<DOC>
[108th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:99686.wais]
SIMPLIFICATION OF THE TAX SYSTEM
=======================================================================
HEARING
SUBCOMMITTEE ON OVERSIGHT
of the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
__________
JUNE 15, 2004
__________
Serial No. 108-68
__________
Printed for the use of the Committee on Ways and Means
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COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
E. CLAY SHAW, JR., Florida FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut ROBERT T. MATSUI, California
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM MCCRERY, Louisiana JIM MCDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. MCNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHIL ENGLISH, Pennsylvania LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona EARL POMEROY, North Dakota
JERRY WELLER, Illinois MAX SANDLIN, Texas
KENNY C. HULSHOF, Missouri STEPHANIE TUBBS JONES, Ohio
SCOTT MCINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia
Allison H. Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
______
SUBCOMMITTEE ON OVERSIGHT
AMO HOUGHTON, New York, Chairman
ROB PORTMAN, Ohio EARL POMEROY, North Dakota
JERRY WELLER, Illinois GERALD D. KLECZKA, Wisconsin
SCOTT MCINNIS, Colorado MICHAEL R. MCNULTY, New York
MARK FOLEY, Florida JOHN S. TANNER, Tennessee
SAM JOHNSON, Texas MAX SANDLIN, Texas
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
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C O N T E N T S
__________
Page
Advisory of June 8, 2004, announcing the hearing................. 2
WITNESSES
Internal Revenue Service, Hon. Don C. Alexander, Commissioner,
1973-1977...................................................... 31
Internal Revenue Service, Hon. Mortimer M. Caplin, Commissioner,
1961-1964...................................................... 25
Internal Revenue Service, Hon. Sheldon S. Cohen, Commissioner,
1965-1969...................................................... 29
Internal Revenue Service, Hon. Fred T. Goldberg, Jr.,
Commissioner, 1989-1992........................................ 34
______
Fordham University School of Law, Tax Litigation Clinic,
Elizabeth Maresca.............................................. 12
H&R Block, Premium Tax Services, Jeannette Parshall.............. 15
New York City Fire Department, Robert Sweeney.................... 8
Rivermine Software, Nina Doherty................................. 9
SUBMISSIONS FOR THE RECORD
Coalition for Tax Fairness, Timothy John Carlson, Arlington, VA,
statement...................................................... 48
Father's Rights Association of New York, Efrain Rodriguez, Jr.,
Mahopac, NY, statement......................................... 50
Klaassen, David R., Marquette, KS, statement..................... 51
Reform AMT, Alan Veeck, Pittsburgh, PA, statement................ 52
SIMPLIFICATION OF THE TAX SYSTEM
----------
TUESDAY, JUNE 15, 2004
U.S. House of Representatives,
Committee on Ways and Means,
Subcommittee on Oversight,
Washington, DC.
The Subcommittee met, pursuant to notice, at 2:02 p.m., in
room 1100, Longworth House Office Building, Hon. Amo Houghton
(Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
SUBCOMMITTEE ON OVERSIGHT
CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE
June 08, 2004
Houghton Announces Hearing on Tax Simplification
Congressman Amo Houghton (R-NY), Chairman, Subcommittee on
Oversight of the Committee on Ways and Means, today announced that the
Subcommittee will hold a hearing on the simplification of the tax
system. The hearing will take place on Tuesday, June 15, in the main
Committee hearing room, 1100 Longworth House Office Building, beginning
at 2:00 p.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only.
Witnesses will include individual taxpayers and a panel of former
commissioners of the Internal Revenue Service (IRS).
BACKGROUND:
On April 2, 2004, Chairman Houghton introduced nine legislative
proposals to simplify the U.S. Tax Code. The Houghton package of
simplification bills highlights areas of the Internal Revenue Code that
can be simplified to make it easier for people to complete their tax
returns. Committee Member Rob Portman (R-OH) introduced a comprehensive
tax simplification bill in the 107th Congress, the ``Tax Simplification
Act of 2002'' (H.R. 5166).
The Houghton simplification package includes bills that would
repeal the Alternative Minimum Tax (AMT), reducing the number of AMT
taxpayers by 114 million, and saving approximately 463 million hours of
tax return preparation time; establish a uniform definition of a child
that is based on residence, relationship, and age; and change the term
``Head of Household'' filing status to ``Single Parent or Guardian''
filing status, a term that is less likely to cause a mistake in
choosing a filing status. Other proposals that would simplify the tax
laws include: the ``Taxation of Minor Children Simplification Act''
(H.R. 4135), the ``Education Tax Credit Simplification Act'' (H.R.
4136), the ``Small Business Tax Modernization Act'' (H.R. 4137), the
``Personal Holding Company Tax Repeal Act'' (H.R. 4138), and the
``State Business Law Tax Conformity Act'' (H.R. 4139). With the
exception of AMT repeal, all of the foregoing proposals are low-cost or
revenue-neutral. Chairman Houghton also introduced a House resolution
to require all future tax bills to contain a simplification title.
In announcing the hearing, Chairman Houghton stated, ``The load
that we place on taxpayers to understand the tax system is, in a word,
heavy. Hard working Americans like Bob Sweeney, a New York City
firefighter, and Robert Klaassen, a Kansas attorney with 13 children,
are being forced to contend with a tangled, shadow tax system: the
Alternative Minimum Tax.''
``Millions of others are unable to navigate the complex series of
rules which determine eligibility for common tax benefits such as the
dependency exemption. I hope this hearing and the bills I introduced to
simplify the tax code will persuade the Congress to take action to
simplify the code.''
FOCUS OF THE HEARING:
The hearing will focus on simplification of the current tax system.
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<F-dash>
Chairman HOUGHTON. Good afternoon, ladies and gentlemen. We
are delighted to have you here. Thank you very much to the
witnesses for being here. I am going to make an opening
statement, then Mr. Pomeroy will, and then Mr. Portman will.
So, let me just begin.
In some ways our tax system represents what one might call
the pinnacle of our civilization. Spanning 7 million words of
statute law and interpretive regulation, it is arguably the
most intricate law of all time. Future archeologists looking
back might view the Rosetta Stone of the tax law and will
marvel at its ability to reconcile competing objectives, such
as the need to treat similarly situated taxpayers in similar
fashions. Yet, unlike complex and natural systems made by God,
our tax system does not always work in harmony. In written
testimony that we are making available today, Professor Joel
Slemrod estimates that this year individuals will spend $85
billion to comply with the complex rules that govern our tax
system. Businesses will spend an additional $40 billion. This
natural overhead expense is an extraordinary 14-and-a-half
percent of income tax receipts.
Many experts have offered recommendations to simplify the
Tax Code, and they have reached at least one consensus:
Congress somehow must repeal the Alternative Minimum Tax (AMT).
If we do not repeal this tax, it will, within in a short period
of time, swallow the ordinary tax system. This clearly will be
a disaster. It will double the work necessary to calculate
income tax for tens of millions of Americans. It will also make
planning difficult or impossible, and it will shift part of the
tax burden of this country onto the shoulders of individuals
like Bob Sweeney, a New York City firefighter; Robert Klaasen,
a father of 13; and Nina Doherty, a casualty of the high-tech
economy you will be seeing. We will be hearing from Mr. Sweeney
and Ms. Doherty today on our first panel. Unfortunately, Mr.
Klaasen could not be here, but he has provided some written
testimony.
Chairman HOUGHTON. Now, Mr. Sweeney fell into the AMT
because he pays relatively high State taxes because he has
work-related expenses that the AMT treats as suspect. Mr.
Klaasen pays AMT because of his large family and high medical
expenses. Ms. Doherty faces AMT because she was restricted from
selling the stock of a small company that later went bankrupt,
as sometimes small companies do.
Another area of agreement among experts is that the
definition of a qualifying child should be made uniform. The
inconsistent rules, millions of Americans face a difficult
challenge to determine whether their care of a child makes them
eligible for tax benefits or not. As Professor Elizabeth
Maresca will testify, they often get it wrong, and these
mistakes can have severe consequences. Congress can and should
make the definition of a child uniform. That should not be too
difficult.
In addition to our individual witnesses, we are honored to
have testify four former Commissioners of the Internal Revenue
Service (IRS), very distinguished citizens of this country.
Collectively their experience spans the Administrations of five
Presidents, and they have more detailed knowledge of the tax
system, I must assume, and its functioning than any other group
that I know of. I look forward to their testimony in how to
simplify the Tax Code.
In April of this year, we introduced a comprehensive
package of 10 pieces of legislation that would substantially
simplify the Tax Code for virtually every individual and small
business. Subcommittee Member Rob Portman, seated to my right,
also has introduced legislation that would repeal the AMT and
make the definition of a child more uniform. Ranking Member
Pomeroy, who is here on my left, shares my interest as well,
and I hope to work with them closely.
Our tax system isn't perfect, but that always is a given.
We should not let the academic pursuit of a perfect system that
may never exist blind us to the work that we can do now, right
now, to improve life for ordinary taxpayers. So, our witnesses
today remind us of the importance of that objective.
Chairman HOUGHTON. I am now pleased to yield to the Ranking
Democrat Mr. Pomeroy.
Mr. POMEROY. I want to thank the Chairman and congratulate
him on convening this hearing and assembling this outstanding
list of witnesses. I suppose that Congress in Presidential
election years is not known for the pursuit of good governance
necessarily, and I don't mean to heap that burden on one party
or the other; I just think that it gets to be extraordinarily
political around here, and we lose our way a little bit in
terms of what good governance really ought to hold us to.
Well, tax simplification is pure good governance, and it
hasn't had a more worthy champion over the years than Chairman,
Amo Houghton. So, it would sure be wonderful in your remaining
months in Congress if we could pass the ``Houghton Memorial Tax
Simplification Straighten It Up Act.'' Count me in. There is a
lot that we can do both big and small, and the fact that we
can't perhaps in one fell swoop fix everything should not
detract us from at least identifying glaring issues and
beginning our work on them. I am very pleased to work with my
colleague Representative Rob Portman in that regard as well.
One of the issues that will come under discussion today,
perhaps one of the most expensive, difficult issues that we
will be encountering, is the AMT issue. My friend and colleague
from Springfield, Massachusetts, Richard Neal, has been the
leader in early identification of this as an emerging problem;
he saw it before many of us did in terms of something that we
are going to have to deal with, and he has led the effort to
date. So, his participation in the course of our discussion
today is going to be very valuable. With that, Mr. Chairman, I
would just conclude by saying you once again have led the way
in terms of something that the Committee on Ways and Means has
got to get real serious about. If we don't provide the
leadership, nobody is going to provide the leadership in terms
of building a Tax Code that basically is a sustaining revenue
basis for this country. Thank you for holding this hearing. I
yield back.
Chairman HOUGHTON. Well, thank you. I would just like to
add something here. This is sort of a personal feeling, that
ever since I was on this Committee with Jake Pickle, I think
this has been the most bipartisan Subcommittee I have known. We
have always worked that way, and we have always worked our
differences out. I think it is productive not only for us in
Congress, but also, I think, for the witnesses. So, what I
would like to do is to turn to Mr. Portman for an opening
statement.
Mr. PORTMAN. Thank you, Mr. Chairman. I hate to start on a
discordant note after that comment, but I must say as an
anthropology major, I find your comparison of the Tax Code to
the Rosetta Stone as an insult to the stone.
Thank you for having this hearing. Mr. Pomeroy, thank you
for your comments; Mr. Neal for your contributions over the
years on the AMT. This is an incredible issue. I think, in all
seriousness, the Chairman is right, our Tax Code in many
respects does represent who we are. It is our attempt to
balance all these competing interests, and I think we have
failed in that. I think we have created such a complex Tax Code
that it has a negative impact on our economy and a frustrating
impact on our service and on our taxpayers.
You have been in the trenches on this over the years, Mr.
Chairman. I appreciate the work you have done on it. I think
you should take some comfort in the fact that we are making
some progress. Last night in this very Committee room we passed
out of this Committee legislation to simplify the International
Tax Code in some significant ways, not as far as many of us
would like to go, but there are some significant
simplifications that you had been promoting for years that are
included, including the foreign tax credit market baskets, and
the interest allocation rules that will help make it a little
bit easier to work through some of our tax complexities. As you
have mentioned, I have also introduced legislation in this
area. Many of the provisions that I have introduced have been
included in your legislations, your bills, as well, Mr.
Chairman. I think one reason both of us have pushed for
simplification is because of its impact on the system.
We are going to hear from taxpayers today. I look forward
to it. The taxpayer frustration I hope everybody understands
and is obvious, but sometimes less obvious is its impact on the
IRS itself. Maybe that doesn't motivate people to push for
simplification, but it does me, because our tax system itself
is under such incredible stress because of complexity. The IRS
has a lot of problems, but a huge one is complexity. We are
going to hear from four former Commissioners today, at least I
see four here with us, and I look forward to talking to them
about that. They have all been through it for years. As Co-
Chairman of the National Commission on Restructuring the IRS,
we were not supposed to look at simplification, but we did,
simply because as we began to peel back the layers of the onion
and get into the myriad of problems that the IRS was then
experiencing, one clearly was its inability to administer the
enormous complexity that we in the Congress have put upon it
through our Tax Code.
So, there are lots of reasons to push for tax reform and
tax simplification. One is there is a decreased level of
voluntary compliance with more complexity. I firmly believe
that from my own experience with my constituents. One of them
called me once and said, Congressman, I would like to pay my
taxes, but I just can't figure it out. I won't give you his
name, nor did he give me his name, but this happens in all of
our offices, I am sure. People just get so frustrated, they
literally cannot figure it out. I'd like to touch on increased
compliance costs. You talked earlier, Mr. Chairman, about the
University of Michigan studies which are very disturbing in
terms of the amount of time, effort, and money put into our tax
compliance system.
Reduced perception of fairness in the Federal tax system.
Being so complex, there is a concern about fairness, and I
believe that this contributes to this lack of voluntary
compliance. Finally, as I said before, the increased
difficulties with the administration of tax laws themselves is
problematic. Of course, there is the frustration of taxpayers.
So, I thank you very much, Mr. Chairman, for holding this
hearing, and look forward to the testimony from our witnesses
and look forward to taking that testimony and trying to put
forward some legislation. As the Chairman said earlier, this is
the art of the possible here in Congress, but at least it moves
us toward simplification. I do think the bill last night is a
small step in the right direction, at least on the
international corporate provisions. Thank you, Mr. Chairman.
Chairman HOUGHTON. Thank you very much, Mr. Portman. Mr.
Neal, would you like to make a statement?
Mr. NEAL. Thank you, Mr. Chairman. Just a note. I think
that you are absolutely right when you say that this has been
the most bipartisan Subcommittee, and indeed you have been one
of the most bipartisan Members of Congress. The sad commentary
on all of this is that year after year there are fewer people
like you. We have been talking here about AMT for a long time.
We have talked about simplifying the Tax Code. I think that
simplification ought to be the middle ground in this
institution. It is something that can be done. On the AMT, I
will just let the witnesses know that I have been at this for a
long period of time. I have never been involved in an issue of
my public career of 31 years where more people patted me on the
back, thanked me, said, great job, and did less about it. It is
because of the financial realities and what ideology now does
in this institution, the intransigence that develops. I think
that this is a problem that gets worse year after year after
year, and trying to bring it up has been most difficult. I will
tell you, as it relates to stock options, an awful lot of fine
people as well as those with a certain number of children are
really being hurt by AMT, and this institution can do something
about it if it only had the will. Thank you.
Chairman HOUGHTON. Thank you very much. Mr. Johnson, would
you like to make an opening statement of any kind? All right.
Thank you very much.
Let us go to our first panel. We have Robert Sweeney of the
New York City Fire Department of Douglaston--that is in the
Queens. Nina Doherty, Sales Engineer at Rivermine Software; and
Elizabeth Maresca, Associate Clinical Professor at Fordham
University School of Law, and Supervising Attorney, Tax
Litigation Clinic; and Jeannette Parshall, director of Premium
Tax Services at H&R Block's office in Wheaton, Maryland. So, we
will start with you, Mr. Sweeney.
Mr. POMEROY. Mr. Chairman, if I might, just at the outset,
Mr. Sweeney and Ms. Maresca are from New York City. Our Ranking
Member Charlie Rangel had hoped to be here to greet you and
introduce you as you testify. He is otherwise detained in light
of his schedule. He has asked me to give you a special welcome
to this Committee. We are very pleased you could take the time
to testify. Thank you, Mr. Chairman.
Chairman HOUGHTON. I thought you were going to say they
were from North Dakota originally.
Mr. POMEROY. You are welcome any time.
Chairman HOUGHTON. Well, anyway. Go ahead, Mr. Sweeney.
Thank you, Mr. Pomeroy.
STATEMENT OF ROBERT SWEENEY, NEW YORK CITY
FIRE DEPARTMENT, DOUGLASTON, NEW YORK
Mr. SWEENEY. Good afternoon, Chairman Houghton, Ranking
Member Pomeroy, and Members of the Committee. My name is Robert
Sweeney. I am a New York fireman. I work for the New York City
Fire Department, and as Assistant Chief I have supervisory
responsibility for all the firehouses in the borough of Queens.
We would like you to know that the New York City firefighters
appreciate the support of Congress. However, I am here today to
discuss what may be unintended consequences of the AMT. My tax
accountant Dr. William Stevenson asked me to accept your
invitation to come before you and explain how the AMT has
affected my family in the negative way.
It is my understanding that the AMT negatively affects
large numbers of middle-class taxpayers like me who earn less
than $150,000 per year, and will in future years affect many
more millions earning even less. While I cannot explain to you
how the AMT works, I can tell you how it affects my wife, my
three children, and me. As I understand it, Congress has
permitted us firemen to deduct various unreimbursed job-related
expenses. A firefighter's job-related expenses include things
like union dues, firehouse taxes, dry cleaning of uniforms,
educational expenses, and many other out-of-pocket
expenditures. Last year my unreimbursed expenses were about
$5,500. My family also had some modest investment fees which
Congress has made deductible. Not only did we lose all of our
miscellaneous firefighters' expense deductions and investment
expense deductions, but we also lost some of our State income
tax and real estate tax deductions as well.
My tax accountant tells me for the second year in a row
that the AMT has taken these lawful deductions from us. We have
received no tax benefits for the job-related expense deductions
that were made a matter of law by Congress many years ago. The
AMT cost my family about $10,000 over the last 2 years. The
extra tax we have paid has reduced what we could spend for our
children's education and well-being. I also learned from my tax
accountant that, when the AMT is calculated, we do not get the
full benefit of deductions or credits for our children.
It seems to me that this tax is affecting people who cannot
afford it. It seems to me that ordinary people should not be
subject to a tax that they have never heard of, that is too
complicated to calculate, that is impossible to plan for, and
that drains their ability to care for their family. It is an
honor to appear before you today, and I hope in some small way
I helped you progress and fix the negative consequences of the
AMT on middle-class families like mine. Thank you.
[The prepared statement of Mr. Sweeney follows:]
Statement of Robert Sweeney, New York City Fire Department,
Douglaston, New York
Good afternoon Chairman Houghton, Ranking Member Pomeroy and
members of the Committee. My name is Robert Sweeney. I am a New York
Fireman. I work for the New York City Fire Department and as Assistant
Chief I have supervisory responsibility for all the fire houses in the
borough of Queens. We would like you to know that New York City
Firefighters appreciate the support of Congress; however, I am here
today to discuss what may be unintended consequences of the Alternative
Minimum Tax.
My tax accountant, Dr. William Stevenson, who is an enrolled agent,
asked me to accept your invitation to come before you and explain how
the Alternative Minimum Tax has affected my family in a negative way.
It is my understanding that the AMT negatively affects large numbers of
middle class taxpayers like me who earn less than $150,000 per year and
will in future years affect many more millions earning even less.
