Race to the Bottom

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JUNE 2, 2003

Race to the Bottom

To understand how deeply the United States has descended into fiscal madness, compare the present situation with the last time GOP tax-cutters ran Washington, the Reagan presidency. Just like George W. Bush, Ronald Reagan used his first year in office to enact a series of tax cuts tilted toward the well-off that helped plunge the nation into debt. For this, Reagan is remembered by both the right and left as an unflinching avatar of supply-side economics. But, in truth, Reagan reacted to the consequences of his 1981 tax cuts in a way that would have put him far out of step with Bush's Republican Party. When the scope of the budget deficit became apparent, Reagan acceded to a series of tax increases in 1982 (in the midst of a severe recession, no less), 1983, and 1984. In 1986, reacting to complaints that his 1981 tax cuts opened too many loopholes for the rich, Reagan enacted a sweeping tax reform that liberals, including this magazine, hailed for making the tax code more progressive. Reagan's record on taxes, in short, consisted of one year of unvarnished conservative ideological warfare followed by seven years of retreat and consolidation.

The Bush administration's record could not be more different. This year, federal income tax revenue as a share of the economy is projected to fall to its lowest level since 1943. (It's true that much of this is a result of the economic slowdown, but it's also true that about half of the 2001 Bush tax cut has yet to take effect--meaning that, even after the economy recovers, revenues will remain low.) Yet Bush has not proposed raising taxes down the line, or even freezing future tax cuts, but rather is cutting them even more. And, far from evincing any regret for having tilted the relative tax burden from the rich to the middle class and poor, the president's new tax cuts are just as regressive as his earlier ones. Indeed, Bush--who cut taxes in 2001 and 2002 (a "stimulus" tax cut consisting mainly of business incentives and forgotten by nearly everyone) and is certain to cut them again this year--intends to cut taxes every year he remains in office, according to ally Grover Norquist.

There must be some theoretical limit to this administration's desire to cut taxes for the affluent. But there's no sign we have come anywhere near that point. The Senate, the only structural force that could have restrained the administration, has now passed a "compromise" version of the tax cut that is, in fact, more costly, dishonest, and less economically stimulative than Bush's original. In other words, we may have a long way to go before we hit rock bottom.

In keeping with its past behavior, the administration has concocted a series of public defenses for its tax cut that bear no relation to its actual purposes. There is, first of all, the usual attempt to put a populist face on a regressive measure. America's highest-earning 1 percent, who pay 22 percent of federal taxes, would receive 28 percent of the benefits from Bush's plan, according to the Urban-Brookings Tax Policy Center. In almost every speech touting his plan, Bush dismisses objections to the distribution of his tax cut as "Washington, D.C., political rhetoric." He then cites a local family, typically earning around $40,000 per year, who will save more than $1,000 on their taxes annually. Earlier this month, speaking to the U.S. Chamber of Commerce in Washington, Bush explained, "You'll hear all kinds of rhetoric about how this plan is not fair. Well, let me just describe to you what it means to the family of four making forty thousand dollars a year. It means their taxes would go from one thousand one hundred seventy-eight dollars a year to forty-five dollars a year. ... That sounds fair to me."

The clear impression is that Bush is fighting to cut taxes for middle-income families, and Democrats (along with some moderate Republicans) are resisting. In fact, this is the opposite of the truth. First, the $40,000-per-year family won't pay only $45 in taxes, since they'll still owe $6,120 in payroll taxes, which Bush ignores. Second, their savings from the Bush plan would come from three elements: increasing the child tax credit ($800), expanding the level of income subject to the low 10 percent tax bracket ($100), and reducing the "marriage penalty" ($233). These cuts, all of which enjoy broad bipartisan support, would only cost $157 billion over ten years--less than one-quarter of the total cost of Bush's plan. What have drawn real opposition are Bush's upper-bracket rate cuts and his repeal of the dividend tax, which will cost in excess of $500 billion over the next ten years and will benefit the rich almost exclusively. Bush could have won a sweeping majority for the middle-class cuts if he had dropped his insistence on the upper-class ones. But he didn't, because the former are merely a sweetener to help him obtain the latter. Indeed, when the Senate voted to reduce the size of the tax cuts, conservative Republicans suggested removing the middle-class provisions altogether so they could squeeze in more upper-bracket cuts.

