Start Over on the Tax Issues

The best thing the Senate can do is strip all the tax issues from the Omnibus Budget Reconciliation Act and get on with the real business of cutting the federal deficit. Proposals to reduce the capital gains tax and to restore some Individual Retirement Account benefits to middle-income Americans should be able to stand on their own, and not sneak through under the Oct. 15 doomsday threat of imposition of Gramm-Rudman budget cuts.

Besides dealing with capital gains and IRAs, the Senate should remove a flock of proposed new tax breaks for special interests from the budget bill. A major purpose of tax reform in 1986 was to eliminate, as much as possible, tax shelters and special benefits in exchange for a significantly lower personal income tax rate. The maximum rate on the income of the wealthiest Americans was trimmed from 46.1% to 28% (except for the anomaly known as the “bubble” that puts a 33% levy on some income). This was the second round of tax cuts in the 1980s.

The 1986 reform was designed to encourage business decisions based on real economic choices by eliminating quirks in the law that made it profitable to channel investments into certain areas just for the tax benefit. Another goal was to create stability and continuity in the tax system so that businesses could make thoughtful long-term investment decisions without having to worry about what tax-tinkering Congress might do a year or two down the road that would necessitate a quick shuffle of investments. But the two-year capital gains reduction, to 19.6%, contained in the budget reconciliation bill passed by the House on Thursday would only create an artificial and unproductive flurry of stock and other dealings cashing in on the temporary tax break.

Democrats have attempted to restore the popular up-front tax deductibility of Individual Retirement Accounts as a political foil to the capital gains cut, which would provide the biggest rewards to the wealthiest taxpayers: those who already have gotten the double bonanza of the tax-rate reductions of the 1980s. Elimination of the IRA deduction of up to $2,000 for many families was one of the illogical aspects of the 1986 tax bill. The IRA was one of the features of the system that provided both tax relief for middle-income families and a positive economic benefit in the encouragement of savings for investment. Reviving the IRA deduction has been a hard sell to many members of Congress who have bought the fanciful line that the capital gains cut will benefit the economy, improve investment opportunities for vast numbers of Americans and create new jobs.

The underlying problem of the economy is not that Americans are taxed too heavily, but that the system does not generate enough revenue to finance spending. The budget bill pretends to cut the deficit to the Gramm-Rudman target of $110 billion for the fiscal year that started Oct. 1, but everyone knows that it will not. The budget bill is jerry-built with mythical savings designed to get the government beyond the Oct. 15 Gramm-Rudman deadline for automatic cuts.

The capital gains cut adds to the charade of the budget bill by offering the prospect of a temporary revenue increase of $2.9 billion this year and $3.8 billion in the next. Beyond the third year, however, the increase turns to a loss and merely adds to the federal deficit. That is not the sort of economic signal Washington should be sending to the nation.