FROM THE OFFICE OF PUBLIC AFFAIRS

It is a great pleasure to be here today to talk with our state partners ingovernment about the important subjects of this year's budget and the prospects for tax reform.

This morning, I would like to begin with a brief overview of the current economicenvironment. Second, I would like to discuss some of the tax initiatives the President announcedas part of the Administration's budget, and how they fit into the Administration's plan to continuebuilding an economy for the twenty-first century. Finally, I will enumerate principles we will useto evaluate tax reform ideas.

The U.S. Economy

By almost any measure, we have a strong economy, one, as Secretary Rubin says, that is thebest we have seen in a generation.

• Last week, figures revealed 4.3% growth in the 4th quarter making growth for the year 3.9%. That's the strongest growth we have experienced in over a decade.
• We are currently 81 months into a strong expansion.
• If the expansion continues through the fall as many forecasters expect, it will be the longestpeacetime expansion in history.
• Unemployment at 4.7% is only a notch above its 25 year low last month.
• Business investment is surging at a 9.7% annual pace.
• All this is occurring against a backdrop of the lowest inflation since John F. Kennedy waspresident.

To be sure, economic conditions are better in some areas of the country than others. Nevertheless, on balance the economy is performing exceptionally well. We are enjoying something that has not been seen in a generation, a sustained, low-inflation, investment and exportled recovery.

A Sound Fiscal Policy

Undoubtedly, sound government fiscal policies have contributed to the strong performance ofour economy. In fiscal 1992, we had a budget deficit of $290 billion. This year the deficit isprojected to be $10 billion and heading lower. As a percent of GDP, we have cut the deficit from4.7% in FY 1992 to 0.3% in FY 1997. And next year, our budget will take that deficit to zero.

On Monday, President Clinton submitted a budget with surpluses for the foreseeable future. This represents a historic turnaround in the Nation's fiscal policy.

How Did We Manage to Do It?

In part, this success reflects the courage shown by members of Congress in 1993 in voting fordeficit reduction. In part it represents the good faith and wisdom of those members of Congresswho voted for the balanced budget agreement last year. It certainly reflects our strong economywhich has increased tax receipts.

At the same time, however, it also reflects the fact that the government is today leaner andmore efficient.

Cutting the Deficit the Right Way

Eliminating the deficit has been an important part of our strategy, but equally important hasbeen eliminating it the right way. Over the last five years, President Clinton has fought to protectSocial Security and Medicare while making the investments we need to make in our people andour future to pave the way for continued growth.

This strategy of pursuing a sound fiscal policy while still making critical investments hasworked exceptionally well. As Secretary Rubin said on Monday, it is vitally important that westay this successful course.

The Budget

At the same time, however, as the President said in his State of the Union, now when thingsare good is not a time to rest. It is a time to build. And this year's budget builds on ouraccomplishments while taking on those challenges that remain.

As you know, one of the major questions confronting Congress and the White House hasbeen what to do with the projected surpluses. There are a number of alternatives that have beenfloated, but the President has sent a clear message--protect Social Security:

The Administration's 1999 budget puts Social Security first. The President has proposed thatwe should not spend a single dime of any of our budget surpluses until we have first addressedSocial Security reform and placed it on a sound path. This is in contrast to some who havesuggested that now is the appropriate time for more major tax cuts. The Administration believesthat this would be premature.

Investing in the Future

The second key feature of this budget is that it invests in our future. Of particular concern tome, of course, are the tax initiatives contained in the budget to provide child-care assistance toworking families, to promote energy efficiency and improve the environment, to promoteeducation, to encourage retirement savings, and to increase the availability of low-incomehousing. The budget also extends certain expiring provisions, and contains provisions to simplifythe tax laws and enhance taxpayers' rights. Importantly, every item on this list is fully paid for bymeasures that, among other things, reduce unwarranted corporate tax subsidies, close taxloopholes, and improve tax compliance.

Let me cover some of these specific items.

Child care: As part of the Administration's comprehensive initiative toaddress the child care needs of low- and moderate-income families, the budget proposes a $5.1billion expansion of the child and dependent care tax credit. This would grant three milliontaxpayers an average annual tax cut of $330. In addition, $500 million is proposed for a newemployer credit for providing employee child care.

