Suddenly, Everyone Wants To Cut Taxes

Washington has a bad case of tax-cut fever. Senate Finance Committee Chairman Lloyd Bentsen (D-Tex.) says: "The economy is dead in the water, and we have to jump-start it." House Minority Whip Newt Gingrich (R-Ga.) and Speaker Thomas S. Foley (D-Wash.) agree that Congress should provide a stimulative jolt before quitting for the year. Housing Secretary Jack F. Kemp, getting a headstart on an Administration that's still pondering its options, is calling for a tax summit to consider "emergency measures." Even curmudgeonly House Ways & Means Committee Chairman Dan Rostenkowski (D-Ill.) is faltering. He plans to lay out a scheme of his own within the next week or so. A tax cut that seemed inconceivable just weeks ago could be reality by yearend. It almost surely would include a cut in the tax on capital gains and a reduction in income taxes for middle-income families. It also will probably contain some kind of rate hike on the wealthy. But despite the growing clamor, there's no assurance that ideological differences can be bridged quickly enough to assure a deal this year. And there's no guarantee any quick-fix tax bill will do much to juice up the sputtering economy. "I doubt there will be much macro effect," says University of Michigan economist Joel B. Slemrod.

In the frenzy of an approaching election year, politicians may agree something should be done. But they're badly divided over details. Congressional Democrats are squabbling among themselves about what kind of middle-class tax relief they favor and how to pay for it.

At the White House, the idea of anti-recessionary action has been given new urgency by polls showing that voter concern about the economy is beginning to chip away at President Bush's reelection support. But the Administration is deeply split. An insurgent faction, led by Kemp and Commerce Secretary Robert A. Mosbacher, is pushing for a big economic-growth package. They are battling Treasury Secretary Nicholas F. Brady, Budget Director Richard G. Darman, Council of Economic Advisers Chairman Michael J. Boskin, and White House Chief of Staff John H. Sununu, who argue the economy doesn't need the kind of "help" that Congress is ready to offer. They fear that altering last year's budget accord would remove the final shred of fiscal restraint. "Once a budget agreement is opened up," warns one Administration aide, "people are going to start driving tanks and trucks through it." Moreover, opponents are concerned that a new tax fight would expose Bush again to Democratic charges that he favors the rich. A worried Bush seems to be tilting to the do-something crowd. "Bush is way out in front of his economic advisers," Kemp says. "What a tragedy it would be if we focus on counting up beans."

STARK CHOICES. The White House is struggling to get control of runaway events. But that effort will be complicated by Bush's travel schedule, which will keep him away from Washington for much of the fall. And even if Bush and congressional leaders come to terms on a tax package, economists doubt it will do much to boost growth. Most feel that a tax cut of $10 billion--or even $20 billion -- a year won't do much for a $5.5 trillion economy, even in the short run. Says former Reagan tax aide Eugene Steuerle: "It's hard to believe that anything this small can really make much of a difference. We're talking about less than 0.5% of GNP."

It's tough to predict the impact of any tax measure until policymakers--who still face a $300 billion-plus federal deficit--decide how, or whether, they want to make up for lower revenues. The choices are stark: Do you cut taxes on some individuals and raise them on others? That won't provide much of a spur to the economy. Paying for a tax cut by cutting defense spending, as Bentsen advocates, could actually slow the economy a bit. According to Laurence H. Meyer & Associates, a St. Louis economic consulting firm, a $10 billion tax cut that's offset by a $10 billion reduction in defense spending by the end of 1992 would trim 0.2% from economic growth. And there's a longer-term issue raised by proposals to use defense savings to cut taxes: Spend future peace dividends on a tax break today and they won't be there tomorrow for education, health, and other "human capital" investments that so many politicians back.

The final choice for policymakers is to cut taxes and simply let the deficit grow. According to economic theory, widening the deficit should be stimulative. But the bond markets, which have tanked since rumors of a tax cut began to fly, aren't cooperating. And a little tax trimming won't do much for the economy if interest rates rise or even if market fears of a higher deficit limit the Federal Reserve's ability to cut rates. Treasury's Brady and chief economist Boskin are warning Bush of the dangers of a tax-cut-induced spike in interest rates.

