TAX reform hasn't arrived yet, but after the Senate Finance Committee's action last week, it's time to take this new version of the bill very seriously. It is the best that has emerged thus far -- better than the Treasury's own plan last year and better than the House-passed version.
The Senate Finance Committee's version is attractive for two reasons: the low maximum rate it achieves, 27 percent, and the means by which it gets there -- that is, cutting off so many tax preferences that now exist.
The public is bound to be sympathetic to a legislative process that left so many lobbyists standing aghast in the Senate hallways. And it's bound to be interested in the bait of a maximum tax rate of 27 percent.
Moreover, the main personal deductions have been left intact. A year ago, the President's plan would have ended deductions for state and local taxes. Those deductions are preserved, other than the one for sales taxes. Some interest deductions have been curtailed, but full deductions for both first and second home mortgages are allowed. (As with other deductions, however, the lower tax rate reduces the deduction's economic value; therefore it becomes less of a factor in decisionmaking.) And here the charitable deduction is fully allowed, unlike the original Reagan plan.
The key areas that lobbyists will try to change as the bill moves to the Senate floor are probably these three: tax shelters, individual retirement accounts (IRAs), and the higher capital-gains tax. What the bill apparently does is allow tax shelter losses to be taken only against gains on similar investments, not against earned income.
This, on the whole, seems fair enough. It does not seem right for the salary of someone earning $30,000 a year to be fully taxed, while someone earning $100,000 a year can escape taxes on even a part of that salary by making investments that he or she can afford solely because of that large salary in the first place.
The IRA deduction is more controversial. The effect of IRAs, even after the five years they've been in operation, is still debatable. Some observers have noted that the saving rate itself has not gone up during this interval, so the money going into tax-free IRAs seems largely to represent a transfer of savings from a taxable account to a nontaxable one.
On the other hand, once into an IRA, the money is untouchable (except for the payment of a penalty) until one reaches retirement age; that factor would seem positive for savings over a longer period of time. But if tax rates can indeed be lowered to 27 percent, giving up the IRA advantage is probably not too high a price to pay.
The third controversial point has to do with ending the lower tax rate for capital gains. Many industrial countries do not even tax gains on capital. President Reagan has wanted to make the rate even lower than the present 20 percent, which has been in effect only since 1981.
Given the relatively high rates at which some states tax capital gains, and the lower value that the state income tax will have as a deduction on the federal return, the Finance Committee may have taken away too much in going for a 27 percent rate here also. This will certainly be one of the areas that will get a thorough discussion during the next month.
Much of the move toward a lower maximum rate was achieved by raising business taxes -- about $100 billion over the next five years. This is, of course, largely illusion, since in the end it's people who pay taxes.
So how can one judge this bill? One of the President's criteria for tax reform was simplicity. For those who itemize their deductions, this bill would not do much to reduce complexity. Nor, for that matter, would deduction of 80 percent of the cost of a business lunch make things any simpler for a company's accounting.
But another criterion was fairness. At first blush, moving toward a very low maximum rate and doing away with most of the tax shelters does seem to move in that direction -- and in a very significant way.
A final criterion was the effect of tax reform on economic growth. Here the Congress should look carefully at whether raising the capital-gains tax at the same time it has done away with many tax shelters that channeled money into socially desirable investments has not paid too little attention to the economic effects of tax reform.
Even with this caveat, however, the Finance Committee bill is the best plan so far. And that's a good thing, given the momentum that is building for passage of some kind of tax reform this year.