Behind All The Tax Reform Blather

The real debate in 1998 will be over more tax cuts

The Republicans got their act together and took their Big Issue on the road in mid-October. House Majority Leader Dick Armey of Texas and Representative W.J. "Billy" Tauzin of Louisiana began barnstorming the country to debate a grand overhaul of the federal tax code. Armey, who favors a flat-rate income tax, and Tauzin, who wants a national sales tax, hope their traveling debate will build public support for junking the current system--and give the gop a juicy issue.

SOUNDS GOOD. But action on these grandiose plans for rewriting the tax code is years away. Back in Washington, the real debate inside the gop is about a more immediate agenda--cutting taxes before the 1998 congressional elections. With the federal budget headed for its first surplus in three decades, Republican lawmakers find the idea irresistible.

But which taxes to cut? While the gop has a lock on the tax-reform issue for now, an intraparty free-for-all has broken out between the family-friendly and pro-growth crowds. "We've got a bunch of folks who want to reduce the burden on taxpayers but without underlying principles to guide them," says J.D. Foster, chief economist at the Tax Foundation, a Washington think tank advocating low taxes.

The pro-family faction, which was behind the $500 child credit in this year's tax bill, is now targeting the "marriage penalty." That's the tax bias against many two-earner couples. Meantime, the pro-investment gang wants to build on the changes it won in 1997--lower capital-gains rates and broader eligibility for tax-deferred savings accounts. Still others want to give workers relief from the regressive payroll tax.

Right now, the drive to repeal the marriage penalty has the most oomph. The effort got a boost on Oct. 9, when House Speaker Newt Gingrich (R-Ga.)--who has supported virtually every gop tax proposal put forward in the past three months--called for ending the bias against two-earner families.

Under current law, a husband and wife who have roughly equal incomes pay higher taxes than they would if they were unmarried. According to the Congressional Budget Office, about 42% of married couples paid the penalty in 1996, which averaged $1,400. The penalty hits the wealthy and the working poor the hardest. For a number of poor couples, marriage can make the difference between paying taxes or not.

Some gop lawmakers would end the penalty by letting taxpayers choose whether to file jointly or as individuals. But that would cost $20 billion a year in revenue. Representative Wally Herger (R-Calif.) has the support of 21 fellow members of the Ways & Means Committee for a less costly plan. He would allow a couple to deduct 10% of the lower-earning spouse's first $30,000 in income. That would restore the law to the way it was before the tax reform of 1986--at a cost of about $9 billion a year. Herger also favors incentives for growth but insists: "I have to put families first."

Senator John Ashcroft (R-Mo.), a gop Presidential hopeful, would rather woo working people. He would let them take an income tax deduction for the 6.2% Social Security tax that's levied on everyone's first $65,400 of wages. The deduction would cost $30 billion a year. Ashcroft's plan is aimed at middle-income earners, most of whom pay more in payroll taxes than in income taxes. "Previous attempts at tax relief have been pretty narrow," Ashcroft says. "It's time to broaden our base."

SCALED BACK. Still, even backdoor tinkering with Social Security funding is risky business, and other Republicans suggest that a better way to broaden the party's base is to boost the economy. Ways & Means Chairman Bill Archer (R-Tex.) says the top capital-gains rate, cut to 20% for 1998, should be slashed again. Senate Finance Committee Chairman William V. Roth Jr. (R-Del.), who pushed for the expansion of individual retirement accounts contained in the 1997 law, would love to make iras even more widely available. And Gingrich wants more estate tax relief on top of this year's gradual phaseout of the levy for estates of $1 million or less.

One tax change does have broad bipartisan support: easing the alternative minimum tax for individuals. That levy, enacted in 1986, was intended to ensure that even wealthy individuals with huge deductions paid some income tax. But in order to protect middle-class taxpayers from being inadvertently hit, Congress granted a $45,000 exemption. Because that number was not indexed for inflation or increased in a decade, the levy may hit far more taxpayers in coming years.

All of this tax tinkering would probably cost $100 billion a year. Given the budget realities, Republicans will be lucky to squeeze out a $20 billion annual tax cut. That's why they may end up passing a tax bill that looks a lot like the one that became law this year: The original proposals get trimmed, and everybody gets a small break.

TOUGHER FOR REFORM. Introducing new complexities, however, fights the gop's promise of a simple tax system that will sharply scale back the powers of the Internal Revenue Service. To be sure, Republicans argue that cutting taxes now is consistent with long-term reform. After all, expanding iras or abolishing capital-gains taxes are steps toward a consumption-based tax. But history has shown that the passage of more breaks only makes reform tougher to achieve. "Every time we open another loophole, we create another winner," says Brookings Institution tax economist William Gale. "That means we'll have to buy off more people to make the transition to a new system." Even tax reformer Archer concedes that "people who have a vested interest in the current system will oppose change."

Despite the headline-grabbing Republican road show, as a practical matter, major reform is a postmillennium prospect. And few politicians want to wait that long. If there is a penny of budget surplus floating around next year, the Republicans will figure out some way to use it to finance a tax cut--if they can only get together on which one.