Gambling on Growth

Bush's sweeping plans will spark the economy -- or drown the nation in red ink

During the 2000 campaign, Democrat Al Gore would plod through debates by attaching the term "risky scheme" to practically everything GOP contender George W. Bush advocated. Voters tuned out what many felt was a crude attempt to demonize a politician who earnestly insisted he was "a different kind of Republican." Ever since, average folks and pundits alike have struggled to get a handle on what Bush meant by that. Is he an Establishment swell like his father, imbued with pragmatism and a sense of noblesse oblige? Or is he a feisty Sunbelt Republican, driven by both a conservative ideology and a desire for political combat?

On Feb. 3, Bush emphatically answered the question by rolling out a 2004 budget that is replete with ambitious and controversial reforms. Despite Yale, Harvard, and summers at the family compound in Kennebunkport, Me., he is a committed Reagan Republican who seeks revolutionary change--and is willing to run huge political risks in the drive to scale back the federal government's reach.

Bush's budget blueprint is a testament to supply-side economic theory, which posits that big cuts in marginal tax rates will spur long-term growth and eventually wipe out any revenue shortfall. So despite a record $300 billion deficit and red ink that will linger for the duration of his term, the President has unfurled a striking agenda. Make that striking and staggeringly expensive. Because Bushonomics is built around $3 trillion in long-term tax cuts and a big boost in national-security spending, Democrats and GOP budget hawks are bringing back a telling description of the Gipper's fiscal formula to characterize the current President's plan: They call it "a riverboat gamble."

Certainly, it is nothing short of breathtaking. Bush is proposing $1.46 trillion in new tax reductions--matching his 2001 tax cuts. He seeks elimination of taxes individuals pay on dividends and an end to the inheritance levy--big steps toward a system that exempts most investment from the tax man's bite. He talks of reforming Medicare to boost competition while adding a new $400 billion prescription-drug benefit for seniors. He calls for a huge expansion of tax-sheltered private savings plans. And in an echo of Reagan's New Federalism drive, Bush would shift to the states control of Medicaid and Head Start--signature programs of the Democrats' Great Society.

As recently as December, the President's advisers were debating over how much money his new economic plan should devote to income tax cuts vs. tax reform built around cutting dividend taxes. He opted for both. The decision swelled a $300 billion tax package into a $694 billion megaplan and has raised deficit alarms in Washington and on Wall Street. But in Bushdom, what's surprising is how all-fired surprised everyone is by the sweep of Bush's ambition. "Left to his own devices," says one Texas chum, "he's inclined to throw the long bomb."

Conventional wisdom in the capital holds that a leader on the brink of war with Iraq would dramatically throttle back to avoid distractions. One might think this especially true, given the hard time Team Bush has had selling its rationale for that war. Not until Bush's Jan. 28 State of the Union address and a powerful Feb. 5 U.N. Security Council presentation by Secretary of State Colin Powell did the Administration begin to effectively address weak Allied support for ousting Saddam Hussein.

But instead of clearing the decks to focus on global crisis management, Bush has done the opposite: He's proposing a profusion of midterm reforms that, if passed, would not only dramatically transform economic policy but also hack away at the role of Washington by shifting power to the states. "The President is willing to take the risk of leading to bring about real reform," says Jay P. Lefkowitz, director of the White House Domestic Policy Council. "Even while you're trying to win the war on terrorism, you have to be prepared to win the peace."

Of course, there's a fine line between the grand gesture and reckless abandon. Bush's strategists are hoping a quick victory in Iraq will give the President a needed lift in opinion polls and provide, in turn, a new slug of political capital to spend on his audacious vision. But if the war doesn't go as quickly or smoothly as planned--particularly if there is an oil shock that causes the economy to sink--the consequences for Bush could be severe.

For starters, an overburdened President could find it tough to do the personal arm-twisting needed for such controversial agenda items as the dividend cut and Medicare overhaul, to cite just two. Already, there are signs that the normally well-oiled White House machine is straining under the pressure. Both the launch of the Bush tax plan and his on-again, off-again mention of a still-vague Medicare reform measure were greeted by a surprising degree of Republican skepticism. And with so many balls in the air, adds independent pollster Thomas Riehle, president of Ipsos-Reid U.S. Public Affairs, "the big risk is that [Bush] never sells anybody on his commitment to any of them."

