NEWS ANALYSIS : Bidding War on Tax Cuts Raises Danger of Backfire : Economy: Some analysts warn reductions would boost deficit, increase interest rates, abort recovery.

Early last fall, when Democrats were groping for a campaign theme to use in this election year, Sen. Lloyd Bentsen (D-Tex.) turned to one of Washington’s favorite recession remedies: Why not spur the sluggish economy by enacting a tax cut for the middle class?

The suggestion became a self-fulfilling prophecy. Seeking to preempt the Democrats, President Bush cranked out a White House proposal combining tax cuts for the middle class with reductions targeted for businesses and investors. Fearful of being left behind, House Democrats quickly cobbled together their own package containing a slightly bigger reduction for the middle class along with higher taxes on the rich.

Now, four months after Bentsen floated the idea, the tax-cut initiative has expanded into a big political tar baby that some analysts warn could drag both parties into a sticky election-year morass. This week, in separate actions, different tax-cut packages will be taken up by the full House and by members of Bentsen’s Senate Finance Committee, with the prospect that the legislation will be enlarged even further--and, some fear, possibly backfire.

Although tax-cut fever clearly is sweeping Congress and the Bush Administration, economists are decrying it as unnecessary. Even worse, they warn, the final package is likely to increase the federal deficit, risking a rise in short-term interest rates that might abort the already weak recovery.

Claims by Congress and the White House that their respective tax reductions would not increase the deficit are being derided by budget analysts and fiscal experts of both parties.

At the same time, polls show that voters are decidedly unenthusiastic about a tax cut and suspicious that it will only widen the deficit.

Rep. Leon E. Panetta (D-Carmel Valley), the House Budget Committee chairman, is fearful that the rivalry between the Administration and the Democrats will cause a replay of the one-upmanship that occurred in 1981, when Democrats and the newly installed Ronald Reagan Administration vied to outdo each other in enlarging the tax-cut package Reagan had proposed. The result: The budget deficit soared out of control.

William Schneider, a political analyst at the Washington-based American Enterprise Institute, warned that cutting taxes at this time entails political as well as economic risks. The proposed legislation “is meaningless and the voters see through it,” he said. And if the economy slips back into a recession, this year’s tax relief crusade could turn out to be a “trap”--particularly if it is widely blamed for impeding the recovery.

Such concerns notwithstanding, the bidding war has already begun. Bush’s original proposal has been made more generous by House Republicans, who expanded the President’s proposed reduction in the tax on capital gains--profits from the sale of stocks or other assets. The “Democratic alternative” drafted by members of the House Ways and Means Committee provides for broader tax cuts for the middle class and more for business and investors as well.

Last week, as the Democratic alternative began to draw criticism from many House members, the Ways and Means Democrats added still more provisions designed to benefit small business and manufacturing. The Senate version, to be drafted by the Finance Committee this week, is expected to go even further.

What is puzzling to many analysts is that the tax-cut campaign is continuing, even though economic experts and opinion surveys suggest there is little demand anywhere outside the halls of Congress for a big tax cut this year:

--Economists, from Federal Reserve Board Chairman Alan Greenspan on down, are almost unanimous in cautioning that the economy is edging back to life on its own and that widening the deficit would run the risk of pushing interest rates up again.

--Critics complain that no matter which tax-cut proposal ultimately is enacted, neither party has provided a formula for a broad economic policy of which tax reductions may--or may not--be a part. Analysts said the tax cuts would not resolve the two biggest problems facing the economy: too much business and consumer debt and a widespread lack of confidence in current economic policies.

Bush is leaving most of the work on the policy front to the Federal Reserve, prodding it to ease money and credit policies further. But analysts said that, too, is reaching the danger point: The Fed has loosened credit so much over the last few months that, if consumers suddenly begin spending again, it could be in the position of having overshot the mark--and possibly fueling inflation once more.

--While Democrats say their plan provides more “tax fairness” than Bush’s, experts say the two packages contain so many similar provisions that it is difficult to see much difference--a measure of how far to the right Democrats have moved in recent years. Robert S. McIntyre, director of Citizens for Tax Justice, said the main difference is that Bush’s plan skews much of its benefits toward high-income taxpayers, while the Democrats’ “comes out even on rich people.” From the standpoint of fairness, “both of them are horrible,” he declared.

--Budget experts said that claims by both White House and congressional Democrats that their tax-cut packages can be financed without adding significantly to the budget deficit are unrealistic, at a minimum, and in some cases patently misleading. And any plan that increases the deficit over the long haul could wind up hurting the economy rather than helping it.

Bush’s plan calls for $24.6 billion in tax reductions, which the Administration says would be “paid for” by cutting spending for popular entitlement programs such as Medicare, changing the accounting rules for the federal agency that guarantees pension benefits and cutting capital gains taxes--actions that the Treasury has said would bring in some $76.3 billion more in new revenues--cutting the deficit over five years by $48 billion.

But many analysts are skeptical of such claims. Rudolph G. Penner, former director of the nonpartisan Congressional Budget Office, pointed out that neither party has ever shown any enthusiasm for cutting entitlement programs--which remain the most stubborn obstacle to reducing the budget deficit--and both sides are unlikely to change that position now.

As for the accounting rules, Penner conceded that the changes proposed by Bush “would finance the tax-cut package in a purely technical sense,” but he is uneasy about relying on such back-door measures to offset that large a revenue drain. “What he’s got there, essentially, are gimmicks,” Penner complained.

Finally, many analysts do not believe the Administration’s contention that the cuts in capital gains taxes will bring in huge amounts of new revenues by spurring more investment and economic activity. The Administration has estimated that the capital gains proposal will reap $20 billion a year in added tax revenues, while Democrats argue that it will be a money-loser. Congress’ Joint Committee on Taxation places the likely loss at $15.4 billion over six years.

By contrast, the Democrats’ plan calls for some $80 billion in tax cuts, to be financed over a six-year period by $90 billion or so in tax increases, primarily on upper-income taxpayers. The difference ostensibly would go to reduce the budget deficit.

But congressional tax experts concede that the Democratic bill as a whole would increase the deficit sharply during the next three years, before the proposed tax increases on the wealthy become fully effective. “It takes them five years of tax increases on the rich to pay for two years of tax cuts for the middle class,” said Carol Cox Wait, president of the Committee for a Responsible Federal Budget, a private budgetary watchdog group.

And the financing scheme assumes that Congress will not want to extend the tax cut for the middle class beyond 1994, when it is scheduled to expire, despite the onset of another election year. Wait lampooned that prospect as “a heroic assumption.”

The financing scheme also assumes that controversial provisions such as a proposal to prohibit corporations from deducting more than $1 million of the salary costs for their top executives will survive the legislative process and become law.

Penner and other analysts are dubious of the Democratic bill. “We’ve tried this game before, where we say we’re going to increase the deficit temporarily and then repay the whole thing in later years, and we all know how that turns out,” he said.

That message has gotten through to some lawmakers. At a meeting of the House Democratic Caucus last week, House leaders were stunned to learn that a sizable number of rank-and-file Democrats are reluctant to enact any tax-cut legislation this year. That revelation, together with opposition to specific provisions of the Democratic alternative, forced the leadership to send it back to the Ways and Means Committee for revisions.

But even if many members are having second thoughts, the House Democratic leadership has gone so far out on a limb in promoting the tax-cut concept that it now feels obliged to push it through no matter what the political risks.

Speaker Thomas S. Foley (D-Wash.), pleading for support for the package in the Democratic Caucus last week, based his appeal more on the need for party unity than on the merits of the bill.

“They’ve upped the ante so much that they can’t get out of it any more,” Schneider of the American Enterprise Institute said.

Ironically, congressional analysts said, the whole dilemma could be resolved if Bush carries out his threat to veto the Democratic package, assuming that it first passes both houses. With barely enough votes to approve the Democratic plan, House leaders would have difficulty overriding a veto--especially if the economy begins to pick up, as now seems the case.

Indeed, there are indications that a good many Democrats are banking on that prospect, and are supporting their leadership for that reason only.

That may be true of the Administration as well. Although Bush has continued to berate the Democrats for proposing to alter his original tax-cut plan, he has asked lawmakers to enact a sharply stripped-down version by March 20--partly to speed passage in Congress. Some Administration aides have begun hinting privately that he might not press that hard to get the rest of the package passed later on.

As a result, Congress watchers consider it increasingly likely that no tax-cut bill will make it into law at all.

William E. Brock III, former chairman of the Republican National Committee, said he believes the odds currently “are against any tax bill” passing. “No President is going to sign a bill that does that amount of damage,” he said. “The Administration is not going to get into that kind of political fix.”

The Bidding War Over Tax Cuts Tax-cut fever is sweeping Congress and the Bush Administration. Here is a look at the attempts to up the ante: Date: October, 1991 Bidder: Sen. Lloyd Bentsen (D-Tex.), trying to help Democrats frame an issue for the 1992 election campaign, proposes cutting taxes for the middle class. Date: Jan. 28, 1992 Bidder: President Bush, under pressure from Democrats to do more for the middle class, tries to preempt them by proposing a multibillion-dollar tax-relief plan, to be paid for by changing the government accounting rules. Date: Feb. 7 Bidder: House Republicans, crafting “streamlined” version of Bush package designed to speed passage, insert more generous provisions for real estate and for cutting taxes on capital gains--profits from the sale of stocks or other assets. Date: Feb. 12 Bidder: House Ways and Means Committee votes to send Bush’s tax-cut plan to the House floor and then craft a Democratic alternative with more generous tax reductions for the middle class. Date: Feb. 14 Bidder: Democrats on the Ways and Means panel complete work on the Democratic alternative, which is loaded with new tax breaks, many of them more generous than Bush’s plan. Date: Feb. 14 Bidder: Senate Majority Leader George J. Mitchell (D-Me.) says he would like to see the Democratic alternative made still more generous by making a proposed middle-class tax cut permanent rather than temporary. Date: Feb. 19 Bidder: Widespread discontent in the full House Democratic Caucus prompts Democrats on the Ways and Means Committee to add still more tax breaks to their proposal--this time for small businesses and for corporate spending on new plants and equipment.