Tax Cutters Trash Themselves by Ignoring Reality

July 28 (Bloomberg) — Republican tax cutters are famous for generating enemies. There's something about a movement espousing tax cuts that makes Democrats froth at the mouth — they long for an opportunity to trash Reaganites or their descendants.

And now those enemies have a new advantage. Their task is much easier than it was in the 1980s, when the first great battles were fought over income tax. They don't have to trash the tax-cut movement. It is already trashing itself in a slow and subtle trend, but a sure one.

The whole process, step by painful step, is laid out in a study published this week by President George W. Bush's own Treasury, "A Dynamic Analysis of Permanent Extension of the President's Tax Relief." The report at once boosts the tax-cut movement and composes an elegy for it.

Let's start with the report's good news. For decades now, Republicans have argued that the traditional form of revenue projection, static analysis, fails to take into account macroeconomic indicators such as growth, which lower tax rates can generate. They wanted dynamic analysis, which highlights the effects of such growth in forecasting. Dynamic analysis, they assumed, would show tax cuts in a more favorable light. The conservative Treasury's use of this model is a coup for the old Reaganites.

The data also vindicate the tax cutters. Republicans have long known the political reason for tax cutting: Voters love tax cuts. Their economic reasoning has been less developed. The Grand Old Party suffers from a bad case of Attention Deficit Disorder. Its platform is less a structure than a collection of impulses —the pro-gun impulse, the pro-marriage impulse, the war impulse, the anti-abortion impulse. The same holds for taxes. The GOP cuts taxes not as part of a plan but rather when the mood strikes.

3 Million Jobs

What the report shows is that, this time at least, the motive for the action matters little. The tax cuts have been good for the national economy. The tax relief acts of 2001 and 2003 strengthened recovery. By 2004, 3 million more jobs were created because Bush and Congress reduced taxes on income, capital gains and dividends. By the end of that year, the real gross domestic product was as much as 4 percent higher than it would have been without the cuts, according to the study.

The report confirms what many observers have already noted: The tax reductions helped sustain U.S. relative competitiveness. Unpredicted revenue flows — generated by increased activity following cuts — have been flooding federal coffers.

The Treasury also predicts more good news. The Bush tax cuts are set to expire at the end of 2010, yet the Treasury estimates that making those reductions permanent has the potential to make the economy grow faster each year than it otherwise might. Sustaining the lower rates on capital gains and dividends is an important component of that increase.

Lesson for Merkel

And the model shows that an even stronger driver of growth would be sustained lower rates of income tax. The individual's tax experience, the Treasury study says, affects the health of the national economy. This thesis flies in the face of the "help business and everything else will follow" model so beloved of American towns and European governments. Angela Merkel of Germany, take note.

Still, the report also reveals a serious issue: While tax cuts may generate future growth, they can only do so if the government spends less. To make their model work, the authors had to assume that government purchases would decline after 2017. Barring the crowning of Newt Gingrich as American King, this premise seems a stretch. Unless the U.S. government curtails spending, the report says, public borrowing will crowd out private investment. In addition, the Treasury model suggests, "across the board, proportional tax increases" will follow. The president's goal of permanent tax cuts becomes impossible.

Rubin's Prophecy

These facts and projections don't themselves undermine the tax-cut idea. Increasing government spending was never part of the tax cutters' agenda. The report doesn't even undermine Bush's statement this year that the country doesn't have to choose between today's deficits and today's tax cuts.

Yet it does suggest the U.S. will have to choose between spending and tax cuts soon. If it doesn't make that choice, the budgetary calamity that people such as former Treasury Secretary Robert Rubin prophesy will come true. All the blame will be on the tax cutters' heads.

To avoid such a fate, Republicans can do two things. The first is to get over their habit of pairing tax cuts with spending increases, or trading spending increases to Democrats to get tax cuts. The second is to change their platform from a collection of impulses to a coherent agenda.

The best move is to unite their tax reductions with more serious long-term budget plans — and to widen the campaign to one for smaller government. If they don't, their great feat will go down in history as a Bush blip, not a national tradition.

(Amity Shlaes is a Bloomberg News columnist. The opinions expressed are her own.)

© Copyright 2006 Bloomberg

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