Economic Viewpoint
CLINTON'S BUDGET ISN'T JUST BAD--IT'S UNCONSTITUTIONAL
Clinton's deficit-reduction plan mounts no attack on federal spending or the government's growing indebtedness, but its retroactive features do assault the U.S. Constitution and legal precedent. Paradoxically, the retroactivity amounts to a tacit concession by Clinton of the validity of the supply-side principle that a rise in marginal tax rates discourages economic activity and hence fails to produce additional revenues.
Misinformation is rife about the deficit reduction in Clinton's plan. In a cover story on the plan's squeaky passage, Time proclaimed the end of the Reagan era of soaring deficits. The facts are quite different. The House Budget Committee estimates that the plan will add $1.1 trillion to the national debt during 1994-98, with deficits averaging $220 billion a year. In contrast, Reagan's deficits during 1981-88 averaged $167 billion.
Moreover, the House Budget Committee estimates are likely to prove optimistic, because they assume higher real economic growth (2.8% in 1993, 3% in 1994, and 2.9% in 1995) than the economy can produce under the higher tax burdens. The Clinton Administration has already cut its real growth forecast for 1993 to 2.1% from 3.1%, adding $108 billion to its deficit estimate for the 1993-98 period. If this one-percentage-point slowdown were to extend over the period, the cumulative deficit would rise by $347 billion, more than wiping out the deficit reduction expected from the tax increase.
SLOW ZONE. Both economic theory and empirical evidence predict that Clinton's tax hike will slow the economy. The only question is: How much? Evidence published in scholarly journals suggests that Clinton's tax increase will reduce real economic growth in future years by one-third of a percentage point, adding $114 billion to the budget deficit during 1994-98.
Altogether, this slowdown in growth would push the deficit estimate up by $222 billion, essentially wiping out the expected revenues from the tax hike. But the final outcome could be much worse. According to the Internal Revenue Service's Statistics of Income, 66% of the approximately 850,000 personal income tax returns that report adjusted gross income of $200,000 or more are filings from small businesses reflecting partnership and S Corporation income. This income is produced by 60-hour workweeks and determines whether a business buys another delivery truck or hires another employee. Hence, Clinton's 33% increase in marginal tax rates on "the rich" is aimed at the small businesses that create most of the new jobs.
Deficit reduction will get no help from "spending cuts" either. The so-called cuts are but promised reductions in the rate of growth in new spending. Moreover, the bulk of the cuts are not scheduled to take effect until after 1996. The same approach failed for Bush in 1990 and for Reagan in 1982 (Tax Equity & Fiscal Responsibility Act) and again in 1984 (Deficit Reduction Act), and it is pointless to repeat the same mistake a fourth time in a decade. Not even politicians' memories are that short.
But the real significance of Clinton's plan has nothing to do with deficit reduction. It lies in another direction entirely, in its attempt to establish new precedents for retroactive law. Article I, Section 9 of the U.S. Constitution explicitly forbids retroactive law. The Supreme Court has permitted some retroactive taxation but has never permitted retroactivity beyond the date that specific tax changes are first proposed in Congress. Clinton's new taxes were first proposed on Apr. 8, 1993, and the Jan. 1, 1993, effective date on Clinton's tax increase violates legal precedent.
DEATH AND TAXES. Moreover, there is no precedent for Clinton's retroactive estate taxes. It is a violation of due process, as well as unseemly, to reach beyond the grave. Retroactive estate taxes strike at the heart of one's right to bequeath property. Obviously, testators cannot confidently plan their affairs if the guiding laws can be overturned after death. This grasping retroactivity, together with the broken 1986 tax reform covenant that closed tax loopholes in exchange for lower rates, bodes ill for the future certainty of U.S. tax law. Uncertainty, as is well known, depresses saving and investment.
Clinton and the Democrats have learned their supply-side lessons all too well. Just as supply-siders predicted, previous efforts to reduce deficits by raising tax rates succeeded only in reducing economic activity, thus enlarging the budget deficit. By making his tax increase retroactive, Clinton is able to apply higher rates to income that is already earned, thus avoiding the disincentive effects that stymie prospective measures for raising revenue.
Clinton's tax increase, for which only Democrats voted, may be challenged and overturned in the courts. If not, a dangerous new precedent will have been established. Clinton's next deficit-reduction plan can be made retroactive two years, and after that a government desperate for revenues can use retroactive tax laws to confiscate wealth. Clinton's tax increase won't reduce any deficit, but it may signal the end of our Constitutional protection against ex post facto laws.PAUL CRAIG ROBERTS
