The Heritage Foundation

Lecture #655 on Taxes

February 8, 2000

February 8, 2000 | Lecture on Taxes

Why the Case for Tax Cuts is Failing (And What Should be Done About It)

MR. LINDBERG:

Good morning, ladies and gentlemen. Welcome to the Heritage Foundation. I am Tod Lindberg, the editor of Policy Review magazine. We are here this morning to talk about tax cuts, why the case for tax cuts is failing, and what should be done about it.

We will not talk about whether tax cuts are a good or bad thing. We will not talk about whether a particular type of tax cut is better or worse than another type of tax cut. We are going to talk about the political case for--or against--tax cuts and the difficulty that people who favor tax cuts are having, at present, in making that political case.

I suppose the occasion for this panel, a very distinguished panel it is, is an article written by Bruce Bartlett that appeared in Policy Review, called "The Trouble With Tax Cuts." It is available on the Policy Review Web site, www.policyreview.com.  I would encourage you to visit the Web site if you have not already. You will find a complete posting of all back issues as well as selected soon-to-be classics from the current issue.

Bruce Bartlett is a nationally syndicated columnist with Creators Syndicate. He is a Senior Fellow with the National Center for Policy Analysis, a graduate of Rutgers University, and has a master's degree from Georgetown.

Stan Collender is senior vice president for Fleishman-Hillard and the managing director of its Federal Budget Consulting Group. He is one of a very small number of people who have worked for both the House and Senate budget committees.

Before joining Fleishman-Hillard, Mr. Collender was director of Federal Budget Policy for two major international accounting firms, Price-Waterhouse and Touche-Ross. Mr. Collender holds a master's degree in public policy from the University of California, and a B.A. from New York University.

Our third speaker this morning is Grover G. Norquist, president of Americans for Tax Reform. He served on the National Commission on Restructuring the Internal Revenue Service and writes the monthly politics column for The American Spectator. He has a B.A. and M.B.A. from Harvard University.

Without further ado, let me turn to Bruce Bartlett and give him the floor.

MR. BARTLETT:

Thank you very much. I became motivated to write this article after an observation I have had for some time by just looking at the poll data. The observation was people simply do not rank tax cuts very high on their list of priorities.

In every single published poll from 1997, 1998, and 1999 that I have gone through, it is with absolute consistency that tax cuts are not the biggest priority. When you ask people what their top priority is or what their top priorities are with government, tax cuts always come in, at best, third or fourth.

I just got a poll the other day that reinforces this point even more. It is the 15th Annual Heritage Foundation poll of its own members. These are people who give money to the Heritage Foundation. In a poll of 2,000 of these people, they asked, what are the three domestic policy issues you believe are most important for the Heritage Foundation to focus on? Tax reform is the only tax issue and it came in at number four. Therefore, if you can't get the Heritage Foundation's own contributors to rank tax reform and tax cuts higher than fourth, clearly something is going on in the electorate that we need to think about.

The immediate motivation to write the article was the debacle of the 1999 tax bill, which I view as one of the most incompetently done tax bills in the history of the United States, bordering on irresponsibility. I say that not because of the substance of the bill, which was no better or worse than the 1997 bill, but because of the way it was done.

If you recall, the bill emerged out of nowhere, as if by immaculate conception. Representative Bill Archer (R-TX), who had no prior hearings on the subjects, offered no details about what, if anything, might be in the tax bill. All of a sudden, poof, it just came out of nowhere, and three days later it passed out of the Ways and Means Committee without even a single day of hearings.

Even in the middle of World War II, when the government was desperate for revenue to pay for the military, they took the time to have some hearings and bring in some experts--the experts were the assistant secretary of the Treasury for Tax Policy and the director of the Joint Tax Committee--if only to point out obvious mistakes. Today, they have to have a Technical Corrections Act for every single major tax bill, to fix all the mistakes. The 1999 bill, however, passed out of the House two weeks later and out of the Senate three weeks later, and then was sent to the President for its expected veto.

