The Taxonomist:

As the country gears up for an intensified battle against
terrorism and the economy slips into recession, almost everyone in Washington is
looking for ways to provide as much economic stimulus as possible while still
preserving long-term fiscal responsibility. Everyone, that is, except
congressional Republican leaders, who are calling for just the opposite.

In a weird display of Bizarro World economics, Senate Minority Leader Trent
Lott and House Majority Leader Dick Armey have proposed what they characterize as
a two-year, temporary revenue increase--to be followed by a much larger revenue
shortfall thereafter.

Specifically, Lott and Armey want to reduce the top capital-gains-tax rate
from 20 percent to 15 percent, but only for two years. Their stated goal is to
spur upper-income investors to accelerate stock sales by taking advantage of the
temporarily lower tax rate. If the sell-off is big enough, then it's conceivable
that the measure might increase revenues in the short run--at the expense of
lower revenues down the road.

If one optimistically assumes that a lot of people would sell assets and that
realized capital gains would jump by about 40 percent in response to the
temporary cut in the tax rate, then government revenues could go up by some $7
billion over the two years that the tax cut is in effect. But the price of this
speed-up in tax payments would be about $74 billion in reduced future taxes that
would have been paid when those gains were eventually realized.

Lott and Armey get the inspiration for their strange idea from the
capital-gains-tax increase, from 20 percent to 28 percent, that was enacted
in 1986 but didn't take effect until 1987. As investors rushed to cash in gains
and take advantage of the expiring lower tax rate, capital-gains realizations
ballooned in 1986, hitting their highest level ever as a share of the GDP. But
Lott and Armey seem oblivious to the fact that thereafter capital gains went down
the toilet, staying well below their pre-1986 levels until the stock market
run-up that began after 1994.

Why do Lott and Armey think that a temporary tax cut would be good for the
economy? Or that an incentive to sell stocks would help out the stock market?
Well, it's possible that they're just deluded. But it's even more plausible that
their supposedly "temporary" rate cut is simply a ploy. That is, they may be
confident that if they can get a temporary cut in place, then it will be easy to
persuade Congress to make it permanent before it expires. After all, anything
else will be condemned (by Lott, Armey, and others) as a "tax increase."

Of course, if investors surmise that "temporary" really means "permanent,"
then the advertised stock-selling spree and its attendant short-term revenue
boost won't materialize. That could take Lott and Armey off the hook for stupid
short-term macroeconomic policy, but the cost of their proposal would skyrocket
to as much as $220 billion over the next 10 fiscal years.

Not surprisingly, cutting the top capital-gains rate, temporarily or
permanently, would mainly benefit the very well-off. Almost three-quarters of the
tax savings would go to the best-off 1 percent of all taxpayers, for whom capital
gains represent more than a third of total taxable income. In fact, on an annual
basis, the Lott-Armey capital gains cut would boost the just-enacted Bush
income-tax-cut windfall for the richest 1 percent by more than half.

Should we be worried? After all, the Democrat-controlled Senate won't let
anything this illogical, unfair, and fiscally destructive happen, right? Well,
don't be too confident. Senator John Kerry, the Massachusetts Democrat, at first
semiendorsed the idea, although he's since backtracked slightly to add the
baffling caveat that "you've got to do this in a responsible way." It may be a
long shot, but one can hope that enough of Kerry's fellow Democrats have more
sense.

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