The Results Are in on the 1990 Budget Agreement

Report Budget and Spending

The Results Are in on the 1990 Budget Agreement

July 18, 1991 24 min read Download Report
Daniel J.
Distinguished Fellow

(Archived document, may contain errors)

842 July18,1991 THE RESULTS ARE IN ON THE WO BUDGET AGREEMENT Daniel J. Mitchell John M. Olin Fellow INTRODUCTION The American public last year witnessed a monumental battle over federal budget policy. Lawmakers , from the beginning of summit negotiations in early May until the final budget was adopted in late October, heatedly debated issues such as taxes, spending, budget process reform, and economic growth. In the end, the White House and congressional liberal s triumphed enacting a balanced package of tax increases and alleged spending cuts that they claimed would strengthen the economy and reduce the budget deficit.

Opponents, including a majority of Republicans in both the House of Rep resentatives and the Se nate, argued that the final budget deal merely raised taxes to avoid the genuine budget cuts and deficit reduction which were scheduled to occur automatically as part of a sequester under the Gramm Rudman-Hollings Deficit Reduction Act of 19

85. Opponents also charged the record $175 billion tax increase would dampen economic growth and he1 additional government spending, which together would increase rather. than reduce the budget deficit Broken Promises. The opponents pointed to the history of budget su m mits Invariably, when the books were closed on the fiscal year, it was found that despite promises, spending was not cut and deficits were not cut. Budget sum mits, warned the critics of last years deal, ended up raising taxes, raising spending, and raisi n g the deficit i :k I .a The results of the 1990 budget summit are The tax burden has reached 19.4 percent of the gross national product GNP) this year and is expected to climb to 20 percent of GNP by 1995 far exceeding the 19.2 percent average tax burden a s a percent of GNP during the Carter Administration.The tax increase was supposed to generate approximately $175 billion of additional tax revenue over five years. Because the tax increase has lowered economic growth, however as supply-side -economists wa rned, actual tax revenue collections have increased only 2.9 percent so far in 1991, far below the 8.1 percent average annual revenue growth between 1983 and 1990.

Federal spending is projected to climb by a record $158 billion this fis cal year, easily exceeding the previous record, a $107.6 billion spending increase in 19

90. The Administration estimates 199 1 federal spending will consume a peacetime record 25.1 percent of GNP, up sharply from 22.3 percent when Ronald Reagan left office. Domestic spending is driv ing the 1991 budget higher, with agriculture spending up 20 percent over last years levels, health spending up 20.7 percent compared to 1990, general go vernment outlays 18.6 percent above last year, and in come security spending 17.4 percent over 1990 levels.

The deficit will be a record $318 billion this year according to the Office of Management and Budget (OMB up almost $100 billion over the 1990 defic it.The deficit, which had fallen to 3 percent of GNP when Ronald Reagan left office in 1989, will consume 5.7 percent of GNP in 19

91. Delays in the S&L deposit insurance bailout may result in the ac tual deficit being below the Administrations $3 18 billion projection but this simply means future years deficits will be even higher.

Process reforms in the budget agreement actually undermine the fiscal discipline imposed by Gramm-Rudman-Hollings. As a result, more spending and higher deficits will be permi tted than would have oc curred had policy makers complied with Gramm-Rudman-Hollings.

With the 1991 fiscal year nearly complete, the American people now see clearly that opponents of the budget deal were right. Administration and Con gressional Budget Off ice (CBO) figures show record high spending and deficit levels, just as foes of the budget deal predicted. In addition, the tax in crease is a major cause of the prolonged and painful economic recession which has thrown approximately two million Americans out of work and abruptly ended the longest period of peacetime economic expansion in American history.

Defenders of the package argue that last years budget process reforms will hold down future spending and thus offset the damage caused by the tax in cre ases and sharply higher spending levels enacted last year. Yet while the spending caps covering appropriations spending and pay-as-you-go provisions doubtlessly will deter some additional spending, the reforms turn out to be weaker than the spending restr i ctions imposed by the old Gramm-Rudman 2 Hollings deficit reduction law. Federal spending will increase faster under the budget deal than it did when Gramm-Rudman-Hollings was in force No Surprise. The failure of last years package to control spending or reduce the budget deficit should come as no surprise. Budget summits in 1982,1984,1987, and 1989 saddled the American economy with higher taxes.

