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JOHN F. LAWRENCE

Tax Proposal Is Badly in Need of Reform Itself

July 21, 1985|JOHN F. LAWRENCE | John F. Lawrence is The Times' economic affairs editor

Among the tax reforms proposed by President Reagan is one that would tax some of the build-up in cash value of insurance policies.

That hardly sounds earthshaking, but the controversy it has spawned serves as an indication of what the overall plan faces if Congress gets around to considering it.

To the Treasury, those values policyholders amass in their so-called whole life policies are simply one more example of unwarranted sheltering of income. Time was when those cash values earned a poor rate of interest, but in today's competitive money markets, the rates often are much higher. It isn't fair, says Treasury, that individuals must pay taxes on savings certificates and other forms of savings but not on those cash values.

Predictably, insurance companies don't agree and are seeking support from their policyholders to pressure Treasury or Congress to drop the idea. They point out that there are only two ways to tap into those cash values--cancel the policy or borrow on it. That's not the same as a savings account.

Tax Shelter Abuse

Treasury argues to the contrary that it's like long-term certificates of deposit, where the interest is taxed even though it's not collected until the CD matures. Moreover, the ability to borrow on policies has led to tax shelter abuse--insurance plans that combine very little insurance with lots of build-up in cash value. The holder can borrow on that and deduct the interest paid from taxable income while not reporting the interest earned.

Even though some of the abuse was rooted out by reforms already instituted, it's still possible to design a policy in which interest earned can be as much as eight times the cost of the insurance itself, according to the Treasury.

Yes, but the change will have a vast impact on individuals and on a major industry, argue insurance industry leaders. For one thing, the reform will probably kill the whole life business. No great loss, some critics of whole life insurance would say. But the industry points out that close to half the life insurance sold is whole life or another form of permanent rather than term insurance and that the policies are a nice contributor to savings in the society.

Wouldn't people just buy cheaper term insurance and put the savings into a bank or savings and loan? Maybe, maybe not.

Would Contradict Goal

"They'd probably just go buy a boat," contends Fred A. Deering, chairman of Security Life of Denver. Which means the Reagan Administration would be contradicting its goal of getting individuals to rely less on the government and do more to take care of themselves, including preparing better financially for retirement.

That's not all. Whole life policies have poured huge sums into insurance company investment portfolios. That money goes into major investments, such as buildings or stocks and bonds, helping to fuel economic prosperity.

That argument suggests that only insurance companies will buy buildings. But it is a stronger argument than it sounds. It points up that tax reform doesn't just affect fairness in tax collection; it also can have a dramatic impact on the way business is conducted. In theory, change may be needed, but getting from the old taxing system to the new one may just throw some industries into such turmoil that everyone will suffer. It is a risk not adequately addressed as yet by tax reform proponents.

The point here is not whether the insurance industry is right. The point is you can multiply this little controversy by, say, 1,000 times or so to understand how special interest groups will to peck away at this Administration plan. Unless very few of these groups win, tax reform will turn into a jumble and a mess.

Last year, the government made a major effort to crack down on deductions for business use of automobiles. After months of battling with corporations and other interested parties, the whole thing got watered down to the point where one accountant friend suggested that it would be fairer just to give everyone a deduction for car expenses.

Consider the auto example a precursor unless the Administration realizes its mistake and sends reform back to the drawing boards.

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