SPEAKERS       CONTENTS       INSERTS    
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PAYING DIVIDENDS: HOW THE PRESIDENT'S
TAX PLAN WILL BENEFIT INDIVIDUAL
INVESTORS AND STRENGTHEN
THE CAPITAL MARKETS

Tuesday, March 18, 2003
U.S. House of Representatives,
Subcommittee on Oversight, and Investigation
Committee on Financial Services,
Washington, D.C.

    The subcommittee met, pursuant to call, at 3:10 p.m., in Room 2128, Rayburn House Office Building, Hon. Sue Kelly [chairman of the subcommittee] presiding.

    Present: Representatives Kelly, Hensarling, Garrett, Murphy, Brown-Waite, Barrett, Oxley (ex officio), Inslee, Moore, Crowley, Hinojosa and Sherman.

    Chairwoman KELLY. [Presiding.] The hearing will come to order please.
    The September 11 terrorist attacks and the end of the telecom and Internet bubbles, the corporate accounting scandals, and now the uncertainties accompanying war have left Americans feeling uncertain about their economic future. Business investment has been flat or down for about two years now. Only consumer spending has kept the economy afloat. Now, there are signs that consumer confidence is down to the 1992 levels.
    President Bush's plan to eliminate the dividend tax is a sound, common sense approach to growing this economy. Cutting taxes and encouraging consumer spending and investment is the way to go. We want to create jobs. We need to spur growth. That will only happen by letting American investors keep more of their own money and giving them incentives to invest it in this economy.
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    For millions of individual Americans, encouraging investment means encouraging the purchase of stock, which has been the best long-term return of any investment. Half of all American households, more than 84 million individual investors, already own stock directly or through mutual funds. Today, millions of Americans of all income levels receive dividends from stock. In fact, 45 percent of all dividend recipients make under $50,000 per year. I am going to repeat that, because that is important for people to understand—45 percent of all dividend recipients make under $50,000 per year. Three-fourths make less than $100,000 per year.
    The problem is that America has the second highest dividend tax rates among the 26 most developed nations in the world, second only to Japan. So it only stands to reason that if we need more corporate investment, we need to reduce the tax rate on the dividends which we receive from corporate stock. Those dividends are already taxed when the corporation earns income. It is fundamentally unfair for us to pay more taxes on that income.
    Another reason we need to end double taxation is to help our seniors live more independent lives. More than half of all dividend income goes to America's seniors, many of whom rely on these checks as a steady source of retirement income. More than nine million seniors would receive an average of $991 in tax relief in 2003 if they did not have to pay income tax on those dividends. Maybe there was a day when ending double taxation would have helped a small handful of rich, privileged Americans, but with 84 million individual investors owning stock, those days are over and it is time to bring economic thinking into the 21st century.
    Our witnesses today will discuss the increases in corporate investment, the hundreds of thousands of new jobs, and the improvement in the quality of life for seniors and all individual investors that will result from passing President Bush's proposal to end the double taxation on dividends. But there is yet another reason for ending double taxation of corporate dividends. On December 12, 2001, I co-chaired the first congressional hearing examining corporate fraud and mismanagement at Enron.
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    Investigations by law enforcement and by this and other congressional committees found that senior Enron management intentionally twisted its corporate finances to hide billions of dollars in debt from investors.
    A massive and detailed report released last month by the bipartisan Joint Committee on Taxation shines a special light on Enron management's sordid actions. Part of the report lays out how Enron raised over $800 million through hybrid financial instruments called tiered preferred securities, which were specifically designed to be treated as debt for income tax purposes and as equity on their books. So Enron could deduct corporate interest payments on its tax returns without revealing its debt service on consolidated financial returns. I have provided copies of this section of the report to the members and to our witnesses, and I invite your attention to the last two pages in which the Joint Economic Committee stated four recommendations for dealing with tiered preferred securities.
    The very last recommendation states, and I quote, ''reduce or eliminate the disparate taxation of interest and dividends for both insurers and holders of financial instruments that creates the market for hybrid financial instruments.'' By providing more equivalence in the tax consequences of debt and equity, this approach would eliminate tax considerations from the process by which corporate taxpayers decide to obtain financing.
    Now, certainly the most important factor in Enron's demise was plain old greed, but the lesson from this bipartisan report, and it was hailed by members on both sides of the aisle and in both parties in both Houses, if we do not want anymore Enrons gaming the system to line their pockets, one step we can take is to end the double taxation on dividends. Ending double taxation is not a panacea for the stock market's ills, but it would add to this committee's record as the home of sound corporate governance on Capitol Hill.
    Numerous Presidents as far back as Franklin Roosevelt have proposed ending the double taxation of dividends, but the proposal always seems to get caught up in outdated, tired class warfare arguments. For the sake of our economy, for the sake of our seniors, for the sake of our financial markets and our investors, Congress should support the President's plan to end double taxation of dividends.
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    Several members of the full committee who are not on this subcommittee have asked to give opening statements today. I am not sure that they are all here, but for those who are, I ask unanimous consent that all members participating today can give opening statements and insert them into the record.
    With that, I turn to you, Mr. Sherman.
    Mr. SHERMAN. As American troops head toward Iraq, it is a shame that when Americans should be coming together, we have these hearings which represent nothing more than something to divide America along class lines—a declaration of class warfare against American working families. Roughly 40 years ago, the corporate income tax, the alleged first of the two payments on corporate income, represented over 4 percent of our GDP. Now, it is below 1.5 percent because we should be in this Congress addressing the incredible loopholes that have made the corporate income tax a fiction, and have given the lie to the idea that corporate profits are taxed twice, for if this bill goes forward they will be taxed not even once.
    Now, this sneak attack, this class warfare against American working families, is not being done under the cover of darkness. Rather, it is under the cover of saying that anyone who resists it is starting a class warfare division of Americans. We in America had reached some consensus as to dividing the burdens of government among the economic classes, until the President came forward with this weapon of mass destruction against that accommodation. You see, 70 percent of the benefits from this will flow to the top 5 percent of Americans. Stated another way, the top .02 percent of tax filers will receive nearly as much benefit from this cut as 95 percent of Americans, and do not tell me about the elderly without mentioning that 75 percent of the benefit goes to those seniors with incomes of over $75,000, while those seniors with incomes below $50,000 receive only 4 percent of the benefit.
    This is class warfare covered by deft use of statistics; covered by an attempt to intimidate those who would shine a light on it by saying we are waging class warfare. Keep in mind, a lot of Americans own stock, but an awful lot of those own stock only through their 401(k) or IRA. They get no benefits.
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    This is also an attack on the American economy. It is an anti-investment proposal. It says if a corporation is thinking of building a new factory, hopefully in America, and instead they are pressured by their shareholders to distribute that money so that the shareholders can afford the new $350,000 Mercedes, that is an improvement to the American economy. It takes money available from corporate investment and moves it further away from corporate investment. A policy this bad could not stand the light of day. Fortunately, these hearings are basically stacked with witnesses that will present pretty much one side.
    I yield back.
    Chairwoman KELLY. Thank you.
    We have three panels today, and I am hopeful that members will keep to the five-minute rule.
    Mr. Hensarling, have you an opening statement? Mr. Murphy? Mr. Garrett, have you an opening statement? Ms. Brown-Waite? Mr. Inslee, have you an opening statement? If there are no more opening statements, then I will introduce our first witness, Mr. Peter Fisher, Under Secretary for Domestic Finance at the Treasury Department.
    We thank you for testifying before us today, and I welcome you on behalf of the committee. Without objection, your written statements and any attachments that you have will be made part of the record. You will now be recognized for a five-minute summary of your testimony. As you I am sure know, when the light changes color from green to amber, that is the time you need to put your own timer on, because when it blinks red, your time is over. Please begin, Mr. Fisher. We welcome you here today.

STATEMENT OF HON. PETER R. FISHER, UNDER SECRETARY FOR DOMESTIC FINANCE, DEPARTMENT OF THE TREASURY

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    Mr. FISHER. Thank you for the opportunity to be here today to testify on the President's jobs and growth package.
    Let me focus my summary on two issues and try to pick up a third. First, the President's overall package is the right prescription for the macroeconomic circumstances that we face today, because it would support consumption and promote investment on a balanced, enduring basis. Second, by enacting the President's proposal to tax corporate income once and only once, this Congress has the opportunity to make the single biggest improvement in the efficiency of capital investment in our economy.
    First, our macroeconomic challenge. In my view, the United States is not just facing another swing of the business cycle, but the aftermath of the extraordinary events of the 1990s, as you, Madam Chairwoman, described. The Federal Reserve monetary policy, global economic integration, telecommunications advances combined to fuel real prosperity and higher productivity, but investors' overestimation of their impact contributed to a stock market bubble. We continue to live with the disinflationary consequences and the destruction of trillions of dollars in household wealth as the bubble burst.
    Under these circumstances, using fiscal policy to deliver only a short-term stimulus would be a mistake. The American people are smart enough to distinguish between a one-off injection of cash and an enduring improvement in their disposable income. When consumers refinance their mortgages at lower rates, they gain an enduring improvement in household cash flow. The same would be true of bringing forward to this year the tax rate reductions the Congress has already approved that are scheduled to come in later in the decade. Together with eliminating double taxation of dividends, these acceleration proposals would put cash in people's pockets right away and in the future.
    The scale of the President's package is central to accelerating growth and job creation. Over the next decade, U.S. economic output is projected to total $142 trillion, generating something on the order of $27 trillion or $28 trillion in federal revenues. The President's jobs and growth package would reduce taxes by $695 billion over that period, scored with static macroeconomic effects. To have an impact on our economy, fiscal policy needs to be large enough to move the needle on the economy.
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    In the past year, Congress, under Chairman Oxley's and Senator Sarbanes' leadership, took a major step toward improving our capital markets performance. Better run, better disclosing corporations make for better capital markets, but there is more to be done to provide the right incentives for corporate executives. By double taxing profits, but not interest, our tax code encourages executives to retain earnings instead of paying them to shareholders, to favor debt over equity finance, and to dedicate some of America's leading minds to tax alchemy instead of value creation.
    By imposing a higher marginal rate on profit, our tax code thins the vital blood of economic growth, risk capital. No other major industrial nation taxes profits at such a punitive effective rate. We have learned since recent testimony that the Japanese have made some changes, so they are no longer number one. We are, according to information I was told about from the Japanese embassy. The President's proposal would reduce that bias.
    A prime benefit would be to raise the burden of proof on corporate executives if they wish to retain profits instead of sending them to shareholders. Under the proposal, shareholders would be tax neutral between reinvesting profits in the best projects a company could offer versus the best projects that the market could offer. Today's tax code cordons off that choice inside the company. Some corporate executives may prefer today's tax code, which places a less onerous burden on them for justifying their decisions to retain earnings. Yet corporations exist to serve shareholders, and our tax code should reflect this.
    The impact on capital efficiency of freeing this boxed-in capital may be huge. Each year, American firms invest over $1 trillion in fresh capital and generate $700 billion to $800 billion in corporate profits. Think of the capital gains utilization and job creation if we accelerate and re-target this investment. The financial and economic markets will reap huge collateral benefits.
    Let me conclude by saying if dividends are suddenly a tax efficient way for paying shareholders, executives will have fewer arguments to justify cash mountains and share buy-backs, which a critic may be tempted to note, offer the insider benefit of boosting the value of executive stock options. Because the President believes that profits should be taxed once, but only once, the company's payment of tax actually accrues as an asset to shareholders. In such a world where corporations paying tax on dividends reduces shareholders' own tax liability, the rationale for corporate inversions would dissipate.
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    Thank you, Madam Chairman. I look forward to the committee's questions.

    [The prepared statement of Hon. Peter R. Fisher can be found on page XX in the appendix.]

