Lifesavers or loopholes? Reasons for tax transition rules may be sound, but critics say US government needs the revenue

Broken windows and bolted doors at the Los Angeles Central Public Library hide the debris left from a ruinous fire in April and a smaller one four weeks ago. For pure tax reformers, the library's tax status is a point of irritation.

The library got a ``transition rule,'' an escape hatch in the new tax reform bill that Congress passed. The cost to the government for the rule: up to $12 million in forgone tax revenues.

The L.A. library is in good company. Beneficiaries range from the New England Patriots, the Dallas rapid transit, and Stanford University to large corporations like Aetna, Atlantic Richfield (Arco), and Chrysler-Mitsubishi. Altogether, there are 649 transition rules worth $10.6 billion.

To their proponents, transition rules are a life preserver in a sea of tax changes, changes never imagined when the beneficiaries set out their long-term business or development plans, only to find the cost of those plans rising sharply when tax breaks are lost. To their critics, the rules are hidden, potentially dangerous loopholes that deprive the government of much needed revenue.

Whatever one thinks about them, transition rules put intrigue into the tax bill. Tax writers go to great lengths to make a rule apply to only one entity and still disguise the identity of the beneficiary.

Consider this item on page 85 of the tax bill: The provision would grant accelerated depreciation ``in the case of expenditures for railroad grading and tunnel bores which were incurred by a common carrier by railroad to replace property destroyed in a disaster occuring on or before April 17, 1983, near Thistle, Utah...''

Lest you be rusty on recent Utah history, the beneficiary is the Denver and Rio Grande Railroad, which spent about $15 million to repair damages after a mudslide wiped out the tracks. The transition rule saves the railroad less than $5 million, a typical amount for a transition rule, one of which does not cost the government much. Collectively, however, the rules add up.

Critics worry that some transition rules are written in more generic language and create unintended tax breaks. ``We know that some of these are not transition rules, but when you look at them, you can't tell which ones are and which ones aren't,'' says one congressional aide. ``Some of them are just loopholes.''

Critics such as Sen. Howard Metzenbaum (D) of Ohio question whether large corporations should get a break. For example, during hearings on the tax reform bill he asked about a rule allowing 15 major insurance companies, including Aetna, Prudential, and John Hancock, to save $103 million in taxes by extending certain bond provisions. Senator Metzenbaum spent much time challenging specific rules, but in the end voted for tax reform -- and transition rules. ``Most of these [rules] are probably very meritorious,'' points out a congressional aide.

For places like the Los Angeles Library, the rules make the difference between providing a service or not. The city had planned to rehabilitate the library even before the fire damaged the building this past spring. The project was expected to cost $110 million. Part of the money, up to $27 million, was to be raised by the city selling the library property to a private investor and leasing it back. The rest would come from tax-exempt bonds.

The tax reform bill, however, would not let the Community Redevelopment Agency do both the sale leaseback and issue tax-exempt bonds for the library, says Donald Spivack, a senior project manager at the agency.

The bonds would have been taxable, the city would have had to pay a higher interest rate to get people to buy them, and the city would have had $5 to $6 million less in the bank for rehabilitation, Mr. Spivack explains.

``When the rules were changed in the middle of the project, the financing became uncertain,'' he said. ``With the transition rule, we expect to be able to proceed with the project.''