Voodoo economics: The sequel

Bush's vast tax cut will fatten the piggies in their starched white shirts and create huge deficits. But the spineless Democrats don't have the will to stop it.

Published January 8, 2003 8:30PM (EST)

On Monday afternoon, hours before the president unveiled his $674 billion tax-cut plan but after its details had already been widely reported, Grover Norquist, the head of the conservative group Americans for Tax Reform, practically shouted with joy during a telephone interview.

"It sails through the House," he predicted, "and every week that the Democrats [in the Senate] argue this they'll lose. And at the end of the day I think we win it."

Norquist, who is affable and boyishly enthusiastic when talking tax cuts, had every reason to be ecstatic. On Tuesday in Chicago, the president showed off his plan. It calls for the acceleration of cuts passed in 2001 as well as the institution of $3,000 "reemployment accounts" that out-of-work people can draw on while they look for a job. But the heart of the plan is a call for the elimination of taxes on income people receive in dividends paid out by stocks, a cut that the White House estimates will cost $364 billion. And according to the White House, the cut isn't just about stimulating the economy, it's about being fair.

"It's fair to tax a company's profits," said Bush. "It's not fair to double-tax by taxing the shareholder on the same profits. So today, for the good of our senior citizens, and to support capital formation across the land, I'm asking the United States Congress to abolish the double taxation of dividends."

The dividends tax cut has already been critiqued as a sellout to the wealthiest sectors of the United States. "This is so flagrant," said Kevin Phillips, author of "Wealth and Democracy: A Political History of the American Rich," in the New York Times on Tuesday. "It's not aimed at the little investor. It's aimed at the big investor and shrouded by a fog of phoniness. This isn't even trickle-down economics. It's mist-down economics."

It's also unlikely to have the kind of immediate effect that worried economy-watchers are clamoring for. By the White House's own calculation only about $98 billion of the tax cut will be provided during the first 16 months -- so it's disingenuous, critics say, to call the cut a short-term "stimulus" package. The cut is also permanent; it will lead to a long-term drop in national revenue, one that liberal economists say will cause disastrous budget effects in the future.

But Norquist predicts an easy political fight, and not only because Republicans control all the levers in Washington. Even if only the wealthiest Americans pay taxes on dividends, the Democrats, Norquist says, will have a hard time convincing people that the tax should stay.

"The Democrats will say only rich people benefit from this," Norquist says. "They'll call it a tax cut for the 'wrong' people. But Daschle and Pelosi are so old, they think that only rich people have stocks. Seventy percent of voters own shares of stock! Seventy percent! And the people who aren't in the market are young, and they plan to be. How will you convince 50 percent of the people to vote for you when you say to 70 percent of them, 'You don't deserve a tax cut because you are too rich'?"

Liberals acknowledge, and fear, that the Bush plan could be attractive to voters who've become worried about their swooning stock portfolios -- even if a hefty proportion of their shares are in tax-sheltered retirement accounts such as IRAs and 401Ks. The elimination of dividend taxes, they concede, may raise stock prices (though how much it will swell the markets, and for how long, and to what economic end, is a matter of fierce debate. The Dow ended up falling slightly on Tuesday).

But what's so brazen, if not very surprising, about the Bush plan is how closely it hews to long-term conservative goals; instead of prescribing minor medicine for a minor economic headache, the president calls for surgery. A host of Democratic lawmakers pointed that out on Tuesday. In a statement, Sen. Joe Lieberman of Connecticut, expected to run for president, called the plan an "irresponsible, ineffective, ideologically driven wish list that is oblivious to the particular problems our faltering economy is facing." Massachusetts Sen. John Kerry, also making an '04 bid, said that Bush was "largely ignoring the needs of the middle class" and "practicing bad economics and even worse ideological class warfare." (In a speech in December, however, Kerry also called for the elimination of the dividend tax.)

To many economists, Bush's plan makes no sense at all; they say it's neither equitable nor economically justifiable. The long-term effects on the budget may be especially pernicious, and liberals say it would be difficult, after the passage of the Bush plan, to think of Republicans as being the party of "fiscal responsibility." They're probably right. But their arguments aren't likely to carry the day, in a Republican-controlled Congress (unless the Democrats show some unexpected backbone, and resort to a time-honored Republican tactic from ages past: the filibuster). Remember the glory days of the Reagan-Bush years, when boosts in defense spending were coupled with tax cuts and resulted in trillion-dollar debt? Supply-side economics is back, with a vengeance.

On Monday, Democrats in the House put forth an economic package of their own. Their plan would provide a one-time, $300 income tax rebate check to every taxpayer, extend benefits to the unemployed, provide money to state governments, and includes a tax cut on business expenditures. The plan would cost $136 billion, much of it going out in the first year; there would be little cost after that. Several Democrats in the Senate have also offered budget plans of their own, all with a similar $100 billion to $200 billion price tag.

If the economy needs a "stimulus," says Joel Friedman, a fellow at the Center on Budget and Policy Priorities, a group that focuses on economic issues facing the poor and middle class, then the Democrats' plans are more likely to provide it. A package meant to give the economy a short-term boost ought to take immediate effect, it should "give money to people who are likely to spend it," and, Friedman said, "you want to make sure it doesn't worsen the long-term fiscal situation."

"The House Democrats' package gets close to those three," he said.

The president's plan -- which isn't immediate, isn't temporary, and isn't giving money to people likely to spend it -- would seem to violate those principles, and would seem like not much of a stimulus. Right?

