INTRODUCTION :: In November 2005, the President’s Advisory Panel on Tax Reform, appointed by President Bush to suggest options for reforming and simplifying the federal tax code, unanimously recommended two alternative plans: a “simplified income tax” (SIT) and a “growth and investment tax” (GIT). The two plans shared much in common. For example, both would: (1) Reduce the top marginal tax rate-to 33% under the SIT plan and 30% under GIT plan; (2) eliminate the alternative minimum tax (AMT); (3) replace the earned income tax credit (EITC) and refundable child credits with a “work credit”; (4) replace personal exemptions, the standard deduction, and child tax credits with a “family credit”; (5) eliminate all deductions for state and local taxes; (6) extend deductions for interest on home mortgages and charities to non-itemizers, but reduce deductible amounts; (7) cap the exclusion for employer-provided health insurance; and (8) expand and simplify tax-favored savings opportunities. In addition, the proposed SIT would eliminate tax on dividends distributed by U.S. corporations from U.S. earnings and would exempt 75% of capital gains on the sale of corporate stock; other dividends and capital gains would be taxed at standard rates.
The two plans also suffered from a common problem. Once the panel decided to eliminate the AMT (a loss of more than $ 1 trillion in revenue over the ten-year budget period), it struggled to find offsetting revenues to achieve revenue neutrality. This required attacking political sacred cows, such as the mortgage interest deduction. As a result, neither of the Panel’s plans has been endorsed by congressional Republicans or Democrats. And toeing their party lines, Republicans complain that the Panel did not recommend a greater reduction in tax rates, while Democrats criticize the Panel for favoring capital over labor income.
The Panel also considered-indeed, found worthwhile, but did not unanimously recommend-“Plan C”: a partial replacement of individual and corporate income taxes with a value-added tax (VAT). This approach holds the most promise of any tax reform proposal. In fact, the VAT has been successful throughout the world, often operating alongside an income tax. I have long favored limiting the income tax to income over $ 100,000 and making up the revenue lost with a VAT. This would eliminate the need for about 100 million tax returns each year, producing real simplification. And yet, despite the obvious advantages of Plan C, the question is: Does a VAT stand a chance of becoming law?
As always, the smart money is against tax reform. In 1986, the smart money bet against tax reform until the night before the new law was enacted. So the smart money doesn’t always win. Beating it, however, demands extraordinary leadership from both the White House and Capitol Hill. In 1986, in addition to President Reagan’s personal efforts, crucial leaders emerged in Congress from both sides of the aisle. The legislative proposals of Democrats Bill Bradley and Dick Gephardt and of Republicans Jack Kemp and William Roth, while different, pointed the way to the income tax reform that actually happened. And Republican Senate Finance Committee Chairman Bob Packwood and Democratic Ways and Means Committee Chairman Dan Rostenkowski supplied essential leadership in passing the legislation. The key question is whether members of Congress will step up this time.
The tax policy debate between Democrats and Republicans so far offers reasons for pessimism. Democrats seem to be looking to cut taxes of the poor, to provide tax breaks to the middle class for this or that expenditure, and to raise taxes for high- income people. Many Republicans seem to be looking mostly to provide more tax cuts for savers and investors, who tend to be those with higher incomes. The 1986 tax- reform coalition of supply-side Republicans and tax-reforming Democrats, which produced the revenue-neutral, distributionally-neutral, rate-lowering, base- broadening, tax-reform legislation signed by Ronald Reagan, has come completely unglued. Tax legislation during the 1990s completed the unraveling of the 1986 Tax Reform Act, which had promised, but failed to deliver, a better and simpler income tax. Republicans seem to favor a narrower tax base with low rates, Democrats a different but also narrower tax base with higher rates. Attempting to overhaul the income tax, as in 1986, does not seem a promising path.