THE GREAT TAX FLIMFLAM OF '86

For practical purposes, Congress has finished work on its most comprehensive overhaul of the nation's tax structure. The actual legislation that will accomplish these changes has not been published - indeed much has yet to be written.

But President Reagan already has hailed the congressional agreement as a triumph, which makes it plain that the basic political deals required to pass the bill have all been cut. Barring an extraordinary, completely unexpected upset, the new Internal Revenue Code of 1986 should become law before the end of September.At the core of the upcoming overhaul of the tax code is a massive reshuffling of tax liabilities - to quote the New York Society of Certified Public Accountants, simultaneously the largest tax cut and the largest tax increase in history.

Theoretically, the legislation will be revenue neutral - it will neither raise nor lower tax revenues. Individual tax rates will decline to just two brackets (15 percent and 28 percent) and six million taxpayers will be dropped

from the tax rolls entirely. As a result, individual liabilities are slated to go down by about $120 billion over the next five years.

Corporate tax rates also will go down, but because of other changes in the law, corporate tax liabilities are supposed to go up - also by about $120 billion. The political arithmetic of the pending tax law changes is powerful: 76 million people are to get tax cuts and only 17.6 million should pay higher taxes.

But this is only part of the story. Approximately $320 billion in tax incentives will be either repealed or curtailed. This means that many taxpayers - chiefly upper-income individuals and corporations - will face both higher and lower taxes at the same time. Some tax rates will go up and others down. Only time will tell the actual net effect of all these changes. Some analysts maintain there will be a serious erosion of revenues.

The basic thrust of the pending tax changes is to reapportion the tax burden by repealing most of the myriad incentives for investment that are embedded in the current tax law - including a sharp hike in the tax rate on long-term capital gains.

The bottom line is that the changes will cut taxes for low-income

families who spend most of their income and raise them for upper-income individuals and companies that save and invest. According to the staff of the Joint Committee on Taxation, based on the expected level of income in 1987,

families with incomes of less than $10,000 will get a tax cut of 55 percent, while families with incomes of more than $200,000 in income will have a tax increase 11.4 percent.

Basic industry - already hard hit by import competition - will lose the most under the new tax code. High-tech manufacturers and the service sector, which have been profitable, generally do the best. The White House has advertised the new tax code as providing a neutral environment for economic decision-making. But this seems unlikely in practice. To quote John D. Connolly, senior vice president of Dean Witter, it tilts toward consumption rather than investment.

President Reagan came into office in 1981 pledging several basic goals for the domestic economy: (1) a balanced Federal budget, (2) new incentives for saving and investment and (3) strict control over growth of the nation's money supply.

The balanced budget has, of course long since been washed away by more than a trillion dollars of red ink. The Federal Reserve - egged on by neo- inflationists on the White House staff - has had a long-running love affair with easy money which has made a mockery of any notion of monetary stabilization. With the pending tax bill, which seems certain to boost substantially the cost of capital and thus discourage productive investment in plant and equipment, Mr. Reagan has come full circle.

In part reflecting the toxic side effects of record-breaking Treasury deficits, the U.S. economy is already suffering from a fundamental loss of competitive position in world markets. U.S. goods and services transactions with the rest of the world resulted in a record deficit of $150 billion in the second quarter (measured at an annual rate in real, 1982 dollars).

The United States' net creditor position in the world economy - which accumulated gradually during the 20th century - has been wiped out in the past five years, as the nation has started to borrow heavily overseas in order to consume more than it is producing.

Since 1980, net investment in productive assets (gross investment less the amount required simply to replace plant and equipment that is wearing out) has dropped by one-half as a percentage of GNP, compared with levels that were characteristic earlier in the postwar period.

At the same time, growth in productivity has also slowed sharply, not simply over the last few years but over the long run. Output an hour in the non-farm business sector grew at an average rate of about 2.6 percent from 1947 through 1969. From 1970 through the second quarter of 1986, the average growth in productivity was about 1.1 percent. This is critical because long- term economic growth is wholly a function of (1) the increase in the size of the labor force and (2) the growth of productivity.

Given this background, it is hard to see the rationale for restructuring the tax code to encourage additional consumption (presumably of imported goods paid for with borrowed money) and to discourage investment in productive assets.

The new tax law could in fact set the stage for a national sales tax or a value-added tax within a few years. The law will raise taxes sharply on key types of saving, investment and capital formation. If past experience holds, the increase in tax rates on capital gains will reduce, rather than increase, Treasury revenues - perhaps by as much as $45 billion over the next five years. In the end, a sales tax or a valued-added tax may be only way to balance the Federal budget.

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