TAX CUTS

By Richard Lacayo

SLASH IT, CUT IT, SHUT IT DOWN. The raging rhetoric in Washington's budget battle has revolved mostly around government spending cuts: who must take the pain, and how much of it. But as the dealing moves into what may be the final stages, the other side of the balance sheet--taxes, specifically tax cuts--has become just as contentious a battleground: who will get the payoff, and how much of it. With both sides closing the gap between their spending plans, the focus will turn to the proposed $245 billion G.O.P. tax reduction and Bill Clinton's $98 billion counter.

Either you love them or you hate them. For the G.O.P., they are sacred. "The tax cut is the glue that holds together the coalition that balances the budget," says House Speaker Newt Gingrich. Yet to purist budget balancers, the cuts are heresy. "We see tax cuts as demagoguery. They take the public's mind off the real issue of sharing the sacrifice," says Michael Holtzman, director of the New York office of the anti-deficit Concord Coalition.

Of all the principles at stake in the fight to balance the budget, there may be just one that neither Republicans nor Democrats dare to abandon: the pleasure principle. It rests on two basic premises. The first is that if you make voters happy, they repay the kindness at election time. The second is that the fastest way to their hearts is through their wallets. As Gingrich put it in November, "No politician in the 20th century has been defeated for cutting taxes.''

In which case the $245 billion tax cut in the G.O.P. budget plan is a potential superhighway. The challenge for Clinton and the Democrats is to convince people that it is not only too much of a good thing, meaning too large for a time of budget deficits, but also too much of a bad thing, meaning heavily skewed in favor of the well favored. The Administration's response was summed up by Clinton last month when he vetoed the Republican budget: "While making such devastating cuts in Medicare, Medicaid and other vital programs, this bill would provide huge tax cuts for those who are already the most well off."

Though they are willing to scale them back, Republicans say tax breaks in some form will have to be part of any budget deal. They were a centerpiece of the Contract with America and remain a priority among the not-to-be-trifled-with House freshmen. The G.O.P. plan includes a $500-per-child tax credit for families, a reduction of the capital gains tax and a plan to make individual retirement accounts available to higher-income earners. For big business, it cuts the alternative minimum tax, which requires corporations to pay at least some tax even when they find enough deductions to offset their tax liability entirely. To Gingrich, the cuts also have a kind of world-historical psychological value. "You have to cut taxes,'' he says, "as a way of rewarding people for going through the process of change."

But which people? The Clinton Administration estimates that the Republican tax plan gives nearly half its benefits to families with incomes of more than $100,000, the top 7% of American earners. Clinton's me-too-but-smaller tax plan focuses its benefits on lower-income earners. Like the Republican plan, for instance, Clinton's offers a per-child tax credit and expands the availability of tax-deductible IRAs but in each case cuts off the benefit at a lower ceiling of earnings. He also offers deductions for college costs of as much as $10,000 a year.

For the most dry-eyed budget balancers, tax reductions now, no matter what size, are a mistake. "Tax cuts should be a reward after spending cuts have achieved a balanced budget," says Pete Peterson, president of the Concord Coalition. A few weeks ago, his group placed full-page newspaper ads signed by the ceos of 90 U.S. corporations, urging Congress and the White House to negotiate seriously about a balanced budget, even if it meant small tax cuts or none. According to Peterson, "a lot of businessmen are willing to sit pretty easy on tax cuts if we get an overall budget deal that makes sense."

For any individual taxpayer, what makes sense may well depend on how much the taxpayer stands to gain, if at all, by any of the major components of the G.O.P. plan.

THE FAMILY TAX CREDIT: Dave Jones of Los Angeles is not completely happy with what he has heard about the tax cuts proposed by the Republicans. The $500-per-child tax credit, for instance, seems unfair to childless taxpayers. "If I were someone without kids," he says, "I would be furious." However, Jones and his wife Lisa do have kids, four of them. That means they could enjoy a $2,000 reduction in their taxes next year under the G.O.P. plan. Even with a combined $90,000 income--he sells decorative laminates, she manages a dentist's office part time--that is a fair amount of money. "Speaking from a selfish standpoint," he says, "I won't send a couple of thousand dollars back." He laughs as he picks up his youngest, 14-month old Taylor, and bounces him on his knee to quiet him. "I wish [the credit] were $1,000 per child."

The biggest chunk of the Republican tax plan is this per-child credit, which would cost $149.7 billion over seven years. Conservative House members wanted to offer it to families earning as much as $200,000 in adjusted income. In the Senate, that was cut to $110,000, though a portion of it would be available to families making as much as $150,000. Clinton's $500-per-child credit phases out for household incomes of $65,000 to $75,000.

While few object to tax breaks for families, the G.O.P. credit is unavailable to the sizable number of working families who don't make enough to pay federal income taxes. So is the credit in the White House plan. Nearly a third of U.S. kids, 24 million, live in families too poor to receive any credit.

THE EARNED INCOME-TAX CREDIT: The tax break that does most for the poor is the EITC, already in place. It gives the working poor a refund to cover payments for Social Security and some other taxes as well as to supplement wages. At the same time it proposes to give family tax credits to the middle class, the G.O.P., unlike Clinton, is proposing to cut the EITC for the poor.

Three-quarters of EITC benefits go to workers making less than $15,000. Last year it paid $1,400 to Karen Montana, 30, a single mother of two children, ages 4 and 6. Her $13,550 salary as a Head Start teaching assistant in Los Angeles is too low for her to pay taxes, making her ineligible for the per-child credit. With the EITC she got last year, "I caught up on a furniture payment, visited my grandmother in Oakland, bought a bed instead of putting it on credit, and saved a little."

