Tax Reform: Who Pays, Who Profits : Would Profit : <i> Clothing Retailer Stands to Benefit </i>

“‘When there is an in come tax,” Plato said, “the just man will pay more and the unjust less on the same amount of income.”

Twenty-three centuries later, the Treasury Department has concluded much the same. It doesn’t buy the Greek philosopher’s premise that income taxes and justice are mutually exclusive, of course.

But in its mission of tax reform, the Treasury has acknowledged that injustice runs deep in the tax laws and must be routed out. On the other hand, many taxpayers would pay a heavy price for the reforms.

To translate the Treasury’s theories to real-world cases, The Times examined how the taxes of three individuals and two companies would be affected if the agency’s tax-simplification proposal were enacted in full. Tax calculations were performed by the Los Angeles office of the Price Waterhouse accounting firm.

The analysis relies on several assumptions: All provisions have been phased in; inflation is at 4%; and the proposed depreciation method was in effect when assets were acquired. To calculate taxes under current law, 1984 tax rates and law are used, even when the taxpayer’s most recent available numbers are from the 1983 tax year.

Among the case studies, the individual “winner” has relatively low income while the individual “loser” is a wealthy man with substantial tax shelters. The family for whom the proposed changes would result in a wash, falls somewhere in the middle.

The business “winner” is in retailing, an industry that isn’t favored under the current tax system. The corporate “loser” is a high-technology company. Some analysts had speculated that high-tech companies would fare well, especially in comparison to smokestack industries.

When a clothing company opens an average of 25 new stores a year and is rapidly expanding its existing 150 outlets, it buys a lot of cash registers and clothes racks.

In fiscal 1984 alone, ClothesTime Inc., a fast-growing women’s off-price clothing company based in Anaheim, spent more than $3 million on such capital equipment.

It therefore reaps considerable benefits from a tax system that encourages investment in such capital equipment through credits of up to 10% of an asset’s value. Because of this investment tax credit, ClothesTime cut its tax bill by $194,069, or nearly 11%, in its 1984 fiscal year, which ended in January, 1984.

So it is with some trepidation that ClothesTime greets the Treasury’s tax-reform plan, which proposes the repeal of the investment tax credit, even though the retailer would be a significant winner overall.

The prospect of losing this credit prompted some discussion at ClothesTime about the wisdom of continuing to expand at its current rapid rate, acknowledged controller Stephen J. Schweickert. But he said company officials concluded “that in most cases, running a business on the basis of tax considerations proves to be a pretty foolhardy approach to business.”

Besides, this is one of only two components of the Treasury’s tax-reform package--albeit, the two most controversial provisions for business--that would have a measurable adverse effect on ClothesTime. The other is the proposed abolition of accelerated depreciation.

Moreover, the company would greatly benefit from the proposed revision in the way corporate tax rates are figured. Currently, business rates are graduated up to a maximum 46%, which ClothesTime pays. The Treasury proposes a flat 33% corporate rate.

The overall result would be a substantial tax reduction for ClothesTime. Its tax cut would amount to 10.8% if a conservative approach is taken to the way depreciation would be calculated under the proposed system. And the cut would approach 20% if a more liberal interpretation is adopted.

Under the proposal, accelerated depreciation would be replaced with a system that forces companies to recapture the cost of assets over a longer period and at a slower pace, in part through a proposed indexing procedure that is enormously complex.

In essence, the value of a depreciable asset would have to be adjusted annually for the rise in the consumer price index before a portion of the value would be allowed to be written off.

Businesses have been highly critical of this proposal because their write-off of assets would be considerably slower and the depreciation amounts calculated for tax purposes would bear little resemblance to the amounts kept on the company’s own books. Moreover, the inflation adjustment promises to be a bookkeeping nightmare.

Trying to recompute the allowable depreciation on thousands of pieces of equipment for the purposes of this story became so unmanageable that both ClothesTime and the other company profiled here simply gave up trying.

ClothesTime opted to interpret the Treasury as disallowing a $434,294 depreciation deduction it took in fiscal 1984. This figure represents the difference between the depreciation ClothesTime reports on its own books and the much larger amount allowed for tax purposes under accelerated depreciation methods. If accelerated depreciation was scrapped in exchange for a straight-line method, ClothesTime reasoned, the $434,294 would not be allowed.

That difference would increase ClothesTime’s taxable income to $4.37 million from the $3.93 million reported in fiscal 1984. At a flat 33% marginal tax rate, its tax becomes $1.44 million.

For fiscal 1984, it paid a tax rate of 46%, minus a $194,069 investment tax credit, for total federal income tax of $1.61 million.

In other words, its tax bill would decline by 10.8% and it would add about $608,000 to earnings.

ClothesTime also could have made an argument for no depreciation change whatsoever, which is what the other company profiled here did. That argument goes like this: The proposed change in depreciation methods is basically nothing more than a timing difference--that is, the depreciation would eventually be allowed, but over a longer period of time. Thus, there would be little long-term material effect.

“Basically what it amounts to,” Schweickert said, “is that we wouldn’t get some cash flow benefits we do now.”

Because its interest expenses are roughly similar in size to its interest income, it would not be significantly affected by the Treasury proposal to index interest income and expense.

Nor would the proposal to begin subjecting private-purpose municipal bonds to taxation affect ClothesTime, since it leases its stores instead of acquiring them through industrial development bonds as many retailers do.

It could lose as much as $20,000 in entertainment deductions if the proposal to eliminate such deductions survives.

On a negative note, ClothesTime would fail to capitalize on what is regarded as the biggest treat for business in the tax package: a provision allowing businesses to deduct from their income half of all dividends paid. ClothesTime pays no dividends.

“We retain 100% of our earnings because we’re in an expansion mode,” Schweickert said. “And while this (proposal) would probably reduce our inhibition to pay dividends, . . . it isn’t in our five-year plan.”