    Chairwoman KELLY. Thank you very much, Mr. Fisher.
    I have just a couple of questions for you. How many new jobs do you think would be created over the next five years by eliminating the double tax penalty on dividends? And how much economic growth do you see that as promoting?
    Mr. FISHER. There are a number of different studies, the administration's numbers that the CEA has put out, that 1.5 million approximately new jobs, 1.4 million by the fourth quarter of next year. I know that there are studies by the Business Roundtable suggesting that perhaps 500,000 jobs will be added to total jobs over the coming years. There are a number of different estimates.
    Let me, though, stick my neck out a little bit. Forecast models are very bad at dealing with changes in behavior. What we are trying to do is re-engineer a profound change in behavior on the part of corporate executives. When we do that, I am confident we are going to have a bigger impact on job creation than anyone's forecast, anyone's model is prepared to project. I think both in terms of job creation in our economy, the numbers we are looking at from static modeling, will understate it, and they will understate it because they do not take into account the break in habit from accelerating the investment process.
    Chairwoman KELLY. If the tax penalty on dividends was removed, would it reduce the use of Enron-style accounting gimmicks and improve corporate governance, as it appears from the report by the Joint Committee on Taxation?
    Mr. FISHER. Yes, I think it would have a profound impact, especially if we do it as designed by the President. If you go back to the mid-1960s, 75 percent of large companies paid dividends in America. Today, it is about 25 percent. If we can re-direct corporate America to cash-flow rather than managed earnings, that will be the biggest thing we can do to improve corporate governance and avoid a lot of the shenanigans, some legal, some illegal, which we know have gone on in corporate America.
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    I think that we also by leveling the playing field between debt and equity, we will increase equity in the system, reducing the risk of bankruptcy, and we will reduce the risk of what I call managed stock option plans. We know stock options are a legitimate tool of employee compensation, but where I think some companies have gone too far is using the stash of retained earnings to justify share buy-back programs, to engineer share prices higher to offset the dilutive effect of stock options they have granted. This became a self-justifying prophecy. We need to lean against that and make corporate management either justify their investment internally or pay the money out to shareholders.
    Chairwoman KELLY. I have another question for you. I think I still have a little time here.
    As I said in my opening statement, more than eight million seniors would get almost $1,000 in additional income a year if they did not have to pay income tax on the dividends. What impact do you think that would have on their lives? And do you think that corporations would be more likely to increase their dividend payouts or would it stop seniors from getting short-changed by the dividend penalty that they now pay? That is really a triple question.
    Mr. FISHER. Yes, I am trying to keep track of all that. We know that 40 percent of tax filers, as you have said, a high number of them that receive dividend income have incomes under $40,000, and among seniors, 40 percent of dividend recipients have incomes below $30,000. Keeping the dividend income streams coming, and reducing the tax burden, is a very short-run effect which gives them a boost to their income.
    Again, I want to go back to thinking about if we can unwind the clock either 10 or 20 or 30 years, and double or triple the number of dividend checks that are mailed, we will have a much greater impact than any of these static numbers we are looking at. While we do not expect that to happen in any one or two year scenario, over time as corporations have a reduced incentive to hang onto earnings, a greater incentive to pay dividends out, then there will be even more dividend checks flowing to seniors and other Americans.
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    Chairwoman KELLY. One more quick question. If we end the double taxation on dividends, how do you see that as changing the incentives on the pool of retained earnings? I think you talked about that—the incentives regarding the behavior with the pool of retained earnings. You talked about that in your testimony a little bit.
    Mr. FISHER. I think that what it will do—I want to be very clear. The President's proposal is about leveling the playing field. We have taken some criticism from some quarters that it is complicated. One provision that I admit adds to the complexity is that we want it to be a level playing field between retained earnings and dividends. So I think it does not distort the incentive structure. It means management of companies should make economic judgments about whether they want to reinvest in their business or pay the money out to shareholders. But it equalizes the hurdle rate, if you will, on internal investment and external investment. That will speed up the investment process.
    Let me just add, if I could, that one of the great strengths of our economy that the rest of the world is envious of is the efficiency of our investment process. Here, we have something which we know creates a huge distortion in that process. I know of no principled argument in favor of our current structure. There are arguments about transition costs, but I do not hear anyone arguing in favor of the current structure that we have. If we can eliminate this, we are going to accelerate investment, business formation, and job creation in America.
    Chairwoman KELLY. Thank you. My time is up.
    Mr. Inslee?
    Mr. INSLEE. Thank you, Mr. Fisher.
    When did you or your department determine that this was such a tremendous idea? When did you make that decision?
    Mr. FISHER. I have been, about me personally, I have since the mid-1990s, and observing the acceleration of retained earnings inside corporate America, it then seemed to me most clear that this was creating a major distortion in our capital structure.
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    Mr. INSLEE. Just roughly, when did your administration propose this in the last year or so?
    Mr. FISHER. The President proposed it the first week of January of this year. There were many discussions between our tax policy shop over the last year, working on different reform proposals.
    Mr. INSLEE. And there have been some changes since then in our both world and economic conditions, haven't there?
    Mr. FISHER. There continue to be a lot of uncertainties about the economic outlook.
    Mr. INSLEE. Let me just mention a couple of them. Number one, we are starting a war in a couple of days and it is going to cost $100 billion just to start. And then it is going to on for years as we occupy Iraq—in the billions of dollars. We have had a recession which have reduced federal revenues dramatically, which since your department came up with this grand scheme, has left the U.S. economy in shambles because we have over a $300 billion deficit this year likely, in part because of the previous revenue reductions that your administration passed.
    I want you to think about the fact that since you came up with this idea, we have had a war; we have got people from my district who got on the USS Rodney Davis, it is a frigate, last weekend to go steam into harm's way, and the 8th hospital unit of the Bangor Military Naval Hospital. They believe, like John F. Kennedy, that we should be willing to, ''pay any price, bear any burden, meet any hardship, support any friend, oppose any foe, in order to assure the survival and the success of liberty.''
    But your administration believes that while we have a war overseas, it is okay to have a fiscal party at home. A lot of my constituents believe this is grossly irresponsible. It would be the first administration in American history to propose a major league tax cut in the middle of starting a war. I would like you to respond to their concerns as to how that is responsible, when we ask our men and women to go into harm's way next week, that you want to have this fiscal largesse at home.
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    Mr. FISHER. Sir, I do not think it is irresponsible. As I look back over the history of the last 50 years, I see that federal task revenues as a share of GDP in our economy peaked at 21 percent in 1944—the last year of the Second World War. From 1960 to 2000, through five Democratic and five Republican administrations, federal revenues as a share of GDP has oscillated in a corridor between 17 and 21 percent, with a very tight average around 18.5 percent.
    Mr. INSLEE. So you think it is responsible even though we start a war, we increase our expenditures over $100 billion, we increase our deficit over $300 billion—it is still responsible, you believe, to grow our federal deficit at the same time you are handing out tax cuts? You believe that is responsible, to have deficits in the $300 billion range, at the same time you are increasing expenditures to a war; at the same time you want to increase these tax cuts? You believe that is responsible fiscal behavior?
    Mr. FISHER. I think fiscal policy needs to focus on making sure our economy grows both now and over the coming 10 years.
    Mr. INSLEE. So how do you explain it to our children? How do you explain it to our children?
    Mr. FISHER. There is nothing more important to our children's financial success than that we grow this economy over the coming decades as rapidly on a sustainable basis as we can. That is where federal revenues come from, to pay for all of the priorities which Congress votes when you enact outlays.
    Mr. INSLEE. Let me explain and convey to you my three children's belief. They are not happy that your administration is putting onto their shoulders a chronic debt burden. They are not happy that 14 percent of all the taxes they pay goes to pay the debt tax. Fourteen percent of all the taxes my son, who is a carpenter, pays goes to pay a debt tax to service the debt that you are increasing, you are exploding on his shoulders. He does not think it is responsible. I do not think it is responsible either, and if you want to go ahead and comment, go ahead.
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    Mr. FISHER. We disagree, I guess, sir.
    Mr. INSLEE. We agree that we disagree. Thank you very much.
    Chairwoman KELLY. Thank you.
    Mr. Oxley?
    Mr. OXLEY. Thank you, Madam Chairwoman.
    It is good to have you here again, Mr. Fisher, and also I want to ask unanimous consent that my full statement be made part of the record, and also while I am at it, welcome our former colleague and friend, Senator Gramm, who will be on the next panel, as well as former member and a member of this committee, Rick Lazio, who will be on the third panel, along with some other distinguished members.
    I am sorry my friend from Washington left. I was interested as to why he might oppose 431,000 jobs in the private sector, higher wages, I assume for his constituents, as well as mine; tax relief, particularly for senior citizens; a very positive impact on the stock market—as a matter of fact, probably a 10 percent increase minimum. I know that the gentleman from Washington state voted for the Sarbanes-Oxley proposals, which brought about better corporate governance. Clearly, as you indicated, Mr. Fisher, the impact on corporate governance would be a very positive one by eliminating the double taxation on dividends, creating a much better climate and a much better incentive within the corporate structure; and of course international competition, which means more exports for the United States.
    So that is a pretty good record of what we can accomplish by eliminating the double taxation of dividends. I guess I would not want to be on the other side of that issue. I feel a lot more comfortable with a pro-growth package that would provide the kind of incentives and the kind of positive developments that would be brought about.
    I asked Chairman Greenspan when he was here two or three weeks ago about his opinion on the elimination of double taxation of dividends. He was very positive—as a matter of fact, so positive that we did a ''dear colleague'' quoting directly from Chairman Greenspan. We may do the same with your testimony, and we appreciate the efforts.
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    Let me ask you, as you know, the telecom and high-tech sectors have been hit particularly hard. They are not making any money. Their earnings dropped precipitously in 2001 and 2002. As a result, they may not be able to take advantage of the dividend exclusion proposal, which would disincentivize their shareholders. Has there been some consideration given to expanding the proposal to permit companies in these circumstances to apply their average tax liability over, say, a five-year period to guide issuance of tax-free dividends to their shareholders?
    It appears that of all of the sectors, perhaps, in our economy, the tech sector and telecom have been hit the hardest, and reflected certainly in their earnings and in their growth, and obviously a negative effect on their shareholders. Has Treasury given any thought to that proposal?
    Mr. FISHER. I do not believe there has been work done on a five-year carry-back, carry-forward. I know there is some work going on there in the tax policy shop. I do not think, though, they have been looking at it on that long a horizon, but I would be happy to talk about it with them and get back to you.
    Mr. OXLEY. There has been some discussion about something less than a five-year?
    Mr. FISHER. We have heard from a lot of people wanting us to focus on that. There are discussions. I am not sure what the reaction is to the different proposals. I have not yet heard of any as long as five years, but I would be happy to get back to you, Mr. Chairman, after talking with our folks in tax policy.
    Mr. OXLEY. Getting back to the issue of corporate governance, you and I were comrades-in-arms on some of these issues. As we look back on an Enron, for example, and as you know, this committee had the first hearing on Enron. It became quite evident, I think, to the committee that Enron was in a situation where they were desperately trying to bury and hide debt through SPEs—special purpose entities. To what extent do you think the tax code may have lent itself to some of the rather strange behavior that took place at Enron, particularly over the last year and a half?
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    Mr. FISHER. I think there are at least three different channels, I would say, of regrettable incentive structures that the tax code puts in play. One is simply the debt equity ratio issue of encouraging companies to be more levered than they might otherwise be, given the tax disadvantage currently in place. The remedy would address, if we unwound this, we would get companies and give them another incentive to focus on cash flow, rather than managed earnings. I think that that is now we are getting toward the heart of some of the issues that came up in Enron, where they went further and further off into the wilderness of managed earnings.
    The third is managing tax liability as aggressively as they apparently did, is another sort of third dimension that this comes up. The remedy the President has put forward, this plan puts in place, as I was beginning to elaborate, is that it is really a fundamental change in thinking that corporate America would have to go through to think of the payment of corporate taxes as a shareholder asset. Instead of having every incentive to maximize tax shelters of every flavor and stripe, once we put in place what the President has proposed, the company has an incentive to think of the taxes they pay at the corporate level as offsetting taxes for the shareholder, and there as a shareholder asset.
    So in those three different channels, I think we would be driving really at the heart of some of the behavioral problems that came up.
    Mr. OXLEY. Thank you.
    Thank you, Madam Chairwoman.

    [The prepared statement of Hon. Michael G. Oxley can be found on page XX in the appendix.]

    Chairwoman KELLY. Thank you.
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    In the absence of subcommittee Democrats, I am turning to Mr. Hensarling.
    Mr. HENSARLING. Thank you, Madam Chair. I hope I am not supposed to give their side of the story.
    [Laughter.]
    Chairwoman KELLY. No, take your pick. You can do whatever you want. This is an educational forum, if you will.
    Mr. HENSARLING. Mr. Fisher, one of my colleagues from across the aisle, who is absent now, spoke quite passionately about his children and future deficits. I, too, am a father. I have a one-year-old and another on the way, and I am very concerned about leaving them a legacy of debt, because I want to leave them a legacy of freedom and opportunity.
    The gentleman spoke about deficits. Can you tell me how the tax relief in the President's package is scored for fiscal year 2004? Isn't it approximately $100 billion?
    Mr. FISHER. Yes, it is about $100 billion. Yes, about $100 billion in terms of the jobs and growth package.
    Mr. HENSARLING. And the administration has proposed roughly a $2.2 trillion budget for fiscal year 2004, is that correct?
    Mr. FISHER. Yes. That is my understanding.
    Mr. HENSARLING. So if I do the math correctly, is the tax relief less than 5 percent of the proposed spending?
    Mr. FISHER. That sounds right. That sounds about right, but maybe even a tad less.
    Mr. HENSARLING. Might it be a fair conclusion then that over 95 percent of the problem appears to be on the spending side and not the tax relief side?
    Mr. FISHER. I would certainly share that view with you.
    Mr. HENSARLING. The $100 billion is under static scoring, is that correct?
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    Mr. FISHER. Yes.
    Mr. HENSARLING. Okay. The administration has not employed dynamic scoring, but I assume that you believe that your tax relief package will indeed have some consequences on human behavior.
    Mr. FISHER. Yes.
    Mr. HENSARLING. I assume the administration has looked at past tax relief, say, in the Reagan administration or the Kennedy administration, since we heard JFK's name mentioned earlier. If you look at the history of earlier tax relief packages, can you tell me what their impact was on economic growth and tax revenues?
    Mr. FISHER. I do not have those figures on the top of my head. We know they were positive and they had a dynamic effect. I am confident this package will, too, but I do not have the figures from 1962, 1964 and the early 1980s in my head. But I think you and I agree, it is going to have a positive impact, lower the loss of federal revenues considerably, and increase the job creation.
    Mr. HENSARLING. One last question, can you go into further detail about how we in the U.S. tax capital and savings vis-a-vis other industrialized nations, and what the consequences of that has been on the availability and cost of capital in the U.S.?
    Mr. FISHER. I think all other OECD industrial countries have worked through different formulas to integrate—it is called tax integration—personal income tax and the corporate income tax, to avoid effects such as the double taxation we are looking at. So they have all been working at it, and it is just in the last few weeks we learned that Japan has actually moved ahead of us, so we are now taxing capital at the highest rate, as they have put through some credits to try to offset.
    So we know it has a dampening effect on investment here, and all the perverse corporate incentives that we have been discussing, and other countries do not put this dampener in their investment process. We should take it out.
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    Mr. HENSARLING. Thank you, Mr. Fisher.
    Mr. FISHER. Thank you.
    Mr. HENSARLING. Madam Chair, I yield the balance of my time.
    Chairwoman KELLY. Thank you.
    Mr. Hinojosa?
    Mr. HINOJOSA. Thank you, Chairwoman Kelly.
    I want to ask for unanimous consent to let my opening remarks, statement be made a part of the record.
    Chairwoman KELLY. So moved.

    [The prepared statement of Hon. Rubén Hinojosa can be found on page XX in the appendix.]

