WSJ: Bush's Big Bang
Wall Street Journal ^
jan 9, 2003 | Editorial
freerepublic.com
We were hoping for a big and bold tax cut from President Bush and, by George, we got one. Yesterday Mr. Bush drew a bead on the twin shibboleths of bad tax policy -- the fear of budget deficits and of benefiting middle- and upper-income workers -- and pulled the trigger.
The President deserves credit for ignoring all of the Beltway trimmers and risking the political capital he won in November in pursuit of a large policy ambition. His proposal is one worth fighting for. But before the discussion plunges into the inevitable politics, it's worth a minute to look at the economic merits of Mr. Bush's plan. Herewith, a scorecard.
• Moving forward the marginal tax cuts. Reducing marginal income-tax rates, as everybody willing to look at the evidence recognizes, creates powerful incentives for earners to earn more -- that is, to work more, invest more and take more risk.
We were disappointed that Mr. Bush's 2001 tax law phased in the cuts in marginal rates over several years, although, granted, the first round did help lift the economy after the stock market's terrifying swoon. Now, however, Mr. Bush is ready to add some real juice by making all the cuts effective immediately and retroactive to January 1, 2003 (last week).
For income earned this year, marginal-rate brackets would start at 10% and the top rate would fall to 35% from 38.6%. This is especially welcome because many small business owners pay the top rate, and these cuts will encourage them to both spend and invest more. Count this as a big win for the economy.
• Eliminate the tax on dividends for investors. This pitch zips right over the plate by ending a harmful distortion in the tax code that taxes dividends twice -- once at the corporate rate and then again after profits are distributed to shareholders at the individual rate. Nobody likes to pay taxes, so investors have been shunning high dividend stocks and companies have responded by retaining earnings. This little interaction promotes a lot of undesirable behavior.
Most important, companies that keep their earnings are also keeping that capital from returning to investors who might have better things to do with it -- like investing in other companies. In fact, the taxation of dividends has resulted in an increasingly large pile of frozen capital. Companies have been using this capital to repurchase shares to plump up earnings and other dubious internal ventures.
Returning profits to shareholders, the true owners of firms, would free this capital to flow to higher-return, more productive companies. It would also bump up stock prices, maybe as much as 10%, thereby reducing the cost of capital and encouraging firms to invest. Count this proposal as another economic win.
• Speeding up the increase in the child tax credit to $1,000 from $600. Here we start to get into politics, because while the credits are popular the economics isn't all that pretty. Tax credits, especially those that phase out above a certain income level, are designed to add progressivity to an already progressive tax system. They are just the sort of flim-flam that economists loathe, because they distort behavior, especially for earners who are nearing the phase-out levels; they also complicate the tax code, forcing taxpayers to spend huge amounts of time and money just to file. Count this proposal as a loser.
Critics are already attacking the elimination of the investor tax on dividends and the acceleration of marginal rate cuts as favors to the rich. Right on cue, they are pointing at charts showing the tax benefits piling up for upper-income taxpayers. Well, duh.
If you look at who precisely pays income taxes, the reason is clear. In 1999, 553,380 taxpayers anted up 28% of tax revenue. IRS data from 2000 shows that the top 5% of taxpayers (those with adjusted gross incomes of $128,366 and higher) paid over half the total tax revenue. Since it is exactly the rich who disproportionately pay most of the income tax, it would be impossible to lower taxes without benefiting them disproportionately. Hey, it's their money.
Mr. Bush's proposal would reduce tax revenue over the next decade, though far less if the growth effects are figured in. And the possibility has already brought out the flock of self-styled "deficit hawks." Pay no attention. Currently the budget deficit is 1.5% of GDP and projections for the next year or so are around 2%. These figures amount to a whole lot of nothing both in historical terms and when compared with the potential growth of the economy.
The notion put forward by the deficit hawks that this will send interest rates to the sky and the economy six feet under is deeply silly. Deficits are the result of weak or negative economic growth, not the other way around. The best way to close a deficit is through strong economic growth.
Mr. Bush is offering, on balance, an excellent program to prevent the economy from weakening amid the short-term uncertainties of war and expensive oil. And by wringing out some of the tax barriers to economic efficiency, he is also creating the conditions for better long-term growth. A bull's-eye, for sure. |
