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Fed Chief's Testimony Makes Income/Consumption Tax System More Likely; Tax-Free Savings/Investments Favored

Federal Reserve Board Chairman Alan Greenspan told President Bush's Tax Reform Panel on March 3 that a hybrid income and consumption tax would not only spur economic growth it would also be more likely to get through Congress than moving the nation to a flat tax or pure consumption tax. With the panel showing rapt attention, the influential chairman highlighted some of the advantages and drawbacks of a hybrid system.

 Comment. In many ways, the U.S. already has a hybrid system. The U.S. does not tax all income. Many lower-income Americans pay no federal taxes. In addition, several provisions in the current Tax Code lower the rate on savings. "To the extent that you're lowering the rate on savings, you're essentially placing it on consumption," Greenspan noted.

Greenspan testified at the panel's second round of hearings in Washington , D.C. The panel first met in Washington on February 17 and will be traveling to Florida and Illinois later this month for more hearings. President Bush has directed the panel to look at every way possible way to reform the Tax Code and make recommendations later this year. Their recommendations likely will be the blueprint for a comprehensive overhaul of the nation's tax system.

Moving toward a hybrid system

At the panel's first meeting in February, several members expressed interest in a hybrid income-consumption tax system and their interest seemed to grow at the second meeting. Speaking from prepared remarks, Greenspan said "a consumption tax would be best from the perspective of promoting economic growth."

Greenspan reminded the panel that in the next few years the first members of the "Baby Boom" generation will start to retire. The country needs to encourage more savings and, at the same time, create incentives for working, he said.

Questions about fairness

Greenspan caution that a consumption tax would not be problem-free. A big issue is determining how to tax consumption financed by old capital that has already been taxed. Another concern, expressed by the vice-chairman of the panel, former Louisiana Democratic Senator John Breaux, is whether a national consumption tax would be unfair to lower-income taxpayers.

"You can always put a degree of progessivity into a tax system. Probably the simplest way is to exclude certain items from the tax, which tend to be disproportionately consumed in a lower bracket," Greenspan said.

View from the IRS

IRS Commissioner Mark Everson, while careful not to endorse any proposal for changing the federal tax regime, urged the panel to get a practical understanding of how a national consumption tax and other tax regimes would work. He suggested that the panel might want to take a look at how tax regimes in other countries, such as a national consumption tax, operate. A number of European countries have hybrid income-consumption tax systems. Several eastern European countries have recently enacted flat tax systems for personal and business income.

Everson also spoke about tax complexity. He waved a copy of CCH INCORPORATED's 1,192-page Law, Explanation and Analysis of the American Jobs Creation Act of 2004 to show how many changes one tax law can make. He highlighted the new manufacturing deduction as an example of a concept that was simple in theory but complex in implementation.

Turning to individuals, Everson reminded the panel that "people don't even begin to understand the Tax Code." Individuals are overwhelmed by the number of credits, deductions and incentives, Everson said.

Other voices

The panel also heard from former Treasury Secretary James Baker who played a key role in passage of the Tax Reform Act of 1986. Baker cautioned against reform proposals that have little political support. "It doesn't do any good to send something up to get it shot down," Baker told the panel.

Nina Olson, the National Taxpayer Advocate, told the panel that the Tax Code can be made less complex by simplifying 10 provisions. They are the Earned Income Tax Credit (EITC), the Alternative Minimum Tax ( AMT ), retirement provisions, education provisions, the "kiddie" tax, worker classifications, family status provisions, e-commerce, joint and several liability, and mortgage interest rules.