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Twenty Counterpoint: The Improbable Triumph of Tax Reform
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Who Wins and Who Loses: Tax Preferences

Let us begin with what was not cut. Start with the overwhelmingly popular homeowner deductions for mortgage interest. Although this has been criticized on the grounds that richer people with more expensive houses and higher marginal rates benefit more and that tenants are discriminated against, which is true, the will of the people is overwhelmingly in favor. No lobbying effort was needed because no one could imagine antihomeowner legislation. (Second homes, however, are more controversial.) It is politically unfeasible to eliminate the mortgage deduction.

Employer-paid fringe benefits—health plans, insurance, pensions, meals—have been a favorite target of economist reformers. Senator Bradley might argue that "a fringe benefit is not a free good. It leaves all of us paying a higher [tax] rate than we would otherwise."[169] Senator Durenberger might argue that setting a cap on tax-free fringe benefits would make consumers more cost conscious; for example, while tax reform was being debated, medical care costs rose far faster than the low rate of inflation. Durenberger also might hope that the need for revenues would compel his colleagues and "some of the selfish corporate and union interests to abandon this open-ended tax subsidy for the richer corporations."[170] Others might argue that fringe benefits were income-in-kind, no different than other things money could buy. But recipients did not think so.


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Just to make sure, the health and life insurance industries launched a massive advertising and lobbying effort against the Treasury's original proposal. More than nine hundred lobbyists reportedly were involved, including the AFL-CIO, NAM, the U.S. Chamber of Commerce, the American Council of Life Insurance, the Business Roundtable, Blue Cross-Blue Shield, and more. Senator Packwood was vehemently opposed to taxing fringe benefits.[171] When Representative William Gradison visited union plants in his Ohio district to drum up support for tax reform, he was told that proposals to tax fringe benefits and to deny deductions for personal safety equipment and union dues made members believe "it would cost them." A union official reported that "it is very difficult to find support for tax reform on the shop floor."[172] Supported by organizations and voters across the political spectrum, fringe benefits remained unscathed.

A centerpiece of the Reagan administration's tax reform, estimated to release $149 billion over five years to pay for lower rates, was an end to deductibility of state and local taxes, taxes most people pay. The Treasury viewed these deductions as a subsidy from low-tax to high-tax states. High-tax, high-services states feared that the end of deductibility would cause richer people to move, thereby lowering state revenues. Governor Mario Cuomo of New York took the view that this reform "punishes states that are trying to provide essential services in the face of massive federal spending cuts."[173] It turned out, however, that low-tax states were not eager to give up their benefits, though smaller, in return for the dubious advantages of such competition. Almost all state and local lobbies united against limiting deductions. That in itself was not enough; they also liked revenue sharing, and it went under in 1986. But voters cared a lot more about taxes than about revenue sharing. Even more important, there was no way to build a majority for tax reform without the big state representatives for whom state income tax deductibility was life or death. If those guys joined with the capital formation types, no bill. Finally, only the sales tax deduction was shaved.

"Don't tax poor people." With this injunction, Joann S. Lublin of the Wall Street Journal aptly summed up the prevailing ethos uniting politicians otherwise as far apart as Ronald Reagan and Ted Kennedy. By increasing the personal exemption, the standard deduction, and the earned income tax credit, six million households would be dropped from the rolls. And for good reason. Largely because ten years of inflation had eroded the value of the standard deduction and personal exemption, people with low incomes found themselves paying much higher rates than they could afford. Because Reagan beat the Democrats on the 1981 tax bill, it cut rates rather than raising exemptions, so the poor had received barely any relief. Whereas in 1979 a family of four started


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paying income tax at $1,200 above the poverty line, by 1984 they began contributing at $1,500 below that line. A single parent with three children who earned $8,000 in 1979, just above the poverty line, paid $481 or 6 percent of income in federal tax. By 1984 that person was earning $11,456, a 43 percent increase in nominal income, but had to pay $1,384 or 12 percent in federal tax.[174]

Tax reform would become the major egalitarian initiative of the Reagan years. Just as exempting poverty entitlements from budget cuts and Gramm-Rudman-Hollings was widely supported, so also redressing the increased tax burden on the poorest elements of the population had wide support in both parties.[175] Here we have not a powerful group but one that had wide sympathy from everyone else. Because recent policy trends were so negative, the norm of "fair shares" required redress. But it was also true that, if poor people had not been helped, no bill would have passed. Liberal Democrats would have defected and combined with business advocates, thereby constituting a majority.

Consideration of reducing tax preferences for business was heavily influenced by the growing perception that it was morally wrong and politically indefensible for large corporations to pay little or no taxes, even though they were using perfectly legal measures designed to enhance economic growth. Parallel with tax reform and urged by mounting deficits was enactment of a stiff minimum tax of 15 or 20 percent that applied after a company had used its tax preferences. Although the data on individual companies had long been available, it took Robert McIntyre to drive home the point with horror stories of huge profits and no tax payments. Trained by Ralph Nader, operating on a modest budget of $150,000 a year or so provided by unions, McIntyre churned out data showing that huge companies—General Dynamics, International Telephone and Telegraph, Transamerica, Boeing, etc.—paid no net tax. "We named names," rather than using aggregate statistics as was common, he said, "and that made all the difference." McIntyre claimed that of 275 firms he studied from 1981 to 1984, 50 paid no net tax. "Despite $568 billion in pre-tax domestic profits," he concluded, "these 50 companies received net tax rebates totaling $72.4 billion." Fortune magazine published his blacklist. Congressman Matsui testified that McIntyre "made a big impact, gave us the fuel … for tax increases on the business community. I'll bet every member used his statistics in speeches back homes."[176]

