Share this article

print logo

THE CASE FOR A TAX CUT

The economic case for a tax cut seems compelling. The U.S. economy is unwinding from an unstable boom. Consumers overborrowed or, dazzled by rising stock prices, overspent. Businesses overinvested thanks to strong profits and cheap capital. Both consumers and businesses will now curb spending: consumers made cautious by high debts, stagnant (or falling) stocks and fewer new jobs; businesses deterred by surplus capacity and scarcer capital. A tax cut would cushion the spending slowdown.

Consumer spending (68 percent of gross domestic product) and business investment (14 percent) constitute four-fifths of the economy. If they are in retreat, the economy is in trouble. (Housing, exports and government represent the rest.) The case against a tax cut is that the spending slowdown will be mild; it will be checked by the Federal Reserve's cut in interest rates. Perhaps. But if businesses have idle capacity and consumers have excess debts, lower interest rates may not stimulate much new borrowing.

Nor will large budget surpluses automatically preserve prosperity. This argument is absurd. The surpluses are the consequence -- not the cause -- of the economic boom and stock market frenzy, which created a tidal wave of new tax revenues. But now surpluses may depress the economy by removing purchasing power.

A year ago, a tax cut would have been folly. Private spending was booming. But a tax cut now is the logical response to the end of the private boom -- an attempt to prevent a "bust" by restoring some of people's incomes. Whose incomes? Who deserves tax cuts? These are the harder questions.

President Bush's across-the-board rate cuts would give the largest dollar tax cuts to the wealthiest Americans, because they pay most taxes. In 2000, the richest 10 percent of Americans -- whose incomes begin at $100,000 -- paid 66 percent of the federal income tax and 50 percent of all federal personal taxes (including payroll and excise taxes), estimates the Congressional Joint Committee on Taxation. In 1977, the richest 10 percent paid only 50 percent of income taxes and 43 percent of all federal taxes. There are two reasons for this trend: (a) the rich's incomes grew faster than everyone else's; and (b) tax relief went more toward the lower half of the income spectrum.

The growing gap between those who pay for government and those who receive its benefits creates a dangerous temptation. It is to tax the few and distribute to the many. Though politically expedient, expanded government programs may have little to do with the broader national interest. They may simply make more people dependent on Washington. Taxes must be fairly broad-based if the public is to weigh the pleasure of new government programs against the pain of higher taxes.

As originally proposed, Bush's plan was avowedly political. It aimed to restrain government spending by depriving government of some money to spend. But Bush is now selling his program as an antidote to economic slump. Ironically, this strengthens the case for skewing the tax cut toward middle- and lower-income households. Almost certainly, their debt burdens are higher than upscale America's. They may also spend more of any tax cut than the rich, providing greater support to the economy.

Finally, it's true that an excessive tax cut would invite future deficits. How to balance these competing pressures is what we will debate. My preference is to accelerate the introduction of Bush's across-the-board rate cuts, with one exception; I would cut the top rate of 39.6 percent to 35 percent, instead of Bush's 33 percent, and use the savings to broaden tax cuts at lower income levels.

I would also accelerate the increase in the child tax credit from $500 to $1,000 but defer Bush's other proposals (ending the estate tax, bigger charitable deductions). This would raise the overall tax cut's immediate economic impact and reduce the long-term budget costs.

As we debate, we should not idealize budget surpluses. They are paper projections, based on various assumptions, including strong economic growth. If the growth doesn't materialize, neither will the surpluses. A slavish effort to preserve the surpluses could perversely destroy them.

Washington Post Writers Group

There are no comments - be the first to comment