The Treasury Department's tax simplification proposal would scrap the existing depreciation structure for a system that would tie depreciation more closely to economic reality.

It would modify the accelerated depreciation program, adopted in 1981, which has provided generous tax breaks to companies that invest heavily in plant and equipment, replacing it with a system reflecting both the real economic value of assets and the impact of inflation.

Treasury's proposal to cut the overall corporate tax rate and eliminate the accelerated depreciation program is likely to be favored by companies in the service and high-technology sectors. Because they do not invest heavily in plant and equipment, they have benefited far less from the accelerated depreciation program.

It is likely to be opposed by the steel industry, automobile manufacturers and other heavy-industry groups that will pay higher taxes if the accelerated depreciation program is modified.

Coupled with a proposal that would cut the tax rate from 46 percent to 33 percent, and other proposals, the new depreciation system -- dubbed the Real Cost Recovery System RCRS -- is part of an effort by the Treasury Department to institute a tax system that would allocate resources in the economy more efficiently. The underlying premise is to encourage businesses and individuals to make decisions based on economic consequences rather than arbitrary tax laws.

Depreciation is the loss of value of an asset over time because of its use or obsolescence. RCRS attempts to match the allowable depreciation expense for tax purposes more closely with the real economic loss of value of assets. It also attempts to eliminate problems in the present laws caused by inflation.

"The ACRS Accelerated Cost Recovery System now in effect made depreciation huge to try to stimulate investment and to favor capital investments over others," said Frank C. Wykoff, a professor at Pomona College and coauthor of a study that Treasury relied upon in designing the program. "Under ACRS, you may stimulate investment, but you may not stimulate it where the economy needs it."

"I think the most important thing about the proposal is that it makes the existing system more flexible," said Charles R. Hulten, a senior research associate at the Urban Institute and coauthor, with Wykoff, of the study that appeared in a book called "Depreciation, Inflation and the Taxation of Income from Capital."

"The current system treats most types of equipment by assigning a five-year life, and is very inflexible. The new system takes this five year class and splits it into four sub-classes," Hulten said.

"For example, in the current system, computers were grouped with assets that have long lives, which does not make sense because computers can become obsolete quickly. The new system takes into account actual rates of depreciation and obsolescence. I regard this as a flexible ACRS system which gets the rates right," he said.

By proposing to index the balance sheet value of an asset to inflation, the RCRS would eliminate the traditional problems caused by depreciation schedules based solely on the historic cost of assets.

Tax liabilities should be imposed on the basis of real economic income, and measurement of real economic income requires an allowance for the economic depreciation of property, the proposal says. If that allowance is understated because of inflation, the proposal says, income from the investment is overtaxed, and a tax disincentive is created, which impairs capital formation and productivity.

Conversely, overstating depreciation, as some claim the present ACRS does, and understating income creates an artificial incentive for one form of investment over another, discriminating among companies within an industry and encouraging nonproductive, tax-motivated investment activity. The proposal seeks to promote activity based on economic consequences rather than inflation.

"The proper measure of economic depreciation in any year is the amount of decline in the real value of an asset over the year. . . . Due to inflationary increases in replacement costs, pre-ACRS depreciation deduction for many assets understated actual economic depreciation and thus resulted in overtaxation. . . .

"The cost recovery system introduced with ACRS . . . continued to base depreciation allowances on historic costs rather than current deductions tied to the rate of inflation . . . at recently experienced levels of inflation, ACRS, in combination with investment tax credits, reduced effective tax rates on investment in depreciable assets substantially below statutory tax rates. Where effective tax rates are reduced substantially below statutory tax rates, the tax system is undertaxing real economic income."

RCRS not only would allow cost recovery of the inflation-adjusted cost of assets, but also would revise the assignment of property among cost recovery classes. For example, all depreciable tangible assets would be assigned to one of seven classes, replacing the present five ACRS groups.

Trucks, buses, trailers, and computing and accounting equipment would be grouped together with similar depreciation periods; railroad equipment, boats, engines and turbines would be grouped together and assigned a life for depreciation purposes about three times that of the truck and computer group.

RCRS would be effective for property purchased on or after Jan. 1, 1986. And the new system would be more evenly distributed over the life of an asset rather than "front loaded," like the ACRS system with ACRS's accelerated depreciation rates and the investment tax credit.

"The hallmark of RCRS is the more realistc reflection of economic depreciation and thus a fair and more acurate measure of real economic income," the proposal says.

" . . . RCRS is designed to . . . preserve the simplicity of a depreciation system based on relatively few classes of property."