In January 2003, the Bush administration unveiled a package of proposed new tax cuts, including provisions to eliminate the taxation of dividends and make permanent the 2001 tax cut. President Bush called the plan "an immediate boost to the economy" as well as "essential for the long run to lay the groundwork for future growth and prosperity." Critics have said that the plan doesn't provide short-term economic stimulus and endangers long-term growth and prosperity. Is the Bush tax plan good for the economy or not?
Peter Robinson: Today on Uncommon Knowledge: President Bush's tax plan-- what's in it for me...and you, of course.
Announcer: Funding for this program is provided by the John M. Olin Foundation and the Starr Foundation.
Peter Robinson: Welcome to Uncommon Knowledge. I'm Peter Robinson. Our show today, does President Bush's tax plan make sense? In January the president unveiled a major new tax plan that will total some $674 billion in cuts over the next ten years. One measure among many others would stop the taxation of dividend income. The president called his plan "an immediate boost to the economy, " and "essential for the long run to lay the groundwork for future growth and prosperity." Critics beg to differ. Who's right?
Joining us, two guests. Michael Boskin is a senior fellow at the Hoover Institution. He served as Chairman of the Council of Economic Advisors in the Administration of President Bush, the elder. Robert Reich is a professor at Brandeis University. He served as Secretary of Labor in the administration of Bill Clinton. Reich's latest book is entitled, I'll Be Short.
Title: The Kindest Cut
Peter Robinson: Vice President Dick Cheney has warned that if Congress fails to enact President Bush's new tax cuts, we might well find ourselves in a new economic downturn that would deepen budget deficits by as much as 800 billion over the next ten years. Vice President Cheney. Senate Democrats have warned that if we do enact the president's new tax cuts, they would lead to, I quote, "fiscal Armageddon." Who's right, Bob?
Robert Reich: Well, the politicians on both sides are exaggerating typically, but there is it seems to me a fundamental problem with the president's proposal and that is it doesn't really stimulate the economy right now. We can debate its long-term supply side effects, but if you're after some way of getting out of the economic doldrums, this is not it.
Peter Robinson: Mike?
Michael Boskin: I think it will help the economy both short term and long term. I think the economy is quite soft right now and hence I strongly support it.
Peter Robinson: Can you two gentlemen who have been watching economics and participating at high levels for a couple of decades now, help me to untangle some recent economic history? I put to you two models. Ronald Reagan ran big deficits and cut taxes and the economy boomed. And Bill Clinton raised taxes and narrowed the deficit and then as he left office the budget was in surplus and the economy boomed. How is George W. Bush to untangle the meaning of these two models? Mike?
Michael Boskin: Well, you have to first of all put them both in context. I think the genius of the Reagan Model was coming on the heels of a tremendous growth of government spending and taxes, horrible inflation, a big explosion of regulation, and people being driven into higher tax brackets even when their real incomes didn't go up just because of inflation.
Peter Robinson: And this begins roughly from the Great Society?
Michael Boskin: This is the late Sixties on. And here we are in 1980, we've got 13% inflation, we've got very high unemployment, so-called stag-flation. And I think there was widespread consensus, the then chairman of the Joint Economic Committee, Lloyd Bentsen turned that around and said we really do also have to work on the supply side of the economy, which was of course what a lot of Republicans were saying. So I think the reduction in tax rates was a good thing. The way I view it is it called a halt to an evolution, which had us heading toward a European-style social welfare state, so I think that was a big part of setting the framework for the boom.
Peter Robinson: I want to come back to you for Clinton, but let me ask Bob to comment, is that your reading of the Reagan era?
Robert Reich: Not at all. We ended up, the Reagan and the first Bush Administration, with deficits of $200 to $300 billion as far as the eye could see so that when the Clinton Administration began, we were in charge of cleaning up the mess. In fact I felt as if we had a giant pooper-scooper. We had to bring the deficit down so that the Federal Reserve board felt free to reserve to actually reduce short-term interest rates, otherwise it feared, for good reason, inflationary outcomes.
