Would it not be the height of fiscal irresponsibility to legislate another $60 billion a year onto the federal deficit? Yet that is exactly what the president's tax reform proposal might do, according to several tax experts who testified before the House Ways and Means Committee.
After a major shakeup of the tax system, it is inevitably difficult to project the level of future revenue with any accuracy. The Treasury itself admits to a moderate loss, the Congressional Budget Office predicts a much larger shortfall, and the outside tax experts say that, by the end of the decade, the tax revenue under the proposed system could be 10 percent lower than the $628 billion projected under current tax rules. And that is without the effect of the revenue-losing changes that Congress is almost certain to make in the president's plan.
The danger is simply that personal tax rates may be reduced too much. Although the principle of financing lower tax rates through base broadening has obvious appeal, there is no good reason to have chosen the three tax rates of 15, 25 and 35 percent. In fact, these rates were chosen quite arbitrarily as part of last fall's Treasury tax proposal. Since then, many features of the Treasury plan have been changed radically. Although the Treasury has gone through endless fiscal contortions to try to raise enough revenue elsewhere in the system to support those arbitrary tax rates, the risk is that they have failed miserably.
The solution could be simple: If another, slightly higher trio of rates had been chosen -- say, 17, 28 and 40 percent -- the danger of revenue shortfall would be eliminated. One approach Congress could take, then, is to accept the president's principle of base-broadening but choose a slightly higher structure of rates to provide a margin of safety.
But there is an even better way, one that would actually act as an incentive for Congress to get its fiscal house in shape. The key is to enact the 15-25-35 percent tax rates now but to reduce actual rates to these levels only gradually as the budget deficit declines as a result of further spending cuts or economic growth.
Under such a phased-in plan, there would still be a large initial reduction in personal tax rates. But further reductions in rates would depend on achieving specific goals in reducing the deficit. The obvious candidate for such a goal would be the 2 percent of GNP limit called for in this year's presidential budget and in the budget resolutions of the Senate and the House.
Let's say that Congress were to set the rates for 1986 at 17, 28 and 40 percent. The rates for 1988 would then be automatically reduced to the 15-25-35 percent levels if the Congressional Budget Office in 1987 calculates that the 1988 deficit would be under the 2 percent of GNP limit. But if that budget goal is not being met, the further tax rate reductions would be postponed for at least another year.
Such a margin of safety in tax revenue is absolutely critical for both economic and political reasons. Right now the betting is that the budget that is likely to emerge from Congress this year will mean a 1988 deficit that is at least $70 billion more than the goal of 2 percent of GNP. That's just about the amount of extra revenue that would be predicted to come from substituting a 17-28-40 percent rate schedule for the president's 15-25-35 percent rates. It would then put Congress on the spot of finding the extra spending cuts to meet its deficit target or living with the smaller reduction in tax rates.
Without the flexibility that would come from a triggered or phased-in tax plan, future deficits are almost certain to remain too large for the health of the economy. Without a strong incentive of the kind that we propose, Congress is unlikely to make any further significant cuts in spending. And experience shows how hard it is to raise tax rates: Congress has not voted to raise tax rates in any peacetime year since the end of World War II. Any overreduction in tax rates now would be difficult to correct -- especially since the tax system has been indexed to prevent automatic revenue increases through bracket creep.
The gradual phasing-in of the personal rate cuts offers much more than a political escape hatch. It would create a strong incentive for further progress on the spending side. But even if that progress didn't happen, the extra revenue would prevent future budget deficits from pushing the economy off the fiscal deep end.