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November 4, 2005



PAUL GIGOT: Welcome to THE JOURNAL EDITORIAL REPORT. Washington was consumed this week with the initial skirmishing over the oresident's nomination of Judge Samuel Alito for the Supreme Court, and with the escalating debate over how we went to war in Iraq. The president also tried to focus national attention on preparing for the avian flu. But not even the president took note of the final report delivered by his Commission on Tax Reform, which was supposed to be a major part of his second term.

The commission said its reform proposals would create a slimmer and simpler tax code. Its plan would eliminate the Alternative Minimum Tax, it would limit deductions on mortgage interest, erase deductions for state and local income and property taxes, and cut deductions for charitable donations. The plan would cut taxes on capital gains and dividends and allow business to expense all capital purchases.

With me to discuss who would get hurt and who would get helped, and whether any reform is likely, are: Dan Henninger, columnist and deputy editor of THE WALL STREET JOURNAL Editorial Page; Steve Moore, our specialist on taxes and a member of the editorial board; and Jason Riley, a senior writer for the editorial pages.

Steve, you've looked at the president's tax commission. Its report -- is this going to be the jump start for tax reform that I think the administration once hoped it would be?

STEVE MOORE: Well you know, tax reform, Paul, was the fall-back position for the administration. First they led with Social Security reform. That didn't go so well. They were looking at tax reform as the next big thing. I believe there's a groundswell of support for just ripping up that tax code, all 45 thousand pages of it, starting with something new.

The problem is, with this report -- and as you said in the opening, there's a lot of good ideas in here. Reducing capital gains taxes and dividend taxes, and getting rid of the hated Alternative Minimum Tax, reducing some of the paperwork. But the public, and even the president, sort of responded to this report with a kind of a big yawn, saying this wasn't the kind of bold, big replacement of income tax that I think the American people wanted.

PAUL GIGOT: Well how do you explain this report, then? I mean, clearly they wanted this to be a big boom for the, kick-off for the campaign. Why did they do what they did?

STEVE MOORE: Well, over the last 10 years -- ever since Dick Armey, really, introduced the idea of the flat tax ...

PAUL GIGOT: Former majority leader in the House.

STEVE MOORE: Right, and then Steve Forbes picked up -- there's been a big debate in the Republican party about a flat tax versus people who want a national sales tax, and just get rid of the income tax entirely.

PAUL GIGOT: A flat tax would be a single tax rate, like 15 or 17 or 19, like they have in Hong Kong, and which is increasingly popular in the former Soviet countries.

STEVE MOORE: Twelve countries, right. Post card return, a very popular idea. And then there are others who want to get rid of the income tax entirely and just have a national sales tax. The problem, I believe, Paul, with this report is it doesn't satisfy either of these groups. Both are saying they're disappointed with the report.

JASON RILEY: And one of the reasons for that might be who the president chose to be in charge of the commission. He chose two legislators, former senators John Breaux and Connie Mack, both very capable, very intelligent men, but consensus-builders by nature. And so we didn't get bold reforms. We got consensus. And that's part of the problem.

DAN HENNINGER: Well one question you have to raise here is, whose interests are actually being served by tax reform. I think there are two interests at play, one is Washington, the other is the rest of the country. The purpose of the tax code is to raise revenue, and that revenue flows straight into thousands of spending accounts, which Congress controls, right? But for the average person, they think of taxes as a tax on them, their families and their income. They don't think in terms of the thousands and thousands of spending accounts that Washington feels the tax code is supposed to support.

So this reform is essentially, I think, canted toward the Beltway's needs. They're undeniable needs. The president is the one who would have to grab it, and form it in a way that people can understand is in their interests. And that's -- I think the president's job is to lead in that direction.

STEVE MOORE: In addition to that, if you're going to take on some of these sacred cow deductions, like the mortgage interest deduction and the health care deduction, and even the charitable deduction, you'd better have something that people are going to say, this is a good trade. And I think a lot of people are saying, we've reformed this federal income tax system something like 20 times in the last 30 years, and it just gets more and more complicated all the time.

And that's, I think, where it struck out, is if they had just come out and said, we want a Steve Forbes-style post-car tax return, 18 percent, no deductions, I think people would be doing cheerleading.

