Bush?s mad cap idea

Larry Kudlow
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Posted: Feb 20, 2005 12:00 AM
One of the defining characteristics of the presidency of George W. Bush has been that he says what he means, and means what he says. Our CEO-like MBA president has always communicated his vision in clear and simple terms. Once he establishes a policy, he moves rapidly to implement it with all the political force he can muster. You could even argue that Bush has been the clearest and most reliable presidential-policy maker since Ronald Reagan -- one would have to go back many more decades to find another chief executive like him. That?s why his latest gambit on Social Security payroll taxes is so hard to fathom.

Bush clearly stated after last November?s election that his visionary Social Security reform plan to include personal savings accounts would not countenance payroll-tax increases. Just this week he undercut that position when he said an increase in the payroll-tax cap -- now $90,000 -- would be ?on the table? in forthcoming negotiations with Congress. White House spokespeople have tried to suggest that an increase in the payroll-tax cap is not a new tax, and that only a rise in the payroll-tax rate would constitute a tax hike. This is nothing but doublespeak. The American public will see it for what it is.

A front-page editorial in the New York Sun referred to this episode as ?sins of the father.? Papa Bush, you may recall, pledged no new taxes. He then broke that pledge with a huge tax hike in his second year in office. That broken promise, along with the added tax burden on working Americans, proved politically catastrophic as Bush 41 was defeated by Bill Clinton.

Why has Bush 43 moved into this fudge-factor trial-balloon zone? It is a politically dangerous space. His proposal could also have highly negative economic consequences.

When John Kerry floated a payroll-tax cap increase during the last election campaign, esteemed Harvard professor Martin Feldstein calculated that a family making $110,000 a year would face a tax increase of more than $2,700, essentially a 20 percent hike. According to Americans for Tax Reform, a new tax cap of $150,000 would increase the combined employer-employee tax burden by roughly $7,400. The Heritage Foundation estimates that raising the cap would directly increase taxes for 7 million middle-class families.

Wall Street economist Michael Darda has also turned in some startling numbers. Eliminating the $90,000 ceiling on payroll taxes would boost the top marginal income-tax rate to 47.6 percent from 35 percent. Darda estimates that after-tax returns on marginal work effort would fall from 65 cents to 52.4 cents on the extra dollar earned, a 20 percent decline.

This is big money. What is more, economists have long acknowledged that the Social Security tax is a direct levy on employment, increasing the wedge between work effort and reward and making new jobs more costly. Any hike in the wage tax cap would most significantly impact small-business owners and the self-employed -- the most dynamic growth sector for job creation. Should the combined marginal tax rate on personal income and Social Security wages increase significantly, both economic and job growth would be greatly deterred.

Ironically, Harvard?s Feldstein argued that hiking the wage cap would create a dead-weight loss on the economy and would lead to significant tax evasion by small-business owners who have chartered as S-Corps or LLCs. Consequently, the net revenue gain from a wage-cap increase might be only $14 billion if the cap were hiked to $110,000. While damaging the economy in terms of rolling back incentives to work, this small revenue yield would do virtually nothing to solve the pending Social Security financial problem.

So why did Bush say it? It is completely out of character for him to shift positions and negotiate with himself. Certainly, the economics are just as bad as the politics. And it?s not as though hundreds of Democrats in the Senate and House are now rushing to the negotiating table. They?re not. If this talk continues the president?s political base could suffer a sizeable morale loss. It might not surface until the 2006 midterm elections, but it could be quite damaging to GOP prospects.

Fortunately, House Majority Leader Tom Delay has publicly stated that the lower body will not pass a Social Security tax hike of any kind -- including increased marginal tax rates or a higher wage cap. Speaker Dennis Hastert and Rules Committee chairman David Dryer have indicated the same. They won?t touch a John Kerry tax-hike proposal, especially one that will inflict serious economic damage. This is good news.

Let?s hope George W. Bush gets the message and returns to the straight talk that has earned him the credibility and respect of American voters and workers.