Snap, Crackle, and Pop -- The Tax Cut Is Gone


By Howard Gleckman Most people have figured out by now that the tax cut President Bush signed on June 7 is a travesty of tax policy. Tax cuts appear and disappear seemingly at random, and much of the promised relief won't even happen until after the next President moves into the Oval Office. Then, of course, the entire law simply disappears in 2010 (see BW Online, 6/1/01, "The Tax Cut: Now You See It, Now You Don't").

But I've been struggling with a different question: How did this happen? There are the obvious theories: long-term budget pressures or the need for compromise in a closely divided Congress. But two professors at the University of Michigan Business School -- Joel Slemrod and Aradhna Krishna -- may have found the real answer. Their conclusion: Think breakfast cereal.

FRUIT-LOOPS LAW. Slemrod, director of the school's Office of Tax Policy Research, and Krishna, a professor of marketing, have concluded that Washington invents these awful phase-ins, phaseouts, and hidden taxes for the same reason a box of Fruit Loops costs $3.99 instead of $4. "They're not writing tax law," Slemrod says, "they're marketing it."

Their theory is that most lawmakers don't really want to cut taxes -- they just want the public to think they do. Or failing that, legislators want to convince voters they'll pay less tax than their neighbors.

Building on well-established marketing theory, Slemrod and Krishna note that a key to getting people to buy stuff is properly framing the price -- or presenting it in the most attractive way.

For example, people really are more likely to buy something if its price ends in a "9" than in a zero. They're more likely to buy if something is advertised as "on sale." And they're more likely to respond to a broad description of a product than to read the fine print. They'll buy a digital camera because it's marketed as the hot new thing, for instance. But they'll probably never read the warning that the gizmo may not work in low light or notice that it carries a crummy warranty. Slemrod and Krishna transfer those marketing theories to tax bills. And, by golly, the theories work.

Take tax rates. The top rate is 39.6%. Not 40%, but 39.6%. The new law trims that rate to 38.6%. Congress could have cut the top rate to, say, 39%. But 38.6% sounds lots more generous.

Then there's the legislative equivalent of "on sale." The new law is full of taxes that are temporarily marked down, just like the sales you'd see at your favorite discount store. The law includes a bunch of new tax deductions for education costs. But they're only good until 2005, when the "sale" ends. The worst, of course, is the estate tax, which is repealed in 2010 and resumes in 2011. I can just see the ad now: "Die tax-free in 2010! Hurry! This is a limited time offer and will not be repeated!" Who knows, Congress may throw in one of those pocket fishermen gizmos as a bonus if you pass on to the Great Beyond before December 31, 2010.

VANISHING ACT. Let's not forget the fine print. The new law promises big tax cuts for everybody. But it doesn't say that as many as 35 million of us will lose some or all of the benefits because we'll get hit by the alternative minimum tax (AMT). The AMT is a separate set of rules for folks whose deductions and credits lower their tax bills too sharply. The law provides limited relief from the AMT -- but only until 2005. Then, just when people need them the most, the protections are snatched away, and the promised tax relief disappears. Remember the theory: Don't cut taxes -- just make people think you did.

Slemrod and Krishna note that the Federal Trade Commission and other agencies bar businesses from egregious false advertising. Could the government regulate its own promises and require some sort of truth-in-tax-cutting? The very idea, the professors admit, is "mind-boggling."

When I asked Slemrod about all this, he raised another question: Who really is the target of all this slick marketing? Were Congress and Bush trying to fool us, the taxpayers, or themselves? You have to wonder. Gleckman is a a senior correspondent in BusinessWeek's Washington bureau. Follow his views every Tuesday in Washington

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