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1986 Federal Tax Policy Memo 1 (1986)

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Editor: Edward A. Sprague, Vice President-Tax and Economic Affairs
The House Tax Bill

What can be said about the 1,363-page House version of tax
reform in one tenth of one percent of the space? For one thing,
they did have the decency to take simplification out of the
title. This was an oft-stated objective of the popular flat tax and
other proposals of recent times and found prominent mention
in the Treasury Report of November 1984, Tax Reform for
Fairness, Simplicity and Economic Growth.
Simplicity has not vanished entirely in the House bill. Many
individuals would find it easier to compute their tax liability,
particularly if they are among the estimated six and a half-
million low-income filers to be dropped from rolls entirely or
among the additional millions who would be encouraged to
switch from itemizing deductions to the standard deduction.
But for those who would have to compute the new alternative
minimum tax and for virtually all businesses-large or small,
economic beneficiary or loser from tax change-tax matters
would be more complicated and careful tax planning even
more important. The potential transition problems alone are
staggering, especially in areas such as capital recovery with
the abandonment of the Accelerated Cost Recovery System
(ACRS) and the investment credit and the institution of a new
depreciation system with minor indexing attached.
Some more complexity was inevitable as the purer ideas of
tax reformers were ground through the legislative mill. Some
of it also reflected the particular way this piece of legislation
was handled-the leisurely pace of post-Treasury Report mas-
saging by the Administration and the extensive trading of
interests within the Ways and Means Committee.
The dimmer the prospects for simplification, the less inter-
est the general public seemed to take in tax reform. By sum-
mer 1985, public sentiment had identified tax reform as just
another Washington dance, and the President was having
great difficulty in generating support for the program. In the
end, the House bill was adopted mainly because of the com-
mitment of the House leadership and an extraordinary effort
by the President to rescue the measure from ambush by
House Republicans.
Aside from lost simplification and last-minute political his-
trionics, there is a degree of continuity in the major themes of
tax reform as set out in the Treasury Report of 1984 and as
evolved in the House bill. These are:
(I.)  Rate reduction and strengthening of tax-free
(II.)  Limited base broadening in the individual sector.
(III.)  Shift of tax burdens to the business sector.
(IV.)  Overall revenue neutrality, at least for the next five
Another major theme was added to the process later on: the
alternative minimum tax.


A few comments on how these played out:
(I.) Rate Reduction and Allowance Increases
The individual tax rate formula of Treasury 1-15-25-35 per-
cent-gathered moral authority of its own over the past year.
Even with the additional 38 percent top rate, the House bill
came closer to it than many thought possible, particularly
after retaining full deduction for state/local taxes. The slightly
asymmetrical 15-25-35-38 individual rate schedule proposed in
the House measure must stand as a singular accomplishment
whatever the eventual fate of reform.
To be sure, there is less incentive value in the way the Ways
and Means Committee constructed its rates. Marginal rates
after the first 15 percent cut in at significantly lower levels of
income than under the Administration program. For joint re-
turns, for example, the House marginal rate is 25 percent over
$22,500, 35 percent over $43,000, and 38 percent over $100,000.
This compares with the Administration's 25 percent over
$29,000 and 35 percent over $70,000. As a result, married
taxpayers currently with $43,000-$49,000 in taxable income
actually would face a two point increase in their marginal rate,
from 33 percent to 35 percent, even though their overall effec-
tive rate of tax might fall. Approximately 9 percent of all joint
returns would be affected by this notch, which would also be a
problem for single and head-of-household returns as well.
These lower thresholds of tax were deemed necessary because
of more limited base broadening and the more decided tilt to
the lower income groups under the House measure.
The importance of a potential twelve point or greater reduc-
tion in the top marginal rate should not be overlooked. This
could have a significant impact on work and savings incen-
tives-more so perhaps than the twenty point reduction from
70 percent to 50 percent in 1981. The latter's impact was ob-
scured by the previous dual treatment of income-earned
income taxed at a maximum of 50 percent and so-called un-
earned or investment income at 70 percent. A maximum rate
of tax in the 35 to 38 percent range could prove effective in
diminishing interest in uneconomic tax shelter investments--
more effective in this respect probably than the complicated
minimum tax proposal in the House bill. Until rates are re-
duced sufficiently so that the combination of Federal and state
marginal rates are well below 50 percent, we will not get a true
test of the market approach to encouraging productive in-
vestment as opposed to tax-motivated shelter investments.
One important drawback to encouraging investment over-
all, however, is the House bill's increase in the effective capital
gains rate to a maximum of 22 percent, compared to 20 percent
currently, and the retention of long-term capital gains as a
preference income item subject to a stiffer alternative mini-
mum tax. Higher capital gains taxes without any indexing of

Material in Federal Tax Policy Meno tnay be reprodiced freely. Credit to Tax Foundation, Incorporated, would be appreciated.

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