Is the Contract good economics? A scorecard - GOP's Contract with America - Gekko's Guide to Prosperity - Cover Story

National Review, Feb 6, 1995 by John Silvia

1. Reducing the Tax on Personal Savings. Score a hit for the Contract. It proposes permitting individuals to exclude 50 per cent of capital gains from their taxable income, in effect reducing the tax rate on capital gains to 15 per cent. Another provision of the Contract would introduce an expanded IRA--an IRA that could be tapped before retirement, with taxation of the interest or dividends not merely deferred but abolished.

Both these provisions will raise the after-tax rate of return on savings and investment and therefore the incentive to save and invest. This would increase the supply of credit to the financial markets, which would, ceteris paribus, reduce real interest rates.

2. Equalizing Tax Rates. The Contract struck out by not proposing a flat rate of personal taxation. Income taxes would affect all households (and thereby their savings) to the same degree if all households saved at the same rate. But they don't. The fraction of income saved rises as income rises. Therefore, taxes collected from higher incomes fall more heavily on saving than do those collected from lower incomes. Higher income taxes directed at the "rich" reduce the level of personal savings--and thus the good effects on the economy discussed above--by a disproportionate amount.

3. Lowering Personal Income Taxation. The Contract struck out again with its provision for tax credits for taxpayers with dependent children. This provision may be attractive politically in the short run, but it is poor economic policy. Not all taxpayers have dependent children; therefore, there is a clear shifting of the tax burden from one taxpayer group to another group. And families at the low end of the income scale do not pay taxes anyway, while families at the high end of the income scale do not qualify for the credit. This credit therefore shifts the tax burden even within the category of taxpayers that may be construed as "families."

4. Reducing the Tax on Business. Score a hit for the Contract's proposal for a neutral cost recovery system, which would reduce the cost of capital by increasing the value of investment depreciation to the full value of the original investment.

This and other reductions of corporate taxes are often challenged by critics such as Minority Leader Richard Gephardt as benefiting corporations at the expense of the ordinary working man and woman. In fact, when each worker has better and more capital to work with, labor productivity improves. This makes labor's input more valuable and therefore, over time, raises the real standard of living of the worker.

5. Reducing the Tax on Labor. Score a fielder's choice. The Contract proposes a reversal of recent trends, but it does not go nearly far enough. It proposes to help the working elderly by raising the limit on the earnings of Social Security recipients and repealing the Clinton tax hike on Social Security benefits.

But the Contract does nothing directly about the overall rate of payroll taxes (the taxes, earmarked for Social Security and Medicare, that are imposed on wages and tips). High payroll taxes drive a wedge between the cost of labor to the employer and the wages received by the employee. That is, they make labor more expensive for the thus reducing the quantity of labor demanded, while at the same time reducing the after-tax earnings of employees, thus reducing the supply of labor.

6. Balancing the Budget. Bringing federal spending and revenues into line looks like a good thing. But what is being brought into line with what? Is spending to be reduced to match revenues, or are revenues to be increased to meet spending? Which of the various versions of the balanced-budget amendment is eventually put forth will determine whether this is a hit or a double play.