Overcoming Barriers to U.S. Economic Growth,
International Competitiveness, and Retirement Security

American Council for Capital Formation
June 23, 1999

ACCF President Mark Bloomfield, accompanied by ACCF Senior Vice President and Chief Economist Dr. Margo Thorning, testified as a committee-invited witness on June 23, 1999, before the Committee on Ways and Means of the U.S. House of Representatives. The executive summary and full text of the ACCF's testimony are presented here.

Overview

ACCF proposes that if Congress decides to enact a multi-year tax cut, a substantial portion should be dedicated to saving and investment initiatives to promote competitiveness, economic growth, and retirement saving. As with past generations, a major responsibility of today's generation is to lay a strong economic base for the future.

New ACCF Research

In anticipation of the Ways and Means Committee hearings on a 1999 tax bill, ACCF commissioned five new studies:

• An analysis of the macroeconomic impact of the 1997 capital gains tax cuts;
• An international survey of "death" taxes in 24 countries;
• An analysis of the impact of the "death" tax on investment, entrepreneurship, and employment;
• An international comparison of the taxation of saving in 24 countries; and
• An analysis of pension reform.

Impact of the U.S. Tax Code on Saving and Investment

Economists agree that the U.S. tax system is strongly biased in favor of consumption and against saving and investment, thus raising capital costs. Indeed, the United States taxes both saving and investment-including U.S. corporate investment and foreign-source income as well as capital gains, dividends, and interest-more harshly than do most of our competitors. This impairs U.S. competitiveness in world markets.

ACCF Tax Menu for Promoting Competitiveness,
Growth, and Retirement Security

Sound tax cuts for individuals include: increasing the deductible IRA contribution limit and/or raising the income level; repealing the death tax; providing a tax-free "rollover" for reinvested savings; reducing the capital gains tax and providing an annual exclusion for capital gains; increasing pension portability; establishing "personal retirement accounts"; and providing a deduction for dividends and interest.

Sound tax cuts for business include: phasing in expensing for plant and equipment outlays; providing more favorable tax treatment for investment to promote environmental goals; providing relief from the corporate AMT; reforming the foreign tax provisions of the U.S. tax code; reducing the corporate capital gains tax; and liberalizing employer-sponsored pension plans.
Conclusion

Persistently low U.S. saving rates, and investment that in recent decades has lagged behind our industrial competitors despite continued economic growth and low unemployment, underline the need for pro-growth tax policies as a substantial part of any tax bill approved by this Committee.  

ACCF TESTIMONY

Introduction

My name is Mark Bloomfield. I am president of the American Council for Capital Formation and I am accompanied by Dr. Margo Thorning, the ACCF's senior vice president and chief economist.

The ACCF represents a broad cross-section of the American business community, including the manufacturing and financial sectors, Fortune 500 companies and smaller firms, investors, and associations from all sectors of the economy. Our distinguished board of directors includes cabinet members of prior Republican and Democratic administrations, former members of Congress, and well-known business leaders. Our affiliated public policy think tank, the ACCF Center for Policy Research, includes on its board leading mainstream scholars from America's most prestigious universities, as well as prominent public finance experts from the private sector.

Mr. Chairman, we commend you for this timely hearing on tax relief to strengthen families and sustain a strong economy as we prepare to enter the next millennium. The question then becomes which taxes should be cut. For example, some experts are calling for using the surplus to promote social goals such as relief of the "marriage penalty" that often results in married couples paying more federal tax than two single people with the same income levels. Other experts support using the budget surplus to reduce death taxes, capital gains, or marginal income tax rates.

The central theme of the ACCF's testimony is that if the Congress does indeed approve a tax cut, any such cut should enhance competitiveness, increase economic growth, and promote retirement saving.

We would also like to use the opportunity of this hearing to showcase several new research projects that our Center for Policy Research commissioned especially in anticipation of the Ways and Means Committee hearings on this year's tax bill. Specifically, our Center's new research focuses on:

• An analysis by David Wyss, chief economist, DRI, on the macroeconomic impact of the 1997 capital gains tax cuts;
  
  
• A new international survey by Arthur Andersen LLP comparing "death" taxes in 24 major industrial and developing countries, including most of the United States' major trading partners;
  
  
• An analysis by Professor Douglas Holtz-Eakin, chairman of the Department of Economics at Syracuse University, which analyzes the impact of the current estate tax on capital accumulation, saving, capital costs, investment, and employment, especially employment in the small business sector;
  
  
• A comparison by Arthur Andersen LLP of the tax treatment of retirement savings, insurance products, social security, and mutual funds in 24 major industrial and developing countries; and
  
  
• An analysis of pension reform by Dr. Sylvester Schieber, director of Watson Wyatt Worldwide Research and Information Center and a member of the Social Security Advisory Council.

