Originally published in THE BOSTON GLOBE
Tuesday, August 17, 1999
"It's either boost government spending or cut taxes"
Time to make a choice
Martin and Kathleen Feldstein
Just before leaving Washington for its summer recess, Congress passed a tax-cut bill that the president has vowed to veto. Now members of Congress are back in their home districts taking soundings on their constituents support for cutting taxes that are now at their highest level in more than 50 years.
We hope there will be healthy debate over the merits of specific proposals like reducing the tax penalty on married couples, or cutting the tax on capital gains. But there is a more fundamental decision for the public to make. Because of the projected federal budget surplus, the public, through Congress, can decide whether to accelerate the increase in government spending (along with taxes to finance that spending) or to limit the growth of spending by returning some of the surplus in the form of tax cuts.
Even this choice is a limited one, because much of the surplus is off limits. The Republican bill calls for just under $800 billion in tax relief over the next 10 years. That is less than one-third of the projected surplus. Two-thirds of the surplus will be set aside by mutual agreement between the president and Congress to buy back national debt and to shore up the Social Security program.
And much of government spending is mandatory. Spending on "entitlement programs" like Medicare, Medicaid, and food stamps is required by law to grow according to benefit formulas and with the numbers of eligible participants. Also off the table for tax cuts are the funds needed to allow all "discretionary" government spending programs to increase with the general price level after the current legislated spending caps come off in 2002.
Although the tax-cut debate refers to less than one-third of the surplus, its still a lot of money. Indeed, the magnitude of the projected surplus has astonished veteran observers of the budget process, who thought they would not live long enough to see any surplus. This welcome surplus has come about in large measure because tax receipts have never been so high.
Total tax revenues in 1998 amounted to 20.5 percent of GDP. That is the highest percentage of national income going to taxes in more than 50 years. The last time taxes took as much as 19 percent of GDP was in the early 1980s, just before the last major tax cut -- the Reagan tax cut of 1981 -- took effect. By the time the Bush administration left office, the tax take was down to 17.7 percent of GDP. The Clinton administration reversed the trend toward lower taxes that had been led by Reagan and Bush. By 1996, taxes were already up to 19 percent of GDP and reached 20.5 percent for fiscal 1998.
The biggest tax increase since 1992 has been in individual income taxes, which have risen from 7.7 percent of GDP in 1992 to 9.9 percent in 1998. And here again there is an interesting historic pattern. Individual income taxes have represented over 9 percent of GDP only twice before in the last 40 years: in 1969, when President Nixon entered the White House, and in 1981 and 1982, just before the Reagan tax cuts took effect. It seems that the Republican reputation for reducing the personal tax burden is well deserved.
Corporate taxes have also gone up and the rise has been even sharper than for the personal income tax. Corporate income taxes rose from 1.6 percent of GDP in 1992 to 2.2 percent in 1998. All of these tax hikes have helped to create the stunning reversal in the federal budget, from a deficit of 4.7 percent of GDP in 1992 to a surplus of 0.8 percent of GDP in 1998. Increased revenues represent more than half of that turnaround.
Slower growth in spending represents the other half, and Democrats cite this in defending their new spending proposals. But it is revealing to look at the composition of the spending changes. Over half of the reduction in government spending as a share of GDP has come from defense spending, which has declined from 4.9 percent of GDP in 1992 to 3.2 percent in 1998. Compare that with the Kennedy years, when defense spending was more than 9 percent of GDP.
The second-biggest drop in government spending was for unemployment compensation, which has fallen a remarkable 0.4 percent of GDP, to 0.2 percent from 0.6 percent. This is strictly a business cycle phenomenon, a result of the long economic expansion and low levels of unemployment. The rules for compensating unemployed workers have not changed, and this reduction in spending does not represent a reduced role for government.
Lower spending on defense and on unemployment compensation, together with the decline in interest payments on government debt, account for more than 80 percent of the total decline in the governments share of GDP over recent years. The rest reflects a netting of increases and decreases in a range of government programs, including programs like Medicare and Medicaid that have increased substantially and programs like agriculture that have had large relative reductions.
On balance, the last six years have seen dramatically higher taxes and a rising role of government in the economy. President Clinton would like to increase that role even further. He proposes using the currently projected budget surpluses for expensive plans like expanding the governments role in education and lowering the age of eligibility for Medicare.
This is really where the choice lies. Congress and the president have agreed to give priority in using the budget surplus to reducing the national debt and shoring up Social Security. Beyond those imperatives, there is a choice. Do we Americans want a bigger role for government? Or do we believe it is time to reverse the growth in government and to return some of our tax dollars to those who earned them?
Martin Feldstein, the former chairman of the Council of Economic Advisers, and his wife, Kathleen, also an economist, write frequently together on economics.