Handbook of Fiscal Policy_2 potx

The Budget Process Is Decentralized, with no Central Policy Structure for Controlling Deficits by Coordinating Stabilization and Allocation Federal budgets are a major tool for achiev

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103

Federal Deficits and Financing the

National Debt

Marcia Lynn Whicker

Rutgers Urlitrersity, Ne~vurk, New Jersey

One of the most controversial aspects of federal budgeting is the annual deficits the United States has accumulated, especially during the past two decades These deficits have contributed significantly to the growth of the national debt By FY 1993, projected deficits were $327 billion Total outstanding federal debt in 1992 reached $4.08 trillion, more than double than the $ I .83 trillion of 1985 Federal debt in 1992 was 68.2% of gross domestic product (GDP), the highest percentage ever since World War I1 and the Korean War Net interest on the debt was $199.4 billion.'

Federal deficits, then, have driven accumulated national debt to unprecedented levels Why have deficits grown and persisted? Few argue that massive federal deficits are good; rather, controversy surrounds exactly how bad federal deficits are and what to do about them Policy makers agree that something should be done, but disagree on what so-

lutions should be embraced Observers agree, however, that federal deficits have been rising, despite all efforts to abate or even just ameliorate their growth Plausible methods of reducing the deficit all create political pain, and thus are controversial

WHY DEFICITS HAVE GROWN

Federal deficits have mounted despite the efforts of policy makers to curb them Critics contend that the budget and spending are out of control So why have deficits mounted and persisted across the past two decades? Several factors are at work, including the following

Budgets Have Dual Stabilization and Allocation Functions that May

Conflict

Budgets are used to implement both economic policy goals and specific program needs This dual purpose of budgets undercuts deficit reduction.? Sometimes the goal of stabilizing the economy by reducing deficits, interest paid, and debt may contradict allocation goals of increasing federal spending for desirable social and defense goals

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By allocating monies to programs, policy makers express national prioritied Trend analysis may present a distorted picture of national priorities since a unified national budget, including programs funded through trust fund revenues, was only adopted in the late 1960s Prior to that time, some government programs, including Social Security, were not included in the budget However, trend analysis is often used anyway to show shifting national priorities when enacting allocation goals

Beginning in 1960, this type of analysis of budget shares reveals a decline in defense, followed by a revival of relative funding National defense received 52.2% of total federal outlays in 1960 This amount declined to 22.7% of outlays in 1980 after the disillusionment

of Vietnam, and then began to climb during the Reagan years By the end of President Ronald Reagan's second term in 1988, national defense constituted 27.3% of outlays; approximately 73% of federal outlays were for nondefense programs With the end of the cold war, defense spending began to decline relative to other functions, and by 1992 was 2 1.6% of outlays Social spending experienced the reverse pattern Since 1960, human resource spending has experienced a dramatic increase in budget share In 1960, human resource expenditures constituted only 28% of total federal outlays By 1987, that share had risen to 49%.' Addressing important defense and social priorities by spending may conflict, however, with the macroeconomic policy goals of reducing deficits by lowering spending.' Ris- ing deficits have caused mounting national debt National debt more than doubled during the Reagan administration In 1980, when Reagan assumed the White House, national debt was slightly under $1 trillion, at $908.5 billion By 1989, when Reagan retired from office, national debt had increased to $2,867.5 billion, or almost $3 trillion Critics contend this growth resulted from deficits accumulated when the supply-side goal of cutting taxes and the allocation goal of increasing defense spending both escalated the gap between receipts and outlays.6 Interest on the federal debt also increased, both in absolute terms and as a

share of total federal spending Between 1960 and 1987, the budget share going to interests payments on national debt accumulated by past deficits had grown from 9% to 17% In each budget year, continued spending for important allocation goals received higher priority than deficit reduction

The Budget Process Is Decentralized, with no Central Policy

Structure for Controlling Deficits by Coordinating Stabilization and

Allocation

Federal budgets are a major tool for achieving fiscal policy goals as well as achieving the specific goals of individual programs, yet only in the past two decades has Congress adopted the structure to realize the potential for fiscal policy stabilization goals Prior to 1974, macroeconomists often theorized about the desired level of federal expenditures to provide the appropriate level of fiscal stimulus, given the existing levels of unemployment, intlation, and interest rates.' But in the real world of congressional budgeting, the actual appropriations subcommittee decisions that determined federal expenditures were mostly divorced from any meaningful consideration of the state of the economy and fiscal policy needs Nor was much weight attributed to revenue limitations, since the two finance committees-the House Ways and Means Committee and the Senate Finance Committee-operated independently in setting tax rates and in establishing modifications, exemptions, and exceptions

in the tax code What drove budget decisions was micro-level attention by members of ap-

propriations subcommittees to incremental requests for increases in program expenditures

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Federal Deficits and Financing the National Debt 1361

The reality of national budget making was a process impacted more by the highly decentralized structure of the U.S government and of Congress itself, as well as by interest group politics than by stabilization theory Major budget refonns have created new institutional actors to increase monitoring of stabilization goal achievement as well as allocations, yet the process remains highly decentralized, with no single actor or institution assuming final responsibility for budgets and deficits Partisanship increased blame shifting The largely Democratic Congress charged that the mostly Republican presidents have not submitted balanced budgets and that they are merely responding to presidential lead Republi- can presidents, in turn, charged that the mostly Democratic Congress was spendthrift and irresponsible

Interest Groups May Block Cuts

Shepherding a federal budget through the various stages of budget development is lengthy and often laborious, filled with points at which the budget can be snagged on some political difficulty and delayed, and spending cuts restored by lobbyists representing powerful interest groups Concerns over federal deficits may take second place to reelection and lobbying pressures placed on members of Congress to restore cuts or increase spending for specific programs

The budget process has four stages during which lobbying and pressure may occur

If interest groups fail to achieve favorable spending outcomes at one stage, the lengthy process provides other opportunities for lobbying and influence The stages of the budget process include planning and analysis, budget formulation, implementation, and audit and review Interest groups have the greatest access to key decision makers, particularly in the formulation stage, and to a lesser extent in the planning stage, although no stage is mmune

In the planning and analysis phase, available resources are assessed, goals are clari- fied, and alternative approaches to attain goals are analyzed This stage is conducted in the executive branch by the budget offices of the federal departments and by the Office of Man- agement and Budget (OMB) In the legislative branch, the budget committee staffs, and especially the Congressional Budget Office (CBO), conduct analyses of policy goals and options The analyses of C B 0 have been particularly well regarded for their accuracy, but the analyses from the administration frequently build in assumptions that favor the interest groups that are its major constituents Agencies also are predisposed to produce analyses that support their clientele

During the policy formulation phase, the budget is developed and approved Interest groups have the greatest probability of exerting influence here Budget development revolves around the budget year (BY)-the fiscal year following the current year Prior to budget development, executive agencies have submitted quarterly financial plans that provide budget reviewers with estimates of 5-year program costs Executive departments and agencies receive guidelines from OMB in the form of a budget call to aid in the development of budget figures Once agency figures are prepared, the remainder of this phase involves budget reviews-first within the executive branch by the department budget offices and OMB, and subsequently within Congress This stage culminates with the final passage

of major appropriations bills Lobbying efforts are particularly intense in Congress, with multiple possible points of intervention

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Redistribution Drives Federal Budgeting, yet the Budget Does not

Include Direct Explicit Information on Who Gets What

Often thick, voluminous, weighty, and seemingly dry to the unsophisticated reader oblivi- ous to the clash of values and political battles symbolized by the numbers included, budgets represent a national plan for accomplishing goals within the BY ' The budget sets forth estimates of resources required and of resources available, in comparison with previous years and estimates for future year resources Federal budgets contain five types of information (See Table 1 .) Yet none of the information in the budget deals directly with redistributive impacts that drive the budget process While beneficiaries may be implied by the

Table 1 The Federal Budget and Financing Deficits

Information provided in the federal budget:

Estimates of outlays, revenues, and budget authority for the budget year

Presidential budget requests for current and prior years

Five-year projections for revenues, outlays, and budget authority

Economic projections for the economy

Current services estimates

Federal budget legislation:

1921 Budget and Accounting Act

Created a national executive budget

Significantly increased the president's role in the budgetary process

Created the Bureau of the Budget (BOB)

Created the General Accounting Office (GAO)

Extended GAO audit authority to government corporations

Required that budgetary policy be used to support full employment

Crcatcd the Council of Economic Advisors (CEA) to advise the president on economic policy Provided sanctions for officials knowingly overspending

Expanded presidential impoundment authority

1974 Congressional Budget and Impoundment Control Act

Created a top-down process to integrate fiscal policy making with allocation goals of' funding Changed executive impoundments into rescissions and deferrals

Created Senate and House budget committees and the Congressional Budget Office

Required 5-year forecasting on new programs, and current services, tax expenditure, and credit

1945 Government Corporations Act:

1946 Full Employment Act

1950 Federal Anti-Deficiency Act amendments

program needs

budgets

1986 Gramm-Rudman-Hollings Act

Set deficit reduction targets to achieve a balanced budget hy 199 1

Established procedures for automatic spcnding cuts dispersed equally across social and defense spending if deficit targets were not met

Set new 5-year deficit targets for 1991-1995

Retained the automatic sequestration of military and civilian expenditures when deficit targets Set discretionary spending totals in defense, international, and domestic spending

Made other process reforms

1990 Budget Enforcement Act

are not met giving the president some new powers

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nature of programs being funded, details on how much wealth and income are being redis- tributed alnong income groups is not in the budget Such details would likely increase resistance to expenditures that are regressive, increasing the wealth ofthose already relatively well off Rather, the information in the budget is more mundane, as shown below

&&1~1.~, reverrrre.s, (7ild budget oufhorify: Each federal budget presents estimates of outlays, revenues, and budget authority for the upcoming year Both outlay and budget authority figures are presented by agency, function, and account Out- lays are actual federal payments or disbursements during the fiscal year Out- lays represent the liquidation of an obligation, usually by check or disburse- ment of cash Most frequently outlays occur in the actual year the obligation was incurred, but not always Outlays may also represent payment of obligations occurred in prior years Revenues are anticipated receipts and collections

In addition to outlays and revenues, the federal budget contains budget authority estimates Budget authority is the legal authority to enter into obligations that will result in immediate or future government outlays The three basic types of budget authority are appropriations, contract authority, and borrowing authority Appropriations are the most common type of budget authority and represent a legislative authorization that permits government agencies to incur obligations and to make payments out of the U.S Treasury for specified purposes An appropriation usually follows enactment of authorizing legislation Borrowing authority is the authority that permits an agency to spend borrowed monies (debt receipts), while contract authority permits obligations to be incurred in advance of appropriations or in anticipation of receipts

Presidetztial success: The budget provides information to assess past presidential success by including data on the most recently completed fiscal year, and a revised estimate of the fiscal year still in progress Presidential requests for appropriations may be compared with actual appropriations

Five-year projections: Five-year projections for outlays, budget authority, and revenues have been included in recent federal budgets, permitting trend analysis, and providing Congress, agencies, and the public with an overview of how the current budget fits into long-term policy While 5-year projections for certain types of budget authorities make government management easier, they also reduce the flexibility of the budget as a fiscal policy tool Presumably the purpose

of S-year program cost projections was to reduce providing members of

Congress with information about future as well as immediate costs, allowing them to avoid enacting programs whose costs increase rapidly These projections have not significantly reduced deficits, however

Ecorlomic projections: Economic projections for the economy are the basis for budget projections and are also included in recent federal budgets The economic projections in the budget represent a sulnlnary of more detailed projections pre-

sented in the Economic Report of’the President If these projections are overly optimistic, they may be used to justify higher spending, which i n turn may produce higher deficits

Currenf services estir~rtrtes: The 1974 Congressional Budget Act requires the president to include current services estimates in his budget proposal A current services budget consists of required outlays to maintain the current service level into the budget year, making changes for adjustments in economic and demo-

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graphic conditions The current services estimates provide a baseline for com- paring the requests in the president's budget If inflation is high or economic conditions are otherwise unfavorable, the president's requests may be higher than last year's outlays, but still represent a decrease in actual service level Current services estimates allow Congressmembers to determine whether the president's requests represent a real increase or a real decrease i n the services provided Current services estimates provide useful information for interest groups lobbying for increased funding by enabling them to argue that services for group members are being reduced, despite increases in nominal funds

Budgeting Has Been Incremental and "Bottom-Up"

Congressional budgeting, especially before the 1974 Congressional Budget Act, was very decentralized Major appropriations bills were examined and marked up by subcommittees

of the appropriations committees of each house The bills were approved by the various subcommittees and passed on to the full appropriations committee for approval at different times, sometimes months apart Before the 1974 reforms, congressional budgeting was a

bottom-up rather than a top-down process." Decision making remained very open to political influence, and focused on program issues rather than on economic policy goals

