Budget Deal: No New Taxes

“Read my lips: no new taxes”–George H. W. Bush at the 1988 Republican National Convention

The final budget bill crafted to allow an increase in the debt cap will be shy one thing: There will be no tax increases of any real significance. Intended or not, this means a new experiment to determine whether taxation helps increase federal receipts.

The debate between Democrats and Republicans in the last month was framed to some extent on the desire of The White House to move certain tax rates higher. This was to be traded for sharp cuts in a number of federal programs. The bargain never took place. Although the federal budget cuts will be modest, the Treasury will have to hope that the current low tax rates will stimulate business and consumer spending and consequentially the total amount of income which can be taxed. The extension of the Bush II tax cuts was based on a similar hope. The hope has not been fulfilled, if the economy in the first seven months of this year is a fair measure.

The deficit reduction bill that is likely to pass both houses provides for a $2.4 trillion in budget cuts over the next decade. The first $971 billion will be cut immediately in exchange for a $1 trillion increase in the government’s borrowing cap.  A second increase in the debt cap, which should allow the government to borrow money until after 2012, will be tied to another $1.5 trillion in cuts in government costs during the next ten years. A committee of Congressmen will have to agree on what those cuts will be ahead of the Thanksgiving recess. Otherwise, a set of reductions decided upon before the bill is signed will occur automatically.

Because a decade is such a long time and because $2.4 trillion is not a great deal over that period, many economists will say the legislation does not mean much. A few tenths of a percent increase or decrease in GDP growth during the next several years could make the new budget agreement nearly meaningless.

Most important, the reductions to spending this time around will not be transformative . The cuts to federal spending for a decade-long period are not only too small, they do not address what nearly every economist believes is the waiting disaster–the cost to pay for entitlement which are primarily for the aged and ill. Social security and Medicare taxes could have been increased to address this. But this was not possible, since the pact between the two parties made all tax increases off-limits.

An increases in taxes would have meant something in the short term, and could have increased the government’s receipts substantially.  Budget gaps for this year and next will be over $1 trillion. The cost cuts for these two years will be in place with the new legislation. That leaves government receipts as the critical unknown factor that will determine actual deficit size. This is entirely due to the fact that Congress and The White House would not gamble together that higher taxes would mean higher revenue.

The agreed upon compromise among Washington politicians relies on the unproved assumption that low tax rates produce better overall economic results when measured by GDP growth. The recent history of the federal budget, particularly this year, would seem to prove that wrong

Douglas A. McIntyre