The day before the resignations the Wall Street Journal reported: “The White House is leaning toward proposing a sharp reduction of taxes that individuals pay on corporate dividends. Treasury secretary Paul O’Neill appears sceptical about a dividend‐tax cut, in part because he worries about the cost and thinks other tax breaks might be more effective in stimulating economic growth.” Mr O’Neill has nebulously opined that he prefers “targeted” tax breaks, which smacks of picking winners or favouring political friends. A few weeks ago, the press was full of his self‐promoting hints that Treasury staffers were designing some sort of spectacular tax reform as though the White House was a mere spectator.
Some rumours about this scheme were implausibly ambitious, such as scrapping corporate tax in favour of a Vat. Others were trivially modest, like explaining tax simplification as ending the five definitions of the word child. That clumsy exercise in press manipulation just added to the uncertainty as to who was in charge of what.
Glenn Hubbard, chairman of the president’s Council of Economic Advisers (CEA), has written several studies confirming that tax policy has a powerful impact on investment and entrepreneurship. Yet Mr O’Neill never displayed awareness of any relationship between tax policy and economic performance. His views about “economic stimulus” were myopic in the extreme.
In late November he told the Financial Times: “There’s a concern that the first two quarters are not going to be up to a 3% standard and so he the president asked us to pull together ideas for his consideration.” In short, Mr O’Neill sometimes acted as though he was chief executive of a department whose status was at least equal to that of the White House, rather than subordinate to it. He had to go. Larry Lindsey, by contrast, is an economist of great skill who stumbles when dabbling in politics, most notably running into trouble by suggesting that the war with Iraq could cost $200bn. He was one of the main architects of the 2001 tax‐cut strategy, which put priority on cutting the lowest tax rate first and the highest tax rates much later.
That advice has now become an uncomfortable legacy because a top goal of 2003 is to undo last year’s mistake, by taking the most damaging tax rates down sooner rather than later.
Taking the top four tax rates down to 25%-35% next year rather than waiting until 2006 involves an ephemeral revenue loss of only about $18bn a year, using the static assumption that the economy would not improve at all.
The meaningless risk of such a trivial revenue loss for a government that collects nearly $2 trillion a year raises the obvious question of why the modest 2001 reduction of tax rates was delayed so long in the first place. The economy would have benefited much more from the reality of lower tax rates in 2002 than it did from last year’s flimsy promise of lower tax rates in2004‐06.
At least some of the blame for that terrible timing surely belongs to Mr Lindsey. In any event, he had his chance and did not do so well. It is time for new heads with new ideas.
The flurry of chatter about who will fill these two empty slots involved wild guesses and thinly disguised lobbying. A pundit on one TV programme speculated about moving Alan Greenspan to Treasury and Bob McTeer, president of the Dallas Fed, to Fed chairman. Other favoured candidates include Dick Grasso, chairman of the New York Stock Exchange, or perhaps Charles Schwab or Ted Forstmann of the companies that bear their names. Those sound like smart choices, so they are likely to be wrong. Politics is rarely smart.
The position Lindsey held, director of the National Economic Council, did not exist before 1993. The last people to hold that job were politically savvy communicators rather than competent economists. This time it seems the job may go to Stephen Friedman, former chairman of Goldman Sachs.
If this redundant patronage job must survive to prove Parkinson’s Law, then it might as well be made frankly political by appointing, say, the articulate and likeable California congressman Chris Cox. There would then be less risk of duplication and potential conflict with the head of the CEA.
Neither the CEA chairman nor Treasury secretary would then bear the burden of persuading congress and the press about every policy proposal. The Treasury secretary could then be a serious economist such as Glenn Hubbard, Phil Gramm or Dick Armey. (After all, Larry Summers was a serious economist.) So, what should be done? There are constructive ideas competing for the US government’s attention (adding investment choices to social security) but also some dangerous fiscal black holes (subsidising prescription drugs for us greybeards to make us indifferent to the cost).
When it comes to tax policy, the administration has short‐term and long‐term objectives. The trick is to make the two consistent.
In the short run, a wise new economic team must not even toy with “stimulating demand”, which is just a Keynesian euphemism for wasting money. It is far more important to bring the lower tax rates forward to 2003 than to make the entire 2001 law “permanent”.
Nothing is permanent because any future congress can change it. Having the government actually take a smaller slice out of every extra dollar earned is a far more effective incentive than listening to politicians argue over whether or not they are ever really going to do what they promised last year.
Cut the rates right away and then people will feel wealthier in an enduring sense and act accordingly. It is also vital to cut the individual tax on dividends to 20% to match the tax on capital gains. Among other benefits, that will reduce the incentive companies have to rely too heavily on tax‐deductible debt rather than double‐taxed equity.
Several other items on the familiar tax cut wish‐list just reduce the attention paid to the two key proposals while making the bloated grab‐bag look unduly complex and costly. The new Treasury secretary will have to set priorities and stay focused.
Rule number one is that every proposed change must move the country in the right direction — namely, toward a simpler system that keeps marginal tax rates to a minimum and does not unduly punish thrift and risk. Rule two is that nothing should ever be done in the name of short‐term “stimulus” that would not make sense as long‐term policy. Whatever is good policy for the long run will quickly be rewarded in the short run by new‐found optimism among businessmen, consumers and investors. With luck, the new Treasury secretary will understand all this.