I thought, what conceivable rationale could there be for ramming through a big tax bill like this without doing anything whatsoever to explain to people what it contains? Why it is necessary. Why would it be good for the country? What are its provisions? Or how would they operate? The only conceivable explanation I could come up with is that in the view of the congressional leadership, people are so desperate for tax cuts, they are like people dying of thirst in the desert; they will drink anything. They just throw them the slop and say, here, this is what you want, vote for us.

It didn't work. These guys went back in August and they found absolutely--not to my surprise--no support whatsoever for this tax bill. They dropped the whole thing. It seems to me that part of what needs to be done is to rethink the whole dynamic of tax cuts. We need to get away from the notion that is, I think, left over from the tax revolt days of the late '70s: Proposition 13, Kemp-Roth, and things like that. There needs to be a more sophisticated job of figuring out what people want and marketing it, of designing a tax package that is not only good for the economy, but good politically. Because the way they are doing this is just ridiculous.

I put forward a couple of theories in my paper. These theories are really just speculation as to why people may not be particularly concerned about tax cuts right now. One idea is that the increase in people's wealth through the stock market is increasing their implicit income so that they don't feel that the taxes they are paying are a very high percentage of the total resources that they have available to themselves. Most people's financial wealth is in tax-exempt accounts, such as 401(k)s, 403(b)s, IRAs, and the like, or they have it in the form of stock options that are unrealized and therefore not taxed. They are not paying any taxes at all, currently, on the increase in their stock market wealth and so for this reason they don't feel that taxes are particularly onerous.

Another fact that I think we simply have to deal with is the change in the tax structure. The fact is that all the stuff that the supply-siders said about the rich paying more taxes has worked. We cut the tax rates and the rich are paying more. The top 10 percent of taxpayers are now paying over 60 percent of federal income taxes. If the rich are paying more, that means that everybody else is paying less. In fact, the average tax rate has fallen, especially for people of low and moderate incomes.

At the same time, the rich, even though they are paying higher average rates, are actually paying lower marginal rates. They are paying less on each additional dollar they earn, which is the really significant tax rate for economic purposes. Basically, we have done exactly what the textbook said you should do if you want to increase output. Increase the average rate and you will lower the marginal tax rate. Go back and you can even read liberal guys, like Richard Musgrave, who wrote this in their textbooks 30 or 40 years ago.

I believe one of the things that can be seen in the polls is that there is significant support for paying down the national debt. I thought about why this might be the case because it seems kind of a silly idea to me, personally. However, people seem to like it, and I have tried to think about why. There is a theory among economists called the Ricardian Equivalence, which basically says that deficits do not stimulate the economy as the Keynesian theory suggests because people think of deficits as implicit taxes or as future taxes that they will have to pay in order to pay off the debt. They increase their saving when the deficit goes up, basically offsetting the stimulus. If that theory is valid, then the converse has to be true. Budget surpluses are equivalent to tax cuts because people are looking toward the future; they see that there is less need for debt service and they will be able to get tax cuts in the future. The theory holds quite well when you look at the data, which show that as the deficit has turned into a surplus, the savings rate has collapsed, exactly as the theory predicts. Another explanation for why tax cuts may not be doing as well is that part of the tax cut coalition has joined this pay-off-the-debt coalition, and if you put those two categories together, they dwarf everything else in the polls. Tax cuts plus paying off the debt is by far the highest priority to the vast majority of people. Very small numbers, relatively speaking, want to spend additional money for anything, even Social Security or Medicare. Consequently, it may be that there is sort of a misperception here in terms of how people perceive tax cuts.

The last thing I believe is extremely important is voter distrust of people who promise tax cuts. We all remember when President Bush said, "Read my lips, no new taxes." He violated the pledge and he was thrown out of office for that reason.

Bill Clinton ran against Bush saying he was going to give a middle-class tax cut. That tax cut turned into a tax increase. We have seen this before. As a consequence, the polls show that 90 percent of the people do not believe any politician who says he is in favor of tax cuts. There is an element of credibility here that I think is a problem.

People simply don't believe the politicians. They think this rhetoric is a promise that will never be accomplished and that politicians are just trying to buy their votes without ever giving them anything in return. Until there is some element of credibility restored, I think you are going to have a problem with tax cuts.

