<DOC>
[109 Senate Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:27532.wais]
S. Hrg. 109-785
POTENTIAL EFFECTS OF A FLAT FEDERAL INCOME TAX IN THE DISTRICT OF
COLUMBIA
=======================================================================
HEARINGS
before a
SUBCOMMITTEE OF THE
COMMITTEE ON APPROPRIATIONS UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
SPECIAL HEARINGS
MARCH 8, 2006--WASHINGTON, DC
MARCH 30, 2006--WASHINGTON, DC
__________
Printed for the use of the Committee on Appropriations
Available via the World Wide Web: http://www.gpoaccess.gov/congress/
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__________
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COMMITTEE ON APPROPRIATIONS
THAD COCHRAN, Mississippi, Chairman
TED STEVENS, Alaska ROBERT C. BYRD, West Virginia
ARLEN SPECTER, Pennsylvania DANIEL K. INOUYE, Hawaii
PETE V. DOMENICI, New Mexico PATRICK J. LEAHY, Vermont
CHRISTOPHER S. BOND, Missouri TOM HARKIN, Iowa
MITCH McCONNELL, Kentucky BARBARA A. MIKULSKI, Maryland
CONRAD BURNS, Montana HARRY REID, Nevada
RICHARD C. SHELBY, Alabama HERB KOHL, Wisconsin
JUDD GREGG, New Hampshire PATTY MURRAY, Washington
ROBERT F. BENNETT, Utah BYRON L. DORGAN, North Dakota
LARRY CRAIG, Idaho DIANNE FEINSTEIN, California
KAY BAILEY HUTCHISON, Texas RICHARD J. DURBIN, Illinois
MIKE DeWINE, Ohio TIM JOHNSON, South Dakota
SAM BROWNBACK, Kansas MARY L. LANDRIEU, Louisiana
WAYNE ALLARD, Colorado
J. Keith Kennedy, Staff Director
Terrence E. Sauvain, Minority Staff Director
------
Subcommittee on the District of Columbia
SAM BROWNBACK, Kansas, Chairman
MIKE DeWINE, Ohio MARY L. LANDRIEU, Louisiana
WAYNE ALLARD, Colorado RICHARD J. DURBIN, Illinois
THAD COCHRAN, Mississippi (ex ROBERT C. BYRD, West Virginia (ex
officio) officio)
Professional Staff
Mary Dietrich
Kate Eltrich (Minority)
Administrative Support
LaShawnda Smith
C O N T E N T S
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Wednesday, March 8, 2006
Page
Opening Statement of Senator Sam Brownback....................... 1
Statement of Hon. Richard K. Armey, Chairman, FreedomWorks....... 4
Prepared Statement of........................................ 6
Statement of Daniel J. Mitchell, McKenna Senior Fellow in
Political Economy Domestic Policy Studies, The Heritage
Foundation..................................................... 10
Prepared Statement of........................................ 13
Statement of Chris Edwards, Director of Tax Policy, Cato
Institute...................................................... 18
Prepared Statement of........................................ 20
Statement of Stephen J. Entin, President and Executive Director,
Institute for Research on the Economics of Taxation............ 23
Prepared Statement of........................................ 26
Prepared Statement of Paul Strauss............................... 51
Thursday, March 30, 2006
Opening Statement of Senator Sam Brownback....................... 53
Statement of Hon. Natwar M. Gandhi, Chief Financial Officer,
Government of the District of Columbia......................... 55
Julia Friedman, Ph.D., Chief Economist, Government of the
District of Columbia........................................... 55
Prepared Statement of Natwar M. Gandhi........................... 61
Statement of Terence C. Golden, Chairman, Federal City Council... 71
John Hill, Chief Executive Officer, Federal City Council......... 71
Prepared Statement of Terence C. Golden.......................... 73
POTENTIAL EFFECTS OF A FLAT FEDERAL INCOME TAX IN THE DISTRICT OF
COLUMBIA
----------
WEDNESDAY, MARCH 8, 2006
U.S. Senate,
Subcommittee on the District of Columbia,
Committee on Appropriations,
Washington, DC.
The subcommittee met at 2:05 p.m., in room SD-124, Dirksen
Senate Office Building, Hon. Sam Brownback (chairman)
presiding.
Present: Senators Brownback and Allard.
opening statement of senator sam brownback
Senator Brownback. Good afternoon. I'm delighted to have
you all here to discuss a very interesting topic, a very
important topic that we're going to explore this afternoon.
We're going to look at creating a fairer, simpler tax
system in the District of Columbia. I believe that a voluntary
flat Federal income tax for the District of Columbia residents
would give us real-world valuable information about whether a
flat tax is actually better than the current cumbersome system.
I believe most taxpayers in the District of Columbia would
welcome this opportunity. I believe most taxpayers in my State
of Kansas would welcome this opportunity. But since I do not
believe that we should merely impose a new system on D.C.
taxpayers overnight, I would suggest that those who want to
stay under the current tax system should feel free to do so. I
think, however, that if people are given a chance, they'll
abandon the current burdensome system.
What we are discussing here is creating an optional flat
tax in the District of Columbia. Every year, taxpayers in the
District of Columbia suffer, like all Americans, from the
burden of our complex and complicated Tax Code, confused by
over 800 pages of IRS tax forms, perplexed by hundreds of pages
of IRS instruction books, and nervous that they will make a
mistake trying to calculate how much of their own money they
have to hand over to the Federal Government.
Now, I want to show you something here. We've got the
Internal Revenue Code here. And here is just the Internal
Revenue Code. I'm just holding it up for thickness. I did my
weightlifting this morning so I could get this done. This is
just the Internal Revenue Code itself. These are the words. I
want to show you, if you're thinking this is the big-print
edition of it, it's not; it's very fine print on all those
pages.
Now, that's not enough. I'm trained as a lawyer, I have to
admit. You don't just go to the Code, you go to the regs to
understand the Code. This is the Internal Revenue Code
regulations that interpret these books. So, this is setting the
guidance for what these laws are. And I want to just stack
these all in front of you, so you can see the size of the
Internal Revenue Code. And the laws and the books that
interpret them is this size. This stack is the Internal Revenue
Code and the regulations. It is unbelievably complex. It is
unintelligible. You can have the most intelligent tax lawyer in
the world, five of them, and they'll give you five answers to
the same question. It is too burdensome. It is too complicated.
As one tax expert told me, it needs to be taken out behind the
barn and killed with a dull axe. It's too much. And I can
barely lift it, on top of that.
We need to create a different system. We need a system that
people can understand, that's comprehensible.
This confusion of the current Tax Code is one reason why
almost two-thirds of all taxpayers have given up trying to
figure out how to complete their own tax returns. Two-thirds
now spend more of their hard-earned money just so someone else
can try to sort it out. And I don't blame them. I do the same
thing.
I believe that our tax system should be fair, simple, and
easy to understand. One way to make the system fair is to have
taxpayers pay taxes based on a single flat rate that is applied
to all taxpayers equally. Such a flat tax rate would only be
applied to the amount of earned income above an exemption
level, based on family size. Such an exemption level should be
somewhere between $5,000 and $7,000 for each member of the
household, so, at the higher exemption level, a couple with two
children earning $28,000 would pay no Federal income tax at
all.
I do not think that the dollars that wage-earners have
already paid taxes on should be taxed again when those dollars
are saved or invested. This is a double taxation. It's a
disincentive to savings and a disincentive to investing.
As long as a flat tax rate is reasonable, it is a fairer
tax than the current system, because it taxes all earned income
at the same rate. Workers would not be punished for working
harder and earning more money, because each dollar that they
earned would be taxed at the exact same rate. This is fairer,
it is simpler, and is a much easier to understand system, which
would produce more economic activity and jobs.
For years and years, policymakers and economists have
debated how taxpayers would fare under a flat tax. I think we
should stop speculating and debating and actually test the idea
of a flat Federal income tax, and do it here in the District of
Columbia, the Federal district. Some have questioned why we
should give the District of Columbia this opportunity for
fairer and simpler tax treatment while the rest of the Nation
must continue to labor under the present nightmarish Tax Code.
Believe me, I'd like to see a fairer tax system for all
taxpayers in every American city, particularly for taxpayers in
Kansas. And I would offer that we could do this as a model for
the District of Columbia and Kansas, if you want to try two
places. That would be fantastic.
Now, while everyone talks about the need to simplify the
Tax Code, real reform has been stymied by those who come up
with all kinds of excuses to prevent us from fixing the broken
system. The Federal Government has the authority to try a
first-ever flat Federal income tax here in the Nation's
Capital, because of the unique relationship it has with the
District of Columbia, which our founding fathers set out in
article I, section 8 of the Constitution. One result of
Washington, DC being the seat of the Federal Government is that
42 percent of all District property is not subject to local
taxation. By Federal law, the District is precluded from taxing
income at its source for those workers who are not residents of
the District. The result is that 70 percent of income earned in
the District cannot be taxed to support District municipal
services. To some extent these Federal restrictions on the
District's taxing authority have led city leaders to impose
very high local income, property, and sales tax. In fact, for
decades, residents of Washington, DC have endured one of the
Nation's highest tax burdens. These high tax rates have been
one reason that between 1970 and 2003, the District's
population dropped by 26 percent, even though every neighboring
county gained in population during this same time period.
I believe that a flat Federal income tax would create more
economic activity and jobs in the District, which would enhance
the District's ability to raise revenues while actually
lowering its own high local taxes.
I look forward to hearing from our panel of distinguished
experts about how a flat Federal income tax could work in the
District of Columbia and what they think the effects of such a
system would be.
I'll introduce our panelists now, all together, and then we
will have each of them present their testimony. And I'm looking
forward to this.
First would be the Honorable Dick Armey. He spent 18 years
in the House of Representatives serving as majority leader from
1994 until 2002. Since he's retired from the House, Mr. Armey
has continued his fight for lower taxes, less government, more
freedom as co-chairman of the grassroots nonprofit organization
FreedomWorks.
Daniel J. Mitchell is the McKenna senior fellow in
political economics at The Heritage Foundation. His major
research interests include tax reform, Social Security, and
international tax competition. He's one the Nation's leading
experts on the flat tax.
Stephen J. Entin is president and executive director of the
Institute for Research on the Economics of Taxation. He was
Deputy Assistant Secretary for Economic Policy at the Treasury
Department from 1981 to 1988, and developed the 1981 tax cuts
in President Reagan's enterprise zone legislation.
And our final witness is Chris Edwards, who's director of
tax policy studies at the Cato Institute. He's an expert on
Federal, State, and local tax and budget issues. Previously, he
was a senior economist on the congressional Joint Economic
Committee examining tax, Social Security, and entrepreneurial
issues.
I want to thank each of you for being here today. We will
include your full statements into the record. I would ask, if
you could, to make your presentations around the 7-minute mark,
if you can, so that we can have a good discussion afterward. I
do appreciate each of you coming to discuss this issue of a
flat tax in the District of Columbia.
Honorable Dick Armey, delighted to have you back in these
halls, and the microphone and the floor is yours.
STATEMENT OF HON. RICHARD K. ARMEY, CHAIRMAN,
FREEDOMWORKS
Mr. Armey. Thank you, Mr. Chairman. And let me say, it's a
pleasure for me to be back, as well, and especially addressing
this subject, which is near and dear to my heart.
Let me--I think maybe I'll give you a little--talk a little
bit about the intellectual history of the flat tax. We have my
formal testimony available for the record.
The flat tax was first conceived at the Hoover Institute by
Professors Hall and Rabushka in 1984. In fact, I ran on the
flat tax in my first race for Congress in 1984. And the--there
was a fervor, as you know, for tax reform that went to 1986,
and, at that point, since many people thought the 1986 bill
either represented the fact that the job was done or that the
job was hopeless--I'm not sure which conclusions were drawn--
tax reform, at least at that level of interest, seemed to wane.
In 1994, I rehabilitated the original Hall-Rabushka idea and
reintroduced it in Congress, along with Senator Shelby, and
we've worked around that, as you know. Then it's become a
matter of issue in Presidential races with Steve Forbes and
others.
It's--it was, in 1984, and remains today, a good idea that
is proven out when it is applied. The idea of applying the
notion to the District, as compared to the rest of the world--
and I won't go into all of the chapter-and-verse details of the
burden of the taxes, all that is very--will be in the record. I
think, though, it is an intriguing idea, about applying in the
District of Columbia.
Let me say that this would probably be the most
comprehensive and effective enterprise zone legislation you
could have for the District or for any other area. The fact
that it is voluntary, I think, results in what could be the
most difficult problem in its application for the District. And
I should remind you that Delegate Eleanor Holmes Norton
advanced this same idea about 10 years ago.
Let me first take the enterprise zone. The fact of the
matter is, if you take the flat tax in its application as an
option available to people who live in the District, obviously
most anybody with a complex, befuddling, and, I dare say, risky
tax filing--and I say that seriously, because the fact of the
matter is, for most of us, even though we do our dead level
best, we ask and obtain good advice, and we do our--an earnest
effort to comply with the law, as you have pointed out, nobody,
even in the IRS, can be 100 percent certain they understand the
law, so that, indeed, we all live with the risk that we may
inadvertently, after the first best rigorous good-faith effort,
have made what somebody construes to be a mistake that would
get us before the auditors; and, frankly, for most Americans,
this is not a happy experience--in any event, most people, when
given the option, I believe, will opt for the simplified form,
largely because it just makes life safer and simpler; second,
because it will lower their taxes, in most instances. Also, if
you are--if you apply it to the business enterprise, when you
throw in the two big innovations in the code as it relates to
business, which is expensing of capital and inventory, it
becomes an enormous attraction for business.
So, the upshot of its application here in the District, I
would argue, would be to attract many people back from the
suburbs into the city--who make their living in the city--and
to attract a good bit of business enterprise, particularly
small-business enterprise, back into the city, and do what we
have seen done effectively with enterprise zone legislation in
other areas, in a large and significant--to a large and
significant degree.
That argument, I think, is verified by watching the
application of the tax in Eastern European nations after the
fall of the Soviet empire. We have seen economic growth coming
most quickly to those countries that most quickly went to the
flat tax and set up their economy to be receptive for that. And
other companies--countries now coming to the notion in order to
catch up with the growth experiences they've seen. And very
little is available to offer the different--an explanation for
the different growth experiences of the different Eastern
European countries, other than their tax structure. So, it
seems to me there is a very good validation of the notion that
the enterprise zone effect will work, and work well, for the
District of Columbia.
The fact that it's voluntary is, I think, very important. I
like to think, because I'm such a fan of the big--of the flat
tax, that I'd like to couch it in terms of those: those who are
foolish may choose to stay with the old system. That's not
altogether fair. Given the fact that so much of income
maintenance is transferred to the American people through the
Tax Code in such things as income tax credits of a variety of
forms, it can appear that lower-income people, who are
accustomed to taking their income transfer from the Federal
Government in the form of the tax credits, might very well opt
to stay with the old Tax Code. Unless there was an also
attendant piece of legislation that alternatively provided for
those same transfers to these people who are currently enjoying
the tax credits, I believe that you would find that you would
have less than a full participation in the flat tax, because
the best, most rational reason for a person to stay with the
old Tax Code would be to enjoy those income transfers not
available under the flat tax. I would say, though, that that
pretty well would define the population of people who would opt
to stay with the old Code. I see no--as I've studied the code
and the contrast of the two, I see no good reason.
There are many myths about the existing Tax Code, that, for
example, if you own a mortgage, you will lose. I promise you,
most mortgage holders find they're better off with the flat tax
than with a mortgage. We can talk about that later. One thing I
do, again, want to say, it is voluntary. That's a good thing.
My final observation, Mr. Chairman, would be that should
you succeed in having this opportunity available to the
citizens of the District of Columbia, you're going to have a
tough time explaining to the citizens of Manhattan, Kansas,
``Why them and not us?'' Because I think it will be observed,
appreciated, and recognized as a great benefit to the citizens
of this city.
Senator Brownback. Well, that's why I've offered to have
two pilots on this. We could do it in Washington, DC, and
Kansas, just to pick a random State out that would be another
one to provide this option to. But this is a particularly
unique situation with the Federal District here. And so, I
wanted to try and offer it here.
Thanks, Congressman Armey, appreciate seeing you,
appreciate you being back.
[The statement follows:]
Prepared Statement of Richard K. Armey
Good afternoon Mr. Chairman and Members of the committee. I am Dick
Armey, former House Majority Leader, and currently Co-Chairman of
FreedomWorks, a nonpartisan, nonprofit grassroots organization with
more than 700,000 members that works for lower taxes, less government,
and more freedom. Thank you for inviting me here today to discuss a
flat federal income tax for the residents of Washington, DC.
This is an opportunity to bring to the residents of Washington, DC,
the benefits of fundamental tax reform that Eleanor Holmes Norton had
hoped to bring to the District 10 years ago when she introduced a
similar bill. She realized the economic growth such reform would offer
the city. It is an opportunity to bring to the residents of Washington,
DC, the benefits we should eventually bring to the whole country.
Currently residents in nine countries around the world enjoy the
benefits of a flat tax, and many other countries are considering this
approach, from the United Kingdom, to Germany, to China.
A flat income tax is fair, honest, simple, and pro-growth. That is
what the American people want. They know that our current income tax
system is broken. It is complex, it is unfair, it inhibits savings,
investment and job creation, it imposes a heavy burden on families, and
it undermines the integrity of the democratic process. It cannot be
repaired by any tinkering or fine-tuning. It must be completely
repealed and replaced with a flat income tax. While we should do this
on a nation-wide basis, doing so for the District of Columbia is a good
start.
Under a flat tax, like in the Armey-Shelby flat tax bill introduced
as recently as the 107th Congress, all income is taxed once and at one
rate. Wage and pension income tax is collected from individuals. All
other income tax, including investment income tax, is collected from
businesses. Individuals fill out a tax return the size of a postcard.
Business owners pay the same tax rate on profit (revenue minus
expenses) and would file an equally straightforward tax form.
To achieve the highest level of simplicity and fairness, all
deductions and credits should be eliminated. The only exception in most
proposals is for a generous personal exemption that every American
would receive. For a family of four, for example, the first $40,000 in
income could be exempt from tax. The personal deduction amount (which
should be indexed to inflation) and the flat tax rate should be
calculated to be revenue neutral, so as to not increase the deficit in
the process of enacting this important reform.
The flat tax is pro-family. It contains no marriage penalty and can
be constructed to nearly double the deduction for dependent children.
By ending the multiple taxation of saving, the flat tax provides all
Americans with the tax equivalent of an unlimited IRA. This will make
it easier for families to save for a home, a vacation, a college
education, or retirement. The flat tax replaces the current income tax
system, but does not affect the Social Security and Medicare payroll
taxes.
With a flat tax, there are no breaks for special interests. No
loopholes for powerful lobbies. Just a simple tax system that treats
every American the same. The flat tax would simplify the tax code,
promote economic opportunity, and restore fairness and integrity to the
tax system--all problems in the current system that need correcting, as
I will detail in these next paragraphs.
Current Tax Code Problems and the Flat Tax Solution
The Current Problem: Complexity
The residents of Washington, DC, alone spend over 12 million hours
completing their taxes. This is because the U.S. income tax code is
unnecessarily complex; it is a monument to unnecessary waste. The IRS
sends out eight billion pages of forms and instructions each year
which, if laid end to end, would circle the earth 28 times. Nearly
300,000 trees are cut down each year to produce the paper on which IRS
forms and instructions are printed. The code exceeds 60,000 pages, and
it takes Americans 6.6 billion hours to complete their taxes every
year, which is more time than it takes to build every car, truck, and
van produced in the United States. It now takes an average of over 26
hours to file a standard 1040 and over 60 percent of Americans turn to
professional help to file their taxes. Simply complying with the tax
code imposes national costs as high as $194 billion annually. That
comes to about $650 for every man, woman, and child in America, or a
cost of about $360 million on the people of Washington, DC alone.
The Flat Tax Solution: Simplicity
The flat tax replaces the current income tax code and its maze of
exemptions, loopholes, and targeted breaks with a system so simple
Washingtonians could file their taxes on a postcard-size form. It has
been estimated that a flat tax would reduce compliance costs by 94
percent, saving Washington DC taxpayers as much as $334 million in
compliance costs each year. That's money that could be saved, invested,
or spent at businesses in Washington.
The Current Problem: Unfair
The main reason the tax code is so complex is the proliferation of
deductions, credits, and other special preferences in the tax law.
Because of these loopholes, taxpayers with similar incomes living next
to each other, or in different parts of Washington can pay vastly
different amounts in taxes. This uneven treatment of taxpayers is
fundamentally unfair and is at odds with the American value of equality
under the law.
The Flat Tax Solution: Fairness
The flat tax will restore fairness to the tax law by treating
everyone the same. No matter how much money you make, what kind of
business you are in, whether or not you have a lobbyist in Washington,
you will be taxed at the same rate as every other taxpayer.
However, by incorporating a large personal deduction, progressivity
is maintained. This is what led D.C. Delegate Eleanor Holmes Norton to
call her proposal a ``uniform tax'' rather than a ``flat tax'' which
she felt incorrectly implied that is was not progressive. Under the
flat tax, or uniform tax, the more you earn, the more you pay. In fact,
because of the high family exemption, the more a taxpayer earns, the
greater the share of his income he pays in tax. A family of four
earning $25,000 would owe no tax under a proposal like the Armey-Shelby
flat tax. A family of four earning $50,000 would pay only 6 percent of
its income in income taxes while a family earning $200,000 would pay 14
percent. But they would all have the same personal deduction, and the
same rate on income above that deduction.
The Current Problem: Hindering Economic Opportunity
The tax code reduces incomes through punitive taxes on saving,
work, and entrepreneurship. It places multiple layers of taxation on
saving, thus reducing investments in new machines and technology that
make Washington's workers more efficient and competitive. High marginal
tax rates (that is, the tax rate on the last dollar earned) discourage
work, saving, and entrepreneurial activity, which leads to a smaller
and less productive economy. By favoring certain economic activities
over others, the tax code distorts financial decisions and reduces
economic efficiency. Dale Jorgenson, the chairman of the Economics
Department at Harvard University, found that each extra dollar the
government raises through the current system costs the economy $1.39.
The Flat Tax Solution: Prosperity
Because the flat tax treats all economic activity equally, it will
promote greater economic efficiency and increased prosperity. When
saving is no longer taxed twice, people will save and invest more,
leading to higher productivity and greater take-home pay. When marginal
tax rates are lower, people will work more, start more businesses, and
devote fewer resources to tax avoidance and evasion. And because tax
rules will be uniform, people will base their financial decisions on
common-sense economics, not arcane tax law.
The calculations that have been done to estimate the national
benefits of a flat tax can be very roughly recalculated to figure out
how much better off Washington, DC, would be. However, these numbers
may be low since the barriers to capital and individual movement within
the United States to a flat tax area like Washington, DC are so much
less than the barriers to such movements from other nations to a flat
tax United States, which is on what the initial estimates are based.
According to one study by a former chief economist for Congress'
Joint Committee on Taxation, under the flat tax the economy would be
5.7 percent larger after five years than under the current system. That
translates into over $500 billion in higher output--or roughly $927
million for Washington, DC. That's more than $3,000 in higher income
for the typical family of four. Michael Boskin, a former chairman of
the Council of Economic Advisors, estimates that the flat tax would
increase the size of the economy by 10 percent.
The Problem: Undermining Good Governance
The current tax code does more than complicate people's lives
during tax season and reduce living standards. It pollutes Washington's
political culture. As special-interest provisions have been added to
the tax code, Washington's lobbying industry has flourished. The
accompanying chart shows how the growth of the lobbying industry has
coincided with the increased number of words (and special-interest
provisions) in the tax code.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Washington's lobbying industry is the largest private employer in
the nation's capital. If the lobbying industry were its own economy, it
would be larger than the economies of about 60 countries. Since 1998,
483 companies have lobbied the IRS alone, hiring 2,884 tax lobbyists,
including 277 former federal government employees. While the thousands
of lobbyists in Washington have prospered in an environment of tax
favoritism, the typical taxpayer has not.
While offering a flat tax to Washington DC alone would have little
impact this problem, but it could be argued that a nation-wide flat tax
would virtually eliminate Washington's tax lobbying industry, which
would be a blow to Washington's economy, but a repercussion about which
few Americans would complain.
The Flat Tax Solution: Transparency
By eliminating itemized deductions and special breaks, the flat tax
would have a chilling effect on special-interest lobbying and transform
the political culture in Washington. Under a simple, transparent system
that taxes all income one time--and requires a supermajority vote to
add a loophole--there will be far fewer lobbyists than under today's
special-interest, free-for-all tax system.
Frequently Asked Questions
Many D.C. residents find the flat tax to be a powerful and
liberating idea. They like the fact that it is in line with the
fundamental American understanding that everyone should be treated
equally before the law. Of course, any major change leads even the
strongest supports to ask questions like the following:
Won't charities suffer as a result of the flat tax?
No. As incomes rise under the flat tax, so, too, will donations to
America's charities. As the nearby chart shows, over the past several
decades, increases in giving have closely tracked increases in personal
income. This trend continued even during the 1980s when the tax value
of the deduction declined and fewer taxpayers were able to take the
charitable deduction. Because incomes will increase significantly under
the flat tax, giving will rise in the long run as well, even without
the charitable deduction.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
But is the flat tax progressive?
Sure it is, because of the generous family allowances--the only
deduction that should be allowed. In the Armey-Shelby flat tax bill,
the first $33,300 of income for a family of four was exempt--about
$40,000 in today's dollars. As a result, middle-income people would pay
a far lower share of their income in taxes than the rich, and the poor
would pay nothing at all. Think about it. If a family of four makes
$50,000 under the Armey-Shelby flat tax, the 17 percent flat-tax rate
applies to less than a third of that family's income. But if a family
of four makes $200,000, the 17 percent flat tax rate applies to 80
percent of that family's income.
But even if the flat tax didn't have this progressive feature, the
rich would still pay a lot more in taxes than the middle class or the
poor. With three times the net income (after taking out your personal
exemption) you would pay three times the taxes. And so on. That seems
pretty fair to me.
Would the family allowance be indexed for inflation?
If the proposal for D.C. is similar to the Armey-Shelby proposal,
yes.
Will the flat tax increase taxes on the middle class?
No. Washingtonians at all income levels will have their taxes
reduced. Not only will taxpayers keep more of their money, but their
incomes will increase. Under the flat tax, the typical family will see
its income rise by $5,000 to $7,000 within five years.
I've heard the flat tax doesn't tax investors' income. Is
this true?
No, that is flat wrong. The flat tax taxes all income at the same
rate, whether it comes from wages, stock dividends, or some other
source.
How will the flat tax affect pensions, 401(k)s, and other
retirement plans?
Because the flat tax ends the bias against saving, in effect, all
income that is saved will be treated like an IRA or a pension.
Currently, IRAs, 401(k)s, and pensions are unusual because they are
taxed only once. Under the flat tax, all savings will be taxed only
once. That will make it easier for Americans to save for their
children's education, their own retirement, or anything else.
Conclusion
The flat tax is so popular with the American people, and so many
Washingtonians, because it embraces the core belief that all Americans
should be treated equally. Rich or poor, black or white, we should all
be viewed equal before the law. No more favoritism toward some citizens
and harassment of others. No more loopholes. No tax breaks for
corporations. No tax shelters. No depreciation schedules. No tables.
Nothing.
Instead of sending out pages and of pages of forms each year, the
IRS would need to send out just one post card to every taxpayer.
Washington's taxpayers would be spared more than 12 million hours of
compliance time as they would be able to fill out their tax form post
card in minutes. Everyone would make the same simple calculation:
income, minus personal deduction, times tax rate. That's it.
The simplicity and fairness would further the economic renaissance
Washington, DC has seen over the past 10 years. The estimated $927
million in higher economic output in Washington over the first five
years of the flat tax would go a long way toward bringing the city's
increased prosperity to every corner of the nation's capital.
Thank you.
