Tilting At Tax Reform

By Evan Thomas

The Internal Revenue Code is 2,052 pages long. To create it took decades of late-night horse trading, millions of pages of expert testimony and billions of dollars in political contributions, often pledged after (taxdeductible) three-martini lunches. To understand it requires the services of a well- paid lawyer. To reform it demands a monumental effort of political will.

For Ronald Reagan, the consummate salesman, tax reform promises to be the hardest sell of his presidency. This week he will launch a ballyhooed campaign to convince Congress that political salvation lies in rebuffing the swarms of special interests whose loopholes now ventilate the tax code. His method of persuasion, as ever, will be to preach over the heads of Congressmen to the voters who elect them.

In a nationwide television address Tuesday night, Reagan will grandly present tax reform as the final battle of what he calls "the Second American Revolution," his crusade to whittle down Big Government and spur opportunities for growth. He will hammer his message all week long at a series of photogenic forums, including a ceremony honoring the drafters of the Declaration of Independence, in Williamsburg, Va.

The package he will unveil, though already frayed by the persistent chafing of special interests, is still highly ambitious, at least when measured against the cautious norms of political reality. By closing or narrowing a raft of loopholes, it would simplify the tax code and allow reduced rates without loss of revenue to the Treasury. Most taxpayers would shell out less, the President will emphatically advertise, while businesses and the wealthy would be stripped of shelters that now reduce or even eliminate their tax burden. The top rate would drop from 50% to 35%; middle-income taxpayers would pay 25%, and those with lower incomes 15%. The personal exemption for every taxpayer would nearly double, from $1,040 this year to $2,000 as early as 1986.

By launching a high-visibility crusade for tax reform, Reagan hopes to regain his political momentum and divert attention from a series of setbacks that began with his trip to the grave sites of Nazi soldiers at Bitburg. Congress is proving increasingly contrary: the House last week roundly rejected his compromise budget plan, restoring Social Security increases and cutting defense. Says one top aide: "If we didn't have a tax-reform project, we'd need to create one, just to get the President out on the offensive."

Indeed, winning the tax-reform battle would forever make mythic Reagan's political touch. But if the rewards for the President are great, there are certainly risks. Losing could stamp him as a feckless lame duck. And at this point, failure is at least an even bet.

But either way, the long-term political benefits that could result from simply proposing a tax-reform plan are significant. By casting the Republicans as the party that defied the special interests for the benefit of the ordinary voter, Reagan hopes to re-establish the G.O.P. as the majority party for the first time in more than half a century. Optimistic Republican strategists believe they can finally rid the party of the country-club conservative label that has clung to it since the days of Coolidge and Hoover. "The President has in his hands the weapon with which to forever dismantle the New Deal coalition," exults New Right Strategist Richard Viguerie.

To pass tax reform will take a bipartisan push. Understandably, however, Democrats are not eager to relegate themselves to minority status by handing Reagan the fairness issue, which was the Democrats' best -- some would say only -- hope in the past two elections. Says Congressman Dan Rostenkowski, the Democratic chairman of the House Ways and Means Committee: "I'm not going to be the Republicans' Colonel Bogey, building a bridge over the River Kwai for the enemy."

Although caught somewhat flat-footed by the Republican embrace of an issue they hoped to make their own, Democrats can hardly afford to oppose tax reform merely out of political spite. Instead, they have begun to denounce Reagan's proposals as not being bold enough and as containing too many concessions to Big Business and Big Oil. "Our President sold out to special interests," charges Democratic Congressman Leon Panetta of California.

The package Reagan will announce this week retreats substantially from the far more ambitious plan, known as Treasury I, floated by then Secretary Donald Regan last November. The new version restores incentives for oil and gas exploration, deductions for charitable contributions and fast write-offs for business investment. It even lowers the maximum capital gains rate from the current 20% to 17.5%. "At this rate, within a few weeks there will be no tax reform left," Democratic Congressman Fortney Stark of California told the Wall Street Journal. Warming to the rhetorical challenge, he added, "It will just be a torn carcass that will have the sad, sour reek of good intentions made rotten by special-interest greed."

For all their carping about givebacks by the Reaganauts, the Democrats are not likely to restore them on their own initiative. "Their starting point is the best we can do," says Missouri Congressman Richard Gephardt, the leading Democratic tax reformer in the House.

To keep tax reform "revenue neutral," meaning it neither adds to nor subtracts from the present tax intake, the funds lost from loopholes being restored and from the large increase in the personal exemption will have to be replaced from other sources. "When you give that stuff back, you've got to get your rates up," says Gephardt. "The whole idea is to get the rates down." The proposed maximum rate of 35% is too high for some Republicans, including New York Congressman Jack Kemp, who favors a top rate no higher than 30%. "I am opposed right now to Reagan's plan," says Kemp, whose defection would be a major blow to the Administration.

