Order C o d e I B 8 4 0 0 5
CAUSES, E F F E C T S AND S O M E R E M E D I A L O P T I O N S
U P D A T E D 07/15/85
O f f i c e of S e n i o r S p e c i a l i s t s
Congressional Research Service
In 1981 Congress enacted extensive changes i n taxing a n d spending policies
that supporters of these changes expected to g e n e r a t e s u f f i c i e n t r e v e n u e s ,
despite a series o f t a x r a t e c u t s , t o balance t h e budget by FY84.
onset o f recession i n early 1 9 8 2 , however, t h e Reagan Administration's
projections showed widening budget deficits, which culminated
in an actual
FY83 deficit of $195.4 billion.
D e s p i t e enactment of the T a x Equity a n d
Fiscal Responsibility Act of 1 9 8 2 , a n d , more r e c e n t l y , the D e f i c i t Reduction
Act of 1 9 8 4 , large deficits are expected t o persist, even under continued
favorable economic conditions, u n l e s s Federal taxing and s p e n d i n g policies
a r e altered dramatically.
How did this unprecedented situation come about? What
i t have f o r the Nation?
What remedial actions could
questions a r e addressed i n this brief.
BACKGROUND AND POLICY ANALYSIS
Earlier Trends a n d P r e s e n t Policies
From F Y 6 5 to F Y 8 1 , growth i n F e d e r a l budget outlays exceeded that of
receipts (See T a b l e 1).
Defense outlays rose a t a compound a n n u a l r a t e of
7.4% during this p e r i o d , somewhat slower than t h e 10.8% growth i n r e c e i p t s ,
while total nondefense spending g r e w a t a 13.0%
entitlements a n d other mandatory spending (largely Social S e c u r i t y , Medicare,
and unemployment compensation) soared a t a 14.8% rate, while growth i n net
interest payments a l s o exceeded that of receipts.
spending (outlays for transportation, a g r i c u l t u r e , environmental protection,
s c i e n c e , s p a c e , technology, revenue sharing a n d other purposes) grew less
quickly than revenues at a 10.1% a n n u a l rate.
Policies enacted s i n c e 1 9 8 1 , a s well as unforeseen economic circumstances,
have altered these patterns markedly.
Annual growth in revenues slowed
sharply during the FY81-85 p e r i o d , due t o enactment o f t a x cuts f o r
individuals and businesses continued in the E c o n o m i c Recovery Tax Act o f 1 9 8 1
and to the s e v e r e 1981-1982 recession. Growth i n total o u t l a y s slowed during
this period, but by f a r less than revenues, w h i l e spending growth for some
categories actually accelerated.
Tabie 1 shows that annual growth i n defense
outlays jumped from 7.4% during the FY65-81 period
FY81-85, while that f o r net i n t e r e s t outlays r o s e from 13.9%
Annual growth i n nondefense discretionary
spending declined abruptly from
10.1% to 3.3%.
President Reagan's F Y 8 6 Budget proposes tax a n d spending policies w h i c h ,
under the administration's economic assumptions, would r e s u l t i n deficits
totaling $705.2 billion during the FY85-88 period.
The P r e s i d e n t ' s budget
envisions 12.2% a n n u a l growth i n d e f e n s e spending and 6.9% growth i n net
interest outlays during the FY85-90 period.
Entitlements a n d other mandatory
a n n u a l rate while nondefense discretionary
spending would r i s e a t a 4.5%
spending would a c t u a l l y decline 4.4% annually d u r i n g this period.
continue the trend observed during t h e FY81-84 period of increasing the share
of Federal outlays f o r national d e f e n s e amid a steady fall i n the portion
devoted to entitlements and other nondefense discretionary programs
Hse Bud Res
Sen Bud Res
Growth of Revenues and Outlays FY65-90
(Compound annual percentage rates)
O U T L A Y S
ments & Othr Non-Def.
Discretionary Int. Receipts
R E V E N U E S
H s e Bud Res
Sen Bud Res
* T h e Reagan Budget projections assume that the President's F Y 8 6
Budget proposal will be enacted while C B O assumes the continuation
of current policies.
Source: Congress of the United States. Congressional Budget Offices.
T h e Economic a n d Budget Outlook:
Fiscal Years 1986-1990. A report
to the Senate a n d House Committees on the Budget.
Executive Office of the President, Office of Management a n d
Budget. Budget of the United States Government FY86.
Feb. 4, 1985.
United States Congress.
House of Representatives.
Report o f the
Committee on the Budget.
First Concurrent Resolution o n the Budget--FYB6
United States Congress.
Report of the Committee
on t h e Budget.
First Concurrent Resolution on the Budget
May 1985. March 2 0 ( l e g i s l a t i v e d a y , F e b r u a r y 1 8 1 , 1985.
