The Treasury Department's proposed overhaul of personal and corporate income taxes is intended to get individuals and businesses to make their spending, saving and investment decisions on economic, not tax, grounds.
Over the years, so many provisions have been built into the tax code to encourage some activity deemed worthy of support -- ranging from buying a house or a productive machine to encouraging drilling for oil -- that many financial choices have become driven by their tax consequences rather than the underlying economic reality of risk and gain.
Tax experts said the Treasury Department plan would go a long way toward removing those distortions. "I think, on balance, that it's a combination of pretty good ideas," said economist Henry Aaron of the Brookings Institution, who is coauthor of a tax revision proposal of his own. "I am not sure how much simplification there is in it, but by removing some of the distortions, they have gone a long way in the right direction."
Treasury Secretary Donald T. Regan said the plan would make the tax system simpler, fairer and more economically efficient. "We do this by eliminating many of the deductions, special credits and loopholes that relatively few taxpayers have used so that all Americans can benefit from substantially lower rates."
In the process, some of the industries that have benefited most under tax changes made under the Reagan administration -- such as real estate -- would see many of those benefits snatched away.
A senior treasury official, who briefed reporters but refused to be named, acknowledged that one of the major proposals likely would mean a drop in investment in business equipment, by far the strongest area of investment during the current economic expansion and the one cited most often by supply-side economists as evidence that the 1981 tax cuts have produced the desired results.
That big increase in spending for equipment was fostered by a combination of an investment tax credit of up to 10 percent of its cost and a very rapid writeoff for tax purposes of the remainder of the cost. These investment incentives were so powerful that in combination they introduced a major new distortion into the economy by greatly favoring most capital-intensive industries at the expense of others, such as those in most services, that use less capital and more labor.
If adopted, the overhaul of the personal and corporate income taxes would also go a long way toward removing some of the tax consequences of varying rates of inflation, another major source of economic inefficiency over time, according to many economists.
The Treasury Department would do this by indexing the value of an asset held for some time and most interest income and interest payments. In the process, they would eliminate the current distinction in rates between capital gains and other types of income.
An individual still would be able to deduct the full amount of interest paid on a principal residence, but all other interest payments and income would be adjusted for tax purposes according to the inflation rate in consumer prices. For instance, if an investor were earning 12 percent a year on a certificate of deposit at a financial institution, and the inflation rate were 6 percent, half of the interest income would not be taxed.
Interest payments likewise would be adjusted, and individuals could still deduct up to $5,000 of such adjusted payments. Beyond the $5,000, no interest payments could be deducted except to the extent that they were matched by interest, dividend or other income from "passive" investments, investments that are not actively managed by the investor.
Corporations would have a set of strong new incentives to seek equity capital, through the issuance of stock, rather than to finance their activities by borrowing. They would have to make the same inflation adjustment as individuals in calculating how much interest they could deduct as a business expense. At the same time, they would gain an important new deduction equal to one-half the dividends they paid to their shareholders.
Meanwhile, the proposed changes would strike at the heart of many of today's highly leveraged tax shelter deals that in 1983, treasury said, were sheltering from tax about $35 billion in personal income.
Oil and gas shelters would be hit hard by the elimination of immediate deduction of intangible drilling costs and an end to the use of percentage depletion in writing off other drilling costs.
Syndicated shelters -- those involving more than 35 limited partners -- would probably be ended by a proposed requirement that they be taxed as corporations rather than as partnerships, undermining their entire rationale.
One result of all these changes would be to increase corporate income taxes in 1986 by about $22 billion, or roughly one-fourth, while reducing individual income tax receipts by about the same amount.
The hope many economists have for a plan such as the Treasury Department's is that in the long run it would make the economy more efficient. Capital would flow into the enterprises that could offer the best economic returns rather than the biggest tax shelter. Meanwhile, the much lower top tax rates should to some extent encourage more saving and investment.