Tax reform in this election year: It's not likely

[February 07, 2012]  WASHINGTON (AP) -- Tax reform sounds like a good idea to lots of people, but where to start? Eliminate the popular deduction for home mortgages? End the write-off for charitable contributions? How about expanding the Social Security payroll tax?

Not likely.

Politicians of all stripes in this presidential election year are clamoring for simplifying the tax code and closing loopholes. But that would mean Americans would lose some of their prized deductions.

Not that Congress actually is likely to end tax breaks for home loans or religious and charitable contributions anytime soon. President Barack Obama and his chief Republican challengers -- Mitt Romney and Newt Gingrich -- certainly aren't advocating that.

In fact, recommendations to trim the mortgage deduction made in 2005 by a tax-overhaul panel convened by then President George W. Bush and again in 2010 by a deficit-reduction committee set up by Obama were ignored by both those presidents.

Overhauling the complex U.S. tax code could mean that for everyone who would pay less someone else would pay more. And every existing provision in the code has its advocates.

"Tax reform is ferociously difficult. If you tackle it straight up, the likelihood of success is rather small," said Henry Aaron, a senior fellow in economic studies at the Brookings Institution. "Whenever you try to take money away from somebody, they will fight harder to keep it than will those who stand to gain."

And if deficit reduction is also a goal, it makes the job even harder.

Most recently, a bipartisan deficit-reduction congressional "supercommittee" failed to meet a Thanksgiving 2011 deadline and had to disband when it could not find common ground on tax changes.

None of the major tax overhaul proposals now on the table seems likely to be enacted given the current political rancor in Washington.

Of course, a lot could depend on the outcome of the November elections.

For now, the urgency for both parties is focused on the Bush-era tax cuts, scheduled to expire at year's end. Republicans generally want to make them permanent. Democrats would like to raise taxes on the wealthy but keep them at present levels for all others.

The income tax as we now know it has been around for nearly 100 years, and it's had only a few major overhauls.

The last major restructuring came in 1986, when Republican President Ronald Reagan and Democratic House Speaker Thomas P. O'Neill were able to put aside their political differences to strike a grand deal that both simplified the tax code and lowered rates on most individuals.

"To get comprehensive tax reform, you have to have tremendous presidential leadership. There's no way around that to be successful," said Douglas Holtz-Eakin, who was the director of the Congressional Budget Office from 2003 to 2005 and now heads the American Action Forum, a conservative public policy institute.

In addition to being a hot issue on the campaign trail, tax reform is also being closely studied by congressional leaders who oversee tax-writing, Holtz-Eakin said. "So with all the key players all saying `Let's do it,' I think that's promising."

"Now the next issue is, what is `it'?" There, we don't have a consensus," he added.

Obama has proposed ending tax breaks for U.S. companies moving jobs or profits to foreign countries. He also would create a minimum tax on their overseas earnings. And he has suggested new tax breaks for businesses that move jobs back to the U.S., for domestic manufacturing and for companies that invest in towns that have suffered major job losses. But getting most attention is his plan to tax personal incomes above $1 million -- including investment income -- at a rate of at least 30 percent.

"Washington should stop subsidizing millionaires," Obama said in his State of the Union address. "Send me these tax reforms, and I'll sign them right away."

Obama also wants to see corporate taxes lowered but hasn't said by how much. The White House has signaled he'll unveil details on Feb. 13 when he submits his budget for the fiscal year that begins Sept. 1.

The nominal corporate tax rate is 35 percent, the highest in the world after Japan. However, few companies pay that much after taking various deductions. Because of recent special deductions in the government's stimulus programs, including the ability to write off the full cost of purchases of new equipment, corporations last year paid just over 12 percent on average. That is expected to rise to about 26 percent this year, according to Congressional Budget Office calculations.

Romney would make permanent most Bush-era tax cuts and would eliminate taxes on interest, dividends and capital gains for those earning under $200,000. He would lower the corporate tax rate to 25 percent.

Jobs and tax reform have been leading issues in the GOP primaries so far. Most Americans believe that the tax system is unfair and would like to see it changed, recent polls suggest. The polls show a majority believe upper-income Americans pay less than their fair share, although far more Democrats believe this than Republicans. There is also a big political divide over whether to keep the current system of taxing investment income -- such as dividends and capital gains -- at lower rates than wages. Far fewer Democrats than Republicans want to keep things the way they are, polls show.

Romney, one of the richest presidential candidates ever, recently disclosed that he paid federal taxes at an effective rate of around 15 percent because most of his income came from investments that are taxed at that rate, compared to a top rate of 35 percent for wages. That disclosure has helped fuel the recent surge of interest in tax reform.

Gingrich would let people choose whether to file under the current system or pay a 15 percent "flat" tax while preserving the mortgage interest and charitable deductions. He would eliminate the capital gains and estate taxes and would cut the corporate tax rate to 12.5 percent.

Former Sen. Rick Santorum, R-Pa., would reduce the number of tax brackets to two -- 10 percent and 28 percent, exempt domestic manufacturers from the corporate tax and halve the top rate for other businesses. He would triple the personal exemption for dependent children.

Rep. Ron Paul, R-Texas, would eliminate the federal income tax altogether. Also the Internal Revenue Service. He would vote for a national sales tax, and he supports certain excise taxes and certain tariffs.

The nonpartisan Tax Policy Center has said that the wealthy would be the biggest beneficiaries of the Romney, Gingrich and Santorum tax plans. The center did not evaluate Paul's plan

The Tax Reform Act of 1986 backed by Reagan and O'Neill reduced the number of tax brackets and lowered the top marginal tax rate to 28 percent from 50 percent (it's now 35 percent).

The reduction in individual taxes was in large part paid for by repeal of the investment tax credit, which effectively raised corporate tax payments to the Treasury by 25 percent, or about $100 billion a year in today's terms.

But the political climate was far difference in 1986. Reagan was a popular second-term president with a good working relationship with Congress. The deficit was under control and the economy was growing, not limping like now.

Economist Bruce Bartlett, author of "The Benefit and the Burden: Tax Reform -- Why We Need It and What It Will Take," is not optimistic for major tax reform no matter who wins the election.

"I think the most we can hope for is a modest improvement to fix some glaring problems in the code," he said.

As to those calling for starting from scratch with a whole new tax system such as the so-called fair tax or flat tax, "I don't believe that's going to happen," Bartlett said. "I think that's just a political non-starter."

[Associated Press; By TOM RAUM]

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