Brookings Study Says Latest Bush Tax Cut Proposal Is "Fundamentally Flawed."

Author: White House Bulletin

Published: August 23, 2002

Two Brookings Institution economists conclude in a new working paper that the latest round of tax cuts President Bush is considering -- increasing the deductibility limit on capital losses, reducing capital gains tax rates, indexing the capital gains tax to inflation, raising or accelerating the phase-in of contribution limits for IRAs and 401(k)s and eliminating or reducing the so-called double taxation of corporate dividends - "are fundamentally flawed" and "would do little to stimulate the economy." The authors also contended that the package appears to be a stimulus measure for the stock market, which potentially sets a dangerous precedent should Social Security ever move to private accounts, because the government would be under enormous pressure to keep stock prices high in order to finance American retirements.

The paper by William Gale, Deputy Director of Economic Studies and Peter Orszag, a senior fellow in economic studies, concludes that "the proposals are flawed as short-run stimulus measures for several reasons":

• "The proposals would do little, if anything, to boost demand for the goods and services produced by firms, which is crucial to economic recovery in the short run. The tax cuts would provide large benefits to higher-income taxpayers, who tend to spend a smaller percentage of additional income than lower-income taxpayers. And some of the proposals - such as the proposed increase in contribution limits for 401(k)s and IRAs - are designed to boost saving at the expense of consumption."
• "The proposals would apparently be permanent rather than temporary. They would therefore exacerbate the nation's long-term fiscal imbalance, which in turn would put upward pressure on long-term interest rates. The increase in long-term interest rates would attenuate any stimulus benefit from the proposals in the short run."
• "The proposals would exacerbate fiscal pressures on state government, which would cause further spending reductions and tax increases at the state level. Such state-level adjustments could further offset any stimulus benefit from the proposals."
• "Most of the proposals would have no direct effect on retirement accounts. For example, neither the deductibility limit on net capital losses nor capital gains taxes directly affects retirement accounts because those provisions do not apply to 401(k) plans, IRAs, or traditional pensions. The only provision that directly affects retirement saving is the proposal to raise contribution limits. But even that provision would be of limited benefit to most workers. A very small fraction of workers contribute the maximum amount allowed by current limits, suggesting little benefit to most workers from increasing the limits still further."

The authors concluded, "Our conclusion is that the proposals are fundamentally flawed because the government should not be in the business of insuring investors against short-term stock market fluctuations; the proposals are not well-designed to stimulate the economy in the short run; they would do little if anything to shore up retirement accounts for most workers; and they would add to the Federal budget deficit over the longer term."