Budget Economics, Politics Collide
Washington Post Staff Writer
Wednesday, July 28, 1999; Page E1
The good news for critics of the big GOP tax packages now moving through Congress is that many economists say tax cuts are a terrible idea right now, since they would probably accelerate consumer spending, pouring gasoline on the fire of an already hot economy.
But the bad news for the critics, many of whom want to use the federal budget surplus to boost spending instead of cutting taxes, is that a lot of those same economists think more government spending is an equally terrible idea--for the same reason.
They fear that further stimulating a booming economy could trigger a destructive outburst of inflation, or even an expectation of inflation that could spur the financial markets or the Federal Reserve to raise interest rates. Then consumers would lose ground to higher mortgage costs, car payments, credit card charges and other expenses that are tied to interest rates, while businesses would have a harder time investing and expanding.
"You really wonder, does Congress not understand this?" said Nicholas S. Perna, chief economist with the Fleet Financial Group in Boston. "If financial markets get spooked by the consequences of big tax cuts and big spending increases, [they] might raise interest rates."
The most influential economist to argue against reducing taxes now is Federal Reserve Board Chairman Alan Greenspan, who bitterly disappointed Republican tax cutters last week when he refused to endorse their plans.
"Hold off for a while," Greenspan said when asked during a congressional hearing whether he thought the cuts were a good idea. "The timing is not right."
Greenspan, a Republican, has long been a supporter of the very reductions in income and capital gains tax rates that congressional Republicans are pushing. But he gave several reasons for delay. First, the forecast surplus that Republicans plan to use for tax cuts might not materialize; better to wait until it actually shows up. Second, doing nothing with the surplus now means it will be used to pay down the publicly held national debt, which drives down interest rates, promotes investment and helps build the government's borrowing capacity for the future.
And finally, Greenspan said, tax cuts would be a powerful weapon to unleash when the economic boom eventually cools off; better to keep the weapon in reserve than to use it now.
"Allow the surpluses to run for a while," Greenspan counseled. "I see no reason why we have to make decisions crucially at this point."
While Greenspan did not say it, many economists fear that the Federal Reserve would raise interest rates to compensate for the unwelcome stimulus of a big tax cut. "You have a strong economy that the Fed would like to see slow [so it could] avoid raising interest rates," said Steve Ricchiuto, chief U.S. economist with the Dutch bank ABN Amro Inc. Ricchiuto's concise translation of Greenspan's lengthy message to Congress on tax cuts: "Save it for a rainy day, guys."
Democrats seized on Greenspan's comments as proof that they are right when they argue that the Republicans' proposed tax cuts are ill-advised. But the rest of what Greenspan said on the subject could not have lifted the spirits of the Democrats, particularly those pushing a plan to divert a substantial amount of the surplus to increased spending for defense and domestic programs.
If not cutting taxes means the surplus would instead be used for "major increases" in government spending, Greenspan said, "I would be far more in the camp of cutting taxes." Increased spending, he said, is "the worst of all possible worlds from a fiscal point of view, and that, under all conditions, should be avoided."
Not all economists fall into line behind Greenspan on the question of deferring tax cuts. Sara Johnson, North American research director with Standard & Poor's DRI, said the GOP tax-cut plans phase in so slowly--next year's reduction would be less than $5 billion of the nearly $800 billion, 10-year package--that the economy could well be cooling off before the full effect of the cuts is felt.
And as for provoking the Fed to raise interest rates, she said, it's likely that other forces would offset any stimulus from the tax cuts. "Interest rates are rising, and the 20 percent to 25 percent annual gains in the stock market are a thing of the past," Johnson said. "Therefore, consumers are likely to become more cautious and save more of what they earn."
The question of what consumers would do with a tax cut is at the core of the economic debate over whether the cuts are a good idea. If people react to lower taxes by buying more cars, clothes and CDs, that "demand-side" stimulus might push the economy to the point at which inflation takes off. But some economists argue that if consumers react by saving more of their money and working longer hours because they could keep more of what they earned, that "supply-side" stimulus would not overheat the economy.
Trouble is, economists say tax cuts often have both demand-side and supply-side effects, and they can disagree wildly over which is bigger, when it kicks in, and so on.
"There will be people that do nothing, but there will be others who may, for instance, postpone retirement," said Ken Mayland, chief economist for KeyCorp, a Cleveland banking company. "People take two jobs; people that weren't working before decide it literally pays to work . . . a combination of all this stuff that goes on at the margin will increase labor supply marginally and therefore has supply-side effects," said Mayland, who argued that tax cuts would help improve the now-tight labor market.
Some economists preach compromise. Perna recommends legislating a tax cut but leaving it on the shelf, unimplemented, until the economy stumbles and needs a boost. "When might that be? That's awfully hard to predict," he said. "You can't gear it to the election cycle."
And others suggest letting the country decide. "There is no overwhelming urgency to do anything now," said Allen Sinai, chief global economist for Primark Decision Economics. "It properly belongs in the politics of the year 2000."
© 1999 The Washington Post Company