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Bush's tax reform at risk

Marie-Josée Kravis

A vote in the U.S. Senate this week seems to have jeopardized President Bush’s 10-year, US$1.6-trillion tax-cut package. A key Republican senator, James M. Jeffords of Vermont, has indicated that he would oppose the president’s full tax cut in favour of a Democratic proposal calling for a US $1.125-trillion tax reduction over 16 years and a substantial increase in education spending and debt reduction. Given the 50-50 split in the Senate, this decision seriously threatens the president’s agenda.

Ironically, the Senate battle coincided with a vote the very same day in the House of Representatives calling for a repeal of estate taxes. Last month, the House had approved US $958-billion in cuts to personal income tax rates, lower taxes for married couples and increased tax credits for children. It is premature to share the conclusions of Senate Democratic Leader Tom Daschle that the president’s tax bill is almost surely dead, but very clever manoeuvering will be necessary to salvage meaningful tax cuts and tax reform.

In part, confusion over tax reform stems from the Bush White House strategy to muster support for the president’s proposals. As the U.S. economy began to weaken, President Bush and Vice-President Cheney eagerly pointed to tax cuts as necessary measures to reinvigorate a faltering economy. They deliberately ‘talked the economy down,’ but in so doing, managed to fuel uncertainty about the likelihood of future budget surpluses. Americans have been very supportive of fiscal caution. Alarmist views of economic prospects shook their confidence about the merits of tax reductions and provided tax-and-spend Democrats with plenty of ammunition to nourish these fears. If the surpluses did not materialize, social security and medicare spending would be cut, debt would rise, and interest rates would follow.

The fiscal 2002 budget package presented February 28 also contributed to this political posturing. To account for lower tax revenues, budget director Mitchell Daniels mandated that discretionary spending grow 4% in 2002 rather than the 6% rate of the past few years. Belt-tightening is anathema to any legislator, and the proposed stringency shifted attention more clearly to the effect of tax cuts on future spending, including, of course, pork-barrelling. Political hypocrisy has couched opposition to tax reductions as a preference for debt reduction, but the real concern is turf, turf and turf. Tax cuts reduce the margin for increased government spending and the creation of new programs. They suggest smaller government and real government reform, but the Bush team has done a rather poor job of staying on message. Tax cuts, or rather, more importantly, tax reform would make sense even if the economy were vigorous. It was a mistake to try to blur the debate and portray them as a remedy to current woes.

The White House tactics linking tax cuts to economic stimulation confused Americans because they appeared to contradict long-standing Republican rejection of Keynesian economics. In true Keynesian fashion, they seemed to support the notion that an activist government could counter cyclical forces and micromanage the economy. This neutralized President Bush’s arguments calling for less government spending and regulation. At least since the years of Ronald Reagan, Republicans had argued vigorously that governments were generally ineffective in constructing counter cyclical policies because consumers and businesses anticipate changes in fiscal policy and modify their decisions accordingly. What mattered, they maintained, was consistency in fiscal policy and the perspective of steady growth of after-tax income and increased incentives to work and produce.

In that sense, the Bush package is anything but Keynesian because it promises to lower taxes, again and again, for ten years. It is not a counter cyclical measure, but the first step towards genuine tax reform. Cuts in marginal tax rates do increase incentives to work, invest and produce. They correct, albeit not completely, the bracket creep of the last decade. By increasing IRAs (Individual Retirement Accounts) the tax package encourages savings, and by reducing capital gains taxes it supports investment. Elimination of special-interest deductions simplifies the tax code and rids it of a number of distortions.

Granted, the package is not perfect and a slowing, possibly stagnant, economy will test the discipline of Congress to rein in spending. However, failure to broach tax reform will simply postpone measures that could sustain productivity growth, boost incomes and provide greater benefits for workers — desirable objectives whether or not the economy is slowing. Unfortunately, President Bush has confused Americans by focusing on short-term palliatives rather than lasting solutions. If only he could return to the fundamentals of tax reform, he may just overturn Democratic zeal.

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