Copyright 1999 Federal Document Clearing House, Inc.
Federal Document Clearing House Congressional Testimony
June 23, 1999
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 7233 words
HEADLINE:
TESTIMONY June 23, 1999 MARK BLOOMFIELD PRESIDENT AMERICAN COUNCIL FOR CAPITAL
FORMATION HOUSE WAYS AND MEANS TAX REDUCTION PROPOSALS
BODY:
Statement of Mark Bloomfield, President
American Council for Capital Formation Testimony Before the House Committee on
Ways and Means Hearing on Reducing the Tax Burden: II. Providing Tax Relief to
Strengthen the Family and Sustain a Strong Economy June 23, 1999 Overview. ACCF
proposes that if Congress decides to enact a multi- year tax cut, a substantial
portion should be dedicated to saving and investment initiatives to promote
competitiveness, economic growth, and retirement saving. As with past
generations, a major responsibility of today's generation is to lay a strong
economic base for the future. New ACCF Research. In anticipation of the Ways and
Means Committee hearings on a 1999 tax bill, ACCF commissioned five new studies:
An analysis of the macroeconomic impact of the 1997 capital gains tax cuts; An
international survey of "death" taxes in 24 countries; An analysis of the impact
of the "death" tax on investment, entrepreneurship, and employment; An
international comparison of the taxation of saving in 24 countries; and An
analysis of pension reform. Impact of the U.S. Tax Code on Saving and
Investment. Economists agree that the U.S. tax system is strongly biased in
favor of consumption and against saving and investment, thus raising capital
costs. Indeed, the United States taxes both saving and investment--including
U.S. corporate investment and foreign- source income as well as capital gains,
dividends, and interest-- more harshly than do most of our competitors. This
impairs U.S. competitiveness in world markets. ACCF Tax Menu for Promoting
Competitiveness, Growth, and Retirement Security. Sound tax cuts for individuals
include: increasing the deductible IRA contribution limit and/or raising the
income level; repealing the death tax; providing a tax-free "rollover" for
reinvested savings; reducing the capital gains tax and providing an annual
exclusion for capital gains; increasing pension portability; establishing
"personal retirement accounts;" and providing a deduction for dividends and
interest. Sound tax cuts for business include: phasing in expensing for plant
and equipment outlays; providing more favorable tax treatment for investment to
promote environmental goals; providing relief from the corporate AMT; reforming
the foreign tax provisions of the U.S. tax code; reducing the corporate capital
gains tax; and liberalizing employer-sponsored pension plans. Conclusion.
Persistently low U.S. saving rates, and investment that in recent decades has
lagged behind our industrial competitors despite continued economic growth and
low unemployment, underline the need for pro-growth tax policies as a
substantial part of any tax bill approved by this Committee. Introduction My
name is Mark Bloomfield. I am president of the American Council for Capital
Formation and I am accompanied by Dr. Margo Thorning, the ACCF's senior vice
president and chief economist. The ACCF represents a broad cross-section of the
American business community, including the manufacturing and financial sectors,
Fortune 500 companies and smaller firms, investors, and associations from all
sectors of the economy. Our distinguished board of directors includes cabinet
members of prior Republican and Democratic administrations, former members of
Congress, and well-known business leaders. Our affiliated public policy think
tank, the ACCF Center for Policy Research, includes on its board leading
mainstream scholars from America's most prestigious universities, as well as
prominent public finance experts from the private sector. Mr. Chairman, we
commend you for this timely hearing on tax relief to strengthen families and
sustain a strong economy as we prepare to enter the next millennium. The
question then becomes which taxes should be cut. For example, some experts are
calling for using the surplus to promote social goals such as relief of the
"marriage penalty" that often results in married couples paying more federal tax
than two single people with the same income levels. Other experts support using
the budget surplus to reduce death taxes, capital gains, or marginal income tax
rates. The central theme of the ACCF's testimony is that if the Congress does
indeed approve a tax cut, any such cut should enhance competitiveness, increase
economic growth, and promote retirement saving. We would also like to use the
opportunity of this hearing to showcase several new research projects that our
Center for Policy Research commissioned especially in anticipation of the Ways
and Means Committee hearings on this year's tax bill. Specifically, our Center's
new research focuses on: An analysis by David Wyss, chief economist, DRI, on the
macroeconomic impact of the 1997 capital gains tax cuts; A new international
survey by Arthur Andersen LLP comparing "death" taxes in 24 major industrial and
developing countries, including most of the United States' major trading
partners; An analysis by Professor Douglas Holtz-Eakin, chairman of the
Department of Economics at Syracuse University, which analyzes the impact of the
current estate tax on capital accumulation, saving, capital costs, investment,
and employment, especially employment in the small business sector; A comparison