T h e projected s l o w r i s e in net interest outlays i s predicated
optimistic assumption that real interest rates d e c l i n e significantly; if
interest rates a r e higher, a s is assumed by C B O , net interest payments could
grow much faster.
T h e Congressional Budget Office (CBO) projects t h a t the unified
deficit will rise steadily to $ 2 4 0 billion i n F Y 8 8 a n d to $ 2 9 0 billion i n
F Y 9 0 under current policies and economic assumptions that a r e somewhat less
optimistic than those o f the Reagan Administration.
CBO's projections o f
nondefense discretionary spending exceed those contained i n the Reagan budget
because they d o not reflect the Administration's
proposed c u t s i n these
Similarly, CBO's forecasts of net interest outlays a r e higher d u e
to higher projected deficits and interest-rate assumptions.
On May 1 0 , the Senate approved its F Y 8 6 Budget Resolution by a 50-49 vote.
The Senate Resolution (SBR) outlines policies, which would reduce cumulative
Federal budget deficits over the FY86-FY88 period by $ 2 9 5 billion under
Senate's economic assumptions.
D e f e n s e budget authority i s allowed to rise
with inflation in F Y 8 6 , then by 3 % more than inflation i n F Y 8 7 and FY88.
This contrasts with President R e a g a n ' s proposed 8 % r e a l annual growth during
the same period.
(COLAS) for Social S e c u r i t y ,
Federal civilian a n d military pensions, and veterans benefits would be
suspended in FY86, a measure not included i n the R e a g a n Budget.
Senate version c a l l s for substantial domestic s p e n d i n g reductions and
numerous program terminations, s o m e domestic cuts advocated by the Reagan
Administration have been scaled back:
e.g., Federal subsidies t o AMTRAK a r e
to be reduced over the FY86-FY88 period rather than terminated i n FY86.
The FY86 House Budget Resolution (HBR) approved o n May
Federal Budget deficits from $173.2 billion in F Y 8 6 to $124.4
Under the House plan, budget authority for nacional defense would
remain a t its FY85 l e v e l in F Y 8 6 , then rise 3 % above inflation in F Y 8 7 and
Cost-of-living Adjustments f o r Social S e c u r i t y , Federal retirement
programs and veterans benefits would be provided
under current l a w , in
contrast to the. Senate Budget Resolution.
recommends less severe
reductions in nondefense discretionary programs than does the Senate:
HBR calls for the elimination of o n e such program -- General Revenue Sharing
- - whereas the Senate recommends that thirteen be ended.
Table 2 shows
deficits, outlays a n d receipts ensuing from the F Y 8 6 Budget Resolutions
approved by the Senate and House respectively.
T h e economic assumptions
which underly these projections a r e similar to those of the
Administration shown in Table 3.
Evolution of Budget Forecasts Since 1 9 8 1
President Reagan amended President Carter's F Y 8 2 budget request in
February 1 9 8 1 , proposing to cut both revenues and o u t l a y s i n f u t u r e years
from the levels requested by President Carter, but t o cut revenues by more.
Based on a forecast for economic recovery and growth that immediately was
dubbed " a rosy scenario," the budget w a s projected t o reach balance i n FY84.
Seven months l a t e r , however, after passage o f the Economic Recovery
of 1 9 8 1 and approval of some, but not a l l , o f t h e President's requested
spending cuts, t h e Congressional Budget Office
revenues, higher o u t l a y s , and a $ 5 0 billion deficit f o r F Y 8 4 (see Table 2).
These changes reflected (1) less rosy assumptions a b o u t the economy, (2) the
decision of Congress to refuse s o m e of the requested spending c u t s , a n d
t,he enactment of tax reductions larger than the President had proposed.
Successive projections of unified budget deficits,
outlays, and receipts, FY82-88
( $ billions)
F I S C A L
Y E A R S
Carter - 1/81
Reagan - 2/81
CBO - 2/85
Reagan - 2/81
CBO - 9/82
Reagan - 1/83
ZBO - 10/83
Reagan - 2/85
Carter - 1/81
CBO - 9/81
Reagan - 2/82
CBO - 10/83 c
CBO - 8/84
666.5 a 736.9
666 a 735
* The CBO forecasts assume the continuation of current
taxing and spending policies whereas the Carter and Reagan
projections assume enactment of the President's policy proposals.
T h e s e figures a r e actual historical results.
These figures include revenues from the contingency surtax
p r o p o s e d f o r 1 9 8 6 t h r o u g h 1 9 8 8 by t h e R e a g a n A d m i n i s t r a t i o n .
Without reserve funding for economic assistance and including
a s i z e a b l e t a x i n c r e a s e i n FY86.