Climate change initiatives: In combination with other proposedinitiatives to improve the environment and combat global warming, the budget includes $3.6billion for nine tax incentives. Among them are credits for purchasers of highly fuel efficientvehicles, a credit to individuals and businesses for rooftop solar equipment, and a credit forcertain energy-efficient building equipment (such as natural gas water heaters and advancedcentral air conditioners).

Education initiatives: This Administration has the abiding goal ofimproving America's educational system and ensuring that all Americans have access to it. Webelieve that sustaining our current economy requires constant improvement in the education ofour people. Last year's tax bill focused on higher education. With this budget, we propose tomake a major contribution to the improvement of our elementary and secondary schools.

To this end, the budget proposes $5 billion for two public school bond initiatives. Underthese initiatives, the Federal Government would pay the interest costs on State and localgovernment bonds by granting a tax credit in lieu of interest accrued.

• First, approximately $19.4 billion in School Modernization bonds would be authorized to payschool construction costs (allocated half to the 100 school districts with the largest populations ofpoor children and half to the States).
• Second, an additional $2.4 billion in Qualified Zone Academy bonds would be authorized. These bonds, which were established last year and originally proposed by Rep. Rangel, providefunding for schools in poorer areas that have established a partnership with business to improvethe schools.

This initiative has received a great deal of attention from Congress already, and we hope thatit will become law in the near future.

Other initiatives

In addition, this Budget continues the Administration's commitment to help improve localcommunities with innovative tax initiatives.

For example, this budget would increase the low-income housing credit for the first time since1986. As I am sure you are aware, the current limit on a State's annual allocation of first-yearlow-income housing tax credits is $1.25 per capita. The budget proposes to increase this amountto $1.75 per capita, at an estimated cost of $1.6 billion.

The budget would also bolster several other important initiatives. The budget would makepermanent a temporary provision that encourages the cleanup of so-called brownfields. It wouldextend the work opportunity tax credit through May 1, 2000. And it would also provide acorresponding one-year extension of the new welfare-to-work tax credit.

Expand pension coverage

The Administration continues to be concerned that all Americans share in the benefits of ourbooming economy, and believes that incentives to save for retirement should help them do so. Thus, the budget contains $900 million in new incentives for retirement savings.

Taken together these provisions will help us create the foundation, as the President said, forthe next American Century.

Other Tax Restructuring Proposals

I have discussed our major tax policy initiatives. Let me turn now to some of the proposalsfor more radical tax restructure that have been advanced in various quarters.

We in the Administration examine every serious tax reform idea that is proposed. We believethat any acceptable idea for tax reform must as a threshold satisfy four vital principles.

• First, changes in the tax code should not increase or cause a deficit-they should provide all therevenues we need to meet our governmental obligations-nor should they lead to deficits at thestate and local level.
• Second, tax law changes should be fair to working families--they should not shift the burdenof taxes from affluent taxpayers to the middle class and poor.
• Third, restructure of the tax laws should contribute to economic growth.
• Finally, restructuring the tax code should not increase its complexity, either to comply with orto administer, at the state or federal level.

Missing from the debate over these proposals has been the effects they would have on thestates. Their effect upon state and local financing has been virtually absent from the discussion.Nor have the state and local governments been consulted as a party to framing proposals, so thattheir needs can be taken into account.

Let me examine several ideas which have gained particular attention of late, the flat tax, anational sales tax and the sunset of most current taxes.

The Flat Tax

The flat tax, at first glance, may appear to possess an attractive simplicity, that of a single rateand the elimination of all deductions. Less discussed is that it also eliminates from taxationunconsumed capital income-dividends, interest, capital gains. True, if fixed at an appropriate rate,it would not have to increase the deficit. But since consumption is a narrower base than income,the rate applied to a consumption base would have to be higher than one applied to income. Withmoderate exemptions for low income persons, the rate would have to be raised for middle incometaxpayers to make up for the drastic reductions in rates on high incomes and the elimination fromthe tax base of capital income that is largely received by affluent taxpayers. It is difficult to arguethat a flat tax would be fair or that it would contribute significantly to savings or growth.

The notion that a flat tax would achieve complete simplicity by eliminating deductions is alsoquestionable. First of all many items now excluded from income would have to be valued andtaxed-health insurance provided by employers and other fringe benefits for example. And in factany discussion of a flat tax rapidly begins to include exceptions by way of deductions-such ashome mortgage interest and gifts to charity-and the single rate necessarily rises, contributing bothto complexity and shift of tax burden to the middle class. As Deputy Secretary Summers oftensays, by the time you figure in all these exceptions, you would need an electron microscope toread the postcard that it is claimed would suffice for a tax return.

