Statement of Ernest S. Christian,
(Former Tax Legislative Counsel and Deputy Assistant
Secretary for Tax Policy,
U.S. Department of the Treasury)
Testimony Before the House Committee
on Ways and Means
Hearing on Fundamental Tax Reform
April 12, 2000
Introduction To Simplified USA Tax
The Simplified USA Tax by Congressman Philip English
(H.R. 134) is a landmark achievement that shows how
genuine tax reform can become a reality without resorting
to radical experimentation. The tax code can be simplified
without repealing the deductions for home mortgage interest
and charitable contributions; the double tax on saving
and investment can be removed without enacting a "consumption"
tax; tax equity for working men and women can be achieved
by allowing them a credit for the payroll tax they pay;
the archaic tax barriers to U.S. competitiveness in
world markets can be removed in a way that protects
and enhances American jobs; a simple deduction for the
cost of post-secondary education can, for the first
time in history, help put investments in human capital
on a par with investments in physical capital; marginal
tax rates can be lowered; progressivity can be preserved;
and transitional dislocations can be avoided.
Simplified USA embodies a new approach that has the
effect of including in the U.S. tax base for the first
time in history all amounts derived by foreign companies
from selling goods and services in the U.S. market.
It seems to me that the result is an enormous tax cut
for the U.S. economy -- perhaps $100 billion per year
or more -- paid for by foreign companies that presently
derive income from U.S. markets on a nearly tax-free
The biggest beneficiaries of this tax cut would seem
to me to be the wage earners of America who receive
a full credit for the payroll tax they pay now.
How Simplified USA Works -- Structural Framework
Like current law, Simplified USA consists of a business
tax and a personal tax with multiple personal rates.
The illustrative tax rates below trace back to H.R.
4700 in the 105th Congress and were carried over without
change into H.R. 134 when Simplified USA was reintroduced
in the 106th Congress.
(1) A Business Cash Flow Tax is paid by corporations
and other businesses. The rate is 12% of gross profit.
Profit is computed using cash accounting; capital equipment
is expensed because the income it produces is fully
taxed when received; no deduction is allowed for interest
or dividends paid for the use of capital, or for wages
paid for labor, but a full credit is allowed for the
7.65% OASDHI payroll tax which is the equivalent of
a deduction for about 65% of wages up to $72,000 per
year for each employee. Export income and all foreign-source
income is excluded from tax. A 12% import tax is collected
when foreign-based companies sell into the U.S. market.
(2) A Progressive-Rate Personal Tax is paid
by individuals when they receive interest, dividends,
wages, salaries, and gains. The two bottom rates are
15% and 25% and the top rate is 30% on taxable income
computed after deducting a Family Allowance of $8,000,
personal exemptions of $2,700 per family member, home
mortgage interest, charitable contributions and post-secondary
education expenses of up to $4,000 per family member.
Individuals are allowed a full tax credit for the employee's
share of the 7.65% OASDHI payroll tax withheld from
their wages and, if the amount of that credit exceeds
their USA income tax for the year, the excess is refunded.
All individuals are also allowed an unlimited USA Roth
IRA for personal saving -- except that, unlike the current
Roth IRA, saving is not limited to retirement and can
be withdrawn for any purpose. Because tax is paid on
the money going into this special savings and investment
account, there is no additional tax on the inside build-up
in the account or on withdrawals from the account. For
the first time in history, the double tax on all personal
savings will be removed and everyone will be allowed
to save for whatever purpose they desire.
Simplified USA is a plain-language, stripped-down version
of the current income tax (individual and corporate)
that is concentrated on the main goals of tax reform
-- which are (1) to be evenhanded as between labor income
and capital income; (2) to be neutral in a person's
choice to consume income or save; (3) to remove the
archaic barriers to international competitiveness; and
(4) to be neutral as between equity and debt financing
and evenhanded among all forms of business organization.
The basic amendments necessary to achieve these results
are neither unfamiliar nor shocking. First-year expensing
of plant and equipment is already allowed for small
businesses and probably would have been made universal
long ago except for revenue limitations under the current
The idea of removing the double tax from personal saving
-- and thereby taxing saved income no more heavily than
consumed income -- has been around a long time. Since
the enactment of the Roth IRA in 1997, the simple yield-exemption
approach to removing the double tax is now familiar
and standard fare. With the Roth IRA already very much
part of the tax landscape, it only remains for Simplified
USA to make it universal by eliminating the dollar caps,
the income limitations and the restriction to retirement
For decades, Treasury reports and bipartisan Congressional
studies on corporate/shareholder tax integration have
recommended uniform treatment of all forms of financing
and all forms of business.