STATEMENT OF DANIEL J. MITCHELL, McKENNA SENIOR FELLOW
IN POLITICAL ECONOMY DOMESTIC POLICY
STUDIES, THE HERITAGE FOUNDATION
Senator Brownback. Dr. Mitchell, good to have you here, and
would appreciate your thoughts and suggestions and advice on
this.
Dr. Mitchell. Well, thank you, Mr. Chairman.
With your permission, I'll just summarize a few of the
points in my testimony and submit the rest for the record.
I want to touch on a couple of, I guess, theoretical
points, but then focus most of my remarks on some of the
practical issues, some of the real-world evidence that
surrounds tax reform.
And probably the number one thing to start with is to keep
in mind that we live in a globalized economy today. It is so
much easier than it's ever been for jobs and capital to cross
borders. This is one of the reasons why a District of Columbia
flat tax would be such a great pilot program, because we would
see so much faster growth, so many new jobs being created in
the District of Columbia, that the rest of the country would
put a lot of pressure on Congress, and I think we would break
through the special-interest logjam and finally get fundamental
tax reform if we had it in one jurisdiction. And the District
of Columbia, of course, would be an ideal place to start it,
because it truly is, as Congressman Armey mentioned, the
enterprise zone of all enterprise zones.
But, of course, this also applies internationally, not just
inside the United States. We have seen--and I'll talk about
this a little bit later--some of the countries that have put in
place flat taxes, how revenues have gone up for government, how
economic growth has boomed, how jobs have been created, how
investment is flooding in. These are all positive things that
maybe 20 years ago we didn't really have that much evidence to
talk about. We had Hong Kong, but, for some reason, people
wanted to say Hong Kong's a special case. I never understood
why it was a special case. It showed that low taxes and a light
burden of government frees up the entrepreneurial energy of
people and leads to incredibly rapid economic growth.
Let me just talk about some of the key principles of what
you find in a flat tax.
A low tax rate. Why a low tax rate? Because taxes are a
price. Lawmakers across the country understand this when
they're talking about tobacco taxes. ``We need to raise tobacco
taxes to discourage people from smoking.'' Now, whether that's
the right job of government to do, the economic analysis is
correct. The higher the tax rate, the less you get of
whatever's being taxed. Let's apply that same lesson to work,
saving, investment, risk-taking, and entrepreneurship. We want
a low tax rate on those things, because those are the things
that create wealth, create jobs, and build a more competitive
country. So, principle one is, you want the tax rate as low as
possible.
Second big principle: don't double tax savings and
investment. If you earn money, pay tax on it, and you then
decide to save and invest it, you shouldn't be hit with extra
discriminatory layers of taxation simply because you save and
invest. And, unfortunately, under our current tax system,
between the capital gains tax, the corporate income tax, the
personal income tax, and the death tax, you can have a single
dollar of income taxed four different times. So, even if you
get the rate low, but if you cycle the dollar through the Tax
Code four times, the effect of marginal tax rate can be very
high. And this is especially foolish. Every economic theory,
even Marxism and socialism, they all agree that capital
formation is really a prerequisite for a long-run economic
growth and higher living standards. And yet, we reserve the
very highest tax rates in our system for the people who are
setting aside the seed corn of savings and investment for
future economic growth.
And then, of course, you want a simple system that gets rid
of all the special preferences and penalties. We don't want
industrial policy through the Tax Code--or at least we
shouldn't want that--if we want people to make decisions on the
basis of market factors, what's going to create the most
wealth, as opposed to political factors. You can--with the Tax
Code, you could encourage people to build factories that make
candy bars that taste like onions. There's no doubt in my mind.
You could do that through the tax system. But would it make
sense? Wouldn't it be better to have that capital being
invested in ways that actually generate long-run economic
growth? And what a flat tax does is, by stripping out all the
special-interest clutter in the tax system, we actually have a
system that not only lowers compliance costs--you know, the
$200 odd billion that people have to pay for tax lawyers,
accountants, lobbyists, preparation, man hours--all that goes
away. But perhaps an even bigger number, which is harder to
calculate, I'll admit, is the notion that people are going to
start making decisions solely on the basis of what's good for
the economy, and that's going to generate much, much better
economic performance.
And probably the thing to focus on is, what have we
actually seen in the countries that make those decisions? Ever
since the collapse of the Soviet empire, we have seen now 10
countries--because we just have Kyrgyzstan--I had to look it up
on the map--Kyrgyzstan just joined the club a couple--less than
1 month ago. But we have the three Baltic countries of
Lithuania, Latvia, and Estonia, we have Slovakia, Ukraine,
Russia, Georgia, Romania, Kyrgyzstan--I should probably cheat
on the--look on the list there--Serbia--make sure I'm not
missing one. If you look at the results in those countries,
it's truly remarkable. The three Baltic countries are now known
as the ``Baltic Tigers.'' They've already made all the
requirements for joining the European Union, which means
they're developed countries, a remarkable period of growth
following the adoption of flat taxes, and, to be fair, lots of
other market-oriented policies.
The whole world--you know, notwithstanding my view on
things, I realize the whole world doesn't revolve around taxes.
But a good tax system is a precondition for rapid economic
growth. And the countries that put in those flat taxes the
longest period ago, back in the mid 1990s for the Baltics, have
certainly grown the fastest. But even if you look more
recently--Russia did a flat tax effective January 1, 2001.
What's happened? They've got strong economic growth. Some of
it's due to oil prices, of course, but it's especially
interesting to see what's happened to personal income tax
revenues. In less than--in just 4 years, personal income tax
revenues, even after adjusting for inflation, have gone up by
more than 100 percent. Why? Two factors. One, when your tax
rate is very low, your incentive to evade the system falls
dramatically. I mean, if you're paying 30 percent, your
incentive to cheat is a lot higher than if you're paying 13
percent. And I will note that former communists came up with a
flat tax four points lower than the former House majority
leader was able to propose, which----
Senator Brownback. I always had questions about Dick
Armey----
Mr. Armey. The communists didn't have CBO scoring, or I'd
have been there.
Dr. Mitchell. Slovakia is another great example. They
probably have one of the purest flat taxes out there, most
closely related to the Hall-Rabushka proposal that was embedded
in the proposal of Congressman Armey's. And Slovakia has just
had an enormous increase in foreign direct investment, an
enormous increase in jobs, and their economy is doing very
well. Again, income tax revenues are above the projections.
And we even have international bureaucracies, like the IMF
and the World Bank, now writing papers and studies trumpeting
the Slovakian flat tax. They weren't that sympathetic when it
was being debated. But even they, who are normally more on the
left of center, have recognized that this has been a great
proposal, a great reform, to help create more jobs and lift
people out of poverty.
And then countries after countries--we're going to probably
see Slovenia do a flat tax this year. We're probably going to
see Kazakhstan do a flat tax this year.
The question is--we now have a reverse Iron Curtain. We
need the flat tax to come to the west. We need it to come to
America. And I think the D.C. flat tax, building upon all this
real-world evidence that we see--we know lower taxes work, and
we know simpler tax systems work--I hope the D.C. flat tax
could be the impetus for bringing this simple and fair system
to America.
Thank you.
Senator Brownback. Thank you very much, Dr. Mitchell.
Thanks for the thoughts.
[The statement follows:]
Prepared Statement of Daniel J. Mitchell
My name is Daniel Mitchell. I am the McKenna Senior Fellow in
Political Economy at The Heritage Foundation. The views I express in
this testimony are my own, and should not be construed as representing
any official position of The Heritage Foundation.
There is widespread consensus that the current tax system is a
complicated failure that hinders the nation's growth while allowing the
politically well-connected to manipulate the system to get special
breaks that are not available to average workers and businesses. This
is stimulating a great deal of interest in shifting to a simple and
fair flat tax.
The United States should move quickly to reform its tax system. In
a competitive global economy, jobs and capital flow to jurisdictions
with better tax law. Traditionally, this process of ``tax competition''
has benefited the United States, but there is growing evidence that
America is falling behind. Nations around the world are lowering tax
rates and reforming their tax systems. Indeed, ten countries that were
part of the former Soviet Bloc have adopted versions of the flat tax.
These pro-growth reforms are yielding impressive results and are a road
map for U.S. policymakers.
Adopting a flat tax for the District of Columbia would be an added
impetus for reform. Many policy makers want to dismiss Eastern European
flat tax regimes. They also have ignored the Hong Kong flat tax, even
though it has been a remarkable success for almost six decades.
A flat tax in the District of Columbia would not be so easy to
overlook. The economic renaissance would become a national case-study.
Improved incentives for work, saving, and investment would create a
laboratory for supply-side economics. There would be a significant
influx of jobs and investment, and other states--especially neighboring
jurisdictions--quickly would clamor for a similarly attractive tax
code.
Indeed, this is the reason why a flat tax for the District is
desirable. Traditionally, economists do not like tax systems that
create unequal treatment. And there is no question that a
geographically restricted flat tax would discriminate against those in
other parts of the country.
But the perfect should not be the enemy of the good. The internal
revenue code is riddled with discriminatory provisions. People are
treated different based on the source of their income, the use of their
income, and the level of their income. So if a geographically-based
flat tax is the ``camel's nose under the tent'' for adoption of a flat
tax for all Americans, then the short-run inequity would be more than
offset by long-run prosperity and equality for the entire nation.
What Is a Flat Tax?
Unlike the current system, a flat tax is simple, fair, and good for
growth. Instead of the 893 forms required by the current system, a flat
tax would use only two postcard-sized forms: one for labor income and
the other for business and capital income. Unlike the current system,
which discriminates based on the source, use, and level of income, a
flat tax treats all taxpayers equally, fulfilling the ``equal justice
under law'' principle etched above the main entrance to the U.S.
Supreme Court building. And unlike the current system, which punishes
people for contributing to the nation's wealth, a flat tax would lower
marginal tax rates and eliminate the tax bias against saving and
investment, thus ensuring better economic performance in a competitive
global economy.
There have been several flat tax proposals over the years, all of
them based on the path-breaking proposal developed by two Hoover
Institution economists. While no two plans are identical, they all
share common features that fix the major flaws of the current Internal
Revenue Code. Simplicity and fairness are also natural consequences of
these component features of tax reform.
These major features of a flat tax are:
A Single Flat Rate.--All flat tax proposals have a single rate,
usually less than 20 percent. The low, flat rate solves the problem of
high marginal tax rates by reducing penalties against productive
behavior, such as work, risk taking, and entrepreneurship.
Elimination of Special Preferences.--Flat tax proposals would
eliminate provisions of the tax code that bestow preferential tax
treatment on certain behaviors and activities. Getting rid of
deductions, credits, exemptions, and other loopholes also helps solve
the problem of complexity, allowing taxpayers to file their tax returns
on a postcard-sized form.
No Double Taxation of Saving and Investment.--Flat tax proposals
would eliminate the tax code's bias against capital formation by ending
the double taxation of income that is saved and invested. This means no
death tax, no capital gains tax, no double taxation of saving, and no
double tax on dividends. By taxing income only one time, a flat tax is
easier to enforce and more conducive to job creation and capital
formation.
Territorial Taxation.--Flat tax proposals are based on the
commonsense notion of ``territorial taxation,'' meaning that
governments should tax only income that is earned inside national
borders. By getting rid of ``worldwide taxation,'' a flat tax enables
U.S. taxpayers and companies to compete on a level playing field around
the world.
Family-Friendly.--All flat tax proposals have one ``loophole.''
Households receive a generous exemption based on family size. For
instance, a family of four would not begin to pay tax until its annual
income reached more than $30,000.
Consumption-Based.--A tax code that does not discriminate against
saving and investment is considered a consumption-based tax system,
regardless of whether taxes are deducted from the paycheck or collected
at the cash register. In this respect, a flat tax is a type of
consumption tax. The difference between a flat tax and a national sales
tax is where the tax is collected. A flat tax is levied on income--but
only once and at one low rate--as it is earned. A sales tax is levied
on income--but only once and at one low rate--as it is spent.
Both the flat tax and the sales tax differ dramatically from the
U.S. Internal Revenue Code. The current tax code has numerous forms of
double taxation, such as its treatment of saving and corporate income.
The current tax code also has several forms of wealth taxation or asset
taxation, such as the capital gains tax and the death tax. (These also
are forms of double taxation since the assets were acquired with after-
tax dollars.) The current tax code even has provisions that force
taxpayers to overstate their income, such as forcing businesses to
``depreciate'' the cost of new investment instead of allowing immediate
and full deduction (a policy known as ``expensing'') when costs are
incurred.
None of these forms of double taxation, wealth taxation, or
overtaxation exist in either a flat tax or a national sales tax, which
is why public finance economists categorize both systems as
consumption-based taxes.
How a Flat Tax Would Work for Individual Taxpayers
Compared to the current system, a flat tax is extremely simple.
Households pay tax on their labor income using a 10-line individual
postcard. (See Form 1 in Figure 1.) They do not need to worry about
reporting dividends, interest, and other forms of business/capital
income. Those forms of income are taxed at the business level, thus
obviating any need to tax them at the individual level since that would
violate the principle of no double taxation.
The individual postcard is so simple that a third-grader could file
a family's tax return in about five minutes. Each household would
report wage, salary, and pension income on Line 1, which should be
easily available from W-2 forms. Using Lines 2-5, the household then
would calculate its personal allowance, which is based on family size.
The personal allowance on Line 5 is then subtracted from Line 1 to
determine taxable income. This amount is reported on Line 6. The amount
of tax is calculated on Line 7. This amount is then compared to the
amount of tax withheld on Line 8, which then leaves either a tax
payment (Line 9) or a refund (Line 10).
How a Flat Tax Would Work for Businesses
Like the individual postcard form, the business postcard form is
very simple. (See Form 2 in Figure 1.) All businesses, from Microsoft
to a hot dog stand, would play by the same rules. There no longer would
be separate tax rules for partnerships, sole proprietorships, S
corporations and regular corporations. All business operations in
America, whether owned by a U.S. company or owned by a foreign company,
would pay tax on the income that they earn in the United States.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
All business taxpayers would put their total receipts on Line 1.
They would then add together their labor costs, their input costs, and
their investment costs on Lines 2 and 3. These costs are subtracted
from gross receipts to determine taxable income on Line 4. Line 5 is
the amount of tax that is due. Lines 6-10 exist in case a company
either had losses from previous years and now has an opportunity to
offset taxable income or has losses this year and needs to ``carry them
forward'' to the next tax year.
How a D.C. Flat Tax Would Work
Administering a geographically-targeted flat tax poses some
challenges. In a modern economy, cross-border economic activity is very
common. Would that activity be taxed under the D.C. flat tax, or in
another state under the rules of the current internal revenue code?
Would the flat tax only apply for those who reside in the District?
Would the flat tax apply to businesses, or just to individuals? And if
it applies just to individuals, would some of the policies outlined by
Professors Hall and Rabushka--such as taxation of fringe benefits--be
implemented?
These are genuinely difficult issues. To minimize the obstacles,
policy makers may want to focus on the easiest approach--which would be
a flat tax for resident individuals. Such an approach would not be as
beneficial as a comprehensive flat tax applying to all individuals and
businesses, but such legislation would still achieve the goals of
boosting economic growth in the District of Columbia and creating a
successful example that would spur fundamental tax reform for the
entire nation.
The Advantages of a Flat Tax
There are two principal arguments for a flat tax--growth and
fairness. Many economists are attracted to the idea because the current
tax system, with its high rates and discriminatory taxation of saving
and investment, reduces growth, destroys jobs, and lowers incomes. A
flat tax would not eliminate the damaging impact of taxes altogether,
but by dramatically lowering rates and ending the tax code's bias
against saving and investment, it would boost the economy's performance
when compared with the present tax code.
However, the most persuasive feature of a flat tax for many
Americans is its fairness. The complicated documents, instruction
manuals, and numerous forms that taxpayers struggle to decipher every
April would be replaced by a brief set of instructions and two simple
postcards. This radical reform appeals to citizens who not only resent
the time and expense consumed by filing their own tax forms, but also
suspect that the existing maze of credits, deductions, and exemptions
gives a special advantage to those who wield political power and can
afford expert tax advisers.
If enacted, a flat tax would yield major benefits to the nation,
including:
Faster Economic Growth.--A flat tax would spur increased work,
saving, and investment. By increasing incentives to engage in
productive economic behavior, it would also boost the economy's long-
term growth rate. Even if a flat tax boosted long-term growth by only
0.5 percent, the income of the average family of four after 10 years
would be as much as $5,000 higher than it would be under current tax
laws.
Instant Wealth Creation.--According to Harvard economist Dale
Jorgenson, tax reform would boost national wealth by nearly $5
trillion. It would do this in part because all income-producing assets
would rise in value since the flat tax would increase the after-tax
stream of income that they generate.
Simplicity.--Complexity is a hidden tax amounting to more than $100
billion. This is the cost of tax preparation, lawyers, accountants, and
other resources used to comply with the Internal Revenue Code. The
Internal Revenue Service even admits that the current tax code requires
taxpayers to devote 6.6 billion hours each year to their tax returns.
Yet even this commitment of time is no guarantee of accuracy. The code
is so complex that even tax experts and the IRS often make mistakes.
All taxpayers, from General Motors to a hamburger-flipping teenager,
would be able to fill out their tax return on a postcard-sized form,
and compliance costs would drop by tens of billions of dollars.
Fairness.--A flat tax would treat people equally. A wealthy
taxpayer with 1,000 times the taxable income of another taxpayer would
pay 1,000 times more in taxes. No longer would the tax code penalize
success and discriminate against citizens on the basis of income. Tax
burdens would no longer depend on the number of lawyers, lobbyists, and
accountants on the payroll.
An End to Micromanaging and Political Favoritism.--A flat tax gets
rid of all deductions, loopholes, credits, and exemptions. Politicians
would lose all ability to pick winners and losers, reward friends and
punish enemies, and use the tax code to impose their values on the
economy. Not only does this end a major source of political corruption,
but it is also pro-growth since companies would no longer squander
resources lobbying politicians or making foolish investments just to
obtain favorable tax treatment.
Increased Civil Liberties.--Under current law, people charged with
murder are presumed innocent and thus have more rights than taxpayers
dealing with the Internal Revenue Service. By contrast, a flat tax
would eliminate almost all sources of conflict between taxpayers and
the government. Moreover, infringements on freedom and privacy would
fall dramatically since the government would no longer need to know the
intimate details of each taxpayer's financial assets.
Economic Migration.--In addition to the aforementioned benefits,
the District of Columbia would enjoy a substantial inflow of jobs and
capital from the rest of the country. Indeed, economic migration might
be the dominant effect when looking at the economics of a
geographically-targeted flat tax. Similar migration (albeit from other
nations) would occur with a nationwide flat tax, of course, but the
impact of economic migration would be particularly pronounced in the
case of a D.C. flat tax since it is much easier to move across state
borders than it is to move across national borders.
Real World Evidence
In a remarkable development, former communist nations are leading a
global tax reform revolution. Estonia was the first to adopt a flat
tax, implementing a 26 percent rate in 1994, just a few years after the
collapse of the Soviet Union. The other two Baltic republics of the
former Soviet Union enacted flat taxes in the mid-1990s, with Latvia
choosing a 25 percent rate and Lithuania picking 33 percent. Along with
other free-market reforms, the flat tax significantly improved economic
growth, and the ``Baltic Tigers'' became role models for the region.
Learning from its neighbors, Russia stunned the world by adopting a 13
percent flat tax, which went into effect in 2001.
The Russian flat tax quickly yielded positive results: The economy
prospered, and revenues poured into government coffers since tax
evasion and avoidance became much less profitable. The flat tax then
spread to Serbia, which in 2003 chose a 14 percent rate. Slovakia
hopped on the bandwagon the following year with a 19 percent flat tax,
as did Ukraine, which chose a 13 percent tax rate. Earlier this year,
Romania joined the flat tax revolution with a 16 percent tax rate, and
Georgia adopted a 12 percent flat tax rate, which has the honor, at
least temporarily, of being the lowest rate in the world.
The flat tax revolution has been so successful that Estonia is
lowering its rate to keep pace with other nations. The Estonian flat
tax is now down to 24 percent and will drop to 20 percent by 2007, and
Lithuania is in the process of lowering its 33 percent flat tax to a
more reasonable 24 percent. Poland's government just announced that it
will implement an 18 percent flat tax, and lawmakers in Croatia,
Bulgaria, and Hungary are also considering tax reform. Last but not
least, the opposition parties in the Czech Republic have promised to
implement 15 percent flat tax regimes if they win the upcoming
elections.
In a global economy, it is increasingly easy for jobs and capital
to escape high-tax nations and migrate to low-tax nations. This means
that the reward for good tax policy is greater than ever before, but it
also means that the penalties for bad policy are greater than ever
before. This is why so many nations are lowering tax rates and
reforming their tax systems. A flat tax will make America a magnet for
investment and job creation.
Conclusion
The current income tax system punishes the economy, imposes heavy
compliance costs on taxpayers, rewards special interests, and makes
America less competitive. A flat tax would dramatically reduce these
ill effects. Perhaps more important, it would reduce the federal
government's power over the lives of taxpayers and get the government
out of the business of trying to micromanage the economy.
There will never be a tax that is good for the economy, but the
flat tax moves the system much closer to where it should be--raising
the revenues that government demands, but in the least destructive and
least intrusive way possible.
A D.C. flat tax should be seen as a means to an end. In the short
run, some will accurately grouse that it creates an additional inequity
in the tax code. They will complain that it will cause tax-motivated
migration. They will fret that taxpayers will engage in arbitrage to
benefit from better tax law in a specific part of the country.
These are all legitimate complaints, but they pay attention to the
trees and forget about the forest. Fundamental tax reform has a great
capacity to make America a freer and more prosperous nation. A D.C.
flat could be the necessary prerequisite for the nationwide adoption of
a simple and fair tax code.
Senator Brownback. Mr. Edwards.
STATEMENT OF CHRIS EDWARDS, DIRECTOR OF TAX POLICY,
CATO INSTITUTE
Mr. Edwards. Thank you very much, Mr. Chairman, for having
me, and for these interesting and important hearings regarding
a possible flat tax in the District of Columbia.
Last November, President Bush's bipartisan Advisory Panel
on Federal Tax Reform sounded the alarm regarding the need for
major reforms. The panel proposed two different reform plans
that would simplify the Tax Code, cut marginal rates, and
reduce taxes on savings and investment. What we're talking
about here today, the flat tax that's long been championed by
Mr. Armey and others, would create even far greater
simplification than the President's Advisory Panel proposed. A
flat tax would have one low rate, and treat savings and
investment in a neutral and efficient manner.
On simplification, I must say that the problem is even more
complex than you touched on with your stack of the Code and
Federal regulations. There is, in addition to the Code and
Federal regulations, thousands of pages of IRS rulings to guide
taxpayers. There's thousands--tens of thousands, hundreds of
thousands of pages of tax court cases. The Joint Committee on
Taxation's report on Enron tax shelters was about 4 or 5 inches
thick, just by itself. I believe the flat tax would eliminate a
lot of that complexity, and it is one of the most important
reasons for moving to a flat tax.
Despite recent tax cuts, the Federal income tax system is
remarkably complex and efficient still. The top Federal income
individual and corporate tax rates are, today, higher than they
were following reforms in 1986 championed by Ronald Reagan, yet
competition in the global economy is even more intense than it
was a couple of decades ago, after 1986. The corporate tax
rates, in particular, have been cut radically around the world
since our leading reforms in 1986. We used to have one of the
lowest corporate tax rates in the world. Now we've got one of
the highest.
So, what sort of reforms should we pursue? Well, as Dan
touched on, the countries of Eastern Europe have shown the way
here. People have wondered about flat taxes--I mean, they've
long been sort of an economist's dream, but we now know that
they're a practical reality, as Dan touched on, in places like
Russia and Slovakia.
In addition to the countries that Dan touched on, I mean,
there's, you know--Estonia is--was the first to install a flat
tax in--back in 1994, with a 26 percent rate. Hong Kong has
long had a--what you can call a voluntary flat tax system.
They've got a regular graduated rate system, but individuals,
as an alternative, can chose to play--pay a 15 to 16 percent
flat tax in Hong Kong. So, that would--is sort of a model for
what we're talking about for the District of Columbia. Hong
Kong, by the way, doesn't tax individuals on dividends and
capital gains at all, as under the flat tax.
It's not just fairly small Eastern European economies that
have radically cut their tax rates. The United States now has a
much higher tax rate than the industrial countries of Western
Europe, who are our main trading partners. And the average
corporate tax rate across 25 European countries is now just 27
percent. We've got a 35 percent Federal tax rate. The average
State tax rate's 5 to 6 percent. But some places, like New York
City, have a 17 percent corporate tax rate on top of the
Federal corporate tax rate, enormously inefficient. I would see
little reason for major corporations to shift, you know, any of
their activity to New York City, when you've got places like
London, and even Paris, these days, with more lower corporate
tax rates.
I think the countries around the world are going to
continue to cut their corporate tax rates, because of the
compelling benefits of attracting greater inflows of foreign
investment. There's as much as $1 trillion a year in foreign
direct investment that now crosses international borders. The
United States is competing against many, many other countries
these days for that investment, and it makes little sense to me
that we have a tax system that repels investment rather than
attracts it.
So, should we start reforms in our Federal tax system with
a flat tax for the District of Columbia? Well, the first thing
I would note is that the District of Columbia has a lot of
reforms it could do on its own. It's got a 9 percent top tax
rate for individuals, much higher than the 50-State average of
5\1/2\ percent. The District of Columbia has got a corporate
tax rate of 10 percent, much higher than the 50-State corporate
tax rate average of 6.9 percent. So, it makes sense, for me, if
we were to go to a flat tax--a Federal flat tax in the District
of Columbia, that any--the economic growth benefits, I think,
would help fill the D.C. coffers, and the District of Columbia
should use any extra economic--revenue from economic growth to
lower its own corporate tax rates so that the Federal tax cuts
don't just become a place for the District of Columbia to spend
more taxpayer money.
I think a District of Columbia--a flat--a voluntary flat
tax in the District of Columbia is a great idea. It would mean
that no one would have to pay higher taxes under an alternative
flat tax system. I must say that one possible issue are--at
least on a static basis, are possible Federal revenue losses. I
would argue that--it would be unpopular in the District of
Columbia, but one way to deal with that problem is to cut
Federal spending in the District, either their special District
appropriations or just general Federal spending in the
District, to create a revenue-neutral plan with lower taxes and
lower spending in the District.
It seems to me if the District of Columbia--if you went to
a tax system with a large revenue loss for the District of
Columbia, neighboring States could complain. But, again, I
think the solution would be to cut Federal spending in the
District at the same time.
And it seems to me there's a parallel idea being proposed
for Federal highway spending. Some bills have been introduced
in Congress that would allow States who opt out of the Federal
highway system--States could pay lower Federal gas taxes, but
they wouldn't get Federal highway spending. So, in that sort of
parallel, States could opt out and pay lower Federal taxes, but
get lower Federal spending. And I think that there's a parallel
argument that could be made for the District of Columbia.
A flat tax for the District of Columbia could include
reforms to both individual and corporate taxes. I would say
that, in general, corporate tax cuts have larger beneficial
effects on the economy than individual tax cuts, although, in
this case, both would be very favorable. The Joint Committee on
Taxation, last year, modeled the effects of a similar-sized
corporate and individual income tax cut. They found that the
long-run growth benefits of corporate tax cuts were much larger
than individual tax cuts. So, I think the upshot for the
District of Columbia is that a corporate tax cut would be
highly beneficial, would give the biggest bang for the buck,
would help create jobs and stronger growth in the District.
So, to conclude, the goal of Federal taxpayers should to,
as the other panelists have said, replace the income tax, on a
national basis, with a flat tax for the whole country.
Certainly, the District could become a great model for broader
national reforms. People want to know whether a flat tax is a
realistic practical idea. As Dan said, the experience in other
countries that have adopted flat taxes show that flat taxes--
the effect of flat taxes has been very positive in the real
world. And it seems to me, in today's global economy we need to
get moving on tax reforms. And so, I applaud you and this
committee for looking at the idea of a flat tax in the District
of Columbia.
Thank you.
Senator Brownback. Thank you, Mr. Edwards.
