Mr. Chairman and Members of the Committee:

      I am Barry Rogstad, president of the American Business Conference (ABC). ABC is a nonpartisan coalition of chief executives of fast-growing, midsize companies. Before coming to ABC, I served as chief economist and Managing Partner for International Consulting at Coopers & Lybrand, a leading accounting and consulting firm.

      I applaud the purpose of this hearing today. Our tax system has a major impact on the behavior of all households and businesses. It is essential that we understand that impact as we examine near-term improvements and more fundamental reform of our tax regime. I believe that we are only at the beginning of a significant national discussion of our income tax system.

      My remarks today come from the perspective of having been involved in the issue of fundamental tax reform over the past eight years. Specifically I have been working,over that period with Senator Pete Domenici and former Senator Sam Nunn on the development and full exposition of the Unlimited Savings Allowance (USA) tax proposal. This experience has caused me to focus on the main economic problems resulting from the current tax system.

      Any effort to improve our tax system must start, as you have noted, with a statement of the principles of fundamental tax reform. They provide discipline for all of us whether we are designing replacement tax proposals or near-term changes. They serve to define the order of magnitude of the key issues and tell us about the right direction. They are particularly useful as we think about proposed interim and marginal changes in tax policy by insuring consistency with the broader objectives.

      What are the attributes of a good tax system?

1. A tax system must raise revenue sufficient to finance the amount of government citizens demand. To do this properly requires that the tax system be visible to the taxpayer and thereby serve the function of pricing out government services. It is desirable to have as many citizens be taxpayers as possible. A situation wherein we have all citizens voting on the size of government and a significantly smaller number paying for that government is not desirable in our democracy.

2. The ideal tax system would seek to raise revenues in a manner that did not change the set of relative prices in our economy. In practice this is impossible to achieve. This "neutrality" objective seeks to minimize the amount of distortion that a tax system imposes on the behavior of business and households. All taxes change the price of economic activities. The challenge is to maintain as far as possible, the same relative prices post-tax that existed before taxes were levied. This assures that the imposition of a tax will bring about the lowest possible disruption to our market based economy.

         The most important violation of the neutrality criterion in our current income tax system is the double taxation of the savings versus consumption uses of income. I will return to this point later in my testimony.

3. A good tax system is one that should be simple to administer and uniformly understood by all taxpayers. Our current system fails this test and unfortunately scores lower and lower with the passage of time.

         The real complexity in the tax code falls most heavily on business and on upper-income Americans. And, at least insofar as that complexity applies to wealthier Americans, there is a common perception among taxpayers of more modest means that that complexity favors the rich and near-rich by allowing them to lower their tax bill. Not everyone seems to be playing by the same rules. If that perception festers, it will undermine the willingness of citizens to participate in what is still a voluntary system of revenue collection.

         I would like to reference a few areas of business tax complexity. The major technical issue in our income tax system arises from the correct tax treatment of income from capital. Our current approach relies on accrual accounting (depreciation) to measure the costs associated with producing capital income. I estimate that if these timing issues were removed from our tax system (for example, by expensing all capital outlays) 70% of the complexity inherent in our corporate income tax would be removed.

         The taxation of foreign source income to American corporations is another significant source of complexity and inefficiency. Most experts agree that the compliance and economic costs of the current set of rules far exceed the revenues derived. American businesses that are succeeding in the global market place understand the importance of using the full array of operating techniques and strategies to correctly position themselves to gain permanent market share around the world. What concerns them most about our current foreign source income rules is that their decisions can be more influenced by tax considerations than the fundamental economic and business realities they must focus on in order to be successful.

         In this area we could achieve significant simplification by moving toward a territorial system where the US tax system taxed all income generated from business activity conducted in the United States and all other nations were encouraged to adopt the same rules.

4. Fairness and equity are the attributes most difficult for our society to agree on. We all seem to share the view that the current system is not fair, but for many different reasons. As an economist, I am very concerned about the efficiency of our market economy. I hold the view that from an efficiency (and neutrality) standpoint, all income should be taxed alike and at the same rate. Increasing marginal rates of taxation at higher income levels, exacerbates the double taxation on saving and investment and discourages additional work effort by our citizens. The degree of progressivity in our income tax rate structure is largely a political determination, involving significant tradeoffs across these attributes.

         Furthermore, the sense of fairness with which the code is viewed is as much a question of uniform understanding of the tax base as it is the result of a particular rate structure on that base. If, for example, we all understand what comprises taxable income and that allowable deductions were limited and available to all citizens, I suspect we would have a very different perception of the fairness of the code. We would perceive each other as playing by the same rules which is far different from our current image of the income tax system.

      I will now return to the core problem inherent in our current tax system: the double taxation of saving and investment.

      Under current rules, consumption outlays are made with after-tax income but we do not tax the services and pleasure they provide. On the other hand, that portion of our income that we save, which has already been subjected to tax, is taxed again when we tax the returns on that saving. In a speech on the Senate floor, former Senator Sam Nunn illustrated the difference:

If you take $200 and buy a television set, you are not again taxed for whatever enjoyment or enlightenment you may receive by watching it. If, however, you take that $200 and put it in a college savings account, all the interest you earn is subject to tax. The act of consumption ... is taxed once, as income. The act of saving ... is taxed twice. The original $200 has already been taxed as income. The returns to that $200, in this case, interest, is taxed again. Saving $200 for tomorrow is more expensive than consuming it today.

