Alan Reynolds

We now see the outlines of what Congress is likely to do about taxes this year, thanks to a surprisingly bold and innovative compromise wrought by Bill Thomas, chairman of the House Ways and Means Committee.

The centerpiece is a souped-up version of something I have been writing about since last summer -- namely, making the individual tax on dividends the same as the tax rate on long-term capital gains. Thomas quickly topped that proposal. By January, he was talking privately of wanting to bring the tax on both dividends and gains down to 17 percent to 18 percent. The big surprise in his new plan is that these two tax rates would go lower still, to 15 percent.

The plan came in from some odd criticism in a Wall Street Journal editorial, which faults Thomas for including items from the president's plan. "Thomas also throws in $25 billion in alternative minimum tax relief," say the editors, but that was actually "thrown in" by the White House. The Journal likewise criticizes Thomas for including plans to speed-up the child credit and other social policies. Such criticism is properly addressed to the White House, which threw all that miscellany into its original plan. With the Senate clearly unwilling to enact such a big bundle, however, something has to go. What should be done right away, and what should be set aside?

Somebody has to set priorities. Changes most important to the economy must take priority over those that just appease interest groups. So far, the White House has appeared to take an all-or-nothing approach. Failure to provide executive leadership just leaves the priorities to legislators. Unfortunately, legislators have strong incentives to take a parochial and myopic approach -- to cater to their noisiest constituents and to favor populist policies that appear to make good soundbites for the next elections.

Shortly before the release of the Thomas plan, my old friend Bruce Bartlett (who supports the plan) initially counseled "abandonment" of any dividend tax relief because he could foresee "no way of doing anything worthwhile" about dividend taxes within the Senate's $350 billion 10-year budget. That depends on what you think is worthwhile.

The Urban Institute and Brookings Institution estimated that taxing dividends at the same rate as capital gains -- surely a worthwhile change -- would cost only $78.3 billion from 2003 to 2012. Ways and Means estimates that speeding-up the already enacted cut in the top four tax rates would cost only $74 billion. So the two most important reforms would cost the IRS about $152 billion -- only $15 billion a year. The government routinely misplaces more than that.

Alan Reynolds

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