Commentary: The Tax Bill: A Welcome Economic Jolt

As politics goes, the Bush tax cut is about as sloppy as it gets. It's an inconsistent, capricious hodgepodge. Changes in the tax code wink on and off like out-of-control Christmas lights. To take only the worst of many egregious examples, the tax law repeals the estate tax in 2010 and then restores it in 2011.

But despite its gimcrack nature, the new tax law has a lot to recommend it. It funnels a hefty chunk of fiscal stimulus to a slowing economy. In the early years, it throws the benefits of the tax cuts to working-class and middle-income taxpayers. And it delays the big cuts for the very rich until later in the decade, when it will be much clearer whether the current budget surpluses are sustainable. If they aren't, everyone in Washington assumes many of those cuts will never actually take place. Ultimately, that could be more fiscally responsible than implementing big cuts now. Although the Administration resisted including a trigger that would halt further cuts if the surplus doesn't materialize, the economy itself will act as the trigger.

Let's look at the short-run fiscal stimulus first. In previous downturns, it has taken many months for tax cuts to get approved--and then many more to get money into the hands of consumers. By the time taxpayers receive anything, the recessions generally have been over. But this tax bill is different. Congress acted with what for it is lightning speed, and thanks to technology-- if all goes well--consumers will receive $45 billion in rebate checks by September. That's a much bigger slug of spending power much sooner than anyone expected.

This could be a crucial factor in keeping the U.S. out of a deep recession in the second half. Depending on how much of it is spent and how much is saved, the rebate could really boost growth in gross domestic product.

Indeed, the Bush tax bill could overturn the conventional bias against tax cuts as a recession-fighting tool. A key reason is technological: To determine who should receive rebate checks, the Internal Revenue Service is using fast computers to compile the list of people who paid taxes in 2000. That would have taken much more time in the past. The technology to accurately and quickly spew out rebates, for instance, wasn't available when Ronald Reagan signed his tax-cut legislation in August, 1981. Instead, his tax cuts were put in place by changing the withholding schedules--a much slower process. That's why the economy received almost no stimulus until the middle of 1982, when the recession was almost over.

A second key feature of the Bush bill: Benefits for working- and middle-class taxpayers come sooner and more certainly than benefits for the rich. A new 10% tax bracket--which applies to the first $12,000 of taxable income for married couples, for example--is retroactive to Jan. 1. But high-income taxpayers must wait for the rate reductions of the top four tax brackets, which will be phased in over the next five years. Similarly, the hefty tax cuts for the wealthiest Americans, such as lowering the estate tax rate and raising the estate tax exemption, don't take full effect until later in the decade.

SANE STRATEGY. Given the uncertainty of today's big surpluses, that's the best approach. The people who need the money get tax relief right away. Meanwhile, the final fate of the high-end tax cuts is pushed off into the future. If fast growth and big federal budget surpluses continue for the rest of the decade, it's likely that the cuts for well-to-do taxpayers will take effect. But if growth slows, or if deficits return, then pressure to reduce or eliminate the tax breaks will grow. Since no one knows how fast the economy will grow in the next decade, this approach delays the hardest decisions to a time when there will be better information--a reasonable strategy.

True, the possibility of such changes makes long-term tax planning difficult. But anyone who expects stability from the U.S. tax code is looking at the wrong country. In the past 20 years, marginal rates have been lowered twice and then raised twice, depreciation allowances have bounced up and down, and savings incentives have been added and subtracted. Even the 1986 tax bill, held up as a paragon of reform, revoked the investment tax credit retroactively. History suggests that major tax bills come every five years or so. While repairing the AMT might require quicker action, that's just about right for fixing most other problems with this bill.

This is by no means a perfect tax bill. It's the result of a messy political process, reflecting a bitterly divided Congress and hastily crafted compromises. But, oddly enough, it gets the job done.

By Michael J. Mandel

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