Why the Republican Congress Hasn’t Cut Your Taxes

Friday, July 30, 1999

When news came in 1994 that the GOP had taken control of the House for the first time in decades, one well-known analyst thought, even before taking his head off the pillow, “Now we can do dynamic analysis.” Which is to say, “Now we can cut tax rates without having to pay for them with spending cuts.” But it never happened. The assumptions underlying congressional budget analysis, which could have been amended when the Republicans gained power, were left untouched. Five years later, they still have not been changed. The then Speaker of the House, Newt Gingrich, was too busy with the Contract with America and never understood their importance. As a result, Republicans have been unable to unite behind their most important weapon and the only one that scares liberals: Tax cuts.

I know “dynamic scoring” sounds a little wonkish and technical, but it is important and its neglect tells us a lot about recent Republican failures. So, after a long absence, I’m afraid economics class will once again come to order. Assume that you sell hamburgers and in the course of a month you take in $10,000. Your burgers are $1 each. Now you reduce the price by half, to 50 cents. Now what is your monthly take? Hard to say. At the lower price, you sell more burgers, maybe many more. In fact, you had better be prepared to stock more meat, more buns, and maybe more workers, too. Possibly more than $10,000 will flow into the till. At the lower price, you may make a profit, maybe a loss. Certainly you will have a larger share of the market.

Dynamic analysis is estimating the real-world effects of price changes. That the demand for something increases when its price is reduced, and declines when its price is increased, is one of the most basic ideas in economics; it is called the law of demand. In fact, it is one of the few things in economics that really deserves to be called a law. Now we come to an important point: There is one place where this law is regarded with grave suspicion: Capitol Hill and, in fact, Washington, D.C., more generally. Applying the law of demand to the government’s own finances, and to the decisions made by the “consumers” of government (otherwise known as taxpayers), is sometimes called ideology, sometimes theology, and in the Reagan era it was called (by an adviser to Reagan, no less) voodoo economics.

Now we must go all the way back to President Bush’s election-losing 1990 budget deal in which he broke his promise of “no new taxes.” The architect of this folly was his budget director, Dick Darman. Not only did Darman undermine his own boss, but he also booby-trapped Republicans in the years ahead. He included in the Budget Enforcement Act a “pay-as-you-go” requirement, now known as PayGo. Fear of the budget deficit was set above all other considerations, so that tax cuts, if enacted, would henceforth have to be offset dollar for dollar by spending cuts, and not just any spending cuts but cuts in entitlement programs such as Social Security and Medicare. (Cutting other budget items such as corporate welfare or highway spending would not count.)

Of course, cutting entitlement spending is politically impossible. And it gets worse, I’m afraid. Darman’s anti-tax-cut provision finally expired in 1997, but the GOP-controlled 105th Congress (the one that ended last December with the impeachment of President Clinton) extended it. So we still are not free from the dead hand of Darman’s 1990 budget deal. In short, tax cuts have been all but ruled out by Washington’s budget procedures, in which the GOP has been at least as heavily implicated as the Democrats.

Since November 1994, nonetheless, the GOP has been free to change the budgetary assumptions used by the Congressional Budget Office—by instituting the aforementioned dynamic analysis. If such a change were made, the revenue change resulting from a reduction in tax rates would be analyzed by assuming that the lower rates would induce behavioral changes that would both increase tax revenues and stimulate growth in the economy. Thus revenues would be sustained even at the lower rates. The earlier experience with tax cuts has shown that this always happens. Cuts in entitlement programs, therefore, would no longer be needed to offset tax rate reductions, if dynamic revenue estimating is used.

The Congressional Budget Office was set up in 1974, at the time of Watergate and GOP disarray. Its first director was Alice Rivlin of the Brookings Institution, who for decades has been a fixture on the liberal side of the policy debate in Washington. She just stepped down as vice chair of the Federal Reserve Board. But her philosophy lives on at the CBO. She both hired the CBO staff and enshrined the methods used to analyze the budgetary and economic impact of tax and spending programs. At the time, 1930s-era Keynesian theory was dominant, with government spending considered a greater contributor to national wealth than private spending, and the discouraging effects of high marginal tax rates always ignored.

With so many signs of degeneration and regeneration, how is it all going to turn out? We don’t know. But now it is at least a contest in which we have a fighting chance.

“Although the CBO would today deny being a bastion of Keynesianism,” Bruce Bartlett of the National Center for Policy Analysis wrote recently in the Wall Street Journal, “it continues to use the methodologies devised during its early days, and many of its early key players are still on board. For example, the CBO’s deputy director and its most powerful presence is James Blum, who has worked for the agency continuously since 1975.” Post-Rivlin, a succession of directors declined to tinker with the existing “model” in use.

The key moment came in 1994, when the Republicans achieved their majority. The Washington Post leaped into the breach immediately with an editorial warning that the budget office might be turned into a “rubber stamp” for tax cuts and that “dynamic scoring” loomed as a real possibility. Horrors! Maybe the Republicans would get their tax cuts after all, despite the best efforts of Darman and the supporters of big government in Washington. All the front-page talk at that time was of the Contract with America, but the Washington Post understood the real threat. The contract, after all, would have to pass both House and Senate and gain the president’s signature: not much danger of all that happening in a hurry. CBO procedures could be changed unilaterally, and immediately, by the new House leadership.

