May 1, 2003

May 1, 2003 | Commentary on Taxes

The Cost of Not Cutting Taxes

Can we afford a big tax cut right now?

That's what the arguments against the president's $726 billion proposal boil down to, really. The fact that we've been at war, that the economy remains sluggish, that we've returned to deficit spending -- all amount to a concern about price.

It would be a valid concern, too, if tax cuts simply extracted money from the economy. Then it would be a bad idea to slash our collective income just as our expenses were set to rise. It would make much more sense to go with $550 billion or $450 billion or $350 billion -- or whatever number congressional skeptics such as Sens. George Voinovich, R-Ohio, and Olympia Snowe, R-Maine, are currently embracing.

But that's not how tax cuts work. Properly constructed, they result in more jobs, more savings and more income.

Indeed, a tax cut that encourages long-term growth by making it cheaper for people to invest -- and eliminating the tax individuals pay on dividends would do that in spades -- is exactly what our fragile economy needs, even (perhaps especially) when there's a war to pay for.

Yet the dividend portion of the president's plan is just what congressional tax-cut opponents are targeting. Many would prefer a temporary, "fiscally responsible" tax cut instead. But that idea has already been found wanting: The $300 and $600 rebates mailed to taxpayers in 2001 were a sop to this way of thinking, and they did nothing to boost the economy.

We should never try to induce consumer spending at the expense of our long-term economic health. As the Congressional Budget Office noted in an analysis of the president's budget, encouraging higher government spending and private consumption hurts economic growth in the long term. By focusing instead on pro-growth tax cuts, lawmakers can ensure a quicker and smoother economic recovery.

A dividend tax cut is an excellent way to do this. It's why the $726 billion plan would lead to more business expansion and more jobs -- an annual average of 914,000 more jobs over the next five years, a recent Heritage Foundation analysis found. By contrast, a $350 billion tax cut would create about 362,000 new jobs annually. That's nothing to sneeze at, but why settle for generating only about one-third the number of new jobs we could get if we go with the original $726 billion package?

Tax-cut critics have one more ace up their sleeve, however -- deficits. Look at what happened when Congress enacted a big tax cut in the 1980s, they say. The budget was plunged into red ink because the 1981 cut drained federal revenues.

But facts sometimes have an inconvenient way of wrecking such tidy cause-and-effect arguments. Take a look at the revenue figures for the 1980s, and a different picture emerges. In 1980, the last year before the tax cut, the government took in $956 billion (in inflation-adjusted dollars). Did government revenues drop like a stone, per the hand-wringing predictions tax-cut opponents made then? On the contrary. In all but two of the next 10 years, revenues rose as much as $265 billion (and even in the two "off" years, they came close to matching it).

The real culprit behind the Great Deficit Mystery is government spending, which also rose in the 1980s. But try telling that to the critics, who still accuse tax-cut advocates of pushing "voodoo economics." They'd rather stick with short-term stimulus, it seems.

Yet it stands to reason that when individuals are faced with job and war uncertainties, providing them with one-time tax rebates will do little to change their outlook, and it's outlook that drives behavior -- how much people save, spend and invest. And that's true whether we're at war or not.


-Norbert Michel is a policy analyst in the Center for Data Analysis at The Heritage Foundation (www.heritage.org).

About the Author

Norbert J. Michel, Ph.D. Research Fellow in Financial Regulations
Thomas A. Roe Institute for Economic Policy Studies

Related Issues: Taxes

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