The Voodoo of Dubya-nomics

By Michael Kinsley

When Congress passed President Bush's tax bill last week, it had all the major elements he wanted: an immediate general income-tax-rate cut, a big tax break for dividends (plus another for capital gains he didn't request), and new deductions for small businesses. The total cost over 10 years, $350 billion, is less than half the $726 billion Bush asked for, but much of the gap is accounting tricks. The President need not worry that this bill won't cost enough.

Bush's victory is intellectual as well as political. This bill reflects an extraordinary, even radical shift of the tax burden from the rich to the middle class. And in the weeks leading up to the bill's passage, Bush made a remarkably detailed and sophisticated case for it, most notably in Albuquerque, N.M., on May 12. Detailed, sophisticated and wrong--which makes his victory all the more impressive.

Here is Bush's case in brief. It begins with a little history. When he took office, he said, "we were in a recession," but "it looked like we were kind of starting to come out." Then came 9/11. After that came revelations that major corporations had "cooked the books." Although "we're overcoming" these setbacks, he noted, "too many of our people aren't working. We're growing, but we're not growing fast enough." And how does he account for the deficit? "We have got a deficit because this economy went into a recession," and "we have got a recession because we went to war. And I told the American people...we're going to spend whatever money is necessary to make sure we win." In other words: Don't blame me for a weak economy.

To solve the problem, Bush called for a plan based on this principle: "If your economy is too slow, you need to increase demand for goods and services." Increased demand leads to new jobs. And the most efficient way of creating new jobs is to "focus on small business" because "small-business owners" create the most jobs. Most small businesses don't pay corporate income tax. Instead, their profits are treated as income to their owners. So cutting ordinary income-tax rates is "really pumping capital into ... small business." The new tax bill also quadruples, to $100,000, the amount a small business can deduct each year for new equipment. Bush called this limit a "cap on investment."

How else do you help the little guy? You eliminate "the double taxation of dividends," said Bush, because that will boost the stock market, thereby "helping our average citizens realize wealth." (Ultimately, Bush had to settle for halving the top rate for the dividend tax.) All in all, he says, accusations that his plan "only helps the rich" are "just empty rhetoric."

So what is wrong with all this? In a nutshell, it doesn't make sense even in its own terms.

Start with the history. Can the weak economy be blamed on Bush's predecessor, on al-Qaeda, on Enron? A recession, as Bush says, "mean[s] three quarters of negative growth." The economy grew through the end of 2000, then growth turned negative in the first three quarters of 2001, including three weeks of Clinton and more than eight months of Bush. That is what allows Bush to say he inherited a recession.

But growth turned positive in the last quarter of 2001, beginning Oct. 1, so it is bizarre to blame the recession on the events of 9/11--which occurred 19 days before the recession officially began to turn around. It is even more bizarre for Bush to blame the recession on money spent fighting the war on terrorism. War spending is historically a way out of a recession, not into one.

What Bush describes as his key principle is a classic if crude statement of Keynesian theory. A tax cut works, he said, by putting more money into people's pockets--which they will spend and thus create jobs. For 25 years, Republicans have sneered at this as "demand-side" economics. If Bush now embraces it, he ought to remember the corollary: that a tax cut should go mainly to low-income people, who are more likely to spend it. And the President should stop pretending he regrets the huge deficits his tax cuts produce. Deficits are essential to a demand-side stimulus. If he cut government spending to pay for the tax cuts--which he is not even attempting to do--this would reduce demand as much as the tax cut would increase it.

Of course, everyone loves a stimulus. In his push for a larger, quicker tax cut, Bush asked, If a $350 billion stimulus is good, why isn't a $750 billion stimulus even better? If tax cuts are good in seven years--his previous tax bill phased in cuts over a decade--then why not more now? Here is a question for him: If a stimulus is always good, and the bigger the better, why have taxes at all? Why not finance the entire government on borrowed money? Once you acknowledge that this won't work--that a stimulus can be too large or badly timed--you can start thinking about how to tell a good stimulus from a bad one. President Bush has yet to begin that journey.

Bush creates a straw man: the critic who says his plan "only helps the rich." The actual criticism is that it mainly helps the rich. The much smaller tax breaks for lower-income people are vital too. They provide cover and act as a bribe. For a few hundred dollars, the government buys your support for a plan worth millions to those who already have millions.

This is the traditional Republican supply-side aspect of Dubya-nomics: you help the poor by helping the rich. In particular, Bush justifies cuts in top-bracket tax rates by noting that they will benefit the small-business owner. That they will. But a lot of top-bracket taxpayers are not small-business owners. So even under the dubious premise that small-business owners are delicate flowers that must be fertilized with extra-rich tax goodies, a general tax cut for the rich is a weird way to go about it.

Bush also makes it sound as if small businesses currently get no tax deduction for anything they spend in excess of $25,000 a year on equipment. In fact, just like big businesses, they can depreciate as much new equipment as they wish. That means spreading the deduction over the years the equipment is helping produce income, under standard accounting principles. Allowing the immediate deduction of all those equipment costs amounts to a subsidy. Only small businesses get it.

The President's argument for eliminating the tax on corporate dividends--he is settling for a cap of 15%--is also disingenuous. Because companies pay the corporate income tax, taxing shareholders' dividends is "double taxation," he says. But the corporate income tax has brought in a declining share of federal revenue for decades, as corporations are granted deductions and discover loopholes. And if taxing the same income twice bothers the President so much, why doesn't he start with ordinary working wages, which are subject to both the income tax and payroll taxes for Social Security and Medicare?

Bush's other rationale for cutting the tax on dividends is that this would be good for the stock market. Share prices would rise, and millions of ordinary investors would have more money to invest or spend. This line of reasoning adopts another aspect of classic Keynesianism: the money illusion. The idea is that when people feel richer, they spend more, which helps the economy, which makes them richer for real. Today's conservative economists, when they are not serving in a Republican Administration, tend to be skeptical of such magic. They would say that unless investors are morons, which they aren't, a dollar added to the return on stocks (because the government has forgone a dollar of taxes on dividends) isn't going to raise the total value of stocks more than a dollar. In terms of bang for the buck, it's a costly way to go about a general economic stimulus. And though Bush emphasizes small investors, big investors will benefit most.

In a fascinating aside during his Albuquerque speech, the President mocked the "new economy," in which "folks said, Would you invest in my company, because the sky is the limit?" even though "nobody seems to be buying my product." The notion that pressure to pay dividends could reduce the risk of another stock bubble like the one that burst in 2000 is not crazy. But Bush's puritanical critique of the "new economy" is an odd fit with his central theme that we need tax cuts because it is too hard for entrepreneurs to raise capital. He describes the "new economy" as a world of easy capital for anyone with a song and dance, sustained by "pie-in-the sky pronouncements." Funny, it sounds a lot like the bill Congress placed on his desk last week.