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White House Panel Targets Middle-Class Tax Breaks

Home Mortgages, Retirements and Health Savings Plans Targeted

By Martin H. Bosworth
ConsumerAffairs.com

October 20, 2005
President Bush's tax panel presented two different proposals for simplifying and streamlining the tax code this week, one based on a "consumption" tax, both eliminating many deductions and breaks prized by middle-class Americans.

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The plans offer a great many changes in the name of "creating a fairer, simpler tax code," in the words of White House spokesman Scott McLellan.

The President's Advisory Panel on Federal Tax Reform issued its proposals yesterday, with its final report scheduled to be delivered on Nov. 1st. Bush is under no obligation to accept the recommendations of the panel.

Both proposals include plans to eliminate the alternative minimum tax (AMT), limit the deductions on home mortgage interest, and remove the deduction for state and local taxes.

Corporations would get some new tax breaks. One proposal would allow businesses with overseas investments to recoup profits from their offshore enterprises tax-free. The top corporate tax rate would also be reduced from 35 percent to 32 percent.

The AMT is a "parallel" tax calculation that strips out many deductions and breaks for those who normally qualify for them. Originally created to prevent wealthier taxpayers from paying less tax, the AMT calculation traps more and more middle-income taxpayers each year due as inflation pushes salaries higher.

In addition, the AMT is so complex and cumbersome that many tax filers end up owing additional taxes without knowing why. It is also triggered by many of the deductions middle-class taxpayers favor, such as the mortgage deduction.

Under the tax panel's proposal, the mortgage interest deduction would be limited to a loan maximum of $312,895, which is the most the Federal Housing Administration (FHA) will insure for in expensive areas, with a nationwide average of $244,000. Rather than allow a deduction, the taxpayer would receive a credit for 15 percent of the loan amount.

Critics of the proposal say that this will hit homeowners the hardest in expensive states such as California and New York, where the median prices for housing are far above the FHA loan limit.

In addition, the proposal eliminates tax breaks for home equity loans or home equity lines of credit (HELOCS), which have become the principal tool for many cash-strapped homeowners to generate extra income.

The overall effect would push housing prices down and put an end to the practice of "flipping" increasingly expensive homes in order to utilize the sizeable deductions, a chief contributor to the soaring prices in the housing market.

However, the proposals offer to increase the amount of profit that is exempt from capital gains taxes in home sales from $500,000 to $600,000, a change that would benefit more affluent homeowners.

Capital gains taxes are a major target in both proposals. One proposal would eliminate taxes on dividends altogether, and equate interest income to wage and salary income. The other proposal would impose a "flat cap" of 15 percent on all dividends, interest, and capital gains.

The proposals would also limit deductions for employer-provided health insurance to individuals to $5,000, and $11,500 for families. Health insurance and retirement savings would also be altered, with three streamlined savings accounts taking the place of the plethora of benefits and deductions taxpayers currently utilize.

The chief differences between the proposals rest in the tax brackets.

The "consumption" tax proposal would reduce the number of tax brackets from six to four, divided at 15 percent, 25 percent, 30 percent, and 35 percent. The ostensible purpose was to encourage taxation on spending rather than income, in order to promote savings and investment.

Sen. Charles Schumer (D-NY) immediately voiced his opposition to the plan, calling it "pernicious" and "a dagger to the heart of the people of New York."

Tax Foundation President Scott Hodge criticized the panel for not going far enough and "tinkering at the edges of the system."

With no written summaries of the proposals distributed at the panel meeting, and opposition to the plans already stirring across the spectrum, it seems likely that the tax reforms won't make it past the recommendation stage. Although the plans offer benefits to many Americans who are already burdened by a complex and impenetrable tax system, such as repealing the AMT, they would offset those benefits by eliminating or reducing popular tax shelters.

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