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Taxing Issues

As the president and Democrats negotiate tax breaks, there are economic and political considerations aplenty.

11:00 PM, Jan 7, 2003 • By FRED BARNES
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It's not just which taxes President Bush and Democrats are proposing to cut and how much. Just as important is when the cuts actually begin to have an impact. You shouldn't be surprised to learn that the Democratic proposal is focused entirely on 2003, after which the economy is on its own without stimulation from Washington. As for Bush, while his plan may jolt the economy a bit this year, its real aim is to boost economic growth, the stock market, and job creation in 2004 and beyond. The president's economists expect only a 0.4 percent increase in growth this year if the Bush plan passes, but a full one percent hike in 2004.

Now you might call this aspect of the Bush tax cut--the when--the Karl Rove effect. Rove is the chief White House political operative as well as an all-round policy adviser. And of course a robust economy is essential to Bush's success in seeking reelection in 2004. But politics isn't the whole story behind the Bush tax proposal, only part of it.

Political concerns surely played a role in steering Bush away from a quick fix in 2003, which is what Democrats are advocating. But there are two other reasons why the president wasn't interested in an instant big bang. One, is he doesn't think the economy is in terrible shape. It merely has some "downside risk" of weakening, as Bush economic adviser Glenn Hubbard puts it. And, two, the president doesn't think injecting a huge amount of cash into the economy today would solve the real problem. Investment in buildings and equipment dropped 5 percent in the year following the terrorist attacks on September 11, 2001, and businesses cut 1.2 million jobs. That's the real problem: a lack of investment, not a lack of consumer spending.

This can't be dealt with except by tilting tax cuts toward the well-to-do and business because that's where the money for investment is. Bush didn't go for shaving the corporate tax rate. Rather his approach is to accelerate all the income tax rate cuts enacted in his 2001 tax bill but not scheduled for phasing-in until 2004 or 2006. Every rate would be reduced, most importantly the top rate (from the current 38.6 percent to 35 percent). Believe it or not, this would enormously aid millions of small businesses who pay regular income tax on their earnings. They are Bush's candidates for new investment.

Were Bush only worrying about the politics of cutting taxes, he probably wouldn't have decided to eliminate the tax on stock dividends. Many economists question whether it would juice up the economy. And most of its benefits are bound to go to wealthy stockholders, thus prompting Democratic criticism. But it's bound to improve the stock market by making dividend-paying stocks more attractive and freeing money for investment. And guess when stockholders will actually get their tax cut? When they file their returns in 2004.

In truth, Bush has proposed the kind of tax cuts he likes, the cuts which provide incentives to save and invest. He wanted to end taxation of dividends even before he heard Charles Schwab, the stockbroker, propose it at the Waco economic summit last August. Anyway, that's the non-political part. And the cuts should be felt strongly in 2004. That's the political part.

Democrats don't care about incentives or making tax cuts permanent and their plan reflects that view. And they loathe reducing income tax rates, so that's not in their bill either. Democrats boasted that the entire $136 billion in cuts and spending in their bill would be provided in 2003. After that, zilch. Might this cause an economic dip by late 2004? Yes. Might that have occurred to Democrats? No doubt.

One final thing. Bush emerged as a strong commander in chief after September 11 and Republican success in the 2002 election increased his political clout. Democrats have tacitly acknowledged his strong political position by proposing their own tax package. Normally they dislike playing the tax cut game because it's one they rarely win. But they had accused Bush of devoting too much time to fighting terrorism and Iraq and too little to the economy. He called their bluff. Much as they didn't want to, they had no choice but enter the fray.

Fred Barnes is executive editor of The Weekly Standard.