There is nothing new about the idea of excluding foreign-source
income from taxation or about the related idea of not
taxing exports. The Foreign Sales Corporation (FSC)
provision in the current code is a flawed attempt to
go halfway, but FSC has run afoul of the WTO and it
remains for Simplified USA to do the job correctly in
a way that is consistent with U.S. tax traditions and
The Road to Simplification
Once the basic amendments necessary to achieve neutrality
and international competitiveness are made, some of
the most complex portions of the code become moot. Substantial
simplification automatically occurs. Simplified USA
also undertakes to eliminate an array of miscellaneous
deductions, credits, exceptions and exceptions to exceptions
that are unnecessary when the basic rules are correct
to start with. But Simplified USA does not make a fetish
out of repealing long-standing and familiar deductions
under the misguided belief that they are the source
of complexity in the code.
The existing and long-standing exclusions from income
for parsonage allowances, combat pay, municipal bond
interest or employer-paid health insurance are not the
reason that Form 1040 is monstrously long and incomprehensible.
Simplified USA retains these and several other exclusions
and deductions that are easily understood and of nearly
universal application without any special eligibility
requirements and that do not require any side calculations.
What, for example, is complicated about the deduction
for home mortgage interest? All the homeowner does is
take one number off the annual statement from the mortgage
lender and put that one number on one line of the tax
Simplified USA will reduce the size and complexity
of the tax code by about 75 percent and the personal
tax return (long Form 1040) will be only a few pages
-- about like it was in 1960 before four decades of
complexity ruined it.
Neutrality Between Saving and Spending
Simplified USA taxes income (whether saved or consumed)
only once. It does that by taxing income when received
(first tax) and then excluding the earnings on after-tax
savings from a second tax.
The current code's bias against income that is saved
is easily illustrated by a simple example: Mr. Jones
earns $100, pays a $40 income tax, and has $60 after-tax
income left over. If he uses the after-tax $60 to buy
a car to drive to work (in lieu of paying bus fare),
he will not have to pay tax on the value of the transportation
services the car provides him; nor should he. After
all, he has already paid tax on the $60 once. On the
other hand, if instead of buying the car, Mr. Jones
saves the after-tax $60, he will have to pay bus fare
(having no car) and he will have to pay tax on the interest
earned by the $60 of savings. This is not a correct
result. It biases Mr. Jones's choice against saving.
Simplified USA produces the correct result: once Mr.
Jones has paid his tax, he is not taxed again, either
on the interest earned by his after-tax savings or on
the value of the transportation services provided by
Simplified USA is carefully crafted to allow American
companies to compete and win in world markets without
in any way providing a tax incentive for American companies
to move their plants and jobs offshore. In fact, it
makes the United States of America a very attractive
place to be for the purpose of conducting a worldwide
Simplified USA does this by the combination of three
things. First, it replaces the current archaic and inconsistent
worldwide tax rule with a territorial rule consistent
with modern practice in other countries. Thus, when
necessary, U.S. companies will be able to invest and
compete directly in foreign markets without having to
pay U.S. tax on the profits they make in some other
country's economy and bring home for investment in America.
Second, export income will be excluded from U.S. tax.
Thus, a U.S. company can stay home, manufacture in the
U.S. and sell into a foreign market without paying U.S.
tax. Third, an import tax will be imposed at the same
rate as the regular USA business tax rate -- 12%. Thus,
while a company may operate abroad when necessary to
gain foreign-market sales that cannot be reached by
exports from the U.S., if it goes abroad for the purpose
of selling back into the U.S. market, it will have to
pay a U.S. tax at the border without the benefit of
International competitiveness will flourish under Simplified
USA, but there will be no runaway plants.
The Way Border Tax Adjustments Work -- A Major Shift
in the Tax Burden
The border tax adjustments in USA have been borrowed
from the European VAT (which is a form of sales tax)
and appended to the business portion of the USA Tax
in a WTO-permissible way -- but when appended to a business
cash flow tax like the USA business tax, the border
tax adjustments operate quite differently from they
way customarily are thought of in the VAT context.
Because the USA business tax is a tax on net cash flow
instead of a tax on goods, USA excludes from tax the
revenues derived by a business from exports. This full
exclusion of export revenues is similar to the partial
exclusion provided by the Foreign Sales Corporation
(FSC) rule in the current corporate income tax which
the USA business tax resembles in many ways.
Except for exports, USA includes in the tax base all
GDP -- which, in turn, is equal to the sum of all returns
to labor (wages and salaries) and all unreinvested returns
to capital (interest and dividends).