Without some concessions to powerful lobbies, argues Treasury Secretary James Baker, the tax-reform bill would be "dead on arrival" on Capitol Hill. In addition, the White House defends its concessions on their merits. The President's aides argue that allowing businesses accelerated depreciation on the cost of new investment promotes growth, encouraging oil exploration with tax breaks enhances national security by reducing dependence on foreign oil.

Effective lobbyists, naturally, can offer credible policy arguments for almost any tax break. Under current law, for instance, apartment builders can quickly write off the cost of construction, particularly for low-income apartments, and deduct their property taxes. By cutting back these tax breaks, the Administration would drive up the cost of building and owning apartments, and consequently drive up rents as well. Taxpayers can now deduct state and ; local taxes from their federal returns. To the outrage of politicians from high-tax states, this break would be wiped out by the Reagan plan, thus saving the Treasury $22 billion a year. By delivering "a really crushing blow" to New Yorkers, charges Governor Mario Cuomo, Reagan is attempting "governmental euthanasia."

Having secured many concessions from the Administration, the business lobbyists who have been so successful in the past at leaving their Gucci- prints on obscure passages of the tax code are now storming Capitol Hill. They are handing out political-action committee checks (last year: $74.3 million for the House alone) and collecting IOUs. "You're looking at an awful lot of deals, and an awful lot of fund raisers, before you see any kind of tax bill," warns Panetta. By the time Congress finishes weighing the reasoned arguments of all the different lobbyists, as well as their PAC contributions, there may be little left of Reagan's original bill.

Many Congressmen would just as soon lower their sights to an easier target: a minimum tax on corporations and individuals. It would appeal to voters outraged by large corporations that pay no taxes (128 out of 250 large corporations in one study), and by wealthy individuals whose lawyers manage to shelter their income altogether (some 9,000 millionaires). A minimum tax of 20% for individuals and 15% for businesses is already on the books, but it is so riddled with exceptions that it covers only 0.3% of U.S. companies and 0.1% of individuals. Reagan's plan would ensure that both corporations and individuals pay a 20% minimum.

A minimum tax offends the tax-reform purists, who argue that it would leave the tax code just as complex and contorted, although perhaps a bit less egregiously unfair. "The weeds would be topped," says Rostenkowski, "but the roots would remain." Indeed, some see a minimum tax as a cynical ruse to avoid real tax reform. "Want to see a specialinterest lobbyist grin over his three-martini lunch?" scoffs a report released last week by the House Republican Conference. "Threaten him with a corporate minimum tax."

A minimum tax alone, without any other tax reform, would have the attraction of generating additional revenue to cut the deficit. To congressional leaders who are more worried about red ink than reform, a tax increase cloaked as tax reform has great appeal. Though few will come right out and endorse a minimum tax at this stage of the budget process, congressional leaders are not + disavowing such a strategy either. "It's a live option," says Senate Majority Leader Bob Dole, whose own aspirations for the White House are tied closely to his effort to slash the deficit.

Ultimately, a minimum tax could provide the compromise solution to a confrontation over the budget. Both Senate and House have made respectable stabs at cutting spending by approving budgets that would save $56 billion next year (leaving the deficit at a still staggering $170 billion), but they did so in different ways. The Senate cut social programs and imposed a one- year freeze on the cost of living increase for Social Security while preserving an inflation hike for defense. The House last week voted for a package that makes fewer cuts in social programs and none in Social Security, but freezes defense spending. Reconciling these differences at a House-Senate conference will be difficult, and each side might be tempted simply to give in to the spending desires of the other. A minimum tax could accommodate the Senate's desire to keep up defense spending and the House's interest in maintaining social programs. A major obstacle to this scenario: Reagan's vow that any attempt to raise taxes would prompt a veto and "make my day."

If the President fails to get tax reform this year, he may have an even harder time in 1986, when election-year politics can tend to send Congressmen scurrying for cover. The real support for tax reform just might have to come from the hustings. Not until Congress feels more pressure from voters to close loopholes than it does from special interests to create them will tax reform succeed. By throwing his immense prestige behind the cause, Reagan may have elevated tax reform from the empty promise of party platforms to a true litmus test for congressional candidates. Conceivably, both parties could even find themselves competing for the high ground of reform, engaging in a refreshing contest over which is better able to resist the special-interest pressures that created all the loopholes and complexities in the first place.

With reporting by Christopher Redman and Barrett Seaman/Washington