When he is promoting the Reagan Administration's package of tax cuts, Treasury Secretary Donald Regan likes to quote a Democrat. Nearly 20 years ago, when he was pushing his own tax cut, John F. Kennedy said that "a rising tide lifts all boats." There is, however, another metaphor that might be more appropriate today. "A rising creek," it goes, "covers a lot of stumps, but they're still there when the waters recede."

Congress and many business people are wondering whether the Reagan Administration's tax proposals will clear out the stumps snagging the U.S. economy, or just cover them up for a while.

Few business executives want to sabotage the Reagan plan, but most find it deficient to some degree. If the plan's objective is to increase national productivity, for instance, many executives wonder why it promises to give four times as much relief to individuals as it does to business.

Nearly 80% of the tax relief granted by the Reagan plan would accrue directly to individuals. Personal tax rates would decline by 30% over three years. Reducing personal tax rates would also bring about a reduction in the maximum capital gains tax rate, from 28% to 20%. But otherwise the Reagan proposal contains no explicit incentives to induce consumers to save more of their after-tax income, thereby increasing the pool of capital available to business for investment in new plants and equipment.

The other 20% of the tax relief from the Reagan plan would flow directly to business through accelerated depreciation of capital assets. But Reagan's 10-5-3 depreciation plan (see box, page 66) has raised some questions itself:

Does 10-5-3 tilt the business tax relief toward big business, which tends to be more capital-intensive than smaller companies?

Does 10-5-3 favor sunset industries over the sunrise industries, upon whose developing technology future international competition will be based?

The business community, large and small, can't agree on answers to these questions. But the National Federation of Independent Business (NFIB), which claims nearly 600,000 small business members, has joined the Business Roundtable and the Chamber of Commerce of the United States in giving its enthusiatic endorsement to 10-5-3.

Some critics of 10-5-3 have pointed out that in one recent year, 1975, just 1.3% of the corporations claimed 75.1% of all depreciation. They conclude that since big business already takes most of the depreciation, increasing the depreciation rate gives big business a break but does little for the small business sector.

Not so, argues the NFIB. Those figures do not include the substantial depreciation claims made by small companies organized as proprietorships and partnerships. When their claims are added to the depreciation pool, the NFIB calculates that business firms with assets of less than $10 million actually claim 42% of depreciation charges.

The NFIB argues that 10-5-3 would boost the proportion of depreciation taken by smaller firms. Large firms can currently use the more favorable depreciation rates prescribed by the Internal Revenue Service's asset depreciation range (ADR) rules. Smaller companies, put off by the complexity of ADR rules, more often use less favorable straightline depreciation. Replacing ADR with 10-5-3, the NFIB says, would put all companies, whatever their size, on an equal footing. Thus, the NFIB argues, the President's proposed depreciation reform will help small business substantially.

Other analysts have evaluated the issue differently. Allen Sinai, senior economist at Data Resources Inc., a Massachusetts-based economic research firm, noted in testimony before a subcommittee of the House Small Business Committee that only 3.3% of small business firms fall into the manufacturing category, which derives most of the tax benefit from depreciation of assets. "Our industry is not helped at all by 10-5-3," says Ken Hagerty, the Washington representative of the American Electronics Association (AEA).

Lingering doubts about the proportional benefits of 10-5-3 for firms of various sizes won't deter congressional passage of some accelerated depreciation proposals, but there will be alterations. Two, in particular, are important to small business.

The first is a provision to permit the immediate write-off (expensing) of the first $25,000 in capital investment annually. That provision is contained in two other depreciation bills in the Senate, which, with minor variations between them, would establish four categories of depreciable assets -- 2, 4, 7, and 10 years -- instead of the Reagan plan's three.

The second change small business groups would like to see in the Reagan plan involves the current $100,000 ceiling on used equipment that's eligible for investment tax credits. A 6% investment tax credit for new assets in the three-year category and a 10% tax credit for other new assets except real estate are integral to Reagan's plan, but small businesses often buy used machines and vehicles. Not surprisingly, such organizations as the Machinery Dealers National Association and the National Tooling and Machining Association are pushing hard to raise the ceiling or eliminate it altogether.

The failure of the Reagan proposal to address the unequal treatment of new and used business assets -- and by extension, the unequal treatment of the businesses that use one more than the other -- is emblematic of the reason many economists and some business executives have reservations about the long-range effects of the President's plan.