Market jitters over the tax talk have "already cost us 25 basis points on the long bond," says one senior Fed official. "And that's just the first round." The Fed's concerns make it clear that the deficit still matters. "The current malaise does call for some kind of fiscal stimulus," says Mellon Bank chief economist Norman Robertson. "But it's hard to contemplate tax cuts when we face the prospect of a $400 billion deficit next year. Any package would have to be very, very small."

How do you get the biggest bang for the paltry bucks out there? Cutting capital gains, Bush's favorite plan, would likely do the least. A months-long debate would probably have the perverse effect of locking up capital, while investors wait for the lower tax rate to take hold. Once the new rate kicked in, it would set off a flurry of transactions, but the net investment probably wouldn't give the economy immediate help. Says Meyer & Associates economist Chris Varvares: "It doesn't offer much stimulus potential. You're not going to unleash investment in small firms overnight." Finally, Bush's capital-gains proposal, which provides explicit incentives for long-term investment, was designed to prevent the kind of asset-flipping that might spur short-run activity.

QUICK FILLIP. What about some kind of middle-income tax relief? There are lots of different versions of this floating around: raising the personal exemption, creating a new credit of $300 or more for each child, or slashing the Social Security payroll tax. Each would put money in the hands of people most likely to spend it fast, giving the economy a short-term boost. Even if the middle-class cut were financed with a new tax on the wealthy, the economy might still get a small jolt. The downside: The wealthy will have a bit less to save and invest. And that, economists say, will hurt in the long run.

Bentsen has been pushing a plan to expand tax benefits greatly for contributions to individual retirement accounts. Economists have been arguing for a decade over whether IRAs create new long-term savings or merely encourage people to shift money from taxable to tax-deferred accounts. Curiously, if the critics of IRAs are right, the new tax break could actually encourage wealthy individuals to spend some of their tax-generated windfall. If IRA boosters are correct, the tax break will increase long-term savings but do nothing for today's economy. Says Varvares: "Tax cuts aimed at boosting savings are good long-term policy, but not good countercyclical policy."

Lurking in the wings is yet another tax-policy evergreen -- restoration of the investment tax credit. Bringing back the old ITC, which was killed in the big 1986 tax reform, would be hugely expensive and just isn't in the cards. But a targeted credit--limited to increased spending for specific types of investment--is getting a second look on Capitol Hill. Many economists believe such a focused cut may be the way to go. Says Lawrence Chimerine, senior economist at DRI/McGraw-Hill and sometime adviser to New York Governor Mario M. Cuomo: "If we're going to cut taxes, we ought to get the maximum bang for every buck." But plans such as Chimerine's would give government a direct role in choosing winners and losers, posing problems for an Administration hostile to any hint of industrial policy.

The truth of the matter is that many tax-cut backers know full well that it would provide little short-term stimulus. Political panic over the sluggish recovery is a chance for them to get some long-desired structural changes written into the tax code. "My concern is the investment side," says Mark Bloomfield, president of the American Council for Capital Formation, a business group. But will a tax cut help the economy now? "It may have some symbolic value," he says.

GATHERING STEAM. Tax reduction may not help today's economy, but the train is on the move. Many Washington hands are reminded of 1981, when Congress and President Reagan engaged in a disastrous bidding war over tax cuts. But in 1981, the deficit was only $78 billion, and the economy was sliding into the worst recession of the postwar era.

Even the huge 1991 deficit may not prevent a new outbreak of tax fever. Says Gail Fosler, chief economist at the Conference Board: "When you are this far away from balancing the budget, it's very hard to argue that $20 billion one way or the other is going to have a material effect."

Spoken like an economist. But at the moment, Bush and congressional leaders are thinking mainly of politics. The President has been stirred by his dip in the polls. More than half of those surveyed in a new Washington Post-ABC News poll believe that the time might be ripe for a new President to "set the nation in a new direction."

And on Capitol Hill? After scandals over check-kiting and unpaid tabs in the House restaurant--to say nothing of the disastrous Clarence Thomas confirmation hearings--lawmakers want desperately to hand voters a Christmas present. When all is said and done, this may be one tax cut that'll do far more for politicians than for the economy.

Before it's here, it's on the Bloomberg Terminal.