How to get a tax cut

Posted: May 06, 2003 12:00 AM

By Thursday (May 8), both the House Ways and Means Committee and the Senate Finance Committee will have completed mark-up of a major tax bill. They will probably bear little resemblance to each other, because the Senate is operating under a $350 billion revenue loss cap, while the House has $550 billion to play with.

Within even the lower number, there is a lot of good that could be done. But it is essential for the White House to push as hard as possible for meaningful growth provisions. Unfortunately, it is not doing so because it is still wedded to its own $726 billion plan that has no chance of passage as-is.

I strongly supported President Bush's proposal to eliminate the double taxation of corporate profits by allowing shareholders to receive dividends tax-free. But since that proposal was made in January, the economy has been much more sluggish than the administration or I expected it to be. This means that there is much greater need for tax cuts that will provide more immediate stimulus than the president's plan does.

The White House recognizes that the political and economic landscape has changed. But rather than alter its proposal, it has simply revised its rhetoric. Now, instead of making the correct argument for its dividend plan -- that it will raise productivity, growth and incomes over time -- the White House talks only about jobs, jobs, jobs. The problem is that the dividend plan probably won't create many new jobs, and very few of those will come in the short run.

True, the Council of Economic Advisers has forecast that by 2004 there will be 900,000 more jobs than would be the case without additional stimulus. But there are any number of stimulus proposals that would be predicted to do as well or better, given the council's methodology for calculating the figures. Basically, it used a standard Keynesian model in which tax cuts stimulate growth mainly by increasing demand via the deficit. There are no supply-side effects in this analysis.

The problem is that fiscal stimulus can probably be delivered more efficiently in other ways. This means that the same model the council used could potentially show more jobs being created in the short-run with the same impact on the deficit. Moreover, the nature of Keynesian demand models is such that the impact of fiscal stimulus wears off once the economy gets back to its potential. In other words, there is no permanent increase in jobs or growth.

By contrast, in a supply-side model, tax cuts can permanently increase jobs by reducing the after-tax cost of employment. By reducing the wedge between what it costs employers to create jobs and the after-tax wages received by workers, it is possible both to lower the cost of employment and increase the reward to work simultaneously. But this only results if tax rates are cut. Tax rebates and other tax cuts that do not alter effective marginal tax rates will have no impact whatsoever.

Oddly, the Bush administration has never made this argument, even though its proposal would reduce income tax rates for all taxpayers. Nor has the administration ever released a revenue estimate of its proposal that would take account of the faster growth that would result from its enactment. Reportedly, such an analysis was done several weeks ago by the Treasury Department but was never released by the White House.

Those who have seen the Treasury analysis tell me that it strongly supports the president's plan and shows why it would lose much less revenue than the official estimate of $726 billion. Why the administration would bury such an analysis when its plan is under severe attack is a mystery.

Another mystery is why the administration continues to press for full elimination of taxes on dividends when it has been clear for weeks that this is untenable, given the limited amount of revenue available under the congressional budget resolution. By continuing to press for its plan -- no matter how stupidly it is implemented, perhaps with long phase-ins and a sunset provision -- it reduces the chances of enacting good supply-side tax measures such as those proposed by Ways and Means Committee Chairman Bill Thomas, R-Calif.

Thomas would cut the tax rate on both capital gains and dividends to 15 percent and increase first-year depreciation allowances on new equipment by 50 percent, along with other measures that President Bush has proposed, such as speeding up rate reductions, increasing the child credit and reduction of the marriage penalty. I believe that such a plan is as solidly growth-oriented as the president's plan, but with the added virtue of being more stimulative in the short-run.

The White House should get behind the Thomas plan and start figuring out how to get as much of it as possible through the Senate.