by Arthur Andersen LLP of the tax treatment of retirement savings, insurance
products, social security, and mutual funds in 24 major industrial and
developing countries. An analysis of pension reform by Dr. Sylvester Schieber,
director of Watson Wyatt Worldwide Research and Information Center and a member
of the Social Security Advisory Council. For our part, if Congress decides to
consider a major multi-year tax cut, we offer as a model two well-thought-out
tax initiatives enacted since World War II that moved this country toward a tax
system suitable for the post-war period. We have the opportunity today to
emulate the Kennedy-Johnson tax cuts of the 1960s and the Reagan tax cuts of the
early 1980s and, in so doing, put in place a tax system appropriate for the
challenges of the new century. In our view, the striking characteristic of the
Kennedy-Johnson and Reagan plans for tax cuts today is that they were not
confined to cuts in taxes on consumption but provided liberal reductions in tax
rates on growth-producing saving and investment. To be sure, these earlier tax
plans included badly needed cuts in marginal income tax rates, but in addition
both included sharp reductions in capital gains tax rates. Moreover, the first
Kennedy tax cuts (1961-1962) liberalized some business depreciation rates and,
of primary importance, created for the first time a tax credit for business
investment in equipment. The Reagan tax plan included similar components and
also liberalized Individual Retirement Accounts (IRAs). Both plans fueled
economic growth in succeeding years. The Kennedy-Johnson initiative opened the
way for the golden economic era of the 1960s, with 4 percent productivity growth
until economic overheating set in as a result of sharp increases in deficit
spending. Similarly, the Reagan tax cut set the stage for strong economic
performance in succeeding years and laid the base for growth in the U.S. economy
in the 1990s. One may quarrel about the financing of the Reagan tax cuts and
whether there was sufficient balance in the form of spending cuts. Our point is
that the tax cuts recognized the essentiality of stronger individual saving and
lower business capital costs for investment to foster economic growth. As with
past generations, a major responsibility of today's generation is to lay a
strong economic base for future generations. To do so, we should follow the
wisdom of these earlier, brilliantly conceived tax plans and ensure that a
significant proportion of any tax cut is dedicated to saving and investment
initiatives. If we are genuinely concerned about our children, grandchildren,
and generations beyond, we should have the discipline to deny a reasonable
amount of consumption to ourselves today in order to enhance prospects for
growth in the future and to provide retirement security for all. It is in that
context that we strongly urge the Congress to dedicate a significant amount of
any multi-year tax cut for competitiveness, growth, and retirement security. In
advocating this position we do not at all deny the merits of other tax proposals
currently advanced. The marriage tax penalty should be corrected over time, and
marginal tax rates are far too high and should be reduced. Indeed, lower
marginal tax rates will foster economic growth but with less leverage than more
direct tax cuts on individual saving and productive business investment. To this
end, our testimony suggests a menu of a dozen direct tax cuts to promote
pro-growth saving and investment (including investments to reduce pollution and
increase energy efficiency in order to address the potential threat of global
warming and other environmental concerns). In essence, the U.S. tax code treats
saving (including retirement saving) and investment very harshly. Since saving
is essential to investment and growth, this harsh taxation of saving in the
United States works against higher living standards for coming generations and
may also impair the economic strength that underlies our world leadership
position. In addition, our tax code hits saving and investment harder than those
of many of our international competitors. The foreign-source income of U.S.
multinationals is also subject to higher taxes than that of many of our
competitors. All of these facts are of increasing concern as globalization
continues. Tax reform can be carried out through a broad-based restructuring in
which consumption, rather than income, becomes the tax base, or it can be
accomplished through incremental changes to the current income tax base which
reduce the tax burden on various types of saving and on investment. Either type
of tax restructuring would enhance U.S. productivity and economic growth and
could promote the achievement of environmental goals. Tax reductions, we want to
stress, should not come at the expense of fiscal responsibility or reforming
social security. As a predicate to our tax cut proposal to promote
competitiveness, economic growth, and retirement security, we would like to set
out the intellectual framework for such a plan by first discussing the impact of
the current U.S. tax code on saving and investment. IMPACT OF THE U.S. TAX CODE
ON SAVING AND INVESTMENT Taxation of U.S. Business Investment Economists are in
broad agreement that the cost of capital for investment is significantly
affected by tax policy. The "user cost of capital" is the pretax rate of return
on a new investment that is required to cover the purchase price of the asset,
the market rate of interest, inflation, risk, economic depreciation, and taxes.
