STATEMENT OF ERNEST S. CHRISTIAN
Appearing on Own Behalf and as Former Tax Legislative Counsel
Deputy Assistant Secretary (Tax Policy) of the Treasury Department
BEFORE THE COMMITTEE ON WAYS AND MEANS
U. S. HOUSE OF REPRESENTATIVES
JUNE 7, 1995
RE: S. 722, THE USA TAX ACT OF 1995
Introduction to USA Tax
Over the last 25 years I have on many occasions appeared before
this Committee but never with as much enthusiasm and conviction
as today. The USA Tax proposal by Senators Domenici and Nunn
is a landmark achievement in the on-going development of tax
policy and design. It shows how you can accomplish revolutionary
change in the American tax system. You can allow a full deduction
for personal savings. You can allow wage earners a full tax
credit for the FICA payroll tax on their wages. You can allow
full expensing of business capital investment. You can exclude
exports from tax while taxing imports. You can simplify the
tax law, thereby making it less wasteful and less intrusive.
You can do all this and more within the framework of a tax
on income -- in this case, consumed income. You can do it
without either raising taxes or increasing the deficit and
without diminishing progressivity unless you choose to do
The USA Tax does not stop at the theoretical stage. S. 722
confronts the hard questions of reality and contains a fully
articulated, fully functional new American tax system that
would actually work in our complex economy and society. Yet,
it is a true and successful exercise in minimalism.
The art of using the fewest and simplest elements to
achieve the greatest effect.
Its hallmark is neutrality, not regulation. The USA Tax is
expressly designed not to interfere in the economic lives
of Americans to any material extent beyond the amount of tax
they pay. It concentrates on removing barriers to individual
choice and barriers to economic growth. These are the keys
to greater personal independence and responsibility. These
are the keys to a higher standard of living which is the true
measure of fairness.
The USA Tax is a completely new replacement tax. It is built
from the ground up around a set of principles derived solely
from the way income is actually created, received and used.
Every dollar of income is created at the business level by
the people who do the work and the people who provide the
capital out of their savings.
When a dollar of income is created through the production
of goods and services, the first part of the total USA Tax
is collected from the business -- unless that income is reinvested
to produce additional goods, services and income for us all.
In that case, the business tax is deferred and is collected
later when reinvestment ends. At that point, assuming a successful
reinvestment, additional dollars of income will have been
created and a greater amount of tax will be collected.
When the same dollars of income, net of the tax paid at the
business level, flow out to and are received by individuals
as compensation for work or as compensation for the use of
capital, the second part of the USA Tax is collected from
them -- unless they choose to put the income back into the
national savings pool where it will again be reinvested to
produce additional goods, services and income for us all.
In that case, the individual tax is deferred and is collected
later when income is withdrawn from savings and spent. Only
at that point have people actually "received" income
for their own use and enjoyment and only at that point is
the individual part of the USA Tax collected.
Although the USA Tax collects tax at points, it also splits
the tax rate into two parts. The total tax is the same as
if (i) individuals were allowed a tax credit for the business
tax or (ii) there were no business tax and all tax was paid
by individuals. This is illustrated below where in all three
cases the desire is to collect $28 of tax on $100 of income
USA Tax Split Rate: $100 of income H 11%
business tax rate = $11 tax; $89 income received by individual
H 19% individual tax rate = $17 tax. Total tax of $28 collected.
Credit For Business Tax: $100 income H 11% business
tax rate = $11 tax; $100 "grossed up" income received
by individual H 28% individual tax rate = $28 gross tax less
$11 credit = $17 tax. Total tax of $28 collected.
Individual-Only Tax: $100 income received by individual
H 28% individual tax rate = $28 total tax collected.
The USA Tax Removes the Tax Bias against Saving and Allows
All Americans a Fair Choice. For individuals, the USA
Tax is a simple tax on income minus the amount saved -- like
a fully deductible IRA but without special governmental restrictions
or accounts. For example, the Jones Family earns a combined
salary of $48,000 and saves $5,000 which they use to start
their own small business. They deduct $5,000 and pay tax only
on the amount by which $43,000 exceeds their other deductions
and exemptions. Having deferred tax on $5,000 of salary, if
the Joneses later withdraw $5,000 from the business (and from
the national savings pool), they will pay tax on the $5,000
of deferred salary at that time -- unless they roll it over
into a stock, bond, a CD or any one of the many other choices
people can make both when they initially save and when they
move savings from one investment to another. So long as earnings
are deferred and remain in the national savings pool, the
tax continues to be deferred. Not only is the USA Tax neutral
in an economic sense -- in the choice to save -- it also gives
people full control over their savings. The USA Tax also does
not tell people how much or how little they can save or for
what purpose. Saving is not limited in amount or restricted
to retirement uses.
