Federal budget developments.
Decisions about alternative policies have been made more complex by the need to reduce the deficit. For example:
* Taxes: If taxes are to be increased, which ones should be increased? Especially if there is prospect of an economic slowdown, by how much, and when, should they be increased?
* Defense spending: What is the goal of defense spending and what rate of increase in real spending is necessary to achieve that goal?
* Entitlement programs: Do reductions in entitlement benefits that are expected by beneficiaries, such as Social Security benefits, violate a trust?
* Discretionary spending: Have major cuts already pushed discretionary spending close to the floor below which problems will arise?
* Interest: Will interest payments on the icreasing debt ballon out of control and perpetuate the deficit?
The administration's first move, in late January 1984, was to call upon Congress to enact spending reductions and revenue measures to provide a "down payment" toward reducing the large deficits. In March, the administration accepted reductions in defense spending and tax increases with the understanding that Congress would accept reductions in nondefense spending. In April, Congress passed the Omnibus Budget Reconciliation Act of 1983. This act reduced spending $8 billion over fiscal years 1984-87, largely by delaying cost-of-living adjustments for Federal retirees. A second act passed in that month, the Agricultural Programs Adjustment Act, reduced spending about $3 billion over 1984-87. The major feature of this act was a freeze on farm subsidies that are triggered when crop prices fail to reach target levels. In late June, Congress passed the Deficit Reduction Act of 1984, which was designed to reduced the deficit further by increasing taxes and reducing spending.
This article will discuss the major features of the Deficit Reduction Act and the unified budget presented in the mid-session review, which incorporated the provisions of this act as well as recent economic developments.
The Deficit Reduction Act of 1984
The Deficit Reduction Act of 1984 consists of two parts: the Tax Reform Act of 1984 (TRA) and the Spending Reduction Act of 1984 (SRA). The combination of net tax increases and spending cuts is described as a "down payment" on reducing the large Federal unified budget deficits foreseen for the remainder of the decade. The revenue increases from TRA will have relatively little impact on the deficit. For example, in the April unified budget update, the administration proposed (as it had in the February budget) tax increases of $7.9 billion for fiscal year 1985. The new act increases taxes $9.4 billion in that year, providing only a $1.5 billion reduction in the deficit. For fiscal years 1986 and 1984, the differences between proposed and enacted tax increases are $4.6 billion and $7.8 billion, respectively. Similarly, the spending reductions from SRA will have little impact on the deficit. For example, the administration proposed to reduce medicare spending by $1.0 billion in fiscal year 1985; SRA reduces it $1.3 billion. For fiscal years 1986 and 1987, the administration proposed to reduce medicare spending by $2.1 billion and $3.5 billion; SRA reduces it $2.2 billion and $3.1 billion, respectively. However, as mentioned earlier, the combination of tax increases and spending cuts--$13.7 billion and $20.1 billion in fiscal years 1985 and 1986, respectively--is considered only a down payment on reducing the size of the deficit. Additional tax increases can be expected and Congress is likely--under threat of presidential veto--to make further cuts in spending, including that for defense, through the appropriation process.
The Tax Reform Act of 1984
In the few years since Congress enacted the Economic Recovery Tax Act of 1981 (ERTA), the largest tax reduction in history, two other pieces of tax legislation have chipped away at the reductions (table 1). The first was the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), which raised taxes by restricting many tax-reducing provisions of its predecessor. The second is the Tax Reform Act of 1984, which continues the efforts of TEFRA to increase taxes and impose additional compliance measures.
The act affects many areas of the tax code but, for the most part, not in any systematic way. Over a 4-year period-fiscal years 1984-87--the act provides $48.4 billion in additional receipts. About 70 percent of the additional receipts will come from only five provisions:
* Tax freezes, which delay, reduce, or repeal tax reductions--such as a net interest exclusion provided for by ERTA--that were to take effect in 1984 or later years;
* Modification of the income averaging provisions;
* Restrictions on depreciation allowable on leased assets of tax-exempt entities;
* Increasing to 18 from 15 the number of years over which real property (other than low-income housing) can be depreciated under the accelerated cost recovery system of ERTA; and,
* Modification of provisions relating to deferred payments for use of property and services.
although the purpose of TRA is to increase taxes, the act does provide for some tax reductions for both individuals and corporations. The major tax reductions are:
* A 20-percent reduction in the tax liability of insurance companies;
* A 4-year extension, through 1987, of the tax exemption for mortgage bonds issued by State and local governments;
* A 1-year extension, through 1985, of the targeted jobs tax credit;
* A 6-month reduction (from 1 year), through 1987, in the length of time an asset must be held before the proceeds from its sale can qualify for capital gains tax treatment; and,
* A technical correction of the percentage depletion rules for secondary and tertiary oil and gas production.
