Tax bill may be reform, but there are flaws in the ointment

The tax bill President Reagan plans to sign today has been hailed as a sweet victory for taxpayers, because it generally lowers rates for many Americans. Now that the ink is dry, however, accountants, lawyers, and congressional staff think the legislation is more correctly a bittersweet victory. Reform may have been necessary, but the legislative process intervened -- and in some cases, Congress used a sledgehammer instead of a chisel.

The tax bill ``is no small accomplishment,'' says Pamela Pecarich, a partner at the accounting firm of Coopers & Lybrand and a former staff member of the House Ways and Means Committee. But, she adds, ``Too often Congress, instead of asking if it was making good policy, asked if it was a good trade-off.''

A key congressional staff member says that ``on balance, it's very good, but it does fall short of an ideal.''

The tax bill also has some niggling shortcomings. Last week Congress was unable to pass legislation that would close overly generous transition rules and fix typographical errors and transposed numbers. Thus President Reagan is literally signing a flawed tax bill. A technical corrections bill will be introduced next year.

While Congress was able to simplify the tax code for millions of lower- and middle-class taxpayers, others will find it more complicated when they do 1988 taxes.

``I feel sorry for many of the people filling out the returns,'' says accountant Michael Frank of KMG Main Hurdman. ``The complexity of the new code will make it difficult deducting all the items you should and adding all the income you should.''

A big gap is in new rules governing interest deductions. The bill permits homeowners to take out a home equity mortgage for medical or educational purposes and deduct the interest expense even if the total new mortgage exceeds the cost of the house plus improvements.

``Why shouldn't renters who have those expenses be able to borrow and deduct those expenses as well?'' Ms. Pecarich asks. Many individuals would also have to go through the expense of paying closing costs to borrow money for educational or medical purposes.

The new law also presents a complex individual tax structure, which is not as pro-family as Congress would like constituents to believe. While it is true that low-income families will see their rates fall, middle- and upper-income couples will actually be penalized for having large families.

These large families will find they remain in the 33 percent bracket, the highest rate, much longer than smaller families with comparable incomes. A family of six, for example, would have to earn $214,770 before it would drop to the 28 percent tax rate. Up to that number, the family would be taxed at 33 percent.

By way of contrast, a family of three would drop to the 28 percent rate when its income reached $182,010. It takes $10,920 in income to phase out each deduction.

``Why discriminate against families?'' asks Pecarich.

Congress was also faced with a dilemma of corporations reporting one profit to the shareholders and another to the Internal Revenue Service. Such dual bookkeeping systems have been used for years.

To remedy the problem, the tax bill makes corporations pay a minimum income tax, figuring out their taxes by a complex formula. ``This,'' notes a congressional aide involved in tax work, ``is going to cause corporations a lot of planning problems. In a few years we will probably want to revisit how we do this.''

In still another part of the bill, dealing with capital gains, Congress has ignored the impact of inflation. Under the original tax bill presented by President Reagan, capital gains were indexed to consider inflation. Under the new bill, they are not. In addition, capital gains are now taxed at the individual's tax rate instead of a low 20 percent.

Greg Ballentine, a former Treasury official and now a tax economist at Peat, Marwick, Mitchell & Co., says Congress eliminated the indexing provision to show that the overall tax cut for the rich was relatively small. Statistically, the well-to-do report large capital gains. Thus Congress decided to raise the tax on capital gains and not index.

When looking at passive losses -- where the investor is not active in management and company decisionmaking -- Congress has written a law with a sledgehammer effect. Investors with paper losses in limited partnerships may now have to pay back taxes if there were no real losses. This was done because upper-income taxpayers tend to have limited partnerships where paper losses are common.

Ballentine calls both changes unfair.

Lower rates, in fact, were the driving force behind much of the tax bill. ``Very tough policy decisions were made,'' says Pecarich, ``because Congress wanted to achieve a 28 percent tax rate.''

As a result, trade-offs took place.