To distract from the regressive nature of his plan, Bush has presented its centerpiece, the repeal of the dividend tax, as a matter of justice. "There's just a simple fairness issue on the double taxation of dividends," Bush told a New Mexico audience last week. "Listen, we should be taxing corporate profits, and we do. But, in this country, not only do we tax corporate profits; when part of those profits are distributed to the owners of the companies, small and large alike, it gets taxed again." It is true that taxation of dividends represents a kind of double tax and that single taxation would make more economic sense. The trouble is that Bush's commitment to the principle of single taxation is highly selective. Corporations have gotten so good at avoiding taxes in recent years that about half of all corporate income is not taxed at all. Bush's original plan would have exempted dividends only on corporate income that had already been taxed. But Senate Republicans changed that provision such that, even when a corporation shelters its income from taxation, it can still pay out dividends on that income tax-free. This represented an acid test of Bush's commitment to the principle of single taxation. If he really believed in it, he would have insisted that his GOP allies accept his version of the dividend tax repeal. Instead, the White House went happily along.

In recent months, the administration has hit upon another tactic to sell the dividend-tax repeal: Pitch it as a tax cut for the elderly. "If you're worried about the senior citizen being able to live a comfortable life upon retirement, then you need to join us in getting rid of the double taxation of dividends," Bush argued last week. "A lot of seniors count on dividend income in order to survive." A Wall Street Journal editorial made this case earlier this year. Pointing out the disproportionate ownership of dividends by seniors, the editorial argued, "That arresting fact has been lost among the Democratic howling that the President's plan is a sop to the rich. In reality, while seniors receive about 15 percent of the nation's income, Treasury statistics show they are the recipients of about 50 percent of the nation's dividend income." So, reasoned the Journal, Democrats claim Bush's tax cut goes to the rich, but in reality it goes to the old!

Can you spot the logical flaw here? Yes--it is actually possible to be both rich and old. This phenomenon has been documented in popular culture for decades, in the form of characters such as Ebenezer Scrooge and C. Montgomery Burns. And, indeed, the 11 percent of the elderly who earn more than $100,000 per year would receive more than 60 percent of the benefit of a dividend-tax repeal. And those old folks who earn less than $50,000 per year--that is, two-thirds of all seniors--would get less than 11 percent of the benefit. All of which suggests that helping Granny afford the early-bird special at Denny's may not be exactly what the Bushies had in mind.

But Bush's primary justification for his tax cut is not providing income support for seniors or middle-class families. It's creating jobs, which he calls the plan's "whole purpose." Speaking in Ohio last month, Bush asserted, "The package needs to be robust so that we can create more than a million new jobs by the end of 2004. That's not my projection. That's the projection of a lot of smart economists who've analyzed the package."

When Bush says, "that's not my projection," one might assume he means it's the work of an objective, nonpartisan body. In fact, the calculation comes from his own Council of Economic Advisers. So Bush's statement is only true in the very narrow sense that he did not personally construct the macroeconomic model that arrived at the result. Furthermore, while it may sound impressive, "one million jobs" is not very many. The economy has lost more than twice that number since Bush took office. With decent population growth, even a sluggish economy could gain one million jobs over a year and a half. To those few who follow economic statistics carefully, Bush's repeated promise of one million new jobs sounds eerily like the Austin Powers character Dr. Evil, who travels forward in time from the 1960s to hold the world hostage for what he considers to be the mind-boggling sum of one million dollars.

