March 1, 2001

President George W. Bush gave four reasons for justifying the $1.6 trillion tax cut over the next decade.

First, the economy needs it. Second, it will prevent runaway government spending. Third, the people are paying too much for their government and they should have the excess returned to them. Fourth, the cuts remove inequities and yet, are "fair".

We already tried the experiment of containing government by containing revenues in the 1980s. That did not work. Furthermore, the argument that tax cuts would improve economic activity and lead to more tax collections is at odds with the claim that tax cuts would contain spending.

I have written in the past that revenues should never be the justification for government spending. Only if the resources used by government provide more benefit to the common good than could be achieved by the private sector should those expenditures occur. How those resources are financed, whether by taxation or borrowing, is a separate issue.

However, President Bush is not the first politician to use revenues as the benchmark for expenditures.

The argument that the people are paying too much for government also is not valid. If our economy is not generating sufficient savings to finance the investment needed to exploit embedded technology or provide growth capacity, then accumulating savings at the government level may be needed to achieve desired investment and growth.

Just because the savings are accumulated by the government rather than households does not mean that savings are not available to finance houses, enterprises, capital spending, or other desirable economic expenditures.

The government does not hold the surpluses in a lock box. Instead, they reduce their borrowing or buy back debt instruments. This releases resources for private investment.

In the past three years, government spending grew an average of 4.5 percent per year while revenues grew more than 10 percent. Does anyone, other than some Bush advisors, really believe that if tax cuts had lowered those revenues to 4.5 percent gains, the economy would have boomed by more than the nearly 5 percent growth with declining inflation that actually occurred?

This argument also raises questions about the economy needing the tax cuts. However, I must now side with the President. During the era of 15 percent growth in capital spending and rapid growth in the economy, revenues expanding faster than government expenditures was justified.

Capital spending has now slowed sharply (declining in the fourth quarter). The private sector no longer is taking the resources released as government bonds are being reduced and converting them into capital goods. (They are buying some houses, however, as reduced government borrowing leads to lower mortgage rates).

This decline in private investment certainly justifies some reduction in government savings. Indeed, a drop in receipts below the proposed 4 percent growth in expenditures could be justified as long as this dearth of private investment persists.

However, can anyone assume that such a condition will persist for an entire decade? Yet receipts are to grow more slowly than the economy for each of the next ten years in the Bush proposal. If the President is right about this need, then he must be wrong about the economic assumptions used to justify the size of the surplus in the first place.

This follows because the economic assumptions are based on the capital accumulation and productivity gains of the past five years, when the need was for higher government savings.

There is a current need for a reduction in receipts relative to economic growth and the President's call to make reductions retroactive to the first of the year certainly is appropriate. Doubling the tax credit per child and lowering the first tax bracket to 12 percent this year may be viewed as relatively fair. (Everyone who pays taxes will benefit from a lower first bracket on some of their taxable income).

Whether the highest brackets need to have reductions depends upon the economic disincentives that high marginal tax rates currently create. The President believes that rates above 33 percent are too onerous. I have seen no studies that support that particular rate, but the economic argument for excessive disincentives may be justified at that rate.

The excessive taxation of wealth at death is another issue that requires substantial discussion. The President's proposal does not generate much simplification if the repeal of the estate tax is coupled with the passing along of transactions records to heirs so they can pay capital appreciation when wealth is finally sold, as the President proposes.

Anyway, the arguments for the changes in tax codes that the President proposes must rest with issues of economic disincentives and inequity, not the other arguments the President inappropriately used to defend his program.


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