As T a b l e 2 shows, President Reagan's F Y 8 3 budget, submitted i n F.ebruary
1 9 8 2 , again foresaw sharply lower revenues a n d slightly h i g h e r . o u t l a y s , this
time because the economy had slumped decisively into recession. T h e d e f i c i t
was projected to subside only gradually even with a r o b u s t economic recovery.
Because interest rates i n mid-1982 remained h i g h , this p r o s p e c t aroused c a l l s
i n Congress and elsewhere for tax increases a n d more s p e n d i n g curbs to r e d u c e
the Federal Government's
demands f o r credit.
though taxes were
increased by a n a v e r a g e o f a b o u t $33 billion per year f r o m F Y 8 3 through F Y 8 5
by the T a x Equity a n d Fiscal Responsibility Act of 1 9 8 2 , updated budget
projections by C B O i n September, 1 9 8 2 , indicated that r e v e n u e estimates had
by m o r e than this a m o u n t , d u e to the prolonged
been scaled down -- not u p
Meanwhile spending projections had been increased by r o u g h l y
equivalent sums. T h e deficit was projected t o grow to a b o u t $ 1 5 0 billion
FY83 and t o remain i n that range.
Projected deficits continued to swell
through the end o f 1 9 8 2 a s the deepening recession f u r t h e r depressed
Since the recession's trough i n November of 1 9 8 2 , the U.S.
experienced one of i t s strongest recoveries s i n c e World War
grew 6.3% in 1983 (on a 4th-quarter o v e r 4th-quarter basis) a n d 5.9% in 1 9 8 4 ,
while inflation remained quiescent.
Nevertheless, the d e f i c i t amounted to
CBO projects that this s h a r e
6.1% of GNP in FY83 a n d 4.9% of G N P i n FY84.
will rise under current policy to 5.3% i n F Y 8 5 and remain a t o r above 5.0%
throughout the remainder of this decade.
T h e s e shares would be greater than
n o t t o mention f o r several y e a r s i n
i n any year since World War
T a b l e 2 shows the unprecedented nature o f the C u r r e n t fiscal plight.
Receipts and outlays a r e not expected t o approach balance even i f the
economic expansion continues steadily f o r 5 o r 6 years.
three-stage personal tax rate r e d u c t i o n , increasing a m o u n t s of business
capital eligible for depreciation under generous new f o r m u l a s , the indexation
of the personal income tax brackets a n d exemption amounts beginning in 1 9 5 5 ,
and the setback ensuing from the 1 9 8 1 - 8 2 r e c e s s i o n , the economy simply cannot
generate Federal Government revenues sufficient to catch up with projected
outlays without further major changes in budget policies.
Even after tax
increases enacted s i n c e 1 9 8 2 , tax code changes since the a d v e n t of the Reagan
Presidency resulted in revenue losses o f a b o u t $99 billion i n F Y 8 4 and this
gap is expected to widen in the future. Recouping such r e v e n u e losses would
have been difficult even amid steady economic growth throughout the early
1 9 8 0 s , but the l o n g , harsh recession that occurred instead deferred the
growth of revenue-raising
Unless additional tax = n c r e a s e s or
spending reductions a r e enacted, CBO projects that cumulative deficits over
the FY85-90 period will amount to $1.4 trillion.
The Economic Outlook and Current Budget Forecasts
Assumptions regarding future economic conditions
projections of Federal revenues, outlays a n d deficits.
I n d e e d , CBO's most
recent baseline budget forecast shows net interest outlays rising to $ 2 3 0
billion i n FY90 while the Office o f Management and Budget (OMB) projects that
this figure will be $164.2 billion.
This discrepancy i s l a r g e l y attributable
to differences i n assumptions regarding interest rates, a l t h o u g h it is partly
a result o f differences i n estimation techniques.
How plausible a r e the economic scenarios set forth by C B O a n d
a r e the implications of alternative scenarios for fiscal policy?
Conventional business cycle wisdom h o l d s that consumer purchases of
housing, automobiles a n d other big-ticket
durable goods lead economic
recovery, precipitating increased demand f o r goods and services a n d a buildup
i n business inventories throughout the economy.
Inflation rises a s the
economy approaches full employment. As a g g r e g a t e demand f o r goods threatens
to strain existing capacity, business investment in plant and equipment
r i s e s , which sustains the latter part of the expansion.
H o w e v e r , the
competing credit demands o f consumers and businesses tend t o raise interest
rates, ultimately slowing both consumption and investment.
The economy's behavior during recession mirrors its rise.
demand slows, businesses deplete their inventories, rather than placing n e w
o r d e r s , further dampening economic activity.
Unemployment t e n d s - t o r i s e a s
increasing amounts of capacity a r e i d l e d , wage and price pressures a b a t e , and
interest rates tend to fall.
