3. What are some of the important provisions of tax and budget legislation, and how does it affect efforts to balance the budget?

[Note: Additional material was added to this analysis on July 6, 1997].

No effort will be made here to provide a detailed breakdown of the four versions (two for each house) of the two reconciliation bills making their way through the conference committees. It will probably take about a month for the compromise legislation to emerge as two single bills to be voted on in both houses of the Congress (expect to see them around early August) and many of the detailed provisions will be very different from what they are now. Instead, summary overviews are offered, with comments on their budgetary impact.

Reconciliation I (HR2014 and S949) - A bill that will reduce net taxes by $85 billion over 5 years.

Generally, this tax reduction bill will reduce a wide array of taxes by an estimated $135 billion over 5 years, offset somewhat by tax increases that close off certain tax privileges and increase some excise taxes, equaling $50 billion over the same period, for a net reduction of $85 billion. Here are the major provisions of the law (remember, not only do House and Senate versions differ somewhat, but the President's version, which will affect negotiations in conference committees add yet a third perspective, and that third perspective is also reflected below):

1. Capital gains - The capital gains tax will be reduced from its present maximum of 28% to (probably) 20%. Capital gains on home resales might be eliminated altogether. Clinton would like to exclude these provisions from the wealthy (generally, those now in the highest 39.6% marginal tax bracket) but Republicans are not going to agree with this. The House would like to index capital gains to inflation, but the President will not agree to this.
2. Child tax credit - A $500-per-child (possibly less) tax credit in addition to the "dependent" credit already allowed is certain, probably restricted to children under age 17 (Clinton has proposed 19), and probably restricted to families below a certain income level (Clinton has proposed $60,000).
3. Estate taxes - There are no federal inheritance taxes in the United States. After the death of the owner or the surviving spouse of an estate, an estate tax is levied before the property is distributed to heirs. Presently, the first $600,000 (approximately) is exempt, thereafter the tax rate rises quickly to a maximum of 55%. Under the new law, the exemption would be increased over the years until it hit $1,000,000. The Senate's and President's version of the law would also reduce or eliminate the tax on specified small businesses and small farms.
4. College deductions - A limited tuition tax credit (probably limited at $1,500) will be allowed for qualified families. Restrictions will apply for families above certain income levels ($80,000?).
5. IRAs - IRA provisions will be expanded, although the particulars have yet to be worked out.
6. Income taxes - Income taxes are unaffected.

Assessment: Everyone loves a tax cut. Compromise is very likely and the final tax bill is likely to be very generous. The cost may be well above $85 billion, especially if optimistic projections for capital gains results are unfounded, and the long-range cost, past the budgetary target year of 2002, is likely to be very substantial. This is not a budget buster, but it will undermine long-term efforts to keep the budget balanced or near a balance, especially if promises on entitlements cuts are not fulfilled.

Reconciliation II (HR2015 and S947) - A bill that will reduce direct (entitlements) spending by $137 billion over 5 years.

Because the House version (HR2015) and Senate version (S947) of the entitlements-reduction component of the 1998 budget are so far apart - a gap that will have to be bridged by the conference committee through the month of July - discussing either individually would not be especially fruitful. Instead a review of Section 104 of the 1998 Congressional Budget (HCR84) identifies the general targets that Reconciliation II is supposed to meet. According to that source, a total savings of $137.237 billion over five years is to be realized. Those targets are shown in the table below. That table identifies the "direct spending" (the term specifically refers to mandatory spending only, generally entitlements) reductions that are to made to programs under the jurisdiction of the Senate committee indicated. For example, the Senate Committee on Veteran's Affairs has been given the task of changing veteran's programs that outlays to those programs will be reduced from current projections by $2.733 billion between FY1998 and 2002.

Strangely, HCR84 provided two sets of targets. One identified the total savings that are to be realized between FY1998 and 2002. The other outlined how much of that should be in the final year, FY 2002. As has been the case in previous budgets, the spending cuts are back-loaded (in a five-year budget, they would not be considered back-loaded if the FY 2002 target equaled 20% or less). For the budget as a whole, fully 43% of all targeted spending cuts are to be realized in the final year (and long after the next presidential election). This issue alone raises some serious doubts about the integrity of this budget.

Because these are entitlements programs, the responsible committees do not have the option of merely capping program outlays, as they would if this were Defense or other discretionary spending. A reduction in direct spending requires a change to the authorizing legislation that regulates the entitlements program. For many programs this would imply some change in entitlements benefits. (See Red Ink, chapter 8, the section entitled Mandatory Spending and PAYGO for more background information mandatory spending cuts and how they are accomplished).

An inspection of the table clearly indicates where the bulk of the savings is supposed to be found. The powerful Senate Finance Committee, chaired by Delaware Republican William Roth, must trim more than $100 billion, 73% of the total, from programs under the committee's jurisdiction. The committee oversees spending for Social Security, Medicare, and Medicaid. Social Security is being excluded from these spending targets. Medicaid may be altered some, but almost all of the savings is to come from Medicare.

Generally, as has been stated in previous Updates, as goes Medicare, so goes the success of efforts to curb spending and balance the budget.

As of the date of this update, the House and Senate versions of the Medicare component are very different. Generally, the Senate version impacts those obtaining benefits now or in the future by (1) proposing that the age for initial benefits be gradually raised from age 65 to age 67, (2) introducing means-testing for the first time, requiring high-income recipients of Medicare benefits to pay higher deductibles, and (c) raising the Plan B premium. The House version, on the other hand, tries to accomplish similar savings by trimming payments for stipulated services to hospitals and medical care providers. These two approaches are very different and it is difficult to project what sort of compromise might emerge from the conference committee.

Assessment: Close to 70% of total savings are to come from one program, Medicare, and House and Senate versions of how that might be accomplished are very far apart. The resulting compromise will probably reduce the final budgetary impact of entitlements cuts.

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