Tax cuts were just the beginning: the President is signalling a far more radical agenda.

[Guest guest]

http://www.newyorker.com/fact/content/?040906fa_fact

 

TAX CODE

by JOHN CASSIDY

Tax cuts were just the beginning: the President is

signalling a far more radical agenda.

Issue of 2004-09-06

Posted 2004-08-30

 

A few weeks ago, George W. Bush crossed the Potomac to

a community college in Annandale, Virginia, where he

hosted an “Ask President Bush” town-hall-style meeting

and took up a favorite campaign theme, saying that one

of the things that separated him from his opponent was

his intention to create a “culture of ownership.” The

same day, the Bush-Cheney campaign released a new

television ad that shows pictures of houses, workers,

and businesses as the President announces, “One of the

most important parts of a reform agenda is to

encourage people to own something. Own their own home,

own their own business, own their own health-care

plan, or own a piece of their retirement. Because I

understand if you own something, you have a vital

stake in the future of America.”

 

The President’s ownership initiative hasn’t featured

prominently in the media coverage of the campaign,

which, strictly from a news perspective, is

understandable: he hasn’t announced many specific

proposals to back up his talk. But in downplaying the

Bush Administration’s economic agenda the media is

missing one of the biggest domestic stories of the

2004 campaign. When the President pledges to create an

“era of ownership,” he is not talking merely about

encouraging people to buy their own homes and start

small businesses. To conservative Republicans who

understand his coded language, he is also talking

about extending and expanding the tax cuts he

introduced in his first term; he is talking about

allowing wealthy Americans to shelter much of their

income from the I.R.S.; about using the tax code to

curtail the government’s role in health care and

retirement saving; and, ultimately, about a vision

that has entranced but eluded conservatives for

decades: the abolition of the graduated income tax and

its replacement with a levy that is simpler, flatter,

and more favorable to rich people.

 

Work on achieving this ambitious program began with

the tax cuts that Congress passed in 2001, 2002, and

2003, but the conservative economists who advise Bush

and the right-wing institutes that support him have

more in mind than consolidating their gains. Despite a

gaping budget deficit, they are pressing the President

to continue down a route that will reverse almost a

century of American history. Since the personal income

tax was introduced, in 1913, it has been based on two

principles: the burden of taxation is distributed

according to the ability to pay; and capital and labor

carry their fair share. The Bush Administration

appears set on undermining both of these principles.

 

It is easy to forget that when George W. Bush made his

bid for the Presidency many conservatives initially

opposed him. Their candidate in the 2000 Republican

primaries was Steve Forbes, the publishing heir, who

had endorsed an annual flat tax of seventeen per cent

on all income above thirteen thousand dollars. This

proposal, a descendant of a tax plan that two

conservative economists from Stanford, Robert Hall and

Alvin Rabushka, had devised in the nineteen-eighties,

was based on supply-side economics: flattening tax

rates and simplifying the tax code would encourage

people to work harder and save more, which would boost

economic growth. Critics of Forbes’s proposal pointed

out that the link between taxes and growth is tenuous,

but it proved popular with Republican activists, and

Bush, whose father had enraged conservatives by

reneging on his “no new taxes” pledge, came under

pressure to match it.

 

In December, 1999, Bush said he would cut federal

taxes by $1.6 trillion over ten years if elected. This

plan, which was enacted into law as the Economic

Growth and Tax Relief Reconciliation Act of 2001,

wasn’t a flat tax, but it was big and bold enough to

establish Bush’s credentials as a fiscal conservative.

 

The timing of the legislation proved lucky. By the

summer of 2001, the stock-market bubble had burst; the

economy had fallen into recession and it badly needed

a boost. But, after the terrorist attacks on 9/11,

there were widespread worries that, despite the fiscal

stimulus and low interest rates, the economy wouldn’t

recover anytime soon. In response, the Bush

Administration introduced the Job Creation and Worker

Assistance Act of 2002, which extended unemployment

benefits and provided businesses with temporary tax

breaks if they invested in plant and equipment. The

economy rebounded in the second half of 2002, but then

suffered a relapse, at which point Congress, at the

urging of the White House, passed the Job and Growth

Tax Relief Reconciliation Act of 2003, which

accelerated and expanded the tax cuts contained in the

2001 law.

