Pennsylvanians in Support of the FairTax Act

WASHINGTON -- A panel appointed by President Bush to devise a simpler tax code yesterday recommended controversial options that would wipe out popular deductions for state and local taxes but vastly simplify the complex system.

The recommendations by the nine-member bipartisan President's Advisory Panel on Tax Reform offered two broad, similar alternatives that will not be formally presented to the administration until Nov. 1 and are sure to face a fight if they make it to Congress.

During 3 1/2 hours of mild debate, the panel dismissed out of hand a so-called Value Added Tax, which effectively assesses sales taxes on products at all stages of production and is patterned after the primary tax system used by countries in the European Union.

Instead, the panel opted for a system of four tax brackets of 15, 20, 30 and 35 percent, saying it would be fairer than the current system of six brackets and much easier for most Americans to understand and fill out.

Under both plans, three out of four taxpayers would fall into the lowest, 15 percent, tax bracket. Under one alternative, individuals would pay no tax on dividends paid by U.S. companies and exclude 75 percent of their capital gains from taxation. Under the second plan, all investment income would be taxed at 15 percent.

Both proposals would abolish the alternative minimum tax, a levy originally drafted to prevent wealthy individuals from escaping taxation but now reaches into the middle class.

Tax deductions eliminated under the plan would be replaced with new, simpler benefits, including three savings plans that supplant dozens currently available for retirement, medical expenses and education.

Individuals could continue to save for retirement by setting aside part of their untaxed salary in a work account. Taxpayers also could stash up to $10,000 each, for a total of $20,000, into a retirement savings account and a family savings account, used for health expenses, education or buying a home.

The home mortgage interest deduction would be converted to a credit worth 15 percent of interest paid during the year, with the eligibility for the credit capped at $300,000on new mortgages -- existing mortgages would not be affected.

The ideas immediately came under fire from Republicans and Democrats worried that taxpayers in their states would lose out under the new rules. But at the group's final public meeting yesterday, members endorsed the changes as what they called a "modified progressive consumption" tax.

The members said that essentially people would pay what they are paying now but that it would no longer take hours to fill out a return.

Asked whether the White House would support the end to the much-beloved home mortgage interest deduction, White House spokesman Scott McClellan said the president "believes that our tax code should encourage home ownership and encourage charitable giving. You've heard him talk about that previously."

But he refused to speculate on whether the panel's proposals would pass muster with Mr. Bush. Eliminating state and local taxes is a "pernicious" idea, said Sen. Chuck Schumer, D-N.Y., a member of the Senate Finance Committee, which would have to sign off on any major changes in the tax code. He said he would do everything he could to scuttle the proposal.

Rep. Steny Hoyer, D-Md., a member of the House Democratic leadership, and Rep. Rahm Emanuel, D-Ill., a member of the House Ways and Means Committee, issued a joint statement saying the tax panel's work seemed "little more than a bait-and-switch for millions of hard-working American families.

But the two legislators said they are pleased that the proposal would create a new family credit.

Former Sen. John Breaux, a Democrat from Louisiana who is vice chairman of the panel, said that the group worked in a cooperative fashion to devise a fair plan.

He did, however, push the panel to agree that if employer-provided health insurance is to be taxed, the tax should start at $11,500 for a family, from a limit first proposed of $8,400, and at $5,000 for individuals.

Charles Rossotti, Internal Revenue Service commissioner from 1997 to 2002 and a member of the panel, said the overall proposal is a major step toward general tax reform, but he stressed there are many details that must be worked out that have not yet been solved.

The panel agreed not to tackle the issue of a coming Social Security shortfall and how that might play into future tax overhaul plans. The panel members stressed that while the plan incorporates the savings plans endorsed by President Bush, the main emphasis is on economic growth. The savings accounts would replace current tax incentives for saving and permit workers to save $5,000 a year for retirement and $5,000 for health, education and homes, with a special $500 credit for low-income families.

Elizabeth Garrett, a panel member who joined the meeting by video-conference from the University of Southern California where she is a law professor, said she supports the general plan but is still worried that taxes might burden some people unfairly because it is a consumption tax and that it does not offer enough savings incentives.

Mr. McClellan said that there would be no comment on the proposal until it goes first to Treasury Secretary John Snow, who then transmits it to the president, probably next year.

He added that the president "strongly believes that we need a tax code that is simpler and fairer and more conducive to economic growth. That's why he appointed a bipartisan advisory panel to take a close look at our tax code, and look at ways we can reform it to make it simpler and fairer."

The panel has said previously that the tax code has become a national headache that must be changed and is perceived as unfair. It noted that since the last major effort to overhaul the system in 1986, when Ronald Reagan was president, there have been 14,000 changes to the tax code.

The panel argues it is time to make the system simple, transparent and fair.

(The Associated Press contributed to this story. Ann McFeatters can be reached at amcfeatters@nationalpress.com or 1-202-662-7071.)