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Out on a Tax Reform Limb, the Economy Stays Strong : Firms Still Worried Although Effect So Far Has Been Mild

October 18, 1987|DEBRA WHITEFIELD | Times Staff Writer

NEW YORK — George Wachtel will never be a fan of tax reform. "I will always believe it is bad for business," said the League of American Theaters and Producers spokesman.

A common view, but, according to virtually every statistic that U.S. business keeps, wrong.

In Wachtel's industry, entertainment, hotel occupancy rates were up 1.3% in the first half, attendance at Broadway shows is running 12% higher for the year and restaurants report that business seems as strong as last year. All were supposed to falter under a provision making business travel and entertainment only 80% deductible.

Capital spending by American business, a sure tax reform victim by the pundits' reckoning, is on the rise again after a brief downturn. And capital appropriations--the amount that business has approved but not yet spent on investments in plants and equipment--rose a rousing 22% from the first quarter of 1987 to the second quarter.

Heavy industry, whose demise by tax reform was widely predicted, has instead added more than 100,000 manufacturing jobs, and profits are up and gaining steam.

"The fact is we're really seeing a revival of the industrial sector, not its demise," said Delos Smith, an economist with the Conference Board, a New York research group.

Even in the construction industry, which many thought would be blind-sided by the tax revisions, the damage has been less onerous than expected. According to the National Assn. of Home Builders, apartment construction is down 30% nationwide instead of the 50% decline that was forecast.

And small investors and institutions, much to the industry's surprise, are pouring money into real estate investment partnerships--an investment that was written off as dead once the ink dried on the House-Senate conference committee tax bill 14 months ago.

In short, "the message to U.S. business is that we have lived with tax reform for a full year and it didn't do us in," said Allen Sinai, chief economist for the investment firm Shearson Lehman Bros. "In fact, business has had a very, very fine year."

But Sinai, like the theater league's Wachtel, is also convinced that American business "would have done even better without tax reform."

The final verdict, however, isn't in. Some provisions are being phased in over five years, and the economy takes many years to fully register the effects of tax code changes.

Harvard University economics professor Lawrence H. Summers, for example, still thinks tax reform will reduce the gross national product by 5%, inflation-adjusted, over the next 10 years and will significantly reduce business investments even though that has not been the case so far.

Restaurateurs, too, remain unconvinced that business won't substantially cut back on business meals once "the fiscal year is over and business can truly gauge the effects of the tax change" on business travel and entertainment expenses, said Ann Papa, a spokeswoman for the National Restaurant Assn. Restaurants had expected to lose $8.9 billion once business meals were no longer fully deductible, but so far "we are hearing that companies are continuing to use meals as a marketing tool," Papa said.

Overestimated Impact

Some industries need even more time to judge the full impact. Apartment rents, for example, lag changes in the pace of construction by several years.

"We'll know as much as we'll ever know by the end of next year," said Douglas B. Diamond Jr., an economist for the National Assn. of Home Builders. "Right now, it's clearly a mixed thing."

Why were economists and tax analysts so wrong about the ramifications of tax reform for business? Some now concede that they overestimated the importance on business investment of the investment tax credit--which was repealed--and longer depreciation schedules.

But, by and large, the doom-sayers' dire predictions have failed to materialize not because of faulty analysis but because of major changes in economic conditions having nothing to do with tax reform.

The dollar has weakened against both the Japanese yen and the German mark--a boon for U.S. exporters--and the U.S. economy has demonstrated unexpected strength.

"The tremendous devaluation of the dollar this year is something no one could have foreseen," observed the Conference Board's Smith. "Even though a lot of tax benefits were gone, manufacturers saw quite a rise in exports because of the lower dollar. That was much more important than tax reform."

So, too, unexpectedly low mortgage interest rates helped buoy the multifamily housing and commercial construction markets. Conventional financing of such projects was available for about 9% in early 1987, down from 13% in 1984 and 10% in early 1986. (Only recently have interest rates begun rising again.)

Some Surprises

Many tax analysts and businesses also were caught off guard by the liberties taken in the regulations issued by the Treasury Department to implement the new laws.

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