The tax cut cometh

It's not of matter of if, but of how much.

Put on your party hats. A tax cut is coming.

At least that's the consensus of inside-the-beltway fortunetellers, who peer into the C-SPAN crystal ball and see tax-cutter Bush in the White House, the economy in a holding pattern, Fed chairman and D.C. courtier Alan Greenspan revising his views on taxes and debt reduction, and the Congressional Budget Office predicting record budget surpluses.

"Virtually 100 percent," are the tax-cut odds given by Brookings Institution economist and anti-tax cut crusader William Gale during a live chat on Washingtonpost.com after Greenspan's testimony last week. On Crossfire earlier this week, Bob "God put Republicans on this earth to cut taxes" Novak was as bubbly as 15-year old in love as he grilled Sen. Jon Corzine (D-N.J.), the Senate's newest limousine liberal, on the matter.

Across partisan lines, the fight over taxes isn't whether to cut them. It's over which taxes to cut and how deeply to slash them. Economic conservatives will try to get a Reaganesque across-the-board marginal-rate reduction, with a kid credit thrown in to humor the social conservatives. "Marginal rate reduction are the first and second most important priorities," says Cato Institute Chairman William Niskanen, a former economic advisor to President Reagan. Adds Niskanen: "I would hope that Bush would pair his marginal rate cuts with some cut in the payroll tax that would get him on the road to Social Security reform. If you want to help people at the bottom of the income distribution with tax cuts, you have to cut the payroll tax."

Having lost the battle over whether to have a tax cut, liberals such as House Minority Leader Richard Gephardt (D-Mo.) and Senate Minority Leader Thomas Daschle (D-S.D.) will push for tax rebates for people who don't even pay federal income taxes; think refundable child credits and an expansion of the Earned Income Tax Credit. Claiming they don't want to risk a return to budget deficits, they will also work to keep any cut as small as possible.

But in economic terms, all tax cuts are not created equal. Economists distinguish between tax cuts that change the incentives facing individuals and those that simply put more money in their pockets. A cut in marginal income tax rates, for example, makes work and investment more rewarding by allowing people to keep more of what they earn. As a result, the story goes, people work and invest more, with positive long-term effects on economic growth. This is the effect economic conservatives invoke when they claim, as Bush and others have in recent weeks, that tax cuts stimulate the economy.

In contrast, a lump-sum tax rebate, such as the child tax credit, has little, if any effect on long-term economic growth, since it doesn't alter the incentives facing individuals to work or invest. Liberals, however, are much more likely than conservative to view short-term stimulus as a solution to any short-term economic slowdown. Seeing the problem as slack consumer spending, they will advocate for policies that put money in the pockets of low- and moderate-income consumers, who tend to spend most, if not all of any windfall from government.

Thus, while Cato's Niskanen calls for a cut in marginal rates as good medicine for the economy, Brookings' Gale thinks targeted payments are in order. "Bush's tax cut would be a great way to fight a recession among high income people ten years from now, but it's not a useful way to fight a recession that would affect all Americans this year," writes Gale in his Washingtonpost.com chat. "A tax cut designed to fight a recession now [needs to] take effect immediately, be small enough not to spook financial markets, and be targeted more heavily than the Bush plan is on low and middle income households."

This dichotomy, of course, is not all encompassing. There are tax policies, such as the marriage penalty, the death tax, and the Earned Income Tax Credit, that don't fit neatly into either category. Still, these two competing worldviews will frame this year's debate over tax cuts and ultimately affect what you get out of it come April 15, 2002.

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