Copyright 2000 Federal News Service, Inc.
Federal News Service
April 12, 2000, Wednesday
SECTION: PREPARED TESTIMONY
LENGTH: 2808 words
HEADLINE:
PREPARED TESTIMONY OF ERNEST S. CHRISTIAN FORMER TAX LEGISLATIVE COUNSEL AND
DEPUTY ASSISTANT SECRETARY (TAX POLICY) OF THE TREASURY DEPARTMENT
BEFORE THE HOUSE COMMITTEE ON WAYS AND MEANS
BODY:
Introduction To Simplified USA Tax
The Simplified USA Tax by Congressman Philip English (H.R. 134) is a
landmark achievement that shows how genuine tax reform can become a reality
without resorting to radical experimentation. The tax code can be simplified
without repealing the deductions for home mortgage interest and charitable
contributions; the double tax on saving and investment can be removed without
enacting a "consumption" tax; tax equity for working men and women can be
achieved by allowing them a credit for the payroll tax they pay; the archaic tax
barriers to U.S. competitiveness in world markets can be removed in a way that
protects and enhances American jobs; a simple deduction for the cost of post-
secondary education can, for the first time in history, help put investments in
human capital on a par with investments in physical capital; marginal tax rates
can be lowered; progressivity can be preserved; and transitional dislocations
can be avoided.
Simplified USA embodies a new approach that has the
effect of including in the U.S. tax base for the first time in history all
amounts derived by foreign companies from selling goods and services in the U.S.
market. It seems to me that the result is an enormous tax cut for the U.S.
economy -- perhaps $100 billion per year or more -- paid for by
foreign companies that presently derive income from U.S. markets on a nearly
tax-free basis. The biggest beneficiaries of this tax cut would seem to me to be
the wage earners of America who receive a full credit for the payroll tax they
pay now.
How Simplified USA Works -- Structural Framework
Like
current .law, Simplified USA consists of a business tax and a personal tax with
multiple personal rates. The illustrative tax rates below trace back to H.R.
4700 in the 105th Congress and were carried over without change into H.R. 134
when Simplified USA was reintroduced in the 106th Congress.
(1) A
Business Cash Flow Tax is paid by corporations and other businesses. The rate is
12% of gross profit. Profit is computed using cash accounting; capital equipment
is expensed because the income it produces is fully taxed when received; no
deduction is allowed for interest or dividends paid for the use of capital, or
for wages paid for labor, but a full credit is allowed for the 7.65% OASDHI
payroll tax which is the equivalent of a deduction for about 65% of wages up to
$72,000 per year for each employee. Export
income and all foreign- source
income is excluded from tax. A 12% import tax
is collected when foreign-based companies sell into the U.S. market.
(2)
A Progressive-Rate Personal Tax is paid by individuals when they receive
interest, dividends, wages, salaries, and gains. The two bottom rates are 15%
and 25% and the top rate is 30% on taxable income computed after deducting a
Family Allowance of $8,000, personal exemptions of
$2,700 per family member, home mortgage interest, charitable
contributions and post-secondary education expenses of up to
$4,000 per family member. Individuals are allowed a full tax
credit for the employee's share of the 7.65% OASDHI payroll tax withheld from
their wages and, if the amount of that credit exceeds their USA income tax for
the year, the excess is refunded. All individuals are also allowed an unlimited
USA Roth IRA for personal saving - except that, unlike the current Roth IRA,
saving is not limited to retirement and can be withdrawn for any purpose.
Because tax is paid on the money going into this special savings and investment
account, there is no additional tax on the inside build-up in the account or on
withdrawals from the account. For the first time in history, the double tax on
all personal savings will be removed and everyone will be allowed to save for
whatever purpose they desire.
Simplified USA is a plain-language,
stripped-down version of the current income tax (individual and corporate) that
is concentrated on the main goals of tax reform - which are (1) to be evenhanded
as between labor income and capital income; (2) to be neutral in a person's
choice to consume income or save; (3) to remove the archaic barriers to
international competitiveness; and (4) to be neutral as between equity and debt
financing and evenhanded among all forms of business organization.
The
basic amendments necessary to achieve these results are neither unfamiliar nor
shocking. First-year expensing of plant and equipment is already allowed for
small businesses and probably would have been made universal long ago except for
revenue limitations under the current code.
The idea of removing the
double tax from personal saving - and thereby taxing saved income no more
heavily than consumed income -- has been around a long time. Since the enactment
of the Roth IRA in 1997, the simple yield-exemption approach to removing the
double tax is now familiar and standard fare. With the Roth IRA already very
much part of the tax landscape, it only remains for Simplified USA to make it
universal by eliminating the dollar caps, the income limitations and the
restriction to retirement savings.
For decades, Treasury reports and
bipartisan Congressional studies on corporate/shareholder tax integration have
recommended uniform treatment of all forms of financing and all forms of
business.