Yet in every case the deficit rose the following year as policy makers, an ticipating higher revenues, increase d spending. Last years budget agreement perpetuated this miserable record; the massive tax increase led to the largest single-year federal spending increase in Americas history As a result, a record budget deficit of approximately 300 billion is projected for this fiscal Because last years budget agreement increased rather than reduced long term deficit spending, pressure soon may mount for another budget summit to solve the problem yet again. Ironically, even though calls for a new sum mit prove the old s u mmit agreement failed, some politicians and policy makers claim the 1990 budget deal is working and presumably will argue that a new summit should follow the same approach. Unfortunately, to the extent politicians get away with .untruths about last years budget catastrophe, there is every reason to suspect a new budget summit will produce the same failed tax-and-spend policies.

Another budget catastrophe, however, need not occur The last ten years provide powerful evidence that deficit reduction is best ac hieved by placing restrictions on the growth of federal spending. Budget summits, on the other hand, consistently have worsened Americas fiscal health. year THE BUDGET SUMMIT: EXERCISE IN FISCAL DISINFORMATION In the first half of 1990, the American peopl e had little reason to suspect that the year would end in a recession with 700,000 workers losing their jobs.

Annual economic growth as of last May had slipped to less than 2 percent but few forecasters saw a recession was on the horizon. Although not per forming as well as it did during the middle 1980s, the economy was still grow ing, continuing the record expansion that began after the 1981 Economic RecoveryTax Act tax cut took effect.

Further, as of last May the estimated budget deficit for fiscal 1991 was projected to be about 150 billion, the level it had been hovering around since 19

87. While nothing to cheer about, that deficit would have consumed less than 3 percent of gross national product (GNP a significant improve ment compared to 200 billion-plus deficits totalling more than 5 percent of GNP in 1985 and 19

86. So long as federal spending growth was restrained, it was almost certain that the deficit gradually would continue to shrink as a share of national output, which is the best measure of the deficits burden on the productive sector of the economy I 3 Fearof Sequester. Still, some Washington policy makers proclaimed a crisis and called for a budget summit to reduce the deficit and save the economy.

Many observers were properly skeptical. With the economy still growing and the deficit slowly shrinking, why the sudden desire for government action? In retrospect, it is clear that what spurred the budget summit was fear on Capitol Hill and in the White H ouse of genuine budget cuts which were scheduled to occur automatically in accordance with Gram-Rudman-Holl ings. Under the 1985 law, if the projected deficit for a new fiscal year was more than $10 billion above the legally mandated maximum deficit amoun t as of October 15, automatic spending reductions were triggered, a process known as sequestration, reducing the projected deficit to the Gramm-Rud man-Hollings target.

With a projected 1991 deficit at the time exceeding $150 billion, and a deficit target of $64 billion, Gramm-Rudman-Hollings would have required a sequester in the.$100 billion range. A $100 billion sequester seemed like a large cut, but to achieve it would have required trimming spending only be tween 5 percent and 10 percent below 1990 le v els. As it turns out, this was too much to swallow for those lawmakers accustomed to annual spending in creases. Even modest cuts would threaten the jobs of some government bureaucrats and the programs of special interest groups. Many politicians feared t h at such cuts would limit their own pork barrel spending would have catastrophic consequences, they overlooked their own role in creating the crisis. The gap between the projected deficit and the Gramm Rudman-Hollings target was largely a result of the pre v ious years budget package.That budget relied heavily on accounting gimmicks to make 1990 spending appear lower than it really was. For instance, the phony savings in cluded moving the Postal Service and Farm Credit expenses off budget and delaying federal employee retirement spending to future years. The 1990 budget also included more than $5 billion in tax increases, which slowed economic growth and lowered tax collections. By resorting to budget gim micks and higher taxes instead of real spending restrai nt, the White House and Congress simply postponed the day of reckoning and therefore created a much larger budget problem the next fiscal year.

