Two steps forward and one step back. That may be the best way to characterize President Reagan`s tax reform proposal.
The problem with taxes directly affecting business has not been that they have been too high. Corporate taxes, for example, finance only 8 cents of every dollar of federal expenditures, far down from the 12 cents of 1981 and the considerably higher figures of earlier years. The problem is that they have been uneven and distortive. General Electric, Dow Chemical, Boeing and some 50 other very largest corporations pay no taxes at all, while many other businesses are stuck with taxes at close to the nominal 46 percent rate.
The major culprit in the tax avoidance and distortion has been the huge tax subsidies directed to business investment in plant and equipment. The Office of Management and Budget`s estimate, under the current tax code, of fiscal 1986 federal revenue losses due to ”tax expenditures” includes $25.3 billion for the investment tax credit, $33.4 billion for accelerated depreciation and $22.1 billion for capital gains exclusions. These total $80.8 billion, a substantial figure.
This can result in an interesting situation for a business contemplating, for example, purchase of a new machine for $100. It may find that without the tax advantage the machine is worth only $90 in what it can add to real productivity. But with the tax advantage, it is worth $110, and hence the purchase is completed. Though sober estimates indicate that the tax subsidies are not even cost-efficient–each dollar of tax giveaway may net only 40 cents of added investment–the investment that is stimulated will be the $90 that is not really productive. The investment worth $110 on its own would have been undertaken anyway, without the tax incentive.
Treasury I, the tax reform proposal put forth last November, aimed at subjecting ”real economic income from all sources to the same tax treatment” and ensuring that ”no longer will the nation`s scarce economic resources–its land, its labor, its capital and its inventive genius–be allocated by the tax system, instead of by market forces.” It went remarkably far in wiping out these tax distortions affecting investment.
It coupled elimination of the investment tax credit and a move to
”economic depreciation” adjusted for inflation. The President`s new proposal would ”liberalize” this depreciation, in most cases even going well beyond the current ”accelerated cost recovery system” (ACRS), which had itself vastly increased depreciation over what was available before 1981. It would thus restore billions of dollars of tax subsidies to capital-intensive business along with the associated incentives to unproductive investment.
Similarly, Treasury I would have taxed all of true, realized capital gains (those over and above inflation) as ordinary income. President Reagan would return to exclusion from taxable income of half of capital gains on stock equity.
These retreats from the general principles of equitable and efficient tax reform are large compared with the much-publicized cave-in to the gas and oil industries, where OMB estimates the federal tax subsidies were a mere $2 billion.
The retreats are all the more striking when contrasted with the resistance to pressure on the elimination of state and local tax deductions. Those currently involve federal tax revenues of $10.7 billion on property taxes on owner-occupied homes and $24.6 billion on other nonbusiness state and local taxes.
Deductions for state and local taxes have been a substantial subsidy to homeowners. They also have made it easier for state and local governments to raise the taxes to finance their services of police and fire protection, roads and sanitation, education and public welfare. Coupled with budgetary proposals to end revenue sharing, their elimination would be a heavy blow to local government services some consider essential to a productive labor force and the efficient operation of private business.
Compared with the current law, however, President Reagan`s proposal must in general be rated a significant improvement. One can dismiss his Hollywood hype about ”a second American Revolution” and still recognize major gains from the reduction in tax rates made possible by broadening the tax base.
Cuts in personal income tax rates should reduce, though hardly eliminate, the distortion in business activity induced by individual demand for tax shelters and tax-free income. Cuts in corporate tax rates coupled with elimination of the investment tax credit and a number of business deductions will reduce the degree of government favoritism in the business world and encourage business decisions for real economic gain rather than tax advantage. But after the high promise of Treasury I, it seems a pity that so much has been given back to those special interests the President apparently favors. One can hope that Congress will pick up former Treasury Secretary Donald Regan`s word processor and restore more of the sound principles and equity of Treasury`s original plan.