[The statement follows:]
Prepared Statement of Chris Edwards
Mr. Chairman and members of the Committee, thank you for inviting
me to testify today regarding a possible flat tax for the District of
Columbia.
Last November President Bush's bipartisan Advisory Panel on Federal
Tax Reform sounded the alarm regarding the need for major tax
reform.\1\ The Panel proposed two reform plans that would simplify the
tax code, cut marginal tax rates, and reduce taxes on savings and
investment. Replacing the income tax with a flat tax would create even
greater simplification and economic gains than the Panel's plans. A
flat tax would have one low rate and would treat savings and investment
in a neutral and efficient manner.
---------------------------------------------------------------------------
\1\ President's Advisory Panel on Federal Tax Reform, ``Simple,
Fair, and Pro-Growth: Proposals to Fix America's Tax System,'' November
2005, www.taxreformpanel.gov.
---------------------------------------------------------------------------
This testimony discusses why it is crucial to move ahead with
federal tax reform along the lines of a flat tax. It also discusses
some aspects to consider regarding a possible flat tax for D.C.
The United States Should be a Tax Reform Leader, Not a Laggard
Despite recent tax cuts, the federal income tax system remains
terribly complex and inefficient. The system is biased against savings
and investment, and top income tax rates are higher today than after
the last major reform in 1986.
Yet competition in the global economy has intensified and most
countries have slashed their income tax rates in order to attract
foreign investment and promote growth. After the 1986 tax reform, the
U.S. corporate tax rate was lower than in most countries, but today the
rate is one of the highest in the world. While U.S. companies face non-
tax challenges such as high pension costs, it makes no sense to also
burden them with an anti-competitive tax regime as they struggle to
expand in domestic and foreign markets.
What tax reforms should the United States pursue? The countries of
Eastern Europe have shown the way ahead with sharp cuts to individual
and corporate income tax rates. These countries have shown that low-
rate flat taxes are not just an economist's dream, but a practical
reality that can boost growth, reduce tax avoidance, and increase
fairness.
Here is a summary of some of the tax reforms abroad:
--Hong Kong.--Hong Kong has long had one of the world's most
efficient tax systems. The corporate income tax has a low 17.5
percent rate. The individual income tax has graduated rates
from 2 to 20 percent and various deductions, but individuals
can instead pay a 16 percent flat tax on a broader base.
Individuals are not taxed on dividends or capital gains.
--Ireland.--Ireland has the second-highest income per capita and the
lowest overall tax burden in Europe. Its economy has grown
rapidly as a result of pro-market reforms including tax cuts.
The corporate tax rate is just 12.5 percent.
--Estonia.--Prime Minister Mart Laar launched the European flat tax
revolution in 1994 by instituting a 26 percent flat tax for
individuals and corporations. Estonia is phasing down its rate
to 20 percent. Another pro-growth change, adopted in 2000, was
to exempt corporate retained earnings from tax. Estonia has
become a magnet for foreign investment and has enjoyed strong
economic growth.
--Lithuania.--In 1994 Lithuania cut its corporate tax rate to 29
percent and its top individual rate to 33 percent. In 2002 the
corporate rate was cut to 15 percent. In 2005 Lithuania passed
a phased-in cut to its top individual rate to 24 percent. The
tax rate on dividends is 15 percent.
--Latvia.--In 1995 Latvia cut its top individual tax rate to 25
percent. The corporate tax rate was reduced from 35 percent in
2001 to 15 percent in 2004. Domestic dividends are exempt from
tax.
--Hungary.--Hungary cut its corporate tax rate to 18 percent in 1995
and reduced it further to 16 percent in 2004. Hungary has a top
individual income tax rate of 38 percent, but dividends are
taxed at a lower rate.
--Russia.--In 2001 Russia replaced its individual income tax, which
had rates up to 30 percent, with a 13 percent flat tax. In 2002
it cut its corporate tax rate from 35 to 24 percent. Russia's
system is not a pure flat tax, as it retains some deductions
and narrow provisions. Domestic dividends are taxed at just 9
percent. Russia's tax reforms have been a big success. In
recent years, the nation's economy has grown strongly, tax
revenues have risen, and tax evasion has fallen.
--Serbia.--In 2003 Serbia enacted a flat income tax with a 14 percent
rate on individuals and corporations.
--Ukraine.--In 2004 Ukraine replaced its individual income tax, which
had a top rate of 40 percent, with a 13 percent flat tax. It
also cut its corporate tax rate from 30 to 25 percent.
--Slovakia.--Slovakia adopted a flat rate tax of 19 percent on
individuals and corporations in 2004. The top tax rates had
been 38 percent and 25 percent, respectively. For individuals,
the flat tax has a large basic exemption and few special
preferences. Dividends are exempt from tax. Slovakia is
attracting large investment inflows and its economy is growing
strongly.
--Poland.--In 2004 Poland cut its corporate tax rate from 27 to 19
percent. The top individual rate is a high 40 percent, but
reforms may be on the way. One party in the new coalition
government favors a low-rate flat tax, while the other favors a
cut in the top rate to 32 percent.
--Georgia.--In 2005 Georgia adopted an individual flat tax with a 12
percent rate. The top individual rate had been 20 percent. The
corporate tax rate is 20 percent.
--Romania.--Soon after coming into office, Romania's new president
issued an edict to replace the nation's income tax with a 16
percent flat tax on individuals and corporations, effective for
2005. The top tax rates had been 40 and 25 percent,
respectively.
The table below shows that the United States has much higher income
tax rates than do these flat tax countries. Indeed, the United States
has a higher corporate tax rate than virtually all our trading
partners. The average top corporate tax rate in the European Union is
26.6 percent, which compares to the U.S. federal and average state rate
of 39.5 percent.\2\
---------------------------------------------------------------------------
\2\ Chris Edwards, ``Catching Up to Global Tax Reforms,'' Cato
Institute Tax & Budget Bulletin no. 28, November 2005.
TOP STATUTORY INCOME TAX RATES, 2005
[In percent]
------------------------------------------------------------------------
Country Individual Corporate
------------------------------------------------------------------------
COUNTIRES WITH INDIVIDUAL FLAT TAXES
Estonia....................................... 24.0 24.0
Georgia....................................... 12.0 20.0
Latvia........................................ 25.0 15.0
Lithuania..................................... 33.0 15.0
Romania....................................... 16.0 16.0
Russia........................................ 13.0 24.0
Serbia........................................ 14.0 14.0
Slovakia...................................... 19.0 19.0
Ukraine....................................... 13.0 25.0
-------------------------
Flat tax countries...................... 18.8 19.1
OTHER COUNTRIES AND REGIONS
Czech Republic................................ 32.0 26.0
Hong Kong..................................... 16.0 17.5
Hungary....................................... 38.0 16.0
Ireland....................................... 42.0 12.5
Poland........................................ 40.0 19.0
Singapore..................................... 22.0 20.0
Europe: 25 countries.......................... 40.6 26.6
United States................................. 38.6 39.5
------------------------------------------------------------------------
Source: Chris Edwards, Cato Institute, based on KPMG data and various
news reports. Rates include the national and average subnational tax
rate.
I suspect that countries around the world will continue to cut
corporate tax rates, partly because of the large benefits that can be
gained by attracting greater inflows of foreign investment. As much as
$1 trillion of direct investment crosses international borders each
year, and research shows that these flows are increasingly sensitive to
taxes.\3\ Our tax system, particularly the corporate income tax, will
have an increasingly negative effect on U.S. growth unless reformed.
Also note that high tax rates and excessive tax complexity create an
ideal breeding ground for Enron-style tax scandals.
---------------------------------------------------------------------------
\3\ Chris Edwards and Veronique de Rugy, ``International Tax
Competition: A 21st-Century Restraint on Government,'' Cato Institute
Policy Analysis no. 431, April 12, 2002.
---------------------------------------------------------------------------
The solution is to sharply cut the top corporate and individual
income tax rates, either within a full flat tax reform package or under
more limited reforms.\4\ U.S. policymakers need to wake up to the new
global tax realities and put marginal tax rate cuts front and center in
federal policy discussions. Replacing the high-rate income tax with a
flat tax would be a great way to accomplish that.
---------------------------------------------------------------------------
\4\ For a discussion of federal tax reform options, see Chris
Edwards, ``Options for Tax Reform,'' Cato Institute Policy Analysis no.
536, February 24, 2005.
---------------------------------------------------------------------------
A Flat Tax for D.C?
The first thing to note about taxation in D.C. is the high marginal
tax rates on individuals and businesses. The top D.C. individual tax
rate is 9.0 percent, which compares to a 50-state average of 5.5
percent.\5\ The top D.C. corporate rate is 10.0 percent, which compares
to a 50-state average of 6.9 percent.
---------------------------------------------------------------------------
\5\ Chris Edwards, ``State Revenue Boom Paves Way for Tax Cuts,''
Cato Institute Tax & Budget Bulletin no. 30, January 2006.
---------------------------------------------------------------------------
Thus, regardless of possible federal tax changes in D.C., it would
make sense for the city to reduce its high local tax rates to at least
national average levels. I have argued that states should kill their
corporate income taxes altogether, as these taxes have very high
compliance costs compared to the little revenue collected.\6\ If a
federal tax reform such as a flat tax were introduced in D.C., extra
local revenue that is generated from higher economic growth should be
used to cut high local income tax rates.
---------------------------------------------------------------------------
\6\ Chris Edwards, ``State Corporate Income Taxes Should Be
Repealed,'' Cato Institute Tax & Budget Bulletin no. 19, April 2004.
---------------------------------------------------------------------------
A D.C. flat tax that is voluntary is an interesting idea for
policymakers to consider. One model for a flat tax is the Hong Kong tax
system. That city's individual income tax has a graduated rate
structure, but it provides taxpayers with an alternative of a 16
percent flat tax applied to a broader tax base.
A voluntary flat tax would presumably result in a (static) federal
revenue loss because no taxpayers would pay more than under the current
system, while some would pay less. Because that may create a political
hurdle, I'd suggest that the revenue loss be at least partly offset
with cuts to federal spending in the District. Cuts could be made both
to D.C. appropriations as well as spending under regular federal
programs. For example, economic development funding could be cut,
including programs such as Community Development Block Grants. Such
spending is dubious to begin with, but certainly would not be needed
with all the new investment pouring into the District to take advantage
of the low federal tax rates.
Another aspect to consider is that if a D.C. flat tax created a
federal revenue loss, neighboring states might complain that D.C.
residents were getting an unfair benefit. Again, the solution would be
to cut federal spending in D.C. We could have a revenue neutral policy
change that resulted from less federal taxes and less federal spending
in the city, which would be combined with a more vibrant private sector
economy.
There is a parallel idea being proposed for federal highway
spending. Bills have been introduced in Congress that would allow a
state to opt-out of the federal highway system by ending both the
federal gas tax and federal highway spending in a state. Thus, a state
would pay less to the federal government but also get less back, in a
roughly revenue neutral fashion.
A flat tax for the District would (or could) include reforms to
both individual and corporate taxes. Note that, in general, corporate
tax cuts have larger beneficial effects on the economy than individual
tax cuts. Last year the Joint Committee on Taxation modeled the effects
of equal-sized hypothetical cuts to the federal corporate and
individual income taxes.\7\ They found that in the long run a corporate
rate cut caused a much larger increase in gross domestic product than
an individual tax cut. The upshot for D.C. is that cutting the
corporate tax rate (either the federal rate in the city or the local
rate) would probably give the biggest bang for the buck to boost the
city's economy.
---------------------------------------------------------------------------
\7\ Joint Committee on Taxation, ``Macroeconomic Analysis of
Various Proposals to Provide $500 Billion in Tax Relief,'' JCX-04-05,
March 1, 2005.
---------------------------------------------------------------------------
Conclusion
The goal of federal policymakers should be to replace the current
income tax with a low-rate consumption-based system--such as the flat
tax--for the whole country. A flat tax for D.C. is an interesting idea
that could be the model for broader national reforms.
Many people are interested in the flat tax, but want to know
whether it would work as well as proponents expect it to. Certainly,
the experience in countries that have adopted flat taxes has been very
positive. In today's competitive global economy, we need to get moving
on major tax reforms, and so I applaud the committee for exploring
these issues.
Thank you for holding these important hearings. I look forward to
working with the Committee on its flat tax agenda.
Senator Brownback. Mr. Entin, glad to have you here.
STATEMENT OF STEPHEN J. ENTIN, PRESIDENT AND EXECUTIVE
DIRECTOR, INSTITUTE FOR RESEARCH ON THE
ECONOMICS OF TAXATION
Mr. Entin. Thank you, Mr. Chairman. Thank you for the
opportunity to testify. I commend you and the subcommittee for
wanting to demonstrate the gains that real tax reform could
bring to workers and savers at all income levels.
If I have any cautionary points to make, they stem from my
concern that you haven't gone far enough. So, I am friend of
the effort.
Fundamental tax reform is about creating a tax system that
is simpler and more conducive to economic growth than the
current income tax. Simplicity alone is not enough. For
example, ``Line 1, put down your income; Line 2, send it in,''
is as simple a tax system as you can get, but it is not
conducive to growth. Economic growth means defining income
correctly to get the tax base right, and taxing it in a
uniform, nondistorting manner.
The key question is, What is the tax base? Today's income
tax falls more heavily on income used for saving and investment
than consumption, and imposes further burdens with an add-on
corporate tax and transfer--that is, estate and gift taxes.
Long depreciation periods further discourage investment. These
taxes reduce productivity, wages, employment, and incomes
across the board.
Neutral taxes, of which the flat tax is one, by contrast,
treat all economic activity alike. They do not discourage those
who produce the most with steeply graduated tax rates, and they
are not biased against saving and investment in favor of
consumption. Neutral tax systems, sometimes called
``consumption-based taxes,'' include the saving-deferred tax,
the national retail sales tax, the value-added tax, returns-
exempt flat tax, or some combination.
Neutral taxes give saving the sort of treatment we give to
limited amounts of pensions and IRAs. They don't double tax the
corporation or the estate. They allow expensing, rather than
depreciation. I go into these reasons in the addendum to the
testimony, but I won't dwell on that here.
Just let me say that if the United States replaced its
personal and corporate income taxes with a saving/consumption-
neutral tax and eliminated the estate and gift taxes, capital
investment, productivity, wages, and employment would increase,
national output and national income would rise by 10 percent
within about 7 to 10 years. A middle-income family of four
earning about $50,000 would see roughly $5,000 in additional
annual income. That's before tax, or about $3,500 after tax.
Allowing for income growth over time, that 10 percent
differential would be enough to allow the family to live in a
$350,000 house instead of a $200,000 house, or to pay to send a
child to a good college, or to retire with greater security.
These are real benefits that we are simply throwing away by
having a tax system that depresses saving and investment.
Now, we hear a lot about the ``flat tax.'' What do we mean
by the term? Several Eastern European countries, as Dan has
described have adopted so-called ``flat'' income taxes. They
apply a single tax rate--hence, ``flat tax''--to personal
income, corporate income, and payroll or sales. These taxes are
flat, only in the sense that they have one tax rate imposed
several times. Saving is taxed twice, compared to consumption,
and corporate income is taxed a third time. These systems are
not fundamental tax reform. They improve simplicity and reduce
compliance costs, but do not maximize growth and income. Now, I
will say they are much better than the systems they replace,
but they don't go far enough.
By contrast, the Hall-Rabushka and Armey-Shelby flat taxes
impose a single tax rate on nearly neutral consumed income
base. They eliminate most tax biases against saving and
investment in the corporate form. They tax capital income at
the source, with many deductions eliminated for simplicity. I
would say that some deductions needed to measure income
accurately are eliminated, which can place some income on the
wrong person's tax form, as by ignoring transfers, or may
misstate income by ignoring certain business and education
costs, including payments for State and local government
services and education.
The other neutral taxes similarly have flat rates in
expensing and eliminate the antisaving biases. They differ in
that they also exempt tuition and training, deduct or exclude
State and local taxes or outlays for education, transfers to
the poor, and services to business. And they correctly handle
transfers such as charitable contributions, gifts, or alimony
as income of the recipient.
That aside, the various consumed income or HR-style, Hall-
Rabushka style, neutral taxes combine simplification with big
spurs to economic growth. They are fundamental tax reforms
worthy of the name. The economic benefits are well known, and
it is long past time that one of them was adopted.
The question here today is, what benefits might be had from
enacting a voluntary saving, consumption-neutral tax--
specifically, a variation of Hall-Rabushka--for the District of
Columbia? Individuals could volunteer to give up certain
deductions in exchange for lower marginal tax rates and less
onerous tax treatment of saving and investment. Such a
demonstration would be feasible if some modifications are made
to allow the tax to apply only to residents of the District or
to any State or region, rather than to the Nation as a whole.
These tax reforms, if enacted for the District, would lower
the cost of capital for firms investing here. It would reduce,
in some manner, the tax imposed on savers living in, or lending
to, the District. Investment and employment would increase, and
some of the increase would be investment attracted from over
the borders from Maryland and Virginia, some would represent a
rise in national economic output.
The District has few manufacturing businesses, perhaps due
to its limited geographical area, and it is likely to remain a
place where human capital and labor-intensive service jobs
dominate. Much of the investment might take the form of
residential rental units. Some savers would find the District
more attractive than their current States of residents for tax
purposes, and might move here. Property values would be bid up.
Additional residential construction should lower rents
regionally, although the impact on specific neighborhoods
within and about the District would vary. District income and
property tax revenues would rise.
Be warned, in scoring the budget cost of a flat tax
proposal, the Treasury and the Joint Committee on Taxation of
the Congress will not assume any gains in national economic
output, because they are wedded to a static scoring method.
They will not show gains in wages for District residents, which
will distort the apparent income distribution of the tax
changes.
The proposal would make the tax voluntary. This is
possible, to some degree, but there would have to be
coordination between borrowers and lenders so that they were
treating the same asset at--the same way on both ends. You
would perhaps have to look at what would happen to fringe
benefits if employers, versus employees, opted for different
treatments.
There would be some regional problems in implementation.
You would have to very clearly define the payments to the
savers that would be eligible for the alternative treatments.
You would have to decide what would happen to that tax
treatment if they moved out of the District. You would have to
look at what would happen if businesses were lending
nationally, not just within the District, and perhaps imposed
some of these same sorts of rules governing international
allocation of interest and income between the District and the
rest of the country, as we now impose between countries--
companies operating here and operating globally. However, these
things could be worked out. I'm not saying they would be easy,
but they could be done.
In conclusion, the benefits of shifting to a saving/
consumption-neutral tax system would be large, and would be
distributed across most of the population. It's long past time
for adopting such a system. I prefer to see it be done quickly
and nationwide, but that may not be possible.
I would hope that, at the very least, we can extend the
2003 tax reductions on capital gains, dividends, marginal tax
rates, and on the elimination of the estate tax. These are all
steps toward fundamental tax reform. They go part of the way
there, and I describe the benefits of that in the addendum to
the report.
Thank you very much.
[The statement follows:]
Prepared Statement of Stephen J. Entin
Mr. Chairman and Members of the Subcommittee: Thank you for the
opportunity to testify on the economic advantages of fundamental tax
reform. The Subcommittee is to be commended for exploring the gains
that reform could bring to workers and savers at all income levels, and
in all corners of the nation.
Fundamental tax reform is about creating a tax system that is
simpler and more conducive to economic growth than the current income
tax. Simplicity alone is not enough. For example--``Line one: Put down
your income. Line two: Send it in.''--is as simple a system as one can
get, but it is not conducive to economic growth. Economic growth means
defining income correctly to get the tax base right, and taxing it in a
uniform, non-distorting manner.
What is the tax base?
The broad-based income tax. The comprehensive or broad-based income
tax in use today taxes most income as it is received, including income
used for saving, and taxes the returns on saving as soon as they accrue
(except for capital gains, which can be deferred until realized). Such
taxes fall more heavily on income used for saving than for
consumption.\1\ The tax bias against saving is made worse by imposing
an add-on corporate tax and transfer (estate and gift) taxes. Long
write-off periods for depreciable assets further discourage
investment.\2\ These taxes impose high economic costs, including
reduced productivity, wages, and incomes across the board.
---------------------------------------------------------------------------
\1\ Income is ordinarily taxed when earned. If the income is used
for consumption, there is generally no further federal tax (except for
a few selective excises). One can buy a loaf of bread and eat it, or
buy a television and watch a stream of programming, and there is no
further federal tax. If it is used for saving, however, the returns on
the saving (the streams of interest, dividends, capital gains, or
profits of non-corporate businesses) are taxed. This is the basic
income tax bias against saving. If used to buy corporate stock, the
returns are also subject to the corporate tax before being paid as a
dividend or reinvested to raise the value of the company (leading to a
capital gain). This is a third layer of tax on saving. The estate tax
is a fourth layer of tax on income that is saved. Even if the inherited
saving was done in a tax deferred pension (offsetting the basic bias),
it will be subject to the heirs' income tax, so the transfer taxes are
always an extra layer of tax on saving.
\2\ Depreciation forces businesses to delay claiming the costs of
their investments in depreciable assets. The long write-off periods
reduce the value of the capital consumption allowances by ignoring
inflation and the time value of money. The allowances fall short of the
real cost of the assets, overstating real profits and raising effective
tax rates. Capital formation is discouraged, and productivity and wages
are reduced. The correct tax treatment would be ``expensing'', that is,
writing off the cost of investment assets immediately, in the year they
are made. Expensing would correctly account for the real cost of
investment, reducing the excess tax burden on capital and expanding
investment and wages.
---------------------------------------------------------------------------
Neutral taxes. Neutral taxes are those that treat all economic
activity alike. In particular, they do not discourage those who produce
the most with steeply graduated tax rates, and they are not biased
against saving and investment in favor of consumption. Neutral tax
systems (sometime called consumption-based taxes) include the saving-
deferred tax \3\, the national retail sales tax, the value added tax
(VAT) \4\, the returns-exempt Flat Tax \5\, or some combination. To put
saving and consumption on an equal footing, a tax system must impose
the same tax, in present value, on income used for immediate
consumption and on income saved for future consumption. To do so,
neutral taxes either defer taxes on income saved (as with a pension or
regular IRA) and tax the subsequent withdrawals of principal and
earnings, or tax the income up front but eliminate taxes on the returns
(as with a Roth IRA). Neutral systems do not have add-on layers of tax
at the corporate level, either taxing the returns on corporate assets
at the business level or the shareholder level, but not both. There is
no estate or gift tax. Capital outlays are expensed immediately, rather
than depreciated over time.
---------------------------------------------------------------------------
\3\ A tax on income less net saving, in which all saving is tax
deferred in the manner that current law allows for limited amounts of
saving in an ordinary IRA, 401(k), or pension. This type of tax is also
called an inflow-outflow tax, a consumed income tax, an individual cash
flow tax, or an expenditure tax.
\4\ Value added tax, including European style credit invoice method
VATs, goods and services taxes or GSTs (as in Canada and Australia), or
subtraction method VATs (also called business transfer taxes in the
United States, such as is proposed in the USA Tax).
\5\ A returns exempt tax does not allow a deduction for or deferral
of current saving, which must be done on an after-tax basis, but it
does not subsequently tax the returns on that after-tax saving. It is
the method used for Roth IRAs, and is how individual savers are treated
in the Hall-Rabushka or Armey-Shelby Flat Tax.
---------------------------------------------------------------------------
Benefits of neutral taxes
A saving-consumption neutral tax with a flat rate would serve every
type of economic actor better than the current income tax system, which
includes the graduated comprehensive personal income tax, the corporate
income tax, and the estate and gift taxes. If the United States were to
replace its personal and corporate income taxes with a savings-
consumption neutral tax, and eliminate the estate and gift taxes, the
country would experience a sharp reduction in the service price of
capital, and a major increase in capital investment. Productivity,
wages, and employment would increase. If the basic tax rate were kept
low, there would be a further labor force response. All told, there
would be something over a ten percent increase in national output and
national income within about seven to ten years.
For a middle income family of four earning about $50,000, that
would mean a roughly $5,000 increase in annual income, before tax (and
about $3,500 after tax). Allowing for a percent a year in real income
growth over a working lifetime due to technological change, that
initial 10 income percent differential would be enough to allow the
family to live in a $350,000 house instead of a $200,000 house, or to
pay to send a child to a good college, or to retire with greater
security. With a ``static'' revenue neutral tax restructuring, there
would be a significant positive revenue feedback for federal, state,
and local tax authorities, reducing budget pressures. Alternatively,
the revenue feedback could be used to further lower tax rates on labor
and capital income. These are non-negligible real benefits that we are
simply throwing away by having a tax system that is unnecessarily harsh
on saving and investment.
What is meant by a ``flat tax?''
The European ``flat taxes'' on an income base. Several Eastern
European countries have adopted so-called ``flat'' income taxes. They
apply a single tax rate (hence ``flat'' tax) to personal income,
corporate income, and payroll or sales. These taxes are non-neutral,
and are ``flat'' only in the sense that they have one tax rate, imposed
several times. Saving is taxed twice compared to consumption, and
corporate income is taxed a third time. These systems are partial, but
not fundamental, tax reform. They improve simplicity and reduce
compliance costs, but do not maximize growth and income.
The Hall-Rabushka-Armey-Shelby Flat Tax on a consumed-income base.
The Hall-Rabushka and Armey-Shelby ``Flat Taxes'' impose a single tax
rate on a nearly neutral consumed-income base. They eliminate most tax
biases against saving and investment and the corporate form. They are
largely saving-consumption neutral because capital investment is
expensed and corporate income is taxed only once at the business level
and not again at the shareholder level. They tax capital income at the
source, with many deductions eliminated for simplicity. However, some
deductions needed to measure income accurately are eliminated for
simplicity. Some call this part of the tax's ``flatness'', but this
feature can place some income on the wrong person's tax form, as by
ignoring transfers, or may misstate income by ignoring certain business
and education costs, including payments for state and local government
services and education.
Other neutral consumed-income or cash-flow taxes. A consumed-income
or consumption-based tax retains only those deductions needed to define
income correctly (as revenue less the cost of earning revenue), and
allocates the income for tax purposes to those who get to spend it by
means of appropriate treatment of transfer payments. These systems
include the consumed-income tax (revenue less saving = consumption
spending), national retail sales tax (consumption spending), or VAT
(consumption spending). All include expensing of investment outlays;
exempt tuition and training; deduct (or exclude) state and local taxes
(or outlays) for education, transfers to the poor, and services to
businesses; and correctly handle transfers such as charitable
contributions, gifts, or alimony as income of the recipient.
The various consumed-income or H-R style neutral taxes combine
simplification with the biggest potential for income growth. These are
fundamental tax reforms worthy of the name. The economic benefits are
well-known, and it is long past time that one of them was adopted. In
recent years, each time we have moved in the direction of a neutral,
pro-growth tax system, the economy has responded with more jobs and
rising output. The tax reductions of 2001, as amended in 2003, with
lower marginal tax rates, reduced double taxation of corporate income
via the 15 percent rate caps on dividends and capital gains, and repeal
of the estate and gift taxes, are steps in the right direction. We
could achieve fundamental reform nationwide in stages, making these
rate reductions permanent, enlarging the amounts of saving eligible for
neutral treatment in IRAs and pensions, and shortening asset lives.
Later, we could more completely integrate the individual and corporate
taxes.
A Flat Tax for the District of Columbia?
The question here today is what benefits might be had from enacting
a voluntary saving-consumption neutral tax, specifically, a variant of
the Hall-Rabushka ``Flat Tax'', for the District of Columbia, as an
example for the nation. Individuals could volunteer to give up certain
deductions in exchange for lower marginal tax rates and less onerous
tax treatment of saving and investment. Such a demonstration would be
feasible if some modifications are made to allow the tax to apply only
to residents of the District (or to any state or region), rather than
to the nation as a whole.
Benefits for the District and the cost to the Treasury. A Flat Tax,
or some variant, if enacted for the District, would lower the cost of
capital for firms investing here. It would reduce, in some manner, the
tax imposed on savers living in or lending to the District. Investment
and employment would increase. Some of the increase would be investment
attracted from over the borders from Maryland and Virginia. Some would
represent a rise in national economic activity.