      Furthermore if the saving is invested in corporate equities, the returns on that saving are subject to multiple levels of taxation: (1) the corporate income tax, (2) the personal income tax, and (3) capital gains tax.

      The income tax thus discourages saving in favor of consumption. We know therefore that because of this distortion we, as individuals, households, business and as a nation save less than we otherwise would.

      Saving is the tool with which people control their own economic fate and achieve a higher standard of living. Saving is the activity that permits investments in new technology, plant and equipment as well as the development of skills in our citizens through education and training. It is the key to sustained economic growth. We do not, therefore, want a tax system that is biased against saving.

      We can make short term changes that help to remove this double tax on saving. Indeed our current treatment of individual retirement accounts, pension plans, and other tax deferred saving vehicles is a recognition of this inherent problem and the need to provide relief. In my opinion, the most important near term step that could be taken in tax policy would be to expand the IRA provisions. I commend the Chairman for his recently introduced legislation, The Investment Revitalization Act of 1997, which expands the amount of income that taxpayers may contribute annually to their ERA and broadens the income eligibility levels as well.

      Many of the goals we seek can be achieved through an unlimited and universal IRA. Advocating a deferral of tax on all saving raises issues of fairness and understandability. Saving benefits everyone regardless of who is doing the saving. It finances the capital that raises worker productivity and therefore workers' wages and living standards. Everyone has a large stake, in fact, in the national stock of savings whether or not they personally own any of that saving at the present time.

      Removing the double taxation of saving is an objective of all the major fundamental tax restructuring proposals. The USA tax, the flat tax, and the sales tax proposals all emphasize the key attributes of taxing all income once and only once. This important commonality has not been sufficiently emphasized.

      Effectively removing the double taxation on saving under our current income tax system requires significant changes in the tax treatment of corporate as well as personal income. How to successfully "integrate" these two components of the income tax system has been a long-standing issue of federal tax policy. A tax system that levies a tax on corporate income when produced and another tax when that same income is distributed to creditors and shareholders fails to meet the neutrality criteria.

      In our economy, income is created at the business level when goods or services are produced and sold. That income then flows to people: employers, investors and owners. We know that the correct income tax base is comprised of the net returns to labor and capital services (net in the sense of payments for the services provided by owners of labor and capital minus all costs associated with producing these services).

      There are three mechanisms by which these incomes can be taxed:

1. All taxes could be levied at the source of these income flows, specifically at the business (or government) entity where they originate. Under this approach all taxes would be collected at the business level and payments of wages, interest, dividends, etc. to households and individuals would be net of tax.

2. On the other hand, all taxes could be levied and collected at the household level when payments for labor and capital services are received by individuals. This approach would eliminate the corporate income tax and recognize the reality that businesses do not pay taxes, but rather they are fully borne by the providers of labor and capital services.

         It is important to note that such an approach becomes attainable when we have correctly taxed all personal income and permitted an unlimited deferral for the savings uses of that income. Under such a framework, there would be no purpose served by keeping earnings in the corporation which has been a long standing rationale for the corporate income tax.

3. It is also possible to maintain a two-tier tax system under which taxes are levied and collected at both the business and the household level. However, this approach faces the daunting, if not impossible, task of avoiding some double taxation on significant elements of our national income stream.

         In setting up such a framework, it quickly becomes evident that the business level tax becomes a pre-collection point for taxes that can be more efficiently collected at the household level. Attempting to maintain a business level tax provides very little net economic benefit, results in no greater revenues than either of the other options and is the source of significant additional complexity.

         It is useful to ask the question, if we were starting from scratch and designing a tax system based on our key attributes for an optimal tax system would we have established a corporate income tax? I think not.

         Avoiding the double taxation of saving involves other elements of the code as well. Of most significance are the areas of estate taxes, the alternative minimum tax, and capital gains. All three are, in effect, additional "excise taxes" on saving and therefore result in further violation of the neutrality criteria. I will comment on capital gains to illustrate this point.

      The case for a significant capital gains differential rests on the fact that reducing capital gains tax would obviously have the effect of mitigating the double tax on saving. As noted earlier the returns to saving invested in corporate equities is subject to multiple levels of taxation. The capital gains tax applied to the increase in the nominal value of the asset is a major part of the problem. The inappropriateness of taxing the inflation component of any gain is clear and should be a high priority for any near term tax policy improvements. In addition, the objective of unlocking and reallocating investment across assets could be achieved by capital gains treatment that "deferred" any tax until the savings were withdrawn from the national saving pool. Such a rollover provision, consistent with the broadening of IRAs, would greatly improve the tax treatment of saving under our current tax regime.

      Finally, I would like to impart a sense of urgency to your proceedings. Increasingly Americans are becoming convinced that there is a saving problem, both on the family and national levels. They are realizing that the economic security of our citizenry, in part, depends on solving that saving problem. They are becoming more aware that the current tax system inhibits national saving and investment, as well as their own capacity to assemble a nest egg. As this happens we will see the right kind of advocacy for change.

      This increased public awareness is happening while we are also discussing the "privatization" of social security and the curtailing of the growth in non-means tested entitlements. The message coming from these discussions to our citizens is one of increased personal responsibility which translates directly to saving behavior. In this environment, making our tax system more saver friendly will become a top Congressional priority.

      There is no single silver bullet answer to the issues this panel raises today. But there is an opportunity to make significant strides in improving the tax regime of our nation. I look forward to working with you and your colleagues in the Congress to achieve this goal.

      Thank you. I would be pleased to answer any questions.

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