Comments for the Record
Senate Committee on Finance
Hearing on CEO Perspectives Regarding
How the Tax Code Affects Hiring and Business Growth
July 27, 2011
By Michael G. Bindner
Center for Fiscal Equity
Chairman Baucus and Ranking Member Hatch, thank you for the opportunity to address these issues. I urge you to take the formal testimony with a large grain of salt.
The Distribution of Productivity Gains
CEOs and personnel in upper management have done quite well under the current tax code, which has seen their salaries absorb most of the productivity gains over the past thirty years while the wages of most workers have barely kept up with inflation.
Prior to the 1981 tax cuts, the income tax system was designed not to maximize revenue but to instead prevent the maldistribution of income by seizing outsize gains at the top of the income scale through the imposition of confiscatory rates. These rates were part of the original grand bargain with labor – which restricted the extent to which organized labor could invest pension funds in order to gain control of individual companies in exchange for protecting collective bargaining rights and limiting the incentives at the top for exacting outsized gains from employees.
This changed with President Kennedy’s tax cuts and changed more profoundly during the tax cuts of the Reagan Administration. The tax cuts enacted in 2001 and 2003 finished the job, both through lowering rates and creating special tax rates for dividends, driving the effective tax rate for the wealthiest to 19%.
With the end of confiscatory tax rates, wage concessions were exacted from employees while unions were subjected to a frontal assault from management in the name of shareholder profit. As dividends are usually rewarded at “normal profit” levels, most of these gains ended up in the pockets of the members of the Executive Suite through higher profits, stock options and outsized bonuses. CEO dominance of compensation committees and the rise of the celebrity CEO did the rest, voiding the social contract with labor that saw the rise of the American middle class in the 20th century.
Today’s witnesses made valid points about how to make American companies more profitable on the world stage, through reducing specific tax benefits and lowering rates. Some economists even cite Laffer Curve information and assert that any rate cut, even absent base broadening, would produce more revenue. The question then arises, who would benefit from these policy changes?
While they would almost assuredly fatten government coffers, and may even provide some benefit to shareholders, by and large the chief beneficiaries of such cuts would be members of the “C Suite,” both those at the top and their immediate staffs in upper management. These benefits would accrue to the largest companies only. Smaller firms without a large international presence would benefit little, since many such firms do not even use a corporate form of ownership.
Any reform to corporate tax rates must be accompanied by general tax reform which includes measures to make work pay for families, such as an increase in the minimum wage, an expansion of programs for displaced workers, increases to the refundable child tax credit so that it more approach living wage levels and, above all, an end to special tax rules for dividends and capital gains so that the incentive to concentrate the benefits of productivity at the top of the income latter are reduced.
The Center for Fiscal Equity has a four-part proposal to replace the current system, including replacement of the corporate income tax with a more generally collected net business receipts tax. The key elements are
- Value Added Taxes (VAT) to fund domestic military and civil spending;
- VAT-like Net Business Receipts Taxes (NBRT) to fund non-Old Age and Survivors(OASI) entitlement spending and to provide a vehicle for both tax benefits, such as a consolidated Child Tax Credit and the continuation of the health care exclusion, as well as any state-level efforts to shift entitlement funding to tax benefit funding (ex. public and private charter schools);
- OASI taxes to allow an income-sensitive benefit based on the employee tax, but with the employer tax credited as an average to move redistribution to the collection end and an increase to the income cap to improve solvency and benefits, possibly in exchange for limited personal accounts invested in insured employee-ownership (rather than in Wall Street assets where they have little control or influence); and
- Income surtaxes, to include distributions from inheritance, to assure period based system progressivity and to fund overseas, naval sea and strategic military spending, net interest on the debt, repayment of the OASI trust fund and any transition costs to personal retirement accounts.
Adequate attention has been paid to the VAT of late, while no debate on fundamental reforms to OASI will likely occur under the current regime. We will, therefore, confine the remainder of our comments to the Net Business Receipts Tax and the need to increase income tax revenue.
