National Review, October 23, 2000
Tax (Credit) & Spend
Liberalism's latest social engineering.

By Lawrence Kudlow, NR contributing editor

s the presidential campaign takes on a more ideological cast, it's the argument over tax cuts that most dramatically captures the different visions of government of the two candidates.

George W. Bush's tax-cut plan would shift a substantial amount of economic power from the federal government back to individuals. Bush aims to limit federal tax revenues to no more than one-third of the income people earn, and there's a strong moral dimension to this economic principle: Bush believes that self-governing individuals — as they exercise their personal responsibilities to each other, their families, their businesses, and their communities — will be a more reliable engine of prosperity than any number of Washington bureaucrats and regulators.

Bush's one-third rule on taxes holds the key to understanding who the Texan really is, and how he would govern if elected president. The contrast with Al Gore couldn't be more striking. Gore's tax plan contains no fewer than 29 targeted tax credits, each with specific government-approved behavioral requirements and means-tested income thresholds for eligibility. This is not a tax-relief package; it's an IRS-administered monopoly of government entitlements, transfers, grants, and subsidies, adding needless complexities to the confusing system of pulleys and levers in the existing tax code. Together with the harsh regulations he has threatened to impose on unfavored businesses, Gore's tax-credit avalanche would drastically enlarge the government's role in the economy. He told the Democratic convention that only "over my dead body" will there be across-the-board tax-rate reduction. In Gore's view, the free-enterprise sector has gotten out of government's control, and his almost $3 trillion in new spending and targeted tax credits will inject a strong dose of federal guidance to curb its power.

The upshot of Gore's plan, however, will be to curb economic growth. Personal tax payments are now rising more than twice as fast as income, forcing middle-income earners into higher tax brackets that erode their purchasing power and weaken their incentives to work and invest. Gore's plan proposes nothing to offset this effect. One major problem with Gore's tax credits is that taxpayers are punished — by losing their tax benefit — when their income rises above the threshold that qualifies them for the credit. Research by the American Enterprise Institute shows that this penalty — effectively, a tax hike for earning more money — will threaten those taxpayers who receive Gore's tax credits for education, after-school care, day care, long-term health care, and health services for disabled workers. This tax hike comes on top of the 28 percent tax rate (for those earning $45,000), the Social Security-Medicare payroll tax, and assorted state and local taxes. A successful worker claiming one or more of Gore's credits could find herself with a combined tax rate well over 50 percent. This is not exactly "tax fairness."

Possibly the worst tax-rate spike involves Gore's retirement savings plan. A married couple earning $30,000 is eligible for a three-to-one matching grant if they save $500. However, should the breadwinner get a salary hike of one extra dollar, then the three-to-one match turns into a one-to-one match — causing a $1,000 income loss for that family.

WEFA, a highly regarded Philadelphia economic-forecasting company, has studied the Gore and Bush tax plans and concluded that Bush's would promote slightly more economic growth and lower unemployment. According to Michael Donnelly, WEFA senior economist and the study's author, "Gore's tax proposal is more of a spending plan. The tax plan is a vehicle for social change based on Gore's behavioral norms."

Under Bush's plan, by contrast, all taxpayers would get relief, with those at the low end of the income scale actually receiving proportionately larger reductions. If one includes Bush's proposal to give a couple of percentage points of payroll taxes back to workers for private investment accounts, then the benefits for low-income earners — especially for the roughly 30 million people who work but pay no income taxes — are even greater. According to Bush adviser John Cogan, 6 million two-parent, two-children families earning less than $35,000 a year would have no income tax liability. What's more, by dropping the current 15 percent rate to 10 percent, and doubling the family allowance, the Bush plan would substantially reduce the penalty now faced by low-income earners whose successful work effort moves them up the ladder, but causes them to lose the refundable earned-income tax credit. This is what Bush means when he talks of lowering the tollgate for entry into the middle class.

But at the heart of the Bush proposal is the increase in economic benefits — and tax revenues — from lower tax rates. He intends to replace the current system, which has tax rates of 15, 28, 31, 36, and 39.6 percent, with a 10-15-25-33 percent schedule. Top earners would take home 67 cents on the extra dollar earned instead of 60 cents: an increased incentive of roughly 11.5 percent. Middle earners dropping to 15 percent from 28 percent receive an 18 percent incentive increase. As supply-side founding father Arthur Laffer taught us many years ago, it must pay to work, produce, and invest. When it pays more, the economy grows and tax revenues rise.

Over the past five years, the U.S. economy has grown at a 4 percent annual rate. Assuming that Bush's tax cuts generate an aggregate 12 percent increase in after-tax rewards, then the future economy would grow at a 4.5 percent yearly rate. The economy would double in 16 years, with a near doubling in the level of productivity. As revenues from more payrolls fill the Social Security coffers, the greater availability of goods and services will absorb the money supply and actually reduce inflation and interest rates. (This is exactly what happened during the Reagan years, though most economists still refuse to admit it.)

By 2020, Bush's plan would produce $400 billion in extra tax revenues (using a 20 percent average tax rate). But if Gore's spend-and-regulate policies were put in place, the old 4 percent yearly growth baseline could slip to 3.5 percent — with the result that, by 2020, revenues would be $800 billion less than those generated by the Bush program.

Bush's plan is not perfect. His roughly $800 billion in new spending proposals may be only a third of Gore's total, but it is still too much. The governor also proposes several new tax credits for education and health care, but these would be unnecessary if the top tax rate were lowered to 25 percent. Eliminating the estate tax, as Bush proposes, is a pro-growth measure, but it would have been improved by the addition of a lower capital-gains tax. He also should have included faster write-offs to lower the cost of new business equipment; this would help generate greater energy output, and ease the adaptation of old-economy industries to the age of the Internet.

But the bottom line remains that Bush's broad-based tax-cut plan would expand the economic pie. It would help everyone and hurt no one. It would advance economic freedom and restrain government planning. "My plan is one that gives people options, not orders," Bush told a recent audience in Chicago.

Fundamentally, Bush believes that the men and women on Main Street — not the government — are the true source of power; their responsibilities must not be usurped by government, lest the community be weakened both socially and economically. This moral vision of how a prosperous society should function would be the guiding force for the policymaking of a George W. Bush administration.