Will Tax Cuts Pay Off?

By Daniel Kadlec

Maybe in a previous life George W. Bush traveled the land selling snake oil. What ails ya? Nothin' his bottled cure-all wouldn't fix. Naturally, he would be long gone when the mob returned with tar and feathers. In this life some things have changed. Snake oil is out; tax cuts are in. High energy prices got ya down? A tax cut will make the spike affordable. Might lose your job in the slowdown? A tax cut will turn this economy around and save your paycheck. That's the Bush pitch: tax cuts as a nostrum for everything, and a lot of folks are buying.

Last week the Senate Finance Committee swiftly approved a $1.35 trillion tax cut over 11 years--only modestly lower than the President's initial $1.6 trillion target and the $1.65 trillion package that emerged from the House last month. A final full-Senate vote should come early this week, setting the stage for a Senate-House conference by week's end. The writing is on the wall. Americans are about to get their largest tax cut in 20 years.

But is this real medicine? Economist and Bush critic Paul Krugman calls the ever changing arguments for tax cuts "startling in their intellectual dishonesty." If that's so, will the mob return in 2004 and run the good doctor out of town?

In truth, Bush doesn't even have that long. Should voters find that his tax initiatives are more placebo than prescription, Republicans will lose their narrow edge in Congress in 2002. That would render the President's plans for things like Social Security reform and national missile defense next to impossible to achieve and leave him limping into the '04 election. So a lot is riding on this giant gift to taxpayers, which the G.O.P. hopes to ram through by Memorial Day.

There's not much the Democrats can do to stop the Republicans. Senate minority leader Tom Daschle tried to delay the bill, but he was undermined when four Democrats on the Senate Finance Committee--its ranking member, Max Baucus of Montana, John Breaux of Louisiana, Arkansas moderate Blanche Lincoln, and the embattled Robert Torricelli of New Jersey--cut separate deals to get their pet rocks in the bill. They then signed on to the G.O.P. plan.

From the Republican point of view, tax cuts were never envisioned as a recession-stopping maneuver but more of a long-term growth driver that would lessen the impact of downturns while keeping the economy on a firm track. "It's the people's money," Bush has said repeatedly. Left unsaid but an integral part of his thinking: if you let them keep it, they will spend it, and that's what makes an economy grow.

That's still the G.O.P.'s overriding view, though the party has agreed to provisions that put $100 billion in taxpayers' hands by the end of next year--a late nod to Democrats, who pushed to speed up relief in an effort to help fight off a recession. How that money will be distributed is an open question--probably either in a one-time check or via reduced income-tax withholding.

The idea of a lump-sum rebate of $600 or so appeals to many economists. The thinking is that with a relatively large sum people will spend a portion on big-ticket items, like a washing machine, and stimulate the deeply depressed manufacturing sector. Reduced withholding, on the other hand, would produce pocket money in dribs and drabs and probably benefit service industries most.

A tax rebate of $100 billion--$60 billion this year and $40 billion next is likely--seems huge, but in a $10 trillion economy, it's a pimple, and everyone knows it. In January, Treasury Secretary Paul O'Neill readily noted that lower interest rates (monetary policy) do more to stimulate the economy than anything the Administration could do on the tax front (fiscal policy). Chimes in Allen Sinai, chief global economist at Decision Economics: "To really prevent a recession, we would have to double, or more, the tax reductions this year and next."

Yet there are those who argue that tax cuts alongside falling interest rates are the proper pick-me-up for the economy. Federal Reserve Chairman Alan Greenspan seems game. He has endorsed tax cuts and took the benchmark Federal Funds rate down to 4% from 6.5% last December. Sinai says that without a tax cut the economy would grow 1.6% this year; with the cut, 1.8%.

Next year, he estimates, the tax cut would make the difference between 2.6% and 3.4% growth. He believes the tax cut would significantly buoy employment and do little to stir inflation. Adds Richard Berner, chief U.S. economist at Morgan Stanley: "These tax cuts are a big deal. The tax-cut train has left the station, and it is clearly going to be stimulative."

That doesn't mean the Dems are without grounds in battling Bush on tax cuts. The bulk of the Senate plan, which Bush favors, produces 62% of the tax savings more than five years from now. The main near-term relief comes in the form of a reduction in the lowest tax bracket. The plan would cut the tax rate on the first $12,000 of income for couples ($6,000 for singles) from 15% to 10%, reducing almost every earner's tax bill by $300 to $600.

More serious relief from a repeal of the estate tax, an expansion of IRAs and 401(k)s and the removal of the marriage penalty (the extra tax some couples owe simply because they are married) would come much later. And the Alternative Minimum Tax, or AMT, which would go away initially for many taxpayers, would resurface in 2006.

Then there's the even bigger issue of who benefits most from the cuts. Answer: the rich. Bush steadfastly argues that those who pay the most tax should get the most relief. But that's hardly a populist cry. Under the Senate proposal, after the taxes are fully phased in by 2011, the top 1% of earners--those now making $373,000 or more a year--would get an average tax cut of $37,300 (including the projected repeal of the estate tax), according to the Center on Budget and Policy Priorities. That's less than the $46,700 they would have got under the original Bush plan but a long way from the average tax cut of $562 that the middle-of-the-pack taxpayer would receive. "The big winners are still the folks with high incomes," says Joel Friedman, a senior fellow at the center.

That's sending Dems into a full-throated roar. They charge that under the Senate bill 72 million middle-class taxpayers making $12,000 to $65,000 a year get almost nothing. "This thing is so loaded, so unfair, so fiscally irresponsible, it flunks every test of a tax bill," rails Senator Kent Conrad of North Dakota, the ranking Democrat on the Budget Committee. Moreover, some fear the tax cut would grow to more than $4 trillion in its second decade, just as baby boomers retire and put a strain on Social Security and Medicare. Certainly, it would add costs in the form of higher interest payments required to service a bigger-than-projected national debt.

So Conrad and other Democrats are on a mission to revamp and redirect before the cuts become law. The push is on to accelerate relief, throw more savings to lower tax brackets and install some kind of trigger that would prevent future cuts from kicking in unless certain debt-repayment and budget-surplus targets were met. But time is short. Tax-cut fever is running high and for now, anyway, Dr. Bush has the elixir that folks want.

--Reported by Bernard Baumohl/New York, Douglas Waller and Adam Zagorin/Washington

With reporting by Bernard Baumohl/New York, Douglas Waller and Adam Zagorin/Washington