‘Winners’ and ‘Losers’: An Analysis
of the Bush Tax Advisory Panel’s Proposals
the NYSSCPA's Tax
2006 - On November 1, 2005, the President’s Advisory
Panel on Federal Tax Reform appointed by George W. Bush issued
its report, Simple, Fair, and Pro-Growth: Proposals to
Fix America’s Tax System (available from www.taxreformpanel.com).
As is typical with any substantive tax proposals, the consequences
of the 273-page report are not simple for the average American
taxpayer to understand.
the release of the Panel’s report, the NYSSCPA’s
Tax Policy Subcommittee of the Tax Division Oversight Committee
decided to study the proposals in detail and prepare an
analysis of how taxpayers would be affected. An immediate
reaction to the Panel’s proposals can be found in
“Reflections on Reform,” a panel discussion
featuring the opinions of several of these subcommittee
members that was published in the February 2006 CPA
Journal. The NYSSCPA’s own proposal for tax reform,
the “SET” Tax, was also presented as a white
paper in the February 2006 issue.
current article compares the treatment of taxpayers in different
kinds of financial situations under the current federal
income tax system to the tax implications under the two
proposals made by the Panel: the Simplified Income Tax Plan
(SITP) and the Growth and Investment Tax Plan (GITP).
President Bush created the Panel in January 2005, his stated
purpose was the development of recommendations and options
for fundamental tax reform. A tax subcommittee of the NYSSCPA
decided to examine the Panel’s substantive proposals
to provide useful information to decision makers and the
public. The need for reform is obvious, even if the politically
acceptable solution has so far proven elusive. This analysis
is policy neutral and is designed to explain how the Panel’s
proposals would affect individual taxpayers in different
President’s Panel claimed that current tax provisions
provide targeted tax benefits to a limited number of taxpayers
while creating complexity, imposing large compliance costs,
and using resources inefficiently. The Panel favored using
a broad tax base while allowing certain popular deductions
and credits, thereby retaining the progressive nature of
the current tax system.
need for greater transparency and simplicity is commonly
found in the vocabulary of tax reform. Many share the view
that, under current tax law, individuals and businesses
cannot easily understand their own tax obligations or be
confident that others are paying their fair share. These
conditions have led to diminishing public support for the
current tax system.
Executive Order establishing the President’s Panel
included the following directives:
Make the tax code simpler, fairer, and more conducive
to economic growth.
Recognize the importance of home ownership and philanthropy
in American society.
Maintain “revenue neutrality.” This means
that reform proposals must collect the same amount of
estimated revenue as projected under existing law. Thus,
if some taxpayers would pay less, others would have to
pay comparably more.
Permanently retain the 2001 and 2003 tax cuts that included
reductions in the tax rates (to a maximum of 15%) on dividend
income and long-term capital gains. The current tax rates
on dividends are scheduled to expire at the end of 2008.
Assume that the increase in the aternative minium tax
(AMT) exemptions for the years 2003 through 2005 would
lapse at the end of 2005. (Congress has since extended
these increased exemptions to 2007.) This assumption increased
the amount of tax revenue needed if the Panel’s
proposal was to repeal the alternative minimum tax (AMT)
while remaining “revenue neutral.”
Maintain the same tax burden on the various income “strata”
of taxpayers as exists under current law. This means that
taxpayers in specific income groups should not pay more
or less income taxes, as a group, than they do now.
of the Tax Panel’s Proposals for Individual Taxpayers
Panel devised two plans to meet the President’s goals:
the Simplified Income Tax Plan (SITP) and the Growth and
Investment Tax Plan (GITP). The two plans differ primarily
in the taxation of businesses and capital income. The plans
developed by the Panel attempt to achieve the President’s
goals in a number of ways:
Reduce complexity by allowing every taxpayer to use a
simple tax form that is less than half the length of the
current Form 1040;
Combine 15 different tax provisions for at-work saving,
health saving, education saving, and retirement saving
into three simple savings plans;
a complicated set of phase-outs that left taxpayers wondering
if they are eligible to benefit from numerous provisions;
a confusing, full-page worksheet for seniors reporting
Social Security income with a simple computation that
is no more than six lines; and
Replace the complicated rules for small businesses with
a system that is based on records that business owners
major features of the plans include the following items
aimed at simplifying the entire tax system and streamlining
tax filing for both families and businesses:
Lower the tax rates on families and businesses while retaining
the progressive nature of our current tax system.
