Tax Reform: It’s Still Them vs. Us : Senate Recycles Business ‘Incentives’ That Failed in 1981

As the tax-reform conference plods along in Washington, the Senate has yet to show that it’s serious about delivering real reform. So far, most Senate conferees have shown more zeal for protecting special-interest tax breaks than for truly restoring fairness to the tax code.

When the conference began, the Senate bill had a major problem: It lacked enough loophole-closing measures to pay for its tax rate reductions. The House conferees laid things on the line for their Senate counterparts. Either the Senate has to accept about $50 billion worth of House corporate reforms, or the top tax rates in the Senate plan will have to go up.

But the senators appear to be caught in a time warp from 1981. Spouting rhetoric about “capital formation and international competitiveness,” they are balking at adopting the bulk of the House reforms. They seem to have forgotten that one of the driving forces behind tax reform today is the abject failure of the 1981-enacted tax “incentives” to boost business investment as they were supposed to.

Let’s review the record. The giant write-offs enacted in 1981 for new equipment were supposed to set off a business investment boom. Instead, from 1981 to 1985, investment in the types of machinery that the “incentives” were supposed to encourage grew at only 1.9% a year--less than one-third the 1976-80 figure.

The trade picture is even gloomier. Our “international competitiveness” was in much better shape in 1981, when we had an overall trade surplus, than today, when the trade deficit exceeds $150 billion.

Tax “incentives” have done a great job in cutting corporate taxes. Indeed, the companies that have enjoyed the largest tax breaks for the past five years--and thereby paid no federal income taxes or got outright tax rebates--reduced their capital investment, laid off workers, and cut exports. In ironic contrast, the companies that paid the highest tax rates increased investment, employment and exports.

The emptiness of the Senate’s rhetoric about international competitiveness and capital formation is underlined by looking at who it is the Senate wants to shower tax breaks on.

Defense contractors lead the list. Over the past four years, only one of the nation’s top six military contractors paid more than 3% of its profits in federal income taxes. The House bill says enough is enough, and would close down the special tax break that makes this freeloading possible. The Senate says the loophole must be kept.

The average tax rate on the nation’s major banks is now only 6%. The House says that the banks ought to pay more; the Senate says that key bank tax breaks must be preserved.

The House wants companies to write off the costs of their new machinery in a way that reflects how the equipment actually wears out. The Senate disagrees, calling for retention of tens of billions of dollars in “depreciation” tax breaks. But the big winners under the Senate depreciation plan are not internationally sensitive industries such as semiconductors or autos. Instead, the Senate’s plan would shower its excess deductions on public utilities and railroads.

What the industries favored by the Senate plan have in common is not their sensitivity to foreign trade, but rather their low taxes under present law.

To find the money that it needs to break even, the Senate is now considering scaling back the tax cuts for middle- and low-income families. Several senators have floated the idea of delaying tax indexing for one year, which would mean permanent reductions in the standard deduction, the personal exemptions and--maybe--the earned-income tax credit for the poor. In addition, the change would push some middle-income taxpayers from the 15% tax bracket to the 27% bracket.

It appears that the House conferees are not about to agree to such a regressive approach.

If the Senate won’t agree to stop protecting corporate freeloaders, the next step, inexorably, will be to look at the top personal tax rate. Right now, the Senate individual tax plan would give half of the people earning more than $200,000 a year tax cuts averaging more than $50,000 each. The reason is the bizarre rate structure in the Senate plan. Although advertised as a two-rate system--15% and 27%--the Senate bill actually has four rates.

Between about $75,000 and $200,000 of income, the Senate’s top tax rate rises to 33%, as the benefits of the 15% bracket and the personal exemption are phased out. The rate then drops back down to 27% again above $200,000.

In other words, the Senate’s top rate of 33% applies to the near-rich, while the truly rich are in the lower 27% bracket!

Extending the Senate’s 33% rate to people earning more than $200,000 a year could raise as much as $50 billion over the next five years--more than enough to pay for House-sized tax reductions for middle- and lower-income families.

If the senators decide to get serious about tax reform, they will have to choose. Will they take on wealthy corporations or wealthy individuals? Either way, the rest of us would end up winners--which is what tax reform is supposed to be all about.