FROM THE OFFICE OF PUBLIC AFFAIRS

I very much appreciate the opportunity to be with you this morning.  ICI, SIA, and the members of both organizations were instrumental in the passage of tax relief legislation last week.  The support of both organizations, both in identifying the technical issues that had to be addressed and in educating the public and legislators on the significance of the President’s proposal to end the double tax on corporate income, was invaluable.  From those of us in the Treasury Department and the Administration who had the pleasure of working alongside you, I thank you.  We simply could not have accomplished what we did without you.

I’d like to start this morning with the importance of the tax legislation that the President signed into law last week, then delve further into our tax system.  That legislation addressed one of the most serious underlying problems in the tax code, but there are others that remain to be addressed.
The legislation the President signed into law last week - the Jobs & Growth Tax Relief Reconciliation Act of 2003 - was designed to give the economy the extra boost it needs to start growing at a faster rate.

The new law provides tax relief across the board.  It increases the amount of income subject to tax at the lowest rate, ends the marriage penalty for lower and moderate income families, increases the child credit from $600 to $1000 per child, and guards middle income families against the AMT.  It also accelerates to 2003 the reduction in the remainder of income tax rates that were delayed until 2004 and 2006. 

Taken together, these changes mean that people will start seeing more money in their paychecks in the next few weeks.  A married couple with two children and income of $40,000 will see their taxes decline by $1,133 (from $1,178 to $45) in 2003, a decline of 96 percent.  Three million families will be taken off the tax rolls entirely. Eight million families who pay no income taxes will see their child credit refunds increase.  In addition, families will not have to wait to see the benefits of the increase in the child credit.  Next month, the IRS will begin cutting checks to families for the increase in the child credit.

What do the changes mean?  They mean that families will get to decide what to do with their own money.  Saving for college tuition.  Preparing for retirement.  Deciding how best to meet their families’ needs using their own money.

The reduction in income tax rates and a significant increase in the amount of investment that small businesses can expense annually will benefit 23 million small business owners, leaving them with cash for further investments and to create new jobs.  The critical role played by small businesses in the American economy is well known.  As President Bush has noted, this law directly affects small business, because most small businesses pay taxes at the individual tax rates.  Reducing the individual income tax rates helps the bottom line of most small businesses in America.  It puts capital into the treasuries of small businesses across America.  More capital means more investment. More investment means more jobs.

The centerpiece of the legislation is the significant reduction - to 5 and 15% rates - in the double tax on corporate dividends and capital gains.  While we did not win the complete end to the double tax, we made great strides.  The change signed into law by President Bush last week is the most significant change to the structure of the income tax in decades.  The President’s goal was complete rationality - an end to the double tax.  While we did not get to complete rationality - this is Washington after all! - we did get to an equal - and substantially reduced - tax rate on dividends and capital gains.

In reading the commentary and listening to the pundits over the last 10 days, it’s clear that a lot of folks don’t understand how positive this change is - so let me spend a minute on it.  For decades now, we’ve been living with a system that diverges from our best economic interests as a country.  We’ve had laws that favor debt, disfavor dividends, and enormously increase the tax costs of businesses growing through outside capital investments.  The result of the decades of bias?  Too much debt.  Attempts to camouflage debt.  Too much attention to manipulable earnings instead of unfakeable cash flow.  Too many complicated transactions designed to produce capital gains.  Transactions that coincidentally yielded enough shares to fulfill generous stock option grants without unacceptably diluting shareholder interests.  Too many small business owners to whom the tax code presents a barrier to growth.  Too long with an arbitrary allocation of the tax burden on the basis of the form in which a company does business.

With last week’s legislative action, we’ve taken the first step to eliminating the tax code’s decades old interference in the capital markets and misallocation of resources.  Perhaps most important is that taxing dividends and capital gains alike removes the fig leaf of “tax inefficiency” behind which some less-than-stellar corporate managers have hidden decisions.  Gone is any justification for retaining earnings without a satisfactory return on those earnings.  That means a certain midwestern oracle, who, it must be noted, has played the tax code like a fiddle, is still safe retaining all his earnings.  Perhaps, however, the equalization of tax on dividends and capital gains will even cause some of his shareholders to lose their complete affinity for capital gains!

Let me note two other significant benefits to the economy of the change in the taxation of corporate income.  Did you know we were number one in the OECD?  Yes, number one for highest tax on corporate income.  This change ends that dubious distinction. 
We operate in a global economy.  We can no longer write rules as though what the rest of the world is doing is irrelevant to us.  The second benefit is that it lowers the cost of capital for corporate investment.  A lower cost of capital means more investment.  More investment will encourage new job creation.