NO strong incentive existed for the full appropriations committees to consider the budget in its entirety."' First, the appropriations bills were forwarded sequentially at different times, a procedure that inhibited examining the budget as a single document requir- ing trade-offs and priority setting Second, an informal norm of reciprocity existed between members of the various subcommittees Members of the appropriations committees in each house typically sought assignments to subcommittees that oversaw spending in programs that affected their own constituencies Members could then take credit for government spending that their own constituents favored and increase their reelection potential Not anxious to have their own subcommittee legislation overturned or drastically modified by the full committee, members would often give cursory approval to the legislation originat- ing in other subcommittees in exchange for equivalent treatment for their own subcommittee work While some debate would occur on the floor of each house once appropriations bills were forwarded, the same incentives to logroll that existed in the appropriations committees diminished the ability of Congress to set priorities, to encourage trade-offs between policy areas, and to curb deficits

Incrementalism dominated budget decision making Little attention was directed toward the budget base, the amount of funds that were appropriated last year.' ' Most attention was focused on the budget increment, the additional funds requested for the budget year One result of bottom-up incremental decision making was rising federal expenditures and deficits An iron triangle based on a common interest in increasing program expenditures often formed between agency officials, the affected interest groups and clientele of the agency, and the appropriations subcommittee that reviewed budget requests by the agency Each side of the iron triangle exerted pressure to increase program expenditures Affected interest groups and clientele were direct beneficiaries of greater funding Agency officials preferred directing large expanding programs to small shrinking program+-em- ployees and clients were happier and life was easier when expenditures were growing Since members of appropriations Committees typically gravitated toward subcommittees that directly affected their constituencies, they also preferred program growth to program

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Federal Deficits and Financing the National Debt

Table 2 Characteristics of Bottom-up and Top-down Budgeting

Log-rolling, functional and geographic specialization and deference, quadriad power, padding, use of political gaming Special interests, subnational constituencies, specific policy groups of Iron Triangle President and the bureaucracy

Post-1974 Constrained trade-offs and Early examination of the budget Budget base, economic policy goals and broad functional Forecasting, expert testimony, greater emphasis on analysis and budgetary justification

National constituencies, finance and economic cross-policy groups

Incrementalism led to role-playing and strategies by various budget actors.” Agency officials, knowing that most attention would be focused on the budget increment, were predisposed to ask for additional funds Sometimes the incremental requests would be padded

or exaggerated in anticipation of cuts by OMB and congressional committees Agencies that were ordered to reduce spending might argue that programs popular in Congress were the only programs that could be cut, expecting Congress to restore the cuts

Members of Congress also resorted to strategies to cope with the mountains of budget detail.I3 In addition to focusing primarily on the increment, congressional members would use spot-checks of the figures in the budget base, assuming that if the few items that were examined closely were realistic and accurate, the remainder of the figures must also

be solid Since budget bills constitutionally were required to be initiated in the House of Representatives, House appropriations subcommittees could often play a more extreme role-inflating the budget of politically popular programs and slashing unpopular programs-knowing that the Senate could modify the excess

Major Budget Actors All Have Incentives for Increasing Federal

Spending

Major budget actors involved in budget formulation and approval all have strong incentives for increasing funding

Agency budget offices: Agency personnel are typically advocates of increased ap-

propriations.’‘ The duties of agency budget offices may vary somewhat, but generally this is where the initial executive budget is developed The functions Inay be quite diverse Agency budget officials, in conjunction with the appropriate operating officials, develop budget estimates for programs and offices, conduct budget reviews, and recommend budget allocations These officials

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justify the submitted budget to OMB antl to Congress by using financial and personnel exhibits, budget narrative material, and additional support data

Agcncy budget officials help prepare aycncy operating personnel for testitnony bcfore both OMB and Congress Apportionments and allotments are prepared

by agency budget officials who also lnaintain overall control o f the agency’s financial resources and position allocations Other functions include ongoing reviews during the fiscal year, making recommendations for reprogramming actions and other funding adjustments Budget officials are also responsible for assuring sound financial management within the agency and for recotnmend- ing any changes needed in financial management procedures Budget officers are usually career civil servants who work closely with politically appointed agency or department heads.I5 These officers serve as contacts with both the legislative branch and the public on financial matters of agency concern Bud- get work is often repetitive and seasonal When the budget is being prepared and deadlines are imminent, the budgct officer may log long hours on the job, working late at night and on weekends Timeliness of information is crucial Budget officials must cope with deadlincs and other pressures, including inter-

est groups anxious to retain program funding As they conduct their analyses,

agcncy officials may interact with clientele, becoming sympathetic with the clientele’s view that more funding is needed Further, as agencies expand, so

do career options and the power of agency officials Working in an expanding agency is more fun than working i n one constantly beset by budget cuts When judgment calls are made, agency officials, within budget constraints, typically advocate spending more

Deptlrt~rlent b ~ l g e t o ~ i r e s : Department budget offices service the entire federal department in the executive branch rather than a single agency, yet tnany of the functions and activities of department budget officers are equivalent to those of

agency budget offices The scope rather than the nature of budget activity dis- tinguishes the two types of offices Department budget offices also are generally advocates for increased appropriations for the entire department In order

to maximize department resources, however, the office may recommend cuts

i n particular agencies within its jurisdiction Under a fiscally conservative administration, or an administration i n which the policy area of the department has fdlen out of favor, the advocacy role o f the departnlent budget office may

be more muted and subdued

O f l k of MtrrlcrKertlerlr wtd B ~ ( y e t : Currently, OMB has the powers of budget development and legislative clearance Its personnel include a staff of several hundred budget exatniners who review agency budget requests Transferred to the executive office of the president in 1939, OMB has been gaining in power and prestige since its creation in I92 I , accumulating additional influence and authority through legislation, execulive orders, and reorganization acts In

1933, it gained the power to make, waive, and modify apportionments of appropriations, a power previously wielded by individual department antl bureau heads This power over apportionment was expanded i n I950 with the passage

of amendments to the Anti-Deficiency Act OMB was reorganized from the Old Bureau of the Budget in I970 and was given an enlarged mandate Its authority to act in the president’s name extends to the entire federal administration, as well as to state and local governtnents when federal funds are involved,

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and to federal contmctors As a result of the 1970 reorganization, legislative

clearance was centralized and most policy decisions were subscqucntly made

by political appointees Previously, decisions made by the OMB director 011

agency budget requests could be appealed over his head to the president by dis- grLu1tIed agency officials Aftcr 1970 decisions made by the OMB director were presented as presidential decisions, making appeal much rime difficult

;111~1 Llnlikely The general thrust of the Nixon administration reforms and reorganization was to heighten the role of political appointees and to make OMB 111ore responsive to the institution of the president OMB theoretically t11:ly ad- vocatc spending cuts rather than incrcascs, especially i n conscrvative presidential administrations Even conservative presidents, howevcr, may want significant increases i n defense and military spending OMB has not been particuIarly successful at holding down spending in other areas either

HOrIsc B//t/p>t Cottlttljttcv: Thc House Budget Committee conducts hearings on the state of the economy, appropriate levels of fiscal stimulus, the need for new programs, and overall spending priorities Along with the Senate Budget Com- mittee, the House Budget Committee is also responsible for developing and passing a first and second concurrent budget resolution, which is the framc- work of the congressional budget When first established by the 1974 Con- gressional Budget Act, thc House Budget Committee had 23 members whosc membership overlapped i n specified ways with the memberships of other powerful financial committees Five members of the House Budget Committee came from the Appropriations Committee, five from the Ways and Means Committee, 1 I frotn other committees, one from the Democratic leadership, and one from the Republican leadership Two more at-large members were added in 1975, increasing the total membership to 25 Membership on the House Budget Committee is on a rotating basis, a feature that weakens the committee institutionally vis-h-vis permancnt standing conmittees such as Ap-

propriations and Ways and Means Originally, members could serve only 4 out

of 10 years on the House Budget Committee Across time, the committee membership has been cnlarged and the tenure has been made more generous

By the Ninety-seventh Conprcss, the committee had thirty members Tenure was lengthened to allow members to serve 6 out of 10 years before rotating off the committee House Budget Committee chairs may serve 8 out of 10 years

In theory, the macroecononlic fiscal targets for total revenues and spending hold down deficits I n reality, partisan clashes on the colnmittec at times have been divisive The conmittcc tnust rely on tnoml suasion to persuade revenue committees to increasc taxes, or authorizing committees to cut spending authority Thus, the success of the Housc Budget Conmittee in holding down spending has been limited

Srtrtrte B d g o t C'ottttnittee: Thc Senate Budget Committee, also established by the

1974 reforms, fulfills a role i n the Senate equivalent to the role played by thc House Budget Committee i n the House of Rcprescntatives Originally the committee had fifteen members, ;I number that had been increascd to twenty-two

by the Ninety-seventh Congress Like other committees, members of the Sen- ate Budget Committec are chosen by the Democratic and Republican caucuses Unlikc the House Budget Colnmittcc, however the Senate Budget Committee

is a stnnding comtnittee with permanent membership, a fact that cnhances its

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power in the Senate to a greater level than the power achieved by the House Budget Committee Despite the greater relative power of the Senate Budget Committee, it was more willing during the era of Democratic control of the Senate between 1974 and 1980 to accommodate requests by standing authorizing committees than was the House Budget Committee Generally, the Sen- ate Budget Committee has been more political and accommodating than the House Budget Committee, which is known for its greater attention to technical budget detail Many of the limits on increased spending confronting the House Budget Committee are also felt by the Senate Budget Committee

Congressiotltrl Budget Office: The 1974 Congressional Budget Act mandated that as- sist congressional committees and members by specified hierarchy Foremost,

it is required to provide assistance to the two budget committees; secondarily

it provides information upon request to the two appropriations committees and the two revenue committees Next it is required, to the extent that is practica- ble, to provide information to additional committees on budget, tax, and economic issues Finally it is charged to provide information to individual members of the House and the Senate The C B 0 director is jointly appointed by the speaker of the House and the president pro tempore of the Senate to a 4-year term The C B 0 director has the authority to hire experts and consultants as well

as to use C B 0 staff to secure information from the various executive and congressional agencies The 1974 Congressional Budget Act charges C B 0 with providing Congress with two kinds of information-budget analysis and policy analysis Several C B 0 duties relate to the provision of budget analysis- the computation of budget and tax estimates One major budget analysis function is scorekeeping-keeping Congress regularly informed of how enacted appropriations legislation compares with the most recent budget resolution The agency also keeps committees that report spending and tax expenditure legislation, especially the Appropriations, Ways and Means, and Finance Com- mittees, informed about the compatibility of their legislation with the most recent budget resolution Five-year cost projections for every authorizing bill reported by a House or Senate committee are the responsibility of CBO, as well

as preparing and issuing an annual report soon after the beginning of each fiscal year that projects total spending, revenues, and tax expenditures for the next

5 years The C B 0 produces an annual report by April 1 on alternative budget courses that Congress might pursue in the upcoming fiscal year with an emphasis on fiscal policy and spending priorities The agency also produces analyses requested by the budget committees on specific aspects of federal policy Scorekeeping (data on the amount of money appropriated toward the budget total so far) and other C B 0 analyses were designed to curb excessive spending and deficits Analyses by C B 0 have gained the reputation of being more accurate and less biased than executive branch estimates, in part because C B 0 serves so many masters Once its estimates and analyses are released to members, however, political forces become more powerful Of major budget actors, then, C B 0 has among the least incentive to increase spending, but it does have some incentive since Congress is its major client, and Congress as an institution is under pressure to spend on constituents Mostly in CBO, however, the multiplicity of “bosses,” some conservative, some liberal, some moderate, provide countervailing pressures, leaving C B 0 the most neutral of budget actors

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ConRI.e.ssiorltr1 c~lrthor-izitzg c.otntllittee.7: Congressional rules require that a program

or agency must first be authorized before funds can be appropriated for it A two-stage decision process results, where program decision making is separated from financial decision making, to prevent the appropriations committees from subsuming the business of substantive committees and to avoid an excessive concentration of legislative powers The sharpness of this distinction has eroded across time, although precedents in each house govern what should be separated from appropriations statutes into distinct authorizing legislation For- mal procedures for waiving or bypassing the restriction against substantive legislation i n appropriations bills exist in each house Traditionally, when

Congress established a new agency it granted that agency a permanent authorization by specifying that the agency continue to operate indefinitely and with

“such sums as necessary” to assure that continuation be appropriated Perma- nent authorizations have the effect of removing the authorizing committees from the annual budget process except when the authorizing committees proposed new programs or modified existing ones The use of permanent authorizations has diminished across time, although they still account for over a third

of the federal budget Currently, the use of permanent authorizations is concentrated in the categories of interest on the national debt; mandatory entitlements such as Social Security, veteran’s benefits, and welfare; and the basic operations of most cabinet departments With the diminishing use of permanent authorizations, the authorizations process has become an avenue for substantive committees to express budgetary preferences by authorizing desired funding levels for particular programs Increasing numbers of agencies must now appear periodically before their authorizing comnittees in the first step of the two-stage process required for securing funding By limiting the use of permanent authorizations, substantive committees have gained a role in the budget process Agencies now subject to annual authorizations include the State Department, the Justice Department, and the intelligence agencies Congress has begun to use the authorization power to control executive actions by including specific limitations into the authorizing statutes Typically, substantive committees are advocates of greater spending for the programs over which they have jurisdiction, and the authorized amount often exceeds the appropriated amount When the authorized amount exceeds the recommended figure in the president’s budget, the appropriations committee has been more likely to follow the latter than the former For most annual authorizations, especially defense, the amount appropriated closely follows the authorized amount For many domestic grant programs however, the gap between authorizations and appropriations has been widening in recent years The two-stage process within Congress that separates authorization from appropriations contributes to budget uncontrollability and increased expenditures