Peter Robinson: Okay.
Michael Boskin: I think if you take a little closer look at history, the facts are a little bit different than that. It is certainly true late in the 1980s expansion, after many years of growth, we still had a large deficit, we peaked at 6% of the gross domestic product, 6% of the economy in 1983 was somewhat smaller, but it was still pretty large. There were a variety of things that needed to be done. Spending had grown for a variety of programs, but in particular we had a big increase in military spending because we needed to do that to meet the challenges of the Soviet Empire, what President Reagan called the Evil Empire. So a lot of this spending, certainly not all of it, but a big part of the increase was investment spending on our future and just as we financed our Second World War heavily with debt, we financed some of this military buildup with that. Now if you look at what happened, there was a lot of pressure to do things about it. There were a couple of programs in Congress, the Graham-Rudman Rules, et cetera, that took a snap shot…
Peter Robinson: Right, to try to get the deficit under control.
Michael Boskin: Took a snap shot and didn't work very well. And so in 1990, President Bush signed a politically very unpopular law. He was dealing with a Congress which was heavily Democratic and wasn't very fond of his particular proposals, and he reached a compromise with them. You can say it was bad politics if you want, and it certainly caused him a lot of difficulty. But about two thirds of the budget reductions were on the spending side and for the first time with the caps on spending, we saw spending start to slow and actually shrink as a share of GDP. President Clinton came in and did somewhat the same thing again. So I think if you project out what the deficits would have been from the Bush Administration, they were going to come down substantially.
Robert Reich: Let me, if you don't mind Michael, let me just say one thing. We're mixing up, it seems to me, two very different phenomena here. The first challenge we have right now in the economy is to deal with basically over-capacity, under-utilization, inadequate demand. We have factories that are running at 75% capacity right now, equipment that is not being utilized, unemployment at 6%, and it may be going up. Now this is a classic either recession or post-recession, I don't care what word you use for it, we've got to pump up demand.
Peter Robinson: It's slow.
Peter Robinson: Bob Reich is calling for an immediate fiscal stimulus, but is that even something of which the government is capable?
Title: Looking for Stimulation in All the Wrong Places
Peter Robinson: George Will stating not only his own thoughts but the thoughts of, for example, Milton Friedman, I quote, "The government is too blunt an instrument for fine tuning an industrial economy." Don't worry about short-term stimulus because it's a short-term matter--by the time a bill is enacted, by the time the results for--the economy will be someplace else all together. It's wrong even to think about short-term stimulus, what the government should address itself to is establishing the proper conditions for long-term growth. Do you both buy that? You don't buy it? Why don't you?
Robert Reich: I don't buy it because I think there are certain things the government can do that will, in addition to monetary policy, in addition to reducing interest rates by the federal reserve board, put more money in people's pockets in the short-term and that they can thereby turn around spend money and stimulate the economy.
Peter Robinson: As a matter of principle, so you agree with Bob on that?
Michael Boskin: No, I agree with both the statements partially. It's certainly true that as a general principle, you don't want to keep adjusting the tax code and spending levels to try to fine-tune the economy, to twiddle the growth rate by a percentage point. However there's something you might call gross tuning, when the economy is in difficult shape, when the federal reserve has or looks like it's about used up most of its ammunition, then you might well decide that you should have some fiscal stimulus.
Robert Reich: And that sounds like it is today.
Michael Boskin: And I think that we're just about there today, I think you could argue both sides, I think it probably makes sense to take out insurance, and I think that's why some fiscal policy that will help the economy in the short term and long term is desirable.
Peter Robinson: Okay. Here is one of the things Bob has proposed, cutting the payroll tax for two years by exempting the first $15,000-$20,000 of income. Why do you propose that?
