Wow! Real Reform!
By John S. DeMott
It all happened so fast. One minute, the long-cherished dream of streamlining and simplifying the cumbersome U.S. tax system seemed moribund, unable to withstand the hordes of lobbyists and influence peddlers arrayed against it. Then, shortly after midnight last Wednesday, the entire Senate Finance Committee was on its feet roundly applauding the chairman, Oregon Republican Bob Packwood. In the committee's offices down the hall, jubilant committee staffers uncorked a case of champagne. In an auditorium downstairs where the deliberations were heard on an intercom, an overflow crowd of lobbyists hissed.
Packwood, who until two weeks ago seemed the least likely champion of sweeping reform, raised his arms in triumph. Joining hands in the committee room celebration was an unlikely combination of allies: Russell Long, the shrewd Louisiana Democrat who for 37 years in the Senate has played the fine print of the tax code like a fiddler at a fais-dodo; Majority Leader Robert Dole, who once argued that tax reform was a lower priority than deficit reduction but who now promises to push through the measure on the Senate floor next month; and Bill Bradley, the New Jersey Democrat who for five years has been building the case for reform. Lobbyists representing interests ranging from real estate syndicators to restaurant owners vowed to descend on Capitol Hill to do battle. Acknowledging that brutal struggles lie ahead, Bradley, a former New York Knicks basketball star, warned, "Unlike many games I have played in, there are five periods. We've only finished the third." But even former skeptics were saying that reform now has the momentum. "Two weeks ago, tax reform was hanging by a thread," said Dole. "Now it's sewn up."
The Finance Committee plan would reduce taxes by an average of 6.2% for individuals by cutting their top rate from 50% to 27%, while eliminating or restricting most deductions. Increased standard deductions and personal exemptions would mean there would be far less incentive to itemize, thus greatly simplifying most returns. The top tax rate for business would be cut from 46% to 33%, but enough corporate loopholes would be closed to raise the total amount paid by business by about 20% in the first five years and keep the measure from losing revenue. Even if the committee's bill survives the upcoming battle on the Senate floor, it will still have to be reconciled with a version passed by the House last December, which also cuts rates and closes many loopholes but is less drastic than the Packwood plan.
Upon his arrival back in Washington after the Tokyo summit, President Reagan telephoned Packwood in Oregon, where the Senator was campaigning for his May 20 primary race. Said Reagan: "Your efforts moved us one giant step down the road toward meaningful, historic tax reform. We stand ready to work with you closely as your bill goes to the floor." In his Saturday radio address on the issue, the President declared, "America today stands poised to lift off into a new age of opportunity, powered by one of the most exciting economic changes | of my lifetime. Passed by an overwhelming 20-0 bipartisan vote, this proposal is really radical in scope."
What the committee did, simply, was approve the most sweeping overhaul of the tax system since World War II. The centerpiece is a reduction in the number of tax brackets: the current law has 15, ranging from 11% to 50%; the House-passed version has four, ranging from 15% to 38%; the Senate version just two--count 'em, two--of 15% and 27%. Although the plan has a complex method of phasing out the lower bracket as well as personal exemptions for wealthy families, which would cause the marginal rate (that paid on each additional dollar) on some of their earnings to be 32%, no one would ever owe more than 27% of their total income in taxes. That would be the lowest ceiling in half a century. The committee's staff figures that about 80% of the 96 million Americans who file returns would qualify for the 15% rate.
Even though the bill would eliminate or reduce a wide array of deductions (see chart), it reflects some of the caution learned during previous attempts at tax reform. It keeps deductions for state and local income and property taxes (though not for sales taxes). It also keeps deductions for mortgage interest on first and second homes and for charitable contributions made by those who itemize.
The bill would maintain so-called revenue neutrality by shifting about $108 billion in taxes from individuals to corporations during the next five years. In addition to ending such breaks as the investment tax credit, it would recover revenue from a stricter minimum tax of 20% on all profitable corporations. There is also a more stringent 20% minimum tax that would catch wealthy individuals who benefit from tax shelters. Gone too would be nearly all the gimmicky tax havens available chiefly to wealthy investors, who used them to translate paper losses into big tax savings.
The Packwood package is the latest in a long line of tax-reform proposals. The earliest two were Bradley-Gephardt (pushed by Democrats Bradley and Missouri Congressman Richard Gephardt) and Kemp-Kasten (pushed by two Republicans, New York Congressman Jack Kemp and Wisconsin Senator Robert Kasten). Then came Treasury I, a radical plan proposed in 1984 by then Treasury Secretary Donald Regan, followed by Treasury II, a modified approach sponsored by James Baker. After the House passed its own plan under the sponsorship of Illinois Democrat Dan Rostenkowski, the ball bounced to Finance Committee Chairman Packwood.
He seemed an unlikely radical. As he told a reporter early last year, "I kind of like the present tax code." While the House was debating its bill last December, Packwood kept slipping away from his office Christmas party to watch on television, hoping it would die. "We held our breath to the last minute," said one aide, "hoping something would go wrong." Packwood, like many members of the Finance Committee, has spent much of his 18-year Senate career stuffing the tax code with preferences for constituents, in his case Oregon's timber interests.
He says his thinking changed when he scanned the list of witnesses who appeared before hearings on tax reform earlier this year. "I thought, Is there a group in America that is not on this list? Is there anyone who does not have some piece of the action?" In fact, Packwood knew full well how bad the system was, and he had been the one opening the door to all these special interests during the markup of the bill. As a consequence, the plan had become festooned with $29 billion worth of tax breaks over five years, several of Packwood's own devising; $100 billion more were waiting for insertion. His loophole largesse prompted the New Republic to dub him "Senator Hackwood."
