Simplified tax code: a tough sell

President Bush's Advisory Panel on Federal Tax Reform is scheduled to present its recommendations to Treasury Secretary John Snow Tuesday. Business tax experts will quickly scour the report to see if the tax suggestions gore their ox - that is, hurt or help their financial interests.

Liberal tax experts will look to judge whether the proposals alter the tax burden distribution among the wealthy, middle-class, and poor.

Income disparities in the United States grew substantially from 2002 to 2003, new Internal Revenue Service statistics indicate. After adjusting for inflation, the after-tax income of the richest 1 percent of households rose by 8.5 percent, or nearly $49,000 apiece - helped by the Bush tax cuts. The bottom 75 percent of filers saw real after-tax incomes fall. The middle fifth of taxpayers, for instance, lost $300.

The nine-person panel outlined its tax suggestions last Tuesday. It emphasized the distributional neutrality of its ideas.

"I don't believe them," says Robert McIntyre, director of Citizens for Tax Justice, after noting some proposed changes.

No one expects Congress or the president to accept the panel's recommendations carte blanche. More likely, the president will wrap some of its proposals, such as streamlining tax breaks for savings, into his 2006 State of the Union address.

Then the tax committees of the Republican-led Congress will have a go at reform. What will emerge, if anything, is anybody's guess. But chances of major reform are "pretty slim," says Tom Ochsenschlager, tax vice president at the American Institute of Certified Public Accountants in Washington.

No one doubts a need for reform. As the panel put it earlier this year: "For millions of Americans, the annual rite of filing taxes has become a headache of burdensome record- keeping; lengthy instructions; and complicated schedules, worksheets, and forms - often requiring multiple computations that are neither logical nor intuitive."

Since the last major tax reform in 1986, Congress has added more than 14,000 changes to the tax code to please its constituents.

If implemented by Washington, the panel's proposals would achieve to a degree one goal: tax simplification. For instance, the panel suggests eliminating tax deductions for state and local taxes (which will save individual taxpayers $50 billion this year) and other measures that would shrink the Form 1040 tax return from 75 lines to 32.

The final result could be an Alternative Minimum Tax "in disguise," warns Milton Ezrati, an economist at Lord, Abbett & Co., a Wall Street firm.

The AMT, a parallel tax to the regular personal income tax enacted in 1970, is aimed at preventing wealthy individuals from escaping income taxes. The AMT does not allow as many tax deductions and other breaks as the regular system. In name, the reform panel recommends eliminating the AMT. But its proposed reformed income tax for everyone would be similar to the AMT in that tax breaks would be sharply curtailed.

As it is, the AMT, not being indexed for inflation, affects about 15 million households this year and could hit 40 million mostly middle-class Americans by 2010. Its elimination would leave a fiscal hole of almost $1.2 trillion over the next decade. So the reform panel, charged with making its reforms "revenue neutral," had to come up with revenue-producing tax changes to offset that loss. One is a cap on the deduction for mortgage interest for homeowners.

That tax break, however, is considered the "third rail" of tax policy. Touch it, and the politician perishes. Real estate tax breaks, including the tax-exempt status on capital gains up to $500,000 from the sale of a house, cost Uncle Sam about $110 billion a year.

Revenue and political difficulties in the 1986 tax reform under President Reagan were overcome by cutting personal income taxes and raising corporate income taxes. The top marginal income-tax rate, the tax on the top dollar earned by high-income people, was lowered from 50 to 28 percent.

But the political popularity of substituting higher corporate taxes for personal income-tax cuts was somewhat misleading, says Joel Slemrod, a tax economist at the University of Michigan Business School in Ann Arbor. That's because corporations pass their tax burden on to individuals in the form of lower dividends, higher product and service prices, and reduced wages.

The panel's proposed tax reforms assume the tax cuts of President Bush and Congress will not expire. That and other reform proposals would reduce federal revenues $7 trillion over 20 years, calculates Mr. McIntyre.

With tax rates already lowered and the federal budget deep in deficits, one potential big reward for tax reform, more big tax cuts, is probably gone. And a politically weakened president is likely to lack the clout to persuade Congress to act on reform with the 2006 election on the horizon, says Mr. Ochsenschlager.

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