Cuts for Gain Now, but Pain Later

William G. Gale
William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow - Economic Studies, Co-Director - Urban-Brookings Tax Policy Center

July 25, 1999

Last week, the House approved a Republican plan to slash federal revenues by almost $800 billion over the next 10 years. The bill cuts income tax rates by 10%, reduces capital gains rates, abolishes the estate tax, and more. It would provide massive benefits to the top 1% or 2% of taxpayers, but the bottom 50% of households would gain next to nothing.

The Senate is considering a cut of similar magnitude, and the Clinton administration, although it doesn’t like the GOP plan, is putting forth smaller tax cuts of its own. This feeding frenzy stems from estimates of large and growing budget surpluses. But despite the surpluses, significant tax cuts would be a big mistake.

Current Congressional Budget Office estimates indicate a total surplus of almost $3 trillion over the next 10 years. That’s a lot of money, but not as much as it might seem. About $1.9 trillion comes from the Social Security trust fund, and in a rare outburst of fiscal responsibility, Republican and Democratic leaders agree that these funds should be preserved for Social Security. Even if the trust fund is left alone, however, Social Security still faces a long-term deficit.

The remaining $1 trillion is up for grabs. But even here, there is much less than meets the eye. About $600 billion is based on the politically untenable assumption that discretionary spending—on everything from environmental and education programs to road and bridge projects to national defense—will decline in real terms. But politicians of both parties already are lining up to raise discretionary spending.

Another $500 billion of the surplus arises from accumulations in trust funds for Medicare and government pensions. These funds are very similar to Social Security balances: They represent future promises to current workers, and they show up as current surpluses only because government accounting is flawed. The logic of not using Social Security surpluses to finance tax cuts should extend to government pensions and Medicare trust funds, too. If it does, given realistic discretionary spending, there is nothing left to finance tax cuts unless we want to head back into deficit territory.

Before we take that road, though, let’s recall a few inconvenient facts. First, despite short-term surpluses, the long-term budget forecast shows a large deficit, primarily because of the future pressures on Social Security and Medicare. These financing problems will become much larger if we cut taxes.

The House bill supposedly ensures that at least some debt reduction will occur, by allowing the income tax cuts only if federal gross interest payments fall. This is a cynical hoax. Gross interest payments can fall even if net debt rises. In a bow to their favored constituencies, Republicans ensured that the tax cuts for the wealthy—on capital gains and estates—are not contingent on interest payments.

Second, recent claims that the typical American taxpayer is laboring under heavier tax burdens than ever are simply incorrect. Yes, aggregate federal revenues are close to an all-time high relative to gross domestic product, but most families will have to forfeit a smaller share of their income to federal taxes in 1999 than at most times in the last 20 to 30 years. Aggregate revenues have increased chiefly because the share of aggregate income going to the highest-income households, who face higher tax rates, has risen over time.

Third, a tax cut wouldn’t do much for an economy that is already bursting at the seams under the watchful eye of the Federal Reserve Board. In fact, a tax cut that boosts spending could induce the authorities to raise interest rates to choke off any economic stimulus, as they did last month, even without a tax cut.

Finally, let’s not overlook the righteous rhetoric: “It’s the American people’s money; give it back.” That is true, but overly simplistic. The problem is that the long-term fiscal deficit also “belongs” to the people. The question in each case is which American people: current or future? It would be irresponsible for taxpayers, or the government, simply to ignore the impending retirement of the baby boomers and the obligations the elected representatives of America’s people have made. The real moral outrage should be focused on those politicians who are willing to promise voters massive future benefits but are unwilling to live with the taxes needed to pay for them.

Our country faces a rare confluence of good fortune: a short-term budget surplus, a strong economy and a tax system that is imposing the lowest burdens on most households in more than two decades. If under these circumstances, we cannot muster the political courage and the economic resources to deal with the difficult choices facing Social Security and Medicare, it is hard to see how these problems can ever be fixed.

Squandering our good fortune on unnecessary tax cuts that would be economically unproductive and make the real problems harder to solve can’t possibly be the right strategy.