To listen to media analysts and Wall Street commentators, the economy is teetering on the edge of catastrophe. The way to save ourselves from economic ruin, according to these prophets of gloom, is a major tax increase. If we simply give bureaucrats and politicians more control of the economy, we can not only reduce the federal deficit but also lower the trade deficit, increase national savings, improve our competitiveness, strengthen financial markets, stabilize the value of the dollar, and maybe cure the common cold.
Along with this solution to the budget crisis, these same folks are quick to explain what caused it. As one might suspect, they say the 1981 Economic Recovery Tax Act radically lowered government revenues. Furthermore, since we all know from watching the evening news that the budget has already been cut to the bone, additional efforts to balance the budget on the spending side are out of the question. Tax increases are the only alternative.
The tax increasers' alleged cause and proposed cure for the budget deficit have this in common: they are totally contradicted by the facts. Perhaps the most outrageous claim is that the government is starved of tax revenue. Those who blame the deficit on the 1981 tax act conveniently overlook the fact that between 1980 and 1990, according to both the Office of Management and Budget (OMB) and the Congressional Budget Office (CBO), tax revenues will have more than doubled. In 1980, the federal government collected tax revenues of $517 billion, an amount thought to be so egregiously high that Ronald Reagan won a landslide victory by promising to cut taxes. OMB estimates that by 1990, however, the government will be collecting $1.059 trillion, an increase of $542 billion. CBO's estimate is even higher.
The real cause of the deficit was excessive spending. Government spending was $591 billion in 1980. In 1990, the federal budget is expected to be at least $1.151 trillion, an increase of $560 billion. The deficit increased, as anyone who understands grade-school math could explain, because spending grew by an even larger amount than tax revenues.
If tax collections have risen so dramatically, why do so many people think the 1981 tax bill caused the deficit? And why do people think spending was cut during the 1980s? Part of the reason some think taxes have been reduced is the confusion between lower tax rates and lower taxes. Ronald Reagan, to his credit, presided over a dramatic reduction in marginal tax rates. The maximum personal income tax rate today is 28 percent, down from 70 percent when he first took office.
Lower tax rates, however, do not mean lower taxes. Large increases in Social Security and business taxes, along with bracket creep (indexing was not instituted until 1985) and broadening the amount of income subject to taxation, all contributed to the flood of money pouring into the government's coffers. It should also be noted that many of the taxes that have been increased in the last eight years are less visible to individual taxpayers, thus helping to hide the fact that revenues have dramatically increased. Indeed, just as Reagan deserves praise for lowering marginal tax rates, he can be blamed for the 13 tax increases he signed into law.
The reason many people think spending has been cut has less innocent origins. To the average American, a spending cut means you spend less next year than this year. Congress, however, has invented its own definition. It assumes that spending should rise a certain amount each year. So any budget proposed by the president that does not increase spending by at least that amount becomes a spending cut—even if spending grows. It is no surprise that so many Americans are confused.
Almost without exception, every "spending cut" of the Reagan years was no more than a moderation of the speed at which government spending was projected to grow, instead of an actual spending reduction. Unfortunately, rather than expose the fraudulent nature of the budget process, the media contributed to the public deception by publicizing sensationalist stories of "bone-wrenching budget cuts." If a private business ever tried to do the same thing by advertising a sale simply because they did not increase prices as fast as they wanted, the government would probably charge them with fraud.
When confronted with the facts, only the most closed-minded will try to defend the idea that the deficit was caused by "tax cuts." Politicians, however, avoid reasonable discussion, and instead resort to dogmatic claims that today's deficit can only be lowered if the tax burden is increased. This argument relies on the explicit assumption that Congress would use the additional money for deficit reduction and not, as has happened each time taxes were raised in the past, for more spending.
This assumption is flat wrong. Under the Gramm-Rudman-Hollings Deficit Reduction Act, the yearly deficit is already determined by law. For instance, the 1990 deficit target is $100 billion. Regardless of whether Congress cuts taxes or raises taxes, the deficit target will remain $100 billion. The only effect of a tax increase in to increase the amount of money Congress can spend. Gramm-Rudman limits total spending in any fiscal year to the sum of projected tax revenues plus that year's deficit target. In other words, Gramm-Rudman sets the deficit; higher taxes simply allow Congress to meet that deficit at a higher level of spending.
The only way to ensure that Congress would not spend the additional money is to amend Gramm-Rudman so that a tax increase would automatically result in a dollar-for-dollar reduction in the deficit targets. Rep. John W. Buechner (R–Mo.) has introduced a bill to this effect. According to his plan, if Congress, for example, raised taxes by $20 billion, the 1990 deficit target would fall from $100 billion to $80 billion.
Don't expect Congress to enact this bill. The real reason some legislators want more taxes is precisely so they can increase spending. Without a tax increase, Congress would be forced to limit next year's spending increase to about $35 billion. While $35 billion is a lot of money, it is only about half the amount needed to meet projected funding increases in existing government programs. Spending would have to increase by at least $70 billion to keep pace with the demands of special-interest groups who benefit from these programs. Unfortunately, when Congress has to choose between protecting economic growth or placating special interests, the choice has all the suspense of a Soviet election.
Both the CBO and OMB project that tax revenues are going to climb by more than $80 billion in 1990 alone. This figure by itself is enough evidence that a further tax increase is not needed. Since more revenues would only mean more spending, there is no reason to risk a recession by raising taxes.
If George Bush maintains his commitment to veto any tax increase, Congress will have no choice but to limit spending growth to stay within the Gramm-Rudman targets. If legislators try otherwise, the automatic spending control device in Gramm-Rudman known as sequestration would take effect, bringing projected spending down to more reasonable levels. At that point Congress might try to repeal Gramm-Rudman, but that would also take legislation which could be vetoed.
While most observers think the president is caught in a no-win situation, George Bush is actually in an enviable position. If he has the determination to withstand the pressure of special-interest groups, he can simply veto any tax increase or change in Gramm-Rudman and thereby single-handedly bring federal spending under control. Not a bad accomplishment.
Daniel J. Mitchell is director of tax and budget policy at Citizens for a Sound Economy in Washington, D.C.