Prepared Testimony By
James Miller

JEC Hearing on Tax Cuts and the Budget Surplus
September 13, 1999

Since serving as Director of the Office of Management and Budget during most of President Reagan's second term, I have been associated with Citizens for a Sound Economy (CSE), a research, education, and advocacy organization with a quarter-million members and supporters.⁽¹⁾ On their behalf as well as mine, I welcome this opportunity to discuss the desirability of tax cuts in an era of budget surpluses.

Let's start by clarifying certain matters that are often overlooked in discussions of fiscal policy.

First, whether at any time we have a budget surplus or a budget deficit is subject to debate because the federal accounts make only limited provision for changes in liabilities and assets. Yearly swings can amount to tens, if not hundreds, of billions of dollars.

Second, it is usual today for the effects of any major tax or expenditure program to be aggregated over 10 years. For example, Congress has passed a $792 billion tax cut; the President says he is willing to accept only a $300 billion tax cut. This was not always the case. When I was budget director, the time frame was five years. Why not make the time frame 20 years, or 50 years? This would run up the numbers and confuse people even more. Also, these aggregates are not discounted; they fail to distinguish between a tax cut that is $10 billion each of the first nine years and then $100 billion in the tenth year, and a tax cut that is $100 billion the first year and $10 billion annually in years two through 10.

Third, forecasts are just that. Actual fiscal aggregates may be more or less. However, there is far more reason to place confidence in forecasts of next year's performance or maybe the next two year's performance than in any of the "out years." I certainly wouldn't bet the farm on the forecasts for years six through 10.

Fourth, the deficit or surplus is the difference between two very large numbers, revenues and outlays. If the forecasters are off just a little bit in either or both -- especially in ways that don't offset -- there can be substantial differences between the deficit/surplus forecasts and actual performance.

Fifth, although some progress has been made, the major federal revenue forecasting agencies -- Office of Tax Analysis (OTA) and Joint Committee on Taxation (JCT) -- still utilize what may be characterized as basically "static," as opposed to "dynamic," forecasting methodologies. Accordingly, they overestimate the size of any revenue "hit" from a tax rate decrease, and they also overestimate the size of any revenue "bump" from a tax rate increase. Thus, everything else equal, the surplus is likely to be larger with the tax cut than forecast by OTA and JCT.

I make these points to emphasize that we don't know with great precision what the deficit or surplus will be -- with or without a tax cut. What we can be more confident about is the following.

First, as I explained in my testimony before this committee last March, government is so large that it constitutes a significant drag on the rate of economic growth. In particular, taxes -- some more than others -- restrict economic activity. By lowering taxes, you encourage (allow) the economy to be more robust.

Second, it reasonably clear that to the extent a tax cut reduces the government's revenue -- and for most aggregate tax cuts this is the case in the short run -- it also constrains spending. For evidence on this proposition, look within your own hearts. Are you more or less likely to vote for a spending increase if you know there's a deficit looming or a smaller surplus, than if the reverse were true? Q.E.D.

That's why James Carter, of the Senate staff, and I recently wrote a piece in USAToday (see attached) indicating that surpluses can be as problematic as deficits. With deficits, because of "fiscal illusion," people underestimate the cost of government and therefore demand too much of it. With surpluses, elected officials are more eager to increase spending. Either way, government expands beyond the size which is optimal!

So, if you want to see the economy continue to expand, and expand at an even faster rate,⁽²⁾ you will opt for a tax cut, the larger the better. In particular, I urge you to stand firm and insist on the tax package that recently passed both Houses and reject the tax program outlined by the President. I make this recommendation not only because your tax cut is larger, but because yours is of a better type. Let me explain.

One view of taxes is that they are necessary to raise the money the government requires to operate. A conflicting view is that taxes should not only raise money, but should be an instrument of social policy: "bads" should be discouraged with higher taxes, and "goods" should be encouraged through tax breaks. This view may work in theory, but experience shows it doesn't work very well in practice. The data show that "tax expenditures" have ballooned way out of control. The tax code is riddled with special-interest breaks and punitive features. Such a tax code slows economic growth and is felt, by the public, to be unfair overall.

Although your tax cut contains an assortment of provisions that benefit special interests, by and large it is a straightforward, "clean" cut in tax rates. In particular, it would cut income tax rates across the board, including the "death tax," and it would remedy the anomaly of taxing two people more if they are married than if they are simply living together. On the other hand, as the President and the Vice President have repeatedly indicated, their preference is for "targeted" tax cuts -- in other words, tax cuts designed to achieve certain policy goals.

Finally, it should be stressed that while both tax plans envision "saving" social security by "banking" the social security surplus, the President's budget proposal explicitly envisions a far greater increase in outlays than does your budget, of which the tax cut is a part. Obviously, the President's plan, if adopted, would lead to further increases in the size of government, while your plan poses a lower risk. For these reasons, your tax plan should be enacted, and the President's plan should not.
 

1. Neither CSE nor CSE Foundation receive any money from the Federal government -- nor, to the best of my knowledge, have I during the relvant time period.

2. The argument that increasing aggregate demand through tax cuts will lead to inflation has little empirical support and contracts common sense in view of how the effects on demand of changes in monetary policy altogether swamp the fiscal effects at issue.