    Mr. HINOJOSA. Thank you.
    Under Secretary Fisher, I apologize that I was unable to come in while you were making your statement. I was at another meeting and I just could not get out of it.
    Mr. FISHER. I understand, sir.
    Mr. HINOJOSA. Currently, the interest payments on many of the State and local government bonds are exempt from federal income taxes, while capital gains on stocks and securities are not. This system is in place to stimulate private investment in our communities and schools, and makes it easier to build roads, schools, and other projects. So that is something that is very important to us, especially who come from congressional districts with large rural areas and school districts that need to have the sale of these government bonds so that it can keep all these projects that I mentioned to you.
    Will the elimination of taxation on capital gains and retained earnings for private securities harm these communities I mentioned, and result in more costly municipal and state construction projects? And will the reduction in taxation of dividends reduce the amount of funding available for community investment?
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    Mr. FISHER. Sir, I do not believe that it will. I think it is very important to understand the different characteristics of municipal bonds and municipal borrowing from equity securities. While in an absolute sense, we see a diminishing of their relative advantage in terms of tax advantage of munis vis-a-vis equity dividends, investors recognize the profound difference between the safety and stability of a government bond issued by a state and local government, and the risks of equity securities, particularly after the last few years we have been through with the wild swings in the equity markets.
    So when investors approach this, they do not think of these as fungible instruments. They might think of a diversified portfolio where, in order to have a very safe and secure revenue stream, you might have some government bonds and municipal securities. A balanced portfolio might also include some equity investment, but it would be quite odd to think of those two instruments as comparable, given how different the risk characteristics of them are.
    So while in some absolute mathematical sense, the tax advantage decreases for municipal securities, these are such profoundly different instruments I think it mistakes how investors approach them to think there would really be an increase in the cost of financing State and local projects.
    Mr. HINOJOSA. Let me tell you why I am not very clear on the reason that you give. In talking to some of our friends in New York about this problem, their comment was that once you take out the capital gains, then you do not have the advantage of these tax exempt bonds that they are investing in and getting a high return, for comparing tax exempt bonds. By taking out the capital gains on those stocks, will they still be attractive to the investors in New York?
    Mr. FISHER. Yes, I believe they will. It has to do with the risk to principle, is one issue, and therefore the volatility of the instruments. Someone who wants to hold a municipal security is looking for something that is very safe and secure, and in which the principle amount is not subject to fluctuation, and which gives them a regular income stream in the form of the interest. An equity instrument is subject to all the risks of the market going up and down, and to the risk the company does not declare a dividend. That is in the discretion of management.
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    So the two instruments have fundamentally different risk characteristics, which make it extremely unlikely that investors think of them in fungible terms.
    Mr. HINOJOSA. Investors also want the highest return possible. It is not just the risk, it has got to be balanced.
    Mr. FISHER. Investors are always struggling to find the highest risk-adjusted returns. That is, to simply say, I want an instrument that pays me the largest interest payment, that will turn out to be a very risk bond, for example, of some company that does not have a very good credit rating.
    Mr. HINOJOSA. You and I both know that they are going to be low-risk, because in many cases they are guaranteed by somebody, especially in Texas where the State permanent school fund guarantees those bonds.
    But let me go to another question. I do not believe that I am sure that there is going to be a high enough interest rate to still make it as attractive as you seem to be anticipating. In your written testimony, you said that the deficits projected are manageable and declining. At their peak, the immediate future, they are below U.S. historical experience. They compare favorably with fiscal conditions in other G-7 countries. Our debt remains modest by historical and international comparisons, and as a share of U.S. credit market it is at a 50-plus year low.
    My research indicates just the opposite. In 2001, the U.S. enjoyed a $127 billion surplus. In 2002, our budget went into a $158 billion deficit. CBO forecasts that the President's new tax cuts and his other budget initiatives would produce deficits of $1.82 trillion over the next 10 years. The CBO projects a deficit of $287 billion in fiscal year 2003, that we are in, and a deficit of $338 billion in fiscal year 2004.
    Chairwoman KELLY. Mr. Hinojosa?
    Mr. HINOJOSA. Yes, ma'am.
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    Chairwoman KELLY. Can you please conclude as quickly as possible. Ask your question.
    Mr. HINOJOSA. In conclusion, how can these deficits be characterized as manageable and declining?
    Mr. FISHER. Looking at the 10-year forecasts that we are working with, that both CBO and OMB have done, we are looking at deficits as a share of our economy—that is the normal way we look at them; as a share of GDP—they are in a range inside our experience and consistent with other G-7 countries. So right now, we are looking at less than 3 percent of GDP. That is a very typical deficit-to-GDP ratio. The projections over the coming decade is that they are around here just a little beneath 3 percent, and then decline over the rest of the decade. That declining trend is one of the reasons that I think both financial markets and we at the Treasury responsible for debt management see these as entirely manageable. So I think that when we look at it scaled to our capital markets, as my testimony alluded to, scaled to our credit markets, we see these as entirely manageable.
    Mr. HINOJOSA. I thank you for your response, and thank you, Chairwoman Kelly.
    Mr. FISHER. Thank you.
    Chairwoman KELLY. Thank you.
    Mr. Murphy?
    Mr. MURPHY. Thank you, Madam Chairman, and welcome here.
    Mr. FISHER. Thank you.
    Mr. MURPHY. I was talking with some folks on the street, and I agree oftentimes constituents, people around America know a heck of a lot more than we inside the Beltway give them credit for. This guy described himself this way. He said, I am just an average American Joe Sixpack that pounds nails and cuts wood during the day, mows my lawn in the summer, and cheers for the Steelers in the fall. He said, we are pretty tired of the Beltway bullfeathers, although he described it a little more colorfully. He said, all I want to know is this—with these plans, what is it going to do to my money in retirement? What is it going to do to my kids' college fund? What is it going to do for job opportunities for my kids? And what is it going to do to put food on my table and keep a roof over my head, for now and in the years to come?
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    How would you respond to him?
    Mr. FISHER. I would say the single most important thing, both for his family finances and for our government's, is to get our economy growing and creating jobs over the next 10 years. As I said in my written statement and alluded to in my summary, I am concerned that we have a little more to confront here than just another swing of the business cycle. If I really thought we just were looking at sort of a normal business cycle issue then maybe we would not need to do something on the scale that the President has proposed. But I think we need to overcome some greater obstacles. So getting the growth rate up, and nothing over the coming 10 years will do a better job of that than speeding up the investment process.
    Mr. MURPHY. In plain speak, do you believe this plan will essentially boost the value of what people have saved in whatever kind of market funds or something else they put away for college or their retirement? And how much do you think it will increase it by?
    Mr. FISHER. There are estimates of the impact. We have not done one at the Treasury, but the estimates of impact on stock market valuations range from 5 percent to 15 percent positive impact.
    Mr. MURPHY. Over how many years? Annually?
    Mr. FISHER. No, that is a one-off effect of doing this, but that is a pretty substantial boost, even just a 5 percent boost. So I think it is going to raise equity valuations and the value of investment.
    Mr. MURPHY. Does this translate also to you saying that you cannot affect the job market unless you affect the stock market?
    Mr. FISHER. I think the effect comes back indirectly. What I would say is, businessmen and consumers want to see something that will be enduring support, so we need something that is going to drive investment higher so there are more jobs for his kids. We need something that is going to provide consumers with the confidence to buy something—a big ticket item—to keep their consumption on track. We need to do both of those things. That is what the President is trying to do.
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    Mr. MURPHY. Another avenue here—I heard someone say that those who oppose the President's plan are opposing a plan that forces corporations to pay their fair share of taxes. Could you respond to that? Does that sound about right? I guess they are referring to the way companies have, I think you were saying before, to keep money to finance buy-backs; they incur debts to falsely pay dividends to keep their stock value up, et cetera. They will find other loopholes to not pay taxes. Does this have any way of helping to keep companies more honest in what they are paying?
    Mr. FISHER. Yes, as I have said, I think it does. I even know one commentator who thinks this will overall increase corporate tax payments because of the incentive effects that if they pay the taxes, then their shareholders do not have to. I think it has a powerful impact on just the other side of getting us away from tax shelters and corporate inversions and the like, reducing the incentives for gaming the system by corporations.
    Mr. MURPHY. What do you mean by ''gaming'' the system?
    Mr. FISHER. Aggressive tax shelters. We know there is a fine line between what the system permits and what then goes over the line—not tax avoidance, but tax evasion. Obviously, there are a lot of people out there who are trying to always push up against that line. We want to try to reduce the whole incentive to be playing that game to begin with.
    Mr. MURPHY. Will this then lead to some job loss for attorneys and accountants whose whole job is to find ways to not pay taxes?
    Mr. FISHER. Yes, if it is successful, it would do that.
    Mr. MURPHY. I am for that. Thank you.
    Chairwoman KELLY. Thank you, Mr. Murphy.
    Mr. Garrett? Mr. Barrett, have you questions?
    Mr. BARRETT. Thank you, Madam Chairwoman.
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    Mr. Fisher, just one quick question. I was reading an article in the Wall Street Journal that quoted Glenn Hubbard, of course, the head architect of the Bush tax package. It talks about urging people to invest more and pushing down the cost of capital. The part that intrigued me, that I really liked, he said a dividend tax cut is a way to raise wages. Tell me how that would work?
    Mr. FISHER. By lowering the hurdle cost of investment, we make it easier for firms. Firms then have a choice of what to do with that additional capital, that additional expense. Now, over time—I think this is in the context Glenn would be discussing that—that drives us to higher productivity. We are going to get more investment, and it is really productivity that leads to enduring improvement in our incomes. It may not change it—if you think about just one person, are they going to get a raise the day this thing is passed—no, I do not see it that way. But this is the key to unlocking productivity gains to beget more investment in our economy, more productivity. That is what leads to a higher level of income for all of us.
    Mr. BARRETT. Thank you, Mr. Fisher.
    With that, Madam Chairwoman, I yield back the balance of my time.
    Chairwoman KELLY. Thank you.
    Ms. Brown-Waite?
    Ms. BROWN-WAITE. Thank you very much.
    One of the things when I got elected was I promised I would not fall in love with a place that people sent me to work at, namely D.C. So I go home every weekend, and I talk to people in the community, talk to seniors. I can just tell the rest of the panel and the rest of the members here that my seniors will appreciate having the dividend not be taxed. When you look at the figures, more than half of the dividend income goes to seniors, and that means about five million seniors nationwide would receive an average tax cut of somewhere around $900 in 2003. That is a substantial impact. That is money that they are going to use in the community. If you cannot see how these jobs are going to be created, how it stimulates the economy, then I do not think you understand Economics 101. It is when people have more money in their pocket that they actually spend it.
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    I was just wondering if you all have done a breakdown of State by State how much it would mean to seniors, to the residents in each State?
    Mr. FISHER. I think we have done that. I do not have it with me. Let me double check that we have done that analysis and we will try to get it to you as quickly as we can. I do not have it with me or in my head.
    Ms. BROWN-WAITE. Have you extended that to number of jobs created as a result of the tax break for each state? I saw some figures that came from a research organization, but I did not know if you all had official figures.
    Mr. FISHER. I am going to have to double check. I think we may be able to do a State by State analysis, but I do not have it in my head or with me. So let me try to get back to you on that.
    Ms. BROWN-WAITE. I can just tell you that the seniors in Florida are looking forward to paying lower taxes as a result of this. Thank you.
    Mr. FISHER. Thank you, ma'am.
    Chairwoman KELLY. Thank you.
    If there are no more questions, the chair notes that some members may have additional questions for Under Secretary Fisher and they may wish to submit those in writing. So without objection, the hearing record will remain open for 30 days for members to submit written questions to him and place their responses in the record.
    Mr. Fisher, there have been some requests by members of the committee for some additional information, so please feel free to—I will officially request that those figures get to us.
    Mr. FISHER. Yes.
    Chairwoman KELLY. We are very grateful that you were willing to be here with us today. You are excused with the committee's great appreciation for your time.
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    Mr. FISHER. Thank you very much. It was a pleasure.
    Chairwoman KELLY. With the agreement of the members, I want to recognize Mr. Hensarling of Texas for the purpose of introducing our next witness.
    Mr. HENSARLING. Thank you, Madam Chair.
    It is indeed a distinct honor and privilege to introduce our next witness. In many respects, Madam Chair, we are getting three witnesses for the price of one, for there is Dr. Phil Gramm; there is Senator Phil Gramm; and there is Vice Chairman Phil Gramm. Dr. Phil Gramm was a professor of economics, who taught economics to thousands of students at Texas A&M University over 12 years. Thousands of students learned about supply, demand, money, banking, and Seays Law due to his inspiring teaching. I was honored to be one of those students.
    He went on to have an almost quarter-century public service career in Congress, first as a Congressman and then as a Senator. He is indeed uniquely qualified to speak to us about economic growth, since he was the co-author of the Reagan economic program in the House, a program that cut marginal tax rates, increased government revenues, and caused one of the largest economic booms in American history to take place.
    As a Senator, he was responsible for the Gramm-Rudman legislation, and was one of the last people in this city to actually put binding restraints on federal spending. I hope he explores in his testimony the relationship between economic growth and the growth in government spending. Once again, I was honored to be his aide for many years during these years.
    Finally, there is now Vice Chairman Phil Gramm. Senator, we are very happy you finally decided to make an honest living.
    [Laughter.]
    Senator GRAMM. So am I.
    Mr. HENSARLING. We have the perspective of an investment banker.
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    So Madam Chairman, I do think indeed we are getting three witnesses for the price of one, to the panel. We have an academician, we have a great public servant who is committed to principle, tenacity, courage; and finally we have an investment banker. But to me, he is a teacher, a friend, and a mentor. I am honored to introduce him, and one statement to the witness: Senator, for 25 years, I have answered your questions; turnabout is fair play.
    [Laughter.]
    Thank you, Madam Chair.
    Chairwoman KELLY. Thank you.

STATEMENT OF HON. PHIL GRAMM, VICE CHAIRMAN AND MANAGING DIRECTOR, UBS WARBURG LLC

    Senator GRAMM. Madam Chairwoman, members of the committee, Mr. Chairman, Congressman Hensarling, let me thank you for that wonderful introduction. If I had never done any of those things other than taught you, I would have had a life well spent, and I want to thank you very much.
    I want to thank you for inviting me to come today. I cannot imagine what is more important than getting America back to work, than rebuilding confidence in our equity markets, than rebuilding the foundations of our retirement program. To the extent that I get to play a small role in advising you on that, I am very flattered and very grateful.
    Let me start by defining the problem. In the 20th century, we had two different kinds of business downturns. In the middle and late part of the 20th century, we had a series of inventory cycles—seven of them—and they all worked basically the same way. Somewhere, signals got crossed between people that were selling things and people that were producing things. We would over-produce. There would be a buildup of inventories. It would be discovered. Orders would go back up the production chain to cut back on production. Businesses would re-trench. People would be laid off and we would have an economic downturn. Economists could never predict when they were going to happen, but we understood a lot about them once they started.
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    In the early part of the 20th century, we had a series of financial panics. They were generated by the fact that we had a very difficult time converting checking account demand deposits into currency, and we had an agricultural economy so you had huge seasonal variants in the demand for money.
    I give you that little history lesson because one thing everybody should know in this debate is that the downturn that we are beginning to recover from is very different than anything we experienced in the 20th century. The downturn we suffer from was a speculative boom and a breaking of that speculative bubble. We do not know for sure whether all the gas is out of it. We do not have good precedents in recent history as to how post-speculative booms work in terms of recovery.
    So the first point I want to make is that we are kind of in uncharted waters here. I would urge you to be cautious and forward-leaning in terms of addressing this downturn and guaranteeing a strong recovery.
    Secondly, Madam Chairwoman, as you mentioned, this has been a very different kind of recession. Consumption has never declined. We are in the midst of a housing boom in the midst of a downturn. Our downturn has been produced by one thing and that has been a collapse in investment. Now, what I think that should tell us is if you want to get the economy growing again, you have got to affect investment. The old pump-priming where we give people money hoping they are going to spend it is not going to be very effective in a recession where consumption has never declined. The problem is investment, and if your policy does not affect investment, it is not going to have much of an impact.
    Now, in terms of the President's stimulus package, despite all the media hype and all the politics, the plain truth is it is not very big—2.4 percent of projected current services spending, which means what you would spend if you created no new programs and did not change anything over the next 10 years. You could literally take 2.4 percent of projected current services spending and fly it over cities in airplanes and throw the money out and would have no substantial impact on this economy. If this stimulus package is going to affect anything, it has got to get people to invest not the money they get from your tax cut, but to invest money they have already got that they are not putting to work.
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    I think there are two things in the President's package that are very important in doing that. One of them you have talked a lot about, and that is the dual taxation on dividends. Eliminating the dual taxation on dividends will change the after-tax rate of return on investment and will, in and of itself, change the value of equities on the American market. The lowest figure that Secretary Fisher talked about was 5 percent. That does not sound very big until you realize that a 5 percent change in equity values is $350 billion. So we are talking about a substantial impact simply by eliminating a current bias in the tax code.
    There are a couple of other things that I think are important. Number one, the current system basically encourages companies to invest internally even when the rate of return of investment in the market is greater than it is inside the company. That creates a wasting of capital and inefficiency, and eliminating this bias will go a long way toward correcting that, and ultimately will correct it.
    By eliminating the bias against dividends, companies will pay more dividends and you will make the internal conditions of companies more transparent. I had an old accounting professor long ago who said, cash flow is real; profits are a fiction. Letting companies exhibit cash flow by paying dividends probably will do more for corporate transparency than any law you could pass.
    Number four, the double taxation of dividends encourages businesses not to incorporate, even though they could get access to more capital; they could grow; they could create jobs. But by incorporating, they end up having to pay a dual taxation on dividends and they are disadvantaged. It cannot make sense to let tax policy dictate corporate structure.
    Finally, the elimination of the dual taxation on dividends will eliminate the non-economic use of debt. How many companies that have had problems during the current downturn overused debt and underused equity because the cost of debt is tax deductible and the cost of equity is not?
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    Those are all sound reasons why this ought to be done. There is one other policy I wanted to touch on, Madam Chairwoman, and that is accelerating the reduction in rates. Let me just focus on one—the highest rate, 38.6 percent. That is in reality the small business tax rate in America, because 38.6 percent is the tax rate paid by proprietorships, partnerships and subchapter S corporations filing as individuals. That tax rate and the revenues collected from it generate revenues 85 percent of which come from small business.
    Small businesses create most of the jobs in America. Probably dollar for dollar, the greatest stimulant in the President's package is accelerating those reductions in marginal rates, specifically the highest rate, from all four to the present, and from all six to the present. It does not change the long-term revenue stream of the government even in a static sense because it is going to go into effect anyway, and it ought to be made retroactive to January 1 and done now. There is no question about the fact that had Congress known how weak this recovery was going to be, how uncertain it was going to be, we would never have strung the tax cut out as we did.
    So I want to urge this committee to move forward. And let me address just two other issues, if I may. First of all, the question about revenues, and I think at least when I was here that I had as good a record on being concerned about the deficit as anybody. But when you are losing five times as much revenue from a recession as the static cost of the stimulus package, I think it makes sense to act, not to sit passively by.
    Secondly, if you take the Wilshire 5000, which is the broadest index of equity value in America, and you go back to the high water mark in 2001, and you compare that to today, we have lost $6.7 trillion in equity value; $6.7 trillion in equities that form the foundation of the life savings of our people; that form the foundation of our retirement programs. Whatever we can do to rebuild that equity value is going to produce many times more revenue than we are talking about in a static sense in this stimulus package.
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    So I think it is very important that we act on it. I think the figure that over the next three years that we would have the potential of creating an extra two million jobs is not out of reach. I think it might be achievable. And I think this stimulus package should be adopted.
    Finally, in terms of this war, I did not see any evidence in 1991 that the war had any significant economic impact, and the economy is twice as big today as it was in 1991. I think the war is very important and I think it is something we ought to be concerned about. It is something we ought to be worried about and praying over. But this economic problem is something that is vitally important, and I do not think simply because we are staring a war in the face that we ought to forget the fact that unemployment is rising, that equity values have declined by $6.7 trillion, and that there is a lot of work to do economically. That is why I want to congratulate this subcommittee on holding this hearing, even when so much of our thought is on the war.

