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998 August 10,1994 ONEYEARLATER HOW THE CLINTON TAXHKE BGAMERICA
Daniel J. Mitchell McKenna Senior Fellow in Political Economy
INTRODUCTION This wtkk marks the first a nniversary of 1993s record
tax hike and the ill effects al ready are becoming apparent. The
Clinton Administrations own numbers show that eco nomic growth and
job creation remain considerably below levels normally found at
this stage in a business cycle. T he White House figures also
reveal that if any deficit reduc tion does occur, it will be only
temporary and largely unrelated to the Presidents eco nomic policy.
Worst of all, the Administrations budget numbers confirm that
govern ment spending remains ou t of control, with rising deficits
in future years entirely due to the unchecked growth of domestic
spending programs.
These dismal results should not be suprising. Other Presidents
who have followed high-tax policies also have experienced
disappointing economic performances as a .re sult. Large payroll
tax increases and bracket creep during the Carter Administration,
for instance, helped stifle a robust economy and create the
phenomenon known as stagfla tion. George Bush also inherited a
strong economy, but his acquiescence to a large tax increase in
1990, combined with other significant reversals of his predecessors
poli cies helped put an end to the longest peacetime expansion in
Americas history.
The Clinton Administration insists that its tax plan is working
and that history will not repeat itself. Unfortunately, the rosy
picture being painted by the White House falls a part upon closer
examination. Consider the following claims CLAlM #I: The
Administrations economic policy has restored REALITY: This
assertion ignores the fact that the recession ended in the spring
of 199 1.
And even though President Clintons tax plan di d impose
retroactive tax increases on small businesses, investors,
upper-income individuals, and the estates of dead Ameri cans, even
the White House is hard-pressed to argue that a tax increase
beginning January 1,1993, caused a recession to end nearly t w o
years earlier. The Administra tion can legitimately claim that 1991
should not count as a recovery because the econ omy experienced
almost no growth, expanding by less than three-tenths of one per
cent during the year. The same cannot be said for 1992, however,
since the economy expanded at a 3.9 percent clip. Growth in 1993,
the year of the Clinton tax increase slipped back to 3.1 percent
and the Administrations new projections show only 3.0 percent
growth in 19
94. As such, the best the Administration can claim is that last
economicgrowth I5 IO 5 years budget deal has not yet caused the
econ omys performance to slow down much com pared to the growth lev
els President Clinton in herited.
The real story, how ever, is that the recovery under both Bush
and Clinton has been woe fully inadequate. In the post-World War 11
pe nod, the U.S. economy traditionally has experi enced strong
recoveries after an economic down turn, with real growth av eraging
5.34 percent for the three years following a recessions end . But
the economys performance this time has fallen far 4 Chart I The
Bush-Cllnton Recovery Lower-than-Average Economic Growth 20a 1
Ecor~wnt Gtuwth short of past recoveries, with growth averaging
only 2.94 percent in the last three years. In other words, e
conomic growth has been barely half as strong as that nor mally
experienced at this stage of a business cycle. Average growth
during this expan sion has not even reached the average of 3.1
percent for the post-World War II era-a figure which includes rece
s sion years 2 1 Instead of taking credit for ending the recession
and restoring economic growth, the 1 Administration should be
trying to explain why the economys performance has been so weak.
