'Indexed' taxes: the lid's on, will it help or hurt?

Of all the bright baubles on the "Christmas tree" tax measure emerging from Washington, the proposal to index personal income taxes may be the one with the most attractive wrapping. But it also has the most uncertain contents.

Depending on which economist or politician you believe, indexing will either dampen inflation or make it worse. It will help those of lesser means or harm them. It will make elected officials more responsible or less responsible. The one point agreed upon is that indexing is revolutionary, that it will significantly change the way Uncle Sam raises money.

Under the administration-approved package passed by the House and Senate, income tax rates, the personal exemption, and the zero-bracket amount (standard deduction) will be adjusted to offset inflation as measured by the consumer price index (CPI). This will occur each year beginning in 1985.

This means that taxpayers should not be affected by "bracket creep," whereby inflation bumps them into higher tax brackets (where they must pay relatively more) even though their real buying power stays the same. In effect, indexing is a permanent tax cut that cannot be eroded by inflation.

Allowing bracket creep to continue, says American Enterprise Institute economist William Fellner, "really has no justification."

"A nonindexed structure gives the government an incentive to continue inflation," says Dr. Fellner, who was a member of the president's Council of Economic Advisers from 1973 to 1975. "It removes a discipline from government practices."

It also tends to more adversely affect those of lesser means. Noting government studies showing this. Sen. William L. Armstrong (R) of Colorado says , "The real victory in indexing will be for low-income earners." Many liberals agree.

The National Taxpayers Union figures that bracket creep will add $17 billion to federal coffers in 1981 alone, providing a government "windfall" at taxpayers' expense without politicians having to take responsibility.

What Congress hasm taken credit for is the half-dozen "tax cuts" enacted since 1969. In fact, say critics, these adjustments only offset a portion of bracket creep for which lawmakers themselves were to blame.

"It is time to abandon that cushion and get on with the job of responsible and antiinflationary fiscal management," says Sen. Bob Dole (R) of Kansas, chairman of the Senate Finance Committee.

But does income tax indexing force more responsible action on Capitol Hill or merely remove options for the future?

With wide public support, lawmakers in recent years already have indexed to the CPI many government payment programs, including social security, federal salaries, military pensions, food stamps, and others. Some observers feel social security is in big trouble today largely because it has been indexed since 1972. Rather than adding more indexing to the nation's economic system, these critics say, lawmakers should be trying to cut it back.

"The more indexing an economy has, the more inflation will become built in," the editors of Forbes magazine wrote recently. "The more inflation becomes accepted, the harder it will be to drive it out -- or even to try."

In Israel, where just about every wage, price, and benefit is indexed, inflation is ripping along at 130 percent.

"What [indexing] does is create a whole new class of citizens who can shrug their shoulders at inflation," says Sen. John H. Chafee (R) of Rhode Island, a member of the Senate Finance Committee. "If we are going to lick inflation in the nation, it is absolutely essential that everyone feel the pain, that the pain be spread around so that the pressure is constantly on us to defeat inflation."

Others say that given these highly uncertain economic times (including the possibility of higher imported energy costs, large defense buildups, and the general desire to hold down federal deficits), it is better not to lock the government into continuing revenue cutbacks. Until it found it necessary to load up its "clean" tax bill with tantalizing vote-getters, the Reagan administration itself wanted to defer the question of indexing. The effects were too uncertain, some advisers urged.

Even those who support indexing concede that using the CPI as the standard (which the just-approved tax plan does) overstates inflation by including such things as the cost of buying a house, which relatively few people do in any given year.

"The CPI is not an ideal index, that is true," says Dr. Fellner. "there is a problem there."

The administration now figures that indexing will reduce federal revenues $31 .3 billion the first two years it is in place (1985 and 1986). The congressional Joint Committee on Taxation puts the figure at $50 billion, which could have the effect of creating a much larger federal deficit. The difference in the two figures is the result of different assumptions about future inflation rates. The administration's is more optimistic.

"There's not so much certainly about what happens in the economy or the government to deprive yourself of future revenues," warns Albert Buckberg, senior economist on the Joint Committee on Taxation. "The experience with indexing on the outlay side has been pretty terrible. You put the two together and you're working perversely with respect to the government being able to pay its own bills."

If that happens -- that is, if the whole tax and spending structure is significantly upset by a continuing troubled economy -- some observers see even greater changes ahead for the nation's tax laws.

"The traditional tax reform movement of closing loopholes one at a time has failed," says Jay Angoff of Ralph Nader's Tax Reform Research Group, which opposes the likely reduction in corporate and estate taxes under the Reagan plan. "Perhaps with indexing, people will realize what a total monstrosity the tax code is. It's the best th ing that could happen for tax reform."