The tax legislation resulting from the latest budget deal will make the federal tax code more complicated and less coherent, but ironically one of its many special-interest provisions points the way to general tax reform.

Here's some friendly advice to members of Congress: Get a new tax reform bill on the table quickly, because as soon as Americans understand what's in the one you just passed, you're in big trouble.

Rep. John Kasich (R-Ohio) calls it "a dream come true," but in truth the new tax law is either a hideous nightmare or a ridiculous joke. It is absurdly complicated and contradictory, giving with one hand and taking away with the other.

It punishes Americans who are so imprudent as to work too hard or save too much, boosting marginal rates--the percentage that goes to the government on each extra dollar you earn--into the stratosphere.

The marriage penalty bites harder than ever. The Alternative Minimum Tax will now ensnare people who make just $50,000. And despite the reduction in capital gains rates, taxes on stocks and mutual funds will soar if you hold shares less than 18 months.

As Tax Notes, a publication for tax professionals, recently put it: "The act is laden with new and complex statutes affecting capital gains, IRAs, tuition tax credits, and dozens of other provisions. In turn, these provisions will spawn a new generation of regulations and new (or significantly revised) tax forms.

The new complexity could well re-ignite a furor for radical tax reform."

We can only hope.

Unfortunately, Republicans this fall are focusing their attention on restructuring the IRS. But it's the system the IRS enforces that's the real problem.

The tax code needs to encourage savings, not consumption. It should be flatter, fairer, and above all simpler. It's the very complexity of the code that permits special-interest boondoggles.

A Favor to One . . .

Which brings us to one great irony in the new law. Buried deep in its bowels (Title III, Sec. 313) is a remarkable tax break that could provide the key to reforming the entire system--even though it certainly wasn't meant that way. The break was the result of the efforts of one man, J. Morton Davis, who built the investment firm D. H. Blair & Co., Inc., and who is well-connected in Washington. Among other things, he owns part of the parent company of The Hill, a newspaper that covers Congress.

Blair has had run-ins with regulators and stock exchanges, resulting most recently in a consent letter with NASD Regulation Inc. that cites "fraudulently excessive markups" and includes a $2 million fine and $2.4 million in restitution to investors.

One of Blair's specialties is bringing small companies public and encouraging its customers to buy and sell them. Prices can jump in the process, but fall quickly as well, sometimes leaving innocents holding the bag. For Blair, a big problem is that these transactions can generate serious tax liabilities for the investors.

The solution is Section 313--call it the Davis Clause--which was backed by a host of senators, from Democrat Tom Daschle to Republican Don Nickles. Section 313 is the platonic ideal of a special-interest tax provision. "We're the only ones who argued for it," says lobbyist Fred Graefe, and my calls around Wall Street yielded no one who knew about it. But the clause lays the groundwork for what could be an extremely beneficial overhaul of the code.

The measure says that if you own shares of a "qualified small business stock" for at least six months and then sell at a profit, you can roll the funds into another small stock and pay no taxes on the capital gain.

This rollover is similar to the break homeowners received when they sold one house and bought another (the homeowner break ends in the new law, but that's another story).

It's also similar to the deal Treasury Secretary Robert Rubin and others received when they joined the Clinton administration. Forced to divest himself of investments at Goldman Sachs, Rubin was allowed to roll all the profits into Treasury bonds or mutual funds--with no taxes paid.

. . . Could Become a Blessing to All

In a piece last year, I advocated tax-free rollovers for all Americans--and for all assets, including real estate, stocks, bonds, and mutual funds. Rollovers are a great way to encourage savings. You can buy and sell at will, but, if you don't quickly reinvest (rather than consume), you'll have to pay taxes.

Rollovers could become the foundation for serious tax reform. Each year, taxpayers would compare what they added to savings with what they took out. A rollover, of course, would be a wash. If you added more to savings than you subtracted, you'd deduct the difference from your income. If you took out more than you added, you'd add the difference to your income.

Then, beyond an exemption of perhaps $30,000 per family, all Americans would pay taxes at a single rate of, say, 20 percent. There would be no capital gains taxes and, at least in my scheme, no other deductions.

Would such a system raise less money for the government? Perhaps, but it would invigorate the economy and end the intrusiveness of the IRS. And raising less money might be admirable. We face likely budget surpluses that politicians won't be able to resist spending--thus increasing the size and reach of government. That's why a real tax cut and real tax reform (not the silliness that was just enacted) are needed urgently.

Now, thanks unwittingly to Morty Davis, the answer is at hand.

James K. Glassman is the DeWitt Wallace-Reader's Digest Fellow at AEI.