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Advisory panel proposes overhaul of tax code

WASHINGTON—A special presidential tax-advisory committee on Tuesday recommended a bold plan to simplify and restructure the tax code, proposing to change the tax treatment of everything from home ownership to health care.

The panel presented Treasury Secretary John Snow with two basic options for changing the federal tax system. One emphasizes a simplified income tax. The second, called a growth and investment plan, would radically change how businesses are taxed. Both plans contain some of the same elements and would offer the president and Congress a wide range of choices for changing the individual and corporate tax structures.

The last overhaul of the federal tax code came in 1986. President Bush early this year tasked a bipartisan panel with finding ways to update the tax system, promote economic growth and make the tax code fairer.

The panel didn't shy from controversy. It proposed radical changes in how Americans write off the interest on their home mortgages and even suggested making some employer-provided health care benefits subject to taxation.

The proposal would reduce the number of tax brackets for individual taxpayers and lower corporate income tax rates. And when Americans sit down with their 1040 tax forms, they would fill out 32 lines instead of 72. The information could fit on the front and back of a 4 x 6 index card.

"These are bold recommendations, these are far-reaching recommendations, these are recommendations that will challenge orthodoxy in a lot of ways on tax policy," Snow said, noting he would make recommendations about the panel's proposals to Bush by year's end. Bush and Congress must agree before any change becomes law.

Bush is expected to propose some tax-law changes early next year, but the political road ahead looks uphill. Next year Congress faces elections, and Bush's popularity is at record lows. Democrats are unlikely to follow his lead on controversial tax proposals, and Republicans too may think twice about changing such tax breaks as mortgage-interest deductions for their constituents.

Still, conventional political wisdom in 1986, another midterm election year, contended that sweeping tax reform would never pass—but it did.

The panel's most controversial proposals call for deep changes in the treatment of interest deductions for mortgages and home-equity loans—moves that would challenge the four-year nationwide housing boom.

The panel proposes replacing the current deduction for mortgage interest with a home credit for all taxpayers equal to 15 percent of interest paid on a principal residence. It would eliminate mortgage-interest deductions on second homes and vacation homes and the current deduction of up to $100,000 interest on home-equity loans.

Currently, taxpayers who itemize can deduct up to $1.1 million of their mortgage debt. That would change; instead only 15 percent of interest up to regionally determined limits could be deducted. Those limits would range, county by county, between $227,000 and $412,000.

"The tax preferences that favor housing exceed what is necessary to encourage home ownership or help more Americans buy their first home. For example, the $1 million mortgage limit may encourage taxpayers to purchase luxury residences and vacation homes," the panel's report said. "In addition, the deduction for home-equity loan interest may encourage taxpayers to use their houses as a source of tax-preferred financing for consumer spending."

Mortgage lenders frowned on the proposal.

"This proposal as it is stated would be bad for the housing market," said Michael Fratantoni, a senior economist with the Mortgage Bankers Association.

Under the proposal, one in five new mortgages last year would have been excluded from the deductions they received, he said. California would be hardest hit, Fratantoni said, because at least 20 percent of the state's new home owners last year took out loans valued between $350,000 and $1 million.

But the panel's chairman, former Sen. Connie Mack, R-Fla., said in an interview that only 5 percent of mortgages nationwide would be affected. That "really makes you ask the question, `Is this really a fair system,'" Mack said. The panel's report said only 35 percent of U.S. homeowners itemize deductions and fewer than 30 percent deduct interest paid on home loans.

Critics may question the fairness of another central plank of the panel's report: It assumes that controversial tax cuts enacted in 2001 and 2003 and worth more than $1.5 trillion will be made permanent.

"It's got a big tax cut built into it. That's not a footnote, but a front and center important issue," said William Gale, an economist at the Brookings Institution, a center-left think tank.

Both of the panel's plans would lower corporate income tax rates from their current maximum of 35 percent to either 31.5 percent or 30 percent. The top tax rate for small businesses and sole proprietorships would drop to either 33 percent or 30 percent. Under the more radical plan, businesses could write off their big-ticket purchases immediately instead of through long depreciation schedules.

The Chamber of Commerce supports the corporate-tax recommendations, but it says not enough thought was given on how to move to a new system. The National Retail Federation is upset with the panel's tax treatment of imports—whether barrels of oil or dime-store products—which it says would be hit with a 32 percent tax that would violate U.S. trade treaties.

The panel also proposes to:

_Simplify the tax code by collapsing the standard deduction, personal exemptions and other credits into a single Family Credit of $3,300 for married couples, $2,800 for unmarried taxpayers with dependent children and $1,650 for single taxpayers without children. Families would add $1,500 to the base credit for each child and $500 for each dependent.

_Treat some employer-provided health care benefits as taxable income. Plans valued at more than $5,000 per person and $11,500 per family—the national average—would be subject to taxation. Individuals purchasing their own health care plans could deduct costs up to those national averages.

_Repeal the federal itemized tax deduction for payment of state and local taxes.

_Collapse the current six tax brackets into four. The top tax bracket, 33 percent, would apply to married couples with income exceeding $200,001 or individual taxpayers with incomes above $100,000. Married couples with incomes between $150,001 and $200,000, and individuals with incomes between $75,001 and $100,000 would fall into the 28 percent bracket. A 25 percent tax bracket would apply to married couples with incomes between $78,001 and $150,000 and individuals with incomes between $39,001 and $75,000. The lowest tax bracket, 15 percent, would apply to couples with incomes less than $78,000 or individuals with incomes less than $39,000.

_Eliminate the alternative minimum tax, or AMT. It's a parallel tax originally designed to close tax shelters, but it increasingly snares middle-class taxpayers. Up to 21.6 million taxpayers will be vulnerable to the tax next year.

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(c) 2005, Knight Ridder/Tribune Information Services.

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