AMT as well. My home was forced to
sell to satisfy that liability in order to pay huge taxes on the
phantom gain.
I reported my ISO/AMT liability, after moving to a new CPA and
having that number computed. I could have chosen not to report the
phantom gain, as some have done. Instead, I reported the liability as
required, and was immediately sent to collections.
My first Face to face meeting with the IRS was staffed by a
collections agent. In that face to face meeting the agent stated ``I
hope you have relatives with money who are going to die soon.'' I have
NEVER sought a face to face meeting since then. This is happening to
hardworking, honest taxpayers.
The fact of the matter is that IRS Collections agents do not set
tax policy. Thus, they are a poor choice for a face to face meeting
over liabilities resulting from flawed tax policy.
How the ISO/AMT tax code distorts your financial economics and
incentives
Given the result of my experience, I find it difficult to put any
further trust in Incentive Stock Options, because what should have been
an incentive for me to make my company successful has quite literally
destroyed my life. Why would I repeat the experience?
The tax code, mixed with prevailing market conditions, timing of
IPO's, blackout periods and so on, presents a Hobson's choice for the
taxpayer, for example:
IRC sec. 422 permits companies to issue ISO's to employees, and if
the employees meet sec. 422 holding requirements, they will qualify for
the lower long term capitol gain rate.
IRC sec. 83 Taxpayers exercising ISO's must claim the fair market
value on the date of exercise, even if those taxpayers are legally
prevented from selling the stock for an extended period.
IRC sec. 56(a)(3) states that the spread between a stock's fair
market value and its exercise price is a tax preference for AMT
purposes.
For a full description of the interplay, and further background,
see www.taxprophet.com/hot_topic/August_02.shtml
How the ISO/AMT tax is a burden
My continuing status of being a tax debtor, and the uncertainty of
my situation have had a most damaging effect on my ability to generate
an income. Homelessness doesn't help either.
Charity is out of the question. Does this kind of tax policy and
enforcement promote homeownership, saving, job creation, investment and
competitiveness in America? Absolutely not
Unfortunately, as I have discovered, it can cost 20 years of an
individual's efforts and a 20 year marriage. In essence, my life has
been destroyed by a huge, unfair tax burden. As I write this, I'm
beginning the process of bankruptcy, which is something I never wanted
to do, yet I'm being forced to as a result of this situation and the
upcoming change in bankruptcy laws.
I would hope that congress has the wisdom to bring some sanity and
morality to the IRC, to make the IRC and indeed the entire tax system a
more transparent, balanced and fair system to the benefit of both
taxpayers and the government.
Once again, I would like to thank the Honorable Chairman William M.
Thomas and House Ways and Means Committee for this opportunity to make
my individual experience known. Please do not hesitate to contact me if
you have any questions.
Respectfully,
Steve Daniels
Statement of Eric Delore, Alameda, California
Dear Chairman Thomas and Committee Members:
I owe $420,000 of Alternative Minimum Tax (AMT) on under $5,000 of
actual income derived from the sale of frightfully deflated Incentive
Stock Options (ISOs), and the IRS's aggressive and disorganized
collection activities threaten to destroy my peace of mind and ruin my
family. I am not wealthy. I am a middle-classed citizen struggling to
raise a family on a single income.
I have already paid the IRS $37,000 of taxes, but they want more.
They want everything. One collection agent suggested that I sell my
home and give them all the proceeds. Bear in mind that by raiding
various immediate and extended family bank accounts, I have already
paid the California State Franchise Tax Board $100,000 of AMT tax on
this same $5,000 of income. That is almost $140,000 of taxes paid to
date.
Like many technology professionals during the dotcom boom years, I
exercised and held unvested ISOs from my company, Commerce One, so that
the long-term capital gains tax period would run concurrently with the
vesting of the stock options. This way, by the time the shares fully
vested, I would be able to sell them and pay the lower long-term
capital gains tax rate. However, the value plummeted while they were
vesting and insider trading rules periodically restricted me from
selling the shares that vested along the way. At exercise, the ISOs
were worth 1.1 million. By the time I was able to sell the shares, they
were worth under $5,000. Disastrously, the outdated and onerous AMT
code forces me to pay taxes on the value of ISOs at the time of
exercise, 1.1 million dollars, not at the time of sale, less than
$5,000.
I hired tax attorneys, and we made two Offers In Compromise (OIC)
to pay the IRS an additional $100,000 of taxes. They rejected both
offers, one without comment and another time because between the time
we made the offer and the time they responded, almost six months, the
value of my house had increased and they wanted that equity, too.
We then were thrust into the jaws of the Automated Collection
Service (ACS). The IRS cleaned out my bank accounts and intercepted my
paychecks twice. They have also intercepted my state and federal tax
refunds since the year 2001. My employer, Commerce One, then declared
bankruptcy and laid off almost all of their work force, including me.
At that point, the ACS decided to have me make another OIC, despite the
fact that another IRS agent had told us that it would be impossible for
us to submit another OIC. We submitted all the OIC forms and waited for
months. After several months, we received a notice from a specific IRS
agent, asking us to resend much of the same information and to
correspond only with him. We submitted the information again and waited
months again. After several more months, we received a letter from a
different IRS agent asking us to resubmit much of the same information
and to correspond only with her. We just resubmitted and are hunkering
down for another several months wait. If the IRS rejects this OIC, this
leaves only bankruptcy available to me, which basically amounts to, ``I
quit, come and sell everything I own to get your money.'' This would be
a very hard step for me to take, considering that I have paid all my
other taxes on time and I do not have any other debts aside from my
mortgage.
The effect of this AMT debt on my family has been terrible and
pervasive. I am on the brink of bankruptcy. I am on antidepressants to
dull the clinical depression and dark thoughts triggered by this
situation. I love these United States of America and I do have
confidence in our government, but this situation has spawned in me a
deep and, perhaps, irrational loathing of the IRS and State tax
agencies that I struggle every day to mitigate and overcome. This
loathing infects my every night's sleep, thought, decision, and
familial interaction.
Headaches, unnecessary complexity, and burdens that taxpayers--both
individuals and businesses--face because of the existing system
AMT Tax--Forces taxpayer to compute taxes twice for
regular income and AMT income. Hard to understand how to compute this.
Places unfair burden on average taxpayers to render tax on huge phantom
gains resulting from the early exercise and holding of ISOs.
OIC Process--Lack of continuity. Slow response times.
Often deal with different agents along the way who need months to come
up to speed on each case.
Tax code--Too complex. Requires accountants to complete
all the forms.
IRS Coordination--Had to inform IRS several times we had
a power of attorney on file and not to contact us directly. One such
instance resulted in the levying of all our money that we had to foight
to reverse.
Aspects of the tax system that are unfair
AMT on ISOs--Requires taxpayer to pay huge taxes on
phantom gains realized at the exercise of ISOs rather than at the sale
of the associated vested stocks. AMT credit policy is laughable. The
amount the IRS refunds every year is so small that only a taxpayer with
a life expectancy of 500 years could ever hope to recover the entire
AMT credit.
OIC Process--IRS refusal to accept OICs based on
Ineffective Tax Administration claim when the claim arises from AMT on
ISOs is unfair. Prolonged OIC process results in increased interest and
penalties assessed against the petitioner.
ACS--Unfair to levy bank accounts and salary after
leaving a cryptic message on an answering machine, such as, ``This is a
message for Eric Delore. Please call me at xxx.xxx.xxxx regarding case
number xxxxxx.''
Specific examples of how the tax code distorts important business or
personal decisions
Because of the AMT on ISOs and the unfair and
unpredictable associated IRS processes, we have avoided starting a
business because we fear the IRS would just take all the money we made
anyway, and postponed having another child because we thought we'd bee
too poor to afford it and we can see the effects of this situation on
our two young daughters. They haven't had vacations in years because we
did not want the IRS to assert that if we can afford vacations, then we
could afford to pay them 400k. We also feel that Tax law compliance is
a risky choice. I voluntarily informed the IRS that I had early
exercised ISOs. The unfair nature of the IRS treatment of AMT on ISOs
may compel otherwise law-abiding citizens towards non-compliance.
Goals that the committee should try to achieve
Fair and Simple--Simplify tax code. Repeal AMT tax laws.
Adopt a flat tax or Value Added Tax (VAT).
OIC for AMT on ISOs--Allow claims of Ineffective Tax
Administration
Retroactive remedy--Forgive tax AMT on ISOs tax debt for
those people affected by the dotcom stock crash.
Statement of Thomas Dudley, Andover, Massachusetts
Dear Chairman Thomas and Committee Members: My name is Thomas
Dudley and I am writing on behalf of myself and my family. We
appreciate this opportunity to discuss the burden and unfairness of the
ISO/AMT tax and the specific impact on our family.
Much as an individual who has been scammed by unscrupulous workmen,
I am embarrassed and very hesitant to speak about the specific
financial impact on my family. My family supported my decision to leave
a secure job at a large company to pursue a goal of financial
independence that might be possible through diligent efforts building a
small company. We gave up family vacations, weekends and evenings
together, had the disruptions of two moves and mounted financial debts.
We thought the hard work and sacrifices finally paid off when my
company (CoreTek) was acquired by Nortel Networks. Suddenly, the
incentive stock options (ISOs) became quite valuable and our ``paper''
wealth was beyond anything we could have imagined. The newfound wealth
was welcome, but also scary. We hired a financial advisor and an
accountant to guide us through the process of exercising the options
and managing our money. Without experience, we followed their advice,
with the exception of large donations to charity and gifts to parents
to allow them to retire. We made decisions on donations and gifts
without consideration of the tax consequences because it was the right
thing to do.
I felt that I had obligations to the acquiring company and believed
that if I worked hard for the success of the business, everything else
would fall into place. I thought the advice of my advisors was sound
and I agreed to exercise and sell approximately 38% of the available
options at $80 per share in July 2000, which provided me with sizable
real wealth. The balance of the options were exercised at the same
price and held. At the time this appeared to be a very sound financial
plan.
The financial plan began to unravel as I learned of the tax
consequences in early 2001. I was prepared to pay income tax at the
highest marginal rate on my substantial year 2000 income which was
driven by the exercise and sale of the stock options. I was not
prepared for the shock of the alternative minimum tax on the ISOs that
were exercised and held. Again, I prefer not to share exact dollar
amounts, but we ended up paying over 90% of year 2000 income in federal
taxes and over 100% when state and other taxes were included. Because
of the distortions of the large income in year 2000, I estimate that we
have paid between 65% and 70% of our lifetime earnings since 1974 in
federal income tax and higher if other income taxes are included. To
add insult to injury, the alternative minimum taxes we paid were on
paper profits that no longer existed, as Nortel Networks stock had
fallen to below $13 per share by the time year 2000 income taxes were
due and eventually went to a low of under $0.50 per share.
I'm thankful that I was able to walk away from the experience free
of debt (except for a mortgage), and I left Nortel with an excellent
reputation for integrity. The payoff for all the hard work never did
materialize and we have a large AMT credit that will probably never be
realized. I'm still paying a mortgage, struggling to make tuition
payments for two daughters and am working out of state and commuting
home on weekends in order for my wife, who is battling cancer, to be
able to continue treatment with her current set of doctors.
I'm comfortable paying my fair share of taxes, but the alternative
minimum tax is one that penalizes hard work, success, and what
otherwise would be considered sound long term financial planning. The
complexity of the tax is mind-boggling and I'm not sure that I
completely understand all the details of the alternative minimum tax
even today.
I request that you consider changes to the tax code to eliminate
the alternative minimum tax and to right the wrong to those who met an
unfair tax burden through the exercise of incentive stock options.
Thank you.
Lawrence, Kansas 66046
June 20, 2005
Dear Chairman Thomas and Committee Members:
My name is Jeff Eden, I am recently married, have been severely
affected by the AMT law and I want to share my story with Congress.
My AMT issue resulted from the exercise (purchase, not sale) of
incentive stock options for Critical Path in August 2000. I was laid
off from my job and had to either exercise my options or lose them.
They were one of the only retirement vehicles I had ever had and I had
worked very hard (60+ hours per week) for several years to vest the
options, so I exercised them thinking they would serve as a nice nest
egg for my future family. My broker advised me to hold the stock for a
year for long-term gain purposes.
Then the stock market crashed in early 2001. Unknown to me (and
apparently tens of thousands of other people), under the current AMT
law a taxpayer who exercises incentive stock options are required to
pay a tax on the VALUE of the stock the day it is exercised (purchased,
not sold) even though income has not yet been earned (they had yet to
be sold). I used the only savings I had to exercise (buy) the stock and
I was not aware of the AMT tax until my return was prepared in March
2001. I ended up owing more than $80,000 in AMT to the IRS and over
$10,000 to the State of Colorado for a stock purchase that actually
resulted in a loss (I paid more for the options than I could sell them
for). The IRS was asking for money I did not have, for income I never
realized since it was all on paper and was now nearly worthless.
Up until the AMT problem I have paid my taxes on time and in full
my entire working life. I am a hard working person who has been dealt a
tremendous blow from a tax law (AMT) that even the IRS recognizes is
flawed.
I have had to borrow money from family members, drain my savings
and re-mortgage my home to pay my AMT tax liabilities (including
substantial interest and penalties) in Colorado and to the IRS. In
total, I have paid over $100,000 with my life savings and borrowed
money to pay my AMT liabilities. I borrowed for and paid my tax
liability as quickly as I could because I didn't want to be in trouble
with the IRS or the State of Colorado. I was hoping my only recourse,
the Offer in Compromise system, would somehow correct this inequity.
In the summer of 2003, after two years in the IRS Offer In
Compromise system (two full years with interest), bounced between 4
offices across the country, over 50 hours of calls, meetings, re-
submissions (four times) of personal and financial data to the IRS,
over two thousand dollars in legal and accountant fee's and after I had
paid my principle tax liabilities in full, the IRS rejected my OIC that
I filed under the Effective Tax Administration rule. I was totally
shocked because I thought if there ever was a reason to claim the need
for Effective Tax Administration, my AMT problem was it. Two years
later I am still shocked by how unfair this whole problem has been and
I'm left without much hope to recoup my life savings.
I will spend the next 10 years paying back the debts I incurred to
pay the IRS for this flawed law and not saving for my own family's
future. The AMT law has cost me so much more than the $100,000+. It has
broken me mentally. Please imagine having to go, hat in hand, to family
members to borrow such large sums of money for taxes that should never
have been levied. This has affected them as well and my relationships
with those who lent me the money. It has been horrible. It seems
terribly unfair.
I would like to see the AMT laws changed. I would like Congress to
consider those of us who have paid the IRS for this flawed law and
figure out a way to allow us to recoup the money we have paid in to
date. I have an $80,000 plus credit with the IRS, but the AMT law says
I can't really use it. It will take me over 30 years to recoup it. With
the time value of money, it will be worth little. Meanwhile, I have a
huge debts to pay to those who lent me money for taxes I never should
have incurred.
I want to regain my confidence in our leaders and our government. I
know this Committee most likely did not have a hand in creating the
law, but I'm fairly certain you have the power and authority to make
things right. I'm looking forward to hearing how you will help those of
us who pay our taxes, follow the tax laws (even when flawed and unfair)
and only want to be treated fairly. Please provide us with the vehicles
to recoup the money we have paid into this flawed system.
Thank you for your consideration and time.
Jeff Eden
Evans, West Virginia 25241
June 6, 2005
As a Certified Public Accountant, I support the plan to abolish the
I.R.S. and the income tax and replace it with a national sales tax.
Elimination of the Federal Income Tax on individuals and businesses and
the replacement thereof with a National Sales Tax is the only genuine
route to a fair and just tax system. The taxation of revenue generation
has served only to burden the taxpayers with costs of compliance and of
implementation of tax reduction strategies. Income taxation has allowed
politicians to obfuscate the actual costs of government to the
citizens. It has enabled the hidden social engineering agenda of
political elites. It has allowed the politicians to clandestinely
redistribute income according to their own peculiar notions of
fairness. It has deprived the individual taxpayer and the taxpayer's
family of the unfettered use and enjoyment of earned income. It has
stultified formation of capital and associated economic activity.
Income taxation has necessitated and facilitated the intrusion of
agents of the government far too deeply into the private lives of
citizens and businesses. Taken in sum, after social security and
welfare, income taxation is the most obstructive and destructive force
applied to the citizens of this federal republic in its history.
There is no fix. We have long understood that the act of applying a
tax guarantees the reduction of the object of the tax. Any activity
which by its nature reduces income cannot provide sufficient good to
overcome that reduction. It is inherent in the taxation of income that
it must perpetuate, if not continually, exacerbate the malignant side
effects discussed above. We have ample evidence of the futility of
applying remedies to ameliorate the negative impact of the income tax
in the very complexity, density, and sheer bulk of our opaque income
tax statutes and regulations. Taken together with bizarre and tortuous
judicial interpretations, the result is a Byzantine pile which beggars
compliance. Tax avoidance, not to say evasion, is therefore weighted in
favor of the high income individual and business who can afford to hire
tax wonks like me to find a way to nullify the manifest intent of a
piece of tax code and reduce its impact on a client's income. Not only
should this malignant tumor on the economic and political body of the
country be excised, the Sixteenth Amendment to the Constitution should
be repealed, lest the temptation to try income taxation again prove too
much for the politicians of some future time.
The Internal Revenue Service is a gargantuan pestilence which has
ostensibly no other function than to coerce compliance with an opaque
and cancerous code. The Service apprehends diametrically opposed
interpretations simultaneously of the same bit of code in order to
maximize tax due. It is infamous for overreaching its own authority to
collect monies from taxpayers on the most dubious of issues. It
arrogates the power to refuse compliance with the findings and
interpretations of the Tax Court. The Service is the only enforcement
arm of government exempt from the constitutional constraint of
presumption of innocence. It cannot depend on its own computer system
nor, indeed, its personnel to maintain confidentiality of tax records.
It has been and will continue to be a weapon for incumbent politicians
to punish the opposition. It is used as a cudgel by the left to
restrict conservative political speech in 501 exempt environments,
while allowing liberals to pollute churches, unions, and NGO's, ad
libidum. In the mind of the public, the IRS rates right along side of
the Spanish Inquisition as a model of fairness and compassion. For all
intents and purposes of the citizenry, the IRS is the American answer
to the Nazi Gestapo and Russian Secret Police. It has no place in a
republican federal system and should be disbanded. One could reemploy
its minions as Border Patrol and ICE agents to much better effect for
the benefit of the citizens of our country.
Please do not be dissuaded from the abolition of these political
and economic malignancies. The blandishments of the Income Tax
apologists are invitations to perpetuate a governmental disaster. On
the other hand, the National Sales Tax (Fair Tax) affords the
opportunity to raise taxes on individuals by attaching to their
purchases of goods and services.
Sales tax is a genuinely voluntary tax (or as voluntary as a tax
gets) because the taxpayer has the option of foregoing the purchase to
avoid the tax. Since it is virtually impossible to exist in our culture
without purchasing some durable goods, consumable goods, and services,
the generation of tax is reasonably guaranteed. It has ever been the
nature of the human being to acquire in proportion to his means, the
tax is self graduating. Chevrolet buyers will be less taxed than will
Cadillac buyers. Whatever the congruence of utility of the vehicles,
the perceived value is reflected in the difference in the price of the
vehicles. Wealthy purchasers may be able to control their acquisitive
instincts sufficiently to content themselves with the Chevy, but most
will purchase the highest perceived value which they can afford.
Thus, the Fair Tax, in effect, is self assessment and is, amazingly,
completely without veiled government device.
The mechanism for efficient collection of the revenue and the
assurance of compliance is in place nearly universally across the
country. The Fair Tax should be collected by the vendors of goods and
services and administrated by the several state tax departments. The
states should provide expert remittance, compliance, and audit services
conjointly with their own sales taxation effort. Remittance by the
states to the U.S. Treasury should be monthly and should be directly
audited by federal authorities.
To satisfy the liberal faction, exemption from the impact of the
Fair Tax could be easily effected by issuance of an exemption card to
be used not unlike the ubiquitous credit, debit, or smart card at the
point of sale. Utilizing a smart card could allow the government to
establish a continuum of exemption amounts by means testing the
individual taxpayer or by exemption of a given class or classes of
purchases for individual citizens. No tax returns need be filled out by
huge numbers of individual taxpayers, but rather Fair Tax collections
would be reported and remitted by the relatively few vendors.
Compliance, while a concern in rare circumstances, becomes an almost
automatic proposition with the Fair Tax as the same process that
records sales, records tax collections. The only downside, if you wish
to view it as such, is that the citizenry will become acutely aware of
the actual cost of government and would thereby be enabled in deciding
if it is a good investment.
Please take the Fair Tax forward to enactment. The abolition of the
cancerous income tax and the institution of the Fair Tax must be the
most important and most lasting benefits that you can provide to the
country.
Respectfully submitted,
Noel H. Eyster, CPA
New Orleans, Louisiana 70125
June 4, 2005
Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington D.C. 20515
Dear Chairman and Committee Members:
Having been a businessperson as well as a taxpayer, I believe that
the Fair Tax proposal (HR 25 /S25) provides the most even-handed and
effective means of providing the necessary funds for government
expenditures. I have formed this belief after examining the competitive
proposals as well as the current taxation system.
I have reached the following conclusions that I hope Committee
members will consider carefully:
The Fair Tax proposal provides the necessary revenue.
The Fair Tax proposal is based on consumer consumption. The
quantity of consumer consumption is calculable and currently well
understood. Therefore, the amount of tax that may be raised is
predictable. By setting an appropriate tax rate, the Government can be
assured of raising the needed funds. Other proposals (including the
current taxation system) do not permit the same level of predictability
nor the assurance of a ``revenue neutral'' implementation.
The Fair Tax proposal is transparent to citizens.
The Fair Tax proposal, for the first time in American history, will
give the taxpayers a clear understanding of what they are paying to
support the Government. All other proposals now being considered have
some form of hidden taxation or unnecessarily complex exceptions,
exclusions, and loopholes.
The Fair Tax Proposal can be implemented almost immediately.
Retailers are already capable of collecting taxes on sales. The
implementation of a federal consumption tax is trivial compared to the
current income tax collection mechanisms. And only the Fair Tax
proposal does this without additional taxpayer identification or
classification at the retail level.
The Fair Tax Proposal is fair to all economic classes.
Only the Fair Tax proposal rebates the taxes on basic living
expenses evenhandedly. Stratified tax rates, complicated tax formulae
for special classes, and welfare payments through ``unearned negative
taxation'' will be a thing of the past. Everyone, including the poorest
Americans, will receive and spend, without tax penalty, 100% of their
income whether from government support programs, sales revenue, or
wages.
Taxpayer confidence will be enhanced by the Fair Tax Proposal
Currently, most taxpayers despise paying into a taxation system
that they believe is slanted toward special interests. Due to the
Congress' using the taxation system to foster certain political,
economic, and cultural programs, this opinion is not entirely wrong.
The Fair Tax proposal will strongly demonstrate that the collection of
necessary taxes is based on the fairest basis--the ability to pay.
The Fair Tax Proposal offers a dramatic boost to the American economy
Only the Fair Tax proposal offers straightforward taxation based on
consumption with no tax on producers or the poor. The results are a
dramatic decrease in producer prices, an increase in foreign sales, and
lowering of interest rates due to the increase in domestic savings.
With these benefits, every person in America is a winner.
The Fair Tax proposal injects $250 billion into the economy.
The savings in tax compliance costs is estimated to be $250 billion
each year if the Fair Tax proposal is implemented. That money will be
spent instead on productive business activities and not squandered on
tax avoidance efforts as it is now.
The Fair Tax proposal will create jobs for Americans.
The current convoluted tax system encourages business to export
jobs to countries where tax rates and systems are less onerous. The
Fair Tax proposal will permit companies to employ Americans to produce
products at competitive prices for sale both domestically and overseas.
The result will be more income from foreign markets and more spending
by gainfully employed Americans.
The Fair Tax proposal will help charities and persons on fixed incomes.
The Fair Tax proposal will allow every American to receive 100% of
their income and decide for themselves how it should be spent. This
means that the retired on fixed incomes will receive an immediate
benefit. Wage earners can decide to save more or donate a larger
portion to charity.
The Fair Tax proposal will effectively tax all Americans.
Currently, income tax is only collected from those with paychecks,
investment income, or sales revenue. Additional ``hidden taxes'' target
specific products, commodities, and producer segments. The Fair Tax
proposal will, for the first time, collect taxes from every American
regardless of how the income was derived and remove ``hidden taxes''.
Thank you,
Michael Fermanis
San Francisco, California 94118
June 20, 2005
Dear Chairman Thomas and Committee Members:
Like so many others, my former employer issued me Incentive Stock
Options several years ago. I am no financial whiz, so I sought advice
from a highly-respected accounting firm in San Francisco on how to best
deal with the potential tax consequences. I paid several thousand
dollars for the advice, which I followed, and now, I find myself in the
following predicament.
On calculating my year 2000 income tax, the combined state and
federal taxes came to $80,000 due to the Alternative Minimum Tax. In a
good faith effort, I sold the stock in January of 2001 for $26,000.
That's right, the taxes I owed were equal to 311% of my actual
gain. I'm glad to pay any percentage of tax, even up to 100% of my
gain, but a tax in excess of 300% is difficult to comprehend.
I gave the state of California and the IRS my entire stock gain,
and all of my additional savings, but I still ``owed'' in excess of
$45,000 on a $26,000 gain!! And the IRS adds penalties and interest
every day . . . my liability has incurred over $10,000 in interest and
penalties so far!!
I can't use my phantom gain to pay off my debt--the government only
accepts real income and I never actually had real money from the stock.
I had to look to other income (my salary), on which I first paid normal
income tax to pay the tax on my ``phantom gain.''
Unfortunately, I've since been laid off. I've given the state and
the IRS all of my savings. Nevertheless, I'm told that although I have
tens of thousands of dollars in AMT and Capital Gains credits, I have
to pay my ``debt'' now. I can collect my credit at a rate of roughly
$2000/year over the next 30+ years. And, although I must pay
significant interest on my ``debt,'' the IRS will pay me no interest
(or penalties) for the credits which I'm owed.
The AMT was designed to prevent the wealthy from avoiding paying
taxes. I'm not wealthy, nor am I trying to avoid paying taxes. I am an
honest hard-working taxpayer. I tried to understand this portion of the
tax code that even Taxpayer Advocate Nina Olsen sees as extremely
confusing and problematic. I went to highly respected accountants. I'm
still trapped.
I've contacted the IRS on multiple occasions to discuss this issue.
Each time the individuals with whom I've spoken tell me that they agree
with me that the law is unjust, but my only recourse is through
legislative action.
Please address this situation! The tax law should not be so
confusing that--even with the planning advice of accountants--a
taxpayer owes 311% of actual gain.
Clearly this is not what the law intended.
Thank you for your consideration,
Mike Fleisher
Statement of Jolynne Flores, American Society of Pension Professionals
and Acutaries, Arlington, Virginia
The American Society of Pension Professionals & Actuaries (ASPPA)
appreciates the opportunity to submit our comments to the House
Committee on Ways and Means on tax reform and the detrimental affect
certain reform options could have on the employer-sponsored retirement
plan system. A 50-page report--``Savings Under Tax Reform: What Is The
Cost to Retirement Savings?''--discussing ASPPA's concerns in depth can
be found at www.asppa.org.
ASPPA is a national organization of almost 5,500 retirement plan
professionals who provide consulting and administrative services for
qualified retirement plans covering millions of American workers. ASPPA
members are retirement professionals of all disciplines, including
consultants, administrators, actuaries, accountants, and attorneys. Our
large and broad-based membership gives it unusual insight into current
practical problems with ERISA and qualified retirement plans, with a
particular focus on the issues faced by small to medium-sized
employers. ASPPA's membership is diverse, but united by a common
dedication to the private retirement plan system.
We understand this hearing is in anticipation of tax reform
recommendations to be made by Treasury Secretary John Snow to Congress.
The President's Advisory Panel on Federal Tax Reform (Advisory Panel)
has been tasked with recommending ways to improve and simplify the tax
code to the Treasury Secretary by July 31, 2005. These recommendations
are to focus on ways to benefit all Americans by making the tax code
fairer, simpler and more pro-growth.
ASPPA applauds the Committee's leadership in working to fashion
such a fairer, simpler, and more pro-growth tax system. Like you, ASPPA
believes our tax system can and should be improved. But this belief is
balanced by wariness that the enthusiasm for broad reform may
jeopardize some tax provisions that have played an important role in
America's economy. ASPPA looks forward to working with Congress and the
Administration on strengthening America's economy through the tax
system, while at the same time recognizing that any reform to the
federal tax system must continue the current policy of providing tax
incentives for long-term savings through the employer-sponsored
retirement plan system.
Tax Reform Could Undermine Long-term Retirement Savings
On May 27, 2005, the ASPPA Pension Education Research Foundation
(PERF) released a Report titled ``Savings Under Tax Reform: What Is The
Cost to Retirement Savings?'' that examines several possible tax
reforms and their impact on retirement savings.\1\ We are attaching the
Executive Summary of the Report at the end of these comments. We ask
that the Report and its summary be included in this hearing's
Congressional Record.
---------------------------------------------------------------------------
\1\ The Report and its Executive Summary can be found at
www.asppa.org.
---------------------------------------------------------------------------
The Report looks specifically at several suggested tax reform
options, including a consumption-style tax or the reduction or
elimination of the tax on capital gains and dividend payments, as a
strategy to boost national saving. Many tax reform advocates favor
proposals such as these. The Report concludes that while this goal
might be achieved, it would be at a high cost--the loss of retirement
savings plans for millions of Americans with modest means who already
have difficulty putting aside adequate funds to support their senior
years. Frankly, this is too high a price to pay, particularly when
there are other mechanisms that could increase savings without
jeopardizing the nation's retirement system.
Any tax reform plan that reduces or eliminates the incentives for
long-term savings would erode both sponsorship and participation in
employer-sponsored retirement savings plans, threatening employees'
future financial security and leading to greater wealth disparities.
Today's workers could face a much bleaker retirement. Indeed, radical
reform that would eliminate the current tax incentives for long-term
savings could virtually destroy the existing system.
The need to preserve successful sections of the tax code is
reflected in President Bush's charge to the Advisory Panel where he
stressed the need to retain incentives that promote home purchases and
charitable giving. ASPPA believes a compelling case can be made to
afford equal protections to provisions that encourage retirement
savings. As the Social Security debate has shown, Americans are
appropriately worried about economic security in retirement.
Employer-Sponsored Retirement Plan System
America is not a nation of savers. Even today about a third of
workers are not saving for retirement and many who are saving have
retirement accounts that are inadequate to fund a comfortable
retirement. Further, demographic shifts illustrate a growing retiree
problem: approximately 85 million Americans will be 65 or older in 2050
compared to 36 million in 2000.
The existing provisions of our nation's income tax system that
incentivize long-term retirement savings have encouraged a significant
number of Americans of modest means to save for their retirement
security. These current long-term savings incentives in the tax code
have been extremely successful and deserve to be retained. The current
employment-based retirement plan system is the backbone of an
``ownership'' society, which has made middle-income Americans
significant investors in the stock market.\2\ However, more needs to be
done.
---------------------------------------------------------------------------
\2\ As of July 2003, an estimated 36.4 million U.S. households, or
almost half of all U.S. households owning mutual funds, held mutual
funds in employer-sponsored retirement plans. Investment Company
Institute, U.S. Household Ownership of Mutual Funds in 2003, Vol. 12,
No. 4 (October 2003).
---------------------------------------------------------------------------
The Report states that households covered by an employer-sponsored
retirement plan are more than twice as likely to achieve retirement
income adequacy. As a result, one goal of tax reform should be
expanding coverage under the employer-sponsored retirement plan system.
Much of today's savings is spurred by plans offered by employers,
which often offer a synergistic combination of advantages. In many
cases, because of employer matching contributions, a dollar contributed
by a worker grows immediately, before interest and other earnings are
added. This means $1 contributed by a worker today may result in an
immediate deposit--before any interest is earned--of $1.50 or more.
Putting money in an employer-sponsored plan is also much easier
than saving independently. Low--to moderate-income workers are 11 times
more likely to save when covered by a workplace retirement plan, in
part due to the convenience of payroll deductions, the culture of
savings fostered in the workplace, and the incentive of the matching
contributions provided by the employer.\3\ The workplace retirement
plan has been shown to be the only effective means to get these workers
to save.
---------------------------------------------------------------------------
\3\ According to the Employee Benefits Research Institute (EBRI),
77.9 percent of workers making from $30,000 to $50,000 and covered by
an employer sponsored 401(k)-type plan actually saved in the plan,
while only 7.1 percent of workers at the same level of income, but not
covered by a 401(k)-type plan, saved in an individual retirement
account.
---------------------------------------------------------------------------
This is not a blanket defense of the status quo. The federal tax
system is imperfect. Its retirement savings provisions could be changed
for the better. But history strongly recommends continuation of
priorities embedded in the existing system:
The opportunity for individual retirement savings tied to
employment should remain. Research shows that many Americans would not
save at all if not offered employer-sponsored retirement plans.
The system should maintain nondiscrimination rules to
assure maximum coverage of all workers.
The system should favor long-term savings, thereby
discouraging savers from withdrawing funds prior to retirement.
The system should acknowledge the priority of retirement
savings plans by assuring that their incentives are more attractive
than other savings incentives.
Small employers hesitate to offer retirement plans for several
reasons, including administrative complexity and cost, and the
unpredictability of their financial condition. These hurdles are offset
partly by the knowledge that the small business owner cannot maximize
personal retirement savings without providing a plan for workers as
well. Any changes that allow small business owners to meet their
retirement savings goals on an individual basis, such as through a
reduction or elimination of the tax on capital gains and dividends,
would inevitably threaten the future of the plans they provide their
workers.
High-income earners are more likely to have retirement savings than
those who earn less. The largest group of workers without access to an
employer-sponsored retirement plan is comprised of those employed by
small firms for a modest wage. The good news is that coverage for this
segment of workers has been steadily rising. Tax reform ought not to
reverse this positive trend.
Many proponents of tax reform share the goal of increasing savings.
No one opposes that priority. But there is a need to focus on who is
saving and how they are saving. The question is not solely how to get
society to save more, but how to encourage low--to moderate income
workers, who are often not saving, to save for retirement.
Tax Reform Must Accommodate Retirement Policy
From a retirement perspective, the most important and daunting goal
involves convincing the low--to moderate-income workers to increase
their retirement savings. The political and policy challenge lies in
ensuring that any plan retains these critically important retirement
savings incentives.
Some tax reforms under consideration would provide greater tax
advantages to individuals investing in stocks, mutual funds and other
capital investments through a reduced tax on capital gains and
dividends. This would undoubtedly create a significant disadvantage to
investing through the employer-sponsored retirement plan system because
individual savings in capital investments generally is not ``locked-
up'' until retirement. If retirement savings no longer enjoy a special
tax advantage, low--to moderate-income workers would save less for
retirement. Instead, if they save at all, it will likely be in a short-
term savings plan to which they will have ready access, making it more
likely than not that these savings will be spent, in whole or in part,
well before retirement.
Summary
Prudent retirement policy suggests that the most efficient and
effective tax retirement policy system must continue to provide long-
term tax incentives to employers to establish and maintain retirement
plans. As the tax reform debate accelerates, it is vital that Congress
acknowledge, protect and extend the positive impact that tax policy has
had on the individual retirement security of millions of Americans
through long-term savings incentives.
Attachment
Savings Under Tax Reform:
What Is The Cost To Retirement Savings?
Executive Summary
More than any other issue, a reform of the federal tax system
represents a significant threat to the tax incentives available for
long-term savings provided through the employer-sponsored retirement
plan system. Any reform to the federal tax system that would diminish
these incentives would jeopardize the individual economic security
currently achieved through the employer-based retirement plan system.
The President has established a tax reform commission that is
exploring various ways to simplify the current tax system. Its findings
are due to the Treasury Department by July 31, 2005. Among the
proposals under consideration are major reforms such as consumption-
style taxes or targeted approaches, such as those that eliminate the
tax on capital gains and dividend income.
This research paper focuses on the crucial need for continued long-
term savings incentives through the employer-sponsored retirement plan
system. It illustrates the potentially devastating effect certain
potential tax reform solutions could have on savings into qualified
retirement plans. It concludes that any reform to the federal tax
system must continue the current policy of providing tax incentives for
long-term savings through the employer-sponsored retirement plan
system.
Highlights
The Need for Long-Term Savings
On their own accord, American workers do not save
adequately for their retirement and other long-term financial needs.
While 63 percent of Americans are saving to some extent for retirement,
more than one-third of the working population is not.
Demographic shifts illustrate a growing retiree
population. Approximately 85 million Americans will be 65 or older in
2050 compared to 36 million in 2000.
The growing retiree population also reflects increased
longevity, with the number of people aged 85 or older expected to
increase five-fold in 2050 over the 2000 population.
Our current tax system provides the strongest incentive
for taxpayers to accumulate assets for long-term savings through the
employer-sponsored retirement plan system by providing for an exclusion
from income for contributions made to a qualified retirement plan or
IRA.
Any reform to the tax system that does not provide
incentives for long-term savings would inherently favor short-term
savings choices, which provide current access to such savings.
The policy implications of reduced long-term savings by
working Americans could be substantial, particularly given the
projected shortfalls in Social Security and the need for current and
future retirees to supplement their Social Security benefits with
personal savings.
