If you want to find a one-stop shop for all your answers to the Bush administration's view on tax cuts, look no further than the American Enterprise Institute. As Washington transforms into Austin on the Potomac, few institutions will have the kind of influence with President Bush as AEI, the think tank where incoming White House Budget Office Manager Larry Lindsey hung his hat, and the place second lady Lynne Cheney works. As host to panel discussions like "Does It Really Make Sense to Pay Off the National Debt (Using the Budget Surplus)," it's not very surprising that AEI falls on the supply-side theory of the tax cut debate.
AEI conservatives like Oxford-trained economist Diana Furchtgott-Roth, argue that tax cuts focused on the upper-income brackets are the best prescription for an ailing economy because they create opportunities for investment and job creation by the individuals who are financially equipped to create new jobs or start new businesses. It's the classic trickle-down theory of tax cuts that drove Reaganomics and now, apparently, will form the theoretical heart of the Bush administration's fiscal policy.
As a former junior economist at the President's Council of Economic Advisors during the Reagan presidency, Furchtgott-Roth is quite familiar with supply-side economics -- and the similarities between the current Bush tax-cut plan and its philosophical predecessor, the 1981 Reagan plan.
There appears to be growing public support for the supply side school of tax cuts. As Nicholas Lemann astutely observes in this week's New Yorker, exit polls taken in November indicate that voters overwhelmingly support the kind of across-the-board tax cuts promoted by the supply-siders and the Bush administration, even though voters know that these types of cuts tend to favor the rich. That, combined with Fed Chairman Alan Greenspan's dire warnings about the tanking economy, is creating an atmosphere that will undoubtedly make it easier for President Bush to hustle a major tax cut on Capitol Hill.
Even Bush's biggest Democratic critics on the Hill are backing up Greenspan's call for a tax cut. The question is not whether or not it's time for a tax cut, but rather how large, and what kind of tax cut it should be.
Democratic critics look back at the massive 1981 tax cut and the hundreds of billions of dollars in budget deficits that ensued and are keen to remind us that it took 15 years to undo the damage of Reaganomics. A more cynical theory is that Bush's tax plan is a wolf in sheep's clothing -- that he's trying to bankrupt Congress in order to make it easier to shift responsibility for social programs to faith-based organizations, education to private schools through proposed voucher programs and to drum up support for privatizing Social Security through the use of private investment savings accounts.
But the supply-siders see it differently. In 1981, we were roiled by recession and just coming off the tail end of an energy crisis. Spending by the Democrat-controlled Congress was spiraling out of control, inflation and tax rates were increasing, and something had to be done to stop it. So Reagan pushed through his 1981 tax package, which was scheduled to cut $455 billion in tax revenues between 1981-85. Problem is, the cuts resulted in a steep increase in the federal deficit; and within the first year of passage, Reagan was already having to increase tax rates.
Times are different now, say the supply-siders. We don't have a budget deficit any longer, and there's no need for surplus cash reserves. Surpluses encourage pork and greed in Congress -- a political evil that is viewed by conservatives the same way soft money is seen by reformers like Sen. John McCain. Surplus cash doesn't belong in Washington's coffers -- it belongs in the hands of the taxpayers and the businesses that drive the economy. And that, they argue, is what Bush's tax plan will do.
In a recent interview with Salon, AEI's Furchtgott-Roth offered a spirited defense of the Bush tax cut proposal and argued that the risk of not offering a tax cut is far greater than the risk that such a cut would entail.
The tax cut proposal submitted by President Bush relies on surplus projections that may never materialize. The surplus projection they're using is $5.6 trillion. But if you take out the Social Security and Medicare trust money that's popular with both Democrats and Republicans, it's down to $2.1 to $2.3 trillion. Bush's proposal would really be at least $2 trillion, because it increases the interest we have to pay on the federal debt, because we're not paying it down as fast. So basically you spend the whole tax surplus -- and that's a projected surplus. How can we even be sure it will materialize?
What they're looking at is a projection of 3 percent growth over a 10-year period, which is very reasonable, even if the current quarter were to be zero. The historical average is about 2.7 percent growth for the past 60 years. It's been higher over the past 10-to-20 years. Even if one quarter is zero, there are others that are as high as 5 or 6 percent. There are different macroeconomic and global factors that increase or decrease economic growth. It's not just the interest rate cut.