The District has relatively few large manufacturing businesses, in
part due to its limited geographical area. It is likely to remain a
place where human capital and labor intensive service jobs dominate
(law firms, hospitals, schools, restaurants). Much of the investment
might take the form of residential rental units. Some savers would find
the District more attractive than their current states of residence for
tax purposes, and might move here. Property values would be bid up.
Additional residential construction should lower rents regionally,
although the impact on specific neighborhoods within and without the
District could vary. District income tax and property tax revenues
would rise.
In scoring the budget cost of a Flat Tax proposal, the Treasury and
the Joint Tax Committee of the Congress will not assume any gains in
national economic output, because they are wedded to a static scoring
method. The revenue estimators will not show the gains in wages for
District residents, which will distort the distribution of the tax
reductions across income classes. If they are being truly static, they
would calculate the revenue change by looking only at the proposal's
effect on current residents, without assuming many more people will
move into the District to take advantage of the tax change. If the
estimators wish to be antagonistic to the idea, they will omit the
economic gains but assume a large influx of people into the District in
search of lower tax rates on their capital and salary income.
A voluntary application. The proposal would make the Flat Tax
voluntary. That is possible to some degree, but there would have to be
some areas of coordination between employers and employees, and between
borrowers and lenders.
For example, under the Flat Tax (and VAT), borrowers are not
allowed to deduct interest, but lenders do not have to pay tax on
interest received. Mortgages would carry the current after-tax interest
rate, instead of the higher pre-tax rate we see today, and borrowers
and lenders would be in the same net position, after-tax, as they are
now. But if a homeowner or business borrower opted out of the Flat Tax,
but its lender opted in, the interest income might escape tax entirely.
There would have to be a requirement for each loan to be treated alike
by the borrower and the lender. For example, financial firms might be
allowed to offer homeowners either a taxable or a non-taxable mortgage,
with both sides treating the interest on that particular loan alike.
Also under the Flat Tax, businesses are not allowed to deduct
fringe benefits, including health insurance premiums. In return, these
are not taxable on the workers' tax forms, and they get a lower tax
rate on their cash wages. If workers participate, but businesses opt
not to participate, some fringe benefits might continue to escape tax
entirely. Workers might get reduced tax rates without the ``base
broadening'' that is meant to offset the revenue loss and make the tax
system more neutral and efficient. If this aspect of the Flat Tax is
retained, it would affect the revenue estimate. Workers and their
bosses might have to opt in or opt out jointly to make the system work
smoothly.
Regional considerations in designing the proposal
Even with adjustments to the voluntary feature of the proposal,
imposing a Flat Tax on a region within the country raises a number of
administrative, enforcement, and compliance issues.
All the major neutral tax systems are internally consistent applied
nationwide. All specify consistent choices and definitions for income
that crosses the national border. Similar care would be needed to
preserve consistency if such taxes were to be implemented on a regional
or state basis.
The Hall Rabushka and other saving-consumption ``neutral'' taxes
are really quite similar, falling on roughly the same amount of
consumed income each year, with the main difference among them being
the point of collection. Because of this difference, two of the systems
would not be suitable for use in a sub-region of the country, such as
the District of Columbia. The retail sales tax could be avoided by
driving to Maryland or Virginia to shop. A ``destination'' type VAT
(imposed on imports, rebated on exports) would require customs sheds at
the bridges and border-crossing roads. An ``origin-type'' VAT (imposed
on wages and capital income of residents) could be adapted to regional
use. So could the Hall-Rabushka ``Flat Tax'' or the consumed income
tax, with appropriate modifications.
Residency requirements. It would be necessary to make rules
relating to part time residents. The federal tax system would need to
include the same sort of rules as states impose when people move in or
out of their jurisdiction during the year. Presumably, the part-time
District residents would be under one system for part of the year, and
another for the remainder.
The IRS would have to determine the validity of claims to residency
status. If state practice is a guide, there would need to be
requirements for people to be physically present for a number of days
to qualify for the favored tax status. As a Federal tax example, under
changes enacted in 2004, the IRS is currently adding a modest days-per-
year residency requirement to narrow eligibility for the federal income
tax relief granted to residents of the U.S. Virgin Islands under
section 936. Some sort of residency requirement would be needed for the
District tax.
Treatment of capital income. Saving-consumption neutral taxes
either defer tax on income that is put into saving (as in a regular IRA
or pension) and tax withdrawals from saving, or they tax income up
front and exempt the returns (interest, dividends, or capital gains, as
with a Roth IRA or municipal bond). Businesses expense outlays instead
of depreciating them. If these features were retained in the District
tax, then rules would be needed to define their application to
individuals and businesses.
Individuals under a regional tax. Individuals willing to give up
some of their existing deductions could be offered a lower tax rate.
High income, high saving individuals who have otherwise maxed out on
their pension IRA and 401(k) contributions would find the District an
attractive place to live, at least for tax purposes, because they would
receive some form of pension treatment on more of their saving. The
legislation setting up the District tax would have to define that
treatment clearly.
For example, under the returns-exempt method of the Hall-Rabushka
tax, what would happen if people have lived and saved in the District,
and later move out? Would they lose the exemption on the returns on the
saving they did while living in the District? Some people would not
save as much as the Flat Tax would ordinarily encourage them to do if
this string were attached.
If, alternatively, the deferral of saving method applied, then
people would get universal IRA treatment of saving contributions for
years in which they live in the District, but not for years they live
outside. If they move out of the District, would they have to pay tax
immediately on such accounts, or only when they withdraw the money?
Would the inside build-up continue to be tax-deferred until withdrawal,
or become taxable annually? Saving would be higher if the accounts were
to retain their saving-deferred treatment until withdrawal. Either
approach is administrable, but the legislation would have to set the
rule.
Businesses under a regional tax. A small business owner living and
working in the District would presumably get to expense his District
business outlays, and would pay tax on all returns. For a corporate or
non-corporate business that operates in many states and the District,
presumably only its investments placed in service in the District would
be expensed.
In the Hall-Rabushka Flat Tax, corporate income is taxed at the
business level, and is not taxed again at the shareholders' level. The
legislation would have to specify whether the District income of
corporations paid as a dividend is to be exempt only for District
residents or for shareholders nationwide. To realize the full economic
effect, it should be nationwide. To determine how much of a capital
gain stemming from reinvested after-tax District business income should
be tax free, a ``deemed dividend'' (a notice allowing shareholders to
raise the tax basis of their shares by the reinvested District income)
could be adopted. Again, the legislation would have to specify if that
were to apply only to shareholders who live in the District, or to all
shareholders.
Under the Hall-Rabushka tax plan, financial transactions are not
taxed. Interest is non-deductible by the borrower, and not taxable to
the lender.\6\ If the tax system is only applied in the District, there
would have to be rules governing the treatment of interest paid and
received by a business with multi-state operations. Presumably, a
multi-state business could deduct interest on loans taken to invest in
Kansas but not on loans taken to invest in the District. Presumably,
interest earned by a District-based lender on loans made to out-of-
District borrowers would be taxable. Money is fungible. We have
international interest allocation rules now to deal with firms that
borrow and invest globally. Similar rules would be needed within the
country to handle the different tax system for the District.
---------------------------------------------------------------------------
\6\ Under Hall-Rabushka, special rules were suggested for taxing
financial firms whose income is earned from the spread between interest
earned and interest paid. Such rules appear to be difficult to design
and implement. Consequently, under the Armey Flat Tax, banks and other
financial institutions would be taxed as under current law, but with
expensing.
---------------------------------------------------------------------------
In a consumed-income tax, there is no corporate tax. Instead,
corporate income is taxed when shareholders receive dividends or sell
assets without reinvesting. If this method were chosen, each company
would have to break its income into two parts, that which is District
income, free of the federal corporate income tax, and that which is
non-District income, taxable under the federal corporate tax. Dividends
paid would then be taxable to the shareholders (wherever they reside).
Non-corporate business income would appear on the owners' tax forms.
Interest payments would be deductible, and interest received would be
taxable, as under current law, for small business owners.
Conclusion
The benefits of shifting to a saving-consumption neutral tax system
would be large and would be distributed across most of the population.
It is long past the time for adopting such a system.
The country could move to such a system on a nationwide basis, step
by step. Alternatively, it could proceed region by region. The latter
is doable, but more difficult. Having one federal tax system for most
of the country and another federal tax system for a single state or
region would potentially create administrative and enforcement issues
for the government and compliance problems for individual and business
taxpayers that would have to be carefully addressed in writing the
legislation and the regulations.
Ideally, Congress would work toward a reformed tax for the whole
country step by step as budget conditions allow. If a region by region
approach is adopted, it might be administratively easier to use the
saving-deferred method rather than the returns-exempt method of neutral
taxation. If the Hall-Rabushka approach is adopted, it would be best to
modify it so as not to eliminate deductions for charitable
contributions and state and local taxes.
Appendix--Economic Benefits of Extending the Fifteen Percent Tax Rate
on Dividends and Capital Gains and the Other Pro-Growth Elements of the
2001 and 2003 Tax Acts, and of Enacting Further Reforms
Several provisions of the Economic Growth and Tax Relief
Reconciliation Act of 2001, as amended by the Jobs and Growth Tax
Relief Reconciliation Act of 2003, helped to end the recession by
turning around a severe slump in investment. Three key provisions
either have expired, or soon will expire, if not extended by the
Congress. The 15 percent top tax rates on dividends and capital gains,
enacted in 2003, will expire at the end of 2008. The marginal income
tax rate cuts enacted in 2001, and accelerated to full effect in 2003,
will expire at the end of 2010. The 50 percent expensing provision in
the 2003 Act was billed as a temporary jump start for investment and
the recovery, and was allowed to expire at the end of 2004.
The expected future tax treatment of saving and investment affects
saving and investment being done today. Allowing the remaining
investment-related provisions to expire would jeopardize the economic
recovery. Extending them now, rather than waiting until the last
minute, would reduce uncertainty as to whether the more favorable tax
treatment will be available for investments whose lives extend beyond
the sunset dates of the tax provisions. Immediate extension would boost
investment spending, employment, and wages starting now, not three to
five years down the road.
All of these provisions are consistent with proposals for a
fundamental reform of the tax system. Full reform would go even further
in reducing tax biases against saving and investment, and the economic
gains from a fundamental reform would be correspondingly larger.
Recent swings in the economy have mirrored swings in investment
The main cause of the 2001 recession was a sharp drop in
investment. The decline in spending on equipment and software, and in
non-residential structures, is shown in Chart 1. The chart also shows
the response of investment to subsequent tax changes.
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The 2001 Tax Act cut passed the Congress on May 26, 2001, but
investment spending continued to slip for the rest of the year. That
tax reduction did very little to encourage additional investment
spending in the short run, giving out money mainly for social policies
that are not related to economic growth. The bill's marginal tax rate
reductions on small business owners, corporate shareholders, and other
savers, which would have reduced the service price of capital and
encouraged investment, were largely deferred until later years, with
only half a percentage point effective in 2001. There was nothing else
in the bill that directly lowered the cost of business investment.
The early stages of the economic recovery in 2002 were weak because
investment remained weak. The Jobs Creation and Worker Assistance Act
of 2002 was signed into law on March 9, 2002. It contained a special 30
percent ``bonus expensing'' provision for investment in equipment and
software (but not for most structures). Also, the second half-point
step in the phased income tax rate reduction became effective in 2002.
Investment in equipment and software (but not structures) began to
recover, modestly, over the next four quarters.
The 2003 Tax Act was signed into law on May 28, 2003. It upped the
special expensing provision to 50 percent, directly cutting the cost of
equipment and software (but not most structures) for corporate and non-
corporate businesses. More importantly, it also brought forward to 2003
the remaining 2 to 3.6 percentage points marginal income tax rate
reductions on small business owners, shareholders, and savers scheduled
for 2004 and 2006. Most importantly, for taxpayers in the top four
brackets, it cut the top tax rates on dividends and capital gains from
20 percent to 15 percent through 2008. For taxpayers in the 10 percent
and 15 percent brackets, the rates were set at 5 percent through 2007,
and zero in 2008.
Investment in equipment and software shot up almost at once.
Investment in non-residential structures, which was helped by the
capital gains, dividend, and marginal tax rate cuts, but got no direct
depreciation relief, abruptly stopped its decline and rose by a slight
amount. Investment and growth remained strong throughout 2004.
Employment and wage growth advanced. The expensing provision expired at
the end of 2004. Investment growth seems to have slowed a bit since.
The tax cuts lowered the service price of capital. Failure to extend
them would raise the service price and reduce GDP
The size of the capital stock and the level of investment depend on
the service price of capital. The service price is the rate of return
that an investment must earn to pay the taxes owed, cover its cost
(depreciation), and yield a normal after-tax return to its owner. A tax
increase on capital income raises the service price, and renders
impractical any investment projects that cannot meet the higher service
price. A tax reduction on capital income lowers the service price, and
makes additional investment projects possible.
Chart 2 and Table 1 show the service prices of various types of
capital (equipment and software, structures, inventory, land) in the
corporate and non-corporate sectors under 2004 law, with all three
investment-related tax provisions in place. They also show the higher
service prices that would result from their expirations, first of the
expensing provision, then the 15 percent tax cap (corporate sector
only), and then the marginal rate reductions. The numbers are for the
private business sector, which is about 80 percent of GDP. The
corporate sector is about 56 percent, and the non-corporate private
sector about 24 percent of GDP.
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TABLE 1.--SERVICE PRICE OF PRIVATE BUSINESS CAPITAL
----------------------------------------------------------------------------------------------------------------
Without 15
percent Without
Without 50 rate on lower
2004 law percent dividends marginal
expensing and capital tax
gains brackets
----------------------------------------------------------------------------------------------------------------
Private Businesses.......................................... 0.132 0.134 0.148 0.157
Corporate Businesses........................................ .165 .168 .191 .202
Equipment and software.................................. .301 .308 .352 .373
Nonresidential structures............................... .096 .097 .110 .116
Residential structures.................................. .102 .102 .115 .122
Inventories............................................. .083 .083 .094 .099
Nonfarm land............................................ .083 .083 .094 .099
Farm land............................................... .083 .083 .094 .099
Noncorporate Businesses..................................... .082 .083 .087
Equipment and structures................................ .237 .243 .246
Nonresidential structures............................... .064 .066 .069
Residential structures.................................. .082 .082 .086
Inventories............................................. .065 .065 .071
Nonfarm land............................................ .065 .065 .071
Farm land............................................... .065 .065 .071
----------------------------------------------------------------------------------------------------------------
Date Source: Gary Robbins, Heritage Center for Data Analysis.
The tax changes of 2003 boosted investment and GDP by lowering the
service prices of various types of capital to the 2004 levels shown.
For the whole private sector, the reduction was 2.5 percentage points,
from 15.7 percent to 13.2 percent. The biggest reduction was in the
corporate sector (a drop of 3.7 points, from 20.2 percent to 16.5
percent), where the largest cut was on equipment and software (7.2
points, from 37.3 percent to 30.1 percent). All three of the
investment-related tax provisions, including the 15 percent tax rate on
dividends, applied to the corporate sector. The non-corporate sector
benefitted mainly from the individual marginal income tax rate
reductions and the expensing provision. The service price in the non-
corporate sector, which fell from 8.7 percent to 8.2 percent, is far
lower than in the double-taxed corporate sector.
The biggest reduction in the corporate service price on equipment
and software (over 4 points) was due to the 15 percent rate cap on
dividends and capital gains, which reduced the double taxation of
corporate income. Next in size was the marginal tax rate reductions on
shareholders (about 2 points), then the expensing provision (under 1
point). In the non-corporate sector, on all assets together, the
marginal tax rate reductions had the bigger impact, with expensing
larger for equipment and software.
Allowing the expensing provision to expire eliminated about 8
percent of the cut in the service price available in 2004. Allowing the
15 percent rate cap on dividends and capital gains to lapse would
eliminate about 56 percent of the cut in the service price. Allowing
the marginal tax rate reductions to expire would end the remaining 36
percent.
Each percentage point reduction in the service price of capital
increases the capital stock over time by about 1.5 percent. The
resulting increase in the productivity of labor increases the demand
for labor, and raises the total wage bill by a roughly similar percent.
Private sector GDP rises by about 1.5 percent, with about two-thirds
going to labor income and about one-third going to capital income, pre-
tax. Various layers of government take a bit over 30 percent of the
increase in income as taxes, a revenue gain of about $40 billion to $50
billion a year. Increases in the service price have the opposite effect
on incomes and tax revenues. Failure to account for the changes in GDP
and incomes, particularly labor incomes, seriously distorts the
estimated revenue consequence of changes in taxation of capital.
Every tax bill relating to capital income and cost recovery that
Congress considers should be examined for its effect on the service
price of capital. The Joint Committee on Taxation, in conjunction with
the Congressional Budget Office, should develop or borrow the software
to conduct that calculation, and report the result to the Finance and
Ways and Means Committees along with the (static) revenue estimate. If
the bill increases the service price, it will reduce investment and
GDP, which will reduce or eliminate the expected revenue from the
provision. If the bill lowers the service price, it will raise GDP,
which will provide some revenue reflow. If you are comparing two tax
provisions, and one raises the service price more than the other
relative to the amount of revenue expected to be raised, then that bill
will do more economic damage, per dollar of revenue raised, than the
other.
Current tax system is biased against saving and investment
The 15 percent top tax rate on capital gains and dividends is a
step toward fundamental tax reform. It may be thought of as mitigating
the double taxation of corporate income. Alternatively, it may be
viewed as offsetting some of the basic income tax bias against saving,
in effect extending to more saving about half of the tax relief given
under Roth IRAs.
Federal and state tax systems hit income that is saved harder than
income used for consumption. At the federal level there are at least
four layers of possible tax on income that is saved.
(1) Income is taxed when first earned (the initial layer of tax).
If one uses the after-tax income to buy food, clothing, or a
television, one can generally eat, stay warm, and enjoy the
entertainment with no additional federal tax (except for a few federal
excise taxes).
(2) But if one buys a bond or stock or invests in a small business
with that after-tax income there is another layer of personal income
tax on the stream of interest, dividends, profits or capital gains
received on the saving (which is a tax on the ``enjoyment'' that one
``buys'' when one saves). The added layer of tax on these purchased
income streams is the basic income tax bias against saving.
(3) If the saving is in corporate stock, there is also the
corporate tax to be paid before any distribution to the shareholder, or
any reinvestment of retained after-tax earnings to increase the value
of the business. (Whether the after-tax corporate income is paid as a
dividend, or reinvested to raise the value of the business, which
creates a capital gain, corporate income is taxed twice--the double
taxation of corporate income.)
(4) If a modest amount is left at death (beyond an exempt amount
that is barely enough to keep a couple in an assisted living facility
for a decade), it is taxed again by the estate and gift tax.
Eliminating the estate and gift tax and the corporate tax would
remove two layers of bias. Granting all saving the treatment given to
pensions or IRAs, either by deferring tax on saving until the money is
withdrawn for consumption (as in a regular IRA), or by taxing income
before it is saved and not taxing the returns (as in a Roth IRA), would
remove the basic bias. Saving-deferred taxes, the Flat Tax, VATs, and
retail sales taxes are examples of saving-consumption neutral taxes.
The tax on capital gains is a double tax even for the non-corporate
sector. The current value of a share of stock or a non-corporate
business is the present (discounted) value of its future after-tax
earnings. If for any reason (reinvested earnings, discovery of a better
mousetrap, etc.) future earnings are expected to rise, the current
value of the business or price of the stock will rise. If the future
income does rise, that added income will be taxed when earned. To also
tax the associated increase in the present value of the business is to
double tax the future income.
Effects of marginal income tax rates on labor and capital
Taxes on labor and capital income force up the cost of labor and
capital, and reduce the quantity offered and employed. The supply of
labor is not very elastic. Consequently, much of any tax imposed on
labor is borne by the workers. [Chart 3.] Most people must work to have
a satisfactory income, and many must conform their hours of work to the
requirements of their employers. Moving across national borders is less
of an option for labor than for capital. (Workers have some choices--to
take or reject overtime, to contribute a second family earner to the
labor force, how long to vacation, and when to retire.)
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
The quantity of capital is more sensitive to taxes than is the
quantity of labor. When a tax is imposed on capital, the quantity of
capital employed falls until the rate of return rises to cover the tax,
leaving the after-tax return about where it was before the tax. The tax
is largely shifted to users of capital and those who work with it.
[Chart 4.] Capital is easily reproduced (elastic supply) and it takes a
large change in the quantity to make a large change in its rate of
return. As for people's willingness to finance capital formation,
people can always consume instead of save, or invest abroad instead of
in the United States, if the rate of return on saving and investment is
driven down by rising taxes.
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The differences in the elasticities of supply and demand for labor
and capital suggest that there is an economic advantage to moving away
from the so-called broad-based income tax, which taxes income used for
saving and capital formation more heavily than income used for
consumption, to various taxes that are saving-consumption neutral.\7\
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\7\ For a further explanation of the biases against saving in the
current income tax, see Stephen J. Entin, ``Fixing the Saving Problem:
How the Tax System Depresses Saving and What To Do About It,'' IRET
Policy Bulletin, No. 85, August 6, 2001, p. 15 ff., Institute for
Research on the Economics of Taxation, available at www.iret.org. Also
see David F. Bradford and the U.S. Treasury Tax Policy Staff,
Blueprints for Basic Tax Reform, second edition, revised (Arlington,
VA: Tax Analysts, 1985).
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The tax treatment of capital hurts labor
The more there is of any one type of factor, the higher will be the
productivity and incomes of the other factors that work with it and
gain from its presence. A tax that reduces the quantity of capital
lowers the wages of labor. Labor thus bears much of the burden of the
tax on capital. (See Chart 5.) Because capital is more sensitive to
taxation than labor, a tax on capital will have a relatively large
adverse impact on the quantity of capital, which will then cause a
relatively large drop in the marginal product and compensation of
labor.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Consider a small trucking company with five vehicles. Suppose that
the rules for depreciating trucks for tax purposes change, with the
government demanding that the trucks be written off over five years
instead of three. The owner has had enough business to run four trucks
flat out, and a fifth part time. He is barely breaking even on the
fifth truck under old law. It is now time to replace one of the trucks.
Under the new tax regime, it does not quite pay to maintain the fifth
truck. The owner decides not to replace it, and his income is only
slightly affected. But what happens to the wages of the fifth truck
driver? If he is laid off, who bears the burden of the tax increase on
the capital?
Several studies in the economic literature illustrate that a zero
tax rate on capital income would raise the after-tax income of labor,
in present value terms, even if labor must pick up the tab for the lost
tax revenue.\8\ Productivity and wages would be higher (Chart 4 in
reverse), leaving workers with higher gross wages and more after-tax
income.
---------------------------------------------------------------------------
\8\ Martin Feldstein, ``Incidence of a Capital Income Tax in a
Growing Economy with Variable Savings Rates,'' The Review of Economic
Studies, 41(4), 1974, pp. 505-513. Christophe Chamley, ``Optimal
Taxation of Capital Income in General Equilibrium with Infinite
Lives,'' Econometrica, 54, May 1986, pp. 607-22. Kenneth L. Judd,
``Redistributive Taxation in a Simple Perfect Foresight Model,''
Journal of Public Economics, 28, October 1985, pp. 59-83. Also, see
Kenneth L. Judd, ``A Dynamic Theory of Factor Taxation,'' American
Economic Review, 77, May 1987, pp. 42-48; H. Greg Mankiw, ``The Savers-
Spenders Theory of Fiscal Policy,'' American Economic Review, 90(2),
2000, pp. 120-125; and Casey B. Mulligan, ``Capital Tax Incidence:
First Impressions from the Time Series,'' NBER Working Paper 9374,
National Bureau of Economic Research, Cambridge, MA, December 2002.
Andrew Atkeson, V.V. Chari, and Patrick J. Kehoe, ``Taxing Capital
Income: A Bad Idea,'' Federal Reserve Bank of Minneapolis Quarterly
Review, Vol. 23, No. 3, Summer 1999, pp. 3-17.
---------------------------------------------------------------------------
Budget impact
The faster economic recovery since the 2003 Tax Act has improved
the budget outlook. For fiscal year 2005, federal revenues ran 14.5
percent, or $274 billion, ahead of 2004 levels. The deficit for fiscal
2005 ran 22.9 percent, or $94 billion, below that of fiscal 2004. There
have been large gains in taxes not withheld. These revenues are from
non-corporate business income, bonuses and options, and capital gains
and dividends. A large part of the improvement in fiscal year 2005
receipts is due to higher capital gains realizations and higher
dividend payments.
Dividend payments have risen sharply since the 2003 Act.\9\ They
would rise further if the 15 percent tax rate were made permanent. More
companies are paying dividends. Many are raising dividends. More would
do so if the rate reductions on their shareholders were made permanent.
Added dividend payouts reduce the revenue loss from lowering the rate
on dividends already being paid. Under their revenue estimating rules,
the JCT and Treasury try to gauge the increase in dividends due to a
tax rate cut. This will be new territory for them, however.
Furthermore, they do not go on to calculate the reduction in the
service price of capital and the resulting increases in investment,
employment, and wages, and so they miss the higher tax revenues
resulting from the higher incomes.
---------------------------------------------------------------------------
\9\ See Daniel Clifton and Elizabeth Karas, ``Two Years Later: Tax
Cut Still Paying Dividends for American Shareholders'', American
Shareholders Association, Washington, DC, June 2005, pages 11-12,
analyzing Standard and Poors 500 historical dividend data. Also Stephen
Moore and Phil Kerpen, ``Show Me the Money! Dividend Payouts after the
Bush Tax Cut'', CATO Institute Briefing Papers No. 88, Washington DC,
October 11, 2004.
---------------------------------------------------------------------------
Treasury estimates for extending the 15 percent tax rate cap on
dividends beyond 2008 include revenue gains of about half a billion a
year from higher dividend payments in 2005-2008. Treasury is
acknowledging that some firms have hesitated to raise dividends, or
have limited the increases, due to uncertainty about how long the lower
rate will last. Extension would boost payouts starting now, adding to
short term revenue. Treasury shows losses in the out years from
lowering the rates on dividends they assume would have been paid in
their baseline. This loss is exaggerated by failure to take account of
the economic impact on investment, employment, and wages.
The Treasury, the Congressional Budget Office, and the Joint
Committee on Taxation underestimate swings in revenue from tax rate
changes on capital gains. A tax rate reduction has three effects: an
``unlocking'' effect as people choose to realize (``take'') more gains
at low tax rates; a valuation effect, as the lower tax rate increases
the market value of stocks and increases the quantity of gains
available to be taken; and an economic effect, as the lower tax rate on
capital reduces the service price of capital, and raises the desired
capital stock, investment, employment, output, and taxable incomes.
Federal revenue estimators try to account for the unlocking effect
under their revenue scoring rules, but they ignore the market effect
(stock markets have risen since the 15 percent capital gains rate was
enacted) and, most importantly, they ignore the economic effect of the
reduction in the service price of capital. In addition, the unlocking
effects have generally been larger than the estimators anticipated.
Studies in the mid-1980s at Treasury suggested that the reductions in
the capital gains tax rate from nearly 40 percent to 28 percent in 1979
and from 28 percent to 20 percent in 1981 have raised revenue.\10\ By
contrast, the capital gains rate hike, from 20 percent to 28 percent,
enacted in 1986, was followed by a collapse in realizations. Long term
gains as a share of GDP did not recover to 1985 levels for twelve
years. [Chart 6.]
---------------------------------------------------------------------------
\10\ See the following Treasury Department Papers: the panel study
in ``Report to Congress on the Capital Gains Tax Reduction of 1978'',
Office of Tax Analysis, September, 1985; Michael R. Darby, Robert
Gillingham, and John S. Greenlees, ``The Direct Revenue Effects of
Capital Gains Taxation: A Reconsideration of the Time Series
Evidence'', Research Paper 8801, Office of the Assistant Secretary for
Economic Policy, May 24, 1988; Gillingham, Greenlees, and Kimberly D.