BEA has prepared estimates of the impact of TRA on Federal sector receipts on the national income and product accounting (NIPA) basis for calendar years 1984-86 (table 2). On this basis, receipts are increased in each of the 3 years: $1.3 billion in 1984 (mostly in corporate profits tax accruals), $11.0 billion in 1985, and $19.4 billion in 1986. Personal tax and nontax receipts
Personal tax and nontax receipts are increased $6.1 billion in 1985 and $9.0 billion in 1986. Withheld income taxes account for only a small part of the increase; they are increased by compliance provisions and by provisions affecting employee health and welfare benefit plans.
Declarations and net settlements account for the bulk of the increase in personal taxes and for about one-half of the increase in total receipts. Among the provisions increasing declarations and net settlements are tax freezes, modifications to income averaging, various changes in the area of tax accounting, and restrictions on depreciation allowable on leased assets of tax-exempt entities. The major tax freeze provision is repeal of a net interest exclusion provided by ERTA. That act allowed taxpayers, after 1984, to exclude up to 15 percent of $3,000 ($6,000 on a joint return) of net interest in determining adjusted gross income. The new act makes three significant changes to the current provisions for income averaging, effective January 1, 1984: (1) The period for determining the base income is decreased to the most recent 3 years from the most recent 4 years; (2) the percentage of base income above which current-year actual income becomes averageable is increased to 140 percent from 120 percent; and (3) the tax is computed on averageable income spread over 4 years instead of over 5 years. The primary feature of the provisions that affect leasing by tax-exempt entities is that property leased to an exempt entity will be depreciated on a straight-line basis--instead of the accelerated cost recovery system--over the following service lives: real property, 40 years; personal property, asset depreciation range (ADR); and personal property with no ADR life, 12 years.
Declarations and net settlements are reduced by TRA under provisions that make a technical correction to the rules for percentage depletion for secondary and tertiary oil and gas production; extend for 4 years, through 1987, the tax exemption of mortgage bonds issued by State and local governments to make low-interest loans to home buyers; and a number of other minor provisions, such as a 1-year extension of the targeted jobs tax credit.
Estate and gift taxes are also increased by TRA as a part of the tax freezes. Under ERTA, the maximum estate and gift tax was scheduled to drop to 50 percent from 55 percent in 1985. The new act delays this reduction until 1988. In addition, there are several minor provisions in the act that relate to the taxation of trusts and estates. Corporate profits tax accruals
Corporate profits tax accruals are increased $4.7 billion in 1985 and $6.7 billion in 1986. Tax freezes account for one-third of the total increase, and include provisions that delay previously enacted tax reductions affecting finance leasing and employee stock ownership plans. Under ERTA, new leasing rules for limited-use property (property that can be used only by the lessee) and fixed-price purchase options became effective January 1, 1984. Under this act, the new rules are delayed until 1988 for leases signed after March 6, 1984. The provision affecting stock ownership plans maintains the 0.5 percent tax credit (based on total compensation of employees under the plan) for employer contributions to these plans; the credit was scheduled to increase to 0.75 percent in 1985. Other major provisions increasing corporate taxes are: (1) The restrictions on tax-exempt leasing discussed earlier; (2) an increase to 18 from 15 in the number of years over which real property can be depreciated; and (3) a variety of new and revised provisions that relate to the taxation of foreign transactions, such as a provision that prevents the factoring of trade receivables through special offshore companies. The act also includes a variety of other tax provisions, such as phasing out the graduated rate for large corporations.
Corporate profits taxes are reduced $1.8 billion in 1985 and 1986, largely through provisions affecting life insurance companies. Although taxes of life insurance companies are reduced on balance, a number of provisions increase them. These include the elimination of the different treatment of mutual and stock companies and a redefinition of taxable income. However, these increases are more than offset by a provision that reduces liabilities by 20 percent. Indirect business tax and nontax accruals
Indirect business tax and nontax accruals are reduced $0.2 billion in 1984 and increased $0.4 billion in 1985 and $3.4 billion in 1986. The reduction in 1984 is due to a provision that lowers the tax rate on heavy trucks to a maximum of $550 from $1600, effective July 1, 1984. To offset this change, the act increases the excise tax on diesel fuel to 15 cents a gallon from 9 cents, effective August 1, 1984. The major increases are a 2-year extension, through 1987, of the current 3-percent telephone excise tax, and an increase in the alcohol excise tax to $12.50 on a gallon of 100 proof liquor from $10.50, effective October 1, 1984. Contributions for social insurance
Contributions for social insurance are initially reduced by small amounts of 1984 and 1985 and increased in 1986. The reductions are due to various provisions that would tend to lower the number of medicare beneficiaries and thus reduce premiums for supplementary medical insurance. The increase results from a provision extending for 2 years a requirement, due to expire at the end of 1985, that beneficiaries' premium payments for coverage of supplementary medical insurnce be calculated so that total premiums cover 25 percent of program costs. The effect is to increase the monthly premium to an estimated $19.100 from $17.70 in 1986 and to $21.30 from $18.60 in 1987. The Spending Reduction Act of 1984
The Spending Reduction Act reduces expenditures $1.j billion in 1984, $3.0 billion in 1985, and $1.6 billion in 1986. In 1984, most of the reduction, which affects the current surplus of government enterprises, is due to a capital assessment by the Credit Union Share Insurance Func (CUSIF) on insured credit unions. The reduction in purchases of goods and services in 1984 is the result of a 90-day delay in pay increases for Federal blue collar workers scheduled during the remainder of fiscal year 1984. The reductions in 1985 and 1986 are concentrated in transfer payments to persons and are due to changes in entitlement programs.