The current employment-based retirement plan system is
the backbone of an ``ownership'' society, which has made middle-income
Americans owners of the stock market.
Employer-Sponsored Retirement Plans
Employer-sponsored retirement plans are heavily dependent
on federal tax incentives and are clearly the most effective method for
encouraging savings by low--to moderate-income workers.
According to the Employee Benefits Research Institute
(EBRI), 77.9 percent of workers making from $30,000 to $50,000 and
covered by an employer sponsored 401(k)-type plan actually saved in the
plan, while only 7.1 percent of workers at the same level of income,
but not covered by a 401(k)-type plan, saved in an individual
retirement account. In other words, low--to moderate-income workers are
11 times more likely to save when covered by a workplace retirement
plan.
This striking disparity is due to the convenience of
payroll deductions, the culture of savings fostered in the workplace,
and the incentive of the matching contributions provided by the
employer.
The likelihood of retiring with adequate savings depends
upon whether an individual participated in an employer-sponsored plan.
Overall, 55 percent of households covered by employer-sponsored
retirement plans will have adequate savings compared to 24 percent of
those without.
Suggested approaches to tax reform, including
consumption-style taxes and/or the elimination of tax on capital gains
and dividend income, would tend to encourage savings outside of
qualified plans since access to such savings is not restricted.
Employers--particularly small employers--would be able to
accomplish their savings objectives outside of a qualified retirement
plan and would be unlikely to incur the cost and potential liability
associated with establishing or maintaining a qualified plan.
As a result, low- to moderate-income workers, now not
covered by a workplace plan, will save less for retirement, impairing
their future economic security.
Tax Reform Must Accommodate Retirement Policy
While some level of reform is needed given the complexity
of the tax code, tax reform proposals must strive for a higher savings
rates for all American workers across all income classes, not just to
increase savings in the aggregate.
Providing favorable tax treatment for individual savings
outside of the employer-sponsored retirement plan system will erode
both sponsorship and participation in qualified retirement savings
plans, threatening financial security and leading to greater wealth
disparities.
A switch to a consumption tax system, which would only
tax amounts consumed and not saved, could result in an alarming
reduction in individuals' retirement savings as employers would choose
not to establish or maintain qualified plans.
Reductions in capital gains and dividend tax rates would
provide greater tax advantages to individuals investing in stocks,
mutual funds and other capital investments, which would create a
significant disadvantage to investing through the employer-sponsored
retirement plan system.
Prudent retirement policy suggests that the most
efficient and effective tax retirement policy system must continue to
provide long-term tax incentives to employers to establish and maintain
retirement plans for their workers.
It would be unacceptable to risk the retirement security
of working Americans by creating a tax system that fails to recognize
the need to encourage long-term retirement savings over short-term
individual savings vehicles (e.g., mutual funds held outside of a
plan).
Statement of Kevin R Frank, Cary, North Carolina
I am in a very bad situation because of the tax liabilities that
were generated in year 2000. Because of the economic down turn of the
telecommunication industry, I was laid off from Cisco in March of 2000.
This situation forced me to execute the NQ stock options I had
accumulated over the 5+ years I had worked at Cisco, or lose them
forever.
I did not know that the single act of executing NQ stock options
becomes a taxable event in the eyes of the IRS. I did not sell stock; I
did not receive any cash; I did not realize any gain whatsoever in the
transaction--not a single dime!
Because of the complexity of the tax forms, I paid a CPA $900 to
prepare my taxes and tell me I owed $1.7 million in taxes for the year
2000 even though I make less than $100,000 a year! How can this be? The
CPA office that prepared my taxes commented to me:
``This is the most unfair and unfortunate tax return our office has
ever prepared. Many officers have verified the accuracy of your return
and we believe it to be correct.''
I was a habitual saver and lived a very meager lifestyle. At the
time I executed the NQ stock options, I lived in a 1,400 sqft house
with my wife a dog and a cat. I drove a 1979 F100 pickup, no air,
manual steering, 3 speed on the column, 160,000 miles--worth about
$600. My wife drove a 1987 Olds Cutlass with 224,000 miles. I did not
live the life of our executives--I was just an engineer trying to save
for a brighter future.
The Cisco stock that I bought declined more than 80%. I sold
everything and took out multiple loans to pay the IRS. Because of my
prior savings, my meager lifestyle, and the kindness of my bank; the
IRS received the money April of 2001. My bank has given me two interest
only loans. Today I live in a 60 X 14 trailer by myself. My wife and I
divorced in 2004. I still drive the same Ford pickup (over 200,000
miles now). 70% of my salary goes to maintaining these loans, which I
have been paying for over 4 years now.
This unfortunate situation has taken my financial future from me. I
am addressing this letter to you so that you may know how this stealth
tax is destroying the lives of so many common people, like me. It is
just plain wrong to tax people on all of their assets when they have
realized no financial gain whatsoever.
Chicago, Illinois 60647
June 17, 2005
Dear Chairman Thomas and Committee Members:
In 2000, I exercised stock options with the company I work for,
PurchasePro.com. As the stock market continued to fall, I was forced to
sell my stock well below the price I paid for them to pay my 2000 AMT
bill. I paid my 2000 AMT taxes in the amount of $286,000 after getting
nothing back from the sale of my stock. I was married in December of
2000 and our family has been set back a great deal financially. I had
to sell many of my assets and borrow a large amount against my house.
We are way too young to have financial problems for the rest of our
lives. The way current tax code is written it will take 43 years before
I get all of my money back without interest! I am now stuck holding
onto thousand of shares of a company that is out of business with NO
HOPE of recouping my money.
Sincerely,
Scott Frisoni
Thousand Oaks, California 91320
June 17, 2005
Dear Chairman Thomas and Committee Members: My name is Brian Fuchs
and I am writing on behalf of my wife Leslie, and our twin children. We
appreciate the opportunity to discuss the hardships we are suffering
due to an outdated and complicated portion of the tax code called
Alternative Minimum Tax.
In April of 2000 I took a job as an engineer with a small startup
telecommunications company in Calabasas, California called Ixia. The
company gave Incentive Stock Options (ISOs) to the employees to help
stay competitive with the offerings of larger corporations and to give
the employees a true sense of ownership and interest in the
profitability of the company.
Being what I consider to be tax-savvy, I knew a little about AMT
and realized that attempting to exercise my ISOs and then hold them for
one year exposed my family to a huge potential `invisible tax'
liability--one that taxed me based on potential gains--not on actual
money I had in my hands. The threat of AMT scared me from the
possibility of investing in my company and reaching out for the chalice
known as ``long term Capital Gains''. Instead, I simply `flipped' some
of my ISO shares, and instead was exposed to what amounted to 48% gains
tax on my shares (38% Federal and 10% State).
More recently, I was granted ESPP shares in my company. ESPP shares
differ from ISO shares in that the company sets aside post-tax dollars
from your paycheck to purchase shares at a discount. These shares are
owned; they do not need to be exercised so as to expose oneself to AMT.
Again, being tax-savvy, I held these shares for the period of 1 year so
they would qualify for Long Term Gains (15% Federal rather than 38%).
After all, these shares couldn't possibly expose me to AMT liability,
right?
Imagine my surprise when I found out that due to AMT, my Long Term
Capital Gains were almost completely wiped out! You see, although my
gains were in fact taxed at the lower 15% rate under AMT, these gains
exposed more of my regular earnings to the AMT. To be specific, I wound
up paying 7% for AMT on top of my 15% Capital Gains.
Let's recap.
One decision I could have made with my ESPP shares was to flip the
shares and expose myself to the aforementioned 48% tax (Federal +
State).
Instead, I chose to hold my shares and go for the Long Term Capital
Gains rate of 25% (Federal + State)--A savings of 23%. Thanks to the
archaic AMT, my actual tax bill amounted to an additional 7%.
Gentlemen and Ladies, my wife and I are not rich. We are the
definition of ``Middle Class''. We have a budget that we find difficult
to stick to. We are a two-income family, and must hire full-time help
to watch our children. I would much prefer our children to have a full-
time parent, but the ultra-high cost of housing in California prevents
that. Finding Ixia was the proverbial needle in the haystack. It has
provided a wonderful addition to our income, but AMT has completely
penalized us at every opportunity from realizing the gains that our Tax
System had intended.
Instead, this system called AMT--that was invented to punish fewer
than 20 persons--has never been adjusted for inflation. It now affects
millions, with tens of millions of taxpayers in its sights. Even if it
were not for my company stock, our family would still be exposed to
AMT. You see, having children and owning a home in California these
days almost guarantees you will pay AMT. The last time I checked,
having children and owning a home was called ``The American Dream''.
AMT makes it ``The American Tax Liability''.
The notion of paying taxes on POTENTIAL earnings rather than actual
earnings is completely immoral. It is akin to being taxed at a higher
rate simply because your neighbor is rich.
Being penalized because you live in a state with a high tax rate is
immoral.
Being penalized because you have a huge mortgage is immoral.
Being penalized because you have children is immoral.
The longer Congress does nothing about AMT, the larger the problem
will grow. I urge you all to wake up, and do the right thing.
Eliminate the AMT.
Thank you,
Brian Fuchs
Government Finance Officers Association
Washington, D.C. 20004
June 22, 2005
The Honorable William Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, DC 20515
Dear Chairman Thomas
On behalf of the over 16,000 members of the Government Finance
Officers Association, we appreciate the opportunity to comment on the
tax reform measures that the Committee is considering, in conjunction
with forthcoming report from the President's Advisory Panel on Federal
Tax Reform. Our membership includes cities, counties, states, and other
governmental entities that are very interested in the tax reform
discussion and its impact on state and local governments.
In April, state and local governments had the opportunity to appear
before the Advisory Panel regarding the relationship between the
federal tax system and state and local governments. Timothy Firestine,
CFO of Montgomery County, Maryland, appeared before the Panel and
discussed the impact that any changes to the current federal tax system
would have at the state and local levels, and how major tax reform
could dramatically reduce state and local tax revenues and services.
A chief concern raised by GFOA and other local and state government
organizations, are possible changes to existing state and local income,
sales, and property tax deductions. Deductibility of these taxes
preserves the ability for state and local governments to raise revenues
and to provide services; promotes equity in the federal taxing system,
discourages the migration of businesses and individuals for tax
purposes; avoids excessive cumulative federal/state/local income tax
rates; and preserves the autonomy of state and local governments. We
urge you to consider the ramifications that would impact nearly every
community across the U.S. if limits to these deductions were made.
Another area of great interest to local and state governments is
preserving the tax-exempt status of municipal bonds. We cannot
emphasize enough the importance of the tax-exempt bond market and the
need to keep its integrity intact as major tax reform is discussed.
Tax-exempt bonds are the mechanism used to provide for essential
infrastructure at the local and state levels. Nearly all schools,
transportation infrastructure, water and wastewater facilities, jails,
airports, and municipal utility facilities exist today because of tax-
exempt bond financing. Altering the federal income tax or imposing new
limitations on issuers or purchasers of tax-exempt bonds would cause a
significant increase in bond interest costs. At a time when direct aid
from the Federal Government is decreasing, it is imperative for local
and state governments to be able to provide these essential
infrastructure and services to their citizens at the lowest possible
cost. Without the ability to access the low cost, tax-exempt bond
market, communities across the United States would suffer, and greater
demands would be placed on the Federal Government to provide additional
direct funding to local and state governments.
In addition, included with this letter are proposals that would
promote economic growth and job creation through simplification
measures in the tax-exempt bond market. We believe that to foster long-
term growth in the United States economy, federal, state and local
governments must act in concert rather than at odds with each other.
These proposals would help increase flexibility and reduce costs for
state and local governments--and taxpayers--and expand the positive
characteristics of the tax-exempt bond market for the future.
Thank you for your consideration of these matters.
Sincerely,
Susan Gaffney
Director, Federal Liaison Center
______
I. SIMPLIFY ARBITRAGE INVESTMENT RESTRICTIONS
A. Provide a Streamlined 3-Year Spending Exception to the Arbitrage
Rebate Requirement in Lieu of the Present 2-Year Construction
Spending Exception
Present law. Generally, interest earnings on investments of tax-
exempt bond proceeds in excess of the bond yield must be rebated to the
Federal Government. The main exception to arbitrage rebate is a complex
2-year spending exception that applies only to governmental bonds and
qualified 501(c)(3) bonds issued to finance certain construction
projects.
Reason for Change. The present 2-year rebate spending exception is
unduly complex due to unrealistic spending periods, complex
bifurcations, difficult computations, and unclear multipart
definitions. Thus, the permitted prompt spending period should be
extended from two to three years. The recommended streamlined 3-year
rebate spending exception should apply as broadly as possible,
recognizing that limited arbitrage potential exists for short-term
investments in most long-term tax-exempt bond issues. This exception
should also be broadened to include both governmental and private
activity bonds and both acquisition and new construction of capital
projects. A rarely-used election to pay a penalty in lieu of rebate
should be removed. A de minimis rule for minor amounts of unspent bond
proceeds should be added. This 3-year rebate spending exception would
provide meaningful administrative relief from complex arbitrage
calculations and related burdens to a broad number of tax-exempt bond
issuers. This exception could be limited to fixed rate tax-exempt bonds
in recognition of some possible arbitrage potential with short-term
floating rate bonds.
B. Increase the Small Issuer Exception to the Arbitrage Rebate
Requirement from $5 Million to $25 Million and Remove the
General Taxing Power Condition
Present Law. A small issuer exception to arbitrage rebate applies
to governmental units with general taxing powers that reasonably expect
to issue not more than $5 million in tax-exempt bonds (excluding
private activity bonds and most current refunding bonds) in a calendar
year.
Reason for Change. The size of this small issuer exception to
rebate should be increased from $5 million to $25 million in
recognition of the dramatic increases in capital costs since the
enactment of this exception in 1986 and the disproportionately-broad
relief from this change. The increased size of this exception will
substantially reduce the administrative burden imposed on a large
number of small issuers while affecting a disproportionately smaller
amount of tax-exempt bond dollar volume. In 2003, tax-exempt issuers of
$10 million or less of bank purchase qualified bonds represented about
32% of the total number of like bond issues but only about 4% of tax-
exempt bond dollar volume. Further, the general taxing power constraint
unfairly narrows the use of this exception for many common tax-exempt
bond programs. This exception should be broadened to cover other State
or local governmental entities eligible to issue tax-exempt bonds which
lack general taxing powers.
C. Add an Exception to the Arbitrage Rebate Requirement for Equity-
Funded Reserve Funds
Present law. Although present law limits the amount of tax-exempt
bond proceeds that may be used to fund a debt service reserve fund to
10% of the bond proceeds, the arbitrage rebate requirement nonetheless
continues to apply to debt service reserve funds for most bond issues.
The rebate requirement will continue to apply to these reserve funds
throughout the term of the bonds even if all other bond proceeds are
spent promptly under a rebate spending exception.
Reason for Change. Most tax-exempt bond proceeds typically are
spent within the first several years. During the remainder of the term
of the bonds, the ongoing costs and administrative tracking burdens of
the arbitrage rebate requirement result mainly from debt service
reserve funds. These reserve funds remain unspent (except to pay debt
service on the bonds in the event of unforeseen financial
difficulties). To relieve these administrative burdens, an exception to
the arbitrage rebate requirement should be created for debt service
reserve funds that are funded from sources besides tax-exempt bonds.
This change would provide an incentive to issuers to reduce the size of
tax-exempt borrowings.
II. SMALL ISSUER BANK BOND PURCHASE EXCEPTION
Increase the Small Issuer Bank Purchase Exception from $10 Million to
$25 Million and Conform it to the Parallel Small Issuer
Exception to the Arbitrage Rebate Requirement
Present law. Banks generally cannot deduct interest on loans used to
carry tax-exempt bonds. A small issuer bank purchase exception
allows banks to deduct these carrying costs for purchases of
tax-exempt bonds issued by certain small issuers which issue
not more than $10 million in tax-exempt bonds (excluding
private activity bonds and most current refunding bonds) in a
calendar year.
Reason for Change. This small issuer bank purchase exception aims
to preserve the ability of small issuers, with limited access to the
capital markets, to place bonds with local banks. The size of this
exception should be increased from $5 million to $25 million in
recognition of the dramatic increases in capital costs since the
enactment of this exception in 1986 and the disproportionately-broad
relief from this change. The slightly different eligibility
requirements for this exception and the small issuer exception to
arbitrage rebate (a trap for these unsophisticated issuers) should be
conformed with a single, simplified definition of a ``small issuer.''
Moreover, increasing this exception would provide access to bank
purchasers for a disproportionately large number of issuers while
affecting a comparatively small amount of bond dollar volume. Despite
the increase in state bond banks and pooled loan programs, many states
have no such programs. Many small issuers still rely heavily on local
banks as their main financing source. Also, for bond-financed loan
programs, an issuer should be permitted to elect to treat each conduit
borrower as the issuer of a separate issue under this exception.
III. SIMPLIFY RULES FOR GOVERNMENTAL TAX-EXEMPT BONDS
A. Repeal 5% Unrelated or Disproportionate Private Business Limit
on Governmental Bonds
Present law. If private business use is unrelated or is
disproportionate to the governmental use of tax-exempt bond proceeds,
then a more restrictive 5% private business use restriction applies to
tax-exempt governmental bonds instead of the general 10% private
business restriction on such bonds.
Reason for Change. The unrelated or disproportionate use test is
cumbersome, vague, arbitrary, and especially complex in multiple-
project financings. Out of an abundance of caution, some issuers
automatically reduce their otherwise-permitted level of private
business involvement from 10% to 5% to avoid the interpretative
difficulties of this requirement. The general 10% private business use
limit effectively controls excess private business use of governmental
tax-exempt bond issues.
B. Repeal Volume Cap Requirement for Governmental Bond Issues with
a Nonqualified Private Business Amount in Excess of $15 Million
Present law. Tax-exempt governmental bond issues are subject to
volume cap for private business use or private payments that exceed $15
million, even if it is within the general permitted 10% threshold.
Reasons for Change. This special volume cap requirement has no
sound tax policy justification in traditional governmental tax-exempt
bond issues. The general 10% private business limits adequately address
the level of private business involvement in traditional governmental
tax-exempt bond issues.
C. Modify Private Loan Financing Limit on Governmental Bonds
Present law. If more than the lesser of 5% or $5 million of the
proceeds of a tax-exempt bond issue are used to finance a loan to a
private person, the bonds generally are treated as private activity
bonds (even if there is no private business use).
Reason for Change. The private loan test should be modified to be a
straight 10% limitation that corresponds to the general private
business limitation. The Federal tax distinction between a ``use'' and
a ``loan'' of bond proceeds is complex. The main intent of the private
loan test was to limit the use of proceeds to finance non-business
loans (e.g., consumer loans), such as single-family housing and student
loans. The existing provision inappropriately could be interpreted to
impose an additional, lower private business restriction on loans made
to private businesses.
IV. ALTERNATIVE MINIMUM TAX
Repeal the Alternative Minimum Tax Preference on Private Activity Bonds
Present law. Interest on qualified tax-exempt private activity
bonds is excluded from Federal gross income but is included in a
bondholder's tax base for purposes of the Federal alternative minimum
tax.
Reason for Change. The repeal of the alternative minimum tax
preference on tax-exempt qualified private activity bonds will simplify
the tax-exempt interest exclusion, enhance market demand for these
bonds, and increase market efficiency. Private activity bonds that are
subject to the alternative minimum tax carry a punitive higher interest
rate. This higher interest cost adds to Federal tax expenditures
without a corresponding increase in Federal tax revenues because
investors subject to the alternative minimum tax generally do not
purchase these bonds. The increased demand for tax-exempt private
activity bonds from this proposed change should have the effect of
lowering the interest rates on private activity bonds by an estimated
10 to 25 basis points and a positive Federal revenue impact.
V. ADVANCE REFUNDING
Permit One More Advance Refunding of Governmental Bonds and Qualified
501(c)(3) Bonds
Present Law. In general, issuers of tax-exempt governmental bonds
(i.e., excluding most private activity bonds) and qualified 501(c)(3)
bonds are provided one ``advance refunding'' for new money tax-exempt
bond issues issued after December 31, 1985. Here, an ``advance
refunding'' means an issuance of refunding bonds used to refund or
refinance other bonds (``refunded bonds'') where the refunding bonds
are issued more than 90 days before the redemption of the refunded
bonds.
Reason for Change. Presently, because State and local governments
and Section 501(c)(3) exempt organizations generally have only one
opportunity to advance refund their debt, they are put in the
inflexible position of having essentially to guess when would be the
optimum time to do that advance refunding to achieve the lowest net
borrowing costs. These entities should be allowed one additional
advance refunding to give them more flexibility to lower their
borrowing costs, to restructure their debt service payments, and to
incorporate more flexible and modern financing techniques. Debt service
represents one of the most significant items of operating expense for
these entities, and they need more flexibility to enable them to
finance the nation's public infrastructure at the lowest possible cost.
Madison, Wisconsin 53703
June 22, 2005
Dear Chairman Thomas and Committee Members:
I am writing to ask for your support and would appreciate your
taking a moment to read this. I feel compelled to increase your
awareness about an issue which is causing devastation amongst many
taxpayers; the inequitable taxation of individuals via the Alternative
Minimum Tax (AMT). This has become a particularly critical issue for
our family.
I'm currently 43 years old and have worked very hard for 9 years
for a start-up Internet Service Provider that was successful. In 1999 I
left the company to move back to Wisconsin to be with family and raise
my own family. When I left the company I was required to exercise my
stock options (WorldCom stock).
Doing so caused us to incur an AMT liability well in excess of
$1million, which we paid in April 2000. It's now well known that the
WorldCom stock lost virtually all its value. Our AMT tax payment is now
a credit that we can never effectively use because the ways in which we
can draw it down are too restricted. In essence, we've lost almost all
of our investment money simply to create a tax credit in our IRS
account. It is fundamentally unfair to have been forced to pay a large
AMT bill on a phantom gain rather than an actual gain.
Along with many of my co-workers, friends and family, I now find
myself in this situation, many others are much worse off. Several of us
had to declare bankruptcy and others are forced to sell or liquidate
assets (including college funds, savings, cars, 401k/IRA pension plans,
homes, etc.) or to refinance homes to help pay the taxes. In our case,
we're hardworking, honest taxpayers who are incurring financial
difficulties due to the unintended consequences of the AMT laws.
To summarize, it's fundamentally unfair that we have provided the
government a substantial (over 1 million dollars) interest free loan
that will never be repaid while we're having to defer college and
retirement savings. Further aggravating the unfair situation, the
complexities of the AMT law require us, an average middle-class family,
to pay premium accounting fees to navigate the complexities of our tax
situation.
We respectfully ask that you further investigate the disastrous
consequences of the Alternative Minimum Tax and please support all
efforts towards reform.
Shari Galitzer
Aloha, Oregon 97007
June 22, 2005
To Honorable Chairman William M. Thomas and House Ways and Means
Committee--Tax Reform Hearing
Dear Chairman Thomas and Committee Members:
We are Liles and Naomi Garcia and we are homeowners. Liles was in
the Air Force for four years, and has worked for three high-technology
companies for a total of thirty years. Naomi has worked for a high-
technology company, Tektronix, for thirty two years. When Liles was
working for PMC-Sierra, Inc, the company gave him some stock options
which often occurs in high technology companies. At the end of
September, 1999, PMC-Sierra laid off some employees and Liles was
terminated at this layoff.
There was no warning of the PMC-Sierra layoff; it was a complete
surprise. Because of the layoff termination, Liles had to purchase his
stock options within a short period of time or else lose them. At that
time the stocks were worth about $965,000.00, and when Liles purchased
his stock, we unknowingly incurred a $273,000 Alternative Minimum Tax.
We have been doing our own income taxes for many years, and did not
know what the AMT was.
We submitted an Offer-in-Compromise to the IRS in July, 2001. The
IRS rejected our OIC and an OIC Appeals Officer told us that he would
only settle for the entire amount. This decision devastated both of us
because of the large amount that we will be required to pay. We are
currently making monthly payments to the IRS, but we still owe more
money than we will ever be able to pay. The IRS can take everything
that we have through their collection process. To us, this does not
seem right. Many thanks for any help that your committee can give us.
Sincerely,
Liles and Naomi Garcia
Southbury, Connecticut 06488
June 21, 2005
Dear Chairman Thomas and Committee Members:
As a 64 year old retired taxpayer the current alternative minimum
tax is of great concern. Each year more and more Americans fall prey to
this unfair tax. Approximately five years ago, because of the ISO AMT
provision, I incurred a huge federal and state tax bill, which I paid.
The year following my huge tax overpayment my accountant informed me
that I would have to live another 60 years to recoup my AMT credit.
This was hard for me to believe! Five years have since passed and I
have reduced my AMT credit by about 8%. At age 64, I do not believe
that I will last another 60 years. The Federal Government continues to
hold my money without paying me one penny of interest. Once I leave
this earth my AMT tax credit will become property of U.S. Treasury
coffers. The credit will not be passed on to my heirs. Does this seem
fair?
One thing that I do know is that my federal tax credit will follow
me no matter where I reside in the United States. This is not true on
the state side. If I move out of Connecticut I lose my ability to
recoup my state AMT tax credit. This foolish law that was intended to
prevent wealthy individuals from escaping federal income tax has become
a burden to the all classes of taxpayers.
I would appreciate hearing from you on this matter and I please
urge your leadership in righting this insidious aspect of AMT.
Sincerely,
Leonard P. Garille
Paso Robles, CA 93446
June 21, 2005
Dear Honorable Panel Members:
I am writing to let you know about the devastating effects the
Alternative Minimum Tax (AMT) as applied to incentive stock options
(ISOs) has had on my wife and I. ISO AMT has devastated our life,
financial situation and our future. I would
respectfully request that part of your recommendation to the President
and Secretary Snow be to work with my California Senators and my
Congressman, the Honorable Bill Thomas, Chairman of the Ways & Means
Committee to help quickly change this grossly unfair and unintended tax
application.
My wife received stock options from her company as part of her
compensation for all her hard work. Throughout the year in 2000, we
saved money and used it to exercise the options. We considered the tax
implications of selling or holding. We were advised and agreed to
follow the strong tax incentives Congress put in place for ISOs to hold
on to the stock for long term capital gain and support her company,
rather than selling immediately and paying approximately $50,000 more
in short term taxes. We believed strongly and still do in our company,
and in the market for the long term, looking to accumulate stock and
other assets for our future and for our eventual retirement.
In 2001, the market's steep decline reduced the value of our stock
by over 90%. To make matters worse, we received a tax bill from the IRS
and the California Franchise Tax Bureau (FTB) for a combined amount of
close to $150,000. This was over 5 times the amount we realized from
our stock holdings. We had never heard of the AMT, nor could we have
ever imagined we would have to pay taxes on stock GAINS WE NEVER
REALIZED.
Our situation grew steadily worse, I lost my job, our savings were
dwindling quickly, and we started getting calls from IRS and FTB
collection agents demanding that we pay the taxes due. We could barely
pay our bills much less pay $150,000 in cash to the IRS and the State
of California. The IRS had suggested an installment agreement, but the
$3,800 a month they required was far beyond anything we could afford.
We were also warned that if we accepted the agreement and missed or
were late on a single payment, the full amount would be due immediately
and collection actions would be taken, i.e. seizing of assets and
property.
The IRS knew we never made the money on the stocks for which we
were being taxed, but that didn't matter to them. They were aware I had
been unemployed for 18 months, and they didn't care. They said I had
the potential to earn, which in their mind is the same as cash.
Meanwhile, we tried to refinance our home to lower our payments so
we could have additional money to pay bills, but the IRS had placed a
lien on our property and we were denied the opportunity to take
advantage of the lowest interest rates in history. The IRS refused to
lift the lien, even temporarily, to allow us to refinance.
We were forced to hire tax attorneys and CPA's to help us with our
predicament, all to no avail. We submitted an Offer In Compromise. We
were rejected, the IRS claimed we had the ability to pay, even though I
had been unemployed for over a year and a half and had been dipping
into my home equity line of credit just to survive and pay our bills.
For over three years we lived in constant fear of losing our home, our
car, our bank accounts, everything. All the while dealing with
harassing calls from the IRS and the FTB. My wife was afraid we'd be
sent to prison for not paying the taxes. She had heard so many horror
stories of what the IRS does to people who don't pay their taxes.
Having been an independent contractor for many years and using
credit cards to pay for travel and business expenses, I had established
a fairly high credit limit. The IRS told me that I had access to credit
so PAY UP. I was forced into an installment agreement to keep from
losing our home (the IRS had placed a lien on it). The IRS demanded
$50,000 in cash and monthly payments of $730 per month to pay of the
remaining $74,000. I was forced into putting it on my credit card.
Since the IRS compounds interest daily, we will never be able to pay
off the balance in our lifetime. Prior to that, we had been forced into
an installment agreement with the FTB, paying $700 per month. There was
no way we could pay both monthly payments, equaling over $1,400 per
month (remember, I had been unemployed for 18 months), so we were
forced into paying the remaining $18,000 balance due the FTB with my
credit card to eliminate at least one of the monthly payments.
I was unable keep up with the credit card payments on an
outstanding balance of close to $70,000. Now, I am several months
behind on credit card payments. The credit card companies and
collection agencies are now making threatening calls daily. I'm now
getting letters from attorneys on behalf of the credit card companies.
My credit rating, which was perfect all my life, is now ruined. This
nightmare just keeps going on and on----
I'm 51 years old and I should be turning my thoughts toward
retirement and a comfortable future. My own government has dashed these
hopes and dreams forever. We are being punished in the worst way
possible, and our crime? Our crime was working hard and being honest. I
always felt that these were the values that America embraced. Study
hard, get a good education, get a good job, work hard, be honest and be
rewarded. Unless relief comes quickly, I will have been sadly mistaken.
This law needs to be changed immediately to help the thousands of
people who are in the same predicament as my wife and I. We hope that
you will understand that there are some very good people who have been
caught in the AMT nightmare and are facing financial ruin for the rest
of their lives. Please show your leadership and do what you can to
change this law.
Sincerely,
Mark Garner
Germantown, Maryland 20876
June 17, 2005
Dear Chairman Thomas and Committee Members:
My name is Mark Gorokhov and I am writing on behalf of my wife
Nadezhda Gorokhova and our family. We appreciate the opportunity to
discuss problems we faced due to an outdated and not fair portion of
the tax code called Alternative Minimum Tax.
In August of 1998 I took a job as a software engineer at Celera
Genomics. The offer letter stated that I was granted a stock option
(ISO). The essence of employee stock options involves employees sharing
in the future growth and success of a company by receiving financial
rewards based on future increases in stock price. In 2000 I exercised
my Incentive Stock Option. In plain English this mean that I bought my
company stock at discounted rate $8.56 while its market value was in
$70--$100 range. I did not have any monetary gain when I exercised my
ISO because I did not sell my stocks. However, the tax law required us
paying huge AMT tax on this phantom gain. This had dramatic impact on
our family. The taxable income we reported on form 1040 in 2000 was
$118,300 and a total tax was $153,458. This was a 130% effective tax
rate which significantly exceeded entire our family income.
The deadline to pay this huge sum to IRS was April 15, 2001. By
that time stock price plunged and we could not pay our tax even we if
sell all stocks we acquired. We borrowed all available money from my
wife's and mine retirement investments, from 2nd mortgage and credit
cards. Also, we emptied all our assets on bank accounts. In year 2005
we are still paying loans we made to pay tax year 2000.
The tax we paid for exercised ISO stocks is a prepayment of tax
with a corresponding Minimum Tax Credit that applies against capital
gains tax when we sell stocks. Now when the stock price drops we do not
have an efficient way to recover the leftover excess pre-payment of
tax. Thus we gave the Federal Government an interest free loan in the
sum of $125,717.
In 2001 tax return we recovered $2,433 from our AMT tax carry
forward. At this pace it would take 51 years to recover the whole sum.
In 2002 tax rate was lowered, but AMT rate stayed the same. In 2002
tax return we recovered $820 from our AMT tax carry forward. At this
pace it would take 149 years to recover the whole sum.
In 2003 tax rate was lowered again, but AMT rate stayed the same.
In 2003 and 2004 tax returns we recovered $0 from our AMT tax carry
forward. At this pace we NEVER recover the whole sum of credit we gave
to a government.
We ask your help to change the outdated AMT tax law and help us to
recover the AMT tax we paid in year 2000.
Mark Gorokhov
San Jose, California 95132
June 17, 2005
To: Honorable Chairman William M. Thomas and House Ways and Means
Committee--Tax Reform Hearing
Dear Chairman Thomas and Committee Members,
I have been directly affected by AMT. I have worked for 18 years in
California. During that time, I accumulated Incentive Stock Options
from my previous employer, which I exercised at various times. The
stock market dropped dramatically in 2001. Because of the current AMT
tax laws, I was taxed based upon the value of his shares at the time I
exercised them (approx. $60/share), not on what they are worth when I
sell them. The company I worked for and bought these shares in, Clarent
Corporation, committed fraud and has since gone bankrupt and is out of
business. As such, I have been unemployed since October of 2001. The
stock is now all but completely worthless and I recently sold 12,080
shares at $0.05/per share and received $573. The stock currently trades
at $0.045/share, yet I paid approximately $40,000 for the stock, had to
get a second mortgage to cover a $91,000 AMT tax bill and am now paying
$19 every day to pay off this loan, in addition to my first mortgage.
To have had to pay a $91,000 tax on a LOSS of $40,000 is more than
ridiculous. Further, should I regain employment and claim $3000/year
off of my taxes, I will never live long enough to use my tax `credit',
minus of course the interest I will have paid over the life of the
second loan. I was also subject to trading windows where selling the
stock was prohibited for six months, only open to trading three weeks
out of every quarter, and the government encouraged me to hold on to
the stock for at least one year for long-term capitol gains. Even
though I have owned my house for 13 years and was paying my 30-year
mortgage off at a 22-year rate, I now owe over $80,000 more then when I
first purchased my house in 1991. I am one of literally thousands in
this country right now who are in a similar or worse position.
The citizens affected by the AMT are not looking to avoid taxes,
only to pay their fair share. Please work to retroactively reform the
tax code regarding the AMT. Changes to this law must be made now in
order to save the savings, homes and futures of many families. These
are people working on the cutting edge of technological industries that
will be our future--their success will be our success. Please help.
Regards,
Howard Greenstein
Arlington, Tennessee 38002
November 7, 2005
The Honorable Marsha Blackburn
7975 Stage Hills Blvd, Suite 1
Memphis, TN 38133
Dear Honorable Blackburn:
I want to first thank you for dedicating your time to serve in
public office. Holding public office in America today is very tough
with all of the media pressures, and I appreciate all that you do for
us. I am writing today about the Alternative Minimum Tax (AMT). This
tax is new to me and I have tried to understand it, but it is far too
complex for the average college graduate to understand. Luckily, I have
not been personally affected by this tax, yet. But I am researching it
because I fear it is only a matter of time before it rears it's ugly
head and affects my family. As a married woman and the primary wage
earner in the household, taxes are something I have to consider on a
very serious matter, and this tax scares me. Mainly because it is
talked about so much by average wage earners like myself. We are middle
class, college degreed, business persons that have no clue how to
calculate the tax and all the research says is it is too complex to
calculate, just hope you are not hit with it.
From the research I have done on the tax, it is affecting more and
more average middle class American's every year it stands unreformed.
Taxes are eating us alive, literally. I believe with your record as a
representative and looking at the way in which you have stood on issues
in the past, this was an issue I should bring to your attention, if you
are not already aware of it. To quote SmartMoney.com, http://
www.smartmoney.com/tax/filing/index.cfm?story=amt, the people that are
especially vulnerable today are those that make $75,000 or more annual
income, that income used to seem like a millionaire's income, not
anymore. As the price of inflation increases, so does the annual income
of households, therefore, along with those increases we, also need to
increase the tax brackets.
Of all the pervasive impacts of AMT the tax as it applies to stock
options seems to be the must unfair and punitive, to see exactly what I
mean please visit WWW.ReformAMT.org
Please take the time to read about the AMT to make your own
decision. This tax is affecting more and more American's as each year
goes by that it is not revisited and reformed. Thank you for taking the
time to read my letter.
Sincerely,
Kayla D. Griffin
San Diego, California 92102
June 17, 2005
Dear Chairman Thomas and Committee Members:
In 1998 I started working for a company called Ask Jeeves as a
project manager. Although it was a mid-level management position, my
compensation package included a very generous grant of 75,000 options
at $0.26 per share. The terms of this grant were standard for the
industry: After one year of employment I would receive one quarter of
my shares. From that time forward I would receive monthly blocks of
shares until I either left the company or ran the course of my four-
year grant and vested all 75,000 shares.
Prior to Ask Jeeves' IPO, I sought the advice of both my accountant
and company-internal experts regarding my shares. Both recommended that
I take part in a special program that allowed employees to pre-purchase
shares--even shares that had not yet vested, as was the case for me. My
risk? If I left the company before I vested all of my shares, I would
lose those shares that I had pre-purchased but had not yet vested. My
upside? Buying then holding onto my shares for one year afforded me a
long-term capital gain rather than a short-term capital gain. As the
stock market was going up at the time, my future looked bright.
In the spring 1999, I borrowed nearly $20,000 to buy all of my
shares. On the day that I purchased all of my shares, Ask Jeeves' stock
was trading on the open market at $42 per share. Little did my
accountant or I realize, the moment I pre-purchased all of my still
unvested shares I incurred a huge tax liability. $560,000 to be exact.
