From Larry Summers to Alan Blinder to Paul Krugman to Laura Tyson, all the liberal economists oppose George W. Bush’s tax cuts. Instead, they want Alan Greenspan to fix the broken Clinton economy by pumping up the money supply. Sort of a Keynesian version of monetarism: Let the government planners at the Fed take charge, not those crazy-assed Laffer Curve supply siders.
It takes too long to implement tax cuts, the liberals tell us. Congress will never pass them in time to fight recession. And anyway, big tax cuts will bring back those awful Reagan deficits that gave us the worst economy since the Depression. (Those awful Reagan tax cuts, by the way, turned 15 years of stagflation into 4% economic growth, generating more than 20 million new jobs with falling inflation and interest rates along the way.)
But the liberals have one thing right. The Bush tax-cut plan will be the political issue of the new millennium. It’s good that the battle lines are being drawn. It will be hammer and tongs, good vs. evil, light vs. darkness. If W. folds on this one, both he and the Republican party will go down — faster than water cascading down a mountain. 2004 will be a disaster.
“For Bush, genetically, it’s a huge deal to keep his promise,” supply-side founder Arthur Laffer told me. “He cannot compromise one inch.”
In a perverse way, it may be just as well that the economy and the stock market are tanking at the end of Clinton’s watch. This sets the stage for the tax-cut battle royale.
Little Gene Sperling, a Clinton economic adviser, tried hard to pin the downturn on Bush by accusing the Texan of talking down the economy and thus damaging confidence. Nice try Gene. But Alan Greenspan just blew Sperling and his goofy argument right out of the water. The Fed completely turned tail and reversed course by acknowledging that recession, not inflation, is the big U.S. economic problem. They took the nearly unprecedented move of dropping their key Fed-funds policy target rate by one-half of a percentage point in between the regularly scheduled Fed meetings. So, even Greenspan admits that the Clinton prosperity is over.
Their whole budget-surplus model of economic growth has fallen apart — not that it had much legs anyway. Huge surpluses were built on record personal tax payments, and this transfer of resources from private hands to government coffers has created fiscal drag that badly undermined economic growth. Meanwhile, as after-tax incomes slumped, personal saving has collapsed. Add to that the energy shock, itself a function of the Clinton failure to deal with OPEC from strength, and the economy has been weighed down even more.
Clintonian regulation of the high-tech frontier, including the attack on Microsoft, and the spate of midnight regulations imposed by executive decree in the last days of the Clinton White House, have also played a negative role. The regulations impose huge business costs that — if left unturned — would continue to pull down profits and growth, Carterlike, as far as the eye can see. In sum, the Clinton policies of rising tax burdens, high interest rates and re-regulation is responsible for the sinking stock market and the slumping economy.
It’s a good thing that the Fed has finally come to their senses that the root-canal policy of liquidity deflation was doing great harm to the technology-driven prosperity wave. However, while the Fed can produce more money, they cannot produce more goods or investment or risk taking. Those supply factors can only be generated through private-sector enterprise. But it must pay — after-tax — to work, produce, invest and take risks. What the sagging economy needs is a fresh round of economic reward incentives to replace lost purchasing power from the cycle of tax-bracket creep that is punishing successful wage earners.
Many years ago, supply-sider Laffer taught us that if something is taxed we get less of it. But if we tax things less, we get more of it. The most efficient and fair way of reducing tax burdens is precisely the sort of across-the-board reduction in marginal tax rates offered by President-elect Bush. What’s more, economic recovery will come faster through tax cuts than through monetary pump priming. If, for example, Washington could button down a big tax-cut package by spring, and make the tax cuts retroactive to January 1, then the IRS will immediately lower withholding rates, and after-tax take-home pay for work and investment purposes would rise immediately. The full effect of monetary stimulus, however, will take at least six months, and might even extend to 18 months, depending how quickly the Fed expands the monetary base and persuades people not to defer spending decisions until lower financing costs kick in.
Remember, inflation is defined as too much money chasing too few goods — a process that devalues the currency and taxes the buying power of money. If high marginal tax rates depress the output of goods, and the Fed floods the economy with new money, we will be left with the same stagflation that occurred in the 1970s when liberal Keynesian thinkers in both political parties were dominant. If, on the other hand, lower tax rates are implemented at the same time the Fed loosens money, then individuals will have the necessary liquidity to put new economic incentives to work. More rapid growth will absorb the money supply and non-inflationary prosperity will resume. Lower tax rates to stimulate growth and greater liquidity to prevent deflation is exactly the right policy mix.
If Mr. Bush is of a mind to adjust his tax plan, he should include a drop in the corporate tax rate, which will allow business to produce and invest at a greater pace. But any shrinkage of the tax plan will have serious economic and political consequences. Too clever-by-one ideas, such as dropping the bottom rate from 15% to 10% this year and deferring to next year the top-rate reduction to 33% from 40%, would be an economic and political defeat of the first rank.
So far, Bush has held firm on his tax plan. And key Democrats such as Richard Gephardt are now moving in his direction. The political force is with Bush. He carried three-fifths of the states and 78% of the counties in the recent election, thereby giving him more political clout in Congress than nearly all political observers recognize. If Bush stands tall in the saddle in the next few weeks and months, he will not only revive the economy, but he will also lay the groundwork for a huge Republican sweep in 2002 and 2004.