While I can't explain to you how the Alternative Minimum Tax works,
I can tell you how it affects my wife, my three children and me. As I
understand it, Congress has permitted us firemen to deduct various
unreimbursed job related expenses. A firefighter's job-related expenses
include things like union dues, professional literature, dry cleaning
of uniforms, educational expenses and many other out of pocket
expenditures. Last year my unreimbursed expenses were about $5,500. My
family also had some modest investment fees which Congress has made
deductible. Not only did we lose all of our miscellaneous fire
fighter's expense deductions and investment expense deductions, but we
also lost some of our state income and real estate tax deductions as
well.
My tax accountant tells me, for the second year in a row, that the
Alternative Minimum Tax has taken these lawful deductions from us. We
have received no tax benefits for the job related expense deductions
that were made a matter of law by Congress many years ago. The
Alternative Minimum Tax cost my family about $10,000 over the last two
years. The extra tax we have paid has reduced what we could spend for
our children's education and well being.
I also learned from my tax accountant, that when the Alternative
Minimum Tax is calculated, we do not get the full benefit of the
deductions or credits for our children. It seems to me that this tax is
affecting people who cannot afford it. It seems to me that ordinary
people should not be subject to a tax they have never heard of, that is
too complicated to calculate, that is impossible to plan for and that
drains their ability to care for their family.
It is an honor to have appeared before you today and I hope in some
small way I have helped you progress and fix the negative consequences
of the Alternative Minimum Tax on middle class families like mine.
<F-dash>
Chairman HOUGHTON. Thank you very much, Mr. Sweeney. Ms.
Doherty, please.
STATEMENT OF NINA DOHERTY, SALES ENGINEER, RIVERMINE SOFTWARE,
FAIRFAX, VIRGINIA
Ms. DOHERTY. Mr. Chairman, Members of the Committee, my
name is Nina Doherty, and I would first like to thank you for
the opportunity to speak with you today. I am married, a
working mother of three, living in a modest northern Virginia
suburb with my husband of 17 years. Today I work full time for
a small software company, and I am sharing my story with you in
the hope that it will shed light on how AMT treatment of
incentive stock options can have a devastating impact on
average, hardworking people like me. In 1994, I became the
first employee of a small startup telecommunications company.
Part of my compensation included incentive stock options. Seven
years later I found out to my huge shock that there could be an
egregious impact from exercising stock options due to
unintended consequences of the AMT.
Back in March of 2002, before I learned of the AMT, I
exercised some stock options, and it appeared that all my hard
work and sacrifice and working for this startup would pay off.
My company was going public, as many did at the time, and it
was everyone's perception that the stock value would remain
stable or maybe even grow. Unfortunately, shortly thereafter
the stock market tumbled, and my paper stock value was reduced
to nothing. Despite the dwindling stock value, I never thought
to sell my stocks even after my restrictions lapsed in
September 2000. I continued to hold on to my stock because I
was told by my financial adviser, before I ever exercised any
options, that due to the way the law was written with regard to
capital gains tax penalties, it was more beneficial for me to
hold on to it for at least a year. In April of 2000, while on a
Girl Scout trip with one of my daughters, I got a call from my
accountant about the taxes he had just prepared. He told me
that because of the AMT, I owed a lot of money, but he didn't
want to tell me how much until I got back to town. Alarmed, I
asked him to tell me right there and then, and that is how I
found out that I owed tax equal to 100 percent of our annual
family income. I was dumfounded, and, quite frankly, so was my
accountant. Now my family is facing potential financial ruin as
a result of this massive penalty.
Unfortunately, the highly complex nature of the AMT
befuddled both my highly trained financial adviser and my
accountant, a situation affecting family after family across
the country. It wasn't just the complicated Tax Code that led
me to hold on to the stock. The spirit and the intent behind
the ``incentive'' in the incentive stock option is that
employees like me are encouraged by law to hold on to our stock
for a longer period of time to help our companies grow by
investing in the future. Certainly it was never the intent to
hurt the very people that contributed to a company's success.
Despite this, countless families are facing financial ruin due
to the AMT International Organization for Standardization (ISO)
issue, and mine is not a unique story. The big problem with
paying the AMT is that the tax prepayment is simply a
prepayment of tax--or, the tax payment is simply a prepayment
of tax. When this all was in the sixties, the volatility of the
stock market was not anticipated by Congress, and there was no
evidence at the time that prepaying this would create hardship.
Unfortunately, many families like mine cannot afford to prepay
this tax.
There was no actual gain for victims like me, this tax will
generate a useless tax credit, meaning that our prepayment of
this tax is nothing more than an interest-free loan to the
government. By today's law we can only recover the tax
prepayment and credits at about 3,000 per year, which for our
family means 30 plus years. For many people the credit will
exceed their life expectancy. Recently the IRS levied our bank
account, seizing $30,000 my husband had in savings from a loan
against his 401(k). The money was needed to do repairs on our
10-year-old house and replace our failing minivan. Next we
received official notice that there was a Federal lien filed by
the IRS on any and all property that we owned. With this and
the past 3 years of worry about this problem, there has been a
terrible strain on my family and my marriage. Every day this
issue is like a dark cloud over our heads, and we wonder if we
should just declare bankruptcy.
My family and I respectfully urge those of you on the
Committee to take immediate action on correcting this injustice
through a repeal of the AMT ISO provision, or through targeted
and principled measures that will help those of us currently
facing this problem, and also prevent similar results from
occurring in the future. For families like mine, time has run
out. The IRS is enforcing the strict letter of the law,
threatening to take our homes and retirement funds to collect
money despite the fact that we never had any actual gain.
Please don't allow this injustice to continue. Taxpayers
deserve fair treatment in connection with simpler rules, and we
appreciate your current consideration of a solution that is
fair and just. Again, thank you for your time.
[The prepared statement of Ms. Doherty follows:]
Statement of Nina Doherty, Sales Engineer, Rivermine Software,
Fairfax, Virginia
Mr. Chairman and Members of the Committee: My name is Nina Doherty
and I would like to first thank you for the opportunity to speak with
you today.
I am a married working mother of three living in a modest Northern
Virginia suburb with my husband of 17 years. Today, I work full time
for a small software company. I am sharing my story with you in the
hope that it will shed light on how the Alternative Minimum Tax
treatment of Incentive Stock Options can have a devastating impact on
average hard working people like me.
In 1994, I became the first employee of a small start up
Telecommunications Company. Part of my compensation included Incentive
Stock Options. Seven years later, I found out to my huge shock that
there could be an egregious impact from exercising Stock Options due to
unintended consequences of the Alternative Minimum Tax.
Back in March 2000, before I learned about the Alternative Minimum
Tax, I exercised some stock options and it appeared that all my hard
work and sacrifice in working for a start-up would pay off. My company
was going public as many did at that time, and it was everyone's
expectation that the stock value would remain stable and perhaps even
grow. Unfortunately, shortly thereafter, the stock market tumbled and
my ``paper'' stock value was reduced to nothing. Despite the dwindling
stock value, I never thought to sell them even after my restrictions
lapsed in September 2000. I continued to hold onto my stock because I
was told by my financial advisor before I ever exercised any options
that due to the way the law was written with regard to capital gains
tax penalties, it was more beneficial for me to hold it for more than
one year.
In April of 2001, while on a Girl Scout trip with one of my
daughters, I got a call from my accountant about the taxes he had just
prepared. He told me that because of the Alternative Minimum Tax, I
owed a lot of money, but he didn't want to tell me how much until I got
back into town. Alarmed, I asked him to tell me right there and then--
and that is how I found out that I owed tax equal to 100% of our annual
family income! I was dumbfounded, and quite frankly, so was my
accountant. Now my family is facing potential financial ruin as a
result of this massive penalty.
Unfortunately, the highly complex nature of the Alternative Minimum
Tax code befuddled both my highly trained financial advisor and my
accountant, a situation affecting family after family across this
country.
And it wasn't just complicated code that led me to hold onto the
stock. The spirit and intent behind the incentive in an Incentive Stock
Option is that employees like me are encouraged by law to hold onto our
stocks for a longer period of time, to help our companies grow by
investing in the future. Certainly, the intent was NEVER to hurt the
very people that contributed to a company's success. Despite this,
countless families are facing financial ruin due to the ISO AMT issue--
mine is not a unique story.
The big problem with paying the AMT is that the tax payment is
simply a prepayment of tax. When this law was written in the sixties,
the volatility of the stock market was not anticipated by Congress and
there was no evidence at that time that prepaying this tax would create
hardship. Unfortunately, many families like mine cannot afford to
prepay this tax. Because there was no actual gain for victims like me,
this tax will generate a useless tax ``credit'', meaning that our
prepayment of this tax is nothing more than an interest-free loan to
the government. By today's law, we can only recover the tax prepayment
in credits at $3,000 per year, which for our family means 30+ years--
for many people the credit will well exceed their life expectancy.
Recently, the IRS levied our bank accounts, seizing $30,000 that my
husband had in savings from a loan against his 401(k). This money was
needed to do repairs on our ten year old home and replace our failing
minivan. Next we received official notice that there was a Federal lien
filed by the IRS on any and all property that we own. With this and the
past three years of worry about this problem, there has been terrible
strain on my family and my marriage. Every day this issue is like a
dark cloud over our heads and we wonder if we should just declare
bankruptcy.
My family and I respectfully urge those of you on the Committee to
take immediate action on correcting this injustice, through a repeal of
the AMT/ISO provision, or through targeted and principled measures that
will help those of us currently facing this problem, and also prevent
similar results from occurring in the future. For many families like
mine, time has run out: the IRS is enforcing the strict letter of the
law--threatening to take our homes and retirement funds to collect the
money despite the fact that we never had any actual gain.
Please don't allow this injustice to continue. Taxpayers deserve
fair treatment in connection with simpler rules, and we appreciate your
current consideration of a solution that is fair and just.
Again, thank you for your time.
<F-dash>
Chairman HOUGHTON. Thank you very much. Those are two
extraordinary stories. Ms. Maresca.
STATEMENT OF ELIZABETH MARESCA, ASSOCIATE CLINICAL PROFESSOR,
FORDHAM UNIVERSITY SCHOOL OF LAW, AND SUPERVISING ATTORNEY, TAX
LITIGATION CLINIC, NEW YORK, NEW YORK
Ms. MARESCA. Good afternoon, Mr. Chairman and Members of
the Subcommittee. My name is Elizabeth Maresca, and I am an
associate professor at Fordham Law School and the supervising
attorney of its Low-Income Taxpayer Clinic. It is my pleasure
to talk to you today about the tax simplification legislation
regarding a uniform definition of ``qualifying child.'' This
change will benefit both taxpayers and the IRS, and it will
make our tax system much more fair and efficient. Fordham Law
School's Low-Income Taxpayer Clinic has been in operation for
about 4 years, and over that time we have represented hundreds
of low-income taxpayers. One of the most frequently recurring
problems in our representation of these taxpayers stems from
the multiple definition of ``qualifying child.'' Simplicity in
this area will go a long way in reducing the burdens on many
taxpayers who are working hard to support their families and
naturally claim their children on their tax returns, as
Congress has long intended that they should. The current law
uses some financial measurements which impose unrealistic
recordkeeping obligations on taxpayers, and these requirements
are specifically daunting for low-income workers who often do
not have bank accounts and are likely to pay for their food and
clothing and shelter with cash and money orders. Under current
law they are required to record all their outlays for these
items and be able to document the support of their children in
their household.
Removal of the financial analysis which is currently under
the law is especially important because it removes the
recordkeeping requirement, but also because of the unique
complications under which low-income people live. They usually
have a financial safety net, and they may rely on such things
like New York City has a free breakfast and school lunch
program for their children. They may shop at a food pantry in
their neighborhood. They may receive groceries or clothing from
a local charitable organization. Many have free health
insurance for their children from New York State. At other
times, of course, the family receives subsidized housing either
from the State or the Federal Government, food stamps, or
Temporary Assistance for Needy Families (TANF). When you
combine all those sources of income into the household, it is
very difficult, if not impossible, to determine how it affects
their eligibility for claiming their children at issue.
However, under the proposed definition for qualifying
child, all of my clients will be able to know if they qualify.
They need to know the age, the relationship, and the residency
of the children under their care. It is easy to determine, and
it is also easy to document. A further problem that occurs in
my work is that the IRS' staff also has difficulty interpreting
the current legislation. When the IRS pulls a return for audit
for a low-income taxpayer who has claimed the earned income
credit, they freeze the refund for that return and all
subsequent tax refunds. Often the audit of the tax year takes 2
to 3 years to complete, which means that the taxpayer is
waiting up to 3 years for 3 tax refunds which he desperately
needs to support his family.
If you use the uniform definition of qualifying child, it
will make it much easier for the IRS to interpret and make the
audit process to go much more quickly, the refunds will be
released sooner to the taxpayers, and a significant burden will
be reduced. One final area that perplexes my clients is their
reliance on the paid tax preparer. In my experience, many of
these tax preparers cause more problems than they solve because
they, too, have difficulty interpreting the legislation as it
applies to the client. Simplifying the law will enable the
taxpayers and their tax preparers to correctly report on the
original return. A correct original return reduces audit
burdens on the IRS. Simplifying the law will reduce the audit
burdens and get the refunds to the taxpayers faster. Increase
compliance, reduce administrative burdens, and decrease of the
length of the IRS audit is very important results of the
proposed legislation. I would like to thank you for the
opportunity to speak to you today, and specifically for
presenting my views based on my clients' experiences.
[The prepared statement of Ms. Maresca follows:]
Statement of Elizabeth Maresca, Associate Clinical Professor, Fordham
University School of Law, and Supervising Attorney, Tax Litigation
Clinic, New York, New York
Mr. Chairman and members of the Committee, my name is Elizabeth
Maresca. I am Associate Professor of Law at Fordham University School
of Law and the Supervising Attorney of its Low-Income Taxpayer Clinic.
It is my privilege to testify before you and urge you to adopt this
much needed tax simplification proposal which will replace the current
multiple definitions of a qualifying child with a single, sensible
Uniform Definition of a Qualifying Child. This change will benefit both
low income taxpayers and the IRS, as it makes our tax system more fair
and efficient.
Fordham Law School and its Clinical Program are located at Columbus
Circle in the heart of Manhattan. The Low Income Taxpayer Clinic has
been in operation for fours years and we have served hundreds of low
income taxpayers. Most of our clients are the working poor who have
been denied their earned income tax credits by the IRS. The typical
client seeks our representation after he or she has made repeated
attempts to correspond with the IRS regarding the disallowance of their
EITC, dependency exemptions and head-of-household filing status. All
too often, the IRS is unable to respond to these requests in a timely
manner or responds with a form letter requesting more documentation
which the taxpayer does not have and has no ability to obtain.
One of the most frequently recurring problems in our representation
of low income taxpayers stems from the multiple definitions of
qualifying child in the tax code. Simplicity in this area will go a
long way in reducing the burdens on the many low income taxpayers who
are working hard to support their families and naturally claim their
qualifying children on their tax returns, as Congress has long intended
they should.
In my work, we represent taxpayers who are in controversies with
the IRS over the correctness of their tax returns. The proposed
legislation will reduce the number and the complexity of IRS audits and
reducing a significant burden on the millions of taxpayers who claim
the tax benefits connected to their children.
A. THE COMPLEXITY OF THE CURRENT LAW MAKES IT DIFFICULT FOR TAXPAYERS
INTERPRET THE LAW AS IT PERTAINS TO THEIR CHILDREN
Current law uses financial measurements which impose unrealistic
record keeping obligations upon taxpayers, requiring extensive record
keeping on everyday household budget matters. These requirements are
specifically daunting for low-income workers, who often do not have
bank accounts and are likely to pay for food, clothing and even shelter
with cash or money order. Under the current law, they are required to
record each modest outlay for food, clothing, heat, electricity, phone
service, rent and other expenses. Many Americans rely on cancelled
checks or electronic banking records;however, for many of my clients it
can be quite a challenge to document that they have paid their rent,
although they may have lived in the same apartment for some years
without any problem. In addition to living without access to banking
services and relying upon check cashing stores, it is very common for
low-income workers in NYC to live in shared apartments for which they
are not on the lease or have an oral arrangement with a landlord. Often
they have moved once or twice since the tax year at issue and have no
way to contact the landlord for proof that they paid their rent during
the tax year under audit.
Removal of the financial analysis currently required under the law
is an especially important change for the low-income taxpayer. This is
true because not only because it removes a burdensome record keeping
requirement, but also because of the unique complications that often
characterize their financial situations. Many low-income workers are
compelled to rely upon some type of financial safety net to supplement
their low wages. They may rely upon something as simple as New York
City's free breakfast and lunch program for school children. Many shop
at food pantries or receive groceries or clothing from religious or
community based organizations. The family may participate in programs
such as New York State's free health insurance for children. Of course
at times the family receiveseasily identified government assistance
such as subsidized housing, food stamps or TANF. Many cases present the
more difficult situation in which another member of the household, who
is not part of the nuclear family we represent, may receive Social
Security Insurance or Disability Insurance benefits. In these
situations, it is difficult if not impossible to determine how these
funds are used and thus how they affect the client's eligibility for
the claiming the children at issue.
All too often, my clients cannot determine what their household
expenses were during the tax year at issue, what other assistance they
received and how it all plays into the total amount of support for the
child or household. Most are not aware that these other sources of
financial support affect their rights to claim their children under the
tax laws.
The proposed definition of qualifying child, and the requirements
for documentation, is very welcome and user friendly to the low-income
worker. All of my clients know the age, relationship and residency of
the children under their care. The proposed legislation allows the low-
income taxpayer to easily determine, and obtain the documents to prove,
that their children and other children under their case are their
``qualifying child'' under the tax laws.
The proposed legislation simplifies the record keeping requirements
under the tax code. The taxpayer needs only a few pages to establish
the three-part test under the proposed legislation--a birth
certificate, or other legal document to prove relationship and age; and
a letter from a school, landlord, health care provider or clergy to
establish residency. In New York, these are the simplest documents to
obtain and often the taxpayer can gather them within a few days at
little or no cost. Further, they are more than sufficient to permit the
IRS to enforce the law and ensure that taxpayers meet their legal
obligations.
B. THE COMPLEXITIES OF THE CURRENT LEGISLATION CAUSE SIGNIFICANT DELAYS
IN RETURN PROCESSING CAUSING DELAYS IN ISSUING THE TAX REFUNDS DUE TO
THE LOW-INCOME WORKERS AND THEIR FAMILIES
It has been my experience that the IRS, their auditors, Appeals
Officers, paralegals and attorneys also have difficulty applying the
current legislation to the low-income family. The IRS' inability to
easily apply the law has an extremely negative affect on the low-income
worker as it delays the completion of the IRS audit. While one tax year
is under audit, the IRS freezes all subsequent tax refunds. The
taxpayer often has to wait 2 to 3 years for their much needed tax
refunds for the year under audit and the subsequent tax years. These
delays cause a significant financial hardship on low-income workers and
their families.
The audit process will be sped up by the proposed legislation
because the documents needed to establish the taxpayer's eligibility
under the laws will also be reduced. Currently, there is a myriad of
documents requested and required to establish the taxpayer's
eligibility to claim their children. As stated earlier, these documents
often do not exist or cannot be obtained. If they do exist it will
often take the taxpayer significant effort and time to gather them. The
documents which will be required under the proposed legislation are
easily obtained and are much less voluminous. Consequently, the burden
to the taxpayer will be significantly reduced.
Unifying the definition of qualifying child will reduce record
keeping requirements and simplify the return preparation process. More
importantly, the proposed legislation reduces the burden on the
taxpayer and the IRS after the return is filed. The proposed
legislation will decrease the time it takes the IRS to complete the
audits, which will in turn allow the Service to release the taxpayer's
much needed refunds in a timelier manner.