CorlSressiotlrrl r/l~~~r-opr-i~/ti[)l?,s comnittees: Each house of Congress has an appropriations committee that has the responsibility for appropriating funds for all government programs and agencies Historically these committees regarded them- selves as watchdogs of the Treasury.’” Until 1974, few guidelines or restraints other than the budget estimates in the president’s budget were available to the appropriations committees as they annually conducted their business Devolu- tion of decision nuking from the committee level to the subcommittee level oc-

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curred within these committees, as it did within other congressional committees The 1974 Congressional Budget Act presented the possibility of jurisdic- tional conflict between the older and established appropriations committees within each house, and the newly created budget committees.” The first concurrent budget resolution established targets for overall spending levels, as well as subtotals for major functional areas Appropriations committees after the 1974 act had to try to work within the time frame established by the act, and within the totals established by the budget committees and approved by both houses of Congress The act changed the role of the appropriations committees from guarders of the federal Treasury to spenders who must be restrained by the reformed process The legislative reforms prohibited appropriations decisions before the passage of the first concurrent budget resolution Appropria- tions committees must allocate their share of the budget among their subcommittees before reporting any appropriations bills to the floor Before the House committee brings any bills to the floor, it must review all its bills and report to Congress on how these bills compare with the first budget resolution A score- card accompanies each appropriations bill showing its impact on the congressional budget Despite the hope that scorekeeping would keep members better informed of the cumulative impact of their actions and help to lower spending, members of appropriations committees often serve on subcommittees that dis- perse monies affecting their constituents and therefore have an incentive to increase spending in specific areas to gain or retain constituent support

C o n ~ t ~ ~ s s i o n r r l r c w n w c~ornmittees: The House Ways and Means Committee and the Senate Finance Committee are the major congressional revenue committees Originally, the revenue and appropriations functions were combined in one committee in both the House and the Senate These functions were separated into two different committees in the House in 1865 and in the Senate in 1867 Until the 1974 reform, a formal fiscal policy did not exist; tax policy was developed by the revenue conmittees relatively independently of the appropriations process The House Ways and Means Committee was particularly powerful in the 63 years between 191 I and 1974 During this time, the Democrats

on the House Ways and Means Committee controlled committee assignments for Democratic house members Democrats seeking committee assignments found their institutional fortunes controlled by Ways and Means Committee members In 1974, the committee assignment function for House Democrats was moved to the Democratic Steering and Policy Committee The Ways and Means Committee, however, continues to attract power-oriented rather than issue-oriented members The Senate Finance Committee has been dominated by members from small and Western states Both committees historically have been defenders of special tax exemptions for many powerful interest groups, including the gas and oil industry Since the U.S Constitution specifies that revenue bills should be initiated in the House, the Ways and Means Commit- tee continues to wield great power Such is its importance that regardless of the overall ratio of Democrats to Republicans, it traditionally has had a dispropor- tionatc number of members from the majority party to ensure its control The Senate Finance Committee has jurisdiction over the nomination of the secretary of the Treasury, the director of the Internal Revenue Service, tax and customs court judges, members of the lnternational Trade Commission the com-

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missioner of social security, and many undersecretaries and assistant secre- taries of the Treasury Since both are prestigious, both revenue committees have had a membership with greater than average seniority The revenue committees, and particularly Ways and Means, are now constrained to postpone any action that changes total federal revenues until after the first budget resolution is passed Also, as a result of the 1974 reforms, both committees must now deal more openly with tax expenditures Tax expenditures are now defined and estimated Despite 1974 reforms that attempted to increase collaboration

of the revenue committees with their respective budget and appropriation committees through the budget reconciliation process, this coordination remains loose Revenue committees are under considerable scrutiny when debating tax increases and are not under mandatory instructions from budget committees or anyone else to do so Thus, resistance to tax increases within the revenue committees as well as within the entire Congress contributes further to budget deficits

Ager1c.T clientele m d ufected interest groups: Powerful interest groups impact on

several aspects of the budget process, but are particularly visible during congressional budgeting Affected interest groups are vocal proponents of increased spending for programs for which they are beneficiaries While both high- and low-income groups are affected by budget authority and outlays, high-income groups in particular stand to benefit from tax expenditures that are part of the post-l974 expanded budget process Traditional tactics used by interest groups include preparing expert testimony for congressional committees, visiting the offices of members of Congress to present the group’s point of view, and monitoring congressional progress on key bills to keep group members informed Mass tactics, less frequently used, include organizing mass mailings and letter-writing campaigns and mass demonstrations

Much of the Federal Budget Is Now “Uncontrollable”

Much of the federal budget is “uncontrollable”; that is, not amenable to change because of long-term commitments and entitlements ‘ x For uncontrollable expenditures, the decision about what total outlays will be in any given budget year has been removed from the annual budget process, and lies elsewhere, is dependent on economic conditions, or both Across time, a growing share of the federal budget has become uncontrollable This trend has alarmed budget watchers who feel that the rapid growth in uncontrollable spending has contributed to mounting federal deficits and rising national debt The OMB estimated that in 1970,63% of the budget was uncontrollable By 1983, the estimate of the uncontrollable budget share had risen to 76%.’” Uncontrollable spending is sometimes called backdoor spending to reflect the fact that growth in these types of expenditures often occurs unobtrusively and unintentionally

Backdoor spending takes several forms One form is contract authority, which allows government officials to make legally binding financial obligations, not necessarily in the current or budget years, that must be paid at some future date Contract authority is used extensively in the procurement of large complex defense weapons systems Borrowing authority is also a form of backdoor spending since it allows government officials to make legally binding obligations that government will liquidate debt at some specified future

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point Interest payments on the debt, another uncontrollable category, grow in response to total debt borrowed and market interest rates rather than explicit decisions by budget makers Earmarked funds are also considered to be a type of backdoor spending, since funds from a particular source may only be spent for a designated purpose The Highway Trust Fund and Social Security Trust Funds represent examples of earmarked funds

A fourth and very large category of backdoor spending is entitlement programs that

require the payment of benefits to any person, or unit of government that meets the eligibility requirements specified in the entitlement program authorizing legislation Major entitlement programs include unemployment compensation, welfare, food stamps, and veter- ans benefits In addition to being uncontrollable, entitlement programs tend to be automatic stabilizers, since entitlement expenditures fluctuate countercyclically.”’ When the economy is booming and inflation is a danger, entitlement spending often falls, as more people are incorporated into the mainstream of economic life When the economy is depressed and recession is a danger, the rising number of needy individuals eligible for benefits causes entitlement expenditures to grow

By including a reconciliation provision, the 1974 reforms attempted to deal with the growth in uncontrollable expenditures The idea of the reform was that in reconciliation, the budget committees could direct authorizing committees to tighten eligibility standards or lower benefit levels if projected spending and consequent deficits were too high Except for the early years of the Reagan administration, however, when benefit levels and eligibility standards for major social programs were altered to reduce total social spending and social spending budget share, the reconciliation process has not been used successfully to this end Even in those years under Reagan, deficits did not decrease as a result of social spending cutbacks, but rather increased for social spending reductions were more than offset by increases in defense spending and revenue losses from tax cuts.”

WHAT HAVE POLICY MAKERS DONE ABOUT DEFICITS

Policy makers have tried several things to address deficits, some substantive, but many COS-

metic

Adopt a Statutory National Debt Limit

For many years, the United States has had a national debt limit Once this limit was ap- proached, if it were not changed, no more borrowing to finance current deficits could OC-

cur The debt ceiling, however, has not been effective, since each time i t is reached, Congress and the president jointly increase it Sometimes the increase in debt levels is tem- porarily held hostage to an ongoing partisan battle within Congress, or between Congress and the president, but not for long

Move Expenditures Off Budget

One strategy policy makers have used is to nlove federal expenditures off budget, so that they are not counted in expenditure totals and do not increase deficits Expenses attached

to various federal credit programs have been moved off budget in this manner, including costs attached to the savings and loans bailout in the early 1990s

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Move Trust Funds Carrying Surpluses on Budget

The Social Security Trust Fund and other funds carrying surpluses have been counted in the budget total Even though their earmarking restricts fund expenditures to purposes specified in the trust funds’ authorizing legislation, the addition of these funds to budget totals allows their surpluses to be used to lower operating deficits Without the inclusion of the trust fund surpluses, operating deficits would be even higher

At one point, Senator Daniel Patrick Moynihan (D-NY) introduced legislation to lower Social Security taxes to reduce Social Security surpluses Moynihan’s rationale was that this would force the president to submit a balanced budget This strategy, however, ignored surpluses in other funds, and would have left the Social Security fund with no cush- ion for future needs His proposal was not enacted, but trust fund surpluses continue to offset operating deficits

Give Authority for Budget Reduction Recommendations to a

Nonpartisan Commission

When faced with a thorny and sensitive political issue, Congress has sometimes delegated the problem to a nonpartisan commission This strategy worked when controlling the money supply proved difficult and the Federal Reserve Board-nonpartisan in character- was created In the 1980s when the Social Security fund was in trouble for unfunded lia- bilities, a nonpartisan commission was established to study the issue and make recommendations Although its recommendations were to increase tax rates and modify benefit structures-politically unpopular solutions that could be used to partisan advantage if advocated by one party or the other-these recommendations were subsequently adopted and rescued the fund

When deficits continued to grow during the Reagan administration, Congress tried the nonpartisan commission solution again, but with less success The National Economic Commission was established in 1987 It studied the deficit for almost 2 years and made a

report, but because deficit reduction must necessarily involve raising taxes-which Presi- dent George Bush pledged not to do in the 1988 presidential campaign-or cutting expenditures from programs with powerful constituencies, the report was largely ignored.”

Introduce a Structure for “Top-Down” Budgeting

One of the two major goals of the Congressional Budget and Impoundment Act of 1974 was to reform budget procedures internal to Congress The act attempted to centralize budgeting, to create a structure capable of viewing the budget as a whole, to encourage priority setting, and to curb deficit spending in order to reduce the high inflation rates of the mid- 1970s The act created three new congressional units, a budget committee in each house and

a support agency-the CBO-to help Congress prepare and manage the federal budget A major function of the budget committees is to construct a congressional budget as an alternative to the executive budget C B 0 was charged with helping the budget committees in budget preparation, as well as providing information on tax expenditures and economic conditions

The architects of the 1974 reforms wanted to change congressional budgeting from a

bottom-up, micro-level, incremental process to more of a top-down, macro-level, nonin- cremental process They had two options: a rigid structure that required coordination and

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formal trade-offs between policy areas once total budget, revenue, and deficit figures were set, or a less rigid structure that relied more on moral persuasion and reasoning than on rigid institutional controls Some conservatives in Congress were anxious to curb mounting deficits and preferred the more rigid structure

Liberals, fearful that rigid controls would be used to gut social programs, favored the less rigid structure Liberals also argued that rigid controls may lead to a failure of the internal congressional budget reforms, causing the entire act to be discredited, including the impoundment portions Such was the tension between the executive and legislative

branches at that time that liberals carried the day The 1974 reforms relied on informal rather than rigid institutional controls to enforce adherence to limits required by previously established budget totals and the trade-offs such commitment requires

The revised congressional process sets overall nonbinding targets for budget authority, budget outlays, and deficits.’’ Recommended levels of federal revenues, federal debt, and the amount to increase the statutory debt ceiling are established The act does not require either a balanced budget or a reduction in national debt Specific targets are developed for budget outlays and budget authority for each of nineteen major functional categories in the budget, such as national defense, international affairs, commerce and housing credit, income security, and health Initially, congressional debate centered on the first and second concurrent budget resolutions within each house Across time, the second concurrent resolution was largely abandoned and the reconciliation process-in which budget committees direct the appropriations committees to cut funds, the taxing committees to raise new revenues, or the authorizing committees to change benefit levels and eligibility requirements-was moved up to closely follow the first concurrent resolution

The 1974 reforms have been modestly successful in some areas, but not in controlling federal deficits As a result of the 1974 act, congressional budget decision makers have more information than ever before Previously relying on the executive branch and interest groups for information about programs, Congress now may use data collected by the C B 0 and budget committee staffs Further, information is available linking the impact of program level decisions to fiscal policy goals

Despite this, the economy was not noticeably improved in the late 1970s in the initial years after the reforms, and some attributed the decline in inflation during the first Rea- gan administration to executive branch initiatives rather than to congressional ones In 198 l during the Reagan honeymoon period when the presidency was receiving favorable political coverage, the congressional budget was virtually ignored and the executive budget was adopted almost in its entirety In addition, the reformed congressional budget process has not noticeably dampened rising deficits

