Still a Bad Idea
The Bush Tax Cut
This article is from the March/April 2001 issue of Dollars & Sense: The Magazine of Economic Justice available at http://www.dollarsandsense.org/archives/2001/0301miller.html
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This article is from the March/April 2001 issue of Dollars & Sense magazine.
We said we didn't want it. Most people didn't even vote for it. In survey after survey, public opinion polls rank a large tax cut as one the least desirable uses of the federal budget surplus. And Republican and Democratic leaders alike have warned the President-select that his tax cut package will never emerge whole from Congress.
But all to no avail. George W. Bush has yet to back off from the monstrous, surplus-draining tax cut proposal that was the cornerstone of his campaign. Now he's even telling us that it's for our own good: His tax cut will cure our softening economy and stave off the threat of recession by "encouraging capital formation, economic growth, and job creation." Even Alan Greenspan, chair of the Federal Reserve Board and a debt-reduction hawk, is prepared to accommodate the Bush plan.
At least one group is happy to swallow the Bush tax cut medicine—"the haves and the haves-more," as Bush referred to his supporters during a fundraiser last year. After all, it is their taxes he will cut. Together, lower income tax rates (with the biggest drop at the top) and the repeal of the estate tax account for nearly three-quarters of the Bush tax cut. Nearly three-fifths of the total benefits of the tax cut package will go to the richest 10% of all taxpayers, and some 43% will go just to the top 1%, those who make more than $319,000 a year and showed average income of $915,000 in 1999.
But no matter what Bush says, his tax giveaway to the wealthy will not inoculate us against recession. Nor are well-to-do taxpayers suffering from over-taxation, as the Bush team insists. One thing is sure. If the Bush tax cut goes through, social programs that have already been neglected for more than two decades will continue to suffer.
Defending the Indefensible
The editors of the Wall Street Journal never met a pro-rich tax cut they didn't like. And the Bush tax cut is much to their liking. Last December, they argued the case for a massive tax cut on three grounds:
- "Taxes are too high. Last year , federal tax revenue as a percentage of the economy reached an historic peak—20.4% of GDP."
- "For the past couple of years, our tax overpayments have put the federal budget in surplus. And Congress, incited by this surplus, has exceeded its own budget caps and increased its spending beyond the rate of inflation. And they've just done it again, passing a humongous budget."
- "The economy is beginning to wobble. Economic forecasters are sniffing a recession; they are busily lowering growth projections for next year. And for good reason; some of the data are starting to look scary."
On closer inspection, none of these arguments holds up. First, let's look at what the Journal editors had to say about government being too large and taxes too high.
Federal tax revenues—as a percentage of Gross Domestic Product (GDP), or national output—are currently, as the editors suggest, at their highest levels since World War II. But that is not because government got bigger during the 1990s or because today's federal budget is "humongous" in historical terms.
The economic boom of the 1990s—faster economic growth and a skyrocketing stock market—did enlarge the tax base and allow the federal government to collect more tax revenues. Those added tax dollars closed a $300 billion deficit in the federal budget and then generated the current surplus. But that surplus hasn't translated into bigger government, as the Journal editors claim. During the 1990s, federal spending as a share of GDP actually got smaller, not bigger, slipping below 20%. In 2000, it reached just 18.2%, the lowest mark in 35 years.
Even some conservatives, if not the Journal's editorial writers, noticed the drop. "The good news of the Clinton presidency," says Stephen Moore of the Cato Institute, a libertarian think tank, is that "the federal government is getting smaller, at least relative to the size of the economy."
So much for the government being too big by historical standards. But what about the beef about "over-taxation"? It misses the mark as well.
The Journal editors are fond of pointing out, in their paeans to the "New Economy," that any serious assessment of the 1990s should take into account the wealth amassed through the stock market boom and other investments. But tax revenue as a share of GDP is a misleading measure of the decade's tax burden precisely because it fails to do this.
Here's how. According to economists Alan Auerbach and William Gale, about one-third of the surge in tax revenues during the 1990s came from taxes on the capital gains realized when stockholders and other investors cashed in their holdings. The calculation of taxes as a share of GDP counts capital gains tax revenues but ignores gains in wealth that have not been cashed in. From 1989 to 1999, the total wealth or net worth of households (their total assets minus debt) more than doubled. Had all of that new wealth been included in the Journal's calculation, then taxes as a share of economic activity would have shown a decline.