As strange as it seems, I owed taxes on shares that I had not yet
vested--shares that I had no legal right or ability to buy or sell. But
that was the law under AMT.
By September 1999, I vested my first chunk of shares. At that time
the stock price was still rising, and I would have been able to pay my
tax liability. Unfortunately I was precluded from selling any of those
shares because of an SEC-mandated, sixth-month post-IPO lockout.
Because of this SEC-mandated lockout, I would not be able to trade
until January 2000. Unfortunately for me, by the time January 2000
rolled around my accountant--who had no experience with stock options
or AMT--still did not know that I would owe $560,000 in taxes.
Additionally, I was still locked out of trading--this time because of
quarterly earnings statements.
In 2000, the IRS stalked and threatened me. Under threat I sold all
of the shares that I could whenevers small windows of trading opened
(usually just two weeks per quarter, again due to earnings
announcements). At the end of 2000 Ask Jeeves shares were in the
doldrums. It was obvious I couldn't vest quickly enough to continue
making my $10,000 per month payments to the IRS, and my IRS
representative knew it. He informed my new accountant that they would
no longer accept payments, and that I needed to pay the nearly $100,000
remaining immediately.
Remember, I was salaried at around $75,000 / year at this time. A
good living to be sure, but I was not wealthy.
Desperate and in despair, I seriously contemplated suicide. Police
officers were called to my home after I left a particularly dark
message on a friend's answering machine. Although I was extremely
embarrassed, my friend was right to call. I was truly on the edge of
ending the deep pain of my complete financial failure. I was on anti-
depressants just to maintain a semblance of hope about life. I thought
that I might get out of the situation by getting a better paying job,
which I did, but it still didn't afford me any greater negotiating
power with my assigned IRS representative. The IRS told me that they
would place a lien on my property--a Honda CRV (I owned nothing else)--
and start proceedings to garnish my wages. My credit would be ruined,
my shame complete.
In December 2000, under the advice of my new accountant, I made the
most humiliating call of my life. It was to my brother and sister-in-
law. I will always owe them the greatest debt for the compassion they
showed me when I requested a nearly $100,000 loan to cover my remaining
liability: ``We'll wire it to you tomorrow,'' my sister-in-law said.
My husband and I are lucky. We are young; we hadn't bought a house
yet; we have no children; we had family members who could help us. We
made it through, and are now living happy, healthy, and productive
lives in San Diego. We are also, by the way, active contributors to the
U.S. economy and tax coffers, filing a combined household income in
2003 of nearly $240,000.
Despite more recent threats from the IRS regarding so-called
``frivolous'' claims,my husband and I are pursuing legal action. We
hold no hope of recovering any of the money I paid to the IRS, nor do
we hold any hope of recovering the
$22,500 in legal fees. We only seek two things: To make a statement to
the U.S. Government that we will not be bullied, and to prevent others
from falling prey to the AMT through legislative action to repeal this
unfair and unethical law.
Lauren Guzak
Orland, California 95963
June 17, 2005
Dear Chairman Thomas and Committee Members:
The current AMT law and how it is applied to stock options
specifically has had a devastating impact on my family and our
financial future.
In 1998 I was given stock options as part of my compensation
package at a small start up company for $2.00/share. My company had a
provision that allowed the employee to purchase the options before they
were actually vested. I did not have enough cash to purchase my options
prior to the company going public and was not comfortable taking out a
loan to purchase the options.
When my company went public the fair market value of our stock was
already $24/share. I purchased my first block of shares the day we went
public and incurred the AMT on the delta between my option price and
the FMV of the stock on the day I purchased it.
The stock priced soared over the next several months, split twice
and reached a maximum value of $198/share. I purchased two more years
of my options and signed an 83-b form when the stock was trading at
around $70/share. The purchase triggered the AMT and for tax year 2000
my AMT income was over $1.5 million dollars. The stock continued to
rise until late summer 2000, so I felt confident in my decision to
exercise my options at the $70 FMV.
Like most high tech stocks, my companies stock started to plummet
in the fall of 2000, by December of 2000 the stock had dropped below
the $70 mark. I got a phone call from my accountant late in December
and they suggested I sell my options before the end of the calendar
year in order to avoid the huge AMT liability. Unfortunately, I was not
able to sell because I was in a stock trading black out period which
lasted through the first week of January 2001.
Once the black out period lifted, we started to sell the stock in
order to cover our tax exposure. We were forced to sell many shares
just a few weeks before we had satisfied the holding periods that would
have qualified us for the most favorable taxation, but since the stock
was by then trading below $40/share we decided to try to cut our
losses. Over the course of the next few months we sold most of our
vested options for an average amount of $30-$35 a share.
We did not have enough money to pay our 2000 AMT of $700,000, so we
hired lawyers to try to work out an offer and compromise with the IRS.
To add insult to injury, I was laid off from the company prior to
vesting in large amount of the shares I had purchased in 2000. The
company repurchased my unvested shares, but of course the tax liability
was still mine since the repurchase was not in the same calendar year
of the purchase.
We have been negotiating with the IRS for more than four years now
and with interest and penalties now have an unpaid tax bill of over
$1.2 million dollars.
Karen Hamerquist
Statement of Kathy Hamor, the Savings Coalition of America
On behalf of its 75 member organizations, the Savings Coalition of
America (``Coalition'') is pleased to submit these comments to the
House Committee on Ways and Means concerning the need to simplify the
federal tax code. The Coalition is extremely encouraged by the
Committee's initiative towards tax simplification.
The Savings Coalition of America was established in 1991 to support
incentives to increase the level of personal savings in the United
States. It has actively supported the expanded Individual Retirement
Account (IRA) provisions that increased contributions to spousal IRAs
from $250 to $2000 in 1996; the increased income limits for IRAs and
the establishment of the Roth IRA in 1997; and the recent increase in
contribution limits for IRAs and the creation of catch up contributions
in the 2001 tax bill.
The Committee's hearing focuses on fairness, simplicity and impacts
on groups. While there are many aspects of the current system to be
addressed, the Savings Coalition of America brings to your attention
the provisions of the tax code that concern income eligibility for
making contributions to IRAs and required minimum distributions from
IRAs. Both are unnecessarily complex, unfair and distort personal
financial decisions for Americans.
In 2001, the Congressional Joint Committee on Taxation made
recommendations for tax simplification in which it recommended the
elimination of income limits on all IRAs and the elimination of the age
requirement for minimum required distributions and described the
complexity surrounding these sections of the tax code. The Coalition
shares the view that these sections of the tax code are complex and
confusing and urges the Committee to review them.
Required Minimum Distributions
Under present law, Americans who reach age 70\1/2\ are required to
begin taking distributions from their IRAs. This is one of the most
complex areas of tax law affecting retirees. For this reason, the staff
of the Joint Committee on Taxation has recommended that the age limit
for minimum required distributions be eliminated. One unintended
consequence of the requirement is that individuals may be forced to
take a distribution at a time when their investment has declined in
value. Over the past several years, many retirees and workers about to
retire have seen a drop in the value of their retirement nest eggs.
Those subject to the requirement may be forced to realize losses on
part of their investments at a time when they can least afford to do
so. The minimum required distributions rules merely determine when
taxes will be imposed on retirement savings, not if. When the IRA owner
withdraws funds, it will be taxed as ordinary income.
In addition, tax reform should take into account such things as a
longer life expectancy for most Americans. For example, as Americans
live longer, we have learned that the minimum required distribution
rules have become more burdensome and need to be eliminated or at the
very least, changed to reflect gains in life expectancy.
Universally Available IRAs
Currently the tax code has a number of income limits for
eligibility to contribute to IRAs. In addition to different income
limits for single and married Americans, there are different income
eligibilities for the traditional, deductible IRA, the Roth IRA, the
nondeductible IRA and conversions from the traditional to the Roth IRA.
Income limits for the Coverdell Education Savings Accounts add further
confusion. The lesson that we learned in the early 1980s, when IRAs
were universally available to all Americans, is that more Americans
saved. The universal eligibility led to mass marketing of these savings
vehicles, which increased participation. When income limits were
imposed after the Tax Reform Act of 1986, there was a precipitous drop
in contributions to IRAs. The 1986 experience teaches us that limiting
IRA eligibility based on income confuses people and scares them away
from establishing a pattern of savings that IRAs would otherwise
promote. One of the most important effects of the IRA cutbacks in the
Tax Reform Act of 1986 is the fact that IRA contributions for those who
continued to be eligible for deductible IRAs dropped by more than 40%
in the first year and have since dropped by over 65%.
Members of the Savings Coalition believe that eliminating income
limits and creating a universally available IRA will help more
Americans save. An IRA that is universally available to all American
workers would leave no doubt to their understanding of their
eligibility. Universally available IRAs will be marketed and advertised
on a massive scale and this advertising will have an ancillary benefit
of educating people about the need to save. History demonstrates that
the simpler it is to save, the more Americans are inclined to save.
Annual income limits are also unfair to taxpayers with fluctuating
income. For many people, income fluctuates from year to year. A
universally available IRA ensures that these individuals can make IRA
contributions in the good years--the years in which they actually have
the financial resources to make a contribution. This is particularly
important for the self-employed and for individuals in cyclical
industries like farming. It simply is not fair to these people to say
you can have an IRA in the years that you don't have the resources to
contribute, but if you have a good year then you can't have an IRA.
Moreover, the uncertainty over whether an individual will be above or
below the income limit tends to force potential savers to wait most of
the year before determining whether or not to contribute, thus reducing
the power of compounding interest. Americans tend to err on the side of
caution, so an individual worried about possibly bumping up against the
eligibility limit is more likely to skip saving altogether.
Another area of confusion with income limits are the restrictions,
for joint filers, around contributing to an IRA and deducting it is
limited by participating in an employer plan in addition to income. If
one spouse is covered by an employer plan and the other is not, as long
as their income is below $150,000, the non-covered spouse is eligible
to make a deductible traditional IRA contribution. If they are both
covered, then the phase out is in place which eventually will be
between $60,000 and $80,000. For making a Roth IRA contribution, income
is considered. Over the limits the person simply can't make a
contribution. Also, if a person is not covered, or both spouses are not
covered by an employer plan, then there is no income limit to making a
deductible traditional IRA contribution. This adds a layer of
complexity and confusion to already complex eligibility requirements
which can have the result of reducing Americans savings in these
important savings vehicles.
In the end, income limits hurt all Americans. Right about the time
someone starts getting interested in setting up a new IRA, they hear a
disclaimer that only certain individuals are eligible for IRAs and that
they should immediately check with an advisor to see if they qualify.
That just scares people, especially middle income families that most
need to start the retirement savings habit. They automatically assume
that they are one of the ones that are excluded. Or they decide not to
start the pattern of saving in an IRA every year because they will
assume they won't be eligible next year and that, as a result, it is
just not worth the trouble. And, in a vicious circle, that taxpayer
confusion and uncertainty will lead to substantially less advertising
that will probably not be sufficient to change Americans' savings
attitudes.
Members of the Savings Coalition of America feel strongly that tax
reform should encourage Americans to take more responsibility for their
retirement. One way in which this can be achieved is to promote values
that we all share; such as savings and thrift. When it comes to
savings, our tax code should encourage Americans to save for their
futures and make it easier to do so. The variety of income limits for
current tax-favored savings vehicles are cumbersome and confusing and
we encourage the Committee to recommending substantial simplification
in this area. Provisions that encourage individually responsible
behavior such as savings should apply to all Americans. Our current
tax-favored savings vehicles already limit the amount that can be
saved. We should not limit eligibility of the people who can save
through them. That just makes them more confusing and frankly,
penalizes success.
The Savings Coalition supports the Committee's goals of simplifying
the federal tax system and offers its assistance in this effort. We
look forward to working with you on this important initiative.
Village of Lakewood, Illinois 60014
June 21, 2005
By way of introduction my name is Michael Hansen. My wife, two
daughters and myself live in Lakewood, Illinois.
In July I will be 54 years old. The son of an auto mechanic I put
myself through school and have worked hard and played fair my entire
life. All in all, I was living the American Dream--up until I stepped
on the IRS landmine in the form of the AMT treatment of ISOs back in
2000. Now I owe the government more than $750,000, my bank account was
seized, there is a lien on my house and my wages are garnished.
As a model taxpayer I always had my taxes professionally prepared--
same tax CPA for 16 years. Prudently, I consulted this firm BEFORE
exercising my options in 2000. We agreed on an options exercise
strategy and I followed it. What an incredible shock it was when in
early 2001 my CPA informed me that I owed far more money in taxes than
I realized in dollars! At that time (Mar 2001), this same accountant--
and I swear this is true--took me into his private office and told me
the following `` I'll deny that this conversation ever happened but
this AMT treatment of ISO options is totally unfair. I'll give you a
tax return that treats the ISOs based on the money you really made, I
just can't sign it''. My response to Mr. Joyce was ``you charged me
$7,200 for tax advice including exercising my options and tax
preparations and now your best advice is to commit a felony?'' He
responded that ``if you pay on what you realize you'll never get
audited.'' I told him that I had no intention of doing anything like
filing a false return and that furthermore I was no longer a client of
his firm!
I immediately started seeking a tax lawyer--that took a
considerable amount of time. I was stunned when the first several firms
I contacted had NO IDEA SUCH TREATMENT WAS IN THE TAX CODE! I contacted
the office of my Congressman, Don Manzullo--they hadn't yet heard of
the AMT/ISO problem--my neighbor who was our State Representative
actually scoffed at me claiming that what I was talking about was
unconstitutional! Even practicing lawyers I knew through my church
hadn't heard of anything like what I was describing.
Finally, I did find a tax lawyer who knew of this area of the tax
code. He had my return once again prepared and filed per the code. At
that time I owed the IRS $650,000--worse yet, the remaining stock that
I had was unsellable as it would have generated an even worse tax
problem (or to put it another way, I was in the 170% tax bracket)!!!
Then came 9/11/01--my unsellable stock kept decreasing in value. I
finally was able to sell some to pay off the State of Illinois and, to
date, $30,000 to my tax lawyer. The real laugh here is that the State
of Illinois owes me roughly $28,000 per the perversion in the tax law--
money that I'll never see!
Sure, my tax attorney and I tried the OIC route. The figure that
the IRS suggested that they might accept is ``only'' equal to 100% of
my gross wages for FOUR YEARS! That's some ``Effective Tax
Administration''!
Now I am strongly considering a bankruptcy. If you can't assure me
of some REAL legislative relief I'll have to go that route because I
fear if I wait to file the new bankruptcy legislation will not help my
struggle to return to a normal life.
Even though I have paid well over $150,000 towards my 2000 Federal
Tax bill the interest and penalties increase faster than I could ever
match--much yet repay in full.
Please don't think that I'm some sort of millionaire--even when
money was plentiful I didn't buy a ``McMansion'', Rolex watches or
jewelry, an Aspen ski chalet, etc, etc. I did however get my eyes
fixed, supplied food and housing for a single mother with 3 children so
she could attend school for 3 years (she's now a respiratory
therapist!) and helped start a new church that I'm proud to say is now
the spiritual home to more 400 families.
Of course, there is much more to my story--and the stories of
thousands of honest Americans who face this monstrosity of the tax code
with integrity and courage. However, I also ask relief not only for the
victims of the AMT/ISO trap, but for the many good and decent IRS
employees who have little choice but to enforce the law as it is
written--if our positions were reversed, I'd resign, but I haven't
``walked a mile in their shoes''.
So Congressmen, stand tall, right this wrong! We love our country,
always pulled more than our own weight and played fair--now is the time
for our government to play fair with us!
Sincerely,
Michael C. Hansen
San Diego, California 92129
March 17, 2005
In 2000, few people were even aware of the AMT, and even fewer
understood it, including many tax professionals and even some IRS
agents. When I exercised Incentive Stock Options in 2000, I followed
the standard recommendation of holding that stock for one full year to
achieve the capital gains treatment for which Incentive Stock Options
had originally been designed. Imagine my surprise when I discovered
that there was a parallel universe called the AMT, where the rules were
opposite of common sense and regular IRS rules, and instead of
benefiting from long term capital gains treatment like an ordinary
stockholder, I was penalized for NOT selling my stock.
As a result, my effective tax rate for 2000 was almost 250% and
left me with state and federal tax obligations well over $300,000. This
was impossible to pay because it was many times my annual income and
the stock had dropped to a fraction of its former value. Although I
have made payments against the debt, it grows too rapidly to ever pay
off.
The irony is that the AMT also allows a credit back to me that
would offset this liability--but there is a cap on the amount of credit
I can recover each year--it will take over 90 years for me to gain the
entire credit back, and unlike my AMT liability to the government, I
receive no interest on the money owed back to me by the government. So
my debt grows by leaps and bounds and the government holds my money
interest-free indefinitely.
I have offered all the equity in my 1500 square foot home, my car,
my life savings, and my retirement to settle this--everything I have
managed to put aside over my entire working life to pay arbitrary and
excessive taxes on profits I did not receive (by the way, the IRS
refused this offer as insufficient). Actually, after paying over
$100,000 so far, I have only about $11,000 left out of my savings/
retirement and the IRS has a lien on my house, which also serves to
ruin my credit. I am 52 years old and have been a compliant taxpayer
since I earned my first dollar, paying in full and on time, without
complaint, but I fail to see how bringing an honest middle-class
taxpayer to financial ruin serves any purpose.
Legislation is being introduced that would allow me to pay the
proper percentage of whatever gains were actually realized from the
stock sale. While I realize the entire AMT needs to be addressed, the
first logical step would be to support relief for those who have
suffered the most unfair and egregious effects of this outdated law.
Please stop the unnecessary financial crippling of some of your most
hard-working and productive citizens. We can't wait two or three more
years--we are losing our homes, our retirement, and our entire economic
futures today!! There is no way a ``fix'' several years from now will
ever allow us to recover.
The AMT no longer serves its intended purpose, if it ever did, and
is increasingly punishing hard-working families. We respectfully ask
that each of you understand the enormous risk involved in ignoring this
growing malignancy in our tax system, and take action now.
Sincerely,
Angela Hartley
Statement of David A. Hartman, Lone Star Foundation, Austin, Texas
Introduction
The current series of hearings by the House Ways and Means
Committee on federal tax reform could not come at a more appropriate
time. The U.S. manufacturing sector is in a state of crisis that
threatens its very survival, principally due to a federal tax code that
handcuffs U.S. competition with foreign produced goods.
I urge you to use these hearings to put the public spotlight on the
border adjustable (destination based) value added taxes of all U.S.
foreign competitors which have no counterpart in the federal tax code.
The result is a 15 to 25 percent price advantage for foreign goods as
imports to the U.S., and against U.S., exports to foreign markets.
While consumption based tax reform could assist competitive U.S.
taxation, it will not suffice without border adjustment.
This submission is based on The Case for Border Adjusted Federal
Tax Reform Via the Business Transfer Tax, a paper recently presented to
the American Enterprise Institute. My presentation plus debate of its
findings by Dan Mitchell of the Heritage Foundation and David Burton of
the Argus Group can be viewed at www.aei.org, the AEI website. It
presents the virtues of a border adjusted subtraction method value
added tax as the vitally needed competitive response to foreign VATs.
It further constructs a more efficient and equitable basis for
consumption based comprehensive tax reform replacing progressive income
taxation with a 17.5 percent BTT and rebates to prevent regressivity on
a tax burden neutral basis. It may prove necessary to patiently
undertake at this time only the first fundamental step, comprised of a
tax neutral replacement of the corporate income tax and the employers'
share of social insurance taxes with the BTT. However, when one
considers its virtues of border adjustable, compatibility with the
trend to VAT taxation worldwide plus its simplicity, economic
efficiency and equity compared to progressive income taxation, the BTT
will be found to be the optimal basis for comprehensive tax reform.
The Lone Star Foundation and its predecessor, Texans for
Responsible Government, have been undertaking visionary studies for
reform of state and federal taxation since 1990. Papers on federal tax
reform have included Priorities for Taxation of Capital presented to
the House Ways and Means Committee; design, editing and sponsoring of
the Institute for Policy Innovation's RoadMap to Tax Reform series; co-
sponsoring with the Heritage Foundation a series of papers on federal
tax scoring currently being published; and Comprehensive Federal Tax
Reform by the Business Transfer Tax presented to the President's Panel
on Tax Reform. Other publications in Tax Notes have included The
Urgency of Border Adjusted Federal Tax Reform, and The Strategic Steps
to Tax Reform.
Summary of the Case for the Business Transfer Tax
The U.S. manufacturing sector is in critical decline due to
inability to compete with foreign producers and U.S. production
relocated abroad. The U.S. currently has a trade deficit totaling 6
percent of GDP, reflecting a deficit with virtually every trade
competitor and in every class of goods. The U.S. now produces only $2
worth of every $3 of goods Americans consume.
The precipitous decline of manufacturing employment's share of U.S.
employment is a principal cause for declining middle and blue collar
share of U.S. incomes. Just since 1998 manufacturing employment has
declined 20 percent, the worst layoff since the Great Depression.
Despite doubling manufacturing productivity since 1978, the real
factory wage has declined 11 percent. A similar trend to manufacturing
appears to be developing in the business services sector due to foreign
outsourcing, although not yet as severe.
The U.S. manufacturing crisis began soon after foreign replacement
of radically reduced tariffs with border adjusted value added taxes
(VATs) on tradable goods not provided U.S. manufacturers by the federal
tax code. Starting with France and the EU, all OECD competitors have
adopted VATs averaging 18 percent abated on their exports to the U.S.,
and 18 percent levied upon imports from the U.S. not matched by abated
U.S. taxes. The transition from U.S. trade surpluses in goods to huge
deficits coincides with previous adoption of border adjusted VATs, by
foreign competitors which in effect replaced tariffs.
The Importance of Replacing the Income Tax with a Business Transfer Tax
The relentless growth of the U.S. trade deficit has not provided
evidently beneficial investment of the resulting ``foreign capital
surplus''. Virtually all foreign investment has been in existing rather
than new productive assets; instead, the U.S. trade deficit has been
reflected in excessive consumption at the expense of U.S. saving for
investment.
The U.S. trade deficit will not be successfully resolved without
border adjusted federal tax reform which equalizes competitive terms of
foreign taxation. This 18 cents on the dollar advantage for foreign
producers cannot be overcome by innovation and productivity given the
rapid rate of diffusion abroad (and by U.S. firms which move abroad) or
by devaluation. Nor will devaluation of the dollar provide more than
temporary relief at an excessive price. What is required is border
adjusted and consumption based federal tax reform if the U.S. is to
restore competitiveness.
The Business Transfer Tax is the most efficient and competitive
alternative for federal tax reform. As a tax on the entire Gross
Domestic Product after expensing of Private Commercial Investment and
on Imports, but not on Exports, it will restore competitive U.S. terms
of trade for U.S. manufacturers as well as territorial taxation of
corporations to restore the U.S. as the preferred location for The
Importance of Replacing the Income Tax with a Business Transfer Tax
headquarters. A 17.5 percent BTT will replace all federal income taxes,
including personal, corporate, employer share of social insurance, and
the ``death'' taxes; except for personal share of social insurance.
Rebates will replace exemptions, deductions, and credits in order to
prevent regressivity. Transition costs can be funded from making
foreign trade subject to the BTT and from increased growth due to BTT
tax reform.
The U.S. needs to confront the reality that since the industrial
revolution all major powers have been leaders in manufacturing as the
source of competitive advantage in growth of incomes, wealth, and
military strength. Preservation and restoration of the manufacturing
sector is vital to U.S. national interests, and adoption of border
adjusted, consumption based BTT taxation is the vital condition for
this remediation. The BTT is the optimal basis for fundamental federal
tax reform enabling equitable and competitive taxation of consumption,
growth of investment and income, and restoration of the U.S. economy as
the leader of free enterprise and freedom.
The Importance of Replacing the Income Tax with a Business Transfer Tax
As the U.S. begins the Twenty-first Century it finds itself
increasingly constrained by an uncompetitive and inefficient federal
tax code. Confiscatory marginal tax rates adopted during the Depression
and WWII which were successively reduced by the Kennedy and Reagan cuts
stimulated resurgent economic growth, subsequently restrained by rising
average income tax rates on capital. The rest of the world has heeded
the effects of these tax cuts, and has entered an era of corporate
income tax reductions being replaced by value added taxes and even
isolated individual income tax reform not matched by the U.S., while
the border adjusted feature of these value added taxes adopted by all
U.S. OECD trade competitors have rendered the U.S. uncompetitive with
world trade at home and abroad.
U.S. federal tax reform debated over the past decade to little
avail has been initiated by President Bush's tax cuts, who now seeks
fundamental reform of the federal tax code. Reform advocates define
neutrality, transparency, and efficiency as the goals of tax reform by
consumption based taxation, by an end to double taxation of saving for
investment, and by lower marginal rates, all worthy objectives.
But it will be shown in this report that missing from these goals
is the most pressing current urgency of tax reform, ``border adjusted''
(or, destination based) taxation to provide equal competitive terms of
trade to the advantage of border adjusted value added taxes of all U.S.
trade competitors in order to restore a competitive U.S. manufacturing
sector.
Presentation of Findings
The U.S. manufacturing sector is in critical decline due to inability
to compete with foreign manufactured goods.
U.S. manufacturing's share of GDP has fallen over 50 percent since
the Fifties, and this decline in share has accelerated to less than 13
percent share of GDP since 1998. The U.S. has a growing trade deficit
in goods with every principal country and in every category of goods
except government subsidized aircraft--including agricultural goods.
The result has been a ``production gap'' in manufactured goods which is
over 6 percent of GDP; the U.S. now produces only $2 of every $3 of
manufactured goods which it consumes. The annualized trade deficit in
goods increased to three quarter of a trillion dollars by 1st quarter
2005, and the cumulative deficit from 1982 to present has converted the
U.S. from the world's largest creditor to the world's largest debtor,
with net foreign ownership of U.S. assets now approaching four trillion
dollars. The National Association of Manufacturers (NAM) warned last
year that ``the country may be dropping below critical mass in
manufacturing.''
The continuation of the disintegration of the U.S. manufacturing
sector threatens future progress and prosperity of the U.S. economy and
loss of the most vital source of U.S. military security. Manufacturing
has perennially been the leading sector in the technological progress
which drives productivity across all sectors of the U.S. economy and
enables superiority of defensive weaponry. The accumulating obligations
from massive trade deficits is irresponsible public policy for a nation
all ready facing unfunded multi-trillion dollar welfare obligations for
``baby boom'' retirees.
The precipitous decline of manufacturing employment's share of U.S.
employment is a principal cause for the declining middle and
blue collar share of U.S. incomes.
Employment in manufacturing as a share of U.S. employment has
fallen over 60 percent over the same period, with a 20 percent decline
just since 1998, the worst layoff since the Great Depression. The real
average factory hourly wage, which traditionally had been the vanguard
of ``blue collar'' compensation, declined 11 percent from 1978 to 2001.
This decline took place despite a doubling of productivity in
manufacturing, compared to an increase by one-half in the U.S. business
sector as a whole. Laid off workers from manufacturing seeking
reemployment in the highly price--elastic services markets have helped
depress blue collar wages in general. The often cited increasing share
of income enjoyed by the top 10 percent of incomes is not due to
excessive growth of returns to physical and intellectual capital, it is
because of the stagnation of middle and labor income. The retrogression
from the 40 hour work-week for one breadwinner to the 80 hour two
person work-week is now a necessity for the typical American family.
The U.S. manufacturing crisis began soon after foreign replacement of
radically reduced tariffs with border adjusted value added
taxes on tradable goods not provided U.S. manufacturers under
the federal tax code.
Under U.S. international leadership, average tariffs of OECD
members declined from 40 percent just after WWII to 4 percent on
average at present; U.S. tariffs now average only 1.7 percent of
imports' value. However, starting with France in the mid-Sixties,
Europe sequentially adopted border adjusted value added taxes now
averaging 19 percent, and all OECD countries other than the U.S. since
have adopted VATs or equivalents averaging 18 percent. Consequently,
U.S. goods carry a full burden of federal, state, and local taxes plus
an added average of 18 percent VAT in foreign markets, and face foreign
goods which enjoy 18 percent VAT abatement in U.S. domestic markets.
The transition of the U.S. manufactured goods trade balance from
surplus to deficit coincides with the successive conversions of foreign
competitors to border adjusted taxes, which in effect have replaced
tariffs.
A similar trend to manufacturing appears to be developing in the
business services sector due to foreign outsourcing.
Growth of the historically positive trade balance in services has
now flattened out and started to decline as well. Relocation of
corporate headquarters of multinational corporations to secure lower
corporate effective tax rates and territorial taxation of international
income is adding to the loss of U.S. business services abroad.
Outsourcing is rapidly expanding in both professional and unskilled
white collar services, with an estimated 14 million jobs possibly at
risk.
U.S. services employees who are U.S. residents pay U.S. taxes,
while those living abroad typically only pay taxes in the county of
residence that uses their services. But the employees of outsourced
services produced abroad serving U.S. producers are subject to no U.S.
taxes.
The relentless growth of the U.S. trade deficit has not resulted in
evidently beneficial investment of the consequent ``foreign
capital surplus.''
Lured by bargain imports for consumption, personal saving as a
percent of GDP has declined to post--WWII lows, as shown by comparable
decline in personal saving as percent GNP to the increase of the trade
deficit in goods. However, corporate saving has offset personal saving
on average such that Gross Private Fixed Investment has remained
relatively constant at 15 percent of GDP over this period. Reoccurring
excessive federal deficits have been the additional principal reason
for declining U.S. saving as a percent of GDP. The so-called ``foreign
capital surplus'' has primarily funded excessive U.S. consumption and
acquisition of existing assets; 96 percent of foreign investment in the
U.S. has purchased existing assets, rather than new investment, while
private fixed investment has not increased on average. The net growth
of foreign held prime income assets and obligations funding consumption
by ``America for Sale'' will result in further unfunded liabilities to
be claimed as the ``baby boom'' retires.
The U.S. trade deficit will not be successfully resolved without border
adjusted federal tax reform which equalize competitive terms of
foreign taxation.
Given the effective VAT advantage of 18 cents on the dollar, the
U.S. is the most profitable market for foreign producers--and also for
offshore U.S. producers. No realistic economic analysis shows that
consumption based federal tax reform without border adjustability would
come close to remediating an 18 percent price advantage from VATs for
producers of foreign goods that makes the U.S. their most profitable
market and renders U.S. goods uncompetitive in their markets.
U.S. productivity gains and innovation will not level the playing
field given the rapid diffusion of U.S. technology and management to
foreign producers. The largest trade deficit measured by exports as a
proportion of U.S. imports is in telecommunication and EDP goods, for
which the U.S. is the world technological leader, which bears witness
to this reality. The recent transfer of manufacturing abroad by U.S.
companies to secure foreign VAT tax advantages has enabled U.S.
corporations to join foreign competitors in further seriously
undermining remaining U.S. competitors.
The U.S. Department of Commerce and MAPI/NAM agendas for restoring
competitiveness of U.S. manufacturers if fully achieved would only
offset 30 percent of the typical foreign manufacturing advantage due to
border adjusted VAT taxation. In order to level the taxation ``playing
field'' in international commerce, a 15 percent consumption based and
border adjusted tax is the minimum requirement, comparable to Canada
and Mexico border adjusted taxation.
According to the National Bureau of Economic Research (NBER)
devaluation of the dollar will not impair competitiveness of foreign
competitors until devaluation considerably exceeds the OECD average of
18 percent. Furthermore, devaluation is not a likely remedy as long as
foreigners continue to have a special appetite for reinvesting trade
surpluses in prime U.S. assets. Devaluation to close the trade deficit
will be frustrated by offsetting increase of U.S. costs of first
commodities, then productive assets, followed by wage increases. Also,
the Fed will likely be forced to limit the extent of devaluation due to
unfavorable effects on domestic inflation, plus preserving the role of
the dollar as a store of value and as a standard for international
exchange.
The ``Business Transfer Tax'' is the most efficient and effective basis
for restoring U.S. competitiveness in manufacturing and
business services via border adjusted, consumption based
federal tax reform.
Of the five principal alternatives for fundamental consumption
based tax reform, the ``Flat Tax'' and the ``consumed income tax'' do
not differentiate between origin and destination, and are ``direct
taxes'' that cannot be border adjusted under WTO rules. Both the
``retail sales tax'' to not differentiate between origin and
destination, and the European-type ``credit invoice VAT taxes'' are
``indirect taxes'' and therefore WTO qualified. But as state retail
sales taxes in the U.S. and credit invoice VATs in Europe and elsewhere
have demonstrated, they tend to be limited in breadth of assessable tax
base beyond levy upon goods for political reasons, resulting in higher
marginal rates and/or lesser revenue yield. The ``business transfer tax
(BTT)'' as a ``subtraction method VAT'' is an ``indirect tax'' on
consumed income at the producer level, which should be more easily
assessable on all commerce and government to enable the broadest base
and the lowest marginal rate, and WTO qualification for border
adjustment.
Determination of BTT Base
As proposed, the BTT Base is Gross Domestic Product, less Gross
Private Commercial Investment and less the Balance of Trade (if a
surplus, additive if a deficit). Tax returns simply require the
following:
All Commercial Entities:
All Revenues
less: Exports of Goods and Services
All Purchases of Goods and Services (Including Equipment and
Structures)
Employer Share of Social Insurance Taxes
plus: Purchases of Imports
equals: BTT Base
All Governments and Not-for-Profits:
All Employment Expenses
plus: All Purchases of Imports
equals: BTTBase
Federal Taxes to be Replaced by the BTT
The BTT as proposed would replace the following, comprising more
than two-thirds of all federal revenues:
Individual Income Taxes, (less EITC replaced by Rebates)
Corporate Income Taxes (less ``Corporate Welfare'')
Employer Share of Social Insurance Taxes
Estate and Gift Taxes
equals: BTT Revenues
The Federal Government would deposit an equal match to individual
payroll taxes for the OASI, DI, and HI Trusts, which would result in
ending ``the bubble'' which is created by currently capping applicable
incomes levied as employer direct taxes. The remaining individual
portion of social insurance taxes should not be considered direct
income taxes, but instead considered conceptually as variable insurance
premiums contributed to secure future retirement benefits.
Addressing Regressivity Concerns
In order to prevent regressivity, the BTT as proposed would provide
rebates of the BTT to all taxpayers on the basis of the product of the
BTT tax rate and the sum of (1) the poverty level for a given family
size, (2) home mortgage interest, and (3) philanthropic giving. The
termination of employer paid matching contribution to social insurance
generally considered to be incident upon employees in a additional
abatement of regressivity.
Tax Rate
Based upon FY 2003, the BTT could replace all federal income and
capital taxes (other than individual FICA and Medicare taxes) with a
16.4 percent BTT on a ``tax neutral'' basis.
The inclusion of imports and exclusion of exports for determination
of BTT taxation will result in ``found money'' while the trade balance
is in deficit and thereafter when the U.S. ``grows'' an end to this
deficit. This results in lower tax burden on U.S. taxpayers at ``tax
revenue neutral BTT receipts''. An alternative BTT level, the ``tax
burden neutral'' rate at 17.5 percent would be preferable in order to
make this surplus available to transition funding.
What are the strategic steps required to replace income taxation with
border adjusted consumption taxation via the BTT?
There are three alternative strategic routes to replacement of
federal income and wealth taxation with the BTT:
A. Terminate income taxation by sequential replacement of current
income and wealth taxes with the BTT.
Step 1. Replace the corporate income taxes, corporate welfare
expenditures, employer social insurance taxes, and inheritance and gift
taxes with a 5.25 percent BTT.
Step 2. End progressive income taxation with increase of the BTT to
11 percent to enable flattening the personal income tax to a simple 11
percent individual income tax rate, subject to current exemptions,
deductions and credits of the present tax code.
Step 3. Replace the personal income taxes entirely with a 17.5
percent tax burden neutral BTT and rebates of BTT on poverty level
incomes, residential mortgage interest, and charitable giving to
complete federal tax reform.
B. Sequential transition from the current tax code by reducing
current taxes by one third (or one fifth) and phasing in the BTT by one
third (or one fifth) increments over three (or five) years.
C. Replace the current income taxes with the BTT and rebates in
one complete step.
It is unlikely that Congress would ``throw caution to the winds''
and reform the tax code in one ``giant step'' as in alternative ``C''.
Alternative ``A'' would address priorities by addressing corporate and
manufacturing first, then reform of personal taxation. But alternative
``B'' is probably the most realistic since by proportional increments
of adopting reform and phasing out the current code, benefits more
proportionally match burdens.
Given that foreign border adjusted VAT taxes are the principal cause of
the U.S. manufacturing crisis, why hasn't the U.S. adopted the
BTT or some other form of border adjusted taxation?
Conservative and libertarian economists alike appear to have
visceral objection to value added taxation and to border adjusted
taxation in general, and also to addressing remediation of the U.S.
manufacturing crisis in particular. Yet value added taxation as
proposed by the Business Transfer Tax potentially has the exact same
base as their popular Flat Tax alternative except for border
adjustment, and is more transparent and more politically assessable in
format. What is really at issue is the question as to whether or not
the U.S. is entitled--much less morally obliged--to provide equal terms
of trade for the survival of its industries and workers' jobs, in its
national interests.