This capital cost concept is often called the "hurdle rate" because it measures
the return an investment must yield before a firm would be willing to start a
new capital project. Stanford University Professor John Shoven, an
internationally renowned public finance scholar, estimates that in the United
States about one-third of the cost of capital is due to taxes. In other words,
hurdle rates are 50 percent higher than they otherwise would be due to the tax
liability on the income produced by the investment. Quite clearly, therefore,
the higher the tax on new investment, the less investment that will take place.
Several measures show that the United States taxes new investment more heavily
than most of our international competitors. For example, according to a study by
the centrist Progressive Policy Institute (the research arm of the Democratic
Leadership Council), the marginal tax rate on domestic U.S. corporate investment
is 37.5 percent, exceeding that of every country in the survey except Canada
(see Figure 1). The tax rate calculations include the major features of each
country's tax code, including individual and corporate income tax rates,
depreciation allowances, and whether the corporate and individual tax systems
are integrated. Tax rates on foreign-source investment, which are indicators of
how much encouragement domestic firms are given to enhance their economic
viability by expanding operations abroad, again show the United States falling
behind. The U.S. tax rate is 43.4 percent versus an average of 36.7 percent in
the other G-7 countries (see Figure 2). Prior to the 1986 Tax Reform Act (TRA),
the United States had one of the best capital cost recovery systems in the
world. For example, the present value of the deductions for investing in
machinery to produce computer chips and in modern and competitive continuous
casting equipment for steel production were close to 100 percent under the
strongly pro-investment tax regime in effect from 1981 to 1985, according to a
study by Arthur Andersen LLP (see Table 1). In contrast, under current law the
present value of the capital cost recovery allowance for that same investment
today for computer chips is only 85 percent and for continuous casting equipment
is only 81 percent. The Arthur Andersen study also shows that the United States
lags behind many of our major competitors in capital cost recovery for equipment
that is technologically innovative, is crucial to U.S. economic strength, or
helps prevent pollution. Capital cost recovery provisions for pollution-control
equipment are much less favorable now than prior to TRA's passage. For example,
the present value of cost recovery allowances for wastewater treatment
facilities used in pulp and paper production was approximately 100 percent prior
to TRA '86. Under TRA '86, the present value for wastewater treatment facilities
dropped to 81 percent. Allowances for scrubbers used in the production of
electricity were 90 percent prior to TRA '86; the present value fell to 55
percent after TRA '86. As is true in the case of productive equipment, both the
loss of the investment tax credit and lengthening of depreciable lives in TRA
raised effective tax rates. While the Taxpayer Relief Act of 1997 substantially
improved cost recovery allowances for corporate alternative minimum tax payers
(AMT), those firms are still disadvantaged relative to firms paying the regular
corporate income tax (see Table 1). The AMT limits or delays the benefit of tax
code provisions that are based on investment in plant, equipment, research and
development, mining, energy exploration and production, pollution abatement, and
many others. Companies that have been subject to the AMT since its enactment
have accumulated numerous AMT credits. These credits reflect cash that is not
available for new productivity-improving investment. Taxation of U.S.
Multinational Firms A tax reduction plan should also focus on the need of U.S.
multinational companies (especially in the industrial and financial sectors) to
be competitive and gain market share, both at home and abroad. Such a tax cut
could enhance the ability of U.S. firms to compete in global markets by reducing
the competitive disadvantages that they face. For example, as a 1997 study
sponsored by the ACCF Center for Policy Research showed, U.S. financial service
firms face much higher tax rates on foreign-source income than do their
international competitors when operating in a third country such as Taiwan (see
Figure 3). A 12-country analysis shows that U.S. insurance firms are taxed at a
rate of 35 percent on income earned abroad compared to 14.3 percent for French-,
Swiss-, or Belgian-owned firms. As a consequence of their more favorable tax
codes, foreign financial service firms can offer products at lower prices than
can U.S. firms, thereby giving them a competitive advantage in world markets.