Economists have long argued that, for tax purposes, changes in net worth should be counted as income. Even conservative economists agree. For instance, Bruce Bartlett, former Reagan administration Treasury official, says that today most people regard increases in net worth as "the equivalent of increases in income," even before they realize their investments. When Bartlett calculated taxes as a share of economic activity, he adjusted his measure for changes in net worth and found that the tax share declined during the 1990s. In 1990, tax revenues measured 18.3% of the sum of GDP plus year-to-year changes in household net worth, but were just 15.1% in 1998.
For Bartlett, that downward trend goes a long way toward explaining why "tax cuts have fallen sharply as an issue of concern to voters" and why "the tax revolt went into hibernation." When the Heritage Foundation, the Washington-based conservative think tank, published Bartlett's study in 1999, they distributed it to journalists with a cover letter instructing "conservatives who favor tax cuts" to "wake up and smell the apathy."
The Journal editors weren't listening. Rather than face up to the implications of an intellectually honest analysis of federal taxes by a fellow conservative, they prefer to spend their time spinning data in a desperate attempt to awaken the tax revolt from its slumber.
No Recession Fighter
Crying recession is the Journal editors' and the Bush team's latest attempt to resuscitate the tax revolt. The threat of recession is genuine enough. Slower economic growth abroad, higher oil prices, stagnating stock prices, and jacked-up interest rates have already damped down U.S. economic growth and surely could bring the current expansion to an end. Still, that is no reason to give in to the chicanery that we must bribe the rich with a tax cut if we want to forestall a recession.
The Bush tax cut is no recession fighter. First off, it will do little to combat slower growth in a timely way. Even if Congress passes the proposal intact, none of the cuts would be enacted before 2002. In truth, much of the Bush proposal would be slowly phased in over ten years, with just 11% of the tax cut coming in the first three years. Worse yet, the later and larger tax cuts would take place regardless of economic conditions—and in all likelihood well after the end of the next recession.
Aside from its poor timing, the Bush tax cut is ill-designed to jumpstart the economy. The immediate effect of lower taxes comes from increasing consumer spending. But by targeting the rich, who consume less of their income than others, the Bush tax cut will offer little of this stimulus. That holds for both the repeal of the estate tax—whose benefits will go exclusively to the richest 2% of the population—and the across-the-board cut in income tax rates, which is weighted heavily in favor of the wealthiest taxpayers.
Nor are repealing the estate tax and cutting income taxes likely to provide the long-term stimulus to capital formation and job creation that Bush promises. Tax-cut backers can't point to a single credible economic study showing that eliminating the estate tax will boost investment. The track record of cutting income taxes is problematic as well. The Reagan administration reduced income tax rates across the board and lowered capital gains taxes—cuts that supply-side economists claimed would encourage people to work, save, and invest. But when mainstream economists, such as Barry Bosworth and Gary Burtless of the Brookings Institution, checked out the effects of the '80s tax cut, they found quite different results. Male workers put in about the same number of hours after the tax cut as before it, and while women did work more hours, their earnings failed to improve. Not only that, relative to the size of the economy, savings plummeted and net investment declined. That hardly fits with the claims of the Bush team.
Finally, if slower growth is now the justification for cutting taxes, then the budgetary implications of the Bush tax cut are even more alarming than when it was originally proposed. In January, the Congressional Budget Office (CBO) projected that the federal budget (except for Social Security) will run a surplus of $3.1 trillion over the period 2002 to 2011. The CBO projection assumes brisk economic growth averaging 3.1% over those ten years (comparable to that of the 1990s), no recession this year, a continuation of the rapid productivity gains of the last five years, and a hot stock market. But deteriorating economic conditions, let alone a prolonged recession, could compromise each of those assumptions and leave a surplus far smaller than the amount of the Bush tax cut, pushing the budget back into deficit.
