Summary of “Simple, Fair & Pro Growth: Proposals to Fix America’s Tax System”by the President’s Advisory Panel on Federal Tax Reform.  November 2005The report issued by the President’s Advisory Panel on Federal Tax Reform contains two separate proposals as well asreasons why they are not proposing a Value Added Tax (VAT) or a National Retail Sales Tax.  The two plans are similar in the way they affect the individual taxpayer and mostly vary in the way they handle corporate taxes.  Both plans attempt to simplify the tax code, maintain their progressive approach to taxes, and find ways to spread benefits equally to all taxpayers.  Nonetheless, a major overhaul of our tax system is not proposed. While certain benefits are eliminated, some are expanded, and some programs are renamed with minor modifications, this is not an overall sweeping tax reform that would change the face of the IRS or how people view taxes.In both plans the twomajor targets for benefit reductions are focused on home ownership incentives and health benefit incentives.  Homeownership is targeted in several different fashions.  First and foremost is the reduction and transformation of the mortgage interest deduction (MID).  Both reform plans would cap the MID to 125% of FHA conforming loan limits, currently ranging from $227,000 to $412,000.  They would also convert the MID into a credit andwould only allow for the credit to be taken on 15% of the interest on the principal mortgage and only on the portion of the mortgage which falls within their new limits.  Mortgage interest on a second house will no longer be deductible.Additionally, deduction of interest on home equity lines of credit (HELOC) is eliminated.  Furthermore, the deduction of state and local states is eliminated, meaning that the deduction of property tax is eliminated.  The unlimited funding of employer-provided health care would also be capped.  The new levels would be $11,500 for families and $5,000 for individuals.  Any cost over this cap would be taxed as normal income.The main differences between the Simplified Income Tax Plan and the Growth and Investment Tax Plan are found in how they approach business taxes.  The transformation of the MID, loss of state and local taxes, reductions in employer-provided health care, etc… are all included in both plans.  The differences are found in the taxation of dividends, capital gains, and a VAT system imposed on transnational trade.There are numerous other changes made to theoverall tax system.  For example, instead of our current six tax brackets, the Simplified Income Tax Plan has only four brackets and the Growth and Investment Tax Plan has only three.  Overall, the other changes made are not drastic reforms as much as they are attempts of simplification.  The changes to Family Credit, Work Credit, Save for Work, Save for Retirement, and Save for Family credit are all designed to consolidate current credit and saving programs. The panel states that they are not trying to hurt homeowners or those who get employer-provided health care. Rather they argue that these programs are actually driving the costs of services higher for everybody else(i.e. because health care companies know that employers cover health care costs and it’s tax deductible the cost of health care has gone up because heath care companies are trying to reap some of the benefits employers/employees are getting).  Their argument is that these changes will allow more people to experience benefits in the tax code.  Nonetheless, they frankly point out that they are attempting to shift the burden of the tax code towards higher incomes.  This means that the fact that a median home in Nashville, TN might cost $166,000 and a median home in Los Angeles costs $561,000; this is not taken into consideration. Therefore, California, being a high cost state, would be disproportionately affected by many of these reforms. There are still many holes left in the panel’s report.  There are glaring questions about revenue neutrality (especially with the Growth and Investment Tax Plan) and they do not mention repealing any special tax breaks that big interest (such as oil, logging, and other special interest favorites) currently get.  The options still lack that substantial reform that the panel claims the people want and deserve.Real Estate Specific Concerns

• They question whether current homeownership provisions encourage excessive investment in housing at the expense of other productive uses and thatthe tax preferences that favor housing exceed what is necessary to encourage home ownership or help more Americans buy their first home.
• Mortgage lenders do not have to compute how much of your mortgage is availablefor your credit.  Therefore, if your lender does not do this, you are responsible for calculating what part of your mortgage interest is available for credit (currently a Form 1098).
• MID is eliminated.  Replaced by a 15% credit on your mortgage interest on loans up to 125% of the median sale price for each county (FHA conforming limits, currently between $227,000 and $412,000).  Mortgage interest on second home isno longer deductible.

• The transition rules for the MID would be phased in over five years.  During the transition period current homeowners can claim either the MID of the newHome Credit, but once Home Credit is claimed a homeowner cannot return to the MID.  The transition for those who wish to claim the MID would follow these rules:

• Any new mortgages would have to move immediately to the Home Credit as would any previous mortgages that are refinanced.
Interest on HELOC is no longer deductible.
• Property tax is no longer deductible since state and local tax deductions are eliminated.
• The transition rules for the MID are quick and harsh (see transition rules under appendix section).
• While not officially proposed, if a VAT system were created the purchase price of a new residential real estate would be taxed, but pre-existing houses would be excluded.
• In chapter 3 (pg. 20) they claim that for a true comprehensive income and consumption tax base that, “In the case of housing, homeowners would also have to declare as incomethe value they receive by living in their houses rather than renting them out – something economist call ‘imputed rental income’”.  The do not recommend doing this, but they use it as a way of showing that homeowners already get special treatments.
• More generous transition relief structures would require higher tax rates on businesses, individuals, and possibly further cuts in the mortgage interest deduction and employer-provided health insurance.
• Increases the capital gains benefit for homeowners (when home is sold) to $600,000 for a married couple and $300,000 for an individual.  It also increase the time an individual or couple must own and use a home as a principle residence to three out of the last five years.