The reason for the poor growth figures, of course, is that the W
hite House is pursu ing policies similar to those that helped cause
the recession in the first place. Presidents Bush and Clinton both
raised taxes. They both increased government spending and they both
increased the burden of regulation and imposed costl y mandates. As
a result, the economic downturn and subsequent weak recovery should
not come as a surprise. Poli cies which raise the cost of
productive economic activity inevitably result in less job
creation, lower savings, and reduced investment I CLAIM # 2:The
Administrations economic pollcy has helped create new jobs CLAIM
#3:The Admlnlstratlons flsd policy Is brlnglng down the deficit
REALITY: Projected short-term reductions in the budget deficit are
largely unrelated to the Presidents policies I final f igures bear
out the Administrations estimates, the 14 12 IO 8 6 4 2 REALITY: As
is the case with economic growth, job creation has been unusually
weak during this expansion. If the current expansion were producing
an average number of jobs for a recovery, total employment would
have jumped by 11.79 percent since the recession ended. But with
tax increases and new regulations raising the cost of hiring new
workers not to mention the threat of an employer man date in health
re form), total em ployment has in creased by only 3.19 percent in
the last three years. Thus while the White House likes to boast
that more jobs have been created to date during the Clin ton years
than were created dur ing the entire stration, officials should
instead be trying to ex plai n why the nearly identical economic
policies of thetwo Administrations have caused the rate of job
creation in this recovery to be less than one-third the usual rate
at this stage of a business cycle. This poor performance means
millions of Americans are u n employed today who would have been
working during an average recovery I Bush Admini Chart 2 The
Bush-Clinton Recovery Fewer Jobs Created than Average prcent
Increase in Total Emolownent I Year I Year 2 Year 3 Yean After End
of Recession kurcr Depamnmtof L a bor. Bureau of Laba Stat 3
three-year decline in government borrowing will be the result of
three factors. First and foremost, the deficit is falling because
the economy has finally climbed out of the recession, albeit
slowly. And even though the expansio n is very tepid by historical
standards, incomes have risen slightly, some jobs have been
created, and corporate profits have staged a mild recovery. All
these factors mean the government collects more tax revenue. The
expansion also has caused a slight de c line in how fast some
government programs, such as unemployment insurance and food
stamps, are grow ing. But as discussed earlier, the economy is
growing much slower than normal. As such, the White Houses economic
policies actually are causing the deficit to be higher than it
would be if normal economic conditions applied.
The second reason for projected lower deficits is the cost shift
for the bailout of the deposit insurance system. The large one-time
costs of the savings and loan (SBrL) de posit insuran ce bailout
artificially swelled the deficit between 1989 and 1992, adding 149
billion to the national debt in that four-year period. The
government now is sell ing off the assets of seized SCQLS, however,
and this is expected to generate $60.3 bil lion of revenue for the
government between 1993 and 19
97. This huge shift, from a big budget expense to a significant
revenue source, lowers the reported budget deficit.
Bill Clinton had the good fortune to capture thewhite House just
as the shift took place, but it certainly is not due to his
policies. More important, it clearly has no im pact on the
long-term deficit.
The third reason the budget deficit is falling, and the one
reason the Administration can take credit for, is the large
reduction in defense sp ending. The Pentagons budget is expected to
go down from $292.4 billion in 1993 to $257 billion in 1997, a
decline of $35.4 billion. With the Administrations foreign policy
in disarray, these sharp cuts may not be wise policy, but they do
contribute to de f icit reduction CLAIM #4: The Administrations tax
bill has produced low interest rates REALITY: Interest rates ac
tually have been rising steadily ever since the Administrations
budget package was ap- proved. As indicated in Chart 3, interest
rates began a steady decline in 1989.This trend came to a halt, how
ever, with the enact ment of the Presidents budget package. To be
fair, the increase in in terest rates following adoption of the tax
in crease has very little to do with fiscal policy and is related m
o re to chart3 Ulnton Tax Hlke Reverses Interest Rate Decllne
Interest Rate on Govanment Bonds toy 1 fears in financial markets
of future inflation. Nonetheless, the White House can hardly 4
claim that its fiscal policy is resulting in lower interest rates
when rates actually have been rising THE REAL STORY The White House
has been trying to convince voters that last year's tax increase is
working. But, every claim made by the Administration proves false
upon closer scrutiny.
Yet the problem is not merely th e lack of good news on the
consequences of 1993's re cord tax-hike. What is of great est
concern is that as has been the case with previous Admini strations
steering through large tax increases (such as those of Hoover,
Carter, and Bush the Clinton tax hi ke is imposing heavy costs upon
the economy. Most notably Rising budget deficits stration's own
forecast, the budget deficit resumes its upward climb in 19
96. The Congressional Budget Of fice, estimates that budget
deficits will swell to more than $360 bi llion by the year 2004 Y
Surging domestic According to the Admini spending As Chart 4 shows,
the rea son for rising deficits is the alarming growth of domes tic
spending programs.
