No way to avoid tax hikes, politicians say. Taxes could boost US out of deficit, but which tax is best?
Politicians from both parties increasingly say a federal tax hike will be needed to trim the federal budget deficit. It is impossible to predict the precise economic effects of a tax hike without knowing which of a variety of federal taxes -- individual, corporate, or excise -- would be hiked, as well as the size and timing of the boost. Another important factor influencing the economic outcome, forecasters say, is the mix of spending cuts to tax increases in any deficit-trimming package.Skip to next paragraph
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But some economists warn that a major federal tax hike would involve a significant risk of pushing the economy into a recession. Forecasters disagree on the precise size of the risk -- and the degree to which expected benefits from narrowing the deficit would offset the risk.
Danger of triggering a recession is increased because the current economic expansion is almost three years old, a fairly ripe age by economic standards, economists say.
``We see the economy only muddling through in 1986,'' as American firms continue to lose sales to imports, says Robert Wescott of Wharton Econometrics. ``If you slap on a major tax increase [$25 billion or more] in 1986, you would run the risk of seeing the economy failing to grow.''
The economy is showing signs of picking up after a sluggish first half. The index of leading economic indicators, designed to predict trends, rose a sharp 1 percent in June, preliminary figures show. Factory orders rose 1.9 percent in June, the government said yesterday.
The risk from any tax hike is tied to the size of the tax boost. ``I don't think the kind of tax increase likely to be enacted -- $10 billion to $20 billion a year -- is likely to have a major impact on the economy,'' says Alan Murray, vice-president at Citicorp Information Services. But if a corporate tax hike were combined with a tax-reform package that cut investment incentives, business investment and overall economic growth could suffer, he says.
In a speech Tuesday, House Ways and Means Committee chairman Dan Rostenkowski (D) of Illinois said taxes would be raised ``one day soon,'' but he hoped the tax code would be revised first. ``We've about hit bottom on the spending side,'' he told the National Press Club.
President Reagan this week torpedoed a plan by Senate Republicans to help trim the budget deficit through a $5-per-barrel tax on imported crude oil. The tax would have raised $25 billion over three years.
A tax hike, if part of an effective plan to reduce mushrooming federal debt and interest payments, may also have several positive effects, economists say. Such a move could reduce uncertainty for individuals and corporations who may be holding off on new investments, waiting to see how the government copes with the deficit.
Signs that the US is getting a firmer grip on its budget could reduce concerns that the government would rein- flate the economy to lower interest costs on a $1.8 trillion debt. That might lead to lower interest rates, which could help the US international competitive position by bringing the dollar into better alignment with other currencies.
Spending cuts are the preferred way of deficit reduction, economists say. Because tax hikes change economic behavior in ways that tend to lower economic efficiency, ``raising one dollar [in tax] costs the economy $1.40,'' says John Makin of the American Enterprise Institute.
Boosting taxes reduces the chance that deficit reduction will have a positive impact on the economy, he says. A 5-to-1 ratio of spending cuts to tax increases ``is about the right mix if you have to go to tax increases.''