One cause of misconception has been the effective concealing of the
manufacturing crisis from the public in the form of disinformation as
to the seriousness of the manufacturing sector's decline, its evident
consequence of foreign border adjusted VATs, and its implausibility of
self-correction under the present tax code. This misrepresentation has
been promoted by the U.S. Commerce Department, and key trade
organizations representing discount retailers and multinational
corporations, without challenge from the economic policy community, or
the media. In effect, they appear to give priority to expansion of
international trade and current consumerism over long term U.S.
national interests. A good example of this misrepresentation is shown
in the trend of U.S. manufacturing, in a recent study by NAM based on
Commerce Department data for manufacturing share of ``real'' GDP in
manufacturing, explained as ``physical'' output rather than dollar
value GDP share. What is ``real'' about physical output as opposed to
value? Ever since currency replaced barter it is money that has
measured economic phenomena, and what one can take to the bank or to
the store. The result is a highly misleading impression of the shocking
relative decline of the manufacturing sector. An endless stream of bad
news regarding U.S. manufacturing which has similarly been reported
from the Commerce Department as good news, augments these
misconceptions, which is uncritically repeated by the media and policy
experts.
Also, VAT taxation, the prime source of U.S. competitiveness
problems, and the prime candidate for effective tax reform, has been
disparaged as the source of runaway growth of the European welfare
states. This misconception fails to recognize that this growth of their
welfare states should be attributed to their adoption of VATs in
addition to rather than in replacement of income taxation. Adoption of
border adjusted taxation has been erroneously labeled as
``protectionist''--but as proposed, the BTT is strictly neutral in
terms of international trade for all parties. VATs also have been
represented as complicated, lacking transparency, inefficient to
administer and too easily evaded; whereas a subtraction method VAT such
as the BTT is simpler to assess and enforce than income taxation, and
can be made comparable in retail transparency to a retail sales tax or
a credit VAT; and, in addition, the BTT has a larger plausibly
assessable base.
The most beneficial reform of the federal tax code will not only
incorporate border adjustability of the BTT, but should also
permanently end income taxation and progressivity.
Direct taxation of income and wealth taxation have especially
undesirable arbitrary features with respect to assessment and
exemption--namely, complexity, discrimination, intrusiveness, and
economic inefficiency. It invites taxation of the few for the benefit
of the many until the increasing burden on success causes economic
stagnation. Small wonder that historically such direct taxation prior
to ``social democracy'' was considered unfit for freemen, and suitable
only for slaves.
Progressive income taxes which incorporate these undesirable
features at their worst are typically ``justified'' as the price of
``social equity'', but the evidence shows the contrary. Over the course
of the four decades 1957-1997 it has been demonstrated that as share of
individual income taxes paid by the top 10 percent of incomes rose
(representing taxation of intellectual and financial capital) the after
tax share of the incomes of the other 90 percent declined. Simply
stated, progressive taxation appears to have worsened rather than
improved income maldistribution. As shown earlier, this was not due to
excess growth of incomes of the top 10 percent; instead it was due to
stagnant incomes of the other 90 percent. Similarly, over the same
period relative rises and declines of taxation on financial capital did
not appreciably alter the real return to financial capital. The
effective incidence of changes in taxation of capital was upon labor.
It has also been shown that at least 70 percent of returns of income
from capital are distributed to labor, in effect showing that growth of
labor income depends primarily upon growth of capital.
Tax reform could best secure economic efficiency and equity not by
progressivity, but instead by proportional taxation of consumption
which mitigates regressivity by exempting necessities. Arbitrary
determination of ``equitable levels'' of profits and taxable income
determined by progressive income should have no place in tax reform,
but rather, should be left to the impartial arbitration of free
markets.
Consumption taxation in combination with income taxation, such a
BTT combined with an upper income personal income tax would be a modest
improvement over the present code for as long as such a political
compromise would last. But a consumption based tax, such as the BTT,
adjusted by limited rebates to prevent regressivity is the optimal
compromise for economic efficiency and equity. Given the opportunity to
demonstrate the results of such reform, repeal of the Sixteenth
Amendment would be the best guarantee of taxation in the best interests
of all Americans.
The Reader's Digest polled a wide range of classifications of
Americans inquiring what was the maximum rate of taxation on income any
citizen should have to pay regardless of amount of income. The median
answer was 25 percent for all groups but one, which proposed 29
percent. The BTT at 17.5 percent would be considered their ``best
buy'', particularly if compared to the current tax code with marginal
rates that are double the 25 percent standard.
Conclusion
The U.S. needs to confront the reality that since the industrial
revolution all major powers have been leaders in manufacturing as the
source of competitive advantage in growth of incomes, wealth, and
military strength. Preservation and restoration of the manufacturing
sector is vital to U.S. national interests, and adoption of border
adjusted, consumption based BTT taxation is the vital condition for
this remediation. The BTT is the optimal basis for fundamental federal
tax reform enabling equitable and competitive taxation of consumption,
growth of investment and income, and restoration of the U.S. economy as
the leader of free enterprise and freedom.
The BTT will achieve these goals by direct remediation of the
serious problems facing the U.S. economy. The manufacturing crisis and
the soaring U.S. trade deficit will be resolved by the BTT's border
adjusted exemption of exports and imposition on imports to equalize
terms of foreign trade. As a consumption based tax code it will close
the deficit in saving for investment. Border adjustment of business
services will curb outsourcing before it creates additional deficits.
And it will restore the U.S. as the preferred location for corporate
headquarters by the best possible resolution of making corporate
taxation territorial--the termination of the corporate income tax. The
end results of adopting the BTT will be not only reversing labor's
share of income, but by increased growth of all incomes. By ending
complex, inefficient, and inequitable income and capital taxation, the
BTT will provide a simple broad based tax that offers the lowest
possible rate for a proportional consumption tax with adequate rebates
to prevent regressivity.
President George W. Bush and the Congress could leave no better
legacy than the vigorous economic future proposed by BTT federal tax
reform.
Cupertino, California 95015
June 29, 2005
Dear Chairman Thomas and Committee Members: My name is Joseph Cena
and I am writing on behalf of my family, Dawn and Justin. We appreciate
the opportunity to discuss the hardships we have suffered due to the
challenges that have been set forth by the Alternative Minimum Tax
Laws. We hope that our situation can assist with putting into place
changes that will allow for more reasonable tax policy as opposed to
such restrictions that have been causing financial turmoil & ruin for
so many Americans.
I am attaching the original letter that we submitted June 04 to the
Ways & Means Oversight ``Tax Simplification Hearing'' although the
language is a tad bitter, I felt it needed to be included as we truly
feel that this has come to harm so many taxpayers. It was a plea for
help because our situation, while unique, is so similar to many other
Americans and we felt helpless. My only hope is that you will read it
with compassion and be open-minded as there are thousands of stories
that are more heart wrenching than ours.
Please help us implement a new tax law that does not create a
phantom tax on unrealized gain. No one should have to pay tax for
something that is not tangible, but rather looks good on paper. We beg
of you and your committee members to take a look at how this would
affect you if you were faced with the same situation. Only then will
change be possible.
Respectfully,
Joseph Cena & Dawn Hasegawa
______
I write to thank you for taking on the difficult task of
simplifying our tax code. I respectfully enlist your support and ask
you to please act for the sake of thousands of families who are being
financially decimated (mine included), for the sake of the general U.S.
economy that is being adversely affected, to help hard working
taxpayers regain faith in the IRS and to repeal one of the most
egregious applications of Tax Policy ever enacted: the dreaded and
stealthy Alternative Minimum Tax (AMT).
This woefully outdated policy forced me and my family into a 2000%
tax bracket in 2000 and required us to provide an interest free loan to
Treasury that will take us 433 years to receive back!!
A little bit about us:
My family has lived and worked in California for 26 years. Our home
is a 56-year-old, 1,245-sq-ft., 3-bedroom ranch home in Cupertino
California. We have a 9-year-old son, Justin. My wife, Dawn, is a
unionized Registered Nurse of 23 years who is currently working in the
Stanford University Hospital Emergency Room. Both of us are approaching
our fifties, and our living parents require our financial support,
which we are unable to provide in our current situation. As you will
easily understand, our experience with the AMT has been very stressful
on our family and we have come close to divorce over this!
I started my career in the electronic manufacturing sector working
on programs for the Department of Defense, the first MRI unit, and
other dynamic technological areas of industry. I proceeded to Stanford
University where I consulted on exciting projects such as the Hubble
Telescope, Sun-Net, the Rel-Gyro project (Testing Einstein's Theories),
and helped the founders of Cisco Systems. From there it was back into
High-Tech in 1994-2001 at Synopsys, and Network Appliance. Both firms
offered stock options, and were on growth paths of 50-100% growth year
over year. I typically worked 10-14 hours per day, 5-6 days a week.
While I was a Customer Service Manager at Network Appliance, I was
diagnosed with a life threatening disability and in December 2000, I
started chemotherapy treatment. In spring 2001, while undergoing chemo,
our accountant informed us that we were subject to a parallel tax
called AMT and we were responsible for $2.1 million in tax to the IRS
and California even though we didn't sell or have a gain.
I was shocked to learn that the tax imposed had absolutely no
correlation to actual gains; and that it would actually be an
overpayment of $1.4 million!!! How is it possible that a law that was
enacted in 1969, to catch 155 wealthy people who didn't pay taxes, is
now forcing tens of thousands of hard working citizens and
entrepreneurs to legally pre-pay a tax and making it nearly impossible
for them to recoup the overpayment in their, or their children's
lifetime? To add insult to injury, the taxpayers who overpaid their
taxes to the government do not earn interest on their own money even
though Congress has established such safeguards for con-
sumers requiring banks, escrow companies, landlords and others to
provide interest income even on funds held in trust for even just a
short--term.
Many are being driven into bankruptcy over phantom gains. I am
certain that Congress did not intend to drive people to bankruptcy when
it created the AMT in 1969. Under the regular tax system if a taxpayer
overpays, he or she receives a refund in a lump sum, not so under AMT.
Impact on Us and the U.S. economy by not having our tax credit
returned:
Other than perhaps homeland security, there is no more important
issue affecting my family than the AMT. Thankfully, my illness is now
in remission. My wife and I had wanted to have more children, but we
discovered we are medically unable. We then thought to adopt but we are
financially unable to do so. I was laid-off during my disability in
2001 and have been out of work for three years. My unemployment ran out
long ago and we need the money. For example, my wife's 1991 Nissan
truck has 132,000 miles and needs replacing. It would help us
tremendously even if all we received was the interest on our credit.
I've have drawn up few business plans for ``start-ups,'' one a
consumer wireless application, real estate venture and others. If I had
my credit back I would put it to use to launch these businesses and
help contribute to our economy-putting putting people back to work--
people who would be paying income tax!!
Thank you for your time and consideration, I hope that with your
leadership and help Congress can quickly enact a fair and principled
reform to the ISO-AMT provisions and help us grow the economy.
D. Hasegawa & J. Cena
La Canada, California 91011
June 18, 2005
To Honorable Chairman William M. Thomas and House Ways and Means
Committee--Tax Reform Hearing
Dear Chairman Thomas and Committee Members,
I'm writing to beg you to change the tax code so that stories such
as mine never happen again.
When eToys was started in 1997, its founders quickly realized that
it would be difficult to know their market if everyone that worked for
them was a childless, young male. So it wasn't surprising that they
hired me as their 5th employee, a mid-thirties suburban mother with
experience in marketing and website design. I initially worked part-
time, as I wanted to spend time with my young children. When the
company was low on cash, they offered to give me part of my
compensation in stock options. I didn't know anything about stock
options, but accepted, knowing that whatever happened, I was there
primarily because I really enjoyed my job.
The company went public in May, 1999, but because of a lockout
period and a blackout period, we weren't able to sell any of our stock
until February, 2000. In the meantime, I exercised as many shares as I
could, sometimes when the stock was trading as high as $68. I had also
become a full-time employee, because the company decided it didn't want
part-timers anymore.
Unfortunately, by February, 2000 I needed to sell my stock just to
pay my tax bill. Even though my income for 1999 had been $85,500, I had
to pay an Alternative Minimum Tax of $424,100 because I was taxed as if
I'd had income as high as the price the stock was selling for each day
I exercised my options.
Thankfully, the company's stock hadn't been de-listed yet, so I was
able to sell my shares to pay my tax bill. I've been trying to get AMT
overpayment back from the IRS, so far to no avail.
I implore you to do what you can to reform our nation's tax code so
that this doesn't happen to anyone else, and so that I can recover the
overpayments that have become a lifetime interest free loan to the
government. I know that ReformAMT and the Coalition for Tax Fairness
are working hard to support targeted ISO AMT legislation to bring
immediate relief to ISO AMT victims, many of whom will be financially
irretrievably destroyed if relief is not provided in the next few
months.
Taxation without income is wrong. Thankfully, so is taxation
without representation, and I'm relying upon you to do the right thing.
Sincerely,
Kathryn C. Hernandez
New York, New York 10024
June 21, 2005
Dear Chairman Thomas and Committee Members:
My name is Tony Kadillak. I was born and raised in Butte, Montana,
and graduated from Montana State University in Bozeman. After college I
moved to the Bay Area in California to get my career start, where I
landed a job with a startup called Ariba, Inc. I worked there nearly
four years before being laid off in a massive restructuring, a result
of the economic downturn and the dot-com meltdown.
I am yet another unsuspecting victim of the Alternative Minimum
Tax. Due to a stock options exercise, I'm being taxed over $1.2 Million
on stock that yielded actual capital gains of approximately $125,000. I
can't possibly afford to pay a tax on money I never received, yet the
IRS seems unable or unwilling to work out a solution that is in line
with the actual capital gain I realized.
Fours years on, I have experienced the following: My Offer in
Compromise experience took almost a full year of my life, and in the
end, the IRS rejected my offer. I decided to take my appeal to Tax
Court in hopes it would provide some relief, but after 2+ years I still
haven't seen any result. Last year my wife and I moved to New York, and
decided to sell our condominium in San Francisco. Unbeknownst to us,
the IRS had placed a lien on the property, and we were forced to
surrender 100% of the equity in the sale. We were rejected for numerous
apartment rentals in the New York area because of the federal lien.
Only after begging a building owner and offering a 4-month security
deposit were we able to find a place to live. We're expecting our first
child in September, and I have no idea how we'll ever cover our basic
costs if the IRS starts garnishing my wages.
Every day I live with this tax looming over me like a dark cloud. I
would love to pay my fair share, but I simply can't fathom how I'm
being taxed on money I never saw. Please act now to correct this
injustice--tax people when they sell the stock, not on phantom gain
they ``receive'' upon exercise. Thousands of us deserve the opportunity
to piece our lives back together.
Thank you for your consideration.
Tony Kadillak
Statement of J. Michael Keeling, The ESOP Association
Summary:
1. The Ways and Means Committee (the Committee) should make
recommendations that are consistent with President Bush's policy goal
to encourage and promote an ``Ownership Society''.
2. If the Ways and Means Committee does not make recommendations
for major changes in the current tax systems, there are several changes
in current tax laws to encourage more employee ownership through ESOPs.
3. In studying the current tax laws encouraging employee ownership
through ESOPs, the legislative history of ESOP law leads to conclusion
that ESOP law may be reviewed in context of tax favored employer proved
benefits, or in the context of tax laws encouraging entrepreneurship,
productivity, and American competitiveness on both a corporate, and
individual scale.
______
The ESOP Association's Written Statement for the Record of Ways and
Means Committee's Hearing On Tax Reform
``To give every American a stake in the promise and future--we
will--build an ownership society. We will widen the ownership of homes
and businesses, retirement savings, and health insurance--preparing our
people for the challenges of life in a free society.
By making every citizen an agenda of his or her own destiny, we
will give our fellow Americans greater freedom from want and fear and
make our society more prosperous and just and equal.''
President George W. Bush, January 20, 2005.
Part I
General and Primary Position
The ESOP Association, on behalf of the employee ownership
community, respectfully asks that the Committee on Ways and Means (the
Committee) make it a goal of any work reforming tax laws that the
Federal tax system continues to encourage and promote an ownership
society, where many average income citizens are owners, in addition to
the goals of a more fair, simple, and efficient Federal tax system.
The ESOP Association recognizes that current Federal tax law
encourages and promotes employee ownership through ESOPs, and that in
the 30 plus years these laws have existed, employee ownership through
ESOPs has in the overwhelming majority of instances provided
significant wealth to employee owners, and has in the overwhelming
majority of instances made the employee-owned companies high performing
companies in comparison to their non-employee-owned competitors.
(Summary of research data attached.)
The ESOP Association recognizes the Committee has many options to
reform the Federal tax laws; for example, the Committee may recommend
to the full House a major overhaul of the current Federal tax system,
moving the current income tax based system to a so-called ``flat-rate''
system with few exceptions to the general rule that all income of
whatever source and form is subject to tax, or to a consumption tax
such as a national sales tax or value added tax, or to a hybrid system
of both.
The ESOP Association notes to the Committee that no matter what the
major structure of the Federal tax system may be, consumption or
income, or both, there are many methods to be sure it contains
provisions that encourages and promotes ownership by average income
citizens.
Based on real world experience, a system that enables average
income citizens to be ``financed'' into an ownership state is more
effective in creating significant ownership than voluntary savings
plans, which are most utilized by citizens with ample income.
Theories of how to expand ownership through finance were put to
Congress by Senator Russell B. Long from 1974 through 1986, and
resulted in the current laws for ESOPs, which do finance average pay
employees into ownership positions. Since 1996, the House Ways and
Means Committee has played a bigger role in protecting and expanding
ownership through ESOPs than has the Senate.
A final point is that the one time that Congress made a major
overhaul of the Federal tax system, coming very close to a pure flat
tax system, was in 1986 under the leadership of President Ronald
Reagan. He and Senator Long made sure the Tax Reform Act of 1986 not
only maintained the tax laws favoring employee ownership through ESOPs,
but enhanced those laws. A similar result is possible with any proposal
by the Committee if it is agreed that promoting an ownership society is
an important goal of any Federal tax system.
In summary, the ESOP community's general position towards the tax
reform efforts is in alignment with the words spoken by President Bush
in his Inaugural Address that an ownership society will build a more
prosperous, more just, and more equal society. Therefore, the ESOP
community urges the Committee to have as a goal whatever tax system it
endorses, income or consumption, the recommended Federal tax system
should encourage and promote an ownership society where ownership is
widespread, among average income Americans.
To reach this goal in the context of the system that the Committee
may endorse, The ESOP Association stands ready to provide input on any
of the details of any tax system in order to be sure it promotes a true
ownership society.
Part II
Specific Ideas to Promote Employee Ownership If Committee Does Not
Recommend Major Changes in Current Federal Tax System
Assuming the Committee does not recommend significant, major
restructuring of the current Federal income tax system, The ESOP
Association recommends modest, but significant steps to create more
employee owners through ESOP arrangements, and to permit better
operation of existing ESOPs. The recommendations are particularly
pointed to two areas: One, situations where an S corporation is
partially owned by an ESOP, and two, in the universe of publicly-traded
companies. Many may be characterized as ``simplification'' proposals of
certain current ESOP related tax provisions.
Brief summary history is in order to understand these recommended
positions. Under current law, Congress has established significant tax
incentives for small to mid-sized privately owned businesses to
establish employee ownership through ESOPs, primarily by encouraging
the current shareholder[s] who are exiting the business to sell shares
to the ESOP, if the business is a C corporation. For S corporations
Congress has established a method of taxing the ESOPs share of an S
corporations' income that encourages the creation of S corporations
owned 100% by the ESOP. Current law does not necessarily encourage S
corporations to establish employee ownership through ESOPs where the
ESOP owns a minority of the S corporation, and even has somewhat of a
barrier to the continued operation of an ESOP that owns a minority of
an S corporation. Current law also does not directly encourage
publicly-traded companies to expand ownership to employees through an
ESOP.
In essence, The ESOP Association would want to see an expansion of
ownership through ESOPs with specific provisions of law that addresses
the barriers to ESOP creation and operation, in both C and S
corporations, and both private and public companies.
Here are some ideas for new law, but certainly not exhaustive, that
assumes no major change in Federal tax law, as all ideas were developed
in the context of current law. Many of these legislative ideas were
included in HR 4796 and S 2298, introduced in the 108th Congress.
1. Repeal the punitive 10% penalty tax on S corporations'
distributions from current earnings, also referred to as dividends,
paid on ESOP stock that are passed through to ESOP participants in
cash. (Participants will pay regular income tax on the cash received.
Based on prior Joint Committee on Taxation revenue estimates of repeal
of excise taxes, this revision should raise revenue.) Such a change
would equalize treatment of cash dividends distributed between C
corporations and S corporations as the treatment for C corporation
dividends has no penalty tax imposed.
2. Permit sellers of stock to the ESOP on an S corporation to
utilize the ESOP tax benefit referred to as the tax deferred rollover,
or the 1042 treatment.
3. Clarify that dividends paid by C corporations on ESOP stock
are not a preference item in calculating the corporate alternative
minimum tax.
4. Permit proceeds received from a 1042 transaction to be
invested in mutual funds consisting of operating U.S. corporation's
securities.
5. Redefine what is a 25% owner for purposes of IRC 1042 to be
25% or more owner of voting stock, or 25% or more owner of all stock of
the corporation, not 25% of any class of stock. IRC 1042 imposes
restrictions on 25% owners' participation in a 1042 ESOP.
6. Permit early withdrawals from ESOP for first time home
purchases, and college tuition under limited circumstances.
7. Increase de minimus amount in an ESOP account not subject to
mandated diversification from $500 per account to $5,000 per account.
There should be no revenue impact from this change. In 1986, Congress
passed a law mandating that an ESOP participant be permitted to
diversity his or her account from employer securities over a five year
period up to 50% of the account balance if the account was over $500.
The $500 level has never been altered in the past 20 years, whereas
nearly all other de minimus amounts cited in ERISA law have increased
either under a standard inflation adjuster, or by specific law. It is
not reasonable to require the administrative headaches of diversifying
accounts under $5,000 as that amount is not enough to ensure a secure
retirement.
8. Allow a corporation selling a division or subsidiary to an
ESOP company to utilize 1042 to defer the corporate capital gains tax.
9. Permit a tax deduction for transfer of stock at less than fair
market value that equals the difference between the transfer price and
the fair market value price. Under certain circumstances, transferring
stock at less than fair market value triggers a favorable gift tax
deduction. The contemplated provision would provide for an income tax
deduction.
10. Clarify impact of 25%/5% ownership rule for allocations in a
post-1042 transaction. Current law has a quirk that eliminates an
exception to the 5% rule for lineal descendants but in the 25%
ownership rule covers the same lineal descendants nullifying the 5%
rule exception.
11. Permitting holders of ``Section 83'' stock to sell that stock,
if not-publicly traded, to an ESOP and utilize the ESOP tax deferred
rollover provision (Code Section 1042) if employees acquired stock at
fair-market value. This provision arises from both a current law
provision in 1042 that does not permit stock held by an employee
because of the exercise of a stock option to utilize 1042, and from a
series of IRS letter rulings in the late 80's that expanded the limit
on 1042 utilization to all stock held by an employee because of his/her
receiving it because of a program of the employer, even if the employee
bought the stock at fair market value. The current law is not fair as
employees who obtained stock paying fair market value because of
employment do not have the same treatment as an owner-founder, or
outside investor, who can sell stock to the ESOP and defer the cap
gains tax under Section 1042.
12. In the estate and gift tax is maintained, and not totally
repealed, consider these ideas:
A. Restoration of the shifting of the estate tax liability
from an estate to the ESOP sponsor if estate transfers stock to
the ESOP. This provision would be a restoration of a 1984 pro-
ESOP law that was repealed in 1989 during a series of cutbacks
in ESOP tax incentives. It was Code Section 2210. At no time
from 1984 to1989 did the provision lose more than $5 million
per year in revenue, and estimates made for a variety of pro-
ESOP bills containing the provision since 1990 have always been
less than $5million.
B. Treat non-corporate donations of company stock to ESOP as
a charitable contribution for purposes of income, estate, and
gift taxes.
Part III
Proper Input from Employee Ownership Community to the Committee
Given the hybrid nature of employee ownership in all of its various
forms, it is possible for the Committee to slot a review of how
employee ownership fits into any tax system in two different general
areas.
One, it is clear, particularly for ESOP discussions, that employee
ownership is tied to the compensation decisions of the employer, either
current, or deferred. Two, nearly all employee ownership plans arise
from deferred compensation schemes. Three, nearly all therefore fall
into the generally accepted category of employer provided benefits. And
four, within the general area of employer provided benefits, the major
employee stock compensation schemes are part of the Federal retirement
income security laws, or ERISA.
Thus, there is no doubt that any review of how our tax system might
impact, or should impact the encouragement of broad ownership in our
society, could be done in the context of how current law, and proposed
law, might impact employers' actions to compensate employees as part of
an employer provided benefits package.
On the other hand, most of the social research, and the
justification for broad based employee ownership revolves not just
around employee income security, but also on how ownership increases
citizen responsibility, citizen entrepreneurship attitudes, self-
esteem, community involvement, and the performance of companies with
broad based ownership among its employees. These concepts are in sync
with the views of President Bush, as expressed in his Inaugural Address
cited above, and certainly are in sync with his expressions of why wide
spread home ownership is important.
Thus, any review of employee ownership by the Committee could focus
on whether the tax system of the United States should encourage
employee ownership, in order to increase not just personal wealth, but
also whether to encourage the ownership behavior that leads to high
performing companies, better and more involved citizens, and employees
who are more likely to approach their work in an entrepreneurial
manner.
Or, of course, the Committee could measure the effectiveness of
broad based employee ownership in the review of both areas of the tax
laws--both as employer provided benefits, and as a way to make American
companies and their employees more productive, entrepreneurial, and
connected to the community.
In any manner, The ESOP Association stands ready to dig into both
the macro and micro evidence of why the Committee should endorse a tax
system that helps create the Ownership Society called for by President
Bush.
______
Attachment
Employee Ownership and Corporate Performance
1. In 2004, the Employee Ownership Foundation, conducting its 13th
Annual Economic Performance Survey, found that a very high percentage
of companies, 88%, declared that creating employee ownership through an
ESOP (employee stockownership plan) was ``a good decision that has
helped the company.'' In addition, the EPS asked companies to indicate
their performance in 2003, relative to 2002. Approximately 65% of
respondents indicated a better performance in 2003 than 2002, 12%
indicated a nearly identical performance, and 23% indicated a worse
performance. Around 70% indicated that revenue increased while 30%
indicated revenue did not increase. In terms of profitability, 64%
indicated that profitability did increase and 36% indicated that
profitability did not increase in 2003. This survey was conducted in
the summer of 2004 among corporate members of The ESOP Association.
2. The most comprehensive and significant study to date of ESOP
performance in closely held companies was conducted by Dr. Joseph R.
Blasi and Dr. Douglas L. Kruse, professors at the School of Management
and Labor Relations at Rutgers University, and funded in part by the
Employee Ownership Foundation. The study, which paired 1,100 ESOP
companies with 1,100 comparable non-ESOP companies and followed the
businesses for over a decade, reported overwhelmingly positive and
remarkable results indicating that ESOPs appear to increase sales,
employment, and sales/employee by about 2.3% to 2.4% over what would
have been anticipated, absent an ESOP. In addition, Drs. Blasi and
Kruse examined whether ESOP companies stayed in business longer than
non-ESOP companies and found that 77.9% of the ESOP companies followed
as part of the survey survived as compared to 62.3% of the comparable
non-ESOP companies. According to Drs. Blasi and Kruse, ESOP companies
are also more likely to continue operating as independent companies
over the course of several years. Also, it is substantially more
probable that ESOP companies have other retirement-oriented benefit
plans than comparable non-ESOP companies, such as defined benefit
plans, 401(k) plans, and profit sharing plans.
3. Research done by the Washington State Department of Community,
Trade and Economic Development of over 100 Washington not publicly-
traded ESOP companies compared to 500 not publicly-traded non-ESOP
companies showed that the ESOP companies paid better benefits, had
twice the retirement income for employees, and paid higher wages than
their non-ESOP counterparts. Wealth and Income Consequences of Employee
Ownership: A Comparative Study from Washington State, Kardas, Peter A.,
Scharf, Adria L., Keogh, Jim, November, 1998.
4. Research conducted by Professor Hamid Mehran, while he served
on the faculty of the J.L. Kellogg Graduate School of Management,
Northwestern University, of nearly 400 publicly traded companies with
significant ESOPs both before and after the adoption of the ESOP,
compared to non-ESOP companies in similar lines of businesses, showed
that the rate of return for the ESOP companies was 2.7% higher, 60% of
the ESOP companies experienced share price increases upon announcement
of the ESOP program, and 82% indicated that the ESOP had a positive
impact on business results.
5. In 1995, Douglas Kruse of Rutgers University examined several
different studies between ESOPs and productivity growth. Kruse found
through an analysis of all studies that ``positive and significant
coefficients [are found] much more often than would be expected if
there were no true relation between ESOPs and productivity.'' Kruse
concludes that ``the average estimated productivity difference between
ESOP and non-ESOP firms is 5.3%, while the average estimated pre/post-
adoption difference is 4.4% and the post-adoption growth rate is 0.6%
higher in ESOP firms. Kruse cites two studies as part of his research:
Kumbhakar and Dunbar's 1993 study of 123 public firms and Mitchell's
1990 study of 495 U.S. business units in public firms. Both reports
found significant positive effects of greater productivity and
profitability in the first few years after a company adopted an ESOP.
6. In 1995, the U.S. Department of Labor released a study entitled
``The Financial and Non-Financial Returns to Innovative Workplace
Practices: A Critical Review.'' This study found that companies that
seek employee participation, give employees company stock, and train
employees, can positively affect American corporations' bottom lines.
In addition, the report cited three studies that analyzed ``the market
reaction to announcements of ESOPs which found significant positive
returns to firms which implemented ESOPs as part of a broader employee
benefit or wage concession plan.'' The three studies are: Chang's 1990
``Employee Stock Ownership Plans and Shareholder Wealth: An Empirical
Investigation''; Dhillon and Ramirez' 1994 ``Employee Stock Ownership
and Corporate Control''; and Gordon and Pound's 1990 ``ESOPs and
Corporate Control.'' citation.
Westminster, Massachusetts 01473
June 22, 2005
Dear Chairman Thomas and Committee Members:
I was contacted yesterday via email by an organization I have been
associated with for the last several years known as ReformAMT
(www.reformat.org). I joined this organization sometime after being hit
with a substantial tax bill in the form of AMT tax in the tax year
2000. They have informed me of your panel and you're looking for input
on the following items regarding current tax laws:
Headaches, unnecessary complexity, and burdens that
taxpayers--both Individual's and businesses--face because of the
existing system.
Aspects of the tax system that are unfair.
Specific examples of how the tax code distorts important
business or personal decisions.
Goals that the Panel should try to achieve as it
evaluates the existing tax system and recommends options for reform.
In regards to the following item:
Headaches, unnecessary complexity, and burdens that
taxpayers--both individuals and businesses--face because of the
existing system.
I have worked most of my adult life at start up high technical
companies which commonly issued stock options as a form of
compensation. One grant I received in 1997 was for ISO options, the
rest were for Non-Qualified options. It is the ISO options that have
created my headache. With the ISO options the general prevailing
philosophy on the sales of these options was to exercise them and hold
them for at least a year so that they would be taxed as long term
capitol gains. This philosophy appears to have been a recipe for over
taxation in the form of AMT tax when held in the context of the boom
period of 1999-2001. While my employer held seminars on the
implications that stock options had on potential tax burdens, we would
be advised to consult with our own private tax consultant on our
specific details. The problem is many tax consultants seemed to be
inadequately informed on the matter of stock sales, ISO options and AMT
tax implications. The result of attempting to do the correct thing for
me to put myself in a tax situation where my ISO options would be
taxable as long term gains resulted in being taxed on potential income
that I have never made. Indeed four years later the stock my ISO's were
granted in have still not approached the values that my AMT tax was
based upon. I have since sold these shares to pay for my AMT
obligation, but I am extremely disappointed at the opportunity lost. I
am not an accountant and to this day still do not know what would have
been the correct way to handle my ISO options.
I have continued to seek accounting help in this area several years
after the fact, I have involved myself in the organization ReformAMT
and hope that some day a clearer more representative taxation on my ISO
sales will be implemented and I will have some restitution on my AMT
taxes paid.
I am not a millionaire. I do not earn $200,000.00 every year. I had
several exceptional earnings years based upon stock options in the late
90's and early 2000. I am not now nor have I ever been close to
bankruptcy. I have paid all my tax bills. I do believe that due to the
current tax laws and lack of correct advice I have been overtaxed in
the form of AMT tax on ISO options for profits I will never earn. I
also feel that the government has impacted my ability to provide
greater stability in the form of financial security to both my children
and my spouse and I as we get older. This seems shameful to me that
taxation laws could have this kind of impact on a family.
In regards to the following item:
Aspects of the tax system that are unfair.
Any tax law that taxes people on potential future earnings and then
does not return those taxes if the earnings are not realized is just
plain unfair.
In regards to the following item:
Specific examples of how the tax code distorts important
business or personal decisions.
For me my important decisions had to do with funding my children's
educations and providing for my wife and I in retirement. Due to the
complexity and lack of correct advice in ISO/AMT matters my ability to
properly plan for these items have been adversely impacted.
In regards to the following item:
Goals that the Panel should try to achieve as it
evaluates the existing tax system and recommends options for reform.
My primary goal for this panel is to recover AMT taxes assessed in
the year 2000 for exercise of ISO stock options. My secondary goal
would be obviously for others who have been impacted similarly to have
there AMT recovered as well. My third goal would be a review of the AMT
tax laws to see if they make since and due whatever it is they were
originally intended to do. If they do a new less complicated method of
implementing these needs to be developed. Currently the AMT taxation
rules are even to complicated for most accountants to properly explain
to clients.
While I have not commented on specifics of my AMT impact other than
the time frames and personal feelings towards the issue, I would be
more than happy to meet with the panel to discuss any specific detail
of my AMT experience. I am not comfortable providing more specific
details in this letter, as I am told it would be public record.
Feel free to contact me.
Sincerely,
Todd Keen
Statement of Debra and John Kelly, San Leon, Texas
Dear Chairman Thomas and Committee Members,
I want to tell you my story to see if you can help by providing
needed legislative Tax reform. Specifically the AMT, (Alternate Minimum
Tax).
In 2002 I retired from a 20 year career in the pharmaceutical
industry.
IDEC Pharmaceuticals did very well and I received some ISO's. All
the hard work and sacrifice was going to pay off and more. I was not in
management.
I wanted to be at home with my Husband and children.
When I retired IDEC stock was trading at $78 a share. My holdings
were in ISO's (incentive stock options). When I retired, by company
policy, I had to exercise my ISO's.
I purchased my ISO's and held my stock.
Now understand, I did not cash this stock, did not realize wealth
from this stock.
In three months, summer of 2002, the ENRON collapse came. Its
effect on the entire stock market was unbelievable. My share price went
from $78 to $21. It would have been only troublesome, had I been able
to wait out the recovery of the IDEC stock.
But I owed a tax on money I never received. How can this be??
April 15th of 2003 I was going to have a tax debt higher than the
stock was worth and my ability to pay.
AMT tax was going to be due. AMT tax I owed for ISO's that were
trading at $78 a share were now trading at $21a share. In addition I
would owe capital gain tax by selling the stock to pay the AMT tax.
Double taxation!
I can not begin to tell you my disbelief, sadness, shock! I am an
honest hard working middle class citizen. How could my government do
this and legally?? My dreams were destroyed.
When the stock crept back up to $40 a share I elected to sell my
stock. I would have enough money to pay my tax debt and pay my bills. I
had little money left.
I was getting advice to take an extension to pay the IRS, ride out
the stock market. But in light of the world events and the volatile
nature of the market my husband and I elected to sell the stock and cut
our losses.
We did not want to risk loosing our home by incurring debt to the
IRS.
April 15th, 2003 I paid my tax owed, in Full. I did not take an
extension with the IRS.
Then the fall of 2003 the tax law changed.
Due to the changes in the tax law the IRS owed me money back.
I received some money back in June 2004.
Now the IRS owes me $239,000.
But the IRS doesn't have to pay me right now. I get a tax credit.
The IRS doesn't have to give me penalties or interest on the amount.
I receive a benefit of about $11,000 credit back each year. I still
have to pay money in to the IRS.
At that rate I'll get my money back in about 30 years.
If I owed the IRS that kind of money they would come take my home.
Garnish my wages.
It is not just.
It's not right.
IF I could have stayed in the stock market, sold my IDEC stock on
an as needed basis and paid regular capital gain on the sell I would be
in incredible financial shape today.
What if??
Now my story isn't as extreme as others I know.
I don't have any debt to the IRS and have not entered into court
battles.
It has not financially devastated me.
But I have had to make decisions that have grossly affected my
financial situation.
I went from $1.2 million in IDEC ISO stock to $40,000 in my
Brokerage account. My Husband and I spend $4,000 a month in household
expenses.
We both are working and saving for retirement.
I am not an extravagant person.
At present I have two children in College.
My mother is entering into assisted living.
My husband and I work to make the college payments and ends meet.
My husband is retired Military and my son is starting his second
tour in Iraq.
I am an Oncology Nurse at MD Anderson.
What's done is done.
But why can't I have what the IRS owes us?
Not so much to ask.
We need to make our government live by real world standards.
We need to make the highly paid CEO's account for mistakes.
I know we all live in a complex world and simple answers are hard
to find.
But enacting legislation that prohibits the IRS from owing money to
tax payers is an easy fix. You have the power.
I cannot believe that this is what the government intended with Tax
Laws.
We depend on you to protect us.
