Rising Doubts May Cool Off Tax-Cut Fever

Tax-cut fever hit Washington with a vengeance this past week, but there are serious questions about how long the enthusiasm will last.

Initially, both the White House and Congress jumped on the bandwagon, with Republicans and Democrats seemingly hellbent on trying to outdo each other by rushing out ambitious new tax-cut measures this fall.

But now, leading economists--as well as some of the more cautious planners in Congress and the Bush Administration--say it may be the wrong medicine at the wrong time for the American economy.

Economists warn that because of the lags before a policy change takes effect, the tax cuts probably would not spur consumer spending until sometime next year at the earliest--which may be long after the stimulus is needed.

What is more, a tax cut that is not fully offset by spending reductions or tax hikes elsewhere would increase the record federal deficit just as the year-old recession may be beginning to wind down. A bigger deficit likely would force interest rates up, further eroding the confidence of consumers and the investment community.

“I think it is bizarre to be talking about tax cuts when we are facing a record deficit of nearly $350 billion,” said Rudolph G. Penner, former director of the Congressional Budget Office and now an analyst at the Urban Institute in Washington.

Alice Rivlin, another former congressional budget director, said: “I don’t think we should be doing anything on tax cuts right now.”

But, in the face of mounting public restlessness over Washington’s failure to bring the lingering recession to an end, some top Administration policy-makers and much of the Democratic leadership in Congress apparently feel under pressure to take strong action on the economic policy front.

And, although the White House signaled late last week that it would postpone announcing any tax-cut decisions because of internal divisions among top policy-makers, Bush still seems committed to forging an economic growth package before the end of the year.

The political pressure for a tax cut is building from liberals and conservatives.

Liberal Democrats, who see the economy as their best issue with which to attack Bush in the 1992 campaign, want the congressional leadership to push a package of tax cuts for the middle class as part of their effort to paint Bush as the protector of the upper class.

In addition, many lawmakers are frustrated by the tough budget discipline imposed on them by last year’s pact between the Administration and Congress. These legislators believe that it is time to reopen that agreement--which was intended to bring the burgeoning federal deficit under control--so that Washington’s priorities can be rearranged by slashing defense spending and cutting taxes.

“A lot of people in Congress feel they have lived under tremendous constraints but haven’t gotten any credit for it from the voters, and so they feel like they should just chuck the budget agreement,” said Robert Reischauer, the current CBO director.

Meanwhile, conservative Republicans--who believe that Bush has betrayed Ronald Reagan’s legacy by failing to develop a more aggressively pro-growth, pro-business economic agenda--are trying to force the White House to campaign for a capital gains tax cut and new investment tax credits.

“The conservative disenchantment with Bush is over the fact that they don’t see any economic policy at all,” said Norman Ture, a supply-side economist and president of the Institute for Research on the Economics of Taxation, a conservative Washington-based organization. “The Bush people have been asleep at the switch.”

The combination of political pressures on Democrats and Republicans, many analysts and some congressional leaders warn, could transform the tax-cut movement into a “bidding war” between Republicans and Democrats to see who can lower tax rates the most--and, in the process, increase the federal deficit. “A lot of people who know better are caught up in this frenzy,” Penner said.

That is what happened in 1981 at the onset of the Reagan era, and the result was massive federal deficits throughout the 1980s. But despite that history, tax-cut proponents are pressing plans to reduce taxes for an array of constituencies--most notably the middle class and the business community.

But there are stark differences between the Democratic and Republican plans, and neither is likely to emerge unchanged.

The White House wants to couple a middle-class tax break with a capital gains tax cut and new business investment tax credits aimed at benefiting the affluent. But the Administration remains split over how far to push its plan. Treasury Secretary Nicholas F. Brady, along with Budget Director Richard G. Darman, believe it is a mistake to push a capital gains tax cut now on the grounds that it would enable the Democrats to reopen the budget agreement and push their own program.

In a series of meetings, Darman and Brady have squared off against conservative Republican leaders in Congress, especially Sen. Phil Gramm of Texas and House Minority Whip Newt Gingrich of Georgia, who believe that the Administration ought to campaign for a pro-business tax-cut package.