 

Taken together, Bush’s tax cuts were even bigger than

the ones Ronald Reagan introduced in his first term.

In 1981, Reagan slashed income-tax rates by about a

quarter, claiming that the government’s revenues would

actually rise as the tax cuts unleashed the economy’s

potential. This claim, which Arthur Laffer, one of the

originators of supply-side economics, formalized in

his famous “Laffer curve,” turned out to be wildly

optimistic, and the budget deficit soared. In the

ensuing years, a panicked Congress reversed some of

Reagan’s tax cuts, and the White House quietly

accepted the rollbacks, which increased tax revenues.

When the International Monetary Fund recently compared

Bush’s fiscal record with Reagan’s, it concluded that

“the revenue effect of the Reagan tax cuts was

considerably smaller than in the current period.”

 

According to the White House, in fiscal 2004 the three

Bush tax cuts will cost the United States Treasury

about $241 billion in revenues, which is about two per

cent of the gross domestic product. (The Congressional

Budget Office, which is nonpartisan, puts the 2004

cost of the tax cuts at closer to three hundred

billion dollars.) The lost revenue has wreaked havoc

with the budget. In 1999, the federal government had a

surplus of $125.6 billion; this year, according to the

latest official forecast, it will have a deficit of

about $450 billion. The 2001 recession and the jump in

spending on defense and homeland security since 9/11

are responsible for some of this reversal, but even

the Bush Administration concedes that tax cuts caused

about a third of it.

 

Still, Bush’s advisers like to portray him as a

pragmatic businessman who has little time for

political agendas and economic ideology. “The

President is a problem-solver,” R. Glenn Hubbard, the

dean of Columbia Business School, who was the chairman

of the Council of Economic Advisers from 2001 to 2003,

told me. “It’s a mistake to think of him as being on

an academic mission for tax reform, as much as trying

to solve real and practical problems in the tax code.”

However, conservative economists outside the

Administration have a different view of the past four

years. “Bush doesn’t talk the language of the

supply-siders,” said Stephen Moore, the president of

the Club for Growth, a Washington-based lobbying group

that pushes for lower taxes. “He doesn’t sound like

Arthur Laffer. He doesn’t talk about incentives.

That’s been a little frustrating. But is Bush a

supply-sider in terms of policy? No question about it.

He has really bought into that philosophy.”

 

Bush’s tax cuts weren’t just bigger than Reagan’s:

they were more strategic. During the

nineteen-nineties, conservative Republicans on Capitol

Hill broke with the deficit hawks in their party and

rallied behind former Congressman Dick Armey’s 1994

proposal for a flat tax (which was similar to the one

Steve Forbes campaigned for in 1996 and 2000). Partly

because the economy was gaining strength after Bill

Clinton’s 1993 tax increases, which helped balance the

budget, and partly because studies showed that a flat

tax would benefit the wealthy, who would see their tax

rates slashed, the Republican tax cutters failed to

make much progress. After George W. Bush was elected,

they changed tactics. Instead of following the Reagan

model and pushing for a single revolutionary reform,

they promoted a series of smaller changes that would

ultimately lead in the same direction. “That’s the

hidden story of what is going on under Bush,” Stephen

Moore said. “People like me have been advocating a

flat tax for a decade. I helped Dick Armey put

together his flat-tax proposal. Nobody could get it

done politically. What Bush has done, in a hidden way,

is move us in baby steps toward the flat tax.”

 

The 2001 tax reform reduced the top rate of income tax

from 39.6 per cent to 38.6 per cent, the second rate

from 36 per cent to 35 per cent, the third rate from

31 per cent to 30 per cent, and the fourth rate from

28 per cent to 27 per cent, with more cuts scheduled

for later years. It also introduced a new lower rate

of ten per cent on the first six thousand dollars of

taxable income, increased the child tax credit,

reduced the tax penalty paid by married couples who

file jointly, and phased out the estate tax.

 

Conservatives supported this reform package, but from

their perspective it had a big shortcoming: the only

part of it that dealt with taxes on savings was the

phasing out of the estate tax, and even that wasn’t

scheduled to be completed until 2010. Flat-tax

enthusiasts argue that saving and investment is the

key to economic growth, and they propose that most of

the income generated from savings—interest payments

from bank accounts and bonds, dividend payouts from

stocks, and capital gains from the sale of any

asset—should be tax exempt.

