Modest Jolt in Economy Seen From Tax Cut

The latest tax cuts approved by the Republican-controlled Congress and embraced by President Bush probably will give the struggling American economy a lift, but only a modest one -- on the order of expanding the nation’s gross domestic product by the annual output of Nevada.

On the plus side, according to analysts, the cuts will pump an extra $160 billion into individuals’ pockets between now and the end of next year. That is substantially more than Bush’s original proposal would have done, and more than the 2001 tax cuts did.

But offsetting this boost is the fact that many of the measure’s provisions will “sunset,” some in only 18 months, which means that as matters stand many of the taxes going down now will go back up later.

“On balance, it will help,” said Ross C. DeVol, a senior economist at the Milken Institute in Santa Monica. “But it’s not sufficiently large to take what’s been a muddling economy and return it to robust growth.”

Claims for how -- and how much -- the latest cuts would help the economy have changed during the torturous five-month debate over the measure.

When the president first called for a new round of cuts -- the third in as many years -- he made elimination of the dividend tax the centerpiece and said his chief aim was improving incentives for businesses to invest, expand and hire.

But the cuts that have emerged from Congress look much more like a traditional fiscal stimulus, at least initially. Checks for as much as $400 are due to go out to 25 million families with children within three weeks, and the taxes withheld from people’s paychecks are scheduled to shrink by midsummer, according to the Treasury Department.

Both steps will help the economy by giving consumers more money to spend.

Indeed, the size of the consumer breaks expected to kick in between now and the 2004 presidential election surprised even some of those involved in crafting the final tax cut package.

“This is one helluva pump-primer in 2003 and 2004,” said G. William Hoagland, a senior budget aide to Senate Majority Leader Bill Frist (R-Tenn.). “If this doesn’t get the economy going, I don’t know what will.”

With key elements of the final package only days old, many economists confined their assessments of the measure to generalities late last week, saying they think the cuts will help lift the economy but dodging the question of how much.

One way to tackle that question is to look back at the proposals that preceded the final compromise. Analysts had a chance to study those before the rush of legislative action produced last-minute changes.

In essence, the tax cut package that’s headed for Bush’s signature takes the form of a $550-billion House measure crammed into a $350-billion budget devised by the Senate. The major change involves “sunsetting” the dividends and capital gains tax cut portions of the House bill more quickly.

In addition to $320 billion in tax cuts, the final package includes $30 billion of new spending, two-thirds of it to help cash-strapped state governments.

An analysis by Congress’ Joint Committee on Taxation concluded that the House proposal would have added between $19 billion and $76 billion annually to the real gross domestic product, the economy’s total output of goods and services, in each of the next five years.

That’s equivalent to expanding the U.S. economy by somewhere between the annual output of North Dakota, the smallest of the states in economic terms, and Nevada, which ranks 31st, according to the latest Commerce Department figures.

Or, to use another measuring stick, it’s the same as adding the economic activity of another Sears, Roebuck & Co. and Dell Computer Corp.

The House measure’s chief author, Ways and Means Committee Chairman Bill Thomas (R-Bakersfield), insisted throughout the tax cut debate that increases of this magnitude would give the economy a sufficient jolt to revive strong growth.

But many independent economists, even ones sympathetic to more tax cuts, doubt that cuts of the size in the House measure or the final bill will be enough to get the economy out of its torpor. “They’ll have some positive effect in the short run, but not much,” said UC Berkeley tax economist Alan J. Auerbach.

Most doubt surrounding the economic effect of the tax cut package centers on its sunset provisions.

The tax committee study of the package’s House predecessor concluded that, after adding jobs and growth in the first years, the measure would have begun subtracting them as key elements relatively quickly.

And the final package includes even more sunsets than the House measure.

Conversely, most arguments that the final package can produce sustained, strong growth are based on the assumption that the sunsets will be removed and the temporary tax cuts will be made permanent by future congressional action.

In their current form, analysts said, many of the package’s elements are likely to produce perverse side effects that damage growth.

For example, the temporary reduction of the top rate on dividends from 38.6% to 15% provides a huge incentive for companies to pay out big dividends now, leaving them with less -- not more -- money to invest in expansion and new growth.

Moreover, unless the sunsets are removed, the economy will in effect have to weather a string of tax hikes over the next decade as cuts switch off and tax rates go back to their original, higher levels.

If the economy responds quickly to the initial blast of the tax cuts and puts on a powerful burst of growth, the later hikes can be easily borne. But many analysts doubt matters will work out so smoothly.

“Congress and the president may not even get the short-term economic reprieve they want before the tax increases (they have built into the new tax cut package) are due to take hold,” warned Reagan administration tax official C. Eugene Steurele.

On the other hand, if Bush and congressional Republicans solve the sunset problem as they have signaled they want to -- by extending the life of the tax cuts -- the result will almost certainly be ballooning federal deficits.

If all the cuts set to expire were made permanent, the 10-year cost of the package would rise from its current $350 billion to between $807 billion and $1.06 trillion, according to the Center on Budget and Policy Priorities, a liberal advocacy group whose numbers are often cited in Washington policy debates.

If all the cuts were made permanent and problems with the tax system that almost every observer agrees must be tackled -- such as the growing reach of the alternative minimum tax -- were fixed, the package’s cost and the additional deficits would be closer to $2 trillion.

(The alternative minimum tax, first levied in the late 1960s to cover a handful of super-rich Americans who had escaped taxation, is on track to cover 36 million Americans by the end of this decade.)

Some officials have suggested in recent months that deficits don’t matter -- that worries they will crowd out private borrowing and drive up interest rates are unfounded. And with long-term rates near half-century lows, they seem to have a point.

But if the economy starts showing strength, the deficit squeeze will certainly return, offsetting or even erasing the very benefits the latest round of tax cuts was intended to produce.

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Times staff writer Joel Havemann contributed to this report.