Losing Big Under Treasury Ii

By William R. Doerner

One item would be a major provider of new revenue for the Federal Government, but it could also turn President Reagan's tax-reform plan into a tax increase for millions of upper-income Americans in high-tax states. The other would bring in only peanuts, relatively speaking, but it could radically change the life-styles of businessmen, professionals and their clients throughout the nation. Together, the proposals to eliminate the deductions of state and local taxes and to restrict severely those for business entertainment have emerged as two of the most controversial parts of the President's tax package. Both have already stirred passionate campaigns of opposition and seem likely to remain at the center of the tax debate. An examination of the two issues:

On the theory that income owed in taxes to state and local authorities should not be taxed again, Washington has traditionally allowed taxpayers to deduct those funds from their federal total. For those who itemize their deductions, especially if they live in a state with high taxes, the largest single write- off on their federal return is often the combined total of state and local taxes on income, real estate and retail sales. Residents of New York State who took the deduction in 1982, for example, saved an average of nearly $1,300 on their federal tax bill. Not coincidentally, the Empire State also imposes the nation's highest state and local tax rates.

Reagan opposes this arrangement on both philosophical and financial grounds. By allowing residents of high-tax states to lessen their federal obligation, he contends, Washington in effect underwrites big spending at the statehouse level, which he abhors. Moreover, since only one-third of U.S. tax returns are itemized, Reagan notes, the benefit is not even available to a majority of taxpayers. "But they are being forced to subsidize the high-tax policies of a handful of states," the President said in his speech Tuesday evening. "This is truly taxation without representation."

But more than principle is at stake. The $33 billion in new federal revenue that would be generated in fiscal 1987 by eliminating the deduction for state and local taxes could not easily be found elsewhere. One of Treasury Secretary James Baker's first decisions in his reshaping of the Treasury I tax-reform package was not to tamper with that provision, and it survived intact in Treasury II. If they give in now on sub-federal tax deductibility, Administration officials fear, they run the risk of losing the whole tax- reform plan.

Not surprisingly, opposition to the Administration proposal runs strongest in states where taxes are highest, starting with New York. By the estimate of one congressional study, loss of deductibility would add some $1,600 to the average 1987 bill of New Yorkers who itemize their returns, about half of the state's taxpayers. Calling the proposal "a crushing blow" that would "cripple" the state, Democratic Governor Mario Cuomo vowed to fight the disallowance provision with every means at his disposal. Those include a plea to New York City's generous political contributors, who help bankroll every national campaign and many important state races, to boycott fund-raising activities on behalf of candidates who support the measure. "This is one- issue politics," said Cuomo. "The issue is called survival." Many prominent Republicans in the state were also alarmed. To protest the proposed change, G.O.P. Senator Alfonse D'Amato staged a mock re-enactment of the Boston Tea Party from a 62-foot sloop in New York City's East River. Even ardent Tax Reformer Jack Kemp, a Congressman from upstate, favors adjustments that would ease the tax burden on New York residents.

Elsewhere, the proposal was assailed less forcefully. Though Californians would also be hit hard by loss of the deduction, Republican Governor George Deukmejian had a muted response on the matter. While Deukmejian said he would look "askance" at any reform that resulted in a net tax increase for residents of the state, he was clearly not anxious to provide early offense to his fellow Californian in the White House. In San Francisco, which has no income tax but exacts hefty real estate levies, Mayor Dianne Feinstein, a Democrat, endorsed the overall Reagan plan as "a major step forward." Only in a few high-tax states in the Midwest did officials echo Cuomo's strong opposition to the loss of deductibility. Said Wisconsin Governor Anthony Earl, a Democrat: "If the federal government wants states to take on more responsibilities in education, in human services, in the environment, then they shouldn't penalize us for raising taxes to pay for them."

In fact, the Reagan Administration not only wants states to assume new responsibilities, in some cases it is forcing them to do so by reducing federal programs. Says Brookings Institution Tax Specialist Henry Aaron: "In an atmosphere where specific expenditure programs are getting cut, it is a little hard on the states to say we are also going to go cold turkey next year on denying deductibility." Norman Beckman, director of the Council of State Governments, referring to the 1978 California tax-cutting measure that hit many city and county governments hard, warned that loss of deductibility would have "a Proposition 13 type effect nationally."

As for the wide variation in state taxing levels, Cuomo argues that those with high ones have "disproportionate need," including large numbers of poor and elderly. According to Joseph Minarik, a senior research associate at the Urban Institute who testified on the loss of deductibility before the Joint Economic Committee last week, it is these least-powerful groups who in the end would pay most heavily for repeal. Reason: as states and cities cut expenses under pressure from taxpayers, the have-nots would lose public services. Finally, opponents of disallowance point out that more taxpayers (33 million) claim deductions for state and local taxes than for home mortgage payments (24.5 million), which remain deductible under Reagan's plan. That hardly makes the deduction for state and local levies an elitist provision, its supporters argue.

