Businessweek Archives

You Can't Cut Taxes And Balance The Budget


Economic Viewpoint

You can't cut taxes and balance the budget

The sheer political genius of the 10 theses nailed to the door of the House of Representatives by Martin Luther Gingrich is its mix of cliche and radicalism: reckless tax cuts, merciless trimming of bloated government, and tax breaks ranging from allowances for legitimate children to lower capital-gains rates. Who cares whether the Contract With America can be fulfilled? The public wants change, he who shouts loudest gets the floor, and Newt Gingrich gets a chance to undo 60 years of U.S. public policy.

There is a lot that's positive about Newt's testament. Tort reform to limit megasettlements in liability suits is an obvious example. Serious welfare reform that requires useful work is another. Crime fighting goes on the plus list, as does pruning down congressional procedures.

PROMISES, PROMISES. But there is one field where the contract goes perversely wrong: The promise of tax cuts and a balanced budget just isn't feasible. There are two acceptable outcomes. One is that, having served its political purpose, the tax-cut proposal proves to be mere talk. The other is that Congress actually cuts spending vigorously while taxpayers collect all the tax cuts and breaks they were promised. But a third possibility--and the probable outcome--is that there will be a tax cut without the spending trim. In today's economy, that would cause a big expansion, overheating, inflation, and high interest rates.

Cutting the deficit means laying our hands on $200 billion. But the contract's various tax cuts and tax breaks will reduce revenue by at least that much, so the spending cuts required to balance the budget will double, to $400 billion. That inevitably means taxing the middle class or cutting back its benefits. Why the middle class? As Willy Sutton observed of banks, that's where the money is.

But it isn't going to happen: The middle class is America, so going after the middle class would be political suicide. And going after the rich or the poor in pursuit of balanced budgets is not worth the trouble. Therefore, just forget the whole balanced-budget-limited-taxes package.

Even so, the notion of tax cuts isn't going to go away. Gingrich's radicals have seized center stage and can't abandon the politically potent idea. If they yield, they will be hooked off the stage, just as President Clinton was when he failed to deliver on his election promise to be a New Democrat.

That raises the dangerous possibility of out-and-out competition between the President and the gop for tax cuts as the economy heads into the next election. Most likely, what otherwise might be budget improvements will be frittered away with a downpayment on the big tax cuts ahead. But Congress may go further: Why not espouse supply-side doctrine and predict that cuts are the seeds of plentiful tax revenues, adopt a so-called "dynamic" budget forecast, and aim for serious cuts in taxes?

It is worth remembering the rhetoric of the early 1980s: Tax cuts beget growth, and growth begets revenue. There is a virtuous merry-go-round, with free rides for everyone. We did not see it in the 1980s, and we won't see it this time around. It simply isn't true that people who pay less in taxes save more and work harder. They get to keep more, and in most cases that is the end of the story. Thus, the contract's American Dream Savings Accounts or reduced capital-gains tax rates are sure to be popular, but they bring little on the supply side.

Of course, Congress might ditch deficit worries altogether. In other words, run open deficits again, as in the early 1980s. In time, a crunch will result in spending discipline.

GOLDEN GOOSE. In an underemployed economy, tax cuts are splendid. But at full employment, they are nice only if matched by reductions in spending. Either Congress legislates major spending cuts, which I doubt, or else the Fed will bring them about by hiking interest rates. On the macroeconomic side, the U.S. economy has done extremely well. There is no inflation to speak of (yet), growth has been strong, there is full employment by almost anyone's definition, balance sheets have blossomed in the sunshine of cheap money, deficits have declined, investment is up. The unprecedented soft landing that is now being piloted by the Fed holds out the promise that moderate growth in output, employment, real wages, and profits could go on for years without the setback of boom and bust.

Trimming entitlements and wasteful government programs--from farm subsidies to trade restrictions--remains the top priority. A tax reduction now is the surest way of derailing the American dream. It is a contract with the devil.RUDI DORNBUSCH


American Apparel's Future
LIMITED-TIME OFFER SUBSCRIBE NOW

(enter your email)
(enter up to 5 email addresses, separated by commas)

Max 250 characters

 
blog comments powered by Disqus