Bigger Share of Income Would Be Taxed : Despite Cut, Businesses Could Pay Higher Levies

For many of the nation’s businesses, President Reagan’s tax reform proposal adds up to a tax increase. Although corporations would pay taxes at a lower rate under Reagan’s plan, many of them would be forced to pay the new rate on a substantially larger share of their income than under current law.

Moreover, Reagan included in his package a special “windfall” tax designed to extract more than $50 billion over three years from many of the businesses that would benefit most from the reduction in the corporate tax rate.

Reagan would trim the top corporate tax rate from 46% under current law to 33%. But a series of fundamental changes in the ways businesses are allowed to measure their taxable income would mean that, by 1990, businesses would pay 23% more in income taxes than they would pay under current law.

“It’s a fundamental change, no question,” said Lawrence M. Axelrod of the accounting firm of Touche Ross. “A number of industries will be hurt,” he said, pointing to the proposed repeal of the 6% to 10% investment tax credit and to many other provisions that would limit today’s corporate tax preferences.

At the same time, Reagan’s plan has some sweeteners. Corporations that must now pay dividends to stockholders out of after-tax profits, for example, could deduct 10% of dividend payments from their taxable income.

Compared with current law, the new proposal would hit hard at some industries that now shield a substantial proportion of income from taxation through accelerated depreciation of the costs of plant and equipment, special accounting procedures, foreign tax credits and other devices that would be modified and, in some cases, radically changed.

By that measure, the losers would include capital-intensive heavy industry such as steel and autos, the oil and gas industry, real estate, some defense contractors, banks and other financial institutions and many corporations doing business overseas.

The winners would include most high-technology companies that now pay taxes on most of their income and would benefit directly from the lower tax rate. Small businesses would continue to retain graduated lower tax rates on lower levels of income and would retain most of their current preferences.

More Winners Than Losers

However, measured against the tax reform package that the Treasury Department proposed shortly after President Reagan’s reelection last November, the Reagan plan has more winners than losers. The Treasury package would have increased the corporate tax burden 37% in 1990, even more than the 23% of the Reagan plan.

But Reagan’s proposal, unlike the original Treasury package, seeks to tax some of the “windfall” that businesses would otherwise enjoy because accelerated depreciation would allow them to defer some taxes until after the reduced 33% corporate tax rate would take effect. The Treasury Department estimates that it can reap $56.5 billion of that windfall by subjecting 40% of it to taxes between mid-1986 and mid-1989.

But, after 1989, when the three-year “windfall” tax would expire, the impact of the new proposals on business would substantially decline. By the time the new tax code would be completely phased in and corporations would have adjusted their behavior to the new tax environment--a process that could take as long as 40 years--Treasury estimates that the increased corporate tax burden would be a more modest 9%.

Heavy Industry Would Suffer

This is how some key industry groups probably would fare:

--Heavy industry would be hit especially hard by the “windfall” tax because, with its large capital costs, it has benefited disproportionately from accelerated depreciation. But heavy industry would be better off under the Reagan plan than the original Treasury plan, which would have tightened depreciation schedules even more.

--The oil and gas industry would fare much better than under last November’s Treasury plan. The percentage depletion allowance, which allows smaller oil companies to deduct a percentage of their profits to offset the depletion of their oil reserves, would be limited to wells producing less than 10 barrels of oil a day. The Reagan plan would preserve the industry’s ability to write off all drilling costs immediately instead of over the life of the well.

--Defense contractors and other companies with long-term construction contracts no longer would be able to write off prospective interest costs immediately. Instead, they would have to spread the deductions over the life of the contract.

--Banks and other financial institutions no longer would be permitted to deduct interest expenses incurred in buying tax-exempt instruments--a ban already imposed on individuals and corporations. They would also lose the ability to deduct from income the reserves they set aside for bad debts; instead, they could only deduct actual bad-debt losses as they occur. Savings and loan associations would be especially hurt.

Higher Real Estate Taxes

--The real estate industry fears substantially higher taxes as a result of the “windfall” tax, and it expects indirect damage as a result of the proposal to abolish the property tax deduction and limit the deduction for second-home mortgages.

--Real estate developers would lose their authority to benefit from the proceeds of tax-free bonds issued by states and cities to help finance such private construction as shopping centers and downtown rehabilitation. But state and local governments could continue to issue tax-free bonds for such public purposes as highway and sewer construction.

The tax plan was praised by service businesses but criticized by heavy industry. Part IV, Page 1.