 

In 2002, Ernest Christian, a Republican tax lawyer,

circulated a plan to create a flat tax in what he

termed “five easy pieces.” Other conservatives

developed Christian’s plan. Grover Norquist, the

president of the lobbying group Americans for Tax

Reform, set up congressional caucuses to support five

specific changes: eliminating the estate tax; ending

the taxation of capital gains; making all income

generated from savings tax free; letting businesses

write off their investments in a single year rather

than depreciating them over a long period; and

abolishing the Alternative Minimum Tax, which

originated in a 1969 congressional act to counter tax

avoidance by the rich, who sometimes had so many

deductions that they ended up paying no tax. “People

don’t trust you to do twenty-seven things at once and

have it come out right,” Norquist, who has close ties

to Karl Rove, Bush’s political strategist, told me.

“Why would you ask people to approve twenty major

changes to the tax code at once, which irritate as

many people as they please, as opposed to a series of

five or six distinct tax cuts, each of which can be

explained and sold to a constituency?”

 

The tax reforms of 2002 and 2003 contained significant

elements of the Christian-Norquist program. The 2002

law allowed businesses to write off half of their

investments immediately, through 2004, a provision

that saved firms billions of dollars. The 2003 law

sharply reduced taxes on dividends and capital gains,

setting their maximum rates at fifteen per cent.

William Beach, an economist at the conservative

Heritage Foundation, later described the 2003 tax bill

as “one of the greatest supply-side changes to tax law

in U.S. history.”

 

Also in 2003, the Administration proposed two new

savings vehicles—Retirement Savings Accounts and

Lifetime Savings Accounts—which would have replaced

I.R.A.s and allowed many wealthy Americans to save

virtually tax free. The accounts were designed to work

in the same way as some existing I.R.A.s but with much

higher contribution limits—seventy-five hundred

dollars a year for each person—and fewer restrictions

on withdrawals. If this proposal had become law, a

well-to-do family of four would have been able to

shelter more than a million dollars over thirty years.

Middle-class families, on the other hand, would have

seen little benefit, because they spend most, if not

all, of their income. More than ninety per cent of

American families fail to put away the maximum sum

allowed under existing retirement accounts, which is

three thousand dollars a year for I.R.A.s and thirteen

thousand dollars a year for 401(k) plans. After the

savings initiative received a lukewarm reception in

Congress, the White House dropped it, only to

resurrect it, in a slightly modified form, earlier

this year.

 

The Bush Administration portrayed most of these

reforms as efforts to boost a lagging economy, rather

than as part of a plan to reshape the tax system in a

radical way, but conservative activists knew they were

making progress. “A little bit like Reagan, people get

the vibes,” Norquist said. “They understand what we

are trying to accomplish. Do you think it was an

accident that the first three tax cuts moved toward

expensing business expenditures, toward universal

I.R.A.s, toward getting rid of the capital-gains tax,

toward getting rid of the double taxation of dividend

income, toward getting rid of the death tax? No. It is

consistent with a vision.”

 

The day after his trip to Virginia, President Bush

went to Niceville, Florida, where he was asked about

the recent proposal from Dennis Hastert, the Speaker

of the House of Representatives, to abolish the I.R.S.

and replace the income tax with a national sales tax.

“It’s an interesting idea,” Bush replied. “You know,

I’m not exactly sure how big the national sales tax is

going to have to be, but it’s the kind of interesting

idea that we ought to explore seriously.” This doesn’t

mean that Bush is about to get rid of the income tax.

Although he needs the support of Hastert and his

followers, if he wins in November he will almost

certainly continue his stealthy approach to tax

reform. When I asked a senior official in the

Bush-Cheney campaign about the idea of a national

sales tax, he replied, “It’s a wonderful debate to

have in a Georgetown salon, but when it comes down to

what is practical politics I don’t think it is

realistic, and the President won’t take up proposals

that aren’t realistic.”

 

Instead, Bush is campaigning to make permanent his

existing tax cuts, which are slated to expire by 2011.