For our part, if Congress decides to consider a major multi-year tax cut, we offer as a model two well-thought-out tax initiatives enacted since World War II that moved this country toward a tax system suitable for the post-war period. We have the opportunity today to emulate the Kennedy-Johnson tax cuts of the 1960s and the Reagan tax cuts of the early 1980s and, in so doing, put in place a tax system appropriate for the challenges of the new century.

In our view, the striking characteristic of the Kennedy-Johnson and Reagan plans for tax cuts today is that they were not confined to cuts in taxes on consumption but provided liberal reductions in tax rates on growth-producing saving and investment. To be sure, these earlier tax plans included badly needed cuts in marginal income tax rates, but in addition both included sharp reductions in capital gains tax rates. Moreover, the first Kennedy tax cuts (1961-1962) liberalized some business depreciation rates and, of primary importance, created for the first time a tax credit for business investment in equipment. The Reagan tax plan included similar components and also liberalized Individual Retirement Accounts (IRAs).

Both plans fueled economic growth in succeeding years. The Kennedy-Johnson initiative opened the way for the golden economic era of the 1960s, with 4 percent productivity growth until economic overheating set in as a result of sharp increases in deficit spending. Similarly, the Reagan tax cut set the stage for strong economic performance in succeeding years and laid the base for growth in the U.S. economy in the 1990s. One may quarrel about the financing of the Reagan tax cuts and whether there was sufficient balance in the form of spending cuts. Our point is that the tax cuts recognized the essentiality of stronger individual saving and lower business capital costs for investment to foster economic growth.

As with past generations, a major responsibility of today's generation is to lay a strong economic base for future generations. To do so, we should follow the wisdom of these earlier, brilliantly conceived tax plans and ensure that a significant proportion of any tax cut is dedicated to saving and investment initiatives. If we are genuinely concerned about our children, grandchildren, and generations beyond, we should have the discipline to deny a reasonable amount of consumption to ourselves today in order to enhance prospects for growth in the future and to provide retirement security for all. It is in that context that we strongly urge the Congress to dedicate a significant amount of any multi-year tax cut for competitiveness, growth, and retirement security.

In advocating this position we do not at all deny the merits of other tax proposals currently advanced. The marriage tax penalty should be corrected over time, and marginal tax rates are far too high and should be reduced. Indeed, lower marginal tax rates will foster economic growth but with less leverage than more direct tax cuts on individual saving and productive business investment. To this end, our testimony suggests a menu of a dozen direct tax cuts to promote pro-growth saving and investment (including investments to reduce pollution and increase energy efficiency in order to address the potential threat of global warming and other environmental concerns).

In essence, the U.S. tax code treats saving (including retirement saving) and investment very harshly. Since saving is essential to investment and growth, this harsh taxation of saving in the United States works against higher living standards for coming generations and may also impair the economic strength that underlies our world leadership position. In addition, our tax code hits saving and investment harder than those of many of our international competitors. The foreign-source income of U.S. multinationals is also subject to higher taxes than that of many of our competitors. All of these facts are of increasing concern as globalization continues.

Tax reform can be carried out through a broad-based restructuring in which consumption, rather than income, becomes the tax base, or it can be accomplished through incremental changes to the current income tax base that reduce the tax burden on various types of saving and on investment. Either type of tax restructuring would enhance U.S. productivity and economic growth and could promote the achievement of environmental goals. Tax reductions, we want to stress, should not come at the expense of fiscal responsibility or reforming social security.

As a predicate to our tax cut proposal to promote competitiveness, economic growth, and retirement security, we would like to set out the intellectual framework for such a plan by first discussing the impact of the current U.S. tax code on saving and investment.