As chairman only since last year, Packwood did not want his leadership marred by this first big test nor to be tagged as the Senator who killed tax reform. So last month he slammed on the brakes by suspending public markup of the bill. That was to be the turning point. At lunch with Bill Diefenderfer, the Finance Committee's chief of staff, Packwood recalls, "We sat down and we kind of looked at each other and said, 'Why not? Let's go back to Bradley- Gephardt, which is square one. Let's lay it before them and see what happens.' "
What happened was, they found a core group of six Senators who favored the approach and signed on as godfathers. The group: Democrats Bradley, Daniel Moynihan of New York and George Mitchell of Maine, along with Republicans John Chafee of Rhode Island, John Danforth of Missouri and Malcolm Wallop of Wyoming. The earlier hearings, says Bradley, were part of an educational process: "Politicians are out for the free lunch, in this case lower rates with all the loopholes. You have to see you can't do that."
For more than a week, the committee met behind closed doors, barring all reporters and lobbyists and violating the Senate's open-meeting rules. At 8:30 | a.m., before the sessions began, the core group met in Packwood's office to plot strategy. Bradley, whose 1984 book Fair Tax is a forceful case for simplification, provided important support for the bipartisan effort. Working with them--and sometimes arriving at Packwood's office for private sessions even before the core group met--was Deputy Treasury Secretary Richard Darman. Mostly Darman listened. Sometimes, however, he made key suggestions, like ways to phase out tax shelters to cause the least resistance. Sensing that a dramatic breakthrough was possible, Darman passed up the trip to the Tokyo economic summit.
The breakthrough was a simple one, the kind that is at the heart of any real tax reform plan. Privately, several Senators told Packwood they would be willing to forsake their favored tax preferences if everyone else would do the same. "I'll give it a run and call their bluff," Packwood noted to Darman. It worked. A majority consensus was reached by Friday, May 2. When the bill was unveiled to the full committee last Monday, some members were surprised. Oklahoma Democrat David Boren, an ally of oil producers, complained that he had not been consulted. "You were not consulted," Packwood admitted as the television cameras rolled. "Many of the final decisions I made. I make no apologies. This was necessary in order to make things come out." In fact, to get the bill out did take a few last-minute concessions to Boren and his oil clique. A compromise was worked to keep certain gas and oil shelters at an additional cost of $700 million over five years.
By then a bandwagon effect had taken over. Said Packwood: "This bill went from immovable to unstoppable in 24 hours. Something came together, some chemistry." Said Moynihan: "There's a dynamic. Once you get eleven, you get 15." In fact, once they had 15, they had everyone. No member wanted to be on the losing side of a vote in favor of reform.
Various interest groups immediately predicted an economic apocalypse should the bill become law. The National Restaurant Assoc. claimed that its industry would lose $32 billion and 1.3 million jobs over the next three years if business meals were only 80% deductible. The real estate industry warned that removal of tax benefits for financing subsidized housing for the poor would cause a serious shortage of rental property.
Some Senators took up the cry. California Democrat Alan Cranston said the bill would be "anti-new business" because it taxes capital gains at the same rate as ordinary income and "extremely disruptive" because some of the tax shelter curtailments are retroactive. Other Senators vowed to make such changes as adding a higher bracket for wealthy taxpayers and preserving the deductions for IRAs. (The Packwood plan would continue to defer taxes on income from IRAs but would make future contributions deductible only for those who do not have a payroll pension plan where they work.)
Nevertheless, the realization seemed to be dawning that an overall lowering of rates might help the entire economy, even those industries ostensibly hurt by a loss of special treatment. Members of the Business Roundtable, an elite group of corporate cheiftains, expressed general support of the plan at their semi-annual meeting in Virginia this past weekend. John H. Bryan, chairman of the Sara Lee Corp. and of the Grocery Manufacturers of America noted that the plan would "build growth in the economy by giving the people money to spend and letting the free enterprise system allocate it." Oliver Carr, a Washington megadeveloper, said, "Most of the overbuilding around the country has been connected to tax breaks. We ought to let the money flow to where the real demand is." Argued Packwood: "Money is going to flow to its best use. You're going to buy a grocery store or a duplex because you think you're a good grocer or a good property manager, not because the tax laws favor them."
Likening the bill to a bear bouncing back and forth in a shooting gallery, Darman said, "There will be additional shots at the bear, but the bear will continue to move in the right direction." The most potent argument against too much tampering is the desire to keep the top tax rate at 27%. Some supporters hope to reach an agreement that will prevent any Senator from offering loophole-opening amendments without specifying how to make up for any revenues that might be lost. If a budget has been passed by then, such trade- offs would be mandatory under the Gramm-Rudman deficit reduction law.
Also working in favor of the bill is the fact that in an election year neither party wants to be tagged as the obstacle to tax reform. A new factor in the equation, television, may also help. Although an army of lobbyists will be following the bill closely, so too will many average taxpayers. On June 2 the Senate will begin allowing debates to be televised for the first time. Majority Leader Dole, who hopes to establish himself as a presidential contender, intends to bring the tax bill up that day, "right after the prayer."
CHART: TEXT NOT AVAILABLE
CHART: TEXT NOT AVAILABLE
With reporting by John E. Yang/Washington