Commentary

Fingers Crossed, Prosperity Prognosticated

This article was published in the Washington Times, April 27, 2003.

The president surprised us all by casually announcing that he intended to reappoint Alan Greenspan as chairman of the Federal Reserve. A few Bush loyalists had wanted to replace Mr. Greenspan simply because he was unsupportive of the president’s efforts to speed-up tax cuts scheduled for 2004-2006.

But why should we expect any official in charge of monetary policy to give sound advice about tax policy? We don’t expect the secretary of the Treasury to dictate what the Fed should do with interest rates, and we should not expect the Fed chairman to dictate what the Treasury should do about taxes. Those tasks are prudently separated, partly to avoid conflict of interest.

Central bankers have always and everywhere tried to blame every conceivable economic problem on insufficient tax revenue, thereby attributing no problems to monetary mismanagement. Mr. Greenspan, for example, somehow imagines that budget deficits cause current account deficits (“twin deficits”) and these terribly high interest rates we are suffering from today.

In the early 1930s, other Fed officials blamed the Depression on the budget deficit. From the late 1960s to the early ’80s, Fed officials blamed inflation on the budget deficit. In the Fed’s spin book, fiscal policy naturally gets the blame when things go badly and monetary policy gets the credit when things go well. This fine art of fiscal scapegoating is a job prerequisite for any central banker.

Perhaps that explains why confusion invariably arises whenever Congress asks the Fed chairman for fiscal policy advice. Tax policy is not Mr. Greenspan’s job, after all, and he is not good at it. In particular, he always wants to postpone tax cuts as long as possible. And that advice contributed to two episodes of notoriously bad timing.

In early 1981, supply-siders on the transition team (myself, Larry Kudlow, Craig Roberts and John Rutledge) wanted to cut marginal tax rates right away, taking the top rate down to 35-40 percent. But Mr. Greenspan successfully advised postponing nearly all of the tax reduction until 1983-84, and he also recommended keeping the top tax rate at 50 percent.

In 2001, supply-siders again urged that the planned reduction of marginal rates take place right away, retroactive to the start of that year. But Mr. Greenspan once again successfully advised taking six years to reduce tax rates by about 3 percentage points. He even recommended a “trigger” that would automatically repeal tax cuts if Congress spent too much, which would have provided an irresistible incentive for pro-tax legislators to do just that.

Gradualist timing was a big mistake in both 1981 and 2001. The recession of 1981-82 could surely have been alleviated if the reduction of tax rates had not been phased-in so slowly. And recovery from the recession of 2001 would likewise have been strengthened if the reduction of tax rates had not been phased-in so slowly. Indeed, much of the president’s new tax plan consists of repairing the latest phase-in blunder.

Phasing-in any reduction in tax rates is always a bad idea. Tax cuts put off until the distant future usually have little credibility. Democratic presidential candidate Dick Gephardt of Missouri has already come out for repealing all tax cuts enacted in 2001. Since taxpayers cannot count on tax cuts promised for future years, that means phased-in tax reductions lose any beneficial effect on expectations and investment plans today.

On the other hand, if people do believe tax rates will be lower in the future, that provides a perverse incentive to delay doing whatever it is that is going to be taxed at a lower rate later. If some state legislature were to announce that sales taxes would be cut two years from now, for example, everyone would wait until then to make any major purchases. The message Congress sends with phased-in reductions in income tax rates is that it makes sense to postpone doing things that would increase income right away. Delaying receipts of taxable income (and accelerating deductions) is not difficult for many small businesses, professionals and retired people.

The device of phasing-in would be particularly inappropriate if it were to be applied to taxation of investment income, since the timing and form of such income is easy to change. Yet talk has nonetheless begun about phasing-in over 10 years the reduction or elimination of individual taxes on dividends. News sources claim this newest phase-in blunder has support from the White House. But public rumors of that sort are often trial balloons launched by various factions.

The message Congress would send with phased-in reductions of dividend taxes would be that it makes sense to postpone investing in securities that pay dividends until later when dividends would be taxed at a lower rate. The message would also be that it makes sense for corporations to postpone paying generous dividends. Phased-in tax reductions, in short, provide precisely the wrong incentives.

Whether for investment income or labor income, phasing-in lower tax rates is a case of bad bookkeeping taking precedence over good economics. Because of the ritual congressional foolishness of trying to budget over 10-year spans, delay appears to reduce the accumulated 10-year “cost” of tax cuts. In reality, phasing-in lower tax rates has zero effect on the long-term budget outlook. Phasing-in just gets us to the same point a few years too late. When it comes to lower tax rates, later is never better than sooner.

I have no idea whether or not Mr. Greenspan’s past propensity to delay any and all tax relief might also apply to dividend tax relief, which he apparently favors. If he ever did endorse phasing-in a lower tax on dividends, however, his past record on phasing-in other tax cuts offers ample warning about the dangers of following such advice.

By all means, let Mr. Greenspan keep doing what he does best — managing the Fed. But if Congress is looking for serious advice on tax policy, the record suggests it would be much safer to ask the secretary of the Treasury, the chairman of the Council of Economic Advisers, the director of the Congressional Budget Office or just about any name randomly selected from any telephone book.

Alan Reynolds is a senior fellow at the Cato Institute and a nationally syndicated columnist.