New Effort to Revive IRA Tax Breaks : Democrats Offer Plan as Option to Administration’s Call for Capital Gains Cuts

Key Senate Democrats, in a surprise move that could pose a political challenge for President Bush, Tuesday proposed restoring tax breaks for all persons who save money in individual retirement accounts. The proposal was offered as an alternative to the Bush plan for cutting taxes on capital gains.

In principle, encouraging personal savings and lowering capital gains taxes would both tend to increase the nation’s long-term economic strength and competitiveness by encouraging investment in future productivity. And, at least initially, Bush hopes that the lower capital gains taxes he wants would produce a surge in government revenue to help with the deficit.

But the Democrats’ proposal has the political advantage of reinstating a form of tax shelter that was enormously popular among middle-income voters before it was curtailed in the 1986 tax changes. As a further sweetener, the proposal would sanction early withdrawal of IRA funds for buying a house or paying college tuition--expenses that hang heavy over the heads of many Americans.

The proposal suggests that a number of congressional Democratic leaders, rather than seeking a compromise on capital gains taxes, now may try to fight the President with an alternative designed to appeal to precisely the kinds of voters who have been the core of his political strength.

Senate Finance Committee Chairman Lloyd Bentsen (D-Tex.), flanked by a handful of Democrats on his panel, announced the plan to allow all taxpayers to receive at least a partial writeoff on IRA contributions and to permit early withdrawal of IRA funds for home buying or college.

“Because of huge, continuing federal deficits, we cannot enact both the Bentsen IRA legislation and the capital gains tax cut proposed by President Bush,” Bentsen said. “We must make a choice and . . . with the IRA we’d have the participation of a broad spectrum of middle America.”

Senate Majority Leader George J. Mitchell (D-Maine) told reporters that he fully supports Bentsen’s proposal as an alternative to cutting capital gains taxes. The White House capital gains tax plan only provides a “large cut for a small group of Americans--those at the very top of the income scale,” Mitchell said, adding:

“The Senate and the American people now have a clear choice between competing plans to advance our economy.”

Under Bentsen’s proposal, taxpayers who are now ineligible for a tax break on IRAs could claim a $1 tax deduction for each $2 saved in an IRA, up to a maximum contribution of $2,000. That would provide a maximum writeoff of $1,000 for each taxpayer. Those who are currently allowed to take a full writeoff--taxpayers who are not covered by a pension plan or whose income falls below certain limits--would not be affected by the change.

The plan would also allow all taxpayers with IRAs to withdraw money from their accounts before reaching age 59 1/2 without paying the current 10% penalty as long as the money was used to buy a home or to pay college education expenses of a family member.

Bentsen’s proposal represents a sharp change in position and clouds the widely expected prospect that Congress would approve a capital gains tax reduction this year. And even if Bush gets his way, the Bentsen plan at least gives Democrats ammunition to criticize the White House for tax giveaways to the wealthy, who would be the prime beneficiaries of a capital gains tax cut.

Only two weeks ago, Bentsen said that he was exploring ways to reduce capital gains taxes, which are imposed on profits from the sale of stocks, real estate and other assets.

The Senate proposal comes as the House Ways and Means Committee, which has been torn over capital gains for months, struggles this week to forge an agreement between its chairman, Rep. Dan Rostenkowski (D-Ill.), and a dissident faction that currently enjoys a slim majority on the House tax-writing committee.

Bentsen’s announcement also upstaged the kickoff of a campaign by Treasury Secretary Nicholas F. Brady to promote higher U.S. savings and investment. In a speech Tuesday evening to the American Business Conference, a group representing fast-growing business firms, Brady announced that the Administration would like to offer new incentives for savings and work toward the elimination of the double taxation of corporate dividends.

But Brady offered no specifics on what incentives the Administration might propose to spur savings, opening the way for the Democrats to take the lead on the issue.

“A reduction in capital gains tax rates remains our top priority,” a Treasury spokesman said. “After we move forward on that issue, we will be looking at incentives for improving personal savings rate.”

Called a Mistake

Treasury officials, worried that corporate America is becoming too burdened with debt, said the Administration’s initial goal is to win approval of a capital gains tax cut and then to look at possible tax changes aimed at discouraging a heavy reliance on borrowing. Those tax changes are aimed more at encouraging wealthy taxpayers and corporations to make long-run investments than at benefits for average taxpayers.

By reducing the current practice of taxing both individual investors and corporations for the same dividend payments, Brady said the Administration could help “end the bias of the tax system toward debt financing.”

A senior Treasury official, however, acknowledged that the budget deficit limits the government’s ability to provide much tax relief for dividends.

Brady said the Administration continues to oppose proposals to limit the deductibility of corporate interest payments. “This would be a mistake,” he said. “We ought not to make capital more expensive for American companies and hurt their ability to compete.”

The Treasury official, who spoke only on the condition that he not be identified, also made it clear that proposals to introduce a broad consumption tax and revive the investment tax credit are unlikely to go far in Administration circles.

Bentsen’s plan to revive tax breaks for IRAs caught Senate Republicans by surprise, but it was immediately embraced by some longtime supporters of savings incentives. “I’m happy to see Sen. Bentsen joining the fight for IRAs,” said Sen. William Roth (R-Del.). Roth said he believes that expanding incentives for IRAs is not incompatible with reducing capital gains taxes. “I would hope this would be an opportunity to gain both targets,” he said.

Another Setback

Bentsen’s move appeared to be a blow to Rostenkowski, who had been seeking to work out a compromise with the Bush Administration on capital gains to avoid a defeat on the issue in the House.

On Tuesday, Rostenkowski met with top Administration officials to discuss modifications to his plan to allow taxes on capital gains to be adjusted for inflation and to add further tax breaks for assets held for long periods of time. He appeared to be making little headway, however, in winning over Republicans or dissident Democrats, who support a competing proposal to cut the top tax rate on capital gains by 30% for the next two years.

Rostenkowski suffered another setback Tuesday as well, announcing that he has agreed to go along with efforts to repeal the controversial Section 89 of the 1986 tax revision law, which was aimed at requiring business to provide health insurance benefits to all employees on an equal basis. Rostenkowski had been seeking to modify the law in hopes of defusing the repeal movement.

Aides to Rostenkowski said that Bentsen’s plan, if approved by the Senate, could set the stage for competing tax packages to be presented to a House-Senate conference committee, but they argued that it comes too late to prevent some kind of capital gains cut from emerging from the Ways and Means Committee.