Last Thursday President Clinton and Republican congressional leaders were within about $50 billion of consummating a deal to balance the budget by 2002. Suddenly, they were given almost a quarter-trillion-dollar tax windfall, when the Congressional Budget Office determined that previous errors in its economic forecast had led it to underestimate revenues by some $225 billion.
Curiously, no tax cuts were offered in the budget deal beyond those that had been contemplated before the windfall, nor was the budget balanced any sooner than the original 2002 schedule. Instead, part of the tax windfall went to finance higher spending.On behalf of American taxpayers, someone must ask: Why won't taxpayers get back any of their hard-earned $225 billion? I propose a new process to break out of the budget trap and begin making good on the Contract With America's "crown jewel," a $350 billion tax cut. Whether Congress accepts the current budget deal or not, the tax-writing committees should produce a much broader set of growth-oriented tax rate reductions than those in the budget agreement's sketchy text.
The $225 billion windfall shows that economic growth can easily produce massive new revenues. A better tax code would do the same, allowing not only a tax cut but an earlier budget balance. Once the tax-writing committees produce growth-oriented tax bills, they should request that CBO revise its economic assumptions to reflect the growth effects of a better tax code.
CBO already has established a precedent for changing its economic assumptions based on budget policy. It contends in its 1997 Budget and Economic Outlook that an agreement to balance the budget would add to the economic growth rate, reduce interest rates and narrow the deficit, creating a "fiscal dividend." Congress should ask CBO to calculate the "growth dividend" from tax reform.
We can begin to judge the revenue potential from tax reform by last week's stock market action. The suggestion of capital gains tax rate cuts sent small-cap stocks soaring. These are the stocks that shoulder the major burden from our world-record taxation of capital gains, most of which are due simply to inflation. When hedge funds see one of their small investments begin to work well, they "mushroom" the position, adding to it rapidly in order to maximize the gain. Congress has the same opportunity with the minor tax reform contained in the budget agreement. Quadruple the tax reforms now under consideration and then sit back and watch just how few months the private sector takes to balance the budget.
"Not broke, don't fix it"? Wrong. In recent years, our nation has spent a staggering amount of its political energy on budget negotiations. So far the payoff has been small or even negative. Despite record tax receipts, the budget process still keeps almost all windfall tax revenues inside the Beltway.
Spending in most areas of government continues growing faster than the economy, and is running well above the highest hopes proposed in the Democrats' 1993 maxispend budget. Add in uncontrollable supplemental appropriations bills and the late 1996 election-year spend-fest, and we find a government that is growing rapidly bigger while claiming "cuts."
After each new budget debate, the paper balances of the retirement trust funds are made to look better through gimmickry (this year's $86 billion gimmick was to move the home health care services from Part A to Part B of Medicare), while the real finances of the retirement system become more fragile. We are leaving a generation with too little money to save for retirement but with no comfort that the government will do it for them.
Perhaps most harmful, the tax burden continues to grow and to penalize growth in real wages, innovation and entrepreneurship - especially for the poor, who face the highest marginal tax rates upon entering the labor force and are the most harmed by a scarcity of capital. Thanks to massive tax hikes in 1990 and 1993, Americans now render a bigger share of income in tribute to government than at any other time in history.
At the core of the problem is a budget process that assumes government is just as productive as the private sector. Whether government spending and taxes take up 40 percent of gross domestic product or 20 percent, economic growth is assumed to be the same. In the budget process, new government programs are assumed to have no negative effect on the private sector's ability to pay taxes.
In the same way, new taxes are assumed to have no negative effect on growth, nor is it recognized that tax relief would spark harder work and increased investment.
It is no coincidence that the nation's fastest sustained private-sector economic growth in a decade came at the end of three years in which the budget process lay in partisan disarray. Under the anti-growth rules of today's budget process, no budget is more pro-growth than the standard compromises embodied in this deal. The strongest bond market rally in years came during the government shutdowns of late 1995, as bond buyers applauded the break from the status quo. In fact, many economists are now arguing that the budget would be balanced well before 2002 if not for this unfortunate budget deal.
As it executes the latest budget agreement, Congress should set out to make two improvements in government policy. First, it should set a dollar figure for the expected level of tax receipts in 1997 and 1998 and, to the extent that revenues exceed those levels, it should embark on a new round of tax rate reductions - a dividend hard-working taxpayers deserve. Second, Congress must insist that the CBO set up a process to provide new economic assumptions in light of proposed improvements to the tax system.
History is shaped by bold strokes. As Congress prepares to debate another budget resolution, I propose a course of action that could turn the U.S. budget process from a series of modest compromises to an opportunity for real change. During the markup process, the tax-writing committees should exercise their prerogative to quadruple the breadth of the tax reforms proposed in the budget resolution. They might consider eliminating capital gains and estate taxes altogether, or at a minimum cutting both rates in half and indexing them for inflation. They might also repeal the 1993 10% income tax rate surcharge and give low- and middle-income workers payroll-tax relief by allowing deductibility of payroll taxes.
The tax chairmen and congressional leaders should insist that CBO provide two sets of economic assumptions and budget estimates - one that recognizes the value of the additional tax reforms under consideration by the tax committees and one that ignores them. In other words, CBO should be instructed in the budget resolution to do for Congress what the Office of Management and Budget routinely does for the president, namely estimate total outlays and receipts - and hence the deficit - based on the assumption that an entire package of pending policy proposals is in effect. These estimates should be completed in time to serve as the benchmark in deciding whether the final tax and spending bill meets the requirements of the balanced-budget agreement.
If CBO makes these estimates properly, it will find that the broader tax-reform scenario causes economic activity to surge, balancing the budget faster than expected and paying for the "losses" from the expanded tax reform. If CBO does not reach this conclusion, it will have a chance to present its reasoning in defense of the current tax code.
The president could hardly object to the tax-writing committees reasserting their rightful place in the legislative process. Far from violating the budget deal, it would strengthen it, to the nation's advantage. If we succeed in making the budget process less resistant to growth-oriented change, Americans would be able to hold on to more of their earnings, enjoying a true growth dividend.