By means of an import adjustment, USA also includes
in the tax base an additional amount which represents
the amount of goods and services that are produced by
foreign-sited labor and capital but sold into the United
States market. The 12 percent import tax might appear
to make imported products more expensive, and, in some
cases, it will, but both neoclassical economic theory
and common sense say that in many more instances involving
a very large portion of the total dollar value of imports,
the foreign companies who sell these imports into the
U.S. market will have to absorb all or a major part
of the 12% import tax. They will do this by adjusting
their pre-tax price downward so that the after-tax price
to the U.S. purchaser is the same or nearly the same
amount that purchasers had previously been paying. When
foreign companies do lower the pre-tax prices, they
are, in effect, paying the U.S. tax and when a company
pays a tax (whether it be U.S. tax or home country tax),
the burden of that tax will ultimately be borne by its
employees (in the form of lower wagers or fewer jobs)
and its shareholders and debtholders (in the form of
lower returns to capital).
As of the end of 1999, imports were $1.3 trillion involving
an almost uncountable number of U.S. buyers and foreign
sellers of an almost uncountable variety of imported
goods and services. Out of all this, no one knows how
many of the foreign companies will be "price takers"
who will absorb all or part of the import tax or how
many will be "price setters" who will not
absorb any of the import tax. Therefore, no one knows
the precise dollar value of the import tax that will
be passed back to foreign labor and capital, but we
do know that much of it will be. The U.S. market is,
after all, the largest market in the world and the pressure
on foreign companies to absorb at least a part of the
tax will be large. Only those who sell a unique product
for which there is no substitutable alternative will
be totally immune from that pressure, but there are
not so many of those situations and, even when they
do exist, what may be a unique product today may not
The point is not to be precise about the exact amount
of import tax that will be borne by foreign labor and
capital. Rather, the point is to know that the dollar
amount is large and that even if 60 percent of the $160
billion import tax revenue increase is borne by foreign
labor and capital, that mans that the U.S. economy has
received roughly a $100 billion per year tax cut.
Payroll Tax Credit -- An Offset to Implicit and
Explicit Taxes on Wages
Not only is the payroll tax credit an historic breakthrough
in fairness, it is essential to the evenhanded treatment
of labor and capital that is the hallmark of Simplified
USA and the foundation on which genuine tax reform must
A. Implicit Withholding Tax Offset by Payroll Tax
Like the current corporate income tax, the USA business
tax is an implicit withholding tax on dividends. (Unlike
the current corporate income tax which favors debt over
equity, the USA business tax also serves as an implicit
withholding tax on interest as well.) This implicit
withholding on interest and dividends arises because
the business pays tax on its as gross profit without
any deductions for interest paid or dividends paid.
Like the current employer-paid OASDHI payroll tax,
the USA business tax also serves as an implicit withholding
tax on wages -- because the business pays tax on its
gross profit without deducting wages.
But for the credit that Simplified USA allows for the
7.65% employer-paid payroll tax (which reduces the implicit
withholding), the implicit withholding on wages up to
$72,000 per employee per year would be 19.65% (12% +
7.65%); whereas the implicit withholding on wages in
excess of $72,000 and on interest and dividends would
be only 12% (the USA business tax rate).
With the payroll tax credit, the implicit withholding
tax is uniform as follows:
Wages up to $72,000
Wages above $72,00
Interest and Dividends
B. Explicit Tax Offset by Payroll Tax Credit
When wages, interest and dividends are received by
individuals, the remainder of the tax on that income
is collected from the individual, and, in the case of
wages, all or part of that tax may be withheld at the
source by the employer as under current law.
In the case of wages up to $72,000, however, current
law imposes an additional 7.65% employee-paid OASDHI
tax that is explicitly withheld at the source by the
Simplified USA allows the employee a credit for the
7.65% OASDHI tax explicitly withheld from wages. With
this credit, wages, interest and dividends are all taxed
equally, the only variation being the rate bracket of
the particular individual -- 15%, 25% or 30%.
Resisting Analogies -- Simplified USA Is Sui Generis
The Simplified USA Tax combines some elements that
may also be found, variously, to some extent, and in
different forms, in taxes said to be based on cash flow,
net income, consumed income or business value added,
but because Simplified USA is a hybrid, none of those
analogies is altogether accurate or especially illuminating.
Simplified USA is best understood as the current income
tax amended to allow (1) first-year expensing of capital
equipment, (2) an unlimited Roth IRA for everyone that
applies to all saving (not just retirement saving) and
(3) a credit for OASDHI payroll taxes. Internationally,
it adopts a "Super FSC" for outbound transfers
(exports) and a "Super §482" adjustment
on inbound transfers (imports).
If one insists on putting Simplified USA into some
preexisting generic category, the USA Tax on individuals
is an "income tax" and the USA Tax on businesses
is a "business cash flow tax" (a concept which
is well-known and long-standing in the tax literature).