When all else fails, try tax reform

Twenty years ago, a newly re-elected Ronald Reagan put his fresh store of political capital behind a cause many people thought would never happen — a top-to-bottom overhaul of the federal income tax system. But happen it did, smack in the middle of the 1986 congressional campaign.

George W. Bush is about to try it again. Looking for a new economic cause after failing to muster support for his Social Security project, Bush is following Reagan’s lead in turning to the tax code for a second-term centerpiece. And just as Reagan did, Bush will pitch it as a bid to simplify an overwhelmingly complex system, to reward savings and investment, and to slash away at the maze of tax preferences that affect everything from home ownership to charitable contributions.

The early line on Bush’s new venture is that he’ll have extremely tough sledding. Reagan spent years building support for his reform plan and was willing to bring in influential Democrats like Sen. Bill Bradley and Reps. Richard Gephardt and Dan Rostenkowski _ huge factors missing from Bush’s strategy.

Further, Bush’s hand-appointed tax commission last week offered some exceedingly controversial remedies _ eliminating deductions for state and local taxes, for example, and minimizing deductions for mortgage interest and charitable contributions.

As a result, the commission’s work received a cool reception, at best. In one of the week’s understatements, Republican Sen. Charles Grassley, chairman of the Senate Finance Committee, said some of the provisions “are bound to be politically unpopular.” But some say a major tax overhaul movement has a shot over the next year or two, in part because there’s a consensus that something needs to be done to simplify and improve the federal tax system. What’s more, the proposal will give congressional Republicans something to talk about, especially with influential economic conservatives, as they launch their 2006 campaigns.

“Taxes need to be front and center in the election year,” said Grover Norquist, president of the influential Americans for Tax Reform. “And this plan gets you there.”

The tax plan signals a shift away from Bush’s first-term strategy of making major income tax cuts every year. Congress later this month is expected to consider yet another round of cuts, a $70 billion reduction package.

For all practical purposes, though, the president’s big tax-cut measures are complete, given that the country is once again borrowing hundreds of billions of dollars a year to finance deficit spending. Bush’s answer is to go to Reagan’s playbook with a tax overhaul aimed at rewarding savings and turning most taxpayers’ returns into a two-page document.

Under two separate plans advanced by the president’s commission, stock-derived capital gains and dividends would either be exempt from taxes or subject to 15 percent maximum rates. Moreover, the documents would make sweeping changes in a multitude of federally subsidized savings programs, replacing the IRA and 401(k) maze with three simple plans _ save at work, save for family, save for retirement.

Meanwhile, the proposals would wipe away or reduce dozens of tax preferences. Both would put limits, for example, on deductions taken for charitable contributions, mortgage interest payments and health insurance costs.

According to the tax commission, there would be no seismic shifts in the tax distribution based on income. Those making $100,000 or more would still pay nearly 80 percent of individual income taxes; those making less than $100,000 would pay the remaining 20-plus percent.

However, individual taxpayers could see rather large ups or downs in their tax obligations, and geography could play a big role.

California State Treasurer Phil Angelides complained in a recent letter to Gov. Arnold Schwarzenegger that, because of proposed limits on mortgage interest deductions, owners of a median-priced home in California could see their tax bill go up $4,000 a year while owners of a similar home elsewhere might see little or no increase.

Angelides said the proposal amounted to a “double-barreled blast aimed squarely at California and the middle class.”

One of the most controversial provisions _ elimination of state and local tax deductions _ could also produce big winners and losers. According to federal statistics, the income tax bill in 2002 for a typical New Yorker, for example, was more than five times that of a North Dakota resident.

Although the White House touted the tax panel as a bipartisan group that would not favor one party over the other, this provision’s benefits seem clearly directed toward Republican states.

Of the 10 states where state income taxes are the highest (and would lose the most from the proposal), nine voted for Democrat John Kerry in the 2004 presidential election. Of the 10 states where state income taxes are the lowest (and would gain the most), eight voted for Republican Bush.

However, the proposal makes dozens of major changes that would subject virtually all taxpayers to both beneficial and ill effects. One big plus for millions of upper-income taxpayers is the proposed elimination of the Alternative Minimum Tax, with 10-year savings estimated at a staggering $1.3 trillion.

Of particular benefit to many lower- and middle-income households, filers who do not itemize their deductions would for the first time get tax relief on their mortgage interest payments and on charitable deductions in excess of 1 percent of their income. Equally important to many proponents, the proposals would streamline business taxes in ways designed to reduce tax preferences and increase American competitiveness.

The tax commission’s recommendations will hardly be the final word on any legislative proposal. Treasury Secretary John Snow is now expected to fashion his own tax package, which could differ markedly.

Any major changes, though, are almost certain to encounter widespread opposition _ from the insurance and housing industries; from economic conservatives who want an even more drastic overhaul; from deficit hawks who fear the new plan would lock into place the Bush tax cuts and make future deficits inevitable.

Norquist of Americans for Tax Reform says the idea’s saving grace is that virtually everyone agrees the income tax system has become so unwieldy that something has to be done.

“The key here is that these are reform ideas that could pass Congress,” he said. “Everybody wants something more. But this is all of the reform that Washington, D.C., could ingest in the next 12 to 18 months.”