C. COMPLEXITIES OF THE CURRENT LEGISLATION CAUSE MANY LOW-INCOME
WORKERS TO PAY FOR PRROFESSIONAL SERVICES TO PREPARE THEIR TAX RETURNS
The current complexities in this area impose another unneeded
burden on my clients by compelling many of them to hire a tax-return
preparer, despite the fact that all their reportable income is often
contained on a single Form 1099 or Form W-2. Although their return is
only 3 pages and 10 to 12 lines on a Form 1040, too many of my clients
that have paid over a week's salary to a tax preparer for a return that
should take only about 30 minutes to prepare. Further, in my
experience, these tax preparers are all too often ``fly-by-night''
operators who cause many more problems than they solve and introduce
errors that plague both the taxpayer and increase the audit burden on
the IRS. Simplifying the law will enable both the taxpayer and these
professionals to correctly report on the original return. Correct
reporting reduces the incidents of audits and math-error notices,
reduces the burden on the taxpayer and allows the refundable credits to
be paid to family much more quickly.
D. CONCLUSION
The proposed legislation for a uniform definition of qualifying
child enjoys wide-support. For the millions of families claiming the
benefits of the earned income credit, dependency exemption, child tax
credit and head-of-household filing status, the proposed legislation
will increase compliance, reduce administrative burdens, decrease the
length of the IRS's audit of these issues and enable the IRS to release
tax refunds in a more-timely manner to a community who desperately rely
on these funds for their families survival.
I wish to thank the Subcommittee for the opportunity to present my
views on the simplification of the tax code and specifically on the
proposed legislation for a uniform definition of qualifying child.
<F-dash>
Chairman HOUGHTON. Thank you very much, Ms. Maresca. Ms.
Parshall.
STATEMENT OF JEANNETTE PARSHALL, DIRECTOR, PREMIUM TAX
SERVICES, H&R BLOCK, WHEATON, MARYLAND
Ms. PARSHALL. Mr. Chairman, Representative Pomeroy, Members
of the Subcommittee, thank you for the invitation to appear
today. Mr. Chairman, I want to commend you, Mr. Portman, and
your colleagues for making tax simplification a priority. I
know that among your proposals are some suggested by H&R Block.
I hope that all of H&R Block's 2004 simplification suggestions
can be included in your record.
I have been an income tax professional, working as one, for
28 years. My practice today centers in Wheaton, Maryland, where
I prepare over 100 tax returns each year, and directing H&R
Block's premium tax office that prepares 2,000 returns. Most of
my own clients are suburban professionals with complex returns.
Much has changed since I started. For the first 14 years, I
prepared returns by hand using a manual calculator. Today I
wouldn't dream of completing a tax return without continual
training and computer technology that does comparative
calculations to ensure that clients pay the lowest legal tax.
Consider some of the complexity taxpayers face today. We
have over 600 forms, schedules, and instructions; 5 different
definitions for child; multiple rates and dates for capital
gains; a plethora of pension plans, each with different rules
and consequences; ever-changing criteria for the earned income
tax credit; and, of course, there are multiple education
deductions and credits. We have a nonrefundable child credit
and a fully or partially refundable child credit. The
worksheets to sort out the order are mind-boggling. We have
sunrises and sunsets; phase-ins and phase-outs.
Tax software and professional preparation enable taxpayers
to manage some of this complexity. Today 85 percent of tax
returns are prepared with a computer, compared to 16 percent in
1990; and 56 percent of taxpayers used a tax professional,
compared to 48 percent in 1990. Of course, complexity is not
the only reason to seek professional tax help. Convenience,
speed, anxiety reductions, life changes such as marriages,
births and moves, and, increasingly, annual financial advice
all play a part. Complexity is a major factor.
Of course, not every taxpayer faces serious complexity.
Two-thirds of taxpayers do not itemize their deductions; 40
percent of taxpayers are able to use short forms. Millions of
self-preparers use software like Tax Cut to make life simpler,
and wage-earners generally have a lighter burden than self-
employed taxpayers. There are understandable reasons for some
complexity as tax laws are tailored for fairness, to fit
available funds, or to favor certain activities like education,
homeownership, or retirement savings. Some complexity can also
bring tax relief. Most of my clients pay less Federal income
tax as a result of recent complex legislation. If complexity
has benefits, it also exacts a price. Some taxpayers overpay as
a result of complexity and confusion. When Congress enacts so
many changes so frequently, it is hard for taxpayers, tax
professionals, or the IRS to fully absorb or appreciate them.
In the 18 years since the Tax Reform Act 1986 (P.L. 99-514),
Congress has made 7,662 changes to the Internal Revenue Code
(IRC), averaging more than 425 a year. Most taxpayers can't
keep up.
Mr. Chairman, we live in a more complex world than the one
in which I started preparing tax returns in 1977. The Tax Code
reflects that. The issue of simplification is not new. Henry
Bloch, who started our tax preparation firm almost 50 years
ago, testified repeatedly in favor of simplifying the Tax Code
through the seventies and early eighties. So, the
simplification effort is ongoing. We can still do more, and we
should. On behalf of H&R Block, I appreciate the opportunity to
support your efforts.
[The prepared statement of Ms. Parshall follows:]
Statement of Jeannette Parshall, Director, Premium Tax Services,
H&R Block, Wheaton, Maryland
Mr. Chairman, Representative Pomeroy, Members of the Subcommittee:
Thank you for the invitation to appear today.
Mr. Chairman, I want to commend you, Mr. Portman, and your
colleagues for making tax simplification a priority. I know that among
your proposals are some suggested by H&R Block. I hope that all of H&R
Block's 2004 simplification suggestions can be included in your record.
I have been a professional tax return preparer for 28 years. My
practice today centers in Wheaton, Maryland, where I prepare over 100
tax returns each year and direct an H&R Block office that prepares
2,000 returns. Most of my own clients are suburban professionals with
complex returns.
Much has changed since 1977, when I started.
For the first 14 years, I prepared returns by hand, using a manual
calculator. Today I wouldn't dream of completing a return without the
help of continual training and computer technology that does
comparative calculations to ensure that clients pay the lowest legal
tax.
Consider some of the complexity taxpayers face today:
<bullet> Over 600 forms, schedules, and instructions.
<bullet> Five different definitions for a child.
<bullet> Multiple rates and dates for capital gains.
<bullet> A plethora of pension plans, each with different rules
and consequences.
<bullet> Ever changing criteria for the Earned Income Tax
Credit.Multiple education deductions and credits.
<bullet> A nonrefundable child credit and a fully or partially
refundable additional child credit. Plus worksheets to sort out the
order when a taxpayer has refundable and nonrefundable credits.
<bullet> Sunrises and sunsets; phase-ins and phase-outs.
<bullet> And, worst of all, the AMT, which is impossible for even
the most-well-educated taxpayer to understand.
Tax software and professional preparation enable taxpayers to
manage some of this complexity. Today, 85 percent of returns are
prepared with a computer compared to 16 percent in 1990; and 56 percent
of taxpayers use a tax professional compared to 48 percent in 1990.
Complexity is not the only reason to seek professional tax help.
Convenience, speed, anxiety reduction, life changes (marriages, births,
moves), and, increasingly, annual financial advice all play a part. But
complexity is a major factor.
Of course, not every taxpayer faces serious complexity: two-thirds
of taxpayers do not itemize their deductions; 40 percent of taxpayers
are able to use short forms; millions of self-preparers use software
like TaxCut<SUP>'</SUP> to make life simpler; and wage earners
generally have a lighter burden than self-employed taxpayers.
There may be understandable reasons for some complexity as tax laws
are tailored for fairness, to fit available funds, or to favor certain
activities like education, homeownership, or retirement savings. And
some complexity can also bring tax relief. Most of my clients pay less
Federal income tax as a result of recent, complex legislation.
But if complexity has benefits, it also exacts a price.
Some taxpayers overpay as a result of complexity and confusion.\1\
And when Congress enacts so many changes so frequently, it is hard for
taxpayers, tax professionals, or the IRS to fully absorb or appreciate
them. In the 18 years since the 1986 tax reform act, Congress has made
7,662 changes to the Internal Revenue Code, averaging more than 425 a
year. Most taxpayers can't keep up.
---------------------------------------------------------------------------
\1\ A March 2002 General Accounting Office report showed missed
deductions and credits alone may have caused over 2 million Americans
to overpay their Federal taxes by an average of over $400 each. A
January 2002 GAO report found that small businesses overpaid their
taxes by $18 billion over the prior two years because of tax return
errors. An October 2002 Treasury report found 600,000 low-income
taxpayers didn't claim the refundable portion of the child credit,
costing them an average of $390 each. A March 2004 Treasury report
found tens of thousands of farmers overpaid taxes by an average of over
$500 because they did not take advantage of income averaging. See also,
Eric Toder, et al., ``Estimating the Compliance Cost of the U.S.
Individual Income Tax,'' 61 National Tax Journal 673 (September 2003).
---------------------------------------------------------------------------
Mr. Chairman, we live in a more complex world than the one in which
I started preparing returns in 1977. The tax code reflects that. But
the issue of simplification is not new. Henry Bloch, who started our
tax preparation firm almost 50 years ago, testified repeatedly in favor
of simplifying the tax code through the 1970s and early 1980s. So the
simplification effort is ongoing. We can still do more, and we should.
On behalf of H&R Block, I appreciate the opportunity to support
your efforts.
<F-dash>
Chairman HOUGHTON. Thank you, Ms. Parshall. That was
wonderful testimony. It was wonderful testimony for everyone
here. I am going to turn to Mr. Pomeroy now to start the
questioning.
Mr. POMEROY. It was wonderfully succinct testimony, Mr.
Chairman, and I think brought us a very good idea about the
havoc this complexity is wreaking in ordinary people's lives
that try to do the right thing, but find a Tax Code that is
absolutely bewildering, unjust, and otherwise increasingly
regressive as it takes away some of the deductions we put in
place for working families. Mr. Sweeney, when did you fall onto
the AMT alternative as a tax obligation?
Mr. SWEENEY. I believe about 2-and-a-half years ago. I have
been promoted up through the ranks, and my salary has gradually
increased, I felt the implications of the AMT.
Mr. POMEROY. Is this a problem with some of your officers?
Mr. SWEENEY. Yes. My colleagues at my rank, they suffer the
same consequences also. That is correct.
Mr. POMEROY. You all would be paying the same high local
taxes, and some of the things that would result----
Mr. SWEENEY. Right. A lot of our common deductions are not
allowed or not accepted under the AMT, so it affects all of us
pretty much along the same lines.
Mr. POMEROY. Well, you are on the vanguard. There will be
35 million of us joining you soon if we don't make some
changes. So, you are bringing us, I think, the early glimpse of
what Congress will expect from constituents, broad swaths of
middle-class family constituents, saying, what is this about?
Mr. SWEENEY. I don't know the exact numbers, but I would
tend to believe that every year the numbers would increase up
the lines until basically the whole middle class would be
involved under the AMT umbrella.
Mr. POMEROY. Ms. Doherty, your situation is very
disturbing. There have been legislative proposals surfaced to
address that issue specifically. Are you aware of anything
percolating along now that might be responsive?
Ms. DOHERTY. Well, one of the things I have found is that
the IRS has not been able or has not been very responsive in
terms of the O and C (offer and compromise) process or
effective tax administration. What I am finding is that my
friends that have gotten all the way through process that are
in a similar situation, they get a nice note saying, thank you
for your application, but we want all the money. So, basically
the IRS is not using these tools. I have heard that there is--
--
Mr. POMEROY. What is the O and C that you are referring to?
Ms. DOHERTY. Offer and compromise. They make their offer,
and unfortunately it is being rejected, and the IRS is still
trying to collect the entire amount even though there was
actually no gain. I understand that there is a bill in the
Senate that would help the IRS, give them a little bit more
latitude and be able to utilize the tool of the O and C in
effective tax administration, so, especially in particular as
it applies to the AMT ISO issue. I would be very grateful to
see support of that bill.
Mr. POMEROY. In the meantime, I hope you will be able to
continue to work with the IRS to resolve it. You are still a
two-income family?
Ms. DOHERTY. Right. We are a two-income family, but it is
very--it is discouraging when we are trying to kind of catch
up, and the IRS is just clamping down, and we feel kind of like
we have no option but to pay the money that we don't have.
Mr. POMEROY. Well, you can't get blood from a turnip. Is
that an old saying?
Ms. DOHERTY. That is right. My husband hails from Ireland,
so he would definitely agree with you on that statement.
Mr. POMEROY. Well, thank you for being so candid with the
personal dimensions of what this stock option has done to you.
Ms. DOHERTY. Well, I think it is important.
Mr. POMEROY. We need to know. All too often we can deal
with broad policy, and the kind of family based horror story
you have brought to our attention is important.
Ms. DOHERTY. This is not a unique story. There are
thousands of families like mine, some in much worse situations.
So, I feel that I represent those people.
Mr. POMEROY. Thank you. In light of my time elapsing, Ms.
Parshall, thank you very much for your testimony. One can just
tell listening to you, you have prepared a lot of returns,
dotted I's, crossed the T's, and taken excellent care of your
clients' tax needs. One of the things that I have had a chance
to visit with your firm about over the years is the growing
dimension of the vending-related services, like the loan in
advance of refund and these kinds of things. Are you finding as
a preparer that you are under a lot of pressure to sell extra
stuff?
Ms. PARSHALL. Not from the company. I don't personally have
that issue. I deal mostly with high-income professionals. The
company is not pushing the refund anticipation loan. That is
something like fifth on the list of options that we are told to
present. What I find is clients come in, they want it. I say, I
think it is a lousy idea, because I do, and I am very honest
with them about it. If you can manage without the money, don't
do this. The sad fact of life is there are people who do need
the money tomorrow. I find that hard to understand, you may
find that hard to understand, but it exists.
Mr. POMEROY. No. I find it pretty easy to understand. I
like the market having choices, but I am very anxious about
abuse of sales, and in the trust relationship between a
preparer and the clients, I am anxious about what might be
abuse there.
Ms. PARSHALL. We have full disclosure of all aspects of the
refund anticipation loan, and, as I say, we do not push it.
Again, we have to provide the service that the client wants. I
can't make his decisions for him.
Mr. POMEROY. Thank you very much. I yield back, Mr.
Chairman.
Chairman HOUGHTON. Thank you very much. Now, Mr. Johnson.
Oh, Mr. Portman.
Mr. PORTMAN. Oh, no. Go ahead.
Chairman HOUGHTON. Mr. Johnson.
Mr. JOHNSON. Thank you, Mr. Chairman. I appreciate that.
Ms. Doherty, because AMT taxes are actually prepaid taxes,
shouldn't you eventually get that money back when you use your
AMT credits?
Ms. DOHERTY. Well, if I live long enough, yes, I will get
it back. The AMT ISO provision operates as a prepayment of tax
based on presumed tax, based on the regular Tax Code. The
problem is this prepayment, in order for it to equal what would
be due under the regular Tax Code, and for that to work, my
stock would have had to have risen and risen and gotten greater
to equal what I would have to prepay. Now, in the real world
that we live in, unfortunately stocks are stable or they drop,
or in my case my company went bankrupt and the stock actually
became worthless. So, certainly there is no way that the
effective tax rate that I am paying would be equal to what gets
paid under AMT rules. So, now we have a gap between the AMT
payment versus regular Tax Code, and that becomes the AMT
credit. Unfortunately, that AMT credit cannot be realized right
away, so mine will take 30 plus years. I suppose there are some
people that might get it back quickly, but I know a number of
people whose credit will not be returned in their lifetime. I
am not exaggerating. It won't even be back in their children's
lifetime in theory. So, I really appreciate you asking that
question, because it is really important that we find a way to
get this prepayment of tax back to the hardworking individuals
that are having to pay it.
Mr. JOHNSON. There are companies in the same boat that, we
are just giving the government a loan, only it is permanent for
the most part.
Ms. DOHERTY. Exactly.
Mr. JOHNSON. She spoke of, Mr. Chairman, a bill over in the
Senate, happens to be John Kerry's, but I have got a companion
bill here that would allow individuals who are stuck in AMT to
recoup about 50 percent of their credits each year depending on
what they pay in taxes, 50 percent of their tax bill. I think I
would like to see that move forward. Ms. Parshall, you talked
about the complexity of taxes. Frankly, we just--what did we
add, 150 pages last night? I don't think there is any--any tax
consultant that knows the Tax Code totally. That is why you
have got specialties out there. Would you like to speak to
that? How in the world can we live when we keep complicating
our lives?
Ms. PARSHALL. Well, there are a bunch of things. Overall
total simplification is down the road, but there are smaller
bites that can be accomplished. Ms. Maresco talked about the
single definition for child.
Mr. JOHNSON. In my opinion, you try to take small bites out
of this Tax Code, and you just complicate it further. So, I
think probably the Chairman agrees with me, you almost have to
take the whole thing out and throw it out and start over. That
is a hard thing to do, because you have got so many forces
pushing against you from all angles. You guys out there in the
consultant world can make it happen if you will just get after
it.
Ms. PARSHALL. Well----
Mr. JOHNSON. That is why you are here today.
Ms. PARSHALL. Yes, sir.
Mr. JOHNSON. Would you like to make another comment?
Ms. PARSHALL. Well, there are a few things that can be done
without small bites as it were, the unified definition of a
child, a couple of things on the educationline. For example, on
education credits and deductions, we have one income level at
which one phases out, a different income level at which the
other phases out. Couldn't that be even just a little uniform
there? Capital gains, I don't know how many rates we have now.
We used to have a deduction. A deduction was a lot simpler. Now
we have all these rates. So, there are some little things that
can be done in the interest of simplification without throwing
out the baby with the bath water.
Mr. JOHNSON. We would like to do that. I wish you would
talk to the U.S. Senate about it.
Ms. PARSHALL. They haven't invited me, sir.
Mr. JOHNSON. Thank you, Mr. Chairman. I appreciate the
time.
Chairman HOUGHTON. Mr. Johnson, I think you bring up a good
point. Obviously the Tax Code is outdated, it is cumbersome.
This is why we are having this hearing. We just can't wait for
nirvana; we have got to do something in the meantime. That is
the whole purpose of this hearing.Would you like to say
something, Mr. Portman?
Mr. PORTMAN. Thank you, Mr. Chairman. Thanks to the
witnesses for helping us today to think through some of these
issues. Mr. Sweeney and Ms. Doherty, your comments are
consistent with what we are hearing back home from our
constituents about the way in which the AMT has now affected
more and more of our families. In my own district, people
making $50,000 a year with four kids are beginning to have to
calculate their taxes in both ways. Your story, Ms. Doherty, is
so compelling.
I do have legislation to repeal the AMT altogether,
personal and corporate. I have felt that, since I got elected,
it is impossible to do this, because that is probably about,
conservatively speaking, $600 billion in revenue loss over the
next 10 years. It is more and more of a revenue raiser for our
government, because people like you are now paying it. So, the
question is, how do you go at it in a way that is reasonable to
get it done rather than just rail against it and say we should
repeal it, which I believe, on a philosophical basis, we have
got to figure out how to get at it.
So, again, your testimony is helpful in figuring out ways--
I like the idea of indexing it. We should have done that
initially. I like the idea of dealing with some of the
individual issues like the options issues. I just think it is
unfair, because I think if some of these provisions in the Code
which are tax preferences, deductions, credits, and so on,
aren't appropriate, we should get rid of them. We shouldn't say
we are going to pick some and have winners and losers, and then
end up making people calculate their taxes both ways. It is the
accountants employment of the last 10 years and going forward.
Even accountants I have talked to would much rather be doing
something else than figuring out our taxes under these two
different regimes. For the IRS, think about that, it is a
nightmare for it. You essentially have two taxes. The
enforcement is obviously a huge problem. I appreciate your
compliance with our Tax Code, Ms. Doherty, but I imagine this
has been tough for you going through with offers of compromise
and so on.
On the AMT, Ms. Maresca, I know you didn't get into that as
much as you did some of the other issues, but have you looked
at this from an academic point of view in terms of what are
some smaller steps we could take? As you know, in our tax
relief bills in 2001, 2002, and 2003, we essentially did hold a
harmless provision where people wouldn't be getting into the
AMT because of the tax relief we put in place. I think it was
$8 billion worth of relief over 10 years in 2003 just to do
that, which is nothing, but just to keep it from getting worse.
Have you looked into this in your academic work?