"I guess that question is really getting to the heart of why Keynesian economics makes no sense and supply-side economics does," said Dan Mitchell, a conservative economist at the Heritage Foundation.

Mitchell says that there's nothing economically attractive about giving money to people to spend it. "Keynesians argue that you help the economy by putting money in people's pockets and they go to spend it -- but what they forget is, where does the government get the money in the first place? All you're doing is reducing investment spending and replacing it with consumer spending. I'm not sure how it gets you out of the game. All you're doing is altering the use of the income."

Mitchell calls this sort of policy, which is at the heart of many "stimulus" plans, the economic version of a "perpetual-motion machine." He acknowledges that it's an argument that people in the White House -- "who know better" -- make from time to time, and when they do it's as annoying, he says, "as fingernails being dragged across a chalkboard."

The reason Bush's plan is being criticized as ideological, Mitchell argues, is because the only tax policies that make any difference to an economy are fundamentally ideological arguments focusing on the question of what makes an economy grow. Mitchell believes that the right policy is one that makes people "work more, save more, and invest more," and people won't do this when they simply get a check from the government for $300. The only way people will change their behavior, he says, is if they see some incentive to do so -- and the incentive is a long-term, permanent tax cut.

A permanent tax cut leads to a permanent reduction in government revenue. Many people consider this a problem, but Dan Mitchell sees this as a kind of bonus. A tax cut that causes or prolongs government deficits can still be thought of as being "fiscally responsible," he said, because "reducing taxes is a way to control spending," and controlling spending reduces the size of government. Indeed, Mitchell said, the sort of government surpluses that were enjoyed under the Clinton administration could be thought of as not a very good thing. "A surplus is a very uninteresting number that measures the difference between two important numbers -- the size of the government and the size of the tax burden," he said. And often when there's a surplus, lawmakers want to spend money. "It's like putting blood in the water with hungry sharks."

When told about Mitchell's ideas, George von Furstenberg, an economist at Indiana University, said it was the stuff of a "programmatic" supply-sider with the idea of "cutting taxes rain or shine."

The dividend cut, he said, is "reckless" in the long term when one considers that the government is spending more on defense and healthcare. "We are looking at structural deficit of a quarter-billion a year, because if you have a permanent increase in spending built into the current political outlook, and you have a Congress, whether Republican or Democrat, that can't reduce nondefense spending, [then] you have a permanent increase in spending built into the system. And so that must have consequences on the tax side."

But what about the idea that reduced revenues will force lawmakers to shrink the size of government? "These are people who have said the same thing since the Reagan administration," he said. "And I say let the facts speak for themselves. Was it possible -- when the Republicans had a free hand in Congress -- was it possible to reduce nondefense spending anything like the rate of the increase in defense spending? These wonderful pipe dreams that you can force spending down, we heard that in the Reagan administration. And do you know what happened? In the reign of 'Bush I' we had $1 trillion added to the debt."

He predicts the new Bush tax cuts will usher in another such debt-ridden era a decade from now. "The Bush administration is now laying in store a policy that will ensure we'll be entering [the period of higher social costs for healthcare and social security] with a continued high deficit and a substantially higher amount of debt. That's unconscionable in my view. When they couple their ideas with highly naive ideas of politics, that's when supply-siders go astray."

But if conservatives are right about the effects of tax cuts -- that reducing taxes makes an economy grow -- then what's so bad about the deficits they create? Even if the government is in debt, wouldn't the economy as a whole be bigger and, therefore, wouldn't life be better for all of us?

The problem with that reasoning, say liberal economists, is that conservatives ignore the second effect of a tax cut -- it might raise future national income by making people work more or save more or take more economic risks, but it also lowers national income by reducing national savings, which "acts as a drag on the economy," according to William Gale, an economist at the Brookings Institution.

The contrasting effects of these two factors mean that any tax cut will have a small net result -- whether positive or negative -- on the economy. In a paper analyzing the effects of fiscal discipline, Gale cites four studies of Bush's 2001 tax cut. One says that it would have a positive effect on economic growth, three say that its effects would be negative -- but they all say the effect would be small either way.

But such an analysis doesn't appeal to conservatives; even if there's little or no evidence that a tax cut causes an economy to grow, it's always better to reduce the size of government, they say, and fairer to eliminate such horrors of the tax system as "double taxation."

In December, people close to the Bush administration were saying that the White House would likely call for a reduction in the dividend tax, not an elimination. News of the elimination came as a surprise to most people, and sent Monday's markets soaring.

Why did the administration change its mind -- why did it go so much further out? Because, says Norquist, "it is easier to sell an elimination than a reduction. The first is principle. The second is tinkering."

Heritage's Mitchell says much the same thing. "This you could only characterize as a political masterstroke. If you say you want a reduction, what does that sound like? A special preference for the president's rich friends. You can already hear the sound bites. On the other hand, if you say we're going to get rid of double taxation, you have an economic case but you also have a moral case. 'We're going to do this because we think it's the right thing to do.'

"Here's what was going on with people in the White House," Mitchell says, "because I've had some conversations with them. Five years ago when we talked about the elimination of the death tax everyone thought we were crazy. You're never going to sell it. It's never going to be a popular idea. But it was one of the most popular parts of the Bush tax cut. Why? Because Republicans were very successful in making it a moral argument. Should you be taxed for a second time? It completely cut the legs out from under class warriors."

By Farhad Manjoo

Farhad Manjoo is a Salon staff writer and the author of True Enough: Learning to Live in a Post-Fact Society.

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