A New Tax Structure to Shelter U.S. Savings

By JAMES FLANIGAN

July 2, 1995 12 AM PT

Sometime in the next year or so, the whole structure of your taxes will change. Tax rates will be lowered--but not to send you out on a spending spree. The intent of this tax reform will be to boost savings and investment in the U.S. economy.

It’s an idea whose time has come. Today in Washington, all the talk is of flat taxes or consumption taxes and national sales taxes that are designed to encourage Americans to save.

One prominent proposal is called the Unlimited Savings Allowance Tax--or USA Tax. It would exempt from tax all income that is saved or invested.

The surge for savings is bipartisan; the USA Tax is proposed by Sens. Sam Nunn (D-Ga.) and Pete Domenici (R-N.M.). House Democratic leader Richard Gephardt of Missouri favors in principle the flat-tax idea, on which legislation is offered by several Republicans.

Most notable is Texas Rep. Richard Armey’s version, which would set personal and corporate income tax rates at 19% and eliminate all other taxes on interest and stock and mutual fund dividends.

The underlying idea is to get serious about boosting the U.S. savings rate, which at 4.9% of disposable income is by far the lowest among industrialized countries--Britain saves 9.8%; Japan is at 14%.

A necessary corollary of such tax-reduction plans is that the budget deficit be eliminated by 2002 or thereabouts.

Legislation that could pass next year would bring profound change to the global economy. Americans’ propensity to consume imported goods would be reduced; U.S. dependence on foreign capital would be eliminated.

Exactly what form tax legislation ultimately takes remains to be seen.

The dream, for instance, of a tax so simple that returns could be filed on a postcard contains potential nightmares.

Flat means no deductions--not even for mortgage interest. If every household’s tax shelter were suddenly eliminated, house prices would fall 25%, experts estimate. On the other hand, roughly $80 billion in increased tax revenue would flow to the U.S. Treasury--budget balancing must accompany tax reductions, after all.

Also, the tax exemption for interest on municipal bonds would go, a threat that already chills the market in which cities raise funds for public facilities.

And depreciation of corporate assets would be eliminated. Henceforth, corporate investments in equipment would be expensed in the same manner of accounting the government now uses with the federal budget. If that happened suddenly, an undepreciated total of $500 billion in corporate assets would have to be written off.

All of which only says that such big and complex ideas would have to be phased in gradually. It doesn’t say they’re bad ideas.

An immediate effect of the new tax structures will be to give a powerful boost to economic growth. Indeed, that’s counted on to help balance the budget and cope with knotty problems like the deficits in Medicare and Medicaid.

It has happened before. The tax reform of 1986 eliminated tax shelters and lowered income taxes to two basic rates, 15% and 28%. The reform’s opponents predicted economic collapse, and even supporters foresaw a “transition downturn,” notes Eugene Steuerle in his book “The Tax Decade.”

Instead, the economy jumped from a growth rate of 2.7% in 1986 to 3.4% in 1987 and 4.5% in 1988. “This growth occurred even while the budget deficit was declining significantly,” says Steuerle, a tax expert at Washington’s Urban Institute.

Tax simplification spurred the economy as much as tax reduction. The reform of 1986 eliminated a forest of tax rates and deductions. It cut the drag that complexity exerts on the economy, explains Lawrence Stone, a tax attorney at the Los Angeles firm of Irell & Manella. “It killed business for lawyers,” said Stone.

We face a similar problem today--a burden of record-keeping and bills for accountants and lawyers that Fortune magazine calculates at $593 billion. That’s one reason there’s momentum behind tax reform.

But if simplicity was so good, why did taxes get complex again? Because the economy made demands and legislators responded. The budget deficit remained a problem; there was a stock market crash in 1987. Congress raised some taxes, then made other adjustments year after year.

Taxes are not isolated phenomena, but silent partners to every business and individual. They reflect what society really wants to do--and if tax policy has changed often in recent decades, it’s because society has sought to cope with a changing world.

What doesn’t change is the percentage of income people pay. The late tax scholar Joseph Pechman of the Brookings Institution found that the burden of tax after deductions in any period ranges between 21% and 27% of income.

The important question for Pechman was the “incidence” of tax: Who bears the burden? Corporate taxes, Pechman found, got passed on to customers in price increases or to employees in wage reductions. The deductibility of interest spurred corporations to take on debt, which lowered their tax burden--but led in part to takeover mania in the 1980s. Tax consequences are often unintended.

Today corporate and individual finances are more intertwined than ever, in health insurance and pension accounts. For most publicly held U.S. companies, more than 60% of the stock is owned by pension funds. And that fact also pushes tax reforms that would increase pensions and savings.

Ironically, current tax debates are over credits for child care and capital gains tax cuts--items of complexity. Flat taxes could do away with both--eliminating income taxes for families with incomes below $36,000 and using only a single tax rate.

So what lies ahead? Passage of some form of savings-promoting legislation next year. Because the real dynamic of tax policy today comes from a bipartisan desire to save for retirement and to preserve the promise of the U.S. economy.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

A New Era?

A majority of Americans say they want to save more. . .

Survey responses to the statement “I am prepared to reduce personal spending now in order to save for retirement”:

Somewhat agree: 44%

Somewhat disagree: 33%

Strongly disagree: 7%

No answer: 6%

Strongly agree: 11%

Note: May not add up to 100% due to rounding

. . .and the ‘official’ personal savings rate is rising again. . .

Personal savings as a percentage of disposable personal income: