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No Wonder We’re Confused About Tax Cuts and the Deficit

February 7th, 2011 . by economistmom

reagan-july-1981-on-tax-cut-bills1

I think I may have found the seeds of the “largest tax increase in American history” rhetoric–the start of Americans’ confusion about tax cuts vs. tax increases, whether tax cuts add or subtract from the deficit, and whether tax cuts shrink or grow the size and reach of government.

One of my kids first shared the photo above, from a July 1981 address of President Reagan to the nation on competing tax proposals being considered in Congress at that time.  Only when I first saw the photo I didn’t know what “our bill” vs. “their bill” referred to and the first thing to come to me (perhaps because the photo came from my daughter) was that “our bill” meant “our generation’s bill” (what we would pay for) and “their bill” meant “our kids’ bill” (what they would end up paying for).

I had to hunt down and watch the video of the address (on YouTube, here) to figure out that Reagan was referring to his Administration’s favored tax cut proposal (which he labels a “bipartisan” bill) versus a competing Democratic proposal (which also was for a tax cut but a smaller tax cut that ends up being labeled a tax increase).

In any case, how is this address supposed to have helped Americans understand what was at stake regarding tax proposals, the deficit, and the role of government?  Note the highly informative (not) labeling of the Y axis scale in the chart Reagan features, and the general obfuscation of the choice between the competing tax (cut) proposals.

If you read Chapter 5 on “The Early Reagan Era: 1981″ in Gene Steuerle’s excellent book “Contemporary U.S. Tax Policy”, you’ll see this assessment of Gene’s in the section titled “It Didn’t Add Up” (pages 96-97):

The 1981 tax reductions were in many ways an extremest parody of previous tax reform efforts, especially the Kennedy round of tax reduction.  Investment incentives proliferated and drove many tax rates to zero or below…Base broadeniing to remove special preferences that reduced that tax base was abandoned–not just early on, as in the Kennedy round–but completely.

Most of all, the change in underlying budget conditions was set in the law, and Congress in 1981 effectively removed the fiscal slack that the next congresses would need to enact their own laws and set their own priorities.  This was the biggest mistake of all…The 1981 cut…was enacted in an era when it would be vastly harder to harvest future revenues that hadn’t yet been committed.

I know there’s a lot of nostalgia right now about President Reagan given his 100th birthday, but it’s clear our politicians didn’t need that as an excuse to renew the early-Reagan-era rhetoric.  But they should read ahead to the next chapter in Gene’s book that talks about the tax increases that began the very next year (1982).  Tax policy tends to be cyclical like fashion; what goes around comes around.

4 Responses to “No Wonder We’re Confused About Tax Cuts and the Deficit”

  1. comment number 1 by: AMTbuff

    Yes, Gene’s book is excellent. I bought it a number of years ago and found it highly informative.

    That said, I’m puzzled by Gene’s wish for what he calls fiscal slack. It would be nice in a perfect world, but it seems so contrary to basic principles of politics. Since the day Social Security changed to pay as you go, Congresses have been committing the government to policies that win votes today despite being unaffordable in the distant future. Surely Gene realizes that Medicare, enacted in the 1960s, was the single largest reduction of long-term fiscal slack. Social Security benefit hikes in excess of inflation during the 1970s were another example. The tax cuts of 1981, which were partially offset by increases in 1984, were not comparable to Medicare in their effect on fiscal slack.

    I agree that a tax system with built-in escalation over time (e.g., through lack of indexation to inflation) is fiscally superior to today’s tax system. But it makes no sense unless it is paired with a spending system with built-in de-escalation over time (e.g., through lack of indexation of dollar benefits, government employee wages, and pension payouts of all sorts). Would the public ever vote for a system that intentionally increased taxes and decreased benefits over time? Not on your life.

    I disagree with Gene that long-term fiscal slack has been present in the system at any time since the New Deal. In my opinion it’s an impossible dream and a waste of time.

    What might help is an end to long-term government commitments of any sort. That requires no legislation, just a complete loss of faith in the government’s ability to keep its promises. When long-term promises become worthless, politicians won’t be able to use hem to buy votes. Problem solved.

  2. comment number 2 by: ST Dog

    I guess I don’t get what the problem with the bill is.

    You don’t like indexing the brackets for inflation?
    Not being indexed is why the AMT is hitting more and more lower income people instead of the original targets, and the need for contuinual “AMT fixes”

    Do you not like that all tax payers can open IRAs?

    You like the Estate tax? Personaly I disagree with the double taxation and think the estate tax should be repealed completely, not just higher exclusions.

    What about lowering the tax burden of the lower income earners and increasing the share on higher earners? Isn’t that the goal of the progressive system?

    I don’t get the fiscal slack concept, but the fact is, mandatory spending programs liek S.S., Medicare, and Medicad are driving the deficits. No changes in discressionay spending will matter until the mandantory programs are dealt with.

    You could cut ALL discressionay spending, and the mandatory spending will drive us back in the red in a few years.

  3. comment number 3 by: Vivian Darkbloom

    There is an excellent Chapter entitled “How Yesterday’s Decisions Affect Today’s Budget and Fiscal Options” written by Joseph Cordes of George Washington University in the book “The New World Fiscal Order”:. The book (1996) was published by the Urban Institute Press and co-edited by Steurele. Cordes comments extensively on the concept of “fiscal slack” and, as AMTbuff does, indicates the issue can’t only be seen from the taxing side. In fact, as he makes very clear, the need for not indexing taxes is made necessary primarily by the indexation of spending programs (almost exlusively entitlements):

    “Although indexing of taxes does not constrain how revenues are to be spent, it can make the yoke imposed by prior commitments harder to bear because it reduces the amount of fiscal slack available for financing both prior claims and new needs. In other words, just as some past actions such as the creation of entitlement programs tie the hands of legislators on the spending side; indexing of taxes ties legislators’ hands on the revenue side by ensuring that real tax collections do not grow faster than the rate of economic growth, without the explicit consent of taxpayers.

    On the spending side, indexation reinforces the future obligations to spend that are created by certain forms of pre-committed expenditures, notably income redistribution programs”

    Although there are many other problems with social security, a main problem early on was the lack of indexation of the wage base. Only since 1974 is the wage base adjusted for inflation by the Social Security Administration. That’s one of the reason social security was such a big windfall for the first generation.

    So, it makes sense to index revenue provisions that finance indexed spending programs;–the symmetry here is needed; however, for the rest it is just the old battle between taxing versus spending. Taxing without indexation and spending with indexation are both Trojan Horses. A very good example of this is the “Cadillac Tax” in the health care bill that was not indexed for inflation. How much attention to this was given by the professional press, much less the general public? So, I’m not very optimistic about AMTbuff’s thought that the public will revolt when they find out certain promises are not kept. Troy will fall again and again by use of this tactic.

  4. comment number 4 by: SteveinCH

    “Promises” on taxes somehow are never accorded the respect that “promises” on spending are. SS is a great example of this. We wax rhapsodic over the “promised” benefits without ever noting the hundredfold increase in taxes.