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Copyright 2000 Federal News Service, Inc.  
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April 11, 2000, Tuesday

SECTION: PREPARED TESTIMONY

LENGTH: 3791 words

HEADLINE: PREPARED TESTIMONY OF LEO E. LINBECK, JR.
 
BEFORE THE HOUSE COMMITTEE ON WAYS AND MEANS
 
SUBJECT - CONGRESSIONAL SUMMIT ON FUNDAMENTAL TAX REFORM

BODY:
 I would like to thank you, Mr. Chairman and members of the committee for the opportunity to testify before your committee on replacing the current tax system. I am the Chairman of Linbeck Corporation and voluntary Chairman of Americans for Fair Taxation (AFT). AFT is a grass roots citizens organization, based in Houston Texas, dedicated to replacing the current tax system with the FairTax. I am testifying today on behalf of AFT.

The FairTax

The FairTax was introduced on a bi-partisan basis by Representatives John Linder and Collin Peterson during the first session of this Congress. The FairTax will repeal individual income taxes, corporate income taxes, all payroll taxes (including Social Security, Medicare and self-employment taxes) and the estate and gift tax. It would replace these taxes with a 23 percent national retail sales tax on all goods and services sold to consumers.

Individuals will no longer file tax returns. Businesses will collect and remit the sales tax in a manner similar to that in 45 states and the District of Columbia. The FairTax is a tax on final consumption. Business to business transactions will not be taxed since those goods and services will be taxed when the goods and services into which they are incorporated are finally sold to consumers. Education and training expenses will be treated as an investment in human capital and not taxed. Exports will not be taxed. Imported goods will be taxed when they are sold at retail in the U.S.

The FairTax is Progressive

Unlike the present tax system which taxes many poor people, the FairTax will literally untax every poor person in America. This is because the FairTax will provide every household in America with a rebate of sales tax paid on necessities. Thus, the FairTax is progressive and every family is protected from tax on essential goods and services. Because of the rebate, those below the poverty line will have negative effective tax rates and lower middle income families will enjoy low effective tax rates. The table below shows the annual allowances and rebate amounts.

(NOTE: Table not transmittable)

The rebate will be paid monthly in advance. The total annual rebate amount will be equal to the sales tax rate times the federal poverty level. In addition, because the federal poverty level for a two person household is not twice as high as that for one person, an additional amount will be provided in the case of married couples to prevent any marriage penalty.

The FairTax effective tax rates for families of four at various consumption levels are shown in the figure below.

Fair Tax Effective Tax Rate (NOTE Figure not transmittable)

A family of four, for example, could spend $22,500 per year free of tax because they will have received over the course of the year rebates totaling $5,175. $5,175 is the amount of sales tax paid on $22,500 in expenditures. A family spending $45,000 per year will effectively pay tax on only half of their spending and, therefore, have an effective tax rate of 11 1/2 percent or half the FairTax rate.

It would be a mistake to emulate the states when they attempt to achieve progressivity by exempting various categories of goods or services from tax. First, this does not achieve the advertised goal. When food is exempted, for example, not only hamburger is exempted but also filet mignon; not only macaroni and cheese is exempted but also caviar and lobster. In fact, research indicates that 60 percent of the gain from such exemptions goes to the top 40 percent of taxpayers. In addition, these exemptions add complexity to the law as lines are necessarily drawn. Moreover, one set of exemptions will inevitably lead to lobbying to exempt other products. Finally, exempting particular goods or services leads to higher tax rates on those that remain taxable which is economically distorting and inefficient as well as unfair to those companies and workers in the sector that remains taxable.

Administration

The FairTax affords state governments the opportunity to administer the FairTax within their states in return for a fee. The fee will be equal to 1/4 of one percent of the revenue collected. Alternatively, the state could contract with another state or simply elect for the federal government to collect the tax directly. In our view, smoother administration and fewer start-up difficulties will result if the sales tax is administered by civil servants that have years of experience administering a sales tax.

Americans for Fair Taxation (AFT)

AFT worked hard to develop the FairTax. We engaged economic researchers at leading universities throughout the country. We engaged professors of law. We conducted focus group research with demographically diverse groups of citizens in many different geographic locations to determine what attributes the American people wanted in a tax system. The result of these efforts was the FairTax.

We have now begun the process of bringing the FairTax to the attention of the public. AFT now has over 250,000 members. AFT's grass roots support is growing every day. We aim to soon have an AFT chapter in every State and Congressional district in the country.