Zieschang, ``New Estimates of Capital Gains Realization Behavior:
Evidence from Pooled Cross-Section Data'', OTA Paper 66, May 1989, and
Gerald E. Auten, Leonard E. Burman, and William C. Randolph,
``Estimation and Interpretation of Capital Gains Realization Behavior:
Evidence from Panel Data'', OTA Paper 67, May 1989, both from the
Assistant Secretary for Tax Policy, Office of Tax Analysis; Gillingham
and Greenlees, ``Evaluating Recent Evidence on Capital Gains
Realization Behavior'', August 4, 1989; and ``The Effect of Marginal
Tax Rates on Capital Gains Revenue, Another Look at the Evidence'',
Research Paper 9003, Dec. 1, 1990, both from the Office of Economic
Policy. Also see Gillingham, Greenlees, and Zieschang, ``An Econometric
Model of Capital Gains Realization Behavior'', presented at the 65th
Annual Conference of the Western Economic Association, July 1, 1990.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Extending the 15 percent top tax rate on dividends and capital
gains now would be excellent insurance against renewed weakness in
investment. It would lower the projected service price of capital, and
would improve the economic outlook. The revenue consequences would be
positive in the short run, and less negative than the static revenue
projections from Treasury and the JCT in the long run. More
importantly, the effect on the economy, wages, and employment would be
---------------------------------------------------------------------------
sharply positive.
Senator Brownback. Thank you very much, Mr. Entin.
Gentlemen, I appreciate all the testimony. I've got some
questions I want to ask each of you.
Congressman Armey, let me start off with you on this.
You've been around this topic for a long period of time. There
has been widespread support for it. There is enormous
frustration about the current Tax Code, across the Nation. I've
held town hall meetings on this, years ago, and people are more
frustrated with the complexity than with the rates. And then,
you note, as well, something that I haven't heard other people
testify, just a fear factor here that, ``Somehow I'm going to
get it wrong, and then somebody's going to come after me for
it.''
Why have we not been able to get fundamental tax reform,
then, with all of that going forward?
Mr. Armey. Well, I--of course, I study and worry about this
all the time. And I appreciate the question. I think there are
a variety of reasons. One, there is confusion in the country
about which way to go. There is a large share of our
population, a large active and vocal group of people in the
country, that believe we ought to have a national sales tax.
This dissipates a lot of energy that could be devoted and
funneled on this--on the tax reform. And I can just say I've
studied on this for years, and I remain even more convinced
today than ever before that a national sales tax would be a
disaster--an economic disaster, administrative disaster, and a
disaster which, among other things, would result in an enormous
growth in the underground economy in this country.
Every good thing that is predicted for a national sales
tax, when, in fact, it has been enacted in the world, has
failed to materialize. Just the opposite. Every good thing
that's been predicted for the flat tax has, indeed,
materialized into greater degrees than hoped for.
So, it strikes me one of the things we're going to have to
do is finally get ourselves settled on one option, as opposed
to flirting with what I, frankly, have to characterize in no
other words than patent foolishness, a national sales tax. But
that does make it difficult to get a nation focused.
The other is, quite frankly, this Nation is behind the
eight ball relative to the relatively new governments in the--
and enterprises--in the liberated Eastern Europe, in that we
have a very large, effective, and well-focused, and highly
well-funded tax complexity system of professionals in the
country. And my favorite is, for example--and there's a lot of
mythology that they attend to. I always like pointing out that
the great myth of the realtors is that the American dream is to
own your own home, when, in fact, it is to get your kids out of
it.
But we have a group of people whose profession is how to
maximize revenues or returns, or whatever, under this existing
Tax Code. If the Code goes away, their job goes away, the
professionals, who are very skillful and able people in
universities, that are responsible for helping people,
nurturing them through the process of giving to universities.
And, quite frankly, as Milton Friedman--I'm going to resort
to Milton Friedman on this one--as Milton Friedman points out,
the two tax-writing committees themselves. I mean, I can
honestly say--I've been in Congress for 18 years--I have not
yet once heard somebody say, ``I would like to be on the Ways
and Means Committee, because I'm fascinated with the subject
area.'' The fact of the matter is, the first best reason people
want to be on the Ways and Means Committee is, it's the best
way, and easiest way, to fund their campaigns, because there is
that professional trading of this and that consideration. Now,
I don't mean to say their work's not legitimate. Within the
context of this Tax Code, it is a legitimate committee that's--
that operates, I think, by and large, with legitimate
governance. But, two observations: One, it has this aberrant
side effect of being--making campaigns easier--more easily
funded; and, two, Armey's axiom is that, ``Even a sane man will
act crazy in crazy institutions.'' And our Tax Code is a crazy
institution.
So, I don't want to be too critical of the committees, but
do understand the committees would, themselves, resist this
kind of a change, because it would, in fact, put them out of
business. And that--so, you've got--you have that system of tax
professionals.
Then, the--finally, from a more ideological point of view,
there are people in the country who still believe that it is a
legitimate and necessary function of the Tax Code, as over and
against my belief that it is a corruption of the Tax Code, to
use the Code for income redistribution and social engineering.
And, again, these poor, misguided souls, in my estimation,
simply don't understand, there's only one legitimate reason to
have a Tax Code, and that is to raise money. And, as Adam Smith
said, in 1776, that ought to be done in such a manner as to
strip the down off the goose with the least amount of squawks.
And our Code doesn't do that.
Senator Brownback. Mr. Edwards, I want to focus in on Hong
Kong, because they have this optional flat tax system, and I
want to ask you about that. First, what's the rate in Hong
Kong?
Mr. Edwards. Yeah, they have a graduate individual system,
with rates that go from 2 to 20 percent. So, their top rate,
under their regular system, is not that high. And if your--
effectively, your effective tax rate rises above their flat 16
percent rate, you pay, at most, 16 percent on a broader income
tax base.
Senator Brownback. So, they basically have an alternative
maximum flat tax?
Mr. Edwards. Basically, that's how it works, yeah.
Senator Brownback. Because I've heard other people say
that's what we ought to do with the AMT, make it into an
alternative maximum tax and just----
Mr. Edwards. Yeah, the AMT certainly has lower rates in the
regular system, and a broader base.
Senator Brownback. What about people opting in and opting
out of the Hong Kong system? Do you know the numbers, or have
you studied that? And do people bounce back and forth in that
system, then?
Mr. Edwards. I think that's allowed. In fact, I think
it's--my understanding, from Allen Reynolds, my colleague,
who's more of an expert on the system than me, is that it's
essentially--the tax authorities do the calculation for you. If
your return goes in, and you pay--and you've got higher than 16
percent effective rate, essentially you're--you know, that's
the cap, that's the most that you can pay. So, it's--they've
essentially enshrined the principle that no one should pay more
than 16 percent of their income in taxes.
Senator Brownback. Dan, what should the flat tax rate be
here in the District of Columbia? I notice you poked your
colleague, Congressman Armey, as asking for too high of a rate.
What should it be in the District of Columbia, other than,
obviously, as low as possible?
Dr. Mitchell. Well, you took away my obvious answer right
there. Frankly, you have a tradeoff. The lower the rate you
have in the District, the better the economic growth results,
the more this will be a pilot program that'll get the rest of
the country excited. But, I think Steve Entin correctly warned
you that the Joint Committee on Taxation is going to get all
nervous about that, because what they will do is make
assumptions about huge amounts of people moving into the
District, and, therefore, Federal tax revenue collections from,
say, Maryland and Virginia, going down. So, they're not just
going to look at the existing tax base in the District and not
give you a very friendly score on that, and not count the
economic growth effects, as Steve mentioned. But they're going
to say, ``If it's so much more attractive, because the rate is
so low in the District, it's going to--you're going to bounce
into some very difficult issues with the revenue scoring,
simply because we've never fixed that process.''
Senator Brownback. Do we have an example of anywhere in the
world that's gone to a flat tax that has not produced positive
economic growth numbers?
Dr. Mitchell. Well, I can best--for instance, Serbia--I've
never studied that system. I have no idea how well it works.
You know, the countries that are in, you know, closer to the
west, and the bigger countries, are the ones that have gotten
the most attention. And, of those, unquestionably, big revenue
increases in Russia; Slovakia, same thing. Romania has only
been in effect just a little bit over a year; they've had very
good results. The three Baltic countries, very, very positive
results over time.
Senator Brownback. So, a flat tax creates positive economic
growth and tax receipt growth.
Dr. Mitchell. Both economic growth--the key relationship is
faster economic growth means a bigger tax base. There's just
more income out there to tax, so, even though it's at a lower
rate than it might have been under the old system, because
people are doing two things, the government can come out
without a loss of revenue. Number one, they're not evading and
avoiding the tax system as much. And, number two, they actually
have better incentives to work, save, and invest. And the
combination of those two factors have resulted, especially if
you look at the better, more purer flat tax systems--you know,
not all these systems, as Steve said, are Hall-Rabushka-style
systems--but, say, Estonia, Slovakia, Hong Kong would probably
be the three best systems that are the most pure. And we've
unambiguously had superb results from those jurisdictions.
Senator Brownback. Both substantial economic growth and
substantial increase in tax revenues.
Dr. Mitchell. Uh-huh.
Senator Brownback. Even though this, here will be scored by
the Joint Committee on Taxation, static, and so, will probably
be scored as a net revenue loser to the Government.
Dr. Mitchell. Yeah. I mean, it depends on your definition
of ``substantial revenue.'' Slovakia, I think you're talking
about a half a percent of GDP income tax collections being
above the static forecast. In Russia, it's been much more
dramatic, but they start it with a bigger problem of tax
evasion. You know, so it just depends on what your base is,
what you're factoring in. But certainly we have not seen
anything that could be characterized as a loss of revenue. The
revenues come in over forecast in all the situations I'm aware
of. Again, I don't want to pretend that I know the intricacies
of Ukraine and Serbia, other than knowing that they have one
rate. I have no idea how well the systems work. They obviously
have a lot of other issues and challenges in those countries.
And so, there's just not good data coming out.
Senator Brownback. Let me turn to my colleague. We're
joined by Senator Allard of Colorado.
Senator Allard. Well, thank you, Mr. Chairman.
And I want to welcome the panel. I want to apologize that I
wasn't here at the start of your hearing. It wasn't that I
wasn't interested. It was that I had a budget hearing going on
at the same time, and I wanted to get there and get my two bits
in before I had an opportunity to come here.
And I want to also compliment you on working hard to
simplify the Tax Code, particularly as it applies to
Washington, DC. I have always been one who has felt that we
needed to have tax reform in this country. I have felt that, in
addition to that, we need to be sure that we reduce the tax
rate. In other words, we not have tax reform, then end up
increasing the tax rate.
The State of Colorado, from which I represent, has a
modified flat tax that they use. It's built off of the Federal
income tax. It does simplify filling out the tax form for many
citizens in the State of Colorado. The disadvantage, of course,
is that they tie their tax policy somewhat to the Federal
level. And that tax policy is not always wise, in my view.
I do think that to apply a flat tax to Washington, DC--and
I think of--we can think of it in terms of a State--I think
it's less problematic than it is for the State of Colorado,
because they're so closely tied in with the Federal budget
anyhow, and they are--basically have to answer to the Congress.
So, I think it's a wonderful idea. And I hope that we can get
this to sell here in the Congress.
There's been other tax reform measures, as was alluded to
by Mr. Armey here, in his comments, the sales tax reform. Most
of that idea was actually promoted in the House of
Representatives, when both Mr. Armey and I served over in the
House, from my good friend from Colorado, Congressman Schaefer.
And he was a strong advocate of the sales tax. And I've--I took
the position that we probably shouldn't be advocating or going
with a sales tax, unless we can assure ourselves that we don't
end up with a double-tax system. And that required a
constitutional amendment to eliminate the income tax
provisions. Otherwise, I felt like we could temporarily
eliminate the income tax, put in place a sales tax at the
national level, and then, a decade or two later, we'd
inevitably be back with an income tax again. We'd have a two-
tax system. And I think we'd be much worse off than we are
today if that should happen.
So, I've always had some reservations about the sales tax.
And the argument was always, ``Well, you could get rid of the
IRS.'' But if you have a sales tax, you'd have to have an
auditing function. And that means--I looked at it from a
perspective of a small business man. I already have--if I have
a sales tax, I already have the State auditors coming in, and
the city auditors coming in. Now I've got to have the Federal
auditors come into my small business and look at it? I didn't--
I wasn't--I didn't shine on that too well.
I think the most practical and the--approach to tax reform
has to be the flat tax. And--now, the proposal that we have
over on the House side was a flat tax--it was a modified flat
tax. We had a couple of exceptions. Number one was the
mortgage--the interest on mortgages of homes, and also
charitable giving. And I don't know whether you're talking
about those exceptions or not here on the District of Columbia
bill.
Senator Brownback. Well, this would be a straight flat
tax----
Senator Allard. Flat tax.
Senator Brownback [continuing]. Option, so that you keep
the current Code, but you also create the option, but the
option doesn't have any--it doesn't include mortgage
deductions, charitable deductions, it is a flat rate, period.
Senator Allard. Flat tax, yeah. And that might----
Mr. Armey. Let me just----
Senator Allard [continuing]. Work a little better,
because----
Mr. Armey [continuing]. Interject that the retention of the
mortgage deduction and the charitable deduction may end up
being a political reality.
Senator Allard. Right.
Mr. Armey. But it is dumb tax policy.
Senator Allard. Yeah. Well, I mean----
Mr. Armey. And there is, in fact, no justification for
doing so, in terms of your desire to see more charitable
contributions or to see more people own their homes. But the
fact of the matter is, these are two very, very strong,
powerful lobbies, and they sell their--as we say in Texas,
their BS very well.
Senator Allard. Well, and I'm assuming that your flat tax
is going to be somewhat like Colorado's, you're going to tie it
into the Federal. And if you do that, it's not a problem.
Mr. Armey. Right.
Senator Allard. It's already there. So, I appreciate it.
I--do you--let me just ask this, sort of, generic question
to the panel. Well, let me--before I do that, let me--I think
the President has us on the right approach on tax policy,
particularly on two of the taxes. Number one, I think reduction
of capital gains worked again, as it did for the Kennedy
administration, when John Kennedy implemented it, and when it
happened with the Reagan administration, when President Reagan
implemented it. And I think we saw it work again. And we saw it
work, even when we had some adverse economic events happening.
We had high energy costs. I remember, in 1970, with high energy
costs, we ended up with a misery index--double-digit
unemployment, double-digit inflation, double-digit interest
rates. And, you know, his tax policy worked, and created
growth, even in the face, not only of high energy costs, but
also paying for a terrorist war out here. And I think that
speaks to the strength of his policy. And I think one of the
strongest aspects of it was the aspect where we allowed
expensing for small business, up to $100,000. To me, that was a
real income driver. It was a driver for small business, a
driver for our economy, and, I mean, the Federal revenues went
up. And so, I just wanted to make that--get that two bits in.
But let me ask you, Do you--ask this panel--do you see any
down sides for having a flat tax here in Washington, DC?
Senator Brownback. If I could, Senator--and I want the
panel to answer this--I've got a markup, upstairs, in
Immigration, I've got to slip up to, to get them a quorum. So,
I'm going to turn the gavel over to Wayne to do that. And I
appreciate very much the panelists being here. I may be able to
come back down. But I think it's been excellent discussion.
I do hope, as well, that you talk with them about the issue
of charitable giving, because people raise the issue of,
``Isn't this going to make a hit on your charitable giving?''
So, I hope we can address that, some, as well--if you don't
mind taking over----
Senator Allard. Sure.
Senator Brownback [continuing]. To charity.
Senator Allard. I'll be glad to. Is there any other
questions you want me to cover?
Senator Brownback. Just on the charitable giving, because I
think it's important to get that out in the record.
Senator Allard. Yeah.
Mr. Armey. Let me----
Senator Allard. If we run out of----
Mr. Armey. Let me respond to both points. The first quick
short answer to yours, on the downside question, is, the answer
is no. I see nothing but good things for the city. I can see
that some of the areas around the city might not be real happy,
but the city--I don't--I can't conceive of a down side for the
city, especially when you recognize the voluntary subscription
aspect.
Now, let me just talk about the charitable giving thing,
because it's been kind of a pet peeve of mine for some time.
When we did the Reagan tax cuts, we cut the tax benefit of
charitable gift to one-third of what it had been prior to the
Reagan tax cuts. And charitable giving went up. The reason
charitable giving went up was, people's incomes went up.
Revenue to the country doubled in the decade of the 1980s in
the aftermath of the tax--Reagan tax cuts.
The fact of the matter is, what happens with charitable
giving is that, once again, as with investment activity, you
get--you will get more charitable giving, and it will be
given--the decisions, the choice criteria, where and how much
to give will be made on charitable criteria, rather than tax
criteria. And I just have to tell you, anytime you have a
decision made on economic criteria, criteria of the heart,
criteria of the mind, you're going to have better choices and
better results than when you have decisions that are made on
political criteria. This, I say to you, pursuant to Armey's
axion number none, ``The market's rational, the Government's
dumb.'' And people, when they're guided by the need to maximize
my well-offness in terms of Government policies, are not going
to make the same rational, and, I would say, equally free,
decision.
My--for example, I might find--I find this interesting--if
I had a--under American tax law today, if I--it would make more
sense for me to give $12,000 to the Society for the Prevention
of Cruelty of Animals than to a relative that's not well off,
because the animals will not be, then, in turn, required to pay
taxes to the Government under $12,000, and my relatives would.
Now, I mean, you've got a tax law that says, now Dick Armey
wants to make a decision of the heart, he'll put people before
animals; if he wants to make a decision compliant with the Tax
Code, he puts animals before people. This is why--now, I know
it sounds harsh for me to say the word ``dumb,'' but I just,
frankly, can't find much of another word to use.
Senator Allard [presiding]. Other members of the panel who
would like to respond to the question?
Mr. Entin. Yeah.
Senator Allard. Mr. Entin, and then Dr. Mitchell.
Mr. Entin. I don't want to sound ``dumb''--but there are
some other principles of sound tax theory that I think we need
to consider. My late boss, Norm Ture, who was a tax expert here
in the city for many years, was a strong advocate of these
neutral taxes, but he also wanted to put the principle forward
that income should be taxed as close to the level at which
people get to spend it as possible. So, that if, for example,
someone is paying alimony to an ex-spouse, the alimony comes
off one's tax return and goes onto the tax return of the
recipient. Similarly, with charity, if I'm giving money to
someone else, it should come off my tax return and go onto
theirs.
Now, under the flat tax, and most of the variations of it,
including that which Senator Brownback has described, there
would be an exempt amount for the poor--in fact, quite a
generous one--so that if people receiving income are too poor
to owe tax on it, they shouldn't have to pay tax on it, nor
should it be taxed before they get it.
So, the point is that you really--for the maximum amount of
visibility and transparency in the tax system, you should
probably tax them on a--at the point where the people who are
spending it can see that there's a tax imposed. So, I would
differ, on that basis.
I would agree that the fuss that the special interests made
over the mortgage interest deduction was just a bunch of a
hullabaloo. If mortgages are at 8 percent, and the borrower and
the lender are in the 25 percent tax bracket, they're both
paying and getting 6 percent, after tax. And if you have the
flat tax, they simply go to a 6 percent rate to start with. It
seems to me that was very much a slander against the flat tax
on the part of the retailer--the realtors.
I would be more concerned with the loss of the deduction of
the property tax. If you're a business, it's clearly an
expense. And taxable income should be revenues minus the cost
of earning revenues.
But there's another consideration. Most of the neutral
taxes would regard tuition as a cost of earning future income.
It's an educational outlay. It's an investment in human
capital. You're expensing physical capital. You should expense
the tuition. To a large degree, the property tax deduction does
that for primary schools. And the State tax deduction does
that, to a considerable degree, for State universities. And
much of the rest of those taxes goes to transfer payments to
the poor.
So, I think those are reasonable, on other principled
grounds. I don't agree that we would have a collapse of
charitable giving if we denied the deduction. I think that most
of the ordinary arguments made against the Armey plan on those
bases are phony. I just have this other kind of tax
consideration that leads me to conclude that those should be
kept.
Chris made a statement about the alternative minimum tax,
in response to Senator Brownback's question about an
alternative maximum tax. I have some serious reservations about
the AMT. Again, it disallows some legitimate business
deductions, so it's overstating the business's real income, and
that of individuals, in many cases. So, you're taxing
something, but it's not income. I don't know what it is, but
it's not income, after costs. And, yes they do lower the rate
in the statute, but they have a large chunk of exempt amount
under the AMT, which they phase out between two levels of
income. If you're in the phase-out range, you're not paying the
26 and 28 percent tax rate, you're paying 32\1/2\ and 35. And
in that range, your rates are as high, or higher, than under
the ordinary income tax, at the margin. It is really not a good
alternative tax system. If you're going to do an alternative
tax system, do the Hall-Rabushka or do the consumed income tax,
but don't do the AMT. That's not a good way to go.
Now, there are two other neutral tax systems, the VAT and
the national retail sales tax. I don't think you could adapt
either one of them, as they are normally put forward, to be a
test case for the District of Columbia. If you tried to put a
major sales tax, at the Federal level, on the District of
Columbia, people would drive to Maryland to get their
groceries. You'd have to have Customs sheds and checkpoints at
all the roads between the District and Maryland, and on the
bridges to Virginia. I don't know what you'd do at the
airports. They're crowded enough.
If you tried to do the value-added tax on the normal basis
where you exempt exports and tax imports, you'd have the same
customs shed problem. And you could perhaps do it on an origin
basis, which is the opposite of the way VATs are treated all
around the world. So, I think there are administrative problems
with those other approaches.
And there are some administrative problems in translating
the flat tax into a regional tax, or a consumed income tax into
a regional tax, that you would have to address carefully in the
legislation.
I do think that the effort to get this discussion going as
to why the tax systems are too complicated and antigrowth is
very important. And if you can come up with demonstration
legislation that takes care of these administrative details
that would otherwise drive the Treasury nuts, you know, more
power to you. I do commend you for being interested in the
issue and trying to get something done to blast it off dead
center.
Thank you.
Senator Allard. Well, it is a more simplified tax, when you
go to a flat tax. Like, in Colorado, you just take the bottom
line off your Federal income tax form. I think the rate's 6
percent or 6\1/2\, something like that. Just multiply that out,
and you've got what you pay in the State. You can do it on a
postcard, if you don't have a complicated tax form. If you have
a complicated tax form, you're not going to get it done on a
postcard.
Dr. Mitchell.
Dr. Mitchell. I was just going to add a couple of quick
points. Only about 30 percent of people in the country itemize,
as it is. So, 70 percent of the people who are homeowners,
people who give to charity, they're not doing it for the tax
benefit, clearly, at all. And to echo what Congressman Armey
said, we had an actual experiment in the 1980s. If itemized
deductions really were critical, then we should have seen
terrible results for housing and for charity in the 1980s,
because marginal tax rates, and, therefore, the value of the
deduction, fell so dramatically. Instead, we saw just the
opposite. Why? What matters for charity, what matters for
housing, what matters for just about everything in the country,
other than maybe bankruptcy law, is strong economic growth. If
you have people earning more income and people generating more
wealth, they're going to give more money to charity, they're
going to buy bigger homes, more homes, and that should be the
key thing about tax policy.
Raise revenue in the least destructive way possible so you
can have the maximum economic output, big tax base, low tax
rates. That's the fundamental principle of taxation, that--I'm
just afraid that we're forgetting about, while the rest of the
world is catching up. And sooner or later, a country like
China's going to adopt a flat tax. I mean, we can look at
Slovakia, be impressed by their results, but that's not going
to have a big echo effect on our competitiveness. It's going to
spread. It's going to keep spreading, because of globalization,
and I just worry that we're going to fall behind while other
countries are doing this.
Senator Allard. Mr. Edwards.
Mr. Edwards. Yeah, to build on that a little, I mean,
Senator Brownback's first question to Mr. Armey was, you know,
why has there been these big hurdles to tax reform? And why
haven't we got it done yet? And it does seem to me, looking
ahead--and I agree with Dan entirely--that, you know, in some
ways, it should get easier to do a big tax reform in the
future, because the gap between the most efficient tax systems,
the highest-growth countries in the world, and us will get
larger and larger. Global capital flows will keep going up and
up and up and up, and that means that the cost of not having an
efficient tax system will rise. And as more--right now, for
small- and medium-sized countries, like in Eastern Europe,
there's a compelling economic interest in radically cutting
your tax rates, because you're a small country within a
gigantic global pool of capital. So, the United States has been
somewhat resistant to tax reform, because we have such a big
economy and because investors want to put money here for nontax
reasons. But as other countries catch up and keep cutting, like
China, the pressure on us will rise and rise. And that's why I
think, you know, sometime in the future we will get a flat tax.
You know, maybe not in this year or next year, but I think the
pressure will keep rising.
Mr. Entin. Chris has made an important point about the
international capital flows and the global economy. I'd like to
bring that down to a specific problem you may face here, and
that the President may face. The President's proposed that the
Treasury begin doing dynamic analysis and get away from the
static estimates. Chairman Thomas, in Ways and Means, has been
trying to get the Joint Committee on Taxation to do that for
some years. The people doing these analyses from the old guard
in the tax theoretic community tend to look at a closed
economy. They tend to neglect the international capital flows.
They tend to assume that domestic saving isn't responsive to
these incentives, and that, therefore, if you did get
investment incentives, there would no money to pay for it,
unless the Government ran huge budget surpluses, which we're
not going to do.
The smaller countries adopting these proposals are
attracting capital from abroad, and they can get the use of
other people's saving. If the French are not investing very
much in France, they can invest in Slovakia. If the taxes in
France aren't doing a good job for their local investment, the
savers in France can just invest somewhere else. The United
States sends a lot of money abroad into global mutual funds. If
we improved our tax climate here, that money might stay home.
Wouldn't be any additional savings in the world, but we'd be
getting to use it more than the others. Foreign saving could
flow in.
When you do these changes that make investment in the
United States look more attractive, the saving materializes.
And those on the static revenue side who don't want to bother
thinking about that, and some of those who are supposedly doing
dynamic analysis, but still think about closed models where
they don't have these savings flows, are going to come up with
the wrong answers.
So, if Treasury doesn't do it right, this effort won't work
well. And if the Joint Committee on Taxation continues to do it
wrong, they may claim they're doing dynamic analysis, but
they're not doing it correctly. And they will still give you
bad outcomes on the bills that you put forward to make the
country grow, which will make it look like it's too expensive
to do them. It's really too expensive not to do them.
I really think that the Congress needs to take the Joint
Committee on Taxation in hand, and I hope the administration
will take the Treasury in hand, when it tries this experiment,
so that it gets done right.
Senator Allard. Well, I agree with you, in your comment.
Again, one of the frustrations I had in coming to the Congress
is the static scoring that they did. And it disadvantaged--
basically, it disadvantaged any of those who were proposing a
tax reduction. In Colorado, we have dynamic scoring. And I
think we did as good a job as they do here at the Federal level
in coming up with what--they actually did a better job than
they actually were coming up here at the Federal level, as far
as projecting what the incomes would be from the policy changes
that we were making.
The--and what we did in Colorado is that we followed the--
you know, when we projected income and expenses, we followed
those. And if we saw them moving in a way that was going to
create--we have an amendment that says that we can't run the
deficit in our budget. So, then, if we saw that, at some point
in time during the fiscal year, where when it extrapolated out
to the end of the year, showed that we're going to end up with
a deficit, we would begin--institute a policy change in the
middle of the year, even if it required a special session of
the legislature, so that we could change it before we got to
that point where we had a deficit at the end of the year.
So, I thought--and--but, you know, I can only think of once
where we had to come in and change that just before we
adjourned. Actually, we didn't even have to call a special
session; just before. But other--the 8 years I was in the State
Senate there, I thought it worked extremely well for us. And I
think once you get people familiar with the process and
familiar with the dynamic scoring methods that work, then the
tradition can carry on. And I think it will work for us. And I
like the idea of dynamic scoring, because I think you remove
the prejudices out of the system. And I think when you go with
a static scoring, you build in some prejudices that
disadvantage those of us.