T h e Economic Assumptions of CBO and OMB
CBO assumes that real GNP growth slows to 3.5% i n 1 9 8 5 and to
1 9 8 6 , while inflation (as measured by the GNP deflator) accelerates
Interest rates (as measured by the 91-day
i n 1986 (see Table 3).
bill rate) rise i n 1 9 8 6 , a s i s typical of the latter phase of a
In its longer-term o u t l o o k , C B O assumes a trend growth r a t e
f o r 1987-90 with stable inflation and interest rates.
T h e small decline in
unemployment in this scenario is consistent with this modest
Furthermore, because unemployment
ttfull-employmentt'rate a b o v e which inflationary pressures a r e thought to
accelerate -- the assumption of stable inflation i s plausible. Real interest
rates (as measured by the 91-day Treasury bill rate less the increase i n the
GNP deflator) remain high by historical standards a t about 4% throughout this
This scenario i s predicated o n the following assumptions: (1) the current
highly stimulative fiscal policy amid restrained growth in the Nation's money
supply continues; (2) the exchange value o f t h e dollar remains a t its present
elevated level throughout the forecast p e r i o d , and ( 3 ) productivity increases
almost 2% per year during the 1987-90 period.
The continuation of current fiscal and monetary policies assumed by C B O
would serve to keep real interest rates h i g h , a s envisioned i n this scenario.
This would tend to raise o r maintain the present high exchange value of the
dollar, which a c t s as a brake on inflation.
However, even if U.S.
interest rates remain h i g h , economic recovery a n d higher real interest rates
abroad or a rise i n U.S. inflation or a default by a major debtor country,
could precipitate decline i n the dollar.
Realization of CBO's third assumption would represent a substantial
improvement in productivity performance from t h e 1973-81 e r a , during Which
nonfarm business productivity grew a t a 0.6% a n n u a l rate.
Productivity r o s e
3.9% over the f o u r quarters of 1 9 8 3 , then slowed t o 2.4% i n 1 9 8 4 ; i t declined
2.5% during the f i r s t quarter of 1985.
T h u s , it is unclear whether
sluggish productivity growth o f the seventies has been f u l l y remedied.
O M B 1 s economic assumptions a r e considerably more optimistic than those of
Real GNP growth is assumed to remain a t a b o u t 4 % throughout the
f o r e c a s t period while inflation (as measured by the GNP deflator),
steadily f r o m 4.3% i n 1 9 8 6 to 3.3% in 1990. Interest rates (as measured
the 91-day Treasury bill rate) f a l l from 8.1% i n 1 9 8 5 t o 5.0% i n 1990.
a business expansion would be unprecedented.
A decline in inflation during a long period o f strong r e a l growth i s
implausible, partly because o f the normal upward pressures that such a boom
would place o n w a g e and price levels. Inflation i s projected
to c o n t i n u e
f a l l i n g even a s the economy n e a r s full employment -- currently considered to
be a b o u t 6 % -- i n 1 9 8 9 , and d r o p s below this threshhold i n 1990.
a d d i t i o n , even without t h e rapid decline i n interest rates assumed i n this
f o r e c a s t , it is likely that t h e dollar's current high exchange rate, which
serves to check inflation by making imports cheap, will deciine.
T h e steady decline in interest rates pictured
i n this scenario a l s o
appears unlikely, given OMB's assumption of continued
growth presumes continually increasing consumption a n d investment amid heavy
F e d e r a l borrowing, which would serve to r a i s e credit demand rapidly a n d ,
h e n c e , interest rates. The likelihood of a rise in inflation would a l s o
s e r v e t o boost interest r a t e s , s i n c e lenders must be compensated for expected
H o w e v e r , a d e c l i n e i n interest rates would be plausible, given assumptions
o f l e s s robust growth. T h e difference between nominal rates a n d inflation
during 1983 w a s very high by historical standards,' possibly because lenders
expected inflation to accelerate eventually.
If inflation rises moderately
and stabilizes i n t h e near f u t u r e , interest rates may decline a s l e n d e r s '
expectations of f u t u r e inflation fall.
(1) enactment of the
T h e following assumptions underlie the O M B scenario:
President's FY86 budget request and the continued gradual tightening o f money
supply g r o w t h , ( 2 ) strong growth in employment due to assumptions of strong
labor-force growth and a n assumed decline in the unemployment r a t e to 5 . 8 % in
1 9 9 0 , (3) r e a l interest rates returning to their long-term levels by the end
o f t h e forecast period, and (4) productivity growth o f 2% per y e a r during the
f o r e c a s t period.
Even assuming enactment of the President's budget a n d t h e realization of
OMB's real growth assumptions, budget deficits would
historical s t a n d a r d s , which, in conjunction with a n ever tightening monetary
policy and robustly growing economy, i s inconsistent with O M B ' s assumption of
continually declining real interest rates. Moreover, the steadily falling
inflation envisioned during the forecast period is implausible given OMB's
assumption of rapid increases i n employment.