Economic Impact of the FairTax

The FairTax will have a dramatic positive impact on the standard of living of the American people and lead to higher rates of economic growth. The current tax system punishes people who are trying to improve the financial position of their families by working, saving or investing. It is a huge barrier to upward mobility. The FairTax will stop the punitive taxation of work inherent in the income and payroll tax and end the multiple taxation of savings and investment. The FairTax will end the taxation of investment in education.

Instead it will tax consumption. It has the broadest possible consumption base. Therefore, the FairTax has the lowest possible marginal tax rate in a consumption tax that protects the public from sales tax on expenditures to purchase essential goods and service.

Economists anticipate the FairTax will lead to much higher levels of savings and investment which in mm will lead to greater productivity and output. Work by Harvard economist Dale Jorgenson shows a quick 9 to 13 percent increase in the GDP. Similarly, Boston University economist Laurence Kotlikoff predicts a 7 to 14 percent increase.2 The FairTax will eliminate the present tax system's bias against savings and investment. Thus, savings and investment will increase. A larger capital stock means that people will have more capital to work with embodying the latest technology and their productivity will increase. Higher productivity, in mm, will increase real wages.

Businesses, in the final analysis cannot pay wages higher than the productivity of their workers warrants. If they do, they will quickly go bankrupt. Thus, the key to increasing real wages is higher productivity. The key to higher productivity is two fold. Education and capital investment. The FairTax makes both education and capital investment more attractive.

Education

The FairTax is the most education friendly of any tax reform proposal and is much more supportive of education than current law. The FairTax embodies the principle that investments in people (human capital) and investments in things (physical capital) should be treated comparably. The current tax system, in stark contrast, treats education expenditures very unfavorably.

Today, to pay $10,000 in college or private school tuition, a typical middle class American must earn $15,540 looking only at federal income taxes and the employee payroll tax.3 The mount one must earn to pay the $10,000 is really more like $20,120 once employer and state income taxes are taken into account.4

The FairTax does not tax education expenditures.5 Education can be paid for with pre-tax dollars. This is the equivalent of making educational expense deductible against both the income tax and payroll taxes today. Thus, under the FairTax, a family will need to earn $10,000 to pay $10,000 in tuition, making education much more affordable.6 The FairTax makes education about half as expensive to American families compared to today.

Education is the best means for the vast majority of people to improve their economic position. It is the most reliable means that people have to invest in themselves and improve their earning potential. Yet the tax system today punishes people who invest in education, virtually doubling its cost. Only the FairTax would remove this impediment to upward mobility. No other tax reform plan will do so.

The FairTax is More Fair than the Current Tax System

The FairTax is more fair than the present tax system. Rather than holding people down by taxing them for working, saving, investing or getting an education, the FairTax taxes people when they consume for their own benefit above the necessities of life. The FairTax eliminates special preferences, credits and deductions for politically favored interests. It treats everyone the same. It has no loopholes.

International Competitiveness

Under the FairTax, imported goods and domestically produced goods will pay the same U.S. tax. This stands in stark contrast to the present system, where U.S. companies and workers must pay income tax and payroll taxes but foreign goods enter the U.S. entirely free of any tax other than whatever modest customs duties are levied.

The FairTax will, by its very nature, be border-adjusted. 7 Exports will not be taxed since they are not sold at retail in the U.S, but imports will be taxed when sold at retail in the U.S. or when brought into the U.S. by a consumer.8

A national sales tax will comply with World Trade Organization (WTO) rules. WTO is the successor to the General Agreement for Tariffs and Trade (GATT). Under WTO rules, an indirect tax may be border adjusted while a direct tax may not.9 Since a sales tax is indisputably an indirect tax, this border adjustment feature will pose no difficulty. Foreign value added taxes, also indirect taxes, are typically border adjusted. Income taxes are direct taxes and may not be border adjusted. 10 Many on this committee may find this aspect of a national sales tax of particular interest since the WTO just found the Foreign Sales Corporation (FSC) export incentives to be a violation of WTO rules.

U.S. businesses will be much less likely to locate their plants overseas and foreign companies will come to the United States. Americans will be employed building these new plants and Americans will be employed in the new plants. America will become the most attractive place in the developed world in which to do business. We will attract more and higher paying jobs.

The FairTax is less Intrusive

The FairTax will be less intrusive. Rather than having to report almost every aspect of their lives to the federal government, Americans will be relieved of such intrusions. April 15th will be just another Spring day. The privacy of the American people will be enhanced considerably when the FairTax is enacted.

The income tax is collected with a heavy hand. In 1995, the IRS assessed over 34 million civil penalties on American taxpayers in an effort to force compliance with the tax system. Of these, about 4.1 million were forgiven. The present system requires that we inform on each other. Americans must provide over one billion information returns to the IRS (primarily 1099s and W2s). Under the FairTax, all of this would no longer be necessary.