IMPACT OF THE U.S. TAX CODE ON SAVING AND INVESTMENT

Taxation of U.S. Business Investment

Economists are in broad agreement that the cost of capital for investment is significantly affected by tax policy. The "user cost of capital" is the pretax rate of return on a new investment that is required to cover the purchase price of the asset, the market rate of interest, inflation, risk, economic depreciation, and taxes. This capital cost concept is often called the "hurdle rate" because it measures the return an investment must yield before a firm would be willing to start a new capital project. Stanford University Professor John Shoven, an internationally renowned public finance scholar, estimates that in the United States about one-third of the cost of capital is due to taxes. In other words, hurdle rates are 50 percent higher than they otherwise would be due to the tax liability on the income produced by the investment. Quite clearly, therefore, the higher the tax on new investment, the less investment that will take place.

Several measures show that the United States taxes new investment more heavily than most of our international competitors. For example, according to a study by the centrist Progressive Policy Institute (the research arm of the Democratic Leadership Council), the marginal tax rate on domestic U.S. corporate investment is 37.5 percent, exceeding that of every country in the survey except Canada (see Figure 1). The tax rate calculations include the major features of each country's tax code, including individual and corporate income tax rates, depreciation allowances, and whether the corporate and individual tax systems are integrated.

Tax rates on foreign-source investment, which are indicators of how much encouragement domestic firms are given to enhance their economic viability by expanding operations abroad, again show the United States falling behind. The U.S. tax rate is 43.4 percent versus an average of 36.7 percent in the other G-7 countries (see Figure 2).

Figure 1	Effective Tax Rates on Domestic Corporate Investment
Note: Tax rates include both the corporate and personal income tax on investment. Source: Enterprise Economics and Tax Reform (Washington, D.C.: Progressive Foundation, Progressive Policy Institute, October 1994).

Figure 2	Effective Tax Rates on Foreign-Source Investment
Note: Tax rates include both the corporate and personal income tax on investment. Source: Enterprise Economics and Tax Reform (Washington, D.C.: Progressive Foundation, Progressive Policy Institute, October 1994).

Prior to the 1986 Tax Reform Act (TRA), the United States had one of the best capital cost recovery systems in the world. For example, the present value of the deductions for investing in machinery to produce computer chips and in modern and competitive continuous casting equipment for steel production were close to 100 percent under the strongly pro-investment tax regime in effect from 1981 to 1985, according to a study by Arthur Andersen LLP (see Table 1). In contrast, under current law the present value of the capital cost recovery allowance for that same investment today for computer chips is only 85 percent and for continuous casting equipment is only 81 percent.

Table 1	International Comparison of the Present Value of Equipment Used to Make Selected Manufacturing Products and Pollution Control Equipment As a percent of cost
	Computer Chips	Telephone Switching Equipment	Factory Robots	Crank- shafts	Continuous Casting for Steel Production	Engine Blocks	Wastewater Treatment for Chemical Production	Wastewater Treatment for Pulp and Paper Equipment	Scrubbers Used in Electricity Plants
United States
1985 Law	100.1	100.1	100.1	100.1	100.1	100.1	100.1	100.1	89.7
MACRS1	85.2	85.2	80.8	80.8	80.8	80.8	85.2	80.8	54.5
AMT2	83.0	83.0	77.9	77.9	77.9	77.9	83.0	78.0	54.5
Brazil	75.7	74.8	74.7	74.7	88.3	74.7	74.7	74.7	79.4
Canada	76.9	75.9	74.0	73.8	74.2	73.6	85.3	85.3	85.3
Germany	83.6	83.0	82.7	83.9	82.2	83.9	71.8	69.7	68.9
Japan	87.1	86.2	83.4	83.9	81.4	83.7	84.6	83.7	82.4
Korea (w/3% ITC)	88.7	84.3	82.6	80.1	77.7	79.6	95.2	93.9	92.2
Singapore	91.7	91.7	91.7	91.7	91.7	91.7	91.7	91.7	91.7
Taiwan	83.9	78.0	79.0	64.3	63.5	63.7	147.0	147.0	147.0
Notes: 1. MACRS = Modified Accelerated Cost Recovery System (current law) for regular taxpayers. 2. AMT = Alternative minimum tax (current law, Taxpayer Relief Act of 1997). Source: Stephen R. Corrick and Gerald M. Godshaw, "AMT Depreciation: How Bad Is Bad?" in Economic Effects of the Corporate Alternative Minimum Tax (Washington, D.C.: American Council for Capital Formation Center for Policy Research, September 1991). Updated by Arthur Andersen LLP, Office of Federal Tax Services, Washington, D.C., January 1998.

