BUDGET:
A Budget Only the Beltway Could Love

By Robert J. Barro

Despite the hurrahs among Republicans and Democrats alike after last summer's budget agreement, Hoover fellow Robert J. Barro sees little cause for celebration. A critique of a big deal.

One had to be worried when the Clinton administration and Republican congressional leaders both described last summer's budget legislation as glorious. Perhaps the oddest part of the deal is its promise to balance the federal budget by 2002, despite the fact that the budget is already balanced (when computed appropriately, as the change over time in the real value of public debt). Notably missing were basic tax reform and serious spending restraint, and there was little that would favor long-run economic growth. There was, in particular, no movement toward a growth-promoting flat-rate income tax. There was only a little movement toward taxation of consumption and away from double taxation of capital income.

The main good thing was the cut in the capital gains tax rate, though for some reason only on assets held long term. (Is it somehow worse for the economy if an equity is held by a sequence of investors, rather than a single investor?) Indexing capital gains to inflation was deleted from the budget, although most economists agree that taxing purely nominal gains makes no sense. The expansion of the estate tax exemption was good, but one wonders why this tax is retained at all. Typically, income taxes have already been paid on the accumulations that estates represent, and death is already pretty traumatic, so why should it be greeted by an additional levy? Moreover, why should the tax system discourage this key form of saving when insufficient saving is often thought to be a national problem?

Both the Clinton Administration and the Congressional leaders have basically turned into moderate Republicans. They are doing things that are neither outright terrible nor terribly imaginative.

The budget deal's $400-per-child tax credit represents mostly redistribution toward politically favored groups. The only incentive effect is to raise fertility. But with the top and bottom income limits on the credit, the budget negotiators seem to want to encourage population growth among the working poor and the middle class but not among the rich and the truly indigent. It's an interesting form of social engineering that apparently regards these last two groups equally as misfits.

One of the problems with the terrific economy--particularly with the tax revenue generated from the surging stock market--is that it has eliminated the heat for cutting spending. This is particularly true of Medicare. With the elimination of the budget deficit, the only Medicare cuts came from curbs on payments to hospitals and doctors. The government now seems to view the medical profession almost as unfavorably as tobacco companies, and the pretense is that these reimbursement payments can be cut without affecting the amount or quality of service.

The expanded deduction for health insurance bought by the self-employed has the virtue of placing this sector on an equal footing with other businesses and workers. A preferable strategy, however--if the tax subsidy to health insurance is to be maintained--would be to make the deduction available to all purchasers. Then we would not have the problems associated with tying medical insurance to employment.

An especially troubling part of the package is the increased spending for higher education in the form of tax credits for college tuition. It's hard to see why we need this new program to subsidize universities. The program would make sense for private elementary and secondary education, however, where it could be the near equivalent of a voucher plan.

With respect to the higher levy on cigarettes, one can only ask whether the budget negotiators view the optimal tax rate here as infinity. The joy attached to each further attack on tobacco can only be appropriate if the ultimate goal is prohibition. Remember how well that worked with alcohol?

Given all these shortcomings, why were the Clinton administration and the congressional leaders so self-congratulatory? Basically, these two groups have both turned into moderate Republicans and are doing things that are neither outright terrible nor terribly imaginative.

Available from the Hoover Press is a videotape of "Deficit Disorder," an episode of the weekly television program Uncommon Knowledge, jointly produced by the Hoover Institution and the San Jose PBS affiliate KTEH, which features as guests Hoover fellow Martin Anderson and John Ellwood, professor of public policy at the University of California, Berkeley. To order, call 800-935-2882.

Robert J. Barro is a senior fellow at the Hoover Institution and the Paul M. Warburg Professor of Economics at Harvard University.

Barro's expertise is in the areas of macroeconomics, economic growth, and monetary theory. He is currently researching the interplay between religion and political economy.