What Reagan has proposed is a "middle-aged tax cut aimed at middleaged industries," contends Sam I. Nakagama, chief economist for the Wall Street brokerage firm of Kidder, Peabody & Co. Inc. Our economy, he said in an interview, is built on security; it's "geriatric-oriented."

The Administration has resisted any suggestions that it "target" its tax cuts toward new industries, small business, or any other economic sector. It insists on maintaining what Administration spokesmen call "neutrality" in the tax code.

"While neutrality is a simple concept in principle," says Dr. Hans Stoll of Vanderbilt University, "it is quite difficult to assess in practice." Stoll, along with Dr. James Walter of the Wharton School, analyzed federal tax policy as it affects small business in a study for the Heller Small Business Institute. In their report, the authors point out that if the corporate tax rate is 46% for large companies and only 30% for smaller companies, the tax is not neutral. "However," they wrote, "there are other factors to consider, such as the ability to take tax deductions, the ability to pass on taxes in product prices, and the like. Nonneutrality in one tax may offset opposite nonneutrality in another tax or another cost. Small businesses, for example, face comparatively high transaction costs in seeking funds in the financial markets. These costs are analogous to taxes, and one may argue that a tax concession simply offsets these higher costs."

Small Business United, a consortium of nine regional small business organizations encompassing 25 states, attempted to document the tax bias against small companies with this table, submitted in testimony to a subcommittee of the House Small Business Committee.

Relative tax disadvantage of small manufacturing corporations

Percentage of

total taxes to

Size of business net worth

receipts ($000) 1969 1974

$50 to $100 18.3% 30.1%

100 to 500 14.8 23.5

500 to 1,000 15.4 21.3

1,000 to 5,000 16.6 19.9

10,000 to 50,000 14.7 16.9

50,000 to 100,000 13.7 13.6

over 1,000,000 11.8 11.5

Source: House Small Business Committee, report of June 10 and 11, 1980.

The SBU table shows that the smallest corporations not only pay a far greater tax in proportion to their net worth, but that this proportion rose by 65% between 1969 and 1974, while the proportion of taxes to net worth for the largest corporations declined over the same period.

"We'd be happy with [tax] neutrality," says Boston financial consultant Edward H. Pendergast, speaking for Small Business United, "but we don't have it now."

Not even congressional Republicans have been able to hew to the President's tax-cut line. "Loyalty is not always being a yes-man," remarked a Republican staff aide to the House Ways and Means Committee. "My boss just can't buy their supply-side line," said another staffer, who works for a senior Republican on the Senate Finance Committee.

Consequently, literally dozens of taxcutting ideas are circulating on Capitol Hill, many of them intended specifically to stimulate the small business sector, and especially high-technology industries.

Kidder, Peabody's Nakagama, for example, is urging Congress to eliminate the capital gains tax on all new investments. Not only would a zero capital gains tax encourage new enterprises and job creation, but eliminating the tax only for new investments would create a revenue windfall for the government, according to Nakagama. Current investors would have to sell the securities they hold now and pay tax on any realized gains before they could take advantage of the new tax treatment.

The American Electronic Association backs Nakagama's proposal. Dr. Edwin V. W. Zschau, an AEA spokesman who is also chairman of System Industries Inc., Sunnyvale, Calif., reminded the House Budget Committee that after the last reduction in the capital gains tax rate -- from 49% to 28% -- equity capital available to young growing firms ballooned. "In 1980, new capital raised through initial public offerings of companies jumped to over $1 billion, double the amount raised in 1979 and more than four times the average raised during the period 1975-78," he reported in testimony.

Zschau also pointed out that after the last capital gains tax reduction, the Treasury collected $8.3 billion in capital gains taxes in 1979, the first year of the lower rates, 14% above the $7.2 billion collected in 1978. "The Treasury is collecting more at the lower rates than at the higher rates without even including the higher corporate and personal income taxes resulting from the economic stimulation that the lower capital gains tax rates are producing," Zschau said.

If other industry associations haven't jumped on the AEA bandwagon with both feet, it is largely because they're skeptical that Congress would accept so radical an idea. Many like other proposals, such as the one offered by Senators Malcolm Wallop (R-Wyo.), Daniel Patrick Moynihan (D-N.Y.), and Alan Cranston (D-Calif.), that would increase from 60% to 75% the portion of capital gains income not subject to taxation.

