Slowing the Surge of Red Ink

By GEORGE J. CHURCH

The new tax bill affects smokers, drinkers, even phone users

It was called a $50 billion tax increase, and was designed in combination with spending cuts to lower U.S. deficits by $63 billion over the next three fiscal years. But if the truth-in-packaging law applied to legislation, the bill that passed Congress last week at President Reagan's urging would have to carry a different label. Something like "a bill to raise revenues largely by blocking extensive tax changes, and thus to make deficits get worse more slowly, assuming some guesses turn out right."

Perhaps the truest identification, however, would be the "Economic and Political Damage Control Act." Economically, the bill is supposed to slow the tide of red ink, before the pressure of that tide pushes interest rates to heights that could damage the nation's robust economic growth. Politically, the bill will enable both Reagan and his Democratic opponents to claim that they took the first, indispensable, though concededly inadequate, steps to control deficits, while still deferring any really painful decisions on taxes and spending until after this year's elections.

To that end, the bill was artfully designed during months of negotiations between the White House, the Republican-controlled Senate and the Democratic-controlled House; it was put into final form by conferees led by Kansas Senator Robert Dole and Illinois Congressman Dan Rostenkowski. Though the bill will have some effect on everybody who drinks whisky, smokes cigarettes, collects savings-bank interest or even makes a phone call, it raises revenues largely in ways that many individual taxpayers will never notice.

Indeed, the bill contains only a few outright increases in taxes. Three important ones: The federal tax on diesel fuel goes up 60 per gal., to 150. Owners of factories, stores, office buildings and other structures used commercially will be forced to take smaller depreciation deductions and will thus pay more to the Internal Revenue Service. So will some people who earn widely fluctuating incomes; the rules under which they can average the high earnings of a fat year with the low incomes of lean years for tax purposes will be tightened.

Many of the big revenue increases result from the repeal or postponement of pending tax cuts from earlier legislation. The 3% federal levy on telephone bills and present tax rates on inheritances, gifts and "windfall" oil discoveries will all be kept for at least three more years. Under old law, beginning in 1985 savers would not have been taxed on 15% of their net interest income up to a maximum of $450. Now they will lose that break. On the whole, says one Administration official, the bill "is not so much a tax increase as an averting of tax losses."

Still, there will be some new tax losses.

Lobbyists swarmed around the bill and exerted pressure that led to contradictory results in the case of so-called sin taxes. Taxes on distilled liquor will rise by 340 on an 86-proof fifth, but cigarette taxes will be cut in half, to 80 a pack, as previously scheduled. House tax writers had sought a smaller reduction, but they lost out to a tobacco lobby that was strongly seconded by North Carolina Republican Jesse Helms, who is running for re-election to the Senate. Securities firms won a big break for investors. For the next two years they can sell stock, real estate or other assets that they have held for six months, vs. one year under present law, and pay only a low long-term capital-gains tax (top rate: 20%) on the profits.

Whether this jumble will really yield the purported $50 billion in net additional tax revenue is subject to doubt. The bill contains scores of highly technical provisions that are supposed to close loopholes and tear down tax shelters. Two examples: businesses will be allowed smaller deductions on luxury cars they buy or lease for executive use, and individuals will not be permitted accelerated business deductions on computers they employ primarily for figuring out their personal finances. But past experience indicates that sharp-eyed lawyers and accountants can find new dodges inadvertently created by tax-law language designed to close old loopholes. Says one expert at the Office of Management and Budget: "Some of these figures are unavoidably flaky."

The $13 billion in spending cuts contained in last week's bill is dubious too. About half is to be taken out of Medicare (see box). But much of the rest reflects a shaky guess as to how much interest the Government might be able to save on future borrowings. Says a Government analyst: "All we can legitimately say is that without this package the deficit would be a lot higher. How much higher? Who knows?"

