Tax reform non-starter

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Two weeks ago, the President's Advisory Panel on Federal Tax Reform issued its final report. Although our federal tax system is in dire need of restructuring and simplification, the panel's approach is a nonstarter. It proposes much pain for very little gain. The likelihood is virtually nil that it will form the basis for congressional action.

The panel proposed two alternative tax plans for restructuring the federal corporate and individual income tax systems. One is called the Simplified Income Tax Plan and basically keeps the income tax while making a number of changes. The other is called the Growth and Investment Tax Plan. It is essentially a consumption-based tax system. However, the two plans have many features in common.

Among the most controversial parts of both proposals are elimination of the deduction for state and local taxes, a severe scale-back of the mortgage interest deduction and sharp limits on the exclusion for employer-provided health insurance.

In return, the Alternative Minimum Tax would end for both corporations and businesses. There would be a small cut in the top income tax rate from 35 percent on individuals to 33 percent under the simplified plan and 30 percent under the growth plan. The corporate rate would fall from 35 percent to 311/2 percent in the former and 30 percent in the latter.

These are extremely modest benefits in return for very substantial pain for many taxpayers -- not to mention politicians. I know. I have written many articles over the years explaining why it would be desirable to do things the commission has recommended.

The mortgage interest deduction encourages families to overinvest in housing at the expense of other investments, such as stocks and bonds that would provide capital for business expansion and modernization. Ideally, we should level the playing field so the tax code does not bias investment, so capital can seek the best returns determined by market conditions, not the government.

The deduction for state and local taxes encourages higher state and local tax rates than would otherwise be politically tolerable. The deduction also encourages excessive consumption through local governments-providing services, such as trash collection, easily be done by the private sector.

The exclusion for health insurance has deeply distorted the market for health care, encouraging people to consume far more of it than they would without a de facto tax subsidy.

When I made these arguments in the past, I quickly ran into a political buzz saw. The mortgage interest deduction, for example, has deep support among homeowners who fear its elimination would cause their home prices to fall. That is because the deduction is capitalized into home values, strongly influencing the prices people will pay for houses. And the 1.2 million-member National Association of Realtors, one of the most powerful trade associations in Washington, will fight to the death to keep the mortgage interest deduction.

State and local governments will fight equally hard to keep the state and local tax deduction, fearing, rightly, ending it would constitute a de facto increase in the state and local tax burden. When the Reagan administration floated this idea in 1984, governors and mayors blanketed Capitol Hill, forcing it to withdraw this recommendation when its tax reform proposal was sent to Congress in 1985.

Needless to say, any tampering with the health insurance exclusion be opposed massively by workers, employers, insurers and health providers.

One could hope to begin to take on such hugely popular tax provisions only if there were a really large payoff at the end. A flat rate income tax of 20 percent or so might provide such a payoff. But even with that to compensate for the lost provisions, the political battle would be very difficult.

Unfortunately, the tax commission offers virtually nothing in return for giving up extremely popular deductions and exclusions. We would be hardly any closer to a flat rate if its proposals were adopted. Ending the misguided AMT would be all to the good, but at present fewer than 3 percent of people pay it. Though the AMT is to rise in coming years, hardly any repeal beneficiaries know who they are and will be greatly outnumbered by those who suffer from the lost deductions.

In short, the tax commission proposals are deeply imbalanced politically and there is no chance Congress will adopt either.

Treasury and the White House may find some way to salvage a more politically attractive tax reform from the commission report, but unfortunately they have little to work with.

Bruce Bartlett is a nationally syndicated columnist.