Ms. MARESCA. I haven't spent a lot of time working with the
AMT. I do know a lot of my colleagues pay the AMT. I can say
that my understanding is that there--some things need to be
adjusted for inflation, and that is part of the issue. Again, I
don't know the revenue consequences, so I can't really speak to
it.
Mr. PORTMAN. On uniform definition of a qualified child, I
have got legislation out there introduced last Congress. There
are five different definitions for dependency, exemption, as
you know now, for the child credit, for dependent care, head of
household, and so on. You would provide for one definition; is
that correct?
Ms. MARESCA. That would----
Mr. PORTMAN. Have you looked at the legislation?
Ms. MARESCA. Yes. One definition is that that removes the
financial measurements because that often is the most
impossible to prove. When you are in audit, and your earned
income credit is frozen, the earned income credit, the purpose
of it is to raise families with children out of poverty. It is
not raising them out of poverty if they can't get it. If I have
a client that comes in with a 2001 tax year with $4,000 that is
frozen, I just have them do their 2003 returns--2001 is frozen,
2002 is frozen, 2003 is frozen. So, a gentleman may make
$10,000 a year, he has got $12,000 of frozen refunds. The IRS
just can't work through them any faster, and I think it is
mostly because the clerks at the service center are confused,
by the way, and they don't know what to do with the paperwork
that comes in, so they either do nothing or just issue a
notice, or a notice of deficiency.
Mr. PORTMAN. Of your clients, what percentage would you say
are affected by the definition of child?
Ms. MARESCA. At least 40 percent. Maybe up to 50 percent.
Mr. PORTMAN. Forty or 50 percent?
Ms. MARESCA. Yes.
Mr. PORTMAN. That is the earned income tax credit (EITC),
but it is also on----
Ms. MARESCA. Well, generally they qualify under the EITC.
The new definition of qualifying child removed the financial
requirements. So, they qualify, they have qualifying children.
What they don't have is a dependent exemption or head of
household filing status or perhaps a child tax credit. The way
it works when you are poor is you don't really need those
things because if you make $10,000 or $12,000 a year, the tax
effect is maybe $200. So, often we amend the returns just to
remove those items, forego that possible $200 just to get the
refundable earned income tax credit back to them.
Mr. PORTMAN. Well, Ms. Parshall, this question is for you,
too. I will follow up in writing because my time has expired,
unless we have a second round.
Mr. PORTMAN. Again, I want to thank each of the panelists
for being here and helping us to work through some of these at
least bites at simplification so that we can come up with a
fair Tax Code. Thank you, Mr. Chairman.
Chairman HOUGHTON. Mr. Tanner.
Mr. TANNER. Thank you, Mr. Chairman. I am sorry I am late.
This is one of the few jobs that you have three different
places to be all at 3:00 p.m. or 2:30 p.m., and nobody thinks
anything of it. It is just sort of routine. Anyway, I am sorry,
Mr. Chairman. Thank you.
I would like to ask Ms. Parshall, what--in your experience,
what is the single most important priority that you see that
Congress could do with respect to your clients to simplify
things? I know that is a very broad question, but what I am
talking about is I read an article that a tax columnist wrote I
guess it was last week, and it said that the 1986 tax bill was
sort of a benchmark, and it really did do some things that
simplified the Tax Code. There was some unintended consequences
in the real estate business and elsewhere, but that it did to
some degree simplify the Tax Code, and that every day since
then the Tax Code has become increasingly more complicated.
Would you agree with that, number one? Number two, what would
be your suggestion if you were sitting where Chairman Houghton
is?
Ms. PARSHALL. Well, let us take the easy one first. The
simplification would be to throw out the AMT. I had more
clients with AMT this past tax year than I had had in my first
27 years of preparing tax returns. I have yet to see the AMT
credit work for anyone. So, it is a form I am filling out that
they are getting charged for, which I then throw out because I
don't want to charge them for a form that isn't doing them any
good. So, that would be the simplest thing. That to me is the
major complex--in my particular practice I am not doing many
earned income credit returns. I am dealing with higher-income
professionals with complex returns, and they are the people who
are being hit hardest. People in States like New York, which
has high local taxes, they are getting hit hard. The higher
your local tax, the more chance there is of you going into AMT
territory. The Federal tax rate has gone down, local tax rates
have gone up, and they meet at AMT.
Addressing 1986, I would have to disagree about 1986 being
a simplification. In 1987, when I did tax returns for the 1986
tax year, I was still working by hand with a thick lead pencil
and a pink pearl eraser, and my desk had more crumbs from the
eraser that year than any year before or since. That was the
year when they took away tax shelters, we had phase-ins of 65,
40, I have lost track. Everything got phased in. Yes, it has
gotten worse since then, but I don't think 1986 as being a
particularly simple year for tax.
Mr. TANNER. I was quoting a tax columnist that I was
reading.
Ms. PARSHALL. He was not out in the trenches, quite
possibly.
Mr. TANNER. Okay. Thank you, Mr. Chairman.
Chairman HOUGHTON. Well, clearly we have some issues to
deal with. General George Catlett Marshall used to say two
things: one, don't get into the minutiae; and second, don't
fight the problem. We seem to be fighting the problem. I hope
that we can help you come up with a solution. Thank you very
much for your testimony. Now we will have the second panel.
Mr. POMEROY. Mr. Chairman, as the second panel comes
forward, I would ask your permission to enter a statement from
Rich Neal in the record. I didn't realize he had to go, or I
would have yielded some of my time to him to make this point.
Here is a very good statement about the AMT and the need to do
something, and I will put it in the record, if you don't mind.
Chairman HOUGHTON. Absolutely. Thank you very much. We will
do it.
[The information follows:]
Thank you Mr. Chairman and Mr. Pomeroy for the opportunity to join
you today. As you know, tax simplification is something we find easy to
talk about, yet hard to achieve. For the last three Congresses, I have
authored a bill on tax simplification, which would include a paid-for
repeal of the Alternative Minimum Tax (AMT).
The AMT is shifting from a ``class tax'' to a ``mass tax.''
Congress, Joint Tax, CBO, and even the Bush Treasury Department have
acknowledged that by the end of this decade, the number of taxpayers on
the AMT will explode and eventually ensnare over 30 million American
taxpayers.
If we do nothing, more than three-quarters of taxpayers with
incomes between $75,000 and $100,000 will be caught by the AMT. More
than one-third of those with incomes between $50,000 and $75,000 will
be caught by the AMT.
Contrast this with the fact that by the end of this decade, the AMT
will only affect one-quarter of households with incomes greater than
$1,000,000. Does this sound like tax fairness and equity--imposing
extra taxes on three-quarters of those making $75,000 a year, but only
one-quarter of the millionaires?
I understand the reasons for the original imposition of the AMT,
but it has outgrown its usefulness.
The AMT is unfair for middle class families, not allowing parents
to claim exemptions for their children and imposing significant
marriage penalties. Again, if we do nothing, the AMT will hit 97% of
all families with two children earning between $75,000 and $100,000 by
the end of the decade.
We cannot continue the piece-meal, short-term AMT relief we had
done the last few years. In fact, just last night, the Committee passed
$4 billion in permanent AMT relief for businesses, but only a short-
term extension through next year to protect individuals and their
personal non-refundable tax credits, like the dependent care or elderly
and disabled tax credits.
I am also pleased that you will be hearing today from individuals
impacted by the AMT on incentive stock options. I cannot understand why
Congress has allowed such punitive taxes on these stock options, which
provide long-term, employee ownership in companies, particularly in the
fast-growing technology sector. The AMT has put many of these employees
in a tax trap, owing 10 to 100 times their annual income in taxes to
the IRS on phantom income, which they will never see. I first offered
legislation in 2001 to try to fix this problem, and since then, I have
been joined in this effort by our colleague Sam Johnson. Unfortunately,
we have not yet been successful.
Perhaps, Mr. Chairman and Mr. Pomeroy, hearings such as this will
help highlight the problem, educating our Members, and building support
for fixing the problem. Thank you again for the opportunity to join you
today.
<F-dash>
Chairman HOUGHTON. Now, the second panel is the Honorable
Mortimer Caplin, Commissioner of the Internal Revenue Service
between 1961 and 1964; the Honorable Sheldon Cohen,
Commissioner of the Internal Revenue Service 1965 to 1969; the
Honorable Donald C. Alexander, Commissioner of the Internal
Revenue Service between 1973 and 1977; and the Honorable Fred
Goldberg, Commissioner of Internal Revenue Service 1989 to
1992. So, we are honored to have you gentlemen here. Mr.
Caplin, would you begin your testimony. Thank you.
STATEMENT OF MORTIMER M. CAPLIN, COMMISSIONER, INTERNAL REVENUE
SERVICE, 1961-1964
Mr. CAPLIN. Mr. Chairman, it is a privilege to be with you
today. I want to commend the Chairman for calling this hearing
on a subject vital to all Americans, tax simplification. The
Nation relies on a self-assessment system to raise trillions of
dollars each year in support of the country. This type of
system is dependent upon the willingness of the American
taxpayer to honestly report his income and deductions and
compute his own taxes or her own taxes, and our level of
success is something admired throughout the world. The
willingness to comply depends upon the taxpayer's trust in the
system and their belief it is being administered fairly across
the board, that their neighbor down the street is paying his or
her fair share. American taxpayers don't like to be suckers.
When they hear of an annual $311 billion tax gap, this hardly
provides any reassurance and hardly encourages compliance. We
see today broad evidence of a lack of confidence in the tax
law, a disrespect for the administration of the law, a tendency
to play the audit lottery--without revenue agents out there to
audit returns--and a readiness to engage in extreme tax
avoidance and fraudulent tax evasion plans.
The current Commissioner is trying to counter this. He has
put greater emphasis on enforcement and looking into evasion
schemes of all sorts. Congress is confronted, obviously, with a
monumental task to try to enact comprehensive tax reform. I am
a believer in undertaking a comprehensive effort, although I
respect the attempts to make some corrections here and there.
Some suggest scrapping the system in its entirety, replacing it
with a complete substitute, perhaps some form of consumption
tax sales or value-added tax. Then there are those who ardently
support the very simple flat tax. No deductions, only a single
rate of tax on income from wages, but not from capital, not on
interest or dividends or rents or capital gains.
Now, I don't see such a monumental change in the
foreseeable future, particularly with the uncertain revenue
raising capacity of a brandnew system like that. The financial
and economic risks at stake in a large and complex society such
as ours, and the sweeping transitional problems that would face
individuals and business taxpayers, as well as the tax
administrators who for years and years would be auditing old
returns under one system and having to switch to another.
Meaningful simplification would be extraordinarily difficult
and, we know, would be challenged by competing interests,
individuals, businesses of all sorts. It would require forceful
Presidential leadership and that would be seriously needed. You
need a carefully chosen commission to make a study of this. You
need adequate staffing and a readiness for hearings. I think it
is worth the effort, because regardless of the outcome, and
this has happened before, there would be a body of knowledge
and background that would help us in later studies. This
happened back in 1954, the studies that were done and which
played a big part in the 1954 Tax Code. Wilbur Mills, he held a
series of hearings beginning in 1959, and they were very
fruitful in terms of the later laws. I think that output is
worth the effort to accumulate that knowledge and learning.
I am reminded of 40 years ago when Senator Russell Long,
who later became Chairman of the Senate Finance Committee, took
up the challenge and offered very bold legislation, a
simplified tax method. It was close to a gross income tax, a
broadening of adjusted gross income tax--and there were no
personal deductions--a lower tax rate, capital gains treated
the same as ordinary income. Although it never passed, it did
show that a simple one-page tax return could be prepared. In
honor of Senator Long, I like to call it the ``Long Short
Form.'' It could be done. Well, close to 20 years ago, a very
successful effort was undertaken that was preceded by many
hearings and many studies and finally wound up as the Tax
Reform Act 1986. It was simple and complex at the same time. It
was not an easy piece of paper to work with but it did create a
fairer and more equitable law, thanks to President Reagan who
was behind it and Chairman Dan Rostenkowski of the Ways and
Means Committee and Chairman Bob Packwood of the Senate Finance
Committee. They got together somehow. It was bipartisan. It was
remarkable.
We have seen, unfortunately, over the years that the 1986
act has been whittled away and we are nearly back where we
started from. I do think it stands as a monument to the art of
the possible. It could be done. I say, in the same tradition,
we ought to undertake a project along comparable lines. I have
laid out in my paper seven steps that I regard as guidelines--
and I see I am running over my time--but it is based upon a
broad-based tax return with lower rates across the board,
elimination of the AMT by broadening the tax base, severely
broadening the tax base to make the revenue available. It would
treat all forms of income alike. Equal tax treatment where
people have equivalent incomes. It will go a long way to
restore confidence in the honesty and integrity of our tax
system and I think it would serve our Nation well.
[The prepared statement of Mr. Caplin follows:]
Statement of The Honorable Mortimer M. Caplin, Commissioner,
Internal Revenue Service, 1961-1964
My name is Mortimer Caplin, of the Washington law firm of Caplin &
Drysdale.
I served as U.S. Commissioner of Internal Revenue from 1961 through
1964, during the Kennedy and Johnson Administrations, and have
specialized in tax law for over 50 years--as a professor at the
University of Virginia School of Law and as a lawyer, representing a
wide variety of business and individual taxpayers.
It is a privilege to appear before the Oversight Subcommittee and I
commend the Chairman for focusing on the issue of ``tax
simplification.'' It is an effort owed to all taxpayers of this country
who, year after year, are overwhelmed by complex tax laws, complex
returns, and complex administration as they struggle to meet their
annual tax obligations. At the very least, they are entitled to the
hope and expectation that some relief is at hand.
Our nation's ability to raise trillions of dollars annually to
support the functioning of our government rests primarily on a
voluntary self-assessment tax system--one dependent upon the
willingness of taxpayers to honestly report their incomes and
deductions and accurately compute their taxes. Their willingness to
comply depends in no small part on their trust in the system and their
belief that the law is being administered fairly and across-the-board,
with their neighbors down the street paying their fair share of taxes,
too. Will Rogers once opined that people want ``just taxes'' more than
they want lower taxes, wisely adding: ``They want to know that every
man is paying his proportionate share according to his wealth.''
American taxpayers do not like to feel they are suckers.
However, word of an annual $311 billion tax gap--from
underreporting, underpayment and non-filing--hardly provides
reassurance and hardly encourages compliance. To counter this, IRS
Commissioner Mark W. Everson, while still striving for improved
taxpayer service, is now placing heightened emphasis on the enforcement
aspect of tax administration, particularly focusing on tax shelters,
tax fraud and other tax abuses. He often quotes President John F.
Kennedy's 1961 tax message to Congress, ``Large continued avoidance of
tax on the part of some has a steadily demoralizing effect on the
compliance of others.'' And this is the very condition that we face
today--lack of confidence in our tax laws, disrespect for the
administration of these laws, tendencies to play the ``audit lottery,''
and a ready willingness to engage in extreme tax avoidance and evasion
schemes of all sorts.
While our tax laws and the IRS will never be loved, the respect of
our citizenry must be earned and public confidence in the system
restored. At the very least, the public is entitled to reassurance of
the law's fairness, honesty and openness; and, to this end, the issues
of complexity and the difficulties of compliance come to the forefront.
Complexity and Alternatives
How often it is that we hear the anguished cries of taxpayers and
tax professionals, ``If only the tax law and tax administration could
be simplified!'' This same theme is heard in the 1997 Report of the
National Commission on Restructuring the Internal Revenue Service as
well as in RRA 98 section 4022, ``Tax Law Complexity Analysis.'' The
Report, for example, states:
``The Commission found a clear connection between the
complexity of the Internal Revenue Code and the difficulty of
tax law administration and taxpayer frustration.''
``. . . The Commission found that significant noncompliance--
both inadvertent and intentional--results from various
obstacles within the current system, including the cost of
compliance and the complexity of the tax law. Reducing taxpayer
burden by simplifying the tax laws and administration must
start with the Congress and the President.''
These challenges have not been met even partway. Complexity reports
required by the statute have done little to ease the problem. Frequent
changes and added complexity continue.
Needless to say, complex laws lead to complex administration and a
highly dissatisfied public--hardly the atmosphere for steadfast
compliance. Taxpayers repeatedly throw up their hands in utter defeat,
voice disdain for both the tax system as well as the entire government,
and frequently follow up by deciding in their own favor every
conceivably uncertain question that may arise. Until greater efforts
are made to address basic roots of the problem--extraordinary
complexity and murky transparency--the nation's fisc suffers and the
IRS is left ``holding the bag,'' with unfair criticisms and a highly
unpopular reputation.
Congress is confronted with a gigantic task in seeking fundamental
simplification. Some suggest that the income tax be scrapped in its
entirety and replaced with a complete substitute--perhaps some form of
consumption tax, a federal sales tax or value added tax. And then there
are those who ardently back the very simple ``Flat Tax''--widely
heralded to require only a postcard return, with no itemized
deductions, and only a single rate of tax to be imposed on income from
wages but not from capital (whether interest, dividends, rents or
capital gains).
Such an entirely new system of taxation, however, is not likely in
the foreseeable future--particularly with its uncertain revenue-raising
capacity, the risks at stake in a large and complex economy like ours,
and the sweeping transitional problems that would confront individual
and business taxpayers as well as tax administrators. Some form of
consumption tax might well be suitable now to complement our income tax
system, but not to substitute for it.
Realistically, to significantly ease complexity, Congress must
think in terms of modification of the income tax law and then
contemplate its complete revision.
Overhaul the Income Tax
``Simplification'' and ``fairness'' must be kept at the heart of
any new proposal. Congress, in my view, could provide unprecedented
relief to taxpayers and, at the same time, could help revitalize public
faith in the running of our government by focusing on a broad-base, low
graduated rate income tax system.
Today, our tax laws are riddled with a vast array of targeted tax
preferences and incentives that complicate compliance, erode our tax
base and necessitate increased tax rates to meet the nation's revenue
demands--special deductions and credits, exemptions and exclusions,
deferrals, special rates and other preferred treatment for particular
industries, groups or individuals. Aside from issues of fairness, such
provisions create unbelievable complexity often leading to distortion
of normal decision-making and encouragement of tax-motivated, non-
economic behavior. Tax avoidance and abuse are inevitable byproducts.
We also see the tax laws excessively used, again and again, to
promote a wide variety of social and economic objectives. The result:
tax base erosion, shifting of the tax burden, added complexities, and
further fueling of taxpayer frustration. Much too often, Congress finds
this ``backdoor financing'' route significantly more convenient, albeit
more revenue costly, than the better-monitored process of direct
appropriations.
A meaningful simplification effort would be an extraordinarily
difficult undertaking, one of lengthy duration and certain to be
sharply challenged by competing forces of all dimensions--business,
political, economic and otherwise. Forceful Presidential leadership, as
in the Reagan years, clearly would be needed; and appointment of a
carefully chosen commission undoubtedly would be required, with
adequate staffing and preparation to undertake extensive hearings.
Regardless of the final outcome, the related studies and analyses would
produce long-range benefits to future enactments of the country's tax
laws.
Some 40 years ago, Senator Russell Long, who became Chairman of the
Senate Finance Committee, took it upon himself to lead a charge to
provide true simplification for individual taxpayers. He offered bold
legislation that called for an across-the-board ``Simplified Tax
Method.'' It was close to a tax on gross income (``simplified taxable
income'')-- no personal deductions; lower rates; capital gains to be
taxed in the same manner as other income. And its special charm was
that the program was optional. A taxpayer had the choice of using the
regular income tax (``the old way,'' with all its complexities), or the
new simplified method. All you had to do was to make a 5-year renewable
election, with the right to terminate in the event of bankruptcy,
disability, or adverse changes in the Code or regulations. While the
legislation was never adopted, it did illustrate how individual income
tax compliance could be made truly simple with hardly any
recordkeeping. An instant tax return was a real possibility. And, in
honor of the Senator, I've always liked to refer to it as ``The Long
Short-Form''!
