The heat is rising in the monumental congressional debate over a "modified flat tax." And no wonder -- for taxpayers, both individual and corporate, reforms enacted by the 99th Congress may drastically change aftertax income as well as long-term investment decisions. But there is another reason for the soaring passion over tax reform in Washington this winter. At stake in the tax debate is more than just deficits and depreciation allowances. At stake is the new leadership of the Democratic and Republican parties as well.

In each party, the most prominent congressional leader of the tax reform movement is positioning himself for a run at the White House in 1988: Bill Bradley, Democratic senator from New Jersey, and Jack Kemp, Republican representative from New York. Each has used the tax issue to seed a populist-style candidacy and to distance himself from the entrenched leadership of his party. Kemp is building an identity separate from the Eastern, so-called moderate Republican wing associated with Vice-President George Bush. Bradley is separating himself from the Mondale candidacy and the archaic Democratic leadership symbolized by Speaker of the House Thomas P. "Tip" O'Nill.

A former professional basketball star, Bradley has distanced himself in part by writing The Fair Tax, which his forces distributed at last year's Democratic convention. His supporters tried to include the principles of his modified flat-tax legislation, known as Bradley-Gephardt, in the Democratic platform. Although it is characterized as neither an overall tax cut not a tax increase, the Bradley bill would repeal nearly every tax credit and deduction on the books and slash the top marginal rate for personal and corporate income taxes to 30%. Walter Mondale ran against the Reagan deficit with an "honest" proposal for tax increases; his humiliation in November, though, has made Bradley's position look more attractive to some Democrats.

Kemp, already the hero of the New Right and champion of the supply-side revolution, didn't need a book to build his credibility as a national candidate in 1988. Instead, he preached the gospel of tax-reform populism around the country last fall, and helped such embattled Republican candidates as Minnesota Senator Rudy Boschwitz win reelection. Not only did that tour help build a national constituency for Kemp's tax bill, called Kemp-Kasten, but it also earned the former pro-football quarterback a pile of political IOUs than he can cash in during this year's tax fight and in his run for the Presidency in 1988.

The Kemp-Kasten bill is similar to Bradley-Gephardt, except that it would cut the top rate to 25%, allow indexing of capital gains for inflation, and retain current accelerated depreciation schedules. This last provision is dear to the powerful industrial lobbies whose member companies reap billions in tax savings by generously depreciating plants and equipment.

The theory behind both Bradley-Gephardt and Kemp-Kasten is that a vastly simplified tax code will restore taxpayers' faith in the essential fairness of the system, thereby encouraging compliance, while radically lower marginal rates will spur investment and help the country grow out of its crippling budget deficits. Bradley and Kemp each talk glowingly about the other's proposal, a major political irony of the tax reform debate, since these men see the world so differently on nearly every other public-policy issue.

The key question now is whether the reformers can translate their populist support into a victory in Congress. And that depends on whether they can out-maneuver three of the most powerful legislators on Capitol Hill: Bob Dole, the new Senate Majority Leader; Dan Rostenkowski, chairman of the House Ways and Means Committee and Bob Packwood; the newly appointed chairman of the Senate Finance Committee.

In style and substance, Rostenkowski and Dole are nearly opposites from Kemp and Bradley, and both represent the oldstyle leadership that the reformers oppose. Backroom negotiators with their eyes trained on political reality, Rostenkowski and Dole are known to be suspicious of, if not downright hostile to, the modified flat tax reform proposals.

Rostenkowski, who was Chicago Mayor Richard Daley's emissary in Washington, suffered an embarrassing defeat over taxes in 1981 and will be "gun shy," as one Democratic tax counsel on the Hill puts it, about sponsoring any tax bill supported by the Reagan Administration. Although the Treasury Department proposed a modified flat tax plan last November, President Reagan won't make the extent of his support known until early this year. It is unclear if he will pause long enough from his budget-cutting efforts to lobby hard for the flat tax.

Dole, another sure Presidential contender, won't commit himself very easily to the Kemp and Bradley movements, either. With Rostenkowski in a foxhole after his defeat on taxes in 1981, it was Dole, then chairman of the Finance Committee, who shepherded two loopholeclosing tax increases through Congress.

The last of them, the 1984 Deficit Reduction Act, emerged last July as a 1,000-plus-page monster of fine print that left tax attorney euphoric over the new business it brought. Dole prefers to take on the tax issue by digging into the minutiae of the Internal Revenue Code, snipping a credit here, tying a loophole there. That approach allowed him to play the special-interest lobbies against each other and to broker tax legislation through the autocratic Finance Committee. "Dole is more inclined to take the nickel-and-dime, divide-and-conquer approach," says Paul Huard, vice-president for tax and fiscal policy of the National Association of Manufacturers.

So, too, is Packwood, Dole's successor as Finance chairman. Often described as a "maverick" -- a Washington euphemism for "disliked" and "difficult to work with" -- Packwood told reporters when his appointment to Finance was announced, "I short of like the tax code just the way it is." The present code gives the committee enormous influence over the economy through the manipulation of tax favors dear to special interest groups. "These kinds of reforms could eliminate or severely reduce the power of the Finance and Ways and Means Committees," says Tom Humbert, Kemp's top tax strategist.

The tax reformers don't care about fiefdoms on Capitol Hill protecting their turf. They are selling their packages as a boon to the country's two most beleaguered political constituencies -- small business and the middle class. Losers under a modified flat tax, say the reformers, would be millionaires and large corporations that use the current tax code to shelter much of their income.

Small business lobbyists agree that the present system favors capital-intensive companies with huge revenues. They are lining up behind the flat tax proposals, although they are unlikely to have any major legislative role in the negotiations to come. For some, that is a bitter pill to swallow, because small business is an important element of the populist coalition on which Kemp and Bradley hope to erect their national candidacies.

The tax reform debate must inevitably become a clash of titans. "The special interest trade associations are clearly going to develop positions where they say, '[Take away tax breaks] from everybody else, but not our industry," says Rachelle Bernstein, manager of tax policy at the U.S. Chamber of Commerce. "Then it will be up to Congress to ignore the special constituencies."

History suggests that is unlikely. If it does happen, Kemp and Bradley may ride a wave of populism right into the next Presidential election.

Stepped up enforcement by the Internal Revenue Service, particularly of payroll tax deposit requirements and 1099 independent contractor reporting, is creating havoc for many small companies. Accountants and small business representatives testifying before Congress say that increased use of computers in auditing, complex tax deposit schedules, and new fringe benefit regulations have turned an already burdensome situation into a "nightmare." Reforms have been introduced, but none are likely to be enacted until the end of 1985 at the earliest.

Job creation by small companies continues to be the most important factor in the return of Americans to the work force after the 1981 recession. But a yearlong study by the Office of Technology Assessment is investigating, among other things, whether office automation in small companies will have an adverse effect on those new jobs. Economists at OTA say the effort is still in its preliminary stages, but early indications are that small business automation is "really taking off."

Hispanic entrepreneurs generally regard the Small Business Administration's loan programs as "absolutely no good for the little guy," in the words of Manuel Zapata, of New York's Interboro Hispanic Merchants. Red tape, long delays, and lack of knowledge about the entrepreneurs' businesses were the main complaints recorded in a survey conducted by the National Chamber Foundation. The Hispanic businesspeople gave much higher marks to the SBA's "Section 8 (a)" minority set-aside program, however.