PAUL GIGOT: Because you're really taking on, with these elimination or reduction in these tax breaks, you're taking on some of the most powerful lobbies in the United States. You're taking on the home builders, for example, who already this week were squawking and saying, look, this is terrible, even with a relatively minor easing of the mortgage interest deduction. So if you're going to get that, if you're going to propose these kinds of deductions and take on these lobbies, you have to have some carrot out there that the public is going to say, wow, that's great. And that probably means just one rate, or a real simplification.

JASON RILEY: Right. A reduction in rates could have been that carrot, and we didn't get a real, bold reduction in rates. And part of the problem is the rules that the commission had to work with. They were told this has to be revenue-neutral. So anywhere we put in place a tax cut, we have to pay for it with a tax increase somewhere else. Which discounts reality, which is that when you reduce rates you can stimulate the economy and lead to more tax receipts.

PAUL GIGOT: One of the things that's interesting they did propose to eliminate is the alternative minimum tax. That's that stealth tax that sometimes hits people who have a lot of deductions under the regular code and forces them to pay more. Now this is intriguing politically, because that tax tends to hit high tax states: New York, California, also known as blue states; also states that elect a lot of Democrats. So this Bush tax commission really did a major favor for these Democratic states, Steve. Was that a smart thing to do politically?

STEVE MOORE: Well, we've called the Alternative Minimum Tax the Hillary Clinton tax, because you're right, it affects high income people in New York and people in California. And you're right. But when this tax first came into being, it literally was supposed to ...


STEVE MOORE: Yeah, literally, like 25 or 30 billionaires that were getting away with not paying any taxes. According to the latest IRS statistic, next year 20 million families are going to be hit by this, and it does tend to be people in the wealthy, liberal states.

DAN HENNINGER: But paradoxically, it has two rates, right? Twenty-six percent and 28 percent and some people suggest that rather than throwing it over, why don't we make it the basis of an essentially flat rate system.

PAUL GIGOT: Well that's right. Now, one of the other critics of this reform, which I thought was interesting, was Tom DeLay, the Republican majority leader who said that it didn't go nearly far enough. And he's proposing this idea of a national sales tax to throw out the income tax entirely and repeal the 16th Amendment, which is the amendment to the Constitution that allowed the income tax.

Now it seems to me, if you want tax reform and you think tax reform generally is difficult, try repealing the income tax and substituting it with a national sales tax. Steve, what's he talking about?

STEVE MOORE: Well, this is an idea that's picked up a lot of steam over about the last 10 or 15 years. There's a major proposal called the fair tax, which would eliminate -- you'll like this part of it, Paul. It gets rid of the corporate income tax, the personal income tax, the capital gains tax, the dividend tax, and the estate tax. And you would then just pay a tax at the cash register when you bought clothes or food or whatever it is.

There's a sizeable number of conservatives like Tom De Lay who are in favor of that. I happen to think maybe some time in the next 10 or 20 years we're going to get there. I think the flat tax, though, is the more politically achievable goal.

JASON RILEY: And more broadly speaking, even if you don't want to go for poor DeLay's plan, there is a bias in the current tax code against saving and investment. And the proposal by the Commission to move towards some sort of consumption tax is a good idea. And it's better to have an argument about which type of consumption tax that should be. But we definitely should get this bias out of our tax code, with things like the capital gains and dividends, that are against savings.

STEVE MOORE: And in fact, it's just we're not too negative about this. I mean, there are some really good ideas in this. And if we just did two things in the Mack proposal -- number one is let businesses expense all their capital purchases when they make them, so if they buy a new plant or equipment or machinery, they can write it off in the first year. Number two, give Americans essentially unlimited tax-free savings accounts. You've done exactly what Jason's talking about. You've moved away from an income tax towards a consumption tax model.

PAUL GIGOT: I think there's one other reason politically, in addition to the Alternative Minimum Tax, which is putting pressure on Democrats for reform, but this might still be an issue next year. And that is, that Republicans in Congress want an issue, and they need an issue to run on in 2006. And this may be taxes are an issue that unifies Republicans.

DAN HENNINGER: And they just lost one big issue, which was Social Security reform. Boy, it'd be terrible to lose this one, too.

PAUL GIGOT: Okay, thanks, Dan. Last word. Next subject.