The President's program, if passed unchanged, would cost the Treasury $364 billion over the next 10 years in lost taxes on dividends alone. Tax-rate cuts scheduled for next year and 2006 would start immediately, as would a $400 increase in the tax credit per child. The proposal would also speed relief from the marriage penalty and alternative minimum tax and lift expense allowances for small businesses. Including a few other measures, the total package would remove $674 billion from federal coffers; after interest on the debt, the tab over a decade could be more than $900 billion.
These proposed tax cuts are more than twice what Bush's allies had expected and certify the baseball-loving President as a man who swings for the fences. In slashing taxes on dividends rather than, say, the payroll tax, Bush is playing to the supply-side crowd and investor class for whom the stock market is critical. In making the wealthy the biggest beneficiaries of the cuts, Bush is willing to face down accusations of class warfare.
In its willingness to risk cranking up the deficit to record levels, the Bush team is repudiating a decade-long Republican fixation on balanced budgets as well as the Clinton Administration's bedrock belief that big deficits lead to higher interest rates and hurt long-term growth. And in focusing on economic expansion in 2004 rather than short-term stimulus now, Bush may imperil an already jobless recovery.
Yet if the stock market is levitating and unemployment is falling around election time, 21 months from now, when most of the benefits will start to kick in, Republicans believe that key voting groups like married couples and seniors will not really care if the rich got richer as long as they did too. "Our first challenge is to allow Americans to keep more of their money so they can spend and save and invest," Bush said in announcing the program in Chicago last Tuesday.
Democrats, several of whom have unveiled their own more modest proposals, say Bush's economics embrace a central stereotype of the Republican Party: only the rich need apply. Although Bush touted the fact that the average tax bill would shrink $1,083, almost half of all filers would get reductions of less than $100, according to the left-leaning Center on Budget and Policy Priorities. The top 1% would get breaks of $24,400, on average. "This is the most reckless policy I have seen pursued by any President in my adult life," fumes Kent Conrad of North Dakota, the ranking Democrat on the Senate Budget Committee.
Reckless or not, here it comes. The House, where the Republicans are comfortably in control, is likely to move quickly to serve up a bill mirroring or exceeding the White House plan. The Senate is a different animal. There, expect a hagglefest over the critical swing bloc of moderate Republicans and Democrats. Republican Senators John McCain and Lincoln Chafee are already calling for more relief for the middle class. There will likely be a scaled-back compromise, finalized perhaps this summer. But that's how the Bush team is playing it: scaling back from 100% gets you more than scaling back from half as much.
That the tax-cut benefits will be concentrated heavily in the upper income brackets--59% of the reductions would go to the top 10% of earners, according to the Brookings Institution--matters little to Republicans. For them, it's a question of mathematics, fairness and job creation. Any percentage cut across the board will always favor those who have more. "You have to give tax cuts to the people who pay taxes," argues House majority whip Roy Blunt. Those same cuts, Bush said last Thursday, give "that small-business owner more money to invest in the growth of the business, which means it's more likely he or she will be able to hire somebody additionally."
But not soon, apparently. Since Bush took office, the economy has shed more than 1.2 million jobs, including 101,000 in December. "It's debatable how much the dividend-tax elimination will stimulate the economy, particularly in the short run," says Ed McKelvey, a vice president and senior economist at Goldman Sachs.
Bush's economic mavens say the cuts will inject $59 billion into the economy this year. But even they shy away from calling this a stimulus package. In their view, a rebound is already under way, and there's no need to light a fire that's already burning. Instead, they say they are selling a growth insurance plan against exogenous events, such as a war. If the economy maintains 3% growth, then the 6% unemployment rate will begin to recede. The White House figures its program will nudge the gdp 0.4% this year and an additional 1.1% next year--which should provide more than enough cushion to hit the 3% growth target.
It was not fast enough for the likes of Alcoa. The day after Bush let the tax dogs loose, the aluminum maker announced a fourth-quarter loss and 8,000 job cuts. "Eliminating that dividend tax will do nothing to help the workers in our plant who may not have a job in the coming months," says Chip Cook, president of United Steelworkers Local 7886. By contrast, Alcoa ceo Alain Belda, who owns about 900,000 shares, stands to reap roughly $200,000 from the dividend-tax elimination. He had better not save it, though, because the Administration views dividend exclusion as a means to increase spending by individuals.
Bush & Co. also believe that emphasizing cash dividends will induce more responsible behavior from corporations. Reason: you can't fake cash the way you can an earnings report. If companies are encouraged to pay dividends, they will have to manage their companies to deliver real earnings. That will make stocks more attractive and help the market. "Frankly, it's the biggest bang for the buck," says Glen Hubbard, chairman of the Council of Economic Advisers. To discourage finagling, only companies that pay federal taxes can issue tax-free dividends. In lieu of cash, growth companies like Microsoft that don't pay dividends can issue "deemed" dividends, which represent reinvested profits.
Hubbard had been pushing the dividend idea for months, but Bush's imagination was captured by Charles Schwab, leader of the eponymous brokerage firm. Schwab suggested the maneuver to Bush at the economic summit that the President convened in Waco, Texas, last August. Bush bit like a hungry bass. Throughout the fall, the number crunchers at Treasury massaged the numbers on all the different elements of the plan, running different options by scores of outside economists. Bush did not seriously consider a payroll-tax reduction, which some economists argue is fairer and would provide the most immediate tax relief and spending incentive. Aides say the President did not want to tinker with the Social Security trust fund that theoretically gets those payments.
The mathematical logic underpinning the plan is already stirring controversy. Hubbard and Friedman are making a huge and controversial macroeconomic bet that deficits don't matter, effectively reversing a decade of policymaking. "This Administration is trying to change the whole intellectual basis for fiscal policy that Alan Greenspan enforced when deficits were large in the early 1990s," says Mark Zandi, chief economist at Economy.com, a research firm. "We got fiscal discipline through the idea that deficits matter. That's been flipped on its head."
Greenspan and Clinton Treasury Secretary Robert Rubin felt that large deficits force interest rates higher because the government is competing with private businesses for funding. And higher interest rates, they thought, act as a drag on both the economy and the stock market. Hubbard dismisses that position, noting that no research conclusively links interest-rate increases to bigger deficits. He says rates will move up just .03% for every $200 billion of debt, or .22% for the $674 billion projected added debt. It's a small enough price, he argues, for growth that might lead to increased revenues that will shrink deficits.
Others disagree. William Gale and Peter Orszag of the Tax Policy Center say by 2011 rates will be 0.9% to 1% higher than they otherwise would be without a big deficit--a significant drag on any economy. Increases in budget deficits, they write in a page turner called The Economic Effects of Long Term Fiscal Discipline, "must produce a reduction in either domestic investment or net foreign investment. It must therefore reduce the capital stock owned by Americans and reduce future national income." Politics isn't as dense as economics, though, and the Bush people see no political risk in the plan. It's difficult enough for people to contemplate what they're going to watch on television tonight. If the economy is rebounding, the fiscal implications of the deficit in 2013 won't matter a whit in November 2004.
Rove, who devised Bush's "big idea" agenda, is steering the President toward Medicare and health-care reform for his State of the Union speech Jan. 28. Medicare is a vexing issue that has resisted all attempts to fix it. Expect the President to be swinging from the heels.
--Reported by Matthew Cooper, John F. Dickerson and Douglas Waller/Washington and Daren Fonda/New York