Robert Reich: Well, again, if you want to stimulate the economy, put more money in people's pockets so that they will spend more. And again consumers are two thirds, consumer spending is two thirds of the economy, it's very important that consumers keep on going, in fact even increase their spending in the short-term, I'm not saying long-term, in the short-term to get us out of the slump. One way to do that, a very good way, is to exempt the first 15,000 say of income from payroll taxes. Most people spend more or pay more in payroll taxes than they do in income taxes.
Peter Robinson: And you'd pay for that how?
Robert Reich: Well, you can pay for it a number of ways. One thing you can simply do is say look, this is the amount of money that we are going to run a deficit in the short-term to compensate for the economy being in a slump. The economy then gets out of the slump, revenues increase, and it pays for itself. Or you could say, we over the long-term, are going to pay for that hole by getting rid of the Bush tax cut on the top 1% or 2% of people--we're going to keep taxes exactly where they are. A lot of things you can do, that's a different debate about whether right now it is important to stimulate the economy by getting more money in more people's pockets. Giving a tax break to people who are very rich is not going to do anything because they already spend as much as they want to spend, that's the definition of being rich.
Peter Robinson: You've granted the need for a stimulus, what's wrong with that plan?
Michael Boskin: Well, I think there are two major problems. One is that all the evidence we have is that temporary tax cuts are not very stimulative. The evidence is that maybe 20%, 25% of it will be spent.
Peter Robinson: Just help me understand that in laymen's terms, people sock the money into a bank account instead of going out and buying refrigerators?
Michael Boskin: We all got $300 or $600 rebates in 2001 and the evidence was that about 20% of it got spent. People socked it away or paid down debt or did something else with it, it's not like the money disappeared, but it didn't go directly in the short-term to stimulate the economy. The second major problem with it is that it gets into some very awkward situations with respect to social security and its financing. Now maybe those could be finessed somehow, but the payroll tax is how we finance current and future social security obligations. But you then get into this issue we were talking about before, the political process being a clumsy way to stimulate the economy because it takes so much time. I think if by the time we got through discussing how this would affect social security, the economy probably would have recovered a year or two later.
Robert Reich: The Business Roundtable endorsed the proposal I put forth…
Peter Robinson: They did, those unreliable rascals, Republicans they were supposed to be, I thought.
Robert Reich: A number of Republicans have endorsed it as well, but let me respond Michael to both of your points. Number one, even if the so-called marginal propensity to consume, that is the likelihood that somebody of moderate means or middle income is going to take the extra money and actually spend it is 25% for middle income people, people below that are more likely to spend more of the money that they get, extra money, and it is certainly the case that people who are very wealthy are not going to spend any extra money they get. Their marginal propensity to consume is very, very small because again, rich people spend what they want to spend. So if you want to stimulate the economy, give a tax break to people who are moderate income.
Peter Robinson: Why is consumption more important than investment if you're looking for stimulus?
Robert Reich: Right now, consumption is the key to getting this economy going. We're not talking about investment, we're not talking--right now there's too much…
Peter Robinson: If you had your druthers, Mike…
Michael Boskin: There are some problems with Bob's analysis. Number one the epicenter of the downturn is business investment. Consumption has held up very well. It's slowed a bit late in 2002, but in the recession and the recovery it's held up much better than in most previous recessions and early recoveries. The epicenter is the downturn in investment spending.
Peter Robinson: Let's take a closer look at the President's tax proposal.
Title: Bush's Little Dividend
Peter Robinson: Well, you have just heard that consumption spending, which you want to fix ain't broken, that what is broken is the business investment aspect of the economy. Now listen to what George W. Bush would like to do. He wants to make permanent the $1.35 trillion tax cut enacted in 2001 intended to be phased out in ten years. He wants to make that permanent and he wants to enact new tax cuts amounting to about six hundred and seventy four billion over the next ten years, including a provision to end the double taxation of dividends pretty directly aimed at investment, which is what's broken. What's wrong with that?
