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Tax change proposals to set off howls of protest

Everyone loves to complain about taxes. But with lawmakers set to tackle the most comprehensive reform of the nation’s tax laws in nearly 20 years, changes that would re-arrange billions of dollars of tax burden are about to touch off much louder howls of protest.
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Everyone loves to complain about taxes. But with lawmakers set to tackle the most comprehensive reform of the nation’s tax laws in nearly 20 years, Congress and the White House now have a chance to do something about them. And as the political battle begins, changes that would rearrange billions of dollars of tax burden among individuals, small businesses and corporations are about to touch off a round of much louder howls of protest.

The last time Congress tackled the morass of federal tax rules, the Tax Reform Act of 1986 cleared away decades of underbrush of deductions, credits, and other goodies narrowly targeted to select groups of well-heeled beneficiaries. Among the most notorious casualties were tax shelters for the rich and the “three-martini lunch.”

In the two decades since then, however, the weeds of special interest giveaways and narrowly targeted tax breaks have grown back. Then, as now, the goal of tax reform was to eliminate these special provisions, making the already painful task of paying taxes simpler, fairer and less burdensome on both individuals and businesses.

While that broader goal enjoys widespread popular and political support, each of the tax provisions up for grabs is attached to a loyal beneficiary stubbornly ready to defend the advantage the law provides them.

“You’re going to have a cacophony of outrage from people who perceive that they will be harmed financially because they have stake in the game,” said Scott Hodge, president of the Tax Foundation, a non-partisan research group. “They’ve structured their lives and their businesses around these archaic items in the tax code, and to some extent they will see those taken away (by tax reform).”

Drafters of the plan, a bipartisan panel that spent the past year reviewing changes in the tax code, have tried to make the overall proposal “revenue neutral” – providing new tax benefits for some groups, even as they take away from others.

Take the case of the home mortgage interest deduction — widely seen as the sacred cow of tax reform due to its wide public popularity and its original goal of increasing home ownership. Today, with home ownership at historic highs and cheap mortgage money available to a record number of borrowers, tax reformers suggest its time to take a second look.

Jerry Howard, chief executive of the National Association of Home Builders, an influential  lobbying group, called that proposal "the biggest tax hike for home owners ever considered."

In an indication of the type of outrage that will be widely heard, he said changing the mortgage interest deduction "would punish millions of home owners, particularly those living in California and other high-cost markets. Equally disturbing, the tax reform proposals would reduce home values and send a chill through the housing market, which has been leading the economic expansion for the past three years."

What makes the home mortgage deduction most tempting to reformers is the size of the pot of money involved. Aside from the huge annual outlays by homeowners for mortgage interest, any change in that deduction will have a ripple effect beyond the housing industry, according to Jeffrey Kelson, a tax partner with the accounting firm BDO Seidman.

“More than just the real estate industry, it’s going to have an impact on the retail industry and home improvement," he said. "There are a lot of dynamics."

Under the proposal unveiled Tuesday, the home mortgage deduction would shrink from the current $1 million limit to a much smaller amount — anywhere from $227,000 to $412,000, based on regional home prices. In return, homeowners would get a tax credit amounting to 15 percent of mortgage interest paid. So the effect would be to take away the incentive to borrow heavily for expensive homes, but preserve the tax incentive.

The plan would also eliminate deductions for state and local taxes, but in return would curb the dreaded Alternative Minimum Tax. That provision, originally intended to insure that wealthy taxpayers pay their fair share, has been slowly reaching further down the income ladder, leaving many middle-class taxpayers with a much bigger bill than the standard tax tables call for. (Other ideas had been floated that were not included in the panel's proposal, including a national sales tax to replace the income tax, and a "flat" income tax that would take the same portion of all taxpayers' incomes.)

But regardless of how the numbers add up, any proposal will be doomed unless Congress and the White House can drum up enough popular support. And the most vocal voters will be the ones who fear they stand to lose under the proposals.

“Most people would not be affected (by the change in the mortgage interest deduction),” said Max Sawicky, and economist with the Economic Policy Institute. “But the ones that are affected will raise a hue and cry and they won’t necessarily be compensated on the other side.”

The changes being proposed will also likely touch off a loud debate in the corporate world. The proposal, if enacted, would change long-standing, fundamental tax rules on business investment.

For example, tax deductions for the cost of a new building or expensive piece of equipment would no longer have to be spread over many years, but could be taken all at once in the year the investment was made. Though corporate tax rates would be pared, companies would no longer be able to deduct interest on corporate debt, a shift that would reduce the appeal of borrowing money in favor of selling new stock. And profits earned on operations based overseas would no longer be subject to U.S. taxes.  

“It will stop companies from thinking about the tax code first and think more about the long business investment,” said the Tax Foundation's Hodge.

But the changes would also upend strategies underlying decades of long-term investment, forcing major changes on some companies that continue to benefit from the current rules.

It’s not at all clear that the latest proposals will ever get past the talking stage. The opening shot in the battle over tax reform two decades ago was fired at the beginning of the Reagan administration’s second term; it still took two years before a compromise was reached. Today, the White House already has its hands full with an unpopular war in Iraq, a criminal indictment against a key aid, a failed bid to overhaul Social Security and a contentious Supreme Court nomination underway.

It also remains to be seen whether a consensus is possible on Capitol Hill, where regional differences may play as important a role as party affiliation. Eliminating deductions for home mortgage interest and state and local tax deductions, for example, would have a bigger impact on taxpayers in states with high taxes and those who live in high-priced housing markets -- regardless of who they vote for.

The debate over the 1986 law was contentious from the beginning, but eventually yielded to bipartisan compromise negotiated by former representative Dan Rostenkowski, the powerful Illinois Democrat, who chaired the House Ways and Means Committee, and former Sen. Robert Packwood, a Republican from Oregon who headed the Senate Finance Committee. Today, with Senate Majority Leader Bill Frist under investigation for insider stock trading, and the House leadership in limbo following former Majority Leader Tom Delay’s indictment on charges of money laundering and conspiracy, it remains to be seen whether the Congressional leadership can tame the hoard of interests that are expected to turn out in force to protect the status quo.'s Martin Wolk contributed to this report.