Tax Gamble

With his tax cuts, Bush pre-empts the future.

Pre-emption is the name of the Bush administration's game, not just abroad but at home. President Bush understands better than any president since Ronald Reagan that the chief executive's chief power is to set the agenda. Bush also understands that this power cannot be banked. Use it or lose it. So he uses it—and how. Abroad, he launches a pre-emptive invasion. At home, he launches a pre-emptive tax cut.

With the invasion, Bush sought to pre-empt Saddam Hussein's development of weapons of mass destruction. With the tax cut, he seeks to pre-empt—well, what, exactly?

Bush's first tax cut, the centerpiece of his pre-9/11 program, was designed to pre-empt large budget surpluses. It worked. The surpluses, like Saddam, are nowhere to be seen. According to the Congressional Budget Office, the government will run a deficit of at least $246 billion this year; outside estimates range well above $300 billion.

Nonetheless, the 2001 tax cut made some sense on its own terms, at least from the point of view of conservatives. They believed, with some reason, that an accumulating surplus would tempt Congress to profligacy. Indeed, they suspected that by the time legislators finished contributing to all their favorite charities, much or perhaps most of the surplus would never materialize at all. Better to give it to taxpayers than to burn it up.

If that was an argument for the previous tax cut, however, it is an argument against the current one. There is no surplus to spend. CBO projects smallish deficits through 2007. That forecast is probably optimistic. For one thing, it omits the costs of the Iraq war and occupation. For another, it assumes that discretionary spending will grow only about as fast as inflation, or roughly 2.6 percent a year. In the real world (according to the nonpartisan Committee for a Responsible Federal Budget), discretionary budget authority has grown at more than 8 percent a year since 2000—and that was before the war.

Under CBO's projections, Bush's budget transforms temporary deficits into permanent ones, lasting at least through 2013, when CBO's forecast period ends. The administration points out that the deficits are modest by historical standards: about 1.3 percent of GDP over the next 10 years. True, but this, again, assumes low spending growth. Deficits could easily be larger than the CBO forecasts.

Cynics suspect that what Bush is really pre-empting is the 2004 election. "The White House knows that no president has been re-elected in the last half-century with less than 3 percent average annual growth in his first term," writes Robert Shapiro, an economic consultant and a former Clinton administration official, in Slate.com. "So the administration has turned up the heat for more tax cuts: If growth is slow, the tax cuts can at least lift people's post-tax incomes next year." Moreover, there is reason to think that the slow economy could use a fiscal nudge, particularly with interest rates already nearly as low as the Federal Reserve can realistically drive them.

The problem with this theory is that if Bush were simply gaming the election, there would be many better ways to do it. His tax cut favors investors over spenders, and the biggest reductions are well in the future. "They're using short-term growth rhetoric when their proposal transparently isn't designed for short-term growth," says Peter Orszag, a Brookings Institution economist (and also a former Clintonite).

The administration does not exactly deny the point. It says that what it is pre-empting is the possibility—real and troubling—of a slow-growth, job-poor recovery that keeps the economy too far below its potential for too long. "The United States…is not facing just another swing of the business cycle, but the aftermath of the extraordinary events of the 1990s," a Treasury official testified in March. "We continue to live with the disinflationary consequences and the destruction of trillions in household wealth as the bubble burst."

Now is a moment, argues the administration, when good long-term tax policy is also good short-term tax policy. By cutting taxes on corporate dividends, by accelerating the tax-rate reductions approved in 2001, and by offering new incentives for saving, the government can help increase both short-term employment and medium-term investment. Higher deficits are a cost, acknowledges the administration, but a modest one and well worth the price.

Many conventional economists consider this proposition and say, "I am not convinced." The economists note that if tax cuts are paid for through higher deficits instead of lower spending, the government borrows back from the economy the capital that it injects. The administration retorts that its dividend tax cut will improve the allocation of capital, increasing economic efficiency and thus growth. Fair enough, but few economists believe that the gains from efficiency would offset more than a small portion of the increases in deficits. CBO tried various ways of estimating how the Bush plan might pay for itself through economic growth, and found only minor effects (on the order of plus or minus 15 percent).

Congress is scaling back Bush's tax cut to perhaps half of his request. But Bush will almost certainly get a tax cut; the question is only how large. So completely has he dominated the agenda that he wins even if he loses. Maybe the agenda is what he really set out to pre-empt. If so, he has done as well in Washington as in Baghdad.

Bush's bold initiative in Iraq looks irresponsible to his critics because it takes great risks for uncertain benefits. His tax-cutting fits the same mold. There is, however, an important difference. The most destabilizing problem in the geopolitical world right now is the lack of democracy in the Arab world; liberating Iraq will almost by definition be a step in the right direction. The most destabilizing problem in the fiscal world is the high cost of paying pension and health care costs for Baby Boom retirees; cutting taxes, however, is almost by definition a step in the wrong direction.

If Social Security and Medicare stay on their present courses, according to the systems' trustees, by 2030 they will absorb a third of every income-tax dollar, in addition to their dedicated payroll-tax revenues; by 2040, almost half. After that, it gets worse. By mid-century, entitlement programs for the elderly will cost twice as much as today, relative to national income.

In a recent paper for the National Center for Policy Analysis ("Is War Between Generations Inevitable?"), Jagadeesh Gokhale and Laurence J. Kotlikoff—economists at the Federal Reserve Bank of Cleveland and Boston University, respectively— calculate the total fiscal burden that each of several generations will face. They find an immense imbalance, with the government's policy strongly favoring current generations at the expense of future ones. "The [2001] Bush tax cut," they argue, "worsened the generational imbalance…by about one-fifth at a time when it was already huge." Further tax cuts this year would do more of the same.

As if to drive home the point, Bush's budget contains one new big-ticket item, for (who else?) the elderly. His prescription drug benefit would add $400 billion to the cost of Medicare over 10 years, with costs soaring as Baby Boomers retire. Democrats, of course, would like to add even more. Then there is the alternative minimum tax. Bush and everyone else agrees that it should be prevented from biting deep into middle-class pockets, but fixing it will cost anywhere from $300 billion to $600 billion. The bulk of those bills would begin coming due late in this decade. After Bush is gone.

The first President Bush agreed to a tax increase that did more than any other single action to break the back of the federal deficit. But look what happened to him. His son, having learned that lesson, is a Time Bandit, encouraging rather than taming politicians' natural tendency to embezzle from the future.

This year's tax cut, assuming one passes, will be moderate in size, and considerably smaller than its 2001 predecessor. Its significance lies less in its scale than in its confirmation of Bush's determination to chart a new course for fiscal policy, one that would reduce federal taxes to pre-Clinton levels. Bush the gambler is betting that he will come out looking like President Reagan, whose deficits bought economic reforms and a stronger national defense.

He may. On the other hand, he may come out looking more like President Nixon, whose profligate fiscal policies (especially his 20 percent Social Security hike, ostentatiously implemented a few weeks before the 1972 election) have caused fiscal heartburn to this day. Reagan has gone down in history as a visionary, Nixon as an opportunist. Caveat pre-emptor.