Tax cut re-boot

Tax cut re-boot

scollender@njdc.com

Back during the Gulf War, Gen. Norman Schwarzkopf himself redesigned the boots that American troops were wearing after it became clear that the ones they had been issued were not appropriate for the task at hand.

The old boots with metal soles had been designed for the last big U.S. military engagement-fighting in the jungles of Vietnam-rather than the current hostilities in the deserts of the Middle East, and what had been intended to protect ground troops was now putting them at some risk. In other words, the U.S. military was still fighting the last war.

Now the Republican majority, by insisting on tax cuts, in effect might be doing the same thing on the budget. They may be insisting on a policy that at one time provided political protection, but now may actually be putting them at some risk in the next election.

Tax cuts rang true as an issue in the 1980s, when the average American family was feeling financially pinched because of very high interest rates and inflation. Not only were people having trouble affording the new homes they wanted, because of the increased use of adjustable rate mortgages, many were also having trouble making the payments on the homes in which there were already living. Higher rates for credit cards, car loans and other types of consumer credit made just keeping up much tougher-let alone moving ahead. It was little wonder, then, that when Ronald Reagan and the GOP made big cuts in federal taxes the cornerpiece of their budget strategy, many voters supported the effort with religious-like fervor. They were being offered a way to make ends meet without having to reduce their lifestyles any further.

Today, however, even a cursory look shows that the economic situation is far different. Mortgage rates, which averaged more than 12 percent through the 1980s, have been averaging slightly less than 8 percent through the 1990s, so many more people are able to buy homes because the monthly payments are more affordable. In fact, first-time homebuyers bought almost 47 percent of all homes purchased in 1998.

We also know that existing homeowners are also finding their current homes more affordable because half of all of the mortgages issued last year were refinancings. Assuming rational behavior, each of these refinanced homes cost their owners less each month than they did before.

But it was not just homeowners who benefited from the improved economic environment of the past few years. Credit card rates, which averaged more than 18 percent in the 1980s, last year averaged less than 16 percent. And as anyone with a mailbox knows, the solicitations for cards with far lower rates come in droves every day. In addition, oil prices over the past year have fallen by half, and gasoline prices have fallen precipitously as a result. Gasoline purchases generally vary little as prices change, so this drop puts more cash directly in every automobile driver's pocket.

Add to this the fact that unemployment, which exceeded 9.5 percent in 1982 and 1983, is currently at 4.3 percent; the increased number of people who own stock; the extraordinary run-up in the value of the stock markets; and the increasing number of states that either already have or are seriously talking about cutting taxes, and it is not hard to understand why a federal tax cut does not have the same salience today it did almost 20 years ago. The cash crunch and financial anxiety that many people felt back then simply does not currently exist.

This may be why the Republican proposals to cut taxes by 10 percent seem to be running into such problems. Some of the most conservative House Republicans have started to question publicly whether a big tax cut can be sold now as the right economic policy when unemployment is nearing unimaginably low levels. Others have proposed smaller and much more targeted tax cuts, which would appeal to particular constituencies that may not have benefited as much from the economic changes. Because of this, the big across-the-board tax cut that only a few weeks ago seemed so likely to dominate Republican efforts on the budget this year is now in some trouble.

This may also explain why reducing the federal debt, which the vast majority of budget and political analysts have always assumed would be the least preferred alternative if there was ever a surplus, now continually shows up in the polls as being the most popular approach. By contrast, tax cuts generally show up (at best) as a distant second. In some cases, they even come in third behind reducing the debt and increasing spending.

All of this points to two things to watch as this year's budget debate continues.

First, the best indication about whether there will be a tax cut could be where interest rates go in the next few months. Second, the real question about what happens may be how quickly those who make budget decisions recognize that the current economic environment represents a substantial change from the past. If this doesn't happen soon, House and Senate Republicans may find that they are doing the equivalent of wearing the wrong boots-and find themselves in desperate need of a Gen. Schwarzkopf to help solve their problem.

Question Of The Week

Last Week's Question. Last week's question, which asked you to come up with the ingredients for a federal budget sandwich, included some of the most inventive ideas ever received from Budget Battles readers. In addition to all the sandwiches made from heaps of pork, there were also details for garnish, sauces and bread. The winners of an "I Won A 1999 Budget Battle" T-shirt are John Raffetto of Podesta.com for his suggestion of the "Taste of the Treasury"-a Rubin sandwich served over a green span of lettuce-and Evelyn Morton for her "Bipartisan Budget Deal" sandwich, which is made with "a slab of crow, a helping of humble pie, and no beef."

This Week's Question. According to the Congressional Budget Office's recent report on the economic and budget outlook for fiscal years 2000-2009, a one percent increase in interest rates over what is assumed in the budget will decrease the surplus by $5 billion in the first year. The question: What would happen if interest rates were one percent lower? Send your response to scollender@njdc.com and you might win an "I Won A 1999 Budget Battle" T-shirt to wear during the next congressional recess.