Up Go the Trial Balloons

By GEORGE J. CHURCH

New tax and spending plans draw heavy fire

Taken together, the two plans would add up to as ambitious a domestic program as any U.S. President has ever proposed. If enacted, the sweeping tax reform outlined by the Treasury Department last week, and the draconian cuts in federal spending suggested by budget planners, would put Ronald Reagan's mark on the U.S. economy, and on American society, for a generation or more.

So much for theory. Now enter reality: the tax and spending plans look like two of the biggest trial balloons ever floated. It is all but impossible that either, let alone both, could get past Congress in toto, and President Reagan took care last week not to embrace officially a single one of the recommendations. He will listen to outraged screams from every imaginable lobby, from farmers to museum directors, before deciding which ideas to put forward as potentially salable, or at any rate worth a fight, in his State of the Union and budget messages early next year. After that, there will be a battle royal on Capitol Hill, with the outcome unpredictable. The tax and budget plans could set the terms for national debate over domestic policy for years into the future.

The tax plan, presented to the President and the press last week by Treasury Secretary Donald Regan in the form of a chart-studded, 262-page booklet (with two fat volumes still to come), puts more flesh than ever before on ideas that would-be tax reformers have been kicking around since the 1950s. It gives Americans their clearest idea yet of who might be helped and who hurt by a thoroughgoing rewrite of tax codes aimed at trading the elimination of most exemptions, deductions and preferences for deep slashes in tax rates.

The spending cuts, proposed by Budget Director David Stockman, were presented to Reagan in a thick loose-leaf book. Although the details were not made public, the outlines became clear after a series of high-level White House meetings late last week. The Stockman plan would demand sacrifices from a broad range of citizens in order to uphold Reagan's campaign pledge not to raise taxes, cut Social Security or countenance much slowdown in the U.S. military buildup.

Formally, the tax reform and budget-cutting plans have nothing to do with each other. On Reagan's orders, the Treasury designed the tax overhaul to be "revenue neutral." Though there would be major shifts in who pays how much tax (generally, individual taxpayers would pay less and corporations more), total revenue would be approximately the same as under present law. Thus the tax changes would supposedly have no effect on the budget deficit, now estimated at $200 billion or more for the foreseeable future; their justification is that they would make the tax system simpler and more equitable.

Stockman's spending cuts, in contrast, aim at slicing the deficit in half by fiscal 1988, to about $100 billion. Some White House officials are referring to the first-stage reductions, in fiscal 1986, as a "freeze," but that term is misleading. Total spending might be held to about the $968 billion now anticipated in fiscal 1985, which started Oct. 1. Within that total, though, outlays for Social Security, defense, interest on the national debt and some "safety net" programs for the poor would continue to rise. The increases would be balanced by deep cuts in everything from farm price supports to veterans' health benefits, and total elimination of such programs as operating subsidies for mass transit and federal aid for the construction of sewage-treatment plants.

But though their goals are quite different, the tax and spending plans are likely to be inextricably entwined. Both would profoundly affect the future growth of the U.S. economy, to the extent that many Senators and Representatives of both parties doubt that they can or should be considered separately. Says Missouri Republican John Danforth, a senior member of the Senate Finance Committee: "Unless tax simplification is linked to raising revenues and is put together with budget cuts, you're not going to have a package."

The proposals are alike in another way: they constitute a headlong assault on every special interest, and some not-so-special interests, represented in Washington (see box). An aide to Democratic Senator William Proxmire enumerates some of those who have expressed opposition to the tax plan: "Organized labor, banks, the life-insurance industry, charities, colleges, state and local governments, aerospace companies, chemical companies, metal-fabricating firms, railroads, airlines, utilities, real estate groups, oil companies, restaurants and hotels, credit-card companies, stock exchanges and credit unions." That list does not include the well-financed and deeply entrenched lobbies, representing veterans, farmers and teachers, among others, which are likely to unite against the spending cuts.

On the tax side, though, the Administration is picking up some oddly assorted allies. Treasury Secretary Regan boasted last week to White House Chief of Staff James Baker, "The Consumer Federation, who are as left wing as they get, and the National Taxpayers Union, who are somewhere to the right of Genghis Khan, are going to appear together to support my proposals." Indeed, the plan is reversing some usual political alignments. J. Hugh Liedtke, chairman of Pennzoil and a staunch Reaganite, declares, "The Treasury proposals are diametrically opposed to the general thrust of President Reagan's philosophies and policies as we understand them." Robert McIntyre, an official of the liberal Citizens for Tax Justice, remarks ironically that Reagan "now has a tax plan that John F. Kennedy, Harry Truman and Franklin Roosevelt would be proud of."

