The Freedom To Save Act:
Getting The Tax Reform Job Done
Ernest S. Christian
Executive Director
of the
Center For Strategic Tax Reform
Before The
President’s Advisory Panel on Federal Tax Reform
May 11, 2005
Washington, DC
Relief From Double Taxation
 I urge first-year expensing for businesses and Universal
Savings and Investment Accounts (USIA) for individuals
 This relief from double taxation --Achieves 80 to 90 percent of the economic goals of
“Big Bang” tax reform
-Forever changes the tax code’s anti-capital character
-Can readily be made revenue neutral
-Stands an excellent chance of being enacted
 Step Two is to enact the Simplified USA Tax (SUSAT)
-Historic simplification of the tax code (as per H.R. 269 in the 108th
Congress)
-Non-radical international tax reform that allows Americans to
compete and win in global markets
The Core Component of Tax Reform
Elimination of double taxes on savings and
investments is the core economic component of
all tax reform proposals
-Some proposals do it in unfamiliar ways
-Others are experimental -- and have uncertain side effects
The tried and true way is to stay within the
familiar framework of the current code
-First-year expensing has predictable results based on
experience
- USIAs are patterned after the familiar Roth IRA
Keeping Our Eye On The Ball
 Why go searching for some new magic elixir that may have
unknown results?
-With expensing and USIAs, there is only an upside and we know what
it is
 Every tax reformer’s inclination is to propose something
dramatic -- something that will capture the public’s
imagination
 But real tax reform is not about dramatic “proposals,” it is
about dramatic “accomplishments”
 The combination of first-year expensing and USIAs gets the
job done
Expensing Versus Depreciation -- A Timing Issue
 Because depreciation postpones deductions, it requires businesses to
prepay tax
-Thus, government tax receipts are increased up front but are lesser by the
same amount in the future
-Prepaying tax increases the cost of capital equipment for a business
 First-year expensing is the opposite: It allows the deductions to be
taken now instead of later
-With expensing, government tax receipts are reduced up front but are greater
by the same amount in the future compared to depreciation
-Expensing reduces the cost of capital equipment compared to depreciation
 The revenue cost of switching to expensing starts out large, as
continuing depreciation deductions on pre-effective-date assets stack up
on top of expensing deductions for new assets
-But, after three years, the impact of the carryover depreciation deductions
starts to diminish, and the revenue cost quickly declines
Switching to Expensing: Example of Revenue Cost Pattern*
-In this example, the cumulative revenue cost over
ten years is $752 billion
-But the PV (in Year 1) of that 10-year cost is
$603 billion
$140
Year
Cost
PV of
Cost
1
$23
$23
2
$114
$108
3
$123
$109
4
$112
$94
5
$102
$81
6
$75
$56
7
$60
$42
8
$51
$34
9
$47
$29
10
$45
$27
TOTAL
$752
$603
$120
$100
$Billions
$80
$60
$40
$20
$0
1
2
3
4
5
6
7
8
9
10
Year
*Equipment Expensing in $Billions, Part-Year Convention
Source: Fiscal Associates
Universal Savings and Investment Accounts
 A USIA account is like a Roth IRA -- except that it is unlimited and
not restricted to retirement savings
-Deposits in USIAs are made out of current-year earnings
-Americans can save in a USIA for whatever purpose they want
-They can withdraw their money whenever they wish
 USIAs will function much like a combination brokerage and
checking account
-Because USIAs are funded with after-tax savings, withdrawals are not
taxed -- and interest, dividends and capital gains on investments inside the
account are taxed at a zero rate
 The pattern of revenue losses from USIAs is just the opposite from
that of first-year expensing
-Because USIAs allow no up-front deduction, the revenue loss is small in the
beginning and builds up over time as greater amounts of dividends, interest
and gains are received in those accounts without further taxation
Paying for the Revenue Cost with a Voluntary Toll Charge
 The revenue cost of first-year expensing and USIAs can be paid for --Step One: Expand USIA accounts to apply to existing savings as well as
to new savings out of current earnings
-Step Two: Charge the owners of existing portfolios who want to put their
savings in a USIA account a toll charge for the privilege of doing so
 Many tax reform proposals automatically exclude from additional tax all
future interest, dividends and gains on existing portfolios
-And tend to pay for the revenue cost with radical changes elsewhere in the
tax code
 The future yields on all after-tax savings (old and new) should be free of
additional tax -- but the “transition” should be paid for in a traditional way
by those who most directly benefit
 Everyone who has retirement savings in §401(k) or other tax-deferred
accounts should be given the option of paying a realistic toll charge for
converting those accounts to Roth IRAs
B.100.e Balance Sheet Data From Federal Reserve
Billions of dollars; amounts outstanding end of period, not seasonally adjusted
Original
Line No.
