So Many Tax Cutters, So Little Room To ManeuverPaul Magnusson
On paper, 1995 looks like the year of the Big Tax Cut. The legislative hopper is already bulging with bills to cut levies on the middle class, on savings and investment, and on capital gains. Other provisions would repeal the so-called marriage tax penalty, roll back tax hikes on the elderly, help build savings for college tuition, and even scrap the entire income-tax code and replace it with a single rate.
But don't start ordering the expensive leather seats on the new car of your dreams just yet. To get to the promised land of tax reduction, Congress and the White House must first cross the narrow bridge of spending cuts. And both parties have agreed that every dollar of proposed tax cuts be offset by a dollar in spending cuts. That pledge may block Americans from getting the cornucopia of goodies promised in the GOP Contract With America or President Clinton's Middle Class Bill of Rights.
The likely outcome: Both sides will have to scale back their proposed cuts and focus on the most popular items--breaks for college tuition, retirement savings, and capital gains. Meanwhile, even ardent supporters acknowledge that flat-tax bills and other tax-reform proposals may not get serious consideration until after the 1996 elections.
At least the debate won't be dull. "We're going to see every possible gimmick to reduce the deficit and offset tax cuts that you can think of, and huge disagreements on baselines, asset sales, and accounting all year long," predicts Susan Tanaka, vice-president of the Committee for a Responsible Federal Budget, a bipartisan group that wants to eliminate the deficit.
SERIOUS DRAIN. Despite detailed plans for tax cuts, neither party is ready to go public with equally explicit spending cuts. And no wonder. To do everything the GOP Contract calls for--cutting taxes, raising defense spending, and balancing the budget by 2002--Congress will have to find more than $1.4 trillion in spending cuts in seven years. Clinton's "family" tax-cut plan is cheaper than the GOP version--just $60 billion over five years vs. $197 billion for the Republican plan--but the White House hasn't yet specified most of its offsetting spending trims.
Fortunately, some of the most politically popular items are also the cheapest--at least in the short term. The GOP's $500-per-child tax credit for families earning under $200,000 a year would cost a colossal $107.2 billion over five years, but its capital-gains cut would cost only $57.5 billion, according to the Treasury Dept. An even better bargain is the GOP's proposal for expanded individual retirement accounts, which would cost a mere $1.5 billion over five years. The Administration's IRA plan would cost just $3.7 billion. And Clinton's proposed deduction of up to $10,000 for college and other postsecondary education would cost $20.6 billion over five years. White House polls show the school deduction to be Clinton's most popular idea by far.
Yet even these lesser tax cuts cause a far larger revenue loss once they are fully phased in. For example, excluding 50% of capital gains from taxes and indexing gains for inflation triples the cost, to $170.4 billion, over 10 years.
Meanwhile, business frets that Congress may drop items from its wish list, such as the capital-gains tax cut. The U.S. Chamber of Commerce is encouraging both parties to drop plans for tax credits for children. Then, it figures, Clinton could swallow a capital-gains cut in return for his college-tuition deduction. Lobbyists also hope to persuade Treasury and Congress to recalculate the effect of a capital-gains cut to show it does not drain much revenue. "It would unlock so much capital and have such an impact on savings and investment, it would be a wash over five years," insists Mark A. Bloomfield, president of the American Council for Capital Formation, a manufacturers' advocacy group.
But many economists doubt that tax cuts of such magnitude are wise with the deficit expected to hit $322 billion in 2002. "The real issue ought to be tax reform, because we can't possibly afford such tax cuts," says Lawrence Chimerine, chief economist at Washington's Economic Strategy Institute.
Although tax reform makes far more economic sense than tax cuts, any overhaul of the code faces huge hurdles--high cost and the enormity of the proposals. House Majority Leader Richard K. Armey (R-Tex.) has proposed the most popular reform: a flat 17% income-tax rate for individual wages and pensions and business cash flow. A family of four, for example, eventually would fill out a 1040 postcard by subtracting from their wages a $26,200 personal allowance and a $10,600 dependent deduction. No withholding and no taxes on savings, inheritance, or capital gains.
LONG HAUL. The concept even has bipartisan appeal. House Minority Leader Richard A. Gephardt (D-Mo.) says he is drafting his own flat tax of 10% or 11%. "If you have two people as unlike as Gephardt and Armey talking about it, it shows the chances for passage are pretty good," says David Keating, executive director of the National Taxpayers Union. But even Keating admits that such a change isn't likely before 1997, after a GOP Presidential candidate raises the issue's visibility. And Armey admits his plan would produce a shortfall of $40 billion in the first year, while the Treasury Dept. pegs the loss at a catastrophic $186 billion a year after full phase-in. Cost aside, experience shows that large-scale tax reform, such as the overhaul of 1986, requires a long process of education and compromise.
Still, it won't hurt the tax-reduction cause that the 1996 Presidential election is looming. Clinton is less likely to risk voters' wrath by vetoing a tax-cut bill now. Yet polls show that much as the public hates income taxes, it hates the federal budget deficit even more. The message from voters: Make 1995 the year of the Big Spending Cut.
SLASH, FLATTEN, SIMPLIFY!
Major tax-cut and reform measures likely to be considered by Congress
CONTRACT WITH AMERICA This GOP measure would offer such tax cuts as a $500-per-child credit for most families, a 50% capital-gains exclusion, and an "American Dream Savings Account" to help fund retirement, medical, or education expenses. The marriage penalty and the 1993 hike on Social Security income would be rolled back.
CHANCES OF PASSAGE House approval likely, but the Senate may scale back to avoid increasing the deficit.
MIDDLE CLASS BILL OF RIGHTS The Clinton plan would include a $500-per-child credit for some families, a $10,000 deduction for expenses for postsecondary training and education, and expanded IRAs.
CHANCES OF PASSAGE Cheaper than the Contract, but won't get GOP backing.
FLAT TAX Representative Dick Armey (R-Tex.) wants to replace the current income tax on businesses and individuals with a flat 17% rate. Representative Richard A. Gephardt (D-Mo.) also has a flat-tax plan.
CHANCES OF PASSAGE Slim in the short run.
SAVINGS-EXEMPT TAX Senators Sam Nunn (D-Ga.) and Pete V. Domenici (R-N.M.) want to replace the individual and corporate federal income tax and a portion mf the Social Security payroll tax. Business would subtract from domestic sales all purchases from other businesses and pay a 7.1% rate. For individuals, savings would be deducted from income.
CHANCES OF PASSAGE Very slim.