    [The prepared statement of Hon. Phil Gramm can be found on page XX in the appendix.]

    Chairwoman KELLY. Thank you so much, Mr. Gramm. Is it okay if I call you ''Senator'' still?
    You have been one of the key players in all of the tax debates over the past 20-plus years. You have talked about some of the lessons that those debates have given you, about economic growth and federal revenues that we should apply to the debate over ending double taxation of dividends. Which fears that were raised by the President's opponents are not valid, based on past experience? You have heard some people earlier today talk about some of their fears. Which of those fears do you feel are not valid?
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    Senator GRAMM. Well, first of all, I think that our first fear ought to be about the economic recovery. Let me make it clear right now, I believe the economy is going to recover no matter what we do. I think the economy is going to recover. It is going to overcome the illness and the absurd prescription of the doctor. But it is going to recover slower if we do not try to do something to stimulate it. For the people who are going to be affected over the next three years, I think we can make their lives better and I think we can strengthen the economy dramatically. So it is not a question of, is America going to recover economically—we are. The question is the speed of the recovery and how it is going to be affected.
    I would say this, Madam Chairwoman, and I do not want to get into a political debate. I have gotten out of political debates. But I would take the concern about the deficit more seriously if the people raising it had the same standard for spending money as they do reducing taxes. I think basically that is the test. In the end, I think that given the state of the economy and given the nature of this downturn we have, and how much uncertainty there is about it—and I can tell you, working today in New York, working with people who want to make investments, that have powerful economic ideas, there is still a great deal of uncertainty. And whatever we can do to allay some of that uncertainty, I think we should do.
    Chairwoman KELLY. Thank you.
    Mr. Hinojosa?
    Mr. HINOJOSA. Thank you, Chairwoman Kelly.
    Senator, it is a pleasure to see you again.
    Senator GRAMM. Thank you.
    Mr. HINOJOSA. Coming from Texas and seeing how you worked and worked so effectively, it is a pleasure to see you back on the Hill, and especially before this committee so that we can ask you some questions. Possibly the questions I am going to ask you may appear to be softball pitches because you come from Texas, but truly I want to ask you a question that is not very clear, and I certainly do not necessarily agree with the President's plan to stimulate the economy. Being the great economics instructor that you were at Texas A&M, I am going to focus my question on housing. Housing seems to be an industry that has created lots of jobs and continues in spite of the decrease of the GDP, which was projected to be at 3 percent and now will be 1.5 percent, according to some experts.
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    Nine national housing lobbies have expressed concern that President Bush's proposal to eliminate the taxation on individual dividends would undermine the country's most successful program producing and rehabilitating affordable housing. The low-income housing tax credit gives investors a dollar for dollar reduction in taxes in return for investing in such housing, which you and I know is greatly needed down in South Texas. The dividend exemption could make all tax credits less attractive to investors and could move investment from tax exempt government bonds to dividend-paying stocks, thus reducing the allure of the low-income housing tax credit and endangering affordable housing programs in the United States. What are your views on this contention?
    Senator GRAMM. Let me say, Congressman Hinojosa, I thank you for your kind comments. I have always appreciated my friendship with you and with your family.
    I have very strong views on this. Let me just begin with some history. When we cut taxes under President Reagan by 30 percent, these same arguments were raised in 1981; that by lowering the highest marginal rate from 70 percent to a 30 percent reduction from that rate, and ultimately with the 1986 Act, by lowering it all the way initially from 1981 at 70 percent to 28 percent, there was concern that the deductions you get for your mortgage interest would be lowered in value; there was concern about the marketability of municipal bonds—you raised that earlier. But let me say, in both those cases, both the 1981 tax cut and the 1986 more simplification—but in neither case was housing affected in a negative way and in neither case was there a perceivable impact on municipal bond sales and on the viability of that market.
    The logic that you are quoting people as saying basically is the logic that if you wanted to make deductions more valuable, you would make the tax rate 100 percent. All I am saying is, in my career in 1981, in 1986, in 2001, when we cut taxes, we did not see any of these dire predictions come true. Remember this, the municipal bond market is a market that is driven by the fact that income is tax free. Even with the elimination of dual taxation on dividends, you are still talking about a 35 percent tax rate.
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    So it is a concern that I do not see any evidence to substantiate it. If you just ask yourself the logic, this logic is used every time we reduce taxes. All I am saying is, I cannot speak for all of the history of mankind, but from 1981 and 1986 and 2001, it just did not happen.
    Chairwoman KELLY. But Senator——
    Mr. HINOJOSA. I am going to finish my question. Is that Okay, Chairwoman Kelly?
    Chairwoman KELLY. As long as it is a short one.
    Mr. HINOJOSA. It is a short one.
    I will come back in the next round and ask you, so be thinking about it. How could it be that from 1980 to 1996, when we had this huge gap between house ownership between minorities and the average American, and we started producing a lot more jobs and reducing the unemployment rate down to its lowest; produced the most millionaires in that period from 1990 to 2000, that national policies were to have taxes at about the rate that they are at now and to pay taxes on these dividends. So they must not have been too bad, because we paid off our deficit.
    Senator GRAMM. That is right. We cut taxes in 1995, if you will remember on the budget summit agreement with the President. We cut taxes. We cut the capital gains tax rate. We controlled spending and we started moving, beginning in 1995 toward a balanced budget. You know, everybody wants to claim credit for what happened. Really, from 1982 until about 2001, we were living in a golden age. I do now know if people knew it then, but I tell you, looking back at it now, in terms of the quality of consumer goods, in terms of the economic development reaching people that had not been reached in 30 years under Democrat or Republican Presidents—in the 1990s, this economic expansion started reaching those people and you and I have seen it all over South Texas. Creating millionaires did not create enough, but it created a lot of them.
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    Mr. HINOJOSA. Madam Chair, I reserve the right to come back in the next round and continue my question and his answer.
    Chairwoman KELLY. Mr. Hinojosa, there will not be a second round with this witness. However, if you would like to submit a question in writing, you certainly are able to do that.
    Mr. HINOJOSA. Thank you.
    Chairwoman KELLY. Mr. Oxley?
    Mr. OXLEY. Thank you, Madam Chairwoman.
    Senator Gramm, welcome. It is good to see you again and we hope this is the first of several appearances before the Financial Services Committee. Let me express my gratitude to you for your leadership, both in the House when we were colleagues here, and in the Senate, and particularly your work on what became known as the Sarbanes-Oxley bill, and your efforts working with me to make certain that we did not go too far in our efforts to seek more corporate accountability.
    To that end, in your testimony you say that eliminating the current bias against the payment of dividends will make the internal condition of corporations more transparent. I am wondering if you could help us with some details and elaborate on how ending the tax penalty on dividends will improve corporate governance and reduce the use of gimmicky off-shore tax shelters. Do you share with me the belief that some of these problems that developed in Enron in particular and other corporations in general in some ways were brought about by the rather odd way that we deal with corporate taxation, and specifically the double taxation of dividends?
    Senator GRAMM. Here is basically my point, that when you have the tax code discriminate against equity financing, and discriminate against dividend payment—let me just give you an example. If I am running a company and I earn a profit, and I pay it out to my shareholders, I have got to pay corporate income taxes on it and then they have got to pay individual income taxes on it, the effective tax rate pushes over 50 percent—up to 60 percent. But if I simply take it and repurchase my stock or if I take it and invest it internally, even though the rate of return inside my company may not be as high as my investors could get by investing somewhere else, they still can be better off economically. I think that when you have a policy that is biased against equity, then you get the instability that comes with these very heavy debt burdens; when you have a policy that discourages the payment of dividends, dividends give people information about companies. Companies cannot pay dividends unless they have got a positive cash flow. The ability to exhibit that tells you a lot about the health of the company.
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    I just think that there just is no intellectual argument in favor of the dual taxation on dividends. The only debate about it is that people would like to have the money to spend. I have never heard anybody say that it is a good, sound economic policy. I am not claiming that the dual taxation of dividends was the source of all of our problems in corporate governance, but I am saying that allowing dividends to be paid by eliminating the bias in the tax code has a lot of other positives, and a big one is increased transparency. If my company is paying me dividends, I know they have got money from somewhere. My old accounting professor was trying to make a point, and as most professors do, overstated the point, but profit has to do with all kinds of complicated calculations—write-offs, depreciations, et cetera. Cash flow has to do with money coming in, the money you are paying out, and the money you can then pay out in dividends. That is as real as real gets in the world we live in.
    Mr. OXLEY. If that is the case, and you particularly make a strong point that it is very hard intellectually to argue against the elimination of double taxation, why has it never been seriously tried until now? I know that I think Charles Schwab really raised the issue with the President at the economic summit down in Texas. But obviously, this is the kind of issue that has been around for a long time. When Chairman Greenspan sat there where you are and testified two or three weeks ago and I asked him those same questions, I started out by saying I can remember studying Econ 101 in college, and that my professor at that point was talking about the double taxation of dividends and how inefficient it was and an odd situation. And yet, now 40 years later, we are still engaged in that debate.
    Is it just that it is so difficult? You were on the Ways and Means Committee over here in the House. Is it just because it is there and the inertia is such that we just cannot move it?
    Senator GRAMM. I think it is hard to do because it is an easy issue to demagogue. It is an easy issue to take yourself back to the 1950s where only rich people owned stock. I think it is important. A question was asked earlier about corporate taxes. Corporations do not pay taxes. Corporations collect taxes from consumers, but they do not pay them. This idea that corporations are paying this tax, ultimately it is their customers that pay it when it is passed to the consumer.
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    I think it is just a hard thing to eliminate and I think it would be good if we could work out a consensus to do something about it. You know, there is this age-old debate about how big should government be and how much of society's resources should go through government. I respect that. I have a strong opinion about it, but I respect other people's opinion. But the way we collect that revenue ought to be in a way that has the least damaging effect on the economy, because whether you want people to spend their money or whether you want the government to spend it, you want the pie to be as big as possible. So there ought to be some way to have this debate where everybody should end up on the same side of this particular issue.
    Mr. OXLEY. Thank you.
    Chairwoman KELLY. Thank you.
    Mr. Chairman, I am glad you brought up the name of Charles Schwab. I have here, and with unanimous consent, will enter into the record a copy of a March 11 Washington Post op/ed written by Charles Schwab, entitled, A Boon to Ordinary Investors: Eliminating the Dividend Tax is Just What the Economy Needs. So without objection, I will enter that into the record.

    [The following information can be found on page XX in the appendix.]

