Banks' tax-repeal drive may stall

With outposts in virtually every congressional district, the banking industry packs considerable clout on Capitol Hill. So the pin-striped leaders of the financial community got results when they declared war on a new law which, under certain circustances, would require that taxes be withheld from interest and dividends.

To date at least 273 representatives and 38 senators are backing bills to repeal a 10 percent withholding tax on interest and dividends, banking industry officials boast. The withholding provisions of last year's tax law are scheduled to take effect July 1.

But in orchestrating a blizzard of mail from customers supporting the industry position, bankers have triggered a dangerous backlash from both the Reagan administration and the chairmen of the House and Senate tax-writing committees.

The result is likely to be a congressional assault on tax-code provisions that allow banks to pay taxes at a rate only dreamed of by most individual taxpayers. In 1981, the latest year for which data is available, commercial banks paid a federal tax rate of 2.3 percent on income earned in the US, according to the congressional Joint Committee on Taxation.

''Banks, who by the way, pay very little in taxes, run a grave risk of infuriating the tax-writing committees'' with efforts to repeal the withholding provisions, Treasury Secretary Donald Regan recently told the House Appropriations Committee.

The fury is felt most keenly by Sen. Robert Dole (R) of Kansas, chairman of the Senate Finance Committee. Last year at the industry's request, Senator Dole offered an amendment to the tax bill giving bankers an additional six months to program their computers to handle withholding.

In a speech to bankers Feb. 17, Senator Dole noted that ''many of you have simply used the time to try to repeal the law. We may learn slowly up here but we do learn and we remember what we learn from bitter experience.''

To drive home that point, in the same speech the senator announced the Finance Committee would hold hearings next month ''to review some of the special tax preferences enjoyed by various members of the financial services industry.''

House Ways and Means Committee chairman Dan Rostenkowski (D) of Illinois has not made a similar formal statement recently on bankers' tax breaks. But bank industry sources say the Ways and Means Committee staff is also exploring the issue of bank tax status. And an aide notes that Rostenkowski's stance on withholding repeal is ''to hold the line.''

Bank industry officials admit that Rostenkowski and Dole are key stumbling blocks in converting their grass-roots support into repeal. ''The problem is a few key votes . . . to get it out of committee,'' says Fritz Elmendorf, a spokesman for the American Bankers Assocation.

The bankers' problem is most acute in the House. With the Democratic leadership opposing repeal, sponsors would have to get 218 signatures on a discharge petition to force a floor vote. And members are less willing to oppose the leadership in this way than they are merely to co-sponser repealing legislation. In the Senate, members could seek a vote on the legislation by attaching it to a related bill.

The banking industry knew its repeal campaign might trigger calls for a higher tax on industry earnings. ''It was anticipated when we decided to seek repeal and make it an important effort,'' Mr. Elmendorf says. Still he notes that ''most bankers are shocked to hear the threats that are being made.''

Withholding of interest and dividends is a high-stakes matter, so the battle is worth it, bankers argue. First, under withholding, customers would not be able to earn interest on the money withheld. This could cost them between $1.5 and $2 billion, according to estimates from Citibank.

Then, too, banks would bear the annual costs of operating the withholding system which Citibank puts at an addtional $1.5 to $2 billion nationwide.

Critics argue that bankers are vastly overestimating the cost of withholding. Many savers will not be affected by withholding, due to a variety of exemptions, including one for low-income individuals and another for those who earn less than $150 in interest annually.

And banks can elect to withhold at the end of the year, ''which virtually eliminates any loss of compound interest,'' Senator Dole contends. Even without year-end withholding, the loss on a $1,000 account at 9 percent would be under 50 cents a year, Dole notes.

Banks already must report interest income to the IRS, so annual operating cost estimates also are inflated, bank industry critics contend. Repeal of withholding would add $25 billionto $26 billion to the federal budget deficit through 1988, according to the IRS. And if withholding is repealed, the tax rate banks pay will come in for close scrutiny.

Banks pay relatively low taxes by using a variety of tax law provisions, many of which they share with other industries. Banks hold some 44.8 percent of the nation's municipal bonds on which interest is tax free. Then, too, banks purchase equipment - such as airplanes - which they lease to others. On these purchases, banks, like other businesses, get to claim accelerated depreciation allowances and invesment tax credits, both of which lower tax bills.

Banks get one exclusive tax benefit since they can deduct from taxable income a reserve for loan losses. Unlike the loan loss reserve which appears on a bank's financial statements, the one for tax purposes is not tied to a bank's loan-loss experience. Until recently, banks have ''been able to write off loan reserves in excess of what banking prudence and caution require,'' says Richard Kaplan, a tax-law expert at the University of Illinois.

The combined effect of these tax-law provisions has been to give banks a tax rate much lower than other industries. Some tax experts argue that wide disparities in tax rates are not good for the economy.Thomas Field, executive director of Tax Analysts, a research group, notes that ''you run into problems of economic efficiency. Too much capital flows to low tax areas and is drained out of others'' where tax rates are higher.

Bank's federal tax burden, among US industries (1981 tax rate on domestic income, in percent Motor vehicles 47.7 Trucking 46.1 Pharmaceuticals 35.9 Tobacco 31.3 Diversified services 29.6 Electronics, appliances 29.3 Beverages 28.8 Food processors 26.8 Office equipment 25.3 Industrial and farm equip. 24.1 Retailing 22.7 Oil and refining 18.6 Diversified financials 16.8 Metal manufacturing 9.8 Utilities 9.2 Aerospace 6.8 Chemicals 5.0 Crude oil production 3.1 Commercial banks 2.3 Railroads (7.5) Paper and wood products (14.2) Note: () denotes negative tax rate Source: Joint Committee on Taxation