These encouragements to invest available funds abroad have also encouraged the development of huge multinational corporations, which may have interests in a dozen or a score or more of countries, and can readily transfer funds from one currency to another. It is of more than passing interest that funds behind the most recent spate of speculation against the United States dollar have been alleged to come in large part from two sources-the oil-rich countries of the Middle East and the big multinational corporations with their large supply of mobile liquid assets. Thus it may well be that tax windfalls to these big corporations with their headquarters in the United States have contributed in part to the speculation which helped force devaluation of the U.S. dollar, and is keeping it still in difficulty. The whole system of tax preferences to foreign investment should be reviewed and reevaluated. Many of its provisions should be eliminated outright. In the case of the tax credit, further study should be given to the alternatives of complete elimination or sharp reduction of the present 100 percent credit for taxes on foreign profits. The elimination of tax deferral on foreign profits, of course, would also eliminate the excuse that was used to secure enactment of the DISC legislation that defers taxes on part of the profits of U.S. export sales subsidiaries. The argument was that the DISC deferment would reduce the advantages of foreign over domestic production for U.S.-based corporations. In other words, a new tax loophole was opened to offset the harmful effects of an existing loophole, when the obvious solution was to close the latter. PERSONAL INCOME TAX REFORMS NEEDED As indicated earlier, revenue savings in the neighborhood of $50 billion could be attained by plugging loopholes in the personal income tax law. Some of these benefit the wealthy almost exclusively, while others appear to benefit those in lower income brackets to some extent, but confer so much greater benefits on the rich that their removal, and the use of the savings either to reduce other taxes which bear more heavily on those with lower incomes, or to finance programs of social need, or a combination of both, would be to the ultimate benefit of those in the lower and middle income brackets. The figures as to savings are selected from a paper. "Individual Income Tax Erosion by Income Classes", prepared for the Joint Economic Committee by Joseph A. Pechman and Benjamin Okner under the auspices of The Brookings Institution, although we have excluded from taxation a few items which they include, notably transfer payments, imputed rents and personal exemptions. The estimates are for calendar 1972. Capital Gains.-Largest among the loopholes which benefit the wealthy almost exclusively is the exclusion from taxation altogether of one-half the profit made on realization of long-term capital gains on such assets as securities, nonresidential property, etc. Although some taxpayers in the middle income brackets may achieve some small capital gains through holding such assets, data on stock holdings in particular show that the overwhelming proportion of them are held by only a small fraction of the population. A still grosser fraud on the public purse, although not as great in the amount of income affected, is the provision by which no capital gains tax at all is paid on such assets if they are given away by the owner or transferred to his heirs at death. Any gain from the time they were acquired until the point of transfer is completely wiped out for tax purposes. Dividend Exclusion.-Associated with this is the exclusion from taxable income of the first $200 on a joint return received each year in dividends. Again, there may be some in the middle income brackets who benefit from this. but since their highest tax bracket is so much smaller than that of the wealthy, and it is to the highest tax bracket that the saving applies. again the wealthy reap by far the greater benefit. By full taxation of all these forms of income, the additional revenues from the wealthy could be used in part to offset whatever small increases in taxation are imposed on those with lower incomes, and still leave billions per year in increased revenues which could be used to reduce taxes for all those in the middle and low income brackets, as well as helping to finance essential social programs. Taxation of Earned Income.-In comparison with this favored treatment for the rich, the average wage or salary earner pays full tax rates on all his earnings except for the usual exemptions and deductions. This illustrates a curious about-face in our government's attitude toward taxation of earned and unearned income respectively. For many years it was felt that the wage or salary earner should be given a tax preference, both because income for which one worked was felt to deserve better treatment than that which came without effort, and also to help offset the costs involved in working. A parallel was also drawn between the depreciation allowed on capital assets, and the actual depreciation of the human ability to earn after years of work. Thus, for many years, an earned income allowance was granted, ranging from 10 to 25 percent of net earned income, although a ceiling was put on the allowance which limited it, at its highest, to $496 for a family of two (in the period 1928-31). Thereafter, this allowance was steadily diminished, and was finally eliminated in 1944. By contrast, from the first taxation of income until 1921, realized capital gains were taxed at the full rate as ordinary income, but since that date they have been subject to preferentially low rates, as they are today. Dividend exclusions as we know them today date only from 1954, although in some earlier years dividends were also given preferential treatment of various kinds. To sharpen the contrast still more, the Tax Reform Act of 1969 imposed a maximum tax rate of what is now 50 percent on earned income, but this applies only to earnings in excess of $50,000 to $100,000, depending on the taxpayer's status single, head of household or married and filing jointly. Thus, only the loftiest salaries and bonuses of the most highly paid get any preferential treatment for earned income. Tax-Exempt Bonds.