Chaos comes to Congress - failure to create economic policies that will reduce the deficit

National Review, July 11, 1994 by Lawrence A. Kudlow

Chaos Theory says that the order one perceives is not the true order. Originally developed to attack forecast models for the weather, and later extended to the economy, chaos theory would apply nicely to the federal budget, where nothing ever turns out as advertised. Take the Clinton Administration's constant boasting that next year's budget deficit (FY 1995) will fall to $170 billion as a result of the budget cuts and tax increases in last year's "deal of the century." In fact, the only real budget cuts came in defense, where spending as a share of GDP will soon drop to 3.5 per cent, its lowest level in over forty years, a fact duly noted by North Korea's Kim Il Sung and other rogues around the world.

Meanwhile, domestic spending, which has increased 9 per cent annually over the past five years, is projected to rise by another 6 per cent per year, or twice the projected inflation rate, over the next five years. Hardly budget-cutting. What is more, the Clintonites have come up with massive new entitlement proposals for health care and welfare reform. These measures may be defeated this year, to be revisited by a more conservative Congress in 1995. But should they pass in this session, universally mandated health care and unlimited training and government jobs for welfare recipients would soon raise entitlement spending to double-digit growth rates. So much for future restraint.

As matters now stand, means-tested entitlements (e.g., Medicaid, food stamps, supplemental security income, AFDC, veterans' pensions, student loans) are expected to grow at a 9 per cent annual rate, or three times predicted inflation, over the next five years. Non-means-tested entitlements (mostly Social Security and Medicare, but also unemployment compensation, farm price supports, and others) are projected to rise 6 per cent per year. So, if all this spending is rising, why does Washington keep telling us about huge reductions in the deficit, not only from last year's deal, but also from George Bush's Presidency-ending deal in 1990? The answer is chaos theory: What is supposed to be is not.

There's even more of this on the revenue side. Remember the tax hike of 1990, when Bush moved his lips? It was supposed to raise $158 billion over five years. The latest estimates from the Congressional Budget Office (CBO) show a $486-billion shortfall from the initial baseline projection. Just a slight miss, really. So why should anyone believe that last year's tax hike will produce the projected $241-billion rise in revenues?

Indeed, revenue is already slipping. Congress expected income-tax receipts to grow by 7.2 per cent as a result of its 'tax-the-rich" hike in the top individual-income-tax rate from 31 per cent to 40 per cent. For the first seven months (October through April) of FY 1994, these receipts have grown by only 6.2 per cent.

If this trend continues, Uncle Sam will come up $5 billion short by the end of the fiscal year. If individual income-tax receipts fall 1 percentage point below projections for five years, then the government will cumulatively fall $90 billion short, just in this one area. No one listened last year to Harvard economist Martin Feldstein and others who argued that higher tax rates on upper-income earners would lead to greater tax avoidance and reduced workforce participation, especially by spouses and other part-time earners. But that is exactly what seems to be happening.

One additional deception, back in the spending area. In 1990, much noise was made over the so-called tight-as-a-drum caps on discretionary (read: non-entitlement) spending. But the drum's canvas cover has badly sagged. The level of defense spending has declined by $24 billion since 1990. However, these savings" were simply re-channeled into domestic discretionary spending; they were not used to reduce the deficit. During the past six years "government investment" (in transportation, community development, education, training, employment, and the environment) increased by $45 billion, or roughly 8 per cent a year.

More recently, Congress and the White House have colluded to break the spending caps by using emergencies such as hurricanes, floods, and earthquakes to lard supplemental appropriations bills with sizable pork. Of the $11 billion expended for the L.A. earthquake, for example, $3.2 billion was clearly non-emergency funding. In fact, domestic emergency" authorizations in recent years have totaled nearly $40 billion, completely busting the spending caps.

Looking at this Alice-in-Wonderland fiscal fairy tale, where tax hikes do not generate higher revenues, and spending cuts turn into increases, one might reasonably ask: How is it that the deficit has still come down below $200 billion? There are two answers. First, the gradual recovery of the nation's banking system has lowered government outlays for deposit insurance by $74 billion in the past two years, as the Resolution Trust Corporation (RTC) is now collecting money from the sale of assets, rather than spending money to purchase them. But this has nothing to do with ongoing program spending.