April 2 , 2003
When the Senate pared back the President's tax cut to
half its proposed size in a budget resolution, were they rejecting the
benefits going to the retired wealthy, were they thinking about "guns and
butter", or was it a little of both.
Of course, the budget resolution will go to a conference
committee because the House approved all the monies needed for President
Bush's proposed tax cuts. Thus,
some reduction in taxes on dividend income still could be approved in a
compromise. However, even some
Republicans in the House appear to be wondering if so many revenues should be
returned to the people when wartime spending remains uncertain.
I am not going to say much more about the double taxation
of dividends that I already discussed in several other columns.
The amount of growth it generates is open to question, its impact upon
near term economic activity is minor according to almost all economists who
opined on the subject, and most of its benefits are received by higher income
To be sure, most of those "wealthy" are retired
and probably will spend as much of any tax cut as even the poor people will.
Indeed, without unreasonable assumptions I can show how the dividend
recipients may spend more per dollar of dividend tax reduction than the poor
would from tax credits.
There undoubtedly was legitimate concern of including a
double taxation of dividend reform into a tax stimulus package.
However, I think the weightier question is the one of
"guns and butter." That
phrase was coined by the Johnson administration during the Vietnam conflict.
That Texas president maintained that spending on military action was
compatible with spending to develop society's infrastructure.
Whether the training and medicare programs of the Great
Society actually improved society's infrastructure is open to question.
Nevertheless, the Great Society with its war on poverty did lower
poverty, at least until the inflation spawned by too much economic stimulus
began to eat away at America's economic competitiveness.
President Bush is not trying to expand government social
investment in addition to more defense spending. Furthermore, even the most Keynesian economists agree that
some incentive to change productive behavior is achieved when marginal tax
rates are cut. Thus, tax cuts try
to pay for themselves by expanding the tax base.
However, only some die hard White House economists
believe that the incentives from tax reductions are strong enough to self
finance tax cuts. Art Laffer, one
of the originators of the term "supply side economics", indicated
that below a certain marginal tax rate, tax cuts would lose tax revenue.
My own empirical work suggests that somewhere below 50
percent, marginal tax rate reductions cannot make up in expanded tax base what
they lose from reduced tax rates. When
tax rates fall to 35 percent, something other than tax policy is dictating why
additional work is being accepted. Moreover,
if the tax reduction is not on the margin, as in eliminating the marriage
penalty, providing a child tax credit, or lowering the initial tax bracket
rate for those paying above that bracket, then no supply side response should
Therefore, only a small portion of the tax cut will be
financed from an expanded tax base derived from additional work.
The remainder is the Republican equivalent of Johnson's
"butter." Not surprisingly, Senators with a sense of history are
wary of adding to a deficit when the costs of war remain uncertain.
Of course, there are differences between
the programs of Johnson and Bush (do all Texas presidents go to war?) I
already discussed how one expanded government spending obligations far into
the future. The other lowers
government revenue far into the future per dollar of GDP.
Also, Johnson's war and spending occurred after an
economic expansion was well along. Bush
really needs to prod this expansion, which most corporations do not view as
other than a long recession. Therefore,
a surge of inflation is unlikely to accompany Bush's policies.
Still, those New England Republicans may feel guilty that
we gain while our soldiers risk much. If
we don't suffer during a war, will we be more prone to have them?
As an economist, I would do exactly what the Senate did. Move those already approved tax cuts forward to prod the economy, but do not provide anything more until we can show the sacrifice that earned it.