Tax Cuts: Fight the Fever

With the fresh news about unemployment rising to 4.9% from 4.5%, tax cut fever is returning to Washington. Once again a Republican administration is set to gut the tax code and send the United States back into deficit spending. Except now the storyline isn’t quite so simple. It isn’t the White House but congressional Republicans and Democrats breathing fire for tax cuts. House Republicans including House Majority Leader Dick Armey are intent on slashing the capital gains tax from 20% to 15%. And Democrats such as Senate Budget Committee Chairman Kent Conrad and Sen. John F. Kerry have also seized upon the ailing economy as a reason for cutting the Social Security payroll tax from its current rate of 12.4% in hopes of creating a short-term stimulus.

Both the Democrats and the Republicans pushing for trims, however, have it wrong. A tax cut is bad medicine.

For starters, the current spate of unfavorable news about the economy is no cause for panic. It is important to remember that the business cycle has not been repealed. Booms are nearly always followed by crashes. It is unclear whether the economy is headed into a full-blown recession or whether the worst is already over. That uncertainty alone means that politicians should wait before they try to gin up the economy. But President Bush’s $1.35-trillion tax cut has complicated the situation. The key to U.S. economic success over the past decade has been to restrain spending and not engage in massive tax cuts. Federal Reserve Chairman Alan Greenspan may have been tardy in carrying out interest rate cuts, but he has cut decisively. The effects will be felt in coming months and should be beneficial. If tax cuts are pushed through and the federal deficit rises, Greenspan’s hands will be tied. He would probably be forced to raise interest rates for fear of encouraging inflation.

What’s more, the tax cuts being urged would do long-term damage. The Republican push to cut the capital gains tax makes no sense in the short term; who’s paying capital gains when the stock market is plunging? Democrats are eager to cut the Social Security payroll tax, which hits the middle class hard, but what happens when the baby boomers retire? Cutting the payroll tax right now makes no sense, either.

Politicians’ urge to pass quick fixes will probably increase in coming weeks. The closer the 2002 midterm election comes, the greater the temptation will become. Wise lawmakers will resist it. Piling on another tax cut would only make things worse.