The Nakagama suggestion, however, isn't so radical as it might appear. In a study done for the Securities Industry Association, Arthur Andersen & Co., the accounting firm, found that of 11 industrial countries only Britain taxes long-term capital gains at a higher rate than the United States. Six countries -- Australia, Belgium, Germany, Italy, Japan, and the Netherlands -- don't tax capital gains at all.

To spur the country's flagging investment in long-term research and development, the AEA has also proposed a 25% tax credit for increases in corporate R&D expenditures. A study by Data Resources Inc., sponsored by Texas Instruments Inc., estimated that a 25% tax credit for all R&D expenditures made during the period 1978-87 would boost annual R&D spending by $5.2 billion and produce a net increase in Treasury revenue of $6.1 billion per year. "While this resulted from an assumed 25% tax credit on all R&D, we would argue that a 25% credit for increases in corporate R&D should stimulate much of the same positive feedback at a substantially lower initial revenue cost," said Herbert M. Dwight, Jr., chairman of Spectra-Physics Inc., Mountain View, Calif., in testimony to the House Budget Committee.

Before he was named chairman of the President's Council of Economic Advisers, Murray Weidenbaum argued for greater encouragement of R&D, which he called "the seedcorn for product and process innovation." In a lecture at Washington University, Weidenbaum discouraged use of government grants and contracts. "Rther," he said, "I urge liberal tax credits for R&D, which could yield a twofold benefit. First, private enterprise would determine the research projects to be undertaken, and, second, private enterprise likewise would continue to bear the bulk of the risk."

Joining the Reagan team seems to have changed Weidenbaum's view. "R&D is an investment you can expense," he said during an interview in his Washington office, "and that's not a bad deal." He dropped the R&D credit proposal into a basket of what he termed targeted programs, and then threw out the whole basket. "It's targeted programs that got us into this mess," Weidenbaum said.

The AEA is pushing for one other change in the tax code, and this one has broad-based support in the small business community. Prior to 1964, corporations were permitted to issue restricted stock options to employees. There was no tax liability to the employee until he sold the stock, at which time the difference between the value of the option when issued and the value of the stock when sold was subject to capital gains tax. Since 1964, Congress has increased the restrictions placed on employee stock options and has subjected the employee to tax at ordinary income rates on the difference between the value of the option and the market value of the stock when the option is exercised. The AEA argues that these changes have diminished the value of stock options in attracting top talent to small firms that can't afford fat corporate salaries. It wants the law returned to its pre-1964 status, and it has built a case to show that the Treasury would actually collect more in taxes under the old law than under current rules.

None of the AEA proposals pertains exclusively to small business. Other ideas do, and most of them are contained in one or more bills before various committees of both houses. No one on the Hill expects that any single bill will become the tax law that Congress eventually passes. Some ideas may never appear as bills, emerging instead out of committee mark-up sessions, floor debate, or conference committee negotiations. (For a summary of small business-related tax proposals, see page 64.)

Probably -- but not yet certainly -- the Reagan Administration will compromise with Congress on a tax policy. Congress does not have to pass a depreciation bill that conforms "in every jiggle and jot to ours," says Norman Ture, Treasury undersecretary for tax policy. The Administration's "bottom line," Ture says, is a major reduction in individual tax rates and a shift in depreciation away from the useful life concept, which is theoretically how depreciation rates are determined now.

But the Administration does not seem prepared to embrace voluntarily many of the suggestions small business has made.

It is "absurd," says Assistant Treasury Secretary Paul Craig Roberts, to suggest that the 10-5-3 proposal benefits capital-intensive firms at the expense of the small business sector. "It's capital-intensive businesses that have borne the brunt of inflation." He is, for example, unenthusiastic about further graduating corporate income-tax rates in an effort to provide some tax relief to small firms that are not capital-intensive. "Why," he asks, "should we help people who aren't hurting?" Roberts insists that the Reagan program will reinvigorate the economy. "Anytime the general economy rises, small business automatically benefits," he says, adding that "there are few superior ways to help small business."

Thus, the Reagan plan accommodates small business through the trickle-down mechanism: What helps the economy will help small business. Many suggest that a bolder plan with greater concern for the long-term economic health of the country would reverse the flow: What helps small business will help the economy -- providing new jobs in new industries with higher productivity and competitive potential.