Essentials of tax reform.

• Author: McIntyre, Robert S.

ESSENTIALS OF TAX REFORM

Cynics said it could never happen, but Congress is on the verge of enacting real tax reform. Last December, the House passed a monumental bill; this May, the Senate Finance Committee approved its own terrific version. If a good bill emerges from the House-Senate conference and the President signs it into law, then taxpayers can celebrate and doubters of the democratic process can begin rethinking their opinions.

But the conference promises to be one of the most heavily lobbied ever, so let's keep in mind the danger that in the horsetrading, certain key reforms--the ones that end the worst abuses-- may be trampled on. Here are those essential reforms and the horrors they will end. Without these reforms, we won't have true tax reform.

Cut taxes for the poor

Horror Story #1: While the rich have enjoyed the President's 1981 tax cuts, working poor families have watched their tax rates skyrocket. In 1979, a couple with two kids and one spouse working 51 hours a week at minimum wage had a gross annual income of $7,395--exactly the proverty line. Their total tax burden was $128, or 1.7 percent. By 1985, a family living on the same income (after inflation) made $11,016, but they paid $1,176 in taxes. That's an effective rate of 10.5 percent--a five-fold increase over 1979.

Supply-siders in the White House and on Capitol Hill caused this experiment in regressive taxation in 1981 when they refused to adjust three key tax provisions for inflation.

The first was the standard deduction. This is the sum--currently $3,540 for couples--you get to deduct if you don't itemize. The second was the personal exemption, the $1,040 you can deduct for yourself and each member of your family. The third item was the earned income tax credit, a tax rebate to working poor families that offsets part of their Social Security tax. Together, these three provisions kept the effective tax rate on working poor families low before 1981. Not raising the value of these provisions as the cost of living rose, inevitably meant vastly higher tax rates for these families. Having argued that welfare gave the poor an incentive not to work, the Reagan administration turned around and gave them another one.

Essential Reforms #1: Raising the value of these three crucial tax breaks and permanently indexing them for inflation is the surest way of giving needed relief to the poor. Both the House and Senate bills do this. Either bill, if passed, will reduce the combined income and Social Security tax rate on a poverty-level family of four from what would have been 11 percent in 1988 under current law to less than 3 percent. A higher personal exemption will also give relief to large families who, because the exemption hasn't kept up with inflation, have also been hard hit.

End corporate freeloading

Horror Story #2: in 1983, General Electric's subsidiary, General Electric Credit Corporation, discovered that Union Pacific, the railroad conglomerate, had millions of dollars worth of investment credits and depreciation tax deductions from its new refinery in Corpus Christi, Texas. But because Union Pacific had already used other tax breaks to reduce its tax rate to around 1 percent, these extra write-offs were all but worthless to it. So G.E. Credit Corporation and Union Pacific cut a "sale-leaseback' deal. G.E. paid Union Pacific a fee in exchange for receiving title to the refinery, which G.E. then leased right back to Union Pacific. Union Pacific continues to operate the refinery as before; but since G.E. Credit "owns' the facility, it can use all the tax credits and deductions it generates to offset G.E.'s income tax liabilities. G.E., in essence, bought Union Pacific's surplus tax breaks.

Creative accounting like this has worked wonders for G.E. In 1978, the company paid about one-third of its U.S. profits in federal income taxes. From...