The Heritage Foundation

Executive Memorandum #179 on Economy

October 23, 1987

October 23, 1987 | Executive Memorandum on Economy

At the Economic Summit: The Key Topic Must Be Spending


(Archived document, may contain errors)

10/23/87 179

AT THE ECONOMIC SUMMIT, THE KEY TOPIC MUST BE SPENDING..

R onald Reagan agreed yesterday to attend a domestic economic "summiC with congressional leaders to discuss proposals to reduce the federal deficit and restore inve stor confidence. At this summit, Reagan says that he will, place everything except Social Security on the negotiating table. This means, presumably, that he is now open to tax hikes. The President should know better. A tax hike -now could turn a financial . p c into an economic collapse. With a $14 billion Social Security tax increase allady scheduled for next year, and with mounting concern about future returns on their stocks, the last thing investors and businesses need is new taxes. They would increase b usiness costs, boost unemployment, make stocks even less attractive, jeopardize economic growth, and make the U.S. even less competitive than it is.in world markets. The main topic of the economic summit needs to be how to curb runaway federal Spending. I f taxes are to be discussed in this context iat all, then it should be a cut in the capital gains tax to spur risk-taking and increase revenues. Not Undertamed. The first requirement for a cure to the federal deficit. is to reco i why the red ink exists. I t is not due to any shortfall in tax revenues. Fed!T tax revenues as a share of Gross National Product (GNP) are at near record highs, well above the share in the 1960s and 1970s. Indeed, of the last nine presidents, only Jimmy Cartef's tenure, which ended with the economy sliding into the nation,s deepest post-war recession, saw the tax share at a higher level than during the Reagan Administration. The United States is not .undertaxed. The fact is that the massive increases in tax revenues during the last s ix years, thanks to economic growth stimulated by reductions in tax rates, have been exceeded by an explosion in federal spending. This growth in spending is due primarily to domestic spending, not to defense outlays. Domestic spending has more than doubl ed in constant dollars since 1970, far outpacing the rise in defense spending. The U.S. today spends just 6.4 percent of GNP on defense, compared with an average of 8.4 percent between 1950 and 1980.

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Doublecrossed by Congress. If Ronald Reagan agrees to a tax hike he would be pouring gasoline on a fire. Indeed, the international financial markets greeted Reagan7s Thursday press conference statements by plunging even further. As for Congress, a tax inc r ease merely would remove the pressure it feels to cut spending. Most likely, a tax and spending compromise between Reagan!and congressional leaders would be a re-run of 1982. The deal that year, aimed at slashing the deficit, led to a tax increase of $150 billion over four years. Reagan was promised $3 in spending cuts for each $1 in new taxes. Reagan agreed to this deal and then was doublecrossed by Congress. Rather than cutting spending, the lawmakers consumed the new taxes. The result: the deficit rose f rom $130 billion in Fiscal 1982 to $212 billion by Fiscal 1985. Congress has been signalling Wall Street and the international markets%-- that -it has no interest in cutting spending. Already this year it has twice overridden Reagan vetos, authorizing doz e ns of porkbarrel. highway and water projects and adding $20 billion to the Administratiores budget request. Moreover, Congress has refused to eliminate a single program in its authorization bills for this year. On the contrary, lawmakers have included nea r ly a dozen new programs, which would add an estimated $8 billion to the deficit in this fiscal year alone. In its determination to keep up pressure for a tax increase to finance this extra spending, Congress has even passed legislation to hide privatizati o n revenues. A recent amendment to the Gramm-Rudman deficit reduction law prevents billions of dollars in revenues from the sale of federal assets even from being counted as a reduction in the deficit. Lawmakers will simply pretend the- revenue does not ex i st-- but they will spend the money. Ronald Reagan should go to the economic summit with, three demands, which would significantly reduce the deficit without a crippling tax increase: 1) He should seek a fi=w on all new pp*ra@w-no new spending. This would s ignal the world that Congress is serious about cutting spending. 2) He should press for agreement on a comprehensivel program of privatization: increased contracting out of services to reduce costs by increasing efficiency; and further sales of federal as s ets, with the revenues no longer hidden from the taxpayer or from international, markets... - . 3) He not only should threaten to vew any tax increase, but should press for a reduction in capital gains tax to boost revenues. When the capital gains rate wa s nearly halved in 1978, revenues jumped almost 50 percent. A cut in the rate would also make investments more attractive, a critically important step to restore investor confidence. The White House-congressional summit is an opportunity for real leadershi p . If Congress demonstrates willingness to end its crusade for new; programs and special interest spending, the international financial crisis could sooni end. If, on the other hand, lawmakers insist on business as usual and Reagan gives in on the tax hike issue, the financial crisis could turn into a world-wide economic disaster.

Stuart M. Butler, Ph.D. Director of Domestic Policy Studies

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