Clinton tax hike worked, bringing in extra revenue but not as much as hoped
SOON after President Clinton took office in 1993 and proposed a major budget package with higher taxes on the well-to-do, economist Martin Feldstein charged that the plan was a path to wider federal deficits - not lower ones.
``The Clinton revenue estimates,'' wrote the former chairman of President Reagan's Council of Economic Advisers, ``are based on the fallacious assumption that taxpayers will not change their behavior in response to a 37 percent jump in their marginal tax rates.... In reality, taxpayers will find ways of converting taxable income into nontaxable income. Tax shelters and deferred compensation will become more attractive. And some individuals, especially in two-earner households, will opt to work less.''
Because of Dr. Feldstein's stature among economists, his opinion article in the Wall Street Journal caused quite a stir in United States financial circles.
But it is now 22 months later, and the flow of red ink has lightened. In fiscal year 1994, which ended Sept. 30, the deficit recorded its largest one-year reduction in seven years, falling from $255 billion to $203 billion. As a percentage of total national output, the 1994 deficit was the smallest among the industrial nations. With revenues up 9 percent, while spending rose only 3.7 percent, the deficit was the lowest in five years.
The administration forecasts an 18 percent drop to a $167 billion deficit in 1995 - barring a sudden recession. In October, the first month of this fiscal year, the deficit was $32.4 billion, way down from the $45.4 billion in the same month in 1993. This pattern of deficit reduction doesn't mean that Feldstein, now a professor at Harvard University, was wrong. ``He is correct in the direction of impact,'' says economist Cynthia Latta, but he exaggerated the revenue loss.
In an analysis for DRI/McGraw-Hill, a Lexington, Mass., consulting firm, she and a colleague, Kristina Frenyea, figure the most important reason for the drop in the deficit was the unexpected strength of the economic recovery. Uncle Sam takes his share of rising personal and corporate incomes.
By their calculation, the economy accounted for $75 billion of a $104 billion increase in federal receipts. Also a help was better prices on federal sales of failed bank and thrift assets and lower farm-subsidy costs. But changes in the ``omnibus'' tax package that Feldstein criticized were responsible for ``most of the remaining $31 billion'' in revenue increases, they say.
With higher tax rates, some wealthy individuals undoubtedly put extra money into tax-free municipal bonds or different tax shelters. Others may have deferred capital gains by not selling assets that had appreciated in value. Many probably took advantage of a provision in the tax bill allowing deferral of extra taxes for up to three years. Personal tax receipts, originally projected to rise $45 billion to $560 billion, came in at $543 billion.
``Either more of the 1993 personal tax liability attributed to the change in the law has been postponed to 1995 and 1996 than expected, or the higher rates have been less productive than predicted,'' Ms. Latta and Ms. Frenyea note.
So it could be some time before further revenue numbers weaken or strengthen Feldstein's thesis. Whether higher taxes prompt high-income individuals to take it easy, Latta comments: ``I suppose some people will reduce their work effort. But most of those I know who make big bucks like to work.''