Mar.Senate Budget Committee Examines Tax Reform Options
At a Senate Budget Committee hearing on March 1, members discussed tax reform with a panel of witnesses from various think tanks and academia. Chairman Kent Conrad (D-N.D.) said the state of the tax code is “currently indefensible. It is completely out of date.” The code is riddled with expiring provisions that create enormous uncertainty and the total cost of tax expenditures “is simply staggering,” he said.
Filling in for Sen. Jeff Sessions (R-Ala.), Sen. Pat Toomey (R-Pa.) said tax reform “is critical” to addressing our deficit problems, while maximizing economic growth. Toomey added that “I’ve been a big fan of a mechanism to reduce the value of deductions to generate offsetting revenue … which I think is one of many possibilities but a particularly constructive way of doing it.”
Testimony
In his testimony, Leonard Burman, Professor of Public Affairs at Syracuse University, said the tax code “desperately needs reform,” which would provide the opportunity to address economic growth and fairness at the same time.
Lowering tax rates “are not a panacea” and can be counterproductive if base broadening is not included in the reform, Burman said. He added that the “starve the beast theory clearly isn’t working.” Burman said tax expenditures are spending and that these expenditures have had a “privileged status in the budget process.”
In her testimony, Diane Lim Rogers, Chief Economist at the Concord Coalition, said it is possible to achieve economic growth, a reduction in the deficit, and fairness from tax reform, but that this reform “will not be without hard choices.” She added that it is impossible to grow the supply side of the economy through deficit enhanced tax cuts, to reduce the deficit without seeking higher revenues, and to promote fairness without raising tax burdens on the rich.
In his testimony, Daniel Mitchell, Senior Fellow at the Cato Institute, said tax reform has the potential to eliminate problems, but it could also make problems worse depending on the guidelines used. Mitchell added that tax rates should be as low as possible, the new tax system should not discriminate against capital formation, preferences and penalties within the tax code should be removed, and Congress should establish a territorial tax system.
The ideal system, he said, “is some sort of low rate, consumption based, loophole free tax system.” A flat tax and a value added tax (VAT), “assuming it’s a replacement tax and not an add-on tax,” closely resembles such an ideal system, he said.
Question and Answer
Cap Gains and Dividends
Conrad asked the panel whether the Simpson-Bowles plan, which had dividends and capital gains taxed at ordinary rates (28 percent), was a good idea.
Burman said the lower capital gains tax rate “is a huge bonanza” for tax shelter activity designed to make wages look like capital gains. The Simpson-Bowles plan is “exactly the right way to go.” He added that there is no right way to tax capital gains under an income tax, but “if we have an income tax, we should tax capital gains the same as other kinds of income.”
Rogers largely agreed with Burman’s answer. She said the disagreement over the incentive effects from taxing capital gains and dividends stems from whether one chooses a consumption-base or income-base as the right basis of taxation of income.
Toomey said he found the administration’s corporate tax reform proposal’s effect on dividend treatment “really stunning.” Since the President is proposing to triple the tax on dividends and double the tax on capital gains, Toomey asked the panel whether they were worried that this could be detrimental to capital formation.
Burman said at current tax rates, “I think there’s something of a concern.” Mitchell said the proposal is a “misguided” approach likely to cause distortions “in terms of retained earnings versus distributive earnings” due to the split between the rates for dividends and capital gains. Mitchell stressed the importance of equal treatment between the two rates.
Sen. Chuck Grassley (R-Iowa) focused on the current code and how it favors debt over equity. He asked the panel whether the President’s proposals on dividends and capital gains would make debt financing even more attractive, and whether they had any ideas on eliminating the current bias towards debt financing.
Burman advocated for integrating individual and corporate taxes to deal with the issue of debt equity, where the corporate tax serves as a withholding tax and individuals would get a credit for taxes paid at the corporate level. “That would be neutral between debt and equity,” he said.
Tax Structure
Conrad asked the panel for their thoughts about a hybrid tax system, with part of the tax on income and a part of the tax on consumption.
Burman said the hybrid system is advantageous for economic growth, while Rogers said the big reason to shift to a hybrid system is due to the fact that if Congress went to a consumption-based system, it would be difficult to retain the progressivity in the system. Mitchell said a hybrid system is already in place today since Congress is protecting savings through IRAs and 401ks from double taxation, in addition to lower rates on capital gains and dividends. Mitchell added that any move towards a consumption-base system would be better for growth.
Sen. Kelly Ayotte (R-N.H.) said the U.S. is at a competitive disadvantage versus foreign tax structures that have adopted a territorial tax, and asked the panel for their thoughts.
Mitchell said territorial taxation is “theoretically the right approach.” The U.S. currently has a worldwide tax system, “which we try to mitigate through a policy known as deferral,” which delays the tax until companies bring back their earnings to the U.S. The President’s plan, he added, goes more in the direction of worldwide taxation, and American companies competing abroad are at a disadvantage as foreign companies do not have to pay an “additional layer of tax in their home country.”
Burman said a territorial tax system provides a huge incentive for companies to shelter income from U.S. tax. If the U.S. shifts to a territorial tax system, U.S. companies will have an even greater incentive to shift activities overseas in order to be exempt from U.S. tax.
