FLATTENING THE TAX RATES\Supporters, opponents disagree over merits of overhaul proposals.

Byline: Gregory J. Wilcox Daily News Staff Writer

Flattening tax rates has fast become the mantra of reform-minded politicians.

Their proposals are simple, grandiose in scope and traverse party lines.

In their various forms they all promise simplified returns for individuals and businesses while streamlining the 110,000-employee Internal Revenue Service and slashing its $7.35 billion annual budget. And they would shred the 40,500-page federal tax code and replace it with a set of clear, concise rules.

Proponents say a flat tax on wages will give consumers more disposable income, encourage savings and end the practice of taxing income multiple times as the money works its way down the economic ladder.

Opponents say it's a massive tax break for the rich. They claim that more of the tax burden will be shifted to the middle class and businesses at a cost of declining property values and jobs.

The truth in this debate is an elusive commodity - subject to the whims of whatever special interest group is crunching the numbers.

And while this type of reform still is considered a long shot for becoming law, there is a consensus that our onerous tax system needs a major overhaul.

Indeed, the snapshot summary of most flat-tax plans is the post card-size return, a welcome relief from the morass of forms and confusing instructions that confront filers at this time every year.

"I think that California taxpayers are looking for a more simplified and fair tax system," said California Controller Kathleen Connell, who is in charge of the state's tax collection agency, the Franchise Tax Board. "I think that the people in California still deeply distrust the taxing agency of this state and the IRS."

Under a flat tax, everyone would pay the same rate, which under the various plans range from 17 percent to 23 percent.

Deductions would be eliminated in most cases to close loopholes and discourage the use of tax shelters. Gone could be the popular deductions for home-mortgage interest and state and property taxes. Businesses would lose a whole raft of deductions, including those for employee benefits like health care.

Under the current system there are five tax brackets for individuals with rates ranging from 15 percent to 39.6 percent depending on income level. Businesses are taxed at 35 percent. Loopholes and deductions abound.

San Diego real estate broker Rick Snyder, president of the California Association of Realtors, thinks individuals and businesses should be wary of anyone promoting a flat tax.

As proof he cites a study commissioned by his group that found that a flat tax would cause homeowners to lose $1.7 trillion in household wealth and $84 billion a year in tax savings.

And 400,000 jobs alone could be lost in California's construction, finance and service sectors, he said.

"The tax code always provided certain incentives to improve the overall life in general in the U.S.," he said of the threatened disappearance of home-mortgage deductions. "It's been a cornerstone of the tax code."

Connell, too, worries that flattening the tax rate would endanger the property-tax revenue base that finances local school districts and force a similar major overhaul of the state's tax system. For a flat tax to be revenue-neutral, meaning that the federal government would continue to collect the same amount of money as it does now, the rate would have to be nearly 23 percent, Connell said the Treasury Department has concluded.

A rate that high would probably not give any tax relief to the vast middle class, Connell said.

And what about businesses? They could deduct wages, but not interest costs, most other taxes and fringe benefits. They could write off all investments in the year they are made rather than spreading them out over a period of years.

Joseph Mazin, president of Flamemaster Corp., a small Sun Valley manufacturer of sealants for the aerospace industry, is ready for a flat tax right now.

"A flat tax would be positive for our company because we won't have anything that we shelter," he said. "It's going to be good for the shareholders and the employees."

Flamemaster has 27 employees and a relatively simple corporate tax return.

At the other end of the spectrum is Los Angeles-based Atlantic Richfield Co., a multinational conglomerate with about $8 billion in debt.

The oil refiner and gasoline marketer with about 23,000 employees worldwide has not made an assessment of a flat-tax impact, said spokesman Al Greenstein.

"You almost have to take the specifics and put them side by side with the current code to see how it compares," he said. "For a corporation that would be extremely complex and it's our feeling that none of the proposals has matured to the point where you could sit down and do this kind of detailed work."

Reformers would likely get a huge bang for their buck.

"You would get a major readjustment in all kinds of things," said Arthur Hall, senior economist at the Washington, D.C.-based Tax Foundation, a nonpartisan research group. "Interest rates are going to fall, housing values might drop a little bit and you'd get a huge increase in the stock market. It's just unimaginable in some ways what could happen."

The reason? We're in uncharted waters here. No industrialized country has ever undertaken such a massive restructuring of its tax system.

The accompanying chart offers some examples of the impact of a flat tax on various income groups. And filers this year can work their own math to see how they would fare under the various plans.

And what about benefits, like health insurance? Would those perks, along with raises, dry up.

No one can say for certain at this point, said Daniel Mitchell, senior fellow at the Heritage Foundation, a Washington, D.C.-based conservative think tank.

But Mitchell theorizes that employees might be better off under these plans.

Since businesses could not deduct health plan costs they might scale them back and use the savings to give employees raises. Employees, in turn, might then use the money to insure themselves against catastrophic illness, he said.

"I don't expect anything to happen quickly to the extent you would cash (benefit plans) out and give employees wages," said Mitchell, who was a staff economist for the Kemp Commission.

Flat-tax proposals are not new and just about all of the current ones can trace their roots back to a book called "Low Tax, Simple Tax, Flat Tax," written in 1985 by economics professors Alvin Rabushka and Robert E. Hall at Stanford University's Hoover Institute.

They believe that their system would encourage savings, generate enough money to operate the government and foster economic growth. The current tax plan discourages savings and forces people and businesses to spend too much time and energy on looking for ways to avoid taxes, they say.

"We should always be thinking about taxes as if we're starting over," said Hall during a recent visit to Los Angeles. "Tax reform like this would raise the level of economic activity by 6 percent or 7 percent over seven years."

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Chart FLATTENING THE TAX RATES