And on flat--on the AMT and the telephone tax, there's two
examples of where you're going to tax the rich. And we ended up
taxing everybody, because everybody grew their revenues up to
the point where they reached into those parameters. We've seen
that happen time and time again. And that's the argument that
we have on the flat tax. I can see it coming. ``All you're
doing is, you're going to help the wealth, and the poor are
going to continue to pay their taxes.'' And that's the
argument, as Mr. Armey knows, that we're going to be facing
here. And if you have a good--you know, I--my response to it,
obviously, is that, you know, when the tide rises, everybody
benefits. If you have a better argument on that, I would
certainly like to hear what that might be, when we get that
argument that all we're doing is benefiting the wealthy.
They'll use that argument in any tax cut that we do, by the
way. But if you have any suggestions, I'd like to hear what you
have.
Yes, Mr.----
Mr. Armey. Why don't I just say, you know, there's a
great--fascinating mythology of American tax discourse--and, of
course, a great lie, and it probably has some truth to it--most
wealthy people have many avenues by which they can shelter or
otherwise disguise, and, therefore, abridge their tax
liabilities. And the flat tax eliminates everything that can be
described as a ``loophole.'' So, I mean, I laugh at the
people--my good friend Charlie Rangel being the most colorful
of these--and I do say this sincerely; I love Charlie Rangel
like a brother, but he is funny--in that, on one hand, ``All my
rich friends''--he's talking to me--``all my rich friends got
them loopholes that you guys put in, you Republicans, put in
for them.'' And then we want to talk about passing a flat tax,
where there are no loopholes, ``Well, that's just another thing
you're doing for your rich friends.'' So, Charlie, he's going
to have it that way, either way.
But one little thing we picked up during one of the
Presidential campaigns when we had a lot of colorful
campaigning going on, was, somebody took the time to figure out
Ross Perot's tax liability. During that year, his tax rate was
11 percent. And had Ross Perot filed under the flat tax in that
year, he would have paid 17 percent. So, I know that's only one
instance, but I have to say it was quite fun for me to traffic
that one around during that period of time.
Senator Allard. Mr. Entin.
Mr. Entin. In addition to analyzing things dynamically to
estimate revenues, you really need to--well, if you did that,
you would need to know what would happen to the economy and to
people's incomes as a result of the tax change. When you cut
taxes on capital, more capital is formed. Old capital has more
competition from the new capital. They don't gain very much.
Senator Allard. Yeah.
Mr. Entin. But with the new capital in place, labor's more
productive, and the wages are bid up, and so is the number of
jobs. Most of the gain from reducing taxes on capital goes to
labor. There's quite an economic literature building on this
now. So, all of those distribution tables and burden tables,
that the Joint Tax people give you, that don't assume any
change in wages when you cut the taxes on capital, and just
show the initial impact of the tax change on who sends the
check in to the Government, are not burden tables at all;
they're initial incidence tables. If you did the burden table
correctly, which you have to do, to do dynamic scoring, you'd
show labor getting the bulk of the gain from moving to
something like the flat tax. You need to reform the Joint
Committee on Taxation in more than one way, is what I'm trying
to say. And if you did that, you'd get the very result that you
described earlier.
Senator Allard. Thank you.
Mr. Edwards. To put that in a quick principle to sort of
remember here, is that the more mobile the tax base, the less
likely that the burden actually ends up being paid by that tax
base. The classic example is the corporate income tax in the
global economy. Probably much of the burden of the U.S.
corporate income tax falls on U.S. labor, not on U.S. capital
holders. High-income individuals generally have much more
mobile tax bases than low-income taxpayers. If you try to--the
more you try to tax the rich, they've got many more options to
try to avoid taxes--by changing their type of income, by moving
income abroad. So, you know, folks may think they're--some
folks may think you're going to gain a lot by taxing the
wealthy and taxing corporations, but you don't, because they've
got a lot more options than average taxpayers.
Senator Allard. Yeah, corporations, too. In fact, that's
one of the challenges, whether it's the State or Federal. If
you look at how much corporations pay from year to year,
there's a big oscillation back and forth, and they have the
capability of moving around their income more than individuals
would have.
Dr. Mitchell, were you going to--did you have a--were you
going to respond?
Dr. Mitchell. I think my panelists----
Senator Allard. Okay.
Dr. Mitchell [continuing]. Did an excellent job.
Mr. Armey. Well, I just--I did want to make the point that
all this was known to us in the works of Bastiat and Mills, in
the last 18th century. So, we keep working at it, we might
understand as much as they did in 1776.
Senator Allard. Yeah. Very good.
Well, let me just draw this to a conclusion. I know you're
all busy people, and I want to thank you for taking the time
from your busy lives to come here and help inform us about the
proper tax policy that we ought to be pursuing. And I, for one,
will be working with the chairman of the committee to see if we
can come up with a good flat tax policy here for Washington,
DC. Thank you for your testimony, and have a safe trip home.
ADDITIONAL SUBMITTED STATEMENT
The subcommittee has received a statement from Paul Strauss
which will be inserted in the record at this pont.
[The statement follows:]
Prepared Statement of Paul Strauss
Chairman Brownback, members of the Subcommittee: I thank you for
the opportunity to present this statement for the record on the subject
of the proposed D.C. flat tax. I am disappointed that the committee
will not be hearing testimony from any individuals or officials who
represent the District of Columbia. Given that the flat tax, if
adopted, would apparently affect only the citizens of D.C., I would
hope that you would consider their needs and concerns above the
theories of ideologues. The Honorable Dick Armey may know about the
Great State of Texas, but he's no expert in D.C.'s taxes.
It is worth noting that the 16th amendment provides that there
shall be a uniform system of federal income taxation. Imposing a flat
tax on D.C., and only on D.C., is not only in violation of the spirit
of that amendment but also smacks of elitism, by imposing an unfair
system on those citizens who do not have a vote to change it. Whether
Congress' plenary power over the District would trump our
constitutional rights under this amendment is a question that would
likely need to be resolved by our courts.
While national tax policy is, of course, within the purview of the
national legislature, it would be unconscionable to impose an unwanted
flat tax system on the people of D.C. The proposed flat tax could
destroy the economic stability of the District of Columbia by taking
from those who already have too little and giving to those who live in
the richest parts of the city. D.C. is in an even worse position to
deal with a flat tax than other places would be because of our unique
situation. Unlike a large state, in which there is not only a sizable
middle class but a diverse economy with industries that would not be so
harmed by switching to a flat tax, D.C. has an economy centered on real
estate, government, and nonprofit work.
Flat tax systems typically remove deductions such as charitable
contributions, the Earned Income Tax Credit, and deductibility of
mortgage interest. D.C. has a dynamic economy; the leading source of
revenue is real property taxes. Additionally, we have an unusually
large number of people employed in the non-profit sector. If the flat
tax eliminates these exemptions, the D.C. economy could suffer
tremendously. Consequently, there would also be less tax revenue
flowing into local coffers as well as the national treasury than under
the current system.
It is morally wrong for Congress to use D.C. as an ``experiment.''
However, that point aside, D.C. is not even a good subject for
experimentation because of the unique economy of the city. It is also
wrong to pick on D.C. to experiment simply because we don't have a
voting representative in this body. I also find it alarming that this
Congress, which has all but bankrupted the federal government, now
wants to change the system in D.C., which has a budget surplus. Perhaps
instead of national tax experts testifying on how to change D.C.'s
federal tax systems, Congress would do well to have the District of
Columbia's financial management team give suggestions about how to
improve our national economy.
Thank you again for the opportunity to offer testimony in
opposition to this proposal. In closing, let me thank Kasey Dunton of
my legislative staff for her help in preparing this statement.
SUBCOMMITTEE RECESS
And I'll go ahead and call the subcommittee--in recess--
recess the subcommittee. Thank you.
[Whereupon, at 3:25 p.m., Wednesday, March 8, the hearing
was recessed, to reconvene subject to the call of the Chair.]
POTENTIAL EFFECTS OF A FLAT FEDERAL INCOME TAX IN THE DISTRICT OF
COLUMBIA
----------
THURSDAY, MARCH 30, 2006
U.S. Senate,
Subcommittee on the District of Columbia,
Committee on Appropriations,
Washington, DC.
The subcommittee met at 1:34 p.m., in room SD-138, Dirksen
Senate Office Building, Hon. Sam Brownback (chairman)
presiding.
Present: Senator Brownback.
OPENING STATEMENT OF SENATOR SAM BROWNBACK
Senator Brownback. Good afternoon. The hearing will come to
order. Thank you all for joining us today. Today we are going
to continue to explore how the Federal Government might test a
fairer, simpler flat system in the District of Columbia. I
might also mention at the outset I have offered numerous times
if people in the District are concerned about being a test
case, I would offer my State of Kansas to be also in that pool
of people to be tested for this prospect.
We are going to dig into more of the specifics today. A few
weeks ago the subcommittee heard testimony about how a
voluntary flat Federal income tax for District of Columbia
residents could give us some valuable real world information
about whether a flat tax is actually better than the current
cumbersome system and I believe also helpful to the District of
Columbia.
I believe most taxpayers in the District of Columbia would
greatly welcome this opportunity. But since we do not believe
that the Federal Government should merely impose a new system
on D.C. taxpayers overnight, I would suggest that this be
voluntary, that those who want to stay under the current system
should feel free to do so.
April 15 is right around the corner and taxpayers across
the country are spending their evenings and weekends racing to
complete their tax returns. This is no small task, given our
complex and complicated and many times unreconcilable Tax Code.
Most taxpayers are confused by the 800 different IRS tax forms
and the hundreds of pages of IRS instruction books. Adding to
this burden is the real fear that taxpayers suffer wondering if
they will make a mistake trying to calculate how much of their
own money they have to hand over to the Federal Government.
They also become suspicious that the existing maze of credits,
and exemptions is unfair and gives some special advantage to
those who wield political power or can afford an expert tax
adviser.
There are two principal arguments for a flat tax, economic
growth and fairness. Earlier this month economists testified
before this subcommittee that the current tax system, with its
high rates and discriminatory taxation of saving and
investment, stymies economic growth, destroys jobs, and lowers
incomes. By lowering tax rates and ending the Tax Code's bias
against savings and investment, witnesses said that a flat tax
would boost the economy's performance.
Of course, I would like to see a fairer tax system for all
taxpayers in every American city, particularly for my taxpayers
in Kansas. But while everyone talks about the need to simplify
the Tax Code, real reform has been blocked by those who come up
with every kind of excuse to prevent us from fixing the broken
system or even testing a new one.
I believe that the Federal Government can pilot a first-
ever flat Federal income tax here in the Nation's Capital
because of the unique constitutional relationship it has with
the District of Columbia. One result of Washington, DC, being
the seat of the Federal Government is that over 40 percent of
all District property is not subject to local taxation. I
repeat that again: 40 percent. By Federal law, the District is
precluded from taxing income at source for those workers who
are not residents of the District. The result is that 70
percent of income earned in the District cannot be taxed to
support District municipal services. Let me repeat that number:
70 percent cannot be taxed.
So to some extent these Federal restrictions on the
District's taxing authority have led city leaders to impose
very high local income tax, property, and sales taxes. In fact,
for decades residents of Washington, DC, have endured one of
the Nation's highest tax burdens. As the District's population
has steady declined, the tax burden on those who have chosen to
stay has become heavier and heavier.
I believe that a voluntary flat Federal income tax would
create more economic activity and jobs in the District, which
would enhance the District's ability to raise revenue while
actually lowering its own high local taxes.
I look forward to hearing from our panel of local District
of Columbia experts about how a flat Federal income tax would
affect the District of Columbia, and that is what the focus of
the hearing today is about. First to testify will be Dr. Natwar
Gandhi. He is Chief Financial Officer (CFO) for the District of
Columbia, a very well known individual that has worked quite
hard and well in getting the city's financial structure back in
shape. He is responsible for the city's finances, including its
approximately $7 billion in annual operating and capital funds.
As the independent CFO, Dr. Gandhi manages the District's
financial operations, which include tax and revenue
administration, the treasury, comptroller, and budget offices,
economic and fiscal analysis, and revenue estimation functions,
and agency fiscal operations.
We also have Mr. Terence Golden and Mr. John Hill,
President and CEO respectively of the Federal City Council. It
is a nonprofit, nonpartisan organization dedicated to the
improvement of our Nation's Capital. Federal City Council is
composed of and financed by 200 business, civic, professional,
and education leaders. Mr. Golden is also Chairman of Bailey
Capital Corporation of Washington, DC. It is a private
investment company. Mr. Hill served as Executive Director for
the District of Columbia Control Board from May 1995 to June
1999.
I want to thank you all for being here and testifying
today. I think we will run the clock at about 6 minutes. I do
want to be able to get to some series of questions, but the
focus of today's hearing--we talked about the theory at the
last hearing. I would like to see the practical impacts in
Washington, DC, of such an effort and that is what our primary
focus will be today.
Dr. Gandhi, delighted to have you here and the floor is
yours.
STATEMENT OF HON. NATWAR M. GANDHI, CHIEF FINANCIAL
OFFICER, GOVERNMENT OF THE DISTRICT OF
COLUMBIA
ACCOMPANIED BY JULIA FRIEDMAN, Ph.D., CHIEF ECONOMIST, GOVERNMENT OF
THE DISTRICT OF COLUMBIA
Dr. Gandhi. Thank you, Mr. Chairman. Mr. Chairman, good
afternoon. I am Natwar M. Gandhi, Chief Financial Officer of
the District of Columbia. I am here to testify on the matter of
the fiscal relationship between the Federal Government and the
District of Columbia and to discuss your idea for a voluntary
Federal flat tax for District businesses and households. I am
joined on my left by Dr. Julia Friedman, our Chief Economist.
A voluntary Federal flat tax may add to the desirability of
the District as a place to live and work. However, it will also
give rise to additional challenges within the District as more
activities compete for the limited amount of available space.
In this testimony, I will speak in general terms about the
concept of a voluntary Federal flat tax in the District. If a
legislative plan is presented by the Congress for implementing
a flat tax in the District, I will work with the Congress to
provide analysis of the plan.
Consistent with my role as the District's independent Chief
Financial Officer, my testimony will only address the fiscal
and economic impact of the flat tax. I will not discuss the
political or social policy aspects of the flat tax since that
role is reserved for the elected officials of the District.
As the Nation's Capital, we enjoy national galleries,
monuments, and parks that are the envy of the world and that
attract millions of tourists and business travelers. These
travelers and the government that draws them create the
economic and fiscal basis of the city. The Federal-city
relationship is complex and not without problems, particularly
in the fiscal arena. The rules are well known, that the
District has the jurisdictional responsibility of a city,
county, State, and school district while it has only the tax
base of a core city.
There is a mutually beneficial relationship between the
District and the Federal Government stemming from the
District's position as the home of the Federal Government. At
the same time, D.C.'s complex jurisdictional responsibility and
limitations result from the special relationship with the
Federal Government. The end result is that the District has an
artificially constricted tax base, as you mentioned, sir, and
the overwhelming needs of an inner city.
Excuse me. I get choked up when I talk about taxes.
Senator Brownback. Well, take a sip of water then.
Dr. Gandhi. For the District the juxtaposition of a limited
tax base against the responsibilities of multiple jurisdictions
produces chronic budgetary distress, ranging annually from $470
million to about $1.1 billion according to the Government
Accountability Office (GAO) report in May 2003. Even in the
wake of D.C.'s phenomenal fiscal recovery of the past decade--
and may I brag a little, Mr. Chairman; it has indeed been a
phenomenal recovery. In the mid-1990s when John Hill was our
Executive Director of the Control Board, we had roughly $500
plus million in deficits. Today we enjoy about $1.6 billion in
surplus in our fund balance, about a $2.1 billion turnaround
which is unmatched, unparalleled anywhere in the municipal
annals of the history in this country. So this is a truly
remarkable achievement on the part of the Control Board, the
Congress, of our elected leaders, Mayor and the Council.
Even in the wake of D.C.'s phenomenal fiscal recovery of
the past decades, it faces pervasive infrastructure problems,
high tax and debt burdens, and the needs of a large number of
urban poor, like that found in every city.
The District's economic recovery in the late 1990s was
hastened by the Federal wisdom and action, for example the
fiscal improvements brought about by the 1997 Revitalization
Act. Still, the District now struggles and will continue to
struggle with the multi-jurisdictional requirements and a
limited urban tax base. There are additional Federal
constraints on use of significant parts of the tax base that is
there. You just mentioned about how we cannot tax the income
tax base here and also the real property base.
Two consequences of this structural imbalance between the
District's revenue base and its spending requirements are: one,
a high per capital tax burden, with some of the highest tax
burdens in the region and the country; and the highest per
capita borrowing. D.C.'s tax burden on households is in the
upper one-third when compared to the largest cities in the
United States. The burden is greater on the business. D.C.'s
tax rate on net business income is 9.975 percent. The gross
receipts tax on public utilities used by businesses is around
11 percent and the real property tax on commercial property is
around $1.85 per $100 value, as compared to a range of 92 cents
to about $1.16 in the neighboring suburbs.
The GAO ranks D.C.'s tax burden among the very highest in
the country. Indeed, sir, there are only two States in the
country that would have a higher tax rate than we do. About 42
States have lower tax rates than we do.
Further, the District's very high per capita borrowing
reflects the city's efforts to sustain infrastructure generally
provided by multiple jurisdictions. The District's per capita
tax-supported debt burden exceeds $8,000, the highest per
capita of any major city in the Nation. For a long time, sir,
our tax policy has been once we find a taxpayer we never let
him go. We keep piling on. And at the same time, either we tax
or we borrow to meet our needs.
Challenges may arise, however, adding to D.C.'s structural
imbalance in coming years. First, all State and local revenue
systems are stressed by the changing nature of the economy as
it evolves more into a service-oriented economy.
Turning another page, page 5, sir, the District of Columbia
has a large urban population that needs help. Census data for
2004 estimate D.C.'s poverty rate at around 19 percent, the
fourth highest in the Nation after Mississippi, Louisiana, and
New Mexico. Of D.C.'s 248,000 plus households, 18 percent have
incomes less than $15,000. Median household income is about
$46,000 in a metropolitan area where median household income is
around $71,000. Only about one-third of the District's
households are at or above the metropolitan median. Like other
cities, the District is accountable for greater efforts to help
the less advantaged in the city's population.
Income discrepancy among D.C.'s residents is reflected in
the distribution of D.C.'s adjusted gross income, as shown in
table 1. The concentration of both income tax burden on a small
number of filers is evident. Those filers with adjusted gross
income of $75,000 and more take up 17 percent of the filers,
have 57 percent of the income, and pay 71 percent of the
District's individual income tax. That is quite a remarkable
number, Mr. Chairman, if you were to look at the table, that
roughly 4 percent of our taxpayers pay 44 percent of our income
taxes, 17 percent pay 71 percent of income taxes, and roughly
50 percent pay 93 percent of our income taxes. So roughly the
other half simply does not pay.
Filers with more than $200,000 income comprise just 4
percent of all filers, 30 percent of income, and 44 percent of
local income tax collections. At the lower income level, about
one-half of all filers have $30,000 or less in the adjusted
gross income (AGI) income and 16 percent have even $10,000 or
less.
Turning to page 7, Mr. Chairman, as you have suggested a
Federal flat tax in the District of Columbia, the tax would
apply both to individuals on their earned income and to
businesses on their gross income net of costs, wages, and
investment in plant and equipment. Individuals would be taxed
only on personal earnings. Businesses would not be taxed on
tangible investment. The flat tax thereby eliminates any
potential double taxation of rents, profits and interest and
eliminates tax disincentives to investment.
The tax would be calculated at a constant tax rate on
taxable income and the rate could be applied either on all
income or income above some threshold amount that is tax
exempt. There would be no other exemptions or deductions.
Depending on how it is formulated, a Federal flat tax could
benefit few, some, or most individual taxpayers living in the
District. Under the chairman's proposal, District taxpayers
will have the choice of either the flat tax or the current tax
depending on which method gives them a more favorable tax
liability.
Table 2 illustrates the Federal tax liabilities on current
District residents. The table also identifies the District's
relatively unusual distribution of taxpayers types. Fifty-five
percent of D.C.'s income tax payers are single filers with no
dependents, another 22 percent are single individuals with
dependents, and 3 percent are dependents with taxable income.
This leaves only 20 percent who are filing as married
households. This is quite a remarkable number, sir, that only
20 percent of our tax filers are married.
Turning to page 9, single filers have D.C. AGI of about
$45,745 and for those with wage and salary income average
earned income is around $44,934.
With the first alternative of the flat tax, about $4,000 of
personal exemption and 18 percent tax on the remainder, the
calculated tax is around $7,368. This amount exceeds current
tax both for the itemizers and for those taking standard
deductions. The average single person is not most likely to
choose this flat tax. The only filer type that most likely
prefers this tax is the married two-earner type that has much
higher average income at $201,000 and plus. This filer
currently pays $35,326 to about $40,000 depending on
deductions. The liability drops to about $25,000 with the flat
tax at $4,000 per exemption and 18 percent tax rate.
The second alternative flat tax is much less restrictive
and would likely be chosen by many filers, including singles
with standard deductions and married people with standard
deductions as well. This alternative has a more generous $8,000
personal exemption and a lower, 16 percent tax rate. Even with
this form, approximately 50,000 D.C. filers who take the
Federal earned income tax credit, so-called EITC, are likely to
prefer the current tax. This Federal credit can actually refund
more than the total tax owed by a working class or low income
filer. Under the current tax treatment for the average head of
the household, for example, the refund adds about $1,350 for a
filer with standard deduction and about $2,170 for a filer with
itemized deductions.
The third alternative is a simple compromise of the two
previous ones, with a more generous personal exemption at
$8,000 and more restrictive tax rate at 18 percent. In this
format there is likely to be a greater mixture of those
choosing the flat and those choosing the current tax forms.
The final column in table 3 confirms that a filer with no
earned income will benefit significantly from a flat tax on
individual income. As compared to the current tax, an average
single filer taking the standard deduction saves about $6,000
and a married filer with one income about $15,000.
I turn to page 12, sir, in the middle of the page. The
first alternative, with $4,000 personal exemption and 18
percent tax rate on earned income, would be selected by
approximately 15 percent of D.C.'s current individual income
tax filers with earned income, based on our very rough
calculations. The second alternative, $8,000 personal exemption
and 16 percent tax rate, would be chosen by about 75 percent of
current filers with earned income. And the third alternative,
with an $8,000 exemption and 18 percent tax rate, would be
chosen by roughly 60 percent of current filers with earned
incomes. We assume that filers with incomes only from other
sources will choose the flat tax alternatives. These
approximate ratios are based on our individual income tax
filers for 2003 D.C. taxes.
In providing the choice between the flat and the current
tax methods, you offer, sir, a significant benefit to the
residents of the District. The Federal Government would lose
revenue from D.C. taxpayers, at least in the startup years. The
amount could be as large as $1 billion in the first year, as
roughly approximated by our data. The billion dollar
calculation is made by us and is based on the District's own
tax base and Tax Code. It is not to be considered an
authoritative number because Federal revenue depends on the
Federal code and Federal base and actual first year losses
depend on the alternative flat tax that is selected. Scoring of
actual losses must come from the Federal sources.
In the later years, the amount of the Federal revenue loss
will depend on how much economic activity is stimulated by the
voluntary flat tax. Individuals moving to the District in order
to take advantage of the flat tax would increase the Federal
losses because their total Federal tax liabilities would fall.
True economic growth, however, could offset these losses. Some
economists argue that businesses will want to locate in the
District for tax purposes because their tangible investments
would be fully expensed by the flat tax and therefore not
subject to Federal taxation. This incentive to invest could
then produce economic growth.
I turn to page 14. The District's own tax base could grow
under a voluntary Federal tax due to two influences: one,
businesses and households that move to the District to get
preferred Federal tax status; and two, expansion of the current
economic base. Both income and real property tax revenues would
grow. This assumes that D.C.'s own tax treatment of households
and businesses does not change and the optional Federal flat
tax is enacted as a permanent change to the Federal tax law.
The District would continue to base tax calculation on the
equivalent of current Federal adjusted gross income and would
continue to tax all income received by the household and not
just earned income.
Turning to the next page, in general we would not expect
that franchise tax revenue to the District government would
grow at a rate comparable to the growth of local business
income. We would expect growth in real property tax revenue, as
competition for limited space becomes more fierce. The property
values, assessments, and costs inevitably will rise with demand
because the District is a small, highly developed jurisdiction
with federally mandated height limitations.
I pass over some of the compliance issues and turn to page
16. More important, what impact there would be on our
households. A small group of very high income taxpayers,
especially with no wage income, fewer than about 1,000 current
households, would be major beneficiaries of the flat tax. These
taxpayers rely on income from interest earnings, rental
activity, and profits and capital gains.
Further, we expect that others with similar sources of
income would want to move into the District for the Federal tax
benefit. For example, a married two-income filer living
elsewhere with $650,000 of gross income currently pays about
$185,000 in Federal tax and may pay up to about $40,000 in a
local non-D.C. tax jurisdiction. If all the income is from non-
wage and salary sources, the filer can save about $185,000 in
Federal tax annually by moving to the District. The filer would
pay about $60,000 in D.C. income tax, about $20,000 more than
previously, thus netting about $165,000 annual tax savings from
the move.
If all the filer's income is due to wage earnings and the
couple moves to the District, Federal tax could drop to
$150,000 under the most restrictive of the flat tax options.
D.C. local tax adds back about $20,000, leaving the taxpayer
with a net tax reduction of at least $50,000 annually. Even
with the higher cost, some households are likely to find the
District a beneficial new location.
Once they move to the District, these new residents would
owe the District local income tax. If for example the District
adds about 500 households, just about 5 percent, to the number
with incomes above $200,000, then individual income tax revenue
would increase roughly $30 million annually. Similarly, an
addition of about 1,000 more such households might generate $60
million in additional D.C. government revenue.
Of course, it is very difficult to estimate how many may
move in or out without analyzing a concrete flat tax proposal.
More new residents would mean more revenue and fewer new
residents means less increase in revenue. While the District
could not close the structural imbalance with these new
residents alone, the net fiscal contribution to the District
would be beneficial.
Non-wage income is not limited to the very wealthy. Other
middle class to upper income households might want to move here
to shelter retirement savings and other investment income from
Federal tax. Much as Florida is a haven from State income taxes
in retirement, the District would be a partial haven from the
Federal income taxes for retirees. Households attracted in this
way are likely to have a net fiscal benefit for the District's
budget.
Because of this tax incentive, a voluntary Federal flat tax
could add to housing price pressures in the District. While
positive occurrences for budgetary purposes, this is a serious
problem for other reasons related to the loss of urban middle
class. For more than 50 years, the population of the District
has been falling. Within the smaller total population, the
District has more people at the lower end of the income
distribution, far fewer in the middle class, and a declining
upper income population. In recent years the number of
households in the District is growing again, but not the
population. Many of these new households are high income, a
nearly necessary condition in a city where housing prices grew
an average 15 percent annually over the last 5 years and
roughly doubled in that period. With only 2 percent increase in
the households overall, the number of households with at least
$100,000 or more in income grew by 27 percent in the time
period of 2000-2004. Population has not grown because, as a
generalization, the filers moving in are single or sometimes
couples, while the filers moving out are more likely to have
children.
We do not know how much the voluntary tax would add to
price pressure for the housing. Because a flat tax neutralizes
the favorable tax treatment of itemizers--most of these are
home buyers--additional housing price pressure can be dampened.
Compared to the current tax system, a person electing to use
the flat tax would not be able to deduct either mortgage
interest or real property taxes from taxable income, thereby
limiting the boost of a potential offer price for housing.
However, if theorists are right and if business demand
rises for the D.C. location under a flat tax, then commercial
users will bid up the prices, shifting the property markets
somewhere or somewhat away from residential land uses and
further increasing housing prices.