Please make the IRS pay me the money they owe us. So we can invest
that money to rebuild our family's future.
Note. This is a simplified version. For answers to any tax
questions contact me and I will put you in contact with my attorney
Scott Mitchell or AMT TAX Reform organization.
Retail Industry Leaders Association
Arlington, Virginia 22209
June 21, 2005
Chairman William M. Thomas
House Ways and Means Committee
1102 Longworth House Office Building
Washington, D.C. 20515
Dear Chairman Thomas:
As President of the Retail Industry Leaders Association (RILA), I
appreciate the opportunity to submit comments related to the
committee's hearing on fundamental tax reform of June 8, 2005.
I commend you for undertaking such a Herculean task as fundamental
tax reform. I understand you have made significant efforts to educate
members of the committee on issues related to fundamental tax reform.
The tutorials provided by the staff of the Joint Committee on Taxation
have given members of the committee a broad understanding of the terms
being used by proponents of the various proposals. I appreciate too,
that you have urged Members of Congress and other interested parties
not to cling too tightly to labels during consideration of the various
proposals.
The Retail Industry Leaders Association (RILA) represents the
nation's most successful and innovative retailer and supplier
companies--the leaders of the retail industry. Retail is the second
largest industry in the U.S., representing $3.8 trillion in annual
sales and 12 percent of our nation's workforce. RILA member retailers
and suppliers operate 100,000 stores, manufacturing facilities and
distribution centers throughout every congressional district in every
state, as well as internationally.
We have serious concerns about the effect of a national sales tax
on retail sales and the economy at large. A 2000 letter from former
Joint Committee on Taxation Chief of Staff Lindy Paull suggests a 59.5%
national retail sales tax rate is needed for the tax to be revenue
neutral over five years. This would have a significant depressing
effect on retail sales, putting the cost of many basic commodities and
other items out of reach for millions of Americans.
Many national sales tax advocates wish to repeal the current income
tax system to eliminate the possibility of having a sales tax layered
on top of the current federal income tax. Repeal of the income tax
would require amending the United States Constitution. Given the
difficultly and infrequency of a Constitutional amendment, the
possibility of both a national sales tax existing along with the
federal income tax seems altogether possible.
RILA members are also concerned about the effect of a value added
tax on consumer goods. We are concerned about the lack of transparency
and the tendency of the tax to be ratcheted up over time without
knowledge of the consumer. I understand that you are looking very
closely at the ``subtraction method'' VAT, as used in Japan. While this
plan does have some characteristics less onerous than the traditional
European method VAT, concerns about transparency remain. Additionally,
retailers are concerned about the complexity of the administration of
the VAT.
Another proposal that has been floated by proponents of fundamental
tax reform is a flat tax. A flat tax is similar to a national sales tax
in that one rate is applied across the board, albeit one levied on
income rather expenditures. Again, the rate needed to be revenue
neutral would be unpalatable to most taxpayers, and the axiom ``simpler
isn't necessarily fairer'' is well-proven by the innate unfairness of a
such a high income tax rate on lower income Americans.
In conclusion, RILA respectfully requests that you keep the retail
sector and the purchasing power of the American consumer in mind as you
consider various tax proposals. We stand ready to assist you, the
Committee and your staff with any additional information you may seek
regarding the retail sector.
Thank you for your consideration of our views.
Sincerely,
Sandra L. Kennedy
Statement of David Koenig, American Forest & Paper Association
Summary
U.S. manufacturing is at the heart of a vibrant economy that has
produced the highest living standards in the world. But today,
manufacturing faces serious domestic and international challenges
which, if not overcome, will lead to reduced economic growth and
ultimately a decline in living standards for future generations of
Americans.
The U.S. forest products industry is no exception to the challenges
facing U.S. manufacturing industries. Today, the forest products
industry is facing serious threats to its continued viability. U.S.
paper mills and wood products mills are permanently closing their
doors, resulting in a loss of American jobs. At the same time, our
foreign competitors, facing generally lower taxes, are expanding their
capacity.
An April 2005 report by PricewaterhouseCoopers on behalf of the
American Forest & Paper Association examined the effect of the U.S.
income tax system--both the individual income tax and the corporate
income tax--on the competitiveness of corporations in the U.S. paper
manufacturing and timber producing sectors.
As described in this submission, the report found that U.S. income
taxes are the second-least favorable of the major competing nations.
U.S. tax rules consistently raise disadvantages for U.S. corporate
investments relative to the tax rules in most of the competing nations.
The overall effect is that U.S. companies cannot profitably undertake
certain investments that foreign competitors can undertake because U.S.
investors would be left with too little after paying tax whereas
foreign investors would enjoy a sufficient return after paying tax.
Because U.S. companies compete against foreign companies in capital and
product markets both at home and abroad, the U.S. tax disadvantage
ultimately limits the degree to which U.S. companies may successfully
challenge foreign competitors.
Significant reform of the U.S. tax system is necessary in order for
the U.S. tax system to not excessively hinder U.S. competitiveness.
Options that should be considered for reform include significant rate
reduction at both the corporate and individual levels and more
advantageous rules for recovering the costs of business investment. The
United States should also consider fully exempting from tax the foreign
income of U.S.-headquartered multinational corporations, as is the
practice of many of our trading partners with respect to the foreign
income of multinational corporations headquartered within their
countries.
A competitive, reformed tax system holds significant promise for
the American forest products industry and can provide the best
opportunity for American workers to attain ever higher living
standards.
Achieving Tax Competitiveness: Options for Tax Reform
U.S. manufacturing is at the heart of a vibrant economy that has
produced the highest living standards in the world. But today,
manufacturing faces serious domestic and international challenges
which, if not overcome, will lead to reduced economic growth and
ultimately a decline in living standards for future generations of
Americans.
The U.S. forest products industry is no exception to the challenges
facing U.S. manufacturing industries. Today, the forest products
industry is facing serious threats to its continued viability. Since
1998, 98 paper mills and 142 wood products mills have permanently
closed their doors, resulting in the loss of nearly 140,000 jobs. At
the same time, our foreign competitors, facing generally lower taxes,
are expanding their capacity.
An April 2005 report by PricewaterhouseCoopers on behalf of the
American Forest & Paper Association examined the effect of the U.S.
income tax system--both the individual income tax and the corporate
income tax--on the competitiveness of corporations in the U.S. paper
manufacturing and timber producing sectors. The report, Taxes in
Competing Nations: Their Effects on Investments in Paper Manufacturing
and Timber Production, and a companion policy paper providing reform
options, Reducing Tax Disincentives for Corporate Investments in Paper
Manufacturing and Timber Production, are included in this submission.
The report compared income taxes in the United States with income taxes
in seven other competing countries in terms of facilitating or
inhibiting investments in paper manufacturing and timber production.
The seven foreign countries selected--Brazil, Canada, China, Finland,
Germany, Indonesia, and Russia--compete aggressively with U.S.
companies in paper manufacturing and timber production.
The report found that U.S. income taxes are the second-least
favorable of the major competing nations. U.S. tax rules consistently
raise disadvantages for U.S. corporate investments relative to the tax
rules in most of the competing nations. The overall effect is that U.S.
companies cannot profitably undertake certain investments that foreign
competitors can undertake because U.S. investors would be left with too
little after paying tax whereas foreign investors would enjoy a
sufficient return after paying tax. Because U.S. companies compete
against foreign companies in capital and product markets both at home
and abroad, the U.S. tax disadvantage ultimately limits the degree to
which U.S. companies may successfully challenge foreign competitors.
Significant reform of the U.S. tax system is necessary in order for
the U.S. tax system to not excessively hinder U.S. competitiveness.
Options that should be considered for reform include significant tax
rate reduction for businesses at both the corporate and individual
levels. Also, restoring a differential in the tax paid by corporations
on capital gains income relative to ordinary income would help the
competitive position of U.S. timber companies. While capital gains
income is insignificant for many manufacturers, most income from the
sale of timber qualifies as capital gain income.
More advantageous rules should be implemented for recovering the
costs of business investment, including expensing for business assets.
Furthermore, the corporate alternative minimum tax, an additional tax
burden placed on corporations that mandates even slower depreciation
allowances, should be repealed.
The United States should also consider exempting foreign income
from the active conduct of a trade or business as is the practice of
many of our trading partners. Further, U.S. companies may be currently
disadvantaged with respect to their exports (and face heightened import
competition) by the absence of border tax adjustments for U.S. income
taxes, while border tax adjustments for value added taxes are made by
our foreign competitors. A reformed system should be amenable to World
Trade Organization rules permitting border tax adjustments.
The Competitiveness Rankings
The specific rankings of the competing nations are displayed in
Exhibits 1 and 2. The rankings refer to income taxes levied on
corporate income, first the tax paid by the corporation and second the
tax paid by shareholders and lenders as a result of their financing the
investments that generated the corporate income. The rankings are based
on laws in effect for 2005, except for the United States where it was
assumed the fully-phased in nine-percent deduction for qualified
production activities applied.
In general, the United States and Canada have the least competitive
income taxes, while Brazil, China, Indonesia, and Russia have the most
competitive income taxes. Finland and Germany are closer to the least
competitive pair.
As explained in more detail in the accompanying report, the
rankings and conclusions are derived by computing effective tax rates
in the competing countries. An effective tax rate is the percentage of
income that is collected in income taxes over the life of a particular
investment project--namely, the project that just barely generates the
minimum rate of return required by investors, measured after taxes and
inflation.
Other rankings included in the report show that U.S. multinational
corporations in paper manufacturing operating abroad are similarly
disadvantaged relative to multinational corporations headquartered in
the competing nations.
As noted in the report, the analysis does not fully account for
several features unique to the U.S. tax system that serve to further
increase tax burdens on U.S. corporations. These include the corporate
alternative minimum tax, which provides for slower recovery of the
costs of business investments, rules requiring the capitalization of
indirect costs in inventory, and rules which serve to reduce the
crediting of foreign taxes.
Options for Reform
A number of options for reform are considered in the accompanying
policy paper to reduce the U.S. effective tax rate to that of the
median, or middle-ranked, of the competing nations. These reforms are
indicative of the extent of change necessary to make the U.S. tax
system simply moderately competitive with the tax systems of the
competing nations in paper manufacturing and timber production.
For corporate paper manufacturing, as shown in Exhibit 3, these
options include:
A 40-percent reduction in all top rates (including rates
on corporate income and individual income from interest, capital gains
and dividends);
Expensing for all equipment and structures;
A 10-percent investment tax credit; and
Various combinations of partial expensing or accelerated
depreciation combined with rate reductions.
The reform options shown in Exhibit 3 would also make U.S. income
taxes more favorable for U.S. investors who want to build a papermaking
facility abroad--provided, of course, that the options were also fully
applicable to foreign investments. In the past, the United States has
not allowed investment tax credits or accelerated depreciation for
equipment used outside the United States. The United States should also
consider fully exempting from tax foreign income from the active
conduct of a trade or business as is the practice of many of our major
trading partners.
Exhibit 4 presents reform optionsto reduce the U.S. tax rate on
corporate timber production income to that of the median of the
competing nations. These reform options include:
A 40-percent reduction in the corporate capital gain rate
for timber gain;
A more than 40-percent reduction in all top corporate and
individual rates;
Various combinations of rate reductions with expensing of
reforestation expenditures or investment tax credits.
We urge the Advisory Panel to study these options and give great
consideration to their adoption. It is important to understand the need
for substantial reductions in the tax burdens on corporate income in
order to provide a tax system that does not excessively hinder the
ability of U.S. corporations and U.S. workers to compete in the global
marketplace.
______
Exhibit 1
ISSUE: Where are the tax hurdles the highest for a corporation that
would invest in papermaking in its own country?
DOMESTIC TAXATION OF DOMESTIC CORPORATE PAPER MANUFACTURING
*Image not available
CONCLUSION: The U.S. tax system raises very high hurdles compared
to other countries. The effective tax rate of the United States is the
Second Highest in the competing group and 17 percentage points higher
than the median of the other countries.
______
Exhibit 2
ISSUE: Where are the tax hurdles the highest for a corporation that
would invest in forestry and timer in its own country?
DOMESTIC TAXATION OF DOMESTIC CORPORATE FORESTRY PRODUCTION
*Image not available
CONCLUSION: The U.S. tax system raises very high hurdles compared
to other countries. The effective tax rate of the United States is the
second highest in the competing group and 16 percentage points higher
than the median of the other countries.
______
Exhibit 3
Corporate Paper Manufacturing
WHAT IT TAKES TO BE COMPETITIVE
Current Status in 2005
U.S. effective tax rate = 51%
Median effective tax rate for competing nations = 34%
U.S. Alternatives for Change
1. Reduce the top individual and corporate income tax rates to 21
percent and to 9 percent for individual capital gains/dividends (a 40-
percent reduction in all top rates)
Makes the U.S. tax system moderately competitive.
2. Allow expensing in lieu of depreciation for new equipment and
structures.
Makes the U.S. tax system moderately competitive.
3. Adopt a 10-percent investment tax credit for new equipment.
Makes the U.S. tax system moderately competitive.
4. Eliminate the individual income tax on capital gains and
dividends.
Falls short. Reduces U.S. effective tax rate to 39
percent.
5. Composite #1. Allow expensing in lieu of depreciation for new
equipment (but not structures), and reduce the top individual and
corporate rate to 30 percent and to 12.5 percent for individual capital
gains/dividends (approximately a 15-percent reduction in all top
rates).
Makes the U.S. tax system moderately competitive.
6. Composite #2. Allow 50-percent bonus depreciation for new
equipment, and reduce the top individual and corporate rate to 25
percent and to 10 percent for individual capital gains/dividends
(approximately a 30-percent reduction in all top rates).
Makes the U.S. tax system moderately competitive.
7. Composite #3. Reduce the depreciation period for new equipment
from 7 years to 3 years (double declining balance) and for new
structures from 39 years to 20 years (straight line); also, reduce the
top individual and corporate rate to 27 percent and to 12 percent for
individual capital gains/dividends (approximately a 20-percent
reduction in all top rates).
Makes the U.S. tax system moderately competitive.
______
Exhibit 4
Corporate Timber Production
WHAT IT TAKES TO BE COMPETITIVE
2Current Status in 2005
U.S. effective tax rate = 37%
Median effective tax rate for competing nations = 22%
U.S. Alternatives for Change
1. Allow 40 percent of long-term capital gain from the sale of
timber to be excluded from taxable income (reducing the capital gain
tax rate on corporate timber to 21 percent).
Makes the U.S. tax system moderately competitive.
2. Reduce the top individual and corporate rate to 20 percent and
to 8.5 percent for individual capital gains/dividends (a more than 40-
percent reduction in all top rates).
Makes the U.S. tax system moderately competitive.
3. Adopt a 10-percent investment tax credit (ITC) for all
reforestation expenditures.
Falls short. Reduces U.S. effective tax rate to 35
percent.
4. Allow expensing for all reforestation expenditures in lieu of
amortization.
Falls short. Reduces U.S. effective tax rate to 35
percent.
5. Composite #1. Allow expensing for all reforestation expenditures
and reduce the top individual and corporate rate to 25 percent and to
10 percent for individual capital gains/dividends (approximately a 30-
percent reduction in all top rates).
Comes very close. Reduces U.S. effective tax rate to 24
percent.
6. Composite #2. 10-percent ITC for all reforestation expenditures
and exclude 30 percent of long-term capital gain on timber sales from
taxable income (reducing the tax rate on capital gain of corporate
timber to 24.5 percent).
Makes the U.S. tax system moderately competitive.
7. Composite #3. Allow expensing for all reforestation costs and
exclude 50 percent of long-term capital gain on timber sales from
taxable income (reducing the tax rate on capital gain of corporate
timber to 17.5 percent).
Makes the U.S. tax system moderately competitive.
Statement of Vivian Kramp, San Jose, California
I exercised 4600 shares of ISO stock at $61.0625 per share on 9/14/
2000. If I had sold at that point, the total value of the stock would
have been $212,827.90. But the stock tanked to $17 a share, for a value
of $78,200.
On my 2000 tax return I had to pay $78,864 in Alternative Minimum
tax, which is more than the stock was worth. My adjusted gross income
for that year was $79,596. Virtually all of my income for the entire
year went to pay the AMT. As a divorced woman I am receiving alimony
that diminishes in amount every year. In 3 more years, that will drop
to zero.
I was counting on the stock options to tide me over until I can
work again. With a special needs child, it is difficult to return to
work at this point. I can ill afford to pay almost $80K in AMT when the
stock value dropped so much. The AMT is affecting many middle class
people like myself, many in more dire straits than I. To pay my 2000
income tax bill I had to spend all of the profit from the sale of my
house after the divorce. I have heard stories of people losing their
homes and savings because of this tax.
To tax someone on paper profits is grossly unfair. If I had
actually sold the stock options, then the tax would be fair. The AMT
was supposed to target wealthy taxpayers, but the unintended
consequence has been to hit middle and lower income wage earners. We
are being destroyed by huge, unfair tax burdens. Please reform the AMT
to eliminate this problem.
Los Gatos, California 95033
March 18, 2005
To Honorable Chairman William M. Thomas and the House Ways and
Means Committee's Tax Reform Hearing:
My wife and I have paid an unfair tax. I am an individual engineer
who took a job with a technology company in 1998. The company offered
me incentive stock options. I exercised some of the options at a time
when the stock's value had dramatically increased. Not being a well
informed investor, I held the stock while its value dropped. I was
finally forced to sell the stock when the company was acquired.I have
gained nothing on this stock, but the U.S. and CA government have taxed
me approximately $50000 because of the Alternative Minimum Tax. I've
only received a fraction of the money back over the years since I paid
that tax. This tax has decimated my savings, and that has caused me and
my wife a lot of frustration. My wife, an immigrant from Russia, says
that her previous government was worthy of such an unfair practice, and
she has lost her faith in the fairness of the U.S. government. I think
the government owes me interest for holding so much of my money for so
long.
My coworkers sold their stock when they saw the value was dropping,
but I believed the hype that the Internet boom would continue and that
technology stock prices would remain strong. Why should the government
punish me for my lack of stock market savvy?
Regards,
Kirk Krauss
Mountain View, California 94040
June 19, 2005
Dear Chairman Thomas and Committee Members:
Thank you for the opportunity to voice my concerns regarding tax
reform. The main point of this submission is to call attention to the
``AMT/ISO problem'' (alternative minimum tax treatment of ``phantom
gains'' on incentive stock options), and to make a specific request for
retroactive relief for those affected in the past by this severely
unfair and inequitable tax burden. While the AMT system in general is
widely regarded as problematic, and deserves attention and
consideration of reform, this specific ``AMT/ISO problem'' is an
especially severe problem for those affected, and therefore requires
special attention. The reason is, while the typical effect of AMT may
be to increase one's tax liability by a few percentage points (say, 25%
of income instead of 20%), the ``AMT/ISO problem'' has, for numerous
taxpayers, caused a tax liability of 200% or more of their annual
income, ostensibly as a pre-payment of tax on anticipated future
capital gains. In theory, the AMT payment is recoverable in future
years as ``AMT credits'' when the anticipated capital gains, or other
similar amounts, are realized as actual income; in reality, if that
income is never realized, the ``excess'' tax paid as AMT may not be
recoverable as ``AMT credits'' within the lifetime of the taxpayer. The
question is, is it fair to assess an income tax on income that will
never be received, effectively imposing a tax rate of 200% or more when
compared with actual income? I think reasonable persons would agree
that the answer is ``no.'' What follows is my own story, and a specific
request for remedy.
Originally from Cincinnati, Ohio, I graduated in 1985 with a degree
in engineering from Case Western Reserve University, and then began a
career in Silicon Valley. I was fortunate to work with many creative
and talented people. In 1996, I joined Netscape to work as an engineer
and technical trainer. In 2001, I exercised incentive stock options and
held the shares, due to my belief in the company. I paid an AMT of over
$180,000, around twice my annual income, by liquidating a substantial
portion of my savings. By 2004, I had sold off all of the stock, but my
actual gains were far lower than the ``phantom gains'' I had paid tax
on. Now, I find that I have a six-figure AMT credit balance that is
probably not recoverable in my lifetime. Needless to say, this is very
disappointing. Whereas I fully accept responsibility for any gains or
losses in the stock that I held, I am at a loss to understand why many
years worth of my hard-earned savings must be permanently forfeited to
pay an outrageously high tax involving ``phantom gains.''
Therefore, I respectfully request relief from this unusual and
unfair tax burden, in the form of being allowed to pay capital gains
tax on my actual gains, while receiving a full refund of any tax on
``phantom gains.'' The net fiscal impact of providing this relief is
theoretically zero, because, as I understand, a refund of AMT credits
takes a liability off of the government's books. I think everyone,
including the government, should be happy with people paying taxes on
their actual gains. I certainly would be happy to do so.
Thank you for your attention to this matter.
Hans Lachman
Ben Lomond, California 95005
June 17, 2005
I am writing this letter to add my testimony to those given by
others who are suffering because the affect of the application of the
complicated AMT provisions to the exercise of incentive stock options
in a down market was unknown. I have been devastated after losing all
that I have saved to carry me through retirement and find myself in a
dire position.
I am a software engineer and have worked for wages all my life.
I've been continuously employed since I was twelve years old. I'm from
a large (5 boys and a girl) poor family. We lived on one income from my
father, who was a technician. I worked my way through high school and
college at various jobs to provide me with clothes and transportation
and to help supplement the family income.
I was fortunate enough to work for the Department of Energy (DOE),
where I implemented operating systems on state of the art
supercomputers. During my 22 years with DOE at various facilities, I
was exempt me from FICA and when I left DOE to work in aerospace, I was
quite behind my peers in acquiring Social Security credits. While at
various positions in Silicon Valley, where I was again working on state
of the art networking and computer security, I did not receive any real
retirement benefits. The work was all consuming and most enjoyable and
the years seemed to fly by.
When I reached fifty-five, I noticed that I quickly needed to amass
a nest egg to carry me through my retirement years. The point was
driven home when my grandmother could no longer take care of herself
and had no support to help provide comfort until she died. I was her
only support as the eldest child (my mother and father died at an early
age). She had nothing but Social Security and that was just not
sufficient to take care of her. While I had sufficient income to allow
her the care she required, it made me aware of the state of risk that I
was in. I had never given the fact that I may not be ABLE to work any
significant thought and at the age of fifty-five, I did not have many
years left to save for a time when I may have to stop working.
I took a position at Exodus Communications as an early employee for
a reasonable, but not outstanding salary with stock options. I was told
that if I worked hard and the company prospered, my stock options would
become valuable. I liked that idea because I have always been an
overachiever. During my tenure at Exodus, I worked harder than I ever
have in my life. I worked days at a time and traveled constantly. I
have never worked under such stress in my life, but I built a security
managed services business for Exodus that was their most profitable
service. Eleven group members generated over $15 million in annual
revenue. We were the highest producers in the corporation and watched
over a world wide network of security services for Exodus customers.
The five years at Exodus took a heavy toll on me and my family but
we all supported each other and took pride in the fact that I was
helping to build a business that anyone could be proud of. We were
counting heavily on the value of the stock options to provide us with
the retirement income necessary. We built a retirement home in Colorado
and purchased a nice home here in Santa Cruz County that we hoped would
provide a little estate for our two children after we passed away.
That was not to be. Shortly after the company went public, a new
set of management was brought in as part of the process of becoming a
large corporation. The new management team squandered all the value
that all the hardworking staff had generated and drove the company into
bankruptcy in a very short time. I was not sure what had happened, but
as I learned about Enron, WorldCom, and other corporate criminals, it
became obvious that I too was a victim of corporate greed. When it
became obvious that all the stock options I had exercised had become
worthless, I was most disappointed, but I comforted myself with the
knowledge that we still had our two houses, an IRA, some savings and I
still had a good reputation as a leading software development manager.
However, that also was not to be. In August, after filing two
extensions, my CPA and financial adviser informed me that I had a $1.7
million dollar tax bill based on all that worthless Exodus stock. I
thought, ``That's just not possible, I paid over a half million dollars
in taxes the year before, how could I owe another 1.7 million based on
worthless stock?``
I can assure you that you have never experienced a shock like the
one I got when I learned that I REALLY owed the State and Federal
Government all that money--many times over what I had left from my time
at Exodus or that I could make in my viable working years. Until that
day, my biggest problem was finding a new job to replace the income I
had at Exodus. Now that I was 60 and the market was tight, no one
wanted to hire me even though I was still one of the best in the
business.
So here I am at 61 and still telling myself that this just CAN'T
happen to me. There must be some way this is incorrect. I've attempted
to work out settlements with the IRS and California Franchise Tax Board
and they now have all the cash and retirement savings I have
accumulated during my 50 years of employment and it appears they are
about to take the rest of my possessions. I never thought I'd end up as
one of those you see on a street corner with a cardboard sign, but I'm
not far away from that today. I've been looking for work for nearly a
year now and living on savings which the IRS has just taken. There are
tax liens on both houses so I can't sell them to buy food and pay rent.
There are zero balances in my bank accounts and all the monthly bills
are coming due.
I feel really bad for my wife who depended on me to provide us with
some sort of retirement. The frustrating thing is that with this job
market, I can't just say ``Oh well, I'll just work until I die.'' I
can't even find a job with sufficient income to pay medical insurance
or rent. I just don't know what I'm going to do. It's a mess.
Thanks for your attention. I do hope that you can make some
equitable changes to the tax system before we lose our last remaining
assets.
Leroy Lacy
Statement of Linda L. Lacy, Mogadore, Ohio
Dear Chairman Thomas and Committee Members:
After struggling with the words that might make my testimonial a
significant statement in favor of reforming the AMT, I keep returning
to the reality of the personal toll that the AMT has taken on my son .
. . and so, I offer a Mother's intimate account:
After months of back-and-forth ``conversations'' with the IRS that
finally resulted in their determination that they had zero interest in
an ``offer in compromise'' and because my son was told by the IRS that
the only monthly payment plan they were willing to offer him was a one-
month plan for the entire amount ``owed'', I obtained a signature loan,
maxed-out three credit cards, and most crushing of all . . . cashed-out
my fifteen-years of retirement savings from my 401k, walked into our
local IRS office and proceeded to hand the clerk a personal check
approximating 95% of the ``debt'' my son ``created'' by exercising a
portion of the stock options given him by a dot.com firm he was working
for in California in 2000. After watching him struggle to figure out a
way to support his wife and children and still pay the IRS for a
phantom gain on those remaining stock options, I decided to utilize MY
borrowing power and deliver him from the specter that is the IRS. I
could ill-afford to do this for him, yet I must confess that I did it
partially for selfish reasons . . . I was tired of the fear that kept
me awake at night wondering if the ``new, friendlier IRS'' would put a
lien on his bank account or encumber his employer by laying claim to
his wages in order to satisfy the most insidious IRS tax regulation
that exists.
What a ridiculously complicated system of taxation we live under!
This young man has been sentenced to years of trying to climb out from
under oppressive and illegitimate taxation debt. I'm appalled by what
our own government is allowing to obscure the dreams of so many.
After considering the power the IRS wields, we determined it was
better to owe almost anyone but the IRS (in fact, the IRS WEB site
encourages that it would be more advantageous to take out a bank loan
than subject oneself to the penalties and interest assessed by the IRS
. . . very helpful information). As I am nearing retirement and need to
direct my financial life toward that phase, I found myself in a rather
precarious position . . . one of choosing to help my son or helping
myself (what would most parents do?).
My children were raised with a respect for the United States
government and all it represents. I led them on several occasions
through the impressive buildings and beautiful monuments of Washington
D.C. and extolled the virtues of living in such a privileged country.
My husband and I managed to provide all three of our children with
college educations and will gladly and appreciatively spend the rest of
our lives repaying the loans that provided them with the excellent
learning experiences they received. But, at least there are solid
educations in exchange for those loans! My son received two engineering
degrees in four years and we were certain that the culmination of his
hard work would be financial reward compensatory to the effort he
expended. That reward must now take a back-seat to the IRS to satisfy
this caustic injustice.
Please give all of us a break . . . reform this tortuous tax and
designate it RETROACTIVE to the 2000 Tax Year when so very many
ambitious, spirited, and intelligent young people were caught
completely off-guard and are now paying dearly for their naivete (some
in amounts reaching hundreds of thousands of dollars). In addition to
those already mired in this mess, so many of us in the middle class
without accountants and lawyers to warn us of impending danger are
indeed poised to be ensnarled also.
To close, I must add that those affected by the AMT extend beyond
those whose social security numbers appear on the IRS debt ledgers. . .
. Thank you for reading a Mother's testimonial.
Hutto, Texas 78634
June 20, 2005
Dear Chairman Thomas and Committee Members:
Thank you for looking into what is an extremely egregious
situation. The AMT as it affected us due to ISO stock options has
forced us into bankruptcy, and due to the extremely large amount of tax
it calculates, it may cause us to lose everything we own, including our
house. At a minimum, it is forcing us into a Chapter 11, preventing us
from a Chapter 13 or Chapter 7, which means our Bankruptcy costs are
about $15,000-$16,000 instead of $2000 to $3000. Our effective tax rate
was over 600% and if nothing is done, it will take us over 70 years to
utilize our tax credits. This happened at a Bio-Tech company not a
telecom company, so there are some of us in many facets of U.S.
industry, not just one.
How is this fair or right? We went from thinking we were on our way
to having a decent retirement after struggling for 20 years to living
the last 5 years under the constant stress of what is going to happen
to us and how are we going to survive. There hasn't been a single day
that we haven't had some issue, be it physical, emotional, stress, or
depression to deal with. So far we have been able too stay married and
sane, but it has not been easy. Instead of helping our children and
parents they are having to help us. Is this the American Dream? Since
finding out about the AMT repercussions, almost everything we do has
been based on how to deal with it. All we did was exercise my ISO
options. How can we owe taxes on something that we never realized? How
can the U.S. government and its tax code be responsible for making
thousands of people paupers?
For those of us that are either on the brink of ruin or over the
edge, it would be a big help to us to be able to resolve this
equitably. It will not put things right for us because we still will
not have any retirement or funds and will have to try to rebuild, but
it will at least help us to get started. If we can either take the
credits that are due to us more quickly so that we can recover the
credits that are due to us or if we can treat the exercise and final
sale/resolution of ISO options/stock as a single year occurrence, we
can at least have a fair way of dealing with this issue.
We have been a middle-income family since we were married almost 25
years ago. We have worked for everything we acquired, and have not been
extravagant spenders. In fact since our 2 children started their
activities, Ballet and Dance, Ice Hockey and Figure Skating, most of
our expendable income has gone for them. I worked at a company, Luminex
Corp. that I helped to be successful enough to go public, and was
offered ISO stock options as a reward for my efforts. Due to management
changes I left the company in July of 2000, and had to exercise my
options, but was not aware of the tax implications of the AMT. Everyone
including our stockbroker told us to hold on to the stock to get long
term gain tax gains as well as I thought the company had a future. What
we didn't realize is that the IRS wanted us to pay the taxes on the
gain (AMT) even though we did not sell the stock. This would be like
paying taxes for the increase (Gain) in value of your land, even though
you never sold it. All we have left is the house we have been living in
for the last 12 years, as we no longer have any savings or retirement,
and both of our vehicles are over 6 years old. Also, since I came from
the technology sector, I was out of a job in my industry for over 2.5
years, and worked at whatever jobs I was able to find. I am now working
in industry again, but this burden of the AMT is having very serious
consequences that are not only affecting ourselves, but is also
affecting our children. Instead of being able to pass along some of the
fruits of our sacrifices and hard work, we are not able to help our
children start their own lives, and in fact are concerned for ours in
our later years as our children (17 and 22) are having to help us now.
We had to exercise my ISO options in August 2000. The IRS says that
due to the AMT, we owed almost $300,000 from that year even though we
didn't sell them. Because of what happened with the stock value, if we
could treat the exercise and the final result as a single transaction,
or if we didn't have to consider the AMT, the amount would be more
realistic and manageable. We currently are in bankruptcy and the IRS
has put a lien on our house for over $400,000, that if we come out of
Bankruptcy (the trustee is trying to say there is no outstanding
question about the validity of the AMT so is trying to get the case
dismissed), they will seize it. We don't understand how we can owe
taxes on a something we never had. The judge just ruled that the IRS
claims are such that we cannot file Chapter 13 but have to file 11,
which increase our costs to recover from $2000-3000 to $15,000-$16000.
If we are already struggling to recover, how is adding $13,000 on top
of our debt helping?
Your consideration in this issue is greatly appreciated. Please
help to make the AMT law apply as it was supposed to, not against
normal middle-income citizens.
Regards,
John Lapaglia
Mountain View, California 94043
June 17, 2005
Dear Chairman Thomas and Committee Members: My name is William
Lazar and I am writing on behalf of my wife Vivian and myself. We
appreciate the opportunity to discuss the hardships we are suffering
due to an outdated and complicated portion of the tax code called
Alternative Minimum Tax.
I moved to Silicon Valley before the dotcom era to work for a small
software company. Like many such firms, our product was interesting and
even innovative but our management was better with technology than
business and nine months later I was out of a job.
Fortunately I hired on almost immediate with another startup in
January, 1997, and this company was much more successful. The ISO
options I earned as part of this work became very valuable when Sun
Microsystems bought the company in 1998. I worked through an
unbelievably difficult two and half years at Sun until my options were
fully vested and decided to take a little time off.
I asked for a six month personal leave, which was granted, but when
that time was up the tech market had crashed and there was no job for
me to return to at Sun; their first major layoff was only three months
later. Since I was no longer a Sun employee I had to exercise my vested
options within 90 days or lose them.
Since I was fortunate enough not to need the money immediately I
exercised and held. Unfortunately Sun's stock continued it's fall from
a high of $64.50 to under $2.50. I had to pay $45,000 to the federal
and California governments all due to AMT calculations. Of course I
never saw a penny of this, the stock was sold for under $20,000.
Just as there was no job for me at Sun, there were no jobs in
general. Since my separation from Sun on 17 Aug. 2001 I've worked 5
months for one company as a contractor (total income of $34,500 but
self-employed so a huge tax bill) and now have worked three months for
another small company at $20 per hour (though as an employee). Only
through the good fortune that my wife has been able to help with the
bills--she's a records clerk at a law firm making under$40,000 per
year--have we been able to avoid serious financial trouble.
Meanwhile, I have an AMT tax credit of over $150,000 that I can
hardly imagine ever being able to claim.
I could have been smarter and sold the stock sooner, I'm not trying
to evade responsibility for my own decisions. But I cannot understand
how a tax program that was intended to make sure very wealthy
individuals didn't hide their good fortune and avoid contributing to
our community can catch up people like myself, who've never made as
much as $100,000 in a year. My story is probably one of the mildest
you're receiving on this subject but I want to add my voice to those
urging you and other members of Congress to change this illogical law.
William Lazar
Statement of Leo Linbeck, Americans for Fair Taxation, Houston, Texas
Mr. Chairman and Members of the Committee on Ways and Means:
The Americans for Fair Taxation (Fairtax.org) welcome the chance to
submit this written testimony for the Committee's first tax reform
hearing. We understand that this, initial hearing is limited to an
overview of the principle objectives of reform--fairness, simplicity
and growth--in anticipation of the recommendations from the President's
Advisory Panel on Federal Tax Reform (which have been delayed until
September 31, 2005). Fairtax.org submits this testimony in order to:
offer its views on the criteria by which tax reform
should be judged, the importance of defining those criteria and the
relevance of holding hearings exploring those criteria;
address two issues discussed by panelists, particularly
the means of measuring fairness and as to the effect of tax reform on
border adjustability;
and, dispel two unfair myths that have been connected
with the FairTax plan, namely the difficulty of compliance and the
relevance of the tax-inclusive rate.
With more than 600,000 supporters, Fairtax.org is the nation's
largest grass roots citizens' organization dedicated to fundamental tax
reform. As a nonpartisan organization, we have engaged some of the
nation's leading scholars and tax policy analysts to explore the
infirmities of the existing system and the best means of correcting
them. The product of our effort is the FairTax, which has been
introduced by Representative John Linder as H.R. 25 and in the Senate
as S. 25 by Senator Saxby Chambliss. The House bill now has 37
cosponsors. We have engaged and we continue to engage academic scholars
to study the effects of the FairTax on economic growth, fairness,
international trade and specific industries. With the benefit of our
research and our efforts towards fundamental reform, we respectfully
offer the following insights within the narrow scope of this hearing.
Relevant Criteria By Which Tax Reform Should be Measured_The
Internal Revenue Code and the U.S. tax system in general are nearly
universally derided. Although many Americans taxpayers share a visceral
disdain for the tax system, they hold that view for diverse reasons.
The Tax reform debate by necessity cannot focus on one problem. The
debate will encompass a wide range of competing problems searching out
competing solutions.
In light of the complexity of the issues demanding resolution, a
consensus must emerge over the common issues tax reform is meant to
address before the effectiveness of competing plans can be analyzed.
The salient problems with the current system must be identified before
we can determine which ideas best address those problems.
As the Committee takes this first step along its historic task, the
Chairman is to be commended for noting three major priorities that
should drive any tax reform we enact: simplicity, fairness and economic
growth. However, we would ask the Committee expand upon those criteria
by developing a methodology for measuring which system most
effectiveness promotes these objectives. As the Committee begins the
task of fact finding and deliberations, Fairtax.org offers what it
considers to be the most important classifications of these problems.
From our own analysis, from our evaluation of testimony and from the
problems most commonly cited in our surveys and in the hearings, we
suggest the Committee measure the success of tax reform alternatives
against the following scorecard:
How do the plans affect economic growth and real incomes?