The very notion that the government should take specific steps to counteract the business cycle derives from the theories of John Maynard Keynes, the patron saint of modern center-left economics. Keynes, in a nutshell, argued that a recession happens when the demand for goods and services drops, and, therefore, the solution is to get consumers to spend. In every speech, Bush casts his plan in classical Keynesian terms. As the president told a New Mexico audience last week, "My proposal is based upon this principle: If your economy is too slow, you need to increase demand for goods and services." Bush is right that tax cuts are one way to spur demand. But, in order to work, such cuts should put money into the hands of the people most likely to spend it--the poor, all economists agree--and do so immediately. Bush's plan, however, is disproportionately aimed at the rich, and, of its ten-year cost, a mere 6 percent will be pumped into the economy this year.

If the goal is to get money into the economy now, why cut taxes permanently? Conservatives say temporary tax cuts won't work because people won't spend their tax cuts if they know they'll be taken away in a year or two. But, if that's true, then having the government spend the money--the other Keynesian response to a recession--would be a better option. Indeed, if we follow the conservative prescription and ratchet down taxes permanently every time the economy slows down, after enough turns of the business cycle, the government will go completely bankrupt.

This is not to say Bush's tax cut wouldn't boost consumer demand at all. It would. While the rich don't spend as high a proportion of their income as do the poor, they do spend some of it, so giving them more money would presumably put something into the economy. The problem is that Bush's plan is wildly inefficient as economic stimulus. In order to pump some money into the economy today, it would require hundreds of billions of dollars in long-term revenue loss that will take place long after the economy has recovered. Economy.com, an independent research group, conducted a study measuring how much any given economic stimulus would boost the economy relative to its cost. None of Bush's preferred measures came anywhere near the top. One dollar's worth of extending unemployment benefits, for instance, would increase GDP by $1.73. Stretching the low-income, 10 percent tax bracket would produce $1.34. Accelerating cuts in higher tax brackets, as Bush prefers, would add only 59 cents for every dollar in lost revenue. And eliminating the dividend tax would produce a pitiful 9 cents of growth for every dollar in revenue loss.

The truth, as even Bush's supporters admit, is that his tax cut is not designed to cure an economic slowdown. The president's economic advisers are supply-siders. By definition, they do not believe in Keynesian, demand-side remedies. The recession, then, is simply a pretext for them to enact policies they support regardless of circumstances. Beneath all the mendacity used to sell Bush's tax cut, there is a set of truly held convictions. The trouble is that the honest rationales for Bush's tax cut are no more convincing than the dishonest ones.

Supply-siders believe taxes on income discourage people from working hard and trying to get rich. All economists believe this is true to some degree--nearly any economist would agree, for example, that the 91 percent top income tax rate of the 1950s was far too high--but supply-siders take this consensus view to theological extremes. By cutting upper-bracket tax rates, they hope to unleash entrepreneurial spirit and revive the economy, not just this year but for years to come.

Understanding why this theory is wrong doesn't take a deep familiarity with economic research, just a bit of common sense. In 1993, President Bill Clinton raised the top tax rate from 31 percent to 39.6 percent. Supply-siders predicted to a man that this would so discourage hard work and risk-taking that the economy would slow down and tax revenue would actually fall. "Higher taxes will shrink the tax base and reduce tax revenues," insisted a Heritage Foundation report. Of course, just the opposite happened. During the '90s, there was no detectable shortage of people trying to get rich. Innovation and entrepreneurship flourished, and the economy boomed, creating so much tax revenue that intractable deficits turned into surpluses. That doesn't prove the boom happened because of the tax hike, but it does make supply-siders' tax-rates-control-everything worldview look extremely dubious. There may have been a discouraging effect brought about by Clinton's higher tax rates, but it was so trivial as to be unnoticeable.