While shady tactics helped policy makers evade Gramm-Rudman Hollingss fiscal discipline for 1990, they would not work for the 1991 budget because of the magnitude of deficit reduction required. To comply with Gramm-Rudman-Hollings, lawmakers either had to enact a 1991 budget with a projected deficit of no more than $74 billion or endure a $100 billion se quester Ac counting Gimmicks. While politicians predicted a $100 billion sequester 1 Fiscal years for the federal government begin on October 1 and run through September 30 of the following year.The 1991 fscal year, for example, began October 1,19

90. Unless otherwis e stated, all years cited in this study are fiscal years 4 THE Budget summit supporters say that the matter involved tough choices, that all sides in the debate put everything on the table, and that tremendous sacrifices were made to end the deficit crisi s threatening Americas economy.

Yet if the real goal had been deficit reduction, policy makers could have ac cepted sequestration. Both the Congressional Budget Office and the Office of Management and Budget had estimated that sequestration would generate the maximum short- and long-term deficit reduction. But a desire to avoid Gramm-Rudman-Hollings sequestration, rather than to reduce the deficit seemed to be the real aim of the budget summit SUMMIT AGREEMENT RETURN OF CARTERNOMICS The actual summit packa g e put together by the budget negotiators was a throwback to the tax-and-spend policies of the 1970s. The budget agreement repealed key features of Grarnm-Rudman-Holling. Most important, the fixed deficit targets requiring a balanced budget by 1993 were je ttisoned, per manently freeing policy makers from the laws discipline.

The agreement allegedly reduced combined 1991-1995 budget deficits by a total of nearly $500 billion. At least $175 billion of the savings came from higher taxes.These included tax incr eases that were disguised as spending cuts or user fees. For example, raising monthly Medicare taxes on senior citizens was considered a spending cut, while higher taxes on bank deposits were defined as user fees. A virtual freeze on defense spending save d more than $180 billion compared to what policy makers projected would be spent.

And approximately $65 billion in deficit reduction would come from interest savings resulting from reductions in projected government debt levels. Out of the entire package, less than $100 billion was to come from reductions in domestic spending revenue from tax increases were based on a Congressional Budget Office model that assumes that changes in the tax code will have no effect on in dividual behavior or the overall econo my. Yet, as the current recession proves, taxes do have supply-side effects in the real world. When individuals and businesses are taxed at a higher rate, they spend less and produce less.

With less economic activity, the government collects less revenue, even though the actual burden of taxation is higher Phony Savings. The projected savings in the budget package from spending cuts were phony. Other than a minor portion of the defense savings, all the spending cuts contained in the agreement were no more t han reductions in projected spending increases. Further, the assumed interest savings are not likely to occur.This reduction is dependent entirely on the integrity of the rest of the package. If the deficit does not decline as promised, interest pay ments will not fall On close inspection, the promised savings are largely fictional. Projected 5 False and misleading claims about the contents of the budget package were only part of the problem.To maintain the fiction that the agreement would balance the budg e t, the White House and Congress used economic assump tions which had little chance of materializing Assumption #1: Adoption of the largest single-year tax increase in history was supposed to double annual economic growth in 1991 and triple it in 1992 Afte r growing approximately 1 percent in the first nine months of 1990, the economy fell into recession. On an an nualized basis, the economy contracted 1.6 percent in the fourth quarter and 2.8 percent in the first three months of 1991 The Facts Assumption #2 : Long-term interest rates are supposed to fall to 5.3 per The Facts cent by 1995 Long-term interest rates are currently 8.3 percent and have not been as low as 5.3 percent since 1967 Assumption #3: Inflation is supposed to drop to less than 3 percent by T h e Facts 1995 Inflation has climbed 5 percent in the last twelve months and rose 6.1 percent in 1990 Assumption #4: Unemployment is projected to drop to 5.1 percent by 1995 The Facts: Unemployment is currently 7 percent and has not been at or below 5.1 per c ent since 1973 Supporters of the budget summit agreement apparently were not bothered by the fact that reputable economists almost universally rejected these as sumptions. Nor did supporters seem bothered by the fact that similar tax-and spend policies in the 1970s caused the economy to deteriorate rather than ex pand. Despite the many objections, however, the agreement was enacted in late October and enthusiastically signed into law by George Bush in early November 6 WHAT HIGHER TAXES HAVE DONE TO THE ECO N OMY AND REVENUE COLLECTIONS It did not take long for the budget agreement to affect the economy.The uncertainty created by months of tax negotiations and the eventual imposi tion of a record tax increase, compounded by the imposition of costly new regulat o ry burdens, needlessly halted Americas longest-ever period of peacetime economic growth. The economic stagnation caused by last years budget package is not surprising.The federal government has reduced sig nificantly incentives for Americans to work, save , and invest, dampening the entrepreneurship so critical to economic expansion.

