201 August 3, 1982 BREACH OF FAITH THE TAX PACKAGE INTRODUCTION A tax rebellion is brewing in Congress. Its message? No tax hikes without budget cuts. In a letter drafted by Represen tatives Jack Kemp (R-NY) and Robert Walker (R-PA), over 70 House GOP con s ervatives have served notice to the President that they will not accept the Senate Finance Committee's package of tax hikes unless the Congress first considers the 40 billion in budget cuts envisioned by the Budget Resolution passed last June faith with R e aganomics and the 1980 election mandate if they pass 100 billion in tax increases with only a faint hope that budget cuts will follow. Conservatives have accepted tax increases as half of a compromise with moderates and liberals that includes as the secon d half substantial budget cuts. Now these House conser vatives feel betrayed because the tax increases are sailing through Congress while the budget cuts are bottled up in House committees. According to the letter sent to President Reagan Tuesday: IIHouse c onservatives were assured that there was only one way to achieve substantial savings in spending: to 'hold our noses' and swallow the largest peacetime legislated tax increase in history It These conservative Congressmen believe they will be breaching The House Democrats are now' ltwelchinglt on the deal to cut reconciliation. According to the letter, What they hope is that Republicans are foolish enough to pass a tax increase.lt 'IQuietly without debate," the letter continues, Itthe Republican Party is in danger of making a U-turn back to its familiar rolc.of tax collector for Democratic spending programs. This is pctentially an explosive scenario politically because the GOP clearly will take the blame for any tax increase passed by Congress.Il 2.

The conservative House Republicans hope that the growing tax rebellion will prompt Reagan to delay or even call a stop to the tax hikes in the final hour. Such presidential courage is not without precedent. Last January, Reagan nixed the call for excise t a x increases against the advice of nearly all his politi cal and economic advisors Is the President ready to repeat this bold action? Perhaps he will be when it becomes apparent that the Senate Finance Committee package he endorsed is actually-the largest tax increase in peacetime history.

Torpedoing tax increases is even more justified today since the House appears to have rejected the budget cuts that were the crucial part of the compromise package which attracted reluctant conservative support. According to a recent minority report of the House Budget Committee, the House has acted on only some $15 billion of the 40 billion in cuts over three years recommended by the Budget Resolution. If these cuts evaporate, as now appears likely, the ratio of budget c u ts to tax increases will be about 1 in cuts for every $7 in tax increases. This is hardly the budget compromise that House conservatives had in mind. As the budget cut momentum has stalled, however, the tax hikes have moved swiftly through Congress and ha v e sharply increased from alone to the current proposal of 24 billion. Some high-level Treasury officials also suspect that, if the current tax levies receive the congressional nod, the tax-raisers will be back next year with a new package of tax "reformi1 measures the original recommendation of $21 billion in the first year I BOTTLED UP BUDGET CUTS J In direct contrast to the clear sailing through Congress of tax increases, budget cuts are foundering on a legislative sandbar.

According to the Committee on the Budget, the House has refused to carry out even the limited budget cuts recommended in the Budget Resolution passed last June. According to the Minority Budget News, the First Concurrent Resolution on the Budget for Fiscal Year 1983 instructed nine Ho u se committees to report spending reductions of $6.57 billion in FY 1983 and $27.1 billion over three years Based on preliminary staff estimates as to expected Committee action," says the report, "total spending will be reduced by $4.1 billion in FY ,1983 and $15 billi,on over three years billion in 1983, growing to almost $12 billion over three years.