-Another loophole which benefits the rich almost exclusively is the exemption from federal taxation of interest paid on state and local bonds. This was originally put forward as a means of assisting state and local governments in financing capital projects, since tax-exempt bonds can naturally be issued at a much lower interest rate. However, it has also provided an extra tax haven for the wealthy which in the past has actually permitted some multimillionaires to escape paying any income tax whatever. And the advantages it conferred on local governments have often been abused, when tax-exempt bonds have been used to build plants which in turn were used to entice runaway shops to municipalities which, through suppression of labor's right to organize, could also offer a supply of nonunion labor willing to work at less than union wages. The reason that the benefits of tax-exempt bonds are largely confined to the rich, incidentally, are first that those with lower incomes usually do not have the savings with which to buy them, and second that the lower interest rates become attractive only to those in the upper income brackets where, for example, tax-free interest at half the normal rate of return provides more after-tax income than normal interest which is subject to taxation. Accelerated Depreciation.—Accelerated depreciation is usually considered as a tax loophole for corporations, but it can also be used by individuals, and has provided large financial rewards for some real estate speculators especially. The "gimmick" used is to take accelerated depreciation in calculating the taxable income from property held (and if the purchase is financed by borrowing, loan interest is also deductible), but when the property is later sold at a profit, the depreciation is included in the profit and is taxed at the preferential rate of a capital gain. Walter Heller, writing in the Wall Street Journal of February 22 last, said that this tax giveaway of about half a billion dollars was "even more inefficient and wasteful" than the subsidies for low-income housing being summarily cut out of the budget. Personal Exemptions.-The system of personal exemptions is a good example of a measure which throws a sop to families in the low and middle income brackets while affording a much greater individual gain to the wealthy. The $750 personal exemption is worth $150 to a taxpayer in the 20 percent bracket, but it is worth $525 to one in the 70 percent bracket. A flat $150 credit per person instead of the $750 exemption would afford just as great a tax saving to the low income taxpayer, while giving only the same amount to the one in the top bracket. Mortgage and Life Insurance Interest.—The deduction for interest on home mortgages has similar effects. It was intended to help average families to become homeowners. In practice, its largest benefits go to the wealthy. A family in the 20 percent bracket paying $1,000 a year in interest to buy a modest home saves $200 in taxes if it itemizes deductions. Another family in the 70 percent bracket, paying $10,000 a year in interest to buy a mansion, saves $7,000 in taxes-and the lower-income family's tax payments go in part to make up for the revenues lost as a result and thus, in effect, to finance the rich family's home purchases. In the same way, in 1972 the 62 percent of taxpaying families with incomes of $15,000 or less received only 33 percent of the income tax savings accruing from exemption of interest on life insurance policies; the remaining 38 percent of families shared 67 percent of the benefit. There are far better and more equitable ways, less costly in lost tax revenues to spare low and middle income families the burden of taxation and to enable them to buy homes and adequate life insurance. Income Splitting.-Income splitting under present tax laws also benefits the affluent far more than it does those at lower income levels. The 62 percent of all taxpaying families with incomes under $15,000 in 1972 obtained only 14.2 percent of the total tax savings from income splitting. The gain in revenues from the elimination of income splitting would have amounted to more than $21 billion. Thus, ending income splitting would permit drastic slashes in tax rates for families with incomes below $15,000, benefiting them far more than do their present meager gains from this source, without affecting total tax revenues. Total Potential Savings.—Altogether, the potential savings from plugging these and a few other minor loopholes are as follows: Billion Realized capital gains---- Constructive realization on gifts and bequests. Dividend exclusion____. Tax-exempt state and local bonds__ Other preference income (accelerated depreciation and depletion). Interest on home mortgages___ Interest on life insurance policies-- Income splitting- $9.3 4. 4 0.7 1.2 0.6 6.6 2.7 21.6 47.1 Taking into account that these figures are for 1972, by 1974, when the proposed tax reforms could first come into effect, the natural growth of the tax base would certainly have increased the savings to $50 billion or more. CREDIT INCOME TAX In recent years there has been much discussion of the negative income tax as a means of aiding the poor and thus cleaning up the mess represented by the present welfare system. In the forms usually proposed, the negative income tax has several defects. First, most such proposals would provide the poor with less income than is needed to lift them out of poverty. Second, the proposals are focused primarily on the poor, ignoring the fact that millions of American families above the official poverty line nevertheless suffer severely from inadequate incomes. Third, because the proposals were designed mainly to meet the welfare problem, they left the present tax structure untouched. Fourth, because the payments would go only to some but not to others, the recipients would be sigmatized as "tax takers" and resented by others who would think of themselves as "taxpayers." As a means of restoring equity to the entire personal income tax system, and also of greatly simplifying it, a new version of the negative income tax called the "credit income tax" has attracted increasing attention. The credit income tax can be implemented on a basis that would have none of the above-mentioned defects of the usual negative income tax proposals. It would provide for a flat payment per person (which, in some versions would be larger for adults than for children) to the entire population, with all income from other sources taxed without any allowance for exemptions, deductions or exclusions. This would eliminate all loopholes in the present personal income tax. The payments would be fixed above the poverty line. Income taxes would gradually reduce the net amount of the payments as income from other sources rose toward the breakeven point-the level at which the income tax would exactly cancel out the payments. Income tax rates would be adjusted so that the cost of the net payments to those below the breakeven point would be recaptured