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A Massive Tax Cut: A Leap Of Faith We Can't Afford

Economic Viewpoint

A Massive Tax Cut: A Leap of Faith We Can't Afford

Another autumn--and it looks like another tax-cut confrontation between the Clinton Administration and the Republican Congress. The GOP majorities in both houses have passed sweeping proposals that the President has repeatedly promised to veto. The veto threat is understandable. What's surprising is that the Republicans are espousing a program that is highly dubious on political grounds and largely indefensible on policy grounds.

A massive tax cut that eats up future budget surpluses is ill-advised for several reasons. First, budget projections are inherently uncertain and subject to a wide range of error. It is true that both the Congress and the Administration have used eminently reasonable economic projections in their budget forecasts. But both have optimistically assumed that the unanticipated and largely unexplained surge in tax revenues during the past six years will be sustained in future years.

DOWNSIDE SURPRISE? John Kenneth Galbraith once quipped: There are only two kinds of economic forecasters-those who don't know and those who don't know they don't know. During the past several years, the economy's substantial surprises have been on the upside. What if the surprises are on the downside in the near future? Tax cuts promised today could easily produce ballooning deficits tomorrow. In just a few years, the elimination of the economy's structural budget deficit, arguably the major economic policy accomplishment of the 1990s, could fall victim to an unexpected tide of red ink.

Second, most of the projected budget surpluses outside of Social Security assume significant real cuts of 20% or more in discretionary federal spending. That means deep cuts in defense, law enforcement, and science and technology. Is it reasonable to believe that Congress will agree on such cuts in light of our educational shortcomings, scientific challenges, drug and crime prevention agenda, and defense commitments? Would such cuts serve the national interest? I don't think so. Nor am I alone. Polls indicate that most Americans are more concerned about crime, education, health care, and Social Security than they are about taxes.

Third, the Republican tax cuts would largely take effect just as the majority of Baby Boomers reach retirement. Would-be tax-cutters argue that future budgetary surpluses belong to the American people. They may be right, but so do the future liabilities of Social Security and Medicare. These programs face long-term financing shortfalls despite the improved budgetary outlook over the next 15 years. Lowering taxes now will only increase the tax burden on future generations to pay for these popular retirement benefits.

Both the Clinton Administration and congressional Republicans agree that the projected surpluses of the Social Security fund should be dedicated to ensuring its future solvency. But they disagree profoundly over what to do about Medicare. The President proposes to allocate 15% of the projected surpluses outside of Social Security to Medicare. Part of the money would be used to cover the cost of a new prescription drug benefit for Medicare beneficiaries. The remainder would extend the life of the Medicare Trust Fund for a quarter of a century.

Meanwhile, congressional Republicans are content either to assume Medicare's future financing gap will solve itself or postpone grappling with it until it reaches crisis proportions. But procrastination will only make solving the shortfall more painful in the future. Even without drug benefits, Medicare will need more revenues unless health-care costs take an unlikely nosedive.

Finally, there is no economic justification for big permanent tax cuts. Temporary tax cuts could be justified to revive the economy if it were sinking into recession. But that's not the case. Or they might be justified as part of a major tax simplification/reform proposal, or as part of a concerted effort to reduce income inequality. But the Republican proposals do not simplify the tax code nor do they reduce the burden of payroll taxes on working Americans. And the majority of the benefits of these proposals are targeted to families in the top 20% of the income distribution.

INCREASE SAVING. The American economy does not need more consumption. It needs more saving and investment. And the best way to increase saving is to use the surplus to reduce the national debt and thus reduce interest rates. Over time, saving the surplus will put more dollars into the pocketbooks of American families than cutting their taxes. And dedicating a portion of this saving to Medicare will reduce the future burden on working Americans to provide for the health care of their elderly family members.By Laura D'andrea Tyson

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