At this week’s Republican National Convention, he is

also likely to expand upon the theme of ownership. He

may well talk about establishing investment accounts

within Social Security, as well as Retirement Savings

Accounts and Lifetime Savings Accounts outside of

Social Security, and health savings accounts, which

his economic advisers view as a step toward

individual, portable health-care coverage. Republican

strategists believe that by emphasizing individual

saving and investment the President is acting

astutely. “The biggest demographic shift in the past

thirty years is not the number of people who speak

Spanish; it is the number of Americans who own

stocks,” Norquist told me. “It was twenty per cent of

adults when Reagan was elected. Now it is sixty per

cent, and seventy per cent of voters.”

 

But while the President makes bland speeches about

ownership, economists close to the Administration are

pushing for a top-to-bottom revision of the tax code,

featuring a major overhaul of corporate income tax and

further cuts in personal income tax rates. If Bush is

reëlected, the anticipated reform of the Alternative

Minimum Tax, which Republicans in Congress loathe, may

well serve as the pretext for this agenda. The A.M.T.

sets a lower limit on the amount of federal tax that

people have to pay, regardless of how many deductions

they have. It already hits about two and a half

million taxpayers, and more people are qualifying for

it every year. “The A.M.T. offers a chance to discuss

fundamental tax reform,” Glenn Hubbard told me. “We

would want a system that could replace the A.M.T. and

the individual income tax with a new individual tax

system.”

 

Although Hubbard returned to his professorship at

Columbia last year, he still acts as an informal

adviser to the Bush campaign. He is one of several

Harvard-trained economists who have worked in the Bush

Administration. Hubbard and Larry Lindsey, who headed

the National Economic Council from 2001 to 2002, both

did graduate work under Martin Feldstein, an adviser

to Bush in 2000, who has long argued that taxes,

particularly taxes on savings, reduce economic growth.

Greg Mankiw, Hubbard’s successor as chairman of the

Council of Economic Advisers, is a colleague of

Feldstein’s in the economics department at Harvard and

shares many of his views. “There are a lot of us who

believe that putting less of the tax on savings would

be a good thing for the economy in the long run,”

Feldstein told me.

 

Rather than coming right out for a flat tax, the

Harvard economists tend to use the less politically

charged term “consumption tax.” Flat taxes and

consumption taxes are closely related: both exempt

saving and tax spending. Theoretically, it is possible

to set up a progressive consumption tax, but most

conservative economists favor a single rate set as low

as possible; i.e. a flat tax. Such a system would

penalize middle-class people, who spend nearly all the

money they earn; a fact Hall and Rabushka, the

originators of the flat tax, were straightforward

about. In 1983, they wrote that a flat tax “would be a

tremendous boon to the economic elite,” adding that

“it is an obvious mathematical law that lower taxes on

the successful will have to be made up by higher taxes

on average people.”

 

Bush’s economic advisers describe their

recommendations as technical changes, supported by

economic research. If Americans saved more, they say,

businesses would have more funds to invest in plant

and equipment, which would enable them to generate

extra output and pay higher wages. (One of the

economic models the conservatives cite to support this

argument was developed in the nineteen-fifties by a

Democrat, Robert Solow, of M.I.T.) In practice,

however, it is far from clear that cutting taxes leads

to more saving in the economy as a whole. A tax cut

that isn’t accompanied by spending cuts, such as

Bush’s, forces the Treasury to borrow more, which

lowers the national rate of saving. By the same logic,

one sure way to increase national saving is for the

government to raise taxes and run a budget surplus.

For some reason, conservative economists rarely

mention this option.

 

Some of the consequences of Bush’s policies are

already clear. This year’s budget deficit, at about

3.8 per cent of G.D.P., isn’t as big as it was twenty

years ago, when it reached six per cent of G.D.P.,

but, as the International Monetary Fund has pointed

out, returning to a balanced budget will be even

harder this time around. A decade ago, it took “tax

hikes, a sharp contraction in military spending, and

an unprecedented economic expansion to achieve fiscal

consolidation,” the I.M.F. noted. None of those things

are on the horizon now.

 

The White House claims that the deficit will fall by

two-thirds, relative to G.D.P., in the next five

years. However, this prediction assumes that the

economy expands by about 3.5 per cent a year; that

spending on programs other than entitlements, defense,

and homeland security rises hardly at all; and that

the Alternative Minimum Tax isn’t cut back much. If

economic growth comes in lower than forecast,

government spending comes in higher, and Congress

substantially modifies the A.M.T.—and all three are

likely—the deficit will be bigger than projected.

