New Tax Code Can’t Find the Funds Required for Responsible Government

This year may be witnessing not just what some call “Iranscam” but also “Taxscam”--the metamorphosis of the 1986 federal “tax reform” into what almost amounts to institutional deception. The Treasury Department’s foul-up in designing unworkable W-4 forms provides a sad hint of the confusion at work, especially after Internal Revenue Service Commissioner Lawrence B. Gibbs’ November proclamation that the new W-4 “captures the spirit of the new tax reform.” If so, another page of the Reagan Administration’s place in history books may need revision.

Much more is involved than public skepticism of “simplification” promises. Americans simply don’t believe that last year’s tax legislation will help them; 53% think the rich benefit the most, according to one poll. Indeed, last year’s “how all of you will benefit” promises from Washington--overblown to begin with--are being nibbled away. Little hints here and vague proposals there by congressional leaders, state politicians and budget officials now seem to be calling more and more of the alleged benefits and net reductions into doubt. For upper-income taxpayers in particular, the new 28% top bracket--to take effect in 1988--may not last any longer in the 1990s than comparable Roaring ‘20s rate reductions did in the troubled 1930s. Old-style progressivity could make a comeback on the coattails of Wall Street’s plea-bargaining yuppie millionaires.

Let’s begin, however, with the central weakness of the 1986 overhaul: The Reagan Administration’s refusal to admit the need for added revenues. With the fiscal 1987 budget deficit still close to $200 billion, virtually everyone now knows new revenues are necessary. So it’s no longer a question of whether taxes will be raised, but how .

For the moment, debate is only over some $15 billion-$20 billion a year. Leading House Democrats have proposed blocking the top income-tax rate’s scheduled reduction to 28% in 1988, keeping it instead at 1987’s interim level of 38.5%. That would raise some $10 billion-$25 billion a year, depending on how capital gains are treated, but Republicans and even many Democrats regard that as an unfair and clumsy breach of 1986 promises--and presidential veto-bait to boot.

Other new ideas? Oil-state politicians from both parties talk about a $10-billion-a-year oil-import fee. House Budget Committee Chairman William H. Gray III (D-Pa.) is promoting the idea of raising $10 billion-$20 billion a year by surcharging imports from countries that won’t take U.S. goods, and auctioning off rights to foreign imports now entering the United States through quotas. Early this month, federal budget director James C. Miller III was hinting the Reagan regime would sign off on increased cigarette and liquor “sin” taxes, but that has been squelched.

Even the Administration has been forced to eat its own no-tax-increase promises. Instead of proposing overt tax hikes for 1987, though, the White House has weighed in with some “user fees”--including a $2 entry charge for national parks, increased Medicare payroll taxes on state and local government employees, a fee on Federal Housing Administration mortgages and the like. Democrats have criticized the implicit deception and regressivity: “A tax by any other name still smells the same,” complained Gray.

But 1987’s needs, to paraphrase Count Dracula, are only the first bite. Over the longer haul, given the persistence of the budget deficit, another major round of federal tax revision seems certain by 1989 or 1990. It could come even sooner, especially if Treasury’s W-4 foul-up worsens the predictable national disillusionment with “reform,” as Mr. and Mrs. America, underwithheld through 1987, sit down in early 1988 to do their Form 1040s. Public amenability to reconsideration of 1986’s handiwork could surge.

Even now, there are hundreds of tax- law corrections and modifications floating around the new 100th Congress. The most important are proposed restorations --for example, of investment tax credits for business, income averaging for farmers or sales tax deductions for ordinary taxpayers. Depending on how different sectors of the economy fare in 1987, the case for some of these could strengthen considerably. In fact, the Reagan Administration is already nervous enough about pressure for new or reinstated tax breaks that it has withheld formally proposing extension of the business research and development tax credit--scheduled to expire in 1987--despite the credit’s huge importance to U.S. competitiveness. The fear? Legitimizing a flood of other demands that would cost a lot of money and put further upward pressure on the new rate structure, the apple of the President’s fiscal eye.

Whether that rate structure can survive is the big question, and the probable answer is: only partly. Much of corporate America would prefer to have targeted breaks back, even if overall corporate rates had to ratchet from 34% halfway back (40%) to 1986’s 46% level. And middle-income America, sure to see its already minimal federal tax benefits nibbled away, could well push for a return to individual rate progressivity--one that pegs Rockefeller family brackets 20 or 30 points higher than rates for carpenters or supermarket managers.

Indeed, there is gathering pressure to escalate upper-income burdens. The states, remember, face a major tax windfall from the broadened federal definition of taxable income brought about by 1986’s deletion of so many credits and deductions. Henceforth, existing state rates will bring in far more money. So if the states did nothing, they’d gain about $4 billion a year, much of it from middle-income taxpayers. Right now it looks like a number of states will keep part of the windfall, effectively raising the state tax burden of middle and (especially) upper-income residents. Rates in many jurisdictions will be cut, but not much.

This targeting of upper-bracket taxpayers could increasingly appeal to Washington, too. A late January CBS News survey found a plurality of Americans favoring the Democratic position of postponing the tax cuts for those with incomes over $50,000. Indeed, fully 61% favored either this postponement or an across-the-board tax increase.

Such pressure seems bound to grow. The reality is that 1981-87 federal fiscal policy, particularly the 1981 tax cuts, has surrendered the tax revenues needed to run a reasonable level of federal activity without deficits.

It’s been pleasant for Greenwich, Conn., and Newport Beach, Calif. Many upper-bracket Americans have been able to keep more of their money than at any time in a half-century. The price, however, has been a budget deficit that jeopardized the economy and put a particular squeeze on federal programs for less favored economic groups. By peacetime yardsticks, this imbalance between federal tax levels and program responsibility levels is particular to the 1980s. Prior Republican Administrations, like those of Dwight D. Eisenhower and Richard M. Nixon, generally assured that revenues from non-Social Security taxes were enough to fund the necessary level of government.

Today’s deficiency, then, is unlikely to last, and the tax code will probably have to be changed to raise new revenues. In the end, a fair part of the great tax reform of 1986 could be remembered in somewhat the same vein as the White House’s anti-terrorist swashbuckling: overambition brought down by naivete and mishandling.