The Heritage Foundation

Executive Memorandum #290 on Federal Budget

October 26, 1990

October 26, 1990 | Executive Memorandum on Federal Budget

The "New" Budget Agreement, Part V: The Brink of Disaster

(Archived document, may contain errors)

10/26/90 290


After weeks of crisis government, the budget agreement that has emerged will damage the American economy even more than would have the agreement that was defeated three weeks ago. The new pact will ffidrease taxes more than the original agreement.The new p act will increase spending, despite rhetoric to the contrary; indeed, the agreement allows spending to increase at -near record rates, again, more than in the original agreement. The new pact dips deeply into the pockets of working class Americans directl y by pushing up the price of gasoline, beer, tobacco and even airline tickets. And the greatest damage is yet to come - in the recession that will follow the tax increase. Businesses will close and contract, jobs willbe lost, and the resulting fall in reve n ue to the Tteasury will drive the budget deficit even higher. The budget pact would undo the progress made in the 1986 Tax ReformAct, which lowered tax rates and created only two statutory rates: 15 percent and 28 percent. To increase progrdssivity, a "bu b ble" wag created, with a 33 percent marginal tax rate for taxpayers with income in the bubble but a 28 percent mar- ginal tax rate for incomes over the bubble.There has been much talk about eliminating this bubble. This*- made sense if the bubble would ha v e been burst by keeping the top marginal tax rate at 28 percent. In- stead, the bubble is being expanded by creating a single top rate of 31 percent.. Tax Trap. What is worse, while politicians and the Bush Administration compliment each other for get tin g rid of the current "bubble" by raising taxes on all Americans, they have created two new bubbles. Not' only will this damage the economy immediately, it sets a tax increase trap for next year when the high-tax advocates in the White House and on Capitol H ill will argue that they again have to raise taxes to remove a bubble. The first new bubble in the proposed tax bill is created when taxpayers with incomes- above a cer- tain level lose part of the value for such itemized deductions as home'mortgage inter e st, state and local in- dome and property taxes, and charitable contributions. This raises the marginal tax rate for taxpayers in the affected income class by about one percentage point; this is a threepercent hike. Marginal tax rates for wealthy taxpayer s , however, will drop to the 31 percent level once the value of their deductions is . depleted, creating the bubble that becomes the political issue that the "rich" are not paying a "fair" share.! The second new bubble is created by the children's surtax. U nder the agreement, the value of personal'- exemptions, including those for children, will be phased out for taxpayers earning a certain level of in-''' S; come. The mechanism for this children's tax, a one-half percentage point increase'in marginal tax r a te . will push many upper-middle class taxpayers into a tax bubble that could reach 37 percent. Once the value of the personal exemptions is depleted, the marginal tax rate will return to the statutory level. Tax-hungry politicians then will quickly seize on the issue, pointing out that the very wealthy pay lower marginal tax rates on the last dollar of income earned than do taxpayers in this new bubble.The tax bill being con-

sidered in Congress will not only wreak damage in the near term, it also sets the stage for equally destruc- tive tax increases next year. Harming the Poor. Tle new agreement raises gasoline taxes by 5 cents per gallon. T'his, harms the poor especially. In this extremely mobile nation with its vast expanses, the poor can least affo r d to pay higher transportation costs. Yet they have little choice but to turn over more of their earning in higher gas taxes to the federal government to keep their jobs. The new agreement hikes taxes for alcohol, tobacco, and air- line tickets. Elitist W a shington policy makers have singled out working men and womenjelaxing after work with a beer, to pay more to make up for the inability of Congress and the White House to cut waste- ful spending. And like gasoline, the poor pay a higher proportion of their income for alcohol and tobacco. Combined with the gasoline tax, the higher tax on air travel is particularly disturbing. Families are spread out across America. Goods are shipped great distances to market. The budget agreement's attack on America's mobili t y will mean, among other things, higher prices for good, fewer visits by families to dis- tant friends bind relatives on holidays. And again, poorer Americans will suffer most. Most harmful to the poor and middle class will be the recession that will be i g nited by the new agree- ment. With the economy barely growing and unemployment inching up, taking more money out of the hands of consumers and businesses will end eight years of economic growth and push the economy over the brink into recession. The White House and congressional leaders seem to assume that a budget agree- ment is an end in itself. They act as if nothing they do will have real economic consequences. Yet the reces- sion will be very real and the poor, as usual, will suffer most. It is puzzli n g how Congressman and Senators with working class voters in their states and districts could support a tax package that would so harm their constituents. As a result, next year the great public discussion will be how policy makers have harmed all American s . As the public eventually examines the budget pact, the failure to cut spending and the new and wasteful outlays will become a focus of outrage. The public, for example, will be entitled to ask: Is it worth paying 5 cents more for a gallon of gasoline so that the federal government can spend $220 million on higher con- gressional salaries, $1 million to study bicycling and walking, $500,000 on a monument to entertainer Lawrence Welk, $500,000 for a parachute drying tower, $ 100,000 for soybean based ink r e search and $ 100,000 to study sand on Waikiki Beach? Forgetting History. T'he new budget pact forgets the lessons of the 1970s and 1980s. In the 1970s spen ing and taxes grew, inflation rose and the economy stagnated. All Americans, rich and poor, were hu r t. Ronald Reagan changed the nation's economic direction. Lower taxes provided incentives for increased economic activity. Unemployment dropped from 10.6 percent at the depths of the 1982 recession to 5.1 percent earlier this year. Inflation tumbled, as d i d interest rates and gasoline prices. Approximately 20 mil- lion net new jobs were created during that period. This historical lesson is being ignored by George Bush and the handful of his top aides responsible for his budget decisions and by Congress. Th e y are returning to the tax-and-spend policies of the 1970s. As the economy declines, the pressures for more spending in- crease. The 1970s cycle of decline will start anew. America peers over the brink of economic disaster. T'his, is not because the Ameri c an people are lazy or unproductive. It is because the White House and Congress are more concerned with feeding the bloated federal bureaucracy and funding pork barrel projects. T'hey forget that all of these excesses are paid for by the American taxpayer. The economy will not be held back from the brink by this proposed budget deal. It may be possible to save the economy, however, if the tax increase is rejected and policy makers rely in- stead on the Gramm-Rudman-Hollings law to reduce the deficit by maki ng automatic cuts in spending. Edward L Hudgins, Ph.D. Daniel J. Mitchell Deputy Director of Domestic Policy Studies John M. Olin Fellow in Political Economy