The Tax Cut Scenario Jude Wanniski July 19, 1999

MOSCOW MYSTERY:  The lead editorial in the Sunday NYTimes, "Go Slow on Taxes," notes that "it may be inevitable that Congress will pass a tax cut before next year's election." But the "grandiose plans" of the GOP committee chairman have to be scaled back, the Times indicates, if there will be a level that would survive a presidential veto. The most interesting argument the Times makes is that tax cuts should make the economy grow faster, something the Federal Reserve has indicated it does not wish to happen, and that the Fed may have to "raise interest rates more than would otherwise be necessary." The Times, of course, still is clinging to its neo-Keynesian demand model, the "neo" permitting it to depart from the original Keynesian argument that taxes should be cut when the economy is sluggish. The "neo" Keynesians since the late 1960s have always opposed tax cuts, when the economy statistically is booming or is in recession. The second most interesting argument in the editorial is that taxes should not be cut because they are being based on projected budget surpluses that could "VANISH if the economy were to weaken." So taxes should not be cut because the economy is growing fast enough and taxes should not be cut because the economy might weaken. And by all means, the editorial insists, "there is no further reason to cut capital gains taxes," as House Ways&Means chairman Bill Archer wants to do. On the other hand, the Times even is conceding that "some adjustment to estate taxes may be in order."

I've been a bit reluctant to write about the tax issue for the last two weeks, even though it is front and center, because I could find no good evidence that it was jelling. There was no analysis to report, other than that there was a lot of milling around on Capitol Hill and mixed signals emerging from the administration. The Times editorial and the discussion on "FoxNewsSunday" -- the only talk show that was not pre-empted by reportage about the Kennedy plane crash -- provided sufficient evidence that a bipartisan tax cut is in the works. Senate Majority Leader Trent Lott now seems confident that legislation sent to the President will be signed, even if Clinton threatens a veto right up to the last minute. Indeed, where all the talk a week ago was that the first bill sent to the White House would be vetoed, renegotiated, sent a second time and signed, this has given way to the possibility a deal could be worked out in a Senate-House conference that would be signed right off. The strength of the high-tech market last week was a sign, I thought, that the market more and more is discounting positive legislation that will increase the efficiency of the economy in a way that continues to push up real wages without getting the Fed excited about "wage inflation."

It is a problem for commodity producers -- especially farmers who still are being driven to despair by the Fed's monetary deflation. Increases in the demand for dollar liquidity that arise from further expansion of the aggregate economy must be met by the Fed, or the deflation problem will persist. What is helping the tax cuts along is the calculation among Democrats that if they allow themselves to be dragged into submission, they also can extract a price in the form of prescription drugs in the Medicare program. And a sizeable tax cut this year will weaken GOP calls for tax cuts going into the 2000 elections. Been there, done that, Al Gore and the Democrats will argue, taking credit for the tax cuts and prescription drugs for the oldsters. What still is not clear is how hard Republicans will fight for the kinds of tax changes that actually will strengthen the markets and the economy -- and how the Fed will accommodate that strength.