Spreading Consensus to Cut, Cut, Cut

Changes are ahead because of worry about creating capital and jobs

"The central issue between the Government and the people is taxes, "says New York Representative Barber Conable, the ranking Republican on the House Ways and Means Committee. But rarely do leading citizens and Government policymakers get an opportunity to exchange their views face to face on this basic and sensitive issue. At a moment when the U.S. Senate is debating where and how much to reduce taxes, and many states are moving to emulate California's tax-slashing Proposition 13, Time Inc. last week brought 90 top businessmen and economists to Washington for a Conference on Taxation.

For two days, Time's guests heard from and fired questions at a long list of panelists and speakers. They included Treasury Secretary Michael Blumenthal, Federal Reserve Board Chairman G. William Miller, White House Economics Adviser Charles Schultze, Senate Finance Committee Chairman Russell Long, Senator Edward Kennedy, House Ways and Means Chairman Al Ullman, and Conable. What emerged, among other things, was a surprisingly broad consensus that tax policy, both as a mirror of the nation's goals and as a tool to help achieve them, is moving--and must continue to move--in a new direction.

In many ways it has been as startling a development as the Great Tax Revolt of 1978 itself. Echoing the worries of citizens--and not just those in the tax-pressed middle class--public officials from statehouse to White House are proclaiming that the choking grip of taxation must be loosened to let the underproductive, inflation-riddled U.S. economy breathe more freely and create more profits, capital and jobs. That sentiment was fully reflected at the Time Inc. conference. Sounding what might well have been the keynote of the proceedings, liberal Democrat Ullman declared that in its approach to taxation the nation is undergoing "a turn-around of major magnitude." After a decade in which tax policy was tilted toward achieving various social goals, Ullman observed, the federal taxing powers are about to be shifted to a new priority. Said he: "We are moving toward economically oriented taxation related to growth and capital formation. Capital is perhaps the key to whether we are able to solve our problems of productivity, of competition in world markets, and of inflation."

Ullman's call for help for private enterprise might have seemed startling a few months ago, but at the conference it was the unchallenged wisdom echoed by speakers of many viewpoints. Former Commerce Secretary Peter Peterson, now head of Wall Street's Lehman Brothers Kuhn Loeb, coupled a persuasive appeal for steps to foster the development of new businesses with a wry observation that "an investment banker calling for a cut in capital gains taxes has all the credibility of Dracula asking for charitable contributions to the blood bank."

Peterson need not have been so apologetic. Other proponents of a capital gains cut included such Democratic powers as Louisiana's Long, whose Senate committee has just begun hearings on what little remains of President Carter's tax reform proposals. Long not only urged a large capital gains reduction, but also sounded an imperative to "try to make this [tax] system less counterproductive" for business. Even Teddy Kennedy, the leader of the Senate's liberals, backed tax relief for companies. While he opposed any easing in the capital gains, he proposed an even deeper cut in the 48% tax on corporate profits than the House passed last month. The House voted for a 46% maximum, but Kennedy wants it pulled down to 44%.

Taxes must be cut not only for business but for everybody, and must be cut not only this year but again and again in the future; so said most of the speakers, echoing a public demand that has become politically irresistible and economically sensible. To a great degree, the new consensus for cutting is the result of inflation. Several years of rising prices have made a tax system that may have once seemed moderate and fair both harsh and inequitable, because it produces illusory gains in incomes, profits and home values that are taxed as heavily as if they were real. But there is wide disagreement on how taxes should be cut. How much can taxes be reduced without deepening the budget deficit and thus making inflation, the crudest tax, even worse? Which cuts can best promote investment? Can they be granted without giving an unfair break to the affluent?

The congressional policymakers are agreed that the era of reform in taxes can be closed out, because most of the loopholes have been sewn up. Indeed, Ullman chided Carter for having raised the reform issue without any acknowledgment of the many steps taken since the 1969 tax reform to remove inequities in the system. Long pointed out that much of the push behind reform derived from public fury in the late 1960s over some widely publicized reports about people with huge incomes who paid no taxes. Indeed, he said, one poll shows that many still think that more than half of all high-income people pay no income taxes. In fact, he insisted, because of reforms already put on the books, there is no longer anyone in the country with a net income of more than $200,000 who dodges federal taxes completely.