The Arthur Andersen study also shows that the United States lags behind many of our major competitors in capital cost recovery for equipment that is technologically innovative, is crucial to U.S. economic strength, or helps prevent pollution. Capital cost recovery provisions for pollution-control equipment are much less favorable now than prior to TRA's passage. For example, the present value of cost recovery allowances for wastewater treatment facilities used in pulp and paper production was approximately 100 percent prior to TRA '86. Under TRA '86, the present value for wastewater treatment facilities dropped to 81 percent. Allowances for scrubbers used in the production of electricity were 90 percent prior to TRA '86; the present value fell to 55 percent after TRA '86. As is true in the case of productive equipment, both the loss of the investment tax credit and lengthening of depreciable lives in TRA raised effective tax rates.

While the Taxpayer Relief Act of 1997 substantially improved cost recovery allowances for corporate alternative minimum tax payers (AMT), those firms are still disadvantaged relative to firms paying the regular corporate income tax (see Table 1). The AMT limits or delays the benefit of tax code provisions that are based on investment in plant, equipment, research and development, mining, energy exploration and production, pollution abatement, and many others. Companies that have been subject to the AMT since its enactment have accumulated numerous AMT credits. These credits reflect cash that is not available for new productivity-improving investment.

Taxation of U.S. Multinational Firms

A tax reduction plan should also focus on the need of U.S. multinational companies (especially in the industrial and financial sectors) to be competitive and gain market share, both at home and abroad. Such a tax cut could enhance the ability of U.S. firms to compete in global markets by reducing the competitive disadvantages that they face. For example, as a 1997 study sponsored by the ACCF Center for Policy Research showed, U.S. financial service firms face much higher tax rates on foreign-source income than do their international competitors when operating in a third country such as Taiwan (see Figure 3). A 12-country analysis shows that U.S. insurance firms are taxed at a rate of 35 percent on income earned abroad compared to 14.3 percent for French-, Swiss-, or Belgian-owned firms. As a consequence of their more favorable tax codes, foreign financial service firms can offer products at lower prices than can U.S. firms, thereby giving them a competitive advantage in world markets.

Figure 3	International Comparison of Tax Rates on Foreign Income Earned by Insurance Companies Operating in a Third Country Such as Taiwan By country of residence of parent company
1. "Parent" means residence country income tax on parent company. 2. "Subsidiary" means local income tax on foreign subsidiary. Source: Thomas Horst, "The Impact of the U.S. Tax Code on the Competitiveness of Financial Service Firms" (Washington, D.C.: American Council for Capital Formation Center for Policy Research, July 1997).

Capital Gains Taxation

The ACCF's first new 1999 study, which is on capital gains taxation, was prepared by Dr. David Wyss, chief economist of Standard & Poor's DRI and a top public finance expert, finds that the Taxpayer Relief Act of 1997, which reduced the long-term individual capital gains tax rate from a top rate of 28.0 percent to 20.0 percent has had several favorable impacts on the U.S. economy in the intervening two years. First, the net cost of capital for new investment fell by about 3 percent; other things being equal, this will raise business investment by 1.5 percent per year. Over a 10-year period, the capital stock will rise by 1.2 percent and productivity will increase by 0.4 percent relative to the baseline forecast. Second, a significant share of the increase in stock prices since 1997 (about 25 percent) is due to lower taxes on individual capital gains realizations. Third, Dr. Wyss's analysis shows that when a dynamic rather than a static analysis is used, the stronger growth of the economy adds to total federal tax revenues in the long run. Finally, Dr. Wyss rebuts several new studies which attempt to debunk the importance of lower capital gains tax rates in encouraging start-ups and venture capital.

In spite of the 1997 tax reductions whose favorable economic impacts are documented by Dr. Wyss's new analysis, U.S. capital gains tax rates, which affect the cost of capital and therefore investment and economic growth, are still high compared to those of other countries. In fact, most industrial and developing countries tax individual and corporate capital gains more lightly than does the United States, according to a 1998 survey of 24 industrialized and developing countries that the ACCF commissioned from Arthur Andersen LLP.

Both short- and long-term capital gains on equities are taxed at higher rates in the United States than in most of the other 23 countries surveyed. Short-term gains are taxed at 39.6 percent in the United States compared to an average of 19.4 percent for the sample as a whole. Long-term gains face a tax rate of 20 percent in the United States versus an average of 15.9 percent for all the countries in the survey. Thus, U.S. individual taxpayers face tax rates on long-term gains that are 26 percent higher than those paid by the average investor in other countries. In addition, the United States is one of only five countries surveyed with a holding period requirement in order for the investment to qualify as a capital asset.

