A Game New Plan On Taxes

By Stephen Koepp

Like Rocky Balboa, the movie boxer, the plan to change the federal tax system keeps coming back for more punishment. Just when the idea has been battered to the canvas, it struggles to its feet again. Last week reform went another round, this time energized by a fresh proposal from the House Ways and Means Committee. Some of the populist ideals found in the Reagan Administration's two earlier proposals remain alive in this one. The bill would cut tax rates, close loopholes, give relief to millions of working poor people and make corporations carry a greater share of the load. Many business leaders, though, claimed that the bill would single them out for unfair burdens. And the Reagan Administration added suspense by momentarily standing back from the debate while trying to decide whether to support the bill.

The reform effort began a year ago, when the Reagan Administration launched a bold plan, dubbed Treasury I, to overhaul the absurdly complicated and loophole-ridden income tax law. The President put his name behind another, more modest plan known as Treasury II last May and promoted it with whistle-stop tours around the U.S. But the tax-reform movement slowed to a crawl until a month ago, when Illinois Democrat Dan Rostenkowski, the Ways and Means chairman, started engineering the new proposal. "We have done," he boasts, "what many people thought couldn't be done."

Under the House committee bill, the average American would get a tax cut of about 9%, with smaller breaks going to upper-income individuals. Like the earlier two proposals, the new plan would reduce the number of tax brackets for individuals from the current 15, which range from 11% to 50%. But while Reagan's proposal had three brackets, 15%, 25% and 35%, the Ways and Means bill has a fourth, 38%, which would be for individuals with taxable income of more than $60,000.

Both the House committee and the Administration expect their reform plans to remove some 6 million people from the tax rolls. A husband and wife with two children would pay no taxes if they earned less than $13,100 in 1987, in contrast to $9,575 currently. The Ways and Means proposal would accomplish this partly by increasing the personal exemption from $1,080 to $2,000 for short-form filers.

The Ways and Means plan, though, differs dramatically from the Administration's in retaining some of Middle America's most hallowed tax breaks. One is the privilege of writing off mortgage interest on a second home. The Administration's proposal to limit that advantage stirred a ruckus not only from homeowners but from the building industry and mortgage lenders. Another break that Ways and Means restored is the deductibility of state and local taxes, which was stoutly defended by legislators from high-levy states. One congressional study estimated that the loss of deductibility would add some $1,600 to the average 1987 bill for about half of New York's taxpayers. The state's Governor, Mario Cuomo, hailed the new plan. Said he: "I am delighted. I will fight for the bill."

Any tax legislation requires minute scrutiny, and the Ways and Means plan had many minor and major changes in the fine print. The proposal would keep the top annual contribution for an Individual Retirement Account at $2,000, but it would reduce a taxpayer's IRA write-off by $1 for every dollar the person puts into a 401(k) plan, another popular tax-deferred savings plan. The committee felt the Government could recoup revenue by limiting how much money taxpayers put into both plans at the same time.

Charitable contributions would remain fully deductible for taxpayers who itemize, but those who use the short income tax form would not be allowed to write off the first $100 of their total donations. The Ways and Means plan would curtail some forms of trusts, making it more difficult for well-off parents to avoid taxes on income earned from money that they have passed along to their children.

If passed into law, the tax plan would probably tighten up loopholes first, then cut rates six months later. In the first year, tax breaks would be lost immediately but rates would be cut later, thus giving the Government more revenue. However, this means that many taxpayers, particularly wealthy ones, would not enjoy the full benefits of reduced taxes until the second year of the reform program, probably 1987 or later. Because the proposals have shifted during the past year, tax advisers have little specific advice to offer their clients at this point. But they generally tell taxpayers to make expenditures now, while some loopholes are still open, and defer income until late 1986 or 1987, when rates may decrease.

To illustrate the plan's impact, the accounting firm of Coopers & Lybrand did a study for TIME based on computer models of how some typical taxpayers would fare. A family of four in Moline, III., with a total income of $25,000 would pay $1,778 in federal taxes under the current law and $1,693 under the Ways and Means proposal. A young, single executive in New York City earning $25,000 would go from a current tax of $3,527 to $3,553. A childless couple in Los Angeles with a combined salary of $82,000 and rental income of $10,400 would experience a sizable tax increase, from $8,024 now to $8,502. A retired factory worker and his wife in Delray Beach, Fla., with pension and Social Security income of $18,000, who currently pay $445, would have no federal tax at all.

