A New Round of Tax Cuts?

Peter R. Orszag and William G. Gale

In the aftermath of the forum held in Waco, Texas, President Bush is considering a new round of tax cuts. The new tax reductions would come on top of the large tax breaks passed last year and the stimulus package enacted this spring.

The Administration has not provided a clear and compelling rationale for these policies,
but there appear to be three possible motivations: to boost the stock market, to spur a slowing
economy, and to ensure adequate retirement income levels and security. Some Administration
officials also argue that the proposals would bolster the economy in the long run, but the
Administration has consistently argued that the long-term economic outlook is sound—and the
primary motivation for the proposals being presented now is undoubtedly not their long-term impact.

The first possible motivation for the proposals—using tax policy to offset short-term fluctuations in the stock market—is particularly troubling. The government should not be in the
business of bailing out private-sector investors when the stock market turns down, especially
since the current downturn was preceded by an unprecedented stock market boom. As Secretary
O’Neill has stated, “I’m certainly not for bailing out investors when they made a free-will decision and it turned out to be wrong.” Having the government bail out investors who voluntarily accepted risks by investing in the stock market would set a dangerous precedent.

The second possible motivation for the proposals—stimulating the economy—is more debatable. The economy appears to be growing more slowly than its potential growth rate, which may argue for additional stimulus from the government. The history of fiscal stimulusmeasures, however, suggests that they are often mistimed, taking effect after the economy had begun growing rapidly again. Furthermore, even if short-term fiscal stimulus were appropriate, none of these proposals would be particularly effective at delivering it—and some could actually be counterproductive.

The third possible motivation for the proposals is to shore up retirement accounts and boost retirement income security. But despite the rhetorical references to losses incurred in 401(k) and other retirement accounts in advocating the need for these provisions, 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. Furthermore, those who are currently constrained by the limits (and who may therefore take advantage of higher limits) typically are
already the best-prepared for retirement.

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.