Advice to Congress: Defer Tax Legislation

THE ides of March were an important milestone in the pilgrimage toward the Nov. 3 polls. Last Friday was President Bush's deadline for action on a tax bill that was supposed to get the economy moving. Happily, the deadline came and went and nothing happened.

The Shadow Open Market Committee (SOMC), a group of economists (including this writer) who comment regularly on policy issues, recommended recently that "President Bush should withdraw his proposed changes in fiscal policy on March 20 if ... Congress fails to enact them into law." On Sunday Mr. Bush said he would prefer that Congress "do nothing" to stimulate the economy rather than try to negotiate a new package.

Washington was unable to agree on a tax bill to deal with the nation's fundamental economic problems - substandard rates of return on capital, inadequate net investment, and slow growth.

The White House clearly intended to provoke a deadlock with the tax program Bush outlined in his State of the Union message. The administration had to respond to the caterwauling of its critics in Congress. However, inaction was obviously preferable to action that would increase the federal deficit and create false hopes of fiscal stimulus.

Furthermore, the pace of recovery has picked up. That should dull the incentive to tinker with the tax code. Full-time employment rose almost 800,000 in December, January, and February. As a result, income is up.

Meanwhile, the Federal Reserve is pouring massive amounts of fresh cash into the credit market in an effort to hold down short-term interest rates. This cash will fuel further temporary gains in employment, income spending, and production in the months ahead.

Herbert Stein, senior fellow at the American Enterprise Institute, pointed out recently that "since 1973, which was a watershed year, all measures show slower improvement in the economic condition of the American population than in the years from 1948 through 1973. The post-1973 rates of growth did not, however, compare unfavorably with the experience before 1948, or before 1929."

"Suppose we stipulate," Dr. Stein asked, "that the middle class is unhappy because its members' incomes have been growing rather slowly for some time, what is to be done?"

Regrettably, he continued, no one offers today's version of financier Bernard Baruch's advice to the nation: "Study, work, and save, stay married so that your children will have supportive families, and get your children to study." Now, Stein said, "Everybody, Republican as well as Democrat, says that he will save the middle class through government action, without those in the middle class having to do a stroke except but pocket what will be given to them."

In fact, both the administration's tax and transfer program and its rebuttal from congressional Democrats focused on short-term stimulus and income redistribution. The tax bills pending in Congress would fail to meet their immediate objectives and would divert attention from needed reforms.

Clearly, changes in tax law are needed to promote faster rates of economic growth, higher productivity, and improved standards of living. Since the early 1970s real wages, real compensation, and real income have grown slowly, reflecting the sluggish growth of labor productivity.

The SOMC argued that short-term tax changes that increase spending cannot solve the problem of lagging productivity growth. It is irresponsible to propose credits for home purchases, reduced withholding taxes, or increased family allowances as solutions to the long-term problems of middle-class taxpayers.

Middle-class and other incomes can be increased permanently only by increasing productivity. Productivity will increase if tax changes (1) favor growth instead of redistribution, (2) favor long-term instead of short-term improvements, and (3) eliminate the bias that currently favors consumption over investment and saving. If a tax policy meeting these criteria cannot be adopted in an election year, the best course would be to defer action.