The 1974 reforms created a structure to force discussion on economic policy goals as

well as the impact of federal expenditures upon those goals, but it could not and did not

force consensus on those goals Conservatives and many Republicans continue to place a higher priority on curbing inflation, while liberals and some Democrats continue to place a higher priority on reducing unemployment Similarly, the reforms created a structure to force discussion on the necessity for trade-offs between different policy areas so that an increase in spending in one area would imply a decrease in another But it could not and did not require consensus on what those trade-offs should be

Some inside budget observers argue that the 1974 reforms worked reasonably well in the pre-Reagan years between I974 and 198 1 if success is measured by the resulting levels

of federal deficits and debt and by process deadlines being met, although interest rates and inflation were high In the Reagan years after 1982, separated from the earlier period by the

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watershed Economic Recovery Tax Act of 198 I , neither process nor results were satisfac- tory This act eliminated $750 billion in revenues over a 5-year period, or $150 billion a year, virtually assuring massive deficits and an uncontrollable budget Nor were process deadlines met in the Reagan years Relatively uninhibited by the 1974 budget structure, congressional Democrats competed with congressional Republicans and President Reagan

to see who could give away the greatest share of benefits and contracts through tax cuts and spending increases, particularly in defense After leaving office, David Stockman, Rea- gan’s OMB director at the time, described the early Reagan years as a period where “the greed level, the level of optimism just got out of control.”‘“

Because the 1974 top-down reforms did not curb deficits, additional reforms have been proposed, most dealing with modifications of the budget process, rather than specific content of the budget Executive branch reforms have typically emphasized efficiency, which indirectly would lower budget totals by achieving more with less Other proposed reforms are to directly reduce federal deficits

Introduce Budget Reforms to Enhance Efficiency

Several budget reforms have been introduced in the executive budget process oriented toward increasing efficiency and rationality in budget formulation.” While these do not directly reduce expenditures, by achieving service delivery and other government outputs with less inputs, one goal of efficiency is to lower deficits The politics of budget reform are such that reformers usually must oversell the merits of their proposals to overcome in- ertia and resistance to change Initially a flurry of excitement occurs and expectations rise Since the reform was oversold and since much of the resistance to change is quite real, dis- appointment and disillusionlncnt soon set in Dramatic changes do not occur and the budget reform is pronounced a failure, yet a residue of increased rationality may remain after the reform has been formally abandoned

One such reform was the programming, planning, and budgeting system (PPBS) first introduced in the federal government in the Defense Department in the 1960s, which stressed the use of analysis in the early stages of the budget cycle Program budgeting and the greater use of data associated with programs were advocated Output nleasures and 5-

year projections beyond the BY were to be employed Special studies and analyses were to accompany specific major program issues While eventually abandoned as unwieldy, many

of the procedures advocated by PPBS, such as 5-year projections and the increased use of

analyses, were incorporated into the 1974 congressional budget reforms

A second executive reform was nlanagement by objective (MBO), urged upon federal departments and agencies by the Nixon administration It called for the establishment

of specific objectives for agencies and required regular high-level periodic reports on progress toward agency objectives While this reform also died an early death some agencies incorporated various aspects of it into their operating procedures

The Carter administration pushed a third executive budget reform-zero base bud-

geting (ZBB) A bottom-up approach, ZBB required program managers to create decision

packages that link budget figures with activities and objectives These packages were ranked at each successively higher level of authority High-ranking packages were funded, while lower-ranking packages may not receive funding This approach was designed to encourage an annual examination of the budget base as well as the budget increment While portions of the process have been retained, the procedure generated excessive detail and proved cumbersome

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Advocate Constitutional Amendments to Deal with Deficits

In the 1970s, an amendment to the U.S Constitution mandating a balanced federal budget was endorsed by many state legislatures who passed resolutions requesting the Congress call a constitutional convention to approve the amendment.'" This movement fell two states short of the necessary number to initiate a constitutional amendment i n this fashion In the 198Os, President Reagan proposed the amendment as a solution to historically large deficits accruing during his first term, but with no greater success in passing it."

Generally, conservatives have favored the balanced budget amendment while liberals have opposed it Critics argue that it would vitiate the use of the federal budget as a stabilization tool to achieve fiscal policy goals, and would not directly address the sources of pressure for rising federal expenditures Proponents argue that safeguards could be built into the amendment so that its provisions could be overridden in the event of a fiscal emergency Another amendment to the U.S Constitution, the presidential item veto amendment, would give the president the authority to veto specific line items within appropriations bills This reform has been urged by recent presidents, but has not been adopted Current inter- pretation of presidential veto power requires that the president either sign into law or veto

an entire bill, and does not give him the discretionary power to judge specific narrow parts

of budget authority Yet governors in forty-three states have item veto power Proponents agree that this additional presidential power would help to hold the line on deficits, while critics are skeptical and fearful that presidents would use the power to thwart congressional intent The presidential item veto joins a long line of budget reforms that, whatever their economic intent, have tapped long-standing partisan and institutional conflict

Enact the Gramm-Rudman-Hollings Deficit Reduction Legislation

The focus of budget reform efforts has been on directly lowering deficits While neither of the proposed constitutional amendments was successfully adopted, the 1985 Gramm-Rud- man-Hollings Act was enacted Despite continual modification of the federal budget process, by mid- 1985 signs of continuing difficulty were plentiful.'x

In no year since 1977 had all thirteen annual appropriations bills that in total constitute the federal budget been delivered by Congress to the president for approval

by the beginning of fiscal year set in the 1974 a c ~ , October I

In two fiscal years, 1986 and 1987, none of the thirteen appropriations bills had been sent to the president by the beginning o f t h e fiscal year, so the entire federal government in those years began the new year operating under a continuing resolution

The first concurrent budget resolution was usually passed from I to 4 months behind the scheduled date of May 1 S, the second resolution had been abandoned, and often appropriations bills were being passed before, not after, the prerequisite authorization bills

In short, the budget process was in disarray by the 1980s, a problem Shuman, a budget insider, attributed to the following four factors:

The 1974 act made the budget process more complex, with sometimes-as in the case of the second concurrent resolution and reconciliation process-unrealistic completion dates

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President Ronald Reagan had overloaded and overwhelmed the Congress with more controversial budget and tax proposals than members could digest and act on

in a 12- no nth period

Some Senate lnelnbers insisted on attaching “riders””unre1ated amendments and provisions-on highly controversial social issues such as abortion, prayer in the schools, and busing to authorization and appropriation bills, ignoring the rule that such riders be germane to the bill

Periodically House Democrats and Senate Republicans would deliberately delay appropriations bills to gain tactical advantage

Most troubling, however, was the growth in federal deficits, which increased from the range of $40 billion to $80 billion in the post-Congressional Budget Act pre-Reagan years between 1974 and 1981 to the range of $80 billion to $220 billion in the 1980s The national debt almost doubled in 4 years, from $914 billion in 1981 to $1,827.5 billion in

1985 Confronted with swelling deficits and national debt, conservatives in Congress re- sponded by proposing the Balanced Budget and Emergency Deficit Control Act of 1985, informally called the Gramm-Rudman-Hollings Act (GRH) after its primary sponsors Senator Rudman, one of the sponsors of GRH called it at the time of its passage “a bad idea whose time has coIne.”20 Its two centerpieces were a schedule of deficit targets designed to balance the budget by 1991 by reducing the deficit an additional $36 billion in each of 5 years, and a mechanism for automatic budget cuts that were to be activated if Congress failed to meet those targets The act allowed for postponing the deficit reduction

if a recession occurred and negating it in the event of war Proponents of GRH argued that only such a drastic measure could withstand the political pressures from special interest groups for increases in spending Opponents argued that the law represented a meat cleaver approach to financial decision making

The process of cutting funds was called sequestration Its activation would cause suf- ficient amounts to be automatically withheld from appropriations to meet GRH totals Cuts were to occur equally in defense and social spending, with certain programs exempted in each category In defense, contracts such as those on large weapons systems to which the government was legally obligated to make payments were exempted, while on the social spending side, Social Security, reflecting in part the growing political power of an enlarg- ing older population, was exempted These were not the only areas protected from cuts, however, since more than forty-five programs were totally exempted from reduction Once

a decision to sequester was made, little discretion remained since the amounts to be cut and where the cuts were to occur were specified by law

While ascertaining that sequestration was required seems like a technical issue, i n reality it became political Estimates of budget deficits may vary widely, depending on the assumptions that are made about overall economic growth and therefore federal tax receipts Optimistic estimates of economic growth will produce higher estimates of tax receipts and lower deficit estimates, while with pessimistic expectations of economic growth, federal tax receipts will be lower and budget deficits will be larger Controlling the economic projections and estimates of tax receipts means controlling in some instances estimates of deficits and therefore whether or not GRH sequestration is required

Shortly after its passage, the constitutionality of the implementation of the sequestration process was challenged by Congressman Mike Synar (D-OK) and eleven colleagues The initial law required the comptroller general, the head of the General Account- ing Office (GAO), to activate the sequestration Congress placed the GAO comptroller in

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charge of deficit forecasting to reflect its greater trust in GAO estimate accuracy over executive branch accuracy The OMB estimates, by contrast, have sometimes been less accurate, due to political pressure to make the most optimistic economic assumptions as possible so deficit estimates will be as low as possible The Supreme Court, however, found that having the GAO comptroller determine if and when GRH provisions would be activated violated the separation of powers principle The Court argued that the GAO comptroller was an agent of Congress, the legislative branch, not the executive branch, since unlike executive branch officers the GAO comptroller could be removed by Congress through a joint resolution The court found this infringed on the executive duties to faith- fully execute the law and therefore violated the separation of powers

Anticipating that the triggering mechanism for sequestration may be found unconstitutional, Congress actually provided for a challenge in the law itself and for a quick Supreme Court review, as well as a backup trigger mechanism After the Supreme Court decision, the backup trigger mechanism became effective It calls for the C B 0 and OMB directors to issue a joint report on August 20 to a temporary joint committee of Congress, consisting of members of the House and Senate Budget Committees The committee reports a joint resolution to Congress on needed sequestration amounts within 5 calendar days Each house then has 5 working days to vote final approval on the resolution before it

is sent to the president Typically, Congress is in summer recess during this period in late August and early September In election years, such as 1988, this resolution addressing the deficit is scheduled for consideration in September, only weeks before the election, placing great pressure on Congress to approve overly optimistic projections and to find alternative strategies for dealing with deficits

Initially, Congress used “smoke and mirrors,” including selling federal assets, using accounting maneuvers, and moving some federal outlays off budget The surplus in the So-

cial Security Trust Fund that grew after reforms in 1983 increased taxes and altered some benefits, was used to offset federal expenditures and lower the deficit, even though Social Security fund are earmarked for that purpose only Great pressure was exerted in 1988 and

1989 to keep funding of the savings and loans thrift “bailout” off budget as well Even so, the revised target was supposed to be $100 billion for 1990, but $140 was anticipated By the Bush administration, some observers felt that the federal deficit had gotten “stuck’ at around $150 billion Despite numerous budget summits between key budget process actors,

no easy solution to large federal deficits appeared in sight

Adopt the Budget Enforcement Act of 1990

A massive disagreement over the FY 199 1 budget provoked yet another process reform to

deal with federal deficits In the fall of 1990, OMB director Richard Darman presented bleak figures to Congress Because of the decline in the economy and the massive increase

in funds needed for the savings and loan bailout3”

The FY 1991 deficit was projected to be $168 billion, not the anticipated $100 bil- Including the S & L bailout funds for that year raised the deficit to $23 I billion Removing the “masking effect” of the Social Security Trust Fund surplus raised the The FY 1990 budget deficit was also raised from its previous estimate of $100 bil-

lion

deficit to $280 to $300 billion

lion to $1 6 l .3 billion

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Congress was deadlocked, and long days were spent hammering out a budget agreement Public confidence in Congress and government plummeted; President Bush was forced to abandon his 1988 campaign pledge of no new taxes, an abandonment he later re- tracted in the 1992 presidential campaign when attacked from the right in Republican pri- maries by challenger Pat Buchanan Budget stalemate led to threats to close government down over the 3-day Columbus Day weekend After 2112 months of negotiation, a 5-year budget agreement was adopted, reducing spending by $500 billion over 5 years between

1991 and 1995 This legislation was technically Title XI11 of the Omnibus Budget Recon- ciliation Act of 1990 (OBRA) Title XI11 is called the Budget Enforcement Act of 1990 The following are the two main features of the agreement:

Most of the reductions would not occur in the first 2 years but in the last 3 years Only 23% would occur in the first 2 years; the remaining 77% in the last 3 years The reductions were not absolute cuts, but rather cuts from the “current services baseline estimates” (last year’s budget adjusted for economic growth, inflation, and other factors)

Subject to changes from presidential reestimates, projected moving deficit targets under the 1990 budget agreement were $327 billion for 1991, $3 17 billion for 1992, $236 billion for 1993, $102 billion for 1994, and $83 billion for 1995 The 1990 Budget Enforce- ment Act also included various process reforms, and effectively vitiated the earlier targets

of GRH Sequestration, or automatic cuts in spending if deficit targets were not met, still are to be applied as under GRH to military and civilian accounts separately Discretionary spending ceilings brought about by a special sequestration procedure applied to three broad categories: defense, international, and domestic spending A pay-as-you-go “minise- quester” could also be enacted Budget actors remained optimistic that the 1990 agreement would be more successful in curbing deficits than its predecessors, but basic pressures driv- ing federal spending and deficits upward were not altered