This experience offers a good baseline to judge the likely effect of Bush's rate cuts. The negative effect of a rate hike ought to be exactly as powerful as the positive effect of a rate cut. Clinton raised the top rate by 8.6 percent. Bush plans to lower the top rate by 4.6 percent, essentially taking back just over half of Clinton's increase. So, however much you think Clinton's 1993 tax hike harmed the economy, divide that in half and you've got a rough sense of how much Bush's tax cut will help--i.e., bordering on zero.

Of course, the calculation doesn't end there. On the other side of the equation, tax cuts increase the national debt, soaking up private capital that could otherwise be used for productive investment. That, all economists (apart from the left- and right-wing fringe) agree, harms the economy by draining away into government debt savings that could otherwise be used for productive investment. That's why just about every mainstream prediction--including those of private forecasters such as Goldman Sachs and Macroeconomic Advisers and that of Congress's Joint Committee on Taxation, which is currently directed by a GOP appointee--shows that the Bush plan would boost the economy slightly in the short term but would actually reduce economic growth after that. Macroeconomic Advisers predict Bush's plan would, in the long run, slow GDP growth by 0.3 percent in 2017. While that is substantial, it's not a huge amount. But, then, if you're exacerbating income inequality and burdening future generations with debt, your answer to the question of what you get in return ought to be better than "well, we're only hampering economic growth a little."

Bush and his allies have three responses to critics who point to the negative effects of long-term structural deficits. The first is that tax cuts will, over the long run, boost economic growth to such a degree that tax revenue actually rises. This is the most extreme claim of supply-side economics, and Bush makes some reference to it in nearly every speech he delivers. "The way to deal with the deficit is not to be timid on the growth package; the way to deal with the deficit is to have a robust enough growth package so we get more revenues coming into the federal Treasury," he asserted earlier this month in California. But even the supply-siders who think Bush's tax cuts will cause the economy to grow don't believe it will bring about so much growth that revenue actually rises above where it would have been otherwise. Even Jude Wanniski--as rabid a supply-sider as ever lived--scoffed at Bush's free-lunch assertion last year.

A second defense, put forward by Bush's defenders but not by Bush himself, is that tax cuts will starve the government of revenue, thereby holding down spending and perhaps even leading to balanced budgets. (One notable thing about this justification is that it contradicts justification number one--either tax cuts cause revenue to rise, or they cause it to shrink; both cannot be true.) A good real-world test of this proposition took place earlier this year. We are facing the largest deficit in U.S. history, and revenue has dropped three years straight for the first time since the 1920s. Republicans control the White House and both branches of Congress, and all express a firm commitment to fiscal discipline. It is not an election year. The conditions for spending cuts, in short, may never be this propitious again. And what has happened? In March, the House proposed $265 billion in entitlement cuts throughout the next decade. This is nowhere near enough to balance the budget. It's not even close to as much as the additional tax cuts Republicans want to pass this year. Even that amount, though, was too high. House Republicans, under pressure from their own moderates, withdrew the plan.

Republicans imagine that deficits will force otherwise free-spending Democrats to eventually accede to major spending cuts. But recent history suggests they have it backward. The high watermark of fiscal conservatism in the Democratic Party took place in the late '90s when surpluses first appeared. Some liberals argued for expanding social programs, but the Clinton administration insisted on reserving surpluses for debt reduction. In fact, the very existence of high revenue offered the most powerful disincentive for spending. In the 2000 primary, Al Gore attacked Bill Bradley's health care proposal by arguing that it would undermine Medicare by weakening fiscal responsibility. The threat of "spending the Social Security surplus" served as a more effective political barrier against spending than any of the deficits of the '80s. Now that the barrier has disappeared--although no one talks about it much, this year's $400 billion (or more) deficit comes on top of the administration spending the Social Security surplus in its entirety--restraint has dwindled. Democratic presidential candidates are once again offering universal health insurance plans and are focusing far less attention on the budget (as opposed to the economy) than Gore did.