As for the other great tax thrust of the past decade--the effort to use the system to shift wealth from richer citizens to poorer ones through various forms of transfer payments--it has gone about as far as it can. Transfer payments, such as Social Security and welfare benefits, account for more of the federal budget than anything else, including defense, and probably cannot be increased further, either as a practical or a political matter. The public's mood, as Conable described it, is, "Quit all this talking about equity, and cut my taxes."

There was also broad agreement at the conference that after a round of changes this year intended to stimulate investment, and perhaps another round next year, Congress should leave the details of the tax code alone for a while. Continued tinkering with the rules governing exemptions, deductions and the types of income subject to tax confuse individual taxpayers and corporate executives, leading them to postpone investment and hiring decisions because they cannot be certain what tax rules will apply. Conable suggested that "perhaps we should have a tax moratorium" on structural change in the system. Added Illinois liberal Democrat Abner Mikva, another Ways and Means member: "Wouldn't it be grand if we finally reached a point in our tinkering with the tax code where we were able to say to the American investor or the American business community, 'This is the way it is going to be for the next five years. Now go out and make all the money you can.' "

But there will be no stability in tax rates, at least for a while. The tax cuts enacted this year to take effect in 1979 must be followed by more reductions in 1980, 1981 and perhaps future years. Charles Schultze, the President's chief economist, came close to making that position Administration policy. Said he: "As we look out over the years ahead, additional tax reductions are almost surely going to be necessary. We are going to need periodic cuts to keep the economy properly balanced."

The reason is inflation. Harvard's Martin Feldstein, president of the National Bureau of Economic Research, pointed out that with no change in tax rates, a 7%-per-year rise in personal income increases federal tax collections 10% to 11% by pushing people into higher brackets. Worse, the taxpayer gets no real benefit from a 7% wage or salary raise, since prices are going up that much or more; the extra taxes come right out of his hide. That trims his buying power to an extent dangerous to the economy--and to the politicians who let it happen.

Why not now enact enormous tax cuts to take effect in succeeding years? That is official Republican Party policy in the form of the Kemp-Roth bill, which would reduce taxes 30% over the next three years. Proponents argue that it would either force deep reductions in federal spending or stimulate so much economic activity that it would eventually raise more revenue than the present tax system does. Kemp-Roth opponents call that a "free-lunch theory." Schultze denounced the bill as "a surefire guarantee of inflation" that would stimulate more demand than the economy could reasonably fill and swell deficits that the Government is trying to reduce. The size of each year's tax cuts, he argued, must be determined by economic conditions and how much federal spending can be held down in that year. The economic arguments against Kemp-Roth have persuaded the House to sidetrack it, and almost no one at the conference defended it.

The size of next year's first-step tax cut is not in much dispute. The House passed a bill reducing taxes $16.3 billion a year; the Senate may increase that to slightly over $19 billion. Nor is there much disagreement that about two-thirds will go to in dividual taxpayers. Federal Reserve Chairman Miller said he would like to see part of that sum go not to cutting income taxes but to reducing the Social Security tax increase coming next year. Treasury Secretary Blumenthal would give more of the cuts to people with taxable incomes of $20,000 to $50,000 a year. But the form of cuts for individuals stirred only mild controversy.

Much hotter disagreement came over both the form and extent of tax cuts for companies and investors. In itself that marks a profound shift in tax philosophy. Past cuts have been aimed pri marily at giving consumers more after-tax dollars to spend, in the hope that their buying would lift the economy; business spending to build new plants, modernize machinery and introduce new products was expected to follow automatically. But investment now is very low, and the absorbing question of tax policy has become how to design cuts to spur the largest rise in investment. Or, to put it another way, how to remove obstacles that the tax code puts in the way of investment. As Robert Anderson, president of Rockwell International, explained: "If I had a partner who put up all the money, took all the risks, did the big gest part of the work and gave me half the profits [a reference to the 48% corporate tax], I would be a hell of a lot more encouraging to that partner than I think the Government has been to business during the past 20 years."

Fed Chairman Miller spelled out some of the reasons for concern: "The Japanese spend 20% of their gross national product in fixed investment, and Germany spends 15%, and we are spending 8% or 9%." He drew an analogy with 16th century Spain, which "became the principal beneficiary of the discovery of the New World in the form of large amounts of gold and silver, introducing into Spain huge amounts of unearned purchasing power. It was spent to build the most elegant society the world had ever seen up to that time in Europe . . . But it was a consumptive society, and when the Spaniards went through their gold, they invested nothing--and economically they entered the 17th century barefoot. The question for us is: Have we found a way to build an affluent society? Are we putting enough back into the system so that we can assure our capacity to produce a high standard of living for our heirs?"

