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Reluctance to Trim Business Tax Breaks Dims 1986 Repeat Chances

Lawmakers Staging Sequel to 1986 Tax Law Will Need New Ideas
U.S. President Ronald Reagan signs the Tax Reform Act on October 22, 1986. The guiding principle of the 1986 tax overhaul was that rates could be lowered if a host of tax benefits were eliminated and the base was broadened. Repeating that scenario would be more difficult today. Photo: Ronald Reagan Library

The 1986 overhaul of the U.S. tax code is often hailed as the gold standard for its bipartisan approach to tax policy that included compromises to raise more corporate revenue and end tax breaks. Today’s estimated budget deficit, which exceeds $1.3 trillion, will make it tough for lawmakers to stage a repeat.

Still, dozens of companies are preparing to protect their interests in the event of another overhaul attempt. 3M Co., Bank of America Corp. and Pepsico Inc., for example, spent between $610,000 and $1.2 million apiece in the second quarter lobbying Congress on issues that included a tax code rewrite.

Veterans of the 1986 overhaul said offsetting lower income tax rates by raising taxes for businesses would be a more complicated political challenge than they faced 25 years ago.

“The context is quite different from the context of the ‘86 act,” Rob Leonard, the chief Democratic tax counsel on the House Ways and Means Committee in 1986, told Bloomberg Government. “The deficit is raging and entitlements are a major part of the conversation. There are also a lot of new personalities and leaders so there’s a lot of feeling out that needs to occur.”

Leonard is now a partner at Akin Gump LLP in Washington. His clients on issues related to a possible tax overhaul include Honeywell International Inc. and Cox Enterprises Inc.

Broadening the Base

Senator Ron Wyden, an Oregon Democrat who is a member of the tax-writing Finance Committee, is among lawmakers looking to the 1986 law for guidance. The broad strategy employed in 1986 - - lowering individual income tax rates by curtailing breaks and expanding the base -- still applies today, he said.

“The concept of cleaning out scores of these special-interest tax breaks to hold down rates for everybody and keep progressivity has been backed up again and again,” he said.

The political dynamic has shifted since the tax code was revamped. Leonard noted that, in the four years leading up to the 1986 law, Congress achieved two bipartisan budget deals and a Social Security overhaul.

“Trust is at the core of what is needed for tax reform to succeed,” Leonard said.

Lawmakers will return to Capitol Hill in September after spending months in a grueling debate over whether to raise the debt ceiling. Still, the guiding principle of a tax overhaul can unify the parties, said former Senator Robert Packwood, an Oregon Republican who headed the Finance Committee in 1986.

‘Same Philosophy’

“What you had in ‘86 was Democrats who wanted to get rid of deductions and Republicans who wanted lower rates,” he said. “That same philosophy holds today.”

House Ways and Means Chairman Dave Camp, a Michigan Republican, and Senate Finance Chairman Max Baucus, a Montana Democrat, have shown willingness to work together. They held a joint hearing in July on the tax treatment of debt and equity, the first such meeting since 1940.

House Budget Committee Chairman Paul Ryan, a Wisconsin Republican, and Camp have called for lowering the top individual income tax rate to 25 percent from 35 percent. Neither lawmaker has specified how they would achieve such a reduction.

Speaking in Decorah, Iowa, on Aug. 15, President Barack Obama urged Congress to pass an overhaul of the tax code. The administration is expected to unveil its proposal as soon as this fall.

The key to any overhaul is how the administration and lawmakers will agree to pay for lower rates. Changes to the individual part of the code, which included reducing income tax rates from a top 50 percent to 28 percent, cost the Treasury $121.7 billion in forgone revenue between 1986 and 1991, according to the congressional Joint Committee on Taxation.

Repealing Corporate Breaks

The lower rates were offset by raising $120.4 billion from corporations by, among other things, repealing an investment tax credit, limiting the ability to deduct charges to bad debt reserves and changing the tax treatment of real estate mortgage investment conduits. The remaining $1.5 billion came from other sources.

It would be tough for lawmakers to replicate that formula because the biggest pot of potential revenue comes from benefits on the individual side of the code. It would be politically difficult to take money from individuals to help pay for lower corporate tax rates.

Meanwhile, Democrats and Republicans aren’t using the same definition of what constitutes a tax cut. Democrats often assume the 2001 and 2003 tax cuts will expire as scheduled at the end of 2012, which would make the extension of current rates appear to be a tax cut.

Current Tax Breaks

Republicans prefer to focus on current tax rates as a baseline, which means any decision to let tax breaks expire as scheduled would represent a tax increase.

Some Republicans are open to revenue generation that is used to offset lower tax rates as long as net revenue doesn’t increase. Democrats, in contrast, are likely to maintain that at least some revenue should go toward deficit reduction, as Obama’s fiscal commission urged last year.

“With the huge long-term fiscal problem we have, you shouldn’t give away the revenue by lowering the rates,” said Daniel Shaviro, a professor of taxation at the New York University School of Law.

Moreover, if congressional leaders are serious about lowering corporate and individual income tax rates to 25 percent, the biggest chunks of revenue may come from benefits on the individual rather than the corporate side of the tax code. The exclusion of employer-provided health care from taxes is projected to cost $659.4 billion in forgone revenue between 2010 and 2014, according to the Joint Committee on Taxation, and the mortgage interest deduction costs $484.1 billion.

In contrast, the last-in, first-out style of accounting, which Obama has sought to repeal, would save companies $22.9 billion between 2010 and 2014. Eliminating oil, gas and coal tax benefits would generate $40.7 billion between 2011 and 2021, according to the Joint Committee on Taxation.

“The ‘86 deal almost fell apart because Republicans were only willing to have so much burden shift to the corporate side,” Shaviro said. “That’s still pretty hard to do today.”

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