A new twist to your tax bill?

By , Staff writer of The Christian Science Monitor

A political cartoon shows Uncle Sam heading down a path marked "General sales tax." He's trying to move forward. But holding him by the coattails is a bearded character labeled "Congress."

That cartoon dates from 1933 but it could easily run today. Fresh from his election victory and saying he wants "a simpler, fairer pro-growth [tax] system," President Bush is considering whether to offer the most sweeping tax-reform package since 1986. Some conservatives are urging him to shutter the Internal Revenue Service and replace today's income tax with a national sales tax collected by states. Or, he might accomplish some of the same thing - taxing consumption instead of income - with a value added tax.

He could also opt for more incremental reform, moving the nation toward one type of flat-tax system where everybody pays the same rate.

Recommended: Income taxes: Five changes for 2012

But the tax system reaches into so many nooks and niches of life that obstacles to reform loom large. If the income tax disappears, what happens to those tax-advantaged IRA and 401(k) accounts, municipal bonds, and state income-tax systems based on the federal system? Will Congress follow the president if retirees, mayors, and governors scream "betrayal?"

"It would be the end of Republican control of Congress," says Robert McIntyre, director of Citizens for Tax Justice, a liberal tax research group.

So far, Mr. Bush hasn't specified what he wants, leaving reform recommendations up to a special commission he'll appoint by year end. Tax experts will be watching for clues to his intentions from the names of those he appoints to the advisory group.

One idea the commission is likely to consider is a national sales tax. Bush last summer called it "an interesting idea that we ought to explore seriously." The House Republican leadership supports substituting a sales tax for the federal tax system. The switch would essentially make interest, dividends, profits, and capital gains tax-free.

"This is the brightest of times," says Tom Wright, executive director of Americans for Fair Taxation. "The opportunity has never been better."

At this Houston-based group, Mr. Wright has spent 14 years and $22 million in research urging that the sales tax replace all current federal taxes - payroll taxes as well as income taxes. Collection would be done by the states, which already have systems to reap state sales taxes. The Internal Revenue Service would become redundant.

A bill that would switch federal taxation to a national sales tax (H.R. 25) has 57 cosponsors in the House, he notes. "In any stand-up fight in the grass roots, we always win," he says.

Yet most observers doubt it could pass Congress. It would engender "intense public opposition and questionable economic benefits," holds David Malpass, chief economist of Bear Stearns, a Wall Street investment firm.

Opposition is already building. In September, the Democratic staff of the tax-writing House Committee on Ways and Means issued a report attacking the "radical restructuring plan."

Critics charge that a national sales tax would be regressive, placing more of the tax burden on the middle class and shrinking it for the rich. Mr. McIntyre estimates it would saddle middle-and low-income families with average tax increases of $3,000 to $4,000 a year.

But Mr. Wright counters that his plan includes a rebate system, which in effect allows each household tax-free spending up to the poverty level. Above that, families would be taxed on how much they consume in goods and services, including almost everything except education expenses, contributions and dues to charitable groups, and used goods.

Only big spenders would pay the maximum 23 percent rate, he says.

Even he concedes that the really rich - those making more than $200,000 a year - usually spend a smaller proportion of their income on goods and services than do the middle class. So they might see their tax burden decline. "But their heirs don't escape," Wright adds.

The Bush tax-reform commission will likely look at other measures. One could be a "flat tax," advocated by Steve Forbes, the magazine owner who sought the Republican nomination for president four years ago.

Another possibility could be a value added tax, such as those imposed by most European nations. The VAT is a cascading tax, collected at each stage of production and distribution and embedded in prices that consumers or other final users pay. By increasing revenues, a VAT would help solve the problems of a large federal deficit combined with rising entitlement spending as baby boomers retire, argues Bruce Bartlett, a former Treasury official under the first President Bush and now a fellow at the National Center for Policy Analysis in Washington. In a new 27-page paper for the Ripon Society, a Republican research and policy group, he argues that the extra revenues would smooth the way for fixing problems in today's tax code.

There's some suspicion in Washington that the presidential commission is merely a way for Bush to impress his more conservative backers that he hates the complex federal tax code with its 45,000 pages as much as they do.

Advocates of a sales tax, such as Rep. Jim DeMint (R) of South Carolina, noticed a damaging assault on the issue from Democratic opponents in the November election. Nonetheless, Mr. DeMint did win a Senate seat.

A national sales tax, in particular, would involve wrenching change. By taxing the services and purchases of states and municipalities, it would require the transfer of $300 billion a year in new taxes to the federal government, maintains John Buckley, an author of the House Ways and Means Committee study. It would clobber state income-tax systems, since most are based on the federal income-tax system. The result would be higher property and state sales taxes.

Also, replacing income taxes with a sales tax would make tax-exempt bonds issued by municipalities less attractive, and thus require higher interest rates. It would take away any tax advantage of life insurance, or of various types of pension savings, such as 401(k)s. Senior citizens would be subject to the tax on their spending from pensions or accumulated wealth after a lifetime of paying payroll taxes.

Flat or VAT? A guide to tax terms.

Americans know what an income tax does. They usually pay a state sales tax when they shop. But as the nation embarks on a debate over tax reform, other terms are likely to come to the fore. Among them:

Value added tax: This European staple is a cascading sales tax. Each enterprise along the production and distribution chain pays, including the retailer or final seller. They calculate the tax on the basis of sales revenue minus the cost of purchased inputs (labor not included). An advantage: The VAT can be rebated on exports, giving exporters an advantage in world trade. Europe's VATs average around 13 percent.

National sales tax: Imposed on the final sale of a product or service, this tax is similar to a state sales tax but applies to transactions nationwide. One proposal would substitute it for the entire current federal system, which taxes personal and corporate income.

Flat tax: This is a system that taxes all individuals at the same rate, no matter how much they make. But the flat tax pushed in the House by majority leader Richard Armey (R) in 1995 was actually a VAT in disguise. It allowed firms to deduct wages and salaries when calculating the tax owed. The tax gained fame when its creators said individuals could fit their tax returns on a postcard.

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