It's Time to Cut Tax Rates

Congress is faced with the unusual question of what to do with the $5.6 trillion surplus expected to accrue over the coming ten years. Almost everyone agrees that this huge amount of taxpayer money ought to be used to shore up Social Security and Medicare, and pay off the nation's short term debt as it comes due. What they don't agree on is whether the remainder of this expected surplus should be left in the pockets of those who earned the money, through lowering tax rates, increasing credits, or eliminating certain kinds of taxes altogether.

President Bush proposes to use $4 trillion (71%) of this surplus for social security, medicare, and the national debt, for increased spending on defense and education, and for a contingency fund. He has asked Congress to let taxpayers keep the remaining $1.6 trillion, by reducing individual income tax rates for all taxpayers, doubling the child care tax credit to $1000, reducing the "marriage penalty", expanding the charitable tax deduction for filers who don't itemize, and repealing the "death tax". The Democrats have grudgingly agreed to a total tax reduction of as much as $900 billion. There the battle line is apparently drawn.

We have had this battle before. President Reagan began his presidency in 1981 by urging a Democratic Congress to reduce individual income tax rates by ten percent each year for three years. At that time the nation was running a $79 billion annual deficit. In late 1980 the inflation rate had reached the annual equivalent of 13%. The bank prime lending rate had reached 21%. The economy was in the tank. Reagan promised that a major tax rate cut plus restraint on government spending would jump start the floundering economy. He also made - correctly, as it turned out - the "supply side argument" offered earlier by John F. Kennedy (1962) and Calvin Coolidge (1926): that the taxes flowing in from a reinvigorated economy would offset some of the calculated revenue reductions.

Reagan bought off enough Democrats in Congress to get a three year 5-10-10% cut in individual income tax rates. This became fully effective in 1984. In 1983 the economy bottomed out and started up. Over the next six years the nation experienced the greatest peacetime economic boom in its history.

Contrary to Democratic expectations, individual income tax revenues climbed steadily from 1983 to 1989. Unfortunately, so did deficits. But the large deficits were not due to any shortage of income tax receipts. They resulted from Reagan demanding more defense spending, and Congress insisting on more domestic spending. Congress increased every budget Reagan sent, and Reagan chose not to veto them.

The Federal government's overall tax take has now risen to 21% of Gross Domestic Product, the highest level since World War II. The revenue inflow has produced unprecedented surpluses. But the economy is slowing after seven excellent years. What better time to stimulate that economy by leaving 28% of the expected 10-year surplus in the hands of taxpayers, to spend and invest in the creation of new (taxable) wealth?

Unlike Reagan, who proposed and got across the board rate cuts, Bush has proposed rate reductions tilted toward the lower brackets. The current five-bracket structure would be reduced to four (10, 15, 25, and 33%). The child tax credit would be doubled to $1000 per child. A family of four earning $35,000 would not owe any income tax at all. A $50,000 family of four would pay at least $1600 less to Uncle Sam. Of course, high income families would get larger dollar reductions, because they paid much more in taxes. In fact, the top 5% of income tax payers pay half of all individual income taxes. But Bush's proposal, approved by House Ways and Means on March 1, offers greater percentage reductions at the lower end of the income scale.

Vermont's income tax is piggy backed to the federal tax liability. Will the rate reductions in Bush's plan starve state government? This is a valid concern for state revenue planners.

In November 1986, faced with a sweeping bipartisan tax reform bill in Washington, Vermont's Joint Fiscal Committee set the Vermont piggyback rate at 25.8% instead of letting it fall to 24% as scheduled. The result was a huge revenue gain. Gov. Kunin and the legislature cheerfully spent the money. Three years later, the state faced a $65 million general fund deficit caused by the legislature's inability to control spending. This unhappy result required two major tax rate increases. It took Vermont taxpayers four years of high income tax rates in a strong economy to pay the state's way out of that hole. (They are still paying the extra sales tax and rooms and meals tax enacted to solve that 1991 problem.)

Sen. James Jeffords, Sen. Patrick Leahy, and Rep. Bernie Sanders are all claiming that the Bush tax reduction proposals are "too much" and "favor the rich". Translated, that means they want the government (i.e., themselves), and not the taxpayers, to enjoy spending the taxpayers' money. With a smaller (or zero) tax reduction, the Congressional spenders could pay for even more Big Government than Bush is asking for. How another $1.6 trillion of Big Government - on top of Bush's proposed new spending for defense, health care, veterans, environment, and education - would improve the nation's economic prospects, not to mention Vermonters' desire to keep more of their paychecks in their own pockets, they have yet to explain.

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March 2001