When Senate Finance Committee Chairman Bob Packwood (R-Ore.) brought his tax-overhaul bill before the Senate three weeks ago, he spoke with pride of how it would take taxes out of daily life.
"For the average Americans who are now in the 25- or 30- or 33-percent tax bracket, their taxes are going to be in the 15 percent bracket, and they are going to make decisions for themselves as to how they invest their money," Packwood said.
"They are going to decide whether or not they want a car, not based upon the fact that they can deduct the interest on the car loan, because that is gone in this bill. . . . What they are likely to do now is save the money and pay cash for the car. That should improve the savings rate in this country."
The legislation approved overwhelmingly by the Senate last week would indeed do away with many tax breaks, equalizing taxes on industries and wiping out unproductive shelters, while reducing tax rates for individuals and companies.
But, like practically every tax bill produced by Congress this century, the Senate measure also has a few gaping loopholes and inequities.
Perhaps the largest escape clause would let many taxpayers get around repeal of the deduction for non-mortgage interest, such as credit-card debt or auto loans. Because the legislation preserves the deduction for interest on mortgages for up to two homes, taxpayers would be able to borrow against their houses without limit -- and use the money for purchases of other goods.
"If the objective of the mortgage interest deduction is to encourage home ownership, why should we subsidize fur-coat purchases? " Sen. Phil Gramm (R-Tex.) asked during floor debate over an amendment to close the loophole. "Why should we subsidize loans for vacations simply because the home is used as collateral? What sense does that make? "
The Senate tax bill must be reconciled with the House version before a compromise measure can be taken up by both bodies, a process that may well result in deduction of some consumer interest in the final package. The House legislation permits deduction of interest on loans for up to two homes, plus an amount equal to investment income plus $20,000. Senate repeal of the interest deduction would be phased in over five years.
But bankers here and elsewhere are expanding their already-growing loan programs based on the equity individuals have in their homes, and say their business could increase significantly if anything close to the Senate package becomes law.
Chemical Bank and Citicorp, among others, are doing market research to find how much interest consumers would have in borrowing against their homes if there were restrictions on other interest deductions. Loans using home equity as security already are expanding beyond conventional refinancing, so that consumers can write checks or draw on lines of credit rather than obtaining a fixed-term loan.
"With the tax bill, the service is going to be a bit more important than it would have been otherwise," said William V. White, executive vice president of the National Bank of Washington, which this fall will begin offering a line of credit secured by home equity.
Eventually, White said, bankers may even be willing to lend homeowners more than the value of their equity, if their income is large enough to ensure that they can make the payments, the same way they now make non-mortgage loans that are not secured. And if the Senate limits become law, some analysts believe even credit-card companies would base their programs on home-lending.
Such lending, of course, would benefit only certain taxpayers. People with considerable equity in their homes -- who own more of it and the bank less -- could borrow more than could heavily indebted homeowners. Renters seeking car loans, college loans or other credit presumably would not be able to use the loophole and could not deduct the interest.
"It gives a big advantage to those older and better-to-do taxpayers who have more equity in their houses," said John Makin of the American Enterprise Institute. "Us poor folks who are mortgaged to the teeth can't borrow against that."
Just as the Senate bill treats homeowners differently than renters, it treats employes differently than the self-employed.
Proprietors who own their own businesses could continue to deduct, as business expenses, such costs as professional dues, special equipment or clothing. But the legislation does away with the deductions under which salaried employes now deduct similar costs, such as those for uniforms, tools and union dues. (There is an exception for handicapped workers.)
Thus a doctor could continue to deduct dues to the American Medical Association, while the nurse working in the same office could not deduct dues to the American Nurses' Association.
The ANA says it is looking into the potential cost of the provision to its members. The change also would affect actors, writers, musicians, carpenters, other tradesmen and some police officers and fire fighters.
"Existing law allows employes to deduct ordinary and necessary expenses incurred in peforming their jobs. I believe the bill went too far in making Draconian changes in this area," said Sen. Bill Bradley (D-N.J.), a supporter of almost every other provision of the bill. Packwood promised on the floor that he would try to remedy the disparity in conference with the House (which limits but does not repeal the deduction).
Another provision of the legislation also treats some taxpayers differently than others, making it possible to continue sheltering income by transferring it to children.
The legislation would require that income earned on gifts from a parent to a child be taxed at the parent's tax rate, which presumably is higher (the gift itself is subject only to the gift tax). But the provision covers only parents, so that grandparents who wish to give money or income-producing property to their grandchildren could do so and the income would be taxed at the child's rate.
An exception placed in the bill with more deliberation and publicity than employe-business deductions or gift rules would give investments in oil and gas more favored treatment than investments in real estate and other industries. Generally, deductions springing from "passive" investments only could be taken if the investment produced income equal to or exceeding the deductions for depreciation and other costs.
But in order to enlist the support of senators from oil- and gas-producing regions, Packwood acceded to an exception for oil and gas investments in cases where investors are liable for additional expenses. Senators supporting the exception defended it on the floor with arguments that the ailing oil industry needed assistance -- a contradiction to the idea of getting the tax code out of economic activity.
"I thought they wanted the market to ride and fall as it will," said Lorin Luchs with the accounting firm of Seidman and Seidman. "It seems to me to be contrary to the whole intention."
Many other provisions retained or added help one group or another. Tax credits to encourage construction of low-income housing, rehabilitation of old buildings and research and development were kept or revised. The benefits of depreciation, the system by which companies write off the loss of value of their equipment and real property as it ages, are bunched into the early years of the write-off periods as an incentive for new purchases.
Taxpayers older than 55 retain their exemption from capital-gains taxation on the one-time sale of their homes. And the deduction for mortgage interest, a roughly $30 billion-per-year subsidy to homeowners, is not changed.
The sanctity of that tax break never has been challenged in any of the major tax-revision plans proposed during the last few years, and sentiment in favor of the mortgage deduction helped beat back an amendment in the Senate to close the loophole letting people borrow against their homes without limit.
The proposal, part of a broader amendment to partially restore the deduction for state and local sales taxes, would have limited borrowing against home equity to home improvement, rehabilitation, purchase or construction, and for college tuition and medical costs. The amendment was withdrawn in the face of charges from opponents that the issue was one of free choice.
"I think that is an undue restriction on the ability of the American people to dip into their savings represented by the equity value of their home," said Sen. David L. Boren (D-Okla.).
"This is not a loophole closer. This is a home-ownership crusher," said Sen. Alfonse D'Amato (R-N.Y.). "This is an invader of the principles of federalism."
Analysts point out that interest deductions, like other tax breaks, would be less valuable to taxpayers if the top tax rate were 27 percent, as proposed in the bill, rather than the current 50 percent. Taxpayers would have less incentive to structure their borrowing and other financial decisions around tax considerations if the taxes saved as a result were negligible.
But if past indications are a guide, once a tax benefit is in place, it is hard to remove. Gramm, who sponsored the amendment to close the interest-deduction loophole, said he believes financial institutions and credit-card companies -- as will homeowners themselves -- will fight to retain their right to lend against homes once it is set in the law.
"People who don't own their own homes can't do it, and people who can't keep books well can't do it," Gramm said. "It will become an abuse for upper-income people." GRAPHIC: 1, A tax loophole in the Senate bill.