Preserving the President's Tax Cuts

A number of lawmakers might be working to shrink the size of the president’s big-bang tax-cut package. But much of the action behind the scenes indicates that the Bush plan is still standing tall.

Pro-growth members of the Senate Finance Committee are right now proposing a very good compromise for the president’s tax-cut package. The reworked plan will achieve 100 percent of the centerpiece dividend tax cut requested in the original package by implementing 50 percent of the exclusion this year (retroactive to Jan. 1, 2003), 75 percent in year two and 100 percent in year three. This will be coupled with an excludible dividend amount (EDA) for after-tax retained earnings (corporate capital gains), which will also go live in year three (2005). All this will give corporations ample time to set up the complex accounting procedures needed to provide accurate information to investors.

As part of this compromise, the whole dividend package will be sunsetted in 2008 — when Congress will have the option of full renewal. Consider this the camel’s-nose-under-the-tent strategy. Once the camel puts his nose under the tent, he always goes right for the full plate of food in the middle. There’s almost no way politically that Congress is going to repeal this tax cut.

What’s more, all the marginal tax-rate cuts will be accelerated in this proposal, along with the marriage penalty and the children’s tax credit. Bonus expensing for plant and equipment cost recovery for small business S-corporations will remain in the package.

This is exactly the sort of compromise that will provide a pro-growth tax jolt to the stock market and the economy by strengthening incentives for capital formation. And under this new plan, the full dividend piece will cost less than $145 billion, in static revenue terms, compared with the much higher price tag of the administration’s original package. The whole tax cut is now estimated to cost $350 billion over five years, thereby meeting the demands of GOP moderates George Voinovich and Olympia Snowe.

Former Bush economic advisor Glenn Hubbard is thinking along similar lines, with a proposal that merits attention. He would like to see the president’s full plan put into place for three years. In year three, he says, let the political wars begin. Would Congress then legislate a humongous tax hike? That’s what democracy is all about.

On other possible compromises that may come out of the House Ways and Means Committee, Hubbard would accept either a 50 percent dividend exclusion or taxing both capital gains and dividends at an 18 percent marginal rate. Actually, it would be 8 percent and 18 percent, since lower-income taxpayers would qualify for the lower rate for both cap gains and dividends. This is Ways and Means chair Bill Thomas’ idea. Both a 50 percent exclusion and an 18 percent tax rate would provide powerful new incentives for growth.

In addition, a dynamic-scoring model of the president’s tax-cut package is now with the National Economic Council, run by Steve Friedman. The model — the work of Secretary of the Treasury John Snow, OMB Director Mitch Daniels and Greg Mankiw, the new chairman of the Council of Economic Advisors — shows that the pro-growth impact of the tax-cut plan would reduce the revenue cost by 31 percent.

Noteworthy is the positive contribution from Mankiw, who has more supply-side blood in him than many supply-siders believe. Also interesting is the pending appointment of Princeton economic professor Harvey Rosen to the council. Rosen, a former Treasury official under Papa Bush, chaired the Princeton economics department for many years, and has developed important dynamic-scoring models that capture the growth effects of personal tax-rate reductions on small businesses. Rosen stood up in favor of former New Jersey Gov. Christine Todd Whitman’s tax-cutting campaign in 1993.

It now remains for the administration to release its dynamic-scoring memo to assure senators on the Finance Committee of the immediate growth impact of the president’s plan and to offset the watered-down CBO study of dynamic scoring that was recently released.

Putting this document in the public domain would also provide new economic-team members — Friedman and Mankiw — the opportunity to show their pro-growth bona fides. Having them weigh-in publicly with clear support of the president’s plan could be persuasive for some fence-sitters in the Senate during the committee markup and the subsequent debate on the floor.