Both the CBO and OMB economic scenarios a r e optimistic i n that they assume
n o recession during the next 5 years. H o w e v e r , CBO indicates t h e potential
magnitude of the fiscal crisis should a downturn occur i n the n e a r future.
Assuming that a recession of the same depth and duration a s the 1973-75
downturn begins in 1 9 8 7 , and that a similar recovery f o l l o w s , the F Y 9 0 budget
deficit would total $425 billion under current policies.
Economic and Budget Outlook -- P a r t 1. pp. 7 1 , 72-73.)
T A B L E 3,
The Economic Assumptions sf CBQ a n d OMB
(Growth ( % ch.)
Inflation ( % ch.)
91-day T-Bill ( % )
Executive Office of the President.
Office of Management
Current Budget Estimates.
Apr. 1 5 , 1985.
Also, Congress of the United States.
The Economic and Budget Outlook.
A Report to the
Senate and House Committees on the Budget
P a r t 1.
H o w serious is t h e fiscal situation i n which the Nation f i n d s itself? H o w
urgent i s the need t o t a k e forceful action t o alter the budget outlook? What
k i n d s of action could b e taken?
Implications f o r the Economy
In F Y 7 5 , with a 16-month recession ending i n the middle of the fiscal
y e a r , the Federal deficit rose t o 3.1% of G N P and in F Y 7 6 to 4.0%.
T h e peak
unemployment r a t e w a s 9.0% i n May, 1975; manufacturing capacity utilization,
according t o the F e d e r a l Reserve Board, f e l l t o 71%.
In F Y 8 3 , by comparison,
with a n 18-month recession following closely o n a brief
earlier o n e , the
deficit r o s e t o 6.1% of GNP.
Unemployment peaked a t 10.7% i n December 1 9 8 2 ,
and nearly one-third of the Nation's manufacturing capacity w a s idle.
After two recessions i n 3 y e a r s , separated by only 1 2 months of recovery,
a Federal deficit of this magnitude may have been appropriate in FY83 to
forestall further declines i n economic activity and help t o f o s t e r recovery.
It i s partly a product of the fiscal system's so-called
stabilizers," including the progressive i n c o m e tax rate structure a n d the
commitment t o a substantial d e g r e e of income maintenance f o r the unemployed.
Ironically, the Economic Recovery Tax Act of 1 9 8 1 , passed
different purposes, may have constituted
countercyclical fiscal actions taken by government s i n c e c o n c e p t s of fiscal
stabilization policy were first implemented i n the 1950s.
It marked o n e o f
the f e w occasions o n which deliberate fiscal changes h a v e been made with
timing appropriate to s l o w a recession rather than to speed a recovery. Even
greater fiscal stimulus was applied in F Y 8 3 largely through the personal
income tax cuts.
T h e aspect o f the f i s c a l situation that causes much c o n c e r n , however, i s
that t h e Federal budget Continued to inject stimulus i n t o the economy far
beyond the period of economic recovery and i n t o the expansion, a n d will not
retract this stimulus unless further significant actions a r e taken to narrow
the budget gap.
w s t r u c t u r a l w deficit (with unemployment hypothetically held constant a t 6%)
will r i s e steadily i n t o the later 1980s; signifying heavy f i s c a l stimulus
throughout the period.
The persistence of l a r g e deficits during periods of
economic expansion constitutes a pro-cyclical policy which works t,o maintain
interest rates at extraordinarily high levels and ultimately could aggravate
Such high interest rates handicap credit-dependent industries
a n d , through their influence on exchange r a t e s , hamper trade-related sectors.
R e a l GNP grew 0.7% during the first quarter of 1985 while the Unemployment
rate has remained a t 7.3% since January 1985. Nevertheless, if the recovery
f a l t e r s , proposals t o curtail the deficit sharply in F Y 8 6 a n d after could be
timed to a g g r a v a t e a renewed business cycle downturn. T h e growth phases of
the last seven business cycles have lasted a n average of nearly 4 years.
Only o n e expansion -- i n the 1 9 6 0 s -- lasted more than 5 years.
expansion will be 4 years old i n late 1986.
T h e proper timing of fiscal actions therefore is critical.
situation would be o n e in Which a new recession occurs before the existing
f i s c a l imbalance i s brought under b e t t e r control.
t h i s would
would r i s e r a p i d l y from a l r e a d y v e r y h i g h l e v e l s w i t h a l l
f o r t h e size of t h e n a t i o n a l d e b t and i n t e r e s t payments on it.
s u c h a t i m e t o r e d u c e t h e d e f i c i t w o u l d t e n d t o be s e l f - d e f e a t i n g
t u r n economic r e c e s s i o n i n t o depression.
