BUDGET-BALANCING NONSENSE:
THE GOP'S CONTRACT WITH THE DEVIL

By Marc Breslow
Marc Breslow is an editor at Dollars & Sense

The new Republican congressional leaders want to accomplish the miracle that eluded Ronald Reagan:cutting income taxes, increasing military spending, and balancing the federal budget all at the same time. As of this writing, the House has overwhelmingly passed the balanced-budget amendment, moving the struggle to the Senate. As Majority Leader Richard Armey of Texas wanted, the House voted without specifying what spending cuts should be made. Incredibly, Armey acknowledged that the necessary cuts are so onerous that no one would vote for the amendment if they knew what it would require.

If the Republicans are intent on counter-revolution, President Clinton's fiscal 1996 budget would reproduce the status quo. While Clinton hyped his own tax and budget cuts, both are too small to matter much during the next few years. Even by the year 2000, his middle class tax cut would be merely 1% of the budget, and his spending reductions about 3%.

While the Republicans claim that the country's economic and social problems result from excessive taxation and spending by Democratic Congresses, the reality of the past 15 years is dramatically different. Federal spending rose slightly faster than growth in the economy during the Reagan-Bush years, while falling in relative terms since Clinton took office. And the largest, fastest-growing spending areas are ones which Republicans have not opposed -- interest on the federal debt, Social Security, Medicare, and other health spending. Meanwhile, the income tax cuts initiated by Ronald Reagan are responsible for the increased federal debt burden.

The federal budget deficit exceeded $300 billion a year five times during 1982 to 1992, and equaled $270 billion in fiscal 1993, George Bush's last budget (all in 1995 inflation-adjusted dollars). It dropped to $209 billion in 1994, and will be $193 billion in 1995, estimates the Office of Management and Budget (OMB). Republican plans to both raise military spending and cut taxes would increase the amount by which spending exceeds revenues, worsening the deficit.

Several of the absurdly-titled provisions in the Contract with America would cut taxes, including:

** the American Dream Restoration Act,-- which would give families an additional $500 tax credit per child, and create a new tax credit to reduce the taxes of married couples;

** the Senior Citizens Fairness Act,-- which would repeal the requirement that seniors who earn more than $34,000 (single) or $44,000 (couple) pay income tax on 85% of their Social Security benefits;

** the Job Creation and Wage Enhancement Act,-- which would cut the capital gains tax by 50% initially, and further reduce such taxes by allowing taxpayers to adjust the purchase prices of their assets for inflation.

** new tax breaks for individual retirement accounts (IRAs).

** greater tax breaks for depreciation of business assets, such as buildings and machinery, allowing deductions for more than the purchase price of the assets.

Altogether, by the year 2000 the tax provisions would reduce federal revenues by $74 billion a year, according to the U.S. Treasury Department. Of these, only the increased credit for children benefits most taxpayers, while the others mainly serve wealthy individuals and corporations. Worse yet, while the middle-class cuts for families would remain relatively stable over time, those benefitting the rich would explode after the first five years. The Treasury estimates that 50% of the money would go to the wealthiest tenth of families (those with incomes above $100,000), while only 20% of the benefits would go to the two-thirds of families with incomes less than $50,000.

To these revenue losses the Republicans would add higher military expenses (the right-wing Heritage Foundation, for example, wants to spend $160 billion more on defense in the next five years). The net result is that the Contract with America would return the deficit to at least its Reagan-Bush levels, erasing the Clinton administration's reduction efforts.

The Balancing Game

For the Republicans to balance the budget, either the non-military portions of federal spending would have to be cut, or taxes other than personal and corporate income taxes would have to be increased. Since the GOP has not proposed increasing the other major revenue source, payroll taxes on workers' wages, their only alternative is to cut spending items. Yet initially Newt Gingrich declared most of the largest pieces of the federal budget, including Social Security and Medicare, off-limits. With the military sacrosanct, and Congress unable to directly affect the annual interest on the federal debt, four of the five largest items in the federal budget could not be reduced.

After the Congressional Budget Office (CBO) published an analysis demonstrating the absurdity of balancing the budget without touching any of this spending, the Newt and friends backtracked, saying that Medicare spending would be addressed. But a few weeks later, apparently chastened by the political power of senior citizens, the Congressional leaders reversed course again, indicating they would not tamper with Medicare.

National defense, Medicare, Social Security, and net interest (on the debt) add up to $977 billion in spending for 1995, or 64% of the federal budget (see the table). This leaves only 36% of the budget, or $540 billion, available for cuts. To eliminate the deficit these remaining items would have to be cut by about one third.

Are such drastic reductions possible? Probably not, unless tens of millions more Americans are to be thrown into poverty or denied health coverage. Of the remaining items in the budget, the largest are $221 billion for "income security" and $123 billion for "health,-- the largest component of which is Medicaid coverage for low-income families and disabled persons.