Real estate developers, syndicators, and investors took the biggest hit from tax reform. In addition to the long-standing view among economists that the triple subsidization of housing—deduction for mortgage interest, local taxes, and artificial tax losses—had led to overinvestment, thereby reducing the prospects for other industries, there was a growing


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distaste for what was called "passive" investment. Limited partners in real estate syndicates had invested in large part to generate early losses to offset against their other income, without actively participating in the business. Whether the active-participation distinction made economic or moral sense—most investment was passive—it still placed the real estate industry on the defensive. When the Senate proposed to eliminate or severely restrict passive losses, as well as most other aspects of real estate preferences, including long-term depreciation, the reaction of the industry was well conveyed by President Wayne Therenot of the National Realty Committee—"Terror and disbelief," but "at least our people have nice big buildings of their own to jump from."[177]

The attack on the Treasury proposal by the National Association of Realtors, with its 600,000 members, was direct: Reform was "anti-savings, anti-investment, and anti-home ownership."[178] But it wouldn't wash. Before long, real estate lobbyists were scrambling to lengthen the phase-in provisions so as to cut their losses.[179] Sensing the prevailing scheme of values, they also changed their tune. Real estate lobbyists claimed that poor people would suffer; increased rents would overwhelm tax cuts. Why, a mere 2.7 percent increase in rents would wipe out the envisaged tax reductions. Unfortunately for the realtors, those legislators who cared most about the poor were not convinced. "Whatever benefits [poor families] do receive," said the skeptical Representative Rangel, "it's an afterthought of the whole process.[180]

This is one time when it is easy to draw simple conclusions. All preferences used by large numbers of people, with the exception of state and local sales taxes, were retained. The overall package was shaped by the need to isolate the losers; thus, they were limited to many businesses and, essentially, those individuals who had used breaks to pay taxes substantially below the average level for their incomes. The reforming impulse, strongest within Treasury, to create a purist code designed only to raise revenue in a neutral manner was overcome by democracy: tax preferences for large numbers of people evidently are judged equitable; thus, such social purposes may be subsidized through the tax system.

"Equity," however, is not graven in stone. Social forces shape its meaning. In 1986, as in 1984 and 1982, it was widely considered "fair" to increase taxes on business. In 1986, equity demanded reducing taxes on the working poor as well as exempting the poor from automatic spending cuts. In 1980 and 1981, equity mattered less—or meant something different. That should remind us that there is a politics of defining such public interest concepts as fair shares, or how to encourage economic growth—a political trend that ran for business from 1979 to 1981 and against it from 1982 to 1986.


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The distributional politics of tax reform was identical to the politics of deficit reduction. Big interests, such as mortgage deductions and untaxed fringe benefits, were protected just like social security, essentially a majority in itself. At the same time, any package that angered the ideological right and left would go nowhere. No proposal, for instance, that combined a flat tax with higher business taxes could ever have passed because protectors of both the poor and the corporations would have united against it. Instead, the costs were imposed on business alone.

Business interests were not, however, simply left standing in a game of musical chairs. At first they failed to mobilize. No one anticipated that Treasury 1 would really be the tax specialists' baby, that they would simply be let loose on the Code by Don Regan. Neither the president's commitment nor the legislative elites' desire to do something important was expected by the lobbyists.

In the usual way of the world, that is, accidentally, tax reform proved well crafted to split business interests. First, entrepreneurs as individuals would get lower rates. Second, within industry, Paul Huard, vice president of NAM, said with an evident sigh, "We're like the guy with one foot on each side of a barbed wire"; the fence divided industries that would gain from lower rates from those that would lose from lower tax preferences. The business community, he continued, with admirable foresight, hoped to avoid "degenerating into a pack of wolves tearing at each other's tax." For "if that happens, … Congress, will walk all over us and pick the bones off the carcass.[181] And so it did.

On the grounds that if you can't beat them, join them, a variety of business groups came together in TRAC (Tax Reform Action Coalition), which proposed to support the president's plan while trying to reshape it to be more helpful for capital accumulation.[182] No one wanted to challenge a popular president, nor did anyone see Reagan as antibusiness. The full-fledged war-against-Reagan tactic tried by the Chamber of Commerce in 1982 on TEFRA was not most businesses' style. Besides, it had not worked.

"Up until four weeks ago," John Malloy, a senior vice president of DuPont noted in June 1986, "we didn't think there was going to be a tax bill."[183] When the politicians moved, they did it for their own reasons, particularly the desire to avoid blame for failure, reasons that businesses could do little about. At that point, a mutual fund lobbyist put it well: "Prayer is our no. 1 strategy. I advise my fellows to go to the church of their choice."[184]

The amazing saga of tax reform should alert us to the possibilities of rapid change. The dean of business lobbyists, Charls Walker, was philosophical about being locked out of tax reform: capital formation might


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yet come back into fashion; he would have a chance to get his back. With one thing Walker says we could not agree more: "This isn't the last tax bill."[185]

Politicians' ability to turn on business might seem like proof of their independence, thus confirming their ability to deal with the deficit. They do have some independence, important in evaluating our political system. Yet independence from individual interest and independence of mind differ greatly from independence from majority control. Politicians rarely buck aware majorities. On tax reform they did not. By definition, it was revenue neutral; its distributional consequences would be no worse than a wash. By contrast, deficit reduction was a negative-sum game.


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