Ronald Reagans Economic RecoveryTax Act of 1981 reduced the tax bur den to 18.1 percent of gross national product in 1983 and 19

84. But sub sequent tax increases have eroded the beneficial effects of that tax cut. By the time Reagan left office, taxes were consuming more than 19 percent of GNP Thanks to the budget summit agreement, the average tax burden under Bush is 19.4 percent and climbing, higher than it was under Jimmy Carter.

Almost no sector of the economy is spared by last years tax hike. Income taxes are higher, gasoline taxes are higher, excise taxes on alcohol products and tobacco are higher, airline ticket taxes are higher, new taxes are imposed on luxuries; and i nsurance companies, telephone users, state and local government workers, and small businesses all pay higher taxes.The elderly are burdened with higher monthly Medicare taxes, and Medicare payroll taxes for many workers also are up. Others paying higher t a x burdens include the banking industry, boaters, pension funds, tourists, inventors, and im porters 7 Supporters of the budget package asserted that these tax increases would raise nearly at least 175 billion of new revenue for the government over the nex t five years? Opponents of the budget agreement, however, noted that these new taxes would probably not generate the revenue claimed because higher taxes would slow the economy and therefore depress revenue collec tions. According to figures published last month by the Financial Manage ment Service FMS) in theTreasury Department, the critics were correct.

The FMS's Monthly Treasury Statement of Receipts and Outlqs of the United States Government shows that tax collections through this May are running only 2 .9 percent ahead of 1990 levels, a sharp dropoff compared to the 8.1 percent average annual revenue growth between 1983 and 1990.

Despite, or perhaps because of, increases in the top personal income tax rate, limits on itemized deductions, and the phase o ut of the personal exemp tion, 1991 personal income tax collections are only 0.4 percent above com parable 1990 levels. By contrast, in previous years, personal income tax collec tions grew by more than 7 percent annually. Payroll taxes such as Social Sec u rity and Medicare are growing somewhat faster, but still are just 4.9 above 1990 levels Chart 2 Federal Budget Receipts by Category in billions Individual Income Tax 302.2 300.8 0.4 Social Insurance Taxes 265.3 253.1 4.9 Excise Taxes 26.1 23.2 12.6 Custom s Duties 10.4 10.9 -4.4 Estate and Gift Taxes 7.6 8.0 -4.9 Miscellaneous Receipts 14.9 17.1 -12.6 Corporate Income Tax 59.9 53.9 11.1 Source: Department of the Treasury, Financial Management Service, May 1991 Reality has forced the Congressional Budget Off i ce to revise its revenue projections. In July 1990, before the tax increase was enacted, the Congres sional Budget Office projected that total tax collections for 1991-1995 would be $6.325 trillion. In January 1991, after the tax increase was signed into l aw the Congressional Budget Office estimated that total tax collections for the 2 Proponents actually attempted to underestimate the tax portion of the package by re-defining tax hikes on the elderly, banks, and others as spending cuts. While supporters c a me up with tax figures as low as $137 billion reliable independent estimates prove the tax portion of the package totalled between $175 billion and $190 billion. All these revenue estimates, however,'hre based on Congressional Budget Office's deeply suspe c t revenue model 8 same time period would be $6.263 trillion, a reduction of $62 billion. Even though the tax increase was supposed to generate a minimum of $175 billion in new revenue, projected revenue fell because of deteriorating economic conditions. I n other words, supply side economists who warned that higher taxes would reduce government revenues were correct.

