Commentary: Clinton's Tax Cuts: Smaller, But Not Smarter

Bill Clinton may have concocted the politically perfect tax-cut package for the '90s. It appeals to key blocs of voters, like homeowners and middle-class parents facing college bills. It's big enough to get the President into the tax-cut derby against GOP challenger Bob Dole, but small enough--$118 billion over six years--to let him claim he won't bust the budget. Best of all, the plan flies under the campaign radar. Thanks to the improbable promises Dole makes for his $548 billion tax cut, Clinton's handouts are skating by unchallenged.

A close look, though, exposes the President's program as a triumph of voter bait over economic wisdom. Clinton hews to the old-time Democratic idea of trying to fine-tune business and consumer behavior. And his goodies could well turn sour, lifting--rather than lowering--the barriers to education and home- ownership.

Take the pair of breaks that Clinton proposes for college. Students or their parents could either subtract a $1,500-per-student credit from their tax bill or deduct up to $10,000 a year in college costs from their taxable income. The goal: to make 14 years of schooling the new minimum for all Americans.

TUITION INFLATION. That's the right destination--but tax breaks are the wrong vehicle. "Deductions and credits paint with a pretty broad brush," warns Macalester College President and economist Michael S. McPherson. Kids who couldn't afford college will win--but so will the 62% of high-school grads who would attend college anyway. The conservative Institute for Policy Innovation says the plan would subsidize 100 existing students to enroll three new ones.

Clintonites don't mind that leakage: Middle-class families, they argue, need help with skyrocketing tuition. But tax relief "will fuel the fire of tuition inflation," argues Brookings Institution economist Robert D. Reischauer. More than 90% of households would qualify for help. Such sweeping subsidies would lower resistance to tuition hikes, allowing colleges to siphon off the money. Given the plan's $43 billion cost, "I'd rather see more money put into scholarships to motivate kids," says Norman R. Augustine, CEO of Lockheed Martin and chair of the Business Roundtable's Education Task Force.

Clinton's handout for homeowners is much smaller--$1.4 billion over six years--but still troubling. Clinton and Dole both propose a backdoor repeal of the capital-gains tax on houses. Under current law, home sellers can roll over profits by buying more expensive homes until they turn 55. Then, they get up to $125,000 in gains tax-free. Clinton's plan would let a seller exempt $500,000 in profit on every sale; Dole's would exempt $250,000 to $500,000, based on years of ownership.

The current law may be more of a nuisance than a revenue raiser. Realtors reported 3.8 million sales of existing homes in 1993, but only 148,000 of those sellers paid taxes on gains. Clintonites argue that the higher exemption will relieve owners of record-keeping and let empty-nesters and relocators buy cheaper homes without a penalty. But the Treasury will shower $502 billion on owners over the next five years even without this idea. The new cuts and exemptions for a few only mean that everyone else--mostly, renters and non-itemizing homeowners--will somehow have to make up the difference. Would-be buyers lose the most, since tax breaks drive up the price of land and homes.

More important, tax breaks for housing hurt the economy. Capital--badly needed for productive uses, such as research or new factories--is instead drawn into housing. Federal Reserve economist Kevin A. Hassett says America's housing investment is 50% higher than it would be without tax advantages. Another break "is a move in the wrong direction," says Princeton University economist Harvey S. Rosen. "There's no good reason except politics."

Ah, yes, politics. Clinton's tax plan shows him to be the master of pandering on the cheap. The President is also capitalizing on the fact, says Reischauer, that "many small, dumb ideas don't seem to get the same attention as one big, dumb idea." In the contest between dumb ideas and dumber, Clinton is likely to come out on top. But perhaps he'll wise up before he hands the country another batch of dumb tax laws.

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