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John F. Lawrence

Tax System Change Can Be Painless

January 20, 1985|JOHN F. LAWRENCE | John F. Lawrence is The Times' economic affairs editor

Living with the U.S. income tax system is like a bad habit. We know we should change our ways, but that may take too much willpower.

It's not difficult to see the unfairness of a system that permits some to avoid paying entirely while others, making the same income, pay a lot. But now that we've finally launched a bold effort at reform, many in our midst aren't so sure they can stand the pain.

Well, here's some good news. Breaking this habit needn't be that painful--complex, maybe, but not painful. There may be no easy way to stop smoking except to stop. It takes the opposite discipline to change the tax system--a willingness to do it very slowly.

Even the reformers at the Treasury Department recognize it. Early in their 670-page reform proposal, they hit the issue head-on:

"Tax reform has often--and long--been held hostage by failure to deal with transition issues; those who would be hurt by tax reform have successfully resisted change. . . . Transition steps are necessary both to ease the impact of tax changes and to make tax reform a political reality. Without them, reform will not occur, and this generation will leave to the next a tax system that remains deeply flawed."

The proposal goes on to suggest gradual implementation, including so-called grandfathering, so the new laws don't apply to some existing situations and thus penalize taxpayers for what they did to legally shelter income in the past.

The immediate question, of course, is just how lenient the Treasury proposes to be. A quick look through the reform proposal suggests not nearly lenient enough. For example, the plan provides for the phasing out of deductions for state and local taxes over only a two-year period. That could mean substantial tax penalties for residents of high-tax states such as California and too little time for those states' legislatures to react and adjust sensibly.

It proposes a cap on interest deductions, not including the mortgage on the principal residence. If applied immediately, such a limit would affect many individuals with second homes, not to mention other debt, incurred under the old system.

The answer to this potential inequity--and by the Treasury's own admission, political hurdle for getting the reforms through Congress--is one word, patience. There is no reason that a complex tax system built over decades to influence how people use their money should be changed abruptly.

The proper course of this all-important tax reform is long-term phase-in, with long-term meaning in some cases as long as a decade, if necessary, to avoid doing undue damage. It might seem that only the tax avoiders will be affected, so why worry? But, in fact, if a change in taxes destroys the value, say, of some real estate deals, real estate prices generally could be affected if too many properties are dumped.

One possible step might well involve offering a temporary choice between the old system and the new. Not that we could continue to seek new tax avoidance schemes, but rather that there would be incentives leading us to phase ourselves into the new plan.

As a carrot, the Treasury proposes to have the Internal Revenue Service study a "return-free" system. The IRS would do the work and just let us know what our taxes are.

Few of us are ready to trust the IRS that far, but who wouldn't like to be free of all that work if the final results were thought to be fair to all?

Is getting there worth it? Ask the fellow whose next-door neighbor pays half the tax he does on the same income and uses the savings to purchase a new car every year.

Or consider that the Treasury figures individuals may have sheltered as much as $35 billion of income in 1983 simply by getting into partnership deals, a common form of tax shelter arrangement. Or that oil and gas and real estate partnerships reported losses for tax purposes of $31.6 billion in 1982 and yet actually wound up the year with $7.6 billion of so-called "positive net cash flow"--a euphemism for "money they can put in the bank."

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