Soak the rich taxes provide the most graphic example of how the budget summits tax increases backfired.The share of total taxes paid by wealthier Americans rose throughout the 1980s. Still, backers of the budget deal felt that wealthier Americans were not paying their fair share and thus sup ported higher personal income taxes. Instead of generating more tax revenue however, personal income tax collections are only 0.4 percent above last years levels after growing by an average annual rate of 7.2 percent b etween 1983 and 19

90. If the economy begins to climb out of the recession, this fig ure could improve somewhat, but personal income tax revenue growth for the year will not come close to the Administrations optimistic 5.5 percent es timate Huge Job Losses . Even more disastrous is the effect the budget agreements luxury taxes are having on affected industries. In a move motivated almost exclusively by politics of envy, a 10 percent excise tax was slapped on furs, jewelry, yachts, private airplanes, and lux ury automobiles.

Rather than getting more money from rich taxpayers, the luxury tax is wreaking havoc in the shipbuilding and imported automobile businesses.

Early estimates already show job losses of more than 3,000 in the auto in dustry and 19,000 in th e boating industry tax is increasing the deficit. Workers without jobs do not pay income and payroll taxes. Bankrupt companies do not pay corporate income taxes. Job less workers collect unemployment benefits and become eligible for other government spend ing programs. These revenue losses and spending increases probably will completely offset what little revenue is being collected as a result of the new taxes on luxury goods.

There is a possible silver lining to the dark tax cloud blanketing America.

Taxp ayers can hope that if policy makers begin to understand the serious con sequences of higher taxes, the likelihood of similar budget summit catastrophes in the future will be reduced.The last ten years offer strong proof that taxes do have real effects an d that the economy performs better when the tax burden is low or is being reduced Beyond the personal tragedies of so many Americans losing jobs, the luxury MORE TAXES CAUSE MORE SPENDING Despite the adverse economic effects of higher taxes, it is not diff i cult to understand why elected officials so frequently increase taxes. While tax hikes entail some political risk, they also generate political rewards. Projected in creases in tax revenues make possible actual increases in federal spending. In 9 terest g r oups that .benefit from higher spending repay the politicians with electoral support. Every time taxes are raised, the perceived political benefits of directing more funds to favored interest groups exceed, in the near term the potential risks of a taxpay er revolt.

These political dynaniics help explain why the 1990 budget summit agree ment, with its record tax increase, ignited the largest spending burst in Americas history. The Bush Administration estimates that federal spending will jump by a.record 158 billion this year, easily breaking the $107.6 billion single-year spending increase mark set in the first year of the Bush Ad ministration. By contrast, average annual spending increases during the Reagan Administration were only 58.2 billion.

Many feder al departments and agencies received substantial budget in Chart 3 in S billions, through May of each fscal year Federal Outlays by Category Note: Revenue collected by the government that is subtracted from spending totals rather than counted as receipts. Source: Department of the Treasury Financial Management Service, May 1991 10 creases for 19

91. The Treasury Departments Financial Management Service reports significantly higher spending in the international affairs budget and in almost all areas of dome stic spending. Looking at the first eight months of fis cal 1991, from last October 1 through May 31, agriculture spending is 20 per cent above comparable 1990 levels, health spending is running 20.7 percent over 1990, general government expenses are up 1 8 .6 percent for the year, and income security spending has jumped 17.4 percent. By comparison, the Bush Administration estimates inflation will be 4.3 percent in 1991 defense outlays and commerce and housing credit expenditures are running below last years levels. While reduced expenditures in these categories offset some of the enormous increases in other areas of the government, this small glimmer of fiscal restraint is largely an illusion.The defense figures are some what distorted by $38.1 billion of fo reign contributions collected as of May to pay for Operation Desert Storm.