Similarly, short- and long-term corporate capital gains tax rates are higher in the United States than in most other industrial and developing countries surveyed. Both short- and long-term gains are taxed at a maximum rate of 35 percent in the United States, compared to an average of 22.8 percent for short-term gains and 19.6 percent for long-term gains in the sample as a whole. In other words, U.S. corporations face long-term capital gains tax rates almost 80 percent higher than those of all but two of the other countries surveyed (Germany [45 percent] and Australia [36 percent], and only four of the 24 countries surveyed impose a holding period in order to be eligible for preferential corporate capital gains tax rates.

Taxation of Interest and Dividends

Interest and dividends received by individuals also are taxed more heavily in the United States than in many other countries, according to the 1998 Arthur Andersen survey of 24 countries. High tax rates on dividends and interest received raise the cost of capital for new investment and slow U.S. economic growth. The top marginal income tax rate is 39.6 percent in the United States compared to an average of 32.4 percent in the countries surveyed as a whole. Nearly 40 percent of the countries surveyed tax interest income at a lower rate than ordinary income; for example, Italy taxes ordinary income at a top rate of 46 percent while its top tax rate on interest income is only 27 percent.

In several countries surveyed, small savers receive special encouragement in the form of lower taxes or exemptions on a portion of the interest they receive. For example, in Germany, the first $6,786 of interest income for married couples filing a joint return ($3,393 for singles) is exempt from tax; in Japan, interest on saving up to $26,805 is exempt from tax for individuals older than 65; in the Netherlands, the first $987 of interest income for married couples ($494 for singles) is exempt from tax; and in Taiwan, the first $8,273 of interest received from local financial institutions is exempt from tax.

Similarly, dividend income is also taxed more heavily in the United States than in the other countries surveyed; the U.S. tax rate is 60.4 percent (combined corporate and individual tax on dividend income) compared to an average of 51.1 percent in the surveyed countries as a whole. Of the countries surveyed, 62.5 percent offset the double taxation of corporate income (the income is taxed at the corporate level and again when distributed in the form of dividends) by providing either a lower tax rate on dividend income received by a shareholder or by providing a corporation with a credit for taxes paid on dividends distributed to their shareholders.

In the case of dividends received, small savers receive preferential treatment in about one-fourth of the countries surveyed. In France, for example, the first $2,661 of dividends on French shares received by a married couple is exempt from tax ($1,330 for singles); in the Netherlands, the first $987 of dividend income for married couples ($494 for singles) is exempt from tax; and in Taiwan, the first $8,273 of dividends from local companies is exempt from tax.

Death and the U.S. Tax Code

Many top academic scholars and policy experts conclude that the estate tax should be repealed or reduced because it adds to the already heavy U.S. tax burden on saving and investment. For example, analysis by MIT's Professor James Poterba shows that the U.S. estate tax can raise the cost of capital by as much as 3 percent. The estate tax also makes it harder for family businesses, including farms, to survive the deaths of their founders. The ACCF's second new study, which was compiled by Arthur Andersen LLP, surveys 24 industrialized and developing countries and shows that the top U.S. federal marginal death tax rate is higher than that of all other countries surveyed except for Japan (see Figure 4). Death tax rates imposed on estates inherited by spouses and children average only 21.6 percent for the 24 countries in the study, compared to 55 percent in the United States. (Tax rates are often higher on assets inherited by more distant relatives or by non-relatives). Seven countries*Argentina, Australia, Canada, China, India, Indonesia, and Mexico*have no death or inheritance taxes. The average marginal top tax rate in the 17 countries with a death tax is only 30.5 percent, which is slightly more than one-half of the U.S. top federal estate tax rate. Not only are U.S. death tax rates higher than those in most of the industrialized and developing world, but the value of the estate where the top tax rate applies is lower. The average value of the estate where the top tax rate applies is over $4 million compared to only $3 million in the United States.

Figure 4	International Comparison of Top Marginal Death Tax Rates
Source: "An International Comparison of Death Tax Rates" (Washington, D.C.: American Council for Capital Formation Center for Policy Research, June 1999).

The third new ACCF-sponsored study, prepared by Professor Douglas Holtz-Eakin, chairman of the Department of Economics at Syracuse University, analyzes the impact of the current death tax on capital accumulation, saving, capital costs, investment, and employment.