 

Moreover, the White House’s forecast extends only to

2009, when the baby boomers are due to start retiring,

putting enormous demands on Medicare and Social

Security. “Perhaps the biggest difference between

Reagan and George W. Bush tax cuts is that, with

Reagan, history gave us time to clean up the mess,”

Peter G. Peterson, who was Secretary of Commerce in

the Nixon Administration, writes in his new book,

“Running on Empty.” “With George W., history may not

be so indulgent.”

 

Instead of trying to build up a surplus to help pay

for the retirement of the boomers, the President would

cut into future tax revenues by making his tax cuts

permanent. According to William G. Gale and Peter R.

Orszag, two economists at the Brookings Institution,

this would cost about $1.8 trillion between now and

2014. “It is the height of deception to say we can

only budget till 2009 but we are going to have massive

tax cuts from 2010 onward,” Gale said. “That is what

the Administration has done.”

 

Most people already know that Bush’s tax cuts favored

the rich, but the size of the giveaway was startling.

Based on figures contained in a recent study from the

Congressional Budget Office, it now appears that about

two-thirds of the benefits went to households in the

top fifth of the income distribution, and about one

third went to households in the top one-hundredth of

the distribution. To put it another way, families

earning $1.2 million a year—that is, the richest one

per cent in the country—received a tax break of

roughly $78,500. Families earning $57,000 a

year—middle-income families—got a tax cut of about

$1,100.

 

Even these numbers, though, do not convey the full

ambition of the Republicans’ agenda, which potentially

involves a historic restructuring of the American

system of government. Roughly two-thirds of taxable

income is paid to workers in the form of wages and

benefits. The other third goes to reward capital, or

accumulated savings, in the form of corporate profits,

dividends, and interest payments. If Bush’s economic

agenda was fully enacted, the vast bulk of these

payments wouldn’t be taxed at all, and labor would end

up shouldering practically the entire burden of

financing the federal government. In a new book,

“Neoconomy: George Bush’s Revolutionary Gamble with

America’s Future,” Daniel Altman, a former economics

reporter for the Times and The Economist, describes

what such a system might look like. “The fortunate and

growing minority who managed to receive all their

income from stocks, bonds and other securities would

pay nothing—not a dime—for America’s cancer research,

its international diplomacy, its military deterrent,

the maintenance of the interstate highway system, the

space program or almost anything else the federal

government did. . . . Broadly speaking, that fortunate

minority would be free-riders.”

 

A return to the Victorian world of rentiers and

laborers may seem like an outlandish scenario, but a

generation ago it would have been difficult to imagine

a White House, even a Republican one, phasing out the

inheritance tax, which affects only a tiny minority of

the richest families, and slashing the taxes on

dividends and capital gains, which few middle-class

families pay, either. The people who devised these

policies simply do not accept the old rules. Glenn

Hubbard, for instance, told me that the progressive

income tax “discourages entrepreneurship and

risk-taking. We have to trade off our interest in

fairness with those costs. I, like many conservative

economists, care a lot about progressivity at the

bottom. President Bush, for example, made the Earned

Income Tax Credit”—a handout to low-income

families—“more generous. But progressivity at the top?

I don’t know. That just sounds like envy to me.”

 

Language like this won’t figure prominently at the

Convention this week, at least from the podium, but

should Bush win in November it is sure to reappear, as

the conservative institutes and right-wing lobbying

groups continue to promote their agenda, which now

includes cutting the dividends tax and the

capital-gains tax to zero, getting rid of the

corporate income tax, and halving the size of federal

spending, from twenty per cent of G.D.P. to ten per

cent. “Here’s the bottom line of it,” Stephen Moore

said. “The Republican Party is now a supply-side

party. It’s a tax-cut party, thanks to people like

Grover Norquist and the Club for Growth. We’ve pushed

it in that direction. It has evolved over the past

forty years from being a party of Eisenhower

balanced-budget Republicans into a party of Reaganite

pro-growth advocates.

 

“That strategy is not just better economically; it

also has political benefits, because, in my opinion,

nobody lost an election in the past twenty years

because of budget deficits. You couldn’t point to a

single congressional race where a candidate lost

because of a big budget deficit. People might say in

the polls, ‘Oh, yes, I’m very concerned about budget

deficits.’ But does it change people’s voting

patterns? No.”