A Cut Below
Conservatives are not picking the best tax-cutting policy.

By Bruce Bartlett, senior fellow, National Center for Policy Analysis
November 14, 2001, 8:00 a.m.

Of course, this caricature is a lie. Conservatives support tax cuts because they favor small government, and they genuinely believe that high taxes on corporations and the wealthy hinder investment, growth, and jobs. But, sadly, they sometimes give liberals evidence for the caricature, as when Republicans in the House recently rammed through, with virtually no scrutiny, a huge tax rebate for big corporations that is unsupported by economic analysis.

Conservative criticism of the House Republican tax bill has been muted because many take the position that all tax cuts are per se good. But that is not true. Some tax cuts can be damaging to the economy by distorting investment and production decisions. In any case, even if one believes that all tax cuts are good, it is obviously not the case that all tax cuts are equally good. Some clearly are better than others.

By failing to distinguish between good and bad tax cuts, conservatives have found themselves on a slippery slope where tax credits and rebates are seen as no different than cuts in marginal tax rates. The marginal rate is the tax that applies to each additional dollar earned. Hence, it is the critical tax rate for deciding whether to increase one's work, savings, or investment. Moreover, marginal tax-rate cuts are always forward-looking, because they affect only incremental economic activity. By contrast, tax rebates have no incentive effects at all, and tax credits are much inferior to tax-rate reductions.

Once upon a time, conservatives were comfortable arguing for tax rate reductions because they understood incentive effects. But somewhere along the way, they forgot their supply-side economics and became lazy. Now they no longer know how to respond appropriately when liberals attack them for cutting the top tax rate just to benefit their wealthy campaign contributors. As a result, conservatives compromised, pushing ill-conceived tax credits and rebates instead of tax-rate reductions.

This was extremely unwise. Tax credits not only have weak or even nonexistent incentive effects, but they are too much like government spending. Soon, tax credits for those who pay taxes morphed into "rebates" for those who pay none. It may be necessary at times to give money to those with no tax liability, but to call such payments "tax rebates" is Orwellian doublespeak. It is a distortion of the language that makes welfare and tax cuts indistinguishable.

We have already seen President Bush's modest tax-rate reduction converted into a de facto spending program through this method. But at least he limited earlier tax rebates to those who actually paid taxes last year. Now, as a stimulus measure, he has endorsed another round of rebates for those with no income tax liability at all, even though there is no evidence whatsoever that rebates raise consumption or growth.

Once the linkage between tax cuts and tax liabilities for individuals was destroyed, the next step was to extend this logic to corporations, as well. Thus House Republicans made rebates to corporations for past-paid alternative minimum taxes the centerpiece of their stimulus plan. But there is not the slightest reason to believe that sending rebate checks to corporations will do any more to stimulate growth than those to individuals.

Since there is no economic rationale for the House plan, liberals are free to assume that it is simply payback for corporate campaign contributions. Left-wing groups like Citizens for Tax Justice are having a field day making this argument. Republican supporters of the corporate rebates implicitly concede the truth of this attack by failing to offer any kind of serious economic justification for their action.

There is a good case that can be made for reducing taxes on investment in order to boost the economy. And there is a very strong case for abolishing the alternative minimum tax on corporations, and indeed the corporate income tax itself. But that case has not been made by those pressing the corporate rebate plan. As a result, not only will they lose legislatively in the end, but they have handed their enemies a potent political issue. They are, in effect, confirming the liberal caricature of conservative tax policy.