Indeed, it's one thing to flood the zone on Capitol Hill with a spate of bold reforms and quite another for a war-distracted White House to marshal the resources for passing them. Some of the President's earlier Big Ideas, such as private Social Security investment accounts and his original vision for school reform have either bitten the dust or been substantially modified by Democrats. One risk the President obviously runs now by unleashing his second reform wave is that rather than demonstrating vision, vigor, and resolve, a heap of failed initiatives will become a testament to scattered focus and political impotence. Another is that by focusing more on long-term economic goals than short-term stimulus, the economy continues to remain sluggish late into this year or beyond.

Bush's political advisers think they will avoid this gloomy scenario. Thanks to a successful midterm election strategy, Republicans now command both houses of Congress. And rather than viewing the looming war with Saddam as a massive downer, White House uberstrategist Karl Rove thinks a quick and decisive U.S. victory could provide propulsion for the conservative agenda. That would mean some Bush reforms now seen as politically dicey could gain support as he rockets up in the polls.

"If the war goes well, the President will have enormous political capital to spend on his domestic agenda," says James A. Klein, president of the American Benefits Council, which represents large employers and administrators of health and pension plans. "And if it goes badly, he'll want something else to talk about."

But perhaps the larger risk, in fiscal-policy terms, isn't that Bush fails in his charge up Capitol Hill. It's that he succeeds too well, muscling many of his new programs to passage without the funds to pay for them over the long haul. The 2004 budget shows that the Administration not only faces the prospect of a $300 billion shortfall in 2004 but could see deficits totaling more than $1 trillion by the end of the decade. "We're looking at a revenue hemorrhage at the same time the baby boomers start to retire," warns Robert Greenstein, executive director of the liberal Center on Budget & Policy Priorities.

Of course, a central tenet of Bushonomics is that enacting permanent changes in marginal tax rates and reducing the tax burden on investment capital will boost the long-term growth potential of the economy from the current consensus forecast of 3% to 3.5% a year. If that happens--or a resumed productivity surge kicks in--tax revenues would again rise and the deficits would again shrink back to manageable levels. In other words, growth, not higher taxes, could be the solution to America's deficit woes.

Trouble is, some economists worry that the latest round of tax incentives won't rebuild the nation's broken-down revenue engine. Here's why: Much of the '90s tax-revenue gusher was propelled by an overheated stock market and frenetic tech spending. But with the market stone-cold after the Big Bust, techdom still saddled by overcapacity, and CFOs compelled by newly aggressive regulators to use real profit numbers vs. the confectionary kind, there is reason to wonder whether revenues can return to anywhere near pre-boom levels. That may help explain why so much of the new economic plan--the dividend-tax exclusion and some of the pension and capital-gains breaks--seem designed to get investors investing again and the stock market sizzling.

Unless that happens, Bush's $3 trillion in out-year tax cuts could eat a large hole in the federal nest egg needed to fund the Baby Boom retirement wave, not to mention the estimated $1 trillion required for the shift to a semi-private Social Security system. Taken as a whole, the President's new reform vision "is as bold an initiative as I've seen," marvels Robert L. Bixby, executive director of the Concord Coalition, which advocates balanced budgets. "It's quite a gamble."

Democrats, who have often been flustered by Bush's fancy footwork in the past, are entering the new budget battle bravely insisting that the President has finally drawn a losing hand. They warn that the Administration's high-rolling fiscal strategy will eventually cause interest rates to spike and stifle long-term growth, and that will vacuum up the cash needed to pay for vital domestic programs, from education to health care. "Bush's new budget should be written in red ink," fumes Senator Joseph I. Lieberman of Connecticut, a Democratic Presidential contender. Adds North Carolina Senator John Edwards, another leading Dem moderate and potential rival for the White House: "It is enormously irresponsible."

One reason Democrats are so steamed is a genuine fear of the fiscal stakes in Bush's gamble. But the other is the concern that by pressing so many reforms at once, he'll increase the odds of ramming some to passage. "You don't have to win [everything] to move the debate to the right," notes Andy Hernandez, a political scientist at St. Mary's University in San Antonio, Tex. Bush's full-court press "puts the Democrats in the position of negotiating" on a broad front.

Bush's Democratic critics, moreover, worry that more is going on here than just letting a thousand flowers bloom. The big fear of liberals is that if Bush's tax cuts don't act as an economic elixir, Democratic domestic spending priorities will bear the brunt of the ensuing crunch. Ultimately, Bush's strategists "want to starve the beast," says Brookings Institution economist William G. Gale.

During the polarizing years of the Newt Gingrich revolution, conservatives talked openly of "defunding the Left." But as a politician who styles himself as the un-Newt, Bush is willing to shower billions on education, AIDS research, and a handful of other high-profile priorities while proposing massive tax cuts and watching the deficit grow. "It's all guns and butter," says Jeff Lemieux, senior economist at the Progressive Policy Institute, a moderate Democratic think tank. "Of course, most of the butter is going to Republican constituencies."