Peterson recited a doleful string of 20th century U.S. examples to prove that "we are losing some of our innovative juice." In the 1950s, U.S. spending for research and development was rising at a brisk average rate of 14% a year, but in the entire four years from 1973 to 1977, R. and D. spending rose only a nearly invisible .8%. The Commerce Department issued 68,000 patents last year, down from 70,000 in 1967. Worse, 25,500 of the 1977 patents went to foreigners, vs. 14,700 ten years earlier; in the key field of business and accounting machines, the number of U.S. patents issued to foreigners has increased 75% in the past decade. Another Peterson observation: "Possibly the single most important [new] product around is video recorders. I do not know of a single American manufacturer making consumer video recorders."

So business taxes must be cut to stimulate more--and more innovative--investment. But which taxes? And how much? The conference turned up a sharp schism between two groups: those who want a deep cut in capital gains taxes and those who prefer almost any other approach.

That the subject should come up in that form at all is rather amazing. Capital gains taxes are levied on profits realized on the sale of stock, real estate, businesses or almost any asset held for twelve months or longer. As late as 1969 the lid on this tax was 25%; one of the supposed triumphs of the loophole closers of the mid-1970s was to raise that maximum to 49% now, and as recently as a year ago the Carter Administration was preparing a proposal to tax capital gams at full ordinary-income rates, which would have meant a doubling of levies on many small and medium-size gains. Then Wisconsin Republican William Steiger, a panelist at the Time conference, introduced an amendment to peel the levy back to 25%, and to his own astonishment got a mighty bandwagon rolling. The House wrote into its tax bill a cut in maximum capital gains rates--though only to 35%.

Steiger and his allies assert that high capital gains taxes hit the economy precisely where it is most vulnerable. They steer investors away from innovative, high-risk ventures and push people to buy such securities as bonds of mature companies, which yield a steady, safe return. That return is taxed at ordinary-income rates, to be sure, but then capital gains rates are no longer low enough to compensate investors for extra risk. Supporters of Steiger argue persuasively that cutting capital gains rates would raise federal revenues rather than reduce them. People would sell assets they have been salting away in safe-deposit boxes, move the money into new investments that help the economy, and produce a greater volume of transactions to be taxed. Russell Long, who will have as much to do with shaping this year's tax legislation as anyone, asserts: "I have no doubt that we are going to cut the capital gains tax. And I am convinced that [the Government is] going to make money on it."

The Administration's original argument against a capital gains cut was that it would unduly favor the affluent, who have the most money to invest and reap the biggest gains. At the conference, Secretary Blumenthal repeated that contention, but in greatly diluted form. He said that "a capital gains tax cut is acceptable if it does not provide an opportunity for people to escape virtually scot free from any kind of taxation."

The opponents of an immediate capital gains tax cut--a clear minority at the conference--made their argument mostly on grounds not of equity but of efficiency. Basically, those grounds are that: 1) it cannot be proved that such a reduction would raise revenue; the safer assumption is that since a capital gains reduction is, after all, a tax cut, it would reduce revenue; 2) cuts in other business taxes would produce more new investment per dollar of forsworn revenue than a capital gains reduction. Senator Kennedy estimates that 85% of all capital gains are realized from real estate sales or other transactions that contribute little if anything to making the economy more efficient.

This school would focus on three alternatives: cutting taxes on corporate profits more deeply than the House-passed bill now does, increasing the tax credit that businesses get for investing in new plant and equipment, and permitting businesses to take faster depreciation write-offs on their plants and machinery. Steiger's opponents disagree on what mix of these alternatives is to be favored. The Fed's Miller argues that tax cuts should be designed to "incentivize" business into expansion and modernization. He advocates not only delaying a capital gains tax reduction but also substituting accelerated depreciation for a cut in the corporate profits tax; in his view that would more directly spur investment in new plant and equipment. Says Miller: "A reduction in rate means that businesses have more cash, but has no relation to how they spend it. They can spend it by reducing debt, by buying up other companies, by putting it in their jeans and declaring more dividends." Many other speakers consider a cut in the profits tax an essential element in any strategy to stimulate investment.