Apart from lowering marginal rates, a system that eliminates the double
taxation of income (is neutral as to savings and investment) will
create more growth.
In a related inquiry, what is the base and therefore the
required marginal rate to achieve revenue neutrality? Not only is the
marginal rate directly related to the base, but the marginal rate has a
direct bearing on economic growth and evasion.
How do the plans encourage savings and investment?
Savings are responsive to a return on capital and consumption taxes
remove the bias against savings.
How is education treated under the plans? The cost of
acquiring education is the cost of America's investment in its
intellectual capital and the route to upward mobility.
How do the plans ameliorate complexity and compliance
costs? Not all plans are created equal in eliminating compliance costs
long-term.
Does border adjustability really have no effect on
international competitiveness or do the plans have vast differences in
the way they affect international competitiveness (the ability of
domestic producers to compete against foreign produced goods)? Only
destination-based consumption taxes are border adjustable.
How fair is the distribution of the burdens and benefits
and how does it affect upward mobility? Under a consumption tax, this
question requires a multi-dimensional analysis.
How reliable is the plan as a source of revenue? Under
some plans, fluctuations in revenues present a problem.
How do the plans expose hidden taxes? Plans can be
distinguished by the ability of taxpayers to see what they truly pay
for the cost of government.How do the plans respect privacy and other
civil liberties? The tax laws need not be intrusive.
What effect will the plans have on charitable giving?
Plans differ as to the after-tax costs of giving.
What effect will the plans have on promoting
homeownership? Plans differ by raising or lowering the costs to the
taxpayer of purchasing a home.
How will the plans affect tax evasion and tax avoidance?
Some tax reform proposals will do nothing to quell the swelling tax
gap.
How permanent is the plan (i.e. how resistant is it to
unraveling)? The Committee should consider the staying power of the
reforms it recommends.
How does each the plan affect global tax competition, tax
rates and reform? Some plans will encourage global tax reform (i.e.
they are more contagious).
To what extent do the plans introduce and dispose of
transition issues? Many plans simply ignore the large transition issues
they present.
The FairTax plan best meets the criteria laid out before the
Committee. We stand ready to offer the Committee more detailed
testimony at future hearings to more fully address each of these
issues. We would urge the Committee to review our web site, which
contains a recent submission to the President's Panel on Tax Reform on
these very points.
In identifying the tax reform alternative that is considered
optimal, the inquiry begins with defining the public policy goals of
tax reform. A more definitive level of agreement over those goals--if
not the prioritization of them--is the political question that will
better enable scholarly and objective analysis to analyze the plan that
best succeeds in achieving those goals. Congress and the American
people will be able to judge the effectiveness of proposals against
these objective criteria without unnecessary political rhetoric. And as
the Committee addresses the key questions, the true strengths and
weaknesses of each plan will become evident.
The Distributional Methodology to Ensure ``Fairness'' Should be
Measured in Ways that are Not Biased Against Pro-Growth Tax Policy.
Fairtax.org views favorably recommendations made by Dr. William Beach
of the Heritage Foundation, who focused much of his oral testimony to
the Committee on the need to change the method of measuring
distribution. Dr. Beach argued that as the tax reform debate commences,
the Committee should avoid the trap of income-tax biases when measuring
distributional burdens of consumption taxes. Fairtax.org agrees, taking
Dr. Beach's testimony one step further. The Committee should recognize
the flaws of current distributional methodologies when seeking to make
the tax system more pro-growth and progressive.
The Chairman recognized the importance of fairness as a key
priority of tax reform and defines it as ``similarly situated taxpayers
bear[ing] similar tax burdens.'' Whether any tax reform plan is more
equitably distributed than another will simultaneously be the most
influential and contentious value judgment of the coming reform debate.
In the final analysis, the question of distributional equity boils down
to three inquiries: (1) how much should people of varying wealth,
income or consumption pay in taxes and on what basis?; (2) how much do
people of varying wealth, income or consumption pay under today's
structure or alternative tax structures?; and, (3) does the tax system
curtail or improve prospects for upward mobility? In the absence of
specific criteria to define and measure `fairness' these relatively
straightforward questions may lend themselves to rhetorical flourishes
rather than economic analysis.
As the Committee approaches the pivotal issue of ``fairness,'' the
definition it ascribes to ``fairness'' and the means of measuring and
presenting distributional data will mean the difference between
informing the debate or constructing a monolith to stifle pro-growth
reform. As the conventions for defining, measuring and portraying
distribution now stand, the answer to the question of whether a
consumption plan is ``fair'' is effectively pre-ordained by standards
of distributional equity that frame the question through reference to
an income tax. In short, the Committee must reevaluate and reconstruct
the manner in which it chooses to measure and view distribution if the
American people are to be given relevant information that can enable
them to make informed decisions about distributional equity.
The centrality of this point is best understood by examining the
narrow but conventional view that ``fairness'' equates to progressivity
of tax burden relative to some measure of annual income. That is the
view that may be shared, for example, by Dr. Joel Slemrod of your
hearing panel, and for a reason. Taxes paid over income is the
preferred quotient of analysis for those who support multiple taxation
of savings and investment at accelerated rates (as opposed to
consumption taxes). Since consumption taxes do not tax returns on
investment multiple times (which under an income tax is considered a
normal part of the income base), and since lower wage earners in the
aggregate spend a disproportionate amount of their earning on
consumption, the more a tax is based on consumption the more it is a
foregone (and incorrect) conclusion (based on such a methodology) that
the tax is ``regressive'' or less ``fair.'' Measuring fairness
according to an annual income methodology will always show an unfair
bias in favor of punishing savings and investment chiefly because it
uses taxes paid over income, rather than consumption, as the unit of
measurement, even though nearly all economists agree a system neutral
as to savings and investment will result in higher real incomes. The
biased nature of basing distributional tables on annual income would
seem apparent.
In reality, measuring distribution as a quotient of taxes paid over
income is only one possible method of portraying fairness, and neither
the most objective nor best method. Income earned in any given period
is, at best, an incomplete measure of one's ability to pay over a
lifetime; and in the case of wealthy individuals, a poor measure.
Proponents of a consumption tax argue instead that the best measurement
of the equity of a tax system is what one individual consumes for his
or her own personal well-being over the course of a lifetime, i.e. the
private as opposed to public uses of capital. Under the FairTax,
consumption at or below the poverty level is simply not taxed at all,
in keeping with the principle that the government should not extract
resources from citizens until they have met their own sustenance. This
is accomplished by a ``prebate.'' Income which is not consumed is
either saved or invested or provided to charitable causes (or
government) to fund the consumption of others. The return on savings
and investment is either used to fund future consumption or reinvested
to increase productivity and output. If income and savings are taxed,
we have simply taxed deferred consumption. Individuals who defer
consumption do so because they elect not to consume it for themselves
immediately, but to make the resource available for others. For this
reason, consumption tax supporters argue that measuring taxes paid over
consumption is an equally valid distributional measure, and a more
appropriate measure, of fairness. If one supports a consumption tax for
pro-growth reasons, even if one supports certain aspects of a
consumption tax (such as the taxation of income only once), then is it
not equally valid to display the distribution as taxes paid as a
function of consumption as opposed to income? Is this is not a decision
that rightfully falls outside the learned realm of economics?
Using income as the denominator is a bias built into conventional
distributional charts that favors the steeply progressive marginal
rates with double or treble taxation of income, but it is far from the
only bias. Another major bias exists if we adhere to the conventional
wisdom of restricting the unit of analysis to annual income. Annual
income wrongly assumes the taxpayers within an income category will
remain financially frozen in perpetuity (i.e. their income will not
change year-by-year and over the course of their lives). By making that
assumption, we not only defy reality, we are often comparing a 45 year
old father with the 18 year old daughter in order to argue that tax
policy should require the father to redistribute more of his income to
his daughter. If Congress is provided charts depicting distribution
only on this basis, those charts will wrongly argue that flatter
marginal rates hurt the poor and benefit the rich, even if they are the
same people at different stages of life. Basing distribution on
stagnation within income deciles not only yields a knowingly wrong
result, but also yields a result knowingly biased against a flattening
of rates that nearly all economists (and those on your panel) agree
increases economic growth.
Rectifying these biases is not only desirable; it is imperative if
we are to make economically sound analysis of competing proposals based
on accepted economic principles. Rather than blindly measuring
distribution on the basis of taxes paid over annual income, Fairtax.org
contends that the proper approach is to examine distribution in the
manner that has been recommended for several years by the President's
Council of Economic Advisors; such as, measuring distribution as taxes
paid over consumption, lifetime income, or by evaluating distribution
on a dynamic basis by measuring what people have after taxation. Such
means of measuring distribution was suggested by Dr. Beach. In
considering distribution, the Committee should make clear the enormous
and uncertain effect that conclusions over incidence of corporate and
other taxes have on distribution. Sometimes these taxes are just
ignored in distributional tables. The Committee should employ a
methodology that requires the distribution tables include the
compliance costs that are regressive under the current tax system and
which have given rise to the need for reform (as well as assumption
over differential compliance rates by income or consumption class since
the $353 billion tax gap itself is not equitably distributed). The
Committee should be aware that plans which seek to significantly lessen
compliance costs should have a ``simplicity dividend'' a ``growth
dividend'' and a ``compliance dividend'' that will also have
distributional effects.
The Committee should also recognize distribution models
underestimate the regressivity of the current system by failing to
account for uncertain incidences of corporate and personal income
taxes, payroll taxes, self-employment taxes, and compliance costs that
are embedded in the price of consumables or the cost of capital. The
Committee should recognize that an important determinant of `fairness'
is whether a particular tax scheme affords greater or lesser upward
mobility. In summary, as the Committee explores the key subject of
fairness, it should resist viewing the distributional debate solely
through the reference frame of an income tax. And it should understand
why such a limited reference frame offers a skewed vantage point that
flies in the face of the pro-growth policies the Committee recognizes
as essential to reform.
The Unsettled Question Concerning Border Adjustability (and
Territoriality.) The FairTax has many merits arguing for its enactment.
These include, among others, the fact the FairTax stimulates economic
growth, untaxes the poor, removes disincentives to work, save and
invest, encourages home ownership, advances investment in human
capital, makes the tax system simpler and more visible, lowers
compliance costs, and honors the privacy and other civil liberties of
taxpayers. Moreover these positive effects are supported by extensive
research. But one often understated reason that deserves further
explanation is that the FairTax is the most border adjusted tax plan
that could be devised.
Allow me to explain further. Fairtax.org asserts that the U.S.
government should not, as a matter of policy, accord a huge advantage
to foreign companies competing in the U.S. market or impose a huge
disadvantage on American producers and workers selling their goods and
services in the U.S. and foreign markets. Regrettably the current tax
system has this adverse consequence on the economy.
Today, the U.S. tax system harms the competitiveness of U.S.
businesses. Heavy income and payroll taxes are imposed on U.S. workers
and businesses producing goods in the U.S. whether those goods are sold
in here or abroad. U.S. corporate taxes are the highest in the
industrialized world; with a top corporate rate about nine percentage
points higher than the OECD average. Our current tax system imposes no
corresponding tax burden on foreign goods sold in the U.S. market.
Moreover, foreign value added taxes, a major component of the total
revenue raised in most developed countries including every OECD country
except the U.S., are rebated if foreign goods are exported. U.S.
manufacturers selling abroad must pay foreign value added taxes at an
average rate of nearly 18 percent in addition to U.S. income and
payroll taxes, creating a large and artificial relative price advantage
for foreign goods, in both the U.S. market and abroad.
Empirical evidence suggests that the U.S. inability to border
adjust its taxes is of tremendous practical importance. With each
passing year, manufacturing is a smaller and smaller part of the
overall economy. The value of all goods manufactured in the United
States was roughly 30 percent of the value of all goods and services in
the economy in 1953, and fell below 15 percent in 2001. The U.S. trade
deficit is now almost six percent of GDP and trade deficits exist in
nearly every category of goods with nearly every country. Most
importantly, there is an unsustainable ``Production Gap.'' The U.S. now
produces only about \2/3\ of the goods it consumes. The reason is the
tremendous price advantage we accord foreign producers and foreign
workers when competing against American products sold in the domestic
market or bound for overseas sales.
The largest single factor in the decline in U.S. manufacturing jobs
is within our power to fix by reforming the tax code.Specifically, we
need to eliminate those aspects of our tax system that artificially
place U.S. production at a competitive disadvantage to foreign
production. The most powerful tool to improve the international
competitiveness of U.S. business is to move to a destination principle
tax system (also known as a border adjusted tax system)--a tax system
that taxes all goods consumed in the U.S. alike, whether the goods are
produced in the U.S. or abroad.
The FairTax accomplishes this result. Foreign manufactured goods
and U.S. manufactured goods will pay the same tax when the goods are
sold at retail. U.S. businesses selling goods or services in foreign
markets will not be subject to federal tax. By comparison, not all
consumption taxes do so. The flat tax does not address this problem.
The Flat Tax is an origin method value added tax. It taxes the
consumption of U.S. value added, whether the consumption occurs in the
U.S. or abroad. Foreign made goods consumed in the U.S. bear no tax
under the Flat Tax. Thus, under the Flat Tax, American businesses and
American workers would still be placed at a large tax disadvantage in
international markets. Other destination based consumption taxes may be
border adjustable, but they accomplish this result less effectively and
efficiently because the entire taxes imposed are not border adjusted as
they would be under the FairTax.
Fairtax.org recognizes that some of your distinguished panelists at
this hearing, particularly, Dr. Alan Auerbach, disagree with us on the
relevancy of border adjustability. For instance, without much
elaboration he asserted that ''border adjustments will simply
strengthen the dollar, putting importers and exporters in the same
competitive positions no matter which approach is adopted.'' By
contract, Fairtax.org contends that border adjustability matters
greatly to U.S. competitiveness, and this view is shared by noted
economists.
The fallacy of the `border adjustability is irrelevant argument'
can be seen most clearly with the FairTax. Advocates of the
``irrelevancy position'' incorrectly argue that if the FairTax were
implemented, any relative price change will be eliminated by an
immediate offsetting 23 percent appreciation in the dollar. This theory
is based on the assumption that appreciation of the dollar will be
caused by a reduction in U.S. demand for foreign currency to acquire
(the now more expensive) foreign goods and an increase in foreign
demand for U.S. currency to acquire (the now less expensive) U.S.
goods. The greatest flaw in this analysis is that the demand for U.S.
dollars is not limited to the traded goods market. Nearly $90 trillion
in U.S. assets owned by households and non-financial businesses are
denominated in dollars. Financial institutions trade trillions of
dollars in securities and currency each day based on expectations and
long and short term assumptions. Furthermore, the non-traded goods and
services sector is also denominated in dollars and exceed the traded
goods sector in size. The value of the traded assets alone cannot
possibly adjust the value of all dollar denominated assets. Consider
for a moment the treatment of commodities, where prices are established
through international markets.
If, however, border adjustability is not relevant and there is no
increase in the competitiveness of U.S. goods because of a 23 percent
increase in the price of the dollar (more or less precisely) relative
to foreign currency, then the FairTax will have succeeded in increasing
the wealth of the American people by something on the order of $20
trillion (23 percent of $90 trillion) relative to the rest of the
world, an instantaneous increase nearly equal to the value of all the
goods and services produced in the U.S. over two years. If that were to
happen, it would be reason enough to enact the FairTax. Unfortunately
for American asset owners, it is impossible for the traded goods sector
to dominate the currency movements since the dollar asset markets are
perhaps 100 times as large as the annual traded goods market (net
basis).\1\ The argument collapses when one understands that currency
fluctuations are influenced by a great deal more than just taxes on
traded goods. An additional legitimate inquiry regarding the reliance
of border adjustability would examine whether the U.S. wants to take
the risk that it is imposing what amounts to a self-inflicted tariff on
its domestic producers and workers when it recognizes the difficulty of
providing direct trade incentives under the WTO?
---------------------------------------------------------------------------
\1\ See, Flow of Funds Accounts, United States of America, Fourth
Quarter 2004, Federal Reserve System, for statistical information on
asset markets.
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The Tax-Inclusive Means of Measuring the FairTax is Not
Disingenuous_Critics of the FairTax wrongfully contend that expressing
the FairTax rate in tax-inclusive terms is disingenuous. For instance
the Ways and Means Committee democratic staff state on their website
that when the rate is quoted as `23 percent' it really means `30
percent' to the consumer.'' As the Committee proceeds with these
hearings, it should clarify that the rates of various tax reform
proposals must be compared on a uniform basis.
When considering the rate of a single stage consumption tax, or any
tax for that matter, one must always decide which of two distinct means
of portraying this rate--the ``tax-inclusive rate'' or ``tax-exclusive
rate''--best reflects the tax burden. Which one we employ changes
absolutely nothing in terms of the taxes that are actually raised or
paid by the taxpayer under the taxing regime examined any more than
describing a hot day as 40 degrees centigrade or 104 Fahrenheit changes
the level of discomfort. But the metric used does change the perception
of those who wish to compare the merits of competing tax proposals.
When making comparisons between alternative taxing systems, it is
important to ensure that these comparisons are consistent, fair in
terms of expectations, and are well explained. Fair comparisons
eliminate rather than exacerbate confusion over a relatively critical
point as the means of expressing the tax rate. The FairTax plan
contends that the rate of the FairTax is properly measured through the
use of the same scale as is used for all competing federal plans. We
contend the only correct and accurate means of measurement is to
compare the tax-inclusive income tax rate to a tax-inclusive sales tax
rate. Therefore, in order to compare apples to apples the FairTax is,
unlike most state sales taxes, imposed on a tax-inclusive basis.
Two examples may help clarify the use of these two rate calculation
methods. Assume a worker earns $100 and uses the entire amount to pay
for a CD player at Wal-Mart. Under the income tax, the worker would
earn $100, pay $20 dollars in income tax, and have $80 left over to buy
the CD player. We would say this tax rate is 20 percent. In a typical
sales tax we would say the worker earned $100, paid $80 for the CD
player and paid $20 in sales tax. We would divide $20 by $80 and say
the rate is 25 percent. Using this method, we would say the sales tax
rate is 25 percent and the income tax rate is 20 percent even though
the tax burden is precisely the same, i.e. $20. The problem of course
is that representing the FairTax as 25 percent and the income tax as 20
percent would lead one to think the FairTax imposes more tax or has a
smaller base, when both conclusions would be wrong. Thus, the FairTax
uses the same method of stating its rate (the tax-inclusive rate) as
does the current system it is designed to replace, and while the
FairTax is agnostic about which method is chosen, it believes the
methods should be consistent across tax plans.
The Ways and Means' Democratic staff observes that on a tax-
exclusive basis, the FairTax would be imposed at a 29.9 percent rate.
Nothing is wrong with that assertion in the abstract. However, on that
basis, the current tax system would impose marginal tax rates on
middle-class taxpayers of 76 percent, if you take into account the
hidden employer payroll tax is borne by workers.\2\ The Flat Tax would
bear a maximum marginal rate of 47.7 percent. The FairTax is expressed
on a tax-inclusive basis not because it shows a lower rate expressed
differently than state sales taxes, but because the price of adherence
to the way state sales taxes are expressed would be misrepresentation
at the national level. Therefore, the FairTax quotes the rate as tax-
inclusive, and explains where it has the chance, the difference between
the two methods.
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\2\ The way of looking at the income tax from a tax-exclusive point
of view is to ask how much a worker must earn to spend $100. Today, a
taxpayer in the 28% tax bracket (who pays 7.65 percent in payroll
taxes) must earn $155 to pay for $100 in goods. If the employer's share
of the payroll tax is considered, this worker must earn $176 to spend
$100. A 15 percent income tax bracket taxpayer must earn $129 to spend
$100. This figure would be $143 if the employer's share of payroll
taxes is taken into account. If we were to apply a tax-exclusive metric
to the income tax, the income tax with the payroll tax bears a maximum
marginal rate that is 75.8 percent of the tax-exclusive rate. Even the
Federal individual income tax alone reflects a maximum marginal tax-
exclusive rate of 43.3 percent, and the FairTax plan bears a maximum
marginal rate of 29.9 percent.
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The Myth that a Single Stage Consumption Tax In Excess of 10
Percent Won't Work. Dr. Joel Slemrod testified that a national sales
tax that would replace the entire tax system would suffer from a lack
of compliance. He repeated an ``urban myth'' of income tax proponents
that a sales tax in excess of 10 percent will create compliance issues.
with a rate beyond 10 percent. This statement has been repeated so
often and with such certainty by income tax proponents, that it must
have academic substantiation or proof. This is not the case.
The author of this conjecture was Vito Tanzi, former Director of
Fiscal Studies at the International Monetary who simply offered this
opinion in a 1995 Brookings Institution publication.\3\ Taxes are
unpopular and breed resentment today--as they undoubtedly always have
and to some degree probably always will. Accordingly, some people will
evade taxes no matter what the governing tax system, but there is no
evidence--empirical or analytical--to suggest that the sales tax would
not be complied with at a national level, extant research and the
empirical evidence suggests that the tax would increase voluntary
compliance while reducing compliance costs. For example, much of the
tax gap today is attributable to mistakes caused by the complexity of
the law. Mistakes and confusion would be all but eliminated under a
system that creates no exemptions, and dispenses with the complex
issues present today. And the FairTax improves all the factors known to
bear upon noncompliance, including reducing the rate and the number of
collection points. The more than 60 years of practical experience in
administering sales taxes at the state level supports the position that
the FairTax would be administrable at higher compliance rates relative
to administrative and compliance costs. Whether or not the plans can be
complied with is also directly related to the costs and intrusions into
privacy. The relative administrability of the various alternatives,
including the single stage consumption tax, should be explored in a
separate hearing devoted to that purpose and not dismissed by
unsubstantiated opinion.
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\3\ Tanzi, Vito, 1995 ``Taxation in an Integrating World.''
Washington: Brookings. 1995, pp. 50-51. For the opposite view, see Dan
R. Mastromarco, ``The `Fair Tax' and Tax Compliance: An Analytical
Perspective.'' Tax Notes 79 No. 3 (April 20, 1998): 379-87.
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The Facts that Influence Pro-Growth Tax Policy. Fairtax.org has
done extensive research on the economic effects of its plan. Economists
estimate that the FairTax plan improves wages and the economic well-
being of all Americans. For example, Boston University economist
Laurence Kotlikoff estimates the shift to consumption taxation raises
the stock of U.S. capital by at least 29 percent (potentially by as
much as 49 percent) and U.S. living standards by at least seven percent
and potentially by as much as 14 percent. Work by Gary Robbins, Ph.D.
of Fiscal Associates shows that replacing the current tax system with a
single-rate system that treats capital and labor income equally--such
as the FairTax--increases the GDP 36.3 percent and private output by
48.4 percent over the long run. Higher investment levels increase the
productivity of employees, demand for workers and real wages.
Even more important than the end result of the FairTax is an
understanding what critical aspects of the various plans generate such
positive effects. Certainly, the FairTax provides substantial benefits
from the non-trivial savings from compliance costs, from greater
compliance itself, from international competitiveness and from the
elimination of the deadweight loss of special interest tax provisions.
However, the Committee should recognize that the majority of the
economic growth will come from lowering marginal rates (which results
from broadening the base and flattening the rates) and the elimination
of the multiple taxation of income (which results in neutrality as to
savings and investment). Not all plans proposed will achieve these
objectives to the same degree.
Conclusion. As the President's Advisory Panel on Federal Tax Reform
noted: ``History has taught us that although it is relatively easy to
achieve consensus on the need for reform, it is much more difficult to
devise a solution that satisfies all competing interests.'' The hard
work of crafting of that solution will fall upon this Committee. As it
undertakes this task, Fairtax.org urges the Committee to define the
goals of reform in the most definitive terms possible and focus the
debate around the type of reforms that best meets these goals. As it
proceeds, Fairtax.org urges the Committee to separate the myth and
rhetoric from the reality and efficiency of each reform plan it
considers. Proponents of the FairTax eagerly await and welcome the
opportunity to participate in such a debate.
Statement of Hendy Lund, Ben Lomond, California
Subject: California dreamin? Try California Nightmare thanks to AMT
Comments: In 2000, I was living a dream. I was working for Redback
Networks in a job I loved, was married to a great guy, and had just
bought a house thanks to stock options I'd been granted when I started
at Redback. With the rest of the options, I'd done an ``exercise and
hold'', with the intention of avoiding short term capital gains by
holding the shares for a year, then selling them to pay the taxes on
the shares I'd sold to buy the house.
Convoluted? Perhaps . . . but it was based on the ``common wisdom''
of the time. After all, ``the shares aren't going to go down anytime
soon, and this way you'll save a bunch on taxes!'' Then the bubble
burst. Come April 2001, when it was time to pay taxes, the shares were
worth 1/50th of what they were in 2000. Still, if I sold those and took
out a mortgage on the house, I could cover the regular income tax. I
wouldn't have the luxury of owning a home free and clear, but a
mortgage is ``normal'', and I still had a house, something that isn't
easy to make happen in California.
Imagine my horror when my accountant presented me with a Federal
tax bill of $1.2 million. Why? That ``exercise and hold``--a
transaction in which I received no actual money--was treated as income
for AMT purposes. My accountant explained that it was a ``prepayment'',
and that it would be applied as a credit when I actually sold the
shares.
Excuse me? The government is taking my money before I even have
it?!? And now that the stock is effectively worthless, they're taking
money I'll *never* have? Now it's 2005. I've sold that home for \2/3\
of what I paid for it. That ``great guy'' and I are divorced--and yes,
the fights over money and the associated stress contributed. I still
owe the IRS $1.2 million thanks to compounding interest and penalties.
The only reason I'm not in collections with the IRS is that I hired a
tax attorney. My financial future--my retirement, my daughter's
education--is on hold until someone flinches and figures out what to do
with my debt.
I think I'm a good citizen. I pay taxes on the money I earn with
hardly a grumble, and I'm honest about how much I earn. But I'm screwed
because AMT considers a ``Monopoly money'' gain to be cold hard cash .
. . and that's just not right.
Boca Raton, Florida 33432
June 17, 2005
Dear Chairman Thomas and Committee Members:
I was an employee of Qtera, in South Florida, of one of the many
acquisitions of Nortel Networks during the telecommunications boon of
1998 to 2000. I received incentive stock options and subsequently have
paid to the U.S. Treasury department, Alternative Minimum Tax, in
excess of $230,000.00.
I was hired as the 17th employee in 1998, three years after
completing a Bachelors degree in Mechanical Engineering. Working for
Qtera, in Boca Raton, FL was a fantastic experience. The team that was
assembled was of the highest quality and some of the most motivated
individuals I have ever worked with. Our devotion, hard work and
technical expertise made us an acquisition target of both Cisco Systems
and Nortel Networks in late 1999, Nortel Networks ultimately acquired
us; seventy employees had achieved the impossible. Instantly, all our
Qtera ISO's were converted to Nortel Networks ISO's at approximately
$60 per share. Our success received a wealth of media coverage, from
the Wall Street Journal to NPR.
Soon after the media broke the news of our success, the
stockbrokers and investment bankers began courting our employees. As
employees with much work ahead of us, we had little time or energy to
learn about the Alternative Minimum Tax code. Some of the investment
firms provided seminars on the Alternative Minimum Tax code but usually
we were left with more questions than answers. AMT soon became the
number one discussion topic, on the surface, we found ourselves quite
versed in the subject, yet few of us really understood the dirty
details.
My plan was to exercise and hold the shares as Congress had
intended then after holding the stock for a year, sell enough shares to
pay AMT and invest the rest. The first sign of trouble was the gradual
decline in Lucent's stock price during 2000. We continued working
incredible hours to meet our company milestones during our one-year
transitional period.
By the middle of 2000 many employees had stockbrokers managing
their investments. Not only brokers, but accountants, estate planners
and life insurance brokers, everyone was after our potential wealth. I
retained a local accounting firm to manage my tax liability and a
nationwide brokerage house to manage my account. The accountants were
confident they were experienced with Alternative Minimum Tax. Their
experience turned out to be limited, but since they had fifteen of my
co-workers on a yearly $4,000 retainer, they had no problem getting
their hands dirty with the tax code. I reasoned that the Alternative
Minimum Tax code was so complicated that I should have professional
support, no mater the cost.
April 15th 2001. The year had gone so quickly and I exercised
options twice during the previous year resulting in an Alternative
Minimum tax on ``Paper Gains'' of $195,000.00. It was strongly
suggested, by my investment broker, use margin to pay the tax bill. The
margin loan sounded like a reasonable idea, the investment firm
provided a low interest loan without liquidating the account, as long
as the account value is not less than the loan. Little did I know the
bottom was about to drop out.
I began to diversify my account, but the majority was still in
Nortel stock. Meanwhile, while no one was watching, Nortel Stock fell
below $20 per share. The Nortel management was positive on the
company's growth and their overall market position, the low price was a
just small correction in the overall market. (We now know these
earnings were inflated.)
By summer of 2001, the margin debt was nerve-racking and I was
forced to sell Nortel shares and diversify as the share price continued
to slide. I began to exercise and sell, just to raise cash for the 2001
Alternative Minimum Tax. Nothing could stop the hemorrhaging stock
price or margin calls. The tax models the accountant had prepared last
year were useless. My only concern was having enough cash to pay the
AMT and pay off the margin debt. By the end of 2001, we got word that
Nortel would soon be downsizing their operations in Florida. Nortel
Networks needed to reach the ``break even point'' and the cutbacks
began. By the third quarter of 2001, the share price was under $10 and
Nortel was laying off two thirds of their worldwide workforce.
April 15th 2002. I had paid estimated tax throughout the year, in
hopes of making the April payment manageable and avoiding penalty fees.
Each of those quarterly tax payments went on the margin loan. By April
2002, I reached my personal debt limit and liquidated my account to pay
off my debt and pay the AMT. The 2001 tax bill was only $37,000.00, a
few thousand less than my yearly salary! I ended my contract with my
accountant, sold 90% of my investment account, and prepared myself for
the possibility that I too would soon lose my job. My fears were
realized and by the second quarter of 2002, I was unemployed.
I learned many valuable lessons through this experience and I am
fortunate that I am not financially ruined like so many of my former
colleagues. Many will have their wages garnished, or have filed for
personal bankruptcy, some were fortunate enough to negotiate
settlements with the IRS. The Alternative Minimum Tax code was
implemented to prevent wealthiest 2% of Americans from using special
tax benefits to pay little or no tax. For various reasons the
Alternative Minimum Tax has reached many hardworking, middle class
Americans in South Florida, some who don't have very high incomes or
special tax benefits. I hope those in the United States Congress have
the compassion and foresight to realize the growing negative effect of
the Alternative Minimum Tax and bring change to the outdated tax code.
Timothy Masters
Fallbrook, California 92028
June 22, 2005
Dear Chairman Thomas and Committee Members:
My wife and I are among other Americans who have been hugely
impacted by the Alternative Minimum Tax (AMT) and its treatment of
Incentive Stock Options (ISOs).
In 1998, I joined a Silicon Valley startup. Within 18 months, I
exercised incentive stock options and we were instantly
``millionaires'' on paper. Unfortunately, our stock value plummeted in
2001 with the rest of the NASDAQ. As a result of the AMT, however, we
were still liable for nearly $300,000 in federal income taxes and
approximately $75,000 in state taxes based on the value of the stock at
exercise. Given the dramatic fall in the value of the stock, we were
unable to pay the liability in full.
Over the next 2\1/2\ years, we tried to reach a reasonable
compromise with the IRS on the remaining balance, but our offer in
compromise (OIC) with the IRS was rejected, as was our appeal of the
rejection. Most recently, at great family hardship, we did a cash-out
refinance of our home and liquidated all of our remaining assets to
come up with $262,000 (which included $187,000 in federal tax and
$75,000 in penalties and interest) to pay the balance of our year 2000
taxes.
My wife and I are now starting over financially due to the AMT. I
am 47 years old and the first of my two teenage children will enter
college next year, which my wife and I are committed to fund. Given
that the AMT has completed depleted all savings, investments, 401ks,
college funds, etc, we plan to cash flow our children's education over
the next 7 years and then at age 54, we will begin to re-save for
retirement.
Please help us, and quickly. We are hopeful that our Leadership
will recognize that the AMT and its impact on families like ours is
unfair and distorted. We are also hopeful that new legislation will
soon provide relief for families in our situation. For example, the
ability to apply our AMT credits against normal income and tax events
would allow us to regain some of our financial security.
Sincerely,
Steve Mazingo
Statement of Monica McGuire, AMT Coalition for Economic Growth
On behalf of the AMT Coalition for Economic Growth, a coalition of
companies and associations representing small, medium and large
businesses from different industries, we direct your attention to
problems created today by the corporate alternative minimum tax (AMT).
While the growing reach of the individual AMT is a major area of focus
in the tax reform debate, any serious reform effort also must address
the adverse effects of the corporate AMT.
Regarding the Ways and Means Committee hearing on Tax Reform June
8, 2005, we submit these comments to highlight aspects of the corporate
AMT that are unfair, including the growing problem companies face of
not being able to recover AMT credits on a timely basis if at all; ways
in which the corporate AMT distorts business investment decisions; and
the complexities and administrative burdens needlessly imposed by the
AMT. In light of these concerns, we urge the Committee to advance the
goals of repealing the corporate AMT and allowing taxpayers to utilize
existing AMT credits (i.e. prepaid taxes) on an expedited basis.
Unfair Impact of the Corporate AMT
One of the most punitive aspects of the AMT system today is the
inability of many taxpayers to utilize AMT credits \1\ within a
reasonable period of time. Companies with unused AMT credits
essentially are making interest-free loans to the Federal Government,
to be repaid only when the company has sufficient regular income tax
liability in the future. Many past AMT taxpayers have significant
amounts of AMT credits that are now older than 10 years. The longer AMT
credits go unused (i.e., the longer the interest-free loan to the
government remains outstanding), the less value they have. Congress
intended for the AMT to serve only as a pre-payment of tax, not as a
permanent tax increase, which effectively becomes the case the longer
taxpayers cannot use AMT credits.
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\1\ Under present law, every dollar of corporate AMT paid results
in an AMT credit that may be carried forward to offset regular tax
liability in future years, but only to the extent regular tax exceeds
tentative minimum tax.
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IRS data show that AMT credit utilization has declined in recent
years, down from more than $5 billion in 2000 to $2 billion in 2002.\2\
While usage has slowed, more than $26 billion of AMT credits remained
outstanding in 2002.\3\
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\2\ IRS Statistics of Income, Table 13--Corporate Income Tax
Returns: Balance Sheet, Income Statement, and Tax Items for Specified
Income Years, 1990-2002.
\3\ In 2002, there were $26.4 billion minimum tax credits carried
forward to 2003, U.S. Dept. of Treasury.
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Many reasons explain why a taxpayer may be unable to recover AMT
credits on a timely basis. The decline in AMT credit usage over the
2000-02 period was in part the result of the recession, which left many
companies with little or no regular tax liability against which to
apply AMT credits. Indeed, a perverse aspect of the corporate AMT is
the fact that the economic benefit of AMT credits is denied at
precisely the time companies are in greatest financial need. For many
past AMT taxpayers, deductions for mounting health care benefit and
pension costs, use of net operating loss (NOL) carryforwards, and other
factors may limit credit utilization significantly for years to come.
In recognition of these systemic problems, Congress in the past has
considered legislation to allow faster use of AMT credits. The AMT
Coalition would be pleased to work with the Committee this year to
suggest other means by which taxpayers can better utilize AMT credits.
Interestingly, fewer and fewer corporations are actually incurring
AMT today.\4\ In 2002, fewer than 7,000 corporations incurred AMT
liability, down from more than 30,000 that paid AMT in 1990 and more
than 25,000 that paid it in 1995.\5\ Looked at another way, only about
0.3 percent of corporations that filed a return in 2002 incurred an AMT
liability. The amount of AMT collected in 2002 was $2.45 billion
compared to more than $8 billion in 1990 and more than $4 billion in
1995. Accordingly, the revenue lost by repealing the corporate AMT,
standing alone, would be far less today than in years past.
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\4\ The decline in the incidence of the corporate AMT, not all of
which is yet reflected in available statistical information, is
attributable in large part to recent legislation. The Taxpayer Relief
Act of 1997, for example, modified the AMT depreciation adjustment to
reduce the likelihood that investments in plant and equipment would
cause a business to incur AMT liability. Most recently, the American
Jobs Creation Act of 2004 repealed the AMT's 90-percent limit on the
use of foreign tax credits, an inappropriate restriction that had
resulted in double taxation of income earned in the global marketplace
by U.S. companies.
\5\ IRS Statistics of Income, op cit.
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Where the corporate AMT does continue to be paid today, its
imposition can be viewed as wholly unfair. For example, the AMT's
limitation on the use of net operating losses (NOLs) prevents companies
from being able to carry back fully a current-year loss to offset taxes
paid in prior years. This limitation only exacerbates the problems many
companies face in struggling through business cycle troughs.