Close to 20 years ago, one of the most successful efforts for basic
income tax reform was achieved in the Tax Reform Act of 1986, under the
leadership of President Ronald Reagan, with the full backing of
Chairman Dan Rostenkowski of the House Ways & Means Committee and
Chairman Bob Packwood of the Senate Finance Committee. Subsequent
legislation has whittled away many of the 1986 Act's achievements on
fairness and simplification. But the legislation still stands as a
monument to ``the art of the possible''--broadening the tax base by
eliminating many tax breaks and loopholes, lowering the rate structure,
taxing capital gains in the same way as ordinary income, and embracing
the principle that ``those with similar amounts of income should pay
essentially the same amount of taxes.''
In the same tradition of the 1986 Act, Congress could begin the
process now to simplify tax reporting, ease administration, and restore
taxpayer confidence in the entire tax system. To this end, I suggest
setting in motion the enactment of tax changes along the following
lines:
1. Focus on tax return simplification by eliminating as many
complexities as possible within the parameters of reasonable revenue
costs.
2. Curtail the use of the tax law as the first responder for
solving our social and economic problems.
3. Eliminate the bulk of special preferences, creating a sizably
broadened tax base.
4. Restore a straightforward graduated rate structure, free of
disguised rate increases inherent to floors, bubbles, phase outs,
clawbacks, and the like.
5. Tax capital gains in the same manner as ordinary income.
6. Lower all graduated rates across the board.
7. Repeal the alternative minimum tax (``AMT'') for individuals as
well as corporations, offsetting the enlargement of the tax base.
We as a people would be better served by a broad-base, low rate
income tax system, with only the most limited of tax favors. Such a
straightforward regime, aimed at treating all forms of income alike and
providing equal tax treatment for persons with equivalent dollar
incomes, would clearly be simpler, fairer and more efficient for the
people at large.
Such a transparent system, free of bells and whistles, would go a
long way to restore faith in the integrity of a sound tax system that
is so vital to the security and well-being of our nation.
<F-dash>
Chairman HOUGHTON. Thank you Mr. Caplin. Mr. Cohen.
STATEMENT OF SHELDON S. COHEN, COMMISSIONER, INTERNAL REVENUE
SERVICE, 1965-1969
Mr. COHEN. Mr. Chairman and Members of the Committee, tax
simplification is something we talk about regularly and do very
little about. It is always our second or third priority.
Shakespeare puts it better than I do. He said, frankly, the
fault dear Brutus, is not in our stars but in ourselves. That
is, we won't do it and we all recognize it. There is a
constituency of one for simplifications. The Commissioner of
IRS and his staff are very interested in this and it would make
their lives easier and their work easier and they would enjoy
it. The rest of us will always opt for some deduction or some
credit when faced with that versus simplification.
Many of you are going to talk about a change to some new
tax system. Mr. Caplin just mentioned that. Of course, they
don't take into account the complications and disruptions that
would cause, and the uncertainty. One little thing: at the end
of the day, if you enact that system and it is perfect, what
gives you the right to think that your confreres, years from
today, won't corrupt that system just as they have done this
one. If we don't have the discipline to fix this one, we don't
have the discipline to enact the new one that will be better.
Now, you need to face up to the issue of dealing with the
expenditure of funds through the tax system. That has become a
corrupting influence and a complication. Rather than expend
money for a variety of public goods, we don't collect money
from people who do those public goods. We think that saves
money. That doesn't, really. We have the wrong agency
administering the thing, whether it is housing or public
welfare or whatever it happens to be. The wrong agency is
administering it and the cost is there. We just don't get a
good administration, so we pretend we get it at a bargain.
Anything you can draft as a spending program, I can draft as a
tax program. You are asked to do that regularly and you do do
it regularly. The budget rules of the last years have pushed
you in that direction. They have been enacted for good reasons,
but as tax evaders do you kind of use the same techniques to
get around the rules.
There are two ways to move to simplification. That is, the
grand move that has been described to you. The second
alternative technique is the shorter, the targeted move. I am
not a grand person. I would take on the smaller targets and I
would pick the targets of opportunity. Wilbur Mills had a
wonderful idea; and that is, pick out five or six good areas,
have small groups plan the attack, and then deal with those
five or six areas. I have outlined in my paper the five or six
areas that I would pick. You could pick four, five others, but
don't make the target too big. If you make the target too big,
you take on all the dragons, all of the lobbyists, all of the
problems of the world. Now the problem, of course, is with the
present lack of money to even it out, you have to have
basically revenue-neutral kind of reform, and that makes it
much more difficult because you are going to have some losers
and some winners. The losers will moan and groan. The winners
won't win so much, but they are going to be on your side. They
will be with you, but not ardently with you, and that makes it
very difficult. I think I will just stop there. I don't want
you to have to listen to the same ideas. I will be glad to
answer any questions.
[The prepared statement of Mr. Cohen follows:]
Statement of The Honorable Sheldon S. Cohen, Commissioner,
Internal Revenue Service, 1965-1969
Mr. Chairman and Members of the Subcommittee, I am pleased to
appear before you today at your request to testify on the issues
relating to Tax Simplification. My testimony today represents my own
views and not those of my firm or any of its clients.
Because of the press of the short time since you requested my
testimony, I will use an outline instead of fully written testimony.
Should you wish me to amplify any of my ideas presented here, I would
be pleased to do so for your record.
Tax Simplification is something all of us talk about but few of us
do much about. I have been practicing in the tax area for 52 years and
it comes up regularly but only on rare occasions does anything
affirmative happen.
Shakespeare, as usual, put it more aptly than I can. He said ``the
fault, dear Brutus, is not in our stars, but in ourselves.'' (Julius
Caesar, I, ii, 134). We all say how much we want and need
simplification. Only the Commissioner of the Internal Revenue and his
staff mean it and try to do something about it. The rest of us try to
rationalize why we should pay less and others more. And you on the
Committee try to please your constituents who are asking for some
deduction or credit or rate cut or similar benefit--but rarely talk
about simplifying the law except in most general terms. Some of those
who do talk about simplification will urge you to change to an entirely
new tax system--but they never take into account the complications and
disruption it would cause to move to any new system. And if we do not
have the discipline to make this system simple and direct--what right
to we have to believe that any proposed new system will not be
corrupted too? (In Pogo's words--``We have met the enemy and it is
us.'')
Many of us have been concerned for a number of years because of the
multiple roles we expect our tax system to play. For example, a portion
of the federal financing of urban renewal and development is
accomplished by enacting a complex series of tax credits and deductions
that must be administered by the IRS. These policies should be financed
through expenditure programs administered by experts in the field. I
realize that because of budget restraints enacted over the years, it is
easier not to collect a tax then it is to get an expenditure bill
through the Congress. They are the net equivalent of each other. What
can be drafted as a spending program can be also drafted as a tax
program. Nevertheless, using the tax system as a surrogate for
expenditure programs is an inefficient means to accomplish the desired
policy and weakens a national asset--our formerly smooth-running, well-
administered tax system. Although from Congress' perspective, it may
have the advantage of showing lower expenditure levels than really
exist.
The Congress will periodically go into a binge of preaching
simplification--but when faced with a real issue you will opt for, what
you conceive as, equity. You can not have simplification and equity.
That is hard to say--but it is true. A simple law is not equitable as
it has arbitrary lines. Cross the line and the result changes. An
equitable law needs fluid lines so it has to be more complex. We face
this issue regularly and most of us choose equity. We must, in order to
move toward simplification, choose to be arbitrary on occasion, much as
that connotes bad things in other situations. An illustration in the
current news is to allow the charitable deduction for some standard
deduction users. Thus negating a measure (the standard deduction)
enacted for simplification reasons.
There are two essential ways to move toward simplification. The
major tax act with major changes (i.e., like the 1986 Act)--or smaller,
more targeted area changes. I have been practicing in and out of the
government for over 50 years. I saw the Code recodified twice: once in
1954 when I was one of its draftsmen and again in 1986 each time with
some success--but most of it eroded in the years that followed.
I am a devotee of the smaller fix not the giant move. Wilber Mills,
back in the 1970s, began studies to do this type of reform. I would
suggest that the Committee pick a few areas which affect the largest
number of taxpayers and those least able to cope with complex Code.
Those areas would be the first to attempt to simplify. The areas I
would start with are the EITC, AMT, dependency definitions, educational
benefits and savings incentives. These effect great numbers of people
and would have the most bang for your buck. For example, in the areas
of educational benefit and savings incentives, you often have multiple
provisions to provide benefits that present confusing choices to the
taxpaying public and impose additional tasks on the IRS.
Dr. Lawrence Woodworth and I designed the first deadwood bill in
the late 1960s. Our idea was to eliminate the provisions of the Code
which by their terms were superseded and outdated. There was no
opposition to the bill--but no enthusiastic support either. It took
until 1976 to pass that bill. There were no sponsors and no real
opposition, as a simplification bill had no monetary benefit directly
and merely reduced paperwork and reading for people. No one up here
seemed interested.
Suggest a new deduction or credit and you will have many co-
sponsors. Suggest a technical change or simplification and you have 435
skeptics.
A revenue neutral change will cause some losers and some winners
among the taxpayers. So the losers will lobby you against the idea and
the winners will get so little they will be quiet. Thus simplification
has little support--but would make administration easier and therefore
make everyone's life a little easier.
I hope this Committee will suggest an effort to the full Committee.
I don't believe new major studies are necessary. Many practicing
lawyers and accountants would be willing to work with you--I am sure
many professors would likewise pitch in. What is lacking is the
determination, grit and leadership to pull it off. Now is a good time
to start. I would be pleased to assist.
<F-dash>
Chairman HOUGHTON. Those are very interesting and we will
get back to them. I see your five areas. Don Alexander.
STATEMENT OF DONALD C. ALEXANDER, COMMISSIONER, INTERNAL
REVENUE SERVICE, 1973-1977
Mr. ALEXANDER. Thank you, Mr. Chairman and Members of the
Subcommittee and thank you, Commissioner Goldberg. Let the
record show that Commissioner Goldberg and I share one red
light while our two predecessors share one each.I want to
commend you, Mr. Chairman, on your nine bills that you have
very recently introduced to try to take some of the steps that
Commissioner Caplin and Commissioner Cohen mentioned, going at
simplification in nine--I would like to say the word ``easy,''
but I can't--nine steps. It would be a major step forward if
all those bills were enacted and I think it is quite unlikely
that they will be.
I wish I could be more optimistic. I wish I could be more
optimistic about the success of the reintroduction of your last
year's bill, Congressman Portman, which would have had a
sweeping effect on the complexity of our current law. I am
dedicated to Congressman Pomeroy's efforts and Congressman
Johnson's to try to simplify our retirement system, which is
badly in need of it. Well, let's talk about the 1986 act. We
all have. I might as well chip in. I think it was a great
expedition, started off by President Reagan in his 1984 State
of the Union address, where he pointed out that he wanted to
simplify the entire Tax Code so all taxpayers, big and small,
would be treated more fairly, and he thought that would have a
very good effect on compliance. I think he was right on all
counts. In 1986, we did manage to do a lot of good and we
didn't do it in little bitty steps, but we did one great big
step, and we did one thing that was really bad and that was the
alternative minimum tax. That was a terrible idea. It was
necessary in 1986 because it was thought to be the only way to
raise the necessary money so the rest of the act could go
through, and also because we were still worried about those 165
taxpayers with incomes of more than $200,000 that had been
mentioned in 1969 by the then-Secretary of the Treasury as not
paying any income tax. Why not give them an AMT?
Now, I think the small step versus big step concept that
you have heard about from this panel might deserve a little
more from me, and I think it is going to get much better and
bigger from Commissioner Goldberg. I don't think you are going
to be able to do reform in small steps. I wish you could. I
hope you could do something about having a uniform definition
of who is entitled to claim a child. Of course, we are not
redefining a child but redefining the relationships that the
taxpayer has to the claimed child. There is no need and no
sense in having the different definitions that you have heard a
little bit earlier from the people that have to cope with this
system. That is something you ought to be able to do. Whether
you could do it separately, I don't know. I think the big bang
theory has much going for it. Maybe we can do what we did in
1986 again, and this time do it right. How we can do that
without raising rates, I am not sure. We can narrow the base if
we are willing to do another thing that Commissioner Cohen
mentioned.
In the past decade the present Congress have used income
tax the way Mike Graetz's mother employed chicken soup, as a
magic elixir to solve all of the Nation's social difficulties.
One problem is that each Congress wants to have its own stamp
on the solution for the child. So, each Congress wants to have
a nice child credit. Each successive Congress doesn't want to
rely on the lifetime learning credit, so it has to enact
something like the Hope credit. In addition to that, I just
want to second what Commissioner Cohen said. Let's stop, at
least, using the Internal Revenue Code to try to solve all of
our social and economic problems. Let us give those to the
agencies of jurisdiction.
[The prepared statement of Mr. Alexander follows:]
Statement of The Honorable Don C. Alexander, Commissioner,
Internal Revenue Service, 1973-1977
My name is Donald C. Alexander, and I am appearing today in my
personal capacity as a former tax collector and a long-time tax
practitioner.
First, I want to commend this Subcommittee for having this hearing
and for seeking to reduce the burden that complexity imposes upon
American taxpayers. As Chairman Houghton stated when he introduced nine
simplification proposals on April 2, 2004, ``if our system becomes too
complex for the ordinary citizen, then noncompliance will no doubt
accelerate.'' Chairman Houghton further pointed out that ongoing
simplification of the tax system should be a top priority of Congress.
Cong. Portman showed his dedication to the goal of simplification when
he introduced the sweeping recommendations contained in his Tax
Simplification Act of 2002, H.R.5166.
In his third State of the Union Address on January 25, 1984,
President Reagan said:
Let us go forward with an historic reform for fairness,
simplicity, and incentives for growth. I am asking Secretary
Don Regan for a plan for action to simplify the entire tax
code, so all taxpayers, big and small, are treated more fairly.
And I believe such a plan could result in that underground
economy being brought into the sunlight of honest tax
compliance. And it could make the tax base broader, so personal
tax rates could come down, not go up. I've asked that specific
recommendations, consistent with those objectives, be presented
to me by December 1984.
The 1986 Act was indeed a triumph in many ways. The tax base was
indeed broadened, the rates were greatly reduced, and many of the
ornaments in the Internal Revenue Code were dropped or greatly
curtailed. Unfortunately, however, the alternative minimum tax on
individuals was not removed but instead was expanded to become the
monster that it is now. More and more individuals fall within it for
its unindexed exemption becomes more inadequate each year. Both
Chairman Houghton's current proposals and Congressman Portman's 2002
proposal would curtail or repeal the alternative minimum tax.
Unfortunately, such action, while necessary, is very expensive.
Congress and the Administration must fix this problem and at last
reverse the trend toward the individual alternative tax becoming the
primary tax for individuals.
Much of the relief in the 1986 Act has been eroded, and an example
of such erosion is the misnamed Taxpayer Relief Act of 1997. In that
Act we saw fit to provide a full deduction for unreimbursed travel
costs of certain Federal employees, to give an above-the-line deduction
for expenses of certain governmental officials compensated on a fee
basis, to provide Roth IRAs and above-the-line deduction for interest
on education loans, to retroactively reinstate an exclusion for
employer-provided educational assistance and to provide education IRAs,
among other things.\1\ Why not give the Department of Education some
more money, to strengthen and expand Pell Grants, and broaden their
scope? But doing the sensible thing requires outlays and does not
reduce taxes, and there is the problem.
---------------------------------------------------------------------------
\1\ Of course we should encourage education, and we have the
Department of Education to do just this.
---------------------------------------------------------------------------
Simplification is a goal to which many have aspired recently.
Unfortunately, however, the tax laws have become more complicated and
the consequent burden on taxpayers and the IRS has increased year by
year. While some of the Code's complexity stems from duplication and
overlap,\2\ much is due to cramming the Code with ornaments that don't
belong in a rational tax system. As Michael Graetz told us in 2001:
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\2\ Such as multiple definitions of a child.
In the past decade the President and Congress have used the
income tax the way my mother employed chicken soup: as a magic
elixir to solve all the nation's economic and social
difficulties. If the nation has a problem in access to
education, child care affordability, health insurance coverage,
or financing of long-term care, to name just a few, an income
---------------------------------------------------------------------------
tax deduction or credit is the answer.
2001 Erwin N. Griswold Lecture before the American College of Tax
Counsel: Erwin Griswold's Tax Law--And Ours, The Tax Lawyer, Vol. 56,
No. 1, at 178 (Fall 2002).
We seem to be addicted to using the tax system as a means of
promoting all sorts of good things\3\ by spending through the Internal
Revenue Code. Thus we avoid the political difficulty of voting for
additional expenditures and give the benefit of an ostensible reduction
in taxes. It's a two-fer.
---------------------------------------------------------------------------
\3\ As well as discouraging a few bad things.
---------------------------------------------------------------------------
The earned income credit is based on a very fine concept: an income
supplement to encourage the poor to work rather than to remain on
welfare. I thought this great idea should be administered by the then
Department of Health, Education and Welfare. Milton Friedman, who
favored a negative income tax, thought otherwise and he persuaded the
then Administration to adopt the EITC. I predicted that it would be
very difficult for the IRS to administer and that the Internal Revenue
Service was not the right agency to engage in social work. Obviously, I
lost, and it doesn't help to say that the predicted problems have
occurred.
Although the Internal Revenue Code had been used long before the
1970s to favor certain activities\4\ we have now developed this into an
art form. In addition to the enormous welfare program that the IRS must
administer, it also administers major segments of our housing
incentives, our education incentives, our health incentives, our child
care needs and all sorts of narrowly-focused economic incentives.
---------------------------------------------------------------------------
\4\ And even particular individuals.
---------------------------------------------------------------------------
That is why alternative tax systems like a national sales tax\5\ or
so-called ``flat tax'' to replace much or all of the individual income
tax seems attractive at first sight and could be made to be reasonably
progressive if we care anymore about the ability to pay. One can be
reasonably certain, however, that the apparent simplicity would likely
evaporate soon when various claimants to favored treatment pressed
their case with Congress and the Administration.
---------------------------------------------------------------------------
\5\ A credit-invoice value added tax would be far superior to a
national sales tax, but those with long memories have not forgotten
Chairman Ullman.
---------------------------------------------------------------------------
Expenditures through the Internal Revenue Code are similar to
regular spending programs for they are intended to achieve policy
objectives that have little or nothing to do with a system designed to
produce the needed amount of revenue by applying a tax rate to an
income tax base. The major difference between a tax expenditure and
regular government spending is that under the tax expenditure approach,
instead of the government sending out a check to the recipient, the
recipient pays less in tax\6\ For example, we now have a national
concern about the dire effects of obesity. We could address this
problem by creating a direct spending program to subsidize weight loss.
Or, we could provide a tax expenditure designed to produce the same
result but place the administrative problems on the IRS.\7\ In theory,
it may not matter whether a government uses direct spending or a tax
expenditure to achieve a policy goal. As the Institute on Taxation and
Economic Policy has pointed out, however, tax expenditures are
evaluated far differently from other government spending:
---------------------------------------------------------------------------
\6\ If the tax expenditure is refundable, the lucky beneficiary
receives a check in addition to, or in lieu of, a tax deduction.
\7\ Would the IRS simply accept the taxpayer's word? Or would it
weigh a representative sample of taxpayers at the beginning of the
taxable year and at the end of the year? What about growing children?
What about pregnant women? How large a weight increase is permitted?
How could you achieve the goal but also discourage anorexia?
<bullet> Unlike most government spending programs, tax
expenditures are usually open-ended: they have no built-in budget
limits, and generally there is no annual appropriations review or
oversight process. Anyone who meets the statutory criteria for
eligibility can get the subsidy.
<bullet> Direct spending usually requires a government agency to
weigh the worthiness of an application from any potential beneficiary.
In contrast, most tax expenditures require no action other than the
filing of a tax return.
<bullet> Tax agencies typically have little expertise, or
interest, in assuring that tax-expenditure programs are working as they
should. By contrast, government agencies tend to look closely at the
effectiveness of their direct spending initiatives.
<bullet> Basic facts about who benefits from tax expenditures--and
what they do with their subsidies--are often hidden behind the cloak of
tax return secrecy, while the beneficiaries of conventional spending
programs are usually to identify.
