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Out on a Tax Reform Limb, the Economy Stays Strong : On Law's First Anniversary, Many Forecasts Falling Flat

October 18, 1987|TOM REDBURN | Times Staff Writer

WASHINGTON — Remember last year's predictions of gloom and doom if Congress passed the tax revision bill? Apartment rents would rise 20% as construction ground to a halt. Contributions to charities and colleges would collapse. More generally, the stock market would almost certainly crash, and the economy as a whole would be brought to its knees.

It hasn't happened.

Like Sherlock Holmes' dog that didn't bark in the night, perhaps the most significant result so far of the massive overhaul of the nation's tax code is how small the effect has been on the economic sectors that figured to be hit the hardest.

And as for the overall economy, it was chugging along a year ago next Thursday, when President Reagan signed the tax overhaul into law. And it is chugging along today.

Analysts will be debating the effect of tax revision for years, but nearly all of them now acknowledge that the widespread forecasts of disaster were wildly overstated.

"Nobody can understand the stock market," fumed Norman Ture, head of the Institute for Research on the Economics of Taxation, who forecast a sharp plunge in the market after Congress raised the capital gains rate. "The market has been wrong before, and it can be wrong again."

Even Lawrence H. Summers, a Harvard economist who is one of the strongest critics of the new law, admitted: "The economy is a very big battleship, and tax reform is a relatively small tugboat."

Dire Predictions

From the moment in May, 1985, when President Reagan presented his own plan for rewriting the nation's tax law, lawmakers were deluged by costly economic studies contending that any major tax overhaul would bring the economy to its knees and wreak havoc on a wide variety of industries and localities.

Nearly every high-powered interest group in the country hired a big-name consulting firm to marshal an authoritative-sounding case against elimination of its own tax preferences:

- The construction industry was going to lay off 350,000 workers because of a "dose of 'Jonestown-type cyanide' " administered by the tax changes, according to one report.

- Oil firms, already hard hit by low energy prices, would lose another 69,000 jobs if Congress dared tamper with "intangible drilling expenses" and other tax breaks.

- Restaurants would be forced to throw 144,000 low-wage employees into the streets once any curbs were imposed on expense-account meals.

- Charitable giving would plunge by $13 billion because lower tax rates would reduce the value of the deduction for contributions to tax-exempt institutions.

- Worst of all, investors would go on strike in the stock market if the favorable treatment of capital gains were changed in any way that boosted the top tax rate on profit.

Somehow, all of these threatened groups have managed to keep their heads above water.

Most surprisingly, construction jobs are running ahead of a year ago despite the elimination of a host of special tax favors combined with rising interest rates and widespread overbuilding in some regions.

Indexes 35% Higher

The oil industry has begun to climb slowly out of its depression even though Congress trimmed several of its tax breaks.

The restaurant business shows no visible signs of collapse in the face of the requirement that only 80% of business meal expenses can be deducted.

Donations to charities have fallen only a fraction of the predicted $13 billion.

And stock market indexes, despite the boost in the maximum capital gains rate to 28% from 20%, are more than 25% above where they were a year ago, even after the market's recent decline.

"All of the specific predictions of doom about investment, the stock market and the economy look pretty silly right now," said economist Joseph Pechman, a longtime tax reform advocate at Washington's Brookings Institution. "I believe the long-run outcome will be positive, but the truth is that other economic and financial trends are always going to swamp the tax effects."

And while the initial shock to the economy from tax overhaul registered high on any economic Richter scale, the damage seems to have dissipated quickly.

Last December, for instance, as consumers rushed to buy cars and other big-ticket items before the expiration of the federal income tax deduction for state and local sales taxes, retail sales soared by a seasonally adjusted $6 billion to $127.6 billion. Then they plunged a stunning $9 billion in January--an unprecedented 7.1%--before rebounding sharply again to a more stable level in February.

Similarly, new orders to manufacturers fell a dizzying $10.6 billion in January but then recovered most of the loss in the following month.

Transition Year

The economy rode out the shock waves easily, though, with inflation-adjusted economic activity rising at a 4.4% annual rate in the first quarter of the year and 2.5% in the second quarter after a 1.5% gain in the fourth quarter of 1986.

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