The Ways & Means Tax Bill
Jude Wanniski and Alan Reynolds
November 25, 1985


Without its flaws, the bill is better than current law and from that point can be improved on the House floor, the Senate and in conference. The President can draw on his post-summit popularity to straighten out the weak points and avoid a partisan clash at the same time.

The bill's biggest failure is that it does not reduce marginal tax rates for most taxpayers, and in fact raises marginal rates in the first year because of the July 1 effective date. The top tax rate for 1986 would be 44% -- half the year at 50%, and the second half at 38%. In the following year, those currently in 11-18% tax brackets would move into a 15% bracket, those now facing 22-28% rates would be taxed at 25%, those at 33-45% would go into a 35% bracket, and those earning over $100,000 on a joint return (currently a 49-50% bracket) would face a new fourth bracket of 38%. Taxpayers would face a 35% rate with a joint income of only $43,000, compared with $70,000 under Treasury II. The July 1 effective date, agreed to over the weekend, is probably what surprised the stock market, sinking it today.

Retaining state-and-local deductibility is the problem; it costs too much. The Ways & Means staff bill cut 60% of this deductibility, which is how it got the lower rates and higher thresholds. One strategy being urged on the President: Invite Rostenkowski to make small changes before final passage in committee, in exchange for White House support on final floor passage if a GOP substitute fails (which is likely). For example: Restore higher middle-income thresholds, top rate of maybe 36%, in exchange for restoring some cuts in deductibility; allow $2000 personal exemption to run across all income classes, paying the bill with elimination of consumer-interest deductibility. This would leave it to the Senate to fix depreciation schedules and win back some business support.

Other glitches: Repeal of income averaging discourages risk-taking in favor of fixed salaries. Raising the corporate and personal minimum tax to 25% on a broader base (up from 15-20%) also hurts. It could impose taxes on legitimate costs, rather than on net income. The top corporate rate drops to 41% in the first year, 36% after that. The top capital gains rate rises to 25% in the first year, 22% in the future. With little improvement in personal tax rates on capital, the net effect of a slightly lower corporate rate and slightly higher capital gains rate is probably insufficient to balance the loss of the investment tax credit and accelerated depreciation. The timing of the "blended" tax rates would tend to push realization of capital gains into 1985 or 1987, and to depress reported profits and personal income in 1986 (e.g., by shifting expenses into 1986 and receipts into 1987). This unravels the "revenue neutrality" excuse for postponing rate reductions until July -- it would not raise more revenue, but would make the economy look worse than it really is.

Bottom line: Considering the fact that the Ways & Means bill was essentially written by liberal Democrats, it's in the ballpark as the basic reform vehicle. Another few passes, with Reagan and Regan getting into the act, and we'd have a fairly decent piece of legislation on the President's desk.