The FairTax respects the Privacy rights of the American people to a vastly greater degree than the income tax. No longer will Americans have to report the details of their lives to the federal government. No longer will they have to confess to whom they gave money, where they earned money, what medical problems they had and so forth.

The FairTax will reduce Evasion

Under the income tax, evasion is a major, continuing and growing problem. Notwithstanding a much larger Internal Revenue Service (IRS), more burdensome information reporting requirements, increasing stiff and numerous penalties and a host of legislative initiatives, the problem is getting worse. Based on IRS figures, tax evasion has increased by 67 percent during the past 11 years. As a percentage of Gross Domestic Product (GDP), tax evasion has reached 2.0 percent compared to 1.6 percent in 1981. Taxes evaded continue to be in the range of 22 to 23 percent of income taxes collected. These IRS figures do not include taxes lost on illegal sources of income. The tax gap now is about $200 billion.

Tax evasion will decline under the FairTax because the chance of evaders being caught will increase and the incentive to cheat will decline. The FairTax will reduce the number of tax filers by roughly 90 percent. Thus, if enforcement resources remain comparable, audit rates will rise. Moreover, since the audits will be much simpler than current audits, audit rates will rise still further. Therefore the chance of evasion being detected will increase.

Since marginal tax rates are much lower under the FairTax than under present law, especially for small businesses and sole proprietorships where disproportionate evasion occurs today, the benefit to cheating will be lower. Today, if a self-employed taxpayer falls to report $1,000 they will benefit by $433 ($280 because of the income tax and $153 due to the self-employment tax). Under the FairTax, they would benefit by $230.

In short, the gains from evasion would decrease and the potential costs of evasion from detection and enforcement would increase. Thus, the amount of tax evasion can be expected to decline markedly.

Compliance Costs will Fall

The FairTax is a simple tax. The administrative burdens placed on businesses are much less. In fact, they are comparable to tracking revenue for income tax purposes. There will be no more alternative minimum tax, no more depreciation schedules, no more complex employee benefit rules, no more complex qualified account and pension rules, no more complex income sourcing and expense allocation rules, no more foreign tax credit, no more complex rules governing corporate acquisitions, divisions and other reorganizations, no more uniform capitalization requirements, no more withholding and the list goes on. Businesses will simply need to keep track of how much they sold to consumers.

Compliance costs will, therefore, fall under the FairTax. Today, according to the Tax Foundation, we spend about $250 billion each year filling out forms, hiring tax lawyers, accountants, benefits consultants, collecting information needed only for tax purposes and the like. These unnecessary costs amount to about $850 for every man, woman and child in America.

To the extent these costs are incurred by businesses, they must be recovered and are embedded in the cost of everything that we buy. The money we spend on unnecessary compliance costs is money we might as well bum for all of the good it does us. The Tax Foundation has estimated that compliance costs would drop by about 90 percent under a national sales tax.

The FairTax is Simple, Understandable and Transparent

The FairTax is simple, understandable and transparent. People understand the FairTax. They don't understand the present tax system. Even tax professionals don't understand the present system. Money magazine, for instance, each year asks 50 CPAs to fill out a relatively straight forward middle class family's tax return. Each year they get 50 or nearly 50 wrong answers. Of course, the answers are only wrong if you believe the magazine's tax advisors are better than the survey participants. Today a huge proportion of the overall tax burden is hidden from the ordinary taxpayers view. Under the FairTax, people will for the first time actually understand their tax burden and have confidence that their fellow citizens are bearing their fair share.

The FairTax will help Charities

Charities will thrive as never before -- for two reasons. First, the FairTax provides the equivalent of a deduction, for itemizers and non- itemizers alike, against both the income and payroll tax. Remember, all the charitable deduction does is allow someone to make their contribution from pre income tax dollars (but after payroll tax dollars). The FairTax will enable all Americans to give to their favorite charity free of income tax, free of payroll tax and free of sales tax. Second, total philanthropy as a percentage of GDP has held steady at around 2 % for at least two decades. As people become more prosperous, they give more to philanthropic causes. The FairTax will enlarge the economy dramatically and will lead to a corresponding increase in charitable giving.

