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By David J. Brillant, J.D., LL.M. in Taxation
The President's Advisory Panel on Federal Tax Reform on November 1 delivered its final report to the Treasury Department. The document is a 272-page document that will serve as the starting point for the administrations recommendations for tax reform. Tax reform is posed to be one of President Bush’s major legislative goals for 2006 and will be a highlight in his January, 2006 State of the Union Address.
The report, which the panel's nine members unanimously support, recommends a plan to revamp the current income tax code -- the Simplified Income Tax option -- and a plan that moves toward a consumption-tax base -- the Growth and Investment Tax option. The panel rejected a pure consumption tax, a national retail sales tax, and a value added tax.
The income-tax-based system proposed by the panel would reduce the current six tax rates to four: 15, 25, 30, and 33 percent. The consumption-based plan would feature three new rates: 15, 25, and 30 percent. Panel members also sought to untangle complex tax calculations by proposing to streamline tax benefits for families and children as well as for saving, and they hoped to increase saving and investing by suggesting relaxing tax rules affecting each.
The Simplified Income Tax Plan – Plan A
The simplified income tax plan favors credits over deductions, eliminates itemizing, and collapses a half-dozen existing tax breaks into two new credits. It would tax income at four rates: 15 percent, 25 percent, 30 percent, and 33 percent. It would reduce the Form 1040 to 32 lines and would cut the form's number of worksheets and schedules to 10. Also, shareholders would not pay tax on dividends paid by U.S. corporations, and capital gains rates would be reduced to between 3.75 percent and 8.75 percent.
Under plan A, three new types of tax-preferred savings vehicles are created: save at work accounts, save for retirement accounts, and save for family accounts.
Save at work accounts would replace all employer-provided savings vehicles, including 401(k), SIMPLE 401(k), 403B, and 457 plans. Under a feature called “autosave”, the plan would change default rules so that every employee is automatically signed up to save in the plan, and it would automatically roll over when the employee left the job.
Save for retirement accounts would replace savings vehicles not offered by employers, including IRAs, Roth IRAs, and nondeductible IRAs. Taxpayers would contribute up to $ 10,000 annually and would be unable to withdraw funds, without penalty, until after age 58.
Save for family accounts would replace all education savings incentives as well as health savings accounts, Archer medical savings accounts, and flexible spending accounts. Penalty-free withdrawals would be limited to medical expenses, education costs, buying a primary residence, and retirement. The plan would allow withdrawals of up to $ 1,000 per year for any reason.
The Consumption-Based Plan – Plan B
The Consumption-Based Plan, which members billed as the "pro- growth" model, would include tax benefits for savings, healthcare, and housing with a consumption-based tax on the corporate side. Important differences for individuals would be that income would be taxed at four rates: 15 percent, 25 percent, 30 percent, and 35 percent. Also, dividends, capital gains, and interest would be taxed at 15 percent.
Tax Code Changes – Both Plans
As expected, both plans would eliminate the individual and corporate alternative minimum taxes and the state and local tax deduction; collapse tax benefits for families and children into a new family credit worth $ 3,300 for married couples and $ 1,650 for singles; streamline the earned income tax credit with a work credit worth up to $ 3,570 for families with one child and $5,800 for families with two or more children; cap the benefit for health insurance up to $ 5,000 for individuals and $ 11,500 for families; and create a deduction for all taxpayers who donate more than 1 percent of income.
As expected, panelists suggested repealing the alternative minimum tax, which would cost as much as $ 1.3 trillion over 10 years. The lost revenue would be made up through capping the benefits for mortgage interest and for healthcare. The panelists also suggested repealing the deduction for state and local taxes. John Breaux, the panel's vice chair, stressed that the group was forced to make tough decisions necessary to pay for repealing the AMT.
On Capitol Hill, lawmakers from both sides of the aisle were skeptical of some of the more radical changes outlined by the panel. "I would say that some of the things they're recommending were hot issues in the 1990s, and they were dropped after being pushed by predecessors of mine very strongly," Senate Finance Committee Chair Chuck Grassley, R-Iowa, told reporters. To use the mortgage interest deduction and the health insurance deduction to pay for AMT repeal, Grassley said, "is just something that just doesn't meet the common-sense test, because you're talking about offsetting money that was never intended to come from middle- class people in the first place." The best route is to disregard the AMT when considering revenue- neutral proposals, he said. "It's ridiculous to offset something that was never supposed to be taxed in the first place," he said.
