Senate Debate Begins Today on Tax Revision

The Senate today will begin debating one of the most far-reaching tax bills in decades, an overhaul of the nation’s creaky tax code that promises a major impact not only on the personal finances of every taxpayer but also on the economic health of the nation.

With most analysts now convinced that some form of tax revision will become law this year, the immediate future is bound to be chaotic as businesses and individuals adjust to a radically different tax system. Compounding the difficulty is the prospect that millions of taxpayers may be hit by a higher tax bite next year as the new plan is phased in.

Yet once a new tax code is fully in place by 1988, the benefits of sharply lower rates and a more efficient array of incentives can be expected to improve the prospects for economic growth.

“In the short run, the turmoil will be tremendous,” said Joseph Minarik, tax analyst at the Urban Institute, a nonprofit research organization. “But in the long run, the payoff will be a stronger economy where it no longer makes sense to waste your money.”

The Finance Committee bill would clear away many of the tax breaks that allow businesses and high-income individuals to shelter their earnings from taxes. And because tax rates would be reduced substantially, the remaining tax breaks would be worth less than they are now.

“The whole idea is that economic merits, not tax considerations, should determine business decisions,” said John A. Makin, a senior economist at the American Enterprise Institute. “That won’t prevent profitable investments from going forward; it will encourage it. Rambo IV and Rambo V will still get made. They will just be financed with real money rather than tax-shelter money.”

Economic Resurgence

While most economists foresee modest benefits from overhauling the tax code, some analysts believe that the Finance Committee bill could spark an economic resurgence by drastically lowering the top personal tax rate from 50% to 27%. Alan Reynolds, chief economist at Polyconomics, a “supply-side” consulting firm based in Morristown, N.J., predicted that “tax reform would liberate entrepreneurs, who are the real engine of economic growth.”

And at the other end of the economic spectrum, a few experts argue that curtailing current tax incentives for savings and investment threatens to weaken the economy.

“The Senate Finance Committee plan represents a gamble with the process of capital formation,” said Harvard economist Martin S. Feldstein, former chairman of President Reagan’s Council of Economic Advisers. “Some of the changes would definitely reduce the rate of savings and drive capital away from growth-enhancing investments in business plant and equipment.”

Could Reduce Savings

Feldstein warns that the proposed curtailment of individual retirement accounts would cut into the nation’s savings--the pool of money that finances business investment and economic growth. The Finance Committee would eliminate the $2,000 tax deduction for contributions to IRAs by individuals who are covered by pension plans at work.

But Robert S. McIntyre, director of tax policy at Citizens for Tax Justice, sees no such risk. “Despite all the supposed ‘incentives,’ personal savings as a share of disposable income fell to only 4.6% in 1985, the lowest rate since 1949,” he said. “What’s the point of keeping something that doesn’t work?”

Among industrial sectors, the complexity of the 1,485-page tax bill makes its impact nearly impossible to forecast with any precision. The cacophonous debate among economic analysts led Senate Finance Committee Chairman Bob Packwood (R-Ore.) to dismiss economists this week as “the kind of people who don’t have the personalities to become actuaries.”

Break for High-Tech Firms

Nonetheless, some conclusions are clear. High-technology firms, for example, now enjoy relatively few tax breaks and pay taxes at near the maximum rate of 46%; they figure to benefit from the reduction in the top corporate tax rate to 33%.

At the same time, however, the elimination of the tax preference for capital gains--profits from the sale of investments held for at least six months--could deter some individuals from investing in risky but potentially high-profit businesses such as high-tech. The current tax code encourages high-risk investments by excluding 60% of capital gains from taxation.

And the loss of the capital gains exclusion would be felt by many more industries than high-tech. “It is going to be devastating for long-term investing,” argued Mark Bloomfield, head of the American Council for Capital Formation.

Good News for Brokers

But the change would spell good news for stock brokers because investors would no longer lose tax benefits by churning their investments more frequently than every six months. “If the bill becomes law as is,” said Hardwick Simmons, vice chairman of Shearson Lehman Bros., a major New York brokerage house, “we’re in fat city.”

Other enterprises that figure to flourish from the reduced corporate tax rate include retail trade, which like high-tech benefits hardly at all from the tax incentives in today’s corporate tax code.

On the other side of that coin, sectors that benefit disproportionately from today’s tax breaks would suffer disproportionately from their loss.

Investment Tax Credit

Feldstein is disturbed by the proposed abolition of the 10% investment tax credit, which would hit particularly hard at electrical utilities and other capital-intensive industries. But other economists argue that what is bad for these industries is not necessarily bad for the economy as a whole.

“Eliminating the investment tax credit is the heart of this tax revision effort,” said Minarik of the Urban Institute. “It has done more to distort investment patterns than any other single provision in the tax code.”

The real-estate sector stands to lose a major source of revenue as tax overhaul virtually abolishes tax shelters that allow individuals who invest in certain real-estate ventures to protect much of their non-real-estate income from taxes. Low-income housing, which depends almost totally on tax-shelter investment after suffering from Reagan Administration cutbacks in subsidized housing, could be devastated.

Fears Called Exaggerated

But most analysts argue that the real-estate industry’s worst horror story--that the bill would virtually end apartment construction and lead to huge increases in rents--is wildly exaggerated. “This is a sledgehammer on real-estate shelters, but real-estate development itself won’t suffer anywhere near as much as their lobbyists would have you believe,” said J. Gregory Ballentine, with the accounting firm Peat, Marwick, Mitchell & Co.

And some real-estate developers might welcome the chance to eliminate tax breaks that have contributed to the construction of dozens of “see-through” office buildings that are practically empty in many cities. “Most of the overbuilding around the country has been connected to tax breaks,” said Oliver Carr, a Washington developer. “We ought to let the money flow to where the real demand is.”

If the economy feels a boost when people have more money in their pockets, the Finance Committee’s tax bill should provide a healthy jolt. The maximum personal tax rate would be slashed from 50% to 27%, and the average taxpayer would enjoy a 6% tax cut--$215 in cash--when the bill becomes fully effective in 1988.

Poor to Gain Most

The poor, who have suffered the most in recent years under the current tax system, stand to gain the most because the bill would nearly double the personal exemption to $2,000 and substantially increase the standard deduction as well. More than 6 million low-income taxpayers would be dropped from the tax rolls.

But the tax cuts would be spread across all income groups. Those earning between $40,000 and $50,000 would receive an average tax cut of 6.6%, or $337, and those between $100,000 and $200,000 would enjoy a 3.8% cut, or $810.

The bill would bestow these blessings only in 1988, however. The lower tax rates would take effect only in the middle of next year, six months after the pruning of many popular tax breaks, and many taxpayers would be hit by a sharper tax bite in 1987.

“The first year is going to be a problem for a lot of people,” said Rep. Robert T. Matsui (D-Sacramento). “I hope there isn’t a backlash in April, 1988--after all, that’s an election year--when taxpayers are filling out their 1987 forms.”