First, using a sample of data collected by the Public Policy Institute of New York State in May, 1999, Professor Holtz-Eakin notes that there is a negative relationship between anticipated death tax liability and growth in employment, particularly for growing firms. His analysis suggests that at least 15,000 jobs will be lost in New York State over the next five years due to the effect of the estate tax on small firms. Second, the death tax reduces U.S. annual investment by sole proprietors in the range of 2 to 10 percent or almost $45 billion in 1996. Third, the death tax hits hard at entrepreneurs; of the total number of people liable for the estate tax, 48 percent are entrepreneurs. Professor Holtz-Eakin states that the death tax should not be viewed as hitting all savers equally. Instead, the tax hits especially hard at entrepreneurs who are trying to put money into their business. For these individuals, their saving is their investment.

Professor Holtz-Eakin concludes that his study suggests that the estate tax is shifted-forward in time to the business operation and onto factors of production (capital and labor). Since most incidence studies suggest that labor supply bears the incidence of labor taxes and that slower capital accumulation hurts productivity and real wages, this suggests that the estate tax on the "rich and dead" small business owners and entrepreneurs may be in part paid by their far-from-rich and very alive employees.

The U.S. Tax Code and Retirement Security

Experts predict that today's federal budget surpluses may be relatively short-lived phenomena. The long-term prosperity of the United States remains threatened by the prospect of looming budget deficits arising from the need to fund the retirement of the baby boom generation in the next century. In addition, the U.S. saving rate continues to compare unfavorably with that of other nations, as well as with our own past experience; U.S. net domestic saving has averaged only 4.8 percent of GDP since 1991 compared to 9.3 percent over the 1960-1980 period (see Table 2). Though the U.S. economy is currently performing better than the economies of most other developed nations, in the long run low U.S. saving and investment rates will inevitably result in a growth rate short of this country's true potential.

The ACCF's fourth new study is a survey of the tax treatment of retirement savings, insurance products, social security, and mutual funds in 24 major industrial and developing countries, including most of the United States' major trading partners. The survey (also compiled for the ACCF by Arthur Andersen LLP) shows that the United States lags behind its competitors in that it offers fewer and less generous tax-favored saving and insurance products than many other countries. For example:

• Life insurance premiums are deductible in 42 percent of the surveyed countries but not for U.S. taxpayers; for many individuals life insurance is a form of saving;
  
  
• Thirty-three percent of the sampled countries allow deductions for contributions to mutual funds for retirement purposes while the United States does not;
  
  
• More than half of the countries surveyed allow a mutual fund investment pool to retain earnings without current tax, a provision which increases the fund's assets; the United States does not;
  
  
• Thirty percent of the countries with social security systems allow individuals to choose increased benefits by increasing their contributions during their working years; and
  
  
• Canada, for example, provides a generally available deduction of up to $9,500 (indexed) yearly for contributions to a private retirement account, compared to a maximum deductible IRA contribution of $2,000 for qualified taxpayers in the United States.

The ACCF's study demonstrates that many countries have gone further than the United States to encourage their citizens to save and provide for their own retirement and insurance needs.

Reform of the Private Pension System

The ACCF's fifth new study, "Improving the Retirement Security System in the United States Through Mechanisms for Added Savings," by Dr. Sylvester Schieber and his colleagues, Richard Joss and Marjorie M. Kulah of Watson Wyatt Worldwide, a prominent pension consulting firm, contends that the U.S. private pension system should be expanded and reformed, particularly for small employers who are responsible for much of the growth in employment in recent years. Pension policy experts contend that long-service, high-income employees of large firms benefit most from the current system. The public interest would be better served, they argue, if pension rules were simpler and easier to administer. For example, complicated and costly rules to prevent "discrimination" discourage employers, especially small ones, from offering pension plans.

Dr. Schieber concludes that all of the elements of the retirement system need to be shored up in order to anticipate the claims the baby boomers will make beginning next decade. In the case of employer sponsored pension plans, most of the policy initiatives undertaken during the last two decades have led to restricted saving through these plans. The long-term implication of this result is that plan sponsors are either going to face higher contribution costs in the future than if they had been allowed to contribute to their plans at historical rates, or they will curtail benefits.

