The battle over the tax cut

The focus of the battle over the 2003 tax cut is the top marginal rate on the income tax.

Some Republicans want to accelerate an already scheduled reduction of the top rate so that the lower rate kicks in this year. Others in the GOP fear that this will look too much like a gift to the rich. Instead, they want to cut taxes on dividends.

Come again? Let's be sure we have this right.

Suddenly, it's valuable and 'stimulative' to cut taxes for a group that includes renters who live off dividend checks. But at the same time, it's unseemly and elitist to cut taxes on income earned by, say, an immigrant pediatrician who is married to an immigrant orthopaedist. This even though the pair happen to send home a good share of their earnings to fund their niece's algebra lessons in Peshawar, a cause arguably more valuable in these times than, say, the soy, corn and dairy subsidies that their federal taxes pay for.

Before January gets going, it's probably worthwhile for us all to consider how the debate came to be framed in such terms.

Historically, Republicans have been, or have tried to be, the party of less government. In the name of this ideal (whether one agrees with it or not), they have tried to fight confiscatory taxation. The important thing about this fight was that it proceeded on moral grounds. The question was how much of an individual's property the government had the right to seize. Economics mattered too, of course, but were not the only issue.

Democrats for their part painted the GOP's tax cutting as evidence of party enslavement to the rich. They did so often that the Republicans became neuralgic on the issue. Arguing that a tax cut was "good for the economy" seemed the only possible defence.

The GOP began to use that defence every time, whether it suited the circumstances or not. They also failed to distinguish between the long-term improvements resulting from a lower tax burden (genuine) and short-term 'stimuli'' from fiddling rate cuts (dubious).

Of course, by giving up their moral argument, the Republicans revealed they were running scared. This emboldened their opponents. Nowadays, too, those opponents receive institutional support from Washington's budget scoring mechanism. Any little tax cut proposal gets picked apart - instantly - to demonstrate it is "for the rich". And when tax cuts don't prove instantly stimulative, the Democrats have the Republicans where they want them. This happened back in 2001: instead of spending rebate checks, as the White House said they would, people saved them.

The trouble this time lies not with the proposal to improve the tax treatment of dividends. This is a good idea, morally and intellectually. Levies on dividends paid at the individual level represent double taxation, since corporations already pay taxes on the very same income. Why should grandma pay again? The reduction could, indeed, also help the economy.

No, the trouble is that the GOP is now quaking at the thought of following through on its own income tax cuts.This is absurd, even on class grounds. Many top earners are professionals who happen to live in localities where the high cost of living drives them into high brackets. The only difference between nowadays and the good old days of the 1980s tax reforms was that in those days millions of voters were in the top bracket, while today that figure is less than a million.

Again, the Republicans were outfoxed. In 1993 their opponents facilitated class warfare by imposing their top rate (39.6 per cent) on a narrower band of people. Perhaps, most crucial though is the clear moral argument for the current income tax reduction. High wage earners, no matter how isolated, still represent the American ideal - they are strivers, the most productive members of society.

As Washington's own data show, owners of flow-through entities, a group that includes small-business owners and entrepreneurs, make up some two-thirds of the group of filers that would benefit from an accelerated rate reduction. Is it right to slam them?

Remember, we're not talking about a 19 per cent flat tax here. We're speaking of a reduction to 35 per cent or higher, well above the top rate obtained after the tax increase of Bush I.

What's more, if the current president fails to accelerate his planned cut to the top rate, but accelerates all other legislated rate cuts, he will be making the tax code more progressive. Better to cut rates now and be a happy warrior.

Finally, there's the matter of how the economy reacts after passage of the new tax law, should that come this spring, as many expect. In the long run, the economy will respond positively to rate cuts, improving incentives as they do.

In the short run, however, the economy may or may not heel like a Springer spaniel. And if it does not behave within a year or so, the president will have failed to deliver, both on instant growth and on principle. Hardly a great record to campaign on come 2004.

© Copyright 2003 Financial Times

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