Commerce and housing credit numbers also are artificially deflated. They include the costs of the Savings Loan deposit insurance bailout. But this bailout is proceeding at a far slo wer rate than earlier projected. Even if this delay causes S&L spending for the full fiscal year to be lower than first forecast, taxpayers will not benefit since the cost is simply shifted to next year.

Actual housing spending is spiralling upwards as measured by 13.6 percent an nual growth in the Department of Housing and Urban Development budget.

While total federal government spending is up only 5.3 percent for the year to date, expected revisions to both the defense figures and the deposit in surance bailout cost will push the annual increase closer to the Administrations original estimate of 12.6 percent annual growth.

With spending growing at such a rapid pace, it is not surprising that govern ment is consuming an ever larger percentage of the nati ons gross national product. Federal spending jumped from 22.3 percent of GNP in 1989 to more than 25 percent of GNP today.This unprecedented burden on the private sec tor is a peacetime record, exceeded only during World War 11 Some proponents of the budg e t deal concede that spending is increasing rapidly, but contend this spurt will end after the first year of the budget agree ment. Yet, even the Administrations budget estimates contradict this claim As the following tables indicate, both entitlement spen d ing and domestic dis cretionary spending will grow faster than inflation while the budget summit agreement is in place Distorted Defense Figures. Among major spending categories, only THE BUDGET SUMMIT LEGACY: HIGHER DEFICITS While politicians claimed las t years budget summit was convened to reduce the deficit, the real motive was find a way of averting Gramm-Rud man-Hollings automatic budget cuts. Automatic cuts of 100 billion out of a 1.4 trillion budget would have meant real deficit reduction.The same c a nnot 11 be said for the budget package law makers adopted. With tax revenues stagnant because of the recession and federal spending rising much faster than inflation. the deficit emloded Chart 4 The Bite of Federal Spending The Congressional Budget Office es timates the 1991 deficit will reach 298 billion, while the Bush Ad ministration projects the deficit will top $318 billion. Considering the deficit was 153.4 billion in 1989 and 220.4 billion in 1990, taxpayers should be thankful deficit reduc tion dea ls do not occur every year.

There is nothing mysterious about higher deficits; they are a direct con sequence of the unwarranted in creases in domestic spending. Accord ing to the Congressional Budget Of 590.9 22.1 678.2 22.7 745.7 23.8 808.3 2 4.3 851.8 23.1 946.3 23.9 990.3 23.7 1003.8 22.7 1064.1 22.3 1144.1 22.3 1251.7 23.3 1409.6 25.1 fi domestic discretionary spending will climb by 9.1 percent in fiscal 1991 and entitlement spending, excluding the deposit insurance bailout will grow by 12. 5 percent. Even if the Source: Office of Management and Budget Budget ojthe United Stares Government, FY 1991, Historical Tables Chart 5 Domestic Discretionary Spending Note: The Budget Summit set spending caps for the Domestic Discretionary category only for fiscal years 1991 to 19

93. After 1993, Congress will be able to once again fund additional domestic discretionary spending by taking funds out of the defense budget, making 1994 and 1995 projections Impractical.

Source: Budget of the United States Government 19

92. Based upon the Composite Deflator 12 I Chart 6 Entitlement Spending Defenders of the budget deal argue that 1991 figures are not representative of the total package because most of the deficit reduction will occur in future years. It is tr ue that spending growth is projected to slow down in future years. But any claims of serious deficit reduction depend on politicians prac ticing long-term fiscal restraint. In the past, however every time Congress has promised future spending restraint in exchange for more taxes, the higher taxes go into effect while the spending cuts are forgotten.