Ironically, ``fairness'' considerations partly drove Congress to
enact the AMT at the outset. Concerns had arisen that companies were
``zeroing out'' their tax liability prior to the Tax Reform Act of 1986
through use of investment tax credits, the ``accelerated cost recovery
system'' of depreciation, ``safe harbor'' leasing, and other tax-
favorable items that have since been repealed or scaled back. The
corporate tax landscape looks far different today, as the Joint
Committee on Taxation staff noted in recommending repeal of the
corporate AMT:
The corporate alternative minimum tax does not necessarily produce
a more accurate measurement of income after the depreciation, inventory
and accounting provisions of the Tax Reform Act of 1986, and subsequent
legislation, have become fully effective. Thus, the Joint Committee
staff believes that the original purpose of the corporate alternative
minimum tax is no longer served in any meaningful way. . . .\6\
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\6\ Joint Committee on Taxation, ``Study of the Overall State of
the Federal Tax System and Recommendations for Simplification'' (JCS-3-
01), April 2001 at II-16.
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The Coalition would challenge anyone to argue how the corporate AMT
system today advances the objective of fairness, or any other tax
policy goal for that matter.
Negative Impact on Investment Decisions
The corporate AMT operates as a significant disincentive for
companies to make productive investments. For example, the AMT blocks
the incentive effect of tax credits like the R&D credit. The AMT does
not allow the R&D credit to offset AMT liability. The AMT also blocks
utilization of R&D credits for many companies that do not incur AMT
liability, since tentative minimum tax liability forms a ``floor'' that
limits the amount of credits a company may claim against regular tax
liability. Accordingly, for many taxpayers, the AMT thwarts the
incentive to invest in U.S.-based R&D that Congress has long sought to
provide. Meanwhile, remaining AMT limitations on depreciation operate
as another disincentive, at the margins discouraging companies from
investing in new plant and equipment.
These investment disincentives kick in just when businesses most
need to be retooling and investing for future growth. That is, a
recession increases AMT liabilities, a counter-cyclical impact that is
not disputed.\7\ For example, AMT liabilities jumped from $1.8 billion
in 2001 to $2.45 billion in 2002.\8\
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\7\ See, e.g., Joint Committee on Taxation, ``Background Materials
on Alternative Minimum Tax and Capital Cost Recovery Prepared for the
House Committee on Ways and Means Tax Policy Discussion Series,'' (JCX-
14-02), March 2002 at 7.
\8\ IRS Statistics of Income, op cit.
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Compliance, Administrative Burdens
The corporate AMT imposes extremely onerous--and well documented--
compliance and recordkeeping burdens.\9\ The AMT requires a calculation
of a second income tax base and computation of a tax on that base. The
result is that the AMT adds an additional layer of administrative
burdens and complexity to the regular corporate tax system.
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\9\ See, e.g., General Accounting Office, Tax System Burden: Tax
Compliance Burden Faced by Business Taxpayers (GAO/T-GGD-95-42, Dec. 9,
1994); Andrew B. Lyon, Cracking the Code: Making Sense of the Corporate
Alternative Minimum Tax (Washington, D.C.: The Brookings Institution),
1997.
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One study has found that calculating the corporate AMT adds 16.9
percent to a corporation's tax compliance costs.\10\ Moreover, these
AMT compliance costs are incurred regardless of whether a corporation
actually ends up paying any AMT. Companies first must undertake the AMT
calculation to determine whether they are liable. All but the very
smallest firms are required to perform the separate calculations. While
most of the tax paid under the AMT comes from large firms, about 75
percent of all AMT returns have come from small and medium-sized
businesses.\11\
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\10\ Joel Slemrod and Marsha Blumenthal, ``The Income Tax
Compliance Cost of Big Business,'' Public Finance Quarterly, 24
(October 1996), pp. 411-438.
\11\ General Accounting Office, Experience with the Corporate
Alternative Minimum Tax (GAO/GGD-95-88, April 1995), p. 35.
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The Joint Committee on Taxation staff recommendation that the
corporate AMT should be repealed was based in part on the premise that
Congress should ``relieve corporations from computing their tax base
using two different methods and complying with burdensome recordkeeping
requirements.'' \12\
---------------------------------------------------------------------------
\12\ Joint Committee on Taxation, ``Study of the Overall State of
the Federal Tax System and Recommendations for Simplification'' (JCS-3-
01), April 2001 at II-16.
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Conclusion
Consequently, the AMT Coalition urges the House Ways and Means
Committee to include as part of any tax reform legislation repeal of
the corporate AMT and allowing taxpayers to utilize existing AMT
credits on an expedited basis. Of course, the means by which taxpayers
may recover AMT credits in a post-tax reform world may depend in part
on what the new system looks like. That said, mechanisms easily could
be developed in connection with any type of reform framework that would
preserve, and quickly unlock, the value of these long-accumulated
prepaid taxes. We look forward to working with the Committee to address
this important issue.
Statement of Arthur and Rita Miller, Reform AMT, Catonsville, Maryland
Dear Chairman Thomas and Committee Members: My name is Rita Miller
and I am writing on behalf of my husband, Arthur W. Miller, Jr and
myself. It is regarding a huge tax debt that we incurred on phantom
gains that were created by the application of the Alternative Minimum
Tax (AMT).
In November 1997, I took a job in Linthicum, Maryland as an
Administrative Assistant for a start-up Internet security company,
VeriSign, Inc. We incurred a huge tax debt starting in the year 1999 by
exercising Incentive Stock Options (ISOs) I received while working for
VeriSign, Inc. We read everything we could about stocks and taxes and
everything pointed to exercising and holding the stock for long term
capital gains. We enlisted the help of a reputable financial advisor.
The advice from the financial advisor was to exercise and hold the
stock so as not to incur the higher short-term capital gains rate. But
unbeknownst to everyone, if you exercise and hold onto stock for the
long term and carry it over a tax year, a tax called AMT (alternative
minimum tax) can apply, and it did.
All other assets, like real estate and stock purchased on the open
market, are taxed based on the value at the time of the sale, when you
actually receive a profit, not at the time of the purchase. Why aren't
we just taxed when, and if, we sell the stock? That then would be a
legitimate profit made and a legitimate tax due.
Our total federal taxes due from the years 1999 through 2002 were
$448,873. We managed to pay $314,784 by selling whatever shares of
stock we had. This is not even to mention the amount that we owed to
the state. We negotiated with the IRS and went on a payment plan to pay
the remaining $134,089, likewise with the State. We never missed a
payment until both my husband and I lost our jobs within a few months
of each other in the year 2002. I was unemployed for over a year, my
husband is still unemployed. I'll be 58 this year and my husband will
be 60.
We submitted several OICs and Appeals and the IRS rejected them
all--stating that we had a house, a car and some retirement money and
if we sold the house, the car or turned in the retirement, we could pay
the ``phantom taxes'' we owed. We came to realize that after filing
subsequent years taxes, that the IRS now ``owes us'' over $125,000 in
credits. We owe them $124,000. We filed an OIC asking the IRS to accept
our credit as payment. It was rejected. The last OIC we offered $30,000
(provided by a family member) and our credit to bring our tax debt to a
``paid-in-full'' status. Can you imagine our disbelief when we received
the notice that the IRS is rejecting this offer too? They accused us of
using ``delay tactics''. The IRS wants us to pay them in full, first.
Then they want to give us back the $125,000 by allowing us to recover a
small portion, approximately $3,000, of the credit per year! It is
highly unlikely that my husband and I will live to recover all the
credit due us. We would have to live to approximately 99and 97
respectively to recover the entire amount. While awaiting a court
hearing, they have put a lien on all our assets.
A travesty occurred in our lives that added additional hardship. My
husband, who has been unemployed since August 2002and spent more than a
year of processing for employment with the Department of Defense, was
notified that the DoD was withdrawing their offer of employment due to
the outstanding IRS debt. They said that the tax issue ``brought into
question his credibility and trustworthiness''. That he didn't meet
their suitability criteria. At almost 60 years old where is he going to
find another opportunity like the one with the DoD? We are hardworking,
trustworthy and honest people. We have never avoided paying taxes and
have always engaged in honest financial practices. We understand the
AMT was put into place to make sure that the very wealthy people paid
their fair share of taxes, but it's not working the way it was
intended. There has to be some consideration for people like us, those
of us that were caught in the AMT trap.
This year we celebrated our 40th wedding anniversary, but for the
past 5 years we have been living a nightmare. We fear that one day when
we open our mailbox there's going to be a letter from the IRS stating
that they are taking our home or making us liquidate our retirement to
pay them taxes that are unjust and unfair.
We respectfully seek the understanding of this Committee and plead
with you to help rectify this wrong.
Marietta, Georgia 30066
June 12, 2005
To Whom It May Concern:
I will keep this brief. I just want it to be known that as a tax-
paying (yes I pay and do not get a ``refund''), law abiding voter that
I am in full support of H.R. 25. As a working mother of two, as well as
financially supporting parents, I see how social security and Medicare
fall down financially in caring for those over the age of sixty-five.
Even with other savings, it is still not enough to cover the external
costs of insurance, medicines, general upkeep of a home, etc. The
current system is perpetuating the current, causing aging parents to
become a financial burden to their children and taking away their
children's choice of wanting to work vs. having to work, in order to
care for a family.
I believe government spending should be audited and downsized as
well in order for us to reap the FULL benefits of H.R. 25.
Please do not take this bill lightly. It is time for change and the
time is now so that we do not have to continue to force citizens to
become financial burdens to the Federal Government.
Thank you for your time and reading this email.
Ashlyn Montague-Hill
Statement of Nield Montgomery, Las Vegas, Nevada
Dear Chairman Thomas and Committee Members:
My name is Nield Montgomery. I very much appreciate the opportunity
to tell my story of suffering and hardship brought on by the
application of the out of date and destructive rules for the treatment
of Incentive Stock Options under the Alternative Minimum Tax (AMT)
code.
My difficulties and those of thousands of others were brought about
by events never contemplated when the AMT was devised, i.e., the
significant negative tax impact that happens with stock options when a
company's stock price experiences a dramatic decline. At the risk of
being too basic, please allow me a brief explanation of stock options.
A stock option is the right to buy a share of stock at its current
price (the strike price) at some time in the future. Non-Qualified
Options (NQOs) and Incentive Stock Options (ISOs) differ in their tax
treatment. I'll talk first to ISOs. When the option holder exercises
the right to buy (obviously the current market price exceeds the strike
price), they create an Alternative Minimum Tax (AMT) taxable event. The
AMT treats the spread between the option strike price and the stock
price when the option is exercised as income (otherwise called
``phantom'' income). That is, even though there's no tangible income, a
tax consequence occurs non-the-less. Now to be fair, when the AMT
exceeds the regular tax owed calculation, the taxpayer gets a credit
against taxes in future years (the credit's application is complex and
can take years if ever to recover). A subsequent sharp decline in stock
price does not alter the tax owed even if the stock price goes to zero.
When the tech bubble burst, huge numbers of share owners were left
with tax bills resulting from the AMT treatment of ISOs while their
shares had become nearly or even totally worthless. Remember, the real
value of the stock has nothing to do with taxes owed. What was supposed
to be an ``incentive'' and accepted in lieu of cash compensation turned
into a tax nightmare (an obligation to pay taxes where no income/gain
was realized). People were forced to mortgage/sell their homes, take
out loans, or sell what ever they could to pay these absurd tax bills.
It seems incomprehensible the IRS would enforce such harsh collection
measures for tax dollars that become a credit in the taxpayers account.
This AMT tax treatment is complex and unfair and has caused untold
financial hardship, ruin, and heartbreak. Side note: how does the
government account for these prepaid taxes?
The tax treatment for NQOs is even worse. Tax law requires the
treatment of the NQO as an income event at the time of grant. The
income results from the difference between the strike price of the
option and the stock price on the grant date. This is without regard as
to whether the NQOs are even exercised and, if they were, whether or
not the shares were sold. Again, in a market such as we've experienced,
a decline in the price of the stock is just a personal misfortune. The
tax is owed even if the stock price goes to zero.
Looking at the larger picture, I'm not sure anyone can assess the
positive impact the awarding of stock options has had on our economy. I
know their use has been wide spread and it's my opinion they've been a
significant factor in holding down wages and inflation. Thousands of
employees had been willing to accept below market wages in exchange for
options. The belief was that by working hard and making their company a
success, they'd have a share of that success. Unfortunately, for many,
it didn't work out that way. If the negative tax treatment of stock
options isn't fixed, their use as an incentive and benefit on holding
down wages will be lost.
Now for my story. By way of background, I worked 31 years in the
telephone industry starting at the lowest entry level job and working
my way to General Manager. In 1993, I left a good paying job to become
and ``entrepreneur''. Two years later, I founded MGC Communications.
Having worked my entire career in large impersonal corporations, I
thought it was important that our employees be owners as well. We
accomplished that goal by granting stock options to everyone who joined
the Company. At the most senior level, we were able to hire very
qualified people at compensation levels below market rates by
sweetening employment packages with stock options. As a young Company,
it was essential we conserve our cash. Since salaries and bonuses
represented such a significant portion of on-going cost, the use of
ISOs was an effective way to do that. ISOs also incented our employees,
as owners of the Company, to really apply their talents to building the
business.
As the most senior officer/leader of the Company, I was committed
to and embodied these goals. In lieu of a salary more typical of my
position (my successor's annual salary was $500,000), mine was $150,000
with ISOs as additional compensation. In lieu of cash bonuses (my
successor's annual bonus was $500,000), I took ISOs. Little did I know
of the tax nightmare lying ahead.
Unlike many victims of this cruel conspiracy of events, I had
access good tax planning help. My personal banker was with one of the
largest public stock firms in New York. When he didn't have answers, he
had the best talent available to him in the corporate offices. My
accounting firm was one of the big five national firms. Like my banker,
when they needed help, they turned to specific experts on their
corporate staff. Yet with all this knowledge and talent, none of them
really understood the complex treatment of options within the AMT.
Here's what happened in my case. When I exercised my options in
early 2000, the stock priced was $66 per share. Since the options had
been granted in the early days of the business, the strike price for
the options was very low. When the spread was calculated and the AMT
rules were applied, I owed an additional tax of $4,400,000. Within six
months of exercising my options, the stock had lost 90% of its value
(the Company eventually declared bankruptcy). While the intended
holding period for ISOs is one year, I was forced to sell shares sooner
to raise the money to pay the taxes. To further compound the situation,
I owed taxes on the shares being sold. In the end, I sold all the
shares acquired thru options to pay the AMT and still ended up $200,000
short. I have said many times jokingly, if the IRS would have accepted
everything I owned in the Company in exchange for the AMT owed, I would
have been money ahead.
All I have to show for the experience is a substantial tax bill; a
tax bill that resulted from a purchase event. I understand and accept
the tax consequences when there's a purchase and sale which results in
a net gain. What I reel at is the application of a 28 percent tax on
the purchase of stock as though some form of gain had been realized.
This is a virtual sales tax! And, as noted earlier, the tax code is so
complex it was/is impossible to find anyone sufficiently knowledgeable
to provide accurate tax planning.
As I've talk to other people similarly situated, I've realized how
pervasive this problem is. I also discovered there are three ways in
which taxpayers deal with this issue. The first group, like me,
reported the exercise event and faced the tax consequences. The second
group knew they should report but chose not to. Since there's no
reporting/tracking mechanism, the IRS doesn't know there's been a
taxable event. The third group just didn't realize they had to report.
Of the three groups, I believe those who reported were in the minority.
One of the fundamentals in our tax code is the uniform application of
the law. Clearly that did not happen here.
As for reform, here are some ideas. Change the AMT formulas so this
kind of injustice doesn't happen in the future. Those of us who have
credits, at a minimum, make the credit directly applicable to all
future taxes owed and not just a factor in the AMT calculation as it is
now. At the extreme, send us a check equal to the credit (that would be
a real ``rebate''; these are real dollars we've paid in excess of what
we would have otherwise owed). And if you must hold our money, at least
pay us interest at the rate the IRS charges us for late payments.
Finally, if the AMT must continue, please insure it is indexed down
proportionate to the regular tax rate schedule.
As for the tax treatment of NQOs, stop treating the event as income
at the time of grant. Taxes should be owed when income/gain is
realized. That means determining taxes owed when the stock is sold. I
would agree a portion could be treated as income and the change in
subsequent stock price as a long/short term gain/loss.
If I sound like a tax professional, I'm not. I'm one of the
thousands of people granted options only to have this tax nightmare.
I've become knowledgeable by default! I just couldn't believe I'd owe
taxes for options granted when I hadn't received income or realized a
gain. In hindsight, I would have been so much better off to have taken
the pay instead of the options. I know thousands of others feel the
same way (not a scenario that bodes well for business and our economy).
At least I'd have the income to pay the related taxes. We need your
help; fix this injustice!
Statement of David W. Moyle, Beaverton, Oregon
Dear Chairman Thomas and Committee Members:
Thank you for the opportunity to express my views on this important
matter. I am a hard-working upper middle class citizen who has
experienced what I believe are unintended consequences of the
Alternative Minimum Tax. Below are my views:
The Alternative Minimum Tax is bad government policy on a number of
fronts:
It is unfair
It has stifled economic recovery
It is difficult to understand and creates taxpayer
resentment
My situation is this: I am a mid-level manager at Intel Corporation
where I've worked for over 20 years. During my first 10 plus years at
Intel I received incentive stock options. During the late 1990s and
early 2000, the value of these options soared about the same time they
were set to expire. Believing in Intel's long-term future, and the
under the assumption that long-term gains would be taxed more favorably
than short-term gains, I purchased the shares and held them. As a
result, I began to trigger the AMT.
For the year 2000, in particular, I generated more than $400,000 in
AMT based on paper gains from the purchase of incentive stock options.
This amount was over four times my base salary. When the price of Intel
stock fell before my taxes were due, going from a high of $75 to an
eventual low of under $13 per share, my alternatives were to sell my
shares to pay my taxes and have very little left, or take out a loan
and hold onto the shares in the hope that Intel would rise again
someday. I chose to borrow. The stock has never fully recovered, and to
this day, I still carry a loan. I now have about $575,000 in AMT
``credit,'' much of which I will probably not get back. The AMT tax I
paid was based on phantom profits . . . in other words, money I never
made.
Below is why I believe the AMT is unfair, has stifled economic
recovery, is very difficult to understand, and has created taxpayer
resentment.
The AMT is Unfair:
Phantom gains and Enron-style accounting: In calculating the AMT,
taxpayers must calculate paper gains on stock option shares purchased,
but not sold, and treat the phantom gain as if it were real income. In
other words, no profit has yet been made. The regulations practically
require us to do Enron-style accounting to show phantom profits as if
they were real, and then pay taxes on them.
It's not really a credit: As I began to pay AMT taxes and build a
``credit,'' I naively assumed I would get this back once I finally sold
the stock. Theoretically, this could happen if the stock reached the
former lofty heights of the dotcom era and if I were able to wait that
long. Most of us get only a portion of this ``credit'' back, at a rate
of only $3000 per year. At this rate, I would have to live to be well
over 200 years old to recoup the credit.
Interest free loan to the government: If we under-pay taxes, the
IRS assesses interest on taxpayer accounts until we pay in full. In the
case of AMT, I have grossly overpaid my taxes, and rather than
receiving interest from the government for my pre-payment of taxes, I
had to take out a loan to pay taxes on money I never made. In essence,
I have given a $575,000 interest free loan to the government . . . and
the government will in all likelihood return only a fraction of the
loan.
The MAT Has Stifled Economic Recovery:
Discretionary Income Has Gone to Payoff Loans Used to Pay Taxes:
Because AMT taxes on ISOs were based on phantom profits, many of us did
not have the cash to pay our huge tax bills when the stock market
crashed. In my case, I had to take out a $375,000 loan to pay taxes.
Interest payments on my loan were double my house payments, and my loan
size grew because my income was insufficient to pay the interest. Prior
to having the huge tax bill, I was shopping for a mountain cabin to
enjoy with my kids while they're still living at home. We scrapped this
plan. We were planning an international vacation. We scrapped this,
too. We planned to make some upgrades to our home. We scrapped this
plan as well. Basically, all our discretionary income went to pay
interest on our loan to pay taxes ON PROFITS WE NEVER MADE.
The AMT is Very Difficult to Understand:
Confusing and Contrary to Existing Tax Incentives: The AMT requires
us to calculate our returns two ways. A ``credit'' is not really a
credit. A paper profit is treated as a real profit. It is very
difficult to do financial planning because many tax incentives and
normally wise investment strategies, such has holding investments for
the long term, actually put us at great risk with AMT. Rather than
encouraging long-term investment and ownership in our companies, the
AMT encourages us to ``cash out'' for short-term gains.
Taxpayer Resentment: Although I can't say I have always enjoyed
paying my taxes, I had always viewed it as a necessary responsibility
of citizenship. The AMT, however, has left me very confused and
frustrated and quite frankly resentful of our tax policy. I feel that
the government has taken advantage of me. I feel ``robbed.'' The U.S.
Government as been the beneficiary of my stock options; by contrast,
I've paid a penalty. After years of growing my equity, I am now in
worse financial shape than I was 5 years ago because I was taxed on
profits I never made. To date, little of consequence has been done to
address this unfair and complex tax. My hope is that your Committee
will be able to do something. In priority order, I would have you:
Refund ``credits'' . . . or let us use the credit against
all taxes owed, not just future AMT taxes. If this is not done, at
least pay fair market interest on the ``loan'' and speed up the process
of giving our money back.
Eliminate the AMT altogether . . . or go back to the
drawing board and address the reasons it was created in the first
place.
Bozeman Granite Works
Bozeman, Montana 59715
June 7, 2005
Dear Sir or Madam:
I respectively request that you support the end item retail
taxation method known as FAIR TAX and elimination of the 16th amendment
and all income taxes on USA labor.
I am a small businessman that runs a manufacturing and retail
business with a storefront on a major retail avenue. My operation
requires three full time employees and two part time people. As all
businesses adding value to a product through manufacture, stocking an
inventory, sales or any number of activities requiring labor I am
confronted at least weekly with the taxes on the labor we politely call
``income tax''. I, as all businessmen, am required to add all taxes
that are paid, to the price of the end product. What I'm trying to
convey here is that all taxes, and specifically income tax, is just an
added value tax. The person, company or corporation that digs the raw
materials adds income tax to the price of the raw materials, the
person, company or corporation that transports the raw materials pays
income tax and adds the tax(s) the transported raw materials, and on
and on and on, until the product is sold at the retail store. The point
I'm making is, income tax is added to the price of the completed
product at all levels of production making it simply an added value
tax. In other words at any time during the manufacturing, distribution
and sales of product that value is added to a product we tax it in the
form of income taxes.
Added value is not that bad? Yes it is. We only tax our domestic
production and tax it and tax it. The tune of 50,60,70,80% and some
products that are heavy in labor 120+% of actual value (untaxed costs).
We are forced to compete with foreign products that are not taxed in
the country of origin nor here. Import dudies or taxes of 1, 2, or even
10% on the untaxed costs of foreign production is basically nothing.
I am lucky. The vast majority of raw materials, semi finished
products and finished products that I either add value by finishing the
production or retail directly are made in USA. They fall in the heavy
labor category, I manufacture granite monuments. Foreign materials and
semi finished production is on it's way to displace the domestic. The
commercial market for natural stone 10 year ago was completely USA and
now is completely foreign, the handwriting is on the wall; I'll be
forced to purchase foreign production to stay in business within the
next 5 years. The loss to our economy will be thousands and thousands
of 20, 30, and 40 dollar/hour jobs. These highly skilled craftsmen will
be shoveling burgers for the importers and retail owners. These people
won't be paid enough to pay taxes, they won't have high paying jobs.
Please understand the rich aren't getting richer and poor aren't
getting poorer. The middle class is shifting from high paying
production jobs to low paying service jobs due to foreign markets
caused by added value taxation on our production.
Fairtax is the only way out of this. We need to shift the taxation
to the end item retail. It's there on domestic production anyway. It's
about time we placed the same tax burden on the foreign retail here in
the USA. Please understand that we already add the taxes to the
domestic production and pay whatever that is at the retail end. Please
understand that prices on domestic production will not change. Food,
housing, clothes and all other ``necessities'' are still being produced
domestically and will not change in price. The beauty of end item
retail taxation will allow domestic production to expand and even take
some of the current foreign markets and even compete internationally
with like products. This will create vast quantities of high paying
production jobs. In other words more money in the hands of more people
resulting in more consumption and more tax dollars.
There are three civilized ways to collect taxes. Fees, the USA
constitution established a fee system. If you wanted to be a citizen
you paid an equal share of federal taxes (consult the body of the
constitution). Fees are color blind, sex blind, handicapped blind,
anyone who wished could pay the tax and have say in the country. Bill
gates and a hobo would have the same opportunity. Our country operated
for more than half it's life on the fee principle of taxation and is
probably the best system. Number 2, value added is the current system.
The worst of the three. Value added can tax only domestic production.
Any changes in production such as imports will displace domestic
production causing low tax basis and loss of tax revenues. Worse yet
added value through income taxes results in imports taking high paying
jobs, poverty and no tax basis. The third is consumption tax (retail
end sales tax) or Fairtax. Basically put, no taxes are added to
domestic production until they are retailed. Foreign production burdens
the same tax, underground economies burden the same tax, collection is
at a small number of locations, consumption is more consistent than
income. High paying jobs come back to our country. I can see no down
side.
Please support the Fairtax.
Thank You,
Thomas M. Olson
Cupertino, California 95014
June 20, 2005
Dear Chairman Thomas and Committee Members:
I am writing to ask for your support and would appreciate your
taking a moment to read this letter.
My name is Kimhoe Pang. I am a software engineer of Network
Appliance. I exercised some stock option in year 2000 under the
Incentive Stock Options (ISO) scheme. I did not sell any of the
exercised stock to get profits. The ISO exercise created a huge AMT
tax. I have $367,684.00 tax due in 2000. It amount is more than 3 time
of my annual salary. This tax payment actually becomes a credit and can
never be recovered by me. In essence, I can lose all the investment
money, and also other assets, simply to create a tax credit in my IRS
account.
Due to the stock crises in 2000, I did not have enough money to pay
tax. I filed an Offer in Compromise (OIC) and the OIC was denied after
two and half years. IRS has started the collection process and has put
a lien on all my properties. I am the only one who brings income to my
family. My family (five people) still live in a two bedrooms rented
apartment. However, the IRS officers told us that they only concern
about the tax we have not paid. They are regardless about the fairness
of the tax.
We are still facing financial crisis. IRS already starts collection
process. We have to pay the huge tax that is base on the profit we
never make.
We need your help to have the IRS to stop the collection
activities. We respectfully ask that you further investigate the
disastrous consequences of the Alternative Minimum Tax and please
support all efforts towards reform.
Sincerely,
Kimhoe Pang
Issaquah, Washington 98027
June 17, 2005
Dear Chairman Thomas and Committee Members:
In 1997 I went to work for a new internet company, Exodus
Communications, who granted sales employees pre IPO stock shares upon
hiring. After the IPO and some time of employment I hired a financial
planning firm to advise me on how to best handle these options. I was
advised to exercise the options as they became available and then hold
for one year from that date before diversification. I took this advice.
During this time between 2000 and 2001 (within several months) the
stock fell from the high $100s per share to landing at less than $10. I
was laid off in May of 2001 when we finally sold our shares at $.10
after Exodus's bankruptcy.
I was laid off just before Exodus declared bankruptcy and found
myself unemployed for 7 months. Meanwhile, we had to sell our house and
all other valuables to make it through this period financially. My
husband had quadruple bypass surgery unexpectedly in 2001 causing
further financial difficulty and personal stress. We have not recovered
from the financial challenges that losing my job, stock value and
medical bills caused our family, not to speak of the outstanding
balance expected by the IRS for AMT fees.
Since 2001 we have been attempting to work with the IRS as the
amount they calculated we owed them based on the AMT value is over
$600,000. As you can tell from this writing we incurred a huge loss on
the ``ownership'' of these granted shares. The IRS denied our Offer In
Compromise and has not proactively worked with us. We have retained
counsel to help us try to avoid all collection issues with the IRS and
had to borrow money exceeding $15,000 to gain representation.
We have no means to pay the IRS and, of course, feel there is no
real debt to re-pay. This has been going on for nearly 5 years with a
lien on our credit and ongoing fees to attorneys to keep collection at
bay. The next step is the IRS waves our fees or we must declare
personal bankruptcy. This AMT situation seems completely unfair and not
the proper application for its original intention. We join AMT Reform
in asking Congress to instruct the IRS to hold off on current
collection efforts until new legislation can be addressed.
Bob and Susan Pessemier
Sunnyvale, California 94086
June 17, 2005
Dear Chairman Thomas and Committee Members:
Thank you for taking on the very important task of investigating
the tangled web of our current tax system with the goal of implementing
a simpler, more equitable system.
We respectfully ask that the committee examine the current tax
system's shortcomings with respect to individual taxpayers' ability to
recover AMT credits. We are a two-income household (both with full-time
jobs as individual contributors--not managers or company officers) with
three young children living in California--a high-tax state, as you
well know.
As a result of exercising and holding (to qualify for the long-term
capital gains tax rate) Incentive Stock Option (ISO) shares in 2000, we
incurred a Federal AMT bill of several times our normal annual income.
Luckily, in that year we sought and received sound advice on the AMT
implications of that plan. Between doing same-day-sales in 2000 on
remaining ISO shares and taking out a loan against a 401(k) retirement
account, we were able to meet our AMT obligation on April 15, 2001.
Thus, we have not run afoul of the IRS and have not had to worry about
losing our home, unlike many others who exercised and held ISOs during
that time period.
With the large decline in the stock markets since 2000, the shares
we still hold are worth a small fraction of their value upon exercise.
So, at this point the government is holding our entire gain
(representing many years of hard work) from the ISOs in the form of a
large AMT credit. Please also note that for tax year 2000 we paid (on
shares that we purchased then, but have held for five years now) at the
AMT rate of 28%, while under the current law our long-term capital
gains rate upon sale would be 15%. The mandatory pre-payment of tax
under AMT was at almost double the rate that the regular tax system
requires!
When we first saw the size of our AMT credit, we thought we would
be lucky to finish recovering it before we both died of old age. After
filing our last four tax returns, though, we see that unless something
changes we will never recover the vast majority of that credit during
our lifetimes.
Here is how much we've been able to recover, on a percentage basis,
for the 2001-2004 tax years. (Note that our tax returns for these years
have included no other extraordinary events.)
Tax Year % of AMT credit recovered
2001 0.56%
2002 0.17%
2003 0.13%
2004 0.00%
------
Total 0.86%
Less than one percent of our AMT credit has been recovered in the
four tax years since the credit was established! And the trend down to
zero in 2004 does not bode well for future years.
Under the current tax law we have very little hope of recovering
this interest-free loan to the government. These funds would go a long
way toward ensuring that we will be able to afford college educations
for our three children.
Please find a way to accelerate individual taxpayers' ability to
recover AMT credits!
Thank you very much for your consideration.
Sincerely,
S. Pintner
D. Pintner
Statement of Philip Priddy, Baton Rouge, Lousiana
Alternative Minimum Tax effects spreading
Filers must pay extra to the IRS
Friday, April 15, 2005
By Bill Walsh
Washington Bureau
WASHINGTON--Every April 15, Americans are reminded just how much
they dislike paying taxes on their income. Philip Priddy is still
paying off a $220,000 tax bill on money he never made.
Priddy, a Baton Rouge sales manager for Nortel, was forced to
liquidate his savings, sell his boat and his wages are still being
garnisheed by the Internal Revenue Service to pay off his debt.
Although an extreme example, he is among a fast-growing segment of
Americans who are feeling the pinch of the Alternative Minimum Tax, or
AMT.
The tax originated in the late 1960s to target super-rich people
who employed clever accountants to shield their income from the long
arm of the IRS. But because it hasn't kept pace with wage inflation,
the U.S. Treasury estimates that 3.8 million Americans this year will
have to pay an AMT on top of their regular income taxes.
Most are upper-middle-class people making a comfortable living, but
that will soon change, according to the Congressional Budget Office. By
2010, the agency said, nearly 30 million Americans--20 percent of all
taxpayers and 40 percent of married couples--will have to pay the extra
tax. By then, it will hit two-thirds of taxpayers with adjusted gross
income between $50,000 and $100,000, the agency projected.
``It is growing every year and taking in people who were never
intended to be hit by the AMT,'' said Rep. Jim McCrery, R-Shreveport,
who has filed a bill to repeal the AMT. ``It is already too pervasive
in our tax system.''
Most taxpayers probably skip right over the line on their 1040F.
Network Appliance Inc.
Barrington, Illinois 60010
June 20, 2005
Dear Chairman Thomas and Committee Members,
I am a sales manager in Illinois and work for a high tech company
in Sunnyvale, CA., Network Appliance. I have paid my federal and state
taxes every year since the age of 16 until 2000 & 2001 when AMT took
over my families' life.
I obtained both a blessing and a curse when Network Appliance stock
options became valuable and eligible to exercise. I followed expert
guidance on tax issues in regards to ISO options and exercised and held
all vested ISO options in 2000 & early 2001. The market collapsed, the
AMT tax bill came due and subsequent loan cover calls collapsed any
value left from the options. These events created a $900,000, and
growing, tax liability with no shares or share value left to pay the
tax bills of 2000 and 2001.
The tax bill was more than my family was worth by a factor of
three. We are on a payment plan with the IRS but it does not allow us
to cover monthly bills eight of the 12 months a year.
It has put a tremendous emotional strain on our family, especially
my wife. From her perspective we were taxed on something we never had.
We have paid our taxes every year after and expect to for the rest
of our lives.
The AMT ISO tax laws should have been written to treat vested ISO
options as standard common stock with standard short term or long term
capital gains to be applied based on vesting periods. If the law had
been written as such in 2000 and 2001, we would have paid 5X the amount
in taxes to the IRS and the state of Illinois. Our family would also
have had several millions to both invest as well as contribute to
various previously identified charities.
The U.S. treasury, the state of Illinois, the economy, several
charities, and my family would all in better shape if the tax laws were
written in better balance with today's stock option equity employment
situation.
Michael T. Pritchett
District Sales Manager
Statement of Gregory Ralph, San Diego, California
My name is Gregory Ralph and I am writing on behalf of myself, my
wife Nikki, and our four pre-school/elementary school age children. We
appreciate the opportunity to discuss the inequities we have
encountered due to the application of the Alternative Minimum Tax (AMT)
on Incentive Stock Options (ISOs).
In the late 1990s, I was working as an electronic design engineer.
As a co-founder of JNI Inc., I was granted Incentive Stock Options
(ISOs). As was Congress's intent, the ISOs encouraged the founders to
hold their stock and build a thriving and profitable company, which we
grew from an initial 11 person staff in 1997, through an IPO in late
1999, to a company employing over 200 people and generating annual
revenues of over $100M in 2000.
In my case, and similar to many others, as a result of the AMT
treatment on the exercise of those ISOs that subsequently declined in
value from the date of exercise, I ended up being taxed at a federal
tax rate of over 60%. The reward for creating a successful company
should never be that the IRS gets more out of it than the entrepreneur
(in some cases more than 100% of it), as this is a clear disincentive
to starting and growing a business. I know this result is clearly
contrary to the intent of Congress in creating the ISOs, and is rather
due to an unanticipated flaw in the complicated AMT treatment of ISOs
that decline in value, resulting in huge taxes on phantom paper gains
that were never realized.
This tax might also be known as the ``Honest Hardworking
Entrepreneur Tax'', since it only affects those dedicated hardworking
employees who hold on to their stock options after exercise (as the
`Incentive' in `ISO' implies) and who are honest enough to report their
option exercises to the IRS after market loses leave them owing more
AMT than their stock may be worth. After paying my unfair share of tax,
I have since found out that anyone who simply did not report the
options exercises on their tax forms probably got away with not paying
the tax, since there is
no employer reporting of ISO option exercises to the IRS. This is
clearly not fair and needs to be rectified.
Another clearly unfair and confusing aspect of this complex and
stealthy part of the tax code is the AMT credit. My understanding was
that the AMT ISO tax is a prepayment of future taxes owed such that
when the stock is sold, the credit can be recouped. To my dismay, I
found out after selling all my stock that this credit was very
difficult to recoup if the stock price had not appreciated since the
time of exercise. Unlike a true credit in the common understanding of
the term, this credit is not immediately refundable to the taxpayer
upon sale of the stock as one would reasonably assume it should be. The
result is that in addition to staggering market losses on my company
stock over a period of only a couple months (during which I was locked
out of trading by insider trading rules and could not sell to prevent
the AMT tax prior to the end of the calendar year), the IRS is also
keeping my huge tax overpayment ``credit'' indefinitely.
My ``credit'' has essentially become a long term interest free loan
to the government of around $700,000 that I am not likely to fully
recover even over the next 50-years or more, even by applying a portion
of the credit each year to 100% of my annual tax bill. To compound
matters further, the IRS has arbitrarily decided to further limit the
amount of credit a taxpayer can use against regular income. The IRS has
imposed this change in the law by a change in the form 1040
instructions with no clear legislative authority.
Legislative action is clearly needed to restore fairness, increase
compliance, and bring the AMT treatment of ISOs in line with original
congressional intent of encouraging long-term ownership of company
stock without unduly and severely punishing those who do. I urge this
committee to work toward implementing a swift and fair solution to this
ISO AMT problem. The fix should include prompt return of prior excess
AMT credits after the sale of the stock that generated the AMT, re-
alignment of the valuation date for AMT to correspond with the one year
long term gain holding period of ISOs to restore the initial intent of
ISO AMT while eliminating the AMT ``trap'', and mandatory ISO exercise
reporting to ensure future compliance.