While we expect the change to have a positive effect on corporate behavior, it is likely that it will take some time for the change to undo decades of engrained practices.  Dividend policy matters to the market - because it is an indicator of the underlying health of a company - and, consequently, dividend policies are not changed lightly nor are they changed overnight.  There are, however, already positive signs.  Shortly after the President unveiled his proposal, Microsoft declared its first ever dividend.  That was followed soon after by IHOP.  As one economist observed, before the proposal was even enacted, it was changing behavior from PCs to pancakes.  And that is why the President didn’t waffle. 

And the trend continues.  Late last week, Sallie Mae increased its dividend pay out, citing the change in the tax law.  As the economy improves, we are likely to see more of that.  Over time, we may again see a time when cash dividends comprise an important part of shareholders’ return.  To my mind, that would be a welcome change.  Lottery tickets are not a good investment strategy, but the investments in some cashless companies that our tax code encouraged are closely akin to it.

While the Jobs and Growth Act has better aligned our tax rules with our economic interests and our values, there are still ways in which our tax rules are inconsistent with the core values of American society.  One of those is of special concern to those of you associated with today’s Retirement Savings Conference: our tax code discourages saving. 

Let’s turn to the basics for a moment. 

Our income tax system began as a system intended simply to fund the government.  Over the years, successive Congresses and Administrations have proposed and enacted both minor changes and major overhauls.  We have grafted on more and more components to the point that the system is nearing collapse.

To be sure, many of the components reflect an increasingly complicated world.  But many do not.  Often changes have been designed to hit a revenue target or to patch a hole, real or perceived.  Whatever the case, changes have been made too frequently, without coherent or consistent policy design, with insufficient overall consideration of their effect on our country or its relation to the global economy, and without adequate thought to how each of the new components fits with the others.

In the tax world, we have done exactly the opposite of what the business world has done to increase productivity - a key to the incredible economic growth the county has experienced in the recent past.  What is it the business world has done to increase productivity?  They’ve simplified.  They’ve taken every process down to its constituent parts and cut out the inefficiencies, the points of friction, the drags that prevent the most streamlined operation and the standardization of transactions. 
In the tax world, instead of simplifying to increase productivity in compliance and administration, we keep adding complexity - more rules, more limitations, more terms, more conditions, more qualifiers, more provisos, more exceptions.  The result is that our system gets slower and slower and more inefficient.  We burn more fuel, and emit ever more heat and smoke, and yet with all that burning, there’s less and less light to show for it.

Nowhere is this problem more evident than in the numerous savings vehicles we have in the Code.  Instead of simplifying to increase saving, we keep adding complexity - more rules, more limitations, more terms, more conditions, more qualifiers, more provisos, more exceptions.  As a result Americans are increasingly disinclined to save, rather than trying to figure out the complex rules.

Two decades ago - before the ’86 Tax Reform Act fixed all sorts of things that weren’t broken - there was one kind of IRA and it worked for everyone.  As Matt Fink has noted, from 1980 to 1986, contributions to IRAs rose nearly ten-fold, from $4 billion to $38 billion.  Even more significant, however, is that the median income of contributing workers declined from $41,000 in 1982 to $29,000 in 1986. 

The ’86 Act added provisos to the simple IRA that limited its availability.  These provisos were based on income and pension plan availability.  The result: participation dropped.  Confusion over eligibility, deductibility, and the benefits of continuing to contribute sidelined many former participants who were still eligible to participate. 

The complexity also sidelined our financial institutions whose marketing abilities - coupled with the convenience of payroll deductions or automatic transfers - had made the IRA popular and successful.  The limitations, qualifiers, and provisos made it impossible for them to standardize transactions.  In short, we told simplicity - and the efficiency and productivity simplicity brings - to take a hike.  It has never returned.  Instead of going back to basics to fix the decline in participation, we have added more complexity.  We now have three versions of the IRA - traditional, nondeductible, and Roth.  All operate differently, including with different limitations, qualifiers, and provisos - and, of course, they are mutually exclusive.

Recognizing that more people would be willing to set aside cash for retirement if they knew they could withdraw it in certain circumstances, we made exceptions for certain kinds of withdrawals in certain situations and added more complexity.

As the list of sympathetic withdrawals lengthened, we added new savings accounts for the new purposes.  ESAs, QSTPs, MSAs.  Hardly a month goes by that someone doesn’t propose yet another account for yet another purpose. 

And so the complexity grows, the inability to standardize transactions grows, the cost of administration grows, and the confusion multiplies! 

