Commentary

Tax Policy Under President Bush

This article appeared in the Fraser Forum on August 14, 2006.

Tax cutting has been a key policy of the administration of George Bush since coming to power in 2001. Under President Bill Clinton in the 1990s, only one modest tax cut bill was signed into law. Thus, when Bush came to power there was a pent-up demand for tax cuts, and the administration soon delivered. Here is a year-by-year summary.

2001. President Bush came into office promising a range of income tax cuts. He succeeded in getting a 10-year $1.35 trillion tax cut plan through Congress in 2001. It was the largest tax cut since 1981. Some key elements were:

  • A reduction of individual income tax rates from 15, 28, 31, 36, and 39.6 percent to 10, 15, 25, 28, 33, and 35 percent;
  • An increase in the child tax credit from $500 to $1,000;
  • A phased-in reduction in estate taxes, and a one-year repeal in 2010;
  • A big expansion of tax-favored retirement savings plans.

While some of the tax changes in the 2001 bill were not growth-oriented, the rate cuts and savings provisions were important reforms. But the 2001 law included complex rules regarding when certain tax changes would be in effect. The estate tax, for example, was repealed for 2010 but then reinstated in 2011. All the 2001 tax cuts are set to expire at the end of 2010 unless Congress acts to extend them.

2002. With concern about the economy in the wake of the recession, Congress enacted a “stimulus” tax cut bill in 2002. The main provision allowed businesses to “expense,” or immediately write-off, 30 percent of the cost of equipment purchases (later increased to 50 percent). Expensing is an important step toward converting the income tax to a consumption-based tax. It simplifies the tax code and spurs growth by removing taxes on the normal return to investment. Unfortunately, the partial expensing was only implemented temporarily and it has now expired.

2003. Under President Bush’s leadership, Congress passed a further package of pro-growth tax cuts in 2003. The centerpiece of the law was a cut in the top capital gains rate from 20 to 15 percent and a cut in the top individual rate on dividends from 35 to 15 percent. Tax experts had long discussed the distortionary effects of the excessive taxation of corporate equity in the U.S. tax code. Under the 2003 law, the capital gains and dividend cuts were set to expire after 2008.

2004. There have been increasing concerns about the uncompetitiveness of the complex and high-rate U.S. corporate income tax. The U.S. corporate tax rate is one of the highest in the world, and it has remained unchanged while other nations have made dramatic cuts. The chairman of the House tax committee, Bill Thomas, was determined to deal with the problem and he pushed for major corporate tax reforms. However, what ended up being signed into law in 2004 was a mixed bag. Some important simplifications in the treatment of foreign income by multinationals were included, but the federal corporate rate was not cut except for certain favored industries.

2005. The main tax event of 2005 was the appointment by President Bush of a commission to look into major tax reforms. The commission produced a very good report that described two detailed and workable reform plans for the income tax (see www.taxreformpanel.gov). Unfortunately, the plans were not as far-reaching as a flat tax, but they did include rate cuts, simplifications, and pro-savings provisions. Sadly, the White House has dropped plans for major tax reform for now, but reform may come back on the agenda in 2007.

2006. This year, Republicans have tried to tie up loose ends from prior tax legislation. They voted to extend the capital gains and dividend tax cuts for two further years (until 2010). But they were less successful in their effort to make estate tax repeal permanent, as repeal narrowly failed in a June Senate vote. A compromise bill with a cut to the estate tax rate might be passed later in the year.

The Years Ahead. While President Bush has been a supporter of pro-growth tax reforms, there are shortcomings in recent tax policies. For one thing, the tax code continues to get more complicated by leaps and bounds. Also, policymakers have not repealed the alternative minimum tax, a parallel income tax system that threatens to hit 30 million households by the end of the decade.

Another shortcoming has been the failure to make tax cuts permanent. Nearly all of the Bush cuts—individual rates, capital gains, dividends, estate tax—are set to expire after 2010. Sixty votes are needed in the 100-member Senate to pass permanent tax cuts. There are just 55 GOP senators, and they have faced a politically far-left Democratic opposition.

Republicans also have their own policies of big spending to blame. Tax cutting has been made more difficult because Bush has been the most profligate president in decades. In his first five years, 2001 to 2006, federal spending increased 45 percent and deficits have soared. It’s tougher to convince the few centrist Democrats in the Senate to go along with making tax cuts permanent when federal red ink is gushing non-stop.

The big spending policies of the Bush administration have been remarkably short-sighted economically and politically, as they have threatened Bush’s primary domestic policy success of pro-growth tax cuts. For its part, the Republican leadership in Congress has gone along with, and often encouraged, the spending feast of recent years. There are only about 50 serious budget reformers in the 435-member House. For the rest, it’s been a pork-barrel pigout in recent years.

The future of the Bush tax cuts depends to a large extent on the next president, who will enter office in 2009. A President Hillary Clinton (currently a senator from New York) may not favor extension of any tax cuts, but a president George Allen (currently a senator from Virginia) would likely try to extend them all. Whether the United States moves toward major tax reform, such as a low-rate flat tax, will also substantially depend on the next resident of the White House.

Chris Edwards is tax director at the Cato Institute and author of Downsizing the Federal Government.