Near the turn of the century, the federal government bestowed what then was a novel favor on small, family farmers: It gave them a tax break. Half a century later, more than 15,000 citrus farmers stunned the Congress with an unheard-of plea: Take away our tax break.

The break allowed citrus growers, together with all other farmers, to take early tax write-offs for long-term costs of cultivating crops. But by the 1960s, with the spread of sophisticated schemes for avoiding taxes, thousands of wealthy investors had started planting oranges and lemons to harvest the tax advantages. The nation soon was awash in citrus, prices fell and longtime growers were losing their land.

Congress revoked the citrus tax break in 1969, an acknowledgment that the government had hurt some of the people it had sought to help.

Today an extraordinary range of public figures, from President Reagan to liberal Democrats to Wall Street financiers, contends that government intervention has had this result throughout the economy. In using the budget and the tax code to help thousands of constituencies, they argue, the government has so distorted choices that Americans now respond more to federal subsidies than to a free market.

Reagan now has moved this debate to the forefront of national politics with tax and budget proposals that would extract the government from the economy in a way that goes far beyond the "revolutionary" fiscal policies of his first term. His 1986 budget proposal and a still-evolving "tax simplification" plan would eliminate tens of billions of dollars in subsidies and tax breaks that have shaped the development of almost every sector of the economy.

These two propositions, flip sides of the same idea, would alter fundamentally the relationship between the government and much of the population, shattering rules that have governed national politics for more than 50 years.

Conservatives long have preached such extraction, but rarely voted for it, and many longtime Reaganites now are leading the opposition to these proposals. At the same time, the cause of tax simplification has drawn wide support, seizing what once was Democratic ground and upstaging congressional leaders who advanced the idea long before Reagan.

The subsidies being challenged are so ingrained that it is difficult to imagine an America without them.

Certain features of the tax code allow large companies and wealthy Americans to avoid billions of dollars in taxes. Others, along with budget subsidies, are mainstays of the middle class: reducing mortgage payments on every home and building, helping to pay tuition for half the current college freshmen, keeping thousands of farmers afloat and propping up institutions as varied as the Metropolitan Museum of Art and the Salvation Army.

In articles over the next several months, The Washington Post will examine this federal support system and its effects on businesses, pastimes, people and regions. It is a system that grew up with the country, a vast web of budget and tax provisions intended to stimulate activities deemed at various points to be "desirable."

The cost of the system is staggering. Federal tax breaks to businesses and people in fiscal 1986 alone will exceed $400 billion, about twice the projected federal deficit for that year, according to Congress' Joint Committee on Taxation. And the current federal budget contains $30 billion in programs that subsidize private activities, from the growing of wheat to the generation of electricity, according to documents compiled by Office of Management and Budget Director David A. Stockman.

By eliminating most tax breaks, the government would raise enough money to allow for dramatically lower tax rates across the board, without any loss in revenue, according to a Treasury Department proposal. But some industries are so heavily subsidized that lower rates would not fill in the gap.

"Everyone likes economic neutrality, but the economy is hooked, and the question is: Can it go cold turkey?" Stanford Ross, chief tax attorney for the Washington law firm of Arnold & Porter, said. Critics Advocate 'Neutral' Economy

A divisive national debate has begun over the president's proposals, pitting the beneficiaries of the current system against those less favored. Oil company executives, bankers, insurers, real estate developers, defense contractors, timber manufacturers, farmers, students and many others who voted enthusiastically for Reagan are pounding the White House with protest, insisting that his vow to "stop spreading dependency" should stop short of their subsidies.

"Our whole system is built on paying people to do things we consider socially beneficial," Sen. Russell B. Long (D-La.), past chairman of the Senate Finance Committee, said. "We have tax subsidies for equipment purchases , and they give us modern plants and machinery. Fly on an American airline, and you fly on good modern equipment. Try it on one of the Latin lines."

Long and others said that without such support, American companies would lose ground to foreign competitors, which also are subsidized.

The advocates of tax revision argue that a "neutral" economy would be much stronger, luring dollars to ventures that create new products, such as "high tech" firms, rather than those carrying tax breaks or subsidies. They foresee more growth and a fairer sharing of the burden. They also acknowledge that the process of getting from here to there would be long and arduous.

