Economics Update (April-June 1996)

Former Budget Director Optimistic
About Federal Deficit Reduction

senior fellow for the Brookings Institution and former director of the Congressional Budget Office said he believes a federal balanced budget agreement will be reached within a year and a half, but he doesn't see major changes coming for the U.S. tax structure.

Robert D. Reischauer explained these forecasts in a speech to the Federal Reserve Bank of Atlanta's board of directors and other business and community leaders in May.

The government recently ended 16 of the most tumultuous months of budget negotiations that the country has ever seen, he said. The federal government twice shut down for more than a month, and half of a fiscal year passed before a spending plan was approved.

Robert D. Reischauer, Senior Fellow, Brookings Institute
Reischauer said he doesn't expect to see substantial progress on the deficit reduction until after the November election. But regardless of who wins the presidential election, he said, agreement should be reached soon afterward on how to balance the budget.

One reason for his optimism is that balancing the budget will boost economic growth, and that boost should result in lower interest rates, he said. Based on these growth and interest-rate projections, the Congressional Budget Office revised its figures and now maintains that just $188 billion will have to be eliminated from the budget. A year ago, the budget office had projected a need for $266 billion in cuts.

So, the problem is shrinking, Reischauer said.

Another reason for his optimism, he said, is that the efforts to reduce the deficit haven't slipped even while negotiations have been contentious. Discretionary spending has been cut while taxes have not been cut. And that cut in discretionary spending will help reduce the deficit.

And the final reason Reischauer offered for his optimism is that the differences between the president's proposals and the Republican leadership's proposal are not that severe. The president's fiscal year 1997 plan shows 45.7 percent for discretionary spending, 25.3 percent for Medicare, 10.8 percent for Medicaid, and 18.2 percent for other mandatory spending. The Republican's March 1996 plan showed 46.4 percent for discretionary spending, 24.1 percent for Medicare, 12.2 percent for Medicaid, and 17.2 percent for other mandatory spending.

"It's hard to go to war over differences like these," Reischauer said.

If the Republicans win the White House, the deficit reduction proposals that have been vetoed will sail through approval, he predicted. And if the president is reelected, chances are still good because "the size of the problem has shrunk," he said.

Reischauer also noted that progress on reducing the deficit is not likely to come by way of tax increases. Almost half of the reduction in the gap between revenue and expenditures was resolved by tax hikes in 1990 and 1993. And, he said, most of those increases, in effect, fell on those in the top one-fifth income bracket, reversing the tax cuts of the early 1980s.

Increasing taxes again to balance the budget is unlikely, he added, because any additional tax increase would have to be spread across a much wider swath of the population.

Reischauer also expressed doubts about major tax reform. He gave three reasons why he believes a flat tax is out of the question.

First, eliminating the tax advantages of charitable donations would hurt the huge nonprofit sector and force the burden on providing many social services back on the government, he said.

Second, home values might fall 15 percent on average if mortgage interest payments lost their tax-deductible status. To those many Americans whose asset is their home, this would be a hefty personal price to pay for the social benefits of greater capital investment, in Reischauer's opinion.

And finally, pension funds would shrink, and savings would decline because individuals would lose the tax incentive to shelter their income from taxation until retirement.

In conclusion, Reischauer said of the deficit, "I remain quite optimistic that this problem that has bedeviled our policymakers for over a decade is going to get closer to resolution, if not completely resolved, in the course of the next 18 months or so."

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