Article...YOU CAN CUT TAX RATES AND BALANCE THE BUDGET AT THE SAME TIME..
William W. Beach
John M. Olin Senior Fellow in Economics
The Heritage Foundation
All across America, support is building for a package that combines tax reform with tax cuts. Taxpayers know they are paying too much for government. At the same time, deeply concerned about persistently large spending deficits, they are demanding that Congress and the President balance the budget. These demands have become especially sharp as voters realize that they could have a tax cut and a balanced budget if Congress and the President would restrain spending growth to 2.1 percent per year, or just slightly less than the 2.4 percent rate since 1992. Politicians have responded to these twin concerns by proposing tax reform plans that reduce taxes while simultaneously cutting deficits.
For example, the Balanced Budget Act of 1995, passed by Congress in November of last year and vetoed by President Clinton, contained both significant tax cuts and a spending plan. The Congressional Budget Office determined that this combination of tax and spending cuts was sufficient to balance the federal budget by the year 2002. Or take another tax proposal, the Armey-Shelby flat tax. This tax reform plan reduces taxes on households and outlines a spending path that would balance the budget over seven years. On August 5 of this year, Senator Robert Dole also proposed substantial tax cuts for households and businesses as well as spending reductions that would result in a balanced budget by 2002.
All of these proposals reflect the fundamental principle that individual households know best how to spend their money and, when they face lower tax rates and have to pay less of their income in taxes, will spend and save in a way that promotes economic growth. The growing economy that results from their actions will expand the tax base, and this will yield more tax revenues at lower tax rates. In short, these current proposals for tax and spending cuts trust taxpayers to produce a strong economy.
When this approach has been tried in the past, newly empowered taxpayers have come through for the economy:
Ronald Reagan reduced tax rates from a top rate of 70 percent to 28 percent, and the U.S. economy grew dramatically. From 1983, when his tax cuts kicked in, through 1989, the last year before rates were increased, the U.S. economy grew at an average annual rate of 4 percent. In fact, the 1984 growth rate that followed full implementation of the Reagan tax cuts was a robust 6.8 percent. This growth stood in stark contrast to the stagnant, inflationary, high-tax economy of the 1970s.
During the tax-cutting 1980s, civilian employment grew by 17 million new jobs. Employment growth during the 1980s averaged 1.9 million jobs per year. Since 1989, and two tax rate increases later, employment growth has averaged 1.2 million jobs per year.
This surge of economic growth produced just what the Reagan economists had predicted: a larger federal tax base and, thus, more federal tax revenues at lower tax rates. Federal tax revenues nearly doubled during the era of tax rate decreases, rising by 99.4 percent between 1980 and 1990.
Those who support tax cuts essentially trust taxpayers to make sensible decisions about how to spend, save, and invest their money in ways that lead to economic growth. Those who oppose tax cuts are not so trusting. They voice four major objections, all of which are myths:
MYTH #1: We tried it before during the Reagan years, and huge deficits resulted.
REALITY: Again, the Reagan tax cuts led to nearly a doubling of federal revenues, largely because the cuts encouraged entrepreneurship, business expansion, and job growth. Unfortunately, federal spending increased at a faster pace: about 112 percent between 1980 and 1990. It is critical to note that much of the increase in the deficit occurred before the tax rate cuts took effect. After the rate reductions were fully implemented, however, deficits fell as a percentage of gross domestic product. At the height of the 1982 recession, the deficit equaled 6.3 percent of GDP. However, by the end of the Reagan years, it was down to 2.9 percent of GDP, or about where it stood during the 1970s.
MYTH #2: If taxpayers have more money, their spending will ignite inflation, which will drive interest rates up and slow the economy.
REALITY: The tax cuts of the 1980s did not ignite inflation and drive up interest rates. Quite the contrary. Between 1980 and 1990, the rate of inflation dropped from 12.4 percent to 4.4 percent. In fact, the inflation rate for 1986 was 1.1 percent, and turned negative during the last month of that year.
MYTH #3: We cannot afford to cut taxes before eliminating the deficit.
REALITY: Cutting deficits before cutting taxes reduces rather than enhances the chances of balancing the budget. When the economy is growing faster than expected, the federal tax base also is growing faster, and a larger tax base means more tax revenues to balance the budget. We know that tax cuts can produce faster growth. Thus, it makes more economic sense to cut tax rates and spending simultaneously rather than in stages. The Congressional Budget Office examined the policy changes leading to a balanced budget proposed by Congress in June of this year and concluded that the proposed tax and spending cuts would eliminate the deficit over six years even if the economy grew no faster than 2.2 percent per year. Higher economic growth clearly would lead more quickly to a balanced budget.
MYTH #4: Current tax and spending policies are reducing the deficit and supporting a growing economy. Why fix something that is not really broken?
REALITY: The deficit has begun to subside, partly because of spending cuts achieved during fiscal year 1996 by the 104th Congress. However, the Congressional Budget Office forecasts a return to higher deficits if the economy fails to pick up speed and Congress fails to make significant additional spending cuts. In fact, the deficit for the next fiscal year, FY 1997, is expected to equal $171 billion, or about $30 billion more than the 1996 deficit. Now is not the time to rest on our laurels.
The tax plans now being discussed by both parties contain tax and spending cuts, but only those proposed by the Republican Congress and Senator Dole would cut tax rates across the board--the key to stimulating economic growth. Once tax rates are reduced, the private economy will receive the boost it needs from new household savings and consumption to produce the new revenues the government needs for deficit reduction. Without tax rate reduction, the prospects for the economy are grim, and the chances for balancing the budget are very slim indeed.
heritage.org |