The USA Tax is also even-handed in its definition of income.
Interest, dividends and gains are treated the same as wages
and salaries. All are included in income -- less the amount
saved -- and are taxed under the same rate schedule.
The USA Tax Simplifies the Tax Law, Thereby Reducing the Presently
High Cost of Compliance and Administration. The proposed
new income tax code in S. 722 is much smaller in size than
the present monstrosity and will be much easier to apply.
It consists primarily of straightforward, understandable rules
of universal application with few exceptions. For a tax statute,
and given the complexities of the economy in which it must
operate, the USA Tax is written in plain English.
The USA Tax retains deductions for charitable contributions
and home mortgage interest, and allows a new deduction for
education costs but these are not the source of any significant
amount of complexity. For example, the home mortgage interest
deduction involves no more than transferring onto a tax return
a single number furnished annually to the homeowner by the
mortgage lender. The USA Tax uses progressive tax rates in
a three-bracket system, but the use of one, two or three rates
has no material effect on complexity one way or the other.
Under the USA Tax, people will still have to file tax returns.
In that respect, paying taxes will still involve some paperwork
and computation, although much less than today. We might all
wish to be totally relieved of that burden, just as we all
might wish to be excused from paying taxes altogether. On
balance, however, the annual process of Americans filing simple
tax returns is a net positive. It reinforces in our minds
an acute awareness of how much tax we pay for what government
The USA Tax Allows Wage Earners a Full Tax Credit for the
Employee-Paid 7.65% FICA Payroll Tax, Thereby Assuring That
the Real Marginal Rate on Wage Income Is No Longer Higher
Than on Dividends, Interest and Other Financial Income.
Because of this credit, the nominal rates under the USA Tax
are inclusive of the payroll tax and are, therefore, the real
marginal rates on both wage income and financial income. In
contrast, the rates under present law are in addition to the
payroll tax. For example, a middle bracket rate of 31% under
present law is 31% on dividends, but the real marginal rate
in the same bracket is 38.65% on wage income up to the OASDI
Another Way of Looking at the Payroll Tax Credit Is to Say
That the Stated Rates under the USA Tax Are Lower Than They
Appear To Be. In the first year, on a joint return, the
USA Tax rates in S. 722 are 19%, 27% and 40%, and after a
transition period are 8%, 19% and 40%. From the perspective
of most wage income, another way of looking at the rates under
the USA Tax is to reduce each bracket rate by 7.65 percentage
points. Viewed that way, the rates under the USA Tax on wage
income up to the OASDI wage base are as follows.
First Year (Joint Return)
Fifth Year (Joint Return)
The USA Tax Removes the Bias against Business Capital
Investment and Levels the International Playing Field.
In the business area, the USA Tax also concentrates on eliminating
arbitrary distinctions and removing barriers to productivity
and growth. All businesses are taxed alike without regard
to size, corporate or noncorporate form of organization, or
whether financed by debt or equity capital. The business tax
rate is a uniform 11%. Because the USA Tax allows all businesses
a full credit for the employer-paid 7.65% FICA payroll tax,
the uniform 11% rate is inclusive of the payroll tax. This
11% inclusive rate compares to a 35% present law corporate
tax rate in addition to a 7.65% employer-paid payroll tax
All businesses are allowed to expense the cost of plant and
equipment, inventory and supplies. Having recovered these
costs out of sales, the remaining "gross profit"
is taxed at 11% before paying employees their share and before
paying shareholders and debtholders their share. The result
is a uniform 11% tax at the business level on returns to labor
and returns to capital. Both are treated the same, just as
they are under the individual tax.
The USA Tax achieves parity in the international arena, thereby
giving American workers and companies a fair chance to compete
and win in global markets. The USA Tax excludes export sales
from the 11% business gross profit tax. It taxes imports at
11%. Thus, the more a U.S. company increases its exports to
foreign markets, the less tax it will pay in proportion to
total revenues and total gross profit. Conversely, the more
foreign-based companies manufacture abroad and compete in
the U.S. market, the more import tax they will pay. All businesses
that compete in our markets will pay their proportionate share
of the cost of government in this country.
The USA Tax Neither Increases Nor Decreases Total Revenues
and Does Not Materially Alter the Distribution of the Total
Tax Burden Either Between Businesses and Individuals or Among
High, Middle and Low Income Groups. The USA Tax concentrates
on restructuring the fundamental components of the tax system.
