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Tax Panel Offers Ideas To Raise Revenue

Study Proposes Limiting Shelters, Other Breaks

By Albert B. Crenshaw
Washington Post Staff Writer
Friday, January 28, 2005; Page E01

The government could raise an additional $400 billion or so over the next decade by tightening rules on tax shelters, simplifying the law and eliminating a range of tax breaks, many of which benefit homeowners and other ordinary taxpayers, congressional experts said in a report yesterday.

The study by Congress's Joint Committee on Taxation was done in response to a request by the senior members of the Senate Finance Committee. Finance Chairman Charles E. Grassley (R-Iowa) and ranking minority member Max Baucus (D-Mont.) praised the report, and the chairman indicated that the revenue-raising ideas in the report may find attentive ears on Capitol Hill.

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"Its suggestions for possible ways to plug big leaks in tax compliance are important as we roll up our sleeves to deal with the deficit and address tax reform," Grassley said in a written statement.

More than half the $400 billion would come from changes that would apply to the way certain income and expenses are treated legally -- loopholes to those who don't like them -- rather than to cheating and accidental noncompliance.

The largest change suggested by the report would be to subject to Social Security and Medicare payroll taxes the pretax income that many employees put into "cafeteria" plans. Salary reductions for retirement plans, such as 401(k) plans, are already subject to payroll taxes, and imposing payroll taxes on transportation benefits and others offered through cafeteria plans would raise $164 billion over 10 years, the committee estimated. (Under cafeteria plans, employees allocate their benefit dollars among a menu of plan choices.)

Changes in the taxation of income earned overseas by U.S. companies would raise $54.8 billion -- "significant problems remain," despite changes enacted by Congress last fall, the report said. Another $22.6 billion could be raised by repealing the deduction for interest on home equity loans, the report said.

According to the report, the current system of taxing foreign income distorts companies' investment decisions, while the existing rules for home equity loans are complicated and subject to manipulation, such as when a taxpayer buys a car with a loan secured by his house.

Many of the changes suggested in the report involve what is by congressional standards small change, but some, even though not large, do move toward tougher enforcement in certain areas.

"They're not exactly breaking new ground but to put it all together in one report, it's a great effort," said Robert S. McIntyre of Citizens for Tax Justice, a group often critical of tax breaks to corporations and the wealthy.

For example, one area widely cited as a key element of the tax gap -- the difference between what taxpayers owe under the law and what they actually pay -- is the failure of self-employed people and small businesses to report income. The gap is estimated at more than $300 billion a year. The national taxpayer advocate at the Internal Revenue Service, Nina E. Olson, has suggested that Congress require that customers who pay those taxpayers report their payments to the IRS, much as employers and banks report wage and interest payments.

The report stopped short of recommending full "third-party reporting," citing the burden that would place on payers. But it suggested that government agencies report to the IRS the payments they make. That would raise an estimated$6.4 billion. "It's the camel's nose under the tent, a nice first step," McIntyre said.

Similarly, the report estimates that writing the so-called economic substance doctrine into the law, at least for certain transactions that look like tax shelters, would raise $7.8 billion. That doctrine, not stated in current law but applied by courts over the years, holds that to be deductible, a transaction has to have some "real" purpose beyond its tax consequences. IRS officials say leaving the requirement vague gives the agency more flexibility and may make taxpayers more cautious.

The report said $57 billion could be raised by changing the law so that shareholders in so-called subchapter S corporations who are also employees of the corporation could not escape Social Security and Medicare taxes on part of their income by treating it as a distribution from the corporation rather than pay.

Democratic vice presidential nominee John Edwards, who was a trial lawyer in North Carolina before his election to the Senate, was accused of using this strategy to cut his taxes. Asked about it in his debate with Vice President Cheney, Edwards said, "I have paid all the taxes that I owe."

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