Transfer payments are reduced, on balance, $3.1 billion in 1985, and $1.8 billion in 1986. Medicare benefits are reduced by a number of provisions, including: (1) A 15-month freeze, effective July 1, 1984, on physician fees; (2) a modification allowing nonworking spouses, aged 65 to 69, to make the employment-based health coverage of their spouses their primary medical plan, making medicare a "secondary payer"; (3) the establishment of a schedule of fixed fees for tests conducted by independent laboratories for outpatients; and (4) a limit for fiscal years 1985 and 1986 on the rate of increase in payments to hospitals. The major provision reducing retirement benefits is a shift in the payment date of military retirement benefits from the last day of the month to the first day of the following month, effective September 30, 1985. (The result of this provision is that fiscal year 1985 will have only 11 months of benefit payments.) Other transfer payments are increased by raising the earned income tax credit to 11 percent from 10 percent of the first $5,000 of earned income effective December 31, 1984, the maximum credit--$550, up from $500--is phased down as income increases from $6,500 to $11,000, compared with $6,000 to $10,000 under previous law.
Grants-in-aid to State and local governments are increased by various medicaid provisions, such as providing coverage to first-tme pregnant women who meet the income and resources requirements of the aid to families with dependent children program.
The Mid-Session Review
Revised estimates of Federal unified budget receipts and outlays for fiscal years 1984 and 1985 were submitted to Congress by the Office of Management and Budget in mid-August. These estimates reflect revised economic assumptions, reestimates of agency spending and tax collections based on more recent experience, policy changes by the administration, and legislation passed by Congress since the April budget update.
On the basis of the revised economic assumptions, real GNP is expected to increase considerably more in calendar year 1984 than expected earlier thisyear (table 3). From the fourth quarter of 1983 to the fourth quarter of 1984, real GNP is estimated to increase 6.5 percent, 1.5 percentage points more than estimated in April. This higher growth is the result of a stronger-than expected first half of 1984. Real GNP is expected to increase from 4.0 percent to 4.5 percent through the rest of 1984 and to increase at 4.0 percent through 1985. Consumer prices rise slightly less in 1984 than assumed in April--3.8 percent compared wth 4.3 percent. The unemployment rate is expected to be lower and interest rates on 91-day Treasury bills are higher than assumed earlier.
For fiscal year 1984, a $174.3 billion deficit is estimated, compared with $177.8 billion in April (table 4). Receipts are $2.0 billion lower; downward revisions of $1.7 billion and $0.6 billion due to reestimates and policy changes were partly offset by a $0.3 billion upward revision due to revised economic assumptions. The major policy change was the net effect of TRA, which lowered receipts $0.4 billion.
Outlays in 1984 are $5.5 billion lower; policy changes contributed $3.6 billion, revised economic assumptions, $1.4 billion, and reestimates, $0.5 billion. On a program-by-program basis, the revision is the net of $9.9 billion in downward revisions and $4.6 billion in upward revisions. The largest downward revision is for national defense ($3.9 billion); it more than accounts for the policy-changes contribution just mentioned. Other major downward revisions are for medicare $(1.4 billion); unemployment compensation ($0.8 billion), reflecting lower unemployment; and the Export-Import Bank ($0.5 billion). The largest upward revsions are for the Federal Deposit Insurance Corporation (FDIC) ($1.7 billion), reflecting the financial assistance program for the Continental Illinois National Bank and Trust Company; aid to families with dependent children ($0.7 billion); and the Commodity Credit Corporation (CCC) ($0.6 billion), reflecting higher-than-expected participation in price support programs.
For fiscal year 1985, a deficit of $166.9 billion is estimated, compared wiht $179.0 billion in April. Receipts are $10.7 billion higher; policy changes--almost entirely from TRA--contributed $5.2 billion, reestimates, $2.9 billion, and revised economic assumptions, $2.6 billion.
