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Republican Tax Cuts Risky Business for the Economy and the Budget

Economic Brief on Republican Tax Bill

On August 5, the Congress adopted a "compromise" tax bill integrating the separate measures adopted earlier by the House and Senate. The $792 billion bill incorporates the highly regressive features of both bills. It threatens vital domestic programs, fails to assure needed improvements in Social Security and Medicare, provides billions of new tax breaks for the most affluent individuals and countless industries, and depends on a highly unlikely projected budget surplus to finance the bulk of the tax cuts.

Even though the bill the Congress ultimately adopted eliminates the Houses 10% across-the- board tax cut and adopts the Senate's one percent rate cut for each tax bracket, and includes a few other, revisions passed by the House and Senate the regressive impact is essentially the same.

The nation's income distribution now is extremely inequitable, with the richest 5% of taxpayers (average annual income of $300,000) garnering 20% of national income and owning over 80% of national wealth. Under the GOP plan, they will receive close to 60% of the total tax cuts while less than 8% of the cuts will go to the bottom 60% of taxpayers who have an average annual income of less than $38,200. The average reduction for the best-off is $12,900, fully 93 times the estimated $138 cut for the 60% group: Another comparison issued by the Treasury showed nearly 80% of tax savings will go to the top 20% of taxpayers (those with more than $62,800 income) while only 0.3% will go to the poorest 20% of taxpayers.

Such an unfair sharing of the tax cuts accentuates the huge income gap between the well-to- do and the rest of Americans. Other provisions in the bill will add significantly to already wide income disparities. Four of the most serious are: eliminating the estate tax, reducing capital gains tax rates, eliminating the alterative minimum tax for individuals, and enhancing IRA contributions.

Estate Tax Elimination

The bill phases out the estate tax on large estates. Currently, because the threshold for paying the tax is one million dollars only 2% of estates pay any federal income tax. The very large estates do pay a substantial tax--but under the Republican bill, the estate tax will be completely eliminated--costing about $25 billion in revenues. Virtually the entire benefit--98%--of this change will go to the wealthiest--the top. 1% of taxpayers.

Capital Gains Tax Reductions

The top capital gains tax rates, which had been cut from 28% to 20%, in 1997 will be cut further to 18% for higher income taxpayers. Not surprisingly, the bulk of the gain from this change also will go to the richest Americans. An estimated 85% will end up in the pockets of the top 5% income earners. Once more the lion's share--69%--of the $15 billion savings from this change will go to the top 1% of taxpayers!!

Alternative Minimum Tax Revision

Another concession to the wealthy is the phasing out of the alternative minimum tax for individuals. Under the current tax code, taxpayers who use various deductions to wipe out any tax liability must pay an alternative minimum tax. Republicans had almost completely deleted that tax provision for corporations in 1997. The new bill reduces corporation alternative tax liability. Now they are providing a full elimination of the alternative tax provisions for individuals. The estimated cost of these changes is $103 billion over the next ten years.

More Generous IRA Contributions

Changes in the rules covering allowable contributions to IRA's and other pension programs benefit higher income taxpayers. The current limit of $500 is raised to $2000 for education IRA's and greater contributions to 401K were also adopted.

Loopholes for Business

A series of industry tax changes mean billions of tax savings for a broad range of industries. These revisions are estimated to reach over $100 billion. The gainers are multinational corporations, financial institution, oil and timber companies and dozens of small industries. Among the latter group were manufacturers of fishing tackle boxes, seaplane operators, and chicken farmers. "Corporate welfare" expands and flourishes.

The Trillion Dollar Surplus Real or Imaginary?

Republicans make two highly questionable assumptions to yield the funds necessary to finance their tax schemes. First, the economy will maintain its vigorous expanding trend, with federal revenues growing annually, without interruption, for the next decade. Second, there will be huge surpluses in the non Social Security section of the budget. This so called "on budget," or government operations, part of the budget has not been in surplus in a single year since 1969!

Under "unified" budget accounting procedures, finances of regular government activities are combined with those of Social Security, Medicare, and other trust funds "off-budget" items. In other words, the surpluses that have occurred in recent years have been solely the result of the "off- budget" surpluses. Federal revenues for regular operations had been less than general government expenses. Illustrating this point are the recent fiscal 1998 budget figures.

The on-budget operations showed a $29.9 billion deficit. Off-budget items, however, registered a $99.2 billion surplus, offsetting the deficit in on-budget items, which led to a unified budget surplus of $69.3 billion. Not until this current fiscal year 2000, will general revenues alone be greater than general government outlays. In 2000, CBO estimates the "on budget" surplus will be $14 billion. From then, it is estimated to grow sharply. For the next ten years CBO (Congressional Budget Office) and the OMB (Office of Management Budget) both are projecting on- budget surpluses of about one trillion dollars.

