Popular Tax Breaks Put on Chopping Block

A presidential advisory commission unanimously recommended Tuesday that deductions for state and local taxes be eliminated and two other popular tax breaks -- for mortgage interest and employer-provided health benefits -- be curtailed as part of a sweeping simplification of the income tax code.

The proposals, which face a long and rocky road before anything like them can become law, would also reduce tax rates and abolish the alternative minimum tax, which was designed to make the wealthy pay more taxes but is snaring millions of upper-middle-class taxpayers.

The commission said the 75-line Form 1040 could be replaced with 32 lines on a 4-by-6-inch card printed on both sides.

The nine-member President’s Advisory Panel on Federal Tax Reform submitted its report to Treasury Secretary John W. Snow in a brief ceremony.

“Now it’s up to us ... to use the report as a starting place for the recommendations we’ll give to the president,” Snow said. He said he hoped to have a proposal on President Bush’s desk by the end of the year.

But any legislation that would emerge from the commission’s proposals faces a problematic future in Congress. The bipartisan panel’s report immediately came under attack from both ends of the political spectrum.

House Minority Leader Nancy Pelosi (D-San Francisco) called the commission a “Trojan horse -- using so-called simplification to cut taxes for the wealthy while increasing taxes for middle-class families.”

From the other direction, Sen. Jim DeMint (R-S.C.), a member of the Joint Economic Committee, said the recommendations were “small and quite complicated, and that’s exactly what we’re trying to get away from.... We need comprehensive reform that will make America the best place in the world to invest and do business.”

The panel proposed two plans that differ primarily in their treatment of corporate taxes. Under the more ambitious Plan B, business profits would be taxed at a flat 30%, and businesses could deduct the entire cost of new plant and equipment in the year they were purchased.

The two plans would differ slightly for individuals, the result in part of Bush’s requirement that any new tax system raise as much money as the current one. Former Sen. Connie Mack (R-Fla.), the panel’s chairman, said the plans would be revenue neutral over their first 10 years, but he offered no such claim for shorter or longer periods.

The panel also said about twice as many taxpayers would pay less than would pay more under the new system. Winners and losers would be about equally distributed along the income spectrum in the first year of the new tax code, but by the 10th year, the winners would be disproportionately concentrated in the low-income brackets.

Both plans would reduce today’s six tax brackets of rates ranging from 10% to 35%. Plan A, which the panel called the simplified income tax plan, would divide taxpayers into four brackets with rates of 15% to 33%; Plan B, or the growth and investment tax plan, would have three brackets of 15%, 25% and 30%.

But in their treatment of deductions, the two plans are virtually identical. Most controversially, they would convert the deduction for home mortgage interest to a credit: Instead of deducting interest payments from taxable income, taxpayers would subtract 15% of the interest payments from their taxes owed -- the equivalent of the deduction for someone in the 15% bracket.

Qualifying interest would be capped at interest on 125% of the local maximum mortgage that the Federal Housing Administration would insure. That would leave Southern Californians with a maximum credit of $412,000.

Vince Malta, president of the California Assn. of Realtors, said the median price of a home in the state is $568,000 and the average mortgage at least $454,000. The proposed ceiling, he said, would limit the tax break for the majority of new mortgages.

“The only good thing,” Malta said, “is that we think the proposal will be dead on arrival in Congress.”

The loss of the deduction for state and local taxes would hit particularly hard in California, a high-tax state.

“It’s not fair to pile a bigger tax load on the backs of middle-class homeowners in the San Fernando Valley in order to preserve tax breaks President Bush has given to the wealthiest Americans,” Rep. Brad Sherman (D-Sherman Oaks) said in a statement.

The exclusion of employer health benefits from taxable income would be limited to the average employer cost -- now about $5,000 for an individual policy and $11,500 for a family. For the first time, the exclusion would be available to those who buy their own insurance.

The two plans would also treat investment income differently. Under Plan A, dividends would not be taxed, 75% of capital gains would be excluded from taxes, and all interest payments would be taxed at regular rates. Under Plan B, all three would be subject to a flat rate of 15%.

It is on the business side that the plans differ most sharply. For large businesses, today’s eight brackets, with a final tax rate of 35%, would be collapsed into one -- 31.5% under Plan A and 30% under Plan B. Small businesses would be taxed at individual rates (Plan A) or 30% (Plan B).

Drew Lyon, a principal at PricewaterhouseCoopers, said the changes could make U.S. business tax rates, now first among industrial countries, second to Japan’s.

Perhaps even more significant, Lyon said, is the feature of both plans that would allow businesses to write off the cost of new plant and equipment in one year. Gone would be the complicated depreciation rules that now govern such write-offs.

The National Assn. of Manufacturers gave its blessing to that recommendation, although Dorothy Coleman, the trade group’s vice president for tax policy, said the association could not comment on the whole package without further study.