- The Washington Times - Thursday, January 18, 2001

Since the government has more money than it needs, what would be the harm in cutting tax rates? Yet criticism of this relatively inexpensive element of the president-elect's tax package lowering the top four tax rates has been surprisingly agitated and adaptable.

A month ago, defenders of depressing taxation castigated the incoming administration for daring to mention recession. President Clinton's chief economist, Martin Bailey, deemed it "irresponsible" to mention contingency plans for a downturn. Mr. Clinton claimed faith in forecasters always last to notice recessions. Newscaster Dan Rather dismissed all talk of recession as a scheme to tarnish the Clinton legacy, and to trick Congress into enacting tax cuts to "mainly benefit the rich."

Such denial of economic trauma was foolhardy. The purchasing manager's survey was 43.7 last December compared with 47 at the start of the previous recession, July 1990. Industrial production and really retail sales have fallen steadily since September. Housing starts and car sales peaked last February. The evidence we are in recession is stronger than in the fall of 1990. Fortunately, the outlook for tax policy is the exact opposite of a decade ago.

In October 1990, the elder President Bush capitulated to pressures from Messrs. Greenspan, Darman, Brady and others to renege on his "no new taxes" campaign pledge. Trying to raise taxes in the third month of recession was the worst timing since Herbert Hoover's tripling of tax rates in June 1932. As in 1932, higher tax rates were bad for the economy and therefore bad for federal revenues. Individual income tax receipts dropped to only 8.8 percent of personal income in 1991-92, down from 9.4 percent in 1988-90.

From one political perspective, however, the failed "tax increase" of October 1990 was marvelously effective. Higher tax rates in 1990 soon helped remove Republicans from the White House, just as higher tax rates in 1993 helped remove Democrats from Congress. Those 1990 and 1993 experiments show the real reason Democrats fear a timely reduction of tax rates.

This year, unlike 1990, nobody has yet dared suggest that because recessions reduce revenue tax rates should go up. Yet some dance close to such nonsense when explaining why tax rates must not go down. Reducing tax rates is now said to be either entirely ineffective against recession (too little too late) or much too effective (causing "overheating").

An article in The Washington Post (headlined "Too late for a tax cut?") denied that lower tax rates could possibly improve things. Laura Tyson, Mr. Clinton's former top economist, explained in a TV interview that enacting lower tax rates this year risks an "overheated" recovery next year. We were first told it would be imprudent to cut tax rates because Mr. Bush was inheriting a booming economy. Now we are told tax rates must not be reduced when the economy is doing poorly either, because the improvement (if any) is likely to kick in next year when prosperity is in danger of being excessive. In other the words, tax rates must never be reduced when the economy is doing well or badly.

A variation on the theme is that we must put our fate entirely in the hands of the Federal Reserve. Seeing no difference between incentives to borrow and incentives to produce, critics of lower tax rates claim lower interest rates have the same effect but faster. The Fed governors "time things better," says Brad de Long, another former Clinton economist. Just look at the expedient way the Fed prevented the 1990 recession by cutting interest rates in half during 1992-93.

Some proponents of the Bush tax plan sound almost as Keynesian (confused) as their critics. The notion that lower tax rates on marginal increases in income simply "put more money in peoples' pockets" assumes revenues end up lower. In this view, it is the smaller surplus that "stimulates" demand. But buying back government bonds also "puts more money in the pockets" of bondholders. The impact of a smaller surplus on overall spending is uncertain in theory and invisible in fact. The Fed alone can print money, but printing money does not print more goods. Lower tax rates improve incentives to produce, enlarging the supply side of the economy.

Actually, the mere likelihood of a significant reduction in the higher marginal tax rates would boost the economy even before it was enacted not because it boosts spending but because it revives enthusiasm among workers and investors. Lower marginal tax rates improve future after-tax rewards for doing the difficult things necessary to raise lifetime income, such as investing time and money in acquiring new skills, and taking entrepreneurial risk in creating new firms.

Opponents and proponents describe the entire Bush plan by the amount of revenue the Treasury is alleged to lose over 10 years $1.3 trillion, according the Joint Committee on Taxation. But the economic impact of lower tax rates is not measured by how much money they lose. If it were, we would have to judge the 1997 reduction of capital gains tax as a miserable failure, because revenues doubled in a few years. And we would have to label the 1932 tripling of tax rates as a huge and wonderful "tax cut" because revenues collapsed.

The indispensable core of the Bush tax plan reducing the top four tax rates accounts for merely one-third of the estimated revenue loss, $439 billion of $1.3 trillion. The expensive part consists of various goodies that are much less threatening to Democratic legislators precisely because they have little immediate economic significance. Lowering the top four marginal tax rates involves a minor revenue loss of less than $44 billion a year only on the nonsensical assumption that lower tax rates do no good at all. Even if that figure made sense, it would be cheaper by far than enduring a prolonged recession and/or feeble recovery.

As we alternately hear that lower tax rates would be both ineffective against recession, and also too effective, it is becoming obvious that the real concern is about politics, not economics. There is an entirely justifiable fear that lower tax rates and their beneficial effects on the economy would be wildly popular with marginal voters, causing big trouble in 2002 for any congressional Democrats who fought to keep taxes high. With the political stakes so high, we can anticipate no end to the cleverness and variety of arguments against tax reduction, even if that requires liberal Democrats to sound just like Herbert Hoover. There need be no lasting harm from such political frivolity, so long as we recognize it for what it is.

Alan Reynolds is director of economic research at the Hudson Institute and a consultant with the Gilder Technology Report.


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