An E v a l u a t i o n o f P r o p o s a l s t o R e d u c e D e f i c i t s
The f o l l o w i n g s e c t i o n s s u r v e y c e r t a i n d e f i c i t - c u t t i n g p r o p o s a l s
from t h e
The review i s limited t o
many t h a t c o u l d b e c o n s i d e r e d .
b a s e d upon
does not treat t h e pros and cons of
e f f i c i e n c y , program needs o r n a t i c n a l d e f e n s e c o n s i d e r a t i o n s .
t h e t i m e p a t t e r n s of revenues and o u t l a y
t o ensue
A comprehensive review
various deficit-reducing measures.
r e d u c e t h e d e f i c i t i s p r e s e n t e d by CBO i n R e d u c i n g t h e D e f i c i t : S p e n d i n g a n d
A R e p o r t t o t h e S e n a t e a n d House Committees on
Revenue O p t i o n s .
-- P a r t I I .
Tax I n c r e a s e s
Changes i n tax p o l i c y s i n c e 1981 have r e s u l t e d i n s u b s t a n t i a l n e t
losses over the past three
i n personal
income t a x rates, g e n e r o u s d e p r e c i a t i o n a l l o w a n c e s and
t h e Economic Recovery Tax A c t of 1 9 8 1
r e v e n u e l o s s e s o f $ 2 7 6 b i l l i o n d u r i n g t h e FY82-84
v a r i e t y of measures t o c l o s e tax loopholes, e l i m i n a t e unintended p r e f e r e n c e s ,
e n s u r e t h e s o l v e n c y of t h e S o c i a l S e c u r i t y T r u s t Fund, and raise monies
r e p a i r t h e N a t i o n ' s highways have g e n e r a l l y s e r v e d t o i n c r e a s e revenues.
e x c e p t i o n i s t h e r e p e a l o f t a x w i t h h o l d i n g on i n t e r e s t a n d d i v i d e n d i n c o m e ,
which r e d u c e d r e v e n u e s by $ 3 b i l l i o n i n FY84.) D e s p i t e t h e s e a c t i o n s , F e d e r a l
t a x policy changes s i n c e 1981 r e s u l t e d i n n e t revenue l o s s e s of
$99 b i l l i o n
i n F Y 8 4 , a n d t h i s g a p i s e x p e c t e d t o w i d e n t o $ 2 2 8 b i l l i o n i n FY90.
R e v e r s a l o r m o d i f i c a t i o n of t h e s e p o l i c y
1 0 % would
r e v e n u e s by $ 8 3 . 8 b i l l i o n , w h i l e e l i m i n a t i o n o f i n d e x i n g w o u l d
A less d r a s t i c approach would
b i l l i o n d u r i n g t h e FY86-88 p e r i o d .
i n c r e a s e i n m a r g i n a l r a t e s on income i n excess of $70,000 f o r a n i n d i v i d u a l
r e t u r n and on income o v e r $100,000 f o r j o i n t r e t u r n s , which would r e s u l t i n a
$14.6 b i l l i o n g a i n d u r i n g t h i s p e r i o d .
Indexing p e r s o n a l income t a x b r a c k e t s
b y t w o - t h i r d s o f t h e CPI i n c r e a s e o r
i n c r e a s e a l s o would r e s u l t i n s i g n i f i c a n t r e v e n u e g a i n s (s,ee T a b l e 4 . ) .
C o r p o r a t e income t a x r e c e i p t s have
p a r t l y because of
i n ERTA.
Modification of t h e s e r u l e s could i n c r e a s e revenues, while reducing t h e
d i s p a r i t i e s i n e f f e c t i v e t a x r a t e s among d i f f e r e n t i n d u s t r i e s ,
I n v e s t m e n t Tax C r e d i t ,
i n v e s t m e n t s i n equipment b u t n o t t h o s e i n b u i l d i n g s are e l i g i b l e ,
$ 6 4 . 8 b i l l i o n t o r e v e n u e s o v e r t h e FY86-88 p e r i o d .
Corporate tax receipts
c o u l d b e f u r t h e r e n h a n c e d b y e x p a n d i n g t h e e x i s t i n g c o r p o r a t e minimum t a x o r
by i m p o s i n g a s u r t a x o n c u r r e n t c o r p o r a t e t a x l i a b i l i t y .
T h e D e f i c i t Reduction Act of 1984
imposed r e s t r i c t i o n s
E l i m i n a t i o n of
a l l
i n d u s t r i a l development bonds ( I D B ' s ) .
tax-exempt bonds, i n c l u d i n g Mortgage Revenue Bonds, S t u d e n t
Loan Bonds a n d
Hospital Bonds, a s w e l l a s I D B 6 s , would result i n higher r e v e n u e gains.
<ax o n a l l f o r m s of domestic energy consumption set a t 5 % o f value would
swell revenues by $9.8, $14.8 and $15.9
billion over the next 3 years
respectively, while a $5-per barrel t a x on domestic a n d imported o i l would
result i n lower but still substantial revenue gains (see T a b l e 4).
