What 15% Tax Cut? Just Ask Greenspan

NEW YORK —  Whatever happens in November, Bob Dole’s 15% tax cut won’t work, and economics has nothing to do with it. The Dole tax cut won’t flop because of its inherent economic flaws; it will flop because of one man.

That man is Alan Greenspan, and although in the excitement of the convention Dole seems to have forgotten, Greenspan’s term as chairman of the Federal Reserve doesn’t run out until the year 2000.

That is plenty of time for Greenspan to kill the Dole plan--and it’s a dead cinch he will.

Why?

Because it’s Greenspan’s job to fight inflation, and Greenspan believes that the U.S. economy can’t grow faster than its current pace--about 2.5% a year--without increasing inflation. If the economy goes any faster, Greenspan will raise interest rates to slam on the brakes.

Greenspan has already mounted one presidential trophy head on his wall. President Bill Clinton came into office toying with ideas of massive public investments to jump-start growth. Greenspan wasn’t buying.

Don’t make investments, said the Fed chairman. Cut deficits. If Clinton’s public investment program increased the deficit, Greenspan would just increase interest rates. The result: slow growth or even a recession.

Clinton, like other presidents before him, could not fight the Fed. He gave up his ambitious public-investment plans and settled down to the dull task of whacking away at the deficit. Over the next four years, the deficit shrank from $290 billion, in 1992, to a projected $117 billion or so this year.

This is what the Fed thinks is virtue, and Clinton got his lollipop--low interest rates that brought about the last four years of economic growth.

So now we have Campaign ’96. Dole, like Clinton in 1992, is campaigning on a platform of faster economic growth. Two and a half percent isn’t good enough for the American people, says Dole, we can do better than that. The trouble is that a Dole White House in 1997 will face the brick wall that the Clinton White House faced in 1993: a Fed chairman bound and determined not to let inflation accelerate on his watch.

If a supply-side economist like Jude T. Wanniski was the head of the Federal Reserve, the Dole plan might have a riverboat gambler’s chance.

But since Greenspan already has that job, and Greenspan loathes supply-side economics, it’s easy to predict what will happen. If Congress and the president try to kick-start growth with tax cuts, the Fed will raise interest rates to keep growth from accelerating.

So much for what campaign flacks somewhat optimistically term the “Dole plan.” The whole thing boils down to one idea: Tax cuts will stimulate the economy to grow faster. When the economy grows faster, the government makes more money in taxes--even if the total tax rate goes down. Faster growth is the magic ingredient in the supply-side formula that allows Dole and Jack F. Kemp to claim their tax cut won’t increase the deficit.

But with the Fed ready to choke off faster growth with interest-rate hikes, none of this can happen. If the Dole tax cuts stimulate a growth spurt, the Greenspan interest-rate hike will knock it on the head.

Net result: The tax cuts won’t shrink the deficit at all. Without extra growth, the deficit will grow.

That may be the end of Dole’s budget and growth plan, but, unfortunately, it won’t be the end of the story. High interest rates don’t just slow growth. They also raise the value of the dollar against other currencies. When the United States raises its interest rates, foreigners rush their money into America so they can earn some of that high interest for themselves. All that foreign money coming in raises the value of the dollar.

This is good news for American tourists; at eight francs to the dollar, Paris is heaven on sale.

But what’s good news for tourists is bad for manufacturers. When the dollar goes up, U.S. exports become more expensive in other countries--and foreign imports become far cheaper here. Result: a skyrocketing trade deficit as hundreds of thousands of U.S. blue-collar workers lose their jobs.

This is exactly what happened the last time we tried supply-side economics, and it will happen again for the same reason. In the early 1980s, Paul A. Volcker was the chairman of the Federal Reserve, and he was as suspicious of supply side as Greenspan. When the tax cuts came through, Volcker responded with a tight-money policy. The dollar shot up, and both the budget and trade deficits ballooned.

Some hope that deep spending cuts could keep the Fed off Dole’s back.

Unfortunately, they won’t.

True, the Fed wouldn’t punish Dole for a 15% tax cut if he first offered Greenspan a no-gimmicks, no-fooling, no-rosy-scenarios 15% spending cut. That means the Fed wouldn’t automatically raise interest rates if Dole cuts about $236 billion in federal spending next year. Unfortunately, there’s no way to do that without slicing programs like defense, Social Security and Medicare.

Even cutting programs like Social Security, however, won’t get Dole home free. Greenspan will still be watching the economy, and if growth gets much above 2.5% a year, he will raise interest rates--no matter what the deficit is doing.

In other words, Dole can knock on the door all he wants. Greenspan still won’t let the economy come out and play if he thinks it has a fever.

If elected, Dole will face an impossible dilemma. To get his tax cuts past the Fed’s hostile scrutiny, he will have to make spending cuts so radical that they make House Speaker Newt Gingrich look like Eleanor Roosevelt. But even if he manages this feat, the economy still won’t grow any faster than it did for Clinton.

Worse still, no matter who wins in November, the average rate of economic growth is probably going to fall in the next four years. The current economic expansion is already getting long in the tooth; if it lasts through the end of the next president’s term, it will be almost 10 years old. No expansion in U.S. history has lasted that long. The odds, unfortunately, suggest that the next president is more likely to be fighting a recession than trying to goose our growth to a higher level.

Either way, he’ll need help from the Fed and, as long as Greenspan sits in the director’s chair, that’s something a supply-side president isn’t going to get.