Many businessmen last week agreed with a blunt assessment by White House Domestic Policy Adviser John Svahn, who was quoted as calling the Ways and Means plan a "Thanksgiving turkey." While Reagan planned to increase business taxes by about $123 billion over the next five years, the Ways and Means proposal aims to boost that collection by an additional $15 billion. The U.S. Chamber of Commerce was so discouraged with the bill that it called for a postponement of any effort at tax reform for two years. "It has gotten too far from its original objectives, and it's time to put it aside," declared Richard Lesher, the group's president. "We're at the point of accepting the current tax code with all its flaws."

In some areas, the House panel's plan is the same as that put forth by the Administration. Both, for example, want to repeal the investment tax credit, which currently enables companies to take immediate deductions of as much as 10% of spending on plant and equipment. Both proposals would also curtail the accelerated cost recovery system, which now enables businesses to depreciate their assets rapidly.

Elsewhere, though, the Ways and Means plan gets tougher on businesses. While the Administration wanted to lower the maximum corporate tax rate from 46% to 33%, the House panel would drop it to 36%. The committee's proposal would raise the top tax rate for capital gains, which is the money that taxpayers earn on growing investments like corporate stock. Reagan's plan would have cut the maximum tax rate from 20% to 17.5%, but the new proposal would boost it to 22%.

Many business leaders charged last week that the committee's changes could hurt the economy by discouraging investment. Some of the loudest complaints came from manufacturing industries, which spend more than most businesses on new plant and equipment. Alexander Trowbridge, president of the National Association of Manufacturers, contended that the bill could "result in reductions of manufacturing capacity and employment" and pose "extremely high risks for the economy."

Other business people were more sanguine, though, especially those in industries where equipment costs are relatively low. These companies eagerly look forward to the lower overall corporate tax rates. "This is clearly reform," asserted John Bryan, chairman of the Sara Lee food-products company. "I can't imagine why anyone in America would not be in favor of it, except for those corporations that have been raiding the Treasury for years with their special preferences because they had high-priced lobbyists in Washington."

The big question now facing the Ways and Means version of the tax bill is how the Reagan Administration will react. Unless the President decides to push it through Congress, the proposal will languish as legislators deal with other pressing issues like the budget and trade deficits. The White House has so far postponed taking a stand on it. Reporters inquired about the President's attitude toward the plan last week, when he appeared for a holiday photo session with a 55-Ib. gobbler named Wilfred. Quipped Reagan: "The only questions I will take today are about the turkey."

Several of Reagan's advisers think the President should distance himself from the House panel's bill and let it die quietly. They oppose many parts of the legislation, including the new maximum tax rates for individuals and businesses. But many politicians think that Treasury Secretary James Baker, a noted pragmatist, will persuade the President to go along with the plan. Reagan wants to leave behind a legacy of tax reform, and the Ways and Means proposal is the only tax bill in town. If the President helps push it through the House, there is still an opportunity to make it more to his liking in the Republican-controlled Senate. "The Rostenkowski bill is not exactly what we wanted," says a senior Administration official, "but it keeps tax reform alive." The House floor vote, which is expected this month, will decide whether this Rocky can get through another round. --By Stephen Koepp. Reported by Christopher Redman/Washington

[This article contains a table. Please see hardcopy of magazine or PDF.]

Individual tax rates

15 tax brackets from 11% to 50%

4 tax brackets: 15%, 25%, 35%, 38%

Exemptions

$1,080 per person

$2,000 non-itemizers, $1,500 itemizers

Mortgage interest

Deductible

Deductible for 2 residences only

Income averaging

Yes

No

Medical expenses

Deductible above 5% of adjusted gross income

No change

Charitable contributions

Deductible

First $100 not deductible for non-itemizers

State & local taxes

Deductible

No change

Entertainment expenses

100% deductible

80% deductible

Business meals

100% deductible

80% deductible

Travel expenses

Deductible

No change

Income shifted to children through trusts

Permitted

Curtailed

Insurance benefits

Not included in taxable income

No change

Corporate tax rates

Graduated up to 46%

Graduated up to 36%

Investment tax credit

6% to 10%

Repealed

TIME Chart by Joe Lertola

With reporting by Reported by Christopher Redman/Washington