Addicted to the Loophole Habit

By Evan Thomas.

Persuading Congress to adopt tax reform is not unlike treating addiction. ( Congressmen have become so dependent on trading tax breaks for political favors from special interest groups that the only way they can stop now is to go cold turkey. For a Congressman to say he can make an exception for one lobbyist but not another is like an alcoholic swearing he can take just one drink.

When President Reagan announces his tax-reform package in a nationwide speech scheduled for next week, he will call on Congress to shun the influence peddlers and approve a program that is both simple and fair. Unfortunately, the Administration has tossed enough favors for interest groups into its own package to stir grumblings that the preacher himself has been tippling on the way to the temperance meeting.

The tax plan the President approved last week in nearly final form is the diluted successor to a widely heralded proposal first unveiled by the Treasury last November. The original plan, now referred to as Treasury I, was a breathtakingly populist document. It offended nearly every special interest. Only the truly sacred cows, like deductions for mortgage interest on family homes, were left unscathed. The package that the President will send to Congress, on the other hand, is a good deal less pristine.

To be sure, Treasury II, also known as President I, is still a sweeping attempt to close a slew of loopholes. Even the infamous three-martini lunch is threatened; businessmen would be able to deduct only $15 per person for lunch, and entertainment expenses like box seats at sporting events would no longer be deductible at all. By eliminating enough deductions, the Treasury can afford to reduce overall tax rates. The top federal income tax bracket would drop from 50% to 35%, with brackets of 25% and 15% for those making less.

At the same time, Treasury Secretary James Baker has made significant concessions to a procession of lobbyists who have trooped through his department over the past four months. The oil and gas industry, for years the sheltered favorite of congressional committees, successfully persuaded Baker to restore up to two-thirds of the tax breaks knocked out by Treasury I. The oil-depletion allowance and fast write-offs for drilling have been at least partly preserved. Without incentives, the oil lobby argued, new energy sources would go untapped, making the U.S. more dependent on foreign oil. The oilmen even wangled a meeting with the President, who was reported to be fully conversant with oil tax shelters, having considered them for his own investments before he took office. "This is no light courtin' here," declares Oil Lobbyist Harold ("Bud") Scoggins. "We mean business."

A centerpiece of the massive $750 billion Reagan tax cut of 1981 was a provision that allowed businesses to deduct the cost of buying new equipment even faster than the equipment wore out. This "accelerated cost-recovery system" would cost $35 billion next year. Treasury I eliminated ACRS, but lobbyists persuaded the Reaganauts that the economic recovery was in large part produced by such enlightened tax cuts. As a result, Treasury II largely restores ACRS.

Fringe benefits for employees, untaxed under current law, were treated like ordinary income under Treasury I. But the insurance industry, which worried that the plan might lead to a cutback in life and health coverage for workers, led a phenomenal lobbying blitz. A $6 million ad campaign included one twelve-minute film that described taxing fringe benefits as "the worst little horror show in taxes" and showed a Dracula character, presumably the U.S. Government, ready to suck the blood out of the hapless taxpayer. The Administration changed its mind.

Charitable deductions were whacked by Treasury I, and capital gains were taxed like ordinary income. But charitable deductions have been largely restored, and Treasury II actually reduces the maximum capital-gains tax from the current 20% rate to 17.5% to encourage investment.

Many of the exceptions made so far favor wealthy individuals or businesses; ordinary taxpayers will have to make up the difference. To keep the tax plan "revenue neutral" -- neither adding to nor subtracting from present tax intake -- the Administration will almost certainly have to scale down its initial proposal in Treasury I to double immediately the personal exemption from $1,040 to $2,000. White House Chief of Staff Donald Regan, who as Treasury Secretary drafted the original reform plan, says the past few days of work on Treasury II have been "a great balancing act to keep it revenue neutral."

Without concessions to powerful lobbies, argue Administration officials, tax reform would not stand a chance in Congress. But as the Administration carves out more and more exceptions, it invites other lobbyists to demand equal treatment.

The Administration's givebacks, coupled with its decision to put off Reagan's tax-reform speech for a week until Congress finishes wrestling with the budget, have begun to deflate tax-reform proponents on Capitol Hill. "I'm losing my enthusiasm," says House Ways and Means Committee Chairman Dan Rostenkowski, whose backing is essential to tax reform. He is particularly put off by the Administration's cave-in to the oil lobby. "I told Jim Baker that the measure of the man will be where you go with energy. But that didn't penetrate."

The idea of simplifying the tax code and making it fairer is heartily supported by most of the public; with Reagan set to launch a full-scale crusade, it still has a chance of passage. But as more and more special benefits and complexities are added even before the plan reaches Congress, the original goal seems to be slipping away. As Senator Bill Bradley, sponsor of the Democrats' tax-reform bill, sighed last week, "At some point, if this continues, you have to ask yourself whether the entire exercise is worth it."

With reporting by David Beckwith and Christopher Redman/Washington