3
Description
Financial assets
2001
2002
2003
2004
32,210.7
29,866.6
34,092.1
36,758.5
4
Deposits
4,800.7
5,071.8
5,251.8
5,693.8
5
Credit market instruments
2,176.4
2,074.8
2,242.1
2,265.0
6
Equity shares at market value
13,106.9
10,051.2
13,051.1
14,278.0
7
Directly held
6,604.2
5,047.8
6,375.8
6,521.6
8
Indirectly held
6,502.8
5,003.5
6,675.2
7,756.5
9
Bank personal trusts and estates
527.0
385.0
469.7
504.5
10
Life insurance companies
806.5
692.5
887.3
1,056.2
11
Private pension funds
2,208.1
1,611.3
2,180.7
2,463.1
12
Defined benefit plans
825.7
535.3
764.3
860.0
13
Defined contribution plans
1,382.4
1,076.0
1,416.4
1,603.1
14
State and local govt. retirement funds
1,084.0
869.8
1,084.4
1,204.7
15
Federal government retirement funds
49.1
45.9
79.9
99.3
16
Mutual funds
1,828.1
1,399.0
1,973.2
2,428.7
12,126.7
12,668.7
13,547.1
14,521.7
17
Other
Potential Approximate Amount Transferable to USIA (or Roth IRA)
Liquid assets (4+5+7+13+16)
18,512.2
20% of less liquid assets (17)
2,904.3
TOTAL APPROXIMATE AMOUNT
21,416.5
Source: Flow of Funds Accounts for the United States, March 2005, Board of Governors of the Federal Reserve System, Washington D.C. 20551.
Theory and Amount of Toll Charge
 Economists tell us that a share of stock is worth the discounted present
value of the future stream of dividends and gains that the market predicts
it will produce
-Thus, the capital invested in the stock and the future stream are two
versions of the same thing and both should not be taxed
 Under current law, the owner of the stock is required to pay a 15 percent
tax on those future dividends and gains -- and because the value of the
stock is equal to the present value of the future stream, current law in
effect imposes a 15 percent tax on the value of stock
-If, however, the share of stock is in a USIA, the owner will not pay tax on
the stream of dividends and gains in the future -- and, therefore, the 15
percent tax on the value of the stock is removed
 In exchange for removing that 15 percent tax on the value of the stock, a
onetime, voluntary toll charge of 10 percent of the value of the stock is
suggested
A Simplified Example of the Toll Charge
 Present Law: Jones owns a stock that will produce a pre-tax stream
of dividends and gains that has a present value of $117.65
-However, because dividends and gains are taxed at 15 percent, the
present value of the after-tax stream is only $100 and the stock is
worth only $100
 USIA Format: Jones paid $100 for the stock. Now, he pays a 10
percent ($10) toll charge for a total of $110. The present value of
the future stream of dividends and gains is $117.65 -- and because
the tax rate is zero, Jones gets to keep the entire amount. Having
paid $110 (including the toll charge) for a stream of dividends and
gains worth $117.65, Jones is $7.65 better off
 As a result, Jones would be strongly motivated to put the stock in a
USIA account and pay the toll charge
Reasonably Predictable Results
 Experience with Other Toll Charges
-Indications are that the repatriation rate of accumulated foreignsource income subject to a 5.2 percent toll charge pursuant to
American Jobs Creation Act (AJCA) of 2004 is going to be about 50
percent of the amount eligible and perhaps closer to 100 percent of
liquid assets where the repatriation is beneficial to the taxpayer
-Conversions of regular IRAs to Roth IRAs have been going on since
1997 even though the option is severely restricted and the toll charge
is very high
-With a 10 percent toll charge, it is likely that the transfer rate into
USIAs (and conversions to Roth IRAs) would be at least 50 percent -and the transfer rate could be higher
 Revenue Results of 10 Percent Toll Charge With Two Assumed
Transfer and Conversion Rates
50 Percent . . . . . . . . . . . . . + $ 1.07 Trillion
75 Percent . . . . . . . . . . . . . + $ 1.61 Trillion
Approximate Net Present Value Budget Impact of Proposals
($ Billions)
10% Toll Charge
12% Toll Charge
Transfer
Rate
Expensing
Cost
Lost
Dividend
&
Capital
Gains
Taxes
50%
($603)
($328)
+ $1,071
+ $140
75%
($603)
($492)
+ $1,606
+ $511
50%
($603)
($328)
+ $1,285
+ $354
75%
($603)
($492)
+ $1,927
+ $833
Toll
Charge
Net
Budget
Effect
Assumes 6% federal government borrowing and discount rate
Source: Fiscal Associates
Conclusion: Simple and Effective Tax Reform
 I am not undertaking to give precise revenue estimates -- nor do I
say that my way of calculating the toll charge is the only way
 Rather, I am suggesting a basic analysis from which I believe that
certain important conclusions flow
-The use of a toll charge is a workable idea with which we have
experience
-An official revenue estimate can be made drawing upon the expertise
of the Treasury Department and the financial community
-The toll charge could pay for part, all or more than the revenue cost
of first-year expensing and USIAs
 Therefore, I conclude that this simple and effective approach to tax
reform should be included in this Panel’s recommendations
Appendix
Explanation of Table Entitled
“Approximate Net Present Value Budget Impact of Proposals”
 On the line showing the result of a 10-percent toll charge applied on the assumption of a
50-percent transfer rate
-$603 billion is the present value of the nominal $752 billion 10-year revenue cost of
expensing
-$328 billion is 50 percent of the present value ($655 billion) of the $840 billion
nominal 10-year revenue cost of excluding all dividends and capital gains from tax
under present law
-$1,070 billion is both the nominal and present value of one-half of a 10-percent toll
charge applied to a base of $21,416 billion
 The Table is intended to encapsulate the way that the combination of expensing, USIAs and
the toll charge would typically be presented in the budget documents which take into account
(as they must) both interest costs and interest savings
-For example, in the budget presentation, the cost of expensing plus the interest cost to
the government on that lost revenue would be presented in annual increments over the
budget period
-Similarly, as an offset thereof, the upfront revenue gain from the toll charge plus the
annual interest cost savings to the government would be presented over that same
budget period
-The net present value presentation in the Table collapses these costs and savings over
a number of years to an equivalent current valuation using an interest rate equal to the
government borrowing rate