When the Treasury first drafted its tax reforms, it adopted a sound and straightforward rule: all income was to be treated similarly. That's a good principle, but it didn't survive the six months of revision within the administration. While it sounds simple, it challenges several longstanding traditions in American taxation -- most important among them, the tradition of taxing capital gains at lower rates than wages and salaries. Abolishing the special low rate for capital gains would automatically have abolished all the tax shelters that depend on it. Retaining the low rate for capital gains, as President Reagan has decided to do, preserves the shelters -- at a high cost to the Treasury.
The president wanted his tax reform plan toclude the lower tax rates that the Treasury had proposed last November. But since he wasn't prepared to shut down shelters as rigorously as the Treasury had recommended, he needed to find new revenue elsewhere to make up for it. That's why his plan includes several revenue raisers that have nothing to do with reform or tax equity -- much less simplification. One of most dubious has become known as the windfall recapture provision.
Perhaps you feel that depreciation is not a subject that you care to follow closely. But bear with it for another paragraph or so, for it's crucial to this year's tax bill. The administration argues that cutting the corporate tax rate will create a windfall for companies as they depreciate their equipment. Depreciation postpones taxation, and those companies would pay their deferred taxes at lower rates than they expected when they bought the equipment. The recapture provision would in effect deny the tax cut, for three years, to income generated by depreciation.
A truly strange thing is happening here. The 1981 Reagan tax bill provided enormous tax benefits to encourage and expand investment; the benefits for many kinds of investment added up to more than 100 percent of the cost of the equipment being depreciated. Using the tax system to subsidize certain selected industries is a poor idea. But to swing around without warning and use the tax system to discriminate against those same industries -- capital-intensive heavy industries, already under strain -- is even worse.
Preserving the capital gains preference mainly helps the kind of investment that is speculation in the financial markets. Imposing the windfall recapture provision puts the cost on the kind of investment that has actually put money into industrial productivity. Is that sensible policy?
Congress seems to have greeted the recapture provision with skepticism. Never was skepticism better justified.