Tax Cuts Were Meant for Rainy Days--Like Today

President Bush’s tax and budget plan tells the American people they can have it all: lower taxes, more spending for education and the military, prescription drug subsidies for seniors--and on top of all this, nearly $2 trillion in debt retirement.

Is this just naive political happy talk? Is Bush relying on voodoo economics?

Not at all. If the U.S. economy gets back on the economic growth path that we enjoyed in the prosperous 1980s and 1990s, the budget surpluses will be large enough to give Reagan Republicans their tax cuts, liberals their new spending programs and old-fashioned fiscal conservative debt hawks a halving of the national debt over the next decade. According to the official budget forecasters, with a 3% rate of economic growth through 2011, the budget surplus will exceed $5 trillion over the next decade. That’s more than the combined annual income of every resident of every state west of the Mississippi River.

But there’s a catch.

If the economy tanks this year and next, our budget surpluses could quickly become a deficit. If more workers lose their jobs, if more businesses declare bankruptcy, if the stock market continues its bearish nose dive, the Niagara Falls of tax revenues that have been streaming into the Treasury since the mid-1990s will dry up. No amount of realistic fiscal discipline could make up for the shortfall that a recession would cause.

The key to keeping the budget in balance and the national debt on a downward slope is the economy, stupid. President Reagan and former U.S. Rep. Jack Kemp (R-N.Y.) were right when said that we would eventually grow our way out of the budget deficit. Five years ago, the budget scorekeepers predicted that by now the federal government would run a deficit. Instead, we’ve run close to a $600-billion surplus. This wasn’t because Congress or the Clinton White House suddenly got religion and started to pull in the reins on the runaway federal budget. Just the opposite. Spending rose faster than expected. But these years were so prosperous that the tax collections far outpaced all the extra spending.

When President Kennedy was trying to sell Congress on a large tax cut in 1963, he said that the best way to balance the federal budget was to create prosperity. He said that it was a “paradoxical truth that when the economy is burdened with tax rates that are too high, we will never create enough jobs and we will never produce enough revenue to balance the budget.” Back then, it was Democrats who wanted to cut tax rates and austerity Republicans who opposed the policy as “fiscally irresponsible.” The Republicans were wrong in 1963, just as many Democrats are wrong now. After the 1963 tax cuts, the U.S. economy blossomed. Federal tax receipts grew so rapidly that President Johnson was able to finance the Great Society programs and the escalation of the Vietnam War without raising taxes.

Recently, Democratic leaders Tom Daschle and Richard Gephardt complained that the Bush tax cut plan would “repeat the mistakes of the 1980s.” But just like Kennedy’s tax cuts, the Reagan tax plan contributed to a revitalization of America’s economic might and a consequent doubling of federal tax revenues from 1980 to 1990. The gigantic deficits were caused, for better or worse, by a huge buildup of federal spending on the military and entitlement programs.

Debt reduction doesn’t cause growth; growth causes debt reduction. The biggest problem our economy faces is not debt but a tax drag. Taxes as a share of gross domestic product are now higher than at any time since the height of World War II. The tax code is particularly onerous on savers. It imposes multiple layers of taxes on savings and investment, a personal income tax, a corporate income tax, a capital gains tax and the death tax. In fact, our national savings rate has fallen in almost direct proportion to the increase in the tax burden.

The Bush tax cut shouldn’t be aimed at stimulating consumer spending, but at reducing the tax penalty on saving, investment, risk taking and work. This means cutting tax rates, eliminating the death tax, dramatically expanding tax-free individual retirement accounts, cutting the capital gains tax. I’d also favor chopping the regressive payroll tax rate by 2% or 3%.

We may not be officially in a recession now, but the manufacturing sector has been in decline for eight months and the wealth of the high-tech sector is evaporating before our very eyes. Budget surpluses are meant to be used for a rainy day. Hey, it’s raining.