"To impose a serious simplification program without triggering a recession would be almost impossible," said Robert S. McIntyre, director of federal tax policy at Citizens for Tax Justice, a tax reform group financed largely by organized labor. "On the other hand, it would probably be worth it."

To study the federal budget and the U.S. tax code is to discover that free enterprise, American style, is far from free; this is a subsidized society.

For oil drilling, there are oil depletion allowances, early write-offs for drilling costs, and cheap leases to federal oil reserves; for real estate, the mortgage interest deduction, early write-offs for buildings and development subsidies; for heavy industries, the investment tax credit and speedy depreciation; for education, the charitable deduction and student loans; for farmers, price supports; for domestic shipping, federally financed inland waterways; for the automotive industry, federal interstate highways; for Amtrak, subsidies of $35 for each person who boarded a train in 1984, and so on.

The government, through tax breaks it provides, shares in the cost of almost every transaction in America: the planting of every crop, the felling of every tree, the laying of every rail line, the drilling of every oil well, the construction of every building, the sale of every house, the building of every weapon, the trading of every stock, donations to every charity, the recruiting of every professional ball player, and much more.

"People think taxation is a terribly mundane subject," said Sheldon S. Cohen, commissioner of internal revenue under President Lyndon B. Johnson and now a Washington tax lawyer. "But what makes it fascinating is that taxation, in reality, is life. If you know the position a person takes on taxes, you can tell their whole philosophy. The tax code, once you get to know it, embodies all the essence of life: greed, politics, power, goodness, charity. Everything's in there. That's why it's so hard to get a simplified tax code. Life just isn't simple."

This year's budget and tax proposals have highlighted the extent to which the government subsidizes not only the weakest segments of society, but also the wealthiest and most powerful, and many in between.

Consider businessman J. Peter Grace, of the government waste-fighting Grace Commission, who has opposed tax simplification. He led an effort to slash the budget in Reagan's first term, while his firm, W.R. Grace & Co., enjoyed numerous budget subsidies and used tax loopholes to wipe out its 1981-83 U.S. tax bill. See accompanying article .

Consider also the Pacific Northwest, where the economy relies largely on cheap electricity, which sells at a fraction of East Coast rates in part because of budget subsidies, and where timber, a tax-favored industry, is a major employer.

"We can't kid ourselves and say we don't need the government," said Tom Mayr, heir to Mayr Brothers Logging Co. in Hoquiam, Wash., which recently reorganized after a bankruptcy.

"We get tax breaks. We get timber from the Forest Service and the Bureau of Indian Affairs. We get cheap power from the Bonneville Power Administration. Good God, the aluminum industry is headquartered in this region purely for the cheap power. What happens if the price of all these things goes up? What's the incentive to stay?"

Reagan's fiscal 1986 budget proposal and the Treasury Department's sweeping tax simplification plan argue that the system is unfair because it helps certain people and business at the expense of others, and not always to the nation's benefit.

According to the Treasury Department's proposal, the internal revenue code favors established industries that invest in tax-favored machinery and penalizes new ones whose main capital is human knowledge, which qualifies for no write-offs. It also favors the rich over lower- and middle-income Americans, according to the department.

Wealthy Americans avoided paying taxes on more than $35 billion of income in 1983, the Treasury Department said, by investing the money in oil drilling, real estate, dairy farms, avocados and other ventures that qualify for deductions, credits and assorted breaks. This shifted the burden to middle- and lower-income taxpayers, who can't afford these "tax-sheltered" investments.

A recent study of tax data from 1966 to 1985 by Brookings Institution economist Joseph E. Pechman showed that these inequities, combined with other changes in taxation, have made the income tax less progressive, no longer transferring wealth from the highest to lowest income groups.

"The U.S. income tax has grown without any conscious design or overall planning since it was enacted in 1913," said White House chief of staff Donald T. Regan, when as treasury secretary he unveiled the department's simplification proposal. "In many is almost as old as the system itself.