MR. LINDBERG: Thanks, Bruce. Stan?

MR. COLLENDER:

Thank you. I found much of what Bruce said to be extremely interesting and very provocative. He seemed to be fighting with himself to find the answer that was right in front of him.

Take one quick step back. Ronald Reagan came to office in 1980, not just promising tax cuts, but saying that tax cuts were important and necessary because the average family was having trouble making ends meet. In fact, if you look back at the economic situation back in the late '70s, that was exactly the case. For those of you who don't remember the pain that was going on, unemployment was around 9 percent. Much more important, inflation was high. Interest rates were extremely high. The average family was having trouble making ends meet.

To the extent that people could get or afford mortgages, they were finding that their adjustable rate mortgages were adjusting upward by the full amount. They were finding that their houses were no longer affordable without making cutbacks on the other things, or the house they wanted was not affordable without substantially cutting back on their lifestyle or making other changes that they just didn't want to make.

Under those circumstances--especially with the cost of daily living being more expensive because of inflation, and with the concern about unemployment being very high because the rate was close to 10 percent at the time--the party coming in offering additional cash per month because of a tax cut was very attractive to the average person and, in fact, very much needed. Under those circumstances, offering somebody $50 to $100 a month in additional cash because the government cut back on what it was providing, without, by the way, cutting back on services, as candidate Reagan, then President Reagan suggested was possible, was extremely doable. It meant there was additional cash being given to you.

Fast forward to today and you find a very, very different economic situation. Inflation is negligible, interest rates, while rising in the last six to nine months, are still fairly low. Unemployment is at 4.1 percent and holding steady. In fact, anybody who wants a job essentially can get one by this afternoon. Has anybody gone past any storefront in any city and not seen a sign that says, "Help Wanted Desperately"? You know, don't bother to fill out an application; just walk in the door. By the way, let me add one other thing: Until six or nine months ago, even gasoline prices were down substantially, so that for the average person buying gas, they were saving $5 a month or $5 a week, depending on how much they drove.

Under those circumstances, a tax cut, as Bruce suggested, probably isn't valued very highly and isn't as necessary as it was 20 years ago. As a result, it wouldn't be surprising under those circumstances to find less support for it, especially when you consider that the average tax cut, in terms of cash in a taxpayer's hand, is not that much money.

We talked last year about $792 billion, but that had to be spread out over ten years to make it look like it was relatively substantial. In the 1980s we talked about tax cuts of five years for the most part because at that point we were talking about what seemed to be real money.

Let me suggest that everything you have in the article is correct, you just didn't take it to the next step. The economy has changed rather substantially from 20 years ago. Under those circumstances, politics has also changed rather substantially from 20 years ago.

What was remarkably popular and right on target and right for the time in the late '70s and early '80s is not as correct today. Saying this very carefully, a small, timid tax cut that doesn't provide that much cash in the average taxpayer's hands on a monthly basis isn't as good as lower interest rates which taxpayers perceive as much more valuable if they can refinance a home mortgage. Home ownership is now at its highest level. Sixty-seven percent of all families currently own homes. They can save more per month by refinancing a mortgage over the next year than if given the tax cut that Congress offered last year.

For those folks who hear the well-respected chairman of the Federal Reserve saying something to the effect, you know what, I would prefer that you just pay down the debt. Whether it is correct or not, the perception is out there that paying down the debt would put some downward pressure on interest rates, which helps with home buying and refinancing. Under those circumstances, for the average person, it is better to pay down the debt than it is to get a tax cut. Putting a little extra money into education or the environment or health care, compared to $50, $60, $75, or even $100 a month in a tax cut that they might or might not get from Washington, becomes a much, much better alternative.

Let me state right up front that if it is a question of tax cuts versus nothing else, tax cuts will always win. If, however, it is a case, as it is now, of tax cuts versus perceived benefits from other things, tax cuts will not always win. There never really was a philosophical preference for tax cuts, as I think people assumed from the late 1970s on. Instead, the preference was, what is going to put more money in my pocket. This implies a couple of things. I think it gets directly to Bruce's bottom-line question: How do we get tax cuts increasingly popular again?