I think the forecast figures for the next 10 years are very reasonable. It's possible that they err on the side of caution. In the past 10 years, you've had a much higher average growth rate, and there's no reason to see that slowing down.
In an editorial in the New York Times last weekend, former Treasury Secretary Robert Rubin said there's also a threat that between the tax cut, Social Security, Medicare and new programs proposed by President Bush like the missile defense and the popular prescription drug benefit, we could be pushed into a deficit.
It's very difficult to forecast levels of these expenditures. We've been surprised at the high levels of tax revenues during the past four years. Even though it might be possible that the Social Security and Medicare numbers would come in higher, tax revenues might come in higher also. This whole forecasting business is a black box. Economists think they know more than they do.
But what if the tax cut does eliminate the surplus and we run into deficit problems. Won't there be a risk of cutting social programs? And won't it be politically difficult to raise taxes again once you've made a dramatic cut?
We have never eliminated any government spending or entitlement programs as a result of tax cuts. On the other hand, we have raised and lowered taxes frequently over the past 20 years. In 1981, we lowered taxes. We raised them again in 1982. We restructured the tax system in 1986; we raised taxes in 1990, and we raised them again in 1993.
But that 1990 tax increase former President Bush promoted also helped lead to Clinton's victory in 1993.
Absolutely. Here Bush had made such a big deal of saying, "Read my lips: No new taxes." And then there was a tax and he was very badly advised. But it wasn't Bush's fault -- he was very badly advised by [then White House Budget Director] Richard Darman to sign this budget agreement that would raise taxes. You'll notice, by the way, that Darman has come nowhere near the new Bush administration. He hasn't been asked for advice; he hasn't appeared.
But wouldn't Bush's defeat suggest that raising taxes once you've cut them is, in fact, is a dangerous political strategy? Or was Bush just an exception?
In his convention speech, he got elected on the basis of not raising taxes. He made a promise that he wouldn't raise taxes. Clinton didn't do that. When he raised taxes, there weren't political consequences. The bottom 50 percent of taxpayers only pay 4 percent of the income taxes. And since the vast majority of Americans don't pay any federal income tax anymore, raising the taxes on, say, the top 5 percent, didn't have that much effect Clinton politically, which is why he got reelected in 1996. That 5 percent was certainly paying a lot more than their proportion.
Former Sen. Daniel Patrick Moynihan, looking back at Reagan, said the cuts were secretly a way to bankrupt the federal government and force social program cuts the Republicans didn't have the political muscle to push through -- absent a budget crisis. Isn't there an element of that now?
If Moynihan really said that that was Reagan's goal, then he was unsuccessful because no social program got cut. We have never cut any entitlement program -- certainly not in the Reagan years. They've only grown.
But Reagan did eliminate the Comprehensive Employment and Training Act, an important vocational and job training program.
It was replaced by the [Job Training and Partnership Act,] and it was replaced because it didn't work -- not because of any tax cut. In fact, what it was replaced with also hasn't worked particularly well. It just obviously wasn't having a beneficial effect on the people it was intended to help.
Clinton reformed welfare, executed conservative fiscal policy and most of his new program spending was on things like putting more teachers in the classroom and more cops on the street. If Bush has to cut that kind of government spending, it will be very unpopular with the masses. How will he avoid that outcome?
Federal spending on programs such as police officers and teachers is really taking over the role of the individual states that have a better sense of their needs in terms of allocating these resources. It's more efficient to have the states do it.
The teachers unions supported Clinton, and he asked for more teacher spending specifically to repay that part of his political constituency.
Surplus figures now show that you can give a tax cut without cutting spending -- that's what a surplus means. But part of what he's talking about is returning certain amounts of the funds to the states for them to spend as they want.
How can the proposed Bush tax cut help the middle class if the highest percentage of savings goes to the highest wage earners? In other words, how do supply-side theory tax cuts help people on the low-to-mid end of the wage scale?
