What Every American Wants
I never met a tax cut I didn't like, and I like President Bush's a lot.

Sunday, January 19, 2003 12:01 a.m.

I have long said, "I never met a tax cut I didn't like"--though I would go on to say that I like some better than others. The reason for my flat, unhedged statement is neither the Keynesian attribution of an economic stimulus to a tax cut, which I believe is generally wrong, nor the supply-side attribution of favorable incentive effects to a tax cut, which I believe is generally correct. It is, rather, the effect of tax cuts on government spending.

I believe that government is too large and intrusive, that we do not get our money's worth for the roughly 40% of our income that is spent by government--federal, state and local--supposedly on our behalf, or the additional 10% or so of income that residents or businesses spend in response to government mandates and regulation. History suggests that Washington spends whatever it receives in taxes plus as much more as it can get away with. Deficits have been the norm. The few exceptions--such as the Clinton surpluses--are an accident of divided government; in President Clinton's case, a Democrat in the White House, a Republican House and Senate. And as we are already seeing, such surpluses are not here to stay. I conjecture that they would have faded away even if there had been no 9/11, and no Iraq war danger.

Under those circumstances, how can we ever cut government down to size? I believe there is one and only one way: the way parents control spendthrift children, cutting their allowance. For government, that means cutting taxes. Resulting deficits will be an effective--I would go so far as to say, the only effective--restraint on the spending propensities of the executive branch and the legislature. The public reaction will make that restraint effective.

Many discussions of the economic effect of tax cuts and deficits implicitly assume that government spending is predetermined and independent of whether there is a tax cut or a deficit. In that world, deficits are produced entirely by a shortage of tax receipts. Raising taxes can eliminate the deficit without affecting spending. As I see the world, the situation is very different. What is predetermined is not spending but the politically tolerable deficit. Raise taxes by enough to eliminate the existing deficit and spending will go up to restore the tolerable deficit. Tax cuts may initially raise the deficit above the politically tolerable deficit, but their longer-term effect will be to restrain spending.

Of course, some tax cuts are better than others. Tax cuts that increase incentives to produce and that eliminate distortions in the price system--supply-side tax cuts--give a double whammy. They restrain government spending and increase future income and current wealth. Permanent tax cuts are much to be preferred to temporary cuts. They are a stronger restraint on spending and do not need to be repeated.

From this point of view, President Bush's tax proposals rank very high. Eliminating double taxation of corporate earnings will end the present bias toward debt rather than equity in the financial structure of corporations as well as the present bias toward retaining earnings rather than distributing them as dividends. The combined result will be a more effective distribution of capital, and will promote a more effective market for corporate control.

Making the already voted tax reductions permanent, bringing their effective dates forward, and lowering the rates further improves the quality of the already enacted tax cuts. These changes increase the restraint on government spending and increase incentives for taxpayers to work, invest, and take risks.

I do not know whether the tax cuts will or will not stimulate the economy in the short run. They put money in the pockets of taxpayers to spend; but simultaneously they take money out of the pockets of the investors who buy the government securities that finance the tax cut, money which would otherwise presumably have been spent on private investment projects. The net effect on total spending could go either way.

Whatever may be that outcome, a major tax cut will be a step toward the smaller government that I believe most citizens of the U.S. want.

Mr. Friedman, a Nobel laureate in economics, is a senior research fellow at the Hoover Institution. He is co-author, with his wife Rose, of "Two Lucky People: Memoirs" (University of Chicago Press, 1998).

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