CONSTRAINTS ON RAISING TAXES TO LOWER DEFICITS

Lowering expenditures is only one of two possible approaches to lowering deficits The other is to raise revenues by raising taxes Confronted with a decentralized and politicized budget process and a budget that is largely uncontrollable, why have politicians not raised taxes to lower deficits? The political reality of raising taxes, however, is if anything more difficult than lowering expenditures

By the 1980s, a pledge of “no new taxes” from politicians was almost a political lit- mus test for voter approval Politicians who acknowledged in the heat of a campaign that they would support raising taxes, such as Democratic nominee Walter Mondale did in the

1984 presidential race, went down to resounding defeat Politicians who railed against new taxes, such as incumbent present Ronald Reagan did, won by large margins The key question for policy makers, then, has been how to raise adequate tax revenues to fund government in a democracy in the face of widespread resistance, and during the Reagan years under the supply-side economics, drastic cuts in taxes, especially for the rich Several

constraints operate on the ability of policy makers to raise taxes as demands on government grow

I Low ttr.ves reltrtive to other r ~ t r t i o ~ s cretrte e.vpectntion.s oj’cmtirluetl l o w ttrscs

Despite the seemingly onerous burden of U.S taxes, they remain lower than those of most

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advanced European countries.” In 1984, after the early Reagan tax cuts, taxes in the United States constituted 29% of GNP While Japan’s taxes constituted a lower percentage of GNP (27%) and Australia (3 1 %) and Canada (33%) slightly higher percentages, of European nations besides Switzerland (32%), only Germany and Britain (at about 38%) were below 40% Austria, Belgium, Denmark, France, Italy, the Netherlands, and Norway all taxed at percentages ranging between 40% and 50%, and Sweden’s taxes exceeded 50% of GNP Yet relatively low U.S taxes do not give policy makers greater room to maneuver for more revenues to fund government; rather, low taxes have created an expectation that taxes will remain low These expectations, in turn, fuel resistance to higher tax levies

2 Taxes trlrecrdy constitute a lcrrge dollar volume Because the U.S economy is large, the volume of taxes and other government funds is large-$844,949,000,000 for all levels of government in FY 1986.’’ Of this, $471,898,000,000 was collected by the federal government, $228,054,000,000 by state governments, and $144,997,000,000 by all forms

of local governments By FY 1988, total receipts for the federal government totaled

$909,200,000,000 In political debate, these large numbers seem overwhelming to many citizens struggling to make ends meet, who erroneously conclude that such a huge dollar volume should be adequate if only politicians were not evil and corrupt

3 Heavy reliance is placed on highly visible trrld despised income ttrxes Compared

to other nations, the United States relies heavily on individual and corporate income taxes, which constitute 42% of tax revenues for all levels of government combined This percentage is somewhat higher for the federal government ( 5 5 % ) and lower for state and local government (21 %) When rate structures are progressive, income taxes are the “fairest” of taxes, according to the ability to pay principle Yet citizens do not judge income taxes to be fair Perhaps because withholding is taken from weekly or monthly paychecks, and the process

of calculating annual taxes every year by April 15 is visible and troublesome, citizens hate the income taxes more than other taxes, increasing resistance to tax hikes

4 The growing reliance on payroll ttr.ue.7 rrlso increases resistrrrwe The importance of payroll taxes, mostly in the form of Social Security taxes, has been increasing in recent decades, and currently makes up over a third of revenues at the national level and a fifth at state and local levels.33 These payroll taxes, like income taxes, are highly visible, increasing resistance, with the additional disadvantage of being regressive

5 Ttrx overlap occurs crcross levels of‘ govertttnent contributing to resenttnent cf

“overttrsation ” Both the federal and state governments have separate constitutional authority to tax, and this contributes to tax overlap, especially between the federal and state governments Considerable tax overlap exists at all three levels of government While some specialization exists, with the federal government relying most heavily on income taxes, states on the general sales tax, and local governments on property tax, tax policy more closely resembles the “marble cake” model of federalism, rather than the neatly categorized

“layer cake” image States also tax income Three-fourths of the states have both sales and income taxes Some localities have a payroll tax in addition to Social Security at the federal level Multiple governments taxing the same income or asset adds to taxpayer feelings

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and local government have shrunk Tax revenues have been increasing at the state and local levels, partially to offset recent declines in federal grants, further contributing to per- ceptions that government taxing is out of control

7 Conrpnrtrtive cwlstrrrlcy in the U.S tar strrrcture 11rr.s incwased resistmce to

t ~ e ~ i ttr.res The current U.S tax structure has remained relatively constant since World War

11, when the federal government substantially increased individual and corporate taxes, in

part to fund the war Changes since then, including lowering the tax rates, increasing exemptions and personal deductions and raising payroll taxes, have not altered the basic structure of the system The relative constancy of the tax structure made the introduction of new taxes already used in other countries, such as the value added tax (VAT), more controversial

8 T m policy llcrs beerr rrsed u s ( r t l illstrlmetlt jiw strrbiliwtiorr nrld redistrihutiorl which sometin1e.s rrtldcrclrts the g o d of' r(ri.hcq revc~~rres to jirrlcl govertrrllerlt Tax policy, particularly involving tax cuts, has been used in the past for stabilization: to increase personal savings, to stimulate investment, to reward businesses for hiring minority workers, and to reduce unemployment Capital gains reductions were passed to stimulate investment Tax cuts such as oil depletion allowances have had redistributive effects, rewarding some producers over others Other tax cuts have helped one income group over others Tax incentives have also been used to encourage energy efficiency Sometimes proponents of these cuts argue that in the long run growth will occur and the tax base will increase, but each one of these cuts reduces the immediate tax base and undercuts the goal of producing adequate revenues to fund government

9 Very little progressive redistributiorz occurs throrqh the tar svstenl, so 1 1 0 otle

supports ttrses becurrse they crre , s r ~ ~ ~ s t ( r t ~ t i ~ ~ l l ~ l relativelv better off: The tax system is only marginally redistributive Depending on the assumptions made about who bears the burden

of indirect taxes, the system as a whole is either proportional or mildly progressive State and local taxes remain both regressive and less responsive to growth Low- and middle-income groups, then, do not become better off relatively as a result of tax policy If they did, resistance to increases in taxes might diminish The affluent are best off from low nonredistributive taxes, since progressive taxation would hit them harder Thus, the nonredistributive nature of the overall tax system keeps high-income groups happy with low taxes and the lack of redistribution does not encourage low- and middle-income groups to lower tax resistance Higher taxes to them, in a nonredistributive system, would mean they were no better off relatively, and were worse off absolutely with lower personal disposable incomes

10 Citizens ,yet little ji)rmcrI edrrcation crborrt tcrxes crrrd the role oj',qovert1mcnt in

the e c ~ ) r ~ o n ~ y Despite the fact that concepts dealing with taxes are no more difficult than those dealing with calculus, finite mathematics, elementary chemistry, beginning physics,

or biology, all of which are regularly taught in high schools, basic information about taxes and the role of government in the economy are often not taught When one-fourth of all high school students drop out prior to graduation, and one-half of those graduating go into the labor force rather than immediately to college, wide exposure to tax concepts must be available in high school or even earlier grades if most citizens are to learn them Yet taxes, the only inevitability confronting all citizens other than death, are not systematically taught When taxes are covered, it is usually either within a civics course or in the context of a course designed to praise free enterprise and markets as the only organizing principles for economic activities Government is often in this context excoriated as being bad and inef- ficient Thus, a lack of education and biased education further bias citizens against taxes to fund government services

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Assuming the Federalists’ position, Alexander Hamilton argued strongly for full re- payment of Revolutionary War debt and for the use of tariffs to protect manufacturing Manufacturing represented the future of the country in the Hamiltonian vision of it, and tariffs, despite their negative impact on consumers and southern plantations, were necessary

to shield budding industries from foreign competition The nation adhered to many of Hamilton’s positions on fiscal affairs After the 1787 constitutional convention, the federal government established the First Bank of the United States to pay off Revolutionary War debt, and in I79 1 also assumed the debts of the states Public monies in those early days were raised through customs duties and excise taxes on whiskey, carriages, snuff, sugar, and auction sales.”

This first tax system has been described as an economic success but a political failure Anti-Federalist groups, disgruntled with the revenue system, contributed to the realigning election of 1800 and the election of anti-Federalist Thomas Jefferson to the presidency, after two Federalist presidents, George Washington and John A d a m Among them were farmers, consumers, and large land owners hurt by tariffs, excise taxes, and Hamil- ton’s sound money policies.35

Extensive changes were made in the U.S tax system between 1800 and the War of

1812, during the presidencies of Jefferson and James Madison These presidents abolished excise taxes, used land taxes to encourage western settlement, and lowered tariff rates De- spite this, the strength of the economy produced substantial tariff revenues until the War of

18 I2 cut off trade, resulting in a reimposition of excise taxes Tariffs remained the main- stay of federal revenues for the next hundred years, producing rare agreement between the two political parties Democrats, in principle, often preferred lower tariffs than did Repub- licans, but in practice often argued for tariffs on different commodities than Republicans, depending on their respective constituencies Increasingly, as the South grew more dependent on cotton, it grew more resistant to tariffs, so that the major differences over taxes were regional rather than partisan Further, tariff revenues were unstable and depended on national and international trends in trade, business cycles, and wars, all largely beyond the control of the U.S government

Civil War Taxes

In the period between 1841 and 1860, preceding the Civil War government control was di- vided, alternating between the Whigs and the Democrats Democrats managed to lower tariffs early in the period, only to see them raised again when Whigs gained control of both houses of Congress Most of the high tariffs Republicans imposed during this period re-

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mained in effect until 1892, when Democrats recaptured control of the national government

During the Civil War, two major changes introduced into tax policy were a progressive income tax and an inheritance tax Republicans, the wealthier partisans, supported a

broad application of the income tax, but in a position that foreshadowed the modern capital gains exclusion, opposed applying it to income from stocks, bonds, and land sales The progressive rate structure was abolished immediately after the war in 1867, and the income tax itself was abandoned in 1872

The growing industrial elite shaped post-Civil War taxes, so that revenues fell as a

proportion of GNP and heavier tax burdens were placed on consumption than on production Excise taxes on liquor and tobacco were adopted for moral purposes, but also had a regressive impact, placing a greater burden on the poor Neither individual nor corporate incomes were taxed Protest from farmers and workers built up against high tariffs, hard money, and lack of credit?’

Early Income Tax Policy: 1894-1 930

Despite broad support for an income tax from populists, Republicans disagreed and were supported by a reversal of the Supreme Court on the issue Previously judged to be constitutional, the Republican-dominated U.S Supreme Court of the period reversed a century of precedents to rule that a tax on incomes was a direct tax and therefore was unconstitutional Republicans remained the majority party, despite a realigning election in I896 that changed the basic composition of each party rather than throwing out the party in power

By the early 1900s, Republican progressives, led by Theodore Roosevelt, advocated

a progressive income tax By that time, the United States had become a net exporter and found high tariffs to be an impediment Eventually, some conservatives also supported the Sixteenth Amendment, which allowed a progressive personal income tax, in an attempt to

avert a proposed tax on corporate income When the United States entered World War I,

the income tax was already in place and was increased to fund the war effort It soon became the major source of federal revenue, surpassing tariff revenues

After World War I revenues subsided, but not to their original level, despite the urg- ings of Secretary of the Treasury Andrew Mellon-now recognized as an early advocate of supply-side economics-to reduce taxes on business and individual wealth After the crash

of 1929, President Hoover increased taxes as classical economic theory advocated to reduce

a growing federal deficit In 1930, to increase federal revenues, Congress approved the highly protectionist Smoot-Hawley Tariff, now widely credited with further depressing the economy and lengthening and deepening the depression Discontent over these policies contributed to the realigning election of 1932 and the return of Democrats to national power

New Deal Taxes

The depression forced President Roosevelt to deficit-finance government expenditures A

payroll tax was enacted to finance Social Security on a “pay-as-you-go” basis The tariff became a foreign policy tool largely controlled by the president, rather than a domestic policy tool that had preoccupied Congress, and by the beginning of World War 11, it was no longer a significant source of federal revenue

Despite Franklin Roosevelt’s campaign rhetoric about shifting the tax burden from the lower classes to the middle class and the rich, many New Deal taxes were regressive,

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including the new Social Security payroll tax placed only on the first $3,000 of income and

a processing tax used to fund an agricultural adjustment program at the federal level States also passed highly regressive sales taxes during this period Further, some experts have argued that New Deal policies actually prolonged the depression, such as the Revenue Act of

1935, which raised taxes and further slowed economic growth with little impact on income di~tribution.~’ Partially because New Dealers did not fully control the Congress, the Supreme Court, or state governments, the impact of New Deal policies was not as great as they hoped or as their opponents feared Eventually, U.S entry into World War I1 expunged the lingering effects of the depression