This development also illustrates the essential logical flaw in the starve-the-beast argument. It assumes that, as Republicans intentionally sink the country deeper into debt in order to shrink the government to the size they prefer, Democrats will respond by acting responsibly. But what if Democrats decide that fiscal responsibility is a loser's game? They might instead adopt the mirror image of the GOP strategy: Spend gobs and gobs of money, and hope deficits will grow so high that the Republicans will have to stop cutting taxes. To expect the Democrats to continuously put their sense of responsibility ahead of their ideological interests, while Republicans continuously do the opposite, is to expect a level of self-abnegation bordering on political suicide.

The third and final conservative defense against the deficit hawks is that deficits will prove to be temporary or are otherwise insignificant. (The Wall Street Journal editorial page has even taken to using scare quotes--"President Bush's tax cut is running into trouble in the Senate, with opponents claiming they are worried about `the deficit,'" it sneered in a typical offering--as if the entire idea were some liberal bogeyman.) In his stump speech, Bush asserts over and over, "We got into deficit because the economy went into the recession," and, "We have got a recession because we went to war." In fact, neither of these statements is true. The White House's own budget shows it running deficits into perpetuity, even after the economy recovers. And the war in Iraq imposed a one-time cost of $80 billion out of a deficit expected to exceed $400 billion this year alone. Do the math.

The administration does have a more plausible-sounding version of this argument: After the economy recovers, the deficit will be far smaller as a share of the economy than it was under Reagan. As Treasury Secretary John Snow told NBC's Tim Russert last week, "If you look at this budget, as a percentage of GDP, they decline, and they get down to well under one percent. That's a modest deficit." But the administration's budget forecasts rely on wildly unrealistic assumptions. They suppose, for example, that tax cuts slated to expire will not be renewed--although, such renewals are routine and the administration will assuredly fight to ensure they take place. They further assume that the Alternative Minimum Tax, a complicated system designed to catch rich tax-avoiders, will grow to the point where it raises taxes on tens of millions of middle-class earners--even though the administration has already promised not to let this happen. Under a more probable scenario, budget deficits should run around 2 percent of GDP or higher for the next decade. If more tax cuts come, that number will grow even larger.

That would still be lower than the Reagan deficits, which reached as high as 6 percent of the economy. Unfortunately, as the Brookings Institution's Bill Gale and Peter Orszag have noted, the nation is far less equipped to handle a deficit than it was 20 years ago. For one thing, the private savings rate has collapsed over the last two decades, from around 8 percent to almost zero; when individuals fail to save any money, it becomes more important that Washington do it for them by running surpluses. A zero-percent private-savings rate combined with a negative public-savings rate (i.e., deficits) is a dangerous combination--it means the capital stock, which determines our economic growth, is continuously falling as a share of the economy. More important still, we're now 20 years closer to the retirement of the baby-boom generation than we were in the Reagan years. We should be using this time--after the economy recovers, anyway--to pay down the national debt and prepare ourselves for a big fiscal shock. Running deficits now is like an aging couple running up their credit card debts just as they get ready to retire.

Oddly, the entitlement crisis strikes the administration as a reason not to worry about the deficit. "Although the resulting deficits [over the next few years] are manageable by any reasonable standard, they are cause for legitimate concern and attention," contends the administration's Office of Management and Budget in an essay, "The Real Fiscal Danger," published last February. "But whatever judgment one reaches about the deficit of this year or even the next several years combined, these deficits are tiny compared to the far larger built-in deficits that will be generated by structural problems in our largest entitlement programs." This is a strange argument to begin with: Yes, we're spending beyond our means now, but in the future we're really going to spend beyond our means, so why sweat it? Moreover, its premise isn't even accurate. According to a calculation by the Center on Budget and Policy Priorities, the long-term cost of Bush's tax cut exceeds the long-term deficits of Social Security and Medicare combined. In other words, if we rescinded all the Bush tax cuts, we could preserve both Social Security and Medicare and have money left over. So, if the entitlement deficits represent a "financial threat," as the administration concedes, what do we call the Bush tax cut?