Income security encompasses all programs that service retired federal workers, the poor, near-poor, unemployed, and disabled. In fiscal 1995, this includes $75 billion for military and civilian pension and disability programs; $72 billion for food stamps, unemployment compensation, and Supplemental Security Income; and a mere 14.4 illion, or 1% of the budget, for the right-wing's public enemy number one, welfare (Aid to Families with Dependent Children, or AFDC).

While income security spending did rise by 38% since 1980, this was a far smaller increase than for the four untouchables, which rose 56%. Moreover, the need for increased aid to low-income people has resulted from economic stagnation and increasing inequality since the 1970s, not from overly-generous programs created by Democratic congresses. The number of families receiving welfare has risen, in large part due to falling real wages and rising unemployment. But the average monthly benefit level has dropped dramatically, from $714 in 1970 to $510 in 1980 and $394 in 1993 (all in 1995 dollars).

All other types of spending, including international affairs, energy, natural resources and the environment, education and training, and transportation, total to only 14% of the budget, or $212 billion -- so that slashing all of them would make only a dent in the federal deficit.

What Caused the Deficit?

Conservatives would have us believe that it was an orgy of spending by Democratic Congresses, particularly on income transfer programs to aid low-income households, that caused the budget to come unglued. This is false. From fiscal 1980 through 1995 federal spending grew by 39% in real terms (adjusted for inflation). This may sound like a lot, but the economy grew faster, as the Gross Domestic Product (GDP) rose 43%. Thus, spending fell as a fraction of GDP, decreasing its economic burden, contradicting conservative claims.

The problem has been on the revenue side. Due to the Reagan tax cuts, during the 1980s tax collections fell far behind spending, creating the massive deficit. The Clinton administration has begun to reverse this trend, raising income tax rates on the wealthy. As a result, the CBO projects 1995 revenues at a level 42% above those in 1980, a growth rate faster than that for spending. If this trend continues, over time the deficit will fall relative to the GDP. But due to the excesses of the Reagan-Bush era, the accumulated federal debt is now above 70% of the GDP, its highest level since the early 1950s.

As most workers realize, Social Security and other payroll taxes have increased in recent years, growing from 5.8% of GDP in 1980 to 6.9% in 1995. What fell was income taxes, which today make up a smaller percentage of federal revenues, and of GDP, than they did in 1980. If individual and corporate income taxes had not been cut, but instead still accounted for the same fraction of GDP today as they did in 1980 (8.9% and 2.4% respectively), the federal government would have another $70 billion in annual revenues -- eliminating more than a third of the deficit.

Suppose one argues, nevertheless, that federal spending should be cut. The third column of the table shows which spending types have grown and shrunk since 1980. Many of the categories which the Republicans view as pork waiting to be cut have already fallen drastically, including energy (-73%); natural resources and the environment(-15%); community and regional development (-56%); education, training, employment, and social services (-9%); and "general government" (-44%).

The biggest spending increases have been in net interest ($116 billion, due to the Reagan-Bush tax cuts), Medicare ($97 billion), health ($80 billion), and Social Security ($117 bllion). Leaving out health (which includes Medicaid), and adding the $23 billion rise in defense, we have an increase of $352 billion in the spending categories that the Republicans were initially not inclined to fiddle with. Everything else in the federal budget combined, including Medicaid and all poverty-related programs, rose by only $70 billion (adjusted for inflation) from 1980 through the present.

Military spending has fallen substantially from its peak levels under Ronald Reagan, but remains higher than it was when Reagan took office. Anxious to upstage the Republicans, in his State of the Union address Bill Clinton called for adding billions of dollars to current spending levels. There is no excuse for such wastefulness in a world where the United States has no enemies of military consequence. As of 1993, the U.S. military budget was greater than that of the next ten highest spenders combined, all of whom are U.S. allies (if one includes Russia, whose budget is now only one-tenth of ours). Cutting the military in half would come close to eliminating the deficit, while still leaving us with more than three times the defense budget of Japan, our closest competitor.

Clinton's original campaign document, "A Vision of Change for America," was right in arguing that eliminating the deficit would mean increasing taxes and halting the unchecked escalation of health care spending (see "Clinton's Weak Vision," Dollars & Sense, April 1992). One way of addressing the latter is to control wasteful costs -- by slashing the administrative burdens of a system run by insurance companies; eliminating unnecessary and inefficient medical practices; and controlling physician salaries. All this could be accomplished by sensible health care reform, reducing the power of insurance companies and doctors. But since the Republicans are opposed to reforms that interfere with the prerogatives of privileged groups, who contribute heavily to their campaigns, we will see none emanating from the new Congress. Instead, we will see increased pressure to save money by denying all Americans, but especially the unemployed, low-wage workers, and the poor, the medical care they need.