However, the similarity between our estimated $1 billion
possible initial revenue loss at the Federal level and the
magnitude of the District's structural imbalance of about $1
billion is striking. Clearly, the benefits of reduced Federal
taxation will accrue to the citizen and business taxpayers
while the structural imbalance is a problem of local
government.
Still, thoughtful policy management could find a way to
narrow the local budgetary problem as a result of this
windfall. It is, after all, much like a negotiated middle
between the current Federal tax policy for the District and the
current Federal treatment allowed Puerto Rico, where there is
no Federal tax on local earnings. In Puerto Rico the state
government receives the revenue from taxation to the local
earnings.
Mr. Chairman, I thank you for holding this hearing and
providing this forum. The possibility of a new, deeper and
better Federal-city relationship is very exciting. I look
forward to any questions you may have. This concludes my oral
comments. I would appreciate kindly putting my full testimony
in the record. Thank you, sir.
Senator Brownback. Your full testimony will be put into the
record.
[The statement follows:]
Prepared Statement of Natwar M. Gandhi
Good afternoon Mr. Chairman and members of the Senate
Appropriations Committee on the District of Columbia. I am Natwar M.
Gandhi, Chief Financial Officer of the District of Columbia. I am here
to testify on the matter of the fiscal relationship between the Federal
government and the District of Columbia and, to discuss your idea for a
voluntary Federal flat tax for the District's businesses and
households.
A voluntary Federal flat tax may add to the desirability of D.C. as
a place to live and to work. However, it will also give rise to
additional challenges within the District as more activities compete
for the limited amount of available space.
In this testimony I will speak in general terms about the concept
of a voluntary Federal flat-tax in the District. If a legislative plan
is presented by the Congress for implementing a flat tax in the
District, I will work with the Congress to provide analysis of the
plan. Consistent with my role as the District's independent Chief
Financial Officer, my testimony will only address the fiscal and
economic impact of the flat tax. My testimony does not discuss the
political or social policy aspects of a flat tax, since that role is
reserved for the elected officials of the District.
Unique relationship
The District of Columbia is home to the Government of the United
States of America. D.C. enjoys national galleries, monuments and parks
that are the envy of the world and that attract tourists and business
travelers. These travelers and the government that draws them create
the economic and fiscal bases of the city.
The Federal-city relationship is complex and not without problems,
particularly fiscal problems. The words are well-worn--D.C. has the
jurisdictional responsibilities of a city, county, state, and school
district while it has only the tax base of a core city. There is a
mutually beneficial relationship between the District and the Federal
government stemming from the District's position as the home of the
Federal government. At the same time D.C.'s complex jurisdictional
responsibilities and limitations result from this special relationship
with the Federal government. The end result is that the District has an
artificially constricted tax base and the overwhelming needs of an
inner city.
For D.C., the juxtaposition of a limited tax base against the
responsibilities of multiple jurisdictions produces chronic budgetary
distress--ranging from $470 million to $1.1 billion, according to the
GAO in their May 2003 report. Even in the wake of D.C.'s phenomenal
economic and fiscal recovery of the past decade, the District faces
pervasive infrastructure problems, high tax burdens, and the needs of a
large number of urban poor (like that found in every city).
The District's economic recovery in the late 1990s was hastened by
Federal wisdom and action--for example in the fiscal improvements
brought by the 1997 Revitalization Act. Still, the District now
struggles, and will continue to struggle, with multi-jurisdictional
requirements on a limited urban tax base. And, there are additional
Federal constraints on use of significant parts of the base that is
there. For example, approximately two-thirds of the income tax-base and
more than one-quarter of the real property tax-base are exempt from
local tax due to Federal restrictions.
Two consequences of this structural imbalance between the
District's revenue base and its spending requirements are: (1) a high
per capita tax burden with some of the highest tax burdens in the
region and the country; and (2) the highest per capita borrowing.
D.C.'s tax burden on households ranks in the upper one-third when
compared to the largest city in each state (for total state and local
burden of sales, income, property, and automobiles).
The burden is greater on businesses. D.C.'s tax rate on net
business income is 9.975 percent; the gross receipts tax on public
utilities used by businesses is 11 percent; purchases of intermediate
products used by D.C. businesses are subject to the general retail tax;
and the real property tax on commercial property is $1.85 per $100 of
value as compared to a range of $0.92 to $1.16 in neighboring suburbs.
The GAO ranks D.C.'s tax burden among the very highest in the
country. ``The District's tax burden (actual revenue collected from
local resources relative to their own-source revenue capacity) is among
the highest of all fiscal systems, . . . The District's actual tax
burden exceeded that of the average state fiscal system by 33 percent,
based on our lower estimate of its own-source revenue capacity, and by
18 percent, based on our higher estimate of that capacity.'' \1\
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\1\ GAO-03-666, District of Columbia, Structural Imbalance and
Management Issues, May 2003, page 41.
---------------------------------------------------------------------------
The District's very high per capita borrowing reflects the city's
effort to sustain infrastructure generally provided by multiple
jurisdictions. At $6,598 per capita, the D.C. debt burden exceeds the
combined state and local burden in New York City by $813--or 14
percent. The District burden exceeds that of other cities by even
larger margins.
Challenges may arise, however, adding to D.C.'s structural
imbalance in coming years. First, all state and local revenue systems
are stressed by the changing nature of the economy, as it evolves more
into a service oriented economy. Because state and local tax systems
were developed around the manufacturing and sale of goods, the old ways
of gathering tax revenue are increasingly inadequate to the newer
economy. The revenue challenge is made even greater in the District by
the Federal prohibitions against taxing incomes earned by non-residents
workers and incomes earned by certain professional services.
Second, the District has a large urban population that needs help.
Census data for 2004 estimate the D.C. poverty rate at about 19
percent, the fourth highest in the nation when compared to states,
after Mississippi, Louisiana, and New Mexico. Of D.C.'s 248,563
households, 18 percent have income of less than $15,000.\2\ Median
household income is about $46,600--in a metropolitan area where median
household income of $70,900. Only about a third of D.C.'s households
are at or above the metropolitan median. Like other cities, D.C. is
accountable for greater efforts to help the less advantaged in the
city's population. The fiscal year 2007 budget, recently submitted by
the Mayor to the Council, works hard to manage the expenditure needs
and fiscal requirements of D.C.'s lower income population.
---------------------------------------------------------------------------
\2\ American Community Survey, 2004.
---------------------------------------------------------------------------
Income discrepancy among D.C. residents is reflected in the
distribution of D.C. Adjusted Gross Income as shown in Table 1. The
concentration of both income and tax burden on a small number of filers
is evident--those filers with adjusted gross income of $75,000 and more
make up 17 percent of filers, have 57 percent of the income, and pay 71
percent of the District's individual income tax. Filers with more than
$200,000 in gross income comprise just 4 percent of all filers, 30
percent of income, and 44 percent of local income tax collections. At
the lower income levels, about one-half of all filers have $30,000 or
less DCAGI--16 percent have $10,000 or below.
TABLE 1.--TY2004 INDIVIDUAL INCOME TAX FILERS, D.C., BY D.C. ADJUSTED GROSS INCOME CATEGORY, FROM FORM D-40
----------------------------------------------------------------------------------------------------------------
DCAGI--
--------------------------------------------------------------
Over
$0-$10K $10-$20K $20-$30K $30K-$75K $75K-$200K $200K
----------------------------------------------------------------------------------------------------------------
Number Returns......................... 262,328 41,368 43,718 39,596 85,971 35,041 9,821
Returns (percent)...................... 100 16 17 15 33 13 4
Income (percent)....................... 99 3 5 7 28 27 30
Tax Amount (millions).................. $1,037 $4 $22 $44 $229 $277 $459
Tax Percentage......................... 100 ........ 2 4 22 27 44
EITC Returns (percent)................. 99 33 33 28 5 .......... ........
----------------------------------------------------------------------------------------------------------------
Note: 6,813 filers have DCAGI of less than or $0. These are not included here.
<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>
Voluntary Federal Flat Tax
The Chairman has suggested a Federal flat tax in the District of
Columbia. The tax would apply both to individuals--on their earned
incomes--and to businesses on their gross income net of costs, wages,
and investment in plant and equipment. Individuals would be taxed only
on personal earnings. Businesses would not be taxed on tangible
investment. The flat tax thereby eliminates any potential double
taxation of rents, profits, and interest and eliminates tax
disincentives to investment. (Because unearned incomes are partly held
in tax exempt portfolios, not all are currently double-taxed.) The tax
would be calculated at a constant tax rate on taxable income and the
rate could be applied either on all income or on income above some
threshold amount that is tax exempt. There would be no other exemptions
or deductions.
Taxation of Individuals.--Depending on how it is formulated, a
Federal flat tax could benefit few, some, or most individual income
taxpayers living in the District. Under the Chairman's proposal,
District taxpayers will have the choice of either the flat tax or the
current tax, depending on which method gives them a more favorable tax
liability.
Table 2 illustrates the Federal tax liabilities on current
residents, based on filer groups and average income of the filer
groups. The table also identifies the District's relatively unusual
distribution of taxpayer-types. Fifty-five percent of D.C. income
taxpayers are single filers with no dependents, another 22 percent are
single individuals with dependents, and 3 percent are dependents with
taxable income. This leaves 20 percent who are filing as part of a
married household.\3\ The incomes reported in Table 2 are the average
D.C. Adjusted Gross Income (DCAGI) for the filer group in TY2004.
---------------------------------------------------------------------------
\3\ The corresponding Federal distribution of filers for TY2003 is
45 percent married, 13 percent head of household, and 42 percent single
(including dependents).
TABLE 2.--CURRENT TAX ON FEDERAL INCOME TAX FILERS FILING FROM A D.C. ADDRESS, BY FILER TYPE AND BY AVERAGE INCOME, TY2004
--------------------------------------------------------------------------------------------------------------------------------------------------------
Est
Percent of Average Ave Current
Number of Total Type of Filer Income, by Deduction, Exemption Federal Tax
Filers Filers Filer by Filer Liability
Group Group
--------------------------------------------------------------------------------------------------------------------------------------------------------
TOTAL.................................... 262,328 100 .................................... .......... .......... .......... ...........
SINGLE................................... 145,433 55 Standard deduction.................. $45,745 $3,370 1 $6,046
Itemized deduction.................. 45,745 12,920 1 4,079
HEAD OF HOUSEHOLD \1\.................... 57,197 22 Standard deduction.................. 30,891 7,300 3 (1,350)
Itemized deduction.................. 30,891 13,756 3 (2,171)
MARRIED FILING JOINT (1 INCOME).......... 27,829 11 Standard deduction.................. 116,802 10,000 4 15,186
Itemized deduction.................. 116,802 27,975 4 10,686
MARRIED FILING JOINT (2 INCOMES)......... 14,825 6 Standard deduction.................. 201,060 10,000 3 40,540
Itemized deduction.................. 201,060 30,274 3 35,326
MARRIED FILING SEPARATELY................ 8,003 3 Standard deduction.................. 58,631 5,000 2 9,271
Itemized deduction.................. 58,631 17,039 2 6,259
DEPENDENT FILER.......................... 7,799 3 Standard deduction.................. 6,952 5,000 .......... 196
Itemized deduction.................. 6,952 5,000 .......... 196
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The mean head-of-household filer is eligible for the Refundable Earned Income Tax Credit. Without EITC, the filer would pay $0 tax.
Data Source: Calculations based on DC Form D-40.
Table 3 identifies the impact of various formats of a Federal flat
tax on D.C. resident filers. To do this, the table first identifies how
much wage and salary ``earned'' income a filer has--and also notes that
some filers have no such income and, instead, rely on other types of
income such as dividends, interest, and profit. This is critical
because current taxpayers with no ``earned'' incomes pay no individual
income tax under the flat tax. Overall, about 86 percent of D.C. filers
have earned income; the other 14 percent (adjusted for those with
earned income deferred from a prior year for current use) would have
zero liability and most likely prefer a flat tax.
Single filers have average DCAGI of $45,745 and, for those with
wage and salary income, average earned income of $44,934. With the
first alternative of the flat tax--a $4,000 personal exemption and 18
percent tax on the remainder, the calculated tax is $7,368. This amount
exceeds current tax both for itemizers (at $4,079) and for those taking
the standard deduction (at $6,046). The average single person is not
most likely to choose this flat tax. The only filer type that prefers
this tax is the married, 2-earner type that has much higher average
income at $201,060 and $155,537 from combined wages and salaries. This
filer currently pays $35,326 or $40,540, depending on deductions; the
liability drops to $25,837 with the flat tax at $4,000 per exemption
and 18 percent tax rate.
The second alternative flat tax is much less restrictive and would
likely be chosen by many filers, including--at average incomes--singles
with standard deductions and married people with standard deductions,
as well as married two income filers with itemized deductions. This
alternative has a more generous $8,000 personal exemption and a lower
16 percent tax rate. Even with this form, the approximately 50,000 D.C.
filers who take the Federal Earned Income Tax Credit (EITC) are likely
to prefer the current tax. This Federal credit can actually refund more
than the total tax owed by a working, low-income filer. Under current
tax treatment for the average head of household, for example, the
refund adds $1,350 for a filer with standard deductions and $2,171 for
a filer with itemized deductions.
The third alternative of a Federal flat tax in Table 3 is a simple
compromise of the two previous, with the more generous personal
exemption at $8,000 and the more restrictive tax rate at 18 percent. In
this format there is likely to be a greater mixture of those choosing
the flat and those choosing the current tax forms.
The final column of Table 3 confirms that a filer with no earned
incomes will benefit significantly from a flat tax on individual
income. As compared to the current tax, an average single filer taking
the standard deduction saves $6,046; a married filer with one income
saves $15,186.
TABLE 3.--CURRENT TAX AND FLAT TAX OPTIONS ON D.C. FEDERAL INCOME TAX FILERS, BY FILER TYPE AND BY AVERAGE INCOME, TY2004
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Flat Tax Flat Tax Flat Tax
Liability Liability Liability
Number Est Average at $4,000 at $8,000 at $8,000
Number Wage & Percent Average W&S Current & 18 & 16 & 18 Any Flat
of Salary of Total Type of Filer Income, Income Exemptions Federal Percent Percent Percent Tax Non-W
Filers Filers Filers by Filer for W&S Tax Wage & Wage & Wage & &S Filer
Group Filers Salary Salary Salary
Filer \1\ Filer \1\ Filer \1\
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
TOTAL....................................... 262,328 224,684 86 .......................... ......... ......... .......... .......... ......... ......... ......... .........
SINGLE...................................... 145,433 122,958 85 Standard.................. $45,745 $44,934 1 $6,046 $7,368 $5,909 $6,648 .........
Itemized.................. 45,745 44,934 1 4,079 7,368 5,909 6,648 .........
HEAD OF HOUSEHOLD \2\....................... 57,197 53,619 94 Standard.................. 30,891 30,531 3 (1,350) 3,336 1,045 1,176 .........
Itemized.................. 30,891 30,531 3 (2,171) 3,336 1,045 1,176 .........
MARRIED FILING JOINT (1 INCOME)............. 27,829 22,804 82 Standard.................. 116,802 107,594 4 15,186 16,487 12,095 13,607 .........
Itemized.................. 116,802 107,594 4 10,686 16,487 12,095 13,607 .........
MARRIED FILING JOINT (2 INCOMES)............ 14,825 12,589 85 Standard.................. 201,060 155,537 3 40,540 25,837 21,046 23,677 .........
Itemized.................. 201,060 155,537 3 35,326 25,837 21,046 23,677 .........
MARRIED FILING SEPARATELY................... 8,003 6,478 81 Standard.................. 58,631 59,600 2 9,271 9,288 6,976 7,848 .........
Itemized.................. 58,631 59,600 2 6,259 9,288 6,976 7,848 .........
DEPENDENT FILER............................. 7,799 6,232 80 Standard.................. 6,952 7,245 .......... 196 1,304 1,159 1,304 .........
Itemized.................. 6,952 7,245 .......... 196 1,304 1,159 1,304 .........
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Shows preference for Flat Tax Option.
\2\ The average head-of-household filer is eligible for the refundable Earned Income Tax Credit. Without EITC, the filer would pay $0 tax.
Data Source: Calculations based on DC Form D-40.
Filers who have no incomes from wages, salaries, or other earned
income sources will pay no tax under a flat tax. This explains the
blank column under ``no-wage filer'' for each flat tax option.
Renters and those who choose standard deductions on the current tax
are more likely to benefit from a flat tax than many homebuyers and
others who itemize (because their Federal tax burden is not eased by
deductible expenditure on mortgage interest, real property tax, and
other itemized deductions). While itemizers also may benefit from flat
taxation, the magnitude of the benefit is likely to be smaller simply
because itemizers already benefit from some tax breaks.
Individuals with incomes from rents, interest, capital gains, and
other unearned sources will gain from a flat tax; these incomes will no
longer be taxed under the individual income tax. They will be taxed
only as part of the income of the business that generates them.
Voluntary Flat Tax.--In providing the choice between flat and
current tax methods, the Chairman offers a significant benefit to
residents of the District. The Federal government will lose revenue
from D.C. taxpayers at least in the start-up years--the amount could be
$1 billion in the first year, as roughly approximated based on D.C.'s
data.\4\
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\4\ The $1 billion is a calculation made by the OCFO of the
District and based on the District's own tax base and tax code. It is
not to be considered authoritative because the Federal revenue depends
on the Federal code and Federal base. Determination of actual losses
must come from Federal sources.
---------------------------------------------------------------------------
In later years, the amount of Federal revenue loss will depend on
how much economic activity is stimulated by the voluntary flat tax.
Individuals moving to D.C. in order to take advantage of the flat tax
would increase Federal losses--because their total Federal tax
liabilities would fall. True economic growth, however, could offset
these losses. Some economists argue that businesses will want to locate
in D.C. for tax purposes because their tangible investments would be
fully expensed by the flat tax and therefore not subject to Federal
taxation. This incentive to invest could then produce economic growth.
The incentive is partly offset by transition costs to businesses
that would lose depreciation benefits under a flat tax. The voluntary
aspect of the proposal is, effectively, a transition plan, allowing
current assets to be depreciated before electing the flat tax. An
explicit transition plan would directly address assets currently being
depreciated. A critical component of the transition plan is to identify
how often a taxpayer can choose between flat and current treatments: is
it annually, only once for all time, or some intermediate number of
choices? Taxpayer behavior will be affected by this component. Also,
taxpayers generally prefer that tax policy be predictable, allowing
them to plan in terms of it. Any flat tax proposal should be offered as
permanent, not temporary or experimental, if taxpayers are going to
adjust their basic behavior around the policy change.
Impact on the District's Revenues
The District's own tax base could grow under a voluntary Federal
flat tax, due to two influences: (1) businesses and households that
move to District to get preferred Federal tax status and (2) expansion
of the current economic base. Both income and real property tax
revenues would grow. This assumes that D.C.'s own tax treatment of
households and businesses does not change and that the optional federal
flat tax is enacted as a permanent change to federal tax law (a
perception that it is temporary would substantially reduce these
effects). D.C. would continue to base tax calculations on the
equivalent of current Federal Adjusted Gross Income and would continue
to tax all incomes received by households, not just earned income.
The fiscal impact on D.C. from the flat tax on business income is
difficult to assess. For D.C., the revenue gains from adding more
incorporated and unincorporated businesses would depend on the ability
of new businesses to shelter income from local taxation. In D.C., about
70 percent of business tax filers pay only the local minimum tax of
$100 annually. Partnerships and proprietorships with 80 percent or more
of their income due to services of the owners do not even file locally.
The issues in taxing business income are known well across state and
local jurisdictions and income tax sheltering is a complex art.
In general, we would not expect that franchise tax revenue to the
District government would grow at a rate comparable to the growth of
local business income. This assumes that D.C.'s tax policy for business
income does not change and that D.C. decouples from the Federal change
in definition of taxable income. If instead D.C. were to adopt the
proposed Federal treatment of expensing investment outlays, then local
revenue would decline.
We would expect growth in real property tax revenue as competition
for limited space becomes more fierce. Property values, assessments,
and costs inevitably will rise with demand because the District is a
small, highly developed jurisdiction with federally mandated height
limitations.
Tax Administration and Compliance.--A voluntary flat tax will
complicate tax compliance for District residents as well as tax
administration at both the Federal and local level. With a voluntary
flat tax, a District taxpayer will have to compute the tax both ways
prior to deciding which option is best for his or her situation.
Assuming that the District decouples from the Federal flat tax, a
District taxpayer who chooses the flat tax will have to maintain
separate records of information that currently is copied from Federal
tax forms, in order to comply with the D.C. tax system. At the Federal
level, the Internal Revenue Service (IRS) would have the added burden
of auditing residency, as the voluntary flat tax will create new tax
sheltering opportunities based on where a taxpayer lives. At the local
level, the D.C. tax administration would lose the benefit from IRS
audit and enforcement activities.
Impact on Households.--A small group of very high-income taxpayers,
especially those with no wage income (fewer than 1,000 current
households), will be major beneficiaries of the flat tax.\5\ These
taxpayers rely on income from interest earnings, rental activity, and
profits and capital gains. Further we expect that others with similar
sources of income would want to move into the District for the Federal
tax benefit.
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\5\ In the District 86 percent of filers have wage or salary income
and an unknown number of others take deferred earnings as part of
current year income. This is subject to a flat tax. Of those filers
with incomes of $500,000 or more, only two-thirds have wage or salary
income.
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For example, a married, 2-income filer living elsewhere, with
$650,000 gross income, currently pays about $185,000 in Federal tax and
may pay $40,000 in local (non-D.C.) tax. If all of the income is from
non-wage-and-salary sources, the filer can save $185,000 in Federal tax
annually by moving to D.C. The filer would pay about $60,000 in D.C.
income tax, about $20,000 more than previously, thus netting $165,000
annual tax savings from the move. If all the filer's income is due to
wage earnings and the couple moves to D.C., Federal tax could drop to
$115,000 under the most restrictive of the flat tax options. D.C. local
tax adds back $20,000--leaving the taxpayer with a net tax reduction of
at least $50,000 annually. Even with higher costs in D.C., some
households are likely to find D.C. a beneficial new location.
Once they move to the District, these new residents would owe the
District's local income tax. If, for example, D.C. added about 500
households, or about 5 percent, to the number with incomes over
$200,000, then individual income tax revenue would increase roughly $30
million annually. Similarly, an addition of 1,000 more such households
might generate $60 million of additional D.C. government revenue. Of
course, it is very difficult to estimate how many may move in or out
without analyzing a concrete flat tax proposal. More new residents
would mean more revenue and fewer new residents mean less increase in
revenue. While D.C. could not close the structural imbalance with these
new residents alone, their net fiscal contribution to D.C. would be
beneficial.
Non-wage income is not limited to the very wealthy; other middle to
upper-income households might want to move here to shelter retirement
savings and other investment income from Federal tax. Much as Florida
is a haven from state income taxes in retirement, D.C. could be a
partial haven from Federal income taxes for retirees. (Pension income
could continue to be taxed under the flat tax.) Households attracted in
this way are likely to have net fiscal benefit for the District's
budget.
Because of this tax incentive, a voluntary Federal flat tax could
add to housing price pressures in D.C. While a positive occurrence for
budgetary purposes, this is a serious problem for other reasons related
to the loss of the urban middle-class. For more than 50 years the
population of the District has been falling. Within the smaller total
population, D.C. has more people at the lower end of the income
distribution, far fewer in the middle class, and a declining upper-
income population. A recent study by the Brookings Institution
documents this change for the period 1979-1999. The data separate
households into national quintiles (the top 20 percent, next 20
percent, and so forth) and then locate households from 100 cities,
including D.C., within those groups. When compared to 1979, the number
of D.C. households in the middle quintile in 1999 is down by nearly 14
percent and, in fact, declined in all but the lowest quintile group.
The number of D.C. households in the lowest national quintile group
increased 14 percent in the 20 year period.\6\
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\6\ A recent study of the 100 largest cities finds that ``in just a
handful of divided cities (7), including Washington, D.C., does the
number of households at the extremes of the (income) distribution
exceed that in the middle.'' The study finds the following for D.C.,
based on the U.S. Census of 1979 and 1999. Income groups are determined
based on national quintiles.
# Households Low Income Lower-Middle Middle Upper-Middle High
1979 57,837 53,611 50,019 40,141 53,897
1999 66,094 51,759 43,157 38,505 49,076
Change +14% -3% -14% -4% -9%
Source: Alan Berube and Thacher Tiffany, ``The Shape of the Curve:
Household Income Distributions in U.S. Cities, 1979-1999, The Brookings
Institution, August 2004.
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D.C. has lost middle-class population in a very pronounced way.
This decline is closely entwined with the loss of school-age population
as families have moved out; the rise in property values as higher-
income singles and couples have moved in; and the decrease in upward
mobility because poorer people have fewer housing options as they work
and improve their earnings capacity. Indeed, much of the out-migration
is known to be of middle-income families looking for better housing and
schooling opportunities.
In recent years, the number of households in D.C. is growing again,
but not the population. Many of these new households are higher
income--a nearly necessary condition in a city where housing prices
grew an average of 15 percent percent annually over the last 5 years
and roughly doubled in the period. With only a 2 percent increase in
households overall, the number of households with at least $100,000
income grew by 27 percent in 2000-2004.\7\ Population has not grown
because, as a generalization, the filers moving-in are single, or
sometimes couples, while the filers moving-out are more likely to have
children.
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\7\ American Communities Survey, U.S. Census, 2000 and 2004.
---------------------------------------------------------------------------
D.C. is a core city and, like other core cities, the home of a
disproportionate share of the region's poor, both those permanently
poor and those working upward out of poverty. Housing prices that
``squeeze out'' the middle-class pose serious obstacles for lower-
income earners. Without access to potentially better housing, they also
have less access to better transportation, perhaps to safer
neighborhoods and higher performing schools. The whole promise of
upward mobility is damaged--except for those who leave.
We believe that the Federal flat tax for D.C. would add to housing
price pressures in the District. Given the recent demand for housing,
especially among higher-income homeowners, it is hard to describe how
much more dramatic the impact might be.
We do not know how much the voluntary flat tax would add to price
pressure. Because a flat tax neutralizes the favorable tax treatment of
itemizers--most of these are homebuyers--additional housing price
pressure is dampened. Compared to the current tax system, a person
electing to use the flat tax would not be able to deduct either
mortgage interest or real property taxes from taxable income, thereby
limiting the boost to a potential offer-price for housing. However, if
theorists are right and business demand rises for D.C. locations under
a flat tax, then commercial users will bid up prices, shifting the
property market somewhat away from residential land uses and further
increasing housing prices.
A New-View of the Federal/city relationship.--The similarity
between the $1 billion possible initial revenue loss at the Federal
level and the magnitude of D.C.'s structural imbalance of about $1
billion is striking. Clearly the benefits of reduced Federal taxation
will accrue to citizen and business taxpayers while the structural
imbalance is a problem of local government. Still, thoughtful policy
management could find a way to narrow the local budgetary problem as a
result of this windfall. It is, after all, much like a negotiated
middle between current Federal tax policy for D.C. and current Federal
treatment allowed Puerto Rico where there is no Federal tax on local
earnings. In Puerto Rico the state government receives the revenue from
taxation of local earnings.
Mr. Chairman, I thank you for holding this hearing and providing
this forum. The possibility of a new, deeper, and better Federal/city
relationship is very exciting. I look forward to any questions.
Senator Brownback. Thank you very much, Dr. Gandhi. That
was very interesting and very thorough. I want to ask some
questions about that afterwards.
Mr. Golden, Chairman of the Federal City Council, thank you
for joining us.
STATEMENT OF TERENCE C. GOLDEN, CHAIRMAN, FEDERAL CITY
COUNCIL
ACCOMPANIED BY JOHN HILL, CHIEF EXECUTIVE OFFICER, FEDERAL CITY COUNCIL
Mr. Golden. Thank you, Mr. Chairman, for allowing me to be
here. I have to say I really appreciate the opportunity to
speak to you and also to be on this board and panel that you
are visiting with today. I think you have three of the
strongest financial minds in our city to talk to you:
obviously, Julia and Dr. Gandhi, who I think has been
tremendous for our city over the long term; John Hill, who is
now our Chief Executive Officer and was the head, the Executive
Director of the Federal Financial Board that oversaw our
improvement, really has a good grip on what's happening. So I
am proud to be with them.
