Toward a Saner Tax Code

[David Farber <dave () farber net>]

Begin forwarded message:

From: Gregory Hicks <ghicks () cadence com>
Date: October 25, 2005 12:15:03 AM EDT
To: dave () farber net
Cc: ghicks () cadence com
Subject: Toward a Saner Tax Code
Reply-To: Gregory Hicks <ghicks () cadence com>


Dave:

For IP if you wish...

http://www.businessweek.com/bwdaily/dnflash/oct2005/ 
nf20051025_1018_db013.htm

OCTOBER 25, 2005

SOUND MONEY
By Chris Farrell

Toward a Saner Tax Code
The President's tax-reform panel has penned a comprehensive plan to
streamline the convoluted code. Is anyone in the White House
listening?  Last January, President George W. Bush named a bipartisan
panel to come up with a better tax system. Final recommendations are
due Nov. 1, but the President's Advisory Panel on Federal Tax Reform
has already issued its preliminary recommendations.

My reaction to the committee's work: Bravo. It has come up with a
sound, practical way to make the tax code simpler and fairer, with
lower compliance costs for the average citizen, while also doing away
with the alternative minimum tax, or AMT (see BW Online, 10/18/05, "An
Either/Or Plan for Tax Reform"[0]). (The panel actually produced two
plans -- one involving income taxes, the other closer to a consumption
tax.  Since the real differences largely involve business taxes as
opposed to individual taxes, I'm concentrating on the income tax
proposal.)

That's why it's disturbing that the reaction so far among Washington
cognoscenti has been a collective yawn. The White House hardly
stirred.  "We're going to take into account all the work they have done
and the recommendations they are making," said White House spokesman
Scott McClellan.

TAXING ISSUES.  There is no question that the American tax code is a
disgrace, riddled with exemptions, deductions, exclusions, credits,
phase-ins, phase-outs, and temporary breaks (see BW Online, 5/30/05,
"Tax Reform's Key? Stop Hammering Investors"[1]). Almost every year,
thanks to congressional and Administration fiddling, the tax code
becomes ever more Byzantine. The total number of pages in the federal
tax code is more than 60,000, up 48% in nine years, according to the
Cato Institute, a Washington, D.C.-based think tank. The percent of
taxpayers who hired a professional to help calculate their taxes jumped
to 62% in 2003 from 50% in 1995.

The Commission's reform mantra can be summed up as simplification,
fairness, and modesty. Specifically, it isn't advocating a radical tax
overhaul, such as a national sales tax or flat tax. Instead, it
suggests broadening the tax base by eliminating many deductions and
exemptions, and replacing many of them with a handful of credits.

The number of schedules and worksheets would decline from 52 to 10. It
would streamline the number of tax rates from six to four, with a top
rate of 33% vs. the current 35%, and it would maintain progressivity,
with the wealthy paying a higher percentage than their lower-income
neighbors. Best of all, the Commission's broadening of the tax base
will make up for any revenue lost by the elimination of the AMT.

MORTGAGE INTEREST.  The most striking recommendation is transformation
of the mortgage-interest deduction into a credit. Currently, interest
payments on a mortgage below $1 million are deductible. Obviously, that
tax break is more valuable to high-income earners.

The panel suggests converting the deduction into a credit equal to 15%
of the mortgage interest paid. The amount of a mortgage eligible for
the credit would be circumscribed by the Federal Housing Administration
loan limitation. That figure varies by region, but currently averages
about $265,000. In other words, the credit will still encourage
homeownership, especially among first-time buyers. Yet it will limit
the tax break for upper-income households moving into McMansions.

Another highlight involves tax-deferred savings. For instance, the
American worker is increasingly responsible for putting away money for
retirement. But the government makes it tougher than necessary. Think
about it: There are 401(k)s, 403(b)s, 457s, SIMPLEs (Savings Incentive
Match Plans for Employees), SEP-IRAs (Simplified Employee
Pension-IRAs), IRAs, nondeductible IRAs, Roth IRAs, Roth 401(k)s, sole
401(k)s, and so on. Each retirement plan has different rules and
regulations, despite some movement in recent years toward making them
more harmonious. There's also a variety of education savings plans.

