Monday, February 04, 2008

Will Budget Deficits Crowd Out Tax Cuts?

The new Bush budget is throwing off $400 billion dollar deficits for FY ‘08 and FY ’09, largely because of the ineffectual and wasteful tax and spend rebate that will have no permanent economic growth impact in the longer run, and very little effect in the short run. Add to that, a slower economy and stock market that is throwing off fewer corporate tax receipts and fewer capital gains.

Will somebody please tell me how extending the Bush investment tax cuts can survive this big deficit onslaught? This is something Senator McCain and Governor Romney should address. Will they be cowed by the reemergence of an oversized deficit, especially at a time when Republican voters appear more concerned with deficit reduction than tax cuts?

Economist Art Laffer correctly noted in a recent WSJ op-ed that reducing the top marginal tax rate on investment and high personal incomes is a pro-growth revenue gainer. But cutting taxes for the middle-class and shoveling more earned income tax credits toward working poor is a huge revenue loser. (Of course, the Congressional Budget Office will score the top rate tax cuts as a revenue loser, despite Laffer’s strong data driven arguments to the contrary.)

But my point is a larger one. It’s really a political issue. What will McCain and Romney do? They both want to expand the defense budget and the size of the military services, as they should, to strengthen our national security in the war on terror. But of course this costs money. Big money. President Reagan argued successfully in the 1980s that low tax rates reignite economic growth — growth that was absolutely essential to generate the resources necessary for a strong national-security posture.

My question is whether McCain and Romney will adopt the Reagan approach, or will they see higher tax rates as a tradeoff to a stronger military à la Eisenhower?

Cato’s Alan Reynolds worries that Sen. McCain will adopt an Ike-like policy favoring high tax rates in order to fund a strong defense. Reagan’s view was completely different. In the battle for the heart and soul of Republican Party, now happening on campaign trail, the big question is will Ike win? Or will the Gipper?