01/24/2003 1:00AM

Reform this tax system

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NEW YORK - The centerpiece of President George W. Bush's most recent tax-cut proposal is the elimination of income taxes on most stock dividends. Bush's advisers reportedly recommended only a partial reduction in these taxes, but the President personally insisted on abolition because he believes there is a basic issue of fairness involved: In his view, dividends are effectively taxed twice, first at the corporate profits level and then at the personal income tax level.

If the President is sincere about the inequity of taxing things twice, there's an even clearer case of it that demands his attention and Internal Revenue Service reforms: The withholding of often modest gambling proceeds from parimutuel bettors, a grossly unfair procedure that drives players from the game and ultimately costs government more than it collects.

The double-taxation argument is only the icing on a big cake of good reasons to reform or eliminate the current system - reporting all proceeds over $602 on 300-1 payoffs, and withholding 27 percent of the gross from all 300-1 payoffs that exceed $5,000.

The basic problem with the system is that it taxes gross proceeds rather than actual profits, resulting in an effective withholding rate that can exceed 100 percent. It is predicated on the absurd notion that someone fortunate enough to hit a big payoff has made exactly one bet for the entire year and his gross return should be treated as pure profit.

A bettor who puts $700 into a race and ends up with half of a $1,300 trifecta may not be a brilliant money manager, but he's not a $649 winner either. He has lost $50 on the race, but his proceeds are reported to the I.R.S. as if he made a score on which taxes are now due.

A bettor who loses $1,000 five days in a row, and on day six bets another $1,000 and hits a $5,202 pick six, has lost $798 for the week. The government, however, confiscates an additional $1,404 on the theory that the bettor's activity for the week consisted of making one winning $2 bet and being $5,200 ahead. It doesn't matter if that winning ticket was a part-wheel that required an investment that makes the payoff 3-1 instead of 300-1. Even if your ticket cost you $1,300, the I.R.S. treats it as a single $2 winning ticket without even recognizing the other $1,298.

No other business would stand for or survive such a system. Imagine if the I.R.S. jumped in to take 27 cents out of every $1 McDonald's sandwich sale on the premise that each such transaction was an expense-free windfall for the seller. The government's argument that if McDonald's kept good records it could get back some of that withholding a year later would not keep the chain from closing its doors long before that.

Many others, terrified of dealing with the I.R.S. at all, end up employing "10 percenters" to cash their big tickets, costing both themselves and the government yet more money.

Then there's double taxation: The betting pool from which payouts emerge has already been taxed once by the government, which takes a slice off the top in the form of a parimutuel tax and through mandated agricultural subsidies, such as payments to state breeding funds. It then steps in again to a pool already reduced by as much as 25 percent and taxes individual winners a second time - the exact same procedure that the President finds so unfair with stock dividends.

Two mild reforms short of abolishing all taxes on gambling proceeds would solve much of the problem. First, the thresholds should be raised to reflect both inflation and the proliferation of multiple wagers, which now account for a majority of the sport's handle. Raising the trigger on reporting from $602 to $2,500, and on withholding from $5,000 to $25,000, would eliminate most of the punitive and regressive transactions while preserving a paper trail for investigative purposes and a tax on true windfalls.

Second, the actual cost of a ticket, rather than the entirely theoretical idea of multiple, individual $1 or $2 bets, should be the basis for determining whether a wager has paid 300-1. If someone buys a four-horse trifecta box for $24, he shouldn't be considered a 300-1 winner unless he actually gets 300-1 by collecting more than $7,200.

Perhaps, though, racing lobbyists should start the negotiation by citing the President's stance on dividend taxes and call for scrapping the entire system. Maybe tracks could rename payoffs and start making announcements like "the $2 trifecta in this race returns a dividend of $5,387." After all, what's fair for stockholders should be fair for horseplayers.