This represents a shortfall in budget cuts of over $2.5 The Budget Resolution also envisioned non-reconciled savings that is, budget cuts that are not mandat ed but are nonetheless recommended by the Budget Committees. These additional budget cuts, amounting to about $14 billion, virtually have been ignored by the House committees. Only one House committee thus far has moved on these non-reconciled savings. On l y about 2 percent of the .budget cuts have been implemented in this area, and no House Committee estimates that only some $15.7 billion of the $41 committee has scheduled further action. In total, the Budget 3 Chart 1 Outlays in millions N 83 N 84 FY 85 R e conciliation Savings (Table 1 Resolution Assumptions 6,573 9,268 11,312 Action to Date 4,026 5,655 5,706 Difference 2,547 -3,613 -5,606 Additional Non-Reconciled Savings (Table 11 Resolution Assumptions 3,126 4,874 5,623 Action to Date Difference 90 100 1 0 4 3,036 -4,774 -5,519 TOTAL DIFFERENCE BETWEEN SAVINGS ASSUMED IN THE BUDGET RESOLUTION AND LEGISLATIVE ACTION Budget Resolution Assumptions 9 699 14,142 16,935 Action to Date 4,116 5,755 5,810 Difference -5,583 -8,387 -11,125 Source: Committee on the Bud g et, Minority Budget News, July 27, 1982 3-Year Totals 27,153 15,387 11,766 13,623 294 13,329 40,776 15,681 25,095 billion in budget cuts recommended in the Budget Resolution will be enacted Perhaps the most egregious example of a House Committee's breachi n g faith is the House Post Office and Civil Service Commit tee. On July 21, the Committee ignored its budget instructions and refused to place a four percent cap on annual cost-of-living adjustments (COLAS) for federal retirees-the largest portion of budge t .savings in the reconciliation package. The Committee's rejection of the cap means that less than 1/30 of the savings envisioned by COLA reforms will be realized directed to make cuts totalling $3.2 billion through 1985, but the panel instead voted to cut only some $113 milli.on. The Committee's defiance also dooms the Armed Services Committee's commitment to cap military retirement benefits and the Foreign Affairs Committee's power to cap Foreign Service personnel COLAS The committee was It is clear that b udget-cutting strategy is unravelling in the House. As one committee balks at making cuts in its jurisdic tion, other committees, no longer attracted to cutting funds for special interests in their jurisdiction, refuse to consider budget cuts levels sugge s ted by the Budget Resolutions are defense and military construction and Foreign Assistance--hardly measures that conser- vatives can support warmly The only major appropriations being cut from the Although the hour is late, it is not too late for the Admi n i stration to reconsider support of the largest tax increase in history. The Finance Committee's tax package is a fundamental betrayal of Reaganomics and a massive denial of supply-side 4 principles largest tax increases in peacetime P::,story will have d e vastating consequences on a weak economy. But'also that the current tax package raises taxes in the worst possible way. Even now, Admini stration officials do not refer to the package as tax increases It has been sold to the public and the President as a m easure to plug loopholes, enhance taxpayer compliance, and impose rela tively harmless tax increases on consumption Yet, for the most part, the package raises taxes on saving, investment, and produc tive activities. Only relatively small sums are to be ra i sed from taxing consumption. While the package masquerades as tax reform, it.really represents a triumph of the liberal Democrat's wish list to soak business, professionals, and other productive investors It is not just the obvious point that imposing the One particularly capital-destructive measure is withholding of interest and dividend income. Touted as a tax compliance provision rather than a tax increase, withholding on dividends and interest will, for the most part, increase the implicit tax on savin g and stock investment, essentially by denying investors the use of their income for up to a year after it was earned.

Thus, a major go.al of Reaganomics--stimulating savings--will be violated. The withholding provision will smother financial institutions with paperwork and cost hundreds of millions to administer. Opposition from financial institutions, at first very strong, has been neutralized by the promise of a 3Orday float" on withheld money. The interest-free loan to financial institutions, however, comes at the expense of the already belea guered saver and stock investor Is this the ,goal of Reaganomics? Last year the President promised help to the nation's highly taxed saver and stock investor.

He said that insufficient saving was the chief cause of lagging sense this year to raise the implicit tax on savers and investors while wrapping financial institutions in yet more government red tape capital formation and sluggish economic growth It makes no The highest single increase of the tax package hits business investment It totals $37 billion over three years. Last year the President promised to spur business investment by expanding depreciation allowances and other capital formation incentives.

Congress responded by reducing taxes on business investme nt by some 68 billion over three years. This sensible strategy will be turned on its head if the Senate Finance Committee has its way. Now the word is that a tax increase on businesses is neces sary to reduce deficits which, in turn, is supposed to spur e conomic recovery. What this means is that the Senate Finance Committee is trying to cancel approximately half of the tax incentives it passed last year by restricting depreciation and other investment tax credits. What does Congress really believe?