• The current system to too complex and almost $150 billion is spent each year by U.S. households, businesses, and the federal government to collect/prepare taxes.
• The current system is confusing.
• Because of constant changes to credits, rates, and deductions taxpayers cannot plan ahead
• The tax code treats similar tax payers in different ways (single person making $45k a year in California not treated the same as single person making $45k a year in Montana).
• Because of generous incentives costs associated with these incentives have gone up (i.e. because we allow college expense to be deduction the cost of college has risen).

• Taxes used to be collected to fund the government.  Now they fund the government, provide social programs, and support policy objectives.
• Since the last tax reform, 1986, there have been more than 100 different acts of Congress which have made nearly 15,000 changes to the tax code – equal to more than two changes a day.

• Our current system is a hybrid tax system with both income tax and consumption tax features
• We currently have numerous credit, deductions, exclusions, and forms to calculateour adjusted gross income and our tax base.
• We currently have six tax brackets (10%, 15%, 25%, 28%, 33%, and 35%)
• Biggest tax preference is health deductions and the second largest is incentives for home ownership.
• We have a progressive tax system (the more earn the higher the percentage you are expected to contribute)
• There are three major burdens ofthe current tax system: administrative costs, compliance costs, and efficiency costs.

• The baseline of the report assumes that the 2001 and 2003 tax cuts will be made permanent.
• The baseline also assumes that the current “patches” limiting the reach of the AMT will expire in 2005 and not be renewed.
• AMT currentlyaffects four million American families and is projected to affect more than 50 million taxpayers by 2015.
• Their revenue neutrality is based on looking at a 10-year period.
• Therewere times the panel elected to make features simpler, even though a more complicated design could have been used to better target benefits to specific taxpayers.

• They propose two options for tax reform.  The first is called the Simplified Income Tax Plan and aims mostly to reduce the size and cost of the current tax code.  The second option is called the Growth and Investment Tax Plan and enhances the first option by reducing the tax burden on saving and investment while moving our tax system closer to a consumption tax.
• Eliminating the personal and corporate AMT.
• Simplify the tax treatment of Social Security benefits with a simple deduction.
• Eliminate marriage penalties by making tax provisions for married couples equal to twice the amount for unmarried taxpayers.
• Move towards eliminating the double taxation of corporate earnings.
• Creates the new Family Credit and Work Credit which are simpler and more uniform than current credits. 
• They question whether current homeownership provisions encourage excessive investment in housing at the expense of other productive uses and that the taxpreferences that favor housing exceed what is necessary to encourage home ownership or help more Americans buy their first home.
• They say the MID should be turned into a credit, which would encourage home ownership,not big homes.  The cap would be 125% of the median home price for each county (based off of FHA conforming limits).
• Limits employer-provided healthcare to $11,500 for families and $5,000 for single individuals.

• Creates four tax brackets: 15%, 25%, 30% and 33%.
  

• They calculate that almost 75% of all households will pay tax on their income at the lowest tax rate.
• Repeals the AMT
• Condenses the personal exemption, standarddeduction, and child tax credit into the Family Credit.  Levels are $3,300 for married couples, $2,800 for unmarried with child, $1,650 for singles, $1,150 for dependent taxpayer, and an additional $1,500 for each child and $500 for each other dependent.
• Earned income tax credit replaced with Work Credit (and is coordinated with the Family Credit).  Maximum credit for working family with one child is $3,570 and with two or more children is $5,800.
• Eliminate marriage penalties by making tax provisions for married couples equal to twice the amount for unmarried taxpayers.
• Home mortgage interest would be changed to a 15% credit and limited to 125% of the median sale price for each county.  Interest on second mortgage no longer deductible and interest on home equity lines of credit no longer deductible.
• The transition rules for the MID would be phased in over five years.  During the transition period current homeowners can claim either the MID of the new Home Credit, but once Home Credit is claimed a homeowner cannot return to the MID.  The transition for those who wish to claim the MID would follow these rules:

• Any new mortgages would have to move immediately to the Home Credit as would any previous mortgages that are refinanced.

