In January 2005, President Bush tasked the President's Advisory Panel on Federal
Tax Reform with reforming the U.S. tax code. Former U.S. Senators Connie Mack
(R-Florida) and John Breaux (D-Louisiana), the panel's chair and vice-chair, recently
presented the panel's final report to Treasury Secretary John Snow. The panel submitted
two proposals: a Simplified Income Tax Plan and a Growth and Investment Tax Plan. Both
proposals recommend extensive and significant changes for employer-provided health care
benefits, retirement savings plans, nonqualified deferred compensation arrangements and
The panel's report steps up the tax reform debate that has been quietly brewing in
Congress. The debate may gain momentum in 2006 — after Secretary Snow considers the
report and makes his own recommendations to President Bush. Some of the recommendations
may find favor on Capitol Hill, but others have already drawn scorching criticism.
Tax reform is technically complex and politically tricky.
The Simplified Income Tax Plan and the Growth and Investment Tax Plan would reduce
the number of tax brackets and replace or eliminate many current deductions and
There are six tax brackets now: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent
and 35 percent. The Simplified Income Tax Plan would establish four tax brackets: 15 percent,
25 percent, 30 percent and 33 percent. The Growth and Investment Tax Plan recommends
three brackets: 15 percent, 25 percent and 30 percent. Both proposals would
replace the personal exemption, standard deduction and child tax credits with a new family
Both proposals would eliminate the alternative minimum tax (AMT). By 2006, the AMT
would increase the taxes of 21 million taxpayers and by 2015 that number would soar to
52 million, according to the report. Congress has become alarmed by the AMT's reaching
into more taxpayers' pockets, but repealing or limiting the tax would be expensive.
Significant Changes for Employer-Provided Benefits and
Individual Savings Programs
The two proposals have many similar — even identical — provisions, especially concerning
the tax treatment of health benefits, retirement savings and fringe benefits.
One key recommendation would limit tax-free, employer-provided health care benefits.
Under current law, all employer-provided health benefits are tax-free. Under the tax panel's
recommendation, workers could exclude the average cost of health coverage in 2006 —
estimated at $5,000 for individual coverage and $11,500 for family coverage. The limit
would be indexed to growth in the overall annual inflation rate, not to the growth in
health cost inflation. There would be no cap on the employer's deduction for providing
health coverage to employees.
Taxpayers who were not covered under an employer-provided plan would receive a tax
deduction equal to the exclusion so they could purchase coverage on the individual
Both tax reform plans would eliminate flexible spending accounts (FSAs) and health
savings accounts (HSAs). Instead, employees could pay qualified out-of-pocket medical
expenses from new Save for Family accounts. Employees could also use these accounts
to pay for education and training, buy a primary residence or supplement other
The panel's proposals would not affect defined benefit plans but would make important
changes to defined contribution plans, individual retirement plans and nonqualified
deferred compensation arrangements.
The reforms would replace current-law 401(k) plans, 403(b) plans, governmental 457
plans, SIMPLE 401(k) plans, SIMPLE IRAs and Salary Reduction Simplified Employee
Pensions with new Save at Work accounts. These accounts would generally impose the
same contribution limits and other rules as 401(k) plans. The panel also recommended
"autosave" features, including:
- Automatic enrollment
- Automatic increases in employee deferrals
- Automatic investment in "balanced, diversified alternatives with low fees, such as broad
index or life-cycle funds," unless the employee chose other investment options
- Automatic rollover
- Clarification that federal law would preempt state wage withholding laws
AutoSave features would be voluntary, although participating plan sponsors would be eligible
for simplified nondiscrimination rules.
Under the Simplified Income Tax Plan, contributions to Save at Work accounts would not be
taxed until the money was withdrawn. Under the Growth and Investment Tax Plan, contributions
would be taxed but earnings would accumulate tax-free, like they do in Roth IRAs.
Under both tax reform proposals, amounts deferred under NQDC plans that were not subject
to substantial risk of forfeiture and were not previously included in income would be
included in income. However, existing annuities, life insurance arrangements and deferred
compensation plans would continue to operate under current-law rules.
The inside buildup in life insurance and annuities would be taxed annually, although life annuities
and life insurance that could not be cashed out would be subject to current-law rules.
Both proposals would replace IRAs, nondeductible IRAs, Roth IRAs, "nonqualified
deferred executive compensation plans" and tax-free "inside buildup of the cash value of
life insurance and annuities" with new Save for Retirement plans. Save for Retirement
plans would be modeled on Roth IRAs — contributions would be taxed, but qualified distributions
would be tax-free. Annual contributions would be limited to $10,000 per
account, indexed annually for inflation. Participants could withdraw money at age 58 or
upon the death or disability of the account-holder. Early distributions would be subject to
income tax plus a 10 percent penalty. There would be no minimum required distributions.
Both proposals would eliminate most tax preferences for employer-provided fringe benefits,
such as dependent care, life insurance and education benefits. In-kind benefits would
be tax-free as long as they were provided to all employees.
Existing education accounts and health care accounts — including FSAs and HSAs —
would be replaced with Save for Family accounts, which would be modeled on Roth IRAs.
Anyone could have a Save for Family account, regardless of age, income, family structure
or marital status. The annual contribution limit would be $10,000. Withdrawals would be
tax-free as long as they were used for:
- Qualified health or medical expenses
- Education or training
- Purchase of a primary residence
All withdrawals at or after age 58 would be qualified withdrawals. Account-holders could
generally withdraw $1,000 per year for any purpose, but unqualified withdrawals of more
than $1,000 would be subject to income taxes and a 10 percent penalty.
Low-income individuals would qualify for a refundable tax credit of up to $500, as long
as they deposited the tax credit into a Save for Retirement or Save for Family account.
Individuals who took advantage of the tax credit would not be eligible for a $1,000 tax-free
Capital Gains and Dividends
Under the Simplified Income Tax Plan, capital gains would generally be taxed at the taxpayer's
regular tax rate. However, the plan would eliminate the tax on dividends unless the dividend
was paid from profits that were not taxed in the United States. And the proposal would
exclude 75 percent of the capital gains received on the sale of stock held for at least one year
in a U.S. corporation. There would also be an exception for a gain on a principal residence.
Under the Growth and Investment Tax Plan, individuals would be taxed on interest, dividends
and capital gains at 15 percent.
Secretary Snow will submit tax reform recommendations to President Bush, who may
include tax reform provisions in his budget proposal for fiscal year 2007 and his next State
of the Union address. On Capitol Hill, the House Ways and Means Committee held several
tax reform hearings in 2005 and will probably hold more hearings in 2006. Senate
Finance Committee chair Charles Grassley (R-Iowa) has indicated that his committee will
hold hearings on the panel's report.
Some of the panel's recommendations were proposed earlier by other lawmakers. For
example, Senate Majority Leader William Frist (R-Tennessee) suggested limiting the exclusion
for employer-provided health benefits in a July 2004 speech. In his budget proposals
for fiscal 2005 and 2006, President Bush suggested employer retirement savings accounts
(ERSAs), retirement savings accounts (RSAs) and lifetime savings accounts (LSAs) —
which are similar to the Save at Work, Save for Retirement and Save for Family accounts
proposed by the panel. But some of the changes would be very unpopular. The panel
acknowledged that some provisions would be controversial but urged that each proposal
be viewed as an "integrated package."