15% BRACKET?  The panel wants to replace these multiple accounts with
three: Save at Work, Save for Retirement, and Save for Family.

The Save at Work account would act like a 401(k), funded with pretax
dollars. The Save for Retirement account would replace various IRAs; it
would largely imitate an expanded Roth, allowing individuals to set
aside up to $10,000 in after-tax dollars that could be withdrawn
tax-free in retirement. The Save for Family account would substitute
for tax-advantaged educational and health savings plans. Taxpayers
could contribute savings of up to $10,000, and withdraw up to $1,000 a
year for any reason and no tax liability.

Other highlights include replacing personal and family tax breaks with
a single family credit, and purging the marriage penalty. The
President's tax-reform panel estimates that three-quarters of all
taxpayers will be in the 15% tax bracket.

The panel's most immediate problem was to resolve the dreaded
individual alternative minimum tax (see BW Online, 9/20/04, "What A
"Fairer" Tax Code Might Look Like"[2]). And it succeeded.

INFLATION'S BITE.  Indeed, the panel's minimal mandate was to eliminate
it. The original goal of the AMT, which became law in the 1970s, was to
do away with tax loopholes that allowed the extremely wealthy to avoid
taxes. But, since 2000, the AMT has evolved into a parallel tax
system.  Assuming the law stays in place, 3.6 million filers -- 30%
with incomes below $200,000 -- could pay the AMT this year, estimates
the Tax Foundation, a nonpartisan tax-research organization based in
Washington, D.C.

What happened? Congress failed to index the AMT for inflation. Over
time, rising real estate values, higher local tax payments, increased
incomes, and the proliferation of credits for children and education
pushed more middle- and upper-middle-income folk into the AMT.

The Bush Administration's tax cuts also reduced regular income tax
liabilities, while the AMT remained essentially unchanged. Since
taxpayers are on the hook for whichever bill is larger, the decline in
income taxes forced more taxpayers out of the regular tax system and
into the AMT. If the panel gets its way with tax reform, middle-class
taxpayers won't have to hold their breath and calculate the AMT as the
Apr. 15 deadline nears.

IN BUSH'S COURT.  To be sure, I don't like everything the panel has
recommended. It's a slam dunk that there will be fierce opposition. The
real estate industry can't be happy. Politicians from high-tax states
are outraged, because the deduction for state and local income taxes
will be eliminated.

And the White House, reeling from a variety of setbacks -- including
the political death of the Administration's main domestic priority,
Social Security reform -- doesn't have a lot of political capital to
spend these days.

The last major overhaul of the tax system occurred in 1986, but that
was a very different time. Back then, President Ronald Reagan and a
bipartisan group of congressional power brokers worked together to pass
the Tax Reform Act of 1986. So far, George W. Bush has shown that he is
no Ronald Reagan, and vitriol -- not bipartisanship -- is now the
language of Washington.

NO EXCUSES.  Still, President Bush may have no choice but to try and
seize the mantle of tax reformer. He may also be able to force a
reluctant Congress to go along. The reason is simple: the AMT.

Without reform, the AMT will hit more and more middle-class families,
provoking the risk of a vicious backlash for the party in power. I say,
shame on Washington if political inertia and special-interest bagmen
prevent Congress and the Administration from embracing the advisory
panel's blueprint for much-needed reform.


[0] http://www.businessweek.com/bwdaily/dnflash/oct2005/ 
nf20051018_2433.htm
[1] http://www.businessweek.com/magazine/content/05_22/ 
b3935045_mz007.htm
[2] http://www.businessweek.com/magazine/content/04_38/ 
b3900051_mz011.htm

---------------------------------------------------------------------
Gregory Hicks                           | Principal Systems Engineer
Cadence Design Systems                  | Direct:   408.576.3609
555 River Oaks Pkwy M/S 6B1             | Fax:      408.894.3479
San Jose, CA 95134                      | Internet: ghicks () cadence com

I am perfectly capable of learning from my mistakes.  I will surely
learn a great deal today.

"A democracy is a sheep and two wolves deciding on what to have for
lunch.  Freedom is a well armed sheep contesting the results of the
decision." - Benjamin Franklin

"The best we can hope for concerning the people at large is that they
be properly armed." --Alexander Hamilton



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