First, the economic situation will have to be different than it is now. As interest rates and inflation rise again, and at some point I assume they will, a reduction in the amount of money that the government is taking will again become a newly popular or a "re-newly" popular political issue.

Second, the tax cuts that could be offered right now, that would be increasingly popular, must be something different than what we have been told about. Although for budget reasons the $792 billion tax cut is difficult to do under the current rules, pay-as-you-go rules, et cetera, from a political standpoint, it is far too small and timid. It just doesn't offer people enough benefits. Therefore, the tax cuts that we are going to have to talk about to get renewed attention are going to have to be far different, far more creative, and probably far more valuable. Take the increasing number of families that own corporate stock, which is a big change from the Reagan years when it was below 20 percent; it is now approaching 50 percent. A far more valuable tax cut for the average person who is holding stock for retirement might be the elimination of the corporate income tax, something that you don't hear anyone talking about. The last time a politician mentioned it, even semi-seriously, was Ronald Reagan, who got skewered almost instantly. Ever since then it has not been brought up in polite company. The times have changed, and if a small, individual income tax cut is no longer politically popular because the amount it would provide is too small compared to the cost that it might create, then we need something bolder to justify taking a risk that people see.

To reiterate a basic, bottom-line point, the world is vastly different than it was 21 or 22 years ago. Simply coming up with a program that is trying to get Ronald Reagan elected, as it did 22 years ago, will no longer work in the current environment. Under those circumstances, it is not surprising that a tax cut isn't going to bring you a great deal of positive attention simply because it is put out there.

Bruce, what you said was exactly right. The most astounding thing that happened last year was Congress passed a tax cut and then decided not to send it to the White House because they felt they had to go home and sell it to the voters. Excuse me? An $800 billion, ten-year tax cut has to be sold? You knew it was in serious trouble before they even hit the sticks. Of course, if anything, that month off, when they were out trying to sell it not only didn't work, it probably failed miserably.

MR. LINDBERG: Thanks, Stan. Grover.

MR. NORQUIST:

I like Bruce's piece very much. I think it is very helpful in thinking through this challenge.

I will start by saying I am not terribly concerned by results of polling data from asking people, "Would you like a tax cut or would you like to save Social Security?" Just because you get low numbers for an amorphous tax cut that isn't specific and high numbers for saving Social Security, which isn't really on the table, is not too troublesome. That is not what they are going to do with the money if they don't give it to you in taxes.

We have seen similar numbers. We all went to high school and we all know what the right answer is. When the press talks about something for four weeks and then they call you on the phone and ask you a question, you know what the right answer is. The answer isn't to be for a tax cut--it's education. Every seven months they get all excited about drugs, and then drugs become the number one issue in America, then disappear, and then the press talks about it for a month and it becomes the number one issue again. That doesn't bother me too much. People are reasonably sane and know that Bill Clinton has the veto. Although they went to public school, many of them have figured out how the Constitution works and they know that just because the Republicans in the House pass a tax cut doesn't mean it is going to happen. They don't get terribly excited about it. I don't get terribly excited about it when we pass a tax cut that we know Clinton is going to veto.

I do think it is extremely helpful to pass tax reduction legislation. To be able to move it through the committees, through the House, through the Senate, through the conference committees and then pass it so that when you do get a different president, you can at least start there as what your tax cut looks like. That is now the floor of the next tax cut, and it also describes the shape of the next tax cut if we get a Republican president to go with the present House and Senate.

I think the more interesting question in judging where people are is how they actually behave in real votes. I think if you go through all the previous presidential elections: Reagan-Carter in 1980; Reagan won on a tax cut promise and Carter lost; in Reagan-Mondale, Mondale lost with the threat of a tax increase; in Bush-Dukakis, Bush won because he promised not to raise taxes, and, four years later, he lost because he had raised taxes and could not credibly argue differently. He was running against a Democrat who said he would cut middle-class taxes and then Dole had a history of being hostile to tax cuts. So even though he eventually picked up on Bruce's very good 15 percent across-the-board cut, it didn't have credibility.

