January 31, 2002

January 31, 2002 | Commentary on Taxes

"Do the Opposite" on Taxes

Fans of the TV show "Seinfeld" will remember an episode in which perpetual loser George Costanza announces a major shift in attitude: From that point on, he will simply "do the opposite" of whatever he would normally do in any given situation. This turns into an immediate success formula. Nothing goes wrong -- until he reverts to form.

It's a lesson that congressional critics of President Bush's tax cut should take to heart. Last year, they decided to "do the opposite" of what they would normally do by agreeing to cut income tax rates across the board. Now, alarmed by a weak economy and the prospect of budget deficits, they propose repealing (or at least delaying) the cuts. In theory, this will balance the budget and spur the economy.

That isn't how it worked for President Herbert Hoover, though. He took office several months before the stock-market crash of 1929. The resulting recession caused tax revenues to run dry and threw the budget into deficit. His solution? Balance the budget by raising income tax rates and tariffs. We all know what happened: The economy collapsed, the budget ran bigger deficits, and the recession turned into the Great Depression.

Fast forward about 50 years. It's 1981, and President Ronald Reagan is also facing an economy in deep recession and a budget in deep deficit. But he knows better than to saddle an already suffering economy with higher taxes. So he helps enact legislation that brings tax rates to their lowest levels in years. Skeptics predict ruin, but once the cuts are phased in, the economy begins what was, at that time, the longest peacetime expansion in American history.

But, critics charge, Reagan's approach caused budget deficits. Wrong: The deficits resulted from runaway federal spending. Even if Congress had just limited spending increases to the rate of inflation, it would have run budget surpluses in 28 of the 32 fiscal years since 1970. Instead, it increased annual spending by 852 percent -- 120 percent above the rate of inflation -- and the federal government wound up running 28 deficits and just four surpluses.

Small wonder, then, that President Bush said in his State of the Union speech that any budget deficit we run "will be small and short-term so long as Congress restrains spending and acts in a fiscally responsible way."

Unfortunately, most lawmakers seem to misunderstand the relationship between the budget and the economy. They think that raising taxes will transfer more money to Washington and ultimately balance the books.

But while higher taxes are busy swelling the government's slice of the economic pie, they're also shrinking the size of the pie itself. The price of working, saving and investing goes up, and people find it harder to start, continue or expand a business. Soon they can't afford to hire the extra workers they had hoped to hire. Economic activity declines -- and, as a result, so do tax revenues.

President Bush understands this. That's why he also said that Congress can promote "long-term growth" if it will "make these tax cuts permanent." If Congress were to repeal them, in the Hoover-like belief that such a step will balance the budget, it will be discouraging the very economic activity we need to end this recession and, not coincidentally, balance the federal budget as well.

The fact is, economic growth drives the federal budget, not the other way around. Too many lawmakers labor under the mistaken belief that budget surpluses cause economic growth. But they don't: Surpluses are a consequence of growth. And economic growth, history clearly shows, can either be encouraged with lower tax rates -- or strangled with higher ones.

The best way for Congress and the president to end the recession is to focus on family budgets rather than the federal budget. That is, they should focus on economic growth and assure that families and businesses aren't burdened by a tax system that discourages work, saving and investment. If Congress wants to see budget deficits disappear, it should follow the Reagan model and hold the line on spending.

Let's hope tax-cut critics have the courage to "do the opposite" here -- and give the economy the helping hand that it needs.


 

Brian Riedl is the Grover M. Hermann fellow in federal budgetary issues at The Heritage Foundation (www.heritage.org), a Washington-based public policy research institute.

About the Author

Brian M. Riedl Grover Hermann Fellow in Federal Budgetary Affairs
Thomas A. Roe Institute for Economic Policy Studies

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