from those with incomes above that point. The breakeven point could be set high enough so that the vast majority of workers' families would enjoy increases in their incomes. By eliminating the need for continuance of the present welfare program, the credit income tax would free billions of dollars of state and local funds, permitting improved services or a reduction of regressive sales and property taxes, or both, at those levels of government. SOCIAL SECURITY TAX REFORM NEEDED Adding to the inequities in the federal personal and corporate profits tax structure is the unfairness of the Social Security tax. This tax applies only to the first $10,800 of earned income, leaving earned income above that figure and unearned income completely free from the tax. In 1973, workers with wage or salary income under $10,800-even if that income is only a thousand dollars for parttime work-pay 5.85 percent of their earnings for Social Security. There is no exemption even for earnings below the poverty line. But as earnings increase the tax load becomes relatively lighter. Those with $15,000 pay 4.2 percent. Those with $35,000 pay only 1.8 percent. The regressive nature of this tax is aggravated by the fact that it completely ignores "ability to pay." At the same income level a worker with dependents is taxed just as much as one without them, a feature which hits the working poor particularly hard. As mentioned at the beginning of this statement, Social Security taxes have steadily grown in the last decade. Ten years ago, the rate was 3.625 percent, or about 2.2 points less than it is now. This increase has more than offset the slight reduction of personal income taxes accomplished in 1964, 1969 and 1971 for those in the low and middle income brackets. The table on page 24 shows combined federal taxes as a percent of earnings in 1963 and 1973, after adjusting earnings for differences in average hourly earnings. While effective income tax rates have declined somewhat, the overall tax burden has increased. The table may fall short of showing "true" burden, because half of the Social Security tax is collected from employers and is not included in our figures. However, economists say almost unanimously that the full burden of both halves of the tax is borne by employees. Assuming this is true, under the present law the payroll tax will be larger in 1973 than the personal income tax for a family of four with one earner and an income of $12,200 or less. FEDERAL INCOME AND SOCIAL SECURITY TAXES OF A FAMILY WITH TWO CHILDREN, ONE EARNER, 1963 AND 1973 1 1963 earnings adjusted by index of average hourly earnings of production workers in the private nonfarm economy. Source: Social Security Administration; Internal Revenue Service; Bureau of Labor Statistics. The payroll tax is also inequitable because it taxes individual earnings instead of pooled family earnings. This feature penalizes families with more than one earner whose combined incomes are higher than the ceiling. The following table shows some examples: 1 In the case of two earners, assume neither earns more than the payroll tax ceiling of $10,800. It is time to stop increasing the payroll tax. Instead, the tax should be reformed to relieve low and middle income workers and tax family earnings equitably. We are on record before this Committee as in favor of exempting income below the poverty level from Social Security contributions. After the introduction of the low-income allowance for federal income taxes in 1971, payroll taxes constitute the entire tax burden of most families under the poverty level. In recent testimony before the Senate Special Committee on Aging, John Brittain of the Brookings Institution has proposed what we do. He calls for exemptions and deductions from pooled earnings identical to those under the income tax, which now amount to $4,300 for a family of four. We also support the concept behind his proposal to extend income relief farther up the scale toward middle incomes, by means of a "disappearing" exemption. In one of his plans families with income above the exemption would have their exemption phased out dollar for dollar of income. For earnings of $8,600 or more and a family of four, the entire exemption would disappear and earnings would be fully taxable. Mr. Brittain proposes to apply this reform to both the employer and the employee tax base. We doubt that employers would pass on the savings from payroll tax relief to their employees, and therefore prefer to tax employers fully. We understand that Senator Nelson will shortly sponsor a bill for payroll tax reform conceived mainly along the lines of Mr. Brittain's work. Although the concepts are sound, we urge that tax relief be extended above $8,600, perhaps up to $12,000 for a family of four. This could be accomplished by means of an exemption which would disappear at the rate of a fraction of dollar for dollar of income. At the same time, the wage ceiling should be raised or even removed. This would reduce regressivity and make up for revenues lost at the lower end of the earnings distribution. Supplementary funding to accomplish these reforms will no doubt have to come from general revenues. The closing of a few of the loopholes mentioned above will make appropriations for this purpose more readily available. This approach to reform is a very feasible means of helping low income groups while benefiting and thus gathering support for it from a majority of the population. REVENUE SHARING For fiscal 1974 the budget provides $12.9 billion for revenue sharing $6.0 billion in general revenue sharing under the legislation passed last year, and $6.9 billion more proposed for so-called "special" revenue sharing. Although the latter is supposed to be earmarked for programs of urban community development, education, manpower training and law enforcement, the concept is so loosely devised that it gives the state governments, at least, practically a free hand to use funds for whatever purpose they see fit. The amounts to be granted are not earmarked for specific programs, but rather for general areas of activity. It is difficult to insure that funds whose use is so loosely guided may not be used to replace state or even local funds already directed to those areas, leaving the funds so replaced free to be used for any desired purpose. Since, however, the revenue sharing funds will be federal funds, levied by action of the Congress from federal taxpayers, we believe that the Congress should have a voice in how they will be spent. This is particularly true because in some of the areas, notably education and manpower training, to which more than |