Not along ago, the kind of structural deficits proposed by the Bush administration would have provoked alarm among fiscal conservatives in the GOP. But, at least at the elite level of the party, classic fiscal conservatism is now nearly extinct. Consider the evolution--or, more accurately, the devolution--of the moderate Republican position since Bush took office. In 2001, Senate moderates such as Susan Collins and Arlen Specter initially advocated a "trigger" by which tax cuts would be postponed if the surplus did not prove as large as forecast. Once that failed, they settled for slowly phasing in the tax cut in order to cancel future installments should the surplus run dry. That is to say, they supported tax cuts this year only if we could be assured of paying off $174 billion worth of debt first. It appears this year we will fall shy of that goal by some $600 billion. Now, it would be understandable if moderates didn't want to raise taxes right now. But nothing in their prior position would indicate a willingness to cut taxes even further, on a permanent basis.

Earlier this year, it appeared the moderates had dealt a serious blow to Bush's tax cut when they voted to restrain its ten-year cost to $350 billion rather than the president's preferred $726 billion. Perhaps the most prominent advocate of this plan was Ohio Republican George Voinovich, who had made his name as a deficit-hawk mayor and governor and had voted against a $792 billion GOP tax cut in 1999. In a recent appearance on NBC's "Meet the Press," Voinovich spoke at length about the growing deficit and asserted that further tax cuts will "undermine our economy instead of stimulating it." By this logic, he should have opposed any tax cut. But, after yet another soliloquy against deficit-financed tax cuts, he concluded, "So the point I'm making is that this three hundred fifty billion dollar package is a responsible package." In fact, the point he made suggested just the opposite. Voinovich's incoherance undermines his self-proclaimed principles.

The other fatal flaw in the position embraced by Voinovich and fellow moderates is that the condition they demanded--holding the tax cut to $350 billion--meant essentially nothing. This is because in recent years the GOP has perfected the art of rapidly phasing in and phasing out tax cuts in order to lower their official costs. The 2001 tax cut, for instance, delayed implementation of many tax cuts and ended others abruptly. This year, Senate Republicans again made full use of such gimmickry, passing a "$350 billion" tax cut that, realistically accounted for, would drain perhaps as much as $1 trillion from federal coffers during the next ten years. Unsurprisingly, arch-conservative Tom DeLay gladly acceded to the "$350 billion" ceiling, explaining to The New York Times, "Numbers don't mean anything."

Take its most obvious gimmick: the decision to have the dividend-tax repeal end after just four years. Voinovich, pathetically, says this will "force us to look at what we have done and make us study whether it has an impact on the economy." In fact, it will do no such thing: The only purpose of the phase-out is to keep down the apparent cost of the tax bill; once the dividend repeal is in place, Republicans will argue overwhelmingly that allowing it to expire would constitute a "tax increase." How do we know this? Because that's what they're doing right now. As Bush told a California rally earlier this month, "[Congress] agreed to [cut taxes in 2001]. The problem is that they weren't going to let you keep your own money for three, five, or seven years from now." He makes it sound like an unwelcome scheme, probably cooked up by Tom Daschle. In fact, Bush's original 2001 plan had phase-ins, and Congress--with the administration's approval--extended the phase-ins in order to include the deepest possible tax cuts while still appearing to comply with its budget. Each tax cut, in other words, is mined with time bombs that must be defused (or else we'll have a "tax increase"), and each fix plants new ones that must be defused again. Bush will soon be back decrying those very gimmicks and demanding they be fixed by yet another tax cut.

It would be nice to imagine that, at some point, Bush's tax-cut hucksterism will be constrained by some feeling of shame, some sense of responsibility to future generations, or--the most fanciful wish--a concern for social equity. But, in George W. Bush's Washington, such quaint notions are all, from the administration's point of view, blessedly in remission.

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posted in: washington, washington, d.c., america, united states, bill clinton, george w. bush, ronald reagan, new mexico, ohio, republican party, senate, white house

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