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Debating the tax cuts
Democratic candidates want to roll back some of the tax cuts. How would that affect the economy?
January 16, 2004: 6:59 PM EST
By Mark Gongloff, CNN/Money Staff Writer

NEW YORK (CNN/Money) - All eight of the Democratic presidential candidates want to repeal at least some of the tax cuts enacted by the Bush administration, saying that will help fend off crippling budget deficits that could threaten the world's largest economy.

But some economists claim it's just not that simple.

At the urging of President Bush, Congress has passed tax cuts in each of the past three years that, combined with a recession, a bear market in stocks, terrorist attacks and wars, helped to turn a $127 billion budget surplus in 2001 into a projected deficit of nearly $500 billion in 2004.

Bush and his fellow Republicans say the cuts have supported consumer spending during the long jobless recovery that has followed the 2001 recession, and promise the cuts will ultimately help create jobs.

Democrats, on the other hand -- including the eight vying to take Bush's job in 2004 -- say most of the cuts have helped only the wealthiest Americans, while ruining the federal budget and setting the stage for a far worse fiscal crisis in the future.

"We ought to go back to Bill Clinton's taxes because most people in America would gladly pay the taxes we paid when Bill Clinton was president, if only we could have the same economy we had when Bill Clinton was president," front-running candidate Howard Dean said in a debate on Monday.

Dean, Rep. Richard Gephardt (Mo.), Rep. Dennis Kucinich (Oh.) and the Rev. Al Sharpton have all favored totally eliminating the Bush tax cuts.

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One of the most obvious 2004 issue targets for Democrats is the Bush tax-cut plan and it's become a big issue among primary candidates. CNNfn's Louise Schiavone takes a look.

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The other candidates -- retired Gen. Wesley Clark, Sen. John Edwards (N.C.), Sen. John Kerry (Mass.) and Sen. Joseph Lieberman (Conn.) -- have offered plans that only roll back tax cuts for the wealthy, while offering further tax breaks for the middle class.

The idea of at least rolling back cuts for the wealthy -- who will get most of the tax-cut benefit by 2005 -- seems to be gaining in political popularity. An NBC/Wall Street Journal poll released Thursday showed 60 percent of respondents suggested rolling back upper-bracket cuts to help balance the federal budget.

Many economists said the question of whether repealing some or all of the tax cuts will help the economy depends largely on where the economy stands by 2005, when one of these candidates could take office.

"By 2005, I expect the economy will be stronger, more fully utilized" but still not up to full strength, said Citigroup senior economist Steven Wieting, who warned that any projection about the budget and its economic impact can't possibly account for unpredictable changes in discretionary and military spending.

"Under those circumstances, my guess is that a full repeal of the tax cuts would be negative," he said.

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Wieting and some other economists worry that rolling back tax cuts, even if only for the wealthiest Americans, could have a negative impact on stock prices, business investment and hiring.

"It's not a popular thing to say, but my suspicion is that it is upper income groups who tend to invest, and it's really investment that leads to stronger future growth, not consumption," said Paul Kasriel, director of economic research at Northern Trust in Chicago. "If the tax code were skewed more in favor of middle-income groups, it's not clear to me that we would have a positive long-run impact on the economy."

1993 all over again?

If, on the other hand, the economy is roaring by 2005, some economists believe it might be strong enough to absorb rolling back tax cuts. Some note that a tax hike in 1993 didn't sink the economy, as many Republicans thought it would.

"In 1993 we had an economy coming out of recession, we had unsustainable budget deficits in the projections and we had a budget package which people were afraid would dampen the recovery -- but it didn't. It had the opposite effect," said Max Sawicky, economist at the Economic Policy Institute, a liberal think tank in Washington, D.C.

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In fact, Sawicky and other economists think there's a downside to not rolling back the tax cuts when the economy is strong: higher interest rates.

If the government still is running big budget deficits when businesses are trying to borrow money to expand, then companies could find themselves competing for funds with Washington, an effect economists call "crowding out."

According to a Federal Reserve study in May 2003, interest rates could rise a quarter percentage point for every projected one-point increase in the ratio of the federal deficit to gross domestic product. A big jump in interest rates would put the brakes on the economy by raising the cost of borrowing.

More recently, former Treasury Secretary Robert Rubin, the International Monetary Fund and other critics have warned big deficits could fuel higher interest rates and financial disruption.

The "crowding out" theory is disputed by many Republicans, some of whom argue that tax cuts will make the economy grow so much that it will boost tax revenue enough to balance the budget. But this "supply side" theory has plenty of critics, too, some of whom doubt tax cuts will be drastic enough to have much stimulative impact.

"I don't buy into those supply-side, trickle-down ideas," said Mark Zandi, chief economist at "Those arguments might have made some sense 25 years ago, when the top tax rate was 70 percent, but not today, when the top rate is half of that."

Any negative effects of repealing tax cuts could be offset, Zandi and some other economists said, by returning some of the money to the economy in other ways.

"It's entirely possible you could repeal tax cuts without injuring the economy if you did it carefully, over a period of time, while offsetting it in part by increasing expenditures you knew were coming anyway or thought desirable," said former Fed economist Lyle Gramley, now a consulting economist with Schwab Washington Research. "But you couldn't simply remove the tax cuts altogether right away and avoid significant negative effects to the economy."  Top of page

-- This is an updated version of a story that originally ran on September 25, 2003.

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