Bush tax plan offers no short term stimulus

Erik Nelson

In Thursday’s issue of the Daily, the basic facts of the George W. Bush tax plan proposal were summarized. It was also said that richer Americans would disproportionably benefit from the tax plan. In Friday’s issue of the Daily, the theoretical merits of the tax plan were discussed.

The proposal’s potential drawbacks

Many economists feel appropriate economic policy at this time is a short-term stimulus package that will nudge the sluggish economy out of a mild recession. Unfortunately, as many economists have said, Bush’s proposed tax cut and spending package is not a short-term stimulus plan.

A short-term stimulus package is a temporary policy that immediately puts money in the pockets of people or companies willing to spend their sudden windfall. An ideal stimulus package would increase demand for the United States’ production capability. Many policy tools can be used in an effort to quickly stimulate an economy, including lowering interest rates (consumer borrowing becomes cheaper); enacting tax cuts, rebates, or job creation programs that puts cash in the hands of lower- and middle-income Americans (lower- and middle-class Americans are more likely to spend money than their investing and saving upper-class countrymen); and accelerating government spending.

As panelists at last month’s American Economics Association meeting said, the income tax rate cuts in the Bush plan are too small to have any stimulating effect on an $11 trillion economy. Further, the bulwark of the proposed package – dividend tax relief – will not accrue to shareholders until they file 2003-year taxes in 2004; not only, then, is the stimulating effect too small to rev today’s economy, it comes at least one year too late. Finally, because the vast majority of the proposed tax rebate accrues to the wealthy, the tax cuts’ potential to satisfy excess capacity in the U.S. economy would surely be hindered; as mentioned earlier, richer Americans have a much higher savings rate than middle- to lower-class Americans. In fact, White House insiders have quietly admitted that the Bush administration is not greatly interested in short-term stimulus; this proposal is more an expression of a philosophical and ideological agenda.

The passage of Bush’s tax cut and spending proposal will surely increase the federal deficit. Recent increases in military and homeland security spending as well as falling tax returns have led government officials to forecast a $250 billion federal budget deficit for the 2003 fiscal year. A war in Iraq and enactment of the proposed tax cut package could easily increase this number to $500 billion for this fiscal year. A $500 billion deficit would be 4.6 percent of this fiscal year’s projected U.S. gross domestic product. A deficit this large would match the largest federal budget deficits of the past 30 years.

A deficit is not necessarily a bad thing, especially in the midst of a recession. Excess government spending on wages and consumption has often been used in an attempt to bump an economy out of its doldrums. However, as many economists have recently argued, a deficit-financed tax cut that largely pads the savings and investments of the rich is not sound policy and will not properly stimulate the economy. Further, as this country braces for the storm of baby-boomer retirement and the resulting strain on Social Security and the federal budget, fiscal discipline might be more important than ever.

Over the last two years the Federal Reserve has cut interest rates to spur consumption and increase demand for production capability. There is a danger that a deficit-financed tax cut could raise interest rates. The reasoning behind the theory goes thusly: After tax cuts, people feel richer, and therefore they consume more, save less, work less, and interest rates rise to attract money for falling investment. Some economists dispute this claim and contend that inflation has a bigger effect on interest rates than deficit-financed tax cuts. Whatever the relationship between interest rates and deficit-financed tax cuts, it is a concern that merits attention.

The biggest problem with the proposed package, however, is that it continues a worrisome trend toward a flat or nonprogressive tax system. As Joseph Pechman, a celebrated tax economist, first said in 1985, “the (U.S.) tax system became less progressive between 1966 and 1985, primarily because the corporation income and property taxes declined in importance while heavier emphasis was being placed on the payroll tax.” Since 1985 this trend, if anything, has continued. As Daniel Altman, a New York Times economic writer, said: “(T)he current tax system is one tipped in favor of those happy few who already control most of the nation’s income. Only during part of President Dwight D. Eisenhower’s term, in the mid-1950s, was the tax system as ever as unfavorable to the disadvantaged as it might be in the Republican’s ideal future.” Enactment of the Bush proposal, and its abolition of the dividend tax, would only exacerbate the trend mentioned both by Pechman and Altman.

Because a capitalist economic system tends to create economic winners and losers, it is only fair that the winners compensate the losers. The passage of Bush’s proposed tax cut and spending package would continue the recent propensity of tax policy to block any redistribution of wealth. While the proposed tax cut and spending package could increase the efficiency of the U.S. economy, encourage more investment, and decrease some idiosyncratic economic behavior, the proposal’s potential to further erode our fair progressive tax system and recklessly expand the federal government’s budget deficit is too much to argue for its endorsement.

The future of Bush’s proposed tax and

spending package

There is no doubt that Congress will tweak the proposal. Congressional watchdogs predict that the House of Representatives will enthusiastically endorse the proposal as is and that the Senate will add and subtract from the proposal. Hopefully, the nation’s lawmaker’s zeal to enact Bush’s proposal will be tempered by an Associated Press poll that was conducted at the end of 2002. In the poll, by a 2-1 margin, Americans said that it would be more prudent to hold off on further tax cuts for the time being. Surprisingly, even a majority of those that identified themselves as Republicans in the poll felt tax cuts at this time were a bad idea. Let us hope that our lawmakers act as their constituents wish.

Erik Nelson is a University graduate

student and a member of the Daily’s

editorial board. Send letters to the editor to [email protected]