Republicans want to deny the EITC to workers without children and to phase it out faster among working families with children as their earnings rise. Over seven years, that would save $28 billion. Taken as a whole, the G.O.P. tax plan would mean a net loss in income for some working families with earnings in the $20,000-to- $25,000 range. Their EITC would be trimmed, but they still wouldn't make enough to get the per-child tax credit.

The Republicans who are going after the EITC insist that when the per-child credit is taken into account, most of the working poor will be better off. "At $30,000 a year, a family will get a 51% cut in their income taxes," explains Scott Hodge, a tax-policy expert at the conservative Heritage Foundation. "A family of four earning $100,000 a year will get a tax cut of only 7.6%."

CAPITAL GAINS: Though it represents just 3% of federal tax revenue each year, there may be no more potent symbolic issue than the capital gains tax, a Republican preoccupation for more than two decades. For nearly as long, Democrats have fought such a cut as a gift to the few who claim capital gains--profits from selling stocks, bonds, real estate or such tangibles as gold coins or art. (Currently, about 7% of taxpayers do that each year.) By making half of such profits untaxable, the G.O.P. plan would effectively cut the capital gains tax rate from 28% to 19.8%. The lowest tax rate for wages, when Social Security taxes are included, is about 23%. Thus in proportional terms the sale of 200 shares from a stock portfolio might be taxed more lightly than the paycheck of a cleaning lady.

While waiting to see a financial consultant on Park Avenue, Dr. Ruth Stoddard Long, 63, a New York ophthalmologist, makes no bones about where she stands. "I'm for it absolutely," she says. "The upper middle class pays a lot of dues. If they get a little break, what's the big deal?" Supporters of the change say lower rates would encourage more investment and spur greater turnover of holdings, thus leading to increased tax revenues. "More people would sell assets, and the U.S. Treasury would collect more taxes," says Stephen Moore, director of fiscal-policy studies at the conservative Cato Institute and author of a new study on the subject. "Every time the rate has been cut, payments by the wealthy have risen substantially."

INHERITANCE: Most Americans would say that when it comes time for them to pass on, and to pass on their assets, the government should stay out of their pockets. For the most part, it does. Of the 2.2 million Americans who die every year, only around 25,000, or slightly more than 1%, pay federal estate taxes. The estates of the rest fall below $600,000 in value or pass from spouse to spouse, which in either case makes them tax free. The G.O.P. would raise the tax-free ceiling to $750,000, a nod to inflation--the limit was set in 1987--that the White House is likely to meet partly or in full. A more controversial provision would exclude the assets of many family businesses up to $1 million. The next $1.5 million would be taxed at half the current rate, which varies between 27.5% and 55%.

The owners of family farms and businesses insist that estate taxes are a big reason why nearly 60% of family-owned businesses are never passed to the second generation. The dairy farm of Elmer Truelove, 68, spreads out over 330 acres in Lake Lanier, Georgia. The area, 60 miles north of Atlanta, has endured creeping suburbanization that has sent land values as high as $4,000 an acre. Truelove has lived there since his parents bought the land in 1929. Retired now, he has passed operation of the farm to two of his children. "But because of this growth,'' he says, his family after he is gone "will have to pay a lot to keep it.''

Opponents of the most sweeping parts of the change insist that estate taxes are not that much of a burden. Assets can be transferred before death, and tax payments can be spread out over 15 years, which diminishes liquidity demands on heirs. Says Robert McIntyre, director of Citizens for Tax Justice, an independent tax-analysis group: "If heirs want to continue to run family companies, they can already do so under existing provisions of the code."

SPECIALIZED BREAKS: The G.O.P. tax plan is full of loopholes that are testimony to the power of well-positioned special interests to hold the pen at tax-writing time. One provision would allow people who buy insurance policies for catastrophic coverage to set up new tax-deductible accounts allowing them to save as much as $2,000 a year to offset medical expenses. The prime mover in favor of these so-called medical savings accounts: Golden Rule Insurance Co. One of the G.O.P.'s biggest donors, Golden Rule and its chairman, Patrick Rooney, contributed $723,505 to the party in connection with the 1994 elections.

Regardless of whether it makes good fiscal sense, some tax cuts are sure to be included in any deal between Clinton and the G.O.P. It is just as certain that both sides will compromise. Clinton has already given way to the Republicans repeatedly, agreeing to balance the budget on their seven-year schedule and to accept the economic projections of the Congressional Budget Office that the Republicans favor. And Republicans have been indicating that much of the tax package may be jettisoned for now, to be taken up again next year. If a deal is struck, the remaining question is which side gets the public credit for the tax handouts. To clinch the advantage, the Republicans have added an appealing twist to their family tax-credit plan: it would be retroactive to the last quarter of 1995. Refund checks for one-fourth of the annual amount, $125 a child, would be sent out separately. The mail date would be a few weeks before the next election.

--Reported by Marcy Lamm/Atlanta, Viveca Novak and Adam Zagorin/Washington, Elaine Rivera/New York and Jacqueline Savaiano/Los Angeles

With reporting by MARCY LAMM/ATLANTA, VIVECA NOVAK AND ADAM ZAGORIN/WASHINGTON, ELAINE RIVERA/NEW YORK AND JACQUELINE SAVAIANO/LOS ANGELES