Extend important tax benefits for home ownership and charitable
giving to all taxpayers (not just the 35% who itemize).
Extend the tax deduction for health insurance premiums
to all taxpayers (not just those who receive insurance
from their employers).
Remove impediments to saving and investment by maintaining
the 15% maximum tax rates on dividends, lowering long-term
capital gains tax rates, and simplifying retirement savings
Eliminate the AMT (projected to affect more than 21 million
taxpayers in 2006 and 52 million taxpayers by 2015).
lists the major provisions of the SITP and the GITP that
apply to individuals. Case studies of representative individual
taxpayers are presented to provide a comparison between
the current tax system and the proposed SITP and GITP. Tables
5.1, 6.3, and 7.3 of the Panel’s report are summarized
in the Exhibit’s presentation of reform options for
Studies of the Effects of the SITP and the GITP
Panel’s two alternative plans for changes to our current
individual tax system can be applied to sample cases to
illustrate their effect on American taxpayers. The data
in the cases described below have been applied to the current
(2006) tax provisions and to the proposed SITP and GITP.
should keep in mind the directives and constraints under
which the Panel operated in order to appreciate how the
directives apply to the different cases. The cases are accompanied
by an explanation of the reasons for the different results
between current tax law (2006) and the proposed SITP and
GITP. The case studies show the likely “winners”
(those who would pay less tax under the proposals) and the
likely “losers” (those who would pay more).
1: Lower-Middle-Income Taxpayers
1 is an example of a lower-middle-income married couple
filing jointly (MFJ) who have four children, two of whom
are over age 16. Their income is derived from $37,400 of
wages, $2,720 of self-employment income, and $2,010 of gains
from the sale of machinery and equipment related to the
itemized deductions under the current tax system are only
$2,530 in state and local income taxes and $50 in tax preparation
fees, so they would take the standard deduction of $10,300
instead of itemizing. With six exemptions, they can deduct
another $19,800 ($3,300 x 6), resulting in a taxable income
of $11,838. Their income tax, before credits, under the
current system is $1,184.
both the SITP and the GITP, the income tax before credits
is $6,291 because the standard deduction and the deduction
for personal and dependency exemptions have been replaced
by a Family Credit.
all three tax systems, however, the couple’s income
tax is completely eliminated by tax credits.
the current tax system, the Child Tax Credit of $2,000 (allowed
only on the two children under age 16, even though they
all qualify as dependents) exceeds the income tax liability.
Full utilization of the allowable Child Credit would cover
the income tax on an additional $6,527 of taxable income.
The couple’s income is too high for the Earned Income
the SITP and the GITP, the Family Credit of $9,300 ($3,300
credit for the married couple, and an additional $1,500
for each dependent) also exceeds the income tax due. The
taxpayers receive the benefit of a Family Credit for each
of the four children, because they all qualify as dependents.
In these cases, the excess Family Credit covers the income
tax on an additional $20,060 of taxable income. (At this
income level, the marginal tax rates of the SITP and the
GITP are both 15%.) The couple’s income is too high
for the proposed Work Credit.
either the current tax system or the proposed SITP/GITP,
the taxpayers will still pay $384 in self-employment tax
on the $2,720 of self-employment income. Nevertheless, the
SITP and the GITP are more beneficial to taxpayers with
ordinary income up to $60,000, as the proposed Family Credit
covers the income tax on a greater amount of taxable income
than the Child Tax Credit, and is available on all dependent
children, without an age cap. Thanks to the Family Credit,
low- to middle-income MFJ taxpayers are winners under either
SITP or GITP. The simplified Work Credit should allow more
of the lowest-income families to not only reduce their income
tax liabilities, but also qualify for refundable tax credits.