A few weeks after the Republicans achieved their congressional majority, the Wall Street Journal published an article by Harvard economics professor Martin Feldstein pointing out that “official revenue estimating staffs [in Washington] base their calculations on the false assumption that taxes do not alter how much or how hard people work.” This “self-imposed rule” disregarded the impact of tax changes on gross domestic product. As a result, he added, official projections “overstate the revenue gains that would result from increasing tax rates, and the revenue loss that would result from lowering rates.” The overall effect was to “slant policy decisions in favor of higher tax rates.” By early 1995, nonetheless, Democrats were more alert to the real source of the threat posed to big government than Republicans were aware of their opportunity.

On January 10, 1995, the incoming chairman of the House Budget Committee, John Kasich of Ohio, and his Senate counterpart, Pete Domenici of New Mexico, held a joint hearing to review the subject at hand. A Strange New Respect Award winner and a resolute opponent of tax cutting for twenty years, Domenici immediately signaled his preference—that “we continue to put the maximum amount of discipline into this system.” Translation: No change in CBO’s methods is either needed or desired. Departing Senator Exon of Nebraska was of the same mind, opposing “the latest fad in budget scorekeeping.” Wouldn’t it be more prudent, he added, “to stick with the current procedures, which are conservative in the truest sense of the word?” The outgoing CBO director, Robert Reischauer, added his voice to the choir, saluting these senators for their “caution and prudence.”

Former Fed chairman Paul Volcker testified that the existing system has provided an “indispensable element of budget discipline,” while Representative Charlie Stenholm of Texas pontificated sagely, “If it ain’t broke, don’t fix it.” Senator Barbara Boxer was “relieved at the comments of the panel because we had better be conservative. . . . We should stick to the conservative estimating.” (Translation: She enjoyed spending other people’s money and hoped that it would continue to flood in to Washington.) Henry Aaron of the Brookings Institution discussed the so-called income effect, a theory that people seek to stabilize their income, so that when tax cuts increase take-home pay, they just might work less hard. (Tax increases would make us all work harder, then.) This justified Mr. Volcker’s claim that there is “no solid theoretical or empirical base” for dynamic scoring. Markets, Volcker promised, would look on any change “with great skepticism,” and if by some mischance the new Republican majority on the Hill was going to insist that tax cuts would yield economic growth, he for one “would not believe it.”

In the end, nothing was done. June O’Neill, a Republican moderate happy to take dictation from those long ensconced at the budget office, became the new director of CBO, and almost overnight the GOP’s fear of increasing deficits, or of being accused of same, overwhelmed their nervous hope of tax cuts.

After the GOP’s further congressional losses in November 1998, Trent Lott began to slap his fist into his palm and promise, “By golly, now we’re going to cut taxes!” Someone might have suggested to him that he get Pete Domenici’s permission first. After Gingrich’s departure, there has been much talk of reforming Social Security. Democrats, by now confident of their ability to control the public perception of these issues, will be happy to cooperate if they think they can get Republicans to agree to payroll tax increases down the road. Proposed tax cuts in 1999 will in any event fall afoul of the PayGo provision, unless the CBO’s scoring procedures are changed. That means dynamic scoring will be more essential than ever.

June O’Neill left the CBO in January 1999 and was followed by Dan L. Crippen, who worked inconspicuously for Ronald Reagan in his second term. In May, Crippen testified in favor of the Comprehensive Budget Process Reform Act of 1999, which is as complicated as it sounds. One is not reassured to learn that it will create “automatic continuing appropriations,” just in case anyone got any funny ideas about serious budget cutting. The one thing that may safely be said about the proposed reform is that it will go one step further in transferring power from the amateurs (the congressmen) to the staffers (with expertise in the decipherment of budgetary arcana). It is not expected to include dynamic scoring. What can one say? If the Republicans were not willing to act when they were self-confident, they will hardly do so at a time of self-doubt.

Bruce Bartlett has a theory that the Republican leaders were never interested in dynamic scoring because they saw it as the enemy of spending cuts, removing the pressure to make those cuts if tax reduction could be achieved without them. If there is one lesson that Republicans must relearn, it is the basic supply-side lesson that it is politically impossible to cut spending (except for defense spending) as long as the media’s message is the liberal Democrats’ message, and there is no sign of that changing. But with determination it is possible to cut taxes. They must be cut as much as possible and without any thought of the deficit and without any fear of newspaper editorials. In the 1995 hearing discussed above, almost everyone said how difficult it is to estimate the revenue effects of tax-rate changes. And indeed it is difficult. But this counsel of perfection only paved the way for leftists like Boxer to urge a “conservative” policy of caution on us all. In fact, the best thing might be to shut the CBO down completely. Its five-year projections mostly succeed in converting politicians into planners.

Federal taxes as a percentage of gross domestic product are now at an all-time high—higher than they were at the peak of World War II. In the Clinton years, revenues captured by Washington have risen by about 2.5 percent of GDP—a huge increase. In fact, some of the old Keynesians still in our midst—BusinessWeek editorial writers, for example—are beginning to worry that taxes are crowding out consumption. Some of them are even calling for tax cuts on such Keynesian grounds. Don’t be surprised, then, if there is a tax cut in the year 2000. Clinton and Gore might well get behind it, and the Democrats could in the end take the credit. If so, they will have succeeded in wresting back from the GOP the most potent (if unused) weapon in its armory. And the GOP will only have itself to blame.