Under the flawed assumptions of the original budget agreement last fall the deficit was supposed to disappear by 19

94. By January 1991, however, the Congress ional Budget Office increased its estimate of the 1994 budget deficit to 211 billion. Under the budget agreement, Congress still is supposed to trim 1994 spending by $5 1 billion. If policy makers follow through on this commitment, the 1994 deficit will o n ly be $160 billion.There are reasons to doubt whether these future spending cuts will be forthcoming; Ronald Reagan still is waiting for the $3 of spending cuts he was promised by Con gress for every $1 of tax increases he agreed to back in 1982 Unrealist i c Assumptions. To make matters worse, the $211 billion 1994 deficit estimate is based on economic assumptions that are unlikely to be met under current government policies. The Congressional Budget Office as sumes the economy will grow 3.3 percent in 1992 , and at least 2.7 percent an nually thereafter. Inflation is supposed to drop to less than 4 percent and un employment is projected to fall under 6 percent.The Congressional Budget Office also assumes significant drops in both short- and long-term interes t rates.The Administrations estimates are even more optimistic If the economy does not perform as well as assumed, however, the deficit will be considerably higher 13 There is little reason to believe the economys performance will match either Congressiona l Budget Office or Office of Management and Budget projections. With the burden of federal spending and taxes at all-time highs even modest economic growth will be an achievement. Indeed, under current policies, the economy of the 1990s is more likely to r e semble the stagnant economy of the 1970s.The economic prosperity of the 1980s is not likely to return unless policy makers return to the pro-growth policies of the 198Os, in cluding, first and foremost, lower taxes. And without strong growth, deficits are likely to remain over 200 billion, and could climb substantially higher PROCESS REFORM: ONE STEP FORWARD,TWO STEPS BACKWARDS i Some supporters of the budget deal argue that reforms in the budget process balance out the damaging effects of higher spending a nd taxes by im posing binding restraints on future congressional spending. The Budget En forcement Act (BEA passed last year as part of the budget deal, might block some spending compared to what would happen if no spending restrictions existed. In the re al world, however, the relevant comparison is how much spending the BEA will allow compared to how much spending would have grown under the Gramm-Rudman-Hollings law which was in effect prior to the BEAs enactment.

Using this criterion,the BEA portion of t he budget summit agreement was yet another step in the wrong direction. Summit supporters assert the pay-as you-go provision, which requires a 60 percent vote of the Senate to enact legislation that could increase the deficit, will block new congressional spend ing proposals. But pay-as-you-go has existed since the Gramm-Rudman-Holl ings law was enacted in 1985.The only difference between the two laws is when a sequester takes place if spending limits are exceeded. There thus was no need to accept higher t axes to get pay-as-you-go, as defenders of the pack age misleadingly contend.

Further, the effectiveness of the pay-as-you-go provision depends on the Congressional Budget Offices estimates of the impact proposed legislation will have on the deficit.These estimates often are influenced by partisan politics and ideology. On tax matters, for instance, the Congressional Budget Office uses the revenue estimates of Congresss Joint Tax Committee; these consistently have been found to be slanted because the Commi ttee model as sumes taxes have no effect on economic behavior. As a result, the revenue gains from all tax increases are vastly overstated, as last years tax package poignantly demonstrates.

Skewed Projections. Tax cut estimates are similarly flawed. Skewe d projec tions, for example, have been used to derail the capital gains tax cut.The Con gressional Budget Office argues that such a cut would reduce tax revenues. In dependent economists, however, estimate a capital gains tax cut would in crease governmen t revenue by billions of dollars annually. The Congressional Budget Offices track record on capital gains has been extremely poor. For ex 14 ample, it overestimated annual capital gains realizations by a shocking $75 bil lion annually beginning in 1989 bec ause it failed to take into account the ef fect of the higher tax rate on capital gains imposed by the 1986 Tax Reform Act.

Supporters of the budget deal maintain that the BEAs spending caps also will limit federal spending. The caps impose ceilings on appropriated defense domestic, and international affairs spending each year through 19

93. If spend ing exceeds thexap in.any category, a sequester automatically will reduce spending in that category to the legally mandated level. In 1994 and 1995, the firew alls between the three categories will disappear, leaving a single cap on combined appropriations. Like the pay-as-you-go provision, the spending caps will block some spending which would occur if no restrictions existed..