2 and 3: Comparison of Middle-Income Taxpayers Renting Versus
Owning Their Home
2 and Case
3 illustrate the different results that occur with MFJ
taxpayers who either rent their residence or own their own
home. In both cases, the couples have no children and have
income in excess of $100,000, mostly from wages. In Case
2, the renting taxpayers take the standard deduction, while
in Case 3, the homeowning taxpayers take itemized deductions
Case 2, in the current, SITP, and GITP scenarios the net
income tax after credits is almost the same. In the SITP
and GITP calculations, the additional income tax incurred
by the loss of the standard deduction and personal exemptions
is almost offset by the Family Credit of $3,300. Case 2
illustrates that middle-income taxpayers using the standard
deduction can expect comparable income tax results under
either SITP or GITP.
Case 3, all of the couple’s itemized deductions and
personal exemptions are lost under SITP and GITP and replaced
by a $3,300 Family Credit and a $1,703 Home Credit (15%
of the mortgage interest). The resultant net income tax
is approximately $3,100 higher than under the current tax
law. This represents a 22% increase. Case 3 illustrates
that middle-income families who own their own home and have
substantial mortgage payments, property taxes, and state
income taxes can expect to pay significantly more in federal
income taxes under either SITP or GITP. Middle-income itemizers
look to be major losers.
the addition of two children would not change the comparison
between the current system and the proposed SITP or GITP.
Under the current system, the exemptions for two children
would reduce the income tax by $1,650 and, assuming that
the children are 16 or younger, would allow a child credit
of $2,000, for a total reduction in income tax of $3,650.
Under SITP or GTIP, the addition of two children would increase
the Family Credit and reduce income taxes by only $3,000.
4: Retired Middle-Income Couple Using the Standard Deduction
4 illustrates the effects of the different treatment
of interest income under SITP and GITP. In this case, the
taxpayers are a retired couple, MFJ, without dependents.
They have $16,910 in interest income, a $3,000 capital loss,
and pension and Social Security income of $129,630. These
taxpayers would take the standard deduction in 2006.
income taxes under the current tax system and under SITP
would be almost the same because the Family Credit offsets
the higher initial income tax under SITP. The big difference
in this case is between SITP and GITP. While SITP taxes
interest income at the regular tax rates, GITP taxes interest
income at a maximum 15% rate. Thus, the $16,910 of interest
income would result in income taxes about $2,000 less under
GITP than under either SITP or the current tax system. Because
interest and dividend income is taxed equally at a maximum
rate of 15% under GITP, the advantage of receiving dividends
(as opposed to interest income) under the current tax system
and SITP would be eliminated. Under GITP, there is an incentive
to own more stable debt instruments. Because many retired
people have moved more of their retirement assets into debt
instruments, they would be major winners under GITP.
5: Upper-Middle-Income Family Owning Their Home with No
5 illustrates the effects of the elimination of the
alternative minimum tax (AMT) under SITP and GITP. In this
case, the MFJ taxpayers have two children and own their
home outright (i.e., they do not take a deduction for mortgage
interest payments). Under current law, these taxpayers will
pay $5,347 in additional AMT due to the loss of their deductions
for property and state income taxes and some of their AMT
exemptions, based upon the level of their adjusted gross
to the current tax system, the taxpayers would see a decrease
in net income tax of $484 under SITP and $2,451 under GITP.