Robert Reich: First of all, in the short-term again, let's agree we have over capacity, too much capacity relative to demand. There are not enough consumers out there to buy up all of our productive capacity, all of our productive potential. You're not in this environment, going to get businesses to invest more when they already have too much plant and equipment relative to what consumers are willing to buy. If businesses want to go out and get a loan, they can get a dirt-cheap loan right now to expand their production facilities, they don't need a tax break. So what we are really talking about with regard to these tax breaks for investment, goes back to the debate over supply-side economics over the long-term, is it good for the economy, is it bad for the economy? My view is if we're going to have a supply-side debate, I am a supply-sider, but not your kind of supply-sider. I say, let's invest in education and job training. Let's invest in mass transit so people have more capacity to be productive and if that causes a deficit, that's fine because that will generate higher productivity over the long-term. This it seems to me, a people based supply-side economics, which is not trickle down, it is bubble up. It is much more convincing and also more--it comports the reality of our economy.
Peter Robinson: Why would Bush structure a tax proposal in which roughly half of the projected loss of revenue is due to ending the double taxation of dividends, which just smacks of a break for the rich. Why do that?
Michael Boskin: Well, first of all a lot of people get dividends, over half the population owns stock. Now some of them own it inside their 401(k)'s, the IRAs, which this proposal wouldn't reach. However the fact of the matter is that the current income tax laws give corporations a tremendous incentive to debt finance because the interest they pay on their loans is deductible, or on their bonds is deductible, and the dividends they pay to their equity holders, their shareholders is not. That, number one, creates an incentive to over-leverage the economy and increase financial instability. Secondly, it gives businesses the opportunity, since the dividends are taxed, a lot of people say well, don't pay them to us now, we would rather get capital gains, which are taxed more lightly, so reinvest them. So businesses that are doing some shenanigans with their accounting don't have to pay out the cash so it makes it easier for them to hide what's really going on. Thirdly it will provide an incentive in the short and long-term to invest, so it will help the stock market. I don't want to exaggerate it. The effect is likely to be quite modest in the short-term. But what the president was trying to do it seems to me was to design some good policies that could be enacted that would help some in the short-term and be good long-term structure reform. Now you can argue we ought to do a much broader base for tax reform, I think the president is sympathetic to that eventually, but the fact of the matter is this is a good step. It's something that economists have a wide range of philosophical beliefs.
Peter Robinson: Is he not making a mistake?
Michael Boskin: …the administrations of both parties have long proposed.
Peter Robinson: But don't they look disingenuous by saying this is a stimulus package when everybody, there's a lot of Keynes in the atmosphere after 50 or 60 years of it, everybody thinks the stimulus package is just the kind of thing that Bob has outlined. This isn't really a stimulus package, it's a long-term--wouldn't the administration be better served if it simply said, look this is a long-term reform that we need?
Michael Boskin: Because I think it does both. Again we don't want to exaggerate how much it helps the economy in the short-term. It will help the economy in the short-term for the reasons I've already mentioned, that people will spend more because of what they have more now and their rates are going to be lower in the future.
Robert Reich: Can I just respond to this?
Peter Robinson: Go ahead.
Robert Reich: A number of points. Number one, almost every analysis I've seen suggests that at most the President's package is going to stimulate the economy in the range of $70 billion. But states, as you know, 49 out of 50 states have to balance their budgets, they are raising taxes, cutting services to the tune of $85 billion. That more than overcompensates for any stimulative effect in the president's tax bill. This particular tax cut on dividends is not a stimulus. Now we can debate whether it's a good idea over the long haul, the fact of the matter is Michael you said, and you are absolutely right, that most middle income Americans who own shares of stock own them through 401(k)s and IRAs. They are already tax deferred or tax sheltered, what this does is again it rewards people who are at the top.
Peter Robinson: Bob suggests that the rich would unfairly benefit under the president's plan. So what sort of tax structure would he like to see instead?
