Tax Revision Bill Passed by Senate : Sweeping Overhaul, OKd by Vote of 97-3, Goes to Conference Panel

The Senate overwhelmingly approved a sweeping overhaul of the tax code Tuesday and set the stage for tough negotiations this summer to settle the differences between the Senate bill and the plan adopted by the House last December.

The 97-3 vote came after 13 days of deliberations. Approval of the legislation moved President Reagan close to final victory on the issue, which he had made the highest domestic priority of his second term. Despite public indifference and high-powered opposition from a host of entrenched interest groups, the Reagan Administration relentlessly pursued the elusive goal of tax revision for more than two years.

“The Senate has voted on tax reform and the score is: taxpayers 1, special interests, nothing,” Reagan said in a written statement. “The Cinderella team came out on top.” The President had given the House-passed bill only lukewarm support.

Tax Breaks Curtailed

The bill passed by the Republican-controlled Senate goes far beyond the tax proposals offered by either Reagan or the Democratic-run House. By curtailing a host of tax breaks, it would slash the top individual tax bracket to 27% from 50%, although some high-income taxpayers would effectively pay a 32% rate on some of their income. It would also drop the maximum business rate to 33% from 46%.

Taxpayers would receive an overall tax cut averaging 6% once the plan becomes fully effective. The Senate would pay for the cut in personal taxes largely by boosting corporate taxes about $105 billion over the next five years.

Despite some fundamental differences between the Senate and House versions, tax overhaul has acquired such formidable political momentum that it now appears all but inevitable that House and Senate negotiators will reach agreement on a final bill, possibly just before the congressional recess scheduled to begin Aug. 15.

However the thorny issues are resolved, the outlines of the final tax bill are already clear:

--Maximum tax rates will fall dramatically from the present top levels of 50% for individuals and 46% for corporations.

--The personal exemption for most taxpayers and their dependents will be nearly doubled to $2,000.

--The standard deduction for taxpayers who do not itemize their deductions will be raised.

Poor to Pay No Tax

--About 6 million poor families will be dropped from the income tax rolls altogether.

--Some cherished tax breaks, including the two-earner deduction, will be killed, and others--such as income averaging, the deduction for union dues and other miscellaneous expenses and the tax advantages of shifting income from parents to children--will be severely curtailed.

--The tax rate on capital gains will rise from the present maximum of 20%.

--Business taxes will rise by more than $100 billion over the next five years to offset an overall tax cut for individuals.

--Businesses will lose the generous investment tax credit, which provides an immediate tax savings of as much as 10% off the cost of business equipment purchases.

Nonetheless, there are plenty of major snarls for the House-Senate conference to untangle.

The House and Senate are at odds over how deeply personal tax rates should be cut. Senate Republicans will fight to keep the maximum tax rate close to the nominal 27% in their bill, but House Democrats, who approved a rate of 38% on the highest-income taxpayers, will push for something close to that so that they can provide greater tax relief for middle-income taxpayers.

And, beyond that, the House and Senate bills take different approaches to scaling back the welter of tax preferences that punctuate the tax code.

The Senate plan would drastically reduce individual tax breaks, notably for IRA (individual retirement account) contributions and consumer interest payments, but it would preserve many preferences for specific industries. The House-passed bill, by contrast, would hit hard at many business tax preferences and leave nearly all personal tax deductions intact.

The Senate barely approved its Finance Committee’s controversial proposal to end deductions for IRA contributions for taxpayers who have company pension plans, and few lawmakers expect that provision of the Senate bill to survive the conference intact.

Differences on IRAs

But salvaging the full IRA deduction would cost $24 billion over five years, and some compromise short of full deductibility is likely. Although House Ways and Means Committee Chairman Dan Rostenkowski (D-Ill.) has privately told some members of his committee that he wants to preserve the popular tax break, even the House bill would effectively put an end to IRAs for taxpayers with 401(k) retirement plans, in which an employer contributes some matching funds to an employee’s tax exempt account.

A strong consensus has emerged in both Congress and the Administration that any tax overhaul be “revenue neutral,” thus not worsening the deficit by reducing revenues or risking a presidential veto by increasing taxes overall.

The Senate’s move to trim deductions for state sales taxes is also likely to fall short. Under the House plan, all state and local taxes would remain fully deductible. Senate Finance Committee Chairman Bob Packwood (R-Ore.) has privately acknowledged that he is willing to trade away the Senate position in hopes of obtaining other concessions.