Separating the way we tax ourselves from the amount
we tax ourselves serves several purposes. First, it permits
full and objective concentration on arriving at the best fundamental
tax structure for the long-term best interests of America,
unimpeded by other considerations that will vary over time
as revenue needs change and as attitudes about progressive
versus proportional taxation change. Second, it serves to
demonstrate that such a tax structure can be created and that
the fundamental goals of tax restructuring can be achieved
even within the constraints of revenue and distributional
neutrality. For example, within these constraints, the USA
Tax still allows a full deduction for personal savings, expenses
business capital investment, excludes exports from tax, and
greatly simplifies the tax law.
If the constraints of revenue and distributional neutrality
were to be relaxed, the rates of tax could be lowered and
compressed -- even into a single rate, if the Congress desired.
Similarly, the Congress could decide not to allow personal
deductions for charitable contributions or home mortgage interest.
The structure of the USA Tax would, however, remain the same
and all the goals related to savings, business investment,
exports and simplification would still be achieved. Rates
of tax, the total revenues raised, etc. are important policy
decisions, but they are extraneous to the highly salutary
basic structure of the USA Tax which is designed to produce
fundamentally correct and consistent results in all events.
It should be kept in mind that by historical standards, the
USA Tax rates are already fairly "flat." There are
only three bracket rates, the brackets are not very wide,
and the top rate is only twice the bottom rate. The credit
for employee-paid FICA tax, allowed by the USA Tax but not
allowed by present law, plays a major role in maintaining
distributional neutrality relative to present law.
USA Tax for Individuals -- Rates, Exemptions, Deductions
and Basic Computations
The USA Tax has three brackets and three rates that increase
as income increases. For illustration, the rate schedule for
married persons filing jointly is set forth below.
Taxable Income Above
Taxable Income equals Gross Income minus Exemptions and Deductions.
|Gross Income =
||Wages and salaries plus financial income such as interest, dividends and amounts
received from the sale of assets.
A Family Allowance:
....................... $7,400 Married/Joint
.................... $3,700 Married/Separate
.................. $5,400 Head-of-Household
||Personal and Dependents: $2,550 each for taxpayer, spouse and all dependents.
||The Unlimited Savings Allowance -- Everyone is allowed a full deduction for the
amount of income they save. E.g., deposits in a savings
account, purchase of a stock or bond, start-up capital
contributed to one=s own small business.
Higher Education Deduction -- The USA Tax allows a
deduction for tuition paid for higher education. The
deduction is limited to $2,000 per person for the taxpayer,
a spouse and up to two dependents. The total deduction
in a year is limited to $8,000. Higher education generally
includes college and similar vocational education. The
deduction is also allowed for remedial education of
students under 18 years of age.
Home Mortgage Interest Deduction -- generally same
as under present law.
Charitable Contribution Deduction -- generally same
as under present law.
||Alimony Paid Deduction -- same as under present law.
Tax Due equals (Taxable Income H Tax Rate) minus Credits.
|A refundable credit for the employee-paid
portion of the FICA payroll tax.
A refundable credit for the amount of withholding tax
paid in advance.
A refundable credit for the amount of estimated tax
paid in advance.
S. 722 also allows a refundable Earned Income Tax Credit,
although the status of the EITC in general may be uncertain
under House and Senate budget resolutions.
Because the deduction for income that is saved defers tax
only for so long as that income is left in the national savings
pool, taxable income for a year may include withdrawals from
savings of income that had been deducted and deferred in a
prior year. Further, in the year that prior-year savings is
withdrawn, the same person may also have deposited some current-year
income in savings. Thus, depending on whether the amount withdrawn
exceeds the amount deposited or vice versa, the person may
have "net withdrawal income" or a net savings deduction.
For example, in 1996 (prior year), the Smith Family deferred
tax on $1,000 of salary income by putting it in Savings Account
A. In 1998 (current-year), the Smith Family deposits $500
of 1998 salary in Savings Account B, but withdraws $1,000
from Savings Account A. In 1998, the Smith Family has net
withdrawal income of $500 ($1,000 withdrawn from Savings Account
A less $500 deposited in Savings Account B). On the other
hand, had the Smiths in 1998 deposited $1,000 in Savings Account
B and withdrawn only $500 from Savings Account A, they would
in 1998 have a net savings deduction of $500 ($1,000 deposited
in Savings Account B minus $500 withdrawn from Savings Account
Because the USA Tax only taxes income (current-year plus prior-year
income on which tax has been deferred), retirees and others
will not have additional taxable income when they withdraw
"old savings" that has already been taxed under
present law. For example, before they retired in 1996 (first
year of USA Tax), Mr. and Mrs. Brown had saved $100,000 out
of after-tax income. Because they had been allowed no deduction
(and had prepaid tax instead of being allowed to defer tax),
they can during retirement withdraw the $100,000 without having
to again pay tax on it. The USA Tax only taxes income once,
Also, because the USA Tax taxes income (not expenditures),
borrowing does not result in tax even though the amount borrowed
is "consumed." For example, James Jones borrows
$7,000 to live on while in his last year of college. James
will not pay tax because he has no "income." However,
when he graduates, gets a job and earns a salary, he will
repay the loan out of income and get no deduction for the
repayment. Thus, when James does have income, he will pay
tax on the income that he had "consumed in advance"
while in school.
