- The Washington Times - Thursday, March 3, 2005

The U.S. tax code has grown too complicated and must be simplified to ensure the economy runs more smoothly, Federal Reserve Chairman Alan Greenspan testified yesterday.

While replacing the income tax with a consumption tax might be the best way to boost growth, it would be too hard to achieve both technically and politically, because it would arouse much opposition, he told President Bush’s advisory panel on tax reform.

“Getting from the current tax system to a consumption tax raises a challenging set of transition issues,” he said, including how to shield low-income consumers from being taxed heavily under the plan.

“At the moment we have a somewhat mixed system,” he said, noting that tax-free retirement accounts and other provisions already encourage saving over consumption. “I would suspect that probably that may be the best route to go.”

White House economists and a co-chairman of the panel, former Sen. John Breaux, are advocating such a hybrid approach, while some Republican lawmakers are attracted to a consumption tax. The panel is charged with coming up with recommendations for the president by July 31.

Mr. Bush said he would wait to see what the commission recommends before making up his mind.

“I told the American people I want to work to simplify the tax code and make it easier to understand, so people are spending less time filing paper,” he said in response to a question from The Washington Times. “I believe a simplified tax code will spur entrepreneurial activity.”

Mr. Greenspan told the advisory panel that, in view of the difficulty of dramatically changing the tax system, “don’t try for purity,” but rather seek to improve the existing system within today’s political realities.

He held out the 1986 tax reform law, which was engineered to cut tax rates while eliminating many loopholes and exemptions, as an exemplary approach that should guide today’s efforts.

“A defining feature of the 1986 reform was the broadening of the tax base and the lowering of tax rates, and it is widely believed these changes enhanced economic efficiency,” he said.

In the intervening 19 years, many new tax preferences have been enacted, while rates have crept higher. The result is many profitable corporations and high-earning individuals once again can escape taxes by taking advantage of loopholes.

“The tax code has drifted back to be overly complicated and burdened by higher marginal tax rates and by many special provisions that have undesirably narrowed the tax base,” Mr. Greenspan said.

“A simpler tax code would reduce the considerable resources devoted to complying with current tax laws, and the freed-up resources could be used for more productive purposes,” he told the panel.

Having a simpler, more predictable tax code would be akin to achieving the Fed’s goal of low inflation, he said. It would enable consumers and businesses to make plans without having to take into account rapidly rising prices — or in this case, the possibility of higher taxes.

Responding to a question from the panel, the Fed chairman said he does not think overhauling the tax system would do much to reduce record U.S. trade deficits, which often are blamed on Americans’ tendency to consume nearly all their incomes, putting aside little in savings.

The personal savings rate last year dropped to an historic low of 1 percent — an abysmal showing that prompted Mr. Greenspan last month to push for creation of private accounts funded from Social Security taxes as a kind of forced personal savings program.

“I believe that as the baby-boom generation begins to retire in a few years, it will become increasingly important for the nation to boost resources available in the future through greater national saving,” he said.

Because they encouraged savings and investment, Mr. Greenspan strongly supported tax cuts during Mr. Bush’s first term that lowered the tax rates on capital gains and dividends. He also gives lukewarm support to tax-free savings programs like those advocated by Mr. Bush, which he said have had mixed success.

Perhaps surprisingly, he downplayed the role that tax reform might play in boosting savings.

“The tax system has the potential to contribute importantly,” he said, but he suggested Congress’ main goal should be to ensure it does not “hinder the achievement” of higher savings rates.

Other experts testifying before the panel favored consumption taxes like a national sales tax or value-added tax, which is a tax on consumer goods imposed at various stages of production. Both approaches are used in Europe and Japan.

James A. Baker III, the former Reagan administration Treasury Department secretary who helped craft the 1986 tax overhaul, said a consumption tax “could certainly meet the fundamental criteria of being simple, fair and pro-growth.”

But Mr. Baker, who testified via satellite from his office in Houston, said the panel should be careful to weigh the political feasibility of any reform plan. He noted that the first plan offered by President Reagan was rejected because it tried to limit the highly popular deductions for mortgage interest and state and local taxes.

“If you’re going to reform the income tax, above all else, you must be conscious of political reality,” he said.

James G. Lakely contributed to this report.

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