Tax Cut Juggernaut

With ever-increasing budget surpluses projected and Federal Reserve Chairman Alan Greenspan singing a new tune, the Beltway is building a consensus that a cut in taxes is inevitable. If a cut indeed happens, careful construction will determine whether it helps the economy.

Some members of Congress already are arguing that President Bush’s proposed $1.6-trillion tax cut is too timid. But both Congress and Bush also plan large spending increases for defense, prescription drug coverage for the elderly and aid to education, among other programs. Both political parties also agree that reduction of the national debt should continue. To meet these competing demands, congressional leaders and the White House should get together and, before considering any tax legislation, agree on how much should be earmarked for tax cuts, new spending and savings, respectively. Budget discipline, which helped bring about the surpluses, should not be lost. Bush himself endorsed such a joint budget process in his campaign, and the chairman of the House Budget Committee, Jim Nussle (R-Iowa), last year introduced legislation to make it a standard procedure.

The tax cutters argue that the U.S. economy needs help; it grew at a mere 1.4% annual pace in the fourth quarter of last year, the slowest in more than five years, and may have gone flat since then. Consumer spending, the engine of growth, slowed to a crawl and business investment is down. Consumer confidence, a measure of future spending, is at an eight-year low, corporate profits are down and reports of substantial layoffs are rising. The Federal Reserve, in a dramatic move to reverse the decline, cut the benchmark short-term interest rate by half a percentage point in early January and by another half a point Wednesday. The last time the Fed cut that much in that short a period was in 1984, and more cuts may be coming.

The interest rate cuts were the right response. Tax cuts are a clumsy way to spark an economy. By the time they filter through the economy, growth may already be restored. Such cuts could be more helpful if enacted retroactively. Also, the Treasury could even reduce taxpayers’ withholding once the size of the cut was decided. The economy gets the biggest bang from cuts for middle- and low-income taxpayers--not for the wealthy as Bush proposes--because they are more likely to spend the extra money.

In a tax cut, plain old rate trims would offer advantages: If revenues dropped below anticipated levels, it would be easier for Congress to raise rates again than impose new taxes. Congress should also consider repealing the marriage tax penalty, an anomaly built into the tax code. But repealing the estate tax, as Bush proposes, is bad social and economic policy. Instead, Congress should merely modify the tax to remove the harsh consequences it can have on some farms and small businesses.