Abstract: As the votes on the President's deficit reduction package came down to the wire, so much arm twisting took place in Washington that chiropractors worked overtime for several days. Now that the rhetoric has subsided, it is appropriate to assess the probable impact both over the next several months as well as the longer term. The ultimate objective of deficit reduction is to improve the econoroy's long-term growth performance by raising saving and investment. Government deficits do drain the savings of a nation. Deficit reduction plans, however, are not created equal. Raising taxes to reduce a country's deficit will cut into private saving. The drive for greater spending restraint stems from the view that the outlay side is the root and the primary solution to the problem. The package approved by Congress implies that spending will still consume over 22% of gross domestic product by fiscal 1997, down from 23.5% in fiscal 1992. This is still substantially above the less than 19% average share recorded during the first half of the 1960s--the last period of low deficits, inflation, and interest rates. Meanwhile, taxes are projected to total 19.5% of the nation's GDP in 1997, up from 18.6% in 1992 and an average 18.0% in the early 1960s. The fact that greater spending cuts were not made underscores the economic and political pain that such cuts can inflict. California, New England, and other defense-dependent regions have already found out too quickly what the loss of federal dollars can mean. Forecasts of the package's impact on the economy have ranged from a boom in new job creation to a retrenchment into another recession. The question is to what extent lower long-term interest rates (emanating from lower deficit projections) will offset higher taxes. At this point, it appears that there will be some retarding effect on the economy--especially in the first half of 1994--but that the impact will not be overwhelming. GDP growth may be about 0.5% lower in 1994 than if tax rates had been left untouched. The tax increases planned at $26 billion for fiscal 1994 and spending cuts of $21 billion are not sufficient by themselves to trigger a major swing in a $6.2 trillion economy even when all the ripple effects are considered. If most households come to realize that their income taxes will not be going up because of the plan just enacted, confidence could be restored, reinforced by the impact of lower long-term interest rates, including mortgage rates. Output and job growth would continue and, perhaps, improve. Fear and uncertainty could create a larger negative impact. If the majority of taxpayers still believe that they will incur higher taxes at some point, that economic growth and employment will be dampened, or that they will have to pay higher health costs, consumer spending could be curbed more substantially. Companies could also remain exceedingly cautious in their hiring plans because of concerns over higher employee costs caused by health care reform. Uncertainty about health care may, thus, replace taxes as the primary cloud over the economy. Although the macroeconomic effects of the tax increases enacted might not be large, as they are swamped by other forces at work domestically and internationally, increases in marginal tax rates will adversely affect incentives to work, save, and invest. …
Publication Year: 1993
Publication Date: 1993-10-01
Language: en
Type: article
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