Wall Street Journal: Taxes Are a Real Drag
March 6, 2001
Commentary
Taxes Are a Real Drag
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By Burton G. Malkiel. Mr. Malkiel,
author of "A Random Walk Down Wall Street"
(W.W. Norton & Co., seventh edition, 2000), is a professor of economics at Princeton University.
In the wake of George W. Bush's impassioned plea to return $1.6 trillion to the American people, I want to lay out the macroeconomic case for tax-cutting.
My argument is straightforward:
The ability of our economy to produce continued gains in
real income depends on removing the "fiscal drag" with
which big government surpluses burden the economy.
There has been broad criticism of the president's proposed
tax cut on macroeconomic grounds. Indeed, Robert Rubin,
the former secretary of the Treasury, has gone so far as to
suggest that a substantial tax cut is fiscally
irresponsible and will jeopardize our economic prosperity.
Nonrecurring Factors
Critics of the tax cut argue the following: The policy of fiscal restraint that we have followed over the past
several years has produced big budget surpluses
that have benefited the economy in important ways.
As the government has been taking in more in tax revenues
than it has been spending, it has beenbuying Treasury bonds
and reducing the supply of government debt.
More funds are therefore made available for private bonds
and other financial instruments.
Interest rates tend to decline and private investment is
stimulated, boosting the economy and increasing the
prospects for long-run economic growth.
Cut taxes
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Those opposed to Mr. Bush's plan go on to argue that a big
tax cut will reverse these virtuous effects.
Smaller surpluses risk increasing interest rates. Private
buyers will then be crowded out of the financial markets,
putting investment spending and future economic growth at
risk.
Yet a substantial tax cut is essential if we are to keep
the economy on a path of long-run growth.
Increasing fiscal restraint worked well during the past
decade, but for nonrecurring reasons.
Because these factors aren't likely to continue over the
next several years, the increasing fiscal drag
that comes when government overtaxes citizens and siphons
money out of the spending stream will
have a depressing effect on economic activity.
Unless corrected, it could lead to considerable slack in
the economy.
Among those nonrecurring factors was consumer spending
(two-thirds of total economic activity),
which was especially strong in the 1990s as savings rates
declined sharply. Consumers saved almost 9% of their
personal income in 1992. Today, the savings rate is
negative as consumers spend more than they earn.
Private debt has increased dramatically, and a continuation
of these consumer-spending trends is clearly unsustainable
in the years ahead.
Investment spending has also been unusually strong, and in
some areas of the economy there is evidence of
overinvestment. Telecom companies, wireless providers,
local exchange carriers, and builders of fiber-optic
networks have all operated on the "if you build it they
will come" principle.
But the massive buildup of fiber-optic networks today is
uncomfortably similar to the overbuilding of track at the
dawn of the railroad age. Retail Internet companies and
business-to-business exchanges have also overbuilt
capacity. The growth rate of high-tech investment spending
over the past decade isn't likely to be sustainable.
The recent high levels of consumption and investment have
both been influenced by another factor that is likely to be
nonrecurring -- the exuberance of the stock market. From
1982 to early 2000,the stock market produced returns of
18% a year -- far above the 9% to 11% returns more typical
of our long-run history. The wealth effect of sharply
increasing stock (and real estate) prices has
been an important factor behind the fall in savings rates.
The unprecedented extent of the public's stake in the
stock market has made rising stock prices a major
determinant of consumption.
Consumers have felt able to spend all of their income as
long as their wealth has been increasing.
The buoyant stock market has also been an important
influence supporting real investment -- particularly
in technology equipment. As long as entrepreneurs with a
good idea could go to the stock market to raise money,
even if future earnings were only a dream, financing was no problem.
But what the Nasdaq Stock Market giveth, so can it take
away. Today the financing window for new high-tech ventures
without earnings is shut. With normal rather than
excessively exuberant stock markets,
neither consumption nor investment can grow at their recent pace.
Much has been made of the unreliability of future surplus
forecasts and the imprudence of spending a surplus that may
not materialize. But, in fact, it is the fiscal drag from
big high-employment surpluses that may stop even the
moderate forecast of 3% real economic growth from being
realized.
The Congressional Budget Office currently projects budget
surpluses that more than double over the forecast
period (2001-2011). The projections assume that the nation
remains at reasonably full employment and on a
sustainable growth path. But without removing at least part
of this increasing drag on the economy, we are highly
unlikely to realize even moderate growth in the years
ahead, and it is very doubtful that surpluses of that
magnitude can be achieved.
Critics worry about the crowding-out effect of a big
tax cut on economic activity.
But fiscal drag suppressing the economy is the far greater danger.
The worst outcome would be to squander the projected
surplus by letting it evaporate through years of inadequate
economic growth. A big tax cut today (front-loaded and passed as soon as possible) will not only strengthen our
defenses against recession but will help us meet our
long-run economic challenges by crowding in
capacity-creating investments.
What Kennedy Did
In 1963, John F. Kennedy proposed a tax cut that was
2% of gross domestic product -- far larger
in percentage than the cut today proposed by
Mr. Bush.
The Kennedy proposal eliminated the
high-employment surplus; the Bush proposal spends only
a fraction of it. In support of his proposal,
Kennedy argued that a tax cut was needed
to remove " the heavy drag our fiscal system now exerts
on personal and business purchasing power" and to
lessen "the tax deterrents to private initiative."
That same argument is equally appropriate today.
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