There is nothing new about the idea of excluding
foreign-source income from taxation or about the related idea of not taxing
exports. The Foreign Sales Corporation (FSC) provision in the current code is a
flawed attempt to go halfway, but FSC has run afoul of the WTO and it remains
for Simplified USA to do the job correctly in a way that is consistent with U.S.
tax traditions and WTO requirements.
The Road to Simplification
Once the basic amendments necessary to achieve neutrality and
international competitiveness are made, some of the most complex portions of the
code become moot. Substantial simplification automatically occurs. Simplified
USA also undertakes to eliminate an array of miscellaneous deductions, credits,
exceptions and exceptions to exceptions that are unnecessary when the basic
rules are correct to start with. But Simplified USA does not make a fetish out
of repealing long-standing and familiar deductions under the misguided belief
that they are the source of complexity in the code.
The existing and
long-standing exclusions from income for parsonage allowances, combat pay,
municipal bond interest or employer-paid health insurance are not the reason
that Form 1040 is monstrously long and incomprehensible. Simplified USA retains
these and several other exclusions and deductions that are easily understood and
of nearly universal application without any special eligibility requirements and
that do not require any side calculations. What, for example, is complicated
about the deduction for home mortgage interest? All the homeowner does is take
one number off the annual statement from the mortgage lender and put that one
number on one line of the tax return.
Simplified USA will reduce
the size and complexity of the tax code by about 75 percent and the personal tax
return (long Form 1040) will be only a few pages - about like it was in 1960
before four decades of complexity ruined it.
Neutrality Between Saving
and Spending
Simplified USA taxes income (whether saved or consumed)
only once. It does that by taxing income when received (first tax) and then
excluding the earnings on after-tax savings from a second tax.
The
current code's bias against income that is saved is easily illustrated by a
simple example: Mr. Jones earns $100, pays a
$40 income tax, and has $60 after-tax income
left over. If he uses the after-tax $60 to buy a car to drive
to work (in lieu of paying bus fare), he will not have to pay tax on the value
of the transportation services the car provides him; nor should he. After all,
he has already paid tax on the $60 once. On the other hand, if
instead of buying the car, Mr. Jones saves the after-tax $60,
he will have to pay bus fare (having no car) and he will have to pay tax on the
interest earned by the $60 of savings. This is not a correct
result. It biases Mr. Jones's choice against saving.
Simplified USA
produces the correct result: once Mr. Jones has paid his tax, he is not taxed
again, either on the interest earned by his after-tax savings or on the value of
the transportation services provided by the car.
International
Competitiveness
Simplified USA is carefully crafted to allow American
companies to compete and win in world markets without in any way providing a tax
incentive for American companies to move their plants and jobs offshore. In
fact, it makes the United States of America a very attractive place to be for
the purpose of conducting a worldwide business.
Simplified USA does this
by the combination of three things. First, it replaces the current archaic and
inconsistent worldwide tax rule with a territorial rule consistent with modern
practice in other countries.
Thus, when necessary, U.S. companies will
be able to invest and compete directly in foreign markets without having to pay
U.S. tax on the profits they make in some other country's economy and bring home
for investment in America. Second, export income will be excluded from U.S. tax.
Thus, a U.S. company can stay home, manufacture in the U.S. and sell into a
foreign market without paying U.S. tax. Third, an import tax will be imposed at
the same rate as the regular USA business tax rate -- 12%. Thus, while a company
may operate abroad when necessary to gain foreign-market sales that cannot be
reached by exports from the U.S., if it goes abroad for the purpose of selling
back into the U.S. market, it will have to pay a U.S. tax at the border without
the benefit of any deductions.
International competitiveness will
flourish under Simplified USA, but there will be no runaway plants.
The
Way Border Tax Adjustments Work - A Major Shift in the Tax Burden
The
border tax adjustments in USA have been borrowed from the European VAT (which is
a form of sales tax) and appended to the business portion of the USA Tax in a
WTO-permissible way -- but when appended to a business cash flow tax like the
USA business tax, the border tax adjustments operate quite differently from they
way customarily are thought of in the VAT context.
Because the USA
business tax is a tax on net cash flow instead of a tax on goods, USA excludes
from tax the revenues derived by a business from exports. This full exclusion of
export revenues is similar to the partial exclusion provided by the Foreign
Sales Corporation (FSC) rule in the current corporate income tax which the USA
business tax resembles in many ways.
Except for exports, USA includes in
the tax base all GDP - which, in turn, is equal to the sum of all returns to
labor (wages and salaries) and all unreinvested returns to capital (interest and
dividends).
