Not all tax cuts are created equal

Posted: Nov 28, 2001 12:00 AM
Don't be misled by the illusion of bipartisanship conjured up in pictures of President George W. Bush and Senate Democratic Leader Tom Daschle hugging. It's more a clinch than a hug as Democrats play "rope-a-dope" on the so-called stimulus package, wrestling with the president and trying to wear him out fending off their class-warfare tactics and big-government spending schemes. Five versions of a stimulus package are on Capitol Hill, none of which has sufficient support to be enacted into law. All of the proposals, including the president's, are premised on stimulating aggregate demand, a discredited Keynesian economic theory that presumes the economy can be kick-started by having the government and consumers spend more money. Past experience and extensive economic research refute both notions. Unfortunately, the administration's use of Keynesian rhetoric makes it difficult to fend off congressional spending schemes and has prevented Bush from supporting the best thing we could do to revive the economy, cutting the capital gains tax rate. The House-passed bill and the Senate Democratic proposal delimit the range of the proposals. The House bill accelerates the income tax rate reductions, modestly cuts the capital gains tax rate, temporarily accelerates business depreciation, rebates $14 billion of payroll taxes to low-income workers and repeals the corporate alternative minimum tax, while rebating $25 billion in past AMT taxes to some of America's largest corporations. The proposal favored by Senate Democrats also rebates $14 billion of the payroll taxes and makes modest temporary changes to business depreciation, makes no additional tax rate reductions and increases federal entitlement and pork-barrel spending dramatically. Bush's stimulus proposal and a hybrid Senate proposal by Senators John Breaux, D-La., and Olympia Snowe, R-Maine, move slightly toward the middle from both ends of this range respectively. Bush would cut taxes a little less than the House - although he would, unlike the House bill, accelerate the reduction of all tax rates, including the top rate - and eschew cutting the capital gains tax rate while spending a little more. Breaux and Snowe would spend a lot more money and cut taxes a lot less. At the center, "between" the other four proposals, is a proposal by Senate Republicans that would cut taxes about the same as Bush and spend about as much money as Breaux and Snowe. None of the five stimulus proposals contains significant marginal tax rate reductions and tax law reforms sufficient to increase long-run economic growth appreciably, and all five contain provisions that distort future investment and production decisions. It is the marginal tax rate that determines how much of each additional dollar earned must be paid to the tax man. Consequently, it is a change in the marginal tax rate, not the average rate, that influences people's decisions to alter their work effort or change their levels of saving and investment since marginal tax rate reductions always apply to future economic activity, i.e., the next dollar earned, produced, sold, saved or invested. Tax credits and tax rebates are a reward for past behavior and hence have no effect on the future. Moreover, if policymakers attempt to shelter individuals from the adverse economic effects of high tax rates and other economic policy errors (such as the Fed's monetary policy errors) by raising entitlement spending, they will only succeed in worsening incentives to work, save and invest in the future and thereby delay economic recovery longer. Out of this political mishmash are several tax rate reductions worth enacting - the capital gains tax rate reduction, the proposed acceleration of marginal income tax rate reductions, the acceleration in depreciation and the AMT repeal - because they offer beneficial, albeit small, reforms to a tax code Treasury Secretary Paul O'Neill has called "an abomination ... unworthy of an advanced civilization." However, if the price for enacting them is that they must be temporary and distort future decisions or that they must be accompanied by discriminatory tax credits and rebates and large increases in federal entitlement spending, then they aren't worth a nickel. There is a congressional election coming within the year, and I can't think of a better issue over which to wage the campaign. The best thing Bush can do for the economy, therefore, is to stop haggling with members of Congress over the stimulus package and give Congress a Dec. 15 deadline to put on his desk for signature a tax rate reduction bill that meets this simple test: It will improve the incentives for labor and capital to work, save and invest in the future. The president should tell Congress he will veto anything that fails to meet this test.