The potential curtailing of benefits from employer-sponsored plans is a direct threat to the retirement security of today's workers. First, Dr. Schieber states it is imperative that employers begin to more effectively communicate to workers the importance and necessity of saving for retirement. Employers should be encouraged to expand existing communications efforts. Second, in the case of employer-sponsored plans, Dr. Schieber advocates further simplification of the multiple funding and contribution limits to which these plans are subject. The funding biases that have skewed plan sponsors toward defined contribution plans should be eliminated. The inconsistencies in public policy that result from a given level of funding resulting in tax penalties for overfunding, on the one hand, and government penalties for underfunding, on the other, should be resolved. Although Dr. Schieber is a strong advocate of employer-sponsored plans and their expanded availability, he recognizes that not everyone has an opportunity to participate in such a plan. For such workers, the playing field should be leveled so they can effectively save on their own through tax-preferred retirement plans.

A TAX MENU FOR COMPETITIVENESS, GROWTH, AND RETIREMENT SECURITY

Those who favor a truly level playing field to encourage saving and investment by individuals and businesses, stimulate economic growth, and create new and better jobs, believe savings (including capital gains) should not be taxed at all. This view was held by top economists in the past and is held by many mainstream economists today. The fact is however that an income tax hits saving more than once-first when income is earned, and again when interest and dividends on the investment financed by saving are received, or when capital gains from the investment are realized. The playing field is tilted away from saving and investment because the individual or company that saves and invests pays more taxes over time than if all income were consumed and no saving took place. Taxes on income that is saved raise the capital cost of new productive investment for both individuals and corporations, thus dampening such investment. As a result, future growth in output and living standards is impaired.

While fundamental reform of the U.S. federal tax code continues to interest policymakers, the public, and the business community, the key question is whether a totally new system would be worth the inevitable disruption, cost, and confusion the switch would create. Several recent analyses by academic scholars and government policy experts including University of California Professor Alan Auerbach, Boston University Professor Laurence Kotlikoff, the Joint Committee on Taxation, and the Congressional Budget Office conclude that substituting a broad-based consumption tax for the current federal income tax would have a positive impact on economic growth and living standards. A consumption tax exempts all saving and investment from tax; all income saved is tax-free and all investment is written off, or "expensed," in the first year. As a result, the cost of capital for new investment would fall by about 30 percent.

If, instead of fundamental tax reform, political reality requires an incremental approach to tax reform, the ACCF recommends a menu cut of tax options that, taken either together or singly, could enhance competitiveness, increase economic growth, and promote retirement security. We have organized the menu into tax cuts for individuals and tax cuts for business.

Tax Cuts for Individuals

• Increase the deductible IRA contribution and/or raise the income limit. This step would make IRAs more accessible to middle and upper-middle income individuals and families. Many academic analyses by top public finance scholars indicate that IRAs do produce new saving that would not otherwise take place. An increase in the $2,000 deductible contribution for each employed person to $4,000 and/or raising the income ceiling for deductible contributions to $120,000 for married couples, for example, would tend to raise the personal saving rate.
  
  
• Repeal the federal estate (death) tax. Many public finance scholars support its elimination because it is a tax on capital and thus reduces the funds available for productive private investment, especially in family-run businesses. The ACCF's two new analyses on the death tax indicate that the death tax is higher in the United States than elsewhere and that the entrepreneurial sector and small businesses are particularly hard hit by the tax.
  
  
• Provide a tax-free "rollover" for reinvested mutual funds, interest, dividends, and capital gains. Allowing individual savers to make tax-free investments from the proceeds from transactions of this type would significantly increase the mobility of capital and would be a powerful incentive to save.
  
  
• Reduce the individual capital gains tax rate and provide an exclusion. A significant reduction from the current maximum tax rate of 20 percent would reduce the cost of capital, stimulate investment, and encourage the entrepreneurial activity that is a major source of U.S. economic growth. In addition, an annual exclusion of $5,000, for example, would help encourage saving and reduce the complexity of the tax code by allowing middle income investors to realize a relatively modest amount of capital gains without paying tax.
  
  
• Increase pension portability and access to tax-preferred saving plans. These reforms would make it more attractive for workers to take part of their compensation in the form of a "nest egg" for retirement than under current law. For example, easing rollover rules to allow employees to transfer between different types of plans and easing benefit transfer rules between qualified plans so employees can move benefits to their new employers' plans would not only increase retirement security but also help productivity growth through not hindering workers from changing jobs among firms and industries. Greater access to and higher ceiling on tax preferred saving accounts such as IRAs would also increase retirement security.
  
