To understand the tax bill now coming out of Congress, apply some good old grammar school skills of arithmetic and history. The arithmetic is that the budget deficit equals federal outlays minus tax receipts. Therefore, a $1.5 trillion tax cut will raise the budget deficit. The history is a review of the past several decades of major tax legislation.
It holds lessons that can help today, as the Republican sponsors would love to invoke the tax reform under President Reagan. One can see why, as the Tax Reform Act of 1986 came close to meeting all the criteria of good fiscal policy. It was efficiency promoting because it reduced marginal tax rates while reducing distortionary deductions, fiscally responsible because it was revenue neutral, and equity enhancing because it put the interests of working families ahead of corporations. It was also the bipartisan outcome of an extended and open process.
{mosads}The tax reform legislation of 2017 is none of these things. The tax cuts of 1981 are a much closer historical precedent, featuring fiscal irresponsibility, benefits going to corporations and the wealthy, and the outcome of a rushed and partisan process. On the plus side, it was well timed from a cyclical standpoint, as the economy in 1981 was heading into recession and so could use the fiscal stimulus. The Reagan tax cuts, like those today, were originally sold on the argument that they would pay for themselves. This claim is rejected by the overwhelming majority of professional economists. The 1981 tax cuts were swiftly followed by a ballooning of the federal deficit, from 2.8 percent of national income in 1980 to a peak of 6.3 percent by 1983.
The White House, surprised at the acceleration in the red ink that resulted from the 1981 tax cuts, agreed to reverse a few of them the next year, in the Tax Equity and Fiscal Responsibility Act of 1982. That law raised taxes well in excess of 1 percent of gross domestic product. Nevertheless, the budget deficit from 1983 to 1986 was still twice the share of gross domestic product that it had been before President Reagan took office. But the 1982 tax increase was enough, roughly, to pay the interest on the increased debt that had been incurred in the meantime.
By the late 1980s, with budget deficits still high and the incoming President George H.W. Bush promising “read my lips, no new taxes,” one could predict that Washington would not acquire the political will to return to fiscal responsibility until the next recession came, which would be precisely the wrong time to do it. That is exactly what happened in 1990. When the president bravely reached a compromise with congressional Democrats, the resulting Omnibus Budget Reconciliation Act of 1990 achieved the criteria of fiscal discipline, equity and bipartisanship. That law raised taxes on upper incomes and capped spending. Unfortunately, the cyclical timing was indeed terrible, as the economy was already sliding into recession.
In 1993, President Clinton renewed the fiscally responsible Bush plan with its caps and all. The cyclical timing was much better suited for fiscal consolidation, as the recession had ended by then. But there was no bipartisan support, as the Omnibus Budget and Reconciliation Act of 1993 passed with only Democratic votes. Despite Republican predictions of doom, there followed the longest U.S. economic expansion on record, the gradual elimination of record budget deficits, and the emergence of record budget surpluses.
In 2001 and 2003, President George W. Bush let the caps system expire and repeated Reagan’s 1981 tax cuts all over again, with legislation that managed to flunk the criteria of fiscal responsibility, equity and bipartisanship. Once again, politicians who self-identified as fiscal conservatives claimed without evidence that the tax cuts were somehow consistent with budget discipline. Once again, the subsequent result was a historic plunge in the budget balance. Once again the national debt rose rapidly, with the predictable result that when the next recession hit in 2007, the government felt sharply constrained in its ability to respond with sustained fiscal stimulus, which helped make the downturn the deepest since the Great Depression of the 1930s.
The partisan tax cuts that the Republicans are about to pass this year will raise the budget deficit, and trade deficit, as the 1981 and 2001 tax cuts did. But there is good reason to think that the long-term effects on the economy will be much worse this time around. That has to do with several issues of timing. Cyclically, the 1981 and 2001 tax cuts went into effect in years when some short-term fiscal expansion was appropriate. The opposite is true today. With unemployment at 4.1 percent, the economy does not need additional stimulus. Indeed, the Federal Reserve will almost certainly raise interest rates this month to head off overheating.
The baby boom generation is now reaching retirement age at a rate of about 10,000 daily. As a result, Medicare and Social Security outlays will increase rapidly from here on out. Meanwhile, the national debt held by the public, which was only 25 percent of gross domestic product when Reagan took office, stands at 76 percent today. This is precisely the wrong time to cut taxes and increase the budget deficit. The Republicans seem intent on repeating the cycle yet again. They refuse to deal with the hole in the roof when the sun is shining, but will suddenly rediscover the urgency of fixing it when the storm hits and repair is most difficult.
Jeffrey Frankel is the James Harpel professor of capital formation and growth at Harvard University. He served on the White House Council of Economic Advisers under President Reagan and President Clinton.