The Net Business Receipts Tax (NBRT)
The NBRT base is similar to a Value Added Tax (VAT), but not identical. Unlike a VAT, and NBRT would not be visible on receipts and should not be zero rated at the border – nor should it be applied to imports. While both collect from consumers, the unit of analysis for the NBRT should be the business rather than the transaction. As such, its application should be universal – covering both public companies who currently file business income taxes and private companies who currently file their business expenses on individual returns.
The NBRT would replace payroll taxes for Hospital Insurance, Disability Insurance, Survivors Insurance for spouses under 60, Unemployment Insurance, the Business Income Taxes, on corporations, business income taxes now collected under the personal income tax system, as well as most of the revenue collected under the personal income and inheritance taxes, less the amount collected under a VAT. The health insurance exclusion now included in the Business Income Tax and other subsidies under the Affordable Care Act. Most importantly, it would fund an expanded and refundable Child Tax Credit.
The expansion of the Child Tax Credit is what makes tax reform worthwhile. Adding it to the employer levy rather than retaining it under personal income taxes saves families the cost of going to a tax preparer to fully take advantage of the credit and allows the credit to be distributed throughout the year with payroll. The only tax reconciliation required would be for the employer to send each beneficiary a statement of how much tax was paid, which would be shared with the government. The government would then transmit this information to each recipient family with the instruction to notify the IRS if their employer short-changes them. This also helps prevent payments to non-existent payees.
The expansion of the child tax credit to $520 per child per month is paid for by ending the tax exemption for children, the home mortgage interest deduction and the property tax deduction. This is more attractive to the housing industry than the alternative proposal, which is to end or limit the credit and use the proceeds to help bring the budget into primary balance. Shifting the benefit in this way holds the housing industry harmless, since studies show that the most expensive cost of adding a child is the need for additional housing.
Assistance at this level, especially if matched by state governments may very well trigger another baby boom, especially since adding children will add the additional income now added by buying a bigger house. Such a baby boom is the only real long term solution to the demographic problems facing Social Security, Medicare and Medicaid, which are more demographic than fiscal. Fixing that problem in the right way definitely adds value to tax reform.
This tax should fund services to families, including education at all levels, mental health care, disability benefits, Temporary Aid to Needy Families, Supplemental Nutrition Assistance, Medicare and Medicaid. If society acts compassionately to prisoners and shifts from punishment to treatment for mentally ill and addicted offenders, funding for these services would be from the NBRT rather than the VAT.
This tax could also be used to shift governmental spending from public agencies to private providers without any involvement by the government – especially if the several states adopted an identical tax structure. Either employers as donors or workers as recipients could designate that revenues that would otherwise be collected for public schools would instead fund the public or private school of their choice. Private mental health providers could be preferred on the same basis over public mental health institutions. This is a feature that is impossible with the FairTax or a VAT alone.
If cost savings under and NBRT, allow companies to offer services privately to both employees and retirees in exchange for a substantial tax benefit. Employers who fund catastrophic care would get an even higher benefit, with the proviso that any care so provided be superior to the care available through Medicaid. Making employers responsible for most costs and for all cost savings allows them to use some market power to get lower rates, but not so much that the free market is destroyed.
Enacting the NBRT is probably the most promising way to decrease health care costs from their current upward spiral – as employers who would be financially responsible for this care through taxes would have a real incentive to limit spending in a way that individual taxpayers simply do not have the means or incentive to exercise. While not all employers would participate, those who do would dramatically alter the market. In addition, a kind of beneficiary exchange could be established so that participating employers might trade credits for the funding of former employees who retired elsewhere, so that no one must pay unduly for the medical costs of workers who spent the majority of their careers in the service of other employers.
Conceivably, NBRT offsets could exceed revenue. In this case, employers would receive a VAT credit.
