Economists Warn Against New Tax Cuts

While lawmakers continued calls Monday for new tax cuts to revive a stumbling economy, economists warned that virtually all the proposals now under consideration would be costly, ineffective and potentially damaging.

“We tend not to get these things right,” UC Berkeley economist Alan J. Auerbach said of tax cuts aimed at spurring growth. The current crop of proposals, he said, “just wouldn’t work.”

The renewed infatuation by lawmakers with tax cuts comes after Friday’s news that the nation’s unemployment rate climbed sharply in August, to 4.9%. Many fear the rise threatens economic recovery.

But it is almost completely at odds with the prevailing view among economists who once endorsed cuts as Washington’s most potent weapon against downturns, but now spurn them as ineffective.

“The basic problem with fiscal stimulus is that the [time] lags are so long it is hard to make it work,” Yale economist William D. Nordhaus said.

In fact, Washington already has approved one tax cut this year, a 10-year, $1.35-trillion package that President Bush touted during the 2000 election campaign as a means of returning money to the taxpayers, then partially recast as a means to spur growth once the economy began stumbling. The Treasury expects to send out almost $40 billion in tax rebates this year.

But to date, the burden of keeping the country from recession has fallen largely to the Federal Reserve, which wields Washington’s other major economic weapon: monetary policy, or the ability to nudge interest rates up and down.

Since January, the central bank has carried out one of the swiftest interest rate reductions in recent history, slashing its benchmark Fed funds rate 3 full percentage points, to 3.5%. Further cuts are expected when the Fed policymaking committee meets Oct. 2.

Even if the Fed approves more interest rate cuts, the move seems unlikely to quiet calls by lawmakers for another round of tax breaks. That’s because neither political party wants to be blamed for having let the prosperity of the last decade sputter out.

At the moment, the parties are split over the form the cuts should take, with congressional Republicans embracing an old favorite, a capital-gains rate cut, while Democrats tout some form of Social Security payroll tax relief.

The White House appears to be trying to slow momentum for any kind of new cut by expressing concern about the state of the economy while suggesting a wait-and-see stance. A key Bush aide said Monday that the administration is in “no rush to immediately do something” about the sagging economy because it expects a recovery shortly.

The president is “deeply concerned” about the economy, but feels under “no extreme pressure” to do something more, R. Glenn Hubbard, the chairman of Bush’s Council of Economic Advisors, told Bloomberg News.

“The economy appears to be turning around by the end of the year,” Hubbard said. “The default option is to stand pat.”

Independent economists interviewed Monday disagreed about when to expect a turnaround, but virtually all endorsed standing pat over embracing any of the current crop of tax cut proposals. Several were especially scathing about a capital-gains cut. “That really has nothing to do with fiscal stimulus,” Yale’s Nordhaus said.

Beyond the particulars, economists have turned against the whole notion of Washington using its taxing and spending powers to manage the economy except in the most extreme cases, arguing that the government moves too slowly to be effective.

In doing so, the economics profession has undergone a sea change. “If you go back to economic textbooks 30 years ago, you’d see much more confidence in fiscal policy than in monetary policy,” Berkeley’s Auerbach said. Now it’s the reverse, he added.

Washington too appeared, at least until recently, to have changed its views on the subject. It rejected the last two major efforts to use tax-and-spend methods to revive growth: a 1992 proposal by the president’s father to speed up recovery from the 1990-91 recession, and a 1993 fiscal stimulus package by President Clinton.

But in both instances, the deciding factor was that the government was running huge budget deficits. Analysts have wondered what would happen when the country slipped into recession during an era of surpluses, such as today.

To the extent economists are willing to endorse any kind of tax cut to cope with the current downturn, most preferred a revamping of the recently approved tax package.

“If, in fact, Washington wants to do something sensible with fiscal policy, it should take the tax cuts it has already passed, move them forward, and structure them so their benefits are a little better distributed,” Nordhaus said.

The lion’s share of the cuts in the current package take effect later in the decade, and much goes to wealthy taxpayers who tend to spend a smaller fraction of their tax savings than less affluent households.