Tax cuts without cuts in spending spell trouble

SUNDAY OUTLOOK

November 20, 1994|By Timothy J. Mullaney

Voters swept Republicans into the driver's seat of the next Congress Nov. 8, setting the stage for the new GOP majority to try to make good on its pledge to cut taxes by $193 billion over five years. Last week, President Clinton's budget director, Alice Rivlin, attempted to put a cold compress on tax cut fever, saying the tax cut would hurt the economy. Her scenario: a big tax cut without larger spending cuts than the $45 billion the GOP proposes would lead to inflation. Then interest rates would be forced so high to fight inflation that the nation would face recession. But would it work out that way? What would a tax cut, especially one not fully matched by spending cuts, really do to

the economy?

Richard J. Paget

Head, Municipal Bond Dept. and managing director, Alex. Brown Inc.

It's funny, you know, because I got an analysis of what the Contract With America will cost. You're talking about, as an example, reduced social spending in the crime bill, that's minus $5 billion, and welfare reform saves $40 billion, but the family tax cut is $107 billion. When you add it all up, you increase the deficit $148 billion on top of what we have right now. And if the Fed jacks interest rates, your debt service goes up.

One of the things that freaked the bond market out, why we didn't get the election rally, is that in this nation you always get the quick fix. One of the problems is that we are seeing a pretty good-sized capital outflow from this country. We haven't dealt with the budget deficit or the trade deficit. Until some of these structural things are dealt with, we are going to have some problems.

William E. Mayer

Dean, University of Maryland Business School

I don't think anyone is sure. There's an ongoing economic debate, not always on party lines, but Democrats would often say you don't get a fiscal stimulus from a tax cut, or you get a fiscal stimulus but it's offset by inflation. I think the popular consensus in the country is that unless we have fiscal policies that are conservative, or are responsible, then the psychology of the American public as well as the rest of the world's attitudes toward America would make interest rates go up and make it harder for Americans to borrow money in the world market. Republicans, if they have the tax cuts, are going to have to make the money up somewhere or the world financial markets will react very negatively.

But I think it would be very ill advised to make tax cuts and not make up most of it somewhere on the other side of the fence. I don't think you can cut $75 billion in taxes and not make up at least half of that, maybe two-thirds. If you don't, you will have a riot in the financial markets.

Timothy R. Doyle

President, Mid-Atlantic Region, Ryland Homes

The barriers to home ownership are rising interest rates, and that's happening now. Each 1 percent increase in mortgage rates causes America to lose 350,000 prospective buyers of new and existing homes. It's hard to say what more deficit spending would do to Ryland's business. You have the positive effect in terms of tax cuts adding to people's income, which drives people's disposable income higher, which creates job growth and greater investment. Job growth is a key force in driving new home purchases.

But the deficit does loom. The deficit is an underlying fundamental that can drive inflation concerns that put pressure on interest rates. We've been fortunate enough to sustain better sales this year than we had at the same time periods last year. In the short term of the interest rate increases we've experienced, it has caused some people to move forward in the short term, but if the higher rates are sustained certain folks are eliminated from home ownership. On the other hand, there are financing vehicles like adjustable-rate mortgages that lessen the shock of rising interest rates. By using them, we have been able to still have a solid number of sales.

Michael A. Conte

L Director, regional economic studies, University of Baltimore

I think it will send us into the recession. At the federal level, because they don't have to balance the budget. That will place upward pressure on interest rates. Because so much of the recovery has been interest-rate driven, that will send us reeling backwards. We've already seen the result of increase in interest rates beginning in August, with the first decline in new home sales in the last year and a half.

We're growing pretty well now, and there are states that would probably not go into recession right away. However, the West Coast, East Coast, and Northeast would probably suffer employment losses as a result.

When the government starts trying to cut back taxes or revenue they're not going to be able to plan their decreases in spending -- not regular, repetitive decreases in spending. It's not that it's not possible; it's probably not politically possible. It's not within my realm of experience, and I'm getting pretty old.

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