(Archived document, may contain errors)

A Special Report to Congress

No. 20 10/19/95

HOW CONGRESS'S $245 BILLION TAX CUT REPEALS JUST ONE-THIRD OF THE 1990 AND 1993 TAX HIKES

Daniel J. Mitchell McKenna Senior Fellow in Political Economy

"I think I raised [your taxes] too much, too." -President Clinton, October 17, 1995 President Clinton claims that the $245 billion seven-year tax cut supported by Congress is exces- sive. But it actually does not come close to eliminating the huge tax increase levied by the last Congress and is dwarfed by the level of tax hikes approved since Ronald Reagan left office. Consider:

X The increased tax burden caused by the 1990 and 1993 tax bills totals three times more than this year's proposed tax cut. Taxpayers will still be worse off compared with their tax burden in 1989.

X This year's tax cut will reduce federal tax collections by less than 2.2 cents on the dollar. And that is the "worst-case' estimate that assumes no revenue feedback from higher growth stimulated by such things as the proposed capital gains tax cut.

X Even with the tax cut, tax revenues are projected to rise from $1.357 trillion this year to $1.820 tril- lion in 2002, an increase of $463 billion (an average of $66 billion per year). By any objective measure, the Administration's claim that the tax cut is too big cannot be justified. Set in proper context, these figures instead make a persuasive case that this year's tax cut should be con- sidered a first step. Indeed, when lawmakers next year begin considering a fiat tax, they should take whatever steps are needed-including further limits on the growth of federal spending-to ensure that tax reform is accompanied by tax reduction. Undoing Damage from 1990 and 1993 Tax Hikes. According to Congressional Budget Office fig- ures, the 1990 tax increase was projected to increase revenues by 0.54 percent of gross domestic prod- uct (GDP). The 1993 tax hike, America's biggest, was projected to raise revenues by a further 0.73 per- cent of GDP. The tax cut now being discussed, by contrast, is estimated to reduce tax collections by a scant 0.4 percent of GDP. Thus, CBO projections suggest that this comparatively modest tax cut at best will reverse only one-third of the damage inflicted by higher taxes in 1990 and 1993.

No Revenue Shordall. chani As Chart 2 illustrates, the CBO projects that federal Tax Cut Only One-Third of Combined 1990 and tax collections will ex- 1993 Tax Increases pand by more than $460 billion if the tax cuts are enacted. These estimates, incidentally, assume that -nab 1993 Tax 0.73% ........... .. .... 10 there is no positive effect tal Tax Increase: Increase of GDP 1.27% of GDP on the economy from low- . . ... .. .... ering the tax burden. 1990 Tax 0.54% Needless to say, several Increase of GDP measures in the proposal, such as reductions in the tax on capital gains, ex- pansion of Individual Re- 1995 Tax Cut -0.4% of GDP tirement Accounts, and partial relief for those sub-; :' Source: Heritage Foundation calculations, based on Congressional Budget Cgice data. ject to the alternative rnini- ....... -17. mum tax, will boost incen- tives to save and invest and therefore trigger higher wages for American workers. This increase in tax- able income will offset some of the projected $245 billion tax cut. Even with the implausible assumption that the economy receives no benefit from lower taxes, the pro- posed tax cut will have only a tiny effect on revenues. Tax revenues still are projected by the CBO to rise by an average of . ... .. .. Chan 2 $66 billion annually be- tween 1995 and 2002. Government Will Still Get Too Much And of the $11.373 tril- lion in tax revenue the Revenue After Tax Cut government is projected $2000 Billions of Dollars to collect over that pe- Current riod, the $245 billion tax 1800 -- - - - - - - - - - - - - - - Revenue - - - - 1600 -- - - - - - - - - - - - - - - - - - - - - - - - - cut will reduce that 1400 _. - . . . . . . . . . . . . . . Revenue With amount by less than 2.2 1200 -- - - - - - - - - - - - - - - - - - - - - - Tax Cut - - - - - - cents for every dollar. 1000 - Taxpayer Burden Is Eased By Less Than - - - - - - - - - - The High-Tax Ap- Boo .. . . . . 1 12 Cents per Dollar With Tax Cut . . . . . . . . . . proach Has Failed. The 600 -- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - White House claims that 400 .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . lower taxes will be coun- 200 . . . . . . . . . . . . . . . . . . . . . . . . . terproductive. Before criticizing tax cuts, how- ever, the Administration \q lep would be well advised Henlap Foundaton catwations. basca an Conpe,.-jonal Eklaget OffiCe data to see how the redistribu - tionist goal of higher taxes has backfired.

X Tax rates on the "rich" were raised in 1990 and 1993. The result: As opponents warned, upper-in- come taxpayer.% reduced the amount of income they reported. P ue . . . . . . :even - - - - - - - - - - - - - - - - - - - - - - - - - - - - - llievenue 7;;ZTZ @ith Tax C . . . - - - - - - - - - - - - - - - - - - - - - - - - - - - . . . . . . . . . .

X The higher taxes from the "rich" from increased income tax rates in 1990 and 1993 were supposed to help boost total income taxes as a proportion of GDP. The result: Income tax collections actually have fallen from 8.6 percent of GDP in 1989 to 8.2 percent of GDP in 1994.

X Revenues grew by an average of 6..6 percent annually in the "tax-cutting" Reagan years, a rate of growth one-fourth higher than the 5.3 percent annual revenue increases under Presidents Bush and Clinton.

X The budget deficit was less than $155 billion in 1989 and was projected by the Congressional Budget Office in January 1989 to fall every year into the future if Reagan's policies were left un- touched. Lawmakers instead imposed large tax hikes in 1990 and 1993. The result: The deficit this year is $161 billion and now projected by the CBO to rise in future years.

X The tax increases in 1990 and 1993 were intended to spur the economy. The result: A recession in 1990-1991 was followed by recovery and expansion well below historical averages for job creation and economic growth. In the last five years, taxpayers have been burdened by two major tax increases. These tax hikes have failed to achieve their economic and income redistribution objectives. The result has been lackluster eco- nomic growth and persistent budget deficits. To help reverse this failed approach, Congress is preparing what is, in reality, a modest tax cut. The tax relief is only a fraction of the 1990 and 1993 tax increases, and taxpayers will see their tax bills decline by less than 2.2 percent compared to current law. But the proposed changes are at least a welcome step in the right direction of a tax code that would stimulate the economy.