Now, Clinton has come out for a tax cut. But he is lying; he doesn't really want a tax cut. It's an oddly shaped tax cut; hypocrisy is the tribute vice pays to virtue. When Clinton is doing all this polling he thinks the right answer is a tax cut. That tells us a lot because he spends a lot of money doing serious focus groups and polling as to what people think. I think it is a healthy sign when your enemies pretend to agree with you. We should never be fooled into thinking they agree with us, but it is nice that they lie in that way.

The statement Bruce made about the credibility factor is central; people tend to think that they are lied to by politicians, that people promise tax cuts and don't deliver them, so they are not going to get excited about the promise. How do you overcome that? The present governor of Virginia, Jim Gilmore, got up and said ten times a day, "I am going to get rid of the car tax. I am going to get rid of the car tax." What made it credible? The specificity of the tax made it credible. It was not a vague statement like "I am going to cut your taxes." It was, "I am going to get rid of this one tax, and you know what it is. By the way, I have said it so many times that if I fail to get rid of it I am really finished politically. My entire career and the rest of my life is based on my ability to get this done. Therefore, you may not like me, but you can trust that I am going to do everything to make that happen because I am finished if it doesn't happen."

Part of this issue of credibility is repetition. If people get up and talk about the same thing over and over and over again and really push it, it becomes more credible because people say, this person is gambling, or risking, his or her political career on the tax cut. I believe it. Whereas, if somebody just says it once in a speech, that person hasn't really made a commitment on cutting taxes.

This was seen in some of the initiatives around the country. Washington State had an initiative to abolish their car tax, but more important, to require a vote of the people to raise taxes at the state or local level. That won overwhelmingly, even though I think our team spent about $200,000 and their team spent $2 million.

Weyerhaeuser contributed money opposing us. Boeing contributed $90,000 against us. Microsoft was against us. Fisher Communications, which owns most of the media in the state, was against us. They ran free ads against us. But we won because there is credibility in a tax cut that is part of an initiative because you actually get to vote on it. You are not electing somebody and then counting on his or her promise to do something.

If we were losing on initiatives like that, I would be more concerned. But we are getting outspent ten to one and winning some. Watch Massachusetts this year. Governor Cellucci, along with the Taxpayers Movement, has joined up to put on the ballot a measure to cut the income tax across the board at 10 percent. I think it will pass, and, again, because of the credibility. You can actually go in and cast a real vote. That, I think, is more interesting than transient polling numbers.

I think I would disagree on the importance of the 1999 tax cut that the House and Senate passed, sent to Clinton, and he vetoed. We passed the abolition of the death tax in that bill. The politics of hate and envy, the Gephardts of the world, didn't get up and scream. This was partly because somebody showed them that about 48 percent of Americans now own shares of stock and a whole bunch of people think the death tax is going to apply to them or their kids or their parents. But that is a huge step forward politically in undermining the politics of envy and hatred that the Left has been operating on for the last 2000 years.

I think it is very healthy that we were able to pass that. When you get a new president--I hope we'll elect a Republican president in the year 2000--you only really get to pass in your first year those things that have already been moved through the process, that went through the committees, that went through the hearings or "non-hearings," that got voted on by the House and Senate, because people have voted on it once.

Whether it is Bush or Forbes or whoever, the tax bill that gets passed in the first six months of the next administration is going to look an awful lot like the one that was passed this summer, because that is what we know the Congress will do: expanding 401(k)s, getting rid of the death tax, and having some across-the-board reductions.

I think it was wise of the Republicans to pass the tax bill--to let the American people know where they are and then take it off the table. If they had gone into the final budget negotiations with Clinton with it on the table, Clinton would have made you pay for some small piece of it with huge amounts of spending.

We just took the tax issue off the table. We said, we will get a Republican president. We will pass the tax bill. Now we go out and negotiate a better spending bill than we certainly got in 1997 or 1998, where huge concessions were made on the spending side. I think we should try to avoid those type of concessions.