Capital Gains Taxation The ACCF's first new 1999 study, which is on capital
gains taxation, was prepared by Dr. David Wyss, chief economist of Standard
& Poor's DRI and a top public finance expert, finds that the Taxpayer Relief
Act of 1997, which reduced the long-term individual capital gains tax rate from
a top rate of 28.0 percent to 20.0 percent has had several favorable impacts on
the U.S. economy in the intervening two years. First, the net cost of capital
for new investment fell by about 3 percent; other things being equal, this will
raise business investment by 1.5 percent per year. Over a 10-year period, the
capital stock will rise by 1.2 percent and productivity will increase by 0.4
percent relative to the baseline forecast. Second, a significant share of the
increase in stock prices since 1997 (about 25 percent) is due to lower taxes on
individual capital gains realizations. Third, Dr. Wyss's analysis shows that
when a dynamic rather than a static analysis is used, the stronger growth of the
economy adds to total federal tax revenues in the long run. Finally, Dr. Wyss
rebuts several new studies which attempt to debunk the importance of lower
capital gains tax rates in encouraging start-ups and venture capital. In spite
of the 1997 tax reductions whose favorable economic impacts are documented by
Dr. Wyss's new analysis, U.S. capital gains tax rates, which affect the cost of
capital and therefore investment and economic growth, are still high compared to
those of other countries. In fact, most industrial and developing countries tax
individual and corporate capital gains more lightly than does the United States,
according to a 1998 survey of 24 industrialized and developing countries that
the ACCF commissioned from Arthur Andersen LLP. Both short- and long-term
capital gains on equities are taxed at higher rates in the United States than in
most of the other 23 countries surveyed. Short-term gains are taxed at 39.6
percent in the United States compared to an average of 19.4 percent for the
sample as a whole. Long-term gains face a tax rate of 20 percent in the United
States versus an average of 15.9 percent for all the countries in the survey.
Thus, U.S. individual taxpayers face tax rates on long-term gains that are 26
percent higher than those paid by the average investor in other countries. In
addition, the United States is one of only five countries surveyed with a
holding period requirement in order for the investment to qualify as a capital
asset. Similarly, short- and long-term corporate capital gains tax rates are
higher in the United States than in most other industrial and developing
countries surveyed. Both short- and long-term gains are taxed at a maximum rate
of 35 percent in the United States, compared to an average of 22.8 percent for
short-term gains and 19.6 percent for long-term gains in the sample as a whole.
In other words, U.S. corporations face long-term capital gains tax rates almost
80 percent higher than those of all but two of the other countries surveyed
(Germany 45 percent and Australia 36 percent , and only four of the 24 countries
surveyed impose a holding period in order to be eligible for preferential
corporate capital gains tax rates. Taxation of Interest and Dividends Interest
and dividends received by individuals also are taxed more heavily in the United
States than in many other countries, according to the 1998 Arthur Andersen
survey of 24 countries. High tax rates on dividends and interest received raise
the cost of capital for new investment and slow U.S. economic growth. The top
marginal income tax rate is 39.6 percent in the United States compared to an
average of 32.4 percent in the countries surveyed as a whole. Nearly 40 percent
of the countries surveyed tax interest income at a lower rate than ordinary
income; for example, Italy taxes ordinary income at a top rate of 46 percent
while its top tax rate on interest income is only 27 percent. In several
countries surveyed, small savers receive special encouragement in the form of
lower taxes or exemptions on a portion of the interest they receive. For
example, in Germany, the first $6,786 of interest income for married couples
filing a joint return ($3,393 for singles) is exempt from tax; in Japan,
interest on saving up to $26,805 is exempt from tax for individuals older than
65; in the Netherlands, the first $987 of interest income for married couples
($494 for singles) is exempt from tax; and in Taiwan, the first $8,273 of
interest received from local financial institutions is exempt from tax.
Similarly, dividend income is also taxed more heavily in the United States than
in the other countries surveyed; the U.S. tax rate is 60.4 percent (combined
corporate and individual tax on dividend income) compared to an average of 51.1
percent in the surveyed countries as a whole. Of the countries surveyed, 62.5
percent offset the double taxation of corporate income (the income is taxed at
the corporate level and again when distributed in the form of dividends) by
providing either a lower tax rate on dividend income received by a shareholder
or by providing a corporation with a credit for taxes paid on dividends
distributed to their shareholders. In the case of dividends received, small
savers receive preferential treatment in about one-fourth of the countries
surveyed. In France, for example, the first $2,661 of dividends on French shares
received by a married couple is exempt from tax ($1,330 for singles); in the
Netherlands, the first $987 of dividend income for married couples ($494 for
singles) is exempt from tax; and in Taiwan, the first $8,273 of dividends from
local companies is exempt from tax. Death and the U.S. Tax Code Many top
academic scholars and policy experts conclude that the estate tax should be
repealed or reduced because it adds to the already heavy U.S. tax burden on
saving and investment. For example, analysis by MIT's Professor James Poterba
shows that the U.S. estate tax can raise the cost of capital by as much as 3
percent. The estate tax also makes it harder for family businesses, including
farms, to survive the deaths of their founders. The ACCF's second new study,
which was compiled by Arthur Andersen LLP, surveys 24 industrialized and
developing countries and shows that the top U.S. federal marginal death tax rate
is higher than that of all other countries surveyed except for Japan (see Figure
4). Death tax rates imposed on estates inherited by spouses and children average
only 21.6 percent for the 24 countries in the study, compared to 55 percent in
the United States. (Tax rates are often higher on assets inherited by more
distant relatives or by non-relatives). Seven countriesArgentina, Australia,
Canada, China, India, Indonesia, and Mexicohave no death or inheritance taxes.
