President Bets Rate Cut Will Speed Growth

President Clinton’s plan to impose the largest tax increase in American history is part of a high-risk strategy for economic revival: By raising billions in new revenue and using most of it to cut the deficit, he hopes to trigger a wave of growth by driving down long-term interest rates.

The gamble is that the interest rates must tumble and growth must surge before the higher taxes begin to drag down economic recovery or Clinton’s plan could turn to ashes.

Though many mainstream economists see few prudent alternatives, it is an economic balancing act that some outside experts are not convinced will work.

If it does, however, then at least in purely economic terms, Clinton will have made a significant beginning on his pledge to bring about fundamental change that would attack the nation’s economic problems.

Clearly, Clinton’s plan would cut the deficit substantially over the next four years, although some details of his plan involve questionable assumptions. The President is gambling that by devoting two of every three dollars raised by his $496-billion package of tax increases and spending cuts directly to deficit reduction, he will be able to break the back of long-term interest rates, which have remained stubbornly high and acted as a giant brake on the economy.

The Federal Reserve has repeatedly cut short-term rates but long-term rates--which affect consumers in such things as home mortgages and businesses in such things as investment in new plants and equipment--have been buoyed by the federal government’s almost insatiable demand for credit to finance the deficit. As a result, the gap between short-term and long-term interest rates has been at record levels over the last year.

On Wednesday, Administration officials repeatedly talked of how their deficit-reduction plan will stimulate the economy through lower interest rates and insisted that middle-class Americans will gain much more from lower interest rates than they will lose in Clinton’s proposed higher taxes on energy and retirement benefits.

The President’s economic blueprint will indeed impose slightly higher taxes on the middle class, Robert E. Rubin, chairman of the Administration’s National Economic Council, said in an interview, but “in exchange you get lower interest rates, improved capacity in the economy and, over the long run, substantially better economic conditions.”

But higher taxes--especially tax hikes on the scale Clinton is proposing--could also pose a threat to continued economic growth. Moreover, Clinton is making his economic policy hostage to the judgments of the world’s financial markets, where long-term interest rates are determined each day.

And although Clinton’s plan overall aims most of its new taxes at the wealthiest Americans--and would sharply increase the overall progressivity of the tax code--some of the taxes Clinton is raising will break his campaign pledge not to hit the middle class, potentially eroding the political credibility he will need to carry out his policies.

So Clinton faces a dual challenge: He must win a “thumbs up” on his overall strategy from the world’s money markets and he must convince wary voters that their sacrifices will deliver practical benefits to almost everyone.

Even before Clinton’s appearance before a joint session of Congress, Administration officials were ready with figures intended to prove that their strategy will do just that. Deputy Treasury Secretary Roger Altman noted in an interview that families earning $60,000 or more a year will pay about $11 more a month in energy taxes, while an elderly family with the same annual income would be hit with an additional $5 or $6 more a month in taxes on their Social Security benefits.

But Altman said that interest rate reductions which have occurred since the November election--which he insisted came as a result of a growing belief in the financial markets that Clinton would cut the deficit--are worth $30 a month in lower interest payments for a family with a $50,000 mortgage and $60 a month for a family with a mortgage of $100,000.

“So I would assert that the cash impact (of Clinton’s economic plan) on middle-income Americans, roughly people earning $75,000 and under, is positive, right now today,” Altman said.

Clinton himself advanced that argument Wednesday night, saying:

“Because of our publicly stated determination to reduce the deficit, if we do these things, we will see the continuation of what’s happened just since the election. Just since the election, since the secretary of the Treasury, the director of the Office of Management and Budget have begun to speak out publicly in favor of a tough deficit-reduction plan, interest rates have continued to fall long-term.

“That means that for the middle class, who will pay something more each month, if they have any credit needs or demand, their increased energy cost will be more than offset by lower interest costs for mortgages, consumer loans, credit cards. This can be a wise investment for them and their country now.”

Lower interest rates also will reduce the budget deficit, the Clinton Administration believes. In fact, the Administration assumes in its economic plan that it will gain $32 billion in government spending cuts as a result of lower interest payments on the national debt over the next four years.

Altman also denied that the Clinton strategy of relying heavily on interest rate reductions to offset tax cuts means that the White House would be a prisoner of the bond market.

“When people think of the bond market, they think of the exchange trading floor,” Altman said, “but when I think of the bond market, I think of mortgage interest payments and auto loans.”

The Clinton strategy seems certain to spark an intense debate among economists, especially since its deficit-reduction program seems to rely far more on tax increases than on immediate spending cuts. Many economists, particularly conservatives, believe that such tax increases will reduce incentives for Americans to save and invest, offsetting any gains achieved from lower interest rates.

Barry Bosworth, an economist at the Brookings Institution supported the Administration’s intention to put the focus on long-term interest rates.

“The only way to stimulate the economy right now is through credible deficit reduction,” Bosworth said.