However the quarrel may be compromised in this year's tax law, it will probably rage on. Steiger, for example, is looking beyond cuts in capital gains taxes to a complex idea of lowering the corporate profits tax to 40% as well as making depreciation allowances reflect the inflated rather than the original costs of assets. In exchange he would wipe out a dozen tax breaks that corporations now get, including the investment tax credit.

Whether that or any foreseeable approach would work is unknowable. Calculating the effects of possible tax changes on business investment decisions is one of the most arcane of arts. Brookings Economist Joseph Pechman, a liberal, points out that one goal of economic policy should be to increase productivity. But, he insists, it is impossible to know what kind of tax changes, if any, would do that, be cause economists are most uncertain what is causing the current slowdown in productivity. His view was disputed by several other speakers, but Pechman has a point: Congress is unlikely to find the best mix of policies to spur investment on its first try this year, and a long period of tinkering probably lies ahead.

A wide range of issues related to tax policy kept coming up at the conference. Blumenthal discussed the Administration's tax strategy as part of the overall fight on inflation, and stressed that the Government cannot wage that battle alone. "There are contributions by labor and by industry that are required also. The President in the next few days will be considering additional options, and I am sure we will be appealing to business and labor for additional help and additional sacrifices." That sounded like a call for a kind of social compact to keep wage and price boosts moderate, and it clearly hinted at the wage-price guidelines that are likely to be a major element in the Administration's Stage Two anti-inflation program.

Blumenthal also pledged "a very tight fiscal policy," and in deed reinstated balancing the federal budget by fiscal 1981 as an Administration goal. That did not satisfy Alan Greenspan, former chairman of President Ford's Council of Economic Advisers. He lamented that basic functions of government at all levels have been broadened over the past several decades "with no internal rational limiting process," generating irresistible pressures to spend. The only solution he could see is a constitutional amendment enforcing budget limits.

The outcry against spending has been particularly loud at state and local levels, where the tax revolt also is fiercest. Iowa's Republican Governor Robert Ray complained about all the mandated federal programs that force states and localities to spend money that they do not have themselves. "We hire people whether we need them or not because that is the only way we can get our share of the [federal] money. We don't really like that." Governors, said Ray, would prefer to receive revenue-sharing funds that they may use as they see fit, to reduce taxes if necessary. But both Congress and the Carter Administration are reluctant to surrender any federal controls. Concluded Ray: "I suppose if we Governors could convey just one message to our federal brother it would be: 'Please, whatever you do, don't impose new congressional or Executive mandates on us without reimbursement for their costs.' "

Jerry Wurf, head of the American Federation of State, County and Municipal Employees, noted that tax problems vary widely from state to state. Not every state had recklessly built surpluses that were bound to outrage tax-oppressed citizens. California's Governor Jerry Brown, said Wurf, had been blind to the "possible devastation" of this development, and an "explosion" resulted. Wurf cited Iowa as a state that had prepared for the tax revolt, and Ray agreed. Iowa's experience, he asserted, could show other states how to "prevent ballooning, rollercoasting and meat-ax budgeting." Back in 1971 Ray persuaded the state legislature to shift increased school costs from property taxes to general revenues. Since then, property taxes have declined from $14.62 per $1,000 of assessed valuation to $11.14, while state aid to schools has jumped $375 million. Elderly and disabled citizens have been given a tax credit of up to $1,000 a year as reimbursement for property levies. Finally, as property values soared in Iowa, as elsewhere, a ceiling of 6% of market value was placed on property taxes; homeowners pay an estimated 20% to 30% less than they would pay had the tax increases not been checked.

The tax debate is bound to raise profound philosophical questions. Fed Chairman Miller asserts that Americans are prepared to pay for sound government and the services they want, "as long as they feel they are getting value for their money and as long as they feel that there is an equitable system in which nobody is getting away with murder." Which in a way echoes Justice Oliver Wendell Holmes' observation that taxes are the price that society pays for civilization.

But just how much government do Americans want? If the drive to cut taxes implies a smaller role for government in society--a point conceded by all speakers at the conference--exactly what should government do less of? In the past, the American tax system has tried to serve many goals: raising revenue, regulating the level of demand in the economy, promoting social equity, rewarding behavior thought to be desirable (buying houses, for instance), and punishing acts judged useless or harmful (e.g., smoking cigarettes). If taxes are now to be cut, which of these sometimes conflicting goals is to be given priority over which others? Perplexing as these problems are, they must be faced. Because there is no mistaking the consensus: taxes must be--and will be--cut, cut, cut. qed

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