A rundown on the two plans:

Taxes. Presidents, economists and ordinary citizens have complained for at least a decade that the income tax code is hideously complex and often unfair. In his State of the Union address last January, Reagan asked Treasury Secretary Regan to suggest by December a thorough rewrite that would simplify the tax code and reduce tax rates. The President later made it clear that the reform should neither raise nor lower the total tax burden. A working group of nine department executives, assisted by 30 tax lawyers, 30 economists and a support staff of roughly 40, began meeting several times a week. Crunching numbers through the night toward the end, the team produced a plan that would constitute the most complete revision of income taxes at least since World War II, and perhaps ever. The guiding principle: reduce tax rates for everybody, but apply those reduced rates to vast amounts of income that is now excluded from taxation. Details: > Individual taxes. The present schedule of 14 income brackets for joint returns, taxed at rates ranging from 11% to 50%, would be replaced by just three rates: 15% on taxable incomes up to $31,800 a year; 25% on incomes between $31,800 and $63,800; 35% on anything higher. Personal exemptions would be roughly doubled to $2,000 each and the "zero-bracket amount" (the sum, equivalent to the old standard deduction, on which no tax is due) would rise from $3,710 to $3,800.

End of good news. The 35% of all taxpayers who now claim itemized deductions would lose many of them. No deductions would be permitted for state and local income, sales or, in most cases, property taxes. Charitable contributions could be deducted only to the extent that they exceed 2% of adjusted gross income (charities figure the average deduction is now 1.97%). Interest would be fully deductible only on a mortgage for a primary residence; deductions for other types of interest--on second-home mortgages, auto loans, personal loans--would be limited to $5,000 in excess of investment income. Thus a taxpayer who received $1,000 in dividends or interest on savings accounts could deduct up to $6,000 of interest payments, but no more. The $1,800 deduction for two-income families would be repealed, which critics charge amounts to reinstituting the notorious "marriage penalty." The Treasury replies that most married couples would save on taxes anyway because of lower rates.

On top of that, individuals would pay tax on many benefits not now counted as "income." Workers would be taxed on any contributions that their employers make to group-term life insurance plans, and on employer contributions to hospital-medical plans that exceed $70 a month for single people and $175 for families. The Treasury estimates that about one-third of all workers covered by such hospital-medical plans would be affected. Every dollar of unemployment compensation, and in some cases portions of workers' compensation payments and miners' black-lung benefits would be subject to tax. Even housing allowances that church congregations grant to their ministers would be taxed.

The upshot: by 1990, when all provisions would be fully in effect, the Treasury estimates that individual taxpayers collectively will pay $38 billion, or 7%, less than they would under present law.

Some 56% of the nation's 91.4 million families would get a tax cut, 22% would pay about what they do now, and 22% would be taxed more heavily. The reductions would be largest for low-and middle-income taxpayers. Treasury Secretary Regan boasts that the truly poor would be "exempt from taxation." For a family of four, the combination of higher personal exemptions and an increased zero-bracket amount would eliminate taxes on 1986 income under $11,800--$200 above the poverty line.

But most tax cuts would be 2% or less, and in every income bracket at least a few families would be hit harder.

Though the Treasury Department says most of the increases also would be minor, skeptics have grave doubts. New York Governor Mario Cuomo figures the average Empire State family that now itemizes deductions would lose $2,400, mostly because of the phasing out of deductions for state and local sales and income taxes.

> Business taxes. The tax rate on corporate profits would drop to 33% from the present 46%. For many companies, however, that provision would be far outweighed by the loss of two big breaks. They could no longer reduce their tax bills by an amount of up to 10% of what they invest in new plant and equipment. And they could not depreciate existing plant and equipment at accelerated rates; they would be limited to deductions representing the actual rate at which assets wear out, plus an allowance for inflation in the cost of replacing those assets.

In addition, many special tax breaks now enjoyed by the oil and banking industries would be wiped out. The Treasury plan even takes a swipe at the fabled three-martini lunch: business meal deductions would be limited to $10 a person for breakfast, $15 for lunch and $25 for dinner.

Sniffed Andre Soltner, owner of Lutece, a four-star restaurant in Manhattan: "You can't come in here at lunch for $15."

By 1990, total taxes paid by business would rise by $45 billion. That would be a net tax increase of 24%, further reversing a long trend. The corporate tax share of federal revenue dropped from 19.5% as recently as 1969 to a mere 6.2% in 1983, and is estimated at 8.5% this year. Under the Treasury proposals it could be expected to rise further.

The Treasury team did not originally set out in this direction. But it was boxed in by Reagan's orders. If taxes on individuals were to be reduced on balance, yet total collections held even, business was the only place to get the money. The team also concluded that the present tax system favors some companies, mostly in "smokestack" industries such as steel and autos, at the expense of others, such as retailers, service industries and fast-growing high-technology corporations, that have less investment in plant and machinery and thus less chance to reduce taxes. An example of the disparity: General Electric paid no federal income tax between 1981 and 1983; indeed it collected $283 million in net tax refunds. IBM during the same years paid almost $4 billion in taxes, equal to 28% of its net income.

> Investment taxes. Both individuals and corporations would pay taxes at full ordinary-income rates on profits on the sale of stock, real estate or other assets (less an allowance for inflation) regardless of how long the assets had been held. At present, only 40% of such capital gains on assets owned for six months or more is subject to tax. Also, the Treasury promises an all-out attack on tax shelters, which allow investors in many oil, real estate and agricultural ventures to deduct accounting "losses" from other income.