The loss of the itemized and personal exemption deductions
under the proposed plans would increase the initial income
tax under both SITP and GITP to more than under the current
law, even with the AMT. However, this increase would be
more than offset by the new $6,300 Family Credit in both
proposed plans. This upper-middle-income family would be
a small winner under the proposals because of the effect
of the Family Credit and the fact that they had no mortgage
will be seen in Case
7, a large mortgage-interest deduction is more beneficial
under the current tax law than the corresponding Home Credit
would be under SITP or GITP because this group of taxpayers
is in a higher than 15% tax bracket. The Family Credit would
appear to be a powerful tool that would offset the fact
that certain current deductions and exemptions would be
eliminated under SITP/GITP.
SITP tax due would be $1,967 greater than the GITP tax due
because of the different tax rates in the new plans: SITP
has four brackets (with the highest, 33%, beginning at $200,000
for MFJ taxpayers), while GITP has three brackets (with
the highest, 30%, beginning at $140,000 for MFJ taxpayers).
Also, as noted above, GITP would tax interest at 15%; SITP
would tax interest at regular rates.
6: Taxation of Capital Gains and Dividends
6 highlights a major difference between the SITP and
GITP, as well as demonstrating once more the effect of repealing
the AMT. Case 6 presents an example of a single retired
taxpayer, with no dependents, and $300 in interest income,
$38,200 in dividends ($37,940 of which are qualified), $296,660
of net long-term capital gains from the sale of U.S. corporate
stock, and Social Security income of $12,680.
current law, the taxpayer is subject to AMT because he has
a deduction of $45,540 for state and local taxes on Schedule
A and $2,980 of net miscellaneous deductions, both of which
must be added back for AMT purposes. In this case, the income
tax under the current system is $50,002, including an AMT
adjustment of $8,634.
SITP, the income tax before credits would be reduced to
$17,605. Most of this change would be due to the fact that,
under SITP, 75% ($225,458) of his long-term capital gains
are excluded from taxable income. In addition, SITP would
exclude dividends from U.S. corporations from taxable income.
This would result in taxable income of $84,183 under SITP.
The SITP income tax before credits would be only 5% of AGI
as computed under the current tax system.
point to emphasize is that this SITP benefit is achieved
only if the long-term capital gain comes from the sale of
stock in a U.S. corporation. Any other long-term capital
gain, such as the sale of real estate or fixed or intangible
assets in a flow-through entity, does not qualify for the
75% exclusion and is taxed at ordinary rates. In this case,
if all the long-term capital gain was from these other sources,
the SITP tax due would be $91,529: $76,140 higher than if
the gain were from the sale of U.S. stock, and $26,138 higher
than under the current tax system.
GITP, both capital gains and dividends would be taxed at
15%, the same as the current tax system. This would result
in an income tax after credits comparable to the current
2006 tax after the AMT adjustment and credits. Under AMT
provisions, almost all of the AMT taxable income would be
taxed at 15% due to the large long-term capital gains.
6 illustrates that SITP makes investors in U.S. corporations
big winners, while owners of flow-through business entities;
real estate investors; and small business owners would be
big losers under the proposal.
7: High-Income Family with a Large Mortgage
7 illustrates high-income taxpayers earning most of
their income through wages and large itemized deductions
because they have a highly mortgaged house and a high property
and income tax locality, like New York, New Jersey, or California.
The MFJ taxpayers have two children.
is surprising to note that, in this case, the net income
tax after credits under current tax law would be more than
the income tax under SITP, approximately $2,500 more, and
approximately $20,000 more than under GITP. One would expect
that the loss of all those itemized deductions under SITP/GITP
would cause the tax to be greater than under the current
tax laws. The loss of deductions under SITP/GITP does not
have much effect in this case because most of those deductions
are already lost under current law due to the AMT.
7 illustrates many of the differences between each of the
three tax systems discussed. Under the current tax system,
the AMT eliminates much of the tax benefit from the major
itemized deductions, with the exception of mortgage interest
and charitable contributions. In addition, at income levels
this high, the full AMT exemption is lost. The resulting
AMT income, excluding the long-term capital gain (taxed
at 15%), is taxed at 28%.
though the maximum SITP rate is 33%, the net income tax
in this case is $2,500 lower than under current law. The
SITP taxable income of $743,144 is much less than the AMT
income of $857,070, thus offsetting the higher SITP rates.