We need this committees help today to correct the injustices caused
by the ISO AMT. I ask not only for my own family which has been harmed
by the ISO AMT's effects, but also for the many others who have lost
everything to this man made disaster that has washed away their
retirement funds, college funds, their homes, even garnished portions
of their future livelihoods. If this were a result of a natural
disaster anywhere in the world, this compassionate country would come
to their aid. The reality is that hard working entrepreneurs right here
in the USA are being destroyed by this ISO AMT disaster, and the only
relief they need is the return or abatement of their tax overpayments
such that they are only taxed on income they actually receive. It is
not too much to ask. It is the fair and just thing to do. We have faith
that this committee will act swiftly and appropriately to enact a fair
and equitable solution. Thank you.
Statement of ReformAMT.org
To the Honorable Chairman Thomas and the Honorable Members of the
Ways and Means Committee:
Thank-you for allowing ReformAMT the opportunity to communicate the
urgent need for legislation addressing the life-destroying impact of
the Alternative Minimum Tax (AMT) and its treatment of Incentive Stock
Options (ISO). The average individual in our organization faces tax
rates that exceed 300% of their income.
Introduction
Formed in April 2001, ReformAMT is a national grass roots
organization whose mission is to educate, correct, and prevent the
injustices created by the ISO AMT and its inappropriate means of taxing
Incentive Stock Options, which are intended to be a form of
compensation. We have members in 48 different states, plus Puerto Rico
and the District of Columbia.
Through ReformAMT, we plead with Congress to correct this flawed
tax code that has resulted in financial devastation for not only our
members but also thousands of others across the country who are too
embarrassed or discouraged to publicize their dilemma. Originally
intended to ``ensure that a very small group of high-income individuals
who paid no income tax would pay at least some income tax'',\1\ the AMT
has hit hardest those honest, hard-working employees who traded longer
work hours, lower salaries, fewer benefits, and job security for stock
options that might someday provide for their children's education,
assist in purchasing a home, or help fund their retirement.
Unfortunately, caught in the AMT trap, these workers were forced to pay
taxes on money they never received and never will receive.
Consequently, they are losing or have lost their homes, education
funds, and retirement funds.
---------------------------------------------------------------------------
\1\ Robert Carroll, Deputy Assistant Secretary (Tax Analysis),
submitted a paper to the President's Advisory Panel on Federal Tax
Reform on March 7, 2005, entitled: ``The Fact Sheet: The Alternative
Minimum Tax''
---------------------------------------------------------------------------
These people were committed, dedicated, and loyal to their
companies. ``Hold for the long term'', ``be a part of the company'',
and ``don't dump and cash in'' was the advice of brokers, Certified
Public Accountants, financial advisors, and the companies themselves.
However, as we all now know, the Incentive Stock Option AMT provisions
tax when you buy, NOT when you sell, forcing these workers to pre-pay
taxes on stock gains they never realized. To add insult to injury,
these taxpayers have honestly complied with this self-reported tax.
While the IRS machine destroys their lives, they have watched many of
their fellow coworkers go unharmed by simply omitting the reporting of
the stock option transaction.
Demographics
These are the results of a recent survey of our members in April
2005:
65% of our members affected by AMT are secretaries,
engineers, lower level managers and other rank & file employees (as
opposed to Managers, Executives and Founders).
Our members owe or owed an average of $322,428 in ISO AMT
over and above what they would owe under the regular tax code for
income received (that is 100 times what the average taxpayer hit with
AMT pays in additional taxes, according to testimony by the GAO at a
recent Senate Hearing).
Our members' average tax rate was 355% of their income.
Our members have an average outstanding AMT credit of
$213,620 due to their overpayment of taxes. With the current annual
deduction for AMT credits of $3,000 per year, it will take 71.2 years--
more than a lifetime--to finally recover their overpayment credit.
Also, this credit does not accrue interest--on the flip side--
individuals who still have outstanding liabilities are expected to pay
interest and penalties on this tax prepayment.
Because of the extreme difficulty/impossibility of paying
huge taxes on money never received, about 3% of ReformAMT members have
filed bankruptcy, with another 18% admitting they are considering
bankruptcy.
For every 2 people who complied with the AMT regulations,
there were 3 people who did not, taking advantage of the fact that no
independent reporting exists.
For every 4 people who complied, there was 1 person who
expatriated rather than have their lives destroyed by working the rest
of their lives to pay taxes on income they never received.
We know of 2 members who committed suicide due to the
horrendous effects this ISO AMT tax had on their lives.
Flaws of the AMT Treatment on ISOs that Distort Business and Personal
Decisions and Create Unfair and Unjust Results for Hardworking
Americans.
Tax Date Flaw--The regular tax code provides significant incentives
to hold on to the stock and grow the company. However, the AMT imposes
tax on the purchase date, not the sale date, making the tax rational
only in a bull market. In a down market, the AMT can result in
unreasonable and totally disproportionate tax rates, easily exceeding
an individual's income or even exceeding an individual's entire net
worth.
Complexity Flaw--Due to the complexity of the AMT,
investment counselors and ``tax experts'' are frequently unable or
unwilling to give proper advice to constituents about the consequences
of the ISO AMT. Many people were completely bind-sided by the AMT
despite getting professional advice on how to treat their stock
options.
Reporting Flaw--The exercise of incentive stock options
is not reported to the IRS by the company or by the broker--it is only
reported by the individual, making it a self-reported tax. Thus, the
ISO AMT provisions punish those who are honest and reward those who
fail to accurately report their taxes under the AMT code (either
through ignorance or intent).
Credit Flaw
ISO AMT credit can easily outlive a taxpayer, since
it can be applied only to the difference between the AMT and
regular income tax. For those who are ready to retire and who
have responsibly saved their entire lives to provide for a
proper retirement, the ability to recoup the credit can be
impossible.
The credit that is generated does not pass along to
your family or estate.
The government does not pay interest on the credit.
Tax Rate Flaw--Taxpayers exercise and hold stock options
in order to pay 15% long-term capital gains tax at sale, but AMT forces
them to instead pay 26 to 28% tax in advance. Thus, the AMT drastically
exacerbates the risk of holding for long-term capital gains and
discourages the economically beneficial practice of holding stock.
Encouraging the Wrong Behavior Flaw
The combination of the Tax Rate Flaw and Tax Date
Flaw results in encouraging behavior that is at odds with the
goals of the company and the country (ie--forcing people to buy
and sell short term and relinquish ownership in their own
companies).
The combination of the Reporting Flaw along with the
horror stories of IRS enforcement has discouraged compliance
and undermines confidence in the government.
Unintended Consequences
In order to pay their AMT bills, taxpayers have been forced to
liquidate much or all of their assets, including savings, retirement
accounts, and children's college funds. Many have lost their homes.
Some are forced to take out second mortgages and loans in order to
comply with this pre-payment of tax. Others are forced into bankruptcy
or expatriation.
Those who have attempted to resolve their outstanding liabilities
through the IRS's Offer in Compromise (OIC) program have faced
rejection after rejection. The offers often take years to resolve and
result in unrealistic IRS demands, requiring the taxpayers to live at
or below the poverty line. According to Nina Olsen's (TAS) 2004 report
to Congress, only one OIC submission under the use of Effect Tax
Administration (ETA) was accepted that year. The Tax Court recently
upheld the IRS position on its refusal to consider the Section 7122
``equity and public policy'' considerations of the offer in compromise
process for ISO AMT, stating that while it sympathized with the
taxpayers, the remedy rests solely with Congress.
The emotional and financial hardship caused by the AMT's treatment
of ISOs has taken its toll on thousands. Marriages and families have
suffered under the daily stress of dealing with the IRS; they have
divorced, decided not to have children or to adopt children; their
friends and parents watch in horror as their loved ones lose an entire
life's work because of how the AMT can force them into pre-paying taxes
on stock for which they never received gains (for individual stories,
visit www.reformamt.org). Meanwhile, those who did not comply with the
law are leading their normal lives.
Aside from the obvious ``un-American'' treatment of imposing taxes
based on no realized gain, the effects also reach beyond individuals
and families. The ISO AMT provisions are destroying and stifling the
productivity, innovation, and companies that contribute greatly to
America's economic success and growth. It undermines confidence in the
tax system, encouraging non-compliance. These effects cannot be what
Congress intended.
Request for Relief
Now, with the new bankruptcy laws going into effect in a few
months, ReformAMT respectfully asks the Ways and Means Committee to
consider an immediate and critical solution that will:
Put a ``stay'' on IRS enforcement of this excessive tax
prepayment and abate the liabilities, interest, and penalties based on
phantom gain; and
Restore taxpayers ISO AMT prepayment credits as quickly
as possible.
The law as related to the AMT treatment of ISOs is fundamentally
unfair and flawed, and comes at a tremendous cost to taxpayers. Our
members are struggling with huge tax bills and IRS collections. They
have pre-paid taxes from stock compensation for which they never
received economic gain. Some of the companies whose stock was affected
are now out of business. Our members are on the brink of financial
ruin, suffering anxiety and depression that is so severe, it is
destroying their daily lives. Please help us.
Thank you for your time. We hope that you will take our voices into
consideration.
Sincerely and gratefully,
ReformAMT.org
Cedar Rapids, Iowa 52403
June 18, 2005
Dear Chairman Thomas and Committee Members:
The Alternative Minimum Tax Law currently requires citizens to pay
huge amounts of taxes on imagined gain that the taxpayer may never
realize.
When my husband and I exercised stock options through his employer
as a portion of our retirement fund in 2000, we did not know about the
Alternative Minimum Tax. There was a large difference between what we
paid for the stock and the stock's value at the time of exercising.
Unfortunately, as complicated as the law is, it does not account for
the possibility that stock might decline substantially before the
taxpayer could sell it, so we had to pay over $40,000 in Alternative
Minimum Tax on stock that has a current value of under $1000.
We paid half our entire income for one year! We, in effect, prepaid
taxes on income we never received to generate credits we may never
receive. This tax on phantom income is unjust and must be reformed.
Thank you for your help.
Floyd and Robbin Rekemeyer
June 8, 2005
Dear Sir, Madam,
I am an American expatriate living on very modest income and
concerned by proposals which could result in double-taxation for the 5
million Americans living abroad, with no true representation in
Congress on matters of concern to expatriates.
We are the only nation which subjects its citizens and green card
holders living abroad to extraterritorial taxation. This is an
infringement upon the freedom of Americans to choose their place of
residence, as compared to the freedom enjoyed by the people of every
other free industrialized nation. It is detrimental to the U.S. economy
by depriving U.S. products of the American salesmen and buyers employed
in foreign countries who can best promote and import these products.
Thank you.
Rebecca Reynaud
Statement of Garth Rieman, National Council of State Housing Agencies
Mr. Chairman, Representative Rangel, and members of the Committee,
thank you for the opportunity to submit testimony on the importance of
preserving the Low Income Housing Tax Credit (Housing Credit) and tax-
exempt private activity housing bond (Housing Bond) programs in any tax
reform you undertake. The National Council of State Housing Agencies
(NCSHA) provides this testimony on behalf of the housing finance
agencies (HFA) of the 50 states, Puerto Rico, the U.S. Virgin Islands,
and the District of Columbia and the tens of thousands of lower-income
families these agencies house each year with the help of Housing
Credits and Bonds. HFAs administer the Housing Credit and issue Housing
Bonds in every state to finance affordable ownership and rental
housing.
NCSHA is deeply grateful to this Committee and the Congress for its
steadfast support of the Housing Credit and Bonds. Over 85 percent of
the Congress, including most members of this Committee, cosponsored
legislation enacted in 2000 to increase Housing Credit and Bond
authority by nearly 50 percent annually.
The Housing Credit and Bond programs are by far the most effective
tools states have to respond to their enormous affordable housing need.
With these programs, HFAs have provided millions of working families
affordable ownership and rental housing and improved the quality of
neighborhoods across the country.
NCSHA also recommends Congress make the already successful Housing
Bond and Credit programs work even harder for America with a few
changes, many at low or no cost to the Federal Government, to make them
even more flexible and responsive to state housing needs.
The Nation's Affordable Housing Crisis
America's need for affordable housing is great and growing. More
than 14 million working families of modest means in this country spend
at least 50 percent of their income on housing. Hundreds of thousands
more live in substandard housing or are homeless. Meanwhile, we are
losing more low-cost housing annually to conversion, disrepair, and
abandonment than we can replace with existing resources.
Federal funding for housing programs is insufficient to make
headway against these problems. Three quarters of those eligible for
federal housing assistance today do not receive it. Even the scare
housing resources we have are in jeopardy. The Administration has
proposed a 12 percent HUD funding cut in FY 2006, the largest reduction
proposed for any federal agency.
Housing Credits--An Efficient Supplier of Affordable Rental Housing
Congress created the Housing Credit program as part of the Federal
Government's last major tax reform effort, the Tax Reform Act of 1986.
At the time, Congress took a remarkable, bold new approach to dealing
with the low-income housing shortages that afflict almost all parts of
our country, recognizing that apartments simply cost too much to build
to rent at rates affordable to low-income families without some form of
tax incentive or subsidy. Congress eliminated previous tax incentives
in favor of a more effective, efficient, and tightly drawn program that
places development and investment responsibility in the hands of the
private sector with strong government oversight.
The Housing Credit program provides a ten-year reduction in tax
liability for owners of low-income rental housing based exclusively on
the development cost of the low-income apartments produced. Credit-
financed apartments are dedicated for 30 years or more at restricted
rents to families with incomes of 60 percent of median area income--on
average, families earning $34,800 or less.
The program authorizes each state to allocate Housing Credits in
proportion to its population. For-profit and nonprofit developers
compete for Credits in an open, transparent process. Successful
applicants exchange Credits for equity that investors supply to help
fund properties' development cost.
States put each proposed development through three separate,
rigorous financial evaluations to make sure it receives only enough
Credit to make it viable as low-income housing for the long-term. Only
investors in properties that pass all three financial reviews, complete
their developments, rent them to eligible low-income families, and keep
them in good condition can claim Housing Credits.
The price investors are willing to pay for Credits and the return
they are willing to accept demonstrate the efficiency of the program.
Over the last ten years, the average price per dollar for Housing
Credits has increased over 50 percent. In some cases today, investors
are paying more than a dollar for a dollar's worth of Housing Credits.
HFAs also finance the acquisition, construction, and rehabilitation
of rental housing with tax-exempt Housing Bonds. Multifamily Housing
Bonds provide debt financing for more than 40 percent of apartments
that receive Housing Credits and other low-cost rental housing.
The Housing Credit and Bond programs have financed over 2.7 million
apartments to respond to the severe shortage of decent, safe, and
affordable housing for low-income families--working families, seniors,
homeless families and individuals, and people with special needs all
across the country. The two programs finance 160,000 apartments each
year and are the only significant producers of affordable rental
housing.
Creating Homeowners With Tax-Exempt Bonds
To help make homeownership affordable to tens of thousands of
working families each year, the Federal Government allows state and
local governments to use tax-exempt mortgage revenue bonds (MRBs) to
finance low-interest mortgages for lower-income first-time homebuyers.
Investors purchase MRBs at low interest rates because the income from
them is tax-free. The interest savings made possible by the tax-
exemption is passed on to homebuyers by lowering their mortgage
interest rates.
MRBs have made first-time homeownership possible for more than 2.5
million lower-income families--more than 100,000 every year. The
average MRB homebuyer earns $38,900--less than three-quarters of the
national median family income.
Each state's annual issuance of Housing Bonds and other so-called
private activity bonds, including industrial development,
redevelopment, and student loan bonds, is capped. Congress in 2000
increased the private activity bond cap by 50 percent and indexed it to
inflation. The 2005 limit is $80 times state population, with a minimum
of $239,180,000.
Congress limits MRB mortgages to first-time homebuyers who earn no
more than the greater of area or statewide median income. Larger
families can earn up to 115 percent of the greater of area or statewide
median income. Congress limits the price of homes purchased with MRB
mortgages to 90 percent of the average area purchase price.
Promoting Economic Growth and Job Creation
The Housing Credit and Bond programs are not just good for housing;
they are good for the economy. In 2003, the construction and operation
of Housing Credit properties generated approximately 76,000 jobs, $2.5
billion in wages and salaries, and $1.3 billion in government revenue.
The MRB program the same year generated over 64,000 jobs, $2.5 billion
in wages and salaries, $465 million in consumer spending, and over $1.3
billion in government revenue, while multifamily bond issuance
generated nearly 89,000 jobs, $2.9 billion in wages and salaries, and
$1.5 billion in government revenue.
Impact of Tax Reform Proposals
Several tax reform proposals put forward by members of Congress
this year and under consideration by the President's Advisory Panel on
Federal Tax Reform would eliminate or diminish the impact of the
Housing Credit and Bond programs. The private market would not make up
for these losses.
The Housing Credit and Bond programs help finance affordable
housing production that would not otherwise occur. Rental development
and operating costs outstrip lower-income renters' ability to pay in
most areas. Conventional mortgages are not as affordable as MRB-
financed mortgages.
Importantly, direct spending programs cannot replicate what the
Housing Credit and Bond programs achieve through their private-sector
discipline. Housing Credit and Bond investors risk losing the primary
economic benefit of their investments (i.e., through Credit recapture
or the loss of the Bonds' tax-exempt status) if the programs fail to
achieve their public purposes. This threat provides a performance
incentive unmatched by direct spending programs that has helped make
the Housing Credit and Bond programs the most effective and efficient
federal mechanisms for providing affordable housing.
Other seemingly benign changes to the existing tax code could have
significant unintended negative effects on the Housing Credit and Bond
programs. The Administration's 2003 proposal to eliminate taxation on
dividends already taxed at the corporate level, for example, threatened
to reduce annual Housing Credit production by as much as 35 percent.
This estimate did not even take into account the impact the proposal
would have had on Housing Bonds, which finance many Housing Credit
apartments.
On the other hand, tax reform could greatly enhance these programs
by eliminating tax code provisions that inhibit their effectiveness.
For example, proposals to eliminate the Alternative Minimum Tax (AMT),
or at least exempt Housing Bonds and Credits from it, would lower bond
and Credit yields, increasing affordability.
Since 1986, the interest income on new money private activity
bonds, unlike general obligation and 501(c)(3) bonds, has not been
exempt from the AMT. As a result, demand for private activity bonds is
weakening. To the extent potential Housing Bond investors are or fear
becoming subject to the AMT, they either demand higher yields on the
Housing Bonds they buy, reducing the dollars available for housing, or
decline to buy Housing Bonds. Higher bond yields lead to higher
mortgage rates, decreasing affordability for lower-income homebuyers
and renters. AMT relief will lower bond yields and improve housing
affordability.
Similarly, Housing Credit investors are increasingly subject to the
AMT. To the extent potential Credit investors are or fear becoming
subject to the AMT, they will either pay less for the Credits they buy,
reducing the dollars available for housing, or decline to buy Credits.
An Opportunity to Strengthen the Housing Credit and Bond Programs
NCSHA also calls on Congress to seize the opportunity tax reform
presents to strengthen the Housing Credit and Bond programs and make
them even more responsive to today's affordable housing needs. Despite
their success, Housing Bonds and Credits could fulfill the objectives
Congress created them to meet even more effectively and make them even
more efficient and responsive to state housing needs if it enacted a
handful of changes, many at low or no cost to the Federal Government.
Though the Housing Bond and Credit programs are extraordinarily
effective, over the years NCSHA and others have contemplated
legislative and regulatory changes that would make them even better. In
2004, NCSHA undertook a year-long effort to identify what changes, if
any, would improve the programs' operations and results. An 18-member
HFA working group conducted a comprehensive review of the programs in
consultation with all state HFAs and housing industry groups. That
review produced the following recommendations:
Exempt Housing Bond and Credit investments from the
alternative minimum tax (AMT) to attract investors and generate
increased proceeds to pass on to homebuyers and renters in lower
housing costs;
Exempt displaced homemakers, single parents, and families
whose homes are destroyed or made uninhabitable by presidentially
declared natural disasters from the single-family Housing Bond--
Mortgage Revenue Bond (MRB)--program's first-time homebuyer
requirement;
Provide relief from the MRB Ten-Year Rule so states can
recycle more MRB mortgage payments into new mortgages for first-time
homebuyers;
Allow states to provide greater Housing Credit amounts to
properties that achieve state-determined goals, such as deeper income
targeting and location in rural and other difficult-to-develop areas;
Encourage mixed-income housing by changing the Housing
Credit rule that requires all scattered-site properties to be 100
percent occupied by low-income families;
Rename the Low Income Housing Tax Credit the Affordable
Housing Tax Credit to encourage community acceptance; and
Make technical changes to the Housing Bond and Credit
programs to simplify their administration.
We would be happy to provide you more information on the rationale
for and details of these recommendations.
Thank you for your attention. NCSHA is available to assist you in
any way.
Aptos, California 95003
June 17, 2005
Dear Chairman Thomas and Committee Members: My name is Marile
Robinson and I am writing you as a hardworking taxpaying citizen that
has been devastated by the unintended consequences of the AMT law. I
appreciate the opportunity to discuss the hardships I have suffered due
to an outdated and complicated portion of the tax code called
Alternative Minimum Tax.
I am a 27 year employee of Intel Corporation and as a Human
Resources middle manager I was awarded ISO stock options as a
compensation award for outstanding performance for many years of
service. I choose not to exercise those options but to save them for my
retirement, which I became eligible for in 2001.
In 1999 and 2000 the bulk of those ISO shares needed to either be
purchased and held or face expiration. I could have just exercised them
as Intel stock was between $59.00--$92.00/share in that timeframe. But
I was advised by my tax consultant and Intel Stock benefits to purchase
them and hold for one year. I purchased thousands of shares and held
them only to painfully find out, literally on the afternoon of April
14th 2001 my tax preparer called me and said ``are you setting down''
YOU OWE $290,000 to the IRS.
I was a part time employee with an annual salary of $60,000/year
less that a year away from retirement.
In order to meet that tax liability I barrowed from a margin
account and paid 6% interest while I tried to figure out a way of
sorting this out. For the next year I wrote letters, appealed to Intel
Corporate Officers, supported Zoe Loftgren and others in their attempt
to reform the AMT law, even sought legal advice. Total expenses
including the initial tax payment totaled $320,000. I then sold my home
of 19 years and the total proceeds went to paying off this phantom
gains tax. I lost my nest egg home, all of saving and postponed my
retirement. It's still painful to even talk about this financial
devastation.
Most people have no idea how this could possibly happen. The way I
explain it is: imagine you paid a dollar for a lottery ticket with a
possible payout of $1,000,000. Well, your numbers didn't come up--
However, the IRS says you could have won $1,000,000 so that's what we
are going to tax you on.
The issue boils down to doing the right thing. I'll never live long
enough to use my AMT credits. Please restore my faith in this nation,
and in this committee. Fix it.
Respectfully,
Marile Robinson
Dayton, Ohio 45440
June 20, 2005
Dear Chairman Thomas and Committee Members:
I started working for a California based company in November 1998.
I live and work from my home in Dayton, Ohio. As part of my
compensation package, I received incentive stock options (ISOs) in the
company. In March 2000, I exercised my vested ISOs (2,455 shares) by
paying $30,000. The market value was $370,000. I planned to hold the
stock for a year and complete the holding period.
By March 2001, the stock price had dropped from $159 to $60 per
share. You can only image the horror as I did my taxes. Our joint
Federal AGI was $100,000 and we owed an AMT of $121,000! Thanks to
outdated tax laws, we were in the 121% Tax bracket!
To pay the tax, I had to sell all the stock by March 2001 (at
$60.00 a share). This was just enough to cover the AMT taxes and pay
off the loan I used to exercise the stock. The gain to my family was
zero!
In April 2001, I sent the IRS a check for $102,000. This was the
entire net proceeds from the sale of the ISOs plus my life savings. We
survived paycheck to paycheck for the remainder of 2001. For my 2001
tax, I had an $82,000 non-refundable tax credit and I owed the IRS
$8,000! The reason for this imbalance is that although I carry a
$215,000 dollar loss on the tax treatment of the ISOs, I am limited to
claiming a $3,000 dollar loss per year on the AMT side!
Now for the best part: the $102,000 check I sent the IRS in 2001 is
treated as income, which places me in the AMT tax bracket. I had to pay
AMT in 2001 on the money I used to pay the AMT in 2000! This is wrong!
The government taxed me on income that I didn't receive! The next year,
I not only don't get a refund, but I can't use the tax credit and I
have to pay taxes on the money used to create the tax credit.
Meanwhile, our government has an interest free loan on my money.
Based on my calculations, I have close to a $90,000 tax credit and
$140,000 loss that I won't be able to fully recover until 2049.
I am 44 years old and a father of two (9 and 12 years of age). I
was planning on using the ISOs to build a college fund for my children.
But thanks to a complex, antiquated tax law, those dreams have vanished
and my family sits on the edge of financial ruin.
Please forgive my sarcasm, but during the past 5 years, AMT has
dominated our finical life. There is no way out under current tax laws.
I spoken with dozens of CPA's and countless Certified Finical Planners,
their only advice has been to seek legislative change.
I written and called my Congressman (Mike Turner). The last verbal
response from his aid was to seek a tax attorney. A tax attorney wants
$60,000 to take the case, sounds like a losing proposition to me.
I have written and called my Senators (George Voinovich and Mike
DeWine). They sent me to Tax Payer Advocate Office. The Tax Payer
Advocates Office could not help. They can not negotiate with the IRS on
matters of un-fair tax laws.
My wife and I wrote letters the President and Vice President in
2001. In August of 2003, my wife received a letter from the department
of the Treasury stating our case has been transferred to the Accounts
Management Center. A few weeks later she received a call from the IRS.
They apologized for the length of time it's taken to respond to her
letter, however, the IRS can only enforce the laws, they can not change
them.
I keep hearing ``tax the rich'', but from my experience, the tax
laws are designed to prevent you from becoming ``rich''. Please help!
God Bless America,
Monte A. Simmons
June 22, 2005
Ask not: ``What can my country do for me?''--Ask: ``What can I do
for my country?'' This concept expressed in President John F. Kennedy,
Jr.'s 1961 presidential inaugural address at the height of the Cold War
was an invitation for young Americans to become unofficial ambassadors
of the U.S. by joining the Peace Corps and taking our republican and
democratic ideals to the poor nations of the world. Many Peace Corps
workers later joined our esteemed Foreign Service and were in part
responsible for the fall of the Iron Curtain some 30 years later,
assisting on the ground the great political leaders, notably President
Ronald Reagan.
It was also in the 1960's that many American companies ventured
abroad, eventually leading up to the creation of many of the America-
based multinational corporations we know today. Those companies sent
U.S. citizens abroad to build these businesses and train foreign
workers. This is still being done today, for the mutual enrichment of
America and its trading partners including the peaceful economic
development of poor countries in the world.
In other words, pro-active international business and economic
development has enriched all concerned. This is simply a reflection of
the American Way already naturally practiced in the United States since
its inception.
The U.S. has also had taxation from its founding and even before--
the hated tax on tea led to our independence from Great Britain. Our
diplomats and Peace Corps workers have not had to worry about double
taxation because international law allows government personnel to
remain taxable in their home countries. Likewise, when most non-
American private citizens who go abroad to promote their private sector
economies: they leave their country's sphere of taxation and become
taxable where they settle; the foreign country where they settle claims
tax jurisdiction over them, as, by the way, does the U.S. for
foreigners arriving on its shores. The home country gives up taxing
rights levied with respect to residence. Not so, however, for private
sector U.S. citizens moving abroad. None except the U.S. taxes on the
basis of citizenship alone.
Among the beauties of the generally-used system is a much
simplified compliance system. These non-U.S. expatriates may in fact
remain taxable as nonresidents in their home countries with respect to
income sourced there: most countries, including the U.S., tax
nonresidents via withholding tax on investment income derived from that
country. Double taxation issues are dealt with via bilateral tax
treaties.
U.S. lawmakers have in the past rejected a residence-based tax
system because of potential abuse, or exaggerated reports of abuse--
A wealthy American can already live in the U.S. income tax-free, or
nearly so, by investing in tax-free municipal bonds, land or works of
art, etc. He can already give up his citizenship and move to tax havens
to avoid future tax. Expatriation to more clement taxation is thus
already possible and legal--However, this sort of situation is (very)
minor in the U.S. tax landscape because most Americans are patriotic
and are not willing to go that far.
America has grown not via the wealthy, but via its vast population
at all levels. For the few who might leave the U.S. for tax purposes,
many talented foreigners are waiting to immigrate to the U.S. When tax
rates were reduced from 70 % to 28 %, under President Reagan,
individual tax collections climbed (!) because investors felt free to
realize latent capital gains without punitive taxation. The economy
soared. Recent economic reports suggest a similar effect is taking
place at this time following the recent U.S. tax cuts.
The American Way is to believe in its people, to let our own magic
mixture of free enterprise and basic social welfare thrive in an almost
undirected economic system. We trust Americans to build our economy.
Lawmakers, you should unleash those adventurous Americans who are
willing to work and trade abroad from undue taxation burdens by letting
them go abroad and promote international business! To do this, stop
citizenship-based taxation!
Stephanie H. Simonard
Tax Committee Chairman, AARO
Ely, Iowa 52227
June 15, 2005
Dear Chairman Thomas and Committee Members:
I am writing to you on behalf of my family because we desperately
need your help. We are suffering under tremendous stress because of a
flaw in the tax code, and we need your help to save our family. In the
year 2000 our taxable income was $105,461. That same year we were
required to pay an Alternative Minimum Tax of $206,191 from Federal and
$46,792 from the State of Iowa. The additional AMT tax was based on
stock that we sold for a loss when our company nearly went bankrupt. We
were taxed $252,893 for a gain that we never made.
In December of 1992 I joined a small telecommunications start up in
Iowa called McLeodUSA. The company provided incentive stock options as
part of its compensation. This is what we were using to plan our
future. We saved all the options we received to use on building a home,
providing for our three daughters education, and providing for our
retirement.
In 2000 we were ready to start building our home so we spoke to our
financial and tax advisers to determine the best way to use the stock.
Based on the current tax laws, they told us to exercise the options and
hold them for a year so we could benefit from long-term capital gains
on the income. We followed that advice, and exercised the stock and
held on to it consistent with these strong tax incentives. As the home
was nearing completion we had our taxes done by an accountant and
received this tax bill which was totally disproportionate to any gain
we received. The stock value had plummeted so we borrowed money from a
local bank to try to pay the tax. We paid the State tax and $94,484 of
the Federal in several payments. Our local IRS collections agent
reviewed our case and told us there was no way we could pay the
remainder off and instructed us to enter into the IRS's Offer In
Compromise program. They said the OIC program was put in place to solve
impossible situations just like ours.
After waiting for 8 months we were finally assigned to an OIC
Specialist. The OIC Specialist utilized the formulas and guidance and
informed us that we were rejected from the OIC program. He told our
attorney that I have three things going against me; I am not old, I am
not disabled, and I have been too consistent. I have been too
consistent because I've been employed and paying income tax since I was
fourteen years old. I've never filed bankruptcy. I've never defaulted
on a loan. According to the archaic computations the IRS used our
family should only have housing and utility costs of $1,067 per month,
but our actual is over $3,700. Based on their allotment we are supposed
to be able to pay $2,366 per month to pay even more unfair taxes, and a
lien has been placed on our home. There is no way we will be able to
pay this amount because we never received the money on which the tax is
theoretically based. We have appealed our case to the U.S. Tax Court
but the Tax Court upheld the IRS position.
Both the IRS and the Court say it's up to Congress to fix this.
Please use the powers you possess to right this inconceivable
injustice. I beg of you to help. I have been nothing but honest to the
letter of the law in paying taxes my entire life. It seems incredible
to me that I should be financially destroyed by a tax that is so unjust
and certainly not fulfilling the purposes that Congress intended.
Ron Speltz
Flossmoor, Illinois 60422
June 18, 2005
Dear Chairman Thomas,
Thank you for the opportunity to submit this letter to detail the
hardships my family has faced as a result of the Alternative Minimum
Tax. My name is Dan Taylor and I am writing on behalf of my wife Vicki
and my children Trent and Stephanie. I write to you today to beseech
you to provide a remedy to taxpayers and families who have been
financially blindsided by the antiquated tax code that is the
Alternative Minimum Tax, especially as it applies to Incentive Stock
Options (ISOs).
In January 1998, I was hired by GeoTel Communications in a sales
position to sell telecommunications software. As an incentive to work
for this small company, I was granted ISOs as part of my compensation
package. These options would vest over time and I would have the
opportunity to receive additional grants for meeting performance goals,
which I did. This was the first position that I held in my career where
I received any form of stock option with my only investment experience
being through personal IRAs and company sponsored 401Ks, so I would
consider myself an unsophisticated investor. I did not know one type of
stock option from another which, would prove to be catastrophic to me
and my family later.
In June 1999, GeoTel, with revenues of approximately $40 Million,
was purchased by Cisco Systems for $2 Billion, or 50 times sales. I
received a bit more than one share of Cisco stock for every share of
GeoTel that I was holding an option on, so this made my accruing
options very valuable. In June 2000, I left Cisco Systems to pursue
other interests and was required to exercise the options and purchase
Cisco stock or lose all the options at no value. I used some options
granted while I was a Cisco employee, Non-qualified (NQs), to purchase
the ISOs that I originally received from GeoTel. The NQs were taxed as
I bought and sold them as ordinary income and the proceeds from the
sale were used to purchase and hold the ISOs. I purchased 28,000 shares
of Cisco stock for $4/share on a day that it was selling in the open
market for $62.
All of these transactions were made with the help of a
professionally licensed financial consultant. Every effort was made on
the part of my wife and me to handle this financial blessing properly
with regard to income taxes. We were advised that we would be taxed
when we sold the ISO-based shares. The resulting tax would be at the
long-term capital gains rate if we held the stock for one year. We were
never advised that we had created a taxable event on the day that I
purchased the stock with a tax liability of approximately $500,000
triggered by the AMT as it is applied to the exercise of ISOs.
Through late 2000 and Spring 2001, the value of the stock
plummeted. Vicki and I filed our taxes using the accountant recommended
by our financial consultant for the 2000 tax year. We were not asked
any questions about our stock transactions other than to provide the
1099 for the exercise of the NQ based options. We were not asked to
provide any records for the ISO based options despite the fact that we
revealed to the accountant that I had exercised the options in June
2000.
In May 2001, I learned through a colleague from GeoTel that he had
paid a tremendous tax bill centered on the exercise of his ISO shares.
We both agreed that our situations were similar enough that I needed to
research and confirm that my taxes had been filed properly. Much to my
horror, I learned that Vicki and I had indeed filed our return
improperly. Though we had paid over $125,000 in Federal taxes, we owed
an additional $438,000 on W-2 income of approximately $350,000. The
additional tax was generated solely by the AMT associated with the ISO
stock purchase. I had not sold one share of that stock during 2000. The
value of the stock was now less than $125,000.
We did not have the money to pay the taxes, but I was confident
that if we came forward voluntarily that we would be treated fairly and
equitably by the Internal Revenue Service. There was no audit trail,
but I wanted my children to see that we should do the right thing even
when no one is watching. I expected the outcome to be painful, but
nothing like what we have experienced.
Everyone that we have come in contact with at the IRS has expressed
sympathy for our plight, but very quickly made the point that they have
no latitude in how the collection process is enforced. The guidelines
are the guidelines. There are no allowances for anything, only formulas
that are something out of the 1950s. After two and one-half years, we
were able to reach an agreement on an Offer in Compromise in October,
2004. My family and I will pay $372,000 over two years or about $14,500
per month. This will require us to sell our home, use all of our
savings and tax deferred retirement accounts, and my son will have to
leave a four year university and attend junior college.
Is this how the tax laws are supposed to work? Are they to be a
snare that catches unsuspecting citizens and devastates them
financially? If financial professionals do not understand how the AMT
applies to stock options, how can the average citizen be expected to
understand and comply with this law?
Thousands of Americans have been caught in this snare, not just my
family. Only Congress can provide a remedy that will insure that more
families will not face similar circumstances. I believe and have faith
that you will enact legislation to abolish the current AMT tax law and
replace it with more straightforward tax code that the general public
can understand. I believe and have faith that you will provide a remedy
and relief to families such as mine with some type of retroactive
abatement of taxes from ISO triggered tax bills. Why do I believe and
have faith that you will do this? The U.S. Congress has the authority
to do so, and it is the right thing to do. Thank you.
Daniel Taylor
Redwood City, California 94062
June 21, 2005
Dear Chairman Thomas and Committee Members,
My family was severely impacted by the Alternative Minimum Tax
(AMT) law. In 2000, I purchased my employee ISO stock shares from my
company. Rather than sell my shares, I held on to them through the high
tech stock crash of 2001. Those purchased shares dropped in value from
$1,500,000 to approximately $400,000. Nevertheless, based on AMT rules,
I owed more than $400,000 in tax. I was sure this was a mistake. How
can an asset be taxed more than it's worth? I had to sell all my stock,
and re-mortgage my home to pay the AMT tax. The mental anguish in this
situation led me to thoughts of suicide and months of therapy. I have a
huge AMT tax credit that I can never hope to regain, based on current
tax laws, and the size of the credit shrinks annually.
I have to believe that Congress, when it drafted the original AMT
tax laws, did not intend for the consequences above. I am not a rich
man (I work as an artist now, and make less than $30,000 annually).
When I tell others about what happened to me, they scarcely believe how
unfair my situation--and many like me--is. The reason I held my shares
to begin with, was because I'm an optimist at heart. I still strive for
that, in the face of this incredible injustice. My hope is that the
committee will do the right thing, and right this wrong.
Best,
Ed Terpening