    Chairwoman KELLY. We go now to Mr. Moore.
    Mr. MOORE. Thank you, Madam Chairwoman.
    Senator Gramm, in January 2001 I believe the projected surplus by CBO was about $5.6 trillion. Does that sound about right, sir?
    Senator GRAMM. For over a 10-year period, that is about right. My mind fades, but it was big.
    Mr. MOORE. Right. I was speaking to a high school government class about the virtues of fiscal responsibility and balanced budgets and paying down debt last year. Even where I am on the other side of the aisle, I am not going where you may think I am going, because I voted for the President's tax cut. I thought it was the right thing to do and I still think it was the right thing to do two years ago. But at that time, we had a $5.6 billion projected surplus. I was talking to this group of high school students, and I said, how would you define ''projected surplus?'' This girl raised her hand and she said, ''Maybe yes; maybe no.'' A pretty good definition, isn't it? Because as it turned out, what we hoped would happen, what we projected would happen, did not happen, did it? Over the 10 years, we did not have a $5.6 trillion surplus.
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    Senator GRAMM. It did not happen, and it did not happen really for several reasons. The economy got weaker.
    Mr. MOORE. I understand.
    Senator GRAMM. Number two, we spent a whole lot more money.
    Mr. MOORE. My point is, when you project something, you hope it happens, but it will not necessarily happen. Isn't that correct?
    Senator GRAMM. It is like an old woman once gave advice that when you are borrowing money, and you want a good analogy, write down on a handkerchief in indelible ink what you have to pay back, and then write down in fruit dye on the other part of it, where your revenues are coming from, and then wash it and see what is guaranteed.
    Mr. MOORE. Fair enough.
    Senator GRAMM. When you are predicting the future, you do not know.
    Mr. MOORE. Exactly right. My point is, we were in surplus mode, and I am not blaming anybody for this. I am not blaming the President or the other party for this. I am just saying we were in surplus mode; now we are not. That is correct, isn't it?
    Senator GRAMM. There is no question about it.
    Mr. MOORE. And the President—and I am not blaming anybody for this; I am not making any political commentary on this—I am just saying we are or appear to be on the advent of a war right now, some sort of military action.
    Senator GRAMM. The only thing I would say on that is——
    Mr. MOORE. I have not asked the question yet. I am just asking. Thank you. With all respect, I do get to ask the questions here.
    We appear to be ready for a military adventure of some sort, and we do not know what it is going to cost. I do not think you know, and I am not going to try to pin you down on that, because you cannot know, I do not think, or anybody. The President has even said we cannot really project what that is going to cost. Would you agree with that, in fairness?
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    Senator GRAMM. I do not think anybody knows what it is going to cost, but in 1991 it did not have any significant impact on the economy.
    Mr. MOORE. Of course, this is 10 years later, and we still do not know what it is going to cost.
    Senator GRAMM. Well, the economy is twice as big as it was 10 years ago.
    Mr. MOORE. Right. We are in deficit mode. The President is proposing tax cuts, and I support some tax cuts, although I have some concerns about the size of the President's proposal. And we are, under the President's budget, at least $320-plus billion still in deficit, in his budget proposal. Isn't that correct?
    Senator GRAMM. I do not think that—$320 billion sounds high to me, but it is too big to suit me.
    Mr. MOORE. Okay. It is too big to suit me, too. I think we agree on that.
    And I do not disagree either with your characterization of the taxation of dividends, in concept at least, because I do have this—I am from Kansas, sir, and I called the state department of revenue in Kansas when the President first proposed this dividend elimination. I talked to analyst there, and I said, do you have any idea what kind of impact this might have on collection of revenues in Kansas if this passed? He said, as a matter of fact, we just did an analysis of that and it is going to cost the state of Kansas $51 million. Well, Kansas is a relatively small state compared to Texas or California or others, and $51 million does not sound like a bunch of money. But when you are in a $750 million revenue shortfall, it is a lot of money to our new governor and to our legislature.
    I submit that it is going to cost some other states a lot more money percentage-wise than it is Kansas in terms of this $51 million. Is that a concern or should it be a concern?
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    Senator GRAMM. Well, we have to believe that the elimination of dual taxation on dividends is going to create investment in America. Some of that will be in Kansas. How large it will be relative to the lost revenue I think is something you could speculate on. But let me make it clear that if we have this deficit and we did not have the current economic downturn that we are in, I would not be in favor of moving up these tax rate reductions. I think in that circumstance, we should be debating eliminating this inefficiency in the tax code and paying for it by either controlling or cutting spending, or by offsetting it somewhere else. I think the only reason it makes sense as a package is that we are in a downturn that is costing us five times as much as the revenues that we are talking about in terms of the economic growth package. That is the only reason it makes sense to me as a whole right now.
    Mr. MOORE. Thank you, Senator.
    Chairwoman KELLY. Thank you.
    We go to Mr. Hensarling.
    Mr. HENSARLING. Thank you, Madam Chair.
    Senator Gramm, in your testimony I believe you said that the aggregate value of the President's proposed tax relief is less than 2.4 percent of the projected current services federal spending. There obviously continues to be great concern about deficits. In my own earlier math dealing only with fiscal year 2004, I came up with less than 5 percent. Can you tell us how you calculated the 2.4 percent?
    Senator GRAMM. I took current services spending over the next decade. I took the value of the tax cut over the decade and divided. It is a little more front-end loaded because you are moving the rates forward to January 1, so in the first year it is more. In other years it is lower, but the average is 2.4 percent. I also would note that the deficit that comes from the increases in spending that the President has proposed is bigger than the deficit that comes from the tax cut the President has proposed, and yet many people who say the tax cut is too big say spending is too small. Yet if that is the case, how can the basis of concern be the deficit?
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    Mr. HENSARLING. I assume the 2.4 percent is based on static scoring?
    Senator GRAMM. That is based on static scoring; how much it costs if no behavior changes; and of course it is based on how much government costs if no behavior changes, but we are in the midst this year of increasing government spending.
    Mr. HENSARLING. I appreciate the fact that you are no longer in the politics business, but I do appreciate the fact also that you are still in the policy business. So let me put it this way, there appears to be at least one alternative economic growth package and it talks about targeting tax relief. Wearing any of your three hats, have you perhaps looked at the alternative economic plan or do you have an opinion about targeted tax relief?
    Senator GRAMM. I think people are getting confused between a stimulus package and just trying to give money away. What we are trying to do here is to get people to invest. A lot of people have trouble accepting that if America is going to be saved, it is going to be saved at a profit; that if you want people to invest their money, you have got to provide them with incentives to do it. The strength of the President's proposal is not in its aggregate value, as I said during my testimony. If you took the amount of money the President is talking about and simply threw it out of airplanes over the major cities of this country, you would have a very modest impact.
    The reason that I believe the two major parts of it will have a significant impact, and that is elimination of the dual taxation on dividends and accelerating these marginal tax rates, especially the highest rate, which is the small business rate—is that you are going to induce people that have got lots of money, that are not now investing it, to invest it. I think that is the hope we are talking about. I think it is a realistic hope. I do believe the stimulus package will help the economy and will stimulate investment if you pass it. Nobody knows by how much. So you know, there are uncertainties about it, but I think given the risk that we are facing, it is a risk you ought to take. At the same time, you ought to be very careful about the money you are spending.
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    Mr. HENSARLING. The same alternative growth package has tax relief in one year only it front-loads all the tax relief. Do you have an opinion on that impact on the economy and job creators?
    Senator GRAMM. It is bigger in the first year than the President's, but again it is not aimed at investment. It is aimed at stimulating consumption, which has never declined to begin with. So you might very well get people to spend the money you give them, but that is not what the effort is. The effort is to get people to spend money they already have that they are not spending. That is what a stimulus proposal is about. It seems to me, if you want to measure the impact of a stimulus proposal, it is how many dollars do you get people that they have to spend based on the number of dollars that you have that you spend.
    If the best argument you can make is, well, if we give it to them, they will spend all of it, why don't you just drop it out of airplanes? By focusing on investment, that is where the problem is, and if we are going to get a substantial response, if we are going to put people to work, it has got to be in investment. Unfortunately, if you want to get into a debate about, well, equity and things of that nature—equity is growth. Equity is jobs. I think that is where people get confused. I think it is why we have such a hard time debating these subjects, but it is something I have watched for a quarter of a century, and it is not likely to be wished away.
    Mr. HENSARLING. Thank you, Senator.
    Thank you, Madam Chair.
    Chairwoman KELLY. Thank you.
    Mr. Crowley?
    Mr. CROWLEY. Thank you, Madam Chair.
    Senator Gramm, both sides recognize your great service to this country and we are very pleased to have you here before us this afternoon.
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    Senator GRAMM. Thank you very much.
    Mr. CROWLEY. I know that you have probably gone over a little bit of the time, Madam Chair, so I will try not to keep you much longer than necessary.
    Senator, you said on the second page of your statement—I was not here for your statement; I read through it afterwards—and I will just quote from the double taxation on dividends portion of your statement, the last paragraph and the last sentence, ''And finally, the elimination of dual taxation on dividends is both an effective stimulant and sound economic policy which will speed up the recovery and increase long-term growth.'' I am assuming the growth you are talking about is job development. Would that be correct?
    Senator GRAMM. When I am talking about economic growth, I am talking about job creation and real income of workers.
    Mr. CROWLEY. Let me just read a statement from the Wall Street Journal, in fact, which is not known to be a liberal newspaper. A quote from a January 17 article of this year, and I quote, the elimination of taxes on dividends will diminish the abilities of businesses to take tax incentives on capital investment in R&D, things that actually create jobs, and basically saying that, my interpretation of it, that this stimulus package will not, through the reduction of the double taxation of dividends, create new jobs. In fact, I was just handed an article from today's—I am sorry—the March 13 Wall Street Journal that says that four Senators, including two Senators from the Republican side, Senators Olympia Snowe and Senator George Voinovich of Ohio, will not support the President's tax cut proposal.
    Is the Wall Street Journal wrong? Are these Senators wrong as well?
    Senator GRAMM. Let me tell you what would be right. What they are saying is that if you lower tax rates that the R&D tax credit is not as valuable. Well, why don't you make tax rates 100 percent and then we could just grow the economy like ''hello?'' The problem is that then people would not have anything to invest. It takes a good idea to limit—I must be getting old using words like ''hello''—but it takes a good idea to sort of an absurd limit. I have supported the R&D tax credit. I support the deductibility of mortgage interest rates. I support the tax exempt nature of municipal bonds. But the idea that making people pay more taxes helps the economy by making those deductions more valuable, I think is taking a good idea and just extending it to where it is illogical.
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    I would say this, and I would ask you to look at it. In 1981, we cut the marginal rate from the top rate from over 70 percent down to the 50 percent range, and then ultimately we cut it in 1986 to 28 percent. I have never seen any evidence to substantiate that that had a negative effect on municipal financing or home ownership. The point is, there is an income and a substitution effect. When people had more money, it is true that the value of the deduction was less, but they had more money to spend and housing was something they wanted, and they spent more money on housing.
    So I think you can take a little point and stretch it to the limit, but I just do not see any economic foundation to any belief that elimination of the dual tax on dividends would do anything other than help the economy.
    Mr. CROWLEY. Let me just reclaim the time, and that is, I come from a city, New York, where we have lost almost 250,000 jobs—about half are related prior to 9-11. So this is not all 9-11-created; 500,000 jobs statewide. We have seen two million jobs lost throughout this country in the last over two years. I see very little in terms of immediate stimulation in this package—maybe long-term, but not immediate. It is not going to put people back to work.
    Let me just ask you this question, do you have—I know you are not in the political realm anymore—do you have any reservations or are you uncomfortable in any way at the timing of this tax proposal, given the fact that we are poised to be in war. There are 300,000 young men and women sacrificing their time away from family right now, many of whom will be asked to make the ultimate sacrifice in defense of this nation. Do you have any reservations or concern about the timing of the calling for this tax cut, that will affect in essence the wealthiest in this country?
    Senator GRAMM. Let me try to give you a totally honest reaction to that. First of all, it is not as if we ought to be raising their taxes because they are going to sacrifice for America. I mean——
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    Mr. CROWLEY. It is not their taxes I am talking about.
    Senator GRAMM. I understand that. Let me just make this point. In 1991 when we had the Gulf War, I do not see, other than bringing down oil prices, which was a rich bounty to the economy of the 1990s, I just did not see any real economic impact coming from the war. If we did not have this lingering downturn, I do not think you could make a case for part of this economic growth package right now. I think you could make a case on dual taxation on dividends, but I think the rest of it you could not take a case for. But the fact that we are getting ready to have a war probably this week does not change the fact that we have got some real economic risk out there.
    If you read the testimony, you know I made the point that this recession is different than the ones we had in the 20th century. We do not totally understand it. There are a lot of uncertainties about it. I am confident that the economy is going to get better. If I did not think so, I would not have gone to work for an investment bank. I would have gone to work for a law firm where you can make money on people's misery.
    But I think there is reason to be cautious about the economy, is all I am saying. I think that I would be for it, given the fears I hear from people in New York who are talking about investing money, the fears they have got about the economy, I would be a little forward-leaning knowing what I know now if I were in public office, in trying to sort of put on a little insurance in terms of this recovery. I think it is going to be fine. I think the recovery is going to occur no matter what we do. I think we can speed it up, but there is enough that is new and different about it that I would just urge in thinking about it. It is obvious in listening to you that you are thinking about it and that you are looking at a lot of different things.
    I think there is a reason to be cautious about this downturn because it is so different than any other one we had in the 20th century; that we just do not know how it is going to behave. That makes me a little bit nervous.
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    Chairwoman KELLY. Thank you.
    Mr. Murphy?
    Mr. MURPHY. Thank you, Senator. I wonder if you could just continue that thought—it makes you a little bit nervous, how?
    Senator GRAMM. Well, because, you know, we have had some speculative bubbles historically. We had the South Sea bubble. We had the tulip bubble. But they were in the 17th and 18th centuries. I do now know anything about them. If any economist has looked back at speculative bubbles and how they behave, I am not aware of it.
    So all I know is during my lifetime of awareness, the kinds of recessions we have had were things that I knew something about. They were inventory cycles. We could never predict them, but we knew how they behaved. If we were at this point in an inventory cycle, we would have a pretty great deal of certainty about what is going to happen.
    This is a different kind of downturn, subject to different kinds of behavior. While I would bet money that things are going to be all right, I still, if I were in your position, I would be cautious—the reason I would vote for the stimulus package, even if I had questions about dual taxation of dividends or even if I had questions about accelerating this tax cut, is because of the economic uncertainty. I think this economic growth package is a good plan overall in terms of economic effect. I think there is one other part of the President's package that is not part of this that is good, and that is that $15,000 IRA-type investment where you can invest up to $15,000 for a couple. You could put after-tax money in, but the buildup for college education, retirement, house, housing, buying your own home is tax-free. I think that is a good policy as well. But I just would be cautious given the uncertainties of this downturn we are in.
    Mr. MURPHY. Thank you. You made a statement in your opening statement I would like you to also elaborate on this, if you would. This has to do with the impact upon small businesses, which you portrayed as the basis of really so many jobs in our economy. You said the elimination of double taxation of dividends will help small businesses that are currently discouraged by tax policy from adopting a corporate structure, even if it would allow them greater access to capital.
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    Do you see that small businesses are willing to—this would give them that incentive to jump in and take some of those? Would it be more risk, less risk for them? I would like for you to comment.
    Senator GRAMM. Currently, if I am running a company and we are beginning to grow, up to a point, I have an incentive to stay away from the full-fledged corporate structure because of the double taxation on dividends, because I can be taxed as an individual with a proprietorship or partnership or subchapter S corporation. Once I start growing, then I begin to get into a conflict between the improved access to capital I can get through full incorporation versus the tax advantages I get by staying a subchapter S or by staying a partnership or proprietorship.
    All I am saying is that no rational society would let the tax code dictate the structure of the business firm. It would let the market do that. That is one of the reasons why the dual taxation on dividends is such bad policy.
    Mr. MURPHY. Thank you.
    I yield back the rest of my time.
    Chairwoman KELLY. Thank you.
    Mr. Garrett?
    Mr. GARRETT. Thank you, and professor in light of the splendid introduction that you received, my first question I guess is are there any grades currently being held back that have not been delivered as of this date?
    Senator GRAMM. Well, if Congressman Hensarling had had poor grades, I would think about going back and changing them. I do not know if after all these years that they would let me do it. In fact, I would say in all of my years as a college professor, I only changed one grade, and it ended up being for now a Democrat member of Congress. So they do not always work out.
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    [Laughter.]
    Mr. GARRETT. You made a statement in your introductory comments with regard to the history. I found that interesting as far as that we are in the speculative phase right now in the equity markets, and that may be part of the cause of where we find ourselves now, and how that differs from what over history it was like. Right now, I am reading a book about the history of going into the late 1920s into the Florida speculative housing boom, and how you had the ups and the downs and the little panicky phases at that time as well. So maybe we have had certain—and I am not as good on history as you are—but maybe we had certain little periods like this in the past that we could look to.
    Senator GRAMM. The Great Depression was a financial panic, and I do not think Alan Greenspan would disagree with this, that in part because of bad government policy, became a full-fledged depression. This is a different kind of downturn, this speculative bubble. I do not see any significant chance of it becoming worse in terms of becoming of depression proportions. It is just not recovering as quickly as we might recover that I think the whole debate is about.
    I do not think there is or should be any realistic debate about, is America going to recover; is investment in American equities the best investment you can make. I think the answer is yes. The question is, how quickly is it going to recover, and what could we do to speed it up. I think that is the debate.
    Mr. GARRETT. Okay. And in that, you continue with your opening remarks with regard to how in this period of time, you have seen the consumption remain strong. So for that reason, you do not want to necessarily go down the road of the consumption-driven alternatives. And yet, a lot of the—I will not use the word ''rhetoric''—but a lot of the language that we hear as far as proponents, and from the proponents of the tax measure is that the average family of this size will receive around $1,000 or $1,100 back, and that is one of the strong reasons why we should be supporting it. Obviously, that $1,000 or $1,100—and I am a supporter of this, I just wonder how we pin this down—that $1,100 is not, I do not think, the same classification where you are talking about the 85 percent language later on and it is really going to the investment side. That $1,100—that is really going to the consumer, the consumption side, correct?
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    Senator GRAMM. Well, there are two different debates here. The one debate is the so-called equity debate. It is always skewed by the fact that half of Americans pay very, very little taxes in income taxes. So it is so easy to stand up and say 50 percent of Americans will get 5 percent of the benefits. Well, 50 percent of Americans pay about 5 percent of the taxes. So all you are saying in saying that is the tax code is progressive, and not saying—but it confuses people.
    The real debate is what gets the economy growing so people are making more income so they can pay taxes with it? I think that that is where we get pulled off the track into this debate about the distribution of the tax cut. The truth is, this economic growth package will make the tax code more progressive than it is. But the reason you ought to vote for it is it gives us a good chance of making the economy bigger than it is going to be over the next three years, so everybody will benefit. I do not think we ought to worry about somebody profiting by investing. I do not understand loving capitalism and hating capitalists. I do not understand this preoccupation that somebody might somewhere benefit by doing something productive. If we do not let people benefit, they will not do it.
    Mr. GARRETT. I will just close, then, on this. I think that point you made just 30 seconds ago as far as the progressive nature of this tax cut is a message that I hear here, and I have heard with the Secretary of Commerce in the past, but it is a message that seems to be lost in the entire discussion and maybe goes back to that last point that you made before with regard to those who are attacking this plan never look at the spending side of the equation, and the fact that that is really a larger cause than the tax cut side of the equation.
    Thank you for your testimony.
    Senator GRAMM. Just always remember this when you are debating this issue, that 19 percent of Americans when they are polled believe they are in the top 1 percent of income and 40 percent believe they are in the top 5 percent of income. So when people are talking about the top 5 percent, 40 percent of Americans believe they are in the top 5 percent and they are voters. So I would never be afraid of this issue.
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    Finally, as sort of a solicitous comment, if this were a society where people somehow were set forever in some kind of class based on economics, maybe all this silly argument would make sense. But I do not know each of your backgrounds, but I know Congressman Hensarling's background and his father was a chicken-raiser. My dad was a sergeant in the United States Army. Congressman Hensarling is a member of the United States Congress and grew up scooping chicken manure out of coops. My dad was a sergeant in the Army. I am an investment banker and a former United States Senator. This class warfare stuff in America is an absolute farce and joke. It is hard for me to see how people can say it with a straight face.
    That is the end of my sermon.
    Chairwoman KELLY. Thank you very much.
    Mr. Sherman, have you any questions for this witness?
    Mr. SHERMAN. I do indeed.
    Senator, rest assured I love capitalists. My father was executive vice President of a New York Stock Exchange-listed company, but I am frankly embarrassed by this class warfare attack against working families. Only in a room like this could we refer to this exemption of dividends as a progressive tax cut, when I can remind the subcommittee that you take all the benefit for 95 percent of Americans—all those with incomes of under $140,000—and it just barely equals the benefit to the top 2 percent; no, correction—the top .02 percent.
    We had the chair of the full committee sit here and say that Alan Greenspan endorses this proposal—I was here. He said he endorsed this proposal if it was revenue-neutral. Senator, other than dynamic storing and other drug-induced fantasies, I would like someone to tell us how this is a revenue-neutral proposal.
    We have concluded or are about to conclude the second panel. We have yet to hear from a witness who opposes this program or would oppose any give-away to the wealthiest. That is why Peter Fisher sat there in the same seat the Senator is and said he had not heard of anyone who supports the present system for taxing dividend income. You know, he could have sat here until now—he may have said that twice—taxing it twice? Taxing it twice. Well, he has not obviously listened to any Democrats and he could have sat here and listened to both the first full two panels and he would not have heard anybody. But there are many advocates of the present system—myself included—but I guess according to Peter, he had not heard my opening statement, although he was sitting there, or I am among the people that do not exist.
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    This proposal went over on the markets like a thud. The President announced it; the markets did not go up. Why? Perhaps there is an understanding that this is going to hurt the economy, or perhaps just an understanding that it is going to hurt the economy, then it is going to hurt the Republican Party, then it is going to get repealed so you cannot count on it as a long-term fixture of American tax policy.
    The Senator pointed out to us that 40 percent of Americans think they are in the top 5 percent, which means the success of this proposal politically is based on Americans being off by a factor of seven. That may not last. You may invest in stocks today assuming that a political party that believes that this is a progressive tax proposal will remain in power. It is just possible that Americans will not continue to be ignorant of the fact that seven out of eight Americans who think they are in the top 5 percent are not.
    Now, if you can bet on continued ignorance of economic facts by the American people, then you can bet on this continuing to retain its level of popularity. But what I want to point out here is the interesting shell game. When you can lower taxes on the ultra-wealthy by saying that we need to favor investment over consumption, then you trot out that argument and justify a low rate on capital gain income, which spends just like regular income, except it spends more because it is not subject to the same tax.
    But when you want to lower taxes on the wealthy and give 70 percent of the benefit to the top 5 percent, then you are neutral as to whether the money remains locked in the corporation available exclusively for business investment, or whether it gets distributed to those who may decide not to reinvest in other stocks, not to re-deploy the money into other investments, but buy that new $350,000 Mercedes. As a matter of fact, I do not think it is a mere coincidence that Mercedes comes out with a $350,000 car and then there is pressure to exempt dividends from taxation. If only Mercedes limited their cars to $100,000, it would place less political pressure on this House to come up with ways to make sure that the top one-tenth of 1 percent can afford the latest imported toy.
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    Chairwoman KELLY. Mr. Sherman, if you have a question, would you ask it please, because your time is up.
    Mr. SHERMAN. My time is up. The flaws of this proposal cannot be summarized in a mere five minutes.
    Thank you. I yield back. If the Senator wants to respond, he can——
    Chairwoman KELLY. Senator Gramm, if you would like to respond, please feel free to do that.
    Senator GRAMM. We had a debate about luxury taxes and taxed yachts. I would have to say that I do not know how the Senator from Maine, the Democrat majority leader at the time voted on the yacht tax, but he discovered something. That is, people build those yachts and they make a good living at it. We came back and repealed the yacht tax. Now, I do not ever intend to own a yacht. I do not intend to own a Mercedes. But I just would say this, that the Joint Committee on Taxation and everybody with any degree of knowledge that has looked at the President's proposal concludes that it makes the system more progressive. I can tell you why.
    Accelerating the marriage penalty, accelerating the child exemption—those are costly benefits that go directly——
    Mr. SHERMAN. Senator, if I can just interrupt—all the benefits that go to working families out of this bill are temporary. They take something that would have happened two years from now and for two years the law is made more progressive. The dividend cut and the estate tax repeal are permanent, so the benefits that go to the wealthiest 1 percent continue to be true next decade, the decade after, the decade after that.
    Senator GRAMM. The President's proposal is to make all the provisions permanent.
    Mr. SHERMAN. But some are going to be permanent anyway because that is existing law.
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    Senator GRAMM. Anyway, Madam Chairman, thank you very much for giving me the opportunity.
    Mr. SHERMAN. Thank you, Madam Chair.
    Chairwoman KELLY. Thank you very much, Senator. We are very pleased to have had you here on your maiden flight testifying before this committee here on the House side. I want to note that some of the members may have additional questions for you that they may wish to submit in writing. So without objection, this hearing will be held open for the next 30 days for members to submit those written questions.
    Senator, we once again thank you so much for your appearance here today. This panel is now excused.
    I want to introduce the third panel as they are seated. First, we will welcome our former colleague in the House on the Banking Committee, the Honorable Rick Lazio, a proud New Yorker and now the President and CEO of the Financial Services Forum; John Castellani, President of the Business Roundtable; Peter Orszag, Joseph A. Peckman Senior Fellow in Economic Studies at the Brookings Institution; Stephen Moore, Senior Fellow in economics at the CATO Institute and President of the Club for Growth; William Spriggs, Executive Director of the National Urban League Institute for Opportunity and Equality; and finally, Bobby Rayburn, First Vice President of the National Association of Home Builders.
    I want to thank you gentlemen for testifying before us today and I welcome you on behalf of the full committee. Mr. Lazio, it certainly is a pleasure to have you back with the committee again. Without objection, your written statements for all of you will be made part of the record. You will have five minutes for your oral testimony, and we will begin with you, Mr. Lazio.

