By Roger Russell

The final report of the President's Advisory Panel on Tax Reform attracted a heavy dose of criticism even before it was released, failing to satisfy the interest groups most concerned about tax reform.

The panel offered two options. Plan A, the "Simplified Income Tax Plan," would create four tax brackets of 15, 25, 30 and 33 percent; replace the standard-deduction personal exemption and the child and earned income tax credits with family and work credits; reduce long-term capital gain rates; replace the mortgage interest deduction with a credit; end tax-free health insurance from employers; and eliminate the deduction for state and local taxes.

Plan B, the "Growth and Investment Tax Plan," would create three tax brackets of 15, 25 and 30 percent, and levy a 15 percent tax on dividends, capital gains and interest. It would end the complexities of the current depreciation system and adopt immediate write-off of business investments.

Both plans would eliminate the alternative minimum tax.

Even prior to the release of the report, Representatives Katherine Harris, R-Fla. and Steve Israel, D-N.Y., sent a letter signed by 20 of their congressional colleagues to panel chair Connie Mack, criticizing interference with the home mortgage interest deduction. And Republican Congressman Vito Fossella of New York said that the plan would be particularly bad for New Yorkers, with its elimination of the deduction for state and local taxes and the cap on mortgage interest.

Chris Edwards, director of tax policy studies at the Cato Institute, said that the panel's plans have features to promote growth, but did not go far enough. "The panel should have been more aggressive with cuts to top marginal rates," he said.

"President Bush and Congress should move forward with the many pro-savings and pro-investment ideas in the panel's final report, but they also need to be more aggressive about responding to global tax competition and cutting marginal tax rates further than proposed," he added.

There is still a long way to go before any legislative proposals are made. The panel reported its recommendations to Treasury Secretary John Snow, who will make his own proposal to President Bush. He called the report "a starting place for the recommendations we will make to the president."

It is shaping up as a missed opportunity, according to Lewisburg, Texas-based Institute for Policy Innovation president Tom Giovanetti. "The first mistake the commission has made is that it has failed to insist on dynamic scoring of its proposals for reform," he said. "In other words, while there is almost universal agreement that the right kind of tax reform will result in increased economic growth, the commission hasn't even bothered to figure in this increased economic growth into its proposals."

"And the second mistake the commission has made is its failure to recognize that our current tax code taxes the wrong thing," he continued. "The current code attempts to tax income, rather than consumption, whereas the conclusion of IPI's 'Road Map to Tax Reform' was that consumption is the appropriate base for taxation."

For E. Martin Davidoff, CPA, chair of the American Association of Attorney-CPAs' Tax Liaison Committee, the panel's report has many of the features of a proposal that he made in 1998 to the Congressional Small Business Summit.

Davidoff is not a fan of the consumption-based taxes favored by many tax reformers. Both a national sales tax and the purest form of a flat tax, which will not tax investment or savings, are consumption taxes, noted Davidoff. "The impact of these is that those who consume the highest percentage of their income bear the largest tax burden," he said.

"In addition to placing an unfair burden of taxation," he added, "consumption taxes threaten the strength of our economy. No one can fairly predict the drag on our economy of a 15 to 20 percent consumption tax. I would not be willing to put at risk our healthy economy in the name of tax simplicity."

Yet Giovanetti believes that some kind of consumption tax, including a savings-exempt consumed-income tax, is the answer to simplification. "Much of the headache and complication in our current tax code is the result of exemptions, exclusions, deductions and credits designed to mitigate the harm done by taxing income rather than consumption," he said.

Ready, SET Tax

"Basically, they're trying to accomplish change with minor tinkering with the Rube Goldberg of a tax system we have," said David Lifson, CPA, a partner of Hays & Co. and chair of the New York State Society of CPAs' Committee on Practical Reform for the Tax System.

Early this year, the NYSSCPA convened a blue-ribbon panel of tax experts that developed its own tax reform plan. The plan, named the SET Tax (for simple, exact, transparent) retains the best aspects of the current tax code, eliminates its worst aspects, and adds new benefits, according to Lifson.

The plan sets a single rate, which is the highest rate at which income is taxed. It attains progressivity through congressionally defined exclusions, Lifson explained. For example, if the single rate were 36 percent, an 18 percent bracket for incomes between $30,000 and $50,000 would be created through a 50 percent exclusion for those incomes.

The SET Tax works equally well for corporations and other entities, according to Lifson. "It doesn't change who is taxed. It just makes it transparent - easier to pay, understand, collect and administer," he said.

The final report was no surprise to George Pieler, former tax counsel to the Senate Finance Committee and IPI research associate. "I never had high expectations, because the presidential mandate was circumscribed, and he did not stress the main point, which should be to reduce rates," said Pieler. "If the plan doesn't reduce rates, the other pieces don't fall into place neatly."

Thomas A. Wright, executive director of Americans for Fair Taxation, was not surprised by the panel's recommendations. "It was no surprise at all, but I am a little surprised that they so totally lost their way when it came to providing the president with fresh options and turned this into a legislative hearing," he said. "But when I consider the members' backgrounds, I shouldn't have been surprised."

Keeping scoring

The role that scoring plays in analyzing tax proposals was underscored by a report released in late September by the Government Accountability Office.

According to the report, tax expenditures - reductions in tax liabilities that result from preferential provisions, such as tax exclusions, credits and deductions - result in "revenue loss" that has tripled in real terms since 1974.

"The 14 largest tax expenditures, headed by the individual income tax exclusion for employer-provided health care, accounted for 75 percent of the aggregate revenue loss in fiscal year 2004," the report said.

The GAO recommended that the Office of Management and Budget, along with the Treasury, take steps to ensure greater transparency of and accountability for tax expenditures by better reporting information and by more fully incorporating them into federal performance management and budget review processes.

The OMB disagreed with the recommendations, noting that the use of tax expenditure estimates for budgeting assumes that economic behavior is not affected by tax expenditures.

"That is clearly not true, and if not corrected, it would lead to very misleading budget estimates," according to the OMB.

For Pieler, the failure to significantly reduce tax rates across the board is the "smoking gun" that their work has failed to meet the test of real, fundamental tax reform.

"Truly serious tax reform comes around once every 20 years, at most," he said. "To miss this rare opportunity by rearranging the tax burden and further complicating the code - as the panel seems determined to do - is unacceptable."