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A Taxing Dilemma
Straying from tax-cuts would be a huge mistake for the GOP.


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Larry Kudlow

For any number of reasons, the latest Republican Congressional leadership brainstorm to give up on tax cuts in next year’s budget, in return for a Clintonian deal that would use 90% of the budget surplus for debt reduction (the rest for spending), is a truly terrible idea.

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Naturally, the New York Times was quick to report this on its front page, calling it a Republican decision to desert George Bush’s broad-based tax-cut plan. The Congressional approach simply fuels the mainstream media’s tax-cut bashing of George Bush’s campaign, creating the false impression that only Gov. Bush and a few supply-side zealots are interested in across-the-board tax relief.

The political reality is much different.

In all the polls that have shown the Texan to be losing his August lead, Bush still comes out ahead on the tax-cut issue. The Zogby poll of likely voters shows Bush with a 5-point lead over Gore on tax cuts; the USA Today/CNN/Gallup poll gives Bush a lead on tax cuts; and the just-released Wall Street Journal/NBC poll shows Bush with a 43-35 lead on the issue.

The Rasmussen poll, meanwhile, shows Bush with a narrow lead on the tax-cut issue among all likely voters, but a 48-40 lead among those who think the issue is very important. And, by the way, tax cuts rate fifth in the poll’s list of “important issues.”

Congressional Republicans should shed their amnesia about their 1998 losses. When Newt Gingrich spoke from the well of the House in support of the grand fiscal compromise with President Clinton, he called the hard-line conservatives “perfectionists,” and ridiculed their opposition to the higher spending in this final deal. But it turned out that conservative Congressional opposition was apocryphal as the conservative Republican base stayed home that November. That led to a loss of 5 seats instead of the anticipated 12-15, off-year-election pickup.

This year’s prospective compromise with Clinton is shaping up to be an equally large election-year mistake. Discretionary spending totals are sure to come in 5-7% above last-year’s levels, which themselves were 5% above the original budget caps. So, with nothing to show for tax cuts but spending increases, the GOP debt-reduction cave-in is sure to be a political loser.

There could be some salvation left in the waning days of this legislative session if the proposal to expand IRAs and 401ks can be implemented. This would be a super connection with the investor class, and Senate Finance Chairman Bill Roth is working hard to salvage his own Senate reelection race as well as to provide new saving possibilities for the investor class.

But passage of this will require a compromise with President Clinton’s USA Savings entitlement plan, an approach that has strong disincentives for income-increasing work effort. In fact, moving above the $30,000 income level — which triggers a 3-to-1 matching government transfer payment — would generate a 50,000% marginal tax rate on the extra dollar earned.

Republican Congressional members would be better advised to go it alone on this savings expansion tax-cut plan, since so many Democrats are in favor of it. Conceivably this would be the only time the Congress overturns a Clinton veto. In any event, Congressional defeat on this Super Saver bill would be a plus for GOP House reelection efforts.

Another point. Pledging to turn 90% of next year’s surplus — which could total $300 billion — over to debt reduction gives up the economic growth message. Ironically, while poll after poll shows support for George Bush’s tax cut plan, the very same polls indicate that voters favor Gore over Bush in terms of the economy. And these self-same polls are revealing that the future of the economy is becoming the number-one issue in this presidential campaign. Well, the economy usually does rank first in national elections.

Sadly, Gov. Bush has failed to connect the dots between his plan to slash marginal tax rates and the positive economic growth effects that would follow.

Here’s some supply-side arithmetic on the link between lower tax rates and stronger economic growth. By dropping the top personal rate to 33% from 40%, upper-end taxpayers (Irving Kristol’s economic activists) would take home $0.67 on each extra dollar earned, rather that $0.60. That’s nearly a 12% incentive reward for working, saving, and investing.

Over the past 5 years, economic growth has averaged 4% annually. But a 12% incentive increase could raise GDP growth to 4.5% annually. In this scenario, the entire economy could double in 16 years. By 2016, inflation-adjusted economic growth could be $1.4 trillion higher than would otherwise be the case.

That otherwise-would-be-the-case scenario stems from the fact that Al Gore has no incentive-oriented tax cuts. In fact, Gore’s tax plan would affect only 40% of tax payers at most, would penalize a large chunk of that group if they successfully work to increase their incomes above means-tested targets, and would incorporate tax credits that are really IRS-administered spending programs, according to liberal analyst Robert McIntyre (it’s the first time I’ve ever agreed with him). According to the National Taxpayers Union, Gore’s entitlement spending binge will amount to $2.3 trillion, a real budget-buster and economy backbreaker.

Meanwhile, at an average tax rate of 25%, that $1.4 trillion increase in real GDP would generate a whopping $350 billion rise in tax revenues. So, as Arthur Laffer’s curve predicted many years ago, lower tax rates will generate additional tax revenues as the economy steadily expands.

George Bush should make this case in his upcoming debates with Al Gore, and he should start making this growth case right now on the campaign trail. Instead of spending all his time looking for $35,000 income-level individuals who may be unmarried and have no need for daycare or higher-education tax credits, Mr. Bush should be loudly proclaiming the prosperity-enhancing benefits of his tax plan. Then he should connect the dots between faster economic growth and a Social Security solution.

Lower marginal tax rates will increase saving and investment, and raise productivity. So, in the future, as the economy doubles, so will productivity. Then, as the system moves toward mid-century, two workers supporting one beneficiary will be as productive as three workers. And at the same time, Bush’s private retirement accounts will enable high stock-market returns to finance a growing portion of the Social Security system (much the same way bankrupt corporate pension plans in the 1980s were rescued by long-term stock market gains).

Moving from tax cuts to stronger economic growth to an ultimate Social Security solution is exactly the sort of economic logic that 21st Century information economy participants will understand and support. But the case has to be made. Twenty years ago Ronald Reagan made a case for tax cuts and economic growth. It worked. Media commentators love to say that Reagan won because he was a congenial fellow with an appealing smile. Sound familiar? Actually, he won because he had a hardheaded tax-cut plan that promoted economic growth and was well received by Republicans, independents, and Democrats.

George W. Bush has the same opportunity today, but he must make the case. And the GOP Congressional leadership should realize they are in the very same boat as Bush. A unified Republican growth message can pull this election out. But right now, Republicans appear to be snatching defeat form the jaws of victory. This doesn’t have to be.



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