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Watching O’Neill
He'll be a tax-cut ally — but there are concerns.


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Larry Kudlow

Treasury Secretary-designate Paul O’Neill didn’t do himself much good among economic conservatives in his confirmation hearing this week. Though, many of these folks are overreacting to a misleading front-page New York Times account where the reporter tried to make the case that O’Neill actually opposed Bush’s tax-cut program. Nothing could be further from the truth.

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The former Alcoa CEO made it clear that he completely supported Bush’s tax-cut program, and was strongly leaning towards accelerating it to a retroactive Jan. 1 effective date. “I don’t know why you wouldn’t want the tax cut now. . . . If we’re going to have a tax cut, do it now and get ready for the next round of expansion, ” O’Neill told the Senate Finance Committee. He also argued that “there’s no reason not to give the taxpayers back some of their money.”

In the course of his three-hour hearing, the former Ford OMB official argued strongly for free trade and a strong dollar. He also showed his free-market instincts by describing Gov. Gray Davis’s handling of the California energy crisis as “lunacy.” And he revealed his strong tax-reform and simplification preference by calling the current U.S. tax code “not worthy of advanced society.” What’s more, O’Neill left the door open for a repeal of the punitive alternative minimum tax, which is expected to reach down into middle-class taxpayer incomes in the near future. The Treasury man also repeated his long-held view that the corporate tax needs a thorough overhaul.

However, he made several other statements that are sticking in supply-side craws. For one thing, he seemed to infer that business people do not respond to lower tax-rate incentives. “I never made an investment decision based on the tax code,” he said.

Now, he could be referring to special-interest corporate loopholes, which surely should be abolished in favor of broad-based business-tax rate relief. But if O’Neill believes that the tax cost of capital plays no role in economic decisions, then he is clearly wrong. After-tax capital returns, as an inducement to business investment, are a well-established notion in economic literature today — even in the precincts of the People’s Republics of Cambridge and New Haven.

These points came up in Friday’s Inaugural Conference, sponsored by the the Club for Growth, where they also discussed O’Neill’s dusting off of a proposed cut in the capital-gains tax. In his testimony, he didn’t exactly rule it out — but he did seem to give it the back of his hand. Enron chairman Ken Lay, a real Bush policy insider, told the group that O’Neill had already been chastised about this by Team Bush.

Also, veteran supply-siders were annoyed at O’Neill’s comments that the Federal Reserve was primarily responsible for recession fighting, not tax cuts. In truth, the economic point is that while the Fed can create plenty of new money, only an incentivized private sector can produce new goods and investments. Without new tax incentives there is always the 1970s inflation risk that the central bank prints too much money, while high marginal tax rates prevent the production of goods. Hence, too much money chasing too few goods would drive inflation and interest rates way up.

In fact, while I have no doubt that O’Neill is totally committed to Bush’s across-the-board call for lower tax rates, and that he would push for an even broader tax-reform and simplification package later on, he remains a demand-sider when it comes to economic thinking. O’Neill told the Senate committee that putting more money in people’s pockets would help reduce consumer debt. While this is certainly true, it really misses the key point that lower marginal tax rates provide better rewards for risk-taking and work effort.

All that said, I still believe O’Neill will be a dependable ally in the coming battle for tax cuts. Remember, George W. Bush is the ultimate quarterback, and while parts of the media continue to mistakingly portray Bush as an amiable airhead, the fact is the Texan is a stern CEO who will insist on supply-side free-market policies.



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