Tax Expenditures: Spending by Another Name, Institute on Taxation
and Economic Policy Brief #4, April 2004.
As a result of these flaws, tax expenditures frequently prove to be
expensive subsidy programs for which there is little or no oversight.
Furthermore, they complicate the tax laws by straining the tax system's
administrative resources; they generally involve unlimited or uncertain
costs; they evade periodic budgetary review;and they are administered
by an agency unfamiliar with the substantive problems addressed by the
subsidies and unable to coordinate particular tax expenditures with
subsidy programs administered by agencies having jurisdiction.
It may be politically correct and socially popular to spend through
the Internal Revenue Code, but doing so violates the basic tenets of
classic tax policy: fairness, efficiency, and simplicity. Furthermore,
the tax system should be designed to impose and to collect taxes, not
to administer social programs. Therefore, if we can muster the
political will, we should replace tax expenditures with nontax outlays.
<F-dash>
Chairman HOUGHTON. Mr. Goldberg.
STATEMENT OF FRED T. GOLDBERG, COMMISSIONER, INTERNAL REVENUE
SERVICE, 1989-1992
Mr. GOLDBERG. Thank you, Mr. Chairman. I would like to echo
my colleagues' sentiment in congratulating each of you and
congratulating you collectively on your bipartisan efforts to
simplify the Tax Code. I think that you--each of you on the
panel, more than most, is seriously committed to this all
important agenda. I am submitting a more detailed written
statement for the record and will limit my comments to three
areas. As a child of the sixties I believe we can have it all,
so I am going to talk about having it all. I think in the short
term, there are clear legislative priorities that are worth
pursuing. The first is to enact a uniform definition of child
and to simplify the earned income tax credit. The second is to
simplify the appalling, unworkable array of education-related
incentives. The third is to continue, under the leadership of
Congressman Portman and Congressman Cardin, efforts to simplify
the rules governing tax-favored savings and simplify and reform
rules governing international taxation.
Each of these areas merits prompt attention. Many affect
tens of millions of Americans and represent our country's core
values: family, work, education and savings. It is possible to
make meaningful improvements quickly and with relatively modest
revenue laws. Without change, we remain in the worst of all
words. A complex system that distorts behavior is perceived as
unfairly favoring the wealthy and leaving many working families
unable to take advantage of the benefits that the Tax Code
purports to offer. Second, a great deal of simplification can
be accomplished in the short run through administrative
actions. The current Administration deserves high marks for its
recent efforts; however, much more can and should be done.
Additionally, initiatives in the areas of form design, filing
requirements, tax accounting and international tax would be
particularly welcome.
Simplification also requires changes in the way the IRS
does business. Without question, the Bush Administration's
split refund proposal is the most significant effort in this
area. This universally acclaimed proposal would dramatically
simplify savings and financial management by literally tens of
millions of taxpayers and provide a platform for other policy
initiatives in years to come. It has no material budget cost.
Given its overriding importance, I encourage you to monitor the
IRS in its efforts to carry out a commitment made by this
Administration. Finally, I urge you and your colleagues to
address the opportunity for fundamental reform. Each of us has
referred to that area. In my judgment, the Federal income tax
has served the Nation well for close to a century, but it is
showing its age. The piling of complex provision on top of
complex provision, coupled with changes brought about by
technology, sophisticated capital markets, and global
competition have left much of the system unworkable, and, in my
judgment, beyond repair.
True simplification requires fundamental change. Now, a
simplification is a worthwhile objective. It does not provide
sufficient impetus for tax reform. However, the tax system's
perfect storm is on the horizon. Nothing can be done to delay
or prevent its arrival later this decade. All of the following
are certain to happen. The AMT is devouring our income tax.
Temporary tax cuts enacted since 2001 will expire and the baby
boomer generation will start retiring. The pressing need to
deal with these issues creates a unique opportunity for
fundamental tax reform. The question is whether Congress and
the Administration will seize that opportunity in a bipartisan
fashion or whether we will continue our futile efforts to patch
the current rules. Simplification that could be accomplished in
this broad framework are striking. One approach would be to try
again what was tried in 1986: reduced rates, eliminate
preference items. Unfortunately, the experience of the past 18
years suggests that reforms along these lines may be short
lived. The alternative is more fundamental change, proposals
ranging from mandated conformity between book and tax
accounting to a comprehensive business income tax.
Others advocate replacing some of all the individual income
tax or corporate tax or the payroll tax with a value-added tax,
national sales tax or flat tax. All of these ideas have been
around for a long time. They merit serious bipartisan
consideration. Pretty much any combination would greatly
simplify the system while reducing distortions and improving
economic efficiency. I want to emphasize they can be
accomplished in ways that maintain, increase, or decrease
revenues and can be implemented in ways that maintain, increase
or decrease the progressives of our system. Mr. Chairman, the
system is far more precarious than many acknowledge and the
benefits of decreased complexity far outweigh the cost of
change. I congratulate you and your colleagues for your
efforts.
[The prepared statement of Mr. Goldberg follows:]
Statement of The Honorable Fred T. Goldberg, Jr., Commissioner,
Internal Revenue Service, 1989-1992
Chairman Houghton, Ranking Member Pomeroy, distinguished Members of
the Subcommittee, thank you for the opportunity to participate in
today's hearing on tax simplification. I am appearing at your request
as a former IRS Commissioner. I am speaking on my own behalf and not on
behalf of any client or other organization.
Before beginning my remarks, I would like to note, as we say
farewell to President Reagan, that the Tax Reform Act of 1986
demonstrates how much can be accomplished in reforming the tax laws
under the right circumstances and with the right kind of visionary and
bi-partisan leadership. For reasons I note below, the opportunity for
fundamental reform will come around again later this decade; the
question is whether those in charge will rise to the challenge.
I would also like to compliment you, Mr. Chairman, for your efforts
to simplify our tax laws and for the noteworthy simplification
proposals you introduced earlier this year. Likewise, your colleagues
Congressman Rob Portman and Congressman Benjamin Cardin should be
acknowledged for their long-standing commitment to simplification and
their ongoing and successful efforts to simplify the rules governing
tax-favored retirement savings. Ways & Means Committee Chairman Thomas
and other members of the Ways & Means Committee, including Congressmen
Neal, Johnson and Ramstad have also put forward meaningful
simplification proposals.
Unfortunately, despite these efforts, tax simplification remains
everyone's favorite orphan. All of us involved in the tax system--
Congress, the executive branch, practitioners and taxpayers--proclaim
our affection for this child of our dreams, but few are willing to
adopt her as our own. The benefits of meaningful simplification include
a more transparent and ``fair'' system; improved compliance and far
less ``tax shelter'' activity; reduced burden, frustration and
compliance costs for taxpayers; and more effective and less costly tax
administration. To date, little has been done to reap these benefits
and the prospects for substantial progress appear dim.
What I find so discouraging is the gulf between what can be done
and what's being done. It's not as though we are lacking for ways to
simplify the system. Proposals introduced by you and your Congressional
colleagues; the Bush Administration's pending budget proposals; the
Joint Committee's comprehensive and compelling tax complexity report of
three years ago; the joint recommendations of the AICPA, the Tax
Executives Institute, and the Tax Section of the ABA--there is no end
to the good ideas; what's lacking is their enactment into law.
I will limit my remarks to three topics: short-term priorities,
administrative action, and long-term opportunities.
Priorities. Given budget constraints and limited legislative
resources, it is important to focus on those areas with the greatest
potential impact. My recommendations:
(a) Enact a uniform definition of ``child'' along the lines of your
proposal, Mr. Chairman, and simplify the Earned Income Tax Credit.
These proposals have been around for a long time; they would be of
great benefit to millions of Americans who are ill-equipped to deal
with the absurd complexity of the current rules. Numerous different
definitions of ``qualifying child'' appear throughout the tax code,
causing needless taxpayer confusion when attempting to claim benefits.
Further, the Earned Income Tax Credit provisions contain complex and
lengthy requirements that exclude many deserving individuals and
necessitate significant record-keeping. Individuals in complicated
family situations face additional complicated rules. To ease taxpayer
confusion and reduce Earned Income Tax Credit and other tax filing
errors, the Bush Administration has proposed simplification in both of
these areas; its five related simplification measures would provide
important relief to low-income families. There is hope for enactment
this year, and the time has come to get it done.
(b) Simplify the appalling array of education-related incentives.
Taxpayers are faced with many options to alleviate the costs of higher
education. However, the mere number and perplexing intricacies of these
benefits make it extremely difficult for taxpayers to choose and
interpret the ideal option. The complexity is understandable but
unnecessary, and the confusion it causes is intolerable. As evidenced
by the Administration's recent proposals to consolidate benefits,
simplify rules for expenses, increase the number of qualifying
taxpayers, and standardize definitions throughout the code, the case
for simplification in this area is compelling.
(c) Simplify the rules governing tax-favored retirement savings.
Congressmen Portman and Cardin have provided bi-partisan leadership in
this area, with many successes to their credit. But more can and should
be done. For example, while recent legislation has improved
portability, there is still far too much friction in the system as
workers' jobs and circumstances change. Likewise, the current IRA
regime should be replaced by some form of the Administration's RSA
proposal and a revised and permanent refundable Savers' Credit. These
proposals would demonstrate that good policy and tax simplification go
hand-in-hand. The so-called Roth IRA model (no current tax deduction
and no tax on distribution) is vastly simpler than the traditional IRA
(current tax deduction and tax on distribution). Taking savings out
from under the tax system is far easier, and provides far greater
certainty, than excluding wages and running the savings through the tax
system. The combination of RSAs and a refundable Savers' Credit has the
compelling virtue of universality and is of greatest benefit to low and
middle income taxpayers.
(d) Simplify and reform the rules governing international taxation.
This is where the tax system is the most outdated, complex, and
generally unworkable. Simple rules may be incompatible with a global
environment in which many taxpayers are governed by different and
conflicting tax regimes, but actions can and should be taken to
minimize the extraordinary complexity of our current system. Economic
activity has changed most rapidly in the international arena, and yet
the underlying rules were created over four decades ago. While patched
repeatedly, these rules are in need of serious overhaul. For example,
the rules governing the foreign tax credit, passive foreign investment
companies, and Subpart F income are complicated to interpret and apply.
They should be substantially updated and simplified. I commend your
efforts on a bi-partisan basis in this area, Mr. Chairman.
Each of these areas merits prompt attention. Many affect tens of
millions of Americans and represent our country's core values--family,
work, education and savings. It is possible to make meaningful
improvements quickly and with relatively modest revenue loss. As
recently noted by tax professionals and behavioral economists, too much
complexity and too many options create legislatively sanctioned
planning opportunities for the few who are well advised, while
bewildering most taxpayers. We are left with the worst of all worlds: a
system that is perceived as unfairly favoring the well off, while
leaving many individuals unable and unlikely to take the benefits the
tax code affords. The simplification measures I described have vast
potential to reduce opacity, ease compliance burdens and enforcement
costs, and curb the corrosive effect of the current complex system.
Administrative Action. A great deal of simplification can be
accomplished through administrative action by Treasury and the IRS. The
current Administration deserves very high marks for its focus on
simplification and its accomplishments over the past several years. In
2002, the Administration adopted multiple tax form simplification
measures. It eased the filing burden on millions of small businesses by
raising the gross receipts and assets threshold for filing Schedules L,
M-1, and M-2 on certain corporate returns. Also in 2002, the Treasury
and the IRS increased the limit for filing separate schedules for
interest and dividend income. This has permitted millions to avoid
having to file an additional schedule and allows many to file Form
1040EZ when this would have otherwise been disallowed. The INDOPCO
regulations, guidance regarding the cash method of accounting,
procedures to stream-line Section 9100 relief and remedy inadvertent S
Corp failures provide a few additional illustrations.
Once again, however, much more can and should be done. Additional
regulatory initiatives in the areas of tax accounting and international
tax would be particularly welcome, although there are targeted
opportunities throughout the Code and existing regulations.
It is important to note the Bush Administration's simplification
initiatives are not limited to guidance, form changes, and the like.
They also include changes in the way the IRS does business. Without
question, the Administration's ``split refund'' proposal is the most
significant initiative in this area. There is a substantial need to
increase household savings in America, and tax refunds are an important
potential source. The ``split refund'' proposal could maximize this
benefit of tax refunds for many families.
Specifically, the Administration's 2005 Budget provides for the IRS
to permit taxpayers to have their refunds wired to more than one
account. The average IRS refund check is more than $2,000; for many
families, this is the biggest single cash payment they receive during
the year. The Administration's proposal has been universally acclaimed
and--if implemented--would dramatically simplify savings and financial
management by millions of taxpayers. Given the importance of this
proposal, you should monitor closely the progress the IRS is making in
carrying out the Administration's policy.
Long-Term Need/Long-Term Opportunity. The Federal income tax has
served the nation well for close to a century. The system, however, is
showing its age. The piling of complex provision on top of complex
provision--coupled with changes brought about by technology,
sophisticated capital markets and global competition--have left much of
the system unworkable and (in my view) beyond repair. True
simplification requires rethinking the tax base and restructuring much
of the system.
While simplification is a worthwhile objective, it does not provide
sufficient grounds for fundamental tax reform. (Perhaps it should, but
it won't). However, the tax system's ``perfect storm'' is on the
horizon. It will arrive this decade and nothing can be done to prevent
or defer its arrival. All of the following are certain to happen:
Unless modified, the AMT will devour the tax system. Without
changes to the tax laws, by 2014, the number of taxpayers
subject to the AMT will increase by a factor of fourteen
relative to the number of taxpayers subject to the AMT in
2003--from 3.3 million in 2003 to over 46 million in 2014
according to Treasury Department estimates. By 2013, the cost
of repealing the AMT will exceed the cost of repealing the
regular individual income tax. It is worth remembering that the
AMT was enacted on account of concerns about high income
individuals avoiding all income tax. Now its reach extends to
the middle class, which is clearly not what Congress intended.
The temporary tax cuts enacted since 2001 will begin to
expire. Some temporary (and limited) AMT relief expired last
year and more expires this year. Across-the-board rate cuts,
the increased child credit, marriage penalty relief, and
various savings incentives expire in 2010. Phase-out of the
estate tax expires in 2010. The reduced tax rate on capital
gains and dividends, enacted in 2003, will expire at the end of
2008. The ten year cost (2005-2014) of making permanent the
rate cuts, reduced rates on dividends and capital gains, and
estate tax repeal would be more than $850 billion.
In 2008, the first of the populous Baby Boomer Generation
turns 62, the earliest age at which Social Security benefits
can be claimed. Without substantial change in the system,
Social Security outlays will exceed payroll revenues during the
next decade, demonstrating that the so-called Trust Fund is
indeed a fiction and placing additional demands on general
revenues. By 2014, Social Security and Medicare outlays will
account for 42% of all federal spending and 8.4% of GDP.
The pressing need to deal with these issues creates a unique
opportunity for a fundamental reconsideration of our tax system. The
question is whether Congress and the Administration will take advantage
of that opportunity or continue futile efforts to patch the current
system, a system that is beyond repair.
The simplification that could be accomplished in this broader
framework extends far beyond the few proposals I have discussed today.
For example, many initiatives have been proposed to reduce complexity
(as well as distortions caused by the current system) in the context of
enterprise income taxation. The Treasury's 1992 exploration of a
comprehensive business income tax (``CBIT'') is one such measure. Under
CBIT, with the exception of small businesses in terms of gross
receipts, all business entities would be subject to a uniform,
comprehensive entity level tax rate regardless of their corporate or
noncorporate form. Generally, CBIT would not impose further taxes at
the owner level and would equate the treatment of debt and equity.
Redefining the tax base in this manner, imposing a single rate of tax,
and exempting small businesses would dramatically simplify the system
and improve economic efficiency by reducing tax-based distortions.
Another alternative at the enterprise level would be to mandate
modified conformity between financial accounting and federal income tax
rules. While some tax provisions permit or require conformity to
financial accounting standards, many do not. This undermines financial
accounting transparency, complicates IRS enforcement efforts, and
increases the number of times a taxpayer must evaluate adjustments and
compute income. Unifying various tax and financial accounting standards
could alleviate many of the burdens imposed on both taxpayers and the
IRS, promote transparency, and help deter tax shelter activities,
without disturbing the distinct objectives of each regime.
In the context of taxes on individuals, similar opportunities
exist. One alternative would be to try--again--what was attempted in
1986: reduce rates and eliminate tax preference items. Unfortunately,
the experience of the past 18 years suggests that reforms along those
lines are short-lived and that more fundamental change is required.
Proposals to replace some or all of the income tax and the payroll tax
with some form of consumption tax (e.g., a value added tax, national
sales tax, or flat tax) have been around for a long time. They merit
serious, bi-partisan consideration during the years to come.
Whether in the context of individual, business entity, or
international taxation, simplification efforts must be taken seriously.
The system is far more precarious than many acknowledge, and the
benefits of decreased complexity far outweigh the costs of change.
Important changes can be accomplished in the short-run through targeted
legislation and administrative initiatives. By the end of this decade,
the coming storm creates the potential for fundamental change. I would
like to commend this Subcommittee for your attention to this issue.
I would be happy to answer any questions.
<F-dash>
Chairman HOUGHTON. Thank you very much. Of course, the
question is not that we don't have a problem; the question is
how do you get at it? Do you do the targeted, do you do the
grand, do you do a combination? One of the things that we had
suggested, that if you get rid of the AMT in one swipe, it
costs you about $600 billion. If you phase it in, start it
now--got to start--then it costs you about $260 billion. The
pain isn't so great there, and it has enormous impact. If we do
nothing--you have seen these figures, but 3, 11, 14, 17 million
people a year just cutting right into the system. So, the
question is, how do you get at it not only from a financial
standpoint but from a political standpoint? What are those
marks that we must look at now specifically rather than just
waiting for the whole system to change? I would appreciate any
other comments that you have. I know that, Mr. Cohen, you feel
we shouldn't wait for the grand plan and do the targeted. What
is the most important targeted thing we could do? Tell us.
Mr. COHEN. AMT is the broadest----
Chairman HOUGHTON. Would you phase it in or cut it out?
Mr. COHEN. You have boxed yourself in. When you went to
indexing you took--Congress over the years--I have been
practicing tax law for 52 years, 53 years--Congress over the
years kept the percentage of Gross Domestic Product (GDP) that
was taken out through the tax system pretty consistent, but it
would change it every 4 to 5 years, and when it would change
it, there was a little juice, if you will, to spread amongst
those provisions where you needed to spread the income. Now,
having indexed the system, you don't have any surplus revenue
to spread to the people, to the losers.
Chairman HOUGHTON. I understand that. What do you do about
it?
Mr. COHEN. You have to bite the dang bullet.
Chairman HOUGHTON. I would like to find what the bullet is
to bite.
Mr. CAPLIN. You may need a surplus to even play with
offsetting tax increases.
Chairman HOUGHTON. Or you could index the AMT.
Mr. ALEXANDER. It would curtail the increase.
Mr. GOLDBERG. I am with Mr. Portman on this issue. I would
simply repeal the damn thing. I think we are fooling ourselves.
By the end of this decade, the combination of expiring
provisions, retirement of the baby boomers, the other pressures
on the entitlement system, are going to require that we rebuild
our fiscal house. In the meantime, as we heard today, there are
real people suffering real costs and I wouldn't screw around
with it. I would just repeal it. You can sunset the repeal in
2010 and deal with that when you deal with all of the sunset
provisions. I think we are monkeying around and just ought to
do it.
Mr. ALEXANDER. That is the time bomb that goes off. You
have to remember that it does go off. We are going to have to
find some money somewhere and that is going to be really
difficult. If we take all the little ornaments--that most
people would agree are ornaments and don't belong in the
Internal Revenue Code--out, then some of those have
constituencies that are going to be very unhappy about the
removal of their particular ornament and they are going to let
you know about it. So, that is going to be a real problem for
you. If, on the other hand, you address the AMT the way it
should have been addressed way back in 1986, that is, what if
we don't cut the rates by the last 2 percentage points, do we
need this monster? Can we get by with a little monster that
might grow, but might take 100 years to grow up to be a big
monster? Maybe we could have done it, but we didn't.
