Trading Breaks for Lower Rates

By Stephen Koepp

At first glance, tax reform appears to offer little to corporate America but a highly uncomfortable new burden. To finance lower tax rates for consumers, the conference committee boosted levies on businesses by $120 billion over the next five years. The new law will wipe out most of the special tax incentives and shelters that industries have lobbied for and protected for decades. Yet surprisingly, most corporate leaders applaud the reform, since they feel that in the long run they will benefit from a more efficient and vibrant, not to mention fairer, economy. Says Robert Silverman, president of Atlanta's Winter Construction, whose business is sure to feel the loss of tax preferences aimed at real estate: "It's wrong for my industry, but I think it's right for the country, and I'm for it."

The reform bill will reverse a 3 1/2decade trend in which businesses have been anteing up an increasingly slender share of the federal tax burden. From a postwar high of 34% in the early 1950s, the corporate contribution to the tax total dwindled to just 8.4% last year. It should now rise to about 13%. Yet the elimination of various loopholes will still allow the maximum tax rate for business to come down from 46% to 34%, enabling the companies that now pay the highest taxes to get substantial relief.

The reform bill should restore market efficiency to industries that have been artificially stimulated by tax rules that encouraged investors to fund money-losing propositions. The distorted sectors range from farming to housing to energy. Says Neil Harl, economics professor at Iowa State University: "It makes no sense whatsoever to be encouraging people to bring land into production right now, not when we're drowning in crops."

Tax reform may also help the economy get a boost from lower interest rates. Under the congressional measure's reduced maximum rates, many bond investors will be paying smaller tax bills, thus enabling them to accept lower returns. "Better interest rates could be the silver lining in the reform," says Jerry Jasinowski, economist for the National Association of Manufacturers, a group that is otherwise expecting taxes to rise for many of its members under the new plan. Any stimulative kick from interest rates would reinforce the boost supplied by the con sumer tax cut, which should give the average household 6.1% more to spend each year.

Yet the precise impact on the economy and even individual businesses remains uncertain at this point. "The tax code is so complicated and interacts with so many aspects of the economy that no one can really figure out what investments will be helped or hurt," says Barry Bosworth, an economist at the Brookings Institution.

Parts of the reform bill may dampen economic activity in certain sectors. Some corporate leaders worry about the reform's repeal of the venerable 6% to 10% investment tax credit for companies that buy heavy capital goods. They fear that the repeal could make it more difficult for industries like steel and machine-tool manufacturing to compete with overseas producers. Reform advocates respond that companies will gain other advantages from lower overall corporate rates. Declares Treasury Secretary James Baker: "U.S. corporations will have the lowest tax rate of any of our major trading partners."

The $68 billion-a-year commercial-real-estate industry faces some of the largest tax increases. Apartment and office builders, which now depend heavily on tax-shelter partnerships for investment money, will find it much harder to raise capital. The $84 billion restaurant industry may also suffer, at least temporarily, because the reform measure allows businesses to deduct only 80% of entertainment expenses, rather than 100%.

Elimination of the capital-gains break, which currently allows individuals to exclude 60% of their long-term profits when they sell stock and other equities, would remove an important tax incentive for those who seek to bankroll budding industrialists. Says David Bossen, president of Measurex, a Silicon Valley computer firm: "There will be no incentive to invest in risky young companies."

The 21% minimum corporate tax will make taxpayers out of dozens of large corporations that have managed to pay almost nothing in recent years. A study conducted for FORTUNE magazine by Tax Analysts of Arlington, Va., projects that under the new law Seattle-based Boeing would have paid 9.1% of its profits in taxes last year, rather than .1%. But even the beneficiaries of the old law seem willing to go along with change. Says J.L. Ketelsen, chairman of Houston's Tenneco, which has paid no corporate income taxes for several years: "We are an example of the need to improve the tax laws. Corporations with $400 million to $700 million of income should be paying taxes."

Many labor-intensive firms will come out ahead under reform's lower maximum tax rates. Chicago-based Hartmarx, a giant apparel manufacturer, would have paid 27.6% of its profits in taxes instead of 35.3% had the new law been in effect in 1985, according to Tax Analysts. The Gannett newspaper chain would have paid 29.9% instead of 38.7%; Kellogg, the cereal maker, would have been at 29.7%, not 38.6%.

For corporate America, regardless of the immediate impact on various bottom lines, the best news is that adoption of tax reform will put an end to nearly two years of uncertainty. Many companies have been postponing important financial investments while waiting to see what Congress would come up with. Says Richard Lindgren, president of Michigan's Cross & Trecker, a major machine-tool maker: "Once you see tax reform, you can figure out a way to live with it."

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With reporting by Jay Branegan/Washington, with other bureaus