U.S. Tax Code May Be Facing a Full Rewrite

As the White House prepares to name a blue-ribbon panel on tax reform, the labyrinthine U.S. revenue code could face the first top-to-bottom rewrite since President Reagan closed loopholes and slashed income tax rates on a historic scale in 1986.

“This is a fundamental look at the entire code, every component of the code,” a senior administration official said late last week. “Nothing is off the table.”

Yet some political analysts and policy advocates think the end result could turn out to be considerably more modest. The commission might come up with provocative proposals, they said, but that does not mean the president will put his weight behind them.

“I don’t think you’ll see in the next four years a 1986-style, Ronald Reagan tax reform bill,” said Grover Norquist, president of Americans for Tax Reform, a conservative advocacy group. “The whole purpose of this is to get the debate going.”

Even if Bush decides to push for major tax revisions, he is likely to be constrained by the soaring federal budget deficits that began in his first term, spurred in part by his huge tax cuts. Bush has already made renewal of those cuts a high priority, stirring concern among Democrats and some Republican conservatives about the effect on the deficit. The president has said any broader program of tax reform must not worsen the deficit.

Basking in the glow of last week’s electoral victory, Bush declared that revamping the tax code was at the top of his second-term domestic agenda, along with Social Security reform.

But the president offered only vague clues as to what he had in mind on taxes: The system should be made simpler and fairer. It should encourage saving and reward risk. There should be fewer “loopholes” for special interests, he said, but existing “incentives” such as the deductions for mortgage interest and charitable contributions should be retained. And the changes, whatever they are, should not cause overall tax collections to rise.

“Simplification would be the goal,” Bush said Thursday during his first postelection news conference. “The main thing is that it would be viewed as fair ... that it wouldn’t be complicated.”

Administration officials said the next step in the process would be the appointment by year’s end of the special commission to study reform options. Bush revealed his intention to name the group during his renomination acceptance speech at the Republican National Convention in New York in September.

Who will serve is not yet known, but the panel will be asked to finish its review and forward its suggestions to Treasury Secretary John W. Snow in early 2005. Snow will review the findings and send a final set of recommendations to Bush.

The administration will not advance any new tax legislation until the panel’s recommendations are in hand, said the senior official, who declined to speculate on which proposals would make the final cut.

“They’ll be looking at the whole thing with three principles in mind: The fundamental reform should be more fair, more simple and more growth-oriented,” the official said. “That’s their marching orders.”

Nearly two decades ago, a similar undertaking led to passage of the tax reform act of 1986. The landmark legislation reduced marginal income tax rates and closed many loopholes, from real estate subsidies to consumer interest deductions.

Some analysts questioned whether Bush or the Republican-led Congress would be inclined to attempt anything like the 1986 initiative, noting that the president has tended to prefer “pain-free” initiatives over those requiring sacrifice.

“Revenue-neutral tax reform inevitably involves a lot of losers as well as a lot of winners, and the losers are always more vocal than the winners are,” said Len Burman, a former Clinton administration Treasury official who is co-director of the nonpartisan Tax Policy Center.

“When it comes down to it, people like their tax breaks,” Burman said. “They like their mortgage interest deduction and charitable contribution deduction and 50 different tax credits. And every one of the special breaks in the law has got a lobby behind it.”

As a result, several experts predicted, rather than present Congress with a single sweeping initiative calling for equal measures of pain and gain, Bush is more likely to advance his tax agenda in piecemeal fashion, with as few losers as possible.

The starting point will be legislation to make Bush’s previous income tax cuts permanent, analysts said. Many provisions of the $2 trillion in tax reductions approved since Bush took office will expire by 2011 unless Congress acts to extend them.

A similar effort is expected to abolish the estate tax, or “death tax” as it is known by its opponents. Although the estate tax is being phased out under existing law, it too will spring back to life in 2011 unless Congress takes action.

Separate bills could be introduced to broaden and perhaps consolidate tax-sheltered savings vehicles such as individual retirement accounts and 401(k)s, further reduce taxation of capital gains and dividends, and expand business expensing by letting firms claim bigger initial deductions for investments in plants and equipment.

Another contender is legislation to rein in the alternative minimum tax. The special levy was created to make sure wealthy filers could not evade taxation completely by claiming lots of deductions and credits. But it was not indexed for inflation, and more and more middle-class taxpayers are falling into its grasp.

“The likely result of this is not a big grandiose plan, but rather incremental steps that take us toward a simpler, more pro-growth tax system,” said Stephen Moore, president of the Club for Growth, a conservative advocacy group.

“Look, we all want to have a flat tax,” Moore said. “We know what the Garden of Eden is. So let’s make sure that every change we make with tax policy is moving us in that direction.”

That is exactly what has occurred with the tax cuts approved during Bush’s first term, according to some analysts.

“In the last four years there were four tax cuts,” said Norquist of Americans for Tax Reform. “People looked at those and thought they were just catch as catch can. But every one of those tax cuts moved us toward a single-rate tax system that taxes income just one time.”

Norquist is among those who believe Bush will stick with gradualism instead of a single big tax initiative.

“Every piece of tax reform is more popular than the whole thing,” he said. “Getting rid of the death tax has 70% support. Expensing is very popular with the business community. Each of these things is popular and has supporters. But a revenue-neutral tax reform has as many enemies as friends.”

A few observers believe that Bush means business when he talks about tax reform, and that 2005 could be a repeat of 1986.

Charles Gabriel, a former congressional staffer who is now senior Washington analyst for Prudential Financial, said Bush was like a boy who put two toy sailboats in the water at the same time, one marked Social Security reform and the other tax reform, to see which would travel farther.

“I’m convinced the one that will catch the wave is tax reform, and we’ll get another tax bill like ‘86,” Gabriel said.

“The Republicans are really only happy when they’ve got some issue to line the Guccis up outside the Ways and Means and Finance committees,” he said, referring to the Italian designer shoes that have become a symbol of wealthy Washington lobbyists.

Part of the problem, analysts said, is that Bush’s comments about tax reform have been too cryptic to provide a good road map of what lies ahead.

“It’s a little of this and a little of that ... but it’s not as if he’s ever spelled it out,” said conservative economist Bruce Bartlett, a former Treasury official in the administrations of Reagan and Bush’s father.

“We all understood what Ronald Reagan’s tax philosophy was,” Bartlett said. “Bush is a little more enigmatic. It’s as frustrating for his friends as it is for his enemies.”