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than annual adjustment. Although the taxes apply to transfers at particular moments in time, the reference to a figure which applies to an entire calendar year would be a simple process and would be sufficient to relieve the problem to which indexation is addressed.
No adjustments are recommended to the amounts of prior gifts or taxes paid thereon. Since these amounts generally are reciprocal their indexation would serve little practical purpose. Thus, only the unused portion of the unified credit would be indexed. This refers to amounts such as the following, which would not be indexed:
The amount of adjusted taxable gifts taken into account in computing the tentative estate tax and the amount of the credit against the estate tax for gift taxes paid by the decedent.
The aggregate sum of the taxable gifts and the gift taxes of preceding years taken into account in computing the gift taxes of a particular year.
The amount of the credit against the estate tax for taxes paid on a prior transfer to the decedent.
Measurement of Inflation
The AICPA believes that the index used to measure inflation should be readily accepted by broad segments of society and should be capable of being consistently applied. Further, we support the use of a single general purpose index. Although arguments have been made that an indexation system should use different indexes for different items so that alternative indexes could be used for specific applications, we believe this would add complexity to the tax code.
An index such as the Consumer Price Index (CPI) would generally meet these requirements. The CPI is a widely used measure of inflationary pressures and of changes in the purchasing power of the consumer dollar. It is the most familiar index, and it is currently used in the Internal Revenue Code and by various states that have adopted indexed tax systems. In addition, among the countries that use indexation in their tax structures, nearly all make use of their equivalent of the CPI. While imperfect, the CPI generally reflects price changes for things people must buy in order to live-food, clothing, rent, household supplies, medical expenses, public utility rates, and so on. 15
15. U.S., Department of Labor, BLS Handbook of Methods for Surveys and Studies (Washington, D.C.: Government Printing Office, 1976), p. 88.
All statistical surveys, by nature, lend themselves to possible inaccuracies, and the CPI as a general measurement of inflation has been criticized for a number of reasons. Shortcomings of the CPI may arise from inaccurate reporting, lack of systematic incorporation of new outlets into the sample, and introduction of new products or changes in product quality. 16 It should also be noted that the CPI has not been developed for use in measuring nonconsumer price level changes.
However, the public generally considers the CPI the official government indicator of inflation. It has widespread use in wage and collective bargaining negotiations. An index based on the CPI is used for Social Security payments and for fixed dollar limitations for defined benefit plans and defined contribution plans.
In conclusion, we believe that a single generally accepted and consistently applied index should be used. Whatever index is selected, it is important that it be continually monitored and adjusted to reflect changes in the economy.
16. Edward Meadows, "Our Flawed Inflation Indexes," Fortune, 24 April 1978, p. 67.
STATEMENT OF GREG JONSSON, VICE PRESIDENT AND COUNSEL UNITED STATES BUSINESS AND INDUSTRIAL COUNCIL, WASHINGTON, D.C.
Mr. JONSSON. Thank you, Mr. Chairman. I appear before you today as the counsel for the U.S. Business & Industrial Council in support of S. 1600. Let me first say that I concur with the testimony given by the previous witness, especially with respect to his statement on depreciation and the need to index that portion of the Tax Code.
USBIC is a national organization of 3,000 senior corporate executives from predominantly medium-sized companies representing all sectors of the U.S. industry. It is a group particularly dedicated to defense of the traditional free enterprise system, composed of many entrepreneurs and independent owners of closely held firms. The objective of private enterprise is not to maximize return to the U.S. Treasury but rather to minimize the tax exposure to enterprise. With respect to statements made by one of the previous witnesses, there will undoubtedly be a revenue impact associated with capital gains indexing, but it should not be viewed with alarm. A recent analysis of the Council of Economic Advisors has indicated that the amount of capital gains reported on tax returns increased dramatically in the year after the tax rate on capital gains was reduced, that is, more revenue at a lower tax rate. The anticipated revenue loss prior to the reduction was certainly exaggerated and I think that the revenue loss associated with indexation of capital gains tax is also likely to be exaggerated.
Just as USBIC views the Economic Recovery Tax Act of 1981, ERTA, as a profound turning point in the history of U.S. tax policy, we also view the import of S. 1600 as a logical extension of that policy. ERTA is nothing less than a first attempt to slow the increase in the Federal Government's share of our gross national product. S. 1600 is an interim step in the same direction for capital assets.
Prior to the passage of ERTA, it was estimated that the Federal Government would claim more than 21 percent of GNP in the years 1981 to 1985, and a continuously rising share thereafter. By reducing marginal tax rates for individuals by 25 percent over 3 years the Government's claim of GNP was reduced to an estimated 17.4 percent, and after adjustments via the highway gasoline tax and the Tax Equity and Fiscal Responsibility Act of 1982 [TEFRA] to about 18.6 percent of GNP.
One of the most significant features of ERTA is the provisions for the annual indexing of individual income tax brackets, the zero bracket, and the personal exemption in accordance with rises in the Consumer Price Index for Urban Households, to begin in calendar year 1985.
