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Businessweek Archives

A Better U.S. Budget Compromise



As House and Senate budget committees begin summerlong discussions on a balanced-budget compromise, one fact stands out: There is an economically rational way to balance the budget and a political way. Cutting taxes while trying to cut government spending doesn't make a lot of macroeconomic sense--if balancing the budget is really the goal. Better to go with Senators Pete V. Domenici (R-N.M.) and Bob Packwood (R-Ore.), who would first take the pain of balancing the budget and then cut taxes. But given demands by congressional conservatives to "give something back" to voters--for the pain and suffering of having entitlements chopped--tax cuts are going to be part of the budget package whether or not they make economic sense.

The goal, then, of the congressional conferees should be to offer up as small a tax cut as politically feasible. The simplest and most equitable way to do that is to lower the income level of families eligible for the proposed $500 tax credit. In the House budget proposal, couples earning $200,000 could (incredibly) receive the credit. This would cost the government approximately $160 billion over seven years. However, a more equitable and reasonable step is to limit the family credit to those making just $50,000 a year. Dropping eligibility down to that level cuts the cost of the tax break virtually in half. This is a more modest political price to pay for passage of essential fiscal legislation.

As for the other major cut in the works, capital-gains tax, economists have been fighting for decades over its efficacy. Short term, it appears to generate more investment. Long term, the impact gets cloudy. Politically, a cut in capital gains appears to be a sine qua non of a balanced-budget deal. So be it. The best kind of capital-gains tax cut would go for future, not past, investments in capital improvements. That would cost a mere fraction of the House bill that comes to $73 billion over seven years.

If Washington blows this chance to get its fiscal house in order, the penalty will be severe. Balancing the federal budget, finally, is critical to boosting savings and investment in America. Making unwise tax cuts based on political realities is a price that probably has to be paid. But they must be kept to a minimum.

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