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After decades of being altered by Washington politicians, today’sfederal tax code is a dizzying array of complexity. Calling the system"monstrously complicated," The Economist reported that tax compliance costs businesses and individuals more than $100 billion annually.

That’sone reason why George W. Bush created the President’s Advisory Panel onFederal Tax Reform in January 2005. "The president believes the taxcode should be simpler, fairer and more conducive to economic growth,"a White House spokeswoman said at the time of the announcement.

Thepresident’s advisory panel, which included former economists, taxprofessionals and members of Congress, last year conducted 12 publichearings in five states and Washington, D.C. The group recommended twocomprehensive plans that, if adopted, would affect the tax burdens ofmidsized businesses and their executives: the Simplified Income Tax(SIT) plan, and the Growth and Investment Tax (GIT) plan.

Both plans would:

• Eliminate the alternative minimum tax (AMT).
• Reduce the number of tax brackets for businesses and individuals.
• Decrease taxes on dividends and capital gains.
• Recalculate home mortgage interest benefits.
• End the deductibility of state taxes for federal tax purposes.

Whilepolitical analysts agree neither plan appears likely to win approvalsoon, the advisory panel’s proposals reflect the reforms many observerssay the federal tax system ought to adopt.

Simplified Income Tax plan
The panel’s SIT plan uses the current system as a "starting point for reform."

This plan would:

• Reduce the corporate income tax rate to 31.5 percent from 35 percent.
• Simplify accelerated depreciation for business investments.
• Eliminate the individual and corporate AMT.
• Lower the top individual tax rate to 33 percent from 35 percent.
• Abolish the "double tax" on U.S. corporate profits.

Althoughhe didn’t mention the SIT plan by name, President Bush urged Congressto adopt one of its key provisions in his January 2006 State of theUnion address.

"We should also strengthen the economy bytreating investors equally in our tax laws," Bush said. "It’s fair totax a company’s profits. It is not fair to again tax the shareholder onthe same profits. To boost investor confidence, and to help the nearly10 million seniors who receive dividend income, I ask you to end theunfair double taxation of dividends."

The president’s advisorypanel also considered moving away from a system that taxes investmentto one that taxes consumption. The panel rejected a pure consumptiontax, such as a value-added tax (VAT), in favor of a "blended" plan thatwould "move the current tax system toward a consumption tax, whilepreserving some elements of income taxation."

Growth and Investment Tax plan
The"blended" proposal the panel created is the GIT plan. It combines a"progressive tax on labor income and flat-rate tax on interest,dividends and capital gains with a single-rate tax on business cashflow."

The GIT plan would:

• Reduce the corporate income tax rate to 30 percent from 35 percent.
• Eliminate the individual AMT and the corporate AMT.
• Tax dividend, capital gains and interest at a rate of 15 percent for individuals.
• Lower the top individual tax rate to 30 percent from 35 percent.

TheGIT plan also would modify the corporate income tax to spur investment.Instead of depreciating capital purchases over many years, businessescould take an immediate write-off. Except for interest paid byfinancial institutions, interest companies pay would no longer betax-deductible, and interest they receive would not be taxable.

These changes are designed to eliminate tax preferences in how businesses pay for new purchases.

"TheGIT plan is a step toward encouraging investment," says James M.Poterba, Massachusetts Institute of Technology professor and panelmember. "It smoothes out the playing field among the different assets.It doesn’t matter how you pay for it."

Paying for rate reductions
Thepresident’s advisory panel recommends paying for the rate reductions byeliminating the deductibility of state taxes and recalculating the taxbenefit for mortgage interest.

Instead of allowing people todeduct the interest on up to $1.1 million of mortgage debt, the newproposals offer a "home credit" equal to 15 percent of mortgageinterest paid on homes worth no more than the "average regional priceof housing." Those limits would range from about $227,000 to $412,000.

"Thesemoves are necessary to pay for the repeal of the AMT," says HarveyCoustan, a member of RSM McGladrey’s Tax Services team.

However,repealing the deductibility of state income taxes may "make itdifficult for states to raise taxes," Coustan says. And congressionalrepresentatives might consider it politically risky to tinker with thepopular mortgage interest deduction.

The SIT and the GIT plansalso would change defined contribution plans, retirement saving plansand education saving plans. Instead of consumers choosing from a mix ofabbreviation-filled programs (IRA, 529, MSA, HRA, for example), theywould have three simple options: Save at Work, Save for Retirement andSave for Family.

The advisory panel’s proposals earned a B+, or"very good," grade from Laurence J. Kotliff, Boston Universityeconomics professor.

"If these reforms are implemented withtransition rules that don’t give away the store, our tax system will bemore efficient and, in many ways, more equitable," Kotliff said in abrief for the National Center for Policy Analysis.

More implications for midsized businesses
Amongthe changes affecting midsized businesses, Kotliff wrote about thebenefit of "writing off all new investment instead of having todepreciate it over many years," allowing firms to "pass on tohouseholds the full pretax return on the investment."

Both theSIT and GIT plans also proposed changing the tax deductibility ofhealth insurance. Currently, employees do not pay taxes on most healthpremiums their employers cover. The panel encourages Congress to extend"tax-free health insurance to all taxpayers, not just those who receiveinsurance from their employers."

To do that, both the SIT andGIT plans would limit tax-free status to the "amount of the averagepremium" — for example, $5,000 for individuals and $11,500 forfamilies. However, that proposal doesn’t appear likely to win approvalfrom the White House, says Al Hubbard, National Economic Councildirector.

It’s been 20 years since Congress successfully passedsweeping tax reform. Since that time, the tax code has had about 14,000alterations.

"Since the exemplary 1986 reform, the tax code hasdrifted back to be overly complicated and burdened by higher marginalrates and by many special provisions that have undesirably narrowed thetax base," Alan Greenspan, former chairman of the Federal Reserve, hassaid.

The U.S. Treasury Department is reviewing the panel’sproposals and is expected to issue a report on the budget implications.Until then, and until Congress acts on the proposed reforms, it’sbusiness as usual for midsized businesses and other taxpayers.