• Deduction for charitable giving available to all taxpayers (standard deduction or itemize) who give more than 1% of income.  For those who donate more than $600 will be required to report more detailed information on donations.
• Family Credit can be used for some full-time students (along with new education savings plan)
• Deductions for state and local taxes (including property taxes) eliminated.
• Limits employer-provided healthcare to $11,500 for families and $5,000 for single individuals.
• Increases the capital gains benefit for homeowners (when home is sold) to $600,000 for a married couple and $300,000 for an individual.  It also increase the time an individual or couple must own and use a home as a principle residence to three out of the last five years.
• No taxes on 100% of dividends of US companies paid out of domestic earnings
• Excludes taxes on 75% of corporate capital gains from US companies (rate would vary from 3.75% to 8.25% on remaining 25%).
• Interest received is taxed at regular rates
• For Social Security benefits married taxpayers with less than $44,000 in income ($22,000 if single) pay no tax on Social Security benefits.  Marriage penalty is also eliminated (everything twiceas much for married couple over single) and is indexed for inflation.
• Save at Work plans would replace 401k and SIMPLE IRA programs.  Save at Work plans would follow the same contribution limits and rules of 401k plans, but the plan qualifications rules would be simplified. 
• A voluntary feature of the Save at Work plan would be AutoSave.  This is designed to encourage workers in the direction of sound saving and investments.  This feature would give employees automatic enrollment, automatic growth (guaranteed increases over time or intervals), automatic investment (into diversified and balanced funds), andautomatic rollover. 
• Save for Retirement accounts would replace existing IRA and Roth IRA accounts.  Contributions would be made with after-tax dollars, like current Roth IRAs andearnings would grow tax free.  It would be used to supplement a Save for Work account and would allow up to an additional $10,000 in contributions.  The annual contribution amount would be indexed annually for inflation.
• Save for Retirement accounts would only be available after the age of 58, or in the event of death or disability.  Early distributions would be treated as taxable income and subject to an additional 10% tax.
• Save for Family accounts would be created to for people to save money for retirement, health, education and training, or a down payment on a home.  They will have limits of $10,000 annually.  Save for Family accounts would replace all other health and educations savings programs.  Contributions would be on an after-tax basis.
• Taxpayers would be allowed to withdraw$1,000 tax-free each year from a Save for Family account for any reason and any distribution over $1,000 annually that is not for qualified expenditures would be treated as taxable income and subject to an additional 10% tax.
• A Saver’s Credit would be introduced to increase likelihood that taxpayers will increase their savings and would provide a subsidy for lower-income taxpayers to save.
• Cash-value annuities and life insurance which increase in value would now be treated as current income and would be subject to a tax on an annual basis.
• Small businesses making less than $1M in receipts would report income based on cash receipts less cash business expenses.  However, special bank accounts would have to be created to only handle business cash and costs.
• Medium businesses (between $1M and $10M) would follow the same rules as asmall business, but would also be required to depreciate the cost of equipment and other capital expenditures.
• Large businesses (over $10M) would be taxed like corporations.  Passive investment vehicles such as REITs would be treated the same as under current law.

• Much of the provisions from the Simplified Income Tax Plan are found in the Growth and Investment Tax Plan.  The differences are noted below.
• Creates three tax brackets: 15%, 25%, and 30%.
  

• Dividends are taxed at a 15% rate.
• Capital gains received at taxed at a 15% rate.
• They believe that few families would pay the 15% tax on interest since they would have the option of the Save for Families plan and other savings plans.
• A flat tax of 30% would be imposed on all businesses cash flow other than sole proprietorships, regardless of their legal structure. 
• All business expenses can be expensed the year that they are made. 
• The business tax base under the Growth and Investment Tax plan would not include financial transactions.  Financial institutions would treat all principle and interest inflows as taxable and deduct all principle and interest outflows.
• Tax losses would not be refundable; however, there would be interest on loss carryforwards.  (If the current interest rate is 10% and a firm incurs $1M loss (They spent $2M and only made $1M) in a year, it may claim a $1.1M loss offset for the next year).
• International trade/taxes would be done on a “destination-basis”.  This means goods sold in the U.S. by a U.S. firm or a foreign firm would be subject to a consumption tax.  This would help force foreign importers to compete in the U.S. on the same basis as local sellers.
• We would use a border tax adjustment, which would mean we would need to provide tax refunds to exporting firms.  However, this may not be allowed under WTO.  Therefore, the panel DID NOT include the revenue that would be raised through border adjustments, which is projected at $774 billion over ten years.
• They recommend transition relief on existing depreciation values phased out evenly over five years.  They also want a similar five year phase out for interest deduction on debt.  They propose a four year phase in for border adjustments.  Finally, theywant specialized transition rules for financial institutions, though no specific rules were proposed. 
• More generous transition relief would require higher tax rates on businesses, individuals, andpossibly further cuts in the mortgage interest deduction and employer-provided health insurance.

• Panel members felt that the lower income rates made possible by VAT revenues could create a tax system that is more efficient and fair, but could not reach consensus on recommending VAT.
• VAT would be in conjunction with lowered income taxes, not a full replacement.
• Panel believes that the idea of a VAT option is still worthy of further discussion and consideration.
• VAT can be thought of as a retail sales tax that is collected at stages instead of all at once from the consumer.
• Would help move us towards a consumption-based tax system.
• Would help US competitiveness since we are the only OECD nationnot to use a VAT.
• There are years of history and experience to help us form our system.
• A VAT would likely increase compliance and administrative costs.

• Would eliminate the progressive nature of our tax system
• Would be seen as encroachment on traditional state tax base
• Difficult to exclude items (such as water or food) from tax base and still have a broad enough tax base for collections.
• Even with favorable assumptions, in order to accommodate the effect this would have on the poor the tax rate would be at least 34% (not including current tax states)
• Hard to administer, high costs for IRS and business filers (especially on small businesses)