SOMEONE ONCE DEFINED a fanatic as someone who redoubles his efforts after losing sight of his objective. Based on this definition, the Bush administration is in danger of becoming fanatical on tax policy. Last fall, as the administration prepared its January budget proposal, there was a spirited debate about what sort of tax initiatives it would offer. A number of proposals were floated in the press, but the one President Bush got behind was a plan to reduce the cost of capital by eliminating the double taxation of corporate profits.
At present, such profits are taxed once by the corporate income tax at rates up to 35 percent, and then again when they are paid out as dividends to shareholders at rates up to 38.6 percent. This creates a high effective tax rate on corporate capital that discourages investment–leading to lower productivity, economic growth, and wages. That is why virtually all other major countries try to avoid or minimize double taxation in some way.
The president’s plan was a good one. However, the dividend portion of it would have reduced federal revenues by $400 billion over 11 years, and the total tax package, including other provisions, would have lowered revenues by $726 billion. But the House budget resolution pared this down to just $550 billion for the entire tax package, and the Senate budget resolution whittled away even further, allowing a total revenue loss of just $350 billion.
Despite this setback, the Bush administration remained wedded to its original plan. Although President Bush said he supported the House figure, he never put forward a revised tax package that would fit within its constraint. Left without White House guidance, House Ways and Means Committee chairman Bill Thomas, Republican from California, was forced to devise his own tax package.
The Thomas plan abandoned full elimination of double taxation as excessively costly in terms of revenue. Instead, he proposed capping the tax rate on dividends received at 15 percent and also cutting the maximum tax rate on capital gains to 15 percent. In addition, Thomas proposed allowing corporations making new investments in capital equipment to deduct a larger portion of such investments in the first year.
The White House was cool to the Thomas proposal because it did not contain the president’s signature initiative–eliminating, not just reducing, double taxation of corporate profits. Still, the White House never explained how its proposal was going to fit into a budget cap 25 percent smaller than the president’s original plan.
Turning its attention to the Senate, the White House redoubled its efforts to salvage the dividend plan. But again, it failed to put forward a proposal of its own that would take account of the lower revenue loss allowed under the budget resolution, not to mention the more difficult political situation in the Senate. Republicans there have a 51-49 majority, but John McCain of Arizona and Lincoln Chafee of Rhode Island are cemented on the anti-tax-cut side, along with every Democrat except Georgia’s Zell Miller.
This meant that it is essential for the White House to get the votes of two wavering Republicans, George Voinovich of Ohio and Olympia Snowe of Maine. Both are adamant about holding a tax cut below $350 billion, and Snowe is also concerned about any tax cut tilted too much toward the wealthy. Unfortunately, very few poor people own stock or receive dividends. And because Snowe sits on the Senate Finance Committee, where Republicans have just a one-seat majority, her views on this matter are pivotal.
Finance Committee chairman Charles Grassley of Iowa did his best to square the circle by phasing in the president’s dividend proposal over three years and then having it expire–the theory being that budget targets are technically being met and Congress can revisit the issue later. But even this watered-down version of eliminating double taxation was too much for Snowe, who insisted that dividend relief be limited to exempting the first $500 of dividends from taxation. To get a bill out of committee, Grassley agreed to the Snowe alternative.
Economically, however, the price was high. Exempting the first $500 of dividends will do little, if anything, to lower the cost of capital or change the behavior of corporate executives. Therefore, it will do nothing to raise growth or productivity, either in the short run or the long run. About the best thing to be said for it is that it looks a little more like President Bush’s plan than the Thomas alternative.
The White House view seems to be that it will make any compromise necessary to get a tax bill–any tax bill–out of the Senate. The real work will then be done in conference between the House and Senate. It is there that the White House will have to decide how adamant it is about salvaging some version of its original plan–even if it is virtually unrecognizable–so that it can declare a legislative victory. But the cost could be prohibitive in terms of sacrificing tax provisions, such as those in the Thomas bill, that would do much more to stimulate growth between now and Election Day 2004.
Legislative triumphs are like what people used to say about Chinese food–an hour later you are hungry again. On the other hand, pollsters, political scientists, and economists are united in their view that economic conditions largely determine the outcome of presidential elections. This suggests that the White House should swallow its pride and push as forcefully as possible for a tax bill that will do as much for growth as possible over the next 18 months, even if it bears little resemblance to the president’s original plan.
Bruce Bartlett is a senior fellow at the National Center for Policy Analysis.
