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Bush wins the tax war

Marie-Josée Kravis

Only a delusional liberal press and Senator Tom Daschle could interpret the US$1.35-trillion tax reduction package accepted by the Congress as a defeat for President George W. Bush. In the recent presidential campaign, Democratic contender Vice-President Al Gore had argued that a tax cut of US$500- to $600-billion was all the country could afford. Candidate Bush’s proposed US$1.6-trillion cut was deemed irresponsible, unaffordable and politically unfathomable. Just a little more than three months after taking office, President Bush has elicited broad bipartisan recognition that tax cuts not only make sense, but are necessary to sustain U.S. economic health.

Granted, the Congressional package is slightly less generous than President Bush had intended it to be, and it is spread over eleven rather than ten years, but this is a modest compromise. President Bush has shifted the tone of discussion in Washington away from the merits of a tax reduction. Debate centres not even on the size of the tax cut, but rather on the distribution of the package.

The budget outline provides a preliminary framework for these discussions. Office of Management and Budget (OMB) director Mitchell Daniels had proposed an increase of discretionary spending of 4% whilst Democrats asked for 8%. It seems that 4.9% will be the compromise number, and that spending for education and defense will increase substantially. It may come as a shock for business leaders, who year after year search for cost cuts to improve the efficiency of their operations, to witness debates over the size of spending increases. No one could run a business based on the assumption of continued increases in costs, but such is the nature of government. Build it and they will come; give them the money and they will spend it. This may be the most compelling argument in support of a tax cut—the limits it places on Congressional spending binges.

The press has deliberately ignored this argument, preferring instead to cast tax cutting as a Republican acceptance of Keynesian principles. The U.S. economy is weak, despite the seeming reassurances provided by first-quarter 2001 GDP growth of 2%. First, it is very likely that these numbers will be revised downwards given the inventory numbers released this week. Moreover, jobless claims released this week were at their lowest level since 1992, signalling a potential deterioration of consumer sentiment and spending. Rising energy prices this summer could further restrain consumer spending. The Democrats maintain that they support tax cuts only because tax relief is necessary to provide Keynesian stimulus to a slow economy. Commentators suggest that Republicans have jumped on this bandwagon.

While it is true that, for some time, candidate and now President Bush and his team have advocated monetary and fiscal stimulus to mitigate the economic slowdown, the tax package is anything but Keynesian. It is not a one-time intervention to jump-start the economy. On the contrary, in addition to the US$100-billion in immediate tax relief, it provides for sustained tax relief for over a decade. In good and bad times U.S. taxpayers will see their tax burden diminished — not quite what Keynes had in mind.

Taking the Keynesian argument further, George Baker of the Financial Times affirmed that the Internet/telecom sector had attracted one of the worst misallocations of capital ever. Would it not have been more effective and efficient to have directed this investment to education, roads and other public works? He conveniently ignores that the Internet/telecom binge has been badly and rapidly punished by markets. In contrast, increased U.S. spending on education has coincided with a sharp deterioration in reading and mathematical scores, attendance and overall school safety and discipline, but the educational establishment remains unaccountable and intact. So much for efficient allocation of capital.

Claims of the demise of demagoguery are indeed premature. Debates over the distribution of tax cuts will rekindle concerns about tax cuts to the rich. Proposals to eliminate the estate tax will probably be withdrawn, but the rich will be singled out as the main beneficiaries of the Bush plan. The top 1% of income earners in the United States pay roughly 35% of personal federal income taxes, and the top 25% pay close to 83% of taxes. The top 50% of taxpayers pay 96% of all federal income taxes. Not surprisingly, tax reductions will benefit these groups. It is impossible to reduce the taxes of someone who pays none, and the Bush plan for across-the-board tax cuts should move more Americans into this category of zero taxes. The preferred Democratic option is targeted tax credits which use tax revenues to subsidize government-directed behaviour. Luckily, these ideas are slowly being discredited as taxpayers begin to understand that tax cuts relate to greater freedom from government decision-making and spending.

This may be the defining domestic policy victory of the Bush administration.

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