By means of an import adjustment, USA also includes in the
tax base an additional amount which represents the amount of goods and services
that are produced by foreign-sited labor and capital but sold into the United
States market. The 12 percent import tax might appear to make imported products
more expensive, and, in some cases, it will, but both neoclassical economic
theory and common sense say that in many more instances involving a very large
portion of the total dollar value of imports, the foreign companies who sell
these imports into the U.S. market will have to absorb all or a major part of
the 12% import tax. They will do this by adjusting their pre-tax price downward
so that the after-tax price to the U.S. purchaser is the same or nearly the same
amount that purchasers had previously been paying. When foreign companies do
lower the pre-tax prices, they are, in effect, paying the U.S. tax and when a
company pays a tax (whether it be U.S. tax or home country tax), the burden of
that tax will ultimately be borne by its employees (in the form of lower wagers
or fewer jobs) and its shareholders and debt holders (in the form of lower
returns to capital).
As of the end of 1999, imports were
$1.3 trillion involving an almost uncountable number of U.S.
buyers and foreign sellers of an almost uncountable variety of imported goods
and services. Out of all this, no one knows how many of the foreign companies
will be "price takers" who will absorb all or part of the import tax or how many
will be "price setters" who will not absorb any of the import tax. Therefore, no
one knows the precise dollar value of the import tax that will be passed back to
foreign labor and capital, but we do know that much of it will be. The U.S.
market is, after all, the largest market in the world and the pressure on
foreign companies to absorb at least a part of the tax will be large. Only those
who sell a unique product for which there is no substitutable alternative will
be totally immune from that pressure, but there are not so many of those
situations and, even when they do exist, what may be a unique product today may
not be tomorrow.
The point is not to be precise about the exact amount
of import tax that will be borne by foreign labor and capital. Rather, the point
is to know that the dollar amount is large and that even if 60 percent of the
$160 billion import tax revenue increase is borne by foreign
labor and capital, that mans that the U.S. economy has received roughly a
$100 billion per year tax cut.
Payroll Tax Credit - An
Offset to Implicit and Explicit Taxes on Wages
Not only is the payroll
tax credit an historic breakthrough in fairness, it is essential to the
evenhanded treatment of labor and capital that is the hallmark of Simplified USA
and the foundation on which genuine tax reform must be built.
A.
Implicit Withholding Tax Offset by Payroll Tax Credit
Like the current
corporate income tax, the USA business tax is an implicit withholding tax on
dividends. (Unlike the current corporate income tax which favors debt over
equity, the USA business tax also serves as an implicit withholding tax on
interest as well.) This implicit withholding on interest and dividends arises
because the business pays tax on its as gross profit without any deductions for
interest paid or dividends paid.
Like the current employer-paid OASDHI
payroll tax, the USA business tax also serves as an implicit withholding tax on
wages -- because the business pays tax on its gross profit without deducting
wages.
But for the credit that Simplified USA allows for the 7.65%
employer- paid payroll tax (which reduces the implicit withholding), the
implicit withholding on wages up to $72,000 per employee per
year would be 19.65% (12% + 7.65%); whereas the implicit withholding on wages in
excess of $72,000 and on interest and dividends would be only
12% (the USA business tax rate).
With the payroll tax credit, the
implicit withholding tax is uniform as follows: Wages up to
$72,000 Wages above $72,00 Interest and
Dividends 12% 12% 12%
B. Explicit Tax Offset by Payroll Tax Credit
When wages, interest and dividends are received by individuals, the
remainder of the tax on that income is collected from the individual, and, in
the case of wages, all or part of that tax may be withheld at the source by the
employer as under current law.
In the case of wages up to
$72,000, however, current law imposes an additional 7.65%
employee-paid OASDHI tax that is explicitly withheld at the source by the
employer.
Simplified USA allows the employee a credit for the 7.65%
OASDHI tax explicitly withheld from wages. With this credit, wages, interest and
dividends are all taxed equally, the only variation being the rate bracket of
the particular individual -- 15%, 25% or 30%.
Resisting Analogies --
Simplified USA Is Sui Generis
The Simplified USA Tax combines some
elements that may also be found, variously, to some extent, and in different
forms, in taxes said to be based on cash flow, net income, consumed income or
business value added, but because Simplified USA is a hybrid, none of those
analogies is altogether accurate or especially illuminating.
Simplified
USA is best understood as the current income tax amended to allow (I) first year
expensing of capital equipment, (2) an unlimited Roth IRA for everyone that
applies to all saving (not just retirement saving) and (3) a credit for OASDI-II
payroll taxes. Internationally, it adopts a "Super FSC" for outbound transfers
(exports) and a "Super ss 482" adjustment on inbound transfers (imports).
If one insists on putting Simplified USA into some preexisting generic
category, the USA Tax on individuals is an "income tax" and the USA Tax on
businesses is a "business cash flow tax" (a concept which is well-known and
long-standing in the tax literature).
END
LOAD-DATE: April 13, 2000 
