A Middle Class Tax Cut Could Blow Up In Bill's Face

Memo to: The President

From: Independent Economic Brain Trust (INDEBT)

Re: Middle-Class Tax Cuts

Mr. President:

Per your request, we've investigated the economic and political case for tax cuts targeted to the middle class. Our examination has been preliminary, recognizing that this proposal is not an official Administration initiative; as Labor Secretary Robert B. Reich told us, "there's more smoke than fire." But with your advisers increasingly worried that the economy may slow between now and 1996, many of them are floating ideas to stimulate demand, increase your standing with average Americans, and counter the "pro-family" platform Republicans will unveil on Sept. 27.

We recommend that you approach tax relief for the middle class--by some definitions, 60% of America's families--with great caution. Because

of pay-as-you-go budget rules, a tax cut wouldn't have a stimulative effect on the economy. Nor would a tax cut reverse the income declines suffered by most middle-class families during the past 15 years. And while tax cuts are hugely popular, the debate could reopen deep divisions between your economic and political advisers, trigger a battle in Congress--and hand the GOP a winning issue.

Background: In the early days of your 1992 campaign, Mr. President, you advocated tax cuts for the middle class. But other Democrats ridiculed the idea, and you switched to a cheaper plan to give working-class parents a tax credit for each child. By the time you unveiled your 1993 deficit-reduction plan, the tax cut was shelved.

It resurfaced last January when Robert J. Shapiro, chief economist of the moderate Progressive Policy Institute, proposed substantial cuts in federal subsidies and tax breaks for the energy, agriculture, transportation, and aerospace industries. Cutting subsidies, he calculated, could free up $225 billion over five years for deficit reduction, spending on education and training, and a $350-per-child tax credit for lower- and middle-income families. The credit's cost: $14 billion a year.

Economic impact: Shapiro's proposal follows current budget rules, which require that any tax cut be offset by raising other taxes or by cutting spending. With no change in the deficit, there's no stimulus: "If you pay for a tax cut, it is not a macroeconomic event," says Federal Reserve Vice-Chairman Alan S. Blinder. Liberal Democrats propose legislation to waive the budget rules if the economy slows. But that would cost you credibility with the bond market and drive up long-term interest rates.

Social policy effects: Tax cuts could be justified on social, if not economic, grounds. As you stated in your campaign speeches, middle-income Americans have suffered for years (chart). From 1979 to 1992, average paychecks adjusted for inflation declined, especially for families with kids. And the expansion has barely begun to repair the damage. "American families have been working harder for less," says Lawrence Mishel, an economist at the liberal Economic Policy Institute.

Shapiro argues for a pro-family policy that would exempt families from taxes on the basic costs of child-rearing--say, $5,000 a year per child. You could do that by doubling the current $2,450 personal exemption or by adding an equivalent $350-per-child tax credit.

Administration dynamics: But small tax cuts would do little to replace the middle class's lost income. And debate over what type of cuts to make would once again highlight your Administration's divided economic camps. Centrists, such as Shapiro, urge pro-family tax cuts. Liberals, such as Reich, will argue that any spare cash can better be used to create public-service jobs or for training programs. Conservatives such as Treasury Secretary Lloyd M. Bentsen would rather reduce the deficit or fund savings incentives, such as the "Super IRA."

Political benefits: Compared to your economists, your political advisers appear unified. But contrary to their claims, the tax cut is not a guaranteed winner. To fund it, you would have to confront either business interests--which would fight subsidy cuts hard--or the elderly, whose Medicare benefits might have to be reduced. In Congress, such GOP leaders as Newt Gingrich would propose bigger tax cuts, funded with appealing but phony budget tricks, such as unenforceable caps on entitlements. You would wind up on the defensive.

In short, Mr. President, the middle-class tax-cut issue is a minefield. It won't win points as economic policy and could explode politically. You were right when you buried the idea in 1993. You would be smart to leave it buried now.

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