The Reagan-Roth 30 percent tax cut is a prime example of "for every problem there is a solution: simply, neat and wrong." Or perhaps more to the point, too simple, too big and too soon. Let me take up those charges in reverse order.
Too soon. Putting a $142 billion personal income tax cut on the books all at once -- the first-year cost of $44 billion rapidly mounts to $142 billion per year by 1985 -- involves unnecessary risks.
First, the Treasury might get a rude jolt on its expectations of a huge savings response to the tax cut. In recent years, inflation-wise consumers have been buying ahead to beat price rises. A huge three-year tax cut on the books is an open invitation to consumers to make a lot of purchases on the cuff. The tax cuts would be seen as "money in the bank" on which they could draw to meet future installment payments on present purchases. w
Second, instead of calming inflationary fears, the all-at-once enactment may agitate them. Poll after poll-shows people lukewarm about a personal tax cut, mainly because they fear it would be inflationary. Tax cuts on the books versus budget cuts "on the come" are hardly a way to calm those fears.
Third, as this suggests, Kemp-Roth adopts a cart-before-the-horse approach. True, taxpayers deserve a tax cut as an offset to built-in tax increases, and our soft economy provides enough slack to absorb sizable personal tax cuts later this year. But beyond this, further personal tax cuts should be put in place only after they have been earned by further budget cuts and/or clear evidence of subdued inflation. That would be the path of fiscal prudence.
Too big. By 1985, President Reagan's tax cuts and defense boosts would outrun his budget cuts by about $100 billion a year. By thus perpetuating large deficits -- the Congressional Budget Office projects a $50 billion deficit in 1984 -- the White House would put fiscal policy on a collision course with monetary policy. Much of the force of tax stimulants to investment would be blunted by tigher money and high interest rates. And much of the savings gained through lower tax rates would be absorbed by continued government borrowing. In moderation, tax cuts can strengthen the economy. In excess, they can be self-defeating.
In another sense, the 10-10-10 personal tax cut is simply too big. It preempts so much of the available tax cut money that the prime tax stimulant to investment -- accelerated depreciation -- has to be phased in over a five-year period. Meanwhile, many a business will postpone investments to qualify for progressively more liberal tax treatment.
By its own supply-side lights, the Reagan administration could do far more for the economy by cutting back its 30 percents personal tax cut and sharply stepping up the depreciation timetable.
too simple. The present menu of across-the-board tax cuts would use up all of our elbow room for tax reduction and thus crowd out other measures that might have a far worthier claim for tax relief, for example:
Reducing the so-called "marriage penalty" would be more effective than across-the-board tax cuts in two way: 1) it would provide relief for an obvious case of overtaxation, and 2) it would have a bigger payoff in stimulating additional work effort. Careful studies show that while tax cuts on existing earners don't have much net effect on work effort, second earners in the family to respond to lower tax rates.
Any even handed approach to adjusting taxes for inflation would have to boost personal exemptions and the standard deductions to overcome the erosion since 1978.
Through apparently low on today's agenda, cutbacks in payroll taxes -- perhaps in the form of income tax credits or payroll paid -- would not only provide needed tax relief but also cut business costs.
The Kennedy cuts. Strangely enough, the Reagan tax-cut pattern reverses the approach taken in the Kennedy tax cuts, which Treasury constantly invokes in behalf of its program. First came the supply-side thrust (or, as we called it, "tax incentives for capital formation and growth") in the form of the 1961-62 actions to initiate the investment tax credit (still the backbone of business tax incentives for growth) and liberalize depreciation.
With these supply-side cuts in place, and the economy still operating well-below par, we followed through with the b ig demand-side tax cut of 1964. To be sure, it had beneficial incentive effects, as we were at pains to point out at the time. But there was no doubt then -- and but for supply-side revisionists would not be now -- about its primary purpose: to boost demand and thus put existing supply capacity -- idle workers and excess plant capacity -- back to work.
If the current tax cutters want to draw the right lesson from Kennedy tax cuts, it would be this: Use much of the existing tax-cut margin for sharply forcused investment incentives and then follow through with bigger personal tax cuts as budget cuts and ebbing inflation allow.
Let me add a word on the non-economic aspects of tax cuts. Nothing in the mandate for such cuts calls for suspending the rules of equity and fairness in taxation. If, in flaunting incentives, we flout equity, we will run a grave risk of undermining the democratic basis for confidence in the tax system.