Before I begin, I would like to first submit my record--my
written statement for the record.
Senator Brownback. It will be in the record.
Mr. Golden. Thank you so much.
I would like to begin by saying thank you to you, chairman,
for all you have done for our city. The record of your
committee in providing us with support through a lot of
difficult challenges is greatly appreciated. I also want to
thank you for your recognition of the challenges that are
facing the District of Columbia. I cannot tell you how many
times I have appeared and a number of us have appeared before
groups similar to this without a real understanding of what
pressures we face as the District of Columbia that are unique
because we are the Nation's Capital.
I also want to acknowledge the efforts that you have made
on this flat tax. It represents a significant step forward and
something that has the potential of making a real difference in
the District of Columbia. So we really do appreciate what you
have done and where you are headed overall.
Dr. Gandhi talked about all the unique relationships of the
District of Columbia and its special place in our country, and
also the situation that occurs as a result of that. From my
point of view, simply there are really two major issues that
cause the business community and cause all of the taxpayers
real concern. First of all, we do a lot of wonderful things for
the Federal Government, for our leaders that come in and work
here in the city, and for the 20 million individuals who visit
our Nation's Capital. But clearly the bottom line is that the
cost of doing this and running this city is very expensive. Our
budget, both the Federal and District component, is $7.5
billion a year. Imagine that for 570,000 residents, and when
you begin to parse that out and look at who are actually paying
taxes, as opposed to receiving benefits, it is an even greater
struggle. So I think you are right on target in understanding
some of the challenges that we face.
I think all of us as businessmen are also very much
concerned about the future outlook. Clearly we have had a great
run in time, but we have also had some tremendous capital
expenditures that we need to deal with in the future.
Unfortunately, when the District became--responsibility for the
District was transferred to its residents, what was also
transferred to us was the burden of an infrastructure that was
old, obsolete, and in tremendous need of repair.
Today we start this year with a bond debt of about $4.4
billion, which is roughly $7,000 per capita, which is the
highest in the Nation. So we are already beginning with some
tremendous challenges.
When we look at the outlook of what we have got to deal
with this infrastructure, things get even worse for us. The
number one priority for us and I think for you and for the
Congress and the Federal Government is we need to get a crime
lab and a lab that deals with biohazards and all those things
that are important. Clearly, we are the first responder in our
city. We have an obligation to be prepared. The cost, however,
for the residents of the District of Columbia for this crime
lab is $200 million.
We had--when the schools were transferred to the District,
the average age of our schools I think was something like 63
years old. Today we have looked and budgeted what the
modernization of those schools is and it is over $2 billion.
Our libraries also, which were in a state of disrepair, are
going to cost us $250 million to improve. Our budget for roads
and bridges is extraordinary. Just as a small indicator, we
have over 300 bridges to maintain here in the District of
Columbia.
So what I am saying is our capital costs, we are already
the highest per capita in the country in terms of capital
obligations, and we have got the outlook of having another $4
billion facing us over the next 10 to 12 years. So we are
concerned. Clearly, as you have identified and as Dr. Gandhi
has identified, we have severe limitations on our ability to
tax and that has certainly had an impact overall.
I think that when you look at this tax burden you cannot
help but question the fact that over the last 3 years our
population has gone from close to 800,000 down to some 570,000
today. I would represent that the taxes and the tax burdens
themselves have a direct impact on that. Most of the people
that have left are middle class taxpayers and that is both
African-American and white.
So just to begin with let me say, do we need to do
something? I think that we absolutely do. Senator Brownback, we
believe that your flat tax does begin to address the District's
financial needs. Until we have something, some specific
legislation to look at, it is hard for us to respond in detail
or make a final recommendation, and I think Dr. Gandhi's
presentation of alternatives will take a week to go through and
decipher exactly what begins to make sense and the like.
But I would say, in the mean time we really can offer some
general observations. First of all, let me say that we believe
that anything that makes the District more attractive to live
and work in and which increases its tax base is worthy of
consideration. The fact that the proposed approach is optional
is good. It allows low income taxpayers to continue to take
advantage of the earned income tax credit and the other
deductions that are available. So I think you have addressed
some of the issues that a lot of people have raised.
It is clear to all of us that under the flat tax the
District would benefit financially. More people would move into
the city, our District tax base would increase. The lower the
flat tax is, the greater would be the impact overall. I think
all of us are having a hard time with estimating exactly how
many people would move in and we would have to do some careful
analysis with that once the legislation got fleshed out. But we
certainly see that the impact would be great.
I think when we look at the legislation itself a host of
issues need to be considered in evaluating the overall impact
of the flat tax legislation. I think for existing and potential
District taxpayers, I think they will be interested in knowing,
one, the size of the personal exemption, whether mortgage
interest payments are to be treated as deductions, the
treatment of charitable deductions, and the level at which
taxpayers begin to receive benefit from the flat tax.
The real question is is the flat tax fair to all of our
taxpayers. From the Federal Government's point of view, I think
the issue is is the District-oriented flat tax good for the
United States and good tax policy? Is the benefit to the
District worth the Federal costs of the program or are there
better alternatives for addressing the District's needs?
I think from our point of view as the business community,
we also want to take a careful look at this legislation for
more than just its financial impact. Our relationship with the
District and our attitudes have certainly changed over the last
20, 30 years. The District community is committed to diversity
within the District. We want to make sure that the new tax
legislation does not have the unintended consequences of
displacing the District's low and middle income residents.
Clearly, the whole issue of gentrification is an issue in our
city and I think, as with all major cities, the cost of living
in the city and the cost of housing in the city is running the
risk of displacing our low and moderate income residents.
In conclusion, Senator Brownback, let me applaud you for
your efforts to get District residents--to propose this
legislation. We appreciate your desire to hear from us and
other District residents. We also appreciate your desire to
hear from our elected leadership. We would like to ask you as
you prepare this legislation if we could not participate and if
you could not work with the Mayor and our delegate and the
District Council to see what we can do together.
Most importantly, I guess in summation, I want to thank you
again for your efforts on our behalf. We do have some major
issues. We recognize that you understand them and we would like
to work with you to see what we can do to make a better
District and one that is worthy of being our Nation's Capital.
Thank you very much.
[The statement follows:]
Prepared Statement of Terence C. Golden
Good afternoon, Mr. Chairman, and members of the Committee.
My name is Terry Golden and I am appearing before you today in
my capacity as Chairman of the Federal City Council. With me is
John Hill, who is the Council's Chief Executive Officer. As you
may know, the Federal City Council is a nonprofit, non-
partisan, business supported civic organization dedicated to
the improvement of the Nation's Capital. Founded in 1954, the
Council's membership includes 200 of the top business,
professional, educational, and civic leaders in the Washington
metropolitan area.
You have invited us to testify today on the possible
effects of creating an optional flat Federal income tax for
District of Columbia residents. We recognize that no specific
legislation has been introduced and that a host of issues
remain to be decided, such as the size of the personal
exemption and whether deductions would be retained for
charitable donations or mortgage interest payments. In view of
the foregoing, we believe that it is difficult to say precisely
what the effects of a flat tax in the District would be.
However, in addressing the issue, we think a good place to
begin is with a brief review of several key facts. First, as
Senator Brownback has frequently acknowledged, the District of
Columbia is unique in our country in that it has the
governmental responsibilities of a city, a county, and a state.
Among the costs that the District must bear with its own
revenue are the costs of developing and maintaining a physical
and human infrastructure (e.g. roads and bridges, mass transit,
police, fire, and other first responders) that serves not only
the City's 570,000 residents but the half million daily
commuters who work in the District and the 20 million annual
visitors to the Nation's Capital. While being the Nation's
Capital confers many advantages on the District, one
disadvantage of Washington, D.C. being the seat of the Federal
government is that more than 40 percent of all District
property is not subject to local property taxes because it is
owned by the Federal government, foreign governments, or
international organizations. Also, the District is uniquely
disadvantaged in that Congress has explicitly prohibited it
from taxing at the source the income of persons who work in the
District but reside elsewhere. The net effect of this
prohibition is that 70 percent of all income earned in the
District cannot be taxed by the District to support District
municipal services.
Senator Brownback, as you pointed out in your opening
statement at this Subcommittee's hearing on March 8th, the
cumulative effect of these Federal restrictions on the
District's tax base has led City leaders to impose on District
residents and businesses a very high tax burden. As you also
noted, this high tax burden undoubtedly is one reason why the
City's population has declined over the past several decades
while the neighboring jurisdictions have gained population.
We believe that as a general proposition, anything that
makes the District a more attractive place to live and work and
that enables the District to grow its tax base is worthy of
consideration.
As we understand your thinking, your proposal would give
District residents the option of continuing to pay their taxes
under the current Federal tax system or they could opt for the
flat tax. Permitting residents to choose is especially
important in this City as many of our low income residents
avail themselves of the Earned Income Tax Credit and we
wouldn't want to see them barred from doing so.
Under a flat tax, the District would benefit financially
and more people, including a number of people of substantial
net worth, would likely move into the City. We believe that the
prospect of substantially lower Federal taxes unquestionably
would be an incentive to move into the District. How many
people would do so, however, is anybody's guess. It's worth
noting that today, in the absence of a flat tax, the District
is experiencing unprecedented growth in its housing stock and
is attracting a substantial number of upper income households.
One concern that has been expressed about a flat tax is
that it could lead to more displacement as wealthier households
displace lower income residents from established neighborhoods.
The District's business community is committed to the strength
of a diverse community and to the idea that the District should
be a community in which all are welcome, irrespective of
income, race, ethnicity, or household composition. We believe
that the issue of displacement is complex and that there are a
host of variables that influence where people choose to live.
Should you decide to develop legislation, we would urge you to
give this matter the serious attention it deserves and, more
generally, we would urge you to work with the District's
elected officials if you decide to put forward specific
legislation.
Finally, we believe that the aggregate loss in Federal tax
revenue resulting from a D.C. flat tax could be considerable.
While we agree that establishing a flat tax for the District
undoubtedly would lead to more locally raised tax revenue for
the District government, whether this is a tax efficient way to
make additional resources available to the District is a matter
that should be more fully explored.
Whether--or how much--net new economic activity and jobs
would be created in the District by a flat tax is unknowable
but we certainly agree that enhancing the District's ability to
raise revenue while enabling the City to lower its own local
taxes is a goal we all share.
We thank you for your commitment to strengthening the
District's economy and for your interest in making the City an
even better place to live, work, and visit.
Senator Brownback. Thank you, Mr. Golden.
I understand, Mr. Hill, you are just here for questions; is
that correct? Or do you have a statement?
Mr. Hill. No, I do not have a separate statement.
Senator Brownback. Okay, good.
Thank you for the comments and thoughts. I want to start
off at the end and maybe work backwards here. Dr. Gandhi, one
of the first meetings that you and I had when I took over this
position was you were discussing with me the structural
imbalance of the District and you were saying, look, we are $1
billion short annually. There seemed to be two main proposals
that you were bringing forward at that time. Now, maybe there
are other options, but as I was seeing it one was discussion of
a commuter tax, so that people that come in, work in the
District, help pay the costs within the District. The second
one was a Federal subsidy of some form or another to help make
up for the Government taking 40 percent of the property.
Are there other options, absent this option of a flat tax.
But are there other options available for that disparity?
Dr. Gandhi. I think basically from the Federal Government
perspective those are the key proposals that should be
considered. But I do not have any illusions about the commuter
taxes, nor do I have any illusion where the Government, the
Federal Government, would just give away $800 million or so or
$1 billion or so. So the question then is how can we find a
way, one, to provide incentives for people to move to the city.
The heart of the matter is, as you pointed out, sir, that
we have lost population. There were 100,000 more people living
in the city. They are not living there today. My issue here is
that if you live in the city you pay city's taxes. I do not
care where you work, Virginia, Maryland, whatever. So how do we
make city more attractive place to live, so that once you live
in the city you pay city's taxes?
Now, as we have pointed out in our testimony, there is some
demographic shift in this, in our households. But our
population is not increasing. So we have to find a way in which
to bring more people in the city.
Obviously, if there is a commuter tax here, that would be
great. If we have a subsidy from the Federal Government, it
would be even better. But I just do not have any illusions
about that, sir.
Senator Brownback. Neither do I have any illusions about
that, because when I chaired the D.C. authorizing committee at
the very outset people were bandying around a commuter tax. I
heard clearly from one Virginia Senator quite quickly about
that and I anticipated I would hear from the other and the
Maryland Senators and some others possibly, too, on that pretty
quickly. Then just the notion of a direct Federal subsidy in
the quantities that would be needed is pretty hard to imagine
in this budgetary environment.
So part of the reason for putting this forward was to offer
another alternative of how you can make up for some of that
lost ground.
You talked about, and maybe you hit it, about what would be
the impact on businesses moving to the District. You go through
a pretty good analysis, it seems like to me, from your office's
perspective, about what happens to individual filers and what
is likely to happen there. But I do not get as much of a feel
from you on what you think would happen to businesses moving
into the District. Do you have that or have I just missed it or
is that just too hard?
Dr. Gandhi. No, sir. I think it is very difficult to gauge
as to how many businesses will move in unless we know a
concrete proposal, a very defined proposal with some specific
provisions. The fundamental point in the case of businesses is
their ability to expense their investment in the year in which
they would incur the cost. That will be the fundamental
attraction for them. So to the extent that we can do that, that
would be a great incentive on the part of the businesses to
come in.
But at the same time, the issue would be what about the
businesses that already have a lot of inventory on their hands,
a lot of equipment already on their hands? Generally, they
claim the cost of goods sold, their depreciation, as tax
deductions. So it depends upon what kind of transition rules
you would provide, what kind of specific flat tax proposal you
will provide for the businesses. All that will be a part of
basic consideration for businesses to move into the city.
Further, they also want some kind of certainty. If they
were to view this merely as a pilot project or an experiment
for, say, 5 years, then my sense here is that they would be
hesitant to move into the city, primarily because what happens
after 5 years? So all these considerations are critical.
But the bottom line here is that businesses are looking at
all times to reduce their costs. Tax is one of the most
fundamental costs of doing business. So let us keep that in
mind. Once you have a proposal that is far more defined, with
specific rules, the transition requirements, then I think it
would be better for us to be able to work with you and come up
with numbers as to what our expectations are about businesses
moving into the city or moving out of the city.
Senator Brownback. Now, one of the people that testified at
the last hearing said what an optional flat tax in the District
would create a super-charged enterprise zone, in his
terminology. What do you think of that as a descriptor for what
this would do?
Dr. Gandhi. Sir, it does provide basically a safe harbor
for people to say, look, if I do not like flat tax I will take
the current tax if I am better off doing it that way. Again, it
depends upon taxpayers, either individual or business, as to
how they are located in their tax situation. If I am a
taxpayer, a business taxpayer, with a lot of inventory on my
hands, a lot of investment already on my hands, then my
preference will be to stay with the current system because it
allows me to take depreciation and cost of goods sold as my
expenditures.
But if I were a new business coming into the city, then I
can write off all my taxes as far as the investment and the
purchases are concerned. So again, it depends upon what kind of
specific provisions do we have for flat tax, what kind of
transitional rules are we going to provide, and, given that you
would give them a choice--hey, pick what you would like--it
removes their initial concerns or fears about coming to the
city.
Senator Brownback. But overall you like the option of a
flat tax for creating growth, economic growth and vitality in
the District.
Dr. Gandhi. I think there is a great promise. But let us
keep in mind, sir, if you look at my table 1 that we have in
the testimony, what you see in the table is a very uneven
distribution, almost a bimodal distribution, of our taxpayers.
So if you look at the taxpayers, say roughly 4 percent of them
are paying 44 percent of the taxes, 17 percent of them paying
71 percent of our taxes. So if you have a flat tax here, what
will happen is that there will be a substantial redistribution
of taxes moving toward lower income taxpayers.
As you can see from the chart, roughly half of our
taxpayers just do not pay taxes. So the question for us then is
how are you going to make up for the lost revenue?
The second issue that we want to keep in mind here is that
it would have social implications. So I think it is better for
our policymakers, the elected leaders, the Mayor and the
Council, to grapple with these issues before coming to a
conclusion that the flat tax is the right thing to do.
Senator Brownback. You noted that and that is a proper
thing to note, is the social impact of this. You do not address
that here and that is a proper thing to note. But I am just
trying to get your outlook from the fiscal position on this.
Now, if it is that you do not think this is a good idea
fiscally for the District, then please state so as well.
Dr. Gandhi. As I pointed out, to the extent that it would
bring in high income individuals or taxpayers, businesses, to
the city, it is better off for the city in terms of it is going
to raise our tax intake. As I just said, if you just add 500
people, 500 taxpayers at $200,000 or above in that income you
are generating $30 million, just 5 percent. Ten percent would
roughly double that.
So it would bring in people here that will pay more taxes.
Two, it would also provide a lot of disposable income. Because
these people are not paying taxes, they would have more to
spend. So that could provide a lot of economic activity to the
city.
The question that we want to keep in mind, however, is that
one cannot simply look at flat tax from fiscal perspective, as
you know better than I, and that is where the concerns are.
Senator Brownback. The District has been losing population
for 50 years. The surrounding suburbs have been growing
rapidly. Why? We note the tax differential, but it cannot be
exclusively that.
Dr. Gandhi. That is correct, sir. There are several
considerations. Tax is one of them. As you have pointed out and
we have pointed out in other testimony, we have a very high tax
rate, even though the Council and the Mayor have engaged in a
tax parity initiative whereby we are reducing our taxes. But
for a long time our tax rates have been very high, higher than
regional jurisdictions and, as I pointed out, higher than
practically all States except two in the country. So that is
one very important consideration.
But at the same time, 10 years ago we had a major public
safety issue here. Schools are a major problem even today, even
though we have a very energetic superintendent and the city has
committed to put a lot of money in our school infrastructure.
But still, if you are a family with young children, schools are
a very, very important consideration.
The last of all is an affordable housing crisis. The city
has a major problem in being able to provide housing at an
affordable level. So when you put all these things together, we
have lost a substantial number of people as you pointed out,
sir.
Senator Brownback. What is the city doing to encourage
middle class families to move into the city?
Dr. Gandhi. Well, as I pointed out, the city is engaged in
lowering our tax rates. Now from something like 9.5 at one
point in time, now our tax rate will be around 8.7 beginning
this year. Further, we have substantially improved our public
safety environment. As I pointed out, the schools are a major
priority for the Mayor and the Council. I think all in all the
city is also engaged in providing a lot of funding for
affordable housing.
But all this will take time, I would say close to 5 to 10
years, before we could turn around the corner on that.
Senator Brownback. I want to look at the number of married
filers in the District.
Dr. Gandhi. Yes, sir.
Senator Brownback. You testified that it was at only 20
percent compared to 45 percent nationally.
Dr. Gandhi. Yes, sir.
Senator Brownback. Now, has the number of married filers in
the District declined over the decades and what is the reason
for this?
Dr. Gandhi. Well, again I think that has been the case. If
you are married with children, schools are extremely important.
And if we cannot provide adequate academic environment here,
people with children would leave, and we have seen people
leaving. The out migration that we have seen are basically with
the families with children. The in migration that we have seen
are the households which are basically single people or two-
income, no children families.
The question at the end of the day is for any married
couple, with or without children, are we going to be safe here?
When we have children, will we have good schools to send our
kids to, and can we afford to live in the city? Those are the
key considerations, and the Mayor and the Council have been
engaged very deliberately in a very considered effort to
improve on those fronts. But as I pointed out, it will take
some time.
Senator Brownback. Mr. Golden and Mr. Hill, I talked at the
outset with Dr. Gandhi about the other sourcing for
infrastructure money. You noted the infrastructure needs that
you have here, budgetary needs that you have, $2 billion needed
for schools, $200 million for a crime lab. I thought you said
$4 billion for roads and road needs. I do not know if you put a
number on that.
Mr. Golden. No, we did not.
Senator Brownback. Okay. I know the number is large. But do
you have another option for creating tax revenue for the
District outside of the two, three we have talked about today,
a Federal subsidy, a commuter tax, or a flat tax that creates
more growth? Do you have another option?
Mr. Golden. I really do not think there are----
Senator Brownback. I do not think that mike is on.
Mr. Golden. There we go. Is that better?
Senator Brownback. Yes.
Mr. Golden. I am not sure that there are a lot of great
options there. Clearly, as far as our capital needs are
concerned, as far as issuing further debt or something of that
sort, we are getting very close to the overall limit. I think
Dr. Gandhi has placed a cap on our city of about 11 percent of
our total budget being used to pay debt service on our bond
debt and so forth. When you look at we were already over $4
billion in indebtedness and the number was a total of around $4
billion, including education and a lot of other factors, we are
at a limit there.
I do not think we can necessarily tax our way out of that
dilemma. So it is a major issue for us. I think clearly what
you are pointing the direction in is the direction of getting
more people inside the city, both businesses and individuals,
to share the burden. And I think that that is clearly a good
strategy.
I also do think that the Federal Government continues to
have an obligation. You know, the crime lab is there to serve
our responsibilities as being a first responder, as an example.
We were saddled when we became in charge of our own welfare
here in the District, the residents had voting power, we were
saddled with an overall burden from the Federal Government from
years past of, as an example, the schools of $2 billion of
facilities there.
So it just seems to me to push that off on another group of
taxpayers when in fact the Federal Government left the District
in a very--when you left it to the District it was 570,000
residents, but very few taxpayers. I do think there continues
to be a Federal responsibility for addressing some of those
issues.
Dr. Gandhi. If I may comment on that, Mr. Chairman. I think
the fundamental point that we want to remember here is that,
even though we enjoy being the Nation's Capital and we are very
proud of being host to the Nation's Capital, but basically the
city is paying roughly $500 million annually for what I would
call a state-like function, like how many States--how many
cities run universities or Medicaid or mental health or a tax
department?
We have to carry all these expenditures on our shoulders
and we cannot afford to do that. As Mr. Golden pointed out, you
cannot tax any more. Indeed, we are going the other way. We are
trying to reform our taxation and lower the tax rates. And also
we cannot borrow any more. I have already pointed out to our
Mayor and the Council that if we want to borrow any more it
would have negative impact on our bond ratings and we do not
want to go there.
Senator Brownback. You noted at the end of your testimony
that this is kind of a halfway step between what we do now and
Puerto Rico.
Dr. Gandhi. Yes, sir.
Senator Brownback. Where we have no Federal tax, tax on
local earnings.
Dr. Gandhi. Yes, sir.
Senator Brownback. Why do you make that analogy and
example? You view this as a way of creating that type of half
step, or just that that is a convenient shorthand way of
looking at what this would do?
Dr. Gandhi. I would like to do it full way. We would like
to basically keep all the local taxation in the city. We pay
roughly $2.5 billion every year from the District to the
Federal Treasury in income taxes. That is a lot of money to be
paid for a jurisdiction that is not a State. My sense here is
that the Puerto Rican solution is an excellent one.
But the question is, do I have illusions about that? I do
not think so. The important point, however, is, how do we get
some way to expand our tax base? Our Mayor had, oddly enough,
said that his goal was to bring in 100,000 more people to the
city. To repeat myself, if you live in the city you pay city's
taxes. So how do we increase our population, taxpaying
population? The more important thing here is that we have to
improve our schools, our public safety environment, we have to
make our housing affordable, and our taxes have to be far more
competitive with our region's, because we are competing against
world-class jurisdictions--Fairfax, Montgomery. One Metro stop
and you are in Fairfax or in Montgomery County.
Senator Brownback. But if you created zero Federal income
tax in the District, say that if we are going to be here but
not represented, taxation without representation, then how
about pulling the taxation off. Would you not take your social
issues that you have been very deeply concerned about and
mentioned here, would you not exacerbate those even greater if
you had zero Federal tax here?
Dr. Gandhi. Well, I think the important thing is that we
have to make sure that even if there is a flat tax here the
District's taxes also have to be moderate, that we cannot be--
we cannot simply compensate, that whatever you were paying to
the Federal Government now you pay to the District government.
I do not think that would work. The question here is that we
ought to provide an economic environment here whereby we can
have more people come into the city and do business and leave
peacefully.
Senator Brownback. I agree with that. It is just it seems
like that if you had a zero Federal tax place here in the
District of Columbia, your charts that you were talking about
skewing people that would be attracted here go off the charts
at that point in time. Then you have got a lot of people with
substantial income saying, all right, I have got a real place I
want to live now.
Are your concerns not magnified?
Dr. Gandhi. That is where the political and the social
policy issues come into play. That is the decision that the
elected leaders and you, sir, would have to make as to what
kind of Nation's Capital do we want, who do we want to live
here. That is a very, very important question. I really do not
have answers for those questions.
Senator Brownback. I am just trying to kind of pin you down
where you are on this and I am having difficulty really trying
to ascertain that, Dr. Gandhi.
Dr. Gandhi. These questions are beyond my----
Senator Brownback. But I think I understand what you are
saying.
Dr. Gandhi [continuing]. Beyond my pay scale, sir.
Senator Brownback. That economically this is a big plus,
but you have got other considerations as well.
Dr. Gandhi. That is correct, sir.
Senator Brownback. But economically that is why I offer my
State up. If you would let us do it, I would be very happy
about that. I recognize there are other considerations to it
and there always are in tax policy because those have social
impact to them as well.
Well, thank you. I am appreciative of your thorough
analysis, particularly on the individual rates and impact and
individual income tax options. I think we ought to be able to
take those same sorts of options and put them in a business
framework and be able to determine what would happen to
business activity. But maybe that is too much to try to model.
It would be interesting to see that, but that is something we
can try to generate from Federal sources of that type of
information, because my guess is there would be a substantial
impact on business creation and formation in the District of
Columbia if there was stability to that type of system, and we
will have to see what that is.
Dr. Gandhi. And we will work with you, Mr. Chairman, to
refine the proposal and also come up with some scenarios as to
how businesses can be expanded with a different kind of flat
tax.
Senator Brownback. Mr. Hill.
Mr. Hill. In answer to your previous question about other
ways that it might be possible to increase and expand the tax
base for the District, there are a number of parcels of land in
the District that are currently owned by the Federal Government
and also ones that are being looked at in terms of
redevelopment. The ability to take some of that property and
put it into the tax base for the city could have significant
benefits for the city.
The Mayor in his plan to increase the number of taxpayers
by 100,000 also included as part of that not just bringing new
people into the city, but trying to address the literacy issue,
which keeps a number of our citizens out of the workforce and
therefore makes them not qualified to take some of the jobs
that are even created here, so that people from outside the
city have to come in because they are more qualified to take
those jobs.
So I think that a combination of those factors as well as
the State functions issue that Dr. Gandhi made could have a
significant impact on additional revenue for the city.
Senator Brownback. Okay. Has the Federal City Council
identified those parcels that you would like to see conveyed
from the Federal Government to the District?
Mr. Hill. Well, there certainly is one parcel now that is
under discussion, Walter Reed Hospital, and what should happen
with Walter Reed. It is clear that the District is very
interested in the possibility of developing that in a way that
it could bring in new residents and also bring in additional
businesses to that area. Certainly the State Department is
interested in it for the possibility of having additional
Embassies, which would further exacerbate the problem of having
this property in the tax base, as well as the General Services
Administration (GSA) is interested in it in order to provide
additional space for government facilities.
So of those three competing uses, it is quite clear that
some of the uses that the District would want for that property
would help. And I know that the city has looked at other
parcels of land as well that could potentially be transferred
to the city.
CONCLUSION OF HEARINGS
Senator Brownback. Good. Thank you all very much for your
time and effort and your analysis on this. If you have
additional statements you want to put into the record, please
let us know.
Julia, I want to thank you particularly as the economist. I
know you did a lot of the work on this analysis and I
appreciate all that effort and focus in your doing that.
The hearing is recessed.
[Whereupon, at 2:43 p.m., Thursday, March 30, the hearings
were concluded, and the subcommittee was recessed, to reconvene
subject to the call of the Chair.]
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