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Make the Tax Cut Bigger

And do it faster

11:00 PM, Jan 21, 2001 • By ARTHUR LAFFER
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THIS TIME LAST YEAR many conservatives wondered aloud whether George W. Bush was genuinely committed to his own tax cut proposal. Now it seems that Bush is the only supply-side tax cutter left in town. He has been heroically unwavering in support of the $ 1.3 trillion tax cut, but the media, many mainstream economists, and congressional leaders in both parties are urging a go-slow approach. Speaker of the House Denny Hastert has suggested to Bush that he divide his tax cut up into small digestible pieces, a compromise that could undermine the chances of the crucial income tax rate cut. Bob Dole has advised that Bush's tax cut be put "on hold." Meanwhile, on Face the Nation, Senate minority leader Tom Daschle moaned: "I can't think of anything that would divide the nation more than pushing that tax cut at that size."


Bush has smartly countered that the slowdown of the economy, the bearish stock market, and the specter of a looming recession only strengthen the case for tax rate cuts. Ironically, six months ago the Clinton Treasury department and other Bush opponents were arguing that a Bush tax cut was inadvisable because it could cause the roaring economy to "over-heat." Of course, that worry's now the least of our problems, but the tax cut foes are as opposed as ever to the Bush proposal. The latest mantra against tax cuts is that they are ineffective at stimulating the economy. The Washington Post, for example, recently editorialized that "the best tool for managing the economic cycle is usually not fiscal policy, but interest rates, which the Fed can change at its annual meeting."


Yikes! This advice is so wrong-headed that it needs to be thoroughly expunged before it begins to steer the economy further off track. So let us try to explain why Bush is right on taxes, and his critics aren't.


First, we should all agree that the U.S. economy does need some anti-recession insurance right now. Just since the election, roughly $ 1 trillion of wealth has disappeared through sliding stock values. The Gross Domestic Product growth rate was a robust 5 percent in 1999; now it's an underwhelming 2 percent. Retailers felt the pinch during the Christmas shopping season; it's going to get worse in the first half of 2001. And if the economy does hit a recession, low-income and working-class Americans will be the ones hurt most, not the rich people whom tax cuts supposedly benefit.


There's some persuasive evidence that the economy is suffering from tax drag. Fiscal policy is way too tight. In 2000, federal, state, and local governments collected a combined $ 300 billion in excess taxes over spending. That's almost 4 percent of GDP devoted to tax overpayments. Over the course of the past 30 years, a tax-to-GDP ratio of more than 20 percent has typically sounded a Code Blue warning of recession. Since 1995 the tax-to-GDP ratio has risen from 18 percent to about 21.5 percent. Amazingly, today's tax burden is higher than that of the stagflationary Carter years. This fiscal anchor needs to be lifted.


So we have a record tax burden, a huge budget surplus, and the near-term horizon shows the potential for an economic crash. If a supply-side tax rate reduction isn't advisable now, just when is the appropriate time to cut tax rates? Even left-leaning Keynesians should be agitating for a tax cut now. Where are they when we need them?


We would note that in the past 18 months many of our major economic competitors -- including France, Germany, and Japan -- have lowered income taxes to jump-start their stagnant economies. Because we have done nothing to chop our own taxes, our international competitive tax advantage has deteriorated.


The alternative economic rescue plan, supported by many Wall Street economists and almost everyone in the media, is to continue to use the Federal Reserve Board to stimulate the economy. This approach is dangerously misguided. If there is a single enduring economic lesson of the past 25 years, it is that loose monetary policy can never offset the contractionary effects of high taxes. Loose money and high taxes were the ill-designed formula of the 1970s that led to high inflation, low growth rates, and a yawning bear market.