"Scaling down the president's proposal, especially the three-year cut in tax rates, would return nothing, but could well destroy the basic incentives for saving and investment which are at the heart of the program."
So said Treasury Secretary Donald T. Regan only a month ago, as he set forth the original "supply-side" rationale for President Reagan's tax cut plan.
Now Reagan himself has proposed scaling down the plan. Has he left intact the supply-side heart his treasury secretary described last month? Or has his plan become, as some Democrats have characterized it all along, less a new kind of restorative for the economy and more on old-fashioned Republican tax cut tilted toward the upper-income regions?
In the last few weeks of bargaining and head-counting on taxes, the original supply-side rationale for Reagan's program has almost been lost sight of.
This rationale was that sizable cuts in marginal tax rates -- those paid on the last dollar of income -- would spur people to work harder and save more. These income tax cuts would boost growth, but not through potentially inflationary increases in demand.Rather they would lead, so the theory went, to enormous increases in investment, financed by much higher savings, and to greater output from harder-working people.
Despite Reaganhs latest concessions on his tax plan, he is sticking firmly to two key elements of the original. The administration is insisting on three years of tax cuts, and that the rate reductions should be "across the board," meaning the same percentage in every income bracket.
Regan says that three years of cuts are needed "generally because of planning." Business and individuals need to know in advance what tax they will pay so they can plan their savings and investment, he told reporters.
But the big uncertainty for most taxpayers is what will happen to inflation and to their wages and taxes because of it. Inflation tends to push people into higher tax brackets, even if their real or after-inflation incomes stay the same. Any tax cuts in the next few years have first to offset this effect, before they can begin to lower the real tax burden.
The other justification given by those who favor a three-year cut has been simply that unless tax cuts are spread out over several years, it will be impossible to win big enough cuts to have a supply side effect.
Reagan has agreed to give up pushing for the full 30 percent tax cut and is now proposing a 25 percent cut in rates over the 33 months of his revised plan. This is still a much larger cut than the mainstream Democrats say they want, although they have left open the possibility of enacting more cuts in later years.
But it may well not be enough to satisfy true supply-siders. The 5 percent rate cut that Reagan now wants in October would only reduce 1981 tax liabilities by 1 1/4 percent.
It would leave most Americans still with a bigger tax burden, facing higher, not lower, marginal tax rates, in the first year of Reagan's administration that in President Carter's last.
A major reason for the administration's change is that Reagan wants to cheer up the financial markets and win the support of conservative Democrats. Both groups would like a lower budget deficit, and the new proposals would reduce next year's deficit significantly.
But "dilution of the tax cut program in order to limit short-run static revenue losses during the remainder of FY 1981 and FY 1982 would be counterproductive," Office of Management and Budget Director David A. Stockman argued last autumn in his famous "Dunkirk" memorandum, which was the purest statement of the administration's original supply-side intentions. He said that supply-side tax cuts were needed to spur production, and thus avoid recession-linked spending.
Cutting back the overall size of the tax cut in the early years runs the risk of rubbing off the supply-side gloss on the original Reagan proposal.
If, undeer the compromise Reagan plan, marginal rates for most people are not actually going to be cut very much (once inflation is taken into account), then the supply side magic, whereby people will work harder and save more because they get a bigger after-tax reward for doing so, vanishes.
It was already somewhat tarnished. Figures produced by the Treasury Department last month showed that the president's first proposal, assuming inflation comes down as the administration predicts, would slice only one percentage point between 1980 and 1984 off the marginal tax rate paid by a middle-income family of four, now earning about $28,000. Critics doubt that really would be enough to transform the family's attitude toward work and saving.
The other point that the administration is sticking to is that cuts should be across the board. This has been challenged by the Democrats on the grounds that it benefits higher income brackets, those earning $50,000 or over, rather than those lower down the scale.
The reason is that while an across-the-board tax cut reduces everybody's tax bill by the same percentage, it gives a bigger boost to the after-tax incomes of those who pay most tax.
Rich people have a high proportion of the total income in this country. But they pay an even higher proportion of the total income taxes.
At present, the top 20 percent of households, earning more than $30,000 a year, have 50 percent of the income and pay 65 percent of all income taxes. This distribution has remained remarkably stable for about the last 20 years. Tax bills have been geared to preserve it.
The Reagan proposals break with that tradition. Administration officials defend the change on the grounds that those who pay the most tax deserve the biggest tax break. They have also sometimes said that it is those better off who have most savings to invest, and so it is there that the supply-side effects will be largest.
But Reagan promised to reduce the tax burden for all Americans on the grounds that all could and would respond to bigger incentives. Regan defended the administration's original cuts as a plan that would "restore the reward to working men and woman" and "help all Americans equally."
He also said that the tax plan proposed was "not the usual tax reform that shifts income between different sets of taxpayers."
However, the distributional changes that would come with an across-the-board cut are quite significant. When combined with the fact that inflation and scheduled Social Security tax increases hit income brackets of less than $50,000 more than those who are better off, such cuts would shift some of the tax burden of those at the top to people lower down the scale, even though the better-off would still be paying proportionally more in taxes than those at the other end of the income spectrum.
If the supply-side rationale slips away, then the Reagan tax proposals start to look more like the old-style Republican bill that the Democrats profess to see.
However, the Democrats themselves have proposed a measure that both helps to back up the supply-side argument and to benefit the rich. The immediate reduction in the top tax rate on unearned income from 70 percent to 50 percent by definition only helps those at the top. The consequential cut in capital gains tax overwhelmingly benefits those with incomes of over $100,000 a year.
Other proposals that Reagan has taken into his bill -- and as the weeks go on there will no doubt be bargaining over these -- include Republican favorites such as special incentives for saving, a reduction in taxes for Americans working overseas, and a major cut in estate taxes. The proposed reduction in the marriage penalty, whereby some couples pay more taxes when married than they would if just living together, is popular with both Democrats and Republicans. But it does help the supply-siders' arguments, as it would cut the marginal tax rates faced by many married women.
Administration officials will no doubt argue, quite rightly, that by standing firm for their tax plan they have forced Congress to move noticeably toward it. If Reagan can force through his revised plan, or something close to it, over the objections of House Democrats he will win a tax bill that is very different from others in the past 20 years. But the shift may be more toward traditional Republican doctrine than toward any new supply-side faith.