In fact, how much deficits can be held down depends less on the effect of last week's tax and spending legislation than on what Congress finally decides to do about military outlays. Both chambers agree that defense expenditures in the next three years must be held below the roughly $1 trillion that Reagan's budget plan originally called for, but the Senate projects only a $40 billion saving with the President's grudging agreement. House Democrats are calling for a $96 billion defense cut, and for a while last week threatened to vote down an urgently needed increase in the national-debt ceiling unless the Senate gave in. Faced with the prospect that the Government would grind to a halt during the three-week congressional recess, the Democrats eventually relented and went along with a $53 billion debt-ceiling increase, raising the figure to an almost unimaginable $1.6 trillion. Even this will allow the Government to borrow only enough to pay its bills through August.

Government borrowing must increase because under most projections the deficit will continue to go up. Recalculating the figures after last week's tax changes and spending cuts, and assuming a roughly halfway compromise on military outlays, congressional budgeteers now predict $174.2 billion of red ink in fiscal 1984, which ends Sept. 30. That would swell during each of the following three fiscal years, to $201.2 billion in 1987. How then can anyone talk about deficit "reduction"? Only by calculating that if nothing were done, the gap would yawn even wider, to $269 billion three years from now.

Borrowing to cover the deficits, in addition to the current surge of credit demand from business and consumers, already seems to be pushing up interest rates. Banks last week raised their basic lending charge half a point, to 13%; it was the fourth increase in as many months, and boosted the prime rate to its highest level since October 1982. White House aides privately expect one or two more rises before the election, and Treasury Secretary Donald Regan concedes that if the prime rate "rises much more, it could be very harmful." The damage would be done by choking off sales of goods that are bought mostly on credit, above all houses and autos.

Happily for the economy, and for Reagan, there are few signs of a fall-off yet. Quite the contrary; auto sales are the highest since 1978, and production of all goods and services in the first half of 1984 rose at the swiftest pace in 34 years. The general outlook for the rest of the year is for a slowdown to a more sustainable rate of growth, accompanied by some further declines in unemployment, which has fallen from 10.8% in December 1982 to 7.5%. Most surprising, there has been no increase in inflation of the type that usually accompanies such a boom. The nation's broadest price index, the so-called G.N.P. deflator, rose at an annual rate of 3.9% in the first quarter, but only 2.8% in the second.

"We have a solid recovery that is going forward without a renewal of inflation," said the President, setting the theme for his campaign oratory. The White House will mention the deficit only when it cannot avoid doing so, then claim somewhat dubious credit for getting a start on controlling it and pledge "to reduce the deficit even more in 1985," as White House Spokesman Larry Speakes puts it. The President evidently feels no embarrassment about agreeing to, and even urging, a second round of tax changes (the first round came two years ago) that take back some of the reductions enacted in the sweeping bill he pushed through Congress in 1981, though a few of his supply-side supporters have raised philosophical objections. Democrats contend that the 1981 tax cuts went much too far and, combined with huge increases in military spending, are the principal reason for the huge deficit. During the campaign they will hammer on the theme that the deficit and interest rates are "ticking time bombs" set to blow up under the economy, in the words of Walter Heller, former economic adviser to Presidents Kennedy and Johnson.

So far that line has failed to make much impression on voters, who either ignore the deficits or regard them as an incomprehensible subject remote from their Olives. Says Savannah, Ga., Mayor John Rousakis: "The majority of Americans are not concerned about the deficit because they don't see it affecting them on a day-to-day basis." Democratic Congressman Matthew McHugh confesses inability to get his fiscally conservative constituents in up state New York excited about the problem. Says he: "Once you start to explain the details, people's eyes begin to glaze over."

These citizens are likely to get a rude jolt after the election. Whoever occupies the White House will have to work with the newly elected Congress to shape some genuine, and painful, tax increases and serious cuts in spending. The alternative is to take the risk that the ticking time bomb might really go off.

-- By George J. Church.

-- Reported by Laurence I. Barrett and Christopher Redman/Washington

With reporting by Laurence I. Barrett, Christopher Redman