  
• Establish personal retirement accounts. Both the Clinton Administration and members of Congress have proposed using part of the budget surplus to fund personal retirement accounts. Chairman Bill Archer (R-TX) and Rep. Clay Shaw (R-FL) have introduced a proposal that both reforms social security and allows for the creation of individual accounts and the purchase of individual annuities for workers.
  
  
• Provide a deduction for dividends and interest received by individuals. Exempting, for example, the first $2,000 of dividends and interest received by married taxpayers ($1,000 for singles) is an approach used in many other countries.

Tax Cuts for Business

Comprehensive tax reform, to shift the federal tax base from income to consumption and thus permit the expensing of all investment, would have the strongest impact on capital costs and economic growth. However, more modest tax cuts on investment would also stimulate capital formation and growth.

• Phase in expensing for plant and equipment outlays. Scholars agree that expensing is the most efficient way of reducing the cost of capital for new investment. In the period 1981­p;1985, the United States had one of the best tax treatments for new investment in the world. In today's global economy, U.S. firms need tax parity with foreign firms in order to compete effectively.
  
  
• Provide more favorable tax treatment for investment to promote environmental goals. Tax credits or other provisions for environmental expenditures required to meet federal, state, and local standards or to enhance energy efficiency would ease the compliance costs facing U.S. industry. In addition, such tax measures would make it easier for capital-intensive manufacturing firms to continue operating their U.S. facilities.
  
  
• Provide relief from the corporate AMT. Eliminating the myriad of investment-based AMT preference items is essential. Additionally, providing for accelerated use of AMT credits will help alleviate the competitive disadvantage faced by commodity- based industries that are suffering low world prices. It will allow and ensure the long-term growth and competitiveness of basic U.S. industry. Relief efforts must take care not to diminish the value of the credits that have accrued in the past.
  
  
• Reform the foreign tax provisions of the U.S. tax code. Moving to a consumption tax in which all foreign-source income is exempt from tax (a "territorial" tax) would have a strong positive impact on the international competitiveness of U.S. firms. However, such a fundamental shift in tax policy is not now "on the table." Still, firms' ability to compete abroad could be enhanced through a variety of reforms to U.S. foreign tax provisions. U.S. industrial and financial service firms face higher taxes on their foreign-source income than do their international competitors (see Figures 2 and 3). Reducing the tax burden on the foreign-source income of U.S. firms would be beneficial by allowing them to be more competitive in foreign markets. For example, making permanent the one-year provision that reforms Subpart F of the Internal Revenue Code for financial service firms such as securities firms, insurance companies, banks, and finance companies would be an important step. As a matter of sound tax policy, U.S.-based financial service firms should be able to defer U.S. tax on the active income of their foreign subsidiaries until those earnings are returned to the U.S. parent company.
  
  It is equally important not to impose stringent new tax policies that make U.S. industrial and financial firms less competitive. For example, proposed changes that tighten the foreign tax credit and deferral would put U.S. firms at a further disadvantage.
  
  
• Reduce the corporate capital gains tax rate. A corporate capital gains tax cut would reduce capital costs and increase investment. Sound tax policy as well as economic considerations argue for a reduction in the U.S. maximum corporate capital gains rate of 35 percent, which is now the same as the top regular corporate tax rate. This would reinstate the historical U.S. treatment of corporate capital gains; an alternative corporate capital gains tax was part of the Internal Revenue Code from 1942 until its repeal by the Tax Reform Act of 1986. Reducing corporate capital gains tax rates would also help move the U.S. tax code toward a consumption tax base by lightening the burden on income from investment.
  
  
• Liberalize employer-sponsored pension plans. Improvements to employer-sponsored pension plans would increase saving and enhance retirement security. Small employers are often unable to provide pensions for their employees because of the cost and complexity of the system. A tax credit for businesses establishing new plans would be especially helpful to small employers. Creating a simplified defined benefit plan for small employers would promote the retirement security of small-firm employees.

CONCLUSION

Persistently low U.S. saving rates, and investment that in recent decades has lagged behind our industrial competitors despite continued economic growth and low unemployment, underline the need for pro-growth tax policies as a substantial part of any tax bill approved by this Committee. Given the projected budget surplus and the desire of many in Congress to enact a major tax cut for Americans, there is clearly an opportunity to move the U.S. tax system in a pro-growth direction.

We therefore urge Congress to give the most careful consideration to the pro-growth tax provisions discussed here.