Title: It's Lovely at the Top
Peter Robinson: In what is ordinarily referred to, commonly referred to as the Old Testament, which is after all concerned with notions of equity and fairness, there is a tax structure laid out which is quite simple. Everybody pays up a tenth of his income; all the households pay up a tenth of their income to support the state and the temple. Is that unfair? Were the patriarchs missing something? Should they have insisted on a more progressive tax code? What I'm getting at is that that strikes everybody as fair, that feels fair, everybody ought to say they will pay the same proportion…
Robert Reich: Even Adam Smith suggested that the principle of equal sacrifice may be different from the same percentage of your income. That is, for somebody who is very wealthy, simply taking 10% of their income may not feel like very much because they are doing so well relative to somebody who is poor--10% of their income, somebody very poor, may feel like a huge amount. So if you believe in the principle of equal sacrifice, you're going to suggest that somebody who is very wealthy actually pay a larger percentage of their income relative to somebody who is very poor.
Peter Robinson: And to what extent is your critique of the tax code, the reforms that you propose, driven by this notion of fairness? Is it secondary to your interest in getting the economy to grow, or is fairness a primary concern in and of itself?
Robert Reich: Well, interestingly in the program so far I actually have not used the term, I don't think, fairness. We've talked, number one, about the fact that people of moderate income, if they get a tax cut, are more likely to spend more of that tax cut than people who are rich.
Peter Robinson: There's been a little bit of an implicit sneer when you talk about the rich.
Robert Reich: No, no. I don't mean to sneer at all. Secondly, over the long-term, I believe that investing in education, job training, healthcare for people, making individuals more productive, I call it bubble up economics, is a more sustainable way of growing the economy than giving tax breaks to the rich and expecting that they through those extra tax breaks are going to have all sorts of incentives to invest in the American economy, particularly when we have a global economy, an investment can go anywhere around the globe.
Peter Robinson: How far are you willing to pursue this principle of equal sacrifice?
Robert Reich: If we are going to keep our society together, widening inequality of the sort that we have had is dangerous. After tax income growth, that is after people have paid their taxes, if you're looking at the top 1% of incomes over the last 15 years, they have increased their after tax incomes adjusted for inflation by about 110%-120%. People who are in the middle of the income ladder, adjusted for inflation, after tax their incomes have gone up anywhere between 5%-8%.
Peter Robinson: Mike? This is the attack that's been leveled on Republican administrations from Reagan on through, how do you answer it?
Michael Boskin: I understand that. Let me tell you how I think about this, and what I think that the overwhelming bulk of the story ought to be. Number one, the main issue is what's good for the economy. It's not quite true that a rising tide lifts all boats, but it's a lot better than an ebbing tide or a stagnant tide. Secondly, the main purpose of the tax system is to raise the necessary revenue to fund the necessary functions of government--defense, some social safety nets, et cetera. That's the primary purpose of the tax code and we ought to raise it as efficiently and effectively as we can doing minimal harm to the economy to raise that. Most of the redistribution that goes on is not in the tax code for lots of reasons, including people figure out ways around high tax rates. Most of the redistribution that goes on is in the transfer payments section of the budget, spending, which is the majority of federal government spending goes for transfer payment purposes.
Peter Robinson: Social security, Medicare…
Michael Boskin: Social security, Medicare, various other types of programs to alleviate various types of suffering, disability payments, things of that sort. So I want to get to the point that I don't think the tax code primarily should be used for redistributing income.
Peter Robinson: Disagreement in principle. You do, don't you?
Robert Reich: No, no I don't. I actually...
Michael Boskin: If you have a very progressive rate structure, rates have to get high and high tax rates discourage working and saving and investing, it causes people to try to shelter their income.
