Commentary

Improvements… and Horror Replays

This article was published in the Washington Times, Jan. 12, 2003.

The main features of President Bush’s tax proposal are to speed up tax-rate reductions already enacted in 2001 and eliminate the individual income tax on dividends. When it comes to moving tax cuts forward to 2003, rather than waiting until 2006 or 2009, the president’s critics have been saying things that make no sense at all.

Critics claim the plan is unduly backloaded into the future, although it moves tax rate cuts forward by three years. Under the president’s plan, those who would otherwise be in tax brackets of 27, 30, 35 and 38.6 percent would immediately find themselves in tax brackets of 25, 28, 33 and 35 percent. That is very powerful medicine indeed, partly because it affects expected after-tax rewards far beyond the current year.

What critics are really complaining about is that the benefits of lower tax rates persist under the Bush plan, rather than being yanked away before next year’s presidential election as partisans may prefer.

Critics say the entire plan is unduly generous to those with higher incomes, although — with the debatable exception of dividends — the plan offers no more tax relief to higher incomes than current law. The only difference is that tax rates fall this year rather than in 2004-2006. Even then, the top two tax rates will still be far too high — far above the highest tax rates of 28 percent to 31 percent in 1988-92.

Critics say cutting tax rates now rather than later would add too much to budget deficits in the distant future, when Baby Boomers retire. Yet moving the rate cuts forward has no budget impact at all after 2006, when tax rates would have gone down anyway. In the meantime, even the estimated revenue loss of $16 billion a year amounts to less than 10 percent of the price tag for the whole package. And even that modest sum depends on the unbelievable assumption that lower tax rates will not help the economy in the slightest.

In short, when it comes to moving the tax-rate reductions from the future into the present, the critics are pushed into the uncomfortable position of arguing that later is better than sooner. If they were truly as concerned as they say about keeping the costs down, they would look in a far more obvious place.

In the 2001 law, the novelty with the least bang for the buck was to reduce from 15 percent to 10 percent the tax on the first $6,000 of taxable earnings. Although that may have sounded like a gift to low-income workers, it was actually a flat $300 tax cut for those with enough taxable income to qualify. Low-income workers have no taxable income, and they collect a check from the Earned Income Tax Credit — which often offsets their Social Security tax.

The costly gesture of providing a $300 tax savings on the first $6,000 accounted for a staggering $421 billion of the estimated 10-year revenue loss from the 2001 tax law. That was larger than the grossly exaggerated estimate of losses from reducing all four top tax rates combined. Cutting the lowest rate to 10 percent was the only tax cut in 2001, advertised as a “rebate.” Marginal rate cuts were postponed. Yet cutting tax rates on the first dollars earned, rather than on the last, has no effect at all on marginal incentives to work, save, invest and take entrepreneurial risks.

This year, the president wants to exclude another $1,000 from the 15 percent bracket, which would cut revenues by another $48 billion. If Congress is seriously concerned about minimizing revenue losses and maximizing economic benefits, it should not widen the 10 percent bracket but repeal it. There are much better uses for such huge sums.

For example, the president’s plan provides a mere $29 billion to provide relief from the alternative minimum tax only through 2005, leaving millions facing a nasty tax surprise after that. And although very small businesses would indeed benefit from the plan to allow $75,000 of equipment to expensed, many U.S. workers and investors depend on big businesses with much larger capital needs. Businesses of all sizes should be allowed to immediately write off the cost of equipment, as they do with other costs, or at least to have much quicker writeoffs.

As for eliminating the tax on dividends, that alone accounts for 54 percent of the estimated $674 billion potential loss of revenue. That $364 billion estimate is higher than others and quite static, which is a polite word for unrealistic. Raising the after-tax return on stocks is sure to lift stock prices, for example, which means more tax revenue from capital gains. With dividends taxed only once, like interest, corporations will have less incentive to take on too much debt. High ratios of debt to equity raise bankruptcy risk and greatly reduce corporate tax revenue (because interest is deductible).

Static “burden tables” purporting to show who benefits from cutting the dividend tax are even worse than the revenue estimates. Information about who collects dividends today is entirely useless for predicting who will collect dividends after dividends stop being so brutally taxed. With little or no individual tax on dividends, many more Americans at all income levels would soon discover an attractive new opportunity to save for preretirement needs and to invest in corporate America, rather than just stashing cash in low-yield money market funds.

President Bush is to be applauded for offering a bold vision and avoiding the short-term gimmicks and bailouts that invariably do more harm than good. As Congress works on and modifies the next tax bill, they should retain the president’s proper focus on lasting economic benefits and not become too distracted by the inevitable political abuse of meaningless statistics and estimates.

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