Tax-Cut Fever

Volume II, Number 9 August 16, 1996

On Sunday, August 4, the Concord Coalition ran a full-page ad in the New York Times telling voters to beware of candidates who promise to enact large tax cuts before the country gets its fiscal house in order. The next day, Bob Dole promised to make just such a tax cut the cornerstone of his economic plan.

Dole plugs his plan as boldly "pro-growth." Upon inspection, however, it turns out to embody nearly every pitfall we warned against. First, Dole promises a vast an unrealistic increase in the rate of total economic growth. Second, his plan's active ingredient, the large tax cut, assumes an improbable "revenue dividend." Third, its proposed outlay cuts are politically if not arithmetically impossible. And finally, for all the future-vision hoopla, the Dole Plan would paralyze any serious effort to address our economy's most pressing long-term policy challenges: raising the national savings rate and controlling the cost of federal entitlements.

While many have thanked Concord for speaking out on behalf of fiscal sanity, others have claimed that we did not give the case for tax cuts a fair hearing and that we are unduly pessimistic about America's economic future. We plead not guilty to both charges, and we answer here some questions from our critics.

Why can't we repeat the economic growth record of the 1960s?

Let's start with the basics. GDP growth equals employment growth plus productivity growth. Much of the postwar slowdown in GDP growth, from 4.4 percent annually in the 1960s to 1.7 percent thus far in the 1990s, has been due to slower growth in the number of workers. While employment grew by 2.1 percent annually in the 1960s, it is now growing by only 1.1 percent. This employment slowdown, in tern, reflects fundamental demographic trends that no amount of tax finagling can reverse. Since the mid-1960s, we've been having fewer babies, which means that fewer new workers are now entering the job market. The share of women in the labor force has plateaued at an unprecedented level, leaving little room for further growth. And almost no one is advocating more immigration, legal or otherwise. According to the rosiest official forecasts, the U.S. labor force cannot grow by more than 1.0 percent annually over the next twenty years.

Thus, for the Dole Plan to reach its announced GDP growth target of "3.5 percent or higher," we would have to quadruple productivity growth, which is averaging 0.6 percent in the 1990s, to at least 2.5 percent -- slightly faster than in the Go-Go Sixties. (Measured from cycle peak to cycle peak, the 1980s was not a stellar growth decade.) Dole's experts to the contrary, no one knows how to raise productivity anywhere near this much. Indeed, a similar productivity slowdown in all other industrial nations suggests that much of our own decline reflects technological and social trends that are beyond the corrective power of government.

We know of only one way to ensure even a modest improvement in productivity: Expand the quantity and quality of tools, research, and education at the disposal of America's workers. But this would require a sustained increase in national savings. Tax cuts that enlarge the deficit or that are financed by starving public investment do not add to savings. They subtract from it and thus push us in precisely the wrong direction.

Isn't it true that cutting taxes increases economic growth?

Not necessarily. Most economists agree that certain small and targeted tax cuts (in the top marginal rate or for business investment) might increase output, savings, and even federal revenues. But such self-financing cuts don't add up to much money -- and in any case are not what Dole has proposed.

Dole has proposed large and across-the-board cuts, and here little is known for certain about the magnitude or even the direction of household response. Orthodox economic theory says it could go either way. So does empirical observation. While a higher take-home wage could induce more work effort (if people want to make more money), it could also induce less work effort (if people want to enjoy more leisure). Experience suggests that, at least in the long run, people may value leisure more than money. Over the last century, while the average U.S. take-home wage has roughly quintupled, the average work day has grown shorter, not longer. Today's household surveys clearly indicate that many (perhaps most) workers would prefer to "downshift" and work a bit less if they did not feel driven by economic necessity. Dole himself, along with other GOP leaders, stresses that "higher wages" will allow parents to spend more time at home with their kids -- a curious argument for someone backing a plan that assumes parents would do just the opposite.

Yes, a large across-the-board tax cut might induce some modest "dynamic" economic gain. But there is nothing modest about the Dole Plan's assumption: 35 cents in new federal revenue for every one dollar in static tax losses -- all coming from a whopping $500 billion in new taxable GDP over the next six years. That's skirting the extreme edge of plausibility.

Can't we offset any revenue loss by cutting federal spending?

Possibly, but not by following the Dole Plan's strategy, which promises to derive nearly all the needed savings from unspecified cuts in "discretionary" outlays. Put this strategy in perspective. Over the last ten years, discretionary spending on everything from education to defense has already shrunk from 10.0 to 7.1 percent of GDP. So deep are these cuts that even the Republican Congress can't agree on where exactly to find further savings. Nonetheless, the Dole Plan intends to reduce discretionary spending all the way to 4.6 percent of GDP by 2002. Defense, in 1996 already smaller than in any year since Pearl Harbor, would be cut from 3.5 to 2.7 percent of GDP. All other spending except entitlements and interest would have to be cut in half, from 3.6 to 1.9 percent of GDP -- the lowest "general government" federal spending level since before the New Deal.

Forget defense and consider just the domestic cuts. If these are to spare vital economic investments (research and infrastructure) and declared GOP priorities (immigration and crime control), most public services to the young and the poor will have to be defunded entirely. This alone is an unlikely scenario. But also keep in mind that Congress would have to slash this spending while phasing in large tax cuts and while leaving the vast and still-growing senior-citizen entitlement edifice (in Dole's words) "off the table." It's hard to see how leaders like Dole and Jack Kemp, who tout their social conscience and the cause of the rising generation, could square this circle. Perhaps this is why more than half of the spending cuts in the Dole Plan are not scheduled to occur until 2001 and 2002 -- that is, as late as possible and after Dole's term expires.

The Concord Coalition has often criticized the Clinton Administration for planning to balance the budget through unsustainable, unspecified, and back-ended cuts in discretionary spending. We have often praised the Republicans for a more realistic approach. With the Dole Plan, that realism has disappeared.

Some voters like the Dole Plan because they think that government shouldn't be taking so much of the taxpayers' money. Concord does not necessarily disagree. All we ask is that voters (and politicians) be willing to identify an equal amount of money they think government can realistically refrain from spending. Tax cuts alone do nothing to shrink government. They merely push the cost of financing it onto our kids.

Why worry about the deficit? Isn't it going down?

Yes, the deficit has recently been declining -- something it often does during a business expansion. What is worrisome is that this is the best we can do at a uniquely favorable moment in our history that we know will soon pass. The world cannot indefinitely remain as peaceful or recession-free as it is today. Nor can our demographic Indian Summer last forever. When Baby Boomers become Senior Boomers, look out. Keeping entitlements "off the table" means that by the 2020s we could fire every federal worker except one -- who would stick around to mail checks to beneficiaries and creditors -- and still not balance the budget.

America ought to be preparing right now for this demographic gauntlet by saving and investing more on behalf of younger workers. To make this possible, we must be sure to eliminate the deficit no later than 2002 and even plan to run a sizable budget surplus through at least the first decade of the next century. And we must do all this without gutting vital public investment. Today's choices may be difficult, but if we squander the opportunity to act now with deliberation and foresight, we risk encountering catastrophic choices tomorrow.

Concord is sometimes accused of being pessimistic about America's future. We disagree. We see ourselves as the optimists. While others promise endless free lunches and cynically conclude that voters can no longer bear to face the truth, we are more hopeful. We believe that Americans are not spoiled children, can think like adults, and are able to make grown-up trade-offs between the present and the future. We are heartened by polls showing that, in the view of most Americans, deficit reduction should be our top fiscal priority and most tax cut plans are "just politics." We believe the citizenry appreciates the difference between substance and rhetoric and will judge leaders accordingly.


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