The Return of Politics As Usual

Alas, the political season is upon us. The bipartisan bonhomie of the post-September 11 period is gone, at least when it comes to domestic issues. With congressional elections only 10 months away, fierce political arguments are breaking out in Washington that have little to do with economic and fiscal reality. It may be wise to take a moment to analyze the accusations and penetrate the posturing.

Democrat Tom Daschle, the Senate majority leader, started it off by accusing President George W. Bush of making the recession worse with his $1.35 billion, 10-year tax cut that killed the budget surplus and raised long-term interest rates. Not so fast, Tom. Economists agree that cutting taxes and running a loose fiscal policy during a recession is a good thing. Besides, the biggest tax cut that went into effect last year was the rebate, which Democrats favored along with Republicans. President Bush's big tax cuts come in 2004 and 2006. As for the switch from surplus to deficit exerting pressure on long-term rates--well, maybe. The prospect of economic recovery could have lifted rates, too. And while interest rates did fall after Bill Clinton raised taxes and pushed the budget into surplus, they also fell when Ronald Reagan cut taxes, deepening the budget deficit.

Bush's response to Daschle--that he would allow Democrats to tamper with his cuts and raise taxes "over my dead body"--is equally partisan. It is true that many taxpayers at the top end are paying nearly 50% of each marginal dollar earned to government. They deserve a break. But the President's own tax cut reverses itself in 2011, raising all income, estate, and marriage-penalty taxes back to 2001 levels. So taxes are already scheduled to go up. People forget that, including, perhaps, the President.

The fact is that two schools of economic thought lie behind the Sturm und Drang of the current political battle. Republicans believe that cutting taxes generates growth. Democrats believe that cutting deficits bolsters growth. The evidence for both beliefs remains mixed.

The only certainty is that all tax legislation gets changed because real-world circumstances change. The shrinking budget surplus is one of those circumstances. Last year's forecast for the surplus was $5.6 trillion over 10 years. The tax cut will take $1.7 trillion out of that sum ($1.3 trillion for the tax cuts plus $400 billion for the extra interest on the federal debt that must be paid because of the tax cut). Higher spending on security is expected to take an additional $400 billion out of the surplus over 10 years. But the real surprise is an unanticipated $1.5 trillion hit to the surplus from the current recession. Because it is coming at the beginning of the 10-year period, the recession lowers the base on which all forecasts of economic growth and tax revenue follow. The new surplus estimate is for about $1.9 trillion over 10 years. That's still a nifty sum. But not if you want to pay off the national debt, transform the military, give seniors a prescription-drug entitlement, and bolster Social Security and Medicare.

No one figured the recession would have this kind of impact. But it has--and politicians will have to deal with it regardless of their beliefs. When the partisan rhetoric ends and the elections are over, choices will have to be made on taxes and spending. Sensible people know this.

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