Current Taxes

Today, the federal tax system relies heavily on income taxes, but draws from other sources

as well

Individual Income Tax

When the income tax was first enacted, resistance to new taxes was overcome by applying the tax to a very small portion of the population; only the top 5% of the population was affected Today, about 45% of all federal tax receipts are raised through the individual income tax, more than from any other source While other western nations have income taxes, none emphasizes it as much in its revenue structure as the United States Until 198 I , the income tax had a progressive rate structure based on the notion that taxpayers have different abilities to pay Progressivity has been further eroded by tax expenditures-special exemptions and exclusions-created throughout the years, as well as a significant reduction

in the number of tax brackets in 1986

Before the 1986 Tax Reform Act, the rate schedule for the personal income tax included fourteen brackets The 1986 changes dropped the number of brackets to two, 15%

and 28%, but due to changes for high-income taxpayers in personal exemptions during the phaseout, the effective high rate for a time was 33% creating a third bracket After the phaseout, the top bracket reverted to 28% For taxpayers with high incomes yet low tax li- abilities due to income exclusions and other tax expenditures, an alternative minimum tax must be calculated

Taxes on wages and salaries are collected through a withholding system, first introduced in 1943 Tax payments on other sources of income must be paid in quarterly install- ments during the year in which the income is received Since withholding minimizes tax cheating, some reformists have tried to apply that collection system to interest and earnings

on intangible assets as well as to earned income

Across time, taxes on earned income have constituted a greater proportion of total taxes collected from the individual income tax, indicating a greater incidence of failure to pay taxes on income derived from assets and sources other than wages and salaries These proposed changes in collection procedures, however, have met with great political resistance by the institutions, such as banks and investment houses, that would be responsible for implementing the extended withholding system, as well as from taxpayers who have such sources of income

In 1982 Congress extended withholding at a rate of 10% to interest and dividend payments exceeding $ I50 a year, with exemptions for lower-income elderly citizens When

a massive campaign against this nleasure was launched by banks and savings and loan as-

sociations, Congress reversed itself the next year, despite evidence that considerable rev-

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enues could be collected from taxpayers not complying with tax law Tax politics have pre- vented proposals for extending withholding to earnings on intangible assets from succeed- ing

The income tax has been criticized for having a deleterious affect on work incentives and savings Pechman concludes, however, that historical trends in the U.S labor supply

do not support the view that taxes have had a significant impact on the aggregate labor supply, and that the effect of taxes on savings is even more ambiguous.3x

Corporate Income Tax

First enacted in 1909, Congress levied the corporate income tax as an excise on the privilege of doing business to avoid a constitutional challenge Congress relied on resentment

to “robber baron” corporate empires to enact it The new tax was challenged anyway, but was upheld by the U.S Supreme Court, which agreed that the privilege of doing business could be measured by corporate profits

The history of the corporate income tax has been one of declining importance in the overall federal revenue structure For 17 of 28 years between 191 3 and I94 1, corporate in-

come tax receipts exceeded those derived from the individual income tax Between 1941 and 1967, the corporate income tax was the second most important source of federal revenue, behind the individual income tax Since 1968, it has been superseded by the payroll tax financing Social Security and has fallen in importance dramatically By 1986, it ac- counted for only 8% of total federal revenues, compared to 28% 30 years earlier During that time frame, corporate tax rates have been reduced from 52% to 34% of taxable profits The corporate income tax has a flat rate schedule, but is still complicated by the myriad of special applications for various types of businesses and business situations

Critics of the corporate income tax have charged that its burden is actually shifted forward to consumers so that it is a consumption tax in disguise; that dividend payments to stockholders are “doubly taxed,” once as retained earnings within the corporation and again

as individual stockholder income; that the tax curtails business investment and retards growth; and that it has been applied in a discriminatory fashion across industries

Supporters counter that the degree of shifting depends on how competitive markets are, and that there is little shifting in competitive markets Further, corporations are separate legal entities with many privileges, and corporate income should accordingly be taxed separately from, and in addition to, taxing stockholder income Supporters also argue that alternative methods of raising government revenue would harm economic growth and investment even more than the corporate income tax Finally, the elimination of the investment tax credit and the adoption of more realistic depreciation allowances in 1987 have helped to reduce some interindustry distortion resulting from the tax

Social Security Tax

The second largest source of federal revenue, payroll taxes, are used in the United States to finance the Social Security system and benefits Resistance to this tax was initially Overcome

by earmarking funds for “pensionlike” benefits Once a substantial portion of the population depended upon Social Security as a major source of retirement income, further increases in rates could be achieved, albeit with difficulty, to keep the system solvent By 1990, the tax contribution made by individuals was scheduled to be 7.65% of earnings, up to an income ceiling set to $43,800 in 1987 The ceiling makes the tax more regressive than it otherwise would be Employee contributions are matched by an equal contribution from the employer Self-employed persons pay both the employee and the employer contributions

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To help reduce the burden of Social Security on low incomes, Congress has imple- mented limited “refundable” income tax credits for some groups One way to reduce the system’s regressivity is to remove the ceiling Alternatively, some reformists advocate abolishing the payroll tax and financing Social Security from a progressive income tax

Other Taxes

In addition to the above, the federal government levies a variety of other taxes, including excise taxes on liquor, gasoline, cigarettes, air travel, long-distance phone calls, and customs taxes Excise taxes, in essence, are selected sales taxes Taxes on commodities or services deemed morally or socially undesirable are sometimes called sumptuary taxes In

1978, to promote fuel efficiency, special automobile excise taxes were imposed that varied with the fuel consumption of the vehicle to which they were applied In 1980, a crude oil windfall profits tax was enacted

A very small source of revenue is derived from estate and gift taxes Applied by the federal government, the gross estate tax consists of all property owned by a decedent at the time of death, including stocks, bonds, real estate, mortgages, and personal property After many allowable deductions, including a marriage deduction for spouses, the unified estate and gift tax rates begin at 18% on the first $10,000 of taxable transfer and rise to 50% for transfers exceeding $2.5 million Estate and gift taxes are not broad-based mass taxes, and less than 2% of all those who died in 1985 had estates subject to the tax

A Value-Added Tax?

Unlike many western nations which derive 20% to 30% of their national revenues from a

VAT, the United States has not adopted such a tax A VAT is one form of national sales tax It is placed on the “value added” at each stage of the production process Proponents argue that it is relatively productive in the countries where it has been used, and by being incorporated into the price as yet another cost, is largely hidden from the public Being hidden, in turn, prevents public annoyance and resistance Proponents further argue that it taxes consumption, or what people take out of society, rather than their income, earnings,

or savings, or what they put into it Because everyone must consume, even those engaged

in underground and illegal activities, it taxes people who have previously escaped taxation The VAT is also self-enforcing in that any attempt by a firm to push the VAT backward to suppliers or forward to consumers will be resisted by those groups, leaving the government its rightful revenue

Opponents argue that the VAT is the equivalent of a national sales tax, and as such,

is regressive It could also raise the prices of U.S products, making them less competitive

in export markets Furthermore, it places the heaviest burden on complex manufactured products, including high technology, whose components may change hands several times

It taxes least those services that have little turnover but constitute one of the fastest-growing sectors of the economy Despite large federal deficits, no serious consideration of the VAT in Congress occurred through the first term of the Bush administration

DO TAXES MAKE GOVERNMENT AND DEFICITS BIGGER?

Controversy surrounds the question of whether or not taxes cause government growth and make government and eventually deficits bigger Those concerned with deficits fear that deficits have grown as government has grown, since public expectations outstrip the ca-

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pacity of taxes to pay for them Plainly, taxes and spending are positively correlated so that both increase or decrease at about the same time, but what is the nature of the relationship? Economists disagree about whether taxes drive spending, or the reverse.”’ Milton Friedman supports the former view, contending that higher taxes do not lead to lower deficits, but rather lead to more spending and bigger government.‘” James Buchanan, Richard Wagner, and others in the public choice school argue that the manner in which the government ob- tains the revenues, rather than the level of the revenues, is the most important element in determining government spending.“

In the Buchanan-Wagner framework, raising revenues from direct taxation acts as a

constraint on government spending, so that when high taxes result in high tax rates, government spending is slowed By contrast, deficit spending and inflationary finance result in higher rates of government spending With this latter method, citizens pay “indirect” taxes through higher interest when government financing “crowds out” private financing and through inflation Further, the economic instability caused by the higher interest rates and inflation expands government further as it intervenes to stabilize the economy

Related to the Buchanan-Wagner view is the argument that voters routinely underes- timate their tax burdens and the cost of public services Taxes are often hidden, either as

product taxes or through withholding This creates a fiscal illusion that also allows governments to become bigger than they otherwise would be.”

Disagreeing with both the Friedman and the Buchanan-Wagner theses, Robert Barro argues that higher spending forces up taxes Nor does Barro believe that deficit spending creates a “fiscal illusion” that allows politicians to spend public funds irresponsibly.43 Us-

ing annual data for the period from 1946 to 1983, Anderson, Wallace, and Warner find some support for this position, concluding that increases in expenditures lead to higher taxes, but not vice versa More causal observations of the recent U.S economy would also

support this view, since the increased taxes have appeared to follow increased deficits and debt Since generalizing from this evidence to a larger arena of circumstances may prove difficult, good minds continue to disagree

THE OVERLAPPING REVENUE AND STABILIZATION ROLES OF

TAXES

Confounding the allocation function of taxes to produce adequate revenues to fund government services is its concurrent role as a fiscal policy tool for stabilization Tax legislation is passed by the Congress and signed into law by the president, who may place different priorities on these two roles for taxes Both Congress and the president agree, however,

that lowering taxes is politically popular, while raising taxes is political anathema As these

policy makers construct, debate, and approve new tax legislation, several stabilization aspects of taxes must be considered

The Multiplier Effect

Tax changes do not have a one-time impact, but rather reverberate throughout the economy for several iterations Thus, tax changes have implications both for total revenues for government services and for stabilization that are far greater than their initial magnitude Cut- ting taxes may have an expansionary effect far greater than the size of the initial amount by which taxes are reduced The initial amount by which disposable income is increased from

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the tax cut is then respent, minus taxes, i n the second round of effects In the third round, the amount left at the end of the second round is respent, again minus taxes The multiplier

is a number that measures the size of this expansionary impact A multiplier of 2.5 means that an initial increase in dollars in the economy will have an expansionary effect 2.5 times greater than the initial expenditures

Similarly, a tax increase has a contractionary effect greater than the initial additional alnount removed from disposable income, and that impact may also be measured by the multiplier The value for the multiplier is determined in large part by the rate of turnover of dollars in the economy The impact of the multiplier is influenced by both its own value and the size of the tax change

Taxation is a somewhat less precise fiscal policy tool than government spending While policy makers can calculate spending increases and decreases in absolute dollars presumably to obtain the desired stabilization effect, they must set tax rates rather than the absolute amount of tax dollars to be withheld from the economy or added to it The final impact

of a tax change, then, depends on several factors: the size of the rate change; the health of the economy, which influences how many taxpayers there are and their levels of income; and taxpayer attitudes toward the economic future

Spending changes typically have a stronger impact than tax changes of the same magnitude When spending for government purchases is increased, the entire amount of the increase is immediately pumped into the economy When government spending is decreased, the entire amount is withheld When taxes are increased by an identical dollar amount, however, individuals may draw down savings to initially postpone the impact of the tax increase

on their disposable income, delaying and possibly reducing the fiscal policy effects of the tax increase Similarly, when taxes are decreased by an identical dollar amount, whether or

not taxpayers immediately spend the entire additional disposable income depends on their attitudes toward the future Pessimistic taxpayers who are fearful of the economic future may choose to save a portion of the additional tax dollars, while more optimistic taxpayers may spend the entire amount, or larger portions of it Thus, the fiscal policy effect of a tax cut is less than that of a government spending increase, because taxpayers benefiting from the tax cut may choose to save rather than spend some of their tax-cut income

Additionally, whether the tax savings results from a one-time windfall reduction or from a permanent reduction in tax rates may affect taxpayer behavior Many economists as- sume that permanent reductions have a stronger impact on consumption behavior than one- time windfalls Temporary tax changes have some impact on spending, but are less powerful than changes expected to be permanent This occurs because taxpayers will alter their spending habits and behavior if they think a tax cut is permanent, but not if they anticipate that i t is temporary

Even if these measurement problems did not confound prepolicy enactment calcula- tions about the size of stimulation or contraction being introduced, changes in government spending have stronger than equivalent changes in taxes The difference derives from the stronger first round effects of a change in government spending, where the entire amount

is available for second round spending By contrast, with a tax cut, consumers save some portion, so the entire first round is not available for second round spending

In addition to purchases for goods and services, transfer payments made to individu-

als are also part of total government spending However, these become personal disposable income, some portion of which may be saved From the viewpoint of fiscal policy makers,

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the sti111ulative effect of a change in transfer payments to individuals is equivalent to the ilnpact of a change in tax rates, rather than an increase or decrease in dollars spent for @V- ernment purchases

The Automatic Stabilizing Effect of Taxes

Some tax and expenditure adjustments occur automatically, varying with changes in the economy These stabilizers supplement the impacts of discretionary changes to diminish economic fluctuations induced by business cycles, and include both income taxes and transfer payments, such as unemployment compensation and welfare payments Automatic stabilizers, then, are countercyclical in impact, and unlike discretionary tax and spending changes do not require any action by Congress and the president to be activated

