Reagan's Second Front

By Ed Magnuson.

Already embattled on its budget plans, the Reagan Administration seems determined to wage a simultaneous economic war on an equally contentious front: tax reform. The President is preparing to unveil "Treasury II," a watered-down version of the Treasury Department's reform proposals of last November. The idea is to produce a simpler and fairer system while raising about the same amount of revenue. The method: eliminate many deductions and reduce overall tax rates. Reagan intends to give the latest reforms a big send-off with a national TV speech, just as he did, with mixed results, when he unveiled his budget.

The scent of reform is in the air on Capitol Hill as well. The leaders of the movement span the political spectrum. They include Senator Bill Bradley of New Jersey and Congressman Richard Gephardt of Missouri, both moderate Democrats, Senator Bob Kasten of Wisconsin and Congressman Jack Kemp of New York, both conservative Republicans. In the Senate last week, Finance Committee Chairman Bob Packwood began hearings on at least three different taxreform packages, predicting flatly, "There will be a tax-reform bill this year." If there is not, declared Delaware Republican William Roth, the committee's first witness, "we will have in this country the tax equivalent of the Boston Tea Party, except that it will be the politicians instead of the tea that gets tossed overboard."

TIME's latest Yankelovich poll shows that, by a 51%-to-17% vote, Americans support the general idea of a "flat tax." The reform concept is popular because, the poll shows, only 2% consider the existing tax system "very fair" and 24% view it as "not fair at all." When specific deductions are cited, however, such as those for home-mortgage interest, charitable contributions and property taxes, large majorities oppose any move to ban them. That, of course, is at the heart of the dilemma faced by the reformers.

The Treasury Department's original plan, produced largely by former Secretary Donald Regan, stirred such a flurry of objections that the President ordered up a revised version designed to retain many popular tax breaks. The work was overseen by the new Secretary, James Baker. Ironically, the changes were funneled to the President through his new chief of staff, Regan, who had switched jobs with Baker.

While Reagan had not approved all details by the end of last week, the outlines of Treasury II are beginning to emerge. As in the earlier version, the top tax rate will be 35% (rather than the current 50%). People will still be allowed to deduct the mortgage interest on their primary home, but the White House is considering limits on tax breaks for vacation houses. In another controversial move, Reagan is expected to call for the elimination of deductions for state and local taxes, including the property tax. Treasury I had proposed that workers must consider as taxable income various fringe benefits, such as health and life insurance; Treasury II will probably recommend that most such benefits escape taxation. Contributions to charities will remain deductible, but probably only if they exceed 1% of an individual's adjusted gross income.

The earlier version proposed treating capital gains as ordinary income and thus taxable at up to 35%. Treasury II would retain roughly the current rate for these gains, a maximum of 20% for individuals, and may even phase in more generous treatment later. Business leaders have been fiercely fighting to protect accelerated depreciation, which permits companies to take write-offs for new investments more quickly than those assets depreciate. The new plan will retain some form of speeded depreciation. In addition, the oil and gas lobbies are likely to win the retention of such tax breaks as oil-depletion allowances and fast write-offs for exploratory drilling costs. Despite corporate protests, however, the plan is likely to call for the elimination of investment tax credits, which provide special benefits to encourage the purchase of new equipment.

With tax reform being compromised and complicated in the face of special- interest pressure, some legislators have proposed a "minimum tax," from 15% to 25% of income, as a way to keep corporations (and perhaps some high- income individuals as well) from piling up deductions so that they pay no federal income tax at all. Many highly profitable corporations have been able to do just that. Still, most of the reformers consider this a cop-out that would hinder enactment of fundamental changes. As Bradley told Packwood's committee: "If we reform the system, we won't need a minimum tax." To adopt one, he claimed, would be "an admission of failure." The minimum tax, however, has won general approval in the Senate, which passed a nonbinding resolution endorsing the principle, and has some 55 sponsors in the House. The Administration may propose such a tax too.

The battle over tax reform and the minimum tax promises to provoke the most heated lobbying that Capitol Hill has seen in years, much of it aimed at protecting the myriad tax deductions enacted over the decades. But with the polls clearly showing that the people want a fairer and simpler tax code, the leaders of both parties seem eager to follow. Now that the President appears ready to join the battle, tax reform may never have a better chance of getting past the proposal stage.

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With reporting by Neil MacNeil and Christopher Redman/ Washington