T h e potential f o r deficit reduction through savings o n
discretionary programs i s limited by (1) the relatively small share o f the
budget devoted to such spending; and (2) the f a c t that spending growth for
many such programs has been constrained or reversed during t h e past 3 years.
S t i l l , savings could be achieved by curtailing outlays f o r transportation,
energy, a n d other federally funded programs.
Alternatively, n e w or increased
charges f o r such program services could be levied o n beneficiaries, provided
that the identification o f users a n d a collection mechanism were feasible.
Defense spending accounts for a much larger share (30%) of Federal outlays
than nondefense discretionary programs, and has experienced substantial real
T h u s , significant
growth i n budget authority during the past 4 years.
long-term savings could be achieved by limiting the growth of such spending.
Reductions i n annual outlays could be achieved by lengthening the period over
which n e w weapons systems a r e purchased, cancellation of certain i t e m s ,
In a d d i t i o n , spending
and/or a delay o r f r e e z e on military pay raises.
increases f o r operations and maintenance, a s well a s f o r research and
development, could be constrained.
Of c o u r s e , these decisions involve
judgments concerning the appropriate level of defense spending and the
optimal allocation of such resources among the various defense activitiess.
Many k i n d s of appropriation actions apply Only t o the current o r coming
fiscal year and not to those beyond.
T h u s , while Congress could vote to
exclude or limit the general cost-of-living
pay increase for Federal
employees i n F Y 8 6 , it would S e unusual for Congress to make a binding
commitment now to d o so in F Y 8 7 or beyond.
In the case of defense
procurement, public w o r k s , and other such multi-year
Members of Congress should be a w a r e of the timing with which budget authority
approved o r cut back this year f o r big-ticket projects would affect spending
throughout the balance of the decade.
This category includes payments for health care (Medicare and Medicaid),
Social Security and other retirement and disability programs, unemployment
insurance, agricultural price supports, General Revenue S h a r i n g , and others.
Outlays for these programs are determined by legislated eligibility criteria
and benefit levels i n conjunction with prevailing economic conditions.
example, expenditures for Federal retirement programs are directly affected
by the a g e distribution of the population, outlays f o r Unemp'loyment Insurance
depend o n the level of unemployment, and the rate of inflation determines
cost-of-living adjustments (COLAS) f o r Federal compensation a n d retirement
Outlays f o r programs not involving means test, which include Social
Security a n d Railroad Retirement, Federal Military a n d Civilian Employee
Retirement and Disability, and o t h e r s , could be substantially reduced by
eliminating the automatic COLA for F Y 8 6 , projected to be 3.7%.
T h i s would
s a v e $24.4 billion during the FY86-88 period.
Limiting a n n u a l COLAs to
two-thirds of the C P I inc,rease would result i n projected
s a v i n g s of $2.2
billion i n FY86 a n d $9.6 billion i n F Y 8 8 , while setting COLAs equal to t h e
C P I minus two percentage points would save $3.6 billion i n F Y 8 6 a n d $ 1 4 . 8
billion i n FY88.
I t should be noted that setting COLAs b e l o w the CPP
increase would r e s u l t i n a steady erosion of beneficiaries'
r e a l purchasing
F u r t h e r actions to reduce budget outlays f o r a n d to i n c r e a s e revenues
f l o w i n g into the health care system could r e s u l t i n significant deficit
reductions. Employers a n d employees covered by the Hospital Insurance
program each currently contribute 9.35% of wages a n d salaries, o n the f i r s t
$39,600 of earnings; taxable earnings ceiling rises automatically with
a v e r a g e wages.
By raising this contribution t o 1.5% i n 1 9 8 6 , r a t h e r than to
the scheduled 1.45%, f u t u r e deficits would be substantially reduced while
maintaining the solvency of the HI trust fund.
of o n e measure
passed a s part o f the Deficit Reduction Act of 1984 would be to increase the
s h a r e o f the program c o s t s covered by Supplementary Medical
premiums from 25% t o 35%. This would result i n cumulative savings of $ 7 , 5
billion over the next 3 years.
Elimination of "deficiency p a y m e n t s w to compensate f a r m e r s where crop
prices fall below target levels would result i n cumulative s a v i n g s of $14.2
billion during the FY86-88 period, if f i r s t applied to 1 9 8 6
Termination of General Revenue Sharing would r e d u c e Federal outlays by
billion during FY86-88.
T h e Grace Commission
T h e President's P r i v a t e Sector Survey o n Cost Control, commonly k n o w n a s
the Grace Commission, has made recommendations w h i c h , i t c l a i m s , would
the Government over $400 billion during a n unspecified 3-year period.
the C o m m i s s i o n ' s original mission was to survey methods for
improving efficiency and reducing waste in Government programs, the three
iargest cost-saving measures would involve substantive policy changes.