Several technical problems also could complicate the effort to meld the two versions of the bill. In both, the eliminations and reductions of various tax breaks would take effect next Jan. 1, but the rate reductions and larger standard deductions would be implemented later. As a result, many people would pay more in 1987 even though they could expect to receive future tax cuts once the plan is fully effective.

Moreover, House lawmakers are prepared to challenge what Sen. George J. Mitchell (D-Me.) called the “myth of the 27% top rate” in the Senate bill.

For some families, the maximum tax rate could reach 32%. That’s because the bill would deny upper-income taxpayers full use of some tax advantages available to lower-income taxpayers. For families earning between $75,000 and $185,320 ($45,000 and $127,240 for single persons), the plan would phase out the benefit of the lower 15% tax rate and the $2,000 personal exemption.

Although the goal of that complex maneuver is to prevent an even greater share of the rate cuts from accruing to the wealthy, it would leave many relatively affluent families paying a higher tax rate on each additional dollar of income than the richest taxpayers would face.

The three senators who voted against the bill, Democrats Carl Levin of Michigan, John Melcher of Montana and Paul Simon of Illinois, said they felt it was unfair, especially to the middle class.

Senate tax writers, bolstered by Reagan’s strong backing for their bill and the huge margin of victory on the floor, vowed Tuesday to resist efforts to compromise key elements of their package.

“The House has some good things we ought to consider, but I’m satisfied we have a better bill,” said Sen. Russell B. Long (D-La.), the ranking Democrat on the committee. And, in that context, he told Reagan in a telephone conversation shortly after the vote: “We’re counting on you, Mr. President, in conference. . . . I hope very much we don’t have to drop too many good things.”

Senate leaders acknowledged that they still expected to make several changes in the bill during negotiations with the House.

“It’s not a perfect bill,” said Majority Leader Bob Dole (R-Kan.). “There are still some loopholes--not all are closed. Some are never touched.”

The Senate bill, which nearly died in the Finance Committee two months ago, was revived by Packwood at what he recalled Tuesday as his “bleakest hour.” Frustrated by his inability to satisfy the competing demands of 20 committee members eager to protect their local interests, Packwood turned as a last resort to the radical concept originally propounded more than four years by Sen. Bill Bradley (D-N.J.), which called for dramatically lower tax rates and elimination of many tax preferences.

“In one historic vote,” a clearly elated Bradley said, “the Senate of the United States told the American people that the general interest can win over the special interests.”

The legislation, although imperiled at nearly every step, so far has survived its stormy odyssey through Congress largely because no politician dared accept the blame for burying Reagan’s top priority.

‘A Sweet Victory’

When the House approved its bill last year, Rostenkowski said its prospects were uncertain amid the election-year pressures on the Senate. He lauded Tuesday’s vote as “a sweet come-from-behind victory . . . . There’s no question now that the President will sign a tax reform bill this year.”

The key victory in the Senate debate occurred two weeks ago, when the bill’s supporters narrowly defeated an effort to restore IRA write-offs for all taxpayers. After that, only a few minor amendments were added to the package that had been approved unanimously by the Finance Committee on May 7.

On the final vote, California’s two senators voted in favor of the bill.

With a majority of senators committed to the bill almost from the moment it emerged from the Finance Committee, the vote Tuesday was almost anti-climactic. Even before tax writers could finish basking in the glow of their overwhelming mandate from the Senate, they began turning their attention to the challenge of reaching agreement with the House.

“We still have one more hurdle,” Bradley cautioned, “before we can declare final victory.”

COMPARING THE HOUSE AND SENATE TAX BILLS

PERSONAL TAXES

Tax rates Current law (1986): 14-15 tax brackets with rates from 11% to 50%. Brackets indexed to reflect inflation. House bill: Four tax brackets with rates of 15%, 25%, 35% and 38%.9 Indexed. Senate bill: Two brackets of 15% and 27%. But effective rate of 32% for high-income taxpayers as value of lower rate is phased out. Indexed.

Personal exemption Current law (1986): $1,080. Indexed. House bill: $2,000 for taxpayers who do not itemize deductions; $1,500 for those who do. Senate bill: $1,900 in 1987, $2,000 in 1988. But phased out for very $1,500 for those who do. Indexed.

Standard deduction Current law (1986): $3,670 for couples, $2,480 for singles, $2,480 for heads of household. Indexed. House bill: In 1987, $4,800 for couples, $2,950 for singles, $4,200 for heads of household. Indexed. Senate bill: In 1988, $5,000 for couples, $3,000 for singles, $4,400 for heads of household. Indexed.

