Tax Cuts, Round One

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The Big Mo has arrived for George W. Bush. His tax-cut plan is beingembraced by Republicans eager to recapture the high ground on "their" issue,and the Democratic minority is finally admitting it can't win the argumentagainst tax cuts. Credit the power of the bully pulpit, but there's nodenying 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 $800billion over 10 years is four times as big as the major Republican tax-cutinitiatives of the last Congress, all of which the Democrats opposed. That'sa 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 surplusover the next decade. It's also quite a small reduction as a percentage ofoverall 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 thegovernment will consume over the next 10 years.

Complicating matters will be competing tax proposals from various businessgroups, which have already begun to lobby for various tax credits anddeductions to defray the burden of the corporate income tax. While loweringtaxes on corporations is important, it should not be done by complicatingthe tax code further. If businesses want lower taxes, they would be welladvised to argue for lower rates for every company, not targeted breaks forsome.

In fact, the preference for simplicity over complexity in the tax code isone of the strongest reasons to favor the Bush tax proposal. The best partabout the Bush plan isn't its size, but the fact that, in addition toreversing the Clinton tax hikes of 1993, it makes the marginal tax ratesflatter across the board -- specifically by creating a new 10 percent bracketfor low-income workers, expanding the middle-income brackets, and loweringthe overall top rate. Under Bush's plan, moving from one income bracket tothe next will be a less painful tax trip thanks to this "flattening" ofrates.

Movement up the income spectrum is important because there has been so muchof it during the economic boom of the past seven years. Inflation-adjustedpersonal income growth has equaled 18 percent over the past five years. Butthe federal government has been eating well thanks to that growth: Personaltax revenues have grown more than twice as fast as income growth, to thetune of 44 percent. That's because the expanding economy has nudged peopleinto higher brackets, subjecting them to the punishing marginal increases ofthe current tax code.

This is called real bracket creep. While the tax code is indexed forinflation, 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 economicgrowth over the past five years, taxpayers would have saved more than $230billion in taxes. That's almost one-and-a-half times the one-year impact ofBush's current proposal

If Bush really wants to keep government within reasonable limits, he coulddo far worse than to integrate real bracket creep protection into the taxcode. After all, if the economy grows as a result of his tax cuts -- and thereis substantial evidence, based on history, that it will -- then Bush needs toprotect taxpayers by making sure they don't get hammered by high future taxburdens as a result of real bracket creep.

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

Stephen Slivinski

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."