Bush's Panel May Propose Version of Flat Tax in Final Report
By Ryan J. Donmoyer
bloomberg.com
Oct. 18 (Bloomberg) -- U.S. President George W. Bush's tax advisory panel may recommend a fundamental overhaul of the current system, replacing it with a variation of the flat tax that would abolish most deductions and end levies on investment income.
The panel plans to present Bush with several options for restructuring the tax code, including the creation of a new system that rewards savings, discourages borrowing, stimulates business investment, and simplifies tax filing for individuals, according to panel members and outside experts on whom they relied. The modified flat-tax proposal will be considered and possibly endorsed during the panel's final meeting today, they said.
``I would bet big money'' that panelists will recommend such a plan, said William Gale, a senior fellow at the Brookings Institution, a research group in Washington, who testified before the panel.
Such a system would face an uphill battle for congressional approval because it would impose a radical reordering of tax rules for companies, financial markets and the economy. The plan would also raise concerns about whether it would shift the tax burden from wealthy individuals to salaried employees, experts said. Proponents say the new system would be simpler and would promote economic growth by encouraging savings and investment.
``I think it's going to land with a thud,'' said Pamela F. Olson, a lawyer at Skadden, Arps, Slate, Meagher & Flom LLP in Washington, who served as assistant secretary for tax policy in Bush's Treasury Department from 2002 to 2004.
Borrowing Costs
Under the proposal, U.S. companies would stop issuing bonds, municipalities would face higher borrowing costs, the housing and life insurance industries would become less attractive to investors, Olson and other experts said. No one is quite certain how financial services companies would be taxed, they said.
Individuals living off investments would pay nothing, while wage earners would continue to have taxes withheld from their paychecks; people earning higher salaries would pay higher rates without the benefit of popular deductions, such as breaks for mortgage interest.
The President's Advisory Panel on Federal Tax Reform, formed in January, is due to make its recommendations to the Treasury Department on Nov. 1. Chairman Connie Mack, a former Republican senator from Florida, has said it will offer at least two proposals that the Bush administration can use as a blueprint for a rewrite of the tax code.
Top Priority
White House officials and congressional Republicans have indicated that Bush may make tax overhaul his top domestic priority next year. With the demise of his Social Security revision plan and conservative resistance to immigration changes, there may be few other options.
A second, less-ambitious tax option the panel is considering would aim to simplify the current system by repealing the alternative minimum tax and curbing dozens of tax breaks, including popular ones benefiting homeowners and those receiving employer-provided health care.
The panel last week rejected recommending a national sales tax, a step advocated by congressional Republicans such as Georgia Representative John Linder and South Carolina Senator Jim DeMint.
The panel's staff director, Jeff Kupfer, said the flat-tax proposal the panel will consider today is a variation of the so- called ``X tax'' devised by David Bradford, an economist at Princeton University in New Jersey who died in February.
Leading Option
Four of the panel's members -- Massachusetts Institute of Technology economist James Poterba, Stanford University economist Ed Lazear, Charles Schwab & Co. Inc. chief investment strategist Liz Ann Sonders and former Louisiana Senator John Breaux -- have been studying Bradford's proposal as a leading option for fundamental overhaul of the current system.
Bradford's proposal, which panel member Charles Rossotti described on Oct. 5 as a ``framework'' for deliberations, is a variation of the original flat tax devised by Stanford economists Robert Hall and Alvin Rabushka in the early 1980s. It has two parts, a business tax and a wage tax.
The ``X tax'' proposal would end taxation of investment income and interest deductions for businesses and individuals. It would also set a single rate for all businesses and allow unlimited write-offs for equipment purchases. Individuals would be taxed only on their wages.
In his proposal, Bradford set graduated tax rates on wages with a top rate of less than 30 percent, while the Hall and Rabushka proposal sets a single rate of about 19 percent on all wages over a set amount of about $41,000 for a family of four.
Under both systems, individuals would pay no taxes on interest, dividends or capital gains. They also would lose deductions for home mortgage interest, charitable contributions and state and local taxes.
Not Taxable
``Things that some people have come to view as income and are used to being taxed on would not be taxable anymore,'' said Joel Slemrod, director of the Office of Tax Policy Research at the University of Michigan in Ann Arbor and a former member of President Ronald Reagan's Council of Economic Advisers.
Gale said Bradford's proposal to allow graduated rates on wages ``is an effort to take the flat tax and make it more progressive.'' To forestall taxpayer opposition triggered by the loss of the home-mortgage deduction, Gale said panelists might preserve incentives for homeownership by providing a tax credit instead.
Leveraged Companies
The flat-tax idea represents an even more radical change for businesses, and not all of them would benefit, especially highly leveraged companies and those that lose money, analysts said.
All businesses would pay at a rate equal to the top rate for individuals, eliminating current differences between large corporations and small businesses. Businesses would pay tax on the sale of all goods and services and receive no deductions except for wages paid. Interest, dividends and capital gains would be tax-free.
The plan's ``central feature'' is abolition of deductions for interest paid, Gale said. ``If you don't take away interest deduction, the whole thing doesn't work.''
Michael Decker, senior vice president for research and public policy at the Bond Market Association in Washington, said such a proposal would make it less attractive for companies to borrow money and cause a reordering of the fixed-income securities market. Companies would race to retire high-interest notes, and municipal-bond yields would rise as investors devalue their tax-favored status and bid down prices.
``You would be shifting some of the tax preference away from debt, toward equity,'' Decker said. ``You would probably see some recapitalization, especially highly leveraged companies.'' |
