Tax reform and the President's second-term agenda.

• Author: Prysock, Mark
• Position: WashingtonINSIGHTS

In the run-up to the November elections--and, indeed, in his victory speech--President Bush promised that his administration would endeavor to enact fundamental tax reform. Very little attention was paid to these remarks, largely because the electorate was preoccupied with the larger issues of national security and the economy. But following recent moves to shake up the Bush economic team, Washington insiders now believe tax reform will join deficit reduction and Social Security reform at the top of the President's second-term domestic agenda.

The administration has toyed with the notion of fundamental tax reform for some time. In 2002, at the President's direction, the Treasury Department reviewed our current tax system, discussed its many shortcomings and developed several options designed, in Treasury's words, "to provide a tax system that is simpler, more efficient, and fair."

Treasury identified several flaws with the current system, including needless complexity, which makes the system susceptible to abusive tax-avoidance schemes. As Treasury noted, the tax code is virtually beyond comprehension, mandatory recordkeeping is confusing and onerous, and there are too many confusing tax forms, schedules and reports to fill out.

Treasury also found that the current system penalizes hard work, discourages savings and investment and hinders the international competitiveness of U.S. firms. While many of these problems were addressed in sweeping tax legislation recently enacted by Congress, some problems remain, especially in the area of international taxation. The many layers of rules in the current system arise out of the difficulties inherent in defining and capturing income for taxation purposes--especially for activities and investments that cross jurisdictional boundaries.

Many of the tax reform proposals likely to be advanced will attempt to address these problems. Major reform proposals will likely include the following:

* Flat consumption tax--This proposal would completely scrap the existing tax system for a broad-based, flat consumption tax. It would simplify the tax system and improve efficiency by reducing the distorting influence of taxes on economic decisions. The proposal would likely retain the use of credits and both personal and dependent deductions, but would exempt most capital income from taxation.

* Flat income tax--This system would greatly simplify filing for individuals and businesses. The reduction in marginal rates...