November 15, 2005
No Chance for Tax Commission Proposals By Bruce
Bartlett
Two weeks ago, the President's Advisory Panel on Federal Tax Reform
issued its final report. Although our federal tax system is in dire
need of restructuring and simplification, the panel's approach is
a non-starter. It proposes a lot of pain for very little gain. The
likelihood that it will form the basis for congressional action
is virtually nil.
The panel proposed two alternative tax plans for restructuring the
federal corporate and individual income tax systems. One is called
the Simplified Income Tax Plan and basically keeps the income tax,
while making a number of changes. The other is called the Growth
and Investment Tax Plan. It is essentially a consumption-based tax
system. However, the two plans have many features in common.
Among the most controversial elements in both proposals are elimination
of the deduction for state and local taxes, a severe scale-back
of the mortgage interest deduction and sharp limits on the exclusion
for employer-provided heath insurance.
In return, the Alternative Minimum Tax would be eliminated for both
corporations and businesses, and there would be a small reduction
in the top income tax rate. It would fall from 35 percent on individuals
today to 33 percent under the simplified plan and 30 percent under
the growth plan. The corporate rate would fall from 35 percent to
31.5 percent under the former, and 30 percent under the latter.
These are extremely modest benefits in return for very substantial
pain for many taxpayers -- not to mention politicians. I know. I
have written many articles over the years explaining why it would
be desirable to do things the commission has recommended.
The mortgage interest deduction encourages families to overinvest
in housing at the expense of other investments, such as stocks and
bonds that would provide capital for business expansion and modernization.
Ideally, we should level the playing field such that the tax code
does not bias investment, so that capital can seek the best returns
determined by market conditions, not the government.
The deduction for state and local taxes encourages states and localities
to impose higher tax rates than would otherwise be politically tolerable.
The deduction also encourages excessive consumption through local
governments -- providing services, such as trash collection, that
could easily be done by the private sector.
The exclusion for health insurance has deeply distorted the market
for health care, encouraging people to consume far more of it than
they would without a de facto tax subsidy.
When I made these arguments in the past, I quickly ran into a political
buzz saw. The mortgage interest deduction, for example, has deep
support among homeowners who fear that its elimination would cause
their home prices to fall. That is because the deduction is capitalized
into home values, strongly influencing the prices people are willing
to pay for houses. And the 1.2 million-member National Association
of Realtors, one of the most powerful trade associations in Washington,
will fight to the death to keep the mortgage interest deduction.
State and local governments will fight equally hard to keep the
state and local tax deduction, fearing, rightly, that it would constitute
a de facto increase in the state and local tax burden. When the
Reagan administration floated this idea back in 1984, governors
and mayors blanketed Capitol Hill, forcing it to withdraw this recommendation
when its tax reform proposal was sent to Congress in 1985.
Needless to say, any tampering with the health insurance exclusion
will bring forth massive opposition from workers, employers, insurers
and health-care providers.
The only way one could even hope to begin to take on such hugely
popular tax provisions would be if there were a really large payoff
at the end. The prospect of a flat-rate income tax of 20 percent
or so might provide such a payoff. But even with that as compensation
for the lost provisions, it would be a very difficult political
battle.
Unfortunately, the tax commission is offering virtually nothing
in return for giving up extremely popular deductions and exclusions.
We would be hardly any closer to a flat rate if its proposals were
adopted than we are now. Elimination of the misguided AMT would
be all to the good, but at present fewer than 3 percent of people
pay it. Although the AMT is scheduled to rise in coming years, hardly
any of those who will benefit from its repeal know who they are
and will be greatly outnumbered by those who will suffer from the
lost deductions.
In short, the tax commission proposals are deeply imbalanced politically.
Therefore, there is no chance whatsoever that Congress will adopt
either one. The Treasury Department and the White House may find
some way to salvage a more politically attractive tax reform proposal
from the commission report, but unfortunately, they have little
to work with.