Robert Reich: I agree with Michael, the purpose of the tax code is to pay for services that we need. As Oliver Wendell Holmes said, taxes are the price we pay for civilized society. But when we decide that we are going to spend a certain amount for protecting the nation from terrorism, for our armed services, for everything else that we spend money on, the question is what is a fair distribution of the burden of paying taxes to support those activities? And here we have, and we can have, I think a useful discussion about fair distribution, but I want to mention one other point.
Peter Robinson: We can't, alas, because we're almost out of time. Mention this one other point and I've got to go to a last question.
Robert Reich: We also have to talk about what are called tax expenditures. If you own a house for example, you get your mortgage interest deduction. If you are a renter, you don't get that. If you are an employee and you get a healthcare package from your employer, that is not taxable. If you're not an employee that gets a healthcare package or a pension package, you've got to pay for that. These tax expenditures have to be assessed as well as all of the other spending and taxing and if you look at them you see that those are quite regressive. Poor people who are renting, poor people who don't get their healthcare and their pensions from their employer, those people are at a tremendous disadvantage in terms of the tax code.
Peter Robinson: Last topic, the future of Bush's tax plan.
Title: You Can't Always Get What You Want
Peter Robinson: President Bush has asked for new tax cuts amounting to some $674 billion over the next ten years. This is not a question about theory or principle. This is practical politics about which you both know a lot. How much of that $674 billion over ten years will he get? Bob?
Robert Reich: He's going to get about, I would say, a third of it. He'll probably get the child--things like the child tax credit, ending the marriage tax penalty so-called. I don't believe he's going to get such things as the ending taxation on dividends. There's just too much…
Peter Robinson: They'll just shut him down all together?
Robert Reich: … Senate Democrats primarily, but also Senate Republicans are feeling that not only is the public against that, doesn't really understand it, but it is not justifiable.
Peter Robinson: Mike?
Michael Boskin: First let me say that I don't think it's going to cost anywhere near $674 billion. Number one there will be some re-flow of revenue, not as some people say enough to pay for the whole tax cut, but there will be some re-flow of revenue, and I think cautious estimates suggest maybe 30% will come back from the rate cuts. Secondly you have to understand that with more money coming in, the proclivity of Congress has been to spend more, not mechanically every dollar. So I think if you took that 674 the way an accountant does, the way it's likely to work out in the political economy is to maybe cost half of that. That being said…
Peter Robinson: You're making the very important point that if you didn't give it to the people in tax cuts, Congress would spend some large portion of it anyway.
Michael Boskin: Some sizable portion, we can argue whether that's a third or two thirds or some people would say a hundred percent, it's certainly not zero.
Peter Robinson: Milton Friedman would say about a hundred and ten percent--they'd borrow against it, too.
Michael Boskin: Look at the late Nineties at the federal level, 2000, 2001 in California, the money is there, they spend it. So that's number one. Number two, I do believe that the president will get most of the income tax reductions that he's called for to speed up and to move the child credit forward and to move the phasing in of the ending of the marriage penalty forward and the rate reductions. I think the dividend, the ending the double taxation of dividends, which primarily is a reform as we've discussed earlier, it helps some in the short-term, but it's primarily reform, may or may not pass in its current form. It may well wind up having limits or it may get separated out into some consideration of reform separate.
Robert Reich: Very, very quickly, Michael assumes that Congress is going to spend everything it has. We had a surplus two years ago…
Michael Boskin: I didn't say that. I said that the more money that came in, some of it would be spent.
Robert Reich: But Michael, you have to, your theory has got to account for the fact we had a huge surplus two years ago and now we have huge deficits.
Peter Robinson: It was gridlock. It was gridlock. Bill Clinton belonged to one party; Congress was in the hands, they just couldn't agree on how to spend it.
Robert Reich: We had a stock market boom, massive amounts of revenue coming in…
Peter Robinson: Gentlemen, you may continue talking but the camera is about to go black. Robert Reich and Michael Boskin, thank you very much. For Uncommon Knowledge, I'm Peter Robinson, thank you for joining us.