Readers of this page during recent weeks might easily come to the conclusion that there is no such thing as a sound argument for a federal tax cut. While it is impossible to defend some of the absurdities of the bill that Congress passed, there actually are some good reasons for a sizable cut that would be phased in over a number of years.
The first justification for a cut is that federal tax revenues are now at a peacetime record as a percentage of GDP: 20.7 percent, compared with slightly less than 18 percent early in this decade. An extra three percentage points of GDP have been lost by taxpayers to the federal government due to the tax increases of 1990 and 1993, as well as rapid growth of the economy, which pushed people into higher brackets. It is interesting to note that the last time the share of GDP going to the federal government increased sharply was when Jimmy Carter was in office. The previous time was when Lyndon Johnson was president. The only time in U.S. history that federal taxes took the current share of GDP was late in World War II.
The federal take-out from GDP has increased sharply precisely when military expenditures have been declining. During the early and mid-1980s, the United States regularly spent slightly more than 6 percent of GDP on national defense. During 1997-98 the average was 3.66 percent. If we have saved almost 2.5 percent of GDP in military expenditures because of the end of the Cold War, and if federal taxes are now the highest percentage of GDP in history except for 1944-45, why can't we get some of the money back?
The response to this argument is that any major tax cut will help only the "rich." Since the top 10 percent of all taxpayers produce 62.5 percent of all personal income tax revenues, it is obvious that the prosperous will be helped by a tax cut. That top 10 percent, it might be noted, includes many families that are far from "rich" if they live in high cost-of-living regions such as Washington or New York. The 1990 and 1993 laws made the federal income tax much more progressive than it had been in many years, and a lot of decidedly middle-class families were affected by these laws.
But then the reply is that the top rates are only 36 and 39.6 percent. That reply is a falsehood. The 36 and 39.6 statutory rates do not include the phase-out of personal deductions and exemptions, and the uncapped Medicare tax of 2.9 percent on self-employment income or 1.45 percent on wages and salaries. The top federal tax rate is now about 45 percent, and those in the 36 percent bracket are actually facing about 41 percent. When state and local income taxes are added to those rates, the final marginal tax rates on labor income can exceed 50 percent in jurisdictions such as New York, California, Maryland or the District. Most people living in these jurisdictions who are in the 36 percent statutory federal bracket actually pay a marginal rate of about 45 percent. The often-repeated claim that the United States is a "low tax" country is absurd.
Then it is argued that the tax bill that passed Congress is too large, that its timing is bad because we are in a boom and that it includes too many special interest give-aways, some of which are intended to benefit only one industry or even one company. Those complaints are largely correct. The bill being sent to the White House is a Christmas tree for major contributors to political campaigns, and many members of both houses who voted for it did so only because they knew it would never become law.
After President Clinton vetoes the current bill, it is time for serious negotiations on a law that makes sense. It should have the following characteristics:
First, there should be no special interest provisions that are directed at a single sector of the economy, industry or firm.
Second, the bill is not to complicate the tax code and wherever possible is to simplify it; the 1997 law was absurdly complex and mainly provided a source of employment for accountants.
Third, although the bill is to become law in 1999, the actual timing of the tax cuts is to be tied to the business cycle. The law might provide for no tax cuts as long as the unemployment rate remains below 5 percent, modest cuts if the rate is between 5 and 6 percent, and more rapid cuts in a clear recession.
Finally, the estimated 10-year cost of the bill (assuming normal business cycles) is not to approach the $792 billion of the bill that Congress passed; somewhere around $500 billion might be appropriate, and probably slightly below that number rather than above it.
If, after the existing bill is vetoed, the White House and the leadership of both houses of Congress will negotiate seriously, a realistic tax cut can be produced. The central point remains: Federal taxes are at a peacetime record share of GDP and are very close to the 1944-45 wartime record. We have saved almost 2.5 percentage points of GDP in the national defense budget because of the end of the Cold War. It is time to pass a law that will give some of the money back to the taxpayers as soon as the economy slows down. It is, after all, their money, not the government's.
The writer is a professor of economics at George Washington University.