Clamor for a Smaller Tax Cut

Inflation changes the political rules -and reform seems a lost cause

Who ever heard of voters demanding a smaller tax cut than the President wants to give them? The Congressmen who are now debating Jimmy Carter's tax package, that's who. They are getting a message from the folks back home that defies all conventional political wisdom. Its essence: voters are so frightened by inflation that they are against anything that might make it worse -including cuts in their own taxes that would swell the federal budget deficit. Such feelings can only be deepened by last week's news that consumer prices in March shot up at an annual rate of 10%.

Says Connecticut Democrat William Cotter, a member of the House Ways and Means Committee, which writes tax legislation: "This is the issue, inflation. I'm one of those who goes home every weekend, and I find that people are fearful. They tell me that hamburger cost $1.29 last week, and now it's $1.69." Adds Ways and Means Chairman Al Ullman: "When people realize that every dollar of a tax cut is another dollar of deficit, and when they relate that to inflation, I think that by and large they would rather have less cuts and therefore less deficit."

Polls show that the public is thoroughly confused by Carter's proposal for a net cut of $25 billion in individual and corporate taxes. Though a Harris poll in March turned up a 55% majority in favor of the program, people questioned earlier by Gallup pollsters declared 9 to 1 that it was more important to control inflation than to trim taxes. As a result, strong pressure is building in Congress to reduce the cut to $18 billion or $20 billion, and perhaps to delay it by three months as well, making it effective Jan. 1. Those two moves would pare the fiscal 1979 deficit from the $61 billion that Carter has budgeted to less than $50 billion.

Along the way, Congress probably will knock out nearly all the revenue-raising reforms that the President has proposed. Many of those changes would strike at corporations and rich people, but two major ones -tightening medical deductions and eliminating deductions for state sales taxes -would hit middle income individuals. Those proposals have fanned hostility to the whole program.

Two weeks ago, when congressional leaders told the President that his program was heading for a mangling, his reply was, "I am shocked." At his press conference last week, he came out swinging. He insisted that his reforms were necessary for establishing equity, repeating a horror story of a surgeon who legally deducted $14,000 "for entertaining other doctors on his yacht."

Carter further insisted that a tax cut of $25 billion, effective Oct. 1, is needed to create jobs, and that it "would not be inflationary." Since only 82% of the nation's production capacity is being used, he asserted, inflation is not being caused by the excess demand that would be aggravated by big budget deficits, but rather by "a cycle of wage increases, price increases that kind of grow on one another." Within hours, he had a congressional answer of sorts: in a preliminary vote on the budget for fiscal 1979, the Senate decided, 65 to 22, to leave room for a tax cut of only $20 billion. Ullman, who briefed Treasury Secretary W. Michael Blumenthal on the bleak prospects for the President's bill over breakfast last week, advocates only $15 billion.

There is little doubt that Congress will legislate some kind of income tax cut this year. And there is still some support in the business and academic communities for a tax cut as large as Carter wants, or even more, as a way to expand consumer buying power and provide companies with larger after-tax profits to invest. Even many of the big-cut advocates would like to see a large chunk of the $25 billion come not out of individual income and corporate-profits taxes, but out of Social Security taxes that are scheduled to shoot up next Jan. 1 and in succeeding years. One reason: the portion of Social Security taxes levied on employers raises their cost of hiring workers, and companies pass those costs on in higher prices. For the moment, however, Congress seems content to postpone a debate on Social Security taxes until next year and do this year's cutting on income taxes.

But when should the tax cut take effect? Federal Reserve Chairman G. William Miller was the first to suggest putting off the date from Oct. 1 to Jan. 1, as a means of lopping $9 billion off the fiscal 1979 deficit. Republican Economist Murray Weidenbaum, an advocate of Carter's $25 billion tax cut, disagrees. Whatever reductions are enacted, he says, should take effect at the start of the Christmas-shopping season to spur retail sales and end 1978 on an upbeat note. But Miller's proposal is gaining ground.

As for the size of the cut, the ruling consideration is how large a budget deficit the U.S. can tolerate. If the deficit is not reduced below $61 billion, Miller has warned, the Federal Reserve will restrict the money supply and raise interest rates as an alternative way of fighting inflation. The Fed already has moved twice in the past two weeks to tighten up; last week, in response, Chase Manhattan Bank raised its prime rate on business loans a quarter point, to 8 1/4%. Democratic Economist Otto Eckstein says that a $25 billion tax cut would be "guaranteed to fail" if it leads to a tighter money policy. He favors both delaying the cut until Jan. 1 and shrinking it to $20 billion.

The controversy over tax reform is inseparably linked to overall economic strategy: every dollar raised by reform is another dollar that can be devoted to general tax cuts. Besides the provisions on medical and sales-tax deductions, Carter proposed a long list of changes: preventing businessmen from writing off the cost of tickets to the theater and sporting events, and making only half the cost of business meals deductible; phasing out the system by which businesses can defer taxes on profits earned either by exporting or by manufacturing goods abroad; further limiting the use of tax shelters, especially those covering investments in real estate -to cite only the main ones.

Judged logically, these recommendations are a mixed bag. Taxing export profits more heavily at a time when the U.S. is striving to reduce giant trade deficits is foolish. Some business really is talked over at most "three martini" lunches, though businessmen could manage to talk on less fuel. On the other hand, tearing down real estate tax shelters might divert into productive investments some money that is now going into unneeded shopping centers.

The Ways and Means Committee voted down four of the first five reforms it considered, and congressional leaders have told Carter that there is "no constituency" for the rest. That is an exaggeration; 75% of the people questioned by Harris in March favored limiting deductions for business entertainment. But many Congressmen think voters do not get excited about any reforms except those that affect them directly.

There are quite a few of those. TIME Washington Correspondent Simmons Fentress reports: "The Congress is carrying on a love affair with the middle class just now -the besieged, embattled, beleaguered middle class. Rightly or wrongly, Congress is afraid that Carter's tax reforms are striking not just at fat cats and oil barons, but at average American households as they struggle with taxes, tuition and inflation. Do not the deductions for interest on home mortgages add up to a major tax loophole? And the exemption for real estate taxes or charitable contributions? If medical-expense deductions can be attacked this time, might not these others be next?"

Carter will continue to fight for his reforms out of populist conviction, and may eventually get a few, but only if he will agree to a rejiggering of his whole program. The tax cut that he proposes would most benefit people who earn less than $20,000 a year, and many Congressmen want more relief for those earning more. That sentiment attests to the rising political power of the middle class. Congress's push to reduce Carter's tax cut is even more eloquent testimony that inflation, besides upsetting economic calculations, is repealing the accepted political rules as well. qed

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