Pre-Tax Prices will Decline

Costs are one of the primary determining factors for prices. One of the costs that businesses must recover if they are to stay in business is taxes. Dale Jorgenson of Harvard University estimates that the income tax and payroll tax are embedded in the price of goods and services to such an extent that they raise prices by 20 to 30 percent. His results are shown in the figure below. When these taxes are repealed by the FairTax, costs will go down and competition will quickly drive prices down 20 to 30 percent depending on the product: In addition, although Dr. Jorgenson research did not consider these effects, higher levels of investment will make the economy more productive and the elimination of loopholes that distort the economy will make it more efficient, These effects will be seen both in the form of higher real wages and lower prices. Moreover, lower compliance costs will reduce costs and prices still further. (NOTE: Figure not transmittable)

The Fairfax helps Homeowners

Homeowners will do very well under the FairTax. Homeowners will have the equivalent of a supercharged mortgage interest deduction because under the FairTax mortgage interest can be paid free of sales tax and free of income and payroll taxes. In terms of the current system, it would be as if the mortgage interest deduction was allowable against payroll taxes. In addition, existing homeowners will be able to make their principal payments with tax free dollars. Buyers of newly constructed homes will have to pay sales tax, just as they must pay for their house from after tax dollars today, but the marginal tax rate is lower under the FairTax. In addition, interest rates will fall by about 25 percent because lenders will no longer have to charge a tax premium to make up for the tax on interest income. Once interest is no longer taxable nor deductible, interest rates will quickly fall toward the current tax-exempt rate. Homeownership will be more affordable and prospective homeowners will be able to save their downpayment more quickly under the FairTax.

Financial Markets

The FairTax will increase the market value of long-term financial assets such as stocks, real estate and non-callable bonds. The price of those assets reflects the fact that the future income stream of those assets will be taxed. When that tax is removed, the future income stream will increase and therefore the present discounted value of those future income streams will increase as well. Thus, the market value of the assets will increase considerably.

Conclusion

Support for the FairTax is growing rapidly. Once people understand the FairTax and grasp all of the positive things it would mean for them and for the country, they generally support it. AFT will continue to bring the FairTax to the attention of the public.

AFT looks forward to working with this committee to pass the FairTax. It is in your power to move beyond the current indefensible tax system and replace it with a tax system more in keeping with what the public wants. We appreciate the opportunity to present our views to you today. Thank you.

FOOTNOTES:

1 Dale W. Jorgenson, Economic Impact of the National Retail Sales Tax, National Tax Research Committee. See also, "The Economic Impact of Fundamental Taxing Consumption", Dale W. Jorgenson, Testimony before the House Ways and Means Committee, March 27, 1996 and "The Economic Impact of Fundamental Tax Reform", Dale W. Jorgenson, Testimony before the House Ways and Means Committee, June 6, 1995.

2 Laurence J. Kotlikoff, Replacing the U.S. Federal Tax System with a Retail Sales Tax: Macroeconomic and Distributional Impacts, National Tax Research Committee. See also, "The Economic Impact of Replacing Federal Income Taxes with a Sales Tax", Laurence J. Kotlikoff, April 15, 1993, Cato Institute Policy Analysis.

3 $15,540 less 7.65 percent in employee Social Security ($ I, 189) and Medicare payroll taxes less 28 percent in federal income taxes ($4,351) leaves $10,000.

4 Economists generally agree that the employer share of payroll taxes is borne by the employee in the form of lower wages. This figure assumes that employees bear the burden of the employer payroll tax and that they are in a seven percent state and local income tax bracket. $20,120 less $5,634 in income tax (28 percent), $3079 in payroll taxes (15.3 percent) and $1,408 in state and local income taxes (7 percent) leaves $10,000.

5 H.R. 2525 defines education and training to mean "tuition for primary, secondary, or postsecondary level education, and job related training courses." It excludes "room, board, sports activities, recreational activities, hobbies, games, arts or crafts or cultural activities."

6 If the states kept their income taxes rather than replacing them with a sales tax, then the family would need to earn $10,753, about half of what they would need to earn today.

7 Border adjusted is a value added tax (VAT) term. Since VATs, unlike the sales tax, impose a tax on all stages of production, a VAT must rebate the tax on earlier stages of production when goods are exported to achieve a zero tax rate on exports. This is called border adjustment. Because a sales tax does not impose any tax on goods unless sold at retail, there is no need for a border tax adjustment rebate.

8 As with domestically produced goods, imported capital goods and other business purchases would not be taxed immediately. But the output of goods produced by capital goods would ultimately be taxed when consumption goods were produced and sold.

9 See Agreement on Subsidies and Countervailing Measures, Annex 1.

10 The status of the fiat tax, which is a subtraction method value added tax but administered like an income tax, is unclear under WTO rules but it seems highly likely that it would be deemed a direct tax given its similarity in appearance and administration to an income tax.

END

LOAD-DATE: April 12, 2000




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