Case in point: the Bush tax strategy. The President is calling for $1.46 trillion in cuts over the next decade. On top of Bush's 2001 cut and a $123 billion stimulus plan in 2002, that makes him the biggest tax-cutter in U.S. history--far outstripping even Reagan.

If enacted, Bush's latest proposals would move the nation toward consumption-based taxation, which many economists believe boosts long-term growth. The plan includes a repeal of the taxes individuals pay on corporate dividends and a speedup of rate reductions enacted in 2001, as well as a big expansion of tax-free savings programs. Nearly all Americans would be able to shelter every dime of their investment income from taxation, either by shifting funds to tax-free accounts or by taking advantage of new breaks for dividends and capital gains.

Passing the Administration's $694 billion plan is by no means assured--at least in its current form. R. Glenn Hubbard, chairman of the White House Council of Economic Advisers, estimates that as much as 40% of the cost of the Administration's proposal would be offset by higher economic growth. But skeptics abound in both parties. With Hill Democrats strongly opposed to Bush's tax cuts, the balance of power is held by moderate Senate Republicans who worry about the size of the package, its impact on the deficit, and whether it would provide much stimulus to the economy. Indeed, the Administration estimates that only about $29 billion of tax relief would kick in over the next eight months, when some contend it is needed most.

And while Bush will fight hard for his dividend plan, Hill aides say the proposal is likely to be sharply cut back. A possible compromise: capping the amount of tax-free dividends at, say, $1,000 or exempting 30% of such income.

Bush's tax-free savings proposal has also come under fire. Under the measure, Americans would pay taxes up front, but not on their earnings on money put in two new "super IRAs." Critics contend that the plans will mainly let wealthier Americans shield more from the Internal Revenue Service. Others worry that, despite the ballyhoo, the new savings vehicles may not even achieve their goal of boosting private thrift. Why? Much of the money invested in such accounts may simply be shifted from taxable accounts. And because the plan encourages nest eggs outside of employer-based plans, many small-business owners may ditch their company retirement programs, leaving workers in the lurch.

Still, the savings proposals could be political winners for Bush. They enjoy widespread support on Capitol Hill. Most taxpayers, however much or little they save, will stand to gain from the plans. And by virtually exempting investment income from taxes, the tax-shielded accounts advance Bush's grand cause of tax reform.

Prospects are dicier for the painful business of controlling runaway Medicare costs. The White House wants to encourage seniors to shift from traditional fee-for-service Medicare into private managed-care plans. But key lawmakers, including Senate Finance Committee Chairman Charles E. Grassley (R-Iowa), insist that those who stay in old-style Medicare also get a drug benefit.

Taking another page from Reagan, Bush would fundamentally remake the relationship between Washington and the states. He is moving to shift greater responsibility for shared programs, such as health care and housing, to governors. That would would give states more flexibility in shaping their programs, but at a price: Governors would bear most of the burden of future cost increases.

While the overall Bush budget reduces spending for some antipoverty programs--for instance, it scales back housing aid and health care for poor kids--there is largesse for a handful of high-profile social causes. The aim: to showcase the President's compassionate side. The biggest winner is a $15 billion initiative to combat AIDS in Africa and elsewhere. "They are looking for things that provide a little cover for doing this very conservative agenda," says Trinity College political scientist Diana Evans. "So they'll talk about initiatives that appeal to suburban moms."

There's good reason for Bush to be concerned about suburban women and other swing voters. His job-approval ratings have been in steady decline for the past year. Some 60% of Americans say he's not paying enough attention to the economy, according to a Jan. 31-Feb. 2 Gallup Poll. And just 41% of respondents in a new Ipsos-Reid survey say they will definitely vote to reelect Bush, down from 54% in the first quarter of 2002.

By historical standards, Bush's 60% approval rating would be the envy of most modern Presidents. But mindful that his father tumbled from a stellar postwar peak to reelection defeat just a year later, Bush is not about to leave anything to chance. After unleashing a storm of new policy initiatives and his third tax-based economic growth plan in three years, Bush reckons that no one will ever be able to question whether he has "the vision thing" or is trying to end Americans' economic squeeze.

But this demonstration of concern via sheer volume of proposals carries one of the highest potential price tags in political history. It's a gamble that could well propel George W. to a second term. It could also commit his successor to years of dreary digging out from a deficit hole.

By Richard S. Dunham, Howard Gleckman, and Lee Walczak, with Mike McNamee and Alexandra Starr, in Washington

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