Lousy Lawmakers, Not Low Taxes, Created Our Woes

Aug. 10 (Bloomberg) -- You can have low taxes, or you can have an economic recovery, but you can't have both. That's the message the administration is hammering this summer.

Democrats argue in particular that extending the George W. Bush rate cuts on people in the top tax brackets will damage the budget to such an extent that our economy will suffer.

Treasury Secretary Timothy Geithner, for example, said that sustaining the Bush tax cuts for the wealthiest Americans would "hurt economic recovery by undermining confidence that we are prepared to make a commitment today to bring down our future deficits."

Some centrists, and even a few conservatives, are talking a similar line. Former Federal Reserve Chairman Alan Greenspan went further recently, saying all the Bush tax cuts, even those for lower earners, should expire as scheduled at year's end, since it is wrong to live "on borrowed money."

The argument that we have to choose between keeping the Bush rates on the one hand and achieve an economic recovery on the other is hypocritical. You know that's true because our leaders aren't alleging the same trade-off when it comes to federal expenditures.

The tax cuts Geithner would like to see expire, those for top earners, cost taxpayers by his own estimate $700 billion over 10 years. Plenty of other items in the federal budget cost $700 billion over 10 years, or a much shorter period. Yet you don't hear the administration positing apocalyptically that those outlays will darken the future. Only lower tax rates can hurt us, Democrats want us to believe.

Entitlements Escalate

When politicians first announced the entitlement of prescription drugs for seniors, they said it would cost $700 billion over 10 years, for example. President Barack Obama's stimulus package prices out at about $819 billion. The Democrats' health-care legislation is supposed to cost $940 billion.

Yet you don't hear the meds or the Obama health-care bill are holding the U.S. economy hostage. The reason for the emphasis on taxes is simple: Democrats aren't willing to consider changes in non-tax areas that might also improve the federal budget. Hiding behind John Maynard Keynes, they argue that the stimulus will generate growth and are therefore worthier than tax cuts.

When it comes to entitlements or intrusions like the health legislation, the Democrats don't have an economic argument at all.

Supply-Side Fix

What about Republicans? They are finding themselves on the defensive. In the 1980s, 1990s and the early part of this decade, the supply-siders who had advised President Ronald Reagan made their own case that tax cuts would be partially or completely offset by growth. That turned out to be true. The Reagan tax cuts may have contributed to the deficits of the period, but they more than compensated by speeding growth over all and restoring U.S. competitiveness around the world.

Democrats are willfully overlooking a general record that shows that tax cuts can increase revenue. The last two times the U.S. trimmed the capital gains rate, in the later 1990s and under Bush in the early 2000s, the lower rate generated extra activity and the Treasury Department saw more cash flow in than predicted.

David Stockman, a former Reagan budget adviser, wrote recently that Republicans have become "hooked for good on the delusion that the economy will outgrow the deficit if plied with enough tax cuts." But there's a more accurate rendering of the reality than Stockman's version: in the past, Republicans liked their tax cuts so much that they neglected to marshal political capital to achieve two of their secondary goals, controlling spending and reforming entitlements.

Not Containing Costs

The Grand Old Party failed to stop Congress from increasing outlays one year over the next. More important, Republicans failed to push through entitlement reform when it would have been much easier. This failure, combined with the Democrats' spending, hurt the economy.

Both parties have squandered many chances to undertake entitlement reform. Democrats squandered the opportunity in the 1990s.

Even Greenspan played a role. Back in the late 1970s and early 1980s, it was already clear that Social Security was out of balance. Congress appointed several commissions to fix the program. One of them, headed by Greenspan, was charged with focusing on short-term fixes.

One member of the commission, then-Congressman William Archer of Texas, warned that the commission itself was flawed due to the scope of its assignment. In a prophetic dissent to the group's final report, Archer wrote that the commission's recommendations leave "the system's future very much in doubt."

Short-Term Solutions

Greenspan's social security commission recommended that higher tax rates kick in sooner and called for postponing the retirement age and other revenue-saving measures. With the commission's blessing, the so-called FICA tax rose to 7.65 percent for employees in 1990 from 6.7 percent in 1983. The retirement age also went up. This shored up the budget temporarily. But neither step addressed the long-term shortfall caused by the country's demographics.

In other words, the Greenspan fix was a poison pill of its own. It didn't prevent huge cash deficits in the long run. To use Greenspan's own phrase, the commission itself and the politicians who implemented its short-term fixes borrowed from the future. Those are the deficits that are in the news in 2010, the first year Social Security will pay out more than Americans paid into it.

Had the Greenspan commission come up with a long-term reform, and had other reformers come up with better formats for our other entitlements, Greenspan wouldn't today need to talk about "borrowed money" as a rationale for preventing tax cuts.

The nation's real ailment comes from having swallowed those entitlement poison pills, not annual budgeting or even financial crises. Yet lawmakers and commentators are not talking about fundamental entitlement reform. Democrats are scolding tax cutters in the hope of diminishing Republican chances in the next election. What a shame. Taxes aren't the economy's big problem.

(Amity Shlaes, senior fellow in economic history at the Council on Foreign Relations, is a Bloomberg News columnist. The opinions expressed are her own.)

To contact the writer of this column: Amity Shlaes at amityshlaes@hotmail.com.

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net.

© Copyright 2010 Bloomberg

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