For more on this hearing, please click here.
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At a Senate Budget Committee hearing on March 1, members discussed tax reform with a panel of witnesses from various think tanks and academia. Chairman Kent Conrad (D-N.D.) said the state of the tax code is “currently indefensible. It is completely out of date.” The code is riddled with expiring provisions that create enormous uncertainty and the total cost of tax expenditures “is simply staggering,” he said.
Filling in for Sen. Jeff Sessions (R-Ala.), Sen. Pat Toomey (R-Pa.) said tax reform “is critical” to addressing our deficit problems, while maximizing economic growth. Toomey added that “I’ve been a big fan of a mechanism to reduce the value of deductions to generate offsetting revenue … which I think is one of many possibilities but a particularly constructive way of doing it.”
Testimony
In his testimony, Leonard Burman, Professor of Public Affairs at Syracuse University, said the tax code “desperately needs reform,” which would provide the opportunity to address economic growth and fairness at the same time.
Lowering tax rates “are not a panacea” and can be counterproductive if base broadening is not included in the reform, Burman said. He added that the “starve the beast theory clearly isn’t working.” Burman said tax expenditures are spending and that these expenditures have had a “privileged status in the budget process.”
In her testimony, Diane Lim Rogers, Chief Economist at the Concord Coalition, said it is possible to achieve economic growth, a reduction in the deficit, and fairness from tax reform, but that this reform “will not be without hard choices.” She added that it is impossible to grow the supply side of the economy through deficit enhanced tax cuts, to reduce the deficit without seeking higher revenues, and to promote fairness without raising tax burdens on the rich.
In his testimony, Daniel Mitchell, Senior Fellow at the Cato Institute, said tax reform has the potential to eliminate problems, but it could also make problems worse depending on the guidelines used. Mitchell added that tax rates should be as low as possible, the new tax system should not discriminate against capital formation, preferences and penalties within the tax code should be removed, and Congress should establish a territorial tax system.
The ideal system, he said, “is some sort of low rate, consumption based, loophole free tax system.” A flat tax and a value added tax (VAT), “assuming it’s a replacement tax and not an add-on tax,” closely resembles such an ideal system, he said.
Question and Answer
Cap Gains and Dividends
Conrad asked the panel whether the Simpson-Bowles plan, which had dividends and capital gains taxed at ordinary rates (28 percent), was a good idea.
Burman said the lower capital gains tax rate “is a huge bonanza” for tax shelter activity designed to make wages look like capital gains. The Simpson-Bowles plan is “exactly the right way to go.” He added that there is no right way to tax capital gains under an income tax, but “if we have an income tax, we should tax capital gains the same as other kinds of income.”
Rogers largely agreed with Burman’s answer. She said the disagreement over the incentive effects from taxing capital gains and dividends stems from whether one chooses a consumption-base or income-base as the right basis of taxation of income.
Toomey said he found the administration’s corporate tax reform proposal’s effect on dividend treatment “really stunning.” Since the President is proposing to triple the tax on dividends and double the tax on capital gains, Toomey asked the panel whether they were worried that this could be detrimental to capital formation.
Burman said at current tax rates, “I think there’s something of a concern.” Mitchell said the proposal is a “misguided” approach likely to cause distortions “in terms of retained earnings versus distributive earnings” due to the split between the rates for dividends and capital gains. Mitchell stressed the importance of equal treatment between the two rates.
Sen. Chuck Grassley (R-Iowa) focused on the current code and how it favors debt over equity. He asked the panel whether the President’s proposals on dividends and capital gains would make debt financing even more attractive, and whether they had any ideas on eliminating the current bias towards debt financing.
Burman advocated for integrating individual and corporate taxes to deal with the issue of debt equity, where the corporate tax serves as a withholding tax and individuals would get a credit for taxes paid at the corporate level. “That would be neutral between debt and equity,” he said.
Tax Structure
Conrad asked the panel for their thoughts about a hybrid tax system, with part of the tax on income and a part of the tax on consumption.
Burman said the hybrid system is advantageous for economic growth, while Rogers said the big reason to shift to a hybrid system is due to the fact that if Congress went to a consumption-based system, it would be difficult to retain the progressivity in the system. Mitchell said a hybrid system is already in place today since Congress is protecting savings through IRAs and 401ks from double taxation, in addition to lower rates on capital gains and dividends. Mitchell added that any move towards a consumption-base system would be better for growth.
Sen. Kelly Ayotte (R-N.H.) said the U.S. is at a competitive disadvantage versus foreign tax structures that have adopted a territorial tax, and asked the panel for their thoughts.
Mitchell said territorial taxation is “theoretically the right approach.” The U.S. currently has a worldwide tax system, “which we try to mitigate through a policy known as deferral,” which delays the tax until companies bring back their earnings to the U.S. The President’s plan, he added, goes more in the direction of worldwide taxation, and American companies competing abroad are at a disadvantage as foreign companies do not have to pay an “additional layer of tax in their home country.”
Burman said a territorial tax system provides a huge incentive for companies to shelter income from U.S. tax. If the U.S. shifts to a territorial tax system, U.S. companies will have an even greater incentive to shift activities overseas in order to be exempt from U.S. tax.
For more on this hearing, please click here.