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August 9, 1996
"Nation's Economy Doesn't Need It - The Dole Tax Cut is Hard to Justify"
San Jose Mercury News
By Timothy Taylor
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AT LEAST five reasons can be used to justify cutting individual income taxes, but Bob Dole's proposed tax cuts don't fit any of them especially well.

One reason would be if the level of such taxes had climbed to a historically unreasonable level. However, the federal individual income tax has collected on average 8.5 percent of gross domestic product each year for the last 30 years, and it's set to pull in 8.4 percent in 1997.

A second rationale for a tax cut would be to pull the economy out of a rut, as when Ronald Reagan pushed for tax cuts in 1981 during the depths of a recession. But the economy has been on an upswing for more than five years now.

When an economy is already running close to its capacity, tax cuts bring only a surge in demand which fuels the risk of inflation. Capital markets and the Federal Reserve would almost certainly react to this risk with higher interest rates; as the tax cuts steamed up the economy, these higher interest rates would cool it off.

To put it another way, as you receive your Dole tax cut with one hand, be ready to write out a check for higher payments on your adjustable-rate loans with the other.

A third justification for a tax cut would be for a government that is running a comfortable budget surplus to return a portion to the taxpayers. But the balanced budget plans of Democrats and Republicans alike depend on the uncertain willingness of future Congresses - those elected in 2000 or 2002 - to make spending cuts that the present Republican Congress was unwilling to attempt.

Even on Dole's own estimates, which include some built-in optimism, financing his tax cuts would require several hundred billion dollars in additional, unspecified budget cuts. In the past, Dole has sensibly argued that spending cuts should be named and implemented before the tax cut is handed out, instead of the other way around.

A fourth ground for an income tax cut would be to favor a particular group. For example, Dole's plan singles out families with kids for a $500-per-child tax credit, which is somewhat defensible since inflation has shrunk the tax exemptions for dependents over time.

Less justifiably, Dole's plan would eliminate a 1993 tax increase on the retirement checks of wealthy Social Security recipients, even though that money had been helping to keep the financially creaky Medicare system from bankruptcy. For those worried about the looming insolvency of Social Security and Medicare, paying out more money now is a move in the wrong direction.

A final argument for altering income taxes is to raise long-run economic growth. From 1950-1970, the U.S. economy expanded at 3.5 percent annually, as it feasted on the growth opportunities provided by catching up after the Depression and World War II. But growth slowed worldwide in the early 1970s, and for the last 25 years, the U.S. economy has grown at 2.8 percent annually.

A resurgence of long-run economic growth must be built on a three-legged stool of advancing technology, well-educated workers, and saving and investment. Dole's tax plans fail to mention the first two, and if the unspecified spending cuts don't materialize and a growing federal deficit sucks up even more of the available saving, the funds available for industry investment could shrink.

The incentives of supply side economics are not likely to rescue this situation. Sure, the average family would be gleeful to receive $1,000-$2,000 from Dole's tax cut (assuming that higher interest rates don't affect them too adversely), but few such families are likely to work or save dramatically more as a result.

Similarly, many investors will be happy to reshuffle their investments to profit from Dole's proposals to halve the taxes on capital gains and expand Individual Retirement Accounts. But while adding this complexity to the tax code will make work for tax lawyers and accountants, the economic evidence that it will lead to higher overall growth is weak.

Dole's tax manifesto reads better in election-year terms than in economic ones.

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