Commentary

Making Choices: Exploring The Tax Issue

This article originally appeared in the Star-Ledger on October 20, 2004.

Whether one supports or opposes President Bush, his policies are easy to understand because he chooses a course of action and sticks to it. Americans certainly know where Bush stands on taxes — his string of five tax cuts in four years is unprecedented. Ronald Reagan is remembered as being a big tax cutter, but he only cut taxes once, in 1981, then enacted a series of tax increases in following years.

Bush’s tax cuts have provided a strong unifying goal in the diverse Republican Party. To his credit, most of Bush’s tax cuts have not been simply populist giveaways. Instead, he has tried to solve real problems in the tax code to spur growth, such as reducing the damaging income tax bias against saving and investment.

Bush’s 2001 tax cut reduced income tax rates to stimulate greater working investment and entrepreneurship. As Bush has pointed out in debates with Sen. John Kerry, the cuts in the top rates were particularly important because of the heavy concentration of small businesses in those brackets. The substantial size of the tax cut at $1.35 trillion made fiscal sense because projections in 2001 showed that there was a huge $5.6 trillion budget surplus to work with.

In March 2002, Bush’s enacted his next tax cut, which was designed to spur business investment in the wake of 9/11 and the lingering recession. Bush continued his focus on pro-growth tax cuts with the dividend and capital gains tax cuts of 2003.

Cutting dividend taxes helped solve a number of problems. U.S. corporations had relied too much on debt instead of equity financing because the tax code gave an advantage to interest over dividends. The 2003 tax law reduced this distortion to make the corporate sector more stable and efficient. High dividend taxes also caused companies to excessively retain earnings, which led to unproductive investments and was a contributing factor to recent corporate scandals.

The economy responded strongly to the dividend tax cut. The stock market soared after the tax cut’s passage, and a recent Cato Institute study found that dividend payouts by Standard and Poor’s 500 companies rose about 20 percent in the year following the cut.

Earlier this year, Bush signed into law an extension of some of his prior individual tax cuts. And he will sign a corporate tax bill passed by Congress this month. The bill has been criticized for the many special interest breaks it contains, but it also includes reforms to help U.S. firms compete in foreign markets.

That’s the good budget news. The bad news is that President Bush has let federal spending and deficits explode. Total federal spending rose 31 percent between fiscal 2001 and 2005. This large increase comes just when the nation can least afford it with the coming cost pressures on Social Security and Medicare as baby boomers begin to retire.

While Bush’s spending policies have been irresponsible, Kerry is promising more of the same with about $2 trillion in new spending. Kerry says that he would reverse some of Bush’s tax cuts, but that would only pay for a fraction of his promised spending. Kerry is right to criticize Bush’s big deficits, but his own promises undermine his claim to be the more fiscally responsible candidate. On spending, voters have little choice since both candidates embrace Big Government.

On taxes, the candidates have different philosophies, but they would find themselves dealing the same problems in the years ahead. For one thing, the next president will need to deal with concerns about America’s tax competitiveness. Global markets are creating pressure for major reforms to the U.S. corporate tax, which has the second highest rate in the industrial world.

Another problem that the next president will face is rapid growth in the alternative minimum tax, which is a complex add-on to the income tax. The AMT currently hits only a few million taxpayers, but by 2010 it will ensnare 30 million unless reforms are made. The AMT is part of a growing tax complexity problem, highlighted by the 50 percent growth in tax code pages during the last decade.

President Bush has made progress in creating a more pro-saving and pro-growth tax code. But other tax code problems are festering, and the next president will have his work cut out to give Americans the low, simple, and efficient tax code that they deserve.

Chris Edwards is director of tax policy at the Cato Institute.