The average marginal top tax rate in the 17 countries with a death tax is only
30.5 percent, which is slightly more than one-half of the U.S. top federal
estate tax rate. Not only are U.S. death tax rates higher than those in most of
the industrialized and developing world, but the value of the estate where the
top tax rate applies is lower. The average value of the estate where the top tax
rate applies is over $4 million compared to only $3 million in the United
States. The third new ACCF-sponsored study, prepared by Professor Douglas
Holtz-Eakin, chairman of the Department of Economics at Syracuse University,
analyzes the impact of the current death tax on capital accumulation, saving,
capital costs, investment, and employment. First, using a sample of data
collected by the Public Policy Institute of New York State in May, 1999,
Professor Holtz-Eakin notes that there is a negative relationship between
anticipated death tax liability and growth in employment, particularly for
growing firms. His analysis suggests that at least 15,000 jobs will be lost in
New York State over the next five years due to the effect of the estate tax on
small firms. Second, the death tax reduces U.S. annual investment by sole
proprietors in the range of 2 to 10 percent or almost $45 billion in 1996.
Third, the death tax hits hard at entrepreneurs; of the total number of people
liable for the estate tax, 48 percent are entrepreneurs. Professor Holtz-Eakin
states that the death tax should not be viewed as hitting all savers equally.
Instead, the tax hits especially hard at entrepreneurs who are trying to put
money into their business. For these individuals, their saving is their
investment. Professor Holtz-Eakin concludes that his study suggests that the
estate tax is shifted--forward in time to the business operation and onto
factors of production (capital and labor). Since most incidence studies suggest
that labor supply bears the incidence of labor taxes and that slower capital
accumulation hurts productivity and real wages, this suggests that the estate
tax on the "rich and dead" small business owners and entrepreneurs may be in
part paid by their far-from-rich and very alive employees. The U.S. Tax Code and
Retirement Security Experts predict that today's federal budget surpluses may be
relatively short-lived phenomena. The long-term prosperity of the United States
remains threatened by the prospect of looming budget deficits arising from the
need to fund the retirement of the baby boom generation in the next century. In
addition, the U.S. saving rate continues to compare unfavorably with that of
other nations, as well as with our own past experience; U.S. net domestic saving
has averaged only 4.8 percent of GDP since 1991 compared to 9.3 percent over the
1960-1980 period (see Table 2). Though the U.S. economy is currently performing
better than the economies of most other developed nations, in the long run low
U.S. saving and investment rates will inevitably result in a growth rate short
of this country's true potential. The ACCF's fourth new study is a survey of the
tax treatment of retirement savings, insurance products, social security, and
mutual funds in 24 major industrial and developing countries, including most of
the United States' major trading partners. The survey (also compiled for the
ACCF by Arthur Andersen LLP) shows that the United States lags behind its
competitors in that it offers fewer and less generous tax-favored saving and
insurance products than many other countries. For example: Life insurance
premiums are deductible in 42 percent of the surveyed countries but not for U.S.
taxpayers; for many individuals life insurance is a form of saving; Thirty-three
percent of the sampled countries allow deductions for contributions to mutual
funds for retirement purposes while the United States does not; More than half
of the countries surveyed allow a mutual fund investment pool to retain earnings
without current tax, a provision which increases the fund's assets; the United
States does not; Thirty percent of the countries with social security systems
allow individuals to choose increased benefits by increasing their contributions
during their working years; and Canada, for example, provides a generally
available deduction of up to $9,500 (indexed) yearly for contributions to a
private retirement account, compared to a maximum deductible IRA contribution of
$2,000 for qualified taxpayers in the United States. The ACCF's study
demonstrates that many countries have gone further than the United States to
encourage their citizens to save and provide for their own retirement and
insurance needs. Reform of the Private Pension System The ACCF's fifth new
study, "Improving the Retirement Security System in the United States Through
Mechanisms for Added Savings," by Dr. Sylvester Schieber and his colleagues,
Richard Joss and Marjorie M. Kulah of Watson Wyatt Worldwide, a prominent
pension consulting firm, contends that the U.S. private pension system should be
expanded and reformed, particularly for small employers who are responsible for
much of the growth in employment in recent years. Pension policy experts contend
that long-service, high-income employees of large firms benefit most from the
current system. The public interest would be better served, they argue, if
pension rules were simpler and easier to administer. For example, complicated
and costly rules to prevent "discrimination" discourage employers, especially
small ones, from offering pension plans. Dr. Schieber concludes that all of the
elements of the retirement system need to be shored up in order to anticipate
the claims the baby boomers will make beginning next decade. In the case of
employer sponsored pension plans, most of the policy initiatives undertaken
during the last two decades have led to restricted saving through these plans.
