Didn't Work the First Time, So Let's Have More Tax Cuts

One month after the terrorist attacks on New York City and Washington, DC, partisanship is alive and well, and perhaps nowhere more visible than in the debate over economic stimulus. The Bush administration offered its proposals on October 4, calling for $75 billion mostly in tax cuts for businesses and individuals, with about 20% targeted at laid-off workers. Democrats denounced the proposals as not offering enough for individuals affected by the economic slowdown. Congressional conservatives objected to the administration proposals because they did not contain calls for capital gains or corporate tax cuts. An administration spokesperson, attempting to prop up the facade of bipartisanship, said that Bush would accept Democratic demands that the stimulus package be evenly divided between tax cuts and spending. But the administration wants to count emergency appropriations that have already passed Congress -- including disaster relief, aid to airlines, and increased military spending -- as part of their current economic stimulus proposal. By their reckoning, only $15 billion would available for aid to the unemployed.

In the Democratic view, devoting half of the $75 billion to tax cuts leaves tens of billions for items such as health care, and unemployment insurance. Democrats recently advocated $16 billion in health care premium subsidies, compared to an administration proposal of $3 billion that was to include health care, job training, and income supplements. After a meeting with labor leaders on October 4, House Minority Leader Richard Gephardt argued that health and unemployment benefits were key components of any stimulus package, especially for part-time and seasonal workers who might not qualify for unemployment benefits under current programs. House Minority Whip David Bonior underscored the Democrats' determination to resist Republican attempts to turn the stimulus package into another round of tax cuts, saying "We're going to fight like hell to make sure working people get their fair share, and that means a 50-50 split, at least."

Corporate tax cuts are key components of the administration stimulus proposals -- and the administration wants to make them permanent. Repealing the corporate minimum tax is very much like the earlier Bush tax cut for individuals: it helps corporations that have hidden their profits with massive deductions, while doing nothing for corporations that pay no taxes because they are losing money. Some observers estimate that repealing the corporate minimum tax would reduce revenue in 2002 by $4 billion, but could cost up to $22 billion over 10 years. The Republican proposal only counts $4 billion as a part of the stimulus package, while Democrats would count the $22 billion. Moreover, the administration will reportedly seek to make its changes permanent, insuring continued loss of government revenue. A Treasury official defended the administration's view, saying that the loss of revenue was not important if it did not cause interest rates to rise. Chairmen and ranking members of the House and Senate Banking committees rejected the administration's call for permanent tax cuts, offering instead a one-year horizon to contain the cost of the package. To complicate the picture further, a group of conservatives, including former pest-exterminator Tom Delay of Texas, put forward their own set of proposals. The conservative group's proposals included some of the administration's requests, as well as a call for reduced capital gains taxes.

A Republican-sponsored bill was voted out of the House Ways and Means Committee on Friday, October 12. It contained $70 billion in tax cuts for corporations this year, approximately $29 billion in tax cuts for individuals, and none of the Democratic proposals for unemployement benefits or job creation. On October 15 Treasury Secretary Paul O'Neill signaled an attempt by the administration to distance itself from the bill, suggesting it represented political posturing. "Part of what you saw on Friday last week was show business," he said.

There is a consensus among some economists that stimulus packages should only be short term. Paul Krugman, writing in a recent New York Times op-ed column argued that prior to September 11 the main problem with the U.S. economy was excess capacity, which, like excess weight, could be worked off over time. In the mean time, he argues, any stimulus package should encourage other kinds of spending. This can be achieved primarily by lowering interest rates, which encourages spending on housing and durable goods. But since interests rates have been lowered considerably over the past year, additional stimulus may be indicated, but should encourage immediate spending. He warned against any measures that worsen the long-term budget situation, or try to take advantage of current events to pursue unrelated goals. In his view, the Bush and Republican proposals are wrong on both of these counts.

A tax break for business investment would have little effect on the economy at the moment, because there is already excess capacity. Over the long term it would likely increase interest rates, because it would create larger government deficits at the same time that it encouraged corporate borrowing. Administration proposals to accelerate tax cuts for upper income individuals may represent more than their religious devotion to the widely repudiated principles of supply-side economics. With the economic situation worsening over the last several months, the debate over economic policy has progressed from a discussion of whether and to what extent Social Security funds would be "raided" to pay for tax cuts and other programs, to a realization that the government will run at a deficit for the foreseeable future. In that context, the real reason for accelerating tax cuts is an implicit acknowledgement that some of them will eventually be repealed. And as the discussion of the corporate minimum tax shows, the administration appears once again to be drastically understating the cost of its proposals.

