Bush tax plan's complications and costs

Despite the plug President Bush gave his proposed $674 billion tax cut in his State of the Union address last week, Congress will likely shrink it.

"We are going to get a pretty big package," says Greg Valliere, chief strategist at Schwab Washington Research Group. "But the details will change considerably."

One problem is that the Bush changes, especially cutting taxes on corporate dividends, would add complexity to an already complicated tax system.

The tax code has grown year by year (see chart).

"Anytime you add something like this with a lot of wheretos and wherefores you make a lot of work for tax lawyers and accountants," says Stanley Collender, a budget expert at Fleishman-Hillard Inc., a Washington consulting group.

Already, when Uncle Sam raises $1 in revenue, costs of tax preparation and the government's tax collection approximate 10 cents. So the total cost of the US tax system today is about $110 billion, says Joel Slemrod, an economist at the University of Michigan Business School, in Ann Arbor.

Many Democrats oppose the centerpiece of the Bush plan, ending "double taxation" of stock dividends. One reason is that the bulk of the $364 billion in tax benefits go to the well-to-do. "Dead on arrival," said Senate minority leader Thomas Daschle.

Even some Republicans have troubles with the plan. House Ways and Means Committee Chairman Bill Thomas (R) of Calif. told the Washington Post that the plan actually leaves some dividends received by investors taxed and others not.

That adds complexity. If a firm pays corporate tax on its earnings, it can issue a tax-free dividend. But it may take years while a corporate audit goes on to determine if that is the case.

A member of Congress visiting constituents may have trouble trying to explain to a widow why some of her stock dividends are tax free, and some aren't, suggests Douglas Shackelford, a tax professor at the University of North Carolina, in Chapel Hill.

There is some speculation that Congress may agree to taxing only half of dividends, or taxing them at the 20 percent capital-gains rate.

In theory, ending the corporate tax entirely would end a great deal of tax complexity. But doing that would be too costly, even for the tax-cutting Bush administration.

One reason the tax cut will likely shrink is the growing concern about a swelling budget deficit. Last week, the Congressional Budget Office projected a deficit this year of $199 billion and a cumulative $407 billion deficit from 2003 to 2007.

These numbers are a lot worse than the CBO projected last August. But because the CBO, in making projections, follows rules set out by Congress, budget experts see them as still unrealistic.

They don't take into account any possible future tax cuts. Nor do they factor in what would happen if the 2001 tax cuts became permanent. Also, there is the near certainty that Congress will not allow the alternative minimum tax to hit 40 million middle-income taxpayers, as it likely will if left unchanged for 10 years.

Neither does the CBO add the cost of renewing 15 or so business-tax breaks, or the cost of a prescription-drug plan, higher defense spending, a war in Iraq, or extra interest costs on additional federal debt. These factors could cost up to $3 trillion over the next 10 years, the Center on Budget and Policy Priorities (CBPP) in Washington calculates. This year, the deficit will exceed $300 billion, several budget experts reckon. Added up, huge deficits and growing federal debt extend as far as the eye can see, these experts maintain.

Dealing with such forecasts, the president asserted that he "will not pass along our problems to other Congresses, other presidents, and other generations."

But William Gale, a Brookings Institution economist, said he "guffawed" when he came across that in the speech. The president's plan is doing just that, passing on the fiscal burden "to future generations." It will be especially troublesome when the numerous baby boomers retire and collect Social Security and Medicare.

Robert Greenstein, head of the CBPP, calls it "double think" - stating something that is the opposite of what is true.

Disputing such charges, the administration says the deficit is manageable in a $10 trillion-plus economy and will diminish as tax cuts speed economic growth.

When the president's budget for fiscal 2004 comes out today, it may include a plan that will push the tax burden on to the next generation, Mr. Greenstein charges. It will do so by greatly expanding Roth retirement savings accounts. These plans allow individuals to set aside income after taxes into an account where it can grow tax free and be withdrawn at retirement without paying taxes.

Traditional Individual Retirement Accounts (IRAs) take before-tax dollars that are then taxed as ordinary income upon withdrawal from the accounts, usually at retirement.

Greenstein objects, because any traditional IRA money switched into the Roth accounts today would be taxed immediately, but the revenue stream 10 years or so in the future would suffer.

Further, the Roth plans would be expanded to benefit primarily the well-off.

Many Americans already regard the Bush tax cuts as favoring the rich. This new scheme would do so by removing the present $150,000 income ceiling on those who can contribute to a Roth account.

Critics like Citizens for Tax Justice will get new ammunition. A CTJ study finds that nearly half of taxpayers get less than $100 in cuts from the $674 billion Bush tax-cut plan, 1 in 3 nothing at all.