The long-term implication of this result is that plan sponsors are either going
to face higher contribution costs in the future than if they had been allowed to
contribute to their plans at historical rates, or they will curtail benefits.
The potential curtailing of benefits from employer-sponsored plans is a direct
threat to the retirement security of today's workers. First, Dr. Schieber states
it is imperative that employers begin to more effectively communicate to workers
the importance and necessity of saving for retirement. Employers should be
encouraged to expand existing communications efforts. Second, in the case of
employer-sponsored plans, Dr. Schieber advocates further simplification of the
multiple funding and contribution limits to which these plans are subject. The
funding biases that have skewed plan sponsors toward defined contribution plans
should be eliminated. The inconsistencies in public policy that result from a
given level of funding resulting in tax penalties for overfunding, on the one
hand, and government penalties for underfunding, on the other, should be
resolved. Although Dr. Schieber is a strong advocate of employer-sponsored plans
and their expanded availability, he recognizes that not everyone has an
opportunity to participate in such a plan. For such workers, the playing field
should be leveled so they can effectively save on their own through
tax-preferred retirement plans. A TAX MENU FOR COMPETITIVENESS, GROWTH, AND
RETIREMENT SECURITY Those who favor a truly level playing field to encourage
saving and investment by individuals and businesses, stimulate economic growth,
and create new and better jobs, believe savings (including capital gains) should
not be taxed at all. This view was held by top economists in the past and is
held by many mainstream economists today. The fact is however that an income tax
hits saving more than once--first when income is earned, and again when interest
and dividends on the investment financed by saving are received, or when capital
gains from the investment are realized. The playing field is tilted away from
saving and investment because the individual or company that saves and invests
pays more taxes over time than if all income were consumed and no saving took
place. Taxes on income that is saved raise the capital cost of new productive
investment for both individuals and corporations, thus dampening such
investment. As a result, future growth in output and living standards is
impaired. While fundamental reform of the U.S. federal tax code continues to
interest policymakers, the public, and the business community, the key question
is whether a totally new system would be worth the inevitable disruption, cost,
and confusion the switch would create. Several recent analyses by academic
scholars and government policy experts including University of California
Professor Alan Auerbach, Boston University Professor Laurence Kotlikoff, the
Joint Committee on Taxation, and the Congressional Budget Office conclude that
substituting a broad-based consumption tax for the current federal income tax
would have a positive impact on economic growth and living standards. A
consumption tax exempts all saving and investment from tax; all income saved is
tax-free and all investment is written off, or "expensed," in the first year. As
a result, the cost of capital for new investment would fall by about 30 percent.
