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Surplus shrinks, attacks on tax cut grow
By W. James Antle III
As the federal budget surplus continues to dwindle, the onslaught against the tax cut President Bush recently signed into law is predictably intensifying. Even though taxpayers are still paying more than even Washington can spend and the surplus for this year will be the second largest on record, the chorus demanding that the government consume even more private sector resources is growing louder.
For the current fiscal year, ending September 30, the White House budget office projected that almost all the surplus comes from Social Security payroll tax receipts in excess of benefits. The surplus outside of Social Security is projected to be only $600 million, out of a nearly $1.9 trillion budget and a $10 trillion economy. As recently as April, the White House had been predicting a $122 billion non-Social Security surplus for this fiscal year.
Since Social Security is actually a pay-as-you go program whereby today's workers subsidize current retirees, this is not as large a problem as the numbers make it appear. The government spends any extra money that comes through Social Security taxes on national debt reduction and a variety of present expenditures. The Social Security trust fund is a polite fiction that never has existed and never will. Not counting the $157 billion Social Security surplus toward the total budget surplus would in effect be an act of denial, which the Democrats were less likely to participate in when the first budget surpluses emerged in the late 1990s, initially themselves predominantly the product of Social Security surpluses.
However, pretending that Social Security is an insurance program rather than income redistribution funded through a separate regressive tax is a politically important act of denial, thus the disappearing non-Social Security surplus is imbued with undue significance. The purpose of this hue and cry is to demonstrate that the Bush tax cut has somehow hurt the economy (Democratic Congressman Martin Meehan of Massachusetts uttered that exact phrase recently) and agitate for higher taxes.
The rebate checks being mailed out, while a political masterstroke, don't represent the main economic benefits of the Bush tax cut, lower marginal rates. Therefore it is disingenuous to claim that the tax cut has failed to stimulate the economy and in light of the weak economy, it is equally disingenuous to blame the tax cut for the shrinking surplus. When the economy grows briskly, federal revenues increase. Anemic growth or a contracting economy produce lower revenues. This is why annual growth rates as high as 4 percent in the late 1990s generated budget surpluses but a barely growing economy in which the real domestic private sector has declined for two consecutive quarters sees progressively smaller surpluses. The surpluses did not cause economic growth, economic growth caused the surpluses and minimal or negative economic growth will surely unmake them.
There was nothing huge about the recent tax cut. Using static analysis that assumes tax policy changes do not sufficiently affect economic behavior to predictably alter tax collections, the original Bush proposal was equal to only 5.7 percent of the estimated $27.9 trillion in estimated federal revenues over the next ten years. It similarly equaled less than 6 percent of federal spending over the same period. As a percentage of GDP, it was roughly half as large as the Kennedy tax cut and only one-fourth as large as Ronald Reagan's tax cut. It consisted of only 1.2 percent of GDP over ten years. And the tax cut that was actually signed into law was even smaller than this proposal! It leaves the top marginal rate higher than when Bill Clinton took office, not even repealing the 1990 and 1993 tax increases.
Nor is it clear how tax cuts harm the economy. What the economy needs is more money available for investment and more wealth creation, not more money hoarded by Congress in an attempt to set surplus records. Those who claim the latter practice boosts the economy by lowering interest rates and making it easier to obtain credit are also misguided. First interest rates fell even during the deficits of the 1980s and early '90s and rose during the early Clinton years. Second, by artificially making it cheaper to borrow money, many bad investments were made in unprofitable businesses now failing in large numbers. This very policy inflated the high-tech boom and then led to the dot-com crash that has contributed so heavily to our current difficulties.
Bush should hold firm based on the historic precedent of the Reagan tax cut, signed into law 20 years ago on August 15. Even the much larger Reagan tax cut was unable to prevent the 1982 recession and the result was a decline in revenues, which ballooned the deficit and led to efforts (some of them partially successful) to reverse the tax cut. But this tax cut, phased in over the course of three years as opposed to Bush's ten, still paid off enormously.
First, the 1982 recession occurred in part because of previously legislated payroll tax increases and inflation pushing families into higher tax brackets with no increase in real income. This nullified the tax cut for most taxpayers and there was no net tax cut until 1983. Bush, with his modest tax cut and longer phase-in time, faces the same problem in allowing tax cuts to counteract a weakening economy.
Once the tax cuts were fully phased in, the results were astounding. The economy would go on to experience 3 percent annual average growth rates from 1981 to 1989 opposed to an average of 2.1 percent during the previous 8 years, with a 4 percent annual growth rate during the peak years of 1983 to 1989. The economy would grow by one-third, unemployment would fall from 10.8 percent to 5.3 percent, the stock market tripled in value and the misery index dropped to 9.6 from 20.6. Manufacturing output grew by half, exports doubled, real family income grew, poverty rates declined, 4.5 million new businesses were established and 21 million net new jobs were created. Larry Lindsey, today a Bush economic adviser, noted in his book The Growth Experiment that from 1981 to 1989 "the real income of the median income family rose $3,000 after falling the same amount between 1973 and 1981."
This did not end with Robert Bartley's famed Seven Fat Years. The American people even today pay lower taxes because of the Reagan tax cut than they otherwise would. Since they were fully phased in, the GDP has grown every single year with the single exception of the brief recession that ended in spring 1991. The stock market has exploded from 800 in 1982 to over 10,000 today. We have experienced economic growth 97 percent of the time, up from the historic trend of two-thirds of the time. Economic problems that plagued America since the end of the Johnson administration and seemed unsolvable during Jimmy Carter's malaise were resolved and have not returned.
In the early 1980s, almost everyone believed the Reagan tax cut was a failure and that it would not survive. Reagan himself signed deficit-reduction tax increases that worked against it. His 1980 campaign promise to revive the economy with tax cuts and rebuild the military while keeping the country from bankruptcy seemed fraudulent. Bush is confronted with similar pressure, although a less menacing economy, today. Yet he also has the opportunity to repeat Reagan's accomplishments on the economy and national defense while preserving the balanced budget that eluded him.
Until the economy rebounds, tax-cut critics will continue to be able to point to a diminished surplus. Yet their policies will undermine the economic conditions that make the surpluses they now make a fetish of possible. When it comes to lower taxes, President Bush must do what his father told the electorate in 1988: Stay the course. Anything less is economic folly.
W. James Antle III is a senior writer for Enter Stage Right and can be reached at email@example.com.
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