Implicit in all of these complicated provisions are two important points.  First, we don’t trust the American taxpayer to make the right decisions, and, second, our tax rules contradict our values.
 If we did trust the American taxpayer to make the right decisions for him or herself and his or her family, we wouldn’t need the long list of qualifiers, provisos, and exceptions, backed up by penalties.  Penalties, incidentally, that particularly discourage participation by lower and moderate income families.  It’s hard enough for people to save today.  The last thing we need is some scold hitting the virtuous saver with a penalty because they need the money for some purpose unsanctioned by Washington.
 
The rules contradict our values because our system penalizes those who save their money instead of spending it.  We will only reduce the penalty for those who agree to save, and in fact do save, for the purposes dictated by us here in Washington.  This contradiction of our values is so engrained that it has become second nature to us - we don’t realize the effect it’s having.

Take a simple example.  Two families - identical except that one of them spends everything they make and the other saves some, whether to buy a new home, for continuing education, for a rainy day, for unexpected emergencies, for their children’s future, or for their own retirement security.  Over time, the family that saves will see its tax bill increase relative to the family that spends everything.  We justify that on the basis that the family that saved has more income and a greater ability to pay.  But the reason they have more income is because they chose to do the right thing.  Like the ant in the parable, they worked and saved for their future.  Virtue may be its own reward, but we’re going to get less of it if we attach penalties to it.  And, mind you, the additional taxes aren’t limited to the tax owed on the savings income.  Nor are the penalties for this virtue limited to the tax code.

We need to go back to the drawing board.  We need to have faith that the American people know how to do the right thing.  The President’s budget proposals for retirement and lifetime savings accounts would do just that.

The proposed simplification of the retirement savings accounts and the addition of a lifetime savings account accessible to all Americans would bring significant simplification benefits.  The lifetime savings account, or LSA, will allow everyone to contribute - with no limitations based on age or income status - up to $7,500 per year of after-tax income.  LSAs could be used to fund a college education, start a business, buy a first home, save for emergencies, or used for retirement.  Earnings would not be subject to income tax and amounts could be withdrawn at any time for any purpose.  Think medical savings accounts without losing unused cash at the end of the year.  Think education savings accounts without the receipts.  LSAs also could be established for children.

The retirement savings account, or RSA, would consolidate traditional IRAs, nondeductible IRAs, and Roth IRAs into a single simple account for retirement savings.  Individuals could save up to $7,500 per year of after-tax compensation -- regardless of the level of that compensation - for retirement, whether or not they also save in an LSA.  Earnings in an RSA would not be subject to income tax provided the earnings are not distributed prior to the owner reaching age 58 or becoming disabled.  Individuals would be able to convert existing tax-preferred savings into these new accounts in order to consolidate and simplify their savings.
 
Confusion and frustration are far too common among individuals trying to save.  In 1982, the IRS publication explaining individual retirement accounts was 12 pages long.  Now it is 104 pages long.  People should not have to worry about the confusing alphabet soup of six different savings accounts and the endless maze of confusing rules.  The two simple accounts will have one powerful goal - making saving for everyday life and retirement security easier and more attractive.

Getting rid of the restrictions and qualifiers simplifies marketing and participation for  everyone and for every purpose.  But make no mistake about it:  the real winners here are average Americans.  In a matter of less than a decade, the accounts would permit all lower and moderate income Americans to enjoy the benefits of tax-free compounding and freedom from the complexity of Schedule B and Schedule D for all of their savings.  This will give more hardworking Americans the chance to enrich their lives and strengthen their retirement security.

Besides simplifying savings for individuals, we need to simplify and rationalize the rules governing employer sponsored retirement plans. Each plan's purpose is to encourage retirement savings. But different sets of rules for different types of plans and different types of employers needlessly complicate and confuse employers and employees and make more difficult the standardization of transactions that reduces cost.  Employer Retirement Savings Accounts, or ERSAs, would promote and vastly simplify employer sponsored retirement plans by consolidating 401(k), SIMPLE 401(k), 403(b), SIMPLE IRAs, SARSEPs, and 457 plans into a single type of plan that could be more easily established and maintained by any employer. 

Less than 50% of the work force is covered by a retirement plan.  Among small businesses, the coverage is even lower, with estimates ranging between 25 and 33% of the workforce.  One look at the complexity of the rules and it is easy to understand why many small businesses would have opted out.  We need to change that.  We need to simplify the rules to make them accessible for all employers, regardless of size or sophistication.

I think you will find these proposals both sensible and constructive - they will simplify our tax code for employers and individuals, so that all Americans can save more for retirement, and for all their investment needs.  We welcome your input on ways to make the proposals even more potent tools to encourage savings.  Like the President’s Jobs and Growth plan, and the Tax Relief Act of 2001, this will mean a long term boost for our economy, and greater prosperity and freedom for every American family.  

Thank you.