Bush's untested path: tax cuts on eve of war

President Bush's plan to lead his nation into armed combat while cutting taxes represents a high-stakes gambit that has big implications not only for his presidency and international order but also for the economy.

It's something that, quite simply, has never been tried in US history.

The risks are large. The undetermined costs of war in Iraq - coupled with new defense-related spending on Afghanistan, an antimissile shield, and homeland security - would add greatly to federal spending.

Add $2 trillion in across-the-board tax cuts, and it all raises a stark question: Can even the world's mightiest economy afford this? Some experts worry that, even if the short-run costs are manageable, surging budget deficits will eventually harm economic growth. If a war in Iraq goes badly, oil supplies could be disrupted and anti-American sentiment harden.

But the White House defends its moves by reversing the question and asking, can we afford not to? That is certainly Bush's argument on disarming Iraq - driven by security more than economics. A successful ouster of Saddam Hussein could open the door to a more stable Middle East, reducing the volatility of oil prices and boosting global business confidence. Tax cuts, meanwhile, could provide crucial short-term stimulus amid an environment of stagnant job growth.

"The risky thing is not to get the economy back on a stronger growth path," US Treasury Secretary John Snow said yesterday in comments to reporters at a Monitor breakfast in Washington (see story).

He said tax cuts are affordable and that after rising for a period, the budget deficit will start "a steady path downward."

Asked about costs of possible war with Iraq, Mr. Snow called it "a one-time sort of thing," and declined estimate the cost of combat and a potential US occupation of Iraq. "There are so many variables," he said. "I don't want to speculate."

Pursuing large tax cuts and a war at once has no precedent in America, in part because the nation had no broad-based tax code before the 20th century. President Reagan showed comparable boldness, arguably, during his first term in the White House. In the early 1980s, he took what critics called a "riverboat gamble" on the economy, selling both a huge tax cut and a massive boost in defense spending.

President Bush's agenda of planned and proposed tax cuts totals more than $2 trillion over a decade.

Mr. Reagan figured "supply-side" economics - fueling economic growth by putting more money in taxpayer pockets - would prevent budget deficits from ballooning. So does president Bush.

Robert Bixby, executive director of the Concord Coalition, doubts that extra growth from the Bush tax cuts will bring the budget back into balance. That would require a 4.3 percent growth rate in gross domestic product in the next five years, rather than the 3.3 percent projected by the administration, he estimates.

If the Bush plan doesn't work adequately, the deficit could grow to a politically embarrassing level. It could make both the budget deficit and the international trade deficit harder to finance, weaken the dollar on foreign exchange markets, and maybe raise interest rates on consumers already stretched to keep up payments on their mortgages and car loans, some economists worry.

An Iraq war carries further risks: Even with a quick and relatively clean victory, the price of oil could rise above the $41.15 a barrel level that it reached in October 1990 at the time of the Gulf War, Merrill Lynch economists estimate. But their forecast is not dire.

"Short of damage to Iraq, Kuwait, or Saudi oil facilities, we don't believe that oil prices would stay high enough for long enough, or that consumer confidence would fall far enough, to trigger another recession," they write. Still, every penny-a-gallon increase in gasoline prices at the pump drains more than $1 billion from the discretionary income of consumers. So, unforeseen oil problems could "push the global economy into recession."

Deficit spending, economists say, is not a problem unless it gets too large. In a sluggish economy, most economists would tolerate and even welcome modest deficits as useful stimulus.

"It's a positive move," says Beryl Sprinkel, who was Reagan's top economic adviser, referring to the Bush tax cuts. He says the plan will encourage more saving and investment, boosting prosperity.

Reagan's tax and spending measures produced record deficits that, at their worst, exceeded 5 percent of GDP. But Mr. Sprinkle credits tax cuts with fueling an economic expansion that lasted for years.

For now, the White House forecasts deficits that don't exceed 3 percent of GDP - including red ink of $3o4 billion in 2003. But budget experts expect the deficit numbers to grow - maybe to $500 billion a year, by Mr. Bixby's estimate. And economists are divided over whether tax cuts deliver long-term supply-side benefits.

Many Republicans, including moderates in Congress, are decidedly unhappy at the return of huge deficits after a brief span of large budget surpluses. Indeed, to critics, the risks of the Bush tax cuts are not as immediate as they are long run.

"We don't face a wolf at the door," says Charles Schultze, top economic adviser to President Carter. "Rather, we are going to get termites in the basement." The "termites" involve higher federal debts that will make it harder for America to deal with Social Security and Medicare costs when baby boomers retire.

But the short-run risks for the economy may lie in the opposite direction. "The risks of not doing something [for the economy] are far greater," says William Beach, an economist at the conservative Heritage Foundation. "The tax cut is well designed to stimulate income and government revenues."