That bu siness tax increases spur economic recovery--that they depress it investment, or it depresses it; Congress cannot have it both ways Accelerated depreciation either stimulates business 5 Although reduction of deficits is a worthy economic objective tax hik e s crowd out productive economic activity as much as, if not more than, budget deficits. A cutback of last year's business incentives will teach business not to trust Congress. The lesson will be: what Congress gives in tax incentives one year, it.wi.11 ta k e back the next. If a fickle Congress impulsively changes the economic rules of the game, distrust and instability mount within the business and investing communities. In such an unpredictable economic environment, business is not likely to cbmmit the cap i tal necessary for an economic recovery The Senate Finance Committee's tax proposal also raises taxes on middle and upper income individuals by limiting medical and casualty deductions. Individual income tax deductions can be eliminated, the Committee says , because the individual income tax cuts enacted last year provided individuals with overly generous tax relief. In fact, however, taxpayers face huge tax increases in coming years because of inflation and mandated Social Security hikes. A glance at Chart 2 below, in fact, shows that the tax increases suggested by the Finance Committee combined with tax bracket creep and Social Security tax levies, wipe 'out the entire personal income tax relief promised over the next three years.

The tax cut, as it turns out, is not overly generous. In fact, it is not a tax cut at all, but a net tax increase of almost $7 billion, if the Senate Finance Committee has its way.

Congress should not be considering further tax increases at all but an acceleration of the 1983 tax cuts. Only then will taxpayers have real protection against inflation and Social Security tax hikes already in the making Chart 2 FY 1983 N 1984 in billions Tax Increases due to Inflation and Social Security $50 78 Finance Committee's Recommendations $20. 9 34.2 Total Tax Increases $70.9 $112.2 Personal Income Tax Reductions 70.1 $113.6 Net Tax Increase Tax Cut 8 1.4 It rate cuts, marriage penalty, .indexing.

Source: Senate Budget Comhittee FY 1985 Total 110 $238 43.9 99 153.9 $337 146.56 $330.26 7.34 6.74 As for the budget deficit, the quickest way to reduce it is by economic recovery. An early recovery would substantially reduce expenditures for social welfare programs and increase tax 6 revenws. Over four-fifths of the recent estimated increase of the de f icit is.caused by a deteriorating economy, not by the tax cuts. Expenditures for unemployment compensation, food stamps and other entitlements have increased rapidly, while the slower than expected economic recovery has depressed tax revenues A reinvigora ted economy could eliminate most of the budget deficit.

The Congressional Budget Office estimates that for each percentage point decline in the unemployment rate, the deficit shrinks $25 billion. A reduction in unemployment from the current 9.5.to say 6 pe rcent would erase the lion's share of the budget decicit predicted for the next three years. A tax-cut acceleration, not an increase, is what is needed.

Cutting taxes, moreover, remains the surest road to trimming spending. Economist Milton Friedman argues that the only way to force Congress to reduce government spending and contain government deficits is to cut government off at the source: tax revenues.

He contends that those.raising the loudest concerns with deficits are simply favoring tax increases to be followed by further spending increases. According to Friedman The reason they are born-again budget balancers and are now talking about raising taxes is not because they've fundamentally changed their view but because they recognize that t h e most effective way to hold down government.spending is to hold down government revenue Would raising taxes result in a balanced budget? Friedman does not think so They are talking as if their concern is to enact higher taxes in order to keep budget defi cits down," he says Their real motive is to keep taxes up so that the govern ment can resume big spending programs as soon as the present public drive for lower taxes.and spending passes."

The.GOP conservatives are sending a strong message that they will n ot dance to this spending and taxing minuet that the way to cut government spending and reduce deficits is to hold tax increases hostage to progress on budget cuts acquiesces to tax increases, the Democrat controlled House Commit tees almost surely will g l eefully balk at budget cut after budget cut package of tax "loopholes" to plug and tax ltcompliancell measures to enact. They will mouth.reassuring words about punishing the tax cheats, fat-cats, and big business They know If Congress And they will be bac k again next year with an additional CONCLUSION A victory for the Senate Finance Committee's package will set in motion the tax-and-tax, spend-and-spend cycle that Reagan has come so close to breaking. Congress still has the chance to keep its faith with t he American people and reject the Senate tax package. If it does not, it is up to the White House. To fail to veto the tax hike is to breach faith with Ronald Reagan's America.

Thomas M. Humbert Walker Fellow in Economics