MEMBERS OF THE President's Advisory Panel on Federal Tax Reform aren't under any illusion that the proposal they unveiled this week is about to become law. One member, former representative Bill Frenzel (R-Minn.), told a conference at the Brookings Institution yesterday that "when you look at the prospects for next year it does not stimulate you to bet the rent money." There's ample reason for Mr. Frenzel's prognosis. Some conservatives say panel members called for tweaking the tax code when they should have blown it up (see, for example, Texas Rep. Tom DeLay's views on the facing page). Liberals say the panel lost a chance to make the code more progressive. There's something there to make almost everyone unhappy.
In our view, the usefulness of the panel was limited by two fundamental restrictions on its work. One was in its charter from President Bush: It was not to generate additional revenue. The panel tied its own hands further by deciding not to change the code's progressivity. Given looming demands on the federal budget and rising income inequality, Congress shouldn't accept the same restrictions if and when it considers tax reform.
But the panel offered a number of suggestions to make the system simpler and fairer. The three most revolutionary would limit deductions for home mortgages and health insurance and eliminate the deduction for state and local taxes.
Currently, taxpayers can deduct interest paid on mortgages up to $1 million; the panel would lower the limit, depending on local housing costs, to a maximum of $412,000 and change the deduction into a tax credit of 15 percent of the interest paid. This would make the tax benefits of mortgages more available to those with lower incomes and of equal value to taxpayers at different income levels, and it would discourage government subsidization of luxury homes. According to the panel's report, between 85 and 90 percent of mortgages written in 2004 would have been under the proposed limits.
The current tax treatment of health insurance and other medical costs also benefits higher-income taxpayers more than lower-income taxpayers, and it encourages over-consumption. The panel's proposed limits on deductibility, in addition to helping keep a lid on health care costs, would begin to level the playing field between those who get health insurance at work and those who do not.
The deduction for state and local taxes forces those who live in low-tax jurisdictions to subsidize the benefits enjoyed by those who live in high-tax areas. It also helps higher-income taxpayers more than those less well-off because only those who earn enough to itemize get the benefit of the deduction and because the deduction is more valuable to those in higher tax brackets.
More problematic is the panel's proposal for new savings accounts that could blow a hole in future budgets. The plan would allow taxpayers to put aside large sums -- $10,000 a year in retirement accounts and another $20,000 per individual a year in family savings accounts to be used for education, health care or buying a home -- that could grow tax-free. Certainly, mechanisms to promote savings are a good thing. But while the costs of these accounts may not show up during the 10-year budget window, they are potentially huge in later years -- and for accounts that would primarily benefit high-income taxpayers. On this proposal, and a companion plan to change the way Social Security benefits are taxed, lawmakers should know the long-term price tag before proceeding.