New tax law will take US, world into unexplored territory

BEGINNING next week, Americans will need a new book. Its title: ``How to Pick the Best Book on How to Profit from Tax Reform.'' Literally dozens of ``how-to'' tax books and magazines are being rushed to market, along with lots of ``all new'' or ``completely revised'' money-management books. Unfortunately, nobody can yet write a more important book: ``How the 1986 Tax Reform Affects America's Future.''

That's the book that Americans interested in their future well-being and that of their children and grandchildren could really profit from. It's also the book that finance ministers and legislators of most other major industrial countries would like to get their hands on.

You've seen the conflicting forecasts. Some economists foresee a decline of United States growth rates because of tax reform. Others anticipate a stimulus to growth when some 70 percent of taxpayers have more disposable income in their pockets.

In fact, we just don't know for sure what happens to a complex modern economy when (1) the top income tax rate dips to 33 percent and the majority of people are in the 15 percent bracket, (2) industrial investment incentives and personal savings incentives shrink, (3) states have to revise their taxes to fit the new federal deductibility rules, and (4) corporations presumably pass along their bigger net tax burden to consumers.

Despite this lack of precise forecasting, it seems likely that Congress will face a need for further tax revision in the next two or three years. The conventional wisdom is that further tinkering will be required because the new tax code will not turn out to be revenue neutral, as planned, but will in fact add to existing deficits.

But that seems likely to be a smaller problem than the new code's backward step on savings and investment incentives. Individual behavior in the new era may not be entirely predictable. But it seems safe to say that much of the money Uncle Sam does not take from the poorest and richest Americans will shift to consumer spending. A portion may go into saving, especially on the rich end of the spectrum.

But even for the rich there will be crosscurrents. With capital gains taxed at a higher rate, there may be some shying away from venture capital and new stock issue investments -- indeed from investment in speculative growth companies that don't pay dividends.

The reaction of the poor and the rich -- those who benefit most directly from the new tax code -- may, in short, not do enough to offset other declines in saving caused by the reform law. One such decline comes from sharp limitations on individual retirement accounts (IRAs) and workplace retirement accounts (401Ks and 403Bs). And a large group of middle-income taxpayers will get no relief -- in fact, they will pay higher taxes at the same time that their savings incentives vanish. Where, then, will the investment capital come from for retooling older American industries and creating new industries and services?

For older industries, a large part of the answer to poor sales abroad and at home is retooling for so-called ``flexible manufacturing systems.'' That means installing modern production machinery, computerized automatic controls, and sometimes robots. Such thorough retooling requires major capital investment. In the American system that investment comes from the private sector (unless there is a military, space, or social-service connection).

So the formula reads: Private saving creates investment capital, which creates retooling, which creates higher productivity and more salable products, which create more jobs and a higher standard of living in the long run. The jobs part of this formula is iffy where automatic controls and robots are introduced. But most of the 20 million new jobs created in the past decade have been produced by thousands of small new industries (especially in the high-technology and service areas). It is those high-tech and service firms that have helped to automate older industries.

If the personal savings pool shrinks, where will the capital for these changes come from? The usual answer is from corporate savings -- plowing back profits.

Doesn't the coming cut in corporate income tax rates help that source of capital formation? Yes and no. Don't forget that, overall, the US business sector is going to be providing some $120 billion more in tax revenues by 1991 to make up for tax cuts for individuals. Some firms may benefit from the income tax cuts, but most will lose ground. They will either have to pass the cost along to buyers of their products or save and invest less.

We will need to wait and see exactly what happens as the Rube Goldberg machine called the US economy reacts to all the new variables. But it seems probable that one result may be to help consumer-goods industries more than basic industries that need to retool and the more venturesome of new venture capital-type start-ups.

If that is the case, Congress may need to go back to the drawing board before the end of the decade to find ways to stimulate savings. Although taxing on consumption has been anathema to lawmakers, it may have to be considered if America is to remain competitive.

Meanwhile, all those modern industrial countries where the top end of the income tax is 20 to 40 percentage points higher than in the US (1987-88) will be watching the great American experiment closely. From Spain to France to Denmark, top rates have been edging downward in the past few years, following the early '80s Reagan cuts. But none of the major nations have taken such a sizable plunge. For them, the US will once more serve as a guinea pig.

Even Japan, where rates have long been low, does not provide an advance prototype of the US experiment. Japanese incentives for personal saving make that low-tax economy different. Those savings provide a buffer against deficit financing by government and a source of capital for continual modernizing of Japanese industries.

Earl W. Foell is editor in chief of The Christian Science Monitor.

QR Code to New tax law will take US, world into unexplored territory
Read this article in
QR Code to Subscription page
Start your subscription today