Small businesses file under the individual tax system, and they're the ones who employ a lot of people in our economy. When their taxes go down, then they're encouraged to expand their businesses, increase their investments, open new businesses. That benefits the people they employ, plus their consumption goes up and that helps growth in employment and production.
Both the Reagan tax cut of 1981 and proposed Bush tax cut are based on theories of supply-side economics, so on the surface they seem very similar. How is Bush's tax cut any different from Reagan's?
They are similar in that both presidents wanted Congress to stop spending money. In Reagan's time, there was a deficit, and he thought that by cutting taxes he would discourage Congress from spending; and perhaps he did -- at least to a certain extent. There were all kinds of budget bills in the 1980s such as Gramm-Rudman-Hollings, for example, which were designed to put the brakes on growth on spending.
With George W. Bush's plan, it's more a question that the government is collecting more than it needs. Even Chairman Alan Greenspan has said that keeping the current surplus means that there would be too many private assets held in government hands. It's a question then of returning the money to taxpayers.
If we pay off all the government debt and the government still has a surplus, they'll have to do something with it. That's what Chairman Greenspan was concerned about if you read his testimony. He's looking at the CBO projections, and he's forecasting that the debt will be paid off in 2006. The question is what does the government do with that money?
Reagan's tax plan was beneficial to the middle class because it reduced rates overall. So does Bush's plan -- it reduces every single rate and it replaces the current system of rates with a lower system. It replaces 15, 28, 31, 33, 36 and 39 with 10, 15, 25 and 33.
Economists dispute whether or not a tax cut could have an immediate impact on the economy.
I believe it could have an immediate impact on the economy if it were a greater tax cut. Right now it's phased in. They might want to consider making it more immediate so that they would have more of an effect on the current economy. But it's difficult to measure the effects of a tax cut on the economy.
But people might also spend more money if they knew they had a tax cut coming, and that could make a difference.
Could front-loading the tax cut, as Bush has suggested he might do, help?
It comes more from adjusting the withdrawals so people wouldn't have as much withdrawn from their paychecks.
Earlier in this interview, you argued that in percentage terms, the tax cuts will have a bigger impact on the lower income margins. How can that be if, as you say, the bottom 50 percent only pay 4 percent of the taxes?
They'll get a bigger percentage cut. There are a lot of people at the bottom who would have their taxes completely eliminated, so that's a reduction of 100 percent. No one at the top would have all his taxes eliminated. So the reduction in percentage terms at the top are lower.
You've stated that you don't think Bush's proposed tax cut goes deep enough.
They should also alter the alternative minimum tax so that everyone can take advantage of the tax cut. Right now more people are going to be thrown into the alternative minimum tax. Individuals who pay too little tax have to file taxes under the second tax system -- and they get an add-on tax. Bush's reduction of marginal rates is going to lower the amount of taxes many Americans pay, but they won't be able to just keep the savings because they'll be subject to the alternative minimum tax. In order for people to get the full effect of the proposed cuts, the alternative minimum tax would have to be altered also.
How would you propose slicing up the surplus if the decision were in your hands?
One way of using the increased surplus would be as a transition to a private Social Security program. You could use it to keep the benefits for all the people over 50 so that they could stay in the program unchanged; and you could require people under 50 to put a certain amount of their money in a savings plan and a certain amount of their payroll tax could go to that.
Is the United States in a better position today for supply-side economic policies than it was in 1981, the year that Reaganomics was ushered in?
Our economy is far more efficient than it was in 1981. Remember, then we had just recovered from an energy crisis. Our economy is a lot more deregulated now. Our macroeconomic picture is much better. In 1981, we had huge unemployment rates, high inflation rates. The misery index was much higher. Now we have very low inflation -- about 2 percent. We have the lowest unemployment rate in 30 years -- 4 percent. Overall, we're in far, far better shape than we were in 1981.
Does that decrease the risks associated with a large-scale tax cut like the one proposed by Bush?
I don't think there are any risks for a large tax cut. The only risk we have is keeping too much of the surplus in government hands. If we have a tax cut and the surplus numbers start going down or the deficit numbers start going up -- whichever way you want to look at it -- then we can increase taxes again, which we've done a number of times in the past. The biggest risk is not having a tax cut rather than having a tax cut.