After his re-election, President Bush set two top domestic priorities: privatization of Social Security, and “reform” of the tax system. Privatization ran into a wall of opposition once the public grasped that the price would be a big cut in guaranteed retirement checks.
On Tuesday, Bush's blue-ribbon commission on tax reform issued its recommendations, and they are hitting with a similar, resounding thud. The right wanted a flat tax, a consumption tax, or a national sales or value-added tax in place of the progressive income tax. Not only did the commission fail to support any of these, but it took on at least one sacred cow -- capping the mortgage interest deduction -- that would raise taxes on the upper middle class.
Taxing consumption rather than income is a practical impossibility because of insurmountable fiscal and political problems of Bush's own making. A consumption tax would represent a huge windfall to the wealthiest, the only Americans who save most of their incomes. But unlike Bush's past tax breaks for the rich, a consumption tax would require an offsetting tax hike for the middle class.
Why? With immense deficits looming, any reform plan would have to be “revenue neutral.” So unlike Bush's earlier tax cuts, which were financed by deficits, sheltering savings from taxation would have to be offset by large tax hikes on working Americans.
A big tax hike on the middle class had to be a non-starter politically, right? Well, not exactly, as it turned out.
The commission did reject consumption taxation, but to the surprise of nearly everyone, it went after the homeowner deduction for interest and property taxes. Karl Rove must have been out conferring with his lawyer the day they called to run that one by him!
The mortgage interest deduction is a curious tax break. On the one hand, it is the most generous tax preference the middle class gets. On the other hand, the richer you are, the bigger a tax break it is. It does very little to help first-time home-buyers, many of whom take the standard deduction and can't deduct items like mortgage interest or local property taxes
Under current law, you can deduct mortgage interest and property taxes of up to $1.1 million from taxable income. So a homeowner with a $300,000 house and a $200,000 mortgage gets deductions that save around $5,000 in taxes, depending on income and tax-bracket, while one with a $1.5 million house and a $1 million mortgage typically saves well over $30,000.
At a time when Bush has overdone past tax cuts, leaving unsustainable deficits, the commission rightly reasoned that the cap on the mortgage-interest deduction should be reduced. The commission proposed a maximum deduction of $412,000. However, politicians from both parties, particularly in states with expensive housing, have complained that the proposed cap is too low. In Los Angeles, New York, and Boston, a lot of basically middle-class people pay more for homes.
This is one of the very few times that a Bush administration entity has been willing to bite the hands that feed it. The commission evidently concluded that other of its proposals congenial to conservatives, like cuts in the taxation of interest and capital gains, would make up for this tax hike. But they didn't anticipate the political outcry.
The commission sensibly proposed replacing the mortgage-interest deduction with a tax credit, so that it would not be worth more to people in higher tax brackets. The credit would be available to taxpayers who don't itemize. This is good policy, since it concentrates the tax break on those who need it.
It would be even better if the government applied the revenue saved to subsidize first-time homeownership, which has suffered as the cost of housing has outstripped incomes. It would be still better if the tax-reform panel had addressed the biggest problem of tax policy -- the huge hole in the revenue code left by Bush's multiple tax cuts for the wealthy and the permanent fiscal shortfall that results. That probably awaits another administration.
Bush's commission was headed by two conservative former senators, Connie Mack of Florida and John Breaux of Louisiana. But it also included several serious tax scholars as well as Bill Clinton's former IRS commissioner. Its recommendations were mostly those of honorable, moderately conservative technocrats.
You wouldn't call this a runaway commission in the spirit of, say, special prosecutor Patrick Fitzgerald. But it was far from what the drown-the-government crowd wanted, and one more sign that Bush is losing control of the agenda.
Robert Kuttner is co-editor of The American Prospect. This column originally appeared in The Boston Globe.