Itemized deductions: Medical Expenses Current law (1986): Deductible above 5% of adjusted gross income. House bill: Same as current law. Senate bill: Deductible above 9% of AGI.

Itemized deductions: State and Local Tax Payments Current law (1986): Income, property and sales taxes deductible. House bill: Same as current law. Senate bill: Sales tax not deductible.

Itemized deductions: Mortgage Interest Current law (1986): Deductible. House bill: Deductible for first and second homes only. Senate bill: Deductible for first and second homes only.

Itemized deductions: Consumer Interest Current law (1986): Fully deductible. House bill: Deduction limited to $10,000 for singles, $20,000 for couples. Senate bill: Not deductible, although interest on second mortgages still deductible.

Itemized deductions: Charitable Contributions Current law (1986): Deductible for itemizers and non-itemizers alike. House bill: Deductible for both, but contributions. Senate bill: Deductible for itemizers only.

Itemized deductions: Miscellaneous deductions Current law (1986): Permitted for such expenses as union dues and some employee business costs. House bill: Limited, including employee business expenses, to amount above 1% of AGI. Senate bill: Repealed. Only unreimbursed employee travel expenses above 1% of AGI deductible.

Retirement savings: Individual Retirement Accts. Current law (1986): For all workers, deduction of up to $2,000 for IRA contributions. House bill: Same, but deduction reduced by each dollar contributed to a 401(k) plan. Senate bill: $2,000 deduction only for those without company pensions. IRA earnings remain tax-deferred.

Retirement savings: 401(k) Plans Current law (1986): $30,000 limit on individuals’ contributions to these employer-based plans. House bill: Limit reduced to $7,000. Senate bill: Limit reduced to $7,000.

Capital gains Current law (1986): 60% of profits from investments held at least six months excluded from taxes. Effective top rate of 20%. House bill: 42% of capital gains excluded from tax. Effective top rate of 22.04%. Senate bill: Capital gains taxed as ordinary income. Effective top rate of 32%.

Two-earner deduction Current law (1986): Up to $3,000. House bill: Repealed. Senate bill: Repealed.

Dividend income Current law (1986): First $100 ($200 for couples) excluded from taxable income. House bill: Fully taxable. Senate bill: Fully taxable.

Unemployment compensation Current law (1986): Taxed for relatively high- income taxpayers. House bill: Fully taxed. Senate bill: Fully taxed.

Income averaging Permitted. Repealed. Repealed except for farmers.

Income shifting to minor children Current law (1986): Permitted. House bill: Curtailed. Senate bill: Eliminated for those under 14.

CORPORATE TAXES

Tax rates Current law (1986): 46% top rate. House bill: 36% top rate. Senate bill: 33% top rate.

Investment tax credit Current law (1986): 6% to 10% of business investments. House bill: Repealed as of last Jan. 1. Senate bill: Repealed as of last Jan. 1.

Depreciation of investments Current law (1986): Accelerated writeoffs of 3 to 19 years from the time of investment. House bill: Generally less favorable writeoffs than under current law. Senate bill: More generous than current law for all investments except real estate.

Capital gains Current law (1986): 28% top tax rate. House bill: Taxed as ordinary income. Senate bill: 28% top tax rate.

Industry tax preferences: Oil and gas Current law (1986): Special tax deductions. House bill: Special deductions trimmed. Senate bill: Special deductions retained.

Industry tax preferences: Timber and mining Current law (1986): Income taxed as corporate capital gains. House bill: Taxed as ordinary corporate income after 3-year phase-in. Senate bill: Taxed as corporate capital gains.

SPECIAL TAX PROVISIONS

Municipal bonds Current law (1986): All bonds tax exempt, but volume of private-purpose bonds limited modestly. House bill: Private-purpose bonds, including housing, more stringently capped. Senate bill: Current caps on private-purpose bonds largely retained.

Tax shelters Current law (1986): No limits on “paper” losses that can be used to offset other income. Real estate not subject to at-risk rules. House bill: Limited under the new minimum tax. Real estate investors’ money must be at risk to qualify for tax at-risk rules. Senate bill: Losses no longer deductible against other income, except for oil and gas partnerships. Phased in over five years.

Minimum tax Current law (1986): 20% rate for individuals and 15% for corporations, but largely ineffective because much income excluded. House bill: Personal minimum tax substantially tightened, with 25% rate. Corporate minimum tax also 25%. Senate bill: Personal minimum tax rate somewhat stiffer. Much stiffer corporate minimum tax at 20% rate.

Business meals and entertainment Current law (1986): Fully deductible. House bill: 80% deductible. Senate bill: 80% deductible.