I want to give a couple of thoughts on strategies for the future. One, I think limits like in Washington State are very healthy, requiring a vote of the people to raise taxes in the future. These initiatives have had great success. A number of states require a two-thirds supermajority to raise taxes. Nevada just passed this recently. South Dakota makes it tougher to raise taxes. They get support from people. They do reasonably well at the polls.

Second, I want to mention what Governor John Engler did. He passed a tax cut that will phase out the Universal Business Tax over the next 23 years. The tax cut comes to like one-tenth of a point every year. You look at 23 years, what is that? This is a dum-dum tax cut. If it goes in small and comes out big, like dum-dum bullets, I think that those kind of tax cuts are extremely helpful, and we ought to be thinking of more of them. That is what the Left does with spending programs. Oh, we have this little tiny spending program, and it only costs a little bit. Twenty-five years out, it is eating up huge quantities of the budget. We should pass tax cuts that also explode like dum-dum bullets.

Third, focusing on any effort that creates new taxes like the threat to tax the Internet. People are much more jealous in opposing tax increases than they are upset by present taxes that they have learned to live with. They may not like it, or whatever, but you can really get people excited about stopping new taxes or tax increases. I think we should spend much of our time on stopping the creation of any new tax. That is why I am spending a fair amount of my time trying to kill this idea that the governor of Utah has been pushing about taxing electronic commerce.

A fourth thought is term limits on tax hikes. I think we may be able to make the case for any tax increase or pass constitutional amendments like the two-thirds requirements to raise taxes that say, you want to raise taxes in Oklahoma? Fine, but any tax increase or new tax you pass sunsets in four years.

One of the challenges that we have is that politicians raise taxes infrequently, but they get to spend all the money each year. So, they don't vote for all of the taxes that bring in the money this year. The guys in the legislature never voted for any tax increase, but they get to spend all the money. So if we made them vote more regularly on the tax burdens that they impose, I think we would be better off.

Lastly, we need to explain what the Conservative Movement's goal is. For a long time a lot of us talked about the deficit as the problem when what we meant was deficit spending. Then the Left in the 1980s got smart and they said, "Oh, we are against deficits," meaning we are against tax cuts but for tax increases.

So the poor American people listen to the Republicans say, "We are against deficit spending," and the Left say that they are against deficits and somehow we are supposed to be disagreeing but we sure sound alike.

Now that we have ended the deficit and we are in a period of surplus, we are like the dog that caught the bus. Now what? Do we say to the Democrats, "Well, you said we couldn't have tax cuts because of the deficit? Now can we have our tax cuts?" The Democrats say, "No, no, we are against tax cuts now, too. We were lying when we said the reason we were against tax cuts was the deficit." Then the Democrats come to us and say, "Well, you said that we couldn't spend money because of the deficit, but the deficit is gone. Now can we spend the money?" We say, "No, we were lying when we said that was the reason. We are against the spending." So, you've got to at least sort out between Republicans and Democrats, Liberals and Conservatives, what our true positions are. We want smaller government. They want bigger government.

I think the clearer we are about that the better off the center-right coalition will be. Look, the federal government is 18.7 percent of GDP. Is it more next year or less? If it is more, we are losing. If it is less, we are winning. We ought to have a goal of reducing the total size and scope of government, federal, state and local, because those guys down at the state level have been spending like drunken sailors; they are worse than the federal guys. We shouldn't just keep our eye on Washington without recognizing that other people are trying to pick our pockets behind us. So what is the total size of government: federal, state, and local? If it is getting smaller, we are winning. If it is getting bigger, we are losing.

I think we ought to set goals. My personal choice is that in the next 25 years--one generation--we cut the total cost of government in half. I think that is doable. It at least lets you know where we are trying to get to, so we won't get sidetracked into questions of surpluses and deficits, when, as Milton Friedman taught us 30 years ago, it is the size of government, the total level of spending. That's the cost of government, not this deficit which is the difference between two interesting numbers, which, by itself, is not an interesting number.

Bruce Bartlett is Senior Fellow at the National Center for Policy Analysis; Stanley Collender is Senior Vice President at Fleishman-Hillard; Grover Norquist is President of Americans for Tax Reform; Tod Lindberg is the Editor of Policy Review.