Even though homeowners across the country would lose their property tax deduction, it is only in seven states (New York, New Jersey, Massachusetts, Michigan, Wisconsin, Minnesota and California) that opposition to the loss of local deductibility is running high. The Administration dismisses these protests as being equivalent to the howls of special interests. Appearing on Good Morning, America, White House Chief of Staff Donald Regan declared, "It's just the wealthy people in New York" who would be affected. Added Baker: "It's a subsidy that we don't think is fair."

Reagan's proposals for business entertainment and travel expenses center on the corporate bete noire of previous Administrations, the celebrated (and all but fictitious) three-martini lunch.* The tax plan would limit the deduction for any business meal to $25 per person, plus half of anything in excess of that amount. The fully deductible $25 would not cover the cost of many a catered buffet cocktail party, let alone lunch or dinner at a first-class restaurant. Even so, it is far less draconian than the original Treasury Department plan, which specified per person limits of $10 for breakfast, $15 for lunch and $25 for dinner.

For business entertaining beyond the dining table, the Administration's knife was much sharper. Barred completely as deductible business expenses would be the cost of tickets to sporting events and the theater, membership fees in country clubs and hunting and fishing lodges, and outlays for executive hospitality toys like yachts. Expenses for travel aboard cruise ships beyond ordinary airfare for the same trip would be disallowed unless medically required, as would conventions and seminars conducted at sea. Finally, no one would be able to claim travel costs as educational expenses, a provision evidently aimed at teachers who go abroad during summer vacations or sabbaticals. Write-offs for other travel expenses, including hotel accommodations and premium airfares, would not be affected so long as they are "reasonable and necessary."

The new restrictions are not expected to produce large amounts of additional

revenue: the Treasury Department estimates that they will raise only about $2 billion annually by 1990, from both individual and corporate returns. But the Administration contends that the changes are justified because nothing has served more effectively to undermine public confidence in the tax system than the high visibility of extravagant business entertainment. Defending the cap on meal expenses, the Treasury Department contended that only 2.5% of all meals served by U.S. restaurants cost more than $19. Stated a summary of the tax plan: "Placing a limit on the deductibility of business meals would eliminate the extreme cases of abuse -- those that offend the average taxpayer the most."

Owners and employees of the $30 billion restaurant industry were quick to disagree. Calling the Reagan proposal "totally unacceptable," National Restaurant Association President Ted Balestreri declared, "Meals purchased in restaurants for potential clients or customers in order to sell goods or services are a legitimate cost of doing business." The Reagan cutoff, he claimed, puts restaurants at an unfair disadvantage in respect to other forms of fully deductible "promotional expenditures," such as advertising. The result, he predicted, perhaps with some extravagance of his own, could be the loss of as many as 100,000 jobs. Warned Chicago Restaurateur Rich Melman, whose eateries include the Pump Room: "A lot of fine restaurants are going to suffer."

The threat to professional sports, which would not be even partly deductible, is potentially even more severe. By Administration estimates, businesses buy nearly one in three of the 45 million big league baseball tickets sold annually and more than half of the 12 million professional hockey admissions. "The Reagan plan could be devastating," said William Wirtz, president of the National Hockey League's Chicago Black Hawks. "All professional leagues are struggling to keep player salaries under control and costs down. Now ticket prices will probably have to rise (to make up for lost revenue), and the fan will suffer."

There was also gloom in Manhattan's Broadway theater district, where business entertainment accounts for close to 20% of ticket sales. Said Harvey Sabinson, executive director of the League of American Theaters and Producers: "If we were to lose a great percentage of those sales, that could close some shows that are running marginally."

Others were not sure that the consequences of the new measures would be quite so dire as predicted. Said Tex Schramm, president of the Dallas Cowboys: "If an $18 sports ticket is a good way for businesses to entertain, they're not going to stop because they cannot write off the cost of the ticket." Moreover, some of the regulations may prove difficult to enforce. Some business hosts, for example, might seek to raise the $25 meal deduction by claiming a few phantom guests.

Nevertheless, the imposition of stricter limits on business entertainment deductions would almost certainly have an effect on corporate folkways. No longer would executives be able to sit down to three-star French fare without thinking of the bottom line. Charles Clotfelter, a professor of economics at Duke University, anticipates that the result will be a healthy dose of moderation. "It's still important for businesses to entertain," he says. "It always has been. But I expect to see entertaining on a much less grandiose scale." So, presumably, does Ronald Reagan.

FOOTNOTE: *Presidential martini rhetoric has inflated at a pace roughly equal to that of the economy. According to former Senator Eugene McCarthy, John F. Kennedy spoke disparagingly of the "martini lunch" and 1972 Democratic Presidential Candidate George McGovern inveighed against the "two-martini lunch." Jimmy Carter, a no-martini Baptist, raised the critical count to three in 1978.

With reporting by Gisela Bolte/Washington, with other bureaus