A joint study by the Congressional Budget Office
(CBO) and the General
Accounting Office (GAO) indicates that implementation of many of these
proposals during t h e FY85-97 period would
r e s u l t i n savings considerably
below the Commission's original estimates.
F o r example, while t h e Commission
estimates that denationalizing Federal power-marketing administrations, such
a s the Bonneville P'ower Administration, would yield a n estimated
billion, CBO projects cumulative savings of $1.2 billion over this period.
F u r t h e r m o r e , GAO w a s critical of some policy
changes advocated by
Commission, such a s the proposal to limit Federal employee's compensation a n d
Other proposals were too vague f o r C B O to re-estimate, e.g.
Commission estimated savings from improved management procedures i n the
procurement process based on their "largely judgmental" assumption that 7% of
such costs could be eliminated.
[ ~ n a l y s i sof the Grace Commission's Major
Proposals for Cost Control. A Joint Study by the Congressional Budget Office
and General Accounting Office. February 1984.1
A number of the Commission's proposals for which CBO w a s u n a b l e to to
estimate budgetary i m p a c t s were deemed conceptually sound by t h e CBO/GAo
report. Recommendations for improving Government procurement practices a n d
r e a l property management, especially i n defense programs, could result i n
specific proposals a r e necessary to
estimate their budgetary impacts (Analysis of the
Proposals, p . 16).
The Deficit Reduction Act included Commi,ssion proposals concerning income
and eligibility verification procedures, collection and deposit of payments
to executive agencies and collection of debts owed to Federal agencies.
The-se measures, aimed a t improving government efficiency and management, a r e
projected to yield savings of $3.2 billion over the FY85-87 period.
Projected results of various measures to reduce
the Federal budget deficit
( $ billions)
Potential Policy Changes
Raise Marginal T a x Rates 1 0 %
Raise Marginal Rates 10%
income over $70,000 for single
return, $100,000 f o r joint
return (p. 226)
Repeal Indexing (p. 228)
Index for inflation over 3%
Delay further indexing until
Jan. 1 9 8 7 (p. 228)
Impose Corp. S u r t a x of (p. 231):
Impose $ 5 tax o n domestic
a n d imported o i l (p. 238)
Impose $5 tax o n imported oil
Impose tax o n domestic energy
consumption (5% of value)
Revise depreciation rules and
repeal ITC (p. 246)
tax-exempt bonds (p. 25,9)
Increase taxation of
benefits (p. 296)
Reduce tax preferences across
the board (p. 303)
Impose 1 5 % alternative
minimum corporate tax (p. 304)
Spending R e d u c t i o n s
National D e f e n s e
Cancel the MX
Cancel the F-15 (PO 75)
Limit spending f o r
Limit growth i n D o D R&D
Limit FY86 O&M spending to
F Y 8 5 level (p. 97)
Limit COLAS f o r non-means-tested
benefits program (P. 135)
Eliminate COLA for FY86
Limit COLA t o 2/3 of
CPI for 5 y e a r s
Limit COLA t o CPI-2 for
Terminate General Revenue
Sharing (p. 151)
Phase out deficiency payments
f o r farmers (p. 159)
Increase SMI premiums to
cover 35% o f program costs
Increase hospital insurance
payroll tax (p. 132)
Nondefense Discretionary Spending
End eximbank direct loan
program (p. 164)
Reduce Federal mass transit
a i d (p. 182)
Raise aviation user fees
to cover Air Traffic Control
costs (p. 185)
Initiatives to reduce Federal
Modify Federal Work Force
(P. 2 0 7 )
E l i m i n a t e a n n u a l pay
adjustment for Federal
civilian employees ( p . 213)
C o n g r e s s of t h e United States.
R e d u c i n g t h e Deficit:
A Report to the Senate and House
C o m m i t t e e s o n t h e B u d g e t -- P a r t 1 1 .
ADDITIONAL REFERENCE SOURCES
CRS reports dealing with effects of deficits include "Large and Continuing
Deficits: Their Influence on Macroeconomic Performancew (Report no. 83-1563)
by G. Thomas Woodward (August 1983), and "Do Deficits Influence the Level of
"Reducing the Federal Deficit: The Macroeconomic Effects
of Expenditure Cuts versus Tax Increases"
83-47E) by Brian
Cashell (January 1983).
For information on major congressional actions on
the FY85 budget, see Issue Brief entitled "The Federal Budget for FY85"
(IB84071), by Philip D. Winters.
For a review of proposed major revisions to
the U.S. Tax System, see CRS MB84211 -- "Tax Revisions: An Economic Overvieww
by Donald Kiefer.
Various other issue briefs deal with budget requests and
congressional actions affecting budgets for particular programs and functions
(see CRS Update).