As early as 1928, Treasury Department official T.S. Adams, a framer of the original internal revenue code, wrote that taxation is "a hard game in which he who trusts wholly to economics, reason and justice, will in the end retire beaten and disillusioned. Class politics is the essence of taxation." The Perception of Unfairness

In 1956, Randolph Paul, Franklin D. Roosevelt's former general counsel at the Treasury Department, literally died testifying to Congress about "inequities" in the tax code. Paul, who founded the law firm of Paul, Weiss, had just observed to the Joint Economic Committee of Congress that the Eisenhower administration was using the tax code to stimulate businesses rather than just to collect revenue.

"Yes, that implication seems to be there . . . ," he said, according to The New York Times, "and then slumped forward with a sharp intake of breath." Paul was laid out on the floor of the hearing room, the old Supreme Court chamber in the Capitol, and pronounced dead.

Tax revision fever surged under President John F. Kennedy and again in 1969, when outgoing Treasury Secretary Joseph W. Barr revealed that 154 people getting more than $200,000 a year had paid no federal taxes in 1967. It peaked again in 1977, when President Jimmy Carter announced that he had received a tax refund despite his wealth and that he was contributing $6,000 to the U.S. Treasury in protest.

But for all this sentiment, the code is as complicated and as problem-plagued today as ever. The most recent statistics from the Treasury Department indicate that 9,000 people getting at least $250,000 legally avoided all taxes in 1983 and thousands more came close. And while Barr's 1969 report about the 154 tax avoiders provoked outrage, many wealthy Americans now brag about tax avoidance.

The cover of a recent Money magazine, for example, featured a picture of three wealthy citizens, all sporting formal attire and holding up champagne glasses, under the headline: "These three people have made fortunes but paid no taxes last year -- here's how you can slash yours."

The perception of inequity is so widespread that Internal Revenue Commissioner Roscoe L. Egger Jr. warned that it could provoke massive disobedience and could bring down the income tax.

Legal tax avoidance among businesses also is common. At least 128 multinational corporations paid no taxes for at least one of the years 1981 to 1983 despite their having received $57 billion in combined profits, according to a study by Citizens for Tax Justice. The companies accomplished this through the use of tax deductions, exemptions and credits for certain tax-favored investments, particularly for purchases of equipment.

Among the chief beneficiaries of business tax breaks were some of Reagan's most prominent supporters. General Electric, Reagan's employer from his days as host of GE Theater, paid no taxes despite having $6.5 billion in total profits over the three years, according to the study. Others wiping out their 1981-83 tax bills included Boeing, Dow Chemical, General Dynamics, Lockheed and Transamerica Corp.

The biggest corporate winners, according to the Treasury Department, are real estate, construction, defense contractors, financial institutions and energy, while the losers include service industries and high tech companies.

Because these "tax expenditures," as the department calls them, do not show up as items in the annual federal budget, they are not subjected to debate with the same rigor as is the budget. But they are no less a factor in shaping national policy or in the creation of the federal deficit, according to economists.

"In the 1960s, the government intervened directly in the economy with the Great Society programs and there was a large conservative backlash," economist John Makin, director of fiscal policy for the American Enterprise Institute, said. "Then in the 1970s, we doled out tax breaks, and a lot of Republicans slept better at night thinking we were not intervening in the economy anymore. But there was no difference. Every time you give someone a break, someone else pays for it, because the money has to come from somewhere.

"One man's subsidy is another man's tax. It's no more respectable than direct spending if your goal is to keep the government out of the economy." Something in the Code for Everyone

The obstacles to change are as numerous as the American people because, for all its inequities, the system has something for everyone, even the poor.

The most formidable demonstration of resistance occurred last month when Reagan tried to harness costly farm credit programs, provoking such outcries from thousands of farmers that Congress bucked the austerity trend and voted to extend the programs. Reagan vetoed the bill, and the fight goes on.

Western senators, who chair the Appropriations, Finance and Energy committees, already are organizing to preserve budget subsidies for hydroelectric power, timber-cutting, farming, Amtrak, recreation and other programs dear to their region that are targeted in Reagan's 1986 budget.

