President Reagan this week will propose a tax reform plan that will include a series of tax increases designed to generate revenue that will be used primarily to cut both personal and corporate income tax rates. None of the revenue-raising measures will be used to reduce prospective federal budget deficits.
Perhaps fearing Congress would try to apply some of that revenue to the deficit rather than cutting rates, the president has insisted that tax reform and the effort to slash future deficits be kept separate. To head off any possibility of an overall tax increase, Reagan's original instructions to the Treasury Department required any plan to be "revenue neutral."
The president also said last year that he would accept a tax increase to reduce the deficit only as a "last resort" -- after he was convinced that federal spending had been cut to the bone. The versions of the fiscal 1986 budget resolution about to go to a House-Senate conference may not meet presidential standards for cutting-to-the-bone, but they must be getting close.
The question then is when, if ever, Reagan might agree the time for the "last resort" has come. After all, neither the president nor other administration officials any longer talk about "growing our way out of the deficit."
Under terms of the Senate-passed budget resolution, which Reagan supported, the deficit would still be $164 billion two years from now in fiscal 1987 and $149 billion in fiscal 1988, according to the Congressional Budget Office. CBO has not recalculated the budget savings from the House version, but it apparently would leave the deficit about $20 billion higher -- in the neighborhood of $170 billion -- in 1988.
CBO used a somewhat less rosy economic forecast than the administration's, but one that still includes steady growth of the gross national product, adjusted for inflation, of between 3 percent and 3.5 percent each year and no recession.
By 1988, with such steady growth, the U.S. economy would be operating with unemployment down to the point that to push it much lower likely would be sharply accelerating wage rates and rising inflation, many economists believe. At that point, the budget should be balanced or perhaps in surplus, according to the rules of thumb used by many of the same economists.
But under the Senate resolution, in 1988, the third year it covers, the deficit would still be equal to 3.1 percent of GNP, the CBO reported in an analysis done last week for Sen. Lawton Chiles of Florida, ranking Democrat on the Senate Budget Committee. The House version of the resolution, if fully implemented, would leave a larger deficit equal to about 3.5 percent of GNP. This year the deficit will be about 5.4 percent of GNP.
With the economy having grown only 2.2 percent over the last three quarters, even the CBO's economic projections could be too optimistic. A full blown recession, which an increasing number of economists now predict will hit sometime in 1986, could send the deficit soaring.
Each year's delay in addressing the deficit problem has added to the national debt and the cost of financing it. As large as the spending cuts are in both versions of the 1986 budget resolution -- and they are considerably larger than most observers thought likely earlier this year -- rising interest payments on the publicly held portion of the debt will offset a substantial portion of the painfully achieved spending cuts. By 1988, CBO estimates that net interest payments will reach $175 billion, or 16 percent of all outlays.
Meanwhile, the Reagan approach to tax reform will make it considerably more difficult to use the personal or corporate income tax for explicit deficit-reducing purposes in the future. Of course, some administration officials, perhaps including the president, see that as a distinct virtue.
On the other hand, the alternative likely will be continued substantial deficits that will eventually reduce economic growth by reducing funds available for investment, or alternatively, continue to keep real interest rates high and draw in foreign capital. The surge in net foreign investment in the United States has boosted the value of the dollar and caused a huge increase in the U.S. trade deficit -- and in the process damaged a large portion of American manufacturing.
Here is why, if a revenue-neutral tax reform plan is passed, it will be more difficult to deal with the deficit in the future through revenue raising measures:
The first version of the Treasury reform plan, released last November after the election, called for raising between $120 billion and $130 billion from individuals and corporations, primarily by changing or eliminating a number of so-called tax preferences. The largest single revenue-raising items were repeal of the deduction for state and local taxes paid by individuals ($18.6 billion in 1987 rising to $33.9 billion in 1988) and repeal of the 10 percent investment tax credit ($27.8 billion in 1987 rising to $31.6 billion in 1988).
Reduction or elimination of the tax preference items was billed in each case as making the tax system both more fair and more simple, in addition in most cases to raising revenue.
Reagan does not plan to reduce or eliminate as many of the tax preference items as the first Treasury proposal would have. On the other hand, he apparently has added some provisions specifically to raise revenue. Those include treating as income the first $10 of a single individual's and $25 of a family's current tax-free fringe benefits, and a substantial expansion of an alternative minimum tax for corporations.
All of the revenue raising power, in effect, will be used to underwrite cuts in individual and corporate income tax rates worth roughly the same $120 billion to $130 billion in fiscal 1987, the first full year in which any of the provisions would be in effect.
Once rates are lowered that way, say congressional budget and tax experts, it would make using either tax for deficit-reducing purposes extremely difficult. "It sort of forecloses fooling around with the income tax to cut the deficits," notes one such analyst.
Reagan has said flatly that he will not accept any tax increases this year. In presenting his self-styled "populist" reform plan, the president can be expected to gloss over the fact that he will be proposing some significant revenue-raising measures and concentrate instead on the revenue-reducing parts, the rate cuts.
And as he seeks to get the nation to focus on the tax-cutting portion of his plan, there will be no mention that individual and corporate rates are to be cut while large federal budget deficits will remain. Not only will the deficits remain, but there are, by OMB's own admission, no major additional spending cuts waiting in the wings that could be used to reduce them.
In effect, Reagan is opting to cut rates and accept large deficits indefinitely.