But, how reliable and realistic are such projections? Remember in the Fall of 1998 CBO estimated the overall surplus for fiscal 2000 would be $79 billion; amended that figure in early 1999 to $110 billion; and then in June raised its estimate to $180 billion!!

Keep in mind that the on-budget surplus can materialize only if revenues continue their recent fast rising trend and Congress agrees to reduced spending for discretionary programs. Those reductions are based on the mandates of the 1997 Balanced Budget Act. The Act called for limits on spending for discretionary programs (those for which Congress yearly appropriates funds) plus reducing those outlays by about 20% in the following decade. If Congress does not apply those stringent caps to military spending (part of discretionary spending) then all other discretionary spending it is estimated will have to be cut by 38%. Such a drastic cut would mean, for example, 1.6 million of the 3.4 million veterans receiving medical care would stop receiving care;

  1. EPA's Superfund program would be slashed by nearly $1 billion--eliminating funding for all new federally-led clean-ups to begin in 2000;
  2. Cutting Head Start opportunities for 375,000 children;
  3. Education for the Disadvantaged: reading excellence, summer jobs and training programs would be slashed by 40%-50%; and
  4. Cutting 600 FBI agents.
  5. Programs supported by politically strong constituencies likely will break the spending caps. Witness the recent action of an appropriation subcommittee which labeled a $3 billion program for veterans' benefit as "emergency" so it would not be counted against the spending limits. To partially offset this "emergency" outlay, the subcommittee denied the Administration request for increased funds for housing for the poor. On July 30, the full committee reversed that action. However, "emergency" funding is frequent as noted below.

Accounting Gimmicks

House Republicans are seeking to recoup over $4 billion in unused block-grant funds provided to State governments for welfare reform. Because welfare rolls have declined sharply as the result of vigorous economic growth and changes in welfare regulations, the states have not fully used their block-grant allotment. Despite protests from governors across the nation that those funds will be needed for welfare recipients should the economy falter, House Republicans want the $4 billion to bolster the surplus for tax cuts.

Similarly, appropriations for the 2000 Census--$4.5 billion--and $7 billion for farmers' aid were designated "emergency" so they would not count against the budget caps. As a result, these emergency amounts will have to be paid from the projected $14 billion non-social security surplus. Budget analysts conclude that surplus has already been exhausted. It should be noted that just a year ago Congress agreed to break the budget caps by approving $21 billion of "emergency"spending. When further "emergency" appropriations are made, there will be no on-budget surplus to use, and then the Social Security, off-budget surplus will have to be tapped despite all the promises not to touch Social Security trust fund money.

This type of accounting gimmickry, plus the draconian cuts in discretionary programs required to finance the tax cuts have led many experts to question the assumptions and projections on which the surplus is based. Note that the CBO itself has estimated that fully $775 billion will have to be trimmed from discretionary programs in the next decade to comply with the 1997 budget act. In other words, key domestic program appropriations will have to be severely curtailed by an amount just about equal to the legislated $792 billion tax cuts.

Criticism of the Tax Bill is Widespread

A lead editorial in Business Week (August 2,1999) titled "Let's Get Real About Cutting Taxes" noted that:

"To get to the magic $1 trillion number Congress has to abide by the budget rules that actually cut discretionary spending through 2002 for such things as national parks, the FBI , trade subsidies, and education. Then it must freeze spending entirely through 2009. This is a scenario that is not likely to see the light of day....Before we launch massive tax cuts, perhaps we ought to make sure that there really will be an extra trillion dollars...It sounds like a phony number based on some highly dubious assumptions."

The Washington Post (July 28, 1999) was especially critical of the Republican projection of the trillion dollar non-Social Security surplus. As the Post wrote:

"Most of the surplus that would be used to pay for it [the tax cuts]...is an accounting illusion(italics added)."

After noting the devastating cuts in domestic programs that would have to be made to yield the non-Social Security surplus, the Post highlighted a scarcely mentioned explosion of tax cuts after the first decade. As the Post editors noted:

"Projected costs for the second ten years, when the bills would be fully in effect are triple force for the first 10..."( Note that according to budget rules the bill cannot extend beyond ten years).

On July 21, more than 50 economists including six Nobel Laureates stated that the massive Republican tax cuts are risky and pose significant threats to the economy and the budget.

In the words of the statement:

"...a massive tax cut that encourages consumption would not be good economic policy. Given the uncertainty of the long-term budget projections, committing to a large cut would create significant risks to our economy and out budg

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