In the tax battle, the conventional wisdom is that big businesses get the most from the system. They reap tax credits for investments in new equipment ranging from company cars to heavy machines (the projected fiscal 1986 cost to the treasury: $25.2 billion). They also get fast write-offs for the same investments (projected cost, $22.9 billion), and myriad breaks for other ventures.

But millions of middle-income Americans also enjoy the tax-exempt status of pensions ($59 billion), employe health insurance ($29.3 billion) and Social Security benefits ($13.2 billion). They get deductions for mortgage interest payments on homes ($28.6 billion), charitable contributions ($15.2 billion), state and local property and income taxes ($35.3 billion), two-earner married couples ($7.28 billion) and more.

The tax code binds the less fortunate to the wealthy to such an extent that when the Ford administration wanted to block a 1975 move to outlaw real estate tax shelters, it dispatched Housing and Urban Development Secretary Carla A. Hills to testify that those shelters lured investment in low-income housing as well as in vacation condominiums. Housing industry spokesmen are saying the same today in response to the Treasury Department plan.

The advocates of tax revision argue that the government should advance its social goals through the budget for federal agencies, which is debated in public every year, rather than through the tax code, whose chief purpose is to raise the money the government needs.

"The tax system is there to raise revenue," Bradley said. "It's in the appropriations process that we should be deciding whether the government spends money on energy development, on railroad beds, on education, on timber reforestation. That's a process that we go through every year with rigorous review. With the tax code, there's no system of public scrutiny to determine what we have received for all this spending."

"What we have done with the tax code is to put a piece of every damned department of the government into the revenue service," said former IRS commissioner Cohen. "We did it in the name of efficiency. We said it was easier to stimulate these things with incentives to the private sector than to pay for them through the budget. In the end, we made the whole system inefficient."

Undoing the system would mean radical change not only for the economy, but also for the political system, which largely centers on the use of budget and tax favors to various constituencies. The critique is not that all subsidies are bad, but that many have outlived their usefulness. The vexing political question is: Which ones should go?

"There's been a lot of demagoguery about subsidies, but every one of them had a laudable purpose and helped somebody or we wouldn't have put it there," said former House Ways and Means Committee chairman Wilbur Mills, a Washington tax lawyer. "We always had a constituency for tax breaks. You almost never have a constituency for eliminating a deduction."

As a result, while there is much consensus on the need for revision, almost every would-be reformer has at least a few tax breaks that he would save, each favoring one group at the expense of others.

Reagan, who, at a recent news conference, called for "a sweeping program of tax simplification and reform," is seeking tax credits for people who send their children to private schools. Overhaul Could Reproduce Inequities

Kemp, along with Reagan, has endorsed the creation of tax credits for businesses that locate in distressed urban areas, known as "enterprise zones." Bradley would keep deductions for business-related expenses and for capital investment in machinery, although he has said he may tighten these.

Reagan also wants some credits and deductions for investments in capital equipment, as "incentives" for economic recovery. And none of the proposals would touch the favored status of retirement pensions or home mortgage interest.

In short, the sum of the favored breaks of those who call for tax overhaul would reproduce large portions of the current code, and many of its inequities.

"The government never purposely does evil," Cohen said. "Everybody comes to Washington saying they want to do good. It's just that different people see good in different things. So while one person says that a certain subsidy helps a part of the system, we have to recognize that it corrupts the system as a whole.

"Congress has to say no to a deserving case -- just to say: 'No, we can't do it because it will set off all these other things that shouldn't happen.' The problem is, of course, that Congress doesn't work that way. The dynamic of Congress is that it responds to the deserving case . . . . "

Dorgan illustrates the pitfalls by telling of a 1976 Democratic presidential contender who vowed in the North Dakota primary to make "tax simplification" a top issue. "I'm going to wipe every volume of that tax code off the shelf and in their place, I'm going to put one page with these words on it: All income will be taxed equally as income," the candidate told Dorgan.

The maverick tax commissioner inquired what would become of a factory worker who was rendered paraplegic by an automobile accident, and who received $700,000 in damages. Would the money be taxed as income all in the same year, at the highest individual taxpayers' rate?

"Oh no, we'd have an exception for cases like that," came the answer.

"You just wrote page two," Dorgan said