It Will Take Guts to Reform Tax Code

The panel that President Bush asked to help carry out his campaign pledge to streamline the tax code has, in its final report, recommended two options that would rewrite most tax laws to lower rates and limit deductions in the name of simplification.

Treasury Secretary John Snow called the proposals “a starting place for what we will recommend to the president” by early next year. “Now it’s up to us,” he said Tuesday in accepting the 272-page draft.

Former Sen. Connie Mack, R-Fla., the panel chairman, said the options fulfill Bush’s charge that any recommendations bring in the same revenue as individual and corporate income taxes produce now and that any changes assume his 2001 and 2003 tax cuts become permanent law. Mack added that the amount of taxes individuals would owe under the proposals is “relatively the same” as they pay now.

The two options changed since the panel’s last hearing, as it ran computer estimates on how much each part of the two packages would affect tax collections.

Former Sen. John Breaux, D-La., the panel vice chairman, acknowledged that the proposals are controversial, “perhaps because we aren’t up for re-election.”

Here, in Q&A format, is a look at what the panel recommended to Bush and an election-minded Congress.

Q: What would individual tax rates be?

A: The simplified income tax would have four tax rates of 15, 25, 30 and 33 percent, not the current six rates with a top rate of 35 percent. Option 2, formerly named the “progressive consumption” tax but renamed the “growth and investment” plan, would have three individual rates: 15, 25 and 30 percent.

Q: They want to cap the mortgage interest deduction, now up to $1 million, and do away with the deduction for up to $100,000 on home equity loans. Any chance?

A: This won’t be a quick sell. The outcry it provoked in Congress and the housing community has George Washington University tax expert Joseph Cordes calling the mortgage write-off “the new third rail of congressional politics,” much as Social Security has had touch-it-and-you-die status.

Instead of giving a home mortgage deduction to the 35 percent who itemize, both options would give every homeowner a tax credit equal to 15 percent of interest on home loans of up to 1.25 percent of their area Federal Housing Administration guarantee limit.

That would put the mortgage size anywhere between $227,000 in low-cost housing areas to $412,000 in high-cost regions.

However, the credit would apply ONLY to a principal residence, not your beach house, townhouse and a place in the mountains.

The National Association of Realtors served notice that the proposal “would drive down real estate values … and negatively impact the nation’s economy.”

Q: Would both options also do away with the deduction for state and local taxes?

A: Yes. This is another flashpoint, especially for states like California, Connecticut, Massachusetts, New Jersey and New York, all “blue” states that didn’t vote for Bush in 2004. The one “red” state among the 10 that account for 60 percent of this write-off is Ohio, the state that delivered the presidency to Bush last year.

Sen. Charles Schumer, D-N.Y., said no more state-and-local deduction spells a $12 billion-a-year tax increase for New Yorkers alone and would cause “a giant sucking sound” as taxpayers move to low-tax, low-service jurisdictions.

Of course, many taxpayers in these high-tax states lose the write-off because their state and local tax bill triggers the Alternative Minimum Tax, a parallel tax system these overhaul plans would abolish before it hits 1 in 3 taxpayers by 2010.

Tax expert Bob Ebel of the nonpartisan Urban Institute notes that $4 out of $5 spent on non-defense purposes are spent by state and local government on education, police and fire protection, roads, sewerage and other infrastructure. “It’s an extremely important sector, and you’re talking about scrambling it when most states conform their tax systems to the federal tax code,” he says.

Q: What about investment and saving?

A: Here the two proposals diverge: The simplified income tax would exclude dividends and capital gains from U.S. companies, but tax interest payments at regular income-tax rates. The “growth and investment” plan would tax dividends, capital gains and interest at a flat 15 percent rate.

On savings, both proposals do away with multiple employment retirement savings plans, education accounts and tax breaks, health-savings accounts and the like.

Instead, a Save at Work account would replace 401(k) and other tax-deferred “defined contribution” retirement plans through employers. Contributions equal to the current 401(k) limits of $14,000 this year, and $4,000 more for workers 50 and older, would be taxed up front for the promise of tax-free withdrawals in retirement.

A second Save for Retirement account that lets individuals save another $10,000 a year on their own would replace IRAs with no income limits on contributors. Money would be put in after taxes for the promise of tax-free withdrawals.

Education-savings accounts like college 529 plans and Coverdell accounts and Health Savings Accounts are combined into $10,000-a-year Save for Family accounts, also using after-tax dollars for future tax-free withdrawal.

Q: And the cap on untaxed health insurance coverage through work?

A: Individuals wouldn’t owe tax on up to $5,000 in insurance coverage, $11,500 for families, and the 43 million Americans with no health coverage through work would get a tax break equal to those limits for policies they buy on their own.

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(Contact Mary Deibel at DeibelM(at)