Small tax cuts carry punch

By Chris Edwards

WASHINGTON -- The U.S. House is preparing to pass a slimmed-down version of the president's tax-cut plan. Some pundits argue that the $550 billion tax bill is still too large. But the tax cut is modest and its economic benefits substantial.Q: Won't the tax cut blow a $550 billion hole in the federal budget?

A: No, the $550 billion is cumulative over 11 years (2003-2013), averaging just $50 billion a year. It's like Congress labeling your $600 child-tax credit a $6,600 tax cut.

Q: But won't the tax cut cause problems for the federal budget?

A: The tax cut is just 1.8 percent of $30 trillion in cumulative federal taxes from 2003 to 2013, according to Congressional Budget Office data.Q: If the tax cut is so small, how will it help?

A: The tax cut is a tiny 0.35 percent of a cumulative U.S. gross domestic product of $155 trillion from 2003 to 2013. The power of the tax plan is not its dollar size, but the pro-growth incentives for workers, businesses and savers. Rate cuts and investment provisions in the bill are power multipliers for economic growth because they increase incentives to expand production.Q: Are today's Republicans trying to outdo Ronald Reagan's tax cut?

A: Reagan's tax cut in 1981 was 10 times larger. The 1981 cut saved taxpayers $715 billion over five years, or 3.8 percent of GDP. The House cut would save taxpayers just 0.35 percent of GDP over 11 years (0.8 percent over the first five years).

Note that after Reagan's cut, Congress increased taxes in 1982, 1984, 1986, 1990 and 1993. The current tax bill would reduce the top rate to 35 percent, but that's still 7 points higher than the top rate of 28 percent in the late 1980s. Q: Do we really need more tax cuts after Bush's cut in 2001?

A: Even with Bush's cut in 2001, federal taxes as a share of GDP will rise to 19.0 percent by 2010 from 17.6 percent this year. Unless cut, taxes automatically consume rising shares of income. That occurs because income growth pushes people into higher tax brackets and because more families are paying the alternative minimum tax. Taxpayers need occasional tax cuts to stay even with the government.Q: With concern about the deficit, do Bush and Congress plan to cut spending?

A: Just the opposite. Bush proposes to increase total federal spending by $102 billion in 2004 and $125 billion each year after. Whereas tax cuts are historically rare, large spending increases occur every year. Thus, even modest spending restraint creates large deficit reductions.Q: Won't dividend and capital gains tax cuts create rising deficits?

A: The effect of the tax cuts on the deficit is dwarfed by rising spending. Under Bush's budget, total annual spending is expected to be $866 billion greater in 2010 than this year. By contrast, the House dividend and capital gains tax cuts would reduce revenue by just $31 billion annually by 2010. Thus, spending increases would be 28 times larger by the end of the decade than proposed investor tax cuts.

To sum up, the House tax cut plan has a small budget effect compared to spending increases. But the plan packs a punch for economic growth by reducing tax rates on workers and entrepreneurs, cutting business financing costs with the capital gains and dividend provisions and spurring business investment with larger depreciation deductions.

As a bonus, the dividend tax cut will improve corporate management and help quash continuing financial scandals. All that is an investment the country cannot afford to miss.

Chris Edwards is director of fiscal policy at the Cato Institute.