Even if the CBO projections hold up, financing the Bush tax cut out of the surplus will be difficult. A recent study by the Center on Budget and Policy Priorities (CBPP), a liberal think tank, found that much of the surplus was unavailable for a tax cut. Some $400 billion of the projected surplus comes from the Medicare Hospital Insurance Fund, and there is overwhelming bipartisan consensus that those funds, along with the Social Security surpluses, should be set aside, not used for tax initiatives. Another $600 billion of the projected surplus disappears if current spending policies are maintained; the bulk of that would go to adjust discretionary spending for inflation and changes in the U.S. population. That still leaves about $2 trillion unallocated. But at least $500 billion, according to the CBPP, would be needed to help restore the long-term solvency of Social Security and Medicare, if Bush intends to keep that campaign promise.
Finally, an honest accounting of the cost of the Bush tax cut reveals that it will drain at least $1.9 trillion from the projected surplus, not $1.3 trillion, as his campaign claimed. According to Citizens for Tax Justice director Robert McIntyre, the Bush figure is based on nine years, not ten, because it starts its projection in 2001, a year before the tax cut would go into effect. On top of that, the government would have to borrow money to finance the Bush tax cut in its first years (before the larger surpluses kick in), but the Bush calculation doesn't include the cost of the interest on that borrowing. Those interest payments will be even larger if the economy slows, drying up projected tax revenues. Not only that, McIntyre now estimates that the total cost of the tax cut could be as high as $2.5 trillion, due to a quicker phase-in of the proposed cuts, new CBO revenue projections, and a likely reduction in the 26% minimum tax that upper-income taxpayers are now required to pay on their taxable income.
We Can Do Better
How might we make better use of the projected surpluses in the federal budget? On that score, the Democrats are not much help. In reaction to the extremism of the Bush tax cuts for the wealthy, they are offering up a warmed-over Eisenhower-moderate-Republican proposal from the 1950s—use the surplus to pay down the debt.
But devoting the surplus to retiring government debt is unlikely to produce a more robust economy. Reduced government borrowing is intended to lower interest rates and thus juice up capital investment, which accelerates economic growth. In practice, however, government borrowing and interest rates are not closely correlated, and lower interest rates are seldom by themselves sufficient to coax balky investors to part with their money. But if lower interest rates are the goal, the Federal Reserve can bring them down without expending the surplus. In fact, the Fed furiously lowered interest rates in the first two months of this year. Fed action makes sense, since it's the Fed's numerous hikes of the interest rate during 1999 and 2000 that helped to jeopardize the current economic expansion in the first place.
It's not hard to enumerate better uses of the budget surplus. To begin with, if a tax cut is needed to bolster the economy, then why not use the surplus to pay for a cut in the payroll taxes paid by wage workers? The majority of taxpayers now pay more in payroll taxes—deductions from paychecks to fund Social Security and Medicare—than in income taxes. Reducing payroll taxes would have a greater impact on most families than an income tax cut of the same size, while disproportionately favoring low-income earners. Also, by targeting wage workers, who are often strapped for cash, a payroll tax cut—in effect an across-the-board raise—would immediately boost consumer spending. A 10% reduction in Social Security and Medicare tax rates would cost about $60 billion in fiscal year 2001, according to the CBO, and could be funded from the projected budget surplus (leaving much of the surplus to meet other demands).
But what we really ought to do with the projected surplus is dedicate it to pressing social needs. In the United States today, 32.3 million people are living below the official poverty line, 44 million go without health insurance, and perhaps as many as seven million have no place to live. Our public schools are deteriorating, the state of public transportation is abysmal, and decent, affordable housing is practically impossible to find.
Even if we simply maintained current spending levels, adjusted for inflation and population growth, we could inject badly-needed funds into a large swath of government activities, including education, environmental protection, food and safety inspection, the National Park Service, and Head Start. While we're at it, we could shore up the Medicare trust fund. That would still leave vast resources to provide universal health care coverage, combat childhood poverty, renew public investment, and support numerous other social programs that the federal government has ignored. Even if the entire $3.1 trillion projected surplus were used for public spending, federal outlays in fiscal year 2011, according to the CBO, would be just 18.4% of GDP—smaller than at any point during the 1970s, 1980s or 1990s.
With budget surpluses now projected for the rest of the decade, these proposals are hardly beyond our means. It's just a matter of political will. In the last 20 years, social programs have been slashed almost beyond recognition. Squandering the surplus on a tax giveaway for the wealthy, while continuing to turn our backs on those in need, would be a criminal act.