With the federal individual income tax, the automatic stabilizing effect results from the progressive rate structure and the fact that moving up the income scale implies moving

up the income scale implies moving into higher marginal tax brackets, while moving down the inconle scale means moving into lower marginal tax brackets The reduction in the number of tax brackets in the federal income tax code and the total progressivity of the system with the adoption of the 1986 tax cuts reduced but did not eliminate the automatic stabilizing potential of the federal income tax

When the economy is in a recession, personal incomes decline With the decline in personal incomes, tax burdens fall as individual slip back to lower marginal tax rates on a progressive income tax schedule, and others either have no immediate income or fall below the income level subject to income tax As individual tax burdens fall, total tax collections decline, leaving a higher portion of disposable income in the hands of consumers, who spend a substantial part of the additional dollars The additional spending helps to reverse the recession and punlp up the economy

When reverse conditions prevail and the economy is becoming overheated with escalating inflation, personal inconles rise As personal incomes rise, taxpayers autonmtically move into higher marginal tax brackets, where a larger portion of their personal income is paid to the government, reducing their personal disposable income This reduction damp- ens personal spending somewhat, thereby reducing inflationary pressures Reductions in federal income tax progressivity in both I98 1 and 1986, leaving larger, fewer brackets and

a flatter structure, have reduced the automatic stabilizing impact of taxes

Transfer payments, such as unemployment and welfare, also serve as automatic stabilizers and vacillate countercyclically to the business cycle With transfer payments, recession conditions typically increase the number of people who become unemployed and eligible for unelnployment compensation or for welfare and other transfer payments As the economy slumps, the stream of transfer payments automatically increases, reflecting the increase in the number of eligible recipients The increase in total transfer payments results

in more disposable income in the hands of people who otherwise would not have it, and again helps to pump up the economy When inflationary pressures develop later as the business cycle progresses, more individuals will be working, and transfer payments will fall as the unemployment rate falls, reducing government spending

The effect of a tax change, or alternatively, of a change in government spending, is considered not only in terms of its impact on the current economy, but also in t e r m of its impact on a full-employment GNP Analysts calculate whether a proposed change would re-

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sult in a deficit or a surplus at full- or high-employment GNP Two types of budget state- ments are available for this purpose: the official unified budget and the national income accounts budget." The unified budget is the official accounting statement for the federal government, but it was not designed expressly for the purpose of calculating fiscal policy effects on the economy The national income accounts budget was designed for this purpose, and is used to calculate full-employment budget deficits and surpluses

Economists contend that to examine actual surpluses and deficits to determine whether or not fiscal policy is expansionary or restrictive is misleading Rather, the impacts

of proposed policy changes should be examined for the full-employment budget If the proposed change would result in a full-employment budget surplus, it is restrictive; proposed changes that would result in full-employment budget deficits are expansionary By this reasoning, proposed changes that result in actual deficits but in full-employment budget surpluses are not inflationary, whereas changes that result in both actual and full-employment budget deficits are inflationary In recent years fiscal policies have been adopted that produce both types of deficits

The strength of private demand for consumption and investment determines what fiscal policies are preferred When private demand is weak, greater economic stimulation is needed Fiscal policy actions including tax cuts that result in a full-employment budget deficit are appropriate Alternatively, when private demand is strong, anti-inflationary fiscal policy is called for Actions including tax increases that result in full-employment surpluses should be pursued

Despite this logic, critics have argued that fiscal policy has not always been appropri- ately applied Full-employment surpluses were sharply increased during the years I959 to

1960, 1969, and 1974 These increases have been blamed for the recessions of 1960 to 196 1,

1970 to 197 I , and I974 to 1975 Excess has also occurred in the opposite direction By 1965, the full-employment surpluses were wiped out by escalating military expenditures for the Vietnam War, and full-employment deficits grew ( 1 I % of potential GNP in 1966,2.4% in

1967, and 1.870 in 1968) The Federal Reserve did not employ monetary policies to offset these expansionary full-employment deficits, and decade-long inflation resulted."

Both of the terms fiscal dividend and fiscal drag have been used to describe an upward creep in full-employment revenues in times of economic growth Critics of fiscal drag argue that it is merely a concept used to justify lower taxes that are needed to fund government services Fiscal dividend and drag result from the elastic nature of the federal tax structure-the fact that tax revenues grow faster than the tax base during expansions and shrink faster than the tax base during periods of retrenchment The elasticity of the tax structure depends in turn on the fact that it is progressive Both terms-fiscal dividend and fiscal drag-refer to the same fiscal policy effect The former, fiscal dividend, refers to the additional revenues the federal government will recoup with economic growth, while the latter, fiscal drag, refers to the depressing effect extracting a larger share of the GNP in taxes will have on personal spending and on the economy

With fiscal dividend or drag, as the economy grows, leading to growth in personal and corporate incomes, taxpayers move into higher tax brackets, automatically raising tax receipts Inflation raises tax receipts even more since it increases money or nominal incomes, even though real incomes and purchasing power may not be rising, or may be rising more slowly

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For example, Pechman calculates that at FY 1988 income levels and tax rates, as-

suming an unemployment rate of 6% and an inflation rate of 4%, federal tax receipts would automatically increase by $60 billion a year, or 1.3% of GNP This would produce a full- employnlent budget surplus of approximately $60 billion, minus cost-of-living adjustments

i n transfer payments Assuming a 6% inflation rate produces a full-employment budget surplus of $80 billion, or 1.5% of GNP

Some policy advocates have proposed indexing the tax system as a way of reducing fiscal drag as well as reducing the tax burden on individuals during inflationary periods With indexing, tax brackets are expanded and exemptions and the standard deduction are increased i n rough accordance with the increases in the inflation rate Federal income tax indexing was imposed during I985 and 1986 and was scheduled to resume in 1990 Index- ing is popular with constituents by undercuts revenues available for government services

The Interface with Monetary Policy

Taxes and spending share their stabilization role with monetary policy, which also has an impact on the total amount of money in the economy at any given time and on consumer spending Developed by the independent Federal Reserve system, monetary policy may be compatible with tax and spending policy, developed separately by Congress and the president, or may work at cross-purposes with it Fiscal policy may be expansionary, but its impact may be partially offset by a tight, contractive monetary policy The reverse is less common but may also occur

Monetary policy may be used to expand the money supply to provide for easier financing of federal deficits and debt, so that federal borrowing does not use up all available capital While centralized coordination of fiscal and monetary policy has often been dis- cussed, their relative independence allows one to be a check on the other

TAX POLITICS

Public Resistance to Taxes and Strategies for Overcoming It

Taxes, never popular, became even less so during the 1980s For politicians, making promises to raise taxes to fund government services as Democratic candidate Walter Mon- dale did in the 1984 presidential race was almost a guarantee of committing political sui- cide By 1988, Republican presidential candidate George Bush gained much attention and support with his pledge “Read my lips-no new taxes,” to the American people Bush received 40 out of 50 states’ electoral votes, sending a clear signal to members of Congress that proposals to increase taxes were not popular with the public and eroded ballot box power Presidential and congressional resistance to considering new taxes during the early Bush administration persisted, despite continuing budget deficits and mounting national debt

Resistance to tax increases and new taxes is not unique to the current era, but rather has existed throughout the nation’s history Given this resistance, timing and environmen- tal conditions have a substantial impact on when tax increases are proposed and how large the increase is New taxes are most likely to be proposed when the opposition party is weak and not as able to take advantage of taxpayer discontent or when there is a compelling and obvious need for new revenues Major expansions in the income tax have coincided with wars and depressions.4”

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Another strategy used for making new taxes politically acceptable is to initially place the tax on a limited number of taxpayers and businesses, and with relatively low rates When the federal income tax was first passed after the adoption of the Sixteenth Amend- ment, for example, the exemption level for the tax was so high that most people paid noth- ing Even with graduated rates, the top rate was only 7% on incomes over $500,000, a bracket that affected few people in 19 13

When the income tax became the major source of funding to pay for World War I,

the exemption level was reduced so that moderate-income taxpayers now had to pay, but to instill a sense of fairness and reduce resistance, rates on the wealthy were increased simul- taneously Despite a reduction in both tax rates and progressivity after World War I, the need to find revenues to fund depression-origin programs drove rates back up again By the end of World War 11, the federal income tax had shifted from being an elite tax to being a mass tax, with the result of a substantial increase in tax receipts and tax yield

Numerous other strategies are used in proposing, passing, and successfully implementing tax increases or new taxes." Among them are the following:

Earmarking new tax revenues for politically popular causes, a strategy used with So-

cial Security taxes and the highway trust fund

Distributing benefits from a tax increase in popular and visible ways as broadly as

possible

Making taxes temporary, a strategy used for the income tax surcharged during the Nixon administration to counter inflation induced from spending i n Vietnam and on new social programs

Stressing accountability to the public

Making tax increases predictable, by stressing the need to the public consistently and persistently before enactment

Taxing the economically weak, a strategy that has resulted in a drop in the contribution corporate taxes make to total federal revenues and a rise in regressive payroll taxes and taxes on individuals

Lower-income groups spend more of their disposable income than do upper-income groups, having what economists call a higher marginal propensity to consume (MPC) and

a lower marginal propensity to invest (MPI) Accordingly, tax changes concentrated on lower-income groups have been assumed by economists to have a stronger impact than those focused on upper-income groups Little empirical evidence supports this view, however, and in fact, contrary evidence exists that the impact of a tax change on consumption

is largely independent of its distribution among income groups

Despite this, political debate over how tax reductions should be dispersed is often couched in terms of stabilization benefits to be derived, rather than in terms of the redistributive benefits to income classes, which really drive much of the politics surrounding tax changes Democrats, for example, have sometimes argued for tax cuts for the lower and lower-middle income groups, primarily Democrat constituencies, on the stabilization grounds that the cut will be more stimulative, since lower-income groups will spend their tax savings, pumping the money into the economy rather than saving it

Republicans, by contrast, have more commonly argued for tax cuts for the upper- middle and upper-income groups, primarily Republican constituencies, also on stabiliza-

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tion grounds Republicans contend that extra disposable income for these groups will be more stimulative than extra money for lower-income groups, because upper-income groups are more likely to spend their additional dollars on consumer durables, such as cars and ap- pliances These types of expenditures are more stimulative to production, according to Re- publican logic, than equal dollar expenditures made by lower-income groups for non- durables, such as food and rent Thus, in the politics of tax changes, rhetoric revolves around stabilization issues while motives and decision making in large part revolve around redistributive concerns

Irregular and Sometimes Infrequent Evaluation of Tax Adequacy

In contrast to government spending, which would not occur without overt action by Congress and the president to pass appropriations annually, once approved, tax rates and schedules remain i n place until altered While the reevaluation and approval of budgets is frequent and regular, the reevaluation and approval of taxes is less frequent and irregular These process differences compound the measurement difficulties mentioned earlier involved in fine-tuning the use of taxes as a component of fiscal policy considerable resistance usually occurs to any proposed tax change, and the fact that reevaluation of the tax code is not incorporated into regular legislative routine makes it easier for special interests

to prevent revenue enhancements impacting on them personally

One goal of the 1974 Congressional Budget Act was to include reevaluation of taxes

as a component of fiscal policy into the annual budget process, as well as to more closely coordinate revenue committee activities with those of the budget and appropriations committees This coordination was to occur through the reconciliation process, when after eval- uating macroeconomic stabilization needs, existing program commitments, and requests for new funding, the budget committees were to instruct their respective revenue committees about recommended revenue needs The revenue committees then were to find new funds in whatever fashion they viewed most appropriate This coordinating process, however, has remained informal, and revenue committees are free to ignore or sidestep budget committee requests

Further, the initial timing for this consultation with the revenue committees proposed

in the act was unrealistic and abandoned Initially, the reconciliation process was to occur after the second budget resolution at the end of the summer Congress, however, did not have enough time to address reconciliation in the short period allowed, and the revenue committees did not have enough time to build the complex coalitions that increasing taxes frequently requires After effectively abandoning the second budget resolution, the reconciliation, in the form of budget committee directives to the finance committees, was moved

to late spring or early summer, shortly after the passage of the first resolution The process, however, remains nonbinding

Tax Politics and the Lengthy Tax Process

Tax policy exists in a public policy arena in which the language is often arcane, abstruse, and dry, but the impacts on both stabilization and redistribution are tremendous and the passions run high Since tax policy affects almost every citizen and business directly, any proposed change is highly debated and scrutinized Many actors provide advice to the Congress on tax policy, including the legislative counsels of the House and Senate that draft tax bills, experts at the GAO and Congressional Research Service who provide analysis,

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and economists at the C B 0 who also provide studies and advice Just as in budgeting, the decentralized lengthy structure provides many points where powerful interest groups may influence outcomes to their liking

