Indexing-Minus-3% Can Salvage the Budget : Deficit: A threshold on inflation adjustments to federal cash benefits and taxes would not endanger the recipients.

After the latest federal budget fiasco, it should be obvious that next year’s budget is going to have to come up with significant new revenues, as well as spending cuts, if future deficits are to shrink in line with the Gramm-Rudman targets.

If the plan is well-designed, it need not hurt the poor, reduce desirable government services, reverse the 1986 tax-rate reductions or violate President Bush’s promise not to introduce new taxes.

Our favorite candidate for a multiyear plan to reduce the deficit is a revision of the rules for indexing, the process of adjusting benefits and taxes for inflation. Under current law, income-tax rates and most cash benefits are fully indexed for inflation. By contrast, excise taxes are not adjusted at all. Although we believe that the benefits paid to the poor should be increased annually in line with inflation, we favor less-than-complete indexing of all taxes and benefits for the nonpoor.

More specifically, we like the idea of CPI-minus-3%. This would mean that benefits and taxes are adjusted only for increases in the consumer price index that exceed 3% a year. For example, if prices rise 5%, as many economists expect they will next year, benefits and taxes would be adjusted by 2%. If inflation ran higher than 5%, benefits and taxes would be adjusted by a correspondingly greater amount.

Although the 3% indexing threshold would make a big dent in the budget deficit, it would not change in any way the current protection that indexing gives. If inflation ever got back to the very high levels that prevailed at the start of the decade, individuals would receive the same inflation-adjusted benefits and pay the same inflation-adjusted taxes as they would if the inflation rate was 3%.

Moreover, the CPI-minus-3% plan need not be a permanent change in the indexing rule. Rather it should be enacted for a period of three years to shrink the deficit. After that, full indexing would return.

Just how much would the CPI-minus-3% rule do to help reduce the deficit? Adjusting personal income-tax indexing in this way would raise approximately $10 billion in 1991, $22 billion in 1992 and at least $35 billion in each year after.

A similar adjustment to Social Security and other cash benefits paid to individuals above the poverty line would reduce the deficit by about $8 billion in 1991, $16 billion in 1992 and at least $25 billion in each year starting in 1993.

Finally, the excise taxes on products like alcohol, tobacco and gasoline are not currently adjusted for inflation. The revenue from this source has actually fallen since 1980. We favor raising these excise taxes by the amount of inflation since personal taxes were indexed in 1985, then adjusting them upward in the future at the same CPI-minus-3% rate as other taxes and benefits. Such a plan would raise $7 billion in 1991, $8 billion in 1992 and at least $9 billion a year starting in 1993.

Putting these three pieces together would yield $25 billion of deficit cuts in 1991 and $70 billion a year starting in 1993.

The 1991 budget that President Bush will present to Congress early in the new year must take the steps that are needed to achieve real deficit reduction. The President now commands the popularity that would allow him to take a bold stand and propose a reliable and balanced plan for deficit reduction.