The rate of economic growth has declined precipitously, shattering any illusion that growth alone will eliminate future budget deficits. The Commerce Department says the economy grew at a rate of less than 2 percent in the third quarter, and the evidence is mounting that growth in the present quarter will also be well below the 4 percent rate previously projected by the administration.
The traditional growth spurt of the early recovery is over. The time has clearly come for the administration to identify major ways to cut the vast deficits that otherwise lie ahead.
Since nearly half of the budget is transfer payments, the administration will have to look hard for savings in this category. But it will have to do so in a way that is consistent with Ronald Reagan's pledge not to reduce the Social Security benefits of current and future retirees. The administration will also have to increase tax revenue in ways that are consistent with the president's opposition to higher tax rates. Although this may seem like an impossible task, in reality a temporary modification in the way that benefits and taxes are adjusted for inflation can slice the future deficit by $75 billion a year without sacrificing the principle of indexing.
The basic idea of indexing is to adjust benefits and taxes so that high rates of inflation do not erode the value of benefits and push taxpayers into higher tax brackets. We have long been advocates of the basic idea of indexing taxes and government transfers. We think it's wrong to allow increases in inflation to push people into higher tax brackets or to reduce the real value of Social Security and other benefits. But we have also long believed that it would be wise to reduce the deficit by indexing taxes and benefits only to the extent that inflation exceeds a 3 percent threshold.
How would such a 3 percent indexing threshold work? Let's look first at the indexing of government transfer payments.
Under existing law, a 5 percent rate of inflation automatically triggers a 5 percent rise in Social Security benefits, government pensions and other transfers that are not targeted at the poor. An $800-a-month benefit check increases to $840. With the 3 percent indexing threshold that we propose, benefits would increase only to the extent that inflation exceeds 3 percent. A 5 percent inflation rate would thus trigger a 2 percent benefit rise. The $800 monthly benefit would rise to $816.
In the same way, a 6 percent inflation would trigger a 3 percent benefit rise, increasing the monthly benefit check to $824. Since benefits would be fully increased for any rise in prices above the virtually certain 3 percent thresholdeal purchasing value of Social Security benefits would not be diminished by any further increases in inflation.
Adjusting Social Security and other benefits in this way would keep President Reagan's pledge not to reduce the Social Security benefits of current or future retirees. All of the budget savings would come just from slowing the growth of benefits. And low income households could be exempted from even this benefit slowdown by not applying the threshold to programs targeted at the poor or to Social Security beneficiaries with small monthly checks.
The same 3 percent threshold should be applied to the indexing of tax brackets. With such a threshold, tax indexing would still provide annual tax cuts in the future, but the size of those tax cuts would be temporarily reduced. Starting in 1985, tax brackets will be adjusted annually for the rise in consumer prices.
For example, the 38 percent tax bracket now begins at $45,800 of 1984 taxable income. With complete indexing, a 4 percent inflation rate in 1984 would raise the 38 percent bracket for 1985 to an income level that is 4 percent higher than in 1984, or $47,632. With a 3 percent indexing threshold, the tax brackets would be adjusted only for the excess of inflation over 3 percent. A 4 percent rate of inflation would mean that the 38 percent bracket for 1985 would begin at a level that is 1 percent higher than for 1984, or $46,258.
One important feature of the 3 percent indexing threshold is that future increases in the rate of inflation would have no effect on the real taxes that any taxpayer is called upon to pay. Moreover, although the indexing threshold still keeps the top tax rate at 50 percent, the 3 percent threshold would raise taxes substantially more for high-income individuals than for those of lower incomes.
A 3 percent indexing threshold would reduce Social Security and other benefits by nearly $40 billion in 1989 and would increase tax revenue in that year by an approximately equal amount. The combined effect would reduce the 1989 deficit by a substantial $75 billion.
Using a temporary indexing threshold to help shrink future deficits is not a new idea. We've been advocating it since 1981, and during the past year a bipartisan group of senators and representatives introduced legislation along these lines. Now that the magnitude of the future deficit is clearly recognized, it's time for the administration to join these congressional Democrats and Republicans and include an indexing threshold in its own overall budget plan.