House Minority Whip Stenly H. Hoyer, D-Md., and Ways and Means Committee member Rahm Emanuel, D-Ill., echoed Grassley's sentiment on the AMT.
Under both the simplified tax plan and the consumption-based plan, the mortgage deduction would be eliminated and replaced with a new home credit of up to 15 percent of mortgage interest paid on a prior-constructed or substantially improved principal residence. This credit would be available to taxpayers; it would not be available to all taxpayers.
The credit would be limited to mortgage indebtedness equal to the Federal Housing Administration's loan limits in the homeowner's area. The limits range from $ 172,000 to $ 312,000.
The plan would continue to exclude capital gains on the sale of a principal home but would increase the current exclusion from $ 500,000 per couple to $ 600,000, with amounts exceeding the threshold taxed as income. The exclusion would be indexed for inflation.
Treasury’s Reactions
Secretary of Treasury Jack Snow was pleased with the work of the President’s Advisory Panel, which was co-chaired by Senators Connie Mack (R-FL) and John Breaux (D-LA). "You have given us the foundation for far-reaching changes in the code," Snow said. "We take the ball. It's our turn to run with it."
Thanks to Treasury's assistance with the tax reform panel's work over the past 10 months, Snow said, Treasury is "in a position" to offer recommendations to President Bush by the end of the year. Snow said he plans on spending a lot of time with Treasury's tax staff as they use the panel's report as a springboard for the department's own policies.
"Beginning today that's our task," he said.
Capitol Hill Reaction
The report was intended to start a serious debate on tax reform and it has done just that. For the most part, lawmakers of all political stripes praised the panel for taking its task seriously, as evidenced by a report that tackled especially thorny issues.
On Capitol Hill, lawmakers credited the panel for starting a national dialogue on tax reform. Senate Finance Committee Chair Chuck Grassley, R-Iowa, and Finance Committee ranking minority member Max Baucus, D-Mont., said they hope to hold hearings on the tax reform panel's report as soon as possible. Baucus also asked the Joint Committee on Taxation to review the revenue effect of the proposals and requested that interested parties who are affected by the recommendations submit formal or informal comments.
Grassley and Baucus praised the panel members for issuing the report, but noted that tax reform will be a tough sell in Congress.
"There are some great ideas here and some not-so-great ideas," Baucus said. "Some of the ideas here are not only a heavy lift politically, but also they may not make good tax policy." Baucus cited proposals for housing and charitable giving.
Across the Capitol, House Ways and Means Committee Chair William M. Thomas, R-Calif., also looked ahead to the unfolding debate.
"As our economy, our society, and our understanding of the impact of tax policy change, it is critical that Congress make changes to the tax code to achieve the essential balance of collecting the necessary funds to run the federal government while maintaining our ability to create jobs, produce goods and prosper as a society," Thomas said in a release. "The panel's tax reform recommendations will provide a foundation for that work."
Outlook for 2006
The Advisory Panel’s report took a long and hard look at the manner in which revenue is generated from taxation. The last major tax overhaul was in 1986 and the recommendations prior to that major tax revision included numerous recommendations that were hotly contested and did not make its way into the final version of legislation that was ultimately passed.
This will certainly be the case with these current recommendations. With Social Security reform, the federal government’s effort to clean-up the Gulf Coast from three major hurricanes, a continuing war effort in Iraq and Afghanistan and estate tax repeal, many components of the Advisory Panel’s plan are sure to fall by the wayside. The most controversial is certainly the transformation from a home mortgage interest deduction up to $1,000,000 to a tax credit up to 15% for mortgage interest paid up to the Federal Housing Administration's loan limits. Economists have already suggested if this change is enacted, sales for higher priced homes would reduce where entry level home sales would rise.
For more information on the President’s Advisory Panel’s report to the Treasury Department, please contact David J. Brillant at
for a copy of the report.
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