A preliminary report by the National Commission on Fiscal Responsibility and Reform has sparked debate over the preservation of many popular tax credits and deductions. The preliminary report generally proposes to eliminate a host of tax credits and deductions, both for individuals and businesses, in exchange for lower individual and corporate tax rates.

The Commission is expected to send a final report to Congress on December 1, 2010, where it is almost certain to receive a controversial welcome. Nevertheless, the alarm sounded by the Commission will certainly give tax reform a platform it may not otherwise have had. The Commission’s report may also provide the “potential cover” necessary for Washington to act on some of the recommendations.

Reducing the national debt
President Obama created the Commission to look at ways to stabilize and reduce the nation’s $13 trillion debt. The Commission is composed of 10 Democrats and eight Republicans. In mid-November, the co-chairs of the Commission released a preliminary report outlining some of the approaches the Commission may take in its final report.

“We must stabilize then reduce the national debt or we could spend $1 trillion a year in interest alone by 2020,” the co-chairs cautioned. To reduce the debt, the co-chairs outlined a five-part plan: (1) Enact spending caps; (2) Pass tax reform; (3) Address health care and Medicare costs; (4) Achieve cost savings in government staffing and farm subsidies; (5) Reform Social Security.

Deductions and credits
The Tax Code includes numerous deductions and credits for all types of taxpayers. Among the most popular for individuals are the home mortgage interest deduction, the state and local tax deduction, the medical expense deduction, the child tax credit, and a variety of energy tax credits. The preliminary report would jettison nearly all of these tax incentives from the Tax Code. The revenue recovered from these tax incentives would go to reducing the national debt and lowering the individual tax rates.

Tax rates
Under current law (effective through the end of 2010), the individual tax rates are 10, 15, 25, 28, 33, and 35 percent. The preliminary report proposed to consolidate the individual rates into three brackets: eight, 14, and 23 percent. However, consolidation would require elimination of all deductions and credits. Keeping one or more tax incentive would require an upward adjustment in the rates. For example, retaining the popular home mortgage interest deduction would result in a consolidated rate schedule of 13, 21 and 28 percent.

AMT and more reforms
The co-chairs also proposed to eliminate the alternative minimum tax (AMT). Abolishing the AMT would cost the federal government a projected $1 trillion in lost revenues over 10 years. The co-chairs did not say where the lost revenues would be recovered.

The preliminary report also briefly described some other reforms. These include raising the federal gasoline tax by 15 cents, treating capital gains and dividends as ordinary income, and capping the income tax exclusion for employer-provided health care at an unspecified amount.

Business taxes
Businesses would also be significantly impacted by proposed reforms. The co-chairs discussed abolishing the Code Sec. 199 domestic production activities deduction, the LIFO method of accounting, and tax incentives for the oil and gas industry. Revenues recovered from the elimination of these incentives would go to reducing the national debt and lowering the corporate tax rate.

At least 14 members of the Commission must agree on the language of the final report to send it to Congress for an up or down vote. It is unclear if 14 members will agree with the final recommendations. Several Commission members have said the preliminary proposals cut too much; others claim they fall short of cutting enough.

If you have any questions about the Commission’s proposals, please contact us.