The Treasury Department will soon produce a package of tax reform options that will range from streamlining the tax code's definition of a child to scrapping the corporate income tax, a senior Treasury official said yesterday.
The package, due out as early as January, will compete next year with other high-profile administration priorities, such as Social Security and Medicare reform. But Treasury's top tax-policy official said a host of serious tax problems may force Congress to act on a broad tax reform package soon.
"The way I look at this, we essentially have a tax system that's held together by chewing gum and chicken wire," said Pamela F. Olson, the assistant Treasury secretary for tax policy. "And it's not like it was strategically applied either."
Tax reform has been a rallying cry for conservatives since the Republican Party took control of the House in 1995. But Olson made it clear that the Treasury would not be suggesting dramatic reform proposals like a flat tax rate or a national sales tax, at least in the short run.
Instead, the study will present to President Bush some short-range proposals to simplify the tax code, with longer-range options to radically transform the tax system.
"We do have to build a new house, but for now, we need to repair the house we're living in," she said.
All of the Treasury's 104 tax-policy analysts, along with some economic policy experts, have been working on the report for nearly a year, Olson said. They have worked with White House economic adviser Lawrence B. Lindsey and R. Glenn Hubbard, chairman of the president's Council of Economic Advisers.
One long-range proposal will be to replace the corporate income tax with a value-added tax, which works like a national sales tax levied on business and consumer purchases. That proposal is bound to face stiff opposition from Democrats because it would shift some tax burden onto poor and middle-class consumers.
Olson said the Treasury hopes to propose changes that would not reduce the government's annual tax revenue but would change how that revenue is collected.
Tax experts and economists involved in the study say the most detailed proposals are likely to be small-scale suggestions toward simplification. For instance, the tax code defines a child in five different ways, depending on whether a taxpayer is claiming a child as a dependent, claiming the child tax credit, filing for the earned-income tax credit, filing as a head of household or filing for a dependent care credit.
Treasury will push its case for the adoption of a single definition.
The department also will suggest immediate changes to the corporate and individual alternative minimum tax (AMT), a separate tax system enacted in 1986 to ensure that taxpayers who take multiple tax credits and exemptions still pay some income tax. The system is increasingly ensnaring middle-class taxpayers, a situation that will grow dramatically worse as the 10-year, $1.35 trillion tax cut of 2001 is phased in.
The administration also is expected to suggest a major change in the way businesses write off the cost of their investments. Instead of the current system, in which businesses slowly write off the expense over several years, the Treasury will probably suggest that businesses be granted a one-time investment credit, according to a source familiar with the study.
And Olson said major changes are needed in the way corporations are taxed on their foreign earnings.
Olson predicted that a confluence of growing problems will give momentum to tax reform, which until now has been more of a political slogan than a legislative agenda.
The growth of tax shelters for corporations and wealthy individuals, the flight of some corporate "headquarters" to post office boxes in off-shore tax havens and the growing disparity between the profit companies show the Internal Revenue Service and the profit they show their shareholders have made headlines, undermined the public's faith in the tax system and could produce a popular groundswell for action, she said.
On top of that, the World Trade Organization has threatened to levy $4 billion in penalties on the United States if it does not eliminate subsidies for exports. Bush has questioned the fairness of taxing corporate earnings and taxing them again when they are distributed to shareholders as dividends. And Congress has been clamoring to fix the AMT.
Rather than fix each of those problems piecemeal, the Treasury will push for a larger tax-reform measure, Olson said.
Former senator Bob Packwood (R-Ore.), an architect of the last major tax-reform law, in 1986, suggested that piecemeal changes would not work anyway.
"If they're going this route, my advice is, 'Do not think little thoughts,' " he said. "If you want to go for reform, think big." But he said any tax-reform proposal will face an uphill climb toward passage.
For one thing, sources suggest, the administration may be divided. In the past three weeks, the Treasury Department, IRS and White House have been soliciting advice from conservative economists and tax lobbyists. Several of those contacted say the Treasury is seeking nuts-and-bolts suggestions about the egregious complexity in the tax code but Lindsey is angling at more dramatic proposals, such as a flat tax.
Where Treasury appears concerned that any proposal not increase the federal budget deficit, White House officials "don't seem to be too worried about cost," said one prominent Republican tax lobbyist.
"They seem pretty naive about how difficult this proposition is going to be," the lobbyist added.
One Democratic tax aide said the issue would get a big boost if the GOP gained control of the Senate, an increased possibility after the death yesterday of Sen. Paul D. Wellstone (D-Minn.) in a plane crash.
But even then, Bush will have to take the lead, said Sen. Charles E. Grassley (R-Iowa), who would be chairman of a Republican-led Senate Finance Committee. Grassley said his first priority would be making the 2001 tax cut permanent.
But that package, which included expanded child and adoption tax credits and new credits for education and child care, actually made the tax code more complex, not less, said Rep. Robert T. Matsui (D-Calif.), a member of the House Ways and Means Committee.
Grassley said the president is likely to make tax reform a major issue in his 2004 reelection campaign, rather than pushing it in the next Congress.
"It's very difficult to bring up interest in something like a flat income tax without a broad consensus," Grassley said. "I'm not going to spend my time trying to educate the public. Only the president can do that."