November 04, 2005
Friday

George W. Bush's handpicked advisory panel has offered options for overhauling the tax code that the White House hopes will help cement Bush's legacy as a president who delivered on his low-tax pledge.

The Advisory Panel on Tax Reform's final report, delivered Tuesday, only kicks off a debate that raises more questions than it answers, starting with Treasury Secretary John Snow's silence on which, if any, ideas he might recommend to the president.

For taxpayers, however, the panel report poses one question only: Do I win or lose under the panel's options and what the president eventually proposes?

Consider the panel's call to kill two provisions that have been in the tax code from the start in 1913: the mortgage interest deduction and the state and local tax write-off.

The mortgage deduction, currently for interest on mortgage debt up to $1 million, would be scrapped and replaced with a 15 percent credit on mortgage amounts that would be limited by region: $227,000 to $412,000, or 125 percent of the area's maximum Federal Housing Administration loan.

Deductions for state and local property and income taxes would be eliminated, and interest on home equity loans wouldn't be deductible anymore.

In exchange for the loss of these tax breaks, the advisory panel would eliminate the Alternative Minimum Tax, add $100,000 to the current $500,000 tax-free exclusion on home sale profits, lower capital gains tax rates, cut the number of tax brackets and provide a variety of other simplifications to the federal tax code.

Lawmakers and the housing industry have signaled their willingness to fight this change to the death even though the mortgage write-off is a huge subsidy: Along with tax-code provisions that let taxpayers deduct property taxes, too, and avoid capital gains on home-sale profits of less than $500,000, homeownership breaks cost $110 billion a year in foregone federal revenue.

In theory, when the median price of a single-family home is $220,000, the change would go after rich folk living in mega mansions. In fact it goes after:

- High-cost housing areas such as New York. Florida and California.

The California Association of Realtors puts the median price at $569,000 and even more in hot markets such as Ventura County, where the average house costs $685,680. The FHA limit for Naples-Collier County, Fla., is $299,250 despite Florida's housing boom, while homeowners in lower-cost areas - including Memphis and Knoxville, Tenn. - could only deduct interest for mortgage debt up of $227,000.

- Vacation homes. Only a principal residence qualifies under the panel's plans, not the beach house at Padre Island, Texas, or the mountain cabin in the Smokies.

- The deduction for interest on $100,000 in home equity loans. The panel recommendations would end this deduction.

So how would such a change affect the typical homeowner? The housing industry predicts Armageddon, with home prices plunging 15 percent or more and houses worth $400,000 or more taking the biggest hit.

"No matter how you dress this up, that's a tax increase for a lot of working Americans," says CEO Jonathan Kempner of the Mortgage Bankers Association.

What would homeowners face on taxes? The Bush advisory panel didn't detail these so-called "transition rules" even though homeowners want to know:

- Would your current mortgage be grandfathered if it's over that regional limit? If so, for how many years?

- What happens to existing mortgages on second and even third homes?

- What happens if you refinance?

- What do you do if you have home-equity debt you counted on deducting?

The tax reform panel makes much of extending the mortgage credit to every homeowner, not just those who itemize. But non-itemizers get an implicit mortgage write-off in the standard deduction, which the panel folds into a "Family Credit" along with current personal exemptions for family size.

On state and local tax deductions, the Bush tax panel concluded it's not fair for low-tax, low-service states such as Texas and Florida to subsidize high-tax states.

Political cynics see another pattern when four out of the top five states hurt by abolishing the state and local write-off are "blue" states that didn't go for Bush in 2004.

States with the highest percentage of tax returns claiming state and local deductions are: California ($8,884 average deduction), New York ($11,098), New Jersey ($10,003), and Illinois ($6,475), according to IRS data. Only fifth highest Ohio ($6,721) was a "red" state last year, providing Bush his electoral vote margin of victory.

Urban Institute tax analyst Bob Ebel reports state and local governments spend $4 out of every $5 non-defense tax dollar these days to keep up public education, police and fire protection, sewerage, roads and other infrastructure.

That's why Indianapolis Mayor Bart Peterson, speaking for the National League of Cities, contends: "The proposal to eliminate the deduction for state and local taxes is nothing but a tax increase for the millions of middle-class taxpayers who itemize. It's a shell game they're proposing, to lower some taxes here and make you pay more over there."

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Tax panel winners include millions of higher-income taxpayers who would lose the state and local tax deduction anyway under the Alternative Minimum Tax, which disproportionately hits blue-state taxpayers, too, notes Scott Hodge of the conservative Tax Foundation.

A parallel tax code that denies popular tax deductions, the Alternative Minimum Tax will hit 3.5 million taxpayers this year but 31 million by 2010 if nothing is changed, including people making as little as $75,000.

The Alternative Minimum Tax typically hits people with big capital gains, employees who exercise stock options, and big families who lose personal exemptions when they claim more than two children. All likely would win under the Bush panel plan.

Because the 10-year cost of fixing the alternative tax is $1.3 trillion, the panel targeted the mortgage interest and state and local tax deductions to help make up the loss.

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Investors also are big winners: Under the Bush panel's two plans - a simplified income tax and a progressive consumption tax - most Americans won't owe tax on investment income because almost all investments grow in tax-free accounts.

The truly wealthy might pay 15 percent on capital gains and dividends they realize outside the panel's three investment accounts that let individual taxpayers shelter $40,000 a year, $80,000 for couples.

These accounts would replace 401(k)-style retirement plans, Individual Retirement Accounts and other education and health tax breaks that use before-tax dollars to cut up-front costs and encourage participation by low- and middle-income workers. The tax reform panel didn't ask if its proposals would cut back their participation, or what happens if Uncle Sam stops taxing capital and only taxes labor income instead.

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