NEW YORK (CNN/Money) -
The federal income tax code took another beating Thursday as Federal Reserve chairman Alan Greenspan echoed the call for a broad overhaul of the current system.
The Fed chairman also noted the benefits of a national consumption tax for boosting the national savings rate and overall economic growth. A consumption tax, such as a retail sales tax, is based on what people spend, not what they earn.
Greenspan was speaking to the second meeting of a bipartisan panel appointed by President Bush to explore options for revamping the tax code. The panel has until July 31 to issue its recommendations.
Based on the reform panel's initial meetings, serious consideration is being given to a consumption tax. One popular idea is to craft a new code that includes both an income and consumption tax. Such combinations are common in other parts of the world, including western Europe.
In prepared remarks to the panel Thursday, Greenspan backed the notion of simplifying the tax code and suggested that a move away from the current income tax in favor of a system that taxes based on the money individuals spend -- not what they save -- could be an effective way to promote economic growth.
Greenspan was not the only speaker to raise the benefits of a consumption-based tax system. Former Treasury Secretary James Baker, who headed the department during the 1986 reform, said that a consumption tax, if done right, "could certainly meet the fundamental criteria of being simple, fair, and pro-growth."
Details of how a consumption tax would work, either as a stand-alone system or in combination with an income tax, aren't entirely clear. Tax experts say, however, that a national sales tax alone would not work.
For one thing, to ensure that government tax coffers remain full, the sales tax rate would have to be high -- some say in the range of 27 percent or so. Bush has asked the any solution from the panel be 'revenue neutral,' meaning they would neither increase nor lower the overall amount of tax dollars collected by the federal government.
Putting tax collection responsibility into the hands of businesses won't happen, some tax experts predict, because the risk of noncompliance would be too high.
"What we would then be doing is shrinking the point of collection down to every retail outlet in America," said Pamela Olson, a former assistant secretary for tax policy during Bush's first term who is now a partner in Skadden, Arps, Slate, Meagher & Flom. "Right now the IRS has a lot of difficulty collecting payroll taxes from small businesses. What if they're at risk of going out of business and decide to pay the meat delivery guy instead of the tax man?"
Critics also say that consumption taxes favor the rich, because wealth enables them to save -- and thus shelter money from taxation. Low-wage earners, in contrast, must spend a greater proportion of their income simply buying necessities.
The consumption tax idea is "at great odds with the political center of the country," said Clint Stretch, the director of tax policy for Deloitte Tax, an affiliate of the accounting giant Deloitte & Touche. "How do we get to a system that better encourages savings and investment, without creating a system that can be characterized as benefiting the rich?"
While Stretch and other tax experts say the odds of radical reform are low, they say the prospect of gradual change is significantly better.
One area that has a decent shot at reform: the alternative minimum tax, another key focus of the reform panel. Criticism of the AMT, a separate income tax code originally set up to limit deductions available to the wealthy, has been mounting as more middle-class taxpayers have been trapped by it.
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