Outlays in 1985 are $1.4 billion lower; a $5.3 billion downward revision due to policy changes is partly offset by upward revisions due to revised economic assumptions ($2.9 billion) and to reestimates ($1.0 billion). On a program-by-program basis, the revision s the net of $16.0 billion in downward revisions and $14.7 billion in upward revisions. The largest downward revisions are for national defense ($5.9 billion), reflecting a policy decision; unemployment compensation ($2.1 billion), reflecting lower unemployment; military retirement ($1.5 billion), reflecting a provision of SRA; CCC ($1.4 billion), reflecting lower-than-expected participation in price support programs; and medicare ($1.2 billion), also due to SRA. The largest upward revisions are for net interest ($5.6 billion), reflecting higher interest rates; medicaid ($1.2 billion); and the FDIC ($1.0 billion), for the same reason as in 1984.
Revised NIPA estimates.--BEA has prepared estimates of the Federal sector on the NIPA basis consistent with the revised unified budget estimates (table 4, and table 5 for the quarterly pattern). On this basis, fiscal year 1984 receipts are $0.4 billion lower, expenditures are $7.9 billion lower, and the deficit is $7.5 billion lower than estimated in April. (Details of the April estimates are discussed in the April 1984 SURVEY OF CURRENT BUSINESS.)
The downward revision in receipts is more than accounted for by corporate profits tax accruals ($3.1 billion), and reflects lower profits in the revised economic assumptions. Contributions for social insurance are down $0.2 billion. Partly offsetting these decreases are upward revisions in personal tax and nontax receipts ($2.4 billion), reflecting higher incomes, and in indirect business tax and nontax accruals ($0.5 billion), reflecting higher customs duties.
The downward revision in expenditures is more than accounted for by national defense purchases of goods and services ($4.8 billion), subsidies less current surplus of government enterprises ($2.7 billion), transfer payments to persons ($2.5 billion), and net interest paid $(0.6 billion). The revision in national defense purchases reflects the policy decision to reduce defense outlays. Revisions in subsidies less current surplus are due to lower agricultural subsidies and CCC deficit, and those in transfer payments, to lower Social Security (including medicare) and unemployment benefits. Partly offsetting these decreases are upward revisions in nondefense purchases ($2.5 billion) and in grants-in-aid to State and local governments ($0.2 billion). The revision in nondefense purchases by the CCC.
For fiscal year 1985, receipts are $9.7 billion higher, expenditures are $2.1 billion lower, and the deficit is $11.8 billion lower. The upward revision in receipts is more than accounted for by personal taxes ($10.3 billion, and is concentrated in declarations and net settlements), reflecting higher incomes in the revised economic assumptions, and in indirect business taxes ($1.0 billion), reflecting higher customs duties. Partly offsetting these increases are downward revisions in corporate profits taxes and ($3.7 billion), due to lower profits, and in contributions ($0.2 billion).
The downward revision in expenditures in more than accounted for by national defense purchases ($4.8 billion), transfer payments to persons ($4.4 billion), and subsidies less current surplus ($1.1 billion). The revision in defense purchases in due to the policy decision mentioned earlier; in transfer payments, to lower benefits for unemployment, military retirement, and medicare; in subsidies less current surplus, to a higher operating surplus of the CUSIF. The latter is the result of the provision in SRA that imposed a capital assessment on insured credit unions. Partly offsetting these decreases are upward revisions in net interest paid ($6.4 billion), reflecting higher interest rates, and in giants-in-aid ($2.1 billion), reflecting higher public assistance.
Table 6 shows the relation between unified budget and NIPA receipts, and table 7 shows the relation between unified budget outlays and NIPA expenditures.
Cyclically adjusted surplus or deficit.--As measured using cyclical adjustments based on middle-expansion trend GNP, the Federal sector of the NIPA's was in deficit in calendar year 1982; the deficit widened in 1983 and will widen further in 1984 (table 8). On a quarterly basis, the deficit increased sharply in the third quarter of 1982, when the second cut in income tax withholding rates under ERTA became effective. The increase in the fourth quarter of 1982 was due to increases in expenditures--especially for defense and nondefense purchases. The deficit declined in the first half of 1983, but then increased in the second half, when the final withholding rate cut under ERTA became effective. The deficit increases further throughout 1984 before declining in 1985.
The cyclically adjusted budget based on middle-expansion trend GNP discussed above is associated with a middle-expansion trend unemployment rate that is 7.4 percent in 1982 and falls to 7.3 percent by mid-1985. Table 8 also shows a measure of the cyclically adjusted budget based on a constant 6-percent unemployment rate. On this basis, the cyclically adjusted deficit is lower, but follows the same quarterly pattern.
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|Author:||Wakefield, Joseph C.|
|Publication:||Survey of Current Business|
|Date:||Aug 1, 1984|
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