STATEMENT OF HON. RICK LAZIO, PRESIDENT AND CEO, FINANCIAL SERVICES FORUM
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    Mr. LAZIO. Thank you, Madam Chair. It is wonderful to be back and to see you again, Madam Chair, and my other colleagues. I appreciate very much the opportunity to be here and to share this table with some distinguished speakers. I hope I can shed some light on our feelings on behalf of the Financial Services Forum on the proposal as it particularly relates to the exclusion of dividend income.
    The Financial Services Forum which I have the pleasure of being the chief executive officer of, is composed of the chief executive officers of some of the largest and most diversified financial institutions in the United States. The purpose of the forum is to promote policies and enhance savings and investment in the United States and that ensure an open, competitive and sound financial services marketplace that contributes to the long-term growth of the American economy.
    We believe that ending the double taxation of dividends will benefit investors, strengthen the capital markets, and improve our prospects for long-term growth. The measure will stimulate the economy in the short term. However, we strongly believe that longer-term positive consequences are most important.
    The most obvious benefit to ending the double taxation of dividends, which has been referred to earlier, is the promotion of a steady dividend payment to investors. Within normal ranges of share prices and business performances, individual investors receive cash in hand with reasonable certainty, and immediate ongoing return on shareholding. This flow of funds enhances the lives of American families, retirees and other individuals in our society. Currently, many shareholders receive the benefit of stock ownership only when they sell their stock. Clearly, it is desirable to increase investor benefits in a manner that does not require stock sales to achieve. Ending the double taxation on dividends also gives the average investor a simple basis on which to evaluate equities—the value of the dividend.
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    Double taxation of dividends results in the inefficient allocation of our nation's resources. Companies are penalized for returning funds to shareholders. Under current law, businesses are incented to reinvest earnings, which often could be put to better use elsewhere. Eliminating these perverse incentives leads to a more efficient capital market and a far more productive economy. Further, this measure would make American firms more competitive in the international arena by lowering overall the cost of capital.
    It has been clear for some time, Madam Chair, that double taxation has created a bias in favor of debt, as opposed to equity capital because of the deductibility of interest payments. We have seen over and over again that excessive levels of debt become problematic during an economic downturn. Firms with too much leverage do not have sufficient flexibility to cope with adverse market conditions, to the detriment of their shareholders. Eliminating the double taxation of dividends removes the bias toward corporate debt, encouraging more equity in capital structures, which allows firms to weather adversity and protect investors in difficult times.
    Double taxation encourages corporations to engage in share repurchases because current law permits the distribution of earnings in this manner at lower capital gains rates. Investors, however, do not realize the cash benefit of the share repurchase until they sell their stock. Eliminating the double taxation of dividends makes it more likely that shareholders will receive higher dividends and realize corporate gains without having to sell their stock.
    Because the tax code discourages payment of dividends, publicly traded companies often are focused on goals that can become problematic. Under present circumstances, shareholder value tends to be equated with an appreciation of stock price by many firms. Regrettably, we have also observed too many companies resorting to accounting manipulation to inflate earnings and stimulate stock price appreciation. Correcting this bias against dividends will cause both firms and their investors to emphasize cash flow and cash dividends as true and more appropriate measures of true value.
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    In summary, Madam Chair, removing the double taxation of dividends results in significant benefits to individual Americans and American families. The measure will restore balance to the manner in which publicly traded firms are managed by removing incentives to issue excess debt, repurchase shares, invest retained earnings in sub-optimal investments, and designing unproductive strategies just to avoid taxes and inflate earnings.
    We believe that eliminating the double taxation of dividends will cause firms to focus on creating true value for shareholders and other stakeholders. Share prices of dividend-paying stocks tend to be less volatile, and thus are a stabilizing force in the capital markets and that certainly has been the case over the last few years, and that is empirically provable. Eliminating the dividend tax will contribute in a major way to restoring and increasing confidence in our markets and contribute to long-term productive growth in the economy.
    Finally, this proposed change would correct the fundamental lack of fairness in the tax code by ending the bias against equity capital and dividends, and increasing the competitiveness of United States firms.
    Thank you, Madam Chair.

    [The prepared statement of Hon. Rick Lazio can be found on page XX in the appendix.]

    Chairwoman KELLY. Thank you, Mr. Lazio.
    Mr. Castellani?

