Commentary

Tax Cuts, Round One

By Stephen Slivinski
February 7, 2001
The Big Mo has arrived for George W. Bush. His tax-cut plan is being embraced by Republicans eager to recapture the high ground on “their” issue, and the Democratic minority is finally admitting it can’t win the argument against tax cuts. Credit the power of the bully pulpit, but there’s no denying that this is an important — indeed, historic — change in the government’s approach to the mounting budget surpluses.

The Democrats’ support for tax cuts is notable: Their preferred cut of $800 billion over 10 years is four times as big as the major Republican tax-cut initiatives of the last Congress, all of which the Democrats opposed. That’s a nice start. But Bush’s $1.6 trillion tax cut is a better start. Still, even Bush’s tax cut is only 50 percent of the projected on-budget surplus over the next decade. It’s also quite a small reduction as a percentage of overall tax burden when compared to the Reagan and Kennedy tax cuts. And it’s only 10 percent of the total personal income tax revenue that the government will consume over the next 10 years.

Complicating matters will be competing tax proposals from various business groups, which have already begun to lobby for various tax credits and deductions to defray the burden of the corporate income tax. While lowering taxes on corporations is important, it should not be done by complicating the tax code further. If businesses want lower taxes, they would be well advised to argue for lower rates for every company, not targeted breaks for some.

In fact, the preference for simplicity over complexity in the tax code is one of the strongest reasons to favor the Bush tax proposal. The best part about the Bush plan isn’t its size, but the fact that, in addition to reversing the Clinton tax hikes of 1993, it makes the marginal tax rates flatter across the board — specifically by creating a new 10 percent bracket for low-income workers, expanding the middle-income brackets, and lowering the overall top rate. Under Bush’s plan, moving from one income bracket to the next will be a less painful tax trip thanks to this “flattening” of rates.

Movement up the income spectrum is important because there has been so much of it during the economic boom of the past seven years. Inflation-adjusted personal income growth has equaled 18 percent over the past five years. But the federal government has been eating well thanks to that growth: Personal tax revenues have grown more than twice as fast as income growth, to the tune of 44 percent. That’s because the expanding economy has nudged people into higher brackets, subjecting them to the punishing marginal increases of the current tax code.

This is called real bracket creep. While the tax code is indexed for inflation, it is not indexed for economic growth. When inflation increases, the tax brackets shift upward, but when the economy grows, the brackets don’t shift at all. In fact, if the tax code had been indexed for economic growth over the past five years, taxpayers would have saved more than $230 billion in taxes. That’s almost one-and-a-half times the one-year impact of Bush’s current proposal

If Bush really wants to keep government within reasonable limits, he could do far worse than to integrate real bracket creep protection into the tax code. After all, if the economy grows as a result of his tax cuts — and there is substantial evidence, based on history, that it will — then Bush needs to protect taxpayers by making sure they don’t get hammered by high future tax burdens as a result of real bracket creep.

But this is only Round One. There’s a long way to go until the Senate schedules debate on Bush’s modest tax plan. That should give the White House plenty of time to prepare for Round Two of tax cuts. There will be a Round Two, right?

Stephen Slivinski is a fiscal policy analyst at the Cato Institute and co-author of the forthcoming “Fiscal Policy Report Card on America’s Governors: 2000.”