BACK INTO THE TAX MAZE

By GEORGE J. CHURCH

Nothing is simple in Washington, least of all simplicity. Eleven years ago, the House and Senate replaced the intricate U.S. tax code with a less convoluted system that aimed, with some success, to tax equal incomes more or less equally. That turned out to be an imperfect victory. Subsequent Congresses put enough complexity back, through juggling of rates, deductions, credits and so forth, so that the tax code is again almost as baroque as it was before the 1986 reform. Today it fills some 7,000 pages. Just trying to comply with it costs Americans $75 billion a year--minimum.

But if Washington has its way, much worse could be coming. The tax bill being fashioned between Congress and the White House will bury much of what remains of the 1986 simplification. The proposed changes are "clearly a step back in terms of complexity," says Joel Slemrod, a tax expert at the University of Michigan. "It is antithetical to the spirit of the 1986 tax reform." Not only is the bill that's shaping up likely to make life more confusing for taxpayers, it's also unlikely to make good on promises to encourage investment and savings or to put more kids into college. When it comes to changing people's behavior, the tax code has never been an effective instrument.

No one knows, of course, exactly which of the myriad details in the bill will become law. As a starting point for their negotiations with President Clinton, Senate and House Republicans last week agreed on a unified position on the central provisions: a $500-per-child tax credit, another tax credit for college tuition, and a cut in the capital-gains tax. The White House has ideas of its own in those areas, so some change is likely in all three. All of it will add more pieces to the tax puzzle:

Per-Child Credits At first blush they seem straightforward: everybody gets a tax credit of $500 for each child under 17. Well...not quite everybody. There will probably be phaseouts for high-income people, as there are now for personal exemptions and itemized deductions. Parents of children between 13 and 17 may have to put the credit into an education savings account. Under one plan, the working poor who qualify for an earned-income credit could not also get the per-child credit--at least not right away. But they could carry it forward for three years and claim it, retroactively, if their incomes rose above the cutoff point for the earned-income credit. Got that?

College Investments Take a deep breath. When the new law is finalized, it may permit withdrawals from an ira without penalty to finance a college education. Another option may be a nondeductible contribution to a new, "education" IRA, one that earns tax-free interest that can be withdrawn tax-free if used for college. President Clinton, meanwhile, has talked of a Kidsave account: parents could contribute the $500 per child tax credit plus another $500 that could be withdrawn tax free for the child's education. Some form of the Hope Scholarship tax credit of up to $1,500 is also likely, but parents probably could claim it only if their incomes fell within a certain range when a son or daughter entered college. What combination will survive is uncertain, but taxpayers may need a calculator just to keep track of what's available, let alone figure which offers the most advantage.

Capital Gains Right now only top-bracket taxpayers have to figure out different rates on their regular income and on capital gains (28% max). But if Republicans get their way, profits on the sale of most investments would be taxed at either 10% or 20%, whatever the taxpayer's regular income rate. There might even be a third rate, of 25%, for the sales of some types of rental property; and a fourth, of 28%, for such collectibles as rare coins. The G.O.P. also wants capital gains to be indexed for inflation--that is, the taxable gain would be reduced by the amount that prices had risen over the life of the investment. Treasury officials contend they would be forced to erect a whole new bureaucratic apparatus of agents, forms and experts to police the change. The changes could tempt investors to divert money into unproductive investments that nonetheless yield lightly taxed capital gains, like the half-empty office buildings that sprouted before the 1986 reform.

IRAs When IRAs were first created, savers could take a deduction of up to $2,000 on money put into an account that paid tax-deferred interest. Since then, changes in the law denied single people with incomes above $40,000 ($50,000 for couples) a deduction on the principal, but they are still permitted to accumulate tax-deferred interest. Next year there may be a so-called American Dream IRA yielding no deduction for principal but, unlike current iras, permitting tax-free withdrawals. Which type will save more tax in the long run? Back to the calculator.

Complexity aside, there is a strong argument that using the tax code is an inefficient and expensive way to accomplish economic or social goals. Most economists will tell you that multiplying IRAs is unlikely to prompt the additional savings the U.S. economy needs; investors may only shift money out of less favored forms of savings. As for college-tuition tax breaks, Richard Murnane, an education professor at Harvard, fears they will turn into "subsidies for middle-class parents sending kids to college. Most middle-class parents do that already, so there's not much gain." Then there's the law of unintended consequences. Much of the benefit of tax credits or deductions could go to college administrations rather than students or parents--because the colleges might be encouraged to raise tuition still higher.

These arguments are being overpowered by pure (if that is the word) politics. In a political climate that has made increased government spending taboo, the tax code is the best remaining means to hand out rewards to constituents. This is why even Republicans who were whooping it up for a flat tax last year (for instance, House majority leader Dick Armey) are now advocating a change as complex as indexing capital gains for inflation (Armey again). That's also why the new tax bill is being stuffed with special breaks for everyone from whaling captains to sky divers.

Meanwhile, the IRS already figures it takes an average taxpayer 11 hours to fill out a standard Form 1040--and six hours more if he or she must also complete Schedule A (itemized deductions) and Schedule B (interest and dividend income). Whatever the final form of a tax bill, it's safe to predict that taxpayers will have to set aside a good deal more time than that before next April 15.

--Reported by John F. Dickerson/Washington

With reporting by John F. Dickerson/Washington