October 4, 2002

October 4, 2002 | Commentary on Taxes

Can't Pin Fiscal Woes on W.

Facts often are the first casualty of any political battle, and never more so than during an election year. But sometimes the debate shifts from routine exaggeration and distortion and becomes flagrantly misleading. As with Al Gore's recent fusillade, including his speech yesterday, against the Bush team's economic policy:

* Myth #1: The sluggish economy proves tax cuts do not boost growth.

Fact: The economy began to weaken in 2000, almost one year prior to the enactment of tax-cut legislation. The economy began to weaken in the middle of 2000, according to Commerce Department figures, averaging less than one percent growth in the final six months of the year.

This anemic performance occurred long before the 2001 tax cut was enacted. Even more important, the economy started to contract in the first three months of 2001. This decline began while President Clinton was still in office, certainly well before any tax cuts were approved.

Fact: The vast majority of the pro-growth provisions in the 2001 tax cut do not take effect until 2004, 2006 and 2010. It is preposterous to say supply-side tax cuts do not work when they have yet to take effect. Repeal of the death tax, meanwhile, will not occur until 2010.

* Myth #2: Tax cuts are driving interest rates higher by increasing the budget deficit.

Fact: Fiscal policy has shifted from large surpluses to large deficits, yet interest rates have dropped dramatically.

In 2000, the federal government had a record budget surplus of $236 billion dollars. The same year, the average interest rate on 10-year government bonds was 6.03 percent, according to the Federal Reserve Board.

According to the latest projections, the budget will have a $157 billion deficit in 2002, a shift of nearly $400 billion. But instead of rising, as tax cut critics argue should have happened, interest rates have declined. The Federal Reserve Board reported that the 10-year government bond rate in August was only 4.26 percent.

Fact: Tax-rate reductions mean investors can achieve a desired rate-of-return at a lower rate of interest.

High tax burdens drive up interest rates because investors require a higher return to compensate them for the money taken by government. This relationship is clearly seen by examining the difference between interest rates charged on tax-free municipal bonds and interest rates charged on taxable government bonds.

* Myth #3: Fiscal discipline requires a balanced budget.

Fact: Limiting government is the best way to demonstrate fiscal discipline. Special-interest groups seek to obtain unearned wealth by convincing politicians to give them other people's money. Resisting these demands is the correct way to demonstrate fiscal discipline.

It is not a sign of fiscal discipline, by contrast, for politicians to impose high tax burdens in order to fund excessive spending. Many European nations maintain this version of fiscal balance, for instance, and tax burdens sometimes consume 50 percent of economic output.

These nations inevitably suffer from sluggish growth and high unemployment. Nations that limit the size and growth of government, by contrast, enjoy more growth and create more jobs, regardless of whether their budgets are balanced.

Fact: Tax-rate reductions help control the growth of federal spending. The shift from budget deficits to budget surpluses in 1998 significantly undermined fiscal discipline.

Budget surpluses were viewed as extra money and lawmakers dramatically increased the growth rate of federal spending. Indeed, federal spending has grown about twice as fast in the four years since 1998 as it did in the four years prior.

This is one of the best - albeit unintended - consequences of the Bush tax cut. It took money out of Washington so it would not be used to fuel even bigger increases in government.

* Myth #4: The bush tax cuts caused the deficit.

Fact: The weak economy is the main reason the deficit has reappeared.

According to Congressional Budget Office figures, lower tax revenues from the tax cut account for just 8 percent of the change in fiscal balance. The vast majority of the change is due to the economy's sluggish performance and forecasting errors - much as the budget surpluses of the late 1990s were caused by strong economic growth. Spending increases, primarily for domestic programs, also has contributed to deficits.

Fact: The economy drives the budget, not the other way around.

Fiscal balance should not be the goal of fiscal policy. Instead, lawmakers should control the size of government and lower tax rates. These policies will boost growth by leaving more resources in the productive sector of the economy and giving people greater reason to work, save and invest. As a result, the amount of taxable income will increase and government will collect additional revenue.

Daniel J. Mitchell is a Heritage Foundation senior fellow in political economy.

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy

Related Issues: Taxes

Originally appeared in The New York Post