In addition, the flat tax rate that proponents argue would cover the government's expenses isinvariably too low. Many proponents of the flat tax have calculated the low rate using a highlycontroversial method of revenue scoring that takes into account completely speculativeprojections of the effect on our economy of the flat tax.

The historical evidence is conclusive; when taxes were cut in the 1980s, the effects hoped forby proponents did not materialize. Instead, deficits soared. Now, when the budget is finallybalanced, is not the time to jeopardize the progress we have made.

There is another problem with the flat tax. Proponents have generally not involved the statesin the analysis. Most states, as you know, use the federal income tax as a foundation for thecalculation of their own income taxes, and rely heavily on federal rules, such as informationreporting rules, to administer their taxes. Moving to a flat tax, or any other type of tax regime,for that matter, would require states to make a Hobson's choice--either make a radical changefrom the current system to a new and untested regime that may have substantial revenueimplications, or try to sustain a separate and independent income tax system without theadministrative tools provided by the current federal system. From what we understand from thosewho have studied this issue, state governments could face serious difficulties if they were forcedinto this position.

A National Sales Tax

The national sales tax also poses a number of problems when compared to our four criteria.

First, unless the sales tax rate was set quite high, it would imperil our fiscal soundness. Again, now when the budget is balanced is not the time to experiment with ideas that wouldthreaten the progress we have made. A national sales tax of 30-40% such as those advocated bysome would crowd out state sales taxes--jeopardizing the financial footing of our state partners ingovernment.

It would shift the point of collection of our tax revenues to retail seller-the weakest point ofour administration.

A national sales tax would also be highly regressive and therefore unfair to working families. There have been some proposals to remedy this flaw, but we have seen none that come close to asatisfactory solution.

Finally, a national sales tax would impose major administrative burdens. We are currently setup to process the income tax. Changing over to a national sales tax would require the federalgovernment to reinvent tax administration. Many of the proposals would make states responsiblefor collecting these taxes without explaining how they would do so and without having consultedwith the states on this challenge.

And once again, these proposals do not address how states should impose and collect theirincome taxes if the federal income tax is eliminated. A national sales tax could even exacerbatethis problem by crowding out state sales tax revenues--thus making the other state tax bases evenmore important to their financial stability.

Sunsetting the Tax Code

Finally, let me briefly examine the idea of sunsetting the tax code, an idea that has a largenumber of Congressional sponsors who intend to bring this proposal to a vote. The legislativeproposal would repeal all taxes under the Internal Revenue Code, except those relating SocialSecurity and Railroad Retirement, as of December 31, 2000. Congress would be then mandatedto come up with a new unspecified system of taxes in the ensuing six months.

Can anything be more designed to produce chaos in our economy for the next three years? Isit responsible to repeal what is now producing enough revenue to balance the budget without anynotion on what business and individuals can base decision making? What if there is a gridlockduring the first six months of 2001? Who would buy state and local bonds if in three years the taxexclusion accepted as a trade for lower interest rates proves to be ephemeral? What will happento the housing market without certainty as to the status of financing? What are the states to dowith their tax systems in the interim or even during the first six months of 2001 while waiting tosee what, if anything, emerges? Would business continue to invest without the certainty ofdepreciation to recover the cost of investment against taxation? Would the bond market supportTreasury notes in the face of permanent annual deficits of over $1 trillion-the amount of taxessunsetted and not being collected during the first part of 2001?

The stability of our economy is built upon relatively settled expectations of tax treatment andon having a dependable, predictable source of revenues to fund our government. Proposals forsunsetting the tax code, with no replacement, therefore cannot be treated as serious on their face,but rather attempts to push some other agenda.

We are concerned however, that the attraction of the political statement made by a vote tosunset the tax code may be too compelling for some to resist. We hope that good judgment andfiscal responsibility will win out in the end.

Conclusion

In conclusion, this economy is strong. And having succeeded in the difficult task of balancingthe budget, now is not the time to endanger the hard won progress we have made. Instead, weshould stay the course of promoting fiscal soundness while protecting Social Security andMedicare and making the critical investments we need to prepare for the future.

As we go forward, we in the Administration look forward to working closely with you ourstate partners to build the foundations, as the President said, for the next American century.