The primary difference between the two net taxable incomes
is the exclusion from SITP taxable income of dividends and
75% of long-term capital gains on the sale of U.S. corporate
stock. A further reduction of the SITP tax is realized by
using the Family Credit and Home Credit, which are not phased
out at higher income levels.
trade-off between the mortgage- interest deduction under
the current system and the Home Credit under the SITP/GITP
proposals should also be considered. First, the Home Credit
is limited to an average regional housing price (in this
case, the $412,000 maximum).
the 15% credit is lower than the tax benefit of 28% under
the AMT. Unless a taxpayer is in the 10% or 15% tax bracket,
or uses the standard deduction, the Home Credit does not
compensate for the lost mortgage-interest deduction.
GITP income tax due in Case 7 is also lower than under current
law, because of three factors. First, the GITP taxable income
of $821,387 is less than the AMT income of $857,070. Second,
the GITP’s lower tax brackets help offset its higher
maximum rate of 30%, yielding an effective tax rate of 25%,
lower than the AMT flat rate of 28%. Third, the Family Credit
and Home Credit are not phased out at higher incomes.
charitable deduction is less under SITP and GITP than under
the current system because only contributions exceeding
1% of gross income are deductible for SITP and GITP.
Case 7, the high-income family is a big winner. This would
also be true even if it did have long-term capital gains.
In that scenario, the current tax would be approximately
$195,000, compared to the SITP tax of $182,000 and the GITP
tax of $173,000. If the long-term capital gains came from
sources other than the sale of U.S. corporate stock, the
tax due under SITP would increase by $33,395. Under GITP,
the tax due would increase by $20,240, because the income
would be taxed at the top marginal rate of 30% instead of
a 15% capital gains rate.
1 illustrates that for lower-income taxpayers, the proposed
tax credits under the SITP and the GITP would offset the
additional income tax caused by the loss of current deductions.
As income levels increase, the effect of the SITP and the
GITP would become more dependent upon whether the taxpayer
is a homeowner or pays substantial state and local income
taxes. Case 2 demonstrates that middle-income taxpayers
who claim the standard deduction would pay about the same
amount of federal income tax under the current or proposed
tax systems. Middle-income taxpayers who lose the benefit
of current itemized deductions would likely pay more under
the SITP and the GITP, as illustrated in Case 3.
“winners” under the SITP would be owners of
common stock in U.S. corporations. Under the SITP, their
dividend income and 75% of their long-term capital gains
would be excluded from taxable income. This effect should
more than offset their loss of certain itemized deductions.
In assessing the potential impact of the proposal by the
President’s Panel, it is important to remember that
under SITP, other long-term capital gains—such as
the sale of real estate or partnership interests—would
be taxed as ordinary income at rates up to 33%. Under
GITP, bond owners are also winners because interest income,
as well as dividend and long-term capital gains on the sale
of U.S. corporate stock, is taxed at a maximum 15% rate.
winners are low- to middle-income taxpayers who can fully
utilize the Family and Home Credits (which do not phase
out with income) to offset their income tax liabilities.
the Panel’s proposals, the major “losers”
would be middle-income taxpayers with fact patterns similar
to those in Case 3. These are homeowners with large mortgages,
high property taxes, and who live in high-income-tax states.
This is a large and broad group. Whereas higher-income taxpayers
have already lost most of these deductions under current
law due to the AMT, this group of homeowners loses the benefit
of these deductions under SITP and GITP, and the gap is
not sufficiently made up by the Family and Home Credits.
losers would be real estate owners and business owners,
who will see the income taxes due on the sale of their property
and businesses increase substantially.
the President required the Panel’s proposals to be
revenue neutral, these cases illustrate that reaching the
goal of revenue neutrality means that some will pay less
and others will pay more. To the individual taxpayer, no
tax law change is neutral.