If, instead of fundamental tax reform, political reality requires an incremental
approach to tax reform, the ACCF recommends a menu cut of tax options that,
taken either together or singly, could enhance competitiveness, increase
economic growth, and promote retirement security. We have organized the menu
into tax cuts for individuals and tax cuts for business. Tax Cuts for
Individuals Increase the deductible IRA contribution and/or raise the income
limit. This step would make IRAs more accessible to middle and upper-middle
income individuals and families. Many academic analyses by top public finance
scholars indicate that IRAs do produce new saving that would not otherwise take
place. An increase in the $2,000 deductible contribution for each employed
person to $4,000 and/or raising the income ceiling for deductible contributions
to $120,000 for married couples, for example, would tend to raise the personal
saving rate. Repeal the federal estate (death)
tax. Many public finance scholars support its elimination
because it is a tax on capital and thus reduces the funds available for
productive private investment, especially in family-run businesses. The ACCF's
two new analyses on the death tax indicate that the death tax is higher in the
United States than elsewhere and that the entrepreneurial sector and small
businesses are particularly hard hit by the tax. Provide a tax-free "rollover"
for reinvested mutual funds, interest, dividends, and capital gains. Allowing
individual savers to make tax-free investments from the proceeds from
transactions of this type would significantly increase the mobility of capital
and would be a powerful incentive to save. Reduce the individual capital gains
tax rate and provide an exclusion. A significant reduction from the current
maximum tax rate of 20 percent would reduce the cost of capital, stimulate
investment, and encourage the entrepreneurial activity that is a major source of
U.S. economic growth. In addition, an annual exclusion of $5,000, for example,
would help encourage saving and reduce the complexity of the tax code by
allowing middle income investors to realize a relatively modest amount of
capital gains without paying tax. Increase pension portability and access to
tax-preferred saving plans. These reforms would make it more attractive for
workers to take part of their compensation in the form of a "nest egg" for
retirement than under current law. For example, easing rollover rules to allow
employees to transfer between different types of plans and easing benefit
transfer rules between qualified plans so employees can move benefits to their
new employers' plans would not only increase retirement security but also help
productivity growth through not hindering workers from changing jobs among firms
and industries. Greater access to and higher ceiling on tax preferred saving
accounts such as IRAs would also increase retirement security. Establish
personal retirement accounts. Both the Clinton Administration and members of
Congress have proposed using part of the budget surplus to fund personal
retirement accounts. Chairman Bill Archer (R-TX) and Rep. Clay Shaw (R-FL) have
introduced a proposal that both reforms social security and allows for the
creation of individual accounts and the purchase of individual annuities for
workers. Provide a deduction for dividends and interest received by individuals.
Exempting, for example, the first $2,000 of dividends and interest received by
married taxpayers ($1,000 for singles) is an approach used in many other
countries. Tax Cuts for Business Comprehensive tax reform, to shift the federal
tax base from income to consumption and thus permit the expensing of all
investment, would have the strongest impact on capital costs and economic
growth. However, more modest tax cuts on investment would also stimulate capital
formation and growth. Phase in expensing for plant and equipment outlays.
Scholars agree that expensing is the most efficient way of reducing the cost of
capital for new investment. In the period 1981-1985, the United States had one
of the best tax treatments for new investment in the world. In today's global
economy, U.S. firms need tax parity with foreign firms in order to compete
effectively. Provide more favorable tax treatment for investment to promote
environmental goals. Tax credits or other provisions for environmental
expenditures required to meet federal, state, and local standards or to enhance
energy efficiency would ease the compliance costs facing U.S. industry. In
addition, such tax measures would make it easier for capital-intensive
manufacturing firms to continue operating their U.S. facilities. Provide relief
from the corporate AMT. Eliminating the myriad of investment-based AMT
preference items is essential. Additionally, providing for accelerated use of
AMT credits will help alleviate the competitive disadvantage faced by commodity-
based industries that are suffering low world prices. It will allow and ensure
the long-term growth and competitiveness of basic U.S. industry. Relief efforts
must take care not to diminish the value of the credits that have accrued in the
past. Reform the foreign tax provisions of the U.S. tax code. Moving to a
consumption tax in which all foreign-source income is exempt from tax (a
"territorial" tax) would have a strong positive impact on the international
competitiveness of U.S. firms. However, such a fundamental shift in tax policy
is not now "on the table." Still, firms' ability to compete abroad could be
enhanced through a variety of reforms to U.S. foreign tax provisions. U.S.
industrial and financial service firms face higher taxes on their foreign-source
income than do their international competitors (see Figures 2 and 3). Reducing
the tax burden on the foreign-source income of U.S. firms would be beneficial by
allowing them to be more competitive in foreign markets. For example, making
permanent the one-year provision that reforms Subpart F of the Internal Revenue
Code for financial service firms such as securities firms, insurance companies,
banks, and finance companies would be an important step. As a matter of sound
tax policy, U.S.-based financial service firms should be able to defer U.S. tax
on the active income of their foreign subsidiaries until those earnings are
returned to the U.S. parent company. It is equally important not to impose
stringent new tax policies that make U.S. industrial and financial firms less
competitive. For example, proposed changes that tighten the foreign tax credit
and deferral would put U.S. firms at a further disadvantage. Reduce the
corporate capital gains tax rate. A corporate capital gains tax cut would reduce
capital costs and increase investment. Sound tax policy as well as economic
considerations argue for a reduction in the U.S. maximum corporate capital gains
rate of 35 percent, which is now the same as the top regular corporate tax rate.
This would reinstate the historical U.S. treatment of corporate capital gains;
an alternative corporate capital gains tax was part of the Internal Revenue Code
from 1942 until its repeal by the Tax Reform Act of 1986. Reducing corporate
capital gains tax rates would also help move the U.S. tax code toward a
consumption tax base by lightening the burden on income from investment.
