- The Washington Times - Sunday, April 1, 2001

Watching the tax debate unfold on Capitol Hill, you would think Congress has been infected with Mad Cow Disease. Both the Republicans and Democrats seem to be trying to outdo each other with dimwitted tax cut proposals designed to help shore up the economy, but with almost no real stimulative effects and almost no chance of reviving the moribund stock market.

A case in point: Last week, as the Dow-Jones and the Nasdaq stock markets continued to plunge into gloomy bearish territory, causing almost all analysts to now concede that a recession is imminent, the House Republicans voted to increase the child exemption from $500 to $1,000 per kid. Will someone please tell these people that while they dither, Rome is burning. A $500 tax credit for kids may be good social policy to help families with kids pay their bills, but it doesn´t do squat for a limping economy that has seen net worth fall by more than $2 trillion just since Election Day.

Meanwhile, Sen. Pete Domenici, New Mexico Republican, called for a $60 billion tax rebate this year. Mr. Domenici deserves praise for at least calling for a lot more short-term tax relief than is contained in the House-passed plan which is so back-loaded that it offers an insultingly small cut this year and next. But a tax-rebate plan is the economic equivalent of flying a helicopter over Central Park in New York and dumping dollar bills out the window as a way to stimulate the economy. It´s not going to work.

Equally baffling is the Democratic tax cut alternative. That plan calls for cutting the bottom tax rate from 15 to 10 percent right now. Sen. Tom Daschle, South Dakota Democrat, says the logic here is to put hundreds of dollars back into the pockets of the lowest-income taxpayers so they can rush out and spend to juice the economy.

Now admittedly the idea imbedded in both plans, which is that we should take tens of billions of dollars out of the federal treasury and give it back to workers, makes a lot of sense. And it can´t hurt the economy. But both these plans are about the worst possible way to cut taxes if the goal is to restore prosperous times.

The problem as I have been saying ad nauseum for two months now is that Capitol Hill is shackled to demand-side logic on tax cuts. They find intellectual support from people like New York Times columnist Paul Krugman, who writes that tax cuts must stimulate consumer demand if they are to aid the economy.

But what´s needed now is supply-side incentivizing tax-rate cuts that reduce the tax penalty on economically productive behavior. Supply-side tax cuts reduce tax rates in order to reward saving, investment and work.

Consider the idea of cutting the bottom tax rate. Imagine for a moment we had a tax system that taxed people at 15 percent for working on Monday, 28 percent on Tuesday, 31 percent on Wednesday, 36 percent on Thursday, and 40 percent on Friday. (This simplistic model actually isn´t too far from the reality of our present day graduated income tax rate system.) Now it stands to reason that a lot of people would quit working on Fridays, or perhaps work until noon. In fact, even though the tax rate is higher on Friday than on Monday, tax collections on Monday could easily be higher than on Fridays. There would clearly be less economic activity on Fridays than on Mondays.

Would it make any sense to cut the tax rate on Mondays, but not the tax rate on Fridays? None whatsoever. That, however, in a nutshell is the reigning tax- cut proposal on Capitol Hill. Cut the lowest tax rate, but not the highest tax rate. Many Republicans, petrified of claims of "tax cuts for the rich," wish to cut the lowest income tax rate, but to delay cutting the highest rate. As I said, a clear sign of Mad Cow Disease.

The rebate plan submitted by Sen. Pete Domenici, New Mexico Republican, is well-intentioned, but also off-base. If you took the income tax structure as described above, and tried to fix things by giving every family $50 a week, they still may not work on Fridays any longer in fact, with the added giveaway dollars in their pockets, they may choose to work less on Fridays, not more.

Clearly, if the goal is to generate more economic output, you cut the highest tax rate i.e., the tax rate for working on Fridays. Economist Arthur Laffer, who converted Ronald Reagan to supply-side economics 25 years ago, has argued that we should raise, not lower the bottom tax rate, and then dramatically lower the top tax rate in order to create a fairer and more uniform tax rate on every day of the week.

The logic here leads us inexorably toward the tax ideal: a flat rate tax system: One uniform low tax rate paid by everyone. To get to a flat rate tax, the top income tax rate has to come down a lot from 40 percent today, to perhaps 20 percent or 25 percent tomorrow. Lowering the bottom rate only makes the tax rate system steeper to climb.

The bottom line is this: There is almost no economic benefit to chopping the lowest tax rate, but a world of benefit from chopping the top rate as much and as soon as possible. The fiscal stimulus the economy needs should come from shaving the top income tax rate from 40 percent to 33 percent right now. A capital-gains tax cut would have a similarly immediate positive impact, especially on stock values. If we were to cut the capital-gains tax from 20 percent to 10 percent, the lower tax rate would be instantly capitalized into the value of stocks.

The economic logic here seems so straightforward that it should be compelling, even to the herd of mad cows on Capitol Hill.


Stephen Moore is president of the Club for Growth.

Stephen Moore is president of the Club for Growth.

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