STATEMENT OF JOHN J. CASTELLANI, PRESIDENT, THE BUSINESS ROUNDTABLE

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    Mr. CASTELLANI. Thank you, Madam Chair.
    I am pleased to be here this afternoon on behalf of the chief executive officers who make up the Business Roundtable. The Business Roundtable is an association of CEOs of major corporations that have a combined workforce of 10 million employees in the United States and $3.7 trillion of annual revenues. Although we are in the business of creating jobs and contributing to economic growth, we have serious concerns about our ability to do so in these times with a fragile economic environment.
    The chief executive officers of the Business Roundtable feel that the U.S. economy is not growing to its potential. Consumer demand and consumer confidence are shaky. The confluence of our nation's war on terrorism, the potential war with Iraq, and the decline in stock prices have resulted in diminished assets and savings and have led to consumer retrenchment. Our CEOs feel that business investment will only return when there is sufficient consumer demand to exhaust the existing capacity in the U.S. economy. Only by increasing demand will we return to a level that supports investment and more importantly supports job growth.
    We feel we need to ignite consumer confidence and stimulate consumer spending, and that is why we are urging the enactment of President Bush's economic growth and jobs package as reflected in H.R. 2. If enacted, we believe that it will significantly stimulate the economy in the short term, as well as boost long-term economic growth. PricewaterhouseCoopers recently conducted a study for us using a widely supported macroeconomic model that is housed at the University of Maryland. The study showed that if H.R. 2 was enacted this year by July 1, it would create an average of 1.8 million jobs in each of the next two years and an average of 1.2 million jobs per year in the next five years. It would boost gross domestic product in the U.S. economy by 2.4 percent by the end of 2004.
    The plan would boost incomes and jobs and help all sectors of the economy, including housing and capital markets. Working consumers will have more money to spend and more confidence to spend it on goods and services. By accelerating the 2001-enacted rate cuts, the marriage penalty reduction and the child tax credit increase and by eliminating the double taxation of dividends, the proposal will not only provide immediate boost to the U.S. economy, it will also add millions of jobs and again increase confidence and economic growth.
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    As importantly, the single element of eliminating the double taxation of dividends will have the most positive impact on long-term economic growth. That provision alone will create by the model's projections 500,000 jobs per year for the next five years. It will also have an additional number of important and multiplying effects. First, it will spur consumer spending by increasing the after-tax income of stock investors. Shareholders will benefit because they will no longer bear the unfair burden of paying taxes twice on the same income, and they will benefit again when companies boost their dividend payments. By our estimates, we would expect a 4 percentage point increase in dividend payout ratios over the next 10 years.
    Second, eliminating the double taxation of dividends will improve corporate governance in a number of ways. Companies will have less incentive to engage in structured financing transactions that have little or nor business purpose. We can expect better transparency in the reporting of corporate earnings because investors will reward companies that pay tax-free dividends. And companies will be less likely to take on excessive debt and risk bankruptcy in pursuit of lower taxes.
    Third, while it is difficult to predict stock market reaction, even the most conservative analysts predict increases in stock prices. All three combined will not only benefit the broad spectrum of the economy that receives dividends, particularly those people who depend on them in their retirement, but it will also benefit all of those funds which are invested in equities, including 401(k)s, IRAs, and public and private pension funds.
    The positive effect on stock prices that would arise from the elimination of the double taxation of dividends would, for example, translate into a potential increase of $4,200 per 401(k) participant and $110 billion in the aggregate of all 401(k) plans. On the defined benefit side, millions of Americans would see substantial improvement in their retirement security and companies would have additional operating capacity to invest, resulting in more profits and increased stock prices.
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    The Roundtable urges the Congress to move quickly to enact an economic growth plan that will give both an immediate boost to the economy and put people back to work. The President's plan is the best means for creating jobs, encouraging business investment, strengthening the capital markets, enhancing corporate governance and igniting economic growth. It is the right prescription for an ailing economy.
    Thank you.

    [The prepared statement of John J. Castellani can be found on page XX in the appendix.]

    Chairwoman KELLY. Thank you, Mr. Castellani.
    Mr. Orszag?

STATEMENT OF PETER ORSZAG, JOSEPH A. PECHMAN SENIOR FELLOW IN ECONOMIC STUDIES, THE BROOKINGS INSTITUTION

    Mr. ORSZAG. Thank you, Madam Chairwoman.
    I would like to make five points in my five minutes, so if I stick to one point per minute, I should be fine.
    The first point is that the administration's tax proposals will exacerbate the long-term budget outlook. We have heard a lot about the effect of the proposals on the deficit, but let's just look at CBO's numbers in 2013. This is after any temporary downturn would presumably be over, when the economy is at full employment, and as Senator Gramm said, in that kind of setting he would be reconsidering the forms of various tax provisions. At that point, the tax cut that the administration is proposing would amount to 1.8 percent of GDP, and the cost would increase thereafter because many of the provisions are so back-loaded that their full cost is not apparent even in 2013.
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    If you look out over the next 75 years, the tax cuts the administration is proposing would amount to 2.3 percent to 2.7 percent of GDP. That may sound abstract, but just to put that in context, the Social Security deficit over the next 75 percent is 0.7 percent of GDP, so these tax cuts are more than three times as large as the entire Social Security deficit over the next 75 years.
    The Medicare part A deficit is 1.1 percent of GDP, so even if you add Social Security and Medicare part A, that is 1.8 percent, that is still smaller than the size of these tax cuts. So these are large.
    The Committee for Economic Development, a leading business organization, has put it in common sense terms. The first step in climbing out of a hole is to stop digging. We already face very large long-term deficits because of the retirement of the baby boomers. We do not need to make them worse. Second, on the economic effects, the long-term economic effects of the proposal, it is very important to remember that these are not revenue-neutral proposals. If it were a revenue-neutral proposal it would be a very different ballgame. Because it is not revenue-neutral and because it does expand the budget deficit, there is a positive effect from the improved allocation of capital across sectors, but a negative effect because of the increased budget deficit which reduces national savings, which is the flow of financing for investment. You have to weigh the two effects against each other. You cannot just look at the positive effect.
    An organization that did that, Macroeconomic Advisers, whose model by the way is the one that is used by the Council of Economic Advisers to produce its own numbers—in other words, it is the model used by the administration—has found that the negative effects from reduced national savings because of those larger budget deficits will outweigh any positive effects from the improved allocation of capital across sectors, so the long-term impact from the proposal is negative.
    I understand that the Business Roundtable model shows somewhat different results than Macroeconomic Advisers. In my opinion, although the details are a bit sketchy in terms of exactly what that model is or how it was applied, I think it was mis-applied for this purpose, and I would be happy to answer questions about that.
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    The third point is on the distributional effects. We have heard a lot about the average tax cut. I think it is very important to remember that averages can be quite misleading. The average of my one-year-old son and Senator Gramm is a 30-year-old who is about four-feet tall. That is not particularly insightful. Instead, you have to look at the distribution of people. When you do that, you see that half of tax filers would get a tax cut of $100 or less; two-thirds of tax filers would get a tax cut of $500 or less; and 78 percent of tax filers would get a tax cut of $1,000 or less.
    Similarly for the elderly, and here I think it is very important. We cannot just look at the number of elderly who benefit, because if an elderly couple had a penny in stocks and received a penny in dividends, they would be counted as receiving dividends. You have to look at the amounts that are involved. When you do that, what you see is that two-thirds of the elderly would get $500 or less from the administration's growth package, and for the dividend proposal alone, the two-thirds of the elderly who have incomes below $50,000 in income would receive just 4 percent of the total tax cut. It is only when you throw in the elderly who have very high incomes that you start to get those numbers up.
    Fourth point, small businesses—58 percent of tax returns with small business income are in the 15 percent or lower tax bracket. Senator Gramm talked a lot about the top tax bracket. Only 2.3 percent of small business tax returns are in the top tax bracket. So most small businesses are not facing that 38.6 percent rate. Furthermore, more than half of those 2.3 percent have a very small share of their income coming from small business income. They are not really small businesses in any meaningful sense.
    Finally, on corporate tax reform, I think it is very important to realize again this proposal is not revenue-neutral. What that means is that as Chairman Greenspan has emphasized, if you did it as a revenue-neutral proposal, there is just that unambiguous positive effect, rather than the positive effect and the negative effect from the expanded budget deficits. From a political economy perspective, you are basically giving away the candy with this proposal. If you think that corporate tax reform is going to involve both spinach and dessert—the spinach of closing down corporate tax loopholes and the dessert of giving away some tax preferences, you want to combine them in a single package to make the package as a whole politically viable.
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    What this proposal does is gives away the dessert without forcing corporations or the tax code as a whole to eat the equivalent of the spinach. It thereby undermines any chance of getting real corporate tax reform.
    Thank you.

    [The prepared statement of Peter Orszag can be found on page XX in the appendix.]

    Chairwoman KELLY. Thank you.
    Mr. Moore?

STATEMENT OF STEPHEN MOORE, PRESIDENT, CLUB FOR GROWTH

    Mr. MOORE. Thank you.
    I support the President's tax plan. I wish it were bigger, but I think it is a good tax plan. I would like it to include a capital gains cut, although there is a capital gains reduction, in that we should cut the capital gains rate to 15 percent. Every time we have cut the capital gains tax for the last 40 years, we have gotten more revenues, not less.
    We also ought to do what Senator Gramm talked about and President Bush is talking about, which is the expansion of the IRAs. That would have a dramatic impact on increasing the investment and savings rate in this country. I thought I would just spend a couple of minutes just talking about some of the points that were made in earlier testimony and some of the questions, and try to clear up some of the points.
    First was the effect on the budget deficit. I hope that the Congress will focus on the most important deficit that we have right now, which is not the budget deficit, it is the growth deficit. The budget deficit that we are facing right now is a ramification of the growth deficit that we face. We have gone from 3 to 4 percent real economic growth rate in the late 1990s to closer to 1 to 2 percent right now. That accounts mostly for the increase in the budget deficit that we have seen. So the Bush tax cut, if it increases growth, which I think it will, can have a very dramatic impact on reducing the growth deficit, and thereby the budget deficit.
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    Just to punctuate that point, if we could grow the economy just by 1 percentage point faster than is currently projected, that will erase about $1.5 trillion of deficits over the next 10 years. So increasing growth can have a very substantial impact on the deficit.
    Second of all, it was brought up several times about the impact of this tax cut on States and localities. I must say I am absolutely baffled about how anyone can make the argument that cutting taxes by $750 billion over the next 10 years could possibly hurt State and city governments. We are talking about taking money out of Washington and putting into the pocketbooks of state and local taxpayers, where it never comes to Washington in the first place. That can only have a very salutary and healthy effect on states and localities. Of course, the best example of that is when we did the Reagan tax cut, which was about three times larger than this tax cut. It led to the most prosperous period in state and local finance in history. Senator Gramm touched on that as well.
    A third point that was made was that now is not the time—that we are on the eve of war and that a time of war, should we really be cutting taxes. I would say again the best example of how a tax cut can actually help us win this war is what happened in the early 1980s with the Reagan tax cut, where basically President Reagan said we are going to do two things. We are going to have a massive increase in defense buildup to win the Cold War, and we are going to cut taxes. I think the evidence is now very clear that the tax cuts helped generate the economic growth that led to the victory in the Cold War. In fact, the Soviets now say that the reason that we won the Cold War was because of the superiority of our economy, and not just our military.
    Fourth and final point is about the revenue loss. I think this is such an important point to make because everybody is throwing around all these numbers about what the tax cut is going to cost. I would just urge you all to think about the fact that every time we have cut taxes over the last 40 years, we have always—always, 100 percent of the time—we have always overestimated how much revenues we are going to lose from the tax cut, in every single case. That was true when Kennedy cut taxes in the 1960s. It was true in the 1980s when Reagan cut taxes.
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    The starkest example and the most recent example was what happened in 1997 when we cut the capital gains tax. If you look at the official revenue estimates that came out of this institution, the Joint Tax Committee, they estimated, Madam Chairwoman, that we were going to lose $50 billion over the next five years if we cut the capital gains tax. In fact what happened is we gained $100 billion in revenue. So oftentimes when we look at these static-based revenue estimates, they tend to be very wrong. We ought to move towards a more dynamic estimation model that takes into effect the economic growth consequences of tax cuts. So I would urge you to pass the Bush tax cut, grow it, and do it as fast as possible.

    [The prepared statement of Stephen Moore can be found on page XX in the appendix.]

    Chairwoman KELLY. Thank you, Mr. Moore.
    Dr. Spriggs?

STATEMENT OF WILLIAM E. SPRIGGS, EXECUTIVE DIRECTOR, NATIONAL URBAN LEAGUE INSTITUTE FOR OPPORTUNITY AND EQUALITY

    Mr. SPRIGGS. I am going to try and behave, Madam Chairwoman, because Steve just finished in under five minutes, so I am going to try and do the same thing.
    Chairwoman KELLY. I appreciate that.
    Mr. SPRIGGS. I want to thank you for allowing me to testify. I do appreciate that this panel does have a diversity of views, and thank you very much for the diversity reflected here.
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    I represent the National Urban League, which is the nation's oldest and largest community-based organization dedicated to moving African Americans into the economic and social mainstream. We are very happy that the President and the Congress recognize that the economy is in a slump. However, we are very concerned about the consequences of some of these proposed fiscal policy changes and their unintended consequences as well.
    The President has proposed excluding dividend income from the taxes of individual taxpayers. Now, as currently constructed, the proposal would allow for the tax redistribution of corporate earnings on which the corporation has paid taxes. This, then, sets up actually our dichotomy, because there is going to be a different interest in terms of those who are institutional investors for whom the tax does not mean anything anyway, and the corporate directors and officers, who will be making the decision, for whom the tax does mean something. So we will have a difference between the motivation of officers and directors, between do they maximize shareholder after-tax income, or do they maximize the corporation's after-tax income? Those two lead to, I think, not ending the type of uneasiness that investors have as to what our corporate leaders' motivations, since there would still be this conflict in what is to be done.
    Now, one of those key areas in which there are differences between what the corporation has in terms of tax liability results from acts of Congress to help encourage certain types of investment by corporations which benefit low-income communities in part, and the Secretary of Treasury talked about other loopholes for corporations as well, but I think that some of these are very well thought out items. They include such things as the low-income housing tax credit, the tax credit for the rehabilitation of historic structures, and the empowerment zone tax incentive, the renewal community tax incentives, the new market tax credits, tax credits for employee-provided child care, tax credits for holders of qualified zone academy bonds—all of these things help low-income neighborhoods.
    I think that it is misleading, as we have heard before, to argue that the relative marginal tax difference for shareholders leads to corporations making decisions about whether they will use equity financing or whether they will use debt finance, then to argue that the change in the relative tax rates has nothing to do with whether businesses would decide to take advantage of these tax credits. Either the relative marginal tax rates matter and do something, or they do not matter.
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    Now, if we live in a world where we are going to be consistent and we are going to say that these marginal tax rates do matter, then there will be negative impacts on these programs. Does that mean that they are going to be eviscerated? No, but it means that their costs will be increased. I think it does mean that we have to think about what are the collateral costs of ending the dividend tax.
    The low-income housing tax credit I am going to mention a little bit more because of its size. That is $15.1 billion over the next four years in terms of tax expenditures. So by comparison to the other ones, this is huge. Then also if you look at it relative to where does the money come from for low-income housing tax credits, almost all of the money comes from corporations taking advantage of this tax credit. Then you look at what does it mean for the low-income housing tax market—the development of units—and it has a huge impact. Most of the growth has been attributable to that tax credit.
    Now, there has been much said about no one would ideologically be opposed to double taxation. Corporations are legal entities unto themselves. The assurance that an investor has is that the corporate officers ought to look after the health of that individual, that corporation. The income from a corporation therefore is not like the income from a partnership. The liability implications are very different between a partnership and a sole proprietorship. So this is not double taxation.
    In any event, even if one bought the idea that there was double taxation, there is no reason to buy into the idea that what we should do is end the tax on the individual as opposed to treating the dividend as an expenditure in the same way that we treat wages. So I do not think that ideologically the argument is there.
    Finally, as to cost, I think we raise the issue of cost because over the projected life of this budget, the 10-year period, this is going to cost $388 billion. That is more money than we are going to spend on the U.S. Department of Education for at least four years. That is more money than we are going to spend on the Department of Labor and Small Business combined. So it is the issue of priorities. Where could that money best be spent? If we try to solve the problem for these many tax credits, which are important to low-income neighborhoods, and increase the cost of this, isn't there a more effective way of achieving some of these same ends?
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    So I would hope that you would think seriously about the size, the magnitude of this proposal, as well as its collateral cost.