It is under the USA Tax conceptually and in every other way
correct not to include in income either borrowing or withdrawals
of "old saving" that has already been taxed. It
is, however, necessary to take these events into account in
another way in a some circumstances. For example, in 1998
Mr. Executive earns $200,000, consumes $200,000, borrows $200,000,
and buys Stock A for $200,000. The USA Tax would not allow
him to claim a $200,000 savings deduction and pay zero tax
on his $200,000 of earnings. Reason: Net of borrowing, Mr.
Executive did not save anything. He did not add to the national
savings pool. He only borrowed someone else=s existing savings
and shifted it into Stock A. Similarly, Mr. Executive could
not withdraw $200,000 of his own "old savings" and
at the same time, claim a deduction for $200,000 Stock A purportedly
bought with his $200,000 current-year earnings. Again, he
did not add anything to the national savings pool. He only
shifted his savings to another investment.
This special netting rule for borrowing and old savings involves
some amount of computation and complexity. Borrowing must
be accounted for and old saving must be distinguished from
new saving that has been deducted. In order to relieve nearly
all taxpayers from the special netting rule, the USA Tax contains
two simplifying rules. First, all home mortgage debt plus
ordinary consumer debt up to $35,000 is excluded. Second,
people with less than $50,000 of previously-taxed "old
savings" can elect to deduct it over three years. Thus,
nearly all taxpayers will be excluded from the special netting
rule and will never be involved with it.
The three-year amortization deduction for $50,000 of old savings
also provides an additional and substantial monetary benefit
to retirees and others. The amortization deduction, in effect,
gives back to them the present law tax that they prepaid on
savings up to $50,000.
The USA Business Tax -- Rates, Deductions and Basic Calculation
Every business that is producing and selling goods and services,
and, therefore, creating income, must file an annual business
tax return and pay the 11% tax on its annual "gross profit"
which is a defined term under the USA business tax. In calculating
its gross profit tax base to which the 11% tax is applied,
the business adds the amount it received from sales of goods
and services and subtracts the amount it paid to other businesses
for the goods and services it had to buy from them (plant,
equipment, inventory, supplies, rent, utilities, telephones,
fuel, legal and accounting fees, etc.). Excluded from the
gross profit calculation are financial receipts and payments.
For example, the business neither includes interest and dividends
received nor deducts interest and dividends paid. Compensation
payments to employees are not deductible. Amounts received
from export sales of goods or services to a purchaser outside
the United States are excluded from the calculation of gross
profit. Correspondingly, an 11% import tax is imposed on the
sale of goods and services into the United States from abroad.
E.g., a foreign business that manufactures outside the United
States but sells its products in the U.S. market will pay
the import tax. A tax credit is allowed for the 7.65% employer
FICA payroll tax that businesses must pay on wages paid to
employees. The USA business tax is territorial. Businesses
will not include in gross profit the proceeds from sales made
or services provided outside the United States and they will
not subtract amounts paid for the purchase of goods or the
provision of services outside the United States. Businesses
will not be taxed on dividends paid by foreign subsidiaries.
Foreign businesses will include in gross profit amounts received
for goods sold or services provided in the United States and
will subtract amounts paid for goods acquired and services
provided in the United States.
Resisting Analogies -- The USA Tax Is Sui Generis
The 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 net cash flow, net income, consumed income
or true business valued added, but because the USA Tax is
a hybrid, none of those analogies is altogether accurate or
Interesting and fairly accurate analogies could also be made
to an amended, much improved and simplified version of present
law. For example, the USA Tax on businesses has been analogized
to a combination of the existing employer payroll tax and
a low-rate version of the existing corporate income tax amended
to provide for expensing of capital investment and amended
to treat debt and equity the same. The USA Tax on individuals
has also been analogized to a simple version of the existing
individual income tax amended to allow an unlimited, unrestricted
IRA deduction for income that is saved and that is taxed only
when withdrawn from the IRA. But, here again, the attempt
to translate the USA Tax into something else tends to obscure
its own merits.
