Tax "Reform" Takes Shape

Down with expense accounts, off with capital gains

"Our national tax system is a disgrace. Basically, I favor a simplified tax system that treats all income the same, taxes all income only once, and makes our system of taxation more progressive."

That was one of Jimmy Carter's key campaign promises last year, and the time is coming to deliver on it. A task force that started work last winter (TIME, July 4) has placed on Carter's desk a loose-leaf notebook with some 150 pages of recommendations. Barring an unforeseen delay, the President expects to present to Congress by Oct. 6 his choices from among those recommendations. Aides are billing the program as the most comprehensive and drastic revision of the nation's income tax laws since the modern system was set up in 1913. About 1,000 items of the tax code would be changed or eliminated--almost one change for each of the code's 1,100- odd pages.

The drafting of the proposals was largely overseen by Treasury Secretary W. Michael Blumenthal, who toured the country to gauge public sentiment at give-and-take sessions. Carter himself has boned up carefully on tax reform. During the summer he summoned Blumenthal, Assistant Treasury Secretary Laurence N. Woodworth, Chief Economic Adviser Charles Schultze and a few other selected staffers to three sessions in the White House, lasting a total of seven hours.

Now the President must check the boxes for yes or no decisions. While some of his choices remain in doubt, the outline of his program seems well set. Major points:

Tax rates will be cut for individuals and corporations alike. The highest bracket of personal taxation--which applies to so-called "unearned" income, such as dividends, interest and rents --would be reduced from 70% to 50%. The top rate of 50% on "earned" income --primarily salaries--would be reduced; the lowest rate would be cut from 14% to 10%, and there would be decreases in all brackets in between. The corporate rate, now 48% of profits in most cases, would be reduced significantly, perhaps by three points. Total reduction: $15 billion a year --$10 billion for individual taxpayers, $5 billion for corporations.

Capital gains would be taxed as ordinary income. At present, only half the profit on sale of stock, real estate or other assets held for nine months or more is usually subject to tax. To soften the blow, exceptions would be made for family homes and family farms. The change would be phased in over several years, and people selling assets at a loss would be allowed to write off more of that loss against other income. Cities and states could continue to issue bonds paying interest that is exempt from federal tax, but they would get a federal subsidy to encourage them to issue bonds that would not qualify for tax exemption. The subsidy might amount to 35% to 40% of the higher interest rate that would have to be offered.

Expense-account deductions would be sharply curtailed. The present idea is to put a ceiling on the deduction that could be taken for a business lunch. Aides are having trouble fixing a figure, since meals and drinks cost so much more in Manhattan than in, say, Cedar Rapids; one guess is $35 for two people. But Carter has railed so vehemently against the "three-martini lunch" that his staff has to come up with something. Carter is also considering eliminating or restricting deductions for club dues, tickets to sports events and the cost of using corporate jets. Business would get new incentives to invest. The tax credit that corporations can take for expansion and modernization expenditures would be increased from 10% to 12% and applied to the costs of putting up industrial buildings as well as buying the machinery to fill them. Double taxation of corporate dividends would be reduced or eliminated. The favorite idea now: shareholders receiving dividends would be allowed to take a credit on their personal returns equal to their proportionate share of the taxes that the company has already paid on its profits. A highly oversimplified example of the basic idea: a person who owned 1% of the shares in a company that paid $100,000 in taxes on its profits would subtract $1,000 from the tax that he otherwise would owe on his dividends. Yet there are many questions, and how this change would work out in practice is most unclear.

Deductions for mortgage interest would be restricted, but not in a way to bother the vast majority of homeowners. Deductions would be limited to $10,000 of interest a year; at present rates, a homeowner would have to be carrying a mortgage of about $110,000 before he ran afoul of that provision.

These proposals are likely to touch off one of the hottest battles of Carter's first term. At best, Congress will hold a few hearings on them before adjourning, and take them up in earnest next year; they will probably go through many changes on the way to enactment. In effect, it will take at least another year before the reforms can be transformed into law. Touching any provision of the tax code hits a raw nerve--and not always a selfish one. Treating capital gains as ordinary income, for example, would penalize not only the very rich but also the middle-income salary earner trying to build up an estate for his children through investing in common stocks or real estate. Also, the elimination of the capital gains break might do more to restrict the flow of funds available for much-needed business expansion than the more generous investment tax credits, and new break on dividends would do to increase new investments. Democrat Al Ullman, chairman of the House Ways and Means Committee, opposes reductions in capital gains--and that is just one indication of the big bruising battle that lies ahead.

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