Since Medicare is politically untouchable, the primary pressure will be on Medicaid. It is true that Medicaid costs more than doubled, rising $53 billion, from 1980 through 1992. This was due, however, not to particular inefficiencies of government-financed health programs, but rather to two factors that cannot be fixed by simple budget-cutting. The first is increased poverty, and extensions of Medicaid coverage to the near-poor, which have caused the number of Medicaid recipients to rise 44% during these years. The second is rapid cost increases for health care in general. In fact, Medicaid costs per person served rose 66% from 1980 to 1993, slightly slower than the 75% rise for the entire health care system.

Because Medicaid reimbursement rates are already low compared to those for Medicare or private insurance, poor families have great difficulty finding doctors who will treat them. Edie Rasell, a physician and economist with the Economic Policy Institute, argues that since payment rates cannot be reduced, and the potential for improved efficiency is small, budget cuts will mean severe reductions in the quality of care provided.

With his health care reform package having failed, and the Democrats having lost control of Congress, Clinton's 1996 budget proposal is an effort at stonewalling the Republicans. The President calls for a gradual phase-in of tax and budget cuts, neither becoming meaningful until fiscal 1997, shortly before he stands for reelection (assuming the Democrats do not find a new candidate). But even by the year 2000, his spending cuts would only be 3% of the budget, reducing the deficit from its current $193 billion to $166 billion (in 1995 dollars).

Clinton's "middle-class tax cut" is only 0.2% of the budget in 1996, rising to 1% in the year 2000, a relatively insignificant change. While the benefits would be more progressively distributed than those in the Contract with America, the middle class label is nly accurate if "middle" means those in the top half, or perhaps the top third, of the income distribution. About 45% of American households have incomes below $30,000, and they would get an average benefit of $19 a year. The 20% of households with incomes between $30,000 and $50,000 would get $175 each. Meanwhile, the 25% of households with incomes between $50,000 and $100,000 would gain by $358 each.

Bill Clinton's responses to the Democrats' Congressional losses are no more than half-hearted attempts to coopt the right's issues. But the economic policies of his first two years were an effort to reverse 12 years of irresponsible leadership from Ronald Reagan and George Bush. Newt Gingrich, Robert Dole and company would return us to those days, in which tax cuts and military spending generated prosperity for some, while the federal debt quadrupled. Perhaps we will find out in 1996 whether the electorate has learned its lesson.

Resources: "The Budget Outlook," Congressional Budget Office, 1994; Budget of the United States Government: Historical Tables, Fiscal Year 1995, Office of Management and Budget; "The New Fiscal Agenda: What Will it Mean and How Will it be Accomplished?," Center on Budget and Policy Priorities, January 1995.

Should the Budget Be Balanced?

from Dollars & Sense

Ever since the Great Depression of the 1930s, and the theories of British economist John Maynard Keynes, running budget deficits has been a primary method for stimulating economies that have high unemployment rates. In theory, the budget should return to balance or surplus during boom times. The Reagan administration discredited this notion, cutting taxes to such a degree that the United States would face perpetually high deficits, regardless of how hot the economy was.

But the answer is not a balanced-budget amendment, unless one wants to prevent the federal government from combatting recessions. Worse yet, under such an amendment, the federal government would be forced to make recessions worse. When the economy slows down, income and Social Security tax revenues drop, due to falling wages and profits. Meanwhile, costs for some programs, such as unemployment compensation, rise.

These changes automatically put the federal budget into deficit, even if a balanced budget had been planned at the beginning of the fiscal year. If a constitutional amendment requires the government to balance spending and revenues at the end of the year (not just in the original plan), then the White House would be forced to cut spending or raise tax rates, thereby slowing the economy down, just at the time when it is most in need of stimulus.

One argument used by conservatives in favor of balancing the federal budget is that each of the 50 states manages to equalize its own revenues and spending. There are several flaws with this idea, as the Center on Budget and Policy Priorities points out. First, it is precisely because states are unable to counter recessions that the federal government must have the power to do so. Second, many states require that a balanced budget be planned for, but not that it actually be achieved at year-end. Third, most states have separate budgets for operating and capital expenses, with borrowing allowed for capital investments such as roads, bridges, and schools (just as households borrow for home mortgages and car purchases). At present, the U.S. government has no separate capital budget, making the deficit appear worse than it really is. In fact, the Clinton administration claims that in fiscal 1995 federal investment spending will be $235 billion (almost half of it for the military), exceeding the deficit.

Resources: "The Balanced Budget Constitutional Amendment," Center on Budget and Policy Priorities, January 9, 1995.