President Bush Tax Panel Recommendations Go To Executive Branch

The President's Advisory Panel on Federal Tax Reform submitted its delayed recommendations to Treasury Secretary John Snow on Tuesday. Secretary Snow said he would study the recommendations and report to President Bush before the end of the year.

The panel's recommendations, which were expected four months ago, differed in part from proposals that were outlined earlier and reported here. Those had sent interest groups such as real estate and home building proponents running for their public relations gurus. They don't feel any better about the "final" recommendations, but at least they have a more or less finished model to shoot at.

The panel's recommendations took the form of two separate plans; one would simplify the existing tax code (The current tax code runs to over 60,000 pages). The other would replace the code with a "progressive consumption tax" that would, among other things, slash taxes on capital gains and income with the goal of rewarding savings and investment while discouraging consumption. Both proposals would eliminate most deductions, replacing them with a few tax credits and three savings accounts designed to encourage homeownership, charitable giving, and savings. The proposal was also touted as providing increased support to lower income workers.

Both sets of recommendations were driven by widespread public demand for elimination of the Alternative Minimum Tax (AMT). This tax was put in place four decades ago as a means to tax the wealthy which, with high powered accountants and innumerable tax shelters, often paid no taxes at all. The AMT is not indexed for inflation, and as incomes have increased, more and more middle class families have been ensnared by AMT rules. About 20 million taxpayers will be affected next year compared to 1 million only six years ago, and the Brookings Institution estimates that number will climb to 31 million by the end of the decade.

Repeal of the AMT, however, will eliminate about $1.2 trillion in tax revenues over the next ten years, and the panel had to find ways to make up that deficit.

Among the proposals to compensate for the AMT shortfall is a limitation on employer financed health benefits. The commission suggests limiting the amount of insurance that an employer can provide tax-free to employees to a maximum of $5,000 for an individual and $11,500 for a family. At the same time, taxpayers could deduct the cost of providing their own health insurance up to the same caps if they did not receive health insurance through their employer. This could have the effect of eliminating high end health care plans for executives but might hurt middle-wage earners with handsome benefit packages.

A second proposal is the elimination of the deduction for state and local taxes. While this is clearly a hit for homeowners who can now deduct property taxes on first and second (maybe even third and fourth) homes, it also eliminates the deduction for ad valorum taxes on autos and boats, and the deduction for income taxes levied by local taxing authorities.

As we mentioned last week, however, it is the proposed reduction/elimination of the home interest deduction that has stirred up opposition from every group with a dog in that hunt.

Today taxpayers are allowed to deduct interest payments on home mortgages of up to $1,000,000, typically enough to finance a home costing $1,250,000. With certain exceptions having to do with the original purchase price of the home, this could include interest on a first mortgage, second mortgage and home equity line of credit. These deductions also embrace payments on mortgages for a second owner-occupied home, although we assume that a combined $1 million limit still applies. (If this is a concern for you, read the tax code. .Not even for you, loyal reader, are we going there.)

The recommendations this week are changed a bit from those we reported a few weeks ago. At that time it looked as though the hammer was going to fall on those with mortgages exceeding $250,000 to $350,000, most likely $313,000, an amount that coincides with the current maximum limit for Federal Housing Administration loan guarantees.

It is now suggested that the deduction would be limited to a regionally determined range of $227,000 to $412,000 with the higher amount allowed to those in higher median price areas such as Florida, California, and the Northeast. It is unclear whether the panel intends that amount be the absolute mortgage amount or the amount of the mortgage needed to finance such purchases.

The panel recommendations will eliminate all deductions for mortgage interest on second homes and, by definition, with local taxes gone bye-bye, also rules out deducting property taxes paid on any number of homes other than those classified as investment properties.

Instead of an outright deduction for mortgage interest, the proposed rules would allow a tax credit of 15 percent of the mortgage interest paid which, the panel contends, would be more helpful for low and middle income homeowners. In other words, if you paid $12,000 in interest on your new $200,000 mortgage this year you could deduct $12,000 from your income before computing taxes. Under the proposed rules you would instead receive a $1,800 credit against taxes owed. Every tax payer will have to evaluate his own situation so see how these potential changes will impact his bottom line.

On the income side, one of the two plans suggests that individuals would be exempt from taxes on dividends paid by U.S. companies and could exclude 3/4 of their capital gains. Under the second plan, all investment income would be taxed at 15 percent.

Regardless of any savings that the changes might bring to the taxpayer, the panel suggests that their proposals would shrink the size and complexity of tax forms and reduce the need for seeking professional help every April - which, in itself, can be a substantial savings. The panel's report also insisted that taxpayers would pay about the same amount of tax under the new rules as they do now.