When he unveiled his tax cut, the biggest selling point was the weakening economy. “We need tax relief now–in fact, we need tax relief yesterday,” he said. “The federal government is simply pulling too much money out of the private economy, and this is a drag on our growth.” No doubt about it, the economic slowdown has improved Bush’s prospects for merchandising his large tax cut. But Bush’s approach also creates new risks, and even if he succeeds in changing conventional wisdom, economics may make it harder for him to get the tax cut he wants.
The obvious risk is this: if the slowdown fades, so would the argument for a tax cut. Bush’s plan might fall prey to false promotion. Even now, the proposal has to overcome economists’ bias against tax cuts as an anti-recessionary weapon. Their skepticism mainly reflects the “clunky” nature of the political process, says Harvard economist Gregory Mankiw. By the time Congress acts, the recession may be over. In contrast, the Fed moves quickly.
Most economists still don’t anticipate a recession. They think the Fed’s interest-rate cuts will revive confidence and growth. (This year, the Fed funds rate has dropped a full percentage point to 5.5 percent; economists expect more cuts.) In the latest Blue Chip Economic Indicators newsletter–which follows 51 forecasts–the average prediction for economic growth in 2001 is 2.1 percent, down from 5 percent last year. Growth would recover to 3.5 percent in 2002.
Of course, forecasts can be wrong–and these may be. By and large, the sharp slowdown has surprised economists. In October, the Blue Chip economists pre- dicted growth of 3.5 percent for this year. Economists’ continued optimism presumes that the slowdown is a temporary inventory correction. Businesses overordered, and once surplus goods are sold, production and employment growth will increase. The harsher possibility–which strengthens the case for a tax cut–is that the economy is suffering the aftershock of an unsustainable boom.
Emboldened by high stock prices, consumers overborrowed and overspent, the argument goes. Businesses overinvested because venture capitalists and new stock offerings provided so much cheap capital. Together, consumer spending (68 percent of gross domestic product) and business investment (14 percent of GDP) constitute four fifths of the economy. If all this spending slows or drops, the economy is in trouble.
“If you argue that the consumption and investment booms are over,” says economist Bill Dudley of Goldman Sachs, “then the time for a contractionary fiscal policy is over.” This was Bush’s line last week. Expanding budget surpluses are sucking purchasing power from the economy. Lower interest rates alone may not spur recovery, if consumers think they’re overindebted and businesses face idle production capacity. Monetary policy must be aided by fiscal policy, which puts money in people’s pockets.
In effect, the theory is: it’s necessary to cut budget surpluses in order to save budget surpluses. After all, the surpluses–now estimated at $5.6 trillion from fiscal 2002 through 2011 by the Congressional Budget Office–are just paper projections. The projections assume healthy economic growth, and without it, the surpluses won’t materialize. To get growth requires sacrificing some surpluses. Ironically, the worse the economy looks now, the better the case for a tax cut.
But not automatically Bush’s tax cut. The plan sent to Congress was his campaign proposal. It aimed mainly to fulfill a political agenda–not serve as an economic stimulus. It promised to discipline government spending by depriving government of money to spend. It would cut “marginal” (i.e., top) rates–a step that, conservatives believe, promotes work and investment. It would help families by doubling the child tax credit to $1,000. It would help small-business owners by eliminating the estate tax. But a political statement now promoted as an economic stimulus invites criticism.
Some provisions (the estate tax, new charitable deductions) would hardly affect the economy. Similarly, the timing is bad. Most tax cuts are phased in so slowly that they wouldn’t much help the economy for a few years. For example, the full rate cuts and child-credit expansion wouldn’t become effective until 2006. In 2002, the tax cut would total only $21 billion, estimates the Congressional Joint Committee on Taxation. That’s not much in a $10 trillion economy. Bush now favors making tax cuts “retroactive” but hasn’t said what he means.
A bigger conflict involves income distribution. All along, the harshest attacks on Bush’s plan have cast it as a giveaway to the rich. For Bush, rolling back government means providing tax relief for those who pay taxes. It’s their money, as he says. Inevitably, this requires aiding upscale America, which pays the most taxes. In 2000, the wealthiest 10 percent of taxpayers–a group whose income begins at about $100,000–paid 66 percent of federal income taxes and 50 percent of all personal federal taxes (including payroll and excise taxes), estimates the Joint Committee. In that group, the wealthiest 1 percent–incomes generally above $300,000–paid 34 percent of income taxes and 19 percent of all taxes.
Bush’s liberal critics have wanted to redistribute income. The slowdown is creating new grounds to concentrate tax breaks on low- and middle-income households. It’s said that the tax cuts would do more as stimulus if they go to these households. Their debt burdens are higher, and they will spend more of what they get. By contrast, the rich would supposedly save more. One plan by independent Congressman Bernie Sanders of Vermont would give a $300 rebate to all Americans, regardless of whether they paid taxes. A family of four with $50,000 of income would get the same $1,200 as a family of four with a $500,000 income.
Whether this would provide more stimulus than Bush’s proposal is unclear. It’s widely believed among economists that richer households would save more of any tax windfall, but according to Harvard’s Mankiw, what people do with extra income (so-called marginal income) is not well understood. Bush and his economic lieutenants will soon be fielding more questions like this. Having pitched their package as stimulus, they will have to convince Americans that what they’ve proposed will provide it. If they can’t, Bush may get from Congress something much different than he sent up.
