Originally published in The Boston Globe
Tuesday, January 2, 2001

An Inspired Choice at Treasury
By Martin and Kathleen Feldstein

Paul O'Neill was an inspired choice for Secretary of the Treasury. He will bring to the job a combination of government and business experience that is both valuable and unprecedented. O'Neill spent more than a decade and a half at the Office of Management Budget under Presidents Nixon and Ford, rising from a relatively modest position to the number two spot as Deputy Director. Not since George Schultz was Nixon's Treasury Secretary has someone come to the job with O'Neill's detailed grasp of the budget process and of the management of government spending.

When he left Washington for the private sector he rose on the strength of his analytic ability and personal skills from a relatively technical position at International Paper to become president of that company before shifting to the CEO job at Alcoa. While achieving considerable success in Alcoa's business, he found time to maintain a broad active interest in public policy. Among other things, he serves as chairman of two prestigious nonprofit organizations, the Rand Corporation (which now does a wide range of studies of defense and civilian government activities) and the Manpower Demonstration Research Corporation (which does careful scientific studies of manpower and welfare experiments.)

It is hard to understand why anyone reviewing O'Neill's record could complain that he has not come from Wall Street. Why would someone who rose to the top of a Wall Street firm because of his skills in sales or management or corporate strategy be better suited for the top Treasury job than someone who combines experience in government and corporate management with strong analytic skills and a deep interest in the specifics of public policy? It is worth remembering, moreover, that monetary policy lies firmly and exclusively in the hands of the Federal Reserve and will continue to do so no matter who is at the Treasury.

When soaring budget deficits were the main problem facing the nation, O'Neill was an advocate of the painful medicine that appeared necessary to balance the budget, even if that included an increase in energy taxation (in spite of the fact that Alcoa is a very heavy user of energy.) It's surprising that some fellow conservatives criticize O'Neill for his past advocacy of an energy tax hike when it was Ronald Reagan who first proposed an energy tax in 1983 to shrink the budget deficit.

But soaring deficits are no longer the nation's problem and O'Neill's challenge will now be to sell the tax cuts proposed by President-elect Bush to a somewhat skeptical Congress and to a public that has been frightened into thinking that they might bring a return to budget deficits. O'Neill's credentials as a fiscal conservative who opposes deficits and accepts tax increases when needed should make it easier for him to command the confidence that will help him in his negotiations with Congress.

The case for a major tax cut is clear. The powerful growth of productivity in the past few years has raised incomes and capital gains in a way that has pushed tax revenue as a share of national income to an all-time high. Most of that increase has come in the personal income tax which now takes 11.3 percent of personal incomes, a sharp rise from the 9.5 percent just five years ago.

At the same time, the rising tax rates of the past decade have reversed much of the increased incentives created by the Reagan tax cuts of the 1980s . In 1990, the highest marginal income tax rate was less than 30 percent. It now exceeds 40 percent. High marginal tax rates are not just a problem of the top income group. An individual who now earns $35,000 faces a combined Federal income and payroll tax of more than 40 percent on every extra dollar that he or she earns. Add the state income and sales taxes and an individual with $35,000 of income gives up half of his additional earnings in taxes. Such high marginal tax rates distort incentives and cause wasteful behavior as taxpayers substitute fringe benefits and other untaxed forms of spending for taxable income.

Now that the election is past, the Bush plan for a $1.3 trillion tax cut over ten years can be seen in a less partisan light. Although that is a large tax cut and one that will lower marginal tax rates for all taxpayers, the total of $1.3 trillion is only about one-third of the total budget surplus forecast for the decade by the professional staff of the Congressional Budget Office. The remaining budget surpluses of more than $3 trillion can be used to strengthen Social Security, to enhance currently underfunded defense and civilian activities, and to reduce the national debt.

The economic slowdown that is now unfolding will bring support for the tax cut from some members of Congress who see it as a way of stimulating additional consumer spending. Although they may try to change the Bush plan to a temporary cut that focuses on low income taxpayers, that would be a mistake. The real case for the tax cut is to strengthen incentives across the board and for the long term, not just to give a temporary boost to spending. Moreover, although the next official revision of the budget forecast might reduce the projected surpluses for the next year or two, the continuing evidence of strong productivity gains is likely to caused an upward revision of the ten year surplus, pointing to even more room for the tax cut.

Although the case for the Bush tax plan should be winnable on the merits of the argument, Paul O'Neill's reputation for nonpartisan objectivity and fiscal prudence should serve him, the President, and the nation well as he seeks to persuade Congressional Republicans and Democrats to adopt the President's plan.