minimum tax rates would be necessary to maintain all taxpayers in the same relative position.

6. Proposals (4) and (5) would eliminate the phaseout and provide permanent 33- and 38.5-percent tax rate brackets, thereby eliminating the inequity under present law of allowing the highest income taxpayers to pay a 28-percent tax rate on taxable income above the phaseout range where the 33-percent phaseout rate applies. For example, on a joint return, a taxpayer could be paying 28 percent on taxable income above $200,000 while another taxpayer with $145,000 taxable income would be paying a 33-percent phaseout rate.

In addition, there is a widespread perception that the tax rate cut for high income individuals was excessive, and that the top marginal tax rate should be different for, e.g., married taxpayers with taxable incomes of $70,000, $150,000, and $500,000.

7. The amount of a taxpayer's income is the best measure of ability to pay taxes. An income tax surtax or increase in marginal tax rates would not be regressive relative to income, as increases in excise taxes tend to be.

Arguments against the proposals

1. Any increase in tax rates, whether in the form of a temporary surtax or an increase in all or selected tax rates, would be an increase in rates that would break a pledge made to taxpayers on enactment of the base-broadening and other provisions of the Tax Reform Act of 1986 that eliminated or reduced deductions, credits, etc.

2. Any need to increase budget receipts through the income tax would be met best by enacting additional base-broadening provisions, which also would increase the equity of the tax structure even further. As a result, greater compliance is more likely to be achieved because low- and middle-income taxpayers would believe that the income tax system would be even more fair to all income groups.

3. Increased income tax rates would have adverse effects on economic efficiency-reduced savings, reduced work effort, and other distortions.

4. Increasing tax rates of higher income individuals would be unfair because many of them incurred the greatest increase in individual tax burdens under the base-broadening provisions of the 1986 Act.

5. Selective increases in other taxes, primarily various excise taxes, would make it possible to tax consumer spending that would not be discouraged by higher taxes, and to adjust excise tax rates to levels that would be perceived as more appropriate than present rates.

6. Individual income and social insurance tax payments make up more than three-fourths of budget receipts. Using other tax sources to raise revenues for budget reduction would provide greater balance and diversification of revenue sources.

7. With respect to temporary surtax proposals, many individuals and corporations would not believe that the increase would not be extended indefinitely.

2. Reduction in Individual and Corporate Tax Preferences

Present Law

A number of provisions in the income tax law and regulations provide economic incentives to the private sector or tax relief to particular kinds of taxpayers. These tax provisions, often referred to as preferences, generally take the form of exclusions, credits, deductions, and deferrals of tax liability.

Preferences make possible the reduction of tax liability in relation to economic income. In some cases, the amount of tax reduction that can be accomplished through the use of preferences is limited by the alternative minimum tax. However, the minimum tax does not apply to all items that could be considered preferences, and applies to some preferences only in part. Moreover, even preferences that are fully subject to the minimum tax can be used by taxpayers to reduce tax liability, because the minimum tax rate is lower than the regular tax rate.

Under present law, corporate tax preferences relating to percentage depletion for coal and iron ore, excess bad debt reserves of banks, interest to acquire certain previously acquired tax-exempt bonds, FSC income, amortization of pollution control facilities, mining development and exploration expenditures, and intangible drilling costs of integrated oil companies are subject to an acrossthe-board cutback ranging from 20 to 30 percent.

Possible Proposals

1. The value of tax preferences could be directly reduced by a specified percentage. Such reductions in the value of preferences would apply to all taxpayers for regular tax purposes and, for preferences currently allowed in computing minimum tax, for minimum tax purposes.

This approach involves reducing by a percentage the gross amount of items such as exclusions, deductions that permit the permanent understatement of income (rather than the deferral of tax liability), and credits. With respect to items that permit the deferral of tax liability, the approach would involve permitting such deferral only with respect to a percentage of the item involved. For example, if applied to accelerated depreciation, the approach would involve requiring a portion of basis to be deducted more slowly, rather than permanent disallowance of a portion of depreciation deductions.

Preferences that could be reduced include the credits for child and dependent care expenses, clinical testing expenses, and producing fuel from nonconventional sources; the investment tax credit; the targeted jobs tax credit; the alcohol fuels tax credit; the research credit; and the possessions tax credit. The reduction could

apply to itemized deductions for individuals, deductions for ACRS, pollution control facility amortization, circulation expenditures, research and experimental expenditures, expenses for tertiary injectants, excess percentage depletion, intangible drilling costs, mining exploration and development expenses, business entertainment deductions, foreign convention attendance expenses, certain travel expenses, financial institution preferences, soil and water conservation expenditures, and the small life insurance company deduction. The benefits of incentive stock options, foreign sales corporations, deferral for foreign controlled corporations, tax exemption for credit unions, certain ESOP loans, lump-sum averaging, sales to ESOPS, and shipping income deferral also could be reduced. Also, the dollar limitations for the one-time housing gain exclusion, the foreign earned income exclusion, the expensing of depreciable property, amortization of reforestation expenditures, IRA deductions, employee gifts, luxury cars, and pension plan benefits and contributions could be reduced. The tax-exempt bond ceilings could be lowered. In addition, the alternative minimum tax rate also could be increased.

2. The present law corporate cutbacks in section 291 could be increased by a set percentage.

Pros and Cons

Arguments for the proposals

1. In periods of large budget deficits, across-the-board reductions in tax preferences are appropriate.

2. The taxpayers affected by the proposals generally would be those paying relatively less tax in relation to economic income.

3. The proposals could be designed to have a relatively uniform effect on preferences, and thus not to have a disproportionate effect on particular taxpayers or tax preference items.

Arguments against the proposals

1. The proposals could reduce the value of preferences that it was considered desirable to retain in full.

2. The proposals could increase the complexity of the income tax system, by requiring additional mathematical computations.

3. The tax preferences that would be reduced were enacted or retained in the Internal Revenue Code of 1986 to accomplish some social or economic purpose. These goals could be undermined by a reduction in the preferences.