The Treasury claims enormous benefits from all this: equity (both corporations and individuals would be taxed equally on equal amounts of income), simplicity (Secretary Regan distributed a revised Form 1040, with 55 lines, 13 fewer than in the present version), and faster economic growth (because investments would be channeled into the most productive activities, rather than those that are most lightly taxed). Yet the Administration appeared astonishingly diffident toward its own initiative. President Reagan issued a written statement asserting that "at first glance" the Treasury plan appeared to fulfill his goals. But he stated that "all of us will need time to study the entire document. We are willing to listen to the comments and suggestions of all Americans and especially those from the Congress." Aides insisted that this tepid response was part of a calculated strategy to sniff out public sentiment before deciding how, and how rapidly, to proceed. In other words, the plan is, precisely, a trial balloon. And nothing more.

To many members of Congress, the balloon seems filled with lead. They are loath to brave the wrath of the many constituents who would be hurt by the plan for the sake of a reform that does nothing to shrink the shockingly menacing deficit. Many would prefer to use tax reform as sugarcoating for a net tax increase, but that approach would clash head on with Reagan's diehard opposition to any overall tax boost. Consequently, Robert Dole, newly elected majority leader of the Republican-controlled Senate (see following story), gently told the White House that Congress would probably give "No. 1 priority" to deficit reduction.

Spending. Reaganauts are agreed on their goal: to reduce the deficit from the current 5% of gross national product to what is regarded as a manageable 2% of G.N.P. in 1988. With tax increases ruled out by the White House and the economy now in a slowdown, precluding a rapid expansion of revenues at present tax rates, there is only one means to dry up red ink: spending cuts even more drastic than the Administration won in 1981. Stockman's recommendation, faced with these all but absurd options, was to slash estimated outlays by $45 billion the next fiscal year, $85 billion in 1987 and $110 billion in 1988.

The Budget Director has proposed reductions in Medicare, Medicaid, farm subsidies veterans' benefits, civil service retirement programs and grants to states and localities for such purposes as education and urban development. A slew of programs and agencies--some of debatable value, some of remarkable worth--would be consigned to oblivion: the Job Corps, the Small Business Administration, the Export-Import Bank, subsidies to Amtrak. Also, the Reaganauts are considering a genuine freeze on cost of living increases in many benefit programs other than Social Security.

Reagan has insisted on a line-by-line review of Stockman's proposals, asking questions when he is dubious, signifying agreement mostly by keeping silent. At one meeting last week Stockman suggested a cut in federal aid to public libraries. A senior White House aide questioned whether Washington should be subsidizing libraries at all. Reagan indicated by silence that he shared the doubt, and library assistance was added to the list of programs facing total elimination.

The big hang-up is on military spending. Stockman wants a reduction of $10 billion in the requested appropriation for fiscal 1986, $20 billion the following year and $30 billion in 1988. Secretary of Defense Caspar Weinberger adamantly insists on a $333 billion request for 1986, which would be a 7% increase after adjustment for inflation. At a Thursday meeting in the White House, House G.O.R Leader Robert Michel and Nevada Senator Paul Laxalt got into what a Reagan aide described as a "heated" exchange with Weinberger. The lawmakers' point: Congress will not buy civilian spending cuts of anything like the depth the Administration desires unless the Pentagon shares in the sacrifice.

The White House wants to put all the budget cuts into a single gargantuan bill for one yes-or-no vote. The aim would be to throw down this challenge to the Democrats who control the House: You have been screaming about the deficit; here is your chance to do something about it. Democrats, predictably, are resisting. They talk of submitting each cut to a vote "on its merits," a process that would doom many of the proposals.

On taxes, the initial challenge is Reagan's. He must make up his mind what he wants and then fight for it. Treasury Secretary Regan gently prodded his boss in that direction, stating in a letter to the President that "the achievement of fundamental tax reform . . . will require extraordinary leadership." Congressional leaders put the point more emphatically. Said House Budget Committee Chairman James Jones, an Oklahoma Democrat: "Tax reform or any kind of tax bill is unlikely to succeed unless the President puts all the force of his personality and office behind it." Democrats also insisted that if Reagan expects to get much in the way of either tax reform or spending cuts, he will have to swallow a revenue increase through tax increases. Said Dan Rostenkowski of Illinois, chairman of the tax-writing House Ways and Means Committee: "This revenue-neutral business is pure fantasy."

Once the battle is joined, there will probably be a series of complicated tradeoffs between tax changes and expenditure reductions lasting not only through 1985 but for some years beyond. The Administration's plans, whatever they finally turn out to be, will probably be too sweeping, and will raise too many philosophical and political issues, to be resolved in one year.

Instead, taxes and spending may remain domestic Topic A throughout Reagan's second term, and perhaps even longer than that.

--By George J. Church. Reported by Gisela Bolte and Christopher Redman/ Washington, with other bureaus

With reporting by Gisela Bolte, Christopher Redman