Watch What Rubin Does, Not What He Says, on Taxes

Nov. 15 (Bloomberg) — If Bob Rubin were a stock, he would be at an all-time high. Trailing Democratic donors wherever he goes, the former U.S. Treasury secretary is telling audiences in Washington and New York that "you cannot solve this nation's fiscal problems without increased revenues." He takes pains to give the impression that he transcends party.

One of the ideas that Rubin conveys from on high is that the federal deficit matters deeply. Another is that the old rule of raising revenue during a period of economic growth makes double sense when you have a deficit.

The press takes all this to mean that Rubin backs tax-rate increases, an assumption that makes sense given his repeated criticism of President George W. Bush's tax cuts. Rubin also argues that tax-rate changes don't affect economic behavior. He said recently that corporate executives work just as hard when tax rates are higher. The average taxpayer's attitude must therefore be the same.

Still, watch what he does, not what he says. Then you begin to see that this man, who knows more about how the economy works than almost anyone, is ambivalent about raising taxes. He knows that tax increases can hurt the economy, and that voters understand that. He also knows that tax cuts can widen revenue.

What's more, while Rubin may be a Wall Street hero, he's also human — and a big party man. When it comes to tax strategy, the only difference between his advice and that of a Democratic National Committee staffer is that Rubin's is more effective.

Restraining the Left

Consider the record. Rubin spent the first half of the 1990s trying to restrain the left side of President Bill Clinton's cabinet. As Bob Woodward reported in "The Agenda," a book worth taking up again in a new political context, Rubin told an ambitious Paul Begala to respect Wall Street.

"Look, they're running the economy and they make the decisions about the economy," Rubin said, according to Woodward. "And so, if you attack them, you wind up hurting the economy and wind up hurting the president."

From the beginning of 1997, or the sixth year of the recovery, Rubin made it clear he would lead the administration in an enormous cut in the capital gains tax rate. This he accomplished, pushing the rate down to a maximum of 20 percent from 28 percent.

That time, the market responded to the incentives. Capital gains revenue rose substantially — and disproportionately compared with other revenue streams.

Surging Revenue

In the mid-1990s, capital gains revenue from individual returns amounted to as little as 3 percent of total tax revenue. After that it went higher, into the 6 percent range, according to the American Council for Capital Formation, whose mission is to reduce rates.

Nor was this especially a surprise. Capital-gains rate cuts almost always increase revenue, as reductions in 1978 and 1981 demonstrated. From his current position on the sidelines at Citigroup Inc., Rubin observed the same phenomenon when Republicans lowered the levy in 2003. The next year, receipts grew 20 percent, according to the Congressional Budget Office.

The standard rebuttal at this point is that such rate cuts don't cause the increase in revenue — the general strength of the economy does.

But that ignores the fact that stock prices reflect taxes — lower rates may be one reason the market went up. What's more, in 1981, Treasury data show, a capital gains rate cut was followed by the recession of 1982 — and increased revenue from capital gains. A converse example: In the mid-1980s, people anticipated a capital gains rate increase, and capital gains revenue almost doubled. But after the increase, revenues dropped, even though the economy was growing.

You Tax, You Lose

What about now? Rubin's recent decision to stop short of calling for tax increases hasn't merely been motivated by a desire to avoid getting ahead of his party. The better guess is that he, or people like him, have been telling Democrats that tax increases are a loser. Hence, the sudden interest among Washington Democrats in looking at the so-called tax gap — the disparity between what the Internal Revenue Service believes people legally owe in taxes and what they are actually paying.

The IRS estimated that between companies and individuals, Americans underpaid their taxes in 2001 by $345 billion. Some $32 billion of that missing cash was noncompliance on tax credits and deductions alone. The methods that the General Accountability Office suggests might narrow that gap included expanding withholding requirements as well as strengthening enforcement. Ouch.

A No-Brainer

For Democrats, fighting the Republican administration on the tax gap is a no-brainer. They can make class war, collect extra revenue, and still claim they are not raising taxes.

What's more, they can assign all the blame to Republicans when citizens get outraged at being pursued by squads of Bush revenue hounds. That, after all, was what Republicans did to them during the Clinton administration. Then, the GOP pushed for, and won, some wonderfully theatrical IRS hearings.

In the end, the Democrats want it both ways. They're trying to avoid the blame for tax increases. But they also want to "get" the rich as they get the revenue. What they are ignoring is a third possibility: that if they team up with Republicans, as they did in overhauling the tax system in 1986, both sides can get credit and perhaps help the economy.

There's a benefit to Rubin's publicly choosing between pro-growth policies and populist ones. He could help his party. Someone should say it: Bob, it's time to pick.

(Amity Shlaes is a visiting senior fellow at the Council on Foreign Relations. The views expressed here are her own.)

© Copyright 2006 Bloomberg

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