These programs, which are rising 78 percent faster than needed
to keep pace with in flation, are projected to in crease by a total
of $229 bil lion over the four years of the Clinton
Administration.
Significantly, if spending for these programs simply olart 4
Surglng Domestlc Spendlng 1993 1994 1995 1996 1997 I998 1999 Soon
Lead s to Rlslng Dcficlt 1 I 1994 1995 1996 1997 1998 1999 2WO 2001
2M)2 2003 2W held to the rate of inflation beginning in 1995, the
five-year savings would be more than $367 billion and the budget
deficit would fall to $70.1 billion by 1999 5 Soak the rich t a x
hike backfiring The lions share of new taxes in last years tax
package is supposed to come from increased income taxes on small
businesses, savers, investors, and the well-to-do. Crit ics of the
proposal pointed out at the time that higher tax rates wou l d
discourage pro ductive economic activity and could actually cause
tax revenue to be lower than it would be if taxes were not boosted.
Known as the supply-side effect, this revenue shortfall results
when taxpayers reduce their work effort, change their b ehavior,
shift their investments, or take other steps to protect
theirearnings from excessive taxation.
As a result, pro jections of tax revenues based on models which
assume taxpayers are oblivious to chang es in the tax code almost
always will be tic. This effect was seen after the 1990 tax in
crease. Com pared with pro jections made before the tax increase
was approved, the 1990 deal actu ally caused tax grossly optimis
chart 5 Soak-the-Rlch Income Tax Hlk e Backfires Income Tax
Revenues Lag Behind Other Tax Revenues I29 IO 8 6 4 2 94 to Date 1
revenues to fall by more than $3 for every $1 the 1990 tax bill was
supposed to raise Since the Clinton economic program is so similar
to that enacted during the Bush Administration, it should come as
no surprise that history seems to be repeating itself.
According to the Treasury Department, personal income tax
revenues are growing slower than other sources of tax revenue this
fiscal year. Nine months into the fiscal year, personal income tax
revenues are only 7.2 percent above their level at this point last
year. Tax revenues from other sources, by contrast, are coming in
at 1 1.2 percent above last years levels. Revenues from the tax
that was raised the most have be e n growing far slower than
revenues from tax sources which were increased by lesser amounts or
not at all. The gap between personal income taxes and other taxes
is con crete evidence that soaking the rich simply does not work.
What makes these num bers par ticularly significant is that some of
the income tax revenue came from the ret roactive tax increase,
which is one tax increase that avoids the supply-side effect since
it raised rates on income that was already earned.
The Administration should have antic ipated that higher income
tax rates would be associated with slower income tax collections.
In the 1980s, when tax rates were slashed, income tax collections
soared, and the share of taxes paid by the rich rose 6 X Out of
step with world trends In an in g l obal econ- omy, changes in
domestic policies can have a'signifi cant impact on interna tional
competi tiveness. Dur ing the 1980s policy makers in the U.S. un
derstood and tage of this phenomenon, cutting tax rates and en
couraging a surge in job creasing l y took advan Chart 6 U.S. Is
Out of Step Wlth World-Wlde Reduction In Tax Rates Source:
Congrraional ReseMh Service creating foreign investment in America.
In recent years, other countries have followed the U.S. example,
lowering their tax rates, oftentim e s dramatically. Tragically,
U.S politicians seem to have forgotten the lessons of the 1980s. As
seen in Chart 6, the United States has been raising tax rates
during a period when most other nations are doing just the opposite
CONCLUSION Policies that did n ot work for Herbert Hoover, Jimmy
Carter, and George Bush are not working any better for Bill
Clinton. The economy's weak performance, the dismal job creation
numbers, and projections of higher spending and deficits are the
inevitable results of a fiscal policy based on this flawed model.
Critics maintained that the 1993 tax hike would harm the prospects
for a solid recovery, not enhance them. They are al ready being
proved correct 7