Tax overhaul may prove to be more incremental than sweeping

WASHINGTON -- President Bush's campaign to make the tax code simpler, fairer and more pro-growth is likely to involve incremental changes to the current system rather than a sweeping effort to scrap the venerable income tax for a radically new approach, such as a national sales tax.

But the changes Bush will propose are still expected to generate huge opposition, especially if he suggests scrapping favored tax breaks such as the deduction for state income tax payments.

Tax experts in close contact with the administration say signs are pointing toward a plan that will seek to improve the income tax code, rather than replace it with a single-rate flat tax with no deductions, a national sales tax or Value Added Tax, all ideas that gained prominence among conservative Republicans in the 1990s.

"Our members think the current tax code is way too complicated, but given the realities of the budget deficit and the embedded interests in the current tax code, it is very hard to make major changes," said Dan Danner, senior vice president for public policy at the 600,000-member National Federation of Independent Business.

No decisions yet

For its part, the administration insists that no decisions have been made on details of a tax overhaul.

"The president has said he wants to look at all the options that would make the code fairer, less complex and more growth oriented," Treasury Secretary John Snow said in an interview.

But tax analysts noted the administration did not showcase any radical tax reforms at last week's two-day White House economic conference, preferring instead to review incremental changes.

Analysts seeking insight into Bush's thinking have seized on a November 2002 internal Treasury Department memo by Pamela Olson, then assistant treasury secretary for tax policy. Her fifth option, described as the "least radical," could serve as a blueprint for Bush's tax reform push, analysts say.

While retaining the current income tax system, this option would eliminate the Alternative Minimum Tax, which was designed to make sure the rich paid their fair share of taxes but is now ensnaring more middle-income taxpayers. The proposal also would significantly expand opportunities for people to set up savings accounts where their investment earnings would be tax-free, something the administration has been pushing for two years.

Eliminating the AMT, which covered 3 million mostly wealthy taxpayers in 2004 but will raise the taxes of 23 million taxpayers by 2008, would cost the government an estimated $600 billion over 10 years.

To pay for that and the more generous savings accounts, the "least radical" proposal would eliminate the itemized deduction for state and local income taxes, while imposing a tax on Social Security benefits and employer-provided health-care benefits.

Members of Congress are vowing to fight any effort to eliminate state and local income tax deductions, a proposal that would nick high-income Democratic-leaning states such as California and New York more than it would Republican-leaning states carried by Bush in the last election.

The money, though, has to come from somewhere. Bush, in a nod to huge budget deficits, has pledged to make any tax overhaul revenue neutral, meaning for every new tax break there will be a tax increase. Since Bush has indicated he wants to protect the popular deductions for home mortgage payments and charitable donations, there are fewer potential revenue targets.

"There are only a handful of things where there is real money and that is where people are going to have to look," said Glenn Hubbard, who was a key architect of tax policy as Bush's first chairman of the Council of Economic Advisers.

Olson said people using her 2002 memo to chart the path of Bush tax reform were "leaping too soon to conclusions." But she agreed that a radical overhaul of the tax code could prove too daunting for Bush "because the whole economy is built around the current income tax."

The administration plans to appoint a tax advisory panel that will make recommendations to Snow by mid-2005. Afterward, the administration will gives its own proposal to Congress. Major debate on tax overhaul likely would not occur until Congress has completed work on Bush's other big second term goal, creating private investment accounts for Social Security.

Since Bush will have to expend political capital on Social Security, many analysts believe his appetite for scrapping the current income tax system will be reduced. Plus, Bush also is likely to face a fight over his push to make permanent the first term tax cuts, given its pricetag of around $2 trillion.

Conservatives, who had hoped for radical tax reform, say it still would be a victory if Congress makes the first-term tax cuts permanent and agrees to Bush's scaled-back overhaul proposals.

"These things may seem like incremental steps, but if he can do even some of them, it would be a tremendous boon for the economy," said Stephen Moore, head of the conservative Club for Growth.

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On the Net:

Olson memo: http://thepriceofloyalty.ronsuskind.com/thebushfiles/

Treasury Department: http://www.treas.gov

White House: http://www.whitehouse.gov/