Bill Me Later

By GEORGE J. CHURCH

October is supposed to be the month of reckoning for the Federal Government, as a new fiscal year begins and the budget is hammered out. In the next four weeks, Congress and the Bush Administration must raise the federal debt ceiling to $3.1 trillion, find a way to reduce next year's deficit -- on paper at least -- to $110 billion, and scrounge for funds to finance the drug war, educational reform and cleanups of the HUD mess and even of the storm-ravaged South Carolina coast.

Faced with such unpleasant responsibilities, what did Washington do? Once again, it lost itself in a politically irresistible orgy of tax reduction. By voting to fulfill George Bush's campaign promise and cut capital-gains taxes, House Republicans and renegade Democrats jumped at a short-term boost in revenues against a long-term loss. The giveaway fractured the foundation of the landmark 1986 tax-reform law. The drain on the Treasury could be compounded when the measure reaches the Senate, where it is expected to pass, and Democrats try to extend the tax breaks on individual retirement accounts. It seemed like a classic outbreak of "now-nowism," as Budget Director Richard Darman, who helped broker the deal, labels the nation's hunger for immediate gratification.

Early this year, the capital-gains cut looked like a pledge that could not be redeemed. It was one of the few campaign issues on which George Bush took a beating from Michael Dukakis; Bush's congressional allies introduced legislation, but with no real hope of passage. When the proposal began to gather surprising momentum, Democratic leaders denounced the idea as a giveaway to Bush's rich friends and thundered about a "defining issue" -- one on which Democrats should hold fast to demonstrate just what the difference is between their party and the Republicans. For Bush to prevail in the House, even assuming total G.O.P. support, he needed no fewer than 42 Democratic defectors.

But the vote last Thursday was not even close. The decision came on a Democratic alternative to the capital-gains cut that would have made tax- deductible IRAs available to more people, balanced by a tax increase on earners of the highest incomes. That proposal lost, 239 to 190. Bush bagged 64 Democrats, while only one Republican, Douglas Bereuter of Nebraska, voted for the alternative.

What happened? To House Speaker Thomas Foley, the answer was simple: Americans love a tax cut -- any kind of tax cut -- and the legislators reflected that feeling. Democrats contended, correctly, that 80% of the benefits from the capital-gains slash would go to people making more than $100,000 a year, 60% to those with incomes over $200,000. No matter, says Foley. Tell an ordinary taxpayer that he will reap $10 from a measure that will save the likes of Donald Trump an average of $25,000 a year, and the taxpayer will reply, "Fine. Give me my $10."

There were other reasons too. Bush undoubtedly swung some votes by last- minute lobbying. Many Congressmen bought the Administration argument that a tax cut would spur business investment, creating more jobs and prosperity for everybody. In theory the lure of a lightly taxed payoff will tempt investors to put up money for risky ventures. Economists have long disputed whether that is true, but it remains an article of faith among conservatives.

In addition, Georgia Democrat Ed Jenkins conducted two shrewd maneuvers in drafting a successful capital-gains compromise. First, he restored a special tax credit for the timber industry that was abolished by the 1986 Tax Reform Act. Jenkins represents a timber-heavy district, and his move won the votes of many legislators representing depressed lumber-producing areas. Jenkins also held out the seemingly magic lure of a tax cut that would increase revenue. At present, capital gains are taxed as ordinary income, at rates up to 33%. Bush initially proposed a permanent cut to 15%, but Jenkins substituted a reduction to an effective top rate of 19.6%, and only for the next two years. That is expected to increase federal revenues as much as $6.7 billion between now and 1991, as investors rush to sell appreciated assets and pocket the lightly taxed gains. That extra income could save Congress from voting for the painful spending cuts or unpopular tax increases that might otherwise be required in the next two weeks to meet the deficit target required by the Gramm-Rudman- Hollings law.

Making the tax cut temporary, however, would seem to take away much of the investment incentive that a permanent reduction might supply. Also, the Jenkins bill over ten years would cost an estimated $21 billion in lost revenues; though the rate goes back up in 1992, capital gains after that would be indexed for inflation, as income-tax brackets and personal exemptions now are. But who in Congress or the Administration cares about the long run?

The outcome was a heavy defeat for the new House Democratic leadership. Ways and Means Committee chairman Dan Rostenkowski looked particularly inept. He took a vacillating, off-again, on-again stand and eventually lost control of his committee. Majority Leader Richard Gephardt, also a member of Ways and Means, failed to recognize the strength of the drive for a capital-gains cut. Finally, but too late, he helped draft the Democratic alternative -- which combined deductible IRA contributions for everybody with an increase, from 28% to 33%, in the tax rate on people with incomes over $200,000 -- and took the lead in selling it as a matter of party philosophy. The capital-gains cut, he declared, was "designed to keep Leona Helmsley's dream alive -- that only the little people pay taxes." Republicans retorted, in effect, There you go again, proposing a tax increase. "Fish gotta swim, birds gotta fly, and Democrats gotta raise taxes" was the way one G.O.P. quip put it.

The biggest loser was the philosophy behind the Tax Reform Act, passed only three years ago with Ronald Reagan's support. The idea was to scrap a system of high tax rates riddled with special breaks, and substitute a simplified system of low rates made possible by wiping out hundreds of deductions and exemptions. That was supposed to promote fairness -- people with similar incomes would be taxed equally -- and make the tax code an instrument merely for collecting revenue rather than furthering economic and social goals. Treating capital gains the same as ordinary income was, in the words of New Jersey Democratic Senator Bill Bradley, a principal architect of tax reform, "the glue that holds the '86 act together."

President Bush never accepted that argument; he still believes that the tax code should promote social and economic goals. He told reporters last week, "I supported the tax-reform law, but in last year's campaign there were one or two areas where I felt that we needed to use the tax system to achieve various ends." Democratic leaders too have lost the faith; their proposed expansion of IRAs would also violate the no-special-breaks principle. Consequently, Congress can expect a flood of demands from other taxpayers who will claim that their income deserves special treatment. Writing in the Washington Post, Senator Bradley gloomily predicted that "the llama farmers, along with all the other dealmakers and tax-shelter merchants who had shut up shop, will put the OPEN FOR BUSINESS sign back in the window."

Prospects for reversing that outlook in the Senate are dim. Finance Committee chairman Lloyd Bentsen will try to stop the capital-gains cut by offering as an alternative broader IRAs, without any tax increase to make up the revenue loss. Failing that, some Democrats favor strategy to combine the capital-gains cut in a monster tax-and-spending bill with so many provisions unacceptable to Bush that he will be forced to veto it. That risks triggering the automatic spending cuts mandated by Gramm-Rudman-Hollings if there is no agreement by Oct. 16 to hold the deficit to $110 billion in the fiscal year that began Oct. 1. But those cuts could always be rescinded later. And if the budget deficit keeps rising? Don't think about it. The public, the President and Congress all seem sold on now-nowism.

CHART: NOT AVAILABLE

CREDIT: TIME Chart by Cynthia Davis

CAPTION: WHO STANDS TO GAIN

With reporting by Michael Duffy and Hays Gorey/Washington