President Bush has vowed to make tax reform a centerpiece of a second term, but an internal Treasury Department study in late 2002 warned that any fundamental simplification of the nation's tax system would "produce windfall winners and losers," would likely lower taxes for the rich, and could have devastating political consequences for its champions.
The document was posted last week on a Web site maintained by author Ron Suskind, who received thousands of documents from former Treasury secretary Paul H. O'Neill for the preparation of a book about O'Neill's tenure in the Bush administration.
Drafted by tax policy experts at O'Neill's request, it demonstrates the difficulty Bush -- or any politician -- would confront in pursuing dramatic changes to the tax system.
Two weeks ago Bush told the Republican National Convention he would "lead a bipartisan effort to reform and simplify the federal tax code." The campaign has said little since then beyond proposing a bipartisan tax reform panel to draft plans for a fairer, simpler, more efficient system.
"We'll get very smart people in a room, give them a set of instructions, and challenge them to come up with a variety of options," said Bush campaign policy director Tim Adams, who served as O'Neill's chief of staff when the study was completed. "It's unknown what the final product will look like, but as long as it achieves the president's priorities, that's what's important."
In the study, Treasury economists were unambiguous in calling for the reform of a tax system that they said has grown needlessly complex, economically inefficient, unpredictable and unfair.
But they identified serious drawbacks -- both economic and political -- with each of the five reform proposals they drafted, especially a "flat consumption" tax that shifts the tax burden from savings and investment to wages and spending.
"The transition accompanying any fundamental tax reform may be disruptive and produce windfall winners and losers," the report said, but "the economic benefits of any fundamental tax reform are uncertain."
Moreover, it added, "Any reform is likely to have vocal losers and largely silent winners. In other countries, adoption of a consumption tax has led to election losses for the incumbent party."
Finally, the study said, fundamental simplification of the tax code would "run counter" to Bush's other tax policy goals. The president doubled the child tax credit from $500 to $1,000 and has championed a significant expansion of tax credits for charitable donations, proposals he wants Congress to make permanent.
But such "social policy goals" are precisely what has complicated the tax code, the Treasury said. Recent studies have suggested three successive tax cuts signed by Bush have made the tax code significantly more complex. And with the political constituencies of such tax credits now firmly entrenched, "it is not clear that widely popular preferences in the current tax system . . . can be eliminated or even reduced," the Treasury found.
The Treasury report documents the trade-offs inherent in tax policy. A tax system can be progressive, for example, and tax the wealthy at a higher percentage than low-income families, or be used to encourage social objectives such as homeownership, affordable child care or charitable giving. But such policies run counter to other goals of tax policy, such as simplicity and economic efficiency.
For instance, the study examined the "flat tax," the long-held proposal of many economic conservatives to scrap the graduated income tax for a flat rate that is applied to earnings but exempts interest income, capital gains and dividends. According to the report, such a system would increase economic efficiency and would eliminate what Treasury economists see as a "disincentive to save and invest."
"But because it would effectively exempt most capital income from taxation, it would necessarily reduce the tax burden of high-income individuals," the study said.
Similarly, creating a "value added tax" -- a sales tax levied on business as well as consumer transactions -- could eliminate the need for most taxpayers to ever file a tax return, but it "would likely lead to an increase in the tax burden on lower-income taxpayers."
Alternative tax reform plans could remedy that issue, the report said, but they "would reduce potential efficiency gains."
"I think the tax system is clearly broken and clearly needs an overhaul," said Pamela F. Olson, who was the report's primary author as then-assistant Treasury secretary for tax policy. "But there are difficulties no matter which way you decide to go, and there are risks, regardless of which way you decide to go."