Chairman HOUGHTON. I am going to turn to Mr. Pomeroy.
Mr. POMEROY. Mr. Chairman, the explorer Ponce de Leon
roamed all over the Southwest looking for the fountain of
youth. Hell, he should have gone to the IRS building. It is
obvious that the commissioners have tapped into it there. The
vitality and energy you still exhibit as our witnesses, there
must be something in the water over there. The Native Americans
I am proud to represent back in North Dakota have a culture of
listening to the elders. I believe that the Committee on Ways
and Means ought to have you in about every month just to hear
your opinion about putting a historic context on what we are
wrestling with.
Mr. CAPLIN. Tax collections is one of the lifeblood of the
Nation. When you live in that environment, they roll right
through us and keep each of us going.
Mr. GOLDBERG. I think we are all meaner than snakes.
Mr. POMEROY. I have enjoyed this panel enormously. I would
ask you a couple of other issues. We are heading toward a train
wreck. In the absence of pressing leadership, we are going to
have another fiscal disaster on our hands and we will have to
do something, and maybe this gets to the perfect storm that
will pave the way for very substantial tax clarification,
simplification. This business of the budget. We are in a fiscal
disaster and that means there is no money to address everything
that the constituencies are asking us to address. That is going
to place enormous pressure on the Tax Code. I have seen it
build in the 12 years that I have served in Congress, and I
believe that is going to build a great deal in the years ahead.
Second, I would like your answers on this one. Our political
system is more expensive than it has ever been and more
dependent upon campaign fundraising, which places really the--
those seeking some agenda in the Tax Code in a very powerful
position, especially if they have financial resources to play
significantly in a political year to drive a legislative
agenda. Have you noticed an acceleration of these tax changes
as we moved into the modern era of campaign finance reform?
Mr. CAPLIN. I think the fact that the Washington Post has
devoted a specific portion of its paper to following the
activities of new lobbying firms and new additions, this has
become an unbelievable industry in the time I have been here.
Mr. COHEN. Once the genie gets out of the bottle and people
learn there are more effective ways in dealing with these
issues than trying to deal with the substance of the issues--
that is, going to you folks for legislative solution--once that
genie is out of the bottle, then, of course, everybody knows
how to do it now so everybody joins. So, you have lobbying from
A to Z on every particular issue from every particular point of
view. You can't--it is hard to stuff that genie back in the
bottle.
Mr. POMEROY. I believe the demise of the legislative
process around here is in no one's interest. Certainly not a
partisan interest, not an ideological interest. The place
doesn't work like it needs to work in a transparent and fair--
we are the world's greatest democracy and it doesn't function
like that. Rather than substantive issue addressing through a
straight-up legislative process, you simply buy your way into
the Chairman's mark.
Mr. COHEN. I remember Mr. Mills, when he was Chairman of
this Committee, in an executive session putting down a number,
saying we won't talk about that because the issue was a very
narrow-based issue. That can't happen today. Number one, we
have all open hearings as opposed to closed executive sessions,
as we used to have then. Two, the lobbyists won't let it
happen. They are sitting there and they are watching. So, if a
Congressman or Senator has promised to bring the issue up, he
has to do it and he has to act serious about it, and all that
takes time and energy and some of it works.
Mr. POMEROY. Well, the hearings are public, the
deliberation on a bill is public. Basically our work product
generates from a mark brought in from somewhere. I don't mean
to talk about this Committee or particular leadership of this
Committee generally. There is no transparency in terms of what
is plunked down in front of us at the beginning of a hearing. I
am out of time, but I would like you to comment on these
issues, demise of the legislative process or the role of
campaign financing in terms of the provision of the Tax Code.
Mr. ALEXANDER. I am not sure that things are demonstrably
worse than they were back when I was working for IRS. Back
then, I was greatly concerned about highly successful lobbying,
in fact, highly successful lobbying that in my judgment
prevented the IRS from being able to produce a better computer
system than my distinguished predecessors had--well, they had a
great computer system at that time, and we still haven't gotten
our new computer system. One of our problems was from very
successful lobbying in my time. I don't know about your time.
Mr. GOLDBERG. I don't know if is as grim as you describe. I
think the work that Congressman Portman and Congressman Cardin
have done really has made the retirement system better than it
otherwise would have been; 1986 isn't all that long ago, and
there were folks who really did a remarkable job. I don't think
it is hopeless. I think we have to keep in mind that the
government is laying claim to 35 percent of the income of all
workers at the high end and all businesses at the high end.
That is a big profit share and I have my 100 shares of IBM. So,
the stakes are very real and very serious. We have exactly what
we designed is my response to your question. I think the issue
is whether it is possible to put a collective good where it
belongs to design a system that reduces these kinds of
pressures. I don't think there is a final solution. I think
Jefferson's notion of a revolution every 12 years is a good
idea. It is trying to strip it off and start over,
recognizing----
Mr. CAPLIN. He wanted to do it every 10 years.
Mr. GOLDBERG. I am more conservative. I don't think we have
a choice. I think when you look at everything that is out
there, the entitlement programs are fiscally a mess. I think
that we are going to be forced to deal with the reality that
all of us folks want to face today, and I think in that
context, I think it is possible to do enormous good and I think
you and your colleagues show that it is possible to work on a
bipartisan basis for the good of the country.
Mr. POMEROY. If I believed it was hopeless I wouldn't be
here. I do think we have to understand very clearly the
pressures so that as we look for that perfect storm moment, we
know how to put it together. Thank you all very much.
Mr. CAPLIN. I taught tax law for some 30 years and the
general approach over this period of time was you had a
problem, you worked it out with the IRS. You didn't call on the
Hill. This was the worst thing you could do in a controversy,
try to go to the Hill. Today the style is changed. The tendency
is to go up to the Hill and deal with the Congressmen and put
it into law.
Chairman HOUGHTON. Mr. Portman.
Mr. PORTMAN. Thank you, Mr. Chairman. I thank the witnesses
for their testimony and their perspective, because Mr. Pomeroy
is absolutely right. It is good to get that historical
perspective as we think we are dealing with these new issues.
Most of them have been dealt with before, some successfully and
some not so successfully. We do get things done around here on
a bipartisan basis that is focused on the public good. Mr.
Pomeroy has been a big part of that. On the retirement
legislation, some of his provisions went in almost as he wrote
them, as opposed to the way perhaps the Committee Members would
have, and it is a tribute to him working with the folks in the
retirement community that know about these issues. So, we do
have some hopeful examples, Earl.
On taxes, I guess my feeling is as we said earlier, the AMT
philosophically is not something we should have in our system,
and yet you have this huge revenue loss due to the fact that it
is taking more and more revenue every year and that would be, I
suppose, a microcosm of the bigger issue we face. If we are
going to go to big bang tax reform, which I support, over the
next couple of years, then maybe we ought to stop the
tinkering, allow the pressure to build, and then do the right
thing, whatever that is. On the other hand, if it is just not
going to happen for all kinds of reasons as it hasn't for 18
years, it is our responsibility as Members of this Subcommittee
to try to figure out ways to simplify in small ways. Again last
night, I would argue we did some of that. Yes, we complicated
the Tax Code in certain ways with that legislation that is
going to be on the floor later this week. On the international
side, we actually put in place some reforms that make some
sense, that simplify the Tax Code and will help with compliance
costs and our competitiveness.
So, having said all that, let me ask you if I can, a
question about a specific reform proposal, and this would be
something that would be in the big bang category. I want to get
the input of all four of you if I could. Starting with
acknowledging that we currently have not one tax system, but
several tax systems. We have a gift and estate tax law system.
We have an AMT tax system. We have an income tax system for
individuals. We have a corporate tax system. I would start by
removing all of those. So, having none of the existing systems
in place. Then putting in place a consumption tax. My personal
preference would be a value-added tax, because I think it is
much more easy to administer, much more efficient and much more
likely to be successful in our complicated economy. Instead of
millions of transactions a day, you would have thousands of
transactions a day. The value-added system, as you know, is
used by all of our competitors now with the possible exception
of one country in the developed world, and so we have a lot of
experience on that. That value-added system, the VAT (Value
Added Tax) tax would take the place of the corporate income tax
system in essence. There wouldn't be a corporate tax--solving
one of our many competitiveness issues we talked about last
night in this Committee room.
Then you would have another tax system on top of the value-
added tax system, and it would be a flat rate for individuals
who have income, defined under the current definition of
income. It is very complicated, but it would be wage income and
so-called unearned income. You would choose a number. I would
choose $125,000 because that is roughly the top 5 percent. You
would index that to inflation if you did this based on the
numbers that I have had run for me. If you had a rate that was
in the high teens for the VAT tax, high teens, maybe low
twenties for the low rate, you could end up with revenue
comparable to the revenue we have today. I am not taking into
account the enormous impact positively on the economy this
could have and should have in terms of compliance costs being
reduced and encouraging savings and investment. You would have
95 percent of the people currently dealing with the IRS and the
Tax Code no longer involved with that. I just wonder what you
think about that just as a big bang idea. I am jumping way
ahead. I believe in Mr. Caplin's idea of a commission, and I
think it needs a lot of legitimacy, and why people like you
want it. What do you think about that?
Mr. CAPLIN. I am intrigued by that very much. I know
professor Michael Graetz of Yale has written on this, and he
has a book that goes into that. I really think that this so-
called $311 billion annual tax gap understates the picture.
That estimate deals with so-called legal income only. It
doesn't touch illegal income. You reach far over $500 billion
very easily if you start expanding the study. I think we need
another sieve in collecting taxes. I think there ought to be
some form of VAT or sales tax underneath the income tax system.
I think it ought to be explored. I think it is worthy of
consideration.
Mr. COHEN. Well, I am not a VAT or consumption tax person.
The British experience is interesting. I have spent time with
the British folks who administer the VAT. I spent several days
with them. The Auditor General of Britain just issued a report
on the VAT. I think there is a 17 percent evasion of the
British VAT. It is approximately equal to our evasion of income
tax. If you forgive me a moment of personal reflection, I was
driving back once in the late sixties from the airport from
Santiago, Chile, and a car passed us and it had a little
platform built on the back of the trunk. I didn't pay attention
to it until I saw two or three like it. I turned to the
economic counselor at the embassy who was driving and I said,
What is that? He said, ``That is a truck.'' The excise tax on
automobiles imported into Chile was 300 percent. The excise tax
on trucks was 50 percent.
So, you get into the same definitional problems some have
with the income taxes. The British had this described to me
vividly, running through the definition of everything, because
you won't enact a VAT that is pure and one-rated; you will
enact the VAT that has got exemptions and multi-rated. By the
way, I think there is one or two in the world that are pure.
So, those are the problems. You see, nothing is pure because,
as I said, that genie is out of the bottle. We now know how to
deal with these issues. All of us good guys or bad guys, as the
case may be, will come at you with these problems and you are
going to have to deal with them.
Mr. CAPLIN. We had that same problem with the excise tax.
Mr. COHEN. We repealed all excise taxes while I was in
office, all except three or four, because they were too costly
to administer.
Mr. PORTMAN. Good point in keeping it broad. I think you
need to have it broad based and keep the rate lower, too.
Mr. ALEXANDER. Back to the VAT, I think that Professor
Gratz's VAT would be a VAT that would replace the income tax on
individuals below a fairly sizeable income level. Whether the
income level was $200,000 as one of the Presidential candidates
was suggesting should be the tip point. I am not sure. I think
a credit-invoice VAT--it would have to be a credit-invoice and
not a subtraction VAT. Subtraction VATs aren't much better than
our old excise taxes were. I think a credit-invoice VAT would
work--sure it will get loused up after a while. We are better
at complicating things than we were a few years ago. It might
take us a little while to complicate the VAT. If you zero rate
it for food, you could have a VAT that makes sense from the
standpoint of ability to pay. Then you might have an income
tax, if you wanted to supplement that with an income tax for
higher income individuals. You might keep an income tax, or you
could change the VAT, of course, for corporate entities. You
would have to deal with the fact that I guess you dealt with
last night, that some businesses are conducted as subchapter
(C) entities and some are pass-through entities. I know that is
a problem that concerns the Chairman, and rightly so.
Mr. PORTMAN. Just one quick comment on that, and Mr. Tanner
has been patient, and the Chairman, but I would want to repeal
the corporate income tax, which is going to be controversial,
and that is different from the proposal by Professor Gratz, and
that would require additional revenue. That amount of revenue
is shrinking as a percentage of our total revenue.
Mr. COHEN. The corporate income tax was a third of our
income tax when we were in office. It is now around 10 percent.
Mr. GOLDBERG. Just a couple of observations. One, you could
look at the consumed business income tax, comprehensive
business tax replacement for the corporate tax. I think the
difficulty with value-added tax is the overall progressives of
the tax system. As I am probably the far-right guy on this
panel, I am little uncomfortable raising that, but I think it
is terribly important. Another piece you want to put in the mix
is what you are going to do with the payroll tax. We need to
deal with entitlements. I think if you would replace the
payroll tax, for example, with the consumption tax, it is a
much more progressive levy. I think you would want to put that
in the mix of what you are thinking about. Having said that,
the path you are describing is the right and probably the only
plausible path to go down in the years ahead.
Mr. PORTMAN. Thank you, Mr. Chairman.
Chairman HOUGHTON. Thank you. Mr. Tanner.
Mr. TANNER. Thank you, Mr. Chairman. I also want to thank
all of you for being here. I have enjoyed thoroughly this
panel. It has been something that I think we need to do more
of, and that is talk to people who have been there. People who
are sitting up here today think they are inventing the wheel
oftentimes instead of realizing that mostly everything that has
been talked about has been talked about before, just by
different people.
I think I get the consensus that we are in a mess and we
need to do something rather dramatic with our Tax Code, our tax
system. I think I am correct in assuming we all believe we are
in a place we don't want to be with respect to our Tax Code. If
that is true, I want to ask how we bridge the gap that we have
immediately to that day when we have the consensus, both inside
and outside, to enact a big bang tax reform. Here's where we
are. This country now owes in hard dollar numbers about $4
trillion. This country--we on your behalf have raised the debt
ceiling $2 trillion in the last 36 months. Last year this
government spent $370 billion more money than we had, 70
percent of which was bought not by American citizens but by
foreigners. The central bank of Beijing has increased the
holdings of our paper by over 100 percent over the last 26
months. China and Japan, Asia, we will say, owns almost over
$900 billion of our paper. We will approach a $500 billion
deficit this year; could go more, depending on what happens in
Iraq.
The best that we have been able to discern from the budget
that we passed, assuming a 4 percent rate of growth in the
economy, is to cut that in half in the next 5 years. That means
we are going to borrow another trillion dollars if we reach
that goal, assuming a 4 percent rate of growth in the economy.
Now, Commissioner Goldberg said we have to face reality. This
reality is that we are spending far more money today than we
have. We are borrowing money from virtually anyone in the world
that will lend it to us. When that day comes when they don't
see the world as we do, they will have enormous leverage, in my
judgment, owing to the policymakers that sit on that day,
because we will owe them so much money that they will be able
to exercise undue influence, if you will.
Now, my question is, with that background--and I don't
think anyone would dispute what I have said, it is right out of
the Treasury reports on where we are--with that background,
Commissioner Goldberg, you said we needed to repeal the AMT
right now. I would love to do that. With this background and
putting that much more on the red-ink pile we are building, how
do we get--in this interim, how do we keep from going another
trillion or $2 trillion in the red? This is just an aside; I
believe it is the largest tax increase in history. The reason I
say that is because at 5 percent, $2 trillion is going to cost
the American taxpayers $100 trillion a year, every year. Five
percent is fairly cheap if China, for example, Japan, Saudi
Arabia or anybody else we owe money to, said we don't want the
interest check, we want the money; then I know of no other way
we get it than to auction it to whoever will buy at whatever
price it takes to refinance.
I just think this is a national security matter. I have
talked a lot about it on the floor. I have written op-eds about
this foreign holding. It is true that the deficit has been as a
percentage of our GDP this high before. What is different is
most of that debt was bought by Americans; war bonds, savings
bonds. This debt is being financed by foreign interest. I think
that is a huge difference, number one, from the national
security standpoint. Number 2, under our present budget we are
operating on, we will never get back to balance. If the best we
can do in 5 years is cut it in half, assuming 4 percent rate of
growth in the economy, which is not a small number, and then if
we make the tax cuts of 2001 permanent, knowing the baby
boomers are going to retire in 2012, if you can figure out how
2 and 2 is going to make 4 in that situation, I sure would be
glad to know it, and I just can't get there. I made my speech.
Chairman HOUGHTON. Let me interrupt, though, because one of
the parts of this piece of legislation that we have is
literally phasing in the elimination of the AMT, so by the end
of 2013 you wouldn't have any AMT at all, but you would start
working on it. It would be $10 billion in 2006 and $26 billion
in 2008 and so on and so forth. So, that you don't take it in
one great huge lump, because I don't think the system can
handle that. You are going to get at it in some way, and it
would be nice to have a value-added tax and I think that would
be great. We could do it. From a political standpoint, you can
see what happened in Canada when that went through and the
Conservative Party went from 150 to 1. Now, maybe it will come
back on June 28. There has got to be some way of starting that
process and also starting the education. Maybe you ought to ask
the question.
Mr. GOLDBERG. Mr. Tanner, I think there are serious
structural issues relating to the entitlements program and
relating to the tax system. I think one of the difficulties we
have is we run the government as a cash-method person and the
rest of the world doesn't function as a cash-method person. I
believe at the end of the day, long-term financing is going to
be necessary as part of a restructuring. That is just what is
going to happen.
I think the current deficits as a percentage of GDP are
actually materially lower than they were 20 years ago. I think,
while foreign ownership of debt is an issue--and I agree with
you, it is in some sense a national security issue--I think the
fundamentals of our political economy and society are such that
I don't think people are going to take a hike. I can't sit here
and listen to these folks tell the stories they have been
telling you. I can't listen to the stories about the EITC
recipients who are just being torched, and say in the scheme of
the issues we are facing, yes, the deficit is a terrible
problem, but I think it is so broke that there is an
opportunity to do some very good things for very real people
over the next 2 or 3 years while those responsible for policy
figure out how we are going to restructure these various
programs.
Frankly, I think fixing the AMT over the next years, fixing
the EITC, fixing the definition of a child, those are rounding
errors in the context of the difficulties we are facing. When
you try to strike a balance, I don't understand why you don't
strike the balance the same way, and say we know this thing is
messed up for the reasons you are saying, but in the short one,
get off these people's backs.
Mr. COHEN. Politically we have gotten ourselves in the
view, or many people into the view, that it is a dirty word to
say raise taxes. When President Johnson was in office, I was
one of those people who told him 2 years before he did to raise
taxes, because I could see what was happening. In any event, he
did have a surtax in 1968. That year was the first surplus in
many, many years and it was the last surplus before those 3 or
4 years in the nineties. There is such a thing as saying you
have to pay the piper. You could either keep the present
corrupt system that we have designed, or you can go honest and
tax yourself what you need to tax yourself in order to do the
right thing. Getting rid of the AMT is the right thing, and the
only thing to do it is to pay for it. Now, whether you pay for
it over 3 years or 5 years or over 1 year, you need to sit down
and say we need to address this now. Let us see politically
whether we can do it in 3 years or 2 years or if it is going to
take us 7 or 8 years, but you need to deal with it.
Mr. CAPLIN. In the olden days, we tried to present tax
packages in a balanced way. If we cut rates or something, we
tried to really close special privileges or preferences. We
tried to balance it out. We seem to have forgotten that in
recent years. I think we ought to stick to this balancing of
our tax legislation. Also we have the whole question of Social
Security. What are we doing about that? We had commissions
before. They have made recommendations. We need to follow up in
terms of what has to be done.
