In January, 2005, the President’s Advisory Panel on Federal Tax Reform was created to recommend options that would make the tax code simpler, fairer, and more conducive to economic growth.  That is obviously an ambitious objective and as anticipated, special interests are already gathering lobbyists in order to fight many of the recommendations.

How The Tax Code Would Change:

Households and Families

Other Major Credits and Deductions

Individual Savings and Retirement

Small Business

Large Business

Analyses of the proposal's impact on various economic groups are already being performed on all sides of the political spectrum, but for purposes of this analysis, we will simply report the Panel's conclusions as they presented them.  The Panel was unable to reach 100% consensus, so they released two competing plans and at the bottom of this commentary, we are presenting a table which outlines current law as compared to each of the two proposals from the Panel.

The Panel analyzed the current federal income tax system and considered a number of proposals to reform it. During the course of the Panel’s work, some themes emerged that guided its deliberations:

• The United States has lost sight of the fact that the fundamental purpose of our tax system is to raise revenues to fund government.

• Tax provisions favoring one activity over another or providing targeted tax benefits to a limited number of taxpayers create complexity and instability, impose large compliance costs, and can lead to an inefficient use of resources. A rational system would favor a broad tax base, providing special treatment only where it can be persuasively demonstrated that the effect of a deduction, exclusion, or credit justifies higher taxes paid by all taxpayers.

• The current tax system distorts the economic decisions of families and businesses, leading to an inefficient allocation of resources and hindering economic growth.

• The complexity of our tax code breeds a perception of unfairness and creates opportunities for manipulation of the rules to reduce tax. The profound lack of transparency means that individuals and businesses cannot easily understand their own tax obligations or be confident that others are paying their fair share.

• The tax system is both unstable and unpredictable. Frequent changes in the tax code, which often add to or undo previous policies, as well as the enactment of temporary provisions, result in uncertainty for businesses and families. This volatility is harmful to the economy and creates additional compliance costs.

• The objectives of simplicity, fairness, and economic growth are interrelated and, at times, may be at odds with each other. Policymakers routinely make choices among these competing objectives, and, in the end, simplification is almost always sacrificed. Although these objectives are often in tension, meaningful reform can deliver a system that is simpler, fairer, and more growth-oriented than our existing tax code.

With these themes in mind, the Panel evaluated a number of reform proposals to find out whether they would meet the President’s goals for current and future generations of Americans. After 12 public meetings in five states and Washington D.C., the Panel reached consensus to recommend two tax reform plans. 

The Panel’s recommended plans, labeled the Simplified Income Tax Plan and the Growth and Investment Tax Plan, include the following major features:

• Simplification of the entire tax system and streamlined tax filing for both families and businesses.

• Lower tax rates on families and businesses, while retaining the progressive nature of our current tax system.

• Extension of important tax benefits for home ownership and charitable giving to all taxpayers, not just the 35 percent who itemize; extension of tax-free health insurance to all taxpayers, not just those who receive insurance from their employers.

• Removal of impediments to saving and investment.

• Elimination of the Alternative Minimum Tax, which is projected to raise the taxes of more than 21 million taxpayers in 2006 and 52 million taxpayers by 2015.

The two plans differ in the taxation of businesses and capital income. Although they use different approaches, the plans share a common goal of providing simple and straightforward ways for Americans to save free of tax and lower the tax burden on productivity-enhancing investment by businesses.

The Panel also developed and considered a progressive consumption tax plan that would be administered using the infrastructure of our familiar tax system, but was unable to reach a consensus to include it as a recommendation. The Panel also considered ideas for a value-added tax and a national retail sales tax, and decided not to recommend either approach.

The Simplified Income Tax Plan and the Growth and Investment Tax Plan put forward by the Panel achieve the goals set by the President in a number of ways.

They reduce complexity by:

• Allowing every taxpayer to use a simple tax form, which is less than half the length of the current Form 1040.

• Combining 15 different tax provisions for at-work saving, health saving, education saving, and retirement saving into three simple saving plans.

• Eliminating a complicated set of phase-outs that leave taxpayers wondering whether they are eligible to benefit from numerous provisions.

• Replacing a confusing, full-page worksheet for seniors reporting Social Security income with a simple computation that is no more than six lines.

• Replacing the complicated rules for small business with a system that is based on the records their owners already keep.

• Ensuring that tax benefits are easily understood and accessible, thereby increasing confidence in the tax system.

• Making most tax benefits available to all taxpayers, not just the 35 percent who itemize.

• Shifting some tax preferences from deductions, which tend to benefit high-income households, to tax credits, which benefit all taxpayers equally.

• Reducing marriage penalties by ensuring that the rate brackets, the Family Credit, and the taxation of Social Security benefits for married couples are twice the amounts for singles.

• Transforming the earned income tax credit and savers credit into provisions that are more accessible and beneficial to low income taxpayers.

• Closing loopholes and eliminating special tax breaks that allow the well-advised to avoid paying their fair share.

• Maintaining the progressive nature of our tax system. 

They promote economic growth by:

• Reducing the double-tax on corporate profits earned in the United States.

• Promoting savings throughout our economy, especially at the household level.

• Equalizing the tax treatment of several forms of corporate financing, raising the incentives for companies to issue equity rather than debt to finance growth.

• Reducing the likelihood that households or businesses will alter economic behavior because of special tax preferences or benefits.

• Lowering the top marginal rates on individuals and businesses.

• Reducing the paperwork burden for small businesses, and providing them an immediate write-off for all purchases of new tools and equipment.

• Updating our international tax system.

These benefits will follow only from a fundamental reform of the tax code. In isolation, some of the recommended pieces may be controversial, but taken as a whole, they accomplish the Panel’s objectives. Each plan is designed to be comprehensive and should be viewed as an integrated package. 

The Panel believes that without large-scale changes, and continued commitment to avoiding complexity and special tax breaks, the tax code will become even more confusing, unfair, and damaging to our economy. We urge the Administration and Congress to consider these recommendations carefully and to move forward with reform.