During the presidential campaign, George W. Bush staked out a case for lowering taxes at a time when the economy didn’t really need a tax cut. Mr. Bush’s economic adviser Larry Lindsey was right that a tax cut was warranted as an anti-recession insurance policy. Mr. Bush made a persuasive case that taxes are way too high for a country enjoying peace and prosperity. And he was exactly right that cutting taxes is the best way to prevent new spending. But a tax cut wasn’t economically essential given the soaring economy at the time.
Well, the world has changed a lot in just the last two months. Now, a tax cut really is imperative. Fiscal drag is finally rearing its ugly head, weighing down the economy in general and the high-tech sector in particular. The financial markets have turned dangerously bearish. Just since the election, roughly $1 trillion of wealth has disappeared because of sliding stock values.
The tax burden has risen from 18 percent to 21.5 percent of gross domestic product (GDP) in just the past five years. The last time taxes were this high was the late 1970s, when the economy was in a mini-depression. Last year, total public sector revenue surpluses were $300 billion that’s about 4 percent of GDP. Fiscal policy is way too tightly wound. A deep tax cut rescue plan is urgently needed.
If Mr. Bush doesn’t cut taxes in his first 100 days, his presidency could suffer a crisis of public confidence right from the get-go. All of his political enemies like Senate Minority Leader Tom Daschle of South Dakota and House Minority Leader Richard A. Gephardt of Missouri, are advising the new administration to shelve the tax cut for now, or drop rate reductions so the plan does not help the rich. No surprise here. Muddle-headed advice is exactly what one would expect from one’s enemies.
What is surprising is how many of Mr. Bush’s “allies” are serving up really dumb guidance. On Friday, House Speaker J. Dennis Hastert of Illinois advised the president-elect to put issues like school funding, debt retirement and health care reform ahead of tax cuts. And then as if an afterthought, Mr. Hastert said: “We can probably give Americans some tax relief to boot.” Wow, Mr. Bush, you may be up against some pretty dense thinking inside your own party when you get to town.
If anything the economy is screaming for a bigger tax cut, not a smaller one, than the one Mr. Bush campaigned on. And features of the Bush tax proposal need to be refined given the new reality of economic slowdown on the horizon. So here are a few tax cut suggestions to help get the economy out of its rut:
1. Make the tax cut retroactive to Jan. 1, 2001. We need a supply side fiscal stimulus immediately not in six months or even 100 days. Making the tax cut effective on Jan. 1 will trigger economic activity instantly regardless of when the tax cut is signed into law.
2. Eliminate the death tax immediately. The Republican bill is flawed. It gets rid of the death tax in 10 years. That’ll never happen. Even Democrat Rep. Charles Rangel of New York wants the tax rate lower in the first few years than the namby-pamby Republican bill. Repeal the death tax all of it right now. Estates should be taxed, if at all, at the capital gains rate.
3. Cut the capital gains tax to 15 percent now. The last capital gains tax cut was an unqualified success: higher revenues, more savings and a surge in asset values. All the arguments against the cap-gains cut are now demonstrably wrong. Moreover, the cap-gains cut would be the single best way to revive the NASDAQ, which is down more than 40 percent over the past year.
4. Don’t give up on the income tax rate cuts. The rate cuts and the death tax repeal are the most economically beneficial features of the plan. In the past 18 months, Germany, Japan, France and even Russia have cut tax rates. The United States has not. What’s wrong with this picture? We’re losing our competitive edge. Tax rate cuts must be a nonnegotiable item in your tax plan. Sen. Charles E. Grassley, Iowa Republican, the incoming chairman of the Senate Finance Committee says that you should promote populist tax cuts with Democratic support, such as marriage penalty relief. Marriage-penalty relief is fine, but it has no supply side growth incentives. We need rate cuts.
5. Make the switch to dynamic scoring of tax policy changes. Republicans have been complaining about static revenue analysis for 20 years. Now they can and must do something about it. The GOP now has control of the computers. Fix them. A model that predicts that when we cut the capital gains rate, the Treasury is going to lose revenue when in fact it gains boat loads of revenues is worthless. Dynamic scoring is critical to selling the tax cut. This has to be done immediately.
6. End real income bracket creep. Your tax bill must insist upon indexing the tax brackets for the increase in nominal income each year. This does not cost any money in the near term but prevents the insidious hidden tax increases that cause the tax burden to rise automatically over time.
The key is to use the political process to grow the tax cut; not to shrink it. The good news is that Mr. Bush has a mandate to cut taxes. Now he’s got to use it.