Behind the budget hoopla: Will 'supply side' work?

Just before Congress scampered off for its Easter recess, Sen. William V. Roth Jr. took his elephant for a walk. The elephant (borrowed from the circus) was intended to dramatize the size of the proposed Kemp-Roth personal income tax cut. Nicknamed "Roth-Kemp" for the occasion, the pachyderm strolled among the flowering azaleas of Senate Park accompanied by Senator Roth and aides carrying signs that read: "The Kemp-Roth tax cut: It's not peanuts."

This bit of political showmanship was a skirmish in a serious struggle. The Reagan administration is fighting to keep its tax bill intact, while critics complain the cuts would be too much of a shock for the economy and that they should be directed more toward increasing investment in new plants and equipment.

Until now, Washington's attention has been focused on budget cuts: a traditional issue for fiscal conservatives. But Mr. Reagan's tax proposals, centered on the Kemp-Roth three-year, 30 percent cut in personal income taxes, are more directly inspired by a belief in "supply side" economics -- a belief that many Republicans don't share.

So the larger issue at stake in the coming tax struggle is not Republicans and the desire for fiscal restraint against Democrats and the commitment to a better society through government programs. Instead, the question is one of economics: Will supply-side theory work, or is it just a crackpot theology?

The President's economic recovery program features just two tax measures: Kemp-Roth and the "10-5-3" depreciation allowance, which would allow businesses to write off new equipment faster. The administration says it wants these tax cuts to remain pure and simple, without being diluted or weighted down by congressional tinkering.

Administration aides say the tax relief would lift a yoke of burden from the economy, providing a strong incentive for business to invest and people to save, providing a stronger economy and increased tax receipts in the long run -- classic supply-side thinking.

And they want the boost to come quickly. John Chapoton, assistant Treasury secretary for tax policy, recently told the House Ways and Means Committee that the Treasury would not take a stand on tinkering with a subsidiary tax issue, because the administration felt all attention and effort should be focused on getting its first tax bill through.

But Washington sources say discontent in Congress means the economic recovery plan won't be able to scoot through Capitol Hill with its tax cuts untouched. The Kemp-Roth cut was controversial even before Reagan was elected, and opposition to it is well publicized.

And a thick Brookings Institutions study has questioned the administration's belief that Kemp-Roth would pay for itself through taxes skimmed from increased business activity.

The House Budget Committee alternative budget, one of two plans the House will consider as it returns from its Easter recess, has toned down K-R to a one-year cut. And the "hard rocks" of the Senate Budget Committee, conservative Republicans concerned about the budget deficit resulting from K-R, swung a key vote against the President's plan earlier in the month.

Many congressmen don't agree with the administration view that people will save most of the Kemp-Roth tax cut, the money flowing together into pools of capital for new investment. Instead, they think it will be spent on a good dinner or a new blouse.

"Many staffers on Ways and Means want to target savings," a lobbying group's legislative liaison says.

So individual members are falling all over themselves to file bills providing tax breaks for small savers. There are now 103 such bills awaiting congressional action.

Less well known is the fact that some congressmen are not too happy about "10 -5-3," either. Some congressional staff members claim the new depreciation schedules speed up write-offs so fast they create severe distortions in the tax code, favoring capital-intensive industry and new building at the expense of the service sector and already built-up urban areas.

"A lot of members are concerned" about the overreaching of 10-5-3, one congressional staffer said.

The Chamber of Commerce of the United States, itself solidly behind the President's program, sponsored a poll released this week which claims nearly two-thirds of the American public supports 10-5-3 accelerated write-offs. The poll, conducted by Opinion Research Corporation, also claimed 57 percent of Americans believe the Kemp-Roth tax cut would moderate inflation.

But the money men of Wall Street, who handle millions of dollars as if they were bus tokens and earn their living by tracking the pulse of the economy, are not so dead set in favor of the tax cuts. Henry Kaufman, chief economist at Salomon Brothers and someone who is always described as "influential," told a luncheon meeting at the National Press Club that the tax cuts would overheat the economy -- giving an upward jolt to inflation and sending interest rates along a "rocket trajectory."

And a former high economic official says that many people in the financial community opposed to the tax cuts "are refraining from speaking out" because they don't want to endanger the parts of Reagan's program they think are "positive."

The economy's strong first-quarter showing (it grew at a 6.5 percent real annual rate) only made financiers more anxious about the cuts.

The administration is already preparing another tax bill that will deal with secondary issues the first cuts don't cover. As described by Mr. Chapoton, the second bill would lighten taxes for Americans living abroad, reduce the so-called "marriage penalty," and board up "commodity straddle" tax shelters, which let wealthy taxpayers shuffle commodity contracts to reduce their taxes.

Such straddles have been a particular embarrassment to the administration. When Treasury Secretary Donald T. Reagan was head of Merrill Lynch & Co., his brokerage house often recommended them to clients.

Reportedly, Mr. Chapoton has said the President is so confident his program will pass that he and his advisers haven't developed a "fallback" position.

But others say such talk is only part of the strategy.

"They know the feeling of Ways and Means. They don't want to start backpedaling too soon," a legislative liaison said.

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