Tax Cuts: The Coming Battle

The Dems will challenge the economics of Bush's mega-plan

For weeks, George W. Bush's Tax-Cut Express has been cruising through Washington, whizzing past a flummoxed opposition as the new President skillfully exploited recession fears to build momentum for his $1.6 trillion tax cut. "A warning light is flashing on the dashboard of the economy," he insisted on Feb. 8. "We just can't drive on and hope for the best."

But for the first time since he began the campaign to sell Congress on his tax plan, Bush may be forced to ease off the accelerator and take evasive action. For one thing, the White House argument that across-the-board rate cuts would provide antirecession medicine is coming in for increased skepticism.

Even that most recent convert to tax-cut fever, Alan Greenspan, is having doubts. Although the Federal Reserve Chairman saw fit to embrace Bushonomics in recent congressional testimony, the less publicized part of his analysis is unambiguous: For all of Bush's fervid talk of "front-loading" rate cuts to stave off recession, the Administration's tax plan, as structured, will do very little to cure the current economic malaise.

With the White House drive to enact hurry-up tax legislation reduced to a political stratagem rather than a clear economic need, opposition Democrats who have given Bush a free ride on taxes now think they may have found a way to slow his juggernaut. They will attack Bush's mega-cut as too big for current economic conditions and too profligate with surplus dollars that ought to be devoted to paying down the national debt. That could appeal to independents and fiscally conservative GOP moderates and lure away votes for an alternative package.

The exact provisions that alternative will entail are still unclear. But some key elements are emerging: The plan will be closer to $800 billion than the GOP's $1.6 trillion. And Bush's plan to collapse the current top 36% and 39% brackets into a new 33% top tier may be significantly scaled back to reduce the windfall for the well-to-do. Bush's plan to help the working poor via lower rates may be modified in favor of other alternatives.

Phase I of the strategy is built around slowing the tax cut stampede. And the White House is already reacting to the threat. On Feb. 13, Treasury Secretary Paul H. O'Neill said the Administration is so anxious to speed up its tax cut that it might be open to early negotiations with House Republicans. In essence, the maneuver involves splitting the Bush package into two parts, with the "fast-track" component consisting of the proposed income tax rate cuts, plus doubling the $500 child tax credit. Deferred under this approach: easing the marriage penalty and phasing out the inheritance tax.

"NOT POWERFUL." Locking in rate cuts early would be a triumph for Bush. But many economists have doubts that it will have a big impact. In an analysis of the impact of front-loading, Standard & Poor's/DRI, an economic consulting firm owned by BusinessWeek's parent The McGraw-Hill Cos., found that, even if the White House succeeds in getting $30 billion into consumers' pockets by this fall, the impact on a $10 trillion economy would be modest. Consumer spending would rise by about $16 billion in the last two quarters of the year and the economy would grow at an annual rate of 3.6%, vs. 3.1%. A sharper jump would come early in 2002, though it would taper off through the year. Another front-loading study by Salomon Smith Barney comes to a similar conclusion. Says SSB Chief Economist Robert V. DiClemente: "At the end of the day, the Bush tax cuts are not all that powerful."

Still, an extra 0.5% to 1% of gross domestic product is nothing to sneer at, particularly now that the economy is, as Greenspan puts it, in the no-growth zone. And business execs would welcome a big and early bout of tax-cutting as a sparkplug to sputtering sales. "A tax cut could boost consumer confidence," says Ford Motor Co. CEO Jacques A. Nassar. "It would begin to help later this year and certainly next year." DRI Chief U.S. Economist Cynthia Latta, moreover, figures that 0.5% faster growth over a full year would generate 300,000 new jobs, and spark a quarter-point drop in the unemployment rate.

Even so, economists doubt that a consumption-oriented tax cut would have much staying power. The Bush tax cut is also susceptible to timing issues. If Democrats balk at the Republicans' bid for an early round of tax cuts, the legislative process could stretch well into the fall. By then, a Federal Reserve committed to injecting large doses of monetary stimulus into the economy may have produced that vigorous V-shaped rebound Greenspan has his sights on. And that would undercut the "recession insurance" rationale for the Bush package. Indeed, on Feb. 13, the Greenspan made clear his view that tax-cut "recession insurance" would only be needed in the event of a prolonged swoon.

What about the argument that the mere prospect of a hefty tax cut will cheer shell-shocked consumers and boost final demand? Unlikely, say economists. Consumer confidence has continued to plunge despite the tax talk. Says John Youngdahl, senior economist at Goldman, Sachs & Co.: "Households tend not to spend the tax cut before the money reaches their hands."

Dems realize tax cuts have far too much momentum to be stopped cold. So despite doubts about the efficacy of front-loading, Bush's opposition is joining the fray by trying to shape an alternative to big rate cuts. Ideas are flying out of congressional Democrats' offices. So far, "we've had a hundred great plans," sighs one Democratic Hill staffer. "What we need is one." Says Senate Minority Leader Tom Daschle (D-S.D.): "We've already reached quite a bit of agreement." He aims to have a concrete set of proposals in hand by late February, when Bush is set to unveil his budget.

Here's where the Democrats are headed: While Bush would cut taxes by $1.6 trillion, they would slash them by $800 billion to $1 trillion. The money freed up by a smaller rate cut would be redirected to such popular programs as military readiness, health care, and education. In addition, Dems would use another $800 billion to pay down the $3.4 trillion national debt, a course they claim is far more prudent than depending on unreliable 10-year surplus forecasts. Other differences: The President would reduce the current five tax brackets to four and reduce the rates from 39.6%, 36%, 31%, 28% and 15% to 33%, 25%, 15%, and 10%. Democrats are likely to target their rate reductions to working-class families. They could do that by trimming the 15% bracket to, say, 12%.

Democrats will also design their plan so that it, unlike Bush's, provides tax relief for families that now pay Social Security and Medicare payroll taxes, but not income taxes. Democratic tax experts have not yet agreed on how to proceed, but they are exploring three choices. They may expand the earned-income tax credit, a refundable break that goes to families making up to $31,000. They may create a new credit to help offset payroll taxes (see box). Or, they could propose an annual rebate, a plan championed by liberals. The government goodie check could amount to $500 for every family, regardless of income level.

TRIGGER POINTS. To garner moderate Republican support, the Democrats are also considering "triggers" to make future tax cuts contingent on federal revenues. Treasury's O'Neill derides the plan as a gimmick. But the "no money, no tax cut" idea is backed by middle-of-the-road Republicans such as Senator Olympia Snowe of Maine. Democratic Leader Daschle probably needs a half-dozen such GOP moderates to make any alternative plan fly. A handful have already expressed concerns about the Bush cut, including Snowe, George Voinovich of Ohio, and Senator James Jeffords (R-Vt.). On Feb. 14, he said he would not support Bush's $1.6 trillion tax cut but would instead favor a $1 trillion cut.

Without a bloc of GOP defectors, Democrats are destined for defeat. That, more than anything else, explains why the party's liberal leaders are now taking a page from the GOP insurgency of Arizona Republican John McCain and are trying to out-maneuver Bush on the issue of the tax cut's fiscal prudence and economic punch. A strange political inversion? Sure. But it has become the Democrats' last best hope for countering Bush's tax-cut surge with what they hope to depict as a smaller, slower, and smarter approach to cutting taxes.

By Howard Gleckman, with Lorraine Woellert, in Washington, and Joann Muller in Detroit

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