Michael J. Boskin, Bush’s chief economic adviser, appears to be caught in the middle. He favors a capital gains cut but also seems wary of reopening the budget agreement. As a result of the rift, the Administration has been forced to delay any decision on exactly what to include in its tax package.

But the Democrats are pushing hard. Opposed to a capital gains tax cut, the Democratic leadership wants to concentrate instead on middle-class tax breaks. But the congressional leadership has not rallied around any of the growing number of Democratic proposals.

Many of the Democratic plans call for paying for middle-class tax breaks by cutting defense spending or by raising taxes on the wealthy.

One of the most highly publicized Democratic plans was introduced by Senate Finance Committee Chairman Lloyd Bentsen (D-Tex.). His plan calls for creation of a $300 tax credit for each child in a family and would expand individual retirement account benefits. It would cost $72 billion over five years and would be paid for by a 5% cut in defense spending over that period. Similar proposals to trade defense spending for middle-class tax cuts have been announced by Sens. Bill Bradley (D-N. J.) and Jim Sasser (D-Tenn.).

Sen. Albert Gore Jr. (D-Tenn.) and Rep. Thomas J. Downey (D-N. Y.) have proposed a more sweeping change in the tax code to ease the burden on the middle class--making up lost revenue with higher taxes on the rich. It would provide families with an $800 tax credit for each child--with equivalent cash payments for families too poor to owe taxes--as a replacement for the $2,150 personal exemption for children. That would be financed by raising the top nominal tax rate to 36% from 31% and would sock a 15% surtax on people who earn more than $200,000.

Both the White House and the Democratic congressional leadership insist that they do not want their tax-cut proposals to increase the federal budget deficit. They all claim that their plans are self-financing, either through offsetting defense spending cuts or by tax increases. As a result, leaders on both sides argue that the existing budget agreement can survive their tax-cut proposals.

The White House is especially eager to preserve the budget pact--which was supposed to last five years--to maintain the rules that now keep the Democrats from slashing defense spending. If the Administration goes ahead with its tax-cut plan, officials are likely to argue that the Bush tax cut will pay for itself and thus will not violate the budget agreement. To blunt Bush’s capital gains proposal, the Democrats are likely to reject those White House claims.

But few analysts believe any fiscal discipline can be maintained.

Now, economists and others concerned about the deficit are pinning their hopes on a handful of congressional leaders--most notably House Ways and Means Committee Chairman Dan Rostenkowski (D-Ill.)--who oppose any effort to lower taxes immediately or tamper with the budget agreement.

Tax-Cut Fever: The Rival Plans

President Bush and members of Congress are struggling over whether--and how--to push through a tax-cut package to help spur the faltering economy. Here are the major elements of what Bush is considering and what some key lawmakers have proposed:

President Bush and Republican congressional leaders:

* Cut tax rates on capital gains.

* Relief for middle-income taxpayers by cutting Social Security payroll taxes.

* Allow home buyers to use money from Individual Retirement Accounts to finance home purchases.

* Other, unspecified investment incentives.

White House Chief of Staff John H. Sununu says the tax relief for middle-income taxpayers would be financed by additional revenues resulting from the economic stimulus provided by the cut in capital gains taxes.

Sen. Lloyd Bentsen (D-Tex.), chairman of Senate Finance Committee:

* Relief for middle-income taxpayers by allowing each family to claim a $300 tax credit for every child up to age 18.

* Expansion of tax breaks for contributions to Individual Retirement Accounts.

Bentsen says his tax cuts would be financed by reducing military spending by 5%--or $72.5 billion over five years.

Sen. Phil Gramm (R-Tex.) and Rep. Newt Gingrich (R-Ga.):

* Cut the top tax rates on capital gains to 19.6%, from the current 28%.

* Expand tax benefits for Individual Retirement Accounts.

* Provide a tax credit for first-time home buyers.

* Make permanent the tax credit for research and experimentation by business.

Like Sununu, Gramm and Gingrich contend that the cut in capital gains tax would produce enough in new revenues to finance the other tax reductions.

Sen. Bill Bradley (D-N.J.):

* Relief for middle-income taxpayers by providing a $350 tax credit for each child up to age 18, with equivalent cash payments for families that are too poor to owe taxes.

Bradley would pay for the cuts by trimming $80 billion from military spending over the next five years and $38 billion from domestic programs.