February 21, 2003
Taking On the Real Issue With Tax Cuts
The economy is in a fragile state, and our political leaders in Washington want to do something about it. Their motives are self-serving, of course, but the beautiful thing about representative democracy is that their aims of getting re-elected will be best served by putting more bread on all of our tables. How can this best be done?
That is the essence of the question that will be addressed by Congress in the coming months as it considers the different stimulus packages put forth by the Bush administration and from Congressional Democrats. Of course, each plan has an immediate impact of the sponsoring party's traditional base of support: low to moderate income households, for the Democrats, and investors and those in higher tax brackets in the case of Republicans.
But if you think that this tax debate is all about each party's leaders simply trying to funnel more public money back to their friends, you're missing the point. While Democrats and Republican share a common desire for political power, their tax proposals reflect genuine differences in opinion about how the actions of government affect the economy. Those beliefs, in turn, stem from differing interpretations of our recent economic history.
There are many Democratic plans on the table, but they largely call for temporary, lump-sum tax rebates to all households. Senate minority leader Daschle's proposal to refund $300 to every taxpayer, plus an additional $300 per child, is offered so that it will stimulate new spending, which will boost production and ultimately yield job growth. An idea with origins in the New Deal stimulus of the Roosevelt administration during the Great Depression, when the collapse in spending threw so many people out of work.
The logic seems simple to follow, but it has a fatal flaw. If the government spends money, it has to collect it, either today, in the form of taxes, or tomorrow, in the form of new debt. Either way, the dollars added in spending are reduced by those obligations. Evidence of this flaw is easily seen from the behavior of the U.S. economy during the 1930's, which remained depressed right up to the beginning of the Second World War. Whatever its other benefits may have been, the New Deal did not bring about the end of the Great Depression.
The Republican plan has two important differences. It makes tax cuts permanent, and it carries them out by slashing marginal rates. This makes the plan more expensive, from the point of view of government, at least at first blush. And the plan cannot escape the same truth that dogs the Democratic plan, namely, that the spending cuts or deficit increases needed to offset the tax decrease will work in the opposite direction as the stimulus of the tax cut.
The key difference is in what happens to the size of the overall economic pie. Under the Democratic plan, we have $300 more in our pockets, but the rewards to work and investment are exactly the same. With lower marginal tax rates, however, we get to keep a little more of what we earn and invest, making us all work a little harder and thus making the economy a little bigger.
Or at least that's the idea. Republicans cling to the record of phenomenal growth of the 1980's in the wake of the Reagan tax cuts as proof of the wisdom of their ideas. But claiming credit for every good thing that happens is a reflex action not confined to politicians in the GOP.
Both parties are silent on what is probably the most honest question that could be asked about a tax stimulus. That is, is there anything that Congress could do to pull us out of a recession, if in fact we are heading that way? Philosophical differences aside, the unavoidable lag between legislation and the impact of tax law changes says that what Congress is really deciding is how to help the economy of next year, not the one we're living in today.
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