The Treaslrlg Depnrtrnetzf: The development of tax bills initiated within the executive branch is supervised by the assistant secretary for tax policy within the Treasury Department (See Table 3.) The assistant secretary for tax policy has three staffs: the offices of tax analysis to estimate the impacts of revenue changes; the office

of the tax legislative counsel to provide legal analyses; and the office of the international tax counsel to examine foreign source income and foreign citizens Work on a new tax bill begins many months, and often more than a year, before

it is submitted to Congress During this time, the assistant secretary for taxation amasses a great amount of information, impact studies, and analyses on the proposed changes, as well as keeping the White House staff informed of the progress and consulting with other government agencies

Table 3 Tax Process Actors

Executive branch actors

Trerr.sut:s Depurttmwt: Analyzes tax bills and makes recommendations to the president

concerning tax policy

Internal Revenue Service: Collects federal taxes

Office of Tax Analysis: Analyzes tax issues and makes revenue projections

Office ofthe Tax Legislative Council: Reviews and approves IRS regulations

Office of International Tax Council: Provides legal analyses for foreign source incomc and

Office ofMarlagemvlt urd Bttdger: Includes revenue estimates in its analyses and advises the Presiderlr: Must sign all revenue laws; galvanizes public opinion on tax issues

Joint Cortrnlittee o r 1 TrocatiorI: Advises Congress on tax issues

Home ofRepre.serltflti~les: Initiates all revenue measures and approves tax legislation i n floor debate

House Budget Committee: Holds hearings on macro-level revenue needs, passes the first

related issues

president on budget-related revenue measures

Legislative branch actors

concurrent budget containing revenue targets, and sends nonbinding directives to the House Ways and Means Committee during the reconciliation process

health, welfare, and Social Security legislation

legislation, including tax legislation

House Ways and Means Committee: Has jurisdiction over revenue, debt, custom, trade, House Rules Committee: Must issue a rule regulating amendments and floor debates for all

Serum: Must approve all tax legislation

Senate Budget Committee: Exercises functions parallel to those ofthe House Budget

Scnate Finance Committee: Exercises jurisdiction over taxation, foreign tradc, health, Social Committee

Security, and other financial issues

Cor!fererlce Cornnlittee: Resolves differences between House and Senate vcrsions of tax bills, with members from each chamber voting as a unit

Corrgressionnl Budget OfSice: Conducts analyses of tax-related issues, issues revenues and

deficit forecasts and issues an economic report on the impact of government taxing and spending on the state of the economy

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T/le Joitlt Committee 011 Tmtrtiow: Along with the Joint Economic Committee, the Joint Committee on Taxation is one of two joint congressional committees established to address major and often controversial policy areas It is involved

in shaping new tax legislation, but unlike the House Ways and Means Corn-

Inittee and the Senate Finance Committee, the Joint Committee on Taxation is

not a veto point or gate through which legislation must pass and is not directly involved in the legislative process; rather, its role is advisory

The Horrse Wtrys (rwd Metms Committee: According to Article I, Section 7 of the U.S

Constitution, all revenue bills must originate in the House of Representatives Hence, tax bills technically begin in the House Ways and Means Committee, although the Senate carries equal weight in the tax legislative process, and of-

ten greatly alters House bills In the late 198Os, about two-thirds of the House Ways and Means Committee members were Democrats and one-third Repub- licans Ways and Means is the most powerful committee in the House, and has jurisdiction over revenue, debt, customs, trade, health, welfare, and Social Se- curity legislation.'x Committee members work through six subcommittees on many issues, but consider general tax legislation as a committee of the whole After administration-sponsored tax bills are presented to the House Ways and Means Committee, usually by the secretary of the Treasury, testimony is so- licited from bankers, businesspersons, lawyers, economists, and affected interest groups Often missing from the general lineup ofexperts, however, are witnesses who represent the general public Although in recent years public interest groups have been testifying on major tax bills with greater regularity, the bulk of nongovernment testimony still comes from special interests Hear- ings may run for months, depending upon the amount of interest sparked by the bill Following hearings, the committee holds markup sessions, open to the public since 1974, in which the committee makes decisions on the bill Despite the attempts to make the markup sessions more open, secrecy still abounds With a recorded vote to enter executive session, the committee can hold closed hearings This practice has been increasingly common in recent years Further, many decisions are made by party caucuses of committee members, which occur behind closed doors The decisions made by the House Ways and Means Committee represent a confluence of partisan and nonpartisan interests In addition to the actual bill, a committee report is generated, prepared by staff of the Joint Taxation Committee, that may approach several hundred pages in length The report details the Ways and Means Committee's rationale for the bill, estimates its revenue impact, and provides a section-by-section analysis of the proposed changes Minority reports of members who disagree may also be included After committee deliberations, both the bill and the committee report are sent to the House

The House of Re/,~eEsentcrtives: Because the House is so large, it must limit and set ground rules for floor debate through the House Rules Committee to prevent the passage of bills from becoming unwieldy Under open rules, bills may be amended on the floor, while under closed rules, they may not be amended Open rules allow for unrelated issues to be attached as riders, and may cause the tax bill to become hostage to the politics surrounding the rider Tax legislation typically emerges from the Rules Committee with a modified closed rule that allows separate debate and floor votes on only a limited set of amendments

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approved by the Ways and Means or the Rules Committee In contrast to the committee hearings, floor debate transpires in a brief day or two Only rarely are House Ways and Means Committee bills rejected Rather a vote will be held to send the bill back to the Ways and Means Committee, which is in- structed to report it back out with one or more amendments appended

The Serurte Finonce Cornnrittee: The counterpart to the House Ways and Means Committee, although somewhat smaller with twenty members, is the Senate Fi- nance Committee It exercises jurisdiction over taxation, foreign trade, health, Social Security, and other financial issues The partisan makeup of the committee is proportionate to the strength of the two parties within the Senate The secretary of the Treasury also appears before this committee, testifying on the House version of the tax bill The lineup of expert witnesses before the Senate Finance Committee closely parallels, and is almost identical to, the earlier lineup before the House Ways and Means Committee Various groups exert strong lobbying efforts here as well as before the House committee The Sen- ate Finance Committee usually makes major changes i n the bill before reporting it to the Senate floor, and in 1982, when the House had no major bill, the Senate Finance Committee tacked its own bill onto some minor tax amendments forwarded by the House The Senate Finance Committee also prepares a

frequently lengthy colnlnittee report that has the same purpose as that of the House committee

The Sewre Floor-: Discussion and action on the Senate floor is much less fettered than on the House floor Except for debate on budget reconciliation bills, which

is limited to 20 hours, the Senate has no limit on debate or amendments While

in most House floor debates the primary intent of many speakers is to establish

an official record for their position, speakers addressing the Senate on pending

major tax legislation may actually try to persuade and convert colleagues Floor debate in the Senate is typically longer and more colorful than in the House, but still very technical and directed toward aspects of the bill that directly benefit

or penalize specific groups Usually amendments proposed on the floor are opposed by either the administration or the Senate Finance Committee or both and are rejected, although occasionally floor amendments survive Bills that fail to win approval are either sent back to the Finance Conmittee or are abandoned

The cotfer-ence cotwrittee: In the increasingly unlikely event that the Senate passes

a House tax bill unamended, it is forwarded to the president for approval More likely, the Senate amends the House bill, making necessary a conference committee, consisting of both Democratic and Republican members from each house Normally, the numbers from each chamber are equal, and include the senior members of the two tax committees Usually, four or five majority party members and two or three minority party members are appointed from both the House and the Senate When voting, each chamber votes as a unit, with the majority party controlling the unit vote While the lnission of the conference committee is to resolve the differences between the House and Senate versions of the bill, sometimes the conference committee exceeds that mandate and inserts provisions that were in neither version of the bill In the interest of achieving a

compromise that meets revenue goals, appointed conferees are usually gen- uinely interested in reaching an agreement, and access to conferees by interest

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groups may be eliminated or severely limited The time for conference committee deliberations varies from a day to a week or two, depending on the degree of disagreement between the House and Senate versions of the bill and its size and complexity Usually, the House and Senate delegations meet separately using a go-between, and may even deputize the delegation chairs to work out compromises and details when impasse points are reached The conference committee bill is reported to both houses for final vote and then submitted to the president

Presidentid acriorz: The president consults with OMB and White House advisors before deciding whether to sign or veto a major tax bill Usually administration officials have exerted great energy and effort to have the bill amended and shaped in earlier stages to eliminate provisions that the administration cannot live with, and to include provisions that it must have Hence, while every detail of a major tax bill is rarely to a president’s liking, rarely also do presidents veto such bills Only four major tax bills were vetoed in the past 35 years A

presidential statement usually accompanies major tax bills, expressing pleasure for approving it, taking umbrance at some of the provisions despite approving

it, or explaining a presidential veto of the bill The newly enacted tax changes may take effect immediately or be phased in gradually The IRS gears up to ad- minister the bill, which Inay include developing regulations The length of time needed to develop administrative regulations and to fully implement the bill depends in part on its statutory specifications and complexity In recent years, bills have been so complex that subsequent legislation to correct unforeseen er- rors has routinely been required

“TAX EXPENDITURES” EXACERBATE DEFICITS

Tax expenditures lower tax revenues and exacerbate federal deficits Tension exists between special interests that wish to chip away at the tax base (the items and income covered by taxes), creating special exemptions and exclusions for their clients and group members, and those concerned with revenue adequacy or fairness, who wish to keep the tax base from being eroded These exemptions from the tax code are called “tax expenditures,” and much of what passes for debate over tax reform is actually debate over the type, nature, and extent of tax expenditures that shall be inserted into the tax code They benefit a large ar- ray of special interest groups, including business Some of the biggest, such as mortgage interest deductions, benefit the middle class, as well as builders, mortgage bankers, and fi- nanciers

Tax expenditures used to be called “tax loopholes.” The term tax expenditure has come into vogue in recent decades as a less biased expression for the transfer of benefits through the tax code, but one that still emphasizes shifting money from the government to

special groups From the viewpoint of recipients, benefits received as tax expenditures are

no less desirable or beneficial than benefits bestowed as transfer payments through budget expenditures

A tax expenditure is a legal reduction in effective tax rates for certain classes of taxpayers, resulting in lower taxes Tax expenditures create effective tax rates lower than nominal tax rates for beneficiaries, and differential effective rates for eligible taxpayers compared to noneligible taxpayers with similar incomes

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The tax expenditure budget has become an important tool for federal policy tnakers

i n judging the extent to which special exemptions have eroded the tax base The 1974 Con- gressional Budget Act requires the president’s budgct to report tax expenditures for revenue plans contained i n the federal budget.““ I n that legislation, tax expenditures are defined within the act as “revenue losses attributable to provisions of the federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability.”

In addition to its redistributive impacts, policy makers have viewed tax expenditures

as an alternative policy tool to budget expenditures, credit assistance, and regulatory in- struments At times, federal tax expenditures have encouraged such diverse activities as investment, housing, charities, municipal borrowing, and oil exploration

Tax expenditure budgets outline the major lcgislative exemptions listed above, the beneficiary group, and the estimated revenue loss/size of benefit emanating from each legislative exception While in practice full tax expenditure budgets have only been developed

at the federal level, in theory they could be developed by state and local governments as well While some fiscal notes developed for states have used some of the same analytic techniques, they have n o t been expanded into full tax expenditure budgets

Initially, analyzing tax expenditures involved estimating revenue loss frotn provisions different from “normal tax structure.” Analysts used the section of the president’s budget message devoted to tax expenditures to guide them in identifying tax expenditures Computing what the government does not collect from individuals and corporations proved difficult Subsequently, tax expenditures have been estimated as outlay equivalents rather than as revenue losses, although revenue losses continue to be shown separately in the bud-

A newer technique involves estimating tax expenditures as the outlays that would be required to provide beneficiaries with an equal after-tax income-a technique that results

i n higher numbers than the revenue loss procedure, since taxpayers would have to pay taxes

on the higher income derived from direct budget outlays Since both outlays and receipts at-e raised by the amount of the outlay equivalent, however, the federal deficit is not changed by the newer methodology

n

Current Federal Tax Expenditures

The 1986 Tax Reform Act lowered marginal tax rates considerably, from a maxinlum of

50% on individuals to a maximum of 33% Simultmeously, the tax base was extended through the abolition of several tax expenditures Among those removed from the tax code were interest on consumer debt, preferential treatment for capital gains, and deductions for state and local sales taxes Tax-deductible contributions to individual retirement accounts (IRAs) were limited Nonetheless, substantial tax expenditures remain

Tax expenditures i n 1988 were estimated at $361 billion, compared to an estimate of direct budget expenditures by the C B 0 of $1,069 billion The estimated deficit for FY I988 was $169 billion, so that tax expenditures exceeded the deficit by almost $200 billion Put another way, eliminating tax expenditures would have eliminated the federal deficit, and additionally generated a surplus to apply toward debt reduction Despite the drain of tax expenditures on federal revenues, the public and many politicians consider the abolition oftax expenditures to be a tax increase, rather than the elimination of some special privilege Cur- rent tax expenditures may be categorized into three major groups

Tiêu đề	Federal Deficits and Financing the National Debt
Tác giả	Marcia Lynn Whicker
Trường học	Rutgers University
Chuyên ngành	Economics
Thể loại	Biểu mẫu tài liệu
Năm xuất bản	1993
Thành phố	New Jersey

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Số trang	412
Dung lượng	27,71 MB