Liberalize employer-sponsored pension plans. Improvements to employer-sponsored
pension plans would increase saving and enhance retirement security. Small
employers are often unable to provide pensions for their employees because of
the cost and complexity of the system. A tax credit for businesses establishing
new plans would be especially helpful to small employers. Creating a simplified
defined benefit plan for small employers would promote the retirement security
of small-firm employees. CONCLUSION Persistently low U.S. saving rates, and
investment that in recent decades has lagged behind our industrial competitors
despite continued economic growth and low unemployment, underline the need for
pro-growth tax policies as a substantial part of any tax bill approved by this
Committee. Given the projected budget surplus and the desire of many in Congress
to enact a major tax cut for Americans, there is clearly an opportunity to move
the U.S. tax system in a pro-growth direction. We therefore urge Congress to
give the most careful consideration to the pro-growth tax provisions discussed
here. Table 1 International Comparison of the Present Value of Equipment Used to
Make Selected Manufacturing Products and Pollution Control Equipment As a
percent of cost Computer Chips Telephone Switching Equipment Factory Robots
Crank- shafts Continuous Casting for Steel Production Engine Blocks Wastewater
Treatment for Chemical Production Wastewater Treatment for Pulp and Paper
Equipment Scrubbers Used in Electricity Plants United States 1985 Law 100.1
100.1 100.1 100.1 100.1 100.1 100.1 100.1 89.7 MACRS1 85.2 85.2 80.8 80.8 80.8
80.8 85.2 80.8 54.5 AMT2 83.0 83.0 77.9 77.9 77.9 77.9 83.0 78.0 54.5 Brazil
75.7 74.8 74.7 74.7 88.3 74.7 74.7 74.7 79.4 Canada 76.9 75.9 74.0 73.8 74.2
73.6 85.3 85.3 85.3 Germany 83.6 83.0 82.7 83.9 82.2 83.9 71.8 69.7 68.9 Japan
87.1 86.2 83.4 83.9 81.4 83.7 84.6 83.7 82.4 Korea (w/3% ITC) 88.7 84.3 82.6
80.1 77.7 79.6 95.2 93.9 92.2 Singapore 91.7 91.7 91.7 91.7 91.7 91.7 91.7 91.7
91.7 Taiwan 83.9 78.0 79.0 64.3 63.5 63.7 147.0 147.0 147.0 Notes: 1. MACRS =
Modified Accelerated Cost Recovery System (current law) for regular taxpayers.
2. AMT = Alternative minimum tax (current law, Taxpayer Relief Act of 1997).
Source: Stephen R. Corrick and Gerald M. Godshaw, "AMT Depreciation: How Bad is
Bad?" in Economic Effects of the Corporate Alternative Minimum Tax (Washington,
D.C.: American Council for Capital Formation Center for Policy Research,
September 1991). Updated by Arthur Andersen LLP, Office of Federal Tax Services,
Washington, D.C., January 1998. Table 2 Flow of U.S. Net Saving and Investment
Percent of GDP in current dollars; national income accounts basis Average
1960-1980 Average 1981-1985 Average 1991-1998*** Net private domestic saving
8.1% 8.0% 5.4% State and local government surpluses 2.1% 1.9% 1.5% Subtotal of
private and state saving 10.2% 9.9% 6.9% Less: Federal budget deficit -0.8%
-3.8% -2.1% Net domestic saving available for private investment 9.3% 6.1% 4.8%
Net inflow of foreign saving* -0.4% 1.2% 1.4% Net private domestic investment
8.9% 7.4% 6.2% line Gross private domestic investment 16.0% 16.9% 14.3%
Nonresidential fixed investment 10.4% 12.2% 9.9% Producers' durable equipment
6.6% 7.4% 7.1% Information processing, related equipment, computers, and
peripheral equipment 1.6% 3.1% 3.2% Industrial equipment 1.9% 1.8% 1.6%
Producers' durable equipment less info processing and related equipment 5.2%
5.0% 4.7% line Personal saving 5.4% 5.8% 2.5% Net business saving** 2.7% 2.2%
2.9% line *In the 1960-1980 period, the United States sent more capital abroad
than it received; thus net inflow was negative during this period. **Net
business saving = gross private saving - personal saving - corporate and
noncorporate capital consumption allowance. ***Preliminary estimate for first
quarter of 1999. Source: Department of Commerce Bureau of Economic Analysis,
National Income Accounts. Update prepared by American Council for Capital
Formation Center for Policy Research, June 1999.
LOAD-DATE: June 25, 1999 
