Tax Cut Fever: What the Budget Future May Hold

by Guest Blogger, 12/9/2002

With the shake-up in the Administration’s economic team, the recent rise in the unemployment rate to 6% (the highest rate in eight years), and absolutely no evidence that the massive Bush tax cut has done anything but send the federal budget on a rapid spiral into deficit, a reasonable person might think that it was time for the Administration to reevaluate the idea that tax cuts are the solution to everything. The President’s economic stimulus plan, currently in the design phase, however, is expected to consist of tax cuts aimed at corporations and individuals in the higher tax brackets.

With the shake-up in the Administration’s economic team, the recent rise in the unemployment rate to 6% (the highest rate in eight years), and absolutely no evidence that the massive Bush tax cut has done anything but send the federal budget on a rapid spiral into deficit, a reasonable person might think that it was time for the Administration to reevaluate the idea that tax cuts are the solution to everything. The President’s economic stimulus plan, currently in the design phase, however, is expected to consist of tax cuts aimed at corporations and individuals in the higher tax brackets.

With the shake-up in the Administration’s economic team, the recent rise in the unemployment rate to 6% (the highest rate in eight years), and absolutely no evidence that the massive Bush tax cut has done anything but send the federal budget on a rapid spiral into deficit, a reasonable person might think that it was time for the Administration to reevaluate the idea that tax cuts are the solution to everything. The President’s economic stimulus plan, currently in the design phase, however, is expected to consist of tax cuts aimed at corporations and individuals in the higher tax brackets.

How will the country pay for the additional revenue loss, now estimated at $300 billion over the next decade? While the Wall Street Journal reported today that savings in the Medicare program are being sought to help pay for the tax cuts, looking at the plans for cuts in the FY 2003 budget ($9 billion less in domestic spending than in 2002) is also instructive. Grover Norquist, President of Americans for Tax Reform, has called for cutting government in half over the next twenty-five years. Given the rate at which this Administration is passing tax cuts, it may take even less time.

This tax cut push comes in spite of the threat of war and strong public demand for a number of spending items, including broader “homeland security” measures, resources for education and for implementing the President’s own “Leave No Child Behind” education plan, a prescription drug benefit that would benefit all seniors, insuring the solvency of Social Security and Medicaid, heath care for the uninsured, and the extension of unemployment benefits, which for many people will expire three days after Christmas, to name just a few.

States, too, are making increasing demands for some federal help, since overall they are in the worst financial shape since WW II, with budget shortfalls totaling $67 billion. Part of the reason for the state budget catastrophe has been laid quite directly at the feet of federal budget decisions. For example, the end of the federal estate tax credit, a source of some $6 billion in annual revenue to the states, was accelerated in the Bush tax cut to expire in 2004 (to make the total cost of the bill add up to less). Further, cuts in federal services have put more burdens on state and local entities. (For more on the state budget crisis, see this Watcher article.)



Last week, Sen. George Voinovich (R-OH) released the Congressional Budget Office (CBO) report that recalculates the deficit based on making the Bush tax cuts, due to expire in 2010, permanent. Under one set of parameters, government spending would remain at the same percentage level of GDP over the next decade, i.e., there would be no increase for inflation, population growth, increased needs, etc. CBO found that the overall deficit would be $1.5 trillion and, if Social Security revenue is excluded, $4 trillion (see "Scenario 2" in the chart at the right). Given a slightly more reasonable condition where government would continue to grow at a rate of 8.5% (which is still low given the new demands for homeland security and defense) ("Scenario 3" in the chart to the right), CBO found that there would be a total deficit of $2.87 trillion over the next decade, or a whopping $5.4 trillion if you exclude Social Security. (The chart to the right also shows, in "Scenario 1," the resulting deficit if the tax cut is extended and discretionary spending grows only at the rate of inflation. The CBO's complete estimates are available online.)

Voinovich is urging passage of a “truth in accounting” budget proposal co-sponsored with Sen. Russell Feingold (D-WI), to extend budget enforcement mechanisms and require scoring of long-term interest costs. Last week Voinovich also said in an interview that, while he would probably vote for making the Bush tax cuts permanent (in spite of the revenue loss), he did have some reservations about making repeal of the estate tax (which is clearly targeted to only the wealthiest Americans) permanent, and he would oppose any new tax cuts unless they would have an immediate, stimulative effect on the economy.

Possible Items in the Administration’s $300 Billion Economic “Growth” Tax Cut Plan:
  • Acceleration of reductions in individual tax rates by advancing to 2003 the top percentage rate cuts scheduled for 2004; and/or advancing to 2004 the cuts scheduled for 2006.
  • Reduction in taxes on corporate dividends either for companies or shareholders. (Fully eliminating corporate dividends would cost over $493 billion over 10 years.)
  • Increase depreciation rules for corporations.
  • Expansion of IRA and 401(k) retirement plans
  • Increase in Child Tax Credit.
  • Make the Bush tax cuts that will expire in 2010 permanent (at a cost of $4 trillion in the first decade after 2012)

The issues of tax cuts, the deficit, spending, and the economy are, of course, closely linked. The Administration and many members of the Republican Congress remain committed to tax cuts that benefit wealthy individuals and corporations -- their constituency -- and would like to portray those tax cuts as the solution to the economic downswing. However, many economists do not support that position. They argue that we actually need to increase spending and that any tax cuts must be temporary and carefully targeted to economic stimulus in order to get the economy rolling again. Once the economy is growing, the deficits will shrink. Temporary or one-time-only tax breaks focused on low- or middle-income Americans who will spend the savings (for instance, several legislators have called for some version of a temporary reduction in payroll taxes, which would give a break to poor working families), or short-term investment credits to encourage businesses to make investments immediately might help. Permanent tax cuts for the wealthy will continue to be ineffective in stimulating the economy and, in fact, will be harmful, since they reduce government revenue, needed, for instance, to provide some help to the states. Leaving the states in a position where they have to raise taxes and cut services will act against federal measures to stimulate the economy, likely canceling out federal efforts. For one example, the Washington Post reported the dilemma of New York City Mayor Bloomberg, who after raising state property taxes higher than ever before and cutting city services, still faces a $4 billion budget shortfall, requiring a tax increase.

Passage of new tax cuts with more revenue loss is one of the biggest threats we face—not because of an increase in the deficit, but because of the loss of federal, state and local government services that are important to low and middle income individuals and families. A tax cut by any other name is still a tax cut.