Indexing the tax basis of capital assets would eliminate the unfair and prejudicial effects of current law. Indexing parity between income and capital gains tax will force the Congress to confront head-on the underlying economic conditions which necessitate its use. Once indexing is in place, Congress will either have to approve continuous and regular tax increases for expenditures, something inflationary bracket creep has allowed them to avoid, or fight
the inflation that the Nation will once again inevitably face in response to horrendous budget deficits projected for the rest of this decade.
As USBIC has stated many times in its policy statement, inflation can be purged from our economy only by substantial reductions in Federal spending, particularly spending on entitlements. There can be no doubt that the widespread support for indexing as a concept is an expression of the American peoples' deep dissatisfaction with congressional failure to reduce deficits without visiting inflation on the economy.
In view of the widespread support for indexing, and given its obvious benefits, it is difficult to understand how it can be opposed on economic grounds. ERTA was approved by the U.S. House of Representatives by a decisive vote of 238 to 195. Yet today, just 2 years later and 17 months before indexing is to take effect, it is facing strenuous opposition. USBIC believes that the basis for these efforts to repeal indexing and resistance to the idea of extending indexing to capital gains is an unwillingness by Congress to accept fiscal discipline. Indexing is a means to insure that real tax revenues are consistent with real economic growth. To the extent that nominal capital gains represent simple inflation in asset values, no additional real capital is created, and taxation of those gains erodes our capital base. We must index the basis of productive assets so that the inflation component will not be subject to tax.
If revenues to the U.S. Treasury are restricted to the actual growth in the Nation's economy rather than the fictional growth attributable to inflation, the beneficiaries of inflation-Congress and certain special interests tied to entitlements-would become accountable to the taxpayer once again. USBIC believes that real economic growth is the best hope for ameliorating the deep and traumatic economic problems caused by the recession of 1981 and 1982. We believe that real growth can only be sustained if consumers, producers, and investors are confident that the labor they perform and the risks they take-in short, enterprise-will not be penalized by the hidden tax of inflation.
Tax reduction, the centerpiece of ERTA, is the only effective means available to the American people by which to impress upon the Congress the need to reduce Federal spending. Without ERTA's indexing feature and without the extension of this approach to capital gains, Federal revenues will continue to increase from bracket creep, notwithstanding the recent tax reduction features enacted by Congress. This is the legacy of inflation as well as the greatest economic threat for America's future.
USBIC specifically endorses the indexation of the capital gains tax to the GNP deflator, which is the substance of S. 1600. Thank you.
Senator ARMSTRONG. Mr. Jonsson, thank you very much for a fine statement. And I especially thank you for pointing out that real economic growth is the best hope for solving the economic problems that our country faces. I will be back to you in a moment.
Next, Mr. Mark A. Bloomfield, executive director of the American Council of Capital Formation. Mr. Bloomfield.
[The prepared statement of Mr. Jonsson follows:]
Prepared Testimony of the U.S. Business & Industrial Council
Mr. Chairman, distinguished Senators:
My name is Gregory N. Jonsson and I appear before you today as Vice President & Washington Counsel of the U.S. Business & Industrial Council.
USBIC is a national organization of 3,000 senior corporate executives
This year the Council observes the fiftieth anniversary of its founding. Our position supporting legislation to index capital gains to a reliable measure of inflation is an expression of our free market philosophy.
We believe that the Economic Recovery Tax Act of 1981 (ERTA)
Prior to the passage of ERTA, it was estimated that the federal government would claim more than 21% of GNP in the years 1981-1985, and a continuously rising share thereafter. By reducing marginal tax rates for individuals by 25% over three years, the government's claim of GNP was reduced to an estimated 17.4%, and after adjustments via the highway gasoline tax and the Tax Equity & Fiscal Responsibility Act of 1982 (TEFRA), to about 18.6% of GNP.
One of the most significant features of ERTA is the provision for the annual indexing of individual income tax brackets, the zero bracket, and the personal exemption in accordance with rises in the consumer price index for urban households, to begin in calendar year 1985.
Indexing is tax technique which is long overdue. It is the best means by which to relieve the invisible tax of inflation on lower and middleincome taxpayers available to this Administration and this Congress. Indexing the tax basis of capital assets would eliminate the unfair and prejudicial effects of current law.
Indexing will force the Congress to confront head-on the underlying economic conditions which necessitate its use. Once indexing is in place, Congress will either have to approve continuous and regular tax increases, something inflationary bracket creep has allowed them to avoid, or fight the inflation that the nation. will again inevitably face in response to horrendous budget deficits projected for the rest of this decade. As USBIC has stated many times, inflation can be purged from our economy only by substantial reductions in federal spending, particularly spending on entitlements. There can be no doubt that the widespread support for indexing is an expression of the American peoples' deep dissatisfaction with Congressional failure to reduce deficits without visiting inflation on the economy.