Chairman HOUGHTON. Well, gentlemen, I hope we continue to
tap into your knowledge, because this thing is not going to go
away and we are not going to be able to solve it this
afternoon. I thank you on behalf of all of us for your wisdom
and guidance. I hope that Ms. Doherty and Ms. Maresca and Ms.
Parshall have gotten something out of this discussion in
addition to your own testimony. So, we thank you very much.
[Whereupon, at 3:55 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
Statement of Timothy J. Carlson, Arlington, Virginia
I am writing to request your help in a serious and urgent matter
threatening to destroy me and thousands of other hardworking,
productive taxpayers. The IRS has filed liens on my friends' assets,
and is weeks--if not days--away from filing liens on my assets also.
After the IRS is done with me, I will be penniless with no apartment or
car, and no matter how hard I work I will have to live on less than
$1,000 a month for many years, despite having already prepaid over
$850,000 in excess of any tax actually owed, a tax rate of over 350%.
And all this because I was honest.
Please allow me to provide some background on who I am, to give
some context for the situation I describe below. My father was a
minister and my mother a stay-at-home housewife in a small town in
Minnesota. I worked my way through college and law school pursuing the
American dream. I am currently the Broadband Communications Group Team
Leader for Legal Affairs at Texas Instruments. Prior to that I was
General Counsel for Telogy Networks, an entrepreneurial software
company. I am Vice President of Childhelp Virginia (a child abuse
prevention and treatment organization) and have worked for years with
World Vision (an international charity) in its children's programs.
Prior to the situation described below, I donated tens of thousands of
dollars to World Vision Africa AIDS Orphans projects, DC Inner City
work, and to Childhelp. For years I have supported my retired parents
by contributing to the mortgage for their modest retirement home in
Minnesota, and have helped to pay for high school and college tuition
for several other family members.
I describe my life merely to show the kind of hardworking,
productive people being negatively affected by the unintended effects
of the Alternative Minimum Tax (AMT) as applied to Incentive Stock
Options (ISOs). I also hope to show you that the ripple effects go far
beyond the victims themselves, but also affect their families, their
ability to work with and support charitable organizations, and of
course their ability to engage in productive and entrepreneurial
activities.
After three years of struggling to work out a compromise with the
IRS, the IRS has rejected my offer in compromise (OIC) for my 2000 tax
liability (more than $1.6 million with penalties and interest). In a
letter I received on June 18, 2004, Joel Goverman, Area Director for
the Small Business Self-Employed Office in Baltimore, assured me that
the IRS has conducted ``a thorough review of [my] particular issue . .
. before preparing a final response.'' Yet, upon even cursory analysis,
the stated reasons for rejecting the offer are so illogical and
irrational as to approach the bizarre. I mean no disrespect to Mr.
Goverman, who I realize is just the messenger in this situation and I
apologize in advance if my writing becomes too colorful or strident,
but the situation is so strange I hardly know how to convey it
otherwise.
The first reason stated for rejecting my OIC was that ``based on
the financial information you submitted, we have determined you can pay
the amount due in full.'' Mr. Goverman concurred with this analysis and
suggested that the Taxpayer Advocate did as well. However, given the
facts, this is nothing short of Kafkaesque. I have nowhere near the
$1.6 million that the IRS currently seeks. The Taxpayer Advocate
determined that the IRS was overestimating my ability to pay by more
than $650,000. I earn less than $175,000 a year and have already
offered all of my tangible assets to the IRS. For years the IRS has
insisted I have money I simply do not have.
Even if I could pay the amount in full, the IRS could, and should,
accept my offer based on something called Effective Tax Administration.
``Effective Tax Administration,'' as Mr. Goverman (and published
regulations) noted, ``is only applicable if . . . requiring full
payment would create an extreme hardship, or if collection of the full
liability would be unfair, inequitable and would adversely impact
voluntary compliance by other taxpayers.'' The second reason stated for
rejecting my OIC was that ``we have determined that [to accept your
OIC] would have a negative impact on compliance by the general
public.''
After years in law school and practicing law, I can not understand
the ``logic'' of the assertion that accepting my offer will ``have a
negative impact on compliance by the general public''). What taxpayer
is going to look at my case and think
OK, let me get this straight, I have two choices:
Choice One, under the regular tax code I am not required to pay any
tax when I exercise ISOs. The regular tax code encourages long term
investment by offering more favorable long term capital gains rates if
hold the stock for at least one year. Of course, if I report under the
AMT code I will owe prepayment taxes that will destroy me and my
family, but if I do not report the transaction the IRS is unlikely to
catch it because the government has no ``checks'' or information
reporting requirements in place to find out about the exercise. If I
don't report under AMT I'm not really cheating the system because I
haven't realized a dime in profits yet because I haven't sold the
stock, and I intend to fully pay my regular taxes once I do so.
Technically, I suppose this is wrong. But, by not reporting I avoid
destroying my life and, in the end, I still fulfill my duties as a
citizen and a taxpayer when I sell my stock and then report and pay my
fair share of tax.
Choice 2, under the ISO AMT provisions, if I report my ISO exercise
and disclose those phantom profits then I will be complying with an
unintended quirk in the tax code that makes me prepay based on tax
rates that exceed 350% of my actual income. I can always ask the `more
friendly' IRS to please recognize the irrationality at work and give me
a `break' by making me overpay `only' 200% rather than more than 350%.
After all, the legislative history relating to offers based on
effective tax administration tells the IRS it has broad discretion to
accept offers based on public policy.
Of course, the IRS will reject my offer despite the legislative
directive. It will charge me interest and penalties on the amount I am
unable to pay, liquidate all my assets and garnish my wages for several
years, leaving me destitute and destroying any incentive I have to
work. It does not matter that the IRS position of not compromising any
AMT liability is based on some secret memo that it will not disclose to
taxpayers and their representatives. The AMT I am able to prepay
through borrowing and selling other assets, will become a `credit' that
will take hundreds of years to recoup at the $3,000 per year maximum.
``So in conclusion, I guess the IRS policy makes a lot of sense; I
really should report my ISO exercise and be forced to pre-pay tons of
taxes on income I haven't received yet. It's okay that this will mean
that I'll lose my house and car, because I will have millions of
dollars of tax `credits' that I can recoup in $3,000 per year
increments. And really, I want to work more than 60 hours a week to
live on less than 1/5 of my salary while the rest goes to build up more
useless tax credits. My family will understand that I can no longer
contribute to sending the kids to college, and that I will need their
help in the years to come because I can no longer save for my own
retirement. I will have the satisfaction of knowing that I reported
honestly, while those who snubbed the law and did not report their AMT
liabilities enjoy their ``ill-gotten'' gains.''
As is obvious from the imaginary internal dialogue above, in fact
this policy to blindly force an outdated, unfair and unjust law in no
way encourages compliance, but rather presents taxpayers a Hobson's
choice--use `self-help' by not reporting ISO exercises or face the
blind, financially devastating, life-altering enforcement of an unjust
and unintended tax law.
Mr. Goverman suggested that a special Effective Tax Administration
Group in Cincinnati had reviewed my file and determined that my offer
did not meet the criteria because ``the position that the tax law
itself is in [sic] inequitable is not a basis for an ETA offer. As you
are aware, the authority to change the tax law rest [sic] with
Congress.'' Unfortunately, with the exception of the last clause, which
properly notes that Congress has the authority to change the law, his
statement is patently false. The Cincinnati committee never received my
file because an IRS agent who acts as ``the gatekeeper'' saw my tax
liability was due to the AMT/ISO problem and sent it back. This agent
said that the IRS does not have the authority to accept any compromise
of an AMT liability because only Congress can change the law. The agent
could not cite any authority for his statement, nor could he explain
how compromising an AMT liability was any different than compromising
any regular tax liability.
Moreover, my request for an offer in compromise is not based on the
blanket assertion that the AMT law is inequitable. I have only ever
asked the IRS to focus on the individual circumstances of my case. The
only way I could have had the money to pay this exorbitant tax was if I
would have sold the stock before it started dropping in value.
Unfortunately, a sale at that point could have subjected me to the risk
of insider trading in violation of SEC guidelines. It is difficult to
find a time when I could have sold the stock without risking a possible
investigation by the SEC or state attorneys generals because of my
position and the rapid and continued decline in the stock's price. How
can the government stated public policy to encourage strong corporate
governance practices if taxpayers must choose between complying with
tax law and securities law?
Accepting my offer in compromise (and, truthfully, those of many
others who were caught by the AMT/ISO labyrinthine rules) will
encourage voluntary compliance. Further, it would and would be more
fair and equitable than forcing hard-working, middle class people into
bankruptcy to pay a tax on phantom gains they did not receive because
they continued to invest in their employers and the economy as the
government encouraged when it created ISOs. Congress has already
recognized that the stock market crash in 2000-2001 was a unique event
divorced from the normal market risk that investors assume. Congress
has enacted a number of tax cuts and other reforms to stimulate the
economy and provide relief to ailing taxpayers. It should do the same
for the hardworking individuals and families who have been financially
ruined by the ISO AMT rules as a result of that crash.
My case as described above is not imaginary, and the facts are not
hyperbole. And, tragically, I am not alone. Thousands of similarly
bizarre cases have arisen across the country. The IRS decision to
blindly enforce an outdated, misguided and misapplied AMT/ISO tax
provision (which became even more absurd in the context of the market
bubble burst) is ruining the lives of good citizens in practically
every state in this country.
I would never have believed this could happen in America if I
wasn't living through it. I encourage you to first (1) as an interim
measure, instruct the IRS to accept reasonable offers in compromise for
ISO AMT liability to prevent honest taxpayers from being destroyed by
this tax before proper legislation can be passed, and then (2) adopt
focused legislation amending the AMT as it relates to ISOs to restore
fairness and justice to a system gone severely awry. Like me, ISO AMT
taxpayers are willing to pay taxes on actual gains and recognize the
risks of losing an investment in the stock market. Our actions and
intentions were honorable and consistent with Congressional policy, and
hurt no one but ourselves. In fact, our faith in our companies and
refusal to foist losses an unsuspecting public is exactly the kind of
behavior the government should encourage--not punish. I am not asking
the government to replace my lost investment; I am simply asking the
government not to collect taxes as if the investment was never lost.
<F-dash>
Statement of Efrain Rodriguez, Jr., Father's Rights Association of
New York, Mahopac, New York
I am Efrain Rodriguez, Jr., President of the Father's Rights
Association of NYS.
I thank the Committee for allowing us the opportunity to be a part
of this system of government.
There has been a bill, H.R. 86 which would call for, among other
things, the ability of a parent who is paying Child Support to be able
to deduct such support from their Federal Income Tax. I am not sure if
this bill is still active or whether it has been re-numbered.
Sir's, the Child Support System in this country is a train wreck.
While the Father's Rights Association agrees with its tenet, it is the
way it is administered and assessed that cause the most frustration and
sadness for Non-Custodial parents, many who have to choose between
paying their support and supporting their own basic needs. We have many
members who are forced to move in with family and friends who cannot
pay their own rent or provide for their own basic needs. And with the
current Poverty Level of $12,123, where can a parent go and live on
that? Also, in most states, Child Support is based on a parents Gross
Income and taken from their Net Income with make that number almost
untenable, especially when that number does not take into account that
payers personal expenses.
Therefore, the Father's Rights Association of NYS respectfully asks
that the Ways and Means Committee consider hearings on the impact Child
Support has on the payers, the so-called ``Dead Beats'' who for what
ever reason cannot come up with their support obligation and still
maintain their own standard of living. We are NOT an organization of
``deadbeats'' who are trying to shirk their parental responsibility to
our children. We just want the same opportunity as everyone else to
live and grow with our children and not have to choose between being a
parent and supporting oneself at the very bare minimum.
Further, we propose the following changes to the current Tax
Formula:
Any parent who pays Child Support be allowed to deduct that amount
that is paid to supporting their children from their Federal and local
taxes. This will serve two purposes; encourage more parents who
currently not paying their support to give an added incentive to paying
and, this will take that ``bitter taste'' put of the mouths of parents
who feel that they pay this support and have nothing to show for it,
especially the inability in many states to know what the custodial
parent does with the money.
Thank you for your time and attention to this very important
matter. If there is an opportunity to speak to the committee in person
I am available to do so.
<F-dash>
Statement of David R. Klaassen, Marquette, Kansas
Thank you for allowing me to provide this written statement
explaining how the Alternative Minimum Tax has affected my family and
how it continues to affect my family today.
My name is David R. Klaassen. I am a resident of McPherson County,
Kansas, duly admitted and licensed to practice law in the State of
Kansas and before the United States Tax Court, the United States
Bankruptcy Court for the District of Kansas, the United States District
Court for the District of Kansas, the Eighth and Tenth Circuit Courts
of Appeal, and the Supreme Court of the United States. I am a solo
practitioner and maintain my business office at 2649 6th Avenue,
Marquette, Kansas 67464. The focus of my practice is representing
individuals and businesses in financial distress or facing bankruptcy
throughout the State of Kansas.
My wifes name is Margaret. Margaret and I are the parents of
thirteen children. The ages of our children range from six years old to
24 years old. Our youngest just started school at Marquette Elementary
School in Marquette, Kansas, where all of her brothers and sisters have
gone before her. This Fall, five of our children will be attending
Marquette Elementary School and three of our children will be attending
Smoky Valley High School in Lindsborg, Kansas. All of our children who
have graduated from high school have graduated with honors and gone on
to Bethany College which is also located in Lindsborg, Kansas. Three of
our children will be in college at Bethany this Fall. Our two oldest
children have graduated from Bethany with honors and gone on to
graduate school. Our oldest child is in medical school and our second
oldest child is pursuing a graduate degree in business. To date, it
does not appear that there is a bad apple in the whole batch and
Margaret and I are very proud of each of them.
In 1987, our second oldest child, Aaron, was diagnosed as having
cancer. While we were not very successful at first, we ultimately won
the battle for his life thanks to a bone marrow transplant in 1991 from
one of his younger brothers. Well prior to 1994, Margaret and I
liquidated any interests we had in outside investments and retirement
accounts to help pay for the costs associated with Aaron's treatment
which were not covered by our health insurance. The only investments
which Margaret and I now have are in our home and in our family. We are
not involved in any tax shelters or other investment activities which
are normally associated with triggering the AMT.
In 1994, Margaret and I were entitled to and claimed 12 total
personal exemptions on our federal tax return. This increased to 13 in
1995, 14 in 1996 and 1997, and 15 in 1998, 1999, 2000, and 2001. In
2002 and 2003, our total personal exemptions fell to 14. Our joint
adjusted gross income for each of these tax years was well below the
threshold amount established by Section 151(d)(3)(C) of the Internal
Revenue Code which would otherwise reduce the total exemption amount we
could claim. Despite this fact, the subtle mathematics of the AMT in
effect has reduced the total exemption amount to which we are entitled
each year. In this manner, the AMT has become a penalty on large
families solely because of their size. I doubt that this was an
intended purpose of the AMT. However, it is in this very manner that
the AMT has cost my family in excess of $25,000.00 over the past ten
years.
While Aarons cancer has given us some experience with the AMT and
its treatment of medical expenses, it appears that our most significant
experience with this aspect of the AMT is happening this very year.
Since 1991, Margaret and I decided that we would try to maintain the
health insurance policy we had at the time of Aaron's bone marrow
transplant as long as we could just in case his cancer reappeared and
we had to go through another round of chemotherapy and radiation.
During the year of 1991, this cost us $263.82 per month. However, the
premiums steadily increased reaching $1,441.20 per month in 2003. In
January of this year, we were notified by our health insurance carrier
that our premiums were increasing to $2,063.47 per month in April of
2004 and that Aaron would no longer be covered by our policy after he
reached the age of 23 that same month. We cannot pay such high monthly
premiums for any extended period of time. Unfortunately, at this very
same time, I was diagnosed as having prostate cancer. The sad point is
that if we are unable to continue to pay our current health insurance
premiums and must drop our current health insurance coverage, our AMT
bill will increase significantly at the very time when we are facing a
substantial increase in our out-of-pocket medical expenses. Once again,
I doubt that this was an intended purpose of the AMT.
We have sought relief for our situation with the AMT through the
Internal Revenue Service's administrative appeals process, the United
States Tax Court, and the Tenth Circuit Court of Appeals. In 1999, the
Tenth Circuit ruled against us. However, in his concurring opinion,
Circuit Judge Kelly made the following comments:
A. The legislative history supports an argument that the original
purpose of the AMT, one of the more complex parts of the Internal
Revenue Code, was to insure that taxpayers with substantial economic
income pay a minimum amount of tax on it.
For a variety of reasons, the number of moderate income taxpayers
subject to the AMT has been steadily increasing. From a fairness
perspective, many of these taxpayers have not utilized I.R.C. '57
preferences (or other more arcane AMT adjustment items) to reduce
regular taxable income but are caught up in the AMT's attempt to impose
fairness. In the interest of progressivity, the regular tax already
reduces or phases out itemized deductions and personal exemptions based
upon income; surely Congress never intended a family of twelve that
still qualified for these items under the regular tax to partly forfeit
them under the AMT.
That said, we must apply the law as it is plainly written, despite
what appears to be the original intent behind the AMT. The solution to
this inequity, must come from Congress, as the tax court rightly
concluded. Klaassen v. C.I.R., 182 F.3d 932 (10th Cir. 1999)
(unpublished) (concurring opinion of Circuit Judge Kelly).
Please help us to obtain from Congress an equitable solution to
these unintended effects of the AMT.
Thank you again for allowing me to present this written statement
to you. If I can be of any further assistance to your Committee, please
let me know.
<F-dash>
Statement of Alan Veeck, Reform AMT, Pittsburgh, Pennsylvania
I strongly urge you to support legislation that would modify or
repeal the Alternative Minimum Tax (AMT), especially as it applies to
incentive stock options (ISOs). Although unintended, the AMT adjustment
for ISOs has had a significantly detrimental, and in some cases,
devastating, financial impact on individuals like me who exercised ISOs
before the stock market downturn of 2000. Due to a severe depression in
stock prices, many taxpayers who exercised ISOs in that year face AMT
liabilities that are far larger than the exercised stock was worth in
2001 and beyond.
Affected taxpayers face huge tax bills, some in the hundreds of
thousands and millions of dollars, on income that they will never
receive. Although taxpayers can use their AMT payments as credits
against future income, they will likely never recover the AMT credit
because of the way the current law is written. Moreover, collecting
credits into the future is hardly a consolation for those facing
unbelievable cash crunches due to the magnitude of the tax. This result
is vastly inconsistent with Congressional intent in enacting the AMT.
Instead of assuring that ``the rich pay their fair share of taxes'',
the AMT on ISOs is literally leaving middle-class Americans like me in,
or near, financial ruin.
Here is my story: in April 2000, I exercised 6,000 options that I
earned with the company that I helped to build in Pittsburgh--
FreeMarkets, Inc. My exercise price was about $5/share, so I had to
scrape together $30,000 to exercise these options. My plan was to hold
the shares for a minimum of year, but more realistically several years
because I truly believed in the long-term success of my company, and in
this way I could recognize profits from stock sale as capital gains as
opposed to income. I always do my own taxes, so when I fired up
TurboTax and input my financials, I was more than a little shocked to
find that I owed the IRS $85,000, and state and local taxing
authorities about $10,000. This amounted to 110% tax on my earnings,
when I have realized no actual cash gain! In analyzing my available
solutions, even if I exercised my next set of options and sold the
entire lot (12,000 shares), I would not be able to meet my tax
obligation for the 2000 tax year.
Quite obviously, this is an absurd situation. I have always, and
will continue to, pay my taxes like every other red-blooded, patriotic
American. I fully agree with the concept of paying my ``fair share'' on
realized cash gains. But the AMT is forcing me and my family of five to
face real financial ruin. My mother and father pulled significant money
from their retirement savings to loan me money to pay the government so
that my family did not have to sell its most important possessions. I
haven't had to borrow money from my parents since I was sixteen!
Your support for AMT reform is crucial, as this unfair and
unintended tax is beginning to affect more and more honest, hard-
working taxpayers in the lower and middle income brackets.
Thank you for your consideration of this very important issue.
<all>