Technical Spending Cuts. The tru th is, however, that these caps will allow spending to increase much faster than the old Gramm-Rudman-Hollings law permitted. The spending caps are similar to imposing a 150 mile-per-hour speed limit on Americas highways. With the limit set so high, there would be few violators. Authorities, technically, could boast of almost universal com pliance to the speeding laws. But almost any reasonable observer would argue the speed limit was set too high to protect lives. Compliance would be up, but safe driving would be down. Similarly, spending caps which allow domestic discretionary spending to grow more than 50 percent faster than the rate of inflation hardly can be said to promote fiscal responsibility.

While better than nothing, the caps are inferior to the old Gramm-Rud man-Hollings restrictions. The spending caps do not apply to entitlement spending, leaving the fastest growing part of the budget completely uncheck ed. Gram-Rudman-Hollings placed restrictions on the entire budget, limit ing total spending t o the sum of projected tax revenues plus the allowable deficit amount. The cap on domestic discretionary spending allows outlays to increase above the rate of inflation. Gramm-Rudman-Hollings held domestic discretionary spending constant in real dollars. T he BEA spending caps are riddled with loopholes, allowing spending to increase if economic assump tions change, if technical estimates are revised, and if spending is declared an emergency. The old Gramm-Rudman-Hollings, while far from perfect, im posed r igid deficit targets that were much less subject to budget gimmickry.

Failing the Test. The crucial issue, however, is whether adoption of the BEA permits higher levels of federal spending compared to what would have happened under Gramm-Rudman-Hollings. The BEA fails this test. Even if politicians had permitted only a part i al sequester last year, below the $100 bil lion level originally required, federal spending this year would be far below the levels imposed by the budget summit. Exact comparisons are difficult since the difference would have depended on the size of the s e quester and es timates of how much stronger the economy would be today if taxes had not been raised last year. Under the BEA, taxpayers already have been burdened with the largest single-year spending increase in history, more than $150 bil lion. By contr a st, while Gramm-Rudman-Hollings was in effect between 1985 15 and 1990, the growth of federal spending fell by 50 percent compared to the previous five-year period VICTORY FOR THE WASHINGTON ESTABLISHMENT Establishment politicians from both parties were u n comfortable with the fiscal discipline of Gram-Rudman-Hollings. Unlike the current BEA Gram-Rudman-Hollings forced lawmakers to choose between different deficit reduction strategies and take responsibility for those choices. This meant either proposing hi g her taxes or proposing to limit federal spending growth to comply with the deficit reduction law. Even worse for policy makers on a spending binge but better for the taxpayer, Gramm-Rudman Hollingss fixed deficit targets gave voters a yardstick to measure politicians performance.

The budget summit solved the problems, at least temporarily. Record tax and spending increases, combined with emasculation of Gramm-Rudman Hollings, gave career politicians from both parties the best of all worlds. Spe cial intere st groups received a windfall of new spending. And since the BEAs new deficit targets are adjusted each year to reflect new economic and tech nical assumptions, politicians will be able to claim that they are complying with the budget summit agreement eve n as the deficit climbs ever higher CONCLUSION The losers, of course, are American taxpayers, workers, and consumers.

While politicians pat themselves on the back for making tough choices that in retrospect, were not tough at all, ordinary Americans must r aise their families with less income. While George Bushs 1988 opponents praise him for courageously breaking his no tax increase promise, lower- and middle income workers struggle to keep their jobs. While government bureaucrats dream up more ways to spen d the new money their programs have received Americans in the productive sector of the economy must deal .with high un employment and the myriad problems brought on by recession.

And the worst may yet come. Since the budget summit increased rather than red uced deficit spending, politicians eventually may decide another budget summit is needed. If this time comes, as it may come right after the 1992 election to minimize the role of public outrage, taxpayers likely will face an even greater hardship. Further increases in income tax rates, imposition of a national sales tax, and another unwarranted increase in federal spending are all likely consequences of another budget summit.The only way to stop such economically damaging policies, however, is for the Amer ican people to remember the failures of the past and let elected officials know that they will not accept a repeat performance 16


Daniel J.

Distinguished Fellow