WASHINGTON - President Bush says his $726 billion tax cut proposal would create more than a million jobs. Democrats say don't trust him, because after Bush's $1.3 trillion tax cut passed in 2001, the economy still lost 1.9 million jobs.
Whom to believe?
No one can accurately predict how many jobs a tax cut would produce, but lower taxes can boost job creation in a meaningful way. For example, most economists believe that the 2001 tax cut cushioned the economy over the past two years. Without it, job losses would have been even greater.
But that's not a blanket endorsement of Bush's proposal or the leading alternatives in Congress.
Though many economists back a tax cut, they don't back just any tax cut. A poorly constructed one could cause more long-term economic harm than immediate benefit, they say.
"I'm worried we're going to end up with something where the near-term help just isn't up to the task and which has some long-term budget costs," said Ed McKelvey, an economist at the Goldman Sachs investment bank in New York.
To minimize that trade-off, many economists favor jettisoning the centerpiece of the Bush proposal - the elimination of the tax on stock dividends - and keeping the rest. The other elements would make some income tax rate cuts now scheduled for the future take effect this year and expand investment tax breaks for firms.
Some analysts also think the Senate's proposal to give $20 billion to state governments to help cover their budget shortfalls is a good way to juice the economy.
Unlike tax cuts, which might be banked in savings accounts, such aid is likely to go directly into the economy as states spend it, analysts say.
Not everyone is convinced that a tax cut would be a good idea. None other than Alan Greenspan, the respected chairman of the Federal Reserve, opposes trying to give the economy a short-term boost with tax cuts, especially if they increase budget deficits.
He holds to conventional wisdom that short-term management of the economy should be left to the Fed through its adjustment of interest rates. Tax policy can set conditions for long-term growth, but rarely can be changed fast enough to manage the short-run ups and downs, according to that view.
That thinking has been challenged by the success of the 2001 tax cut in helping to keep the economy afloat in subsequent months. But Greenspan recently called that effect "fortuitous" and said "I don't think we can count on that generally."
If tax cuts fire up the economy too much, the Fed will respond by raising interest rates to guard against inflation. The higher rates will negate some of the job creation from the tax cut. In that case, it might have been better to have skipped the tax cut and the interest rate increase.
Still, many economists think there's enough uncertainty about the economic outlook to justify a tax cut.
"The economy still is looking dicey enough that a little extra fiscal policy insurance at this point might be a good idea," said Chris Varvares, an economist with Macroeconomic Advisers, a leading forecasting firm in St. Louis.
The political case for tax cuts is clearer. Even if the economy is already en route to recovery, the timing remains uncertain. With an election campaign on the horizon, the sooner and faster the economy grows, the better for incumbents seeking approval for their records. An analysis by Global Insight, an economic forecasting firm, found that the Bush proposal would boost growth next year to 5 percent from an expected 4.1 percent, an already quite healthy rate.
"What they want to do is hasten the recovery," said Cynthia Latta, principal U.S. economist at Global Insight, which is based in Lexington, Mass. "No congressman wants to be seen twiddling his thumbs when unemployment is rising."
Nonetheless, lawmakers, worried about expanding budget deficits, have scaled back the Bush dividend tax proposal. The House would reduce the tax on dividends to 15 percent. The Senate would exclude only part of dividend income from taxes.
Both the House and Senate plans would cut taxes less over 10 years than the $726 billion Bush proposal. But they would provide almost as much or more of a short-run boost to the economy. The House plan would cut taxes by $204 billion through September 2004, more than Bush's $154 billion. The Senate proposal, including tax cuts and aid to state governments, totals $143 billion over the same period.
However, it's not only the size of the tax cut that matters. If people put their tax savings in the bank instead of spending it, the economy won't get any immediate boost. Economists tend to favor proposals that pump money into the economy quickly and carry little or no long-term cost.
On those fronts, the merits of the dividend tax elimination are debatable.
Though the proposal is designed to boost long-term growth, its effect could actually be the opposite. The lost federal revenue could add to a growing budget deficit, which in turn could slow growth by pushing up interest rates. Any boost could be outweighed by higher interest rates.
Some analysts also question White House estimates that removing the dividend tax alone would create 431,000 jobs by the end of 2004.
Even some who agree with Bush that eliminating the dividend tax would generate jobs don't support it because of the long-term budget effects.
"The problem is it's permanent stimulus that raises rates," Varvares said.
But David Greenlaw, the chief bond market economist at the Morgan Stanley investment bank in New York, disagrees. Deficits are an issue, but the lost revenue from eliminating the dividend tax - $32 billion a year by 2007 - is a relatively small factor.
"In the big scheme of things, $30 billion will be swamped by other factors," he said, citing proposals to add a prescription drug benefit to Medicare and defense spending increases. "The direct impact on rates from something like the dividend change is going to be minor."
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