The Common Good
May-June 2001

Who Doesn't Want a Tax Cut?

by Rebecca M. Blank | May-June 2001

Bush's plan looks like the 'gimme-mine' generation at it again.

President Bush argues that his proposed $1.6 trillion tax cut will be good for the economy and good for American families, as it will return current surpluses in the federal budget back to the American people rather than the government hoarding them. Is he right?

One alternative to a tax cut is for the federal government to use this money to continue to pay down the accumulated federal debt and reduce federal interest payments. That would almost surely create a healthier economy in the long run.

A second alternative is for the government to spend the money in another way. There are obviously major public needs in this country. Most pressing is the large demographic bulge of the baby boom, people who are going to be retiring over the next 30 years. Our current Social Security system is not able to fully pay its commitments to these citizens. Today's surpluses provide an opportunity to make our public pension system solvent in the long run.

Other needs—such as health insurance for low-income working families and prescription drug insurance for the elderly—are also good uses for the surplus. Why should the immediate consumer needs of American taxpayers be more important? Finally, these surpluses may be more illusory than we think. If the economy slows down, if the Bush administration and Congress increase spending, the surpluses could shrink fast. But the proposed tax cut will reduce government revenues permanently and could easily produce a reappearance of budget deficits.

Do we need this tax cut to stimulate the economy? It's pretty amazing to hear a Republican administration making this argument. Fiscal stimulus—using the federal budget to stimulate the economy—has been derided by the last four Republican presidents. While it's true that expanded federal spending can help boost economic growth when timed exactly right, fiscal stimulus has fallen into disuse precisely because it's rarely a well-timed tool. The proposed tax cuts are phased in over several years. If the stimulus hits after a slowdown and as the economy is expanding, it can fuel inflation and harm the expansion.

But maybe we need this tax cut to give tax relief to poor and low- income working families? For families with two children, there's no gain from this tax cut until their incomes exceed about 150 percent of the poverty line. The reason for this is good news—these families no longer pay income tax, largely because of recent expansions in the Earned Income Tax Credit. But it means that cutting income tax rates won't give poor families more money to spend.

The bulk of Bush's tax cut will benefit those with the highest incomes. The Center on Budget and Policy Priorities, a respected source of information on tax policy, estimates that the wealthiest 1 percent of families would receive between 36 and 43 percent of the tax cut dollars. The administration says that high-income families pay more in taxes so they should get more in tax relief. But high-income families almost surely don't need tax relief as much as lower income families. If we must have a tax cut, why not a multi-year reduction of $500 to $1,000 in everyone's tax bill? That provides a tax reduction for everyone but will reduce the share of total taxes owed by low-income families much more than among the rich.

Tax cuts are sometimes a good idea, and there are some groups in our society who would benefit greatly from increased spendable income. For instance, expanding the Dependent Care Tax Credit (which Bush proposes) and making it refundable for low- income families (which he doesn't) would be a very good idea. The problem is that the proposed tax cut largely doesn't go to these groups. Much better to spend the money assuring that Social Security is available for all retirees or providing expanded insurance coverage for prescription drugs bought by lower-income elderly persons. With these needs in front of us, providing large tax reductions to increase consumption among middle and upper-income families makes little sense.

Rebecca M. Blank, an economist, is dean of the Gerald R. Ford School of Public Policy at the University of Michigan. She is a former member of the Council of Economic Advisers and serves on the Call to Renewal policy team.

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