Tax Cut Plan Mired in Economic, Political Debate

Senior GOP Senator Recommends That Stimulus Package Be Shelved if Democrats Won't Sign on

Author: Jonathan Weisman

Published: September 5, 2002

Sharp divisions at the White House have delayed the release of a package of tax cuts aimed at boosting the stock market, and new questions over its political wisdom may scuttle the plan altogether, congressional and White House officials said.

President Bush met with economic and legislative advisers yesterday, but the White House made no decisions on the shape of the tax cut proposal, or even whether there would be a proposal. Bush's economic policymakers had hoped to unveil a broad package of tax cuts shortly after Labor Day that would stimulate the stock market and ease the pain of individual investors.

That timetable appeared all but certain in mid-August, when Bush tipped his hand to reporters and sketched out a proposal that included raising the amount of stock losses that could be deducted from income taxes, cutting tax rates on capital gains and dividends and speeding up measures to increase the contribution limits for individual retirement accounts (IRAs) and 401(k) plans.

But since then, the idea has languished as economists argue over the plan's merits and political advisers hash out its impact on November's congressional elections.

"It's very controversial at the White House," said Sen. Charles E. Grassley (Iowa), senior Republican on the Senate Finance Committee.

Congressional and White House sources say three camps have emerged. National Economic Council Director Lawrence B. Lindsey is championing the tax cuts as a good policy initiative that would help inoculate GOP candidates from charges that the White House has done nothing in the face of this summer's stock swoon.

Treasury Department tax experts, however, have raised questions over the cost in the face of deepening budget deficits.

And legislative aides are increasingly concerned that Democrats would turn the proposal into a political liability by framing it as a fiscally reckless tax cut for the affluent. Grassley said he told White House officials that they had better get Democrats to sign on to the plan before it is released, otherwise, "Republicans will be mouse-trapped by Democrats who will say anything about capital gains is for the rich."

If Democrats are not willing to sign on, Grassley said, the package should be shelved.

On top of those philosophical disputes is a simple logistical question: Does Congress have time to act on the package, as well as pass earlier Bush initiatives on energy policy, homeland defense, terrorism insurance and pension protection? The heated debate on Iraq has only further clouded the tax plan's future, an administration official said.

"The president continues to review the issue," said Claire Buchan, White House spokeswoman. "He's not satisfied with economic growth, and he isn't satisfied to sit back and hope for the best."

Supporters of the plan say it could boost the Dow Jones industrial average by 1,000 points. If it dies on Capitol Hill, it could put Democrats on the political defensive.

Ending taxation on dividends -- or at least significantly lowering the tax -- would translate directly into boosted company earnings, and higher earnings would bump up stock prices. It could also encourage companies that have moved away from issuing dividends to return to the practice. And nothing would buoy investor confidence like a tangible cash return.

"The math is pretty clear on the wisdom of cutting rates on dividends," said Kevin A. Hassett, an economist with the American Enterprise Institute.

Lowering the tax on profits from stock sales could pull buyers into the market by making long-term gains more attractive, advocates say. Raising the contribution limit on retirement plans could put more money into the hands of institutional investors.

And increasing the $3,000 annual limit on capital loss deductions would directly benefit shareholders who suffered in this year's bear market. Republican candidates could make the case that they tried to help investors while Democrats played politics with the ailing economy, Lindsey's supporters say.

"Let the Democrats go into November saying we don't want to help people with their 401(k) plans; they're all rich," said Grover G. Norquist of Americans for Tax Reform. "Then all the people with 401(k) plans can vote against them."

But economists of all political stripes have raised sharp questions about the wisdom of government intervening in the stock market, especially as Bush pushes his plan to allow workers to invest some of their Social Security taxes in stocks.

William G. Gale, a Brookings Institution economist, asked: If the government acts to bail out private investors now, what would lawmakers do if constituents suffered losses in government-sanctioned, tax-financed retirement accounts? William A. Niskanen, chairman of the Cato Institute and a former economic adviser to President Ronald Reagan, shared Gale's concern. "What we'd have is the whole economy becoming like the agriculture sector, where farmers get bailed out for a good harvest and a bad harvest," he said. "That's a terrible way to run an economy."

There are also questions about the economic impacts of the proposals. Raising the loss deduction could spur more stock selling, as investors cash out on poorly performing stocks. A recent Congressional Budget Office report concluded that cutting the capital gains tax rate would have a tiny effect on savings rates and economic growth.

Cutting or eliminating taxes on dividends would almost certainly buoy company earnings, but in the 1990s, most companies got out of the dividend business and instead reinvested their cash earnings.

And the proposals would have no real impact on this year's losses to 401(k) plans and IRAs, since those plans are not subject to capital gains or dividend taxes, Gale said.

A White House official said the arguments over substance are being taken seriously, especially concerns that some of the proposals could actually hurt the markets. And, the aide said, it was never certain there would be a package, even if the president supported one.