    [The prepared statement of William E. Spriggs can be found on page XX in the appendix.]

    Chairwoman KELLY. Thank you, Dr. Spriggs. Although you did not make it to your goal on timing, I appreciate your testimony.
    Mr. Rayburn?

STATEMENT OF BOBBY RAYBURN, FIRST VICE PRESIDENT, NATIONAL ASSOCIATION OF HOMEBUILDERS

    Mr. RAYBURN. Thank you, Madam Chairwoman, for the opportunity to testify today on the impacts of the President's economic growth package. My name is Bobby Rayburn and I am a homebuilder and developer from Jackson, Mississippi. I am also the First Vice President of the National Association of Home Builders, which I am here today to represent.
    First, I want to say that NAHB supports President Bush and the Congress in their efforts to achieve an economic stimulus package that will provide near-term stimulus to consumer spending and capital investment, including more housing consumption and production. We were disappointed that the stimulus package did not contain a housing component, specifically the proposed homeownership tax credit. This proposal has bipartisan support in the Congress and has been part of the administration's budget for the previous three years.
    The primary focus of my testimony today is on the impact of the administration's proposal to eliminate the double taxation on corporate earnings on the low-income tax credit program. The distribution of a dividend from tax corporate earnings to a shareholder, who then pays tax on the dividend, is double taxation of the corporate earnings. One of the ways corporations reduce the impact of the double taxation and increase corporate earnings is to buy low-income housing tax credits. Unfortunately, the dividend exclusion proposal reduces the value of tax credits like the low-income tax credit. The value of tax credits is reduced compared to today's value of tax credits, because corporate earnings that are exempted from tax by the credit are taxable to the shareholder and will not increase the cost basis of the shareholder's stock when the corporation retains the earnings.
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    Affordable housing uses a variety of financing sources, including the low-income housing tax credit, home funds, Federal Home Loan Bank affordable housing program, and revenue bonds. These projects operate on very narrow margins. States try to serve the lowest income tenants possible and locate affordable properties in areas where development frequently is difficult, such as rural and inner-city areas. Even a modest change in the value of the credit and the resulting reduction in the amount of equity the credit can generate will have adverse consequences to the low-income housing program.
    Two studies have been published that analyze the impact of the administration's dividend proposal on the low-income housing tax credit program. The first study prepared by Ernst and Young predicted that there would be a reduction of 40,000 low-income housing tax credit units per year, which is a 35 percent reduction from the current level of 115,000 units. The Mortgage Bankers Association published a second study that predicted the dividend proposal would actually benefit the production of low-income housing tax credits and have virtually no negative effects at all. We are still reviewing this particular study.
    It is our view that the Ernst and Young study overstates the impact of the credit. The emphasis on units produced fails to reflect the full range of the impact on the dividend proposal on the operation of the low-income housing tax credit program. NAHB estimates that a more realistic decline in the value of the credit is from 10 to 15 percent, rather than 21 percent. We also believe that there will be significant revisions in state priorities for the low-income housing tax credit programs. Tenants at the upper end of the eligible income will be sought, and fewer properties will be built, particularly in hard to develop areas.
    There are several approaches that could be used to protect the credit. The first approach would be to exempt the low-income housing tax credit from the dividend proposal. This can be done within the structure of the administration's proposal by treating earnings corresponding to the low-income housing tax credit as taxed earnings. Other solutions would be to exempt all or part of the dividends received by the shareholders from the tax and by providing the corporation with a deduction for dividends paid.
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    The other approach to protecting the low-income housing tax credit would be to make up for any adverse impact on the program by expanding availability and the market for the credit. The first step in this approach would be to eliminate restrictions on the individual's passive loss reductions and to provide them with exemption from alternative minimum tax. Since the individual market for the credits is not as efficient as the corporate market, the amount of the credit that can be sold to raise equity, as well as the amount of the credits that can be dedicated to individual properties would need to be increased.
    Madam Chairwoman, that concludes my remarks. NAHB looks forward to continuing to work with you, the members of your committee, the Ways and Means Committee, and the Treasury Department to keep the low-income housing tax credit program operating at today's levels well into the future.
    Thank you.

    [The prepared statement of Bobby Rayburn can be found on page XX in the appendix.]

    Chairwoman KELLY. Thank you, Mr. Rayburn.
    Mr. Castellani, I have a question for you. You cited the Joint Committee on Taxation report for ending the double taxation of dividends. The Business Roundtable was among the first groups to encourage new measures for honest corporate governance last year. I wonder if you could quickly elaborate on the link between the double taxation of dividends and the use of the Enron-style accounting gimmicks that I spoke about in my opening statement.
    Mr. CASTELLANI. I would be delighted to. As you know, we have been, particularly with this committee's leadership, working on trying to restore the confidence of the American investor in our system of corporate governance. I think the Sarbanes-Oxley Act has gone a long way in doing so. Part of the issue, which has been alluded to and discussed by several of the folks who have been testifying here, has been what the impact of the double taxation of dividends has been on corporate behavior.
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    Since the tax code as it currently exists benefits debt financing over using equity to raise funds, stocks have not been valued as in the past, based upon their future dividends. When dividends are not paid, investors have to value stocks based on a corporation's earnings statement, which in the case of Enron could have been manipulated or can be manipulated to make a company appear to be more profitable on paper than it is in reality.
    In addition to removing this incentive to cook the books, which I guess, was the case with Enron, eliminating the double taxation of dividends will put more money in the hands of individuals because shareholders at all levels will demand that, and it will give an incentive to those companies that do pay dividends. So again, cash will be paid out; cash will become a premium; cash flow will become a premium; corporations that pay dividends will be rewarded, and the kind of paper manipulation that we saw in the Enron case will be further inhibited because shareholders will be looking for true cash flow.
    Chairwoman KELLY. Thank you.
    Mr. Lazio, I wonder if you would discuss how States like New York, Texas, Florida will benefit from this tax plan?
    Mr. LAZIO. I would be happy to, Madam Chair. As you know, because I know you spend a lot of time with the people of the New York City prudential marketplace getting to know how those markets work and understanding what the problems and concerns are in the banking and securities market and the insurance industry, this is going to have a very significant impact on the employment base in the New York metropolitan area and the tax base. In New York alone, it is estimated that just the dividend exclusion would return about $2 billion in the first year. I think Texas is about $1.6 or $1.7 billion. I can get that exact number—and Florida is about $1.4 billion. So very significant returns to those states just on this one element of dividend exclusion.
    It is not difficult to see why, for two reasons. First of all, it obviously has the immediate impact of providing higher after-tax income for those individuals that depend on dividend income. That is skewed to, frankly, older Americans who benefit disproportionately on this initiative. The second, longer-term, and in my opinion more important reason is that it does overall strengthen corporate management, that it provides superior financing for expansion, for acquisitions. That, in turn, leads to jobs, higher income and more tax revenue.
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    The real question, it seems to me, is between immediate consumption today and lowering taxes so that we can get higher growth numbers later. It is very difficult to see how we are going to create the kinds of jobs that Americans are calling for in the shorter, intermediate run unless we get on a higher growth path. We are not going to do that at 1.5 or 2 percent.
    Chairwoman KELLY. Thank you.
    Mr. Orszag and Mr. Moore, I have seen the two of you before, talking with each other about the various economic issues. I am going to fire this question to the two of you and let you answer it. I want to know what the record of the impacts on economic growth—now, you both presented two different views here—the impacts on economic growth and on federal revenues from the cuts in taxes on savings and investment, specifically the 1997 capital gains tax cut. By the way, Mr. Moore, I ran on my maiden flight for Congress was to zero the capital gains tax, so I am right there with you on that.
    I would like to know—the 1997 capital gains tax cut, the 1981 Reagan tax cut, and the Kennedy tax cut in the early 1960s. Mr. Orszag, let's go with you first.
    Mr. ORSZAG. Okay. You want to know what the impact was on the economy of those proposals?
    Chairwoman KELLY. Yes.
    Mr. ORSZAG. First, with regard to the 1997 capital gains reduction, I think it is very difficult to interpret the data, given that that was occurring in the midst of a stock market boom. Some may argue that the capital gains tax reductions is what caused the stock boom—which is what Mr. Moore will argue. But the stock market boom was occurring before that capital gains reduction, and if the capital gains tax reduction caused the boom, then it led to the bubble that everyone is complaining about now. So there is sort of an inconsistency there. But I think it is difficult to interpret because we were in the midst of such a strong stock market performance at the time, so there is a natural upswing in capital gains from year to year as the stock market continued to increase, which could outweigh the effect from a reduced rate.
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    With regard to the early 1980s tax cuts, there is an ongoing debate about what the effect was. A couple of things are relevant. First, it is important to realize that we reversed about a third of the tax cut in 1982. So in 1981 we cut taxes; in 1982 we came back with TEFRA and reversed about a third of the tax cut that remained in place because of concerns about the long-term deficit. That is in marked contrast to what appears to be occurring now, when circumstances have changed, but we are not trying to reverse course to take that into account.
    Secondly, there is a lot of movement between personal income and small business income that makes it difficult to interpret the data. Some people have looked at what happens to personal income returns following a reduction in personal income tax rates. What you see is a significant amount of shifting from income from small businesses onto personal tax returns, which does not necessarily correspond to any change in the underlying economy.
    The bottom line is I think it is a very difficult question. I think people who give an unambiguous answer that is either unambiguously positive or unambiguously negative are probably oversimplifying the situation. There is an ongoing academic debate about it.
    Chairwoman KELLY. Thank you.
    Mr. Moore?
    Mr. MOORE. We have a much better tax system today than we did 20 years ago. I do not think there is any question about that. When I first arrived in this town, we had a 70 percent top marginal tax rate; you could get tax deductions for investing in windmills and bull sperm and all sorts of things. I think the two Acts that we did in the 1980s were very positive—the 1981 Act which cut the top rate from 70 to 50 percent, and all the rates, by the way, and indexed for inflation.
    And then, I am a big believer in what we did in 1986. I know there is some disagreement about that, but we brought the top rate down from 50 to 28 percent. The reason I mention that is that I do not think there is any question that nobody wants to go back to 70 percent rates. In fact, when you cut the rate from 70 to 50 percent, you are going to have an extremely strong supply side effect. You are not going to get the same kind of supply side growth effect when you got from 39 to 35 percent that we did when we went from—well, when Kennedy went from 91 to 70 percent, and then Reagan went from 70 to 50 percent. So we should not oversell the supply side effects from cutting these rates by a few percentage points.
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    I guess my advice to you, Madam Chairwoman, is we ought to move toward the promised land in tax policy, and that is a flat tax type of regime where you have a single rate, where you are taxing consumption, you are taxing income only once, but once, with as little leakage as possible. The thing that I like about the President's approach to tax policy is if you look at what he has done over the last two or three years on tax policy, he has basically said we are going to get rid of the death tax, which is a double tax on savings; we are going to get rid of the dividend tax, which is a double tax on savings; we are going to expand IRAs; we are going to cut the rates. And all those things, I am in favor of.
    I probably would be in favor of some of the things that Peter is in favor of in terms of broadening the base at the same time, but I think the dividend tax cut is probably the jewel of this package. If we took out the dividend tax cut, I probably would not be very enthusiastic about the rest.
    Mr. ORSZAG. We did agree on something.
    [Laughter.]
    Chairwoman KELLY. Thank you.
    Dr. Spriggs, do you agree with the Home Builders' assessment of the flaws in the Ernst and Young study? Have you reviewed the MBA study, and if so, I would like to know what your judgment is on that.
    Mr. SPRIGGS. I have not reviewed the MBA study. I have reviewed the Ernst and Young study. I am not sure that they have, in fact, overstated, because again part of this has to do with how the gap financing takes place for low-income housing. Low-income housing tax credit picks up a portion of it, and then what happens is the local government steps in with a bond. Those bonds are going to cost more money. I think unambiguously the dividend break means that those bonds are going to have to cost more money. Given the current situation of where states are right now, it is unlikely that they will make it up in some other way. So I am not sure if you look at the totality of the issue that Ernst and Young have overstated what the likely impact would be.
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    Part of this has to do with the growth pattern we see in the willingness of corporations to pay for the credit keeps going up. Part of that was reflected in making the credit permanent. So corporations could lock this into their tax strategy. This changes their tax strategy. We saw when it had to be annually reauthorized that corporations were not as willing to pay as much.
    So I think there are a number of issues within the Ernst and Young that actually make them understated, which I think will probably wash out with whatever the Home Builders think is overstating it.
    Mr. LAZIO. Madam Chair, could I give some feedback on that as well?
    Chairwoman KELLY. By all means.
    Mr. LAZIO. As you know, I was very active in housing issues and the tax credit in particular during my years in the House. Just a few observations—first of all, the thought that somehow the yields or municipal bonds would have to necessarily increase because an equity would be more attractive to an investor because of its tax free flow-through, I think probably overstates the case. Right now, you have, for example, taxable and non-taxable bonds. The spread is very small between taxable and non-taxable bonds. The reason why people invest in municipal instruments is for preservation of capital; for security for a long-term investment, in that sense. And there is a trade-off involved in that. So I just do not see that the same investor that invests in a municipal security or bond is going to be attracted to a more volatile equity simply because of the tax treatment of dividends.
    The second thing is, less than half of the earned income of the S&P 500 is paid out in dividends. Unless there is an enormous increase in the amount of dividends that we paid out, and I do believe in speaking to some of our members, for example, that companies will call for higher dividends if this passes, which will be very good for shareholders, and that is across the quadrants. There is still going to be plenty of room for companies to invest in tax credits.
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    Finally, less than 1 percent of all corporate tax right now is offset by way of housing tax credits. So they are an exceedingly valuable housing tool. I think the case that is made that somehow that they are going to be overwhelmed or eviscerated because of this provision is overstated.
    Chairwoman KELLY. Thank you very much.
    Mr. SPRIGGS. If I can be allowed just one point, though, I think again this is inconsistent to argue that on the one hand marginal tax rates matter, and then to argue that they do not matter. Yes, there is a risk premium, but we are changing the size of that risk premium by making these things deductible. I think we have to look at it from the real world perspective. When Microsoft decided for the first time in its history that it would give an eight cents dividend, for Bill Gates that is $96 million. Now, under this proposal that is $96 million tax free. There is a huge difference for those who are making these investments, in terms of how much money we are talking about.
    So I think it is inconsistent, and I think we should be consistent about whether relative tax rates matter or not in terms of investment decisions.
    Chairwoman KELLY. Thank you, Dr. Spriggs.
    I want to thank all of you for testifying today. Without objection, I want to enter into the record the Business Roundtable's study that was done by Pricewaterhouse, the Ernst and Young study, and the MBA studies that are referred to today, and the SIA report ''Defending the Dividend,'' which was issued January 31, 2003.
    I note that some members may have additional questions for this panel they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to these witnesses and to place their responses in the record.
    The third panel is excused, with the great appreciation of the committee. I want to briefly thank all of the members and the staff for their assistance in making the hearing possible.
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    This hearing is adjourned.
    [Whereupon, at 6:04 p.m., the subcommittee was adjourned.]