The Center calculates an NBRT rate of 27% before offsets for the Child Tax Credit and Health Insurance Exclusion, or 33% after the exclusions are included. This is a “balanced budget” rate. It could be set lower if the spending categories funded receive a supplement from income taxes. As importantly, the combination of this tax with a Value Added Tax, retention of a separate OASI payroll tax and retention of progressive income surtaxes allows for a low enough tax rate, after offsets, to provide a competitive advantage to American corporations while distributing these gains beyond the CEO Suite.
Income and Inheritance Surtax
Retaining an income surtax could have few rates or many rates, although we suspect as rates go up, taxpayers of more modest means would prefer a more graduated rate structure. The need for some form of surtax at all is necessary both to preserve the progressivity of the system overall, especially if permanent tax law enacted before 2001 is considered the baseline (which it should be) and to take into account the fact that at the higher levels, income is less likely to be spent so that higher tax rates are necessary to ensure progressivity.
This tax would fund net interest on the debt, repayment of the Social Security Trust fund, any other debt reduction and overseas civilian, military, naval and marine activities, most especially international conflicts, which would otherwise require borrowing to fund. It would also fund transfers to discretionary and entitlement spending funds when tax revenue loss is due to economic recession or depression, as is currently the case. Unlike the other parts of the system, this fund would allow the running of deficits.
Explicitly identifying this tax with net interest payments highlights the need to raise these taxes as a means of dealing with our long term indebtedness, especially in regard to debt held by other nations. While consumers have benefited from the outsourcing of American jobs, it is ultimately high income investors which have reaped the lion’s share of rewards.
The loss of American jobs has led to the need for foreign borrowing to offset our trade deficit. Without the tax cuts for the wealthiest Americans, such outsourcing would not have been possible. Indeed, there would have been any incentive to break unions and bargain down wages if income taxes were still at pre-1981 or pre-1961 levels. The middle class would have shared more fully in the gains from technical productivity and the artificial productivity of exploiting foreign labor would not have occurred at all. Increasing taxes will ultimately provide less of an incentive to outsource American jobs and will lead to lower interest costs overall. Additionally, as foreign labor markets mature, foreign workers will demand more of their own productive product as consumers, so depending on globalization for funding the deficit is not wise in the long term.
Identifying deficit reduction with this tax recognizes that attempting to reduce the debt through either higher taxes on or lower benefits to lower income individuals will have a contracting effect on consumer spending, but no such effect when progressive income taxes are used. Indeed, if progressive income taxes lead to debt reduction and lower interest costs, economic growth will occur as a consequence.
Using an income tax to fund deficit reduction explicitly shows which economic strata owe the national debt. Only income taxes have the ability to back the national debt with any efficiency. Payroll taxes are designed to create obligation rather than being useful for discharging them. Other taxes are transaction based or obligations to fictitious individuals. Only the personal income tax burden is potentially allocable and only taxes on dividends, capital gains and inheritance are unavoidable in the long run because the income is unavoidable, unlike income from wages.
Even without progressive rate structures, using an income tax to pay the national debt firmly shows that attempts to cut income taxes on the wealthiest taxpayers do not burden the next generation at large. Instead, they burden only those children who will have the ability to pay high income taxes. In an increasingly stratified society, this means that those who demand tax cuts for the wealthy are burdening the children of the top 20% of earners, as well as their children, with the obligation to repay these cuts. That realization should have a healthy impact on the debate on raising income taxes.
The last question is whether the income and inheritance surtax can be incorporated into the NBRT, as proposed by Lawrence B. Lindsey in testimony to this committee earlier this year. While it is feasible, we reject it because it will either lead some to be overtaxed while others are under-taxed or will require a personal financial reporting system that many employees and investors would regard as intrusive if it came at the hands of employers or investments. While there is resistance to letting the government know all of one’s financial details, we are quite certain letting your employer into all your business would be considered worse. What bartender wants to work for a lower wage (if he or she could even find a job) if part of being hired was the requirement to disclose family trust fund income to management, who would have to pay taxes on behalf of that employee at a higher rate? Better to leave the personal income tax in place so that only the government knows who is really rich.
Thank you for this opportunity to provide comments to the Committee.
