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 atching
the tax debate unfold on Capitol Hill you'd think Congress has been
infected with Mad Cow Disease. Both
the Republicans and Democrats seem to be trying to outdo each other
with dimwitted tax-cut proposals designed to help sturdy the economy,
but with almost no real stimulative effects and almost no chance
of reviving the moribund stock market.
A case in point: Last week, as the Dow Jones and the NASDAQ stock
markets continued to plunge into gloomy bearish territory, causing
almost all analysts to now concede that a recession is imminent,
the House Republicans voted to increase the child exemption from
$500 to $1,000 per kid. Will someone please tell these people that
while they dither, Rome is burning? A $500 tax credit for kids may
be good social policy to help families with kids pay their bills,
but it doesn't do squat for a limping economy that has seen net
worth fall by more than $2 trillion just since election day.
Meanwhile, Republican Sen. Pete Domenici of New Mexico called for
a $60 billion tax rebate this year. Domenici deserves praise for
at least calling for a lot more short-term tax relief than is contained
in the House-passed plan — which is so back-loaded that it
offers an insultingly small cut this year and next. But a tax-rebate
plan is the economic equivalent of flying a helicopter over Central
Park in New York and dumping dollar bills out the window as a way
to stimulate the economy. It's not going to work.
Equally baffling is the Democratic tax-cut alternative. That plan
calls for cutting the bottom tax rate from 15 to 10% right now.
Sen. Tom Daschle says that the logic here is to put hundreds of
dollars back into the pockets of the lowest income taxpayers so
they can rush out and spend to juice the economy.
Now admittedly the idea imbedded in both plans, which is that we
should take tens of billions of dollars out of the federal treasury
and give it back to workers, makes a lot of sense. And it can't
hurt the economy. But both these plans are about the worst possible
way to cut taxes if the goal is to restore prosperous times.
The problem — as I have been saying ad nauseum for two months
now — is that Capitol Hill is shackled to demand-side logic
on tax cuts. They find intellectual support from people like New
York Times columnist Paul Krugman, who writes that tax cuts
must stimulate consumer demand if they are to aid the economy.
But what's needed now is supply side incentivizing of tax-rate cuts
that reduce the tax penalty on economically productive behavior.
Supply-side tax cuts reduce tax rates in order to reward saving,
investment, and work.
Consider the idea of cutting the bottom tax rate. Imagine for a
moment that we had a tax system that taxed people at 15% for working
on Monday, 28% on Tuesday, 31% on Wednesday, 36% on Thursday, and
40% on Friday. (This simplistic model actually isn't too far from
the reality of our present-day graduated income tax-rate system!)
Now it stands to reason that a lot of people would quit working
on Fridays, or perhaps work until noon. In fact, even though the
tax rate is higher on Friday than on Monday, tax collections on
Monday could easily be higher than on Fridays. There would clearly
be less economic activity on Fridays than on Mondays.
Would it make any sense to cut the tax rate on Mondays, but not
the tax rate on Fridays? None whatsoever. That, however, in a nutshell
is the reigning tax-cut proposal on Capitol Hill. Cut the lowest
tax rate, but not the highest tax rate. Many Republicans, petrified
of claims of "tax cuts for the rich," wish to cut the lowest income
tax rate, but to delay cutting the highest rate. As I said, a clear
sign of Mad Cow Disease.
The rebate plan submitted by Sen. Pete Domenici is well intentioned,
but also off base. If you took the income tax structure as described
above, and tried to fix things by giving every family $50 a week,
they still may not work on Fridays any longer--in fact, with the
added give-away dollars in their pockets, they may choose to work
less on Fridays, not more.
Clearly, if the goal is to generate more economic output, you cut
the highest tax rate — i.e., the tax rate for working on Fridays.
Economist Arthur Laffer, who converted Ronald Reagan to supply side
economics 25 years ago, has argued that we should RAISE, not lower
the bottom tax rate, and then dramatically lower the top tax rate
in order to create a fairer and more uniform tax rate on every day
of the week.
The logic here leads us inexorably toward the tax ideal: a flat
rate tax system: One uniform low tax rate paid by everyone. To get
to a flat-rate tax, the top income tax rate has to come down a lot
— from 40% today, to perhaps 20 or 25% tomorrow. Lowering the
bottom rate only makes the tax-rate system steeper to climb.
The bottom line is this: There's almost no economic benefit to chopping
the lowest tax rate, but a world of benefit from chopping the top
rate as much and as soon as possible. The fiscal stimulus the economy
needs should come from shaving the top income tax rate from 40%
to 33% right now. That goes for the death tax too. Forget about
increasing the exemption. Cut the confiscatory 55% rate to reduce
the adverse incentive effects of this tax.
The economic logic here seems so straightforward that it should
be compelling, even to the herd of mad cows on Capitol Hill.
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