The USA Tax is best understood in terms of its own actual
substance and its own consistently applied concepts -- not
in terms of the tax system of the past that is being repealed
and not in terms of some tax system that exists somewhere
else or that is only generally described in academic literature.
Fundamental Concepts -- Understanding the USA Tax as an Integrated
The USA Tax is an integrated, internally consistent whole
that collects a single amount of tax in two parts and at two
points in the economy. The first part is collected at the
business level where income first arises from the production
of goods and services and the second part is collected when
the income (net of the tax collected at the business level)
is received by individuals either as wages and salaries or
as interest, dividends, gains, etc.
Because the rate of tax is also split into two parts, with
one part applying to income when created and another part
applying to income when received, the total amount of tax
and the total rate of tax on a dollar of income is the same
as if the total amount of tax had been collected solely at
the business level or, in the alternative, solely at the individual
The USA Tax derives from the way the economy actually works
-- from the way real goods and services are actually produced,
from the fact that this productive process is the source of
all income, and from the way that individuals actually receive
that income either as employment flows (wages and salaries
as compensation for work) or as financial flows (interest
and dividends, etc. as compensation for the use of their capital
and, ultimately, a return of that capital). When a tax is
injected into the economic process by which income is created,
it must be collected either at the point of production (businesses)
or the point of receipt (individuals). If the tax is collected
at the point of production, it must be based either on the
labor component of production or the capital component of
production, or both. If the tax is collected at the point
of receipt, it must be based either on the employment flows
to individuals, or the financial flows to individuals, or
both. Therefore, this basic structure and operation of the
economy dictates the structure of almost any tax -- whether
it is called the USA Tax or, generically, "X."
A potential component of a tax base appears
at each of the four endpoints marking the extremities of the
two intersecting lines in the form of an "X," but
there is, in a sense, some duplication. The Employments Flows
(4) are a reappearance at the individual level of the Labor
Component (1) at the business level, and (4) is equal in amount
to (1) less any tax already collected out of (1) at the business
level. Similarly, the Financial Flows (3) are a reappearance
at the individual level of the Capital Component (2) at the
business level, and (3) is equal in amount to (2) less any
tax already collected out of (2) at the business level.
Within this rigid construct, there is flexibility in the design
of a tax in choosing to impose tax at all or only on some
of the four possible points, in choosing to impose tax at
uniform or varied rates on one, more or all of the potential
components of the tax base, and in choosing to specially define
one, more or all of the potential components of the tax base.
Even these choices are, however, not open-ended. Great care
must be exercised in order to avoid inconsistent treatments
of "likes" and similar anomalies that cause undesirable
economic or political consequences. The administrative consequences
of choices and combinations of choices must also be taken
Setting aside matters such as the tax rates, and concentrating
on fundamentals, there are four basic constructs that are
highly pertinent to the origins and development of both the
USA Tax as well as various alternatives.
Basic Construct X-1. Collect all tax at
the business level based on the Labor Component (1) of production
and the Capital Component (2) of production.
Basic Construct X-2. Collect all tax, in the same total
amount, at the individual level based on the Financial Flows
(3) and the Employment Flows (4).
Basic Construct X-3. Collect the same total amount
of tax, but collect it in part at the business level and in
part at the individual level as follows. Tax the Capital Component
(2) at the business level and tax the Employment Flows (4)
at the individual level.
Basic Construct X-4. The same as X-3 except that a
partial tax at the business level is collected from both the
Labor Component (1) and the Capital Component (2), and, at
the individual level, the remainder of the tax is collected
from both the Employment Flows (4) and the Financial Flows
Basic Construct X-4 represents the USA Tax. The essential
ingredients of a modified business cash flow tax or true tax
on business value added (as distinguished from the VAT form
of retail sales tax) can be found in Basic Construct X-1.
Basic Construct X-2 contains the basic building blocks of
a household-only cash flow tax. Basic Construct X-3 represents
the Flat Tax.
Although less clearly and completely, a sales tax can also
to some extent be fitted into and understood within this framework.
Like X-2, a sales tax is also a household-only tax. Unlike
X-2, however, the sales tax is not based on any direct measurement
of total Employment Flows (4) and Financial Flows (3), but
is instead based solely on item-by-item purchases. Therefore,
it involves no tax return by a household and because it does
not, the sales tax cannot vary the rate of tax by household
income and cannot distinguish between purchases made with
income, purchases made with previously taxed savings, or purchases
made with borrowed funds.
* * *