Senate Finance Committee Kicks Off US Tax Reform Debate

by Mike Godfrey, Tax-News.com, Washington

08 August 2006

The Senate Finance Committee has kicked off the first in a series of hearings exploring the subject of possibly far-reaching reform of the United States tax code.

Attending last Thursday's hearing were Connie Mack and John Breaux, chairman and vice chairman respectively of the presidential tax reform panel, which reported its recommendations last November, David Walker, US Comptroller General, and Dr Jane Gravelle, an economist at the Congressional Research Service.

While finance committee chairman Chuck Grassley stated that he has no preconceived notions as to which direction tax reform will take, the hearings, which will take place in the fall, are likely to focus on the two proposals offered by the tax reform panel.

The first plan, known as the 'Simplified Income Tax Plan' proposes to:

• Reduce the number of income tax brackets to four at 15%, 25%, 30%, 33%.
• Exclude 100% of dividends of US companies paid out of domestic earnings.
• Exclude 75% of corporate capital gains from US companies (the tax rate would vary from 3.75% to 8.25%).
• Tax interest at regular income tax rates.
• Tax small businesses at individual rates (top rate lowered to 33%).
• Tax large businesses at 31.5% under a territorial system with simplified accelerated depreciation.

The second plan, known as the 'Growth and Investment Tax Plan' proposes:

• Three tax brackets: 15%, 25%, 30%.
• Dividends, capital gains and interest income all taxed at 15%.
• Sole proprietorships taxed at individual rates (top rate lowered to 30%).
• Other small businesses taxed at 30%.
• Large businesses taxed at 30% on a destination basis with expensing for all new investment.
• Interest paid and received will be non-deductible except for financial institutions.

Both plans also call for the elimination of the Alternative Minimum Tax, a shadow tax system originally designed to ensure that wealthy individuals cannot reduce their tax liability to zero through deductions and tax breaks. However, since the tax isn't indexed to inflation, it is beginning to eat into the ranks of the middle income earners, and it is projected to raise the taxes of more than 21 million taxpayers in 2006 and 52 million taxpayers by 2015.

However, since President Bush has stipulated that tax reform must be revenue neutral, it is expected that the elimination of the state and local tax deduction will have to pay for the removal of the AMT.

Comptroller General David Walker argued that reform will help increase rates of compliance with the tax system by making it easier to understand and eliminating loopholes.

"The complexity of, and frequent revisions to, the tax system make it more difficult and costly for taxpayers who want to comply to do so and for the IRS to explain and enforce tax laws," he stated.

"Complexity also creates a fertile ground for those intentionally seeking to evade taxes, and often trips others into unintentional noncompliance," he added.

The Treasury Department has estimated that the Growth and Investment Plan would also boost national income by up to 1.8% over 10 years, and by up to 4.7% over the long-term. However, this was disputed by Dr Gravelle who argued in prepared remarks that the Treasury's largest growth projections of the plans "are based on complex economic models whose assumptions are probably not realistic." She also contended that economic growth from the Simplified Income Tax Plan would be "negligible" because of a limited change in marginal tax rates.

It remains unclear when Congress will get the opportunity to work on tax reform legislation. The Treasury Department is charged with studying the reform panel's tax proposals and recommending what it considers to be the best option to President Bush. However, the department has given little indication of when this will happen.

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