The Wall Street Journal observed, "If the economic-stimulus package before Congress can stir the economy as it has business lobbyists, recovery should be right around the corner." Lobbyists for manufacturers, retailers, airlines, and hoteliers, have been contending for a piece of the stimulus package in the hope that it will enable them to turn around their businesses over the coming year. The urgency is also motivated by the realization that the coming budget deficits may make this their last chance to obtain tax cuts for some time. Most businesses and financial firms have lobbied for outright cuts in corporate and capital gains taxes -- proposals that have so far been rejected by most in Congress and the administration. In an ironic twist, some retailers are actually advocating payroll-tax relief, in the hope that recipients would spend their extra money on retail purchases. Allowing faster depreciation of capital investments is a proposal popular with some businesses, particularly technology companies.

To the Economist all this looks like "any other Washington budget battle. Conservative and liberal partisans are both crying foul; the White House is using fuzzy numbers; business lobbyists are swarming to push their pet provisions; and economists cannot agree about whether the whole endeavour makes sense." From their international perspective, the resolution of the economic situation is as important as the war on terrorism. Bush's return to an emphasis on tax cuts is seen as "mollycoddling" conservative Republicans. The Economist agrees with Paul Krugman, " the Bush White House is once again playing games with numbers." The $75 billion figure usually associated with the stimulus package refers only to outlays in 2002. The joint bipartisan Congressional tax committee estimates the cost of the tax cut alone at $90 to $120 billion in 2002. And the Center for Budget and Policy Priorities calculates the cost of accelerating tax cuts from 2006 to 2002 as $120 billion.

The most-debated economic question is how any stimulus package will affect long term interest rates. Economist Martin Feldstein argued in 1986 that a percentage point increase in the ratio of budget deficit to Gross National Product raises the long-term government bond rate by 1.2 percentage points. Many economists agree that there is such an effect, but it is difficult to measure because real rates are influenced by many other factors. But the stimulus package may influence the long term fiscal health less than the combined effect of the Bush tax cuts already in place, and the pre-existing economic downturn. The worst-case estimate from the House and Senate budget committees puts the cumulative 10-year surplus at a mere $270 billion. And that doesn't take into account the additional $1.2 trillion in spending and tax cuts that are still under discussion.

Administration support for more tax cuts for the wealthy in the stimulus package has puzzled some observers, since there does not seem to be a pressing political reason to do so. It is also ironic, because Bush has presented himself as a president who would tackle the difficult problems facing Social Security as baby boomers reach retirement age, yet additional tax cuts would almost certainly exacerbate that looming crisis. Federal Reserve Chairman Alan Greenspan is on record as opposing large budget deficits, and supported Bush tax cuts only if they were phased in. He also advocated that Congress reconsider the tax cuts if there was a significant change in economic outlook -- a point he repeated in a closed Senate session on September 25. Writing in the Washington Post, columnist Sebastian Mallaby suggests that if Greenspan were to advocate funding a stimulus package by rescinding tax cuts, long term interest rates would drop. "So why does he hold back? Again, the clue lies in the Reagan years, when administration officials recklessly attacked the Fed, undermining the perception of its independence. Remembering that time, Greenspan does not want to risk the Fed's authority by provoking a public argument with the White House over taxes. It is a sad irony that one lesson from the 1980s prevents him from reminding the country of the other one, which is that tax cutting can be dangerous. "

References:

Kessler, Glenn and Juliet Eilperin "Democrats Resist Bush's Push For Stimulus Heavy on Tax Cuts" Washington Post 5 Oct. 2001

Krugman, Paul "RECKONINGS:Fuzzy Math Returns" NY Times 7 Oct. 2001


"A Flawed Stimulus Plan" Editorial. NY Times 6 Oct.2001

Murray, Shailagh And John D. Mckinnon "Firms Push Government for Tax Breaks In Hopes of Reviving Stalled Businesses" The Wall Street Journal 10 Oct. 2001

"America's fiscal shock" Economist.com 11 Oct. 2001

Mallaby, Sebastian "The Stimulus That Could Depress" Washington Post 15 Oct. 2001