The debate over that issue would be more clear-cut if Clinton were not also attempting to do far more than simply reduce the deficit and slash interest rates. At the same time that Clinton is raising taxes and trimming some government outlays, he is also mounting an ambitious plan to raise federal “investment spending” in a wide array of domestic programs by $160 billion over four years.

That clearly complicates the economic policy equation and sets a far more difficult test of budget credibility for Clinton to meet. By raising taxes and raising spending at the same time, Clinton must convince the public that his spending cuts are genuine. Otherwise, he will find it difficult to assure voters that his plan is not just another Democratic agenda of “tax and spend.”

That may prove to be a big selling job. In the early years, Clinton’s multi-year plan relies heavily on higher taxes. Only in the final years do spending cuts outweigh tax increases.

Leon E. Panetta, director of the White House Office of Management and Budget, acknowledged Wednesday that the plan relies more heavily on taxes early on. But he insisted that by the end of Clinton’s term, 60% of the plan would be financed by spending cuts, and only 40% by tax increases.

The spending cuts include reductions of $124 billion over four years on the domestic side, including $76 billion in so-called entitlement programs--the largest being a set of $38 billion in cuts in Medicare and Medicaid spending. The plan would cut defense spending by $76 billion more over four years than the George Bush Administration had planned to spend.

Some of the spending cuts that the Administration outlined seemed to be less than totally straightforward. Administration officials counted at least $32 billion in new taxes and user fees over four years as spending cuts. For Clinton, that had the effect of reducing the size of the tax hikes he had to announce to the public.

For instance, Clinton counted a rise in the tax rate on Social Security benefits as a spending cut.

In fact, while Clinton claimed that his plan only raises--on balance--$245 billion in new taxes over four years, the plan actually includes $285 billion in new taxes over five years. As a result, the plan represents the largest tax hike in history, slightly bigger, even in inflation-adjusted terms, than a 1982 tax hike that was designed to reverse some of the tax cuts enacted by the Reagan Administration the year before.

Given such a huge tax bill, Treasury Secretary Lloyd Bentsen, the Administration’s chief spokesman on economic matters, admitted that he had a tough sales job ahead of him. He insisted in a meeting with reporters that, in inflation-adjusted terms, the tax bill actually is smaller than the 1982 plan.

“And now,” Bentsen added wryly, “I’m going up to Capitol Hill and try to convince them of that.”

The Impact On You

On Income

The Clinton Administration’s economic program calls on most Americans to contribute to deficit reduction, but asks some to dig deeper than others. According to an Administration analysis, families with more than $30,000 in annual income will experience a net tax increase. The figures reflect the combined effect of income taxes, the earned income credit, the energy tax, higher taxes on Social Security benefits and other elements of the Clinton agenda on each income group.

CURRENT LAW CLINTON PLAN Federal taxes Federal taxes per income % of per income % of Family group federal group federal income (in billions) income (in billions) income Below $10,000 $6.7 7.8% $6.5 7.6% $10,000 $26.9 9.8% $26.9 9.8% to $20,000 $20,000 $55.7 14.0% $56.0 14.1% to $30,000 $30,000 $152.1 17.3% $156.5 17.8% to $50,000 $50,000 $203.1 19.0% $210.7 19.7% to $75,000 $75,000 $174.3 20.4% $180.2 21.1% to $100,000 $100,000 $242.6 21.2% $250.6 21.8% to $200,000 Above $200,000 $247.5 20.9% $281.8 23.8% Total $1,110.5 19.0% $1,170.9 20.0%

CLINTON PLAN Change in Family tax burden income (in billions) Below $10,000 -$0.2 $10,000 no change to $20,000 $20,000 +$0.4 to $30,000 $30,000 +$4.4 to $50,000 $50,000 +$7.6 to $75,000 $75,000 +$5.9 to $100,000 $100,000 +$8.0 to $200,000 Above $200,000 +$34.3 Total +$60.4

*

On Fuel Bills

The broadest impact of President Clinton’s tax program would be from a new tax on energy. Here is the projected impact of the proposed energy tax on three hypothetical four-person families: Family Income / Energy Tax Burden $25,000 / $105 per year $40,000 / $118 per year $60,000 / $133 per year Increase Per Capita

NATURAL GAS

Annual cost: $9

GASOLINE

Annual cost: $11.13

NUCLEAR / HYDROELECTRIC

Annual cost: $3.51

COAL

Annual cost: $8.75

Source: Treasury Department

The State of the Economy

Here are some key yardsticks for the nation, still mired in record budget deficits and trying to shake free of stagnation.

1992 FEDERAL BUDGET (billions of dollars) Social Security: $285.1 Medicare: $129.4 Medicaid: $67.8 Defense: $304.3 Total: $1,381.8 Sources: Labor Department, Office of Management and Budget, Congressional Budget Office, Census Bureau via Associated Press