on State Taxation
the effects of the Panel’s proposals on the federal
income tax system are the center of this discussion, the
proposed changes would affect individuals’ state income
taxes directly and, possibly, substantially. Many states
base their income tax calculations on federal law, and would
be affected immediately if either SITP or GITP were adopted.
in states that compute taxable income based on federal tax
return income and deductions would find that several deductions
disappear. In the case of SITP, dividend income and 75%
of long-term capital gains would no longer be included as
taxable income. Large decreases or increases would occur
in a taxpayer’s state income tax.
excellent example of the changes is illustrated in Case
6. If a state uses federal taxable income as its starting
point, the unadjusted taxable income for the calculation
of state taxes could vary from $347,840 under the GITP to
$84,183 under the SITP, whereas under current federal law
it would be $296,747.
state legislative actions to address the consequences that
would arise at the state level were taken prior to the enactment
of either of the Panel’s proposals, certain taxpayers
could see a substantial change in their state income taxes.
Likewise, state governments would see income tax collections
change substantially with the resultant effects on budgeting
and financial planning. Taxpayers in states that base their
income tax on a percentage of the federal income tax would
also see their state tax increase or decrease correspondingly.
Thus, the adoption of either the SITP or the GITP would
likely spur immediate action by many states to revise their
own tax laws.
are some easy-to-implement measures that states could take
to reverse the consequences of changes in the federal tax
system. For example, dividends received from U.S. companies
out of domestic earnings that are excluded from the computation
of gross income under the SITP could be added back for state
tax purposes. In addition, the 75% of the capital gain on
the sale of U.S. company stock that would be excluded under
the SITP could be added back to the computation of gross
income. Such actions would be similar to states’ disallowance
of the 30% and 50% special depreciation deductions in the
2001 and 2003 federal tax law changes.
the Panel’s proposals are adopted, some deductions
would be eliminated unless appropriate state legislation
was enacted to continue to allow them for state income tax
purposes. This applies particularly to the mortgage-interest
deductions that would become a home credit on the proposed
federal tax return. It is hard to know what the states would
do with the charitable-contribution deduction floor of 1%
of AGI. While the loss of the federal deduction for state
and local income taxes would not affect state income tax
filings, it could renew concerns about individual state
income tax burdens and their interplay with the federal
income tax burden.
Fair, and Pro-Growth?
analysis above is intended to offer CPA Journal
readers an informed perspective on the potential effects
of the SITP and the GITP on a cross-section of hypothetical
taxpayers, so they can make their own judgments as to whether
the President’s Panel’s proposals are truly
“simple, fair, and pro-growth,” as the title
of the report title claims. As with any major tax reform,
even if the aggregate results are revenue neutrality and
income progressivity, there will inevitably be “winners”
and “losers” based upon individual circumstances.
To properly understand an individual’s tax situation
under each of the Panel’s Proposals, taxpayers should
consult their own tax advisors to make a case-by-case comparison
in the manner shown here.
the Authors: This report was prepared by the following
members of the NYSSCPA’s Tax Policy Subcommittee of
the Tax Division Oversight Committee: Subcommittee Chair Richard
L. Hecht, CPA, is a senior partner of Marks Paneth
& Shron LLP, New York, N.Y. Alan J. Dlugash, CPA,
is a partner of Marks Paneth & Shron LLP, New York, N.Y.
Robert L. Goldstein, CPA, is a partner of
Marks Paneth & Shron LLP, New York, N.Y. Janice
M. Johnson, CPA, is the managing director of the
A.B. Watley Group, New York, N.Y. Mark H. Levin, CPA,
is manager, state and local taxes, at H.J. Behrman & Company,
LLP, New York, N.Y. Stephen A. Sacks, CPA,
is with Ernst & Young LLP, New York, N.Y. Substantial
contributions were made by William H. Jones, CPA, with Marks
Paneth & Shron LLP, New York, N.Y., and William R. Lalli,
CPA, tax policy manager at the NYSSCPA.